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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, 1997
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
200 Clarendon Street
P.O. Box 9130
Boston, Massachusetts 02116
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (617) 330-6700
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 Par Value
Series A Junior Preferred Stock Purchase Rights
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. / /
The aggregate market value of Common Stock held by non-affiliates of the
registrant was $265,287,358 based on the last reported sale price of $44.0625
on The Nasdaq National Market on February 17, 1998 as reported by Nasdaq.
As of February 17, 1998, there were 6,472,188 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant intends to file a definitive Proxy Statement pursuant to
Regulation 14A within 120 days of the end of the fiscal year ended December
31, 1997. Portions of such Proxy Statement are incorporated by reference in
Part III.
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-Registered Trademark-. The Company provides global custody,
multicurrency accounting, institutional transfer agency, performance
measurement, foreign exchange, securities lending, mutual fund administration
and investment advisory services to a variety of financial asset managers,
including mutual fund complexes, investment advisors, banks and insurance
companies. The Company provides financial asset administration services for
assets that totaled approximately $139 billion at December 31, 1997,
including assets managed by 53 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. 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").
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 global custody, multicurrency
accounting, transfer agency, portfolio performance measurement, foreign
exchange, securities lending, administration and investment 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 on the next
page, total financial assets managed by mutual fund companies, insurance
companies, private pension funds and banks have grown at an average annual
rate of over 13% since 1990. Mutual funds, such as those serviced by the
Company, make up a large part of the financial assets in pooled investment
vehicles. The U.S. mutual fund market has grown at an average annual rate of
more than 20% since 1990, with over $4 trillion in assets at September 30,
1997. According to the International Mutual Funds Survey, worldwide fund
assets were over $7 trillion in September 1997, an increase of $5 trillion in
approximately six years.
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TOTAL U.S. FINANCIAL ASSETS DECEMBER 31, SEPTEMBER 30, GROWTH
(IN BILLIONS) 1990 1997 RATE
- --------------------------------------------------------------------------------- ------------ ------------- -----------
Mutual Funds..................................................................... 1,154.6 4,132.2 20.79%
Life Insurance Companies......................................................... 1,367.4 2,510.4 9.42
Private Pension Funds............................................................ 1,610.9 3,523.5 12.30
Bank Personal Trusts and Estates................................................. 522.1 999.2 10.09
------------ -------------
Total............................................................................ 4,655.0 11,165.3 13.84%
------------ -------------
------------ -------------
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 core 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, supports these services with its integrated
functionality, so that information input once is entered into various
administrative subsystems without manual intervention.
Providing asset administration services offshore is a growing activity in
the financial services industry. While the tax laws requiring funds based
outside the U.S. to conduct certain processing from an offshore location were
repealed in 1997, offshore locations are still serving as distribution
channels for offshore funds. In July 1993, the Company opened a subsidiary in
Toronto, Canada to service the offshore mutual fund market. In July 1994, the
Company opened an office in Dublin, Ireland to service investment managers
distributing to European clients. In February 1996, the Company opened an
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 patented variation of the master-feeder
structure, Hub and Spoke-Registered Trademark-, is marketed by Signature
Financial Group, Inc. At December 31, 1997, the Company processed over $40
billion of assets in the master-feeder structures, including $37 billion of
assets processed in the Hub and Spoke structure.
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
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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 administration service industry continues to
experience 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. While
consolidation within the industry may adversely affect the Company's ability
to retain clients that have been acquired, consolidation also creates
opportunity for the Company as prospective clients review their relationships
with existing service providers. The Company's client management, sales and
marketing groups actively monitor these situations as they develop.
COMPANY STRATEGY
Global 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, 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.
- 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
technological 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 to
differentiate the Company from its competitors.
Technological 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. Over the past few years,
the Company 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 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 technology 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 offshore processing capabilities. In July 1994, the Company
opened an office in Dublin, Ireland to service the growing European
client base. Assets processed by the Dublin subsidiary increased from
$27
4
million at December 31, 1996 to over $1.1 billion at December 31,
1997. 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 requirements for offshore
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.
SERVICE OFFERINGS
The Company provides a broad range of asset administration services to
the financial services industry, including global custody, multicurrency
accounting, securities lending, foreign exchange, mutual fund administration,
institutional transfer agency, performance measurement, private banking and
investment advisory services. Global custody and multicurrency accounting are
the principal asset administration services provided to the Company's
clients. Fees charged for these services reflect the highly competitive
nature and price-sensitivity of the market for 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.
