Filed On 8/20/03 3:00pm ET ˇ SEC File 33-43446 ˇ Accession Number 1193125-3-40073
As Of Filer Filing As/For/On Docs:Pgs Issuer Agent
8/20/03 Smith Barney Investment Trust 497 8/20/03 1:71 RR Donnelley/FA
Document/Exhibit Description Pages Size
1: 497 Smith Barney Intermediate Maturity California and 71 423K
New York Municipals Fund
March 28, 2003
as amended on August 20, 2003
STATEMENT OF ADDITIONAL INFORMATION
SMITH BARNEY INVESTMENT TRUST
Smith Barney Intermediate Maturity California Municipals Fund
Smith Barney Intermediate Maturity New York Municipals Fund
125 Broad Street
New York, New York 10004
(800) 451-2010
This Statement of Additional Information ("SAI") is meant to be read in
conjunction with the prospectuses of the Smith Barney Intermediate Maturity
California Municipals Fund (the "California Fund") and the Smith Barney
Intermediate Maturity New York Municipals Fund (the "New York Fund")
(collectively the "funds") dated March 28, 2003, as amended or supplemented
from time to time, and is incorporated by reference in its entirety into the
prospectuses. Additional information about each fund's investments is available
in each fund's annual and semi-annual reports to shareholders, which are
incorporated herein by reference. The prospectuses and copies of the reports
may be obtained free of charge by contacting a Smith Barney Financial
Consultant, a broker/dealer, financial intermediary, or financial institution
(each called a "Service Agent") or by writing or calling the fund at the
address or telephone number above. The funds are separate investment series of
Smith Barney Investment Trust (the "trust").
TABLE OF CONTENTS
[Download Table]
Investment Objective and Management Policies for the Funds....... 2
Risk Factors..................................................... 10
Risk Factors--Investing in State Municipal Obligations........... 15
Portfolio Transactions........................................... 35
Portfolio Turnover............................................... 36
Investment Restrictions.......................................... 37
Trustees and Executive Officers of the Trust or Funds............ 39
Investment Management and Other Services......................... 42
Distribution Plan Fees........................................... 47
Purchase of Shares............................................... 48
Redemption of Shares............................................. 53
Valuation of Shares.............................................. 54
Exchange Privilege............................................... 55
Performance Data................................................. 56
After-Tax Return................................................. 60
Dividends and Distributions...................................... 60
Taxes............................................................ 61
Additional Information........................................... 65
Financial Statements............................................. 66
Other Information................................................ 66
Appendix......................................................... 67
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES FOR THE FUNDS
The prospectuses discuss the investment objective of each fund and the
principal policies employed to achieve those objectives. Supplemental
information is set out below concerning the types of securities and other
instruments in which the funds may invest, the investment policies and
strategies that the funds may utilize and certain risks attendant to those
investments, policies and strategies. Smith Barney Fund Management LLC ("SBFM"
or the "manager") serves as investment adviser to each fund.
California Fund and New York Fund
Under normal market conditions, each of the California Fund and the New York
Fund attempts to invest 100% of its assets in a portfolio of investment grade
debt obligations issued by or on behalf of the State of California and the
State of New York, respectively, and other states, territories and possessions
of the United States, the District of Columbia and their respective
authorities, agencies, instrumentalities and political subdivisions the
interest from which debt obligations is, in the opinion of bond counsel to the
issuer, excluded from gross income for Federal income tax purposes and exempt
from California personal income taxes and New York State and New York City
personal income taxes, respectively, are defined as "California Exempt
Obligations" and "New York Exempt Obligations" respectively ("municipal
securities").
The California Fund will operate subject to a fundamental investment policy
providing that, under normal circumstances, the California Fund will invest at
least 80% of its assets, in investment grade California municipal securities
(or other investments with similar economic characteristics). Up to 20% of the
California Fund's total assets may be invested in unrated securities that are
deemed by the manager to be of a quality comparable to investment grade. The
California Fund will not invest in California municipal securities that are
rated lower than investment grade at the time of purchase.
The New York Fund will operate subject to a fundamental investment policy
providing that, under normal circumstances, the fund will invest at least 80%
of its assets (net assets plus any borrowings for investment purposes) in
investment grade New York municipal securities (or other investments with
similar economic characteristics). Up to 20% of the New York Fund's total
assets may be invested in unrated securities that are deemed by the manager to
be of a quality comparable to investment grade. The New York Fund will not
invest in New York municipal securities that are rated lower than investment
grade at the time of purchase.
Securities Rating Criteria. The ratings of Moody's, S&P, Fitch and other
nationally recognized statistical rating organizations ("NRSRO") represent
their opinions as to the quality of the municipal securities that they
undertake to rate; the ratings are relative and subjective and are not absolute
standards of quality. The manager's judgment as to credit quality of a
municipal security, thus, may differ from that suggested by the ratings
published by a rating service. See Appendix for a description of such
organization's ratings. The policies of the funds as to ratings of portfolio
investments will apply only at the time of the purchase of a security, and
neither fund will be required to dispose of a security in the event Moody's,
S&P, Fitch or any NRSRO downgrades its assessment of the credit characteristics
of the security's issuer. In addition, to the extent that ratings change as a
result of changes in rating organizations or their rating systems or as a
result of a corporate restructuring of Moody's, S&P, Fitch or any NRSRO the
manager will attempt to use comparable ratings as standards for each fund's
investments.
Municipal securities rated no lower than Baa, MIG 3 or Prime-1 by Moody's,
BBB, SP-2 or A-1 by S&P, BBB or F-1 by Fitch or have the equivalent rating of
any NRSRO are considered investment grade securities. Municipal securities
rated Baa by Moody's, for example, are considered medium grade obligations that
lack outstanding investment characteristics and have speculative
characteristics as well. Municipal securities rated BBB by S&P are regarded as
having an adequate capacity to pay principal and interest. Municipal securities
rated BBB by Fitch are deemed to be subject to a higher likelihood that their
rating will fall below investment grade than higher rated bonds.
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Maturity of Obligations Held By The Funds. The manager believes that each
fund may offer an attractive investment opportunity for investors seeking a
higher effective tax yield than a tax-exempt money market fund or a tax-exempt
short-term bond fund and less fluctuation in net asset value than a longer term
tax-exempt bond fund. Each fund normally invests in intermediate maturity
securities; the weighted average maturity of each fund's portfolio will
normally be not less than three nor more than 10 years. The maximum remaining
maturity of the securities in which both the California Fund and New York Fund
normally invest will be no greater than 20 years.
Municipal securities. Municipal securities are classified as general
obligation bonds, revenue bonds and notes. General obligation bonds are secured
by a municipal issuer's pledge of its full faith, credit and taxing power for
the payment of principal and interest. Revenue bonds are payable from the
revenue derived from a particular facility or class of facilities or, in some
cases, from the proceeds of a special excise tax or other specific revenue
source, but not from the general taxing power. Notes are short-term obligations
of issuing municipalities or agencies and are sold in anticipation of a bond
sale, collection of taxes or receipt of other revenues. Municipal securities
bear fixed, floating and variable rates of interest, and variations exist in
the security of municipal securities, both within a particular classification
and between classifications.
The yields on, and values of, municipal securities depend on a variety of
factors, including general economic and monetary conditions, conditions in the
municipal securities markets, size of a particular offering, maturity of the
obligation and rating of the issue. Consequently, municipal securities with the
same maturity, coupon and rating may have different yields or values, whereas
obligations of the same maturity and coupon with different ratings may have the
same yield or value.
Issuers of municipal securities may be subject to the provisions of
bankruptcy, insolvency and other laws, such as the Federal Bankruptcy Reform
Act of 1978, affecting the rights and remedies of creditors. In addition, the
obligations of those issuers may become subject to laws enacted in the future
by Congress, state legislatures or referenda extending the time for payment of
principal and/or interest, or imposing other constraints upon enforcement of
the obligations or upon the ability of municipalities to levy taxes. The
possibility also exists that, as a result of litigation or other conditions,
the power or ability of any issuer to pay, when due, the principal of, and
interest on, its obligations may be materially affected.
Private Activity Bonds. Each fund may invest without limit in municipal
securities that are "private activity bonds," as defined in the Internal
Revenue Code of 1986, as amended (the "Code"), which are in most cases revenue
bonds. Private activity bonds generally do not carry the pledge of the credit
of the issuing municipality, but are guaranteed by the corporate entity on
whose behalf they are issued. Interest income on certain types of private
activity bonds issued after August 7, 1986 to finance non-governmental
activities is a specific tax preference item for purposes of the Federal
individual and corporate alternative minimum taxes. Individual and corporate
shareholders may be subject to a Federal alternative minimum tax to the extent
the fund's dividends are derived from interest on these bonds. Dividends
derived from interest income on Exempt Obligations are a "current earnings"
adjustment item for purposes of the Federal corporate alternative minimum tax.
See "Taxes." Private activity bonds held by a fund will be included in the term
Exempt Obligations for purposes of determining compliance with the fund's
policy of investing at least 80% of its total assets in Exempt Obligations.
Related Instruments. The fund may invest without limit in municipal
securities that are repayable out of revenues generated from economically
related projects or facilities or debt obligations whose issuers are located in
the same state. Sizable investments in these obligations could involve an
increased risk to the fund should any of the related projects or facilities
experience financial difficulties.
U.S. Government Securities. Each fund may invest in debt obligations of
varying maturities issued or guaranteed by the United States government, its
agencies or instrumentalities ("U.S. Government Securities"). Direct
obligations of the U.S. Treasury include a variety of securities that differ in
their interest rates, maturities
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and dates of issuance. U.S. Government Securities also include securities
issued or guaranteed by the Federal Housing Administration, Farmers Home Loan
Administration, Export-Import Bank of the United States, Small Business
Administration, Government National Mortgage Association ("GNMA"), General
Services Administration, Central Bank for Cooperatives, Federal Farm Credit
Banks, Federal Home Loan Banks, Federal Home Loan Mortgage Corporation
("FHLMC"), Federal Intermediate Credit Banks, Federal Land Banks, Federal
National Mortgage Association ("FNMA"), Maritime Administration, Tennessee
Valley Authority, District of Columbia Armory Board and Student Loan Marketing
Association. A fund may also invest in instruments that are supported by the
right of the issuer to borrow from the U.S. Treasury and instruments that are
supported by the credit of the instrumentality. Because the U.S. government is
not obligated by law to provide support to an instrumentality it sponsors, a
fund will invest in obligations issued by such an instrumentality only if the
manager determines that the credit risk with respect to the instrumentality
does not make its securities unsuitable for investment by the fund.
Municipal Obligations. Each fund invests principally in municipal
obligations. Municipal obligations are debt obligations issued to obtain funds
for various public purposes, including construction of a wide range of public
facilities, refunding of outstanding obligations, payment of general operating
expenses and extensions of loans to public institutions and facilities. Private
activity bonds issued by or on behalf of public authorities to finance
privately operated facilities are considered to be municipal obligations if the
interest paid on them qualifies as excluded from gross income (but not
necessarily from alternative minimum taxable income) for Federal income tax
purposes in the opinion of bond counsel to the issuer. Municipal obligations
may be issued to finance life care facilities, which are an alternative form of
long-term housing for the elderly that offer residents the independence of a
condominium life-style and, if needed, the comprehensive care of nursing home
services. Bonds to finance these facilities have been issued by various state
industrial development authorities. Because the bonds are secured only by the
revenues of each facility and not by state or local government tax payments,
they are subject to a wide variety of risks, including a drop in occupancy
levels, the difficulty of maintaining adequate financial reserves to secure
estimated actuarial liabilities, the possibility of regulatory cost
restrictions applied to health care delivery and competition from alternative
health care or conventional housing facilities.
Municipal Leases. Each fund may invest without limit in "municipal leases."
Municipal leases may take the form of a lease or an installment purchase
contract issued by state or local government authorities to obtain funds to
acquire a wide variety of equipment and facilities such as fire and sanitation
vehicles, computer equipment and other capital assets. Interest payments on
qualifying municipal leases are exempt from Federal income taxes and state
income taxes within the state of issuance. Although lease obligations do not
constitute general obligations of the municipality for which the municipality's
taxing power is pledged, a lease obligation is ordinarily backed by the
municipality's covenant to budget for, appropriate and make the payments due
under the lease obligation. However, certain lease obligations contain
"non-appropriation" clauses, which provide that the municipality has no
obligation to make lease or installment purchase payments in future years
unless money is appropriated for such purpose on a yearly basis. In addition to
the "non-appropriation" risk, these securities represent a relatively new type
of financing that has not yet developed the depth of marketability associated
with more conventional bonds. Although "non-appropriation" lease obligations
are often secured by the underlying property, disposition of the property in
the event of foreclosure might prove difficult. Each fund may invest in
municipal leases without non-appropriation clauses only when the municipality
is required to continue the lease under all circumstances except bankruptcy.
There is no limitation on the percentage of a fund's assets that may be
invested in municipal lease obligations. In evaluating municipal lease
obligations, the manager will consider such factors as it deems appropriate,
which my include: (a) whether the lease can be canceled; (b) the ability of the
lease obligee to direct the sale of the underlying assets; (c) the general
creditworthiness of the lease obligor; (d) the likelihood that the municipality
will discontinue appropriating funding for the leased property in the event
such property is no longer considered essential by the municipality; (e) the
legal recourse of the lease obligee in the event of such a failure to
appropriate funding; (f) whether the security is backed by a credit enhancement
such as insurance; and (g) any limitations which are imposed on the lease
obligor's ability to utilize substitute property or services other than those
covered by the lease obligation.
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Municipal leases that a fund may acquire will be both rated and unrated.
Rated leases include those rated investment grade at the time of investment or
those issued by issuers whose senior debt is rated investment grade at the time
of investment. Each fund may acquire unrated issues that the manager deems to
be comparable in quality to rated issues in which the fund is authorized to
invest. A determination that an unrated lease obligation is comparable in
quality to a rated lease obligation will be subject to oversight and approval
by the trust's board of trustees.
Municipal leases held by a fund will be considered illiquid securities
unless the trust's board of trustees determines on an ongoing basis that the
leases are readily marketable. An unrated municipal lease with a
non-appropriation risk that is backed by an irrevocable bank letter of credit
or an insurance policy issued by a bank or insurer deemed by the manager to be
of high quality and minimal credit risk, will not be deemed to be illiquid
solely because the underlying municipal lease is unrated, if the manager
determines that the lease is readily marketable because it is backed by the
letter of credit or insurance policy.
Zero Coupon Securities. Each fund may invest up to 10% of its assets in
zero coupon municipal securities. Zero coupon municipal securities are
generally divided into two categories: pure zero obligations, which are those
that pay no interest for their entire life and zero/fixed obligations, which
pay no interest for some initial period and thereafter pay interest currently.
In the case of a pure zero obligation, the failure to pay interest currently
may result from the obligation having no stated interest rate, in which case
the obligation pays only principal at maturity and is issued at a discount from
its stated principal amount. A pure zero obligation may, in the alternative,
carry a stated interest rate, but provide that no interest is payable until
maturity. The value to the investor of a zero coupon municipal securities
consists of the economic accretion either of the difference between the
purchase price and the nominal principal amount (if no interest is stated to
accrue) or of accrued, unpaid interest during the zero coupon municipal
securities life or payment deferral period.
Custodial Receipts. Each fund may acquire custodial receipts or
certificates under-written by securities dealers or banks that evidence
ownership of future interest payments, principal payments, or both, on certain
municipal securities. The underwriter of these certificates or receipts
typically purchases municipal securities and deposits the obligations in an
irrevocable trust or custodial account with a custodian bank, which then issues
receipts or certificates evidencing ownership of the periodic unmatured coupon
payments and the final principal payment on the obligations. Custodial receipts
evidencing specific coupon or principal payments have the same general
attributes as zero coupon municipal securities described above. Although under
the terms of a custodial receipt a fund would typically be authorized to assert
its rights directly against the issuer of the underlying obligations, the fund
could be required to assert through the custodian bank those rights as may
exist against the underlying issuer. Thus, if the underlying issuer fails to
pay principal and/or interest when due, the fund may be subject to delays,
expenses and risks that are greater than those that would have been involved if
the fund had purchased a direct obligation of the issuer. In addition, if the
trust or custodial account in which the underlying security has been deposited
is determined to be an association taxable as a corporation, instead of a
non-taxable entity, the yield on the underlying security would be reduced in
recognition of any taxes paid.
Municipal Securities Components. Each fund may invest in municipal
securities, the interest rate on which has been divided by the issuer into two
different and variable components, which together result in a fixed interest
rate. Typically, the first of the components (the "Auction Component") pays an
interest rate that is reset periodically through an auction process; whereas
the second of the components (the "Residual Component") pays a residual
interest rate based on the difference between the total interest paid by the
issuer on the municipal securities and the auction rate paid on the Auction
Component. Each fund may purchase both Auction and Residual Components.
Because the interest rate paid to holders of Residual Components is
generally determined by subtracting from a fixed amount the interest rate paid
to the holders of Auction Components, the interest rate paid to Residual
Component holders will decrease as the Auction Component's rate increases and
increase as the Auction Component's rate decreases. Moreover, the magnitude of
the increases and decreases in market value of
5
Residual Components may be larger than comparable changes in the market value
of an equal principal amount of a fixed rate municipal securities having
similar credit quality, redemption provisions and maturity.
Floating and Variable Rate Instruments. Each fund may purchase floating and
variable rate demand notes and bonds, which are municipal securities normally
having a stated maturity in excess of one year, but which permit their holder
to demand payment of principal at any time, or at specified intervals. The
maturity of a floating or variable rate demand note or bond will be deemed
shortened by virtue of a demand feature.
The issuer of floating and variable rate demand obligations normally has a
corresponding right, after a given period, to prepay at its discretion the
outstanding principal amount of the obligations plus accrued interest upon a
specified number of days' notice to the holders of these obligations. The
interest rate on a floating rate demand obligation is based on a known lending
rate, such as a bank's prime rate, and is adjusted automatically each time that
rate is adjusted. The interest rate on a variable rate demand obligation is
adjusted automatically at specified intervals. Frequently, floating and
variable rate obligations are secured by letters of credit or other credit
support arrangements provided by banks. Use of letters of credit or other
credit support arrangements will not adversely affect the tax-exempt status of
these obligations. Because they are direct lending arrangements between the
lender and borrower, floating and variable rate obligations generally will not
be traded. In addition, generally no secondary market exists for these
obligations, although their holders may demand payment at face value. For these
reasons, when floating and variable rate obligations held by a fund are not
secured by letters of credit or other credit support arrangements, the fund's
rights to demand payment is dependent on the ability of the borrower to pay
principal and interest on demand. The manager, on behalf of the fund, will
consider on an ongoing basis the creditworthiness of the issuers of floating
and variable rate demand obligations held by the fund.
Participation Interests. Each fund may purchase from financial institutions
tax-exempt participation interests in municipal securities. A participation
interest gives the fund an undivided interest in the municipal securities in
the proportion that the fund's participation interest bears to the total amount
of the municipal securities. These instruments may have floating or variable
rates of interest. If the participation interest is unrated, it will be backed
by an irrevocable letter of credit or guarantee of a bank that the trust's
board of trustees has determined meets certain quality standards, or the
payment obligation otherwise will be collateralized by U.S. government
securities. The funds will have the right, with respect to certain
participation interests, to demand payment, on a specified number of days'
notice, for all or any part of the fund's interest in the municipal securities,
plus accrued interest. Each fund intends to exercise its right with respect to
these instruments to demand payment only upon a default under the terms of the
municipal securities or to maintain or improve the quality of its investment
portfolio.
Taxable Investments. Under normal conditions, each fund may hold up to 20%
of its net assets in cash or money market instruments, including taxable money
market instruments (collectively, "Taxable Investments"). In addition, the
manager believes that if market conditions warrant, a fund may take a temporary
defensive posture and invest without limitation in short-term municipal
securities and Taxable Investments. To the extent, a fund holds Taxable
Investments and, under certain market conditions, certain floating and variable
rate demand obligations or Auction Components, the fund may not achieve its
investment objective.
Money market instruments in which the funds may invest include: U.S.
Government Securities; tax-exempt notes of municipal issuers rated, at the time
of purchase, no lower than MIG 1 by Moody's, SP-1 by S&P of F-1 by Fitch, have
the equivalent rating by any NRSRO or, if not rated, by issuers having
outstanding, unsecured debt then rated within the three highest rating
categories; bank obligations (including certificates of deposit, time deposits
and bankers acceptances of domestic banks, domestic savings and loan
associations and similar institutions); commercial paper rated no lower than
P-1 by Moody's, A-1 by S&P of F-1 by Fitch or the equivalent from any NRSRO or,
if unrated of an issuer having an outstanding, unsecured debt issue then rated
within the three highest rating categories; and repurchase agreements. At no
time will the funds' investments in bank obligations, including time deposits,
exceed 25% of the value of each fund's assets.
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U.S. Government Securities in which the funds may invest include direct
obligations of the United States and obligations issued by U.S. government
agencies and instrumentalities. Included among direct obligations of the United
States are Treasury Bills, Treasury Notes and Treasury Bonds, which differ
principally in terms of their maturities. Included among the securities issued
by U.S. government agencies and instrumentalities are: securities that are
supported by the full faith and credit of the United States (such as GNMA
certificates); securities that are supported by the right of the issuer to
borrow from the United States Treasury (such as securities of Federal Home Loan
Banks); and securities that are supported by the credit of the instrumentality
(such as FNMA and FHLMC bonds).
Investment Techniques
The funds may employ, among others, the investment techniques described
below, which may give rise to taxable income:
Financial Futures and Options Transactions. To hedge against a decline in
the value of municipal securities it owns or an increase in the price of
municipal securities it proposes to purchase, each fund may enter into
financial futures contracts and invest in options on financial futures
contracts that are traded on a domestic exchange or board of trade. The futures
contracts or options on futures contracts that may be entered into by a fund
will be restricted to those that are either based on an index of municipal
securities or relate to debt securities the prices of which are anticipated by
the manager to correlate with the prices of the municipal securities owned or
to be purchased by a fund.
In entering into a financial futures contract, a fund will be required to
deposit with the broker through which it undertakes the transaction an amount
of cash or cash equivalents equal to approximately 5% of the contract amount.
This amount, which is known as "initial margin," is subject to change by the
exchange or board of trade on which the contract is traded, and members of the
exchange or board of trade may charge a higher amount. Initial margin is in the
nature of a performance bond or good faith deposit on the contract that is
returned to a fund upon termination of the futures contract, assuming all
contractual obligations have been satisfied. In accordance with a process known
as "marking-to-market," subsequent payments, known as "variation margin," to
and from the broker will be made daily as the price of the index or securities
underlying the futures contract fluctuates, making the long and short positions
in the futures contract more or less valuable. At any time prior to the
expiration of a futures contract, a fund may elect to close the position by
taking an opposite position, which will operate to terminate the fund's
existing position in the contract.
A financial futures contract provides for the future sale by one party and
the purchase by the other party of a certain amount of a specified property at
a specified price, date, time and place. Unlike the direct investment in a
futures contract, an option on a financial futures contract gives the purchaser
the right, in return for the premium paid, to assume a position in the
financial futures contract at a specified exercise price any time prior to the
expiration date of the option. Upon exercise of an option, the delivery of the
futures position by the writer of the option to the holder of the option will
be accompanied by delivery of the accumulated balance in the writer's futures
margin account, which represents the amount by which the market price of the
futures contract exceeds, in the case of a call, or is less than, in the case
of a put, the exercise price of the option on the futures contract. The
potential loss related to the purchase of an option on financial futures
contracts is limited to the premium paid for the option (plus transaction
costs). The value of the option may change daily and that change would be
reflected in the net asset value of the fund.
Regulations of the Commodity Futures Trading Commission (the "CFTC")
applicable to each fund require that a fund's transactions in financial futures
contracts and options on financial futures contracts be engaged in for bona
fide hedging purposes, or if a fund enters into futures contracts for
speculative purposes, that the aggregate initial margin deposits and premiums
paid by the fund will not exceed 5% of the market value of its assets (or such
other amount permitted by the CFTC). In addition, each fund will, with respect
to its purchases of financial futures contracts, establish a segregated account
on the fund's books consisting of cash or cash
7
equivalents in an amount equal to the total market value of the futures
contracts, less the amount of initial margin on deposit for the contracts. Each
fund's ability to trade in financial futures contracts and options on financial
futures contracts may be affected to some extent by the requirements of the
Code, applicable to a regulated investment company that are described below
under "Taxes."
Each fund intends to enter into financial futures contracts and options on
financial futures contracts that are traded on a domestic exchange or board of
trade only if an active market will exist for them at any particular time. If
closing a futures position in anticipation of adverse price movements is not
possible, each fund would be required to make daily cash payments of variation
margin. In those circumstances, an increase in the value of the portion of a
fund's investments being hedged, if any, may offset partially or completely
losses on the futures contract. No assurance can be given, however, that the
price of the securities being hedged will correlate with the price movements in
a futures contract and, thus, provide an offset to losses on the futures
contract or option on the futures contract. In addition, in light of the risk
of an imperfect correlation between securities held by a fund that are the
subject of a hedging transaction and the futures or options used as a hedging
device, the hedge may not be fully effective because, for example, losses on
the securities held by a fund may be in excess of gains on the futures contract
or losses on the futures contract may be in excess of gains on the securities
held by the fund that were the subject of the hedge. In an effort to compensate
for the imperfect correlation of movements in the price of the securities being
hedged and movements in the price of futures contracts, each fund may enter
into financial futures contracts or options on financial futures contracts in a
greater or lesser dollar amount than the dollar amount of the securities being
hedged if the historical volatility of the futures contract has been less or
greater than that of the securities. This "over hedging" or "under hedging" may
adversely affect a fund's net investment results if market movements are not as
anticipated when the hedge is established.
If a fund has hedged against the possibility of an increase in interest
rates adversely affecting the value of securities it holds and rates decrease
instead, the fund will lose part or all of the benefit of the increased value
of securities that it has hedged because it will have offsetting losses in its
futures or options positions. In addition, in those situations, if a fund has
insufficient cash, it may have to sell securities to meet daily variation
margin requirements on the futures contracts at a time when it may be
disadvantageous to do so. These sales of securities may, but will not
necessarily, be at increased prices that reflect the decline in interest rates.
When-Issued Securities and Delayed-Delivery Transactions. Each fund may
purchase municipal securities on a "when-issued" basis or for delayed delivery
(i.e., payment or delivery occur beyond the normal settlement date at a stated
price and yield). Each fund does not intend to engage in these transactions for
speculative purposes, but only in furtherance of its investment goal. These
transactions occur when securities are purchased or sold by a fund with payment
and delivery taking place in the future to secure what is considered an
advantageous yield and price to a fund at the time of entering into the
transaction. The payment obligation and the interest rate that will be received
on when-issued securities or delayed delivery are fixed at the time the buyer
enters into the commitment. Due to fluctuations in the value of securities
purchased or sold on a when-issued or delayed- delivery basis, the prices
obtained on such securities may be higher or lower than the prices available in
the market on the dates when the investments are actually delivered to the
buyers.
When a fund agrees to purchase when-issued or delayed-delivery securities,
the fund will set aside cash or liquid securities equal to the amount of the
commitment in a segregated account on the fund's books. Normally, a fund will
set aside portfolio securities to satisfy a purchase commitment, and in such a
case a fund may be required subsequently to place additional assets in the
segregated account on the fund's books in order to ensure that the value of the
account remains equal to the amount of the fund's commitment. The assets
contained in the segregated account will be marked-to-market daily. It may be
expected that a fund's net assets will fluctuate to a greater degree when it
sets aside portfolio securities to cover such purchase commitments than when it
sets aside cash. When a fund engages in when-issued or delayed-delivery
transactions, it relies on the other party to consummate the trade. Failure of
the seller to do so may result in a fund incurring a loss or missing an
opportunity to obtain a price considered to be advantageous.
8
Stand-by Commitments. Each fund may acquire "stand-by commitments" with
respect to municipal securities held in its portfolio. Under a stand-by
commitment, a broker, dealer or bank is obligated to repurchase at a fund's
option specified securities at a specified price and, in this way, a stand-by
commitment, therefore, is subject to the ability of the seller to make payment
on demand. A fund will acquire stand-by commitments solely to facilitate
portfolio liquidity and does not intend to exercise the rights afforded by the
commitments for trading purposes. Each fund anticipates that stand-by
commitments will be available from brokers, dealers and banks without the
payment of any direct or indirect consideration. Each fund may pay for stand-by
commitments if payment is deemed necessary, thus increasing to a degree the
cost of the underlying municipal securities and similarly decreasing the
security's yield to the funds.
