<PAGE> 1
SIERRA
------
PRIME INCOME
FUND
ANNUAL REPORT
FOR THE PERIOD ENDED
SEPTEMBER 30, 1996
-----------
SIERRA
PRIME
-----------
INCOME FUND
<PAGE> 2
SIERRA PRIME INCOME FUND
STATEMENT OF ASSETS AND LIABILITIES
SEPTEMBER 30, 1996
<TABLE>
<S> <C>
ASSETS
Investments, at value (Cost $12,338,792) (Note 2)
See portfolio of investments . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12,345,109
Receivable for investment securities sold . . . . . . . . . . . . . . . . . . . . . 2,387
Receivable for Fund shares sold . . . . . . . . . . . . . . . . . . . . . . . . . . 2,873
Interest receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54,938
Unamortized organization costs (Note 7) . . . . . . . . . . . . . . . . . . . . . . 213,781
Receivable from investment advisor (Note 3) . . . . . . . . . . . . . . . . . . . . 29,252
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119
---------------
Total Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,648,459
---------------
LIABILITIES
Deferred facility fees (Note 2) . . . . . . . . . . . . . . . . . . . . . . . . . . 6,604
Dividends payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28,233
Administration fee payable (Note 3) . . . . . . . . . . . . . . . . . . . . . . . . 2,554
Accrued legal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,601
Accrued audit fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,000
Accrued Trustees' fees and expenses . . . . . . . . . . . . . . . . . . . . . . . . 1,000
Due to Custodian . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,470
Accrued expenses and other payables (Note 3) . . . . . . . . . . . . . . . . . . . 7,462
---------------
Total Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114,924
---------------
NET ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12,533,535
===============
NET ASSETS CONSIST OF:
Paid in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,526,373
Undistributed net investment income . . . . . . . . . . . . . . . . . . . . . . . . 845
Net unrealized appreciation of investments . . . . . . . . . . . . . . . . . . . . 6,317
---------------
NET ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12,533,535
===============
Class A Common Shares Outstanding . . . . . . . . . . . . . . . . . . . . . . . . . 1,252,700
===============
Net asset value per share of beneficial
interest outstanding* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10.01
===============
Maximum sales charge . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.5%
Maximum offering price per share of
beneficial interest outstanding ($10.01/0.955) . . . . . . . . . . . . . . . . . $ 10.48
===============
</TABLE>
- ----------------
* Redemption price per share is equal to Net Asset Value less any applicable
contingent deferred sales charge.
See Notes to Financial Statements.
- 1 -
<PAGE> 3
SIERRA PRIME INCOME FUND
STATEMENT OF OPERATIONS
FOR THE PERIOD FEBRUARY 16, 1996* THROUGH SEPTEMBER 30, 1996
<TABLE>
<S> <C>
INVESTMENT INCOME:
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 414,601
Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,741
---------------
Total Investment Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . 416,342
---------------
EXPENSES:
Investment advisory fee (Note 3) . . . . . . . . . . . . . . . . . . . . . . . . . 58,878
Administration fee (Note 3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18,571
Legal fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105,570
Audit fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,750
Trustees' fees and expenses (Note 3) . . . . . . . . . . . . . . . . . . . . . . . 31,434
Amortization of organization costs . . . . . . . . . . . . . . . . . . . . . . . . 30,426
Printing and postage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,813
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,782
---------------
Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294,224
Fees waived and expenses absorbed
by investment advisor (Note 3) . . . . . . . . . . . . . . . . . . . . . . . . . (294,224)
---------------
Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0
---------------
NET INVESTMENT INCOME . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 416,342
---------------
NET UNREALIZED GAIN
ON INVESTMENTS (NOTES 2 AND 4):
Net change in unrealized appreciation of securities . . . . . . . . . . . . . . . . 6,317
---------------
Net unrealized gain on investments . . . . . . . . . . . . . . . . . . . . . . . . 6,317
---------------
NET INCREASE IN NET ASSETS
RESULTING FROM OPERATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 422,659
===============
</TABLE>
- ----------------
* Commencement of operations.
See Notes to Financial Statements.
