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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
For the fiscal year ended December 31, 1996
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
For the transition period from _______ to _______
COMMISSION FILE NUMBER 0-26996
INVESTORS FINANCIAL
SERVICES CORP.
(Exact name of registrant as specified in its charter)
DELAWARE 04-3279817
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
89 SOUTH STREET
P.O. BOX 1537 02205
BOSTON, MASSACHUSETTS (Zip Code)
(Address of principal executive offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (617) 330-6700
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.01 PAR VALUE
CLASS A COMMON STOCK, $.01 PAR VALUE
SERIES A JUNIOR PREFERRED STOCK PURCHASE RIGHTS
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No_____
-----
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of Common Stock held by non-affiliates of the
registrant was $189,006,707 based on the last reported sale price of $34.25 on
The Nasdaq National Market on February 18, 1997 as reported by Nasdaq.
As of February 18, 1997, there were 6,101,636 shares of Common Stock
outstanding and 342,676 shares of Class A Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant intends to file a definitive proxy statement pursuant to
regulation 14A within 120 days of the end of the fiscal year ended December 31,
1996. Portions of such proxy statement are incorporated by reference into Part
III of this report.
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ITEM 1. BUSINESS
GENERAL
Investors Financial Services Corp. (the "Company"), based in Boston,
Massachusetts, provides asset administration services for the financial services
industry through its wholly-owned subsidiary, Investors Bank & Trust Company(R).
The Company provides domestic and global custody, multicurrency accounting,
institutional transfer agency, performance measurement, foreign exchange,
securities lending, mutual fund administration and investment advisory services
to a variety of financial asset managers, including mutual fund complexes,
investment advisors, banks and insurance companies. The Company provides
financial asset administration services for assets that totaled approximately
$122 billion at December 31, 1996, including assets managed by 51 mutual fund
complexes and insurance companies and approximately $9 billion of foreign
assets. The Company also engages in private banking transactions, including
secured lending and deposit accounts.
The Company operated as a subsidiary of Eaton Vance Corp. ("Eaton Vance"),
an investment management firm conducting business through subsidiaries, from its
formation in 1969 through November 1995. In 1995, the boards of directors of
the Company and Eaton Vance determined to separate the business operations of
the Company from those of Eaton Vance by means of a tax free, pro rata
distribution of Eaton Vance's ownership interest in the Company to the
stockholders of Eaton Vance (the "Spin-Off Transaction"). The principal reasons
for the Spin-Off Transaction were to eliminate certain regulatory restrictions
to which the Company was subject under the Competitive Equality Banking Act of
1987 ("CEBA"), and to enable the Company to pursue its business goals
independent of Eaton Vance. In order to avoid being regulated as a bank holding
company under the Bank Holding Company Act of 1956, Eaton Vance had operated
Investors Bank & Trust Company under certain growth and activity restrictions.
The elimination of the CEBA growth and activity restrictions enabled the Company
to expand its current business activities and participate in certain additional
business activities. The Spin-Off Transaction was completed on November 10,
1995, prior to the completion of an initial public offering of 2,300,000 shares
of the Company's Common Stock, $.01 par value, (the "Common Stock") on November
14, 1995 (the "Offering"). As used herein, the defined term "Company" shall
mean Investors Financial Services Corp. from and after June 29, 1995, the date
of organization of Investors Financial Services Corp., and shall mean Investors
Bank & Trust Company prior to that date, unless the context otherwise indicates.
Investors Bank & Trust Company is sometimes referred to herein as the "Bank."
Prior to the completion of the Spin-Off Transaction, the Company's fiscal
year end was October 31, the fiscal year end observed by Eaton Vance and the
Company filed an annual report on Form 10-K with the Securities and Exchange
Commission for the year ended October 31, 1995. In December 1995, the Company
elected to change its fiscal year end from October 31 to December 31 in order to
align its fiscal year end with its regulatory, tax and budget reporting period.
The Company filed a Transition Report on Form 10-K for the two-month period from
November 1, 1995 through December 31, 1995 (the "Transition Period").
Accordingly, this report contains certain financial information and operating
results for the years ended October 31, 1994 and 1995, for the Transition Period
and for the year ended December 31, 1996. The operating results for the
Transition Period are not necessarily indicative of annualized results.
OVERVIEW OF THE FINANCIAL SERVICES INDUSTRY
In the financial services industry, asset managers, whether independent or
affiliated with investment management companies, banks or insurance companies,
manage and invest financial assets entrusted to them. Asset managers utilize a
broad range of pooled investment products such as mutual funds, unit investment
trusts, separate accounts and variable annuities to achieve their clients'
investment goals. Asset administration companies, such as the Company, perform
various services for the asset managers and the pooled products they sponsor,
including domestic and global custody, multicurrency accounting, transfer
agency, portfolio performance measurement, foreign exchange, securities lending,
administration and advisory services.
The Company believes that the rapid pace of financial asset creation
through the flow of assets into pooled products and other investment products
and the related asset administration of those products is the key to revenue
growth for asset administration companies. As shown in the chart below, total
financial assets managed by mutual fund companies, insurance companies, private
pension funds and banks have grown at an average annual rate of over 12% since
1990. Mutual funds, such as those serviced by the Company, make up a large part
of the financial assets in pooled investment vehicles and have grown at the most
rapid pace. The U.S. mutual fund market has grown at an average annual rate of
19.32% since 1990, with over $3.0 trillion in assets at September 30, 1996.
According to Bank Securities Journal, worldwide fund assets were over $5.4
trillion in June 1996, an increase of $3.0 trillion in approximately five years.
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TOTAL U.S. FINANCIAL ASSETS
(in billions) DECEMBER 31, 1990 SEPTEMBER 30, 1996 GROWTH RATE
Mutual Funds 1,154.6 3,197.7 19.32%
Life Insurance Companies 1,367.4 2,199.0 8.60
Private Pension Funds 1,610.9 2,873.1 10.57
Bank Personal Trusts and Estates 522.1 773.5 7.07
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Total 4,655.0 9,043.3 12.22%
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Source: Federal Reserve Bank
The asset administration environment differs by asset management
organization and operational philosophy. Most asset managers outsource custody
services. In many cases, they use multiple custodians to foster cost reduction
through competition. Large asset managers may have the critical mass necessary
to justify the cost of in-house facilities to handle accounting, administration
and transfer agency services, while smaller asset managers outsource these
services as well. The Company believes that asset administration companies such
as the Company operate most efficiently when bundling services such as custody
and accounting with value-added services such as securities lending and foreign
exchange. The Fund Accounting and Custody Tracking System ("FACTS"), the
software system developed and owned by the Company, with its integrated
functionality, supports these services, so that information is input once and is
entered into various administrative subsystems without manual intervention.
Providing asset administration services offshore is a growing activity in
the financial services industry. Non-U.S. investors in certain pooled
investment vehicles are subject to U.S. income tax if their income is
effectively connected with the conduct of a trade or business in the U.S.
Operating an investment fund from an offshore location is a requirement for
sheltering an investment fund from U.S. taxation. In July 1993, the Company
opened a subsidiary in Toronto, Canada to service the growing offshore mutual
fund market. In July 1994, the Company opened an office in Dublin, Ireland to
service European clients. In February 1996, the Company opened a small
administration site in the Cayman Islands to service Caribbean-based funds.
Another driving force in the financial services industry is information
technology. Asset managers are able to create innovative investment products
using data from world markets as a result of more powerful and affordable
information processing power, coupled with the ability to send large volumes of
information instantly through widely dispersed communication networks. Timely
on-line access to electronic information on security positions, prices and price
shifts facilitate on-line currency trading, indexation of assets, real time
arbitrage, and hedging through the use of derivative securities. Asset
administration providers use technology as a competitive tool to deliver precise
and functional information to the asset managers, and to increase value-added
services. Value-added services include performance measurement and analytical
tools for asset managers, such as reports showing time-weighted return,
performance by sector, and time-weighted return by sector. Other factors, such
as the reduction in settlement times in world markets, have created greater
demand for asset administration service providers to have on-line, real-time
systems. The Company believes that the integrated nature of FACTS, compared
with the disparate systems used for different tasks by many other financial
service providers, provides the Company with a competitive advantage and
positions the Company well to respond to the changing technological demands of
the financial services industry.
Competition in the asset administration industry has reduced pricing in
almost all business segments, particularly with respect to custody services and
trustee services. Partially offsetting this trend is the development of new
services that have higher margins. The Company's continuous investment in
technology has permitted it to offer new value-added services to clients, such
as offshore custody and fund accounting, securities lending and foreign exchange
at competitive prices around the globe. Technological evolution and new service
innovation enable the Company to generate additional revenues to offset price
pressure in maturing service lines.
Asset managers create different investment structures in an effort to
capture the efficiencies of larger pools of assets. One example of this
innovation is the master-feeder structure. In the master-feeder structure, one
or more investment vehicles (the "feeder funds") with identical investment
objectives pool their assets in a common portfolio held by a separate investment
vehicle (the "master fund"). This structure permits each of the feeder funds to
be sold to a separate target market and through a different distribution channel
even if the feeder fund, on a stand alone basis, would not be large enough to
support its operating costs. The feeder funds benefit from economies of scale
available to the larger pool of funds invested in the master fund. A
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patented variation of the master-feeder structure, Hub and Spoke(R), is marketed
by Signature Financial Group, Inc. ("SFG"). At December 31, 1996, the Company
processed over $30 billion of assets in the master-feeder structures, including
$27 billion of assets processed in the Hub and Spoke structure. See "The
Company - Company Strategy."
In addition, a growing number of mutual funds have been structured as
multiple class funds in order to address the differing requirements and
preferences of potential investors. In the typical multiple class environment,
investors have the option of purchasing fund shares with the sales load
structure that best meets their short-term and long-term investment strategy.
Multiple class arrangements allow an investment company to sell interests in a
single investment portfolio to separate classes of stockholders. Multiple class
funds, due to the increased complexity of their structure, present new
opportunities for asset administration companies.
The financial asset service industry has recently experienced a
consolidation among service providers. The Company believes that its size and
its responsiveness to client needs provide the financial services industry with
an asset administration alternative to superregional and money center banks and
other administration providers. In addition, consolidation within the industry
creates opportunity for the Company as prospective clients review their
relationships with existing service providers. The Company's sales and
marketing group actively monitors these situations as they develop.
