1933 Act Registration No. 333-
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form N-14AE24
REGISTRATION STATEMENT UNDER THE
SECURITIES ACT OF 1933
[ ] Pre-Effective [ ] Post-Effective
Amendment No. Amendment No.
EVERGREEN MUNICIPAL TRUST
[Exact Name of Registrant as Specified in Charter)
Area Code and Telephone Number: (617) 210-3200
200 Berkeley Street
Boston, Massachusetts 02116
-----------------------------------
(Address of Principal Executive Offices)
Rosemary D. Van Antwerp, Esq.
Keystone Investment Management Company
200 Berkeley Street
Boston, Massachusetts 02116
-----------------------------------------
(Name and Address of Agent for Service)
Copies of All Correspondence to:
Robert N. Hickey, Esq.
Sullivan & Worcester LLP 1025
Connecticut Avenue, N.W.
Washington, D.C. 20036
Approximate date of proposed public offering: As soon as possible after
the effective date of this Registration Statement.
The Registrant has registered an indefinite amount of securities under
the Securities Act of 1933 pursuant to Section 24(f) under the Investment
Company Act of 1940 (File No. 333-36033); accordingly, no fee is payable
herewith. Registrant is filing as an exhibit to this Registration Statement a
copy of an earlier declaration under Rule 24f-2. Pursuant to Rule 429, this
Registration Statement relates to the aforementioned registration on Form N-1A.
A Rule 24f-2 Notice for the Registrant's fiscal year ending May 31, 1998 will be
filed with the Commission on or about July 30, 1998.
<PAGE>
It is proposed that this filing will become effective on November 10,
1997 pursuant to Rule 488 of the Securities Act of 1933.
<PAGE>
EVERGREEN MUNICIPAL TRUST
CROSS REFERENCE SHEET
Pursuant to Rule 481(a) under the Securities Act of 1933
Item of Part A of Form Location in Prospectus/Proxy
N-14 Statement
1. Beginning of Cross Reference Sheet; Cover
Registration Page
Statement and
Outside Front Cover
Page of Prospectus
2. Beginning and Table of Contents
Outside Back Cover
Page of Prospectus
3. Fee Table, Synopsis Comparison of Fees and
and Risk Factors Expenses; Summary; Comparison
of Investment Objectives and
Policies; Risks
4. Information About Summary; Reasons for the
the Transaction Reorganizations; Comparative
Information on Shareholders'
Rights; Exhibits A-1 and A-2
(Agreements and Plans of
Reorganization)
5. Information about Cover Page; Summary; Risks;
the Registrant Comparison of Investment
Objectives and Policies;
Comparative Information on
Shareholders' Rights;
Additional Information
6. Information about Cover Page; Summary; Risks;
the Company Being Comparison of Investment
Acquired Objective and Policies;
Comparative Information on
Shareholders' Rights;
Additional Information
<PAGE>
Item of Part A of Form Location in Prospectus/Proxy
N-14 Statement
7. Voting Information Cover Page; Summary; Voting
Information Concerning the
Meeting
8. Interest of Certain Financial Statements and
Persons and Experts Experts; Legal Matters
9. Additional Inapplicable
Information
Required for
Reoffering by
Persons Deemed to
be Underwriters
Item of Part B of Form
N-14
10. Cover Page Cover Page
11. Table of Contents Omitted
12. Additional Statement of Additional
Information About Information of the Evergreen
the Registrant Municipal Trust - Evergreen
Tax Free Fund November 10,
1997
13. Additional Statement of Additional
Information about Information of Keystone Tax
the Company Being Free Income Fund dated March
Acquired 31, 1997; Statement of
Additional Information of
Keystone Tax Free Fund dated
April 30, 1997
14. Financial Financial Statements dated May
Statements 31, 1997 of Keystone Tax Free
Income Fund; Financial
Statements of Keystone Tax
Free Fund dated December 31,
1996 and June 30, 1997
<PAGE>
Item of Part A of Form Location in Prospectus/Proxy
N-14 Statement
Item of Part C of Form
N-14
15. Indemnification
Incorporated by Reference to
Part A Caption - "Comparative
Information on Shareholders'
Rights - Liability and
Indemnification of Trustees"
16. Exhibits Item 16. Exhibits
17. Undertakings Item 17. Undertakings
<PAGE>
KEYSTONE TAX FREE INCOME FUND
KEYSTONE TAX FREE FUND
200 BERKELEY STREET
BOSTON, MASSACHUSETTS 02116
November 14, 1997
Dear Shareholder,
I am writing to shareholders of the Keystone Tax Free Fund and the Keystone Tax
Free Income Fund to inform you of a Special Shareholders' meeting to be held on
January 6, 1998. Before that meeting, I would like your vote on the important
issues affecting your fund as described in the attached Prospectus/Proxy
Statement.
The Prospectus/Proxy Statement includes the proposed reorganization of the
Keystone Tax Free Fund and the Keystone Tax Free Income Fund. All of the assets
of both funds would be acquired by a new fund, the Evergreen Tax Free Fund.
Details about the new fund's investment objective, portfolio management team,
performance, etc. are contained in the attached Prospectus/Proxy Statement.
The Boards of Trustees have unanimously approved the proposal and recommend that
you vote FOR this proposal.
You will receive shares of the new fund in the same class, with the same letter
designation, the same fees and the same contingent deferred sales charges as the
shares you held prior to the reorganization. This is a non-taxable event for
shareholders.
I realize that this Prospectus/Proxy Statement will take time to review, but
your vote is very important. Please take the time to familiarize yourself with
the proposal presented and sign and return your proxy card(s) in the enclosed
postage-paid envelope today. You may receive more than one proxy card if you own
shares in more than one fund. Please sign and return each card you receive.
If we do not receive your completed proxy card(s) after several weeks, you may
be contacted by our proxy solicitor, Shareholder Communications Corporation.
They will remind you to vote your shares or will record your vote over the phone
if you choose to vote in that manner. You may also call Shareholder
Communications Corporation directly at 800-733- 8481 ext.404 and vote by phone.
<PAGE>
Thank you for taking this matter seriously and participating in this important
process.
Sincerely,
William M. Ennis
Managing Director
Evergreen Funds
<PAGE>
November 1997
IMPORTANT NEWS
FOR EVERGREEN SHAREHOLDERS
We encourage you to read the attached Prospectus/Proxy Statement in full;
however, the following questions and answers represent some typical concerns
that shareholders might have regarding this document.
Q: WHY IS EVERGREEN SENDING ME THIS PROSPECTUS/PROXY
STATEMENT?
Mutual funds are required to get shareholders' votes for certain types of
changes. As a shareholder, you have a right to vote on major policy decisions,
such as those included here.
Q: WHAT ARE THE ISSUES CONTAINED IN THIS PROSPECTUS/PROXY
STATEMENT?
You are being asked to vote to approve a proposal to reorganize the Keystone Tax
Free Income Fund and the Keystone Tax Free Fund into a new fund, called
Evergreen Tax Free Fund. The new fund's investment objective is substantially
the same as that of the former funds.
Q: HOW WILL THIS CHANGE AFFECT ME AS A FUND SHAREHOLDER?
The reorganization of these funds into the Evergreen Tax Free Fund, means that
the Keystone Tax Free Income Fund and the Keystone Tax Free Fund would no longer
exist after January 23, 1998. Shareholders would receive shares of the new fund
in the same class, with the same letter designation, the same fees and the same
contingent deferred sales charges as the shares held prior to the
reorganization. This is a non-taxable event for shareholders.
<PAGE>
Q: WHY IS EVERGREEN PROPOSING THIS CHANGE?
This proposal represents one of the final steps we are undertaking to unify the
Evergreen and Keystone fund families. Shareholders can anticipate the following
benefits:
A comprehensive fund family with a common risk/reward spectrum
The elimination of any overlap or gaps in fund offerings
Reduced confusion surrounding privileges associated with each fund,
specifically regarding exchangeability, letter of intent, and rights of
accumulation.
A user-friendly product line for both shareholders and investment
professionals
A single location for fund information, whether you're looking up funds
in the newspaper or locating a Morningstar report on the Internet.
Q: HOW DO THE BOARD MEMBERS OF MY FUND RECOMMEND THAT I VOTE?
The Board members of each fund recommend that you vote in favor or FOR the
proposal on the enclosed proxy card.
Q: WHOM DO I CALL FOR MORE INFORMATION OR TO PLACE MY VOTE?
Please call Shareholder Communications at 800-733-8481 ext.
404 for additional information. You can vote one of three
ways:
Use the enclosed proxy card to record your vote either FOR, AGAINST or
ABSTAIN, then return the card in the postpaid envelope provided.
or
Complete the enclosed proxy card and FAX to 800-733- 1885.
Call 800-733-8481 ext. 404 and record your vote by
telephone.
Q: WHY ARE MULTIPLE CARDS ENCLOSED?
<PAGE>
If you own shares of more than one fund, you will receive a proxy card for each
fund you own. Please sign, date and return each proxy card you receive.
<PAGE>
[SUBJECT TO COMPLETION, OCTOBER 10, 1997 PRELIMINARY COPY]
KEYSTONE TAX FREE INCOME FUND
KEYSTONE TAX FREE FUND
200 BERKELEY STREET
BOSTON, MASSACHUSETTS 02116
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
TO BE HELD ON JANUARY 6, 1998
Notice is hereby given that a Special Meeting (the "Meeting") of
Shareholders of each of Keystone Tax Free Income Fund, and Keystone Tax Free
Fund (each a "Fund"), will be held at the offices of the Evergreen Keystone
Funds, 200 Berkeley Street, Boston, Massachusetts 02116 on January 6, 1998 at
3:00 p.m. for the following purposes:
1. To consider and act upon the Agreement and Plan of Reorganization
(the "Plan") dated as of September 30, 1997, providing for the acquisition of
all of the assets of the Fund by Evergreen Tax Free Fund, a series of Evergreen
Municipal Trust, ("Evergreen Tax Free") in exchange for shares of Evergreen Tax
Free and the assumption by Evergreen Tax Free of certain identified liabilities
of the Fund. The Plan also provides for distribution of such shares of Evergreen
Tax Free to shareholders of the Fund in liquidation and subsequent termination
of the Fund. A vote in favor of the Plan is a vote in favor of the liquidation
and dissolution of the Fund.
2. To transact any other business which may properly come before the
Meeting or any adjournment or adjournments thereof.
The Trustees of Keystone Tax Free Income Fund and the Trustees of
Keystone Tax Free Fund have fixed the close of business on November 10, 1997 as
the record date for the determination of shareholders of each respective Fund
entitled to notice of and to vote at the Meeting or any adjournment thereof.
IT IS IMPORTANT THAT PROXIES BE RETURNED PROMPTLY. SHAREHOLDERS WHO DO
NOT EXPECT TO ATTEND IN PERSON ARE URGED WITHOUT DELAY TO SIGN AND RETURN THE
ENCLOSED PROXY IN THE ENCLOSED ENVELOPE, WHICH REQUIRES NO POSTAGE, SO THAT
THEIR SHARES MAY BE REPRESENTED AT THE MEETING. YOUR PROMPT ATTENTION TO THE
ENCLOSED PROXY WILL HELP TO AVOID THE EXPENSE OF FURTHER SOLICITATION.
By Order of the Boards of Trustees
George O. Martinez
<PAGE>
Secretary
November 14, 1997
<PAGE>
INSTRUCTIONS FOR EXECUTING PROXY CARDS
The following general rules for signing proxy cards may be of
assistance to you and may help to avoid the time and expense involved in
validating your vote if you fail to sign your proxy card(s) properly.
1. INDIVIDUAL ACCOUNTS: Sign you name exactly as it
appears in the Registration on the proxy card(s).
2. JOINT ACCOUNTS: Either party may sign, but the name
of the party signing should conform exactly to a name shown in
the Registration on the proxy card(s).
3. ALL OTHER ACCOUNTS: The capacity of the individual signing the proxy
card(s) should be indicated unless it is reflected in the form of Registration.
For example:
REGISTRATION VALID SIGNATURE
CORPORATE
ACCOUNTS
(1) ABC Corp. ABC Corp.
(2) ABC Corp. John Doe, Treasurer
(3) ABC Corp.
c/o John Doe, Treasurer John Doe, Treasurer
(4) ABC Corp. Profit Sharing Plan John Doe, Trustee
TRUST ACCOUNTS
(1) ABC Trust Jane B. Doe, Trustee
(2) Jane B. Doe, Trustee Jane B. Doe
u/t/d 12/28/78
CUSTODIAL OR ESTATE ACCOUNTS
(1) John B. Smith, Cust. John B. Smith
f/b/o John B. Smith, Jr. UGMA
(2) John B. Smith, Jr. John B. Smith, Jr.,
Executor
<PAGE>
PROSPECTUS/PROXY STATEMENT DATED NOVEMBER 14, 1997
Acquisition of Assets of
KEYSTONE TAX FREE INCOME FUND
200 Berkeley Street
Boston, Massachusetts 02116
and
KEYSTONE TAX FREE FUND
200 Berkeley Street
Boston, Massachusetts 02116
By and in Exchange for Shares of
EVERGREEN TAX FREE FUND
a series of
Evergreen Municipal Trust
200 Berkeley Street
Boston, Massachusetts 02116
This Prospectus/Proxy Statement is being furnished to shareholders of
Keystone Tax Free Income Fund ("Keystone Tax Free Income") and Keystone Tax Free
Fund ("Keystone Tax Free") in connection with a proposed Agreement and Plan of
Reorganization (the "Plan") to be submitted to shareholders of each of Keystone
Tax Free Income and Keystone Tax Free for consideration at a Special Meeting of
Shareholders to be held on January 6, 1998 at 3:00 p.m. at the offices of the
Evergreen Keystone Funds, 200 Berkeley Street, Boston, MA 02116, and any
adjournments thereof (the "Meeting"). Each Plan provides for all of the assets
of Keystone Tax Free Income and Keystone Tax Free, respectively, to be acquired
by Evergreen Tax Free Fund ("Evergreen Tax Free") in exchange for shares of
Evergreen Tax Free and the assumption by Evergreen Tax Free of certain
identified liabilities of Keystone Tax Free Income and Keystone Tax Free,
respectively (hereinafter referred to individually as the "Reorganization" or
collectively as the "Reorganizations"). Evergreen Tax Free, Keystone Tax Free
Income and Keystone Tax Free are sometimes hereinafter referred to individually
as the "Fund" and collectively as the "Funds." Following the Reorganizations,
shares of Evergreen Tax Free will be distributed to shareholders of Keystone Tax
Free Income and Keystone Tax Free in liquidation of Keystone Tax Free Income and
Keystone Tax Free and such Funds will be terminated. Holders of shares of
Keystone Tax Free Income will receive shares of the class of Evergreen Tax Free
(the "Corresponding Shares") having the same letter designation and the same
distribution-related fees, shareholder servicing-related fees and contingent
deferred sales charges ("CDSCs"), if any, as the shares of the class of Keystone
Tax Free Income held by them prior to the
<PAGE>
Reorganization. Holders of shares of Keystone Tax Free will receive shares of
Evergreen Tax Free having the same distribution-related fees, shareholder
servicing-related fees and CDSCs as the shares of Keystone Tax Free held by them
prior to the Reorganization. As a result of the proposed Reorganizations,
shareholders of Keystone Tax Free Income will receive that number of full and
fractional Corresponding Shares of Evergreen Tax Free, and shareholders of
Keystone Tax Free will receive that number of full and fractional shares of
Evergreen Tax Free having an aggregate net asset value equal to the aggregate
net asset value of such shareholder's shares of Keystone Tax Free Income or
Keystone Tax Free. Each Reorganization is being structured as a tax-free
reorganization for federal income tax purposes.
Evergreen Tax Free is a separate series of Evergreen Municipal Trust,
an open-end management investment company registered under the Investment
Company Act of 1940, as amended (the "1940 Act"). The investment objective of
Evergreen Tax Free is to provide shareholders with the highest possible current
income exempt from federal income taxes, while preserving capital. Such
investment objective is substantially similar to those of Keystone Tax Free
Income and Keystone Tax Free.
This Prospectus/Proxy Statement, which should be retained for future
reference, sets forth concisely the information about Evergreen Tax Free that
shareholders of Keystone Tax Free Income and Keystone Tax Free should know
before voting on the Reorganizations. Certain relevant documents listed below,
which have been filed with the Securities and Exchange Commission ("SEC"), are
incorporated in whole or in part by reference. A Statement of Additional
Information dated November 14, 1997, relating to this Prospectus/Proxy Statement
and the Reorganizations incorporating by reference the financial statements of
Keystone Tax Free Income dated May 31, 1997 and Keystone Tax Free dated December
31, 1996 and June 30, 1997, has been filed with the SEC and is incorporated by
reference in its entirety into this Prospectus/Proxy Statement. Evergreen Tax
Free is a newly created series of Evergreen Municipal Trust and has had no
operations to date. Consequently, there are no current financial statements of
Evergreen Tax Free. A copy of such Statement of Additional Information is
available upon request and without charge by writing to Evergreen Tax Free at
200 Berkeley Street, Boston, Massachusetts 02116 or by calling toll-free
1-800-343-2898.
The Prospectus of Evergreen Tax Free dated November 10, 1997 is
incorporated herein by reference in its entirety. The Prospectus, which pertains
to Class A, Class B and Class C shares, describes the separate distribution and
shareholder
<PAGE>
servicing arrangements applicable to the classes. Shareholders of Keystone Tax
Free Income and Keystone Tax Free will receive, with this Prospectus/Proxy
Statement, copies of the Prospectus pertaining to the class of shares of
Evergreen Tax Free that they will receive as a result of the consummation of
each Reorganization. Additional information about Evergreen Tax Free is
contained in its Statement of Additional Information of the same date which has
been filed with the SEC and which is available upon request and without charge
by writing to or calling Evergreen Tax Free at the address or telephone number
listed in the preceding paragraph.
The Prospectus of Keystone Tax Free Income dated March 31, 1997, as
supplemented, and the Prospectus of Keystone Tax Free dated April 30, 1997, as
supplemented, are incorporated herein in their entirety by reference. Copies of
the Prospectuses and related Statements of Additional Information dated the same
respective dates are available upon request without charge by writing or calling
the Fund of which you are a shareholder at the address listed in the second
preceding paragraph.
Included as Exhibits A-1 and A-2 to this Prospectus/Proxy Statement are
copies of each Plan.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS/PROXY STATEMENT. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
The shares offered by this Prospectus/Proxy Statement are not deposits
or obligations of any bank and are not insured or otherwise protected by the
U.S. government, the Federal Deposit Insurance Corporation, the Federal Reserve
Board or any other government agency and involve investment risk,
including possible loss of capital.
<PAGE>
TABLE OF CONTENTS
Page
COMPARISON OF FEES AND EXPENSES........................................ 5
SUMMARY................................................................ 11
Proposed Plans of Reorganization.............................. 11
Tax Consequences.............................................. 12
Investment Objectives and Policies
of the Funds................................................ 13
Comparative Performance Information
For Each Fund............................................... 13
Management of the Funds....................................... 14
Investment Adviser ........................................... 14
Portfolio Management.......................................... 15
Distribution of Shares........................................ 15
Purchase and Redemption Procedures............................ 19
Exchange Privileges........................................... 19
Dividend Policy............................................... 20
Risks......................................................... 20
REASONS FOR THE REORGANIZATIONS........................................ 22
Agreements and Plans of Reorganization........................ 25
Federal Income Tax Consequences............................... 27
Pro-forma Capitalization...................................... 29
Shareholder Information....................................... 30
COMPARISON OF INVESTMENT OBJECTIVES AND POLICIES....................... 32
COMPARATIVE INFORMATION ON SHAREHOLDERS' RIGHTS........................ 35
Forms of Organization......................................... 35
Capitalization................................................ 36
Shareholder Liability......................................... 36
Shareholder Meetings and Voting Rights........................ 37
Liquidation or Dissolution.................................... 38
Liability and Indemnification of Trustees..................... 38
ADDITIONAL INFORMATION................................................. 40
VOTING INFORMATION CONCERNING THE MEETINGS............................. 41
FINANCIAL STATEMENTS AND EXPERTS....................................... 44
LEGAL MATTERS.......................................................... 44
OTHER BUSINESS......................................................... 44
<PAGE>
COMPARISON OF FEES AND EXPENSES
It is anticipated that on or about January 9, 1998 Keystone Tax Free
will become a multiple class fund. As of that date the Fund will offer Class A,
Class B and Class C shares, each of which Class of shares will be similar in all
respects to the Class A, Class B and Class C shares of Evergreen Tax Free. It is
further anticipated that at that time current outstanding shares of Keystone Tax
Free will become Class B shares of the Fund. On or about January 16, 1998, it is
anticipated that any Class B shares of Keystone Tax Free purchased prior to
January 1, 1994 will be converted to Class A shares of the Fund. Should these
events occur, shareholders of Keystone Tax Free will receive on the date of the
Reorganization the same Class of shares of Evergreen Tax Free held by them in
the Fund after January 16, 1998.
The amounts for shares of Keystone Tax Free Income and Keystone Tax
Free set forth in the following tables and in the examples are based on the
expenses for each Fund for the fiscal years ended May 31, 1997 and December 31,
1996, respectively. The pro forma amounts for Class A, Class B and Class C
shares of Evergreen Tax Free are based on the estimated expenses of Evergreen
Tax Free for the fiscal year ending May 31, 1998.
The following tables show for Keystone Tax Free Income, Keystone Tax
Free and Evergreen Tax Free pro forma the shareholder transaction expenses and
annual fund operating expenses associated with an investment in the shares of
each Fund. The pro forma numbers reflect the events described in the first
paragraph of this section.
Comparison of Shares of Evergreen Tax Free
With Shares of Keystone Tax Free Income
and Keystone Tax Free
Keystone Tax Free Income
-------------------------
Shareholder
Transaction Class A Class B Class C
Expenses ------- ------- -------
Maximum Sales Load 4.75% None None
Imposed on
Purchases (as a
percentage of
offering price)
<PAGE>
Maximum Sales Load
Imposed on None None None
Reinvested
Dividends (as a
percentage of
offering price)
Contingent Deferred None 5.00% in 1.00% in the
Sales Charge (as a the first first year
percentage of year, and 0.00%
original purchase declining thereafter
price or redemption to 1.00%
proceeds, whichever in the
is lower) sixth year
and 0.00%
thereafter
Exchange Fee None None None
Annual Fund
Operating Expenses
(as a percentage of
average daily net
assets)
Management Fee 0.61% 0.61% 0.61%
12b-1 Fees (1) 0.24% 1.00% 1.00%
Other Expenses 0.34% 0.34% 0.34%
----- ----- -----
Annual Fund 1.19% 1.95% 1.95%
Operating Expenses ----- ----- -----
(3) ----- ----- -----
Keystone Tax Free
-----------------
Shareholder
Transaction Expenses
Contingent Deferred 4.00% in the
Sales Charge (as a first year,
percentage of original declining to
purchase price or 1.00% in the
redemption proceeds, fourth year and
whichever is lower) 0.00% thereafter
<PAGE>
Exchange Fee
None
Annual Fund Operating
Expenses (as a
percentage of average
daily net assets)
Management Fee 0.42%
12b-1 Fees (1) 0.30%
Other Expenses 0.15%
-----
Annual Fund Operating 0.87%
Expenses(3) -----
-----
Evergreen Tax Free Pro Forma
----------------------------
Shareholder Class A Class B Class C
Transaction ------- ------- -------
Expenses
Maximum Sales Load 4.75% None None
Imposed on
Purchases (as a
percentage of
offering price)
Maximum Sales Load None None None
Imposed on
Reinvested
Dividends (as a
percentage of
offering price)
Contingent Deferred None 5.00% in the 1.00% in
Sales Charge (as a first year, the first
percentage of declining to year and
original purchase 1.00% in the 0.00%
price or redemption sixth year thereafter]
proceeds, whichever and 0.00%
is lower) thereafter
(2)
Exchange Fee None None None
<PAGE>
Annual Fund
Operating Expenses
(as a percentage of
average daily net
assets)
Management Fee 0.42% 0.42% 0.42%
12b-1 Fees (1) 0.25% 1.00% 1.00%
Other Expenses 0.16% 0.16% 0.16%
------ ------ ------
Annual Fund
Operating 0.83% 1.58% 1.58%
Expenses(3) ------ ------ ------
------ ------ ------
- ---------------
(1) Class A Shares of Evergreen Tax Free and Keystone Tax Free Income can pay
up to 0.75% of average daily net assets as a 12b-1 fee. For the foreseeable
future, the Class A 12b-1 fees will be limited to 0.25% of average daily
net assets. For shares of Keystone Tax Free and for Class B and Class C
shares of Evergreen Tax Free and Keystone Tax Free Income, a portion of the
12b-1 fees equivalent to 0.25% of average daily net assets will be
shareholder servicing-related. Distribution-related 12b- 1 fees will be
limited to 0.75% of average daily net assets as permitted under the rules
of the National Association of Securities Dealers, Inc.
(2) The contingent deferred sales charge, if any, applicable to shares of
Keystone Tax Free Income and Keystone Tax Free prior to the date of the
Reorganizations will carry over to the shares of Evergreen Tax Free
received in the Reorganizations.
(3) Expense ratios include indirectly paid expenses.
Examples. The following tables show for Keystone Tax Free Income and
Keystone Tax Free and for Evergreen Tax Free pro forma, assuming consummation of
the Reorganizations, examples of the cumulative effect of shareholder
transaction expenses and annual fund operating expenses indicated above on a
$1,000 investment in each class of shares for the periods specified, assuming
(i) a 5% annual return, and (ii) redemption at the end of such period, and
additionally for Class B and Class C shares of Evergreen Tax Free and Keystone
Tax Free Income and shares of Keystone Tax Free, no redemption at the end of
each period.
<PAGE>
Keystone Tax Free Income
------------------------
One Three Five Ten
Year Years Years Years
---- ----- ----- -----
Class A $59 $83 $110 $185
Class B $70 $91 $125 $198
(Assuming
redemption
at end of
period)
Class B $20 $61 $105 $198
(Assuming no
redemption
at end of
period)
Class C $30 $61 $105 $227
(Assuming
redemption
at end of
period)
Class C $20 $61 $105 $227
(Assuming no
redemption
at end of
period)
Keystone Tax Free
-----------------
One Three Five Ten
Year Years Years Years
---- ----- ----- -----
(Assuming $49 $48 $48 $107
redemption at
end of period)
(Assuming no $9 $28 $48 $107
redemption at
end of period)
<PAGE>
Evergreen Tax Free - Pro Forma
------------------------------
One Three Five Ten
Year Years Years Years
----- ----- ----- -----
Class A $56 $73 $91 $145
Class B $66 $80 $106 $158
(Assuming
redemption at
end of period)
Class B $16 $50 $86 $158
(Assuming no
redemption at
end of period)
Class C $26 $50 $86 $188
(Assuming
redemption at
end of period)
Class C $16 $50 $86 $188
(Assuming no
redemption at
end of period)
The purpose of the foregoing examples is to assist Keystone Tax Free
Income and Keystone Tax Free shareholders in understanding the various costs and
expenses that an investor in Evergreen Tax Free as a result of the
Reorganizations would bear directly and indirectly, as compared with the various
direct and indirect expenses currently borne by a shareholder in each Fund.
These examples should not be considered a representation of past or future
expenses or annual return. Actual expenses may be greater or less than those
shown.
SUMMARY
This summary is qualified in its entirety by reference to the
additional information contained elsewhere in this Prospectus/Proxy Statement,
and, to the extent not inconsistent with such additional information, the
Prospectus of Evergreen Tax Free dated November 10, 1997 and the Prospectuses of
Keystone Tax Free Income and Keystone Tax Free
<PAGE>
dated March 31, 1997, as supplemented, and April 30, 1997, as supplemented,
respectively, (which are incorporated herein by reference), and the Plans, forms
of which are attached to this Prospectus/Proxy Statement as Exhibits A-1 and
A-2.
Proposed Plans of Reorganization
The Plans provide for the transfer of all of the assets of Keystone Tax
Free Income and Keystone Tax Free, as applicable, in exchange for shares of
Evergreen Tax Free and the assumption by Evergreen Tax Free of certain
identified liabilities of each Fund. The Plans also call for the distribution of
shares of Evergreen Tax Free to Keystone Tax Free Income and Keystone Tax Free
shareholders in liquidation of those Funds as part of the Reorganizations. As a
result of the Reorganizations, the shareholders of Keystone Tax Free Income will
become owners of that number of full and fractional Corresponding Shares of
Evergreen Tax Free and the shareholders of Keystone Tax Free will become the
owners of that number of full and fractional shares of Evergreen Tax Free having
an aggregate net asset value equal to the aggregate net asset value of the
shareholder's respective class of shares of Keystone Tax Free Income and
Keystone Tax Free, as of the close of business immediately prior to the date
that such Fund's assets are exchanged for shares of Evergreen Tax Free. See
"Reasons for the Reorganizations Agreements and Plans of Reorganization."
The Trustees of Keystone Tax Free Income and the Trustees of Keystone
Tax Free, including the Trustees who are not "interested persons," (the
"Trustees") as such term is defined in the 1940 Act (the "Independent
Trustees"), have concluded that the Reorganizations would be in the best
interests of shareholders of Keystone Tax Free Income and Keystone Tax Free,
respectively, and that the interests of the shareholders of Keystone Tax Free
Income and Keystone Tax Free, respectively, will not be diluted as a result of
the transactions contemplated by the Reorganizations. Accordingly, the Trustees
have submitted the Plans for the approval of Keystone Tax Free Income's and
Keystone Tax Free's shareholders.
THE BOARD OF TRUSTEES OF KEYSTONE TAX FREE INCOME RECOMMENDS
APPROVAL BY SHAREHOLDERS OF KEYSTONE TAX FREE INCOME
OF THE PLAN EFFECTING THE REORGANIZATION.
THE BOARD OF TRUSTEES OF KEYSTONE TAX FREE RECOMMENDS
APPROVAL BY SHAREHOLDERS OF KEYSTONE TAX FREE
OF THE PLAN EFFECTING THE REORGANIZATION.
<PAGE>
The Trustees of Evergreen Municipal Trust have also
approved the Plans, and accordingly, Evergreen Tax Free's
participation in the Reorganizations.
Approval of a Reorganization on the part of Keystone Tax Free Income
and Keystone Tax Free will require the affirmative vote of a majority of each
Fund's shares present and entitled to vote, with all classes voting together as
a single class at Meetings at which a quorum of each Fund's shares is present. A
majority of the outstanding shares of each Fund entitled to vote, represented in
person or by proxy, is required to constitute a quorum at the Meetings. See
"Voting Information Concerning the Meetings."
The Reorganizations are scheduled to take place on or about January 23,
1998.
If the shareholders of Keystone Tax Free Income or Keystone Tax Free do
not vote to approve the Reorganizations, the Trustees will consider other
possible courses of action in the best interests of shareholders.
Tax Consequences
Prior to or at the completion of a Reorganization, Keystone Tax Free
Income and Keystone Tax Free will each have received an opinion of counsel that
the Reorganization has been structured so that no gain or loss will be
recognized by the Fund or its shareholders for federal income tax purposes as a
result of the receipt of shares of Evergreen Tax Free in the Reorganization. The
holding period and aggregate tax basis of shares of Evergreen Tax Free that are
received by each Fund's shareholders will be the same as the holding period and
aggregate tax basis of shares of the Fund previously held by such shareholders,
provided that shares of the Fund are held as capital assets. In addition, the
holding period and tax basis of the assets of each Fund in the hands of
Evergreen Tax Free as a result of the Reorganization will be the same as in the
hands of each Fund immediately prior to the Reorganization, and no gain or loss
will be recognized by Evergreen Tax Free upon the receipt of the assets of each
Fund in exchange for shares of Evergreen Tax Free and the assumption by
Evergreen Tax Free of certain identified liabilities.
Investment Objectives and Policies of the Funds
The investment objective and policies of each of Evergreen Tax Free,
Keystone Tax Free Income and Keystone Tax Free are substantially identical. Each
Fund seeks to provide shareholders with the highest possible current income,
exempt
<PAGE>
from federal income taxes, while preserving capital. Under normal circumstances,
each Fund invests substantially all and at least 80% of its assets in federally
tax-exempt obligations. These obligations include municipal bonds and notes and
tax-exempt commercial paper obligations that are issued by or on behalf of
states, territories and possessions of the United States ("U.S."), the District
of Columbia and their political subdivisions, agencies and instrumentalities,
the interest from which is, in the opinion of counsel to the issuers exempt from
federal income taxes, including the alternative minimum income tax. At least 80%
of the municipal bonds in which the Fund invests will be rated within the four
highest categories by a nationally recognized statistical rating organization
("NRSRO"). Each Fund may invest 20% of their assets in lower rated bonds but
will not invest in bonds rated below B.
Each Fund may invest in taxable corporate and bank obligations,
obligations issued or guaranteed by the U.S. government or by any of its
agencies or instrumentalities, commercial paper and repurchase agreements. Each
Fund may also purchase certain derivative securities including futures and
options. See "Comparison of Investment Objectives and Policies" below.
Comparative Performance Information For Each Fund
Discussions of the manner of calculation of total return are contained
in the respective Prospectuses and Statements of Additional Information of the
Funds. Evergreen Tax Free, as of the date of this Prospectus/Proxy Statement,
had not commenced operations. The total return of Keystone Tax Free Income and
Keystone Tax Free for the one, five and ten year periods ended August 31, 1997
and for the periods from inception through August 31, 1997 are set forth in the
table below. The calculations of total return assume the reinvestment of all
dividends and capital gains distributions on the reinvestment date and the
deduction of all recurring expenses (including sales charges) that were charged
to shareholders' accounts.
Average Annual Total Return
5 Years
1 Year Ended 10 Years From
Ended August Ended Inception
August 31, August To August Inception
31, 1997 1997 31, 1997 31, 1997 Date
-------- ------- -------- --------- -----
<PAGE>
Keystone Tax
Free Income
Class A 3.49% 4.46% 6.27% 6.34% 4/14/87
shares
Class B 2.90% N/A N/A 4.15% 2/1/93
shares
Class C 6.90% N/A N/A 4.50% 2/1/93
shares
Keystone Tax 5.21% 5.57% 7.07% 7.05% 1/19/78
Free
- --------------
Management of the Funds
The overall management of Evergreen Tax Free, of Keystone Tax Free
Income and of Keystone Tax Free is the responsibility of, and is supervised by,
the Board of Trustees of Evergreen Municipal Trust, Keystone Tax Free Income and
Keystone Tax
Free, respectively.
Investment Adviser
The investment adviser to Evergreen Tax Free, Keystone Tax Free Income
and Keystone Tax Free is Keystone Investment Management Company ("Keystone").
Keystone has provided investment advisory and management services to investment
companies and private accounts since 1932. Keystone is an indirect wholly-owned
subsidiary of First Union National Bank ("FUNB"). Keystone is located at 200
Berkeley Street, Boston, Massachusetts 02116-5034.
FUNB is a subsidiary of First Union Corporation ("First Union"), the
sixth largest bank holding company in the U.S.
based on total assets as of June 30, 1997.
Evergreen Tax Free, Keystone Tax Free Income and Keystone
Tax Free each pay Keystone a fee for its services at the
annual rate below:
Aggregate Net Asset
Value of the Shares
Management Fee Incomeof the Fund
2.00% of Gross Dividend
and Interest Income
Plus
<PAGE>
0.50% of the first
$100,000,000, plus
0.45% of the next $100,000,000, plus
0.40% of the next $100,000,000, plus
0.35% of the next $100,000,000, plus
0.30% of the next $100,000,000, plus
0.25% of amounts
over $500,000,000.
Keystone may, at its discretion, also reduce or waive its fee or
reimburse a Fund for certain of its other expenses in order to reduce its
expense ratios. Keystone may reduce or cease these voluntary waivers and
reimbursements at any time.
Portfolio Management
The portfolio manager of both Evergreen Tax Free and Keystone Tax Free is
Betsy A. Hutchings, a Keystone Senior Vice President since 1995 and Senior
Portfolio Manager since 1993. Ms. Hutchings joined Keystone in 1988 and has
managed Keystone Tax Free since 1990.
Distribution of Shares
Evergreen Keystone Distributor, Inc. ("EKD"), an affiliate of BISYS
Fund Services, acts as underwriter of Evergreen Tax Free's, Keystone Tax Free
Income's and Keystone Tax Free's shares. EKD distributes each Fund's shares
directly or through broker-dealers, banks (including FUNB), or other financial
intermediaries. Evergreen Tax Free offers three classes of shares: Class A,
Class B and Class C. Keystone Tax Free currently offers only one class of shares
and Keystone Tax Free Income offers Class A, Class B and Class C shares.
However, it is anticipated that on or about January 9, 1998, Keystone Tax Free
will offer three classes of shares, Class A, Class B and Class C. Each class has
separate distribution arrangements. (See "Distribution-Related and Shareholder
Servicing-Related Expenses" below.) No class bears the distribution expenses
relating to the shares of any other class.
In the proposed Reorganizations, shareholders of Keystone Tax Free
Income will receive the corresponding class of shares of Evergreen Tax Free
which they currently hold. The Class A, Class B and Class C shares of Evergreen
Tax Free have substantially identical arrangements with respect to the
imposition of initial sales charges, CDSCs and distribution and service fees as
the comparable classes of Keystone Tax Free Income. Holders of shares of
Keystone Tax Free will receive Class A and/or Class B shares of Evergreen Tax
Free. As of January 9, 1998, it is anticipated that each Class of
<PAGE>
shares of Evergreen Tax Free, Keystone Tax Free Income and Keystone Tax Free
will have identical arrangements with respect to CDSCs and distribution and
service fees. Because the Reorganizations will be effected at net asset value
without the imposition of a sales charge, Evergreen Tax Free shares acquired by
shareholders of Keystone Tax Free Income and Keystone Tax Free pursuant to the
proposed Reorganizations would not be subject to any initial sales charge or
CDSC as a result of the Reorganizations. However, shares acquired as a result of
the Reorganizations would continue to be subject to a CDSC upon subsequent
redemption to the same extent as if shareholders had continued to hold their
shares of Keystone Tax Free Income and Keystone Tax Free. The CDSC applicable to
a class of shares received in the Reorganizations will be the CDSC schedule in
effect at the time shares of Keystone Tax Free Income or Keystone Tax Free were
originally purchased.
The following is a summary description of charges and fees for each of
the different classes of shares. More detailed descriptions of the distribution
arrangements applicable to the classes of shares are contained in the respective
Evergreen Tax Free Prospectus, the Keystone Tax Free Income Prospectus, the
Keystone Tax Free Prospectus and in each Fund's respective Statement of
Additional Information.
Currently, Keystone Tax Free offers only one class of shares. Shares
are sold without any front-end sales charges, but are subject to a CDSC which
ranges from 4% to 1% if shares are redeemed during the first four calendar years
after purchase. In addition, shares are subject to distribution- related and
shareholder servicing-related fees as described below. It is anticipated that
Keystone Tax Free will become a multiple class fund on or about January 9, 1998.
Should this occur, the Fund will offer three classes of shares identical to the
Class A, Class B and Class C shares of Evergreen Tax Free and hereafter
described, including identical distribution-related and shareholder
servicing-related expenses.
Class A Shares. Class A shares are sold at net asset value plus an
initial sales charge and, as indicated below, are subject to
distribution-related fees.
Class B Shares. Class B shares are sold without an initial sales charge
but are subject to a CDSC, which ranges from 5% to 1%, if shares are redeemed
during the first six years after the month of purchase. In addition, Class B
shares are subject to distribution-related fees and shareholder
servicing-related fees as described below. Class B shares issued in the
Reorganizations will automatically convert to Class A shares in accordance with
the conversion
<PAGE>
schedule of Evergreen Tax Free in effect at the time of the Reorganizations. For
purposes of determining when Class B shares issued in the Reorganizations to
shareholders of Keystone Tax Free Income and Keystone Tax Free will convert to
Class A shares, such shares will be deemed to have been purchased as of the date
the shares of Keystone Tax Free Income and Keystone Tax Free were originally
purchased.
Class B shares are subject to higher distribution-related fees than the
corresponding Class A shares on which a front-end sales charge is imposed (until
they convert to Class A shares). The higher fees mean a higher expense ratio, so
Class B shares pay correspondingly lower dividends and may have a lower net
asset value than Class A shares of the Fund.
Class C Shares. Class C shares are sold without an initial sales charge
but, as indicated below, are subject to distribution and shareholder
servicing-related fees. Class C shares are subject to a 1% CDSC if such shares
are redeemed during the month of purchase and the 12-month period following the
month of purchase. No CDSC is imposed on amounts redeemed thereafter. Class C
shares incur higher distribution and shareholder servicing-related fees than
Class A shares but, unlike Class B shares, do not convert to any other class of
shares.
The amount of the CDSC applicable to redemptions of shares of Keystone
Tax Free, Evergreen Tax Free and Keystone Tax Free Income is charged as a
percentage of the lesser of the then current net asset value or original cost.
The CDSC is deducted from the amount of the redemption and is paid to the Fund's
distributor or its predecessor, as the case may be. Shares of each Fund acquired
through dividend or distribution reinvestment are not subject to a CDSC. For
purposes of determining the schedule of CDSCs, and the time of conversion to
Class A shares, applicable to shares of Evergreen Tax Free received by Keystone
Tax Free Income's or Keystone Tax Free's shareholders in the Reorganizations,
Evergreen Tax Free will treat such shares as having been sold on the date the
shares of Keystone Tax Free Income or Keystone Tax Free were originally
purchased by such Fund's shareholder. Additional information regarding the
Classes of shares of each Fund is included in their respective Prospectus and
Statement of Additional Information.
Distribution-Related and Shareholder Servicing-Related Expenses.
Evergreen Tax Free and Keystone Tax Free Income have each adopted a Rule 12b-1
plan with respect to its Class A shares under which the class may pay for
distribution- related expenses at an annual rate which may not exceed 0.75% of
average daily net assets attributable to the Class.
<PAGE>
Payments with respect to Class A shares of Evergreen Tax Free and Keystone Tax
Free Income are currently limited to 0.25% of average daily net assets
attributable to the Class, which amount may be increased to the full plan rate
for such Fund by the Trustees without shareholder approval.
Each of Evergreen Tax Free and Keystone Tax Free Income has also
adopted a Rule 12b-1 plan with respect to its Class B and Class C shares under
which each Class may pay for distribution-related and shareholder
servicing-related expenses at an annual rate which may not exceed 1.00% of
average daily net assets attributable to the Class.
The Class B and Class C Rule 12b-1 plans provide, that of the total
1.00% 12b-1 fees, up to 0.25% may be for payment in respect of "shareholder
services." Consistent with the requirements of Rule 12b-1 and the applicable
rules of the National Association of Securities Dealers, Inc. ("NASD"),
following the Reorganizations Evergreen Tax Free may make distribution-related
and shareholder servicing-related payments with respect to Keystone Tax Free
Income and Keystone Tax Free shares sold prior to the Reorganizations, including
payments to Keystone Tax Free Income's and Keystone Tax Free's former
underwriter.
Keystone Tax Free has adopted a Rule 12b-1 plan with respect to its
shares pursuant to which the Fund may pay for distribution-related and
shareholder servicing-related expenses at an annual rate that may not exceed
1.25% of average daily net assets. The NASD limits the amount that the Fund may
pay annually in distribution costs for the sale of its shares and shareholder
service fees. The NASD currently limits such annual expenditures to 1.00% of the
aggregate average daily net asset value of the Fund's shares, of which 0.75% may
be used to pay distribution costs and 0.25% may be used to pay shareholder
service fees.
Additional information regarding the Rule 12b-1 plans adopted by each
Fund is included in its respective Prospectus and Statement of Additional
Information.
Purchase and Redemption Procedures
Information concerning applicable sales charges, distribution-related
fees and shareholder servicing-related fees are described above. Investments in
the Funds are not insured. The minimum initial purchase requirement for each
Fund is $1,000. There is no minimum for subsequent purchases of shares of any
Fund. Each Fund provides for telephone, mail or wire redemption of shares at net
asset value, less any CDSC, as next determined after receipt of a redemption
request
<PAGE>
on each day the New York Stock Exchange ("NYSE") is open for trading. Additional
information concerning purchases and redemptions of shares, including how each
Fund's net asset value is determined, is contained in the respective Prospectus
for each Fund. Each Fund may involuntarily redeem shareholders' accounts that
have less than $1,000 of invested funds. All funds invested in each Fund are
invested in full and fractional shares. The Funds reserve the right to reject
any purchase order.
Exchange Privileges
Shares of Keystone Tax Free Income may be exchanged for shares of a
similar class of any other fund in the Evergreen Keystone fund family other than
shares of any fund in the Keystone Classic fund family. Exchanges of shares of
Keystone Tax Free are limited to the shares of funds in the Keystone Classic
fund family and Class K shares of Evergreen Money Market Fund. Shares of
Evergreen Tax Free may be exchanged for shares of a similar class of any fund in
the Evergreen Keystone fund family other than any shares of any fund in the
Keystone Classic fund family. No sales charge is imposed on an exchange. An
exchange which represents an initial investment in another fund must amount to
at least $1,000. The current exchange privileges, and the requirements and
limitations attendant thereto, are described in each Fund's respective
Prospectus and Statement of Additional Information.
Dividend Policy
Each Fund declares dividends daily and distributes such income monthly.
Distributions of any net realized gains of each Fund will be made at least
annually. Shareholders begin to earn dividends on the first business day after
shares are purchased unless shares were not paid for, in which case dividends
are not earned until the next business day after payment is received. Dividends
and distributions are reinvested in additional shares of the same class of the
respective Fund, or paid in cash, as a shareholder has elected. See the
respective Prospectus of each Fund for further information concerning dividends
and distributions.
After the Reorganizations, shareholders of Keystone Tax Free Income and
Keystone Tax Free who have elected to have their dividends and/or distributions
reinvested will have dividends and/or distributions received from Evergreen Tax
Free reinvested in shares of Evergreen Tax Free. Shareholders of Keystone Tax
Free Income and Keystone Tax Free who have elected to receive dividends and/or
distributions in cash will receive dividends and/or distributions from Evergreen
Tax Free in cash after the Reorganizations, although they may, after
<PAGE>
the Reorganizations, elect to have such dividends and/or distributions
reinvested in additional shares of Evergreen Tax Free.
Each of Keystone Tax Free Income and Keystone Tax Free has qualified
and intends to continue to qualify, and Evergreen Tax Free intends to qualify,
to be treated as a regulated investment company under the Internal Revenue Code
of 1986, as amended (the "Code"). While so qualified, so long as each Fund
distributes all of its investment company taxable income and any net realized
gains to shareholders, it is expected that a Fund will not be required to pay
any federal income taxes on the amounts so distributed. A 4% nondeductible
excise tax will be imposed on amounts not distributed if a Fund does not meet
certain distribution requirements by the end of each calendar year. Each Fund
anticipates meeting such distribution requirements.
Risks
Since the investment objectives and policies of each Fund are
substantially identical, the risks involved in investing in each Fund's shares
are comparable. Each Fund's ability to achieve its objective depends partially
on the prompt payment by issuers of the interest on and principal of the
municipal bonds held by the Fund. A moratorium, default, or other nonpayment of
interest or principal when due on any municipal bond, in addition to affecting
the market value and liquidity of that particular security, could affect the
market value and liquidity of other municipal bonds held by a Fund. In addition,
the market for municipal bonds is often thin and can be temporarily affected by
large purchases and sales, including those by a Fund.
From time to time, proposals have been introduced before the U.S.
Congress for the purpose of restricting or eliminating the federal income tax
exemption for interest on municipal bonds, and similar proposals may be
introduced in the future. The enactment of such a proposal could materially
affect the availability of municipal bonds for investment by a Fund and the
value of the Fund's portfolio. In the event of such legislation, each Fund would
re-evaluate its investment objective and policies and consider changes in the
structure of the Fund or dissolution.
Each Fund stresses earning income by investing in fixed income
securities, which are generally considered to be interest rate sensitive. This
means that their market values (and the Fund's share prices) will tend to vary
inversely with changes in interest rates (i.e., decreasing when interest rates
rise and increasing when interest rates fall). For
<PAGE>
example, if interest rates increase after a security is purchased, the security,
if sold prior to maturity, may return less than its cost. Shorter term bonds are
less sensitive to interest rate changes, but longer term bonds generally offer
higher yields.
In addition, to the extent that investments are made in debt securities
(other than U.S. government securities), derivatives or structured securities,
such investments, despite favorable credit ratings, are subject to some risk of
default.
Each Fund may invest up to 20% of its assets in below- investment grade
bonds. For a discussion of the risks involved in such investments, see
"Comparison of Investment Objectives and Policies."
Each Fund may invest in derivatives. The market values of derivatives
or structured securities may vary depending upon the manner in which the
investments have been structured and may fluctuate much more rapidly and to a
much greater extent. As a result, the values of such investments may change at a
rate in excess of the rates at which traditional fixed income securities change
and, depending on the structure of a derivative, would change in a manner
opposite to the change in the market value of a traditional fixed income
security. See each Fund's Prospectus and Statement of Additional Information for
further discussion of the risks inherent in the use of derivatives.
REASONS FOR THE REORGANIZATIONS
At a regular meeting held on September 17, 1997, the Board of Trustees
of Keystone Tax Free Income considered and approved the Reorganization as in the
best interests of shareholders and determined that the interests of existing
shareholders of Keystone Tax Free Income will not be diluted as a result of the
transactions contemplated by the Reorganization.
At a regular meeting held on September 17, 1997, the Board of Trustees
of Keystone Tax Free considered and approved the Reorganization as in the best
interests of shareholders and determined that the interests of existing
shareholders of Keystone Tax Free will not be diluted as a result of the
transactions contemplated by the Reorganization.
In approving each Plan, the Trustees reviewed various factors about the
respective Funds and the proposed Reorganizations. The Reorganizations are part
of an overall plan to convert the Evergreen Keystone funds into series of
<PAGE>
Delaware business trusts and, to the extent practicable, simplify and make
consistent various investment restrictions and policies. Holders of shares of
beneficial interest in a Massachusetts business trust may, under certain
circumstances, be held personally liable as partners for their obligations of
the trust. Although provisions of the Declaration of Trust and other legal
documents pertaining to each Fund's affairs seek to minimize the potential for
such liability, some degree of exposure, however unlikely, continues to exist
with respect to the Funds as long as they are governed by Massachusetts law.
Substantially all written agreements, obligations, instruments, or undertakings
made by Keystone Tax Free Income or Keystone Tax Free must contain a provision
limiting the obligations created by that transaction to the Fund to which the
transaction relates, as well as related provisions to the effect that the
shareholders of the Fund and Trustees of the Trust under which the Fund operates
are not personally liable thereunder. Although the Declarations of Trust of
Keystone Tax Free Income and Keystone Tax Free provide for indemnification out
of the Funds' property of any shareholder held personally liable for the
obligations of a Fund solely by reason of his or her being or having been a
shareholder, a shareholder could conceivably incur financial loss exceeding any
amounts indemnified on account of shareholder liability if the circumstances
were such that the Fund had insufficient assets or would otherwise be unable to
meet its obligations.
As a Delaware business trust, the Evergreen Municipal Trust's
operations will be governed by applicable Delaware law rather than by applicable
Massachusetts law. The Delaware Business Trust Act (the "Delaware Act") provides
that a shareholder of a Delaware business trust shall be entitled to the same
limitation of personal liability extended to stockholders of Delaware
corporations. Shareholders of Delaware corporations do not have personal
liability for obligations of the corporation.
Delaware has obtained a favorable national reputation for its business
laws and business environment. The Delaware courts, which may be called upon to
interpret the Delaware Act, are among the nation's most highly respected and
have an expertise in corporate matters which in part grew out of the fact that
Delaware corporate legal issues are concentrated in the Court of Chancery where
there are no juries and where judges issue written opinions explaining their
decisions. Thus, there is a well established body of precedent which may be
relevant in deciding issues pertaining to a Delaware business trust.
There are other advantages that may be afforded by a
Delaware business trust. Under Delaware law, the Evergreen
<PAGE>
Municipal Trust will have the flexibility to respond to future business
contingencies. For example, the Trustees will have the power to change the
Evergreen Municipal Trust to a corporation, to merge or consolidate it with
another entity, to cause each series to become a separate trust, and to change
the Evergreen Municipal Trust's domicile without a shareholder vote. This
flexibility could help to assure that the Evergreen Municipal Trust operates
under the most advanced form of organization and could reduce the expense and
frequency of future shareholder meetings for non-investment related issues.
In addition, although it is proposed that Keystone Tax Free Income and
Keystone Tax Free each sell all of its assets to Evergreen Tax Free, a newly
established series of Evergreen Municipal Trust, an important part of the
Reorganizations is that Keystone Tax Free Income, for all practical purposes,
will be combined with Keystone Tax Free. The investment objective and policies
of Evergreen Tax Free are substantially identical to those of Keystone Tax Free
and Keystone Tax Free Income. Consequently, in considering the Reorganizations,
each Fund's Trustees reviewed the Reorganization in the context of Keystone Tax
Free Income being combined with Keystone Tax Free.
Keystone Tax Free Income and Keystone Tax Free have substantially
identical investment objectives and policies and comparable risk profiles. See
"Comparison of Investment Objectives and Policies" below. At the same time, the
Boards of Trustees of Keystone Tax Free Income and Keystone Tax Free evaluated
the potential economies of scale associated with larger mutual funds and
concluded that operational efficiencies may be achieved upon the combination of
Keystone Tax Free Income with another Evergreen Keystone fund with a greater
level of assets. As of August 31, 1997, Keystone Tax Free's net assets were
approximately $1,392 million and Keystone Tax Free Income's net assets were
approximately $108 million.
In addition, assuming that an alternative to the Reorganizations would
be to propose that Keystone Tax Free Income and Keystone Tax Free continue their
existences as separate series of Evergreen Municipal Trust, Keystone Tax Free
Income would be offered through common distribution channels with the
substantially identical Keystone Tax Free. Keystone Tax Free Income would also
have to bear the cost of maintaining its separate existence. Keystone believes
that the prospect of dividing the resources of the Evergreen Keystone mutual
fund organization between two substantially identical funds could result in each
Fund being disadvantaged due to an inability to achieve optimum size,
performance
<PAGE>
levels and the greatest possible economies of scale. Accordingly, for the
reasons noted above and recognizing that there can be no assurance that any
economies of scale or other benefits will be realized, Keystone believes that
the proposed Reorganizations would be in the best interests of each Fund and its
shareholders.
The Board of Trustees of Keystone Tax Free Income and the Board of
Trustees of Keystone Tax Free met and considered the recommendation of Keystone,
and, in addition, considered among other things, (i) the disadvantages which
apply to operating each Fund as a Massachusetts business trust or a series of a
Massachusetts business trust; (ii) the advantages which apply to each Fund
operating as a series of a Delaware business trust; (iii) the terms and
conditions of the Reorganization; (iv) whether the Reorganization would result
in the dilution of shareholders' interests; (v) expense ratios, fees and
expenses of Keystone Tax Free Income and Keystone Tax Free; (vi) the comparative
performance records of each of the Funds; (vii) compatibility of their
investment objectives and policies; (viii) the investment experience, expertise
and resources of Keystone; (ix) service features available to shareholders of
the respective Funds and Evergreen Tax Free; (x) the fact that FUNB will bear
the expenses incurred by Keystone Tax Free Income and Keystone Tax Free in
connection with the Reorganizations; (xi) the fact that Evergreen Tax Free will
assume certain identified liabilities of Keystone Tax Free Income and Keystone
Tax Free; and (xii) the expected federal income tax consequences of the
Reorganizations.
The Trustees of Keystone Tax Free Income also considered the benefits
to be derived by shareholders of Keystone Tax Free Income from its combination,
for all practical purposes, with Keystone Tax Free. In this regard, the Trustees
considered the potential benefits of being associated with a larger entity and
the economies of scale that could be realized by the participation by
shareholders of Keystone Tax Free Income.
In addition, the Trustees of Keystone Tax Free Income and Keystone Tax
Free considered that there are alternatives available to shareholders of
Keystone Tax Free Income and Keystone Tax Free, including the ability to redeem
their shares, as well as the option to vote against the Reorganizations.
During their consideration of the Reorganizations the
Trustees met with Fund counsel and counsel to the Independent
Trustees regarding the legal issues involved. The Trustees of
Evergreen Municipal Trust on behalf of Evergreen Tax Free also
<PAGE>
approved at a meeting on September 17, 1997 the proposed
Reorganizations.
THE TRUSTEES OF KEYSTONE TAX FREE INCOME RECOMMEND
THAT SHAREHOLDERS APPROVE THE PROPOSED
REORGANIZATION.
THE TRUSTEES OF KEYSTONE TAX FREE RECOMMEND THAT
SHAREHOLDERS APPROVE THE PROPOSED REORGANIZATION.
Agreements and Plans of Reorganization
The following summary is qualified in its entirety by reference to the
Plans (Exhibits A-1 and A-2 hereto).
Each Plan provides that Evergreen Tax Free will acquire all of the
assets of Keystone Tax Free Income and Keystone Tax Free in exchange for shares
of Evergreen Tax Free and the assumption by Evergreen Tax Free of certain
identified liabilities of Keystone Tax Free Income and Keystone Tax Free on or
about January 23, 1998 or such other date as may be agreed upon by the parties
(the "Closing Date"). Prior to the Closing Date, Keystone Tax Free Income and
Keystone Tax Free will endeavor to discharge all of their known liabilities and
obligations. Evergreen Tax Free will not assume any liabilities or obligations
of Keystone Tax Free Income and Keystone Tax Free other than those reflected in
an unaudited statement of assets and liabilities of Keystone Tax Free Income and
Keystone Tax Free prepared as of the close of regular trading on the NYSE,
currently 4:00 p.m. Eastern time, on the business day immediately prior to the
Closing Date. Evergreen Tax Free will provide the Trustees of Keystone Tax Free
Income and Keystone Tax Free with certain indemnifications as set forth in each
Plan. The number of full and fractional shares of Evergreen Tax Free to be
received by the shareholders of Keystone Tax Free Income and Keystone Tax Free
will be as follows: Shareholders of Keystone Tax Free will receive the number of
shares of each class of Evergreen Tax Free equal to the number of shares of each
corresponding class as they currently hold of Keystone Tax Free. Shareholders of
Keystone Tax Free Income will receive the number of shares of Evergreen Tax Free
determined by multiplying the respective outstanding class of shares of Keystone
Tax Free Income by a factor which shall be computed by dividing the net asset
value per share of the respective class of Keystone Tax Free Income by the net
asset value per share of the respective class of Evergreen Tax Free. Such
computations will take place as of the close of regular trading on the NYSE on
the business day immediately prior to the Closing Date. The net asset value per
share of each class will be determined by dividing assets, less liabilities, in
<PAGE>
each case attributable to the respective class, by the total
number of outstanding shares.
State Street Bank and Trust Company, the custodian for the Funds, will
compute the value of Keystone Tax Free Income's and Keystone Tax Free's
respective portfolio securities. The method of valuation employed will be
consistent with the procedures set forth in the Prospectus and Statement of
Additional Information of Evergreen Tax Free, Rule 22c-1 under the 1940 Act, and
with the interpretations of such Rule by the SEC's Division of Investment
Management.
At or prior to the Closing Date, Keystone Tax Free Income and Keystone
Tax Free will have declared a dividend or dividends and distribution or
distributions which, together with all previous dividends and distributions,
shall have the effect of distributing to each Fund's shareholders (in shares of
each Fund, or in cash, as the shareholder has previously elected) all of each
Fund's investment company taxable income for the taxable period ending on the
Closing Date (computed without regard to any deduction for dividends paid) and
all of its net capital gains realized in all taxable periods ending on the
Closing Date (after reductions for any capital loss carryforward).
As soon after the Closing Date as conveniently practicable, Keystone
Tax Free Income and Keystone Tax Free will liquidate and distribute pro rata to
shareholders of record as of the close of business on the Closing Date the full
and fractional shares of Evergreen Tax Free received by each Fund. Such
liquidation and distribution will be accomplished by the establishment of
accounts in the names of each Fund's shareholders on the share records of
Evergreen Tax Free's transfer agent. Each account will represent the respective
pro rata number of full and fractional shares of Evergreen Tax Free due to each
Fund's shareholders. All issued and outstanding shares of each Fund, including
those represented by certificates, will be canceled. The shares of Evergreen Tax
Free to be issued will have no preemptive or conversion rights. After such
distributions and the winding up of its affairs, each of Keystone Tax Free
Income and Keystone Tax Free will be terminated. In connection with such
terminations, Keystone Tax Free Income and Keystone Tax Free will file with the
SEC applications for termination as registered investment companies.
The consummation of each Reorganization is subject to the conditions
set forth in the Plan for Keystone Tax Free Income and the Plan for Keystone Tax
Free, including approval by each Fund's shareholders, accuracy of various
representations and warranties and receipt of opinions of counsel, including
<PAGE>
opinions with respect to those matters referred to in "Federal Income Tax
Consequences" below. Notwithstanding approval of each Fund's shareholders, each
Plan may be terminated (a) by the mutual agreement of the Fund and Evergreen Tax
Free; or (b) at or prior to the Closing Date by either party (i) because of a
breach by the other party of any representation, warranty, or agreement
contained therein to be performed at or prior to the Closing Date if not cured
within 30 days, or (ii) because a condition to the obligation of the terminating
party has not been met and it reasonably appears that it cannot be met.
The expenses of Keystone Tax Free Income and Keystone Tax Free in
connection with the Reorganizations (including the cost of any proxy soliciting
agent) will be borne by FUNB whether or not the Reorganizations are consummated.
If the Reorganization is not approved by shareholders of a Fund, the
Board of Trustees of Keystone Tax Free Income and Keystone Tax Free, as
applicable, will consider other possible courses of action in the best interests
of shareholders.
Federal Income Tax Consequences
Each Reorganization is intended to qualify for federal income tax
purposes as a tax-free reorganization under section 368(a) of the Code. As a
condition to the closing of a Reorganization, Keystone Tax Free Income and
Keystone Tax Free will each receive an opinion of counsel to the effect that, on
the basis of the existing provisions of the Code, U.S. Treasury regulations
issued thereunder, current administrative rules, pronouncements and court
decisions, for federal income tax purposes, upon consummation of the
Reorganization:
(1) The transfer of all of the assets of the Fund solely in exchange
for shares of Evergreen Tax Free and the assumption by Evergreen Tax Free of
certain identified liabilities, followed by the distribution of Evergreen Tax
Free's shares by the Fund in dissolution and liquidation of the Fund, will
constitute a "reorganization" within the meaning of section 368(a)(1)(C) (with
respect to Keystone Tax Free Income and 368(a)(1)(F) with respect to Keystone
Tax Free) of the Code, and Evergreen Tax Free and the Fund will each be a "party
to a reorganization" within the meaning of section 368(b) of the Code;
(2) No gain or loss will be recognized by the Fund on the transfer of
all of its assets to Evergreen Tax Free solely in exchange for Evergreen Tax
Free's shares and the assumption by Evergreen Tax Free of certain identified
liabilities of the Fund or upon the distribution of Evergreen Tax Free's shares
<PAGE>
to the Fund's shareholders in exchange for their shares of the
Fund;
(3) The tax basis of the assets transferred will be the same to
Evergreen Tax Free as the tax basis of such assets to the Fund immediately prior
to the Reorganization, and the holding period of such assets in the hands of
Evergreen Tax Free will include the period during which the assets were held by
the Fund;
(4) No gain or loss will be recognized by Evergreen Tax Free upon the
receipt of the assets from the Fund solely in exchange for the shares of
Evergreen Tax Free and the assumption by Evergreen Tax Free of certain
identified liabilities of the Fund;
(5) No gain or loss will be recognized by the Fund's shareholders upon
the issuance of the shares of Evergreen Tax Free to them, provided they receive
solely such shares (including fractional shares) in exchange for their shares of
the Fund; and
(6) The aggregate tax basis of the shares of Evergreen Tax Free,
including any fractional shares, received by each of the shareholders of the
Fund pursuant to the Reorganization will be the same as the aggregate tax basis
of the shares of the Fund held by such shareholder immediately prior to the
Reorganization, and the holding period of the shares of Evergreen Tax Free,
including fractional shares, received by each such shareholder will include the
period during which the shares of the Fund exchanged therefor were held by such
shareholder (provided that the shares of the Fund were held as a capital asset
on the date of the Reorganization).
Opinions of counsel are not binding upon the Internal Revenue Service
or the courts. If a Reorganization is consummated but does not qualify as a
tax-free reorganization under the Code, shareholders of Keystone Tax Free Income
and Keystone Tax Free would recognize a taxable gain or loss equal to the
difference between his or her tax basis in his or her Fund shares and the fair
market value of Evergreen Tax Free shares he or she received. Shareholders of
Keystone Tax Free Income and Keystone Tax Free should consult their tax advisers
regarding the effect, if any, of the proposed Reorganization in light of their
individual circumstances. It is not anticipated that the securities of the
combined portfolio will be sold in significant amounts in order to comply with
the policies and investment practices of Evergreen Tax Free. Since the foregoing
discussion relates only to the federal income tax consequences of the
Reorganization, shareholders of Keystone Tax Free Income and Keystone Tax Free
should also
<PAGE>
consult their tax advisers as to the state and local tax
consequences, if any, of the Reorganization.
Pro-forma Capitalization
The following table sets forth the capitalizations of Keystone Tax Free
Income and Keystone Tax Free as of August 31, 1997 and the capitalization of
Evergreen Tax Free on a pro forma basis as of that date, giving effect to the
proposed acquisitions of assets at net asset value and the conversion of certain
Keystone Tax Free shares. As a newly created series of Evergreen Municipal
Trust, Evergreen Tax Free, immediately preceding the Closing Date, will have
nominal assets and liabilities. The pro forma data reflects an exchange ratio of
approximately 1.28, 1.27, and 1.27 Class A, Class B and Class C shares of
Evergreen Tax Free issued for each Class A, Class B and Class C share of
Keystone Tax Free Income, respectively, and an exchange ratio of approximately
1.00 Class B share of Evergreen Tax Free issued for each share of Keystone Tax
Free.
Capitalization of Keystone Tax Free Income,
Keystone Tax Free and Evergreen
Tax Free (Pro Forma)
Evergreen Tax
Keystone Free (After
Tax Free Keystone Reorgani-
Income Tax Free zations)
-------- -------- ------------
Net Assets
Class A........ $70,385,204 N/A $1,327,660,888
Class B........ $27,442,064 $1,392,023,565 $162,189,945
Class C........ $9,990,647 N/A $9,990,647
Net Asset
Value Per
Share
Class A........ $9.91 N/A $7.75
Class B........ $9.82 $7.75 $7.75
Class C........ $9.82 N/A $7.75
Shares
Outstanding
Class A........ 7,099,916 N/A 171,379,107
Class B........ 2,794,366 179,694,836 20,935,192
Class C........ 1,017,062 N/A 1,288,716
All 10,911,344 179,694,836 193,603,015
Classes........
The table set forth above should not be relied upon to
reflect the number of shares to be received in the
<PAGE>
Reorganizations; the actual number of shares to be received will depend upon the
net asset value and number of shares outstanding of each Fund at the time of the
Reorganizations.
Shareholder Information
As of November 10, 1997 (the "Record Date"), there were shares of
Keystone Tax Free outstanding and Class A,
Class B and Class C shares of Keystone Tax Free Income outstanding.
As of September 30, 1997, the officers and Trustees of Keystone Tax
Free Income beneficially owned as a group less than 1% of the outstanding shares
of Keystone Tax Free Income. To Keystone Tax Free Income's knowledge, the
following persons owned beneficially or of record more than 5% of Keystone Tax
Free Income's total outstanding shares as of September 30, 1997:
Percen-
Percen- tage of
tage of Shares of
Shares of Class
Class Outstand-
Before ing After
No. of Reorgani- Reorgani-
Name and Address Class Shares zations zations
- ---------------- ----- ------ --------- ---------
Merrill Lynch Pierce A 1,545,032 22.20 1.16
Fenner & Smith
For the Sole Benefit
of its Customers
Attn: Fund
Administration
4800 Deer Lake Drive
East
3rd Floor
Jacksonville, FL
32246-6484
<PAGE>
Merrill Lynch Pierce
Fenner & Smith B 537,858 19.67 3.28
For the Sole Benefit
of its Customers
Attn: Fund
Administration
4800 Deer Lake Drive
East
3rd Floor
Jacksonville, FL
32246-6484
Alletta Laird Downs B 205,973 7.53 1.26
TTEE
Alletta Laird Downs
Trust
U/A DTD 03-29-89
P.O. Box 3666
Wilmington, DE
19807-0666
Merrill Lynch Pierce C 442,374 44.65 44.65
Fenner & Smith
For the Sole Benefit
of its Customers
Attn: Fund
Administration
4800 Deer Lake Drive
East
3rd Floor
Jacksonville, FL
32246-6484
As of September 30, 1997, the officers and Trustees of Keystone Tax
Free beneficially owned as a group less than 1% of the outstanding shares of
Keystone Tax Free. To Keystone Tax Free's knowledge, the following persons owned
beneficially or of record more than 5% of Keystone Tax Free's total outstanding
shares as of September 30, 1997:
Percen- Percentage of
tage of Shares of
Shares of Class
Class Outstanding
Before After
No. of Reorgani- Reorgani-
Name and Address Shares zations zations
- ---------------- ------ --------- ---------
<PAGE>
Merrill Lynch Pierce
Fenner & Smith 22,801,239 12.76 12.10 Class A
For the Sole Benefit 10.63 Class B
of its Customers
Attn: Fund
Administration
4800 Deer Lake Drive
East
3rd Floor
Jacksonville, FL
32246-6484
COMPARISON OF INVESTMENT OBJECTIVES AND POLICIES
The following discussion is based upon and qualified in its entirety by
the descriptions of the respective investment objectives, policies and
restrictions set forth in the respective Prospectuses and Statements of
Additional Information of the Funds. The investment objective, policies and
restrictions of Evergreen Tax Free can be found in the Prospectus of Evergreen
Tax Free under the caption "Investment Objective and Policies." The investment
objectives, policies and restrictions of Keystone Tax Free Income and Keystone
Tax Free can be found in the respective Prospectus of each Fund under the
caption "Investment Objective and Policies."
The investment objective and policies of Evergreen Tax Free, Keystone
Tax Free Income and Keystone Tax Free are substantially identical. These Funds
seek to provide shareholders with the highest possible current income exempt
from federal income taxes, while preserving capital. Unlike Evergreen Tax Free,
the investment objective of Keystone Tax Free Income and Keystone Tax Free
cannot be changed without shareholder approval.
Under ordinary circumstances, each Fund invests substantially all and
at least 80% of its assets in federally tax-exempt obligations. These
obligations include municipal bonds and notes and tax-exempt commercial paper
obligations that are issued by or on behalf of states, territories and
possessions of the U.S., the District of Columbia and their political
subdivisions, agencies and instrumentalities, the interest from which is, in the
opinion of counsel to the issuer exempt from federal income taxes, including the
alternative minimum tax.
Municipal bonds include debt obligations issued by or on
behalf of a political subdivision of the U.S. or any agency or
<PAGE>
instrumentality thereof to obtain funds for various public purposes. In
addition, municipal bonds include certain types of industrial development bonds
issued by or on behalf of public authorities to finance privately operated
facilities. Each Fund's policies limit its investments in qualified "private
activity" industrial development bonds to no more than 20% of the Fund's total
assets. No Fund currently intends to invest in "private activity" (private
purpose) bonds.
Each Fund invests at least 80% of its assets in bonds that, at the date
of investment, are rated within the four highest categories by Standard & Poor's
Ratings Group ("S&P") (AAA, AA, A and BBB), by Moody's Investors Service
("Moody's") (Aaa, Aa, A and Baa), by Fitch Investors Services, L.P. ("Fitch")
(AAA, AA, A and BBB) or, if not rated or rated under a different system, are of
comparable quality to obligations so rated as determined by another or by the
Fund's investment adviser.
Evergreen Tax Free and Keystone Tax Free may invest 20% of their assets
in lower rated bonds, but it will not invest in bonds rated below B. A Fund is
not required to sell or otherwise dispose of any security that loses its rating
or has its rating reduced after the Fund has purchased it.
