PART I

ITEM 1. BUSINESS.

General

Unless otherwise indicated or unless the context requires otherwise, all references in this Report to “Investors Financial,” “we,” “us,” “our,” or similar references mean Investors Financial Services Corp., together with our subsidiaries. “Investors Bank” or the “Bank” means our subsidiary, Investors Bank & Trust Company, alone.

We provide a broad range of services to financial asset managers, such as mutual fund complexes, investment advisors, hedge funds, family offices, banks and insurance companies. We define these services as core services and value-added services. Our core services include global custody, multicurrency accounting, fund administration and middle office outsourcing. Our value-added services include foreign exchange, cash management, securities lending, investment advisory, performance measurement, institutional transfer agency, lines of credit and brokerage and transition management services. At December 31, 2006, we provided services for approximately $2.2 trillion in net assets, including approximately $0.4 trillion of foreign net assets.

Investors Financial Services Corp. is a bank holding company. We were organized as a Delaware corporation in 1995. Our primary operating subsidiary is Investors Bank & Trust Company® which was founded in 1969 as a banking subsidiary of Eaton Vance Corp., an investment management firm. In 1995, we reorganized as a bank holding company, were spun-off to the stockholders of Eaton Vance and completed our initial public offering. We provide our services from offices in Boston, New York, Sacramento, Toronto, Dublin, London, Luxembourg and the Cayman Islands.

On February 4, 2007, we entered into an Agreement and Plan of Merger (the ‘Merger Agreement’) with State Street Corporation (‘State Street’). At the closing of the transaction contemplated by the Merger Agreement, we will merge into State Street and our shareholders will receive 0.906 shares of State Street common stock for each share of our common stock. Each company’s Board of Directors has approved the Merger Agreement. We expect to complete the transaction in the third quarter of 2007, subject to customary closing conditions, including regulatory and shareholder approval.

Overview of the Asset Servicing Industry

Asset managers invest and manage the financial assets entrusted to them. They do so using a broad range of financial products, including mutual funds, alternative investment vehicles, unit investment trusts, separate accounts, variable annuities and other products that pool together money from multiple investors. Asset servicing companies like ours perform various back and middle office services for asset managers and the pooled financial products they sponsor, allowing asset managers to focus on core competencies such as product development and distribution. In addition, asset servicing companies like ours provide these back office services such as the third-party safekeeping of assets and administrative services to give investors more confidence in the integrity of their investments. The following discussion sets forth our view of the key drivers in today’s asset servicing industry.

Historical Financial Asset Growth. Despite the stock market declines of 2000 through 2002, over the past ten years, growth in financial assets under management has remained strong. Factors driving this growth include an aging population, the privatization of retirement systems and the increased popularity of pooled investment products such as mutual funds. The total amount of U.S. financial assets held in mutual funds, life insurance companies, private pension funds and bank personal trust accounts was $17.5 trillion at December 31, 2005, up from $7.6 trillion in 1995, a compounded annual growth rate of approximately 9%. Mutual funds, one of the primary markets for our services, hold a large portion of the money invested in pooled investment vehicles. The U.S. mutual fund market has grown at a compounded annual growth

rate of approximately 12% since 1995, and held approximately $8.1 trillion in assets at December 31, 2005. The following table presents U.S. financial assets, including mutual funds (Dollars in billions):

	December 31, 2005			December 31, 1995			Compounded Annual Growth Rate
U.S. Financial Assets
Mutual Funds		$	8,056		$	2,594		12	%
Life Insurance Companies		4,351			2,064			8
Private Pension Funds		5,120			2,899			6
Total		$	17,527		$	7,557		9	%

Source: Federal Reserve Bank

Consolidation and Outsourcing Trends. Another important factor affecting the asset servicing industry is the consolidation of asset servicing providers. Since the early 1990s, a number of small and mid-size asset servicers have consolidated with larger service providers or divested their asset servicing operations to focus their finite resources on their core businesses. Also, numerous service providers have combined their operations with other companies. This ongoing consolidation has concentrated the industry around a smaller number of service providers and presents us with opportunities for growth as clients react to consolidation and review their relationships with existing providers. In addition, as consolidated financial institutions dispose of businesses that do not fit with their core services, we may see opportunities to acquire those business lines at a reasonable price.

The unique operational philosophy of a particular asset management organization determines its view of asset servicing. The majority of asset managers hire third parties to provide custody services. Some use more than one custodian in an attempt to foster cost reduction through competition. Large asset managers may have enough assets to justify the cost of providing in-house facilities to handle accounting, administration and transfer agency services. Other asset managers generally hire third parties to provide accounting, administration and transfer agency services in addition to custody services. Keeping abreast of developments like regulatory changes, internet data delivery, compressed settlement cycles, and complex investment strategies, structures and instruments has forced significant increases in technology spending across the financial services industry. We believe that this increase in spending requirements has accelerated the pace at which asset managers outsource back and middle office operations to asset servicers.

Technology. Information technology is a driving force in the financial services industry. Asset managers are able to create innovative investment products using technological tools including:

· Access to data from world markets as a result of more powerful and affordable information processing power.

· The ability to send and receive large volumes of information almost instantly through widely dispersed communication networks.

· Timely on-line access to electronic information on security positions, prices and price shifts that facilitate activities, including on-line currency trading, indexing of assets, real time arbitrage and hedging through the use of derivative securities.

Asset servicers use technology as a competitive tool to deliver precise and functional information to asset managers. Technology also allows asset servicers to offer more value-added services, such as performance measurement. Examples of analytical tools used in performance measurement include reports showing time-weighted return, performance by sector and time-weighted return by sector.

Complex Investment Products. Asset managers create different investment structures in an effort to capture efficiencies and appeal to investors with diverse means, risk tolerances, diversification requirements and time horizons. One innovative example of this is exchange traded funds, or ETFs. ETFs are securities that replicate an index and are traded on a national securities exchange, such as the New York Stock Exchange or the American Stock Exchange. Unlike investing in a conventional index mutual fund, investing in an ETF allows investors to buy and sell shares throughout the trading day at market prices. ETFs also offer potential tax efficiencies. According to the Investment Company Institute, domestic ETF assets increased 34% to approximately $397 billion as of November 30, 2006 from approximately $296 billion as of December 31, 2005.

Alternative investments, including hedge funds, private equity funds, venture capital funds and commodity pools, are another example of complex investment products that have recently experienced dramatic growth. According to HFMWeek’s latest hedge fund administrator survey, hedge fund assets totaled approximately $2.1 trillion as of November 30, 2006, which represents an increase of 53% as compared to November 30, 2005. Hedge fund assets have increased due to widening interest from institutional investors such as pension plans and endowments, as well as high net worth individuals. These asset pools often feature increasingly sophisticated trading strategies, financial instruments and product structures such as distressed debt, swaps and asset-backed securities that require more specialized operational support than traditional mutual funds.

In addition, a growing number of mutual funds have been structured as multi-class funds or as multi-manager funds in order to address the differing requirements and preferences of potential investors. Multi-class arrangements allow an investment company to sell interests in a single investment portfolio to separate classes of stockholders. Multi-manager funds have two or more investment managers, who may have different investing styles, managing the assets of one fund. Multi-manager funds offer investors diverse investment styles with a single investment.

Another product 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 the common portfolio of a separate investment vehicle (the ‘master fund’). This structure permits each of the feeder funds to be sold to a separate target market or through a different distribution channel. The feeder fund, if it were a stand-alone fund, might not be large enough to support its operating costs. The feeder funds benefit from the economies of scale available to the larger pool of assets invested in the master fund.

International Investing. Asset managers have also expanded their reach in the global marketplace to capitalize on cross-border and multi-national marketing opportunities. This creates demand for asset servicing around the world and particularly for value-added services like foreign exchange. At December 31, 2006, we provided services for approximately $2.2 trillion in net assets, including approximately $0.4 trillion of foreign net assets, which represents an increase of 23% and 33%, respectively, from December 31, 2005.

Our Strategy

We believe that asset servicing companies operate most efficiently when bundling core services such as custody and accounting with value-added services such as foreign exchange and securities lending. We also believe that efficient integration of these services is critical to both service quality and profitability. The following discussion outlines the key components of our growth strategy:

Maintain Our Technological Expertise. One of our core strategies is to commit the necessary capital and resources to maintain our technological expertise. The asset servicing industry requires the technological capability to support a wide range of global security types, currencies and complex portfolio structures. Asset servicers must also maintain the telecommunications flexibility to support the diversity of

global communications standards. Technological change creates opportunities for product differentiation and cost reduction.

Our Fund Accounting and Custody Tracking System, or FACTS™, is a single integrated technology platform that combines our service offerings into one solution for customers and can accommodate rapid growth in net assets processed. FACTS provides the following functions in a single information system:

· Custody

· Securities movement and control

· Portfolio accounting

· Multicurrency general ledger accounting

· Pricing

· Net asset value calculation

· Middle office outsourcing

· Multi-class and multi-manager processing

· ETF processing

By consolidating these functions, we have eliminated redundancy in data capture and reduced the opportunity for clerical error.

The consolidation of functions available through FACTS allows us to assign a dedicated client team to provide a full suite of services to each account. We believe that this approach helps us to provide high quality service and to maintain better overall relationships with our clients.

The FACTS architecture also enables us to modify the system quickly. Rapid modifications allow us to constantly improve processing quality and efficiency and to implement service innovations for our clients. We believe that the integrated nature of FACTS provides us with a competitive advantage by allowing us to respond quickly to the continuously changing technological demands of the financial services industry. We believe the separate systems used for different tasks by many other asset servicing providers may not provide the same advantages.

Maintain Our Expertise in Complex Products. Another of our core strategies is to maintain our strength in the rapidly growing area of complex investment products. We have developed expertise in servicing ETFs, various alternative investment structures, master-feeder funds and multi-managed funds. We are able to respond rapidly to the systems requirements of complex structures since the design of FACTS allows us to effect modifications or enhancements quickly.

Deliver Superior Service. We strive to deliver superior and innovative client service. We believe service quality is the key to maintaining and expanding existing client relationships and to attracting new clients. The consolidation of functions available through FACTS allows us to take an integrated approach to client servicing. We believe this approach is different from that employed by many of our competitors. We dedicate a single operations team to handle all tasks for a particular client. 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.

Cross-Sell Our Services. We believe that our strong client relationships provide opportunities to cross-sell value-added services to broaden our customer relationships. Many of our clients manage multiple pools of assets. Once an investment manager becomes a client, we believe that this client is more likely to select us to service more products, provide additional services, or both. If we are engaged to provide services for only certain pools of assets managed by our clients, we strive to expand the

relationship to include more asset pools by providing superior client service. Also, some of our clients engage us to provide core services such as global custody and multicurrency accounting, but do not use us for value-added services such as foreign exchange or cash management. We target expanding these relationships through increasing the number of services provided for each client.

Service Offerings

Core Services		Value-Added Services
·	Global Custody	·	Foreign Exchange
·	Multicurrency Accounting	·	Cash Management
·	Fund Administration	·	Securities Lending
·	Middle Office Outsourcing	·	Investment Advisory
		·	Performance Measurement
		·	Institutional Transfer Agency
		·	Lines of Credit
		·	Brokerage and Transition Management Services

Our value-added services help clients develop and execute their strategies, and evaluate and manage their risks, which we believe provides them with the opportunity to enhance their returns. We strive to maximize the use of our value-added services by our client base.

Fees charged for core services vary from client to client based on the value of assets processed, the number of securities held and the number of portfolio transactions. Generally, fees are billed to our clients monthly in arrears and, upon their approval, charged directly to their account. Fees charged for core services reflect the price sensitivity of the market for such services. Fees charged for value-added services reflect a more favorable pricing environment for us because we can increase activity in these areas without a necessarily proportionate increase in personnel or other resources. We also derive net interest income by investing cash balances that our clients leave on deposit with us. Our share of earnings from these investments is viewed as part of the total compensation that our clients pay us for servicing their assets.

The following is a description of the various services we offer:

Core Services

Global Custody. Global custody entails the safekeeping of securities for clients and settlement of portfolio transactions. Our net assets processed have grown from $22 billion at October 31, 1990 to $2.2 trillion at December 31, 2006. At December 31, 2006, our foreign net assets processed totaled approximately $0.4 trillion.

In order to service our clients worldwide, we have established a network of global subcustodians in almost 100 markets. Since we do not have our own branches in these countries, we are able to operate in the foreign custody arena with minimal fixed costs, while our clients benefit from the ability to use a single custodian, Investors Bank, for all of their international investment needs.

Multicurrency Accounting. Multicurrency accounting entails the daily recordkeeping for each account or investment vehicle, including the calculation of net asset value per share. In addition to providing these services to domestic-based accounts and investment vehicles, we also provide fund accounting services to clients in Europe and Canada, which we continue to view as areas of significant business opportunity.

Fund Administration. Fund administration services include management reporting, regulatory reporting, compliance monitoring, tax accounting and return preparation, partnership administration and chief compliance officer services and support. In addition to these ongoing services, we also provide fund start-up consulting services, which typically include assistance with product definition, service provider selection and fund structuring and registration. We have worked with a number of investment advisors to assist them in the development of new funds and other pooled investment vehicles.

Middle Office Outsourcing. Middle office outsourcing services represent the tasks that need to be performed for financial asset managers after they have initiated a particular trade to ensure accurate and timely trade processing and communications to any party affected by the trades. We perform some or all of the following functions for our middle office outsourcing clients: trade operations management, settlements, portfolio and fund accounting, fund administration, cash management, reconciliation, corporate actions, tax reclaims and tax filings, performance measurement, broker performance and vendor data management.

Value-Added Services

Foreign Exchange. We provide foreign exchange services to facilitate settlement of international securities transactions for funds and other accounts and to convert income payments denominated in a non-base currency to base dollars. By using us rather than a third-party foreign exchange bank to perform these functions, clients can reduce the amount of time spent coordinating currency delivery and monitoring delivery failures and claims.

Cash Management. We provide a number of investment options for cash balances held by our clients. Typically, we have a standing arrangement to sweep client balances into one or more investments, including deposit accounts, short-term funds and repurchase agreements. This allows our clients to conveniently maximize their earnings on idle cash balances.

Securities Lending. Securities lending involves the lending of clients’ securities to brokers and other institutions for a fee. Receipt of securities lending fees improves a client’s return on the underlying securities. We act as agent for our clients for both international and domestic securities lending services.

Investment Advisory. The Bank acts as the investment advisor to the Merrimac Master Portfolio, an open-end investment management company registered under the Investment Company Act of 1940, as amended (the ‘ICA’). The portfolio currently consists of a series of six master funds in a master-feeder structure. The Merrimac Cash Portfolio, the Merrimac Prime Portfolio and the Merrimac U.S. Government Portfolio are subadvised by Lehman Brothers Asset Management LLC. The Merrimac Treasury Portfolio and the Merrimac Treasury Plus Portfolio are subadvised by M&I Investment Management Corp. The Merrimac Municipal Portfolio is subadvised by ABN AMRO Asset Management Inc. At December 31, 2006, the total net assets of the portfolio approximated $4.5 billion. The portfolio’s master funds serve as investment vehicles for seven domestic and two active offshore feeder funds whose shares are sold to institutional investors.

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 in a customized format.

Institutional Transfer Agency. Transfer agency encompasses shareholder recordkeeping and communications. We provide these services only to institutional clients with a small number of shareholder accounts or omnibus positions of retail shareholders.

Lines of Credit. We offer credit lines to our clients for the purpose of leveraging portfolios, covering overnight cash shortfalls and other borrowing needs. We do not conduct retail banking operations. At December 31, 2006, we had gross loans outstanding to clients of approximately $271 million, which represented approximately 2% of our total assets. The interest rates charged on the Bank’s loans are indexed to either the Prime rate or the Federal Funds rate. We have never had a loan loss. All loans are secured, or may be secured, by marketable securities and virtually all loans to individually managed account customers are due on demand.

Brokerage and Transition Management Services. In 2002, we began offering “introducing broker-dealer” services to clients by accepting customer orders, which we have elected to clear through a clearing broker-dealer. The clearing broker-dealer processes and settles customer transactions and maintains detailed customer records. This arrangement allows us to use the back office processing infrastructure of the clearing broker-dealer while earning a commission on trades executed on behalf of clients. Transition management services are designed to assist the process of moving a portfolio from one asset manager to another in as seamless a manner as possible. Components of these services include planning and customizing a strategy for the transition, conducting performance analysis and executing the transition in an efficient, risk-managed fashion. The brokerage services we offer do not include margin accounts, short selling or market making activities.

Sales, Marketing and Client Support

We employ a direct sales staff that targets potential market opportunities, including investment management companies, insurance companies, family offices, banks and investment advisors. Sales personnel are primarily based at our headquarters in Boston, and are given geographic area sales responsibility. We also have sales personnel located in Dublin, Toronto, Luxembourg and London who are responsible for international markets. Included in the sales staff are individuals who are dedicated to marketing services to institutional accounts. Senior managers from all functional areas are directly involved in obtaining new clients, frequently working as a team with a sales professional.

In order to service existing clients, a separate team of client management professionals based in our Boston, Sacramento, New York, Toronto, Dublin and London offices provides dedicated client support. Each client is assigned a client manager responsible for the client’s overall satisfaction. The client manager is usually a senior professional with extensive industry experience who works with the client on designing new products and specific systems requirements, provides consulting support, anticipates the client’s needs and coordinates service delivery.

Financial information regarding our geographic reporting can be found in Note 21 of our Notes to Consolidated Financial Statements included in this Report.

Significant Clients

Barclays Global Investors, N.A. (‘BGI’) accounted for approximately 18% of our consolidated net operating revenues for the years ended December 31, 2006 and 2005, and approximately 17% for the year ended December 31, 2004. No client other than BGI accounted for more than 10% of our net operating revenues for the years ended December 31, 2006, 2005 and 2004. See Item 1A “Risk Factors—A material portion of our revenue is derived from our relationship with Barclays Global Investors, N.A. (‘BGI’) and related entities.”

Software Systems and Data Center

Our business requires that we provide daily and periodic reports of asset accounting and performance, and provide measurement and analytical data to asset managers on-line on a real-time basis. To help us meet these requirements, our asset servicing operations are supported by sophisticated information

technology. We receive vast amounts of information across a worldwide computer network. That information covers a wide range of global security types in various currencies and must be processed before system-wide updating and reporting.

Our proprietary system, FACTS, is multi-tiered. FACTS uses personal computers linked to mainframe processing by means of local and wide area networks. This configuration combines the best features of each platform. FACTS uses the power and capacity of the mainframe, the data distribution capabilities of the network and the independence of personal computers. The fully functional microcomputer component of FACTS works independently of the mainframe throughout the processing cycle. This minimizes the amount of system-wide delay inherent in data processing. The FACTS configuration also allows for fully distributed processing capabilities within multiple geographic locations in an effective and efficient manner.

The integrated nature of the FACTS architecture allows us to effect modifications and enhancements quickly. Swift modifications and enhancements result in increased processing quality and efficiency for our clients. These modifications and enhancements also help us quickly implement service innovations for our clients. This integrated architecture helps differentiate us from our competitors. Technological enhancements and upgrades are an ongoing part of asset servicing that are necessary for asset administrators to remain competitive and to create information delivery mechanisms that add value to the information available as part of clearing and settling transactions.

Technology also helps us add value to the custody and fund accounting information we gather by processing client assets. We have developed a comprehensive suite of standardized data extracts and reports and created automated interfaces that allow our clients to access the full range of custody and fund accounting data. We have also developed interfaces that allow our clients to connect electronically with our host systems and access data collected from clearance and settlement transactions in multiple currencies. Through these information-sharing tools, we are better equipped to supplement our custody and accounting services with foreign exchange services and asset and transaction reporting and monitoring services. Electronic linkages also position us to respond quickly to client requests.

We use the internet as a means to communicate with clients and external parties. We also provide secure value-added services to our clients over the internet. We utilize a secure extranet environment that provides the authentication, access controls, intrusion detection, encryption and firewalls needed to ensure the protection of client information and assets. Internet-based applications provide our clients with secure electronic access to their data as well as flexible ad-hoc data query and reporting tools.

Our mainframe processing and mainframe disaster recovery capability is provided by Electronic Data Systems (‘EDS’), located in Plano, Texas. In addition, International Business Machines (‘IBM’), located in Armonk, New York, provides support for our network and hardware environments and our help desk services. By outsourcing these infrastructure support functions, we can focus our resources on systems development and minimize our capital investment in large-scale computer equipment. EDS and IBM offer us state-of-the-art computer products and services, access to which we could not otherwise afford, while removing the risk of product obsolescence. Due to their large and diverse customer bases, EDS and IBM can invest in the latest computer technology and spread the related costs over multiple users. We also receive the benefit of the continuing investment by EDS and IBM in their computer hardware. Under both contracts we are billed monthly for services provided by EDS or IBM on an as-used basis in accordance with a predetermined pricing schedule for specific products and services. Our current agreement with EDS is scheduled to expire on December 31, 2008. Our current agreement with IBM is scheduled to expire on June 30, 2011.

Each year we target spending approximately 18-20% of our consolidated net operating revenue on technology. Because of our relationships with EDS and IBM and our system architecture, we are able to devote the majority of our technology investments to development, rather than support or infrastructure.

Our trust processing services are provided by SEI Investments Company (‘SEI’), located in Oaks, Pennsylvania. SEI is a global provider of asset management and investment technology solutions. We pay SEI certain monthly service fees based upon usage. Our current agreement with SEI is scheduled to expire on December 31, 2009.

Investors Bank maintains a comprehensive Business Continuity Plan (‘BCP’). The program has been developed to comply with guidelines issued by various regulatory and industry bodies such as the Federal Financial Institutions Examination Council (‘FFIEC’). The planning process begins with a business impact analysis which isolates critical business processes and determines their recoverability under various disruption scenarios. In addition to maintaining regional backup facilities for all offices, our locations are geographically diverse in order to allow recovery of essential functions at another location in the event of a widespread disruption. In 2006, BCP staff conducted 132 different tests to ensure that our technology infrastructure, facilities and staff could respond and recover in a disaster.

Competition

We operate in a highly competitive environment in all areas of our business. Many of our competitors, including State Street Corporation, JP Morgan Chase, The Bank of New York, Mellon, Citigroup, PNC and Northern Trust, possess substantially greater financial and marketing resources than we do and process a greater amount of financial assets. Other competitive factors include technological advancement and flexibility, breadth of services provided and quality of service. We believe that we compete favorably in these categories.

Competition in the asset servicing industry, especially over the past decade, has impacted both pricing and margins in core services such as global custody. Partially offsetting this more competitive pricing environment is the development of new services that have higher margins. Our continuous investment in technology has permitted us to offer value-added services to clients, such as foreign exchange, securities lending and performance measurement, on a global basis and at competitive prices. Technological evolution and service innovation have enabled us to generate additional revenue to offset competitive pricing in maturing service lines.

We believe that our size, commitment to technology development and enhancement and responsiveness to client needs provide the asset management industry with a very attractive asset servicing alternative to large money center banks and other asset servicers. As many of our competitors grow larger through acquisition, we believe that our customized and highly responsive service offerings become even more attractive. While consolidation within the investment management and asset servicing industries may adversely affect our ability to retain clients that have been acquired, it also creates opportunity for us as prospective clients review their relationships with existing service providers that are affected by acquisitions. In addition, consolidation among large financial institutions may enable us to acquire, at a reasonable price, asset servicing businesses that do not fit within the core focus of these newly consolidated financial institutions.

Intellectual Property

Our success is dependent upon our software development methodology and other intellectual property rights that we have developed and own, including FACTS. We rely on trade secret, copyright and trademark laws, and confidentiality agreements with employees and third parties to protect our proprietary technology, all of which offer only limited protection. There can be no assurance that the steps we take in this regard will be adequate to deter misappropriation of our proprietary information or that we will be able to detect unauthorized use. Furthermore, our intellectual property rights may be invalidated or our competitors may develop similar technology independently. In addition, effective copyright, trademark, trade secret and other protection may not be available in certain international markets that we service.

Employees

On December 31, 2006, we had 4,265 employees. We maintain a professional development program for entry level staff. Successful completion of the program is required of most newly hired employees. This training program is supplemented by ongoing education on systems and technological developments and innovations, the financial services industry, the regulatory environment and our client base. This program is administered by experienced full-time trainers that continually enhance existing courses and develop new programs to match an evolving business and regulatory environment.

None of our employees are covered by collective bargaining agreements, and we believe our relations with our employees are good.

Regulation and Supervision

Virtually all aspects of our business and operations are regulated under state and federal law. In addition to the laws governing businesses and employers, we are subject to federal and state laws and regulations applicable to financial institutions and their parent companies. The operations of our securities broker affiliate, Investors Securities Services, LLC, are also subject to federal and state securities laws, as well as the rules of both the Securities and Exchange Commission (‘SEC’) and the National Association of Securities Dealers, Inc. (‘NASD’). The principal objective of state and federal banking laws is the maintenance of the safety and soundness of financial institutions and the federal deposit insurance system, the protection of consumers or classes of consumers and the furtherance of broad public policy goals, rather than the specific protection of stockholders of a bank or its parent company. Some of the significant statutory and regulatory provisions to which we and our subsidiaries are subject are described below. The description of these statutory and regulatory provisions is not complete and is qualified in its entirety by reference to the particular statutory or regulatory provision. Any change in applicable law or regulation may have a material effect on our business, prospects and operations, as well as those of our subsidiaries.

Investors Financial

General. As a registered Bank Holding Company (‘BHC’), Investors Financial is subject to regulation under the Bank Holding Company Act of 1956, as amended (‘BHCA’), and to inspection, examination and supervision by the Board of Governors of the Federal Reserve System (‘FRB’) and by the Massachusetts Commissioner of Banks (‘Commissioner’). We are required to file reports of our operations with, and are subject to examination by, the FRB and the Commissioner. The FRB has the authority to issue orders to BHCs to cease and desist from unsafe or unsound banking practices and violations of conditions imposed by, or violations of agreements with, the FRB. The FRB is also empowered to assess civil money penalties against companies or individuals who violate the BHCA or orders or regulations thereunder, to order termination of nonbanking activities of nonbanking subsidiaries of BHCs and to order termination of ownership and control of a nonbanking subsidiary by a BHC.

BHCA-Activities and Other Limitations. The BHCA prohibits a BHC from acquiring substantially all the assets of a bank or acquiring direct or indirect ownership or control of more than 5% of any class of the voting shares of any bank, BHC or savings association, or increasing such ownership or control of any bank, BHC or savings association, or merging or consolidating with any BHC without prior approval of the FRB. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (‘Riegle-Neal’) permits adequately capitalized and adequately managed BHCs, as determined by the FRB, to acquire banks located in any state, subject to certain concentration limits and other conditions. Subject to certain conditions, Riegle-Neal also generally authorizes the interstate mergers of banks and, to a lesser extent, interstate branching, as long as the law of the host state specifically authorizes such action. Massachusetts law imposes certain approval requirements with respect to acquisitions by a BHC of certain banking institutions and to mergers of BHCs.

Unless a BHC becomes a financial holding company (‘FHC’) under the Gramm-Leach-Bliley Act of 1999 (‘GLBA’), the BHCA also prohibits a BHC from acquiring a direct or indirect interest in or control of more than 5% of the voting securities of any company that is not a bank or a BHC 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 determined to be so closely related to banking or managing and controlling banks as to be a proper incident thereto. Before permitting a BHC to engage in such activities that are closely related to banking or making an investment in a company engaged in such activities, 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 GLBA permits a BHC that qualifies and elects to be treated as a FHC to engage in a significantly broader range of financial activities than BHCs, such as Investors Financial, that have not elected FHC status. “Financial activities” is broadly defined to include not only banking, insurance and securities activities, but also merchant banking and additional activities that the FRB, in consultation with the Secretary of the Treasury, determines to be financial in nature or incidental to such financial activities, or that the FRB determines to be complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. To elect to become a FHC, a BHC, such as Investors Financial, must meet certain tests and file an election with the FRB. To qualify, all of a BHC’s subsidiary banks must be well-capitalized and well-managed, as measured by regulatory guidelines. In addition, each of the BHC’s banks must have been rated “satisfactory” or better in its most recent federal Community Reinvestment Act (‘CRA’) evaluation. A BHC that elects to be treated as a FHC may face significant consequences if its banks fail to maintain the required capital and management ratings, including entering into an agreement with the FRB which imposes limitations on its operations. Investors Financial has not elected to become a FHC.

Capital Requirements. The FRB has adopted capital adequacy guidelines applicable to United States banking organizations. The FRB’s capital adequacy guidelines generally require BHCs to maintain total capital equal to 8% of total risk-adjusted assets and off-balance sheet items (the ‘Total Risk-Based Capital Ratio’), with at least 50% of that amount consisting of Tier 1, or core capital, and the remaining amount consisting of Tier 2, or supplementary capital. Tier 1 capital for BHCs generally consists of the sum of common stockholders’ equity and perpetual preferred stock (subject to certain limitations), less goodwill and other nonqualifying intangible assets. Tier 2 capital generally consists of hybrid capital instruments, perpetual debt and mandatory convertible debt securities; perpetual preferred stock, not included as Tier 1 capital; term subordinated debt and intermediate-term preferred stock; and, subject to limitations, general allowances for loan and lease losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics.

