SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Quarterly period ended September 30, 2002

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

For the Transition period from to

0-26996
(Commission File Number)

INVESTORS FINANCIAL SERVICES CORP.

(Exact name of registrant as specified in its charter)

Delaware		04-3279817
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

200 Clarendon Street, P.O. Box 9130, Boston, MA		02117-9130
(Address of principal executive offices)		(Zip Code)

(617) 937-6700
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

As of October 31, 2002 there were 64,593,149 shares of Common Stock outstanding.

INVESTORS FINANCIAL SERVICES CORP.

INDEX

PART I.	FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements

	Condensed Consolidated Balance Sheets (unaudited) September 30, 2002 and December 31, 2001

	Condensed Consolidated Statements of Income and Comprehensive Income (unaudited) Nine months ended September 30, 2002 and 2001

	Condensed Consolidated Statements of Income and Comprehensive Income (unaudited) Three months ended September 30, 2002 and 2001

	Condensed Consolidated Statements of Stockholders’ Equity (unaudited) Nine months ended September 30, 2002 and 2001

	Condensed Consolidated Statements of Cash Flows (unaudited) Nine months ended September 30, 2002 and 2001

	Notes to Condensed Consolidated Financial Statements (unaudited)

	Independent Accountants’ Report

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3.	Quantitative and Qualitative Disclosure about Market Risk

Item 4.	Controls and Procedures

PART II.	OTHER INFORMATION

Item 6.	Exhibits and Reports on Form 8-K

SIGNATURES

CERTIFICATIONS

PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

INVESTORS FINANCIAL SERVICES CORP.

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)

September 30, 2002 and December 31, 2001

(Dollars in thousands, except per share data)

	September 30, 2002			December 31, 2001

Assets
Cash and due from banks	$	81,936		$	15,605
Federal funds sold and securities purchased under resale agreements	120,000			—
Securities held to maturity (approximate fair value of $3,444,558 and $3,157,209 at September 30, 2002 and December 31, 2001, respectively)	3,412,587			3,135,784
Securities available for sale	2,725,585			1,621,661
Non-marketable equity securities	50,000			50,000
Loans, less allowance for loan losses of $100 at September 30, 2002 and December 31, 2001	138,998			232,113
Accrued interest and fees receivable	68,302			59,751
Equipment and leasehold improvements, less accumulated depreciation of $20,386 and $13,023 at September 30, 2002 and December 31, 2001, respectively	70,186			42,618
Goodwill, net	79,969			79,969
Other assets	67,655			61,144

Total Assets	$	6,815,218		$	5,298,645

Liabilities and Stockholders’ Equity
Liabilities:
Deposits:
Demand	$	375,784		$	507,067
Savings	2,311,034			1,681,810
Time	90,000			90,000
Total deposits	2,776,818			2,278,877

Securities sold under repurchase agreements	2,295,375			1,663,312
Short-term and other borrowings	1,175,529			910,281
Other liabilities	124,724			79,123
Total liabilities	6,372,446			4,931,593

Commitments and contingencies (See Note 9)	—			—

Company-obligated, mandatorily redeemable, preferred securities of subsidiary trust holding solely junior subordinated deferrable interest debentures of the Company	23,295			24,274

Stockholders’ Equity:
Preferred stock, par value $0.01 (shares authorized: 1,000,000; issued and outstanding: 0 at September 30, 2002 and December 31, 2001)	—			—
Common stock, par value $0.01 (shares authorized: 100,000,000 at September 30, 2002 and December 31, 2001; issued and outstanding: 64,583,399 at September 30, 2002 and 31,971,404 at December 31, 2001)	646			320
Surplus	230,124			222,440
Deferred compensation	(1,812		)	(2,563		)
Retained earnings	180,784			132,877
Accumulated other comprehensive income/(loss), net	9,735			(10,296		)
Treasury stock, par value $0.01 (10,814 shares at September 30, 2002 and December 31, 2001)	—			—
Total stockholders’ equity	419,477			342,778

Total Liabilities and Stockholders’ Equity	$	6,815,218		$	5,298,645

See Notes to Condensed Consolidated Financial Statements.

INVESTORS FINANCIAL SERVICES CORP.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)

Nine Months Ended September 30, 2002 and 2001

(Dollars in thousands, except per share data)

	September 30, 2002			September 30, 2001
Operating Revenue:
Interest income:
Federal funds sold and securities purchased under resale agreements	$	680		$	1,611
Investment securities held to maturity and available for sale	181,394			184,774
Loans	2,891			4,279
Total interest income	184,965			190,664

Interest expense:
Deposits	31,777			53,147
Short-term and other borrowings	47,205			60,075
Total interest expense	78,982			113,222

Net interest income	105,983			77,442

Noninterest income:
Asset servicing fees	218,103			179,308
Other operating income	1,645			2,378

Net operating revenue	325,731			259,128

Operating Expenses:
Compensation and benefits	146,819			120,395
Technology and telecommunications	30,070			28,951
Transaction processing services	26,078			17,412
Occupancy	18,247			12,649
Depreciation and amortization	11,179			5,781
Professional fees	4,968			3,460
Travel and sales promotion	4,217			4,064
Amortization of goodwill	—			2,565
Other operating expenses	9,956			10,557
Total operating expenses	251,534			205,834

Income Before Income Taxes and Minority Interest	74,197			53,294

Provision for income taxes	22,352			16,384
Minority interest expense, net of income taxes	1,204			1,191

Net Income	$	50,641		$	35,719

Basic Earnings Per Share	$	0.79		$	0.57

Diluted Earnings Per Share	$	0.76		$	0.54

Comprehensive Income:
Net income	$	50,641		$	35,719
Other comprehensive income net of tax of $10,786 and $97 for the nine months ended September 30, 2002 and 2001, respectively:
Cumulative effect of a change in accounting principle	—			(3,934		)
Net unrealized investment gain	31,500			14,746
Net unrealized derivative instrument loss	(11,469		)	(10,631		)
Other comprehensive income	20,031			181
Comprehensive income	$	70,672		$	35,900

See Notes to Condensed Consolidated Financial Statements.

INVESTORS FINANCIAL SERVICES CORP.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (unaudited)

Three Months Ended September 30, 2002 and 2001

(Dollars in thousands, except per share data)

	September 30, 2002			September 30, 2001
Operating Revenue:
Interest income:
Federal funds sold and securities purchased under resale agreements	$	473		$	415
Investment securities held to maturity and available for sale	62,378			64,200
Loans	930			1,431
Total interest income	63,781			66,046

Interest expense:
Deposits	10,750			16,417
Short-term and other borrowings	17,165			20,601
Total interest expense	27,915			37,018

Net interest income	35,866			29,028

Noninterest income:
Asset servicing fees	73,982			66,677
Other operating income	515			829

Net operating revenue	110,363			96,534

Operating Expenses:
Compensation and benefits	47,951			44,879
Technology and telecommunications	10,004			9,272
Transaction processing services	8,764			7,896
Occupancy	6,841			4,847
Depreciation and amortization	4,540			2,558
Professional fees	1,752			1,127
Travel and sales promotion	1,463			1,670
Amortization of goodwill	—			992
Other operating expenses	3,747			3,427
Total operating expenses	85,062			76,668

Income Before Income Taxes and Minority Interest	25,301			19,866

Provision for income taxes	7,622			5,990
Minority interest expense, net of income taxes	410			397

Net Income	$	17,269		$	13,479

Basic Earnings Per Share	$	0.27		$	0.22

Diluted Earnings Per Share	$	0.26		$	0.20

Comprehensive Income:
Net income	$	17,269		$	13,479
Other comprehensive (loss)/income net of tax of ($373) and $1,844 for the three months ended September 30, 2002 and 2001, respectively:
Net unrealized investment gain	8,347			12,427
Net unrealized derivative instrument loss	(9,040		)	(9,003		)
Other comprehensive (loss)/income	(693		)	3,424
Comprehensive income	$	16,576		$	16,903

See Notes to Condensed Consolidated Financial Statements.

INVESTORS FINANCIAL SERVICES CORP.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (unaudited)

Nine Months Ended September 30, 2002 and 2001

(Dollars in thousands, except share data)

	September 30, 2002			September 30, 2001
Common shares
Balance, beginning of period	31,971,404			29,912,711
Exercise of stock options	381,880			325,322
Common stock issuance	61,193			1,645,133
Restricted stock issuance	—			4,000
Stock dividend, two-for-one split	32,168,922			—
Balance, end of period	64,583,399			31,887,166

Treasury shares
Balance, beginning of period	10,814			10,814
Balance, end of period	10,814			10,814

Common stock
Balance, beginning of period	$	320		$	299
Exercise of stock options	4			4
Common stock issuance	—			16
Stock dividend, two-for-one split	322			—
Balance, end of period	646			319

Surplus
Balance, beginning of period	222,440			95,007
Exercise of stock options	2,212			1,719
Tax benefit from exercise of stock options	3,559			3,875
Common stock issuance	1,835			117,361
Stock option issuance	78			—
Balance, end of period	230,124			217,962

Deferred compensation
Balance, beginning of the period	(2,563		)	(247		)
Common stock issuance	—			(335		)
Exercise of stock options	—			(13		)
Amortization of deferred compensation	829			120
Stock option issuance	(78		)	—
Balance, end of period	(1,812		)	(475		)

Retained earnings
Balance, beginning of period	132,877			85,188
Net income	50,641			35,719
Stock dividend, two-for-one split	(322		)	—
Cash dividend, $0.0375 and $0.0300 per share in the periods ending September 30, 2002 and 2001, respectively	(2,412		)	(1,873		)
Balance, end of period	180,784			119,034

Accumulated other comprehensive income/(loss), net
Balance, beginning of period	(10,296		)	(1,439		)
Cumulative effect of a change in accounting principle	—			(3,934		)
Net unrealized investment gain	31,500			14,746
Net unrealized derivative instrument loss	(11,469		)	(10,631		)
Balance, end of period	9,735			(1,258		)

Treasury stock
Balance, beginning of period	—			—
Balance, end of period	—			—

Total Stockholders’ Equity	$	419,477		$	335,582

See Notes to Condensed Consolidated Financial Statements.

INVESTORS FINANCIAL SERVICES CORP.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

Nine Months Ended September 30, 2002 and 2001

(Dollars in thousands)

	September 30, 2002			September 30, 2001

Cash Flows From Operating Activities:
Net income	$	50,641		$	35,719
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	11,179			8,346
Amortization of deferred compensation	829			120
Amortization of premiums on securities, net of accretion of discounts	4,921			(2		)
Changes in assets and liabilities:
Accrued interest and fees receivable	(8,551		)	(26,308		)
Other assets	(19,913		)	(3,899		)
Other liabilities	34,133			14,162
Total adjustments	22,598			(7,581		)
Net cash provided by operating activities	73,239			28,138

Cash Flows From Investing Activities:
Proceeds from maturities of securities available for sale	411,825			308,465
Proceeds from maturities of securities held to maturity	1,403,792			747,100
Purchases of securities available for sale	(1,467,910		)	(597,293		)
Purchases of securities held to maturity	(1,684,895		)	(2,058,154		)
Purchases of non-marketable equity securities	—			(35,000		)
Net (increase)/decrease in federal funds sold and securities purchased under resale agreements	(120,000		)	360,000
Net decrease/(increase) in loans	93,115			(8,560		)
Purchase of businesses	—			(49,383		)
Purchases of fixed assets, capitalized software and leasehold improvements	(38,726		)	(27,840		)
Net cash used for investing activities	(1,402,799		)	(1,360,665		)

Cash Flows From Financing Activities:
Net decrease in demand deposits	(131,283		)	(17,991		)
Net increase/(decrease) in time and savings deposits	629,224			(12,258		)
Net increase in short-term and other borrowings	897,311			1,233,254
Proceeds from exercise of stock options	2,216			1,710
Proceeds from issuance of common stock	1,835			117,042
Repurchase of Company-obligated, mandatorily redeemable, preferred securities of subsidiary trust	(1,000		)	—
Cash dividends to shareholders	(2,412		)	(1,873		)
Net cash provided by financing activities	1,395,891			1,319,884

Net Increase / (Decrease) In Cash And Due From Banks	66,331			(12,643		)

Cash and Due From Banks, Beginning of Period	15,605			30,489

Cash and Due From Banks, End of Period	$	81,936		$	17,846

Supplemental Disclosure of Cash Flow Information:
Cash paid for interest	$	78,641		$	113,819
Cash paid for income taxes	$	22,789		$	9,823

See Notes to Condensed Consolidated Financial Statements.