The Funds are permitted to make taxable investments, and may from time
to time generate income subject to federal regular income tax.
While each Fund may invest in securities of any maturity, it is
currently expected that Keystone Tax Free Income Fund will not invest in
securities with maturities of more than 30 years or less than 5 years (other
than certain money market instruments).
Debt rated BBB by S&P, Baa by Moody's or BBB by Fitch is regarded as
having an adequate capacity to pay interest and repay principal. While it
normally exhibits adequate protection parameters, adverse economic conditions or
changing circumstances are generally more likely to lead to a weakened capacity
to pay interest and repay principal for debt in this category than in high rated
categories.
Securities rated BB or lower by S&P or Fitch or Ba or lower by Moody's
are considered predominantly speculative with respect to the ability of the
issuer to meet principal and interest payments. The lower ratings of certain
securities held by the Fund reflect a greater possibility that adverse changes
in the financial condition of the issuer or in general economic conditions, or
both, or an unanticipated rise in
<PAGE>
interest rates may impair the ability of the issuer to make payments of interest
and principal, especially if the issuer is highly leveraged. Such issuer's
ability to meet its debt obligations may also be adversely affected by specific
corporate developments, the issuer's inability to meet specific projected
business forecasts, or the unavailability of additional financing. Also, an
economic downturn or an increase in interest rates may increase the potential
for default by the issuers of these securities.
Values of such securities are more sensitive to real or perceived
adverse economic, company or industry conditions and publicity than is the case
for higher quality securities. Their values, like those of other fixed income
securities, fluctuate in response to changes in interest rates; generally rising
when interest rates decline and falling when interest rates rise. For example,
if interest rates increase after a fixed income security is purchased, the
security, if sold prior to maturity, may return less than its cost. The prices
of below-investment grade bonds, however, are generally less sensitive to
interest rate changes than the prices of higher- rated bonds.
Each Fund also may invest in securities that pay interest that is not
exempt from federal income taxes, such as corporate and bank obligations,
obligations issued or guaranteed by the U.S. government or by any of its
agencies or instrumentalities, commercial paper and repurchase agreements. Such
securities must be rated, for Evergreen Tax Free and Keystone Tax Free, at least
BBB by S&P or Baa by Moody's, and, for Keystone Tax Free Income, at least A, or,
if not rated, must be determined by Keystone to be of comparable quality. Each
Fund will not invest more than 20% of its total assets under ordinary
circumstances and up to 100% of its total assets for temporary or defensive
purposes in such securities.
Each Fund also may enter into reverse repurchase agreements and firm
commitment agreements for securities and currencies. A Fund may enter into
options transactions and may write covered call and put options, purchase call
and put options, including purchasing call and put options to close out existing
positions, and purchase call options to fix the interest rates of obligations
held by it. A Fund may enter into currency and other financial futures contracts
and related options transactions for hedging purposes and not for speculation.
In addition, each Fund may also invest in obligations denominated in foreign
currencies that are exempt from federal income tax.
The characteristics of each investment policy and the
associated risks are described in each Fund's respective
<PAGE>
Prospectus and Statement of Additional Information. The Funds have other
investment policies and restrictions which are also set forth in the Prospectus
and Statement of Additional Information of each Fund.
COMPARATIVE INFORMATION ON SHAREHOLDERS' RIGHTS
Forms of Organization
Evergreen Municipal Trust, Keystone Tax Free Income and Keystone Tax
Free are open-end management investment companies registered with the SEC under
the 1940 Act, which continuously offer shares to the public. Each of Keystone
Tax Free Income and Keystone Tax Free is organized as a Massachusetts business
trust. Evergreen Municipal Trust is organized as a Delaware business trust. Each
Trust is governed by a Declaration of Trust, By-Laws and a Board of Trustees.
Each Trust is also governed by applicable Delaware, Massachusetts and federal
law. Evergreen Tax Free is a series of Evergreen Municipal Trust.
Capitalization
The beneficial interests in Evergreen Tax Free are represented by an
unlimited number of transferable shares of beneficial interest without par
value. The beneficial interests in Keystone Tax Free Income and Keystone Tax
Free are represented by an unlimited number of transferable shares of beneficial
interest without par value per share. The respective Declaration of Trust under
which each Fund has been established permits the Trustees to allocate shares
into an unlimited number of series, and classes thereof, with rights determined
by the Trustees, all without shareholder approval. Fractional shares may be
issued. Except with respect to Evergreen Tax Free where each share of the Fund
is entitled to one vote for each dollar of net asset value applicable to such
share, each Fund's shares have equal voting rights with respect to matters
affecting shareholders of all classes of each Fund and represent equal
proportionate interests in the assets belonging to each class of shares of the
Funds. Shareholders of each Fund are entitled to receive dividends and other
amounts as determined by the Trustees. Shareholders of each Fund vote
separately, by class, as to matters, such as approval of or amendments to Rule
12b-1 distribution plans, that affect only their particular class and by series
as to matters, such as approval of or amendments to investment advisory
agreements or proposed organizations, that affect only their particular series.
Shareholder Liability
<PAGE>
Under Massachusetts law, shareholders of a business trust could, under
certain circumstances, be held personally liable for the obligations of the
business trust. However, the respective Declaration of Trust under which
Keystone Tax Free Income and Keystone Tax Free was established disclaims
shareholder liability for acts or obligations of the series and requires that
notice of such disclaimer be given in each agreement, obligation or instrument
entered into or executed by the Fund or the Trustees. Each Declaration of Trust
provides for indemnification out of the series property for all losses and
expenses of any shareholder held personally liable for the obligations of the
series. Thus, the risk of a shareholder incurring financial loss on account of
shareholder liability is considered remote since it is limited to circumstances
in which a disclaimer is inoperative and the series or the Trust itself would be
unable to meet its obligations. A substantial number of mutual funds in the
United States are organized as Massachusetts business trusts.
Under Delaware law, shareholders of a Delaware business trust are
entitled to the same limitation of personal liability extended to stockholders
of Delaware corporations. No similar statutory or other authority limiting
business trust shareholder liability exists in any other state. As a result, to
the extent that Evergreen Municipal Trust or a shareholder is subject to the
jurisdiction of courts in those states, the courts may not apply Delaware law,
and may thereby subject shareholders of a Delaware trust to liability. To guard
against this risk, the Declaration of Trust of Evergreen Municipal Trust: (a)
provides that any written obligation of the Trust may contain a statement that
such obligation may only be enforced against the assets of the Trust or the
particular series in question and the obligation is not binding upon the
shareholders of the Trust; however, the omission of such a disclaimer will not
operate to create personal liability for any shareholder; and (b) provides for
indemnification out of Trust property of any shareholder held personally liable
for the obligations of Evergreen Municipal Trust. Accordingly, the risk of a
shareholder of the Trust incurring financial loss beyond that shareholder's
investment because of shareholder liability is limited to circumstances in
which: (i) the court refuses to apply Delaware law; (ii) no contractual
limitation of liability was in effect; and (iii) the Trust itself would be
unable to meet its obligations. In light of Delaware law, the nature of the
Trust's business, and the nature of its assets, the risk of personal liability
to a shareholder of Evergreen Municipal Trust is remote.
Shareholder Meetings and Voting Rights
<PAGE>
Neither Evergreen Municipal Trust on behalf of Evergreen Tax Free,
Keystone Tax Free Income nor Keystone Tax Free is required to hold annual
meetings of shareholders. However, a meeting of shareholders for the purpose of
voting upon the question of removal of a Trustee must be called when requested
in writing by the holders of at least 10% of the outstanding shares. In
addition, each is required to call a meeting of shareholders for the purpose of
electing Trustees if, at any time, less than a majority of the Trustees then
holding office were elected by shareholders. Each Trust currently does not
intend to hold regular shareholder meetings. Each Trust does not permit
cumulative voting. Except when a larger quorum is required by applicable law,
twenty-five percent (25%) and, with respect to Keystone Tax Free Income and
Keystone Tax Free, a majority of the outstanding shares entitled to vote on a
matter, constitutes a quorum for consideration of such matter. For Evergreen Tax
Free, a majority of the shares voted, and for Keystone Tax Free Income and
Keystone Tax Free, a majority of the shares present and entitled to vote is
sufficient to act on a matter (unless otherwise specifically required by the
applicable governing documents or other law, including the 1940 Act).
Under the Declaration of Trust of Evergreen Municipal Trust, each share
of Evergreen Tax Free is entitled to one vote for each dollar of net asset value
applicable to each share. Under the current voting provisions governing Keystone
Tax Free Income and Keystone Tax Free, each share is entitled to one vote. Over
time, the net asset values of the Funds have changed in relation to one another
and are expected to continue to do so in the future. Because of the divergence
in net asset values, a given dollar investment in a Fund with a lower net asset
value will purchase more shares, and under the Funds' current voting provisions,
have more votes, than the same investment in a Fund with a higher net asset
value. Under the Declaration of Trust of Evergreen Municipal Trust, voting power
is related to the dollar value of the shareholders' investment rather than to
the number of shares held.
Liquidation or Dissolution
In the event of the liquidation of Evergreen Tax Free, Keystone Tax
Free Income and Keystone Tax Free the shareholders are entitled to receive,
when, and as declared by the Trustees, the excess of the assets belonging to
such Fund or attributable to the class over the liabilities belonging to the
Fund or attributable to the class. In either case, the assets so distributable
to shareholders of the Fund will be distributed among the shareholders in
proportion to the number
<PAGE>
of shares of a class of the Fund held by them and recorded on
the books of the Fund.
Liability and Indemnification of Trustees
The Declarations of Trust of Keystone Tax Free Income and Keystone Tax
Free provide that a Trustee shall be liable only for his own willful defaults,
and that no Trustee shall be protected against any liability to which he would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in the conduct of his
office. The Declarations of Trust of Keystone Tax Free Income and Keystone Tax
Free provide that present and former Trustees or officers are entitled to
indemnification against liabilities and expenses with respect to claims related
to their position with the Fund unless such Trustee or officer shall have been
adjudicated not to have acted in good faith in the reasonable belief that his or
her action was in the best interest of the Fund, or unless such Trustee or
officer is otherwise subject to liability to the Fund or its shareholders by
reason of willful misfeasance, bad faith, gross negligence or reckless disregard
of the duties involved in the conduct of his office. In the event of settlement,
no such indemnification shall be provided unless there has been a determination
that such Trustee or officer appears to have acted in good faith in the
reasonable belief that his action was in the best interests of the Fund and that
such indemnification would not protect such person against any liability to the
Fund to which such person would otherwise be subject by reason of willful
misfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of his office.
Under the Declaration of Trust of Evergreen Municipal Trust, a Trustee
is liable to the Trust and its shareholders only for such Trustee's own willful
misfeasance, bad faith, gross negligence, or reckless disregard of the duties
involved in the conduct of the office of Trustee or the discharge of such
Trustee's functions. As provided in the Declaration of Trust, each Trustee of
the Trust is entitled to be indemnified against all liabilities against him or
her, including the costs of litigation, unless it is determined that the Trustee
(i) did not act in good faith in the reasonable belief that such Trustee's
action was in or not opposed to the best interests of the Trust; (ii) had acted
with willful misfeasance, bad faith, gross negligence or reckless disregard of
such Trustee's duties; and (iii) in a criminal proceeding, had reasonable cause
to believe that such Trustee's conduct was unlawful (collectively, "disabling
conduct"). A determination that the Trustee did not engage in disabling conduct
and is, therefore, entitled to indemnification may be
<PAGE>
based upon the outcome of a court action or administrative proceeding or by (a)
a vote of a majority of those Trustees who are neither "interested persons"
within the meaning of the 1940 Act nor parties to the proceeding or (b) an
independent legal counsel in a written opinion. The Trust may also advance money
for such litigation expenses provided that the Trustee undertakes to repay the
Trust if his or her conduct is later determined to preclude indemnification and
certain other conditions are met.
The foregoing is only a summary of certain characteristics of the
operations of the Declarations of Trust, By-Laws, Delaware and Massachusetts law
and is not a complete description of those documents or law. Shareholders should
refer to the provisions of such Declarations of Trust, By-Laws, Delaware and
Massachusetts law directly for more complete information.
ADDITIONAL INFORMATION
Evergreen Tax Free. Information concerning the operation and management
of Evergreen Tax Free is incorporated herein by reference from the Prospectus
dated November 10, 1997, a copy of which is enclosed, and Statement of
Additional Information dated November 10, 1997. A copy of such Statement of
Additional Information is available upon request and without charge by writing
to Evergreen Tax Free at the address listed on the cover page of this
Prospectus/Proxy Statement or by calling toll-free 1-800-343-2898.
Keystone Tax Free Income. Information about the Fund is included in its
current Prospectus dated March 31, 1997, as supplemented, and in the Statement
of Additional Information of the same date that have been filed with the SEC,
all of which are incorporated herein by reference. A copy of the Prospectus and
Statement of Additional Information are available upon request and without
charge by writing to the address listed on the cover page of this
Prospectus/Proxy Statement or by calling toll-free 1-800-343-2898.
Keystone Tax Free. Information about the Fund is included in its
current Prospectus dated April 30, 1997, as supplemented, and in the Statement
of Additional Information of the same date that has been filed with the SEC, all
of which are incorporated herein by reference. A copy of the Prospectus and
Statement of Additional Information are available upon request and without
charge by writing to the address listed on the cover page of this
Prospectus/Proxy Statement or by calling toll-free 1-800-343-2898.
<PAGE>
Evergreen Tax Free, Keystone Tax Free Income and Keystone Tax Free are
each subject to the informational requirements of the Securities Exchange Act of
1934 and the 1940 Act, and in accordance therewith file reports and other
information including proxy material, and charter documents with the SEC. These
items can be inspected and copies obtained at the Public Reference Facilities
maintained by the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549, and at
the SEC's Regional Offices located at Northwest Atrium Center, 500 West Madison
Street, Chicago, Illinois 60661-2511 and Seven World Trade Center, Suite 1300,
New York, New York 10048.
VOTING INFORMATION CONCERNING THE MEETINGS
This Prospectus/Proxy Statement is furnished in connection with a
solicitation of proxies by the Trustees of Keystone Tax Free Income and Keystone
Tax Free to be used at each Special Meeting of Shareholders to be held at 3:00
p.m., January 6, 1998, at the offices of the Evergreen Keystone Funds, 200
Berkeley Street, Boston, MA 02116 and at any adjournments thereof. This
Prospectus/Proxy Statement, along with a Notice of the meeting and a proxy card,
is first being mailed to shareholders of Keystone Tax Free Income and Keystone
Tax Free on or about November 14, 1997. Only shareholders of record as of the
close of business on the Record Date will be entitled to notice of, and to vote
at, the Meeting or any adjournment thereof. The holders of a majority of the
outstanding shares entitled to vote of each Fund at the close of business on the
Record Date present in person or represented by proxy will constitute a quorum
for the Meeting. If the enclosed form of proxy is properly executed and returned
in time to be voted at the Meeting, the proxies named therein will vote the
shares represented by the proxy in accordance with the instructions marked
thereon. Unmarked proxies will be voted FOR the proposed Reorganization and FOR
any other matters deemed appropriate. Proxies that reflect abstentions and
"broker non-votes" (i.e., shares held by brokers or nominees as to which (i)
instructions have not been received from the beneficial owners or the persons
entitled to vote or (ii) the broker or nominee does not have discretionary
voting power on a particular matter) will be counted as shares that are present
and entitled to vote for purposes of determining the presence of a quorum. Such
proxies will have the effect of being counted as votes against the Plan since
the vote required is a majority of the shares present and entitled to vote. A
proxy may be revoked at any time on or before the Meeting by written notice to
the Secretary of Keystone Tax Free Income or Keystone Tax Free, as applicable,
200 Berkeley Street, Boston, Massachusetts 02116. Unless revoked, all valid
proxies will be voted in accordance with the specifications thereon or, in the
absence of such
<PAGE>
specifications, FOR approval of the Plan and the
Reorganization contemplated thereby.
Approval of each Plan will require the affirmative vote of a majority
of the shares present and entitled to vote, with all Classes voting together as
a single class at Meetings at which a quorum of each Fund's shares is present.
Each full share outstanding is entitled to one vote and each fractional share
outstanding is entitled to a proportionate share of one vote.
Proxy solicitations will be made primarily by mail, but proxy
solicitations may also be made by telephone, telegraph or personal solicitations
conducted by officers and employees of FUNB, its affiliates or other
representatives of Keystone Tax Free Income and Keystone Tax Free (who will not
be paid for their soliciting activities). Shareholders Communications Corp.
("SCC") has been engaged by Keystone Tax Free Income and Keystone Tax Free to
assist in soliciting proxies, and may contact certain shareholders of the Funds
over the telephone. Shareholders who are contacted by SCC may be asked to cast
their vote by telephonic proxy. Such proxies will be recorded in accordance with
the procedures set forth below. Each Fund believes these procedures are
reasonably designed to ensure that the identity of the shareholder casting the
vote is accurately determined and that the voting instructions of the
shareholder are accurately reflected. Each Fund has received an opinion of
counsel that addresses the validity, under the applicable law of The
Commonwealth of Massachusetts, of a proxy given orally. The opinion concludes
that a Massachusetts court would find that there is no Massachusetts law or
Massachusetts public policy against the acceptance of proxies signed by an
orally-authorized agent.
In all cases where a telephonic proxy is solicited, the SCC
representative will ask you for your full name, address, social security or
employer identification number, title (if you are authorized to act on behalf of
an entity, such as a corporation), and number of shares owned. If the
information solicited agrees with the information provided to SCC by each Fund's
transfer agent, then the SCC representative will explain the process, read the
proposals listed on the proxy card and ask for your instructions on each
proposal. The SCC representative, although he or she will answer questions about
the process, will not recommend to the shareholder how he or she should vote,
other than to read any recommendations set forth in the proxy statement. Within
72 hours, SCC will send you a letter or mailgram to confirm your vote and asking
you to call immediately if your instructions are not correctly reflected in the
confirmation.
<PAGE>
If you wish to participate in the Meeting, but do not wish to give your
proxy by telephone, you may still submit the proxy card included with this
Prospectus/Proxy Statement or attend in person. Any proxy given by you, whether
in writing or by telephone, is revocable.
In the event that sufficient votes to approve a Reorganization are not
received by January 6, 1998, the persons named as proxies may propose one or
more adjournments of the Meeting to permit further solicitation of proxies. In
determining whether to adjourn the Meeting, the following factors may be
considered: the percentage of votes actually cast; the percentage of negative
votes actually cast; the nature of any further solicitation and the information
to be provided to shareholders with respect to the reasons for the solicitation.
Any such adjournment will require an affirmative vote by the holders of a
majority of the shares present in person or by proxy and entitled to vote at the
Meeting. The persons named as proxies will vote upon such adjournment after
consideration of all circumstances which may bear upon a decision to adjourn the
Meeting.
A shareholder who objects to a proposed Reorganization will not be
entitled under either Massachusetts law or the Declaration of Trust of Keystone
Tax Free Income or Keystone Tax Free, as applicable, to demand payment for, or
an appraisal of, his or her shares. However, shareholders should be aware that
the Reorganizations as proposed are not expected to result in recognition of
gain or loss to shareholders for federal income tax purposes and that, if the
Reorganizations are consummated, shareholders will be free to redeem the shares
of Evergreen Tax Free which they receive in the transaction at their
then-current net asset value. Shares of Keystone Tax Free Income and Keystone
Tax Free may be redeemed at any time prior to the consummation of the
Reorganizations. Shareholders of Keystone Tax Free Income and Keystone Tax Free
may wish to consult their tax advisers as to any differing consequences of
redeeming Fund shares prior to the Reorganizations or exchanging such shares in
the Reorganizations.
Keystone Tax Free Income and Keystone Tax Free do not hold annual
shareholder meetings. If a Reorganization is not approved, shareholders wishing
to submit proposals for consideration for inclusion in a proxy statement for a
subsequent shareholder meeting should send their written proposals to the
Secretary of Keystone Tax Free Income or Keystone Tax Free, as applicable, at
the address set forth on the cover of this Prospectus/Proxy Statement such that
they will be received by the Funds in a reasonable period of time prior to any
such meeting.
<PAGE>
The votes of the shareholders of Evergreen Tax Free are not being
solicited by this Prospectus/Proxy Statement and are not required to carry out
the Reorganizations.
NOTICE TO BANKS, BROKER-DEALERS AND VOTING TRUSTEES AND THEIR NOMINEES.
Please advise Keystone Tax Free Income and Keystone Tax Free whether other
persons are beneficial owners of shares for which proxies are being solicited
and, if so, the number of copies of this Prospectus/Proxy Statement needed to
supply copies to the beneficial owners of the respective shares.
FINANCIAL STATEMENTS AND EXPERTS
The financial statements of Keystone Tax Free Income as of May 31, 1997
and the financial statements and financial highlights for the periods indicated
therein have been incorporated by reference herein and in the Registration
Statement in reliance upon the report of KPMG Peat Marwick LLP, independent
certified public accountants, incorporated by reference herein and upon the
authority of said firm as experts in accounting and auditing.
The financial statements of Keystone Tax Free as of December 31, 1996
and the financial statements and financial highlights for the periods indicated
therein have been incorporated by reference herein and in the Registration
Statement in reliance upon the report of KPMG Peat Marwick LLP, independent
certified public accountants, incorporated by reference herein and upon the
authority of said firm as experts in accounting and auditing.
LEGAL MATTERS
Certain legal matters concerning the issuance of shares of Evergreen
Tax Free will be passed upon by Sullivan & Worcester LLP, Washington, D.C.
OTHER BUSINESS
The Trustees of Keystone Tax Free Income and Keystone Tax Free do not
intend to present any other business at the Meeting. If, however, any other
matters are properly brought before the Meeting, the persons named in the
accompanying form of proxy will vote thereon in accordance with their judgment.
THE RESPECTIVE TRUSTEES OF KEYSTONE TAX FREE INCOME AND KEYSTONE TAX
FREE RECOMMEND THEIR APPROVAL OF EACH RESPECTIVE PLAN AND ANY UNMARKED PROXIES
WITHOUT INSTRUCTIONS TO THE CONTRARY WILL BE VOTED IN FAVOR OF APPROVAL OF THE
PLANS.
<PAGE>
November 14, 1997
<PAGE>
EXHIBIT A-1
AGREEMENT AND PLAN OF REORGANIZATION
THIS AGREEMENT AND PLAN OF REORGANIZATION (the "Agreement") is made as
of this 30th day of September, 1997, by and between the Evergreen Municipal
Trust, a Delaware business trust, with its principal place of business at 200
Berkeley Street, Boston, Massachusetts 02116 (the "Trust"), with respect to its
Evergreen Tax Free Fund series (the "Acquiring Fund"), and Keystone Tax Free
Income Fund, a Massachusetts business trust, with its principal place of
business at 200 Berkeley Street, Boston, Massachusetts 02116 (the "Selling
Fund").
This Agreement is intended to be, and is adopted as, a plan of
reorganization and liquidation within the meaning of Section 368(a)(1)(C) of the
United States Internal Revenue Code of 1986, as amended (the "Code"). The
reorganization (the "Reorganization") will consist of (i) the transfer of all of
the assets of the Selling Fund in exchange solely for Class A, Class B and Class
C shares of beneficial interest, without par value, of the Acquiring Fund (the
"Acquiring Fund Shares"); (ii) the assumption by the Acquiring Fund of certain
identified liabilities of the Selling Fund; and (iii) the distribution, after
the Closing Date hereinafter referred to, of the Acquiring Fund Shares to the
shareholders of the Selling Fund in liquidation of the Selling Fund as provided
herein, all upon the terms and conditions hereinafter set forth in this
Agreement.
WHEREAS, the Selling Fund and the Acquiring Fund are a registered
open-end investment company and a separate investment series of an open-end,
registered investment company of the management type, respectively, and the
Selling Fund owns securities that generally are assets of the character in which
the Acquiring Fund is permitted to invest;
WHEREAS, both Funds are authorized to issue their shares
of beneficial interest;
WHEREAS, the Trustees of the Trust have determined that the exchange of
all of the assets of the Selling Fund for Acquiring Fund Shares and the
assumption of certain identified liabilities of the Selling Fund by the
Acquiring Fund on the terms and conditions hereinafter set forth are in the best
interests of the Acquiring Fund's shareholders;
WHEREAS, the Trustees of the Selling Fund have determined that the
Selling Fund should exchange all of its assets and certain identified
liabilities for Acquiring Fund Shares and
<PAGE>
that the interests of the existing shareholders of the Selling
Fund will not be diluted as a result of the transactions
contemplated herein;
NOW, THEREFORE, in consideration of the premises and of the covenants
and agreements hereinafter set forth, the parties hereto covenant and agree as
follows:
ARTICLE I
TRANSFER OF ASSETS OF THE SELLING FUND IN EXCHANGE FOR
THE ACQUIRING FUND SHARES AND ASSUMPTION OF SELLING FUND
LIABILITIES AND LIQUIDATION OF THE SELLING FUND
1.1 THE EXCHANGE. Subject to the terms and conditions herein set forth
and on the basis of the representations and warranties contained herein, the
Selling Fund agrees to transfer all of the Selling Fund's assets as set forth in
paragraph 1.2 to the Acquiring Fund. The Acquiring Fund agrees in exchange
therefor (i) to deliver to the Selling Fund the number of Acquiring Fund Shares,
including fractional Acquiring Fund Shares, determined by multiplying the shares
outstanding of each class of the Selling Fund by the ratio computed by dividing
the net asset value per share of each such class of the Selling Fund by the net
asset value per share of the corresponding class of Acquiring Fund Shares
computed in the manner and as of the time and date set forth in paragraph 2.2;
and (ii) to assume certain identified liabilities of the Selling Fund, as set
forth in paragraph 1.3. Such transactions shall take place at the closing
provided for in paragraph 3.1 (the "Closing Date").
1.2 ASSETS TO BE ACQUIRED. The assets of the Selling Fund to be
acquired by the Acquiring Fund shall consist of all property, including, without
limitation, all cash, securities, commodities, and futures interests and
dividends or interest receivables, that is owned by the Selling Fund and any
deferred or prepaid expenses shown as an asset on the books of the Selling Fund
on the Closing Date.
The Selling Fund has provided the Acquiring Fund with its most recent
audited financial statements, which contain a list of all of Selling Fund's
assets as of the date thereof. The Selling Fund hereby represents that as of the
date of the execution of this Agreement there have been no changes in its
financial position as reflected in said financial statements other than those
occurring in the ordinary course of its business in connection with the purchase
and sale of securities and the payment of its normal operating expenses. The
Selling Fund reserves the right to sell any of such securities, but will not,
without the prior written approval
<PAGE>
of the Acquiring Fund, acquire any additional securities other than securities
of the type in which the Acquiring Fund is permitted to invest.
The Acquiring Fund will, within a reasonable time prior to the Closing
Date, furnish the Selling Fund with a statement of the Acquiring Fund's
investment objectives, policies, and restrictions and a list of the securities,
if any, on the Selling Fund's list referred to in the second sentence of this
paragraph that do not conform to the Acquiring Fund's investment objectives,
policies, and restrictions. In the event that the Selling Fund holds any
investments that the Acquiring Fund may not hold, the Selling Fund will dispose
of such securities prior to the Closing Date. In addition, if it is determined
that the Selling Fund and the Acquiring Fund portfolios, when aggregated, would
contain investments exceeding certain percentage limitations imposed upon the
Acquiring Fund with respect to such investments, the Selling Fund if requested
by the Acquiring Fund will dispose of a sufficient amount of such investments as
may be necessary to avoid violating such limitations as of the Closing Date.
1.3 LIABILITIES TO BE ASSUMED. The Selling Fund will endeavor to
discharge all of its known liabilities and obligations prior to the Closing
Date. Except as specifically provided in this paragraph 1.3, the Acquiring Fund
shall assume only those liabilities, expenses, costs, charges and reserves
reflected on a Statement of Assets and Liabilities of the Selling Fund prepared
on behalf of the Selling Fund, as of the Valuation Date (as defined in paragraph
2.1), in accordance with generally accepted accounting principles consistently
applied from the prior audited period. The Acquiring Fund shall assume only
those liabilities of the Selling Fund reflected in such Statement of Assets and
Liabilities and shall not except as specifically provided in this paragraph 1.3
assume any other liabilities, whether absolute or contingent, known or unknown,
accrued or unaccrued, all of which shall remain the obligation of the Selling
Fund. The Acquiring Fund hereby agrees with the Selling Fund and each Trustee of
the Selling Fund: (i) to indemnify each Trustee of the Selling Fund against all
liabilities and expenses referred to in the indemnification provisions of the
Selling Fund's Declaration of Trust and ByLaws, to the extent provided therein,
incurred by any Trustee of the Selling Fund; and (ii) in addition to the
indemnification provided in (i) above, to indemnify each Trustee of the Selling
Fund against all liabilities and expenses and pay the same as they arise and
become due, without any exception, limitation or requirement of approval by any
person, and without any right to require repayment thereof by any such Trustee
(unless such Trustee has had the
<PAGE>
same repaid to him or her) based upon any subsequent or final disposition or
findings made in connection therewith or otherwise, if such action, suit or
other proceeding involves such Trustee's participation in authorizing or
permitting or acquiescing in, directly or indirectly, by action or inaction, the
making of any distribution in any manner of all or any assets of the Selling
Fund without making provision for the payment of any liabilities of any kind,
fixed or contingent, of the Selling Fund, which liabilities were not actually
and consciously personally known to such Trustee to exist at the time of such
Trustee's participation in so authorizing or permitting or acquiescing in the
making of any such distribution.
In addition, upon completion of the Reorganization, for purposes of
calculating the maximum amount permitted to be charged to the Acquiring Fund
under the National Association of Securities Dealers, Inc. Conduct Rule 2830,
minus the amount of the sales charges paid or accrued (including asset based
sales charge), plus permitted interest ("Aggregate NASD Cap"), the Acquiring
Fund will add to its Aggregate NASD Cap immediately prior to the Reorganization
the Aggregate NASD Cap of the Selling Fund immediately prior to the
Reorganization.
1.4 LIQUIDATION AND DISTRIBUTION. On or soon after the Closing Date as
is conveniently practicable (the "Liquidation Date"), (a) the Selling Fund will
liquidate and distribute pro rata to the Selling Fund's shareholders of record,
determined as of the close of business on the Valuation Date (the "Selling Fund
Shareholders"), the Acquiring Fund Shares received by the Selling Fund pursuant
to paragraph 1.1; and (b) the Selling Fund will thereupon proceed to dissolve as
set forth in paragraph 1.8 below. Such liquidation and distribution will be
accomplished by the transfer of the Acquiring Fund Shares then credited to the
account of the Selling Fund on the books of the Acquiring Fund to open accounts
on the share records of the Acquiring Fund in the names of the Selling Fund
Shareholders and representing the respective pro rata number of the Acquiring
Fund Shares due such shareholders. All issued and outstanding shares of the
Selling Fund will simultaneously be canceled on the books of the Selling Fund.
The Acquiring Fund shall not issue certificates representing the Acquiring Fund
Shares in connection with such exchange.
1.5 OWNERSHIP OF SHARES. Ownership of Acquiring Fund Shares will be
shown on the books of the Acquiring Fund's transfer agent. Shares of the
Acquiring Fund will be issued in the manner described in the combined Prospectus
and Proxy Statement on Form N-14 to be distributed to shareholders of the
Selling Fund as described in paragraph 5.7.
<PAGE>
1.6 TRANSFER TAXES. Any transfer taxes payable upon issuance of the
Acquiring Fund Shares in a name other than the registered holder of the Selling
Fund shares on the books of the Selling Fund as of that time shall, as a
condition of such issuance and transfer, be paid by the person to whom such
Acquiring Fund Shares are to be issued and transferred.
1.7 REPORTING RESPONSIBILITY. Any reporting responsibility of the
Selling Fund is and shall remain the responsibility of the Selling Fund up to
and including the Closing Date and such later date on which the Selling Fund is
terminated.
1.8 TERMINATION. The Selling Fund shall be terminated promptly
following the Closing Date and the making of all distributions pursuant to
paragraph 1.4.
ARTICLE II
VALUATION
2.1 VALUATION OF ASSETS. The value of the Selling Fund's assets to be
acquired by the Acquiring Fund hereunder shall be the value of such assets
computed as of the close of business on the New York Stock Exchange on the
business day next preceding the Closing Date (such time and date being
hereinafter called the "Valuation Date"), using the valuation procedures set
forth in the Trust's Declaration of Trust and the Acquiring Fund's then current
prospectus and statement of additional information or such other valuation
procedures as shall be mutually agreed upon by the parties.
2.2 VALUATION OF SHARES. The net asset value per share of the Acquiring
Fund Shares shall be the net asset value per share computed as of the close of
business on the New York Stock Exchange on the Valuation Date, using the
valuation procedures set forth in the Trust's Declaration of Trust and the
Acquiring Fund's then current prospectus and statement of additional
information.
2.3 SHARES TO BE ISSUED. The number of the Acquiring Fund Shares of
each class to be issued (including fractional shares, if any) in exchange for
the Selling Fund's assets shall be determined by multiplying the shares
outstanding of each class of the Selling Fund by the ratio computed by dividing
the net asset value per share of the Selling Fund attributable to each of its
classes by the net asset value per share of the respective classes of the
Acquiring Fund determined in accordance with paragraph 2.2.
<PAGE>
2.4 DETERMINATION OF VALUE. All computations of value shall be made by
State Street Bank and Trust Company in accordance with its regular practice in
pricing the shares and assets of the Acquiring Fund.
ARTICLE III
CLOSING AND CLOSING DATE
3.1 CLOSING DATE. The Closing (the "Closing") shall take place on or
about January 23, 1998 or such other date as the parties may agree to in writing
(the "Closing Date"). All acts taking place at the Closing shall be deemed to
take place simultaneously immediately prior to the opening of business on the
Closing Date unless otherwise provided. The Closing shall be held as of 9:00
a.m. at the offices of the Evergreen Keystone Funds, 200 Berkeley Street,
Boston, MA 02116, or at such other time and/or place as the parties may agree.
3.2 CUSTODIAN'S CERTIFICATE. State Street Bank and Trust Company, as
custodian for the Selling Fund (the "Custodian"), shall deliver at the Closing a
certificate of an authorized officer stating that (a) the Selling Fund's
portfolio securities, cash, and any other assets shall have been delivered in
proper form to the Acquiring Fund on the Closing Date; and (b) all necessary
taxes including all applicable federal and state stock transfer stamps, if any,
shall have been paid, or provision for payment shall have been made, in
conjunction with the delivery of portfolio securities by the Selling Fund.
3.3 EFFECT OF SUSPENSION IN TRADING. In the event that on the Valuation
Date (a) the New York Stock Exchange or another primary trading market for
portfolio securities of the Acquiring Fund or the Selling Fund shall be closed
to trading or trading thereon shall be restricted; or (b) trading or the
reporting of trading on said Exchange or elsewhere shall be disrupted so that
accurate appraisal of the value of the net assets of the Acquiring Fund or the
Selling Fund is impracticable, the Valuation Date shall be postponed until the
first business day after the day when trading shall have been fully resumed and
reporting shall have been restored.
3.4 TRANSFER AGENT'S CERTIFICATE. Evergreen Keystone Service Company,
as transfer agent for the Selling Fund as of the Closing Date ("EKSC"), shall
deliver at the Closing a certificate of an authorized officer stating that its
records contain the names and addresses of the Selling Fund Shareholders and the
number and percentage ownership of outstanding shares owned by each such
shareholder immediately
<PAGE>
prior to the Closing. The Acquiring Fund shall issue and deliver or cause EKSC,
its transfer agent as of the Closing Date, to issue and deliver a confirmation
evidencing the Acquiring Fund Shares to be credited on the Closing Date to the
Secretary of the Selling Fund or provide evidence satisfactory to the Selling
Fund that such Acquiring Fund Shares have been credited to the Selling Fund's
account on the books of the Acquiring Fund. At the Closing, each party shall
deliver to the other such bills of sale, checks, assignments, share
certificates, if any, receipts and other documents as such other party or its
counsel may reasonably request.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES
4.1 REPRESENTATIONS OF THE SELLING FUND. The Selling
Fund represents and warrants to the Acquiring Fund as follows:
(a) The Selling Fund is a Massachusetts business trust duly
organized, validly existing, and in good standing under the laws of The
Commonwealth of Massachusetts.
(b) The Selling Fund is a registered investment company
classified as a management company of the open-end type, and its registration
with the Securities and Exchange Commission (the "Commission") as an investment
company under the Investment Company Act of 1940, as amended (the "1940 Act"),
is in full force and effect.
(c) The current prospectus and statement of additional
information of the Selling Fund conform in all material respects to the
applicable requirements of the Securities Act of 1933, as amended (the "1933
Act"), and the 1940 Act and the rules and regulations of the Commission
thereunder and do not include any untrue statement of a material fact or omit to
state any material fact required to be stated therein or necessary to make the
statements therein, in light of the circumstances under which they were made,
not misleading.
(d) The Selling Fund is not, and the execution, delivery, and
performance of this Agreement (subject to shareholder approval) will not result,
in violation of any provision of the Selling Fund's Declaration of Trust or
By-Laws or of any material agreement, indenture, instrument, contract, lease, or
other undertaking to which the Selling Fund is a party or by which it is bound.
<PAGE>
(e) The Selling Fund has no material contracts or other
commitments (other than this Agreement) that will be terminated with liability
to it prior to the Closing Date.
(f) Except as otherwise disclosed in writing to and accepted
by the Acquiring Fund, no litigation, administrative proceeding, or
investigation of or before any court or governmental body is presently pending
or to its knowledge threatened against the Selling Fund or any of its properties
or assets, which, if adversely determined, would materially and adversely affect
its financial condition, the conduct of its business, or the ability of the
Selling Fund to carry out the transactions contemplated by this Agreement. The
Selling Fund knows of no facts that might form the basis for the institution of
such proceedings and is not a party to or subject to the provisions of any
order, decree, or judgment of any court or governmental body that materially and
adversely affects its business or its ability to consummate the transactions
herein contemplated.
(g) The financial statements of the Selling Fund at May 31,
1997 are in accordance with generally accepted accounting principles
consistently applied, and such statements (copies of which have been furnished
to the Acquiring Fund) fairly reflect the financial condition of the Selling
Fund as of such date, and there are no known contingent liabilities of the
Selling Fund as of such date not disclosed therein.
(h) Since May 31, 1997 there has not been any material adverse
change in the Selling Fund's financial condition, assets, liabilities, or
business other than changes occurring in the ordinary course of business, or any
incurrence by the Selling Fund of indebtedness maturing more than one year from
the date such indebtedness was incurred, except as otherwise disclosed to and
accepted by the Acquiring Fund. For the purposes of this subparagraph (h), a
decline in the net asset value of the Selling Fund shall not constitute a
material adverse change.
(i) At the Closing Date, all federal and other tax returns and
reports of the Selling Fund required by law to have been filed by such dates
shall have been filed, and all federal and other taxes shown due on said returns
and reports shall have been paid, or provision shall have been made for the
payment thereof. To the best of the Selling Fund's knowledge, no such return is
currently under audit, and no assessment has been asserted with respect to such
returns.
(j) For each fiscal year of its operation, the Selling Fund has met the
requirements of Subchapter M of the
<PAGE>
Code for qualification and treatment as a regulated investment company and has
distributed in each such year all net investment income and realized capital
gains.
(k) All issued and outstanding shares of the Selling Fund are,
and at the Closing Date will be, duly and validly issued and outstanding, fully
paid and non-assessable by the Selling Fund (except that, under Massachusetts
law, Selling Fund Shareholders could under certain circumstances be held
personally liable for obligations of the Selling Fund). All of the issued and
outstanding shares of the Selling Fund will, at the time of the Closing Date, be
held by the persons and in the amounts set forth in the records of the transfer
agent as provided in paragraph 3.4. The Selling Fund does not have outstanding
any options, warrants, or other rights to subscribe for or purchase any of the
Selling Fund shares, nor is there outstanding any security convertible into any
of the Selling Fund shares.
(l) At the Closing Date, the Selling Fund will have good and
marketable title to the Selling Fund's assets to be transferred to the Acquiring
Fund pursuant to paragraph 1.2 and full right, power, and authority to sell,
assign, transfer, and deliver such assets hereunder, and, upon delivery and
payment for such assets, the Acquiring Fund will acquire good and marketable
title thereto, subject to no restrictions on the full transfer thereof,
including such restrictions as might arise under the 1933 Act, other than as
disclosed to the Acquiring Fund and accepted by the Acquiring Fund.
(m) The execution, delivery, and performance of this Agreement
have been duly authorized by all necessary action on the part of the Selling
Fund and, subject to approval by the Selling Fund Shareholders, this Agreement
constitutes a valid and binding obligation of the Selling Fund, enforceable in
accordance with its terms, subject as to enforcement, to bankruptcy, insolvency,
reorganization, moratorium, and other laws relating to or affecting creditors'
rights and to general equity principles.
(n) The information to be furnished by the Selling Fund for
use in no-action letters, applications for orders, registration statements,
proxy materials, and other documents that may be necessary in connection with
the transactions contemplated hereby shall be accurate and complete in all
material respects and shall comply in all material respects with federal
securities and other laws and regulations thereunder applicable thereto.
<PAGE>
(o) The Proxy Statement of the Selling Fund to be included in
the Registration Statement (as defined in paragraph 5.7)(other than information
therein that relates to the Acquiring Fund) will, on the effective date of the
Registration Statement and on the Closing Date, not contain any untrue statement
of a material fact or omit to state a material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which such statements were made, not misleading.
4.2 REPRESENTATIONS OF THE ACQUIRING FUND. The Acquiring
Fund represents and warrants to the Selling Fund as follows:
(a) The Acquiring Fund is a separate investment series of a
Delaware business trust duly organized, validly existing and in good standing
under the laws of the State of Delaware.
(b) The Acquiring Fund is a separate investment series of a
Delaware business trust that is registered as an investment company classified
as a management company of the open-end type, and its registration with the
Commission as an investment company under the 1940 Act is in full force and
effect.
(c) The current prospectuses and statement of additional
information of the Acquiring Fund conform in all material respects to the
applicable requirements of the 1933 Act and the 1940 Act and the rules and
regulations of the Commission thereunder and do not include any untrue statement
of a material fact or omit to state any material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading.
(d) The Acquiring Fund is not, and the execution, delivery and
performance of this Agreement will not result, in violation of the Trust's
Declaration of Trust or By-Laws or of any material agreement, indenture,
instrument, contract, lease, or other undertaking to which the Acquiring Fund is
a party or by which it is bound.
(e) Except as otherwise disclosed in writing to the Selling
Fund and accepted by the Selling Fund, no litigation, administrative proceeding
or investigation of or before any court or governmental body is presently
pending or to its knowledge threatened against the Acquiring Fund or any of its
properties or assets, which, if adversely determined, would materially and
adversely affect its financial condition and the conduct of its business or the
ability of the Acquiring Fund to carry out the transactions contemplated by this
<PAGE>
Agreement. The Acquiring Fund knows of no facts that might form the basis for
the institution of such proceedings and is not a party to or subject to the
provisions of any order, decree, or judgment of any court or governmental body
that materially and adversely affects its business or its ability to consummate
the transactions contemplated herein.
(f) The Acquiring Fund has no known liabilities of a material
amount, contingent or otherwise.
(g) At the Closing Date, there will not be any material
adverse change in the Acquiring Fund's financial condition, assets, liabilities,
or business other than changes occurring in the ordinary course of business, or
any incurrence by the Acquiring Fund of indebtedness maturing more than one year
from the date such indebtedness was incurred, except as otherwise disclosed to
and accepted by the Selling Fund. For the purposes of this subparagraph (g), a
decline in the net asset value of the Acquiring Fund shall not constitute a
material adverse change.
(h) At the Closing Date, all federal and other tax returns and
reports of the Acquiring Fund required by law then to be filed by such dates
shall have been filed, and all federal and other taxes shown due on said returns
and reports shall have been paid or provision shall have been made for the
payment thereof. To the best of the Acquiring Fund's knowledge, no such return
is currently under audit, and no assessment has been asserted with respect to
such returns.
(i) All issued and outstanding Acquiring Fund Shares are, and
at the Closing Date will be, duly and validly issued and outstanding, fully paid
and non-assessable. The Acquiring Fund does not have outstanding any options,
warrants, or other rights to subscribe for or purchase any Acquiring Fund
Shares, nor is there outstanding any security convertible into any Acquiring
Fund Shares.
(j) The execution, delivery, and performance of this Agreement
have been duly authorized by all necessary action on the part of the Acquiring
Fund, and this Agreement constitutes a valid and binding obligation of the
Acquiring Fund enforceable in accordance with its terms, subject as to
enforcement, to bankruptcy, insolvency, reorganization, moratorium, and other
laws relating to or affecting creditors' rights and to general equity
principles.
(k) The Acquiring Fund Shares to be issued and delivered to
the Selling Fund, for the account of the Selling Fund Shareholders, pursuant to
the terms of this Agreement will, at the Closing Date, have been duly authorized
and, when
<PAGE>
so issued and delivered, will be duly and validly issued Acquiring Fund Shares,
and will be fully paid and non-assessable.
(l) The information to be furnished by the Acquiring Fund for
use in no-action letters, applications for orders, registration statements,
proxy materials, and other documents that may be necessary in connection with
the transactions contemplated hereby shall be accurate and complete in all
material respects and shall comply in all material respects with federal
securities and other laws and regulations applicable thereto.
(m) The Prospectus and Proxy Statement (as defined in
paragraph 5.7) to be included in the Registration Statement (only insofar as it
relates to the Acquiring Fund) will, on the effective date of the Registration
Statement and on the Closing Date, not contain any untrue statement of a
material fact or omit to state a material fact required to be stated therein or
necessary to make the statements therein, in light of the circumstances under
which such statements were made, not misleading.
(n) The Acquiring Fund agrees to use all reasonable efforts to
obtain the approvals and authorizations required by the 1933 Act, the 1940 Act,
and such of the state Blue Sky or securities laws as it may deem appropriate in
order to continue its operations after the Closing Date.
ARTICLE V
COVENANTS OF THE ACQUIRING FUND AND THE SELLING FUND
5.1 OPERATION IN ORDINARY COURSE. The Acquiring Fund and the Selling
Fund each will operate its business in the ordinary course between the date
hereof and the Closing Date, it being understood that such ordinary course of
business will include customary dividends and distributions.
5.2 APPROVAL OF SHAREHOLDERS. The Selling Fund will call a meeting of
its Shareholders to consider and act upon this Agreement and to take all other
action necessary to obtain approval of the transactions contemplated herein.
5.3 INVESTMENT REPRESENTATION. The Selling Fund covenants that the
Acquiring Fund Shares to be issued hereunder are not being acquired for the
purpose of making any distribution thereof other than in accordance with the
terms of this Agreement.
<PAGE>
5.4 ADDITIONAL INFORMATION. The Selling Fund will assist the Acquiring
Fund in obtaining such information as the Acquiring Fund reasonably requests
concerning the beneficial ownership of the Selling Fund shares.
5.5 FURTHER ACTION. Subject to the provisions of this Agreement, the
Acquiring Fund and the Selling Fund will each take, or cause to be taken, all
action, and do or cause to be done, all things reasonably necessary, proper or
advisable to consummate and make effective the transactions contemplated by this
Agreement, including any actions required to be taken after the Closing Date.
5.6 STATEMENT OF EARNINGS AND PROFITS. As promptly as practicable, but
in any case within sixty days after the Closing Date, the Selling Fund shall
furnish the Acquiring Fund, in such form as is reasonably satisfactory to the
Acquiring Fund, a statement of the earnings and profits of the Selling Fund for
federal income tax purposes that will be carried over by the Acquiring Fund as a
result of Section 381 of the Code, and which will be reviewed by its independent
auditors and certified by the Selling Fund's President and Treasurer.
5.7 PREPARATION OF FORM N-14 REGISTRATION STATEMENT. The Selling Fund
will provide the Acquiring Fund with information reasonably necessary for the
preparation of a prospectus, which will include the proxy statement, referred to
in paragraph 4.1(o) (the "Prospectus and Proxy Statement"), all to be included
in a Registration Statement on Form N-14 of the Acquiring Fund (the
"Registration Statement"), in compliance with the 1933 Act, the Securities
Exchange Act of 1934, as amended (the "1934 Act"), and the 1940 Act in
connection with the meeting of the Selling Fund Shareholders to consider
approval of this Agreement and the transactions contemplated herein.
ARTICLE VI
CONDITIONS PRECEDENT TO OBLIGATIONS OF THE SELLING FUND
The obligations of the Selling Fund to consummate the transactions
provided for herein shall be subject, at its election, to the performance by the
Acquiring Fund of all the obligations to be performed by it hereunder on or
before the Closing Date, and, in addition thereto, the following further
conditions:
6.1 All representations, covenants, and warranties of the Acquiring
Fund contained in this Agreement shall be true and correct as of the date hereof
and as of the Closing Date
<PAGE>
with the same force and effect as if made on and as of the Closing Date, and the
Acquiring Fund shall have delivered to the Selling Fund a certificate executed
in its name by the Trust's President or Vice President and its Treasurer or
Assistant Treasurer, in form and substance reasonably satisfactory to the
Selling Fund and dated as of the Closing Date, to such effect and as to such
other matters as the Selling Fund shall reasonably request.
6.2 The Selling Fund shall have received on the Closing Date an opinion
from Sullivan & Worcester LLP, counsel to the Acquiring Fund, dated as of the
Closing Date, in a form reasonably satisfactory to the Selling Fund, covering
the following points:
(a) The Acquiring Fund is a separate investment series of a
Delaware business trust duly organized, validly existing and in good standing
under the laws of the State of Delaware and has the power to own all of its
properties and assets and to carry on its business as presently conducted.
(b) The Acquiring Fund is a separate investment series of a
Delaware business trust registered as an investment company under the 1940 Act,
and, to such counsel's knowledge, such registration with the Commission as an
investment company under the 1940 Act is in full force and effect.
(c) This Agreement has been duly authorized, executed, and
delivered by the Acquiring Fund, and, assuming that the Prospectus and Proxy
Statement, and Registration Statement comply with the 1933 Act, the 1934 Act,
and the 1940 Act and the rules and regulations thereunder and, assuming due
authorization, execution and delivery of this Agreement by the Selling Fund, is
a valid and binding obligation of the Acquiring Fund enforceable against the
Acquiring Fund in accordance with its terms, subject as to enforcement, to
bankruptcy, insolvency, reorganization, moratorium, and other laws relating to
or affecting creditors' rights generally and to general equity principles.
(d) Assuming that a consideration therefor not less than the
net asset value thereof has been paid, the Acquiring Fund Shares to be issued
and delivered to the Selling Fund on behalf of the Selling Fund Shareholders as
provided by this Agreement are duly authorized and upon such delivery will be
legally issued and outstanding and fully paid and non-assessable, and no
shareholder of the Acquiring Fund has any preemptive rights in respect thereof.
<PAGE>
(e) The Registration Statement, to such counsel's knowledge,
has been declared effective by the Commission and no stop order under the 1933
Act pertaining thereto has been issued, and to the knowledge of such counsel, no
consent, approval, authorization or order of any court or governmental authority
of the United States or the State of Delaware is required for consummation by
the Acquiring Fund of the transactions contemplated herein, except such as have
been obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be
required under state securities laws.
ARTICLE VII
CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING FUND
The obligations of the Acquiring Fund to complete the transactions
provided for herein shall be subject, at its election, to the performance by the
Selling Fund of all the obligations to be performed by it hereunder on or before
the Closing Date and, in addition thereto, the following conditions:
7.1 All representations, covenants, and warranties of the Selling Fund
contained in this Agreement shall be true and correct as of the date hereof and
as of the Closing Date with the same force and effect as if made on and as of
the Closing Date, and the Selling Fund shall have delivered to the Acquiring
Fund on the Closing Date a certificate executed in its name by the Selling
Fund's President or Vice President and the Treasurer or Assistant Treasurer, in
form and substance satisfactory to the Acquiring Fund and dated as of the
Closing Date, to such effect and as to such other matters as the Acquiring Fund
shall reasonably request.
7.2 The Selling Fund shall have delivered to the Acquiring Fund a
statement of the Selling Fund's assets and liabilities, together with a list of
the Selling Fund's portfolio securities showing the tax costs of such securities
by lot and the holding periods of such securities, as of the Closing Date,
certified by the Treasurer of the Selling Fund.
7.3 The Acquiring Fund shall have received on the Closing Date an
opinion of Sullivan & Worcester LLP, counsel to the Selling Fund, in a form
satisfactory to the Acquiring Fund covering the following points:
(a) The Selling Fund is a Massachusetts business trust duly
organized, validly existing and in good standing under the laws of The
Commonwealth of Massachusetts and has the power to own all of its properties and
assets and to carry on its business as presently conducted.
<PAGE>
(b) The Selling Fund is a Massachusetts business trust
registered as an investment company under the 1940 Act, and, to such counsel's
knowledge, such registration with the Commission as an investment company under
the 1940 Act is in full force and effect.
(c) This Agreement has been duly authorized, executed and
delivered by the Selling Fund, and, assuming that the Prospectus and Proxy
Statement, and Registration Statement comply with the 1933 Act, the 1934 Act,
and the 1940 Act and the rules and regulations thereunder and, assuming due
authorization, execution, and delivery of this Agreement by the Acquiring Fund,
is a valid and binding obligation of the Selling Fund enforceable against the
Selling Fund in accordance with its terms, subject as to enforcement, to
bankruptcy, insolvency, reorganization, moratorium and other laws relating to or
affecting creditors' rights generally and to general equity principles.
(d) To the knowledge of such counsel, no consent, approval,
authorization or order of any court or governmental authority of the United
States or The Commonwealth of Massachusetts is required for consummation by the
Selling Fund of the transactions contemplated herein, except such as have been
obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be
required under state securities laws.
ARTICLE VIII
FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING
FUND AND THE SELLING FUND
If any of the conditions set forth below do not exist on or before the
Closing Date with respect to the Selling Fund or the Acquiring Fund, the other
party to this Agreement shall, at its option, not be required to consummate the
transactions contemplated by this Agreement:
8.1 This Agreement and the transactions contemplated herein shall have
been approved by the requisite vote of the holders of the outstanding shares of
the Selling Fund in accordance with the provisions of the Selling Fund's
Declaration of Trust and By-Laws and certified copies of the resolutions
evidencing such approval shall have been delivered to the Acquiring Fund.
Notwithstanding anything herein to the contrary, neither the Acquiring Fund nor
the Selling Fund may waive the conditions set forth in this paragraph 8.1.
8.2 On the Closing Date, the Commission shall not have issued an
unfavorable report under Section 25(b) of the 1940 Act, nor instituted any
proceeding seeking to enjoin the
<PAGE>
consummation of the transactions contemplated by this Agreement under Section
25(c) of the 1940 Act and no action, suit or other proceeding shall be
threatened or pending before any court or governmental agency in which it is
sought to restrain or prohibit, or obtain damages or other relief in connection
with, this Agreement or the transactions contemplated herein.
8.3 All required consents of other parties and all other consents,
orders, and permits of federal, state and local regulatory authorities
(including those of the Commission and of state Blue Sky securities authorities,
including any necessary "no-action" positions of and exemptive orders from such
federal and state authorities) to permit consummation of the transactions
contemplated hereby shall have been obtained, except where failure to obtain any
such consent, order, or permit would not involve a risk of a material adverse
effect on the assets or properties of the Acquiring Fund or the Selling Fund,
provided that either party hereto may for itself waive any of such conditions.
8.4 The Registration Statement shall have become effective under the
1933 Act, and no stop orders suspending the effectiveness thereof shall have
been issued and, to the best knowledge of the parties hereto, no investigation
or proceeding for that purpose shall have been instituted or be pending,
threatened or contemplated under the 1933 Act.
8.5 The Selling Fund shall have declared a dividend or dividends which,
together with all previous such dividends, shall have the effect of distributing
to the Selling Fund Shareholders all of the Selling Fund's investment company
taxable income for all taxable periods ending on the Closing Date (computed
without regard to any deduction for dividends paid) and all of its net capital
gains realized in all taxable periods ending on the Closing Date (after
reduction for any capital loss carryforward).
8.6 The parties shall have received a favorable opinion of Sullivan &
Worcester LLP, addressed to the Acquiring Fund and the Selling Fund
substantially to the effect that for federal income tax purposes:
(a) The transfer of all of the Selling Fund assets in exchange
for the Acquiring Fund Shares and the assumption by the Acquiring Fund of
certain stated liabilities of the Selling Fund followed by the distribution of
the Acquiring Fund Shares to the Selling Fund in dissolution and liquidation of
the Selling Fund will constitute a "reorganization" within the meaning of
Section 368(a)(1)(C) of the Code and the Acquiring Fund and the Selling Fund
will each be a "party to a
<PAGE>
reorganization" within the meaning of Section 368(b) of the
Code.
(b) No gain or loss will be recognized by the Acquiring Fund
upon the receipt of the assets of the Selling Fund solely in exchange for the
Acquiring Fund Shares and the assumption by the Acquiring Fund of certain stated
liabilities of the Selling Fund.
(c) No gain or loss will be recognized by the Selling Fund
upon the transfer of the Selling Fund assets to the Acquiring Fund in exchange
for the Acquiring Fund Shares and the assumption by the Acquiring Fund of
certain stated liabilities of the Selling Fund or upon the distribution (whether
actual or constructive) of the Acquiring Fund Shares to Selling Fund
Shareholders in exchange for their shares of the Selling Fund.
(d) No gain or loss will be recognized by the Selling Fund
Shareholders upon the exchange of their Selling Fund shares for the Acquiring
Fund Shares in liquidation of the Selling Fund.
(e) The aggregate tax basis for the Acquiring Fund Shares
received by each Selling Fund Shareholder pursuant to the Reorganization will be
the same as the aggregate tax basis of the Selling Fund shares held by such
shareholder immediately prior to the Reorganization, and the holding period of
the Acquiring Fund Shares to be received by each Selling Fund Shareholder will
include the period during which the Selling Fund shares exchanged therefor were
held by such shareholder (provided the Selling Fund shares were held as capital
assets on the date of the Reorganization).
(f) The tax basis of the Selling Fund assets acquired by the
Acquiring Fund will be the same as the tax basis of such assets to the Selling
Fund immediately prior to the Reorganization, and the holding period of the
assets of the Selling Fund in the hands of the Acquiring Fund will include the
period during which those assets were held by the Selling Fund.
Notwithstanding anything herein to the contrary, neither the Acquiring
Fund nor the Selling Fund may waive the conditions set forth in this paragraph
8.6.
8.7 The Acquiring Fund shall have received from KPMG Peat Marwick LLP a
letter addressed to the Acquiring Fund, in form and substance satisfactory to
the Acquiring Fund, to the effect that:
<PAGE>
(a) they are independent certified public accountants with
respect to the Selling Fund within the meaning of the 1933 Act and the
applicable published rules and regulations thereunder;
(b) on the basis of limited procedures agreed upon by the
Acquiring Fund and described in such letter (but not an examination in
accordance with generally accepted auditing standards), the Capitalization Table
appearing in the Registration Statement and Prospectus and Proxy Statement has
been obtained from and is consistent with the accounting records of the Selling
Fund;
(c) on the basis of limited procedures agreed upon by the
Acquiring Fund and described in such letter (but not an examination in
accordance with generally accepted auditing standards), the data utilized in the
calculations of the projected expense ratios appearing in the Registration
Statement and Prospectus and Proxy Statement agree with underlying accounting
records of the Selling Fund or to written estimates by Selling Fund's management
and were found to be mathematically correct.
In addition, the Acquiring Fund shall have received from KPMG Peat
Marwick LLP a letter addressed to the Acquiring Fund dated on the Closing Date,
in form and substance satisfactory to the Acquiring Fund, to the effect, that on
the basis of limited procedures agreed upon by the Acquiring Fund (but not an
examination in accordance with generally accepted auditing standards), the
calculation of net asset value per share of the Selling Fund as of the Valuation
Date was determined in accordance with generally accepted accounting practices
and the portfolio valuation practices of the Acquiring Fund.
8.8 The Selling Fund shall have received from KPMG Peat Marwick LLP a
letter addressed to the Selling Fund, in form and substance satisfactory to the
Selling Fund, to the effect that:
(a) they are independent certified public accountants with
respect to the Acquiring Fund within the meaning of the 1933 Act and the
applicable published rules and regulations thereunder;
(b) on the basis of limited procedures agreed upon by the
Selling Fund and described in such letter (but not an examination in accordance
with generally accepted auditing standards), the Capitalization Table appearing
in the Registration Statement and Prospectus and Proxy Statement has been
obtained from and is consistent with the accounting records of the Acquiring
Fund; and
<PAGE>
(c) on the basis of limited procedures agreed upon by the
Selling Fund (but not an examination in accordance with generally accepted
auditing standards), the data utilized in the calculations of the projected
expense ratio appearing in the Registration Statement and Prospectus and Proxy
Statement agree with written estimates by each Fund's management and were found
to be mathematically correct.
8.9 The Acquiring Fund and the Selling Fund shall also have received
from KPMG Peat Marwick LLP a letter addressed to the Acquiring Fund and the
Selling Fund, dated on the Closing Date in form and substance satisfactory to
the Funds, setting forth the federal income tax implications relating to capital
loss carryforwards (if any) of the Selling Fund and the related impact, if any,
of the proposed transfer of all of the assets of the Selling Fund to the
Acquiring Fund and the ultimate dissolution of the Selling Fund, upon the
shareholders of the Selling Fund.
ARTICLE IX
EXPENSES
9.1 Except as otherwise provided for herein, all expenses of the
transactions contemplated by this Agreement incurred by the Selling Fund and the
Acquiring Fund will be borne by First Union National Bank. Such expenses
include, without limitation, (a) expenses incurred in connection with the
entering into and the carrying out of the provisions of this Agreement; (b)
expenses associated with the preparation and filing of the Registration
Statement under the 1933 Act covering the Acquiring Fund Shares to be issued
pursuant to the provisions of this Agreement; (c) registration or qualification
fees and expenses of preparing and filing such forms as are necessary under
applicable state securities laws to qualify the Acquiring Fund Shares to be
issued in connection herewith in each state in which the Selling Fund
Shareholders are resident as of the date of the mailing of the Prospectus and
Proxy Statement to such shareholders; (d) postage; (e) printing; (f) accounting
fees; (g) legal fees; and (h) solicitation costs of the transaction.
Notwithstanding the foregoing, the Acquiring Fund shall pay its own federal and
state registration fees.
ARTICLE X
ENTIRE AGREEMENT; SURVIVAL OF WARRANTIES
10.1 The Acquiring Fund and the Selling Fund agree that neither party
has made any representation, warranty or
<PAGE>
covenant not set forth herein and that this Agreement constitutes the entire
agreement between the parties.
10.2 The representations, warranties, and covenants contained in this
Agreement or in any document delivered pursuant hereto or in connection herewith
shall survive the consummation of the transactions contemplated hereunder.
ARTICLE XI
TERMINATION
11.1 This Agreement may be terminated by the mutual agreement of the
Acquiring Fund and the Selling Fund. In addition, either the Acquiring Fund or
the Selling Fund may at its option terminate this Agreement at or prior to the
Closing Date because:
(a) of a breach by the other of any representation, warranty,
or agreement contained herein to be performed at or prior to the Closing Date,
if not cured within 30 days; or
(b) a condition herein expressed to be precedent to the
obligations of the terminating party has not been met and it reasonably appears
that it will not or cannot be met.
11.2 In the event of any such termination, in the absence of willful
default, there shall be no liability for damages on the part of either the
Acquiring Fund, the Selling Fund, the Trust, the respective Trustees or
officers, to the other party or its Trustees or officers.
ARTICLE XII
AMENDMENTS
This Agreement may be amended, modified, or supplemented in such manner
as may be mutually agreed upon in writing by the authorized officers of the
Selling Fund and the Acquiring Fund; provided, however, that following the
meeting of the Selling Fund Shareholders called by the Selling Fund pursuant to
paragraph 5.2 of this Agreement, no such amendment may have the effect of
changing the provisions for determining the number of the Acquiring Fund Shares
to be issued to the Selling Fund Shareholders under this Agreement to the
detriment of such shareholders without their further approval.
ARTICLE XIII
HEADINGS; COUNTERPARTS; GOVERNING LAW; ASSIGNMENT;
LIMITATION OF LIABILITY
<PAGE>
13.1 The Article and paragraph headings contained in this Agreement are
for reference purposes only and shall not affect in any way the meaning or
interpretation of this Agreement.
13.2 This Agreement may be executed in any number of counterparts, each
of which shall be deemed an original.
13.3 This Agreement shall be governed by and construed in accordance
with the laws of the State of Delaware, without giving effect to the conflicts
of laws provisions thereof; provided, however, that the due authorization,
execution and delivery of this Agreement, in the case of the Selling Fund, shall
be governed and construed in accordance with the laws of The Commonwealth of
Massachusetts, without giving effect to the conflicts of laws provisions
thereof.
13.4 This Agreement shall bind and inure to the benefit of the parties
hereto and their respective successors and assigns, but no assignment or
transfer hereof or of any rights or obligations hereunder shall be made by any
party without the written consent of the other party. Nothing herein expressed
or implied is intended or shall be construed to confer upon or give any person,
firm, or corporation, other than the parties hereto and their respective
successors and assigns, any rights or remedies under or by reason of this
Agreement.
13.5 It is expressly agreed that the obligations of the Selling Fund
hereunder shall not be binding upon any of the Trustees, shareholders, nominees,
officers, agents, or employees of the Selling Fund personally, but bind only the
trust property of the Selling Fund, as provided in the Declaration of Trust of
the Selling Fund. The execution and delivery of this Agreement have been
authorized by the Trustees of the Selling Fund and signed by authorized officers
of the Selling Fund, acting as such, and neither such authorization by such
Trustees nor such execution and delivery by such officers shall be deemed to
have been made by any of them individually or to impose any liability on any of
them personally, but shall bind only the trust property of the Selling Fund as
provided in the Declaration of Trust of the Selling Fund.
IN WITNESS WHEREOF, the parties have duly executed and sealed this
Agreement, all as of the date first written above.
EVERGREEN MUNICIPAL TRUST
ON BEHALF OF EVERGREEN
TAX FREE FUND
<PAGE>
By:
Name:
Title:
KEYSTONE TAX FREE INCOME FUND
By:
Name:
Title:
<PAGE>
EXHIBIT A-2
AGREEMENT AND PLAN OF REORGANIZATION
THIS AGREEMENT AND PLAN OF REORGANIZATION (the "Agreement") is made as
of this 30th day of September, 1997, by and between the Evergreen Municipal
Trust, a Delaware business trust, with its principal place of business at 200
Berkeley Street, Boston, Massachusetts 02116 (the "Trust"), with respect to its
Evergreen Tax Free Fund series (the "Acquiring Fund"), and Keystone Tax Free
Fund, a Massachusetts business trust, with its principal place of business at
200 Berkeley Street, Boston, Massachusetts 02116 (the "Selling Fund").
This Agreement is intended to be, and is adopted as, a plan of
reorganization and liquidation within the meaning of Section 368(a)(1)(F) of the
United States Internal Revenue Code of 1986, as amended (the "Code"). The
reorganization (the "Reorganization") will consist of (i) the transfer of all of
the assets of the Selling Fund in exchange solely for shares of beneficial
interest, without par value, of the Acquiring Fund (the "Acquiring Fund
Shares"); (ii) the assumption by the Acquiring Fund of certain identified
liabilities of the Selling Fund; and (iii) the distribution, after the Closing
Date hereinafter referred to, of the Acquiring Fund Shares to the shareholders
of the Selling Fund in liquidation of the Selling Fund as provided herein, all
upon the terms and conditions hereinafter set forth in this Agreement.
WHEREAS, the Selling Fund and the Acquiring Fund are a registered
open-end investment company and a separate investment series of an open-end,
registered investment company of the management type, respectively, and the
Selling Fund owns securities that generally are assets of the character in which
the Acquiring Fund is permitted to invest;
WHEREAS, both Funds are authorized to issue their shares
of beneficial interest;
WHEREAS, the Trustees of the Trust have determined that the exchange of
all of the assets of the Selling Fund for Acquiring Fund Shares and the
assumption of certain identified liabilities of the Selling Fund by the
Acquiring Fund on the terms and conditions hereinafter set forth are in the best
interests of the Acquiring Fund's shareholders;
WHEREAS, the Trustees of the Selling Fund have determined that the
Selling Fund should exchange all of its assets and certain identified
liabilities for Acquiring Fund Shares and
<PAGE>
that the interests of the existing shareholders of the Selling
Fund will not be diluted as a result of the transactions
contemplated herein;
NOW, THEREFORE, in consideration of the premises and of the covenants
and agreements hereinafter set forth, the parties hereto covenant and agree as
follows:
ARTICLE I
TRANSFER OF ASSETS OF THE SELLING FUND IN EXCHANGE FOR
THE ACQUIRING FUND SHARES AND ASSUMPTION OF SELLING FUND
LIABILITIES AND LIQUIDATION OF THE SELLING FUND
1.1 THE EXCHANGE. Subject to the terms and conditions herein set forth
and on the basis of the representations and warranties contained herein, the
Selling Fund agrees to transfer all of the Selling Fund's assets as set forth in
paragraph 1.2 to the Acquiring Fund. The Acquiring Fund agrees in exchange
therefor (i) to deliver to the Selling Fund the number of Acquiring Fund Shares,
including fractional Acquiring Fund Shares, determined by multiplying the shares
outstanding of each class of the Selling Fund by the ratio computed by dividing
the net asset value per share of each such class of the Selling Fund by the net
asset value per share of the corresponding class of Acquiring Fund Shares
computed in the manner and as of the time and date set forth in paragraph 2.2;
and (ii) to assume certain identified liabilities of the Selling Fund, as set
forth in paragraph 1.3. Such transactions shall take place at the closing
provided for in paragraph 3.1 (the "Closing Date").
1.2 ASSETS TO BE ACQUIRED. The assets of the Selling Fund to be
acquired by the Acquiring Fund shall consist of all property, including, without
limitation, all cash, securities, commodities, and futures interests and
dividends or interest receivables, that is owned by the Selling Fund and any
deferred or prepaid expenses shown as an asset on the books of the Selling Fund
on the Closing Date.
The Selling Fund has provided the Acquiring Fund with its most recent
audited financial statements, which contain a list of all of Selling Fund's
assets as of the date thereof. The Selling Fund hereby represents that as of the
date of the execution of this Agreement there have been no changes in its
financial position as reflected in said financial statements other than those
occurring in the ordinary course of its business in connection with the purchase
and sale of securities and the payment of its normal operating expenses. The
Selling Fund reserves the right to sell any of such securities, but will not,
without the prior written approval
<PAGE>
of the Acquiring Fund, acquire any additional securities other than securities
of the type in which the Acquiring Fund is permitted to invest.
The Acquiring Fund will, within a reasonable time prior to the Closing
Date, furnish the Selling Fund with a statement of the Acquiring Fund's
investment objectives, policies, and restrictions and a list of the securities,
if any, on the Selling Fund's list referred to in the second sentence of this
paragraph that do not conform to the Acquiring Fund's investment objectives,
policies, and restrictions. In the event that the Selling Fund holds any
investments that the Acquiring Fund may not hold, the Selling Fund will dispose
of such securities prior to the Closing Date. In addition, if it is determined
that the Selling Fund and the Acquiring Fund portfolios, when aggregated, would
contain investments exceeding certain percentage limitations imposed upon the
Acquiring Fund with respect to such investments, the Selling Fund if requested
by the Acquiring Fund will dispose of a sufficient amount of such investments as
may be necessary to avoid violating such limitations as of the Closing Date.
