DEFINED ASSET FUNDS
MUNICIPAL INVESTMENT TRUST FUND
MUNICIPAL INSURED SERIES
INFORMATION SUPPLEMENT
This Information Supplement provides additional information concerning the
structure, operations and risks of municipal bond trusts (each, a "Fund") of
Defined Asset Funds not found in the prospectuses for the Funds. This
Information Supplement is not a prospectus and does not include all of the
information that a prospective investor should consider before investing in a
Fund. This Information Supplement should be read in conjunction with the
prospectus for the Fund in which an investor is considering investing
("Prospectus").
This Information Supplement is dated November 8, 2000. Capitalized terms
have been defined in the Prospectus.
TABLE OF CONTENTS
Description of Fund Investments................................................2
Fund Structure............................................................2
Portfolio Supervision.....................................................3
Risk Factors...................................................................5
Concentration.............................................................5
General Obligation Bonds..................................................5
Moral Obligation Bonds....................................................5
Refunded Bonds............................................................5
Industrial Development Revenue Bonds......................................6
Municipal Revenue Bonds...................................................6
Municipal Utility Bonds...............................................6
Lease Rental Bonds ...................................................9
Housing Bonds.........................................................9
Hospital and Health Care Bonds.......................................10
Facility Revenue Bonds...............................................11
Solid Waste Disposal Bonds...........................................12
Special Tax Bonds....................................................12
Student Loan Revenue Bonds...........................................13
Transit Authority Bonds..............................................13
Municipal Water and Sewer Revenue Bonds..............................13
University and College Bonds.........................................13
Puerto Rico..............................................................14
Bonds Backed by Letters of Credit or Repurchase Commitments..............14
Liquidity................................................................17
Bonds Backed by Insurance................................................18
State Risk Factors.......................................................21
Payment of Bonds and Life of a Fund......................................21
Redemption...............................................................22
Tax Exemption............................................................22
Income and Returns............................................................23
Income...................................................................23
State Matters............................................................23
Arizona .............................................................23
California...........................................................27
Colorado.............................................................36
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Connecticut .........................................................38
Florida..............................................................41
Louisiana............................................................47
Maryland.............................................................49
Massachusetts .......................................................52
Michigan ............................................................61
Missouri ............................................................64
New Jersey...........................................................66
New York.............................................................67
North Carolina.......................................................74
Ohio.................................................................79
Pennsylvania.........................................................84
Texas................................................................86
Virginia.............................................................92
DESCRIPTION OF FUND INVESTMENTS
Fund Structure
The Portfolio contains different issues of Bonds with fixed final maturity
or disposition dates. In addition up to 10% of the initial value of the
Portfolio may have consisted of units ("Other Fund Units") of previously-issued
Series of Municipal Investment Trust Fund ("Other Funds") sponsored and
underwritten by certain of the Sponsors and acquired by the Sponsors in the
secondary market. The Other Fund Units are not bonds as such but represent
interests in the securities, primarily state, municipal and public authority
bonds, in the portfolios of the Other Funds. See Investment Summary in the
Prospectus for a summary of particular matters relating to the Portfolio.
The deposit of the Bonds in the Fund on the initial date of deposit
established a proportionate relationship among the face amounts of the Bonds.
During the 90-day period following the initial date of deposit, the Sponsors may
deposit additional Bonds in order to create new Units, maintaining to the extent
possible that original proportionate relationship. Deposits of additional Bonds
subsequent to the 90-day period must generally replicate exactly the
proportionate relationship among the face amounts of the Bonds at the end of the
initial 90-day period.
The portfolios underlying any Other Fund Units (the units of no one Other
Fund represented more than 5%, and all Other Fund Units represented less than
10%, of the aggregate offering side evaluation of the Portfolio on the Date of
Deposit) are substantially similar to that of the Fund. The percentage of the
Portfolio, if any, represented by Other Fund Units on the Evaluation Date is set
forth under Investment Summary in the Prospectus. On their respective dates of
deposit, the underlying bonds in any Other Funds were rated BBB or better by
Standard & Poor's or Baa or better by Moody's. While certain of those bonds may
not currently meet these criteria, they did not represent more than 0.5% of the
face amount of the Portfolio on the Date of Deposit. Bonds in each Other Fund
which do not mature according to their terms within 10 years after the Date of
Deposit had an aggregate bid side evaluation of at least 40% of the initial face
amount of the Other Fund. The investment objectives of the Other Funds are
similar to the investment objective of the Fund, and the Sponsors, Trustee and
Evaluator of the Other Funds have responsibilities and authority paralleling in
most important respects those described in this Prospectus and receive similar
fees. The names of any Other Funds represented in the Portfolio and the number
of units of each Other Fund in the Fund may be obtained without charge by
writing to the Trustee.
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Portfolio Supervision
Each Fund is a unit investment trust which follows a buy and hold
investment strategy. Traditional methods of investment management for mutual
funds typically involve frequent changes in fund holdings based on economic,
financial and market analyses. Because a Fund is not actively managed, it may
retain an issuer's securities despite financial or economic developments
adversely affecting the market value of the securities held by a Fund. However,
Defined Asset Funds' financial analysts regularly review a Fund's Portfolio, and
the Sponsors may instruct a Trustee to sell securities in a Portfolio in the
following circumstances: (i) default in payment of amounts due on the security;
(ii) institution of certain legal proceedings; (iii) other legal questions or
impediments affecting the security or payments thereon; (iv) default under
certain documents adversely affecting debt service or in payments on other
securities of the same issuer or guarantor; (v) decline in projected income
pledged for debt service on a revenue bond; (vi) if a security becomes taxable
or otherwise inconsistent with a Fund's investment objectives; (vii) a right to
sell or redeem the security pursuant to a guarantee or other credit support; or
(viii) decline in security price or other market or credit factors (including
advance refunding) that, in the opinion of Defined Asset Funds research, makes
retention of the security detrimental to the interests of Holders. If there is a
payment default on any Bond and the Agent for the Sponsors fails to instruct the
Trustee within 30 days after notice of the default, the Trustee will sell the
Bond.
A Trustee must reject any offer by an issuer of a Bond to exchange another
security pursuant to a refunding or refinancing plan unless (a) the Bond is in
default or (b) in the written opinion of Defined Asset Funds research analysts,
a default is probable in the reasonably foreseeable future, and the Sponsors
instruct the Trustee to accept the offer or take any other action with respect
to the offer as the Sponsors consider appropriate.
Units offered in the secondary market may reflect redemptions or
prepayments, in whole or in part, or defaults on, certain of the Bonds
originally deposited in the Fund or the disposition of certain Bonds originally
deposited in the Fund to satisfy redemptions of Units (see Redemption) or
pursuant to the exercise by the Sponsors of their supervisory role over the Fund
(see Risk Factors--Payment of the Bonds and Life of the Fund). Accordingly, the
face amount of Units may be less than their original face amount at the time of
the creation of the Fund. A reduced value per Unit does not therefore mean that
a Unit is necessarily valued at a market discount; market discounts, as well as
market premiums, on Units are determined solely by a comparison of a Unit's
outstanding face amount and its evaluated price.
The Portfolio may contain debt obligations rated BBB by Standard & Poor's
and Baa by Moody's, which are the lowest "investment grade" ratings assigned by
the two rating agencies or debt obligations rated below investment grade. The
Portfolio may also contain debt obligations that have received investment grade
ratings from one agency but "junk Bond" ratings from the other agency. In
addition, the Portfolio may contain debt obligations which are not rated by
either agency but have in the opinion of Merrill Lynch, Pierce, Fenner & Smith
Incorporated, as Agent for the Sponsors, comparable credit characteristics to
debt obligations rated near or below investment grade. Investors should
therefore be aware that these debt obligations may have speculative
characteristics and that changes in economic conditions or other circumstances
are more likely to lead to a weakened capacity to make principal and interest
payments on these debt obligations than is the case with higher rated bonds.
Moreover, conditions may develop with respect to any of the issuers of debt
obligations in the Portfolio which may cause the rating agencies to lower their
ratings below investment grade on a given security or cause the Agent for the
Sponsors to determine that the credit characteristics of a given security are
comparable to debt obligations rated below investment grade. As a result of
timing lags or a lack of current information, there can be no assurance that the
rating currently assigned to a given debt obligation by either agency or the
credit assessment of the Agent for the Sponsors actually reflects all current
information about the issuer of that debt obligation.
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Subsequent to the Date of Deposit, a Debt Obligation or other obligations
of the issuer or guarantor or bank or other entity issuing a letter of credit
related thereto may cease to be rated, its rating may be reduced or the credit
assessment of the Agent for the Sponsors may change. Because of the fixed nature
of the Portfolio, none of these events require an elimination of that Debt
Obligation from the Portfolio, but the lowered rating or changed credit
assessment may be considered in the Sponsors' determination to direct the
disposal of the Debt Obligation (see Administration of the Fund--Portfolio
Supervision).
Because ratings may be lowered or the credit assessment of the Agent for
the Sponsors may change, an investment in Units of the Trust should be made with
an understanding of the risks of investing in "junk bonds" (bonds rated below
investment grade or unrated bonds having similar credit characteristics),
including increased risk of loss of principal and interest on the underlying
debt obligations and the risk that the value of the Units may decline with
increases in interest rates. In recent years there have been wide fluctuations
in interest rates and thus in the value of fixed-rate debt obligations
generally. Debt obligations which are rated below investment grade or unrated
debt obligations having similar credit characteristics are often subject to
greater market fluctuations and risk of loss of income and principal than
securities rated investment grade, and their value may decline precipitously in
response to rising interest rates. This effect is so not only because increased
interest rates generally lead to decreased values for fixed-rate instruments,
but also because increased interest rates may indicate a slowdown in the economy
generally, which could result in defaults by less creditworthy issuers. Because
investors generally perceive that there are greater risks associated with
lower-rated securities, the yields and prices of these securities tend to
fluctuate more than higher-rated securities with changes in the perceived credit
quality of their issuers, whether these changes are short-term or structural,
and during periods of economic uncertainty. Moreover, issuers whose obligations
have been recently downgraded may be subject to claims by debtholders and
suppliers which, if sustained, would make it more difficult for these issuers to
meet payment obligations.
Debt rated below investment grade or having similar credit characteristics
also tends to be more thinly traded than investment-grade debt and held
primarily by institutions, and this lack of liquidity can negatively affect the
value of the debt. Debt which is not rated investment grade or having similar
credit characteristics may be subordinated to other obligations of the issuer.
Senior debtholders would be entitled to receive payment in full before
subordinated debtholders receive any payment at all in the event of a bankruptcy
or reorganization. Lower rated debt obligations and debt obligations having
similar credit characteristics may also present payment-expectation risks. For
example, these bonds may contain call or redemption provisions that would make
it attractive for the issuers to redeem them in periods of declining interest
rates, and investors would therefore not be able to take advantage of the higher
yield offered.
The value of Units reflects the value of the underlying debt obligations,
including the value (if any) of any issues which are in default. In the event of
a default in payment of principal or interest, the Trust may incur additional
expenses in seeking payment under the defaulted debt obligations. Because
amounts recovered (if any) in respect of a defaulted debt obligation may not be
reflected in the value of Units until actually received by the Trust, it is
possible that a Holder who sells Units would bear a portion of the expenses
without receiving a portion of the payments received. It is possible that new
laws could be enacted which could hurt the market for bonds which are not rated
investment grade. For example, federally regulated financial institutions could
be required to divest their holdings of these bonds, or proposals could be
enacted which might limit the use, or tax or other advantages, of these bonds.
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RISK FACTORS
Concentration
A Portfolio may contain or be concentrated in one or more of the types of
Bonds discussed below. An investment in a Fund should be made with an
understanding of the risks that these bonds may entail, certain of which are
described below. Political restrictions on the ability to tax and budgetary
constraints affecting the state or local government may result in reductions of,
or delays in the payment of, state aid to cities, counties, school districts and
other local units of government which, in turn, may strain the financial
operations and have an adverse impact on the creditworthiness of these entities.
State agencies, colleges and universities and health care organizations, with
municipal debt outstanding, may also be negatively impacted by reductions in
state appropriations.
General Obligation Bonds
General obligation bonds are backed by the issuer's pledge of its full
faith and credit and are secured by its 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, including an erosion of the tax base due to
population declines, natural disasters, declines in the state's industrial base
or inability to attract new industries, economic limits on the ability to tax
without eroding the tax base and the extent to which the entity relies on
Federal or state aid, access to capital markets or other factors beyond the
entity's control.
Over time, many state and local governments may confront deficits due to
economic or other factors. In addition, a Portfolio may contain obligations of
issuers who rely in whole or in part on ad valorem real property taxes as a
source of revenue. Certain proposals, in the form of state legislative proposals
or voter initiatives, to limit ad valorem real property taxes have been
introduced in various states, and an amendment to the constitution of the State
of California, providing for strict limitations on ad valorem real property
taxes, has had a significant impact on the taxing powers of local governments
and on the financial condition of school districts and local governments in
California. It is not possible at this time to predict the final impact of such
measures, or of similar future legislative or constitutional measures, on school
districts and local governments or on their abilities to make future payments on
their outstanding bonds.
Moral Obligation Bonds
The repayment of a "moral obligation" bond is only a moral commitment, and
not a legal obligation, of the state or municipality in question. Even though
the state may be called on to restore any deficits in capital reserve funds of
the agencies or authorities which issued the bonds, any restoration 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 bonds are generally noncallable prior
to maturity or the predetermined redemption date. In a few isolated instances,
however, bonds which were thought to be escrowed to maturity have been called
for redemption prior to maturity.
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Industrial Development Revenue Bonds
Industrial Development Revenue Bonds, or "IDRs", including pollution
control revenue bonds, are tax-exempt bonds issued by states, municipalities,
public authorities or similar entities to finance the cost of acquiring,
constructing or improving various projects, including pollution control
facilities and certain manufacturing facilities. These projects are usually
operated by private corporations. IDRs are not general obligations of
governmental entities backed by their taxing power. Municipal issuers are only
obligated to pay amounts due on the IDRs to the extent that funds are available
from the unexpended proceeds of the IDRs or from receipts or revenues under
arrangements between the municipal issuer and the corporate operator of the
project. These arrangements may be in the form of a lease, installment sale
agreement, conditional sale agreement or loan agreement, but in each case the
payments to the issuer are designed to be sufficient to meet the payments of
amounts due on the IDRs.
IDRs are generally issued under bond resolutions, agreements or trust
indentures pursuant to which the revenues and receipts payable to the issuer by
the corporate operator of the project have been assigned and pledged to the
holders of the IDRs or a trustee for the benefit of the holders of the IDRs. In
certain cases, a mortgage on the underlying project has been assigned to the
holders of the IDRs or a trustee as additional security for the IDRs. In
addition, IDRs are frequently directly guaranteed by the corporate operator of
the project or by an affiliated company. Regardless of the structure, payment of
IDRs is solely dependent upon the creditworthiness of the corporate operator of
the project, corporate guarantor and credit enhancer. 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. These include cyclicality of revenues and earnings, regulatory and
environmental restrictions, litigation resulting from accidents or
environmentally-caused illnesses, extensive competition (including that of
low-cost foreign companies), unfunded pension fund liabilities or off-balance
sheet items, and financial deterioration resulting from leveraged buy-outs or
takeovers. However, certain of the IDRs in the Portfolio may be additionally
insured or secured by letters of credit issued by banks or otherwise guaranteed
or secured to cover amounts due on the IDRs in the event of a default in
payment.
Municipal Revenue Bonds
Municipal Utility Bonds. The ability of utilities to meet their
obligations under revenue bonds issued on their behalf is dependent on various
factors, including the rates they may charge their customers, the demand for
their services and the cost of providing those services. Utilities, in
particular investor-owned utilities, are subject to extensive regulation
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. Any difficulty in obtaining timely and adequate
rate increases could adversely affect a utility's results of operations.
The demand for a utility's services is influenced by, among other factors,
competition, weather conditions and economic conditions. Electric utilities, for
example, have experienced increased competition as a result of the availability
of other energy sources, the effects of conservation on the use of electricity,
self-generation by industrial customers and the generation of electricity by
co-generators and other independent power producers. Also, increased competition
will result if federal regulators determine that utilities must open their
transmission lines to competitors. Utilities which distribute natural gas also
are subject to competition from alternative fuels, including fuel oil, propane
and coal.
The utility industry is an increasing cost business making the cost of
generating electricity more expensive and heightening its sensitivity to
regulation. A utility's costs are affected by its cost of capital, the
availability and cost of fuel and other factors. There can be no assurance that
a utility will be able to pass on these increased costs to customers through
increased
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rates. Utilities incur substantial capital expenditures for plant and equipment.
In the future they will also incur increasing capital and operating expenses to
comply with environmental legislation such as the Clean Air Act of 1990, and
other energy, licensing and other laws and regulations relating to, among other
things, air emissions, the quality of drinking water, waste water discharge,
solid and hazardous substance handling and disposal, and citing and licensing of
facilities. Environmental legislation and regulations are changing rapidly and
are the subject of current public policy debate and legislative proposals. It is
increasingly likely that many utilities will be subject to more stringent
environmental standards in the future that could result in significant capital
expenditures. Future legislation and regulation could include, among other
things, regulation of so-called electromagnetic fields associated with electric
transmission and distribution lines as well as emissions of carbon dioxide and
other so-called greenhouse gases associated with the burning of fossil fuels.
Compliance with these requirements may limit a utility's operations or require
substantial investments in new equipment and, as a result, may adversely affect
a utility's results of operations.
The electric utility industry in general is subject to various external
factors including (a) the effects of inflation upon the costs of operation and
construction, (b) substantially increased capital outlays and longer
construction periods for larger and more complex new generating units, (c)
uncertainties in predicting future load requirements, (d) increased financing
requirements coupled with limited availability of capital, (e) exposure to
cancellation and penalty charges on new generating units under construction, (f)
problems of cost and availability of fuel, (g) compliance with rapidly changing
and complex environmental, safety and licensing requirements, (h) litigation and
proposed legislation designed to delay or prevent construction of generating and
other facilities, (i) the uncertain effects of conservation on the use of
electric energy, (j) uncertainties associated with the development of a national
energy policy, (k) regulatory, political and consumer resistance to rate
increases and (l) increased competition as a result of the availability of other
energy sources. These factors may delay the construction and increase the cost
of new facilities, limit the use of, or necessitate costly modifications to,
existing facilities, impair the access of electric utilities to credit markets,
or substantially increase the cost of credit for electric generating facilities.
The National Energy Policy Act ("NEPA"), which became law in October,
1992, makes it mandatory for a utility to permit non-utility generators of
electricity access to its transmission system for wholesale customers, thereby
increasing competition for electric utilities. NEPA also mandated demand-side
management policies to be considered by utilities. NEPA prohibits the Federal
Energy Regulatory Commission from mandating electric utilities to engage in
retail wheeling, which is competition among suppliers of electric generation to
provide electricity to retail customers (particularly industrial retail
customers) of a utility. However, under NEPA, a state can mandate retail
wheeling under certain conditions.
The industry is currently undergoing deregulation, restructuring,
privatization, and consolidation. This began with the Federal Energy Regulatory
Commission order 888 and 889, issued in April 1996, requiring all utilities to
functionally unbundle their interstate electric transmission rates to allow for
open access non-discriminatory transmission rates and service. Many state
legislatures and/or public service commissions are now in the process of having
enacted or investigating introducing various forms of competition on utilities
providing electric service within the state borders. These measures generally
allow for the sale or function separation in the generation and sale of electric
power to become competitive but transmission remaining FERC regulated while
distribution remaining state regulated. Competition in the generation and sale
of electric power will require resolution of complex issues, including who will
pay for the unused generating plant and other stranded costs incurred by the
utility when a customer stops buying power from the utility, how will the rules
of competition be established, how will the reliability of the transmission
system be ensured, and how will the utility's obligation to serve be changed.
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There is concern by the public, the scientific community, and the U.S.
Congress regarding environmental damage resulting from the use of fossil fuels.
Congressional support for the increased regulation of air, water, and soil
contaminants is building and there are a number of pending or recently enacted
legislative proposals which may affect the electric utility industry. In
particular, on November 15, 1990, legislation was signed into law that
substantially revises the Clean Air Act (the "1990 Amendments"). The 1990
Amendments seek to improve the ambient air quality throughout the United States
by the year 2000. A main feature of the 1990 Amendments is the reduction of
sulfur dioxide and nitrogen oxide emissions caused by electric utility power
plants, particularly those fueled by coal. Under the 1990 Amendments the U.S.
Environmental Protection Agency ("EPA") must develop limits for nitrogen oxide
emissions by 1993. The sulfur dioxide reduction was achieved in two phases.
Phase I addresses specific generating units named in the 1990 Amendments. In
Phase II the total U.S. emissions will be capped at 8.9 million tons by the year
2000. The 1990 Amendments contain provisions for allocating allowances to power
plants based on historical or calculated levels. An allowance is defined as the
authorization to emit one ton of sulfur dioxide.
The 1990 Amendments also provide for possible further regulation of toxic
air emissions from electric generating units pending the results of several
federal government studies to be presented to Congress by the end of 1995 with
respect to anticipated hazards to public health, available corrective
technologies, and mercury toxicity.
The U.S. Environmental Protection Agency has also attempted to apply
sticter controls over nitrogen oxide (NO(x)) and ozone standards. The EPA has
also required certain states to develop plans to reduce the emissions of
nitrogen oxides by late 2003. The costs depend on the state-specific compliance
method to be adopted in the future and the effectiveness of the various
technologies available for nitrogen oxide emission control. The U.S. Court of
Appeals for the District of Columbia has vacated, remanded, stayed, or upheld
some of the standards as it applies to new sources. The Federal EPA and several
others have filed appeals with the U.S. Supreme Court.
Other environmental issues include potential public health impacts of the
Kyoto Protocol for global climate change. Additionally, the Department of
Justice, on behalf of the Federal EPA, filed on November 3, 1999 a complaint
alleging that several utilities made modifications to certain coal-fired
generating units over the past 25 years that extend unit operating lives or
increase capacity, thus making them effectively new plants in violation of the
Clean Air Act. The eventual timing and outcome of these studies and suits are
uncertain and may depend on future political decisions.
Electric utilities which own or operate nuclear power plants are exposed
to risks inherent in the nuclear industry. These risks include exposure to new
requirements resulting from extensive federal and state regulatory oversight,
public controversy, decommissioning costs, and spent fuel and radioactive waste
disposal issues. While nuclear power construction risks are no longer of
paramount concern, the emerging issue is radioactive waste disposal. In
addition, nuclear plants typically require substantial capital additions and
modifications throughout their operating lives to meet safety, environmental,
operational and regulatory requirements and to replace and upgrade various plant
systems. The high degree of regulatory monitoring and controls imposed on
nuclear plants could cause a plant to be out of service or on limited service
for long periods. When a nuclear facility owned by an investor-owned utility or
a state or local municipality is out of service or operating on a limited
service basis, the utility operator or its owners may be liable for the recovery
of replacement power costs. Risks of substantial liability also arise from the
operation of nuclear facilities and from the use, handling, and possible
radioactive emissions associated with nuclear fuel. Insurance may not cover all
types or amounts of loss which may be experienced in connection with the
ownership and operation of a nuclear plant and severe financial consequences
could result from a significant accident or occurrence. The Nuclear Regulatory
Commission has promulgated regulations mandating the establishment of funded
reserves to assure financial
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capability for the eventual decommissioning of licensed nuclear facilities.
These funds are to be accrued from revenues in amounts currently estimated to be
sufficient to pay for decommissioning costs. Since there have been very few
nuclear plants decommissioned to date, these estimates may be unrealistic.
The ability of state and local joint action power agencies to make
payments on bonds they have issued is dependent in large part on payments made
to them pursuant to power supply or similar agreements. Courts in Washington,
Oregon and Idaho have held that certain agreements between the Washington Public
Power Supply System ("WPPSS") and the WPPSS participants are unenforceable
because the participants did not have the authority to enter into the
agreements. While these decisions are not specifically applicable to agreements
entered into by public entities in other states, they may cause a reexamination
of the legal structure and economic viability of certain projects financed by
joint action power agencies, which might exacerbate some of the problems
referred to above and possibly lead to legal proceedings questioning the
enforceability of agreements upon which payment of these bonds may depend.
Lease Rental Bonds. Lease rental bonds are issued for the most part 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 (administrative offices, convention centers
and prisons, for example) or the purchase of equipment (police cars and computer
systems, for example) that will be used by a state or local government (the
"lessee"). Thus, the bonds are subject to the ability and willingness of the
lessee government to meet its lease rental payments which include debt service
on the bonds. Willingness to pay may be subject to changes in the views of
citizens and government officials as to the essential nature of the finance
project. Lease rental bonds are subject, in almost all cases, to the annual
appropriation risk, i.e., 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 statesCrental
obligations cease in the event that damage, destruction or condemnation of the
project prevents its use by the lessee. (In these cases, insurance provisions
and reserve funds designed to alleviate this risk become important credit
factors). 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. Some of these issues, particularly those for equipment
purchase, contain the so-called "substitution safeguard", which bars the lessee
government, in the event it defaults on its rental payments, from the purchase
or use of similar equipment for a certain period of time. This safeguard is
designed to insure that the lessee government will appropriate the necessary
funds even though it is not legally obligated to do so, but its legality remains
untested in most, if not all, states.
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 the revenues derived from mortgage loans to
housing projects for low to moderate income families. Single-family mortgage
revenue bonds are issued for the purpose of acquiring from originating financial
institutions notes secured by mortgages on residences.
Housing bonds are not general obligations of the issuer although certain
obligations may be supported to some degree by Federal, state or local housing
subsidy programs. Budgetary constraints experienced by these programs as well as
the failure by a state or local housing issuer to satisfy the qualifications
required for coverage under these programs or any legal or administrative
determinations that the coverage of these programs is not available to a housing
issuer, probably will result in a decrease or elimination of subsidies available
for payment of amounts due on the issuer's bonds. The ability of housing issuers
to make debt service payments on their bonds will also be affected by various
economic and non-economic developments including, among other things, the
achievement and maintenance of sufficient occupancy levels and adequate rental
income in multi-family projects, the rate of default on mortgage loans
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underlying single family issues and the ability of mortgage insurers to pay
claims, employment and income conditions prevailing in local markets, increases
in construction costs, taxes, utility costs and other operating expenses, the
managerial ability of project managers, changes in laws and governmental
regulations and economic trends generally in the localities in which the
projects are situated. Occupancy of multi-family housing financial projects may
also be adversely affected by high rent levels and income limitations imposed
under Federal, state or local programs.
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, and 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. Single-family issues are subject to mandatory
redemption in whole or in part from prepayments on underlying mortgage loans;
mortgage loans are frequently partially or completely prepaid prior to their
final stated maturities as a result of events such as declining interest rates,
sale of the mortgaged premises, default, condemnation or casualty loss.
Multi-family issues are characterized by mandatory redemption at par upon the
occurrence of monetary defaults or breaches of covenants by the project
operator. Additionally, housing obligations are generally subject to mandatory
partial redemption at par to the extent that proceeds from the sale of the
obligations are not allocated within a stated period (which may be within a year
of the date of issue).
The tax exemption for certain housing revenue bonds depends on
qualification under Section 143 of the Internal Revenue Code of 1986, as amended
(the "Code"), in the case of single family mortgage revenue bonds or Section
142(a)(7) of the Code or other provisions of Federal law in the case of certain
multi-family housing revenue bonds (including Section 8 assisted bonds). These
sections of the Code or other provisions of Federal law contain certain ongoing
requirements, including requirements relating to the cost and location of the
residences financed with the proceeds of the single family mortgage revenue
bonds and the income levels of tenants of the rental projects financed with the
proceeds of the multi-family housing revenue bonds. While the issuers of the
bonds and other parties, including the originators and servicers of the
single-family mortgages and the owners of the rental projects financed with the
multi-family housing revenue bonds, generally covenant to meet these ongoing
requirements and generally agree to institute procedures designed to ensure that
these requirements are met, there can be no assurance that these ongoing
requirements will be consistently met. The failure to meet these requirements
could cause the interest on the bonds to become taxable, possibly retroactively
from the date of issuance, thereby reducing the value of the bonds, subjecting
Holders to unanticipated tax liabilities and possibly requiring a Trustee to
sell these bonds at reduced values. Furthermore, any failure to meet these
ongoing requirements might not constitute an event of default under the
applicable mortgage or permit the holder to accelerate payment of the bond or
require the issuer to redeem the bond. In any event, where the mortgage is
insured by the Federal Housing Administration, its consent may be required
before insurance proceeds would become payable to redeem the mortgage bonds.
Hospital and Health Care 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, including the level of payments
received from private third-party payors and government programs and the cost of
providing health care services.
A significant portion of the revenues of hospitals and other health care
facilities is derived from private third-party payors and government programs,
including the Medicare and Medicaid programs. Both private third-party payors
and government programs have undertaken cost containment measures designed to
limit payments made to health care facilities. Furthermore, government programs
are subject to statutory and regulatory changes, retroactive rate adjustments,
administrative rulings and government funding restrictions, all of which may
materially decrease the rate of program payments for health care facilities.
Certain special revenue obligations (i.e., Medicare or Medicaid revenues) may be
payable subject to appropriations by state legislatures.
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There can be no assurance that payments under governmental programs will remain
at levels comparable to present levels or will, in the future, be sufficient to
cover the costs allocable to patients participating in these programs. In
addition, there can be no assurance that a particular hospital or other health
care facility will continue to meet the requirements for participation in these
programs.
The costs of providing health care services are subject to increase as a
result of, among other factors, changes in medical technology and increased drug
and labor costs. In addition, health care facility construction and operation is
subject to federal, state and local regulation relating to the adequacy of
medical care, equipment, personnel, operating policies and procedures,
rate-setting, and compliance with building codes and environmental laws.
Facilities are subject to periodic inspection by governmental and other
authorities to assure continued compliance with the various standards necessary
for licensing and accreditation. These regulatory requirements are subject to
change and, to comply, it 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 subject to claims and legal
actions by patients and others in the ordinary course of business. Although
these claims are generally covered by insurance, 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. In addition, a substantial
increase in the cost of insurance could adversely affect the results of
operations of a hospital or other health care facility. Congress may impose
regulations which could limit price increases for hospitals or the level of
reimbursements for third-party payors or other measures to reduce health care
costs and make health care available to more individuals, which would reduce
profits for hospitals. Some states, such as New Jersey, have significantly
changed their reimbursement systems. If a hospital cannot adjust to the new
system by reducing expenses or raising rates, financial difficulties may arise.
Also, Blue Cross has denied reimbursement for some hospitals for services other
than emergency room services. The lost volume would reduce revenues unless
replacement patients were found.
Certain hospital bonds provide for redemption at par at any time upon the
sale by the issuer of the hospital facilities to a non-affiliated entity, if the
hospital becomes subject to ad valorem taxation, or in various other
circumstances. For example, certain hospitals may have the right to call bonds
at par if the hospital may be legally required because of the bonds to perform
procedures against specified religious principles or to disclose information
that is considered confidential or privileged. Certain FHA-insured bonds may
provide that all or a portion of those bonds, otherwise callable at a premium,
can be called at par in certain circumstances. If a hospital defaults upon a
bond, the realization of Medicare and Medicaid receivables may be uncertain and,
if the bond is secured by the hospital facilities, legal restrictions on the
ability to foreclose upon the facilities and the limited alternative uses to
which a hospital can be put may severely reduce its collateral value.
The Internal Revenue Service is currently engaged in a program of
intensive audits of certain large tax-exempt hospital and health care facility
organizations. Although these audits have not yet been completed, it has been
reported that the tax-exempt status of some of these organizations may be
revoked.
Facility Revenue Bonds. Facility revenue bonds are generally payable from
and secured by the revenues from the ownership and operation of particular
facilities such as airports (including airport terminals and maintenance
facilities), bridges, marine terminals, turnpikes and port authorities. For
example, the major portion of gross airport operating income is generally
derived from fees received from signatory airlines pursuant to use agreements
which consist of annual payments for airport use, occupancy of certain terminal
space, facilities, service fees, concessions and leases. Airport operating
income may therefore be affected by the ability of the
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airlines to meet their obligations under the use agreements. The air transport
industry is experiencing significant variations in earnings and traffic, due to
increased competition, increased aviation fuel, deregulation, traffic
constraints and other factors. As a result, several airlines are experiencing
severe financial difficulties. The Sponsors cannot predict what effect these
industry conditions may have on airport revenues which are dependent for payment
on the financial condition of the airlines and their usage of the particular
airport facility. Furthermore, proposed legislation would provide the U.S.
Secretary of Transportation with the temporary authority to freeze airport fees
upon the occurrence of disputes between a particular airport facility and the
airlines utilizing that facility.
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 these factors and increased cost of maintenance
or decreased use of a facility, lower cost of alternative modes of
transportation or scarcity of fuel and reduction or loss of rents.
Solid Waste Disposal Bonds. Bonds issued for solid waste disposal
facilities are generally payable from dumping 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. All of these factors may be affected by a
failure of municipalities to fully utilize the facilities, an insufficient
supply of waste for disposal due to economic or population decline, rising
construction and maintenance costs, any delays in construction of facilities,
lower-cost alternative modes of waste processing and changes in environmental
regulations. Because of the relatively short history of this type of financing,
there may be technological risks involved in the satisfactory construction or
operation of the projects exceeding those associated with most municipal
enterprise projects. 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. These costs include compliance
with frequently changing and complex regulatory requirements, the cost of
obtaining construction and operating permits, the cost of conforming to
prescribed and changing equipment standards and required methods of operation
and, for incinerators or waste-to-energy facilities, the cost of disposing of
the waste residue that remains after the disposal process in an environmentally
safe manner. In addition, waste disposal facilities frequently face substantial
opposition by environmental groups and officials to their location and
operation, to the possible adverse effects upon the public health and the
environment that may be caused by wastes disposed of at the facilities and to
alleged improper operating procedures. Waste disposal facilities benefit from
laws which require waste to be disposed of in a certain manner but any
relaxation of these laws could cause a decline in demand for the facilities'
services. Finally, waste-to-energy facilities are concerned with many of the
same issues facing utilities insofar as they derive revenues from the sale of
energy to local power utilities.
Special Tax Bonds. Special tax bonds are payable from and secured by the
revenues derived by a municipality from a particular tax such as 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 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 due to a general decline in the local economy or
population or due to a decline in the consumption, use or cost of the goods and
services that are subject to taxation. 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.
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Student Loan Revenue Bonds. Student loan revenue bonds are issued by
various authorities to finance the acquisition of student loan portfolios or to
originate new student loans. These bonds are typically secured by pledged
student loans, loan repayments and funds and accounts established under the
indenture. Student loans are generally either guaranteed by eligible guarantors
under the Higher Education Act of 1965, as amended, and reinsured by the
Secretary of the U.S. Department of Education, directly insured by the federal
government or financed as part of supplemental or alternative loan programs with
a state (e.g., loan repayment is not guaranteed).
Certain student loan revenue bonds may permit the issuer to enter into an
"interest rate swap agreement" with a counterparty obligating the issuer to pay
either a fixed or a floating rate on a notional principal amount of bonds and
obligating the counterparty to pay either a fixed or a floating interest rate on
the issuer's bonds. The payment obligations of the issuer and the counterparty
to each other will be netted on each interest payment date, and only one payment
will be made by one party to the other. Although the choice of counterparty
typically requires a determination from a rating agency that any rating of the
bonds will not be adversely affected by the swap, payment on the bonds may be
subject to the additional risk of the counterparty's ability to fulfill its swap
obligation.
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 these 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 such as a sales tax or a property 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.
Municipal 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 failure of
municipalities to utilize fully the facilities constructed by these authorities,
economic or population decline and resulting decline in revenue from user
charges, rising construction and maintenance costs and delays in construction of
facilities, impact of environmental requirements, failure or inability to raise
user charges in response to increased costs, the difficulty of obtaining or
discovering new supplies of fresh water, the effect of conservation programs and
the impact of "no growth" zoning ordinances. In some cases this ability may be
affected by 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, including 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, and, in the case
of public institutions, the financial condition of the relevant state or other
governmental entity and its policies with respect to education. The
institution's ability to maintain enrollment levels will depend on such factors
as tuition costs, demographic trends, geographic location, geographic diversity
and quality of the student body, quality of the faculty and the diversity of
program offerings.
Legislative or regulatory action in the future at the Federal, state or
local level may directly or indirectly affect eligibility standards or reduce or
eliminate the availability of funds for certain types of student loans or grant
programs, including student aid, research grants and work-study programs, and
may affect indirect assistance for education.
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Puerto Rico
Various Bonds may be affected by general economic conditions in Puerto
Rico. Puerto Rico's unemployment rate remains significantly higher than the U.S.
unemployment rate. Furthermore, the Puerto Rican economy is largely dependent
for its development upon U.S. policies and programs that are being reviewed and
may be eliminated.
Aid for Puerto Rico's economy has traditionally depended heavily on
Federal programs, and current Federal budgetary policies suggest that an
expansion of aid to Puerto Rico is unlikely. An adverse effect on the Puerto
Rican economy could result from other U.S. policies, including a reduction of
tax benefits for distilled products, further reduction in transfer payment
programs such as food stamps, curtailment of military spending and policies
which could lead to a stronger dollar.
In a plebiscite held in November, 1993, the Puerto Rican electorate chose
to continue Puerto Rico's Commonwealth status. Previously proposed legislation,
which was not enacted, would have preserved the federal tax exempt status of the
outstanding debts of Puerto Rico and its public corporations regardless of the
outcome of the referendum, to the extent that similar obligations issued by
states are so treated and subject to the provisions of the Code currently in
effect. There can be no assurance that any pending or future legislation finally
enacted will include the same or similar protection against loss of tax
exemption.