- 2 -
<PAGE> 4
SIERRA PRIME INCOME FUND
STATEMENT OF CHANGES IN NET ASSETS
FOR THE PERIOD FEBRUARY 16, 1996* THROUGH SEPTEMBER 30, 1996
<TABLE>
<S> <C>
Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 416,342
Net unrealized appreciation of investments during the period . . . . . . . . . . . 6,317
---------------
Net increase in net assets resulting from operations . . . . . . . . . . . . . . . 422,659
---------------
Distributions to shareholders from net investment income:
Class A Common Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (416,342)
Net increase in net assets from Fund share transactions:
Class A Common Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,427,218
---------------
Net increase in net assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,433,535
---------------
NET ASSETS:
Beginning of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000
---------------
End of year (includes undistributed net investment income of $845) . . . . . . . . $ 12,533,535
===============
AMOUNT
Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12,610,620
Issued as reinvestment of dividends . . . . . . . . . . . . . . . . . . . . . 255,107
Repurchased . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (438,509)
---------------
Net Increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12,427,218
===============
SHARES
Sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,261,061
Issued as reinvestment of dividends . . . . . . . . . . . . . . . . . . . . . 25,490
Repurchased . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (43,851)
---------------
Net Increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,242,700
===============
</TABLE>
- ----------------
* Commencement of operations.
See Notes to Financial Statements.
- 3 -
<PAGE> 5
SIERRA PRIME INCOME FUND
STATEMENT OF CASH FLOWS
FOR THE PERIOD FEBRUARY 16, 1996* THROUGH SEPTEMBER 30, 1996
<TABLE>
<S> <C> <C>
Cash flows from operating activities:
Investment income received . . . . . . . . . . . . . . . . . . . $ 220,511
Fee income received . . . . . . . . . . . . . . . . . . . . . . 8,345
Payment of operating expenses . . . . . . . . . . . . . . . . . (166,535)
Proceeds from sales of long-term securities . . . . . . . . . . 1,981,821
Purchases of long-term securities . . . . . . . . . . . . . . . (8,513,000)
Net proceeds from short-term investments . . . . . . . . . . . . (5,670,848)
---------------
CASH USED FOR OPERATING ACTIVITIES . . . . . . . . . . . . . . . . . $ (12,139,706)
Cash flows from financing activities:
Proceeds from shares sold . . . . . . . . . . . . . . . . . . . 12,607,747
Payments on shares repurchased . . . . . . . . . . . . . . . . . (438,509)
Distributions paid** . . . . . . . . . . . . . . . . . . . . . . (133,002)
Due to Custodian . . . . . . . . . . . . . . . . . . . . . . . . 3,470
---------------
CASH PROVIDED BY FINANCING ACTIVITIES . . . . . . . . . . . . . . . . 12,039,706
---------------
Decrease in cash . . . . . . . . . . . . . . . . . . . . . . . . . . (100,000)
Cash at beginning of period . . . . . . . . . . . . . . . . . . . . . 100,000
---------------
Cash at end of period . . . . . . . . . . . . . . . . . . . . . . . . $ 0
===============
RECONCILIATION OF NET INCREASE IN NET ASSETS FROM OPERATIONS
TO CASH USED FOR OPERATING ACTIVITIES:
Net increase in net assets resulting from operations . . . . . . $ 422,659
Increase in investments+ . . . . . . . . . . . . . . . . . . $ (12,345,109)
Increase in interest receivable . . . . . . . . . . . . . . . (54,938)
Increase in receivable for investment securities sold . . . . (2,387)
Increase in unamortized organization costs . . . . . . . . . (213,781)
Increase in other assets . . . . . . . . . . . . . . . . . . (29,371)
Increase in accrued expenses . . . . . . . . . . . . . . . . 76,617
Increase in deferred facility fees . . . . . . . . . . . . . 6,604
---------------
Total adjustments . . . . . . . . . . . . . . . . . . (12,562,365)
----------------
CASH PROVIDED BY OPERATING ACTIVITIES . . . . . . . . . . . . . . . . $ (12,139,706)
================
</TABLE>
- ----------------
* Commencement of operations.
** Non cash activities include reinvestment of dividends of $255,107.
+ Includes unrealized appreciation of $6,317.
See Notes to Financial Statements.
- 4 -
<PAGE> 6
SIERRA PRIME INCOME FUND
FINANCIAL HIGHLIGHTS
FOR A FUND SHARE OUTSTANDING THROUGHOUT THE PERIOD
FEBRUARY 16, 1996* TO SEPTEMBER 30, 1996
<TABLE>
<S> <C>
Net asset value, beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10.00
--------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .40
Net realized and unrealized gain on investments . . . . . . . . . . . . . . . . . . . . . .01
--------
Total from investment operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . .41
--------
LESS DISTRIBUTIONS:
Dividends from net investment income . . . . . . . . . . . . . . . . . . . . . . . . . . (.40)
--------
Total distributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (.40)
--------
Net asset value, end of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10.01
========
TOTAL RETURN+ 4.19%
========
RATIOS TO AVERAGE NET ASSETS/SUPPLEMENTAL DATA:
Net assets, end of period (in 000's) . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12,534
Ratio of operating expenses to average net assets . . . . . . . . . . . . . . . . . . . . 0.00%**
Ratio of net investment income to average net assets . . . . . . . . . . . . . . . . . . 6.72%**
Portfolio turnover rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44%
Ratio of operating expenses to average net assets without fees
waived and expenses absorbed by investment advisor . . . . . . . . . . . . . . . . . . 4.75%**
Net investment income per share without fees waived
and expenses absorbed by investment advisor . . . . . . . . . . . . . . . . . . . . . $ 0.12
</TABLE>
- ----------------
* Commencement of operations.