Fees charged vary from client to client based on the volume of assets
under custody, the number of securities held and portfolio transactions,
income collected, and whether other value-added services such as foreign
exchange and performance measurement are needed. Generally, fees are billed
to the client monthly in arrears and, upon their approval, charged directly
to their account.
The 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.
GLOBAL CUSTODY. Global custody entails overseeing the safekeeping of
domestic and cross border securities for clients and settlement of portfolio
transactions. The Company's domestic assets under custody have grown from $22
billion at October 31, 1990 to $126 billion at December 31, 1997. Examples of
the safekeeping of cross-border securities for clients include the
safekeeping of Hong Kong stocks for a Dutch mutual fund or German bonds held
for a U.S. bank-sponsored mutual fund. At December 31, 1997, the Company's
foreign assets under custody totaled approximately $9 billion.
Custody functions are fully integrated with security movement and
control, portfolio accounting, general ledger accounting, and pricing and
evaluation through FACTS. Custody functions include:
- Settlement of purchases and sales of securities.
- Safekeeping of securities and cash.
- Tracking and collection of income and receivables, such as dividends and
distributions.
- 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.
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
throughout the world have evolved to highly automated environments, and the
transition in developing countries is proceeding rapidly.
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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 77 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 the National Association of Securities Dealers for
publication in newspapers.
In addition to providing the above services to domestic-based accounts
and investment vehicles, the Company also provides offshore fund accounting.
The Company views the offshore market as a significant business opportunity
and will continue to invest in expansion to support client demand. The
Company's Toronto operations, conducted by the Company's wholly-owned
Canadian subsidiary, currently provide offshore services to 47 portfolios. As
of December 31, 1997, the Canadian subsidiary processed over $16 billion in
assets requiring the calculation of 105 daily net asset values. The Company's
Dublin operations provide offshore services to 36 portfolios. As of December
31, 1997, the Dublin subsidiary processed over $1.1 billion in assets
requiring the calculation of 25 daily net asset values and 11 weekly net
asset values. In February 1996, the Company opened an 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 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.
- Preparation and monitoring of a fund's expense budget.
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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 and other pooled
investment vehicles. Its services typically include assistance with product
definition, service provider selection, and fund structuring and
registration. The Company's Administration Group is staffed by 81 accounting
and legal professionals who have prior experience in either mutual fund
complexes or mutual fund servicing organizations.
INVESTMENT ADVISORY. The Bank acts as investment advisor to the Merrimac
Master Portfolio and the Merrimac Funds, master-feeder investment companies
(the "Funds"). Currently, the Funds have two operating master funds, the
Merrimac Cash Portfolio and the Merrimac Treasury Portfolio, and three
operating feeder funds, the Merrimac Cash Fund, the Merrimac Global Cash
Fund, and the Merrimac Treasury Fund, with assets totaling over $1.4 billion
at December 31, 1997. The Company has engaged The Bank of New York to act as
sub-advisor to manage the investments of the Merrimac Cash Portfolio and has
engaged Aeltus Investment Management, Inc. to act as sub-advisor to manage
the investments of the Merrimac Treasury Portfolio. In addition to acting as
advisor 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. The Merrimac feeder funds offer shares only to
institutions and other "accredited investors" (as that term is defined in
Rule 501(a) under the Securities Act of 1933) and invest all of their assets
in the Merrimac master funds. 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 34,000 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 $1,044,000, $237,000,
$2,106,000, and $4,427,000 for the year ended October 31, 1995, for the
Transition Period, and for the years ended December 31, 1996 and 1997,
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 $1.8 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 $1,142,000, $157,000,
$1,947,000, and $2,865,000 for the year ended October 31, 1995, for the
Transition Period, and for the years ended December 31, 1996 and 1997,
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
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
7
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 24,000 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 $23 billion in assets managed by 46
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 5,900 at December 31, 1997. 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.
At December 31, 1997, the Company had gross loans outstanding to
individuals and non-profit institutions of approximately $56 million, which
represented 4% of the Company's total assets. The interest rates charged on
the Bank's loans are indexed to either the prime rate or the rate paid on
90-day Treasury bills. The Company has never had a loan loss, and has no
delinquent loans. Other than a loan made to a non-profit association for
purposes of the Community Reinvestment Act, all loans are secured 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 $854 million daily of these balances into its own deposit
products and may now offer these deposit services directly to existing and
potential clients.
