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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1999
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
COMMISSION FILE NUMBER 0-26996
INVESTORS FINANCIAL
SERVICES CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 04-3279817
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
200 CLARENDON STREET
P.O. BOX 9130
BOSTON, MASSACHUSETTS 02116
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (617) 330-6700
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
SERIES A JUNIOR PREFERRED STOCK PURCHASE RIGHTS
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. / /
The aggregate market value of Common Stock held by non-affiliates of
the registrant was $592,271,332 based on the last reported sale price of $40.125
on The Nasdaq National Market on February 16, 2000 as reported by Nasdaq.
As of February 16, 2000, there were 14,760,656 shares of Common
Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant intends to file a definitive Proxy Statement pursuant
to Regulation 14A within 120 days of the end of the fiscal year ended December
31, 1999. Portions of such Proxy Statement are incorporated by reference in Part
III.
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ITEM 1. BUSINESS.
GENERAL DEVELOPMENT OF BUSINESS
Investors Financial Services Corp. (the `Company') is a bank holding
company, organized under the laws of the state of Delaware, that provides asset
administration services for the financial services industry. The Company was
organized in 1995 and conducts its business through its wholly-owned
subsidiaries, Investors Bank & Trust Company (Registered Trademark) and
Investors Capital Services, Inc. As used herein, the defined term `Company'
shall mean Investors Financial Services Corp. from and after June 29, 1995, the
date of organization of Investors Financial Services Corp., and shall mean
Investors Bank & Trust Company prior to that date, unless the context otherwise
indicates. Investors Bank & Trust Company is sometimes referred to herein as the
`Bank.'
The Company operated as a subsidiary of Eaton Vance Corp. (`Eaton
Vance'), an investment management firm conducting business through subsidiaries,
from the Bank's formation in 1969 through November 1995. In 1995, the Company
was spun off to the stockholders of Eaton Vance (the `Spin-Off Transaction').
The Spin-Off Transaction was completed in November 1995, immediately prior to
the Company's initial public offering.
The Company provides global custody, multicurrency accounting,
institutional transfer agency, performance measurement, cash management, foreign
exchange, securities lending, mutual fund administration, institutional trust
services and investment advisory services. The Company provides these services
to financial asset managers, such as mutual fund complexes, investment advisors,
banks and insurance companies. At December 31, 1999, the Company provided
financial asset administration services for net assets totaling approximately
$290 billion, including approximately $17 billion of foreign assets. The Company
also engages in private banking transactions, including secured lending and
deposit accounts. Services are provided from offices in Boston, New York,
Toronto, the Cayman Islands and Dublin.
OVERVIEW OF THE FINANCIAL SERVICES INDUSTRY
Asset managers manage and invest the financial assets entrusted to
them utilizing a broad range of pooled products, including mutual funds, unit
investment trusts, separate accounts and variable annuities. Asset
administration companies such as the Company perform various services for asset
managers and the pooled products they sponsor.
The Company believes the strong inflow of assets into pooled
products and other investment vehicles and the related asset administration of
those products provides an opportunity for revenue growth for asset
administration companies. As shown in the chart below, total U.S. financial
assets managed by mutual fund companies, insurance companies, private pension
funds and banks have grown at an average annual rate of over 16% since 1990.
Mutual funds, a primary market for the Company's services, make up a large part
of the financial assets in pooled investment vehicles. The U.S. mutual fund
market has grown at an average annual rate of more than 24% since 1990, with
over $5 trillion in assets at September 30, 1999.
TOTAL U.S. FINANCIAL ASSETS COMPOUND ANNUAL
(Dollars in billions) DECEMBER 31, 1990 SEPTEMBER 30, 1999 GROWTH RATE
Mutual Funds $ 1,154.6 $ 5,458.1 24.85%
Life Insurance Companies 1,367.4 2,921.0 11.45
Private Pension Funds 1,610.9 4,500.8 15.81
Bank Personal Trusts and Estates 522.1 976.5 9.36
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Total $ 4,655.0 $ 13,856.4 16.86
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SOURCE: FEDERAL RESERVE BANK
In addition to the growth in total U.S. financial assets managed,
there has been tremendous growth in the European and other offshore markets.
Total European fund assets have increased from approximately $1.9 trillion in
1997 to over $2.8 trillion in 1999, a compound annual growth rate of 23%.
The asset administration environment differs by asset management
organization and operational philosophy. The majority of asset managers
outsource custody services, using multiple custodians to foster cost reduction
through competition. Large asset managers may have the critical mass necessary
to justify the cost of in-house facilities to handle accounting, administration
and transfer agency services, while smaller asset managers outsource these
services as well. The Company believes that asset administration companies
operate most efficiently when bundling core services such as custody and
accounting with value-added services such as securities lending and foreign
exchange. The Company also
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believes that efficient integration of these various services is critical to
both quality of service and profitability for asset administration companies.
The Fund Accounting and Custody Tracking System (`FACTS'), the software system
developed and owned by the Company, supports these services with its integrated
functionality.
Providing asset administration services world-wide remains a focus
in the financial services industry as asset managers expand their reach in the
global marketplace to capitalize on cross-border and multi-national marketing
opportunities. The Company has offices located in Toronto, Canada, Dublin,
Ireland, and the Cayman Islands for servicing offshore funds. The Company's
offices in Toronto and Dublin were opened prior to 1995 and the Company opened
its administrative site in the Cayman Islands in 1996.
Information technology is a driving force in the financial services
industry. Asset managers are able to create innovative investment products using
data from world markets as a result of more powerful and affordable information
processing power, coupled with the ability to send large volumes of information
instantly through widely dispersed communication networks. Timely on-line access
to electronic information on security positions, prices and price shifts
facilitates on-line currency trading, indexation of assets, real time arbitrage,
and hedging through the use of derivative securities. Asset administration
providers use technology as a competitive tool to deliver precise and functional
information to the asset managers, and to increase value-added services such as
performance measurement. Examples of analytical tools used in performance
measurement include reports showing time-weighted return, performance by sector,
and time-weighted return by sector. The Company believes that the integrated
nature of FACTS, compared to the disparate systems used for different tasks by
many other financial service providers, provides the Company with a competitive
advantage and positions the Company to respond to the continuously changing
technological demands of the financial services industry.
In an effort to capture efficiencies of larger pools of assets,
asset managers create different investment structures. One example of this
innovation is the master-feeder structure. In the master-feeder structure, one
or more investment vehicles (the `feeder funds') with identical investment
objectives pool their assets in a common portfolio held by a separate investment
vehicle (the `master fund'). This structure permits each of the feeder funds to
be sold to a separate target market and through a different distribution channel
even if the feeder fund, on a stand-alone basis, would not be large enough to
support its operating costs. The feeder funds benefit from economies of scale
available to the larger pool of funds invested in the master fund.
In addition, a growing number of mutual funds have been structured
as multi-tiered or multi-class funds in order to address the differing
requirements and preferences of potential investors. In this environment,
investors have the option of purchasing fund shares with the sales load
structure that best meets their short-term and long-term investment strategy.
Multiple class arrangements allow an investment company to sell interests in a
single investment portfolio to separate classes of stockholders.
Another innovation in the mutual fund industry is the advent of
Exchange Traded Funds (`ETFs') as a more efficient alternative to fast-growing
index mutual funds. ETFs are single shares of stock that replicate an index and
are traded on a national securities exchange, usually the American Stock
Exchange. Unlike investing in a conventional index mutual fund, investing in an
ETF allows investors to buy and sell shares at intraday prices throughout the
trading day. The Company has entered into agreements to service a number of new
ETFs beginning in 2000.
COMPANY STRATEGY
The principal asset administration services provided by the Company
to its clients are custody and multicurrency accounting. Value-added services
utilized by clients based upon their individual needs include securities
lending, foreign exchange, cash management, transfer agency, and mutual fund
administration. These value added services help support clients in developing
and executing their strategies, enhancing their returns, and evaluating and
managing risk. The Company seeks to provide a broad range of services to all
clients, maximize the use of its value-added services and increase the size of
its client base.
The Company's core strategy is to deliver superior and innovative
client service. The Company believes service quality in asset administration
relationships is the key to maintaining and expanding existing business as well
as attracting new clients. To achieve this goal, the Company, unlike its
competitors, takes an integrated approach to servicing by dedicating a single
operations team to handle all work for a particular account or fund. In
addition, each client is assigned a Client Manager, independent of the
operations team, to anticipate the client's needs, to coordinate service
delivery, and to provide consulting support. The Company believes that its
strong client relationships create continuing opportunities to cross-sell
products and value-added services to broaden its customer relationships. Once a
mutual fund complex becomes a client, that complex is more likely to select the
Company to provide more services, service more funds, or both.
To deliver superior and innovative client service, the Company must
also maintain technological expertise. The asset administration industry
requires the technological capability to support a wide range of global security
types,
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currencies, and complex portfolio structures, as well as the telecommunications
flexibility to support the diversity of global communications standards.
Technological change creates opportunities for product differentiation and
reduced costs. From a technological standpoint, FACTS is an integrated
computerized information system that provides custody, securities movement and
control, portfolio accounting, multi-currency general ledger accounting,
pricing, net asset value calculation, and master-feeder processing into a single
information system. By consolidating these functions, the Company has eliminated
redundancy in data capture and reduced the opportunity for clerical error. The
FACTS architecture enables the Company to modify the system quickly, resulting
in increased processing quality, efficiency and an increased ability to
implement innovations in services provided to its clients. The Company believes
that this integrated architecture helps to differentiate the Company from its
competitors.
Technological enhancements and upgrades are an ongoing part of asset
administration, caused both by a need to remain competitive and to create
information delivery mechanisms that add value to the information available as
part of clearing and settling transactions. The Company has met and continues to
meet these needs through standardized data extracts and automated interfaces
developed over the past several years, which allow the Company's clients to
connect electronically with the Company's host computer and access data
collected from clearance and settlement transactions in multiple currencies on a
real-time basis. Through these information-sharing tools, the Company is better
equipped to expand its custody and accounting services with foreign exchange
services and asset and transaction reporting and monitoring services. This
electronic linkage also positions the Company to respond quickly to client
requests.