Illiquid Securities. Each fund may invest up to 10% of its net assets in
illiquid securities, which term includes securities subject to contractual or
other restrictions on resale and other instruments that lack readily available
markets. In addition, up to 5% of the value of each fund's assets may be
invested in securities of entities that have been in continuous operation for
fewer than three years.
Repurchase Agreements. Each fund may agree to purchase securities from a
bank or recognized securities dealer and simultaneously commit to resell the
securities to the bank or dealer at an agreed-upon date and price reflecting a
market rate of interest unrelated to the coupon rate or maturity of the
purchased securities ("repurchase agreements"). A fund would maintain custody
of the underlying securities prior to their repurchase; thus, the obligation of
the bank or dealer to pay the repurchase price on the date agreed to would be,
in effect, secured by such securities. If the value of such securities were
less than the repurchase price, plus interest, the other party to the agreement
would be required to provide additional collateral so that at all times the
collateral is at least 102% of the repurchase price plus accrued interest.
Default by or bankruptcy of a seller would expose a fund to possible loss
because of adverse market action, expenses and/or delays in connection with the
disposition of the underlying obligations. The financial institutions with
which a fund may enter into repurchase agreements will be banks and non-bank
dealers of U.S. Government securities that are on the Federal Reserve Bank of
New York's list of reporting dealers, if a fund's manager deems such banks and
non-bank dealers creditworthy. The manager will continue to monitor
creditworthiness of the seller under a repurchase agreement, and will require
the seller to maintain during the term of the agreement the value of the
securities subject to the agreement to equal at least 102% of the repurchase
price (including accrued interest). In addition, the manager will require that
the value of this collateral, after transaction costs (including loss of
interest) reasonably expected to be incurred on a default, be equal to 102% or
greater than the repurchase price (including accrued premium) provided in the
repurchase agreement or the daily amortization of the difference between the
purchase price and the repurchase price specified in the repurchase agreement.
The manager will mark-to-market daily the value of the securities. Repurchase
agreements are considered to be loans by a fund under the Investment Company
Act of 1940, as amended (the "1940 Act").
9
RISK FACTORS
Investments in Specified Private Activity Bonds
Under current Federal income tax law, (a) interest on tax-exempt municipal
securities issued after August 7, 1986 that are "specified private activity
bonds" under the Code and the proportionate share of any exempt-interest
dividend paid by a regulated investment company which receives interest from
such specified private activity bonds, will be treated as an item of tax
preference for purposes of the Federal alternative minimum tax imposed on
individuals and corporations (the "AMT"), though for regular Federal income tax
purposes such interest will remain fully tax-exempt, and (b) interest on all
tax-exempt obligations will be included in "adjusted current earnings" of
corporations for AMT purposes. Specified private activity bonds referred to in
clause (1) in the preceding sentence ("AMT-Subject Bonds") have provided, and
may continue to provide, somewhat higher yields than other comparable municipal
securities.
Investors should consider that, in most instances, no state, municipality or
other governmental unit with taxing power will be obligated with respect to
AMT-Subject Bonds. AMT-Subject Bonds are in most cases revenue bonds and do not
generally have the pledge of the credit or the taxing power, if any, of the
issuer of such bonds. AMT-Subject Bonds are generally limited obligations of
the issuer supported by payments from private business entities and not by the
full faith and credit of a state or any governmental subdivision. Typically the
obligation of the issuer of an AMT-Subject Bond is to make payments to bond
holders only out of and to the extent of, payments made by the private business
entity for whose benefit the AMT-Subject Bonds were issued. Payment of the
principal and interest on such revenue bonds depends solely on the ability of
the user of the facilities financed by the bonds to meet its financial
obligations and the pledge, if any, of real and personal property so financed
as security for such payment. It is not possible to provide specific detail on
each of these obligations in which a fund's assets may be invested.
Risk of Concentration In a Single State
The primary purpose of investing in a portfolio of a single state's
municipal securities is the special tax treatment accorded the state's resident
individual investors. However, payment of interest and preservation of
principal is dependent upon the continuing ability of the state's issuers
and/or obligors on state, municipal and public authority debt obligations to
meet their obligations thereunder. Investors should be aware of certain factors
that might affect the financial condition of issuers of municipal securities,
consider the greater risk of the concentration of the fund versus the safety
that comes with a less concentrated investment portfolio and compare yields
available in portfolios of state issues with those of more diversified
portfolios, including out-of-state issues, before making an investment decision.
Municipal securities in which each fund's assets are invested may include
debt obligations of the municipalities and other subdivisions of the state
issued to obtain funds for various public purposes, including the construction
of a wide range of public facilities such as airports, bridges, highways,
schools, streets and water and sewer works. Other purposes for which municipal
securities may be issued include the obtaining of funds to lend to public or
private institutions for the construction of facilities such as educational,
hospital, housing, and solid waste disposal facilities. The latter, including
most AMT-subject bonds, are generally payable from private sources which, in
varying degrees, may depend on local economic conditions, but are not
necessarily affected by the ability of the state and its political subdivisions
to pay their debts. It is not possible to provide specific details on each of
these obligations in which fund assets may be invested. However, all such
securities, the payment of which is not a general obligation of an issuer
having general taxing power, must satisfy, at the time of an acquisition by the
fund, the minimum rating(s). See "Appendix" for a description of ratings and
rating criteria. Some municipal securities may be rated based on a "moral
obligation" contract, which allows the municipality to terminate its obligation
by deciding not to make an appropriation. Generally, no legal remedy is
available against the municipality that is a party to the "moral obligation"
contract in the event of such non-appropriation.
Municipal Market Volatility. Municipal securities can be affected
significantly by political changes as well as uncertainties in the municipal
market related to taxation, legislative changes, or the rights of municipal
10
security holders. Because many municipal securities are issued to finance
similar projects, especially those relating to education, health care,
transportation and utilities, conditions in those sectors can affect the
overall municipal market. In addition, changes in the financial condition of an
individual municipal insurer can affect the overall municipal market.
Interest Rate Changes. Municipal securities have varying levels of
sensitivity to changes in interest rates. In general, the price of a debt
security can fall when interest rates rise and can rise when interest rates
fall. securities with longer maturities can be more sensitive to interest rate
changes. In other words, the longer the maturity of a security, the greater the
impact a change in interest rates could have on the security's price. In
addition, short-term and long-term interest rates do not necessarily move in
the same amount or the same direction. Short-term securities tend to react to
changes in short-term interest rates, and long-term securities tend to react to
changes in long-term interest rates.
Issuer-Specific Changes. Changes in the financial condition of an issuer,
changes in specific economic or political conditions that affect a particular
type of security or issuer, and changes in general economic or political
conditions can affect the credit quality or value of an issuer's securities.
Lower-quality debt securities (those of less than investment-grade quality)
tend to be more sensitive to these changes than higher-quality debt securities.
These types of changes also can affect entities providing credit support or a
maturity-shortening structure. Municipal securities backed by current or
anticipated revenues from a specific project or specific assets can be affected
negatively by the discontinuance of the taxation supporting the project or
assets or the inability to collect revenues from the project or from the
assets. If the Internal Revenue Service determines an issuer of a municipal
security has not complied with applicable tax requirements, or the structure of
a security fails to function as intended, interest from the security could
become taxable or the security could decline significantly in value.
Municipal Market Disruption Risk. The value of municipal securities may be
affected by uncertainties in the municipal market related to legislation or
litigation involving the taxation of municipal securities or the rights of
municipal securities holders in the event of a bankruptcy. Proposals to
restrict or eliminate the federal income tax exemption for interest on
municipal securities are introduced before Congress from time to time.
Proposals also may be introduced before the respective state legislature that
would affect the state tax treatment of a municipal fund's distributions. If
such proposals were enacted, the availability of municipal securities and the
value of a municipal fund's holdings would be affected and the trustees would
reevaluate each fund's investment objectives and policies. Municipal
bankruptcies are relatively rare, and certain provisions of the U.S. Bankruptcy
Code governing such bankruptcies are unclear and remain untested. Further, the
application of state law to municipal issuers could produce varying results
among the states or among municipal securities issuers within a state. These
legal uncertainties could affect the municipal securities market generally,
certain specific segments of the market, or the relative credit quality of
particular securities. Any of these effects could have a significant impact on
the prices of some or all of the municipal securities held by a fund.
Risks Inherent in an Investment in Different Types of Municipal Securities
General Obligation Bonds. General obligation bonds are backed by the
issuer's pledge of its full faith, credit and taxing power for the payment of
principal and interest. However, the taxing power of any governmental entity
may be limited by provisions of state constitutions or laws and an entity's
credit will depend on many factors. Some such factors are the entity's tax
base, the extent to which the entity relies on federal or state aid, and other
factors which are beyond the entity's control.
Industrial Development Revenue Bonds ("IDRs"). IDRs including pollution
control revenue bonds, are tax-exempt securities issued by states,
municipalities, public authorities or similar entities to finance the cost of
acquiring, constructing or improving various projects. These projects are
usually operated by corporate entities. IDRs are not general obligations of
governmental entities backed by their taxing power. Issuers are only
11
obligated to pay amounts due on the IDRs to the extent that funds are available
from the unexpended proceeds of the IDRs or receipts or revenues of the issuer.
Payment of IDRs is solely dependent upon the creditworthiness of the corporate
operator of the project or corporate guarantor. Such corporate operators or
guarantors that are industrial companies may be affected by many factors, which
may have an adverse impact on the credit quality of the particular company or
industry.
Hospital and Health Care Facility Bonds. The ability of hospitals and other
health care facilities to meet their obligations with respect to revenue bonds
issued on their behalf is dependent on various factors. Some such factors are
the level of payments received from private third-party payors and government
programs and the cost of providing health care services. There can be no
assurance that payments under governmental programs will remain at levels
comparable to present levels or will be sufficient to cover the costs
associated with their bonds. It also may be necessary for a hospital or other
health care facility to incur substantial capital expenditures or increased
operating expenses to effect changes in its facilities, equipment, personnel
and services. Hospitals and other health care facilities are additionally
subject to claims and legal actions by patients and others in the ordinary
course of business. There can be no assurance that a claim will not exceed the
insurance coverage of a health care facility or that insurance coverage will be
available to a facility.
Single Family and Multi-Family Housing Bonds. Multi-family housing revenue
bonds and single family mortgage revenue bonds are state and local housing
issues that have been issued to provide financing for various housing projects.
Multi-family housing revenue bonds are payable primarily from mortgage loans to
housing projects for low to moderate income families. Single-family mortgage
revenue bonds are issued for the purpose of acquiring notes secured by
mortgages on residences. The ability of housing issuers to make debt service
payments on their obligations may be affected by various economic and
non-economic factors. Such factors include: occupancy levels, adequate rental
income in multi-family projects, the rate of default on mortgage loans
underlying single family issues and the ability of mortgage insurers to pay
claims. All single-family mortgage revenue bonds and certain multi-family
housing revenue bonds are prepayable over the life of the underlying mortgage
or mortgage pool. Therefore, the average life of housing obligations cannot be
determined. However, the average life of these obligations will ordinarily be
less than their stated maturities. Mortgage loans are frequently partially or
completely prepaid prior to their final stated maturities.
Power Facility Bonds. The ability of utilities to meet their obligations
with respect to bonds they issue is dependent on various factors. These factors
include the rates they may charge their customers, the demand for a utility's
services and the cost of providing those services. Utilities are also subject
to extensive regulations relating to the rates, which they may charge
customers. Utilities can experience regulatory, political and consumer
resistance to rate increases. Utilities engaged in long-term capital projects
are especially sensitive to regulatory lags in granting rate increases.
Utilities are additionally subject to increased costs due to governmental
environmental regulation and decreased profits due to increasing competition.
Any difficulty in obtaining timely and adequate rate increases could adversely
affect a utility's results of operations. The manager cannot predict at this
time the ultimate effect of such factors on the ability of any issuers to meet
their obligations with respect to bonds.
Water and Sewer Revenue Bonds. Water and sewer bonds are generally payable
from user fees. The ability of state and local water and sewer authorities to
meet their obligations may be affected by a number of factors. Some such
factors are the failure of municipalities to utilize fully the facilities
constructed by these authorities, declines in revenue from user charges, rising
construction and maintenance costs, impact of environmental requirements, the
difficulty of obtaining or discovering new supplies of fresh water, the effect
of conservation programs, the impact of "no growth" zoning ordinances and the
continued availability of federal and state financial assistance and of
municipal bond insurance for future bond issues.
University and College Bonds. The ability of universities and colleges to
meet their obligations is dependent upon various factors. Some of these
factors, of which an investor should be aware, are the size and diversity of
their sources of revenues, enrollment, reputation, management expertise, the
availability and restrictions on the use of endowments and other funds, the
quality and maintenance costs of campus facilities.
12
Also, in the case of public institutions, the financial condition of the
relevant state or other governmental entity and its policies with respect to
education may affect an institution's ability to make payments on its own.
Lease Rental Bonds. Lease rental bonds are predominantly issued by
governmental authorities that have no taxing power or other means of directly
raising revenues. Rather, the authorities are financing vehicles created solely
for the construction of buildings or the purchase of equipment that will be
used by a state or local government. Thus, the bonds are subject to the ability
and willingness of the lessee government to meet its lease rental payments,
which include debt services on the bonds. Lease rental bonds are subject to the
risk that the lessee government is not legally obligated to budget and
appropriate for the rental payments beyond the current fiscal year. These bonds
are also subject to the risk of abatement in many states as rental bonds cease
in the event that damage, destruction or condemnation of the project prevents
its use by the lessee. Also, in the event of default by the lessee government,
there may be significant legal and/or practical difficulties involved in the
reletting or sale of the project.
Capital Improvement Facility Bonds. Capital improvement bonds are bonds
issued to provide funds to assist political subdivisions or agencies of a state
through acquisition of the underlying debt of a state or local political
subdivision or agency. The risks of an investment in such bonds include the
risk of possible prepayment or failure of payment of proceeds on and default of
the underlying debt.
Solid Waste Disposal Bonds. Bonds issued for solid waste disposal
facilities are generally payable from tipping fees and from revenues that may
be earned by the facility on the sale of electrical energy generated in the
combustion of waste products. The ability of solid waste disposal facilities to
meet their obligations depends upon the continued use of the facility, the
successful and efficient operation of the facility and, in the case of
waste-to-energy facilities, the continued ability of the facility to generate
electricity on a commercial basis. Also, increasing environmental regulation on
the federal, state and local level has a significant impact on waste disposal
facilities. While regulation requires more waste producers to use waste
disposal facilities, it also imposes significant costs on the facilities.
Moral Obligation Bonds. If an issuer of moral obligation bonds is unable to
meet its obligations, the repayment of the bonds becomes a moral commitment but
not a legal obligation of the state or municipality in question. Thus, such a
commitment generally requires appropriation by the state legislature and
accordingly does not constitute a legally enforceable obligation or debt of the
state. The agencies or authorities generally have no taxing power.
Refunded Bonds. Refunded bonds are typically secured by direct obligations
of the U.S. Government, or in some cases obligations guaranteed by the U.S.
Government, placed in an escrow account maintained by an independent trustee
until maturity or a predetermined redemption date. These obligations are
generally noncallable prior to maturity or the predetermined redemption date.
In a few isolated instances to date, however, bonds which were thought to be
escrowed to maturity have been called for redemption prior to maturity.
Airport, Port and Highway Revenue Bonds. Certain facility revenue bonds are
payable from and secured by the revenue from the ownership and operation of
particular facilities, such as airports, highways and port authorities. Airport
operating income may be affected by the ability of airlines to meet their
obligations under the agreements with airports. Similarly, payment on bonds
related to other facilities is dependent on revenues from the projects, such as
use fees from ports, tolls on turnpikes and bridges and rents from buildings.
Therefore, payment may be adversely affected by reduction in revenues due to
such factors and increased cost of maintenance or decreased use of a facility.
The manager cannot predict what effect conditions may have on revenues, which
are dependent for payment on these bonds.
Special Tax Bonds. Special tax bonds are payable from and secured by the
revenues derived by a municipality from a particular tax. Examples of such
special taxes are a tax on the rental of a hotel room, on the purchase of food
and beverages, on the rental of automobiles or on the consumption of liquor.
Special tax bonds
13
are not secured by the general tax revenues of the municipality, and they do
not represent general obligations of the municipality. Therefore, payment on
special tax bonds may be adversely affected by a reduction in revenues realized
from the underlying special tax. Also, should spending on the particular goods
or services that are subject to the special tax decline, the municipality may
be under no obligation to increase the rate of the special tax to ensure that
sufficient revenues are raised from the shrinking taxable base.
Tax Allocation Bonds. Tax allocation bonds are typically secured by
incremental tax revenues collected on property within the areas where
redevelopment projects, financed by bond proceeds are located. Such payments
are expected to be made from projected increases in tax revenues derived from
higher assessed values of property resulting from development in the particular
project area and not from an increase in tax rates. Special risk considerations
include: reduction of, or a less than anticipated increase in, taxable values
of property in the project area; successful appeals by property owners of
assessed valuations; substantial delinquencies in the payment of property
taxes; or imposition of any constitutional or legislative property tax rate
decrease.
Tobacco Settlement Revenue Bonds. Tobacco settlement revenue bonds are
secured by a state or local government's proportionate share in the Master
Settlement Agreement ("MSA"). The MSA is an agreement, reached out of court in
November 1998 between the attorneys general of 46 states (Florida, Minnesota,
Mississippi and Texas all settled independently) and six other U.S.
jurisdictions (including the District of Columbia, Puerto Rico and Guam), and
the four largest U.S. tobacco manufacturers (Philip Morris, RJ Reynolds, Brown
& Williamson, and Lorillard). Subsequently 34 smaller tobacco manufacturers
signed on to the MSA, bringing the current combined market share of
participating tobacco manufacturers to approximately 99%. The MSA basically
provides for payments annually by the manufacturers to the states and
jurisdictions in perpetuity, in exchange for releasing all claims against the
manufacturers and a pledge of no further litigation. The MSA established a base
payment schedule and a formula for adjusting payments each year. Manufacturers
pay into a master escrow trust based on their market share, and each state
receives a fixed percentage of the payment as set forth in the MSA. Annual
payments are highly dependent on annual domestic cigarette shipments and
inflation, as well as several other factors. As a result, payments made by
tobacco manufacturers could be negatively impacted by a decrease in tobacco
consumption over time. A market share loss by the MSA companies to non-MSA
participating manufacturers would also cause a downward adjustment in the
payment amounts. A participating manufacturer filing for bankruptcy could cause
delays or reductions in bond payments.
Certain Tobacco settlement revenue bonds are issued with "turbo" redemption
features. Under the turbo structure, all available excess revenues are applied
as an early redemption to the designated first turbo maturity until it is
completely repaid, and then to the next turbo maturity until paid in full, and
so on. The result is that the returned principal creates an average maturity
that could be much shorter than the legal final maturity.
Transit Authority Bonds. Mass transit is generally not self-supporting from
fare revenues. Therefore, additional financial resources must be made available
to ensure operation of mass transit systems as well as the timely payment of
debt service. Often such financial resources include federal and state
subsidies, lease rentals paid by funds of the state or local government or a
pledge of a special tax. If fare revenues or the additional financial resources
do not increase appropriately to pay for rising operating expenses, the ability
of the issuer to adequately service the debt may be adversely affected.
Convention Facility Bonds. Bonds in the convention facilities category
include special limited obligation securities issued to finance convention and
sports facilities payable from rental payments and annual governmental
appropriations. The governmental agency is not obligated to make payments in
any year in which the monies have not been appropriated to make such payments.
In addition, these facilities are limited use facilities that may not be used
for purposes other than as convention centers or sports facilities.
Correctional Facility Bonds. Bonds in the correctional facilities category
include special limited obligation securities issued to construct, rehabilitate
and purchase correctional facilities payable from governmental rental payments
and/or appropriations.
14
RISK FACTORS--INVESTING IN STATE MUNICIPAL OBLIGATIONS
The following summaries are included for the purpose of providing certain
information regarding the economic climate and financial condition of the State
of California, the State of New York, Puerto Rico, the U.S. Virgin Islands and
Guam are based primarily on information from official statements made available
in connection with the issuance of certain securities and other documents and
sources and does not purport to be complete. Neither the trust nor the manager
have undertaken to verify independently such information and neither the trust
nor the manager assume responsibility for the accuracy of such information.
These summaries do not provide information regarding most securities in which a
fund is permitted to invest and in particular do not provide specific
information on the issuers or types of municipal securities in which the fund
invests or the private business entities whose obligations support the payments
on AMT-Subject bonds in which a fund will invest. Therefore, the general risk
factors as to the credit of the state or its political subdivisions discussed
herein may not be relevant to a fund. Although revenue obligations of a state
or its political subdivisions may be payable from a specific project or source,
there can be no assurance that future economic difficulties and the resulting
impact on state and local government finances will not adversely affect the
market value of a fund or the ability of the respective obligors to make timely
payments of principal and interest on such obligations. In addition, a number
of factors may adversely affect the ability of the issuers of municipal
securities to repay their borrowings that are unrelated to the financial or
economic condition of a state, and that, in some cases, are beyond their
control. Furthermore, issuers of municipal securities are generally not
required to provide ongoing information about their finances and operations to
holders of their debt obligations, although a number of cities, counties and
other issuers prepare annual reports.
Following is a brief summary of select state factors affecting each fund. It
does not represent a complete analysis of every material fact effecting each
state's debt obligations. Each summary is based on a sampling of offering
statements for the debt of each state's issuers, data from independent rating
agencies, and/or data reported in other public sources.
California Fund Risk Factors
The following information is a brief summary of factors affecting the
economy of the State of California and does not purport to be a complete
description of such factors. Other factors will affect issuers. The summary is
based primarily upon one or more publicly available offering statements
relating to debt offerings of California issuers. The fund has not
independently verified the information. The creditworthiness of obligations
issued by local California issuers may be unrelated to the creditworthiness of
obligations issued by the State of California, and there is no responsibility
on the part of the State of California to make payments on such local
obligations.
General Economic Conditions
The economy of the State of California (sometimes referred to herein as the
"State") is the largest among the 50 states and one of the largest in the
world. This diversified economy has major components in high technology, trade,
entertainment, agriculture, tourism, construction and services. Certain of the
State's significant industries are sensitive to trade disruptions in their
export markets and the State's rate of economic growth, therefore, could be
adversely affected by any such disruption.
A significant downturn in U.S. stock market prices could adversely affect
California's economy by reducing household spending and business investment,
particularly in the important high technology sector. Moreover, a large and
increasing share of the State's General Fund revenue in the form of income and
capital gains taxes is directly related to, and would be adversely affected by,
a significant downturn in the performance of the stock markets.
Since early 2001, the State has faced severe financial challenges, which may
continue for several years. The State has experienced an economic recession in
2001 and a sluggish recovery in 2002 (with greatest impacts in
15
the high technology, internet, and telecommunications sectors, especially in
Northern California); weakened exports; and most particularly, large stock
market declines (with attendant declines in stock option values and capital
gains realizations). These adverse fiscal and economic factors have resulted in
a serious erosion of General Fund tax revenues. The three largest General Fund
tax sources (personal income, sales and use, and corporate taxes) totaled $72.8
billion in fiscal year 2000-01; they were an estimated $59.7 billion in
2001-02, and are projected to be $61.7 billion in 2002-03 and $63.1 billion in
2003-04. The bulk of the revenue declines from 2000-01 through 2001-02 were
from personal income taxes, principally from reduced capital gains realizations
and stock option income.
It is impossible to predict the time, magnitude or location of a major
earthquake or its effect on the California economy. In January 1994, a major
earthquake struck the Los Angeles area, causing significant damage in a four
county area. The possibility exists that another such earthquake could create a
major dislocation of the California economy and significantly affect State and
local government budgets.
Prior Years' Financial Results. Following a severe recession beginning in
1990, the State's financial condition improved markedly during the fiscal years
starting in 1995-96, due to a combination of better than expected revenues, a
slowdown in growth of social welfare programs, and continued spending restraint
based on actions taken in earlier years. The State's cash position also
improved, with the State's General Fund taking in substantially greater tax
revenue than was initially planned when the budgets were enacted for the fiscal
years ended in 1996, 1997, 1998, 1999 and 2000 ($2.2 billion, $1.6 billion,
$2.4 billion, $1.7 billion and $8.2 billion, respectively), and no external
deficit borrowing occurred over the end of the five fiscal years prior to
2001-02.
2000 Budget Act. The 2000 Budget Act assumed General Fund revenues and
transfers of $73.9 billion, a 3.8 percent increase over 1999-00 estimates. This
budget appropriated $78.8 billion from the General Fund, a 17.3 percent
increase over 1999-00, and reflected the use of $5.5 billion from the Special
Fund for Economic Uncertainties (the "SFEU") available from surpluses in the
prior year. About $7.0 billion of the increased spending in 2000-01 was for
one-time expenditures and investments. Because of the State's strong cash
position, its administration announced that it would not undertake a revenue
anticipation note borrowing in 2000-01.
The 2002-03 Governor's Budget, released in January 2002, provided final
2000-01 revenue and expenditures. Expenditures in 2000-01 were $78.0 billion,
about $2.0 billion below the 2001 Budget Act estimates. The 2002-03 Governor's
Budget reported that the June 30, 2001 SFEU balance, the budget reserve, was
approximately $1.3 billion. This figure recognized the disbursement prior to
June 30, 2001 of about $6.2 billion from the General Fund to make loans for the
DWR power supply program (see "Repayment of Energy Loans" below).
2001 Budget Act. The 2001 Budget Act's spending plan for 2001-02 included
General Fund expenditures of $78.8 billion, a reduction of $1.3 billion from
the prior year. This could be accomplished without serious program cuts because
such a large part of the 2000 Budget Act comprised one-time expenditures. The
spending plan utilized more than half of the budget surplus as of June 30,
2001, but still left a projected balance in the SFEU at June 30, 2002, of $2.6
billion, the largest appropriated reserve in State history. The 2001 Budget Act
assumed that, during the course of the fiscal year, the $6.2 billion advanced
by the General Fund to the Department of Water Resources for power purchases
would be repaid with interest.
The final estimate of 2001-02 revenues and expenditures, included in the
2003-04 Governor's Budget in January 2003, showed an unprecedented drop in
revenues compared to the prior year. The final estimate for the three largest
tax sources was $59.7 billion, a drop of over $13 billion from 2000-01, the
vast bulk of which was attributable to reduced personal income taxes from stock
option and capital gains activity. This revenue shortfall and the delay of the
DWR power revenue bonds past June 30, 2002, resulted in a substantial budgetary
deficit and cash flow difficulties. The Department of Finance estimates that,
on a budgetary basis, the General Fund had a $2.1 billion deficit at June 30,
2002.
16
Current Fiscal Year. The 2002-03 Budget projected a fall-off in General
Fund revenues due to the national economic recession combined with the stock
market decline, which began in mid-2000. Personal income tax receipts,
including stock option and capital gain realizations, have been particularly
impacted. As a result, the Administration projected a combined budget gap for
2001-02 and 2002-03 of approximately $12.5 billion.
The May 2002 Revision to the Governor's Budget projected further
deterioration in revenues of $9.5 billion and additional costs of $1.6 billion
over the 2001-02 and 2002-03 fiscal years. As a result, the combined budget gap
rose from the $12.5 billion estimated in January to $23.6 billion.
On September 5, 2002, the Governor signed the budget bill for fiscal year
2002-03. The budget initially forecast $79.2 billion in General Fund revenues
and transfers and $76.7 billion in expenditures. The revenue estimates have
proved to be substantially overstated, as expected economic recovery has not
occurred, among other factors. Based on revised estimates in the 2003-04
Governor's Budget, revenues and transfers in 2002-03 will be $73.1 billion,
with expenditures of $75.5 billion.
In the summer of 2002, the Governor notified all State agencies to prepare
2003-04 budget proposals for a minimum of 20 percent cut in funding. In
November 2002, the Governor further directed State agencies to take immediate
action to reduce any non-critical or non-essential activities by not filling
any vacant positions; to cancel, postpone or amend contracts, grants, purchase
orders and similar commitments; to eliminate additional non-essential vacant
positions; to delay construction or signing of new leases for space; to cancel
or postpone non-essential trips; and to generate new proposals for current year
program reductions.
On December 6, 2002, the Governor released proposals for immediate action to
reduce the budget gap by about $10.2 billion, of which $3.4 billion would be
seen in 2002-03 and the balance in 2003-04. The Legislature began to consider
these proposals in conjunction with the 2003-04 Governor's Budget. Certain of
the proposals require two-thirds approval of each house of the Legislature. As
of February 5, 2003, the Legislature had adopted certain budget corrections,
but they differed in some significant respects from the Governor's proposals,
and the Governor may not approve all of them.