Bonds Backed by Letters of Credit or Repurchase Commitments
In the case of Bonds secured by letters of credit issued by commercial
banks or savings banks, savings and loan associations and similar institutions
("thrifts"), the letter of credit may be drawn upon, and the Bonds consequently
redeemed, if an issuer fails to pay amounts due on the Bonds or defaults under
its reimbursement agreement with the issuer of the letter of credit or, in
certain cases, if the interest on the Bonds is deemed to be taxable and full
payment of amounts due is not made by the issuer. The letters of credit are
irrevocable obligations of the issuing institutions, which are subject to
extensive governmental regulations which may limit both the amounts and types of
loans and other financial commitments which may be made and interest rates and
fees which may be charged.
Certain Intermediate Term and Put Series and certain other Series contain
Bonds purchased from one or more commercial banks or thrifts or other
institutions ("Sellers") which have committed under certain circumstances
specified below to repurchase the Bonds from the Fund ("Repurchase
Commitments"). The Bonds in these Funds may be secured by one or more Repurchase
Commitments (see Investment Summary in the Prospectus) which, in turn may be
backed by a letter of credit or secured by a security interest in collateral. A
Seller may have committed to repurchase from the Fund any Bonds sold by it,
within a specified period after receiving notice from the Trustee, to the extent
necessary to satisfy redemptions of Units despite the market-making activity of
the Sponsors (a "Liquidity Repurchase"). The required notice period may be 14
days (a "14 Day Repurchase") or, if a repurchase date is set forth under
Investment Summary in the Prospectus, the Trustee may at any time not later than
two hours after the Evaluation Time on the repurchase date (or if a repurchase
date is not a business day, on the first business day thereafter), deliver this
notice to the Seller. Additionally, if the Sponsors elect to remarket Units
which have been received at or before the Evaluation Time on any repurchase date
(the "Tendered Units"), a Seller may have committed to repurchase from the Fund
on the date 15 business days after that repurchase date, any Bonds sold by the
Seller to the Fund in order to satisfy any tenders for redemption by the
Sponsors made within 10 business days after the Evaluation Time. A Seller may
also have made any of the following commitments: (i) to repurchase at any time
on 14 calendar days' notice any Bonds if the issuer thereof shall fail to make
any payments of principal thereof and premium and interest thereon (a "Default
Repurchase"); (ii) to repurchase any Bond on a fixed disposition date (a
"Disposition Date") if the
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Trustee elects not to sell the Bond in the open market (because a price in
excess of its Put Price (as defined under Investment Summary in the Prospectus)
cannot be obtained) on this date (a "Disposition Repurchase")); (iii) to
repurchase at any time on 14 calendar days' notice any Bond in the event that
the interest thereon should be deemed to be taxable (a "Tax Repurchase"); and
(iv) to repurchase immediately all Bonds if the Seller becomes or is deemed to
be bankrupt or insolvent (an "Insolvency Repurchase"). (See Investment Summary
in the Prospectus.) Any repurchase of a Bond will be at a price no lower than
its original purchase price to the Fund, plus accrued interest to the date of
repurchase, plus any further adjustments as described under Investment Summary
in the Prospectus.
Upon the sale of a Bond by the Fund to a third party prior to its
Disposition date, any related Liquidity and Disposition Repurchase commitments
will be transferable, together with an interest in any collateral or letter of
credit backing the repurchase commitments and the Liquidity Repurchase
commitments will be exercisable by the buyer free from the restriction that the
annual repurchase right may only be exercised to meet redemptions of Units. Any
Default Repurchase, Tax Repurchase and Insolvency Repurchase commitments also
will not terminate upon disposition of the Bond by the Fund but will be
transferable, together with an interest in the collateral or letter of credit
backing the Repurchase Commitments or both, as the case may be.
A Seller's Repurchase Commitments apply only to Bonds which it has sold to
the Fund; consequently, if a particular Seller fails to meet its commitments, no
recourse is available against any other Seller nor against the collateral or
letters of credit of any other Seller. Each Seller's Repurchase Commitments
relating to any Bond terminate (i) upon repurchase by the Seller of the Bond,
(ii) on the Disposition Date of the Bond if its holder does not elect to have
the Seller repurchase the Bond on that date and (iii) in the event notice of
redemption shall have been given on or prior to the Disposition Date for the
entire outstanding principal amount of the Bond and that redemption or maturity
of the Bond occurs on or prior to the Disposition Date. On the scheduled
Disposition Date of a Bond the Trustee will sell that Bond in the open market if
a price in excess of the Put Price as of the Disposition Date can be obtained.
An investment in Units of a Fund containing any of these types of
credit-supported Bonds should be made with an understanding of the
characteristics of the commercial banking and thrift industries and of the risks
which an investment in Units may entail. Banks and thrifts are subject to
extensive governmental regulations which may limit both the amounts and types of
loans and other financial commitments which may be made and interest rates and
fees which may be charged. The profitability of these industries is largely
dependent upon the availability and cost of funds for the purpose of financing
lending operations under prevailing money market conditions. Also, general
economic conditions play an important part in the operations of this industry
and exposure to credit losses arising from possible financial difficulties of
borrowers might affect an institution's ability to meet its obligations. These
factors also affect bank holding companies and other financial institutions,
which may not be as highly regulated as banks, and may be more able to expand
into other non-financial and non-traditional businesses.
In December 1991 Congress passed and the President signed into law the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"). This
law imposed limitations on the way in which banks, savings banks, and thrifts
may conduct their business and mandated early and aggressive regulatory
intervention for unhealthy institutions.
In certain cases, the Sponsors have agreed that the sole recourse in
connection with any default, including insolvency, by thrifts whose
collateralized letter of credit, guarantee or Repurchase Commitments may back
any of the Debt Obligations will be to exercise available remedies with respect
to the collateral pledged by the thrift; should the collateral be insufficient,
the Fund will, therefore, be unable to pursue any default judgment against that
thrift. Certain of these collateralized letters of credit, guarantees or
Repurchase Commitments may provide that they are to be called upon in the event
the thrift becomes or is deemed to be insolvent.
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Accordingly, investors should recognize that they are subject to having the
principal amount of their investment represented by a Debt Obligation secured by
a collateralized letter of credit, guarantee or Repurchase Commitment returned
prior to the termination date of the Fund or the maturity or disposition dates
of the Debt Obligations if the thrift becomes or is deemed to be insolvent, as
well as in any of the situations outlined under Repurchase Commitments below.
In 1989 Congress enacted the Financial Institutions Reform, Recovery and
Enforcement Act ("FIRREA") which significantly altered the legal rules and
regulations governing banks and thrifts. Moreover, FIRREA generally permits the
FDIC or the RTC, as the case may be, to prevent the exercise of a Seller's
Insolvency Repurchase commitment and empowers that agency to repudiate a
Seller's contracts, including a Seller's other Repurchase Commitments. FIRREA
also creates a risk that damages against the FDIC or RTC would be limited and
that investors could be left without the full protections afforded by the
Repurchase Commitments and the Collateral. Policy statements adopted by the FDIC
and the RTC concerning collateralized repurchase commitments have partially
ameliorated these risks for the Funds. According to these policy statements, the
FDIC or the RTC, as conservator or receiver, will not assert the position that
it can repudiate the repurchase commitments without the payment of damages from
the collateral, and will instead either (i) accelerate the collateralized
repurchase commitments, in which event payment will be made under the repurchase
commitments to the extent of available collateral, or (ii) enforce the
repurchase commitments, except that any insolvency clause would not be
enforceable against the FDIC and the RTC. Should the FDIC choose to accelerate,
however, there is some question whether the payment made would include interest
on the defaulted Debt Obligations for the period after the appointment of the
receiver or conservator through the payment date.
The FDIC has not given similar comfort with respect to collateralized
letters of credit. Consequently, there can be no assurance that collateralized
letters of credit issued by thrifts for which the FDIC would be the receiver or
conservator appointed, as described three paragraphs earlier, will be available
in the event of the failure of any such thrift.
The possibility of early payment has been increased significantly by the
enactment of FDICIA, which requires federal regulators of insured banks, savings
banks and thrifts to act more quickly to address the problems of
undercapitalized institutions than previously, and specifies in more detail the
actions they must take. One requirement virtually compels the appointment of a
receiver for any institution when its ratio of tangible equity to total assets
declines to two percent. Others force aggressive intervention in the business of
an institution at even earlier stages of deterioration. Upon appointment of a
receiver, if the FDIC or RTC pays as provided, in the policy statements and
notwithstanding the possibility that the institution might not have deteriorated
to zero book net worth (and therefore might not satisfy traditional definitions
of "insolvent"), the payment could therefore come substantially earlier than
might have been the case prior to FDICIA.
Certain letters of credit or guarantees backing Bonds may have been issued
by a foreign bank or corporation or similar entity (a "Foreign Guarantee").
Foreign Guarantees are subject to the risk that exchange control regulations
might be adopted in the future which might affect adversely payments to the
Fund. Similarly, foreign withholding taxes could be imposed in the future
although provision is made in the instruments governing any Foreign Guarantee
that, in substance, to the extent permitted by applicable law, additional
payments will be made by the guarantor so that the total amount paid, after
deduction of any applicable tax, will not be less than the amount then due and
payable on the Foreign Guarantee. The adoption of exchange control regulations
and other legal restrictions could have an adverse impact on the marketability
of any Bonds backed by a Foreign Guarantee.
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Liquidity
Certain of the Bonds may have been purchased by the Sponsors from various
banks and thrifts in large denominations and may not have been issued under bond
resolutions or trust indentures providing for issuance of bonds in small
denominations. These Bonds were generally directly placed with the banks or
thrifts and held in their portfolios prior to sale to the Sponsors. There is no
established secondary market for those Bonds. The Sponsors believe that there
should be a readily available market among institutional investors for the Bonds
which were purchased from these portfolios in the event it is necessary to sell
Bonds to meet redemptions of Units (should redemptions be made despite the
market making activity of the Sponsors) in light of the following
considerations: (i) the credit characteristics of the companies obligated to
make payments on the Bonds; (ii) the fact that these Bonds may be backed by
irrevocable letters of credit or guarantees of banks or thrifts; and (iii) the
fact that banks or thrifts selling these Bonds to the Sponsors for deposit in
the Fund or the placement agent acting in connection with their sale generally
have stated their intentions, although they are not legally obligated to do so,
to remarket or to repurchase, at the then-current bid side evaluation, any of
these Bonds proposed to be sold by the Trustee. The interest on these Bonds
received by the Fund is net of the fee for the related letter of credit or
guarantee charged by the bank or thrift issuing the letter of credit or
guarantee.
Any Bonds which were purchased from these portfolios are exempt from the
registration provisions of the Federal securities laws, and, therefore, can be
sold free of the registration requirements of the securities laws. Because there
is no established secondary market for these Bonds, however, there is no
assurance that the price realized on sale of these Bonds will not be adversely
affected. Consequently it is more likely that the sale of these Bonds may cause
a decline in the value of Units than a sale of debt obligations for which an
established secondary market exists. In addition, in certain Intermediate Term
and Put Series and certain other Series, liquidity of the Fund is additionally
augmented by the Sellers' collateralized or letter of credit-backed Liquidity
Repurchase commitment in the event it is necessary to sell any Bond to meet
redemptions of Units. If, upon the scheduled Disposition Date for any Bond, the
Trustee elects not to sell the Bond scheduled for disposition on this date in
the open market (because, for example, a price in excess of its Put Price cannot
be obtained), the Seller of the Bond is obligated to repurchase the Bond
pursuant to its collateralized or letter of credit-backed Disposition Repurchase
commitment. There can be no assurance that the prices that can be obtained for
the Bonds at any time in the open market will exceed the Put Price of the Bonds.
In addition, if any Seller should become unable to honor its repurchase
commitments and the Trustee is consequently forced to sell the Bonds in the open
market, there is no assurance that the price realized on this sale of the Bonds
would not be adversely affected by the absence of an established secondary
market for certain of the Bonds.
In some cases, the Sponsors have entered into an arrangement with the
Trustee whereby certain of the Bonds may be transferred to a trust (a
"Participation Trust") in exchange for certificates of participation in the
Participation Trust which could be sold in order to meet redemptions of Units.
The certificates of participation would be issued in readily marketable
denominations of $5,000 each or any greater multiple thereof and the holder
thereof would be fully entitled to the repayment protections afforded by
collateral arrangements to any holder of the underlying Bonds. These
certificates would be exempt from registration under the Securities Act of 1933
pursuant to Section 3(a)(2) thereof.
For Bonds that have been guaranteed or similarly secured by insurance
companies or other corporations or entities, the guarantee or similar commitment
may constitute a security (a "Restricted Security") that cannot, in the opinion
of counsel, be sold publicly by the Trustee without registration under the
Securities Act of 1933, as amended, or similar provisions of law subsequently
exacted. The Sponsors nevertheless believe that, should a sale of these Bonds be
necessary in order to meet redemptions, the Trustee should be able to consummate
a sale with institutional investors. Up to 40% of the Portfolio may initially
have consisted of Bonds purchased
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from various banks and thrifts and other Bonds with guarantees which may
constitute Restricted Securities.
The Fund may contain bonds purchased directly from issuers. These Bonds
are generally issued under bond resolutions or trust indentures providing for
the issuance of bonds in publicly saleable denominations (usually $5,000), may
be sold free of the registration requirements of the Securities Act of 1933 and
are otherwise structured in contemplation of ready marketability. In addition,
the Sponsors generally have obtained letters of intention to repurchase or to
use best efforts to remarket these Debt Obligations from the issuers, the
placement agents acting in connection with their sale or the entities providing
the additional credit support, if any. These letters do not express legal
obligations; however, in the opinion of the Sponsors, these Bonds should be
readily marketable.
Bonds Backed by Insurance
Municipal bond insurance may be provided by one or more of ACA Financial
Guaranty Corp. ("ACA"), AMBAC Indemnity Corporation ("AMBAC"), Asset Guaranty
Insurance Co. ("AGIC"), Capital Guaranty Insurance Company ("CGIC"), Capital
Markets Assurance Corp. ("CAPMAC"), Connie Lee Insurance Company ("Connie Lee"),
Financial Guaranty Insurance Company ("FGIC"), Financial Security Assurance Inc.
("FSA"), or Municipal Bond Investors Insurance Corporation ("MBIA")
(collectively, the "Insurance Companies"). The claims-paying ability of each of
these companies, unless otherwise indicated, is rated AAA by Standard & Poor's
or another acceptable national rating agency. The ratings are subject to change
at any time at the discretion of the rating agencies. In determining whether to
insure bonds, the Insurance Companies severally apply their own standards. The
cost of this insurance is borne either by the issuers or previous owners of the
bonds or by the Sponsors. The insurance policies are non-cancelable and will
continue in force so long as the insured Bonds are outstanding and the insurers
remain in business. The insurance policies guarantee the timely payment of
principal and interest on but do not guarantee the market value of the insured
Bonds or the value of the Units. The insurance policies generally do not provide
for accelerated payments of principal or cover redemptions resulting from events
of taxability. If the issuer of any insured Bond should fail to make an interest
or principal payment, the insurance policies generally provide that a Trustee or
its agent will give notice of nonpayment to the Insurance Company or its agent
and provide evidence of the Trustee's right to receive payment. The Insurance
Company is then required to disburse the amount of the failed payment to the
Trustee or its agent and is thereafter subrogated to the Trustee's right to
receive payment from the issuer.
Financial information relating to the Insurance Companies has been
obtained from publicly available information. No representation is made as to
the accuracy or adequacy of the information or as to the absence of material
adverse changes since the information was made available to the public. Standard
& Poor's has rated the Units of any Insured Fund AAA because the Insurance
Companies have insured the Bonds. The assignment of a AAA rating is due to
Standard & Poor's assessment of the creditworthiness of the Insurance Companies
and of their ability to pay claims on their policies of insurance. In the event
that Standard & Poor's reassesses the creditworthiness of any Insurance Company
which would result in the rating of an Insured Fund being reduced, the Sponsors
are authorized to direct the Trustee to obtain other insurance.
Certain Bonds may be entitled to portfolio insurance ("Portfolio
Insurance") that guarantees the scheduled payment of the principal of and
interest on those Bonds ("Portfolio-Insured Bonds") while they are retained in
the Fund. Since the Portfolio Insurance applies to Bonds only while they are
retained in the Fund, the value of Portfolio-Insured Bonds (and hence the value
of the Units) may decline if the credit quality of any Portfolio-Insured Bonds
is reduced. Premiums for Portfolio Insurance are payable monthly in advance by
the Trustee on behalf of the Fund.
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As Portfolio-Insured Bonds are redeemed by their respective issuers or are
sold by the Trustee, the amount of the premium payable for the Portfolio
Insurance will be correspondingly reduced. Nonpayment of premiums on any policy
obtained by the Fund will not result in the cancellation of insurance but will
permit the portfolio insurer to take action against the Trustee to recover
premium payments due it. Upon the sale of a Portfolio-Insured Bond from the
Fund, the Trustee has the right, pursuant to an irrevocable commitment obtained
from the portfolio insurer, to obtain insurance to maturity ("Permanent
Insurance") on the Bond upon the payment of a single predetermined insurance
premium from the proceeds of the sale. It is expected that the Trustee will
exercise the right to obtain Permanent Insurance only if the Fund would receive
net proceeds from the sale of the Bond (sale proceeds less the insurance premium
attributable to the Permanent Insurance) in excess of the sale proceeds that
would be received if the Bonds were sold on an uninsured basis. The premiums for
Permanent Insurance for each Portfolio-Insured Bond will decline over the life
of the Bond.
The Public Offering Price does not reflect any element of value for
Portfolio Insurance. The Evaluator will attribute a value to the Portfolio
Insurance (including the right to obtain Permanent Insurance) for the purpose of
computing the price or redemption value of Units only if the Portfolio-Insured
Bonds are in default in payment of principal or interest or, in the opinion of
the Agent for the Sponsors, in significant risk of default. In making this
determination the Agent for the Sponsors has established as a general standard
that a Portfolio-Insured Bond which is rated less than BB by Standard & Poor's
or Ba by Moody's will be deemed in significant risk of default although the
Agent for the Sponsors retains the discretion to conclude that a
Portfolio-Insured Bond is in significant risk of default even though at the time
it has a higher rating, or not to reach that conclusion even if it has a lower
rating. The value of the insurance will be equal to the difference between (i)
the market value of the Portfolio-Insured Bond assuming the exercise of the
right to obtain Permanent Insurance (less the insurance premium attributable to
the purchase of Permanent Insurance) and (ii) the market value of the
Portfolio-Insured Bond not covered by Permanent Insurance.
In addition, certain Funds may contain Bonds that are insured to maturity
as well as being Portfolio-Insured Bonds.
The following are brief descriptions of the Insurance Companies. The
financial information presented for each company has been determined on a
statutory basis and is unaudited.
ACA is a de novo financial guaranty insurance company that commenced
operations at the end of October 1997. ACA is a wholly-owned subsidiary of
American Capital Access Holdings, Inc., which is, in turn, owned by American
Capital Access Holdings, L.L.C. (ACH), a limited liability company. ACH is owned
by a group of institutional investors and management as follows: Stephens Group,
Inc. (24%); GCC Investments, Inc. (24%); Insurance Partners L.P. (24%); Third
Avenue Fund, Inc. (12%); AEGON, USA Inc. (12%); and management (5%). ACA, the
operating company, is domiciled in Maryland for insurance regulatory purposes,
but is headquartered in New York, NY. It purchased the shell corporation and
insurance licenses of the former Capital Guaranty Insurance Company from
Financial Security Assurance Holdings. ACA insures (with a single-A
Claims-Paying-Ability rating from S&P) municipal, asset-backed, special surety
and international transactions, in both the primary and secondary markets.
Note: This company is rated A by Standard & Poor's and would only be
appropriate for non-insured municipal funds.
AGIC is an insurance company licensed in New York to write financial
guaranty, credit, residual value and surety insurance. AGIC is a wholly-owned
subsidiary of Enhance Fianancial Services Group, Inc. (EFSG), an insurance
holding company. EFSG's main subsidiary is Enhance Reinsureance Co. (Enhance),
which is organized to provide reinsurance to the financial guaranty
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industry. AGIC and Enhance are separate legal entitites, but share common
facilities and management. SwissRe is EFSG's largest single shareholder with a
stake of 9%. The public holds approximately three-quarters of EFSG's stock. AGIC
provides additional capacity and portfolio flexibility to Enhance. AGIC also
enters into primary bond insurance transactions, but not in direct competition
with the primary mono-line bond insurers which both AGIC and Enhance serve as
reinsurers.
Note: This company is rated AA by Standard & Poor's and would only be
appropriate for non-insured municipal funds.
Ambac is a wholly-owned subsidiary of Ambac Financial Group, Inc. (AFG)
(F/K/A AMBAC, Inc.), a holding company. The company is widely held by the
public. Ambac is one of the four large, mono-line financial guaranty companies
that dominate the bond insurance market. Investment management services and
interest rate risk management products for municipalities are also provided.
During 4Q97 AFG announced an agreement to acquire and closed its acquisition of
the Construction Loan Insurance Corp., the parent company of the Connie Lee
Insurance Co. Ambac has entered into a support agreement that is, in effect, a
reinsurance agreement, whereby any losses incurred by Connie Lee that would
cause its (Connie Lee's) statutory surplus to drop below $75 million would be
reinsured by Ambac. No new financial guaranty insurance will be written out of
Connie Lee.
Financial Guaranty is a wholly-owned subsidiary of FGIC Corporation (the
"Corporation"), a Delaware holding company. The Corporation is a subsidiary of
General Electric Capital Corporation ("GE Capital"). Neither the Corporation nor
GE Capital is obligated to pay the debts of or the claims against Financial
Guaranty. Financial Guaranty is a monoline financial guaranty insurer domiciled
in the State of New York and subject to regulation by the State of New York
Insurance Department. As of June 30, 2000, the total capital and surplus of
Financial Guaranty was approximately $1.293 billion. Financial Guaranty prepares
financial statements on the basis of both statutory accounting principles and
generally accepted accounting principles. Copies of such financial statements
may be obtained by writing to Financial Guaranty at 115 Broadway, New York, New
York 10006, Attention: Communications Department (telephone number:
212-312-3000) or to the New York State Insurance Department at 25 Beaver Street,
New York, New York 10004-2319, Attention: Financial Condition Property/Casualty
Bureau (telephone number: 212-480-5187).
FSA is a wholly-owned subsidiary of Financial Security Assurance Holdings
Ltd. (Holdings), a New York-based insurance holding company. FSA originally
operated as a primary mono-line insurer of investment grade taxable bonds, but
expanded its underwriting activities to include investment grade tax-exempt
bonds during 1989. During August 1995, Holdings reached an agreement to acquire
Capital Guaranty Corp. (CGC), the parent company of Capital Guaranty Insurance
Co. (CGIC). CGIC was originally renamed Financial Security Assurance of Maryland
and is now known as FSA Insurance Co. FSAIC is a member of FSA's intercompany
pool. Under the terms of the intercompany pooling agreement, the pool members
share in net insurance written in proportion to their statutory capital.
Holdings was acquired by the European banking group Dexia, a world leader in
public finance, in July of 2000.
MBIA is a mono-line financial guaranty insurance company that was
established in 1986 as the successor to the business of the Municipal Bond
Insurance Association (Association). The holding company, MBIA, Inc., owns all
the stock of the operating insurance company, MBIA. MBIA, Inc. is a publicly
owned company. During 1Q98, MBIA completed its acquisition of CAPMAC, which
specialized in the insurance of asset-backed and other structured transactions.
The acquisition has strengthened MBIA's asset-backed capabilities and has made
it a leader in asset-backed and other insured products. The full financial
resources of MBIA back CAPMAC's policies.
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Insurance companies are subject to regulation and supervision in the
jurisdictions in which they do business under statutes which delegate
regulatory, supervisory and administrative powers to state insurance
commissioners. This regulation, supervision and administration relate, among
other things, to: the standards of solvency which must be met and maintained;
the licensing of insurers and their agents; the nature of and limitations on
investments; deposits of securities for the benefit of policyholders; approval
of policy forms and premium rates; periodic examinations of the affairs of
insurance companies; annual and other reports required to be filed on the
financial condition of insurers or for other purposes; and requirements
regarding reserves for unearned premiums, losses and other matters. Regulatory
agencies require that premium rates not be excessive, inadequate or unfairly
discriminatory. A significant portion of the assets of insurance companies is
required by law to be held in reserve against potential claims on policies and
is not available to general creditors.
Although the Federal government does not regulate the business of
insurance, Federal initiatives can significantly impact the insurance business.
Insurance companies are also affected by a variety of state and Federal
regulatory measures and judicial decisions that define and extend the risks and
benefits for which insurance is sought and provided. These developments may
result in short-term adverse effects on the profitability of various lines of
insurance. Longer-term adverse effects can often be minimized through prompt
repricing of coverages and revision of policy terms. In some instances these
developments may create new opportunities for business growth. All insurance
companies write policies and set premiums based on actuarial assumptions about
mortality, injury, the occurrence of accidents and other insured events. These
assumptions, while well supported by past experience, necessarily do not take
account of future events. The occurrence in the future of unforeseen
circumstances could affect the financial condition of one or more insurance
companies. The insurance business is highly competitive and with the
deregulation of financial service businesses, it should become more competitive.
In addition, insurance companies may expand into non-traditional lines of
business which may involve different types of risks.
State Risk Factors
Investment in a single State Trust, as opposed to a Fund which invests in
the obligations of several states, may involve some additional risk due to the
decreased diversification of economic, political, financial and market risks.
See "State Matters" for brief summaries of some of the factors which may affect
the financial condition of the States represented in various State Trusts of
Defined Asset Funds, together with summaries of tax considerations relating to
those States.
Payment of Bonds and Life of a Fund
Because Bonds from time to time may be redeemed or prepaid or will mature
in accordance with their terms or may be sold under certain circumstances
described herein, no assurance can be given that a Portfolio will retain for any
length of time its present size and composition. Bonds may be subject to
redemption prior to their stated maturity dates pursuant to optional refunding
or sinking fund redemption provisions or otherwise. In general, optional
refunding redemption provisions are more likely to be exercised when the offer
side evaluation is at a premium over par than when it is at a discount from par.
Generally, the offer side evaluation of Bonds will be at a premium over par when
market interest rates fall below the coupon rate on the Bonds. Bonds in a
Portfolio may be subject to sinking fund provisions early in the life of a Fund.
These provisions are designed to redeem a significant portion of an issue
gradually over the life of the issue; obligations to be redeemed are generally
chosen by lot. Additionally, the size and composition of a Portfolio will be
affected by the level of redemptions of Units that may occur from time to time
and the consequent sale of Bonds. Principally, this will depend upon the number
of Holders seeking to sell or redeem their Units and whether or not the Sponsors
continue to reoffer Units acquired by them in the secondary market. Factors that
the Sponsors will consider in
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the future in determining to cease offering Units acquired in the secondary
market include, among other things, the diversity of a Portfolio remaining at
that time, the size of a Portfolio relative to its original size, the ratio of
Fund expenses to income, a Fund's current and long-term returns, the degree to
which Units may be selling at a premium over par relative to other funds
sponsored by the Sponsors and the cost of maintaining a current Prospectus for a
Fund. These factors may also lead the Sponsors to seek to terminate a Fund
earlier than would otherwise be the case.
Redemption
The Trustee is empowered to sell Bonds in order to make funds available
for redemption if funds are not otherwise available in the Capital and Income
Accounts. The Bonds to be sold will be selected from a list supplied by the
Sponsors. Securities will be chosen for this list by the Sponsors on the basis
of those market and credit factors as they may determine are in the best
interests of the Fund. Provision is made under the Indenture for the Sponsors to
specify minimum face amounts in which blocks of Bonds are to be sold in order to
obtain the best price for the Fund. While these minimum amounts may vary from
time to time in accordance with market conditions, the Sponsors believe that the
minimum face amounts which would be specified would range from $25,000 for
readily marketable Bonds to $250,000 for certain Restricted Securities which can
be distributed on short notice only by private sale, usually to institutional
investors. Provision is also made that sales of Bonds may not be made so as to
(i) result in the Fund owning less than $250,000 of any Restricted Security or
(ii) result in more than 50% of the Fund consisting of Restricted Securities. In
addition, the Sponsors will use their best efforts to see that these sales of
Bonds are carried out in such a way that no more than 40% in face amount of the
Fund is invested in Restricted Securities, provided that sales of unrestricted
Securities may be made if the Sponsors' best efforts with regard to timely sales
of Restricted Securities at prices they deem reasonable are unsuccessful and if
as a result of these sales more than 50% of the Fund does not consist of
Restricted Securities. Thus the redemption of Units may require the sale of
larger amounts of Restricted Securities than of unrestricted Securities.
Tax Exemption
In the opinion of bond counsel rendered on the date of issuance of each
Bond, the interest on each Bond is excludable from gross income under existing
law for regular Federal income tax purposes (except in certain circumstances
depending on the Holder) but may be subject to state and local taxes and may be
a preference item for purposes of the Alternative Minimum Tax. Interest on Bonds
may become subject to regular Federal income tax, perhaps retroactively to their
date of issuance, as a result of changes in Federal law or as a result of the
failure of issuers (or other users of the proceeds of the Bonds) to comply with
certain ongoing requirements.
Moreover, the Internal Revenue Service has announced an expansion of its
examination program with respect to tax-exempt bonds. The expanded examination
program will consist of, among other measures, increased enforcement against
abusive transactions, broader audit coverage (including the expected issuance of
audit guidelines) and expanded compliance achieved by means of expected
revisions to the tax-exempt bond information return forms.
In certain cases, a Bond may provide that if the interest on the Bond
should ultimately be determined to be taxable, the Bond would become due and
payable by its issuer, and, in addition, may provide that any related letter of
credit or other security could be called upon if the issuer failed to satisfy
all or part of its obligation. In other cases, however, a Bond may not provide
for the acceleration or redemption of the Bond or a call upon the related letter
of credit or other security upon a determination of taxability. In those cases
in which a Bond does not provide for acceleration or redemption or in which both
the issuer and the bank or other entity issuing the letter of credit or other
security are unable to meet their obligations to pay the amounts due on the Bond
as a result of a determination of taxability, a Trustee would be obligated to
sell the Bond and, since it would be sold as a taxable security, it is expected
that it would have to be sold at a
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substantial discount from current market price. In addition, as mentioned above,
under certain circumstances Holders could be required to pay income tax on
interest received prior to the date on which the interest is determined to be
taxable.
INCOME AND RETURNS
Income
Because accrued interest on Bonds is not received by a Fund at a constant
rate throughout the year, any monthly income distribution may be more or less
than the interest actually received by the Fund. To eliminate fluctuations in
the monthly income distribution, a portion of the Public Offering Price consists
of an advance to the Trustee of an amount necessary to provide approximately
equal distributions. Upon the sale or redemption of Units, investors will
receive their proportionate share of the Trustee advance. In addition, if a Bond
is sold, redeemed or otherwise disposed of, a Fund will periodically distribute
the portion of the Trustee advance that is attributable to that Bond to
investors.
The regular monthly income distribution stated in the Prospectus is based
on a Public Offering Price of $1,000 per Unit after deducting estimated Fund
expenses, and will change as the composition of the Portfolio changes over time.
Income is received by a Fund upon semi-annual payments of interest on the
Bonds held in a Portfolio. Bonds may sometimes be purchased on a when, as and if
issued basis or may have a delayed delivery. Since interest on these Bonds does
not begin to accrue until the date of delivery to a Fund, in order to provide
tax-exempt income to Holders for this non-accrual period, the Trustee's Annual
Fee and Expenses is reduced by the interest that would have accrued on these
Bonds between the initial settlement date for Units and the delivery dates of
the Bonds. This eliminates reduction in Monthly Income Distributions. Should
when-issued Bonds be issued later than expected, the fee reduction will be
increased correspondingly. If the amount of the Trustee's Annual Fee and
Expenses is insufficient to cover the additional accrued interest, the Sponsors
will treat the contracts as Failed Bonds. As the Trustee is authorized to draw
on the letter of credit deposited by the Sponsors before the settlement date for
these Bonds and deposit the proceeds in an account for the Fund on which it pays
no interest, its use of these funds compensates the Trustee for the reduction
described above.
STATE MATTERS
ARIZONA
The following information is a brief summary of some of the factors
affecting the economy in the State and does not purport to be a complete
description of such factors. This summary is based on publicly available
information and forecasts which have not been independently verified by the
Sponsors or their legal counsel.
RISK FACTORS--The State Economy. The Arizona economy over the last several
decades has grown faster than in most other regions of the United States, as
measured by population, employment and personal income.
Historically, the State economy has been somewhat dependent on the
construction industry and is sensitive to trends in that sector. A substantial
amount of overbuilding occurred during the early 1980's while the State's
economy was flourishing, which adversely affected Arizona's financial-based
institutions and caused them to be placed under the control of the Resolution
Trust Corporation ("RTC"). In the aftermath of the savings and loan crisis,
which hit Arizona hard beginning in the late 1980's, the RTC sold over $23
billion in Arizona assets, consisting mostly of real-estate secured loans and
real property. The construction and real estate
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industries have rebounded from their substantial declines experienced during the
late 1980's and early 1990's and are experiencing positive growth. Regulations
to control growth, land use and development in Arizona have been proposed in the
legislature and through voter initiatives. It is impossible to predict whether
any such proposals will ever be enacted and, if so, what effect any such
proposals would have on the construction and real estate industries or the
Arizona economy in general. Other principal economic sectors include services,
manufacturing, mining, tourism and the military.
Few of Arizona's largest employers are based entirely in Arizona; many
have headquarters and operations in other states. Therefore, economic factors in
other states could affect the employment and economic situation in Arizona.
Job growth in Arizona, defined as growth of total wage and salary
employment, was consistently in the range of 2.1% to 2.5% for the years 1988
through 1990, declined to 0.6% in 1991, then increased to 1.7% in 1992, 3.0% in
1993, and 6.7% in 1994. Job growth was 6.1% in 1995, 5.4% in 1996, 4.9% in 1997,
4.5% in 1998, 4.1% in 1999, and is forecast at 3.8% for 2000 and 2.8% for 2001.
The unemployment rate in Arizona was 5.3% in 1990, 5.6% in 1991, 7.4% in
1992, 6.2% in 1993, 6.4% in 1994, 5.1% in 1995, 5.5% in 1996, 4.6% in 1997 and
4.2% in 1998 and 1999. Arizona's unemployment rate is forecast at 4.3% for 2000
and 4.6% for 2001.
Current personal income in Arizona has continued to rise, but at slower
rates than in the early to mid-1980's. Personal income grew at a rate of 5.8% in
1990 and dropped to 4.6% in 1991. Growth in personal income increased at a rate
of 6.7% in 1992, 7.3% in 1993, 8.7% in 1994, 9.0% in 1995, 8.0% in 1996, 7.2% in
1997, 7.9% in 1998 and 6.8% in 1999. Growth in Arizona personal income is
forecast at 6.2% for 2000 and 5.4% for 2001.
Bankruptcy filings in the District of Arizona increased dramatically in
the mid-1980's, but percentage increases decreased during the early 1990's, with
1993 resulting in the first drop in bankruptcy filings since 1984. Bankruptcy
filings totaled 19,686 in 1991, 19,883 in 1992, 17,381 in 1993, 15,008 in 1994,
15,767 in 1995, 19,989 in 1996, 24,686 in 1997 and 23,721 in 1998. Bankruptcy
filings during 1999 totaled 21,946.
For several decades the population of the State of Arizona has grown at a
substantially higher rate than the population of the United States. Arizona's
population rose 35% between 1980 and 1990, according to the 1990 census, a rate
exceeded only in Nevada and Alaska. Nearly 950,000 residents were added during
this period. Population growth across Arizona between 1990 and 1996 greatly
outpaced the national average; Arizona's population rose more than three times
as fast as the national average during this period. Although significantly
greater than the national average population growth, it is lower than Arizona's
population growth in the mid-1980's. The rate of population growth in Arizona
has been slowing slightly since 1996, with increases of 3.3% in 1996, 3.0% in
1997, 2.9% in 1998, and 2.8% in 1999. Population growth is forecast at 2.6% in
2000 and 2.4% in 2001. Census data show that in the 1990's, California has been
Arizona's largest source of in-migration. Out-migration from California has now
slowed, which could affect the level of Arizona's net in-migration.
The State Budget, Revenues and Expenditures. The state operates on a
fiscal year beginning July 1 and ending June 30. Fiscal year 2000 refers to the
year ending June 30, 2000. Fiscal year 2001 refers to the year ending June 30,
2001.
The General Fund revenues for fiscal year 2000 are estimated at $6.198
billion. Total General Fund revenues of $6.451 billion are projected during
fiscal year 2001. Approximately 47% of this expected revenue comes from sales
and use taxes, 49% from income taxes (both
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individual and corporate) and 4% from other sources. In addition to taxes,
revenue includes non-tax items such as income from the state lottery, licenses,
fees and permits, and interest.
The General Fund expenditures for fiscal year 2000 are estimated at $6.017
billion. For fiscal year 2001, General Fund expenditures of $6.414 billion are
projected. Approximately 40% of major General Fund appropriations are for the
Department of Education for K-12, 12% is for higher education, 7% is for school
facilities, 8% is for the administration of the AHCCCS program (the State's
alternative to Medicaid), 7% is for the Department of Economic Security, 4% is
for the Department of Health Services and 9% is for the Department of
Corrections.
We have been informed by the Sponsor that most or all of the Debt
Obligations of the Arizona Trust are not obligations of the State of Arizona,
and are not supported by the State's taxing powers, and that the particular
source of payment and security for each of the Debt Obligations is detailed in
the instruments themselves and in related offering materials. There can be no
assurances, however, with respect to whether the market value or marketability
of any of the Debt Obligations issued by an entity other than the State of
Arizona will be affected by the financial or other condition of the State or of
any entity located within the State. In addition, it should be noted that the
State of Arizona, as well as counties, municipalities, political subdivisions
and other public authorities of the state, are subject to limitations imposed by
Arizona's constitution with respect to ad valorem taxation, bonded indebtedness
and other matters. For example, the state legislature cannot appropriate
revenues in excess of 7% of the total personal income of the state in any fiscal
year. These limitations may affect the ability of the issuers to generate
revenues to satisfy their debt obligations.