** Annualized.
+ Total return represents aggregate total return for the period indicated.
The total return would have been lower if certain fees and expenses had not
been waived and absorbed by the investment advisor.
- 5 -
<PAGE> 7
SIERRA PRIME INCOME FUND
PORTFOLIO OF INVESTMENTS
SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
Principal Loan Stated
Amount Borrower Rate* Type Maturity** Value
------ -------- ---- ---- -------- -----
<S> <C> <C> <C>
SENIOR LOAN INTERESTS -- 52.1%
BROADCASTING -- 0.8%
$ 104,259 SKTV, Inc. . . . . . . . . . . . . 7.440% Term 07/31/2000 $ 104,259
--------------
CABLE -- 2.7%
344,000 Marcus Cable Operating Company, L.P. 7.136 Term 12/31/2002 344,017
--------------
FOOD & BEVERAGES -- 14.6%
573,000 Keebler Holding Corporation . . . . 7.874 Term 01/31/2002 572,813
259,565 SC International Services, Inc. . . 8.624 Term 09/30/2001 259,565
323,710 SC International Services, Inc. . . 8.624 Term 09/30/2002 323,710
71,187 SC International Services, Inc. . . 8.874 Term 09/30/2003 71,187
600,000 Stroh Brewery Company . . . . . . . 8.127 Term 06/30/2001 601,551
--------------
1,828,826
--------------
FOOD STORES -- 5.6%
104,125 Bruno's, Inc. . . . . . . . . . . . 7.775 Term 02/18/2002 104,109
596,630 Carr-Gottstein Foods . . . . . . . 8.625 Term 12/31/2002 596,684
--------------
700,793
--------------
HEALTHCARE -- 2.9%
359,000 Merit Behavioral Care Corporation . 8.434 Term 10/06/2003 358,968
--------------
MANUFACTURING -- 5.0%
358,820 International Wire Group, Inc. . . 8.545 Term 09/30/2002 358,783
161,061 T.K.G. Acquisition Corporation . . 7.749 Term 02/28/2002 161,053
111,714 Thompson Minwax Company . . . . . . 8.440 Term 12/31/2002 111,714
--------------
631,550
--------------
PAPER -- 6.8%
107,708 Fort Howard Corporation . . . . . . 7.719 Term 03/31/2002 107,712
158,464 Jefferson Smurfit Corporation . . . 6.938 Term 04/30/2001 158,465
118,370 Stone Container Corporation . . . . 8.655 Term 04/01/2000 118,379
472,613 Stone Container Corporation . . . . 8.813 Term 10/01/2003 473,556
--------------
858,112
--------------
RETAIL -- 3.6%
446,791 Federated Department Stores, Inc. . 6.219 Term 03/31/2000 448,725
--------------
OTHER -- 10.1%
361,875 AMF Group, Inc. . . . . . . . . . . 8.063 Term 03/31/2001 361,855
429,057 AMF Group, Inc. . . . . . . . . . . 8.438 Term 03/31/2003 429,033
169,132 AMF Group, Inc. . . . . . . . . . . 8.688 Term 03/31/2004 169,123
297,711 Borg-Warner Security Corporation . . 8.750 Term 12/31/1998 299,848
--------------
1,259,859
--------------
Total Senior Loan Interests (cost $6,528,792) . . . . . . . . . . . 6,535,109
--------------
</TABLE>
See Notes to Financial Statements.