Fiscal Year 2003-04 Budget. The 2003-04 Governor's Budget, released on
January 10, 2003 (the "2003-04 Governor's Budget"), projected a significant
downward revision in State revenues as a result of the longer than expected
economic recovery. The decline was mainly due to weak personal income tax
revenues, which dropped by nearly 26 percent in 2001-02 and are expected to
decline by another 0.5 percent in 2002-03. As a result, the Administration
projected a $34.6 billion budget shortfall for 2002-03 and 2003-04.
The 2003-04 Governor's Budget projected revenues from the three largest tax
sources to be about $61.7 billion in 2002-03, more than $6 billion lower than
projected in the 2002 Budget Act. Most of the decline is attributable to the
personal income tax revenues, which are particularly impacted by the stock
market's decline. The 2003-04 Governor's Budget projected total revenues and
transfers of $73.1 billion and $69.2 billion in 2002-03 and 2003-04,
respectively. The estimate for 2002-03 included about $2.8 billion of transfers
and loans.
The 2003-04 Budget addresses the $34.6 billion gap by proposing cuts and
savings ($20.7 billion), State-local program realignment ($8.1 billion), fund
shifts ($1.9 billion), transfers/other revenue ($2.1 billion), and
loans/borrowing ($1.7 billion). Although the budget does not propose any tax
increases to support General Fund obligations, the budget does fund the
State-local program realignment through dedicated revenue streams based on a
one-cent sales tax increase ($4.6 billion), new 10% and 11% tax brackets ($2.6
billion) and an increased excise tax on cigarettes and other tobacco products
($1.2 billion). Many of these proposals are controversial and there can be no
assurance which will eventually be enacted by the Legislature.
The Legislative Analyst's Office released a report following publication of
the 2002-03 Governor's Budget, in which the two-year budget gap was projected
to be around $26 billion, as compared to the Governor's estimate of $34.6
billion. This projection can be attributed to more optimistic economic and
revenue forecasts and a
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difference in methods and timing by which the agencies identify future spending
requirements, though this difference does not have any budgetary impact since
the Governor had proposed spending reductions to offset his higher estimate.
Final action on budget adjustments for 2002-03 and enactment of the 2003
Budget Act will occur following negotiations between the Legislature and the
Governor over the coming months. Additional estimates and proposals will be
contained in the May Revision to the 2003-04 Governor's Budget, to be released
on May 14, 2003.
Future Budgets. It cannot be predicted what actions will be taken in the
future by the State Legislature and the Governor to deal with changing State
revenues and expenditures. The State budget will be affected by national and
State economic conditions and other factors.
State Indebtedness
General Obligation Bonds. As of January 1, 2003, the State had
approximately $25.7 billion aggregate amount of its general obligation bonds
outstanding. General obligation bond authorizations in an aggregate amount of
approximately $29.2 billion remained unissued as of that date.
Ratings. As of February 10, 2003, the State's general obligation bonds were
rated A2 by Moody's, A by Standard & Poor's, and A by Fitch Ratings. On
February 10, 2003, Moody's lowered its rating from A1 to A3 to reflect the
magnitude of the imbalance between the State's revenues and expenditures, and
the expectation the State will not be able to sufficiently address the
imbalance in the upcoming fiscal year--given the inherent obstacles to reaching
consensus on solutions to the problem. Citing a sharply higher General Fund
deficit of $34.8 billion for fiscal years 2002-03 and 2003-04, in December
2002, Standard & Poor's lowered its rating to A from A+. Fitch Ratings
similarly lowered its rating to A from AA citing financial pressure since 2001,
reflecting in part recessionary conditions and an unprecedented drop in
personal income tax receipts which it expects to continue in 2003-04. It is not
presently possible to determine whether, or the extent to which, Moody's, S&P
or Fitch Ratings will change such ratings in the future. It should be noted
that the creditworthiness of obligations issued by local California issuers may
be unrelated to the creditworthiness of obligations issued by the State, and
there is no obligation on the part of the State to make payment on such local
obligations in the event of default.
Commercial Paper Program. Pursuant to the terms of the bank credit
agreement presently in effect supporting the general obligation commercial
paper program, not more than $1.5 billion of general obligation commercial
paper notes may be outstanding at any time; this amount may be increased or
decreased in the future. As of January 1, 2003, the Finance Committees had
authorized the issuance of up to approximately $6.1 billion of commercial paper
notes; as of that date approximately $0.5 billion aggregate principal amount of
general obligation commercial paper notes was outstanding.
Lease-Purchase Debt. In addition to general obligation bonds, the State
builds and acquires capital facilities through the use of lease-purchase
borrowing. As of January 1, 2003, the State had approximately $6.7 billion of
outstanding lease purchase debt.
Non-Recourse Debt. Certain State agencies and authorities issue revenue
obligations for which the General Fund has no liability. Revenue bonds
represent obligations payable from State revenue-producing enterprises and
projects, which are not payable for the General Fund, and conduit obligations
payable only from revenues paid by private users of facilities financed by the
revenue bonds. There are 17 agencies and authorities authorized to issue
revenue obligations (excluding lease-purchase debt). State agencies and
authorities had $30.5 billion aggregate principal amount of revenue bonds and
notes, which are non-recourse to the General Fund outstanding as of June 30,
2002.
Cash Flow Borrowings. As part of its cash management program, the State has
regularly issued short-term obligations to meet cash flow needs. The State did
not issue any revenue anticipation notes for the 2000-01 fiscal
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year. The State issued $5.7 billion of 2001-02 Revenue Anticipation Notes on
October 4, 2001, which matured on June 28, 2002. In late October and early
November of 2002, the State issued a total of $12.5 billion of 2002-03 Revenue
Anticipation Notes to partially fund its cash flow needs in the 2002-03 fiscal
year, including repayment of the $7.5 billion in revenue anticipation warrants
it issued in June 2002. If State revenues fall significantly below current
projections, or the second part of the tobacco securitization bonds are not
sold during the current fiscal year, the State may have to issue additional
warrants to meet its cash obligations.
Repayment of Energy Loans
The Department of Water Resources of the State ("DWR") borrowed money from
the General Fund for DWR's power supply program between January and June 2001.
DWR has issued approximately $11.25 billion in revenue bonds in several series
and in the fall of 2002 used the net proceeds of the revenue bonds to repay
outstanding loans from banks and commercial lenders in the amount of
approximately $3.5 billion and a loan from the General Fund in the amount of
$6.1 billion plus accrued interest of approximately $500 million. Issuance of
the DWR revenue bonds had been delayed since mid-2001 by a number of factors,
including administrative and legal challenges.
The loans from the General Fund and the banks and commercial lenders
financed DWR's power supply program costs during 2001 that exceeded DWR's
revenues from the sale of electricity. The general purpose of the power supply
program has been to provide to customers of the three major investor-owned
electric utilities in the State (the "IOUs") the portion of their power not
provided by the IOUs. The power supply program has become self-supporting and
no additional loans from the General Fund are authorized. As of January 1,
2003, the DWR's authority to enter into new power purchase contracts
terminated, and the IOUs resumed responsibility for obtaining electricity for
their customers
The primary source of money to pay debt service on the DWR revenue bonds
will be revenues derived from customers of the IOUs resulting from charges set
by the California Public Utilities Commission. The DWR revenue bonds are not a
debt or liability of the State or directly or indirectly or contingently
obligate the State to levy or to pledge any form of taxation whatever therefor
or to make any appropriation for their payment.
Local Government
The primary units of local government in California are the counties,
ranging in population from 1,200 (Alpine) to approximately 9,800,000 (Los
Angeles). Counties are responsible for the provision of many basic services,
including indigent healthcare, welfare, courts, jails and public safety in
unincorporated areas. There are also 477 incorporated cities and thousands of
other special districts formed for education, utility and other services. The
fiscal condition of local governments has been constrained since the enactment
of "Proposition 13" in 1978 and later constitutional amendments, which reduced
and limited the future growth of property taxes and limited the ability of
local governments to impose "special taxes" (those devoted to a specific
purpose) without two-thirds voter approval. Proposition 218, another initiative
constitutional amendment enacted in 1996, further limited the ability of local
governments to impose or raise various taxes, fees, charges and assessments
without voter approval. Counties, in particular, have had fewer options to
raise revenues than many other local government entities, and have been
required to maintain many services.
Some local governments in California have experienced notable financial
difficulties, including Los Angeles County and Orange County, and there is no
assurance that any California issuer will make full or timely payments of
principal or interest or remain solvent.
A program to offset a portion of the vehicle license fees paid by vehicle
owners was established in 1998. The amount of this offset has increased from 25
percent in 1999 to the current level of 67.5 percent. This offset is expected
to provide tax relief of $3.850 billion in 2002-03 and $3.916 billion in
2003-04. Since 1999, the General Fund has backfilled the offset so that the tax
relief did not result in a revenue loss to local governments.
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However, as the amount paid by taxpayers has been reduced the amount backfilled
by the General Fund has increased. In order to continue funding vital State
programs in spite of a substantial reduction in State revenues, the 2003-04
Governor's Budget proposes to fund only the backfill amounts related to
realignment and debt repayment in Orange County, beginning in February 2003.
This action would, if approved by the Legislature, reduce General Fund
expenditures by $1.26 billion in 2002-03, and $2.93 billion in 2003-04, and
result in a commensurate decrease in revenues to local governments.
The 2003-04 Governor's Budget also proposes a State-local realignment of
various programs including mental health, substance abuse, childcare, health,
social services, long-term care, and court security. The realignment proposal
would transfer the responsibility for these programs from the State to the
local governments. The Governor's Budget also proposes to fund these new
responsibilities with sales, income and tobacco tax increases.
Constitutional and Statutory Limitations; Recent Initiatives; Pending
Legislation
The State is subject to an annual appropriations limit imposed by Article
XIII B of the State Constitution (the "Appropriations Limit"). The
Appropriations Limit does not restrict appropriations to pay debt service on
voter-authorized bonds.
The State is prohibited from spending "appropriations subject to limitation"
in excess of the Appropriations Limit. "Appropriations subject to limitation,"
with respect to the State, are authorizations to spend "proceeds of taxes,"
which consist of tax revenues, and certain other funds, including proceeds from
regulatory licenses, user charges or other fees to the extent that such
proceeds exceed "the cost reasonably borne by that entity in providing the
regulation, product or service," but "proceeds of taxes" exclude most state
subventions to local governments, tax refunds and some benefit payments such as
unemployment insurance. No limit is imposed on appropriations of funds which
are not "proceeds of taxes," such as reasonable user charges or fees and
certain other non-tax funds. There are various types of appropriations excluded
from the Appropriations Limit.
The State's Appropriations Limit in each year is based on the limit for the
prior year, adjusted annually for changes in state per capita personal income
and changes in population, and adjusted, when applicable, for any transfer of
financial responsibility of providing services to or from another unit of
government or any transfer of the financial source for the provisions of
services from tax proceeds to non-tax proceeds.
The Legislature has enacted legislation to implement Article XIII B which
defines certain terms used in Article XIII B and sets forth the methods for
determining the Appropriations Limit. California Government code Section 7912
requires an estimate of the Appropriations Limit to be included in the
Governor's Budget, and thereafter to be subject to the budget process and
established in the Budget Act.
On November 8, 1988, voters of the State approved Proposition 98, a combined
initiative constitutional amendment and statute called the "Classroom
Instructional Improvement and Accountability Act." Proposition 98 changed State
funding of public education below the university level and the operation of the
State appropriations funding, primarily by guaranteeing K-14 schools a minimum
share of General Fund revenues. Proposition 98 permits the Legislature by
two-thirds vote of both houses, with the Governor's concurrence, to suspend the
K-14 schools' minimum funding formula for a one-year period. Proposition 98
also contains provisions transferring certain State tax revenues in excess of
the Appropriation Limit to K-14 schools.
Substantially increased General Fund revenues in the fiscal years 1994-95
through 2001-02 have resulted in significant increases in the level of
Proposition 98 appropriations budgeted for those years. However, in fiscal year
2002-03, the projected level of revenues have decreased $6.3 billion since the
enactment of the budget, changing the calculation of the General Fund share of
the minimum K-14 funding level from approximately $31.6 billion to
approximately $28.9 billion. As a result of this decrease in the calculated
minimum, the 2003-04
20
Governor's Budget proposes funding for K-14 education at the minimum guarantee
funding level in 2002-03. The revised 2002-03 Proposition 98 appropriations
also reflect a mid-year proposal to reduce appropriations by approximately $2.6
billion.
The revenue projection for 2003-04 exceeds the revised 2002-03 estimates by
approximately $991 million. The General Fund share of the guarantee will
decrease approximately $672 million, from $28.9 billion in 2002-03 to $28.2
billion in 2003-04. Despite this decline in the General Fund share of the
guarantee, the 2003-04 Governor's Budget proposes to fully fund enrollment
growth. The 2003-04 Governor's Budget also proposes total funding for K-14
education of approximately $44.1 billion ($6,708 per K-12 pupil), an increase
of 2.6 percent compared to the revised 2002-03 level adjusted for the child
care realignment proposal.
Because of the complexities of Appropriation Limit, the ambiguities and
possible inconsistencies in its terms, the applicability of its exceptions and
exemptions and the impossibility of predicting future appropriations, the
Sponsor cannot predict the impact of this or related legislation on the Bonds
in the California Trust portfolio.
Other Constitutional amendments affecting State and local taxes and
appropriations have been proposed from time to time. If any such initiatives
are adopted, the State could be pressured to provide additional financial
assistance to local governments or appropriate revenues as mandated by such
initiatives. Propositions such as Proposition 98 and others that may be adopted
in the future, may place increasing pressure on the State's budget over future
years, potentially reducing resources available for other State programs,
especially to the extent the Appropriation Limit spending limit would restrain
the State's ability to fund such other programs by raising taxes.
Future Initiatives. Articles XIII A, XIII B, XIII C and XIII D were each
adopted as measures that qualified for the ballot pursuant to the State's
initiative process. From time to time, other initiative measures could be
adopted that could affect revenues of the State or public agencies within the
State.
Pending Litigation
The State of California is a party to numerous legal proceedings, many of
which normally occur in governmental operations. In addition, the State is
involved in certain other legal proceedings that, if decided against the State
might require the State to make significant future expenditures or impair
future revenue sources. Because of the prospective nature of these proceedings,
it is not presently possible to predict the outcome of such litigation or
estimate the potential impact on the ability of the State to pay debt service
costs on its obligations.
New York Fund Risk Factors
Some of the significant financial considerations relating to the New York
Fund's investments in New York Municipal Obligations are summarized below. This
summary information is not intended to be a complete description and is
principally derived from the Annual Information Statement of the State of New
York as supplemented and contained in official statements relating to issues of
New York Municipal Obligations that were available prior to the date of this
Statement of Additional Information. The accuracy and completeness of the
information contained in those official statements have not been independently
verified.
The State of New York's most recent fiscal year began on April 1, 2002 and
ends on March 31, 2003. The most recent published Update to the Annual
Information Statement was dated February 3, 2003 with supplement dated March 3,
2003.
Special Considerations. Current economic and financial trends have
substantially heightened the risk that actual receipts for the 2002-03 fiscal
year will fall significantly below the levels reported in the current Financial
Plan. An unusual amount of uncertainty surrounds those factors that have
historically been most prominent in determining the State's revenue
performance. These factors include the profit performance of the financial
sector and the timing of tax payments from high-income individuals and
businesses.
21
It now appears more likely that the national and State economies will
rebound at a slower pace than projected under the current forecast. Equity
market instability (fueled by poor earnings, accounting concerns, and fears of
further terrorist attacks), a further escalation of tensions in the Middle East
and the resultant upward pressure on energy prices, a weakening of growth in
consumer spending, and a failure of investment spending to rebound are all
factors that are combining to produce a potential return to recessionary
conditions.
More important from a revenue perspective, the prolonged and substantial
decline in equity markets has increased the likelihood that tax payments will
fall below current projections, as well as increased the uncertainty of the
timing of such tax payments. The State receives a substantial portion of tax
receipts from the income and profits of financial service employees and
companies. In addition, the taxable income of State taxpayers is affected by
the changing value of equities and the associated impact on the value of
capital gain transactions. Historically, declines in the stock market are
followed by declines in personal income tax payments as tax liability
associated with market transactions declines.
Finally, financial service firms have suffered a second consecutive year of
poor profit performance related to stock market declines and the fallout
associated with the corporate accounting scandals. As a result, there have
been, and it is generally expected that there will continue to be, further
reductions in employment for this industry and declines in the compensation of
highly paid financial service employees.
For these reasons, it now appears more likely that the State will experience
a significant decline in its revenue situation in fiscal year 2002-03. The
Division of the Budget ("DOB") is continuously analyzing actual data and
available information from the financial services industry and the economy in
general to assess any potential negative impact on receipts. However, given the
uncertainties surrounding the economy in general and the financial services
sector in particular, DOB is unable at this time to quantify with confidence
the potential impact on expected tax receipts.
The State currently has $710 million in the Tax Stabilization Reserve Fund
to guard against potential risks. Consistent with prudent fiscal practices, DOB
is also developing a range of approaches totaling five percent of General Fund
spending to help bolster the State's reserves and respond to the heightened
uncertainties surrounding the receipts forecast. Accordingly, DOB will continue
to maintain a strict hiring freeze and controls on all discretionary spending,
initiate debt management actions to lower debt service costs, and take other
administrative measures to reduce costs in the current year. In the past, the
State has taken both administrative and legislative actions to address
potential Financial Plan shortfalls, and DOB believes similar actions can be
taken to respond to adverse variances in the current year.
In addition, the Governor of the State of New York (the "Governor") has
proposed legislation to permit the State to securitize all or a portion of its
share of future payments from the tobacco industry under the national master
settlement agreement. The most significant short-term risk to the Financial
Plan is that the Legislature will fail to enact legislation authorizing the
State to securitize its tobacco settlement payments during State fiscal year
2002-03 as recommended in the Governor's Executive Budget. To securitize its
tobacco payments, the Executive Budget recommends the sale of the tobacco
payment stream to a statutorily created, bankruptcy-remote corporation that
would be a subsidiary of the Municipal Bond Bank Agency. In exchange for the
sale of the tobacco payment stream asset, the State will receive one or more
upfront payments from the proceeds generated from the issuance of bonds by the
corporation.
As of March 3, 2003, the Legislature has not acted on the enabling
legislation submitted by the Governor, or on any other budget bills for the
2003-04 fiscal year. If the Legislature does not act on the tobacco
securitization legislation promptly, the State will be required to defer
payments budgeted in 2002-03 until 2003-04. If necessary, the State may also
take other actions to reduce disbursements or increase receipts. The State has
no plans to issue short-term tax and revenue anticipation notes or borrow funds
from the Tax Stabilization Reserve Fund (the "rainy day" fund) to bring the
budget into balance in the current fiscal year.
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Any payment deferrals from 2002-03 are expected to be made in 2003-04 and
would therefore weaken the State's cashflow in the first quarter of that year,
and would also adversely affect the cashflow of school districts and local
governments. The Financial Plan, which assumes the enactment of the Governor's
budget recommendations in their entirety (including the receipt of tobacco
securitization proceeds), projects that the General Fund will have closing
balances of $195 million in May, $369 million in July, and $358 million in
August 2003 (such levels are below those achieved in recent years). To meet its
cash-flow needs during this period in the absence of an enacted budget, DOB may
limit the level of spending authorized through interim spending appropriations
to essential contractual and statutory obligations. The State is investigating
other austerity measures to augment its cash-flow position if the Legislature
fails to enact a budget during this period.
As in any year, there can be no assurance that a budget will be enacted by
the Legislature by the start of the fiscal year, or that the budget that is
enacted will not differ materially and adversely from the projection described
herein.
In every year, many uncertainties exist in the forecast of the national and
State economies. Two variables which stand out as being particularly vulnerable
to financial market volatility, and which are closely associated with State
personal income tax receipts, are finance sector bonus income and capital gains
realizations. Historically, financial sector bonus income has been closely tied
to security firm profits. Both bonus income and capital gains realizations have
historically been subject to a high degree of variation and may produce results
below the current receipts forecast. Also, the United States Congress is
expected to consider several economic stimulus packages during the winter of
2003. Several proposals could have a detrimental impact on New York State
income receipts.
There are several significant risks that could adversely affect the U.S.
economic recovery or perhaps even derail it and put the nation back into
recession. By far the greatest is the risk of another terrorist attack, or
series of attacks, that could lead to a steep decline in consumer confidence
and spending, as well as a postponement of investment plans by businesses.
Similarly, a conflict in Iraq carries the potential for a large spike of some
duration in oil prices as well as a sharp drop in consumer sentiment and
business confidence.
Financial market performance also impacts the level of contributions
required for the pension funds. The Financial Plan assumes that the State's
2003-04 pension contribution will be toward the lower end of the range of
contributions provided by the State Comptroller in October 2002. On February 7,
2003 the Comptroller provided in updated estimate of pension costs for the
2003-04 fiscal year that estimates that State contributions are likely to be
$660 million higher than the amounts budgeted in the Financial Plan. To the
extent the required contribution is greater than such amount, the State will be
required by law to pay the deficiency, with interest, by the second fiscal year
following such underpayment. The Comptroller does not estimate pension
contribution costs beyond those due in the upcoming fiscal year, and any such
future costs would be dependent on numerous variables, including the
performance of the assets of the New York State and Local Retirement Systems
(the "Systems").
The State Comptroller is the Administrative Head of the Systems, and Trustee
of the assets of those Systems. If the proposed pension reform changes are
authorized by the State Legislature, any proposed changes to the method of
computing employer contributions would have to be reviewed and approved by the
State Comptroller to ensure that such changes (i) do not violate the State
Constitution and (ii) are consistent with his fiduciary responsibilities to
System members and beneficiaries.
An ongoing risk to the State Financial Plan arises from the potential impact
of certain litigation and Federal disallowances now pending against the State,
which could produce adverse effects on the State's projections of receipts and
disbursements. The Financial Plan assumes no significant Federal disallowances
or other Federal actions that could adversely affect State finances.
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State Economy. The New York economy suffered more than the nation as a
whole during the recession, due to the September 11 devastation of downtown New
York City and the importance of the finance and tourism industries to the State
economy. Only now are there signs of an economic turnaround. Total State
employment is expected to rise 0.7 percent in 2003, following a decline of 1.6
percent for 2002. Private sector employment is expected to rise 0.9 percent in
2003, following a decline of 2.1 percent for 2002. Bonus payments paid to
financial services workers have been reduced significantly due to the recession
and the steep decline in the stock market. On a calendar year basis, bonuses
are estimated to have fallen 23.0 percent for 2002, followed by a 10.2 percent
decline projected for 2003. In the aftermath of the bursting of the stock
market bubble, it is expected that for the next two years bonuses in the
finance and insurance sector will remain at about one-half of their 2001 peak
level. Wages are expected to rise 2.3 percent in 2003, following a decline of
3.2 percent for 2002. Total State personal income is projected to increase 3.1
percent in 2003.
The risks to the New York forecast are substantial. Weaker than expected
growth for both the national and international economies could delay the onset
of the State's recovery. This would result in even slower employment and income
growth than projected. This decline, if it continues, could result in a large
negative impact in underlying economic activity. Adverse developments in the
equity markets have the potential to significantly disrupt economic activity in
New York, given the prominence of financial services in the State's economy. In
contrast, stronger national and international growth could result in an earlier
recovery than projected. At the State level, the cleanup of the World Trade
Center site has been completed and redevelopment is expected to commence
shortly. As a result, employment growth could be stronger than projected.
Financial sector activity remains the largest risk to the New York forecast.
Wall Street compensation fell precipitously in early 2002. Continued weakness
in this sector would have a deleterious impact on the State's prospects for
economic recovery, while a sharp improvement in profits for the financial
industry would likely have a significant beneficial impact on the State's
economy.
Recent events, such as the war with Iraq and the concomitant threat of
terrorist acts, have increased the risks to the forecast for both employment
and wages. The continuing erosion of investor confidence has had a major impact
on Wall Street and the New York City economy. Securities industry profits for
2002 were the lowest in eight years; including research settlement charges and
write-offs for potential litigation costs, profits were a negative $1 billion
for the fourth quarter. After suffering its second consecutive annual loss in
2002, the stock market continued to deteriorate in January and February of this
year, due largely to uncertainty related to pending military conflict. If
global tensions resolve quickly, equity markets could strengthen more quickly
than expected. If not, financial sector weakness, combined with weak domestic
and global demand for New York State goods and services, will continue to have
an adverse impact on the State's economic recovery.
New York is the third most populous state in the nation and has a relatively
high level of personal wealth. The State's economy is diverse with a
comparatively large share of the nation's finance, insurance, transportation,
communications and services employment, and a very small share of the nation's
farming and mining activity. The State's location and its air transport
facilities and natural harbors have made it an important link in international
commerce. Travel and tourism constitute an important part of the economy. Like
the rest of the nation, New York has a declining proportion of its workforce
engaged in manufacturing, and an increasing proportion engaged in service
industries.
Services. The services sector, which includes entertainment, personal
services, such as health care and auto repairs, and business-related services,
such as information processing, law and accounting, is the State's leading
economic sector. The services sector accounts for more than three of every ten
nonagricultural jobs in New York and has a noticeably higher proportion of
total jobs than does the rest of the nation.
Manufacturing. Manufacturing employment continues to decline in New York,
as in most other states, and New York's economy is less reliant on this sector
than in the past. However, it remains an important sector of the State economy,
particularly for the upstate economy, as high concentrations of manufacturing
industries for transportation equipment, optics and imaging, materials
processing, and refrigeration, heating, and electrical equipment products are
located in the upstate region.
24
Trade. Wholesale and retail trade is the second largest sector in terms of
nonagricultural jobs in New York but is considerably smaller when measured by
income share. Trade consists of wholesale businesses and retail businesses,
such as department stores and eating and drinking establishments.
Finance, Insurance and Real Estate. New York City is the nation's leading
center of banking and finance and, as a result, this is a far more important
sector in the State than in the nation as a whole. Although this sector
accounts for under one-tenth of all nonagricultural jobs in the State, it
contributes about one-fifth of total wages.
Agriculture. Farming is an important part of the economy in rural areas,
although it constitutes a very minor part of total State output. Principal
agricultural products of the State include milk and dairy products, greenhouse
and nursery products, fruits, and vegetables. New York ranks among the nation's
leaders in the production of these commodities.
Government. Federal, State and local governments together are the third
largest sector in terms of nonagricultural jobs, with the bulk of the
employment accounted for by local governments. Public education is the source
of nearly one-half of total State and local government employment.
State Budget. The State Constitution requires the Governor to submit to the
State legislature (the "Legislature") a balanced executive budget which
contains a complete plan of expenditures for the ensuing fiscal year and all
moneys and revenues estimated to be available therefor, accompanied by bills
containing all proposed appropriations or reappropriations and any new or
modified revenue measures to be enacted in connection with the executive
budget. The entire plan constitutes the proposed State financial plan for that
fiscal year. The Governor is required to submit to the Legislature quarterly
budget updates which include a revised cash-basis state financial plan, and an
explanation of any changes from the previous state financial plan.
State law requires the Governor to propose a balanced budget each year. In
recent years, the State has closed projected budget gaps which DOB estimated at
$5.0 billion (1995-96), $3.9 billion (1996-97), $2.3 billion (1997-98), less
than $1 billion (in each of the fiscal years 1998-99 through 2000-01) and $6.8
billion in 2002-03. The 2002-03 Financial Plan projected budget gaps of $2.8
billion in 2003-04, $2.8 billion in 2004-05 and $4.1 billion in 2005-06.
Four governmental fund types comprise the State Financial Plan: the General
Fund, the Special Revenue Funds, the Capital Projects Funds, and the Debt
Service Funds. The State's fund structure adheres to the accounting standards
of the Governmental Accounting Standards Board.
General Fund. The General Fund is the principal operating fund of the State
and is used to account for all financial transactions except those required to
be accounted for in another fund. It is the State's largest fund and receives
almost all State taxes and other resources not dedicated to particular
purposes. In the State's 2002-03 fiscal year, the General Fund is expected to
account for approximately 42 percent of All Governmental Funds disbursements.
General Fund moneys are also transferred to other funds, primarily to support
certain capital projects and debt service payments in other fund types.
Total General Fund receipts, including transfers from other funds and
tobacco securitization proceeds, are projected to total $39.74 billion in
fiscal year 2002-03, a decrease of $1.41 billion from the 2001-02 fiscal year.
This total includes $28.36 billion in tax receipts, $4.09 billion in
miscellaneous receipts, and $7.30 billion in transfers from other funds.