1.3 LIABILITIES TO BE ASSUMED. The Selling Fund will endeavor to
discharge all of its known liabilities and obligations prior to the Closing
Date. Except as specifically provided in this paragraph 1.3, the Acquiring Fund
shall assume only those liabilities, expenses, costs, charges and reserves
reflected on a Statement of Assets and Liabilities of the Selling Fund prepared
on behalf of the Selling Fund, as of the Valuation Date (as defined in paragraph
2.1), in accordance with generally accepted accounting principles consistently
applied from the prior audited period. The Acquiring Fund shall assume only
those liabilities of the Selling Fund reflected in such Statement of Assets and
Liabilities and shall not except as specifically provided in this paragraph 1.3
assume any other liabilities, whether absolute or contingent, known or unknown,
accrued or unaccrued, all of which shall remain the obligation of the Selling
Fund. The Acquiring Fund hereby agrees with the Selling Fund and each Trustee of
the Selling Fund: (i) to indemnify each Trustee of the Selling Fund against all
liabilities and expenses referred to in the indemnification provisions of the
Selling Fund's Declaration of Trust and ByLaws, to the extent provided therein,
incurred by any Trustee of the Selling Fund; and (ii) in addition to the
indemnification provided in (i) above, to indemnify each Trustee of the Selling
Fund against all liabilities and expenses and pay the same as they arise and
become due, without any exception, limitation or requirement of approval by any
person, and without any right to require repayment thereof by any such Trustee
(unless such Trustee has had the
<PAGE>
same repaid to him or her) based upon any subsequent or final disposition or
findings made in connection therewith or otherwise, if such action, suit or
other proceeding involves such Trustee's participation in authorizing or
permitting or acquiescing in, directly or indirectly, by action or inaction, the
making of any distribution in any manner of all or any assets of the Selling
Fund without making provision for the payment of any liabilities of any kind,
fixed or contingent, of the Selling Fund, which liabilities were not actually
and consciously personally known to such Trustee to exist at the time of such
Trustee's participation in so authorizing or permitting or acquiescing in the
making of any such distribution.
In addition, upon completion of the Reorganization, for purposes of
calculating the maximum amount permitted to be charged to the Acquiring Fund
under the National Association of Securities Dealers, Inc. Conduct Rule 2830,
minus the amount of the sales charges paid or accrued (including asset based
sales charge), plus permitted interest ("Aggregate NASD Cap"), the Acquiring
Fund will add to its Aggregate NASD Cap immediately prior to the Reorganization
the Aggregate NASD Cap of the Selling Fund immediately prior to the
Reorganization.
1.4 LIQUIDATION AND DISTRIBUTION. On or soon after the Closing Date as
is conveniently practicable (the "Liquidation Date"), (a) the Selling Fund will
liquidate and distribute pro rata to the Selling Fund's shareholders of record,
determined as of the close of business on the Valuation Date (the "Selling Fund
Shareholders"), the Acquiring Fund Shares received by the Selling Fund pursuant
to paragraph 1.1; and (b) the Selling Fund will thereupon proceed to dissolve as
set forth in paragraph 1.8 below. Such liquidation and distribution will be
accomplished by the transfer of the Acquiring Fund Shares then credited to the
account of the Selling Fund on the books of the Acquiring Fund to open accounts
on the share records of the Acquiring Fund in the names of the Selling Fund
Shareholders and representing the respective pro rata number of the Acquiring
Fund Shares due such shareholders. All issued and outstanding shares of the
Selling Fund will simultaneously be canceled on the books of the Selling Fund.
The Acquiring Fund shall not issue certificates representing the Acquiring Fund
Shares in connection with such exchange.
1.5 OWNERSHIP OF SHARES. Ownership of Acquiring Fund Shares will be
shown on the books of the Acquiring Fund's transfer agent. Shares of the
Acquiring Fund will be issued in the manner described in the combined Prospectus
and Proxy Statement on Form N-14 to be distributed to shareholders of the
Selling Fund as described in paragraph 5.7.
<PAGE>
1.6 TRANSFER TAXES. Any transfer taxes payable upon issuance of the
Acquiring Fund Shares in a name other than the registered holder of the Selling
Fund shares on the books of the Selling Fund as of that time shall, as a
condition of such issuance and transfer, be paid by the person to whom such
Acquiring Fund Shares are to be issued and transferred.
1.7 REPORTING RESPONSIBILITY. Any reporting responsibility of the
Selling Fund is and shall remain the responsibility of the Selling Fund up to
and including the Closing Date and such later date on which the Selling Fund is
terminated.
1.8 TERMINATION. The Selling Fund shall be terminated promptly
following the Closing Date and the making of all distributions pursuant to
paragraph 1.4.
ARTICLE II
VALUATION
2.1 VALUATION OF ASSETS. The value of the Selling Fund's assets to be
acquired by the Acquiring Fund hereunder shall be the value of such assets
computed as of the close of business on the New York Stock Exchange on the
business day next preceding the Closing Date (such time and date being
hereinafter called the "Valuation Date"), using the valuation procedures set
forth in the Trust's Declaration of Trust and the Acquiring Fund's then current
prospectus and statement of additional information or such other valuation
procedures as shall be mutually agreed upon by the parties.
2.2 VALUATION OF SHARES. The net asset value per share of the Acquiring
Fund Shares shall be the net asset value per share computed as of the close of
business on the New York Stock Exchange on the Valuation Date, using the
valuation procedures set forth in the Trust's Declaration of Trust and the
Acquiring Fund's then current prospectus and statement of additional
information.
2.3 SHARES TO BE ISSUED. The number of the Acquiring Fund Shares of
each class to be issued (including fractional shares, if any) in exchange for
the Selling Fund's assets shall be determined by multiplying the shares
outstanding of each class of the Selling Fund by the ratio computed by dividing
the net asset value per share of the Selling Fund attributable to each of its
classes by the net asset value per share of the respective classes of the
Acquiring Fund determined in accordance with paragraph 2.2.
<PAGE>
2.4 DETERMINATION OF VALUE. All computations of value shall be made by
State Street Bank and Trust Company in accordance with its regular practice in
pricing the shares and assets of the Acquiring Fund.
ARTICLE III
CLOSING AND CLOSING DATE
3.1 CLOSING DATE. The Closing (the "Closing") shall take place on or
about January 23, 1998 or such other date as the parties may agree to in writing
(the "Closing Date"). All acts taking place at the Closing shall be deemed to
take place simultaneously immediately prior to the opening of business on the
Closing Date unless otherwise provided. The Closing shall be held as of 9:00
a.m. at the offices of the Evergreen Keystone Funds, 200 Berkeley Street,
Boston, MA 02116, or at such other time and/or place as the parties may agree.
3.2 CUSTODIAN'S CERTIFICATE. State Street Bank and Trust Company, as
custodian for the Selling Fund (the "Custodian"), shall deliver at the Closing a
certificate of an authorized officer stating that (a) the Selling Fund's
portfolio securities, cash, and any other assets shall have been delivered in
proper form to the Acquiring Fund on the Closing Date; and (b) all necessary
taxes including all applicable federal and state stock transfer stamps, if any,
shall have been paid, or provision for payment shall have been made, in
conjunction with the delivery of portfolio securities by the Selling Fund.
3.3 EFFECT OF SUSPENSION IN TRADING. In the event that on the Valuation
Date (a) the New York Stock Exchange or another primary trading market for
portfolio securities of the Acquiring Fund or the Selling Fund shall be closed
to trading or trading thereon shall be restricted; or (b) trading or the
reporting of trading on said Exchange or elsewhere shall be disrupted so that
accurate appraisal of the value of the net assets of the Acquiring Fund or the
Selling Fund is impracticable, the Valuation Date shall be postponed until the
first business day after the day when trading shall have been fully resumed and
reporting shall have been restored.
3.4 TRANSFER AGENT'S CERTIFICATE. Evergreen Keystone Service Company,
as transfer agent for the Selling Fund as of the Closing Date ("EKSC"), shall
deliver at the Closing a certificate of an authorized officer stating that its
records contain the names and addresses of the Selling Fund Shareholders and the
number and percentage ownership of outstanding shares owned by each such
shareholder immediately
<PAGE>
prior to the Closing. The Acquiring Fund shall issue and deliver or cause EKSC,
its transfer agent as of the Closing Date, to issue and deliver a confirmation
evidencing the Acquiring Fund Shares to be credited on the Closing Date to the
Secretary of the Selling Fund or provide evidence satisfactory to the Selling
Fund that such Acquiring Fund Shares have been credited to the Selling Fund's
account on the books of the Acquiring Fund. At the Closing, each party shall
deliver to the other such bills of sale, checks, assignments, share
certificates, if any, receipts and other documents as such other party or its
counsel may reasonably request.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES
4.1 REPRESENTATIONS OF THE SELLING FUND. The Selling
Fund represents and warrants to the Acquiring Fund as follows:
(a) The Selling Fund is a Massachusetts business trust duly
organized, validly existing, and in good standing under the laws of The
Commonwealth of Massachusetts.
(b) The Selling Fund is a registered investment company
classified as a management company of the open-end type, and its registration
with the Securities and Exchange Commission (the "Commission") as an investment
company under the Investment Company Act of 1940, as amended (the "1940 Act"),
is in full force and effect.
(c) The current prospectus and statement of additional
information of the Selling Fund conform in all material respects to the
applicable requirements of the Securities Act of 1933, as amended (the "1933
Act"), and the 1940 Act and the rules and regulations of the Commission
thereunder and do not include any untrue statement of a material fact or omit to
state any material fact required to be stated therein or necessary to make the
statements therein, in light of the circumstances under which they were made,
not misleading.
(d) The Selling Fund is not, and the execution, delivery, and
performance of this Agreement (subject to shareholder approval) will not result,
in violation of any provision of the Selling Fund's Declaration of Trust or
By-Laws or of any material agreement, indenture, instrument, contract, lease, or
other undertaking to which the Selling Fund is a party or by which it is bound.
<PAGE>
(e) The Selling Fund has no material contracts or other
commitments (other than this Agreement) that will be terminated with liability
to it prior to the Closing Date.
(f) Except as otherwise disclosed in writing to and accepted
by the Acquiring Fund, no litigation, administrative proceeding, or
investigation of or before any court or governmental body is presently pending
or to its knowledge threatened against the Selling Fund or any of its properties
or assets, which, if adversely determined, would materially and adversely affect
its financial condition, the conduct of its business, or the ability of the
Selling Fund to carry out the transactions contemplated by this Agreement. The
Selling Fund knows of no facts that might form the basis for the institution of
such proceedings and is not a party to or subject to the provisions of any
order, decree, or judgment of any court or governmental body that materially and
adversely affects its business or its ability to consummate the transactions
herein contemplated.
(g) The financial statements of the Selling Fund at December
31, 1996 are in accordance with generally accepted accounting principles
consistently applied, and such statements (copies of which have been furnished
to the Acquiring Fund) fairly reflect the financial condition of the Selling
Fund as of such date, and there are no known contingent liabilities of the
Selling Fund as of such date not disclosed therein.
(h) Since December 31, 1996 there has not been any material
adverse change in the Selling Fund's financial condition, assets, liabilities,
or business other than changes occurring in the ordinary course of business, or
any incurrence by the Selling Fund of indebtedness maturing more than one year
from the date such indebtedness was incurred, except as otherwise disclosed to
and accepted by the Acquiring Fund. For the purposes of this subparagraph (h), a
decline in the net asset value of the Selling Fund shall not constitute a
material adverse change.
(i) At the Closing Date, all federal and other tax returns and
reports of the Selling Fund required by law to have been filed by such dates
shall have been filed, and all federal and other taxes shown due on said returns
and reports shall have been paid, or provision shall have been made for the
payment thereof. To the best of the Selling Fund's knowledge, no such return is
currently under audit, and no assessment has been asserted with respect to such
returns.
(j) For each fiscal year of its operation, the
Selling Fund has met the requirements of Subchapter M of the
<PAGE>
Code for qualification and treatment as a regulated investment company and has
distributed in each such year all net investment income and realized capital
gains.
(k) All issued and outstanding shares of the Selling Fund are,
and at the Closing Date will be, duly and validly issued and outstanding, fully
paid and non-assessable by the Selling Fund (except that, under Massachusetts
law, Selling Fund Shareholders could under certain circumstances be held
personally liable for obligations of the Selling Fund). All of the issued and
outstanding shares of the Selling Fund will, at the time of the Closing Date, be
held by the persons and in the amounts set forth in the records of the transfer
agent as provided in paragraph 3.4. The Selling Fund does not have outstanding
any options, warrants, or other rights to subscribe for or purchase any of the
Selling Fund shares, nor is there outstanding any security convertible into any
of the Selling Fund shares.
(l) At the Closing Date, the Selling Fund will have good and
marketable title to the Selling Fund's assets to be transferred to the Acquiring
Fund pursuant to paragraph 1.2 and full right, power, and authority to sell,
assign, transfer, and deliver such assets hereunder, and, upon delivery and
payment for such assets, the Acquiring Fund will acquire good and marketable
title thereto, subject to no restrictions on the full transfer thereof,
including such restrictions as might arise under the 1933 Act, other than as
disclosed to the Acquiring Fund and accepted by the Acquiring Fund.
(m) The execution, delivery, and performance of this Agreement
have been duly authorized by all necessary action on the part of the Selling
Fund and, subject to approval by the Selling Fund Shareholders, this Agreement
constitutes a valid and binding obligation of the Selling Fund, enforceable in
accordance with its terms, subject as to enforcement, to bankruptcy, insolvency,
reorganization, moratorium, and other laws relating to or affecting creditors'
rights and to general equity principles.
(n) The information to be furnished by the Selling Fund for
use in no-action letters, applications for orders, registration statements,
proxy materials, and other documents that may be necessary in connection with
the transactions contemplated hereby shall be accurate and complete in all
material respects and shall comply in all material respects with federal
securities and other laws and regulations thereunder applicable thereto.
<PAGE>
(o) The Proxy Statement of the Selling Fund to be included in
the Registration Statement (as defined in paragraph 5.7)(other than information
therein that relates to the Acquiring Fund) will, on the effective date of the
Registration Statement and on the Closing Date, not contain any untrue statement
of a material fact or omit to state a material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which such statements were made, not misleading.
4.2 REPRESENTATIONS OF THE ACQUIRING FUND. The Acquiring
Fund represents and warrants to the Selling Fund as follows:
(a) The Acquiring Fund is a separate investment series of a
Delaware business trust duly organized, validly existing and in good standing
under the laws of the State of Delaware.
(b) The Acquiring Fund is a separate investment series of a
Delaware business trust that is registered as an investment company classified
as a management company of the open-end type, and its registration with the
Commission as an investment company under the 1940 Act is in full force and
effect.
(c) The current prospectuses and statement of additional
information of the Acquiring Fund conform in all material respects to the
applicable requirements of the 1933 Act and the 1940 Act and the rules and
regulations of the Commission thereunder and do not include any untrue statement
of a material fact or omit to state any material fact required to be stated
therein or necessary to make the statements therein, in light of the
circumstances under which they were made, not misleading.
(d) The Acquiring Fund is not, and the execution, delivery and
performance of this Agreement will not result, in violation of the Trust's
Declaration of Trust or By-Laws or of any material agreement, indenture,
instrument, contract, lease, or other undertaking to which the Acquiring Fund is
a party or by which it is bound.
(e) Except as otherwise disclosed in writing to the Selling
Fund and accepted by the Selling Fund, no litigation, administrative proceeding
or investigation of or before any court or governmental body is presently
pending or to its knowledge threatened against the Acquiring Fund or any of its
properties or assets, which, if adversely determined, would materially and
adversely affect its financial condition and the conduct of its business or the
ability of the Acquiring Fund to carry out the transactions contemplated by this
<PAGE>
Agreement. The Acquiring Fund knows of no facts that might form the basis for
the institution of such proceedings and is not a party to or subject to the
provisions of any order, decree, or judgment of any court or governmental body
that materially and adversely affects its business or its ability to consummate
the transactions contemplated herein.
(f) The Acquiring Fund has no known liabilities of a material
amount, contingent or otherwise.
(g) At the Closing Date, there will not be any material
adverse change in the Acquiring Fund's financial condition, assets, liabilities,
or business other than changes occurring in the ordinary course of business, or
any incurrence by the Acquiring Fund of indebtedness maturing more than one year
from the date such indebtedness was incurred, except as otherwise disclosed to
and accepted by the Selling Fund. For the purposes of this subparagraph (g), a
decline in the net asset value of the Acquiring Fund shall not constitute a
material adverse change.
(h) At the Closing Date, all federal and other tax returns and
reports of the Acquiring Fund required by law then to be filed by such dates
shall have been filed, and all federal and other taxes shown due on said returns
and reports shall have been paid or provision shall have been made for the
payment thereof. To the best of the Acquiring Fund's knowledge, no such return
is currently under audit, and no assessment has been asserted with respect to
such returns.
(i) All issued and outstanding Acquiring Fund Shares are, and
at the Closing Date will be, duly and validly issued and outstanding, fully paid
and non-assessable. The Acquiring Fund does not have outstanding any options,
warrants, or other rights to subscribe for or purchase any Acquiring Fund
Shares, nor is there outstanding any security convertible into any Acquiring
Fund Shares.
(j) The execution, delivery, and performance of this Agreement
have been duly authorized by all necessary action on the part of the Acquiring
Fund, and this Agreement constitutes a valid and binding obligation of the
Acquiring Fund enforceable in accordance with its terms, subject as to
enforcement, to bankruptcy, insolvency, reorganization, moratorium, and other
laws relating to or affecting creditors' rights and to general equity
principles.
(k) The Acquiring Fund Shares to be issued and delivered to
the Selling Fund, for the account of the Selling Fund Shareholders, pursuant to
the terms of this Agreement will, at the Closing Date, have been duly authorized
and, when
<PAGE>
so issued and delivered, will be duly and validly issued Acquiring Fund Shares,
and will be fully paid and non-assessable.
(l) The information to be furnished by the Acquiring Fund for
use in no-action letters, applications for orders, registration statements,
proxy materials, and other documents that may be necessary in connection with
the transactions contemplated hereby shall be accurate and complete in all
material respects and shall comply in all material respects with federal
securities and other laws and regulations applicable thereto.
(m) The Prospectus and Proxy Statement (as defined in
paragraph 5.7) to be included in the Registration Statement (only insofar as it
relates to the Acquiring Fund) will, on the effective date of the Registration
Statement and on the Closing Date, not contain any untrue statement of a
material fact or omit to state a material fact required to be stated therein or
necessary to make the statements therein, in light of the circumstances under
which such statements were made, not misleading.
(n) The Acquiring Fund agrees to use all reasonable efforts to
obtain the approvals and authorizations required by the 1933 Act, the 1940 Act,
and such of the state Blue Sky or securities laws as it may deem appropriate in
order to continue its operations after the Closing Date.
ARTICLE V
COVENANTS OF THE ACQUIRING FUND AND THE SELLING FUND
5.1 OPERATION IN ORDINARY COURSE. The Acquiring Fund and the Selling
Fund each will operate its business in the ordinary course between the date
hereof and the Closing Date, it being understood that such ordinary course of
business will include customary dividends and distributions.
5.2 APPROVAL OF SHAREHOLDERS. The Selling Fund will call a meeting of
its Shareholders to consider and act upon this Agreement and to take all other
action necessary to obtain approval of the transactions contemplated herein.
5.3 INVESTMENT REPRESENTATION. The Selling Fund covenants that the
Acquiring Fund Shares to be issued hereunder are not being acquired for the
purpose of making any distribution thereof other than in accordance with the
terms of this Agreement.
<PAGE>
5.4 ADDITIONAL INFORMATION. The Selling Fund will assist the Acquiring
Fund in obtaining such information as the Acquiring Fund reasonably requests
concerning the beneficial ownership of the Selling Fund shares.
5.5 FURTHER ACTION. Subject to the provisions of this Agreement, the
Acquiring Fund and the Selling Fund will each take, or cause to be taken, all
action, and do or cause to be done, all things reasonably necessary, proper or
advisable to consummate and make effective the transactions contemplated by this
Agreement, including any actions required to be taken after the Closing Date.
5.6 STATEMENT OF EARNINGS AND PROFITS. As promptly as practicable, but
in any case within sixty days after the Closing Date, the Selling Fund shall
furnish the Acquiring Fund, in such form as is reasonably satisfactory to the
Acquiring Fund, a statement of the earnings and profits of the Selling Fund for
federal income tax purposes that will be carried over by the Acquiring Fund as a
result of Section 381 of the Code, and which will be reviewed by its independent
auditors and certified by the Selling Fund's President and Treasurer.
5.7 PREPARATION OF FORM N-14 REGISTRATION STATEMENT. The Selling Fund
will provide the Acquiring Fund with information reasonably necessary for the
preparation of a prospectus, which will include the proxy statement, referred to
in paragraph 4.1(o) (the "Prospectus and Proxy Statement"), all to be included
in a Registration Statement on Form N-14 of the Acquiring Fund (the
"Registration Statement"), in compliance with the 1933 Act, the Securities
Exchange Act of 1934, as amended (the "1934 Act"), and the 1940 Act in
connection with the meeting of the Selling Fund Shareholders to consider
approval of this Agreement and the transactions contemplated herein.
ARTICLE VI
CONDITIONS PRECEDENT TO OBLIGATIONS OF THE SELLING FUND
The obligations of the Selling Fund to consummate the transactions
provided for herein shall be subject, at its election, to the performance by the
Acquiring Fund of all the obligations to be performed by it hereunder on or
before the Closing Date, and, in addition thereto, the following further
conditions:
6.1 All representations, covenants, and warranties of the Acquiring
Fund contained in this Agreement shall be true and correct as of the date hereof
and as of the Closing Date
<PAGE>
with the same force and effect as if made on and as of the Closing Date, and the
Acquiring Fund shall have delivered to the Selling Fund a certificate executed
in its name by the Trust's President or Vice President and its Treasurer or
Assistant Treasurer, in form and substance reasonably satisfactory to the
Selling Fund and dated as of the Closing Date, to such effect and as to such
other matters as the Selling Fund shall reasonably request.
6.2 The Selling Fund shall have received on the Closing Date an opinion
from Sullivan & Worcester LLP, counsel to the Acquiring Fund, dated as of the
Closing Date, in a form reasonably satisfactory to the Selling Fund, covering
the following points:
(a) The Acquiring Fund is a separate investment series of a
Delaware business trust duly organized, validly existing and in good standing
under the laws of the State of Delaware and has the power to own all of its
properties and assets and to carry on its business as presently conducted.
(b) The Acquiring Fund is a separate investment series of a
Delaware business trust registered as an investment company under the 1940 Act,
and, to such counsel's knowledge, such registration with the Commission as an
investment company under the 1940 Act is in full force and effect.
(c) This Agreement has been duly authorized, executed, and
delivered by the Acquiring Fund, and, assuming that the Prospectus and Proxy
Statement, and Registration Statement comply with the 1933 Act, the 1934 Act,
and the 1940 Act and the rules and regulations thereunder and, assuming due
authorization, execution and delivery of this Agreement by the Selling Fund, is
a valid and binding obligation of the Acquiring Fund enforceable against the
Acquiring Fund in accordance with its terms, subject as to enforcement, to
bankruptcy, insolvency, reorganization, moratorium, and other laws relating to
or affecting creditors' rights generally and to general equity principles.
(d) Assuming that a consideration therefor not less than the
net asset value thereof has been paid, the Acquiring Fund Shares to be issued
and delivered to the Selling Fund on behalf of the Selling Fund Shareholders as
provided by this Agreement are duly authorized and upon such delivery will be
legally issued and outstanding and fully paid and non-assessable, and no
shareholder of the Acquiring Fund has any preemptive rights in respect thereof.
<PAGE>
(e) The Registration Statement, to such counsel's knowledge,
has been declared effective by the Commission and no stop order under the 1933
Act pertaining thereto has been issued, and to the knowledge of such counsel, no
consent, approval, authorization or order of any court or governmental authority
of the United States or the State of Delaware is required for consummation by
the Acquiring Fund of the transactions contemplated herein, except such as have
been obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be
required under state securities laws.
ARTICLE VII
CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING FUND
The obligations of the Acquiring Fund to complete the transactions
provided for herein shall be subject, at its election, to the performance by the
Selling Fund of all the obligations to be performed by it hereunder on or before
the Closing Date and, in addition thereto, the following conditions:
7.1 All representations, covenants, and warranties of the Selling Fund
contained in this Agreement shall be true and correct as of the date hereof and
as of the Closing Date with the same force and effect as if made on and as of
the Closing Date, and the Selling Fund shall have delivered to the Acquiring
Fund on the Closing Date a certificate executed in its name by the Selling
Fund's President or Vice President and the Treasurer or Assistant Treasurer, in
form and substance satisfactory to the Acquiring Fund and dated as of the
Closing Date, to such effect and as to such other matters as the Acquiring Fund
shall reasonably request.
7.2 The Selling Fund shall have delivered to the Acquiring Fund a
statement of the Selling Fund's assets and liabilities, together with a list of
the Selling Fund's portfolio securities showing the tax costs of such securities
by lot and the holding periods of such securities, as of the Closing Date,
certified by the Treasurer of the Selling Fund.
7.3 The Acquiring Fund shall have received on the Closing Date an
opinion of Sullivan & Worcester LLP, counsel to the Selling Fund, in a form
satisfactory to the Acquiring Fund covering the following points:
(a) The Selling Fund is a Massachusetts business trust duly
organized, validly existing and in good standing under the laws of The
Commonwealth of Massachusetts and has the power to own all of its properties and
assets and to carry on its business as presently conducted.
<PAGE>
(b) The Selling Fund is a Massachusetts business trust
registered as an investment company under the 1940 Act, and, to such counsel's
knowledge, such registration with the Commission as an investment company under
the 1940 Act is in full force and effect.
(c) This Agreement has been duly authorized, executed and
delivered by the Selling Fund, and, assuming that the Prospectus and Proxy
Statement, and Registration Statement comply with the 1933 Act, the 1934 Act,
and the 1940 Act and the rules and regulations thereunder and, assuming due
authorization, execution, and delivery of this Agreement by the Acquiring Fund,
is a valid and binding obligation of the Selling Fund enforceable against the
Selling Fund in accordance with its terms, subject as to enforcement, to
bankruptcy, insolvency, reorganization, moratorium and other laws relating to or
affecting creditors' rights generally and to general equity principles.
(d) To the knowledge of such counsel, no consent, approval,
authorization or order of any court or governmental authority of the United
States or The Commonwealth of Massachusetts is required for consummation by the
Selling Fund of the transactions contemplated herein, except such as have been
obtained under the 1933 Act, the 1934 Act and the 1940 Act, and as may be
required under state securities laws.
ARTICLE VIII
FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF THE ACQUIRING
FUND AND THE SELLING FUND
If any of the conditions set forth below do not exist on or before the
Closing Date with respect to the Selling Fund or the Acquiring Fund, the other
party to this Agreement shall, at its option, not be required to consummate the
transactions contemplated by this Agreement:
8.1 This Agreement and the transactions contemplated herein shall have
been approved by the requisite vote of the holders of the outstanding shares of
the Selling Fund in accordance with the provisions of the Selling Fund's
Declaration of Trust and By-Laws and certified copies of the resolutions
evidencing such approval shall have been delivered to the Acquiring Fund.
Notwithstanding anything herein to the contrary, neither the Acquiring Fund nor
the Selling Fund may waive the conditions set forth in this paragraph 8.1.
8.2 On the Closing Date, the Commission shall not have issued an
unfavorable report under Section 25(b) of the 1940 Act, nor instituted any
proceeding seeking to enjoin the
<PAGE>
consummation of the transactions contemplated by this Agreement under Section
25(c) of the 1940 Act and no action, suit or other proceeding shall be
threatened or pending before any court or governmental agency in which it is
sought to restrain or prohibit, or obtain damages or other relief in connection
with, this Agreement or the transactions contemplated herein.
8.3 All required consents of other parties and all other consents,
orders, and permits of federal, state and local regulatory authorities
(including those of the Commission and of state Blue Sky securities authorities,
including any necessary "no-action" positions of and exemptive orders from such
federal and state authorities) to permit consummation of the transactions
contemplated hereby shall have been obtained, except where failure to obtain any
such consent, order, or permit would not involve a risk of a material adverse
effect on the assets or properties of the Acquiring Fund or the Selling Fund,
provided that either party hereto may for itself waive any of such conditions.
8.4 The Registration Statement shall have become effective under the
1933 Act, and no stop orders suspending the effectiveness thereof shall have
been issued and, to the best knowledge of the parties hereto, no investigation
or proceeding for that purpose shall have been instituted or be pending,
threatened or contemplated under the 1933 Act.
8.5 The Selling Fund shall have declared a dividend or dividends which,
together with all previous such dividends, shall have the effect of distributing
to the Selling Fund Shareholders all of the Selling Fund's investment company
taxable income for all taxable periods ending on the Closing Date (computed
without regard to any deduction for dividends paid) and all of its net capital
gains realized in all taxable periods ending on the Closing Date (after
reduction for any capital loss carryforward).
8.6 The parties shall have received a favorable opinion of Sullivan &
Worcester LLP, addressed to the Acquiring Fund and the Selling Fund
substantially to the effect that for federal income tax purposes:
(a) The transfer of all of the Selling Fund assets in exchange
for the Acquiring Fund Shares and the assumption by the Acquiring Fund of
certain stated liabilities of the Selling Fund followed by the distribution of
the Acquiring Fund Shares to the Selling Fund in dissolution and liquidation of
the Selling Fund will constitute a "reorganization" within the meaning of
Section 368(a)(1)(F) of the Code and the Acquiring Fund and the Selling Fund
will each be a "party to a
<PAGE>
reorganization" within the meaning of Section 368(b) of the
Code.
(b) No gain or loss will be recognized by the Acquiring Fund
upon the receipt of the assets of the Selling Fund solely in exchange for the
Acquiring Fund Shares and the assumption by the Acquiring Fund of certain stated
liabilities of the Selling Fund.
(c) No gain or loss will be recognized by the Selling Fund
upon the transfer of the Selling Fund assets to the Acquiring Fund in exchange
for the Acquiring Fund Shares and the assumption by the Acquiring Fund of
certain stated liabilities of the Selling Fund or upon the distribution (whether
actual or constructive) of the Acquiring Fund Shares to Selling Fund
Shareholders in exchange for their shares of the Selling Fund.
(d) No gain or loss will be recognized by the Selling Fund
Shareholders upon the exchange of their Selling Fund shares for the Acquiring
Fund Shares in liquidation of the Selling Fund.
(e) The aggregate tax basis for the Acquiring Fund Shares
received by each Selling Fund Shareholder pursuant to the Reorganization will be
the same as the aggregate tax basis of the Selling Fund shares held by such
shareholder immediately prior to the Reorganization, and the holding period of
the Acquiring Fund Shares to be received by each Selling Fund Shareholder will
include the period during which the Selling Fund shares exchanged therefor were
held by such shareholder (provided the Selling Fund shares were held as capital
assets on the date of the Reorganization).
(f) The tax basis of the Selling Fund assets acquired by the
Acquiring Fund will be the same as the tax basis of such assets to the Selling
Fund immediately prior to the Reorganization, and the holding period of the
assets of the Selling Fund in the hands of the Acquiring Fund will include the
period during which those assets were held by the Selling Fund.
Notwithstanding anything herein to the contrary, neither the Acquiring
Fund nor the Selling Fund may waive the conditions set forth in this paragraph
8.6.
8.7 The Acquiring Fund shall have received from KPMG Peat Marwick LLP a
letter addressed to the Acquiring Fund, in form and substance satisfactory to
the Acquiring Fund, to the effect that:
<PAGE>
(a) they are independent certified public accountants with
respect to the Selling Fund within the meaning of the 1933 Act and the
applicable published rules and regulations thereunder;
(b) on the basis of limited procedures agreed upon by the
Acquiring Fund and described in such letter (but not an examination in
accordance with generally accepted auditing standards), the Capitalization Table
appearing in the Registration Statement and Prospectus and Proxy Statement has
been obtained from and is consistent with the accounting records of the Selling
Fund;
(c) on the basis of limited procedures agreed upon by the
Acquiring Fund and described in such letter (but not an examination in
accordance with generally accepted auditing standards), the data utilized in the
calculations of the projected expense ratios appearing in the Registration
Statement and Prospectus and Proxy Statement agree with underlying accounting
records of the Selling Fund or to written estimates by Selling Fund's management
and were found to be mathematically correct.
In addition, the Acquiring Fund shall have received from KPMG Peat
Marwick LLP a letter addressed to the Acquiring Fund dated on the Closing Date,
in form and substance satisfactory to the Acquiring Fund, to the effect, that on
the basis of limited procedures agreed upon by the Acquiring Fund (but not an
examination in accordance with generally accepted auditing standards), the
calculation of net asset value per share of the Selling Fund as of the Valuation
Date was determined in accordance with generally accepted accounting practices
and the portfolio valuation practices of the Acquiring Fund.
8.8 The Selling Fund shall have received from KPMG Peat Marwick LLP a
letter addressed to the Selling Fund, in form and substance satisfactory to the
Selling Fund, to the effect that:
(a) they are independent certified public accountants with
respect to the Acquiring Fund within the meaning of the 1933 Act and the
applicable published rules and regulations thereunder;
(b) on the basis of limited procedures agreed upon by the
Selling Fund and described in such letter (but not an examination in accordance
with generally accepted auditing standards), the Capitalization Table appearing
in the Registration Statement and Prospectus and Proxy Statement has been
obtained from and is consistent with the accounting records of the Acquiring
Fund; and
<PAGE>
(c) on the basis of limited procedures agreed upon by the
Selling Fund (but not an examination in accordance with generally accepted
auditing standards), the data utilized in the calculations of the projected
expense ratio appearing in the Registration Statement and Prospectus and Proxy
Statement agree with written estimates by each Fund's management and were found
to be mathematically correct.
8.9 The Acquiring Fund and the Selling Fund shall also have received
from KPMG Peat Marwick LLP a letter addressed to the Acquiring Fund and the
Selling Fund, dated on the Closing Date in form and substance satisfactory to
the Funds, setting forth the federal income tax implications relating to capital
loss carryforwards (if any) of the Selling Fund and the related impact, if any,
of the proposed transfer of all of the assets of the Selling Fund to the
Acquiring Fund and the ultimate dissolution of the Selling Fund, upon the
shareholders of the Selling Fund.
ARTICLE IX
EXPENSES
9.1 Except as otherwise provided for herein, all expenses of the
transactions contemplated by this Agreement incurred by the Selling Fund and the
Acquiring Fund will be borne by First Union National Bank. Such expenses
include, without limitation, (a) expenses incurred in connection with the
entering into and the carrying out of the provisions of this Agreement; (b)
expenses associated with the preparation and filing of the Registration
Statement under the 1933 Act covering the Acquiring Fund Shares to be issued
pursuant to the provisions of this Agreement; (c) registration or qualification
fees and expenses of preparing and filing such forms as are necessary under
applicable state securities laws to qualify the Acquiring Fund Shares to be
issued in connection herewith in each state in which the Selling Fund
Shareholders are resident as of the date of the mailing of the Prospectus and
Proxy Statement to such shareholders; (d) postage; (e) printing; (f) accounting
fees; (g) legal fees; and (h) solicitation costs of the transaction.
Notwithstanding the foregoing, the Acquiring Fund shall pay its own federal and
state registration fees.
ARTICLE X
ENTIRE AGREEMENT; SURVIVAL OF WARRANTIES
10.1 The Acquiring Fund and the Selling Fund agree that neither party
has made any representation, warranty or
<PAGE>
covenant not set forth herein and that this Agreement constitutes the entire
agreement between the parties.
10.2 The representations, warranties, and covenants contained in this
Agreement or in any document delivered pursuant hereto or in connection herewith
shall survive the consummation of the transactions contemplated hereunder.
ARTICLE XI
TERMINATION
11.1 This Agreement may be terminated by the mutual agreement of the
Acquiring Fund and the Selling Fund. In addition, either the Acquiring Fund or
the Selling Fund may at its option terminate this Agreement at or prior to the
Closing Date because:
(a) of a breach by the other of any representation, warranty,
or agreement contained herein to be performed at or prior to the Closing Date,
if not cured within 30 days; or
(b) a condition herein expressed to be precedent to the
obligations of the terminating party has not been met and it reasonably appears
that it will not or cannot be met.
11.2 In the event of any such termination, in the absence of willful
default, there shall be no liability for damages on the part of either the
Acquiring Fund, the Selling Fund, the Trust, the respective Trustees or
officers, to the other party or its Trustees or officers.
ARTICLE XII
AMENDMENTS
This Agreement may be amended, modified, or supplemented in such manner
as may be mutually agreed upon in writing by the authorized officers of the
Selling Fund and the Acquiring Fund; provided, however, that following the
meeting of the Selling Fund Shareholders called by the Selling Fund pursuant to
paragraph 5.2 of this Agreement, no such amendment may have the effect of
changing the provisions for determining the number of the Acquiring Fund Shares
to be issued to the Selling Fund Shareholders under this Agreement to the
detriment of such shareholders without their further approval.
ARTICLE XIII
HEADINGS; COUNTERPARTS; GOVERNING LAW; ASSIGNMENT;
LIMITATION OF LIABILITY
<PAGE>
13.1 The Article and paragraph headings contained in this Agreement are
for reference purposes only and shall not affect in any way the meaning or
interpretation of this Agreement.
13.2 This Agreement may be executed in any number of counterparts, each
of which shall be deemed an original.
13.3 This Agreement shall be governed by and construed in accordance
with the laws of the State of Delaware, without giving effect to the conflicts
of laws provisions thereof; provided, however, that the due authorization,
execution and delivery of this Agreement, in the case of the Selling Fund, shall
be governed and construed in accordance with the laws of The Commonwealth of
Massachusetts, without giving effect to the conflicts of laws provisions
thereof.
13.4 This Agreement shall bind and inure to the benefit of the parties
hereto and their respective successors and assigns, but no assignment or
transfer hereof or of any rights or obligations hereunder shall be made by any
party without the written consent of the other party. Nothing herein expressed
or implied is intended or shall be construed to confer upon or give any person,
firm, or corporation, other than the parties hereto and their respective
successors and assigns, any rights or remedies under or by reason of this
Agreement.
13.5 It is expressly agreed that the obligations of the Selling Fund
hereunder shall not be binding upon any of the Trustees, shareholders, nominees,
officers, agents, or employees of the Selling Fund personally, but bind only the
trust property of the Selling Fund, as provided in the Declaration of Trust of
the Selling Fund. The execution and delivery of this Agreement have been
authorized by the Trustees of the Selling Fund and signed by authorized officers
of the Selling Fund, acting as such, and neither such authorization by such
Trustees nor such execution and delivery by such officers shall be deemed to
have been made by any of them individually or to impose any liability on any of
them personally, but shall bind only the trust property of the Selling Fund as
provided in the Declaration of Trust of the Selling Fund.
IN WITNESS WHEREOF, the parties have duly executed and sealed this
Agreement, all as of the date first written above.
EVERGREEN MUNICIPAL TRUST
ON BEHALF OF EVERGREEN
TAX FREE FUND
<PAGE>
By:
Name:
Title:
KEYSTONE TAX FREE FUND
By:
Name:
Title:
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
Acquisition of the Assets of
KEYSTONE TAX FREE INCOME FUND
200 Berkeley Street
Boston, Massachusetts 02116
(800) 343-2898
and
KEYSTONE TAX FREE FUND
200 Berkeley Street
Boston, Massachusetts 02116
(800) 343-2898
By and In Exchange For Shares of
EVERGREEN TAX FREE FUND
a Series of
EVERGREEN MUNICIPAL TRUST
200 Berkeley Street
Boston, Massachusetts 02116
(800) 343-2898
This Statement of Additional Information, relating specifically to the
proposed transfer of the assets and liabilities of Keystone Tax Free Income Fund
("Keystone Tax Free Income"), and Keystone Tax Free Fund ("Keystone Tax Free"),
to Evergreen Tax Free Fund ("Evergreen Tax Free"), a series of the Evergreen
Municipal Trust, in exchange, as applicable, for Class A, Class B and Class C
shares of beneficial interest, no par value, of Evergreen Tax Free, consists of
this cover page and the following described documents, each of which is attached
hereto and incorporated by reference herein:
(1) The Statement of Additional Information of Keystone
Tax Free Income dated March 31, 1997;
(2) The Statement of Additional Information of Keystone
Tax Free dated April 30, 1997;
(3) Annual Report of Keystone Tax Free Income for the
period ended May 31, 1997;
(4) Annual Report of Keystone Tax Free for the year
ended December 31, 1996; and
<PAGE>
(5) Semi-Annual Report of Keystone Tax Free for the six month
period ended June 30, 1997.
This Statement of Additional Information, which is not a prospectus,
supplements, and should be read in conjunction with, the Prospectus/Proxy
Statement of Evergreen Tax Free, Keystone Tax Free Income and Keystone Tax Free
dated November 14, 1997. A copy of the Prospectus/Proxy Statement may be
obtained without charge by calling or writing to Evergreen Tax Free, Keystone
Tax Free Income or Keystone Tax Free at the telephone numbers or addresses set
forth above.
The date of this Statement of Additional Information is November 14,
1997.
<PAGE>
KEYSTONE STATE TAX FREE FUND
PART B
STATEMENT OF ADDITIONAL INFORMATION
<PAGE>
EVERGREEN KEYSTONE STATE TAX FREE FUNDS
STATEMENT OF ADDITIONAL INFORMATION
JULY 21, 1997
AS SUPPLEMENTED SEPTEMBER 18, 1997
Keystone California Tax Free Fund
Keystone Florida Tax Free Fund
Keystone Massachusetts Tax Free Fund
Keystone Missouri Tax Free Fund
Evergreen New Jersey Tax Free Income Fund
Keystone New York Tax Free Fund
Keystone Pennsylvania Tax Free Fund
This statement of additional information is not a prospectus, but relates
to, and should be read in conjunction with, the prospectus of the Evergreen
Keystone State Tax Free Funds comprised of the Keystone California Tax Free Fund
(the "California Fund"), the Keystone Florida Tax Free Fund (the "Florida
Fund"), the Keystone Massachusetts Tax Free Fund (the "Massachusetts Fund"), the
Keystone Missouri Tax Free Fund (the "Missouri Fund"), the Evergreen New Jersey
Tax Free Income Fund (the "New Jersey Fund"), the Keystone New York Tax Free
Fund (the "New York Fund"), and the Keystone Pennsylvania Tax Free Fund (the
"Pennsylvania Fund") (each a "Fund" and, collectively, the "Funds") dated July
21, 1997, as supplemented from time to time, relating to Class A, Class B and
Class C shares (Class A and Class B shares for the New Jersey Fund), the
separate prospectus of Pennsylvania Fund offering Class Y shares dated September
18, 1997 or the separate prospectus of the New Jersey Fund offering Class Y
shares dated July 21, 1997. You may obtain a copy of the prospectus from the
Funds' principal underwriter, Evergreen Keystone Distributor, Inc., or your
broker-dealer. See "Service Providers" below.
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
- --------------------------------------------------------------------------------
Page
The Trusts and Their Funds....................................................2
Service Providers.............................................................2
Investment Policies...........................................................3
Investment Restrictions.......................................................5
Valuation of Securities.......................................................7
Brokerage.....................................................................7
Sales Charges................................................................ 9
Distribution Plans...........................................................11
Trustees and Officers........................................................13
Investment Advisers..........................................................16
Principal Underwriter........................................................18
Administrator................................................................19
Sub-administrator............................................................19
Declarations of Trust........................................................19
Expenses ....................................................................20
Standardized Total Return and Yield Quotations...............................22
Financial Statements.........................................................24
Additional Information.......................................................24
Appendix A..................................................................A-1
Appendix B..................................................................B-1
20445
<PAGE>
2
- --------------------------------------------------------------------------------
THE TRUSTS AND THEIR FUNDS
- --------------------------------------------------------------------------------
Each of the Funds is a series of an open-end, nondiversified management
investment company, commonly known as a mutual fund. The Florida, Massachusetts,
New York and Pennsylvania Funds are investment series evidencing interests in
different portfolios of securities of the Keystone State Tax Free Fund
("KSTFF"). The California and Missouri Funds are investment series evidencing
interests in different portfolios of securities of the Keystone State Tax Free
Fund - Series II ("KSTFFII"). The New Jersey Fund is an investment series of The
Evergreen Tax Free Trust (formerly FFB Funds Trust) ("TETFT"). KSTFF, KSTFFII
and TETFT were formed as Massachusetts business trusts in 1990, 1993 1985,
respectively.
The essential information about the Trusts and their Funds is contained in
their respective prospectuses. This statement of additional information (the
"SAI") provides additional information about each Trust and its Fund(s) that may
be of interest to some investors.
For special factors affecting each Fund, see Appendix A to this statement
of additional information.
- --------------------------------------------------------------------------------
SERVICE PROVIDERS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Service Provider
- ----------------------------------------- --------------------------------
<S> <C>
Investment adviser to the Keystone Investment Management Company, 200 Berkeley
Florida, Massachusetts, New Street, Boston, Massachusetts 02116. Keystone is a wholly-
York and Pennsylvania Funds owned subsidiary of First Union Keystone, Inc., (formerly
(referred to in this SAI as Keystone Investments, Inc.) ("First Union Keystone") also
"Keystone") located at 200 Berkeley Street, Boston, Massachusetts
02116.
Investment adviser to the New The Capital Management Group of First Union National
Jersey Fund (referred to Bank, located at 301 So. College Street,
in this SAI as "CMG") Charlotte, North Carolina 28288.
Principal underwriter ( referred Evergreen Keystone Distributor, Inc. (formerly Evergreen
to in this SAI as "EKD") Funds Distributor, Inc.), 125 W. 55th Street, New York,
New York 10019.
Marketing services agent and Evergreen Keystone Investment Services, Inc. (formerly
administrator to the New Jersey Keystone Investment Distributors Company and
Fund (referred to in this SAI as predecessor to EKD with regard to the California, Florida,
"EKIS") Massachusetts, Missouri, New York and Pennsylvania
Funds), 200 Berkeley Street, Boston, Massachusetts 02116.
Sub-administrator (referred to in BISYS Fund Services, Inc., 125 W. 55th Street, New York,
this SAI as "BISYS") New York 10019.
Transfer and dividend Evergreen Keystone Service Company, 200 Berkeley
disbursing agent (referred to in Street, Boston, Massachusetts 02116 (formerly Keystone
this SAI as "EKSC") Investor Resource Center, Inc.). (EKSC is a wholly-owned
subsidiary of First Union Keystone.)
Independent auditors KPMG Peat Marwick LLP, 99 High Street, Boston,
Massachusetts 02110, Certified Public Accountants
Custodian State Street Bank and Trust Company, 225 Franklin
Street, Boston, Massachusetts 02110.
</TABLE>
- --------------------------------------------------------------------------------
INVESTMENT POLICIES
- --------------------------------------------------------------------------------
Each Fund invests primarily in municipal obligations that are exempt
from federal income tax and are also exempt from certain specified taxes in the
state for which it is named. In addition, the Funds invest in certain other
securities as described below.
MUNICIPAL OBLIGATIONS
Municipal obligations include debt obligations issued by or on behalf of a
state, a territory or a possession of the United States ("U.S."), the District
of Columbia or any political subdivision, agency or instrumentality thereof (for
example, counties, cities, towns, villages, districts, authorities) to obtain
funds for various public purposes, including the construction of a wide range of
public facilities such as airports, bridges, highways, housing, hospitals, mass
transportation, schools, streets and water and sewer works. Other public
purposes for which municipal obligations may be issued include the refunding of
outstanding obligations, obtaining funds for general operating expenses and
obtaining funds to lend to public or private institutions for the construction
of facilities, such as educational, hospital and housing facilities. In
addition, certain types of industrial development bonds have been or may be
issued by or on behalf of public authorities to finance certain
privately-operated facilities, and certain local facilities for water supply,
gas, electricity or sewage or solid waste disposal. Such obligations are
included within the term municipal obligations if the interest paid thereon
qualifies as fully exempt from federal income tax. The income of certain types
of industrial development bonds used to finance certain privately-operated
facilities (qualified private activity bonds) issued after August 7, 1986, while
exempt from federal income tax, is includable for the purposes of the
calculation of the alternative minimum tax. Other types of industrial
development bonds, the proceeds from which are used for the construction,
equipment, repair or improvement of privately operated industrial or commercial
facilities, may constitute municipal obligations, although the current federal
tax laws place substantial limitations on the size of such issues.
The two principal classifications of municipal obligations are "general
obligation" and limited obligation or "revenue" bonds. General obligation bonds
are obligations involving the credit of an issuer possessing taxing power and
are payable from the issuer's general unrestricted revenues and not from any
particular fund or revenue source. Their payment may be dependent upon an
appropriation by the issuer's legislative body and may be subject to
quantitative limitations on the issuer's taxing power. The characteristics and
methods of enforcement of general obligation bonds vary according to the law
applicable to the particular issuer. Limited obligation or revenue bonds are
payable only from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise or other
specific revenue source, such as the user of the facility. Industrial
development bonds that are municipal obligations are, in most cases, revenue
bonds and generally are not payable from the unrestricted revenues of the
issuer. The credit quality of industrial development revenue bonds is usually
directly related to the credit standing of the owner or user of the facilities.
There are, of course, variations in the security of municipal obligations, both
within a particular classification and between classifications, depending on
numerous factors.
The yields on municipal obligations are dependent on a variety of factors,
including general money market conditions, the financial condition of the
issuer, general conditions of the municipal obligations market, size of a
particular offering, and the maturity of the obligation and rating of the issue.
The ratings of Standard & Poor's Ratings Group ("S&P"), Moody's Investors
Service ("Moody's") and Fitch Investor Services, L.P. ("Fitch"), as described
herein and in the prospectus, represent their opinions as to the quality of the
municipal obligations that they undertake to rate. It should be emphasized,
however, that ratings are general and not absolute standards of quality.
Consequently, municipal obligations with the same maturity, interest rate and
rating may have different yields while municipal obligations of the same
maturity and interest rate with different ratings may have the same yield. It
should also be noted that the standards of disclosure applicable to and the
amount of information relating to the financial condition of issuers of
municipal obligations are not generally as extensive as those generally relating
to corporations.
Subsequent to its purchase by a Fund, a municipal obligation or other
investment may cease to be rated or its rating may be reduced below the minimum
rating required for purchase by the Fund. Neither event requires a Fund to sell
such obligation from its portfolio, but its investment adviser will consider
such an event in its determination of whether the Fund should continue to hold
such obligation in its portfolio.
The ability of each Fund to achieve its investment objective depends upon
the continuing ability of issuers of municipal obligations to pay interest and
principal when due. Municipal obligations are subject to the provisions of
bankruptcy, insolvency and other laws affecting the rights and remedies of
creditors, such as the federal Bankruptcy Act, and laws, if any, that may be
enacted by Congress or state legislatures extending the time for payment of
principal or interest, or both, or imposing other constraints upon enforcement
of such obligations. There is also the possibility that the result of litigation
or other conditions may materially affect the power or ability of an issuer to
pay principal of and interest on its municipal obligations when due. In
addition, the market for municipal obligations is often thin and can be
temporarily affected by large purchases and sales, including those by a Fund.
From time to time, proposals have been introduced before Congress for the
purpose of restricting or eliminating the federal income tax exemption for
interest on municipal obligations, and similar proposals may well be introduced
in the future. The enactment of such a proposal could materially affect the
availability of municipal obligations for investment by the Funds and the value
of the Funds' portfolios. In which event, each Trust would reevaluate the
investment objectives and policies of its Fund(s) and consider changes in the
structure of the Fund(s) or dissolution.
The Tax Reform Act of 1986 made significant changes in the federal tax
status of certain obligations that were previously fully federally tax-exempt.
As a result, three categories of such obligations issued after August 7, 1986
now exist: (1)"public purpose" bonds, the income from which remains fully exempt
from federal income tax; (2) qualified "private activity" industrial development
bonds, the income from which, while exempt from federal income tax under Section
103 of the Internal Revenue Code of 1986, as amended (the "Code"), is includable
in the calculation of the federal alternative minimum tax; and (3) "private
activity" (private purpose) bonds, the income from which is not exempt from
federal income tax. A Fund will not invest in private purpose bonds and, except
as described under "Other Eligible Investments," will not invest in qualified
"private activity" industrial development bonds whose distributions are subject
to the alternative minimum tax.
OTHER ELIGIBLE INVESTMENTS
A Fund may invest up to 20% of its assets under ordinary circumstances,
and up to 100% of its assets for temporary defensive purposes in the following
types of instruments: (1) commercial paper, including master demand notes, that
at the date of investment is rated A-1 (the highest grade by S&P), Prime-1 (the
highest grade by Moody's) or, if not rated by such services, is issued by a
company that at the date of investment has an outstanding issue rated A or
better by S&P or Moody's; (2) obligations, including certificates of deposit and
bankers' acceptances, of banks, or savings and loan associations, that have at
least $1 billion in assets as of the date of their most recently published
financial statements that are members of the Federal Deposit Insurance
Corporation, including U.S. branches of foreign banks and foreign branches of
U.S. banks; (3) corporate obligations (maturing in 13 months or less) that at
the date of investment are rated A or better by S&P or Moody's; (4) obligations
issued or guaranteed by the U.S. government or by any agency or instrumentality
of the U.S.; (5) qualified "private activity" industrial development bonds the
income from which, while exempt from federal income tax under Section 103 of the
Code, is includable in the calculation of the federal alternative minimum tax;
and (6) municipal obligations, the income of which is exempt from federal income
tax, personal property tax or intangibles tax in a state for which a Fund is
named and where such taxes apply.
Each Fund may assume a temporary defensive position upon its investment
adviser's determination that market conditions so warrant. If a Fund is
investing defensively, it is not pursuing its investment objectives.
From time to time, the Massachusetts Fund and the New Jersey Fund may
invest in zero coupon bonds. The Funds do not expect to have enough zero coupon
bonds to have a material effect on dividends. Zero coupon securities pay no
interest to holders prior to maturity, and the interest on these securities is
reported as income to a Fund and distributed to its shareholders. These
distributions must be made from a Fund's cash assets or, if necessary, from the
proceeds of sales of portfolio securities. The Funds will not be able to
purchase additional income producing securities with cash used to make such
distributions, and its current income ultimately may be reduced as a result.
FUNDAMENTAL NATURE OF INVESTMENT OBJECTIVES
The investment objective of each Fund is fundamental and may not be changed
without approval of the holders of a majority of such Fund's outstanding voting
shares (as defined in the Investment Company Act of 1940, as amended (the "1940
Act") i.e., the lesser of (1) 67% of the shares represented at a meeting at
which more than 50% of the outstanding shares are represented or (2) more than
50% of the outstanding shares).
- --------------------------------------------------------------------------------
INVESTMENT RESTRICTIONS
- --------------------------------------------------------------------------------
The investment restrictions as summarized below are fundamental for each
Fund and may not be changed without the approval of a 1940 majority of such
Fund's outstanding shares. Unless otherwise stated, all references to the assets
of a Fund are in terms of current market value.
Each Fund may not do the following:
(1) purchase any security of any issuer (other than issues of the U.S.
government, its agencies or instrumentalities) if as a result more than 25% of
its total assets would be invested in a single industry, (for the California,
Florida, Massachusetts, Missouri, New York and Pennsylvania Funds) including
industrial development bonds from the same facility or similar types of
facilities; governmental issuers of municipal bonds are not regarded as members
of an industry and a Fund may invest more than 25% of its assets in industrial
development bonds and, for the New Jersey Fund, in certificates of deposit and
banker's acceptances issued by domestic branches of U.S. banks or New Jersey
municipal obligations;
(2) (for the California, Florida, Massachusetts, Missouri, New York and
Pennsylvania Funds only) invest more than 10% of its assets in securities with
legal or contractual restrictions on resale or in securities for which market
quotations are not readily available, or in repurchase agreements maturing in
more than seven days;
(3) issue senior securities; the purchase or sale of securities on a "when
issued" basis, or collateral arrangement with respect to the writing of options
on securities, are not deemed to be the issuance of a senior security;
(4) (for the California, Florida, Massachusetts, Missouri, New York and
Pennsylvania Funds only) borrow money or enter into reverse repurchase
agreements, except that a Fund may enter into reverse repurchase agreements or
borrow money from banks for temporary or emergency purposes in aggregate amounts
up to one-third of the value of the Fund's net assets; provided that while
borrowings from banks (not including reverse repurchase agreements) exceed 5% of
the Fund's net assets, any such borrowings will be repaid before additional
investments are made;
(5) purchase securities on margin except that it may obtain such
short-term credit as may be necessary for the clearance of purchases and sales
of securities;
(6) make loans, except that a Fund may purchase or hold debt securities
consistent with its investment objectives, lend portfolio securities valued at
not more than 15% of its total assets to broker-dealers and enter into
repurchase agreements;
(7) purchase securities of other investment companies (for the California,
Florida, Massachusetts, Missouri, New York and Pennsylvania Funds) except as
part of a merger, consolidation, purchase of assets or similar transaction; and,
for the New Jersey Fund, except to the extent such purchases are not prohibited
by applicable law.
(8) purchase or sell commodities or commodity contracts or real estate,
except that it may purchase and sell securities secured by real estate and
securities of companies which invest in real estate, and, with the exception of
the New Jersey Fund, may engage in currency or other financial futures contracts
and related options transactions; and
(9) underwrite securities of other issuers, except that the Fund may
purchase securities from the issuer or others and dispose of such securities in
a manner consistent with its investment objective.
For the New Jersey Fund only:
(10) issue senior securities, borrow money or pledge or mortgage its
assets, except that the Fund may borrow from banks up to 10% of the value of its
total net assets for temporary or emergency purposes only to meet anticipated
redemption requirements. The Fund will not purchase securities while any such
borrowings are outstanding.
(11) write, purchase or sell put or call options, or combinations thereof,
except that the Fund may purchase securities with rights to put securities to
the seller in accordance with its investment program.
(12) purchase restricted securities, which are securities that must be
registered under the Securities Act of 1933 before they may be offered or sold
to the public. This restriction does not apply to restricted securities which
are determined to be liquid by the Fund's investment adviser under supervision
of the Board of Trustees.
(13) purchase equity securities or securities convertible into equity
securities.
The Funds are nondiversified under the federal securities laws. The 1940
Act does not restrict the percentage of a nondiversified fund's assets that may
be invested at any time in the securities of any one issuer. The Funds intend to
comply, however, with the Code's diversification requirements and other
requirements applicable to "regulated investment companies" so that they will
not be subject to U.S. federal income tax on income and capital gain
distributions to shareholders. For this reason, each Fund, with the exception of
the New Jersey Fund, has adopted the additional investment restriction set forth
below, which may not be changed without the approval of shareholders.
Specifically, a Fund may not purchase a security if more than 25% of the Fund's
total assets would be invested in the securities of a single issuer (other than
the U.S. government, its agencies and instrumentalities); or, with respect to
50% of the Fund's total assets, if more than 5% of such assets would be invested
in the securities of a single issuer (other than the U.S. government, its
agencies and instrumentalities).
To the extent the Funds are not fully diversified, they may be more
susceptible to adverse economic, political or regulatory developments affecting
a single issuer than would be the case if the Funds were more broadly
diversified.
As a matter of practice, each Fund permitted to enter into repurchase
agreements treats reverse repurchase agreements as borrowings for purposes of
compliance with the limitations of the 1940 Act. Reverse repurchase agreements
will be taken into account along with borrowings from banks for purposes of the
5% limit set forth in the fourth fundamental investment restriction above.
None of the Funds presently intends to invest more than 25% of its total
assets in municipal obligations the payment of which depends on revenues derived
from a single facility or similar types of facilities. Since certain municipal
obligations may be related in such a way that an economic, business or political
development or change affecting one such security could likewise affect the
other securities, a change in this policy could result in increased investment
risk, but no change is presently contemplated.
For the purposes of the first and ninth fundamental investment restrictions
set forth above, each Fund will treat (1) each state, territory and possession
of the U.S., the District of Columbia and, if its assets and revenues are
separate from those of the entity or entities creating it, each political
subdivision, agency and instrumentality of any one (or more, as in the case of a
multi state authority or agency) of the foregoing as an issuer of all securities
that are backed primarily by its assets or revenues; (2) each company as an
issuer of all securities that are backed primarily by its assets or revenues;
and (3) each of the foregoing entities as an issuer of all securities that it
guarantees; provided, however, that for the purpose of the first fundamental
investment restriction no entity shall be deemed to be an issuer of a security
that it guarantees so long as no more than 10% of a Fund's total assets (taken
at current value) are invested in securities guaranteed by the entity and
securities of which it is otherwise deemed to be an issuer.
If a percentage limit is satisfied at the time of investment, a later
increase or decrease resulting from a change in asset value is not a violation
of the limit.
- --------------------------------------------------------------------------------
VALUATION OF SECURITIES
- --------------------------------------------------------------------------------
Current values for each Fund's portfolio securities may be determined in
the following manner:
1. short-term investments with maturities of sixty days or less when
purchased are valued at amortized cost (original purchase cost as adjusted for
amortization of premium or accretion of discount), which, when combined with
accrued interest, approximates market;
2. short-term investments having maturities of more than sixty days for
which market quotations are readily available are valued at current market
value; and
3. short-term investments having maturities of more than sixty days when
purchased that are held on the sixtieth day prior to maturity are valued at
amortized cost (market value on the sixtieth day adjusted for amortization of
premium or accretion of discount), which, when combined with accrued interest,
approximates market;
All other investments are valued at market value or, where market
quotations are not readily available, at fair value as determined in good faith
according to procedures established by a Trust's Board of Trustees.
The Trusts believe that reliable market quotations are generally not
readily available for purposes of valuing municipal obligations. As a result,
depending on the particular municipal obligations owned by a Fund, it is likely
that most of the valuations for such obligations will be based upon their fair
value determined under procedures approved by each respective Board of Trustees.
The Boards of Trustees have authorized the use of a pricing service to determine
the fair value of each Fund's municipal obligations and certain other
securities.
Taxable securities for which market quotations are readily available are
valued on a consistent basis at that price quoted that, in the opinion of the
Boards of Trustees or the person designated by the Boards of Trustees to make
the determination, most nearly represents the market value of the particular
security.
- --------------------------------------------------------------------------------
BROKERAGE
- --------------------------------------------------------------------------------
SELECTION OF BROKERS
In effecting transactions in portfolio securities for a Fund, Keystone or
CMG seeks the best execution of orders at the most favorable prices. Keystone or
CMG determines whether a broker-dealer has provided a Fund with best execution
and price in the execution of a securities transaction by evaluating, among
other things:
1. overall direct net economic result to such Fund;
2. the efficiency with which the transaction is effected;
3. the broker-dealer's ability to effect the transaction where a
large block is involved;
4. the broker-dealer's readiness to execute potentially difficult
transactions in the future;
5. the financial strength and stability of the broker-dealer; and
6. the receipt of research services, such as analyses and reports
concerning issuers, industries, securities, economic factors
and trends and other statistical and factual information.
The Funds' management weighs these considerations in determining the
overall reasonableness of the brokerage commissions paid.
Should a Fund, Keystone or CMG receive research and other statistical and
factual information from a broker, such Fund would consider such services to be
in addition to, and not in lieu of, the services Keystone or CMG is required to
perform under their respective Advisory Agreements (as defined below). Keystone
and CMG believe that the cost, value and specific application of such
information are indeterminable and cannot be practically allocated between a
Fund and its other clients who may indirectly benefit from the availability of
such information. Similarly, a Fund may indirectly benefit from information made
available as a result of transactions effected for Keystone or CMG's other
clients. Under the Advisory Agreements, Keystone and CMG are permitted to pay
higher brokerage commissions for brokerage and research services in accordance
with Section 28(e) of the Securities Exchange Act of 1934. In the event Keystone
and CMG follow such a practice, they will do so on a basis that is fair and
equitable to the Funds.
Each Trust's Board of Trustees has determined that a Fund may consider
sales of such Fund's shares as a factor in the selection of brokers to execute
portfolio transactions, subject to the requirements of best execution described
above.
BROKERAGE COMMISSIONS
Each Trust expects that purchases and sales of municipal obligations and
temporary instruments usually will be principal transactions. Municipal
obligations and temporary instruments are normally purchased directly from the
issuer or from an underwriter or market maker for the securities. There usually
will be no brokerage commissions paid by a Fund for such purchases. Purchases
from underwriters will include the underwriting commission or concession, and
purchases from broker-dealers serving as market makers will include a dealer's
mark up or reflect a dealer's mark down. Where transactions are made in the
over-the-counter market, each Fund will deal with primary market makers unless
more favorable prices are otherwise obtainable.
GENERAL BROKERAGE POLICIES
In order to take advantage of the availability of lower purchase prices, a
Fund may participate, if and when practicable, in group bidding for the direct
purchase from an issuer of certain securities.
Keystone and CMG make investment decisions for each Fund independently from
those of their other clients. It may frequently develop, however, that Keystone
or CMG will make the same investment decision for more than one client.
Simultaneous transactions are inevitable when the same security is suitable for
the investment objective of more than one account. When two or more of its
clients are engaged in the purchase or sale of the same security, Keystone or
CMG will allocate the transactions according to a formula that is equitable to
each of its clients. Although, in some cases, this system could have a
detrimental effect on the price or volume of a Fund's securities, each Trust
believes that in other cases its ability to participate in volume transactions
will produce better executions.
A Fund does not purchase portfolio securities from or sell portfolio
securities to Keystone, CMG, EKD or any of their affiliated persons, as defined
in the 1940 Act.
Each Board of Trustees will, from time to time, review that Trust's
brokerage policy. Because of the possibility of further regulatory developments
affecting the securities exchanges and brokerage practices generally, the
respective Board of Trustees may change, modify or eliminate any of the
foregoing practices.
- --------------------------------------------------------------------------------
SALES CHARGES
- --------------------------------------------------------------------------------
Each Fund offers the classes of shares indicated below that differ
primarily with respect to sales charges and distribution fees. As described
below, depending upon the class of shares that you purchase, a Fund will impose
a sales charge when you purchase Fund shares, a contingent deferred sales charge
(a "CDSC") when you redeem Fund shares or no sales charges at all. A Fund
charges a CDSC as reimbursement for certain expenses, such as commissions or
shareholder servicing fees, that it has incurred in connection with the sale of
its shares (see "Distribution Plans"). If imposed, a Fund deducts CDSCs from the
redemption proceeds you would otherwise receive. CDSCs attributable to your
shares are, to the extent permitted by the National Association of Securities
Dealers, Inc. ("NASD"), paid to EKD or its predecessor. See the prospectus for
additional information on a particular class.
FUND CLASSES
California Fund A, B, C
Florida Fund A, B, C
Massachusetts Fund A, B, C
Missouri Fund A, B, C
New Jersey Fund A, B, Y
New York Fund A, B, C
Pennsylvania Fund A, B, C, Y
CLASS DISTINCTIONS
CLASS A SHARES
With certain exceptions, when you purchase Class A shares you will pay a
maximum sales charge of 4.75%, payable at the time of purchase. (The prospectus
contains a complete table of applicable sales charges and a discussion of sales
charge reductions or waivers that may apply to purchases.) If you purchase Class
A shares in the amount of $1 million or more, without an initial sales charge,
the Fund will charge a CDSC of 1.00% if you redeem during the month of your
purchase and the 12-month period following the month of your purchase. See
"Calculation of Contingent Deferred Sales Charge" below.
CLASS B SHARES
Each Fund offers Class B shares at net asset value (without an initial
sales charge). With respect to Class B shares, each Fund charges a CDSC on
shares redeemed as follows:
REDEMPTION TIMING CDSC RATE
Month of purchase and the first twelve-month
period following the month of purchase..................5.00%
Second twelve-month
period following the month of purchase..................4.00%
Third twelve-month
period following the month of purchase..................3.00%
Fourth twelve-month
period following the month of purchase..................3.00%
Fifth twelve-month
period following the month of purchase..................2.00%
Sixth twelve-month
period following the month of purchase..................1.00%
Thereafter...................................................0.00%
Class B shares that have been outstanding for seven years after the month
of purchase, will automatically convert to Class A shares without imposition of
a front-end sales charge or exchange fee. (Conversion of Class B shares
represented by stock certificates will require the return of the stock
certificate to Evergreen Keystone Service Company ("EKSC") each Trust's transfer
and dividend disbursing agent.)
CLASS C SHARES - CALIFORNIA, FLORIDA, MASSACHUSETTS, MISSOURI, NEW YORK AND
PENNSYLVANIA FUNDS ONLY
Class C shares are available only through broker-dealers who have entered
into special distribution agreements with the Underwriter. Each Fund offers
Class C shares at net asset value (without an initial sales charge). With
certain exceptions, however, a Fund will charge a CDSC of 1.00%, if you redeem
shares during the month of your purchase and the 12-month period following the
month of your purchase. See "Calculation of Contingent Deferred Sales Charge"
below.
CLASS Y SHARES - NEW JERSEY AND PENNSYLVANIA FUNDS ONLY
No CDSC is imposed on the redemption of class Y shares. Class Y shares are
not offered to the general public and are available only to (i) persons who at
or prior to December 31, 1994 owned shares in a mutual fund advised by Evergreen
Asset Management Corp. ("Evergreen Asset"), (ii) certain institutional
investors, and (iii) investment advisory clients of FUNB, or their affiliates.
Class Y shares are offered at net asset value without a front-end or back-end
sales charge and do not bear any Rule 12b-1 distribution expenses.
CALCULATION OF CONTINGENT DEFERRED SALES CHARGE
Any CDSC imposed upon the redemption of Class A, Class B or Class C shares
is a percentage of the lesser of (1) the net asset value of the shares redeemed
or (2) the net cost of such shares. Upon request for redemption, a Fund will
redeem shares not subject to the CDSC first. Thereafter, a Fund will redeem
shares held the longest first.
SHARES THAT ARE NOT SUBJECT TO A SALES CHARGE OR CDSC
EXCHANGES
A Fund does not charge a CDSC when you exchange your shares for the shares
of the same class of another Evergreen Keystone Fund. However, if you are
exchanging shares that are still subject to a CDSC, the CDSC will carry over to
the shares you acquire by the exchange. Moreover, a Fund will compute any future
CDSC based upon the date you originally purchased the shares you tendered for
exchange.
WAIVER OF SALES CHARGES
Purchases of Class A (i) in the amount of $1 million or more; (ii) by a
corporate or certain other qualified retirement plan or a non-qualified deferred
compensation plan or a Title 1 tax sheltered annuity or TSA plan sponsored by an
organization having 100 or more eligible employees (a "Qualifying Plan") or a
TSA plan sponsored by a public educational entity having 5,000 or more eligible
employees (an "Educational TSA Plan"); or (iii) by (a) institutional investors,
which may include bank trust departments and registered investment advisers; (b)
investment advisers, consultants or financial planners who place trades for
their own accounts or the accounts of their clients and who charge such clients
a management, consulting, advisory or other fee; (c) clients of investment
advisers or financial planners who place trades for their own accounts if the
accounts are linked to the master account of such investment advisers or
financial planners on the books of the broker-dealer through whom shares are
purchased; (d) institutional clients of broker-dealers, including retirement and
deferred compensation plans and the trusts used to fund these plans, which place
trades through an omnibus account maintained with a Fund by the broker-dealer;
and (e) employees of First Union National Bank of ("FUNB") and its affiliates,
EKD and any broker-dealer with whom EKD has entered into an agreement to sell
shares of a Fund, and members of the immediate families of such employees, will
be at net asset value without the imposition of a front-end sales charge.
Certain broker-dealers or other financial institutions may impose a fee on
transactions in shares of the Funds.
Shares of a Fund may also be sold, to the extent permitted by applicable
law, regulations, interpretations, or exemptions, at net asset value without the
imposition of an initial sales charge to (1) certain Directors, Trustees,
officers, full-time employees or sales representatives of the Fund, FUNB,
Keystone, EKD, and certain of their affiliates who have been such for not less
than ninety days, and to members of the immediate families of such persons; (2)
a pension and profit-sharing plan established by such companies, their
subsidiaries and affiliates, for the benefit of their Directors, Trustees,
officers, full-time employees, and sales representatives; or (3) a registered
representative of a firm with a dealer agreement with EKD; provided, however,
that all such sales are made upon the written assurance that the purchase is
made for investment purposes and that the securities will not be resold except
through redemption by a Fund.