COMPANY STRATEGY
Global and domestic custody and multicurrency accounting are the principal
asset administration services provided to the Company's clients. The Company's
securities lending, foreign exchange, transfer agency and mutual fund
administration and investment advisory services are value-added services
utilized by clients based on their particular needs. The Company's objective is
to provide a broad range of services to all clients, maximize the use of its
value-added services and increase the size of its client base. To achieve this
objective, the Company has adopted the following strategy:
. Deliver superior service and expand client relationships. Service
quality in asset administration relationships is a key to maintaining
existing business and attracting new clients. The Company takes an
integrated approach to asset administration rather than the functional
approach of some of its competitors. Instead of separate departments
managing components of the custody and accounting task (e.g., trade
settlement, income collection, corporate actions, general ledger
accounting, portfolio accounting and pricing), the Company has
integrated these custody and accounting functions and dedicates a
single operations team to handle all work for a particular account or
fund. In addition, each client is assigned a Client Manager,
independent of the operations team, to anticipate the client's needs,
to coordinate service delivery, and to provide consulting support.
The Company believes that its strong client relationships create
continuing opportunities to provide additional services to existing
customers. Financial assets processed by the Company for existing
clients increased by $21.6 billion during the year ended December 31,
1996.
. Maintain technological expertise. The asset administration industry
requires the technological capability to support a wide range of
global security types and complex portfolio structures in both local
and base currencies, as well as the telecommunications flexibility to
support the diversity of global communications standards. FACTS was
developed in the mid-1980s to support the Company's integrated
approach to the provision of services to its clients. From a systems
standpoint, FACTS is an integrated computerized information system
that provides custody, securities movement and control, portfolio
accounting, general ledger accounting, pricing, net asset value
calculation, and Hub and Spoke or master-feeder processing into a
single information system. By consolidating these functions, the
Company has eliminated redundancy in data capture and reduced the
opportunity for clerical error. The FACTS architecture enables the
Company to modify the system quickly, resulting in increased
processing quality and efficiency for its clients. The Company
believes that this integrated architecture helps differentiate the
Company from its competitors.
System enhancements and upgrades are an ongoing part of asset
administration, both to remain competitive and to create information
delivery mechanisms that add value to the information available as
part of clearing and settling transactions. During the past two
years, the Company has developed standardized data extracts and
automated interfaces that allow its clients to connect electronically
with the Company's host computer and access data collected from
clearance and settlement transactions in multiple currencies on a
real-time basis. Through these information-sharing tools, the Company
is better equipped to expand its custody and accounting services with
4
foreign exchange services and asset and transaction reporting and
monitoring services. This electronic linkage also positions the
Company to respond quickly to client requests.
The Company's 75 systems professionals have developed expertise
in various advanced technologies, including graphical user interfaces,
relational database management systems, distributed processing and
imaging technology. The Company intends to continue to utilize these
technologies to provide the responsiveness necessary to keep pace with
the rapidly changing requirements of the industry and the needs of its
clients.
. Expand the range of value-added service offerings. Asset
administration companies gain competitive advantage by offering a
range of value-added services to their financial services clients. The
Company operates most efficiently when bundling basic services such as
custody and accounting with value-added services such as performance
measurement, securities lending and foreign exchange. Since the Spin-
Off Transaction, the Company has not been subject to the activity
restrictions imposed by CEBA and now is able to participate in
additional business activities.
The Company's clients, which consist mainly of managers of mutual
funds, unit investment trusts and other pooled asset products,
typically generate large cash balances from securities sales and other
transactions which they wish to invest on a short-term basis. Because
the Company was subject to a 7% annual asset growth cap under CEBA, it
was not able to accept those deposits and directed those deposits to
other financial institutions, foregoing a potential source of revenue.
The Company directed client deposits averaging almost $1.2 billion
daily to other financial institutions in fiscal year 1995. Similarly,
many of the Company's clients use credit lines to leverage their
portfolios or to handle overnight cash shortfalls; however, CEBA rules
restricted the Company from making commercial loans of this type. As a
result of the Spin-Off Transaction, the Company may now offer these
deposit and lending services directly to existing and potential
clients.
In November 1996, the Bank executed agreements with the Merrimac
Master Portfolio and the Merrimac Funds, newly formed master-feeder
investment companies (the "Funds"), pursuant to which the Company has
agreed to act as investment advisor to the Funds. At the same time,
the Company engaged The Bank of New York to act as sub-advisor to
manage the investments of the Funds. Currently, the Funds have one
operating master fund, the Merrimac Cash Portfolio, and one operating
feeder fund, the Merrimac Cash Fund.
. Expand offshore processing capabilities. Non-U.S. investors in certain
pooled investment vehicles are subject to U.S. income tax if their
income is effectively connected with the conduct of a trade or
business in the U.S. To shelter effectively an investment fund from
U.S. taxation, the fund's operations, including asset administration
functions, must be conducted outside the U.S. In July 1993, the
Company opened a subsidiary in Toronto, Canada to service the growing
offshore mutual fund market. As of December 31, 1996, the Canadian
subsidiary processed over $12 billion in assets requiring the
calculation of 84 daily net asset values. In July 1994, the Company
opened an office in Dublin, Ireland to service European clients. In
February 1996, the Company opened a small administration site in the
Cayman Islands to service Caribbean based funds. The technology
requirements of the offshore fund accounting operations are
facilitated by the architecture of FACTS. FACTS allows microcomputers
located at offshore processing centers to use the FACTS software
system to perform the components of processing on-site in compliance
with local jurisdiction and Internal Revenue Service requirements for
off-shore investment funds, while utilizing the Company's existing
U.S. based mainframe processing, storage and archive capabilities. In
contrast, other fund accounting providers typically utilize entirely
separate systems for domestic and offshore processing.
. Build expertise in the employee base. The Company believes that in
order to compete successfully for new business and obtain additional
business from existing clients, a qualified employee base is required
together with a commitment to ongoing training to keep employees
abreast of technological advances and industry developments in the
financial services industry. Successful completion of a Professional
Development Training Program is required of all newly hired employees.
Topics covered during the training program include an overview of the
financial services industry and pooled asset vehicles, principles of
mutual fund accounting and custody, instruction in control procedures,
manual performance of fund accounting tasks and intensive training on
FACTS. This training program is supplemented by continuing education
to keep employees informed of industry or client base changes.
5
. Seek strategic alliances. The Company intends to continue to pursue
strategic marketing and other alliances with participants in the
financial services industry. In May 1993, the Company signed a Hub
and Spoke license agreement with Signature Financial Group, Inc. the
developer of the Hub and Spoke structure. Hub and Spoke is an
investment structure that makes it possible for investment advisers to
reach new markets and avoid the inefficiencies of maintaining separate
portfolios that have common investment objectives. The Company
processes assets in Hub and Spoke products that totaled approximately
$27 billion as of December 31, 1996. See "The Company - Overview of
Financial Services Industry."
SERVICE OFFERINGS
The Company provides a broad range of asset administration services to the
financial services industry, including domestic and global custody,
multicurrency accounting, securities lending, foreign exchange, mutual fund
administration, institutional transfer agency, performance measurement, private
banking and investment advisory services. Global and domestic custody and
multicurrency accounting are the principal asset administration services
provided to the Company's clients. Fees charged for these services reflect the
highly competitive nature and price-sensitivity of the market for custody and
multicurrency accounting services. Securities lending and foreign exchange
services provide a more favorable pricing environment for the Company and
increased activity by the Company in these areas would not involve a
proportionate increase in personnel or other resources. Mutual fund
administration and institutional transfer agency services provide additional
revenue generating opportunities, but require a corresponding increase in
personnel and processing resources.
Client fees vary from client to client based on the volume of assets under
custody, the number of securities held and portfolio transactions, income
collected and whether other value-added services such as foreign exchange and
performance measurement are needed. Fees are generally billed to the client
monthly in arrears, and upon their approval, charged directly to their account.
The Company takes an integrated approach to asset administration rather
than the functional approach of some of its competitors. The Company has
integrated the components of the custody and accounting task (e.g., trade
settlement, income collection, corporate actions, general ledger accounting,
portfolio accounting and pricing) and dedicates a single operations team to
handle all work for a particular account or fund, instead of using separate
departments to manage these custody and accounting functions. In addition, each
client is assigned a Client Manager, independent of the operations team, to
anticipate the client's needs, to coordinate service delivery, and to provide
consulting support. The Company's accounting control group independently checks
and verifies transfer agency, custody and administrative operations each day.
The following is a description of the various services offered by the
Company.
Domestic Custody. Custody entails overseeing the safekeeping of client
securities and settlement of portfolio transactions. The Company's domestic
assets under custody have grown from $22 billion at October 31, 1990 to $102
billion at December 31, 1996. Custody functions are fully integrated with
security movement and control, portfolio accounting, general ledger accounting,
and pricing and evaluation through FACTS. Custody functions include:
. Settlement of purchases and sales of securities.
. Safekeeping of securities and cash.
. Tracking and collection of income and receivables, such as dividends
and distributions.
. Reconciliation of cash and security positions.
. Disbursement of expenses.
. Calculation and reporting of cash availability to asset managers.
. Reporting and processing of corporate actions, such as stock splits
and bond calls.
. Initiation of settlement inquiries, including reclaims for foreign tax
withholding.
. Periodic reporting of holdings, transactions, income, corporate
actions and cash flow.
Foreign Custody. Foreign custody includes the safekeeping of cross-border
securities for clients, such as the safekeeping of Hong Kong stocks for a Dutch
mutual fund or German bonds held for a U.S. bank-sponsored mutual fund. The
Company entered the foreign custody marketplace in 1988, when the nature of
foreign custody began to change dramatically. In the 1970s, foreign custody was
a series of manual, labor intensive exchanges; settlement was a slow process
where most securities were re-registered and vaulted in the U.S. and the volume
of assets was relatively small. Major developed countries
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throughout the world have evolved to highly automated environments, and the
transition in developing countries is proceeding rapidly. At December 31, 1996,
the Company's foreign assets under custody totaled approximately $9 billion.
Given the evolution of information technology and the industry's acceptance
of computer technology as the preferred vehicle to support foreign custody, the
Company established a worldwide network of global subcustodians. In countries
with centralized clearing houses such as Euroclear, the Company establishes a
subcustodian relationship with the clearing house and is able to receive
information from the subcustodian in electronic format directly onto FACTS. In
nations without automated environments, subcustodians hold physical securities
in their own vaults and provide reporting in hard copy format to the Company for
input onto FACTS. Today, the Company has custody agreements in 72 countries,
typically with regional providers of custody services. Since the Company does
not have its own branches in these countries, it is able to operate in the
foreign custody arena with minimal fixed costs, while the Company's clients
benefit from the ability to use only one custodian, the Company, for their
international investment needs.