In addition to the risk-based capital requirements, the FRB requires BHCs to maintain a minimum leverage capital ratio of Tier 1 capital to its average total consolidated assets (the ‘Leverage Ratio’) of 3%. Total average consolidated assets for this purpose does not include goodwill and any other intangible assets and investments that the FRB determines should be deducted from Tier 1 capital. The FRB has announced that the 3% Leverage Ratio requirement is the minimum for the top-rated BHCs. All other BHCs are required to maintain a minimum Leverage Ratio of 4%. BHCs with supervisory, financial, operational or managerial weaknesses, as well as BHCs that are anticipating or experiencing significant growth, are expected to maintain capital ratios well above the minimum levels. Because we anticipate significant future growth, we will be required to maintain a Leverage Ratio of 4% or higher.

We are currently in compliance with both the Total Risk-Based Capital Ratio and the Leverage Ratio requirements, and management expects these ratios to remain in compliance with the FRB’s capital

adequacy guidelines. At December 31, 2006, our Total Risk-Based Capital Ratio and Leverage Ratio were 19.04% and 7.63%, respectively.

In June 2004, the Basel Committee on Banking Supervision (‘Basel Committee’) released the document “International Convergence of Capital Measurement and Capital Standards: A Revised Framework”. The Framework, also referred to as Basel II, is designed to secure international convergence on regulations and standards governing the capital adequacy of internationally active banking organizations. In September 2006, the U.S. banking and thrift supervisory agencies issued a Notice of Proposed Rulemaking setting forth a proposed framework for the timing and qualification process for U.S. banks that are either required (‘core banks’) or choose (‘opt-in banks’) to be subject to Basel II. As currently proposed, the new rules as applied in the U.S. are expected to become effective on January 1, 2009, subject to transitional parallel testing beginning on January 1, 2008. Although Investors Bank is not required to be compliant with the new rules, we are in the process of developing and implementing a program to achieve Basel II compliance. Ultimately, U.S. implementation of Basel II will depend on, and will be subject to, final regulations and related policies promulgated by the U.S. supervisory agencies. We cannot predict the final form of the rules, nor their impact on our risk-based capital.

Control Acquisitions. The Change in Bank Control Act prohibits a person or group of persons from acquiring “control” of a depository institution or a depository institution holding company unless the FRB has been notified and has not objected to the proposal. Under a rebuttable presumption established by the FRB, the acquisition of 10% or more of a class of voting securities of a depository institution or depository institution 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 of the depository institution or a depository institution holding company. In addition, any company, as that term is broadly defined in the statute, would be required to obtain the approval of the FRB under the BHCA before acquiring 25% (5% in the case of an acquirer that is a BHC) or more of any class of voting securities of a bank or BHC or a savings association, or otherwise obtaining control or a controlling influence over such an institution.

Massachusetts Law. Investors Financial is also considered a BHC for purposes of Massachusetts law. Accordingly, we have registered with the Commissioner and are obligated to make reports to the Commissioner. Under Massachusetts law, any person that proposes to acquire, directly or indirectly, 25% or more of any class of voting securities of a company must give prior notice to the Massachusetts Commissioner of Banks, who may disapprove the transaction. Additionally, any company that is a BHC under Massachusetts law must obtain the approval of the Massachusetts Board of Bank Incorporation before acquiring more than 5% of the voting stock of a company. As a general matter, however, the Commissioner does not rule upon or regulate the activities in which a BHC or its nonbank subsidiaries engage.

Cash Dividends. FRB policy provides that a bank or a BHC generally should not maintain its existing rate of cash dividends on common stock unless the organization’s net income available to common shareholders over the past year has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition. FRB policy further provides that a BHC should not maintain a level of cash dividends to its shareholders that places undue pressure on the capital of bank subsidiaries, or that can be funded only through additional borrowings or other arrangements that may undermine the BHC’s ability to serve as a source of strength.

Source of Strength. FRB policy requires BHCs to serve as sources of financial and managerial strength to their subsidiary banks and, if necessary, to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity and to maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks in a

manner consistent with FRB policy. This support may be required at times when the BHC may not have the resources to provide it. Accordingly, Investors Financial is expected to commit resources to the Bank in circumstances where it might not do so absent such policy.

Investors Bank

General. The Bank is subject to extensive regulation and examination by the Commissioner and the FRB, its primary federal banking regulator. The Bank became a member of the Federal Reserve System (‘FRS’) (a ‘state member bank’) in October 2006. Prior to becoming a state member bank, the Bank’s primary federal regulator was the Federal Deposit Insurance Corporation (‘FDIC’). Although the FDIC is no longer its primary federal regulator, the Bank, like all insured depository institutions, is nevertheless subject to certain requirements established by the FDIC, which insures the Bank’s deposits. The federal and state laws and regulations that 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 certain deposited funds, the amount of loans to individuals and related borrowers, the nature and amount of and collateral for certain loans, and the amount of interest that may be charged on loans. Various state consumer laws and regulations also affect the operations of state banks.

FDIC Insurance Premiums. The Bank currently pays deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC for Bank Insurance Fund (‘BIF’)-member institutions. The FDIC has established a risk-based premium system under which the FDIC classifies institutions based on their capital ratios and on other relevant information and generally assesses higher rates on those institutions that tend to pose greater risks to the federal deposit insurance funds. Prior to the enactment of the Federal Deposit Insurance Reform Act of 2005 (the ‘FDIR Act’) on February 8, 2006, the FDIC was not required to charge all banks deposit insurance premiums when the ratio of deposit insurance reserves to insured deposits was maintained above specified levels. Under new rules issued by the FDIC pursuant to the FDIR Act, however, the FDIC will impose assessments on all banks at a rate determined by the institution’s risk classification regardless of the ratio of deposit insurance reserves to insured deposits. The new rules were issued November 2, 2006 and became effective on January 1, 2007. An increase in the Bank’s deposit insurance assessments over previous levels as a result of the new rules would have an adverse effect on net earnings.

Additionally, as a result of the passage of the FDIR Act: (i) the BIF will be merged with the FDIC’s Savings Association Insurance Fund creating the Deposit Insurance Fund (the ‘DIF’); (ii) the $100,000 per account insurance level will be indexed to reflect inflation; (iii) deposit insurance coverage for certain retirement accounts will be increased to $250,000; and (iv) a cap will be placed on the level of the DIF and dividends will be paid to banks once the level of the DIF exceeds the specified threshold.

Capital Requirements. The FRB 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 BHCs.

The Federal Deposit Insurance Corporation Improvement Act of 1991 (‘FDICIA’) identifies five capital categories for insured depository institutions (well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the federal bank regulatory agencies to implement systems for “prompt corrective action” for insured depository institutions that do not meet minimum capital requirements within such categories. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital-raising requirements. An “undercapitalized” bank must develop a capital restoration plan, and its parent holding company must guarantee that bank’s compliance with the plan. The liability of a parent holding company under any such guarantee is limited to the lesser of 5% of a

bank’s assets at the time it became “undercapitalized” or the amount needed to comply with the plan. Furthermore, in the event of the bankruptcy of a parent holding company, such guarantee would take priority over a parent’s general unsecured creditors. In addition, FDICIA requires the various regulatory agencies to prescribe certain non-capital standards for safety and soundness relating generally to operations and management, asset quality and executive compensation, and permits regulatory action against a financial institution that does not meet such standards.

The various regulatory agencies have adopted substantially similar regulations that define the five capital categories identified by FDICIA, using the total risk-based capital, Tier 1 risk-based capital and leverage capital ratios as the relevant capital measures. Such regulations establish various degrees of corrective action to be taken when an institution is considered undercapitalized. Under the regulations, a “well-capitalized” institution must have a Tier 1 risk-based capital ratio of at least 6%, a total risk-based capital ratio of at least 10% and a leverage ratio of at least 5% and not be subject to a capital directive order. Regulators also must take into consideration (a) concentrations of credit risk; (b) interest rate risk (when the interest rate sensitivity of an institution’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position); and (c) risks from non-traditional activities, as well as an institution’s ability to manage those risks, when determining the adequacy of an institution’s capital. This evaluation will be made as a part of an institution’s regular safety and soundness examination. At December 31, 2006, the Bank was deemed to be a well-capitalized institution.

The Community Reinvestment Act. The Community Reinvestment Act (‘CRA’) requires lenders to identify the communities served by the institution’s offices and other deposit-taking facilities and to make loans and investments and provide services that meet the credit needs of these communities. Regulatory agencies examine each of the banks and rate such institutions’ compliance with CRA as “Outstanding”, “Satisfactory”, “Needs to Improve” or “Substantial Noncompliance”. Failure of an institution to receive at least a “Satisfactory” rating could inhibit such institution or its holding company from undertaking certain activities, including engaging in activities newly permitted as a financial holding company under the GLBA and acquisitions of other financial institutions. The FRB and other federal banking agencies must take into account the record of performance of banks in meeting the credit needs of the entire community served, including low- and moderate-income neighborhoods, before they approve certain bank acquisitions, mergers, branch establishments and other transactions proposed by banking organizations. Massachusetts has also enacted a similar statute that requires the Commissioner to evaluate the Bank’s performance in helping to meet the credit needs of its entire community and to take that record into account in considering certain applications. Management believes the Bank is currently in compliance with all CRA requirements.

Customer Information Security. The FRB and other bank regulatory agencies have established standards for safeguarding nonpublic personal information about customers that implement provisions of the GLBA. Specifically, the Information Security Guidelines established by the GLBA require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate Board committee, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against anticipated threats or hazards to the security or integrity of such information and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.

Privacy. The GLBA requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to nonaffiliated third parties. In general, the statute requires financial institutions to explain to consumers their policies and procedures regarding the disclosure of such nonpublic personal information, and, unless otherwise required or permitted by law, financial institutions are prohibited from disclosing such information except as provided in their policies and procedures.

USA Patriot Act. The USA Patriot Act of 2001 (the ‘USA Patriot Act’), designed to deny terrorists and others the ability to obtain anonymous access to the U.S. financial system, has significant implications for depository institutions, broker-dealers and other businesses involved in the transfer of money. The USA Patriot Act, together with the implementing regulations of various federal regulatory agencies, require financial institutions, including the Bank, to adopt and implement policies and procedures with respect to, among other things, anti-money laundering compliance, suspicious activity and currency transaction reporting, customer identity verification and customer risk analysis. The statute and its underlying regulations also permit information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions, and require federal banking agencies to evaluate the effectiveness of an applicant in combating money laundering activities when considering applications filed under Section 3 of the BHCA or the Bank Merger Act. Management believes that we are currently in compliance with all requirements prescribed by the USA Patriot Act and all applicable regulations.

Dividends. The FRB has the authority to use its enforcement powers to prohibit a bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice, and generally restricts a state member bank’s ability to pay dividends or other capital distributions. For example, a state member bank may not declare or pay a dividend if the total of all dividends declared during the calendar year, including the proposed dividend, exceeds the sum of the bank’s net income during the current calendar year and the retained net income of the prior two calendar years, unless the dividend has been approved by the FRB. Federal law also prohibits the payment of dividends by a bank that will result in the bank failing to meet its applicable capital requirements on a pro forma basis. Under Massachusetts law, the board of directors of a trust company, such as the Bank, may declare from “net profits” cash dividends no more often than quarterly, provided that there is no impairment to the trust company’s capital stock. Moreover, prior Commissioner approval is required if the total of all dividends declared by a trust company in any calendar year would exceed the total of its net profits for that year combined with its retained net profits for the previous two years, less any required transfer to surplus or a fund for the retirement of any preferred stock. These restrictions on the Bank’s ability to declare and to pay dividends may limit Investors Financial’s ability to pay dividends to its stockholders.

Investments. The FRB imposes quantitative limitations and other conditions, including notice requirements, on a state member bank’s investments in bank premises, stocks and investment securities. The FRB also imposes conditions on a state member bank’s ability to invest in foreign corporations. These limitations may prevent the Bank from making investments it would otherwise make.

Other Securities Law Issues. The GLBA requires a bank that acts as investment adviser to a registered investment company to register as an investment adviser or to conduct such advisory activities through a separately identifiable department or division of the bank so registered. Accordingly, the Bank furnishes investment advice to registered investment companies through a separately identifiable department or division of the Bank that is registered with the SEC as an investment adviser. Federal and state laws impose onerous obligations on registered investment advisers, including fiduciary duties, recordkeeping requirements and disclosure obligations. Currently, management believes that the Bank is in compliance with these requirements.

Regulation of Investment Companies. Certain of our mutual fund and unit investment trust clients are regulated as “investment companies” as that term is defined under the ICA and are subject to examination and reporting requirements applicable to the services we provide. 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 we serve as custodian for a number of our investment company clients, these regulations require, among other things, that we maintain certain minimum aggregate capital, surplus, and undivided profits. Additionally, arrangements between us and clearing agencies or other securities depositories must meet

ICA requirements for segregation of assets, identification of assets and client approval. Currently, management believes we are in compliance with all minimum capital and securities depository requirements. Investment companies are also subject to extensive recordkeeping and reporting requirements. These requirements dictate the type, volume and duration of the recordkeeping we undertake, either in our role as custodian for an investment company or as a provider of administrative services to an investment company. Further, we 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 we conduct our operations.

Availability of Filings

You may access, free of charge, copies of the following documents and related amendments, if any, in the Investor Relations section of our web site at www.ibtco.com:

1) Our Annual Reports on Form 10-K;

2) Our Quarterly Reports on Form 10-Q;

3) Our Current Reports on Form 8-K; and

4) Our Proxy Statement.

You may also access, free of charge, copies of the following corporate governance documents in the Investor Relations section of our website at www.ibtco.com:

1) Our Code of Conduct;

2) Our Corporate Governance Guidelines;

3) Our Audit Committee Charter;

4) Our Nominating and Corporate Governance Committee Charter; and

5) Our Compensation Committee Charter.

We post these documents on our web site as soon as reasonably practicable after we file or furnish them electronically with or to the Securities and Exchange Commission or, in the case of the corporate governance documents, as soon as reasonably practicable after material amendment. The information contained on our web site is not incorporated by reference into this document and should not be considered a part of this Report. Our web site address is included in this document as an inactive textual reference only.

ITEM 1A. RISK FACTORS.

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

A significant portion of our fees is based on the market value of the assets we process. Accordingly, our operating results are subject to fluctuations in interest rates and securities markets as these fluctuations affect the market value of assets processed. Our net interest income is primarily driven by the spread between earnings on our investments and loan portfolios relative to our cost of funds. The relationship between short-term and long-term interest rates, referred to as the shape of the yield curve, affects the market value of, and the earnings produced by, our investment and loan portfolios, and thus could impact our net interest income. In addition, narrower investment portfolio reinvestment and purchase spreads have impacted, and could potentially continue to impact, our net interest income.

Volatility in the equity markets can have a material effect on our asset-based fees. While reductions in asset servicing fees may be offset by increases in other sources of revenue, a sustained downward movement of the broad equity markets will likely have an adverse impact on our earnings.

Our growth depends in part on the ability of our clients to generate fund flows by selling their investment products to new and existing investors. Fluctuations in interest rates or the securities markets can lead to investors seeking alternatives to the investment offerings of our clients, which could result in a lesser amount of assets processed and correspondingly lower fees. For example, if the value of equity or fixed income assets held by our clients were to increase or decrease by 10% for a sustained period of time, we estimate currently that this market movement, by itself, would cause a corresponding change of less than 5% in our earnings per share.

We may not consummate our merger with State Street Corporation.

Consummation of the transaction contemplated by the Agreement and Plan of Merger is subject to customary closing conditions, including stockholder and regulatory approval. Failure to complete the merger could have a material adverse impact on our ability to sell our services to new clients.

A material portion of our revenue is derived from our relationship with Barclays Global Investors, N.A. (‘BGI’) and related entities.

As a result of our ongoing relationship with BGI’s iShares and Master Investment Portfolios, our assumption of the operations of the U.S. asset administration unit of BGI in 2001 and our servicing assets for Barclays Global Investors Canada, Ltd., BGI accounted for approximately 18%, 18% and 17% of our net operating revenue for the years ended December 31, 2006, 2005 and 2004, respectively. During 2006, we renewed our U.S. asset administration outsourcing agreement and our iShares and Master Investment Portfolio custody and fund accounting agreements with BGI, and we expect that BGI will continue to account for a significant portion of our net operating revenue. We provide services to BGI under long-term contracts that may be terminated before the expiration of the contracts under certain circumstances that we have described in filings with the SEC as described below. While we believe that our relationship with BGI is excellent, the loss of BGI’s business would cause our net operating revenue to decline significantly and would have an adverse effect on our quarterly and annual results.

The outsourcing agreement was renewed pursuant to an amendment (the ‘Amendment’) to the Custodial, Fund Accounting and Services Agreement between the Bank and BGI dated May 1, 2001 (the ‘Custodial Agreement’). Under the terms of the Amendment, the Custodial Agreement is extended through April 30, 2013. As provided in the Amendment, BGI may terminate the Custodial Agreement upon sixty days prior written notice: (i) as to any underlying account if BGI fails to receive any consent required by law for the Bank to act as servicing agent for such account; (ii) as to any underlying account if the continued provision of services by the Bank to such account would be inconsistent with BGI’s fiduciary duties under applicable law; or (iii) as to the entire Custodial Agreement in the event a conservator or receiver is appointed for the Bank under applicable federal law. In addition, BGI may terminate the Custodial Agreement prior to April 30, 2013 if the Bank fails to meet a certain number of service level commitments for four consecutive months in any rolling twelve-month period or if the Bank materially breaches a material provision of the Custodial Agreement, in both cases subject to customary notice and opportunity to cure provisions.

Also, under the terms of the Amendment, the parties have agreed to assess the fee schedule and status of each party and of the industry 90 days prior to November 1, 2009 and to negotiate in good faith any appropriate amendments to the fee schedule arising from that assessment. If the parties are unable to agree on an amended fee schedule by November 1, 2009, BGI may terminate the Custodial Agreement.

The Amendment also provides that the Bank will continue to service BGI for up to two years, or longer under certain circumstances, after expiration or termination by BGI of the Custodial Agreement.

We may incur losses due to operational errors.

The services that we provide require complex processes and interaction with numerous third parties. While we maintain sophisticated computer systems and a comprehensive system of internal controls, and our operational history has been excellent, from time to time we may make operational errors for which we are responsible to our clients. In addition, even though we maintain appropriate errors and omissions and other insurance policies, an operational error could result in a significant liability to us and may have a material adverse effect on our results of operations.

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

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

We may incur significant costs defending legal claims.

We have been named in lawsuits in U.S. District Court in Massachusetts alleging, among other things, violations of securities laws. While we believe these claims are without merit, we cannot be sure that we will prevail in the defense of these claims. We are also party to other litigation and we may become subject to other legal claims in the future. Litigation is costly and could divert the attention of management. For a more detailed discussion of our ongoing lawsuits, please see Item 3. Legal Proceedings, in Part I of this report.

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

We have experienced a period of rapid growth that has required the dedication of significant management and other resources. Continued growth could place a strain on our management and other resources. To manage future growth effectively, we must continue to invest in our operational, financial and other internal systems, and our human resources, which could affect our profitability.

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

Qualified personnel, in particular managers and other senior personnel, are in great demand throughout the financial services industry. As a result, we could find it increasingly difficult to continue to attract and retain sufficient numbers of these highly skilled employees, which could affect our ability to attract and retain clients. In addition, uncertainty regarding integration in our merger with State Street Corporation could cause key employees to seek employment elsewhere.

We may not reap all or any of the expected benefits of our recent increased spending.

To position us for future growth, we have accelerated some disciplined investments during 2006. We believe our investments in personnel, technology and office space are necessary to support our future growth in areas such as Europe, technology, alternative investments, middle office outsourcing and fund

services. While these investments have and will continue to decrease our short-term operating margins, we believe they are necessary to build the foundation for future growth. However, we may not reap any or all of the expected benefits of our recent investments.

We may not be able to protect our proprietary technology.

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

Our quarterly and annual operating results may fluctuate.

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

· The timing of commencement or termination of client engagements;

· Changes in interest rates, the relationship between different interest rates or equity values;

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

· The timing and magnitude of share repurchases under our share repurchase plan.

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

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

Federal and state laws and regulations applicable to financial institutions and their parent companies apply to us. Our primary regulators are the Federal Reserve Board of Governors (‘FRB’), the Federal Deposit Insurance Corporation (‘FDIC’), the Office of the Commissioner of Banks of the Commonwealth of Massachusetts, the Securities and Exchange Commission, the National Association of Securities Dealers, Inc. (‘NASD’), the State of Vermont Department of Banking, Insurance, Securities and Health Care Administration (‘BISHCA’), the Office of the Superintendent of Financial Institutions in Canada (‘OSFI’), the Irish Financial Services Regulatory Authority (‘IFSRA’), the Cayman Islands Monetary Authority (‘CIMA’), the Financial Services Authority in the United Kingdom (‘FSA’) and the Commission de Surveillance du Secteur Financier in Luxembourg (‘CSSF’). Virtually all aspects of our operations are subject to specific requirements or restrictions and general regulatory oversight including the following:

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

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

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

· The NASD maintains certain regulatory requirements that our securities broker affiliate, Investors Securities Services, LLC, must meet. Failure to meet those requirements could lead to severe regulatory action;

· BISHCA maintains certain regulatory requirements that our insurance captive affiliate, Investors Vermont Insurance Company, must meet. Failure to meet those requirements could lead to regulatory action; and

· Our international operations are subject to regulatory oversight by regulators in the jurisdictions in which we operate, including the OSFI, the IFSRA, the CIMA, the FSA and the CSSF. Failure to comply with applicable international regulatory requirements could result in regulatory action and impact our ability to provide services in those jurisdictions.

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

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES.

The following table provides certain summary information with respect to the principal properties that we leased as of December 31, 2006:

Location	Function	Sq. Ft.	Expiration Date
200 Clarendon Street, Boston, MA	Principal Executive Offices and Operations Center	387,127		2014
100 Huntington Avenue, Boston, MA	Operations Center	350,647		2014
800 Boylston Street, Boston, MA	Operations Center	49,430		2014
1 Exeter Plaza, Boston, MA	Training Center	14,870		2007
980 Ninth Street, Sacramento, CA	Operations Center	79,421		2015
1277 Treat Boulevard, Walnut Creek, CA	Operations Center	18,921		2008
33 Maiden Lane, New York, NY	Operations Center	21,994		2011
Iveagh Court, Dublin	Offshore Processing Center	67,183		2028	*
Park Place, Dublin	Offshore Processing Center	40,388		2031	**
1 First Canadian Place, Toronto	Offshore Processing Center	17,790		2011
17 Dominion Street, London	Operations Center	4,478		2010
26 Boulevard Royal, Luxembourg	Operations Center	474		2007

* Pursuant to the terms of the contract, this lease can be terminated in 2013 by paying six months rent as compensation.

** Pursuant to the terms of the contract, this lease can be terminated in 2019 by paying twelve months rent as compensation.

For more information, see Note 16 of our Notes to Consolidated Financial Statements included in this Report.

ITEM 3. LEGAL PROCEEDINGS.

On June 27, 2003, we and an individual employee of ours were named in a lawsuit alleging, among other things, that we breached an implied covenant of good faith and fair dealing in a subadvisory contract with Opus Investment Management, Inc. and that our individual employee engaged in a breach of fiduciary duties and tortious interference with a contract. The lawsuit was filed in the Superior Court of Worcester, Massachusetts and sought unspecified damages. In October 2006, the parties settled the

lawsuit. Included in other operating expenses in our consolidated statement of income for the year ended December 31, 2006 is approximately $1.8 million for settlement costs, legal fees and administrative costs related to the settlement.

We and certain of our officers were named as defendants in three purported class action complaints that were filed on or about August 4, 2005, August 15, 2005, and September 30, 2005 in the United States District Court for the District of Massachusetts, Boston, Massachusetts. The U.S. District Court has consolidated those cases and appointed lead plaintiffs, who filed a consolidated complaint against us and seven of our current and former officers on February 3, 2006. Among other things, the consolidated complaint asserts that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 during the period April 10, 2001 until July 15, 2005. The allegations in the consolidated complaint predominantly relate to: (1) our October 2004 restatement of our financial results, and (2) our July 2005 revision of public guidance regarding our future financial performance. The consolidated complaint seeks unspecified damages, interest, fees, and costs. On May 14, 2006, we filed a motion to dismiss all claims asserted in the consolidated complaint. That motion is currently pending before the Court. We strongly believe that the lawsuit lacks merit and we intend to defend against the claims vigorously. However, we cannot predict the outcome of the lawsuit at this time, and we can give no assurance that it will not materially adversely affect our financial condition or results of operations.

We and nine of our officers and directors are named as defendants in two shareholder derivative complaints that were filed on or about September 22, 2005 and October 17, 2005 in the United States District Court for the District of Massachusetts, Boston, Massachusetts. Among other things, the complaints assert that the defendants are liable for breach of fiduciary duty, unjust enrichment, abuse of control, mismanagement, misappropriation of information, insider trading, and violation of Section 14(a) of the Securities Exchange Act of 1934. The complaint filed on September 22, 2005 also seeks reimbursement under the Sarbanes-Oxley Act of 2002. The allegations in the complaints predominantly relate to: (1) our October 2004 restatement of our financial results, and (2) our July 2005 revision of public guidance regarding our future financial performance. The complaints seek unspecified damages, attorneys’ fees, accountant and expert fees, and costs. We are also named as a nominal defendant in these complaints, although the actions are derivative in nature and purportedly asserted on behalf of us. We are in the process of evaluating these claims. However, we cannot predict the outcome of the lawsuits at this time, and we can give no assurance that they will not materially adversely affect our financial condition or results of operations.

In July 2000, two of our Dublin subsidiaries, Investors Trust & Custodial Services (Ireland) Ltd. (‘ITC’) and Investors Fund Services (Ireland) Ltd. (‘IFS’), received a plenary summons in the High Court, Dublin, Ireland. The summons named ITC and IFS as defendants in an action brought by the FTF ForexConcept Fund Plc (the ‘Fund’), a former client. The summons also named as defendants FTF Forex Trading and Finance, S.A., the Fund’s investment manager, Ernst & Young, LLP, the Fund’s auditors, and Dresdner Bank-Kleinwort Benson (Suisse) S.A., a trading counterparty to the Fund. The Fund is an investment vehicle organized in Dublin to invest in foreign exchange contracts. A total of approximately $4.7 million had been invested in the Fund. Most of that money was lost prior to the Fund’s closing to subscriptions in June 1999. In January 2001, ITC, IFS and the other defendants named in the plenary summons received a statement of claim by the Fund seeking unspecified damages allegedly arising from breach of contract, misrepresentation and breach of warranty, negligence and breach of duty of care, and breach of fiduciary duty, among others. We have notified our insurers and intend to defend this claim vigorously. Based on our investigation through December 31, 2006, we do not expect this matter to have a material adverse effect on our business, financial condition or results of operations.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASE OF EQUITY SECURITIES.

Price Range of Common Stock and Dividend History and Policy

Our common stock is quoted on the NASDAQ Global Select Market under the symbol “IFIN”. The following table sets forth, for the calendar periods indicated, the high and low sale prices for the common stock as reported by NASDAQ and dividends per share paid on the common stock.

	High		Low		Dividend
2006
First quarter	$	48.11	$	36.36	$	0.0225
Second quarter	50.98		41.40		0.0225
Third quarter	46.82		41.49		0.0225
Fourth quarter	44.26		37.00		0.0225
2005
First quarter	$	53.44	$	45.33	$	0.0200
Second quarter	51.05		36.05		0.0200
Third quarter	42.80		31.67		0.0200
Fourth quarter	40.98		30.64		0.0200

As of January 31, 2007, there were approximately 587 stockholders of record.

We currently intend to retain the majority of future earnings to fund the development and growth of our business. Our ability to pay dividends on our common stock may depend on the receipt of dividends from Investors Bank. In addition, we may not pay dividends on our common stock if we are in default under certain agreements that we entered into in connection with the sale of the 9.77% Capital Securities by Investors Capital Trust I. See Note 10 of our Notes to Consolidated Financial Statements included with this Report. Any dividend payments by Investors Bank are subject to certain restrictions imposed by federal law and by the Massachusetts Commissioner of Banks. See ‘Business - Regulation and Supervision’ for additional information. Subject to regulatory requirements, we expect to pay an annual dividend to our stockholders, currently estimated to be in an amount equal to $0.10 per share of outstanding common stock (approximately $6.6 million based upon 65,628,108 shares outstanding as of December 31, 2006). We expect to declare and pay such dividend ratably on a quarterly basis.

The information required under this item regarding securities authorized for issuance under equity compensation plans is incorporated herein by reference to the section entitled ‘Stock Plans’ contained in our definitive proxy statement pursuant to Regulation 14A, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of our fiscal year ended December 31, 2006.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

Period	a	b		c	d
October 1 - October 31, 2006	113,600	$	38.40	113,600	$	145,638,023
November 1 - November 30, 2006	656,434	$	38.80	641,639	$	120,735,516
December 1 - December 31, 2006	—	—		—	$	120,735,516
Total	770,034	$	38.74	755,239	$	120,735,516

(a) Total number of shares purchased

(b) Average price paid per share

(d) Approximate dollar value that may yet be purchased under the plan

In June 2006, we announced that our Board of Directors had authorized a new repurchase plan of up to $150.0 million of our common stock in the open market over the twelve months following the announcement. We do not expect our stock repurchase program to have a material impact on our capital resources, such as maintaining risk-based capital ratios in excess of capital adequacy guidelines and our ability to pay dividends on our common stock. As of December 31, 2006, we have repurchased 755,239 shares totaling approximately $29.3 million under this plan. The plan expires in June 2007.