No initial sales charge or CDSC is imposed on purchases or redemptions of
shares of a Fund by a bank or trust company in a single account in the name of
such bank or trust company as trustee, if the initial investment in shares of a
Fund or any fund in the Evergreen Keystone Funds, purchased pursuant to this
waiver is at least $500,000 and any commission paid at the time of such purchase
is not more than 1.00% of the amount invested.
With respect to Class C shares purchased by a Qualifying Plan, no CDSC will
be imposed on any redemptions made specifically by an individual participant in
the Qualifying Plan. This waiver is not available in the event a Qualifying
Plan, as a whole, redeems substantially all of its assets.
In addition, no CDSC is imposed on a redemption of shares of a Fund in the
event of (1) death or disability of the shareholder; (2) a lump-sum distribution
from a benefit plan qualified under the Employee Retirement Income Security Act
of 1974 ("ERISA"); (3) automatic withdrawals from ERISA plans if the shareholder
is at least 59 1/2 years old; (4) involuntary redemptions of an account having
an aggregate net asset value of less than $1,000; (5) automatic withdrawals
under a Systematic Income Plan of up to 1.0% per month of the shareholder's
initial account balance; (6) withdrawals consisting of loan proceeds to a
retirement plan participant; (7) financial hardship withdrawals made by a
retirement plan participant; or (8) withdrawals consisting of returns of excess
contributions or excess deferral amounts made to a retirement plan participant.
- --------------------------------------------------------------------------------
DISTRIBUTION PLANS
- --------------------------------------------------------------------------------
Rule 12b-1 under the 1940 Act permits investment companies, such as the
Funds, to use their assets to bear expenses of distributing their shares if they
comply with various conditions, including adoption of a distribution plan
containing certain provisions set forth in Rule 12b-1 (a "Distribution Plan").
The Funds' Class A, Class B, and Class C (as applicable) Distribution Plans
have been approved by the appropriate Trust's Board of Trustees, including a
majority of the Trustees who are not interested persons of each Trust, as
defined in the 1940 Act, and who have no direct or indirect financial interest
in the Distribution Plans or any agreement related thereto (the "Independent
Trustees").
The NASD limits the amount that a Fund may pay annually in distribution
costs for sale of its shares and shareholder service fees. The NASD limits
annual expenditures to 1.00% of the aggregate average daily net asset value of
its shares, of which 0.75% may be used to pay such distribution costs and 0.25%
may be used to pay shareholder service fees. The NASD also limits the aggregate
amount that a Fund may pay for such distribution costs to 6.25% of gross share
sales since the inception of the Distribution Plan, plus interest at the prime
rate plus 1% on such amounts (less any CDSCs paid by shareholders to EKD)
remaining unpaid from time to time.
CLASS A DISTRIBUTION PLAN
The Class A Distribution Plan provides that a Fund may expend daily amounts
at an annual rate, which is currently limited to 0.25% of such Fund's average
daily net asset value attributable to Class A shares, to finance any activity
that is primarily intended to result in the sale of Class A shares, including,
without limitation, expenditures consisting of payments to EKD to enable EKD to
pay or to have paid to others who sell Class A shares a service or other fee, at
any such intervals as EKD may determine, in respect of Class A shares maintained
by any such recipient and outstanding on the books of such Fund for specified
periods.
Amounts paid by a Fund under the Class A Distribution Plan are currently
used to pay others, such as broker-dealers, service fees at an annual rate of up
to 0.25% of the average net asset value of Class A shares maintained by such
others and outstanding on the books of such Fund for specified periods.
CLASS B DISTRIBUTION PLANS
The Class B Distribution Plans provide that a Fund may expend daily amounts
at an annual rate of up to 1.00% of such Fund's average daily net asset value
attributable to Class B shares to finance any activity that is primarily
intended to result in the sale of Class B shares, including, without limitation,
expenditures consisting of payments to EKD and/or, in the case of the
California, Florida, Massachusetts, Missouri, New York and Pennsylvania Funds,
its predecessor. Payments are made to EKD (1) to enable EKD to pay to others
(broker-dealers) commissions in respect of Class B shares sold since inception
of a Distribution Plan; (2) to enable EKD to pay or to have paid to others a
service fee, at such intervals as EKD may determine, in respect of Class B
shares maintained by any such recipient and outstanding on the books of such
Fund for specified periods; and (3) as interest.
EKD generally reallows to broker-dealers or others a commission equal to
4.00% of the price paid for each Class B share sold. The broker-dealer or other
party may also receive service fees at an annual rate of 0.15% of the average
daily net asset value of such Class B share maintained by the recipient and
outstanding on the books of a Fund for specified periods.
EKD intends, but is not obligated, to continue to pay or accrue
distribution charges incurred in connection with the Class B Distribution Plans
that exceed current annual payments permitted to be received by EKD from a Fund
("Advances"). EKD intends to seek full reimbursement of such Advances from such
Fund (together with annual interest thereon at the prime rate plus 1.00%) at
such time in the future as, and to the extent that, payment thereof by such Fund
would be within the permitted limits. If a Trust's Independent Trustees
authorize such reimbursements of Advances, the effect would be to extend the
period of time during which such Fund incurs the maximum amount of costs allowed
by the Class B Distribution Plans.
In connection with financing its distribution costs relating to the
California, Florida, Massachusetts, Missouri, New York and Pennsylvania Funds,
including commission advances to broker-dealers and others, EKIS, the
predecessor to EKD, sold to a financial institution substantially all of its
12b-1 fee collection rights and CDSC collection rights in respect of Class B
shares sold during the period beginning approximately June 1, 1995 through
November 30, 1996. KSTFF and KSTFFII have agreed not to reduce the rate of
payment of 12b-1 fees in respect of such Class B shares unless it terminates
such shares' Distribution Plan completely. If it terminates such Distribution
Plans, the Funds may be subject to adverse distribution consequences.
The financing of payments made by EKD to compensate broker-dealers or other
persons for distributing shares of the Funds will be provided by FUNB or its
affiliates.
CLASS C DISTRIBUTION PLAN - CALIFORNIA, FLORIDA, MASSACHUSETTS, MISSOURI, NEW
YORK AND PENNSYLVANIA FUNDS ONLY
The Class C Distribution Plan provides that a Fund may expend daily amounts
at an annual rate of up to 1.00% of such Fund's average daily net asset value
attributable to Class C shares to finance any activity that is primarily
intended to result in the sale of Class C shares, including, without limitation,
expenditures consisting of payments to EKD and/or its predecessor. Payments are
made to EKD (1) to enable EKD to pay to others (broker-dealers) commissions in
respect of Class C shares sold since inception of the Distribution Plan; (2) to
enable EKD to pay or to have paid to others a service fee, at such intervals as
EKD may determine, in respect of Class C shares maintained by any such recipient
and outstanding on the books of such Fund for specified periods; and (3) as
interest.
EKD generally reallows to broker-dealers or others a commission in the
amount of 0.75% of the price paid for each Class C share sold plus the first
year's service fee in advance in the amount of 0.25% of the price paid for each
Class C share sold. Beginning approximately fifteen months after purchase,
broker-dealers or others receive a commission at an annual rate of 0.75%
(subject to NASD rules) plus service fees at the annual rate of 0.25%,
respectively, of the average daily net asset value of each Class C share
maintained by the recipient and outstanding on the books of a Fund for specified
periods.
DISTRIBUTION PLANS - GENERAL
The total amounts paid by a Fund under the foregoing arrangements may not
exceed the maximum Distribution Plan limits specified above. The amounts and
purposes of expenditures under a Distribution Plan must be reported to the
Independent Trustees quarterly. The Independent Trustees may require or approve
changes in the implementation or operation of a Distribution Plan, and may also
require that total expenditures by a Fund under a Distribution Plan be kept
within limits lower than the maximum amount permitted by such Distribution Plan
as stated above.
At March 31, 1997, total unpaid distribution costs were as follows:
CLASS B CLASS C
(% OF CLASS B NET ASSETS) (% OF CLASS C NET ASSETS)
- ------------------ -------------------------------- ----------------------------
California Fund $1,556,143 (7.14%) $ 130,741 (7.07%)
Florida Fund 3,352,712 (7.15%) 1,350,164 (13.99%)
Massachusetts Fund 446,206 (5.72%) 140,981 (6.83%)
Missouri Fund 1,287,330 (6.40%) 137,003 (10.49%)
New York Fund 1,184,099 (6.21%) 228,676 (12.22%)
Pennsylvania Fund 2,464,474 (6.62%) 831,646 (12.18%)
Broker-dealers or others may receive different levels of compensation
depending on which class of shares they sell. Payments pursuant to a
Distribution Plan are included in the operating expenses of the class.
Each of the Distribution Plans may be terminated at any time by a vote of
the Independent Trustees, or by vote of a majority of the outstanding voting
shares of the respective class of Fund shares. If the Class B Distribution Plan
is terminated, EKD and if appropriate, EKIS, will ask the Independent Trustees
to take whatever action they deem appropriate under the circumstances with
respect to payment of such Advances.
Any change in a Distribution Plan that would materially increase the
distribution expenses of a Fund provided for in a Distribution Plan requires
shareholder approval. Otherwise, a Distribution Plan may be amended by votes of
the majority of both (1) the Trust's Trustees and (2) the Independent Trustees
cast in person at a meeting called for the purpose of voting on each amendment.
While a Distribution Plan is in effect, the Trust will be required to
commit the selection and nomination of candidates for Independent Trustees to
the discretion of the Independent Trustees.
The Independent Trustees of each Trust have determined that the sales of
the Funds' shares resulting from payments under the Distribution Plans have
benefited the respective Fund.
- --------------------------------------------------------------------------------
TRUSTEES AND OFFICERS
- --------------------------------------------------------------------------------
Trustees and officers, their principal occupations and some of their
affiliations over the last five years are as follows:
<TABLE>
<CAPTION>
<S> <C>
FREDERICK AMLING: Trustee of the Trusts, other than TETFT; Trustee or Director of 28 other
Evergreen Keystone funds; Professor, Finance Department, George
Washington University; President, Amling & Company (investment
advice); and former Member, Board of Advisers, Credito Emilano (bank
ing).
LAURENCE B. ASHKIN: Trustee of the Trusts; Trustee or Director of all Evergreen Keystone
funds other than Evergreen Investment Trust; real estate developer and
construction consultant; and President of Centrum Equities and
Centrum Properties, Inc.
CHARLES A. AUSTIN III: Trustee of the Trusts, other than TETFT; Trustee or Director of 28 other
Evergreen Keystone funds; Investment Counselor to Appleton Partners,
Inc.; and former Managing Director, Seaward Management Corporation
(investment advice).
FOSTER BAM: Trustee of the Trusts; Trustee or Director of all other Evergreen
Keystone funds other than Evergreen Investment Trust; Partner in the
law firm of Cummings & Lockwood; Director, Symmetrix, Inc. (sulphur
company) and Pet Practice, Inc. (veterinary services); and former
Director, Chartwell Group Ltd. (Manufacturer of office furnishings and
accessories), Waste Disposal Equipment Acquisition Corporation and
Rehabilitation Corporation of America (rehabilitation hospitals).
*GEORGE S. BISSELL: Chairman of the Board and Chief Executive Officer and Trustee of,
other than TETFT, 28 other Evergreen Keystone funds; Chairman of the
Board and Trustee of Anatolia College; Trustee of University Hospital
(and Chairman of its Investment Committee); former Director and
Chairman of the Board of Hartwell Keystone Advisers, Inc.; and former
Chairman of the Board, Director and Chief Executive Officer of
Keystone Investments, Inc.
EDWIN D. CAMPBELL: Trustee of the Trusts, other than TETFT; Trustee or Director of 28 other
Evergreen Keystone funds; Principal, Padanaram Associates, Inc.; and
former Executive Director, Coalition of Essential Schools, Brown
University.
CHARLES F. CHAPIN: Trustee of the Trusts, other than TETFT; Trustee or Director of 28 other
Evergreen Keystone funds; and former Director, Peoples Bank
(Charlotte, NC).
K. DUN GIFFORD: Trustee of the Trusts, other than TETFT; Trustee or Director of 28 other
Evergreen Keystone funds; Trustee, Treasurer and Chairman of the
Finance Committee, Cambridge College; Chairman Emeritus and Direc
tor, American Institute of Food and Wine; Chairman and President,
Oldways Preservation and Exchange Trust (education); former
Chairman of the Board, Director, and Executive Vice President, The
London Harness Company; former Managing Partner, Roscommon
Capital Corp.; former Chief Executive Officer, Gifford Gifts of Fine
Foods; former Chairman, Gifford, Drescher & Associates (environmental
consulting); and former Director, Keystone Investments, Inc. and
Keystone.
JAMES S. HOWELL: Trustee of the Trusts; Chairman and Trustee or Director of 12 other
Evergreen Keystone funds; former Chairman of the Distribution
Foundation for the Carolinas; and former Vice President of Lance Inc.
(food manufacturing).
LEROY KEITH, JR.: Trustee of the Trusts, other than TETFT; Trustee or Director of 28 other
Evergreen Keystone funds; Chairman of the Board and Chief Executive
Officer, Carson Products Company; Director of Phoenix Total Return
Fund and Equifax, Inc.; Trustee of Phoenix Series Fund, Phoenix Multi-
Portfolio Fund, and The Phoenix Big Edge Series Fund; and former
President, Morehouse College.
F. RAY KEYSER, JR.: Trustee of the Trusts, other than TETFT; Trustee or Director of 28 other
Evergreen Keystone funds; Chairman and Of Counsel, Keyser, Crowley
& Meub, P.C.; Member, Governor's (VT) Council of Economic Advisers;
Chairman of the Board and Director, Central Vermont Public Service
Corporation and Lahey Hitchcock Clinic; Director, Vermont Yankee
Nuclear Power Corporation, Grand Trunk Corporation, Grand Trunk
Western Railroad, Union Mutual Fire Insurance Company, New
England Guaranty Insurance Company, Inc., and the Investment
Company Institute; former Director and President, Associated
Industries of Vermont; former Director of Keystone, Central Vermont
Railway, Inc., S.K.I. Ltd., and Arrow Financial Corp.; and former
Director and Chairman of the Board, Proctor Bank and Green Mountain
Bank.
GERALD M. MCDONNELL: Trustee of the Trusts; Trustee or Director of all other Evergreen
Keystone funds; Trustee or Director of all of the funds in the Evergreen
Family of Funds; and Sales Representative with Nucor-Yamoto, Inc.
(Steel producer).
THOMAS L. MCVERRY: Trustee of the Trusts; Trustee or Director of all other Evergreen
Keystone funds; former Vice President and Director of Rexham
Corporation; and former Director of Carolina Cooperative Federal Credit
Union.
*WILLIAM WALT PETTIT: Trustee of the Trusts; Trustee or Director of all other Evergreen
Keystone funds; and Partner in the law firm of Holcomb and Pettit, P.A.
DAVID M. RICHARDSON: Trustee of the Trusts, other than TETFT; Trustee or Director of 28 other
Evergreen Keystone funds; Vice Chair and former Executive Vice
President, DHR International, Inc. (executive recruitment); former
Senior Vice President, Boyden International Inc. (executive recruit
ment); and Director, Commerce and Industry Association of New Jersey,
411 International, Inc., and J&M Cumming Paper Co.
RUSSELL A.
SALTON, III MD: Trustee of the Trusts; Trustee or Director of all other Evergreen
Keystone funds; Medical Director, U.S. Health Care/Aetna Health
Services; and former Managed Health Care Consultant; former
President, Primary Physician Care.
MICHAEL S. SCOFIELD: Trustee of the Trusts; Trustee or Director of all other Evergreen
Keystone funds; and Attorney, Law Offices of Michael S. Scofield.
RICHARD J. SHIMA: Trustee of the Trusts, other than TETFT; Trustee or Director of 28 other
Evergreen Keystone funds; Chairman, Environmental Warranty, Inc.
(insurance agency); Executive Consultant, Drake Beam Morin, Inc.
(executive outplacement); Director of Connecticut Natural Gas Corpora
tion, Hartford Hospital, Old State House Association, Middlesex Mutual
Assurance Company, and Enhance Financial Services, Inc.; Chairman,
Board of Trustees, Hartford Graduate Center; Trustee, Greater Hartford
YMCA; former Director, Vice Chairman and Chief Investment Officer,
The Travelers Corporation; former Trustee, Kingswood-Oxford School;
and former Managing Director and Consultant, Russell Miller, Inc.
ANDREW J. SIMONS: Trustee of the Trusts, other than TETFT; Trustee or Director of 28 other
Evergreen Keystone funds; Partner, Farrell, Fritz, Caemmerer, Cleary,
Barnosky & Armentano, P.C.; Adjunct Professor of Law and former
Associate Dean, St. John's University School of Law; Adjunct Professor
of Law, Touro College School of Law; and former President, Nassau
County Bar Association.
ROBERT J. JEFFRIES: Trustee Emeritus of 12 Evergreen Keystone Funds and Corporate
Consultant since 1967.
JOHN J. PILEGGI: President and Treasurer of the Trusts; President and Treasurer of all
other Evergreen Keystone funds; Senior Managing Director, Furman
Selz LLC since 1992; Managing Director from 1984 to 1992; Consultant
to BISYS Fund Services since 1996; 230 Park Avenue, Suite 910, New
York, NY.
GEORGE O. MARTINEZ: Secretary of the Trusts; Secretary of all other Evergreen Keystone
funds; Senior Vice President and Director of Administration and
Regulatory Services, BISYS Fund Services; Vice President/Assistant
General Counsel, Alliance Capital Management from 1988 to 1995;
3435 Stelzer Road, Columbus, Ohio.
</TABLE>
* This Trustee may be considered an "interested person" of the Funds within
the meaning of the 1940 Act.
For the fiscal year ended March 31, 1997, none of the Trustees or officers
of the Funds received any direct remuneration from the California, Florida,
Massachusetts, Missouri, New York and Pennsylvania Funds. For the fiscal period
ending March 31, 1997, Independent Trustees of the New Jersey Fund received
$2,148 in retainers and fees. For the year ending March 31, 1997, fees paid to
Independent Trustees on a fund complex wide basis (which included approximately
60 mutual funds) were approximately $846,350. With the exception of the
Massachsuetts Fund, on August 29, 1997, the Trustees and officers of the Trusts,
as a group, beneficially owned less than 1% of each Funds' then outstanding
shares. Trustees and officers of the Trusts, as a group, beneficially owned 2.8%
of the Massachsuetts Fund's outstanding shares as of August 29, 1997.
Except as set forth above, the address of all the Trusts' Trustees and
officers is 200 Berkeley Street, Boston, Massachusetts 02116-5034.
Set forth below for each of the Trustees receiving in excess of $60,000 for
the fiscal period of April 1, 1996 through March 31, 1997 is the aggregate
compensation paid to such Trustee by the EvergreenKeystone Funds:
Total Compensation
From Fund Complex
NAME PD. TO TRUSTEE
James S. Howell $66,000
Russell A Salton, III M.D. $61,000
Michael S. Scofield $61,000
- --------------------------------------------------------------------------------
INVESTMENT ADVISERS
- --------------------------------------------------------------------------------
Subject to the general supervision of each Trust's Board of Trustees, the
Funds' investment advisers provide investment advice, management and
administrative services to each Fund.
On December 11, 1996, the predecessor corporation to First Union Keystone,
Keystone Investments, Inc. ("Keystone Investments") and indirectly each
subsidiary of Keystone Investments, including Keystone, were acquired (the
"Acquisition") by FUNB, a wholly-owned subsidiary of First Union Corporation
("First Union"). Keystone Investments was acquired by FUNB by merger into a
wholly-owned subsidiary of FUNB, which entity then assumed the name "First Union
Keystone, Inc." and succeeded to the business of the predecessor corporation.
Contemporaneously with the Acquisition, each Fund other than the New Jersey Fund
entered into a new investment advisory agreement with Keystone and into a
principal underwriting agreement with EKD, a wholly-owned subsidiary of The
BYSIS Group, Inc. The new investment advisory agreements between KSTFF, KSTFFII
and Keystone were approved by the shareholders of each Fund on December 9, 1996,
and became effective on December 11, 1996.
First Union Keystone (and each of its subsidiaries, including Keystone) is
indirectly owned by First Union. First Union is headquartered in Charlotte,
North Carolina, and had $137 billion in consolidated assets as of March 31,
1997. First Union and its subsidiaries provide a broad range of financial
services to individuals and businesses throughout the United States. CMG,
Keystone and Evergreen Asset Management Corp., a wholly-owned subsidiary of
FUNB, manage or otherwise oversee the investment of over $62 billion in assets
as of March 31, 1997 belonging to a wide range of clients, including the
Evergreen Keystone funds.
Pursuant to the advisory agreements (the "Advisory Agreements") between the
Trusts and their respective investment advisers, and subject to the supervision
of the appropriate Trust's Board of Trustees, Keystone and CMG furnishes to each
Fund investment advisory, management and administrative services, office
facilities, and equipment in connection with its services for managing the
investment and reinvestment of each Fund's assets. Keystone and CMG pay for all
of the expenses incurred in connection with the provision of its services.
Each Fund pays for all charges and expenses, other than those specifically
referred to as being borne by Keystone or CMG, including, but not limited to,
(1) custodian charges and expenses; (2) bookkeeping and auditors' charges and
expenses; (3) transfer agent charges and expenses; (4) fees and expenses of
Independent Trustees; (5) brokerage commissions, brokers' fees and expenses; (6)
issue and transfer taxes; (7) costs and expenses under the Distribution Plan;
(8) taxes and trust fees payable to governmental agencies; (9) the cost of share
certificates; (10) fees and expenses of the registration and qualification of
such Fund and its shares with the SEC or under state or other securities laws;
(11) expenses of preparing, printing and mailing prospectuses, statements of
additional information, notices, reports and proxy materials to shareholders of
such Fund; (12) expenses of shareholders' and Trustees' meetings; (13) charges
and expenses of legal counsel for such Fund and for the Independent Trustees of
the Trust on matters relating to such Fund; (14) charges and expenses of filing
annual and other reports with the SEC and other authorities; and all
extraordinary charges and expenses of such Fund.
The California, Florida, Massachusetts, Missouri, New York and Pennsylvania
Funds each pay Keystone a fee for its services at the annual rate of:
Aggregate Net Asset
Management Value of the
FEE SHARES OF THE FUND
0.55% of the first $ 50,000,000, plus
0.50% of the next $ 50,000,000, plus
0.45% of the next $ 100,000,000, plus
0.40% of the next $ 100,000,000, plus
0.35% of the next $ 100,000,000, plus
0.30% of the next $ 100,000,000, plus
0.25% of amounts over $ 500,000,000.
Keystone's fee is computed as of the close of business each business day
and payable monthly.
Under its Advisory Agreements, any liability of Keystone in connection with
rendering services thereunder is limited to situations involving its willful
misfeasance, bad faith, gross negligence or reckless disregard of its duties.
The New Jersey Fund pays CMG a fee for its services equal to 0.50 of 1% of
the average daily net asets up to $500 million, 0.45 of 1% of the next $500
million of assets, 0.40 of 1% of assets in excess of $1 billion but not
exceeding $1.5 billion, and 0.35 of 1% of assets in excess of $1.5 billion.
The Advisory Agreements continue in effect for two years from their
respective effective dates and, thereafter, from year to year only if approved
at least annually by the Board of Trustees of a Trust or by a vote of a majority
of a Fund's outstanding shares (as defined in the 1940 Act). In either case, the
terms of a Advisory Agreement and continuance thereof must be approved by the
vote of a majority of the Independent Trustees cast in person at a meeting
called for the purpose of voting on such approval. An Advisory Agreement may be
terminated, without penalty, on 60 days' written notice by the Trust's Board of
Trustees or by a vote of a majority of outstanding shares. An Advisory Agreement
will terminate automatically upon its "assignment" as that term is defined in
the 1940 Act.
Keystone has voluntarily limited the expenses of the Class A, Class B and
Class C shares of each Fund advised by it to 0.75%, 1.50%, and 1.50% of average
daily net assets, respectively. Keystone currently intends to continue the
foregoing expense limitations on a calendar month-by-month basis. Keystone will
periodically evaluate the expense limitations and may modify or terminate them
in the future. Keystone would not be required to make such reimbursement to any
Fund to the extent it would result in the Fund's inability to qualify as a
regulated investment company under the Code.
- --------------------------------------------------------------------------------
PRINCIPAL UNDERWRITER
- --------------------------------------------------------------------------------
Each Trust has entered into Principal Underwriting Agreements (each an
"Underwriting Agreement") with EKD with respect to each class. EKD, which is not
affiliated with First Union, replaces EKIS as KSTFF's and KSTFFII's principal
underwriter. EKIS may no longer act as principal underwriter of such Trusts due
to regulatory restrictions imposed by the Glass-Steagall Act upon national banks
such as FUNB and their affiliates, that prohibit such entities from acting as
the underwriters of mutual fund shares. While EKIS may no longer act as
principal underwriter of the Trusts as discussed above, EKIS may continue to
receive compensation from KSTFF and KSTFFII or EKD in respect of underwriting
and distribution services performed prior to the termination of EKIS as
principal underwriter. In addition, EKIS may also be compensated by EKD for the
provision of certain marketing support services to EKD at an annual rate of up
to .75% of the average daily net assets of a Fund, subject to certain
restrictions.
EKD, as agent, has agreed to use its best efforts to find purchasers for
the shares. EKD may retain and employ representatives to promote distribution of
the shares and may obtain orders from broker-dealers, and others, acting as
principals, for sales of shares to them. The Underwriting Agreements provide
that EKD will bear the expense of preparing, printing, and distributing
advertising and sales literature and prospectuses used by it. EKD or EKIS, its
predecessor, may receive payments from the Trusts pursuant to the Distribution
Plans.
All subscriptions and sales of shares by EKD are at the public offering
price of the shares, which is determined in accordance with the provisions of
each Trust's Declaration of Trust, By-Laws, current prospectuses and statement
of additional information. All orders are subject to acceptance by the
respective Trust and each Trust reserves the right, in its sole discretion, to
reject any order received. Under the Underwriting Agreements, a Trust is not
liable to anyone for failure to accept any order.
Each Trust has agreed under the Underwriting Agreements to pay all expenses
in connection with the registration of its shares with the Securities and
Exchange Commission (the "Commission") and auditing and filing fees in
connection with the registration of its shares under the various state "blue-
sky" laws.
EKD has agreed that it will, in all respects, duly conform with all
state and federal laws applicable to the sale of the shares. EKD has also agreed
that it will indemnify and hold harmless each Trust and each person who has
been, is, or may be a Trustee or officer of a Trust against expenses reasonably
incurred by any of them in connection with any claim, action, suit, or
proceeding to which any of them may be a party that arises out of or is alleged
to arise out of any misrepresentation or omission to state a material fact on
the part of EKD or any other person for whose acts EKD is responsible or is
alleged to be responsible, unless such misrepresentation or omission was made in
reliance upon written information furnished by the respective Trust.
Each Underwriting Agreement provides that it will remain in effect as long
as its terms and continuance are approved annually (i) by a vote of a majority
of the respective Trust's Independent Trustees, and (ii) by vote of a majority
of the respective Trust's Trustees, in each case, cast in person at a meeting
called for that purpose.
Each Underwriting Agreement may be terminated, without penalty, on 60 days'
written notice by the respective Board of Trustees or by a vote of a majority of
outstanding shares subject to such agreement. Each Underwriting Agreement will
terminate automatically upon its "assignment," as that term is defined in the
1940 Act.
From time to time, if, in EKD's judgment, it could benefit the sales of
shares, EKD may provide to selected broker-dealers promotional materials and
selling aids, including, but not limited to, personal computers, related
software, and data files.
- --------------------------------------------------------------------------------
ADMINISTRATOR
- --------------------------------------------------------------------------------
EKIS, a subsidiary of First Union Keystone, serves as administrator to the
New Jersey Fund and is entitled to receive a fee based on the average daily net
assets of the Fund at a rate based on the total assets of the mutual funds
administered by EKIS for which CMG, Keystone or Evergreen Asset also serve as
investment adviser, calculated in accordance with the following schedule: .050%
of the first $7 billion; .035% on the next $3 billion; .030% on the next $5
billion; .020% on the next $10 billion; .015% on the next $5 billion; and .010%
on assets in excess of $30 billion.
- --------------------------------------------------------------------------------
SUB-ADMINISTRATOR
- --------------------------------------------------------------------------------
BISYS provides personnel to serve as officers of the Funds, and provides
certain administrative services to the Funds pursuant to a sub-administrator
agreement. For its services under that agreement, BISYS receives a fee based on
the aggregate average daily net assets of the Funds. The subadministrator fee is
calculated in accordance with the following schedule:
Aggregate Average Daily Net Assets Of Funds For
Which Any Affiliate Of FUNB Serves As
Investment Adviser or Administrator
Sub-Administrator Fee And for Which BISYS Serves as Sub- Administrator
- --------------------------------------------------------------------------------
0.0100% on the first $7 billion
0.0075% on the next $3 billion
0.0050% on the next $15 billion
0.0040% on assets in excess of $25 billion
The total assets of the mutual funds for which FUNB affiliates also serve
as investment advisers were approximately $29 billion as of March 31, 1997.
- --------------------------------------------------------------------------------
DECLARATIONS OF TRUST
- -------------------------------------------------------------------------------
MASSACHUSETTS BUSINESS TRUST
Each Trust is a Massachusetts business trust established under a
Declaration of Trust (the "Declaration of Trust" or "Declarations of Trust"). A
Trust is similar in most respects to a business corporation. The principal
distinction between a Trust and a corporation relates to the shareholder
liability described below. A copy of each Trust's Declaration of Trust was filed
as an exhibit to the Trust's Registration Statement. This summary is qualified
in its entirety by reference to the Declarations of Trust.
DESCRIPTION OF SHARES
Each Declaration of Trust authorizes the issuance of an unlimited number of
shares of beneficial interest of classes of shares. Each share of a Fund
represents an equal proportionate interest in such Fund with each other share of
the Fund. Upon liquidation, Fund shares are entitled to a pro rata share of the
Fund based on the relative net assets of each class.
SHAREHOLDER LIABILITY
Pursuant to certain decisions of the Supreme Judicial Court of
Massachusetts, shareholders of a Massachusetts business trust may, under certain
circumstances, be held personally liable as partners for the obligations of the
trust. If a Trust were held to be a partnership, the possibility of the
shareholders incurring financial loss for that reason appears remote because
each Trust's Declaration of Trust (1) contains an express disclaimer of
shareholder liability for obligations of the Trust; (2) requires that notice of
such disclaimer be given in each agreement, obligation or instrument entered
into or executed by the Trust or its Trustees; and (3) provides for
indemnification out of Trust property for any shareholder held personally liable
for the obligations of the Trust.
VOTING RIGHTS
Under the terms of its Declaration of Trust, a Trust does not hold annual
meetings. At meetings called for the initial election of Trustees or to consider
other matter, shares of a Fund are entitled to one vote per share. Shares
generally vote together as one class on all matters, except that each Fund has
exclusive voting rights with respect to matters which affect only that Fund.
Classes of shares of a Fund have equal voting rights except that each class of
shares has exclusive voting rights with respect to its respective Distribution
Plan. No amendment may be made to a Declaration of Trust that adversely affects
any class of shares without the approval of a majority of the shares of that
class. Shares have non-cumulative voting rights, which means that the holders of
more than 50% of the shares voting for the election of Trustees can elect 100%
of the Trustees to be elected at a meeting and, in such event, the holders of
the remaining 50% or less of the shares voting will not be able to elect any
Trustees.
After the initial meeting to elect Trustees no further meetings of
shareholders for the purpose of electing Trustees will be held, unless required
by law, unless and until such time as less than a majority of the Trustees
holding office have been elected by shareholders, at which time the Trustees
then in office will call a shareholders' meeting for election of Trustees.
Except as set forth above, the Trustees shall continue to hold office
indefinitely, unless otherwise required by law, and may appoint successor
Trustees. A Trustee may be removed from or cease to hold office (as the case may
be) (1) at any time by two-thirds vote of the remaining Trustees; (2) when such
Trustee becomes mentally or physically incapacitated; or (3) at a special
meeting of shareholders by a two-thirds vote of the outstanding shares. Any
Trustee may voluntarily resign from office.
LIMITATION OF TRUSTEES' LIABILITY
Each Declaration of Trust provides that a Trustee shall be liable only for
his own willful defaults and, if reasonable care has been exercised in the
selection of officers, agents, employees or investment advisers, shall not be
liable for any neglect or wrongdoing of any such person; provided, however, that
nothing in the Declaration of Trust shall protect a Trustee against any
liability for his willful misfeasance, bad faith, gross negligence or reckless
disregard of his duties.
The Trustees have absolute and exclusive control over the management and
disposition of all assets of the Funds and may perform such acts as in their
sole judgment and discretion are necessary and proper for conducting the
business and affairs of a Trust or promoting the interests of a Trust and its
Funds and the shareholders.
- --------------------------------------------------------------------------------
EXPENSES
- --------------------------------------------------------------------------------
The tables below list the total dollar amounts paid by the Funds for
services rendered for the periods specified. For more information on specific
expenses, see the "Investment Advisers", "Distribution Plans", "Principal
Underwriter" and "Sales Charges" sections of the SAI.
1997 FUND EXPENSES
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C> <C>
AGGREGATE DOLLAR
AMOUNT OF
AGGREGATE DOLLAR UNDERWRITING
PERCENTAGE OF AMOUNT OF COMMISSIONS
ADVISORY FUND AVERAGE CLASS A CLASS B CLASS C UNDERWRITING RETAINED BY EKIS
FEES NET ASSETS 12B-1 FEES 12B-1 FEES 12B-1 FEES COMMISSIONS OR EKD
========== ============== ============ ============== ========== ================= ==================
CALIFORNIA FUND(1) $51,555 0.55% $2,121 $66,054 $4,972 $133,966 $60,931
FLORIDA FUND(2) $507,576 0.55% $46,410 $469,958 $97,209 $683,260 $452,797
MASSACHUSETTS FUND(2) $63,584 0.55% $2,689 $67,185 $19,460 $97,579 $29,745
MISSOURI FUND(1) $46,447 0.55% $1,259 $64,269 $3,949 $96,918 $55,982
NEW JERSEY FUND(3) $135,196 0.50% $47,320 $25,809 N/A N/A N/A
- ------------------------ ---------- -------------- ------------ -------------- ---------- ----------------- ------------------
NEW YORK FUND(2) $135,473 0.55% $5,586 $166,682 $19,837 $236,114 $20,175
PENNSYLVANIA FUND(2) $390,366 0.53% $39,570 $343,818 $71,610 $504,459 $106,694
======================== ========== ============== ============ ============== ========== ================= ==================
</TABLE>
(1) For fiscal period of December 1, 1996 to March 31, 1997
(2) For fiscal year ended March 31, 1997
(3) For fiscal period of September 1, 1996 to March 31, 1997
1996 FUND EXPENSES
AGGREGATE
DOLLAR AMOUNT
AGGREGATE OF
PERCENTAGE DOLLAR AMOUNT UNDERWRITING
OF FUND OF COMMISSIONS
ADVISORY AVERAGE NET UNDERWRITING RETAINED BY
FEES ASSETS COMMISSIONS EKIS OR EKD
============== ============= =============== ===============
CALIFORNIA FUND $163,334(1) 0.55% $341,589 $67,534
FLORIDA FUND $557,537(2) 0.52% $771,514 $213,167
MASSACHUSETTS
FUND $62,760(2) 0.55% $108,131 $18,234
MISSOURI FUND $146,922(1) 0.55% $230,925 $94,279
NEW JERSEY
FUND $107,212(3) 0.50% N/A N/A
- ----------------- -------------- ------------- --------------- ---------------
MASSACHUSETTS
FUND $62,760(2) 0.55% $108,131 $18,234
-------------- ------------- --------------- ---------------
NEW YORK FUND $118,589(2) 0.55% $201,162 $201,162
PENNSYLVANIA $402,467(2) 0.53% $482,423 $482,423
FUND
1995 FUND EXPENSES
AGGREGATE
DOLLAR AMOUNT
AGGREGATE OF
PERCENTAGE DOLLAR AMOUNT UNDERWRITING
OF FUND OF COMMISSIONS
ADVISORY AVERAGE NET UNDERWRITING RETAINED BY
FEES ASSETS COMMISSIONS EKIS OR EKD
============== ============= =============== =================
$113,353(4) 0.55% $170,600 $170,600
$515,205(5) 0.52% $740,118 $740,118
$43,636(5) 0.55% $88,538 $88,538
$120,166(4) 0.55% $165,772 $65,153
$190,195(6) 0.50% N/A N/A
-------------- ------------- --------------- -----------------
$43,636(5) 0.55% $88,538 $88,538
-------------- ------------- --------------- -----------------
$63,808(5) 0.55% $88,538 $88,538
$357,852(5) 0.54% $474,847 $353,409
(1) For fiscal year ended November 30, 1996
(2) For fiscal year ended March 31, 1996
(3) For fiscal period of March 1, 1996 to August 31, 1996
(4) For fiscal year ended November 30, 1995
(5) For fiscal year ended March 31, 1995
(6) For fiscal period of March 1, 1995 to February 28, 1996
In accordance with voluntary expense limitations in effect during the
fiscal year or period ended March 31, 1997, Keystone or CMG voluntarily
reimbursed or waived fees for the California, Florida, Massachusetts, Missouri,
New Jersey, New York, Pennsylvania and Funds in the amounts of $43,885,
$160,819, $97,150, $46,528, $135,196, $106,560, and $169,740, respectively.
BROKERAGE COMMISSIONS
The Funds paid no brokerage commissions during the fiscal years ended March
31, 1997 and 1996 and 1995.
- --------------------------------------------------------------------------------
STANDARDIZED TOTAL RETURN AND YIELD QUOTATIONS
- --------------------------------------------------------------------------------
TOTAL RETURN
Total return quotations for a class of shares of a Fund as they may appear
from time to time in advertisements are calculated by finding the average annual
compounded rates of return over one, five and ten year periods, or the time
periods for which such class of shares has been effective, whichever is
relevant, on a hypothetical $1,000 investment that would equate the initial
amount invested in the class to the ending redeemable value. To the initial
investment all dividends and distributions are added, and all recurring fees
charged to all shareholder accounts are deducted. The ending redeemable value
assumes a complete redemption at the end of the relevant periods.
The annual total returns for Class A shares of the Funds (including
applicable sales charge) are as follows for the periods indicated:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Commencement
Five Years Three Years One Year Of Operations
NAME OF FUND ended 03/31/97 ended 03/31/97 ended 03/31/97 to 03/31/97
- ------------ -------------- -------------- -------------- -----------
California Fund(1) N/A 4.28% (0.55)% 2.07%
Florida Fund(2) 5.19% 4.30% (1.41)% 6.35%
Massachusetts Fund(3) N/A 4.23% (0.07)% 1.51%
Missouri Fund(1) N/A 4.50% 0.22% 2.66%
New Jersey Fund(4) 5.74% 4.51% (0.29)% 6.03%
New York Fund(3) N/A 4.84% (0.11)% 2.60%
Pennsylvania Fund(5) 5.66% 4.25% 0.30% 7.14%
</TABLE>
<PAGE>
27
- -------------
(1) Commenced operations on February 1, 1994
(2) Commenced operations on December 28, 1990
(3) Commenced operations on February 4, 1994
(4) Commenced operations on July 16, 1991
(5) Commenced operations on December 27, 1990
The average annual total returns for Class B shares of the Funds are as
follows for the periods indicated:
Commencement
Three Years One Year Of Operations
NAME OF FUND ended 03/31/97 ended 03/31/97 to 03/31/97
- ------------ -------------- ---------------- -----------
California Fund(1) 4.33% (1.31)% 2.22%
Florida Fund(2) 4.35% (2.16)% 3.92%
Massachusetts Fund(3) 4.23% (0.72)% 1.59%
Missouri Fund(1) 4.45% (0.51)% 2.57%
New Jersey Fund(4) N/A (1.25)% (1.72)%
New York Fund(3) 4.87% (0.95)% 2.61%
Pennsylvania Fund(2) 4.24% (0.50)% 4.40%
- -------------
(1) Commenced operations on February 1, 1994
(2) Commenced operations on February 1, 1993
(3) Commenced operations on February 4, 1994
(4) Commenced operations on January 30, 1996
The average annual total returns for Class C shares of the Funds that
offer Class C are as follows for the periods indicated:
Commencement
Three Years One Year Of Operations
NAME OF FUND ended 03/31 97 ended 03/31/97 to 03/31/97
- ------------ ------------- ---------------- -----------
California Fund(1) 5.10% 2.55% 2.96%
Florida Fund(2) 5.26% 1.76% 4.31%
Massachusetts Fund(3) 5.07% 3.14% 2.36%
Missouri Fund(1) 5.33% 3.49% 3.39%
New York Fund(3) 5.77% 3.14% 3.42%
Pennsylvania Fund(2) 5.15% 3.49% 4.82%
- -------------
(1) Commenced operations on February 1, 1994
(2) Commenced operations on February 1, 1993
(3) Commenced operations on February 4, 1994
The average annual total return for Class Y shares of the New Jersey Fund
was 4.74% for the year ended March 31, 1997 and 2.31% for the period of February
8, 1996 (Commencement of Operations) to March 31, 1997.
CURRENT YIELD AND TAX EQUIVALENT YIELD
Current yield quotations as they may appear from time to time in
advertisements will consist of a quotation based on a 30-day period ended on the
date of the most recent balance sheet of a Fund, computed by dividing the net
investment income per share earned during the period by the maximum offering
price per share on the last day of the base period. Such yield will include
income from sources other than municipal obligations, if any. For the 30-day
period ended March 31, 1997, the current and tax-equivalent yields of the Funds
are shown below. Tax equivalent yield is, in general, the current yield divided
by a factor equal to one minus a stated income tax rate and reflects the yield a
taxable investment would have to achieve in order to equal on an after-tax basis
a tax-exempt yield.
The tax equivalent yields for each class of the Funds for the an investor
in the 31% federal tax bracket are as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
30-DAY YIELD TAX-EQUIVALENT YIELD
Class A Class B Class C Class A Class B Class C
=================== ============ ============= ============= =============== ============== ==============
California Fund 4.80% 4.28% 4.28% 6.96% 6.20% 6.20%
Florida Fund 5.06% 4.56% 4.56% 7.33% 6.61% 6.61%
Massachusetts 4.91% 4.38% 4.39% 7.12% 6.35% 6.36%
Fund
Missouri Fund 4.99% 4.48% 4.47% 7.23% 6.49% 6.48%
New Jersey Fund 4.94% 4.01% N/A 7.16% 5.81% N/A
New York Fund 4.80% 4.28% 4.27% 6.96% 6.20% 6.19%
Pennsylvania 4.96% 4.46% 4.46% 7.19% 6.46% 6.46%
Fund
=================== ============ ============= ============= =============== ============== ==============
</TABLE>
The 30-day yield and tax-equivalent yield for Class Y shares of the New
Jersey Fund were 5.07% and 7.35%, respectively.
Any given yield or total return quotation should not be considered
representative of the Fund's yield or total return for any future period.
- --------------------------------------------------------------------------------
FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The Funds' financial statements for the fiscal year or period ended March
31, 1997, and the report thereon of KPMG Peat Marwick LLP, are incorporated by
reference herein from the Funds' Annual Report, as filed with the Commission
pursuant to Section 30(d) of the 1940 Act and Rule 30d-1 thereunder.
You may obtain a copy of each Fund's Annual Report without charge by
writing to EKSC, P.O. Box 2121, Boston, Massachusetts 02106-2121, or by calling
EKSC toll free at 1-800-343-2898.
- --------------------------------------------------------------------------------
ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
REDEMPTIONS IN KIND
If conditions arise that would make it undesirable for the Funds to pay for
all redemptions in cash, the Funds may authorized payment to be made in
portfolio securities or other property. The Funds have obligated themselves,
however, under the 1940 Act, to redeem for cash all shares presented for
redemption by any one shareholder up to the lesser of $250,000 or 1% of the
Fund's net assets in any 90-day period. Securities delivered in payment of
redemptions would be valued at the same value assigned to them in computing the
net asset value per share and would, to the extent permitted by law, be readily
marketable. Shareholders receiving such securities would incur brokerage costs
upon the securities' sale.
GENERAL
State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110, is the custodian (the "Custodian") of all securities and
cash of the Trusts. The Custodian performs no investment management functions
for the Trusts, but, in addition to its custodial services, is responsible for
accounting and related record keeping on behalf of the Trusts.
Except as otherwise stated in its prospectuses or required by law, each
Trust reserves the right to change the terms of the offer stated in its
prospectuses without shareholder approval, including the right to impose or
change fees for services provided.
No dealer, salesman or other person is authorized to give any information
or to make any representation not contained in each Trust's prospectuses,
statement of additional information or in supplemental sales literature issued
by the Trust or EKD, and no person is entitled to rely on any information or
representation not contained therein.
The Funds' prospectuses and statement of additional information omit
certain information contained in the registration statement filed with the
Commission, a copy of which may be obtained from the Commission's principal
office in Washington, D.C. upon payment of the fee prescribed by the rules and
regulations promulgated by the Commission.
Set forth below is information with respect to each person,who, to each
Fund's knowledge, owned beneficially or of record more than 5% of a class of
each Fund's total outstanding shares and their aggregate ownership of each
Class' total outstanding shares as of August 29, 1997.
Fund Name and Address Class % of Class
California MLPF & S for the Sole Benefit A 10.04%
of its Customers
Attn: Fund Administration
4800 Deer Lake Dr E 3rd Fl
Jacksonville, FL 32246-6484
California MLPF & S for the Sole Benefit B 15.51%
of its Customers
Attn: Fund Administration
4800 Deer Lake Dr E 3rd Fl
Jacksonville, FL 32246-6484
California MLPF & S for the Sole Benefit C 34.98%
of its Customers
Attn: Fund Administration
4800 Deer Lake Dr E 3rd Fl
Jacksonville, FL 32246-6484
California Victor Edward Rylander C 9.50%
Lucille Rylander Co-TTEES
Victor & Lucille Rylander Trust
U/A DTD 09-18-96
4102 Caflur Ave
San Diego, CA 92117
California Prudential Securities FBO C 6.11%
Rakesh C Gupta
Neelam Gupta CO-TTEES
FBO Gupta Family Living Trust 12/22/94
Hemet, CA 92544
California Alex Brown & Sons Incorporated C 5.79%
FBO 489-31533-14
PO Box 1346
Baltimore, MD 21203-1346
California Alex Brown & Sons Incorporated C 5.67%
FBO 489-30559-15
P O Box 1346
Baltimore, MD 21203-1346
California Smith Barney Inc. C 5.67%
00154933343
388 Greenwich Street
New York, NY 10013
California Richard B Smith C 5.48%
Doris M. Smith TTEE
Smith Trust
U/A DTD 4/8/93
4853 Mt Royal Court
San Diego, CA 92117-2917
Florida MLPF&S for the sole benefit A 10.20%
of it customers
Attn: Fund Administration
4800 Deer Lake Dr. E, 3rd Floor
Jacksonville, FL 32246-6484
Florida MLPF&S for the sole benefit B 19.34%
of it customers
Attn: Fund Administration
4800 Deer Lake Dr. E, 3rd Floor
Jacksonville, FL 32246-6484
Florida MLPF&S for the sole benefit C 32.48%
of it customers
Attn: Fund Administration
4800 Deer Lake Dr. E, 3rd Floor
Jacksonville, FL 32246-6484
Florida Painewebber for the benefit of C 6.96%
Betty J. Puskar Ttee
Betty J. Puskar Rev. Trust
708 Ocean Drive
Juno Beach, FL 33408-1911
Florida Painewebber for the benefit of C 5.14%
Wayne D. Rebertus Ttee
U/A/DTD 8/3/89
FBO Wayne D. Rebertus
720 NW 73 Terrace
Plantation, FL 33317-1028
Massachusetts Richard Nakashian A 9.89%
P O Box 3150
Pocasset, MA 02559-3150
Massachusetts Ida R Rodriguez A 7.62%
TR # 21528
Keystone Trust Company TTEE
58 Helen Rd
Needham, MA 02192-3934
Massachusetts Robert M. Buddington A 7.50%
P.O. Box 549
S. Orleans, MA 02662-0549
Massachusetts Bertha M. Beauchemin A 6.45%
TR #21843
Keystone Trust Company TTEE
299 Cambridge St.
Winchester, MA 0189-2389
Massachusetts Margaret Vogel A 8.08%
TR #21720
Keystone Trust Company TTEE
865 Central Ave H403
Needham, MA 02192-1341
Massachusetts Joann L. Lyndon B 6.73%
22 Glenbrook Rd.
Wellesley Hills, MA 02181-1428
Massachusetts Bear Stearns Securities Corp. C 11.03%
FBO 176-12556-19
1 Metrotech Center North
Brooklyn, NY 11201-3859
Massachusetts Salvatore M Moscariello C 7.51%
Irene A Moscariello JT TEN
24 Van Norden Road
Reading, MA 01867-1244
Massachusetts Malcolm F. Groves & Jean C 5.61%
N Groves Ttee Malcolm F
Groves Rev Liv Trust
U/A Dtd 05-18-94
80 Indian Hill Road.
Cummaquid, MA 02637
Missouri MLPF & S for the Sole Benefit A 10.99%
of its Customers
Attn: Fund Administration
4800 Deer Lake Dr E 3rd Fl
Jacksonville, FL 32246-6484
Missouri BHC Securities, Inc. A 7.54%
FAO 54356697
Attn: Mutual Funds Dept.
One Commerce Square
2005 Market STreet, Suite 1200
Philadelphia, PA 19103
Missouri MLPF & S for the Sole Benefit B 26.23%
of its Customers
Attn: Fund Administration
4800 Deer Lake Dr E 3rd Fl
Jacksonville, FL 32246-6484
Missouri Painewebber for the Benefit of C 16.01%
Dorothy K. Pruett Trustee
Dorothy K. Pruett Revocable
C/O Mid America Mortgage
8645 College Blvd
Overland Park, KS 66210
Missouri Edward D. Jones and Co. F/A/O/ C 17.09%
Ronald Ralph Wilder Ttee
U/A DTD 07/26/88 for
EDJ# 642-02131-1-4
P.O. Box 2500
Maryland Heights, MO 63043-8500
Missouri MLPF & S for the Sole Benefit C 12.36%
of its Customers
Attn: Fund Administration
4800 Deer Lake Dr E 3rd Fl
Jacksonville, FL 32246-6484
New Jersey First Union National Bank Y 81.08%
Trust Accounts
Attn: Ginny Batten CMG-1151-2
401 S. Tryon St., 3rd Floor
Charlotte, NC 28202-1911
New Jersey First Union National Bank Y 17.90%
Trust Accounts
Attn: Ginny Batten
11th Floor, CMG-1151
301 S. Tryon St.
Charlotte, NC 28288-0002
New York Prudential Securities Inc FBO A 5.10%
Ms. Sandra M. Franck
345 W. 70th St., Apt 6F
New York, NY 10023-3554
New York MLPF & S for the Sole Benefit B 12.49%
of its Customers
Attn: Fund Administration
4800 Deer Lake Dr E 3rd Fl
Jacksonville, FL 32246-6484
New York Bear Stearns Securities Corp. C 14.94%
FBO 626-60277-10
1 Metrotech Center North
Brooklyn, NY 11201-3857
New York Henry W. Demoy C 5.36%
Patricia K. Demoy JT WROS
Rd. 2 King Road
Cambridge, NY 12816-9802
New York Carol T Whitman C 11.40%
P O Box 43
Whippleville, NY 12995
New York Carol L Moore C 8.52%
Rt 2 Box 1055
Chateaugay, NY 12920-9522
New York MLPF&S for the sole C 5.96%
Benefit of its customers
Attn: Fund Administration
4800 Deer Lake Dr E, 3rd Fl.
Jacksonville, FL 32246-6484
New York Elizabeth Frost C 5.06%
9 Heathcote Road
Scarsdale, NY 10583-4413
Pennsylvania MLPF&S for the sole A 6.05%
benefit of its customers.
Attn: Fund Administration
4800 Deer Lake Dr E 3rd Fl
Jacksonville, FL 32246-6484
Pennsylvania MLPF&S for the sole B 10.11%
benefit of its customers.
Attn: Fund Administration
4800 Deer Lake Dr E 3rd Fl
Jacksonville, FL 32246-6484
Pennsylvania MLPF&S for the sole C 29.07%
benefit of its customers.
Attn: Fund Administration
4800 Deer Lake Dr E 3rd Fl
Jacksonville, FL 32246-6484
Pennsylvania Painewebber FBO C 6.22%
Robert Couble
Debra K. Couble JT WROS
10506 old 22
Kutztown, PA 19530-8551
- --------------------------------------------------------------------------------
APPENDIX A
- --------------------------------------------------------------------------------
KEYSTONE CALIFORNIA TAX FREE FUND
GENERAL
California's economy is the largest among the 50 states and one of the
largest in the world. The State's population of over 32 million represents over
12% of the total U.S. population and grew by 27% in the 1980's, and at about
half that rate in the first half of the 1990s. Total personal income in the
State, at an estimated $815 billion in 1996 -- a 13% increase in the last two
years -- accounts for more than 12% of all personal income in the nation. Total
civilian employment is over 14.3 million, the majority of which is in the
service, trade and manufacturing sectors.
From mid-1990 to late 1993, the State suffered a recession with the worst
economic, fiscal and budget conditions since the 1930's. Construction,
manufacturing (especially aerospace), and financial services, among others, were
all severely affected, particularly in Southern California. Job losses were the
worst of any post-war recession. Employment levels stabilized by late 1993 and
steady growth has occurred since the start of 1994; pre-recession job levels
were reached in 1996. Unemployment, while higher than the national average, has
come down significantly from the January, 1994 peak of 10% and is now at the
pre-recession level. Economic indicators show a steady recovery underway in
California since the start of 1994, with greatest strength in manufacturing,
high technology, exports, services, entertainment and tourism. However, the
residential housing sector has been weaker than in previous recoveries. Any
delay or reversal of the economic recovery may cause a recurrence of revenue
shortfalls for the State.
CONSTITUTIONAL LIMITATIONS ON TAXES, OTHER CHARGES AND APPROPRIATIONS
LIMITATION ON PROPERTY TAXES. Certain California municipal obligations may
be obligations of issuers that rely in whole or in part, directly or indirectly,
on ad valorem property taxes as a source of revenue. The taxing powers of
California local governments and districts are limited by Article XIIIA of the
California Constitution, enacted by the voters in 1978 and commonly known as
"Proposition 13." Briefly, Article XIIIA limits to 1% of full cash value the
rate of ad valorem property taxes on real property and generally restricts the
reassessment of property to 2% per year, except upon new construction or change
of ownership (subject to a number of exemptions). Taxing entities may, however,
raise ad valorem taxes above the 1% limit to pay debt service on voter-approved
bonded indebtedness.
Under Article XIIIA, the basic 1% ad valorem tax levy is applied against
the assessed value of property as of the owner's date of acquisition (or as of
March 1, 1975, if acquired earlier), subject to certain adjustments. This system
has resulted in widely varying amounts of tax on similarly situated properties.
Several lawsuits have been filed challenging the acquisition-based assessment
system of Proposition 13, and on June 18, 1992 the U.S. Supreme Court announced
a decision upholding Proposition 13.
Article XIIIA prohibits local governments from raising revenues through ad
valorem property taxes above the 1% limit; it also requires voters of any
governmental unit to give two-thirds approval to levy any "special tax." Court
decisions, however, allowed non-voter approved levy of "general taxes" that were
not dedicated to a specific use.
LIMITATIONS ON OTHER TAXES, FEES AND CHARGES. On November 5, 1996, the
voters of the State approved Proposition 218, called the "Right to Vote on Taxes
Act." Proposition 218 added Articles XIIIC and XIIID to the State Constitution,
which contain a number of provisions affecting the ability of local agencies to
levy and collect both existing and future taxes, assessments, fees and charges.
Article XIIIC requires that all new or increased local taxes be submitted
to the electorate before they become effective. Taxes for general governmental
purposes require a majority vote and taxes for specific purposes require a
two-thirds vote. Further, any general purpose tax which was imposed, extended or
increased without voter approval after December 31, 1994 must be approved by a
majority vote within two years.
Article XIIID contains several new provisions making it generally more
difficult for local agencies to levy and maintain "assessments" for municipal
services and programs. Article XIIID also contains several new provisions
affecting "fees" and "charges", defined for purposes of Article XIIID to mean
"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 existing property related fees and charges must conform to
requirements prohibiting, among other things, fees and charges which generate
revenues exceeding the funds required to provide the property related service or
are used for unrelated purposes. There are new notice, hearing and protest
procedures for levying or increasing property related fees and charges, and,
except for fees or charges for sewer, water and refuse collection services (or
fees for electrical and gas service, which are not treated as "property related"
for purposes of Article XIIID), 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.
In addition to the provisions described above, Article XIIIC removes
limitations on the initiative power in matters of local taxes, assessments, fees
and charges. Consequently, local voters could, by future initiative, repeal,
reduce or prohibit the future imposition or increase of any local tax,
assessment, fee or charge. It is unclear how this right of local initiative may
be used in cases where taxes or charges have been or will be specifically
pledged to secure debt issues.
The interpretation and application of Proposition 218 will ultimately
be determined by the courts with respect to a number of matters, and it is not
possible at this time to predict with certainly the outcome of such
determinations. Proposition 218 is generally viewed as restricting the fiscal
flexibility of local governments, and for this reason, some ratings of
California cities and counties have been, and others may be, reduced.
APPROPRIATION LIMITS. The State and its local governments are subject
to an annual "appropriations limit" imposed by Article XIIIB of the California
Constitution, enacted by the voters in 1979 and significantly amended by
Propositions 98 and 111 in 1988 and 1990, respectively. Article XIIIB prohibits
the State or any covered local government from spending "appropriations subject
to limitation" in excess of the appropriations limit imposed. "Appropriations
subject to limitation" are authorizations to spend "proceeds of taxes," which
consist of tax revenues and certain other funds, including proceeds from
regulatory licenses, user charges or other fees, to the extent that such
proceeds exceed the cost of providing the product or service, but "proceeds of
taxes" excludes most State subventions to local governments. No limit is imposed
on appropriations of funds that are not "proceeds of taxes," such as reasonable
user charges or fees, and certain other non-tax funds, including bond proceeds.
Among the expenditures not included in the Article XIIIB appropriations
limit are (1) the debt service cost of bonds issued or authorized prior to
January 1, 1979, or subsequently authorized by the voters, (2) appropriations
arising from certain emergencies declared by the Governor, (3) appropriations
for certain capital outlay projects, (4) appropriations by the State of post
1989 increases in gasoline taxes and vehicle weight fees, and (5) appropriations
made in certain cases of emergency.
The appropriations limit for each year is adjusted annually to reflect
changes in cost of living and population and any transfers of service
responsibilities between governmental units. The definitions for such
adjustments were liberalized in 1990 to follow more closely growth in the
State's economy.
"Excess" revenues are measured over a two year cycle. Local governments
must return any excess to taxpayers by rate reductions. The State must refund
50% paid to schools and community colleges. With more liberal annual adjustment
factors since 1988, and depressed revenues for several years after 1990 because
of the recession, few governments, including the State, are currently operating
near their spending limits, but this condition may change over time. The State's
1996-97 Budget Act provides for State appropriations of more than $7 billion
under the Article XIIIB limit. Local governments may by voter approval exceed
their spending limits for up to four years.
Because of the complex nature of Articles XIIIA, XIIIB, XIIIC and XIIID, of
the California Constitution, the ambiguities and possible inconsistencies of
their terms, and the impossibility of predicting future appropriations or
changes in population and cost of living, and the probability of continuing
legal challenges, it is not currently possible to determine fully the impact of
these articles on California municipal obligations. It is not presently possible
to predict the outcome of any pending litigation with respect to the ultimate
scope, impact or constitutionality of these articles, or the impact of any such
determinations upon State agencies or local governments, or upon their ability
to pay debt service on their obligations. Future initiatives or legislative
changes in laws or the California Constitution may also affect the ability of
the State or local issuers to repay their obligations.
OBLIGATIONS OF THE STATE OF CALIFORNIA
As of March 1, 1997, the State had approximately $17.7 billion of general
obligation bonds outstanding, and $8.4 billion remained authorized but unissued.
The State also had outstanding at March 1, 1997 $368 million of general
obligation commercial paper notes which will be refunded into long-term bonds at
a later date. In addition, at March 1, 1997, the State had lease-purchase
obligations, payable from the State's General Fund, of approximately $6.1
billion. State voters approve $7.1 billion of new bond authorizations during
1996. In fiscal year 1995-1996, debt service on general obligation bonds and
lease-purchase debt was approximately 5.2% of General Fund revenues. The State
has paid the principal of and interest on its general obligation bonds,
lease-purchase debt and short-term obligations when due.
RECENT FINANCIAL RESULTS
The principal sources of General Fund revenues in 1995-1996 were the
California personal income tax (45% of total revenues), the sales tax (34%),
bank and corporation taxes (13%), and the gross Fund for Economic Uncertainties
("SFEU"), derived from General Fund revenues, as a reserve to meet cash needs of
the General Fund. Because of the recession, the SFEU has not been funded for the
past four years.
GENERAL. Throughout the 1980's, State spending increased rapidly as the
State population and economy also grew rapidly, including increased spending for
many assistance programs to local governments, which were constrained by
Proposition 13 and other laws. The largest State program is assistance to local
public school districts. In 1988, an initiative (Proposition 98) was enacted
which (subject to suspension by a two-thirds vote of the Legislature and the
Governor) guarantees local school districts and community college districts a
minimum share of State General Fund revenues (currently 35%).
Since the start of 1990-91 Fiscal Year, the State has faced adverse
economic, fiscal, and budget conditions. The economic recession seriously
affected State tax revenues. It also caused increased expenditures for health
and welfare programs. The State is also facing a structural imbalance in its
budget with the largest programs supported by the General Fund (education,
health, welfare and corrections) growing at rates higher than the growth rates
for the principal revenue sources of the General Fund. These structural concerns
will continue in future years with the expected need to increase capital and
operating costs of the correctional system in response to a "Three Strikes" law
enacted in 1994 which mandates life imprisonment for certain felony offenders.
RECENT BUDGETS. As a result of these factors, among others, from the late
1980's until 1992-93, the State had a period of nearly chronic budget imbalance,
with expenditures exceeding revenues in four out of six years, and the State
accumulated and sustained a budget deficit in the budget reserve, the SFEU
approaching $2.8 billion at its peak at June 30, 1993. Starting in the 1990-91
Fiscal Year and for five years thereafter, each budget required multi-billion
dollar actions to bring projected revenues and expenditures into balance and to
close large "budget gaps" which were identified. The Legislature and Governor
eventually agreed on a number of different steps to produce Budget Acts in the
Years 1991-92 to 1995-96 (although not all these actions occurred in each year),
including:
* significant cuts in health and welfare program expenditures;
* transfers of program responsibilities and some funding sources from the
state to local governments, coupled with some reduction in mandates on local
government;
* transfer of about $3.6 billion in annual local property tax revenues from
cities, counties, redevelopment agencies and some other districts to local
school districts, thereby reducing state funding for schools;
* reduction in growth of support for higher education programs, coupled
with increases in student fees;
* revenue increases (particularly in the 1991-92 Fiscal Year budget), most
of which were for a short duration;
* increased reliance on aid from the federal government to offset the costs
of incarcerating, educating and providing health and welfare services to
undocumented aliens (although these efforts have produced much less federal aid
than the State Administration had requested); and
* various one-time adjustment and accounting changes.
Despite these budget actions, the effects of the recession led to large
unanticipated deficits in the SFEU, as compared to projected positive balances.
By the start of the 1993-94 Fiscal Year, the accumulated deficit was so large
(almost $2.8 billion) that it was impractical to budget to retire it in one
year, so a two-year program was implemented, using the issuance of revenue
anticipation warrants to carry a portion of the deficit over the end of the
fiscal year. When the economy failed to recover sufficiently in 1993-94, a
second two-year plan was implemented in 1994-95, to carry the final retirement
of the deficit into 1995-96.
The combination of stringent budget actions cutting State expenditures, and
the turnaround of the economy by late 1993, finally led to the restoration of
positive financial results. While General Fund revenues and expenditures were
essentially equal in FY 1992-93 (following two years of excess expenditures over
revenues), the General Fund had positive operating results in FY 1993-94 through
FY 1995-96, which have reduced the accumulated budget deficit to less than $100
million as of June 30, 1996.
The State Department of Finance estimated that the General Fund received
revenues of about $46.3 billion in FY 1995-96, more than $2 billion higher than
was originally expected, as a result of the strengthening economy. Expenditures
totaled about $45.4 billion, also about $2 billion higher than budgeted,
because, among other factors, the State Constitution requires disbursement of a
percentage of revenues to local school districts and federal actions to reduce
welfare costs and to pay for costs of illegal immigrants were not forthcoming to
the extent expected.
A consequence of the accumulated budget deficits in the early 1990's,
together with other factors such as disbursement of funds to local school
districts "borrowed" from future fiscal years and hence not shown in the annual
budget, was to significantly reduce the state's cash resources available to pay
its ongoing obligations. When the Legislature and the Governor failed to adopt a
budget for the 1992-93 Fiscal Year by July 1, 1992, which would have allowed the
state to carry out its normal annual cash flow borrowing to replenish its cash
reserves, the State Controller was forced to issue approximately $3.8 billion of
registered warrants ("IOUs") over a 2-month period to pay a variety of
obligations representing prior years' or continuing appropriations, and mandates
from court orders. Available funds were used to make constitutionally-mandated
payments such as debt service on bonds and warrants.
The State's cash condition became so serious that from late spring 1992
until 1995, the State had to rely on issuance of short-term notes which matured
in a subsequent fiscal year to finance its ongoing deficit and pay current
obligations. With the repayment of the last of these deficit notes in April,
1996, the State does not plan to rely further on external borrowing across
fiscal years, but will continue its normal cash flow borrowing during a fiscal
year.
CURRENT BUDGET. The 1996-97 Budget Act was signed by the Governor on July
15, 1996, along with various implementing bills. The Legislature rejected the
Governor's proposed 15% cut in personal income taxes (to be phased over three
years), but did approve a 5% cut in bank and corporation taxes, to be effective
for income years starting on January 1, 1997. Revenues for the Fiscal Year were
estimated to total $47.643 billion, a 3.3 percent increase over the final
estimated 1995-96 revenues. The Budget Act contains General Fund appropriations
totaling $47.251 billion, a 4.0 percent increase over the final estimated
1995-96 expenditures.
The following are principal features of the 1996-97 Budget Act:
1. Funding for schools and community college districts increased by $1.65
billion total above revised 1995-96 levels. Almost half of this money was
budgeted to fund class-size reductions in kindergarten and grades 1-3. Also, for
the second year in a row, the full cost of living allowance (3.2 percent) was
funded. The funding increases have brought K-12 expenditures to almost $4,800
per pupil, an almost 15% increase over the level prevailing during the recession
years.
2. Proposed cuts in health and welfare totaling $660 million. All of these
cuts required federal law changes (including welfare reform, which was enacted),
federal waivers, or federal budget appropriations in order to be achieved.
Ultimate federal actions after enactment of the Budget Act will allow the State
to save only about $360 million of this amount.
3. A 4.9 percent increase in funding for the University of California and
the California State University system, with no increases in student fees for
the second consecutive year.
4. The Budget Act assumed the federal government would provide
approximately $700 million in new aid for incarceration and health care costs of
illegal immigrants. These funds reduce appropriations in these categories that
would otherwise have to be paid from the General Fund.
With signing of the Budget Act, the State implemented its regular cash flow
borrowing program with the issuance of $3.0 billion of Revenue Anticipation
Notes to mature on June 30, 1997. The Budget Act appropriated a modest budget
reserve in the SFEU of $305 million, as of June 30, 1997. The General Fund
balance, however, still reflects $1.6 billion of "loans" which the General Fund
made to local schools in the recession years, representing cash outlays above
the mandatory minimum funding level. Settlement of litigation over these
transactions in July 1996 calls for repayment of these loans over the period
ending in 2001-02, about equally split between outlays from the General Fund and
from schools' entitlements. The 1996-97 Budget Act contained a $150 million
appropriation from the General Fund toward this settlement.
The Department of Finance projected, when the Budget Act was passed, that,
on June 30, 1997, the State's available internal borrowable (cash) resources
will be $2.9 billion, after payment of all obligations due by that date, so that
no external cross-fiscal year borrowing will be needed. The State will continue
to rely on internal borrowing and intra-year external note borrowing to meet its
cash flow requirements.
The Department of Finance has reported that, based on stronger than
expected revenues during the first six months of the 1996-97 fiscal year,
reflecting the continued strength of the State's economic recovery, General Fund
revenues for the full 1996-97 fiscal year will be almost $1 billion above
projections, at about $48.4 billion. This is expected to be offset by required
increased payments to schools, and lower than expected savings resulting from
federal welfare reform actions and federal aid for illegal immigrants. As a
result, the expected balance of the SFEU at June 30, 1997 has been slightly
reduced to about $197 million, still the first positive balance in the decade of
the 90's. The State has not yet given any prediction of how the federal welfare
reform law will impact the State's finances, or those of its local agencies; the
State is in the midst of making many decisions concerning implementation of the
new welfare law.
PROPOSED 1997-98 BUDGET. On January 9, 1997, the Governor released his
proposed budget for FY 1997-98. Assuming continuing strength in the economy, the
Governor projects General Fund revenues of $50.7 billion, and proposes
expenditures of $50.3 billion, to leave a budget reserve in the SFEU of $550
million at June 30, 1998. The Governor proposed further programs to reduce class
size in lower primary grades, using excess revenues from FY 1996-97. He also
proposed a further cut in corporate taxes, and sweeping changes in public
assistance programs to respond to the new federal welfare reform law.
Although the State's strong economy is producing record revenues to the
State government, the State's budget continues to be under stress from mandated
spending on education, a rising prison population, and social needs of a growing
population with many immigrants. These factors which limit State spending growth
also put pressure on local governments. There can be no assurances that, if
economic conditions weaken, or other factors intercede, the State will not
experience budget gaps in the future.
BOND RATINGS
The ratings on California's long-term general obligation bonds were reduced
in the early 1990's from "AAA" levels which had existed prior to the recession.
In 1996, Fitch and Standard & Poor's raised their ratings of California's
general obligation bonds, which are currently assigned ratings of "A+" from
Standard & Poor's, "A1" from Moody's and "A+" from Fitch. There can be no
assurance that such ratings will be maintained in the future. It should be noted
that the creditworthiness of obligations issued by local California issuers may
be unrelated to the creditworthiness of obligations issued by the State of
California, and that there is no obligation on the part of the State to make
payment on such obligations in the event of default.
LEGAL PROCEEDINGS
The State is involved in certain legal proceedings (described in the
State's recent financial statements) that, if decided against the State, may
require the State to make significant future expenditures or may substantially
impair revenues.
OBLIGATIONS OF OTHER ISSUERS
OTHER ISSUERS OF CALIFORNIA MUNICIPAL OBLIGATIONS. There are a number of
state agencies, instrumentalities and political subdivisions of the State that
issue municipal obligations, some of which may be conduit revenue obligations
payable from payments from private borrowers. These entities are subject to
various economic risks and uncertainties, and the credit quality of the
securities issued by them may vary considerably from the credit quality of
obligations backed by the full faith and credit of the State.
STATE ASSISTANCE. Property tax revenues received by local governments
declined more than 50% following passage of Proposition 13. Subsequently, the
California Legislature enacted measures to provide for the redistribution of the
State's General Fund surplus to local agencies, the reallocation of certain
State revenues to local agencies and the assumption of certain governmental
functions by the State to assist municipal issuers to raise revenues. Through
1990-91, local assistance (including public schools) accounted for around 75% of
General Fund spending. To reduce State General Fund support for school
districts, the 1992-93 and 1993-94 Budget Acts caused local governments to
transfer a total of $3.9 billion of property tax revenues to school districts,
representing loss of all the post-Proposition 13 "bailout" aid. The largest
share of these transfers came from counties, and the balance from cities,
special districts and redevelopment agencies. In order to make up part of this
shortfall, the Legislature proposed, and voters approved, dedicating 0.5% of the
sales tax to counties and cities for public safety purposes. In addition, the
Legislature has changed laws to relieve local governments of certain mandates,
allowing them to reduce costs.