The Company intends to further utilize the internet as a means to
communicate with clients and external parties through the creation of
applications that provide data access via the internet. Through the
implementation of its strategic internet plan, the Company will position itself
to take advantage of internet technologies while providing secure value added
services to its clients over the internet. The Company will utilize a secure
extranet environment that will serve as a foundation to all internet access and
provide authentication, access controls, intrusion detection, encryption and
firewalls needed to assure the protection of client information assets.
Internet-based applications will provide the Company's clients with secure
access to their data over the internet as well as additional flexible ad-hoc
data query and reporting tools. The internet will also be used by the Company as
a means to promote efficient hands-free operations between external parties
wherever possible.
SERVICE OFFERINGS
The Company provides a broad range of asset administration services
to the financial services industry, including global custody, multicurrency
accounting, securities lending, foreign exchange, mutual fund administration,
institutional transfer agency, performance measurement, private banking and
investment advisory services. Global custody and multicurrency accounting are
the principal asset administration services provided to the Company's clients.
Fees charged for these services reflect the highly competitive nature and
price-sensitivity of the market for such services. Securities lending and
foreign exchange services provide a more favorable pricing environment for the
Company and increased activity by the Company in these areas would not involve a
proportionate increase in personnel or other resources. Mutual fund
administration and institutional transfer agency services provide additional
revenue-generating opportunities, but require a corresponding increase in
personnel and processing resources.
Fees charged vary from client to client based on the volume of
assets under custody, the number of securities held and portfolio transactions,
income collected, and whether other value-added services such as foreign
exchange, securities lending, and performance measurement are needed. Generally,
fees are billed to the client monthly in arrears and, upon their approval,
charged directly to their account.
The following is a description of the various services offered by
the Company.
GLOBAL CUSTODY. Global custody entails overseeing the safekeeping of
domestic and cross border securities for clients and settlement of portfolio
transactions. The Company's domestic net assets under custody have grown from
$22 billion at October 31, 1990 to $269 billion at December 31, 1999. Examples
of the safekeeping of cross-border securities for clients include the
safekeeping of Hong Kong stocks for a Dutch mutual fund or German bonds held for
a U.S. bank-sponsored mutual fund. At December 31, 1999, the Company's foreign
net assets under custody totaled approximately $17 billion.
Custody functions are fully integrated with security movement and
control, portfolio accounting, general ledger accounting, and pricing and
evaluation through FACTS. Custody functions include:
- Settlement of purchases and sales of securities.
- Safekeeping of securities and cash.
- Tracking and collection of income and receivables, such as
dividends and distributions.
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- Reconciliation of cash and security positions.
- Disbursement of expenses.
- Calculation and reporting of cash availability to asset
managers.
- Reporting and processing of corporate actions, such as stock
splits and bond calls.
- Initiation of settlement inquiries, including reclaims for
foreign tax withholding.
- Periodic reporting of holdings, transactions, income,
corporate actions and cash flow.
In order to service its clients world-wide, the Company established
a network of global subcustodians. The Company's subcustodian network spans 91
markets, serving the growing demands for its services around the world. Since
the Company does not have its own branches in these countries, it is able to
operate in the foreign custody arena with minimal fixed costs, while the
Company's clients benefit from the ability to use a single custodian, the
Company, for all of their international investment needs.
MULTICURRENCY ACCOUNTING. Multicurrency accounting entails the daily
recordkeeping for each account or investment vehicle, including calculations of
net asset value per share, dividend rates per share, and the maintenance of all
books, records and financial reports required by the Securities and Exchange
Commission and other regulatory agencies. Due to the growth in international
investments by asset managers, traditional fund accounting tasks must be
reconciled across multiple currencies. The primary approach of the Company is to
bundle the sale of fund accounting and custody services in order to work within
the natural efficiencies and control mechanisms of its integrated custody/fund
accounting system and operational philosophy. Multicurrency accounting functions
include:
- Maintenance of the books and records of a fund in accordance
with the Investment Company Act of 1940.
- Tracking of investment transactions for use in the calculation
of tax gains and losses.
- Calculation and accrual of expenses.
- Booking of purchases, redemptions and transfers of fund shares
as directed by the transfer agent.
- Calculation of gains and losses by security and currency.
- Determination of net income.
- Calculation of daily yields in accordance with Securities and
Exchange Commission formula requirements.
- Preparation of statements of assets and liabilities and
statements of operations.
- Computation of the market value of the account.
- Calculation of the daily Net Asset Value of the account and
reporting of this value to the National Association of
Securities Dealers for publication in newspapers.
In addition to providing the above services to domestic-based
accounts and investment vehicles, the Company also provides offshore fund
accounting. The Company views the offshore market as a significant business
opportunity and will continue to invest in expansion to support client demand.
MUTUAL FUND ADMINISTRATION. The Company provides mutual fund
administration services, including management reporting, regulatory reporting,
tax and accounting, and partnership administration. Management reporting
consists of information and reporting which is of primary interest to the fund's
asset managers and its board of trustees/directors and includes:
- Preparation of detailed quarterly financial information for
presentation to fund management and its board of
trustees/directors.
- Monitoring the reporting of net asset value, settlement of
trades, and processing of stockholder transactions.
- Monitoring compliance with investment portfolio restrictions.
- Calculation of fund dividends to be declared in accordance
with management guidelines.
- Preparation and monitoring of a fund's expense budget.
Regulatory reporting is the reporting and accumulation of
information required of the fund by the Securities and Exchange Commission and
state securities regulators and includes:
- Coordination of preparation and filing of Securities and
Exchange Commission reports.
- Maintenance of effective `blue sky' registrations in
jurisdictions selected for fund sales.
- Coordination of the preparation and printing of stockholder
reports.
- Preparation of prospectus update and proxy material.
- Coordination of on-going `blue sky' compliance.
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Tax and accounting is required either by the fund's auditors or by
Internal Revenue Service rules and regulations and includes:
- Performing portfolio compliance testing to establish
qualification as a regulated investment company.
- Preparation of income and excise tax returns.
- Preparation of audit package for use by independent public
accountants.
- Coordination of review of income, capital gains, and
distribution information.
In addition to on-going services, the Company also provides mutual
fund start-up consulting services, which typically include assistance with
product definition, service provider selection, and fund structuring and
registration. The Company has worked with a number of investment advisors to
assist them in the development of new mutual funds and other pooled investment
vehicles.
FOREIGN EXCHANGE. The Company provides foreign exchange services to
facilitate settlement of international securities transactions for U.S. dollar
denominated mutual funds and other accounts and to convert income payments
denominated in a non-U.S. currency to U.S. dollars. By using the Company rather
than a third party foreign exchange bank to perform these functions, clients
reduce the amount of time spent coordinating currency delivery and monitoring
delivery failures and claims. The Company engages in limited foreign exchange
trading transactions for its own account.
SECURITIES LENDING. Securities lending involves the lending of
clients' securities to brokers and other institutions for a fee, which improves
a client's return on the underlying securities. The Company acts as agent for
its clients for both international and domestic securities lending services. The
Company retains as compensation a portion of the lending fee due to the client
as owner of the borrowed asset.
Through a network of broker/dealers, the Company places the
securities out on loan pursuant to client instruction, delivers the subject
securities and performs the necessary loan accounting. Accounting entails
monitoring each security out on loan by broker, allocating the loans to each
fund, tracking the fixed or variable rebate due the broker, updating the daily
investments, applying the earnings to each security loan and preparing daily and
monthly earnings statements for each fund and all the brokers.
All loans are fully collateralized with cash, government securities
or a letter of credit. This collateral is reinvested according to each client's
instructions. The Company monitors all outstanding loans on a daily basis by
reviewing exposure by broker, performing asset reconciliations, and marking each
security to market to ensure that proper collateral levels are maintained.
INSTITUTIONAL TRANSFER AGENCY. Transfer agency encompasses mutual
fund shareholder recordkeeping and communications. Services include tracking
capital shares, fulfilling purchase, transfer, and redemption requests, and
sending account statements, tax reporting information and distributions to
shareholders. These services are generally provided only to institutional
clients with smaller numbers of outstanding shareholders or omnibus positions of
retail shareholders.
PERFORMANCE MEASUREMENT. Performance measurement services involve
the creation of systems and databases that enable asset managers to construct,
manage, and analyze their portfolios. Services include portfolio profile
analysis, portfolio return analysis, and customized benchmark construction.
Performance measurement uses data already captured by FACTS to calculate
statistics and report them to asset managers.
INSTITUTIONAL CUSTODY SERVICES. The Company offers institutional
custody services to individuals, family groups, trusts, endowments and
foundations, and retirement plans. The Company develops this client base by
forming relationships with investment advisors and working with the advisors to
service mutual clients. The Company provided institutional custody services to
approximately 12,000 accounts at December 31, 1999.
While competitors tend to focus on the large institutional
opportunities, the Company targets the small to mid-size institutional custody
market. Custody services provided to these clients include the safekeeping of
securities and the settlement of securities transactions. Custody service fees
are determined based on assets under custody and the number of transactions in
each account.
Acting as a fiduciary for certain of these accounts, the Company
provides trust administration and estate settlement services. These services
include on-going fiduciary review of the trust instrument, collection and
safekeeping of assets, distribution of income, appropriate reporting for court
and tax purposes, preparation of tax returns, and distribution of assets as
required. The Company does not provide investment advice, but works closely with
third-party investment advisors chosen by each client to carry out the
investment of assets. The acquisition in 1998 of BankBoston's domestic
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institutional trust and custody business expanded the Company's presence in the
institutional custody marketplace and added greater depth and diversity to the
Company's client base.
BANKING SERVICES. The Company offers credit lines to its clients for
the purpose of leveraging portfolios and covering overnight cash shortfalls.
Additionally, the Company's clients, which consist mainly of managers of mutual
funds, unit investment trusts and other pooled asset products, typically
generate large cash balances from securities sales and other transactions which
they wish to invest on a short-term basis. The Company does not conduct
consumer-banking operations.
At December 31, 1999, the Company had gross loans outstanding to
individuals, non-profit institutions and mutual funds of approximately $109
million, which represented approximately 4% of the Company's total assets. The
interest rates charged on the Bank's loans are indexed to either the prime rate
or the rate paid on 90-day Treasury bills. The Company has never had a loan
loss, and has no delinquent loans. Other than a loan made to a non-profit
association for purposes of the Community Reinvestment Act, all loans are
secured, or may be secured, by marketable securities and are due on demand.