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, direct mailing to targeted clients,
attendance at trade shows and seminars, and advertising in trade publications.
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
8
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 53 mutual fund
complexes and insurance companies. The Company's largest current client,
Eaton Vance, accounted for 14%, 11%, 10% and 10% of the Company's net
operating revenues for the year ended October 31, 1995, for the Transition
Period, and for the years ended December 31, 1996 and 1997, respectively. A
former client of the Company, Merrill Lynch, accounted for 5% of the
Company's net operating revenues for the year end October 31, 1995. 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 years ended December 31,
1996 and 1997. 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 years ended December 31, 1996 and
1997. 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 has 60 days after receipt of
written notice to such effect to (i) correct its performance or (ii)
renegotiate such terms. If the corrective action or renegotiation is not
satisfactory to the trustees, the agreement may be terminated on sixty days
prior notice. The Company has long-term contracts with 11 other clients with
terms ranging from three to five years. Total assets processed under
long-term contracts at December 31, 1997 were over $42 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.
FACTS utilizes microcomputers networked to servers 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. This 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 master/ feeder
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.
9
- 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 the 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. Over the past few 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 mainframe computer hardware, owned and operated by
Electronic Data Systems ("EDS"), contained in the EDS Information Processing
Center ("IPC") in Plano, Texas. Processing and networking functions and
equipment are located at the IPC, and in the Boston, Camp Hill, and Detroit
metropolitan areas. 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 Plano IPC and at a designated
alternate IPC which may be used in the event of equipment failure. The Plano
facility is also supported by an uninterruptable power supply and diesel
generators which can supply power to continue operations for an extended
period of time. Critical software and data files are backed-up daily and
stored off-site. Disaster recovery plans are 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 Bank & Trust 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
10
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, 1997, the Company had 1,009 full-time employees,
including six in senior management, 18 in marketing and client management,
837 in operations and 148 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
most 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, 1997, the
Company's staff increased from 463 to 1,009 employees.
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.
11
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 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
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Capital Resources."
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% Leverage
Ratio requirement is the minimum for the top-rated bank holding companies
without any supervisory, financial or operational weaknesses or deficiencies
or those which are not experiencing or anticipating significant growth.
Because the Bank, and consequently, the Company, anticipates significant
future growth, the Company will be required to maintain Leverage Ratios of at
least 4.0% to 5.0% or more. Management currently intends to maintain Leverage
Ratios of 6.0%.
The Company currently is in compliance with both the Risk Based Capital
Ratio and the Leverage Ratio requirements. At December 31, 1997, the Company
had a Tier I Risk Based Capital Ratio and a Total Risk Based Capital Ratio
equal to 29.00% and 29.03%, respectively and a Leverage Ratio equal to 6.39%.
12
LIMITATIONS ON ACQUISITIONS OF COMMON STOCK. The Federal Change in Bank
Control Act prohibits a person or group of persons from acquiring "control"
of a bank holding company unless the FRB has been given 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 "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% Leverage 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 Leverage 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
Leverage Ratio shall, within 45 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
13
that any insured depository institution with a Leverage 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 Leverage 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
implement a capital plan for achieving an adequate level of capital,
consistent with the provisions of the risk-based capital framework.
At December 31, 1997, 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 a Tier I Risk Based Capital
Ratio and a Total Risk Based Capital Ratio equal to 28.54% and 28.57%,
respectively, and a Leverage Ratio equal to 6.31%.
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 Leverage Ratio of 5.0% or more and is
not subject to any written capital order or directive; (ii) "adequately
capitalized" if it has a total Risk Based Capital Ratio of 8.0% or more, a
Tier I Risk Based Capital Ratio of 4.0% or more, and a Leverage Ratio of 4.0%
or more (3.0% under certain circumstances) and does not meet the definition
of "well capitalized," (iii) "undercapitalized" if it has a Total Risk Based
Capital Ratio that is less than 8.0%, a Tier I Risk Based Capital Ratio that
is 4.0% or greater or a Leverage Ratio that is less than 4.0% (3.0% under
certain circumstances), (iv) "significantly undercapitalized" if it has a
Total Risk Based Capital Ratio that is less than 6.0%, a Tier I Risk Based
Capital Ratio that is less than 3.0% or a Leverage Ratio that is less than
3.0%, and (v) "critically undercapitalized" if it has a ratio of tangible
equity to total assets that is equal to or less than 2.0%. 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.