Stock Performance

The following graph compares the change in the cumulative total stockholder return on the Company’s common stock for the period from January 1, 2002 through December 31, 2006, with the cumulative total return on the Center for Research in Securities Prices Index for the NASDAQ Stock Market (‘NASDAQ Stock Market Index’) and the Center for Research in Securities Prices Index for NASDAQ financial stocks (‘NASDAQ Financial Stocks Index’). The comparison assumes $100 was invested on December 31, 2001 in the Company’s common stock at the $32.77 closing price on that day and in each of the foregoing indices and assumes reinvestment of dividends, if any.

Comparison of Five Year Cumulative Total Return Among

Investors Financial Services Corp., NASDAQ Stock Market Index

and NASDAQ Financial Stocks Index

The following graph compares the change in the cumulative total stockholder return on the Company’s common stock for the period from January 1, 1996 through December 31, 2006, with the cumulative total return on the Center for Research in Securities Prices Index for the NASDAQ Stock Market (‘NASDAQ Stock Market Index’) and the Center for Research in Securities Prices Index for NASDAQ financial stocks (‘NASDAQ Financial Stocks Index’). The comparison assumes $100 was invested on December 29, 1995 in the Company’s common stock at the $2.53 closing price on that day and in each of the foregoing indices and assumes reinvestment of dividends, if any.

Comparison of Ten Year Cumulative Total Return Among

Investors Financial Services Corp., NASDAQ Stock Market Index

and NASDAQ Financial Stocks Index

ITEM 6. SELECTED FINANCIAL DATA.

The following table contains certain of our consolidated financial and statistical information and should be read in conjunction with ‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’, our Consolidated Financial Statements and Notes to Consolidated Financial Statements, and other financial information appearing elsewhere in this Report. (Dollars in thousands, except per share and employee data):

	For the Year Ended December 31,
	2006			2005			2004			2003(1)			2002
Statement of Income Data:
Noninterest income	$	639,454		$	525,537		$	425,491		$	336,193		$	298,844
Net interest income	164,194			170,425			187,680			153,914			138,725
Net operating revenues	803,648			695,962			613,171			490,107			437,569
Operating expenses	579,354			460,109			398,383			344,921			341,395
Income before income taxes	224,294			235,853			214,788			145,186			96,174
Income taxes	70,491			76,035			72,826			52,765			28,737
Net income	$	153,803		$	159,818		$	141,962		$	92,421		$	67,437
Per Share Data:
Basic earnings per share	$	2.34		$	2.42		$	2.15		$	1.42		$	1.05
Diluted earnings per share	$	2.28		$	2.37		$	2.09		$	1.39		$	1.02
Dividends per share	$	0.09		$	0.08		$	0.07		$	0.06		$	0.05
Balance Sheet Data:
Total assets at end of period	$	11,558,206		$	12,088,734		$	11,142,690		$	9,223,178		$	7,214,740
Average Balance Sheet Data:
Interest-earning assets	$	11,288,335		$	11,364,656		$	9,770,924		$	7,556,061		$	5,769,971
Total assets	11,929,813			12,033,698			10,276,479			8,139,985			6,173,187
Total deposits	5,453,856			4,099,305			4,495,858			3,153,306			2,342,247
Junior subordinated debentures(2)	24,774			24,774			24,774			24,194			—
Trust preferred securities(2)	—			—			—			—			24,667
Common stockholders’ equity	866,514			758,552			625,964			483,923			395,101
Selected Financial Ratios:
Return on average equity	17.7		%	21.1		%	22.7		%	19.1		%	17.1		%
Return on average assets	1.3		%	1.3		%	1.4		%	1.1		%	1.1		%
Average common equity as a % of
average assets	7.3		%	6.3		%	6.1		%	5.9		%	6.4		%
Dividend payout ratio(3)	3.9		%	3.4		%	3.3		%	4.3		%	4.9		%
Tier 1 capital ratio(4)	19.0		%	18.5		%	20.5		%	17.6		%	15.3		%
Leverage ratio(4)	7.6		%	6.0		%	5.9		%	5.4		%	5.4		%
Noninterest income as % of net
operating income	79.6		%	75.5		%	69.4		%	68.6		%	68.3		%
Other Statistical Data:
Assets processed at end of period(5)	$	2,211,740,622		$	1,792,571,911		$	1,430,471,217		$	1,056,871,924		$	785,418,321
Employees at end of period	4,265			3,252			2,778			2,413			2,591

(1) Effective July 1, 2003, we adopted the provisions of Statement of Financial Accounting Standards No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, which resulted in a reclassification of the trust preferred securities from mezzanine financing to liabilities. As such, interest expense associated with the trust preferred securities was reclassified to net interest income.

(2) Effective October 1, 2003, we adopted the provisions of FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, which resulted in the deconsolidation of Investors Capital Trust I, the trust that holds the trust preferred securities.

(3) We intend to retain the majority of future earnings to fund development and growth of our business. We currently expect to pay cash dividends at an annualized rate of $0.10 per share subject to regulatory requirements. Refer to ‘Liquidity’ included in Management’s Discussion and Analysis of Financial Condition and Results of Operations for further information.

(4) Refer to ‘Capital Resources’ included within Management’s Discussion and Analysis of Financial Condition and Results of Operations for further information.

(5) Assets processed is the total dollar value of financial assets on the reported date for which we provide one or more of the following services: global custody, multicurrency accounting, fund administration, middle office outsourcing, foreign exchange, cash management, securities lending, investment advisory, performance measurement, institutional transfer agency, lines of credit and brokerage and transition management services.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

You should read the following discussion together with our Consolidated Financial Statements and related Notes to Consolidated Financial Statements, which are included elsewhere in this Report. The following discussion contains forward-looking statements that reflect plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. See “Certain Factors That May Affect Future Results” herein.

Overview

We provide asset administration services for the financial services industry through our wholly-owned subsidiary, Investors Bank & Trust Company. We provide core services and value-added services to a variety of financial asset managers, including mutual fund complexes, investment advisors, hedge funds, family offices, banks and insurance companies. Core services include global custody, multicurrency accounting, fund administration and middle office outsourcing. Value-added services include foreign exchange, cash management, securities lending, investment advisory, performance measurement, institutional transfer agency, lines of credit and brokerage and transition management services. We have offices located in the United States, Ireland, Canada, the Cayman Islands, the United Kingdom and Luxembourg with a vast global subcustodian network established to accommodate the international needs of our clients. At December 31, 2006, we provided services for approximately $2.2 trillion in net assets, including approximately $0.4 trillion in foreign net assets.

We grow our business by selling our services to new clients and by further penetrating our existing clients. We believe that we service approximately 12% of the assets managed by our existing clients, and we have traditionally achieved significant success in growing client relationships. Our ability to service new clients and expand our relationships with existing clients depends on our provision of superior client service. Our growth is also affected by conditions in the global securities markets, the interest rate environment, the regulatory environment for us and our clients and the success of our clients in marketing their products.

We derive our asset servicing revenue from providing core and value-added services. We derive our net interest income by investing the cash balances our clients leave on deposit with us. Since we price our service offerings on a bundled basis, our share of earnings from these investments is viewed as part of the total compensation that our clients pay us for servicing their assets. In establishing a fee structure for a specific client, we analyze all expected revenue and expenses. We believe net operating revenue (noninterest income plus net interest income ) and net income are the most meaningful measures of our financial results.

As an asset administration services company, the amount of net operating revenue that we generate is impacted by overall market conditions, client activity and the prevailing interest rate environment. A significant portion of our core services revenue is based upon the amount of assets we process. As market values of underlying assets fluctuate, so will our revenue. We have managed this volatility by offering a tiered pricing structure for our asset-based fees. As asset values increase, the basis point fee is reduced for the incremental assets. When asset values decrease, revenue is only impacted at the then marginal rate. Many of our value-added services are transactional based, and we receive a fee for each transaction processed. The lower net interest margin experienced during 2006 as compared to 2005 is primarily a result of external market factors and the repricing characteristics of our balance sheet. The yield curve remained inverted for the majority of 2006, impacting reinvestment and purchase spreads on investments. The majority of our liability base reprices to overnight or short-term rates which, given the increase in short-term rates during the first half of 2006, has also contributed to lower net interest margin results year-to-date.

To position us for future growth, we accelerated some disciplined investments during the third and fourth quarters of 2006. We believe our investments in personnel, technology and office space are necessary to support our future growth in areas such as technology, alternative investments, middle office outsourcing, fund services and our European presence. While these investments have and will continue to decrease our short-term operating margins through the first half of 2007, we believe they are necessary to position us for future growth.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, which require us to make estimates and assumptions. We have identified the following accounting policies that, as a result of the complexities of the underlying accounting standards and operations involved, could result in significant changes to our consolidated financial condition or consolidated results of operations under different conditions or using different assumptions. Senior management has discussed these critical accounting policies with the Audit Committee.

Derivative Financial Instruments—Cash flow hedge accounting requires that we measure the changes in fair value of derivatives designated as hedges as compared to changes in expected cash flows of the underlying hedged transactions for each reporting period. This process involves the estimation of the expected future cash flows of hedged transactions. Interest rate swaps are valued using a nationally recognized swap valuation model. The LIBOR (London InterBank Offered Rate) curve in this model serves as the basis for computing the market value of the swap portfolio. If short-term interest rates increase, as they did during the first half of 2006, we would expect the swaps to gain in value. Conversely, if short-term interest rates decrease, we would expect there to be a corresponding decline in the market value of the swap portfolio. The measurement of fair value of our derivatives portfolio is based upon market interest rate curve and spreads.

Defined Benefit Pension Assumptions—Each fiscal year, we must assess and select the discount rate, compensation increase percentage and average return on plan assets assumptions in order to determine our net periodic pension cost and to project our benefit obligations under our defined benefit plans. The discount rate is based on the weighted-average yield on high-quality fixed-income investments that are expected to match the plan’s projected cash flows. The compensation increase percentage is based upon management’s current and expected salary increases. The average return on plan assets is based on the expected return on the plan’s current investment portfolio, which can reflect the historical returns of the various asset classes.

For the fiscal year ended December 31, 2006, the discount rate used to determine the projected benefit obligations for both our qualified defined benefit pension plan (‘pension plan’) and our nonqualified, unfunded, supplemental retirement plan (‘SERP’) was 6.00%. The discount rate was 0.25% higher than the rate at December 31, 2005 primarily due to increased yields in long-term bond indices. The compensation increase percentage assumption for our SERP ranged from 4.00% to 10.00% at December 31, 2006, which was consistent with the prior year.

For the fiscal year ended December 31, 2006, the discount rate used to determine net periodic pension benefit/cost for both our pension plan and our SERP was 5.75%. The rate of compensation increase for both our pension plan and our SERP of 4.00% at December 31, 2006 was consistent with the rate used in the prior year. The average return on plan assets for our pension plan of 8.50% for the year ended December 31, 2006 has remained consistent with the prior year.

Effective December 31, 2005, all pension plan participant’s accounts were frozen, and effective January 1, 2006, no further pension plan benefit will accrue on behalf of any pension plan participant. As a result, we recorded a net periodic pension benefit on our pension plan for 2006 of $0.2 million, as

compared to a $0.8 million net periodic pension expense, excluding the effect of curtailment, for the year ended December 31, 2005. We expect the net periodic pension benefit on our pension plan to be approximately $0.5 million in fiscal year 2007.

The net periodic pension expense for the SERP was $4.4 million for the year ended December 31, 2006, which was consistent with the prior year. We expect the net periodic pension expense on our SERP to be approximately $4.2 million in fiscal year 2007.

New Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (‘FASB’) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (‘FIN 48’). FIN 48 establishes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Pursuant to FIN 48, the effects of a tax position are recognized in the financial statements when it is more likely than not, based on the technical merits, that the position will be sustained upon examination by the taxing authority. Conversely, previously recognized tax positions are derecognized when it is no longer more likely than not that the tax position would be sustained upon examination. FIN 48 also requires certain disclosures regarding unrecognized tax benefits and the amounts and classification of the related interest and penalties. FIN 48 is effective for fiscal years beginning after December 15, 2006. Accordingly, we adopted FIN 48 on January 1, 2007, and there was no material impact to our financial condition or results of operations.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (‘SFAS 157’). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands upon existing disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements. Rather, the guidance contained in SFAS 157 applies to assets, liabilities, and certain equity instruments that are already measured at fair value under existing accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. We do not anticipate any material impact to our financial condition or results of operations as a result of the adoption of SFAS 157.

In September 2006, the SEC issued Staff Accounting Bulletin 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements (‘SAB 108’). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year financial statement misstatements should be considered in quantifying a current year misstatement. SAB 108 is effective for financial statements covering the first fiscal year ending after November 15, 2006. Accordingly, we adopted SAB 108 on December 31, 2006, and there was no material impact to our financial condition or results of operations.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (‘SFAS 159’). SFAS 159 permits entities to elect to measure certain financial instruments and other items at fair value through earnings. The fair value option may be applied on an instrument by instrument basis, is irrevocable and is applied only to entire instruments. SFAS 159 requires additional financial statement presentation and disclosure requirements for those entities that elect to adopt the standard and is effective for fiscal years beginning after November 15, 2007. We do not anticipate any material impact to our financial condition or results of operations as a result of the adoption of SFAS 159.

Certain Factors That May Affect Future Results

From time to time, information provided by us, statements made by our employees, or information included in our filings with the SEC (including this Form 10-K) may contain statements which are not historical facts, so-called “forward-looking statements,” which are made under Section 21E of the

Securities Exchange Act of 1934 and which involve risks and uncertainties. These statements relate to future events or our future financial performance and are identified by words such as “may”, “could”, “should”, “expect”, “plan”, “intend”, “seek”, “anticipate”, “believe”, “estimate”, “potential”, or “continue” or other comparable terms or the negative of those terms. Forward-looking statements in this Form 10-K include certain statements regarding closing of our acquisition by State Street Corporation, liquidity, capital resources, growth rate, annual dividend payments, interest rate conditions, the shape of the yield curve, interest rate sensitivity, compliance with capital adequacy guidelines, loss exposure on lines of credit, foreign exchange revenue, cash management revenue, securities lending revenue, net interest income, operating margin, operating expenses, including occupancy expenses and needs, transaction processing services expense, professional fee expense, compensation expense, travel and sales expense, investments in technology, pension plan and supplemental pension expense, depreciation expense, investments in Federal Home Loan Bank of Boston (‘FHLBB’) capital stock, the effect on earnings of changes in equity values or fixed income values, the effects of increased prepayments and reduced investment opportunities for our net interest income, the effect of any anticipated activity under our stock repurchase plan, contributing to our supplemental retirement plan, the effect of new accounting pronouncements, the effect of amortization, the effect of an opportunity arising from industry consolidation, our expected effective tax rate and the effect of certain legal claims against us. Our actual future results may differ significantly from those stated in any forward-looking statements. Factors that may cause such differences include, but are not limited to, the factors discussed in Item 1A of this Form 10-K. Each of these factors, and others, are discussed from time to time in our filings with the SEC.

Statements of Income

Comparison of Operating Results for the Years Ended December 31, 2006 and 2005.

Net income for the year ended December 31, 2006 was $153.8 million, down 4% from $159.8 million for the same period in 2005. The decrease primarily resulted from continued pressure on our net interest margin, as well as increased operating expenses. This decrease was offset substantially by increased asset servicing fees, which reflect our ability to sell to new and existing clients combined with market appreciation and strong client fund flows.

Fees and Other Revenue

The components of fees and other revenue are as follows (Dollars in thousands):

	For the Year Ended December 31,
	2006		2005		Change
Total asset servicing fees	$	631,240	$	509,059		24	%
Other operating income	5,691		4,081			39	%
Gain on sale of investments	2,523		12,397			*
Total fees and other revenue	$	639,454	$	525,537		22	%

* Percentage is not considered meaningful.

The largest components of asset servicing fees are custody, multicurrency accounting and fund administration, which increased 21% to $453.6 million for the year ended December 31, 2006 from $375.6 million for the same period in 2005. Custody, multicurrency accounting and fund administration fees are based in part on the value of assets processed. Assets processed is the total dollar value of financial assets on the reported date for which we provide one or more of the following services: global custody, multicurrency accounting, fund administration, middle office outsourcing, foreign exchange, cash management, securities lending, investment advisory, performance measurement, institutional transfer agency, lines of credit and brokerage and transition management services.

The change in net assets processed includes the following components (Dollars in billions):

	For the Year Ended December 31, 2006				For the Three Months Ended December 31, 2006
Net assets processed, beginning of period		$	1,793			$	2,035
Change in net assets processed:
Sales to new clients		8				7
Further penetration of existing clients		29				4
Lost clients		(1		)		—
Fund flows and market gain		383				166
Total change in net assets processed		419				177
Net assets processed, end of period		$	2,212			$	2,212

The majority of the increase in assets processed was due to sales to new and existing clients, the ability of our clients to develop and sell product, which generates fund flows that have a direct, positive impact on our business, and higher asset values compared to a year ago. As indicated in the ‘Overview’ section, our core services fees are generated by charging a fee based upon the value of assets processed. As market values or clients’ asset levels fluctuate, so will our revenue. Our tiered pricing structure, coupled with minimum and flat fees, allow us to manage this volatility to a certain extent. As asset values increase, the basis point fee typically lowers. When asset values decrease, revenue is only impacted by the asset decline at the then marginal rate.

If the value of equity or fixed income assets held by our clients were to increase or decrease by 10% for a sustained period of time, we estimate currently that this market movement, by itself, would cause a corresponding change of less than 5% in our earnings per share. Earnings per share do not track precisely to the value of the equity and fixed-income markets because conditions present in a market increase or decrease may generate offsetting increases or decreases in other revenue and expense items that are influenced by the value of the assets we administer. For example, increased market volatility often results in higher transaction fee revenue. Also, market value declines may result in increased interest income and sweep fee income as clients move larger amounts of assets into the cash management vehicles that we offer. In addition, our tiered pricing structure reduces the impact of volatility in asset values to a certain extent. However, there can be no assurance that any of these offsetting revenue and expense movements will occur during any future upturn or downturn in the equity or fixed-income markets, or that our tiered pricing structure will reduce the impact on us of a sustained change in asset values.

Transaction-driven income includes our value-added services, such as foreign exchange, cash management, securities lending and investment advisory services.

· Foreign exchange fees were $81.0 million for the year ended December 31, 2006, up 30% from the same period in 2005. The increase in foreign exchange fees is attributable to new business, increased volume of client activity and volatility in currency markets. Future foreign exchange income is dependent on the volume of new and existing client activity and overall volatility in the currencies traded.

· Cash management fees, which consist of sweep fees, were $58.8 million for the year ended December 31, 2006, up 56% from the same period in 2005. The increase is primarily due to higher balances placed by our clients in the cash management products we offer. Cash management revenue will continue to depend on the level of client balances maintained in the cash management products we offer. If our clients’ investment products continue to maintain higher cash balances than they did in comparable periods, we expect our cash management revenue to be positively impacted.

· Securities lending fees were $27.4 million for the year ended December 31, 2006, up 21% from the same period in 2005, primarily due to new business, higher volumes and improved market conditions. Securities lending transaction volume is positively affected by merger and acquisition activity, increased IPO activity, the seasonality of international dividend arbitrage and a steeper short-end of the yield curve. If the capital markets experience any of the aforementioned activity, it is likely that our securities lending revenue will be positively impacted. If we experience any of the following: 1) a reduction in our securities lending portfolio, 2) lower market values or 3) compression of the spreads earned on our securities lending activity, our securities lending revenue will likely be negatively impacted.

· Investment advisory fees were $7.5 million for the year ended December 31, 2006, down 12% from the same period in 2005. The decrease in investment advisory fees is attributable to lower asset values in our proprietary Merrimac money market funds. Future investment advisory fee income is dependent upon the asset levels within the Merrimac money market funds, which are driven by overall market conditions, client activity and transaction volumes.

· Other service fees were $3.1 million for the year ended December 31, 2006, up 11% from the same period in 2005. Other service fees include income earned on compliance advisory, brokerage and transition management services. The increase in other service fees was primarily due to an increase in commission fees and compliance service fees.

· Other operating income for the year ended December 31, 2006 was $5.7 million, up 39% from the same period in 2005. The increase is primarily due to an increase in interest earned on clearing agency deposits and an increase in the dividend rate on our FHLBB stock.

During the year ended December 31, 2006, we sold municipal securities held in our available for sale portfolio, resulting in the recognition of $2.5 million in gains. During the year ended December 31, 2005, we sold municipal securities and U.S. Treasury securities held in our available for sale portfolio, resulting in the recognition of $12.4 million in gains. These security sales in 2005 and 2006 were the result of a strategy to improve the after-tax yield of our municipal securities portfolio by replacing the sold municipal securities with those that offer a more attractive after-tax yield, as well as to capitalize on strong market conditions.

Net Interest Income

The following table presents the components of net interest income (Dollars in thousands):

	For the Year Ended December 31,
	2006		2005		Change
Interest income	$	557,749	$	447,705		25	%
Interest expense	393,555		277,280			42	%
Total net interest income	$	164,194	$	170,425		(4	)%

Net interest income is affected by the volume and mix of assets and liabilities and the movement and level of interest rates. The decrease in our net interest income from the year ended December 31, 2006 was primarily driven by increasing short-term interest rates without a concurrent increase in longer-term rates, which resulted in an inverted yield curve. Consequently, our interest-bearing liabilities, of which the majority is priced based on overnight and short-term rates, have repriced at higher rates faster than our interest-earning assets have repriced, resulting in a lower net interest margin as compared to the year ended December 31, 2005. In addition, reinvestment and purchase spreads on fixed and floating-rate assets were lower than expected due to many factors, including yield curve shape and level of rates. Average investment security balances were down $0.3 billion for the year ended December 31, 2006, compared to the year ended December 31, 2005, primarily due to slower reinvestment.

The table below presents the changes in net interest income resulting from changes in the volume of interest-earning assets or interest-bearing liabilities and changes in interest rates for the year ended December 31, 2006 compared to the year ended December 31, 2005. Changes attributed to both volume and rate have been allocated based on the proportion of change in each category (Dollars in thousands):

	For the Year Ended December 31, 2006 vs. December 31, 2005
	Change Due to Volume				Change Due to Rate				Net
Interest-earning assets
Federal funds sold, interest-bearing deposits with other banks and other short-term investments		$	5,331			$	1,560		$	6,891
Investment securities		(10,160		)		101,543			91,383
Loans		3,374				8,396			11,770
Total interest-earning assets		(1,455		)		111,499			110,044
Interest-bearing liabilities
Deposits		36,572				66,049			102,621
Borrowings		(51,892		)		65,546			13,654
Total interest-bearing liabilities		(15,320		)		131,595			116,275
Change in net interest income		$	13,865			$	(20,096	)	$	(6,231	)

Amortization and accretion of debt securities purchased at a premium or discount are amortized or accreted into income using a method which approximates the constant effective yield method. We apply Statement of Financial Accounting Standards No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases (‘SFAS 91’) for the amortization of premiums and accretion of discounts. In calculating the effective yield for securities that represent holdings of large numbers of similar loans for which prepayments are probable and the timing and amount of prepayments can be reasonably estimated, prepayments are anticipated using our actual three-month prepayment experience.

The amount of amortization or accretion to recognize in income is driven by the calculation of the constant effective yield. When calculating this yield, we assume that prepayments will continue from the analysis date to the date of the security’s expected maturity at our most recent three-month prepayment rate. The prepayment rate is updated monthly based on our previous three-month actual prepayment experience.

We utilize three-month prepayment rates to anticipate prepayments because such rates are based on our own actual prepayment experience and because we believe three-month rates are a better estimate of future experience than either one-month or six-month or longer rates. In the opinion of management, a one-month rate does not capture enough experience to predict future prepayment behavior and may create undue volatility in interest income due to one-time fluctuations in prepayment activity. Conversely, in the opinion of management, a six-month or longer rate would not capture enough volatility to predict future prepayment behavior.

If a difference arises between our estimated prepayments and our actual prepayments received, the constant effective yield is recalculated based on our actual payments to date and anticipated future payments. This monthly recalculation results in the carrying value of the security being adjusted to the amount that would have existed had the new effective yield been applied since the purchase date, and a corresponding charge or credit is recognized to interest income.

For securities that do not represent holdings of large numbers of similar loans for which prepayments are probable and the timing and amount of prepayments can be reasonably estimated, the associated

premiums and discounts are amortized or accreted over their contractual term using the constant effective yield. Actual prepayment experience for such securities is reviewed monthly and a proportionate amount of premium or discount is recognized in income at that time such that the effective yield on the remaining portion of the securities continues unchanged.

As of and for the years ended December 31, 2006, 2005, and 2004, we anticipated prepayments on our residential mortgage-backed securities. All other securities do not meet the SFAS 91 criteria for anticipating prepayments. Accordingly, no prepayments were anticipated for these securities.

In addition to investing in both variable and fixed-rate securities, we use derivative instruments to manage our exposure to interest rate risks. See the ‘Market Risk’ section for more detailed information.

Operating Expenses

Total operating expenses were $579.4 million in 2006, up 26% from 2005. The increase in total operating expenses was primarily due to increased compensation and benefits, technology and telecommunications, transaction processing services, occupancy and other operating expenses, as detailed below. The components of operating expenses were as follows (Dollars in thousands):

	For the Year Ended December 31,
	2006		2005		Change
Compensation and benefits	$	327,342	$	250,459		31	%
Technology and telecommunications	73,909		54,732			35	%
Transaction processing services	61,396		49,873			23	%
Occupancy	33,653		26,490			27	%
Depreciation and amortization	32,819		31,578			4	%
Professional fees	13,845		13,380			3	%
Travel and sales promotion	8,883		6,825			30	%
Insurance	3,929		4,219			(7	)%
Loss and loss adjustment expenses	30		5,837			*
Other operating expenses	23,548		16,716			41	%
Total operating expenses	$	579,354	$	460,109		26	%

* Percentage is not considered meaningful.

Compensation and benefits increased 31% from 2005 due to higher headcount in our North American and European offices. Annual salary increases, bonus accruals and options expense also contributed to the growth in the compensation and benefits expense. Further increases in compensation expense in 2007 will be primarily dependant upon hiring needs driven by sales to new and existing clients, the full year impact of staff additions made in 2006, annual salary increases and share-based compensation.

Technology and telecommunications expense increased 35% from 2005 as a result of increased infrastructure investments in 2006. The increase is primarily due to our investment in enhancing our global integrated technology platform, which we view as a significant competitive advantage and growth in new business and customer volumes. Generally, we expect technology reinvestment to equal approximately 18-20% of net operating revenue each year, including related compensation costs.

Transaction processing services expense increased 23% from 2005 due to increases in transaction volumes, higher market values and new business. Future transaction processing servicing expense will be dependent on asset levels and the volume of client transaction activity.

Occupancy expense increased 27% from 2005 and is also expected to increase into the middle of 2007, due to the addition of new office space worldwide needed to accommodate growth.

Professional fees expense increased 3% from 2005, primarily due to higher consulting fees for technology. Future professional fees are dependent upon changes in the value of the Merrimac portfolios and upon other business needs for outside professional services.

Travel and sales promotion expense increased 30% from 2005. Travel and sales promotion expense consists of expenses incurred by our sales force, client management staff and other employees in connection with sales calls on potential clients, as well as traveling to existing client sites and our foreign offices. The increases resulted from a higher level of sales calls on potential clients, a higher level of travel to client sites and foreign offices and attendance at industry conferences. Travel and sales promotion expense in 2007 will be dependent upon new business leads and other client and business needs.

The decrease in loss and loss adjustment expenses from 2005 to 2006 is primarily due to a processing error that occurred during the fourth quarter of 2005.

Other operating expense increased 41% from 2005 primarily due to higher recruitment costs, higher temporary staffing expenses and our settlement of pending litigation.

Income Taxes

Income taxes were $70.5 million for the year ended December 31, 2006, down 7% from the same period in 2005. This decrease in income taxes is primarily related to a decrease in pretax earnings, as well as a 1% decrease in the 2006 effective tax rate resulting from a change in the recognition threshold of a tax position. The decrease in income taxes and the effective tax rate was partially offset by the decrease in one-time tax benefits. During the second quarter of 2005, we adopted the indefinite reversal provisions of Accounting Principles Board Opinion No. 23, Accounting for Income Taxes—Special Areas (‘APB 23’), which specifies that U.S. income taxes should not be recorded on the undistributed earnings of a foreign subsidiary if those undistributed earnings have been or will be invested indefinitely in that subsidiary. We determined that the undistributed earnings of our Irish subsidiaries will be permanently invested in our Irish operations to support continued growth. During the second quarter of 2006, we reversed previously accrued taxes resulting from a tax position that no longer met the probable recognition threshold under Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (‘SFAS 5’).

In 2007, we expect that our effective tax rate will approximate 33.5% of pretax income.

Comparison of Operating Results for the Years Ended December 31, 2005 and 2004.

Net income for the year ended December 31, 2005 was $159.8 million, up 13% from $142.0 million for the same period in 2004. The principal factors contributing to our net income growth were growth in asset servicing fees of 20% and increased gain on sale of investments. Net income growth was partially offset by a 15% increase in operating expenses (largely due to new business wins, additional headcount and technology requirements) and a 9% decrease in net interest income.

Fees and Other Revenue

The components of fees and other revenue are as follows (Dollars in thousands):

	For the Year Ended
	December 31,
	2005		2004		Change
Total asset servicing fees	$	509,059	$	423,200		20	%
Gain on sale of investments	12,397		234			*
Other operating income	4,081		2,057			98	%
Total fees and other revenue	$	525,537	$	425,491		24	%

* Percentage is not considered meaningful.

The largest components of asset servicing fees are custody, multicurrency accounting and fund administration, which increased 20% to $375.6 million for the year ended December 31, 2005 from $314.3 million for the same period in 2004.