- 6 -
<PAGE> 8
SIERRA PRIME INCOME FUND
PORTFOLIO OF INVESTMENTS (CONTINUED)
SEPTEMBER 30, 1996
<TABLE>
<CAPTION>
Principal
Amount Value
------ -----
<S> <C>
U.S. GOVERNMENT AGENCY DISCOUNT NOTES -- 46.4% (cost $5,810,000)
$ 5,810,000 Federal Home Loan Bank (FHLB)
5.700%, due 10/01/1996 . . . . . $ 5,810,000
--------------
TOTAL INVESTMENTS (Cost $12,338,792+) . . . . . . . . . 98.5% 12,345,109
OTHER ASSETS AND LIABILITIES (Net) . . . . . . . . . . 1.5 188,426
---- --------------
NET ASSETS . . . . . . . . . . . . . . . . . . . . . . 100.0% $ 12,533,535
===== ==============
</TABLE>
- ----------------
* Senior loans in which the Sierra Prime Income Fund invests generally pay
interest at rates which are periodically redetermined by reference to a base
lending rate plus a premium. These base lending rates are generally (i) the
prime rate offered by one or more major United States banks; (ii) the lending
rate offered by one or more major European banks, such as the London Inter-Bank
Offered Rate (LIBOR); or (iii) the certificate of deposit ratio. Senior loans
are generally considered to be restricted in that the Fund ordinarily is
contractually obligated to receive approval from the Agent Bank and/or borrower
prior to the disposition of a senior loan. Within each loan there may be
different rates due to different reset dates. The rates disclosed for each
loan are the weighted average coupon rates as of September 30, 1996.
** Senior loans in the Sierra Prime Income Fund's portfolio generally are
subject to mandatory and/or optional prepayment. Because of these mandatory
prepayment conditions and because there may be significant economic incentives
for a Borrower to prepay, prepayments of senior loans in the Fund's portfolio
may occur. As a result, the actual remaining maturity of senior loans held in
the Fund's portfolio may be substantially less than the stated maturities
shown. Although the Fund is unable to accurately estimate the actual remaining
maturity of individual senior loans, the Fund estimates that the actual average
maturity of the senior loans held in its portfolio will be approximately 18-24
months.
+ At September 30, 1996 the aggregate cost for federal tax purposes was
$12,338,792. The gross unrealized appreciation for all securities in which
there is an excess of value over tax cost and aggregate gross unrealized
depreciation for all securities in which there is an excess of tax cost over
value were $6,694 and $377, respectively.
See Notes to Financial Statements.
- 7 -
<PAGE> 9
SIERRA PRIME INCOME FUND
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND BUSINESS
Sierra Prime Income Fund (the "Fund") is registered under the Investment
Company Act of 1940, as amended ("1940 Act"), as a non-diversified, closed-end
management investment company. The Fund was organized as a Massachusetts
business trust on October 4, 1995. During the period October 4, 1995 to
February 15, 1996, the Fund had no operations other than those related to
organizational matters, including the initial capital contribution of $100,000
and the issuance of 10,000 shares of beneficial interest to Sierra Fund
Administration Corporation.
The Trustees of the Fund authorized an unlimited number of Common Shares with
separate classes of beneficial interest. Currently there are only Class A
Common Shares. Shares are continuously offered at a price equal to the next
determined net asset value ("NAV") per share plus a maximum sales charge based
on a determined schedule.
2. SIGNIFICANT ACCOUNTING POLICIES
The preparation of financial statements in accordance with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts and disclosures in the financial statements.
Actual results could differ from those estimates. The following is a summary
of significant accounting policies consistently followed by the Sierra Prime
Income Fund in the preparation of its financial statements.
Portfolio Valuation:
Senior Loans are not actively traded in a public market. Sierra Investment
Advisors Corporation (the "Advisor"), and Van Kampen American Capital
Management Inc. (the "Sub-Advisor"), following procedures established by the
Fund's Board of Trustees, value the Senior Loan interests held by the Fund at
fair value. In valuing a Senior Loan interest, the Advisor and Sub-Advisor
consider relevant factors, data and information, including: (i) the
characteristics of and fundamental analytical data relating to the Senior Loan,
including the cost, size, current interest rate, period until next interest
rate reset, maturity and base lending rate of the Senior Loan interest, the
terms and conditions of the Senior Loan and any related agreements, and the
position of the Senior Loan in the Borrower's debt structure; (ii) the nature,
adequacy and value of the collateral, including the Fund's rights, remedies and
interests with respect to the collateral; (iii) the creditworthiness of the
Borrower's business, cash flows, capital structure and future prospects; (iv)
information relating to the market for Senior Loans, including price quotations
for (if considered reliable) and trading in Senior Loans and interests in
similar Loans; (v) the reputation and financial condition of the Agent and any
Intermediate Participants in the Senior Loans; and (vi) general economic and
market conditions affecting the fair value of Senior Loans.