INVESTMENT ADVISORY. The Bank acts as investment adviser to the
Merrimac Master Portfolio (the `Portfolio'), an open-end management investment
company registered under the Investment Company Act of 1940. The Portfolio
currently consists of a series of four master funds in a master-feeder
structure. The Merrimac Cash Portfolio and the Merrimac U.S. Government
Portfolio are sub-advised by Allmerica Asset Management, Inc. The Merrimac
Treasury Portfolio and the Merrimac Treasury Plus Portfolio are sub-advised by
M&I Investment Management Corp. At December 31, 1999, the total net assets of
the Portfolio approximated $1.7 billion.
The Portfolio funds serve as investment vehicles for five domestic
and one offshore feeder funds which have been created by the Bank and whose
shares are sold to institutional investors. The Bank or its affiliates also have
entered into agreements to provide custody, fund accounting, administration and
transfer agency to the Portfolio and the feeder funds. Additional master funds
or feeder funds may be added in the future.
SALES, MARKETING AND CLIENT SUPPORT
The Company employs a direct sales staff that targets potential
market areas, including investment management companies, insurance companies,
banks and investment advisors. Sales personnel are primarily based at the
Company's headquarters in Boston, and are given geographic area sales
responsibility. The Company also has one sales person located in Dublin who is
responsible for international markets. Included in the sales staff are
individuals who are dedicated to marketing services to institutional accounts.
Senior managers from all functional areas are directly involved in obtaining new
clients, frequently working as a team with a sales professional.
In order to service existing clients, a client management staff
based in the Company's Boston office and an individual located in Dublin,
provide client support. Each client is assigned a Client Manager responsible for
the overall satisfaction of the client. The Client Manager is usually a senior
professional with extensive industry experience and works with the client on
contracts, new products and specific systems requirements, providing consulting
support, anticipating the client's needs and coordinating service delivery.
SIGNIFICANT CLIENTS
The Company presently provides services to approximately 78 mutual
fund complexes and insurance companies. The Company's largest current client,
Eaton Vance, accounted for 10%, 9% and 7% of the Company's net operating
revenues for the years ended December 31, 1997, 1998 and 1999 respectively. No
other single client of the Company represented more than 10% of net operating
revenues during this three-year period.
SOFTWARE SYSTEMS AND DATA CENTER
The Company's asset administration operations are supported by
sophisticated computer technology. The Company receives vast amounts of
information across a worldwide computer network. That information, which covers
a wide range of global security types and complex portfolio structures in
various currencies, must then be processed, resulting in system-wide updating
and reporting. The Company must have the capability to provide not only daily
and periodic reports of asset accounting and performance, but also to provide
measurement and analytical data to asset managers on-line on a real time basis.
FACTS is a multi-tiered system that utilizes microcomputers linked
to mainframe processing by means of local and wide area networks. This
configuration combines the best features of each platform by utilizing the power
and capacity of the mainframe, the data distribution capabilities of the network
and the independence of microcomputers. The fully
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functional microcomputer component of FACTS works independently of the mainframe
throughout the processing cycle, minimizing the amount of system-wide delay
inherent in data processing. The FACTS configuration also allows for full
distributed processing capabilities within multiple geographic locations in an
effective and efficient manner.
The integrated nature of the FACTS architecture allows the Company
to effect modifications and enhancements quickly, resulting in increased
processing quality and efficiency for the Company's clients and an increased
ability to implement innovation in services provided to the Company's clients.
This integrated architecture helps differentiate the Company from its
competitors. System enhancements are an ongoing part of asset administration,
both to keep ahead of the competition by providing innovative processing
solutions and to create information delivery mechanisms that add value to the
custody and fund accounting information. The Company has developed a
comprehensive suite of standardized data extracts and reports and created
automated interfaces that allow its clients to access the full range of custody
and fund accounting data on a real-time basis.
The Company's mainframe processing services component is provided by
Electronic Data Systems (`EDS') located in Plano, Texas. By outsourcing
mainframe processing, the Company can focus its resources on systems development
and minimize its capital investment in large-scale computer equipment. EDS is
able to offer the Company up-to-date computer products and services to which the
Company would not otherwise have access, while removing the risk of product
obsolescence. Due to its diverse customer base, EDS can invest in the latest
computer technology and spread the related costs over multiple users. In
addition, the defined pricing charged by EDS for its products and services
provides the Company with the financial certainty needed to be able to dedicate
its efforts to the ongoing enhancement of its software systems while receiving
the benefit of the continuing investment by EDS in its computer hardware.
The current agreement between the Company and EDS obligates EDS to
provide the Company with comprehensive data processing services and obligates
the Company to utilize EDS's services for substantially all of the Company's
data processing requirements. The Company is billed monthly for these services
on an as-used basis in accordance with a predetermined pricing schedule for
specific products and services. EDS began providing services to the Company in
December 1990 and the Company's current agreement with EDS is scheduled to
expire on December 31, 2005.
In addition, EDS provides mainframe disaster recovery services. EDS
maintains additional processing equipment at the Plano information processing
center (`IPC') and at a designated alternate IPC which may be used in the event
of equipment failure. The Plano facility is also supported by an uninterruptable
power supply and diesel generators which can supply power to continue operations
for an extended period of time. EDS ensures critical software and data files are
backed-up daily and stored off-site. Disaster recovery plans are tested through
simulations conducted by the Company annually. Notwithstanding these
precautions, there can be no assurance that a fire or other natural disaster
affecting the data center would not disable the host computer system.
The Company maintains a comprehensive disaster recovery plan. The
plan identifies teams to manage disaster situations and re-establish a
functioning operational environment and provides for the relocation of
employees, forms and supplies, report distribution and the coordination of all
activities between users and data processing functions. The plan also identifies
the core business processes for each functional area within the Company and the
associated contingency plans for each area.
The Company has entered into an agreement with Comdisco, a leader in
the business recovery field. Comdisco provides continuity services to ensure
minimal disruption to critical business operations. Comdisco's client/server
facilities are fully equipped to recreate the Company's processing and
information flows. Comdisco will provide the Company with an off-site facility
equipped with hardware, networking and communication functions, in the event of
a disaster, containing sufficient office space, equipment and data required to
restore the Company's core business in as little as four to six hours. The
Company has access to Comdisco's recovery sites in MA., New Jersey, and New York
as well as 25 additional recovery locations throughout North America. The
Company's use of Comdisco's off-site facility is shared with other companies and
is subject to a `first-come, first-served' policy in the event of a disaster
declaration.
With the securities industry moving to a Trade Date +1 (`T+1')
settlement cycle, the Company has begun making systems infrastructure and
functional modifications required to provide straight through processing
capabilities in a T+1 environment. A comprehensive development and
implementation plan is in place to assure that all industry imposed deadlines
are met and that the transition to the T+1 environment is accomplished without
adversely affecting the operations of the Company or the services provided to
its clients.
The securities industry's initiative that will change market quotes
for securities to a decimal format will have virtually no impact on the systems
processing of the Company. The Company has reviewed its core systems and their
internal and external interfaces and has verified that security quotations are
currently maintained in decimal format throughout and that processing will not
be affected by this industry change.
8
COMPETITION
The Company operates in a highly competitive environment in all
areas of its business. Many of the Company's competitors possess substantially
greater financial, sales and marketing resources than the Company and process a
greater amount of financial assets than the Company. Moreover, under the
Gramm-Leach-Bliley Act of 1999 (the "Gramm-Leach-Bliley Act"), effective March
11, 2000, securities firms, insurance companies and other financial services
providers that elect to become financial holding companies may acquire banks and
other financial institutions. The Gramm-Leach-Bliley Act may significantly
change the competitive environment in which the Company conduct business. See
"Regulation and Supervision" below. In addition to facing competition from other
deposit-taking institutions, the Company also faces competition from large
in-house accounting departments of mutual fund complexes, insurance companies
and banks offering proprietary mutual funds. Competitive factors include
technological advancement and flexibility, breadth of services provided and
quality of service. The Company believes that it competes favorably in these
categories.
Competition in the asset administration industry has reduced pricing
in almost all business segments, particularly with respect to custody services
and trustee services. Partially offsetting this trend is the development of new
services that have higher margins. The Company's continuous investment in
technology has permitted it to offer value-added services to clients, such as
offshore custody and fund accounting, securities lending and foreign exchange,
at competitive prices on a global basis. Technological evolution and service
innovation enable the Company to generate additional revenues to offset price
pressure in maturing service lines.
The Company believes that its size and responsiveness to client
needs provide the financial services industry with an asset administration
alternative to superregional and money center banks and other administration
providers. While consolidation within the industry may adversely affect the
Company's ability to retain clients that have been acquired, consolidation also
creates opportunity for the Company as prospective clients review their
relationships with existing service providers. In addition, consolidation among
large financial institutions may enable the Company to acquire, at a reasonable
price, asset administration businesses that do not fit within the core focus of
these new, consolidated financial institutions.
INTELLECTUAL PROPERTY
The Company's success is dependent upon its software development
methodology and other intellectual property rights developed and owned by the
Company, including FACTS. The Company relies on a combination of trade secret,
nondisclosure and other contractual arrangements and technical measures, and
copyright and trademark laws to protect its proprietary rights. The Company
generally enters into confidentiality agreements with its employees and
consultants, and limits access to and distribution of its proprietary
information. There can be no assurance that the steps taken by the Company in
this regard will be adequate to deter misappropriation of its proprietary
information or that the Company will be able to detect unauthorized use and take
appropriate steps to enforce its intellectual property rights. Furthermore, such
protections may not preclude competitors from developing products and services
with functionality or features similar to those of the Company. In addition,
effective copyright, trademark and other trade protection may not be available
in certain international markets serviced by the Company. The registration of
the service mark Investors Bank & Trust Company will remain in force until 2006,
at which time it may be renewed.
Although the Company believes that its services do not infringe on
the intellectual property rights of others, there can be no assurance that such
a claim will not be asserted against the Company in the future.
EMPLOYEES
At December 31, 1999, the Company had 1,507 employees. The Company
maintains a five-week professional development program for entry level staff.
Successful completion of the program is required of most newly hired employees.