The Arizona voters have passed a measure which requires a two-thirds vote
of the legislature to increase State taxes, which could make it more difficult
to reverse tax reduction measures which have been enacted in recent years. This
measure could adversely affect State fund balances and fiscal conditions. There
have also been periodic attempts in the form of voter initiatives and
legislative proposals to further limit the amount of annual increases in taxes
that can be levied by the various taxing jurisdictions without voter approval.
It is impossible to predict whether any such proposals will ever be enacted or
what the effect of any such proposals would be. However, if such proposals were
enacted, there could be an adverse impact on State or local government
financing.
In 1996, a lower court found unlawful the practice used by some localities
in Arizona pursuant to which so-called "Capital Appreciation Bonds" (which pay
no current interest) were issued. In 1996, the legislature enacted legislation
validating all bonds of this type outstanding on March 31, 1996. However, the
legislation contains restrictions which may have an adverse impact on the
overall financial condition of municipalities that have issued bonds of this
type and their ability to issue additional debt.
School Finance. In July of 1994, the Supreme Court of Arizona found that
the formulas for funding public schools in Arizona caused "gross disparities"
among school districts and therefore violated the Arizona Constitution. In
response to the judgment, the Arizona legislature adopted a new funding program
which provides extensive changes in the previous budget and expenditure system,
and among other things, provides state funds for construction and maintenance of
capital facilities and establishes minimum standards for such facilities. The
legislation also sets limits on the amount of bonds school districts can issue
after December 31, 1998. In July, 1998, the Supreme Court of Arizona dismissed
the lawsuit challenging the State's educational financing system. It remains
unclear what on-going effects the 1998 legislation will have on state and county
finances or school district budgets.
Health Care Facilities. Arizona does not participate in the federally
administered Medicaid program. Instead, the state administers an alternative
program, the Arizona Health Care Cost Containment System ("AHCCCS"), which
provides health care to indigent persons meeting
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certain financial eligibility requirements, through managed care programs.
AHCCCS is financed by a combination of federal, state and county funds.
Under state law, hospitals retain the authority to raise rates with
notification and review by, but not approval from, the Department of Health
Services. Hospitals in Arizona have experienced profitability problems along
with those in other states.
Health care firms have been in the process of consolidating. Continuing
consolidation and merger activity in the health care industry is expected.
Utilities. Arizona's utilities are currently subject to regulation by the
Arizona Corporation Commission. This regulation extends to, among other things,
the issuance of certain debt obligations by regulated utilities and periodic
rate increases needed by utilities to cover operating costs and debt service.
The inability of any regulated public utility to secure necessary rate increases
could adversely affect the utility's ability to pay debt service. In May, 1998,
Arizona adopted the Electric Power Competition Act. This represents the initial
phase of deregulation of electric power utilities in Arizona, which began to be
phased in January, 1999.
This deregulation act affects Arizona's largest regulated utility, Arizona
Public Service Company ("APS"), which currently serves all or part of 11 of
Arizona's 15 counties and provides electric service to approximately 700,000
customers. APS is a significant part owner of Arizona's nuclear generator, the
Palo Verde Nuclear Generating Station. APS is owned by Pinnacle West Capital
Corporation.
This deregulation act also affects the Salt River Project Agricultural
Improvement and Power District ("SRP"), even though as an agricultural
improvement district organized under state law, SRP is not subject to regulation
by the Arizona Corporation Commission. SRP, one of the nation's five largest
locally owned public power utilities, provides electric service to over 600,000
customers (consumer, commercial and industrial) within a 2,900 square mile area
in parts of Maricopa, Gila and Pinal Counties in Arizona. Under Arizona law,
SRP's board of directors has the exclusive authority to establish rates for
electricity. SRP must follow certain procedures, including certain public notice
requirements and a special board of directors meeting, before implementing any
changes in standard electric rates.
It remains unclear at this time how Arizona's electric utilities will
implement and respond to the changes required under the new deregulation act,
and what effects the new act may have on Arizona utility providers, consumers or
the Arizona economy in general.
Two special purpose irrigation districts formed for the purpose of issuing
bonds to finance the purchase of Colorado River water from the Central Arizona
Project filed for bankruptcy in 1994 under Chapter 9 of the United States
Bankruptcy Code as a result of the districts' inability to collect tax revenue
sufficient to service their bonded debt. The financial problems arose from a
combination of unexpectedly high costs of constructing the Central Arizona
Project, plummeting land values resulting in a need to increase property taxes
and refusal by many landowners in the districts to shoulder the increased tax
burden. In June 1995 a bankruptcy plan was confirmed for one district, which
returned to bondholders 57 cents on the dollar of their principal and placed an
additional 42 cents on the dollar in new 8% bonds maturing in seven years. The
proceedings with respect to the second district are continuing. Although a plan
of reorganization was confirmed for the second district, it has been appealed
and certain elements of the plan are subject to continuing litigation.
Litigation. The State of Arizona is a party to various lawsuits in which
an adverse final decision could materially affect the State's resources and
governmental operations and consequently its ability to satisfy its obligations.
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Other Factors. Uncertainty concerning the Mexico economy could have an
impact on Arizona's economy, as trade and tourism in the southern regions of the
state bordering Mexico could be affected by the condition of the Mexico economy.
It is also unclear the extent to which weakness in other foreign markets may
have on the Arizona economy.
CALIFORNIA
The following information is a brief summary of some of the factors
affecting the economy in the State and does not purport to be a complete
description of such factors. This summary is based on publicly available
information and forecasts which have not been independently verified by the
Sponsors or their legal counsel.
The following information constitutes only a brief summary, does not
purport to be a complete description, and is based on information drawn from
official statements and Prospectuses relating to securities offerings of the
State of California and various local agencies in California, available as of
the date of this Prospectus. While the Sponsors have not independently verified
such information, they have no reason to believe that such information is not
correct in all material respects.
Economic Factors.
1995-96 through 1997-98 Fiscal Years. With the end of the recession of the
early 1990's, and a growing economy beginning in 1995, the State's financial
condition improved markedly through a combination of increasing revenues,
slowdown in growth of social welfare programs, and continued spending restraint.
The economy grew strongly during these fiscal years, and as a result, the
General Fund took in substantially greater tax revenues (around $2.2 billion in
1995-96, $1.6 billion in 1996-97, $2.4 billion in 1997-98 and $1.7 billion in
1998-99) than were initially planned when the budgets were enacted. These
additional funds were largely directed to school spending as mandated by
Proposition 98, to make up shortfalls from reduced federal health and welfare
aid in 1995-96 and 1996-97 and to fund new program incentives in 1998-1999. The
accumulated budget deficit from the recession years was eliminated.
1998-99 Fiscal Year Budget.
The following were major features of the 1998 Budget Act and certain
additional fiscal bills enacted before the end of the legislative session.
1. The most significant feature of the 1998-99 Budget was agreement on a
total of $1.4 billion of tax cuts. The central element was a bill which provided
for a phased-in reduction of the Vehicle License Fee ("VLF"). Since the VLF is
transferred to cities and counties under existing law, the bill provided for the
General Fund to replace the lost revenues. Starting on January 1, 1999, the VLF
was reduced by 25%, at a cost to the General Fund of approximately $500 million
in the 1998-99 Fiscal Year and about $1 billion annually thereafter.
In addition to the cut in VLF, the 1998-99 Budget included both temporary
and permanent increases in the personal income tax dependent credit ($612
million General Fund cost in 1998-99 but less in future years), a nonrefundable
renters tax credit ($133 million), and various targeted business tax credits
($106 million).
2. Proposition 98 funding for K-14 schools is increased by $1.7 billion in
General Fund moneys over revised 1997-98 levels, about $300 million higher than
the minimum Proposition 98 guaranty. Of the 1998-99 funds, major new programs
included money for
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instructional and library materials, previously deferred maintenance, support
for increasing the school year to 180 days and reduction of class sizes in Grade
9.
3. Funding for higher education increased substantially above the actual
1997-98 level. General Fund support was increased by $340 million (15.6%) for
the University of California and $267 million (14.1%) for the California State
University system. In addition, Community College funding increased by $300
million (6.6%).
4. The Budget included increased funding for health, welfare and social
services programs. A 4.9% grant increase was included in the basic welfare
grants, the first increase in those grants in 9 years.
5. Funding for the judiciary and criminal justice programs increased by
about 11% over 1997-98, primarily to reflect increased State support for local
trial courts and rising prison population.
6. Major legislation enacted after the 1998 Budget Act included new
funding for resources projects, a share of the purchase of the Headwaters
Forest, funding for the Infrastructure and Economic Development Bank ($50
million) and funding for the construction of local jails. The State realized
savings of $433 million from a reduction in the State's contribution to the
State Teacher's Retirement System in 1998-99.
1999-2000 Fiscal Year Budget
On January 8, 1999, Governor Davis released his proposed budget for Fiscal
Year 1999-2000 (the "January Governor's Budget"). The January Governor's Budget
generally reported that general fund revenues for FY 1998-99 and FY 1999-2000
would be lower than earlier projections (primarily due to weaker overseas
economic conditions perceived in late 1998), while some caseloads would be
higher than earlier projections. The January Governor's Budget proposed $60.5
billion of general fund expenditures in FY 1999-2000, with a $415 million SFEU
reserve at June 30, 2000.
The 1999 May Revision showed an additional $4.3 billion of revenues for
combined fiscal years 1998-99 and 1999-2000. The final Budget Bill was adopted
by the Legislature on June 16, 1999, and was signed by the Governor on June 29,
1999 (the "1999 Budget Act"), meeting the Constitutional deadline for budget
enactment for only the second time in the 1990's.
The final 1999 Budget Act estimated General Fund revenues and transfers of
$63.0 billion, and contained expenditures totaling $63.7 billion after the
Governor used his line-item veto to reduce the legislative Budget Bill
expenditures by $581 million (both General Fund and Special Fund). The 1999
Budget Act also contained expenditures of $16.1 billion from special funds and
$1.5 billion from bond funds. The Administration estimated that the State's
Special Fund for Economic Uncertainties (the "SFEU") would have a balance at
June 30, 2000, of about $880 million. Not included in this amount was an
additional $300 million which (after the Governor's vetoes) was "set aside" to
provide funds for employee salary increases (to be negotiated in bargaining with
employee unions), and for litigation reserves. The 1999 Budget Act anticipates
normal cash flow borrowing during the fiscal year.
The principal features of the 1999 Budget Act include the following:
1 . Proposition 98 funding for K-12 schools was increased by $1.6 billion
in General Fund moneys over revised 1998-99 levels, $108.6 million higher than
the minimum Proposition 98 guarantee. Of the 1999-2000 funds, major new programs
included money for reading improvement, new textbooks, school safety, improving
teacher quality, funding teacher
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bonuses, providing greater accountability for school performance, increasing
preschool and after school care programs and funding deferred maintenance of
school facilities.
2. Funding for higher education increased substantially above the actual
1998-99 level. General Fund support was increased by $184 million (7.3 percent)
for the University of California and $126 million (5.9 percent) for the
California State University system. In addition, Community Colleges funding
increased by $324.3 million (6.6 percent). As a result, undergraduate fees at
the University of California and the California State University System will be
reduced for the second consecutive year, and the per-unit charge at Community
Colleges will be reduced by $1.
3. The Budget included increased funding of nearly $600 million for health
and human services.
4. About $800 million from the General Fund will be directed toward
infrastructure costs, including $425 million in additional funding for the
Infrastructure Bank, initial planning costs for a new prison in the Central
Valley, additional equipment for train and ferry service, and payment of
deferred maintenance for state parks.
5. The Legislature enacted a one-year additional reduction of 10 percent
of the VLF for calendar year 2000, at a General Fund cost of about $250 million
in each of FY 1999-2000 and 2000-01 to make up lost funding to local
governments. Conversion of this one-time reduction to a permanent cut will
remain subject to the revenue tests in the legislation adopted last year.
6. A one-time appropriation of $150 million, to be split between cities
and counties, was made to offset property tax shifts during the early 1990's.
Additionally, an ongoing $50 million was appropriated as a subvention to cities
for jail booking or processing fees charged by counties when an individual
arrested by city personnel is taken to a county detention facility.
The revised 1999-2000 budget included in the 2000-01 Governor's Budget
also reflects the latest estimated costs or savings as provided in various
legislation passed and signed after the 1999 Budget Act. The revised budget
includes $730 million for various departments for enrollment, caseload and
population changes and $562 million for Smog Impact Fee refunds. Revised
1999-2000 revenues are $65.2 billion or $2.2 billion higher than projections at
the 1999 Budget Act. Revised 1999-2000 expenditures are $65.9 billion or $2.1
billion higher than projections at the 1999 Budget Act.
The State's Legislative Analyst ("LAO") issued a report in February 2000
indicating General Fund revenues for the 18-month period (January 2000 through
June 2001) could be as much as $4.2 billion higher than the 2000-01 Governor's
Budget estimates. The LAO estimate was issued after analyzing actual revenues
for December 1999 and January 2000, which were not available at the time the
Governor's Budget estimates were prepared. The LAO report assumed the
continuation of strong economic growth in the State during this period.
Proposed 2000-01 Fiscal Year Budget
On January 10, 2000, Governor Davis released his proposed budget for
Fiscal Year 2000-01. The 2000-01 Governor's Budget generally reflects that
General Fund revenues for Fiscal Year 1999-2000 will be higher than projections
made at the time of the 1999 Budget Act.
The Governors Budget projects General Fund revenues and transfers in
2000-01 of $68.2 billion. This includes anticipated payments from the tobacco
litigation settlement of $387.9 million and the receipt of one-time revenue from
the sale of assets. More accurate revenue
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estimates will be available in May and June before the adoption of the Budget.
The Governor has proposed $167 million in tax reduction initiatives.
The Governor's Budget proposes General Fund expenditures of $68.8 billion.
Included in the Budget are set-asides of $500 million for legal contingencies
and $100 million for various one-time legislative initiatives. Based on the
proposed revenues and expenditures, the Governor's Budget projects the June 30,
2001 balance in the SFEU to be $1.238 billion.
Constitutional, Legislative and Other Factors.
Certain California constitutional amendments, legislative measures,
executive orders, administrative regulations and voter initiatives could produce
the adverse effects described below.
Revenue Distribution. Certain Debt Obligations in the Portfolio may be
obligations of issuers which rely in whole or in part on California State
revenues for payment of these obligations. Property tax revenues and a portion
of the State's general fund surplus are distributed to counties, cities and
their various taxing entities and the State assumes certain obligations
theretofore paid out of local funds. Whether and to what extent a portion of the
State's general fund will be distributed in the future to counties, cities and
their various entities, is unclear.
Health Care Legislation. Certain Debt Obligations in the Portfolio may be
obligations which are payable solely from the revenues of health care
institutions. Certain provisions under California law may adversely affect these
revenues and, consequently, payment on those Debt Obligations.
The Federally sponsored Medicaid program for health care services to
eligible welfare beneficiaries in California is known as the Medi-Cal program.
Historically, the Medi-Cal program has provided for a cost-based system of
reimbursement for inpatient care furnished to Medi-Cal beneficiaries by any
hospital wanting to participate in the Medi-Cal program, provided such hospital
met applicable requirements for participation. California law now provides that
the State of California shall selectively contract with hospitals to provide
acute inpatient services to Medi-Cal patients. Medi-Cal contracts currently
apply only to acute inpatient services. Generally, such selective contracting is
made on a flat per diem payment basis for all services to Medi-Cal
beneficiaries, and generally such payment has not increased in relation to
inflation, costs or other factors. Other reductions or limitations may be
imposed on payment for services rendered to Medi-Cal beneficiaries in the
future.
Under this approach, in most geographical areas of California, only those
hospitals which enter into a Medi-Cal contract with the State of California will
be paid for non-emergency acute inpatient services rendered to Medi-Cal
beneficiaries. The State may also terminate these contracts without notice under
certain circumstances and is obligated to make contractual payments only to the
extent the California legislature appropriates adequate funding therefor.
California enacted legislation in 1982 that authorizes private health
plans and insurers to contract directly with hospitals for services to
beneficiaries on negotiated terms. Some insurers have introduced plans known as
"preferred provider organizations" ("PPOs"), which offer financial incentives
for subscribers who use only the hospitals which contract with the plan. Under
an exclusive provider plan, which includes most health maintenance organizations
("HMOs"), private payors limit coverage to those services provided by selected
hospitals. Discounts offered to HMOs and PPOs may result in payment to the
contracting hospital of less than actual cost and the volume of patients
directed to a hospital under an HMO or PPO contract may vary significantly from
projections. Often, HMO or PPO contracts are enforceable for a stated term,
regardless of provider losses or of bankruptcy of the respective HMO or PPO. It
is expected that failure to execute and maintain such PPO and HMO contracts
would reduce a hospital's patient base or
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gross revenues. Conversely, participation may maintain or increase the patient
base, but may result in reduced payment and lower net income to the contracting
hospitals.
These Debt Obligations may also be insured by the State of California
pursuant to an insurance program implemented by the Office of Statewide Health
Planning and Development for health facility construction loans. If a default
occurs on insured Debt Obligations, the State Treasurer will issue debentures
payable out of a reserve fund established under the insurance program or will
pay principal and interest on an unaccelerated basis from unappropriated State
funds. The Office of Statewide Health Planning and Development, commissioned
various studies commencing in December, 1983, to evaluate the adequacy of the
reserve fund established under the insurance program and based on certain
formulations and assumptions found the reserve fund substantially underfunded.
The most recent study, prepared in December 1998 by Ernst & Young LLP,
concluded, among other things, that although the fund would not meet California
private insurance reserve standards, reserves were sufficient and, assuming
"normal and expected" conditions, the Health Facility Construction Loan
Insurance Fund, as of June 30, 1998, should maintain a positive balance over the
long term.
Mortgages and Deeds. Certain Debt Obligations in the Portfolio may be
obligations which are secured in whole or in part by a mortgage or deed of trust
on real property. California has five principal statutory provisions which limit
the remedies of a creditor secured by a mortgage or deed of trust. Two statutes
limit the creditor's right to obtain a deficiency judgment, one limitation being
based on the method of foreclosure and the other on the type of debt secured.
Under the former, a deficiency judgment is barred when the foreclosure is
accomplished by means of a nonjudicial trustee's sale. Under the latter, a
deficiency judgment is barred when the foreclosed mortgage or deed of trust
secures certain purchase money obligations. Another California statute, commonly
known as the "one form of action" rule, requires creditors secured by real
property to exhaust their real property security by foreclosure before bringing
a personal action against the debtor. The fourth statutory provision limits any
deficiency judgment obtained by a creditor secured by real property following a
judicial sale of such property to the excess of the outstanding debt over the
fair value of the property at the time of the sale, thus preventing the creditor
from obtaining a large deficiency judgment against the debtor as the result of
low bids at a judicial sale. The fifth statutory provision gives the debtor the
right to redeem the real property from any judicial foreclosure sale as to which
a deficiency judgment may be ordered against the debtor.
Upon the default of a mortgage or deed of trust with respect to California
real property, the creditor's nonjudicial foreclosure rights under the power of
sale contained in the mortgage or deed of trust are subject to the constraints
imposed by California law upon transfers of title to real property by private
power of sale. During the three-month period beginning with the filing of a
formal notice of default, the debtor is entitled to reinstate the mortgage by
making any overdue payments. Under standard loan servicing procedures, the
filing of the formal notice of default does not occur unless at least three full
monthly payments have become due and remain unpaid. The power of sale is
exercised by posting and publishing a notice of sale after expiration of the
three-month reinstatement period, which notice of sale must be given at least 20
days before the scheduled sale date. The debtor may reinstate the mortgage in
the manner described above, up to five business days prior to the scheduled sale
date. Therefore, the effective minimum period for foreclosing on a mortgage
could be in excess of seven months after the initial default. Such time delays
in collections could disrupt the flow of revenues available to an issuer for the
payment of debt service on the outstanding obligations if such defaults occur
with respect to a substantial number of mortgages or deeds of trust securing an
issuer's obligations.
In addition, a court could find that there is sufficient involvement of
the issuer in the nonjudicial sale of property securing a mortgage for such
private sale to constitute "state action," and could hold that the
private-right-of-sale proceedings violate the due process requirements of
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the Federal or State Constitutions, consequently preventing an issuer from using
the nonjudicial foreclosure remedy described above.
Certain Debt Obligations in the Portfolio may be obligations which finance
the acquisition of single-family home mortgages for low and moderate income
mortgagors. These obligations may be payable solely from revenues derived from
the home mortgages, and are subject to California's statutory limitations
described above applicable to obligations secured by real property. Under
California antideficiency legislation, there is no personal recourse against a
mortgagor of a single-family residence purchased with the loan secured by the
mortgage, regardless of whether the creditor chooses judicial or nonjudicial
foreclosure.
Under California law, mortgage loans secured by single-family
owner-occupied dwellings may be prepaid at any time. Prepayment charges on such
mortgage loans may be imposed only with respect to voluntary prepayments made
during the first five years during the term of the mortgage loan, and then only
if the borrower prepays an amount in excess of 20% of the original principal
amount of the mortgage loan in a 12-month period; a prepayment charge cannot in
any event exceed six months' advance interest on the amount prepaid during the
12-month period in excess of 20% of the original principal amount of the loan.
This limitation could affect the flow of revenues available to an issuer for
debt service on the outstanding debt obligations which financed such home
mortgages.
Proposition 13. Certain of the Debt Obligations may be obligations of
issuers who rely in whole or in part on ad valorem real property taxes as a
source of revenue. On June 6, 1978, California voters approved an amendment to
the California Constitution known as Proposition 13, which added Article XIIIA
to the California Constitution. The effect of Article XIIIA was to limit ad
valorem taxes on real property and to restrict the ability of taxing entities to
increase real property tax revenues.
Section 1 of Article XIIIA, as amended, limits the maximum ad valorem tax
on real property to 1% of full cash value, to be collected by the counties and
apportioned according to law. The 1% limitation does not apply to ad valorem
taxes or special assessments to pay the interest and redemption charges on any
bonded indebtedness for the acquisition or improvement of real property
approved, by two-thirds of the votes cast by the voters voting on the
proposition. Section 2 of Article XIIIA defines "full cash value" to mean "the
County Assessor's valuation of real property as shown on the 1975/76 tax bill
under "full cash value" or, thereafter, the appraised value of real property
when purchased, newly constructed, or a change in ownership has occurred after
the 1975 assessment." The full cash value may be adjusted annually to reflect
inflation at a rate not to exceed 2% per year, or reduction in the consumer
price index or comparable local data, or reduced in the event of declining
property value caused by damage, destruction or other factors.
Legislation enacted by the California Legislature to implement Article
XIIIA provides that notwithstanding any other law, local agencies may not levy
any ad valorem property tax except to pay debt service on indebtedness approved
by the voters prior to July 1, 1978, and that each county will levy the maximum
tax permitted by Article XIIIA.
Proposition 9. On November 6, 1979, an initiative known as "Proposition 9"
or the "Gann Initiative" was approved by the California voters, which added
Article XIIIB to the California Constitution. Under Article XIIIB, State and
local governmental entities have an annual "appropriations limit" and are not
allowed to spend certain moneys called "appropriations subject to limitation" in
an amount higher than the "appropriations limit." Article XIIIB does not affect
the appropriation of moneys which are excluded from the definition of
"appropriations subject to limitation," including debt service on indebtedness
existing or authorized as of January 1, 1979, or bonded indebtedness
subsequently approved by the voters. In general terms, the "appropriations
limit" is required to be based on certain 1978/79 expenditures, and is to be
adjusted annually to reflect changes in consumer prices, population, and certain
services provided by these entities.
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Article XIIIB also provides that if these entities' revenues in any year exceed
the amounts permitted to be spent, the excess is to be returned by revising tax
rates or fee schedules over the subsequent two years.
Proposition 98. 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 Limit, primarily by
guaranteeing K-14 schools a minimum share of General Fund revenues. Under
Proposition 98 (modified by Proposition 111 as discussed below), K-14 schools
are guaranteed the greater of (a) in general, a fixed percent of General Fund
revenues ("Test 1"), (b) the amount appropriated to K-14 schools in the prior
year, adjusted for changes in the cost of living (measured as in Article XIII B
by reference to State per capita personal income) and enrollment ("Test 2"), or
(c) a third test, which would replace Test 2 in any year when the percentage
growth in per capita General Fund revenues from the prior year plus one half of
one percent is less than the percentage growth in State per capita personal
income ("Test 3"). Under Test 3, schools would receive the amount appropriated
in the prior year adjusted for changes in enrollment and per capita General Fund
revenues, plus an additional small adjustment factor. If Test 3 is used in any
year, the difference between Test 3 and Test 2 would become a "credit" to
schools which would be the basis of payments in future years when per capita
General Fund revenue growth exceeds per capita personal income growth.
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 Article XIII B limit to
K-14 schools.
Proposition 111. On June 30, 1989, the California Legislature enacted
Senate Constitutional Amendment 1, a proposed modification of the California
Constitution to alter the spending limit and the education funding provisions of
Proposition 98. Senate Constitutional Amendment 1, on the June 5, 1990 ballot as
Proposition 111, was approved by the voters and took effect on July 1, 1990.
Among a number of important provisions, Proposition 111 recalculated spending
limits for the State and for local governments, allowed greater annual increases
in the limits, allowed the averaging of two years' tax revenues before requiring
action regarding excess tax revenues, reduced the amount of the funding
guarantee in recession years for school districts and community college
districts (but with a floor of 40.9 percent of State general fund tax revenues),
removed the provision of Proposition 98 which included excess moneys transferred
to school districts and community college districts in the base calculation for
the next year, limited the amount of State tax revenue over the limit which
would be transferred to school districts and community college districts, and
exempted increased gasoline taxes and truck weight fees from the State
appropriations limit. Additionally, Proposition 111 exempted from the State
appropriations limit funding for capital outlays.
Proposition 62. On November 4, 1986, California voters approved an
initiative statute known as Proposition 62. This initiative provided the
following: (i) requires that any tax for general governmental purposes imposed
by local governments be approved by resolution or ordinance adopted by a
two-thirds vote of the governmental entity's legislative body and by a majority
vote of the electorate of the governmental entity; (ii) requires that any
special tax (defined as taxes levied for other than general governmental
purposes) imposed by a local governmental entity be approved by a two-thirds
vote of the voters within that jurisdiction; (iii) restricts the use of revenues
from a special tax to the purposes or for the service for which the special tax
was imposed; (iv) prohibits the imposition of ad valorem taxes on real property
by local governmental entities except as permitted by Article XIIIA; (v)
prohibits the imposition of transaction taxes and sales taxes on the sale of
real property by local governments; (vi) requires that any tax imposed by a
local government on or after August 1, 1985 be ratified by a majority
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vote of the electorate within two years of the adoption of the initiative; (vii)
requires that, in the event a local government fails to comply with the
provisions of this measure, a reduction in the amount of property tax revenue
allocated to such local government occurs in an amount equal to the revenues
received by such entity attributable to the tax levied in violation of the
initiative; and (viii) permits these provisions to be amended exclusively by the
voters of the State of California.
In September 1988, the California Court of Appeal in City of Westminster
v. County of Orange, 204 Cal. App. 3d 623, 215 Cal. Rptr. 511 (Cal. Ct. App.
1988), held that Proposition 62 is unconstitutional to the extent that it
requires a general tax by a general law city, enacted on or after August 1, 1985
and prior to the effective date of Proposition 62, to be subject to approval by
a majority of voters. The Court held that the California Constitution prohibits
the imposition of a requirement that local tax measures be submitted to the
electorate by either referendum or initiative. It is not possible to predict the
impact of this decision on charter cities, on special taxes or on new taxes
imposed after the effective date of Proposition 62.
The California Court of Appeal in City of Woodlake v. Logan, (1991) 230
Cal. App. 3d 1058, subsequently held that Proposition 62's popular vote
requirements for future local taxes also provided for an unconstitutional
referenda. The California Supreme Court declined to review both the City of
Westminster and the City of Woodlake decisions.
In Santa Clara Local Transportation Authority v. Guardino, (Sept. 28,
1995) 11 Cal. 4th 220, reh'gdenied, modified (Dec. 14, 1995) 12 Cal. 4th 344e,
the California Supreme Court upheld the constitutionality of Proposition 62's
popular vote requirements for future taxes, and specifically disapproved of the
City of Woodlake decision as erroneous. The Court did not determine the
correctness of the City of Westminster decision, because that case appeared
distinguishable, was not relied on by the parties in Guardino, and involved
taxes not likely to still be at issue. It is impossible to predict the impact of
the Supreme Court's decision on charter cities or on taxes imposed in reliance
on the City of Woodlake case.
In McBrearty v. City of Brawley, 59 Cal. App. 4th 1441, 69 Cal. Rptr. 2d
862 (Cal. Ct. App., 1997), the Court of Appeal held that the city of Brawley
must either hold an election or cease collection of utility taxes that were not
submitted to a vote. In 1991, the city of Brawley adopted an ordinance imposing
a utility tax on its residents and began collecting the tax without first
seeking voter approval. In 1996, the taxpayer petitioned for writ of mandate
contending that Proposition 62 required the city to submit its utility tax on
residents to vote of local electorate. The trial court issued a writ of mandamus
and the city appealed.
First, the Court of Appeal held that the taxpayer's cause of action
accrued for statute of limitation purposes at the time of the Guardino decision
rather than at the time when the city adopted the tax ordinance which was July,
1991. Second, the Court held that the voter approval requirement in Proposition
62 was not an invalid mechanism under the state constitution for the involvement
of the electorate in the legislative process. Third, the Court rejected the
city's argument that Guardino should only be applied on a prospective basis.
Finally, the Court held Proposition 218 (see discussion below) did not impliedly
protect any local general taxes imposed prior January 1, 1995, against
challenge.
Assembly Bill 1362 (Mazzoni), introduced February 28, 1997, which would
have made the Guardino decision inapplicable to any tax first imposed or
increased by an ordinance or resolution adopted before December 14, 1995, was
vetoed by the Governor on October 11, 1997. The California State Senate had
passed the Bill on May 16, 1996, and the California State Assembly had passed
the bill on September 11, 1997. It is not clear whether the Bill, if enacted,
would have been constitutional as a non-voted amendment to Proposition 62 or as
a non-voted change to Proposition 62's operative date.
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Proposition 218. On November 5, 1996, the voters of the State approved
Proposition 218, a constitutional initiative, entitled the "Right to Vote on
Taxes Act" ("Proposition 218"). Proposition 218 adds Articles XIII C and XIII D
to the California Constitution and contains a number of interrelated provisions
affecting the ability of local governments to levy and collect both existing and
future taxes, assessments, fees and charges. Proposition 218 became effective on
November 6, 1996. The Sponsors are unable to predict whether and to what extent
Proposition 218 may be held to be constitutional or how its terms will be
interpreted and applied by the courts. However, if upheld, Proposition 218 could
substantially restrict certain local governments' ability to raise future
revenues and could subject certain existing sources of revenue to reduction or
repeal, and increase local government costs to hold elections, calculate fees
and assessments, notify the public and defend local government fees and
assessments in court. For example, discussed below, a California appellate court
in the case of Consolidated Fire Protection Dist. et al. v. Howard Jarvis
Taxpayers' Assoc., 63 Cal. App. 4th 211 (1998) upheld one of the provisions of
Proposition 218 that allows a majority of affected property owners to defeat
local government attempts to increase certain property-based fee or charges.
Article XIII C of Proposition 218 requires majority voter approval for the
imposition, extension or increase of general taxes and two-thirds voter approval
for the imposition, extension or increase of special taxes, including special
taxes deposited into a local government's general fund. Proposition 218 also
provides that any general tax imposed, extended or increased without voter
approval by any local government on or after January 1, 1995 and prior to
November 6, 1996 shall continue to be imposed only if approved by a majority
vote in an election held within two years of November 6, 1996.
Article XIII C of Proposition 218 also expressly extends the initiative
power to give voters the power to reduce or repeal local taxes, assessments,
fees and charges, regardless of the date such taxes, assessments, fees or
charges were imposed. This extension of the initiative power to some extent
constitutionalizes the March 6, 1995 State Supreme Court decision in Rossi v.
Brown, which upheld an initiative that repealed a local tax and held that the
State constitution does not preclude the repeal, including the prospective
repeal, of a tax ordinance by an initiative, as contrasted with the State
constitutional prohibition on referendum powers regarding statutes and
ordinances which impose a tax. Generally, the initiative process enables
California voters to enact legislation upon obtaining requisite voter approval
at a general election. Proposition 218 extends the authority stated in Rossi v.
Brown by expanding the initiative power to include reducing or repealing
assessments, fees and charges, which had previously been considered
administrative rather than legislative matters and therefore beyond the
initiative power.
The initiative power granted under Article XIII C of Proposition 218, by
its terms, applies to all local taxes, assessments, fees and charges and is not
limited to local taxes, assessments, fees and charges that are property related.
Article XIII D of Proposition 218 adds several new requirements making it
generally more difficult for local agencies to levy and maintain "assessments"
for municipal services and programs. "Assessment" is defined to mean any levy or
charge upon real property for a special benefit conferred upon the real
property.
Article XIII D of Proposition 218 also adds several provisions affecting
"fees" and "charges" which are defined as "any levy other than an ad valorem
tax, a special tax, or an assessment, imposed by a local government upon a
parcel or upon a person as an incident of property ownership, including a user
fee or charge for a property related service." All new and, after June 30, 1997,
existing property related fees and charges must conform to requirements
prohibiting, among other things, fees and charges which (i) generate revenues
exceeding the funds required to provide the property related service; (ii) are
used for any purpose other than those for which the fees and charges are
imposed; (iii) are for a service not actually used by, or immediately available
to, the owner of the property in question; or (iv) are used for general
governmental
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services, including police, fire or library services, where the service is
available to the public at large in substantially the same manner as it is to
property owners. Further, before any property related fee or charge may be
imposed or increased, written notice must be given to the record owner of each
parcel of land affected by such fee or charges. The local government must then
hold a hearing upon the proposed imposition or increase of such property based
fee, and if written protests against the proposal are presented by a majority of
the owners of the identified parcels, the local government may not impose or
increase the fee or charge. This aspect of Proposition 218, section 4 of Article
XIIID, was found not to constitute an unlawful referendum pursuant to Article
II, section 9 of the California constitution. Following Guardino, supra, in this
regard, the court held that these "balloting procedures" were constitutional.
Consolidated Fire Protection Dist., supra, at 225-26. Moreover, except for fees
or charges for sewer, water and refuse collection services, no property related
fee or charge may be imposed or increased without majority approval by the
property owners subject to the fee or charge or, at the option of the local
agency, two-thirds voter approval by the electorate residing in the affected
area.
Proposition 87. On November 8, 1988, California voters approved
Proposition 87. Proposition 87 amended Article XVI, Section 16, of the
California Constitution by authorizing the California Legislature to prohibit
redevelopment agencies from receiving any of the property tax revenue raised by
increased property tax rates levied to repay bonded indebtedness of local
governments which is approved by voters on or after January 1, 1989.
COLORADO
The following information is a brief summary of some of the factors
affecting the economy in the State and does not purport to be a complete
description of such factors. This summary is based on publicly available
information and forecasts which have not been independently verified by the
Sponsors or their legal counsel.
RISK FACTORS--Generally. The portfolio of the Colorado Trust consists
primarily of obligations issued by or on behalf of the State of Colorado and its
political subdivisions. The State's political subdivisions include approximately
1,600 units of local government in Colorado, including counties, statutory
cities and towns, home-rule cities and counties, school districts and a variety
of water, irrigation, and other special districts and special improvement
districts, all with various degrees of constitutional and statutory authority to
levy taxes and incur indebtedness.
Following is a brief summary of some of the factors which may affect the
financial condition of the State of Colorado and its political subdivisions. It
is not a complete or comprehensive description of these factors or analysis of
financial conditions and may not be indicative of the financial condition of
issuers of obligations contained in the portfolio of the Colorado Trust or any
particular projects financed by those obligations. Many factors not included in
the summary, such as the national economy, social and environmental policies and
conditions, and the national and international markets for petroleum, minerals
and metals, could have an adverse impact on the financial condition of the State
and its political subdivisions, including the issuers of obligations contained
in the portfolio of the Colorado Trust. It is not possible to predict whether
and to what extent those factors may affect the financial condition of the State
and its political subdivisions, including the issuers of obligations contained
in the portfolio of the Colorado Trust. Prospective investors should study with
care the issues contained in the portfolio of the Colorado Trust, review
carefully the information set out in the Prospectus under the caption "Colorado
Risk Factors" and consult with their investment advisors as to the merits of
particular issues in the portfolio.
The following summary is based on publicly available information which has
not been independently verified by the Sponsor or its legal counsel.
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The State Economy. The State's economic growth continues to exceed that of
the nation. Since 1995, Colorado's growth rates have been higher than the
nation's in all of the following categories: income, population, employment and
inflation. Although both new home construction and home resales showed gains in
1999, the number of single-family home permits declined in the first quarter of
2000 and multi-family home permits increased.
Net migration into the State peaked in 1993 at 77,400 (an increase of
approximately 16.6% over 1992's net migration), with the overall State
population increasing 2.94% in 1993. Net migration into the State is estimated
to have been 54,400 in 1999 (a decrease of approximately 11.8% from 1998's net
migration of 61,700, but with the overall State population still increasing
approximately 2.2% in 1999). Population growth in 1999 was 2.2%. As of July,
1999, Colorado's population topped 4,056 million. The State's job growth rate
was 3.7% in 1999, the same as the rate at the national level, and 3.9% for 1998,
compared to 2.6% at the national level. Non-farm employment increased 3.5% in
1998. The State's unemployment rate of 2.9% in 1999 was less than the 3.8%
reported for 1998, and lower than the national average of 4.2% in 1998.