The change in net assets processed includes the following components (Dollars in billions):

	For the Year Ended
	December 31, 2005
Net assets processed, beginning of period		$	1,430
Change in net assets processed:
Sales to new clients		159
Further penetration of existing clients		42
Lost clients		(11		)
Fund flows and market gain		173
Total change in net assets processed		363
Net assets processed, end of period		$	1,793

· Foreign exchange fees were $62.1 million for the year ended December 31, 2005, up 14% from the same period in 2004. The increase in foreign exchange fees is attributable to new business, increased volume of client activity and volatility in currency markets.

· Cash management fees were $37.6 million for the year ended December 31, 2005, up 42% from the same period in 2004. The increase is primarily due to higher balances placed by our clients in the cash management products we offer.

· Securities lending fees were $22.5 million for the year ended December 31, 2005, up 117% from the same period in 2004, primarily due to new business, higher volumes and improved market conditions.

· Investment advisory fees were $8.4 million for the year ended December 31, 2005, down 44% from the same period in 2004. The decrease in investment advisory fees is attributable to lower asset values in our proprietary Merrimac money market funds combined with advisory fee waivers on certain of the funds.

· Other service fees for the year ended December 31, 2005 were $2.8 million, up 5% from the same period in 2004. The increase in 2005 was due to an increase in compliance and brokerage services.

· Other operating income for the year ended December 31, 2005 was $4.1 million, up 98% from the same period in 2004. The increase is primarily due to an increase in the dividend rate on our holding of FHLBB stock.

Net Interest Income

The following table presents the components of net interest income (Dollars in thousands):

	For the Year Ended December 31,
	2005		2004		Change
Interest income	$	447,705	$	313,149		43	%
Interest expense	277,280		125,469			121	%
Total net interest income	$	170,425	$	187,680		(9	)%

The decrease in our net interest income was primarily driven by lower interest rate spreads, which was partially offset by growth in our investment portfolio. Average investment security balances were up approximately $1.5 billion for the year ended December 31, 2005 compared to the same period in 2004.

The table below presents the changes in net interest income resulting from changes in the volume of interest-earning assets or interest-bearing liabilities and changes in interest rates for the year ended December 31, 2005 compared to the year ended December 31, 2004. Changes attributed to both volume and rate have been allocated based on the proportion of change in each category (Dollars in thousands):

	For the Year Ended
	December 31, 2005 vs. December 31, 2004
	Change Due				Change Due
	to Volume				to Rate				Net
Interest-earning assets
Federal funds sold and short-term investments		$	226			$	1,357		$	1,583
Investment securities		53,222				75,076			128,298
Loans		2,281				2,394			4,675
Total interest-earning assets		55,729				78,827			134,556
Interest-bearing liabilities
Deposits		(6,879		)		33,864			26,985
Borrowings		38,994				85,832			124,826
Total interest-bearing liabilities		32,115				119,696			151,811
Change in net interest income		$	23,614			$	(40,869	)	$	(17,255	)

Operating Expenses

Total operating expenses were $460.1 million in 2005, up 15% from 2004. The components of operating expenses were as follows (Dollars in thousands):

	For the Year Ended December 31,
	2005		2004		Change
Compensation and benefits	$	250,459	$	205,728		22	%
Technology and telecommunications	54,732		49,816			10	%
Transaction processing services	49,873		42,159			18	%
Depreciation and amortization	31,578		32,124			(2	)%
Occupancy	26,490		29,032			(9	)%
Professional fees	13,380		15,346			(13	)%
Travel and sales promotion	6,825		5,470			25	%
Loss and loss adjustment expenses	5,837		924			*
Insurance	4,219		4,625			(9	)%
Other operating expenses	16,716		13,159			27	%
Total operating expenses	$	460,109	$	398,383		15	%

* Percentage is not considered meaningful.

Compensation and benefits increased 22% from 2004 due to higher headcount and annual salary increases.

Technology and telecommunications expense increased 10% from 2004 as a result of increased infrastructure investments in 2005. The increase is also due to our outsourcing agreement with IBM, which we entered into in July of 2004. A portion of the increase is offset by lower compensation costs due to

employees transferring to IBM. Also, increases in our processing volumes drove higher technology and telecommunications expense.

Transaction processing services expense increased 18% from 2004 as a result of higher global asset values and transactions with our subcustodians.

Professional fees expense decreased 13% from 2004, primarily due to lower subadvisory expense associated with our Merrimac money market funds, resulting from lower average fund balances.

Travel and sales promotion expense increased 25% from 2004. The increase resulted from a higher level of travel to client sites, a higher level of sales calls to potential clients, attendance at industry conferences, and travel related to the establishment of our new European offices.

The increase in loss and loss adjustment expenses from 2004 to 2005 is due to a processing error identified during the fourth quarter of 2005.

Other operating expense increased 27% from 2004 primarily as a result of higher recruiting and staffing expense.

Income Taxes

Income taxes were $76.0 million for the year ended December 31, 2005, up 4% from the same period in 2004. The increase in income taxes and the effective tax rate (excluding the effect of APB 23) is primarily attributable to increased pretax earnings as well as a decrease in the percentage of tax-exempt income to pretax income. The increase in income taxes was partially offset by the reversal of a deferred income tax liability related to the undistributed earnings of our Irish subsidiaries. During the second quarter of 2005, we recognized the indefinite reversal provision of APB 23, which specifies that U.S. income taxes should not be recorded on the undistributed earnings of a foreign subsidiary if those undistributed earnings have been or will be invested indefinitely in that subsidiary. We have determined that the undistributed earnings of our Irish subsidiaries will be permanently invested in our Irish operations to support continued growth.

The following tables present average balances, interest income and expense, and yields earned or paid on the major categories of assets and liabilities for the periods indicated (Dollars in thousands):

	Year Ended December 31, 2006								Year Ended December 31, 2005								Year Ended December 31, 2004
	Average Balance			Interest		Average Yield/Cost			Average Balance			Interest		Average Yield/Cost			Average Balance			Interest		Average Yield/Cost
Interest-earning assets
Federal funds sold, interest- bearing deposits with other banks and other short-term investments	$	181,272		$	9,141		5.04	%	$	66,926		$	2,250		3.36	%	$	52,544		$	667		1.27	%
Investment securities:(1)
Mortgage-backed securities	8,154,233			403,717			4.95		8,034,870			315,845			3.93		6,677,678			221,248			3.31
Federal agency securities	1,976,985			91,861			4.65		2,333,005			89,864			3.85		2,084,988			53,977			2.59
State and political subdivisions	467,649			20,071			4.29		465,451			21,217			4.56		490,621			22,300			4.55
Other securities	204,551			11,927			5.83		230,832			9,267			4.01		299,529			10,370			3.46
Total investment securities	10,803,418			527,576			4.88		11,064,158			436,193			3.94		9,552,816			307,895			3.22
Loans(2)	303,645			21,032			6.93		233,572			9,262			3.97		165,564			4,587			2.77
Total interest-earning assets	11,288,335			557,749			4.94		11,364,656			447,705			3.94		9,770,924			313,149			3.20
Allowance for loan losses	(100		)						(100		)						(100		)
Noninterest-earning assets	641,578								669,142								505,655
Total assets	$	11,929,813							$	12,033,698							$	10,276,479
Interest-bearing liabilities
Deposits:
Demand	$	96,292		$	4,227		4.39	%	$	24,470		$	866		3.54	%	$	—		$	—		0.00	%
Savings	4,576,730			168,247			3.68		3,428,223			74,391			2.17		3,947,865			49,622			1.26
Time	152,708			7,853			5.14		80,729			2,449			3.03		68,594			1,099			1.60
Securities sold under repurchase agreements(3)	4,490,240			164,970			3.67		5,244,614			142,681			2.72		4,162,132			54,376			1.31
Junior subordinated debentures	24,774			2,420			9.77		24,774			2,420			9.77		24,774			2,420			9.77
Other borrowings(4)	913,340			45,838			5.02		1,643,948			54,473			3.31		841,708			17,952			2.13
Total interest-bearing liabilities	10,254,084			393,555			3.84		10,446,758			277,280			2.65		9,045,073			125,469			1.39
Noninterest-bearing liabilities:
Demand deposits	323,228								305,289								252,246
Savings	74,008								61,745								72,536
Time deposits	230,890								198,849								154,617
Other liabilities	181,089								262,505								126,043
Total liabilities	11,063,299								11,275,146								9,650,515
Equity	866,514								758,552								625,964
Total liabilities and equity	$	11,929,813							$	12,033,698							$	10,276,479
Net interest income				$	164,194							$	170,425							$	187,680
Net interest margin(5)							1.45	%							1.50	%							1.92	%
Average interest rate spread(6)							1.10	%							1.29	%							1.81	%
Ratio of interest-earning assets to interest-bearing liabilities							110.09	%							108.79	%							108.02	%

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

(2) Average yield/cost on demand loans includes only performing loan balances. During the years ended December 31, 2006, 2005 and 2004 there were no non-performing loan balances.

(3) Interest expense includes penalties of $2.9 million in 2004 for prepayment of two term repurchase agreements.

(4) Interest expense includes contractual prepayment penalties of $3.9 million in 2004 for prepayment of certain FHLBB borrowings.

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

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

Financial Condition

At December 31, 2006, our total assets were $11.6 billion, down 4% from December 31, 2005, primarily due to a net decrease in our investment portfolio. Average interest-earning assets decreased $0.1 billion, or 1%, for the year ended December 31, 2006 compared to the same period last year, primarily due to paydowns on our Federal agency securities.

Investment Portfolio

The income we derive from our investment portfolio is generated primarily by investing client cash balances and is a component of our asset processing business. In addition, we use our investment portfolio to secure open positions at securities clearing institutions in connection with our custody services. The following table summarizes our investment portfolio as of the dates indicated (Dollars in thousands):

	December 31,
	2006		2005		2004
Securities held to maturity:
Mortgage-backed securities	$	3,753,497	$	4,342,254	$	3,543,961
Federal agency securities	1,680,458		2,305,331		2,274,665
State and political subdivisions	98,375		114,345		124,091
Total securities held to maturity	$	5,532,330	$	6,761,930	$	5,942,717
Securities available for sale:
Mortgage-backed securities	$	4,275,051	$	3,766,101	$	3,854,900
State and political subdivisions	344,304		392,391		404,909
Corporate debt	169,850		200,692		176,546
US Treasury securities	—		—		118,688
Foreign government securities	10,535		10,536		10,462
Total securities available for sale	$	4,799,740	$	4,369,720	$	4,565,505

The $1.2 billion, or 18%, decrease in our held to maturity securities portfolio from December 31, 2005 to December 31, 2006 is primarily due to paydowns and slower reinvestment. Our investment security purchases primarily consisted of floating interest rate mortgage-backed securities which offer an attractive yield and reprice as interest rates increase. Our held to maturity portfolio securities are purchased with the intent and ability to hold to maturity and are not viewed as our primary source of funds to satisfy liquidity needs.

Our available for sale securities portfolio increased $0.4 billion, or 10% from December 31, 2005 to December 31, 2006. The increase was mainly due to purchases of new investment securities, offset by maturities and prepayments. Our investment security purchases included mortgage-backed securities and municipal securities. We believe that purchasing these securities allows us to take advantage of attractive yields and cash flows which aligns with our asset and liability strategy. Refer to the gap analysis under the ‘Market Risk’ section for additional details regarding the matching of our interest-earning assets and interest-bearing liabilities.

The average balance of our investment securities for the year ended December 31, 2006 was $10.8 billion, with an average yield of 4.88%, compared to an average balance of $11.1 billion with an average yield of 3.94% during the same period in 2005. The increased portfolio yield is primarily due to higher rates on our variable-rate securities. Anticipating prepayments in calculating the constant effective yield for mortgage-backed securities may result in more monthly earnings volatility due to the impact of changing interest rates and the resulting adjustments to the amount of amortization. We do not expect

changes to the amount of amortization resulting from anticipating prepayments to have a material effect on our future reported financial results or financial condition.

Prepayment cash flow levels on our Federal agency securities increased in 2006, which we believe was attributable to the expiration of borrower prepayment penalties, increased refinancing and loan payoff activity. Mortgaged-backed security prepayment cash flow levels decreased for most of 2006, primarily attributable to decreased refinancing opportunities.

We invest in mortgage-backed securities and Federal agency securities because they provide a risk/return profile consistent with our investment objectives. Mortgage-backed securities and Federal agency securities generally have a higher yield than U.S. Treasury securities due to credit and prepayment risk. Credit risk results from the possibility that a loss may occur if a counterparty, such as the Federal agency issuing the securities, is unable to meet the terms of the contract. Credit risk related to mortgage-backed securities and Federal agency securities is substantially reduced by payment guarantees and credit enhancements. Prepayment risk results from the possibility that changes in interest rates and other economic factors will result in investment securities paying off earlier than the scheduled maturity date. Refer to the ‘Market Risk’ section for additional details regarding our net interest income simulation model, which includes the impact of changes in interest rates, and therefore prepayment risk, on our net interest income.

We invest in AAA rated, insured municipal securities to generate stable, tax advantaged income. Municipal securities generally have lower stated yields than Federal agency and U.S. Treasury securities, but their after-tax yields are comparable. Municipal securities are subject to call risk. Call risk is similar to prepayment risk and results from the possibility that fluctuating interest rates and other factors may result in the exercise of the call option by the issuing municipality prior to the maturity date of the security.

The carrying value, weighted-average yield, and contractual maturity of our securities held to maturity at December 31, 2006 are reflected in the following table (Dollars in thousands):

	Years to maturity
	Under 1						1 to 5						5 to 10					Over 10
	Amount			Yield			Amount			Yield			Amount		Yield			Amount		Yield
Mortgage-backed securities		$	341		5.67	%		$	2,846		5.69	%	$	5,108		6.68	%	$	3,745,202		5.61	%
Federal agency securities		—			—			2,520			6.67		339,928			5.99		1,338,010			4.47
State and political subdivisions		—			—			8,297			4.85		10,764			5.19		79,314			4.97
Total securities held to maturity		$	341		5.67	%		$	13,663		5.36	%	$	355,800		5.98	%	$	5,162,526		5.31	%

The carrying value, weighted-average yield, and contractual maturity of our securities available for sale at December 31, 2006 are reflected in the following table (Dollars in thousands):

	Years to maturity
	Under 1						1 to 5						5 to 10					Over 10
	Amount			Yield			Amount			Yield			Amount		Yield			Amount		Yield
Mortgage-backed securities		$	—		0.00	%		$	24,676		5.60	%	$	135,013		5.40	%	$	4,115,362		5.01	%
State and political subdivisions		968			5.00			3,358			4.78		96,048			3.94		243,930			4.06
Corporate debt		—			—			—			—		—			—		169,850			6.08
Foreign government		10,535			3.82			—			—		—			—		—			—
Total securities available for sale		$	11,503		3.92	%		$	28,034		5.50	%	$	231,061		4.79	%	$	4,529,142		5.00	%

Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

Loan Portfolio

Our loan portfolio decreased $131.7 million, or 33%, from 2005 to 2006 primarily due to repayments of lines of credit.

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

	December 31,
	2006			2005			2004			2003			2002
Loans to mutual funds	$	152,491		$	286,144		$	22,520		$	104,954		$	49,372
Loans to individuals	64,118			81,392			69,402			67,641			70,023
Commercial and industrial	6,634			15,697			12,177			7,739			6,240
Other	47,550			19,237			30,531			19,296			18,202
	270,793			402,470			134,630			199,630			143,837
Less: allowance for loan losses	(100		)	(100		)	(100		)	(100		)	(100		)
Net loans	$	270,693		$	402,370		$	134,530		$	199,530		$	143,737
Floating rate	$	270,781		$	402,458		$	134,618		$	199,618		$	143,825
Fixed rate	12			12			12			12			12
Gross loans	$	270,793		$	402,470		$	134,630		$	199,630		$	143,837

We make loans to individually managed account customers and to mutual funds and other pooled product clients. We offer overdraft protection and lines of credit to our clients for the purpose of funding redemptions, covering overnight cash shortfalls, leveraging portfolios and meeting other client borrowing needs. The majority of loans to individually managed account customers are written on a demand basis, bear variable interest rates tied to the Prime rate or the Federal Funds rate and are fully secured by liquid collateral, primarily freely tradable securities held in custody by us for the borrower. We monitor the value of collateral daily to ensure the amount of collateral held by us exceeds the loan balance by a certain threshold. Loans to mutual funds and other pooled product clients include unsecured lines of credit that may, in the event of default, be collateralized at our option by securities held in custody by us for those clients. Loans to individually managed account customers, mutual funds and other pooled product clients also include advances that we make to certain clients pursuant to the terms of our custody agreements with those clients to facilitate securities transactions and redemptions.

At December 31, 2006, our only lending concentrations that exceeded 10% of total loan balances were the lines of credit to mutual fund clients discussed above. These loans were made in the ordinary course of business on substantially similar terms and conditions prevailing at the time for comparable transactions.

We periodically issue lines of credit and advances to our mutual fund clients to help those clients with security transactions. The President of one of our clients is a related party to James M. Oates, a member of our Board of Directors. At December 31, 2006, we had total contractual agreements for $150.0 million of committed lines of credit with two mutual funds within the related party complex (the ‘mutual funds’). The primary source of repayment of the loans is the proceeds from the sale of investments in the normal course of the mutual funds’ business. As part of the agreement, the mutual funds are required to segregate and maintain specific collateral for us equal to 200% of the lines of credit. At December 31, 2006, loans due from the mutual funds totaled $63.7 million. At December 31, 2005, loans due from the mutual funds totaled $125.0 million. The terms and conditions of our contractual agreements with the mutual funds, including collateral requirements, lending limits and fees, are consistent with other lending clients that have similar composition, size and overall business relationships with us. Also, Mr. Oates must abstain from voting on any board matter involving any proposed transaction with the mutual funds.

Our loan portfolio credit performance has been excellent. There have been no loan charge-offs in the history of our Company. It is our policy to place a loan on nonaccrual status when either principal or

interest becomes 90 days past due and the loan’s collateral is not sufficient to cover both principal and accrued interest. As of December 31, 2006, there were no loans on nonaccrual status and no troubled debt restructurings. Although virtually all of our loans are fully collateralized with freely tradable securities, management recognizes some credit risk inherent in the loan portfolio, and therefore we have recorded an allowance for loan losses of $0.1 million at December 31, 2006, a level which has remained consistent for the past five years. This allowance is not allocated to any particular loan, but is intended to absorb any risk of loss inherent in the loan portfolio at the balance sheet date that is not captured in our historical loss rates. Management actively monitors the loan portfolio and the underlying collateral and regularly assesses the adequacy of the allowance for loan losses.

Deposits

Total deposits were $6.1 billion at December 31, 2006, up 23% from December 31, 2005. The increase in our deposit balances is a result of new business and our clients holding larger cash positions in their portfolios.

Repurchase Agreements and Short-Term and Other Borrowings

Repurchase agreements decreased $1.1 billion, or 22%, from December 31, 2005 to December 31, 2006. The majority of our repurchase agreements are with clients who seek collateralized deposits. Wholesale repurchase agreements are a stable source of funding and are used to offset the variability of deposit flow. The average balance of securities sold under repurchase agreements for the year ended December 31, 2006 was $4.5 billion with an average cost of approximately 3.67%, compared to an average balance of $5.2 billion and an average cost of approximately 2.72% for the same period in 2005. The increase in the average cost of repurchase agreements was due to higher short-term interest rates in 2006 compared to 2005.

The following table represents information regarding our securities sold under repurchase agreements (Dollars in thousands):

	December 31,				December 31,				December 31,
	2006				2005				2004
Outstanding at end of year		$	3,727,800			$	4,797,868			$	4,255,497
Maximum outstanding at any month end		4,977,489				5,972,855				4,749,456
Average balance for the year		4,490,240				5,244,614				4,162,132
Weighted-average rate at end of year		4.15		%		3.55		%		1.98		%
Weighted-average rate for the year		3.67		%		2.72		%		1.31		%

Short-term and other borrowings decreased $0.8 billion, or 62%, from December 31, 2005 to December 31, 2006. Short-term and other borrowings are sources of funding and are used to offset the variability of deposit flow. The average balance of short-term and other borrowings for the year ended December 31, 2006 was $0.9 billion with an average cost of approximately 5.02%, compared to an average balance of $1.6 billion and an average cost of approximately 3.31% for the same period in 2005. The increase in the average cost of short-term and other borrowings was due to an increase in short-term rates during 2006 compared to 2005.

The following table represents information regarding our Federal Funds purchased (Dollars in thousands):

	December 31,				December 31,				December 31,
	2006				2005				2004
Outstanding at end of year		$	391,967			$	810,511			$	344,491
Maximum outstanding at any month end		1,145,025				1,603,757				739,038
Average balance for the year		743,101				1,298,684				491,170
Weighted-average rate at end of year		5.20		%		4.25		%		1.94		%
Weighted-average rate for the year		4.91		%		3.33		%		1.45		%

Market Risk

Our clients, in the course of their financial asset management, maintain cash balances, which they can deposit with us on a short-term basis in interest-bearing accounts or client repurchase agreements. We either directly invest these cash balances to earn interest income, or place these deposits in third-party vehicles and remit a portion of the earnings on these investments to our clients after deducting a fee as our compensation for investing clients’ funds in these investment vehicles. In the conduct of these activities, we are subject to market risk.

Market risk is the risk of an adverse financial impact from changes in market prices. The level of risk we assume is a function of our overall strategic objectives and liquidity needs, client requirements and market volatility. The active management of market risk is integral to our operations.

Our balance sheet is primarily subject to interest rate risk, which is the risk of loss due to movements in interest rates. Prepayment risk, which is the risk that changes in interest rates and other economic factors will result in investment securities paying off earlier than the scheduled maturity date, is inherent in our investment securities, mainly our mortgage-backed securities and Federal agency securities. Prepayment levels for mortgage-backed securities are primarily driven by changes in interest rates. Prepayment levels for Federal agency securities are driven by a number of factors, including expiration of prepayment penalty provisions, the economic condition of the borrower, borrower refinancing alternatives, and interest rates. The objective of interest rate sensitivity management is to provide sustainable net interest income under various economic conditions.

Our Board of Directors has set asset and liability management policies that define the overall framework for managing interest rate sensitivity, including accountabilities and controls over investment activities. These policies delineate investment limits and strategies that are appropriate, given our liquidity and regulatory requirements. For example, we have established a policy limit stating that projected net interest income will not be impacted by more than 10% given a change in interest rates of 200 basis points (+ or -) over a twelve-month period. Each quarter, our Board of Directors reviews our asset and liability positions, including simulations of the effect of various interest rate scenarios on our net interest income.

The day-to-day responsibility for oversight of the Asset and Liability Management function has been delegated by our Board of Directors to our Asset and Liability Committee (‘ALCO’). ALCO is a senior management committee consisting of the Chief Executive Officer, the President, the Chief Financial Officer, the Chief Risk Officer and members of the Treasury function. ALCO meets twice monthly. Our primary tool in managing interest rate sensitivity is an income simulation model. Key assumptions in the simulation model include the timing of cash flows, which include forecasted prepayment speeds that are based on market and industry data, maturities and repricing of financial instruments, changes in market conditions, capital planning and deposit sensitivity. The model assumes that the composition of our interest-sensitive assets and liabilities will change over the period being measured. The model also assumes that the change in interest rates is a parallel shift of the yield curve across all maturities. These assumptions are inherently uncertain, and as a result, the model cannot precisely predict the effect of changes in

interest rates on our net interest income. Actual results may differ from simulated results due to the timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies.

The results of the income simulation model as of December 31, 2006 and 2005 indicated that an upward shift of interest rates by 200 basis points over a twelve-month period would result in a reduction in projected net interest income of approximately 6.2% and 7.0%, respectively, which are both within our 10% policy limit. We also simulate a 200 basis point rate reduction over a twelve-month period. This simulation would result in an increase in projected net interest income of approximately 3.3% and 1.1% at December 31, 2006 and 2005, respectively, both within our 10% policy limit.

We also use gap analysis as a secondary tool to manage our interest rate sensitivity. Gap analysis involves measurement of the difference in asset and liability repricing on a cumulative basis within a specified time frame. A positive gap indicates that more interest-earning assets than interest-bearing liabilities reprice/mature in a time frame, and a negative gap indicates the opposite. As shown in the cumulative gap position in the table presented on the following page, at December 31, 2006, interest-bearing liabilities repriced faster than interest-earning assets in the short term. Generally speaking, net interest income would benefit from lower short-term interest rates. During a period of rising interest rates, such as the one we experienced during 2005 and the first half of 2006, net interest income would be lower than it would have been until interest rates stabilize. Other important determinants of net interest income are the shape of the yield curve, general rate levels, reinvestment spreads, balance sheet growth and mix, and interest rate spreads. We continue to run a closely matched balance sheet by investing the majority of our assets in short duration, variable-rate securities and executing interest rate swaps against client liabilities, including client repurchase agreements.

We manage the structure of interest-earning assets and interest-bearing liabilities by adjusting their mix, yield, maturity and/or repricing characteristics based on market conditions. Client deposits and repurchase agreements, which are predominantly short term, are our primary sources of funds. We also use term borrowings and interest rate swap agreements to augment our management of interest rate exposure. The effect of the swap agreements is to lengthen both a forecasted series of fixed-rate overnight liabilities incurred at different daily fixed rates and short-term variable-rate liabilities into longer-term fixed-rate liabilities. The weighted-average fixed-payment rates on our swap agreements were 3.82% and 3.51% at December 31, 2006 and 2005, respectively. Variable-interest payments received are currently indexed to the overnight Federal Funds rate. At December 31, 2006 and 2005, the weighted-average rates of variable market-indexed interest payment obligations to us were 5.24% and 4.00%, respectively. The remaining terms of swaps at December 31, 2006 range from 1 to 22 months. These contracts had net fair values of approximately $13.8 million and $24.2 million at December 31, 2006 and 2005, respectively.

The following table presents the repricing schedule for our interest-earning assets and interest-bearing liabilities at December 31, 2006 (Dollars in thousands):

	Within			Three			Six				One
	Three			To Six			To Twelve				Year to				Over Five
	Months			Months			Months				Five Years				Years			Total
Interest-earning assets(1):
Investment securities(2,3)	$	5,921,097		$	488,872			$	740,712			$	2,412,779		$	770,003		$	10,333,463
Federal funds sold, interest-bearing deposits with other banks and other short-term investments	323,189			—				—				—			—			323,189
Loans—variable rate	269,781			1,000				—				—			—			270,781
Loans—fixed rate	—			—				—				12			—			12
Total interest-earning assets	6,514,067			489,872				740,712				2,412,791			770,003			10,927,445
Interest-bearing liabilities:
Demand deposit accounts	110,647			—				—				—			—			110,647
Savings accounts	4,854,711			—				—				—			—			4,854,711
Time deposits	224,386			—				—				—			—			224,386
Interest rate contracts	(1,330,000		)	260,000				400,000				670,000			—			—
Securities sold under repurchase agreements	3,277,800			150,000				200,000				100,000			—			3,727,800
Short-term and other borrowings	517,051			—				—				—			—			517,051
Junior subordinated debentures	24,774			—				—				—			—			24,774
Total interest-bearing liabilities	7,679,369			410,000				600,000				770,000			—			9,459,369
Net interest-sensitivity gap during the period	$	(1,165,302	)	$	79,872			$	140,712			$	1,642,791		$	770,003		$	1,468,076
Cumulative gap	$	(1,165,302	)	$	(1,085,430	)		$	(944,718	)		$	698,073		$	1,468,076
Interest-sensitive assets as a percent of interest-sensitive liabilities (cumulative)	84.83		%	86.58		%		89.13		%		107.38		%	115.52		%
Interest-sensitive assets as a percent of total assets (cumulative)	56.36		%	60.60		%		67.01		%		87.88		%	94.54		%
Net interest-sensitivity gap as a percent of total assets	(10.08		)%	0.69		%		1.22		%		14.21		%	6.66		%
Cumulative gap as a percent of total assets	(10.08		)%	(9.39		)%		(8.17		)%		6.04		%	12.70		%

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

(2) Mortgage-backed securities are included in the pricing category that corresponds with the earlier of their first repricing date or principal paydown schedule generated from industry sourced prepayment projections.

(3) Excludes $26.4 million of unsettled securities purchases and $27.8 million of net unrealized losses as of December 31, 2006.

Liquidity

Liquidity represents the ability of an institution to meet present and future financial obligations through either runoff due to prepayments, asset sales, maturity of existing assets or the acquisition of additional funds through liability management. These obligations arise from the withdrawals of deposits, the payment of operating expenses, and the inclusion of capital expenditures for fixed assets and leasehold improvements.

Our primary sources of liquidity include cash and cash equivalents, Federal Funds sold, new deposits, short-term borrowings, interest and principal payments on securities held to maturity and available for sale, fees collected from asset administration clients, FHLBB borrowings and the Federal Reserve Discount Window. As a result of our management of liquid assets and our ability to generate liquidity through liability funds, management believes that we maintain overall liquidity sufficient to meet our depositors’ needs, to satisfy our operating requirements and to fund the payment of an anticipated annual cash dividend of $0.10 per share for 2007 (approximately $6.6 million based upon 65,628,108 shares outstanding as of December 31, 2006).