Topics covered during the program include an overview of the financial services
industry and regulatory environment, principles of investment company
accounting, instruction in operating and control procedures, manual performance
of fund accounting tasks and intensive training on FACTS. This training program
is supplemented by ongoing education on the industry and client base.
9
REGULATION AND SUPERVISION
In addition to the generally applicable state and federal laws
governing businesses and employers, the Company and the Bank are further
regulated by federal and state laws and regulations applicable to financial
institutions and their parent companies. Virtually all aspects of the Company's
and the Bank's operations are subject to specific requirements or restrictions
and general regulatory oversight. State and federal banking laws have as their
principal objective either the maintenance of the safety and soundness of
financial institutions and the federal deposit insurance system or the
protection of consumers or classes of consumers, rather than the specific
protection of stockholders of a bank or its parent company. To the extent the
following material describes statutory or regulatory provisions, it is qualified
in its entirety by reference to the particular statute or regulation.
THE COMPANY
GENERAL. The Company, as a bank holding company, is subject to
regulation and supervision by the Federal Reserve Board (the `FRB') and by the
Massachusetts Commissioner of Banks (the `Commissioner'). The Company is
required to file annually a report of its operations with, and is subject to
examination by, the FRB and the Commissioner. The FRB has the authority to issue
orders to bank holding companies to cease and desist from unsound banking
practices and violations of conditions imposed by, or violations of agreements
with, the FRB. The FRB is also empowered to assess civil monetary penalties
against companies or individuals who violate the Bank Holding Company Act of
1956, as amended, (the `BHCA') or orders or regulations thereunder, to order
termination of non-banking activities of non-banking subsidiaries of bank
holding companies, and to order termination of ownership and control of a
non-banking subsidiary by a bank holding company.
BHCA - ACTIVITIES AND OTHER LIMITATIONS. The BHCA prohibits a bank
holding company from acquiring substantially all the assets of a bank or
acquiring direct or indirect ownership or control of more than 5% of the voting
shares of any bank, or increasing such ownership or control of any bank, or
merging or consolidating with any bank holding company without prior approval of
the FRB. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
(the `Interstate Act') generally authorizes bank holding companies to acquire
banks located in any state, possibly subject to certain state-imposed age and
deposit concentration limits, and also generally authorizes interstate mergers
and to a lesser extent, interstate branching.
Provided that a bank holding company does not become a "financial
holding company" under the recently enacted Gramm-Leach-Bliley Act (as discussed
below), the BHCA also prohibits a bank holding company from acquiring a direct
or indirect interest in or control of more than 5% of the voting shares of any
company which is not a bank or bank holding company and from engaging directly
or indirectly in activities other than those of banking, managing or controlling
banks or furnishing services to its subsidiary banks, except that it may engage
in and may own shares of companies engaged in certain activities the FRB has
determined to be so closely related to banking or managing and controlling banks
as to be a proper incident thereto. In making such determinations, the FRB is
required to weigh the expected benefit to the public, such as greater
convenience, increased competition or gains in efficiency, against the possible
adverse effects, such as undue concentration of resources, decreased or unfair
competition, conflicts of interests or unsound banking practices.
As to the Gramm-Leach-Bliley Act, the legislation, which became law
on November 12, 1999, repeals provisions of the Glass-Steagall Act: Section 20,
which restricted the affiliation of banks with firms "engaged principally" in
specified securities activities; and Section 32, which restricts officer,
director, or employee interlocks between a bank and any company or person
"primarily engaged" in specified securities activities. Moreover, the general
effect of the law is to establish a comprehensive framework to permit
affiliations among commercial banks, insurance companies, securities firms, and
other financial service providers by revising and expanding the BHCA framework
to permit a holding company system, such as the Company, to engage in a full
range of financial activities through a new entity known as a financial holding
company. "Financial activities" is broadly defined to include not only banking,
insurance, and securities activities, but also merchant banking and additional
activities that the FRB, in consultation with the Secretary of the Treasury,
determines to be financial in nature, incidental to such financial activities,
or complementary activities that do not pose a substantial risk to the safety
and soundness of depository institutions or the financial system generally. In
sum, the Gramm-Leach-Bliley Act is intended to permit bank holding companies
that qualify and elect to be treated as a financial holding company to engage in
a significantly broader range of financial activities than the companies
described above that are not so treated.
10
Generally, although significant implementing regulations have yet to
be published, the Gramm-Leach-Bliley Act:
- repeals historical restrictions on, and eliminates many
federal and state law barriers to, affiliations among banks,
securities firms, insurance companies, and other financial
service providers;
- provides a uniform framework for the functional regulation of
the activities of banks, savings institutions, and their
holding companies;
- broadens the activities that may be conducted by national
banks (and derivatively state banks), banking subsidiaries of
bank holding companies, and their financial subsidiaries;
- provides an enhanced framework for protecting the privacy of
consumer information;
- adopts a number of provisions related to the capitalization,
membership, corporate governance, and other measures designed
to modernize the Federal Home Loan Bank system;
- modifies the laws governing the implementation of the
Community Reinvestment Act of 1977; and
- addresses a variety of other legal and regulatory issues
affecting both day-to-day operations and long-term activities
of financial institutions.
In order to elect to become a financial holding company and engage
in the new activities, a bank holding company, such as the Company, must meet
certain tests and file an election form with the FRB which generally is acted on
within thirty days. To qualify, all of a bank holding company's subsidiary banks
must be well-capitalized (as discussed below under "The Bank") and well-managed,
as measured by regulatory guidelines. In addition, to engage in the new
activities each of the bank holding company's banks must have been rated
"satisfactory" or better in its most recent federal Community Reinvestment Act
evaluation. Furthermore, a bank holding company that elects to be treated as a
financial holding company may face significant consequences if its banks fail to
maintain the required capital and management ratings, including entering into an
agreement with the FRB which imposes limitations on its operations and may even
require divestitures. Such possible ramifications may limit the ability of a
bank subsidiary to significantly expand or acquire less than well-capitalized
and well-managed institutions. At this time, the Company has not determined
whether it will become a financial holding company.
CAPITAL REQUIREMENTS. The FRB has adopted capital adequacy
guidelines pursuant to which it assesses the adequacy of capital in examining
and supervising a bank holding company and in analyzing applications to it under
the BHCA. These capital adequacy guidelines generally require bank holding
companies to maintain total capital equal to 8% of total risk-adjusted assets
and off-balance sheet items (the `Total Risk-Based Capital Ratio'), with at
least one-half of that amount consisting of Tier I or core capital and the
remaining amount consisting of Tier II or supplementary capital. Tier I capital
for bank holding companies generally consists of the sum of common stockholders'
equity and perpetual preferred stock (subject in the case of the latter to
limitations on the kind and amount of such stocks which may be included as Tier
I capital), less goodwill. Tier II capital generally consists of hybrid capital
instruments; perpetual preferred stock, which is not eligible to be included as
Tier I capital; term subordinated debt and intermediate-term preferred stock;
and, subject to limitations, general allowances for loan losses. Assets are
adjusted under the risk-based guidelines to take into account different risk
characteristics.
In addition to the risk-based capital requirements, the FRB requires
bank holding companies to maintain a minimum leverage capital ratio of Tier I
capital (defined by reference to the risk-based capital guidelines) to total
assets (the `Leverage Ratio') of 3.0%. Total assets for this purpose does not
include goodwill and any other intangible assets and investments that the FRB
determines should be deducted from Tier I capital. The FRB has announced that
the 3.0% Leverage Ratio requirement is the minimum for the top-rated bank
holding companies without any supervisory, financial or operational weaknesses
or deficiencies or those, which are not experiencing or anticipating significant
growth. Because the Bank, and consequently, the Company, anticipates significant
future growth, the Company will be required to maintain Leverage Ratios of at
least 4.0% to 5.0% or more.
The Company currently is in compliance with both the Risk Based
Capital Ratio and the Leverage Ratio requirements. At December 31, 1999, the
Company had a Tier I Risk Based Capital Ratio and a Total Risk Based Capital
Ratio equal to 14.96% and 14.97%, respectively and a Leverage Ratio equal to
5.46%. International bank supervisory organizations, principally the Basel
Committee on Banking Supervision, currently are considering changes to the
risk-based capital adequacy framework which ultimately could affect the FRB's
guidelines.
11
LIMITATIONS ON ACQUISITIONS OF COMMON STOCK. The Federal Change in
Bank Control Act prohibits a person or group of persons from acquiring `control'
of a bank holding company unless the FRB has been given at least 60 days to
review the proposal. Under a rebuttable presumption established by the FRB, the
acquisition of 10% or more of a class of voting stock of a bank holding company,
such as the Company, with a class of securities registered under Section 12 of
the Securities Exchange Act of 1934, as amended (the `Exchange Act') would,
under the circumstances set forth in the presumption, constitute the acquisition
of control.
In addition, any company, as that term is broadly defined in the
statute, would be required to obtain the approval of the FRB under the BHCA
before acquiring 25% (5% in the case of an acquirer that is a bank holding
company) or more, or such lesser percentage as the FRB deems to constitute
control over the Company, of the outstanding Common Stock of the Company.
MASSACHUSETTS LAW. Massachusetts law generally defines a bank
holding company as a company which owns or controls two or more banks. Although
the Company owns or controls only one bank, it is deemed a bank holding company
for purposes of Massachusetts law due to the manner in which it acquired the
Bank. Accordingly, the Company has registered with the Commissioner and is
obligated to make reports to the Commissioner. Further, as a Massachusetts bank
holding company, the Company may not acquire all or substantially all of the
stock or assets of a banking institution or merge or consolidate with another
bank holding company without the prior consent of the Massachusetts Board of
Bank Incorporation (the `BBI'). As a condition of such consent, the BBI must
receive notice from the Massachusetts Housing Partnership Fund (the `Fund') that
arrangements satisfactory to the Fund have been made by the Company to make 0.9%
of its assets available for financing, down payment assistance, share loans,
closing costs and other costs related to programs promoted by the Fund,
including those related to creating affordable rental housing, limited equity
cooperatives, and tenant management programs. As a general matter, however, the
Commissioner does not rule upon or regulate the activities in which bank holding
companies or their nonbank subsidiaries engage.