14
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 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, 1997, 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 (x) accept, renew or roll over any brokered deposit
unless it has applied for and been granted a waiver of this prohibition by
the FDIC or (y) solicit deposits by offering an effective yield that exceeds
by more than 75 basis points the prevailing effective yields on insured
deposits of comparable maturity in such institution's normal market area or
in the market area in which such deposits are being solicited and (iii) an
undercapitalized institution may not (x) accept, renew or roll over any
brokered deposits or (y) solicit deposits by offering an effective yield that
exceeds by more than 75 basis points the prevailing effective yields on
insured deposits of comparable maturity in such institution's normal market
area or in the market area in which such deposits are being solicited. 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, 1997, 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 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
15
purpose. Management believes the Bank is currently in compliance with all CRA
requirements. The Bank has pending an application with the FDIC to become
designated a "special purpose" institution, which designation would exempt
the Bank from CRA review by the FDIC. The Bank would still be subject to
review by the Commissioner.
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 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, management believes the Company is in compliance with these
registration, reporting and recordkeeping requirements.
REGULATION OF INVESTMENT COMPANIES. Certain of the Company's mutual fund
and unit investment trust clients are regulated as "investment companies" as
that term is defined under the Investment Company Act of 1940, as amended
(the "ICA"), and are subject to examination and reporting requirements
applicable to the services provided by the Company.
The provisions of the ICA and the regulations promulgated thereunder
prescribe the type of institution which may act as a custodian of investment
company assets, as well as the manner in which a custodian administers the
assets in its custody. Because the Company serves as custodian for a number
of its investment company clients, these regulations require, among other
things, that the Company maintain certain minimum aggregate capital, surplus,
and undivided profits. Additionally, arrangements between the Company and
clearing agencies or other securities depositories must meet ICA requirements
for segregation of assets, identification of assets and client approval.
Future legislative and regulatory changes in the existing laws and
regulations governing custody of investment company assets, particularly with
respect to custodian qualifications, may have a material and adverse impact
on the Company. Currently, management believes the Company is in compliance
with all minimum capital and securities depository requirements. Further, the
Company is not aware of any proposed or pending regulatory developments,
which, if approved, would adversely affect the ability of the Company to act
as custodian to an investment company.
Investment companies are also subject to extensive recordkeeping and
reporting requirements. These requirements dictate the type, volume and
duration of the record-keeping undertaken by the Company, either in its role
as custodian for an investment company or as a provider of administrative
services to an investment company. Further, the Company must follow specific
ICA guidelines when calculating the net asset value of a client mutual fund.
Consequently, changes in the statutes or regulations governing recordkeeping
and reporting or valuation calculations will affect the manner in which the
Company conducts its operations.
New legislation or regulatory requirements could have a significant
impact on the information reporting requirements applicable to the Company's
clients and may in the short term adversely affect the Company's ability to
service those clients at a reasonable cost. Any failure by the Company to
provide such support could cause the loss of customers and have a material
adverse effect on the Company's financial results. Additionally, legislation
or regulations may be proposed or enacted to regulate the Company in a manner
which may adversely affect the Company's financial results.
16
ITEM 2. PROPERTIES.
As of December 31, 1997, the Company leased three 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:
EXPIRATION
LOCATION FUNCTION SQ. FT. DATE
- --------------------------------- --------------------------------- --------- ------------------
200 Clarendon St., Boston, MA Principal Executive Offices and 233,992 2007
Operations Center
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 2001
Earlsfort Terrace, Dublin Offshore Processing Center 3,400 2000
In January 1997, the Company entered into an agreement to lease 4,116
square feet at the 1 First Canadian Place location for a four-year term to
commence in 1998 in order to expand its Toronto operations. In August 1997,
the Company entered into an agreement to lease 3,735 square feet at the
Earlsfort Terrace location for a two-year term to commence in 1998 in order
to expand its Dublin operations. See Note 15 of the Notes to the Consolidated
Financial Statements.
ITEM 3. LEGAL PROCEEDINGS.