Other Fund holdings (other than short term obligations, but including listed
issues) are valued on the basis of prices furnished by one or more pricing
services which determine prices for normal, institutional-size trading units of
such securities using market information, transactions for comparable
securities and various relationships between securities which are generally
recognized by institutional traders. In certain circumstances, portfolio
securities will be valued at the last sale price on the exchange that is the
primary market for such securities, or the average of the last quoted bid price
and asked price for those securities for which the over-the-counter market is
the primary market or for listed securities in which there were no sales during
the day. The value of interest rate swaps is determined in accordance with a
discounted present value formula and then confirmed by obtaining a bank
quotation. As of September 30, 1996 there were no interest rate swaps.
- 8 -
<PAGE> 10
SIERRA PRIME INCOME FUND
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Short-term obligations which mature in 60 days or less are valued at amortized
cost, if their original term to maturity when acquired by the Portfolio was 60
days or less, or are valued at amortized cost using their value on the 61st day
prior to maturity, if their original term to maturity when acquired by the Fund
was more than 60 days, unless in each case this is determined not to represent
fair value. Repurchase agreements will be valued by the Fund at cost plus
accrued interest. Securities for which there exist no price quotations or
valuations and all other assets are valued at fair value as determined in good
faith by or on behalf of the Board of Trustees.
Illiquid Investments:
Senior Loans in which the Fund will invest presently are not readily marketable
and may be subject to restrictions on resale. Interests in Senior Loans
generally are not listed on any national securities exchange or automated
quotation system and no regular market has developed for such interests.
Although interests in Senior Loans are traded among certain financial
institutions in private transactions between buyers and sellers these loans
continue to be considered illiquid. Senior Loans' illiquidity may impair the
Fund's ability to realize the full value of its assets in the event of a
voluntary or involuntary liquidation of such assets. Liquidity relates to the
ability of the Fund to sell an investment in a timely manner. The market for
relatively illiquid securities tends to be more volatile than the market for
more liquid securities. The Fund has no limitation on the amount of its assets
which may be invested in securities which are not readily marketable or are
subject to restriction on resale. The substantial portion of the Fund's assets
invested in relatively illiquid Senior Loan interests may restrict the ability
of the Fund to dispose of its investments in Senior Loans in a timely fashion
and at a fair price, and could result in capital losses to the Fund and holders
of Common Shares. However, many of the Senior Loans in which the Fund invests
are of a relatively large principal amount and are held by a relatively large
number of owners which should, in the Advisor's opinion, enhance the relative
liquidity of such interests. The risks associated with illiquidity are
particularly acute in situations where the Fund's operations require cash, such
as when the Fund tenders (Note 5) for its Common Shares and may result in the
Fund borrowing to meet short-term cash requirements.
Cash Flow Information:
The cash amount in the Statement of Cash Flows is the amount reported in the
Statement of Assets and Liabilities and does not include any short-term
investments at September 30, 1996. The Fund issues its shares, invests in
securities, and makes distributions from net investment income and net capital
gains (which are either paid in cash or reinvested at the discretion of
shareholders). These activities are reported in the Statement of Changes in
Net Assets. Information on cash receipts and payments is presented in the
Statement of Cash Flows.
Repurchase Agreements:
The Fund may enter into repurchase agreements (a purchase of, and a
simultaneous commitment to resell, a financial instrument at an agreed upon
price on an agreed upon date) only with member banks of the Federal Reserve
System and member firms of the New York Stock Exchange. When participating in
repurchase agreements, the Fund buys securities from a vendor (e.g., a bank or
brokerage firm) with the agreement that the vendor will repurchase the
securities at a higher price at a later date. Such transactions afford an
opportunity for the Fund to earn a return on available cash at minimal market
risk, although the Fund may be subject to various delays and risks of loss if
the vendor is unable to meet its obligation to repurchase. Under the 1940 Act,
repurchase agreements are deemed to be collateralized loans of money by the
Fund to the seller. In evaluating whether to enter into a repurchase
agreement, the Advisor will consider carefully the creditworthiness of the
vendor. If the member bank or member firm that is the party to the repurchase
agreement petitions for bankruptcy or otherwise becomes subject to the U.S.
Bankruptcy Code, the law regarding the rights of the Fund is unsettled. The
securities underlying a
- 9 -
<PAGE> 11
SIERRA PRIME INCOME FUND
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
repurchase agreement will be marked to market every business day so that the
value of the collateral is at least equal to the value of the loan, including
the accrued interest thereon, and the Advisor will monitor the value or the
collateral. No specific limitations exists as to the percentage of the Fund's
assets which may be used to participate in repurchase agreements.