Estimated General Fund receipts for 2003-04 are projected at $38.19 billion or
$1.75 billion below 2002-03 estimate.
The significant year-to-year decline in receipts is caused primarily by the
economic dislocation caused by the terrorist attacks of September 11, 2001, the
national recession, the decline in equity markets, and the drop in compensation
paid to financial service workers. The estimated impact of the World Trade
Center disaster on 2002-03 receipts remains significant, and within the range
estimated in the immediate aftermath of the September 11 attacks. Personal
income tax payments associated with the 2001 tax year are significantly below
2000 levels, with associated impacts on final payments and refunds.
25
General Fund disbursements, including transfers to other funds, are
projected to total $39.77 billion for 2002-03, an annual decrease of $1.45
billion from the 2001-02 fiscal year. All Governmental Funds spending for
2002-03 is projected to be $90.95 billion. General Fund disbursement for
2003-04 is projected to be $38.64 billion, a decrease of $1.14 billion (2.9
percent) from the current year.
The projected 2002-03 General Fund closing balance of $1.0 billion, consists
of $710 million in the Tax Stabilization Reserve Fund (the State's "rainy day"
fund), $198 million in remaining projected extra tobacco securitization
receipts, $20 million in the Contingency Reserve Fund (the State's litigation
reserve) and $75 million in the Community Projects Fund.
All Governmental Funds receipts are projected to be $90.22 billion in
2003-04, a decrease of $401 million from 2002-03. Tax receipts are projected to
decrease by $310 million to total $40.93 billion, while miscellaneous receipts
are projected to increase by $288 million to total $17.23 billion over 2002-03.
Federal Grants are projected to total $32.06 billion, a decrease of $379
million from 2002-03. Federal grants represent reimbursement from the Federal
government for programs financed by the State in the first instance.
On an All Governmental Funds basis, the State Financial Plan budgets
spending for World Trade Center costs of $2.06 billion in 2002-03 and $496
million in 2003-04 which represents both pass-through aid and disbursements
financed by the State. Most of the spending is supported by Federal funds ($2
billion in 2002-03 and $946 million in 2003-04). In addition to disaster
cleanup and recovery spending, Federal money will finance, among other things,
expanding counseling and trauma services ($99 million). In 2001-02, the State
spent $654 million for World Trade Center costs ($352 million of which was
pass-through aid).
The Financial Plans reflect pass-through aid related to reimbursement for
September 11 costs within the amounts shown for total disbursement. For
2002-03, pass-through aid is projected to total $1.7 billion, of which $1
billion relates to expected reimbursement for liability insurance. Aid amounts
decline in 2003-04 to $861 million, as reimbursement for initial response
efforts - debris removal and crisis counseling - nears completion. Nearly all
of the Federal disaster aid is expected to flow from the Federal Emergency
Management Agency through the State Emergency Management Office (SEMO) to New
York City and other localities affected by the disaster.
Through December 2002, preliminary General Fund receipts and transfers from
other funds (based on DOB's estimate) totaled $27.32 billion, $1.17 billion
below cash-flow projections for fiscal year 2002-03 derived from the October
2002 Financial Plan, with negative variances against planned collections
concentrated in the personal income tax and in business taxes. However, it
remains uncertain at this point how much of the receipts shortfall to date is
related to the timing of tax payments within the same fiscal year (but across
individual and business tax years), and how much is related to economic
conditions. Preliminary General Fund disbursements and transfers to other funds
totaled $26.88 billion, $400 million below cash-flow projections derived from
the October 2002 Financial Plan. The variances result in a preliminary General
Fund closing balance of $1.47 billion at the end of December 2002, which is
$772 million below DOB's cash-flow projections.
Based on operating results through December 31, 2002, the anemic performance
of the national economy, faltering retail sales, and continuing weakness in the
State's financial services sector, DOB believes the State will experience a
budgetary shortfall in the range of $2 billion to $2.5 billion in the current
fiscal year.
Special Revenue Funds. State special revenue spending is projected to be
$14.57 billion, an increase of $3.0 billion or 25.9 percent from 2001-02. The
largest area of growth in State special revenue funding is for Medicaid, which
is projected to total $2.50 billion in 2002-03, an increase of $1.35 billion.
Special Revenue Funds, which include Federal grants and State Special Revenue
Funds, comprise 50 percent of the All Governmental Funds Financial Plan.
Spending from Special Revenue Funds is projected to total $45.58 billion in
2003-04.
26
Capital Projects Funds. Spending from Capital Projects Funds in 2002-03 is
projected at $5.29 billion, an increase of $977 million or 22.7 percent from
last year. The increase will primarily support capital investments to promote
economic development ($340 million), transportation ($291 million), and
education ($210 million). Capital Projects Funds spending in 2003-04 is
projected at $5.64 billion.
Debt Service Funds. Estimated debt service disbursements from the debt
service funds type are projected at $3.10 billion for 2002-03 and $3.37 billion
for 2003-04. The $271 million increase is due to a combination of ongoing debt
management actions that lower the State's cost of borrowing in 2002-03 to
provide recurring savings.
The historical financial results for the prior three fiscal years are
presented below.
2001-02 Fiscal Year. The State ended its 2001-02 fiscal year on March 31,
2002 in balance on a cash basis. There was no General Fund surplus reported by
DOB. After year-end adjustments related to the refund reserve account, the
closing balance in the General Fund was $1.03 billion, a decrease of $67
million from the 2000-01 fiscal year. Of this balance, $710 million was held in
the Tax Stabilization Reserve Fund ("TSRF") (after a deposit of $83 million in
fiscal year 2001-02), $157 million in the Contingency Reserve Fund ("CRF"),
$159 million in the Community Projects Fund ("CPF"), and $5 million in the
Universal Pre-kindergarten Fund. The closing fund balance excludes $1.68
billion on deposit in the refund reserve account at the end of the 2001-02
fiscal year.
General Fund receipts, including transfers from other funds, totaled $41.14
billion for the 2001-02 fiscal year, an increase of $1.26 billion (3.3 percent)
over fiscal year 2000-01 results. Receipts results for fiscal year 2001-02
reflect refund reserve transactions that had the effect of reducing personal
income tax receipts in the 2001-02 fiscal year and increasing them in the
2002-03 fiscal year. When the refund reserve is adjusted for the set-aside of
$1.07 billion for economic uncertainties, General Fund receipts and transfers
from other funds totaled $42.21 billion. General Fund disbursements, including
transfers to other funds, totaled $41.22 billion for the 2001-02 fiscal year,
an increase of $1.52 billion (3.8 percent) from the 2000-01 fiscal year.
2000-01 Fiscal Year. The State ended its 2001-01 fiscal year on March 31,
2001 in balance on a cash basis with a General Fund surplus of $2.73 billion as
reported by DOB. After year-end adjustments described below, the closing
balance in the General Fund was $1.10 billion, a decrease of $69 million from
the 1999-2000 fiscal year. Of this balance, $627 million was held in the TSRF
(after a deposit of $80 million in fiscal year 2000-01), $150 million in the
CRF, $292 million in the CPF, and $29 million in the Universal Pre-kindergarten
Fund.
The closing fund balance excluded $3.52 billion on deposit in the tax refund
reserve account at the end of the 2000-01 fiscal year. The State retained $2.65
billion of the $3.52 billion balance for reserves, with $2.4 billion set aside
for economic uncertainties and $250 million deposited into the Debt Reduction
Reserve Fund in 2001-02. The remaining balance of $865 million was comprised of
$293 million in resources to pay for costs incurred in 2000-01 but disbursed in
2001-02, $521 million from the Local Government Assistance Corporation ("LGAC")
that was used to pay tax refunds during fiscal year 2001-02 and $51 million in
additional funds used to pay refunds related to the Earned Income Tax Credit
and the Dependent Care Tax Credit.
The 2000-01 General Fund closing balance also excluded $1.2 billion that was
on deposit in the School Tax Relief ("STAR") Special Revenue Fund at the end of
the 2000-01 fiscal year (to meet a portion of the STAR payments in fiscal year
2001-02) and $250 million on deposit in the Debt Reduction Reserve Fund
("DRRF") for debt reduction in fiscal year 2001-02.
General Fund receipts, including transfers from other funds, totaled $39.88
billion for the 2000-01 fiscal year, an increase of $2.49 million (6.7 percent)
over fiscal year 1999-2000 results. General Fund disbursements, including
transfers to other funds, totaled $39.70 billion for the 2000-01 fiscal year,
an increase of $2.53 billion (6.8 percent) from the 1999-2000 fiscal year.
27
1999-00 Fiscal Year. The State ended its 1999-2000 fiscal year in balance
on a cash basis, with a General Fund cash-basis surplus of $1.51 billion as
reported by DOB. As in recent years, strong growth in receipts above forecasted
amounts produced most of the year-end surplus. Spending was also modestly below
projections, further adding to the surplus.
The State reported a closing balance of $1.17 billion in the General Fund,
an increase of $275 million over the closing balance from the prior year. The
balance was held in four accounts within the General Fund: the TSRF, the CRF,
the DRRF and the CPF. The balance is comprised of $547 million in the TSRF
after a deposit of $74 million in 1999-2000; $107 million in the CRF; $250
million in the DRRF; and $263 million in the CPF.
The closing fund balance excludes $3.97 billion that the State deposited
into the tax refund reserve account at the close of 1999-2000 to pay for tax
refunds in 2000-01 of which $521 million was made available as a result of the
LGAC financing program and was required to be on deposit as of March 31, 2000.
The tax refund reserve account transaction has the effect of decreasing
reported personal income tax receipts in 1999-2000, while increasing reported
receipts in 2000-01.
General Fund receipts and transfers from other funds (net of tax refund
reserve account activity) for the 1999-2000 fiscal year totaled $37.40 billion,
an increase of 1.6 percent over 1998-99. General Fund disbursements and
transfers to other funds totaled $37.17 billion, an increase of 1.6 percent
from the prior fiscal year.
Debt Limits and Outstanding Debt. There are a number of methods by which
the State of New York may incur debt. The State may issue general obligation
bonds. Under the State Constitution, the State may not, with limited exceptions
for emergencies, undertake long-term general obligation borrowing (i.e.,
borrowing for more than one year) unless the borrowing is authorized in a
specific amount for a single work or purpose by the Legislature and approved by
the voters. There is no constitutional limitation on the amount of long-term
general obligation debt that may be so authorized and subsequently incurred by
the State. However, the Debt Reform Act of 2000 (the "Debt Reform Act") imposes
statutory limitations on new State-supported debt outstanding, which apply to
general obligations bonds as well as other State-supported bonds issued on and
after April 1, 2000. The State Constitution also provides that general
obligation bonds must be paid in equal annual installments or installments that
result in substantially level or declining debt service payments, within 40
years after issuance, and beginning not more than one year after issuance of
such bonds. General obligation housing bonds must be paid within 50 years after
issuance, commencing no more than three years after issuance. However, the Debt
Reform Act of 2000 limits the maximum term of State-supported bonds, including
general obligation bonds, to thirty years.
The Debt Reform Act implemented statutory initiatives intended to improve
the State's borrowing practices. The Debt Reform Act imposes phased-in caps on
new debt outstanding and new debt service costs. The Act also limited the use
of debt to capital works and purposes only.
The cap on new State-supported debt outstanding began at 0.75 percent of
personal income in 2000-01 and is gradually increasing until it is fully
phased-in at 4 percent of personal income in 2010-11. Similarly, the cap on new
State-supported debt service costs began at 0.75 percent of total governmental
funds receipts on 2000-01 and is gradually increasing until it is fully phased
at 5 percent in 2013-14.
The Debt Reform Act requires the limitations on the issuance of
State-supported debt and debt services costs to be calculated by October 31 of
each year and reported in the quarterly Financial Plan Update most proximate to
October 31st of each year. If the calculations for new State-supported debt
outstanding and debt service costs are less than the State-supported debt
outstanding and debt service costs permitted under the Debt Reform Act, new
State-supported debt may continue to be issued. However, if either the debt
outstanding or the debt service cap is met or exceeded, the State would be
precluded from contracting new State-supported debt until the next annual cap
calculation is made and State-supported debt is found to be within the
appropriate
28
limitations. The DOB expects that the prohibition on issuing new
State-supported debt if the caps are met or exceeded will provide an incentive
to treat the debt caps as absolute limits that should not be reached, and
therefore DOB intends to manage subsequent capital plans and issuance schedules
under these limits.
Pursuant to the provisions of the Debt Reform Act, the first calculation of
the Debt Reform Act's limitations was reported in the Financial Plan Update
most proximate to October 31, 2001. For the 2001-02 fiscal year, both caps are
set at 1.25 percent. On October 30, 2002, the State reported that it was in
compliance with both debt caps, with new debt outstanding at 0.67 percent of
personal income and new debt service at 0.36 percent of total governmental
receipts. The DOB expects that debt outstanding and debt service costs for the
2002-03 fiscal year will also be within the statutory caps.
The State may undertake short-term borrowings without voter approval (i) in
anticipation of the receipt of taxes and revenues, by issuing tax and revenue
anticipation notes, and (ii) in anticipation of the receipt of proceeds from
the sale of duly authorized but unissued general obligation bonds, by issuing
bond anticipation notes. The State may also, pursuant to specific
constitutional authorization, directly guarantee certain obligations of the
State of New York's authorities and public benefit corporations
("Authorities"). The State has never been called upon to make any direct
payments pursuant to any such guarantees. Payments of debt service on New York
State general obligation and New York State-guaranteed bonds and notes are
legally enforceable obligations of the State of New York.
State Finance Law requires the State to update its five-year Capital Program
and Financing Plan (the "Financing Plan") within 90 days after the enactment of
the State Budget. DOB issued an update to the Financing Plan covering the years
2002-03 through 2006-07 on August 16, 2002. Over the five-year Financing Plan,
annual debt issuances are expected to average $3.1 billion to support average
annual capital projects spending of $5.1 billion, with the remainder financed
with State and Federal pay-as-you-go resources. Total State-supported debt
service costs are projected to increase from $3.65 billion in 2002-03 to $4.75
billion in 2006-07, an average annual increase of 6.8 percent, and total
State-supported debt outstanding is expected to increase from $39.0 billion in
2002-03 to $41.9 billion in 2006-07, an average annual increase of 1.8 percent.
In 2001, legislation was enacted to provide for the issuance by certain
State authorities of State Personal Income Tax Revenue Bonds, which are
expected to become the primary financing vehicle for a broad range of
State-supported debt programs authorized to be secured by service contract or
lease-purchase payments. These State Personal Income Tax Revenue Bonds are
expected to reduce borrowing costs by improving the marketability and
creditworthiness of State-supported obligations and by permitting the
consolidation of multiple bonding programs to reduce administrative costs.
The legislation provides that 25 percent of personal income tax receipts
(excluding refunds owed to taxpayers and deposits to STAR) be deposited to the
Revenue Bond Tax Fund for purposes of making debt service payments on these
bonds, with excess amounts returned to the General Fund. In the event that (i)
the State Legislature fails to appropriate amounts required to make all debt
service payments on the State Personal Income Tax Revenue Bonds or (ii) having
been appropriated and set aside pursuant to a certificate of the Director of
the Budget, financing agreement payments have not been made when due on the
bonds, the legislation requires that personal income tax receipts continue to
be deposited to the Revenue Bond Tax Fund until amounts on deposit in the Fund
equal the greater of 25 percent of annual personal income tax receipts or $6
billion.
The State issued its first State Personal Income Tax Revenue Bonds (in an
aggregate principal amount of $225 million) on May 9, 2002.
The State employs additional long-term financing mechanisms, lease-purchase
and contractual-obligation financings, which involve obligations of public
authorities or municipalities that are State-supported but are not general
obligations of the State. Under these financing arrangements, certain public
authorities and municipalities
29
have issued obligations to finance the construction and rehabilitation of
facilities or the acquisition and rehabilitation of equipment, and expect to
meet their debt service requirements through the receipt of rental or other
contractual payments made by the State. Although these financing arrangements
involve a contractual agreement by the State to make payments to a public
authority, municipality or other entity, the State's obligation to make such
payments is generally expressly made subject to appropriation by the
Legislature and the actual availability of money to the State for making the
payments. The State has also entered into a contractual-obligation financing
arrangement with the LGAC to restructure the way the State makes certain local
aid payments.
On January 13, 1992, S&P reduced its ratings on the State's general
obligation bonds from A to A- and, in addition, reduced its ratings on the
State's moral obligation, lease purchase, guaranteed and contractual obligation
debt. On August 28, 1997, S&P revised its ratings on the State's general
obligation bonds from A- to A and revised its ratings on the State's moral
obligation, lease purchase, guaranteed and contractual obligation debt. On
March 5, 1999, S&P affirmed its A rating on the State's outstanding bonds. On
March 10, 2000, S&P assigned its A+ rating on New York State's long-term
general obligations. On December 19, 2000, S&P assigned its AA rating on New
York State's long-term general obligations.
On January 6, 1992, Moody's reduced its ratings on outstanding
limited-liability State lease purchase and contractual obligations from A to
Baa1. On February 28, 1994, Moody's reconfirmed its A rating on the State's
general obligation long-term indebtedness. On March 20, 1998, Moody's assigned
the highest commercial paper rating of P-1 to the short-term notes of the
State. On March 5, 1999, Moody's affirmed its A2 rating with a stable outlook
to the State's general obligations. In June 2000, Moody's revised its outlook
on the State's general obligations from stable to positive. On December 6,
2002, Moody's changed its outlook on the State's general obligation bonds from
stable to negative but retained its A2 rating.
New York State has never defaulted on any of its general obligation
indebtedness or its obligations under lease-purchase or contractual-obligation
financing arrangements and has never been called upon to make any direct
payments pursuant to its guarantees.
Litigation. The legal proceedings listed below involve State finances and
programs and miscellaneous civil rights, real property, contract and other tort
claims in which the State is a defendant and the potential monetary claims
against the State are deemed to be material, generally in excess of $100
million. These proceedings could adversely affect the financial condition of
the State in the 2002-03 fiscal year or thereafter. The State will describe
newly initiated proceedings which the State believes to be material, as well as
any material and adverse developments in the listed proceedings, in updates or
supplements to its Annual Information Statement.
Certain litigation pending against New York State or its officers or
employees could have a substantial or long-term adverse effect on New York
State finances. Among the more significant of these cases are those that
involve (1) the validity of agreements and treaties by which various Indian
tribes transferred title to New York State of certain land in central and
upstate New York; (2) certain aspects of New York State's Medicaid policies,
including its rates, regulations and procedures; (3) a challenge to the
Governor's application of his constitutional line item veto authority; (4) a
challenge to the funding for New York City public schools; (5) the Governor
seeking a judgment declaring that the actions of the Senate and the Assembly in
voting and passing 46 budget bills violated the State Constitution, because
they deleted provisions of appropriations proposed by the Governor, substituted
other appropriations, and considered other bills prior to taking action on the
appropriation bills submitted by the Governor; and (6) the constitutionality of
those portions of Chapter 1 of the Laws of 2002 which relate to the
authorization of the conversion of Empire Health Choice, d/b/a/ Empire Blue
Cross and Blue Shield from a not-for-profit corporation to a for-profit
corporation.
Adverse developments in the proceedings described above, other proceedings
for which there are unanticipated, unfavorable and material judgments, or the
initiation of new proceedings could affect the ability of
30
the State to maintain a balanced 2002-03 Financial Plan. The State believes
that the proposed 2002-03 Financial Plan includes sufficient reserves to offset
the costs associated with the payment of judgments that may be required during
the 2002-03 fiscal year. These reserves include (but are not limited to)
amounts appropriated for Court of Claims payments and projected fund balances
in the General Fund. In addition, any amounts ultimately required to be paid by
the State may be subject to settlement or may be paid over a multi-year period.
There can be no assurance, however, that adverse decisions in legal proceedings
against the State would not exceed the amount of all potential 2002-03
Financial Plan resources available for the payment of judgments, and could
therefore affect the ability of the State to maintain a balanced 2002-03
Financial Plan.
Although other litigation is pending against New York State, except as
described herein, no current material litigation involves New York State's
Constitutional or statutory authority to contract indebtedness, issue its
obligations, or pay such indebtedness when due, or affects New York State's
power or ability, as a matter of law, to impose or collect significant amounts
of taxes and revenues.
On November 23, 1998, the attorneys general for 46 states (including New
York) entered into a master settlement agreement ("MSA") with the nation's
largest tobacco manufacturers. Under the terms of the MSA, the states agreed to
release the manufacturers from all smoking-related claims in exchange for
specified payments and the imposition of restrictions on tobacco advertising
and marketing. New York is projected to receive $25 billion over 25 years under
the MSA, with payments apportioned among the State (51 percent), counties (22
percent), and New York City (27 percent). The projected payments are an
estimate and subject to adjustments for, among other things, the annual change
in the volume of cigarette shipments and the rate of inflation. From 1999-2000
through 2002-03, the State expects to receive $1.54 billion under the
nationwide settlement with cigarette manufacturers. Counties, including New
York City, will receive settlement payments of $1.47 billion over the same
period.
Authorities. The fiscal stability of New York State is related, in part, to
the fiscal stability of its Authorities, which generally have responsibility
for financing, constructing and operating revenue-producing public benefit
facilities. Authorities are not subject to the constitutional restrictions on
the incurrence of debt which apply to the State itself, and may issue bonds and
notes within the amounts of, and as otherwise restricted by, their legislative
authorization. The State's access to the public credit markets could be
impaired, and the market price of its outstanding debt may be materially and
adversely affected, if any of the Authorities were to default on their
respective obligations, particularly with respect to debt that is
State-supported or State-related.
Authorities are generally supported by revenues generated by the projects
financed or operated, such as fares, user fees on bridges, highway tolls and
rentals for dormitory rooms and housing. In recent years, however, New York
State has provided financial assistance through appropriations, in some cases
of a recurring nature, to certain of the Authorities for operating and other
expenses and, in fulfillment of its commitments on moral obligation
indebtedness or otherwise, for debt service. This operating assistance is
expected to continue to be required in future years. In addition, certain
statutory arrangements provide for State local assistance payments otherwise
payable to localities to be made under certain circumstances to certain
Authorities. The State has no obligation to provide additional assistance to
localities whose local assistance payments have been paid to Authorities under
these arrangements. However, in the event that such local assistance payments
are so diverted, the affected localities could seek additional State funds.
For purposes of analyzing the financial condition of the State, debt of the
State and of certain public authorities may be classified as State-supported
debt, which includes general obligation debt of the State and lease-purchase
and contractual obligations of public authorities (and municipalities) where
debt service is paid from State appropriations (including dedicated tax
sources, and other revenues such as patient charges and dormitory facilities
rentals). In addition, a broader classification, referred to as State-related
debt, includes State-supported debt, as well as certain types of contingent
obligations, including moral obligation financings, certain contingent
contractual-obligation financing arrangements, and State-guaranteed debt
described above, where debt service is expected to be paid from other sources
and State appropriations are contingent in that they may be made and used only
under certain circumstances.
31
New York City and Other Localities. The fiscal health of the State may also
be affected by the fiscal health of New York City (the "City"), which continues
to receive significant financial assistance from the State. State aid
contributes to the city's ability to balance its budget and meet its cash
requirements. The State may also be affected by the ability of the City, and
certain entities issuing debt for the benefit of the city, to market their
securities successfully in the public credit markets.
On September 11, 2001, two hijacked passenger jetliners flew into the world
Trade Center, resulting in a substantial loss of life, destruction of the World
Trade Center, and damage to other buildings in the vicinity. Trading on the
major New York stock exchanges was suspended until September 17, 2001, and
business in the financial district was interrupted. Recovery efforts were
completed on May 30, 2002.
Recovery, cleanup, and repair efforts resulted in substantial expenditures.
The U.S. congress passed emergency legislation that authorized $40 billion for
disaster assistance, increased security costs, and the rebuilding of
infrastructure systems and other public facilities, and disaster recovery and
related activities. Congress and the President have already appropriated over
$10 billion of this amount for disaster assistance in New York, Pennsylvania
and Virginia. The President has submitted a bill to congress that would bring
the total commitment of federal disaster assistance for New York to $21.4
billion. In addition, the State legislature increased the financing capacity of
the New York City Transitional Finance authority (TFA) by $2.5 billion to fund
recovery costs, and has authorized the TFA to issue debt without limit as to
principal amount that is payable solely from State or Federal aid received on
account of the disaster.
On March 9, 2002, the President signed nationwide stimulus legislation that
includes $5.5 billion toward the $21.4 billion commitment, in the form of
temporary tax provisions aimed at creating redevelopment incentives for
businesses located in the Liberty Zone, the area surrounding the World Trade
Center site. The Liberty Zone provisions expand the work opportunity tax
credit, provide a bonus 30 percent depreciation deduction, authorize the
issuance of $8 billion in tax-exempt private activity bonds, allow for advance
refunding of certain bonds for facilities in the City, and increase the small
business expensing limit.
The City is seeking to be reimbursed by the Federal government for all of
its direct costs for response and remediation of the World Trade Center site.
These costs are now expected to be substantially below previous estimates. The
City also expects to receive Federal funds for costs of economic revitalization
and other needs, not directly payable through the City budget, relating to the
September 11 attack.
The City has achieved balanced operating results for each of its fiscal
years since 1981 as measured by the GAAP standards in effect at that time. The
City prepares a four-year financial plan annually and updates it periodically,
and prepares a comprehensive annual financial report each October describing
its most recent fiscal year.
In 1975, the City suffered a fiscal crisis that impaired the borrowing
ability of both the City and New York State. In that year the City lost access
to the public credit markets. The City was not able to sell short-term notes to
the public again until 1979. In 1975, S&P suspended its A rating of City bonds.
This suspension remained in effect until March 1981, at which time the City
received an investment grade rating of BBB from S&P.
On July 2, 1985, S&P revised its rating of City bonds upward to BBB+ and on
November 19, 1987, to A-. On February 3, 1998 and again on May 27, 1998, S&P
assigned a BBB+ rating to the City's general obligation debt and placed the
ratings on CreditWatch with positive implications. On March 9, 1999, S&P
assigned its A- rating to Series 1999H of New York City general obligation
bonds and affirmed the A- rating on various previously issued City bonds. On
November 27, 2002, S&P changed its outlook for the City's general obligation
debt to "negative" from "stable" but maintained its single-A rating.
32
Moody's ratings of City bonds were revised in November 1981 from B (in
effect since 1977) to Ba1, in November 1983 to Baa, in December 1985 to Baa1,
in May 1988 to A and again in February 1991 to Baa1. On February 25, 1998,
Moody's upgraded approximately $28 billion of the City's general obligations
from Baa1 to A3. On June 9, 1998, Moody's affirmed its A3 rating to the City's
general obligations and stated that its outlook was stable. In August 2000,
Moody's upgraded approximately $26 billion of the City's general obligations
from A3 to A2.
On March 8, 1999, Fitch IBCA upgraded the City's $26 billion outstanding
general obligation bonds from A- to A. Subsequent to that time, the City's
general obligation bonds have not been downgraded by Fitch IBCA.
In response to the City's fiscal crisis in 1975, the State took action to
assist the City in returning to fiscal stability. Among those actions, the
State established the Municipal Assistance Corporation for the City of New York
("NYC MAC") to provide financing assistance to the City; the New York State
Financial Control Board (the "Control Board") to oversee the City's financial
affairs; and the Office of the State Deputy Comptroller for the City of New
York ("OSDC") to assist the Control Board in exercising its powers and
responsibilities. A "control period" existed from 1975 to 1986, during which
the City was subject to certain statutorily-prescribed fiscal controls. The
Control Board terminated the control period in 1986 when certain statutory
conditions were met. State law requires the Control Board to reimpose a control
period upon the occurrence, or "substantial likelihood and imminence" of the
occurrence, of certain events, including (but not limited to) a City operating
budget deficit of more than $100 million or impaired access to the public
credit markets.
Currently, the City and its Covered Organizations (i.e., those organizations
which receive or may receive moneys from the City directly, indirectly or
contingently) operate under the City's Financial Plan. The City's Financial
Plan summarizes its capital, revenue and expense projections and outlines
proposed gap-closing programs for years with projected budget gaps. The City's
projections set forth in its Financial Plan are based on various assumptions
and contingencies, some of which are uncertain and may not materialize.
Unforeseen developments (such as the World Trade Center attack) and changes in
major assumptions could significantly affect the City's ability to balance its
budget as required by State law and to meet its annual cash flow and financing
requirements.