State Revenues. The State operates on a fiscal year beginning July 1 and
ending June 30. Fiscal year 1999 refers to the year ended June 30, 1999, and
fiscal year 2000 refers to the year ended June 30, 2000.
The State derives substantially all of its General Fund revenues from
taxes. The two most important sources of these revenues are sales and use taxes
and individual income taxes, which accounted for approximately 29.4% and 57.4%,
respectively, of total net General Fund revenues during fiscal year 1999. Based
upon Office of State Planning and Budgeting figures it is estimated that, during
fiscal year 2000, sales and use taxes will account for approximately 29.9% of
total General Fund revenues and individual income taxes will account for
approximately 58.7% of total net General Fund revenues.
The Colorado Constitution contains strict limitations on the ability of
the State to create debt except under certain very limited circumstances.
However, the constitutional provisions have been interpreted not to limit the
ability of the State or its political subdivisions to issue certain obligations
which do not constitute debt in the constitutional sense, including short-term
obligations which do not extend beyond the fiscal year in which they are
incurred and lease purchase obligations which are made subject to annual
appropriation.
The State is authorized pursuant to State statute to issue short-term
notes to alleviate temporary cash flow shortfalls. The most recent issue of such
notes, expected to be issued on July 5, 2000 and mature June 27, 2001, was given
the highest rating available for short-term obligations by Standard & Poor's
Ratings Group a division of The McGraw-Hill Companies, Inc. and Fitch Investors
Service, Inc. Because of the short-term nature of such notes, their ratings
should not necessarily be considered indicative of the State's general financial
condition.
Tax and Spending Limitation Amendment. On November 3, 1992, Colorado
voters approved a State constitutional amendment ("TABOR") that restricts the
ability of the State and local governments to increase taxes, revenues, debt and
spending. TABOR provides that its provisions supersede conflicting State
constitutional, State statutory, charter or other State or local provisions.
The provisions of TABOR apply to "districts," which are defined in TABOR
as the State or any local government, with certain exclusions. Under the terms
of TABOR, districts must have prior voter approval to impose any new tax, tax
rate increase, mill levy increase, valuation for assessment ratio increase or
extension of an expiring tax. Prior voter approval is also required, except in
certain limited circumstances, for the creation of "any multiple-fiscal year
direct or indirect district debt or other financial obligation." TABOR
prescribes the timing and procedures for any elections required by it.
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Colorado appellate court cases decided since the adoption of TABOR have
resolved a number of questions concerning the required methods for authorizing
new indebtedness, the treatment of tax levies for existing indebtedness and
other purposes, the procedures for conducting elections under TABOR, the ability
of local governments to obtain voter approval for the exclusion of certain
revenues from the limitations on revenues and spending, the ability of local
governments to enter into annually-appropriated lease purchase obligations
without voter approval, and other interpretive matters.
Because TABOR's voter approval requirements apply to any "multiple-fiscal
year" debt or financial obligation, short-term obligations which do not extend
beyond the fiscal year in which they are incurred are treated as exempt from the
voter approval requirements of TABOR. Case law both prior to and after the
adoption of TABOR held that obligations maturing in the current fiscal year, as
well as lease purchase obligations subject to annual appropriation, do not
constitute debt under the Colorado Constitution.
TABOR's voter approval requirements and other limitations (discussed in
the following paragraph) do not apply to "enterprises," which term is defined to
include government-owned businesses authorized to issue their own revenue bonds
and receiving under 10% of annual revenue in grants from all Colorado state and
local governments combined. Enterprise status under TABOR has been and is likely
to continue to be subject to legislative and judicial interpretation.
Among other provisions, TABOR requires the establishment of emergency
reserves, limits increases in district revenues and limits increases in district
fiscal year spending. As a general matter, annual State fiscal year spending may
change no more than inflation plus the percentage change in State population in
the prior calendar year. Annual local district fiscal year spending may change
no more than inflation in the prior calendar year plus annual local growth, as
defined in and subject to the adjustments provided in TABOR. TABOR provides that
annual district property tax revenues may change no more than inflation in the
prior calendar year plus annual local growth, as defined in and subject to the
adjustments provided in TABOR. District revenues in excess of the limits
prescribed by TABOR are required, absent voter approval, to be refunded by any
reasonable method, including temporary tax credits or rate reductions. In
addition, TABOR prohibits new or increased real property transfer taxes, new
State real property taxes and new local district income taxes. TABOR also
provides that a local district may reduce or end its subsidies to any program
(other than public education through grade 12 or as required by federal law)
delegated to it by the State General Assembly for administration.
The foregoing is not intended as a complete description of all of the
provisions of TABOR. Many provisions of TABOR are ambiguous and will require
judicial interpretation. Several statutes enacted or proposed in the State
General Assembly have attempted to clarify the application of TABOR with respect
to certain governmental entities and activities. However, many provisions of
TABOR are likely to continue to be the subject of further legislation or
judicial proceedings. The application of TABOR, particularly in periods of slow
or negative growth, may adversely affect the financial condition and operations
of the State and local governments in the State to an extent which cannot be
predicted.
An initiated constitutional amendment will appear on the November 2000
statewide general election ballot which, if adopted, would add new provisions to
TABOR requiring substantial reductions in property taxes and certain other
taxes. While the impacts of the proposed amendment are difficult to estimate, it
appears that all local governments, particularly property-tax dependent
entities, would suffer adverse financial impacts if the proposed amendment is
adopted.
CONNECTICUT
The following information is a brief summary of some of the factors
affecting the economy in the State and does not purport to be a complete
description of such factors. This
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summary is based on publicly available information and forecasts which have not
been independently verified by the Sponsors or their legal counsel.
RISK FACTORS--The State Economy. Manufacturing has historically been of
prime economic importance to Connecticut (sometimes referred to as the State).
The State's manufacturing industry is diversified, with the construction of
transportation equipment (primarily aircraft engines, helicopters and
submarines) being the dominant industry, followed by fabricated metals,
non-electrical machinery, and electrical equipment. As a result of a rise in
employment in service-related industries and a decline in manufacturing
employment, however, manufacturing accounted for only 16.92% of total
non-agricultural employment in Connecticut in 1998. Defense-related business
represents a relatively high proportion of the manufacturing sector. On a per
capita basis, defense awards to Connecticut have traditionally been among the
highest in the nation, and reductions in defense spending have considerably
reduced this sector's significance in Connecticut's economy.
The average annual unemployment rate in Connecticut increased from a low
of 3.6% in 1989 to a high of 7.6% in 1992 and, after a number of important
changes in the method of calculation, was reported to be 3.0% in 1999.
Per-capita personal income of Connecticut residents increased in every year from
1990 to 1999, rising from $25,935 to $38,747. However, pockets of significant
unemployment and poverty exist in several Connecticut cities and towns.
State Revenues and Expenditures. At the end of the 1990-91 fiscal year,
the General Fund had an accumulated unappropriated deficit of $965,712,000. For
the eight fiscal years ended June 30, 1999, the General Fund recorded operating
surpluses, based on the State's budgetary method of accounting, of approximately
$110,200,000, $113,500,000, $19,700,000, $80,500,000, $250,000,000,
$262,600,000, $312,900,000, and $71,800,000, respectively. General Fund budgets
adopted for the biennium ending June 30, 2001, authorized expenditures of
$10,581,600,000 for the 1999-2000 fiscal year and $11,085,200,000 for the
2000-2001 fiscal year and projected surpluses of $64,400,000 and $4,800,000,
respectively, for those years.
As of April 30, 2000, the Comptroller estimated an operating surplus of
$402,200,000 for the 1999-2000 fiscal year. Thereafter, following a declaration
by the Governor needed to permit the appropriation of funds beyond the limits of
the State's expenditure cap, midterm budget adjustments were enacted. For the
1999-2000 fiscal year, expenditures not previously budgeted totaling
$196,400,000 were authorized and, after a required deposit into the Budget
Reserve Fund from unappropriated surplus of 5% of General Fund expenditures,
provision was made for the disposition of substantially the entire remaining
surplus, most of which would be used to avoid having to issue debt for school
construction. For the 2000-2001 fiscal year, the midterm budget adjustments
anticipate General Fund expenditures of $11,280,800,000, revenue of
$11,291,300,000, and a resulting surplus of only $500,000. A special legislative
session will be needed to implement various provisions of the mideterm budget
adjustments, which could result in changes to them.
State Debt. During 1991 the State issued a total of $965,710,000 Economic
Recovery Notes, of which $78,055,000 were outstanding as of December 1, 1998.
The notes were to be payable no later than June 30, 1996, but as part of the
budget adopted for the biennium ended June 30, 1997, payment of the notes
scheduled to be paid during the 1995-96 fiscal year was rescheduled to be made
over the four fiscal years ending June 30, 1999.
The primary method for financing capital projects by the State is through
the sale of the general obligation bonds of the State. These bonds are backed by
the full faith and credit of the State. As of January 1, 2000, the state had
authorized direct general obligation bond indebtedness totaling $13,310,385,000,
of which $11,338,459,000 had been approved for issuance by the State Bond
Commission and $9,872,122,000 had been issued. As of January 1, 2000, net state
direct general obligation bond indebtedness outstanding was $6,795,705,000.
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In 1995, the State established the University of Connecticut as a separate
corporate entity to issue bonds and construct certain infrastructure
improvements. The University was authorized to issue bonds totaling $962,000,000
by June 30, 2005, that are secured by a State debt service commitment to finance
the improvements, $359,475,000 of which were outstanding on October 15, 1999.
Additional costs for the improvements anticipated to be $288,000,000 are
expected to be funded from other sources.
In addition, the State has limited or contingent liability on a
significant amount of other bonds. Such bonds have been issued by the following
quasi-public agencies: the Connecticut Housing Finance Authority, the
Connecticut Development Authority, the Connecticut Higher Education Supplemental
Loan Authority, the Connecticut Resources Recovery Authority and the Connecticut
Health and Educational Facilities Authority. Such bonds have also been issued by
the cities of Bridgeport and West Haven and the Southeastern Connecticut Water
Authority. As of January 1, 2000, the amount of bonds outstanding on which the
State has limited or contingent liability totaled $4,315,600,000.
In 1984, the State established a program to plan, construct and improve
the State transportation system (other than Bradley International Airport). The
total cost of the program through June 30, 2004, is currently estimated to be
$14.0 billion, to be met from federal, state, and local funds. The State expects
to finance most of its $5.5 billion share of such cost by issuing $5.0 billion
of special tax obligation ("STO") bonds. The STO bonds are payable solely from
specified motor fuel taxes, motor vehicle receipts, and license, permit and fee
revenues pledged therefor and credited to the Special Transportation Fund, which
was established to budget and account for such revenues.
The State's general obligation bonds are rated Aa3 by Moody's and AA by
Fitch. On October 8, 1998, Standard & Poor's upgraded its rating of the State's
general obligation bonds from AA- to AA.
Litigation. The State, its officers and its employees are defendants in
numerous lawsuits. Although it is not possible to determine the outcome of these
lawsuits, the Attorney General has opined that an adverse decision in any of the
following cases might have a significant impact on the State's financial
position: (i) an action on behalf of all persons with traumatic brain injury who
have been placed in certain State hospitals, and other persons with acquired
brain injury who are in the custody of the Department of Mental Health and
Addiction Services, claiming that their constitutional rights are violated by
placement in State hospitals alleged not to provide adequate treatment and
training, and seeking placement in community residential settings with
appropriate support services; (ii) litigation involving claims by Indian tribes
to portions of the State's land area; and (iii) an action by certain students
and municipalities claiming that the State's formula for financing public
education violates the State's Constitution and seeking a declaratory judgment
and injunctive relief; (iv) an action for money damages for the death of a young
physician killed in an automobile accident allegedly as a result of negligence
of the State; (v) actions by several hospitals claiming partial refunds of taxes
imposed on hospital gross earnings to the extent such taxes related to tangible
personal property transferred in the provision of services to patients; and (vi)
an action against the State and the Attorney General by importers and
distributors of cigarettes previously sold by their manufacturers seeking
damages and injunctive relief relating to business losses alleged to result from
the 1998 Master Settlement Agreement entered into by most states in litigation
against the major domestic tobacco companies and challenging certain related
so-called Non Participating Manufacturer statutes.
As a result of litigation on behalf of black and Hispanic school children
in the City of Hartford seeking "integrated education" within the Greater
Hartford metropolitan area, on July 9, 1996, the State Supreme Court directed
the legislature to develop appropriate measures to remedy the racial and ethnic
segregation in the Hartford public schools. The Superior Court recently ordered
the State to show cause as to whether there has been compliance with the Supreme
Court's
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ruling and concluded that the State had complied but that the plaintiffs had not
allowed the State sufficient time to take additional remedial steps.
Accordingly, the plaintiffs might be able to pursue their claim at a later date.
The fiscal impact of this decision might be significant but is not determinable
at this time.
The State's Department of Information Technology coordinated a review of
the State's Year 2000 exposure and completed its plans on a timely basis. As of
December 31, 1999, 99.5% of the testing cycles required to validate compliance
in mission critical systems had been completed. Nevertheless, there is still a
risk that testing for all failure scenarios did not reveal all software or
hardware problems or that systems of others on whom the State's systems or
service commitments rely were not tested and remediated in a timely fashion. If
the necessary remediations were not adequately tested, the Year 2000 problem may
have a material impact on the operations of the State.
Municipal Debt Obligations. General obligation bonds issued by
municipalities are payable primarily from ad valorem taxes on property located
in the municipality. A municipality's property tax base is subject to many
factors outside the control of the municipality, including the decline in
Connecticut's manufacturing industry. Certain Connecticut municipalities have
experienced severe fiscal difficulties and have reported operating and
accumulated deficits. The most notable of these is the City of Bridgeport, which
filed a bankruptcy petition on June 7, 1991. The State opposed the petition. The
United States Bankruptcy Court for the District of Connecticut held that
Bridgeport had authority to file such a petition but that its petition should be
dismissed on the grounds that Bridgeport was not insolvent when the petition was
filed. State legislation enacted in 1993 prohibits municipal bankruptcy filings
without the prior written consent of the Governor.
In addition to general obligation bonds backed by the full faith and
credit of the municipality, certain municipal authorities finance projects by
issuing bonds that are not considered to be debts of the municipality. Such
bonds may only be repaid from revenues of the financed project, the revenues
from which may be insufficient to service the related debt obligations.
Regional economic difficulties, reductions in revenues, and increased
expenses could lead to further fiscal problems for the State and its political
subdivisions, authorities, and agencies. Difficulties in payment of debt service
could result in declines, possibly severe, in the value of their outstanding
obligations, increases in their future borrowing costs, and impairment of their
ability to pay debt service on their obligations.
FLORIDA
The following information is a brief summary of some of the factors
affecting the economy in the State and does not purport to be a complete
description of such factors. This summary is based on publicly available
information and forecasts which have not been independently verified by the
Sponsors or their legal counsel.
The Portfolio of the Florida Trust contains different issues of long-term
debt obligations issued by or on behalf of the State of Florida (the "State")
and counties, municipalities and other political subdivisions and public
authorities thereof or by the Government of Puerto Rico or the Government of
Guam or by their respective authorities, all rated in the category A or better
by at least one national rating organization (see Investment Summary in Part I).
Investment in the Florida Trust should be made with an understanding that the
value of the underlying Portfolio may decline with increases in interest rates.
RISK FACTORS--The State Economy. In 1980 Florida ranked seventh among the
fifty states with a population of 9.7 million people. The State has grown
dramatically since then and,
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as of April 1, 1998, ranked fourth with an estimated population of 15 million.
Since the beginning of the eighties, Florida has surpassed Ohio, Illinois and
Pennsylvania in total population. Because of the national recession, Florida's
net in-migration declined to 140,000 in 1992, but migration has since recovered
and reached 232,000 in 1998. In recent years the prime working age population
(18-64) has grown at an average annual rate of more than 2.0%. The share of
Florida's total working age population (18-64) to total State population is
about 60%. Non-farm employment has grown by over 24.6% since 1992. Total
non-farm employment in Florida is expected to increase by 4.0% in State Fiscal
Year 1999-2000 and by 3.5% in State Fiscal Year 2000-01. By the end of State
Fiscal Year 2000-01, non-farm employment in the State is expected to reach more
than 7.0 million jobs. The State is gradually becoming less dependent on
employment related to construction, agriculture and manufacturing, and more
dependent on employment related to trade and services. Presently services
constitute 36% and trade 25.5% of the State's total non-farm jobs. Manufacturing
jobs in Florida are concentrated in the area of high-tech and high value-added
sectors, such as electrical and electronic equipment, as well as printing and
publishing. While both the State and national proportion of manufacturing jobs
has declined over time, Florida's proportion of manufacturing jobs has been
about half the nation's for many years. Foreign Trade has contributed
significantly to Florida's employment growth. Trade jobs are expected to grow by
2.5% in State Fiscal Year 1999-2000 and by 2.9% in State Fiscal Year 2000-01.
Florida's dependence on highly cyclical construction and construction-related
manufacturing has declined. Total contract construction employment as a share of
total non-farm employment reached a peak of 10% in 1973. Before the recession of
the early 1980's the share was 7.7%. In the late 1980's construction's share was
7.5% and in 1998 it was 5.3%. The job creation rate for the State of Florida is
almost twice the rate for the nation as a whole. Throughout most of the 1980's
the unemployment rate for the State tracked below that of the nation. In the
nineties, the trend was reversed until 1995, when the state's unemployment rate
again tracked below or about the same as that of the U.S. In 1998 Florida's
unemployment rate was 4.3% while the nation's was 4.5%. Florida's unemployment
rate is forecasted at 4.2% in State Fiscal Year 1999-2000 and 4.4% in State
Fiscal Year 2000-01. Because Florida has a proportionately greater retirement
age population, property income (dividends, interest and rent) and transfer
payments (Social Security and pension benefits) are a relatively more important
source of income. From 1992 to 1997, Florida's total nominal personal income
grew by 35.2% and per capita income expanded by approximately 24.8%. For the
nation, total and per capita personal income increased by 32.3% and 25.9%,
respectively. Real personal income in Florida is forecasted to increase by 4.5%
in State Fiscal Year 1999-2000 and by 3.6% in State Fiscal Year 2000-01. During
this time real personal income per capita is expected to grow at 2.5% in
1999-2000 and 1.6% in 2000-2001.
The ability of the State and its local units of government to satisfy the
Debt Obligations may be affected by numerous factors which impact on the
economic vitality of the State in general and the particular region of the State
in which the issuer of the Debt Obligation is located. South Florida is
particularly susceptible to international trade and currency imbalances and to
economic dislocations in Central and South America, due to its geographical
location and its involvement with foreign trade, tourism and investment capital.
The central and northern portions of the State are impacted by problems in the
agricultural sector, particularly with regard to the citrus and sugar
industries. Short-term adverse economic conditions may be created in these
areas, and in the State as a whole, due to crop failures, severe weather
conditions or other agriculture-related problems. The State economy also has
historically been somewhat dependent on the tourism and construction industries
and is sensitive to trends in those sectors.
The State Budget. Florida prepares an annual budget which is formulated
each year and presented to the Governor and Legislature. Under the State
Constitution and applicable statutes, the State budget as a whole, and each
separate fund within the State budget, must be kept in balance from currently
available revenues during each State fiscal year (the State's fiscal year runs
from July 1 through June 30). The Governor and the Comptroller of the State are
charged with the responsibility of ensuring that sufficient revenues are
collected to meet appropriations and that no deficit occurs in any State fund.
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The financial operations of the State covering all receipts and
expenditures are maintained through the use of four types of funds: the General
Revenue Fund, Trust Funds, the Working Capital Fund and the Budget Stabilization
Fund. The majority of the State's tax revenues are deposited in the General
Revenue Fund and monies for all funds are expended pursuant to appropriations
acts. In State Fiscal Year 1999-2000, appropriations from the General Revenue
Fund for education, health and welfare and public safety amounted to
approximately 55%, 24% and 16%, respectively, of total General Revenue Funds
available. The Trust Funds consist of monies received by the State which under
law or trust agreement are segregated for a purpose authorized by law. Revenues
in the General Revenue Fund which are in excess of the amount needed to meet
appropriations may be transferred to the Working Capital Fund.
State Revenues. For State Fiscal Year 1999-2000 the estimated General
Revenue plus Working Capital and Budget Stabilization Funds available total
$20,604.9 million, a 5.2% increase over State Fiscal Year 1998-99. The $18,738.6
million in Estimated Revenues represent an increase of 4.8% over the analogous
figure in State Fiscal Year 1998-99. With combined General Revenue, Working
Capital and Budget Stabilization Funds appropriations at $18,870.0 million,
unencumbered reserves at the end of State Fiscal Year 1999-2000 are estimated at
$1,795.0 million. For State Fiscal Year 2000-01, the estimated General Revenue
plus Working Capital and Budget Stabilization Funds available total $21,359.0
million, a 3.7% increase over 1999-2000. The $19,320.7 million in Estimated
Revenues represent a 3.1% increase over the analogous figure in 1999-2000.In
State Fiscal Year 1998-99, the State derived approximately 67% of its total
direct revenues for deposit in the General Revenue Fund, Trust Funds, Working
Capital Fund and Budget Stabilization Fund from State taxes and fees. Federal
funds and other special revenues accounted for the remaining revenues. The
largest single source of tax receipts in the State is the 6% sales and use tax.
For the fiscal year ended June 30, 1999, receipts from the sales and use tax
totaled $13,918 million, an increase of 7.3% from the prior fiscal year. The
second largest source of State tax receipts is the tax on motor fuels including
the tax receipts distributed to local governments. Receipts from the taxes on
motor fuels are almost entirely dedicated to trust funds for specific purposes
or transferred to local governments and are not included in the General Revenue
Fund. Preliminary data for the fiscal year ended June 30, 1999, show collections
of this tax totaled $2,215.7 million.
The State currently does not impose a personal income tax. However, the
State does impose a corporate income tax on the net income of corporations,
organizations, associations and other artificial entities for the privilege of
conducting business, deriving income or existing within the State. For the
fiscal year ended June 30, 1999, receipts from the corporate income tax totaled
$472.2 million, an increase of 5.5% from fiscal year 1997-98. The Documentary
Stamp Tax collections totaled $1,185.1 million during fiscal year 1998-99,
posting a 13.4% increase from the previous fiscal year. The Alcoholic Beverage
Tax, an excise tax on beer, wine and liquor totaled $466.3 million in fiscal
year ending June 30, 1999. The Florida Lottery produced gross sales of $2.11
billion in fiscal year 1998-99 of which $802.9 million was used for education
purposes.
While the State does not levy ad valorem taxes on real property or
tangible personal property, counties, municipalities and school districts are
authorized by law, and special districts may be authorized by law, to levy ad
valorem taxes. Under the State Constitution, ad valorem taxes may not be levied
by counties, municipalities, school districts and water management districts in
excess of the following respective millages upon the assessed value of real
estate and tangible personal property: for all county, municipal or school
purposes, ten mills, and for water management districts, no more than 0.05 mill
or 1.0 mill, depending upon geographic location. These millage limitations do
not apply to taxes levied for payment of bonds and taxes levied for periods not
longer than two years when authorized by a vote of the electors, (Note: one mill
equals one-tenth of one cent.)
The State Constitution and statutes provide for the exemption of
homesteads from certain taxes. The homestead exemption is an exemption from all
taxation, except for assessments for
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special benefits, up to a specific amount of the assessed valuation of the
homestead. This exemption is available to every person who has the legal or
equitable title to real estate and maintains thereon his or her permanent home.
All permanent residents of the State are currently entitled to a $25,000
homestead exemption from levies by all taxing authorities, however, such
exemption is subject to change upon voter approval.
The property valuations for homestead property are subject to a growth cap
of the lesser of 3% or the change in the Consumer Price Index during the
relevant year, except in the event of a sale thereof during such year, and
except as to improvements thereto during such year. If the property changes
ownership or homestead status, it is to be re-valued at full just value on the
next tax roll.
Since municipalities, counties, school districts and other special purpose
units of local governments with power to issue general obligation bonds have
authority to increase the millage levy for voter approved general obligation
debt to the amount necessary to satisfy the related debt service requirements,
the property valuation growth cap is not expected to adversely affect the
ability of these entities to pay the principal of or interest on such general
obligation bonds. However, in periods of high inflation, those local government
units whose operating millage levies are approaching the constitutional cap and
whose tax base consists largely of residential real estate, may, as a result of
the above-described property valuation growth cap, need to place greater
reliance on non-ad valorem revenue sources to meet their operating budget needs.
The State Constitution limits the amount of taxes, fees, licenses and
charges imposed by the Legislature and collected during any fiscal year to the
amount of revenues allowed for the prior fiscal year, plus an adjustment for
growth. The revenue limit is determined by multiplying the average annual rate
of growth in Florida personal income over the previous five years times the
maximum amount of revenues permitted under the cap for the prior fiscal year.
The revenues allowed for any fiscal year can be increased by a two-thirds vote
of the Legislature. Any excess revenues generated will be deposited in the
Budget Stabilization Fund. Included among the categories of revenues which are
exempt from the proposed revenue limitation, however, are revenues pledged to
state bonds.
State General Obligation Bonds and State Revenue Bonds. The State
Constitution does not permit the State to issue debt obligations to fund
governmental operations. Generally, the State Constitution authorizes State
bonds pledging the full faith and credit of the State only to finance or
refinance the cost of State fixed capital outlay projects, upon approval by a
vote of the electors, and provided that the total outstanding principal amount
of such bonds does not exceed 50% of the total tax revenues of the State for the
two preceding fiscal years. Revenue bonds may be issued by the State or its
agencies without a vote of the electors only to finance or refinance the cost of
State fixed capital outlay projects which are payable solely from funds derived
directly from sources other than State tax revenues.
Exceptions to the general provisions regarding the full faith and credit
pledge of the State are contained in specific provisions of the State
Constitution which authorize the pledge of the full faith and credit of the
State, without electorate approval, but subject to specific coverage
requirements, for: certain road projects, county education projects, State
higher education projects, State system of Public Education and construction of
air and water pollution control and abatement facilities, solid waste disposal
facilities and certain other water facilities.
Local Bonds. The State Constitution provides that counties, school
districts, municipalities, special districts and local governmental bodies with
taxing powers may issue debt obligations payable from ad valorem taxation and
maturing more than 12 months after issuance, only (i) to finance or refinance
capital projects authorized by law, provided that electorate approval is
obtained; or (ii) to refund outstanding debt obligations and interest and
redemption premium thereon at a lower net average interest cost rate.
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Counties, municipalities and special districts are authorized to issue
revenue bonds to finance a variety of self-liquidating projects pursuant to the
laws of the State, such revenue bonds to be secured by and payable from the
rates, fees, tolls, rentals and other charges for the services and facilities
furnished by the financed projects. Under State law, counties and municipalities
are permitted to issue bonds payable from special tax sources for a variety of
purposes, and municipalities and special districts may issue special assessment
bonds.
Bond Ratings. General obligation bonds of the State are currently rated
Aa2 by Moody's, AA+ by Standard & Poor's, and AA by Fitch Investors Services,
Inc.
Litigation. Due to its size and its broad range of activities, the State
(and its officers and employees) are involved in numerous routine lawsuits. The
managers of the departments of the State involved in such routine lawsuits
believe that the results of such pending litigation would not materially affect
the State's financial position. In addition to the routine litigation pending
against the State, its officers and employees, the following lawsuits and claims
are also pending:
A. In a case involving the issue of whether Florida's refund statute for
dealer repossessions authorizes the Department of Revenue to grant a refund to a
financial institution as the assignee of numerous security agreements governing
the sale of automobiles and other property sold by dealers, the question turned
on whether the Legislature intended the statute only to provide a refund or
credit to the dealer who actually sold the tangible personal property and
collected and remitted the tax or intended that right to be assignable. Judgment
was granted in the Plaintiff's favor, however, the First District Court of
Appeal overturned the trial court's decision in favor of the Department.
B. In a taxpayer challenge of the imposition of interest on additional
amounts of corporate income tax due as a result of Federal audit adjustments
reported to Florida, the taxpayer contended that interest should be accrued from
the date the Federal audit adjustments were due to be reported to Florida. An
Order was issued adopting the position asserted by the Department of Revenue;
however, the taxpayer filed and won on appeal. Potential refunds or lost revenue
are estimated to be approximately $12 to $20 million per year.
C. This was a class action suit on behalf of clients of residential
placement for the developmentally disabled seeking refunds for services where
children are entitled to free education under the Education for Handicapped Act.
The District Court ruled in favor of the plaintiffs and ordered repayment of the
maintenance fees. The Department of Health and Rehabilitative Services repaid
the $217,694 in maintenance fees paid by the parents; however, amounts due to
various third parties estimated up to $42 million have not been paid since the
affected parties have not been identified.
D. A class action suit, among other similar suits, wherein the plaintiffs
challenge the constitutionality of the Public Medical Assistance Trust Fund
(PMATF) annual assessment on net operating revenue of free-standing out-patient
facilities offering sophisticated radiology services is now in the discovery
process. If the State is unsuccessful the potential refund liability for all
such suits could total approximately $116.8 million.
E. In a case against the Agency for Healthcare Administration seeking
retroactive and prospective relief on behalf of a class of Medicaid providers
(doctors) demanding reimbursement of differential between Medicare and Medicaid
rates for dual-enrolled eligibles, Plaintiffs' motion for summary judgment is
under advisement by the court. If the Plaintiffs prevail, the State's potential
liability could be up to $270 million.
F. Tower Environmental has sued the State of Florida and the Florida
Department of Environmental Protection (FDEP) alleging that both the State and
FDEP "breached" contracts with them by changing the petroleum contamination
reimbursement program. Alternatively,
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Tower claims that these actions constitute torts or impairment of contractual
obligations. Tower also alleges that the termination of the reimbursement
program pursuant to Section 376.3071, F.S., is a breach of contract. In addition
to damages, Tower seeks recovery of attorneys' fees and costs. There has been a
ruling that the statute was a written contract and that the State's sovereign
immunity defense was thereof invalid. If attorney's fees and costs are awarded,
the potential liability could amount to approximately $49 million, however, the
parties are currently negotiating a settlement.
G. Where the plaintiff claims that the Florida Department of
Transportation has been responsible for construction of roads and attendant
drainage facilities in Hillsborough County and, as a result of its construction,
has caused the Plaintiffs' property to become subject to flooding, thereby
amount to an uncompensated taking the Court granted the State's Motion for More
Definite Statement as to certain portions of the Plaintiffs complaint. An
amended complaint was filed, and trial is scheduled to begin this summer. If the
State is unsuccessful, potential losses could exceed $10 million.
H. The Florida Department of Transportation used a Value Engineering
Change Proposal (VECP) design submitted by State Contracting and Engineering
Corp. (SCEC) for the construction of a barrier sound-wall in Broward County and
several subsequent Department projects. Subsequent to the initial use of the
VECP design, SCEC patented the design. SCEC claims that the Department owes SCES
royalties and compensation for other damages involving the Department's use of
the VECP design on subsequent projects. The case is pending a ruling as to the
application of recent U.S. Supreme Court cases to certain legal issues in this
lawsuit. If the State is unsuccessful, potential losses could range from $30 to
$60 million.
I. Pursuant to Section 440.51, F.S., the Department of Labor and
Employment Security, collects assessments on "net premiums collected" and "net
premiums written" from carriers of workers' compensation insurance and by
self-insurers in the State. Claimants allege that there is no statutory
definition of "net premiums" and the Department does not currently have a rule
providing guidance as to how "net premiums" are calculated. Claimants allege
that industry standards would allow them to deduct various costs of doing
business in calculating "net premiums." The litigation arose from the
Department's denial of claims for refunds totaling approximately $27 million. In
addition, at least 20 other carriers have filed similar claims for refund which,
in the aggregate, total more than $39 million. The Department cannot anticipate
how many additional claims will be filed. The Department has answered the
complaint and discovery is in progress.
J. In an action brought by the US Environmental Protection Agency against
the Florida Department of Transportation title to contaminated land is in
dispute. The Department maintains that it is not the owner of the contaminated
land. The U.S. Environmental Protection Agency (EPA) is conducting additional
tests at the site for pollution and has asserted a cost recovery claim against
the Department of approximately $25.5 million. The Department's Motion for
Declaratory Judgment on the Department's ownership of the property was denied
and upheld on appeal.
Summary. Many factors including national, economic, social and
environmental policies and conditions, most of which are not within the control
of the State or its local units of government, could affect or could have an
adverse impact on the financial condition of the State. Additionally, the
limitations placed by the State Constitution on the State and its local units of
government with respect to income taxation, ad valorem taxation, bond
indebtedness and other matters, discussed above, as well as other applicable
statutory limitations, may constrain the revenue-generating capacity of the
State and its local units of government and, therefore, the ability of the
issuers of the Debt Obligations to satisfy their obligations thereunder.
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The Sponsors believe that the information summarized above describes some
of the more significant matters relating to the Florida Trust. For a discussion
of the particular risks with each of the Debt Obligations, and other factors to
be considered in connection therewith, reference should be made to the Official
Statement and other offering materials relating to each of the Debt Obligations
included in the portfolio of the Florida Trust. The foregoing information
regarding the State, its political subdivisions and its agencies and authorities
constitutes only a brief summary, does not purport to be a complete description
of the matters covered and is based solely upon information drawn from official
statements relating to offerings of certain bonds of the State. The Sponsors and
their counsel have not independently verified this information, and the Sponsors
have no reason to believe that such information is incorrect in any material
respect. None of the information presented in this summary is relevant to Puerto
Rico or Guam Debt Obligations which may be included in the Florida Trust.
For a general description of the risks associated with the various types
of Debt Obligations comprising the Florida Trust, see the discussion under "Risk
Factors", above.
LOUISIANA
The following information is a brief summary of some of the factors
affecting the economy in the State and does not purport to be a complete
description of such factors. This summary is based on publicly available
information and forecasts which have not been independently verified by the
Sponsors or their legal counsel.
RISK FACTORS. The following discussion regarding the financial condition
of the State government may not be relevant to general obligation or revenue
bonds issued by political subdivisions of and other issuers in the State of
Louisiana (the "State"). Such financial information is based upon information
about general financial conditions that may or may not affect issuers of the
Louisiana obligations. The Sponsors have not independently verified any of the
information contained in such publicly available documents, but are not aware of
any facts which would render such information inaccurate.
The ratings on the State's general obligation bonds are: Fitch IBCA, A;
Standard & Poor's, A-1 and Moody's, A2. There can be no assurance that the
economic conditions on which these ratings were based will continue or that
particular bond issues may not be adversely affected by changes in economic or
political conditions.
The Revenue Estimating Conference (the "Conference") was established by
Act No. 814 of the 1987 Regular Session of the State Legislature. The Conference
was established by the Legislature to provide an official estimate of
anticipated State revenues upon which the executive budget shall be based, to
provide for a more stable and accurate method of financial planning and
budgeting and to facilitate the adoption of a balanced budget as is required by
Article VII, Section 10(E) of the State Constitution. Act No. 814 provides that
the Governor shall cause to be prepared an executive budget presenting a
complete financial and programmatic plan for the ensuing fiscal year based only
upon the official estimate of anticipated State revenues as determined by the
Revenue Estimating Conference. Act No. 814 further provides that at no time
shall appropriations or expenditures for any fiscal year exceed the official
estimate of anticipated State revenues for that fiscal year. An amendment to the
Louisiana Constitution was approved by the Louisiana Legislature in 1990 and
enacted by the electorate which granted constitutional status to the existence
of the Revenue Estimating Conference.
State General Fund: The State General Fund is the principal operating fund
of the State and was established administratively to provide for the
distribution of funds appropriated by the Louisiana Legislature for the ordinary
expenses of the State government. Revenue is provided from the direct deposit of
federal grants and the transfer of State revenues from the Bond Security and
Redemption Fund after general obligation debt requirements are met. While the
robust
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national economy significantly increased revenues in most states in fiscal year
1998-1999, Louisiana's tax revenues fell by $11.4 million, largely due to a
$90.1 million decline in severance taxes. For the first time in seven (7) years,
Louisiana had a General Fund deficit, $27 million. By law, that deficit must be
discharged in fiscal year 1999-2000. It is anticipated that deficit will be
covered by spending less than budgeted and by greater than anticipated revenue
in fiscal year 1999-2000. In December 1999, Governor Foster issued an executive
order freezing spending throughout the executive branch of State Government to
achieve a General Fund savings of at least $50 million for the remainder of the
1999-2000 fiscal year.
Tobacco Settlement: Louisiana was one of 46 states who participated in a
settlement with the tobacco industry. Pursuant to that settlement, Louisiana is
projected to receive approximately $4.6 billion over the next 25 years.
Currently, the settlement is structured so that the state will receive
approximately $180 million annually in payments over the next 25 years. However,
because of the future stability of the tobacco industry is uncertain, Governor
Foster has appointed a task force to recommend ways to optimize the State's
return while minimizing risks.
The state legislature allocated the state's first annual payment for the
tobacco settlement to balance the 1999-2000 budget. The remaining funds have
been constitutionally dedicated. They are divided between the Louisiana Fund and
the Millennium Trust, which is specifically dedicated to supplying health and
education initiatives and the TOPS Scholarship program, which is designed to
attract Louisiana students to colleges and universities located in Louisiana.
Beginning in fiscal year 2002-2003 75% of the tobacco settlement payments will
be constitutionally required to go into the Millennium Trust.