Our ability to pay dividends on common stock may depend on the receipt of dividends from the Bank. Any dividend payments by the Bank are subject to certain restrictions imposed by the Massachusetts Commissioner of Banks. During all periods presented in this report, the Company did not require dividends from the Bank in order to fund the Company’s own dividends. In addition, we may not pay dividends on our common stock if we are in default under certain agreements entered into in connection with the sale of our Capital Securities. The Capital Securities were issued in 1997 by Investors Capital Trust I, a Delaware statutory business trust sponsored by us, and qualify as Tier 1 capital under the capital guidelines of the Federal Reserve Board of Governors (‘FRB’).

In June 2006, we announced that our Board of Directors had authorized a new repurchase plan of up to $150.0 million of our common stock over the twelve months following the announcement. We do not expect the stock repurchase program to have a material impact on our capital resources, such as maintaining risk-based capital ratios in excess of capital adequacy guidelines and our ability to pay dividends on our common stock. As of December 31, 2006, we have repurchased $29.3 million of our common stock under this plan.

We have informal borrowing arrangements with various counterparties. Each counterparty has agreed to make funds available to us at the Federal Funds overnight rate. Each counterparty may terminate its arrangement at any time and is under no contractual obligation to provide us with requested funding. Our borrowings under these arrangements are typically on a short-term basis. We cannot be certain, however, that such funding will be available. Lack of availability of liquid funds could have a material adverse impact on our operations.

We also have Master Repurchase Agreements in place with various counterparties. Each counterparty has agreed on an uncommitted basis to make funds available to us at various rates in exchange for collateral consisting of marketable securities.

Our capital stock investment in the FHLBB totaled $29.4 million as of December 31, 2006. This amount reflects a $20.6 million decrease from December 31, 2005. The $29.4 million capital stock investment includes both a $25.0 million membership component and a $4.4 million activity-based component. The membership component of the FHLBB capital stock investment requires a five-year advance notice of withdrawal. Our $29.4 million capital stock investment in the FHLBB provides an overnight borrowing capacity of up to $146.4 million. The amount outstanding under this arrangement as of December 31, 2006 was $125.0 million. Additional borrowing is available to us based on prescribed collateral levels and increased investment in FHLBB capital stock. We currently have the ability to

purchase up to $25.0 million of activity-based capital, which would provide a total overnight borrowing capacity of $833.3 million.

In October 2006, we became a member of the Federal Reserve Bank of Boston (‘FRBB’). In connection with our membership, we were required to subscribe to purchase stock of the FRBB totaling 6% of the Bank’s capital and surplus. We fulfilled our obligation to purchase 50% of the subscribed amount by purchasing $7.4 million of FRBB stock. The remaining subscription amount is subject to purchase upon the request of the FRBB.

The following table details our contractual obligations as of December 31, 2006 (Dollars in thousands):

	Payments due by period
			Less than 1		1-3		4-5		More than
	Total		year		years		years		5 years
Contractual obligations
Debt obligations(1)	$	517,051	$	517,051	$	—	$	—	$	—
Repurchase agreements	3,727,800		3,627,800		100,000		—		—
Junior subordinated debentures(2)	24,000		24,000		—		—		—
Operating lease obligations	299,416		35,189		70,328		72,020		121,879
Total	$	4,568,267	$	4,204,040	$	170,328	$	72,020	$	121,879

(1) Debt obligations presented are variable in nature and do not include interest amounts.

(2) These securities ultimately mature in 2027; however, we have the right to redeem the securities as early as February 2007.

	Payments due by period
			Less than 1		1-3		4-5		More than
	Total		year		years		years		5 years
Other commitments
Unused commitments to lend	$	1,053,632	$	1,044,632	$	—	$	9,000		$	—
Other	148,156		37,777		74,844		35,535			—
Total	$	1,201,788	$	1,082,409	$	74,844	$	44,535		$	—

Included in the other commitments line presented above are contracts in which we are obligated to utilize the data processing services of Electronic Data Systems through December 31, 2008, SEI Investments Company through December 31, 2009 and International Business Machines Corporation through June 30, 2011. The commitments to pay for these services are based upon transaction volumes and include inflationary price clauses.

Capital Resources

Historically, we have financed our operations principally through internally generated cash flows. We incur capital expenditures for furniture, fixtures, capitalized software and miscellaneous equipment needs. We lease office space and computing equipment through operating leases. Capital expenditures have been incurred and leases entered into on an as-required basis, primarily to meet our growing operating needs. As a result, our capital expenditures were $76.7 million and $33.1 million for the years ended December 31, 2006 and 2005, respectively. For the year ended December 31, 2006, capital expenditures were comprised of approximately $33.2 million in capitalized software and projects in process, $22.8 million in leasehold improvements and $20.7 million in fixed assets. For the year ended December 31, 2005, capital expenditures were comprised of approximately $19.0 million in capitalized software and projects in process, $13.6 million in fixed assets and $0.5 million in leasehold improvements.

Stockholders’ equity at December 31, 2006 was $938.7 million, up 21% from 2005, primarily due to net income earned and the exercise of stock options. The ratio of average stockholders’ equity to average assets was approximately 7% for the year ended December 31, 2006 compared to 6% for the year ended December 31, 2005.

The FRB has adopted capital adequacy guidelines applicable to United States banking organizations. The FRB’s capital adequacy guidelines generally require bank holding companies (‘BHCs’) to maintain total capital equal to 8% of total risk-adjusted assets and off-balance sheet items (the ‘Total Risk-Based Capital Ratio’), with at least 50% of that amount consisting of Tier 1, or core capital, and the remaining amount consisting of Tier 2, or supplementary capital. Tier 1 capital for BHCs generally consists of the sum of common stockholders’ equity and perpetual preferred stock (subject to certain limitations), less goodwill and other nonqualifying intangible assets. Tier 2 capital generally consists of hybrid capital instruments, perpetual debt and mandatory convertible debt securities; perpetual preferred stock, not included as Tier 1 capital; term subordinated debt and intermediate-term preferred stock; and, subject to limitations, general allowances for loan and lease losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics.

We are currently in compliance with both the Total Risk-Based Capital Ratio and the Leverage Ratio requirements, and management expects these ratios to remain in compliance with the FRB’s capital adequacy guidelines. At December 31, 2006, our Total Risk-Based Capital Ratio and Leverage Ratio were 19.04% and 7.63%, respectively.

Off Balance Sheet Arrangements

Lines of Credit—At December 31, 2006, we had commitments to mutual funds, individuals and others under collateralized open lines of credit totaling $1.2 billion, against which $184.6 million in loans were drawn. The credit risk involved in issuing lines of credit is essentially the same as that involved in extending demand loans. We do not anticipate any loss as a result of these lines of credit.

Securities Lending—On behalf of our clients, we lend securities to creditworthy broker-dealers. In certain circumstances, we may indemnify our clients for the fair market value of those securities against a failure of the borrower to return such securities. We require the borrowers to provide collateral in an amount equal to, or in excess of, 102% of the fair market value of U.S. dollar-denominated securities borrowed and 105% of the fair market value of non-U.S. dollar-denominated securities borrowed. The borrowed securities are revalued daily to determine whether additional collateral is necessary. As guarantor, we are required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. We measure the fair value of our indemnification obligation by marking our securities lending portfolio to market on a daily basis and comparing the value of the portfolio to the collateral holdings position. The fair value of the indemnification obligation to be recorded would be the deficiency of collateral as compared to the value of the securities out on loan.

With respect to the indemnified securities lending portfolio, the cash and U.S. government securities held by us as collateral at December 31, 2006 totaled $11.1 billion, while the fair value of the portfolio

totaled approximately $10.7 billion. Given that the value of the collateral held was in excess of the value of the securities that we would be required to replace if the borrower defaulted and failed to return such securities, our indemnification obligation was zero and no liability was recorded.

All securities loans are categorized as overnight loans. The maximum potential amount of future payments that we could be required to make would be equal to the market value of the securities borrowed. Since the securities loans are overcollateralized by 2% (for U.S. dollar-denominated securities) to 5% (for non-U.S. dollar-denominated securities) of the fair market value of the loan made, the collateral held by us would be used to satisfy the obligation. In addition, each borrowing agreement includes “set-off” language that allows us to use any excess collateral on other loans to that borrower to cover any collateral shortfall of that borrower. However, there is a potential risk that the collateral would not be sufficient to cover such an obligation if the security on loan increased in value between the time the borrower defaulted and the time the security is “bought-in”. In those instances, we would “buy-in” the security using all available collateral and a loss would result from the difference between the value of the security “bought-in” and the value of the collateral held. We have never experienced a broker default.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

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

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

The information required by this item is contained in the financial statements and schedules set forth in Item 15(a) under the captions ‘Consolidated Financial Statements’ and ‘Financial Statement Schedules’ as a part of this Report.

ITEM 9A. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

As of December 31, 2006, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Our disclosure controls and procedures are the controls and other procedures that we designed to ensure that we record, process, summarize and report in a timely manner the information we must disclose in reports that we file or submit to the Securities and Exchange Commission and that the information required to be disclosed is accumulated and communicated to our principal executive and principal financial officers as appropriate to allow timely decisions regarding required disclosure. Kevin J. Sheehan, our Chairman and Chief Executive Officer, and John N. Spinney, Jr., our Senior Vice President and Chief Financial Officer, reviewed and participated in this evaluation. Based on this evaluation, Messrs. Sheehan and Spinney concluded that, as of December 31, 2006, our disclosure controls and procedures were effective. During the year ended December 31, 2006, there were no significant changes in our internal control over financial reporting that materially affected our internal control over financial reporting.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

The information required under this item is incorporated herein by reference to our definitive proxy statement pursuant to Regulation 14A, which proxy statement will be filed with the Securities and Exchange Commission not later than 120 days after the close of our fiscal year ended December 31, 2006.

ITEM 11. EXECUTIVE COMPENSATION.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

(a) 1. Consolidated Financial Statements.

For the following consolidated financial information included herein, see Index to Consolidated Financial Statements on Page F-1:

Report of Independent Registered Public Accounting Firm.

Consolidated Balance Sheets as of December 31, 2006 and December 31, 2005.

Consolidated Statements of Income and Comprehensive Income for the Years Ended December 31, 2006, 2005 and 2004.

Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2006, 2005 and 2004.

Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004.

Notes to Consolidated Financial Statements.

2. Financial Statement Schedules.

None.

3. List of Exhibits.

Exhibit No.				Description
2.1(13)				Agreement and Plan of Merger between the Company and State Street Corporation, dated February 4, 2007
3.1(6)				Certificate of Incorporation of the Company
3.2(3)				Certificate of Amendment of Certificate of Incorporation of the Company
3.3(5)				Certificate of Amendment of Certificate of Incorporation of the Company
3.4(8)				Certificate of Amendment of Certificate of Incorporation of the Company
3.5(9)				Certificate of Amendment of Certificate of Incorporation of the Company
3.6(6)				Amended and Restated Bylaws of the Company
4.1(6)				Specimen certificate representing the common stock of the Company
10.1(7)*				Amended and Restated 1995 Stock Plan
10.2(7)*				Amended and Restated 1995 Non-Employee Director Stock Option Plan
10.3(11)*				2005 Equity Compensation Plan
10.4(6)				Information Technology Services Contract between the Company and Electronic Data Systems, Inc., dated September 20, 1995
10.5(1)				Lease Agreement between the Company and John Hancock Mutual Life Insurance Company, dated November 13, 1995, for the premises located at 200 Clarendon Street, Boston, Massachusetts
10.6(11)**				Amendment to Lease between Investors Financial Services Corp. and 100 & 200 Clarendon LLC (successors to the John Hancock Mutual Life Insurance Company), dated January 1, 2005
10.7(9)*				1997 Employee Stock Purchase Plan, as amended
10.8(2)				Amended and Restated Declaration of Trust among the Company and the Trustees named therein, dated January 31, 1997
10.9(2)				Indenture between the Company and The Bank of New York, dated January 31, 1997

10.10(2)		Common Securities Guarantee Agreement by the Company as Guarantor, dated January 31, 1997
10.11(2)		Capital Securities Guarantee Agreement between the Company as Guarantor and The Bank of New York as Capital Securities Guarantee Trustee, dated January 31, 1997
10.12(4)		First Amendment, effective January 1, 2000 to Information Technology Services Contract between the Company and Electronic Data Systems, Inc. dated September 20, 1995
10.13(4)*		Amended and Restated Employment Agreement between the Company and Kevin Sheehan
10.14(4)*		Change of Control Employment Agreement between the Company and Kevin Sheehan
10.15(4)*		Amended and Restated Employment Agreement between the Company and Michael Rogers
10.16(4)*		Change of Control Employment Agreement between the Company and Michael Rogers
10.17(4)*		Amended and Restated Employment Agreement between the Company and Edmund Maroney
10.18(4)*		Change of Control Employment Agreement between the Company and Edmund Maroney
10.19(4)*		Amended and Restated Employment Agreement between the Company and Robert Mancuso
10.20(4)*		Change of Control Employment Agreement between the Company and Robert Mancuso
10.21(4)*		Amended and Restated Employment Agreement between the Company and John Henry
10.22(4)*		Change of Control Employment Agreement between the Company and John Henry
10.23(6)*		Change of Control Employment Agreement between the Company and John N. Spinney, Jr.
10.24(7)*		Employment Agreement between the Company and John N. Spinney, Jr.
10.25(9)		Information Technology Services Agreement dated July 1, 2004 between the Company and International Business Machines Corporation.
10.26(10)		Stock Option Agreement dated November 15, 2004 between the Company and Kevin J. Sheehan
10.27(10)*		Stock Option Agreement dated November 15, 2004 between the Company and Kevin J. Sheehan
10.28(10)*		Stock Option Agreement dated November 15, 2004 between the Company and Michael F. Rogers
10.29(10)*		Stock Option Agreement dated November 15, 2004 between the Company and Michael F. Rogers
10.30(10)*		Stock Option Agreement dated November 15, 2004 between the Company and Edmund J. Maroney
10.31(10)*		Stock Option Agreement dated November 15, 2004 between the Company and Edmund J. Maroney
10.32(10)*		Stock Option Agreement dated November 15, 2004 between the Company and John N. Spinney, Jr.

10.33(10)*		Stock Option Agreement dated November 15, 2004 between the Company and Robert D. Mancuso
10.34(12)**		Amended and Restated Trust 3000 Service Agreement between the Company and SEI Investments Company dated July 1, 2004.
10.35(12)		Lease agreement between the Company and Copley Place Associates, LLC dated August 2, 1999, as amended.
21.1		Subsidiaries of the Company
23.1		Consent of Deloitte & Touche LLP
24.1		Power of Attorney (see Power of Attorney and Signature Page of this Report).
31.1		Certificate of Kevin J. Sheehan, Chief Executive Officer
31.2		Certificate of John N. Spinney, Jr., Chief Financial Officer
32.1		Certification of Kevin J. Sheehan, Chief Executive Officer, and John N. Spinney, Jr., Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1) Previously filed as an exhibit to Form 10-K for the fiscal year ended October 31, 1995.

(2) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 1996 (File No. 000-26996).

(3) Previously filed as an exhibit to Form 10-Q for the fiscal quarter ended March 31, 2000.

(4) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2000.

(5) Previously filed as an exhibit to the Company’s Registration Statement on Form S-8 filed with the Commission on November 5, 2001 (File No. 333-72786).

(6) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2001.

(7) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2002.

(8) Previously filed as an exhibit to Form 10-Q for the fiscal quarter ended June 30, 2003.

(9) Previously filed as an exhibit to Form 10-Q for the fiscal quarter ended June 30, 2004.

(10) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2004.

(11) Previously filed as an exhibit to Form 10-Q for the fiscal quarter ended March 31, 2005.

(12) Previously filed as an exhibit to Form 10-K for the fiscal year ended December 31, 2005.

(13) Previously filed as an exhibit to Form 8-K filed on February 6, 2007.

* Indicates a management contract or a compensatory plan, contract or arrangement.

** Confidential treatment requested pursuant to rule 24b-2 promulgated under the Securities Exchange Act of 1934.

(b) Exhibits.

The Company hereby files as part of this Form 10-K the exhibits listed in Item 15(a)(3) above. Exhibits which are incorporated herein by reference can be inspected and copied at the public reference facilities maintained by the Securities and Exchange Commission, 450 Fifth Street, N.W., Room 1024, Washington, D.C.

(c) Financial Statement Schedules.

None.

INVESTORS FINANCIAL SERVICES CORP.
CONSOLIDATED BALANCE SHEETS
December 31, 2006 and 2005 (Dollars in thousands, except per share data)

	December 31,				December 31,
	2006				2005
Assets
Cash and due from banks		$	92,776			$	60,743
Interest-bearing deposits with other banks		21,218				18,894
Other short-term investments		1,971				—
Federal funds sold		300,000				—
Securities held to maturity (including securities pledged of $4,096,013 and $4,529,421 at December 31, 2006 and 2005, respectively) (approximate fair value of $5,508,788 and $6,725,729 at December 31, 2006 and 2005, respectively) (Note 3)		5,532,330				6,761,930
Securities available for sale (including securities pledged of $3,071,503 and $2,997,958 at December 31, 2006 and 2005, respectively) (Note 3)		4,799,740				4,369,720
Nonmarketable equity securities (Note 3)		40,054				51,251
Loans, less allowance for loan losses of $100 at December 31, 2006 and 2005 (Note 4)		270,693				402,370
Accrued interest and fees receivable		134,748				119,583
Equipment and leasehold improvements, less accumulated depreciation of $64,290 and $59,156 at December 31, 2006 and 2005, respectively (Note 5)		113,287				69,401
Goodwill, net		79,969				79,969
Other assets		171,420				154,873
Total Assets		$	11,558,206			$	12,088,734
Liabilities and Stockholders’ Equity
Liabilities:
Deposits (Note 6):
Demand		$	695,821			$	537,558
Savings		4,924,735				4,224,908
Time		524,386				230,124
Total deposits		6,144,942				4,992,590
Securities sold under repurchase agreements (Note 7)		3,727,800				4,797,868
Short-term and other borrowings (Note 8)		517,051				1,356,649
Due to brokers for open trades payable		26,359				21,293
Junior subordinated deferrable interest debentures (Note 10)		24,774				24,774
Accrued expenses		77,821				37,418
Other liabilities		100,721				85,284
Total liabilities		10,619,468				11,315,876
Commitments and contingencies (Note 16)		—				—
Stockholders’ Equity:
Preferred stock, par value $0.01 (shares authorized: 1,000,000; issued: none at December 31, 2006 and 2005)		—				—
Common stock, par value $0.01 (shares authorized: 175,000,000; issued: 68,523,129 and 67,177,306 at December 31, 2006 and 2005, respectively)		685				672
Surplus		334,929				286,265
Deferred compensation		—				(311		)
Retained earnings		720,433				572,549
Accumulated other comprehensive loss, net		(14,514		)		(13,369		)
Treasury stock, at cost (2,895,021 and 2,124,669 shares at December 31, 2006 and 2005, respectively)		(102,795		)		(72,948		)
Total stockholders’ equity		938,738				772,858
Total Liabilities and Stockholders’ Equity		$	11,558,206			$	12,088,734

See Notes to Consolidated Financial Statements.

F-3

INVESTORS FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
Years Ended December 31, 2006, 2005 and 2004 (Dollars in thousands, except per share data)

	December 31,				December 31,				December 31,
	2006				2005				2004
Fees and Other Revenue:
Asset servicing fees:
Core service fees		$	453,573			$	375,596			$	314,272
Value-added service fees		177,667				133,463				108,928
Total asset servicing fees		631,240				509,059				423,200
Other operating income		5,691				4,081				2,057
Gain on sale of investments		2,523				12,397				234
Total fees and other revenue		639,454				525,537				425,491
Interest income		557,749				447,705				313,149
Interest expense		393,555				277,280				125,469
Net interest income		164,194				170,425				187,680
Net operating revenue		803,648				695,962				613,171
Operating Expenses:
Compensation and benefits		327,342				250,459				205,728
Technology and telecommunications		73,909				54,732				49,816
Transaction processing services		61,396				49,873				42,159
Occupancy		33,653				26,490				29,032
Depreciation and amortization		32,819				31,578				32,124
Professional fees		13,845				13,380				15,346
Travel and sales promotion		8,883				6,825				5,470
Insurance		3,929				4,219				4,625
Losses and loss adjustment expenses		30				5,837				924
Other operating expenses		23,548				16,716				13,159
Total operating expenses		579,354				460,109				398,383
Income Before Income Taxes		224,294				235,853				214,788
Provision for income taxes (Note 9)		70,491				76,035				72,826
Net Income		$	153,803			$	159,818			$	141,962
Basic Earnings Per Share		$	2.34			$	2.42			$	2.15
Diluted Earnings Per Share		$	2.28			$	2.37			$	2.09
Weighted-Average Basic Shares		65,730,456				66,139,323				66,179,286
Weighted-Average Diluted Shares		67,493,081				67,473,804				67,916,217
Comprehensive Income:
Net income		$	153,803			$	159,818			$	141,962
Other comprehensive income (loss) (Note 12):
Net unrealized investment gain (loss)		10,695				(46,054		)		(7,854		)
Net unrealized derivative instrument (loss) gain		(6,525		)		8,745				13,031
Cumulative translation adjustment		1,444				52				846
Other comprehensive income (loss)		5,614				(37,257		)		6,023
Comprehensive income		$	159,417			$	122,561			$	147,985

See Notes to Consolidated Financial Statements.

F-4

INVESTORS FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Years Ended December 31, 2006, 2005, and 2004 (Dollars in thousands, except per share data)

	December 31,				December 31,				December 31,
	2006				2005				2004
Common shares
Balance, beginning of year		67,177,306				66,668,584				65,463,296
Exercise of stock options		1,211,518				394,018				1,114,051
Common stock issuance		134,305				114,704				91,237
Balance, end of year		68,523,129				67,177,306				66,668,584
Treasury shares
Balance, beginning of year		2,124,669				73,235				26,508
Common stock repurchased		770,352				2,051,434				46,727
Balance, end of year		2,895,021				2,124,669				73,235
Common stock
Balance, beginning of year		$	672			$	667			$	655
Exercise of stock options		12				4				12
Common stock issuance		1				1				—
Balance, end of year		$	685			$	672			$	667
Surplus
Balance, beginning of year		$	286,265			$	272,536			$	242,662
Share-based awards and exercise of stock options		37,407				7,775				16,056
Tax benefit from exercise of stock options		6,431				2,087				10,651
Common stock issuance		4,826				3,867				3,355
Transfer of deferred compensation to surplus		(311		)		—				—
Amortization of deferred compensation		311				—				—
Stock option forfeiture		—				—				(188		)
Balance, end of year		$	334,929			$	286,265			$	272,536
Deferred compensation
Balance, beginning of year		$	(311	)		$	(572	)		$	(1,076	)
Transfer of deferred compensation to surplus		311				—				—
Amortization of deferred compensation		—				261				316
Stock option forfeiture		—				—				188
Balance, end of year		$	—			$	(311	)		$	(572	)
Retained earnings
Balance, beginning of year		$	572,549			$	418,034			$	280,701
Net income		153,803				159,818				141,962
Cash dividend, $0.09, $0.08 and $0.07 per share in the years ended December 31, 2006, 2005 and 2004, respectively		(5,919		)		(5,303		)		(4,629		)
Balance, end of year		$	720,433			$	572,549			$	418,034
Accumulated other comprehensive (loss) income, net
Balance, beginning of year		$	(13,369	)		$	23,888			$	17,865
Net unrealized investment gain (loss)		11,773				(46,054		)		(7,854		)
Net unrealized derivative instrument (loss) gain		(5,184		)		10,473				12,990
Amortization of terminated interest rate swap agreements		(1,341		)		(1,728		)		41
Adjustment to initially apply SFAS 158		(7,837		)		—				—
Cumulative translation adjustment		1,444				52				846
Balance, end of year		$	(14,514	)		$	(13,369	)		$	23,888
Treasury stock
Balance, beginning of year		$	(72,948	)		$	(2,291	)		$	(550	)
Common stock repurchased (770,352 shares at an average price of $38.74, 2,051,434 shares at an average price of $34.44, and 46,727 shares at an average price of $37.24 in the years ended December 31, 2006, 2005, and 2004, respectively)		(29,847		)		(70,657		)		(1,741		)
Balance, end of year		$	(102,795	)		$	(72,948	)		$	(2,291	)
Total Stockholders’ Equity		$	938,738			$	772,858			$	712,262

See Notes to Consolidated Financial Statements.

F-5

INVESTORS FINANCIAL SERVICES CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2006, 2005 and 2004 (Dollars in thousands)

	December 31,				December 31,				December 31,
	2006				2005				2004
Cash Flows From Operating Activities:
Net income		$	153,803			$	159,818			$	141,962
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed loss of unconsolidated subsidiary		28				28				28
Depreciation and amortization		32,819				31,578				32,124
Share-based compensation		4,538				—				—
Amortization of deferred compensation		—				261				316
Amortization of premiums on securities, net of accretion of discounts		55,057				49,578				40,743
Gain on sale of investments		(2,523		)		(12,397		)		(234		)
Excess tax benefit related to share-based compensation		(8,017		)		—				—
Deferred income taxes		(390		)		(6,944		)		2,997
Changes in assets and liabilities:
Accrued interest and fees receivable		(15,165		)		(30,291		)		(16,476		)
Other assets		(17,182		)		51,657				(66,625		)
Accrued expenses		33,025				7,586				5,672
Other liabilities		15,409				(38,475		)		81,040
Net cash provided by operating activities		251,402				212,399				221,547
Cash Flows From Investing Activities:
Proceeds from maturities and paydowns of securities available for sale		1,111,359				1,400,359				1,392,295
Proceeds from maturities and paydowns of securities held to maturity		1,245,399				1,628,989				1,410,133
Proceeds from sale of securities available for sale		134,131				376,143				25,041
Proceeds from the redemption of non-marketable equity securities		41,048				700				328
Purchases of securities available for sale		(1,662,417		)		(1,649,167		)		(1,704,293		)
Purchases of securities held to maturity		(67,274		)		(2,489,882		)		(3,078,456		)
Purchases of non-marketable equity securities		(29,851		)		(116		)		(542		)
Net increase in due to brokers for open trades payable		5,066				15,818				5,475
Net increase in other short-term investments		(1,971		)		—				—
Net increase in Federal funds sold		(300,000		)		—				—
Net decrease (increase) in loans		131,677				(267,840		)		65,000
Purchases of equipment, leasehold improvements and software		(76,677		)		(33,068		)		(23,559		)
Net cash provided by (used in) investing activities		530,490				(1,018,064		)		(1,908,578		)
Cash Flows From Financing Activities:
Net increase (decrease) in demand deposits		158,263				(152,750		)		355,485
Net increase (decrease) in time and savings deposits		994,089				(251,042		)		833,779
Net (decrease) increase in securities sold under repurchase agreements		(1,070,068		)		542,371				997,496
Net (decrease) increase in short-term borrowings		(839,598		)		761,968				(503,406		)
Proceeds from exercise of stock options		33,096				7,779				16,068
Proceeds from issuance of common stock		4,827				3,868				3,355
Common stock repurchase		(29,847		)		(70,657		)		(1,741		)
Excess tax benefit related to share-based compensation		8,017				—				—
Dividends paid to stockholders		(5,919		)		(5,303		)		(4,629		)
Net cash (used in) provided by financing activities		(747,140		)		836,234				1,696,407
Effect of exchange rates on changes in cash		(395		)		9				(6		)
Net Increase In Cash and Due From Banks		34,357				30,578				9,370
Cash and Due From Banks, Beginning of Year		79,637				49,059				39,689
Cash and Due From Banks, End of Year		$	113,994			$	79,637			$	49,059
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest		$	387,190			$	270,121			$	121,542
Cash paid for income taxes		$	75,636			$	68,664			$	77,819

See Notes to Consolidated Financial Statements.

F-6

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2006, 2005 and 2004

1. Description of Business

Investors Financial Services Corp. (‘IFSC’) provides asset administration services for the financial services industry through its wholly-owned subsidiary, Investors Bank & Trust Company (‘the Bank’). As used herein, the defined term “the Company” shall mean IFSC together with the Bank and its domestic and foreign subsidiaries. The Company provides core services and value-added services to a variety of financial asset managers, including mutual fund complexes, investment advisors, family offices, hedge funds, banks and insurance companies. Core services include global custody, multicurrency accounting, fund administration and middle office outsourcing. Value-added services include foreign exchange, cash management, securities lending, investment advisory, performance measurement, institutional transfer agency, lines of credit and brokerage and transition management services. The Company is subject to regulation by the Federal Reserve Board of Governors (‘FRB’), the Federal Deposit Insurance Corporation (‘FDIC’), the Office of the Commissioner of Banks of the Commonwealth of Massachusetts (‘Commissioner’), the Securities and Exchange Commission (‘SEC’), the National Association of Securities Dealers, Inc. (‘NASD’), the State of Vermont Department of Banking, Insurance, Securities & Health Care Administration (‘BISHCA’), the Office of the Superintendent of Financial Institutions in Canada (‘OSFI’), the Irish Financial Services Regulatory Authority (‘IFSRA’), the Cayman Islands Monetary Authority (‘CIMA’), the Financial Services Authority in the United Kingdom (‘FSA’) and the Commission de Surveillance du Secteur Financier in Luxembourg (‘CSSF’).

On February 4, 2007, the Company entered into an Agreement and Plan of Merger (the ‘Merger Agreement’) with State Street Corporation (‘State Street’). At the closing of the transaction contemplated by the Merger Agreement, the Company will merge into State Street and the Company’s shareholders will receive 0.906 shares of State Street common stock for each share of the Company’s common stock. Each company’s Board of Directors has approved the Merger Agreement. The Company expects to complete the transaction in the third quarter of 2007, subject to customary closing conditions, including regulatory and shareholder approval.