For the 2000-01 and 2001-02 fiscal years (ending June 30), the City had
operating surpluses of $2.9 billion and $682 million, respectively, before
discretionary and other transfers, and achieved balanced operating results
after discretionary and other transfers, in accordance with GAAP. Prior to its
gap-closing program, the City projected a $4.8 billion budget gap for fiscal
year 2003, and even larger gaps in subsequent years. The City's June Financial
Plan, which incorporates the enacted budget for 2002-03, includes gap-closing
actions of $4.8 billion that balance the 2002-03 budget. The gap-closing
program includes resources from agency actions and anticipates actions to be
taken by the Federal and State governments and the municipal unions. The
2002-03 budget also includes $1.5 billion in bond proceeds from the TFA to
mitigate a portion of the lost tax revenues related to the September 11 attack
on the World Trade Center. The financial plan does not include wage increases
for any City employees beyond the current round of collective bargaining.
On January 28, 2003, the City released a modification to its four-year
financial plan, which incorporates changes since the June 2002 Financial Plan.
Compared to the June Plan, the January modification projects significantly
lower tax revenues due to the continuing decline in financial services sector
profits, and reflect other revised forecasts, such as significantly higher
pension costs. The modification also reflects the implementation of an 18.49
percent property tax increase, effective January 1, 2003, as well as agency
actions to reduce planned spending and increase revenues that were included in
the November modification.
The January modification assumes the successful implementation of a program
to close projected gaps of approximately $486 million in fiscal year 2002-03
and $3.4 billion in fiscal year 2003-04. The modification includes further
reductions in planned agency spending, revenue increases, and City proposals
that require
33
approval by the State ($1.7 billion) and Federal governments ($850 million) and
the municipal unions ($600 million). The gap-closing program also assumes a
$600 million retroactive payment and an ongoing $92 million payment from the
Port Authority of New York and New Jersey for airport leases. The financial
plan does not include wage increases for any City employees beyond the current
round of collective bargaining and assumes that the Governor's Executive Budget
will not reduce the level of State aid assumed in the financial plan.
The City is heavily dependent on New York State and federal assistance to
cover insufficiencies in its revenues. There can be no assurance that in the
future Federal and State assistance will enable the City to make up its budget
deficits. Although the City has consistently maintained balanced budgets and is
projected to achieve balanced operating results for the current fiscal year,
there can be no assurance that the gap-closing actions proposed in its
Financial Plan can be successfully implemented or that the City will maintain a
balanced budget in future years without additional State aid, revenue increases
or expenditure reductions. Additional tax increases and reductions in essential
City services could adversely affect the City's economic base.
The projections set forth in the City's Financial Plan were based on various
assumptions and contingencies which are uncertain and which may not
materialize. Changes in major assumptions could significantly affect the City's
ability to balance its budget as required by State law and to meet its annual
cash flow and financing requirements. Such assumptions and contingencies
include the condition of the regional and local economies, the impact on real
estate tax revenues of the real estate market, wage increases for City
employees consistent with those assumed in the Financial Plan, employment
growth, the ability to implement proposed reductions in City personnel and
other cost reduction initiatives, the ability of the Health and Hospitals
Corporation to take actions to offset reduced revenues, the ability to complete
revenue generating transactions, provision of State and Federal aid and mandate
relief and the impact on City revenues and expenditures of Federal and State
welfare reform and any future legislation affecting Medicare or other
entitlements.
To successfully implement its Financial Plan, the City and certain entities
issuing debt for the benefit of the City must market their securities
successfully. This debt is issued to finance the rehabilitation of the City's
infrastructure and other capital needs and to refinance existing debt, as well
as to finance seasonal needs and recovery costs related to the attacks on the
World Trade Center. In recent years, the State Constitutional debt limit would
have prevented the City from entering into new capital contracts. To prevent
disruptions in the capital program, two actions were taken to increase the
City's capital financing capacity: (i) the State Legislature created the New
York City Transitional Finance Authority in 1997, and (ii) in 1999, the City
created TSASC, Inc., a not-for-profit corporation empowered to issue tax-exempt
debt backed by tobacco settlement revenues. The City expects that these
actions, combined with the City's remaining capacity, will provide sufficient
financing capacity to continue its capital program through City fiscal year
2011.
The City Comptroller and other agencies and public officials have issued
reports and made public statements which, among other things, state that
projected revenues and expenditures may be different from those forecast in the
City's financial plans. It is reasonable to expect that such reports and
statements will continue to be issued and to engender public comment.
Certain localities, in addition to the City, have experienced financial
problems and have requested and received additional New York State assistance
during the last several State fiscal years. The potential impact on the State
of any future requests by localities for additional assistance is not included
in the State's projections of its receipts and disbursements for the fiscal
year.
Municipalities and school districts have engaged in substantial short-term
and long-term borrowings. State law requires the Comptroller to review and make
recommendations concerning the budgets of those local government units other
than the City that are authorized by State law to issue debt to finance
deficits during the period that such deficit financing is outstanding.
34
From time to time, Federal expenditure reductions could reduce, or in some
cases eliminate, Federal funding of some local programs and accordingly might
impose substantial increased expenditure requirements on affected localities.
If the State, the City or any of the Authorities were to suffer serious
financial difficulties jeopardizing their respective access to the public
credit markets, the marketability of notes and bonds issued by localities
within the State could be adversely affected. Localities also face anticipated
and potential problems resulting from certain pending litigation, judicial
decisions and long-range economic trends. Long-range potential problems of
declining urban population, increasing expenditures and other economic trends
could adversely affect localities and require increasing the State assistance
in the future.
Puerto Rico Risk Factors
The fund may invest in obligations of the Commonwealth of Puerto Rico and
its political subdivisions, agencies and instrumentalities that qualify as
double tax-exempt Municipal Obligations. The majority of Puerto Rico's debt is
issued by 10 of the major public agencies that are responsible for many of its
public functions, such as water, wastewater, highways, telecommunications,
education and public construction.
The Puerto Rico economy generally parallels the economic cycles of the
United States; as most goods are imported from the U.S. Interest rates also
generally mirror those of the United States. For decades, Puerto Rico has had a
very open economy, with large flows of trade, investment and income. The
magnitude of those flows is so large compared to the scale of the whole
economy, that their behavior is a key element in the analysis of Puerto Rico's
Gross National Product accounting.
Virgin Island Risk Factors
The United States Virgin Islands include St. Thomas, St. John and St. Croix.
The islands are located in the Lesser Antilles, 1,100 east, southeast of Miami.
Historically a center of sugar production and commerce, by the 1980s tourism
had become the leading economic factor in the Virgin Islands. The Virgin
Islands are the Caribbean's most popular tourist destination. Circumstances,
which negatively impact the tourism industry, such as natural disasters,
economic difficulties, political events and terrorist activities in the United
States, and to a lesser extent other countries, could have a negative impact on
the overall economy of the Virgin Islands.
Guam Risk Factors
Guam, the westernmost territory of the U.S., is located 3,800 miles to the
west-southwest of Honolulu, Hawaii and approximately 1,550 miles southeast of
Japan. Guam's economy is heavily dependent upon the U.S. military and tourism,
particularly from Japan. A weakened Japanese economy has affected Guam's
tourism sector. Public sector employment in Guam is significant with
approximately 40% of the labor force working for the local government or in
federal jobs. The rest of the labor force works in the private sector. Major
private sector employment categories include construction, trade and services.
Guam has experienced U.S. military reductions, and it is unclear whether plans
to increase tourism may succeed in limiting the negative effects of such
reductions. The government of Guam has taken steps to improve its financial
position, which include the development of local labor; however, there can be
no assurances that an improvement will be realized.
PORTFOLIO TRANSACTIONS
Decisions to buy and sell securities for each fund are made by the manager,
subject to the overall review of the trust's board of trustees. Although
investment decisions for each fund are made independently from those of the
other accounts managed by the manager, investments of the type that a fund may
make also may be made by those other accounts. When a fund and one or more
other accounts managed by the manager are prepared to invest in, or desire to
dispose of, the same security, available investments or opportunities for sales
will be
35
allocated in a manner believed by the manager to be equitable to each. In some
cases, this procedure may adversely affect the price paid or received by a fund
or the size of the position obtained or disposed of by a fund. The trust has
paid no brokerage commissions since its commencement of operations.
Allocation of transactions on behalf of the funds, including their
frequency, to various dealers is determined by the manager in its best judgment
and in a manner deemed fair and reasonable to the funds' shareholders. The
primary considerations of the manager in allocating transactions are
availability of the desired security and the prompt execution of orders in an
effective manner at the most favorable prices. Subject to these considerations,
dealers that provide supplemental investment research and statistical or other
services to the manager may receive orders for portfolio transactions by a
fund. Information so received is in addition to, and not in lieu of, services
required to be performed by the manager, and the fees of the manager are not
reduced as a consequence of their receipt of the supplemental information. The
information may be useful to the manager in serving both a fund and other
clients, and conversely, supplemental information obtained by the placement of
business of other clients may be useful to the manager in carrying out its
obligations to a fund.
The Board has approved procedures in conformity with Rule 10f-3 under the
1940 Act whereby the fund may purchase securities that are offered in
underwritings in which a Citigroup affiliate participates. These procedures
prohibit the fund from directly or indirectly benefiting a Citigroup affiliate
in connection with such underwritings. In addition, for underwritings where a
Citigroup affiliate participates as a principal underwriter, certain
restrictions may apply that could, among other things, limit the amount of
securities that the fund could purchase in the underwritings.
No fund will purchase U.S. Government Securities or Municipal Obligations
during the existence of any underwriting or selling group relating to the
securities, of which the manager is a member, except to the extent permitted by
the SEC. Under certain circumstances, a fund may be at a disadvantage because
of this limitation in comparison with other funds that have similar investment
objectives but that are not subject to a similar limitation.
The trust has paid no brokerage commissions for portfolio transactions since
its commencement of operations. Portfolio securities transactions on behalf of
the fund are placed by the manager with a number of brokers and dealers,
including Citigroup Global Markets Inc. ("CGM"). CGM has advised the fund that
in transactions with the fund, CGM charges a commission rate at least as
favorable as the rate that CGM charges its comparable unaffiliated customers in
similar transactions.
PORTFOLIO TURNOVER
While a fund's portfolio turnover rate (the lesser of purchases or sales of
portfolio securities during the year, excluding purchases or sales of
short-term securities, divided by the monthly average value of portfolio
securities) is generally not expected to exceed 100%, it has in the past
exceeded 100% with respect to each fund. The rate of turnover will not be a
limiting factor, however, when a fund deems it desirable to sell or purchase
securities. This policy should not result in higher brokerage commissions to a
fund, as purchases and sales of portfolio securities are usually effected as
principal transactions. Securities may be sold in anticipation of a rise in
interest rates (market decline) or purchased in anticipation of a decline in
interest rates (market rise) and later sold. In addition, a security may be
sold and another security of comparable quality purchased at approximately the
same time to take advantage of what a fund believes to be a temporary disparity
in the normal yield relationship between the two securities. These yield
disparities may occur for reasons not directly related to the investment
quality of particular issues or the general movement of interest rates, such as
changes in the overall demand for, or supply of, various types of tax-exempt
securities.
36
The portfolio turnover rates are as follows:
[Download Table]
Year Year Year
Ended Ended Ended
Fund 11/30/02 11/30/01 11/30/00
---- -------- -------- --------
California Fund............ 12% 4% 8%
New York Fund.............. 8% 9% 10%
INVESTMENT RESTRICTIONS
The investment restrictions numbered 1 through 7 below have been adopted by
the trust as fundamental policies of the funds. Under the 1940 Act, a
fundamental policy may not be changed with respect to a fund without the vote
of a majority of the outstanding voting securities of the fund. Majority is
defined in the 1940 Act as the lesser of (a) 67% or more of the shares present
at a fund meeting, if the holders of more than 50% of the outstanding shares of
the fund are present or represented by proxy, or (b) more than 50% of
outstanding shares. The remaining restrictions may be changed by a vote of a
majority of the trust's board of trustees at any time.
Under the investment restrictions adopted by the trust with respect to the
funds, a fund will not:
1. Invest more than 25% of its total assets in securities, the issuers
of which conduct their principal business activities in the same industry.
For purposes of this limitation, securities of the U.S. government
(including its agencies and instrumentalities) and securities of state or
municipal governments and their political subdivisions are not considered to
be issued by members of any industry.
2. Borrow money, except that (a) the fund may borrow from banks for
temporary or emergency (not leveraging) purposes, including the meeting of
redemption requests which might otherwise require the untimely disposition
of securities, and (b) the fund may, to the extent consistent with its
investment policies, enter into reverse repurchase agreements, forward roll
transactions and similar investment strategies and techniques. To the extent
that it engages in transactions described in (a) and (b), the fund will be
limited so that no more than 33 1/3% of the value of its total assets
(including the amount borrowed), valued at the lesser of cost or market,
less liabilities (not including the amount borrowed), is derived from such
transactions.
3. Issue "senior securities" as defined in the 1940 Act and the rules,
regulations and orders thereunder, except as permitted under the 1940 Act
and the rules, regulations and orders thereunder.
4. Make loans. This restriction does not apply to: (a) the purchase of
debt obligations in which the fund may invest consistent with its investment
objectives and policies; (b) repurchase agreements; and (c) loans of its
portfolio securities, to the fullest extent permitted under the 1940 Act.
5. Purchase or sell real estate, real estate mortgages, commodities or
commodity contracts, but this restriction shall not prevent the fund from
(a) investing in securities of issuers engaged in the real estate business
or the business of investing in real estate (including interests in limited
partnerships owning or otherwise engaging in the real estate business or the
business of investing in real estate) and securities which are secured by
real estate or interests therein; (b) holding or selling real estate
received in connection with securities it holds or held; (c) trading in
futures contracts and options on futures contracts (including options on
currencies to the extent consistent with the funds' investment objective and
policies); or (d) investing in real estate investment trust securities.
6. Engage in the business of underwriting securities issued by other
persons, except to the extent that the fund may technically be deemed to be
an underwriter under the Securities Act of 1933, as amended, in disposing of
portfolio securities.
37
7. Under normal circumstances, invest less than 80% of its assets (net
assets plus any borrowings for investment purposes), in its respective State
investment grade municipal securities, or other investments with similar
economic characteristics, the income from which is exempt from regular
federal income taxes and its respective State personal income taxes.
Each fund considers any investments in municipal obligations that pay
interest subject to the AMT as part of the 80% of the fund's assets to be
invested in municipal securities.
8. Purchase any securities on margin (except for such short-term credits
as are necessary for the clearance of purchases and sales of portfolio
securities) or sell any securities short (except "against the box"). For
purposes of this restriction, the deposit or payment by the fund of
underlying securities and other assets in escrow and collateral agreements
with respect to initial or maintenance margin in connection with futures
contracts and related options and options on securities, indexes or similar
items is not considered to be the purchase of a security on margin.
9. invest in oil, gas or other mineral leases or exploration or
development programs.
10. write or sell puts, calls, straddles, spreads or combinations of
those transactions, except as permitted under the fund's investment
objective and policies.
11. purchase a security if, as a result, the fund would then have more
than 5% of its total assets invested in securities of issuers (including
predecessors) that have been in continuous operation for fewer than three
years, except that this limitation will be deemed to apply to the entity
supplying the revenues from which the issue is to be paid, in the case of
private activity bonds purchased.
12. make investments for the purpose of exercising control of management.
If any percentage restriction described above is complied with at the time of
an investment, a later increase or decrease in percentage resulting from a
change in values or assets will not constitute a violation of such restriction.
38
TRUSTEES AND EXECUTIVE OFFICERS OF THE TRUST OR FUNDS
The board of trustees in accordance with the laws of the Commonwealth of
Massachusetts manages the business and affairs of each fund. The board elects
officers who are responsible for the day-to-day operations of a fund and who
execute policies authorized by the board. Under each fund's Master Trust
Agreement, the board may classify or reclassify any unissued shares of the
funds into one or more additional classes by setting or changing in any one or
more respects their relative rights, voting powers, restrictions, limitations
as to dividends, qualifications and terms and conditions of redemption. The
board may similarly classify or reclassify any class of a fund's shares into
one or more series and, without shareholder approval, may increase the number
of authorized shares of a fund.
The trustees, including trustees who are not "interested persons" of the
trust or the manager, as defined in the 1940 Act ("independent trustees") and
executive officers of the trust, together with information as to their
principal business occupations during the past five years, are shown below.
[Enlarge/Download Table]
Term Number
of of
Office Portfolios
and in Fund
Length Complex
of Overseen
Position(s) Held Time Principal Occupation(s) by Other Directorships
Name, Address, and Age with Fund Served* During Past 5 Years Trustee Held by Trustee
---------------------- ---------------- ------- --------------------------------- ---------- -------------------
INDEPENDENT TRUSTEES
Herbert Barg Trustee Since Retired 42 None
1460 Drayton Lane 1995
Wynnewood, PA 19096
Age 79
Dwight B. Crane Trustee Since Professor-Harvard Business School 49 None
Harvard Business School 1995
Soldiers Field Morgan Hall #375
Boston, MA 02163
Age 65
Burt N. Dorsett Trustee Since President--Dorsett McCabe 27 None
201 East 62nd Street 1991 Capital Management Inc.; Chief
Apt. 3C Investment Officer-Leeb Capital
New York, NY 10021 Management, Inc. 1999-Present
Age 72
Elliot S. Jaffe Trustee Since Chairman of The Dress Barn Inc. 27 Zweig Total Return
The Dress Barn Inc. 1991 Fund; Zweig Fund,
Executive Office Inc.
30 Dunnigan Drive
Suffern, NY 10901
Age 76
Stephen E. Kaufman Trustee Since Attorney 60 None
Stephen E. Kaufman PC 1995
277 Park Avenue,
47th Fl
New York, NY 10172
Age 71
Joseph J. McCann Trustee Since Retired 27 None
200 Oak Park Place 1995
Suite One
Pittsburgh, PA 15243
Age 72
Cornelius C. Rose, Jr. Trustee Since Chief Executive Officer- 27 None
Meadowbrook Village 1991 Performance Learning Systems
Building 1, Apt. 6
W. Lebanon, NH 03784
Age 70
39
[Enlarge/Download Table]
Term Number
of of
Office Portfolios
and in Fund
Length Complex
of Overseen
Position(s) Held Time Principal Occupation(s) by Other Directorships
Name, Address, and Age with Fund Served* During Past 5 Years Trustee Held by Trustee
---------------------- ---------------- ------- ---------------------------------- ---------- -------------------
INTERESTED TRUSTEE**
R. Jay Gerken President and Since Managing Director of CGM; 219 None
Citigroup Asset Management Chief Executive 2002 Chairman, President and Chief
("CAM") Officer Executive Officer of SBFM,
399 Park Avenue Travelers Investment Adviser, Inc
New York, NY 10022 ("TIA") and Citi Fund Management
Age 52 Inc.
OFFICERS
Lewis E. Daidone Senior Vice Since Managing Director of CGM; N/A N/A
SSB President and 1995 Director and Senior Vice President
125 Broad Street Chief of SBFM and TIA; Former
New York, NY 10004 Administrative Treasurer and Chief Financial
Age 45 Officer Officer of certain Smith Barney
Mutual Funds
Richard L. Peteka Chief Financial Since Chief Financial Officer and N/A N/A
CAM Officer and 2002 Treasurer of certain Smith Barney
125 Broad Street Treasurer Mutual Funds; Director and Head
New York, NY 10004 of Internal Control for CAM
Age 41 U.S. Mutual Fund Administration
from 1999-2002; Vice President
and Head of Mutual Fund
Administration and Treasurer at
Oppenheimer Capital from 1996-
1999
Christina T. Sydor Secretary Since Managing Director of CGM; N/A N/A
CAM 1995 General Counsel and Secretary of
300 First Stamford Place SBFM and TIA
Stamford, CT 06902
Age 51
Kaprel Ozsolak Controller Since Vice President of CGM N/A N/A
CAM 2002
125 Broad Street
New York, NY 10004
Age 36
Joseph Deane Vice President Since Managing Director of CGM; N/A N/A
CAM and Investment 1988 Investment Officer of SBFM
399 Park Avenue Officer
New York, NY 10022
Age 53
David Fare Vice President Since Managing Director of CGM; N/A N/A
CAM and Investment 1998 Investment Officer of SBFM
399 Park Avenue Officer
New York, NY 10022
Age 39
Andrew Beagley Chief Since Director, CGM (since 2000); N/A N/A
CAM Anti-Money 2002 Director of Compliance, North
399 Park Avenue Laundering America, (since 2000); Director of
New York, NY 10022 Compliance Compliance, Europe, the Middle
Age 40 Officer East and Africa, CAM (from
1999 to 2000); Compliance Officer,
Salomon Brothers Asset
Management Limited, Smith Barney
Global Capital Management Inc.,
Salomon Brothers Asset
Management Asia Pacific Limited
(from 1997 to 1999)
Robert I. Frenkel Chief Legal Since Managing Director and General N/A N/A
CAM Officer 2003 Counsel, Global Mutual Funds for
300 First Stamford Place CAM (since 1994).
Stamford, CT 06902
Age 48
--------
* Trustees are elected until the trust's next annual meeting and until their
successors are elected and qualified.
** Mr. Gerken is an independent trustee because Mr. Gerken is an officer of
SBFM and its affiliates.
40
For the calendar year ended December 31, 2002, the trustees beneficially
owned equity securities of the funds within the dollar ranges presented in the
table below:
[Download Table]
Aggregate Dollar Range of Equity
Dollar Range of Securities in All Registered Investment
Equity Securities Companies Overseen by Trustee in
Name of Trustee in the Fund Family of Investment Companies
--------------- ----------- ---------------------------------------
Herbert Barg None None
Alfred J. Bianchetti* None None
Dwight B. Crane None $50,001-$100,000
Burt N. Dorsett None None
Elliot S. Jaffe None None
Stephen E. Kaufman None None
Joseph J. McCann None None
R. Jay Gerken None Over $100,000
Cornelius C. Rose, Jr. None Over $100,000
--------
* Mr. Bianchetti became a trustee emeritus on December 31, 2002.
As of December 31, 2002, none of the independent trustees, or their
immediate family members, beneficially owned or of record any securities in the
manager or principal underwriter of the fund, or in a person (other than a
registered investment company) directly or indirectly controlling, controlled
by, or under common control with the manager or principal underwriter of the
fund.
The trust has an Audit Committee and a Nominating Committee. The members of
the Audit Committee and the Nominating Committee consist of all the independent
trustees of the Company, namely Messrs. Barg, Crane, Dorsett, Jaffe, Kaufman,
McCann and Rose.
In accordance with its written charter adopted by the board of trustees, the
Audit Committee assists the board in fulfilling its responsibility for
oversight of the quality and integrity of the accounting, auditing and
financial reporting practices of the funds. It also makes recommendations to
the board as to the selection of the independent public accountants, reviews
the methods, scope and result of the audits and audit fees charged, and reviews
the funds' internal accounting procedures and controls. The Audit Committee
also considers the scope and amount of non-audit services provided to the
funds, its adviser and affiliates by the independent public accountants. During
each fund's most recent fiscal year, the Audit Committee met twice.
The Nominating Committee is charged with the duty of making all nominations
for independent trustees to the board of trustees. The Nominating Committee
will consider nominees recommended by each fund's shareholders when a vacancy
becomes available. Shareholders who wish to recommend a nominee should send
nominations to the trust's Secretary. The Nominating Committee did not meet
during each fund's most recent fiscal year.
The trust also has a Pricing Committee composed of the Chairman of the Board
and one independent trustee which is charged with determining the fair value
prices for securities when required.
As of March 11, 2003, the trustees and officers owned, in the aggregate,
less than 1% of the outstanding shares of each of the funds. No officer,
director or employee of CGM or any of its affiliates receives any compensation
from the trust for serving as an officer of the funds or trustee of the trust.
The trust pays each trustee who is not an officer, director or employee of CGM
or any of its affiliates a fee of $14,000 per annum plus $1000 per in-person
meeting and $100 per telephonic meeting. Each trustee emeritus who is not an
officer, director or employee of CGM or its affiliates receives a fee of $7,000
per annum plus $500 per in-person meeting and $50 per telephonic meeting. All
trustees are reimbursed for travel and out-of-pocket expenses incurred to
attend such meetings and for the last fiscal year the aggregate reimbursement
was $6,562.
41
The following table shows the compensation paid by other Smith Barney Mutual
Funds to each trustee during the calendar year ended December 31, 2002. None of
the officers of the fund received any compensation from the fund for such
period. The trust does not pay retirement benefits to its trustees and officers.
[Enlarge/Download Table]
Compensation Number of Funds
Aggregate From Fund and for Which Trustee Serves
Compensation Fund Complex Within
Name of Person From Fund Paid to Trustees Fund Complex
-------------- ------------ ---------------- ------------------------
Herbert Barg/(2)/............. $2,228 $119,450 44
Alfred J. Bianchetti/(3)/..... 2,148 60,900 28
Dwight B. Crane/(2)/.......... 1,348 152,200 51
Burt N. Dorsett/(2)/.......... 2,148 61,300 28
Elliot S. Jaffe/(2)/.......... 1,688 57,750 28
Stephen E. Kaufman/(2)/....... 2,228 114,700 62
Joseph J. McCann/(2)/......... 2,188 62,400 28
R. Jay Gerken/(1)/............ -- -- 226
Cornelius C. Rose, Jr./(2)/... 1,788 58,050 28
--------
(1) Designates an "interested" trustee.
(2) Designates member of Audit Committee.
(3) Mr. Bianchetti became a trustee emeritus on December 31, 2002.
At the end of the year in which they attain age 80, trustees are required to
change to emeritus status. Trustees emeritus are entitled to serve in emeritus
status for a maximum of 10 years, during which time they are paid 50% of the
annual retainer fee and meeting fees otherwise applicable to trustees, together
with reasonable out-of-pocket expenses for each meeting attended. Trustees
emeritus may attend meetings but have no voting rights. During the trust's last
fiscal year, aggregate compensation paid to trustees emeritus was $430.
The following table contains a list of shareholders of record or who
beneficially owned at least 5% of the outstanding shares of a particular class
of shares of the California Fund as of March 11, 2003.
[Enlarge/Download Table]
Shares
Class Held Percent Name Address
----- ---- ------- ---- -------
O 59,910.798 5.8698 Monty Finefrock and Paula Finefrock 8 Skyline Drive
JTWROs Woodside, CA 94062-3720
Y 350,921 89.1994 Mark E. Merhab, Donna Bower 17 Sailcrest
Merhab TTEES FBO Mark E. Merhab Newport Coast, CA 92657-1800
and Donna Bower Merhab Living Trust
U/A/D 11/29/00
Y 42,490 10.8005 Anthony S. Wong, Mandy Tang Wong 1071 Piedmont Drive
TTEES FBO The AMP Wong Family Sacramento, CA 95822-1703
Trust U/A/D 12/8/89
As of March 11, 2003, no shareholders of record owned more than 5% of the
outstanding shares of a particular class of shares of the New York Fund.
INVESTMENT MANAGEMENT AND OTHER SERVICES
Investment Adviser and Administrator--SBFM (Manager)
SBFM serves as investment adviser to each fund pursuant to an investment
advisory agreement (the "Advisory Agreement") with the trust, which was
approved by the board of trustees, including a majority of the
42
independent trustees. The manager is an indirect wholly-owned subsidiary of
Citigroup Inc. ("Citigroup"). SBFM (through its predecessor entities) has been
in the investment company business since 1968. As of December 31, 2002, SBFM
had aggregate assets under management of approximately $97 billion. Subject to
the supervision and direction of the trust's board of trustees, the manager
manages each fund's portfolio in accordance with the fund's stated investment
objective and policies, makes investment decisions for the fund, places orders
to purchase and sell securities, and employs professional portfolio managers
and securities analysts who provide research services to the fund. The manager
pays the salary of any officer and employee who is employed by both it and the
trust. The manager bears all expenses in connection with the performance of its
services.
The Advisory Agreement has an initial term of two years and continues in
effect, from year to year thereafter if such continuance is specifically
approved at least annually by the fund's board of trustees or by a majority of
the outstanding voting securities of the fund, and in either event, by a
majority of the independent trustees of the fund's board with such independent
trustees casting votes in person at a meeting called for such purpose, or by a
vote of a majority of the outstanding shares. In approving the continuation of
the fund's Advisory Agreement, the board, including the independent trustees,
considered the reasonableness of the advisory fee in light of the extent and
quality of the advisory services provided and any additional benefits received
by the manager or its affiliates in connection with providing services to the
fund, compared the fees charged by the manager to those paid by similar funds
or clients for comparable services, and analyzed the expenses incurred by the
manager with respect to the fund. The board also considered the fund's
performance relative to a selected peer group and to other benchmarks, the
expense ratio of the fund in comparison to other funds of comparable size, and
other factors. Specifically, the board noted information received at regular
meetings throughout the year related to fund performance and manager services,
and benefits potentially accruing to the manager and its affiliates from
securities lending, administrative and brokerage relationships with affiliates
of the manager, as well as research services received by the manager from
brokers-dealers who execute transactions on behalf of the fund. After
requesting and reviewing such information, as they deemed necessary, the board
concluded that the continuation of the Advisory Agreement was in the best
interests of the fund and its shareholders. The independent trustees were
advised by separate independent legal counsel throughout the process. The fund
or the manager may terminate the Advisory Agreement on sixty days' written
notice without penalty. The Advisory Agreement will terminate automatically in
the event of assignment (as defined in the 1940 Act).