INVESTORS FINANCIAL SERVICES CORP.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Information as of and for the nine months and the three months

ended September 30, 2002 and 2001 is unaudited)

1. Description of Business

Investors Financial Services Corp. (‘IFSC’) provides asset servicing for the financial services industry through its wholly-owned subsidiaries, Investors Bank & Trust Company (the ‘Bank’) and Investors Capital Services, Inc. As used herein, the defined term “the Company” shall mean IFSC together with the Bank and its domestic and foreign subsidiaries. The Company provides global custody, multicurrency accounting, mutual fund administration, securities lending, foreign exchange, cash management, performance measurement, institutional transfer agency, investment advisory services and lines of credit 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.

On February 1, 2001, the Company completed the issuance and sale of 1,624,145 shares of Common Stock at $71.62 per share in a public offering. A portion of the proceeds was used to fund the acquisition of the operations of the advisor custody unit of The Chase Manhattan Bank. The remaining proceeds were used for the assumption of the U.S. asset administration unit of Barclays Global Investors, N.A. and for working capital.

On April 23, 2002, the Board of Directors approved a two-for-one stock split in the form of a 100% stock dividend to stockholders of record as of May 24, 2002. All share numbers have been restated to reflect the two-for-one stock split paid June 14, 2002, where applicable.

2. Interim Financial Statements

The condensed consolidated interim financial statements of the Company and subsidiaries as of September 30, 2002 and 2001 and for the nine-month periods and the three-month periods ended September 30, 2002 and 2001 have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted as permitted by such rules and regulations. All adjustments, consisting of normal recurring adjustments, necessary for their fair presentation in conformity with accounting principles generally accepted in the United States of America are included. Management believes that the disclosures are adequate to present fairly the financial position, results of operations and cash flows at the dates and for the periods presented. It is suggested that these interim financial statements be read in conjunction with the financial statements and the notes thereto included in the Company’s latest annual report on Form 10-K. Results for interim periods are not necessarily indicative of those to be expected for the full fiscal year. Certain amounts in the prior periods’ financial statements have been reclassified to conform to the current periods’ presentation.

On January 1, 2001, the Company adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted, which established accounting and reporting standards for derivative instruments. The Company also adopted SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities.” All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value. If the derivative is designated as a fair value hedge, the change in the fair value of the derivative and the item being hedged will be recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in Other Comprehensive Income (‘OCI’). Ineffective portions of changes, as determined in accordance with SFAS No. 133, in the fair value of the cash flow hedges are recognized in earnings. For derivatives that do not qualify as hedges, changes in their fair value are recognized in earnings. The adoption of SFAS No. 133 on January 1, 2001, resulted in no cumulative effect-type adjustment to net income. However, the Company recorded a reduction to OCI of $3.9 million, net of tax, and a corresponding liability for the fair value of the interest rate swaps. The reduction to OCI and the recognition of the liability are primarily attributable to net unrealized losses on previously designated cash flow hedges. In conjunction

with the adoption, the Company elected to reclassify approximately $402 million of securities from held to maturity to available for sale, which further reduced OCI, net of tax, by approximately $1.4 million.

The Company uses derivative instruments to manage exposures to interest rate risks. The Company routinely enters into interest rate swap agreements in which the Company pays a fixed interest rate and receives a floating interest rate. These transactions are designed to hedge a portion of the Company’s liabilities. By entering into a pay-fixed/receive-floating interest rate swap, a portion of these liabilities is effectively converted to a fixed rate liability for the term of the interest rate swap agreement. Most of these derivatives have been designated as cash flow hedges. An insignificant portion of the derivatives used to manage exposures to interest rate risks were not considered highly effective and, therefore, did not qualify for hedge accounting.

Hedge ineffectiveness, determined in accordance with SFAS No. 133, had an insignificant impact on earnings for the nine months ended September 30, 2002. No cash flow hedges were dedesignated or discontinued for the nine months ended September 30, 2002.

Net interest income included net gains of $1.2 million and $0.6 million, net of tax, for the nine months and three months ended September 30, 2002, respectively, on interest rate swaps relating to SFAS No. 133. The net gains were $2.7 million and $1.0 million, net of tax, for the nine-month and three-month periods ended September 30, 2002, respectively, on changes in the fair value of derivative instruments designated as hedging instruments. There were also $1.5 million and $0.4 million of derivative losses, net of tax, for the nine-month and three-month periods ended September 30, 2002, respectively, that resulted primarily from the reclassification of transition adjustment-related derivative losses from OCI to net interest income in accordance with SFAS No. 133. The Company estimates that $0.5 million, net of tax, of the remaining transition adjustment of net derivative losses included in OCI will be reclassified into earnings within the next twelve months. The recognition in net interest income of the transition adjustment derivative losses from OCI will be offset by derivative gains from changes in the fair value liability of the interest rate swaps as they reach maturity.

In June 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets,” which supersedes APB No. 17, “Intangible Assets.” SFAS No. 142 addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. This statement affects the accounting of premiums, includes guidelines for the determination, measurement and testing of impairment, and requires disclosure of information about goodwill and other intangible assets in the years subsequent to their acquisition that was not previously required. On January 1, 2002, the Company adopted SFAS No. 142 and ceased amortization of goodwill. As of September 30, 2002 there was no impairment of goodwill.

In November 2001, the FASB issued Emerging Issues Task Force (‘EITF’) No. 01-14, applicable in financial reporting periods beginning after December 15, 2001, “Income Statement Characterization of Reimbursements Received for Out-Of-Pocket Expenses Incurred.” This guidance requires companies to recognize the reimbursement of client-related expenses as revenue and the costs as operating expense. Client reimbursements for out-of-pocket expenses are reflected in fee revenue in the accompanying financial statements. Prior periods have been reclassified to reflect this presentation, which resulted in an increase to fee revenue and operating expense of $6.5 million and $6.2 million for the nine months ended September 30, 2002 and 2001, respectively, and $2.2 million and $2.1 million for the three months ended September 30, 2002 and 2001, respectively.

3. Loans

Loans consist of demand loans to custody clients of the Company, including individuals and not-for-profit institutions, and loans to mutual fund clients. The loans to mutual funds and other pooled product clients include lines of credit and advances pursuant to the terms of the custody agreements between the Company and those mutual fund clients to facilitate securities transactions and redemptions. Generally, the loans are, or may be, in the event of default, collateralized with marketable securities held by the Company as custodian. There were no impaired or nonperforming loans at September 30, 2002 and December 31, 2001. In addition, there were no loan charge-offs or recoveries during the nine months ended September 30, 2002 and the year ended December 31, 2001. Loans are summarized as follows (Dollars in thousands):

	September 30, 2002			December 31, 2001

Loans to individuals	$	73,986		$	164,443
Loans to mutual funds	46,721			50,359
Loans to others	18,391			17,411
	139,098			232,213
Less allowance for loan losses	(100		)	(100		)

Total	$	138,998		$	232,113

The Company had commitments to lend of approximately $660 million and $390 million at September 30, 2002 and December 31, 2001, respectively. The terms of these commitments are similar to the terms of the outstanding loans.

4. Acquisitions

Goodwill related to the Company’s acquisitions is summarized as follows (Dollars in thousands):

	For the Nine Months Ended September 30, 2002		For the Year Ended December 31, 2001

Goodwill, beginning of period	$	79,969	$	34,094
Plus purchase of businesses	—		49,434
Less amortization	—		(3,559		)

Goodwill, end of period	$	79,969	$	79,969

On February 1, 2001, the Company purchased the operations of the advisor custody unit of The Chase Manhattan Bank. This unit provided institutional custody services to individual accounts holding approximately $27 billion in assets as of February 1, 2001. These accounts consist of individual accounts, trusts, endowments and corporate accounts whose assets are managed by third-party investment advisors. Pursuant to the terms of the asset purchase agreement, the Company paid to Chase as of closing approximately $31.5 million of the total purchase price, plus another $39.8 million in exchange for the book value of loans to clients. Under the terms of the asset purchase agreement, the Company is not obligated to make any further purchase price payments to Chase. The transaction was accounted for as a purchase.

On May 1, 2001, the Company assumed the operations of the U.S. asset administration unit of Barclays Global Investors, N.A. (‘BGI’), a large international institutional investment manager. The unit, located in Sacramento, California, provides custody accounting and other operations functions for BGI’s clients. The transaction was accounted for as a purchase.

No pro forma financial results of Chase or BGI are presented as they were not material to the Company’s financial condition and operating results for the periods presented.

On January 1, 2002, the Company adopted SFAS No. 142 and ceased amortization of goodwill. See “Interim Financial Statements” (Footnote 2) for a further discussion of this pronouncement.

5. Deposits

Time deposits at September 30, 2002 and December 31, 2001 included noninterest-bearing amounts of $90 million. All time deposits had a minimum balance of $100,000 and a maturity of less than three months at September 30, 2002 and December 31, 2001.

6. Short-term and other borrowings

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

	September 30, 2002		December 31, 2001

Federal funds purchased	$	375,000	$	130,000
Federal Home Loan Bank of Boston overnight advances	300,000		380,000
Federal Home Loan Bank of Boston long-term advances	300,000		300,000
Federal Home Loan Bank of Boston short-term advances	200,000		100,000
Treasury, Tax and Loan account	529		281

Total	$	1,175,529	$	910,281

The Company has a borrowing arrangement with the Federal Home Loan Bank of Boston (“FHLBB”), which is utilized on an overnight and on a term basis to satisfy funding requirements. The Company has utilized both short-term and long-term features of the term advances.

As of September 30, 2002 and December 31, 2001, there were $300 million of long-term term advances outstanding with interest rates ranging from 3.28% to 5.17% as of September 30, 2002 and from 3.59% to 5.17% as of December 31, 2001. Maturities ranged from May 2004 to September 2006 as of September 30, 2002 and ranged from June 2003 to February 2005 as of December 31, 2001.

There was a $200 million short-term term advance outstanding at September 30, 2002 with an interest rate of 1.76% maturing in October 2002. The interest rate on the $100 million short-term term advance outstanding at December 31, 2001 was 1.82% and matured in January 2002. Outstanding overnight advances, with interest rates based on the Federal funds rate, were $300 million at September 30, 2002 and $380 million at December 31, 2001.

The rates on the outstanding balances of federal funds purchased from other banks at September 30, 2002 and December 31, 2001 were 1.96% and 1.61%, respectively.

The Company receives federal tax deposits from clients as agent for the Federal Reserve Bank and accumulates these deposits in the Treasury, Tax and Loan account. The Federal Reserve Bank charges the Company interest based on the Federal Funds rate on such deposits. The interest rate on the outstanding balance was 1.56% at September 30, 2002 and 1.51% at December 31, 2001.

7. Stockholders’ Equity

As of September 30, 2002, the Company has authorized 1,000,000 shares of Preferred Stock and 100,000,000 shares of Common Stock, all with a par value of $0.01 per share.

At the Annual Meeting of Stockholders of the Company held on April 17, 2001, stockholders approved an increase in the number of authorized shares of Common Stock from 40,000,000 to 100,000,000. On April 25, 2001, the Company amended its Certificate of Incorporation increasing the number of authorized shares of

Common Stock to 100,000,000. These shares are available for general corporate purposes as determined by the Company’s Board of Directors.

On April 23, 2002, the Board of Directors approved a two-for-one stock split in the form of a 100% stock dividend to shareholders of record on May 24, 2002. The dividend was paid on June 14, 2002. A total of 32,168,922 shares of common stock were issued in connection with the stock split. The stock split did not result in a change in the $0.01 par value per share of the common stock or in total stockholders’ equity.

The Company has three stock option plans: the Amended and Restated 1995 Stock Plan (‘Stock Plan’), the Amended and Restated 1995 Non-Employee Director Stock Option Plan (‘Director Plan’), and the 1997 Employee Stock Purchase Plan.

At the Annual Meeting of Stockholders of the Company held on April 17, 2001, stockholders approved the amendment and restatement of the Company’s Stock Plan to increase the number of shares available for grant pursuant to the plan from 4,640,000 to 6,140,000. At the Annual Meeting of Stockholders of the Company held on April 23, 2002, stockholders approved the amendment and restatement of the Company’s Stock Plan to increase the number of shares available for grant pursuant to the plan from 6,140,000 to 7,640,000. Effective with the June 2002 stock split, the number of shares available to grant increased to 15,280,000. Of the 15,280,000 shares of Common Stock authorized for issuance under the Stock Plan at September 30, 2002, 4,728,130 were available for grant as of that date. Under the Stock Plan, the Company may grant options to purchase 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. No options were granted to consultants during the nine months ended September 30, 2002.