THE BANK
GENERAL. The Bank is subject to extensive regulation and examination
by the Commissioner and by the FDIC, which insures its deposits to the maximum
extent permitted by law, and to certain requirements established by the FRB. The
federal and state laws and regulations which are applicable to banks regulate
among other things, the scope of their business, their investments, their
reserves against deposits, the timing of the availability of deposited funds and
the nature and amount of and collateral for certain loans.
FDIC INSURANCE PREMIUMS. The Bank pays deposit insurance premiums to
the FDIC based on an assessment rate established by the FDIC for Bank Insurance
Fund-member institutions. The FDIC has established a risk-based assessment
system under which institutions are classified, and generally pay premiums
according to their perceived risk to the federal deposit insurance funds. In
addition, starting in the Year 2000 banks will have to pay the same assessments
for FICO bonds issued in connection with the thrift bailout in the late 1980s
and early 1990s, as Savings Association Insurance Fund-insured banks must pay.
CAPITAL REQUIREMENTS. The FDIC has promulgated regulations and
adopted a statement of policy regarding the capital adequacy of state-chartered
banks, which, like the Bank, are not members of the Federal Reserve System.
These requirements are substantially similar to those adopted by the FRB
regarding bank holding companies, as described above.
Moreover, the federal banking agencies have promulgated
substantially similar regulations to implement the system of prompt corrective
action established by Section 38 of the FDIA. Under the regulations, a bank
generally shall be deemed to be (i) `well capitalized' if it has Total Risk
Based Capital Ratio of 10.0% or more, has a Tier I Risk Based Capital Ratio of
6.0% or more, has a Leverage Ratio of 5.0% or more and is not subject to any
written capital order or directive; (ii) `adequately capitalized' if it has a
total Risk Based Capital Ratio of 8.0% or more, a Tier I Risk Based Capital
Ratio of 4.0% or more, and a Leverage Ratio of 4.0% or more (3.0% under certain
circumstances) and does not meet the definition of `well capitalized,' (iii)
`undercapitalized' if it has a Total Risk Based Capital Ratio that is less than
8.0%, a Tier I Risk Based Capital Ratio that is less than 4.0% or a Leverage
Ratio that is less than 4.0% (3.0% under certain circumstances), (iv)
`significantly undercapitalized' if it has a Total Risk Based Capital Ratio that
is less than 6.0%, a Tier I Risk Based Capital Ratio that is less than 3.0% or a
Leverage Ratio that is less than 3.0%, and (v) `critically undercapitalized' if
it has a ratio of tangible equity to total assets that is equal to or less than
2.0%.
An institution generally must file a written capital restoration
plan which meets specified requirements with an appropriate federal banking
agency within 45 days of the date that the institution receives notice or is
deemed to have notice that it is undercapitalized, significantly
undercapitalized or critically undercapitalized. A federal banking agency must
provide the institution with written notice of approval or disapproval with 60
days after receiving a capital restoration plan, subject to extensions by the
agency. An institution, which is required to submit a capital restoration plan,
must concurrently submit a performance guaranty by each company that controls
the institution.
12
A critically undercapitalized institution is to be placed in
conservatorship or receivership within 90 days unless the FDIC formally
determines that forbearance from such action would better protect the deposit
insurance fund. Unless the FDIC or other appropriate federal banking regulatory
agency makes specific further findings and certifies that the institution is
viable and is not expected to fail, an institution that remains critically
undercapitalized on average during the fourth calendar quarter after the date it
becomes critically undercapitalized must be placed in receivership.
Immediately upon becoming undercapitalized, an institution becomes
subject to the provisions of Section 38 of the FDIA (i) restricting payment of
capital distributions and management fees, (ii) requiring that the appropriate
federal banking agency monitor the condition of the institution and its efforts
to restore its capital, (iii) requiring submission of a capital restoration
plan, (iv) restricting the growth of the institution's assets and (v) requiring
prior approval of certain expansion proposals. The appropriate federal banking
agency for an undercapitalized institution also may take any of a number of
discretionary supervisory actions if the agency determines that any of these
actions is necessary to resolve the problems of the institution at the least
possible long-term cost to the deposit insurance fund, subject in certain cases
to specified procedures.
At December 31, 1999, the Bank was deemed to be a well capitalized
institution for the above purposes. Bank regulators may raise capital
requirements applicable to banking organizations beyond current levels. Because
the Company is unable to predict whether higher capital requirements will be
imposed and, if so, at what levels and on what schedules, it therefore cannot
predict what effect such higher requirements may have on the Company and the
Bank. As is discussed above, being a well-capitalized institution is one
requirement for the Company to be treated as a financial holding company, if it
elects to be so treated.
BROKERED DEPOSITS. The FDIA restricts the use of brokered deposits
by certain depository institutions. Under the FDIA and applicable regulations,
(i) a well capitalized institution may solicit and accept, renew or roll over
any brokered deposit without restriction, (ii) an adequately capitalized
institution may not (x) accept, renew or roll over any brokered deposit unless
it has applied for and been granted a waiver of this prohibition by the FDIC or
(y) solicit deposits by offering an effective yield that exceeds by more than 75
basis points the prevailing effective yields on insured deposits of comparable
maturity in such institution's normal market area or in the market area in which
such deposits are being solicited and (iii) an undercapitalized institution may
not (x) accept, renew or roll over any brokered deposits or (y) solicit deposits
by offering an effective yield that exceeds by more than 75 basis points the
prevailing effective yields on insured deposits of comparable maturity in such
institution's normal market area or in the market area in which such deposits
are being solicited. Currently, the Bank is deemed to be an well capitalized
insured depository institution for purposes of the restriction on the use of
brokered deposits by such institutions. The bank historically has not relied
upon brokered deposits as a source of funding and, at December 31, 1999, the
Bank did not have any brokered deposits.
TRANSACTIONS WITH AFFILIATES. The FDIA restricts the range of
permissible transactions between a bank and an affiliated company. The Bank is
subject to certain restrictions on loans to the Company, on investment in the
stock or securities thereof, on the taking of such stock or securities as
collateral for loans to any borrower, and on the issuance of a guarantee or
letter of credit on behalf of the Company. The Bank also is subject to certain
restrictions on most types of transactions with the Company, requiring that the
terms of such transactions be substantially equivalent to terms to similar
transactions with non-affiliates.
ACTIVITIES AND INVESTMENTS OF INSURED STATE-CHARTERED BANKS. Section
24 of the FDIA generally limits the activities as principal and equity
investments of FDIC-insured, state-chartered banks to those that are permissible
for national banks. Effective January, 1999 the FDIC substantially revised its
regulations implementing Section 24 to ease the ability of state banks to engage
in certain activities not permissible for national banks, and to expedite FDIC
review of bank applications and notices to engage in such activities.
Further, the Gramm-Leach-Bliley Act includes new sections of the
National Bank Act and the Federal Deposit Insurance Act governing the
establishment and operation of financial subsidiaries to permit national banks
and state banks, to the extent permitted under state law, to engage in certain
new activities which are permissible for subsidiaries of a financial holding
company. Further, it expressly preserves the ability of national banks and state
banks to retain all existing subsidiaries. In order to form a financial
subsidiary, a national bank or state bank must be well-capitalized, and such
banks would be subject to certain capital deduction, risk management and
affiliate transaction rules.
COMMUNITY REINVESTMENT ACT. The Federal Community Reinvestment Act
(`CRA') requires the FDIC and the Commissioner to evaluate the Bank's
performance in helping to meet the credit needs of the community. The Bank has
been designated as a `wholesale institution' for CRA purposes by the
Commissioner and the FDIC. This designation reflects the nature of the Company's
business as other than a retail financial institution and proscribes CRA review
criteria applicable to the Bank's particular type of business. As a part of the
CRA program, the Bank is subject to periodic examinations by the FDIC and the
Commissioner, and maintains comprehensive records of its CRA activities for this
13
purpose. Management believes the Bank is currently in compliance with all CRA
requirements. The Bank has pending an application with the FDIC to become
designated a `special purpose' institution, which designation would exempt the
Bank from CRA review by the FDIC. The Bank would still be subject to review by
the Commissioner, if granted such status.
MASSACHUSETTS LAW - DIVIDENDS. 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 Commissioner approval 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.
REGULATORY ENFORCEMENT AUTHORITY. The enforcement powers available
to federal banking regulators include, among other things, the ability to assess
civil money penalties, to issue cease-and-desist or removal orders and to
initiate injunctive actions against banking organizations and
institution-affiliated parties, as defined. In general, these enforcement
actions may be initiated for violations of law and regulations and unsafe or
unsound practices. Other actions or inactions may provide the basis for
enforcement action, including misleading or untimely reports filed with
regulatory authorities. Federal law requires, except under certain
circumstances, public disclosure of final enforcement actions by the federal
banking agencies.
TRANSFER AGENCY. In order to serve as transfer agent to its clients
that execute transactions in publicly traded securities, the Company must
register with the SEC as a transfer agent under the Exchange Act. As a
registered transfer agent, the Company is subject to certain reporting and
recordkeeping requirements. Currently, management believes the Company is in
compliance with these registration, reporting and recordkeeping requirements.
REGULATION OF INVESTMENT COMPANIES. Certain of the Company's mutual
fund and unit investment trust clients are regulated as `investment companies'
as that term is defined under the Investment Company Act of 1940, as amended
(the `ICA'), and are subject to examination and reporting requirements
applicable to the services provided by the Company.
The provisions of the ICA and the regulations promulgated thereunder
prescribe the type of institution which may act as a custodian of investment
company assets, as well as the manner in which a custodian administers the
assets in its custody. Because the Company serves as custodian for a number of
its investment company clients, these regulations require, among other things,
that the Company maintain certain minimum aggregate capital, surplus, and
undivided profits. Additionally, arrangements between the Company and clearing
agencies or other securities depositories must meet ICA requirements for
segregation of assets, identification of assets and client approval. Future
legislative and regulatory changes in the existing laws and regulations
governing custody of investment company assets, particularly with respect to
custodian qualifications, may have a material and adverse impact on the Company.
Currently, management believes the Company is in compliance with all minimum
capital and securities depository requirements. Further, the Company is not
aware of any proposed or pending regulatory developments, which, if approved,
would adversely affect the ability of the Company to act as custodian to an
investment company.