As compensation for investment advisory services, each fund pays the manager
a fee computed daily and paid monthly at the annual rate of 0.30% of the funds'
average daily net assets. The funds paid the manager investment advisory fees,
and the investment manager waived fees and reimbursed expenses as follows:
For the fiscal years ended November 30, the California Fund paid the manager
the following investment advisory fees:
[Download Table]
2002................... $223,528
2001................... $128,965
2000................... $109,291
For the fiscal years ended November 30, for the California Fund, the manager
waived fees and reimbursed expenses in the following amounts:
[Download Table]
2002........................ $82,959
2001........................ $51,586
2000........................ $43,717
43
For the fiscal years ended November 30, the New York Fund paid the manager
the following investment advisory fees:
[Download Table]
2002............ $313,917
2001............ $219,113
2000............ $176,419
For the fiscal years ended November 30, for the New York Fund, the manager
waived fees and reimbursed expenses in the following amounts:
[Download Table]
2002............ $68,007
2001............ $61,352
2000............ $49,397
SBFM also serves as administrator to the New York Fund and California Fund
pursuant to a written agreement (the "Administration Agreement"), which was
approved by the trustees of the trust, including a majority of trustees who are
not "interested persons" of the trust or the administrator. The administrator
pays the salary of any officer and employee who is employed by both it and the
trust and bears all expenses in connection with the performance of its services.
As administrator, the manager (a) assists in supervising all aspects of the
funds' operations except those performed by the funds' investment manager under
its investment advisory agreement; (b) supplies the fund with office facilities
(which may be in the manager's own offices), statistical and research data,
data processing services, clerical, accounting and bookkeeping services,
including, but not limited to, the calculation of (i) the net asset value of
shares of the fund, (ii) applicable contingent deferred sales charges
("deferred sales charge") and similar fees and charges and (iii) distribution
fees, internal auditing and legal services, internal executive and
administrative services, and stationary and office supplies; and (c) prepares
reports to shareholders of the fund, tax returns and reports to and filings
with the SEC and state blue sky authorities.
As compensation for administrative services rendered to each fund, the
administrator receives a fee computed daily and paid monthly at the annual rate
of 0.20% of each fund's average daily net assets. The funds paid the
administrator administration fees and the administrator waived fees and
reimbursed expenses as follows:
For the fiscal years ended November 30, the California Fund paid the manager
the following administration fees:
[Download Table]
2002......................................... $149,018
2001......................................... $ 85,977
2000......................................... $ 72,861
For the fiscal years ended November 30, for the California Fund, the
administrator waived fees and reimbursed expenses in the following amounts:
[Download Table]
2002......................................... $33,798
2001......................................... $34,390
2000......................................... $29,144
For the fiscal years ended November 30, the New York Fund paid the manager
the following administration fees:
[Download Table]
2002......................................... $209,279
2001......................................... $146,075
2000......................................... $117,613
44
For the fiscal years ended November 30, for the New York Fund, the
administrator waived fees and reimbursed expenses in the following amounts:
[Download Table]
2002......................................... $33,284
2001......................................... $40,901
2000......................................... $32,932
The trust bears expenses incurred in its operation, including: taxes,
interest, brokerage fees and commissions, if any; fees of trustees who are not
officers, directors, shareholders or employees of CGM or the manager, SEC fees
and state blue sky qualification fees; charges of custodians; transfer and
dividend disbursing agent fees; certain insurance premiums; outside auditing
and legal expenses; costs of maintaining corporate existence; costs of investor
services (including allocated telephone and personnel expenses); costs of
preparing and printing prospectuses for regulatory purposes and for
distribution to existing shareholders; costs of shareholders' reports and
shareholder meetings; and meetings of the officers or board of trustees of the
trust.
Code of Ethics
Pursuant to Rule 17j-1 of the 1940 Act, the funds, its managers and
principal distributor have adopted a code of ethics that permits personnel to
invest in securities for their own accounts, including securities that may be
purchased or held by the funds. All personnel must place the interests of
clients first and avoid activities, interests and relationships that might
interfere with the duty to make decisions in the best interests of the clients.
All personal securities transactions by employees must adhere to the
requirements of the code and must be conducted in such a manner as to avoid any
actual or potential conflict of interest, the appearance of such a conflict, or
the abuse of an employee's position of trust and responsibility. A copy of the
fund's, the manager's and the distributor's code of ethics is on file with the
SEC.
Auditors
KPMG LLP, independent auditors, 757 Third Avenue, New York, New York 10017,
has been selected as each fund's independent auditor to examine and render
opinions on each fund's financial statements for the fiscal year ending
November 30, 2003.
Counsel
Willkie Farr & Gallagher, 787 Seventh Avenue, New York, New York 10019,
serves as counsel to the trust.
Stroock & Stroock & Lavan LLP, 180 Maiden Lane, New York, New York, 10038,
serves as counsel to the independent trustees.
Custodian, Transfer Agent and Sub-Transfer Agent
The trust has entered into a Custodian Agreement and a Fund Accounting
Agreement with State Street Bank and Trust Company ("State Street"), pursuant
to which custodial and fund accounting services, respectively, are provided for
the fund. Among other things, State Street calculates the daily net asset value
for the fund. Securities may be held for the funds by a sub-custodian bank
approved by the funds' trustees. The principal business address of State Street
is 225 Franklin Street, Boston, Massachusetts 02110.
Citicorp Trust Bank, fsb (the "transfer agent"), located at 125 Broad
Street, New York, New York 10004, serves as the fund's transfer and
dividend-paying agent. Under the transfer agency agreement, the transfer agent
maintains the shareholder account records for the fund, handles certain
communications between shareholders and the fund distributes dividends and
distributions payable by the fund and produces statements with respect to
account activity for the fund and its shareholders. For these services, the
transfer agent receives fees from the
45
fund computed on the basis of the number of shareholder accounts that the
transfer agent maintains for each fund during the month and is reimbursed for
out-of-pocket expenses.
PFPC Global Fund Services ("PFPC" or "sub-transfer agent"), located at 4400
Computer Drive, Westborough, Massachusetts 01581, serves as a sub-transfer
agent. Under the transfer agency agreement, the sub-transfer agent maintains
the shareholder account records for the trust, handles certain communications
between shareholders and the trust and distributes dividends and distributions
payable by the trust. For these services, the sub-transfer agent receives a
monthly fee computed on the basis of the number of shareholder accounts it
maintains for the trust during the month, and is reimbursed for out-of-pocket
expenses.
Distributor
CGM, located at 388 Greenwich Street, New York, New York 10013 serves as the
fund's distributor pursuant to a written agreement dated June 5, 2000 (the
"Distribution Agreement"), which was last approved by each fund's board of
trustees, including a majority of the independent trustees, on July 17, 2002.
Commissions on Class A Shares. For 2000, 2001 and 2002 fiscal years, the
aggregate dollar amounts of commissions on Class A shares, are as follows:
[Enlarge/Download Table]
Fiscal year ended Fiscal year ended Fiscal year ended
Name of Fund 11/30/02 11/30/01 11/30/00*
------------ -------- -------- ---------
California Fund........................ $258,000 $116,000 $32,000
New York Fund.......................... $389,000 $377,000 $42,000
--------
*The following amounts were paid to CGM: $28,800 and $37,800 with regard to the
California Fund and the New York Fund, respectively, of which a portion was
paid to CFBDS.
Class L shares were established on July 22, 2002. Class L shares have no
initial sales charge, no deferred sales charge and has a 12b-1 fee of 0.75%.
Commissions on Class O Shares. For the 2000, 2001 and 2002 fiscal years,
the aggregate dollar amounts of commission on Class L shares are as follows:
[Enlarge/Download Table]
Fiscal year ended Fiscal year ended Fiscal year ended
Name of Fund 11/30/02* 11/30/01 11/30/00**
------------ --------- -------- -----------------
California Fund........................ $41,000 $39,000 $ 3,000
New York Fund.......................... $23,000 $43,000 $15,000
--------
*On June 12, 1998, Class C shares were renamed Class L Shares. On July 22,
2002, Class L shares were renamed Class O Shares.
**The following amounts were paid to CGM: $2,700 and $13,500 with regard to the
California Fund and the New York Fund, respectively, of which a portion was
paid to CFBDS.
Deferred Sales Charges on Class O Shares. For the 2000, 2001 and 2002
fiscal years, the following deferred sales charges were paid to CGM on
redemptions of the funds' shares:
[Enlarge/Download Table]
Fiscal year ended Fiscal Year Ended Fiscal Year Ended
Name of Fund 11/30/02* 11/30/01 11/30/00
------------ ----------------- ----------------- -----------------
California Fund........................ $4,000 $ 0 $0
New York Fund.......................... $4,000 $6,000 $0
--------
*On July 22, 2002, Class L shares were renamed Class O Shares. On June 12,
1998, Class C shares were renamed Class L Shares
46
When payment is made by the investor before the settlement date, unless
otherwise requested in writing by the investor, the funds will be held as a
free credit balance in the investor's brokerage account and CGM may benefit
from the temporary use of the funds. The trust's board of trustees has been
advised of the benefits to CGM resulting from these settlement procedures and
will take such benefits into consideration when reviewing the Advisory,
Administration and Distribution Agreements for continuance.
For the fiscal year ended November 30, 2002, CGM incurred distribution
expenses for advertising, printing and mailing prospectuses, support services
and overhead expenses, to Smith Barney Financial Consultants and for accruals
for interest on the excess of CGM expenses incurred in the distribution of the
fund's shares over the sum of the distribution fees and deferred sales charge
received by CGM are expressed in the following table:
[Enlarge/Download Table]
Financial Consultant Branch Advertising Printing Interest
Fund Name Compensation Expenses Expenses Expenses Expenses
--------- -------------------- -------- ----------- -------- --------
California Fund........... $62,114 $24,345 $36,630 $89 $11,009
New York Fund............. $86,161 $33,794 $41,158 $86 $ 9,438
Distribution Arrangements for the New York Fund and California Fund
To compensate CGM for the services it provides and for the expense it bears,
the trust has adopted a services and distribution plan (the "Plan") pursuant to
Rule 12b-1 under the 1940 Act. Under the Plan, both the New York Fund and
California Fund pays CGM a service fee, accrued daily and paid monthly,
calculated at the annual rate of 0.15% of the value of each fund's average
daily net assets attributable to a fund's Class A, Class B and Class O shares
and 0.25% of the average daily net assets of a fund attributable to the Class L
Shares. In addition, each fund pays CGM a distribution fee with respect to the
Class B, Class L and Class O shares primarily intended to compensate Smith
Barney for its initial expense of paying its Financial Consultants a commission
upon sales of those shares. The Class B distribution fee is calculated at the
annual rate of 0.50% of the value of each fund's average net assets
attributable to the share of class. The Class L distribution fee is calculated
at the annual rate of 0.60% of the value of each fund's average net assets
attributable to the shares of the Class. The Class O distribution fee is
calculated at the annual rate of 0.20% of the value of each fund's average net
assets attributable to the shares of the Class. The following service and
distribution fees were incurred during the periods indicated:
DISTRIBUTION PLAN FEES
[Download Table]
Year Ended Year Ended Year Ended
11/30/02 11/30/01 11/30/00
---------- ---------- ----------
California Fund:
Class A......... $ 83,596 $51,349 $46,462
Class L#........ $ 29,991 N/A N/A
Class O*........ $ 38,936 $23,065 $17,978
New York Fund:
Class A......... $134,269 $98,712 $81,341
Class L#........ $ 33,022 N/A N/A
Class O*........ $ 37,533 $25,303 $16,028
--------
# Class L shares were established on July 22, 2002.
* Class L shares were renamed Class O Shares on July 27, 2001.
47
PURCHASE OF SHARES
Sales Charge Alternatives
The following classes of shares are available for purchase. See the
prospectus for a discussion of factors to consider in selecting which Class of
shares to purchase.
Class A Shares. Class A shares are sold to investors at the public offering
price, which is the net asset value plus an initial sales charge as follows:
[Download Table]
Sales Charge as Sales Charge as Dealers'
a % Of a % Of Reallowance as %
Transaction Amount Invested Of Offering Price
--------------- --------------- -----------------
Amount of Investment
Less than $500,000.. 2.00% 2.04% 1.80%
$500,000 and over... * * *
--------
* Purchases of Class A shares of $500,000 or more will be made at net asset
value without any initial sales charge, but will be subject to a deferred
sales charge of up to 1.00% on redemptions made within 12 months of
purchase. The deferred sales charge on Class A shares is payable to CGM,
which compensates Smith Barney Financial Consultants and other dealers whose
clients make purchases of $500,000 or more. The deferred sales charge is
waived in the same circumstances in which the deferred sales charge
applicable to Class O shares is waived. See "Purchase of Shares-Deferred
Sales Charge Provisions" and "Purchase of Shares--Waivers of Deferred Sales
Charge."
Members of the selling group may receive up to 90% of the sales charge and
may be deemed to be underwriters of the fund as defined in the Securities Act
of 1933, as amended (the "1933 Act"). The reduced sales charges shown above
apply to the aggregate of purchases of Class A shares of the funds made at one
time by "any person," which includes an individual and his or her immediate
family, or a trustee or other fiduciary of a single trust estate or single
fiduciary account.
Class B Shares. Class B Shares are sold without an initial sales charge but
are subject to a deferred sales charge payable upon certain redemptions. Class
B shares are available only in exchange from another fund. See "Deferred Sales
Charge Provisions" below.
Class L Shares. Class L shares are sold without an initial sales charge and
are not subject to a deferred sales charge.
Class O Shares. Class O shares are sold with an initial sales charge of
1.00% (which is equal to 1.01% of the amount invested) and are subject to a
deferred sales charge payable upon certain redemptions. See "Deferred Sales
Charge Provisions" below. Until June 22, 2004 purchases of Class O shares by
investors who were holders of Class C shares of the fund and/or other Smith
Barney mutual funds on June 12, 1998 will not be subject to the 1% initial
sales charge.
Class Y Shares. Class Y shares are sold without an initial sales charge or
deferred sales charge and are available only to investors investing a minimum
of $15,000,000 (except there is no minimum purchase amount for purchases by
Smith Barney Allocation Series Inc.; qualified and non-qualified retirement
plans with $75,000,000 in plan assets for which CitiStreet LLC acts as the
plan's recordkeeper; or 401(k) plans of Citigroup and its affiliates).
General
Investors may purchase shares from a Service Agent. In addition, certain
investors may purchase shares directly from the fund. When purchasing shares of
the fund, investors must specify whether the purchase is for Class A, Class B,
Class L, Class O (Class O is only available for subsequent investment by
existing Class O
48
shareholders) or Class Y shares. Your Service Agent may charge their customers
an annual account maintenance fee in connection with a brokerage account
through which an investor purchases or holds shares. Accounts held directly at
the sub-transfer agent are not subject to a maintenance fee.
Investors in Class A and Class L shares may open an account in the fund by
making an initial investment of at least $1,000 for each account, in the fund.
Investors in Class Y shares may open an account by making an initial investment
of $15,000,000. Subsequent investments of at least $50 may be made for all
Classes. For shareholders purchasing shares of the fund through the Systematic
Investment Plan on a monthly basis, the minimum initial investment requirement
for Class A, Class B, Class L and Class O shares and subsequent investment
requirement for all Classes is $25. For shareholders purchasing shares of the
fund through the Systematic Investment Plan on a quarterly basis, the minimum
initial investment required for Class A, Class B, Class L and Class O shares
and the subsequent investment requirement for all Classes is $50. There are no
minimum investment requirements for Class A shares for employees (and their
immediate family) of Citigroup and its subsidiaries, including CGM, unitholders
who invest distributions from a Unit Investment Trust ("UIT") sponsored by CGM,
and directors/trustees of any of the Smith Barney mutual funds, and their
spouses and children. The fund reserves the right to waive or change minimums,
to decline any order to purchase its shares and to suspend the offering of
shares from time to time. The sub-transfer agent will hold shares purchased in
the shareholder's account. Share certificates are issued only upon a
shareholder's written request to the sub-transfer agent. It is not recommended
that the fund be used as a vehicle for Keogh, IRA or other qualified retirement
plans.
Purchase orders received by the fund or a Service Agent prior to the close
of regular trading on the NYSE, on any day the fund calculates its net asset
value, are priced according to the net asset value determined on that day (the
"trade date"). Orders received by a Service Agent prior to the close of regular
trading on the NYSE on any day the fund calculates its net asset value, are
priced according to the net asset value determined on that day, provided the
order is received by the fund or the fund's agent prior to its close of
business. For shares purchased through CGM or a Service Agent purchasing
through CGM, payment for shares of the fund is due on the third business day
after the trade date. In all other cases, payment must be made with the
purchase order.
Systematic Investment Plan. Shareholders may make additions to their
accounts at any time by purchasing shares through a service known as the
Systematic Investment Plan. Under the Systematic Investment Plan, CGM or the
sub-transfer agent is authorized through preauthorized transfers of at least
$25 on a monthly basis or at least $50 on a quarterly basis to charge the
shareholder's account held with a bank or other financial institution on a
monthly or quarterly basis as indicated by the shareholder, to provide for
systematic additions to the shareholder's fund account. CGM or the sub-transfer
agent will charge a shareholder who has insufficient funds to complete the
transfer a fee of up to $25. The Systematic Investment Plan also authorizes CGM
to apply cash held in the shareholder's CGM brokerage account or redeem the
shareholder's shares of a Smith Barney money market fund to make additions to
the account. Additional information is available from the fund or a Service
Agent.
Sales Charge Waivers and Reductions
Initial Sales Charge Waivers. Purchases of Class A shares may be made at
net asset value without a sales charge in the following circumstances: (a)
sales to (i) Board Members and employees of Citigroup and its subsidiaries and
any Citigroup affiliated funds including the Smith Barney mutual funds
(including retired Board Members and employees); the immediate families of such
persons (including the surviving spouse of a deceased Board Member or
employee); and to a pension, profit-sharing or other benefit plan for such
persons and (ii) employees of members of the National Association of Securities
Dealers, Inc., provided such sales are made upon the assurance of the purchaser
that the purchase is made for investment purposes and that the securities will
not be resold except through redemption or repurchase; (b) offers of Class A
shares to any other investment company to effect the combination of such
company with the fund by merger, acquisition of assets or otherwise; (c)
purchases of Class A shares by any client of a newly employed Service Agent
(for a period up to 90 days from the commencement of the Financial Consultant's
employment with CGM), on the condition the purchase of
49
Class A shares is made with the proceeds of the redemption of shares of a
mutual fund which (i) was sponsored by the Financial Consultant's prior
employer, (ii) was sold to the client by the Financial Consultant and (iii) was
subject to a sales charge; (d) purchases by shareholders who have redeemed
Class A shares in the fund (or Class A shares of another Smith Barney mutual
fund that is offered with a sales charge) and who wish to reinvest their
redemption proceeds in them, provided the reinvestment is made within 60
calendar days of the redemption; (e) purchases by accounts managed by
registered investment advisory subsidiaries of Citigroup; (f) investments of
distributions from or proceeds from a sale of a UIT sponsored by CGM; (g)
purchases by investors participating in a CGM fee-based arrangement; (h)
separate accounts used to fund certain Section 403(b) or 401(a) or (k)
accounts; and (i) Intergraph Corporate Stock Bonus Plan participants
reinvesting distribution proceeds from the sale of the Smith Barney
Appreciation Fund and; (j) purchase by executive deferred compensation plans
participating in the CGM ExecuChoice Program. In order to obtain such
discounts, the purchaser must provide sufficient information at the time of
purchase to permit verification that the purchase would qualify for the
elimination of the sales charge.
Right of Accumulation. Class A shares of the funds may be purchased by "any
person" (as defined above) at a reduced sales charge or at net asset value
determined by aggregating the dollar amount of the new purchase and the total
net asset value of all Class A shares of the funds and of other Smith Barney
mutual funds that are offered with a sales charge as currently listed under
"Exchange Privilege" then held by such person and applying the sales charge
applicable to such aggregate. In order to obtain such discount, the purchaser
must provide sufficient information at the time of purchase to permit
verification that the purchase qualifies for the reduced sales charge. The
right of accumulation is subject to modification or discontinuance at any time
with respect to all shares purchased thereafter.
Letter of Intent--Class A Shares. A Letter of Intent for an amount of
$50,000 or more provides an opportunity for an investor to obtain a reduced
sales charge by aggregating investments over a 13 month period, provided that
the investor refers to such Letter when placing orders. For purposes of a
Letter of Intent, the "Amount of Investment" as referred to in the preceding
sales charge table includes (i) all Class A shares of a fund and other Smith
Barney mutual funds offered with a sales charge acquired during the term of the
Letter plus (ii) the value of all Class A shares previously purchased and still
owned. Each investment made during the period receives the reduced sales charge
applicable to the total amount of the investment goal. If the goal is not
achieved within the period, the investor must pay the difference between the
sales charges applicable to the purchases made and the charges previously paid,
or an appropriate number of escrowed shares will be redeemed. The term of the
Letter will commence upon the date the Letter is signed, or at the options of
the investor, up to 90 days before such date. Please contact a Service Agent or
the transfer agent to obtain a Letter of Intent application.
Letter of Intent--Class Y Shares. A Letter of Intent may also be used as a
way for investors to meet the minimum investment requirement for Class Y shares
(except purchases of Class Y shares by Smith Barney Allocation Series Inc., for
which there is no minimum purchase amount). Such investors must make an initial
minimum purchase of $5,000,000 in Class Y shares of a fund and agree to
purchase a total of $15,000,000 of Class Y shares of a fund within 13 months
from the date of the Letter. If a total investment of $15,000,000 is not made
within the 13-month period, all Class Y shares purchased to date will be
transferred to Class A shares, where they will be subject to all fees
(including a service fee of 0.15%) and expenses applicable to the fund's Class
A shares, which may include a deferred sales charge of 1.00%. Please contact a
Service Agent or the transfer agent for further information.
Deferred Sales Charge Provisions
"Deferred Sales Charge Shares" are: (a) Class A shares; and (b) Class B
shares and (c) Class O shares that were purchased without an initial sales
charge but are subject to a deferred sales charge. A deferred sales charge may
be imposed on certain redemptions of these shares.
Any applicable deferred sales charge will be assessed on an amount equal to
the lesser of the original cost of the shares being redeemed or their net asset
value at the time of redemption. Deferred Sales Charge Shares that
50
are redeemed will not be subject to a deferred sales charge to the extent the
value of such shares represents: (a) capital appreciation of fund assets; (b)
reinvestment of dividends or capital gain distributions; (c) with respect to
Class A, Class B shares and Class O shares that are Deferred Sales Charge
Shares, shares redeemed more than 12 months after their purchase.
Class A, Class B shares and Class O shares that are Deferred Sales Charge
Shares are subject to a 1.00% deferred sales charge if redeemed within 12
months of purchase. Solely for purposes of determining the number of years
since a purchase payment, all purchase payments made during a month will be
aggregated and deemed to have been made on the last day of the preceding CGM
statement month.
The following table sets forth the rates of the charge for redemptions of
Class B shares by shareholders.
Year Since Purchase Payment Was Made Deferred sales charge
[Download Table]
First............................................. 4.50%
Second............................................ 4.00
Third............................................. 3.00
Fourth............................................ 2.00
Fifth............................................. 1.00
Sixth and thereafter.............................. 0.00
Class B shares will convert automatically to Class A shares eight years
after the date on which they were purchased and thereafter will no longer be
subject to any distribution fees. There will also be converted at that time
such proportion of Class B Dividend Shares (Class B shares that were acquired
through the reinvestment of dividends and distributions) owned by the
shareholders as the total number of his or her Class B shares converting at the
time bears to the total number of outstanding Class B shares (other than Class
B Dividend Shares) owned by the shareholder.
Class B shares, which may be acquired only upon an exchange with another
fund in the Smith Barney Group of funds, are subject upon redemption to the
highest deferred sales charge (if any) of the shares from which the exchange or
any preceding exchange was made. A deferred sales charge payable to CGM is
imposed on any redemption of Class B shares that causes the value of a
shareholder's account to fall below the dollar amount of all payments by the
shareholder for the Class B shares (or any predecessor of those shares) that
were exchanged for Class B shares of the fund ("purchase payments") during the
preceding five years. No charge is imposed to the extent that the net asset
value of the Class B shares redeemed does not exceed (a) the current net asset
value of Class B shares purchased through reinvestment of dividends or capital
gains distributions, plus (b) the current net asset value of Class B shares
acquired in an exchange that were originally purchased more than five years
prior to the redemption, plus (c) increases in the net asset value of the
shareholder's Class B shares above the purchase payments made during the
preceding five years.
In determining the applicability of any deferred sales charge, it will be
assumed that a redemption is made first of shares representing capital
appreciation, next of shares representing the reinvestment of dividends and
capital gains distributions and finally of other shares held by the shareholder
for the longest period of time. The length of time that deferred sales charge
shares acquired through an exchange have been held will be calculated from the
date the shares exchanged were initially acquired in one of the other Smith
Barney Mutual Funds, and fund shares being redeemed will be considered to
represent, as applicable, capital appreciation or dividend and capital gain
distribution reinvestments in such other funds. For Federal income tax
purposes, the amount of the deferred sales charge will reduce the gain or
increase the loss, as the case may be, on the amount realized on redemption.
The amount of any deferred sales charge will be paid to CGM.
To provide an example, assume an investor purchased 100 Class B shares of a
fund at $10 per share for a cost of $1,000. Subsequently, the investor acquired
5 additional shares of a fund through dividend reinvestment.
51
During the fifteenth month after the purchase, the investor decided to redeem
$500 of his or her investment. Assuming at the time of the redemption the net
asset value had appreciated to $12 per share, the value of the investor's
shares would be $1,260 (105 shares at $12 per share). The deferred sales charge
would not be applied to the amount, which represents appreciation ($200) and
the value of the reinvested dividend shares ($60). Therefore, $240 of the $500
redemption proceeds ($500 minus $260) would be charged at a rate of 4.00% (the
applicable rate for Class B shares) for a total deferred sales charge of $9.60.
Waivers of Deferred Sales Charge
The deferred sales charge will be waived on: (a) exchanges (see "Exchange
Privilege"); (b) automatic cash withdrawals in amounts equal to or less than
1.00% per month of the value of the shareholder's shares at the time the
withdrawal plan commences (see "Automatic Cash Withdrawal Plan") (however,
automatic cash withdrawals in amounts equal to or less than 2.00% per month of
the value of the shareholder's shares will be permitted for withdrawal plans
established prior to November 7, 1994); (c) redemptions of shares within 12
months following the death or disability of the shareholder; (d) involuntary
redemptions; and (e) redemptions of shares to effect a combination of a fund
with any investment company by merger, acquisition of assets or otherwise. In
addition, a shareholder who has redeemed shares from other Smith Barney mutual
funds may, under certain circumstances, reinvest all or part of the redemption
proceeds within 60 days and receive pro rata credit for any deferred sales
charge imposed on the prior redemption.
Deferred sales charge waivers will be granted subject to confirmation (by
CGM in the case of shareholders who are also CGM clients or by the transfer
agent in the case of all other shareholders) of the shareholder's status or
holdings, as the case may be.
Volume Discounts
The schedule of sales charges on Class A shares described in the Prospectus
applies to purchases made by any "purchaser," which is defined to include the
following: (a) an individual; (b) an individual's spouse and his or her
children purchasing shares for their own account; (c) a trustee or other
fiduciary purchasing shares for a single trust estate or single fiduciary
account; and (d) a trustee or other professional fiduciary (including a bank,
or an investment adviser registered with the SEC under the Investment Advisers
Act of 1940, as amended) purchasing shares of the fund for one or more trust
estates or fiduciary accounts. Purchasers who wish to combine purchase orders
to take advantage of volume discounts on Class A shares should contact a
Service Agent.