The terms of the Director Plan provide for the grant of options to non-employee directors to purchase up to a maximum of 400,000 shares of Common Stock. Effective with the June 2002 stock split, the number of shares available to grant increased to 800,000. Of the 800,000 shares of Common Stock authorized for issuance under the plan, 124,658 were available for grant at September 30, 2002.

Pursuant to the terms of the Director Plan, options to purchase 20,000 shares of Common Stock were awarded on November 8, 1995 to each non-employee director then in office. Each non-employee director receives an automatic annual grant of options to purchase the number of shares then specified by the Director Plan, as described below. Additionally, any non-employee director may elect to receive options to acquire shares of the Company’s Common Stock in lieu of such director’s cash retainer. Any such election is subject to certain restrictions under the Director Plan. The number of shares of stock underlying the option granted in lieu of cash is equal to the quotient obtained by dividing the cash retainer by the fair market value of an option on the date of grant, which is based on the Black-Scholes option-pricing model.

At the Annual Meeting of Stockholders of the Company held on April 23, 2002, stockholders approved amendments to the Director Plan providing that on the date of each Annual Meeting, each person who is a member of the Board immediately after the Annual Meeting of the Company and who is not an employee of the Company, shall be automatically granted an option to purchase the number of shares called for by the Director Plan as of that date. Formerly, each non-employee director received a grant of options upon their election or appointment and annually thereafter on their anniversary date. The amendments also provide that the number of shares granted to each non-employee director annually be adjusted for stock splits and other capital changes. After giving effect to the stock split paid on June 14, 2002, non-employee directors shall receive an annual grant of options to purchase 5,000 shares. In addition, the amendments provide that options granted under the Director Plan will vest in 36 equal monthly installments beginning on the date of grant, rather than 48 equal monthly installments, subject to certain restrictions. Finally, the amendments to the Director Plan provide that in the event a non-employee director ceases to be a member of the Board by reason of his or her retirement, the Board may vote to accelerate and fully vest all unvested options held by the retiring non-employee director.

The exercise price of options under the Director Plan and the incentive options under the Stock Plan may not be less than the fair market value at the date of the grant. The exercise price of non-qualified options under

the Stock Plan is determined by the compensation committee of the Board of Directors. All options become exercisable as specified by the compensation committee at the date of the grant.

On February 13, 2001, the Company granted 8,000 shares of Common Stock under the Stock Plan to former employees of the Chase advisor custody unit. This grant is subject to the Company’s right to repurchase the shares if the employees’ employment with the Company terminates. The Company’s right to repurchase the shares lapses in five equal annual installments beginning one year from the date of grant. On September 30, 2002, the Company chose not to exercise its right to repurchase 3,200 shares issued in connection with this grant when an employee’s employment with the Company did terminate.

On May 1, 2001, the Company granted 58,000 nonqualified stock options under the Stock Plan to former employees of the U.S. asset administration unit of BGI in connection with the assumption of the operations of the unit. The exercise price of the options is 10% of the fair market value of the Common Stock at the close of market on the date of grant. The grants are exercisable immediately, but any shares acquired on exercise are subject to the Company’s right to repurchase the shares at the exercise price if the employees’ employment with the Company terminates. The Company’s right to repurchase the shares lapses in five equal annual installments beginning one year from the date of grant.

On October 16, 2001, the Company granted 10,000 nonqualified stock options to an officer of the Company under the Stock Plan. The exercise price of the options is 10% of the fair market value of the Common Stock at the close of market on the date of grant. The grants are exercisable immediately, but any shares acquired on exercise are subject to the Company’s right to repurchase the shares at the exercise price if the officer’s employment with the Company terminates. The Company’s right to repurchase the shares lapses in five equal annual installments beginning one year from the date of grant.

The Company has recorded deferred compensation of $1.8 million and $2.6 million at September 30, 2002 and December 31, 2001, respectively, related to the grants described in the above three paragraphs.

Under the terms of the 1997 Employee Stock Purchase Plan, the Company may issue up to 1,120,000 shares of Common Stock pursuant to the exercise of nontransferable options granted to participating employees. The 1997 Employee Stock Purchase Plan permits eligible employees to purchase up to 1,000 shares of Common Stock per payment period, subject to limitations provided by Section 423(b) of the Internal Revenue Code, through accumulated payroll deductions. The purchases are made twice a year at a price equal to the lesser of (i) 90% of the market value of the Common Stock on the first business day of the payment period, or (ii) 90% of the market value of the Common Stock on the last business day of the payment period. The payment periods consist of two six-month periods, January 1 through June 30 and July 1 through December 31.

A summary of option activity under the Director Plan and the Stock Plan is as follows:

	Number of Shares		Weighted-Average Exercise Price
Outstanding at December 31, 2001	6,921,610		$	20
Granted	202,498		35
Exercised	(649,345	)	7
Canceled	(162,499	)	29
Outstanding at September 30, 2002	6,312,264		$	21
Outstanding and exercisable at September 30, 2002	3,540,427

Outstanding at December 31, 2000	5,793,324		$	14
Granted	269,658		30
Exercised	(711,002	)	5
Canceled	(36,800	)	30
Outstanding at September 30, 2001	5,315,180		$	16
Outstanding and exercisable at September 30, 2001	2,840,518

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

	For the Nine Months Ended September 30, 2002		For the Year Ended December 31, 2001

Total shares available under the Plan, beginning of period	500,764		598,068
Issued at June 30	(61,193	)	(41,976	)
Issued at December 31	—		(55,328	)

Total shares available under the Plan, end of period	439,571		500,764

For the six-month period ended June 30, 2002, the purchase price of the stock was $30.00, or 90% of the market value of the Common Stock on the first business day of the payment period ending June 30, 2002.

For the year ended December 31, 2001, the purchase price of the stock was $30.25 and $29.875, or 90% of the market value of the Common Stock on the first business day of the payment periods ending June 30, 2001 and December 31, 2001, respectively.

Earnings Per Share—Reconciliation from Basic EPS to Diluted EPS is as follows (Dollars in thousands, except per share data):

	For the Nine Months Ended September 30,				For the Three Months Ended September 30,
	2002		2001		2002		2001
Income available to common stockholders	$	50,641	$	35,719	$	17,269	$	13,479

Basic average shares	64,356,467		63,125,702		64,547,952		63,763,376
Dilutive effect of stock options	2,065,632		2,485,564		1,729,045		2,364,474
Diluted average shares	66,422,099		65,611,266		66,276,997		66,127,850

Earnings per share:
Basic	$	0.79	$	0.57	$	0.27	$	0.22

Diluted	$	0.76	$	0.54	$	0.26	$	0.20

8. Off-Balance Sheet Financial Instruments

Lines of Credit—At September 30, 2002, the Company had commitments to individuals and mutual funds under collateralized open lines of credit totaling $660 million, against which $61 million in loans were drawn. The credit risk involved in issuing lines of credit is essentially the same as that involved in extending loan facilities. The Company does not anticipate any loss as a result of these lines of credit.

Securities Lending—On behalf of its clients, the Company lends its securities to creditworthy brokers and other institutions. In certain circumstances, the Company may indemnify its clients for the fair market value of those securities against a failure of the borrower to return such securities. The Company requires the borrowers to provide collateral in an amount equal to or in excess of 102% of the fair market value of U.S. dollar denominated securities borrowed and 105% of the fair market value of non-U.S. dollar denominated securities borrowed. The borrowed securities are revalued daily to determine if additional collateral is necessary. The Company held, as collateral, cash and U.S. government securities totaling approximately $4.6 billion and $2.1 billion for indemnified securities on loan at September 30, 2002 and December 31, 2001, respectively.

9. Commitments and Contingencies

Restrictions on Cash Balances—The Company is required to maintain certain average cash reserve balances. The average required reserve balance with the Federal Reserve Bank (“FRB”) for the two-week period including September 30, 2002 was approximately $11.3 million. In addition, other cash balances in the amount of approximately $12.1 million were pledged to secure clearings with a depository institution, Depository Trust Company, as of September 30, 2002.

Lease Commitments— Minimum future commitments on noncancelable operating leases at September 30, 2002 were as follows (Dollars in thousands):

Fiscal Year Ending	Premises		Equipment		Total

2002	$	5,742	$	1,631	$	7,373
2003	21,812		5,329		27,141
2004	21,428		3,550		24,978
2005	21,548		986		22,534
2006 and beyond	60,008		56		60,064
Total	$	130,538	$	11,552	$	142,090

Total rent expense was $24.7 million and $17.5 million for the nine months ended September 30, 2002 and 2001, respectively. Total rent expense was $9.0 million and $6.4 million for the three months ended September 30, 2002 and 2001, respectively.

Effective January 1, 2000, the Company renewed its five–year service agreement with Electronic Data Systems (“EDS”), which now expires on December 31, 2005. Under the terms of the agreement, EDS provides data processing services to the Company, which has agreed to pay certain monthly service fees based on usage. Service expense under this contract was $5.3 million and $3.5 million for the nine months ended September 30, 2002 and 2001, respectively, and was $1.9 million and $1.3 million for the three months ended September 30, 2002 and 2001, respectively.

In 2001, the Company renewed its agreement with SEI Investments Company, which now expires on December 31, 2005. Under the terms of the agreement, SEI provides data processing services to the Company, which has agreed to pay certain monthly service fees based upon usage. Service expense under this contract was $3.9 million and $3.0 million for the nine months ended September 30, 2002 and 2001, respectively, and was $1.2 million and $1.3 million for the three months ended September 30, 2002 and 2001, respectively.

Contingencies—The Company provides a broad range of services to financial asset managers, such as mutual fund complexes, investment advisors, banks and insurance companies. The core services include global custody, multicurrency accounting and mutual fund administration. The value-added services include securities lending, foreign exchange and cash management. Assets under custody and management, held by the Company in a fiduciary capacity, are not included in the consolidated balance sheets since such items are not assets of the Company. Management conducts regular reviews of its fiduciary responsibilities and considers the results in preparing its consolidated financial statements. In the opinion of management, there are no contingent liabilities at September 30, 2002 that are material to the consolidated financial position or results of operations of the Company.

In June 2002, the Bank received from the Commonwealth of Massachusetts Department of Revenue (‘DOR’) a Notice of Intent to Assess additional state excise taxes of approximately $5.5 million plus interest and penalties with respect to the Bank’s tax years ended December 31, 1999 and December 31, 2000.

The DOR contends that dividend distributions to the Bank by Investors Funding Corp. (‘IFC’), a real estate investment trust 99.9% owned by the Bank, are fully taxable in Massachusetts. The Company, after consultation with its advisors, believes that the Massachusetts statute that provides for a dividend received deduction equal to 95% of certain dividend distributions applies to the distributions made by IFC to the Bank.

Accordingly, no provision has been made in the Company’s financial statements for the amounts assessed or additional amounts that might be assessed in the future.

The Company has been informed that the DOR has sent similar notices to numerous other financial institutions in Massachusetts that reported a deduction for dividends received from a real estate investment trust on their 1999 and 2000 Massachusetts financial institution excise tax returns. Because the legal issues raised are identical for all of the financial institutions involved, the Company is acting together with those institutions to appeal the assessments and to pursue all available means to defend its position vigorously. Assessed amounts ultimately paid, if any, would be deductible expenses for federal income tax purposes.

On January 16, 2001, Mopex, Inc. filed an action entitled Mopex, Inc. v. Chicago Stock Exchange, Inc., et al., Civil Action No. 01 C 0302 (the “Complaint”), in the United States District Court for the Northern District of Illinois. In the Complaint, Mopex alleges that the Company and numerous other entities, including Barclays Global Investors, State Street Bank and Trust Company, and Merrill Lynch, Pierce, Fenner & Smith, Inc., infringed U.S. Patent No. 6,088,685, entitled, “Open End Mutual Fund Securitization Process,” assigned to Mopex. In particular, Mopex alleges that the ‘685 patent covers the creation and trading of certain securities, including the Barclays iShares exchange traded funds. The Complaint seeks injunctive relief, damages, and enhanced remedies (including attorneys’ fees and treble damages). On April 3, 2001, the Company filed an answer and counterclaim, denying any liability on Mopex’s claim and seeking a declaratory judgment that the ‘685 patent is invalid and not infringed by the Company’s activities. The Company, which is indemnified by the iShares Trust for certain defense costs and damages resulting from Mopex’s claim, believes the claim is without merit.