Transportation Trust Fund: The Transportation Trust Fund was established
pursuant to (i) Section 27 of Article VII of the State Constitution and (ii) Act
No. 16 of the First Extraordinary Session of the Louisiana Legislature for the
year 1989 (collectively the "Act") for the purpose of funding construction and
maintenance of state and federal roads and bridges, the statewide flood-control
program, ports, airports, transit and state police traffic control projects and
to fund the Parish Transportation Fund. The Transportation Trust Fund is funded
by a levy of $0.20 per gallon on gasoline and motor fuels and on special fuels
(diesel, propane, butane and compressed natural gas) used, sold or consumed in
the state (the "Gasoline and Motor Fuels Taxes and Special Fuels Taxes"). This
levy was increased from $0.16 per gallon (the "Existing Taxes") to the current
$0.20 per gallon pursuant to Act No. 16 of the First Extraordinary Session of
the Louisiana Legislature for the year 1989, as amended. The additional tax of
$0.04 per gallon (the "Act 16 Taxes") became effective January 1, 1990, and will
expire on the earlier of January 1, 2005, or the date on which obligations
secured by the Act No. 16 taxes are no longer outstanding. The Transportation
Infrastructure Model for Economic Development Account (the "TIME Account") was
established in the Transportation Trust Fund. Moneys in the TIME account will be
expended for certain projects identified in the Act aggregating $1.4 billion and
to fund not exceeding $160 million of additional capital transportation
projects. The State issued $263,902,639.95 of Gasoline and Fuels Tax Revenue
Bonds, 1990 Series A, dated April 15, 1990, payable from the (i) Act No. 16
Taxes; (ii) any Act No. 16 Taxes and Existing Taxes deposited in the
Transportation Trust Fund; and (iii) any additional taxes on gasoline and motor
fuels and special fuels pledged for the payment of said Bonds. As of December
31, 1995, the outstanding principal amount of said Bonds was $193,323,000.00.
Ad Valorem Taxation: Only local governmental units presently levy ad
valorem taxes. Under the 1921 State Constitution a $5.75 mills ad valorem tax
was being levied by the State until January 1, 1973, at which time a
constitutional amendment to the 1921 Constitution abolished the ad valorem tax.
Under the 1974 State Constitution a State ad valorem tax of up to $5.75 mills
was provided for but is not presently being levied. The property tax is
underutilized at the parish level due to a constitutional homestead exemption
from the property tax applicable to the first $75,000 of the full market value
of single-family residences. Homestead exemptions do not apply to ad valorem
property taxes levied by municipalities, with the exception of the City of New
Orleans.
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Because local governments also are prohibited from levying an individual income
tax by the constitution, their reliance on State government is increased under
the existing tax structure.
Litigation: In 1988, the Louisiana legislature created a Self-Insurance
Fund within the Department of Treasury. That Fund consists of all premiums paid
by State agencies under the State's Risk Management program, the investment
earnings on those premiums and commissions retained. The Self-Insurance Fund may
only be used for payment of losses incurred by State agencies under the
Self-Insurance program, together with insurance premiums, legal expenses and
administration costs. For fiscal year 1995-1996, the sum of $119,946,754.00 was
paid from the Self-Insurance Fund to satisfy claims and judgments. It is the
opinion of the Attorney General for the State of Louisiana that only a portion
of the dollar amount of potential liability of the State resulting from
litigation which is pending against the State and is not being handled through
the Office of Risk Management ultimately will be recovered by plaintiffs. It is
the opinion of the Attorney General that the estimated future liability for
existing claims is in excess of $81 million. However, there are other claims
with future possible liabilities for which the Attorney General cannot make a
reasonable estimate.
Accrued Unfunded Pension Fund Liability: The state has a constitutional
obligation to guarantee the retirement benefits of the following state
retirement systems: Teachers, State Employees, School Employees and State
Police. As of the end of fiscal year 1999, unfunded accrued liability for those
systems was, collectively, approximately $6 billion.
The foregoing information constitutes only a brief summary of some of the
financial difficulties which may impact certain issuers of Bonds and does not
purport to be a complete or exhaustive description of all adverse conditions to
which the issuers of the Louisiana Trust are subject. Additionally, many factors
including national economic, social and environmental policies and conditions,
which are not within the control of the issuers of Bonds, could affect or could
have an adverse impact on the financial condition of the State and various
agencies and political subdivisions located in the State. The Sponsors are
unable to predict whether or to what extent such factors may affect the issuers
of Bonds, the market value or marketability of the Bonds or the ability of the
respective issuers of the Bonds acquired by the Louisiana Trust to pay interest
on or principal of the Bonds.
Prospective investors should study with care the Portfolio of Bonds in the
Louisiana Trust and should consult with their investment advisors as to the
merits of particular issues in that Trust's Portfolio.
MARYLAND
The following information is a brief summary of some of the factors
affecting the economy in the State and does not purport to be a complete
description of such factors. This summary is based on publicly available
information and forecasts which have not been independently verified by the
Sponsors or their legal counsel.
RISK FACTORS--State Debt. The Public indebtedness of the State of Maryland
and its instrumentalities is divided into three general types. The State issues
general obligation bonds for capital improvements and for various State projects
to the payment of which the State ad valorem property tax is exclusively
pledged. In addition, the Maryland Department of Transportation issues for
transportation purposes its limited, special obligation bonds payable primarily
from specific, fixed-rate excise taxes and other revenues related mainly to
highway use. Certain authorities issue obligations payable solely from specific
non-tax, enterprise fund revenues and for which the State has no liability and
has given no moral obligation assurance. The State and certain of its agencies
also have entered into a variety of lease purchase agreements to finance the
acquisition of capital assets. These lease agreements specify that payments
thereunder are subject to annual appropriation by the General Assembly.
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General Obligation Bonds. General obligation bonds of the State are
authorized and issued primarily to provide funds for State-owned capital
improvements, including institutions of higher learning, and the construction of
locally owned public schools. Bonds have also been issued for local government
improvements, including grants and loans for water quality improvement projects
and correctional facilities, and to provide funds for repayable loans or
outright grants to private, non-profit cultural or educational institutions.
The Maryland Constitution prohibits the contracting of State debt unless
it is authorized by a law levying an annual tax or taxes sufficient to pay the
debt service within 15 years and prohibiting the repeal of the tax or taxes or
their use for another purpose until the debt is paid. As a uniform practice,
each separate enabling act which authorizes the issuance of general obligation
bonds for a given object or purpose has specifically levied and directed the
collection of an ad valorem property tax on all taxable property in the State.
The Board of Public Works is directed by law to fix by May 1 of each year the
precise rate of such tax necessary to produce revenue sufficient for debt
service requirements of the next fiscal year, which begins July 1. However, the
taxes levied need not be collected if or to the extent that funds sufficient for
debt service requirements in the next fiscal year have been appropriated in the
annual State budget. Accordingly, the Board, in annually fixing the rate of
property tax after the end of the regular legislative session in April, takes
account of appropriations of general funds for debt service.
In the opinion of counsel, the courts of Maryland have jurisdiction to
entertain proceedings and power to grant mandatory injunctive relief to (i)
require the Governor to include in the annual budget a sufficient appropriation
to pay all general obligation bond debt service for the ensuing fiscal year;
(ii) prohibit the General Assembly from taking action to reduce any such
appropriation below the level required for that debt service; (iii) require the
Board of Public Works to fix and collect a tax on all property in the State
subject to assessment for State tax purposes at a rate and in an amount
sufficient to make such payments to the extent that adequate funds are not
provided in the annual budget; and (iv) provide such other relief as might be
necessary to enforce the collection of such taxes and payment of the proceeds of
the tax collection to the holders of general obligation bonds, pari passu,
subject to the inherent constitutional limitations referred to below.
It is also the opinion of counsel that, while the mandatory injunctive
remedies would be available and while the general obligation bonds of the State
are entitled to constitutional protection against the impairment of the
obligation of contracts, such constitutional protection and the enforcement of
such remedies would not be absolute. Enforcement of a claim for payment of the
principal of or interest on the bonds could be subject to the provisions of any
statutes that may be constitutionally enacted by the United States Congress or
the Maryland General Assembly extending the time for payment or imposing other
constraints upon enforcement.
There is no general debt limit imposed by the Maryland Constitution or
public general laws, but a special committee created by statute annually submits
to the Governor an estimate of the maximum amount of new general obligation debt
that prudently may be authorized. Although the committee's responsibilities are
advisory only, the Governor is required to give due consideration to the
committee's findings in preparing a preliminary allocation of new general debt
authorization for the next ensuing fiscal year.
Department of Transportation Bonds. Consolidated Transportation Bonds are
limited obligations issued by the Maryland Department of Transportation, the
principal of which must be paid within 15 years from the date of issue, for
highway, port, transit, rail or aviation facilities or any combination of such
facilities. Debt service on Consolidated Transportation Bonds is payable from
those portions of the excise tax on each gallon of motor vehicle fuel and the
motor vehicle titling tax, all mandatory motor vehicle registration fees, motor
carrier fees, and the corporate income tax as are credited to the Maryland
Department of Transportation, plus all departmental
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operating revenues and receipts. Holders of such bonds are not entitled to look
to other sources for payment.
The Maryland Department of Transportation also issues its bonds to provide
financing of local road construction and various other county transportation
projects and facilities. Debt service on these bonds is payable from the
subdivisions' share of highway user revenues held to their credit in a special
State fund.
The Maryland Transportation Authority operates certain highway, bridge and
tunnel toll facilities in the State. The tolls and other revenues received from
these facilities are pledged as security for revenue bonds of the Authority
issued under and secured by a trust agreement between the authority and a
corporate trustee. As of March 31, 1999, $340.8 million of the Transportation
Authority's revenue bonds were outstanding.
Maryland Stadium Authority Bonds. The Maryland Stadium Authority is
responsible for financing and directing the acquisition and construction of one
or more new professional sports facilities in Maryland. Currently, the Stadium
Authority operates Oriole Park at Camden Yards which opened in 1992. In
connection with the construction of that facility, the Authority issued $155
million in notes and bonds. These notes and bonds are lease-backed revenue
obligations, the payment of which is secured by, among other things, an
assignment of revenues received under a lease of the sports facilities from the
Stadium Authority to the State.
The Stadium Authority currently operates PSINET stadium, which opened in
1998. In connection with the construction of that facility, the Stadium
Authority sold $87.565 million in lease-backed revenue bonds on May 1, 1996. The
proceeds from the bonds, along with cash available from State lottery proceeds,
investment earnings, and other sources were used to pay project design and
construction expenses of approximately $229 million. The bonds are solely
secured by an assignment of revenues received under a lease of the project from
the Stadium Authority to the State.
The Stadium Authority was also assigned responsibility for constructing an
expansion of the Convention Centers in Baltimore and Ocean City and has been
assigned responsibility for construction of a conference center in Montgomery
County. The Baltimore Convention Center expansion cost $167 million and was
financed through a combination of funding from Baltimore City, Stadium Authority
revenue bonds, State general obligation bonds and other state appropriations.
The Ocean City Convention Center expansion cost $33.2 million and was financed
through a matching grant from the State and a combination of funding from Ocean
City and the Stadium Authority. The Montgomery County conference center is
expected to cost $27.5 million and is being financed through a combination of
funding from Montgomery County and the Stadium Authority.
Miscellaneous Revenue and Enterprise Financings. Certain other
instrumentalities of the State government are authorized to borrow money under
legislation which expressly provides that the loan obligations shall not be
deemed to constitute a debt or a pledge of the faith and credit of the State.
The Community Development Administration of the Department of Housing and
Community Development ("CDA"), higher educational institutions (including St.
Mary's College of Maryland, the University of Maryland System, and Morgan State
University), the Maryland Water Quality Financing Administration and the
Maryland Environmental Service ("MES") have issued and have outstanding bonds of
this type. The principal of and interest on bonds issued by these bodies are
payable solely from various sources, principally fees generated from use of the
facilities or enterprises financed by the bonds.
The Water Quality Revolving Loan Fund is administered by the Water Quality
Financing Administration in the Department of the Environment. The Fund may be
used to provide loans, subsidies and other forms of financial assistance to
local government units for wastewater
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treatment projects as contemplated by the 1987 amendments to the federal Water
Pollution Control Act. The Administration is authorized to issue bonds secured
by revenues of the Fund, including loan repayments, federal capitalization
grants, and matching State grants.
The University of Maryland System, Morgan State University, and St. Mary's
College of Maryland are authorized to issue revenue bonds for the purpose of
financing academic and auxiliary facilities. Auxiliary facilities are any
facilities that furnish a service to students, faculty, or staff, and that
generate income. Auxiliary facilities include housing, eating, recreational,
campus, infirmary, parking, athletic, student union or activity, research
laboratory, testing, and any related facilities.
CDA is responsible for housing finance and assistance programs. CDA issues
bonds and notes to provide funding for various home ownership and rental housing
loan programs. The debt service on CDA's revenue bonds and notes generally is
paid from mortgage repayments.
MES was established to provide water supply, waste water treatment, and
waste management services to state agencies, local governments, and private
entities. MES is authorized to issue revenue bonds secured by the revenue
derived from its various facilities and projects. MES plans to issue additional
revenue bonds in fiscal year 1999.
Lease and Conditional Purchase Financings. The State has financed and
expects to continue to finance the construction and acquisition of various
facilities through conditional purchase, sale-leaseback, and similar
transactions. All of the lease payments under these arrangements are subject to
annual appropriation by the Maryland General Assembly. In the event that
appropriations are not made, the State may not be held contractually liable for
the payments.
Ratings. The general obligation bonds of the State of Maryland have been
rated by Moody's Investors Service, Inc. as Aaa, by Standard & Poor's
Corporation as AAA, and by Fitch Investors Service, Inc. as AAA.
Other Risk Factors. The manufacturing sector of Maryland's economy, which
historically has been a significant element of the State's economic health, has
experienced severe financial pressures and an overall contraction in recent
years. This is due in part to the reduction in defense-related contracts and
grants, which has had an adverse impact that is substantial and is believed to
be disproportionately large compared with the impact on most other states. The
State has endeavored to promote economic growth in other areas, such as
financial services, health care and high technology. Whether the State can
successfully make the transition from an economy reliant on heavy industries to
one based on service-and science-oriented businesses is uncertain. Moreover,
future economic difficulties in the service sector and high technology
industries could have an adverse impact on the finances of the State and its
subdivisions, and could adversely affect the market value of the Bonds in the
Maryland Trust or the ability of the respective obligors to make payments of
interest and principal due on such Bonds.
The State and its subdivisions, and their respective officers and
employees, are defendants in numerous legal proceedings, including alleged torts
and breaches of contract and other alleged violations of laws. Adverse decisions
in these matters could require extraordinary appropriations not budgeted for,
which could adversely affect the ability to pay obligations on indebtedness.
MASSACHUSETTS
RISK FACTORS--GENERAL. The following description highlights some of the
more significant financial information regarding the Commonwealth of
Massachusetts. The following information is a brief summary of some of the
factors affecting the economy in the State and does not purport to be a complete
description of such factors. This summary is based on publicly
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available information and forecasts which have not been independently verified
by the Sponsors or their legal counsel.
STATE BUDGET AND REVENUES. The Commonwealth's operating fund structure
satisfies the requirements of state finance law and is in accordance with GAAP.
The General Fund and those special revenue funds which are appropriated in the
annual state budget receive most of the non-bond and non-federal grant revenues
of the Commonwealth. They do not include the Capital Projects Fund of the
Commonwealth, into which the proceeds of Commonwealth bonds are deposited. The
three principal budgeted operating funds are the General Fund, the Highway Fund
and the Local Aid Fund. Expenditures from these three funds generally account
for approximately 93% of total expenditures of the budgeted operating funds.
Generally, funds for the Commonwealth's programs and services must be
appropriated by the Legislature. The process of preparing a budget at the
administrative level begins early in the fiscal year preceding the fiscal year
for which the budget will take effect. The Commonwealth's fiscal year ends June
30. The legislative budgetary process begins in late January (or, in the case of
a newly elected Governor, not later than March) with the Governor's submission
to the Legislature of a budget recommendation for the fiscal year commencing in
the ensuing July. The Massachusetts Constitution requires that the Governor
recommend to the Legislature a budget which contains a statement of all proposed
expenditures of the Commonwealth for the fiscal year, including those already
authorized by law, and of all taxes, revenues, loans and other means by which
such expenditures are to be defrayed. By statute, the Legislature and the
Governor must approve a balanced budget for each fiscal year, and no
supplementary appropriation bill may be approved by the Governor if it will
result in an unbalanced budget. However, this is a statutory requirement that
may be superseded by an appropriation act.
It should be noted that by statute, the Commonwealth maintains a tax
revenue growth limit for each fiscal year equal to the average positive rate of
growth in total wages and salaries in the Commonwealth, as reported by the
federal government, during the three calendar years immediately preceding the
end of such fiscal year. The limit could affect the Commonwealth's ability to
pay principal and interest on its debt obligations. It is possible that other
measures affecting the taxing or spending authority of Massachusetts or its
political subdivisions may be approved or enacted in the future. State tax
revenues in fiscal 1995 through fiscal 1999 were lower than the limits set by
this statute. The Executive Office for Administration and Finance currently
estimates that state tax revenues in fiscal 2000 will not reach the limit.
State finance law provides for a Stabilization Fund, a Capital Projects
Fund and a Tax Reduction Fund relating to the use of any aggregate fiscal
year-end surpluses. A limitation equal to 0.5% of total tax revenues is imposed
on the amount of any such aggregate surplus which may be carried forward as a
beginning balance for the next fiscal year. For any fiscal year for which the
Comptroller determines on or before October 31 of the succeeding fiscal year
that there is a negative balance in the state's capital projects funds, the
Comptroller may transfer up to 40% of the remaining year-end surplus to a
separate Capital Projects Fund to be used in lieu of bonds to finance capital
expenditures. The remainder of any such aggregate year-end surplus is reserved
in the Stabilization Fund, from which funds can be appropriated (i) to make up
any difference between actual state revenues and allowable state revenues in any
fiscal year in which actual revenues fall below the allowable amount; (ii) to
replace state and local losses of federal funds or; (iii) for any event, as
determined by the Legislature, which threatens the health, safety or welfare of
the people or the fiscal stability of the Commonwealth or any of its political
subdivisions. Up to 7.5% of budgeted revenues and other financial resources
pertaining to the budgeted funds may be accumulated in the Stabilization Fund.
Amounts in excess of that limit are to be transferred to a Tax Reduction Fund,
from which they are to be applied to the reduction of personal income taxes. For
fiscal 1997, the statutory ceiling on the Stabilization Fund was 5% of budgeted
revenues and other financial resources pertaining to the budgeted funds, and
prior to fiscal 1997,
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the statutory ceiling on the Stabilization Fund was 5% of total tax revenues
less the amount of annual debt service costs.
At the end of each of the fiscal years 1997, 1998, and 1999, the
Legislature has mandated extraordinary fund transfers that have had the effect
of using revenues collected in those years that would otherwise have been
surplus. In addition, at the end of fiscal 1997 and fiscal 1998 the Legislature
increased the statutory ceiling on Stabilization Fund deposits. The effect of
those changes was to increase the ceiling for fiscal 1997 to approximately
$908.5 million and for fiscal 1998 to approximately $1.485 billion. By the end
of fiscal 1999, the Stabilization Fund had a balance of approximately $1.389
billion measured against a ceiling of approximately $1.512 billion. On account
of fiscal 1999, extraordinary fund transfers included the transfer of (i)
approximately $408.9 million to a Debt Defeasance Trust Fund to establish a
sinking fund for certain outstanding Commonwealth debt; (ii) $118.6 million to
the Capital Improvement and Investment Trust Fund for specified capital
expenditures; (iii) $86 million to a Collective Bargaining Reserve Fund; and
(iv) $92 million to a Transitional Escrow Fund to be expended subject to
appropriation by December 31, 1999. Any unappropriated balances in the
Transitional Escrow Fund as of December 31, 1999 are to be transferred 40% to a
Capital Projects Fund and 60% to the Stabilization Fund. In addition, pursuant
to state finance law, approximately $110.4 million was transferred to the
Capital Projects Fund and approximately $165.6 million was transferred to the
Stabilization Fund.
The Commonwealth budget for fiscal 2000 was not agreed upon and signed by
the Governor until November 16, 1999. Prior to the enactment of the final
budget, the Commonwealth operated under a series of five monthly interim budgets
providing cumulatively for spending through November 30, 1999. The Executive
Office for Administration and Finance projects fiscal 2000 spending of
approximately $21.348 billion, a 5.4% increase over fiscal 1999 spending. The
fiscal 2000 budget established a Health Care Security Trust, to which will be
credited all payments received by the Commonwealth pursuant to the national
litigation settlement with the tobacco industry, and a Tobacco Settlement Fund.
Thirty percent of the settlement payments received by the Commonwealth and 30%
of the investment earnings generated by the Health Care Security Trust Fund are
to be transferred annually to the Tobacco Settlement Fund, where they may be
used, subject to appropriation, for health-related purposes, including tobacco
control, but are not to be used to supplant or replace other state expenditures
or obligations. The fiscal 2000 budget as enacted was based on the consensus tax
revenue estimate of $14.850 billion that had been agreed to by both houses of
the Legislature in late April 1999. The Executive Office for Administration and
Finance increased the fiscal 2000 tax estimate on April 18, 2000 to $15.458
billion. As of early March, 2000, fiscal 2000 was projected to end with a cash
balance of $776.6 million excluding any fiscal 2000 activity that will occur
after June 30, 2000 and excluding the Stabilization Fund. A revised cash flow
projection is anticipated. The Executive Office for Administration and Finance
projects fiscal 2000 spending of approximately $21.259 billion as compared to
$21.151 billion for fiscal 1999
On January 26, 2000, the Governor submitted his fiscal 2001 budget
recommendations calling for budgeted expenditures of approximately $21.346
billion. The proposed fiscal 2001 spending level represents the transfer off
budget of $645 million of sales tax revenues (and approximately $632 million of
spending) as a result of forward funding of the Massachusetts Bay Transportation
Authority. Budged revenues for fiscal 2001 are projected to be $21.315 billion
based on a tax revenue estimate of $14.903 billion. The Governor's proposal
projects a fiscal 2001 ending balance in budgeted funds of approximately $1.979
billion, including a Stabilization Fund balance of approximately $1.599 billion.
On April 14, 2000, the Massachusetts House of Representatives approved its
version of the fiscal 2001 budget providing for total appropriations of
approximately $21.8 billion based on a tax revenue estimate of $15.283 billion,
excluding $645 million of sales tax receipts dedicated to the Massachusetts Bay
Transportation Authority as a result of forward funding legislation. On May 25,
2000, the Senate adopted its version of the fiscal 2001 budget in the amount of
approximately $21.55 billion based on a tax revenue estimate
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of approximately $15.204 billion. The differences between the House and Senate
versions will be reconciled by a legislative committee.
PENSION LIABILITIES. Comprehensive pension funding legislation approved in
January, 1988 requires the Commonwealth to fund future pension liabilities
currently and to amortize the Commonwealth's accumulated unfunded liabilities to
zero by June 30, 2028. The legislation was revised July 1, 1997 as part of the
fiscal 1998 budget to require the amortization of such liabilities by June 30,
2018.
The most recent funding schedule that has been approved by the Legislature
was filed by the Secretary of Administration and Finance on February 25, 1999.
The schedule was based on an actuarial valuation dated as of January 1, 1998
which was released by the Public Employee Retirement Administration Commission
("PERAC") on October 26, 1998. On April 28, 1999, a pension valuation report
prepared by independent actuarial consultants to the Pension Reserves Investment
Management ("PRIM") board was released. Using the same data and assumptions
employed by PERAC in its October 1998 valuation report, the independent
consultants found the total unfunded liability to be $7.841 billion rather than
$5.803 billion. The report ascribed the differences between the consultants'
results and PERAC's results to be deficiencies in the actuarial valuation
software used by PERAC for its valuation. PERAC has since converted to a new
actuarial software system and has produced results approximating those reported
by the PRIM Board consultants. After revising certain actuarial assumptions on
the basis of an experience study (which although never previously done is
required every six years by the 1988 legislation), the PRIM Board consultants
recalculated the January 1, 1998 unfunded actuarial liability to be, in the
aggregate, $10.604 billion. Projecting forward to January 1, 1999 and June 30,
1999, the comparable total unfunded liability figures were calculated to be
$10.398 billion and $9.483 billion respectively. The appropriations contained in
the fiscal 2000 budget and in the Governor's 2001 budget recommendations are
consistent with the February 25, 1999 funding schedule.
The Commonwealth has now completed the transition from a pay-as-you-go
system to an actuarially funded system. Accordingly, as contemplated by the
pension funding legislation of 1988, amounts required to be appropriated in the
eleventh and later years of the funding schedule need not be sufficient to cover
the benefit costs payable in those years.
MEDICAID EXPENDITURES. During fiscal years 1995, 1996, 1997, 1998 and
1999, Medicaid expenditures were $3.398 billion, $3.416 billion, $3.456 billion,
$3.666 billion and $3.856 billion, respectively. The average annual growth rate
from fiscal 1995 to fiscal 1999 was 3.3%. The moderate rate of growth is due to
a number of savings and cost control initiatives that the Division of Medical
Assistance continues to implement and refine, including managed care,
utilization review and the identification of third party liabilities. Fiscal
1999 Medicaid expenditures increased approximately 5.2% from fiscal 1998, and
fiscal 2000 spending for the current Medicaid program is projected to total
$4.092 billion, an increase of 6.1% from fiscal 1999. The Division of Medical
Assistance is projecting a deficiency of $184.5 million in fiscal 2000 resulting
from increased caseloads, rate increases and an internal accounting issue
related to the Division's billing system. The projected deficiency will be
partially offset from several sources, resulting in a net balance sheet impact
of $62.1 million.
CITIES AND TOWNS. Proposition 2 1/2 , passed by the voters in 1980, led to
large reductions in property taxes, the major source of income for cities and
towns. Between fiscal 1981 and fiscal 1999, the aggregate property tax levy grew
from $3.346 billion to $6.753 billion, representing an increase of approximately
101.8%. By contrast, according to federal Bureau of Labor Statistics, the
Consumer price index for all urban consumers in Boston grew during the same
period by approximately 1.07.9%.
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During the 1980's, the Commonwealth increased payments to its cities,
towns and regional school districts through direct local aid ("Local Aid") to
mitigate the impact of Proposition 2 1/2 on local programs and services. In
fiscal 2000, approximately 21.7% of the Commonwealth's budget is estimated to be
allocated to direct Local Aid. In addition to direct Local Aid, the Commonwealth
has provided substantial indirect aid to local governments, including, for
example, payments for MBTA assistance and debt service, pensions for teachers,
pension cost-of-living allowances for municipal retirees, housing subsidies and
the costs of courts and district attorneys that formerly had been paid by the
counties.
Many communities have responded to the limitations imposed by Proposition
2 1/2 through statutorily permitted overrides and exclusions. Override activity
steadily increased throughout the 1980's before peaking in fiscal 1991 and
decreasing thereafter. In fiscal 1999, 24 communities had successful override
referenda which added an aggregate of $8.7 million to their levy limits. In
fiscal 1999, the impact of successful override referenda, going back as far as
fiscal 1993, was to raise the levy limits of 125 communities by $67 million.
Although Proposition 2 1/2 will continue to constrain local property tax
revenues, significant capacity exists for overrides in nearly all cities and
towns.
In addition to overrides, Proposition 2 1/2 allows a community, through
voter approval, to assess taxes in excess of its levy limit for the payment of
certain capital projects (capital outlay expenditure exclusions) and for the
payment of specified debt service costs (debt exclusions). Capital exclusions
were passed by 20 communities in fiscal 1999 and totaled $4.6 million. In fiscal
1999, the impact of successful debt exclusion votes going back as far as fiscal
1993, was to raise the levy limits of 250 communities by $945.8 million.
A statute adopted by voter initiative petition at the November, 1990
statewide election regulates the distribution of Local Aid to cities and towns.
This statute requires that, subject to annual appropriation, no less than 40% of
collections from personal income taxes, sales and use taxes, corporate excise
taxes and lottery fund proceeds be distributed to cities and towns. Under the
law, the Local Aid distribution to each city or town would equal no less than
100% of the total Local Aid received for fiscal 1989. Distributions in excess of
fiscal 1989 levels would be based on new formulas that would replace the current
Local Aid distribution formulas. By its terms, the new formula would have called
for a substantial increase in direct Local Aid in fiscal 1992 and in subsequent
years. However, Local Aid payments expressly remain subject to annual
appropriation by Legislature, and the appropriations for Local Aid since the
enactment of the initiative law have not met the levels set forth in the
initiative law.
CAPITAL SPENDING. Since fiscal 1992 the Executive Office for
Administration and Finance has maintained a five-year capital spending plan,
including an administrative limit on the amount of capital spending to be
financed by bonds issued by the Commonwealth. The policy objective of the
Five-Year Capital Spending Plan is to limit the debt burden of the Commonwealth
by controlling the relationship between current capital spending and the
issuance of bonds by the Commonwealth. In fiscal 1992, the annual limit was set
at approximately $825 million. During fiscal 1995, the limit was raised to
approximately $900 million and during fiscal 1998 to approximately $1.0 billion.
Actual bond-financed capital expenditures during fiscal years 1995, 1996, 1997,
1998 and 1999 were approximately, $902 million, $909 million, $995 million, $1.0
billion, and $1.0 billion, respectively. For fiscal 2000 through 2004, the plan
forecasts total capital spending to be financed by Commonwealth debt of
approximately $5 billion in the aggregate, which is significantly below
legislatively authorized capital spending levels. The current plan assumes that
the projected level of capital spending will leverage approximately $2.301
billion in federal highway funding. Legislation enacted in 1997 and 1998
authorizes the Commonwealth to issue $1.5 billion of grant anticipation notes in
anticipation of future federal highway reimbursements.
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To date, the Commonwealth has issued approximately $900 million of such
notes. Prior to the enactment in November 1999 of legislation restructuring the
finances of the Massachusetts Bay Transportation Authority ("MBTA"), the
Commonwealth's five-year capital plan also incorporated the MBTA's capital plan
because of the Commonwealth's responsibility for paying debt service on the
MBTA's bonds. In recent years the MBTA's capital plan has called for
expenditures of approximately $500 million per year, funded by approximately
$300 million of MBTA bonds and approximately $200 million of federal transit
aid. Effective July 1, 2000, Commonwealth support for the MBTA will be limited
to a portion of the state sales tax, although the Commonwealth will remain
contingently liable for MBTA bonds issued prior to July 1, 2000.
Expenditures on capital projects have increased from approximately $2.3
billion in fiscal year 1995 to approximately $2.7 billion in fiscal year 1999.
Transportation related spending constitutes the bulk of the Commonwealth's
capital expenditures, accounting for 80% of all such expenditures over the last
five years. The Central Artery/Ted Williams Tunnel project has become the single
largest part of the Commonwealth's capital spending, totaling some $5.6 billion
over the last five years, increasing from $878 million in fiscal year 1995 to
$1.515 billion in fiscal year 1999
The Federal Transportation Equity Act for the 21st Century ("TEA-21")
approved in 1998 clarifies the amount of federal highway aid the Commonwealth
can expect to receive through the federal fiscal year ending on September 30,
2003. According to the Federal Highway Administration, Commonwealth
apportionments for those years are as follows: $642.9 million in federal fiscal
year 1998, $497.9 million in federal fiscal year 1999, $537.2 million in federal
fiscal year 2000, $518.1 million in federal fiscal year 2001, $529.2 million in
federal fiscal year 2002 and $538.2 million in federal fiscal year 2003. As a
result of the annual Congressional appropriations process, it is likely that the
Commonwealth will receive a ceiling on apportionment at the outset of each year
that is less than 100% of the estimated apportionments during the six-year life
of the legislation. Additional funding may be available at the end of each
federal fiscal year through Federal Highway Administration redistributions of
unused obligation authority from states unable to use their full amount to those
states with the greatest need. In fact, for federal fiscal year 1998, the amount
of apportionment that the Commonwealth actually received was approximately
$592.0 million including redistribution. For federal fiscal year 1999, the
Commonwealth received an apportionment of $434.6 million with an additional $100
million appropriated for transportation projects in the Commonwealth of which
$71 million will be available for the Central Artery/Ted Williams Tunnel
project. The five-year capital plan, however, assumes federal highway aid equal
to 100% of the apportionment pursuant to TEA-21 for fiscal year 2000 and beyond.
The current revised estimates of the Federal Highway Administration for
Commonwealth apportionment for federal fiscal years 2000 through 2003,
inclusive, are $537.2 million, $518.1 million, $529.2 million and $538.2 million
respectively.
As previously mentioned, the largest component of the Commonwealth's
capital program currently is the Central Artery/Ted Williams Tunnel project, a
major construction project that is part of the completion of the federal
interstate highway system. The magnitude of this project has resulted in the
realignment of certain transportation assets in the Commonwealth and the
development of additional financing mechanisms to support is completion
currently scheduled for 2005, including payments from the Massachusetts Turnpike
Authority and the Massachusetts Port Authority and state borrowing in
anticipation of further federal highway reimbursements.
On February 1, 2000, the Massachusetts Turnpike Authority revised upward
by $1.398 billion its estimate of the total expenditures expected to be required
to complete the project.
On February 17, 2000 the Secretary of the U.S. Department of
Transportation announced that he had approved an action plan provided by the
Federal Highway Administrator to enhance federal oversight of the project, which
includes implementation of recommendations proposed by the Inspector General,
one of which requires an independent validation of all project status and
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cost data. The Secretary's plan also provides for withholding of further
"advance construction" approvals until the Federal Highway Administration has
approved a new finance plan reflecting the higher costs and revenue sources for
completing the project, an evaluation of whether the Federal Highway
Administration should freeze all federal-aid obligation authority until it has
determined the soundness of the new finance plan and the establishment of a task
force to conduct a complete review of Federal Highway Administration oversight
processes.
The federal task force reported that senior management of the project had
deliberately withheld information concerning cost overruns from the Federal
Highway Administration and recommended a change in project leadership (which was
done) as well as an evaluation of whether the Massachusetts Turnpike Authority
should continue to be responsible for the management of the project. The task
force estimated a realistic total cost estimate for the project at $13.4 million
to $13.6 billion, with which the Massachusetts Turnpike Authority has initially
concurred. The report stated the Commonwealth appeared to have adequate
resources to finance the additional costs but had not yet identified how it
would do so. On May 17, the Governor approved legislation identifying and
authorizing sources of funding totaling approximately $2.5 billion dollars,
meeting a deadline imposed by the Federal Highway Administration of May 19. The
Federal Highway Administration also required a completely revised finance plan
update to be submitted by June 16, 2000. On June 16, the Massachusetts Turnpike
Authority filed with that Administration a financing plan update identifying
total project costs through completion of $13.513 billion. The Federal Highway
Administration imposed limits on the amount of federal funding at $8.549 billion
based on a total project cost of $11.667 billion, meaning that all additional
costs will have to be met by non-federal funds. Congress has adopted a bill
confirming the limits imposed by the Federal Highway Administration.
On May 8, 2000, the State Treasurer's Office was advised that the staff of
the Securities and Exchange Commission is conducting a formal investigation in
the matter of "Certain Municipal Securities/Massachusetts Central Artery
(B-1610)", pursuant to a formal order of private investigation issued by the
Commission.
Notwithstanding the foregoing actions, there can be no determination at
this time as to any additional effects such increased federal oversight and
requirements may have on future federal funding of the project nor the total
expenditures which will be required ultimately to complete the project.
COMMONWEALTH DEBT. The Commonwealth is authorized to issue three types of
debt: general obligation debt, special obligation debt and federal grant
anticipation notes. General obligation debt is secured by a pledge of the full
faith and credit of the Commonwealth. Special obligation debt may be secured
either with a pledge of receipts credited to the Highway Fund or with a pledge
of receipts credited to the Boston Convention and Exhibition Center Fund.
Federal grant anticipation notes are secured by a pledge of federal highway
construction reimbursements. In addition, certain independent authorities and
agencies within the Commonwealth are statutorily authorized to issue bonds and
notes for which the Commonwealth is either directly, in whole or in part, or
indirectly liable. The Commonwealth's liabilities with respect to these bonds
and notes are classified as either (a) Commonwealth-supported debt; (b)
Commonwealth-guaranteed debt; or (c) indirect obligations. Because of recent
legislation restructuring the finances of the Massachusetts Bay Transportation
Authority, the Commonwealth will, beginning in fiscal 2001, no longer make
direct debt service payments on the MBTA's bonds, but the Commonwealth will
remain obligated to pay such debt service if the MBTA cannot.
The liabilities of the Commonwealth with respect to outstanding bonds and
notes payable as of April 1, 2000 totaled $15.937 billion. These liabilities
consisted of $10.274 billion of general obligation debt, $586 million of special
obligation debt, $922 million of federal grant anticipation notes, $3.941
billion of supported debt, and $215 million of guaranteed debt.
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In January, 1990 legislation was enacted to impose a limit on debt service
appropriations in Commonwealth budgets beginning in fiscal 1991. The law
provides that no more than 10% of the total appropriations in any fiscal year
may be expended for payment of interest and principal on general obligation debt
of the Commonwealth. This law may be amended or repealed by the Legislature at
any time, and may be superseded in the annual appropriations act for any year.
From fiscal year 1995 through fiscal year 1999, this percentage has been below
the limits established by this law, averaging approximately 5.7% per year. The
estimated debt service for fiscal 2000 is estimated to fall below the limit as
well.
Legislation enacted in December, 1989 imposes a limit on the amount of
outstanding direct bonds of the Commonwealth. The limit for fiscal 2000 is
$10.549 billion; as of April 1, 2000 there were $9.629 billion of outstanding
direct bonds. The law provides that the limit for each subsequent fiscal year
shall be 105% of the previous fiscal year's limit. Since this law's inception,
the limit has never been reached. The Commonwealth's outstanding special
obligation highway revenue bonds, its federal grant anticipation notes and bonds
issued to pay the operating notes issued by the Massachusetts Bay Transportation
Authority are not to be included in computing the amount of the bonds subject to
this limit.
The Commonwealth has waived its sovereign immunity and consented to be
sued under contractual obligations including bonds and notes issued by it.
However, the property of the Commonwealth is not subject to attachment or levy
to pay a judgment, and the satisfaction of any judgment generally requires
legislative appropriation. Enforcement of a claim for payment of principal or
interest on bonds and notes of the Commonwealth may also be subject to
provisions of federal or Commonwealth statutes, if any, hereafter enacted
extending the time for payment or imposing other constraints upon enforcement,
insofar as the same may be constitutionally applied. The United States
Bankruptcy Code is not applicable to states.