Determination of Public Offering Price
Each fund offers its shares to the public on a continuous basis. The public
offering price for a Class A, Class B, Class L, Class O (effective July 22,
2002, the former Class L shares were renamed Class O shares, which prior to
June 12, 1998 were named Class C shares) and Class Y share of a fund is equal
to the net asset value per share at the time of purchase, plus for Class A, and
Class O shares an initial sales charge based on the aggregate amount of the
investment. The public offering price for a Class L share (and Class A share
purchases, including applicable rights of accumulation, equaling or exceeding
$500,000) is equal to the net asset value per share at the time of purchase and
no sales charge is imposed at the time of purchase. A deferred sales charge,
however, is imposed on certain redemptions of Class O shares, and Class A
shares when purchased in amounts equaling or exceeding $500,000. The method of
computation of the public offering price is shown in the fund's financial
statements, incorporated by reference in their entirety into this SAI.
52
REDEMPTION OF SHARES
The right of redemption of shares of either fund may be suspended or the
date of payment postponed (a) for any periods during which the New York Stock
Exchange, Inc. (the "NYSE") is closed (other than for customary weekend and
holiday closings), (b) when trading in the markets the fund normally utilizes
is restricted, or an emergency exists, as determined by the SEC, so that
disposal of the fund's investments or determination of its net asset value is
not reasonably practicable or (c) for any other periods as the SEC by order may
permit for the protection of the fund's shareholders.
If the shares to be redeemed were issued in certificate form, the
certificates must be endorsed for transfer (or be accompanied by an endorsed
stock power) and must be submitted to the sub-transfer agent together with the
redemption request. Any signature appearing on a share certificate, stock power
or written redemption request in excess of $50,000 must be guaranteed by an
eligible guarantor institution such as a domestic bank, savings and loan
institution, domestic credit union, member bank of the Federal Reserve System
or member firm of a national securities exchange. Written redemption requests
of $50,000 or less do not require a signature guarantee unless more than one
such redemption request is made in any 10-day period or the redemption proceeds
are to be sent to an address other than the address of record. Unless otherwise
directed, redemption proceeds will be mailed to an investor's address of
record. The transfer agent may require additional supporting documents for
redemptions made by corporations, executors, administrators, trustees or
guardians. A redemption request will not be deemed properly received until the
transfer agent receives all required documents in proper form.
If a shareholder holds shares in more than one Class, any request for
redemption must specify the Class being redeemed. In the event of a failure to
specify which Class, or if the investor owns fewer shares of the Class than
specified, the redemption request will be delayed until the transfer agent
receives further instructions from CGM, or if the shareholder's account is not
with CGM, from the shareholder directly. The redemption proceeds will be
remitted on or before the third business day following receipt of proper
tender, except on any days on which the NYSE is closed or as permitted under
the 1940 Act, in extraordinary circumstances. Generally, if the redemption
proceeds are remitted to a CGM brokerage account, these funds will not be
invested for the shareholder's benefit without specific instruction and CGM
will benefit from the use of temporarily uninvested funds. Redemption proceeds
for shares purchased by check, other than a certified or official bank check,
will be remitted upon clearance of the check, which may take up to fifteen days
or more.
The fund does not issue share certificates unless a written request signed
on all registered issuers is made to PFPC Global Fund Services. If you hold
share certificates, it will take longer to exchange or redeem shares.
Distribution in Kind
If the board of trustees of the trust determines that it would be
detrimental to the best interests of the remaining shareholders to make a
redemption payment wholly in cash, a fund may pay, in accordance with SEC
rules, any portion of a redemption in excess of the lesser of $250,000 or 1.00%
of the fund's net assets by a distribution in kind of portfolio securities in
lieu of cash. Securities issued as a distribution in kind may incur brokerage
commissions when shareholders subsequently sell those securities.
Automatic Cash Withdrawal Plan
An automatic cash withdrawal plan (the "Withdrawal Plan") is available to
shareholders of any fund who own shares of the fund with a value of at least
$10,000 and who wish to receive specific amounts of cash monthly or quarterly.
Withdrawals of at least $50 may be made under the Withdrawal Plan by redeeming
as many shares of the fund as may be necessary to cover the stipulated
withdrawal payment. Any applicable deferred sales charge will not be waived on
amounts withdrawn by shareholders that exceed 1.00% per month of the value of a
shareholder's shares at the time the Withdrawal Plan commences. (With respect
to Withdrawal Plans in effect prior to November 7, 1994, any applicable
deferred sales charge will be waived on amounts withdrawn that do not exceed
2.00% per month of the value of a shareholder's shares at the time the
Withdrawal Plan commences). To the extent that withdrawals exceed dividends,
distributions and appreciation of a shareholder's investment in a fund,
continued withdrawal payments will reduce the shareholder's investment,
53
and may ultimately exhaust it. Withdrawal payments should not be considered as
income from investment in a fund. Furthermore, as it generally would not be
advantageous to a shareholder to make additional investments in the fund at the
same time he or she is participating in the Withdrawal Plan, purchases by such
shareholder in amounts of less than $5,000 ordinarily will not be permitted.
Shareholders of a fund who wish to participate in the Withdrawal Plan and
who hold their shares of the fund in certificate form must deposit their share
certificates with the sub-transfer agent as agent for Withdrawal Plan members.
All dividends and distributions on shares in the Withdrawal Plan are reinvested
automatically at net asset value in additional shares of the fund involved. A
shareholder who purchases shares directly through the sub-transfer agent may
continue to do so and applications for participation in the Withdrawal Plan
must be received by the sub-transfer agent no later than the eighth day of the
month to be eligible for participation beginning with that month's withdrawal.
For additional information, shareholders should contact a Service Agent or the
sub-transfer agent.
VALUATION OF SHARES
The net asset value per share of each fund's Classes is calculated on each
day, Monday through Friday, except days on which the NYSE is closed. The NYSE
currently is scheduled to be closed on New Year's Day, Martin Luther King, Jr.
Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving and Christmas, and on the preceding Friday or subsequent Monday
when one of these holidays falls on a Saturday or Sunday, respectively. Because
of the differences in distribution fees and Class-specific expenses, the per
share net asset value of each Class may differ. The following is a description
of the procedures used by the trust in valuing its assets.
Securities listed on an exchange or traded in an over-the-counter market
will be valued at the closing price on the exchange or market on which the
security is primarily traded (the "Primary Market") at the time of valuation
(the "Valuation Time"). If the security did not trade on the Primary Market,
the security will be valued at the closing price on another exchange or market
where it trades at the Valuation Time. If there are no such sales prices, the
security will be valued at the most recent bid quotation as of the Valuation
Time or at the lowest asked quotation in the case of a short sale of
securities. If there are no such quotations, the value of the security will be
taken to be the most recent asked quotation at the Valuation Time.
In determining the market value of portfolio investments, each fund may
employ outside organizations (each, a "Pricing Service") which may use a
matrix, formula or other objective method that takes into consideration market
indexes, matrices, yield curves and other specific adjustments. The officers of
each fund under the general supervision and responsibility of the Board, which
may replace a Pricing Service at any time, review the procedures of Pricing
Services periodically. If a Pricing Service is not able to supply closing
prices and bid/asked quotations, and there are two or more dealers, brokers or
market makers in the security, the security will be valued at the mean between
the highest bid and the lowest asked quotations from at least two dealers,
brokers or market makers or, if such dealers, brokers or market makers only
provide bid quotations, at the mean between the highest and the lowest bid
quotations provided.
If a Pricing Service is not able to supply closing prices and bid/asked
quotations, and there is only one dealer, broker or market maker in the
security, the security will be valued at the mean between the bid and the asked
quotations provided, unless the dealer, broker or market maker can only provide
a bid quotation in which case the security will be valued at such bid
quotation. Options contracts will be valued similarly. Futures contracts will
be valued at the most recent settlement price at the time of valuation.
Short-term obligations with maturities of 60 days or less are valued at
amortized cost, which constitutes fair value as determined by the Board.
Amortized cost involves valuing a portfolio instrument at its initial cost and
thereafter assuming a constant amortization to maturity of any discount or
premium, regardless of the impact of fluctuating interest rates on the market
value of the instrument. The amortized cost method of valuation may also be
used with
54
respect to other debt obligations with 60 days or less remaining to maturity.
Securities, options, futures contracts and other assets which cannot be valued
pursuant to the foregoing will be valued at their fair value as determined in
good faith pursuant to consistently applied procedures established by the
Board. In addition, the Board or its delegates may value a security at fair
value if it determines that such security's value determined by the methodology
set forth above does not reflect its fair value.
In carrying out valuation policies adopted by the trust's board of trustees
for each fund, the administrator, may consult with an independent pricing
service (the "Pricing Service") retained by the trust. Debt securities of
domestic issuers (other than U.S. Government Securities and short-term
investments), including Municipal Obligations, are valued by the manager after
consultation with the Pricing Service. U.S. Government Securities will be
valued at the mean between the closing bid and asked prices on each day, or, if
market quotations for those securities are not readily available, at fair
value, as determined in good faith by the trust's board of trustees. With
respect to other securities held by a fund, when, in the judgment of the
Pricing Service, quoted bid prices for investments are readily available and
are representative of the bid side of the market, these investments are valued
at the mean between the quoted bid prices and asked prices. Investments, for
which no readily obtainable market quotations are available, in the judgment of
the Pricing Service, are carried at fair value as determined by the Pricing
Service. The officers of the trust under the general supervision and
responsibility of the board of trustees review the procedures of the Pricing
Service periodically.
EXCHANGE PRIVILEGE
Except as noted below, shareholders of certain Smith Barney Mutual Funds may
exchange all or part of their shares for shares of the same class of other
Smith Barney Mutual Funds, to the extent such shares are offered for sale in
the shareholder's state of residence, on the basis of relative net asset value
per share at the time of exchange. Exchanges of Class A, Class B and Class L
shares are subject to minimum investment requirements (except for systematic
investment plan exchanges), and all shares are subject to the other
requirements of the fund into which exchanges are made. The deferred sales
charge (if any) will continue to be measured from the date of a shareholder's
original purchase of shares subject to a deferred sales charge. If the fund
exchanged into has a higher deferred sales charge, the shareholder will be
subject to that charge. If a shareholder exchanges at any time into a fund with
a lower charge, the sales charge will not be reduced. Please note specific
exchange requirements as follows:
A. Class A, O, Y and Class L shareholders of the fund who wish to
exchange all or a portion of their shares for shares of the respective Class
in any of the funds of the Smith Barney Mutual Fund Complex may do so
without imposition of any charge.
B. Upon exchange, the new Class O shares will be deemed to have been
purchased on the same date as the Class L shares of the fund that have been
exchanged.
C. Class B shares are available only in an exchange from another fund of
the Smith Barney Mutual Fund Complex.
The exchange privilege enables shareholders in any Smith Barney mutual fund to
acquire shares of the same Class in a fund with different investment objectives
when they believe a shift between funds is an appropriate investment decision.
This privilege is available to shareholders residing in any state in which the
fund shares being acquired may legally be sold. Prior to any exchange, the
shareholder should obtain and review a copy of the current prospectus of each
fund into which an exchange is being considered. Prospectuses may be obtained
from a Service Agent.
Upon receipt of proper instructions and all necessary supporting documents,
shares submitted for exchange are redeemed at the then-current net asset value
and, subject to any applicable deferred sales charge, the proceeds are
immediately invested, at a price as described above, in shares of the fund
being acquired. CGM reserves the right to reject any exchange request. The
exchange privilege may be modified or terminated at any time after written
notice to shareholders.
55
Additional Information Regarding Exchanges. The funds are not designed to
provide investors with a means of speculation on short-term market movements. A
pattern of frequent exchanges by investors can be disruptive to efficient
portfolio management and, consequently, can be detrimental to a fund and its
shareholders. Accordingly, if a fund's management in its sole discretion
determines that an investor is engaged in excessive trading, a fund, with or
without prior notice, may temporarily or permanently terminate the availability
to that investor of fund exchanges, or reject in whole or part any purchase or
exchange request with respect to such investor's account. Such investors also
may be barred from purchases and exchanges involving other funds in the Smith
Barney Mutual Fund family. Accounts under common ownership or control will be
considered as one account for purposes of determining a pattern of excessive
trading. A fund may notify an investor of rejection of a purchase or exchange
order after the day the order is placed. If an exchange request is rejected,
the fund will take no other action with respect to the shares until it receives
further instructions from the investor. A fund's policy on excessive trading
applies to investors who invest in the fund directly or through Service Agents,
but does not apply to any systematic investment plans described in the
prospectus.
During times of drastic economic or market conditions, a fund may suspend
the Exchange Privilege temporarily without notice and treat exchange requests
based on their separate components--redemption orders with a simultaneous
request to purchase the other fund's shares. In such a case, the redemption
request would be processed at the fund's next determined net asset value but
the purchase order would be effective only at the net asset value next
determined after the fund being purchased formally accepts the order, which may
result in the purchase being delayed.
Additional Information Regarding Telephone Redemption and Exchange Program.
Neither the funds nor their agents will be liable for following instructions
communicated by telephone that are reasonably believed to be genuine. The funds
and its agents will employ procedures designed to verify the identity of the
caller and legitimacy of instructions (for example, a shareholder's name and
account number will be required and phone calls may be recorded). Each fund
reserves the right to suspend, modify or discontinue the telephone redemption
and exchange program or to impose a charge for this service at any time
following at least seven days prior notice to shareholders.
PERFORMANCE DATA
From time to time, the trust may quote a fund's yield or total return in
advertisements or in reports and other communications to shareholders. The
trust may include comparative performance information in advertising or
marketing each fund's shares. Such performance information may be included in
the following industry and financial publications--Barron's, Business Week, CDA
Investment Technologies, Inc., Changing Times, Forbes, Fortune, Institutional
Investor, Investor's Business Daily, Money, Morningstar Mutual Fund Values, The
New York Times, USA Today and The Wall Street Journal. To the extent any
advertisement or sales literature of a fund describes the expenses or
performance of any Class it will also disclose such information for the other
Classes.
Yield and Equivalent Taxable Yield
A fund's 30-day yield described in the Prospectuses is calculated according
to a formula prescribed by the SEC, expressed as follows:
Yield = 2[(A - B + 1)/6/ - 1]
[Download Table]
Where: a = Dividends and interest earned during the period
b = Expenses accrued for the period (net of reimbursements)
c = The average daily number of shares outstanding during the period that
were entitled to receive dividends
d = The maximum offering price per share on the last day of the period
56
For the purpose of determining the interest earned (variable "a" in the
formula) on debt obligations that were purchased by a fund at a discount or
premium, the formula generally calls for amortization of the discount or
premium; the amortization schedule will be adjusted monthly to reflect changes
in the market values of the debt obligations.
A fund's "equivalent taxable 30-day yield" for a Class is computed by
dividing that portion of the Class's 30-day yield which is tax-exempt by one
minus a stated income tax rate and adding the product to that portion, if any,
of the Class's yield that is not tax-exempt.
The yield on municipal securities is dependent upon a variety of factors,
including general economic and monetary conditions, conditions of the municipal
securities market, size of a particular offering, maturity of the obligation
offered and rating of the issue. Investors should recognize that, in periods of
declining interest rates, a fund's yield for each Class of shares will tend to
be somewhat higher than prevailing market rates, and in periods of rising
interest rates a fund's yield for each Class of shares will tend to be somewhat
lower. In addition, when interest rates are falling, the inflow of net new
money to a fund from the continuous sale of its shares will likely be invested
in portfolio instruments producing lower yields than the balance of the fund's
portfolio, thereby reducing the current yield of the fund. In periods of rising
interest rates, the opposite can be expected to occur.
[Download Table]
Equivalent
New York Fund Yield Taxable Yield(1)
------------- ----- ----------------
Class A....................... 2.93% 5.33%
Class B/(2)/.................. N/A N/A
Class L/(3)/.................. 2.44% 4.44%
Class O....................... 2.56% 4.66%
Class Y/(4)/.................. N/A N/A
--------
(1) Assuming the payment of Federal income taxes at a rate of 38.6% and New
York taxes at a rate of 10.498%.
(2) Class B shares commenced operations on March 28, 2003.
(3) Class L shares commenced operations on July 22, 2002.
(4) There were no Class Y shares outstanding during the last fiscal year.
[Download Table]
Equivalent
California Fund Yield Taxable Yield(1)
--------------- ----- ----------------
Class A....................... 2.89% 5.19%
Class B/(2)/.................. N/A N/A
Class L/(3)/.................. 2.52% 4.53%
Class O....................... 2.40% 4.31%
Class Y....................... 3.25% 5.84%
--------
(1) Assuming the payment of Federal income taxes at a rate of 38.6% and
California taxes at a rate of 9.3%.
(2) Class B shares commenced operations on March 28, 2003.
(3) Class L shares commenced operations on July 22, 2002.
Average Annual Total Return
A fund's "average annual total return," as described below, is computed
according to a formula prescribed by the SEC. The formula can be expressed as
follows:
P(1 + T)/n/ = ERV
[Enlarge/Download Table]
Where: P = a hypothetical initial payment of $1,000.
T = average annual total return.
n = number of years
ERV = Ending Redeemable Value of a hypothetical $1,000 investment made at
the beginning of a 1-, 5- or 10-year period at the end of a 1-, 5- or 10-year
period (or fractional portion thereof), assuming reinvestment of all
dividends and distributions.
57
The ERV assumes complete redemption of the hypothetical investment at the
end of the measuring period. A fund's net investment income changes in response
to fluctuations in interest rates and the expenses of the fund.
[Download Table]
Average Annual Total Return for the
fiscal year ended November 30, 2002*
--------------------------------
Since
California Fund 1-Year 5-Year 10-Year Inception(1)
--------------- ------ ------ ------- ------------
Class of Shares
Class A/(1)(2)(3)/............ 2.61% 4.48% 5.46% 5.58%
Class B....................... N/A N/A N/A N/A
Class L....................... N/A N/A N/A 0.54++
Class O/(3)/.................. 2.42% 4.47% N/A 5.94%
Class Y....................... 5.01% 5.15% N/A 5.55%
--------
(1) Class A shares commenced operations on December 31, 1991, Class B shares
commenced operations on March 28, 2003, Class L shares commenced operations
on July 22, 2002, Class O shares commenced operations on November 8, 1994,
and Class Y commenced operations on September 8, 1995.
(2) The average annual total return figure assumes that the maximum 2.00% sales
charge has been deducted from the investment at the time of purchase. If
the maximum sales charge had not been deducted, the average annual total
return for Class A shares for the same period would have been 4.70%,
4.91%,5.67% and 5.77% for one year, five years, ten years and since
inception of the fund, respectively.
(3) Assumes reinvestment of all dividends and capital gains distributions, if
any, at net asset value. In addition, Class A and O shares reflect the
deduction of the maximum initial sales charges of 2.00% and 1.00%,
respectively. Class O shares also reflect the deduction of a 1.00% CDSC,
which applies if shares are redeemed within the first year of purchase.
* The returns shown do not reflect the deduction of taxes that a shareholder
would pay on fund distributions or the redemptions of fund shares.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
[Download Table]
Average Annual Total Return for the
fiscal year ended November 30, 2002*
-------------------------------
Since
New York Fund 1-Year 5-Year 10-Year Inception(1)
------------- ------ ------ ------- ------------
Class of Shares
Class A/(1)(2)/............... 4.29% 4.85% 5.44% 5.77%
Class B....................... N/A N/A N/A N/A
Class L*...................... N/A N/A N/A 1.00%++
Class O/(3)/.................. 4.22% 4.82% N/A 5.94%
Class Y/(4)/.................. N/A N/A N/A N/A
--------
(1) Class A shares commenced operations on December 31, 1991, Class B shares
commenced operations on March 28, 2003, Class L shares commenced operations
on July 22, 2002, and Class O shares commenced operations on December 5,
1994.
(2) The average annual total return figure assumes that the maximum 2.00% sales
charge has been deducted from the investment at the time of purchase. If
the maximum sales charge had not been deducted, the average annual total
return for Class A shares for the same period would have been 6.45%, 5.26%,
5.66% and 5.97% for one year, five years, ten years and since inception of
the fund, respectively.
(3) The average annual total return figure assumes that the maximum applicable
initial and deferred sales charges have been deducted from the investment
at the time of redemption. If the maximum initial and deferred sales
charges had not been deducted, the average annual total return for Class O
shares for the same period would have been 6.30%, 5.04% and 6.08% for one
year, five years and since inception of the fund, respectively.
(4) There is no information for Class Y shares because no Class Y shares were
outstanding for the periods shown.
* The returns shown do not reflect the deduction of taxes that a shareholder
would pay on fund distributions or the redemptions of fund shares.
++ Total return is not annualized, as it may not be representative of the
total return for the year.
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Aggregate Total Return
The fund's "aggregate total return," as described below, represents the
cumulative change in the value of an investment in the fund for the specified
period and is computed by the following formula:
ERV - P
-------
P
[Enlarge/Download Table]
Where: P = a hypothetical initial payment of $10,000.
ERV = Ending Redeemable Value of a hypothetical $10,000 investment made at
the beginning of the 1-, 5- or 10-year period at the end of the 1-, 5- or 10-
year period (or fractional portion thereof), assuming reinvestment of all
dividends and distributions.
The ERV assumes complete redemption of the hypothetical investment at the
end of the measuring period.
[Download Table]
Aggregate Annual Total Return for the
fiscal year ended November 30, 2002
---------------------------------
Since
California Fund 1-Year 5-Year 10-Year Inception(1)
--------------- ------ ------ ------- ------------
Class of Shares
Class A/(1)(2)/............... 2.61% 24.47% 70.13% 80.84%
Class B....................... N/A N/A N/A N/A
Class L....................... N/A N/A N/A 0.54%
Class O/(3)/.................. 2.42% 24.44% N/A 59.18%
Class Y/(4)/.................. 5.01% 5.15% N/A 5.55%
--------
(1) Class A shares commenced operations on December 31, 1991, Class B shares
commenced operations on March 29, 2003, Class L shares commenced operations
on July 22, 2002, Class O commenced operations on November 8, 1994, and
Class Y commenced operations on September 8, 1995.
(2) The aggregate annual total return figure assumes that the maximum 2.00%
sales charge has been deducted from the investment at the time of purchase.
If the maximum sales charge had not been deducted, the average annual total
return for Class A shares for the same period would have been 4.70%,
27.06%, 73.52% and 84.51% for one year, five years, ten years and since
inception of the fund, respectively.
(3) The aggregate annual total return figure assumes that the maximum
applicable initial and deferred sales charges have been deducted from the
investment at the time of redemption. If the maximum initial and deferred
sales charges had not been deducted, the average annual total return for
Class O shares for the same period would have been 4.47%, 25.74% and 60.82%
for one year, five years and since inception of the fund, respectively.
(4) Class Y shares do not incur initial sales charges nor deferred sales
charges.
[Download Table]
Aggregate Annual Total Return for the
fiscal year ended November 30, 2002
---------------------------------
Since
New York Fund 1-Year 5-Year 10-Year Inception(1)
------------- ------ ------ ------- ------------
Class of Shares
Class A/(2)/.................. 4.29% 69.87% 69.87% 84.56%
Class B/(3)/.................. N/A N/A N/A N/A
Class L/(4)/.................. N/A N/A N/A 1.00%
Class O/(3)/.................. 4.22% 26.51% N/A 58.64%
Class Y/(4)/.................. N/A N/A N/A N/A
--------
(1) Class A commenced operations on December 31, 1991, Class B shares commenced
operation on July 28, 2003, Class L shares commenced operation on July 22,
2002, and Class O commenced operations on December 5, 1994.
(2) The aggregate annual total return figure assumes that the maximum 2.00%
sales charge has been deducted from the investment at the time of purchase.
If the maximum sales charge had not been deducted, the average annual total
return for Class A shares for the same period would have been 6.45%,
29.21%, 73.40% and 88.30% for one year, five years, ten years and since
inception of the fund, respectively.
(3) The aggregate annual total return figure assumes that the maximum
applicable initial and deferred sales charges have been deducted from the
investment at the time of redemption. If the maximum initial and deferred
sales charges had not been deducted, the average annual total return for
Class O shares for the same period would have been 6.30%, 27.84% and 60.26%
for one year, five years and since inception of the fund, respectively.
(4) There is no information for Class Y shares because no Class Y shares were
outstanding for the periods shown.
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It is important to note that the total return figures set forth above are
based on historical earnings and are not intended to indicate future
performance. Each Class's net investment income changes in response to
fluctuations in interest rates and the expenses of the fund. Performance will
vary from time to time depending upon market conditions, the composition of the
fund's portfolio and operating expenses and the expenses exclusively
attributable to the Class. Consequently, any given performance quotation should
not be considered representative of the Class's performance for any specified
period in the future. Because performance will vary, it may not provide a basis
for comparing an investment in the Class with certain bank deposits or other
investments that pay a fixed yield for a stated period of time. Investors
comparing a Class's performance with that of other mutual funds should give
consideration to the quality and maturity of the respective investment
companies' portfolio securities.
AFTER-TAX RETURN
From time to time a fund may include after-tax performance information in
advertisements. To the extent the fund includes such information, it will be
computed according to the following formulas:
Average Annual Total Return (After Taxes on Distributions)
P(1 + T)/n/ = ATVD
[Enlarge/Download Table]
Where: P = a hypothetical initial payment of $1,000.
T = average annual total return (after taxes on distributions).
n = number of years.
ATVD = ending value of a hypothetical $1,000 investment made at the beginning of
the 1-, 5- or 10-year period at the end of the 1-, 5- or 10-year period (or
fractional portion thereof), after taxes on fund distributions but not after
taxes on redemption.
Average Annual Total Return (After Taxes on Distributions and Redemptions)
P(1 + T)/n/ = ATVDR
[Enlarge/Download Table]
Where: P = a hypothetical initial payment of $1,000.
T = average annual total return (after taxes on distributions and redemption).
n = number of years.
ATVDR = ending value of a hypothetical $1,000 investment made at the beginning of
the 1-, 5- or 10-year period at the end of the 1-, 5- or 10-year period (or
fractional portion thereof), after taxes on fund distributions and
redemption.
DIVIDENDS AND DISTRIBUTIONS
Each fund's policy is to declare and pay exempt-interest dividends monthly.
Dividends from net realized capital gains, if any, will be distributed
annually. Each fund may also pay additional dividends shortly before December
31 each year from certain amounts of undistributed ordinary income and capital
gains in order to avoid a Federal excise tax liability. If a shareholder does
not otherwise instruct, exempt-interest dividends and capital gain
distributions will be reinvested automatically in additional shares of the same
Class at net asset value, with no additional sales charge or deferred sales
charge. A shareholder may change the option at any time by notifying his
Service Agent.
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The per-share amounts of the exempt-interest dividends on Class B, Class L
and Class O shares may be lower than on Class A and Class Y shares, mainly as a
result of the distribution fees applicable to Class B, Class L and Class O
shares. Similarly, the per-share amounts of exempt-interest dividends on Class
A shares may be lower than on Class Y shares, as a result of the service fee
attributable to Class A shares. Capital gain distributions, if any, will be the
same for all Classes of a fund's shares (A, B, L, O, and Y).
TAXES
The following is a summary of some of the material United States federal
income tax considerations regarding the purchase, ownership and disposition of
shares of a fund. Each prospective shareholder is urged to consult his or her
tax adviser with respect to the specific federal, state and local consequences
of investing in each fund. The summary is based on the laws in effect on the
date of this SAI and existing judicial and administrative interpretations
thereof, both of which are subject to change, possibly with retroactive effect.
The Funds and Their Investments
As described in the each fund's Prospectus, each fund is designed to provide
shareholders with current income that is excluded from gross income for federal
income tax purposes and is exempt from California or New York State and New
York City personal income taxes, as applicable. Neither fund is intended to
constitute a balanced investment program nor is either fund designed for
investors seeking capital gains or maximum tax-exempt income irrespective of
fluctuations in principal. Investment in each fund would not be suitable for
tax-exempt institutions, qualified retirement plans, H.R. 10 plans and
individual retirement accounts because such investors would not gain any
additional tax benefit from the receipt of tax-exempt income.
Each fund intends to continue to qualify as a regulated investment company
under the Code each taxable year. To so qualify, each fund must, among other
things: (a) derive at least 90% of its gross income in each taxable year from
dividends, interest, payments with respect to securities loans, and gains from
the sale or other disposition of stock or securities or foreign currencies, or
other income (including, but not limited to, gains from options, futures or
forward contracts) derived with respect to its business of investing in such
stock, securities or currencies; and (b) diversify its holdings so that, at the
end of each quarter of the fund's taxable year, (i) at least 50% of the market
value of the fund's assets is represented by cash, securities of other
regulated investment companies, United States government securities and other
securities, with such other securities limited, in respect of any one issuer,
to an amount not greater than 5% of the fund's assets and not greater than 10%
of the outstanding voting securities of such issuer and (ii) not more than 25%
of the value of its assets is invested in the securities (other than United
States government securities or securities of other regulated investment
companies) of any one issuer or any two or more issuers that the fund controls
and which are determined to be engaged in the same or similar trades or
businesses or related trades or businesses.