Multicurrency Accounting. Multicurrency accounting entails the daily
recordkeeping for each account or investment vehicle, including calculations of
net asset value per share, dividend rates per share, and the maintenance of all
books, records and financial reports required by the Securities and Exchange
Commission and other regulatory agencies. Due to the growth in international
investments by asset managers, traditional fund accounting tasks must be
reconciled across multiple currencies. The primary approach of the Company is
to bundle the sale of fund accounting and custody services in order to work
within the natural efficiencies and control mechanisms of its integrated
custody/fund accounting system and operational philosophy. Multicurrency
accounting functions include:
. Maintenance of the books and records of a fund in accordance with the
Investment Company Act of 1940.
. Tracking of investment transactions for use in the calculation of tax
gains and losses.
. Calculation and accrual of expenses.
. Booking of purchases, redemptions and transfers of fund shares as
directed by the transfer agent.
. Calculation of gains and losses by security and currency.
. Determination of net income.
. Calculation of daily yield in accordance with Securities and Exchange
Commission formula requirements.
. Preparation of statements of assets and liabilities and statements of
operations.
. Computation of the market value of the account.
. Calculation of the daily Net Asset Value of the account and reporting
of this value to National Association of Securities Dealers for
publication in newspapers.
In addition to providing the above services to domestic-based accounts and
investment vehicles, the Company also provides offshore fund accounting. The
Company views the offshore market as a significant business opportunity and will
continue to invest in expansion to support client demand. The Company's Toronto
operations, conducted by the Company's wholly-owned Canadian subsidiary,
currently provide offshore services to 39 portfolios. As of December 31, 1996,
the Canadian subsidiary processed over $12 billion in assets requiring the
calculation of 84 daily net asset values. In 1994, the Company opened a
processing site in Dublin to service European clients and in February 1996, it
opened a small administration site in the Cayman Islands for Caribbean-based
funds.
The technology requirements of the offshore fund accounting operations are
facilitated by the architecture of FACTS. FACTS allows microcomputers located
at offshore processing centers to use the FACTS software system to perform the
components of account processing on-site in compliance with local jurisdiction
and Internal Revenue Service requirements for off-shore investment funds, while
utilizing the Company's mainframe processing, storage and archive capabilities.
In contrast, other fund accounting providers typically utilize entirely separate
systems for domestic and offshore processing.
Mutual Fund Administration. The Company provides mutual fund
administration services, including management reporting, regulatory reporting,
and tax and accounting reporting. Management reporting consists of information
and reporting which is of primary interest to the fund's asset managers and its
board of trustees and includes:
. Preparation of detailed quarterly financial information for
presentation to fund management and its board of trustees.
. Monitoring the reporting of net asset value, settlement of trades, and
processing of stockholder transactions.
. Monitoring compliance with investment portfolio restrictions.
. Calculation of fund dividends to be declared in accordance with
management guidelines.
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. Preparation and monitoring of a fund's expense budget.
Regulatory reporting is the reporting and accumulation of information
required of the fund by the Securities and Exchange Commission and state
securities regulators and includes:
. Coordination of preparation and filing of Securities and Exchange
Commission reports.
. Maintenance of effective "blue sky" registrations in jurisdictions
selected for fund sales.
. Coordination of the preparation and printing of stockholder reports.
. Preparation of prospectus update and proxy material.
. Coordination of on-going "blue sky" compliance.
Tax and accounting reporting is required either by the fund's auditors or
by Internal Revenue Service rules and regulations and includes:
. Performing portfolio compliance testing to establish qualification as
a regulated investment company.
. Preparation of income and excise tax returns.
. Preparation of audit package for use by independent public
accountants.
. Coordination of review of income, capital gains, and distribution
information.
The Company also provides mutual fund start-up services in addition to
ongoing services. The Company has worked with a number of investment advisors
to assist them in the development of new mutual funds. Its services typically
include assistance with product definition, service provider selection, and fund
structuring and registration. The Company's Administration Group is staffed by
48 accounting and legal professionals who have prior experience in either mutual
fund complexes or mutual fund servicing organizations.
Investment Advisory. In November 1996, the Bank executed agreements with
the Merrimac Master Portfolio and the Merrimac Funds, newly formed master-feeder
investment companies, pursuant to which the Company has agreed to act as
investment adviser to the Funds. At the same time, the Company engaged The Bank
of New York to act as sub-adviser to manage the investments of the Funds.
Currently, the Funds have one operating master fund, the Merrimac Cash
Portfolio, and one operating feeder fund, the Merrimac Cash Fund, with assets
totaling over $1 billion at December 31, 1996. The Merrimac Cash Fund offers
its shares only to institutions and other "accredited investors" (as that term
is defined in Rule 501(a) under the Securities Act of 1933) and invests all of
its assets in the Merrimac Cash Portfolio. The Merrimac Cash Portfolio invests
its assets in high quality money market instruments. The Funds may add
additional feeder funds and/or master funds in the future.
Foreign Exchange. The Company offers foreign exchange services to
facilitate settlement of international securities transactions for U.S. dollar
denominated mutual funds and other accounts and to convert income payments
denominated in a non-U.S. currency to U.S. dollars. By using the Company rather
than a third party foreign exchange bank to perform these functions, clients
reduce the amount of time spent coordinating currency delivery and monitoring
delivery failures and claims. The Company, as principal, enters into a foreign
exchange contract with a client and simultaneously enters into a matched trade
with another financial institution. The current volume of trades processed by
the Company is approximately 20,000 trades per year, which vary in size. The
Company initiates foreign exchange transactions only in response to a client's
request and engages in no foreign exchange trading transactions for its own
account. Foreign exchange fee revenue totaled $536,000, $1,044,000, $237,000,
and $2,106,000 for the years ended October 31, 1994 and 1995, for the Transition
Period, and for the year ended December 31, 1996, respectively.
Securities lending. Securities lending involves the lending of clients'
securities to brokers and other institutions for a fee, which improves a
client's return on the underlying securities. The Company acts as agent for its
clients for both international and domestic securities lending services.
Currently, lending services are provided to seven clients, and the current loan
portfolio aggregates approximately $1.1 billion. The Company retains as
compensation a portion of the lending fee due to the client as owner of the
borrowed asset. Securities lending fee revenue totaled $1,181,000, $1,142,000,
$157,000 and $1,947,000 for the years ended October 31, 1994 and 1995, for the
Transition Period, and for the year ended December 31, 1996, respectively.
Through a network of broker/dealers, the Company places the securities out
on loan pursuant to client instruction, delivers the subject securities and
performs the necessary loan accounting. Accounting entails monitoring each
security out on loan by broker, allocating the loans to each fund, tracking the
fixed or variable rebate due the broker, updating the daily
8
investments, applying the earnings to each security loan and preparing daily and
monthly earnings statements for each fund and all the brokers.
All loans are fully collateralized with cash, government securities or a
letter of credit. This collateral is reinvested according to each client's
instructions. The Company monitors all outstanding loans on a daily basis by
reviewing exposure by broker, performing asset reconciliations, and marking each
security to market to ensure that proper collateral levels are maintained.
Institutional Transfer Agency. Transfer agency encompasses mutual fund
shareholder recordkeeping and communications. Services include tracking capital
shares, fulfilling purchase, transfer, and redemption requests, and sending
account statements, tax reporting information and distributions to shareholders.
The Company provides mutual fund shareholder servicing and recordkeeping for
clients representing approximately 26,000 shareholder accounts. These services
are generally provided only to institutional clients with smaller numbers of
outstanding shareholders or omnibus positions of retail shareholders.
Performance Measurement. Performance measurement services involve the
creation of systems and databases that enable asset managers to construct,
manage and analyze their portfolios. Services include portfolio profile
analysis, portfolio return analysis, and customized benchmark construction.
Performance measurement uses data already captured by FACTS to calculate
statistics and report them to asset managers. The Company provides this service
for an aggregate of over $16 billion in assets managed by 49 investment
advisors.
Private Banking Services. The Company offers private banking services to
individuals, family groups, trusts, endowments and foundations, and retirement
plans. The Company develops this client base by forming relationships with
investment advisors and working with the advisors to service mutual clients.
The Company services individually managed trust and custody accounts that
numbered approximately 6,100 at December 31, 1996. The Company does not conduct
consumer banking operations.
Acting as a fiduciary, the Company provides trust administration and estate
settlement services. These services include on-going fiduciary review of the
trust instrument, collection and safekeeping of assets, distribution of income,
appropriate reporting for court and tax purposes, preparation of tax returns,
and distribution of assets as required. The Company does not provide investment
advice, but works closely with third-party investment advisors chosen by each
client to carry out the investment of assets. Custody services, such as the
safekeeping of securities and the settlement of securities transactions, are
also provided to these clients. Custody service fees are determined based on
assets under custody and number of transactions in each account.
Because it was a subsidiary of Eaton Vance, prior to the Spin-Off
Transaction the Company was restricted by CEBA from making commercial loans or
from writing residential mortgages. As a result, the Company has traditionally
specialized in lending to individuals and non-profit institutions on a secured
basis.
At December 31, 1996, the Company had gross loans outstanding to
individuals and non-profit institutions of approximately $66 million, which
represented 7% of the Company's total assets. The interest rates charged on the
Bank's loans are indexed to either the prime rate or the rate paid on 90-day
Treasury bills. The Company has never had a loan loss, and has no delinquent
loans. Other than a loan made to a non-profit association for purposes of the
Community Reinvestment Act, all loans are secured by marketable securities and
are due on demand.
Commercial Banking Services. As a result of the Spin-Off Transaction, the
Company is now able to offer commercial banking services. The Company offers
credit lines to its clients for the purpose of leveraging portfolios and
covering overnight cash shortfalls. Since the Spin-Off Transaction, the Company
has entered into agreements to provide up to an aggregate of $40 million under
secured lines of credit to mutual fund clients. Additionally, the Company's
clients, which consist mainly of managers of mutual funds, unit investment
trusts and other pooled asset products, typically generate large cash balances
from securities sales and other transactions which they wish to invest on a
short-term basis. Because the Company was subject to a 7% annual asset growth
cap under CEBA, it was not able to accept those deposits and directed those
deposits to other financial institutions. The Company directed an average of
approximately $1.2 billion of such deposits daily to other financial
institutions in fiscal year 1995. Since the completion of the Spin-Off
Transaction and the Offering, the Company has redirected an average of
approximately $734 million daily of these balances into its own deposit products
and may now offer these deposit services directly to existing and potential
clients.
9
SALES, MARKETING AND CLIENT SUPPORT
The Company employs a direct sales staff of five employees that targets
potential market areas, including investment management companies, insurance
companies, banks and investment advisors. Sales personnel are primarily based
at the Company's headquarters in Boston and are given geographic area sales
responsibility. Additionally, the Company provides the sales staff with market
data and presentation materials. Senior managers from all functional areas are
directly involved in obtaining new clients, frequently working as a team with a
sales professional.