UNEMPLOYMENT. The Massachusetts unemployment rate averaged 4.3%, 4.0% and
3.3% in calendar years 1996, 1997 and 1998, respectively. The Massachusetts
unemployment rate in both October 1999 and November 1999 was 3.2%.
The assets and liabilities of the Commonwealth Unemployment Compensation
Trust Fund are not assets and liabilities of the Commonwealth. As of April 30,
2000 the private contributory sector of the Massachusetts Unemployment Trust
Fund had a surplus of $1.709 billion. The Division of Employment and Training's
April 2000 quarterly report indicates that the contributions provided by current
law should build reserves in the system to $2.335 billion by the end of 2004.
LITIGATION. The Attorney General of the Commonwealth is not aware of any
cases involving the Commonwealth which in his opinion would affect materially
its financial condition. However, certain cases exist containing substantial
claims, among which are the following.
The Commonwealth is engaged in various lawsuits concerning environmental
and related laws, including an action brought by the United States on behalf of
the U.S. Environmental Protection Agency alleging violations of the Clean Water
Act and seeking to enforce the clean-up of Boston Harbor. The Massachusetts
Water Resources Authority (the "MWRA") has assumed primary responsibility for
developing and implementing a court approved plan and time table for the
construction of the treatment facilities necessary to achieve compliance with
the federal requirements. The MWRA currently projects the total cost of
construction of the wastewater facilities required under the court's order not
including costs pursuant to the draft combined sewer outflow plan ("CSO"), will
be approximately $3.142 billion in current dollars, with approximately $601
million to be spent after June 30, 1997. With CSO costs, the MWRA anticipates
spending approximately $901 million after that date. Under the Clean Water Act,
the Commonwealth may be liable for any costs of complying with any judgment in
this case to the extent that the MWRA
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or a municipality is prevented by state law from raising revenues necessary to
comply with such a judgment.
On February 12, 1998, the U.S. Department of Justice filed a complaint
seeking to compel the MWRA to construct a water filtration plant for water drawn
from the Wachusett Reservoir and, together with the Metropolitan District
Commission, to take certain watershed protection measures. The U.S. District
Court issued a decision on May 5, 1999 allowing the U.S. government's motion for
summary judgment by finding the MWRA liable under the Safe Water Drinking Act,
but denying its motion for summary judgment on the remedy issue. On May 5, 2000,
the court ruled that the MWRA does not need to build a filtration system based
on a finding that ozonation treatment and improvement of the Wachusett watershed
are sufficient at this time.
Wellesley College is seeking contribution from the Commonwealth for costs
related to environmental contamination on the Wellesley College campus and
adjacent areas, including Lake Waban. Such costs may reach $35 million.
Currently, the Commonwealth and Wellesley College are mediating this potential
claim for contribution. As of February 9, 2000, no litigation against the
Commonwealth has been filed.
From time to time actions are brought against the Commonwealth by the
recipients of governmental services, particularly recipients of human services
benefits, seeking expanded levels of services and benefits and by the providers
of such services challenging the Commonwealth's reimbursement rates and
methodologies. To the extent that such actions result in judgments requiring the
Commonwealth to provide expanded services or benefits or pay increased rates,
additional operating and capital expenditures might be needed to implement such
judgments.
A class action was brought by mentally retarded nursing home patients
seeking community placements and services. The court approved a settlement
agreement entered into by the parties which will provide certain benefits to
nursing home residents with mental retardation and other developmental
disabilities over the next seven years. The Department of Mental Retardation
estimates that the agreement will cost approximately $5 million per fiscal year
for seven years.
A class action was brought against the Department of Mental Retardation
and the Division of Medical Assistance asserting that the Commonwealth has an
obligation under the Medicaid Home and Community Based Services Waiver Program
to provide group residences for adult mentally retarded individuals who
currently reside with their parents. The Department of Mental Retardation
estimates that the cost of eliminating its existing waiting list for placements
would be $50 million. Cross motions for summary judgment are pending.
The Department of Medical Assistant ("DMA") is also engaged in four
related lawsuits in which numerous hospitals seek injunctive and declaratory
relief from DMA's implementation of its prepayment review program and its
postpayment review program. The hospitals also damages consisting of the value
of all claims for payment previously denies by DMA under these two review
programs, where the basis for denial was DMA's determination that the claims
were not medically necessary.
In a suit filed against the Department of Transitional Assistance,
plaintiffs allege that the Department violated state and federal law, by failing
to accommodate welfare recipients with learning disabilities in its Employment
Services Program. The court has denied plaintiff's motion for class
certification and injunctive relief. If the case remains limited to the two
plaintiffs, potential liability will likely be under $50,000. However, if the
court at some point allows a motion for class certification, potential liability
could increase to $33.5 million.
BankBoston, N.A. (known at the time as The First National Bank of Boston)
has also challenged the constitutionality of the former version of the
Commonwealth's bank excise tax. In
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1992, several pre-1992 petitions filed by the bank, which raised the same
issues, were settled prior to an Appellate Tax Board decision. The bank has a
claim pending with respect to 1994 claiming that the tax violated the Commerce
Clause of the United States Constitution by including its worldwide income
without apportionment. The Department of Revenue estimates that the amount of
abatement, including interest, sought by BankBoston could total $199 million.
In addition, there are several other tax cases pending which could result
in significant refunds if taxpayers prevail. Approximately $80 million in taxes
and interest in the aggregate are at issue in several other cases pending before
the Appellate Tax Board or on appeal to the Appeals Court or the Supreme
Judicial Court.
There are several large eminent domain cases pending against the
Commonwealth.
On January 4, 2000, the Attorney General, at the request of the
Commissioner of Insurance, obtained a court order from the Supreme Judicial
Court placing Harvard Pilgrim Health Care, Inc., Pilgrim Health Care, Inc. and
Harvard Pilgrim Health Care of New England, Inc. (collectively "HPHC") into
temporary receivership. HPHC is one of the largest nonprofit managed care
operations in the United States, providing care and coverage to more than 1.2
million members in New England, approximately 1.1 million of whom are
Massachusetts residents. On January 17, 2000, the Commissioner of Insurance as
temporary receiver engaged an investment banker to identify and evaluate all
viable options to recapitalize HPHC and ensure continuity of care and coverage
to HPCH members. While the receivership statute does not provide for state
financial assistance, various health care providers and other interested parties
have publicly discussed state participation in the resolution of this matter.
RATINGS. The Commonwealth's general obligation debt is rated at AA-,
Aa2and AA- by Standard & Poor's Rating Service, Moody's Investors Service, Inc.
and Fitch IBCA, Inc., respectively.
Ratings may be changed at any time and no assurance can be given that they
will not be revised or withdrawn by the rating agencies, if in their respective
judgments, circumstances should warrant such action. Any downward revision or
withdrawal of a rating could have an adverse effect on market prices of the
state's bonds.
MICHIGAN
The following information is a brief summary of some of the factors
affecting the economy in the State and does not purport to be a complete
description of such factors. This summary is based on publicly available
information and forecasts which have not been independently verified by the
Sponsors or their legal counsel.
RISK FACTORS--Due primarily to the fact that the leading sector of the
State's economy is the manufacturing of durable goods, economic activity in the
State has tended to be more cyclical than in the nation as a whole. While the
State's efforts to diversify its economy have proven successful, as reflected by
the fact that the share of employment in the State in the durable goods sector
has fallen from 33.1 percent in 1960 to 16.1 percent in 1998, durable goods
manufacturing still represents a sizable portion of the State's economy. As a
result, any substantial national economic downturn is likely to have an adverse
effect on the economy of the State and on the revenues of the State and some of
its local governmental units. Although historically, the average monthly
unemployment rate in the State has been higher than the average figures for the
United States, for the last four years, the State's unemployment rate has been
at or below the national average. During 1998, the average monthly unemployment
rate in this State was 3.7% as compared to a national average of 4.2% in the
United States.
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The State's economy could be affected by changes in the auto industry,
notably consolidation and plant closings resulting from competitive pressures,
over-capacity and labor disputes. Such actions could adversely affect Sate
revenues, and the financial impact on the local units of government in the areas
in which plants are or have been closed could be more severe.
The Michigan Constitution limits the amount of total revenues of the State
raised from taxes and certain other sources to a level for each fiscal year
equal to a percentage of the State's personal income for the prior calendar
year. In the event the State's total revenues exceed the limit by 1% or more,
the Constitution requires that the excess be refunded to taxpayers. To avoid
exceeding the revenue limit in the State's 1994-95 fiscal year the State
refunded approximately $113 million through income tax credits for the 1995
calendar year. The State has determined that state revenues subject to the limit
in the 1998-99 fiscal year exceeded the constitutional limit by $21.7 million
which is less than 1% of the limit. This amount was transferred to the State's
Budget Stabilization Fund. The State Constitution does not prohibit the
increasing of taxes so long as revenues are expected to amount to less than the
revenue limit and authorizes exceeding the limit for emergencies when deemed
necessary by the governor and a two-thirds vote of the members of each house of
the legislature. The State Constitution further provides that the proportion of
State spending paid to all local units to total spending may not be reduced
below the proportion in effect in the 1978-79 fiscal year. The Constitution
requires that if the spending does not meet the required level in a given year
an additional appropriation for local units is required for the following fiscal
year. The State Constitution also requires the State to finance any new or
expanded activity of local units mandated by State law. Any expenditures
required by this provision would be counted as State spending for local units
for purposes of determining compliance with the provisions cited above.
The State Constitution limits State general obligation debt to (i)
short-term debt for State operating purposes; (ii) short-and long-term debt for
purposes of making loans to school districts; and (iii) long-term debt for a
voter-approved purpose. Short-term debt for operating purposes is limited to an
amount not in excess of fifteen (15%) percent of undedicated revenues received
by the State during the preceding fiscal year and must mature in the same fiscal
year in which it is issued. Debt incurred by the State for purposes of making
loans to school districts is recommended by the Superintendent of Public
Instruction who certifies the amounts necessary for loans to school districts
for the ensuing two (2) calendar years. These bonds may be issued without vote
of the electors of the State and in whatever amount required. There is no limit
on the amount of long-term voter-approved State general obligation debt. In
addition to the foregoing, the State authorizes special purpose agencies and
authorities to issue revenue bonds payable from designated revenues and fees.
Revenue bonds are not obligations of the State and in the event of shortfalls in
self-supporting revenues, the State has no legal obligation to appropriate money
to meet debt service payments. The Michigan State Housing Development Authority
has a capital reserve fund pledged for the payment of debt service on its bonds
derived from State appropriation. The act creating this Authority provides that
the Governor's proposed budget include an amount sufficient to replenish any
deficiency in the capital reserve fund. The legislature, however, is not
obligated to appropriate such moneys and any such appropriation would require a
two-thirds vote of the members of the legislature. Obligations of all other
authorities and agencies of the State are payable solely from designated
revenues or fees and no right to certify to the legislature exists with respect
to those authorities or agencies.
The State finances its operations through the State's General Fund and
special revenue funds. The General Fund receives revenues of the State that are
not specifically required to be included in the Special Revenue Fund. General
Fund revenues are obtained approximately 56% from the payment of State taxes and
44% from federal and non-tax revenue sources. The majority of the revenues from
State taxes are from the State's personal income tax, single business tax, use
tax, sales tax and various other taxes. Approximately two-thirds of total
General Fund expenditures have been for State support of public education and
for social services programs. Other significant expenditures from the General
Fund provide funds for law enforcement, general
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State government, debt service and capital outlay. The State Constitution
requires that any prior year's surplus or deficit in any fund must be included
in the next succeeding year's budget for that fund.
The State ended the five fiscal years 1992-1996 with its general fund in
balance after substantial transfers from the General Fund to the Budget
Stabilization Fund. For the 1997 fiscal year, the State closed its books with
its general fund in balance. During the 1997-98 fiscal year, an error was
identified pertaining to the Medicaid program administered by the Department of
Community Health ("DCH"). Over a ten-year period, DCH did not properly record
all Medicaid expenditures and revenues on a modified accrual basis as required
by GAAP. For the fiscal year ended September 30, 1997, the General Fund did not
reflect Medicaid expenditures of $178.7 million and federal revenue of $24.6
million. As a result, the total ending fund balance and unreserved fund balance
for the fiscal year ended September 30, 1997, were reduced by $154.1 million to
account for the correction of the prior period error. The general fund was in
balance as of September 30, 1998 and September 30, 1999. The balance in the
Budget Stabilization Fund as of September 30, 1999, was $1,222.4 million after
net transfers into the fund of $221.9 million, which includes the excess
revenues of $21.7 million described above. In all but two of the last seven
fiscal years the State has borrowed between $500 million and $900 million for
cash flow purposes. It borrowed $900 million in each of the 1996, 1997 and 1998
fiscal years. The State has no current plan to borrow for cash flow purposes in
2000.
In January, 1998, Standard & Poor's raised its rating on the State's
general obligation bonds to AA+. In March, 1998, Moody's raised the State's
general obligation credit rating to Aa1. Fitch Investor's Service has issued a
rating of Aa+ on the State's general obligation bonds.
Amendments to the Michigan Constitution which place limitations on
increases in State taxes and local ad valorem taxes (including taxes used to
meet debt service commitments on obligations of taxing units) were approved by
the voters of the State of Michigan in November 1978 and became effective on
December 23, 1978. To the extent that obligations in the Portfolio are
tax-supported and are for local units and have not been voted by the taxing
unit's electors and have been issued on or subsequent to December 23, 1978, the
ability of the local units to levy debt service taxes might be affected.
State law provides for distributions of certain State collected taxes or
portions thereof to local units based in part on population as shown by census
figures and authorizes levy of certain local taxes by local units having a
certain level of population as determined by census figures. Reductions in
population in local units resulting from periodic census could result in a
reduction in the amount of State collected taxes returned to those local units
and in reductions in levels of local tax collections for such local units unless
the impact of the census is changed by State law. No assurance can be given that
any such State law will be enacted. In the 1991 fiscal year, the State deferred
certain scheduled payments to municipalities, school districts, universities and
community colleges. While such deferrals were made up at later dates, similar
future deferrals could have an adverse impact on the cash position of some local
units. Additionally, while total State revenue sharing payments have increased
in each of the last six years, the State reduced revenue sharing payments to
municipalities below that level otherwise provided under formulas in each of
those fiscal years.
On March 15, 1994, the electors of the State voted to amend the State's
Constitution to increase the State sales tax rate from 4% to 6% and to place an
annual cap on property assessment increases for all property taxes. Companion
legislation also cut the State's income tax rate from 4.6% to 4.4%, reduced some
property taxes for school operating purposes and shifted the balance of school
funding sources among property taxes and state revenues, some of which are being
provided from new or increased State taxes. The legislation also contained other
provisions that may reduce or alter the revenues of local units of government
and tax increment bonds could be particularly affected. In 1999, the legislature
voted to further reduce the State personal income tax
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by 0.1% each year for 5 years, beginning in 1999. While the ultimate impact of
the constitutional amendment and related legislation cannot yet be accurately
predicted, investors should be alert to the potential effect of such measures
upon the operations and revenues of Michigan local units of government.
The State is a party to various legal proceedings seeking damages or
injunctive or other relief. In addition to routine litigation, certain of these
proceedings could, if unfavorably resolved from the point of view of the State,
substantially affect State or local programs or finances. These lawsuits involve
programs generally in the area of corrections, highway maintenance, social
services, tax collection, commerce and budgetary reductions to school districts
and governmental units and court funding.
In November of 1997, the State Legislature adopted legislation to provide
for the funding of claims of local schools districts, some of whom had alleged
in a lawsuit, Durant v State of Michigan, that the State had, over a period of
years, paid less in school aid than required by the State's Constitution. Under
this legislation, the State paid or is required to pay to school districts which
were plaintiffs in the suit approximately $212 million from the Budget
Stabilization Fund on April 15, 1998, and to or on behalf of other school
districts from the Budget Stabilization Fund (i) an additional $32 million per
year in the fiscal years 1998-99 through 2007-08; and (ii) up to an additional
$40 million per year in the fiscal years 1998-99 through 2012-13.
The foregoing financial conditions and constitutional provisions could
adversely affect the State's or local unit's ability to continue existing
services or facilities or finance new services or facilities, and, as a result,
could adversely affect the market value or marketability of the Michigan
obligations in the Portfolio and indirectly affect the ability of local units to
pay debt service on their obligations, particularly in view of the dependency of
local units upon State aid and reimbursement programs.
The Portfolio may contain obligations of the Michigan State Building
Authority. These obligations are payable from rentals to be paid by the State as
part of the State's general operating budget. The foregoing financial conditions
and constitutional provisions could affect the ability of the State to pay
rentals to the Authority and thus adversely affect payment of the State Building
Authority Bonds.
The Portfolio may contain obligations issued by various school districts
pledging the full faith and credit of the school district. The ability of the
school district to pay debt service may be adversely affected by those factors
described above for general obligation bonds and, if the obligations were not
voted by that schools' district's electors, by the restructuring of school
operating funding as described above. The school district obligations also may
be qualified for participation in the Michigan School Bond Loan Fund. If the
bonds are so qualified, then in the event the school district is for any reason
unable to pay its debt service commitments when due, the school district is
required to borrow the deficiency from the School Bond Loan Fund and the State
is required to make the loan. The School Bond Loan Fund is funded by means of
debt obligations issued by the State. In the event of fiscal and cash flow
difficulties of the State the availability of sufficient cash or the ability of
the State to sell debt obligations to fund the School Bond Loan Fund may be
adversely affected and this could adversely affect the ability of the State to
make loans it is required to make to school districts issuing qualified school
bonds in the event the school district's tax levies are insufficient therefor.
MISSOURI
The following information is a brief summary of some of the factors
affecting the economy in the State and does not purport to be a complete
description of such factors. This summary is based on publicly available
information and forecasts which have not been independently verified by the
Sponsors or their legal counsel.
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RISK FACTORS--Revenue and Limitations Thereon. Article X, Sections 16-24
of the Constitution of Missouri (the "Hancock Amendment"), imposes limitations
on the amount of State taxes which may be imposed by the General Assembly of
Missouri (the "General Assembly") as well as on the amount of local taxes,
licenses and fees (including taxes, licenses and fees used to meet debt service
commitments on debt obligations) which may be imposed by local governmental
units (such as cities, counties, school districts, fire protection districts and
other similar bodies) in the State of Missouri in any fiscal year.
The State limit on taxes is tied to total State revenues for fiscal year
1980-81, as defined in the Hancock Amendment, adjusted annually in accordance
with the formula set forth in the amendment, which adjusts the limit based on
increases in the average personal income of Missouri for certain designated
periods. The details of the amendment are complex and clarification from
subsequent legislation and further judicial decisions may be necessary.
Generally, if the total State revenues exceed the State revenue limit imposed by
Section 18 of Article X by more than one percent, the State is required to
refund the excess. The State revenue limitation imposed by the Hancock Amendment
does not apply to taxes imposed for the payment of principal and interest on
bonds, approved by the voters and authorized by the Missouri Constitution. The
revenue limit also can be exceeded by a constitutional amendment authorizing new
or increased taxes or revenue adopted by the voters of the State of Missouri.
The Hancock Amendment also limits new taxes, licenses and fees and
increases in taxes, licenses and fees by local governmental units in Missouri.
It prohibits counties and other political subdivisions (essentially all local
governmental units) from levying new taxes, licenses and fees or increasing the
current levy of an existing tax, license or fee without the approval of the
required majority of the qualified voters of that county or other political
subdivision voting thereon.
When a local government unit's tax base with respect to certain fees or
taxes is broadened, the Hancock Amendment requires the tax levy or fees to be
reduced to yield the same estimated gross revenue as on the prior base. It also
effectively limits any percentage increase in property tax revenues to the
percentage increase in the general price level (plus the value of new
construction and improvements), even if the assessed valuation of property in
the local governmental unit, excluding the value of new construction and
improvements, increases at a rate exceeding the increase in the general price
level.
School Desegregation Lawsuits. Desegregation lawsuits in St. Louis and
Kansas City continue to require significant levels of state funding and are
sources of uncertainty; litigation continues on many issues, notwithstanding a
1995 U.S. Supreme Court decision favorable to the State in the Kansas City
desegregation litigation, court orders are unpredictable, and school district
spending patterns have proven difficult to predict. The State paid $274 million
for desegregation costs in fiscal 1996, $227 million for fiscal 1997, $279
million for fiscal 1998 and $286 million for fiscal 1999. This expense accounted
for approximately 5% of General Revenue Fund spending in fiscal 1996,
approximately 6% for fiscal 1997 and 1998 and approximately 5.5% for fiscal
1999. The State has entered into a settlement agreement with respect to the
Kansas City desegregation lawsuit, pursuant to which the State will cease
additional desegregation payments to the Kansas City Missouri School District
after fiscal 2000.
Industry and Employment. Missouri has a diverse economy with a
distribution of earnings and employment among manufacturing, trade and service
sectors closely approximating the average national distribution. Missouri
characteristically has had a pattern of unemployment levels equal to or lower
than the national average. A pattern of high unemployment could adversely affect
the Missouri debt obligations acquired by the Missouri Trust and, consequently,
the value of the Units in the Trust.
The Missouri portions of the St. Louis and Kansas City metropolitan areas
collectively contain over fifty percent of Missouri's 1998 estimated population
census of approximately
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5,438,559. Economic reversals in either of these two areas would have a major
impact on the overall economic condition of the State of Missouri. Additionally,
the State of Missouri has a significant agricultural sector which is
experiencing farm-related problems comparable to those which are occurring in
other states. To the extent that these problems were to intensify, there could
possibly be an adverse impact on the overall economic condition of the State of
Missouri.
Defense related business plays an important role in Missouri's economy.
There are a large number of civilians employed at the various military
installations and training bases in the State. In addition, aircraft and related
businesses in Missouri are the recipients of substantial annual dollar volumes
of defense contract awards. There can be no assurances there will not be further
changes in the levels of military appropriations, and, to the extent that
further changes in military appropriations are enacted by the United States
Congress, Missouri could be disproportionately affected. It is impossible to
determine what effect, if any, continued consolidation in defense-related
industries, will have on the economy of the State. However, any shift or loss of
production operations now conducted in Missouri could have a negative impact on
the economy of the State.
NEW JERSEY
The following information is a brief summary of some of the factors
affecting the economy in the State and does not purport to be a complete
description of such factors. This summary is based on publicly available
information and forecasts which have not been independently verified by the
Sponsors or their legal counsel.
RISK FACTORS--Potential purchasers of Units of the New Jersey Trust should
consider the fact that the Trust's portfolio consists primarily of securities
issued by the State of New Jersey, its municipalities and authorities and should
realize the substantial risks associated with an investment in such securities.
As of June 30, 2000, the State's General Fund (the fund into which all State
revenues not otherwise restricted by statute are deposited) had an estimated
balance of $200.1 million, but it is preliminarily estimated that balance will
be reduced to $175.0 million as of June 30, 2001. The State's Surplus Revenue
Fund, which had an estimated balance of $650.3 million as of June 30, 2000, is
preliminarily estimated to remain at $650.3 million as of June 30, 2001.
The State's diverse economic base consists of a variety of manufacturing,
construction and service industries supplemented by recreational and tourist
attractions and commercial agriculture. The State's overall economy has improved
since the end of the nationwide recession of 1992, with job growth concentrated
primarily in health, high technology, logistics, financial and entertainment
businesses. Business investment expenditures and consumer spending have also
increased substantially in the State as well as in the nation. The State has
experienced increases in personal income, low inflation and low unemployment in
recent years. However, future economic difficulties could have an adverse impact
on the finances of the State or its municipalities and could adversely affect
the market value of the Bonds in the New Jersey Trust or the ability of the
respective obligors to make payments of interest and principal due on such
Bonds.
Certain litigation is pending against the State that could adversely
affect the ability of the State to pay debt service on its obligations. These
include the following matters: (i) a coalition of churches and church leaders in
Hudson County have filed suit asserting the State-owned Liberty State Park in
Jersey City violates environmental standards; (ii) representatives of the
trucking industry have filed a constitutional challenge to annual hazardous and
solid waste licensure renewal fees; (iii) several litigations are pending that
involve challenges to the adequacy of educational funding and other programs in
respect of poor and middle income school districts within the State; (iv) a
group of insurance companies have filed a constitutional challenge to the
State's assessment of monies pursuant to the Fair Automobile Insurance Reform
Act of 1990; (v) a class action has been brought in federal court challenging
the State's method of determining the
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monthly needs of a spouse of an institutionalized person under the Medicare
Catastrophic Act; (vi) nineteen State hospitals have brought suits challenging
the State's Medicaid hospital reimbursement practices since 1995; (vii) a
private healthcare system in a liquidating reorganization has disputed certain
debts owed to the State Departments of Health and Senior Services and Human
Services and asserted counterclaims totaling approximately $40 to $50 million;
(viii) claims and cross-claims for contribution and indemnification have been
asserted against the State by an owner-operator of a resource recovery facility
and the county pollution control financing authority that issued bonds to
finance the facility, in a dispute over the county's solid waste procurement
process; (ix) an action has been pending since 1997 for retroactive payment of
welfare benefits to persons who have been denied an increase in benefits due to
the "family cap" provisions of the State Work First New Jersey Act; (x) several
actions have been brought by hospitals challenging the $10 per adjusted hospital
admission charges that have been imposed by the State since 1995; (xi) a federal
class action was commenced in August 1999 alleging that the State Division of
Youth and Family Services has failed to protect abused and neglected children in
the State and to furnish legally required services to children and their
families; (xii) an owner of approximately 80 acres of wetlands in the City of
Cape May has challenged as an unlawful taking the State Department of
Environmental Protection's refusal to permit development of the property and is
seeking in excess of $28 million in damages; and (xiii) a class action has been
brought on behalf of pre-April 1, 1991 recipients of accidental disability
retirement benefits under the State Police and Firemen Retirement System,
asserting that their benefits should be increased and should be exempted from
State taxes. In addition to these specific cases, there are various numbers of
tort, medical malpractice, contract and other claims pending against the State
and its agencies and employees at any given time, on which the State is unable
to estimate its exposure.
Although there can be no assurance that such conditions will continue, the
State's general obligation bonds are currently rated Aa1 by Moody's and AA+ by
Standard and Poor's.
NEW YORK
The following information is a brief summary of some of the factors
affecting the economy in the State and does not purport to be a complete
description of such factors. This summary is based on publicly available
information and forecasts which have not been independently verified by the
Sponsors or their legal counsel.
RISK FACTORS--Prospective investors should consider the financial
difficulties and pressures which the State of New York and several of its public
authorities and municipal subdivisions have undergone. The following briefly
summarizes some of these difficulties and the current financial situation, based
principally on certain official statements currently available; copies may be
obtained without charge from the issuing entity, or through the Agent for the
Sponsors upon payment of a nominal fee. While the Sponsors have not
independently verified this information, they have no reason to believe that it
is not correct in all material respects.
New York State. For many years, there have been extended delays in
adopting the State's budget, repeated revisions of budget projections and often
significant revenue shortfalls (as well as increased expenses). These
developments reflect faster long-term growth in State spending than revenues and
the sensitivity of State revenues to economic factors, as well as its
substantial reliance on non-recurring revenue sources. The State's general fund
incurred significant cash basis deficits for the 1990 through 1992 and 1995
fiscal years. Measures to deal with deteriorating financial conditions included
transfers from reserve funds, recalculating the State's pension fund obligations
(subsequently ruled illegal), hiring freezes and layoffs, reduced aid to
localities, sales of State property to State authorities, and additional
borrowings (including until 1993 issuance of additional short-term tax and
revenue anticipation notes payable out of impounded revenues in the next fiscal
year).
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Approximately $4.8 billion of State general obligation debt was
outstanding at March 31, 1999, State supported debt (restated to reflect LGAC's
assumption of $4.7 billion obligations previously funded through issuance of
short-term debt) was $36 billion at March 31, 1999, up from $9.8 billion in
1986. The State in 2000 adopted a Debt Reform Act which will limit the amount
and debt service costs of future State debt, reduce the maximum term for bonds
and restrict use to capital purposes. However, an additional $3.8 billion
transportation bond authority is being submitted for voter approval in November
2000. Standard & Poor's rates the State's general obligation bonds A+ and
Moody's, A2.
More than two months after the beginning of the 1996 fiscal year, the
State adopted a budget to close a projected gap of approximately $5 billion,
including a reduction in income and business taxes. The financial plan projected
nearly $1.6 billion in savings from cost containment, disbursement reestimates
and reduced funding for social welfare programs and $2.2 billion from State
agency actions. Approximately $1 billion of the gap-closing measures were
non-recurring. The State Comptroller sued to prevent reallocation of $110
million of reserves from a special pension fund. In October 1995, the Governor
released a plan to reduce State spending by $148 million to offset risks that
developed, including proposed reductions in Federal aid and possible adverse
court decisions. A $445 million surplus was realized.
To address a $3.9 billion projected budget gap for the 1997 fiscal year,
in July, 1996, the State adopted a budget that included $1.3 billion of
non-recurring measures. A surplus of $1.4 billion was realized, due primarily to
higher than expected revenue and reduced social service spending.
The financial plan for the 1998 fiscal year, adopted 126 days after it
began, used most of the 1997 surplus to close a budget gap estimated at $2.3
billion. $11 billion of spending increases (5.4% or twice the rate of
inflation), primarily for local assistance including $2.3 billion for education,
and $4.75 billion of tax cuts will be phased in over the next five years, most
after 1998. Use of non-recurring resources was estimated at $270 million. The
State achieved a surplus of $2.1 billion for the year, resulting in a positive
balance of $600 million in the General Fund, for the first time in many years.
A substantial projected increase, principally in personal income tax
collections, was used in the financial plan for fiscal 1999 to provide for $1.2
billion increase in education (totalling $9.65 billion), and smaller increases
for Medicaid, mental hygiene and other health and social welfare programs. The
budget also includes several multi-year tax reduction initiatives including for
senior citizens, expansion of a child care credit and a phased-in reduction of
the general business tax. State spending increased $5 billion in the budget for
the 1999 fiscal year even after the Governor vetoed $1.6 billion of spending
measures (including $500 million for school construction). $567 million of the
prior year's surplus was used toward this fiscal year. A $2.5 billion surplus is
forecast.
The State continues to receive personal income tax revenues substantially
above projections, reflecting the current growth of the national economy. In
January, 1999, the Governor proposed a $72.7 billion budget for the 2000 fiscal
year, which would increase spending by 1.8%. This reflects a $266 million
reduction in health care (with a total impact of $727 million when matching
grants are added) and a 1.3% increase in school aid (but only 1/8 to New York
City). He proposed to spend $1 billion in surplus Federal welfare money on
programs to encourage transition to the workforce. State welfare rolls have been
reduced by 500,000 persons over the last four years. The State ended the year
with a cash basis surplus of $1.5 billion, the fifth consecutive year with a
surplus.
The State's budget for the fiscal year ending March 31, 2001, adopted on
May 5, 2000, projects 5.7% increased spending (including 1.1% for the STAR
School Property Tax Cut program and $1.2 billion for school aid), while reducing
taxes by $1.4 billion additional (for a
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total of $6.8 billion by 2005). The budget assumes continued growth in the
overall economy, but a downturn in the financial markets or the wider economy
could adversely affect these projections. The Governor projects cash basis
budget gaps of $1.2 billion and $2.7 billion, respectively, for the 2002 and
2003 fiscal years. Preliminary analysis of the adopted budget indicates higher
potential imbalances. Expiration of Federal 5-year limits on welfare funds could
leave the State with substantial additional obligations.
The State normally adjusts its cash basis balance by deferring until the
first quarter of the succeeding fiscal year substantial amounts of tax refunds
and other disbursements. For many years, it also paid in that quarter more than
40% of its annual assistance to local governments. Payment of these annual
deferred obligations and the State's accumulated deficit was substantially
financed by issuance of short-term tax and revenue anticipation notes shortly
after the beginning of each fiscal year. The New York Local Government
Assistance Corporation ("LGAC") was established in 1990 to issue $4.7 billion of
long-term bonds over several years, payable from a portion of the State sales
tax, to fund certain payments to local governments traditionally funded through
the State's annual seasonal borrowing. The legislation will normally prevent
State seasonal borrowing until an equal amount of LGAC bonds are retired. The
State's last seasonal borrowing was in May, 1993.
Generally accepted accounting principles ("GAAP") for municipal entities
apply modified accrual accounting and give no effect to payment deferrals. On an
audited GAAP basis, reflecting payments by LGAC to local governments out of
proceeds from bond sales, the general fund realized surpluses of $0.4 billion,
$1.9 billion, $1.8 billion and $1.1 billion for the 1996, 1997, 1998 and 1999
fiscal years and a deficit of $1.4 billion for the 1995 fiscal year.
For decades, the State's economy has grown more slowly than that of the
rest of the nation as a whole. Part of the reason for this decline has been
attributed to the combined State and local tax burden, which is among the
highest in the nation. The State's dependence on Federal funds and sensitivity
to changes in economic cycles, as well as the high level of taxes, may continue
to make it difficult to balance State and local budgets in the future. The total
employment growth rate in the State has been below the national average since
1984. The State lost 524,000 jobs in 1990-1992. Only in the last year have the
State's total jobs reached the levels of before the recession of the early
1990s.
Despite recent budgetary surpluses, actions affecting the level of
receipts and disbursements, the relative strength of the State economy and
actions by the federal government have helped to create projected structural
budget gaps for the State. These gaps result from a significant disparity
between recurring revenues and costs of maintaining or increasing the level of
support for State programs. There can be no assurance that the Legislature will
enact the Governor's proposals or that the State's actions will be sufficient to
preserve budgetary balance in a given fiscal year or to align recurring receipts
and disbursements for future fiscal years. The fiscal effects of tax reductions
adopted in recent years are projected to grow more substantially in future
years, to over $4 billion a year by the State's 2002-03 fiscal year.
New York City (the "City"). The City is the State's major political
subdivision. In 1975, the City encountered severe financial difficulties,
including inability to refinance $6 billion of short-term debt incurred to meet
prior annual operating deficits. The City lost access to the public credit
markets for several years and depended on a variety of fiscal rescue measures
including commitments by certain institutions to postpone demands for payment, a
moratorium on note payment (later declared unconstitutional), seasonal loans
from the Federal government under emergency congressional legislation, Federal
guarantees of certain City bonds, and sales and exchanges of bonds by The
Municipal Assistance Corporation for the City of New York ("MAC") to fund the
City's debt.
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MAC has no taxing power and pays its obligations out of sales taxes
imposed within the City and per capita State aid to the City. The State has no
legal obligation to back the MAC bonds, although it has a "moral obligation" to
do so. MAC is now authorized to issue bonds only for refunding outstanding
issues and up to $1.5 billion should the City fail to fund specified transit and
school capital programs. S&P increased its rating of MAC bonds to AA in January
1998. MAC plans to covenant not to issue additional parity or prior lien debt in
the future other than refunding bonds. The State also established the Financial
Control Board ("FCB") to review the City's budget, four-year financial plans,
borrowings and major contracts. The FCB is required to impose a review and
approval process of the proposals if the City were to experience certain adverse
financial circumstances. The City's fiscal condition is also monitored by a
Deputy State Comptroller and by the City's Independent Budget Office.
From 1989 through 1993, the gross city product declined by 10.1% and
employment, by almost 11%, while the public assistance caseload grew by over
25%. The City's unemployment declined from 10.8% in 1992 to 8.1% in 1995.
Although the City added more jobs in 1997 than any year since 1987, unemployment
averaged 9.4% for the year. Unemployment fell to 6.4% in the last quarter of
1999, still well above the national average. With new fraud detection procedures
(including fingerprinting) since January, 1995, public assistance recipients
decreased to 622,000 by the end of 1999.
While the City, as required by State law, has balanced its budgets in
accordance with GAAP since 1981, this has required exceptional measures in
recent years. City expenditures grew faster than revenues each year since 1986,
masked in part by a large number of non-recurring gap closing actions. To
eliminate potential budget gaps of $1-$3 billion each year since 1988 the City
has taken a wide variety of measures. In addition to increased taxes and
productivity increases, these have included hiring freezes and layoffs,
reductions in services, reduced pension contributions, and a number of
nonrecurring measures such as bond refundings, transfers of surplus funds from
MAC, sales of City property and tax receivables. The FCB concluded that the City
has neither the economy nor the revenues to do everything its citizens have been
accustomed to expect.
The City closed a projected $3.1 billion budget gap for the 1996 fiscal
year. The Financial Plan reduced a wide range of City services. City agency and
labor savings were projected at $1.2 billion and $600 million respectively.
During the fiscal year, the Major implemented several additional spending
reductions as various proposals (including projected State and Federal aid
increases) failed to be implemented. An additional debt refinancing was also
made. Non-recurring measures (including a $250 million payment from the MTA in
exchange for an agreement to issue $500 million in bonds over the next four
years for transit improvements and a $300 million sale of tax liens) rose to
$1.3 billion. One of the Mayor's privatization proposals has been to sell or
lease City hospitals. In October, 1995, S&P reduced its rating on Health and
Hospitals Corporation debt to BBB- (its lowest investment-grade rating), citing
City failure to articulate a coherent strategy for the hospital system. Other
proposals including mandatory managed care programs for Medicaid recipients have
been blocked. The City Comptroller predicted that certain reductions in Medicaid
and welfare expenditures may lead to job reductions and higher costs for other
programs. The Board of Education also faced reductions of $265 million in State
aid and $189 million in Federal aid.
For the 1997 fiscal year, the City faced a projected $2.6 billion gap
including $1.7 billion of increased operating expenditures, $800 million of
increased debt service and a $150 million decline in revenues. Gap-closing
measures in the Financial Plan included $1.2 billion of agency spending
reductions and extension of the personal income tax surcharge. In August, 1996,
the Major directed City agencies to plan for $500 million in further spending
reductions. A surplus of $1.4 billion, in large part because of the boom in the
financial sector, was used to prepay debt service due during the 1998 and 1999
fiscal years.