2. Summary of Significant Accounting Policies

Basis of Presentation—The consolidated financial statements include the accounts of the Company and its domestic and foreign subsidiaries. All significant intercompany accounts and transactions have been eliminated.

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Certain amounts in the prior years’ financial statements have been reclassified to conform to the current year’s presentation.

Revenue Recognition

Asset servicing revenue—The Company recognizes revenue from asset servicing and investment advisory services based on contractual terms signed by the Company’s clients. Generally, revenue is

F-7

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

2. Summary of Significant Accounting Policies (Continued)

accrued by multiplying average or month-end net assets by contracted rates. Asset servicing revenue is considered earned daily as transactions are processed or services are provided and when collectibility is reasonably assured.

Value-added services revenue—The Company recognizes revenue from its value-added services, such as foreign exchange, cash management and securities lending, based on the specific type of transaction processed. Value-added services revenue is considered earned daily as transactions are processed or services are provided and when collectibility is reasonably assured.

Interest income—The Company recognizes and accrues income on its interest-earning assets as earned using a method which approximates the constant effective yield method.

Cash and Cash Equivalents—For purposes of reporting cash flows and amounts on the consolidated balance sheets, the Company defines cash and cash equivalents to include cash, due from banks, and interest-bearing deposits with other banks that have original maturities of 90 days or less.

Securities—The Company classifies all equity securities that have readily determinable fair values and all investments in debt securities into one of three categories. Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and carried at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and carried at fair value, with unrealized gains and losses included in earnings. All other debt and equity securities not classified as either held to maturity or trading are classified as available for sale and carried at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income.

Non-marketable securities primarily consist of stock of the Federal Home Loan Bank of Boston (‘FHLBB’) and stock of the Federal Reserve Bank of Boston (‘FRBB’). The FHLBB stock is carried at cost and redeemable at par value. The Company is required to hold this stock under its borrowing arrangement with the FHLBB. The Company was required to purchase stock of the FRBB in connection with its membership with the FRBB.

An investment is considered impaired if the fair value of the investment is less than its cost. The Company recognizes an impairment charge if, based on the facts and circumstances, management determines the impairment to be other than temporary. For example, the Company will record an other than temporary impairment charge on a debt security if it is determined that it is probable that the Company will be unable to recover all amounts due under the contractual obligations of the security.

Amortization and accretion of debt securities purchased at a premium or discount are amortized or accreted into income using a method which approximates the constant effective yield method. The Company applies Statement of Financial Accounting Standards No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases (‘SFAS 91’) for the amortization of premiums and accretion of discounts. In calculating the effective yield for securities that represent holdings of large numbers of similar loans for which prepayments are probable and the timing and amount of prepayments can be reasonably estimated, prepayments are anticipated using the Company’s actual three-month prepayment experience.

F-8

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

2. Summary of Significant Accounting Policies (Continued)

The amount of amortization or accretion to recognize in income is driven by the calculation of the constant effective yield. When calculating this yield, the Company assumes that prepayments will continue from the analysis date to the date of the security’s expected maturity at its most recent three-month prepayment rate. The prepayment rate is updated monthly based on the Company’s previous three-month actual prepayment experience.

The Company utilizes three-month prepayment rates to anticipate prepayments because such rates are based on its own actual prepayment experience and because the Company believes three-month rates are a better estimate of future experience than either one-month or six-month or longer rates. In the opinion of management, a one-month rate does not capture enough experience to predict future prepayment behavior and may create undue volatility in interest income due to one-time fluctuations in prepayment activity. Conversely, in the opinion of management, a six-month or longer rate would not capture enough volatility to predict future prepayment behavior.

If a difference arises between the Company’s estimated prepayments and its actual prepayments received, the constant effective yield is recalculated based on the Company’s actual payments to date and anticipated future payments. This monthly recalculation results in the carrying value of the security being adjusted to the amount that would have existed had the new effective yield been applied since the purchase date, and a corresponding charge or credit is recognized to interest income.

For securities that do not represent holdings of large numbers of similar loans for which prepayments are probable and the timing and amount of prepayments can be reasonably estimated, the associated premiums and discounts are amortized or accreted over their contractual term using the constant effective yield. Actual prepayment experience for such securities is reviewed monthly and a proportionate amount of premium or discount is recognized in income at that time such that the effective yield on the remaining portion of the securities continues unchanged.

As of and for the years ended December 31, 2006, 2005 and 2004, the Company anticipated prepayments on its residential mortgage-backed securities. All other securities do not meet the SFAS 91 criteria for anticipating prepayments. Accordingly, no prepayments were anticipated for these securities.

Loans—Interest on loans is credited to income as earned using a method which approximates the effective yield method, and interest is only accrued if deemed collectible. Accrual of interest on loans is discontinued when management determines that collection of interest is not probable, or when a loan is both greater than 90 days delinquent and the loan’s collateral is not sufficient to cover both principal and accrued interest. Accrual of interest is restored after all past due principal and interest has been paid and the Company expects repayment of the remaining contractual principal and interest, or when an improvement in the condition of the loan has occurred that would warrant resumption of interest accruals. Other loan fees and charges, including service costs for the prepayment of loans, delinquent charges and other miscellaneous loan services, are recorded as income when collected.

Equipment, Leasehold Improvements and Capitalized Software Costs—Equipment and leasehold improvements are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are recognized using the straight-line method over the estimated useful lives of the assets which range from three to seven years, and for leasehold improvements over the lesser of the useful life or the life of the lease. For costs incurred to develop computer software for internal use, the Company

F-9

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

2. Summary of Significant Accounting Policies (Continued)

capitalizes costs incurred during the application development stage, which includes costs to design the software configuration and interfaces, coding, installation and testing. Costs incurred during the preliminary and post-implementation stages are expensed as incurred. Capitalized software costs are amortized over the estimated useful life of the project, which can range from three to five years.

Long-Lived Assets—Long-lived assets to be held and used by the Company are reviewed on a quarterly basis to determine whether any events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. For long-lived assets to be held and used, the Company bases its evaluation on such impairment indicators as the nature of the assets, the future economic benefit of the assets, any historical or future profitability measurements, as well as other external market conditions or factors that may be present. During the years ended December 31, 2006 and 2005, the Company’s analyses indicated there were no material impairments of its long-lived assets.

Income Taxes—Income tax expense is based on estimated taxes payable or refundable on a tax return basis for the current year and the changes in deferred tax assets and liabilities during the year. Deferred tax assets and liabilities are established for temporary differences between the accounting bases and the tax bases of the Company’s assets and liabilities at enacted tax rates expected to be in effect when the amounts related to such temporary differences are realized or settled. If the Company determines that it is “more likely than not” that some portion or all of a deferred tax asset will not be realized, the Company records a valuation allowance in accordance with the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (‘SFAS 109’).

In accordance with Accounting Principles Board Opinion No. 23, Accounting for Income Taxes—Special Areas (‘APB 23’), the Company presumes the undistributed earnings of its foreign subsidiaries will be distributed to its parent company unless the Company adopts the indefinite reversal provisions of APB 23, which would require the Company to provide sufficient evidence to support that the subsidiary has invested or will invest the undistributed earnings indefinitely. The Company recognizes the indefinite reversal provision of APB 23 for its Irish and Cayman Islands subsidiaries due to the projected capital needs necessary to support the continued growth of these entities. As such, the Company does not record U.S. income taxes on the undistributed earnings of its Irish and Cayman Island subsidiaries.

Translation of Foreign Currencies—Where the functional currency is not the U.S. dollar, the Company translates the financial statements of its foreign operations into U.S. dollars. Assets and liabilities are translated into U.S. dollars at period-end exchange rates, while income and expenses are translated using average rates for the period. The resulting translation adjustments are recorded as a component of accumulated other comprehensive income (‘OCI’) in stockholders’ equity.

For foreign operations where the functional currency is the U.S. dollar, the local currency financial statements are remeasured into U.S. dollars using period-end exchange rates for monetary assets and liabilities, exchange rates in effect on the date of acquisition for non-monetary assets and liabilities (such as premises and equipment and the related depreciation), and the average exchange rates during the period for income and expenses. The resulting exchange gains or losses are recorded in current period income.

Derivative Financial Instruments—Derivative financial instruments are recorded in the Company’s consolidated balance sheets at fair value as other assets or other liabilities, depending on the rights and obligations under the contracts. The Company utilizes derivative financial instruments primarily for

F-10

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

2. Summary of Significant Accounting Policies (Continued)

balance sheet asset and liability management purposes. The effective portion of a change in the fair value of a derivative that is designated and qualifies as a cash flow hedge is reported in OCI, net of taxes. The ineffective portion, which is the extent to which the change in the fair value of the derivative exceeds the change in the variability of the expected future cash flows of the hedged item (on an absolute basis), is reported in net interest income. The changes in the fair value of a derivative that is designated and qualifies as a fair value hedge is reported in net interest income, along with the change in the fair value of the hedged item attributable to the risk being hedged. The change in fair value of a derivative that is not designated or does not qualify as a hedge is recognized in earnings.

Hedge accounting is discontinued prospectively if a) the hedging relationship no longer meets the hedging criteria, b) the derivative expires, or is sold, terminated or exercised, or c) the Company removes the hedge designation. When hedge accounting is discontinued under cash flow hedge accounting, the component of OCI related to the discontinued hedge is amortized to net interest income over the remaining term of the derivative financial instrument. Under fair value hedge accounting, when a hedge is discontinued, the hedged item is no longer adjusted for changes in fair value and the existing basis adjustment is amortized to net interest income. If cash flow hedge accounting is discontinued due to the probability that the forecasted transaction will not occur within the specified period, gains and losses accumulated in OCI related to that hedge are recognized immediately to net interest income.

The Company enters into interest rate derivative contracts that are designated as cash flow hedges of (a) the variability in interest payments related to the planned rollover of short-term liabilities at different fixed rates (thereby resulting in a variable interest expense pattern) and (b) the variability in interest payments related to variable-rate liabilities. The unrealized gains or losses related to these contracts are reported in other assets and other liabilities on the Company’s consolidated balance sheets.

The Company also enters into fixed price purchase contracts that are designed to hedge the variability of the consideration to be paid for the purchase of investment securities. By entering into these contracts, the Company is fixing the price to be paid at a future date for certain investment securities. The changes in fair value of these fixed price contracts are included as a component of OCI. The unrealized gains and losses are included in other assets and other liabilities on the Company’s consolidated balance sheets.

The Company enters into foreign exchange contracts with clients and enters into matched or offsetting positions with either another client or a financial institution. These contracts are subject to market value fluctuations in foreign currencies. Gains and losses from such fluctuations are netted and recorded as an adjustment to asset servicing fees in the Company’s consolidated statements of income. Unrealized gains or losses resulting from purchases and sales of foreign exchange contracts are included within the respective other assets and other liabilities categories on the Company’s consolidated balance sheets. Foreign exchange contracts with the same counterparty are netted in the Company’s consolidated balance sheets when a master netting agreement exists.

Securities Sold Under Repurchase Agreements—The Company enters into sales of securities under agreements to repurchase as a low cost source of funding for its operations. These agreements are treated as secured borrowings, and the obligations to repurchase securities sold are reflected as liabilities in the consolidated balance sheets. Securities pledged as collateral under agreements to repurchase are reflected as assets in the accompanying consolidated balance sheets.

F-11

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

2. Summary of Significant Accounting Policies (Continued)

Share-Based Compensation—On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (‘SFAS 123R’). SFAS 123R requires that compensation cost relating to share-based payment transactions be recognized in the financial statements, with measurement based upon the fair value of the equity or liability instruments issued. The Company adopted SFAS 123R using the modified prospective application method. Under that method, compensation cost for equity awards granted after January 1, 2006 is recognized over the service period based on the grant date fair value. In addition, compensation cost for the portion of awards for which the requisite service has not been rendered that are outstanding as of January 1, 2006 is recognized prospectively as the requisite service is rendered. The compensation cost for that portion of awards is based on the grant date fair value of those awards as calculated under the pro forma disclosures of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (‘SFAS 123’). In accordance with the modified prospective application method, the financial statements of periods prior to the adoption of SFAS 123R have not been restated.

The following table sets forth share-based compensation cost and the related tax benefit recognized in the consolidated income statements for all of the Company’s share-based compensation plans (Dollars in thousands):

	For the Year Ended December 31,
	2006		2005		2004
Share-based compensation cost	$	4,538	$	261	$	316
Income tax benefit	$	580	$	—	$	—

Certain of the Company’s share-based awards contain terms that provide for a graded vesting schedule whereby portions of the awards vest in increments over the requisite service period. As provided for under SFAS 123R, the Company has elected to recognize compensation cost for awards granted on or after January 1, 2006 with graded vesting schedules on a straight-line basis over the requisite service period for the entire award.

F-12

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

2. Summary of Significant Accounting Policies (Continued)

Prior to adopting SFAS 123R, the Company measured compensation cost for share-based compensation plans using the intrinsic value method under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (‘APB 25’), and made pro forma disclosures of the fair value method under SFAS 123. The intrinsic value method measures compensation cost as the amount by which the fair market value of the Company’s common stock exceeds the option exercise price on the measurement date, which is typically the date of grant. Generally, options granted had an exercise price equivalent to the fair market value at the measurement date. Accordingly, no compensation cost was recorded. If share-based compensation cost were recognized using the fair value method, stock options would be valued at grant date using the Black-Scholes valuation model and the resulting compensation cost would have decreased net income as indicated below (Dollars in thousands, except per share data):

	For the Year Ended				For the Year Ended
	December 31, 2005				December 31, 2004
Net income as reported		$	159,818			$	141,962
Deduct: Total share-based employee compensation cost determined under the fair value method for all awards, net of related tax effects		(19,832		)		(16,679		)
Pro forma net income		$	139,986			$	125,283
Earnings per share:
Basic-as reported		$	2.42			$	2.15
Basic-pro forma		$	2.12			$	1.89
Diluted-as reported		$	2.37			$	2.09
Diluted-pro forma		$	2.07			$	1.85

The fair value of each option grant was estimated on the date of grant using the Black-Scholes valuation model with the following weighted-average assumptions for the years ended December 31, 2005 and 2004, respectively: an average assumed risk-free interest rate of 4.55% and 3.08%, an expected term of four years, an average expected volatility of 41.04% and 50.49%, and an average dividend yield of 0.20% and 0.16%.

The amount of share-based compensation cost (net of tax) included in net income as reported was $0.2 million for both the years ended December 31, 2005 and 2004.

F-13

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

2. Summary of Significant Accounting Policies (Continued)

The following table presents the effect of changing from the intrinsic value method under APB 25 to the fair value method under SFAS 123R for the year ended December 31, 2006 (Dollars in thousands, except per share data):

	For the Year Ended
	December 31, 2006
Increase/(Decrease) in:
Income from continuing operations		$	(4,325	)
Income before income taxes		(4,325		)
Net income		(2,966		)
Cash flow from operations		(8,017		)
Cash flow from financing activities		8,017
Basic EPS		$	(0.05	)
Diluted EPS		$	(0.05	)

The fair value of each option grant under the Director Plan, the Stock Plan, and the 2005 Plan (each as described further in Note 11) was estimated on the grant date using the Black-Scholes valuation model with the following weighted-average assumptions for the year ended December 31, 2006: an average assumed risk-free interest rate of 4.76%, an average expected term of five years, an average expected volatility of 41.92%, and an average dividend yield of 0.20%.

The Company bases its estimate of expected term on the historical exercise and post-vesting employment termination behavior for similar grants. The Company’s volatility assumption is based on the historical volatility of the Company’s stock over a period equating to the expected term of the employee share option, using weekly price observations and looking backward from the date of grant.

The fair value of the option feature of grants under the 1997 Employee Stock Purchase Plan (‘ESPP’) (as described further in Note 11) was estimated on the grant date using the Black-Scholes valuation model with the following weighted-average assumptions for the year ended December 31, 2006: an average assumed risk-free rate of 4.79%, an expected term of 0.5 years, an average volatility of 37.55%, and an average dividend yield of 0.23%.

The expected term for the ESPP is equal to the six-month payment period. The Company estimates expected volatility for the ESPP in the same manner as for employee stock options, except that daily volatility is used instead of weekly volatility. The Company uses daily volatility for the ESPP because weekly volatility over six months does not result in a statistically significant number of data points upon which to base the volatility calculation.

SFAS 123R also requires that any deferred compensation related to share-based awards granted prior to January 1, 2006 must be eliminated against the appropriate equity accounts. In connection with the Company’s adoption of SFAS 123R, the presentation in the consolidated statement of stockholders’ equity for the year ended December 31, 2006 was revised to reflect the transfer of balances previously reported in deferred compensation to surplus.

F-14

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

2. Summary of Significant Accounting Policies (Continued)

Earnings Per Share—Basic earnings per share (‘EPS’) is computed by dividing net income by the weighted-average number of common shares outstanding during the year. Diluted EPS reflects the potential dilution that could occur if contracts to issue common stock were exercised into common stock that then shared in the earnings of the Company. The reconciliation from Basic EPS to Diluted EPS is as follows (Dollars in thousands, except per share data):

		Weighted-Average		Per Share
	Income	Shares		Amount
December 31, 2006
Basic EPS
Income available to common stockholders	$ 153,803		65,730,456		$ 2.34
Dilutive effect of common equivalent shares of stock options	—		1,762,625		(0.06	)
Diluted EPS	$ 153,803		67,493,081		$ 2.28
December 31, 2005
Basic EPS
Income available to common stockholders	$ 159,818		66,139,323		$ 2.42
Dilutive effect of common equivalent shares of stock options	—		1,334,481		(0.05	)
Diluted EPS	$ 159,818		67,473,804		$ 2.37
December 31, 2004
Basic EPS
Income available to common stockholders	$ 141,962		66,179,286		$ 2.15
Dilutive effect of common equivalent shares of stock options	—		1,736,931		(0.06	)
Diluted EPS	$ 141,962		67,916,217		$ 2.09

For the years ended December 31, 2006, 2005 and 2004, there were 132,905 options 733,015 options and 29,451 options which were not considered dilutive for EPS calculations, respectively.

Guarantees—On behalf of its clients, the Company lends securities to creditworthy broker-dealers. In certain circumstances, the Company may indemnify its clients for the fair market value of those securities against a failure of the borrower to return such securities. The Company requires the borrowers to provide collateral in an amount equal to, or in excess of, 102% of the fair market value of U.S. dollar-denominated securities borrowed and 105% of the fair market value of non-U.S. dollar-denominated securities borrowed. The borrowed securities are revalued daily to determine whether additional collateral is necessary. As guarantor, the Company is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The Company measures the fair value of its indemnification obligation by marking its securities lending portfolio to market on a daily basis and comparing the value of the portfolio to the collateral holdings position. The fair value of the indemnification obligation to be recorded would be the deficiency of collateral as compared to the value of the securities out on loan.

F-15

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

2. Summary of Significant Accounting Policies (Continued)

Goodwill—The Company reviews goodwill for impairment on an annual basis, or if events or changes in circumstances indicate it would be more likely than not that the fair value of the goodwill would be reduced below its carrying value. As of December 31, 2006, there was no impairment of goodwill.

New Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (‘FASB’) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (‘FIN 48’). FIN 48 establishes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Pursuant to FIN 48, the effects of a tax position are recognized in the financial statements when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. Conversely, previously recognized tax positions are derecognized when it is no longer more likely than not that the tax position would be sustained upon examination. FIN 48 also requires certain disclosures regarding unrecognized tax benefits and the amounts and classification of the related interest and penalties. FIN 48 is effective for fiscal years beginning after December 15, 2006. Accordingly, the Company adopted FIN 48 on January 1, 2007, and there was no material impact to the financial condition or results of operations of the Company.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (‘SFAS 157’). SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands upon existing disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements. Rather, the guidance contained in SFAS 157 applies to assets, liabilities, and certain equity instruments that are already measured at fair value under existing accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company does not anticipate any material impact to its financial condition or results of operations as a result of the adoption of SFAS 157.

In September 2006, the SEC issued Staff Accounting Bulletin 108, Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements (‘SAB 108’). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year financial statement misstatements should be considered in quantifying a current year misstatement. SAB 108 is effective for financial statements covering the first fiscal year ending after November 15, 2006. Accordingly, the Company adopted SAB 108 on December 31, 2006, and there was no material impact to the financial condition or results of operations of the Company.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (‘SFAS 159’). SFAS 159 permits entities to elect to measure certain financial instruments and other items at fair value through earnings. The fair value option may be applied on an instrument by instrument basis, is irrevocable and is applied only to entire instruments. SFAS 159 requires additional financial statement presentation and disclosure requirements for those entities that elect to adopt the standard and is effective for fiscal years beginning after November 15, 2007. The Company does not anticipate any material impact to its financial condition or results of operations as a result of the adoption of SFAS 159.

F-16

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

3. Securities

Amortized cost amounts and fair values of securities are summarized as follows as of December 31, 2006 (Dollars in thousands):

	Amortized	Unrealized		Unrealized
Held to Maturity	Cost	Gains		(Losses)			Fair Value
Mortgage-backed securities	$ 3,753,497		$ 7,271		$ (25,584	)	$ 3,735,184
Federal agency securities	1,680,458		2,956		(12,328	)	1,671,086
State and political subdivisions	98,375		4,206		(63	)	102,518
Total	$ 5,532,330		$ 14,433		$ (37,975	)	$ 5,508,788

	Amortized	Unrealized		Unrealized
Available for Sale	Cost	Gains		(Losses)			Fair Value
Mortgage-backed securities	$ 4,302,932		$ 7,400		$ (35,281	)	$ 4,275,051
State and political subdivisions	343,204		2,090		(990	)	344,304
Corporate debt	170,797		226		(1,173	)	169,850
Foreign government securities	10,559		—		(24	)	10,535
Total	$ 4,827,492		$ 9,716		$ (37,468	)	$ 4,799,740

Amortized cost amounts and fair values of securities are summarized as follows as of December 31, 2005 (Dollars in thousands):

	Amortized	Unrealized		Unrealized
Held to Maturity	Cost	Gains		(Losses)			Fair Value
Mortgage-backed securities	$ 4,342,254		$ 11,420		$ (29,818	)	$ 4,323,856
Federal agency securities	2,305,331		1,560		(23,914	)	2,282,977
State and political subdivisions	114,345		4,646		(95	)	118,896
Total	$ 6,761,930		$ 17,626		$ (53,827	)	$ 6,725,729

	Amortized	Unrealized		Unrealized
Available for Sale	Cost	Gains		(Losses)			Fair Value
Mortgage-backed securities	$ 3,810,797		$ 3,882		$ (48,578	)	$ 3,766,101
State and political subdivisions	388,789		5,515		(1,913	)	392,391
Corporate debt	201,499		736		(1,543	)	200,692
Foreign government securities	10,539		—		(3	)	10,536
Total	$ 4,411,624		$ 10,133		$ (52,037	)	$ 4,369,720

Excluded from the above tables are nonmarketable equity securities, which consisted primarily of stock of the FRBB and FHLBB at December 31, 2006 and stock of the FHLBB at December 31, 2005. There was no FRBB stock held as of December 31, 2005. The Company’s capital stock investment in the FHLBB totaled $29.4 million as of December 31, 2006. This amount reflects a $20.6 million decrease from December 31, 2005. The $29.4 million capital stock investment includes both a $25.0 million membership component and a $4.4 million activity-based component. The membership component of the FHLBB capital stock investment requires a five-year advance notice of withdrawal. The Company’s $29.4 million capital stock investment in the FHLBB provides an overnight borrowing capacity of up to $146.4 million. The amount

F-17

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

3. Securities (Continued)

outstanding under this arrangement as of December 31, 2006 was $125.0 million. The Company currently has the ability to purchase up to $25.0 million of activity-based capital, which would provide a total overnight borrowing capacity of $833.3 million.

In October 2006, the Company became a member of the FRBB. In connection with its membership, the Company was required to subscribe to purchase stock of the FRBB totaling 6% of the Bank’s capital and surplus. The Company fulfilled its obligation to purchase 50% of the subscribed amount by purchasing $7.4 million of FRBB stock. The remaining subscription amount is subject to purchase upon the request of the FRBB.

The amortized cost amounts and fair values of securities by contractual maturity are as follows (Dollars in thousands):

	December 31, 2006
	Amortized
Held to Maturity	Cost	Fair Value
Due within one year	$ 341	$ 342
Due from one to five years	13,663	13,804
Due five years up to ten years	355,800	357,776
Due after ten years	5,162,526	5,136,866
Total	$ 5,532,330	$ 5,508,788

	December 31, 2006
	Amortized
Available for Sale	Cost	Fair Value
Due within one year	$ 11,514	$ 11,503
Due from one to five years	27,591	28,034
Due five years up to ten years	228,318	231,061
Due after ten years	4,560,069	4,529,142
Total	$ 4,827,492	$ 4,799,740

During the year ended December 31, 2006, the Company sold forty-two securities classified as available for sale totaling $134.1 million using the specific identification method. The book value of the securities was $131.6 million and resulted in a gross realized gain of $2.5 million for the year ended December 31, 2006. During the year ended 2005, the Company sold eighty-five securities classified as available for sale totaling $376.1 million using the specific identification method. The book value of the securities was $363.7 million and resulted in a gross realized gain of $12.4 million for the year ended December 31, 2005. During the year ended December 31, 2004, the Company sold one security classified as available for sale totaling $25.0 million using the specific identification method. The book value of the security was $24.8 million and resulted in a gross realized gain of $0.2 million for the year ended December 31, 2004.

F-18

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

3. Securities (Continued)

The carrying value of securities pledged amounted to approximately $7.2 billion at December 31, 2006 and $7.5 billion at December 31, 2005. Securities are pledged primarily to secure clearings with other depository institutions, secure repurchase agreements and secure outstanding FHLBB borrowings.

On a quarterly basis the Company reviews its investment portfolio on a security by security basis for any investment that may be other than temporarily impaired. In its evaluation, the Company considers the length of time the security has been impaired, the severity of the impairment, the financial condition and future prospects of the issuer, and the Company’s ability and intent to hold the security to maturity or until it recovers in value.

The unrealized losses related to the Company’s investment in mortgage-backed and Federal agency securities are attributable to changes in market interest rates. The contractual cash flows of these securities are guaranteed by agencies of the U.S. government, including government sponsored agencies. As a result, the Company’s exposure to the credit risk of these securities is minimal. At December 31, 2006, there were 876 mortgage-backed and Federal agency securities that were in unrealized loss positions. The market value decline as a percentage of amortized cost for the Company’s mortgage-backed and Federal agency securities portfolio was less than 1% at December 31, 2006. The Company has the intent and ability to hold these securities until forecasted recovery, which may in some cases be maturity. The Company does not consider these investments to be other than temporarily impaired at December 31, 2006. Corporate debt securities include trust preferred securities (‘trups’) issued by reputable financial institutions. The credit ratings of the underlying issuers range from A1 to Aa3 ratings. The Company holds senior tranches of these issuances and believes that it will recover all contractual payments. The unrealized losses related to the trups portfolio are due to changes in credit spreads. At December 31, 2006, there were 6 corporate debt securities that were in unrealized loss positions. The Company has the intent and ability to hold these securities until forecasted recovery and does not consider these investments to be other than temporarily impaired at December 31, 2006.

Unrealized losses related to the Company’s investments in state and political subdivisions securities were due to changes in market interest rates. At December 31, 2006, there were 185 state and political subdivisions investment securities in an unrealized loss position. The credit rating on the securities were all Aaa and scheduled payments continue to be made on a timely basis. Given the minimal amount of unrealized losses and the limited amount of credit exposure, the Company does not consider these investments to be other than temporarily impaired at December 31, 2006.

F-19

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

3. Securities (Continued)

The following table presents the information about the Company’s temporarily impaired investments at December 31, 2006 (Dollars in thousands):

	Less than 12 months					12 months or longer					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Mortgage-backed securities	$	1,816,592		$	7,677	$	3,572,895		$	53,188	$	5,389,487		$	60,865
Federal agency securities	167,095			409		1,065,865			11,919		1,232,960			12,328
Corporate debt	10,082			8		48,317			1,165		58,399			1,173
State and political subdivisions	127,530			907		16,446			146		143,976			1,053
Foreign	—			—		10,535			24		10,535			24
Total temporarily impaired securities	$	2,121,299		$	9,001	$	4,714,058		$	66,442	$	6,835,357		$	75,443

The following table presents the information about the Company’s temporarily impaired investments at December 31, 2005 (Dollars in thousands):

	Less than 12 months					12 months or longer					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Mortgage-backed securities	$	4,566,743		$	43,821	$	1,486,521		$	34,575	$	6,053,264		$	78,396
Federal agency securities	1,443,951			10,809		883,807			13,105		2,327,758			23,914
Corporate debt	—			—		47,911			1,543		47,911			1,543
State and political subdivisions	146,147			1,856		8,173			152		154,320			2,008
Foreign	10,536			3		—			—		10,536			3
Total temporarily impaired securities	$	6,167,377		$	56,489	$	2,426,412		$	49,375	$	8,593,789		$	105,864

F-20

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

4. Loans

Loans consist of demand loans to custody clients of the Company, including individuals, not-for-profit institutions and mutual fund clients. The loans to mutual funds and other pooled product clients include lines of credit and advances pursuant to the terms of the custody agreements between the Company and those clients to facilitate securities transactions and redemptions. Almost all of the Company’s commitments to fund loans are at variable rates. The credit risk associated with these loans is considered low since the loans are, or may be, in the event of default, collateralized with marketable securities held by the Company as custodian. However, management recognizes some credit risk inherent in the portfolio, and therefore the Company has recorded an allowance for loan losses of $0.1 million at December 31, 2006, a level which has remained consistent for the past five years. This allowance is not allocated to any particular loan, but is intended to absorb any risk of loss inherent in the loan portfolio at the balance sheet date that is not captured in the Company’s historical loss rates. Management actively monitors the loan portfolio and the underlying collateral and regularly assesses the adequacy of the allowance for loan losses. There were no impaired loans, non-performing loans, or loans on nonaccrual status at December 31, 2006 and 2005. In addition, there were no loan charge-offs or recoveries during the years ended December 31, 2006, 2005 and 2004. Loans are summarized as follows (Dollars in thousands):

	December 31,				December 31,
	2006				2005
Loans to mutual funds		$	152,491			$	286,144
Loans to individuals		64,118				81,392
Commercial and industrial		6,634				15,697
Other		47,550				19,237
		270,793				402,470
Less allowance for loan losses		(100		)		(100		)
Total		$	270,693			$	402,370

The Company had unused commitments to lend approximately $1.1 billion and $0.9 billion at December 31, 2006 and 2005, respectively. The terms of these commitments are similar to the terms of outstanding loans.