To the extent the State should be constrained by its Article XIIIB
appropriations limit, or its obligation to conform to Proposition 98, or other
fiscal considerations, the absolute level, or the rate of growth, of State
assistance to local governments may continue to be reduced. Any such reductions
in State aid could compound the serious fiscal constraints already experienced
by many local governments, particularly counties. A number of other counties
have indicated that their budgetary condition is extremely serious. In the
1995-96 and 1996-97 fiscal years, Los Angeles County, the largest in the State,
had to make significant cuts in services and personnel, particularly in the
health care system, in order to balance its budget. The County's debt was
downgraded by Moody's and S&P in the summer of 1995. Orange County, which
recently emerged from federal bankruptcy protection, has substantially reduced
services and personnel in order to live within much reduced means.
Counties and cities may face further budgetary pressures as a result of
changes in welfare and public assistance programs, which will have to be enacted
by June, 1997 in order to comply with the federal welfare reform law. It is now
yet known how the State's legislation will turn out and what its overall impact
will be on local government finances.
ASSESSMENT BONDS. California municipal obligations that are assessment
bonds may be adversely affected by a general decline in real estate values or a
slowdown in real estate sales activity. In many cases, such bonds are secured by
land that is undeveloped at the time of issuance, but anticipated to be
developed within a few years after issuance. In the event of such reduction or
slowdown, such development may not occur or may be delayed, thereby increasing
the risk of a default on the bonds. Because the special assessments or taxes
securing these bonds are not the personal liability of the owners of the
property assessed, the lien on the property is the only security for the bonds.
Moreover, in most cases the issuer of these bonds is not required to make
payments on the bonds in the event of delinquency in the payment of assessments
or taxes, except from amounts, if any, in a reserve fund established for the
bonds.
CALIFORNIA LONG-TERM LEASE OBLIGATIONS. Certain California long-term lease
obligations, though typically payable from the general fund of the municipality,
are subject to "abatement" in the event the facility being leased is unavailable
for beneficial use and occupancy by the municipality during the term of the
lease. Abatement is not a default, and there may be no remedies available to the
holders of the certificates evidencing the lease obligation in the event
abatement occurs. The most common cases of abatement are failure to complete
construction of the facility before the end of the period during which lease
payments have been capitalized and uninsured casualty losses to the facility
(e.g. due to earthquake). In the event abatement occurs with respect to a lease
obligation, lease payments may be interrupted (if all available insurance
proceeds and reserves are exhausted) and the certificates may not be paid when
due.
Several years ago the Richmond Unified School District (the "District")
entered into a lease transaction in which certain existing properties of the
District were sold and leased back in order to obtain funds to cover operating
deficits. Following a fiscal crisis in which the District's finances were taken
over by a State receiver (including a brief period under bankruptcy court
protection), the District failed to make rental payments on this lease,
resulting in a lawsuit by the Trustee for the Certificate of Participation
holders, in which the State was a named defendant (on the grounds that it
controlled the District's finances). One of the defenses raised in answer to
this lawsuit was the invalidity of the District's lease. The trial court upheld
the validity of the lease, and the case has subsequently been settled. Any
judgment in a similar case against the position taken by the Trustee may have
adverse implications for lease transactions of a similar nature by other
California entities.
OTHER CONSIDERATIONS
The repayment of industrial development securities secured by real property
may be affected by California laws limiting foreclosure rights of creditors.
Securities backed by health care and hospital revenues may be affected by
changes in State regulations governing cost reimbursements to health care
providers under Medi-Cal (the State's Medicaid program), including risks related
to the policy of awarding exclusive contracts to certain hospitals.
Limitations on AD VALOREM property taxes may particularly affect "tax
allocation" bonds issued by California redevelopment agencies. Such bonds are
secured solely by the increase in assessed valuation of a redevelopment project
area after the start of redevelopment activity. In the event that assessed
values in the redevelopment project decline (e.g. because of major natural
disaster such as an earthquake), the tax increment revenue may be insufficient
to make principal and interest payments on these bonds. Both Moody's and S&P
suspended ratings on California tax allocation bonds after the enactment of
Articles XIIIA and XIIIB, and only resumed such ratings on a selective basis.
Proposition 87, approved by California voters in 1988, requires that all
revenues produced by a tax rate increase go directly to the taxing entity that
increased such tax rate to repay that entity's general obligation indebtedness.
As a result, redevelopment agencies (which typically are the issuers of tax
allocation securities) no longer receive an increase in tax increment when taxes
on property in the project area are increased to repay voter-approved bonded
indebtedness.
The effect of these various constitutional and statutory changes upon the
ability of California municipal securities issuers to pay interest and principal
on their obligations remains unclear. Furthermore, other measures affecting the
taxing or spending authority of California or its political subdivisions may be
approved or enacted in the future. Legislation has been or may be introduced
that would modify existing taxes or other revenue raising measures or that
either would further limit or, alternatively, would increase the abilities of
state and local governments to impose new taxes or increase existing taxes. It
is not presently possible to predict the extent to which any such legislation
will be enacted. Nor is it presently possible to determine the impact of any
such legislation on California municipal obligations in which the Fund may
invest, future allocations of state revenues to local governments or the
abilities of state or local governments to pay the interest on, or repay the
principal of, such California municipal obligations.
Substantially all of California is within an active geologic region subject
to major seismic activity. Northern California in 1989 and Southern California
in 1994 experienced major earthquakes causing billions of dollars in damages.
The federal government provided more than $13 billion in aid for both
earthquakes, and neither event is expected to have any long-term negative
economic impact. Any security in the California Fund could be affected by an
interruption of revenues because of damaged facilities, or, consequently, income
tax deductions for casualty losses or property tax assessment reductions.
Compensatory financial assistance could be constrained by the inability of (i)
an issuer to have obtained earthquake insurance coverage at reasonable rates;
(ii) an insurer to perform on its contracts of insurance in the event of
widespread losses; or (iii) the federal or State governments to appropriate
sufficient funds within their respective budget limitations.
KEYSTONE FLORIDA TAX FREE FUND
REVENUES
The State accounts for its receipts using fund accounting. It has
established the General Revenue Fund, the Working Capital Fund and various other
trust funds, which are maintained for the receipt of monies which under law or
trust agreements must be maintained separately.
The General Revenue Fund consists of all monies received by the State from
every source whatsoever which are not allocable to the other funds. Major
sources of tax revenues for the General Revenue Fund are the sales and use tax,
the corporate income tax, and the intangible personal property tax, which are
projected for fiscal year 1997-98 to amount to 71%, 8% and 4%, respectively, of
the total receipts of that fund.
The Florida Constitution and its statutes mandate that the State budget as
a whole and each separate fund within the State budget be kept in balance from
currently available revenues for each fiscal year.
SALES AND USE TAX
The greatest single source of tax receipts in Florida is the sales and use
tax, which is projected to amount to $11.7 billion for fiscal year 1997-98. The
sales tax is 6% of the sales price of tangible personal property sold at retail
in the state. The use tax is 6% of the cash price or fair market value of
tangible personal property when it is not sold but is used, or stored for use,
in the State. In other words, the use tax applies to the use of tangible
personal property in Florida, which was purchased in another state but would
have been subject to the sales tax if purchased in Florida. Approximately 10% of
the sales tax is designated for local governments and is distributed to the
respective counties in which collected for use by such counties and
municipalities therein. In addition to this distribution, local governments may
(by referendum) assess a 1% sales surtax within their county. Proceeds from this
local option sales surtax can be earmarked for funding countywide bus and rapid
transit systems, local infrastructure construction and maintenance, medical care
for indigents and capital projects for county school districts as set forth in
Section 212.055(2), of the Florida Statutes.
The two taxes, sales and use, stand as complements to each other, and taken
together provide a uniform tax upon either the sale at retail or the use of all
tangible personal property irrespective of where it may have been purchased. The
sales tax also includes a levy on the following: (I) rentals on tangible
personal property and accommodations in hotels, motels, some apartments,
offices, real estate, parking and storage places in parking lots, garages and
marinas for motor vehicles or boats; (ii) admissions to places of amusements,
most sports and recreation events; (iii) utilities, except those used in homes;
and (iv) restaurant meals and expendables used in radio and television
broadcasting. Exemptions include: groceries; medicines; hospital rooms and
meals; seeds, feeds, fertilizers and farm crop protection materials; purchases
by religious, charitable and educational nonprofit institutions; professional
services, insurance and certain personal service transactions; newspapers;
apartments used as permanent dwellings; and kindergarten through community
college athletic contests or amateur plays.
OTHER STATE TAXES
Other taxes which Florida levies include the motor fuel tax, corporate
income tax, intangible property tax, documentary stamp tax, gross receipts
utilities tax and severance tax on the production of oil and gas and the mining
of solid minerals, such as phosphate and sulfur.
LOCAL GOVERNMENT DEBT
Numerous government units, counties, cities, school districts and special
taxing districts, issue general obligation bonds backed by their taxing power.
State and local government units may issue revenue obligations, which are
supported by the revenues generated from the particular projects or enterprises.
Examples include obligations issued to finance the construction of water and
sewer systems, health care facilities and educational facilities. In some cases,
sewer or water revenue obligations may be additionally secured by the full faith
and credit of the State.
OTHER FACTORS
The performance of the obligations issued by Florida, its municipalities,
subdivisions and instrumentalities are in part tied to state-wide, regional and
local conditions within Florida. Adverse changes to state-wide, regional or
local economies may adversely affect the creditworthiness of Florida, its
municipalities, etc. Also, some revenue obligations may be issued to finance
construction of capital projects which are leased to nongovernmental entities.
Adverse economic conditions might affect those lessees' ability to meet their
obligations to the respective governmental authority which in turn might
jeopardize the repayment of the principal of, or the interest on, the revenue
obligations.
KEYSTONE MASSACHUSETTS TAX FREE FUND
The Commonwealth of Massachusetts and certain of its cities and towns and
public bodies have experienced in the past, and may experience in the future,
financial difficulties that may adversely affect their credit standing. The
prolonged effects of such financial difficulties could adversely affect the
market value of the municipal securities held by the Massachusetts Fund. The
information summarized below describes some of the more significant factors that
could affect the Massachusetts Fund or the ability of the obligors to pay debt
service on certain of the securities. The sources of such information are the
official statement of issuers located in the Commonwealth of Massachusetts as
well as other publicly available documents, and statements of public officials.
The Massachusetts Fund has not independently verified any of the information
contained in such statements and documents but the Massachusetts Fund is not
aware of facts which would render such information inaccurate.
GENERAL
The Commonwealth's constitution requires, in effect, that its budget,
though not necessarily its operating expenditures and revenue, be balanced each
year. In addition, the Commonwealth has certain budgetary procedures and fiscal
controls in place that are designed to ensure that sufficient cash is available
to meet the Commonwealth's obligations, that state expenditures are consistent
with periodic allotments of annual appropriations and that funds are expended
consistent with statutory and public purposes. The condition of the three
principal operating funds (the General Fund, the Local Aid Fund and the Highway
Fund), viewed on a consolidated basis, is generally regarded as the principal
indicator of whether the Commonwealth's operating revenues and expenses are in
balance.
Although the Commonwealth experienced an economic slowdown during the
recession of 1990 to 1991, budgeted expenditures for fiscal 1992 were
approximately $13.416 billion, while budgeted revenues and other sources for
that year were approximately $13.728 billion, including tax revenues of
approximately $9.484 billion. Budgeted expenditures in fiscal 1992 were
approximately $300 million higher than July, 1991 estimates of budgeted
expenditures. The budgeted operating funds ended fiscal 1992 with a combined
balance of $549.4 million.
Budgeted revenues and other sources in fiscal 1993 were approximately
$14.710 billion, including tax revenues of approximately $9.930 billion.
Budgeted expenditures and other uses in fiscal 1993 were approximately $14.696
billion. Furthermore, total revenues and other sources for fiscal 1993 increased
approximately 6.9% from fiscal 1992, while tax revenues increased by 4.7% for
the same period. Budgeted expenditures and other uses in fiscal 1993 were
approximately 9.6% higher than fiscal 1992 expenditures and other uses. Fiscal
1993 budgeted expenditures were $23 million lower than estimated in July 1992.
As of 1993 fiscal year end, the Commonwealth had aggregated balances of
approximately $562.5 million in the budgeted operating funds, including a
combined balance of $452.1 million in the stabilization and undesignated general
funds.
In June 1993, new comprehensive education reform legislation was enacted.
This legislation required annual increases in expenditures for education
purposes above fiscal 1993 base spending of $1.289 billion, estimated at
approximately $175 million in fiscal 1994, $396 million in fiscal 1995, $629
million in fiscal 1996, and $881 million in fiscal 1997, with additional annual
increases anticipated in later years. The fiscal 1994, 1995, 1996 and 1997
budgets have fully funded the requirements imposed by this legislation.
Municipalities and agencies of the Commonwealth are experiencing the same
economic effects. Moreover, they are affected by the financial condition of the
Commonwealth, because they receive substantial funding from the Commonwealth.
The fiscal 1994 budget provided for expenditures and other uses of
approximately $15.523 billion, an increase of 5.6% over fiscal 1993 levels.
Budgeted revenues and other sources for fiscal 1994 were approximately $15.55
billion. This amount included tax revenues of approximately $10.607 billion,
which is 6.8% higher than fiscal 1993 tax revenues. 1994 tax revenues were
approximately $87 million below the Department of Revenue's estimate of $10.694
billion. Total revenues and other sources were approximately 5.7% higher than
fiscal 1993 levels. Fiscal 1994 ended with a combined balance of approximately
$589.3 million in the budgeted operating funds.
Fiscal 1995 tax revenue collections were approximately $11.163 billion,
approximately $12 million above the Department of Revenue's revised fiscal year
1995 tax revenue estimate of $11.151 billion and approximately $556 million, or
5.2%, above fiscal 1994 tax revenues of $10.607 billion. Budgeted revenues and
other sources, including non-tax revenues, collected in fiscal 1995 were
approximately $16.387 billion, approximately $837 million, or 5.4%, above the
fiscal 1994 budgeted revenues of $15.55 billion. Budgeted expenditures and other
uses of funds in fiscal 1995 were approximately $16.251 billion, approximately
$728 million, or 4.7%, above fiscal 1994 budgeted expenditures and uses of
$15.523 billion. The Commonwealth ended fiscal 1995 with a combined fund balance
of $726 million. As calculated by the Comptroller, the amount of surplus funds
(as so defined) for fiscal 1995 was approximately $94.9 million, of which $55.9
million was available to be carried forward as a beginning balance for fiscal
1996. Of the balance approximately $27.9 million was deposited in the
Stabilization Fund, and approximately $11.1 million was deposited in the Cost
Relief Fund.
Budgeted revenues and other sources for fiscal 1996 totaled approximately
$17.328 billion, including tax revenues of approximately $12.049 billion. From
fiscal 1995 to fiscal 1996, budgeted revenues and other sources increased by
approximately 5.7%, while tax revenues increased by approximately 7.9% for the
same period. The Department of Revenue believes that the strong tax revenue
growth in fiscal 1996 was due partly to one-time factors which may not recur in
fiscal 1997 and which have been incorporated into the Department's forecast for
fiscal 1997 tax revenues. Such factors include the rise in the stock and bond
markets in calendar 1995, which may have created unusually large capital gains
and corresponding increases in personal income tax payments in fiscal 1996.
Budgeted expenditures and other uses in fiscal 1996 were approximately $16.881
billion, an increase of approximately $630.6 million, or 3.9%, over fiscal 1995
budgeted expenditures and other uses of $16.251 billion. The Commonwealth ended
the 1996 fiscal year with a combined balance of approximately $1.172 billion in
the budgeted operating funds.
Approximately $177.4 million was transferred to the Stabilization Fund at
the end of fiscal 1996, bringing that Fund balance to approximately $625.0
million, which exceeded the amount of $543.3 million that can remain in the
Stabilization Fund by law. Under state law, year-end surplus amounts in excess
of the amount that can remain in the Stabilization Fund are transferred to the
Tax Reduction Fund, to be applied, subject to legislative appropriation, to the
reduction of personal income taxes. Of the $177.4 million transferred to the
Stabilization Fund in fiscal 1996, $81.7 million was subsequently transferred to
the Tax Reduction Fund and the 1996 balance in the Tax Reduction Fund as
calculated by the Comptroller, was approximately $231.7 million. Pursuant to
fiscal 1996 supplemental appropriations legislation signed by the Governor on
July 30, 1996, approximately $150 million was appropriated from the Tax
Reduction Fund for personal income tax reductions in fiscal 1997, to be
implemented by a temporary increase in the amount of the personal exemption
allowable for the 1996 taxable year. On September 15, 1996 the Governor filed
legislation proposing to use the full amount in the Tax Reduction Fund to
increase the personal income tax exemption for the 1996 tax year, but this
legislation was not enacted in the 1996 legislative session.
The final fiscal 1996 appropriation bills approved by the Governor on July
30, 1996 and August 10, 1996 contained approximately $246.9 million in fiscal
1996 appropriations, $38.2 million in fiscal 1997 appropriations and $221.7
million in fiscal 1996 appropriations continued for use in fiscal 1997. Amounts
carried forward from fiscal 1995 and deposited in the Cost Relief Fund were
appropriated in these bills for further subsidies to local government units.
The fiscal 1997 budget, as signed into law by the Governor on June 30,
1996, provides for estimated expenditures and other uses of approximately
$17.704 billion, an $823 million, or 4.9%, increase over fiscal 1996 spending.
The fiscal 1997 budget includes a spending increase of approximately $254
million to continue funding the comprehensive educational reform legislation
enacted in 1993. Budgeted revenues and other sources to be collected in fiscal
1997 are estimated to be approximately $17.394 billion. This amount includes a
revised estimate of fiscal 1997 tax revenues of $12.307 billion, which is
approximately $257 million, or 2.1%, higher than fiscal 1996 tax revenues, and
is $184 million higher than the October 1996 estimate of $12.123 billion. The
combined ending fund balances for fiscal year 1997 are estimated at
approximately $863 million, which is $309 million below the fiscal 1996 year-end
fund balance. Approximately $255 million of the $309 million is attributable to
non-recurring factors, the largest of which is the $150 million personal income
tax reduction.
On January 23, 1997, the Governor filed legislation to appropriate the
remaining balance of approximately $85 million in the Tax Reduction Fund for an
additional temporary personal exemption increase during the 1997 taxable year.
As a result, the $85 million in tax cuts initially proposed by the Governor for
fiscal 1997 are now estimated to occur in fiscal 1998. Based on preliminary
figures, through February 1997, fiscal 1997 tax revenue collections have totaled
approximately $7.903 billion, approximately $602 million, or 8.3%, greater than
tax revenue collections for the same period in fiscal 1996. Tax revenue
collections to date are approximately $227 million above the midpoint of the
benchmark range set by the Department of Revenue, based on the current fiscal
1997 tax collection estimate of $12.307 billion, and are approximately $155
million above the top of such benchmark range.
The Governor's fiscal 1998 budget recommendation, which was submitted to
the Legislature on January 22, 1997, calls for budgeted expenditures of
approximately $18.15 billion or total spending of $18.224 billion, which
represents a $520 million, or 2.9%, increase over estimated fiscal 1997
expenditures and other uses of $17.704 billion. Budgeted revenues for fiscal
1998 are estimated at $17.998 billion or total revenues of $18.072 billion,
which is a $219 million, or 1.2%, increase over the $17.853 total revenues and
other sources forecast for fiscal 1997. The budget recommendation is based on a
tax revenue estimate of $12.667 billion, a 2.9% increase over fiscal 1997
projected tax revenues of $12.307 billion. The fiscal 1998 tax revenue estimate
incorporates $82 million in personal and business tax cuts proposed by the
Governor and includes an $85 million income tax reduction for the taxable year
1997, the second consecutive tax cut of this kind. The Governor's proposal
projects a fiscal 1998 ending balance of approximately $711 million, including a
Stabilization Fund balance of $585.8 billion, assuming passage of legislation
filed on January 23, 1997 which would increase the statutory cap on the
Stabilization Fund from 5% of tax revenues (less debt service) to 5% of total
budgeted revenues. The budget proposal also recommends an increase of $259
million in local education aid to fund the 1993 education reform legislation.
The Governor has begun to phase in a plan to provide permanent passenger
vehicle registration and lifetime operating licenses. These proposals are not
estimated to affect revenues until fiscal 1998, when the elimination of vehicle
registration fees is estimated to reduce state revenues by approximately $13.75
million, and by approximately $55 million in fiscal 1999. Lifetime operating
licenses are estimated to reduce revenues by approximately $5 million in fiscal
2001 and by $31 million in fiscal 2002.
On November 28, 1995 the Governor approved a modified version of the
legislation he had filed in September to establish a "single sales factor"
apportionment formula for the business corporations tax. As finally enacted, the
legislation applies the new formula, effective January 1, 1996, to certain
federal defense contractors and phases the new formula in over five years to
manufacturing firms generally. The Department of Revenue estimates that the new
law reduced revenues by $44 million in fiscal 1996 and will reduce revenues by
$90 million in fiscal 1997. If the new formula were fully effective for all
covered businesses, the Department estimates that the annual revenue reduction
would be $100 million to $150 million. On August 8, 1996, the Governor approved
legislation changing the apportionment formula for the business corporations tax
payable by certain mutual fund service corporations. The legislation changes the
computation of the sales factor effective January 1, 1997 and adopts the "single
sales factor" formula effective July 1, 1997 with respect to these companies. It
also requires the affected corporations to increase their numbers of employees
by 5% per year for five years, subject to certain exceptions. The Department of
Revenue estimates that the changes will reduce revenues by $10 million in fiscal
1997 and by approximately $39 million to $53 million per year beginning in
fiscal 1998.
On January 7, 1997 the Governor filed legislation to abolish county
government on July 1, 1998. Most county functions and properties, including
jails, houses of correction and courts, would be transferred to the
Commonwealth, and all liabilities, debts, leases and contracts of any county
would become obligations of the Commonwealth. Under legislation enacted in 1996,
Franklin County government will terminate on July 1, 1997 in favor of a regional
council of governments. On December 13, 1996 Middlesex County defaulted on a
required payment of revenue anticipation notes. The legislature is currently
considering legislation that would abolish Middlesex County government on final
approval of the legislation and transfer its functions to the Commonwealth. The
county's debts and liabilities would be assumed by the Commonwealth.
The Commonwealth is evaluating the impact upon the Commonwealth of federal
welfare reform legislation enacted on August 22, 1996. Current estimates
indicate no fiscal 1997 spending impact associated with the federal legislation
and an increase of approximately $86 million in federal revenues for the
Commonwealth in fiscal 1997.
LIMITATIONS ON TAX REVENUES
In Massachusetts, efforts to limit and reduce levels of taxation have been
underway for several years. Limits were established on state tax revenues by
legislation enacted on October 25, 1986 and by an initiative petition approved
by the voters on November 4, 1986. The two measures are inconsistent in several
respects.
Chapter 62F, which was added to the General Laws by initiative petition in
November 1986, establishes a state 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. Chapter 62F also
requires that allowable state tax revenues be reduced by the aggregate amount
received by local governmental units from any newly authorized or increased
local option taxes or excises. Any excess in state tax revenue collections for a
given fiscal year over the prescribed limit, as determined by the State Auditor,
is to be applied as a credit against the then current personal income tax
liability of all taxpayers in the Commonwealth in proportion to the personal
income tax liability of all taxpayers in the Commonwealth for the immediately
preceding tax year.
Unlike Chapter 29B, as described below, the initiative petition did not
exclude principal and interest payments on Commonwealth debt obligations from
the scope of its tax limit. However, the preamble contained in Chapter 62F
provides that "although not specifically required by anything contained in this
chapter, it is assumed that from allowable state tax revenues as defined herein
the Commonwealth will give priority attention to the funding of state financial
assistance to local governmental units, obligations under the state governmental
pension systems, and payment of principal and interest on debt and other
obligations of the Commonwealth."
The legislation enacted in October 1986, which added Chapter 29B to the
General Laws, also establishes an allowable state revenue growth factor by
reference to total wages and salaries in the Commonwealth. However, rather than
utilizing a three-year average wage and salary growth rate, as used by Chapter
62F, Chapter 29B utilizes an allowable state revenue growth factor equal to 1/3
of the positive percentage gain in Massachusetts wages and salaries, as reported
by the federal government during the three calendar years immediately preceding
the end of a given fiscal year. Additionally, unlike Chapter 62F, Chapter 29B
allows for an increase in maximum state tax revenues to fund the increase in
local aid and excludes from its definition of state tax revenues (i) income
derived from local option taxes and excises, and (ii) revenues needed to fund
debt service costs.
Tax revenues in fiscal 1992 through fiscal 1996 were lower than the limit
set by either Chapter 62F or Chapter 29B. The Executive Office for
Administration and Finance currently estimates that state tax revenues in fiscal
1997 will not reach the limit imposed by either of these statutes.
PROPOSITION 2 1/2
In November 1980, voters in the Commonwealth approved a statewide tax
limitation initiative petition, commonly known as Proposition 2 1/2, to
constrain levels of property taxation and to limit the charges and fees imposed
on cities and towns by certain governmental entities, including county
governments. Proposition 2 1/2 is not a provision of the state constitution and
accordingly is subject to amendment or repeal by the legislature. Proposition 2
1/2, as amended to date, limits the property taxes that may be levied by any
city or town in any fiscal year to the lesser of (i) 2.5% of the full and fair
cash valuation of the real estate and personal property therein, and (ii) 2.5%
over the previous year's levy limit plus any growth in the tax base from certain
new construction and parcel subdivisions. Proposition 2 1/2 also limits any
increase in the charges and fees assessed by certain governmental entities,
including county governments, on cities and towns to the sum of (i) 2.5% of the
total charges and fees imposed in the preceding fiscal year, and (ii) any
increase in charges for services customarily provided locally or services
obtained by the city or town at its option. The law contains certain override
provisions and, in addition, permits debt service on specific bonds and notes
and expenditures for identified capital projects to be excluded from the limits
by a majority vote at a general or special election.
Many communities have responded to the limitations imposed by Proposition 2
1/2 through statutorily permitted overrides and exclusions. Override activity
peaked in fiscal 1991 and decreased thereafter. In fiscal 1992, 65 communities
approved one of the three types of referenda questions (override of levy limit,
exclusion of debt service, or exclusion of capital expenditures), adding $31.0
million to their levy limits.
In fiscal 1993, 59 communities added $16.3 million through override votes
and in fiscal 1994, only 48 communities had successful override referenda which
added $8.4 million to their levy limits. In fiscal 1995, 32 communities added
$8.8 million, and in fiscal 1996, 30 communities added $5.8 million to their
levy limits. 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 19 communities in fiscal 1996 and totaled $1.5 million. In fiscal
1996, the impact of successful debt exclusion votes going back as far as fiscal
1983, was to raise the levy limits of 229 communities by $125.8 million.
LOCAL AID
During the 1980's, the Commonwealth increased payments to its cities,
towns, and regional school districts ("Local Aid") to mitigate the impact of
Proposition 2 1/2 on local programs and services. In fiscal 1997, approximately
20% of the Commonwealth's budget is estimated to be allocated to direct Local
Aid. Local Aid payments to cities, towns, and regional school districts take the
form of both direct and indirect assistance.
Direct Local Aid increased from $2.359 billion in fiscal 1992 to $2.547
billion in fiscal 1993 and increased to $2.727 billion in fiscal 1994. Fiscal
1995 expenditures for direct Local Aid were $2.976 billion, which was an
increase of approximately 9.1% above the fiscal 1994 level. Fiscal 1996
expenditures for direct Local Aid were $3.246 billion, an increase of
approximately 9.1% above the fiscal 1995 level. It is estimated that fiscal 1997
expenditures for direct Local Aid will be $3.538 billion, which is an increase
of approximately 9.0% above the fiscal 1996 level.
A statute adopted by voter initiative petition at the November 1990
statewide election regulates the distribution of Local Aid to cities and towns,
by requiring, subject to appropriation, that 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. By its terms, the new formula would have
called for a substantial increase in direct Local Aid in fiscal 1992, and would
call for such an increase in fiscal 1993 and in subsequent years. However, Local
Aid payments expressly remain subject to annual appropriation, and fiscal 1992,
fiscal 1993, fiscal 1994, fiscal 1995 and fiscal 1996 appropriations for Local
Aid did not meet, and fiscal 1997 appropriations for Local Aid do not meet, the
levels set forth in the initiative law.
COMMONWEALTH EXPENDITURES
Fiscal 1992 budgeted expenditures were $13.416 billion. For fiscal 1993,
budgeted expenditures were $14.696 billion, representing a 9.6% increase from
fiscal 1992. Fiscal 1994 budgeted expenditures were $15.523 billion, an increase
of 5.6% from fiscal 1993. Fiscal 1995 budgeted expenditures were $16.251
billion, an increase of 4.7% from fiscal 1994. Fiscal 1996 budgeted expenditures
were $16.881 billion, an increase of 3.9% from fiscal 1995. It is estimated that
fiscal 1997 budgeted expenditures will be $17.704 billion, an increase of 4.9%
over fiscal 1996 levels.
Commonwealth expenditures since fiscal 1992 largely reflect significant
growth in several programs and services provided by the Commonwealth,
principally Local Aid, Medicaid and group health insurance, public assistance
programs, debt service, pensions, higher education and assistance to the
Massachusetts Bay Transportation Authority and regional transit authorities.
The Commonwealth is responsible for the payment of pension benefits for
state employees and for school teachers throughout the state. The Commonwealth
is also responsible for cost of living increases payable to local government
retirees. State pension expenditures have risen dramatically as the Commonwealth
has appropriated moneys to partially address the unfunded liabilities that had
accumulated over several decades of "pay-as-you-go" administration of the
pension systems for which it is responsible. For several years during the 1980s,
the Commonwealth made substantial direct appropriations to pension reserves, in
addition to paying current benefits. In 1988, the Commonwealth adopted a funding
schedule under which it is required to fund future pension liabilities currently
and to amortize the accumulated unfunded liabilities over 40 years. Total
pension expenditures increased at an average annual rate of 7.6% from $751.5
million in fiscal 1992 to $1.005 billion in fiscal 1996. Total pension
expenditures are estimated at $1.067 billion for fiscal 1997. In fiscal 1996, a
number of reform measures affecting pensions were enacted into law. Among the
most notable were a measure consolidating the assets of the state employees' and
teachers' retirement systems into a single investment fund and another that will
reform the disability pension system. On November 6, 1996 the Governor filed
with the legislature a proposed revised pension funding schedule under which the
Commonwealth's unfunded liability for its pension obligations would be amortized
more rapidly and would be eliminated by fiscal 2019, ten years earlier than
under the current schedule.
LITIGATION
There are pending in state and federal courts within the Commonwealth and
in the U.S. Supreme Court various suits in which the Commonwealth is a party. In
the opinion of the Attorney General, no litigation is pending or, to his
knowledge, threatened which is likely to result, either individually or in the
aggregate, in final judgments against the Commonwealth that would affect
materially its financial condition.
OTHER FACTORS
Many factors affect the financial condition of the Commonwealth, including
many social, environmental, and economic conditions, which are beyond the
control of the Commonwealth. As with most urban states, the continuation of many
of the Commonwealth's programs, particularly its human service programs, is, in
significant part, dependent upon continuing federal reimbursements, which are
expected to decline in fiscal 1997.
KEYSTONE MISSOURI TAX FREE FUND
GENERAL
Missouri's economy includes manufacturing, commerce, trade, services,
agriculture, tourism and mining. The State's economy is diversified and closely
resembles that of the nation's although growth prospects are less favorable than
in the past. It is the nation's fifteenth largest state. The State employment
sectors, services, trade and manufacturing, also account for the primary sources
of national employment. Recent growth in the manufacturing sector has outpaced
the nation as a whole. Labor force growth has remained steady, totaling 2.65
million in 1993, up from 2.3 million in 1980. Through the 1980's and early
1990's the State's unemployment rate essentially mirrored that of the nation;
however, adverse changes in military appropriations, which play an important
role in the State's economy, could contribute to a significant increase in
unemployment. In 1996, according to the Bureau of Labor Statistics, the State
ranked seventeenth among the states in unadjusted nonagricultural employment. In
November 1996, the State's unemployment rate was estimated to be 4.0% as against
the national rate of 5.3%. In recent years, Missouri's wealth indicators have
grown at a slower rate than national levels and in 1995 the State's per capita
personal income was approximately 94.0% of the average for the nation as a
whole.
Missouri displayed strong fiscal performance during most of the 1980's.
However, Missouri has recently experienced difficulties in balancing its budget
as a result of increased expenses and declining sources of revenues. Other
factors contributing to Missouri's weak fiscal position relate to the reduction
of large manufacturing companies, including those in aerospace and the auto
industry. The Missouri portions of the St. Louis and Kansas City metropolitan
areas together contain over 50% of Missouri's population. 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 may experience problems comparable to
those which are occurring in other states. To the extent that any such problems
intensify, there could possibly be an adverse impact on the overall economic
condition of the State.
Currently, general obligations of Missouri are rated "AAA," "Aaa" and
"AAA," by S&P, Moody's and Fitch, respectively. 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,
political or other conditions.
REVENUE AND LIMITATIONS THEREON
Article X, Section 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.
INDUSTRY AND EMPLOYMENT
While Missouri has a diverse economy with a distribution of earnings and
employment among manufacturing, trade and service sectors closely approximating
the average national distribution, the national economic recession of the early
1980's had a disproportionately adverse impact on the economy of Missouri.
During the 1970's, Missouri characteristically had a pattern of unemployment
levels well below the national averages. However, since the 1980 to 1983
recession periods Missouri unemployment levels generally approximated or
slightly exceeded the national average. A return to a pattern of high
unemployment could adversely affect the Missouri debt obligations acquired by
the Missouri Fund and, consequently, the value of the shares of the Fund.
The Missouri portions of the St. Louis and Kansas City metropolitan areas
contain approximately 1,945,813 and 1,016,457 residents, respectively,
constituting over fifty percent of Missouri's 1995 population census of
approximately 5,339,041. St. Louis is an important site for banking and
manufacturing activity, as well as a distribution and transportation center,
with nine Fortune 500 industrial companies (as well as other major educational,
financial, insurance, retail, wholesale and transportation companies and
institutions) headquartered there. Kansas City is a major agribusiness center
and an important center for finance and industry. 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 and recent action of the Defense
Base Closure and Realignment Commission will result in the loss of a substantial
number of civilian jobs in the St. Louis Metropolitan area. Further, aircraft
and related businesses in Missouri are the recipients of substantial annual
dollar volumes of defense contract awards. The contractor receiving the second
largest dollar volume of defense contracts in the United States in 1995 was
McDonnell Douglas Corporation which lost the number one position it held in 1994
by reason of the merger of the Lockheed and Martin Companies. McDonnell Douglas
Corporation is the State's largest employer, currently employing approximately
20,000 employees in Missouri. Recent changes in the levels of military
appropriations and the cancellation of the A-12 program has affected McDonnell
Douglas Corporation in Missouri and over the last four years it has reduced its
Missouri work force by approximately 30%. There can be no assurances that there
will 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. On December 15,
1996, The Boeing Company and McDonnell Douglass Corporation announced that The
Boeing Company planned to acquire McDonnell Douglas Corporation. It is
impossible to determine what effect, if any, completion of the acquisition will
have on the operations of McDonnell Douglas Corporation. However, any shift or
loss of production now conducted in Missouri would have a negative impact on the
economy of the state and particularly the economy of the St. Louis metropolitan
area.
OTHER FACTORS
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, court orders are unpredictable, and school district
spending patterns have proven difficult to predict. A recent Supreme Court
decision favorable to the State may decrease the level of State funding required
in the future, but the impact of this decision is uncertain. The State paid $282
million for desegregation costs in fiscal 1994, $315 million for fiscal 1995 and
$274 million for fiscal 1996. This expense accounted for close to 7% of total
state General Revenue Fund spending in fiscal 1994 and 1995, and close to 5% in
fiscal 1996.
KEYSTONE NEW YORK TAX FREE FUND
As described in the prospectus, the New York Fund will generally invest in
New York municipal obligations. The New York Fund is therefore susceptible to
political, economical, or regulatory factors affecting New York State and
governmental bodies within New York State. Some of the more significant events
and conditions relating to the financial situation in New York are summarized
below. The following information provides only a brief summary of the complex
factors affecting the financial situation in New York, is derived from sources
that are generally available to investors and is believed to be accurate. It is
based on information drawn from official statements and prospectuses issued by,
and other information reported by, the State of New York by its various public
bodies, and by other entities located within the State, including the City of
New York, in connection with the issuance of their respective securities.
THE STATE
New York State (for purposes of this section of the Appendix, "the State")
historically has been one of the wealthiest states in the nation. For decades,
however, the State has grown more slowly than the nation as a whole, gradually
eroding its relative economic affluence. Statewide, urban centers have
experienced significate changes involving migration of the more affluent to the
suburbs and an influx of generally less affluent residents. Regionally, the
older Northeast cities have suffered because of the relative success that the
South and the West have had in attracting people and business. New York City
(for purposes of this section of the Appendix, "the City") has also had to face
great competition as other major cities have developed financial and business
capabilities which make them less dependent on the specialized services
traditionally available almost exclusively in the City.
During the 1982-83 recession, overall economic activity in the State
declined less than that of the nation as a whole. However, in calendar years
1984 through 1991, the State's rate of economic expansion was somewhat slower
than that of the nation. In the 1990-91 recession, the economy of the State, and
that of the rest of the Northeast, was more heavily damaged than that of the
nation as a whole and has been slower to recover. The total employment growth
rate in the State has been below the national average since 1984. The
unemployment rate in the State dipped below the national rate in the second half
of 1981 and remained lower until 1991; since then, it has been higher. According
to data published by the U.S. Bureau of Economic Analysis, during the past ten
years, total personal income in the State rose slightly faster than the national
average only from 1986 through 1988.
Between 1975 and 1990 total employment grew by 21.3 percent while the labor
force grew only by 15.7 percent, unemployment fell from 9.5 percent to 5.2
percent of the labor force. In 1991 and 1992, however, total employment in the
State fell by 457,000, or 5.5 percent. As a result, the unemployment rate rose
to 8.5 percent, reflecting a recession that has had a particularly strong impact
on the entire Northeast. Calendar years 1993 and 1994 saw only a partial
recovery.
Although the State ranks 22nd in the nation for its state tax burden, the
State has the second highest combined state and local tax burden in the United
States. The burden of State and local taxation, in combination with the many
other causes of regional economic dislocation, may have contributed to the
decisions of some businesses and individuals to relocate outside, or not locate
within, the State. To stimulate economic growth, the State has developed
programs, including the provision of direct financial assistance, designed to
assist businesses to expand existing operations located within the State and to
attract new businesses to the State. In addition, the State has provided various
tax incentives to encourage business relocation and expansion.
The 1995-96 budget reflected significant actions to reduce the burden of
State taxation, including adoption of a 3-year, 20 percent reduction in the
State's personal income tax and a variety of more modest changes in other
levies. In combination with business tax reductions enacted in 1994, these
actions will reduce State taxes by over $5.5 billion by the 1997-98 fiscal year,
when compared to the estimated yield in that year of the State tax structure as
it applied in 1993-94.
In recent years, State actions affecting the level of receipts and
disbursements, as well as the relative strength of the State and regional
economy, actions of the Federal government and other factors, have created
structural budget gaps for the State. These gaps resulted from a significant
disparity between recurring revenues and the costs of maintaining or increasing
the level of support for State programs. The 1995-96 enacted budget combined
significant tax and program reductions which will, in the current and future
years, lower both the recurring receipts base (before the effect of any economic
stimulus from such tax reductions) and the historical annual growth in State
program spending. Notwithstanding these changes, the State can expect to
continue to confront structural deficits in future years.
1997-98 FISCAL YEAR (EXECUTIVE BUDGET FORECAST)
The governor presented his 1997-98 Executive Budget to the Legislature on
January 14, 1997. The Executive Budget also contains financial projections for
the State's 1998-99 and 1999-2000 fiscal years, detailed estimates of receipts
and an updated Capital Plan. There can be no assurance that the Legislature will
enact the Executive Budget as proposed by the Governor into law, or that the
State's adopted budget projections will not differ materially and adversely from
the projections as set forth in the Update.
The 1997-98 Financial Plan projects balance on a cash basis in the General
Fund. It reflects a continuing strategy of substantially reduced State spending,
including program restructurings, reductions in social welfare spending, and
efficiency and productivity initiatives. Total General Fund receipts and
transfers to other funds are projected to be $32.88 billion, a decrease of $88
million from total receipts projected in the current fiscal year. Total General
Fund disbursements and transfers to other funds are projected to be $32.84
billion, a decrease of $56 million from spending totals projected for the
current fiscal year. As compared to the 1996-97 State Financial Plan, the
Executive Budget proposes a year-to-year decline in General Fund spending of 0.2
percent. State funds spending (i.e., General Fund plus other dedicated funds
with the exception of federal aid) is projected to grow by 1.2 percent. Spending
from All Governmental Funds (excluding transfers) is proposed to increase by 2.2
percent from the prior fiscal year.
The Executive Budget proposes $2.3 billion in actions to balance the
1997-98 Financial Plan. Before reflecting any actions proposed by the Governor
to restrain spending, General Fund disbursements for 1997-98 were projected to
grow by approximately 4 percent. This increase would have resulted from growth
in Medicaid, higher fixed costs such as pensions and debt service, collective
bargaining agreements, inflation, and the loss of non-recurring resources that
offset spending in 1996-97. General Fund receipts were projected to fall by
roughly 3 percent. This reduction would have been attributable to modest growth
in the State's economy and underlying tax base, the loss of non-recurring
revenues available in 1996-97 and implementation of previously enacted tax
reduction programs
The Executive Budget proposes to close this gap primarily though a series
of spending reductions and Medicaid cost containment measures, the use of a
portion of the 1996-97 projected budget surplus,and other actions. The 1997-98
Financial Plan projects receipts of the $32.88 billion and spending of $32.84
billion, allowing for a deposit of $24 million into the CRF and a year-ending
CRF reserve of $65 million, and a required repayment of $15 million to the TSRF.
Detailed explanations of the 1997-98 Financial Plan follow a discussion of the
economic outlook.
ECONOMIC OUTLOOK
U.S. Economy
The State has updated its mid-year forecast of national and State economic
activity through the end of calendar year 1998. The current projection is for
slightly slower growth than expected in the MidYear Update. The revised forecast
projects real Domestic Gross National Product (GDP) growth of 2.3 percent in
1997, which is the same rate now estimated for 1996, followed by a 2.4 percent
increase in 1998. The growth of nominal GDP is expected to rise from 4.3 percent
in 1996 to 4.5 percent in 1997 and 4.8 percent in 1998. The inflation rate is
expected to remain stable at 2.9 percent in 1997 and decrease to 2.8 percent in
1998. The annual rate of job growth is expected to slow to 1.6 percent in both
1997 and 1998, down from the 2.0 percent increase in 1996. Growth in personal
income and wages are expected to slow accordingly in 1997 and 1998.
State Economy
The State economic forecast has been changed only slightly from the one
formulated with the Mid-Year Update. Moderate growth is projected to continue in
1997 for employment, wages, and personal income, followed by a slight slowing in
1998. Personal income is estimated to have grown by 5.2 percent in 1996, fueled
in part by an unusually large increase in financial sector bonus payments, and
is projected to grow 4.5 percent in 1997 and 4.2 percent in 1998. Overall
employment growth will continue at a modest rate, reflecting the moderate growth
of the national economy, continued spending restraint in government, and
restructuring in the health care, social service, and banking sectors.
1996-97 FISCAL YEAR
The State is required to issue Financial Plan updates to the cash-basis
State Financial Plan in July, October, and January, respectively. These
quarterly updates reflect analysis of actual receipts and disbursements for each
respective period, and revise estimates of receipts and disbursements for the
then current fiscal year. The First Quarter Update was incorporated into the
cash-basis State Financial Plan of July 25, 1996.
The State issued its first update to the cash-basis 1996-97 State Financial
Plan (the "Mid-Year Update") on October 25, 1996. Revisions have been made to
estimates of both receipts and disbursements based on: (1) updated economic
forecasts for both the nation and the State, (2) an analysis of actual receipts
and disbursements through the first six months of the fiscal year, and (3) an
assessment of changing program requirements. The Mid-Year Update reflects a
balanced 1996=97 State Financial Plan, and a projected reserve in the General
Fund of $300 million.
The State also updated its forecast of national and State economic activity
through the end of calendar year 1997 to reflect the stronger-than-expected
growth in the first half of 1996. The national economic forecast has been
changed slightly from the initial forecast on which the original 1996-97 State
Financial Plan was based. The revised forecast projects real Gross Domestic
Product growth in the nation of 2.5 percent for 1996 and 2.4 percent in 1997.
The inflation rate is expected to be 3.0 percent in 1996 and 2.9 percent in
1997. The annual rate of job growth is expected to slow gradually to about 1.8
percent in 1997, down from 2.2 percent in 1996. Growth in personal income and
wages are expected to slow accordingly.
The State economic forecast haws been changed slightly from the one
formulated with the July 1996-97 State Financial Plan. Moderate growth is
projected to continue through the second half of 1996, with employment wages and
incomes continuing their modest rise. Personal income is projected to increase
by 5.2 percent in 1996 and 4.7 percent in 1997, reflecting robust projected wage
growth fueled in part by financial sector bonus payments. Overall employment
growth will continue at a modest rate, reflecting the slowdown in the national
economy, continued spending restraint in government, and restructuring in the
health care and financial sectors.
Actual receipts thought the first two quarters of the 1996-97 State fiscal
year reflected strongerthan-expected growth in most taxes, with actual receipts
exceeding expectations by $250 million. Based on the revised economic outlook
and actual receipts for the first six months of 1996-97, projected General Fund
receipts for the 1996-97 State fiscal years were increased by $420 million. Most
of this projected increase was in the yield of the personal income tax ($241
million), with additional increases expected in business taxes ($124 million)
and other tax receipts ($49 million). Projected collections from user taxes and
fees were revised downward slightly ($5 million). Revisions were also made to
both miscellaneous receipts and in transfers from other funds (an $11 million
combined projected increase).
The 1996-97 General Fund Financial Plan continues to be balanced. The
Division of the Budget projects that, prior to taking the actions described
below, the General Fund Financial Plan would have shown an operating surplus or
approximately $1.3 billion. These actions include implementing reduced personal
income tax withholding to reflect the impact of tax reduction actions which took
effect on January 1, 1997. This has the effect of raising taxpayer's current
take-home pay rather than requiring taxpayers to wait until the spring of 1998
for larger refunds. The Financial Plan assumes the use of $250 million for this
purpose. In addition, $943 million is projected to be used to pay tax refunds
during the 1996-97 fiscal year or reserved to pay refunds during the 1997-98
fiscal year, which produces a benefit for the 1997-98 Financial Plan. Finally,
$65 million is projected to be deposited into the TSRF (in addition to the
required deposit of $15 million), increasing the cash balance in that fund to
$317 million by the end of 1996-97.
Projected General Fund disbursements are reduced by a total of $348 million
from the Mid-Year Update, with changes made in most categories of the Financial
Plan. Most of this savings is attributable to reductions in local assistance
spending, primarily due to significant reestimates in social services spending
to reflect lower case load growth, yielding savings of $226 million. General
State Charges are reduced $76 million to reflect lower pension and fringe
benefit costs. The General State Charges estimate includes savings achieved from
the refinancing of certain pension liabilities through the issuance of long-term
debt as planned, and the payment of that liability to the State Retirement
System. Transfers for the Capital Projects Fund have been reduced $31 million to
reflect slower-than-expected capital disbursements for the balance of the fiscal
year. Reductions in debt service costs of $21 million reflect savings from
refundings undertaken in the current fiscal year, as well as savings from
improved interest rates in the financial markets.
The General Fund closing balance is expected to be $358 million at the end
of 1996-97. Of this amount, $317 million would be on deposit in the TSRF, while
another $41 million would remain on deposit in the CRF as a reserve for
litigation or other unbudgeted costs to the Financial Plan. The TSRF had an
opening balance of $237 million, to be supplemented by a required payment of $15
million and an extraordinary deposit of $645 million from surplus 1996-97
monies. The $9 million on deposit in the Review Accumulation fund will be drawn
down as planned. A planned deposit if $85 million to the CRF, projected to be
received from contractual efforts to maximize federal revenue, is no longer
expected to be deposited this year.
1995-96 FISCAL YEAR
The State's budget for the 1995-96 fiscal year was enacted by the
Legislature on June 7, 1995, more than two months after the start of the fiscal
year. Prior to adoption of the budget, the Legislature enacted appropriations
for disbursements considered to be necessary for State operations and other
purposes, including all necessary appropriations for debt service. The State
Financial Plan for the 1995- 96 fiscal year was formulated on June 20, 1995 and
was based on the State's budget as enacted by the Legislature and signed into
law by the Governor. The State Financial Plan is updated quarterly pursuant to
law in July, October and January.
The 1995-96 budget was the first to be enacted in the administration of the
Governor, who assumed office on January 1, 1995. It was the first budget in over
half a century which proposed and, as enacted, projected an absolute
year-over-year decline in General Fund disbursements. Spending for State
operations was projected to drop even more sharply, by 4.6 percent. Nominal
spending from all State funding sources (I.E., excluding Federal aid) was
proposed to increase by only 2.5 percent from the prior fiscal year, in contrast
to the prior decade when such spending growth averaged more than 6.0 percent
annually.
In his Executive Budget, the Governor indicated that in the 1995-96 fiscal
year, the State Financial Plan, based on then-current law governing spending and
revenues, would be out of balance by almost $4.7 billion, as a result of the
projected structural deficit resulting from the ongoing disparity between
sluggish growth in receipts, the effect of prior-year tax changes, and the rapid
acceleration of spending growth; the impact of unfunded 1994-95 initiatives,
primarily for local aid programs; and the use of one-time solutions, primarily
surplus funds from the prior year, to fund recurring spending in the 1994-95
budget. The Governor proposed additional tax cuts, to spur economic growth and
provide relief for low and middle-income taxpayers, which were larger than those
ultimately adopted, and which added $240 million to the then projected imbalance
or budget gap, bringing the total to approximately $5 billion.
This gap was projected to be closed in the 1995-96 State Financial Plan
based on the enacted budget, through a series of actions, mainly spending
reductions and cost containment measures and certain reestimates that are
expected to be recurring, but also through the use of one-time solutions. The
State Financial Plan projected (I) nearly $1.6 billion in savings from cost
containment, disbursement reestimates, and other savings in social welfare
programs, including Medicaid, income maintenance and various child and family
care programs; (ii) $2.2 billion in savings from State agency actions to reduce
spending on the State workforce, SUNY and CUNY, mental hygiene programs, capital
projects, the prison system and fringe benefits; (iii) $300 million in savings
from local assistance reforms, including actions affecting school aid and
revenue sharing while proposing program legislation to provide relief from
certain mandates that increase local spending; (iv) over $400 million in revenue
measures, primarily a new Quick Draw Lottery game, changes to tax payment
schedules, and the sale of assets; and (v) $300 million from reestimates in
receipts.
There are risks and uncertainties concerning the future-year impact of tax
reductions and other measures in the 1995-96 budget.
The 1995-96 State Financial Plan included actions that will have an effect
on the budget outlook for State fiscal year 1996-97 and beyond. The DOB
estimated that the 1995-96 State Financial Plan contains actions that provide
nonrecurring resources or savings totaling approximately $900 million. These
included the use of balances set aside originally for mass transportation aid
($220 million), the use of a reserve established to fund pension supplementation
cost ($110 million) and the use of lottery balances ($62 million) The
Comptroller believed that the amount of nonrecurring resources or savings
exceeds $1.0 billion. The DOB also estimates that the 1995-96 State Financial
Plan contained nonrecurring expenditures totaling nearly $250 million. These
include the payment of social services litigation ($65 million), the deposit to
the Contingency Reserve Fund ($40 million), the payment of 1993- 94 pension
charges ($56 million) and aid for maintenance costs of local schools ($45
million). The net amount of nonrecurring resources used in the 1995-96 State
Financial Plan, accordingly, was estimated by the DOB at over $600 million.
In addition to this use of nonrecurring resources, the 1995-96 State
Financial Plan reflected actions that will directly affect the State' 1996-97
fiscal year baseline receipts and disbursements. The three-year plan to reduce
State personal income taxes will decrease State tax receipts by an estimated
$1.7 billion in State fiscal year 1996-97, in addition to the amount of
reduction in State fiscal year 1995- 96. Further significant reductions in the
personal income tax are scheduled for the 1997-98 State fiscal year. Other tax
reductions enacted in 1994 and 1995 are estimated to cause an additional
reduction in receipts of over $500 million in 1996-97, as compared to the level
of receipts in 1995-96. Similarly, many actions taken to reduce disbursements in
the State's 1995-96 fiscal year are expected to provide greater reductions in
State fiscal year 1996-97. These include actions to reduce the State workforce,
reduce Medicaid and welfare expenditures and slow community mental hygiene
program development. The net impact of these factors is expected to produce a
potential imbalance in receipts and disbursements in State fiscal year 1996-97
As part of the early release of the 1996-97 Executive Budget, the State
updated its 1995-96 cash-basis State Financial Plan (the "Financial Plan
Update") on December 15, 1995, as a part of the Governor's Executive Budget
presentation.
The State updated its forecast of national and State economic activity
through the end of calendar year 1996. The national economic forecast remained
basically unchanged from the initial forecast on which the original 1995-96
State Financial Plan was based, while the State economic forecast was marginally
weaker.
Actual receipts through the first two quarters of the 1995-96 State fiscal
year fell short of expectations by $101 million. Much of this shortfall was due
to timing-related delays in sources other than taxes. Based on the revised
economic outlook and actual receipts for the first six months of 1995- 96,
projected General Fund receipts for the 1995-96 State fiscal year were reduced
by $73 million, offset by $2 million in increased revenues and transfers
associated with actions taken in the Management Review Plan. Actual
disbursements through the first six months of the fiscal year were $89 million
less than projected, primarily because of delays in processing payments
following delayed enactment of the State budget. No savings were included in the
Mid-Year Update from this slower-than-expected spending. Projected disbursements
for the 1995-96 State fiscal year were reduced by $30 million because spending
increases in local assistance and State operations was more than offset by debt
service savings and the reductions from the Management Review Plan.
The 1995-96 General Fund Financial Plan continued to be balanced, with
reductions in projected receipts offset by an equivalent reduction in projected
disbursements. Modest changes were made to the Mid-Year Update, reflecting two
more months of actual results, deficiency requests by State agencies (the
largest of which is for school aid resulting from revisions to data submitted by
school districts), and administrative efficiencies achieved by State agencies.
Total General Fund receipts are expected to be approximately $73 million lower
than estimated at the time of the Mid-Year Update. Tax receipts were projected
to be $29.57 billion, $8 million less than in the earlier plan. Miscellaneous
receipts and transfers from other funds were estimated at $3.15 billion, $65
million lower than in the Mid-Year Update. The largest single change in these
estimates is attributable to the lag in achieving $50 million in proceeds from
sales of State assets, which are unlikely to be completed prior to the end of
the fiscal year.
Projected General Fund disbursements were reduced by a total of $73
million, with changes made in most major categories of the 1995-96 State
Financial Plan. The reduction in overall spending masks the impact of deficiency
requests totaling more than $140 million, primarily for school aid and tuition
assistance to college students. Offsetting reductions in spending are
attributable to the continued maintenance of strict controls on spending through
the fiscal year by State agencies, yielding savings of $50 million. Reductions
of $49 million in support for capital projects reflect a stringent review of all
capital spending. Reductions of $30 million in debt service costs reflect
savings from refundings undertaken in the current fiscal year, as well as
savings from lower interest rates in the financial market. Finally, the 1995-96
Financial Plan reflected reestimates based on actual results through November,
the largest of which is a reduction of $70 million in projected costs for income
maintenance. This reduction is consistent with declining caseload projections.
The balance in the General Fund at the close of the 1995-96 fiscal year was
expected to be $172 million, entirely attributable to monies in the Tax
Stabilization Reserve Fund following the required $15 million payment into that
Fund. A $40 million deposit to the Contingency Reserve Fund included as part of
the enacted 1995-96 budget will not be made, and the minor balance of $1 million
currently in the Fund will be transferred to the General Fund. These Contingency
Reserve Fund monies are expected to support payments from the General Fund for
litigation related to the State's Medicaid program, and for federal
disallowances.
Changes in federal aid programs currently pending in Congress were not
expected to have a material impact on the State's 1995-96 Financial Plan,
although prolonged interruptions in the receipt of federal grants could create
adverse developments, the scope of which can not be estimated at this time. The
major remaining uncertainties in the 1995-96 State Financial Plan continue to be
those related to the economy and tax collections, which could produce either
favorable or unfavorable variances during the balance of the year.
PAST YEARS
New York State's financial operations have improved during recent fiscal
years. During the period 1989-90 through 1991-92, the State incurred General
Fund operating deficits that were closed with receipts from the issuance of tax
and revenue anticipation notes ("TRANs"). First, the national recession, and
then the lingering economic slowdown in the New York and regional economy,
resulted in repeated shortfalls in receipts and three budget deficits. For its
1992-93, 1993-94 and 1994-95 fiscal years, the State recorded balanced budgets
on a cash basis, with substantial fund balances in 1992-93 and 1993-94, and a
smaller fund balance in 1994-95 as described below.
1994-95 FISCAL YEAR
New York State ended its 1994-95 fiscal year with the General Fund in
balance. The closing fund balance of $158 million reflects $157 million in the
Tax Stabilization Reserve Fund and $1 million in the Contingency Reserve Fund
("CRF"). The CRF was established in State fiscal year 1993-94, funded partly
with surplus moneys, to assist the State in financing the 1994-95 fiscal year
costs of extraordinary litigation known or anticipated at that time; the opening
fund balance in State fiscal year 1994-95 was $265 million. The $241 million
change in the fund balance reflects the use of $264 million in the CRF as
planned, as well as the required deposit of $23 million to the Tax Stabilization
Reserve Fund. In addition, $278 million was on deposit in the tax refund reserve
account, $250 million of which was deposited at the end of the State's 1994-95
fiscal year to continue the process of restructuring the State's cash flow as
part of the Local Governmental Assistance Corporation ("LGAC") program.
Compared to the State Financial Plan for 1994-95 as formulated on June 16,
1994, reported receipts fell short of original projections by $1.163 billion,
primarily in the categories of personal income and business taxes. Of this
amount, the personal income tax accounts for $800 million, reflecting weak
estimated tax collections and lower withholding due to reduced wage and salary
growth, more severe reductions in brokerage industry bonuses than projected
earlier, and deferral of capital gains realizations in anticipation of potential
Federal tax changes. Business taxes fell short by $373 million, primarily
reflecting lower payments from banks as substantial overpayments of 1993
liability depressed net collections in 1994-95 fiscal year. These shortfalls
were offset by better performance in the remaining taxes, particularly the user
taxes and fees, which exceeded projections by $210 million. Of this amount, $227
million was attributable to certain restatements for accounting treatment
purposes pertaining to the CRF and LGAC; these restatements had no impact on
balance in the General Fund.
Disbursements were also reduced from original projections by $848 million.
After adjusting for the net impact of restatements relating to the CRF and LGAC
which raised disbursements by $38 million, the variance is $886 million. Well
over two-thirds of this variance is in the category of grants to local
governments, primarily reflecting the conservative nature of the original
estimates of projected costs for social services and other programs. Lower
education costs are attributable to the availability of $110 million in
additional lottery proceeds and the use of LGAC bond proceeds.
The spending reductions also reflect $188 million in actions initiated in
January 1995 by the Governor to reduce spending to avert a potential gap in the
1994-95 State Financial Plan. These actions included savings from a hiring
freeze, halting the development of certain services, and the suspension of
non-essential capital projects. These actions, together with $71 million in
other measures comprised the Governor's $159 million gap-closing plan, submitted
to the Legislature in connection with the 1995- 96 Executive Budget.
1993-94 FISCAL YEAR
The State ended its 1993-94 fiscal year with a balance of $1.140 billion in
the tax refund reserve account, $265 million in the CRF and $134 million in its
Tax Stabilization Reserve Fund. These fund balances were primarily the result of
an improving national economy, State employment growth, tax collections that
exceeded earlier projections and disbursements that were below expectations.
Deposits to the personal income tax refund reserve have the effect of reducing
reported personal income tax receipts in the fiscal year when made and
withdrawals from such reserve increase receipts in the fiscal year when made.
The balance in the tax refund reserve account was used to pay taxpayer refunds.
Of the $1.140 billion deposited in the tax refund reserve account, $1.026
billion was available for budgetary planning purposes in the 1994-95 fiscal
year. The remaining $114 million was redeposited in the tax refund reserve
account at the end of the State's 1993-94 fiscal year to continue the process of
restructuring the State's cash flow as part of the LGAC program. The balance in
the CRF was reserved to meet the cost of litigation facing the State in its
1994-95 fiscal year.
Before the deposit of $1.140 billion in the tax refund reserve account,
General Fund receipts in 1993-94 exceeded those originally projected when the
State Financial Plan for that year was formulated on April 16, 1993 by $1.002
billion. Greater-than-expected receipts in the personal income tax, the bank
tax, the corporation franchise tax and the estate tax accounted for most of this
variance, and more than offset weaker-than-projected collections from the sales
and use tax and miscellaneous receipts. Collections from individual taxes were
affected by various factors including changes in Federal business laws,
sustained profitability of banks, strong performance of securities firms, and
higher-than-expected consumption of tobacco products following price cuts.
The higher receipts resulted, in part, because the New York economy
performed better than forecasted. Employment growth started in the first quarter
of the State's 1993-94 fiscal year, and, although this lagged behind the
national economic recovery, the growth in New York began earlier than
forecasted. The New York economy exhibited signs of strength in the service
sector, in construction, and in trade. Long Island and the Mid-Hudson Valley
continued to lag behind the rest of the State in economic growth. The DOB
believes that approximately 100,000 jobs were added during the 1993-94 fiscal
year.
Disbursements and transfers from the General Fund were $303 million below
the level projected in April 1993, an amount that would have been $423 million
had the State not accelerated the payment of Medicaid billings, which in the
April 1993 State Financial Plan were planned to be deferred into the 1994-95
fiscal year. Compared to the estimates included in the State Financial Plan
formulated in April 1993, lower disbursements resulted form lower spending for
Medicaid, capital projects, and debt service (due to refundings) and $114
million used to restructure the State's cash flow as part of the LGAC program.
Disbursements were higher than expected for general support for public schools,
the State share of income maintenance, overtime for prison guards, and highway
snow and ice removal. The State also made the first of six required payments to
the State of Delaware related to the settlement of Delaware's litigation against
the State regarding the disposition of abandoned property receipts.
During the 1993-94 fiscal year, the State also established and funded the
CRF as a way to assist the State in financing the cost of litigation affecting
the State. The CRF was initially funded with a transfer of $100 million
attributable to the positive margin recorded in the 1992-93 fiscal year. In
addition, the State augmented this initial deposit with $132 million in debt
service savings attributable to the refinancing of State and public authority
bonds during 1993-94. A year-end transfer of $36 million was also made to the
CRF, which, after a disbursement for authorized fund purposes, brought the CRF
balance a the end of 1993-94 to $265 million. This amount was $165 million
higher than the amount originally targeted for this reserve fund.
1992-93 FISCAL YEAR
The State ended its 1992-93 fiscal year with a balance of $671 million in
the tax refund reserve account and $67 million in the Tax Stabilization Reserve
Fund.
The State's 1992-93 fiscal year was characterized by performance that was
better than projected for the national and regional economies. National gross
domestic product, State personal income, and State employment and unemployment
performed better than originally projected in April 1992. This favorable
economic performance, particularly at year end, combined with a tax-induced
acceleration of income into 1992, was the primary cause of the General Fund
surplus. Personal income tax collections were more than $700 million higher than
originally projected (before reflecting the tax refund reserve account
transaction), primarily in the withholding and estimated payment components of
the tax.
There were large, but mainly offsetting, variances in other categories of
receipts. Significantly higher-than-projected business tax collections and the
receipt of unbudgeted payments from the Medical Malpractice Insurance
Association ("MMIA") and the New York Racing Association approximately offset
the loss of an anticipated $200 million Federal reimbursement, the loss of
certain budgeted hospital differential revenue as a result of unfavorable court
decisions, and shortfalls in certain miscellaneous revenues.
Disbursements and transfers to other funds were $45 million above
projections in April 1992, although this includes a $150 million payment to
health insurers (financed with a receipt from the MMIA made pursuant to
legislation passed in January 1992). All other disbursements were $105 million
lower than projected. This reduction primarily reflected lower costs in
virtually all categories of spending, including Medicaid, local health programs,
agency operations, fringe benefits, capital projects and debt service as
partially offset by higher-than-anticipated costs for education programs.
LOCAL GOVERNMENT ASSISTANCE CORPORATION
In 1990, as part of a State fiscal reform program, legislation was enacted
creating LGAC, a public benefit corporation empowered to issue long-term
obligations to fund certain payments to local governments traditionally funded
through the State's annual seasonal borrowing. The legislation authorized LGAC
to issue its bonds and notes in an amount not in excess of $4.7 billion
(exclusive of certain refunding bonds) plus certain other amounts. Over a period
of years, the issuance of these long-term obligations, which are to be amortized
over no more than 30 years, was expected to eliminate the need for continued
short-term seasonal borrowing. The legislation also dedicated revenues equal to
one-quarter of the four cent State sales and use tax to pay debt service on
these bonds. The legislation also imposed a cap on the annual seasonal borrowing
of the State at $4.7 billion, less net proceeds of bonds issued by LGAC and
bonds issued to provide for capitalized interest, except as cases where the
Governor and the legislative leaders have certified the need for additional
borrowing and provided a schedule for reducing it to the cap. If borrowing above
the cap is thus permitted in any fiscal year, it is required by law to be
reduced to the cap by the fourth fiscal year after the limit was first exceeded.
This provision capping the seasonal borrowing was included as a covenant with
LGAC's bondholders in the resolution authorizing such bonds.
As of June 1995, LGAC had issued bonds and notes to provide net proceeds of
$4.7 billion, completing the program. The impact of LGAC's borrowing is that the
State is able to meet its cash flow needs in the first quarter of the fiscal
year without relying on short-term seasonal borrowings. The 1995- 96 State
Financial Plan includes no spring borrowing nor did the 1994-95 State Financial
Plan, which was the first time in 35 years there was no short-term seasonal
borrowing. This reflects the success of the LGAC program in permitting the State
to accelerate local aid payments form the first quarter of the current fiscal
year to the fourth quarter of the previous fiscal year.
In June 1994, the Legislature passed a proposed constitutional amendment
that would significantly change the long-term financing practices of the State
and its public authorities. The proposed amendment would permit the State,
within a formula-based cap, to issue revenue bonds, which would be debt of the
State secured solely by a pledge of certain State tax receipts (including those
allocated to State funds dedicated for transportation purposes), and not by the
full faith and credit of the State. In addition, the proposed constitutional
amendment would (i) permit multiple purpose general obligation bond proposals to
be proposed on the same ballot, (ii) require that State debt be incurred only
for capital projects included in a multi-year capital financing plan, and (iii)
prohibit, after its effective date, lease-purchase and contractual-obligation
financings mechanisms for State facilities.
The State anticipates that its capital programs will be financed, in part,
through borrowings by the State and public authorities in the 1995-96 fiscal
year. The State expects to issue $248 million in general obligation bonds
(including $70 million for purposes of redeeming outstanding BANs) and $186
million in general obligation commercial paper. The Legislature has also
authorized the issuance of up to $33 million in COPs during the State's 1995-96
fiscal year for equipment purchases and $14 million for capital purposes. The
projection of the State regarding its borrowings for the 1995-96 fiscal year may
change if circumstances require.
LGAC is authorized to provide net proceeds of up to $529 million during the
State's 1995-96 fiscal year, to redeem notes sold in June 1995, completing its
financing program as discussed above.
RATINGS
On July 13, 1995, Standard & Poor's confirmed its rating on the State's
general obligation bonds of A-. On July 3, 1995 Moody's confirmed its rating on
the State's general obligation long-term indebtedness of A.
THE CITY OF NEW YORK
The fiscal health of the State is closely related to the fiscal health of
its localities, particularly the City of New York, which has required and
continues to require significant financial assistance from the State. The City
depends on State Aid both to enable the City to balance its budget and to meet
its cash requirements. The City has achieved balanced operating results for each
of its fiscal years since 1981 as reported in accordance with the
then-applicable GAAP Standards. During the 1990 and 1991 fiscal years, the City
experienced significant shortfalls in almost all of its major tax sources and
increases in social service costs, and was required to take actions to close
substantial budget gaps in order to maintain balanced budgets in accordance with
its financial plan. For fiscal 1993, the City achieved balanced operating
results.
In response to the City's financial crisis in 1975, the State took action
to assist the City in returning to fiscal stability. Among these actions, the
State created the Municipal Assistance Corporation for the City of New York
("MAC") to provide financing assistance to the City. The State also enacted the
New York State Financial Emergency Act for the City of New York ( the "Financial
Emergency Act") which, among other things, established the New York State
Financial Control Board (the "Control Board") to oversee the City's financial
affairs, the Office of the State Deputy Comptroller for New York ("OSDC") in the
Office of the State Comptroller to assist the Control Board in exercising its
powers and responsibilities, and a "Control Period" which existed from 1975 to
1986 during which the City was subject to certain statutorily-prescribed fiscal
controls. Although the Control Board terminated the Control Period in 1986 when
certain statutory conditions were met, thus suspending certain Control Board
powers, the Control Board, MAC and OSDC continue to exercise various fiscal
monitoring functions over the City, and upon the occurrence or "substantial
likelihood and imminence" of the occurrence of certain events, including, but
not limited to, a City operating budget deficit of more than $100 million, the
Control Board is required by law to reimpose a "Control Period." Currently, the
City and its "Covered Organizations" (i.e., those which receive or may receive
monies from the City directly, indirectly or contingently) operate under a
four-year financial plan which the City prepares annually and periodically
updates. The City's Financial Plan includes its capital, revenue and expense
projections and outlines proposed gap-closing programs for years with projected
budget gaps.
The City submits its financial plans as well as the periodic updates to the
Control Board for its review. In August 1993, the City submitted to the Control
Board its 1994-1997 Financial Plan. The Financial Plan projected a balanced
budget in fiscal 1994, based on revenues of approximately $31.250 billion. The
Financial Plan also predicted budget gaps of approximately $1.3 billion in
fiscal year 1995, $1.8 billion in fiscal year 1996 and $2.0 billion in fiscal
year 1997.
Estimates of the City's revenues and expenditures are based on numerous
assumptions and are subject to various uncertainties. If expected federal or
State aid are not forthcoming, if unforeseen developments in the economy
significantly reduce revenues derived from economically sensitive taxes or
necessitate increased expenditures for public assistance, if the City should
negotiate wage increases for its employees greater than the amounts provided for
in the City's Financial Plan or if other uncertainties materialize that reduce
expected revenues or increase projected expenditures, then, to avoid operating
deficits, the City may be required to implement additional actions, including
increases in taxes and reductions in essential City services. The City might
also seek additional assistance from the State.
On July 10, 1995, Standard & Poor's revised downward its rating on City
general obligation bonds from A- to BBB+ and removed City bonds from
CreditWatch. Standard & Poor's stated that "structural budgetary balance remains
elusive because of persistent softness in the City's economy, highlighted by
weak job growth and a growing dependence on the historically volatile financial
services sector." Other factors identified by Standard & Poor's in lowering its
rating on City bonds included a trend of using one-time measures, including debt
refinancings, to close projected budget gaps, dependence on unratified labor
savings to help balance the Financial Plan, optimistic projections of additional
federal and State aid or mandate relief, a history of cash flow difficulties
caused by State budget delays and continued high debt levels. Fitch Investors
Service, Inc. continues to rate City general obligation bonds A-. Moody's rating
for City general obligation bonds is Baa1.