New client contacts are generated by a variety of methods, including client
referrals, personal sales calls, attendance at trade shows and seminars,
advertising in trade publications, and direct mailing to targeted clients.
In order to service existing clients, a client management staff of
approximately 12 professionals based in the Company's Boston office provides
client support. Each client is assigned a Client Manager responsible for the
overall satisfaction of the client. The Client Manager is usually a senior
professional with extensive industry experience and works with the client on
contracts, new products and specific systems requirements.
SIGNIFICANT CLIENTS
The Company presently provides services to approximately 51 mutual fund
complexes and insurance companies. The Company's current largest client, Eaton
Vance, accounted for 18%, 14%, 11% and 10% of the Company's net operating
revenues for the years ended October 31, 1994 and 1995, for the Transition
Period, and for the year ended December 31, 1996, respectively. A former client
of the Company, Merrill Lynch, accounted for 16% and 5% of the Company's net
operating revenues for the years ended October 31, 1994 and 1995, respectively.
Merrill Lynch paid the Company to assign the Company's servicing rights to The
Bank of New York effective March 1, 1995 and therefore accounted for no net
operating revenue in the Transition Period or in the year ended December 31,
1996. The percentages of consolidated revenues attributable to Eaton Vance and
Merrill Lynch for the periods referenced above were substantially the same as
the percentages of net operating revenues described above. Eaton Vance
accounted for 10% of the Company's consolidated revenues for the Transition
Period. No single client represented more than 10% of the Company's
consolidated revenues for the year ended December 31, 1996. No other single
client of the Company represented more than 10% of net operating revenues or
consolidated revenues for the periods discussed above. Eaton Vance has been a
client of the Company since 1975. The Company's agreements with mutual funds
managed by Eaton Vance, pursuant to which the Company provides custody and fund
accounting services, extend through August 2000 and continue thereafter until
terminated by either party upon sixty days prior notice. If a majority of non-
interested trustees of a fund determines that the performance of the Company
under any such agreement has been unsatisfactory or adverse to the interests of
the fund's shareholders, or that the terms of the agreement are no longer
consistent with publicly available industry standards, the Company shall have 60
days after receipt of written notice to such effect to (i) correct its
performance or (ii) renegotiate such terms. If such corrective action or
renegotiation is not satisfactory to such trustees, such agreement may be
terminated on sixty days prior notice. The Company has long-term contracts with
15 other clients with terms ranging from two to five years. Total assets
processed under long-term contracts at December 31, 1996 were over $45 billion.
All other client engagements are, and in the future may be, terminable upon 60
days notice.
SOFTWARE SYSTEMS AND DATA CENTER
The Company's asset administration operations are supported by
sophisticated computer technology. The Company receives vast amounts of
information across a world-wide computer network. That information, which
covers a wide range of global security types and complex portfolio structures in
various currencies, must then be processed, resulting in system-wide updating
and reporting. The Company must have the capability to provide not only daily
and periodic reports of asset accounting and performance, but also to provide
measurement and analytical data to asset managers on-line on a real time basis.
These technology requirements call for powerful and sophisticated computer
hardware and software systems operated in a cost effective manner.
The primary software system used by the Company is FACTS. The system was
developed over a four-year period by the Bank of New England, and was put into
operation in 1986. It was acquired by the Company in 1990 in connection with
the acquisition by the Company of the Financial Products Services Division of
the Bank of New England.
10
FACTS utilizes microcomputers networked to a mainframe computer system.
The microcomputers can be located in any location with the requisite
telecommunications network for the automated interface to the mainframe,
enabling the Company to provide geographically dispersed processing services
effectively and efficiently. The microcomputer to mainframe configuration also
provides redundant processing capability; if the mainframe fails, FACTS is able
to process independently on the microcomputers.
FACTS emphasizes efficiency and accuracy because it integrates custody,
securities movement and control, portfolio accounting, general ledger
accounting, pricing, net asset value calculation, and Hub and Spoke processing
into a single system. The traditional industry approach is to have separate
applications for each of these functions and to interconnect the component
applications with manual intervention at various points in the process.
The integrated and automated nature of FACTS is best reflected in following
a transaction through the system. For example, a purchase of a security is
entered on a client trading system and the transaction information is
electronically transmitted to FACTS. The receipt of the trade information by
FACTS will trigger the following activities with no manual intervention by the
Company:
. Creation of a Securities Movement and Control transaction to track and
control the trade for the entire settlement cycle (e.g., confirmation,
affirmation, settlement).
. Updating of the portfolio position for the security being purchased.
. Immediate updating of all required general ledger accounts.
. Creation of a pricing record to enable pricing of the security and
inclusion in the total market value and net asset value determination.
. Affirmation and settlement of the trade upon notification from the
counterparty with associated transaction and general ledger updates
occurring simultaneously.
. Accounting for all income for the holding period of the security.
FACTS also complies with current industry standards such as the requirement
that mandates a three business day settlement cycle for public securities
transactions rather than the traditional five business day cycle. The
enhancements made to FACTS to address this change included enabling FACTS to
interact with the Depository Trust Company via its new Interactive Institutional
Delivery System, which allows institutions to confirm trades earlier in the
trade life cycle.
The integrated nature of FACTS architecture allows the Company to affect
modifications and enhancements quickly, resulting in increased processing
quality and efficiency for the Company's clients. This integrated architecture
helps differentiate the Company from its competitors. System enhancements and
upgrades are an ongoing part of asset administration, both to keep ahead of the
competition and to create information delivery mechanisms that add value to the
information available as part of clearing and settling transactions. During the
past two years, the Company has developed standardized data extracts and
automated interfaces that allow its clients to connect electronically with the
Company's host computer and access data collected from clearance and settlement
transactions in multiple currencies on a real-time basis. This electronic
linkage also positions the Company to respond quickly to client requests.
A substantial portion of the Company's electronic transaction processing
services depends upon a mainframe computer system, owned and operated by
Electronic Data Systems ("EDS"), contained in the EDS Information Processing
Center ("IPC") in Camp Hill, Pennsylvania. Processing and networking functions
and equipment are located at the IPC, and in the Boston and Detroit metropolitan
areas. The Company has outsourced its mainframe data processing to EDS since
December 1990. By outsourcing data processing, the Company can focus its
resources on its core line of business and minimize its capital investment in
computer equipment. EDS is able to offer the Company up to date computer
products and services to which it would not otherwise have access, while
removing the risk of product obsolescence. Due to its diverse customer base,
EDS can invest in the latest computer technology and spread the costs over
multiple users. In addition, the defined pricing provided by EDS for products
and services allows the Company to match its data processing cost with the
related revenue stream. The use of EDS as a hardware provider allows the
Company to dedicate its efforts to the ongoing enhancement of its software
systems while receiving the benefit of the continuing investment by EDS in its
computer hardware.
EDS provides mainframe disaster recovery services. EDS maintains
additional processing equipment at the Camp Hill IPC and at a designated
alternate IPC which may be used in the event of equipment failure. The Camp
Hill facility is also supported by an uninterruptable power supply and diesel
generators which can supply power to continue operations for an extended period
of time. Critical software and data files are backed-up daily and stored off-
site. Disaster recovery plans are
11
tested through simulations conducted by the Company twice a year.
Notwithstanding these precautions, there can be no assurance that a fire or
other natural disaster affecting the data center would not disable the host
computer system.
The current agreement between the Company and EDS obligates EDS to provide
the Company with comprehensive data processing services and obligates the
Company to utilize EDS's services for substantially all of its data processing
requirements. The Company is billed for these services monthly on an as-used
basis as determined by a pricing schedule for specific products and services.
EDS began providing services to the Company in December 1990 and the current
agreement is scheduled to expire on December 31, 2000.
COMPETITION
The market for asset administration services is highly competitive. The
Company's most significant competitors are State Street Boston Company, The Bank
of New York, Chase Manhattan Corp., Brown Brothers Harriman & Co., and PNC Bank.
These competitors possess substantially greater financial, sales and marketing
resources than the Company and process a greater amount of financial assets than
the Company. In addition, the Company also encounters competition in the sale
of fund accounting services from large in-house accounting departments of mutual
fund complexes, insurance companies and banks offering proprietary mutual funds.
Competitive factors include technological advancement and flexibility, breadth
of services provided and quality of service. The Company believes that it
competes favorably in these categories.
INTELLECTUAL PROPERTY
The Company's success is dependent upon its software development
methodology and other intellectual property rights developed and owned by the
Company, including FACTS. The Company relies on a combination of trade secret,
nondisclosure and other contractual arrangements and technical measures, and
copyright and trademark laws to protect its proprietary rights. The Company
generally enters into confidentiality agreements with its employees and
consultants, and limits access to and distribution of its proprietary
information. There can be no assurance that the steps taken by the Company in
this regard will be adequate to deter misappropriation of its proprietary
information or that the Company will be able to detect unauthorized use and take
appropriate steps to enforce its intellectual property rights. Furthermore,
such protections may not preclude competitors from developing products and
services with functionality or features similar to those of the Company. In
addition, effective copyright, trademark and other trade protection may not be
available in certain international markets serviced by the Company. Finally,
there can be no assurance that intellectual property protection will be
available in certain foreign countries. The registration of the service mark
Investors Bank & Trust Company will remain in force until 2006, at which time it
may be renewed.
Although the Company believes that its services do not infringe on the
intellectual property rights of others, there can be no assurance that such a
claim will not be asserted against the Company in the future.
EMPLOYEES AND TRAINING
As of December 31, 1996, the Company had 792 full-time employees, including
seven in senior management, 19 in marketing and client management, 662 in
operations and 104 in general and administration. None of the Company's
employees are represented by a union. The Company believes that its relations
with its employees are good.
The Company has developed a five-week professional development program for
entry level staff. Successful completion of the program is required of all
newly hired employees. Topics covered during the program include an overview of
the financial services industry and pooled asset vehicles, principles of mutual
fund accounting and custody, instruction in control procedures, manual
performance of fund accounting tasks and intensive training on FACTS. This
training program is supplemented by ongoing education on the industry and client
base.
The Company's business is labor-intensive, and its success depends to a
significant extent upon a number of key management employees and skilled
technical, managerial and marketing personnel, few of which are bound by
employment agreements. From October 31, 1990 to December 31, 1996, the
Company's staff increased from 463 to 792 employees.
12
REGULATION AND SUPERVISION
In addition to the generally applicable state and federal laws governing
businesses and employers, the Company and the Bank are further regulated by
federal and state laws and regulations applicable only to financial institutions
and their parent companies. Virtually all aspects of the Company's and the
Bank's operations are subject to specific requirements or restrictions and
general regulatory oversight. State and federal banking laws have as their
principal objective either the maintenance of the safety and soundness of
financial institutions and the federal deposit insurance system or the
protection of consumers or classes of consumers, rather than the specific
protection of stockholders of a bank or its parent company. To the extent the
following material describes statutory or regulatory provisions, it is qualified
in its entirety by reference to the particular statute or regulation.