As a regulated investment company, each fund will not be subject to United
States federal income tax on its net investment income (i.e., taxable income
other than its net realized long-term and short-term capital gains) and on its
net realized long-term and short-term capital gains, if any, that it
distributes to its shareholders, provided that an amount equal to at least (i)
90% of the sum of its investment company taxable income (i.e., its taxable
income minus the excess, if any, of its net realized long-term capital gains
over its net realized short-term capital losses (including any capital loss
carryovers), plus or minus certain other adjustments as specified in the Code),
and (ii) 90% of its net tax-exempt income for the taxable year, is distributed
to its shareholders in compliance with the Code's timing and other
requirements. However, any taxable income or gain that it does not distribute
will be subject to tax at regular corporate rates.
On November 30, 2002, the unused capital loss carryovers, of the funds were
approximately as follows: California Fund $770,000 and New York Fund
$1,228,000. For federal income tax purposes, these amounts are available to be
applied against future capital gains of the fund that has the carryovers, if
any, which are realized prior to the expiration of the applicable carryover.
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The carryovers expire as follows:
[Download Table]
2003 2004 2007 2008 2009
-------- ------- -------- -------- -------
California Fund............ $269,000 $ 0 $216,000 $285,000 $ 0
New York Fund.............. $337,000 $76,000 $454,000 $329,000 $32,000
The Code imposes a 4% nondeductible excise tax on each fund to the extent it
does not distribute by the end of any calendar year at least 98% of its taxable
ordinary income for that year and at least 98% of its net capital gains (both
long-term and short-term) for the one-year period ending, as a general rule, on
October 31 of that year. For this purpose, however, any taxable ordinary income
or net capital gains retained by a fund that is subject to corporate income tax
will be considered to have been distributed by year-end. In addition, the
minimum amounts that must be distributed in any year to avoid the excise tax
will be increased or decreased to reflect any under distribution or over
distribution, as the case may be, from the previous year. Each fund anticipates
that it will pay such dividends and will make such distributions as are
necessary in order to avoid the application of this excise tax.
If, in any taxable year, a fund fails to qualify as a regulated investment
company under the Code or fails to meet the distribution requirement, it would
be taxed in the same manner as an ordinary corporation and distributions to its
shareholders would not be deductible by such fund in computing its taxable
income. In addition, in the event of a failure to qualify, a fund's
distributions, to the extent derived from the fund's current or accumulated
earnings and profits, would constitute dividends (eligible for the corporate
dividends-received deduction) that are taxable to shareholders as ordinary
income, even though those distributions might otherwise (at least in part) have
been treated in the shareholders' hands as tax-exempt interest. If a fund fails
to qualify as a regulated investment company in any year, it must pay out its
earnings and profits accumulated in that year in order to qualify again as a
regulated investment company. In addition, a fund may be required to recognize
any net built-in gains with respect to certain of its assets (i.e. the excess
of the aggregate gains, including items of income, over aggregate losses that
would have been realized with respect to such assets if the fund had been
liquidated) in order to qualify as a regulated investment company in a
subsequent year.
Each fund's transactions in municipal bond index and interest rate futures
contracts and options on these futures contracts (collectively "section 1256
contracts") will be subject to special provisions of the Code (including
provisions relating to "hedging transactions" and "straddles") that, among
other things, may affect the character of gains and losses realized by the fund
(i.e., may affect whether gains or losses are ordinary or capital), accelerate
recognition of income to the fund and defer fund losses. These rules could
therefore affect the character, amount and timing of distributions to
shareholders. These provisions also (a) will require each fund to
mark-to-market certain types of the positions in its portfolio (i.e., treat
them as if they were closed out) at the end of each year and (b) may cause each
fund to recognize income without receiving cash with which to pay dividends or
make distributions in amounts necessary to satisfy the distribution
requirements for avoiding income and excise taxes. Each fund will monitor its
transactions, will make the appropriate tax elections and will make the
appropriate entries in its books and records when it engages in these
transactions in order to mitigate the effect of these rules and prevent
disqualification of the fund as a regulated investment company.
All section 1256 contracts held by each fund at the end of its taxable year
are required to be marked to their market value, and any unrealized gain or
loss on those positions will be included in such fund's income as if each
position had been sold for its fair market value at the end of the taxable
year. The resulting gain or loss will be combined with any gain or loss
realized by such fund from positions in section 1256 contracts closed during
the taxable year. Provided such positions were held as capital assets and were
not part of a "hedging transaction" nor part of a "straddle," 60% of the
resulting net gain or loss will be treated as long-term capital gain or loss,
and 40% of such net gain or loss will be treated as short-term capital gain or
loss, regardless of the period of time the positions were actually held by the
fund.
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Taxation of Shareholders
Because each fund will distribute exempt-interest dividends, interest on
indebtedness incurred by a shareholder to purchase or carry fund shares is not
deductible for federal income tax purposes. In addition, the interest on any
such indebtedness is not deductible by a shareholder of the California Fund for
California personal income tax purposes, or by a New York Fund shareholder for
New York State, New York City and the City of Yonkers personal income tax
purposes. If a shareholder receives exempt-interest dividends with respect to
any share and if the shareholder holds such share for six months or less, then,
for federal income tax purposes, any loss on the sale or exchange of such share
may, to the extent of exempt-interest dividends, be disallowed. In addition,
the Code may require a shareholder, if he or she receives exempt-interest
dividends, to treat as federal taxable income a portion of certain otherwise
non-taxable social security and railroad retirement benefit payments.
Furthermore, that portion of any exempt-interest dividend paid by each fund
that represents income derived from "private activity bonds" held by such fund
may not retain its federal tax-exempt status in the hands of a shareholder who
is a "substantial user" of a facility financed by such bonds or a "related
person" thereof. Moreover, some or all of each fund's dividends may be a
specific preference item, or a component of an adjustment item, for purposes of
the federal individual and corporate alternative minimum taxes. In addition,
the receipt of each fund's dividends and distributions may affect a foreign
corporate shareholder's federal "branch profits" tax liability and the federal
or California "excess net passive income" tax liability of a shareholder of a
Subchapter S corporation.
Shareholders should consult their own tax advisors to determine whether they
are (a) substantial users with respect to a facility or related to such users
within the meaning of the Code or (b) subject to a federal alternative minimum
tax, the federal branch profits tax or the federal or California "excess net
passive income" tax.
Neither of the funds expects to realize a significant amount of capital
gains. Net realized short-term capital gains are taxable to a United States
shareholder as ordinary income, whether paid in cash or in shares.
Distributions of net-long-term capital gains, if any, that a fund designates as
capital gains dividends are taxable as long-term capital gains, whether paid in
cash or in shares and regardless of how long a shareholder has held shares of
that fund.
Shareholders receiving dividends or distributions in the form of additional
shares should have a cost basis in the shares received equal to the amount of
money that the shareholders receiving cash dividends or distributions will
receive.
Upon the sale or exchange of shares, a shareholder will realize a taxable
gain or loss equal to the difference between the amount realized and basis in
the shares. Such gain or loss will be treated as capital gain or loss if the
shares are capital assets in the shareholder's hands, and will be long-term
capital gain or loss if the shares are held for more than one year and
short-term capital gain or loss if the shares are held for one year or less.
Any loss realized on a sale or exchange will be disallowed to the extent the
shares disposed of are replaced, including replacement through the reinvesting
of dividends and capital gains distributions in the fund, within a 61-day
period beginning 30 days before and ending 30 days after the disposition of the
shares. In such a case, the basis of the shares acquired will be increased to
reflect the disallowed loss. Any loss realized by a shareholder on the sale of
a fund share held by the shareholder for six months or less (to the extent not
disallowed pursuant to the six-month rule described above relating to
exempt-interest dividends) will be treated for United States federal income tax
purposes as a long-term capital loss to the extent of any distributions or
deemed distributions of long-term capital gains received by the shareholder
with respect to such share.
If a shareholder incurs a sales charge in acquiring shares of a fund,
disposes of those shares within 90 days and then acquires shares in a mutual
fund for which the otherwise applicable sales charge is reduced by reason of a
reinvestment right (e.g., an exchange privilege), the original sales charge
will not be taken into account in computing gain or loss on the original shares
to the extent the subsequent sales charge is reduced. Instead, the disregarded
portion of the original sales charge will be added to the tax basis in the
newly acquired shares.
63
Furthermore, the same rule also applies to a disposition of the newly acquired
shares made within 90 days of the second acquisition. This provision prevents a
shareholder from immediately deducting the sales charge by shifting his or her
investment in a family of mutual funds.
Backup Withholding. Each fund may be required to withhold, for United
States federal income tax purposes, a portion of (a) taxable dividends and
distributions and (b) redemption proceeds payable to shareholders who fail to
provide such fund with their correct taxpayer identification number or to make
required certifications, or who have been notified by the IRS that they are
subject to backup withholding. Certain shareholders are exempt from backup
withholding. Backup withholding is not an additional tax and any amount
withheld may be credited against a shareholder's United States federal income
tax liabilities.
Notices. Shareholders will be notified annually by each fund as to the
United States federal income tax and California or New York State and New York
City personal income tax status of the dividends and distributions made by the
fund to its shareholders. These statements also will designate the amount of
exempt-interest dividends that is a preference item for purposes of the federal
individual and corporate alternative minimum taxes. The dollar amount of
dividends excluded or exempt from federal income taxation and California or
New York State and New York City personal income taxation and the dollar amount
of dividends subject to federal income taxation and California or New York
State and New York City personal income taxation, if any, will vary for each
shareholder depending upon the size and duration of such shareholder's
investment in a fund. To the extent each fund earns taxable net investment
income, it intends to designate as taxable dividends the same percentage of
each day's dividend as its taxable net investment income bears to its total net
investment income earned on that day.
State Tax Information
California State Taxes. California shareholders will not be subject to
California state personal income tax on dividends they receive from the
California Fund to the extent that such distributions qualify as
exempt-interest dividends under the Code and California law and provided that,
at the close of each quarter of the California Fund's taxable year, at least
50% of the California Fund's total assets are invested in California Exempt
Obligations. To the extent that distributions are derived from taxable income,
including long-term or short-term capital gains, such distributions will not be
exempt from California state personal income tax. Dividends on the California
Fund are not excluded in determining California state franchise taxes on
corporations and financial institutions.
The foregoing is only a brief summary of the tax considerations generally
affecting the California Fund and its shareholders who are California
residents. Investors are urged to consult their tax advisors with specific
reference to their own tax situation.
New York State and City Taxes. New York resident shareholders of the New
York Fund will not be subject to New York State or New York City personal
income tax on exempt-interest dividends attributable to interest on tax-exempt
obligations of the State of New York and its political subdivisions, as well as
certain other obligations the interest on which is considered exempt for New
York State and New York City purposes. The New York Fund is required to report
annually the source, tax status and recipient information related to its
exempt-interest dividends distributed within the State of New York.
Exempt-interest dividends are not excluded in determining New York State
franchise or New York City business taxes on corporations and financial
institutions.
The foregoing is only a brief summary of some of the tax considerations
generally affecting the New York Fund and its shareholders who are New York
residents. Investors are urged to consult their tax advisors with specific
reference to their own tax situation.
The foregoing is only a summary of certain material tax consequences
affecting each fund and its shareholders. Shareholders are advised to consult
their own tax advisors with respect to the particular tax consequences to them
of an investment in each fund.
64
ADDITIONAL INFORMATION
The trust was organized on October 17, 1991 under the laws of the
Commonwealth of Massachusetts and is a business entity commonly known as a
"Massachusetts business trust." The trust offers shares of beneficial interest
of five separate funds with a par value of $.001 per share. The funds may offer
shares of beneficial interest currently classified into nine Classes--A, B, L,
O, Y, Z, 1 and Smith Barney Shares and Citi Shares. Each Class of a fund
represents an identical interest in a fund's investment portfolio. As a result,
the Classes have the same rights, privileges and preferences, except with
respect to: (a) the designation of each Class; (b) the effect of the respective
sales charges; if any, for each class; (c) the distribution and/or service fees
borne by each Class pursuant to the Plan; (d) the expenses allocable
exclusively to each Class; (e) voting rights on matters exclusively affecting a
single Class; (f) the exchange privilege of each Class; and (g) the conversion
feature of the Class B shares. The trust's board of trustees does not
anticipate that there will be any conflicts among the interests of the holders
of the different Classes. The trustees, on an ongoing basis, will consider
whether any such conflict exists and, if so, take appropriate action.
Under Massachusetts's law, shareholders could, under certain circumstances,
be held personally liable for the obligations of each fund. The Master Trust
Agreement disclaims shareholder liability for acts or obligations of the fund,
however, and requires that notice of such disclaimer be given in each
agreement, obligation or instrument entered into or executed by each fund or a
trustee. The Master Trust Agreement provides for indemnification from fund
property for all losses and expenses of any shareholder held personally liable
for the obligations of each fund. Thus, the risk of a shareholder's incurring
financial loss on account of shareholder liability is limited to circumstances
in which each fund itself would be unable to meet its obligations, a
possibility which management of the fund believes is remote. Upon payment of
any liability incurred by each fund, a shareholder paying such liability will
be entitled to reimbursement from the general assets of each fund. The trustees
intend to conduct the operation of each fund in such a way so as to avoid, as
far as possible, ultimate liability of the shareholders for liabilities of each
fund.
The Master Trust Agreement of the funds permits the trustees of the funds to
issue an unlimited number of full and fractional shares of a single class and
to divide or combine the shares into a greater or lesser number of shares
without thereby changing the proportionate beneficial interests in the fund.
Each share in each of the funds represents an equal proportional interest in
each respective fund with each other share. Shareholders of each fund are
entitled upon its liquidation to share pro rata in its net assets available for
distribution. No shareholder of each fund has any preemptive or conversion
rights. Shares of each fund are fully paid and non-assessable.
Pursuant to the Master Trust Agreement, each fund's trustees may authorize
the creation of additional series of shares (the proceeds of which would be
invested in separate, independently managed portfolios) and additional classes
of shares within any series (which would be used to distinguish among the
rights of different categories of shareholders, as might be required by future
regulations or other unforeseen circumstances).
Each fund does not hold annual shareholder meetings. There normally will be
no meetings of shareholders for the purpose of electing trustees unless and
until such time as less than a majority of the trustees holding office have
been elected by shareholders, at which time the trustees then in office will
call a shareholders' meeting for the election of trustees. Shareholders of
record of no less than two-thirds of the outstanding shares of the trust may
remove a trustee through a declaration in writing or by vote cast in person or
by proxy at a meeting called for that purpose. The trustees will call a meeting
for any purpose upon written request of shareholders holding at least 10% of
the trust's outstanding shares and the trust will assist shareholders in
calling such a meeting as required by the 1940 Act.
When matters are submitted for shareholder vote, shareholders of each Class
will have one vote for each full share owned and a proportionate, fractional
vote for any fractional share held of that Class. Generally, shares of each
fund will be voted on a fund-wide basis on all matters except matters affecting
only the interests of one Class, in which case only shares of the affected
Class would be entitled to vote.
65
The trust was organized as an unincorporated Massachusetts business trust on
October 17, 1991 under the name Shearson Lehman Brothers Intermediate-Term
Trust. On October 14, 1994 and August 16, 1995, the trust's name was changed to
Smith Barney Income Trust and Smith Barney Investment Trust, respectively.
Annual and Semi-Annual Reports. Each fund sends its shareholders a
semi-annual report and an audited annual report, which include listings of
investment securities held by each fund at the end of the period covered. In an
effort to reduce the funds' printing and mailing costs, each fund consolidates
the mailing of its semi-annual and annual reports by household. This
consolidation means that a household having multiple accounts with the
identical address of record will receive a single copy of each report. In
addition, each fund also consolidates the mailing of its prospectus so that a
shareholder having multiple accounts will receive a single Prospectus annually.
Shareholders who do not want this consolidation to apply to their accounts
should contact their Service Agent or the transfer agent.
FINANCIAL STATEMENTS
Each fund's annual report for the fiscal year ended November 30, 2002 is
incorporated herein by reference in its entirety. The annual report was filed
on February 7, 2003, Accession Number 0000811-06444.
OTHER INFORMATION
Styles of Fund Management: In an industry where the average portfolio
manager has seven years of experience (source: ICI, 1998), the portfolio
managers of Smith Barney mutual funds average 21 years in the industry and 15
years with the firm.
Smith Barney mutual funds offers more than 60 mutual funds. We understand
that many investors prefer an active role in allocating the mix of funds in
their portfolio, while others want the asset allocation decisions to be made by
experienced managers.
That's why we offer four "styles" of fund management that can be tailored to
suit each investor's unique financial goals.
Classic Series--our portfolio manager driven funds
Our Classic Series lets investors participate in mutual funds whose
investment decisions are determined by experienced portfolio managers,
based on each fund's investment objectives and guidelines. Classic
Series funds invest across asset classes and sectors, utilizing a range
of strategies in order to achieve their objectives.
Premier Selections Series--our best ideas, concentrated funds
We offer a series of Premier Selections funds managed by several of our
most experienced and proven managers. This series of funds is built on a
unique strategy of combining complementary investment management styles
to create broader, multiclass and multicap products that are
distinguished by a highly concentrated focus.
Research Series--driven by exhaustive fundamental securities analysis
Built on a foundation of substantial buy-side research under the
direction of our Citigroup Asset Management colleagues, our Research
funds focus on well-defined industries, sectors and trends.
Style Pure Series--our solution to funds that stray
Our Style Pure Series funds are the building blocks of asset allocation.
The funds stay fully invested within their asset class and investment
style, enabling you to make asset allocation decisions in conjunction
with your financial professional.
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APPENDIX
RATINGS ON DEBT OBLIGATIONS
BOND (AND NOTES) RATINGS
Short-Term Note Ratings
The following summarizes the two highest ratings used by S&P for short-term
notes:
SP-1--Loans bearing this designation evidence a very strong or strong
capacity to pay principal and interest. Those issues determined to possess
overwhelming safety characteristics will be given a plus sign designation.
SP-2--Loans bearing this designation evidence a satisfactory capacity to pay
principal and interest.
The following summarizes the two highest ratings used by Moody's for
short-term notes and variable rate demand obligations:
MIG-1/VMIG-1--Obligations bearing these designations are of the best
quality, enjoying strong protection from established cash flows of funds for
their servicing or from established and broad-based access to the market for
refinancing, or both.
MIG-2/VMIG-2--Obligations bearing these designations are of high quality
with margins of protection ample although not so large as in the preceding
group.
Municipal Obligations Ratings
The following summarizes the ratings used by S&P for Municipal Obligations:
AAA--This is the highest rating assigned by S&P to a debt obligation and
indicates an extremely strong capacity to pay interest and repay principal.
AA--Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from AAA issues only in small degree.
A--Debt rated A has a strong capacity to pay interest and repay principal
although they are somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions than debt in higher-rated categories.
BBB--This is the lowest investment grade. Debt rated BBB has an adequate
capacity to pay interest and repay principal. Although adverse economic
conditions or changing circumstances are more likely to lead to a weakened
capacity to pay interest and repay principal for debt in this category than in
higher rated categories.
BB, B, CCC, CC, C--Debt rated BB, B, CCC, CC and C is regarded, on balance,
as predominately speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. BB represents a lower
degree of speculation than B and C the highest degree of speculation. While
such bonds will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
BB--Bonds rated BB have less near-term vulnerability to default than other
speculative issues. However, they face major ongoing uncertainties or exposure
to adverse business, financial, or economic conditions, which could lead to
inadequate capacity to meet timely interest and principal payments. The BB
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied BBB rating.
B--Bonds rated B have a greater vulnerability to default but currently have
the capacity to meet interest payments and principal repayments. Adverse
business, financial, or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The B rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
BB or BB- rating.
67
CCC--Debt rated CCC has a currently identifiable vulnerability to default
and is dependent upon favorable business, financial and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, it is not likely to have
the capacity to pay interest and repay principal. The CCC rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied B or B- rating.
CC--This rating is typically applied to debt subordinated to senior debt
that is assigned an actual or implied CCC rating.
C--This rating is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC- debt rating. The C rating may be
used to cover a situation where a bankruptcy petition has been filed, but debt
service payments are continued.
Additionally, the rating CI is reserved for income bonds on which no
interest is being paid. Such debt is rated between debt rated C and debt rated
D.
To provide more detailed indications of credit quality, the ratings from
"AA" to "CCC" may be modified by the addition of a plus or minus sign to show
relative standing within this major rating category.
D--Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments are not made on the date due even if
the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period. The D rating also will be used
upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
The following summarizes the highest four municipal ratings used by Moody's:
Aaa--Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edge." Interest payments are protected by a large or exceptionally stable
margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
Aa--Bonds which are rated as are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high-grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in Aaa
securities.
A--Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving security
to principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future.
Baa--Bonds which are rated Baa are considered as medium-grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba--Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B--Bonds which are rated B generally lack characteristics of desirable
investments. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
68
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's believes
possess the strongest investment attributes are designated by the symbols Aa1,
A1, Baa1, Ba1, and B1.
Caa--Bonds that are rated Caa are of poor standing. These issues may be in
default or present elements of danger may exist with respect to principal or
interest.
Ca--Bonds which are rated Ca represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked
shortcomings.
C--Bonds which are rated C are the lowest rated class of bonds, and issues
so rated can be regarded as having extremely poor prospects of ever attaining
any real investment standing.
Fitch IBCA, Inc.
AAA--Bonds rated AAA by Fitch have the lowest expectation of credit risk.
The obligor has an exceptionally strong capacity for timely payment of
financial commitments which is highly unlikely to be adversely affected by
foreseeable events.
AA--Bonds rated AA by Fitch have a very low expectation of credit risk. They
indicate very strong capacity for timely payment of financial commitment. This
capacity is not significantly vulnerable to foreseeable events.
A--Bonds rated A by Fitch are considered to have a low expectation of credit
risk. The capacity for timely payment of financial commitments is considered to
be strong, but may be more vulnerable to changes in economic conditions and
circumstances than bonds with higher ratings.
BBB--Bonds rated BBB by Fitch currently have a low expectation of credit
risk. The capacity for timely payment of financial commitments is considered to
be adequate. Adverse changes in economic conditions and circumstances, however,
are more likely to impair this capacity. This is the lowest investment grade
category assigned by Fitch.
BB--Bonds rated BB by Fitch carry the possibility of credit risk developing,
particularly as the result of adverse economic change over time. Business or
financial alternatives may, however, be available to allow financial
commitments to be met. Securities rated in this category are not considered by
Fitch to be investment grade.
B--Bonds rated B by Fitch carry significant credit risk, however, a limited
margin of safety remains. Although financial commitments are currently being
met, capacity for continued payment depends upon a sustained, favorable
business and economic environment.
CCC, CC, C--Default on bonds rated CCC,CC, and C by Fitch is a real
possibility. The capacity to meet financial commitments depends solely on a
sustained, favorable business and economic environment. Default of some kind on
bonds rated CC appears probable, a C rating indicates imminent default.
Plus and minus signs are used by Fitch to indicate the relative position of
a credit within a rating category. Plus and minus signs however, are not used
in the AAA category.
69
COMMERCIAL PAPER RATINGS
Moody's Investors Service, Inc.
Issuers rated "Prime-1" (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations. Prime-1 repayment
will normally be evidenced by the following characteristics: leading market
positions in well-established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on debt
and ample asset protection; broad margins in earnings coverage of fixed
financial changes and high internal cash generation; well-established access to
a range of financial markets and assured sources of alternate liquidity.
Issuers rated "Prime-2" (or related supporting institutions) have strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
Standard & Poor's
A-1--This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Those issuers determined to
possess overwhelming safety characteristics will be denoted with a plus (+)
sign designation.
A-2--Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as high as for issues designated
A-1.
Fitch IBCA, Inc.
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
The short-term rating places greater emphasis than a long-term rating on the
existence of liquidity necessary to meet financial commitment in a timely
manner.
Fitch's short-term ratings are as follows:
F1+--Issues assigned this rating are regarded as having the strongest
capacity for timely payments of financial commitments. The "+" denotes an
exceptionally strong credit feature.
F1--Issues assigned this rating are regarded as having the strongest
capacity for timely payment of financial commitments.
F2--Issues assigned this rating have a satisfactory capacity for timely
payment of financial commitments, but the margin of safety is not as great as
in the case of the higher ratings.
F3--The capacity for the timely payment of financial commitments is
adequate; however, near-term adverse changes could result in a reduction to non
investment grade.
The Thomson BankWatch ("TBW")
TBW-1--Indicates a very high degree of likelihood that principal and
interest will be paid on a timely basis.
TBW-2--While the degree of safety regarding timely repayment of principal
and interest is strong, the relative degree of safety is not as high as for
issues rated TBW-1.
70
SMITH BARNEY INVESTMENT
TRUST
Smith Barney
Intermediate Maturity
California Municipals Fund
Smith Barney
Intermediate Maturity
New York Municipals Fund
March 28, 2003,
as amended on
August 20, 2003
SMITH BARNEY INVESTMENT TRUST
125 Broad Street
New York, NY 10004
[LOGO] Citigroup Global Markets Inc.
A member of Citigroup
71
Dates Referenced Herein and Documents Incorporated By Reference
| Referenced-On Page |
|---|
| This 497 Filing | | Date | | First | | Last | | | Other Filings |
|---|
| |  |
| | 1/6/92 | | 30 |
| | 1/13/92 | | 30 |
| | 2/28/94 | | 30 |
| | 10/14/94 | | 66 |
| | 11/7/94 | | 52 | | 53 |
| | 11/8/94 | | 58 | | 59 |
| | 12/5/94 | | 58 | | 59 |
| | 8/16/95 | | 66 |
| | 9/8/95 | | 58 | | 59 |
| | 8/28/97 | | 30 |
| | 2/3/98 | | 32 |
| | 2/25/98 | | 33 |
| | 3/20/98 | | 30 |
| | 5/27/98 | | 32 |
| | 6/9/98 | | 33 |
| | 6/12/98 | | 46 | | 52 | | | 497 |
| | 11/23/98 | | 31 |
| | 3/5/99 | | 30 |
| | 3/8/99 | | 33 |
| | 3/9/99 | | 32 |
| | 3/10/00 | | 30 |
| | 3/31/00 | | 28 | | | | | 497J |
| | 4/1/00 | | 28 |
| | 6/5/00 | | 46 |
| | 12/19/00 | | 30 |
| | 3/31/01 | | 27 |
| | 6/30/01 | | 16 | | | | | N-30D, NSAR-A, NT-NSAR |
| | 7/27/01 | | 47 |
| | 9/11/01 | | 25 | | 32 |
| | 9/17/01 | | 32 |
| | 10/4/01 | | 19 |
| | 10/31/01 | | 29 |
| | 3/9/02 | | 32 |
| | 3/31/02 | | 27 |
| | 4/1/02 | | 21 |
| | 5/9/02 | | 29 |
| | 5/30/02 | | 32 |
| | 6/28/02 | | 19 |
| | 6/30/02 | | 16 | | 18 | | | N-30D, NSAR-A |
| | 7/17/02 | | 46 | | | | | 485BPOS |
| | 7/22/02 | | 46 | | 59 |
| | 8/16/02 | | 29 |
| | 9/5/02 | | 17 |
| | 10/30/02 | | 29 |
| | 11/27/02 | | 32 |
| | 11/30/02 | | 47 | | 66 | | | 24F-2NT, N-30D, NSAR-B |
| | 12/6/02 | | 17 | | 30 |
| | 12/31/02 | | 26 | | 43 | | | 24F-2NT, N-30D, NSAR-B |
| | 1/1/03 | | 18 | | 33 |
| | 1/10/03 | | 17 |
| | 1/28/03 | | 33 |
| | 2/3/03 | | 21 |
| | 2/5/03 | | 17 | | | | | 497, N-14 |
| | 2/7/03 | | 23 | | 66 | | | N-30D |
| | 2/10/03 | | 18 |
| | 3/3/03 | | 21 | | 22 |
| | 3/11/03 | | 41 | | 42 |
| | 3/28/03 | | 1 | | 71 | | | 485BPOS |
| | 3/29/03 | | 59 |
| | 3/31/03 | | 21 | | | | | 24F-2NT |
| | 5/14/03 | | 18 |
| | 7/28/03 | | 59 |
| Filed On / Filed As Of / Effective As Of | | 8/20/03 | | 1 | | 71 | | | 497 |
| | 11/30/03 | | 45 | | | | | 24F-2NT, 24F-2NT/A, N-CSR, NSAR-B |
| | 6/22/04 | | 48 |
| |
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