AUTHORITIES
New York State's authorities are generally responsible for financing,
constructing and operating revenue-producing public benefit facilities. The
fiscal stability of the State is related, in part, to the fiscal stability of
its public authorities. Public authorities are not subject to the constitutional
restrictions on the inccurrence of debt which applies to the State itself and
may issue bonds and notes within the amounts permitted by, and as otherwise
restricted by, their legislative authorization. The State's access to the public
credit markets could be impaired, and the market price of its outstanding debt
may be materially adversely affected, if any of its public authorities were to
default on their respective obligations, particularly those using the financing
techniques referred to as State-supported or State-related.
As of September 30, 1994, the date of the latest data available, there were
18 public authorities that had outstanding debt of $100 million or more, and the
aggregate outstanding debt including refunding bonds, of the these 18 public
authorities was $70.3 billion.
As of March 31, 1995, aggregate public authority debt outstanding as
State-supported debt was $27.9 billion and as State-related debt was $36.1
billion.
Public authority operating expenses and debt service costs are generally
paid by revenues generated by the projects financed or operated, such as tolls
charged for the use of highways, bridges or tunnels, rentals charged for housing
units, and charges for occupancy at medical care facilities. In addition, State
legislation authorizes several financing techniques for public authorities.
Also, there are statutory arrangements providing for state local assistance
payments, otherwise payable to localities, to be made under certain
circumstances to public authorities. Although the state has no obligation to
provide additional assistance to localities whose local assistance payments have
been paid to public authorities under those arrangements if local assistance
payments are so diverted, the affected localities could seek additional state
assistance. Some authorities also received monies from state appropriations to
pay for the operating costs of certain programs.
The Metropolitan Transportation Authority (the "MTA") oversees the
operation of New York City's bus and subway systems and, through its affiliates
and subsidiaries, operates certain commuter rail and bus lines and a rapid
transit line. Through an affiliate, the MTA operates certain intrastate toll
bridges and tunnels. The MTA has depended and will continue to depend upon
Federal, State, local government and agency support to operate the mass transit
portion of these operations because fare revenues are insufficient. If current
revenue projections are not realized and/or operating expenses exceed current
projections, the MTA may be required to seek additional state assistance, raise
fares or take other actions.
Since 1980, the State has enacted several taxes that provide revenues for
mass transit purposes, including assistance to the MTA. In addition, since 1987,
State law has required that the proceeds of 1/4 of 1% of mortgage recording tax
paid on certain mortgages in the Metropolitan Transportation Region served by
the MTA be deposited in a special MTA fund for operating or capital expenses.
Further, in 1993, the State dedicated a portion of certain additional state
petroleum business tax receipts to fund operating or capital assistance to the
MTA. For the 1995-1996 State Fiscal Year, total state assistance to the MTA is
estimated at approximately $1.1 billion.
In 1993, State legislation authorized the funding of a 5-year $9.56 billion
MTA Capital Plan for the 5-year period, 1993 through 1996 (the "1992-1996
Capital Program"). The MTA has received approval of the 1992-1996 Capital
Program based on this legislation from the MTA Capital Program Review Board, as
state law requires. This is the third 5-year plan since the legislature
authorized procedures for the adoption, approval and amendment of a 5-year plan
in 1981 for a capital program designed to upgrade the performance of the MTA's
transportation system and to supplement, replace and rehabilitate facilities and
equipment. The MTA and its affiliates are collectively authorized to issue an
aggregate of $3.1 billion of bonds (net of certain statutory exclusion) to
finance a portion of the 1992- 1996 Capital Program.
There can be no assurance that all the necessary governmental actions for
the 1992-1996 Capital Program or future capital programs will be taken, that
funding sources currently identified will not be decreased or eliminated, or
that the 1992-1996 Capital Program, or parts thereof, will not be delayed or
reduced. If the Capital Program is delayed or reduced, ridership and fair
revenues may decline, which could, among other things, impair the MTA's ability
to meet its operating expenses without additional state assistance.
AGENCIES AND LOCALITIES
Certain localities in addition to New York City could have financial
problems leading to requests for additional State assistance during the State's
1995-1996 fiscal year and thereafter. The potential impact on the State of such
requests by localities is not included in the projections of the State receipts
and disbursements in the State's 1995-1996 fiscal year.
Fiscal difficulties experienced by the City of Yonkers ("Yonkers") resulted
in the creation of the Financial Control Board of the City of Yonkers (the
"Yonkers Board") by the State in 1984. The Yonkers Board is charged with
oversight of the fiscal affairs of Yonkers. Future actions taken by the State to
assist Yonkers could result in allocation of State resources in amounts that
cannot yet be determined.
Municipalities and school districts have engaged in substantial short term
and long term borrowing. In 1993, the total indebtedness of all localities in
the State other than New York City was approximately $17.7 billion. A small
portion of this indebtedness represented borrowing to finance budgetary deficits
and was issued pursuant to enabling State legislation. State law requires the
Comptroller to review and make recommendations concerning the budgets of these
local government units other than New York City authorized by State law to issue
debt to finance deficits during the period that such deficit financing is
outstanding. Fifteen localities had outstanding indebtedness for deficit
financing at the close of their fiscal year ending 1993.
From time to time, Federal expenditure reductions could reduce, or in some
cases eliminate, Federal funding of some local programs and accordingly might
impose substantial increased expenditure requirements on affected localities. If
the State, New York City or any of the Authorities were to suffer serious
financial difficulties jeopardizing their respective access to the public credit
markets, the marketability of notes and bonds issued by localities within the
State could be adversely affected. Localities face anticipated and potential
problems resulting from certain pending litigation, judicial decisions, and
long-range economic trends. Long range potential problems of declining urban
population, increasing expenditures and other economic trends could adversely
affect localities and require increasing State assistance in the future.
LITIGATION
Certain litigation pending against the State or its officers or employees
could affect adversely the financial condition of the State in the 1995-1996
fiscal year or thereafter. Adverse developments in these proceedings or the
initiation of new proceedings could affect the ability of the State to maintain
a balanced 1995-1996 State Financial Plan. The State believes that the 1995-1996
State Financial Plan includes sufficient reserves for the payment of judgments
that may be required during the 1995-1996 fiscal year. There can be no
assurance, however, that an adverse decision in any of these proceedings would
not exceed the amount of the 1995-1996 State Financial Plan reserves for the
payment of judgments and, thereby, affect the ability of the State to maintain a
balanced 1995-1996 State Financial Plan. Among the more significant of these
cases are those that involve: (1) the validity of agreements and treaties by
which various Indian tribes transferred title to the state of certain land in
central and upstate New York; (2) certain aspects of the State's Medicaid rates
and regulations; (3) treatment provided at several state mental health
facilities; (4)alleged responsibility of State officials to assist in remedying
racial segregation in the City of Yonkers;(5) the validity of certain surchages
on hospital bills and (6) the assessment of petroleum business taxes on fuel
purchased out of state.
KEYSTONE PENNSYLVANIA TAX FREE FUND
GENERAL
The Commonwealth of Pennsylvania, the fifth most populous state,
historically has been identified as a heavy industry state, although that
reputation has changed with the decline of the coal, steel and railroad
industries and the resulting diversification of the Commonwealth's industrial
composition. The major new sources of growth are in the service sector,
including trade, medical and health services, educational and financial
institutions. Manufacturing has fallen behind in both the service sector and the
trade sector as a source of employment in Pennsylvania. The Commonwealth is the
headquarters for 58 major corporations. Pennsylvania's average annual
unemployment rate for the years 1990 has generally not been more than one
percent greater or lesser than the nation's annual average unemployment rate.
The seasonally adjusted unemployment rate for Pennsylvania for March, 1997 was
5.1% and for the United States for March, 1997 was 5.2%. The population of
Pennsylvania, 12,056 million people in 1996 according to the U.S. Bureau of the
Census, represents an increase from the 1987 estimate of 11,811 million. Per
capita income in Pennsylvania for 1995 of $23,558 was higher than the per capita
income of the United States of $23,208. . The Commonwealth's General Fund, which
receives all tax receipts and most other revenues and through which debt service
on all general obligations of the Commonwealth are made, closed fiscal years
ended June 30, 1994, June 30, 1995 and June 30, 1996 with positive fund balances
of $892,940, $688,304 and $635,182, respectively.
DEBT
The Commonwealth may incur debt to rehabilitate areas affected by disaster,
debt approved by the electorate, debt for certain capital projects (for projects
such as highways, public improvements, transportation assistance, flood control,
redevelopment assistance, site development and industrial development) and tax
anticipation debt payable in the fiscal year of issuance. The Commonwealth had
outstanding general obligation debt of $5,054 million at June 30, 1996. The
Commonwealth is not permitted to fund deficits between fiscal years with any
form of debt. All year-end deficit balances must be funded within the succeeding
fiscal year's budget. At March 11, 1997, all outstanding general obligation
bonds of the Commonwealth were rated AA- by Standard & Poor's Corporation and
A-1 by Moody's Investors Service, Inc. (see Appendix A). There can be no
assurance that these ratings will remain in effect in the future. Over the
five-year period ending June 30, 2001, the Commonwealth has projected that it
will issue notes and bonds totaling $2,325 million and retire bonded debt in the
principal amount of $2,239 million.
Certain agencies created by the Commonwealth have statutory authorization
to incur debt for which Commonwealth appropriations to pay debt service thereon
are not required. As of December 31, 1996, total combined debt outstanding for
these agencies was $8,356 million. The debt of these agencies is supported by
assets of, or revenues derived from, the various projects financed and is not an
obligation of the Commonwealth. Some of these agencies, however, are indirectly
dependent on Commonwealth appropriations. The only obligations of agencies in
the Commonwealth that bear a moral obligation of the Commonwealth are those
issued by the Pennsylvania Housing Finance Agency ("PHFA"), a statecreated
agency which provides housing for lower and moderate income families, and The
Hospitals and Higher Education Facilities Authority of Philadelphia (the
"Hospital Authority"), an agency created by the City of Philadelphia to acquire
and prepare various sites for use as intermediate care facilities for the
mentally retarded.
LOCAL GOVERNMENT DEBT
Numerous local government units in Pennsylvania issue general obligation
(i.e., backed by taxing power) debt, including counties, cities, boroughs,
townships and school districts. School district obligations are supported
indirectly by the Commonwealth. The issuance of non-electoral general obligation
debt is limited by constitutional and statutory provisions. Electoral debt,
i.e., that approved by the voters, is unlimited. In addition, local government
units and municipal and other authorities may issue revenue obligations that are
supported by the revenues generated from particular projects or enterprises.
Examples include municipal authorities (frequently operating water and sewer
systems), municipal authorities formed to issue obligations benefitting
hospitals and educational institutions, and industrial development authorities,
whose obligations benefit industrial or commercial occupants. In some cases,
sewer or water revenue obligations are guaranteed by taxing bodies and have the
credit characteristics of general obligations debt.
LITIGATION
Pennsylvania is currently involved in certain litigation where adverse
decisions could have an adverse impact on its ability to pay debt service. For
example, in BABY NEAL V. COMMONWEALTH, the American Civil Liberties Union filed
a lawsuit against the Commonwealth seeking an order that would require the
Commonwealth to provide additional funding for child welfare services. COUNTY OF
ALLEGHENY V. COMMONWEALTH OF PENNSYLVANIA involves litigation regarding the
state constitutionality of the statutory scheme for county funding of the
judicial system. In PENNSYLVANIA ASSOCIATION OF RURAL AND SMALL SCHOOLS V.
CASEY, the constitutionality of Pennsylvania's system for funding local school
districts has been challenged. No estimates for the amount of these claims are
available.
OTHER FACTORS
The performance of the obligations held by the Fund issued by the
Commonwealth, its agencies, subdivisions and instrumentalities are in part tied
to state-wide, regional and local conditions within the Commonwealth and to the
creditworthiness of certain non-Commonwealth related obligers, depending upon
the Pennsylvania Fund's portfolio mix at any given time. Adverse changes to the
state-wide, regional or local economies or changes in government may adversely
affect the creditworthiness of the Commonwealth, its agencies and
municipalities, and certain other non-government related obligers of
Pennsylvania tax-free obligations (e.g., a university, a hospital or a corporate
obligor). The City of Philadelphia, for example, experienced severe financial
problems which impaired its ability to borrow money and adversely affected the
ratings of its obligations and their marketability. Conversely, some obligations
held by the Fund will be almost exclusively dependent on the creditworthiness of
one underlying obligor, such as a project occupant or provider of credit or
liquidity support.
- --------------------------------------------------------------------------------
APPENDIX B
- -------------------------------------------------------------------------------
CORPORATE AND MUNICIPAL BOND RATINGS
S&P CORPORATE AND MUNICIPAL BOND RATINGS
A. MUNICIPAL NOTES
An S&P note rating reflects the liquidity concerns and market access
risks unique to notes. Notes due in three years or less will likely receive a
note rating. Notes maturing beyond three years will most likely receive a
long-term debt rating. The following criteria are used in making that
assessment:
a. Amortization schedule (the larger the final maturity relative to other
maturities the more likely it will be treated as a note), and
b. Source of payment (the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note).
Note ratings are as follows:
1. SP-1 - Very strong or strong capacity to pay principal and interest.
Those issues determined to possess overwhelming safety characteristics will be
given a plus (+) designation.
2. SP-2 - Satisfactory capacity to pay principal and interest.
3. SP-3 - Speculative capacity to pay principal and interest.
B. TAX EXEMPT DEMAND BONDS
S&P assigns "dual" ratings to all long-term debt issues that have as part
of their provisions a demand or double feature.
The first rating addresses the likelihood of repayment of principal and
interest as due, and the second rating addresses only the demand feature. The
long-term debt rating symbols are used for bonds to denote the long-term
maturity and the commercial paper rating symbols are used to denote the put
option (for example, "AAA/A-1+"). For the newer "demand notes," S&P note rating
symbols, combined with the commercial paper symbols, are used (for example,
"SP-1+/A-1+" ).
C. CORPORATE AND MUNICIPAL BOND RATINGS
An S&P corporate or municipal bond rating is a current assessment of the
creditworthiness of an obligor, including obligors outside the U.S., with
respect to a specific obligation. This assessment may take into consideration
obligors such as guarantors, insurers or lessees. Ratings of foreign obligors do
not take into account currency exchange and related uncertainties. The ratings
are based on current information furnished by the issuer or obtained by S&P from
other sources it considers reliable.
The ratings are based, in varying degrees, on the following considerations:
a. Likelihood of default and capacity and willingness of the obligor as to
the timely payment of interest and repayment of principal in accordance with the
terms of the obligation;
b. Nature of and provisions of the obligation; and
c. Protection afforded by and relative position of the obligation in the
event of bankruptcy reorganization or other arrangement under the laws of
bankruptcy and other laws affecting creditors' rights.
PLUS (+) OR MINUS (-): To provide more detailed indications of credit
quality, ratings from "AA" to "BBB" may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
A provisional rating is sometimes used by S&P. It assumes the successful
completion of the project being financed by the debt being rated and indicates
that payment of debt service requirements is largely or entirely dependent upon
the successful and timely completion of the project. This rating, however, while
addressing credit quality subsequent to completion of the project, makes no
comment on the likelihood of, or the risk of default upon failure of, such
completion.
C. BOND RATINGS ARE AS FOLLOWS:
a. AAA - Debt rated AAA has the highest rating assigned by S&P. Capacity to
pay interest and repay principal is extremely strong.
b. AA - Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
3. A - Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
4. BBB - Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
5. BB, B, CCC, CC AND C - Debt rated BB, B, CCC, CC AND C is regarded, on
balance, as predominantly speculative with respect to capacity to pay interest
and repay prncipal in accordance with the terms of teh obligation. BB indicates
the lowest degree of speculation and C the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
D. MOODY'S CORPORATE AND MUNICIPAL BOND RATINGS
Moody's ratings are as follows:
1. AAA - Bonds which are rated AAA are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt-edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
2. AA - Bonds which are rated AA are judged to be of high quality by all
standards. Together with the AAA group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in AAA securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long term risks appear somewhat larger than in AAA securities.
3. A - Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment sometime in the future.
4. BAA - Bonds which are rated BAA are considered as medium grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
5. BA - Bonds which are rated BA are judged to have speculative elements.
Their future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
6. B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating
classification from AA through BAA in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
CON. (---) - Municipal bonds for which the security depends upon the
completion of some act or the fulfillment of some condition are rated
conditionally. These are bonds secured by (a) earnings of projects under
construction, (b) earnings of projects unseasoned in operation experience, (c)
rentals which begin when facilities are completed, or (d) payments to which some
other limiting condition attaches. Parenthetical rating denotes probable credit
stature upon completion of construction or elimination of basis of condition.
Those municipal bonds in the AA, A, and BAA groups which Moody's believes
possess the strongest investment attributes are designated by the symbols AA 1,
A 1, and BAA 1.
MONEY MARKET INSTRUMENTS
Money market securities are instruments with remaining maturities of one
year or less such as bank certificates of deposit, bankers' acceptances,
commercial paper (including variable rate master demand notes), and obligations
issued or guaranteed by the U.S. government, its agencies or instrumentalities,
some of which may be subject to repurchase agreements.
COMMERCIAL PAPER
Commercial paper will consist of issues rated at the time of purchase A-1,
by Standard & Poor's Ratings Group (S&P), or PRIME-1 by Moody's Investors
Service, Inc., (Moody's) or F-1 by Fitch Investors Services, L.P. (Fitch's); or,
if not rated, will be issued by companies which have an outstanding debt issue
rated at the time of purchase AAA, AA or A by Moody's, or AAA, AA or A by S&P,
or will be determined by a Fund's investment adviser to be of comparable
quality.
A. S&P RATINGS
An S&P commercial paper rating is a current assessment of the likelihood of
timely payment of debt having an original maturity of no more than 365 days.
Ratings are graded into four categories, ranging from "A" for the highest
quality obligations to "D" for the lowest. The top category is as follows:
1. A: Issues assigned this highest rating are regarded as having the
greatest capacity for timely payment. Issues in this category are delineated
with the numbers 1, 2 and 3 to indicate the relative degree of safety.
2. A-1: This designation indicates that the degree of safety regarding
timely payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics are denoted with a plus (+) sign
designation.
B. MOODY'S RATINGS
The term "commercial paper" as used by Moody's means promissory obligations
not having an original maturity in excess of nine months. Moody's commercial
paper ratings are opinions of the ability of issuers to repay punctually
promissory obligations not having an original maturity in excess of nine months.
Moody's employs the following designation, judged to be investment grade, to
indicate the relative repayment capacity of rated issuers.
1. The rating PRIME-1 is the highest commercial paper rating assigned by
Moody's. Issuers rated PRIME-1 (or related supporting institutions) are deemed
to have a superior capacity for repayment of short term promissory obligations.
Repayment capacity of PRIME-1 issuers is normally evidenced by the following
characteristics:
1) leading market positions in well-established industries;
2) high rates of return on funds employed;
3) conservative capitalization structures with moderate reliance
on debt and ample asset protection;
4) broad margins in earnings coverage of fixed financial charges
and high internal cash generation; and
5) well established access to a range of financial markets and
assured sources of alternate liquidity.
In assigning ratings to issuers whose commercial paper obligations are
supported by the credit of another entity or entities, Moody's evaluates the
financial strength of the affiliated corporations, commercial banks, insurance
companies, foreign governments or other entities, but only as one factor in the
total rating assessment.
CERTIFICATES OF DEPOSIT
Certificates of deposit are receipts issued by a bank in exchange for the
deposit of funds. The issuer agrees to pay the amount deposited plus interest to
the bearer of the receipt on the date specified on the certificate. The
certificate usually can be traded in the secondary market prior to maturity.
Certificates of deposit will be limited to U.S. dollar-denominated
certificates of U.S. banks or of savings and loan associations, including their
branches abroad, and of U.S. branches of foreign banks, which are members of the
Federal Reserve System or the Federal Deposit Insurance Corporation, and have at
least $1 billion in deposits as of the date of their most recently published
financial statements.
The Funds will not acquire time deposits or obligations issued by the
International Bank for Reconstruction and Development, the Asian Development
Bank or the Inter-American Development Bank. Additionally, the Funds do not
currently intend to purchase foreign securities (except to the extent that
certificates of deposit of foreign branches of U.S. banks may be deemed foreign
securities) or purchase certificates of deposit, bankers' acceptances or other
similar obligations issued by foreign banks.
BANKERS' ACCEPTANCES
Bankers' acceptances typically arise from short-term credit arrangements
designed to enable businesses to obtain funds to finance commercial
transactions. Generally, an acceptance is a time draft drawn on a bank by an
exporter or an importer to obtain a stated amount of funds to pay for specific
merchandise. The draft is then "accepted" by the bank that, in effect,
unconditionally guarantees to pay the face value of the instrument on its
maturity date. The acceptance may then be held by the accepting bank as an
earning asset or it may be sold in the secondary market at the going rate of
discount for a specific maturity. Although maturities for acceptances can be as
long as 270 days, most acceptances have maturities of six months or less.
Bankers' acceptances acquired by a Fund must have been accepted by U.S.
commercial banks, including foreign branches of U.S. commercial banks, having
total deposits at the time of purchase in excess of $1 billion and must be
payable in U.S. dollars.
U.S. GOVERNMENT SECURITIES
Securities issued or guaranteed by the U.S. government include a variety of
Treasury securities that differ only in their interest rates, maturities and
dates of issuance and securities issued by the Government National Mortgage
Association (GNMA). Treasury bills have maturities of one year or less. Treasury
notes have maturities of one to ten years and Treasury bonds generally have
maturities of greater than ten years at the date of issuance. GNMA securities
include GNMA mortgage pass-through certificates. Such securities are supported
by the full faith and credit of the U.S. government.
Securities issued or guaranteed by U.S. government agencies or
instrumentalities include securities issued or guaranteed by the Federal Housing
Administration, Farmers Home Administration, Export-Import Bank of the U.S.,
Small Business Administration, General Services Administration, Central Bank for
Cooperatives, Federal Home Loan Banks, Federal Loan Mortgage Corporation,
Federal Intermediate Credit Banks, Federal Land Banks, Maritime Administration,
The Tennessee Valley Authority, District of Columbia Armory Board and Federal
National Mortgage Association.
Some obligations of U.S. government agencies and instrumentalities, such as
securities of Federal Home Loan Banks, are supported by the right of the issuer
to borrow from the Treasury. Others, such as bonds issued by the Federal
National Mortgage Association, a private corporation, are supported only by the
credit of the instrumentality. Because the U.S. government is not obligated by
law to provide support to an instrumentality it sponsors, a Fund will invest in
the securities issued by such an instrumentality only when a Fund's investment
adviser determines under standards established by the Board of Trustees that the
credit risk with respect to the instrumentality does not make its securities
unsuitable investments. U.S. government securities do not include international
agencies or instrumentalities in which the U.S. government, its agencies or
instrumentalities participate, such as the World Bank, Asian Development Bank or
the Inter-American Development Bank, or issues insured by the Federal Deposit
Insurance Corporation.
MUNICIPAL LEASE OBLIGATIONS
Municipal lease obligations purchased primarily through Certificates of
Participation ("COPs") are used by state and local governments to finance the
purchase of property, and function much like installment purchase obligations.
The payments made by the municipality under the lease are used to repay interest
and principal on the bonds issued to purchase the property. Once these lease
payments are completed, the municipality gains ownership of the property for a
nominal sum. The lessor is, in effect, a lender secured by the property being
leased. A feature which distinguishes CPOs from municipal debt is that the lease
which is the subject of the transaction must contain a "nonappropriation" or
"abatement" clause. A nonappropriation clause provides that provides that, while
the municipality will use its best efforts to make lease payments, the
municipality may terminate the lease without penalty if the municipality's
appropriating body does not allocate the necessary funds. Local administrations,
being faced with increasingly tight budgets, therefore have more discretion to
curtail payments under COPs than they do to curtail payments on traditionally
funded debt obligations. If the government lessee does not appropriate
sufficient monies to make lease payments, the lessor or its agent is typically
entitled to repossess the property. In most cases, however, the private sector
value of the property will be less than the amount the government lessee was
paying.
Criteria considered by the rating agencies and a Fund's investment adviser
in assessing the risk of appropriation include the issuing municipality's credit
rating, evaluation of how essential the leased property is to the municipality
and term of the lease compared to the useful life of the leased property. The
Board of Trustees reviews the COPs held in each Fund's portfolio to assure that
they constitute liquid investments based on various factors reviewed by the
Fund's investment adviser and monitored by the Board. Such factors include (a)
the credit quality of such securities and the extent to which they are rated or,
if unrated, comply with existing criteria and procedures followed to ensure that
they are of quality comparable to the ratings required for each Fund's
investment, including an assessment of the likelihood that the leases will not
be cancelled; (b) the size of the municipal securities market, both in general
and with respect to COPs; and (c) the extent to which the type of COPs held by
each Fund trade on the same basis and with the same degree of dealer
participation as other municipal bonds of comparable credit rating or quality.
FUTURES CONTRACTS AND RELATED OPTIONS TRANSACTIONS
The Funds (with the exception of the New Jersey Fund) intend to enter into
financial futures contracts as a hedge against changes in prevailing levels of
interest rates to seek relative stability of principal and to establish more
definitely the effective return on securities held or intended to be acquired by
a Fund or as a hedge against changes in the prices of securities held by a Fund
or to be acquired by a Fund. A Fund's hedging may include sales of futures as an
offset against the effect of expected increases in interest rates or securities
prices and purchases of futures as an offset against the effect of expected
declines in interest rates.
For example, when a Fund anticipates a significant market or market sector
advance, it will purchase a stock index futures contract as a hedge against not
participating in such advance at a time when a Fund is not fully invested. The
purchase of a futures contract serves as a temporary substitute for the purchase
of individual securities which may then be purchased in an orderly fashion. As
such purchases are made, an equivalent amount of index based futures contracts
would be terminated by offsetting sales. In contrast, a Fund would sell stock
index futures contracts in anticipation of or in a general market or market
sector decline that may adversely affect the market value of the Fund's
portfolio. To the extent that the Fund's portfolio changes in value in
correlation with a given index, the sale of futures contracts on that index
would substantially reduce the risk to the portfolio of a market decline or
change in interest rates, and, by doing so, provide an alternative to the
liquidation of the Fund's securities positions and the resulting transaction
costs.
The Funds intend to engage in options transactions which are related to
financial futures contracts for hedging purposes and in connection with the
hedging strategies described above.
Although techniques other than sales and purchases of futures contracts and
related options transactions could be used to reduce the Funds' exposure to
interest rate and/or market fluctuations, the Funds may be able to hedge their
exposure more effectively and perhaps at a lower cost through using futures
contracts and related options transactions. While the Funds do not intend to
take delivery of the instruments underlying futures contracts they hold, the
Funds do not intend to engage in such futures contracts for speculation.
FUTURES CONTRACTS
Futures contracts are transactions in the commodities markets rather than
in the securities markets. A futures contract creates an obligation by the
seller to deliver to the buyer the commodity specified in the contract at a
specified future time for a specified price. The futures contract creates an
obligation by the buyer to accept delivery from the seller of the commodity
specified at the specified future time for the specified price. In contrast, a
spot transaction creates an immediate obligation for the seller to deliver and
the buyer to accept delivery of and pay for an identified commodity. In general,
futures contracts involve transactions in fungible goods such as wheat, coffee
and soybeans. However, in the last decade an increasing number of futures
contracts have been developed which specify financial instruments or financially
based indexes as the underlying commodity.
U.S. futures contracts are traded only on national futures exchanges and
are standardized as to maturity date and underlying financial instrument. The
principal financial futures exchanges in the United States are The Board of
Trade of the City of Chicago, the Chicago Mercantile Exchange, the International
Monetary Market (a division of the Chicago Mercantile Exchange), the New York
Futures Exchange and the Kansas City Board of Trade. Each exchange guarantees
performance under contract provisions through a clearing corporation, a
nonprofit organization managed by the exchange membership, which is also
responsible for handling daily accounting of deposits or withdrawals of margin.
A futures commission merchant ("Broker") effects each transaction in connection
with futures contracts for a commission. Futures exchanges and trading are
regulated under the Commodity Exchange Act by the Commodity Futures Trading
Commission ("CFTC") and National Futures Association ("NFA").
INTEREST RATE FUTURES CONTRACTS
The sale of an interest rate futures contract creates an obligation by a
Fund, as seller, to deliver the type of financial instrument specified in the
contract at a specified future time for a specified price. The purchase of an
interest rate futures contract creates an obligation by a Fund, as purchaser, to
accept delivery of the type of financial instrument specified at a specified
future time for a specified price. The specific securities delivered or
accepted, respectively, at settlement date, are not determined until at or near
that date. The determination is in accordance with the rules of the exchange on
which the futures contract sale or purchase was made.
Currently, interest rate futures contracts can be purchased or sold on
90-day U.S. Treasury bills, U.S. Treasury bonds, U.S. Treasury notes with
maturities between 6 1/2 and 10 years, Government National Mortgage Association
(GNMA) certificates, 90-day domestic bank certificates of deposit, 90-day
commercial paper, and 90-day Eurodollar certificates of deposit. It is expected
that futures contracts trading in additional financial instruments will be
authorized. The standard contract size is $100,000 for futures contracts in U.S.
Treasury bonds, U.S. Treasury notes and GNMA certificates, and $1,000,000 for
the other designated contracts. While U.S. Treasury bonds, U.S. Treasury bills
and U.S. Treasury notes are backed by the full faith and credit of the U.S.
government and GNMA certificates are guaranteed by a U.S. government agency, the
futures contracts in U.S. government securities are not obligations of the U.S.
Treasury.
INDEX BASED FUTURES CONTRACTS, OTHER THAN STOCK INDEX BASED
It is expected that bond index and other financially based index futures
contracts will be developed in the future. It is anticipated that such index
based futures contracts will be structured in the same way as stock index
futures contracts but will be measured by changes in interest rates, related
indexes or other measures, such as the consumer price index. In the event that
such futures contracts are developed, the Funds will sell interest rate index
and other index based futures contracts to hedge against changes which are
expected to affect the Funds' portfolios.
The purchase or sale of a futures contract differs from the purchase or
sale of a security, in that no price or premium is paid or received. Instead, to
initiate trading an amount of cash, cash equivalents, money market instruments,
or U.S. Treasury bills equal to approximately 1 1/2% (up to 5%) of the contract
amount must be deposited by a Fund with the Broker. This amount is known as
initial margin. The nature of initial margin in futures transactions is
different from that of margin in security transactions. Futures contract margin
does not involve the borrowing of funds by the customer to finance the
transactions. Rather, the initial margin is in the nature of a performance bond
or good faith deposit on the contract which is returned to a Fund upon
termination of the futures contract assuming all contractual obligations have
been satisfied. The margin required for a particular futures contract is set by
the exchange on which the contract is traded and may be significantly modified
from time to time by the exchange during the term of the contract.
Subsequent payments, called variation margin, to the Broker and from the
Broker, are made on a daily basis as the value of the underlying instrument or
index fluctuates making the long and short positions in the futures contract
more or less valuable, a process known as mark-to-market. For example, when a
Fund has purchased a futures contract and the price of the underlying financial
instrument or index has risen, that position will have increased in value, and
the Fund will receive from the Broker a variation margin payment equal to that
increase in value. Conversely, where a Fund has purchased a futures contract and
the price of the underlying financial instrument or index has declined, the
position would be less valuable and the Fund would be required to make a
variation margin payment to the Broker. At any time prior to expiration of the
futures contract, a Fund may elect to close the position. A final determination
of variation margin is then made, additional cash is required to be paid to or
released by the Broker, and the Fund realizes a loss or gain.
Each Trust intends to enter into arrangements with its custodian and with
Brokers to enable the initial margin of a Fund and any variation margin to be
held in a segregated account by its custodian on behalf of the Broker.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of financial instruments, and index based futures
contracts call for the delivery of cash equal to the difference between the
closing value of the index on the expiration date of the contract and the price
at which the futures contract is originally made, in most cases such futures
contracts are closed out before the settlement date without the making or taking
of delivery. Closing out a futures contract sale is effected by an offsetting
transaction in which a Fund enters into a futures contract purchase for the same
aggregate amount of the specific type of financial instrument or index and same
delivery date. If the price in the sale exceeds the price in the offsetting
purchase, the Fund is paid the difference and thus realizes a gain. If the
offsetting purchase price exceeds the sale price, the Fund pays the difference
and realizes a loss. Similarly, the closing out of a futures contract purchase
is effected by an offsetting transaction in which a Fund enters into a futures
contract sale. If the offsetting sale price exceeds the purchase price, the Fund
realizes a gain. If the purchase price exceeds the offsetting sale price the
Fund realizes a loss. The amount of the Fund's gain or loss on any transaction
is reduced or increased, respectively, by the amount of any transaction costs
incurred by the Fund.
As an example of an offsetting transaction, the contractual obligations
arising from the sale of one contract of September U.S. Treasury bills on an
exchange may be fulfilled at any time before delivery of the contract is
required (i.e. on a specified date in September, the "delivery month") by the
purchase of one contract of September U.S. Treasury bills on the same exchange.
In such instance the difference between the price at which the futures contract
was sold and the price paid for the offsetting purchase, after allowance for
transaction costs, represents the profit or loss to a Fund.
There can be no assurance, however, that a Fund will be able to enter into
an offsetting transaction with respect to a particular contract at a particular
time. If a Fund is not able to enter into an offsetting transaction, the Fund
will continue to be required to maintain the margin deposits on the contract and
to complete the contract according to its terms.
OPTIONS ON FINANCIAL FUTURES
The Funds intend to purchase call and put options on financial futures
contracts and sell such options to terminate an existing position. Options on
futures are similar to options on stocks except that an option on a futures
contract gives the purchaser the right, in return for the premium paid, to
assume a position in a futures contract (a long position if the option is a call
and a short position if the option is a put) rather than to purchase or sell
stock at a specified exercise price at any time during the period of the option.
Upon exercise of the option, the delivery of the futures position by the writer
of the option to the holder of the option will be accompanied by delivery of the
accumulated balance in the writer's futures margin account. This amount
represents the amount by which the market price of the futures contract at
exercise exceeds, in the case of a call, or is less than, in the case of a put,
the exercise price of the option on the futures contract. If an option is
exercised the last trading day prior to the expiration date of the option, the
settlement will be made entirely in cash equal to the difference between the
exercise price of the option and value of the futures contract.
The Funds intend to use options on financial futures contracts in
connection with hedging strategies. In the future the Funds may use such options
for other purposes.
PURCHASE OF PUT OPTIONS ON FUTURES CONTRACTS
The purchase of protective put options on financial futures contracts is
analogous to the purchase of protective puts on individual stocks, where an
absolute level of protection is sought below which no additional economic loss
would be incurred by a Fund. Put options may be purchased to hedge a portfolio
of stocks or debt instruments or a position in the futures contract upon which
the put option is based.
PURCHASE OF CALL OPTIONS ON FUTURES CONTRACTS
The purchase of call options on financial futures contracts represents a
means of obtaining temporary exposure to market appreciation at limited risk. It
is analogous to the purchase of a call option on an individual stock, which can
be used as a substitute for a position in the stock itself. Depending on the
pricing of the option compared to either the futures contract upon which it is
based, or upon the price of the underlying financial instrument or index itself,
purchase of a call option may be less risky than the ownership of the interest
rate or index based futures contract or the underlying securities. Call options
on commodity futures contracts may be purchased to hedge against an interest
rate increase or a market advance when a Fund is not fully invested.
USE OF NEW INVESTMENT TECHNIQUES INVOLVING FINANCIAL FUTURES CONTRACTS OR
RELATED OPTIONS
The Funds may employ new investment techniques involving financial futures
contracts and related options. The Funds intend to take advantage of new
techniques in these areas which may be developed from time to time and which are
consistent with the Fund's investment objective. Each Trust believes that no
additional techniques have been identified for employment by the Funds in the
foreseeable future other than those described above.
LIMITATIONS ON PURCHASE AND SALE OF FUTURES CONTRACTS AND RELATED OPTIONS ON
SUCH FUTURES CONTRACTS
A Fund will not enter into a futures contract if, as a result thereof, more
than 5% of the Fund's total assets (taken at market value at the time of
entering into the contract) would be committed to margin deposits on such
futures contracts.
The Funds intend that its futures contracts and related options
transactions will be entered into for traditional hedging purposes. That is,
futures contracts will be sold to protect against a decline in the price of
securities that a Fund owns, or futures contracts will be purchased to protect a
Fund against an increase in the price of securities it intends to purchase. The
Funds do not intend to enter into futures contracts for speculation.
In instances involving the purchase of futures contracts by a Fund, an
amount of cash and cash equivalents, equal to the market value of the futures
contracts will be deposited in a segregated account with each Trust's custodian
and/or in a margin account with a Broker to collateralize the position and
thereby insure that the use of such futures is unleveraged.
FEDERAL INCOME TAX TREATMENT
For federal income tax purposes, a Fund is required to recognize as income
for each taxable year its net unrealized gains and losses on futures contracts
as of the end of the year as well as those actually realized during the year.
Any gain or loss recognized with respect to a futures contract is considered to
be 60% long term and 40% short term, without regard to the holding period of the
contract. In the case of a futures transaction classified as a "mixed straddle,"
the recognition of losses may be deferred to a later taxable year. The federal
income tax treatment of gains or losses from transactions in options on futures
is unclear.
In order for a Fund to continue to qualify for federal income tax treatment
as a regulated investment company, at least 90% of its gross income for a
taxable year must be derived from qualifying income. Any net gain realized from
the closing out of futures contracts, for purposes of the 90% requirement, will
be qualifying income. In addition, gains realized on the sale or other
disposition of securities held for less than three months must be limited to
less than 30% of a Fund's annual gross income. The 1986 Tax Act added a
provision which effectively treats both positions in certain hedging
transactions as a single transaction for the purpose of the 30% requirement. The
provision provides that, in the case of any "designated hedge," increases and
decreases in the value of positions of the hedge are to be netted for the
purposes of the 30% requirement. However, in certain situations, in order to
avoid realizing a gain within a three month period, a Fund may be required to
defer the closing out of a contract beyond the time when it would otherwise be
advantageous to do so.
RISKS OF FUTURES CONTRACTS
Financial futures contracts prices are volatile and are influenced, among
other things, by changes in stock prices, market conditions, prevailing interest
rates and anticipation of future stock prices, market movements or interest rate
changes, all of which in turn are affected by economic conditions, such as
government fiscal and monetary policies and actions, and national and
international political and economic events.
At best, the correlation between changes in prices of futures contracts and
of the securities being hedged can be only approximate. The degree of
imperfection of correlation depends upon circumstances, such as variations in
speculative market demand for futures contracts and for securities, including
technical influences in futures contracts trading; differences between the
securities being hedged and the financial instruments and indexes underlying the
standard futures contracts available for trading, in such respects as interest
rate levels, maturities and creditworthiness of issuers, or identities of
securities comprising the index and those in a Fund's portfolio. In addition,
futures contract transactions involve the remote risk that a party be unable to
fulfill its obligations and that the amount of the obligation will be beyond the
ability of the clearing broker to satisfy. A decision of whether, when and how
to hedge involves the exercise of skill and judgment, and even a well conceived
hedge may be unsuccessful to some degree because of market behavior or
unexpected interest rate trends.
Because of the low margin deposits required, futures trading involves an
extremely high degree of leverage. As a result, a relatively small price
movement in a futures contract may result in immediate and substantial loss, as
well as gain, to the investor. For example, if at the time of purchase, 10% of
the value of the futures contract is deposited as margin, a 10% decrease in the
value of the futures contract would result in a total loss of the margin
deposit, before any deduction for the transaction costs, if the account were
then closed out, and a 15% decrease would result in a loss equal to 150% of the
original margin deposit. Thus, a purchase or sale of a futures contract may
result in losses in excess of the amount invested in the futures contract.
However, a Fund would presumably have sustained comparable losses if, instead of
entering into the futures contract, it had invested in the underlying financial
instrument. Furthermore, in order to be certain that a Fund has sufficient
assets to satisfy its obligations under a futures contract, the Fund will
establish a segregated account in connection with its futures contracts which
will hold cash or cash equivalents equal in value to the current value of the
underlying instruments or indices less the margins on deposit.
Most U.S. futures exchanges limit the amount of fluctuation permitted in
futures contract prices during a single trading day. The daily limit establishes
the maximum amount that the price of a futures contract may vary either up or
down from the previous day's settlement price at the end of a trading session.
Once the daily limit has been reached in a particular type of contract, no
trades may be made on that day at a price beyond that limit. The daily limit
governs only price movement during a particular trading day and therefore does
not limit potential losses because the limit may prevent the liquidation of
unfavorable positions. Futures contract prices have occasionally moved to the
daily limit for several consecutive trading days with little or no trading,
thereby preventing prompt liquidation of futures positions and subjecting some
futures traders to substantial losses.
RISKS OF OPTIONS ON FUTURES CONTRACTS
In addition to the risks described above for financial futures contracts,
there are several special risks relating to options on futures contracts. The
ability to establish and close out positions on such options will be subject to
the development and maintenance of a liquid secondary market. There is no
assurance that a liquid secondary market will exist for any particular contract
or at any particular time. A Fund will not purchase options on any futures
contract unless and until it believes that the market for such options has
developed sufficiently that the risks in connection with such options are not
greater than the risks in connection with the futures contracts. Compared to the
use of futures contracts, the purchase of options on such futures involves less
potential risk to a Fund because the maximum amount at risk is the premium paid
for the options (plus transaction costs). However, there may be circumstances
when the use of an option on a futures contract would result in a loss to a
Fund, even though the use of a futures contract would not, such as when there is
no movement in the level of the futures contract.
<PAGE>
KEYSTONE TAX FREE FUND
STATEMENT OF ADDITIONAL INFORMATION
April 30, 1997
This statement of additional information (the "SAI") is not a
prospectus, but relates to, and should be read in conjunction with, the
prospectus of Keystone Tax Free Fund (the "Fund") dated April 30, 1997, as
supplemented from time to time. A copy of the prospectus may be obtained from
Evergreen Keystone Distributor, Inc. or your broker-dealer.
TABLE OF CONTENTS
Page
The Fund ...............................................................2
Service Providers.......................................................2
Investment Restrictions.................................................3
Valuation of Securities.................................................5
Brokerage...............................................................5
Sales Charges...........................................................7
Distribution Plan.......................................................9
Trustees and Officers..................................................10
Investment Adviser.....................................................14
Principal Underwriter..................................................16
Sub-administrator......................................................16
Declaration of Trust...................................................17
Expenses ..............................................................18
Financial Statements...................................................19
Standardized Total Return and Yield Quotations.........................19
Additional Information.................................................20
Appendix .............................................................A-1
<PAGE>
THE FUND
The Fund is an open-end diversified management investment company. The
Fund's investment objective is to provide shareholders with the highest possible
current income, exempt from federal income taxes, while preserving capital. The
Fund invests primarily in municipal bonds, but also may invest in certain other
securities as described in the Appendix hereto and in the "Additional Investment
Information" section of the Fund's prospectus.
Certain information about the Fund is contained in its prospectus. This
statement of additional information provides additional information about the
Fund that may be of interest to some investors.
SERVICE PROVIDERS
<TABLE>
<S> <C>
Service Provider
- ----------------------------------------- -----------------------------------------------------------------------
Investment adviser (referred to Keystone Investment Management Company, 200 Berkeley
in this SAI as "Keystone") Street, Boston, Massachusetts 02116. (Keystone is a
wholly-owned subsidiary of First Union Keystone, Inc.,
(formerly Keystone Investments, Inc.) ("First Union
Keystone") also located at 200
Berkeley Street, Boston,
Massachusetts 02116.
Principal underwriter ( referred Evergreen Keystone Distributor, Inc. (formerly Evergreen
to in this SAI as "EKD") Funds Distributor, Inc.), 125 W. 55th Street, New York,
New York 10019.
Marketing services agent and Evergreen Keystone Investment Services, Inc. (formerly
predecessor to EKD (referred to Keystone Investment Distributors Company), 200 Berkeley
in this SAI as "EKIS") Street, Boston, Massachusetts 02116.
Sub-administrator (referred to in BISYS Fund Services, Inc., 125 W. 55th Street, New York,
this SAI as "BISYS") New York 10019.
Transfer and dividend Evergreen Keystone Service Company, 200 Berkeley
disbursing agent (referred to in Street, Boston, Massachusetts 02116. (EKSC is a wholly-
this SAI as "EKSC") owned subsidiary of Keystone.)
Independent auditors KPMG Peat Marwick LLP, 99 High Street, Boston,
Massachusetts 02110, Certified Public Accountants
Custodian State Street Bank and Trust Company, 225 Franklin
Street, Boston, Massachusetts 02110.
</TABLE>
INVESTMENT RESTRICTIONS
None of the restrictions enumerated in this paragraph may be changed
without a vote of the holders of a majority of the Fund's outstanding shares as
defined in the Investment Company Act of 1940 (the "1940 Act") as the lesser of
(1) 67% of the shares, represented at a meeting at which more than 50% of the
outstanding shares are represented or (2) more than 50% of the outstanding
shares. The Fund shall not do the following:
(1) purchase securities on margin, but the Fund may obtain such
short-term credits as may be necessary for the clearance of purchases and sales
of securities;
(2) make short sales of securities or maintain a short position, unless
at all times when a short position is open it owns an equal amount of such
securities or of securities which without payment of any further consideration
are convertible into or exchangeable for securities of the same issue as, and
equal in amount to, the securities sold short;
(3) borrow money, except that the Fund may (a) borrow money from banks
for emergency or extraordinary purposes in aggregate amounts up to one-third of
its net assets, and (b) enter into reverse repurchase agreements;
(4) pledge, mortgage or hypothecate its assets except to secure
indebtedness permitted by subparagraph (3) above, with pledged assets to be no
more than 15% of its total assets;
(5) purchase any security other than United States ("U.S.") government
securities of any issuer if as a result more than 25% of its total assets would
be invested in a single industry, including industrial development bonds from
the same facility or similar types of facilities; governmental issuers of
municipal bonds are not regarded as members of an industry and the Fund may
invest more than 25% of its assets in industrial development bonds;
(6) purchase any security, other than U.S. government securities, if as
a result more than 5% of the Fund's total assets would be invested in securities
of the issuer, or the Fund would hold more than 10% of the voting securities of
the issuer;
(7) invest for the purpose of exercising control over or management of
any company;
(8) invest in securities of other investment companies, except as part
of a merger, consolidation, purchase of assets or similar transaction approved
by the Fund's shareholders;
(9) purchase or sell commodities or commodity contracts or real estate,
except that it may purchase and sell securities secured by real estate and
securities of companies which invest in real estate, and may engage in currency
or other financial futures and related options transactions;
(10) act as an underwriter except to the extent that, in connection
with the disposition of its portfolio investments, it may be deemed to be an
underwriter under federal securities laws; or purchase securities which are not
readily marketable except for repurchase agreements;
(11) purchase or retain securities of an issuer if, to the knowledge of
the Fund, an officer, Trustee or Director of the Fund or Keystone owns
beneficially more than 1/2 of 1% of the shares or securities of such issuer and
all such officers, Trustees and Directors owning more than 1/2 of 1% of such
shares or securities together own more than 5% of such shares or securities;
(12) purchase securities of any issuer if the person responsible for
payment, together with any predecessor, has been in operation for less than
three years if, as a result, the aggregate of such investments would exceed 5%
of the Fund's total assets; provided, however, that this restriction shall not
apply to U.S. government securities or to any obligation the payment of which
involves the credit and taxing power of any person authorized to issue municipal
bonds;
(13) invest in interests in oil, gas or other mineral exploration or
development programs;
(14) make loans, except to the extent that the purchase of debt
instruments or repurchase agreements may be deemed to be loans; repurchase
agreements maturing in more than seven days will not exceed 10% of the Fund's
total assets; and
(15) purchase securities of foreign issuers.
The foregoing percentage restrictions will apply at the time of the
purchase of a security and shall not be considered violated unless an excess or
deficiency occurs or exists immediately after and as a result of a purchase of
such security. For the purpose of Investment Restrictions (5) and (6), the Fund
will treat each state, territory and possession of the U.S., the District of
Columbia and, if its assets and revenues are separate from those of the entity
or entities creating it, each political subdivision, agency and instrumentality
of any one (or more, as in the case of a multistate authority or agency) of the
foregoing as an issuer of all securities that are backed primarily by its assets
or revenues; each company as an issuer of all securities that are backed
primarily by its assets or revenues; and each of the foregoing entities as an
issuer of all securities that it guarantees; provided, however, that for the
purpose of limitation (6) no entity shall be deemed to be an issuer of a
security that it guarantees so long as no more than 10% of the Fund's total
assets (taken at current value) are invested in securities guaranteed by the
entity and securities of which it is otherwise deemed to be an issuer.
The Fund does not presently intend to invest more than 25% of its total
assets in (1) municipal bonds of a single state and its subdivisions, agencies
and instrumentalities; of a single territory or possession of the U.S. and its
subdivisions, agencies or instrumentalities; or of the District of Columbia and
any subdivision, agency or instrumentality thereof; or (2) municipal bonds the
payment of which depends on revenues derived from a single facility or similar
types of facilities. Since certain municipal bonds may be related in such a way
that an economic, business or political development or change affecting one such
security could likewise affect the other securities, a change in this policy
could result in increased investment risk, but no change is presently
contemplated. The Fund may invest more than 25% of its total assets in
industrial development bonds.
In addition, the Fund will not issue senior securities, except as
appropriate to evidence indebtedness which the Fund is permitted to incur
pursuant to Investment Restriction (3) above and except for shares of any
additional series or portfolios which may be established by the Trustees.
Notwithstanding the eighth investment restriction enumerated above or
any of the other limitations above, the Fund may invest all of its assets in the
securities of a single open-end management investment company with substantially
the same fundamental investment objectives, policies, and restrictions as the
Fund. See "Investment Objective and Policies" in the prospectus.
VALUATION OF SECURITIES
The Fund believes that reliable market quotations generally are not
readily available for purposes of valuing municipal bonds. As a result,
depending on the particular municipal bonds owned by the Fund, it is likely that
most of the valuations for such bonds will be based upon their fair value
determined under procedures that have been approved by the Fund's Board of
Trustees. The Fund's Board of Trustees has authorized the use of a pricing
service to determine the fair value of its municipal bonds and other securities.
Non-tax exempt securities for which market quotations are readily
available are valued on a consistent basis at that price quoted that, in the
opinion of the Fund's Board of Trustees or the person designated by the Board of
Trustees to make the determination, most nearly represents the market value of
the particular security.
Short-term investments that are purchased with maturities of sixty days
or less are valued at amortized cost (original purchase cost as adjusted for
amortization of premium or accretion of discount), which, when combined with
accrued interest, approximates market; short-term investments maturing in more
than sixty days for which market quotations are readily available are valued at
current market value; and short-term investments maturing in more than sixty
days when purchased that are held on the sixtieth day prior to maturity are
valued at amortized cost (market value on the sixtieth day adjusted for
amortization of premium or accretion of discount), which, when combined with
accrued interest, approximates market and which, in any case, reflects fair
value as determined by the Fund's Board of Trustees.
Any securities for which market quotations are not readily available
are valued on a consistent basis at fair value as determined in good faith using
methods prescribed by the Fund's Board of Trustees.
BROKERAGE
Selection of Brokers
In effecting transactions in portfolio securities for the Fund,
Keystone seeks the best execution of orders at the most favorable prices.
Keystone determines whether a broker has provided the Fund with best execution
and price in the execution of a securities transaction by evaluating, among
other things:
1. overall direct net economic result to the Fund;
2. the efficiency with which the transaction is effected;
3. the broker's ability to effect the transaction where a large
block is involved;
4. the broker's readiness to execute potentially difficult
transactions in the future;
5. the financial strength and stability of the broker; and
6. the receipt of research services, such as analyses and reports
concerning issuers, industries, securities, economic factors
and trends and other statistical and factual information
("research services.")
The Fund's management weighs these considerations in determining the
overall reasonableness of the brokerage commissions paid.
Should the Fund or Keystone receive research services from a broker,
the Fund would consider such services to be in addition to, and not in lieu of,
the services Keystone is required to perform under the Advisory Agreement.
Keystone believes that the cost, value and specific application of research
services are indeterminable and cannot be practically allocated between the Fund
and its other clients who may indirectly benefit from the availability of
research services. Similarly, the Fund may indirectly benefit from information
made available as a result of transactions effected for Keystone's other
clients. Under the Advisory Agreement, Keystone is permitted to pay higher
brokerage commissions for brokerage and research services in accordance with
Section 28(e) of the Securities Exchange Act of 1934. In the event Keystone
follows such a practice, it will do so on a basis that is fair and equitable to
the Fund.
Neither the Fund nor Keystone intends on placing securities
transactions with any particular broker. The Fund's Board of Trustees has
determined, however, that the Fund may consider sales of Fund shares as a factor
when selecting brokers-dealers to execute portfolio transactions, subject to the
requirements of best execution described above.
Brokerage Commissions
The Fund expects that purchases and sales of municipal bonds and temporary
instruments usually will be principal transactions. Municipal bonds and
temporary instruments are normally purchased directly from the issuer or from an
underwriter or market maker for the securities. There usually will be no
brokerage commissions paid by the Fund for such purchases. Purchases from
underwriters will include the underwriting commission or concession, and
purchases from dealers serving as market makers will include a dealer's mark up
or reflect a dealer's mark down. Where transactions are made in the
over-the-counter market, the Fund will deal with primary market makers unless
more favorable prices are otherwise obtainable.
General Brokerage Policies
In order to take advantage of the availability of lower purchase
prices, the Fund may participate, if and when practicable, in group bidding for
the direct purchase from an issuer of certain securities.
Keystone makes investment decisions for the Fund independently from
those of its other clients. It may frequently develop, however, that Keystone
will make the same investment decision for more than one client. Simultaneous
transactions are inevitable when the same security is suitable for the
investment objective of more than one account. When two or more of its clients
are engaged in the purchase or sale of the same security, Keystone will allocate
the transactions according to a formula that is equitable to each of its
clients. Although, in some cases, this system could have a detrimental effect on
the price or volume of the Fund's securities, the Fund believes that in other
cases its ability to participate in volume transactions will produce better
executions.
The Fund does not purchase portfolio securities from or sell portfolio
securities to Keystone, EKD or any of their affiliated persons, as defined in
the 1940 Act.
The Board of Trustees periodically reviews the Fund's brokerage policy.
In the event of further regulatory developments affecting the securities
exchanges and brokerage practices generally, the Board of Trustees may change,
modify or eliminate any of the foregoing practices.
SALES CHARGES
The Fund may charge a contingent deferred sales charge (a "CDSC") when
you redeem certain of its shares within four calendar years after you purchase
the shares. The Fund charges a CDSC as reimbursement for certain expenses, such
as commissions or shareholder servicing fees, that it has incurred in connection
with the sale of its shares (see "Distribution Plan"). If imposed, the Fund
deducts the CDSC from the redemption proceeds you would otherwise receive. CDSCs
attributable to your shares are, to the extent permitted by the National
Association of Securities Dealers, Inc. ("NASD"), paid to EKD or its
predecessor.
Calculating the CDSC
The CDSC is a declining percentage of the lesser of (1) the net asset
value of the shares you redeemed, or (2) the total cost of such shares. The CDSC
is calculated according to the following schedule:
Redemption Timing CDSC
During the calendar year of purchase........................4.00%
During the calendar year after the
year of purchase..........................................3.00%
During the second calendar
year after the year of purchase...........................2.00%
During the third calendar year
after the year of purchase................................1.00%
Thereafter..................................................0.00%
In determining whether a CDSC is payable and, if so, the percentage
charge applicable, the Fund assumes that you have redeemed shares not subject to
a CDSC first and then it will redeem shares you have held the longest first.
Shares That Are Not Subject to a CDSC
However, the Fund will only sell shares to these parties upon the
purchaser's written assurance that he or she is buying the shares for investment
purposes only. Such purchasers may not resell the securities except through
redemption by the Fund.
CDSC Waivers. The Fund does not impose a CDSC when the amount you are
redeeming represents:
1. an increase in the value of the shares redeemed above the
total cost of such shares due to increases in the net asset
value per share of the Fund;
2. certain shares for which the Fund did not pay a commission on
issuance, including shares acquired through reinvestment of
dividend income and capital gains distributions;
3. shares you have held for all or part of more than four
consecutive calendar years;
4. shares that are held in the accounts of a shareholder who has
died or become disabled;
5. a lump-sum distribution from a 401(k) plan or other benefit
plan qualified under the Employee Retirement Income Security
Act of 1974 ("ERISA");
6. automatic withdrawals from the ERISA plan of a shareholder who
is a least 59 1/2 years old;
7. shares in an account that the Fund has closed because the
account has an aggregate net asset value of less than $1,000;
8. automatic withdrawals under a Systematic Withdrawal Plan of up
to 1.00% per month of your initial account balance;
9. withdrawals consisting of loan proceeds to a retirement plan
participant;
10. financial hardship withdrawals made by a retirement plan
participant;
11. withdrawals consisting of returns of excess contributions or
excess deferral amounts made to a retirement plan;
12. shares purchased by a bank or trust company in a single
account in the name of such bank or trust company as trustee
if the initial investment in shares of the Fund, any other
Keystone Classic fund, and/or any Evergreen Keystone fund, is
at least $500,000 and any commission paid by the Fund and such
other fund at the time of such purchase is not more than 1% of
the amount invested;
13. any Director, Trustee, officer, full-time employee or sales
representative of the Fund, Keystone, First Union Keystone,
EKD or their affiliates, who has held such position for at
least ninety days; or
14. the pension and profit-sharing plans established by such
companies and their affiliates, for the benefit of their
Directors, Trustees, officers, full-time employees and sales
representatives.
Exchanges. The Fund does not charge a CDSC on exchanges of shares
between Keystone Classic funds that have adopted distribution plans pursuant to
Rule 12b-1 under the 1940 Act. If you do exchange shares of one such fund for
shares of another such fund, the Fund will deem the calendar year of the
exchange, for purposes of any future CDSC, to be the year the shares tendered
for exchange were originally purchased.
- --------------------------------------------------------------------------------
DISTRIBUTION PLAN
- --------------------------------------------------------------------------------
Rule 12b-1 under the 1940 Act permits investment companies, such as the
Fund to use their assets to bear the expenses of distributing their shares, if
they comply with various conditions, including adoption of a distribution plan
containing certain provisions set forth in Rule 12b-1. The Fund bears some of
the costs of selling its shares under a Distribution Plan adopted on June 1,
1983 pursuant to Rule 12b-1 (the "Distribution Plan").
The Fund's Distribution Plan provides that the Fund may expend up to
0.3125% quarterly (1.25% annually) of the average daily net asset value of its
shares to pay distribution costs for sales of its shares and to pay shareholder
service fees. The NASD currently limits such annual expenditures to 1.00%, of
which 0.75% may be used to pay such distribution costs and 0.25% may be used to
pay shareholder service fees. The NASD also limits the aggregate amount that the
Fund may pay for such distribution costs to 6.25% of gross share sales since the
inception of the Fund's Distribution Plan plus interest at the prime rate plus
1% on unpaid amounts thereof (less any CDSC paid by shareholders to the
Principal Underwriter).
Payments under the Distribution Plan are currently made to the
Principal Underwriter (which may reallow all or part to others, such as dealers)
(1) as commissions for Fund shares sold, (2) as shareholder service fees in
respect to shares maintained by the recipients and outstanding on the Fund's
books for specified periods and (3) as interest. Amounts paid or accrued to the
Principal Underwriter and its predecessor in the aggregate may not exceed the
annual limitations referred to above. The Principal Underwriter generally
reallows to brokers or others a commission equal to 4.00% of the price paid for
each Fund share sold as well as a shareholder service fee at a rate of 0.25% per
annum of the net asset value of shares maintained by such recipients and
outstanding on the books of the Fund for specified periods.
If the Fund is unable to pay the Principal Underwriter a commission on
a new sale because the annual maximum (0.75% of average daily net assets) has
been reached, the Principal Underwriter intends, but is not obligated, to
continue to accept new orders for the purchase of Fund shares and to pay or
accrue commissions and service fees to broker-dealers in excess of the amount it
currently receives from the Fund ("Advances"). While the Fund is under no
contractual obligation to reimburse the Principal Underwriter or its predecessor
for Advances, the Principal Underwriter and its predecessor intend to seek full
payment for such Advances from the Fund (together with interest at the prime
rate plus 1.00%) at such time in the future as, and to the extent that, payment
thereof by the Fund would be within permitted limits. EKIS currently intends to
seek payment of interest only on such Advances paid or accrued by EKIS
subsequent to July 7, 1992. If the Fund's Independent Trustees authorize such
payments, the effect would be to extend the period of time during which the Fund
incurs the maximum amount of costs allowed by the Distribution Plan.
The Distribution Plan may be terminated at any time by vote of a
majority of the Independent Trustees or by vote of a majority of the outstanding
voting shares of the Fund. If the Distribution Plan is terminated, EKD will ask
the Independent Trustees to take whatever action they deem appropriate under the
circumstances with respect to payment of such Advances.
The total amounts paid by the Fund under the foregoing arrangements may
not exceed the maximum Distribution Plan limit specified above. In addition, the
amounts and purposes of expenditures under the Distribution Plan must be
reported to the Fund's Independent Trustees
<PAGE>
10
quarterly. The Fund's Independent Trustees may require or approve changes in the
implementation or operation of the Distribution Plan, and may also require that
total expenditures by the Fund under the Distribution Plan be kept within limits
lower than the maximum amount permitted by the Distribution Plan as stated
above. If such costs are not limited by the Independent Trustees, such costs
could, for some period of time, be higher than such costs permitted by most
other plans presently adopted by other investment companies.
The Distribution Plan may be terminated at any time by vote of the
Independent Trustees or by vote of a majority of the outstanding voting
securities of the Fund. Any change in the Distribution Plan that would
materially increase the distribution expenses of the Fund provided for in the
Distribution Plan requires shareholder approval. Otherwise, the Distribution
Plan may be amended by the votes of the majority of both (1) the Fund's Board of
Trustees and (2) the Independent Trustees, cast in person at a meeting called
for the purpose of voting on such amendment.
While the Distribution Plan is in effect, the Fund will be required to
commit the selection and nomination of candidates for Independent Trustees to
the discretion of the Independent Trustees.
Whether any expenditure under the Distribution Plan is subject to a
state expense limit will depend upon the nature of the expenditure and the terms
of the state law, regulation or order imposing the limit. A portion of the
Fund's Distribution Plan expenses may be includable in the Fund's total
operating expenses for purposes of determining compliance with state expense
limits.
The Independent Trustees of the Fund have determined that the sales of
the Fund's shares resulting from payments under the Distribution Plan have
benefited the Fund.
TRUSTEES AND OFFICERS
The Trustees of the Fund, their principal occupations and some of their
affiliations over the last five years, and the officers of the Fund are as
follows:
FREDERICK AMLING: Trustee of the Fund; Trustee or Director of
all other funds in the Key
stone Families of Funds; Professor, Finance
Department, George Washington University;
President, Amling & Company (investment
advice); and former Member, Board of
Advisers, Credito Emilano (bank ing).
LAURENCE B. ASHKIN: Trustee of the Fund; Trustee or Director of
all other funds in the Keystone Families of
Funds; Trustee or Director of all of the
funds in the Evergreen Family of Funds other
than Evergreen Investment Trust; real estate
developer and construction consultant; and
President of Centrum Equities and Centrum
Properties, Inc.
CHARLES A AUSTIN III: Trustee of the Fund; Trustee or Director of
all other funds in the Keystone Families of
Funds; Investment Counselor to Appleton
Partners, Inc.; and former Managing
Director, Seaward Management Corporation
(investment advice).
FOSTER BAM: Trustee of the Fund; Trustee or
Director of all other funds in the Keystone
Families of Funds; Trustee or Director of
all of the funds in the Evergreen Family of
Funds other than Evergreen Investment Trust;
Partner in the law firm of Cummings &
Lockwood; Director, Symmetrix, Inc. (sulphur
company) and Pet Practice, Inc. (veterinary
services); and former Director, Chartwell
Group Ltd. (manufacturer of office
furnishings and accessories), Waste Disposal
Equipment Acquisition Corporation and
Rehabilitation Corporation of America
(rehabilitation hospitals).
*GEORGE S. BISSELL: Chief Executive Officer of the
Fund and each of the other funds in the
Keystone Families of Funds; Chairman of the
Board and Trustee of the Fund; Chairman of
the Board and Trustee or Director of all
other funds in the Keystone Families of
Funds; Chairman of the Board and Trustee of
Anatolia College; Trustee of University
Hospital (and Chairman of its Investment
Committee); former Director and Chairman of
the Board of Hartwell Keystone; and former
Chairman of the Board, Director and Chief
Executive Officer of Keystone Investments,
Inc.
EDWIN D. CAMPBELL: Trustee of the Fund; Trustee or
Director of all other funds in the Keystone
Families of Funds; Principal, Padanaram
Associates, Inc.; and former Executive
Director, Coalition of Essential Schools,
Brown University.
CHARLES F. CHAPIN: Trustee of the Fund; Trustee or
Director of all other funds in the Keystone
Families of Funds; and former Director,
Peoples Bank (Charlotte, NC).
K. DUN GIFFORD: Trustee of the Fund; Trustee or
Director of all other funds in the Keystone
Families of Funds; Trustee, Treasurer and
Chairman of the Finance Committee, Cambridge
College; Chairman Emeritus and Direc tor,
American Institute of Food and Wine;
Chairman and President, Oldways Preservation
and Exchange Trust (education); former
Chairman of the Board, Director, and
Executive Vice President, The London Harness
Company; former Managing Partner, Roscommon
Capital Corp.; former Chief Executive
Officer, Gifford Gifts of Fine Foods; former
Chairman, Gifford, Drescher & Associates
(environmental consulting); and former
Director, Keystone Investments, Inc.
JAMES S. HOWELL: Trustee of the Fund; Trustee or
Director of all other funds in the Keystone
Families of Funds; Chairman and Trustee or
Director of all of the funds in the
Evergreen Family of Funds; former Chairman
of the Distribution Foundation for the
Carolinas; and former Vice President of
Lance Inc. (food manufacturing).
LEROY KEITH, JR.: Trustee of the Fund; Trustee or
Director of all other funds in the Keystone
Families of Funds; Chairman of the Board and
Chief Executive Officer, Carson Products
Company; Director of Phoenix Total Return
Fund and Equifax, Inc.; Trustee of Phoenix
Series Fund, Phoenix Multi-Portfolio Fund,
and The Phoenix Big Edge Series Fund; and
former President, Morehouse College.
F. RAY KEYSER, JR.: Trustee of the Fund;
Trustee or Director of all other funds in
the Keystone Families of Funds; Chairman and
Of Counsel, Keyser, Crowley & Meub, P.C.;
Member, Governor's (VT) Council of Economic
Advisers; Chairman of the Board and
Director, Central Vermont Public Service
Corporation and Lahey Hitchcock Clinic;
Director, Vermont Yankee Nuclear Power
Corporation, Grand Trunk Corporation, Grand
Trunk Western Railroad, Union Mutual Fire
Insurance Company, New England Guaranty
Insurance Company, Inc., and the Investment
Company Institute; former Director and
President, Associated Industries of Vermont;
former Director of Keystone, Central Vermont
Railway, Inc., S.K.I. Ltd., and Arrow
Financial Corp.; and former Director and
Chairman of the Board, Proctor Bank and
Green Mountain Bank.
GERALD M. MCDONNELL: Trustee of the Fund; Trustee
or Director of all other funds in the
Keystone Families of Funds; Trustee or
Director of all of the funds in the
Evergreen Family of Funds; and Sales
Representative with Nucor- Yamoto, Inc.
(steel producer).
THOMAS L. MCVERRY: Trustee of the Fund; Trustee or
Director of all other funds in the Keystone
Families of Funds; Trustee or Director of
all of the funds in the Evergreen Family of
Funds; former Vice President and Director of
Rexham Corporation; and former Director of
Carolina Cooperative Federal Credit Union.
*WILLIAM WALT PETTIT: Trustee of the Fund; Trustee or
Director of all other funds in the Keystone
Families of Funds; Trustee or Director of
all of the funds in the Evergreen Family of
Funds; and Partner in the law firm of
Holcomb and Pettit, P.A.
DAVID M. RICHARDSON: Trustee of the Fund; Trustee
or Director of all other funds in the
Keystone Families of Funds; Vice Chair and
former Executive Vice President, DHR
International, Inc. (executive recruitment);
former Senior Vice President, Boyden
International Inc. (executive recruit ment);
and Director, Commerce and Industry
Association of New Jersey, 411
International, Inc., and J&M Cumming Paper
Co.
RUSSELL A.
SALTON, III MD: Trustee of the Fund; Trustee or
Director of all other funds in the Keystone
Families of Funds; Trustee or Director of
all of the funds in the Evergreen Family of
Funds; Medical Director, U.S. Health
Care/Aetna Health Services; and former
Managed Health Care Consultant; former
President, Primary Physician Care.
MICHAEL S. SCOFIELD: Trustee of the Fund; Trustee or
Director of all other funds in the Evergreen
Family of Funds; and Attorney, Law Offices
of Michael S. Scofield.
RICHARD J. SHIMA: Trustee of the Fund; Trustee or
Director of all other funds in the Keystone
Families of Funds; Chairman, Environmental
Warranty, Inc. (insurance agency); Executive
Consultant, Drake Beam Morin, Inc.
(executive outplacement); Director of
Connecticut Natural Gas Corpora tion,
Hartford Hospital, Old State House
Association, Middlesex Mutual Assurance
Company, and Enhance Financial Services,
Inc.; Chairman, Board of Trustees, Hartford
Graduate Center; Trustee, Greater Hartford
YMCA; former Director, Vice Chairman and
Chief Investment Officer, The Travelers
Corporation; former Trustee,
Kingswood-Oxford School; and former Managing
Director and Consultant, Russell Miller,
Inc.
ANDREW J. SIMONS: Trustee of the Fund; Trustee or
Director of all other funds in the Keystone
Families of Funds; Partner, Farrell, Fritz,
Caemmerer, Cleary, Barnosky & Armentano,
P.C.; Adjunct Professor of Law and former
Associate Dean, St. John's University School
of Law; Adjunct Professor of Law, Touro
College School of Law; and former President,
Nassau County Bar Association.
JOHN J. PILEGGI: President and Treasurer of the
Fund; President and Treasurer of all other
funds in the Keystone Families of Funds;
President and Treasurer of all of the funds
in the Evergreen Family of Funds; Senior
Managing Director, Furman Selz LLC since
1992; Managing Director from 1984 to 1992;
Consultant to BISYS Fund Services since
1996; 230 Park Avenue, Suite 910, New York,
NY.
GEORGE O. MARTINEZ: Secretary of the Fund;
Secretary of all other funds in the Keystone
Families of Funds; Secretary of all the
funds in the Evergreen Family of Funds;
Senior Vice President and Director of
Administration and Regulatory Services,
BISYS Fund Services; Vice
President/Assistant General Counsel,
Alliance Capital Management from 1988 to
1995; 3435 Stelzer Road, Columbus, Ohio.
* This Trustee may be considered an "interested person" of the Fund within the
meaning of the 1940 Act.
For the fiscal year ended December 31, 1996, none of the affiliated or
Independent Trustees and officers of the Fund received any direct remuneration
from the Fund. For the year ending December 31, 1996, fees paid to Independent
Trustees on a fund complex wide basis (which included approximately 60 mutual
funds) were approximately $846,350. On March 29, 1996, the Trustees and officers
of the Fund, as a group, beneficially owned less than 1% of the Fund's then
outstanding shares.
Except as set forth above, the address of all the Fund's Trustees and
officers is 200 Berkeley Street, Boston, Massachusetts 02116-5034.
Set forth below for each of the Trustees receiving in excess of $60,000
for the fiscal period of January 1, 1996 through December 31, 1996 is the
aggregate compensation paid to such Trustee by the Evergreen-Keystone Funds:
Aggregate Total Compensation
Compensation From Registrant
from and Fund Complex
Name Registrant Pd. To Trustee
James S. Howell $0 $66,000
Russell A Salton,III M.D. $0 $61,000
Michael S. Scofield $0 $61,000
INVESTMENT ADVISER
Subject to the general supervision of the Fund's Board of Trustees,
Keystone provides investment advice, management and administrative services to
the Fund.