The Company periodically issues lines of credit and advances to its mutual fund clients to help those clients with security transactions. The President of one of those clients is a related party to James M. Oates, a member of the Company’s Board of Directors. As of December 31, 2006, the Company had total contractual agreements for $150.0 million of committed lines of credit with two mutual funds within the related party complex (the ‘mutual funds’). The primary source of repayment of the loans is the proceeds from the sale of investments in the normal course of the mutual funds’ business. As part of the agreement, the mutual funds are required to segregate and maintain specific collateral for the Company equal to 200% of the lines of credit. At December 31, 2006, loans due from the mutual funds totaled $63.7 million. At December 31, 2005, loans due from the mutual funds totaled $125.0 million. Total interest and commitment fee revenue from the mutual funds for the years ended December 31, 2006, 2005 and 2004 was $5.7 million, $2.7 million and $0.4 million, respectively. The terms and conditions of the Company’s contractual agreements with the mutual funds, including collateral requirements, lending limits and fees, are consistent with other lending clients that have similar composition, size and overall business

F-21

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

4. Loans (Continued)

relationships with the Company. Also, Mr. Oates abstains from voting on any board matter involving any proposed transaction with the mutual funds.

5. Equipment and Leasehold Improvements

The major components of equipment and leasehold improvements are as follows (Dollars in thousands):

	December 31,				December 31,
	2006				2005
Furniture, fixtures and equipment		$	138,459			$	112,310
Leasehold improvements		39,118				16,247
Total		177,577				128,557
Less accumulated depreciation and amortization		(64,290		)		(59,156		)
Equipment and leasehold improvements, net		$	113,287			$	69,401

Included in furniture, fixtures and equipment were capitalized internal software costs of $87.6 million and $73.3 million at December 31, 2006 and 2005, respectively. Depreciation expense was $29.0 million, $29.4 million and $30.1 million for the years ended December 31, 2006, 2005 and 2004, respectively. Amortization expense was $3.8 million, $2.2 million and $2.0 million for the years ended December 31, 2006, 2005 and 2004, respectively.

6. Deposits

The following is a summary of deposit balances by type (Dollars in thousands):

	December 31,			December 31,
	2006			2005
Interest-bearing deposits:
Demand		$	110,647		$	85,157
Savings		4,854,711			4,195,486
Time		224,386			55,124
Total interest-bearing deposits		5,189,744			4,335,767
Noninterest-bearing deposits:
Demand		585,174			452,401
Savings		70,024			29,422
Time		300,000			175,000
Total noninterest-bearing deposits		955,198			656,823
Total		$	6,144,942		$	4,992,590

Time deposits with balances greater than $100,000 totaled $524.4 million and $230.1 million at December 31, 2006 and 2005, respectively. All time deposits had a maturity of less than three months at December 31, 2006 and 2005. The aggregate amounts of overdraft deposits that have been reclassified as loan balances were $86.2 million and $162.2 million at December 31, 2006 and 2005, respectively.

F-22

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

7. Securities Sold Under Repurchase Agreements

Information on the Company’s repurchase agreements and the corresponding securities pledged as collateral at December 31, 2006 is as follows (Dollars in thousands):

	Securities Pledged as Collateral
	Mortgage-backed					Federal Agency					Repurchase Agreements
	Amortized Cost			Fair Value		Amortized Cost			Fair Value		Carrying Value			Rate
Maturity of Repurchase Agreements:
Overnight		$	2,427,665	$	2,417,385		$	915,827	$	907,608		$	3,177,800	4.26	%
2 to 30 days		—		—			—		—			—		—
30 to 90 days		77,939		77,360			—		—			100,000		3.40	%
Over 90 days		498,404		492,436			—		—			450,000		3.52	%
Total		$	3,004,008	$	2,987,181		$	915,827	$	907,608		$	3,727,800

The weighted-average interest rate paid on repurchase agreements was 3.67% and 2.72% for the years ended December 31, 2006 and 2005, respectively.

8. Short-Term and Other Borrowings

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

	December 31, 2006			December 31, 2005
Federal Funds purchased		$	391,967		$	810,511
FHLBB overnight advances		125,000			400,000
FHLBB short-term advances		—			146,000
Treasury, Tax and Loan account		84			138
Total		$	517,051		$	1,356,649

The Company has borrowing arrangements with the Federal Reserve Discount Window and the FHLBB, which have been utilized on an overnight and short-term basis to satisfy funding requirements.

F-23

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

8. Short-Term and Other Borrowings (Continued)

A summary of the borrowing arrangements are as follows (Dollars in thousands):

	December 31,
	2006		2005
Federal Reserve Discount Window:
Borrowing capacity	$	1,984,499	$	1,372,312
Borrowing utilized	—		—
Maturity range	—		—
Securities pledged	2,077,291		1,447,941
Federal Home Loan Bank of Boston:
Borrowing capacity	$	146,430	$	833,333
Borrowing utilized	125,000		546,000
Maturity range	Overnight		Overnight to September 2006
Securities pledged	925,286		955,743

For the years ended December 31, 2006 and 2005, the weighted-average interest rate paid on short-term and other borrowings was 5.02% and 3.31%, respectively. The Company currently has the ability to purchase up to $25.0 million of activity-based capital of the FHLBB, which would provide a total overnight borrowing capacity of $833.3 million.

9. Income Taxes

The components of income tax expense are as follows (Dollars in thousands):

	December 31,				December 31,				December 31,
	2006				2005				2004
Current:
Federal		$	64,665			$	76,533			$	62,690
State		5,168				5,420				5,892
Foreign		1,048				1,026				1,247
Total current		70,881				82,979				69,829
Deferred:
Federal		(687		)		(9,543		)		3,413
State		318				1,788				94
Foreign		(21		)		811				(510		)
Total deferred		(390		)		(6,944		)		2,997
Total income taxes		$	70,491			$	76,035			$	72,826

F-24

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

9. Income Taxes (Continued)

Differences between the effective income tax rate and the federal statutory rates are as follows:

	December 31,			December 31,			December 31,
	2006			2005			2004
Federal statutory rate		35.00	%		35.00	%		35.00	%
State income tax rate, net of federal benefit		1.59			2.00			1.81
Tax-exempt income, net of disallowance		(3.04	)		(2.89	)		(3.61	)
Foreign taxes		0.53			0.83			—
Undistributed foreign earnings		(1.09	)		(4.12	)		—
Other		(1.56	)		1.41			0.71
Effective tax rate		31.43	%		32.23	%		33.91	%

The Company reversed previously accrued taxes of approximately $5.3 million in the second quarter of 2006, resulting from a tax position that no longer met the probable recognition threshold under Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (‘SFAS 5’).

At December 31, 2006, the Company had a foreign non-capital loss carryforward of approximately $6.8 million, which begins to expire in 2009. In accordance with the provisions of SFAS 109, the Company believes that it is more likely than not that the related deferred tax asset of $2.2 million will not be realized. As a result, a valuation allowance for the entire deferred tax asset amount has been recorded.

The Company provides U.S. federal income taxes on the unremitted earnings of foreign subsidiaries, except to the extent that such earnings are permanently reinvested outside the United States. At December 31, 2006, there were accumulated unremitted earnings of certain foreign subsidiaries of $36.5 million. Pursuant to the provisions of APB 23, the Company has not provided for U.S. federal income taxes or foreign withholding taxes on these earnings since it is the Company’s current intention to permanently reinvest those earnings outside of the U.S. If the capital in these subsidiaries had been temporarily invested, a U.S. deferred tax liability of $9.0 million would have been recorded.

F-25

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

9. Income Taxes (Continued)

The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities consist of the following (Dollars in thousands):

	December 31,				December 31,
	2006				2005
Deferred tax assets:
Securities available for sale		$	13,017			$	16,622
Employee benefit plans		14,470				7,094
Other		3,481				3,691
Deferred tax assets		30,968				27,407
Valuation allowance		(2,239		)		(565		)
Total deferred tax assets		28,729				26,842
Deferred tax liabilities:
Unrealized hedging gain		(7,998		)		(13,224		)
Depreciation and amortization		(11,364		)		(10,698		)
Undistributed income of foreign subsidiaries		—				(69		)
Pension plan		(1,312		)		(1,196		)
Total deferred tax liabilities		(20,674		)		(25,187		)
Net deferred tax asset		$	8,055			$	1,655

10. Subsidiary Trust Holding Junior Subordinated Deferrable Interest Debentures of the Company

On January 31, 1997, Investors Capital Trust I (‘ICTI’), a trust sponsored and wholly-owned by the Company, issued $25 million in 9.77% Trust Preferred Securities (the ‘Capital Securities’), the proceeds of which were invested by ICT1 in the same aggregate principal amount of the Company’s newly issued 9.77% Junior Subordinated Deferrable Interest Debentures due February 1, 2027 (the ‘Junior Subordinated Debentures’). The Capital Securities were callable on February 1, 2007; however, the Company did not redeem the Capital Securities at that time. The $25 million aggregate principal amount of the Junior Subordinated Debentures represents the sole asset of ICTI. The Company has guaranteed, on a subordinated basis, distributions and other payments due on the Capital Securities (the ‘Guarantee’). The Guarantee, when taken together with the Company’s obligations under (i) the Junior Subordinated Debentures; (ii) the indenture pursuant to which the Junior Subordinated Debentures were issued; and (iii) the Amended and Restated Declaration of Trust governing ICTI, constitutes a full and unconditional guarantee of ICTI’s obligations under the Capital Securities. No other subsidiary of the Company guarantees these Capital Securities. Certain of the Company’s subsidiaries may require prior approval of the Commissioner of Banks of the Commonwealth of Massachusetts if the total dividends for a calendar year would exceed net profits for the year combined with retained net profits for the previous two years. These restrictions on the ability to pay dividends to the Company may restrict the Company’s ability to pay dividends to its shareholders. ICTI is an unconsolidated wholly-owned trust and therefore, the Company presents the junior subordinated debentures as a liability and its investment in ICTI as a component of other assets in its consolidated financial statements.

F-26

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

11. Stockholders’ Equity

As of December 31, 2006, the Company’s capital stock consisted of 1,000,000 authorized shares of preferred stock, of which no shares were issued, and 175,000,000 authorized shares of common stock, of which 68,523,129 shares were issued. All shares have par value of $0.01 per share.

The Company has four equity incentive plans: the Amended and Restated 1995 Stock Plan (‘Stock Plan’), the Amended and Restated 1995 Non-Employee Director Stock Option Plan (‘Director Plan’), the 1997 Employee Stock Purchase Plan (‘ESPP’) and the 2005 Equity Incentive Plan (the ‘2005 Plan’). The 2005 Plan supersedes both the Stock Plan and the Director Plan, both of which continue in effect only with regard to options outstanding under those plans. Options awarded under the Stock Plan, the Director Plan and the 2005 Plan generally vest over zero to four years of continuous service and generally have ten-year contractual terms. The exercise prices of these awards are generally equal to the fair market value of the Company’s common stock on the date the awards are granted. There were no amendments to any plans during the year ended December 31, 2006.

Cash received from options exercised under all share-based payment arrangements for the year ended December 31, 2006 was $33.1 million. The actual tax benefit realized for the tax deductions related to these exercises amounted to $7.0 million for the year ended December 31, 2006.

In June 2006, the Company announced that its Board of Directors authorized a repurchase of up to $150.0 million of the Company’s common stock over the next twelve months following the announcement. As of December 31, 2006, the Company has repurchased $29.3 million of its common stock. The plan expires in June 2007.

The Stock Plan, the Director Plan, and the 2005 Plan

Effective with the start of the 2005 Plan, 45,703 shares of the Director Plan and 3,439,197 shares of the Stock Plan were transferred to the 2005 Plan. On April 14, 2005, the shareholders authorized an additional 2,000,000 shares of common stock for issuance under the 2005 Plan.

Of the shares authorized for issuance under the 2005 Plan at December 31, 2006, 4,107,719 were available for grant as of that date. No options were granted to consultants during the years ended December 31, 2006, 2005 and 2004.

The Company has recorded deferred compensation of $0 and $0.3 million at December 31, 2006 and 2005, respectively. Amortization of deferred compensation was $0, $0.3 million and $0.3 million for the years ended December 31, 2006, 2005 and 2004, respectively.

F-27

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

11. Stockholders’ Equity (Continued)

A summary of option activity under the Director Plan, Stock Plan and 2005 Plan for the year ended December 31, 2006 are as follows:

	Number of Options		Weighted- Average Exercise Price			Weighted- Average Remaining Contractual Term		Aggregate Intrinsic Value ($000)
Outstanding at January 1, 2006	6,919,316			$	31
Granted	81,557			46
Exercised	(1,257,593	)		28
Forfeited or expired	(36,007	)		39
Outstanding at December 31, 2006	5,707,273			31			5.6 years		$	65,115
Exercisable at December 31, 2006	5,524,039			$	31		5.5 years		$	64,217

The weighted-average grant-date fair values per option of options granted during the years ended December 31, 2006, 2005 and 2004 were $19.68, $14.81, and $16.78, respectively. The total intrinsic value of options exercised during the years ended December 31, 2006, 2005 and 2004 were $21.8 million, $8.0 million, and $27.3 million, respectively.

As of December 31, 2006, there was $1.4 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Stock Plan, the Director Plan and the 2005 Plan. That cost is expected to be recognized over a weighted-average period of approximately 1 year.

A summary of the status of the Company’s nonvested shares for the year ended December 31, 2006 is presented below:

Nonvested Shares	Number of Shares			Weighted-Average Grant-Date Fair Value
Nonvested at January 1, 2006		5,000			$	34
Granted		—			—
Vested		(1,000	)		34
Forfeited		—			—
Nonvested at December 31, 2006		4,000			$	34

The total fair values of shares vested during the year ended December 31, 2006, 2005 and 2004 were $0.03 million, $0 and $0, respectively.

ESPP

Under the terms of the ESPP, the Company may issue up to 1,620,000 shares of common stock pursuant to the exercise of nontransferable options granted to participating employees. The ESPP permits eligible employees to purchase up to 8,000 shares of common stock per payment period, subject to limitations provided by Section 423(b) of the Internal Revenue Code, through accumulated payroll

F-28

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

11. Stockholders’ Equity (Continued)

deductions. The purchases are made twice a year at a price equal to the lesser of (i) 90% of the market value of the Company’s common stock on the first business day of the payment period or (ii) 90% of the market value of the Company’s common stock on the last business day of the payment period. The payment periods consist of two six-month periods, January 1 through June 30 and July 1 through December 31. The NASDAQ Stock Market became a registered national securities exchange with the SEC in August 2006. In accordance with the terms of the plan, because the Company is now traded on a national securities exchange, the Company will calculate the market value on a measurement day to be the average of the high and low prices of the Company’s common stock on that day. This calculation method applies to all purchases made during and after the six-month period ended December 31, 2006.

A summary of the ESPP shares is as follows:

	December 31,
	2006		2005		2004
Total shares available under the plan, beginning of year	521,563		636,267		227,504
Approved increase in shares available	—		—		500,000
Issued at June 30	(68,506	)	(54,862	)	(47,681	)
Issued at December 31	(65,802	)	(59,842	)	(43,556	)
Total shares available under the plan, end of year	387,255		521,563		636,267

At the Annual Meeting of Stockholders of the Company held on April 13, 2004, stockholders approved an amendment to the Company’s ESPP to increase the number of shares of common stock that may be issued thereunder from 1,120,000 to 1,620,000.

For the first payment period in the year ended December 31, 2006, the purchase price of the stock was $33.52, or 90% of the market value of the Company’s common stock on the first business day of the payment period ending June 30, 2006. For the second payment period in the year ended December 31, 2006, the purchase price of the stock was $38.45, or 90% of the market value of the average of the high and low price of the Company’s common stock on the last business day of the payment period ending December 31, 2006.

During the year ended December 31, 2005, the purchase prices of the stock were $34.25 and $33.25, or 90% of the market value of the common stock on the last business day of the payment periods ending June 30, 2005 and December 31, 2005, respectively.

During the year ended December 31, 2004, the purchase prices of the stock were $35.00 and $38.75, or 90% of the market value of the common stock on the first business day of the payment periods ending June 30, 2004 and December 31, 2004, respectively.

Prior to the adoption of SFAS 123R, the ESPP was considered a non-compensatory plan and, therefore, no compensation cost was recognized. However, pursuant to SFAS 123R, the ESPP is considered a compensatory plan, effective January 1, 2006. Accordingly, compensation cost is computed as the sum of: (a) 10% of the fair market value of the Company’s common stock on the first day of the purchase period and (b) the fair value of the option features, calculated using the Black-Scholes valuation model. Compensation cost is recognized ratably over the payment period based on the components of fair

F-29

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

11. Stockholders’ Equity (Continued)

value in the preceding sentence and the number of shares that could be purchased at grant date based on the estimated total withholdings and the discounted market price of the stock on grant date. The weighted-average grant-date fair value of awards granted under the ESPP was $7.86 per share for the payment period from January 1, 2006 through June 30, 2006 and $9.86 per share for the payment period from July 1, 2006 through December 31, 2006. Compensation cost related to the ESPP was $1.2 million for the year ended December 31, 2006.

F-30

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

12. Comprehensive Income

Comprehensive income represents the change in equity of the Company during a period from transactions and other events and circumstances from non-shareholder sources. It includes all changes in equity during a period except those resulting from investments by shareholders and distributions to shareholders. The Company’s other comprehensive income and related tax effects for the years ended December 31, 2006, 2005 and 2004 are as follows (Dollars in thousands):

	Pre-tax Amount			Tax (Expense) Benefit				After-tax Amount
2006
Unrealized gains on securities:
Unrealized holding gains arising during the period	$	16,675			$	(4,629	)	$	12,046
Less: reclassification adjustment for gains included in net income	2,523				(1,073		)	1,450
Net unrealized holding gains arising during the period	14,152				(3,556		)	10,596
Other	156				(57		)	99
Net unrealized gains	14,308				(3,613		)	10,695
Net unrealized derivative instrument loss	(9,020		)		3,836			(5,184		)
Amortization of terminated interest rate swap agreements	(2,360		)		1,019			(1,341		)
Currency translation adjustment	1,444				—			1,444
Other comprehensive income	$	4,372			$	1,242		$	5,614
2005
Unrealized losses on securities:
Unrealized holding losses arising during the period	$	(60,552	)		$	21,481		$	(39,071	)
Less: reclassification adjustment for gains included in net income	12,397				(5,185		)	7,212
Net unrealized holding losses arising during the period	(72,949		)		26,666			(46,283		)
Other	394				(165		)	229
Net unrealized losses	(72,555		)		26,501			(46,054		)
Net unrealized derivative instrument gain	18,002				(7,529		)	10,473
Amortization of terminated interest rate swap agreements	(2,970		)		1,242			(1,728		)
Currency translation adjustment	52				—			52
Other comprehensive income	$	(57,471	)		$	20,214		$	(37,257	)
2004
Unrealized losses on securities:
Unrealized holding losses arising during the period	$	(9,168	)		$	3,202		$	(5,966	)
Less: reclassification adjustment for gains included in net income	234				(82		)	152
Net unrealized holding losses arising during the period	(9,402		)		3,284			(6,118		)
Other	(2,671		)		935			(1,736		)
Net unrealized losses	(12,073		)		4,219			(7,854		)
Net unrealized derivative instrument gain	19,984				(6,994		)	12,990
Amortization of terminated interest rate swap agreements	63				(22		)	41
Currency translation adjustment	846				—			846
Other comprehensive income	$	8,820			$	(2,797	)	$	6,023

F-31

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

13. Employee Benefit Plans

Pension Plan—The Company has a trusteed, noncontributory, qualified defined benefit pension plan (‘Pension Plan’) covering substantially all of its employees who were hired before January 1, 1997. The benefits are based on years of service and the employee’s compensation during employment. Generally, the Company’s funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. Contributions are intended to provide not only for benefits attributed to service to date but also for benefits expected to be earned in the future. The plan document was amended in December 2001 and December 2004 to freeze benefit accruals for certain highly compensated participants. Effective December 31, 2005, all Pension Plan participants’ accounts were frozen and effective January 1, 2006, no further Pension Plan benefit will accrue on behalf of any Pension Plan participant.

Supplemental Retirement Plan—The Company also has a nonqualified, unfunded, supplemental retirement plan (‘SERP’) which was established in 1994 and covers certain employees and pays benefits that supplement any benefits paid under the Pension Plan. Benefits under the SERP are generally based on compensation not includable in the calculation of benefits to be paid under the Pension Plan. The plan document was amended in April 2000 to eliminate the compensation cap and include bonuses and commissions of certain employees.

Effective December 31, 2006, the Company adopted the provisions of FASB Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (‘SFAS 158’). SFAS 158 changes current practice by requiring employers to recognize the overfunded or underfunded positions of defined benefit postretirement plans, including pension plans, on the balance sheet. The funded status is defined as the difference between the projected benefit obligation and the fair value of plan assets. SFAS 158 also requires employers to recognize the change in funded status in other comprehensive income (a component of shareholders’ equity). Upon adopting SFAS 158, the Company recognized the funded status of its SERP and pension plans on its consolidated balance sheet. As a result, the Company recognized an adjustment of $6.8 million to the ending balance of accumulated other comprehensive income, net of tax, which represented the net losses, transition (assets) obligations, and prior service costs that had not been included in net periodic benefit cost as of December 31, 2006.

F-32

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

13. Employee Benefit Plans (Continued)

The incremental effect of applying SFAS 158 on individual line items of the Company’s consolidated balance sheet consisted of the following:

	Before Application of SFAS 158			Adjustments				After Application of SFAS 158
Pension Plan
Asset for pension benefits	$	3,095			$	(2,079	)	$	1,016
Deferred income tax asset	—				884			884
Accumulated other comprehensive income	—				1,195			1,195
SERP
SERP liability	$	(19,908	)		$	(9,408	)	$	(29,316	)
Deferred income tax asset	648				4,916			5,564
Intangible assets	2,150				(2,150		)	—
Accumulated other comprehensive income	876				6,642			7,518
Pension Plan & SERP
Total assets	$	11,556,635			$	1,571		$	11,558,206
Total liabilities	10,610,060				9,408			10,619,468
Total stockholders’ equity	946,575				(7,837		)	938,738

F-33

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

13. Employee Benefit Plans (Continued)

The following table sets forth the status of the Company’s Pension Plan and SERP (Dollars in thousands):

	December 31, 2006							December 31, 2005
	Pension Plan				SERP			Pension Plan				SERP
Change in benefit obligation:
Benefit obligation at beginning of year		$	16,817		$	27,576			$	22,141		$	23,543
Service cost		—			1,846				744			1,788
Interest cost		1,015			1,571				1,143			1,475
Actuarial loss		146			(1,170		)		249			1,057
Benefits paid		(1,052		)	(507		)		(1,100		)	(287		)
Curtailments		—			—				(6,360		)	—
Projected benefit obligation at the end of the year		16,926			29,316				16,817			27,576
Change in plan assets:
Assets at the beginning of the year		16,888			—				17,185			—
Employer contributions		—			507				—			287
Actual return		2,106			—				803			—
Benefits paid		(1,052		)	(507		)		(1,100		)	(287		)
Assets at the end of the year		17,942			—				16,888			—
Funded status at the end of year		$	1,016		$	(29,316	)		71			(27,576		)
Unrecognized net transition (asset) obligation		NM			NM				(28		)	10
Unrecognized prior service cost		NM			NM				—			2,294
Unrecognized net loss		NM			NM				2,817			12,902
Net amount recognized		NM			NM				$	2,860		$	(12,370	)

NM—information is not meaningful. Due to the adoption of SFAS 158, these amounts are now recorded as a component of accumulated other comprehensive income.

Amounts recognized in the consolidated balance sheet prior to the adoption of SFAS 158 consisted of the following (Dollars in thousands):

	December 31, 2005
	Pension Plan			SERP
Prepaid benefit cost		$	2,860	$	—
Accrued benefit cost		—		(18,074		)
Intangible assets		—		2,304
Accumulated other comprehensive income		—		3,400
Net amount recognized		$	2,860	$	(12,370	)

F-34

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

13. Employee Benefit Plans (Continued)

Amounts recognized in the consolidated balance sheet upon adoption of SFAS 158 on December 31, 2006 consisted of the following (Dollars in thousands):

	December 31, 2006
	Pension Plan			SERP
Pension assets		$	1,016	$	—
Pension liabilities		—		29,316
		$	1,016	$	29,316

Amounts recognized in accumulated other comprehensive income upon adoption of SFAS 158 consist of (Dollars in thousands):

	December 31, 2006
	Pension Plan			SERP
Net loss		$	1,195	$	6,280
Prior service cost		—		1,235
Net transition obligation		—		3
		$	1,195	$	7,518

The accumulated benefit obligation for the Pension Plan was $16.9 million and $16.8 million at December 31, 2006 and 2005, respectively. The accumulated benefit obligation for the SERP was $19.9 million and $18.1 million at December 31, 2006 and 2005, respectively.

Net periodic pension cost for the Company’s Pension Plan and SERP included the following components (Dollars in thousands):

	December 31, 2006						December 31, 2005
	Pension Plan				SERP		Pension Plan				SERP
Net Periodic Benefit Cost
Service cost—benefits earned / benefit obligations		$	—		$	1,846		$	744		$	1,788
Interest cost on projected benefit obligations		1,015			1,571			1,143			1,475
Expected return on plan assets		(1,413		)	—			(1,435		)	—
Curtailment gain		—			—			(275		)	—
Amortization of net transition (asset) obligation		(28		)	5			(38		)	5
Amortization of prior service cost		—			145			(22		)	145
Amortization of net loss		191			805			373			942
Net periodic pension (benefit) cost		$	(235	)	$	4,372		$	490		$	4,355

The estimated net loss, prior service cost, and transition obligation for the defined benefit pension plans that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year are $665, $145 and $5, respectively.

F-35

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

13. Employee Benefit Plans (Continued)

The weighted-average discount rate and the rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligations were as follows:

	December 31, 2006					December 31, 2005
	Pension Plan			SERP		Pension Plan			SERP
Discount rate		6.00	%	6.00	%		5.75	%	5.75	%
Rate of compensation increases		N/A		4.00-10.00			4.00		4.00-10.00

The weighted-average discount rate, rate of increase in future compensation levels, and expected rate of return on plan assets used in determining the net periodic pension cost were as follows:

	December 31, 2006						December 31, 2005
	Pension Plan			SERP			Pension Plan			SERP
Discount rate		5.75	%		5.75	%		5.80	%		5.80	%
Rate of compensation increases		4.00			4.00			4.00			4.00
Expected rate of return on plan assets		8.50			—			8.50			—

The Company has utilized an expected rate of return on plan assets of 8.50%, which is consistent with the weighted-average of the historical return indices for specific portfolio assets.

The Company’s Pension Plan allocation by asset category is as follows:

Asset Category	December 31, 2006			December 31, 2005
Cash and short-term investments		1.4	%		1.3	%
Equity securities		70.5			68.4
Debt securities		28.1			30.3
Total		100.0	%		100.0	%

The Company’s core investment objectives for the Pension Plan are long-term capital appreciation and growth of income, while protecting the principal value of trust assets from long-term permanent loss and, within reason, from large short-term fluctuations. The approved investment policies of the trust anticipate fixed income investments to compose 25-55% and equity securities to compose 45-75% of the total portfolio. Cash equivalents may be used to provide liquidity, income and stability to the portfolio.

Cash and short-term investments represent money market funds at December 31, 2006 and 2005. Equity securities supply current income and growth through market appreciation. The Company invests in quality companies with securities that are readily marketable. Debt securities offer a source of current income and reduce the variability of the portfolio’s total market value. Fixed income investments were limited to issues by the U.S. government and its agencies, and investment grade corporate bonds at December 31, 2006 and 2005. The Pension Plan was in full compliance with the approved pension objectives and policies for the years ended December 31, 2006 and 2005. At December 31, 2006 and 2005, the pension did not hold any securities of the Company.

The Company does not expect to contribute to its Pension Plan during 2007, and no contributions were made during 2006.

F-36

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

13. Employee Benefit Plans (Continued)

At December 31, 2006 and 2005, the SERP remained an unfunded plan. The Company does not anticipate making any contributions to the SERP during 2007.

The following table shows the expected future benefit payments for the next ten years (Dollars in thousands):

	Pension Plan			SERP
2007		$	270	$	177
2008		292		180
2009		339		185
2010		363		191
2011		384		199
2012 - 2016		2,748		3,214

Employee Savings Plan—The Company sponsors a qualified defined contribution employee savings plan covering substantially all employees. The Company matches employee contributions to the plan up to specified amounts. The total cost of this plan to the Company was $4.5 million, $3.7 million and $3.2 million for the years ended December 31, 2006, 2005 and 2004, respectively.