The Company
General. The Company, as a bank holding company, is subject to regulation
and supervision by the Federal Reserve Board (the "FRB") and by the
Massachusetts Commissioner of Banks (the "Commissioner"). The Company is
required to file annually a report of its operations with, and is subject to
examination by, the FRB and the Commissioner. The FRB has the authority to
issue orders to bank holding companies to cease and desist from unsound banking
practices and violations of conditions imposed by, or violations of agreements
with, the FRB. The FRB is also empowered to assess civil monetary penalties
against companies or individuals who violate the Bank Holding Company Act of
1956, as amended, (the "BHCA") or orders or regulations thereunder, to order
termination of non-banking activities of non-banking subsidiaries of bank
holding companies, and to order termination of ownership and control of a non-
banking subsidiary by a bank holding company.
BHCA -Activities and Other Limitations. The BHCA prohibits a bank holding
company from acquiring substantially all the assets of a bank or acquiring
direct or indirect ownership or control of more than 5% of the voting shares of
any bank, or increasing such ownership or control of any bank, or merging or
consolidating with any bank holding company without prior approval of the FRB.
No approval under the BHCA is required, however, for a bank holding company
already owning or controlling 50% or more of the voting shares of a bank to
acquire additional shares of such bank. The Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994 (the "Interstate Act") generally authorizes
bank holding companies to acquire banks located in any state. In addition, the
Interstate Act generally authorizes national and state chartered banks to merge
across state lines (and thereby create interstate branches) commencing June 1,
1997. Under the provisions of the Interstate Act, states are permitted to "opt
out" of this latter interstate branching authority by taking action prior to the
commencement date. States may also "opt in" early (i.e., prior to June 1, 1997)
to the interstate merger provisions.
The BHCA also prohibits a bank holding company from acquiring a direct or
indirect interest in or control of more than 5% of the voting shares of any
company which is not a bank or bank holding company and from engaging directly
or indirectly in activities other than those of banking, managing or controlling
banks or furnishing services to its subsidiary banks, except that it may engage
in and may own shares of companies engaged in certain activities the FRB has
determined to be so closely related to banking or managing and controlling banks
as to be a proper incident thereto. In making such determinations, the FRB is
required to weigh the expected benefit to the public, such as greater
convenience, increased competition or gains in efficiency, against the possible
adverse effects, such as undue concentration of resources, decreased or unfair
competition, conflicts of interests or unsound banking practices.
The FRB has by regulation determined that certain activities are closely
related to banking within the meaning of the BHCA. Should the Company desire to
expand its activities beyond its current financial services activities, it would
generally be limited to the following activities: operating a mortgage company,
finance company, credit card company, factoring company, trust company or
savings association; performing certain data processing operations; providing
limited securities brokerage services; acting as an investment or financial
advisor; acting as an insurance agent for certain types of credit-related
insurance; leasing personal property on a full-payout, non-operating basis;
providing tax planning and preparation services; operating a collection agency;
and providing certain courier services. The FRB also has determined that
certain other activities, including real estate brokerage and syndication, land
development, property management and underwriting of life insurance not related
to credit transactions, are not closely related to banking and a proper incident
thereto.
Commitments to Affiliated Institutions. Under FRB policy, the Company is
expected to act as a source of financial strength to the Bank and to commit
resources to support the Bank in circumstances when it might not do so absent
such policy and is expected to maintain the financial flexibility and capital-
raising capacity to obtain additional resources for assisting the Bank. The
legality and precise scope of this policy is unclear, however, in light of
federal judicial precedent. Additionally, the
13
Federal Deposit Insurance Act (the "FDIA") requires the holding company parent
of an undercapitalized bank to guarantee, up to certain limits, the bank's
compliance with a capital restoration plan approved by the bank's primary
federal supervisory agency. Because Investors Financial Services Corp., as a
holding company for the Bank, has no assets other than its ownership interest in
the Bank, its ability to serve as a source of strength to the Bank through the
contribution of capital is, presently, limited to contributing proceeds from the
sale of securities such as the Capital Securities discussed under "Market for
Registrant's Common Equity and Related Stockholder Matters - Recent Sales of
Unregistered Securities."
Capital Requirements. The FRB has adopted capital adequacy guidelines
pursuant to which it assesses the adequacy of capital in examining and
supervising a bank holding company and in analyzing applications to it under the
BHCA. These capital adequacy guidelines generally require bank holding
companies to maintain total capital equal to 8% of total risk-adjusted assets
and off-balance sheet items, with at least one-half of that amount consisting of
Tier I or core capital and the remaining amount consisting of Tier II or
supplementary capital. Tier I capital for bank holding companies generally
consists of the sum of common stockholders' equity and perpetual preferred stock
(subject in the case of the latter to limitations on the kind and amount of such
stocks which may be included as Tier I capital), less goodwill. Tier II capital
generally consists of hybrid capital instruments; perpetual preferred stock
which is not eligible to be included as Tier I capital; term subordinated debt
and intermediate-term preferred stock; and, subject to limitations, general
allowances for loan losses. Assets are adjusted under the risk-based guidelines
to take into account different risk characteristics, with the categories ranging
from 0% (requiring no additional capital) for assets such as cash to 100% for
such assets as premises, plant and equipment and traditional consumer loans.
Claims on, or guaranteed by, U.S. government agencies, as well as the portion of
claims that are collateralized by securities issued or guaranteed by the U.S.
Treasury are assigned a 20% level in the risk-weighting system. Off-balance
sheet items also are adjusted to take into account certain risk characteristics.
In addition to the risk-based capital requirements, the FRB requires bank
holding companies to maintain a minimum leverage capital ratio of Tier I capital
(defined by reference to the risk-based capital guidelines) to total assets of
3.0%. Total assets for this purpose does not include goodwill and any other
intangible assets and investments that the FRB determines should be deducted
from Tier I capital. The FRB has announced that the 3.0% Tier I Leverage
Capital Ratio requirement is the minimum for the top-rated bank holding
companies without any supervisory, financial or operational weaknesses or
deficiencies or those which are not experiencing or anticipating significant
growth. Because the Bank, and consequently, the Company, anticipates
significant future growth, the Company will be required to maintain Tier I
Leverage Capital Ratios of at least 4.0% to 5.0% or more. Management currently
intends to maintain Tier I Leverage Capital Ratios of 6.0%.
The Company currently is in compliance with both the Risk Based Capital
Ratios and the Leverage Capital Ratio requirements. At December 31, 1996, the
Company had Tier I Risk Based Capital Ratio and Total Risk Based Capital Ratio
equal to 24.67% and 24.71%, respectively and Tier I Leverage Capital Ratio equal
to 6.30%.
Limitations of Acquisitions of Common Stock. The Federal Change in Bank
Control Act prohibits a person or group of persons from acquiring "control" of a
bank holding company unless the FRB has been given 60 days prior written notice
of such proposed acquisition and within that time period the FRB has not issued
a notice disapproving the proposed acquisition or extending for up to another 30
days the period during which such a disapproval may be issued. An acquisition
may be made prior to expiration of the disapproval period if the FRB issues
written notice of its intent not to disapprove the action. Under a rebuttable
presumption established by the FRB, the acquisition of 10% or more of a class of
voting stock of a bank holding company with a class of securities registered
under Section 12 of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") would, under the circumstances set forth in the presumption,
constitute the acquisition of control.
In addition, any company, as that term is defined in the statute, would be
required to obtain the approval of the FRB under the BHCA before acquiring 25%
(5% in the case of an acquirer that is a bank holding company) or more, or such
lesser percentage as the FRB deems to constitute control over the Company, of
the outstanding Common Stock of the Company. Such approval would be contingent
upon, among other things, the acquirer registering as a bank holding company,
divesting all impermissible holdings and ceasing any activities not permissible
for a bank holding company.
Massachusetts Law. Massachusetts law generally defines a bank holding
company as a company which owns or controls two or more financial institutions.
Although the Company owns or controls only one financial institution, it is
deemed a bank holding company for purposes of Massachusetts law due to the
manner in which it acquired the Bank. Accordingly, the Company has registered
with the Commissioner and is obligated to make reports to the Commissioner.
Further, as a Massachusetts bank holding company, the Company may not acquire
all or substantially all of the assets of a banking institution or merge or
consolidate with another bank holding company without the prior consent of the
Board of Bank Incorporation (the
14
"BBI"). As a condition of such consent, the BBI must receive notice from the
Massachusetts Housing Partnership Fund (the "Fund") that arrangements
satisfactory to the Fund have been made by the Company to make 0.9% of its
assets available for financing, down payment assistance, share loans, closing
costs and other costs related to programs promoted by the Fund, including those
related to creating affordable rental housing, limited equity cooperatives, and
tenant management programs.
The Bank
General. The Bank is subject to extensive regulation and examination by
the Commissioner and by the FDIC, which insures its deposits to the maximum
extent permitted by law, and to certain requirements established by the FRB.
The federal and state laws and regulations which are applicable to banks
regulate among other things, the scope of their business, their investments,
their reserves against deposits, the timing of the availability of deposited
funds and the nature and amount of and collateral for certain loans.
FDIC Insurance Premiums. The Bank pays deposit insurance premiums to the
FDIC based on an assessment rate established by the FDIC for Bank Insurance
Fund-member institutions. The FDIC has established a risk-based assessment
system under which institutions are assigned to one of three capital groups -
"well capitalized," "adequately capitalized" and "undercapitalized" - which are
defined in substantially the same manner as under the regulations establishing
the prompt corrective action system pursuant to Section 38 of the FDIA, as
discussed below. These three capital groups are then each divided into three
subgroups which reflect varying levels of supervisory concern, from those which
are considered to be healthy to those which are considered to be of substantial
supervisory concern. The matrix so created results in nine assessment risk
classifications, with corresponding assessment rates ranging from .04% for well
capitalized, healthy institutions to .31% for undercapitalized institutions with
substantial supervisory concerns. There is a statutory minimum assessment of
$1,000 per semi-annual period. The Bank is currently subject to the statutory
minimum assessment.
Capital Requirements. The FDIC has promulgated regulations and adopted a
statement of policy regarding the capital adequacy of state-chartered banks
which, like the Bank, are not members of the Federal Reserve System. These
requirements are substantially similar to those adopted by the FRB regarding
bank holding companies, as described above.