On December 11, 1996, the predecessor corporation to First Union
Keystone, Keystone Investments, Inc. ("Keystone Investments") and indirectly
each subsidiary of Keystone Investments, including Keystone, were acquired (the
"Acquisition") by First Union National Bank of North Carolina ("FUNB"), a
wholly-owned subsidiary of First Union Corporation ("First Union"). Keystone
Investments was acquired by FUNB by merger into a wholly-owned subsidiary of
FUNB, which entity then assumed the name "First Union Keystone, Inc." and
succeeded to the business of the predecessor corporation. Contemporaneously with
the Acquisition, the Fund entered into a new investment advisory agreement with
Keystone and into a principal underwriting agreement with EKD, a wholly-owned
subsidiary of The BISYS Group, Inc. ("BISYS"). The new investment advisory
agreement (the "Advisory Agreement") was approved by the shareholders of the
Fund on December 9, 1996, and became effective on December 11, 1996. As a result
of the above transactions, Keystone Management, Inc. ("Keystone Management"),
which, prior to the Acquisition, acted as the Fund's investment manager, no
longer acts as such to the Fund. Keystone currently provides the Fund with all
the services that may previously have been provided by Keystone Management.
First Union Keystone and each of its subsidiaries, including Keystone,
are now indirectly owned by First Union. First Union is headquartered in
Charlotte, North Carolina, and had $140 billion in consolidated assets as of
December 31, 1996. First Union and its subsidiaries provide a broad range of
financial services to individuals and businesses throughout the United States.
The Capital Management Group of FUNB and Evergreen Asset Management Corp.,
wholly-owned subsidiaries of FUNB, manage or otherwise oversee the investment of
over $60 billion in assets as of December 31, 1996, belonging to a wide range of
clients, including the Evergreen Family of Funds.
Pursuant to the Advisory Agreement and subject to the supervision of
the Fund's Board of Trustees, Keystone furnishes to the Fund investment
advisory, management and administrative services, office facilities, and
equipment in connection with its services for managing the investment and
reinvestment of the Fund's assets. Keystone pays for all of the expenses
incurred in connection with the provision of its services.
All charges and expenses, other than those specifically referred to as
being borne by Keystone, will be paid by the Fund, including, but not limited
to, (1) custodian charges and expenses; (2) bookkeeping and auditors' charges
and expenses; (3) transfer agent charges and expenses; (4) fees and expenses of
Independent Trustees; (5) brokerage commissions, brokers' fees and expenses; (6)
issue and transfer taxes; (7) costs and expenses under the Distribution Plans;
(8) taxes and trust fees payable to governmental agencies; (9) the cost of share
certificates; (10) fees and expenses of the registration and qualification of
the Fund and its shares with the Securities and Exchange Commission (the
"Commission") or under state or other securities laws; (11) expenses of
preparing, printing and mailing prospectuses, statements of additional
information, notices, reports and proxy materials to shareholders of the Fund;
(12) expenses of shareholders' and Trustees' meetings; (13) charges and expenses
of legal counsel for the Fund and for the Independent Trustees of the Fund on
matters relating to the Fund; and (14) charges and expenses of filing annual and
other reports with the Commission and other authorities, and all extraordinary
charges and expenses of the Fund.
The Fund pays Keystone a fee at the end of each month for its services
consisting of (i) an amount calculated as set forth below:
Aggregate Net Asset
Management Value of the Shares
Fee Income of the Fund
- --------------------------------------------------------------------------
0.50% of the next 2.0% of Gross Dividend $ 100,000,000, plus
0.45% of the next and Interest Income Plus $ 100,000,000, plus
0.40% of the next $ 100,000,000, plus
0.35% of the next $ 100,000,000, plus
0.30% of the next $ 100,000,000, plus
0.25% of amounts over $ 500,000.000;
and (ii) an amount equal to the amount of the reimbursable expenses of Keystone
accrued during such calendar month.
Under the Advisory Agreement, any liability of Keystone in connection
with rendering services thereunder is limited to situations involving its
willful misfeasance, bad faith, gross negligence or reckless disregard of its
duties.
The Advisory Agreement continues in effect for two years from its
effective date and, thereafter, from year to year only if approved at least
annually by the Board of Trustees of the Fund or by a vote of a majority of the
Fund's outstanding shares (as defined in the 1940 Act). In either case, the
terms of the Advisory Agreement and continuance thereof must be approved by the
vote of a majority of the Independent Trustees cast in person at a meeting
called for the purpose of voting on such approval. The Advisory Agreement may be
terminated, without penalty, on 60 days' written notice by the Fund's Board of
Trustees or by a vote of a majority of outstanding shares. The Advisory
Agreement will terminate automatically upon its assignment.
- --------------------------------------------------------------------------------
PRINCIPAL UNDERWRITER
- --------------------------------------------------------------------------------
The Fund has entered into a Principal Underwriting Agreement (the
"Underwriting Agreement") with EKD. EKD, which is not affiliated with First
Union, replaces EKIS as the Fund's principal underwriter. EKIS may no longer act
as principal underwriter of the Fund due to regulatory restrictions imposed by
the Glass-Steagall Act upon national banks such as FUNB and their affiliates,
that prohibit such entities from acting as the underwriters of mutual fund
shares. While EKIS may no longer act as principal underwriter of the Fund as
discussed above, EKIS may continue to receive compensation from the Fund or EKD
in respect of underwriting and distribution services performed prior to the
termination of EKIS as principal underwriter. In addition, EKIS may also be
compensated by EKD for the provision of certain marketing support services to
EKD at an annual rate of up to 0.75% of the average daily net assets of the
Fund, subject to certain restrictions.
EKD, as agent, has agreed to use its best efforts to find purchasers
for the shares. EKD may retain and employ representatives to promote
distribution of the shares and may obtain orders from broker-dealers, and
others, acting as principals, for sales of shares to them. The Underwriting
Agreement provides that EKD will bear the expense of preparing, printing, and
distributing advertising and sales literature and prospectuses used by it. In
its capacity as principal underwriter, EKD or EKIS, its predecessor, may receive
payments from the Fund pursuant to the Fund's Distribution Plan.
The Underwriting Agreement provides that it will remain in effect as
long as its terms and continuance are approved annually (i) by a vote of a
majority of the Independent Trustees, and (ii) by vote of a majority of the
Trustees, in each case, cast in person at a meeting called for that purpose.
The Underwriting Agreement may be terminated, without penalty, on 60
days' written notice by the Board of Trustees or by a vote of a majority of
outstanding shares. The Underwriting Agreement will terminate automatically upon
its assignment.
From time to time, if, in EKD's judgment, it could benefit the sales of
Fund shares, EKD may provide to selected broker-dealers promotional materials
and selling aids, including, but not limited to, personal computers, related
software and Fund data files.
- --------------------------------------------------------------------------------
SUB-ADMINISTRATOR
- --------------------------------------------------------------------------------
BISYS, or an affiliate, provides officers and certain administrative
services to the Fund pursuant to a sub-administration agreement. For its
services under that agreement, BISYS will receive from Keystone an annual fee at
the maximum annual rate of 0.01% of the average daily net assets of the Fund.
DECLARATION OF TRUST
The Fund is a Massachusetts business trust originally established under
a Declaration of Trust dated April 12, 1977, as amended and restated on July 27,
1993 (the "Declaration of Trust"). The Fund is similar in most respects to a
business corporation. The principal distinction between the Fund and a
corporation relates to the shareholder liability described below. This summary
is qualified in its entirety by reference to the Declaration of Trust.
Description of Shares
The Declaration of Trust authorizes the issuance of an unlimited number
of shares of beneficial interest and the creation of additional series and/or
classes of series of Fund shares. Each share represents an equal proportionate
interest in the Fund with each other share of that class. Upon liquidation,
shares are entitled to a pro rata share in the net assets of their class of Fund
shares. Shareholders shall have no preemptive or conversion rights. Shares are
transferable. The Fund currently intends to issue only one class of shares.
Shareholder Liability
Pursuant to court decisions or other theories of law, shareholders of a
Massachusetts business trust could possibly be held personally liable as
partners for the obligations of the Fund. The possibility of Fund shareholders
incurring financial loss for that reason appears remote, however, because the
Declaration of Trust (1) contains an express disclaimer of shareholder liability
for obligations of the Fund; (2) requires that notice of such disclaimer be
given in each agreement, obligation or instrument entered into or executed by
the Fund or the Fund's Board of Trustees; and (3) provides for indemnification
out of Fund property for any shareholder held personally liable for the
obligations of the Fund.
Voting Rights
Under the terms of the Declaration of Trust, the Fund does not hold
annual meetings. At meetings called for the initial election of Trustees or to
consider other matters, shares are entitled to one vote per share. Shares
generally vote together as one class on all matters. No amendment may be made to
the Declaration of Trust that adversely affects any class of shares without the
approval of a majority of the shares of that class. There shall be no cumulative
voting in the election of Trustees.
After the initial meeting as described above, no further meetings of
shareholders for the purpose of electing Trustees will be held, unless required
by law or until such time as less than a majority of the Trustees holding office
have been elected by shareholders, at which time, the Trustees then in office
will call a shareholder's meeting for the election of Trustees.
Except as set forth above, the Trustees shall continue to hold office
indefinitely unless otherwise required by law and may appoint successor
Trustees. A Trustee may cease to hold office or may be removed from office (as
the case may be) (1) at any time by a two-thirds vote of the remaining Trustees;
(2) when such Trustee becomes mentally or physically incapacitated; or (3) at a
special meeting of shareholders by a two-thirds vote of the outstanding shares.
Any Trustee may voluntarily resign from office.
Limitation of Trustees' Liability
The Declaration of Trust provides that a Trustee will not be liable for
errors of judgment or mistakes of fact or law, but nothing in the Declaration of
Trust protects a Trustee against any liability to which he would otherwise be
subject by any reason of willful misfeasance, bad faith, gross negligence or
reckless disregard of his duties involved in the conduct of his office.
- --------------------------------------------------------------------------------
EXPENSES
- --------------------------------------------------------------------------------
Investment Advisory Fees
For each of the Fund's last three fiscal years, the table below lists
the total dollar amounts paid by (1) the Fund to Keystone Management, the Fund's
former investment manager, for investment management and administrative services
rendered and (2) by Keystone Management to Keystone for investment advisory
services rendered. For more information, see "Investment Adviser."
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Fiscal Year ended
December 31, Total Management Percent of Fund's
1996 Fee Paid Average Net Assets
- ------------------------- ---------------------------- ---------------------------- -----------------------
$6,642,609 0.42%
Fee Paid to Keystone Fee Paid to
Management under Keystone under
the Management the Advisory
Agreement Agreement
---------------------------- -----------------------
$6,272,478 $5,646,218
Period of 12/12/96
to 12/31/96 $370,131
Percent of Fund's
Fee Paid to Keystone Average Net Assets Fee Paid to
Management under represented by Keystone under
Fiscal Year Ended the Management Keystone the Advisory
December 31, Agreement Management's Fee Agreement
- ------------------------- ---------------------------- ---------------------------- -----------------------
1995 $5,327,202 0.44% $4,528,122
1994 $5,941,545 0.43% $5,050,313
</TABLE>
Distribution Plan Expenses
For the fiscal year ended December 31, 1996, the Fund paid $4,706,968
to EKIS under its Distribution Plan. For more information, see "Distribution
Plan."
Underwriting Commissions For each of the Fund's last three fiscal
years, the table below lists the aggregate dollar amounts of underwriting
commissions distribution fees plus CDSCs) paid with respect to the public
distribution of the Fund's shares. The table also indicates the aggregate dollar
amount of underwriting commissions retained by EKD and/or EKIS. For more
information, see "Principal Underwriter" and "Sales Charges."
<TABLE>
<CAPTION>
<S> <C> <C>
Aggregate Dollar Amount of
Fiscal Year Ended Aggregate Dollar Amount of Underwriting Commissions
December 31, Underwriting Commissions Retained by EKIS and/or EKD
- -------------------------- ---------------------------------------- -----------------------------------------
1996 $2,402,158 $632,014
1995 $2,537,213 $845,504
1994 $10,904,376 $9,742,842
</TABLE>
Brokerage Commissions
The Fund paid no brokerage commissions for the fiscal years ended December
31, 1996, 1995 and 1994.
- --------------------------------------------------------------------------------
FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
The Fund's financial statements for the fiscal year ended December 31,
1996, and the report thereon of KPMG Peat Marwick LLP, are incorporated by
reference herein from the Fund's Annual Report, as filed with the Commission
pursuant to Section 30(d) of the 1940 Act and Rule 30d-1 thereunder.
You may obtain a copy of the Fund's Annual Report without charge by
writing to EKSC, P.O. Box 2121, Boston, Massachusetts 02106-2121, or by calling
EKSC toll free at 1-800-343-2898.
STANDARDIZED TOTAL RETURN AND YIELD QUOTATIONS
Total return quotations for the Fund as they may appear from time to
time in advertisements are calculated by finding the average annual compounded
rates of return over the one-, five- and ten-year periods on a hypothetical
$1,000 investment that would equate the initial amount invested to the ending
redeemable value. To the initial investment all dividends and distributions are
added, and all recurring fees charged to all shareholder accounts are deducted.
The ending redeemable value assumes a complete redemption at the end of the one,
five or ten year periods.
The annual total return of the Fund for the one year period ended
December 31, 1996, including applicable sales charge, was 0.21%. The average
annual returns for the five- and ten-years ended December 31, 1996 were 5.91%
and 6.64%, respectively (including contingent deferred sales charge).
Current yield quotations as they may appear from time to time in
advertisements will consist of a quotation based on a 30-day period ended on the
date of the most recent balance sheet of the Fund, computed by dividing the net
investment income per share earned during the period by the maximum offering
price per share on the last day of the base period. The current yield for the
30-day period ended December 31, 1996 was 5.09%.
Tax equivalent yield is, in general, the current yield divided by a
factor equal to one minus a stated income tax rate and reflects the yield a
taxable investment would have to achieve in order to equal on an after tax-basis
a tax exempt yield. The tax equivalent yield for an investor in the 31% federal
tax bracket for the 30-day period ended December 31, 1996 was 7.38%.
Any given yield or total return quotation should not be considered
representative of the Fund's yield or total return for any future period.
ADDITIONAL INFORMATION
Except as otherwise stated in its prospectus or required by law, the
Fund reserves the right to change the terms of the offer stated in its
prospectus without shareholder approval, including the right to impose or change
fees for services provided.
As of April 1, 1997, Merrill Lynch Pierce Fenner & Smith, For Sole
Benefit of its Customers, Attn: Fund Administration, 4800 Deer Lake Dr. E., 3rd
Floor, Jacksonville, FL 32246-6484 owned of record 12.97% of the Fund's
outstanding shares.
No dealer, salesman or other person is authorized to give any
information or to make any representation not contained in the Fund's
prospectus, this statement of additional information, or in supplemental sales
literature issued by the Fund or the Principal Underwriter, and no person is
entitled to rely on any information or representation not contained therein.
For information on taxes, particularly with respect to dividends and
the Fund's qualifications as a registered investment company, please refer to
the section of your prospectus entitled "Dividends and Taxes."
The Fund's prospectus and this statement of additional information omit
certain information contained in the registration statement filed with the
Commission, which may be obtained from the Commission's principal office in
Washington, D.C. upon payment of the fee prescribed by the rules and regulations
promulgated by the Commission.
<PAGE>
Evergreen Keystone
National Tax Free
Funds
(Photo of mountain and stream surrounded by trees)
1997 Annual Report
Evergreen Keystone
(logo) FUNDS (logo)
<PAGE>
(logo) EVERGREEN KEYSTONE
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C>
Letter to Shareholders............................... 1
Evergreen High Grade Tax Free Fund
Fund at a Glance................................... 2
Management Report.................................. 3
Evergreen Short-Intermediate Municipal Fund
Fund at a Glance................................... 4
Management Report.................................. 5
Keystone Tax Free Income Fund
Fund at a Glance................................... 6
Management Report.................................. 7
Growth of Investments................................ 8
Financial Highlights
Evergreen High Grade Tax Free Fund................. 9
Evergreen Short-Intermediate Municipal Fund........ 11
Keystone Tax Free Income Fund...................... 13
Schedule of Investments
Evergreen High Grade Tax Free Fund................. 16
Evergreen Short-Intermediate Municipal Fund........ 20
Keystone Tax Free Income Fund...................... 22
Statements of Assets and Liabilities................. 27
Statements of Operations............................. 28
Statements of Changes in Net Assets.................. 30
Combined Notes to Financial Statements............... 33
Report of Independent Accountants-- Price Waterhouse
LLP................................................ 39
Independent Auditors' Report-- KPMG Peat Marwick
LLP................................................ 41
</TABLE>
ABOUT EVERGREEN KEYSTONE
Since 1971, the Evergreen Funds have been providing investors with a proven,
value-driven approach to equity investment management. For over 60 years of
changing economic conditions, Keystone has taken pride in helping investors meet
their financial goals through a broad range of financial products and services.
Combined, Evergreen Keystone offers over 70 funds designed to meet a broad range
of objectives, including fixed-income, balanced, growth and income, and
aggressive growth. Assets under management total more than $30 billion.
<PAGE>
EVERGREEN KEYSTONE
(logo)
LETTER TO SHAREHOLDERS
July 1997
(Photo of William M. Ennis)
WILLIAM M. ENNIS
Dear Shareholders:
They don't have the glamour or the impressive recent returns of stock funds, but
municipal bond funds quietly have been doing their job for the past three years.
In fact, the average annual return of the Lehman Brothers Municipal Bond Index
for the three years that ended on May 31, 1997 was 7.32%. Considering the tax
advantages and relatively low volatility of municipal bonds and the modest
inflation we have been enjoying, that is nothing to ignore. In fact, on May 31,
the average AAA-rated 30-year municipal bond was yielding 5.50%. For investors
in the 31% federal income tax bracket, that's equivalent to a
before-federal-taxes yield of 7.97% on a taxable bond at a time when the 30-year
Treasury bond was yielding less than 7%.
The outlook for municipal bonds is no less encouraging. Thanks to factors that
include the careful monetary policy of the Federal Reserve Board and the
increasing productivity of American industry, we continue to expect a sustained
economic environment of moderate growth, contained inflation, low unemployment,
and stable interest rates. That is an ideal climate for bond investing in
general, and municipal bond investing in particular, especially considering the
rather limited supply of new municipal bonds available in the market. During
1996, new municipal bond issuance totaled $185 billion, compared to the $292
billion peak in 1993. In the face of this limited supply, an increase in demand
for municipal bonds could have a favorable impact on performance.
It is easy to believe we could see an increase in demand. As stock market prices
reach record highs in late spring and early summer, it makes more and more sense
for investors to allocate at least a portion of their portfolios into bond
funds. That makes sense for both diversification purposes and for risk reduction
reasons. For investors in higher income tax brackets, municipal bond funds make
even more sense. At Evergreen Keystone, we also believe it is important for
investors to remain in close touch with their professional advisers for guidance
on changing markets and strategies.
I am delighted to inform you that Evergreen Keystone successfully integrated all
service functions of the Evergreen and Keystone Funds in early May. This means
that you now have full exchange privileges among all Evergreen and Keystone
America Funds. In addition, you will be receiving the top-flight shareholder
service that earned Evergreen Keystone the 1996 Dalbar Quality Tested Service
Seal, the highest award for mutual fund service presented by Dalbar, an
independent mutual fund survey and rating firm.
In the following pages, Evergreen Keystone investment professionals will give
you more detailed information about the investment environment and the
strategies employed in managing your funds. You will notice that this annual
report is a departure from past reports in format. It represents the effort of
Evergreen Keystone Funds to provide honest, thoughtful reports and to present
them in a format that is attractive and makes information easily accessible. We
are very interested in hearing your thoughts on this new format, and we welcome
any suggestions you may have.
Sincerely,
/s/ William M. Ennis
WILLIAM M. ENNIS
MANAGING DIRECTOR
1
<PAGE>
(logo) EVERGREEN
HIGH GRADE TAX FREE FUND
FUND-AT-A-GLANCE
As of May 31, 1997
<TABLE>
<CAPTION>
ONE YEAR PERFORMANCE CLASS A CLASS B CLASS Y
<S> <C> <C> <C>
One year with sales charge 1.90% 1.19% 7.25%
One year w/o sales charge 6.99% 6.19% 7.25%
One year dividends per share 50.2(cents) 42.1(cents) 52.0(cents)
30-day SEC Yield
(as of 5/31/97) 4.19% 3.63% 4.66%
<CAPTION>
AVERAGE
ANNUAL RETURNS** CLASS A CLASS B CLASS Y
<S> <C> <C> <C>
Three years 5.11% 5.16% 7.10%
Five years 5.75% N/A N/A
Since Inception* 6.00% 5.13% 5.11%
<CAPTION>
CUMULATIVE RETURNS** CLASS A CLASS B CLASS Y
<S> <C> <C> <C>
Nine months w/o sales charge 5.13% 4.55% 5.32%
Three years 16.13% 16.30% 22.83%
Five years 32.24% N/A N/A
Since Inception* 36.01% 24.55% 17.64%
</TABLE>
* CLASS A BEGAN 2/21/92; CLASS B BEGAN 1/11/93;
CLASS Y BEGAN 2/28/94
** ALL RETURNS INCLUDE THE MAXIMUM SALES CHARGE, IF APPLICABLE.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS MAY 31, 1997
<S> <C> <C> <C>
Total Net Assets (all classes) $102.1 million
Average Credit Quality AAA
Average Maturity 12.3 years
Average Duration 8.2 years
</TABLE>
PORTFOLIO COMPOSITION MAY 31, 1997
(AS A PERCENTAGE OF PORTFOLIO ASSETS)
(Pie chart appears here with the following plot points.)
Hospital 14.8%
Ports 9.4%
Industrial Development
(pollution control) 8.5%
Electric 8.0%
General Obligation
(schools) 8.8%
Water/Sewer 6.5%
Airport 6.2%
Industrial Development 5.3%
Housing 4.9%
Pre-refunded 4.6%
General Obligation
(municipalities) 3.8%
General Obligation 3.8%
Toll Roads 3.3%
Other 12.1%
PORTFOLIO ALLOCATIONS ARE SUBJECT TO CHANGE.
OBJECTIVE
Evergreen High Grade Tax Free Fund seeks income exempt from federal income taxes
while conserving capital. Income may be subject to local taxes and the Federal
Alternative Minimum Tax for certain investors.
STRATEGY
The Fund seeks its objective by investing in insured municipal securities and
municipal securities rated high grade by independent bond rating services. The
portfolio management team will, in seeking the Fund's objectives, buy and sell
securities to effect changes in portfolio maturities and to change allocations
among different sectors. Insured bonds are bonds insured as to timely payment of
principal and interest. The Fund itself is not insured, nor is the value of its
shares guaranteed. Insured bonds must be insured by a municipal bond insurance
company which is rated AAA by Standard & Poors Ratings Group (S&P) and/or Aaa by
Moody's Investors Service, Inc., (Moody's). Bonds that are considered high grade
are rated A or better by S&P or Moody's or, if unrated, are considered of
comparable quality as determined by the Fund's investment advisor.
PORTFOLIO MANAGEMENT TEAM
(Photo of James T. Colby, III, the Senior Portfolio Manager, is a Vice
James T. Colby, President and Senior Portfolio Manager of Evergreen Asset
III) Management. He also is Senior Portfolio Manager for Evergreen
U.S. Government Securities Fund and is co-manager of the
Evergreen Tax Strategic Foundation Fund. Prior to joining
Evergreen in 1992, Mr. Colby was Vice President and Senior
Portfolio Manager for $5 billion in tax-exempt holdings at
American Express. Mr. Colby also has served in portfolio
management capacities at Marinvest, a subsidiary of Marine
Midland Bank. He is a graduate of Brown University, and holds
an MBA from Hofstra University. In 1996, Mr. Colby was
Chairman of the Municipal Bond Buyers Conference.
2
<PAGE>
EVERGREEN
HIGH GRADE TAX FREE FUND
(logo)
MANAGEMENT REPORT
July 1997
Dear Fellow Shareholders:
We are pleased to report on Evergreen High Grade Tax Free Fund for the fiscal
period that ended on May 31, 1997. You may recall that you recently received a
semiannual report for the six-month period that ended on February 28, 1997. We
have changed your Fund's fiscal year so it now will end each May 31. This is
part of an effort by Evergreen Keystone Funds to streamline, and increase the
efficiency of, fund administration. Funds with similar investment objectives, in
this case national tax free funds, are placed on the same fiscal year cycle.
Information about these funds will be presented in common annual and semi-annual
reports. The next report you will receive will be a semiannual report for the
period ending November 30, 1997. You should expect to receive it in January
1998.
PERFORMANCE
We believe your Fund performed well as a high quality municipal bond fund during
a period marked by short-term interest rate volatility. The charts and tables on
page 2 provide a comprehensive view of the performance for the fiscal period, as
well as since each class of shares began.
STRATEGY
Evergreen High Grade Tax Free Fund is managed with a long-term view, with the
goal of providing federally tax-free income from insured and high quality
municipal bonds while protecting principal. We do not structure the portfolio in
anticipation of short-term movements in interest rates, but try to employ
strategies that build value over time based on longer-term trends in the
municipal bond market. The nine-month period that ended on May 31 was a
generally favorable period for municipal bond investing. During this period, we
kept the maturities of bonds in the portfolio relatively consistent, with
average maturities remaining in the 12-to-16 year range, and average duration in
the 7-to-9-year range. This policy proved successful during a time when
long-term interest rates, despite some short-term volatility, remained in a
consistent trading range of 6 1/2% to 7%.
Your Fund is required to invest at least 65% of net assets in high grade
municipal bonds. In fact, the Fund held 87% of net assets in insured municipal
bonds, with 95% of net assets AAA-rated at the end of the period. The bonds are
insured for the timely payment of principal and interest. The value of insured
bonds can fluctuate. The Fund itself is not insured. The Fund does not search
for opportunities among bonds that are below investment grade.
Evergreen High Grade Tax Free Fund invests in different sectors of the market
based upon evolving trends. For example, two sectors-- the hospital/health care
and the electric utility sectors-- have experienced changes which affected
portfolio strategy recently. In the hospital sector, the process of
consolidation has left behind the weaker institutions which we have pointedly
avoided. We hold only the dominant regional facilities or those aligned with
strong national systems, which we believe have the strongest potential to
survive the new era of competition. Accordingly, we have increased the Fund's
allocation to 14.8% of the net assets. Conversely, the impact of deregulation
and competition upon municipal utilities is less clear and we have decreased the
Fund's allocation to this sector to 7.9%, though we will closely monitor
important legislation pending in states on the east and west coasts which may
soon set new strategic parameters for this sector. For comparison, three years
ago this Fund's relative weightings of these two sectors would have been
reversed.
OUTLOOK
Looking ahead, we continue to see a favorable investment environment for
municipal bonds. We anticipate long-term interest rates, as represented by the
benchmark 30-year U.S. Treasury Bond, to trade in the 6-to-7% range, with
relatively firm economic growth and stable inflation.
Within this environment, we will continue our strategy of seeking to provide as
reasonable a yield as is possible, without assuming significant market risks by
extending maturities. At the same time, we will continue to monitor changes in
the municipal bond industry and put in place further strategies that have the
potential to benefit from evolving trends.
Thank you for your support of the Evergreen High Grade Tax Free Fund.
Sincerely,
/s/ James T. Colby, III
JAMES T. COLBY, III
VICE PRESIDENT
SENIOR PORTFOLIO MANAGER
Evergreen Asset Management Corp.
3
<PAGE>
EVERGREEN
(logo) SHORT-INTERMEDIATE MUNICIPAL FUND
FUND-AT-A-GLANCE
As of May 31, 1997
<TABLE>
<CAPTION>
ONE YEAR PERFORMANCE CLASS A CLASS B CLASS Y
<S> <C> <C> <C>
One year with sales charge 0.92% 1.51% 4.62%
One year w/o sales charge 4.31% 3.49% 4.62%
One year dividends per share 39.7(cents) 30.7(cents) 40.7 (cents)
30-day SEC Yield
(as of 5/31/97) 3.74% 2.94% 3.93%
<CAPTION>
AVERAGE
ANNUAL RETURNS** CLASS A CLASS B CLASS Y
<S> <C> <C> <C>
Three years N/A N/A 3.95%
Five years N/A N/A 4.44%
Since Inception* 3.40% 2.76% 4.88%
<CAPTION>
CUMULATIVE RETURNS** CLASS A CLASS B CLASS Y
<S> <C> <C> <C>
Nine months w/o sales charge 3.08% 2.49% 3.36%
Three years N/A N/A 12.33%
Five years N/A N/A 24.26%
Since Inception* 8.38% 6.76% 30.24%
</TABLE>
* CLASSES A AND B BEGAN 1/5/95; CLASS Y BEGAN 7/17/91. SINCE
INCEPTION RETURN FOR CLASS Y SHARES REFLECTS TOTAL RETURN FROM
11/18/91 WHEN THE FUND CHANGED TO A FLUCTUATING NET ASSET VALUE FUND.
** ALL RETURNS INCLUDE THE MAXIMUM SALES CHARGE, IF APPLICABLE.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS MAY 31, 1997
<S> <C> <C> <C>
Total Net Assets (all classes) $45.1 million
Average Credit Quality AA
Average Maturity 2.7 years
Average Duration 2.4 years
</TABLE>
PORTFOLIO QUALITY MAY 31, 1997
(AS A PERCENTAGE OF PORTFOLIO ASSETS)
(Pie chart appears here with the following plot points.)
NR 2.25%
AAA 45.52%
AA 37.37%
A 12.63%
BBB 2.23%
PORTFOLIO ALLOCATIONS ARE SUBJECT TO CHANGE.
OBJECTIVE
Evergreen Short-Intermediate Municipal Fund seeks income that is exempt from
federal income taxes, while preserving capital. Income may be subject to local
taxes and the Federal Alternative Minimum Tax for certain investors.
STRATEGY
The Fund invests in high-quality and upper medium-quality municipal bonds. The
average maturity of bonds in the portfolio is expected to be between two and
five years.
PORTFOLIO MANAGEMENT TEAM
(Photo of Steven Steven C. Shachat, Portfolio Manager of Evergreen
C. Shachat) Short-Intermediate Municipal Fund, has been a member of the
investment team of Evergreen Asset Management team since 1988,
concentrating on short-term tax exempt investments. He also is
manager of the Evergreen Tax-Exempt Money Market Fund and the
Evergreen Short-Intermediate Municipal Fund-California. Prior
to joining Evergreen, Mr. Shachat served at Mitchell Hutchins
Asset Management, Inc., a subsidiary of Paine Webber, Inc., as
a Portfolio Manager in the tax-exempt area. Earlier, he served
at Donald Sheldon & Co., a firm specializing in tax-exempt
securities. Mr. Shachat is a graduate of Boston University.
4
<PAGE>
EVERGREEN
SHORT-INTERMEDIATE MUNICIPAL FUND
(logo)
MANAGEMENT REPORT
July 1997
Dear Fellow Shareholders:
We are pleased to report on Evergreen Short-Intermediate Municipal Fund for the
fiscal period that ended on May 31, 1997. You may recall that you recently
received a semiannual report for the six-month period that ended on February 28,
1997. We have changed your Fund's fiscal year so that it now will end each May
31. This is part of an effort by Evergreen Keystone Funds to streamline, and
increase the efficiency of, fund administration. Funds with similar investment
objectives, in this case national tax free funds, are placed on the same fiscal
year cycle. Information about these funds will be presented in common annual and
semiannual reports. The next report you will receive will be a semiannual report
for the period ending November 30, 1997. You should expect to receive it in
January 1998.
PERFORMANCE
We believe the Fund performed satisfactorily, consistent with its objective,
which is to seek to provide as high a level of income, exempt from federal
income taxes other than the alternative minimum tax, as is consistent with
preserving capital and providing liquidity. The tables on page 4 provide a
comprehensive view of the performance for the fiscal period, as well as since
each class of shares began.
STRATEGY
Evergreen Short-Intermediate Municipal Fund, in the face of a significant amount
of near-term interest rate volatility, maintained a laddered structure of its
portfolio securities. This strategy, which seeks to maintain as stable a price
as possible, is one in which the maturities of the portfolio are spread
throughout the range in which the Fund invests. There is not an over-emphasis on
securities that are on either the long end or the short end of the range. The
allocation of the maturity dates of the Fund's portfolio securities is
illustrated in the pie chart on this page. As interest rates changed during the
period, your Fund was able to use the proceeds from the minority of securities
which had matured to re-invest at current market rates.
An additional factor which contributed to your Fund's dividend income was the
employment of a strategy to seek opportunities in sectors that we believed may
have been undervalued. One example is the healthcare sector, where a series of
consolidations and mergers among hospitals and other health care delivery
institutions have
PORTFOLIO MATURITIES MAY 31, 1997
(AS A PERCENTAGE OF PORTFOLIO ASSETS)
(Pie chart appears here with the following plot points.)
0-1 years 17 %
1-2 years 19.8%
2-3 years 11.8%
3-4 years 21.4%
4-5 years 24.4%
5-7 years 5.6%
PORTFOLIO ALLOCATIONS ARE SUBJECT TO CHANGE.
helped some previously weaker institutions become stronger. This made bonds
issued by these institutions more attractive, given the institutions' new
strength. Another area in which we increased the Fund's emphasis was in general
obligation bonds, backed by the full taxing ability of municipalities and other
public agencies.
The Fund continues to maintain an emphasis on quality, with an average credit
rating of AA at the end of the period.
OUTLOOK
We anticipate the demand for municipal bonds in the short-to-intermediate
maturity range to continue to be strong. At a time of some uncertainty over the
direction of interest rates, at least for the near term, investors appear to
want to take a conservative approach and maintain short-to-intermediate term
securities in their portfolios. We believe the potential implications are that
these securities should continue to exhibit relatively stable prices because of
the strong demand, but that yields available may not rise significantly.
Thank you for your support of Evergreen Short-Intermediate Municipal Fund.
Sincerely,
/s/ Steven C. Shachat
STEVEN C. SHACHAT
PORTFOLIO MANAGER
Evergreen Asset Management Corp.
5
<PAGE>
KEYSTONE
(logo) TAX FREE INCOME FUND
FUND-AT-A-GLANCE
As of May 31, 1997
<TABLE>
<CAPTION>
ONE YEAR PERFORMANCE CLASS A CLASS B CLASS C
<S> <C> <C> <C>
One year with sales charge 1.80% 1.03% 5.03%
One year w/o sales charge 6.88% 6.03% 6.03%
One year dividends per share 50.7(cents) 43.5(cents) 43.5 (cents)
30-day SEC Yield
(as of 5/31/97) 4.58% 4.05% 4.05%
<CAPTION>
AVERAGE
ANNUAL RETURNS** CLASS A CLASS B CLASS C
<S> <C> <C> <C>
Three years 4.39% 4.39% 5.26%
Five years 4.64% N/A N/A
Ten years 6.23% N/A N/A
Since Inception* N/A 3.84% 4.22%
<CAPTION>
CUMULATIVE RETURNS** CLASS A CLASS B CLASS C
<S> <C> <C> <C>
Six months w/o sales charge 1.34% 0.97% 0.97%
Three years 13.75% 13.76% 16.63%
Five years 25.44% N/A N/A
Ten years 83.03% N/A N/A
Since Inception* N/A 17.73% 19.61%
</TABLE>
* CLASS A BEGAN 2/13/87. CLASS B AND CLASS C BEGAN 2/1/93.
** ALL RETURNS INCLUDE THE MAXIMUM SALES CHARGE, IF APPLICABLE. FOR CLASSES WITH
MORE THAN 10-YEAR HISTORY, THE 10-YEAR HISTORY IS PRESENTED.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS MAY 31, 1997
<S> <C>
Total Net Assets (all classes) $113.3 million
Average Credit Quality AA+
Average Maturity 17 years
Average Duration 8 years
</TABLE>
PORTFOLIO QUALITY MAY 31, 1997
(AS A PERCENTAGE OF PORTFOLIO ASSETS)
(Pie chart appears here with the following plot points.)
AAA 62.8%
NR 5.0%
A 9.5%
AA 10.5%
BBB 12.2%
PORTFOLIO ALLOCATIONS ARE SUBJECT TO CHANGE.
OBJECTIVE
Keystone Tax Free Income Fund seeks the highest possible current income exempt
from federal taxes, while preserving capital. Income may be subject to local
taxes and the Federal Alternative Minimum Tax for certain investors.
STRATEGY
The Fund invests in high quality municipal bonds from different regions of the
country. In pursuing the Fund's objective, the portfolio management team may
make adjustments in the portfolio's maturity, asset allocation among sectors, or
credit quality. When targeting investments, the portfolio management team seeks
out bonds that meet high standards for safety and creditworthiness. These bonds
are principally rated within the four highest grades by established rating
agencies. Keystone's fixed income analysts also conduct extensive in-house
research and regularly monitor bonds in the portfolio.
PORTFOLIO MANAGEMENT
(Photo of Betsy Betsy A. Hutchings, a Senior Vice President and Group Leader
A. Hutchings) of the Municipal Bond Team of Keystone Investment Management
Company, is Portfolio Manager of the Fund. A professional with
more than 15 years' experience in investment management, Ms.
Hutchings also is Portfolio Manager of Keystone Tax Free Fund.
Prior to joining Keystone in 1988, Ms. Hutchings served in
portfolio management and research positions at Scudder Stevens
& Clark, New York, and John Nuveen & Co., Chicago. Ms.
Hutchings is active in the Boston Municipal Analysts Forum and
the Municipal Bond Buyers Conference. She is a graduate of
Wheaton College.
6
<PAGE>
KEYSTONE
TAX FREE INCOME FUND
(logo)
MANAGEMENT REPORT
July 1997
Dear Shareholders:
We are pleased to report on Keystone Tax Free Income Fund for the fiscal period
that ended on May 31, 1997. You may recall that you recently received an annual
report for the fiscal period that ended November 30, 1996. We have changed your
Fund's fiscal year so that it will now end each May 31. This is part of an
effort by Evergreen Keystone Funds to streamline, and increase the efficiency
of, fund administration. Funds with similar investment objectives, in this case
national tax free funds, are being placed on the same fiscal year cycle, and
information about these funds will be presented in common annual and semi-annual
reports. The next report you will receive will be a semi-annual report for the
period ending November 30, 1997. You should expect to receive it in January
1998.
PERFORMANCE
We believe your Fund performed satisfactorily in a challenging interest rate
environment over the past six months. During this period, rates moved down and
then up before ending at approximately the same point as they began. The bond
market in general was vigilant about a possible pickup of inflation and the
potential of higher interest rates. In fact, after interest rates fell during
late 1996 and very early 1997, they started to rise again in February and March,
hurting the prices of bonds in general, including municipal bonds.
STRATEGY
In this changing environment, we managed your Fund conservatively, as we both
shortened the overall maturity of portfolio holdings and upgraded the average
quality of the bonds. At the same time as we were reducing the interest rate
risk by selling longer maturity bonds into the market as rates were falling, we
were also reducing credit risk by improving overall quality. This quality
upgrade was achieved by paring back BBB-rated and nonrated bonds and using the
proceeds to buy higher quality holdings, principally AAA-rated bonds. During the
past 12 months, the percentage of AAA-rated holdings in the portfolio went from
40% to 54%.
Through the full 12-month period, the average maturity of bond holdings was
reduced from 18.5 years to 17 years, while the average credit quality was
increased from AA- to AA+.
We pursued these tactics with two objectives:
(Bullet) To lock-in gains through the sale of bonds that had performed well.
(Bullet) To position the Fund more defensively by lowering both interest rate
risk and credit risk.
OUTLOOK
Looking forward, we are positive about the investment environment for municipal
bonds. On a technical basis, the demand for bonds is strong, with a relatively
limited
PORTFOLIO COMPOSITION MAY 31, 1997
(AS A PERCENTAGE OF NET ASSETS)
(Pie chart appears with the following plot points)
General Obligations 16.6%
Hospital 14.0%
Water & Sewer 12.9%
Electric 8.5%
Transportation 8.0%
Industrial Development
(pollution control) 7.1%
Pre-Refunded 6.9%
Housing 6.5%
Education 6.4%
Airports 4.8%
Solid Waste 1.3%
Other 7.0%
supply of available bonds as public agencies in general have been restrained in
borrowing. On an after-tax, after-inflation basis, municipal bonds continue to
appear to be an attractive value. At the close of the period, for example, an
AA-rated 30-year municipal bond was yielding 85% of the yield of a 30-year
Treasury bond.
On a fundamental economic basis, the overall economy is growing at a moderate
basis, with inflation well under control. Shorter-term, fixed income investors
can be expected to continue to watch nervously for signs of inflation, and there
may be some month-to-month interest rate volatility. Longer term, we see more
reason for stability in interest rates, as it appears that the policies of the
Federal Reserve Board have been successful in keeping inflation well under
control.
With this outlook, we continue to emphasize the income from higher quality bonds
in the 15-to-20-year maturity range and to be guardedly optimistic.
Thank you for your support of Keystone Tax Free Income Fund.
Sincerely,
/s/ Albert H. Elfner, III
ALBERT H. ELFNER, III
CHAIRMAN
Keystone Investment Management Company
/s/ Betsy A. Hutchings
BETSY A. HUTCHINGS
SENIOR VICE PRESIDENT
HEAD, MUNICIPAL BOND GROUP
Keystone Investment Management Company
7
<PAGE>
EVERGREEN KEYSTONE
(logo)
GROWTH OF INVESTMENTS
EVERGREEN HIGH GRADE TAX FREE FUND
Comparisons of a $10,000 investment in Evergreen High Grade Tax Free Fund,
Class A shares, versus a similar investment in the Lehman Brothers Insured
Bond Index (LBIBI) and the Consumer Price Index (CPI).
In Thousands
Average Annual Total Returns
1 Year 5 Year Life of Class
Class A 1.90% 5.75% 6.00%
Class B 1.19% -- 5.13%
Class Y 7.25% -- 5.11%
(Line graph appears here with the following plot points.)
2/92 5/92 5/93 5/94 5/95 5/96 5/97
Class A Shares (PLEASE FILL IN) $13,601
CPI (PLEASE FILL IN) $11,591
LBIBI (PLEASE FILL IN) $14,607
Past performance is no guarantee of future results. The performance of each
class may vary baed on differences in loads and fees paid by the shareholder
investing in the different classes. The Lehman Brothers Insured Bond Index
is an unmanaged, market index. The index does not include transaction costs
associated with buying and selling securities, nor any management fees. The
Consumer Price Index, a measure of inflation, is through May 31, 1997.
EVERGREEN SHORT-INTERMEDIATE MUNICIPAL FUND
Comparisons of a $10,000 investment in Evergreen Short-Intermediate
Municipal Fund, Class A shares, versus a similar investment in the Lehman
Brothers 3 Year Municipal Bond Index (LB3YMBI) and the Consumer Price
Index (CPI).
In Thousands
Average Annual Total Returns
1 Year 5 Year Life of Class
Class A 0.92% -- 3.40%
Class B 1.51% -- 2.76%
Class Y 4.62% 4.44% 4.88%
(Line graph appears here with the following plot points.)
1/95 5/95 11/95 5/96 11/96 5/97
Class A Shares (PLEASE FILL IN) $10,695
CPI (PLEASE FILL IN) $10,838
LB3YMBI (PLEASE FILL IN) $11,560
Past performance is no guarantee of future results. The performance of each
class may vary based on differences in loads and fees paid by the shareholder
investing in the different classes. The Lehman Brothers 3 Year Municipal Bond
Index is an unmanaged, market index. The index does not include transaction
costs associated with buying and selling securities, nor any management fees.
The Consumer Price Index, a measure of inflation, is through May 31, 1997.
KEYSTONE TAX FREE INCOME FUND
Comparisons of a $10,000 investment in Keystone Tax Free Income Fund,
Class A shares, versus a similar investment in the Lehman Brothers Municipal
Bond Index (LMBI) and the Consumer Price Index (CPI).
In Thousands
Average Annual Total Returns
1 Year 5 Year 10 Year Life of Class
Class A 1.80% 4.64% 6.23% --
Class B 1.03% -- -- 3.84%
Class Y 5.03% -- -- 4.22%
(Line graph appears here with the following plot points.)
<TABLE>
<CAPTION>
5/97 5/88 5/89 5/90 5/91 5/92 5/93 5/94 5/95 5/96 5/97
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Class A Shares (PLEASE FILL IN) $18,303
CPI (PLEASE FILL IN) $14,158
LMBI (PLEASE FILI IN) $22,346
</TABLE>
Past performance is no guarantee of future results. The performance of each
class may vary based on differences in loads and fees paid by the shareholder
investing in the different classes. The Lehman Brothers Municipal Bond
Index is an unmanaged, market index. The index does not include transaction
costs associated with buying and selling securities, nor any management fees.
The Consumer Price Index, a measure of inflation, is through May 31, 1997.
8
<PAGE>
EVERGREEN
HIGH GRADE TAX FREE FUND
(logo)
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
EIGHT
MONTHS
NINE MONTHS YEAR ENDED ENDED YEAR ENDED
ENDED AUGUST 31, AUGUST 31, DECEMBER 31,
MAY 31, 1997 (a) 1996 1995 (d) 1994 1993
<S> <C> <C> <C> <C> <C>
CLASS A SHARES
NET ASSET VALUE BEGINNING OF PERIOD... $ 10.72 $ 10.69 $ 9.79 $ 11.16 $ 10.42
INCOME FROM INVESTMENT OPERATIONS:
Net investment income................. 0.37 0.52 0.34 0.52 0.54
Net realized and unrealized gain
(loss) on investments............... 0.17 0.03 0.90 (1.37) 0.81
Total from investment operations...... 0.54 0.55 1.24 (0.85) 1.35
LESS DISTRIBUTIONS FROM:
Net investment income................. (0.37) (0.52) (0.34) (0.52) (0.54)
Net realized gains on investments..... 0 0 0 0 (0.07)
Total distributions................... (0.37) (0.52) (0.34) (0.52) (0.61)
NET ASSET VALUE END OF PERIOD......... $ 10.89 $ 10.72 $ 10.69 $ 9.79 $ 11.16
Total return (c)...................... 5.13% 5.21% 12.83% (7.71%) 13.25%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses...................... 1.03%(b) 0.89% 1.06%(b) 1.01% 0.85%
Total expenses excluding indirectly
paid expenses..................... 1.03%(b) -- -- -- --
Total expenses excluding waivers and
reimbursements.................... 1.11%(b) 1.09% 1.09%(b) 1.02% 1.07%
Net investment income............... 4.60%(b) 4.78% 4.93%(b) 5.04% 4.99%
Portfolio turnover rate............... 114% 65% 27% 53% 14%
NET ASSETS END OF PERIOD
(THOUSANDS)......................... $ 45,814 $ 50,569 $ 58,751 $57,676 $101,352
<CAPTION>
FEBRUARY 21, 1992
(COMMENCEMENT
OF CLASS OPERATIONS)
THROUGH
DECEMBER 31, 1992
<S> <C>
CLASS A SHARES
NET ASSET VALUE BEGINNING OF PERIOD... $ 10.00
INCOME FROM INVESTMENT OPERATIONS:
Net investment income................. 0.51
Net realized and unrealized gain
(loss) on investments............... 0.42
Total from investment operations...... 0.93
LESS DISTRIBUTIONS FROM:
Net investment income................. (0.51)
Net realized gains on investments..... 0
Total distributions................... (0.51)
NET ASSET VALUE END OF PERIOD......... $ 10.42
Total return (c)...................... 9.48%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses...................... 0.49%(b)
Total expenses excluding indirectly
paid expenses..................... --
Total expenses excluding waivers and
reimbursements.................... 1.11%(b)
Net investment income............... 5.79%(b)
Portfolio turnover rate............... 7%
NET ASSETS END OF PERIOD
(THOUSANDS)......................... $ 90,738
</TABLE>
(a) The Fund changed its fiscal year end from August 31 to May 31 during the
current period.
(b) Annualized.
(c) Excluding applicable sales charges.
(d) The Fund changed its fiscal year end from December 31 to August 31.
SEE COMBINED NOTES TO FINANCIAL STATEMENTS.
9
<PAGE>
EVERGREEN
HIGH GRADE TAX FREE FUND
(logo)
FINANCIAL HIGHLIGHTS (CONTINUED)
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
EIGHT MONTHS
NINE MONTHS ENDED YEAR ENDED
ENDED YEAR ENDED AUGUST 31, DECEMBER 31,
MAY 31, 1997 (a) AUGUST 31, 1996 1995 (d) 1994
<S> <C> <C> <C> <C>
CLASS B SHARES
NET ASSET VALUE BEGINNING OF PERIOD.... $ 10.72 $ 10.69 $ 9.79 $ 11.16
INCOME FROM INVESTMENT OPERATIONS:
Net investment income.................. 0.31 0.44 0.29 0.46
Net realized and unrealized gain (loss)
on investments....................... 0.17 0.03 0.90 (1.37)
Total from investment operations....... 0.48 0.47 1.19 (0.91)
LESS DISTRIBUTIONS FROM
Net investment income.................. (0.31) (0.44) (0.29) (0.46)
Net realized gain on investments....... 0 0 0 0
Total Distributions.................... (0.31) (0.44) (0.29) (0.46)
NET ASSET VALUE END OF PERIOD.......... $ 10.89 $ 10.72 $ 10.69 $ 9.79
Total return (c)....................... 4.55% 4.42% 12.27% (8.24%)
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses....................... 1.78%(b) 1.64% 1.81%(b) 1.58%
Total expenses excluding indirectly
paid expenses...................... 1.78%(b) -- -- --
Total expenses excluding waivers and
reimbursements..................... 1.86%(b) 1.84% 1.84%(b) 1.59%
Net investment income................ 3.85%(b) 4.03% 4.18%(b) 4.47%
Portfolio turnover rate................ 114% 65% 27% 53%
NET ASSETS END OF PERIOD
(THOUSANDS).......................... $ 31,874 $32,221 $34,206 $ 32,435
<CAPTION>
JANUARY 11, 1993
(COMMENCEMENT
OF CLASS OPERATIONS)
THROUGH
DECEMBER 31, 1993
<S> <C>
CLASS B SHARES
NET ASSET VALUE BEGINNING OF PERIOD.... $ 10.42
INCOME FROM INVESTMENT OPERATIONS:
Net investment income.................. 0.47
Net realized and unrealized gain (loss)
on investments....................... 0.81
Total from investment operations....... 1.28
LESS DISTRIBUTIONS FROM
Net investment income.................. (0.47)
Net realized gain on investments....... (0.07)
Total Distributions.................... (0.54)
NET ASSET VALUE END OF PERIOD.......... $ 11.16
Total return (c)....................... 12.52%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses....................... 1.35%(b)
Total expenses excluding indirectly
paid expenses...................... --
Total expenses excluding waivers and
reimbursements..................... 1.57%(b)
Net investment income................ 4.44%(b)
Portfolio turnover rate................ 14%
NET ASSETS END OF PERIOD
(THOUSANDS).......................... $ 41,030
</TABLE>
(a) The Fund changed its fiscal year end from August 31 to May 31 during the
current period.
(b) Annualized.
(c) Excluding applicable sales charges.
(d) The Fund changed its fiscal year end from December 31 to August 31.
<TABLE>
<CAPTION>
NINE MONTHS YEAR EIGHT MONTHS
ENDED ENDED ENDED
MAY 31, AUGUST 31, AUGUST 31,
1997 (a) 1996 1995 (c)
<S> <C> <C> <C>
CLASS Y SHARES
NET ASSET VALUE BEGINNING OF PERIOD......................... $ 10.72 $ 10.69 $ 9.79
INCOME FROM INVESTMENT OPERATIONS:
Net investment income....................................... 0.39 0.55 0.36
Net realized and unrealized gain (loss) on investments...... 0.17 0.03 0.90
Total from investment operations............................ 0.56 0.58 1.26
LESS DISTRIBUTIONS FROM NET INVESTMENT INCOME............... (0.39) (0.55) (0.36)
NET ASSET VALUE END OF PERIOD............................... $ 10.89 $ 10.72 $ 10.69
Total return................................................ 5.32% 5.47% 13.02%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses............................................ 0.78%(b) 0.64% 0.81%(b)
Total expenses excluding indirectly paid expenses......... 0.78%(b) -- --
Total expenses excluding waivers and reimbursements....... 0.86%(b) 0.84% 0.84%(b)
Net investment income..................................... 4.85%(b) 5.03% 5.18%(b)
Portfolio turnover rate..................................... 114% 65% 27%
NET ASSETS END OF PERIOD (THOUSANDS)........................ $ 24,441 $ 25,112 $ 25,079
<CAPTION>
FEBRUARY 28, 1994
(COMMENCEMENT
OF CLASS OPERATIONS)
THROUGH
DECEMBER 31, 1994
<S> <C>
CLASS Y SHARES
NET ASSET VALUE BEGINNING OF PERIOD......................... $10.93
INCOME FROM INVESTMENT OPERATIONS:
Net investment income....................................... 0.46
Net realized and unrealized gain (loss) on investments...... (1.14)
Total from investment operations............................ (0.68)
LESS DISTRIBUTIONS FROM NET INVESTMENT INCOME............... (0.46)
NET ASSET VALUE END OF PERIOD............................... $ 9.79
Total return................................................ (6.29%)
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses............................................ 0.76%(b)
Total expenses excluding indirectly paid expenses......... --
Total expenses excluding waivers and reimbursements....... 0.77%(b)
Net investment income..................................... 5.46%(b)
Portfolio turnover rate..................................... 53%
NET ASSETS END OF PERIOD (THOUSANDS)........................ $4,318
</TABLE>
(a) The Fund changed its fiscal year end from August 31 to May 31 during the
current period.
(b) Annualized.
(c) The Fund changed its fiscal year end from December 31 to August 31.
SEE COMBINED NOTES TO FINANCIAL STATEMENTS.
10
<PAGE>
EVERGREEN
SHORT-INTERMEDIATE MUNICIPAL FUND
(logo)
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
JANUARY 5, 1995
(COMMENCEMENT
NINE MONTHS OF CLASS OPERATIONS)
ENDED YEAR ENDED THROUGH
MAY 31, 1997 (a) AUGUST 31, 1996 AUGUST 31, 1995
<S> <C> <C> <C>
CLASS A SHARES
NET ASSET VALUE BEGINNING OF PERIOD................................... $10.08 $ 10.17 $ 9.97
INCOME FROM INVESTMENT OPERATIONS:
Net investment income................................................. 0.30 0.43 0.30
Net realized and unrealized gain (loss) on investments................ 0.01 (0.09) 0.20
Total from investment operations...................................... 0.31 0.34 0.50
LESS DISTRIBUTIONS FROM NET INVESTMENT INCOME......................... (0.30) (0.43) (0.30)
NET ASSET VALUE END OF PERIOD......................................... $10.09 $ 10.08 $10.17
Total return (c)...................................................... 3.08% 3.37% 5.09%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses...................................................... 0.84%(b) 0.80% 0.70%(b)
Total expenses excluding indirectly paid expenses................... 0.83%(b) -- --
Total expenses excluding waivers and reimbursements................. 0.96%(b) 1.11% 1.14%(b)
Net investment income............................................... 3.94%(b) 4.05% 4.32%(b)
Portfolio turnover rate............................................... 34% 29% 80%
NET ASSETS END OF PERIOD (THOUSANDS).................................. $6,072 $27,722 $6,820
</TABLE>
(a) The Fund changed its fiscal year end from August 31 to May 31 during the
current period.
(b) Annualized.
(c) Excluding applicable sales charges.
<TABLE>
<CAPTION>
JANUARY 5, 1995
(COMMENCEMENT
NINE MONTHS OF CLASS OPERATIONS)
ENDED YEAR ENDED THROUGH
MAY 31, 1997 (a) AUGUST 31, 1996 AUGUST 31, 1995
<S> <C> <C> <C>
CLASS B SHARES
NET ASSET VALUE BEGINNING OF PERIOD................................... $10.08 $ 10.17 $ 9.97
INCOME FROM INVESTMENT OPERATIONS:
Net investment income................................................. 0.23 0.34 0.24
Net realized and unrealized gain (loss) on investments................ 0.02 (0.09) 0.20
Total from investment operations...................................... 0.25 0.25 0.44
LESS DISTRIBUTIONS FROM NET INVESTMENT INCOME......................... (0.23) (0.34) (0.24)
NET ASSET VALUE END OF PERIOD......................................... $10.10 $ 10.08 $10.17
Total return (c)...................................................... 2.49% 2.44% 4.50%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses...................................................... 1.73%(b) 1.67% 1.58%(b)
Total expenses excluding indirectly paid expenses................... 1.73%(b) -- --
Total expenses excluding waivers and reimbursements................. 1.86%(b) 2.07% 2.26%(b)
Net investment income............................................... 3.04%(b) 3.28% 3.50%(b)
Portfolio turnover rate............................................... 34% 29% 80%
NET ASSETS END OF PERIOD (THOUSANDS).................................. $6,742 $ 7,413 $6,050
</TABLE>
(a) The Fund changed its fiscal year end from August 31 to May 31 during the
current period.
(b) Annualized.
(c) Excluding applicable sales charges.
SEE COMBINED NOTES TO FINANCIAL STATEMENTS.
11
<PAGE>
EVERGREEN
SHORT-INTERMEDIATE MUNICIPAL FUND
(logo)
FINANCIAL HIGHLIGHTS (CONTINUED)
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED YEAR ENDED AUGUST 31,
MAY 31, 1997 (a) 1996 1995 1994 1993 1992 (c)
<S> <C> <C> <C> <C> <C> <C>
CLASS Y SHARES
NET ASSET VALUE BEGINNING OF PERIOD... $ 10.07 $ 10.17 $ 10.21 $ 10.58 $ 10.33 $ 10.00
INCOME FROM INVESTMENT OPERATIONS:
Net investment income................. 0.30 0.43 0.46 0.47 0.49 0.51
Net realized and unrealized gain
(loss) on investments............... 0.03 (0.10) (0.04) (0.32) 0.25 0.33
Total from investment operations...... 0.33 0.33 0.42 0.15 0.74 0.84
LESS DISTRIBUTIONS FROM:
Net investment income................. (0.30) (0.43) (0.46) (0.47) (0.49) (0.51)
In excess of net investment income.... 0 0 0 (0.03) 0 0
Net realized gain on investments...... 0 0 0 (0.02) 0 0
Total distributions................... (0.30) (0.43) (0.46) (0.52) (0.49) (0.51)
NET ASSET VALUE END OF PERIOD......... $ 10.10 $ 10.07 $ 10.17 $ 10.21 $ 10.58 $ 10.33
Total return.......................... 3.36% 3.30% 4.20% 1.40% 7.40% 8.56%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses...................... 0.74%(b) 0.70% 0.74% 0.58% 0.40% 0.17%
Total expenses excluding indirectly
paid expenses..................... 0.73%(b) -- -- -- -- --
Total expenses excluding waivers and
reimbursements.................... 0.86%(b) 0.90% 0.86% 0.83% 0.81% 0.86%
Net investment income............... 4.04%(b) 4.27% 4.52% 4.54% 4.73% 4.85%
Portfolio turnover rate............... 34% 29% 80% 32% 37% 57%
NET ASSETS END OF PERIOD
(THOUSANDS)......................... $ 32,293 $34,893 $40,581 $53,417 $66,607 $ 54,470
<CAPTION>
JULY 17, 1991
(COMMENCEMENT
OF CLASS OPERATIONS)
THROUGH
AUGUST 31, 1991 (c)
<S> <C>
CLASS Y SHARES
NET ASSET VALUE BEGINNING OF PERIOD... $10.00
INCOME FROM INVESTMENT OPERATIONS:
Net investment income................. 0.06
Net realized and unrealized gain
(loss) on investments............... 0
Total from investment operations...... 0.06
LESS DISTRIBUTIONS FROM:
Net investment income................. (0.06)
In excess of net investment income.... 0
Net realized gain on investments...... 0
Total distributions................... (0.06)
NET ASSET VALUE END OF PERIOD......... $10.00
Total return.......................... 0.62%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses...................... 0.00%(b)
Total expenses excluding indirectly
paid expenses..................... --
Total expenses excluding waivers and
reimbursements.................... 1.40%(b)
Net investment income............... 4.93%(b)
Portfolio turnover rate............... --
NET ASSETS END OF PERIOD
(THOUSANDS)......................... $4,025
</TABLE>
(a) The Fund changed its fiscal year end from August 31 to May 31 during the
current period.
(b) Annualized
(c) On November 18, 1991, the Fund was changed to a diversified municipal bond
fund with a fluctuating net asset value per share from a non-diversified
money market fund with a stable net asset value per share. The shares
outstanding and the related per share data as of August 31, 1991 are
restated to reflect both a 1 for 2 reverse share split on October 30, 1991
and a 1 for 5 reverse share split on August 19, 1992. Total return
calculated after November 18, 1991 reflects the fluctuation in net asset
value per share.
SEE COMBINED NOTES TO FINANCIAL STATEMENTS.
12
<PAGE>
KEYSTONE
TAX FREE INCOME FUND
(logo)
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR ENDED NOVEMBER 30,
MAY 31, 1997 (a) 1996 (f) 1995 (f) 1994
<S> <C> <C> <C> <C>
CLASS A SHARES
NET ASSET VALUE BEGINNING OF PERIOD................................. $ 9.90 $ 10.05 $ 8.93 $ 10.25
INCOME FROM INVESTMENT OPERATIONS:
Net investment income............................................... 0.24 0.51 0.51 0.51
Net realized and unrealized gain (loss) on investments and
futures contracts................................................. (0.11) (0.14) 1.13 (1.28)
Total from investment operations.................................... 0.13 0.37 1.64 (0.77)
LESS DISTRIBUTIONS FROM:
Net investment income............................................... (0.24) (0.52) (0.51) (0.52)
In excess of net investment income.................................. (0.01) 0(e) (0.01) 0
Net realized gain on investments.................................... 0 0 0 0
Tax basis return of capital......................................... 0 0 0 (0.03)
Total distributions................................................. (0.25) (0.52) (0.52) (0.55)
NET ASSET VALUE END OF PERIOD....................................... $ 9.78 $ 9.90 $ 10.05 $ 8.93
Total return (c).................................................... 1.34% 3.83% 18.71% (7.81%)
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses.................................................... 1.19%(b) 1.13% 1.19% 1.13%
Total expenses excluding indirectly paid expenses................. 1.18%(b) 1.12% 1.18% --
Net investment income............................................. 4.85%(b) 5.21% 5.35% 5.27%
Portfolio turnover rate............................................. 54% 128% 30% 98%
NET ASSETS END OF PERIOD (THOUSANDS)................................ $ 72,629 $ 82,425 $ 94,183 $95,691
<CAPTION>
YEAR ENDED
NOVEMBER 30,
1993
<S> <C>
CLASS A SHARES
NET ASSET VALUE BEGINNING OF PERIOD................................. $ 10.17
INCOME FROM INVESTMENT OPERATIONS:
Net investment income............................................... 0.57
Net realized and unrealized gain (loss) on investments and
futures contracts................................................. 0.36
Total from investment operations.................................... 0.93
LESS DISTRIBUTIONS FROM:
Net investment income............................................... (0.57)
In excess of net investment income.................................. (0.04)
Net realized gain on investments.................................... (0.24)
Tax basis return of capital......................................... 0
Total distributions................................................. (0.85)
NET ASSET VALUE END OF PERIOD....................................... $ 10.25
Total return (c).................................................... 9.37%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses.................................................... 1.21%
Total expenses excluding indirectly paid expenses................. --
Net investment income............................................. 5.40%
Portfolio turnover rate............................................. 47%
NET ASSETS END OF PERIOD (THOUSANDS)................................ $124,102
</TABLE>
<TABLE>
<CAPTION>
FEBRUARY 13, 1987
(COMMENCEMENT
YEAR ENDED NOVEMBER 30, OF OPERATIONS) TO
1992 1991 1990 1989 1988 NOVEMBER 30, 1987
<S> <C> <C> <C> <C> <C> <C>
CLASS A SHARES (CONTINUED)
NET ASSET VALUE BEGINNING OF PERIOD................. $ 10.13 $ 9.94 $ 10.24 $ 9.96 $ 9.64 $ 10.00
INCOME FROM INVESTMENT OPERATIONS:
Net investment income............................... 0.63 0.61 0.59 0.62 0.63 0.33
Net realized and unrealized gain (loss) on
investments and futures contracts................. 0.30 0.31 (0.06) 0.34 0.37 (0.32)
Total from investment operations.................... 0.93 0.92 0.53 0.96 1.00 0.01
LESS DISTRIBUTIONS FROM:
Net investment income............................... (0.62) (0.61) (0.60) (0.63) (0.68) (0.37)
In excess of net investment income.................. 0 0 (0.03) 0 0 0
Net realized gain on investments.................... (0.27) (0.12) (0.20) (0.05) 0 0
Tax basis return of capital......................... 0 0 0 0 0 0
Total distributions................................. (0.89) (0.73) (0.83) (0.68) (0.68) (0.37)
NET ASSET VALUE END OF PERIOD....................... $ 10.17 $ 10.13 $ 9.94 $ 10.24 $ 9.96 $ 9.64
Total return (c).................................... 9.35% 9.59% 5.55% 9.97% 10.60% 0.17%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses.................................... 1.25% 1.58% 1.66% 1.62% 1.57% 1.00%(d)
Total expenses excluding indirectly paid
expenses........................................ -- -- -- -- -- --
Net investment income............................. 6.02% 5.95% 6.03% 6.15% 6.13% 6.85%(d)
Portfolio turnover rate............................. 32% 37% 42% 49% 109% 67%
NET ASSETS END OF PERIOD (THOUSANDS)................ $120,660 $133,524 $146,335 $162,013 $179,191 $16,090
</TABLE>
(a) The Fund changed its fiscal year end from November 30 to May 31 during the
current period.
(b) Annualized.
(c) Excluding applicable sales charges.
(d) Annualized for the period April 14, 1987 (Commencement of Investment
Operations) to November 30, 1987.
(e) Reflects distributions in excess of net investment income which were under
$0.01 per share.
(f) Calculation based on average shares outstanding.
SEE COMBINED NOTES TO FINANCIAL STATEMENTS.
13
<PAGE>
KEYSTONE
TAX FREE INCOME FUND
(logo)
FINANCIAL HIGHLIGHTS (CONTINUED)
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR ENDED NOVEMBER 30,
MAY 31, 1997 (a) 1996 (e) 1995 (e) 1994
<S> <C> <C> <C> <C>
CLASS B SHARES
NET ASSET VALUE BEGINNING OF PERIOD......................... $ 9.81 $ 9.97 $ 8.88 $ 10.25
INCOME FROM INVESTMENT OPERATIONS:
Net investment income....................................... 0.19 0.44 0.44 0.45
Net realized and unrealized gain (loss) on investments and
futures contracts......................................... (0.10) (0.16) 1.11 (1.29)
Total from investment operations............................ 0.09 0.28 1.55 (0.84)
LESS DISTRIBUTIONS FROM:
Net investment income....................................... (0.20) (0.44) (0.45) (0.50)
In excess of net investment income.......................... (0.01) 0(d) (0.01) 0
Net realized gain on investments............................ 0 0 0 0
Tax basis return of capital................................. 0 0 0 (0.03)
Total distributions......................................... (0.21) (0.44) (0.46) (0.53)
NET ASSET VALUE END OF PERIOD............................... $ 9.69 $ 9.81 $ 9.97 $ 8.88
Total return (c)............................................ 0.97% 2.99% 17.84% (8.43%)
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses............................................ 1.95%(b) 1.90% 1.96% 1.88%
Total expenses excluding indirectly paid expenses......... 1.94%(b) 1.89% 1.94% --
Net investment income..................................... 4.09%(b) 4.44% 4.59% 4.60%
Portfolio turnover rate..................................... 54% 128% 30% 98%
NET ASSETS END OF PERIOD (THOUSANDS)........................ $ 28,822 $ 33,063 $ 33,449 $28,860
<CAPTION>
FEBRUARY 1, 1993
(DATE OF INITIAL
PUBLIC OFFERING)
TO NOVEMBER 30,
1993
<S> <C>
CLASS B SHARES
NET ASSET VALUE BEGINNING OF PERIOD......................... $ 10.27
INCOME FROM INVESTMENT OPERATIONS:
Net investment income....................................... 0.37
Net realized and unrealized gain (loss) on investments and
futures contracts......................................... 0.30
Total from investment operations............................ 0.67
LESS DISTRIBUTIONS FROM:
Net investment income....................................... (0.37)
In excess of net investment income.......................... (0.08)
Net realized gain on investments............................ (0.24)
Tax basis return of capital................................. 0
Total distributions......................................... (0.69)
NET ASSET VALUE END OF PERIOD............................... $ 10.25
Total return (c)............................................ 6.59%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses............................................ 1.96%(b)
Total expenses excluding indirectly paid expenses......... --
Net investment income..................................... 4.42%(b)
Portfolio turnover rate..................................... 47%
NET ASSETS END OF PERIOD (THOUSANDS)........................ $ 14,091
</TABLE>
(a) The Fund changed its fiscal year end from November 30 to May 31 during the
current period.
(b) Annualized.
(c) Excluding applicable sales charges.
(d) Reflects distributions in excess of net investment income which were under
$0.01 per share.
(e) Calculation based on average shares outstanding.
SEE COMBINED NOTES TO FINANCIAL STATEMENTS.
14
<PAGE>
KEYSTONE
TAX FREE INCOME FUND
(logo)
FINANCIAL HIGHLIGHTS (CONTINUED)
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR ENDED NOVEMBER 30,
MAY 31, 1997 (a) 1996 (e) 1995 (e) 1994
<S> <C> <C> <C> <C>
CLASS C SHARES
NET ASSET VALUE BEGINNING OF PERIOD......................... $ 9.81 $ 9.97 $ 8.88 $ 10.26
INCOME FROM INVESTMENT OPERATIONS:
Net investment income....................................... 0.18 0.41 0.44 0.43
Net realized and unrealized gain (loss) on investments and
futures contracts......................................... (0.09) (0.13) 1.11 (1.27)
Total from investment operations............................ 0.09 0.28 1.55 (0.84)
LESS DISTRIBUTIONS FROM:
Net investment income....................................... (0.20) (0.44) (0.45) (0.51)
In excess of net investment income.......................... (0.01) 0(d) (0.01) 0
Net realized gain on investments............................ 0 0 0 0
Tax basis return of capital................................. 0 0 0 (0.03)
Total distributions......................................... (0.21) (0.44) (0.46) (0.54)
NET ASSET VALUE END OF PERIOD............................... $ 9.69 $ 9.81 $ 9.97 $ 8.88
Total return (c)............................................ 0.97% 2.99% 17.84% (8.52%)
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses............................................ 1.95%(b) 1.90% 1.96% 1.89%
Total expenses excluding indirectly paid expenses......... 1.94%(b) 1.89% 1.94% --
Net investment income..................................... 4.09%(b) 4.44% 4.59% 4.52%
Portfolio turnover rate..................................... 54% 128% 30% 98%
NET ASSETS END OF PERIOD (THOUSANDS)........................ $ 11,879 $ 13,769 $ 20,386 $23,230
<CAPTION>
FEBRUARY 1, 1993
(DATE OF INITIAL
PUBLIC OFFERING)
TO NOVEMBER 30,
1993
<S> <C>
CLASS C SHARES
NET ASSET VALUE BEGINNING OF PERIOD......................... $ 10.27
INCOME FROM INVESTMENT OPERATIONS:
Net investment income....................................... 0.37
Net realized and unrealized gain (loss) on investments and
futures contracts......................................... 0.31
Total from investment operations............................ 0.68
LESS DISTRIBUTIONS FROM:
Net investment income....................................... (0.37)
In excess of net investment income.......................... (0.08)
Net realized gain on investments............................ (0.24)
Tax basis return of capital................................. 0
Total distributions......................................... (0.69)
NET ASSET VALUE END OF PERIOD............................... $ 10.26
Total return (c)............................................ 6.70%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Total expenses............................................ 1.94%(b)
Total expenses excluding indirectly paid expenses......... --
Net investment income..................................... 4.41%(b)
Portfolio turnover rate..................................... 47%
NET ASSETS END OF PERIOD (THOUSANDS)........................ $ 27,261
</TABLE>
(a) The Fund changed its fiscal year end from November 30 to May 31 during the
current period.