While the Company does not offer or sell the securities discussed in the Complaint, it provides certain custody, accounting or other administrative services for the Barclays iShares family of exchange traded funds. Barclays is one of the defendants named in the Complaint. The Company cannot be sure that it will prevail in the defense of this claim. Patent litigation can be costly and could divert the attention of management. If the Company was found to infringe the patent, it would have to pay damages and would be ordered to cease any infringing activity or seek a license under the patent. The Company cannot be sure that it will be able to obtain a license on a timely basis or on reasonable terms, if at all. As a result, any determination of infringement could have a material adverse effect upon its business, financial condition and results of operations.

In July 2000, two of the Company’s Dublin subsidiaries, Investors Trust & Custodial Services (Ireland) Ltd. (ITC) and Investors Fund Services (Ireland) Ltd. (IFS), received a plenary summons in the High Court, Dublin, Ireland. The summons named ITC and IFS as defendants in an action brought by the FTF ForexConcept Fund Plc (the “Fund”), a former client. The summons also named as defendants FTF Forex Trading and Finance, S.A., the Fund’s investment manager, Ernst & Young, the Fund’s auditors, and Dresdner Bank-Kleinwort Benson (Suisse) S.A., a trading counterparty to the Fund. The Fund is an investment vehicle organized in Dublin to invest in foreign exchange contracts. A total of approximately $4.7 million had been invested in the Fund. Most of that money was lost prior to the Fund’s closing to subscriptions in June 1999.

In January 2001, ITC, IFS and the other defendants named in the plenary summons received a statement of claim by the Fund seeking unspecified damages allegedly arising from breach of contract, misrepresentation and breach of warranty, negligence and breach of duty of care, and breach of fiduciary duty, among others. The Company continues to investigate this matter. The Company has notified its insurers and intends to defend itself vigorously. Based on its investigation through September 30, 2002, the Company’s management does not expect this matter to have a material adverse effect on its results of operations and financial condition.

10. Regulatory Matters

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material adverse effect on the Company’s and the Bank’s results of operations and financial condition. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of September 30, 2002, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of September 30, 2002, the most recent notification from the FDIC categorized the Company and the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Company and the Bank must maintain minimum Total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Company’s or the Bank’s category. The following table presents the capital ratios for the Company and the Bank (Dollars in thousands):

	Actual				For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
As of September 30, 2002:
Total Capital (to Risk Weighted Assets—the Company)	$	353,169	15.08	%	$	187,364	8.00	%	N/A		N/A
Total Capital (to Risk Weighted Assets—the Bank)	$	349,302	14.92	%	$	187,339	8.00	%	$	234,174	10.00	%
Tier I Capital (to Risk Weighted Assets—the Company)	$	353,069	15.08	%	$	93,682	4.00	%	N/A		N/A
Tier I Capital (to Risk Weighted Assets—the Bank)	$	349,202	14.91	%	$	93,669	4.00	%	$	140,504	6.00	%
Tier I Capital (to Average Assets—the Company)	$	353,069	5.64	%	$	250,363	4.00	%	N/A		N/A
Tier I Capital (to Average Assets—the Bank)	$	349,202	5.58	%	$	250,278	4.00	%	$	312,847	5.00	%

As of December 31, 2001:
Total Capital (to Risk Weighted Assets—the Company)	$	297,479	16.77	%	$	141,932	8.00	%	N/A		N/A
Total Capital (to Risk Weighted Assets—the Bank)	$	293,706	16.56	%	$	141,898	8.00	%	$	177,373	10.00	%
Tier I Capital (to Risk Weighted Assets—the Company)	$	297,379	16.76	%	$	70,966	4.00	%	N/A		N/A
Tier I Capital (to Risk Weighted Assets—the Bank)	$	293,606	16.55	%	$	70,949	4.00	%	$	106,424	6.00	%
Tier I Capital (to Average Assets-the Company)	$	297,379	5.88	%	$	202,377	4.00	%	N/A		N/A
Tier I Capital (to Average Assets—the Bank)	$	293,606	5.80	%	$	202,334	4.00	%	$	252,917	5.00	%

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

11. Segment Reporting

The Company does not utilize segment information for internal reporting as management views the Company as one segment. The following represents net operating revenue and long-lived assets (including goodwill) by geographic area (Dollars in thousands):

	Net Operating Revenue								Long-Lived Assets
	For the Nine Months Ended September 30,				For the Three Months Ended September 30,				September 30,		December 31,
Geographic Information:	2002		2001		2002		2001		2002		2001

United States	$	315,869	$	251,577	$	106,851	$	93,801	$	149,667	$	122,200
Ireland	8,322		5,788		3,046		2,151		482		370
Canada	1,477		1,699		445		561		6		17
Cayman Islands	63		64		21		21		—		—

Total	$	325,731	$	259,128	$	110,363	$	96,534	$	150,155	$	122,587

BGI accounted for 16.44% and 16.68% of the Company’s consolidated net operating revenues for the nine months and three months ended September 30, 2002, respectively.

The following represents the Company’s asset servicing fees by service line (Dollars in thousands):

	Asset Servicing Fees
	For the Nine Months Ended September 30,				For the Three Months Ended September 30,
	2002		2001		2002		2001

Asset servicing fees by service line:
Custody, accounting, transfer agency, and administration	$	173,017	$	145,588	$	57,718	$	54,801
Foreign exchange	18,706		12,771		7,669		4,713
Cash management	12,362		11,328		4,416		3,989
Securities lending	8,605		6,837		2,362		1,985
Investment advisory	5,413		2,784		1,817		1,189

Total	$	218,103	$	179,308	$	73,982	$	66,677

INDEPENDENT ACCOUNTANTS’ REPORT

To the Board of Directors and Stockholders of

Investors Financial Services Corp.

Boston, Massachusetts

We have reviewed the accompanying condensed consolidated balance sheet of Investors Financial Services Corp. and subsidiaries (the “Corporation”) as of September 30, 2002, and the related condensed consolidated statements of income and comprehensive income for the three-month and nine-month periods then ended, and the condensed consolidated statements of stockholders’ equity and cash flows for the nine-month period then ended. These financial statements are the responsibility of the Corporation’s management.

We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and of making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to such condensed consolidated financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.

We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the consolidated balance sheet of Investors Financial Services Corp. and subsidiaries as of December 31, 2001, and the consolidated statements of income, stockholders’ equity and cash flows for the year then ended, and in our report dated February 8, 2002, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2001 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

DELOITTE & TOUCHE LLP

Boston, Massachusetts

November 14, 2002

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

You should read the following discussion together with our Condensed Consolidated Financial Statements and related notes, which are included elsewhere in this Report. The following discussion contains forward-looking statements that reflect plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements.

We provide a broad range of services to a variety of financial asset managers. These services include our core services, global custody, multicurrency accounting and mutual fund administration, as well as our value-added services, such as securities lending, foreign exchange, cash management, performance measurement, institutional transfer agency, investment advisory services and lines of credit. At September 30, 2002, we provided services for approximately $742 billion in net assets, including approximately $78 billion of foreign net assets.

On January 1, 2001, we adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and the corresponding amendments and SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities.” On adoption of these new accounting standards, we recorded a transition adjustment recognizing an after tax reduction in Other Comprehensive Income (‘OCI’) of $3.9 million. In conjunction with the adoption, we elected to reclassify approximately $402 million of securities from held to maturity to available for sale, which further reduced OCI, net of tax, by approximately $1.4 million.

On February 1, 2001, we completed the issuance and sale of 1,624,145 shares of Common Stock at $71.62 per share in a public offering. A portion of the proceeds was used to fund the acquisition of the advisor custody unit of the Chase Manhattan Bank. The remaining proceeds were used for the assumption of the operations of the U.S. asset administration unit of Barclays Global Investors, N.A. and for working capital.

On February 1, 2001, we purchased the operations of the advisor custody unit of The Chase Manhattan Bank (‘Chase’). This unit provided institutional custody services to individual accounts holding approximately $27 billion in assets as of February 1, 2001. These accounts consist of individual accounts, trusts, endowments and corporate accounts whose assets are managed by third-party investment advisors. Pursuant to the terms of the asset purchase agreement, we paid to Chase at the closing of the transaction approximately $31.5 million of the total purchase price, plus another $39.8 million in exchange for the book value of loans to its clients. Under the terms of the asset purchase agreement, we are not obligated to make any further purchase price payments to Chase. The transaction was accounted for as a purchase.

On May 1, 2001, we assumed the operations of the U.S. asset administration unit of Barclays Global Investors, N.A. (‘BGI’), a large international institutional investment manager. The unit, located in Sacramento, California, provides custody, fund accounting and other operations functions for BGI’s clients. The transaction was accounted for as a purchase.

On April 23, 2002, the Board of Directors approved a two-for-one stock split in the form of a 100% stock dividend payable to shareholders of record as of May 24, 2002. The dividend was paid on June 14, 2002.

In June 2002, we received from the Commonwealth of Massachusetts Department of Revenue a Notice of Intent to Assess additional state excise taxes of approximately $5.5 million plus interest and penalties with respect to the Bank’s tax years ended December 31, 1999 and December 31, 2000.

The Department of Revenue contends that dividend distributions to the Bank by Investors Funding Corp., a real estate investment trust 99.9% owned by the Bank, are fully taxable in Massachusetts. After consultation with our advisors, we believe that the Massachusetts statute that provides for a dividend received deduction equal to 95% of certain dividend distributions applies to the distributions made by Investors Funding to the Bank. Accordingly, no provision has been made in our financial statements for the amounts assessed or additional amounts that might be assessed in the future.

We have been informed that the Department of Revenue has sent similar notices to numerous other financial institutions in Massachusetts that reported a deduction for dividends received from a real estate investment trust on their 1999 and 2000 Massachusetts excise tax returns. Because the legal issues raised are identical for all of the financial institutions involved, we are acting together with those institutions to appeal the assessments and to pursue all available means to defend our position vigorously. Assessed amounts ultimately paid, if any, would be deductible expenses for federal income tax purposes.

Revenue and Expense Overview

We derive our revenue from financial asset servicing. Although interest income and noninterest income are reported separately for financial statement presentation purposes, our clients view the pricing of our service offerings on a bundled basis. In establishing a fee structure for a specific client, management analyzes all expected revenue and related expenses, as opposed to separately analyzing fee income and interest income and related expenses for each from the relationship. Accordingly, we believe net operating revenue (net interest income plus noninterest income) and net income are the most meaningful measures of our financial results. Net operating revenue increased 26% and 14% to $325.7 million and $110.4 million from $259.1 million and $96.5 million for the nine months and three months ended September 30, 2002 and 2001, respectively. Net income increased 42% and 28% to $50.6 million and $17.3 million from $35.7 million and $13.5 million for the nine months and three months ended September 30, 2002 and 2001, respectively.

Noninterest income consists primarily of fees for financial asset servicing and is principally derived from global custody, multicurrency accounting, mutual fund administration and institutional transfer agency services for financial asset managers and the assets they control. Our clients pay fees based on the volume of assets under custody, portfolio transactions, income collected and whether other value-added services such as foreign exchange, securities lending and performance measurement are needed. Asset-based fees are usually charged on a sliding scale and are subject to minimum fees. As such, when the assets in a portfolio under custody grow as a result of changes in market values or cash inflows, our fees may be a smaller percentage of those assets. Conversely, as asset values fall, our revenue decreases by the marginal rate charged on our sliding scale pricing model. As a result, as asset values decrease, fees will decrease, but at a smaller percentage than the asset value decrease.

If the value of equity assets held by our clients were to increase or decrease by 10%, we estimate that this, by itself, would currently cause a corresponding change of approximately 3% in our earnings per share. If the value of fixed income assets held by our clients were to increase or decrease by 10%, we estimate that this, by itself, would currently cause a corresponding change of approximately 2% in our earnings per share. In practice, earnings per share do not track precisely to the value of the equity markets because conditions present in a market decline may generate offsetting increases in other revenue items. For example, market volatility often results in increased transaction fee revenue. Also, market declines may result in increased interest income and sweep fee income as clients move larger amounts of assets into cash management vehicles that we offer. As a result, our earnings have remained strong despite the recent steep declines in the broad equity markets. However, there can be no assurance that these offsetting revenue increases will continue.