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For the fiscal year ended June 30, 1998, the City adopted a budget to
close a projected $1.6 billion gap, including $2.0 billion of non-recurring
measures. A surplus of over $2 billion was realized.
The City transferred $920 million from fiscal 1998 for payment of 1999
debt service and $210 million for 2000 debt service. For the fiscal year ended
June 30, 1999, the City realized a surplus of over $2 billion. Despite repeal of
the commuter tax, reflecting the strong economy and a $2.6 billion discretionary
transfer from fiscal 1999, the City projects another balanced budget for fiscal
2000, and is proposing a discretionary transfer of a projected $2.9 billion
surplus to the 2001 fiscal year. However, fiscal monitors warn that this surplus
is non-recurring. The City proposes a tax reduction program totaling $364-$1100
million a year for 2001-04.
City-projected future budget gaps are $1.7 billion, $2.0 billion and $1.8
billion, respectively, for the 2002, 2003 and 2004 fiscal years; fiscal monitors
have higher estimates, commenting that the City needs to take significant
additional actions to work toward structural balance.
A major uncertainty is the City's labor costs, which represent about 50%
of its total expenditures. Although the City workforce was reduced by over
12,000 workers since January 1994, with wage and benefit increases and overtime,
wage costs continue to grow. Contracts with virtually all of the City's labor
unions expire in 2000 and 2001. The City's Financial Plan projects merit
increases for the two years, after current collective bargaining agreements
expire and no increases for later years. Initial City contract proposals for
merit pay increases were rejected out of hand.
Budget balance may also be adversely affected by the effect of the economy
on economically sensitive taxes, should the current national expansion slow or
reverse. The City also faces uncertainty in its dependence on Federal and State
aid. Federal and State welfare reform provisions may require additional training
programs to satisfy workfare guidelines and also additional City expenditures
for immigrants disqualified. A Federal judge barred the City from expanding
welfare qualification requirements until the City assures prompt access to food
stamps and Medicaid applications. There can be no assurance that City pension
contributions will continue to be reduced by investment performance exceeding
assumptions. Other uncertainties include additional expenditures to combat
deterioration in the City's infrastructure (such as bridges, schools and water
supply), the costs of providing alternative disposition of City trash to the
Fresh Kills landfill (required to close by December 2001), cost of the AIDS
epidemic and problems of drug addiction and homelessness. Elimination of any
additional budget gaps will require various actions, including by the State, a
number of which are beyond the City's control.
City hospitals are struggling with increasing numbers of uninsured
patients, while the Governor vetoed a bill that would have lifted a cap on
Federal Medicaid grant requests by these hospitals. The State's highest court in
1999 ruled that the City is not authorized to lease or sell its hospitals
without enabling legislation from the State. The courts have also ordered the
Mayor to cooperate with audits by the State Comptroller and to provide
information requested by the Independent Budget Office. The Mayor continues to
encounter opposition from the City council, including on his plan to increase
the police force, to build a new stadium for the Yankees, and to locate homeless
shelters. And the City has failed thus far in several years' efforts to force
the Port Authority to increase its lease payments on the City's two airports;
the claims are being arbitrated.
The City sold $1.1 billion, $500 million and $750 million of short-term
notes, respectively, during the 1998, 1999 and 2000 fiscal years. At March 31,
2000, there were outstanding $26.2 billion of City bonds (not including City
debt held by MAC), $2.9 billion of MAC bonds and $1.7 billion of City-related
public benefit corporation indebtedness, each net of assets held for debt
service. Standard & Poor's and Moody's during the 1975-80 period either withdrew
or reduced their ratings of the City's bonds. Standard & Poor's rates the City's
general
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obligation debt A-. Moody's rates City bonds A3. City-related debt doubled since
1987, although total debt declined as a percentage of estimated full value of
real property. The City also anticipates spending about $1 billion over the next
ten years on its upstate watershed area in an effort to avoid building a
filtration plant, estimated to cost $7 billion. Efforts to modernize upstate
sewage disposal are significantly behind schedule. There can be no assurance
that these measures will satisfy Environmental Protection Agency water purity
standards. To prevent the City from reaching the constitutional limit on its
general obligation debt (based on real estate values), the State in 1997
authorized creation of the New York City Transitional Finance Authority, to sell
up to $7.5 billion of additional bonds. Bonds are backed by City personal income
and sales tax revenues, to fund capital projects. The bonds are rated Aa3 by
Moody's and AA by S&P. The City is seeking to have the TFA's authorization
raised to $11.5 billion. Without this relief, City bond issuances would reach
the debt limit in the 2001 fiscal year. The City's Budget Director advised that
the City will hold off any new construction or debt issuance unless legislation
this year authorizes the increase. The City's financing program projects
long-term financing during fiscal years 2000-2004 to aggregate $25.5 billion,
including $5.8 billion from the Transitional Finance Authority, $6.6 billion of
Water Authority financing and $2.4 billion from the TSASC Inc. (which issues
bonds against anticipated settlements from tobacco litigation). Debt service is
expected to reach 19% of City tax revenues by 2002, up from 12.3% in 1990. The
City's Ten Year Capital Strategy plans capital expenditures of $48.1 billion
during 2000-2009 (96% City funded). This plan assumes State repeal of the Wicks
law governing City contracting, for a saving of $1.9 billion in construction
costs over the 10-year period.
Other New York Localities. In 1997, other localities had an aggregate of
approximately $20.7 billion of indebtedness outstanding. $102.3 million was for
deficit financing. In recent years, several experienced financial difficulties.
A Financial Control Board was established for Yonkers in 1984 and a Municipal
Assistance Corporation for Troy in 1995. In 1996, the State purchased debt
issued by Troy and Utica to avert defaults when those bonds were not bought by
others. Troy, Utica, Newburgh, Cohoes and Niagara Falls general obligations are
rated below investment grade. Buffalo, with a minimum investment grade rating,
is on CreditWatch with negative implications. In the last fiscal year, Nassau
County averted a deficit by selling its hospital and anticipating the tobacco
litigation settlement. The County is anticipating a deficit of nearly $200
million for the current year, exacerbated by a political stalemate. The Governor
appointed a special advisor to review the County's finances and has offered
Nassau County a $100 million bailout plan, contingent upon $260 million of
budget cuts over the next 4 years. He also proposed reissuance of $220 million
of debt through a temporary oversight board. The special advisor projected
annual deficits rising to $321 million in 2003 without further action; he also
criticized excessive debt issued for cash flow purposes ($485 million in 2000).
After two postponements, the County recently sold some $200 million in bonds,
mostly insured. The County's general obligation debt is rated BBB by Standard
and Poor's and Baa3 by Moody's, with a negative outlook. A March 1993 report by
Moody's Investors Service concluded that the decline in ratings of most of the
State's largest cities in recent years resulted from the decline in the State's
manufacturing economy. Any reductions in State aid to localities may cause
additional localities to experience difficulty in achieving balanced budgets.
County executives have warned that reductions in State aid to localities to fund
future State tax reductions are likely to require increased local taxes. If
special local assistance were needed from the State in the future, this could
adversely affect the State's as well as the localities' financial condition.
Most localities depend on substantial annual State appropriations. Legal actions
by utilities to reduce the valuation of their municipal franchises, if
successful, could result in localities becoming liable for substantial tax
refunds.
State Public Authorities. In 1975, after the Urban Development Corporation
("UDC"), with $1 billion of outstanding debt, defaulted on certain short-term
notes, it and several other State authorities became unable to market their
securities. From 1975 through 1987 the State provided substantial direct and
indirect financial assistance to UDC, the Housing Finance Agency ("HFA"), the
Project Finance Agency, the Environmental Facilities Corporation and other
authorities.
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Practical and legal limitations on these agencies' ability to pass on rising
costs through rents and fees could require further State appropriations. In July
1996, the Public Authorities Control Board approved a $650 million refinancing
by the Empire State Development Corp. (formerly the UDC) to bail out the
deficit-ridden Job Development Authority. 17 State authorities had an aggregate
of $94.1 billion of debt outstanding at December 31, 1998, of which
approximately $31 billion was State-supported. At March 31, 1999, approximately
$0.2 billion of State public authority obligations was State-guaranteed, $0.6
billion was moral obligation debt and $25.9 billion was financed under
lease-purchase or contractual obligation financing arrangements with the State.
Various authorities continue to depend on State appropriations or special
legislation to meet their budgets.
The Metropolitan Transportation Authority ("M.T.A."), which oversees
operation of the City's subway and bus system by the City Transit Authority (the
"TA") and operates certain commuter rail lines, has required substantial State
and City subsidies, as well as assistance from several special State taxes. The
City's Financial Plan forecasts cash-basis gaps of $229 million in 2000 (which
is expected to be closed), $528 million in 2001 and $659 million in 2002.
Substantial claims have been made against the TA and the City for damages
from a 1990 subway fire and a 1991 derailment. The M.T.A. infrastructure,
especially in the City, needs substantial rehabilitation. The M.T.A. $18 billion
capital plan for 2000-2004 has been approved, including $10 billion in new debt
backed increasingly by fare revenue. It also proposes to refinance $12 billion
of outstanding debt and would extend payments, costing $5.4 billion over the
bonds' 30-year life. Revised covenants in the new plan would lower the debt
service reserve fund and eliminate the capital reserve fund. State subsidies
will almost double in the State budget approved May 2000. The State expects to
provide $847 million in operating funds, postponing any fare increases for the
next year. It is anticipated that the M.T.A. and the TA will continue to require
significant State and City support.
Litigation. The State and the City are defendants in numerous legal
proceedings, including challenges to the constitutionality and effectiveness of
various welfare programs, alleged torts and breaches of contract, condemnation
proceedings and other alleged violations of laws. Adverse judgments in these
matters could require substantial financing not currently budgeted. The State
estimates unfavorable judgments of $895 million, of which $132 million was
expected to be paid during the latest fiscal year. Claims in excess of $458
billion were outstanding against the City at June 30, 1999, for which it
estimated its potential future liability at $3.5 billion, in addition to real
estate certiorari proceedings with an estimated liability of $406 million. City
settlements were $424 million in fiscal 1999, up from $175 million in fiscal
1990. Several actions seek judgments that, as a result of an overestimate by the
State Board of Equalization and Assessment, the City's real estate tax levy in
1993-1996 exceeded constitutional limits; if upheld, substantial tax refunds
would be due and this could also adversely affect the City's constitutional debt
limit. A class action on behalf of some 65,000 persons challenging the
Department of Corrections' strip search policy could pose a risk of more than $1
billion to the City.
Final adverse decisions in any of these cases could require extraordinary
appropriations at either the State or City level or both.
Year 2000 Compliance. Both the State and City have programs under way to
address compliance of mission-critical and high priority computer systems. The
State, in March, 1998, estimated that work had been completed on 20% of these
systems, with at least 40% of the work completed on the remaining systems. The
City recently stated that remediation and testing had been completed on 54% of
its mission critical and high priority systems.
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NORTH CAROLINA
The following information is a brief summary of some of the factors
affecting the economy in the State and does not purport to be a complete
description of such factors. This summary is based on publicly available
information and forecasts which have not been independently verified by the
Sponsors or their legal counsel.
RISK FACTORS--See Portfolio for a list of the Debt Obligations included in
the North Carolina Trust. The portions of the following discussion regarding the
financial condition of the State government may not be relevant to general
obligation or revenue bonds issued by political subdivisions of the State. Those
portions and the sections which follow regarding the economy of the State are
included for the purpose of providing information about general economic
conditions that may or may not affect issuers of the North Carolina Debt
Obligations. None of the information is relevant to any Puerto Rico or Guam Debt
Obligations which may be included in the portfolio of the North Carolina Trust.
General obligations of a city, town or county in North Carolina are
payable from the general revenues of the entity, including ad valorem tax
revenues on property within the jurisdiction. Revenue bonds issued by North
Carolina political subdivisions include (1) revenue bonds payable exclusively
from revenue-producing governmental enterprises and (2) industrial revenue
bonds, college and hospital revenue bonds and other "private activity bonds"
which are essentially non-governmental debt issues and which are payable
exclusively by private entities such as non-profit organizations and business
concerns of all sizes. State and local governments have no obligation to provide
for payment of such private activity bonds and in many cases would be legally
prohibited from doing so. The value of such private activity bonds may be
affected by a wide variety of factors relevant to particular localities or
industries, including economic developments outside of North Carolina. In
addition, the Trust is concentrated on Debt Obligations of North Carolina
issuers and is subject to additional risk from decreased diversification as well
as factors that may be particular to North Carolina or, in the case of revenue
bonds payable exclusively from private party revenues or from specific state
non-tax revenue, factors that may be particular to the related activity or
payment party.
Section 23-48 of the North Carolina General Statutes appears to permit any
city, town, school district, county or other taxing district to avail itself of
the provisions of Chapter 9 of the United States Bankruptcy Code, but only with
the consent of the Local Government Commission of the State and of the holders
of such percentage or percentages of the indebtedness of the issuer as may be
required by the Bankruptcy Code (if any such consent is required). Thus,
although limitations apply, in certain circumstances political subdivisions
might be able to seek the protection of the Bankruptcy Code.
State Budget and Revenues
The North Carolina State Constitution requires that the total expenditures
of the State for the fiscal period covered by each budget not exceed the total
of receipts during the fiscal period and the surplus remaining in the State
Treasury at the beginning of the period. In November 1996, the voters of the
State approved a constitutional amendment giving the Governor the power to veto
certain legislative matters, including budgetary matters.
From 1994 until 1998, the State had a budget surplus, in part as a result
of new taxes and fees and spending reductions put into place in the early 1990s.
In addition, the State, like the nation, has experienced economic recovery
during the 1990s. However, the State faces a budget shortfall for the fiscal
year ending June 30, 2000. The State budget is based upon estimated revenues and
a multitude of existing and assumed State and non-State factors, including State
and national economic conditions, international activity and federal government
policies and legislation. The authorized unreserved General Fund balance at June
30, 1999, the end of the
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1998-99 fiscal year, was approximately $323,574,714, and the reserved balance of
the General Fund was $40,898,397.
Growth in the individual income tax is expected to be solid, although
unspectacular in 2000-01. Strong labor market conditions along with acceleration
in average wages will continue to propel state total withholding payments in
2000-01. Rising interest rates and the beginnings of the post-Floyd recovery of
the state's farm sector will provide a boost to non-withholding tax receipts.
Overall, growth in the individual income tax is currently forecast at 8.1% in
2000-01.
In the 2000-01 Budget prepared by the Office of State Budget and
Management, it was projected that General Fund net revenues, including non-tax
revenues, would increase 5.8% over 1999-2000.
It is unclear what effect these developments at the State level may have
on the value of the Debt Obligations in the North Carolina Trust.
Litigation
Bailey v. State and Patton v. State--State Income Tax Refunds for Retired
State and Federal Workers. Bailey is a class action involving the claim that the
General Assembly acted unconstitutionally in 1989 when it repealed the full
exemption from State income tax for the pensions of retired state and local
government employees. This action was taken in response to the United States
Supreme Court decision in Davis v. Michigan Department of Treasury that the
intergovernmental tax immunity doctrine prohibits states from taxing pensions of
state and federal retirees differently. Patton is a class action involving the
claim that the General Assembly's 1989 legislation did not cure the defects in
the State's taxation of the pensions of state and federal retirees.
The State defended Bailey on the grounds that the people of the State in
enacting Article V, Sec. 1 of the State Constitution ("The power of taxation
shall . . . never be surrendered, suspended or contracted away") vested in the
General Assembly the full discretion to change tax exemptions as conditions
warranted. On May 8, 1997, the North Carolina Supreme Court chose not to apply
Article V, Sec. 1 of the State Constitution and held that the General Assembly
acted unconstitutionally when it repealed the full tax exemption for state and
local government retirees who had "vested" interests in their pensions.
Overturning a long line of prior decisions, the Court further held that the
State was liable for full refunds of all state income taxes paid by these
retirees since 1989 regardless of whether they had followed required procedures.
One potential result of the Bailey decision was to recreate a difference
in the treatment of the pensions of federal and state retirees for the period
since 1989, and thus make the State liable to federal retirees in Patton. Given
the Supreme Court's decision in Bailey and its potential impact in Patton, the
General Assembly agreed to settle all claims for refunds by all state and
federal retirees for $799 million. The North Carolina General Assembly reserved
$400 million to pay the first installment of the settlement, which was paid
during fiscal year 1999-2000. This amount has been reported in the State's
financial statements as a liability of the General Fund. The remaining $399
million has been reported as a liability in the General Long-term Obligation
Account Group.
Faulkenbury v. Teachers' and State Employees' Retirement System, Peele v.
Teachers' and State Employees' Retirement System and Woodard v. Local Government
Employees' Retirement System--Payment of Retirement Benefits. Plaintiffs are
disability retirees who brought class actions in state court challenging changes
in the formula for payment of disability retirement benefits and claiming
impairment of contract rights, breach of fiduciary duty, violation of other
federal constitutional rights, and the violation of state constitutional and
statutory rights. Their claims were heard in the Superior Court of Wake County
in May, 1995. The trial court ruled in
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favor of the plaintiffs, and the State appealed to the North Carolina Supreme
Court. The Supreme Court affirmed the judgment of the trial court in favor of
the plaintiffs on April 11, 1997. The court concluded that at the time
plaintiffs' rights to pensions became vested, the law provided that they would
have disability retirement benefits calculated in a certain way; and that these
were contractual rights that plaintiffs earned and that could not be taken away
by the Legislature. The trial court is now supervising the payment of back
benefits to class members. The estimated amount of back benefits due to class
members is $126 million, plus interest. This amount has been reported in the
financial statements of the State as a liability of the Teachers' and State
Employees' Retirement System.
As of June 30, 2000, there remain about 387 eligible estates which have
not made claims, as well as several hundred eligible individuals class members
who have not exercised their right to make an election. Additionally, the court
has ordered additional interest to be paid to class members, the amount of which
totals less than 2% of the original payout amount. A hearing is scheduled August
11, 2000 for these matters. The last payment date was October, 1999.
Leandro et al. v. State of North Carolina and State Board of Education
--Adequacy of Public Education System. On May 25, 1994, students and boards of
education in five counties in the State filed suit in Superior Court requesting
a declaration that the State's public education system does not meet standards
established by the State Constitution. In January, 1995, the trial court refused
to dismiss the suit and the State appealed. Subsequently, the North Carolina
Court of Appeals reversed the trial court and dismissed the suit. On July 24,
1997, the North Carolina Supreme Court reversed the Court of Appeals. The Court
concluded that the North Carolina Constitution guarantees "every child of this
state an opportunity to receive a sound basic education," and remanded that
issue to the trial court for further proceedings.
The Attorney General's Office believes that there are sound legal
arguments to support the State's position on remand that plaintiffs are
receiving an opportunity to obtain a sound basic education.
N.C. School Boards Association, et al. v. Harlan E. Boyles, State
Treasurer, et al.--Use of Administrative Payments. On December 14, 1998,
plaintiffs, including county school boards for Wake, Durham, Johnston, Buncombe,
Edgecombe and Lenoir Counties, filed suit in Superior Court requesting a
declaration that certain payments to State administrative agencies must be
distributed to the public schools on the theory that such amounts are fines
which under the North Carolina Constitution must be paid to the schools.
Smith/Shaver Cases--State Tax Refunds--Intangibles Tax. The Smith case is
a class action tax refund lawsuit related to litigation in Fulton Corporation v.
Faulkner, a case filed by a single taxpayer and decided by the United States
Supreme Court in 1996 regarding the constitutionality of intangibles taxes
previously collected by the State on shares of stock. On July 7, 1995, while the
Fulton case was pending before the United States Supreme Court, the Smith class
action was commenced in North Carolina Superior Court on behalf of all taxpayers
who paid the tax and complied with the requirements of the applicable tax refund
statute, N.C. Gen. Stat. ss. 105-267, including its 30-day demand requirements.
These original plaintiffs were later designated Class A when a second group of
taxpayers were added. The new class, designated Class B, consisted of taxpayers
who had paid the tax but failed to comply with the refund statute's 30-day
demand requirement. On June 11, 1997, judgment was entered awarding the Class A
plaintiffs refunds totaling $120,000,000, with interest, and these refunds have
been paid. In a separate order also entered on June 11, 1997, Class B was
decertified and the refund claims of Class B taxpayers were dismissed. Class
counsel appealed the Class B decertification/dismissal order, and on December 4,
1998, the North Carolina Supreme Court reversed the dismissal. As a result of
the Smith decision, the State will be required to pay refunds to Class B
intangibles taxpayers. The State estimates that its liability for tax refunds,
with interest through June 30, 1999, plus administrative costs and legal fees,
will be approximately $440,000,000.
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A second class action tax refund lawsuit, Shaver, et al. v. North
Carolina, et al., was filed on January 16, 1998, by the same taxpayers as Class
B plaintiffs in Smith under alternative theories of recovery for tax years 1991
through 1994 and for refunds for one additional tax year, 1990. Their additional
claim for 1990 totals approximately $100,000,000. Given the outcome of the Smith
case, the North Carolina Attorney General's Office believes that sound legal
arguments support dismissal as moot of the Shaver refund claims for tax years
1991 through 1994 and dismissal of the refund claims for tax year 1990 as barred
by the statute of limitations.
Southeast Compact Commission--Disposal of Low-level Radioactive Waste.
North Carolina and seven other southeastern states created the Southeast
Interstate Low-level Radioactive Waste Management Compact to plan and develop a
site for the disposal of low-level radioactive waste generated in the member
states. North Carolina was assigned responsibility for development of the first
disposal site, with costs to be distributed equitably among the Compact members.
In 1997 the Compact Commission discontinued funding of the development of the
North Carolina site, alleging that the State was not actively pursuing the
permitting and development of the proposed site. North Carolina withdrew from
the Compact in 1999. The Compact recently voted to pursue sanctions against
North Carolina, including the repayment, with interest, by the State to the
Compact Commission of $80 million of Compact member payments expended on the
permitting of the site. The North Carolina Attorney General's office believes
that sound legal arguments support the State's position on this matter.
The State is involved in numerous other claims and legal proceedings, many
of which normally occur in governmental operations; however, the North Carolina
Attorney General does not expect any of the other outstanding lawsuits to
materially adversely affect the State's ability to meet its financial
obligations.
General
The State is located on the Atlantic seacoast and is bordered by the
states of South Carolina, Georgia, Tennessee and Virginia. The State has a land
area, exclusive of waterways and lakes, of 48,718 square miles. During the
period from 1980 to 1990 the State experienced a 12.9% increase in population,
growing to 6,655,455 persons and maintaining its position as the tenth most
populous state. According to the North Carolina Office of State Planning, the
State's estimated population as of July 1999 was 7,658,145, and it estimates
this population will reach 7,756,517 by July 2000. The State has six
municipalities with populations in excess of 100,000.
Economic Characteristics
The economic profile of the State consists of a combination of industry,
agriculture and tourism. Nonagricultural wage and salary employment accounted
for approximately 3,866,100 jobs in 1999. The largest segment of jobs was
approximately 802,700 in manufacturing. Based on July 1997 data from the United
States Bureau of Labor Statistics, the State ranked tenth among the states in
non-agricultural employment and eighth among the states in manufacturing
employment. During the period from 1990 to 1998, per capita income in the State
grew from $16,674 to $24,036, an increase of 44.2%. The Employment Security
Commission estimated the seasonally adjusted unemployment rate in March 2000 to
be 3.4% of the labor force, as compared with an unemployment rate of 4.0%
nationwide. According to the Employment Security Commission, the labor force has
grown from 2,855,200 in 1980 to 3,953,500 in 2000, an increase of 38.5%.
North Carolina's economy continues to benefit from a vibrant manufacturing
sector. Manufacturing firms employ approximately 21% of the total
non-agricultural workforce. North Carolina has the fourth highest percentage of
manufacturing workers in the nation. The State's annual value of manufacturing
shipments totaled $156 billion in 1997, ranking the State eighth in the nation.
The State leads the nation in the production of textiles, tobacco products, and
furniture
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and is among the largest producers of electronics and other electrical equipment
and industrial and commercial machinery and computer equipment.
In 1998, the State ranked fourth in the nation after Michigan, California,
Ohio, and New York in new corporate locations and expansions, with 1,044
announced new facilities and expansions. The State also ranked first in both new
jobs and new location projects per one million residents for 1996-1998.
In 1998 there was an unprecedented $8 billion in new corporate investment
in the State, led by Nucor Corporation and Federal Express, with investments of
approximately $300 million each. Total manufacturing investments increased 18.8
percent to $4.7 billion over 1997, and non-manufacturing investments more than
doubled at $3.1 billion over 1997.
More than 734 international firms have established a presence in the
State. Charlotte is the second largest financial center in the country, based on
assets of banks headquartered there. Bank of America, N.A., the nation's largest
bank, is based in Charlotte. The strength of the State's manufacturing sector
also supports the growth in exports. Foreign-owned firms invested more than $1
billion in the State in 1998, and created 7,173 new jobs. The 1997 annual
statistics showed $18.0 billion in exports, tenth among the States in export
trade.
Agriculture is a basic element in the economy of the State. Gross
agricultural income reached over $7 billion in 1998, placing the State eighth in
the nation in gross agricultural income. The poultry industry is the leading
source of agricultural income in the State, accounting for approximately 31% of
gross agricultural income. The pork industry provides approximately 18% of the
gross agricultural income. The tobacco industry remains important to the State
providing approximately 14% of gross agricultural income. In 1997, the State
also ranked third in the nation in net farm income.
The diversity of agriculture in North Carolina and a continuing emphasis
on marketing efforts have protected farm income from some of the wide variations
that have been experienced in other states where most of the agricultural
economy is dependent on a small number of agricultural commodities. North
Carolina has the third most diversified agricultural economy in the nation.
According to the State Commissioner of Agriculture, the State ranks first
in the nation in the production of all tobacco, flue-cured tobacco, turkeys and
sweet potatoes and second in hog production, trout, the production of Christmas
trees, and cucumbers for pickles. The State ranks third in poultry and egg
products. In 1998 there were approximately 58,000 farms in the State. A strong
agribusiness sector also supports farmers with farm inputs (agricultural
chemicals and fertilizer, farm machinery and building supplies) and processing
of commodities produced by farmers (vegetable canning and cigarette
manufacturing). North Carolina's agricultural industry, including food, fiber
and forest, contributes over $46 billion annually to the State's economy,
accounts for nearly 25% of the State's income and employs approximately 22% of
the State's work force.
As stated in the August 27, 1999 Official Statement of the Department of
State Treasurer relating to the State of North Carolina General Obligation
Bonds, on November 23, 1998, 46 states' Attorneys General and the major tobacco
companies signed a proposed settlement that reimburses states for
smoking-related medical expenses paid through Medicaid and other health care
programs. North Carolina could receive approximately $4.6 billion over the next
25 years. The settlement was approved in North Carolina by a Consent Decree in
December 1998. On March 16, 1999, the General Assembly enacted a law approving
the establishment of a foundation, in compliance with the Consent Decree, to
help communities in North Carolina hurt by the decline of tobacco farming. The
court must review the law for compliance with the intent outlined in the Consent
Decree. The foundation would receive fifty percent of the settlement. A trust
fund for
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tobacco farmers and quota holders and a second trust fund for health programs,
both to be created by the General Assembly, would each get twenty-five percent
of the settlement.
North Carolina is also one of the 14 states that has entered into a major
settlement agreement with several cigarette manufacturers. Approximately $1.9
billion of settlement payments (under the National Tobacco Growers Settlement
Trust phase of the settlement agreement) will be paid to North Carolina tobacco
growers and allotment holders. Payments of this amount are scheduled to begin in
December 1999 and are expected to average $155 million per year over a 12-year
period.
The North Carolina Department of Commerce, Division of Tourism, Film and
Sports Development, indicates that travel and tourism is increasingly important
to the State's economy. Forty-four million visitors in 1999 contributed to the
$11.9 billion travel and tourism economic impact for the state, a 5.8% increase
over 1998. The North Carolina travel and tourism industry directly supports
198,200 jobs. Without these jobs generated by travel, North Carolina's
unemployment rate would have been 5.2 percent higher.
Employment indicators have varied somewhat in the annual periods since
June of 1990, but have demonstrated an upward trend since 1991. The following
table reflects the fluctuations in certain key employment categories.
<TABLE>
<CAPTION>
========================================================================================================================
Category (all seasonally adjusted) June 1995 June 1996 June 1997 June 1998 July 1999
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Civilian Labor Force 3,578,000 3,704,000 3,797,000 3,776,000 3,846,000
------------------------------------------------------------------------------------------------------------------------
Nonagricultural Employment 3,419,100 3,506,000 3,620,300 3,758,800 3,837,900
------------------------------------------------------------------------------------------------------------------------
Goods Producing Occupations 1,036,700 1,023,800 1,041,000 1,045,400 1,025,800
(mining, construction and
manufacturing)
------------------------------------------------------------------------------------------------------------------------
Service Occupations 2,382,400 2,482,400 2,579,300 2,713,400 2,812,100
------------------------------------------------------------------------------------------------------------------------
Wholesale/Retail Occupations 776,900 809,1000 813,500 848,300 875,000
------------------------------------------------------------------------------------------------------------------------
Government Employees 555,300 570,800 579,600 594,800 617,600
------------------------------------------------------------------------------------------------------------------------
Miscellaneous Services 742,200 786,100 852,500 923,100 960,200
------------------------------------------------------------------------------------------------------------------------
Agricultural Employment 53,000 53,000 not available not available not available
========================================================================================================================
</TABLE>
Bond Ratings
Currently, Moody's rates North Carolina general obligation bonds as Aaa
and Standard & Poor's rates such bonds as AAA.
The Sponsor believes the information summarized above describes some of
the more significant events relating to the North Carolina Trust. The sources of
this information are the official statements of issuers located in North
Carolina, State agencies, publicly available documents, publications of rating
agencies and statements by, or news reports of statements by, State officials
and employees and by rating agencies. The Sponsor and its counsel have not
independently verified any of the information contained in the official
statements and other sources, and counsel have not expressed any opinion
regarding the completeness or materiality of any matters contained in this
Prospectus other than the tax opinions set forth below under North Carolina
Taxes.
OHIO
The following information is a brief summary of some of the factors
affecting the economy in the State and does not purport to be a complete
description of such factors. This summary is based on publicly available
information and forecasts which have not been independently verified by the
Sponsors or their legal counsel.
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RISK FACTORS--The following summary is based on publicly available
information which has not been independently verified by the Sponsors or their
legal counsel.
Employment and Economy. Economic activity in Ohio, as in many other
industrially developed states, tends to be more cyclical than in some other
states and in the nation as a whole. In 1999, Ohio ranked seventh in the nation
with $362 billion in gross state products, and was third in manufacturing.
Payroll employment in Ohio peaked in 1991, decreased slightly in 1992 and 1993,
but has increased steadily through 1999. Growth in recent years has been
concentrated among non-manufacturing industries, with manufacturing tapering off
since its 1969 peak. Approximately 80% of the payroll workers in Ohio are
employed by non-manufacturing industries.
The average monthly unemployment rate in Ohio was 3.6% in May, 2000.
With approximately 14.9 million acres in farm land, agriculture and
related sectors are a very important segment of the economy in Ohio, providing
an estimated 1,055,000 jobs or approximately 16% of total Ohio employment as of
year end 1996.
Ohio continues to be a major "headquarters" state. Of the top 500
corporations (industrial and service) based on 1999 revenues as reported in 2000
by Fortune magazine, 28 had headquarters in Ohio, placing Ohio tied for fifth as
a "headquarters" state for corporations.
The State Budget, Revenues and Expenditures and Cash Flow. Ohio law
effectively precludes the State from ending a fiscal year or a biennium with a
deficit. The State Constitution provides that no appropriation may be made for
more than two years and consistent with that provision the State operates on a
fiscal biennium basis. The current fiscal biennium runs from July 1, 1999
through June 30, 2001.
Under Ohio law, if the Governor ascertains that the available revenue
receipts and balances for the general revenue fund ("GRF") or other funds for
the then current fiscal year will probably be less than the appropriations for
the year, he must issue orders to State agencies to prevent their expenditures
and obligations from exceeding the anticipated receipts and balances.
As a first step toward addressing a then estimated $520 million GRF
shortfall for fiscal year 1993, the Governor ordered, effective July 1, 1992,
selected GRF appropriations reductions totalling $300 million (but such
reductions did not include debt service). Subsequent executive and legislative
actions provided for positive biennium-ending GRF balances. The GRF ended the
1992-93 biennium with a balance of approximately $111 million and a cash balance
of approximately $394 million.
The GRF appropriations act for the 1994-95 biennium provided for total GRF
biennial expenditures of approximately $30.7 billion. The 1994-95 biennium
ending GRF balance was $928 million.
The GRF appropriations act for the 1996-1997 biennium provided for total
GRF biennial expenditures of approximately $33.5 billion. The GRF 1996-1997
biennium GRF ending balance was over $834 million.
The GRF appropriations act for the 1998-1999 biennium provided for total
GRF biennial expenditures of approximately $36 billion. The 1998-1999 biennium
GRF ending balance was over $976 million.
The GRF appropriations act for the current biennium provides for total GRF
biennial expenditures of over $39.8 billion. Necessary GRF debt service was
provided for in the act. Litigation pending in the Ohio Court of Claims contests
the Ohio Department of Human Services
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("ODHS") prior Medicaid financial eligibility rules for married couples where
one spouse is living in a nursing facility and the other spouse resides in the
community. ODHS promulgated new eligibility rules effective January 1, 1996.
ODHS appealed an order of the federal court directing it to provide notice to
persons potentially affected by the former rules from 1990 to 1995, and the
Court of Appeals ruled in its favor. Plaintiffs' petition for certiorari was not
granted by the U.S. Supreme Court. As to the Court of Claims case, it is not
possible to state the period (beyond the current fiscal year) during which
necessary additional Medicaid expenditures would have to be made. Plaintiffs
have estimated total additional Medicaid expenditures at $600,000,000 for the
retroactive period and, based on current law, it is estimated that the State's
share of those additional expenditures is approximately $240,000,000. In April,
1999, the Court of Claims decertified the action as a class action; plaintiffs
have appealed the decertification. The State is seeking to appeal this decision
and filed a notice of appeal and memorandum seeking jurisdiction in the Ohio
Supreme Court on May 15, 2000.
Because GRF cash receipts and disbursements do not precisely coincide,
temporary GRF cash flow deficiencies often occur in some months of a fiscal
year, particularly in the middle months. Statutory provisions provide for
effective management of these temporary cash flow deficiencies by permitting
adjustment of payment schedules and the use of total operating funds. In fiscal
year 1998, a GRF cash flow deficiency occurred in five months with the highest
being approximately $742 million. In fiscal year 1999, a GRF cash flow
deficiency occurred in six months with the highest being approximately $498
million. The OBM projects GRF cash flow deficiencies will occur in fiscal year
2000.
State and State Agency Debt. The Ohio Constitution prohibits the
incurrence or assumption of debt by the State without a popular vote except for
the incurrence of debt to cover causal deficits or failures in revenue or to
meet expenses not otherwise provided for, but which are limited to $750,000 or
to repel invasions, suppress insurrection or defend the State in war. Under
interpretations by Ohio courts, revenue bonds of the State and State agencies
that are payable from net revenues of or related to revenue producing facilities
or categories of such facilities are not considered "debt" within the meaning of
these constitutional provisions.
From 1921 to date, Ohio voters approved sixteen constitutional amendments
authorizing the incurrence of State debt to which taxes or excises were pledged
for payment. The only such tax-supported debt still authorized to be incurred
are highway, coal development, local infrastructure, natural resources general
obligation bonds and common school and higher education facilities bonds.
A November, 1999 constitutional amendment provides a new annual debt
service cap for future issues of State general obligation bonds and other State
direct obligations payable from the GRF or net State lottery proceeds.
Generally, those new bonds may not be issued if future Fiscal Year debt service
on those new and the then outstanding bonds would exceed 5% of the total
estimated GRF revenues plus net State lottery proceeds during the Fiscal Year of
issuance. Application of the cap may be waived in a particular instance by a
three-fifths vote of each house of the General Assembly, and may be changed by
future constitutional amendments. Those direct obligations of the State include,
for example, bonds issued by the Ohio Public Facilities Commission, the Ohio
Building Authority and the Treasurer of the State that are paid from GRF
appropriations, but exclude bonds such as highway bonds that are paid from
highway user receipts. Pursuant to the amendment and implementing legislation,
the Governor has designated the Office of Budget Management Director as the
State official to make the 5% determinations and certifications.
Not more than $1.2 billion in certain state highway obligations may be
outstanding at any time and not more than $220 million can be issued in a fiscal
year. As of June 1, 2000, approximately $682.5 million of such highway
obligations were outstanding. The authority to issue certain other highway
obligations expired in December, 1996; however, as of June 1, 2000,
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approximately $174 million of such highway obligations were outstanding. Not
more than $100 million in State obligations for coal development may be
outstanding at any one time. As of June 1, 2000, approximately $31.3 million of
such coal obligations were outstanding. Not more than $2.4 billion of State
general obligation bonds to finance local capital infrastructure improvements
may be issued at any one time, and no more than $120 million can be issued in a
calendar year. As of June 1, 2000, approximately $1.062 billion of those bonds
were outstanding. Not more than $200 million of natural resources bonds may be
outstanding at any time, and no more than $50 million can be issued in any year.
As of June 1, 2000, approximately $135.3 million of those bonds were
outstanding. As of June 1, 2000, approximately $130.16 million common school
facilities bonds and approximately $150 million higher education facilities
bonds were outstanding.
The Ohio Constitution authorizes State bonds for certain housing purposes,
but tax moneys may not be obligated or pledged to those bonds. In addition, the
Ohio Constitution authorizes the issuance of obligations of the State for
certain purposes, the owners or holders of which are not given the right to have
excises or taxes levied by the State legislature to pay principal and interest.