Securities Transactions and Investment Income:
Securities transactions are recorded on trade date (the date the order to buy
or sell is executed). Realized gains and losses from securities sold are
recorded on the identified cost basis. Income is recorded on the accrual basis
and consists of interest accrued and discount earned less premiums amortized.
Facility fees are received upon the purchase of a new loan and are recognized
as income ratably over the expected life of the loan. The deferred facility
fees are the "unearned" portion of these facility fees. The Fund may purchase
and sell interest in Senior Loans and other portfolio securities on a "when
issued" and "delayed delivery" basis. No income accrues to the Fund on such
interests or securities in connection with such purchase transactions prior to
the date the Fund actually takes delivery of such interest or securities. When
the Fund is the buyer in such a transaction, however, it will maintain, in a
segregated account with its custodian, cash or high-grade portfolio securities
having an aggregate value equal to the amount of such purchase commitments
until payment is made.
Dividends and Distributions to Shareholders:
The Fund's policy is to declare daily and pay monthly distributions to holders
of Class A Common Shares of substantially all net investment income of the
Fund. Distributions of any net long-term capital gains earned by the Fund are
made annually. Distributions of any net short- term capital gains earned by
the Fund are distributed no less frequently than annually at the discretion of
the Board of Trustees. Additional distributions of net investment income and
capital gains for the Fund may be made at the discretion of the Board of
Trustees in order to avoid the application of a 4% non-deductible excise tax on
certain undistributed amounts of ordinary income and capital gains. Income
distributions and capital gain distributions are determined in accordance with
income tax regulations which may differ from generally accepted accounting
principles. These differences are primarily due to differing treatments of
income and gains on various investment securities held by the Fund, timing
differences and differing characterization of distributions made by the Fund.
For the year ended September 30, 1996, permanent differences resulting from
book and tax accounting for organizational costs were reclassified causing a
decrease of $845 to paid-in capital and an increase to undistributed net
investment income for the same amount.
Federal Income Taxes:
It is the Fund's policy to qualify as a regulated investment company by
complying with the requirements of the Internal Revenue Code of 1986, as
amended, applicable to regulated investment companies and by, among other
things, distributing substantially all of its taxable earnings to its
shareholders. Therefore, no Federal income tax provision is required.
3. INVESTMENT ADVISORY, SUB-ADVISORY, ADMINISTRATION FEES AND OTHER
TRANSACTIONS
Sierra Advisors, an indirect wholly-owned subsidiary of Great Western Financial
Corporation ("GWFC"), is the Fund's investment advisor. Sierra Advisors is
entitled to a monthly fee at an annual rate of 0.95% of the average daily net
assets of the Fund. These fees were $58,878 for the period ended September 30,
1996 and have been voluntarily waived by Sierra Advisors. Sierra Advisors pays
a monthly fee at an
- 10 -
<PAGE> 12
SIERRA PRIME INCOME FUND
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
annual rate of 0.475% to Van Kampen American Capital Management Inc. for
services rendered as the Sub-Advisor.
Sierra Fund Administration Corporation ("Sierra Administration") is the Fund's
administrator. As a result of a change in transfer agent responsibilities
effective July 1, 1996, Sierra Administration now receives a monthly fee at an
annual rate of 0.25% of the Fund's average daily net assets and the Fund now
pays First Data Investor Services Group, Inc. ("First Data") directly for all
transfer agent services. Prior to this Sierra Administration was entitled to a
monthly fee at an annual rate of 0.35% of the Fund's average daily net assets,
and Sierra Administration paid First Data for certain transfer agency services.
The Administration fees for the period ended September 30, 1996 were $18,571.
Sierra Administration pays State Street Bank and Trust Company ("State Street")
for certain administrative and custodial services. The Fund pays for the
sub-administrator and custodial out-of pocket expenses.
Sierra Advisors has agreed to voluntarily reimburse the Fund's total operating
expenses. For the period ended September 30, 1996 the total reimbursement to
the Fund was $235,346.
The compensation of the officers and Trustees who are interested persons (as
defined in the 1940 Act) of the Advisor is paid by the Advisor or by its
parent, GWFC. The Fund pays the compensation of all other officers and
Trustees of the Fund. Trustees who are not interested persons are paid an
annual fee of $5,000, a fee of $1,000 per meeting of the Board of Trustees and
a fee of $750 per committee meeting of the Fund, plus expenses.
As of September 30, 1996 there was one shareholder who owned greater than five
percent of Class A Common Shares, representing 16.55% of the Fund at this date.