14. Off Balance Sheet Financial Instruments

Lines of Credit—At December 31, 2006, the Company had commitments to mutual funds, individuals and others under collateralized open lines of credit totaling $1.2 billion, against which $184.6 million in loans were drawn. The credit risk involved in issuing lines of credit is essentially the same as that involved in extending demand loans. The Company does not anticipate any loss as a result of these lines of credit.

Securities Lending—On behalf of its clients, the Company lends securities to creditworthy broker-dealers. In certain circumstances, the Company may indemnify its clients for the fair market value of those securities against a failure of the borrower to return such securities. The Company requires the borrowers to provide collateral in an amount equal to, or in excess of, 102% of the fair market value of U.S. dollar-denominated securities borrowed and 105% of the fair market value of non-U.S. dollar-denominated securities borrowed. The borrowed securities are revalued daily to determine whether additional collateral is necessary. As guarantor, the Company is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The Company measures the fair value of its indemnification obligation by marking its securities lending portfolio to market on a daily basis and comparing the value of the portfolio to the collateral holdings position. The fair value of the indemnification obligation to be recorded would be the deficiency of collateral as compared to the value of the securities out on loan.

With respect to the indemnified securities lending portfolio, the cash and U.S. government securities held by the Company as collateral at December 31, 2006 totaled $11.1 billion, while the fair value of the securities lending portfolio totaled approximately $10.7 billion. Given that the collateral held was in excess of the value of the securities that the Company would be required to replace if the borrower defaulted and failed to return such securities, the Company’s indemnification obligation was zero and no liability was recorded.

F-37

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

14. Off Balance Sheet Financial Instruments (Continued)

All securities loans are categorized as overnight loans. The maximum potential amount of future payments that the Company could be required to make would be equal to the market value of the securities borrowed. Since the securities loans are overcollateralized by 2% (for U.S. dollar-denominated securities) to 5% (for non-U.S. dollar-denominated securities) of the fair market value of the loan made, the collateral held by the Company would be used to satisfy the obligation. In addition, each borrowing agreement includes “set-off” language that allows the Company to use any excess collateral on other loans to that borrower to cover any collateral shortfall of that borrower. However, there is a potential risk that the collateral would not be sufficient to cover such an obligation if the security on loan increased in value between the time the borrower defaulted and the time the security is “bought-in”. In those instances, the Company would “buy-in” the security using all available collateral and a loss would result from the difference between the value of the security “bought-in” and the value of the collateral held. The Company has never experienced a broker default.

15. Derivative Financial Instruments

Interest Rate Contracts—Interest rate contracts involve an agreement with a counterparty to exchange cash flows based on an underlying interest rate index. A swap agreement involves the exchange of a series of interest payments, either at a fixed or variable-rate, based upon the notional amount without the exchange of the underlying principal amount. The Company’s exposure from these interest rate contracts results from the possibility that one party may default on its contractual obligation when the contracts are in a gain position. The Company has experienced no terminations by counterparties of interest rate swaps. Credit risk is limited to the positive fair value of the derivative financial instrument, which is significantly less than the notional value. The positive fair values related to the Company’s interest rate contracts were approximately $13.8 million and $24.3 million at December 31, 2006 and 2005, respectively, which are included in other assets on the Company’s consolidated balance sheets.

The Company enters into pay-fixed/receive-floating interest rate swap agreements. These instruments have been designated as cash flow hedges of variable-rate liabilities and a forecasted series of fixed-rate overnight liabilities incurred at different daily fixed rates (thereby resulting in a variable interest expense pattern). The contractual or notional amounts of the interest rate swap agreements held by the Company were approximately $1.6 billion and $1.9 billion at December 31, 2006 and 2005, respectively. These contracts had net fair values of approximately $13.8 million and $24.2 million at December 31, 2006 and 2005, respectively. These fair values are included in the respective other assets and other liabilities categories on the Company’s consolidated balance sheets. See also Note 17 for additional information on the fair value of the interest rate contracts.

For the year ended December 31, 2006, the Company recognized a net pre-tax loss of $1.5 million, which represented the total ineffectiveness for all cash flow hedges. For the years ended December 31, 2005 and 2004, the Company recognized net pre-tax gains of $3.5 million and $4.1 million, respectively, which represented the total ineffectiveness for all cash flow hedges.

F-38

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

15. Derivative Financial Instruments (Continued)

As of December 31, 2006, the Company expects that approximately $5.9 million of deferred net after-tax gains on derivative contracts included in other comprehensive income will be reclassified to net interest income within the next twelve months. This expectation is based on the net discounted cash flows from existing cash flow hedging derivatives, as well as the amortization of gains from the terminated cash flow hedging derivatives.

Foreign Exchange Contracts—Foreign exchange contracts involve an agreement to exchange the currency of one country for the currency of another country at an agreed-upon rate and settlement date. Foreign exchange contracts consist of spot, forward and swap contracts. Spot contracts call for the exchange of one currency for another and usually settle in two business days. Forward contracts call for the exchange of one currency for another at a date beyond spot. In a currency swap, the holder of a currency transacts simultaneously both a spot and a forward transaction in that currency for an equivalent amount of another currency to get temporary liquidity in the currency owned. The Company’s risk from foreign exchange contracts results from the possibility that one party may default on its contractual obligation or from movements in exchange rates. Credit risk is limited to the positive market value of the derivative financial instrument, which is significantly less than the notional value. The notional value of the Company’s foreign exchange contracts at December 31, 2006 and 2005 was $13.5 billion and $6.3 billion, respectively. The Euro foreign exchange contracts represented approximately 71% and 57% of the notional value outstanding as of December 31, 2006 and 2005, respectively. Unrealized gains or losses resulting from purchases and sales of foreign exchange contracts are included within the respective other assets and other liabilities categories on the Company’s consolidated balance sheets. Unrealized gains in other assets were $27.5 million and $20.8 million at December 31, 2006 and 2005, respectively. Unrealized losses in other liabilities were $27.0 million and $19.7 million at December 31, 2006 and 2005, respectively. See also Note 17 for additional information on the fair value of the Company’s foreign exchange contracts. Foreign exchange contracts with the same counterparty are netted in the Company’s consolidated balance sheets when a master netting agreement exists. These contracts have not been designated as hedging instruments; therefore, all changes in fair value are included in asset servicing fees.

Other—The Company also enters into fixed price purchase contracts that are designed to hedge the variability of the consideration to be paid for the purchase of investment securities. By entering into these contracts, the Company is fixing the price to be paid at a future date for certain investment securities. At December 31, 2006 the Company had no fixed price purchase contracts outstanding to purchase investment securities. At December 31, 2005, the Company had $97.5 million of fixed price purchase contracts outstanding to purchase investment securities. Changes in fair value of these cash flow hedges are included as a component of other comprehensive income.

16. Commitments and Contingencies

Restrictions on Cash Balances—The Company is required to maintain certain average cash reserve balances. The average required reserve balance with the FRB for the two-week period including December 31, 2006 was approximately $35.8 million. In addition, the Company’s consolidated balance sheet includes deposits totaling $44.4 million, which were pledged to secure clearings with depository institutions as of December 31, 2006.

F-39

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

16. Commitments and Contingencies (Continued)

Lease Commitments—Minimum future commitments on noncancelable operating leases at December 31, 2006 were as follows (Dollars in thousands):

Fiscal Year Ending	Bank Premises			Equipment			Total
2007		$	32,722		$	2,467	$	35,189
2008		32,813			1,351		34,164
2009		35,793			371		36,164
2010		35,581			49		35,630
2011		36,366			24		36,390
2012 and beyond		121,879			—		121,879
Total		$	295,154		$	4,262	$	299,416

Total rent expense was approximately $36.8 million, $29.2 million and $33.4 million for the years ended December 31, 2006, 2005 and 2004, respectively.

In 2005, the Company renewed its service agreement with Electronic Data Systems (‘EDS’), which now expires December 31, 2008. Under the terms of the agreement, EDS provides data processing services to the Company, which has agreed to pay certain monthly service fees based on usage. Service expense under this contract was $4.7 million, $7.3 million and $8.3 million for the years ended December 31, 2006, 2005 and 2004, respectively.

In 2004, the Company renewed its agreement with SEI Investments Company (‘SEI’), which now expires on December 31, 2009. Under the terms of this agreement, SEI provides data processing services to the Company, which has agreed to pay certain monthly service fees based upon usage. Service expense under this contract was $6.4 million, $5.3 million and $5.0 million for the years ended December 31, 2006, 2005 and 2004, respectively.

In 2004, the Company signed a service agreement with International Business Machines Corporation (‘IBM’). Under the terms of this agreement, IBM provides support for our network and hardware environments and the Company’s help desk services. The Company has agreed to pay certain monthly services fees based upon usage. This agreement expires June 30, 2011. Service expense under this contract was $26.4 million, $13.7 million and $9.5 million for the years ended December 31, 2006, 2005 and 2004, respectively.

Contingencies—Assets held by the Company in a fiduciary capacity are not included in the consolidated balance sheets since these items are not assets of the Company. Management conducts regular reviews of its fiduciary responsibilities and considers the results in preparing its consolidated financial statements. In the opinion of management, there were no contingent liabilities related to its fiduciary capacity at December 31, 2006 that were material to the consolidated financial position or consolidated results of operations of the Company.

The Company and certain of its officers were named as defendants in three purported class action complaints that were filed on or about August 4, 2005, August 15, 2005, and September 30, 2005 in the United States District Court for the District of Massachusetts, Boston, Massachusetts. The U.S. District

F-40

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

16. Commitments and Contingencies (Continued)

Court has consolidated those cases and appointed lead plaintiffs, who filed a consolidated complaint against the Company and seven of its current and former officers on February 3, 2006. Among other things, the consolidated complaint asserts that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 during the period April 10, 2001 until July 15, 2005. The allegations in the consolidated complaint predominantly relate to: (1) the Company’s October 2004 restatement of its financial results, and (2) the Company’s July 2005 revision of public guidance regarding its future financial performance. The consolidated complaint seeks unspecified damages, interest, fees, and costs. On May 14, 2006, the Company filed a motion to dismiss all claims asserted in the consolidated complaint. That motion is currently pending before the Court. The Company strongly believes that the lawsuit lacks merit and the Company intends to defend against the claims vigorously. However, the Company cannot predict the outcome of the lawsuit at this time, and the Company can give no assurance that it will not materially adversely affect the Company’s financial condition or results of operations.

The Company and nine of its officers and directors are named as defendants in two shareholder derivative complaints that were filed on or about September 22, 2005 and October 17, 2005 in the United States District Court for the District of Massachusetts, Boston, Massachusetts. Among other things, the complaints assert that the defendants are liable for breach of fiduciary duty, unjust enrichment, abuse of control, mismanagement, misappropriation of information, insider trading, and violation of Section 14(a) of the Securities Exchange Act of 1934. The complaint filed on September 22, 2005 also seeks reimbursement under the Sarbanes-Oxley Act of 2002. The allegations in the complaints predominantly relate to: (1) The Company’s October 2004 restatement of its financial results, and (2) the Company’s July 2005 revision of public guidance regarding its future financial performance. The complaints seek unspecified damages, attorneys’ fees, accountant and expert fees, and costs. The Company is also named as a nominal defendant in these complaints, although the actions are derivative in nature and purportedly asserted on behalf of the Company. The Company is in the process of evaluating these claims. However, the Company cannot predict the outcome of the lawsuits at this time, and the Company can give no assurance that they will not materially adversely affect our financial condition or results of operations.

In July 2000, two of the Company’s Dublin subsidiaries, Investors Trust & Custodial Services (Ireland) Ltd. (‘ITC’) and Investors Fund Services (Ireland) Ltd. (‘IFS’), received a plenary summons in the High Court, Dublin, Ireland. The summons named ITC and IFS as defendants in an action brought by the FTF ForexConcept Fund Plc (the ‘Fund’), a former client. The summons also named as defendants FTF Forex Trading and Finance, S.A., the Fund’s investment manager, Ernst & Young, LLP, the Fund’s auditors, and Dresdner Bank-Kleinwort Benson (Suisse) S.A., a trading counterparty to the Fund. The Fund is an investment vehicle organized in Dublin to invest in foreign exchange contracts. A total of approximately $4.7 million had been invested in the Fund. Most of that money was lost prior to the Fund’s closing to subscriptions in June 1999. In January 2001, ITC, IFS and the other defendants named in the plenary summons received a statement of claim by the Fund seeking unspecified damages allegedly arising from breach of contract, misrepresentation and breach of warranty, negligence and breach of duty of care, and breach of fiduciary duty, among others. The Company has notified its insurers and intends to defend this claim vigorously. Based on its investigation through December 31, 2006, the Company does not expect this matter to have a material adverse effect on its business, financial condition or results of operations.

F-41

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

17. Fair Value of Financial Instruments

The carrying amount and estimated fair value of financial instruments are as follows (Dollars in thousands):

	December 31, 2006				December 31, 2005
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
Financial Assets:
Cash and due from banks	$	92,766	$	92,766	$	60,743	$	60,743
Interest-bearing deposits with other banks	21,218		21,218		18,894		18,894
Other short-term investments	1,971		1,971		—		—
Securities held to maturity	5,532,330		5,508,788		6,761,930		6,725,729
Securities available for sale	4,799,740		4,799,740		4,369,720		4,369,720
Loans, net of allowance	270,693		270,693		402,370		402,370
Interest rate contracts	13,845		13,845		24,251		24,251
Foreign exchange contracts	27,459		27,459		20,805		20,805
Financial Liabilities:
Deposits	$	6,144,942	$	6,144,942	$	4,992,590	$	4,992,590
Securities sold under repurchase agreements	3,727,800		3,726,154		4,797,868		4,736,958
Short-term and other borrowings	517,051		517,051		1,356,649		1,356,649
Interest rate contracts	86		86		101		101
Foreign exchange contracts	26,975		26,975		19,665		19,665

The fair value estimates presented herein are based on pertinent information available to management at December 31, 2006 and 2005. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been significantly revalued for the purposes of these consolidated financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.

The Company uses the following methods and assumptions to determine the fair value of selected financial instruments:

Short-term financial assets and liabilities—For financial instruments with a short or no stated maturity, prevailing market rates and limited credit risk, carrying amounts approximate fair value. Those financial instruments include cash and due from banks, interest bearing deposits with other banks, other short-term investments, loans and deposits.

Securities, available for sale and held to maturity—Fair values were based on prices obtained from an independent nationally recognized pricing service, or in the absence of such, prices were obtained directly from selected broker-dealers.

Securities sold under repurchase agreements and short-term and other borrowings—Fair values of the Company’s long-term borrowings and long-term repurchase agreements were based on quoted market prices, when available, and prevailing market rates for borrowings of similar terms. Carrying amounts for

F-42

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

17. Fair Value of Financial Instruments (Continued)

short-term borrowings and short-term repurchase agreements approximate fair value due to the short-term nature of these instruments.

Interest rate contracts—Fair values were based on the estimated amount that the Company would receive or pay to terminate the swap agreements, taking into account the current interest rates and the creditworthiness of the swap counterparties.

Foreign exchange contracts—Fair values were based on quoted market prices of comparable instruments. Foreign exchange contracts have been reduced by offsetting balances with the same counterparty where a master netting agreement exists.

18. Regulatory Matters

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

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2006, that the Company and the Bank meet all capital adequacy requirements to which they are subject.

As of December 31, 2006, the most recent notification from the Federal Deposit Insurance Corporation categorized the Company and the Bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Company and the Bank must maintain minimum Total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Company’s or the Bank’s category.

F-43

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

18. Regulatory Matters (Continued)

The following table presents the capital ratios for the Company and the Bank (Dollars in thousands):

										To Be Well-
										Capitalized Under
					For Capital					Prompt Corrective
	Actual				Adequacy Purposes					Action Provisions
	Amount		Ratio		Amount		Ratio			Amount		Ratio
As of December 31, 2006:
Total Capital
(to Risk-Weighted Assets-the Company)	$	900,299	19.04	%	$	378,305		8.00	%	N/A		N/A
Total Capital
(to Risk-Weighted Assets-the Bank)	$	863,841	18.28	%	$	378,048		8.00	%	$	472,560	10.00	%
Tier 1 Capital
(to Risk-Weighted Assets-the Company)	$	900,199	19.04	%	$	189,152		4.00	%	N/A		N/A
Tier 1 Capital
(to Risk-Weighted Assets-the Bank)	$	863,741	18.28	%	$	189,024		4.00	%	$	283,536	6.00	%
Tier 1 Capital
(to Average Assets-the Company)	$	900,199	7.63	%	$	472,082		4.00	%	N/A		N/A
Tier 1 Capital
(to Average Assets-the Bank)	$	863,741	7.32	%	$	471,715		4.00	%	$	589,643	5.00	%
As of December 31, 2005:
Total Capital
(to Risk-Weighted Assets-the Company)	$	731,833	18.50	%	$	316,553		8.00	%	N/A		N/A
Total Capital
(to Risk-Weighted Assets-the Bank)	$	720,113	18.21	%	$	316,349		8.00	%	$	395,436	10.00	%
Tier 1 Capital
(to Risk-Weighted Assets-the Company)	$	731,733	18.49	%	$	158,276		4.00	%	N/A		N/A
Tier 1 Capital
(to Risk-Weighted Assets-the Bank)	$	720,013	18.21	%	$	158,174		4.00	%	$	237,262	6.00	%
Tier 1 Capital
(to Average Assets-the Company)	$	731,733	5.95	%	$	491,685		4.00	%	N/A		N/A
Tier 1 Capital
(to Average Assets-the Bank)	$	720,013	5.86	%	$	491,549		4.00	%	$	614,437	5.00	%

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

F-44

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

18. Regulatory Matters (Continued) (Continued)

The operations of the Company’s securities broker affiliate, Investors Securities Services, LLC (‘ISS’), are subject to federal and state securities laws, as well as the rules of both the SEC and the NASD. Management believes, as of December 31, 2006, that ISS is in material compliance with all of the foregoing requirements to which it is subject.

The operations of the Company’s captive insurance affiliate, Investors Vermont Insurance Company (‘IVIC’), are subject to the laws and regulations of the BISHCA. Management believes, as of December 31, 2006, that IVIC is in material compliance with all of the foregoing requirements to which it is subject.

The operations of the Company’s affiliated international subsidiaries are subject to laws and regulations of various regulators, including the OSFI, the IFSRA, the CIMA, the FSA and the CSSF. Management believes, as of December 31, 2006, that its affiliated international subsidiaries are all in compliance with all of the foregoing requirements to which each is subject.

In June 2004, the Basel Committee on Banking Supervision (‘Basel Committee’) released the document “International Convergence of Capital Measurement and Capital Standards: A Revised Framework.” The Framework, also referred to as Basel II, is designed to secure international convergence on regulations and standards governing the capital adequacy of internationally active banking organizations. In September 2006, the U.S. banking and thrift supervisory agencies issued a notice of Proposed Rulemaking setting forth a proposed framework for the timing and qualification process for U.S. banks that are either required (“core banks”) or choose (“opt-in banks”) to be subject to Basel II. As currently proposed, the new rules as applied in the U.S. are expected to become effective on January 1, 2009, subject to transitional parallel testing beginning on January 1, 2008. Although the Bank is not required to be compliant with the new rules, the Bank is in the process of developing and implementing a program to achieve Basel II compliance. Ultimately, U.S. implementation of Basel II will depend on, and will be subject to, final regulations and related policies promulgated by the U.S. supervisory agencies. The Bank cannot predict the final form of the rules, nor their impact on its risk-based capital.

F-45

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

19. Net Interest Income

The components of interest income and interest expense are as follows (Dollars in thousands):

	December 31,
	2006		2005		2004
Interest income:
Federal funds sold, interest-bearing deposits with other banks and other short-term investments	$	9,141	$	2,250	$	667
Investment securities:
Mortgage-backed securities	403,717		315,845		221,248
Federal agency securities	91,861		89,864		53,977
State and political subdivisions (exempt from federal tax)	20,071		21,217		22,300
Other securities	11,927		9,267		10,370
Loans	21,032		9,262		4,587
Total interest income	$	557,749	$	447,705	$	313,149
Interest expense:
Deposits	$	180,327	$	77,706	$	50,721
Securities sold under repurchase agreements	164,970		142,681		54,376
Short-term and other borrowings	45,838		54,473		17,952
Junior subordinated debentures	2,420		2,420		2,420
Total interest expense	$	393,555	$	277,280	$	125,469
Net interest income	$	164,194	$	170,425	$	187,680

20. Selected Quarterly Financial Data (unaudited) (Dollars in thousands, except per share data):

	First		Second		Third		Fourth
Year Ended December 31, 2006	Quarter		Quarter		Quarter		Quarter
Noninterest income	$	149,467	$	169,128	$	154,874	$	165,985
Interest income	134,437		137,921		140,338		145,053
Interest expense	91,116		99,356		101,348		101,735
Operating expenses	135,684		148,925		139,154		155,591
Income before income taxes	57,104		58,768		54,710		53,712
Income taxes	19,701		14,469		18,327		17,994
Net income	37,403		44,299		36,383		35,718
Basic earnings per share	0.57		0.68		0.55		0.54
Diluted earnings per share	0.56		0.65		0.54		0.53

F-46

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

20. Selected Quarterly Financial Data (unaudited) (Dollars in thousands, except per share data): (Continued)

	First		Second		Third		Fourth
Year Ended December 31, 2005	Quarter		Quarter		Quarter		Quarter
Noninterest income	$	120,176	$	128,676	$	131,215	$	145,470
Interest income	98,055		108,103		114,512		127,035
Interest expense	50,442		66,057		76,471		84,310
Operating expenses	104,792		113,237		116,130		125,950
Income before income taxes	62,997		57,485		53,126		62,245
Income taxes	22,049		13,358		17,894		22,734
Net income	40,948		44,127		35,232		39,511
Basic earnings per share	0.61		0.66		0.54		0.61
Diluted earnings per share	0.60		0.64		0.53		0.60

21. Geographic Reporting and Service Lines

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

	Net Operating Revenue						Long-Lived Assets
	For the Years Ended December 31,						December 31			December 31
Geographic Information	2006		2005		2004		2006			2005
United States	$	748,133	$	653,305	$	579,168		$	182,276		$	141,810
Ireland	48,567		37,061		28,835			9,269			6,325
Canada	6,233		5,427		4,989			116			385
United Kingdom	364		3		—			1,520			850
Luxembourg	196		—		—			75			—
Cayman Islands	155		166		179			—			—
Total	$	803,648	$	695,962	$	613,171		$	193,256		$	149,370

Barclays Global Investors, N.A. (‘BGI’) accounted for 18%, 18% and 17% of the Company’s consolidated net operating revenues for the years ended December 31, 2006, 2005 and 2004, respectively. No client other than BGI accounted for more than 10% of the Company’s consolidated net operating revenues in the years ended December 31, 2006, 2005 and 2004.

F-47

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

21. Geographic Reporting and Service Lines (Continued)

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

	For the Years Ended December 31,
Asset servicing fees by service lines:	2006		2005		2004
Core service fees:
Custody, multicurrency accounting and fund administration	$	453,573	$	375,596	$	314,272
Value-added service fees:
Foreign exchange	80,957		62,107		54,466
Cash management	58,777		37,592		26,396
Securities lending	27,381		22,536		10,385
Investment advisory	7,464		8,442		15,020
Other service fees	3,088		2,786		2,661
Total value-added service fees	177,667		133,463		108,928
Total	$	631,240	$	509,059	$	423,200

22. Financial Statements of Investors Financial Services Corp. (Parent Only)

The following represents the separate condensed financial statements of IFSC (Dollars in thousands):

	Year ended				Year ended				Year ended
Statements of Income	December 31, 2006				December 31, 2005				December 31, 2004
Equity in undistributed income of bank subsidiary		$	156,798			$	99,809			$	144,595
Equity in undistributed loss of unconsolidated nonbank subsidiary		(29		)		(28		)		(28		)
Dividend income from bank subsidiary		—				63,000				—
Dividend income from unconsolidated nonbank subsidiary		76				76				76
Interest expense on junior subordinated deferrable interest debentures		(2,420		)		(2,420		)		(2,420		)
Operating expenses		(2,260		)		(2,254		)		(1,703		)
Income tax benefit		1,638				1,635				1,442
Net Income		$	153,803			$	159,818			$	141,962

F-48

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

22. Financial Statements of Investors Financial Services Corp. (Parent Only) (Continued)

Balance Sheets	December 31, 2006				December 31, 2005
Assets:
Cash		$	34,554			$	10,303
Investments in bank subsidiary		926,279				785,138
Investments in nonbank subsidiaries		681				710
Receivable due from bank subsidiary		2,600				1,991
Other assets		666				709
Total Assets		$	964,780			$	798,851
Liabilities and Stockholders’ Equity:
Liabilities:
Accrued expenses		$	98			$	62
Payable due to nonbank subsidiary		1,157				1,157
Junior subordinated deferrable interest debentures		24,774				24,774
Income tax payable		13				—
Total liabilities		26,042				25,993
Stockholders’ Equity:
Common stock		685				672
Surplus		334,929				286,265
Deferred compensation		—				(311		)
Retained earnings		720,433				572,549
Accumulated other comprehensive loss, net		(14,514		)		(13,369		)
Treasury stock		(102,795		)		(72,948		)
Total stockholders’ equity		938,738				772,858
Total Liabilities and Stockholders’ Equity		$	964,780			$	798,851

F-49

INVESTORS FINANCIAL SERVICES CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Years Ended December 31, 2006, 2005 and 2004

22. Financial Statements of Investors Financial Services Corp. (Parent Only) (Continued)

	Year ended				Year ended				Year ended
Statements of Cash Flows	December 31, 2006				December 31, 2005				December 31, 2004
Cash flows from operating activities:
Net income		$	153,803			$	159,818			$	141,962
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Equity in undistributed income of bank subsidiary		(156,798		)		(99,809		)		(144,595		)
Equity in undistributed loss of unconsolidated
nonbank subsidiary		29				28				28
Share-based awards		4,538				—				—
Amortization of deferred compensation		—				261				316
Amortization of premium expense		28				28				28
Excess tax benefit related to share-based awards		(8,017		)		—				—
Change in assets and liabilities:
Receivable due from bank subsidiary		(609		)		44				(376		)
Income tax receivable/payable		111				(98		)		484
Other assets		9				13				(8		)
Accrued expenses		36				19				(13		)
Net cash (used in) provided by operating activities		(6,870		)		60,304				(2,174		)
Cash flows from financing activities:
Proceeds from exercise of stock options		33,096				7,779				16,068
Proceeds from issuance of common stock		4,827				3,868				3,355
Common stock repurchase		(29,847		)		(70,657		)		(1,741		)
Excess tax benefit related to share-based awards		8,017				—				—
Dividends paid to stockholders		(5,919		)		(5,303		)		(4,629		)
Tax benefit related to the issuance of share-based awards		20,947				—				—
Net cash provided by (used in) financing activities		31,121				(64,313		)		13,053
Net increase (decrease) in cash and due from banks		24,251				(4,009		)		10,879
Cash and due from banks, beginning of year		10,303				14,312				3,433
Cash and due from banks, end of year		$	34,554			$	10,303			$	14,312

F-50

Delaware		04-3279817
(State or other jurisdiction of		(I.R.S Employer
incorporation or organization)		Identification No.)
200 Clarendon Street P.O. Box 9130 Boston, Massachusetts		02116
(Address of principal executive offices)		(Zip Code)

/s/ KEVIN J. SHEEHAN
Kevin J. Sheehan
Chairman and Chief Executive Officer
/s/ JOHN N. SPINNEY, JR.
John N. Spinney, Jr.
Senior Vice President and Chief Financial Officer

		INVESTORS FINANCIAL SERVICES CORP.
		By:	/s/ KEVIN J. SHEEHAN
			Kevin J. Sheehan
			Chief Executive Officer and Chairman of the Board

	Signature		Title(s)
/s/ KEVIN J. SHEEHAN		Chief Executive Officer and Chairman of the Board
Kevin J. Sheehan		(Principal Executive Officer); Director
/s/ MICHAEL F. ROGERS		President
Michael F. Rogers
/s/ JOHN N. SPINNEY, JR.		Senior Vice President and Chief Financial Officer
John N. Spinney, Jr.		(Principal Financial Officer and Principal Accounting Officer)
/s/ RICHARD P. BOYATZI		Director
Richard P. Boyatzi
/s/ FRANK B. CONDON, JR.		Director
Frank B. Condon, Jr.

/s/ THOMAS P. MCDERMOTT		Director
Thomas P. McDermott
/s/ JAMES M. OATES		Director
James M. Oates
/s/ JOHN I. SNOW III		Director
John I. Snow III
/s/ PHYLLIS S. SWERSKY		Director
Phyllis S. Swersky

		Page
Report of Independent Registered Public Accounting Firm	F-2
Consolidated Balance Sheets as of December 31, 2006 and December 31, 2005	F-3
Consolidated Statements of Income and Comprehensive Income for the Years Ended December 31, 2006, 2005 and 2004	F-4
Consolidated Statements of Stockholders’ Equity for the Years Ended December 31, 2006, 2005 and 2004	F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004	F-6
Notes to Consolidated Financial Statements	F-7

	/s/ Kevin J. Sheehan
	Kevin J. Sheehan
	Chairman and Chief Executive Officer

	/s/ John N. Spinney, Jr.
	John N. Spinney Jr.
	Senior Vice President and Chief Financial Officer