The FDIC's capital regulation establishes a minimum 3.0% Tier I Leverage
Capital Ratio requirement for the most highly-rated state-chartered, non-member
banks, with an additional cushion of at least 100 to 200 basis points for all
other state-chartered, non-member banks, which effectively will increase the
minimum Tier I Leverage Capital Ratio for such other banks to 4.0% to 5.0% or
more. Under the FDIC's regulation, highest-rated banks are those that the FDIC
determines are not anticipating or experiencing significant growth and have well
diversified risk, including no undue interest rate risk exposure, excellent
asset quality, high liquidity, good earnings and, in general, which are
considered a strong banking organization, rated composite 1 under the Uniform
Financial Institutions Rating System. A bank having less than the minimum Tier
I Leverage Capital Ratio shall, within 60 days of the date as of which it fails
to comply with such requirement, submit to its FDIC regional director for review
and approval a reasonable plan describing the means and timing by which the bank
shall achieve its minimum leverage capital requirement. A bank which fails to
file such plan with the FDIC is deemed to be operating in an unsafe and unsound
manner, and could be subject to a cease-and-desist order from the FDIC. The
FDIC's amended regulation also provides that any insured depository institution
with a Tier 1 Leverage Capital Ratio less than 2.0% is deemed to be operating in
an unsafe or unsound manner pursuant to Section 8(a) of the FDIA and is subject
to potential termination of deposit insurance. Such an institution, however,
will not be subject to an enforcement proceeding thereunder, solely on account
of its capital ratios if it has entered into and is in compliance with a written
agreement with the FDIC to increase its Tier I Leverage Capital Ratio to such
level as the FDIC deems appropriate and to take such other action as may be
necessary for the institution to be operated in a safe and sound manner. The
FDIC capital regulation also provides, among other things, for the issuance by
the FDIC or its designee(s) of a capital directive, which is a final order
issued to a bank that fails to maintain minimum capital to restore its capital
to the minimum leverage capital requirement within a specified time period.
Such directive is enforceable in the same manner as a final cease-and-desist
order.
The FDIC has augmented the capital leverage ratios described above with a
risk-based capital framework which is more explicitly and systematically
sensitive to the risk profiles of individual banks. Under the risk-based
capital framework, the assets of the Bank are weighted pursuant to the risk
category in which each asset falls. These risk categories are substantially the
same as those described in the discussion of FRB capital requirements above.
Banks generally will be expected to maintain a minimum Tier I Risk Based Capital
Ratio of 4.0% and a Total Risk Based Capital Ratio of 8.0%. Any bank that does
not meet the minimum requirements, or whose capital is otherwise considered
inadequate, generally will be expected to develop and
15
implement a capital plan for achieving an adequate level of capital, consistent
with the provisions of the risk-based capital framework.
At December 31, 1996, the Bank was in compliance with all minimum Federal
regulatory capital requirements which are generally applicable to FDIC insured
banks. As of such date, the Bank had Tier I Risk Based Capital Ratio and Total
Risk Based Capital Ratio equal to 24.67% and 24.71%, respectively, and Tier I
Leverage Capital Ratio equal to 6.30%.
Prompt Corrective Action. Under Section 38 of the FDIA, each federal
banking agency is required to implement a system of prompt corrective action for
institutions which it regulates. The federal banking agencies have promulgated
substantially similar regulations to implement the system of prompt corrective
action established by Section 38 of the FDIA. Under the regulations, a bank
shall be deemed to be (i) "well capitalized" if it has Total Risk Based Capital
Ratio of 10.0% or more, has a Tier I Risk Based Capital Ratio of 6.0% or more,
has a Tier I Leverage Capital Ratio of 5.0% or more and is not subject to any
written capital order or directive; (ii) "adequately capitalized" if it has a
total Risk Based Capital Ratio of 8.0% or more, a Tier I Risk Based Capital
Ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the
definition of "well capitalized," (iii) "undercapitalized" if it has a Total
Risk Based Capital Ratio that is less than 8.0%, a Tier I Risk Based Capital
Ratio that is less than 4.0% or a Tier I Leverage Capital Ratio that is less
than 4.0% (3.0% under certain circumstances), (iv) "significantly
undercapitalized" if it has a Total Risk Based Capital Ratio that is less than
6.0%, a Tier I Risk Based Capital Ratio that is less than 3.0% or a Tier I
Leverage Capital Ratio that is less than 3.0%, and (v) "critically
undercapitalized" if it has a ratio of tangible equity to total assets that is
equal to or less than 2.0%. Section 38 of the FDIA and the regulations also
specify circumstances under which a federal banking agency may reclassify a well
capitalized institution as adequately capitalized and may require an adequately
capitalized institution or an undercapitalized institution to comply with
supervisory actions as if it were in the next lower category, except that the
FDIC may not reclassify a significantly undercapitalized institution as
critically undercapitalized.
An institution generally must file a written capital restoration plan which
meets specified requirements with an appropriate federal banking agency within
45 days of the date that the institution receives notice or is deemed to have
notice that it is undercapitalized, significantly undercapitalized or critically
undercapitalized. A federal banking agency must provide the institution with
written notice of approval or disapproval with 60 days after receiving a capital
restoration plan, subject to extensions by the agency.
An institution which is required to submit a capital restoration plan must
concurrently submit a performance guaranty by each company that controls the
institution. Such guaranty shall be limited to the lesser of (i) an amount
equal to 5.0% of the institution's total assets at the time the institution was
notified or deemed to have notice that it was undercapitalized or (ii) the
amount necessary at such time to restore the relevant capital measure of the
institution to the levels required for the institution to be classified as
adequately capitalized. Such a guarantee shall expire after the federal banking
agency notifies the institution that it has remained adequately capitalized for
each of four consecutive calendar quarters. An institution which fails to
submit a written capital restoration plan within the requisite period, including
any required performance guarantee, or fails in any material respect to
implement a capital restoration plan, shall be subject to the restrictions in
Section 38 of the FDIA which are applicable to significantly undercapitalized
institutions.
A critically undercapitalized institution is to be placed in
conservatorship or receivership with 90 days unless the FDIC formally determines
that forbearance from such action would better protect the deposit insurance
fund. Unless the FDIC or other appropriate federal banking regulatory agency
makes specific further findings and certifies that the institution is viable and
is not expected to fail, an institution that remains critically undercapitalized
on average during the fourth calendar quarter after the date it becomes
critically undercapitalized must be placed in receivership.
Immediately upon becoming undercapitalized, an institution becomes subject
to the provisions of Section 38 of the FDIA (i) restricting payment of capital
distributions and management fees, (ii) requiring that the appropriate federal
banking agency monitor the condition of the institution and its efforts to
restore its capital, (iii) requiring submission of a capital restoration plan,
(iv) restricting the growth of the institution's assets and (v) requiring prior
approval of certain expansion proposals. The appropriate federal banking agency
for an undercapitalized institution also may take any of a number of
discretionary supervisory actions if the agency determines that any of these
actions is necessary to resolve the problems of the institution at the least
possible long-term cost to the deposit insurance fund, subject in certain cases
to specified procedures. These discretionary supervisory actions include
requiring the institution to raise additional capital; restricting transactions
with affiliates; restricting interest rates paid by the institution on deposits;
requiring replacement of senior executive officers and directors; restricting
the activities of the institution and its affiliates; requiring divestiture of
the institution or the sale of the
16
institution to a willing purchaser; and any other supervisory action that the
agency deems appropriate. These and additional mandatory and permissive
supervisory actions may be taken with respect to significantly undercapitalized
and critically undercapitalized institutions.
At December 31, 1996, the Bank was deemed to be a well capitalized
institution for the above purposes. Bank regulators may raise capital
requirements applicable to banking organizations beyond current levels. Because
the Company is unable to predict whether higher capital requirements will be
imposed and, if so, at what levels and on what schedules, it therefore cannot
predict what effect such higher requirements may have on the Company and the
Bank.
Brokered Deposits. The FDIA restricts the use of brokered deposits by
certain depository institutions. Under the FDIA and applicable regulations, (i)
a well capitalized institution may solicit and accept, renew or roll over any
brokered deposit without restriction, (ii) an adequately capitalized institution
may not accept, renew or roll over any brokered deposit unless it has applied
for and been granted a waiver of this prohibition by the FDIC and (iii) an
undercapitalized institution may not (x) accept, renew or roll over any brokered
deposits or (y) solicit deposits by offering an effective yield that exceeds by
more than 75 basis points the prevailing effective yields on insured deposits of
comparable maturity in such institution's normal market area or in the market
area in which such deposits are being solicited. The term "undercapitalized
insured depository institution" is defined to mean any insured depository
institution that fails to meet the minimum regulatory capital requirement
prescribed by its appropriate federal banking agency. The FDIC may, on a case-
by-case basis and upon application by an adequately capitalized insured
depository institution, waive the restriction on brokered deposits upon a
finding that the acceptance of brokered deposits does not constitute an unsafe
or unsound practice with respect to such institution. Currently, the Bank is
deemed to be a well capitalized insured depository institution for purposes of
the restriction on the use of brokered deposits by such institutions. The bank
historically has not relied upon brokered deposits as a source of funding and,
at December 31, 1996, the Bank did not have any brokered deposits.
Transactions with Affiliates. The FDIA restricts the range of permissible
transactions between a member bank and an affiliated company. The Bank is
subject to certain restrictions on loans to the Company, on investment in the
stock or securities thereof, on the taking of such stock or securities as
collateral for loans to any borrower, and on the issuance of a guarantee or
letter of credit on behalf of the Company. The Bank also is subject to certain
restrictions on most types of transactions with the Company, requiring that the
terms of such transactions be substantially equivalent to terms to similar
transactions with non-affiliates.
Activities and Investments of Insured State-Chartered Banks. Section 24 of
the FDIA generally limits the activities and equity investments of FDIC-insured,
state-chartered banks to those that are permissible for national banks. Under
the FDIC's regulations dealing with equity investments, an insured state bank
generally may not directly or indirectly acquire or retain any equity investment
of a type, or in an amount, that is not permissible for a national bank. An
insured state bank is not prohibited from, among other things, (i) acquiring or
retaining a majority interest in a subsidiary, (ii) investing as a limited
partner in a partnership the sole purpose of which is direct or indirect
investment in the acquisition, rehabilitation or new construction of a qualified
housing project, provided that such limited partnership investments may not
exceed 2% of the Bank's total assets, (iii) acquiring up to 10% of the voting
stock of a company that solely provides or reinsures directors', trustees', and
officers' liability insurance coverage or bankers' blanket bond group insurance
coverage for insured depository institutions, and (iv) acquiring or retaining
the voting shares of a depository institution if certain requirements are met.