The Company is from time to time subject to claims arising in the
ordinary course of business. While the outcome of any claim cannot be
predicted with certainty, management does not expect these matters,
individually or in the aggregate, to have a material adverse effect on the
results of operations and financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the Company's security holders
during the quarter ended December 31, 1997.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The Company's Common Stock is currently included in The Nasdaq National
Market under the symbol IFIN. The following table sets forth the range of
quarterly high and low bid quotations for the Company's Common Stock as
reported by NASDAQ. The quotations represent interdealer quotations without
adjustment for retail markups, markdowns or commissions, and may not
necessarily represent actual transactions.
1996 HIGH BID LOW BID
- -------------------------------------- --------- ---------
First Quarter......................... $ 23.125 $ 20.500
Second Quarter........................ $ 23.500 $ 21.000
Third Quarter......................... $ 26.000 $ 20.875
Fourth Quarter........................ $ 28.000 $ 25.750
1997 HIGH BID LOW BID
- -------------------------------------- --------- ---------
First Quarter......................... $ 35.125 $ 27.500
Second Quarter........................ $ 50.000 $ 30.750
Third Quarter......................... $ 48.250 $ 41.250
Fourth Quarter........................ $ 51.250 $ 41.250
As of February 17, 1998, there were approximately 1,101 stockholders of
record.
17
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 depends on the receipt of dividends from
Investors Bank & Trust Company. In addition, the Company may not pay
dividends on its Common Stock if it is in default under certain agreements
which the Company entered into in connection with the sale of the 9.77%
Capital Securities. See "Management Discussion and Analysis of Financial
Condition and Results of Operations--Capital Resources." 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 $.12 per share of outstanding Common
Stock (approximately $776,438 based upon 6,470,313 shares outstanding as of
December 31, 1997). The Company expects to declare and pay such dividend
ratably on a quarterly basis.
18
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 Notes thereto, and other financial information
appearing elsewhere in this Report.
FOR THE TWO
MONTHS ENDED FOR THE YEAR
FOR THE YEAR ENDED OCTOBER 31, DECEMBER 31, ENDED DECEMBER 31,
------------------------------------------------------------------------------------------
1993 1994 1995(1) 1995 1996 1997
------------- ------------- ------------- ------------- -------------- --------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Statement of Income Data:
Net interest income......... $ 4,494 $ 4,778 $ 5,870 $ 1,966 $ 17,944 $ 26,173
Noninterest income.......... 32,967 43,049 51,562 8,085 56,634 76,702
Gain/(loss) on sale of
investment securities..... 48 -- -- -- (2) 114
------------- ------------- ------------- ------------- -------------- --------------
Net operating revenues...... 37,509 47,827 57,432 10,051 74,576 102,989
Operating expenses.......... 33,939 42,503 50,224 8,481 61,935 82,649
------------- ------------- ------------- ------------- -------------- --------------
Income before income
taxes..................... 3,570 5,324 7,208 1,570 12,641 20,340
Income taxes................ 1,211 1,863 2,800 670 4,867 7,323
Minority interest expense... -- -- -- -- -- 1,437
------------- ------------- ------------- ------------- -------------- --------------
Net income.................. $ 2,359 $ 3,461 $ 4,408 $ 900 $ 7,774 $ 11,580
------------- ------------- ------------- ------------- -------------- --------------
------------- ------------- ------------- ------------- -------------- --------------
Per Share Data:
Basic earnings per share.... $ 0.14 $ 1.21 $ 1.80
------------- -------------- --------------
------------- -------------- --------------
Diluted earnings per
share..................... $ 0.14 $ 1.20 $ 1.75
------------- -------------- --------------
------------- -------------- --------------
Average Balance Sheet Data:
Interest earning assets..... $ 87,965 $ 94,351 $ 106,130 $ 219,775 $ 575,662 $ 1,167,361
Total assets................ 109,477 116,810 128,174 249,064 628,893 1,236,519
Total deposits.............. 99,523 102,664 106,446 197,013 377,219 594,768
Common stockholders'
equity.................... 9,022 11,779 16,119 34,000 56,137 68,370
Selected Financial Ratios:
Return on equity (2)........ 26.15% 29.38% 27.35% 15.11% 13.85% 16.94%
Return on assets (2)........ 2.15% 2.96% 3.44% 2.12% 1.24% 0.94%
Common equity as % of total
assets.................... 8.24% 10.08% 12.58% 16.57% 6.41% 5.13%
Dividend payout ratio (3)... 2.54% 1.73% 1.36% 0.00% 2.49% 4.45%
Tier 1 capital ratio (4).... 37.08% 42.53% 37.62% 62.10% 24.67% 29.00%
Noninterest income as % of
net operating income...... 87.89% 90.01% 89.78% 80.44% 75.94% 74.48%
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.......... 0.34% 0.26% 0.26% 0.15% 0.15% 0.18%
Other Statistical Data:
Assets processed at end of
period (5)................ $ 61,239,242 $ 72,418,449 $ 91,099,976 $94,208,228 $ 122,563,401 $ 139,418,241
Employees at end of
period.................... 522 678 671 674 792 1,009
- ------------------------
(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.