Investment companies are also subject to extensive recordkeeping and
reporting requirements. These requirements dictate the type, volume and duration
of the record keeping undertaken by the Company, either in its role as custodian
for an investment company or as a provider of administrative services to an
investment company. Further, the Company must follow specific ICA guidelines
when calculating the net asset value of a client mutual fund. Consequently,
changes in the statutes or regulations governing recordkeeping and reporting or
valuation calculations will affect the manner in which the Company conducts its
operations.
New legislation or regulatory requirements could have a significant
impact on the information reporting requirements applicable to the Company's
clients and may in the short term adversely affect the Company's ability to
service those clients at a reasonable cost. Any failure by the Company to
provide such support could cause the loss of customers and have a material
adverse effect on the Company's financial results. Additionally, legislation or
regulations may be proposed or enacted to regulate the Company in a manner,
which may adversely affect the Company's financial results.
OTHER SECURITIES LAWS ISSUES. The Gramm-Leach-Bliley Act also
amended the federal securities laws to, effective May, 2001, eliminate the
blanket exceptions that banks traditionally have had from the definition of
broker dealer and investment adviser. Accordingly, banks not falling within the
specific exemptions provided by the new law may have to register with the SEC as
a broker-dealer and/or investment adviser, as appropriate, and became subject to
SEC jurisdiction. For example, banks acting as investment advisors to registered
mutual funds, such as the Bank, will not be exempt, nor likely will banks that
engage in third party non-custodial securities lending arrangements.
14
ITEM 2. PROPERTIES.
As of December 31, 1999, the Company leased two offices located in
Boston, MA, one in New York, NY, and foreign offices in Toronto, Canada and
Dublin, Ireland for its offshore funds processing business.
The following table provides certain summary information with
respect to the principal properties that the Company leases:
LOCATION FUNCTION SQ. FT. EXPIRATION DATE
- -------- -------- ------- ---------------
200 Clarendon St., Boston, MA Principal Executive Offices 259,178 2007
and Operations Center
1 Exeter Plaza, Boston, MA Training Center 11,375 2001
600 Fifth Avenue, New York, NY Operations Center 7,751 2005
1 First Canadian Place, Toronto Offshore Processing Center 17,790 2001
Earlsfort Terrace, Dublin Offshore Processing Center 10,635 2002
The Company entered into an agreement to lease 62,840 square feet at
Copley Place, located in Boston, Massachusetts, to commence in 2000 in order to
expand its Boston operations. See Note 15 of the Notes to Consolidated Financial
Statements.
ITEM 3. LEGAL PROCEEDINGS.
The Company is from time to time subject to claims arising in the
ordinary course of business. While the outcome of any such claim cannot be
predicted with certainty, management does not expect these matters, either
individually or in the aggregate, to have a material adverse effect on the
results of operations and financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the Company's security
holders during the quarter ended December 31, 1999.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The Company's Common Stock is currently included in The Nasdaq National Market
under the symbol IFIN. The following table sets forth the range of high and low
sales prices for the Company's Common Stock as reported by NASDAQ.
1999
HIGH LOW
---- ---
First Quarter $33.000 $26.750
Second Quarter $40.563 $29.000
Third Quarter $45.000 $32.000
Fourth Quarter $49.438 $31.250
1998
HIGH LOW
---- ---
First Quarter $28.000 $20.500
Second Quarter $29.782 $24.750
Third Quarter $34.188 $20.188
Fourth Quarter $32.500 $15.750
As of February 16, 2000, there were approximately 937 stockholders of record.
15
DIVIDENDS
The Company currently intends to retain the majority of future
earnings to fund the development and growth of its business. The Company's
ability to pay dividends on the Common Stock may depend on the receipt of
dividends from the Bank. In addition, the Company may not pay dividends on its
Common Stock if it is in default under certain agreements which the Company
entered into in connection with the sale of the 9.77% Capital Securities by
Investors Capital Trust I. See `Management's Discussion and Analysis of
Financial Condition and Results of Operations - Capital Resources.' Any dividend
payments by the Bank are subject to certain restrictions imposed by the
Massachusetts Commissioner of Banks. See `Business - Regulation and
Supervision.' Subject to regulatory requirements, the Company expects to pay an
annual dividend to its stockholders, currently estimated to be in an amount
equal to $.12 per share of outstanding Common Stock (approximately $1.8 million
based upon 14,610,154 shares outstanding as of December 31, 1999). The Company
expects to declare and pay such dividend ratably on a quarterly basis.
16
ITEM 6. SELECTED FINANCIAL DATA.
The following table contains the Company's consolidated financial
and statistical information, and should be read in conjunction with
`Management's Discussion and Analysis of Financial Condition and Results of
Operations,' the Company's Consolidated Financial Statements and Notes to
Consolidated Financial Statements, and other financial information appearing
elsewhere in this Annual Report. Information reported for years prior to 1998
have been restated for the acquisition of AMT Capital Services, Inc., which was
accounted for as a pooling-of-interests. This restated information was first
filed with the Securities and Exchange Commission (`SEC') on August 18, 1998.
For the Two
Months Ended
For the Year Ended December 31, December 31,
------------- -------------- ------------- ------------- -------------
1999 1998 1997 1996 1995
------------- -------------- ------------- ------------- -------------
(Dollars in thousands, except per share and employee data)
STATEMENT OF INCOME DATA:
Net interest income $ 35,773 $ 26,694 $ 26,173 $ 17,944 $ 1,966
Non-interest income 133,761 98,023 82,524 59,189 8,407
Gain/(loss) on sale of investment
securities -- 833 114 (2) --
------------- ------------- ------------- ------------- -------------
Net operating revenues 169,534 125,550 108,811 77,131 10,373
Operating expenses 135,815 99,584 87,362 64,613 8,877
------------- ------------- ------------- ------------- -------------
Income before income taxes and
minority interest 33,719 25,966 21,449 12,518 1,496
Income taxes 10,790 9,348 7,382 4,852 664
Minority interest expense 1,661 1,563 1,437 -- --
------------- ------------- ------------- ------------- -------------
Net income $ 21,268 $ 15,055 $ 12,630 $ 7,666 $ 832
============= ============= ============= ============= =============
PER SHARE DATA (6):
Basic earnings per share $ 1.49 $ 1.12 $ 0.95 $ 0.58 $ 0.07
============= ============= ============ ============ =============
Diluted earnings per share $ 1.43 $ 1.09 $ 0.93 $ 0.57 $ 0.06
============= ============ ============ ============ =============
Dividends per share $ 0.08 $ 0.06 $ 0.04 $ 0.02
============= ============ ============ =============
BALANCE SHEET DATA:
Total assets at end of period $ 2,553,080 $ 1,465,508 $ 1,460,447 $ 965,394 $ 332,436
AVERAGE BALANCE SHEET DATA:
Interest earning assets $ 1,837,963 $ 1,443,487 $ 1,167,361 $ 575,662 $ 219,775
Total assets 1,970,702 1,542,765 1,236,519 628,893 249,064
Total deposits 1,150,814 845,093 594,768 377,219 197,013
Common stockholders' equity 118,622 81,456 68,370 56,137 34,000
SELECTED FINANCIAL RATIOS:
Return on average equity (2) 17.93% 18.48% 18.47% 13.65% 14.68%
Return on average assets (2) 1.08% 0.98% 1.02% 1.22% 2.00%
Common equity as % of total assets 6.02% 5.28% 5.18% 6.39% 16.61%
Dividend payout ratio (3) 5.59% 5.25% 4.45% 2.49% 0.00%
Tier 1 capital ratio (4) 14.96% 15.32% 29.17% 24.57% 44.47%
Non-interest income as % of net
operating income 78.90% 78.08% 75.84% 76.74% 81.05%
OTHER STATISTICAL DATA:
Assets processed at end of period (5) $ 290,162,547 $ 244,935,314 $ 139,418,241 $ 122,563,400 $ 94,208,228
Employees at end of period 1,507 1,258 1,028 827 682
For the Year
Ended
October 31,
-------------
1995(1)
-------------
(Dollars in thousands, except
per share and employee data)
STATEMENT OF INCOME DATA:
Net interest income $ 5,870
Non-interest income 53,607
Gain/(loss) on sale of investment
securities --
-------------
Net operating revenues 59,477
Operating expenses 52,569
-------------
Income before income taxes and
minority interest 6,908
Income taxes 2,782
Minority interest expense --
-------------
Net income $ 4,126
=============
PER SHARE DATA (6):
Basic earnings per share
Diluted earnings per share
Dividends per share
BALANCE SHEET DATA:
Total assets at end of period $ 186,773
AVERAGE BALANCE SHEET DATA:
Interest earning assets $ 106,130
Total assets 128,174
Total deposits 106,446
Common stockholders' equity 16,119
SELECTED FINANCIAL RATIOS:
Return on average equity (2) 25.60%
Return on average assets (2) 3.22%
Common equity as % of total assets 12.58%
Dividend payout ratio (3) 1.36%
Tier 1 capital ratio (4) 37.62%
Non-interest income as % of net
operating income 90.13%
OTHER STATISTICAL DATA:
Assets processed at end of period (5) $ 91,099,976
Employees at end of period 679
- -------------
(1) Non-interest income for the year ended October 31, 1995 includes the
recognition of net proceeds of $2,572,000 from the assignment to a third
party of asset administration rights associated with $5 billion of unit
investment trust assets.
(2) Ratios for the two months ended December 31, 1995 have been annualized.
The ratios for the year ended October 31, 1995 include the effect of the
unit investment trust transaction described in (1) above. Without the
earnings associated with this transaction, return on equity and return on
assets for the year ended October 31, 1995 would have been 15.84% and
1.99%, respectively.
(3) The Company intends to retain the majority of future earnings to fund
development and growth of its business. The Company currently expects to
pay cash dividends at an annualized rate of $.12 per share subject to
regulatory requirements. See "Dividends."
(4) Tier I capital consists of the sum of common stockholders' equity and
non-cumulative perpetual preferred stock minus all intangible assets
(other than certain qualifying goodwill) and excess deferred tax assets.
(5) Assets processed is the total dollar value of financial assets on the
reported date for which the Company provides one or more of the following
services: custody, multicurrency accounting, institutional transfer
agency, performance measurement, foreign exchange, securities lending and
mutual fund administration and investment advisory services.
(6) All share numbers shown in this table have been restated to reflect the
two-for-one stock split paid March 17, 1999 where applicable.