Community Reinvestment Act. The Federal Community Reinvestment Act ("CRA")
requires the FDIC and the Commissioner to evaluate the Bank's performance in
helping to meet the credit needs of the community. The Bank has been designated
as a "wholesale institution" for CRA purposes by the Commissioner and has an
application for similar treatment pending with the FDIC. This designation
reflects the nature of the Company's business as other than a retail financial
institution and proscribes CRA review criteria applicable to the Bank's
particular type of business. As a part of the CRA program, the Bank is subject
to periodic examinations by the FDIC and the Commissioner, and maintains
comprehensive records of its CRA activities for this purpose. The Bank is
currently in compliance with all CRA requirements.
Massachusetts Law - Dividends. Under Massachusetts law trust companies
such as the Bank may pay dividends only out of "net profits" and only to the
extent that such payments will not impair the Bank's capital stock and surplus
account. If, prior to declaration of a dividend, the Bank's capital stock and
surplus accounts do not equal at least 10.0% of its deposit liabilities, then
prior to the payment of the dividend the Bank must transfer from net profits to
its surplus account the amount required to make its surplus account equal to
either (i) together with capital stock, 10.0% of deposit liabilities or, (ii)
subject to
17
certain adjustments, 100% of capital stock. These restrictions on the ability of
the Bank to pay dividends to the Company may restrict the ability of the Company
to pay dividends to its stockholders.
Regulatory Enforcement Authority. The enforcement powers available to
federal banking regulators include, among other things, the ability to assess
civil money penalties, to issue cease-and-desist or removal orders and to
initiate injunctive actions against banking organizations and institution-
affiliated parties, as defined. In general, these enforcement actions may be
initiated for violations of law and regulations and unsafe or unsound practices.
Other actions or inactions may provide the basis for enforcement action,
including misleading or untimely reports filed with regulatory authorities.
Federal law requires, except under certain circumstances, public disclosure of
final enforcement actions by the federal banking agencies.
Transfer Agency. In order to serve as transfer agent to its clients that
execute transactions in publicly traded securities, the Company must register as
a transfer agent under the Exchange Act. As a registered transfer agent, the
Company is subject to certain reporting and recordkeeping requirements.
Currently, the Company is in compliance with these registration, reporting and
recordkeeping requirements.
Regulation of Investment Companies. Certain of the Company's mutual fund
and unit investment trust clients are regulated as "investment companies" as
that term is defined under the Investment Company Act of 1940, as amended (the
"ICA"), and are subject to examination and reporting requirements applicable to
the services provided by the Company.
The provisions of the ICA and the regulations promulgated thereunder
prescribe the type of institution which may act as a custodian of investment
company assets, as well as the manner in which a custodian administers the
assets in its custody. Because the Company serves as custodian for a number of
its investment company clients, these regulations require, among other things,
that the Company maintain certain minimum aggregate capital, surplus, and
undivided profits. Additionally, arrangements between the Company and clearing
agencies or other securities depositories must meet ICA requirements for
segregation of assets, identification of assets and client approval. Future
legislative and regulatory changes in the existing laws and regulations
governing custody of investment company assets, particularly with respect to
custodian qualifications, may have a material and adverse impact on the Company.
Currently, the Company is in compliance with all minimum capital and securities
depository requirements. Further, the Company is not aware of any proposed or
pending regulatory developments, which, if approved, would adversely affect the
ability of the Company to act as custodian to an investment company.
Investment companies are also subject to extensive recordkeeping and
reporting requirements. These requirements dictate the type, volume and
duration of the record-keeping undertaken by the Company, either in its role as
custodian for an investment company or as a provider of administrative services
to an investment company. Further, the Company must follow specific ICA
guidelines when calculating the net asset value of a client mutual fund.
Consequently, changes in the statutes or regulations governing recordkeeping and
reporting or valuation calculations will affect the manner in which the Company
conducts its operations.
New legislation or regulatory requirements could have a significant impact
on the information reporting requirements applicable to the Company's clients
and may in the short term adversely affect the Company's ability to service
those clients at a reasonable cost. Any failure by the Company to provide such
support could cause the loss of customers and have a material adverse effect on
the Company's financial results. Additionally, legislation or regulations may
be proposed or enacted to regulate the Company in a manner which may adversely
affect the Company's financial results.
18
ITEM 2. PROPERTIES.
As of December 31, 1996, the Company leased four offices located in Boston,
as well as foreign offices in Toronto, Canada and Dublin, Ireland for its
offshore funds processing business.
The following table provides certain summary information with respect to
the principal properties that the Company leases:
Location Function Sq. Ft. Expiration Date
- -------- -------- ------ ---------------
89 South St., Boston, MA Principal Executive Offices 115,504 1997
and Operations Center
200 Clarendon St., Boston, MA Operations Center 25,300 2007
1 Exeter Plaza, Boston, MA Training Center 11,375 2001
24 Federal Street, Boston, MA Operations Center 3,658 Tenant at will
1 First Canadian Place, Toronto Offshore Processing Center 13,674 1997
Earlsfort Terrace, Dublin Offshore Processing Center 3,400 1997
In November 1995, the Company entered into an agreement to lease 158,656
square feet at the 200 Clarendon Street location for a ten-year term to commence
in 1997 in order to consolidate its Boston operations. See Note 14 of Notes to
Consolidated Financial Statements. In December 1996, the Company exercised an
option under this ten-year lease to activate an additional 24,834 square feet at
this location.
ITEM 3. LEGAL PROCEEDINGS.
The Company is from time to time subject to claims arising in the ordinary
course of business. While the outcome of any claim cannot be predicted with
certainty, management does not expect these matters to have a material adverse
effect on the results of operations and financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the Company's security holders
during the quarter ended December 31, 1996.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The Company's Common Stock is currently included in The Nasdaq National Market
under the symbol IFIN. The Company's Common Stock began trading on November 8,
1995 in connection with the Company's initial public offering priced at $16.50
per share. The following table sets forth, on a per share basis for the periods
shown, the range of high and low sales prices of the Company's Common Stock as
reported by Nasdaq.
_____________________
HIGH LOW
---- ---
First Quarter $23.125 $20.500
Second Quarter $23.500 $21.000
Third Quarter $26.000 $20.875
Fourth Quarter $28.000 $25.750
As of February 18, 1997, there were approximately 2,045 stockholders of record.
19
DIVIDENDS
The Company currently intends to retain the majority of future earnings to
fund the development and growth of its business. The Company's ability to pay
dividends on the Common Stock and Class A Common Stock depends on the receipt of
dividends from Investors Bank & Trust Company. In addition, the Company may not
pay dividends on its Common Stock or Class A Common Stock if it is in default
under certain agreements which the Company entered into in connection with the
sale of the 9.77% Capital Securities described below. Any dividend payments by
Investors Bank & Trust Company are subject to certain restrictions imposed by
the Massachusetts Commissioner of Banks. See "Business -Regulation and
Supervision." Subject to regulatory requirements, Investors Bank & Trust
Company expects to pay an annual dividend to the Company, which the Company
expects to pay to its stockholders, currently estimated to be in an amount equal
to $.08 per share of outstanding Common Stock and Class A Stock (approximately
$515,545 based upon 6,444,312 shares outstanding as of December 31, 1996). The
Company expects to declare and pay such dividend ratably on a quarterly basis.
RECENT SALES OF UNREGISTERED SECURITIES
On January 31, 1997, the Company completed the issuance and sale of
$25,000,000 in 9.77% Capital Securities (the "Capital Securities"). The Capital
Securities were issued by Investors Capital Trust I, a Delaware statutory
business trust sponsored by the Company. The sale of the Capital Securities was
underwritten by Keefe, Bruyette & Woods, Inc. ("Keefe"), pursuant to which Keefe
received compensation in the amount of $562,500. The Capital Securities were
sold only to "Qualified Institutional Buyers" (as defined in Rule 144A under the
Securities Act of 1933 (the "Act") and institutional "accredited investors" (as
defined in Rule 501(a)(1), (2), (3) or (7) under the Act) pursuant to the
exemption provided by Section 4(2) of the Act. See Exhibits 10.19 through 10.24
to this Report.
20
ITEM 6. SELECTED FINANCIAL DATA.
Except as discussed below, the selected financial data presented below have
been derived from the Company's audited financial statements. This data should
be read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations," the Company's Consolidated Financial
Statements, and other financial information appearing elsewhere in this Report.
For the Two Months For the Year
For the Year Ended October 31, Ended December 31, Ended December 31,
----------------------------------------------------------------------------------------------
1992 1993 1994 1995(1) 1995 1996
-------------- ----------- ----------- ---------- ----------- -------------
(Dollars in thousands, except per share data)
STATEMENT OF INCOME DATA:
Net interest income $ 3,659 $ 4,494 $ 4,778 $ 5,870 $ 1,966 $ 17,944
Noninterest income 29,664 32,967 43,049 51,562 8,085 56,632
Gain on sale of investment securities - 48 - - - -
-------------- ----------- ----------- ---------- ----------- ------------
Net operating revenues 33,323 37,509 47,827 57,432 10,051 74,576
Operating expenses 30,589 33,939 42,503 50,224 8,481 61,935
-------------- ----------- ----------- ---------- ----------- ------------
Income before income taxes 2,734 3,570 5,324 7,208 1,570 12,641
Income taxes 1,163 1,211 1,863 2,800 670 4,867
-------------- ----------- ----------- ---------- ----------- ------------
Net income $ 1,571 $ 2,359 $ 3,461 $ 4,408 $ 900 $ 7,774
============== =========== =========== ========== =========== ============
PER SHARE DATA
Earnings per share $ 0.14 $ 1.20
=========== ============
Average number of shares outstanding 6,467 6,504
=========== ============
AVERAGE BALANCE SHEET DATA:
Interest earning assets $ 81,148 $ 87,965 $ 94,351 $ 106,130 $ 219,775 $ 575,662
Total assets 99,609 109,477 116,810 128,174 249,064 628,893
Total deposits 88,684 99,523 102,664 106,446 197,013 377,219
Stockholders'equity 7,053 9,022 11,779 16,119 34,000 56,137
SELECTED FINANCIAL RATIOS:
Return on equity (2) 22.27% 26.15% 29.38% 27.35% 15.11% 13.85%
Return on assets (2) 1.58% 2.15% 2.96% 3.44% 2.12% 1.24%
Equity as % of total assets 6.52% 8.24% 10.08% 12.58% 16.57% 6.41%
Dividend payout ratio (3) 3.82% 2.54% 1.73% 1.36% 0.00% 2.49%
Tier 1 capital ratio (4) 37.78% 37.08% 42.53% 37.62% 62.10% 24.67%
Noninterest income as % of net
operating income 89.02% 87.89% 90.01% 89.78% 80.44% 75.94%
Nonperforming assets as % of
total assets 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Allowance for loan losses as %
of total loans 0.59% 0.34% 0.26% 0.26% 0.15% 0.15%
OTHER STATISTICAL DATA:
Assets processed at end of period (5) $43,348,597 $61,239,242 $72,418,449 $91,099,976 $94,208,228 $122,563,401
Employees at end of period 460 522 678 671 674 792
_______________
(1) Noninterest income for the year ended October 31, 1995 includes the
recognition of net proceeds of $2,572,000 from the assignment to a third
party of asset administration rights associated with $5 billion of unit
investment trust assets. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
(2) Ratios for the two months ended December 31, 1995 have been annualized. The
ratios for the year ended October 31, 1995 include the effect of the unit
investment trust transaction described in (1) above. Without the earnings
associated with this transaction, return on equity and return on assets for
the year ended October 31, 1995 would have been 18.10% and 2.28%,
respectively.