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 our clients who, in the course of their financial asset management, generate cash balances which they deposit on a short-term basis with us. We invest these cash balances and remit a portion of the earnings on these investments to our clients. Our share of earnings from these investments is viewed as part of the total package of compensation paid to us from our clients for performing asset servicing.

Operating expenses consist of costs incurred in support of our business activities. As a service provider, our largest expenditures are staffing costs, including compensation and benefits. We rely heavily on technological tools and services for processing, communicating and storing data. As a result, our technology and telecommunication expense is also a large percentage of our operating expenses. We also rely on an established network of global subcustodians in order to service our clients worldwide, which is reflected in our transaction processing service expense.

Significant Accounting Policies

The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the U.S., which require us to make estimates and assumptions. We have identified the following accounting policies that, as a result of the complexities of the underlying accounting standards and operations involved, could result in significant changes to our consolidated financial condition or results of operations under different conditions or using different assumptions.

Derivative Financial Instruments - We do not purchase derivative financial instruments for trading purposes. Interest rate swap agreements are matched with specific financial instruments reported on the consolidated balance sheet. We use derivative instruments to manage exposures to interest rate risks. We routinely enter into interest rate swap agreements in which we pay a fixed interest rate and receive a floating interest rate. These transactions are designed to hedge a portion of our liabilities. By entering into a pay-fixed/receive-floating interest rate swap, a portion of these liabilities is effectively converted to a fixed rate liability for the term of the interest rate swap agreements.

On January 1, 2001, we adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted, which established accounting and reporting standards for derivative instruments. We also adopted SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities.” All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value. If the derivative is designated as a fair value hedge, the change in the fair value of the derivative and the item being hedged will be recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in OCI. Ineffective portions of changes, as determined in accordance with SFAS No. 133, in the fair value of the cash flow hedges are recognized in earnings. For derivatives that do not qualify as hedges, changes in their fair value are recognized in earnings.

Hedge accounting requires that we measure the changes in fair value of derivatives designated as hedges as compared to changes in expected cash flows of the underlying hedged transactions for each reporting period. Changes in conditions or the occurrence of unforeseen events could affect the timing of the recognition of changes in fair value of certain hedging derivatives. The measurement of fair value is based upon market values, however, in the absence of quoted market values, measurement involves valuation estimates. These estimates are based on methodologies deemed appropriate in the circumstances. However, the use of alternative assumptions could have a significant effect on estimated fair value.

We enter into foreign exchange contracts with clients and attempt to enter 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 servicing fees. Unrealized gains (losses) resulting from purchases and sales of foreign exchange contracts are included within the respective other assets and other liabilities categories on our consolidated balance sheet. The foreign exchange contracts have been reduced by balances with the same counterparty where a master netting agreement exists.

Stock-Based Compensation – We account for stock-based compensation using the intrinsic value-based method of Accounting Principles Board (‘APB’) No. 25, “Accounting for Stock Issued to Employees,” as allowed under SFAS No. 123, “Accounting for Stock-Based Compensation.” Under APB No. 25, no compensation costs are recognized because the option exercise price is equal to the fair market price of the common stock on the date of the grant. If SFAS No. 123 were adopted, stock options would be valued at grant date using the Black-Scholes valuation model and compensation costs would be recognized pro rata over the vesting period. The Black-Scholes option-pricing model uses assumptions including the expected life of an option, the expected volatility of the underlying stock and an assumed risk-free interest rate.

We reported a 37% dilution in earnings per share for the fiscal year ended December 31, 2001 using the following assumptions: an expected volatility of 57%, an expected option life of 10 years, an assumed risk-free interest rate of 5.16% and a dividend yield of 0.12%. We reexamined the actual expected life of our options and the volatility of our stock, and determined our historical option life to be less than four years and the related volatility to be 55%. Since SFAS No. 123 requires us to use an option life no less than the vesting period, a four-year life was chosen. Based upon an expected option life of four years and the related volatility of 55% over the same period, the dilution in earnings per share for the year ended December 31, 2001 would have been 20% versus the 37% that was previously disclosed in our December 31, 2001 annual report on Form 10-K.

Capitalized Software Costs – Capitalized software costs are accounted for under the method prescribed by AICPA Statement of Position 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” (‘SOP 98-1’) and are included within the furniture, fixtures and equipment component. Capitalized software costs are amortized over the estimated useful life, not to exceed 5 years. Our policy is to capitalize costs relating to system development projects that provide significant functionality enhancements. Assets are placed in service and depreciation and/or amortization commences when successful testing has been achieved. Please see the “Capital Resources” section of this Report regarding capitalized software expenditures made during the nine months ended September 30, 2002 and 2001.

New Accounting Principles – On January 1, 2002, we adopted SFAS No. 142, “Goodwill and Other Intangible Assets,” which supersedes APB No. 17, “Intangible Assets.” SFAS No. 142 addresses how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. This statement also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. This statement affects the accounting of premiums, includes guidelines for the determination, measurement and testing of impairment, and requires disclosure of information about goodwill and other intangible assets in the years subsequent to their acquisition that was not previously required. This Statement eliminates the amortization of goodwill, and requires that goodwill be reviewed at least annually for impairment. This Statement affects all goodwill recognized on our consolidated balance sheet, regardless of when the assets were initially recorded. Upon adoption of SFAS No. 142, we ceased amortization of goodwill. As of September 30, 2002 there was no impairment of goodwill.

In November 2001, the FASB issued Emerging Issues Task Force (‘EITF’) No. 01-14, “Income Statement Characterization of Reimbursements Received for Out-Of-Pocket Expenses Incurred.” This guidance requires companies to recognize the reimbursement of client-related expenses as revenue and the costs as operating expense. Client reimbursements for out-of-pocket expenses are reflected in fee revenue in the accompanying financial statements. Prior periods have been reclassified to reflect this presentation, which resulted in an increase to fee revenue and operating expense of $6.5 million and $6.2 million for the nine months ended September 30, 2002 and 2001, respectively, and $2.2 million and $2.1 million for the three months ended September 30, 2002 and 2001, respectively.

Certain Factors That May Affect Future Results

From time to time, information provided by us, statements made by our employees, or information included in our filings with the SEC (including this Form 10-Q) may contain statements which are not historical facts, so-called “forward-looking statements,” and which involve risks and uncertainties. These statements relate to future events or our future financial performance and are identified by words such as “may,” “will,” “could,” “should,” “expect,” “plan,” “intend,” “seek,” “anticipate,” “believe,” “estimate,” “potential,” or “continue” or other comparable terms or the negative of those terms. Forward-looking statements in this Form 10-Q include certain statements regarding liquidity, interest rate conditions, interest rate sensitivity, loss exposure on lines of credit, the timing and effect on earnings of derivative gains and losses, the effect on earnings of changes in equity values, and the effect of certain tax and legal claims against us. Our 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 our filings with the SEC.

Our operating results are subject to fluctuations in interest rates and the securities markets.

We base some of our fees on the market value of the assets we process. Accordingly, our operating results are subject to fluctuations in interest rates or the securities markets as these fluctuations affect the market value of assets processed. Current market conditions, including the recent decline in equity markets, adversely affect our asset-based fees. While reductions in these fees may be offset by increases in other sources of revenue, continued downward movement of the broad equity markets will have an adverse impact on our earnings. Fluctuations in interest rates or the securities markets can also lead to investors seeking alternatives to the investment offerings of our clients, which could result in a lesser amount of assets processed and correspondingly lower fees. Also, our net interest income is earned by investing depositors’ funds and making loans. Rapid changes in interest rates or changes in the relationship between different index rates could adversely affect the market value of, or the earnings produced by, our investment and loan portfolios.

The failure to properly manage our growth could adversely affect the quality of our services and result in the loss of clients.

We have been experiencing a period of rapid growth that has required the dedication of significant management and other resources, including the assumption of the operations of the U.S. asset administration unit of Barclays Global Investors, N.A. (‘BGI’). Continued rapid growth could place a strain on our management and other resources. To manage future growth effectively, we must continue to invest in our operational, financial and other internal systems, and our human resources. Also, we must continue to expand our office space at reasonable rates in a competitive real estate market.

Our future results depend, in part, on successful integration of pending and possible future acquisitions and outsourcing transactions.

The integration of the BGI asset administration unit presents us with challenges and demands management attention that has to be diverted from other matters. Integration of acquisitions and outsourcing transactions is complicated and frequently presents unforeseen difficulties and expenses which can affect whether and when a particular acquisition will be accretive to our earnings per share. Any future acquisitions or outsourcing transactions will present similar challenges.

A material portion of our revenues is derived from our relationship with Barclays Global Investors, N.A.

As a result of our assumption of the operations of the U.S. asset administration unit of BGI in 2001 and our ongoing relationship with BGI’s iShares and Master Investment Portfolios, BGI accounted for approximately 16% of our net operating revenue during the nine months and three months ended September 30, 2002. We expect that BGI will continue to account for a significant portion of our net operating revenue. While we provide services to BGI under long-term contracts, those contracts may be terminated for certain regulatory and fiduciary reasons. The loss of BGI’s business would cause our net operating revenue to decline and would have a material adverse effect on our quarterly and annual results.

We face significant competition from other financial services companies, which could negatively affect our operating results.

We are part of an extremely competitive asset servicing industry. Many of our current and potential competitors have longer operating histories, greater name recognition and substantially greater financial, marketing and other resources than we do. These greater resources could, for example, allow our competitors to develop technology superior to our own. In addition, we face the risk that large mutual fund complexes may build in-house asset servicing capabilities and no longer outsource these services to us. As a result, we may not be able to compete effectively with current or future competitors.

We may not win our appeal of the Massachusetts Department of Revenue Notice of Assessment.

We received from the Commonwealth of Massachusetts Department of Revenue a Notice of Intent to Assess additional state excise taxes with respect to the years 1999 and 2000. After consultation with our advisors, we do not believe that we owe the additional excise tax. The Company intends to appeal the assessment and to pursue all available means to defend its position vigorously. Legal proceedings to appeal and defend our position could be expensive and divert management’s attention. In addition, if we do not prevail, payment of the additional excise tax would have a material adverse impact on our earnings for the period in which we pay the assessment.

We may not be able to protect our proprietary technology.

Our proprietary technology is important to our business. We rely on trade secret, copyright and trademark laws and confidentiality agreements with employees and third parties to protect our proprietary technology, all of which offer only limited protection. These intellectual property rights may be invalidated or our competitors may develop similar technology independently. Legal proceedings to enforce our intellectual property rights may be unsuccessful, and could also be expensive and divert management’s attention.

We may incur significant costs defending infringement claims.

We have been sued in federal court claiming that we and others are infringing a patent allegedly covering the creation and trading of certain securities, including exchange traded funds. While we believe the claim is without merit, we cannot be sure that we will prevail in the defense of this claim. Any patent litigation would be costly and could divert the attention of management. If we were found to infringe the patent, we would have to pay damages and would be ordered to cease any infringing activity or seek a license under the patent. We cannot be sure that we will be able to obtain a license on a timely basis or on reasonable terms, if at all. While we are indemnified against some defense costs and damages related to this claim, we may incur significant expenses defending the claim. As a result, any determination of infringement could have a material adverse effect upon our business, financial condition and results of operations. We may become subject to other infringement claims in the future.

We must hire and retain skilled personnel in order to succeed.

Qualified personnel, in particular managers and other senior personnel, are in great demand throughout the financial services industry. We could find it increasingly difficult to continue to attract and retain sufficient numbers of these highly skilled employees.

Our quarterly and annual operating results may fluctuate.

Our quarterly and annual operating results are difficult to predict and may fluctuate from quarter to quarter and annually for several reasons, including:

• The timing of commencement or termination of client engagements; and

• The rate of net inflows and outflows of investor funds in the investment vehicles offered by our clients.

Most of our expenses, like employee compensation and rent, are relatively fixed. As a result, any shortfall in revenue relative to our expectations could significantly affect our operating results.

We are subject to extensive federal and state regulations that impose complex restraints on our business.

Federal and state laws and regulations applicable to financial institutions and their parent companies apply to us. Our primary banking regulators are the Federal Reserve Board (‘FRB’), the Federal Deposit Insurance Corporation (‘FDIC’) and the Massachusetts Commissioner of Banks. Virtually all aspects of our operations are subject to specific requirements or restrictions and general regulatory oversight including the following:

• The FRB and the FDIC maintain capital requirements that we must meet. Failure to meet those requirements could lead to severe regulatory action or even receivership. We are currently considered to be “well capitalized”;

• Under Massachusetts law, the Bank may be restricted in its ability to pay dividends to Investors Financial, which may in turn restrict our ability to pay dividends to our stockholders; and

• The FRB and the FDIC are empowered to assess monetary penalties against, and to order termination of activities by, companies or individuals who violate the law.