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
The following discussion and analysis of the financial condition and
results of operations of the Company should be read in conjunction with the
Company's Consolidated Financial Statements and related Notes to Consolidated
Financial Statements, which are included elsewhere in this Annual Report. The
Company, through its wholly owned subsidiaries, Investors Bank & Trust Company
and Investors Capital Services, Inc., provides global custody, multicurrency
accounting, institutional transfer agency, performance measurement, foreign
exchange, securities lending, mutual fund administration and investment advisory
services to a variety of financial asset managers, including 78 mutual fund
complexes, investment advisors, banks and insurance companies. The Company
provides financial asset administration services for net assets that totaled
approximately $290 billion at December 31, 1999, including approximately $17
billion of foreign net assets. The Company also engages in private banking
transactions, including secured lending and deposit accounts.
On May 29, 1998 the Company acquired AMT Capital Services, Inc. and
an affiliated company (`AMT Capital'), a New York-based firm recognized for
providing fund administration services to global and domestic institutional
investment management firms. Under the terms of the acquisition agreement, the
Company acquired all of the outstanding capital stock of AMT Capital in exchange
for 388,012 shares of the Company's common stock. The acquisition was accounted
for under the pooling-of-interests method of accounting. Upon completion of the
acquisition, AMT Capital became a wholly owned subsidiary of the Company and was
re-named Investors Capital Services, Inc. On April 12, 1999, 6,814 of the shares
issued by the Company were returned to the Company pursuant to the
indemnification and escrow provisions of the acquisition agreement.
On October 1, 1998, the Bank acquired the domestic institutional
trust and custody business (`the Business') of BankBoston, N.A. Under the terms
of the purchase agreement, the Bank paid approximately $48 million to BankBoston
as of the closing and paid an additional amount of approximately $4.8 million in
February 2000 based upon client retention and business performance. The Business
provides master trust and custody services to endowments, pension funds,
municipalities, mutual funds and other financial institutions, primarily in New
England. The acquisition was accounted for using the purchase method of
accounting. In connection with the acquisition, the Bank and BankBoston also
entered into an outsourcing agreement. Pursuant to the outsourcing agreement,
the Bank acted as custodian, and provided certain other services, for three
BankBoston asset management related businesses: domestic private banking,
institutional asset management and international private banking. In September
1999, the Bank received notification from BankBoston of its intent to terminate
the outsourcing agreement. The termination, to be effective in early 2000, will
have no impact on the remaining business purchased from BankBoston. Pursuant to
the terms of the outsourcing agreement, the Bank received a termination fee of
$7 million in February 2000. Therefore, a net adjustment to decrease the
purchase price, resulting from the two above mentioned items, was made for $2.2
million. The Bank does not anticipate a material impact on net income due to the
termination of the outsourcing agreement. The Bank was informed by BankBoston
that its decision to terminate the outsourcing agreement was not related in any
way to the Company's quality of service but was made as part of the integration
process undertaken in connection with the recently completed BankBoston/Fleet
merger.
On February 16, 1999, the Board of Directors of the Company declared
a two-for-one stock split in the form of a 100% stock dividend payable March 17,
1999 to stockholders of record on March 1, 1999. All share numbers shown in this
Annual Report have been restated to reflect the two-for-one stock split paid
March 17, 1999 where applicable.
On March 26, 1999, the Company completed the issuance and sale of
900,000 shares of Common Stock at $29 per share in a private placement to one
investor. The net capital raised in the private placement was used to support
the Company's balance sheet growth.
On October 29, 1999, the Bank entered into an agreement with Sanwa
Bank California, pursuant to which the Bank agreed to purchase the right to
provide institutional custody and related services to accounts managed by the
Trust Company of the West. The accounts subject to the agreement totaled
approximately $3.6 billion in assets at October 26, 1999. The Bank expects to
complete the purchase by March 31, 2000, subject to customary closing
conditions.
18
The Company's current largest client, Eaton Vance, accounted for
10%, 9% and 7% of the Company's net operating revenues for the years ended
December 31, 1997, 1998 and 1999 respectively. The Company believes its
relationship with Eaton Vance is good and expects it to continue. The Company's
agreements with mutual funds managed by Eaton Vance, pursuant to which the
Company provides custody and fund accounting services, extend through August
2000 and continue thereafter until terminated by either party upon sixty days
prior notice.
The Company derives its revenues from financial asset administration
services and private banking transactions. Although interest income and
non-interest income are reported separately for financial statement presentation
purposes, the Company's clients view the pricing of the Company's asset
administration and banking service offerings on a bundled basis. In establishing
a fee structure for a specific client, management analyzes all expected revenue
and related expenses, as opposed to separately analyzing fee income and interest
income and related expenses for each from such relationship. Accordingly,
management believes net operating revenue (net interest income plus non-interest
income) and net income are the most meaningful measures of financial results.
Revenue generated from asset administration and other fees and interest income
increased 35% to $169.5 million for the year ended December 31, 1999 from $125.6
million for the year ended December 31, 1998.
Non-interest income consists primarily of fees for financial asset
administration and is principally derived from custody, multicurrency
accounting, transfer agency and administration services for financial asset
managers and the assets they control. The Company's clients pay fees based on
the volume of assets under custody, the number of securities held and portfolio
transactions, income collected and whether other value-added services such as
foreign exchange, securities lending and performance measurement are needed.
Asset-based fees are usually charged on a sliding scale. As such, when the
assets in a portfolio under custody grow as a result of changes in market values
or cash inflows, the Company's fees may be a smaller percentage of those assets.
Fees for individually managed accounts, such as custodial, trust and portfolio
accounting services for individuals, investment advisors, private trustees,
financial planners, other banks and fiduciaries, and other institutions are also
included in non-interest income.
Net interest income represents the difference between income
generated from interest-earning assets and expense on interest-bearing
liabilities. Interest-bearing liabilities are generated by the Company's clients
who, in the course of their financial asset management, generate cash balances,
which they deposit on a short-term basis with the Company. The Company invests
these cash balances and remits a portion of the earnings on these investments to
its clients. The Company's share of earnings from these investments is viewed as
part of the total package of compensation paid to the Company from its clients
for performing asset administration services.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
From time to time, information provided by the Company, statements
made by its employees or information included in its filings with the SEC
(including this Form 10-K) may contain statements, which are not historical
facts, so-called `forward-looking statements,' which involve risks and
uncertainties. Forward-looking statements in this Form 10-K include certain
statements regarding liquidity, the effects of BankBoston's termination of the
outsourcing agreement, customary closing conditions relating to the Sanwa Bank
transaction and the effect of certain potential legal claims against the
Company. The Company's actual future results may differ significantly from those
stated in any forward-looking statements. Factors that may cause such
differences include, but are not limited to, the factors discussed below. Each
of these factors, and others, are discussed from time to time in the Company's
filings with the SEC.
The Company's future results may be subject to substantial risks and
uncertainties. The Company's liquidity is dependent, in part, upon the continued
availability of current borrowing facilities, the loss of which may impair the
Company's access to liquid funds. Because certain fees charged by the Company
for its services are based on the market values of assets processed, such fees
and the Company's quarterly and annual operating results are sensitive to
changes in interest rates, declines in stock market values, and investors
seeking alternatives to the investment offerings of the Company's clients. Also,
the Company's interest-related services, along with the market value of the
Company's investments, may be adversely affected by rapid changes in interest
rates or changes in the relationship between certain index rates. In addition,
many of the Company's client engagements are, and in the future are likely to
continue to be, terminable upon 60 days notice. If the Company is not able to
recognize expense reduction or reallocation of resources after the termination
of the outsourcing agreement, the termination may have an adverse impact on the
Company's results of operations and financial condition. Also, the outcome of
any legal claim against the Company cannot be predicted with certainty and, even
if the Company is successful in defending or settling any claims, the existence
of the claims may harm the Company's reputation or ability to add new clients.
The Company has been experiencing a period of rapid growth, which
places a strain on all of its resources, including management. In addition, the
Company must integrate future acquisitions, if any, into the Company's business.
Also, the Company must continue to attract and retain skilled personnel in a
tight labor market. In particular, the current market for financial services
employees is extremely competitive. If the Company fails to manage growth
effectively,
19
integrate acquisitions successfully or attract and retain skilled employees, it
could reduce the quality of the Company's services, lead to loss of key
employees and clients, and have a material adverse effect on the Company's
operations.
The Company relies on certain intellectual property protections to
preserve its intellectual property rights. Any invalidation of the Company's
intellectual property rights or lengthy and expensive defense of those rights
could have a material adverse effect on the Company. The segment of the
financial services industry in which the Company is engaged is extremely
competitive. Certain current and potential competitors of the Company are more
established and benefit from greater market recognition and have substantially
greater financial, development and marketing resources than the Company.
The Company's quarterly and annual operating results are affected by
a wide variety of factors that could materially adversely affect revenues and
profitability, including: the timing of the commencement or termination of
client engagements, the rate of net inflows and outflows of investor funds in
the debt and equity-based investment vehicles offered by the Company's clients,
fluctuations in global equity and debt markets, the introduction and market
acceptance of new services by the Company and changes or anticipated changes in
economic conditions. Because the Company's operating expenses are relatively
fixed, any unanticipated shortfall in revenues in a specified period may have an
adverse impact on the Company's results of operations for that period. As a
result of the foregoing and other factors, the Company may experience material
fluctuations in future operating results on a quarterly or annual basis which
could materially and adversely affect its business, financial condition,
operating results and stock price.
STATEMENT OF OPERATIONS
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
Non-interest Income
Non-interest income increased $34.9 million to $133.8 million for the
year ended December 31, 1999 from $98.9 million for the year ended December 31,
1998. Non-interest income consists of the following items:
For the Year Ended December 31,
------------------------------------ ---------------
1999 1998 Change
---------------- ---------------- ---------------
(Dollars in thousands)
Asset administration fees $132,478 $ 96,757 37%
Computer service fees 488 518 (6%)
Other operating income 795 748 6%
Net gain/(loss) on sale of securities -- 833 --
---------------- ----------------
Total non-interest Income $133,761 $ 98,856 35%
=============== ================
Asset administration fees increased $35.7 million due principally to
higher levels of assets processed resulting from the addition of new clients as
well as the expansion of existing client relationships. The Company earns such
fees on assets processed by the Company on behalf of a variety of financial
asset managers. Assets processed is the total dollar value of financial assets
on the reported date for which the Company provides one or more of the following
services: global custody, multicurrency accounting, institutional transfer
agency, performance measurement, foreign exchange, securities lending, mutual
fund administration and investment advisory services. Total net assets processed
increased 18% to $290 billion at December 31, 1999 from $245 billion at December
31, 1998. The largest component of asset administration fees is asset-based
fees, which increased between periods due to the increase in assets processed.