(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 $.12 per share, subject to
receipt of a like dividend from the Bank and further subject to regulatory
requirements.
(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.
19
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 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 53 mutual fund complexes, investment advisors, banks and insurance
companies. The Company provides financial asset administration services for
assets that totaled approximately $139 billion at December 31, 1997,
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 Bank acts as investment advisor to the Merrimac Master Portfolio and
the Merrimac Funds, master-feeder investment companies (the "Funds").
Currently, the Funds have two operating master funds, the Merrimac Cash
Portfolio and the Merrimac Treasury Portfolio, and three operating feeder
funds, the Merrimac Cash Fund, the Merrimac Global Cash Fund, and the
Merrimac Treasury Fund, with assets totaling over $1.4 billion at December
31, 1997. The Company has engaged The Bank of New York to act as sub-advisor
to manage the investments of the Merrimac Cash Portfolio and has engaged
Aeltus Investment Management, Inc. to act as sub-advisor to manage the
investments of the Merrimac Treasury Portfolio. In addition to acting as
advisor 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. The Merrimac feeder funds offer shares only to
institutions and other "accredited investors" (as that term is defined in
Rule 501(a) under the Securities Act of 1933) and invest all of their assets
in the Merrimac master funds. The Funds may add additional feeder funds
and/or master funds in the future.
On January 31, 1997, the Company completed the issuance and sale of
$25,000,000 in 9.77% Capital Securities. The Capital Securities were issued
by Investors Capital Trust l, a Delaware statutory business trust sponsored
by the Company. The capital raised in the offering, along with existing
capital and earnings generated in the future, will be used to support the
Company's balance sheet growth. The Capital Securities qualify as Tier I
capital under the capital guidelines of the Federal Reserve. Under current
Federal Reserve guidelines, no more than 25% of the Company's Tier 1 capital
may comprise Capital Securities and other capital securities and cumulative
preferred stock of the Company. In September 1997 the Company completed an
exchange offer pursuant to which all outstanding capital securities were
exchanged for substantially identical capital securities registered under the
Securities Act of 1933.
The Company's current largest client, Eaton Vance, accounted for 14%,
11%, 10%, and 10% of the Company's net operating revenues for the year ended
October 31, 1995, for the Transition Period, and for the years ended December
31, 1996 and 1997, 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
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 the most
meaningful measures of financial results. Revenue generated from asset
administration and other fees and interest income increased 38% from
$74,576,000 for the year ended December 31, 1996 to $102,989,000 for the year
ended December 31, 1997.
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
20
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.
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. Forward looking statements in this 10-K
include certain statements regarding capital ratios and liquidity. 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 the investment offerings of the Company's clients. Also, the
Company's interest-related services, along with the market value of the
Company's investments, may be adversely affected by rapid changes in interest
rates. 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.
The Company relies on certain intellectual property protections to
preserve its intellectual property rights. Any invalidation of the Company's
intellectual property rights or lengthy and expensive defense of those rights
could have a material adverse effect on the Company. In addition the Year
2000 Issue discussed below may affect the Company's operations. The segment
of the financial services industry in which the Company is engaged is
extremely competitive. Certain current and potential competitors of the
Company are more established and benefit from greater market recognition and
have substantially greater financial, development and marketing resources
than the Company.