Banking law restricts our ability to own the stock of certain companies and also makes it more difficult for us to be acquired. Also, we have not elected financial holding company status under the federal Gramm-Leach-Bliley Act of 1999. This may place us at a competitive disadvantage with respect to other organizations.

Statement of Operations

Comparison of Operating Results for the Nine Months and the Three Months Ended September 30, 2002 and 2001

Noninterest Income

Noninterest income was $219.7 million for the nine months ended September 30, 2002, up 21% from the same period in 2001, and was $74.5 million for the three months ended September 30, 2002, up 10% from the same period in 2001. Noninterest income consists of the following items (Dollars in thousands):

	For the Nine Months Ended September 30, 2002						For the Three Months Ended September 30, 2002
	2002		2001		Change		2002		2001		Change
Asset servicing fees:
Custody, accounting, transfer agency and administration	$	173,017	$	145,588	19	%	$	57,718	$	54,801	5	%
Foreign exchange	18,706		12,771		47	%	7,669		4,713		63	%
Cash management	12,362		11,328		9	%	4,416		3,989		11	%
Securities lending	8,605		6,837		26	%	2,362		1,985		19	%
Investment advisory	5,413		2,784		94	%	1,817		1,189		53	%
Total asset servicing fees	218,103		179,308		22	%	73,982		66,677		11	%

Other operating income	1,645		2,378		(31	)%	515		829		(38	)%

Total noninterest income	$	219,748	$	181,686	21	%	$	74,497	$	67,506	10	%

Asset servicing fees for the nine months ended September 30, 2002 increased 22% to $218.1 million from the same period in 2001, and were $74.0 million for the three months ended September 30, 2002, up 11% from the same period in 2001. The largest component of asset servicing fees is asset-based fees, which are based on assets processed. Assets processed is the total dollar value of financial assets on the reported date for which we provide one or more of the following services: global custody, multicurrency accounting, mutual fund administration, securities lending, foreign exchange, cash management, performance measurement, institutional transfer agency, investment advisory services and lines of credit. Total net assets processed decreased $72 billion from $814 billion at December 31, 2001 to $742 billion at September 30, 2002, and decreased $93 billion from $835 billion at June 30, 2002. Changes in net assets processed include the following components (Dollars in billions):

	For the Nine Months Ended September 30, 2002			For the Three Months Ended September 30, 2002

Sales to new clients	$	24		$	5
Further penetration of existing clients	23			7
Fund flows and market loss	(119		)	(105		)

Net change in assets processed	$	(72	)	$	(93	)

Our ability to win business and the ability of our clients to sell additional product, thus generating fund flows, allowed us to minimize the impact of the market downturn in 2002. Also contributing to this inverse correlation is our tiered pricing structure for asset based fees. Since we have decremental pricing schedules for asset based fees, as asset values deteriorate, revenue is only impacted by the asset decline at the then marginal rate.

Another significant portion of the increase in asset servicing fees resulted from our success in marketing ancillary services, such as foreign exchange, cash management, securities lending, and mutual fund advisory services. Foreign exchange fees increased due to higher transaction volumes and volatility in the currencies traded by our clients. Cash management and securities lending fees increased with the addition of new clients and through cross-selling to existing clients. Increased investment advisory service fees were the result of growth in the asset size of the Merrimac Master Portfolio, an investment company for which the Company acts as advisor.

Other operating income consists of dividends received relating to the Federal Home Loan Bank of Boston (‘FHLBB’) stock investment and miscellaneous fees for systems consulting services. The decrease in other operating income for the nine months ended September 30, 2002 resulted primarily from a decrease in the dividend rate paid on the FHLBB stock and from systems consulting work performed in 2001, but not in 2002. The decrease in other operating income for the three months ended September 30, 2002 was due to the decreased FHLBB stock dividend.

Operating Expenses

Total operating expenses were $251.5 million for the nine months ended September 30, 2002, up 22% from the same period in 2001. For the three months ended September 30, 2002, total operating expenses were $85.1 million, up 11% from the same period in 2001. The components of operating expenses were as follows (Dollars in thousands):

	For the Nine Months Ended September 30,						For the Three Months Ended September 30,
	2002		2001		Change		2002		2001		Change

Compensation and benefits	$	146,819	$	120,395	22	%	$	47,951	$	44,879	7	%
Technology and telecommunications	30,070		28,951		4	%	10,004		9,272		8	%
Transaction processing services	26,078		17,412		50	%	8,764		7,896		11	%
Occupancy	18,247		12,649		44	%	6,841		4,847		41	%
Depreciation and amortization	11,179		5,781		93	%	4,540		2,558		77	%
Professional fees	4,968		3,460		44	%	1,752		1,127		55	%
Travel and sales promotion	4,217		4,064		4	%	1,463		1,670		(12	)%
Amortization of goodwill	—		2,565		(100	)%	—		992		(100	)%
Other operating expenses	9,956		10,557		(6	)%	3,747		3,427		9	%

Total operating expenses	$	251,534	$	205,834	22	%	$	85,062	$	76,668	11	%

Compensation and benefits expense was $146.8 million for the nine months ended September 30, 2002, up 22% from the same period in 2001, and was $48.0 million for the three months ended September 30, 2002, up 7% from the same period in 2001. The average number of employees increased 20% to 2,649 during the nine months ended September 30, 2002 from 2,202 for the same period last year. The average number of employees for the three months ended September 30, 2002 was 2,698, up 7% compared to 2,515 during the same period in 2001. We increased the number of employees to support new business and the expansion of existing client relationships. For the nine months ended September 30, 2002, compensation expense related to our management-incentive plans increased $2.9 million as a result of higher earnings and additional incentive-eligible managers. This expense decreased $2.0 million for the three months ended September 30, 2002 compared to the same period last year, as certain earnings goals were reached earlier in 2002. Benefits, including payroll taxes, group insurance plans, retirement plan contributions and tuition reimbursement, increased $5.8 million for the nine months ended September 30, 2002, and $1.3 million for the three months ended September 30, 2002, consistent with the increased headcount. Increased capitalized software development in 2002 offset the increase in compensation and benefits by approximately $8.4 million and $2.5 million for the nine months and the three months ended September 30, 2002 compared to the same periods last year.

Technology and telecommunications expense was $30.1 million for the nine months ended September 30, 2002, up 4% from the same period in 2001, and was $10.0 million for the three months ended September 30, 2002, up 8% from the same period in 2001. Technology and telecommunications expense consists primarily of contract programming, outsourced services, hardware rent, telecommunications expense and software licenses. Increased hardware, software, mainframe and trust processing and telecommunications expenditures needed to support new business and increased transaction volumes accounted for $7.4 million and $1.7 million of the nine- and three-month increases, respectively. The nine-month increase was offset by decreased expenses of $6.3 million related to outsourced network monitoring, help desk and other outsourced services required in 2001, and not in 2002, primarily due to the Chase acquisition. The three-month increase was offset primarily by continued cost management in 2002.

Transaction processing services expense, which consists primarily of subcustodian and pricing fees, was $26.1 million for the nine months ended September 30, 2002, up 50% from the same period in 2001. For the three months ended September 30, 2002, transaction processing services expense was $8.8 million, up 11% from the same period last year. The increase relates primarily to increased subcustodian fees, driven by increased volumes of transactions and changes in assets processed for clients, largely a result of the BGI U.S. asset administration unit assumption in May 2001 and the addition of new business in 2002.

Occupancy expense was $18.2 million for the nine months ended September 30, 2002, up 44% from the same period in 2001 and was $6.8 million for the three months ended September 30, 2002, up 41% compared to the same

period in 2001. These increases were primarily due to increased space in our Boston, New York, and Dublin offices and the California offices assumed from BGI.

Depreciation and amortization expense was $11.2 million for the nine months ended September 30, 2002, up 93% from the same period in 2001, reflecting a full nine months of this expense in 2002 compared to a partial year in 2001 when the Chase acquisition and BGI business unit assumption occurred. This expense was $4.5 million for the three months ended September 30, 2002, up 77% from the same period in 2001. This increase resulted from completion of capitalized software projects in 2002 and their placement into service and the addition of leasehold improvements as a result of the new space we occupied in Boston, New York, Dublin and California.

Professional fees were $5.0 million for the nine months ended September 30, 2002, up 44% from the same period in 2001, and $1.8 million for the three months ended September 30, 2002, up 55% from the same period in 2001. Included in professional fees are increased accounting, legal and consulting services provided during the periods, as well as increased fees associated with the Merrimac fund. These fees are asset-based and the increases result from growth in the size of the fund.

Travel and sales promotion expense was $4.2 million for the nine months ended September 30, 2002, up 4% from the same period in 2001, and $1.5 million for the three months ended September 30, 2002, down 12% from the same period in 2001. Travel and sales promotion expense consists of expenses incurred by the sales force, client management staff and other employees in connection with sales calls on potential clients, traveling to existing client sites, to our offices in New York and California and to our foreign subsidiaries.

Amortization of goodwill expense ended as of January 1, 2002, as a result of the adoption of SFAS No. 142. Please refer to the “Significant Accounting Policies” section for a further discussion of this pronouncement.

Other operating expenses remained relatively flat at $10.0 million and $3.7 million for the nine months and three months ended September 30, 2002, respectively, compared to the same periods in 2001. Other operating expenses include fees for recruiting, office supplies and postage, storage, temporary help, client accommodations and various regulatory fee assessments.

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 compared to the same periods in 2001. Changes attributed to both volume and rate have been allocated based on the proportion of change in each category (Dollars in thousands):

	For the Nine Months Ended September 30, 2002									For the Three Months Ended September 30, 2002
	Change Due to Volume			Change Due to Rate			Net			Change Due to Volume			Change Due to Rate			Net

Interest-earning assets:
Federal funds sold and securities purchased under resale agreements	$	220		$	(1,151	)	$	(931	)	$	309		$	(251	)	$	58
Investment securities	52,373			(55,753		)	(3,380		)	14,820			(16,642		)	(1,822		)
Loans	(118		)	(1,270		)	(1,388		)	(50		)	(451		)	(501		)

Total interest-earning assets	$	52,475		$	(58,174	)	$	(5,699	)	$	15,079		$	(17,344	)	$	(2,265	)

Interest-earning liabilities:
Deposits	$	1,692		$	(23,062	)	$	(21,370	)	$	974		$	(6,641	)	$	(5,667	)
Borrowings	25,775			(38,645		)	(12,870		)	5,939			(9,375		)	(3,436		)

Total interest-bearing liabilities	$	27,467		$	(61,707	)	$	(34,240	)	$	6,913		$	(16,016	)	$	(9,103	)

Change in net interest income	$	25,008		$	3,533		$	28,541		$	8,166		$	(1,328	)	$	6,838

Net interest income was $106.0 million for the nine months ended September 30, 2002, up 37% from the same period in 2001. Net interest income was $35.9 million for the three months ended September 30, 2002, up 24% from the same period in 2001. The improvement in net interest income primarily reflects the positive effect of balance sheet growth driven by increased client deposits and borrowings and a more favorable interest rate environment. The net interest margin increased 8 basis points to 2.53% for the nine months ended September 30, 2002, compared to the first nine months of 2001. The net interest margin decreased 6 basis points to 2.39% for the three months ended September 30, 2002, compared to the same period last year, due to prepayment costs incurred in the third quarter of 2002 associated with replacing borrowed funds at a more favorable rate.

Average interest-earning assets, primarily investment securities, increased $1.4 billion or 32% for the nine months ended September 30, 2002 and increased $1.3 billion or 27% for the three months ended September 30, 2002 compared to the same periods last year. Funding for the asset growth for the nine-month period was provided by a combination of client balances of $0.5 billion and external borrowings of $ 0.8 billion. Funding for the asset growth for the three-month period was provided by a combination of client balances of $0.7 billion and external borrowings of $0.5 billion. The effect of changes in volume of interest-earning assets and interest-bearing liabilities was an increase in net interest income of approximately $25.0 million and $8.2 million for the nine months and three months ended September 30, 2002, respectively.