Another significant portion of the increase in asset administration fees
resulted from the Company's success in marketing ancillary services such as cash
management and securities lending.
Computer service fees consist of amounts charged by the Company for
data processing services related to client accounts. Other operating income
consists of dividends received relating to the Federal Home Loan Bank of Boston
(`FHLBB') stock investment and miscellaneous transaction-oriented private
banking fees. Gain on sale of securities decreased in 1999 due to the Company's
sale in 1998 of certain available for sale mortgage-backed securities in
anticipation of prepayment risk.
20
Operating Expenses
In 1999 total operating expenses were $135.8 million, up 36% from 1998.
The components of operating expenses were as follows:
For the year ended December 31,
----------------------------------- ------------
1999 1998 Change
----------------- -------------- ------------
(Dollars in thousands)
Compensation and benefits $ 83,302 $ 61,901 35%
Technology and telecommunications 15,744 10,965 44
Transaction processing services 9,234 7,251 27
Occupancy 8,032 6,991 15
Depreciation and amortization 3,911 2,657 47
Professional fees 3,573 1,590 125
Travel and sales promotion 2,551 1,920 33
Amortization of goodwill 1,756 442 297
Insurance 769 783 (2)
Other operating expenses 6,943 5,084 37
----------------- --------------
Total operating expenses $135,815 $ 99,584 36%
================= ==============
Compensation and benefits expense, the largest component of expense,
increased by $21.4 million or 35% from year to year due to several factors. The
average number of employees increased 25% to 1,423 at December 31, 1999 from
1,139 at December 31, 1998. This increase relates to the increase in client
relationships and the expansion of existing client relationships during the
year. In addition, compensation expense related to the Company's management
incentive plans increased $4.0 million between years because of the increase in
earnings subject to incentive payments in 1999 compared to 1998. Benefits,
including payroll taxes, group insurance plans, retirement plan contributions
and tuition reimbursement, increased by $2.4 million for the year ended December
31, 1999 from the same period in 1998.
Technology and telecommunications expense consists of operating lease
payments for microcomputers, fees charged by Electronic Data Systems for
mainframe data processing, telephone expense, software maintenance fees and
licenses, optical imaging and contract programming fees. Technology and
telecommunication fees increased $4.8 million year over year. Increased
hardware, software and telecommunications expenses needed to support the growth
in assets processed accounted for $956,000 of the increase. The Company's use of
contract programmers to perform information systems development projects
accounted for $799,000 of the increase. Fees charged by EDS increased $666,000
due to increased volume of mainframe data processing. Expenses relating to the
conversion of the BankBoston business accounted for $535,000 of the increase.
Transaction processing services expense consists of volume related
expenses including subcustodian fees and external contract services. The
increase of $2.0 million from year to year relates primarily to an increase in
subcustodian fees driven by growth in foreign assets processed for clients.
Occupancy expense increased $1.0 million to $8.0 million for the
year ended December 31, 1999 from $7.0 million for the year ended December 31,
1998. This increase resulted from the temporary rental of office space relating
to the BankBoston acquisition along with the expansion of office space in the
Company's Boston location.
Depreciation and amortization expense increased $1.2 million to $3.9
million for the year ended December 31, 1999 from $2.7 million for the year
ended December 31, 1998. This increase resulted from software costs capitalized
under AICPA Statement of Position 98-1, `Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use,' (`SOP 98-1'), which were
placed in service in 1999.
Professional fees increased $2.0 million to $3.6 million for the year
ended December 31, 1999 from $1.6 million for the year ended December 31, 1998.
The increase in professional fees relates primarily to consulting services
related to the integration of the BankBoston business and tax planning.
Travel and sales promotion expense consists of expenses incurred by
the sales force, client management staff and other employees in connection with
making sales calls on potential clients, traveling to existing client sites and
the Company's foreign subsidiaries, and attending industry conferences. This
expense increased $631,000 to $2.6 million for the year ended December 31, 1999
from $1.9 million for the year ended December 31, 1998 due primarily to
increased travel relating to the integration of the BankBoston business.
21
The acquisition of BankBoston's institutional trust and custody
business was accounted for under the purchase method of accounting and as a
result, the purchase price was allocated first to all identifiable tangible and
intangible assets acquired and liabilities assumed. The remainder of the
purchase price (excess of purchase price over the fair value of intangible net
assets) was then allocated to goodwill. Goodwill expense relates to the
amortization of the resulting goodwill from the acquisition, which is being
amortized over its estimated useful life. In September 1999, the Bank received
notification of BankBoston's intent to terminate the outsourcing agreement. The
termination, expected to be effective in early 2000, will have no impact on the
remaining business purchased from BankBoston. Pursuant to the terms of the
outsourcing agreement, the Bank received a termination fee of $7.0 million in
February 2000. The Bank does not anticipate a material impact on net income due
to the termination. The Bank was informed by BankBoston that its decision to
terminate the outsourcing agreement was not related in anyway to the Company's
quality of service, but was made as part of the integration process undertaken
in connection with the BankBoston/Fleet merger. In addition, a contingent
payment of approximately $4.8 million was made by the Company based upon
business performance in accordance with the purchase agreement. Therefore, a net
adjustment was made to decrease the purchase price by approximately $2.2 million
based upon these two items.
Other operating expenses increased $1.8 million to $6.9 million for the
year ended December 31, 1999 from $5.1 million for the year ended December 31,
1998. Other operating expenses include fees for office supplies, recruiting
costs, temporary help and various fees assessed by the Massachusetts Banking
Commission. Recruiting costs accounted for $914,000 of the increase due to the
growth of the Company's staffing needs. The growth in assets processed has
resulted in an overall increase in operating expenses.
Net Interest Income
Net interest income is the amount of interest received on
interest-earning assets less the interest paid on interest-bearing liabilities.
Net interest income is affected by the volume and mix of assets and liabilities,
and the movement and level of interest rates. The table below presents the
changes in net interest income resulting from changes in the volume of
interest-earning assets or interest-bearing liabilities and changes in interest
rates for the year ended December 31, 1999 compared to the year ended December
31, 1998. Changes attributed to both volume and rate have been allocated based
on the proportion of change in each category.
Change Change
Due to Due to
Volume Rate Net
----------- ----------- -----------
(Dollars in thousands)
INTEREST-EARNING ASSETS
Fed funds sold and
interest-earning deposits $ 480 $ (144) $ 336
Investment securities 21,146 (1,374) 19,772
Loans 1,046 (284) 762
------- ------- -------
Total interest-earning assets $22,672 $(1,802) $20,870
------- ------- -------
INTEREST-BEARING LIABILITIES
Deposits $15,143 $(3,500) $11,643
Borrowings 973 (825) 148
------- ------- -------
Total interest-bearing liabilities $16,116 $(4,325) $11,791
------- ------- -------
Change in net interest income $ 6,556 $ 2,523 $ 9,079
======= ======= =======
Net interest income increased $9.1 million or 34% to $35.8 million
for the year ended December 31, 1999 from $26.7 million for the year ended
December 31, 1998. This net increase resulted from an increase in interest
income of $20.9 million offset by an increase in interest expense of $11.8
million. The net impact of the above changes was a 10 basis point increase in
net interest margin.
The increase in interest income resulted from an expansion of the
balance sheet. The equity obtained in the $26 million private placement
completed in March 1999 allowed the Company to expand the average balance sheet
with deposits that had been in third-party sweeps. The Company's average
interest-earning assets increased 27% compared to the same period in 1998.
22
Interest expense increased due to a 32% increase in average
interest-bearing liabilities. The increase was offset by a decrease in the
average interest rates paid by the Company from 4.80% to 4.36% between periods.
Income Taxes
Taxes for the year ended December 31, 1999 were $10.8 million, up
from $9.3 million a year ago. The overall effective tax rate for the period was
32%, which compares to 36% for the prior year. The year-to-year decrease
resulted from the restructuring of corporate entities for state tax planning
purposes.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
Non-interest Income
Non-interest income increased $16.3 million to $98.9 million for the
year ended December 31, 1998 from $82.6 million for the year ended December 31,
1997. Non-interest income consists of the following items:
For the Year Ended December 31,
----------------------- ----------
1998 1997 Change
---------- ---------- ----------
(Dollars in thousands)
Asset administration fees $96,757 $78,325 24%
Computer service fees 518 643 (19%)
Other operating income 748 3,556 (79%)
Net gain/(loss) on sale of securities 833 114 --
---------- ----------
Total Non-interest Income $98,856 $82,638 20%
========== ==========
Asset administration fees increased $18.4 million due principally to
higher levels of assets processed. Total net assets processed increased to $245
billion at December 31, 1998 from $139 billion at December 31, 1997.
Approximately $76 billion of this increase relates to the Company's acquisition
of BankBoston's domestic institutional custody business on October 1, 1998. The
largest component of asset administration fees is asset-based fees, which
increased between periods due to the increase in assets processed. Another
significant portion of the increase in asset administration fees resulted from
the Company's success in marketing ancillary services such as securities
lending, foreign exchange and advisory services.
The decrease in computer service fees is related to the renegotiation
of contracts performed by Investors Capital Services, Inc. in 1998. The decrease
in other operating income resulted from services previously provided by
Investors Capital Advisors, Inc., a wholly owned subsidiary of the Company which
could no longer be provided due to regulatory restrictions imposed on the
Company. Investors Capital Advisors, Inc. was merged into Investors Capital
Services, Inc. on December 31, 1998. Gain on sale of securities increased in
1998 due to the Company's sale of certain available for sale mortgage-backed
securities in anticipation of prepayment risk.
23
Operating Expenses
Total operating expenses increased by $12.2 million to $99.6 million
for the year ended December 31, 1998 compared to $87.4 million for the year
ended December 31, 1997. The comp