The Company's quarterly and annual operating results are affected by a
wide variety of factors that could materially adversely affect revenues and
profitability, including: the timing of the commencement or termination of
client engagements, the rate of net inflows and outflows of investor funds in
the debt and equity-based investment vehicles offered by the Company's
clients, the introduction and market acceptance of new services by the
Company and changes or anticipated changes in economic conditions. Because
the Company's operating expenses are relatively fixed, any unanticipated
shortfall in revenues in a specified period may have an adverse impact on the
Company's results of operations for that period. As a result of the foregoing
and other factors, the Company may experience material fluctuations in future
operating results on a quarterly or annual basis which could materially and
adversely affect its business, financial condition, operating results and
stock price.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Company's computer programs that have date-sensitive software may recognize a
date using "00" as the year 1900 rather than the year 2000. This could result
in a system failure or miscalculations causing disruptions of operations,
including, among other things, a temporary inability to process transactions,
send invoices, or engage in similar normal business activities.
In late 1997 the Company, with the assistance of an outside consultant,
completed a detailed assessment of the Company's Year 2000 compliance status. As
part of the assessment process, the Company also developed project plans for
application renovation and testing. Based on this assessment, the Company
determined that it will be required to modify or upgrade portions of its
software so that its computer systems will properly utilize dates beyond
December 31, 1999. The Company presently believes that with modifications to, or
upgrades of, existing software, the Year 2000 Issue can be
21
mitigated. However, if such modifications and upgrades are not made, or are
not completed in a timely manner, the Year 2000 Issue could have a material
impact on the operations of the Company.
The Company has initiated formal communications with all of its
significant suppliers and large customers to determine the extent to which
the Company is vulnerable to those third parties' failure to remediate their
own Year 2000 Issue. The Company's total Year 2000 project cost and estimates
to complete include the estimated costs and time associated with the impact
of a third party's Year 2000 Issue, and are based on presently available
information. However, there can be no guarantee that the systems of other
companies on which the Company's systems rely will be timely converted, or
that a failure to convert by another company, or a conversion that is
incompatible with the Company's systems, would not have a material adverse
effect on the Company.
The Company will utilize both internal and external resources to modify
or upgrade existing software and to test such software for Year 2000
compliance. The Company plans to complete the Year 2000 project, including
all testing, by December 31, 1998. The total remaining cost of the Year 2000
project is estimated at $1,600,000, which will be expensed as incurred over
the next twelve months, and is being funded through operating cash flows.
These amounts are not expected to have a material effect on the Company's
results of operations. To date, the Company has incurred and expensed
approximately $165,000 related to the assessment of, and preliminary
remediation efforts in connection with, its Year 2000 project and the
development of a remediation plan.
The costs of the project and the date on which the Company plans to
complete the Year 2000 modifications are based on management's best
estimates, which were derived utilizing numerous assumptions of future events
including the continued availability of certain resources, third party
modification plans and other factors. However, there can be no guarantee that
these estimates will be achieved and actual results could differ materially
from those plans. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel
trained in this area, the ability to locate and correct all relevant computer
code, the compatibility of third-party interfaces and similar uncertainties.
STATEMENT OF OPERATIONS
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 1997 AND
1996
NONINTEREST INCOME
Noninterest income increased $20,184,000 to $76,816,000 for the year
ended December 31, 1997 from $56,632,000 for the year ended December 31,
1996. Noninterest income consists of the following items:
FOR THE YEAR ENDED
DECEMBER 31,
-----------------------------------
1996 1997 CHANGE
--------- --------- -------------
(DOLLARS IN
THOUSANDS)
Asset administration fees..................... $ 56,076 $ 75,873 35%
Computer service fees......................... 482 468 (3)
Other operating income........................ 76 361 375
Net gain/(loss) on sale of securities......... (2) 114 --
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Total Noninterest Income...................... $ 56,632 $ 76,816 36%
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Asset administration fees increased due principally to higher levels of
assets processed. The Company earns such fees on assets processed by the
Company on behalf of a variety of financial asset managers. Assets processed
is the total dollar value of financial assets on the reported date for which
the Company provides one or more of the following services: global custody,
multicurrency accounting, institutional transfer agency, performance
measurement, foreign exchange, securities lending, mutual fund administration
and investment advisory services. Total assets processed increased to $139
billion at December 31, 1997 from $122 billion at December 31, 1996. Of the
$17 billion net increase in assets processed from December 31, 1996 to
December 31, 1997, approximately 24% of the increase reflects assets
processed for ne