Average yield on interest-earning assets was 4.42% for the nine months ended September 30, 2002, down 160 basis points from the same period in 2001, and was 4.25% for the three months ended September 30, 2002, down 132 basis points from the same period in 2001. The average rate paid on interest-bearing liabilities was 2.09% for the nine months ended September 30, 2002, down 189 basis points from the same period in 2001. The average rate paid on interest-bearing liabilities was 2.06% for the three months ended September 30, 2002, down 138 basis points from the same period in 2001. The decreases reflect the lower interest rate environment for both the nine months and three months ended September 30, 2002 compared to the same periods in 2001. The effect on net interest income due to

changes in rates was an increase of approximately $3.5 million for the nine months ended September 30, 2002. The effect on net interest income due to changes in rates for the three months ended September 30, 2002 was a decrease of $1.3 million, as the favorable rate environment was offset by prepayment costs associated with replacing borrowed funds at a lower rate in 2002.

During the past 24 months, our net interest margin has been unusually favorable. While interest rates remain low, the yield curve is flattening, meaning the difference between short-term interest rates and long-term interest rates is decreasing. In addition, with mortgage rates at historic lows, refinancing activities increase, resulting in prepayments of higher yielding mortgage-backed securities that we hold, the proceeds of which are reinvested at current market rates. These factors, among others, may decrease our net interest margin to more traditional levels and reduce the unusually high growth rates in net interest income that we have experienced during the last two years.

On January 1, 2001, we adopted SFAS No. 133, as amended and interpreted, which established accounting and reporting standards for derivative instruments. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value. If the derivative is designated as a fair value hedge, the change in the fair value of the derivative and the item being hedged will be recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in Other Comprehensive Income (‘OCI’). Ineffective portions of changes, as determined in accordance with SFAS No. 133, in the fair value of the cash flow hedges are recognized in earnings. For derivatives that do not qualify as hedges, changes in their fair value are recognized in earnings. The adoption of SFAS No. 133 on January 1, 2001, resulted in no cumulative effect-type adjustment to net income. However, we recorded a reduction to OCI of $3.9 million, net of tax, and a corresponding liability for the fair value of the interest rate swaps. The reduction to OCI and the recognition of the liability are primarily attributable to net unrealized losses on cash flow hedges as of initial adoption. In conjunction with the adoption, we elected to reclassify approximately $402 million of securities from held to maturity to available for sale, which further reduced OCI, net of tax, by approximately $1.4 million.

We use derivative instruments to manage exposures to interest rate risks. We routinely enter into interest rate swap agreements in which we pay a fixed interest rate and receive a floating interest rate. These transactions are designed to hedge a portion of our liabilities. By entering into a pay-fixed/receive-floating interest rate swap, a portion of these liabilities is effectively converted to a fixed rate liability for the term of the interest rate swap agreement. Most of these derivatives have been designated as highly effective cash flow hedges, as determined in accordance with SFAS No. 133. An insignificant portion of the derivatives used to manage exposures to interest rate risks were not considered highly effective and, therefore, did not qualify for hedge accounting.

Income Taxes

Taxes for the nine months ended September 30, 2002 were $22.4 million, up 36% from the same period in 2001. Taxes for the three months ended September 30, 2002 were $7.6 million, up 27% from the same period in 2001. The increases in tax expense reflect the higher level of pretax income during both periods. The effective tax rate for the nine- and three-month periods ended September 30, 2002 was 30%, down from 31% for the nine-month period last year, and consistent with 30% for the three-month period last year. The decrease in the effective tax rate reflects our increased investment in tax-exempt municipal securities in 2002.

Financial Condition

Investment Portfolio

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

	September 30, 2002		December 31, 2001
Securities held to maturity:
Mortgage-backed securities	$	2,295,478	$	2,585,287
Federal agency securities	1,003,045		456,108
State and political subdivisions	114,064		91,888
Foreign government securities	—		2,501

Total securities held to maturity	$	3,412,587	$	3,135,784

Securities available for sale:
Mortgage-backed securities	$	2,240,132	$	1,228,841
Federal agency securities	31,022		30,848
Corporate debt	174,963		120,505
State and political subdivisions	279,468		241,467

Total securities available for sale	$	2,725,585	$	1,621,661

Our investment portfolio is used to invest depositors’ funds and provide a secondary source of earnings for us. In addition, we use the investment portfolio to secure open positions at securities clearing institutions in connection with our custody services. The portfolio is comprised of securities of state and political subdivisions (‘municipal 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 of Boston, securities issued by the Small Business Administration (‘SBA’) and corporate debt securities.

We invest in mortgage-backed securities, Federal agency callable bonds and corporate debt to increase the total return of the investment portfolio. Mortgage-backed securities generally have a higher yield than U.S. Treasury securities due to credit and prepayment risk. Credit risk results from the possibility that a loss may occur if a counterparty is unable to meet the terms of the contract. Prepayment risk results from the possibility that changes in interest rates may cause mortgage securities to be paid off prior to their maturity dates. Federal agency callable bonds generally have a higher yield than U.S. Treasury securities due to credit and call risk. Credit risk results from the possibility that the Federal agency issuing the bonds may be unable to meet the terms of the bond. Call risk results from the possibility that fluctuating interest rates and other factors may result in the exercise of the call option by the Federal agency. Credit risk related to mortgage-backed securities and Federal agency callable bonds is substantially reduced by payment guarantees and credit enhancements.

We invest in municipal securities to generate stable, tax advantaged income. Municipal securities generally have lower stated yields than Federal agency and U.S. Treasury securities, but the after-tax yields are comparable. Municipal securities are subject to credit risk, however, all municipal securities that we invest in are AAA rated.

The book value and weighted average yield of our securities held to maturity at September 30, 2002 are reflected in the following table (Dollars in thousands):

	Years to Maturity
	Under 1				1 to 5				5 to 10				Over 10
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield
Mortgage-backed securities	$	459,372	4.60	%	$	1,481,432	4.09	%	$	276,933	4.14	%	$	77,741	3.83	%
Federal agency securities	—		—		13,692		3.88	%	504,525		3.88	%	484,828		3.88	%
State and political subdivisions	—		—		2,356		5.08	%	5,917		5.08	%	105,791		5.08	%
Total securities held to maturity	$	459,372	4.60	%	$	1,497,480	4.09	%	$	787,375	3.98	%	$	668,360	4.06	%

The carrying value and weighted average yield of our securities available for sale at September 30, 2002 are reflected in the following table (Dollars in thousands):

	Years to Maturity
	Under 1				1 to 5				5 to 10				Over 10
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield
Mortgage-backed securities	$	—	—		$	772,881	5.40	%	$	98,978	5.56	%	$	1,368,273	5.38	%
Federal agency securities	—		—		31,022		5.63	%	—		—		—		—
Corporate debt	—		—		—		—		—		—		174,963		2.65	%
State and political subdivisions	3,209		4.68	%	40,297		4.68	%	191,108		4.72	%	44,854		4.68	%
Total securities available for sale	$	3,209	4.68	%	$	844,200	5.37	%	$	290,086	5.00	%	$	1,588,090	5.06	%

Loan Portfolio

The following table summarizes our loan portfolio for the dates indicated (Dollars in thousands):

	September 30, 2002			December 31, 2001

Loans to individuals	$	73,986		$	164,443
Loans to mutual funds	46,721			50,359
Loans to others	18,391			17,411
	139,098			232,213
Less: allowance for loan losses	(100		)	(100		)

Net loans	$	138,998		$	232,113

Floating Rate	$	139,086		$	232,189
Fixed Rate	12			24

	$	139,098		$	232,213

We make loans to individually managed account customers and to mutual funds and other pooled product clients. Virtually all loans to individually managed account customers are written on a demand basis, bear variable interest rates tied to the prime rate or the Federal Funds rate and are fully secured by liquid collateral, primarily freely tradable securities held in custody by us for the borrower. Loans to mutual funds and other pooled product clients include unsecured lines of credit that may, in the event of default, be collateralized at our option by securities held in custody by us for those mutual funds. Loans to individually managed account customers, mutual funds and other pooled product clients also include advances that we make to certain clients pursuant to the terms of our custody agreements with those clients to facilitate securities transactions and redemptions.

At September 30, 2002, our only lending concentrations that exceeded 10% of total loan balances were the 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.

Our credit loss experience has been excellent. There have been no loan charge-offs in our history. It is our policy to place a loan on nonaccrual 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 September 30, 2002, there were no loans on nonaccrual status, no loans greater than 90 days past due, and no troubled debt restructurings. Although virtually all of our loans are fully collateralized with freely tradable securities, management recognizes some credit risk inherent in the loan portfolio, and has recorded an allowance for loan losses of $0.1 million at September 30, 2002. 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.

Market Risk

We engage in investment activities to accommodate clients’ cash management needs and contribute to overall corporate earnings. Interest-bearing liabilities are generated by our clients who, in the course of their financial asset management, maintain cash balances which they deposit on a short-term basis with us. We invest these cash balances and remit a portion of the earnings on these investments to our clients. In the conduct of these activities, we are subject to market risk. Market risk is the risk of an adverse financial impact from changes in market prices and interest rates. The level of risk we assume is a function of our overall strategic objectives and liquidity needs, client requirements and market volatility.

The active management of market risk is integral to our operations. The objective of interest rate sensitivity management is to provide sustainable net interest revenue under various economic conditions. We manage the structure of interest-earning assets and interest-bearing liabilities by adjusting their mix, yield, maturity and/or repricing characteristics, based on market conditions. Since client deposits and repurchase agreements, our primary sources of funds, are predominantly short term, we maintain a generally short-term structure for our interest-earning assets, including money-market assets and investments. We also use term borrowings and interest rate swap agreements to augment our management of interest rate exposure. The effect of the swap agreements is to lengthen short-term variable-rate liabilities into longer-term fixed-rate liabilities.

Our Board of Directors has set asset and liability management policies that define the overall framework for managing interest rate sensitivity, including accountabilities and controls over investment activities. These policies delineate investment limits and strategies that are appropriate, given our liquidity and regulatory requirements. For example, we have established a policy limit stating that projected net interest income over the next 12 months will not be reduced by more than 10% given a change in interest rates of up to 200 basis points (+ or -) over 12 months. Each quarter, our Board of Directors reviews our asset and liability positions, including simulations of the effect of various interest rate scenarios on our capital. Due to current interest rate levels, the Company’s Board of Directors has approved a temporary exception to the 10% limit for decreases in interest rates. The Board of Directors approved the policy exception because, with the Federal Funds target rate currently at 1.25%, a 200 basis point further reduction would move rates into a negative position and is therefore not likely to occur.

Our Board of Directors has delegated day-to-day responsibility for oversight of the Asset and Liability Management function to our Asset and Liability Committee (‘ALCO’). ALCO is a senior management committee consisting of the Chief Executive Officer, the President, the Chief Financial Officer and members of the Treasury function. ALCO meets twice monthly. Our primary tool in managing interest rate sensitivity is an income simulation model. Key assumptions in the simulation model include the timing of cash flows, maturities and repricing of financial instruments, changes in market conditions, capital planning and deposit sensitivity. The model assumes that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period will change periodically over the period being measured. The model also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. These assumptions are inherently uncertain, and as a result, the model cannot precisely predict the effect of changes in interest rates on our net interest income. Actual results may differ from simulated results due to the timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies.

The results of the income simulation model as of September 30, 2002 and 2001 indicated that an upward shift of interest rates by 200 basis points would result in a reduction in projected net interest income of 2.84% and 3.79%, respectively. A downward shift of 200 basis points would result in a decrease in projected net interest income of 13.97%

and 10.35% at September 30, 2002 and 2001, respectively. As discussed above, these exceptions to policy were approved by the Board of Directors.

We also use gap analysis as a secondary tool to manage our interest rate sensitivity. Gap analysis involves measurement of the difference in asset and liability repricing on a cumulative basis within a specified time frame. A positive gap indicates that more interest-earning assets than interest-bearing liabilities mature in a time frame, and a negative gap indicates the opposite. By seeking to minimize the amount of assets and liabilities that could reprice in the same time frame, we attempt to reduce the risk of significant adverse effects on net interest income caused by interest rate changes. As shown in the table below, at September 30, 2002, interest-bearing liabilities repriced faster than interest-earning assets in the short term, as has been typical for us. Generally speaking, falling interest rates would lead to net interest income that is higher than it would have been; rising rates would lead to lower net interest income. However, at the current absolute level of interest rates, lower interest rates may also lead to lower net income due to a diminished ability to lower interest-bearing liabilities, including certain client funds, as rates approach zero. Other important determinants of net interest income are rate levels, balance sheet growth and mix, and interest rate spreads.