Such debt obligations include the bonds and notes issued by the Ohio Public
Facilities Commission, the Ohio Building Authority and certain obligations of
the Treasurer of State.
The capital appropriations act for the 2001-2002 biennium authorized
additional borrowings, including over $930 million in general obligations for
education purposes.
A November, 1999 constitutional amendment authorizes State general
obligation debts to pay costs of facilities for a system of common schools
throughout the State and for State supported and State assisted institutions of
higher education. The amendment also provides that the additional general
obligation debt and other direct obligations of the State will be subject to the
5% GRF/lottery proceeds debt service cap previously described.
A statewide economic development program assists with loans and loan
guarantees, and the financing of facilities for industry, commerce, research and
distribution. The law authorizes the issuance of State bonds and loan guarantees
secured by a pledge of portions of the State profits from liquor sales. The
General Assembly has authorized the issuance of these bonds by the State
Treasurer, with a maximum amount of $300 million, subject to certain
adjustments, currently authorized to be outstanding at any one time. A 1996
issue of approximately $168.7 million of taxable bonds refunded previously
outstanding bonds. A 1998 issue of $101,980,000 of taxable forward purchase
refunding bonds were issued to refund certain term bonds of the 1996 issue. The
highest future fiscal year debt service on the outstanding bonds of these
issues, which are payable through 2021, is approximately $16.2 million.
An amendment to the Ohio Constitution authorizes revenue bond financing
for certain single and multifamily housing. No State resources are to be used
for the financing. As of June 1, 2000, the Ohio Housing Financing Agency,
pursuant to that constitutional amendment and implementing legislation, had sold
revenue bonds in the aggregate principal amount of approximately $391.9 million
for multifamily housing and approximately $6.23 billion for single family
housing. A constitutional amendment adopted in 1990 authorizes greater State and
political subdivision participation in the provision of housing for individuals
and families. The General Assembly could authorize State borrowing for this
purpose by the issuance of State obligations secured by a pledge of all or a
portion of State revenues or receipts, although the obligations may not be
supported by the State's full faith and credit.
A constitutional amendment approved in 1994 pledges the full faith and
credit and taxing power of the State to meet certain guarantees under the
State's tuition credit program. Under the amendment, to secure the tuition
guarantees, the General Assembly is required to appropriate moneys sufficient to
offset any deficiency that may occur from time to time in the trust fund that
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provides for the guarantee and at any time necessary to make payment of the full
amount of any tuition payment or refund required by a tuition payment contract.
Schools and Municipalities. The 611 public school districts and 49 joint
vocational school districts in the State receive a major portion (approximately
50% in fiscal year 1999) of their operating funds from State subsidy
appropriations, the primary portion known as the Foundation Program. They also
must rely heavily upon receipts from locally-voted taxes. Some school districts
in recent years have experienced varying degrees of difficulty in meeting
mandatory and discretionary increased costs. Current law prohibits school
closings for financial reasons.
State appropriations for primary and secondary education for the 1994-95
biennium provided for 2.4% and 4.6% increases in basic aid for the two fiscal
years of the biennium. State appropriations for primary and secondary education
for the 1996-97 biennium provided for a 13.6% increase in school funding
appropriations over those in the preceding biennium. State appropriations for
the 1998-99 biennium provide for an 18.3% increase over the previous biennium.
State appropriations for the current 2000-2001 biennium provide for a 15%
increase over the previous biennium.
In fiscal years 1979 through 1989, school districts facing deficits at
year end had to apply to the State for a loan from the Emergency School
Advancement Fund. From fiscal years 1990 through 1998, legislation replaced the
Fund with enhanced provisions for local school district borrowing, including
direct application of Foundation Program distributions to repayment if needed.
The annual number of loans under the Program ranged from 10 to 44, and aggregate
dollar amounts of loans ranged from over $11 million to approximately $113
million. In 1997, the Ohio Supreme Court found these provisions for local school
district borrowing to be unconstitutional. Beginning in fiscal year 1999, local
school districts facing operating deficits certified by the State Auditor may
apply for an advancement of future year Program distributions to be reimbursed
to the State over a two-year period. Six school districts received a total of
$12.1 million in solvency assistance advancements during fiscal year 1999, with
another six districts receiving a total of approximately $8.7 million in fiscal
year 2000, as of June 1, 2000. This solvency assistance program was held to be
not in compliance with the Ohio constitution in the Ohio Supreme Courts decision
in May, 2000.
In May, 2000, the Ohio Supreme Court concluded, as it had in 1997, that
major aspects of the State's system of school funding are unconstitutional. The
Court set as general base threshold requirements that every school district have
enough funds to operate, an ample number of teachers, sound and safe buildings,
and equipment sufficient for all students to be afforded an educational
opportunity. The Court maintained continuing jurisdiction and has schedule a
June, 2001 further review of the State's responses to its ruling. With respect
to funding sources, the Court repeated its 1997 conclusion that property taxes
no longer may be the primary means of school funding in Ohio, noting that recent
efforts to reduce the historic reliance have been laudable but in the Court's
view insufficient. It is not possible at this time to state what further actions
may be taken by the State to effect compliance, or what effect those actions may
have on the State's overall financial condition. In response to the ongoing
litigation, the General Assembly has significantly increased State funding for
public schools.
Various Ohio municipalities have experienced fiscal difficulties. Due to
these difficulties, the State established procedures to identify and assist
cities and villages experiencing defined "fiscal emergencies". A commission
appointed by the Governor monitors the fiscal affairs of municipalities facing
substantial financial problems. As of June 1, 2000, five municipalities are on
fiscal emergency status and two municipalities are on fiscal watch status.
State Employees and Retirement Systems. The State has established five
public retirement systems which provide retirement, disability retirement and
survivor benefits. Federal
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law requires newly-hired State employees to participate in the federal Medicare
program, requiring matching employer and employee contributions, each now 1.45%
of the wage base. Otherwise, State employees covered by a State retirement
system are not currently covered under the federal Social Security Act. The
actuarial evaluations reported by these five systems showed aggregate unfunded
accrued liabilities of approximately $8,469.3 million covering both State and
local employees.
The State engages in employee collective bargaining and currently operates
under three-year agreements, expiring at the end of June 2000, with all of its
21 bargaining units. New contracts have been agreed to with 14 of the State's
bargaining units and negotiations are underway, as of June 1, 2000, with the
remaining seven bargaining units.
Health Care Facilities Debt. Revenue bonds are issued by Ohio counties and
other agencies to finance hospitals and other health care facilities. The
revenues of such facilities consist, in varying but typically material amounts,
of payment from insurers and third-party reimbursement programs, such as
Medicaid, Medicare and Blue Cross. Consistent with the national trend,
third-party reimbursement programs in Ohio have begun new programs, and modified
benefits, with a goal of reducing usage of health care facilities. In addition,
the number of alternative health care delivery systems in Ohio has increased
over the past several years. For example, the number of health insuring
corporations licensed by the Ohio Department of Insurance increased from 12 in
1983 to 32 as of May 30, 2000. Due in part to changes in the third-party
reimbursement programs and an increase in alternative delivery systems, the
health care industry in Ohio has become more competitive. This increased
competition may adversely affect the ability of health care facilities in Ohio
to make timely payments of interest and principal on the indebtedness.
PENNSYLVANIA
The following information is a brief summary of some of the factors
affecting the economy in the State and does not purport to be a complete
description of such factors. This summary is based on publicly available
information and forecasts which have not been independently verified by the
Sponsors or their legal counsel.
RISK FACTORS--Potential purchasers of Units of the Pennsylvania Trust
should consider the fact that the Trust's portfolio consists primarily of
securities issued by the Commonwealth of Pennsylvania (the "Commonwealth"), its
municipalities and authorities and should realize the substantial risks
associated with an investment in such securities. Although the General Fund of
the Commonwealth (the principal operating fund of the Commonwealth) experienced
deficits in fiscal 1990 and 1991, tax increases and spending decreases have
resulted in surpluses the last several years; as of June 30, 1999, the General
Fund had a surplus of $2,863.4 million.
Pennsylvania's economy historically has been dependent upon heavy
industry, but has diversified recently into various services, particularly into
medical and health services, education and financial services. Agricultural
industries continue to be an important part of the economy, including not only
the production of diversified food and livestock products, but substantial
economic activity in agribusiness and food-related industries. Service
industries currently employ the greatest share of nonagricultural workers,
followed by the categories of trade and manufacturing. Future economic
difficulties in any of these industries could have an adverse impact on the
finances of the Commonwealth or its municipalities and could adversely affect
the market value of the Bonds in the Pennsylvania Trust or the ability of the
respective obligors to make payments of interest and principal due on such
Bonds.
Certain litigation is pending against the Commonwealth that could
adversely affect the ability of the Commonwealth to pay debt service on its
obligations, including, as of October 13,
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2000, suits relating to the following matters: (i) In February 1999, a taxpayer
filed a petition for review in the Pennsylvania Commonwealth Court asking the
court to declare that Chapter 5 (relating to Sports Facilities Financing) of the
Capital Facilities Debt Enabling Act violates the Pennsylvania Constitution. The
Commonwealth Court dismissed the action with prejudice, and the Supreme Court of
Pennsylvania affirmed the Commonwealth Court's decision. The petitioner has
filed a petition for a writ of certiorari with the United States Supreme Court;
(ii) In 1987, the Pennsylvania Supreme Court held the statutory scheme for
county funding of the judicial system to be in conflict with the Pennsylvania
Constitution, but it stayed its judgment to permit enactment by the legislature
of funding legislation consistent with the opinion. The Court appointed a
special master to submit a plan for implementation, and the special master
recommended a four-phase transition to state funding of a unified judicial
system, during each of which specified court employees would transfer into the
state payroll system. Phase 1, involving the transfer of approximately 165
county-level court administrators, was implemented in legislation enacted in
1999. The remainder of the recommendation for later phases remains pending
before the Supreme Court of Pennsylvania; (iii) In March 1998, certain
Philadelphia residents, the School District of Philadelphia and others brought
suit in the United States District Court for the Eastern District of
Pennsylvania against the Governor, the Secretary of Education and others
alleging that the defendants are violating a regulation of the U.S. Department
of Education promulgated under Title VI of the Civil Rights Act of 1964 and
certain other provisions in that the Commonwealth's system for funding public
schools has the effect of discriminating on the basis of race. The district
court dismissed the complaint, but in August 1999 the Third Circuit Court of
Appeals reversed and remanded for further proceedings. On June 23, 2000, by
agreement of the parties, the district court stayed all proceedings and placed
the case in civil suspense until approximately June 8, 2001; (iv) PPG Industries
has challenged the constitutionality of the manufacturing exemption from the
capital stock/franchise tax insofar as it limits the exemption for headquarters
property and payroll only to headquarters property and payroll attributable to
manufacturing in Pennsylvania. On appeal, the Pennsylvania Supreme Court held
that this limitation discriminates against interstate commerce, and it remanded
the case to Commonwealth Court for a determination whether the tax is a
"compensatory tax" justifying the discrimination or, failing that, a
recommendation for a remedy. In September 1999, the Commonwealth Court
recommended that (1) for the duration of the contested period, the limitation be
invalidated; and (2) prospectively, the manufacturing exemption be invalidated
in its entirety, leaving to the Pennsylvania legislature the task of amending
the statute to restore any exemption it chooses to adopt in a constitutional
manner. The legislature subsequently amended the state tax law to provide that
for the years 1999 and 2000 the manufacturing exemption will apply to both
in-state and out-of-state property and payroll. The Pennsylvania Court is
considering the Commonwealth Court's recommendation and the position of the
parties; and (v) Unisys Corporation has challenged the three-factor
apportionment formula used for the apportionment of capital stock value in the
Pennsylvania franchise tax. In a decision issued in March 1999, the Commonwealth
Court held for the taxpayer on statutory grounds, but denied its constitutional
claims. Both the Commonwealth and the taxpayer appealed to the Pennsylvania
Supreme Court. Briefs were filed during 1999. Recently, the Supreme Court
ordered the filing of supplemental briefs and scheduled oral argument for the
week of December 4, 2000.
Although there can be no assurance that such conditions will continue, the
Commonwealth's general obligation bonds are currently rated AA by Standard &
Poor's and Aa3 by Moody's, and Philadelphia's general obligation bonds are
currently rated BBB by Standard & Poor's and Baa2 by Moody's.
The City of Philadelphia (the "City") experienced a series of General Fund
deficits for Fiscal Years 1988 through 1992 and, while its general financial
situation has improved, the City is still seeking a long-term solution for its
economic difficulties. The audited balance of the City's General Fund as of June
30, 1998, was a surplus of approximately $169.2 million up from approximately
$128.8 million as of June 30, 1997.
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In recent years an authority of the Commonwealth, the Pennsylvania
Intergovernmental Cooperation Authority ("PICA"), has issued approximately $1.76
billion of Special Revenue Bonds on behalf of the City to cover budget
shortfalls, to eliminate projected deficits and to fund capital spending. As one
of the conditions of issuing bonds on behalf of the City, PICA exercises
oversight of the City's finances. The City is currently operating under a five
year plan approved by PICA in 2000. PICA's power to issue further bonds to
finance capital projects expired on December 31, 1994. PICA's power to issue
bonds to finance cash flow deficits expired on December 31, 1996, but its
authority to refund outstanding debt is unrestricted. PICA had approximately
$959 million in special revenue bonds outstanding as of June 30, 2000.
TEXAS
The following information is a brief summary of some of the factors
affecting the economy in the State and does not purport to be a complete
description of such factors. This summary is based on publicly available
information and forecasts which have not been independently verified by the
Sponsors or their legal counsel.
RISK FACTORS--The State Economy. As with most of the United States, Texas
has experienced significant economic growth during recent years. However, state
officials see indications that such economic growth has slowed and may continue
to slow for the foreseeable future. For the year ended December 31, 1999, such
officials estimate that the Texas economy grew at an annual rate of 4.6%, but
project that the growth (2000-2020) will be only 3.1% annually. A number of
factors now exist that indicate that such projections may be appropriate.
Over the past decade, the Texas economy has become more diverse and more
similar to the national economy. As a result of these changes, the Texas
workforce has now become more concentrated in the service and trade industries
as the concentration of workers in the petroleum industry has lessened. Although
the Texas economy has become more diverse, that diversity has made the economy
vulnerable to additional forces in the global and national economies. As
segments of the Texas economy, such as the computer, communications and
electronics industries, grow, the state's economy has also become subject to the
effects of downturns in those industries.
During the 1990s, Texas added more jobs than any other state (2.35
million), accounting for more than one-ninth of the nation's total job growth.
Through these ten years, the state ranked sixth in the rate of job growth,
exceeded only by five western mountain states with comparatively small
populations. Over the twelve months ending in February 2000, Texas gained
208,200 jobs, based on information from the Texas Workforce Commission.
The State's unemployment rate has fallen every year since 1992 and dropped
in 1999 to its lowest level since 1979. After averaging over 7.5% in 1992, the
unemployment rate successively fell to about 4.5 percent at May 1, 2000. There
were about 100,000 fewer Texans unemployed at the end of the 1990s than at the
beginning, despite employment rolls expanding by nearly 2.4 million over the ten
years.
The mix of job growth in Texas provides a strong base for sustainable
growth because the new jobs are largely in industries with better-than-average
prospects for continued growth, such as knowledge-based manufacturing and
services. Combined, Texas' goods industries-manufacturing, construction, and
mining, added a net of 186,500 jobs over the five years ending in February 2000,
although growth over the last year has slowed to 3,900 of these. Mining, which
is about 95 percent oil and gas in Texas, lost jobs during most of 1998 and the
first half of 1999, as oil prices bottomed out at their lowest level since the
1960s and mining employment fell to its lowest level since 1977. About 12,500
mining jobs were lost in the first half of 1999, before firming prices prompted
the industry to stabilize in the second half of the year. The number of Texas
mining jobs stood at 143,500 in February 2000, compared to 175,700 at the
beginning of the 1990s. The generally increasing oil prices in 2000 may result
in such lost jobs being regained.
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After six years of increases, Texas manufacturing employment saw small
declines in 1999 in the face of rising productivity. Texas manufacturing
employment dropped by 12,300 jobs (-1.1 percent) from February 1999 through
February 2000, with the entire net loss due to losses in oil and gas equipment
and instruments and apparel manufacturing. Despite net losses over the past
year, Texas added a net of 95,300 jobs in manufacturing during the 1990s, with
more than three-fourths of these jobs added in computers, electronics and the
manufacturing of building materials.
Over the past three years, construction has been the state's fastest
growing source of jobs among major Texas industries. Housing permits increased
at a rate that led the nation during much of 1998, advancing 24 percent for the
year. Single-family permits advanced another 1 percent in 1999, although
multi-family permits dropped 19 percent, following nearly 57,000 multi-family
units build in 1998. Market demand for single-family housing and nonresidential
construction have allowed construction employment to increase an average 6.4
percent a year over the last three years, although in recent months demand for
new houses has softened in Texas.
Over the past twelve months, 98 percent of the net new jobs added to Texas
employment rolls were in service-oriented sectors. From February 1999 to
February 2000, health, business, and miscellaneous services alone added 70,600
jobs, for an increase of 2.7 percent. Regional Financial Associates notes a
three-year growth of 18.4% in Texas' "information technology" jobs. Because of
the rapid growth of Internet and cellular communications, the transportation,
communications, and public utilities (TCPU) industry has grown 14.6 percent over
the past three years. The boom in high tech communications allowed
transportation services and communications to add 17,900 Texas jobs during the
past year. Only government, among the service-producing industries, grew more
slowly than the overall economy, adding 31,800 jobs. Although local government
experienced 2.8 percent growth and state government added 2.6 percent, with
growth almost entirely in school districts and higher education, federal
government jobs continued to decrease in Texas, due primarily to the loss of
civilian defense-related jobs.
The economic difficulties in Asia during 1997 and 1998 also had an adverse
impact on the Texas economy as Japan, Singapore, South Korea and Taiwan have
recently been among the top ten destinations for Texas exports. However, as
trade with Pacific Basin countries currently accounts for only approximately 15%
of Texas' total exports, substantial economic crises in that area do not have
the potential for harm to the Texas economy as do economic crises in Mexico.
In the recent past, the federal Base Closure and Realignment Commission
has made decisions to close military bases in Texas, and such closures may
affect certain regions in Texas significantly. As the base closures occur,
reduced spending by the military and military personnel in the local economies
and the loss of civilian jobs on the closed bases and related job losses in the
general economy affect the state and local economies adversely. Most notably,
Kelly Air Force Base in San Antonio, Texas, is slated for closure over the next
several years with the resulting direct civilian job loss estimated to be
between 10,000 and 18,000 jobs. Local officials in San Antonio have asserted
that loss of those jobs would increase unemployment in the significant Hispanic
population of metropolitan San Antonio by 73%. In addition, three other
metropolitan areas in Texas may be affected by the actions of the commission.
State officials and members of the Texas Congressional delegation have been
working to reduce the adverse effect of the Commission's actions, both through
attempts to save jobs by redeveloping the closed bases for industrial or
municipal uses and by otherwise reducing community dependence on defense
establishments. There is no way to predict accurately at this time the effect
these closures may ultimately have on the Texas economy generally and economy of
the San Antonio metropolitan region in particular.
The state government of Texas still faces significant financial challenges
as demands for state and social services increase and spending of state funds
for certain purposes is mandated by the courts and federal law and is required
by growing social services caseloads. The population of
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Texas has grown significantly in the recent past and was estimated by the U.S.
Bureau of the Census to be approximately 20 million persons as of July 1999.
Illegal immigration into Texas continues to be problematic for the state,
creating additional demand for governmentally provided social services. In
addition, among the ten most populous states, Texas has had the highest
percentage of its population living below the poverty line, with almost 18% of
its populace living below that line. Some state officials are concerned that
Texas' growth pattern and the number of persons living in poverty in Texas are
not and will not be recognized properly by programs distributing federal funds
available for social assistance programs to the states, resulting in Texas
having fewer funds than a fair allocation of federal funding would otherwise
provide to Texas. As a result, unless funding is appropriately allocated or
additional sources of funding can be found, the growing need for social services
will further strain the limited state and local resources for these programs.
Texas potentially faces issues related to its long-term population growth.
The Texas State Data Center estimates that the population of Texas will reach
33.9 million by 2030, almost doubling the 1990 population of the state. State
officials anticipate that minorities will account for at least two-thirds of
this growth. A significant portion of such growth may occur in the region along
the Texas-Mexico border, an area that has traditionally had significantly
greater social problems than has the rest of Texas. Poverty rates, birth rates,
unemployment rates and crime rates in that region exceed those rates in the
remainder of the state. Consequently, to the extent the projected population
growth occurs and is concentrated in the border region, the state government may
have to devote an increasing portion of its resources to social services in the
region. In addition, local governments, hospital districts and school districts
may be expected to expend substantial additional amounts to provide the new and
expanded infrastructure necessary to cope with the additional population. All of
these factors could raise the total public debt incurred by various Texas debt
issuers. If the resulting tax revenues from the increased population do not rise
to an adequate level, the Texas issuers may find their debt ratings adversely
affected and encounter difficulty when attempting to sell their debt instruments
at interest rates acceptable to those issuers. Moreover, to the extent the
federal government reduces federal funding of the social services provided by
state and local governments, Texas and its local governments will be faced with
additional challenges to provide social services at acceptable levels and to
finance those services.
During Texas' fiscal year ended August 31, 1999, Texas expended
approximately $16 billion on health and human services compared with spending on
health and human services of approximately $14.7 billion in fiscal 1998. In
fiscal 1999, Texas received over $13.9 billion in federal funding for all
purposes, which constituted 29% of all state revenues for that fiscal year, as
compared with federal funding of $12.6 billion in fiscal 1998, which was 28.4%
of all state revenues in that fiscal year.
The percentage that the total federal funds received by Texas were of
Texas' total health and human services spending actually increased by 1.2% from
fiscal 1998 to fiscal 1999. Generally, over half of the federal funding received
by Texas in any fiscal year is allocated to health and human services programs
provided and administered by Texas. The federal welfare reform law enacted in
August 1996, provides for limits on Aid to Dependent Children benefits, reduces
food stamp benefits and prohibits the provision of food stamps and Supplemental
Security Income to legal immigrants. In addition, certain limits are imposed on
the amount of lifetime benefits that can be paid to any recipients of welfare
benefits. The legislation also provides for block grants of funds from the
federal government and for the states to be able to fashion programs for the use
of those funds. Although the ultimate and full effect of the federal welfare
reform law on Texas' public assistance programs remains unclear, with its high
number of legal immigrants and dependence of poorer Texans on food stamps rather
than other types of assistance, the law may have a disproportionate effect on
Texas' public assistance programs. Formulas for the allocation of block grant
funds have typically favored states with demographics different from those of
Texas with its rapidly increasing population and high incidence of poverty among
its
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population. Texas has typically provided low levels of assistance for the
working poor, with the assistance given being centered on the provision of food
stamps to this group. If Texas continues to provide assistance to these groups
at current levels of spending, even with block grants from the federal
government, such public assistance programs could adversely affect state
finances. The welfare reform initiatives are also expected to result in
additional requirements that Texas provide additional job training to its
residents, while the federal government will provide less aid to subsidize that
job training. The Texas Workforce Commission estimated that in 1997 Texas would
be required to provide work activities for an additional 29,000 clients (who are
public assistance recipients) beyond the prior federal requirements. Under the
welfare reform law, within five years of the program's commencement, Texas must
have 50 percent of its welfare recipients working at least 30 hours per week or
lose up to five percent of its federal funds that are used to fund public
assistance programs. Such loss of funds would be required to be made up out of
the state's general revenues. Under the federal welfare law, Texas could lose
substantial amounts of federal funding of its public assistance programs,
placing even greater strains on Texas' state and local finances if public
assistance is to continue at current levels. However, it is impossible to
predict at this time what the long term effect of this welfare reform
legislation will be on the Texas economy.
Peak demand for electricity in Texas has grown significantly in recent
years for reasons including sustained economic growth, increasing population,
and hotter than normal temperatures. As high volume users, Texans currently
spend more for electricity than residents of many other states. In addition,
state officials believe that generating capacity within the state is not keeping
up with demand, creating the potential for future power shortages. Such
shortages could result in the slowdown of new job creation, the loss of
employers to other states and an adverse effect on the Texas economy. The Texas
Legislature recently adopted a new law introducing retail competition in the
sale of electricity, which will go into effect on January 1, 2002. Although the
deregulation of electric utilities will likely lower the cost of electricity to
consumers ultimately, consumers are expected to bear a substantial portion of
the costs of the transition to a deregulated industry. Such costs could have a
short-term adverse effect on the ability of Texas to attract new businesses to
locate in Texas and to create the new jobs needed to provide work for the
growing Texas workforce.
Bond Ratings. In June 1999, Moody's Investors Service raised the rating on
the State of Texas general obligations to Aa1 from Aa2. This upgrade effects
self-supporting and non-self-supporting general obligation debt issued by
various state agencies. Additionally, the rating on lease revenue debt was
upgraded to Aa2 from A1, affecting approximately $640 million in lease revenue
obligations. In August 1999, Standard and Poor's revised its outlook on Texas to
stable from positive and affirmed its AA rating on the State's outstanding
general obligation debt. Their rating on Texas' general obligation debt reflects
"a steadily growing and diversifying economy, solid long-term economic
prospects, good trends of revenue growth supporting a balanced budget and a low
tax-supported debt burden. The rating outlook is returned to stable from
positive due to the expectation that, while revenues continue to grow with the
economy, financial reserves will be kept at modest levels." As of August 31,
1999, general obligation bonds issued by the State of Texas were rated AA+ by
Fitch's Investor Services.
State Finances. In its 1999 fiscal year, the Texas state government's
total net revenue exceeded its total net expenditures by approximately $1.3
billion. With prior surpluses, Texas ended fiscal 1990 with a surplus of $4.3
billion in its treasury. The Comptroller of Public Accounts has projected that
the State will have revenues of approximately $96.9 billion for the 2000-01
biennium, while the Texas legislature has adopted a budget for the biennium that
authorizes expenditures of approximately $98.2 billion. This recommendation
includes spending of approximately $27.5 billion on health and human services
during the two-year period and expenditures of approximately $44.5 billion on
education during that period. The budget recommendation does not include the
anticipated expenditures of local governments, school districts and hospital
districts and special governmental districts during the biennium. While state
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government officials have based their estimates on historical revenues, expected
tax collections and expectations of receipts from sources other than taxes,
revenues in the estimated amounts may not be received by the State of Texas
during that period and the state could suffer a budget deficit for that two-year
period. The revenue estimates for the 2000-01 biennium assume aggregate receipts
of approximately $28.0 billion from the federal government during the biennium.
As noted above, changes in federal law could result in the amounts of federal
funding being less than those assumed by the state government for budgeting
purposes.
The two major sources of state revenue are state taxes and federal funds.
Other revenue sources include income from licenses, fees and permits, interest
and investment income, the state lottery, income from sales of goods and
services and land income (which includes income from oil, gas and other mineral
royalties as well as from leases on state lands). The major sources of state
government tax collection are the sales tax, the sales and rentals taxes on
motor vehicles and interstate carriers, and the franchise tax. Texas does not
impose a state income tax, although the state's franchise tax on corporations,
limited liability companies and certain other entities functions as an income
tax on those entities' incomes.
At the end of fiscal 1998, the latest date for which complete data is
available, Texas had a relatively low state debt burden compared to other
states, ranking thirty-sixth among all states and tenth among the ten most
populous states in net tax-supported debt per capita, according to state
officials. The State of Texas and all of its political subdivisions and public
agencies, including municipalities, counties, public school districts and other
special districts, had estimated total tax-supported debt of $39.4 billion as of
August 31, 1998, including $33.59 billion of local government debt. In addition,
the State of Texas and all of its political subdivisions and public agencies had
an estimated additional $38.97 billion of revenue debt as of that date including
$33.06 billion of local government debt. The long-term debt of Texas local
governments has grown significantly. During fiscal 1998, the long-term debt of
local governments in Texas grew to approximately $66.7 billion, a net increase
of approximately $6 billion over the prior year's level. In fiscal 1997, the net
increase of that long-term debt approximated $4 billion. Of that debt, tax
supported debt constituted approximately $33.6 billion and revenue supported
debt constituted approximately $33.1 billion. Of such debt, cities and towns
were the issuers of approximately $27.17 billion (of which approximately $10.1
billion was tax supported), public school districts were issuers of
approximately $15.6 billion (almost all of which was tax supported) and water
districts and authorities were the issuers of approximately $14.7 billion (of
which $11.0 billion was revenue supported).
The total long-term debt of the state government and its instrumentalities
grew only modestly during fiscal 1999 to approximately $11.5 billion at the end
of fiscal 1999, up by approximately $293 million over the fiscal 1998 year-end
level. However, the mix of bonds changed during that period with general
obligation debt decreasing approximately $86 million to approximately $4.9
billion and total state revenue bonds increasing by approximately $387 million
to approximately $6.6 billion. Of the outstanding state general obligation
bonds, approximately $2.3 billion of such bonds were not self-supporting.
Approximately $678 million of the outstanding state revenue bonds were not
self-supporting. The state government's total debt service for fiscal 1999
amounted to approximately $873 million.
The state government has the potential to substantially increase its debt
burden, considering the bond authorization that was unused as of August, 1999.
At August 31, 1999, approximately $2.5 billion in general obligation debt had
been authorized by the state legislature, but not issued, and approximately $2.7
billion in revenue bonds had been authorized but not issued. Texas law limits
the amount of tax-supported debt that the state government and its
instrumentalities may incur to five percent of average annual general revenue
fund revenues. The Texas Constitution limits the amount of state debt payable
from the state's general revenue fund. The maximum annual debt service in any
fiscal year on state debt payable from the general revenue fund may not exceed
five percent of an amount equal to the average of the amount of
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general revenue fund revenues, excluding revenues constitutionally dedicated for
purposes other than payment of state debt, for the three preceding fiscal years
and the legislature may not authorize additional state debt if the resulting
annual debt service exceeds this limitation.
The balance in the Texas Economic Stabilization Fund was approximately $80
million on August 31, 1999. The statute establishing the fund sets the maximum
amount that can be held in the fund at 10% of the general revenue income from
the previous biennium. Accordingly, even with a fund balance of $600 million, an
amount previously predicted to be the fund balance at the end of the 2000-01
biennium, the fund would not come close to exceeding the maximum. The state will
use the fund as a reserve to meet revenue shortfalls in times of economic
downturns. At its current and projected levels and in view of the projected
total state expenditures in the upcoming biennium, the amount of the fund would
likely prove to be insufficient to offset a substantial downturn in the Texas
economy.
Limitations on Bond Issuances and Ad Valorem Taxation. Although Texas has
few debt limits on the incurrence of public debt, certain tax limitations
imposed on counties and cities are in effect debt limitations. The requirement
that counties and cities in Texas provide for the collection of an annual tax
sufficient to retire any bonded indebtedness they create operates as a
limitation on the amount of indebtedness which may be incurred as counties and
cities may never incur indebtedness which cannot be satisfied by revenue
received from taxes imposed within the tax limits. The same requirement is
generally applicable to indebtedness of the State of Texas. However, voters have
authorized from time to time, by constitutional amendment, the issuance of
general obligation bonds of the state for various purposes.
The State of Texas cannot itself impose ad valorem taxes. Although the
state franchise tax system does function as an income tax on corporations,
limited liability companies and certain banks, the State of Texas does not
impose an income tax on personal income. Consequently, the state government must
look to sources of revenue other than state ad valorem taxes and personal income
taxes to fund the operations of the state government and to pay interest and
principal on outstanding obligations of the state and its various agencies.
To the extent the Texas Debt Obligations in the Portfolio are payable,
either in whole or in part, from ad valorem taxes levied on taxable property,
the limitations described below may be applicable. The Texas Constitution limits
the rate of growth of appropriations from tax revenues not dedicated to a
particular purpose by the Constitution during any biennium to the estimated rate
of growth for the Texas economy, unless both houses of the Texas Legislature, by
a majority vote in each, find that an emergency exists. In addition, the Texas
Constitution authorizes cities having more than 5,000 inhabitants to provide
further limitations in their city charters regarding the amount of ad valorem
taxes which can be assessed. Furthermore, certain provisions of the Texas
Constitution provide for exemptions from ad valorem taxes, of which some are
mandatory and others are available at the option of the particular county, city,
town, school district or other political subdivision of the state. The following
is only a summary of certain laws which may be applicable to an issuer of the
Texas Debt Obligations regarding ad valorem taxation.
Counties and political subdivisions are limited in their issuance of bonds
for certain purposes (including construction, maintenance and improvement of
roads, reservoirs, dams, waterways and irrigation works) to an amount up to
one-fourth of the assessed valuation of real property. No county, city or town
may levy a tax in any one year for general fund, permanent improvement fund,
road and bridge fund or jury fund purposes in excess of $.80 on each $100
assessed valuation. Cities and towns having a population of 5,000 or less may
not levy a tax for any one year for any purpose in excess of 1-1/2% of the
taxable property ($1.50 on each $100 assessed valuation), and a limit of 2 1/2%
($2.50 on each $100 assessed valuation) is imposed on cities having a population
of more than 5,000. Hospital districts may levy taxes up to $.75 on each $100
assessed valuation. School districts are subject to certain restrictions
affecting the issuance of bonds and the imposition of taxes.
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Governing bodies of taxing units may not adopt tax rates that exceed
certain specified rates until certain procedural requirements are met
(including, in certain cases, holding a public hearing preceded by a published
notice thereof). Certain statutory requirements exist which set forth the
procedures necessary for the appropriate governmental body to issue and approve
bonds and to levy taxes. To the extent that such procedural requirements are not
followed correctly, the actions taken by such governmental bodies could be
subject to attack and their validity and the validity of the bonds issued
questioned.
Property tax revenues are a major source of funding for public education
in Texas. Texas law now attempts to reduce the disparity of revenues per student
between low-wealth school districts and high-wealth school districts by causing
the high-wealth school districts to share their ad valorem tax revenues with the
low-wealth school districts. State law also provides for school districts to
receive state aid to help pay principal and interest on eligible new bonds whose
proceeds are used to construct instructional facilities. Moreover, all revenue
from the state lottery will now be dedicated to a school fund.
VIRGINIA
The following information is a brief summary of some of the factors
affecting the economy in the State and does not purport to be a complete
description of such factors. This summary is based on publicly available
information and forecasts which have not been independently verified by the
Sponsors or their legal counsel.
RISK FACTORS--The Constitution of Virginia limits the ability of the
Commonwealth to create debt. An amendment to the Constitution requiring a
balanced budget was approved by the voters on November 6, 1984.
General obligations of cities, towns or counties in Virginia are payable
from the general revenues of the entity, including ad valorem tax revenues on
property within the jurisdiction. The obligation to levy taxes could be enforced
by mandamus, but such a remedy may be impracticable and difficult to enforce.
Under section 15.1--227.61 of the Code of Virginia, a holder of any general
obligation bond in default may file an affidavit setting forth such default with
the Governor. If, after investigating, the Governor determines that such default
exists, he is directed to order the State Comptroller to withhold State funds
appropriated and payable to the entity and apply the amount so withheld to
unpaid principal and interest. The Commonwealth, however, has no obligation to
provide any additional funds necessary to pay such principal and interest.
Revenue bonds issued by Virginia political subdivisions include (1)
revenue bonds payable exclusively from revenue producing governmental
enterprises; and (2) industrial revenue bonds, college and hospital revenue
bonds and other "private activity bonds" which are essentially non-governmental
debt issues and which are payable exclusively by private entities such as
non-profit organizations and business concerns of all sizes. State and local
governments have no obligation to provide for payment of such private activity
bonds and in many cases would be legally prohibited from doing so. The value of
such private activity bonds may be affected by a wide variety of factors
relevant to particular localities or industries, including economic developments
outside of Virginia.
Virginia municipal securities that are lease obligations are customarily
subject to "non-appropriation" clauses. See "Municipal Revenue Bonds-Lease
Rental Bonds." Legal principles may restrict the enforcement of provisions in
lease financing limiting the municipal issuer's ability to utilize property
similar to that leased in the event that debt service is not appropriated.
No Virginia law expressly authorizes Virginia political subdivisions to
file under Chapter 9 of the United States Bankruptcy Code, but recent case law
suggests that the granting of general
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powers to such subdivisions may be sufficient to permit them to file voluntary
petitions under Chapter 9.
Virginia municipal issuers are generally not required to provide ongoing
information about their finances and operations, although a number of cities,
counties and other issuers prepare annual reports.
Although revenue obligations of the Commonwealth or its political
subdivisions may be payable from a specific project or source, including lease
rentals, there can be no assurance that future economic difficulties and the
resulting impact on Commonwealth and local government finances will not
adversely affect the market value of the Virginia Series portfolio or the
ability of the respective obligors to make timely payments of principal and
interest on such obligations.
The Commonwealth has maintained a high level of fiscal stability for many
years due in large part to conservative financial operations and diverse sources
of revenue. The budget for the 2000-2002 biennium does not contemplate any
significant new taxes or increases in the scope or amount of existing taxes.
The economy of the Commonwealth is based primarily on manufacturing, the
government sector (including defense), agriculture, mining and tourism. Defense
spending is a major component. Defense installations are concentrated in
Northern Virginia, the location of the Pentagon, and the Hampton Roads area,
including the Cities of Newport News, Hampton, Norfolk and Virginia Beach, the
locations of, among other installations, the Army Transportation Center (Ft.
Eustis), the Langley Air Force Base, Norfolk Naval Base and the Oceana Naval Air
Station, respectively. Any substantial reductions in defense spending generally
or in particular areas, including base closings, could adversely affect the
state and local economies.
The Commonwealth has a Standard & Poor's rating of AA+ and a Moody's
rating of Aa1 on its general obligation bonds. There can be no assurance that
the economic conditions on which these ratings are based will continue or that
particular bond issues may not be adversely affected by changes in economic or
political conditions.
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