For the period ended September 30, 1996, Great Western Financial Securities
Corporation and Sierra Investment Services Corporation ("SISC"), both
registered broker-dealers, have received $232,067 and $32,221, respectively,
representing commissions (front-end sales charges).
4. PURCHASE AND SALES OF SECURITIES
The aggregate cost of purchases and proceeds from sales of securities,
excluding U.S. Government and short-term investments, for the period ended
September 30, 1996 was $8,513,000 and $1,984,208, respectively.
5. TENDER OF SHARES
The Board of Trustees of the Fund currently intends, each quarter, to consider
authorizing the Fund to make tender offers for a portion of its outstanding
Class A Common Shares at the then current net asset value of these Common
Shares. The Fund does not intend to list its Common Shares on any national
securities exchange and none of the Fund, the Advisor or SISC intends to make a
secondary trading market in the classes of the Common Shares at any time.
Accordingly, there is not expected to be any secondary trading market in the
Common Shares and an investment in such Common Shares should be considered
illiquid. There can be no assurance that the Fund will in fact tender for any
of its Common Shares. If the Fund tenders for Common Shares there is no
guarantee that all, or any, Common Shares tendered will be purchased. An early
withdrawal charge may be charged by SISC on those repurchases or tenders done
during the first or second year after purchase. For the period ended September
30, 1996, 43,851 shares were tendered and repurchased by the Fund with no early
withdrawal charge.
- 11 -
<PAGE> 13
SIERRA PRIME INCOME FUND
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. SHARES OF BENEFICIAL INTEREST
The Declaration of Trust permits the Fund to issue an unlimited number of full
and fractional Common Shares of beneficial interest with no par value. The
Fund initially is offering 5,000,000 Class A Common Shares in a continuous
offering pursuant to Rule 415 under the Securities Act of 1933, as amended.
7. ORGANIZATION COSTS
Expenses incurred in connection with the organization of the Fund, including
the fees and expenses of registering and qualifying its shares for distribution
under Federal and state securities regulations, are being amortized on a
straight-line basis over a period of five years from commencement of operations
of the Fund. In the event any of the initial shares of the Fund are redeemed
by any holder thereof during the amortization period, the proceeds of such
redemptions will be reduced by an amount equal to the pro-rata portion of
unamortized deferred organizational expenses in the same proportion as the
number of shares being redeemed bears to the number of initial shares of such
Fund outstanding at the time of such redemption. To the extent that proceeds
of the redemptions are less than such pro-rata portion of any unamortized
organizational expenses, Sierra Administration has agreed to reimburse the
Fund.
8. SENIOR LOAN PARTICIPATIONS
The Fund invests primarily in participations, assignments, or acts as a party
to the primary lending syndicate of a Variable Rate Senior Loan interest to
United States corporations, partnerships, and other entities. When the Fund
purchases a participation of a Senior Loan interest, the Fund typically enters
into a contractual agreement with the lender or other third party selling the
participation, but not with the borrower directly. As such, the Fund assumes
the credit risk of the Borrower, Selling Participant or other persons
interpositioned between the Fund and the Borrower.
At September 30, 1996, the following sets forth the selling participants with
respect to interests in Senior Loans purchased by the Fund on a participation
basis.
<TABLE>
<CAPTION>
Principal
Selling Participant Amount Value
------------------- -------------- -----
<S> <C> <C>
Pearl Street L.P. $ 2,187,525 $ 2,187,286
Chase Securities Inc. 2,001,911 2,001,831
Morgan Guaranty 600,000 601,550
Bankers Trust 596,630 596,684
Lehman Commercial Paper, Inc. 472,613 473,557
Canadian Imperial Bank of Commerce 458,772 460,901
NationsBank 211,341 213,300
------------ -------------
$ 6,528,792 $ 6,535,109
============ ============
</TABLE>
9. LINE OF CREDIT
Sierra Prime Income Fund and the Sierra Trust Funds participate in a $40
million line of credit provided by Deutsche Bank AG, New York Branch (the
"Bank") under a Credit Agreement (the "Agreement") dated May 22, 1996,
primarily for temporary or emergency purposes, including the meeting of
redemption requests that otherwise might require the untimely disposition of
securities. Under the Agreement, Sierra Prime Income Fund may borrow up to
$433,000 plus its pro rata portion of any unused base commitment allocation of
the other borrowers under the Agreement. Interest is payable at one of the
following rates depending on the type of loan designated by the borrower: (i)
the higher of 0.50% in excess of the Federal Funds Rate and the prime lending
rate announced by the Bank; (ii) the New York Interbank Offered Rate (NIBOR)
plus 0.35% on an annualized basis; or (iii) the London Interbank Offered Rate
(LIBOR) plus
- 12 -
<PAGE> 14
SIERRA PRIME INCOME FUND
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
0.35% on an annualized basis. The Fund is charged an aggregate commitment fee
computed at a rate equal to 0.05% on an annual basis of the daily average
unutilized credit balance. The Agreement requires that the aggregate
outstanding principal amount of the loan made shall not exceed 33 1/3 % of the
value of the total assets of the fund less all liabilities and indebtedness not
represented by senior securities. The Fund currently expects, however, to
limit its borrowing to an amount sufficient to meet its tender offer purchases
or 10% of its assets, whichever is greater. During the period ended September
30, 1996, the Fund had not borrowed under the Agreement.