The following table presents the repricing schedule of our interest-earning assets and interest-bearing liabilities at September 30, 2002 (Dollars in thousands):

	Within Three Months			Three to Six Months			Six to Twelve Months			One Year to Five Years			Over Five Years			Total

Interest-earning assets(1):
Investment securities (2)	$	3,104,654		$	500,866		$	640,482		$	1,539,582		$	352,588		$	6,138,172
Federal funds sold and securities purchased under repurchase agreements	120,000			—			—			—			—			120,000
Loans—variable rate	138,986			—			—			—			—			138,986
Loans—fixed rate	12			—			—			—			—			12
Total interest-earning assets	$	3,363,652		$	500,866		$	640,482		$	1,539,582		$	352,588		$	6,397,170
Interest-bearing liabilities:
Savings accounts	$	2,129,614		$	—		$	—		$	27,621		$	—		$	2,157,235
Interest rate contracts	(980,000		)	60,000			130,000			790,000			—			—
Short-term and other borrowings	3,070,904			—			—			400,000			—			3,470,904
Total interest-bearing liabilities	$	4,220,518		$	60,000		$	130,000		$	1,217,621		$	—		$	5,628,139
Net interest-sensitivity gap during the period	$	(856,866	)	$	440,866		$	510,482		$	321,961		$	352,588		$	769,031

Cumulative gap	$	(856,866	)	$	(416,000	)	$	94,482		$	416,443		$	769,031
Interest-sensitive assets as a percent of interest sensitive liabilities (cumulative)	79.70		%	90.28		%	102.14		%	107.40		%	113.66		%
Interest-sensitive assets as a percent of total assets (cumulative)	49.36		%	56.70		%	66.10		%	88.69		%	93.87		%

Net interest-sensitivity gap as a percent of total assets	(12.57		)%	6.47		%	7.49		%	4.72		%	5.17		%
Cumulative gap as a percent of total assets	(12.57		)%	(6.10		)%	1.39		%	6.11		%	11.28		%

(1) Adjustable rate assets are included in the period in which interest rates are next scheduled to adjust rather than in the period in which they are due. Fixed-rate loans are included in the period in which they are scheduled to be repaid.

(2) Mortgage-backed securities are included in the pricing category that corresponds with their effective maturity.

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 ours, these obligations arise from the withdrawals of deposits and the payment of operating expenses.

Our primary sources of liquidity include cash and cash equivalents, federal funds sold, new deposits, short-term borrowings, interest payments on securities held to maturity and available for sale, and fees collected from asset administration clients. As a result of our management of liquid assets and the ability to generate liquidity through liability funds, management believes that we maintain overall liquidity sufficient to meet our depositors’ needs, to satisfy our operating requirements and to fund the payment of an anticipated annual cash dividend of $0.05 per share for 2002 (approximately $3.2 million based upon 64,583,399 shares outstanding as of September 30, 2002).

Our ability to pay dividends on Common Stock may depend on the receipt of dividends from the Bank. Any dividend payments by the Bank are subject to certain restrictions imposed by the Massachusetts Commissioner of Banks. In addition, we may not pay dividends on our Common Stock if we are in default under certain agreements entered into in connection with the sale of our Capital Securities. The Capital Securities were issued by Investors Capital Trust I, a Delaware statutory business trust sponsored by us, and qualify as Tier I capital under the capital guidelines of the Federal Reserve.

We have informal borrowing arrangements with various counterparties. Each counterparty has agreed to make funds available to us at the Federal funds overnight rate. The aggregate amount of these borrowing arrangements as of September 30, 2002 was $1.4 billion. Each bank may terminate its arrangement at any time and is under no contractual obligation to provide us with requested funding. Our borrowings under these arrangements are typically on an overnight basis. We cannot be certain, however, that such funding will be available. Lack of availability of liquid funds could have a material adverse impact on our operations.

We also have Master Repurchase Agreements in place with various counterparties. Each broker has agreed to make funds available to us at various rates in exchange for collateral consisting of marketable securities. The aggregate amount of these borrowing arrangements at September 30, 2002 was $2.8 billion.

We also have a borrowing arrangement with the FHLBB. We may borrow amounts determined by prescribed collateral levels and the amount of FHLBB stock we hold. We are required to hold FHLBB stock equal to no less than (i) 1% of our outstanding residential mortgage loan principal (including mortgage pool securities), (ii) 0.3% of total assets, or (iii) total advances from the FHLBB, divided by a leverage factor of 20. The aggregate amount of borrowing available to us under this arrangement at September 30, 2002 was $2.4 billion. The amount outstanding under this arrangement at September 30, 2002 was $0.8 billion.

Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities, and financing activities. Net cash provided by operating activities was $73.2 million for the nine months ended September 30, 2002. Net cash used for investing activities for the nine months ended September 30, 2002 was $1.4 billion, consisting primarily of the excess of purchases of investment securities over proceeds from maturities of investment securities and increased Federal funds sold and securities purchased under resale agreements. Net cash provided by financing activities, consisting primarily of increased short-term and other borrowings, time deposits and savings deposits, was $1.4 billion for the nine months ended September 30, 2002.

Capital Resources

Historically, we have financed our operations principally through internally generated cash flows. We incur capital expenditures for furniture, fixtures, capitalized software and miscellaneous equipment needs. We lease microcomputers through operating leases. Capital expenditures have been incurred and leases entered into on an as-required basis, primarily to meet our growing operating needs. As a result, our capital expenditures were $38.7 million and $27.8 million for the nine months ended September 30, 2002 and 2001, respectively. For the nine months ended September 30, 2002, capital expenditures were comprised of approximately $25.2 million in capitalized software and projects in process, $11.0 million in fixed assets and $2.5 million in leasehold improvements. For the nine months ended September 30, 2001, capital expenditures were comprised of approximately $15.1 million in fixed assets, $8.4 million in capitalized software and projects in process and $4.3 million in leasehold improvements.

Stockholders’ equity at September 30, 2002 was $419.5 million, up 22% from December 31, 2001. The ratio of stockholders’ equity to assets decreased to 6.2% at September 30, 2002 from 6.5% at December 31, 2001.

The FRB 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. Some off-balance sheet items are added to the risk-weighted asset base by converting them to a balance sheet equivalent and assigning them the appropriate risk weight.

FRB 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 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 our Tier I and total capital ratios at September 30, 2002 (Dollars in thousands):

	Amount		Ratio

Tier I capital	$	353,069	15.08	%
Tier I capital minimum requirement	93,682		4.00	%

Excess Tier I capital	$	259,387	11.08	%

Total capital	$	353,169	15.08	%
Total capital minimum requirement	187,364		8.00	%

Excess total capital	$	165,805	7.08	%

Risk adjusted assets, net of intangible assets	$	2,342,056

The following table summarizes the Bank’s Tier I and total capital ratios at September 30, 2002 (Dollars in thousands):

	Amount		Ratio

Tier I capital	$	349,202	14.91	%
Tier I capital minimum requirement	93,669		4.00	%

Excess Tier I capital	$	255,533	10.91	%

Total capital	$	349,302	14.92	%
Total capital minimum requirement	187,339		8.00	%

Excess total capital	$	161,963	6.92	%

Risk adjusted assets, net of intangible assets	$	2,341,736

In addition to the risk-based capital guidelines, the FRB and the FDIC use a “Leverage Ratio” as an additional tool to evaluate capital adequacy. The Leverage Ratio is defined to be a company’s Tier I capital divided by its adjusted total average assets. The Leverage Ratio adopted by the federal banking agencies requires a ratio of 3.0% for top-rated banking institutions not experiencing a period of rapid growth. All other banking institutions will be expected to maintain a Leverage Ratio of 4.0% to 5.0%. The computation of the risk–based capital ratios and the Leverage Ratio requires that our capital and that of the Bank be reduced by most intangible assets. Our Leverage

Ratio at September 30, 2002 was 5.64%, which is in excess of regulatory requirements. The Bank’s Leverage Ratio at September 30, 2002 was 5.58%, which is in excess of regulatory requirements.

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 (Dollars in thousands):

	Nine Months Ended September 30, 2002							Nine Months Ended September 30, 2001
	Average Balance			Interest		Average Yield/Cost		Average Balance			Interest		Average Yield/Cost
Interest earning assets:
Federal funds sold and securities purchased under resale agreements	$	54,144		$	680	1.67	%	$	46,850		$	1,611	4.58	%
Investment securities (1)	5,411,656			181,394		4.47	%	4,062,126			184,774		6.06	%
Loans (2)	110,747			2,891		3.48	%	113,960			4,279		5.01	%
Total interest-earning assets	5,576,547			184,965		4.42	%	4,222,936			190,664		6.02	%
Allowance for loan losses	(100		)					(100		)
Noninterest-earning assets	346,204							251,413
Total assets	$	5,922,651						$	4,474,249

Interest bearing liabilities:
Deposits:
Demand	$	1,100		$	4	0.48	%	$	3,845		$	56	1.94	%
Savings	1,797,890			31,749		2.35	%	1,741,390			53,078		4.06	%
Time	1,862			24		1.72	%	319			13		5.43	%
Short-term borrowings	2,846,157			28,079		1.32	%	1,795,578			50,731		3.77	%
Other borrowings	398,901			19,126		6.39	%	248,913			9,344		5.01	%
Total interest-bearing liabilities	5,045,910			78,982		2.09	%	3,790,045			113,222		3.98	%
Noninterest-bearing liabilities Demand deposits	182,606							175,658
Savings	120,666							66,715
Noninterest-bearing time deposits	90,000							73,333
Other liabilities	75,971							49,104
Total liabilities	5,515,153							4,154,855
Trust preferred stock	24,280							24,256
Equity	383,218							295,138
Total liabilities and equity	$	5,922,651						$	4,474,249
Net interest income				$	105,983						$	77,442
Net interest margin (3)						2.53	%						2.45	%
Average interest rate spread (4)						2.33	%						2.04	%

Ratio of interest-earning assets to interest-bearing liabilities						110.52	%						111.42	%

(1) Average yield/cost on available for sale securities is based on amortized cost.

(2) Average yield on loans includes accrual loan balances.

(3) Net interest income divided by total interest-earning assets.

(4) Yield on interest-earning assets less rate paid on interest-bearing liabilities.

Item 3. Quantitative and Qualitative Disclosure about Market Risk

The information required by this item is contained in the “Market Risk” section in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as part of this Report.

Item 4. Controls and Procedures

(a) Evaluation of disclosure controls and procedures.

Within 90 days before filing this report, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Our disclosure controls and procedures are the controls and other procedures that we designed to ensure that we record, process, summarize and report in a timely manner the information we must disclose in reports that we file or submit to the SEC. Kevin J. Sheehan, our Chairman and Chief Executive Officer, and John N. Spinney, Jr., our Senior Vice President and Chief Financial Officer, reviewed and participated in this evaluation. Based on this evaluation, Messrs. Sheehan and Spinney concluded that, as of the date of the evaluation, our disclosure controls were effective.

(b) Internal controls.

Since the date of the evaluation described above, there have not been any significant changes in our internal accounting controls or in other factors that could significantly affect those controls.

PART II. OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits

99.1 Certification of Kevin J. Sheehan, Chief Executive Officer, and John N. Spinney, Jr., Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(b) Reports on Form 8-K

On July 11, 2002, August 14, 2002 and September 20, 2002, the Company filed current reports on Form 8-K providing information therein under Item 9 (Regulation FD Disclosure). The current report on Form 8-K filed July 11, 2002 contained the following financial statements: Consolidated Statement of Income for the Quarter Ended June 30, 2002; Consolidated Balance Sheet as of June 30, 2002; Average Balance Sheet as of June 30, 2002; and Asset Servicing Fees for the Quarter Ended June 30, 2002.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		INVESTORS FINANCIAL SERVICES CORP.

Date: November 14, 2002	By:	/s/ Kevin J. Sheehan
		Kevin J. Sheehan
		Chairman and Chief Executive Officer


	By:	/s/ John N. Spinney, Jr.
		John N. Spinney, Jr.
		Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

Certifications

I, Kevin J. Sheehan, Chairman and Chief Executive Officer, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Investors Financial Services Corp.;

2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

(a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

(b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

(c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

(a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 14, 2002
	/s/ Kevin J. Sheehan
	Kevin J. Sheehan
	Chairman and Chief Executive Officer

I, John N. Spinney, Jr., Senior Vice President and Chief Financial Officer, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Investors Financial Services Corp.;

(b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

(c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

Date: November 14, 2002
	/s/ John N. Spinney, Jr.
	John N. Spinney, Jr.
	Senior Vice President and Chief Financial Officer