(3) The Company intends to retain the majority of future earnings to fund
development and growth of its business but the Company currently expects to
pay cash dividends at an annualized rate of $.08 per share, subject to
receipt of a like dividend from the Bank and further subject to regulatory
requirements and the terms of certain documents entered into in connection
with the sale of the Capital Securities described under "Market for
Registrant's Common Equity and Related Stockholder Matters - Recent Sales of
Unregistered Securities. "
(4) Tier I capital consists of the sum of common stockholders' equity and non-
cumulative perpetual preferred stock minus all intangible assets (other than
certain qualifying goodwill) and excess deferred tax assets.
(5) Assets processed is the total dollar value of financial assets on the
reported date for which the Company provides one or more of the following
services: custody, multicurrency accounting, institutional transfer agency,
performance measurement, foreign exchange, securities lending and mutual
fund administration and investment advisory services.
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The following discussion and analysis of the financial condition and
results of operations of the Company should be read in conjunction with the
Company's Consolidated Financial Statements and related notes, which are
included elsewhere in this Report. The Company, through its wholly owned
subsidiary, Investors Bank & Trust Company, provides domestic and global
custody, multicurrency accounting, institutional transfer agency, performance
measurement, foreign exchange, securities lending and mutual fund administration
and investment advisory services to a variety of financial asset managers,
including mutual fund complexes, investment advisors, banks and insurance
companies. The Company provides financial asset administration services for
assets that totaled approximately $122 billion at December 31, 1996, including
approximately $9 billion of assets based outside the United States. The Company
also engages in private banking transactions, including secured lending and
deposit accounts.
The Company's historical business and financial results have been
significantly influenced by the restrictions imposed under CEBA. Under the CEBA
restrictions, the Company could not: (a) engage in any activity in which it was
not engaged as of March 5, 1987; (b) increase its assets by more than 7% during
any 12-month period beginning after August 10, 1988; (c) engage in certain
cross-marketing activities with affiliates; or (d) permit overdrafts by or incur
overdrafts on behalf of affiliates at a Federal Reserve Bank. As a result of
the Offering and the Spin-Off Transaction, the Company is no longer subject to
such restrictions. Accordingly, the Company's historical operating results may
not necessarily be indicative of either the full scope of the future conduct of
the Company's business or its future operating results.
The Company is now able to expand current business activities and
participate in certain additional business activities which may result in
increased revenues generated by a possible increase in client deposits and
lending opportunities. The Company's clients typically generate cash balances
from securities sales and other transactions which they seek to invest on a
short-term basis. Because the Company had been subject to the CEBA 7% annual
asset growth cap, it was not able to accept those deposits prior to the
completion of the Spin-Off Transaction and directed them to other financial
institutions, foregoing a potential source of revenue. The Company directed
client deposits averaging approximately $1.2 billion daily to other financial
institutions in fiscal year 1995. Since the completion of the Spin-Off
Transaction and the Offering, the Company has redirected an average of
approximately $734 million daily of these balances into its own deposit
products. Similarly, many of the Company's clients use credit lines to leverage
their portfolios or to handle overnight cash shortfalls. CEBA requirements
restricted the Company from making commercial loans of this type. As a result
of the removal of CEBA limitations, the Company is now able to make commercial
loans. Additionally, since the Spin-Off Transaction, the Company has entered
into agreements to provide up to an aggregate of $40 million in secured lines of
credit to mutual fund clients.
In November 1996, the Bank executed agreements with the Merrimac Master
Portfolio and the Merrimac Funds, newly formed master-feeder investment
companies (the "Funds"), pursuant to which the Company has agreed to act as
investment adviser to the Funds. At the same time, the Company engaged the Bank
of New York to act as sub-adviser to manage the investments of the Funds. In
addition to acting as adviser to the Funds, the Bank has entered into agreements
to provide custody, fund accounting, administration, transfer agency and certain
other related services to the Funds. Currently, the Funds have one operating
master fund, the Merrimac Cash Portfolio, and one operating feeder fund, the
Merrimac Cash Fund, with assets totaling over $1 billion at December 31, 1996.
The Merrimac Cash Fund offers its shares only to institutions and other
"accredited investors" (as that term is defined in Rule 501(a) under the
Securities Act of 1933) and invests all of its assets in the Merrimac Cash
Portfolio. The Merrimac Cash Portfolio invests its assets in high quality money
market instruments. The Funds may add additional feeder funds and master funds
in the future.
The Company's current largest client, Eaton Vance, accounted for 18%, 14%,
11% and 10% of the Company's net operating revenues for the years ended October
31, 1994 and 1995, for the Transition Period, and for the year ended December
31, 1996, respectively. The Company believes its relationship with Eaton Vance
is good and expects it to continue. The Company's agreements with mutual funds
managed by Eaton Vance, pursuant to which the Company provides custody and fund
accounting services, extend through August 2000 and continue thereafter until
terminated by either party upon sixty days prior notice. If a majority of
noninterested trustees of a fund determines that the performance of the Company
under any such agreement has been unsatisfactory or adverse to the interests of
the fund's shareholders, or that the terms of the agreement are no longer
consistent with publicly available industry standards, the Company shall have 60
days after receipt of written notice to
22
such effect to (i) correct its performance or (ii) renegotiate such terms. If
such corrective action or renegotiation is not satisfactory to such trustees,
such agreement may be terminated on sixty days prior notice. There have been no
requests for corrective action or renegotiation to date pursuant to these
contract clauses.
The Company derives its revenues from financial asset administration
services and private banking transactions. Although interest income and
noninterest income are reported separately for financial statement presentation
purposes, the Company's clients view the pricing of the Company's asset
administration and banking service offerings on a bundled basis. In
establishing a fee structure for a specific client, management analyzes the
expected revenue and related expenses, as opposed to separately analyzing fee
income and interest income and related expenses for each from such relationship.
Accordingly, management believes net operating revenue (net interest income plus
noninterest income) and net income are meaningful measures of financial results.
Noninterest income consists primarily of fees for financial asset
administration and is principally derived from custody, multicurrency
accounting, transfer agency and administration services for financial asset
managers and the assets they control. The Company's clients pay fees based on
the volume of assets under custody, the number of securities held and portfolio
transactions, income collected and whether other value-added services such as
foreign exchange, securities lending and performance measurement are needed.
Asset-based fees are usually-charged on a sliding scale. As such, when the
assets in a portfolio under custody grow as a result of changes in market values
or cash inflows, the Company's fees may be a smaller percentage of those assets.
Fees for individually managed accounts, such as custodial, trust and portfolio
accounting services for individuals, investment advisors, private trustees,
financial planners, other banks and fiduciaries, and other institutions are also
included in noninterest income.
Net interest income represents the difference between income generated from
interest-earning assets and expense on interest-bearing liabilities. Interest-
bearing liabilities are generated by the Company's clients who, in the course of
their financial asset management, generate cash balances which they deposit on a
short-term basis with the Company. The Company invests these cash balances and
remits a portion of the earnings on these investments to its clients. The
Company's share of earnings from these investments is viewed as part of the
total package of compensation paid to the Company from its clients for
performing asset administration services.
The Company, because it is no longer subject to the CEBA balance sheet
growth restrictions, is able to accept client deposits it had historically
directed to other financial institutions. As compensation for directing these
deposits to other financial institutions, the Company had retained a portion of
the earnings on the deposits; this amount was recognized as fee income.
Generally, the Company invests these deposits in various interest-earning assets
and pays its clients interest expense. As a result, the mix of fee income and
interest income that comprise the total compensation package from clients is
shifting as the relative amount of fee income decreases while the relative
amount of interest income increases.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
From time to time, information provided by the Company, statements made by
its employees or information included in its filings with the Securities and
Exchange Commission (including this Form 10-K) may contain statements which are
not historical facts, so-called "forward-looking statements," which involve
risks and uncertainties. The Company's actual future results may differ
significantly from those stated in any forward-looking statements. Factors that
may cause such differences include, but are not limited to, the factors
discussed below. Each of these factors, and others, are discussed from time to
time in the Company's filings with the Securities and Exchange Commission.
The Company's future results may be subject to substantial risks and
uncertainties. Because certain fees charged by the Company for its services are
based on the market values of assets processed, such fees and the Company's
quarterly and annual operating results are sensitive to changes in interest
rates, declines in stock market values, and investors seeking alternatives to
investment offerings of the Company's clients. Also, the Company's interest-
related services, along with the market value of the Company's investments, may
be adversely affected by rapid changes in interest rates. In addition, many of
the Company's client engagements are, and in the future are likely to continue
to be, terminable upon 60 days notice. Also, a substantial portion of the
assets held in the Merrimac Cash Fund are contributed by accounts managed by the
fund's sub-advisor, The Bank of New York. Because the Company's fee income from
its investment advisory services is based on a percentage of assets invested in
the Merrimac Cash Fund, withdrawal from the fund by the accounts managed by The
Bank of New York could have an adverse affect on the Company's revenues. Also,
the Company relies on certain intellectual property protections to preserve its
intellectual property rights. Any invalidation of the Company's intellectual
property rights or lengthy and expensive defense of
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those rights could have a material adverse affect on the Company. The segment of
the financial services industry in which the Company is engaged is extremely
competitive. Certain current and potential competitors of the Company are more
established and benefit from greater market recognition and have substantially
greater financial, development and marketing resources than the Company.
The Company's quarterly and annual operating results are affected by a wide
variety of factors that could materially adversely affect revenues and
profitability, including: the timing of the commencement or termination of
client engagements, the rate of net inflows and outflows of investor funds in
the debt and equity-based investment vehicles offered by the Company's clients,
the introduction and market acceptance of new services by the Company and
changes or anticipated changes in economic conditions. Because the Company's
operating expenses are relatively fixed, any unanticipated shortfall in revenues
in a specified period may have an adverse impact on the Company's results of
operations for that period. As a result of the foregoing and other factors,
the Company may experience material fluctuations in future operating results on
a quarterly or annual basis which could materially and adversely affect its
business, financial condition, operating results an