10. SUBSEQUENT EVENTS (UNAUDITED)
The second tender offer of the Sierra Prime Income Fund expired on October 25,
1996. As of this date 44,043 additional shares were tendered and repurchased
by the Fund.
On October 31, 1996 VKAC Holding, the parent of the Sub-Advisor, was merged
with Morgan Stanley Group Inc. ("Morgan Stanley") whereby VKAC Holding and the
Sub-Advisor became indirect subsidiaries of Morgan Stanley. As a result of
this merger, a Special Meeting of Shareholders, of record of the Fund at the
close of business on September 10, 1996, was held on October 29, 1996, to vote
on approval of a new investment sub- advisory agreement with the current
Sub-Advisor, Van Kampen American Capital Management Inc.. The voting results
were as follows:
<TABLE>
<CAPTION>
Number of Shares % of Outstanding Shares % of Shares Voted
---------------- ----------------------- -----------------
<S> <C> <C> <C>
Affirmative 679,731 54.638% 89.666%
Against 2,558 .206% .338%
Abstain 75,780 6.091% 9.996%
---------- -------- ----------
Total 758,069 60.935% 100.000%
========== ======== ==========
</TABLE>
Accordingly, shareholders of the Fund approved the new investment sub-advisory
agreement with the Sub-Advisor resulting from the "change of control" due to
its merger with Morgan Stanley.
- 13 -
<PAGE> 15
Sierra Prime Income Fund
Report of Independent Accountants
TO THE SHAREHOLDERS AND TRUSTEES
OF SIERRA PRIME INCOME FUND
In our opinion, the accompanying statement of assets and liabilities, including
the portfolio of investments, and the related statements of operations, of
changes in net assets and of cash flows and the financial highlights present
fairly, in all material respects, the financial position of Sierra Prime Income
Fund (the "Fund") at September 30, 1996, and the results of its operations, its
cash flows, the changes in its net assets and the financial highlights for the
period February 16, 1996 (commencement of operations) through September 30,
1996, in conformity with generally accepted accounting principles. These
financial statements and financial highlights (hereafter referred to as
"financial statements") are the responsibility of the Fund's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these financial statements in accordance
with generally accepted auditing standards which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audit, which included confirmation of
securities at September 30, 1996 by correspondence with the custodian and, with
respect to senior collateralized loans, the selling participants and agent
banks, provides a reasonable basis for the opinion expressed above.
As explained in Note 2, the financial statements include senior collateralized
loans valued at $6,535,109 (52.1 percent of net assets), which values have been
determined in accordance with procedures established by the Trustees in the
absence of readily ascertainable market values. We have reviewed the
procedures which were established by the Trustees in determining the fair
values of such senior collateralized loans and have inspected underlying
documentation, and, in the circumstances, we believe the procedures are
reasonable and the documentation appropriate. However, those values determined
in accordance with procedures established by the Trustees may differ
significantly from the values that would have been used had a ready market for
the senior collateralized loans existed, and the differences could be material.
PRICE WATERHOUSE LLP
Boston, Massachusetts
November 6, 1996
- 14 -
<PAGE> 16
-----------
SIERRA
PRIME
-----------
INCOME FUND
SIERRA PRIME INCOME FUND
9301 CORBIN AVENUE, SUITE 333
NORTHRIDGE, CALIFORNIA 91324
800-222-5852
THE SIERRA PRIME INCOME FUND is advised
by SIERRA INVESTMENT ADVISORS CORPORATION (SIAC)
distributed by SIERRA INVESTMENT SERVICES CORPORATION (SISC)
and sold through Great Western Financial Securities Corporation (GWFSC)
SIAC, SISC and GWFSC are independent affiliates of Great Western Bank.