(b) Annualized.
(c) Excluding applicable sales charges.
(d) Reflects distributions in excess of net investment income which were under
$0.01 per share.
(e) Calculation based on average shares oustanding.
SEE COMBINED NOTES TO FINANCIAL STATEMENTS.
15
<PAGE>
EVERGREEN
HIGH GRADE TAX FREE FUND
(logo)
SCHEDULE OF INVESTMENTS
May 31, 1997
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
LONG-TERM INVESTMENTS-- 97.4%
ARIZONA-- 1.1%
$1,000,000 Creighton Elem. Sch. Dist.
No. 14 of Maricopa Cnty.,
Sch. Imp. Bonds (Proj. of
1990), (Series C 1991),
6.50%, 7/1/07, (FGIC)............. $ 1,125,240
CALIFORNIA-- 2.6%
2,000,000 Redevelopment Agcy. of the
City of San Jose Merged Area
Redev. Proj., Tax Allocation
Bonds, (Series 1993),
6.00%, 8/1/15, (MBIA)............. 2,144,880
500,000 San Mateo Cnty. Joint Pwrs.
Financing Auth. Lease RB
(Capital Projs. Prog.), (1993
Refunding Series A),
6.50%, 7/1/16, (MBIA)............. 560,505
2,705,385
COLORADO-- 3.7%
Arapahoe Cnty. Pub. Hwy.
Auth. Capital Imp. Trust Fund
Hwy. RB (E-470 Proj.):
1,000,000 6.15%, 8/31/26, (MBIA).............. 1,053,890
Sr. Current Interest Bonds,
2,000,000 7.00%, 8/31/26...................... 2,144,720
500,000 School Dist. No. 1,
City & Cnty. of Denver, GO
Refunding Bonds, (Series
1994A),
6.50%, 6/1/10, (MBIA)............. 560,370
3,758,980
FLORIDA-- 1.1%
1,000,000 Orange Cnty. Forida Hlth.
Facs. Auth. Hosp. RB (Orlando
Regional Healthcare Sys.),
(Series 1996C),
6.25%, 10/1/16, (MBIA)............ 1,089,760
GEORGIA-- 5.2%
500,000 City of Atlanta Arpt. Facs.
RRB, (Series 1994A),
6.50%, 1/1/10, (AMBAC)............ 557,990
1,000,000 Metropolitan Atlanta Rapid
Transit Auth. Georgia
Refunding Second Indenture,
(Series A),
5.50%, 7/1/17, (MBIA)............. 998,740
<CAPTION>
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
<C> <S> <C>
GEORGIA-- CONTINUED
Municipal Elec. Auth. Georgia
Spec. Oblig. Fifth Crossover
Series Proj. One:
$1,000,000 6.40%, 1/1/13, (AMBAC).............. $ 1,102,190
2,400,000 6.50%, 1/1/17, (MBIA)............... 2,694,720
5,353,640
HAWAII-- 3.7%
2,500,000 Hawaii St., GO, (Series. CM),
6.00%, 12/1/10, (FGIC)............ 2,679,750
1,000,000 State of Hawaii Arpt. Sys.
RB, (Second Series of 1990),
7.50%, 7/1/20, (FGIC)............. 1,088,990
3,768,740
IDAHO-- 0.9%
845,000 Idaho Hsg. Agcy. Single
Family Mtge. Bonds, (1994
Series C-1 Sr. Bonds &
Mezzanine Bonds),
6.30%, 7/1/11..................... 869,657
ILLINOIS-- 16.9%
4,725,000 City of Chicago Wtr. RRB,
(Series 1993),
6.50%, 11/1/15, (FGIC)............ 5,308,727
2,150,000 City of Chicago GO Current
Interest Bonds, (Proj. Series
1995),
6.13%, 1/1/16, (AMBAC)............ 2,229,249
Illinois Dev. Fin. Auth.
Poll. Ctrl. RRB (Commonwealth
Edison Co. Proj.):
(Series 1991),
2,000,000 7.25%, 6/1/11, (MBIA)............... 2,182,060
(Series 1994D),
3,000,000 6.75%, 3/1/15, (AMBAC).............. 3,293,160
1,750,000 Illinois Hlth. Facs. Auth.
Hlth. Facs. RRB (SSM Hlth.
Care), (Series 1992AA),
6.50%, 6/1/12, (MBIA)............. 1,953,875
5,625,000 Metropolitan Pier &
Exposition Authority Illinois
Refunding McCormick Place
Expn, Project B, (Eff. Yield
5.80%)(a),
0.00%, 6/15/13, (MBIA)............ 2,258,550
17,225,621
</TABLE>
(CONTINUED)
16
<PAGE>
EVERGREEN
HIGH GRADE TAX FREE FUND
(logo)
SCHEDULE OF INVESTMENTS (CONTINUED)
May 31, 1997
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<C> <S> <C>
LONG-TERM INVESTMENTS-- CONTINUED
INDIANA-- 3.5%
$ 1,000,000 Indiana Muni. Pwr. Agcy.,
Pwr. Supply Sys. RRB, (1993
Series B),
6.00%, 1/1/13, (MBIA)............... $ 1,063,720
700,000 Indiana Trans. Fin. Auth.
Hwy. RB, (Series 1992A),
6.80%, 12/1/16, (MBIA).............. 808,024
1,500,000 Middle Sch. Bldg. Corp. of
Lawrence Township of Marion
Cnty., First Mtge. Bonds,
6.88%, 7/5/11, (MBIA)............... 1,729,185
3,600,929
1,000,000 LOUISIANA-- 1.3%
Orleans Parish Louisiana,
School Board RB
9.05%, 2/1/10, (MBIA)............. 1,339,390
1,000,000 MAINE-- 1.1%
Maine Turnpike Auth.,
Turnpike RB, (Series 1994),
7.13%, 7/1/08, (MBIA)............. 1,171,010
2,500,000 MARYLAND-- 2.4%
Maryland St. GO, St. & Local
Facilities, (First Series),
5.00%, 3/1/10..................... 2,455,900
MASSACHUSETTS-- 1.6%
500,000 Massachusetts Hsg. Fin.
Agcy., Hsg. Proj. RB, (1993
Series A),
6.15%, 10/1/15, (AMBAC)........... 508,015
1,000,000 Massachusetts St., Refunding,
(Series A),
6.50%, 11/1/14, (AMBAC)........... 1,119,500
1,627,515
MINNESOTA-- 0.5%
490,000 Minnesota Hsg. Fin. Agcy.
Single Family Mtge. Bonds,
(1994 Series H),
6.70%, 1/1/18..................... 514,397
<CAPTION>
PRINCIPAL
AMOUNT VALUE
<S> <C>
LONG-TERM INVESTMENTS-- CONTINUED
NEW MEXICO-- 1.0%
City of Albuquerque, Arpt. RB:
(Series 1995 A),
$ 500,000 6.35%, 7/1/07, (AMBAC).............. $ 540,220
$ 500,000 (Series 1995 B),
7.00%, 7/1/16, (AMBAC).............. 501,170
1,041,390
NEW YORK-- 11.2%
1,000,000 Albany Cnty., Arpt. Auth.
Arpt. Rev.,
5.25%, 12/15/10, (FSA)............ 980,990
1,500,000 New York St. Housing Finance
Agency Revenue, (Series 1994 B),
6.35%, 8/15/23, (AMBAC)........... 1,538,700
2,590,000 New York St. Local Government
Assistance Corporation RB,
(Prerefunded @ $102), (Series B),
7.38%, 4/1/01..................... 2,895,076
5,000,000 Port Auth. New York & New
Jersey Special Obligation
(for JFK Intl. Arrivals
Terminal),
6.25%, 12/1/10, (MBIA)............ 5,453,950
500,000 The Port Auth. of New York &
New Jersey Consolidated Bonds
Fifth Installment,
(Ninety-Seventh Series),
6.50%, 7/15/19, (FGIC)............ 529,900
11,398,616
NORTH DAKOTA-- 3.0%
3,000,000 Mercer Cnty. Poll. Ctrl. RRB
(Basin Elec. Pwr.
Cooperative-Antelope Valley
Unit 1 & Common Facs.),
(Second 1995 Series),
6.05%, 1/1/19, (AMBAC)............ 3,107,910
OHIO-- 3.3%
1,000,000 Board of Ed., Kings Local
Sch. Dist. (City of Warren)
Sch. Imp. Bonds (Unltd. Tax
GO), (Series 1995),
7.50%, 12/1/16, (FGIC)............ 1,254,130
1,500,000 City of Toledo, GO (Ltd. Tax)
Hsg. Imp. Bonds (Macy's
Proj.), (Series 1995A),
6.35%, 12/1/25, (MBIA)............ 1,580,835
</TABLE>
(CONTINUED)
17
<PAGE>
EVERGREEN
HIGH GRADE TAX FREE FUND
(logo)
SCHEDULE OF INVESTMENTS (CONTINUED)
May 31, 1997
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
OHIO-- CONTINUED
$ 475,000 Ohio Hsg. Fin. Agcy.
Residential Mtge. RB (GNMA
Mortgage-Backed Securities
Prog.), (1995 Series A-2),
6.63%, 3/1/26..................... $ 490,252
3,325,217
SOUTH CAROLINA-- 3.4%
3,250,000 South Carolina St., Port
Auth. RB, (Series 1991),
6.63%, 7/1/11, (AMBAC)............ 3,468,563
SOUTH DAKOTA-- 4.2%
4,000,000 South Dakota Hlth. & Edl.
Facs. Auth. RRB (St. Luke's
Midland Regional Med. Center
Issue), (Series 1991),
6.63%, 7/1/11, (MBIA)............. 4,304,240
TENNESSEE-- 3.1%
1,200,000 The Hlth. & Edl. Facs. Board
of the City of Bristol Hosp.
RRB (Bristol Mem. Hosp.),
(Series 1993),
6.75%, 9/1/07, (FGIC)............. 1,366,740
1,700,000 The Hlth., Edl. & Hsg. Facs.
Board of the Cnty. of Knox
Hosp. RRB (Fort Sanders
Alliance Obligated Group),
(Series 1993),
6.25%, 1/1/13, (MBIA)............. 1,843,378
3,210,118
TEXAS-- 4.4%
1,500,000 City of Austin Arpt. Sys.
Prior Lien RB, (Series 1995A),
6.13%, 11/15/25, (MBIA)........... 1,533,060
1,000,000 City of Houston Wtr.
Conveyance Sys. Contract COP,
(Series 1993H),
7.50%, 12/15/14, (AMBAC).......... 1,221,290
6,000,000 Harris County Texas, RB Toll
Road, (Prerefunded @
$53.836), (Eff. Yield 5.39%)(a),
0.00%, 8/15/09, (AMBAC)........... 1,699,500
4,453,850
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
UTAH-- 3.6%
$2,500,000 Board of Ed. of Iron Cnty.
Sch. Dist. GO Sch. Bldg.
Bonds, (Series 1994),
6.40%, 1/15/12, (MBIA)............ $2,675,325
1,000,000 Salt Lake City, Salt Lake
Cnty. Arpt. RB, (Series 1993A),
6.00%, 12/1/12, (FGIC)............ 1,030,860
3,706,185
VIRGINIA-- 2.1%
2,000,000 Industrial Dev. Auth. of
Hanover Hosp. RB (Mem.
Regional Med. Center Proj. at
Hanover Med. Park), (Series 1995),
6.38%, 8/15/18, (MBIA)............ 2,196,040
WASHINGTON-- 2.6%
2,500,000 City of Tacoma Elec. Sys.
RRB, (Series 1994),
6.25%, 1/1/15, (FGIC)............. 2,619,825
WEST VIRGINIA-- 0.5%
500,000 West Virginia St. Hsg. Dev.
Fund Hsg. Fin. (Series. A),
6.05%, 5/1/27..................... 501,605
WISCONSIN-- 7.3%
4,500,000 City of Superior Ltd. Oblig.
RRB (Midwest Energy Res. Co.
Proj.), (Series E-1991),
6.90%, 8/1/21, (FGIC)............. 5,275,890
2,000,000 Wisconsin Hlth. & Edl. Facs.
Auth. RB (Wausau Hosps., Inc.
Proj.), (Series 1991B),
6.63%, 8/15/11, (AMBAC)........... 2,142,580
7,418,470
PUERTO RICO-- 2.1%
500,000 Commonwealth of Puerto Rico,
Elec. Pwr. Auth. RRB,
(Series Y),
6.50%, 7/1/06, (MBIA)............. 558,460
500,000 Commonwealth of Puerto Rico,
Hsg. Bank & Fin. Agcy.
Affordable Hsg. Mtge. Subsidy
Prog. Single Family Mtge. RB,
Portfolio I,
6.10%, 10/1/15,
(Collateralized by GNMA, FNMA
& FHLMC Certificates)............. 506,220
(CONTINUED)
18
<PAGE>
EVERGREEN
HIGH GRADE TAX FREE FUND
(logo)
SCHEDULE OF INVESTMENTS (CONTINUED)
May 31, 1997
LONG-TERM INVESTMENTS-- CONTINUED
PUERTO RICO-- CONTINUED
$1,000,000 Commonwealth of Puerto Rico,
Elec. Pwr. Auth.,
RB, (Series BB),
6.25%, 7/1/10, (MBIA)............. $ 1,100,720
2,165,400
TOTAL LONG-TERM INVESTMENTS
(COST $95,320,879)................ 99,523,593
SHORT-TERM INVESTMENTS-- 0.9%
ALABAMA-- 0.1%
100,000 Phenix Cnty. Alabama RB
Refunding Mead Coated Board
Project B, VRDN
4.15%, 10/1/25.................... 100,000
KANSAS-- 0.8%
800,000 Kansas City Kansas Industrial
Revenue PQ Corporation
Project, VRDN
4.10%, 8/15/01.................... 800,000
TOTAL SHORT-TERM INVESTMENTS
(COST $900,000)................... 900,000
PRINCIPAL
AMOUNT VALUE
MUTUAL FUND SHARES-- 0.2%
167,000 Federated Tax Free Fund
(cost $167,000)................... $ 167,000
TOTAL INVESTMENTS--
(COST $96,387,879)....... 98.5% 100,590,593
OTHER ASSETS AND
LIABILITIES-- NET........ 1.5 1,538,629
NET ASSETS--............... 100.0% $102,129,222
(a) Effective yield (calculated at date of purchase) is the annual yield at
which the bond accrues until its maturity date.
SUMMARY OF ABBREVIATIONS
AMBAC-- American Municipal Bond Assurance Corp.
COP-- Certificate of Participation
FGIC-- Financial Guaranty Insurance Corp.
FHLMC-- Federal Home Loan Mortgage Corporation
FNMA-- Federal National Mortgage Association
FSA-- Financial Security Assurance Corp.
GNMA-- Government National Mortgage Association
GO-- General Obligation Bonds
MBIA-- Municipal Bond Investors Assurance Corp.
RB-- Revenue Bonds
RRB-- Revenue Refunding Bonds
VRDN-- Variable Rate Demand Notes are payable on demand at par on no more than
seven calendar days' notice given by the Fund to the issuer or other parties not
affiliated with the issuer. Interest rates are determined and reset by the
issuer daily or weekly depending upon the terms of the security. The interest
rates presented for these securities are those in effect at May 31, 1997.
SEE COMBINED NOTES TO FINANCIAL STATEMENTS.
19
<PAGE>
EVERGREEN
SHORT - INTERMEDIATE MUNICIPAL FUND
(logo)
SCHEDULE OF INVESTMENTS
May 31, 1997
LONG-TERM INVESTMENTS-- 97.0%
ARIZONA-- 3.8%
$1,600,000 Pima Cnty. GO RFB, (Series 1992),
6.55%, 7/1/01..................... $ 1,718,384
COLORADO-- 1.2%
520,000 Colorado Stud. Oblig. Board
Auth., Stud. Loan RB,
(Series 1985B),
6.13%, 12/1/98.................... 530,104
DISTRICT OF COLUMBIA-- 3.4%
1,500,000 Dist. of Columbia GO RFB,
(Series 1989B),
6.63%, 6/1/98, (MBIA)............. 1,539,375
ILLINOIS-- 2.4%
1,000,000 Central Lake Cnty. Joint
Action Wtr. Agcy. RB,
(Prerefunded @ $102),
(Series 1990A),
7.00%, 5/1/00, (AMBAC)............ 1,086,340
MARYLAND-- 4.0%
635,000 Maryland Energy Financing
Administration Solid Waste
Disp. RB, (Wheelabrator Wtr.
Technologies Baltimore L.L.C.
Projs.), (Series 1996),
4.80%, 12/1/98.................... 638,156
1,140,000 Montgomery Cnty. GO Bonds
Consolidated Pub. Imp. RB,
(Series 1992A),
5.30%, 7/1/01..................... 1,174,075
1,812,231
MASSACHUSETTS-- 12.1%
Massachusetts Ind. Fin. Agcy. IDR:
460,000 (Series 1986G),
5.30%, 12/1/06.................... 467,149
565,000 (Series 1986I),
5.30%, 12/1/06.................... 573,780
1,185,000 (Series 1996A),
5.35%, 11/1/07.................... 1,208,368
1,160,000 (Series 1996B),
5.35%, 11/1/07.................... 1,182,875
New England Ed. Loan
Marketing Corp. Stud. Loan RB:
1,000,000 (Series 1993B),
5.40%, 6/1/00..................... 1,016,840
1,000,000 (Series 1993C),
4.75%, 7/1/98..................... 1,007,330
5,456,342
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
MINNESOTA-- 2.3%
$1,015,000 City of Minneapolis & Hsg.
& Redev. Auth. of the City of
St. Paul, Single Family Mtge.
RRB, (Series 1996A),
5.13%, 6/1/32..................... $ 1,015,974
MISSOURI-- 3.2%
North Kansas City Sch. Dist.
GO, Direct Deposit Prog.,
(Series 1996),
710,000 6.70%, 3/1/00....................... 750,179
665,000 7.00%, 3/1/99....................... 695,204
1,445,383
NEW JERSEY-- 4.7%
2,000,000 New Jersey St. GO, (Series 1991),
5.90%, 8/1/02..................... 2,116,380
NEW YORK-- 4.5%
1,000,000 New York, New York, (Series 1997L),
5.25%, 8/1/00..................... 1,009,710
1,000,000 Pwr. Auth. of the St. of New
York, General Purpose Bonds,
(Series Z),
5.85%, 1/1/00..................... 1,033,310
2,043,020
OHIO-- 2.3%
1,000,000 The Stud. Loan Funding Corp.
(Cincinnati) Stud. Loan RB,
(Series 1993A),
5.50%, 12/1/01.................... 1,019,940
OREGON-- 2.5%
1,125,000 Josephine Cnty., Sch. Dist.
#007 GO,
5.00%, 6/1/99, (FGIC)............. 1,140,818
PENNSYLVANIA-- 7.9%
1,000,000 Lancaster Cnty. Hosp. Auth.
Hosp. RB (The Lancaster
General Hosp. Proj.), (Series
1992),
5.60%, 7/1/00, (AMBAC)............ 1,031,900
1,950,000 Sayre Hlth. Care Facs. Auth.
RB, Guthrie Healthcare Sys.,
(Series 1991A),
6.40%, 3/1/99, (AMBAC)............ 2,017,489
500,000 St. of Pennsylvania GO,
(Series 1971),
6.00%, 12/15/98................... 503,270
3,552,659
(CONTINUED)
20
<PAGE>
EVERGREEN
SHORT - INTERMEDIATE MUNICIPAL FUND
(logo)
SCHEDULE OF INVESTMENTS (CONTINUED)
May 31, 1997
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
SOUTH CAROLINA-- 1.2%
$ 500,000 Charleston Cnty. Arpt.
Dist. Arpt. System RRB,
(Series 1993),
8.25%, 7/1/00, (MBIA)............. $ 552,420
TEXAS-- 15.0%
1,000,000 Brazos Higher Ed. Auth.,
Inc., Stud. Loan RRB,
(Series 1992A),
5.30%, 12/1/97.................... 1,006,210
500,000 City of Dallas GO,
5.90%, 2/15/01.................... 523,625
1,000,000 City of Houston Pub. Imp.
RFB, (Series 1992C),
5.70%, 3/1/01..................... 1,038,490
1,300,000 Dallas Cnty. Imp. (Ltd. Tax)
RB, (Series 1992A),
6.00%, 8/15/01.................... 1,373,905
505,000 San Antonio Independent Sch.
Dist. Pub. Facs. Corp. RB,
(Series 1996),
5.00%, 10/15/00, (AMBAC).......... 510,969
Texas Dept. Hsg. & Cmnty.
Affairs Single Family Mtge.
RB, (Series 1996E):
1,260,000 4.45%, 3/1/99, (MBIA)............... 1,261,562
1,045,000 4.65%, 3/1/00, (MBIA)............... 1,049,034
6,763,795
UTAH-- 6.4%
2,500,000 Intermountain Pwr. Agcy.,
Pwr. Supply RFB, (Series C),
6.00%, 7/1/00, (MBIA)............. 2,603,150
290,000 Utah Hsg. Fin. Agcy. Single
Family Mtge. RRB, (Series 1993A),
5.20%, 1/1/01..................... 293,996
2,897,146
VIRGINIA-- 3.4%
1,500,000 Virginia Hsg. Dev. Auth.
Commonwealth Mtge. Bonds,
(Series 1992B, Subseries B-1),
6.00%, 1/1/98..................... 1,513,845
WASHINGTON-- 11.9%
2,950,000 St. of Washington GO RB,
Motor Vehicle Fuel Tax,
(Series R-92D),
5.60%, 9/1/01..................... 3,064,844
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
WASHINGTON-- CONTINUED
$ 550,000 Washington Pub. Pwr. Supply
Sys. RRB (Nuclear Proj. #1),
(Series 1992A),
5.00%, 7/1/98..................... $ 556,122
Washington Pub. Pwr. Supply
Sys. RRB (Nuclear Proj. #2),
(Series 1992A):
1,070,000 5.00%, 7/1/98....................... 1,081,909
675,000 5.00%, 7/1/99....................... 681,088
5,383,963
WISCONSIN-- 4.8%
1,000,000 Milwaukee GO,
Pub. Imps., (Series BZ),
6.30%, 6/15/01.................... 1,064,300
1,000,000 Milwaukee Metropolitan Sewage
Dist. GO, (Series 1989A),
7.00%, 9/1/01..................... 1,092,060
2,156,360
TOTAL LONG-TERM INVESTMENTS
(COST $43,306,201)................ 43,744,479
SHORT-TERM INVESTMENTS-- 3.3%
COLORADO-- 3.3%
1,500,000 Arapahoe Cnty. MHRB Ref.
Stratford Sta., (Series 1994),
VRDN, (LOC: Heller Finl., Inc.)
4.45%, 11/1/17 (cost $1,500,000).. 1,500,000
TOTAL INVESTMENTS--
(COST $44,806,201)....... 100.3% 45,244,479
OTHER ASSETS AND
LIABILITIES-- NET........ (0.3) (137,878)
NET ASSETS--............... 100.0% $ 45,106,601
SUMMARY OF ABBREVIATIONS:
AMBAC-- American Municipal Bond Assurance Corp.
FGIC-- Financial Guaranty Insurance Corp.
GO-- General Obligation Bonds
IDR-- Industrial Development Revenue Bonds
LOC-- Letter of Credit
MBIA-- Municipal Bond Investors Assurance Corp.
MHRB-- Municipal Housing Revenue Bonds
RB-- Revenue Bonds
RFB-- Refunding Bonds
RRB-- Refunding Revenue Bonds
VRDN-- Variable Rate Demand Notes are payable on demand at par on no more than
seven calendar days' notice given by the Fund to the issuer or other parties not
affiliated with the issuer. Interest rates are determined and reset by the
issuer daily or weekly depending upon the terms of the security. The interest
rates presented for these securities are those in effect at May 31, 1997.
SEE COMBINED NOTES TO FINANCIAL STATEMENTS.
21
<PAGE>
KEYSTONE
TAX FREE INCOME FUND
(logo)
SCHEDULE OF INVESTMENTS
May 31, 1997
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- 98.2%
ALABAMA-- 0.2%
$ 265,000 Alabama Housing Finance Agency,
Single Family Mortgage,
10.75%, 6/1/13.................... $ 281,125
ALASKA-- 0.4%
470,000 Alaska Housing Finance Corp.,
Collateralized Home Mortgage,
8.75%, 12/1/16.................... 483,898
ARIZONA-- 1.6%
1,875,000 Page, Arizona, Municipal Property
Corp., Excise Tax Revenue,
5.00%, 7/1/11, (MBIA)............. 1,806,450
CALIFORNIA-- 7.0%
500,000 Anaheim, California, Public
Financing Authority, Series C,
6.00%, 9/1/16..................... 529,385
1,400,000 California Health Facilities,
Children's Hospital,
5.38%, 7/1/20..................... 1,341,914
2,115,000 Central Coast, California, Water
Authority Revenue,
State Water Project, Regional
Facilities, Series A,
5.00%, 10/1/16, (AMBAC)........... 1,977,737
1,785,000 East Bay, California, Municipal
Utility District, Water System
Revenue,
5.00%, 6/1/16, (FGIC)............. 1,678,382
San Francisco, California, State
Building Authority, Lease Revenue,
San Francisco Civic Center
Complex-- A:
1,000,000 5.25%, 12/1/16...................... 964,440
500,000 5.25%, 12/1/21...................... 476,840
2,450,000 Victor Valley, California, Joint
Union High School District,
Capital Appreciation, (effective
yield
5.69%) (b),
0.00%, 9/1/13, (MBIA)............. 991,172
7,959,870
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
COLORADO-- 5.5%
City and County of Denver, Colorado,
Airport System:
Series A:
$1,250,000 7.00%, 11/15/99..................... $ 1,314,500
720,000 7.25%, 11/15/25..................... 821,102
1,000,000 8.00%, 11/15/25..................... 1,105,710
750,000 8.75%, 11/15/23..................... 876,570
Series B,
750,000 7.25%, 11/15/12..................... 814,590
Series D,
1,100,000 7.75%, 11/15/13..................... 1,339,877
6,272,349
FLORIDA-- 8.6%
750,000 Gainesville, Florida, Utilities
System Revenue, Series A,
5.20%, 10/1/22.................... 710,595
1,500,000 Martin County, Florida, Industrial
Development Authority, Industrial
Development Revenue, Indiantown
Cogeneration Project, Series A,
7.88%, 12/15/25................... 1,682,865
2,000,000 Orange County, Florida, Health
Facilities Authority, Orlando
Hospital Regional Healthcare,
Series A,
6.25%, 10/1/18.................... 2,186,940
1,000,000 Sarasota County, Florida, Utility
Systems Revenue,
6.50%, 10/1/22, (FGIC)............ 1,122,620
2,640,000 Tallahassee, Florida, Health
Facilities, Tallahassee Memorial
Regional Medical Project,
6.63%, 12/1/13, (MBIA)............ 2,927,971
1,015,000 Tampa, Florida, Subordinated
Guaranteed Entitlement Revenue,
Series 1988B,
8.40%, 10/1/08.................... 1,070,226
9,701,217
(CONTINUED)
22
<PAGE>
KEYSTONE
TAX FREE INCOME FUND
(logo)
SCHEDULE OF INVESTMENTS (CONTINUED)
May 31, 1997
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
ILLINOIS-- 1.9%
$910,000 Chicago, Illinois, Gas Supply
Revenue (People's Gas, Light and
Coke Co.), Series A,
8.10%, 5/1/20..................... $ 998,316
1,000,000 Illinois Health Facilities
Authority, United Medical Center,
8.38%, 7/1/12..................... 1,187,550
2,185,866
INDIANA-- 2.8%
1,300,000 Indiana Municipal Power Supply,
Systems Revenue,
5.50%, 1/1/16..................... 1,289,340
1,640,000 St. Joseph County, Indiana,
Educational Facilities Revenue,
University of Notre Dame,
6.50%, 3/1/26..................... 1,835,226
3,124,566
LOUISIANA-- 1.3%
1,415,000 Louisiana Public Facilities
Authority, Health and Education,
Pre-refunded,
7.90%, 12/1/15.................... 1,505,461
MASSACHUSETTS-- 8.2%
Massachusetts Bay Transportation
Authority, Series A:
1,875,000 6.25%, 3/1/12....................... 2,050,763
1,000,000 7.00%, 3/1/11....................... 1,167,180
1,950,000 7.00%, 3/1/21....................... 2,315,450
400,000 Massachusetts, General Obligation,
(effective yield 7.00%) (b),
0.00%, 6/1/07, (FGIC)............. 241,104
1,490,000 Massachusetts State Housing Finance
Agency, Residential Housing,
Series A,
8.40%, 8/1/21..................... 1,552,967
500,000 Massachusetts State Industrial
Finance Agency, Senior Lien,
Massachusetts Recycling
Association,
9.00%, 8/1/16 (a)................. 200,000
Massachusetts Water Resources
Authority, General Revenue Bonds:
1,000,000 Series A,
6.00%, 8/1/20..................... 1,012,170
1,000,000 1995, Series B,
4.00%, 12/1/18.................... 774,880
9,314,514
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
MICHIGAN-- 0.5%
$ 500,000 Monroe County, Michigan, Economic
Development Corp.,
Detroit Edison Co.,
6.95%, 9/1/22, (FGIC)............. $ 594,535
MINNESOTA-- 0.5%
595,000 Minnesota Housing Finance Agency,
Single Family Mortgage, Series A,
8.20%, 8/1/19..................... 611,785
MISSOURI-- 0.5%
500,000 Sikeston, Missouri, Electric
Revenue,
6.00%, 6/1/14, (MBIA)............. 530,165
NEW JERSEY-- 5.0%
1,000,000 New Jersey Economic Development
Authority, Water Facilities
Revenue, NJ American Water Co.,
Inc. Project,
6.50%, 4/1/22, (FGIC)............. 1,055,410
4,325,000 Salem County, New Jersey, Pollution
Control Financing Authority,
Waste Disposal Revenue,
6.50%, 11/15/21................... 4,560,496
5,615,906
NEW MEXICO-- 3.8%
500,000 Albuquerque, New Mexico, Airport
Revenue, Series B,
8.75%, 7/1/19..................... 506,720
1,950,000 Albuquerque, New Mexico, Joint Water
and Sewer System Revenue,
Capital Appreciation, Series A,
(effective yield 5.42%) (b),
0.00%, 7/1/08, (FGIC)............. 1,083,030
1,590,000 New Mexico Mortgage Finance
Authority, Single Family Mortgage,
8.63%, 7/1/17, (FGIC)............. 1,637,970
1,000,000 University of New Mexico, University
Revenue, Series A,
6.00%, 6/1/21..................... 1,045,860
4,273,580
(CONTINUED)
23
<PAGE>
KEYSTONE
TAX FREE INCOME FUND
(logo)
SCHEDULE OF INVESTMENTS (CONTINUED)
May 31, 1997
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
NEW YORK-- 14.4%
New York City, New York, GO:
$1,410,000 Fiscal 1992, Pre-refunded, Series A,
7.75%, 8/15/15 (d)................ $ 1,602,056
2,500,000 Series G,
6.75%, 2/1/09..................... 2,733,600
500,000 New York and New Jersey, Port
Authority, Special Obligation
Revenue, JFK International Airport
Terminal-- 6 Project,
5.75%, 12/1/25, (MBIA)............ 498,675
2,000,000 New York State Dormitory Authority,
State University Dormitory
Facilities, Series A,
6.00%, 7/1/09..................... 2,142,620
New York State Dormitory Authority,
State University Educational
Facilities Revenue:
800,000 Series A,
5.25%, 5/15/15, (AMBAC)........... 778,120
1,300,000 Series C,
7.38%, 5/15/10.................... 1,515,046
1,600,000 New York State Local Government
Assistance Corp., Series A
5.50%, 4/1/17..................... 1,573,072
2,510,000 New York State Tollway Authority,
Highway and Bridge
Trust Fund, Series A,
5.25%, 4/1/16, (AMBAC)............ 2,422,225
New York State Urban Development
Corp.:
Correctional Facilities, Series A:
1,000,000 6.50%, 1/1/10....................... 1,084,510
1,000,000 7.50%, 4/1/11....................... 1,121,870
805,000 Higher Education Technology Grants,
6.00%, 4/1/10, (MBIA)............... 847,528
16,319,322
1,000,000 NORTH CAROLINA-- 0.8%
North Carolina Medical Care, Duke
University Hospital, Series C,
5.25%, 6/1/21..................... 941,530
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
OHIO-- 1.8%
$1,000,000 Montgomery County, Ohio, Hospital
Revenue, Kettering Medical
Center, 6.25%, 4/1/20............. $1,087,260
1,000,000 North Olmsted, Ohio, GO,
5.00%, 12/1/16, (AMBAC)........... 935,880
2,023,140
PENNSYLVANIA-- 8.2%
1,500,000 Pennsylvania Convention Center
Authority, Series A,
(effective yield 7.00%) (b),
0.00%, 9/1/08, (FGIC)............. 840,405
2,450,000 Pennsylvania Economic Development
Financing Authority, Resources
Recovery, Northampton Project,
6.50%, 1/1/13 (c)................. 2,420,085
1,000,000 Philadelphia, Pennsylvania, Hospital
and Higher Education Facilities,
Community College, Series B,
6.50%, 5/1/07, (MBIA)............. 1,104,070
4,000,000 Pittsburgh, Pennsylvania, School
District, Capital Appreciation,
Series B, (effective yield 5.42%)
(b),
0.00%, 8/1/09, (AMBAC)............ 2,135,320
2,200,000 Scranton-Lackawanna, Pennsylvania,
Health and Welfare
Authority Revenue, Walters
Institute Project,
8.13%, 7/15/28.................... 2,307,184
500,000 Southeastern Pennsylvania
Transportation Authority,
Special Revenue,
5.38%, 3/1/22, (FGIC)............. 481,765
9,288,829
PUERTO RICO-- 3.5%
2,000,000 Commonwealth of Puerto Rico, GO,
7.00%, 7/1/10, (MBIA)............. 2,336,700
1,365,000 Puerto Rico Electric Power
Authority, Series S,
7.00%, 7/1/07..................... 1,584,287
3,920,987
(CONTINUED)
24
<PAGE>
KEYSTONE
TAX FREE INCOME FUND
(logo)
SCHEDULE OF INVESTMENTS (CONTINUED)
May 31, 1997
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
TENNESSEE-- 4.9%
$2,000,000 Bristol, Tennessee, Health and
Education Authority,
Bristol Memorial Hospital,
6.75%, 9/1/10, (FGIC)............. $ 2,303,820
Knox County, Tennessee, Health and
Educational Facilities,
Fort Sanders Hospital Alliance:
1,000,000 Series B,
7.25%, 1/1/10, (MBIA)............. 1,171,990
1,000,000 Series C,
5.25%, 1/1/15, (MBIA)............. 969,670
1,000,000 Metropolitan Government of Nashville
and Davidson County,
Tennessee Water and Sewer,
step bond, (effective yield 5.20%)
(b),
0.00%, 1/1/12, (FGIC)............. 1,100,570
5,546,050
TEXAS-- 10.7%
3,000,000 Brazos River Authority, Texas,
Revenue Refunding,
Houston Light and Power Project,
8.10%, 5/1/19, (MBIA)............. 3,154,980
1,000,000 Harris County, Texas, Toll Road,
Senior Lien, Series A,
7.00%, 8/15/10.................... 1,166,690
3,000,000 Houston, Texas, Water and Sewer
System Revenue,
Jr. Lien, Series C,
(effective yield 6.05%) (b),
0.00%, 12/1/11, (AMBAC)........... 1,349,400
1,500,000 Northwest, Texas, Independent School
District, Capital Appreciation,
(effective yield 5.50%) (b),
0.00%, 8/15/08, (PSFG)............ 832,260
1,000,000 Nueces River Authority, Texas Water
Supply, Facilities Corpus Christie
Lake,
5.25%, 7/15/16.................... 960,200
2,125,000 Tarrant County, Texas, Health
Facilities Development, Harris
Methodist Health Systems, Series
A,
5.13%, 9/1/12, (AMBAC)............ 2,036,388
2,125,000 Texas Municipal Power Agency,
(effective yield 7.09%) (b),
0.00%, 9/1/08, (AMBAC)............ 1,176,294
1,500,000 United Independent School District,
Texas, GO,
5.25%, 8/15/15, (PSFG)............ 1,438,335
12,114,547
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
UTAH-- 0.4%
$ 750,000 Intermountain Power Agency, Utah,
Power Supply Refunding, Series A,
(effective yield 6.95%) (b),
0.00%, 7/1/07..................... $ 445,320
WASHINGTON-- 4.7%
3,000,000 Chelan County, Washington, Public
Utilities District, Series A,
(effective yield 5.53%) (b),
0.00%, 6/1/09..................... 1,563,210
1,500,000 Tacoma, Washington, Solid Waste
Utility Revenue, Series B,
5.50%, 12/1/17, (AMBAC)........... 1,453,305
1,000,000 Washington Public Power Supply
System, Nuclear Project #2,
Series C,
7.63%, 7/1/10..................... 1,118,080
1,000,000 Washington State GO, Series A,
6.75%, 2/1/15..................... 1,146,110
5,280,705
WYOMING-- 1.0%
1,140,000 Wyoming Community Development
Authority, Single Family Mortgage,
Series A,
7.88%, 6/1/18..................... 1,180,196
TOTAL LONG-TERM INVESTMENTS
(COST-- $107,046,798)............. 111,321,913
SHORT-TERM INVESTMENTS-- 0.5%
FLORIDA-- 0.5%
565,000 Dade County, Florida, Water and
Sewer Systems Revenue, VRDN,
3.85%, 10/5/22.................... 565,000
WASHINGTON-- 0.0%
5,000 Washington State Health Care
Facilities, VRDN,
4.00%, 10/1/05.................... 5,000
TOTAL SHORT-TERM
INVESTMENTS (COST-- $570,000)... 570,000
TOTAL INVESTMENTS
(COST-- $107,616,798)...... 98.7% 111,891,913
OTHER ASSETS AND
LIABILITIES-- NET.......... 1.3% 1,437,886
NET ASSETS................... 100.0% $113,329,799
(CONTINUED)
25
<PAGE>
KEYSTONE
TAX FREE INCOME FUND
(logo)
SCHEDULE OF INVESTMENTS (CONTINUED)
May 31, 1997
(a) Securities which have defaulted on payment of interest and/or principal.
The Fund has stopped accruing income on those so identified.
(b) Effective yield (calculated at date of purchase) is the yield at which the
bond accretes on an annual basis until maturity date.
(c) Securities that may be resold to "qualified instituional buyers" under Rule
144A or securities offered pursuant to Section 4(2) of the Securities Act
of 1933, as amended. These securities have been determined to be liquid
under guidelines established by the Board of Trustees.
(d) At May 31, 1997, $300,000 principal amount of New York City, New York, GO,
Fiscal 1992, Pre-refunded, Series A, 7.75%, 8/15/15 was pledged to cover
margin requirements for open futures contracts.
LEGEND OF PORTFOLIO ABBREVIATIONS:
AMBAC-- American Municipal Bond Assurance Corporation
FGIC-- Financial Guaranty Insurance Company
GO-- General Obligation Bonds
MBIA-- Municipal Bond Investors Assurance Corp.
PSFG-- Permanent School Fund Guaranteed
VRDN-- Variable Rate Demand Notes are payable on demand at par on no more than
seven calendar days' notice given by the Fund to the issuer or other parties not
affiliated with the issuer. Interest rates are determined and reset by the
issuer daily or weekly depending upon the terms of the security. The interest
rates presented for these securities are those in effect at May 31, 1997.
FUTURES CONTRACTS-- SHORT POSITIONS
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
NUMBER INITIAL CONTRACT UNREALIZED
EXPIRATION OF CONTRACTS AMOUNT DEPRECIATION
JUNE 97 17 U.S. TREASURY BOND INDEX $1,833,031 $(37,500)
</TABLE>
SEE COMBINED NOTES TO FINANCIAL STATEMENTS.
26
<PAGE>
EVERGREEN KEYSTONE
(logo)
STATEMENTS OF ASSETS AND LIABILITIES
May 31, 1997
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(logo) (logo) (logo)
HIGH GRADE SHORT-INTERMEDIATE TAX FREE
FUND FUND INCOME FUND
ASSETS
Investments at market value (identified cost-- $96,387,879, $44,806,201
and $107,616,798, respectively)....................................... $100,590,593 $ 45,244,479 $111,891,913
Cash.................................................................... 0 66,326 4,334
Receivable for investments sold......................................... 0 0 2,466,140
Interest receivable..................................................... 1,897,863 843,625 1,892,703
Receivable for Fund shares sold......................................... 107,105 35,048 22,000
Prepaid expenses and other assets....................................... 26,968 30,724 58,554
Total assets........................................................ 102,622,529 46,220,202 116,335,644
LIABILITIES
Payable for investments purchased....................................... 0 1,008,560 2,341,411
Payable for Fund shares redeemed........................................ 228,082 17,401 290,463
Dividends payable....................................................... 140,678 44,499 244,167
Distribution fee payable................................................ 52,967 10,616 63,516
Due to related parties.................................................. 19,104 4,250 13,902
Due to custodian bank................................................... 18,471 0 0
Payable for daily variation margin on open futures contracts............ 0 0 12,219
Accrued expenses and other liabilities.................................. 34,005 28,275 40,167
Total liabilities................................................... 493,307 1,113,601 3,005,845
NET ASSETS................................................................ $102,129,222 $ 45,106,601 $113,329,799
NET ASSETS REPRESENTED BY
Paid-in capital......................................................... $ 99,066,689 $ 45,350,089 $112,869,280
Undistributed net investment income (accumulated distributions in excess
of net investment income)............................................. 124,532 0 (244,167 )
Accumulated net realized loss on investments and futures contracts...... (1,264,713) (681,766) (3,532,929 )
Net unrealized appreciation on investments and futures contracts........ 4,202,714 438,278 4,237,615
Total net assets.................................................... $102,129,222 $ 45,106,601 $113,329,799
NET ASSETS CONSIST OF
Class A................................................................. $ 45,814,519 $ 6,072,249 $72,629,064
Class B................................................................. 31,874,058 6,741,653 28,821,838
Class C................................................................. -- -- 11,878,897
Class Y................................................................. 24,440,645 32,292,699 --
$102,129,222 $ 45,106,601 $113,329,799
SHARES OUTSTANDING
Class A................................................................. 4,207,467 601,763 7,424,946
Class B................................................................. 2,927,195 667,292 2,974,366
Class C................................................................. -- -- 1,225,559
Class Y................................................................. 2,244,589 3,197,322 --
NET ASSET VALUE PER SHARE
Class A................................................................. $ 10.89 $ 10.09 $ 9.78
Class A-- Offering price (based on sales charge of 4.75%, 3.25% and
4.75%, respectively).................................................. $ 11.43 $ 10.43 $ 10.27
Class B................................................................. $ 10.89 $ 10.10 $ 9.69
Class C................................................................. -- -- $ 9.69
Class Y................................................................. $ 10.89 $ 10.10 --
</TABLE>
SEE COMBINED NOTES TO FINANCIAL STATEMENTS.
27
<PAGE>
EVERGREEN KEYSTONE
(logo)
STATEMENTS OF OPERATIONS
Period Ended May 31, 1997
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(logo) (logo) (logo)
HIGH GRADE SHORT-INTERMEDIATE TAX FREE
FUND* FUND* INCOME FUND**
INVESTMENT INCOME
Interest....................................................... $ 4,496,797 $2,373,153 $ 3,631,204
EXPENSES
Management fee................................................. 399,929 248,564 367,154
Distribution Plan expenses..................................... 333,154 71,757 307,124
Transfer agent fees............................................ 65,152 45,027 99,665
Registration and filing fees................................... 52,562 30,280 6,147
Custodian fees................................................. 49,228 48,597 41,888
Administrative services fees................................... 33,901 0 17,396
Professional fees.............................................. 22,955 22,587 25,138
Trustees' fees and expenses.................................... 4,431 7,083 6,480
Other.......................................................... 57,713 23,623 12,229
Fee waivers by investment manager.............................. (64,199) (60,003) 0
Total expenses............................................... 954,826 437,515 883,221
Less: Indirectly paid expenses................................. (197) (639) (7,261)
Net expenses................................................. 954,629 436,876 875,960
NET INVESTMENT INCOME.......................................... 3,542,168 1,936,277 2,755,244
NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS AND
FUTURES CONTRACTS
Net realized gain on:
Investments.................................................. 640,025 18,940 1,212,437
Futures contracts............................................ 0 0 50,174
Net realized gain on investments and futures contracts......... 640,025 18,940 1,262,611
Net change in unrealized appreciation (depreciation) on:
Investments.................................................. 982,691 139,624 (2,667,451)
Futures contracts............................................ 0 0 (37,500)
Net change in unrealized appreciation (depreciation) on
investments and futures contracts............................ 982,691 139,624 (2,704,951)
Net realized and unrealized gain (loss) on investments and
futures contracts............................................ 1,622,716 158,564 (1,442,340)
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........... $ 5,164,884 $2,094,841 $ 1,312,904
</TABLE>
* Nine months ended May 31, 1997. During the period, the Fund changed its
fiscal year end from August 31 to May 31.
** Six months ended May 31, 1997. During the period, the Fund changed its fiscal
year end from November 30 to May 31.
SEE COMBINED NOTES TO FINANCIAL STATEMENTS.
28
<PAGE>
EVERGREEN KEYSTONE
(logo)
STATEMENTS OF OPERATIONS
Fiscal Year Ended 1996
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(logo) (logo) (logo)
HIGH GRADE SHORT-INTERMEDIATE TAX FREE
FUND FUND INCOME FUND
YEAR ENDED YEAR ENDED YEAR ENDED
AUGUST 31, 1996 AUGUST 31, 1996 NOVEMBER 30, 1996
INVESTMENT INCOME
Interest....................................................... $ 6,526,273 $2,837,285 $ 8,727,446
EXPENSES
Management fee................................................. 575,456 287,149 844,486
Distribution plan expenses..................................... 483,026 83,180 709,281
Custodian fees................................................. 100,816 55,841 94,590
Transfer agent fees............................................ 76,905 55,501 186,105
Administrative services fees................................... 59,073 0 21,926
Registration and filing fees................................... 49,627 67,347 36,773
Professional fees.............................................. 25,849 27,986 26,696
Trustees' fees and expenses.................................... 3,640 8,457 6,780
Amortization of organization expenses.......................... 0 8,846 0
Other.......................................................... 76,011 30,530 18,810
Fee waivers and/or expense reimbursement by investment
manager...................................................... (228,548) (140,581) 0
Total expenses............................................... 1,221,855 484,256 1,945,447
Less: Expenses paid indirectly................................. 0 0 (12,939)
Net expenses................................................. 1,221,855 484,256 1,932,508
NET INVESTMENT INCOME.......................................... 5,304,418 2,353,029 6,794,938
NET REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS AND
FUTURES CONTRACTS
Realized gain (loss) on:
Investments.................................................. 1,622,360 161,202 2,300,652
Futures contracts............................................ 0 0 (301,239)
Net realized gain on investments and futures contracts......... 1,622,360 161,202 1,999,413
Net change in unrealized appreciation (depreciation) on
investments.................................................. (1,135,792) (564,810) (4,259,520)
Net realized and unrealized gain (loss) on investments and
futures contracts............................................ 486,568 (403,608) (2,260,107)
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS........... $ 5,790,986 $1,949,421 $ 4,534,831
</TABLE>
SEE COMBINED NOTES TO FINANCIAL STATEMENTS.
29
<PAGE>
EVERGREEN KEYSTONE
(logo)
STATEMENTS OF CHANGES IN NET ASSETS
Period Ended May 31, 1997
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(logo) (logo) (logo)
HIGH GRADE SHORT-INTERMEDIATE TAX FREE
FUND* FUND* INCOME FUND**
OPERATIONS
Net investment income................................................ $ 3,542,168 $ 1,936,277 $ 2,755,244
Net realized gain on investments and futures contracts............... 640,025 18,940 1,262,611
Net change in unrealized appreciation (depreciation) on investments
and futures contracts.............................................. 982,691 139,624 (2,704,951)
Net increase in net assets resulting from operations............... 5,164,884 2,094,841 1,312,904
DISTRIBUTIONS TO SHAREHOLDERS FROM
Net investment income:
Class A............................................................ (1,696,428) (755,942) (1,868,216)
Class B............................................................ (934,247) (159,979) (649,369)
Class C............................................................ 0 0 (262,024)
Class Y............................................................ (929,415) (1,020,356) 0
In excess of net investment income:
Class A............................................................ 0 0 (73,369)
Class B............................................................ 0 0 (25,502)
Class C............................................................ 0 0 (10,290)
Total distributions to shareholders................................ (3,560,090) (1,936,277) (2,888,770)
CAPITAL SHARE TRANSACTIONS
Proceeds from shares sold............................................ 9,286,983 9,393,392 1,652,335
Proceeds from reinvestment of distributions.......................... 2,003,093 973,716 1,527,184
Payment for shares redeemed.......................................... (18,667,515) (35,446,549) (17,530,768)
Net decrease in net assets resulting from capital share
transactions..................................................... (7,377,439) (25,079,441) (14,351,249)
Total decrease in net assets..................................... (5,772,645) (24,920,877) (15,927,115)
NET ASSETS
Beginning of period.................................................. 107,901,867 70,027,478 129,256,914
END OF PERIOD........................................................ $102,129,222 $ 45,106,601 $113,329,799
Undistributed net investment income (accumulated distributions in
excess of net investment income)..................................... $ 124,532 $ 0 $ (244,167)
</TABLE>
* Nine months ended May 31, 1997. During the period, the Fund changed its
fiscal year end from August 31 to May 31.
** Six months ended May 31, 1997. During the period, the Fund changed its fiscal
year end from November 30 to May 31.
SEE COMBINED NOTES TO FINANCIAL STATEMENTS.
30
<PAGE>
EVERGREEN KEYSTONE
(logo)
STATEMENTS OF CHANGES IN NET ASSETS
Fiscal Year Ended 1996
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(logo) (logo) (logo)
HIGH GRADE SHORT-INTERMEDIATE TAX FREE
FUND FUND INCOME FUND
YEAR ENDED YEAR ENDED YEAR ENDED
AUGUST 31, 1996 AUGUST 31, 1996 NOVEMBER 30, 1996
OPERATIONS
Net investment income............................................. $ 5,304,418 $ 2,353,029 $ 6,794,938
Net realized gain on investments and futures contracts............ 1,622,360 161,202 1,999,413
Net change in unrealized depreciation on investments.............. (1,135,792) (564,810) (4,259,520)
Net increase in net assets resulting from operations............ 5,790,986 1,949,421 4,534,831
DISTRIBUTIONS TO SHAREHOLDERS FROM
Net investment income:
Class A......................................................... (2,655,984) (541,615) (4,538,414)
Class B......................................................... (1,385,989) (229,080) (1,498,516)
Class C......................................................... 0 0 (758,007)
Class Y......................................................... (1,262,445) (1,582,334) 0
In excess of net investment income:
Class A......................................................... 0 0 (31,491)
Class B......................................................... 0 0 (10,398)
Class C......................................................... 0 0 (5,260)
Total distributions to shareholders............................. (5,304,418) (2,353,029) (6,842,086)
CAPITAL SHARE TRANSACTIONS
Proceeds from shares sold......................................... 16,695,647 37,737,994 6,339,187
Proceeds from shares issued in acquisition of Keystone Texas Tax
Free Fund....................................................... 0 0 5,119,680
Proceeds from reinvestment of distributions....................... 3,093,850 1,651,747 3,629,202
Payment for shares redeemed....................................... (30,410,409) (22,410,625) (31,540,948)
Net increase (decrease) in net assets resulting from capital
share transactions............................................ (10,620,912) 16,979,116 (16,452,879)
Total increase (decrease) in net assets....................... (10,134,344) 16,575,508 (18,760,134)
NET ASSETS
Beginning of year................................................. 118,036,211 53,451,970 148,017,048
END OF YEAR....................................................... $ 107,901,867 $ 70,027,478 $ 129,256,914
Undistributed net investment income (accumulated distributions in
excess of net investment income).................................. $ 115,656 $ 0 $ (245,552)
</TABLE>
SEE COMBINED NOTES TO FINANCIAL STATEMENTS.
31
<PAGE>
EVERGREEN KEYSTONE
(logo)
STATEMENTS OF CHANGES IN NET ASSETS
Fiscal Year Ended 1995
<TABLE>
<CAPTION>
<S> <C> <C> <C>
(logo) (logo) (logo)
HIGH GRADE SHORT-INTERMEDIATE TAX FREE
FUND FUND INCOME FUND
YEAR ENDED YEAR ENDED YEAR ENDED
AUGUST 31, 1995 AUGUST 31, 1995 NOVEMBER 30, 1995
OPERATIONS
Net investment income........................................ $ 3,187,579 $ 2,318,884 $ 7,600,756
Net realized gain (loss) on investments and futures
contracts.................................................. 437,882 (713,222) (760,743)
Net change in unrealized appreciation on investments......... 7,804,353 529,821 18,451,939
Net increase in net assets resulting from operations....... 11,429,814 2,135,483 25,291,952
DISTRIBUTIONS TO SHAREHOLDERS FROM
Net investment income:
Class A.................................................... (1,935,789) (178,721) (5,042,433)
Class B.................................................... (936,437) (96,022) (1,531,824)
Class C.................................................... 0 0 (1,026,499)
Class Y.................................................... (315,353) (2,044,141) 0
In excess of net investment income:
Class A.................................................... 0 0 (70,626)
Class B.................................................... 0 0 (21,455)
Class C.................................................... 0 0 (14,377)
Total distributions to shareholders........................ (3,187,579) (2,318,884) (7,707,214)
CAPITAL SHARE TRANSACTIONS
Proceeds from shares sold.................................... 3,098,389 25,128,726 11,472,775
Proceeds from shares issued in acquisition of Evergreen
National
Tax-Free Fund.............................................. 28,779,194 0 0
Proceeds from reinvestment of distributions.................. 1,826,205 1,923,116 4,018,869
Payment for shares redeemed.................................. (18,339,492) (26,833,640) (32,840,818)
Net increase (decrease) in net assets resulting from
capital share transactions............................... 15,364,296 218,202 (17,349,174)
Total increase in net assets............................. 23,606,531 34,801 235,564
NET ASSETS
Beginning of year............................................ 94,429,680 53,417,169 147,781,484
END OF YEAR.................................................. $ 118,036,211 $ 53,451,970 $ 148,017,048
Undistributed net investment income (accumulated distributions
in excess of net investment income).......................... $ 22,568 $ 0 $ (288,160)
</TABLE>
SEE COMBINED NOTES TO FINANCIAL STATEMENTS.
32
<PAGE>
EVERGREEN KEYSTONE
(logo)
COMBINED NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The Evergreen Keystone National Tax Free Funds consist of Evergreen High Grade
Tax Free Fund ("High Grade Fund"), Evergreen Short-Intermediate Municipal Fund
("Short-Intermediate Fund") and Keystone Tax Free Income Fund ("Tax Free Income
Fund") (collectively, the "Funds"), all of which are registered under the
Investment Company Act of 1940, as amended (the "1940 Act"), as diversified,
open-end management investment companies. High Grade Fund is a series of
Evergreen Investment Trust and Short-Intermediate Fund is a series of Evergreen
Municipal Trust.
The Funds offer Class A, Class B, Class C and/or Class Y shares. Class A shares
are sold with a maximum front-end sales charge of 4.75% for both the High Grade
and Tax Free Income Funds and a maximum front-end sales charge of 3.25% for the
Short-Intermediate Fund. Class B and Class C shares are sold without a front-end
sales charge, but pay a higher ongoing distribution fee than Class A. Class B
shares are sold subject to a contingent deferred sales charge that is payable
upon redemption and decreases depending on how long the shares have been held.
Class C shares are sold subject to a contingent deferred sales charge payable on
shares redeemed within one year after the month of purchase. Class B shares
purchased after January 1, 1997 will automatically convert to Class A shares
after seven years. Class B shares purchased prior to January 1, 1997 retain
their existing conversion rights. Class Y shares are sold at net asset value and
are not subject to contingent deferred sales charges or distribution fees. Class
Y shares are sold only to investment advisory clients of First Union and its
affiliates, certain institutional investors or Class Y shareholders of record of
certain other funds managed by First Union and its affiliates as of December 30,
1994.
The following is a summary of significant accounting policies consistently
followed by the Funds in the preparation of their financial statements. The
policies are in conformity with generally accepted accounting principles, which
require management to make estimates and assumptions that affect amounts
reported herein. Actual results could differ from these estimates.
A. VALUATION OF SECURITIES
An independent pricing service values each Fund's municipal bonds at fair value
using a variety of factors which may include yield, liquidity, interest rate
risk, credit quality, coupon, maturity and type of issue. Securities for which
valuations are not available from an independent pricing service, including
restricted securities, are valued at fair value as determined in good faith
according to procedures established by the Board of Trustees.
Short-term investments with remaining maturities of sixty days or less are
carried at amortized cost, which approximates market value.
B. FUTURES CONTRACTS
In order to gain exposure to or protect against changes in security values, Tax
Free Income Fund may buy and sell futures contracts.
The initial margin deposited with a broker when entering into a futures
transaction is subsequently adjusted by daily payments or receipts as the value
of the contract changes. Such changes are recorded as unrealized gains or
losses. Realized gains or losses are recognized on closing the contract.
Risks of entering into futures contracts include (i) the possibility of an
illiquid market for the contract, (ii) the possibility that a change in the
value of the contract may not correlate with changes in the value of the
underlying instrument or index, and (iii) the credit risk that the other party
will not fulfill their obligations under the contract. Futures contracts also
involve elements of market risk in excess of the amount reflected in the
statement of assets and liabilities.
C. SECURITY TRANSACTIONS AND INVESTMENT INCOME
Securities transactions are accounted for no later than one business day after
the trade date. Realized gains and losses are computed on the identified cost
basis. Interest income is recorded on the accrual basis and includes accretion
of discounts and amortization of premiums.
D. FEDERAL INCOME TAXES
The Funds have qualified and intend to continue to qualify as regulated
investment companies under the Internal Revenue Code of 1986, as amended (the
"Code"). Thus, the Funds will not incur any federal income tax liability since
they are expected to distribute all of their net investment company taxable
income and net capital gains, if any, to their shareholders. The Funds also
intend to avoid any excise tax liability by making the required distributions
under the Code. Accordingly, no provision for federal income taxes is required.
To the extent that realized capital gains can be offset by capital loss
carryforwards, it is each Fund's policy not to distribute such gains.
E. DISTRIBUTIONS
Distributions from net investment income for the Funds are declared daily and
paid monthly. Distributions from net realized capital gains, if any, are paid at
least annually. Distributions to shareholders are recorded at the close of
business on the ex-dividend date.
Income and capital gains distributions to shareholders are determined in
accordance with income tax regulations, which may differ from generally accepted
accounting principles. The significant differences between financial statement
amounts available for distributions and distributions made in accordance with
income tax regulations are primarily due to differing treatment for market
discount on securities.
F. CLASS ALLOCATIONS
Income, expenses (other than class specific expenses) and realized and
unrealized gains and losses are prorated among the classes based on the relative
net assets of each class. Currently, class specific expenses are limited to
expenses incurred under the Distribution Plans for each class.
33
<PAGE>
EVERGREEN KEYSTONE
(logo)
COMBINED NOTES TO FINANCIAL STATEMENTS (CONTINUED)
G. ORGANIZATION EXPENSES
Organizational expenses of High Grade Fund were initially borne by a prior
administrator. As a result of a change in the administration agreement, First
Union purchased the remaining unreimbursed organizational expenses from the
prior administrator. The High Grade Fund had agreed to reimburse such expenses
during the five year period following its commencement of operations. Pursuant
to these arrangements, as of May 31, 1997, the High Grade Fund has fully
reimbursed First Union for such expenses.
2. CAPITAL SHARE TRANSACTIONS
The High Grade and Short-Intermediate Funds have an unlimited number of shares
of beneficial interest with a par value of $0.0001 authorized. The Tax Free
Income Fund has an unlimited number of shares of beneficial interest with no par
value authorized. Shares of beneficial interest of the Funds are currently
divided into Class A, Class B, Class C or Class Y. Transactions in shares of the
Funds were as follows:
HIGH GRADE FUND
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
NINE MONTHS
ENDED YEAR ENDED YEAR ENDED
MAY 31, 1997 AUGUST 31, 1996 AUGUST 31, 1995
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
CLASS A
Shares sold..................................... 138,267 $ 1,503,579 728,801 $ 7,875,800 95,059 $ 1,003,763
Shares issued in acquisition of Evergreen
National Tax Free Fund........................ 0 0 0 0 369,661 3,970,157
Shares issued in reinvestment of
distributions................................. 91,672 998,917 144,023 1,571,241 109,500 1,150,986
Shares redeemed................................. (737,802) (8,010,676) (1,652,697) (17,891,048) (967,409) (10,152,313)
Net decrease.................................... (507,863) $ (5,508,180) (779,873) $ (8,444,007) (393,189) $ (4,027,407)
CLASS B
Shares sold..................................... 418,834 $ 4,553,869 420,508 $ 4,595,803 112,511 $ 1,186,133
Shares issued in acquisition of Evergreen
National Tax Free Fund........................ 0 0 0 0 243,174 2,611,688
Shares issued in reinvestment of
distributions................................. 50,410 549,306 75,686 825,507 52,945 556,311
Shares redeemed................................. (546,605) (5,937,166) (691,236) (7,495,373) (520,448) (5,459,057)
Net decrease.................................... (77,361) $ (833,991) (195,042) $ (2,074,063) (111,818) $ (1,104,925)
CLASS Y
Shares sold..................................... 296,083 $ 3,229,535 387,417 $ 4,224,044 85,773 $ 908,493
Shares issued in acquisition of Evergreen
National Tax Free Fund........................ 0 0 0 0 2,066,792 22,197,349
Shares issued in reinvestment of
distributions................................. 41,755 454,870 63,909 697,102 11,174 118,908
Shares redeemed................................. (434,833) (4,719,673) (455,583) (5,023,988) (258,812) (2,728,122)
Net increase (decrease)......................... (96,995) $ (1,035,268) (4,257) $ (102,842) 1,904,927 $ 20,496,628
</TABLE>
34
<PAGE>
EVERGREEN KEYSTONE
(logo)
COMBINED NOTES TO FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
SHORT-INTERMEDIATE FUND
NINE MONTHS
ENDED YEAR ENDED YEAR ENDED
MAY 31, 1997 AUGUST 31, 1996 AUGUST 31, 1995
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
CLASS A
Shares sold..................................... 182,673 $ 1,860,992 2,806,176 $ 28,333,550 1,438,502 $ 14,469,110
Shares issued in reinvestment of
distributions................................. 17,182 174,056 24,978 253,579 16,308 164,891
Shares redeemed................................. (2,348,922) (23,711,903) (750,660) (7,689,314) (784,474) (7,943,982)
Net increase (decrease)......................... (2,149,067) $(21,676,855) 2,080,494 $ 20,897,815 670,336 $ 6,690,019
CLASS B
Shares sold..................................... 144,261 $ 1,461,443 291,382 $ 2,967,713 673,520 $ 6,777,013
Shares issued in reinvestment of
distributions................................. 11,819 119,733 16,079 163,265 7,150 72,369
Shares redeemed................................. (224,553) (2,272,638) (166,441) (1,686,967) (85,925) (870,798)
Net increase (decrease)......................... (68,473) $ (691,462) 141,020 $ 1,444,011 594,745 $ 5,978,584
CLASS Y
Shares sold..................................... 600,756 $ 6,070,957 635,204 $ 6,436,731 385,625 $ 3,882,603
Shares issued in reinvestment of
distributions................................. 67,156 679,927 121,645 1,234,903 167,271 1,685,856
Shares redeemed................................. (934,601) (9,462,008) (1,283,965) (13,034,344) (1,791,852) (18,018,860)
Net decrease.................................... (266,689) $ (2,711,124) (527,116) $ (5,362,710) (1,238,956) $(12,450,401)
</TABLE>
TAX FREE INCOME FUND
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
SIX MONTHS ENDED YEAR ENDED YEAR ENDED
MAY 31, 1997 NOVEMBER 30, 1996 NOVEMBER 30, 1995
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
CLASS A
Shares sold..................................... 32,393 $ 317,311 181,417 $ 1,689,450 224,063 $ 2,127,732
Share issued in acquisition of Keystone Texas
Tax Free Fund................................. 0 0 131,228 1,269,729 0 0
Shares issued in reinvestment of
distributions................................. 105,269 1,024,777 243,221 2,380,811 270,624 2,608,685
Shares redeemed................................. (1,038,464) (10,140,338) (1,600,793) (15,690,464) (1,843,241) (17,659,525)
Net decrease.................................... (900,802) $ (8,798,250) (1,044,927) $(10,350,474) (1,348,554) $(12,923,108)
CLASS B
Shares sold..................................... 136,707 $ 1,324,403 332,958 $ 3,194,770 647,077 $ 6,139,897
Share issued in acquisition of Keystone Texas
Tax Free Fund................................. 0 0 374,545 3,592,334 0 0
Shares issued in reinvestment of
distributions................................. 35,437 341,830 80,112 776,860 82,512 790,394
Shares redeemed................................. (568,355) (5,489,766) (773,268) (7,498,073) (625,195) (5,968,412)
Net increase (decrease)......................... (396,211) $ (3,823,533) 14,347 $ 65,891 104,394 $ 961,879
CLASS C
Shares sold..................................... 1,101 $ 10,621 140,724 $ 1,454,967 338,010 $ 3,205,146
Share issued in acquisition of Keystone Texas
Tax Free Fund................................. 0 0 26,855 257,617 0 0
Shares issued in reinvestment of
distributions................................. 16,648 160,577 48,553 471,531 64,840 619,790
Shares redeemed................................. (195,509) (1,900,664) (857,965) (8,352,411) (974,642) (9,212,881)
Net decrease.................................... (177,760) $ (1,729,466) (641,833) $ (6,168,296) (571,792) $ (5,387,945)
</TABLE>
35
<PAGE>
EVERGREEN KEYSTONE
(logo)
COMBINED NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. SECURITIES TRANSACTIONS
Cost of purchases and proceeds from sales of investment securities (excluding
short-term securities) were as follows for the periods ended May 31, 1997:
<TABLE>
<CAPTION>
<S> <C> <C>
COST OF PROCEEDS
PURCHASES FROM SALES
High Grade Fund*........................................................ $116,031,811 $122,344,118
Short-Intermediate Fund*................................................ 21,730,862 46,574,525
Tax Free Income Fund**.................................................. 64,224,477 78,272,042
</TABLE>
* For the nine months ended May 31, 1997
** For the six months ended May 31, 1997
On May 31, 1997, the composition of unrealized appreciation and depreciation of
investment securities based on the aggregate cost of investments for federal tax
purposes was as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
GROSS GROSS NET
TAX UNREALIZED UNREALIZED UNREALIZED
COST APPRECIATION DEPRECIATION APPRECIATION
High Grade Fund.................................................. $ 96,387,879 $4,291,252 $ (88,538) $4,202,714
Short-Intermediate Fund.......................................... 44,806,201 438,278 0 438,278
Tax Free Income Fund............................................. 107,616,798 4,709,914 (434,799) 4,275,115
</TABLE>
As of May 31, 1997, the Funds had capital loss carryovers for federal income tax
purposes as follows:
EXPIRATION
2002 2003 2004
High Grade Fund............................ $1,265,000 -- --
Short-Intermediate Fund.................... -- $249,000 $433,000
Tax Free Income Fund....................... 2,704,000 867,00 --
4. DISTRIBUTION PLANS
Since December 11, 1996, Evergreen Keystone Distributor, Inc. (formerly,
Evergreen Funds Distributor, Inc.) ("EKD"), a wholly-owned subsidiary of The
BISYS Group Inc. ("BISYS") has served as principal underwriter for the Tax Free
Income Fund. Prior to December 11, 1996, Evergreen Keystone Investment Services,
Inc. (formerly, Keystone Investment Distributors Company) ("EKIS"), a
wholly-owned subsidiary of Keystone, served as the principal underwriter for the
Tax Free Income Fund. EKD also serves as the principal underwriter for the High
Grade and Short-Intermediate Funds.
Each Fund has adopted Distribution Plans for each class of shares as allowed by
Rule 12b-1 of the 1940 Act. Distribution plans permit the fund to reimburse its
principal underwriter for costs related to selling shares of the fund and for
various other services. These costs, which consist primarily of commissions and
services fees to broker-dealers who sell shares of the fund, are paid by
shareholders through expenses called "Distribution Plan expenses." Each class,
except Class Y, currently pays a service fee equal to 0.25% of the average daily
net asset of the class. The expenses are currently limited to 0.25% annually of
the average daily net assets of the Class A shares of the High Grade and Tax
Free Income Funds and limited to 0.10% annually of the average daily net assets
of the Class A shares of the Short-Intermediate Fund. Class B and Class C also
presently pay distribution fees equal to 0.75% of the average daily net assets
of the Class. Distribution Plan expenses are calculated daily and paid monthly.
With respect to Class B and Class C shares of the Tax Free Income Fund, the
principal underwriter may pay 12b-1 fees greater than the allowable annual
amounts the Fund is permitted to pay. The Fund may reimburse the principal
underwriter for such excess amounts in later years with annual interest at the
prime rate plus 1.00%.
During the period ended May 31, 1997, amounts paid to EKD and/or EKIS pursuant
to each Fund's Class A, Class B and Class C Distribution Plans were as follows:
CLASS A CLASS B CLASS C
High Grade Fund............................... $92,644 $240,510 N/A
Short-Intermediate Fund....................... 19,181 52,576 N/A
Tax Free Income Fund.......................... 90,496 154,261 $62,367
Each of the Distribution Plans for the Tax Free Income Fund may be terminated at
any time by a vote of the Independent Trustees or by a vote of a majority of the
outstanding voting shares of the respective class. However, after the
termination of any Distribution Plan, and subject to the discretion of the
Independent Trustees, payments to EKIS and/or EKD may continue as compensation
for services which had been earned while the Distribution Plan was in effect.
36
<PAGE>
EVERGREEN KEYSTONE
(logo)
COMBINED NOTES TO FINANCIAL STATEMENTS (CONTINUED)
EKD intends, but is not obligated, to continue to pay distribution costs that
exceed the current annual payments from the Fund. EKD intends to seek full
payment of such distribution costs from the Fund at such time in the future as,
and to the extent that, payment thereof by the Class B or Class C shares would
be within permitted limits.
EKD and/or its predecessor has advised the Funds that it has retained front-end
sales charges resulting from the sales of Class A shares for the High Grade,
Short-Intermediate and Tax Free Income Funds during the period ended May 31,
1997 of $6,389, $3,820 and $9,477, respectively.
Contingent deferred sales charges paid by redeeming shareholders are paid to EKD
or its predecessor.
5. INVESTMENT MANAGEMENT AGREEMENT AND OTHER AFFILIATED TRANSACTIONS
First Union National Bank of North Carolina ("FUNB"), a wholly-owned subsidiary
of First Union Corporation ("First Union"), serves as the investment adviser to
the High Grade Fund and is paid a fee computed daily and paid monthly at an
annual rate of 0.50% of the Fund's average daily net assets. EKIS, a subsidiary
of First Union, is the administrator. Prior to March 11, 1997, Evergreen Asset
Management Corp. ("Evergreen Asset"), a wholly owned subsidiary of First Union,
was the administrator. Furman Selz LLC ("Furman Selz") was the sub-administrator
through December 31, 1996. Effective January 1, 1997, BISYS acquired Furman
Selz' mutual fund unit and accordingly BISYS became sub-administrator. The
administrator and sub-administrator for the Fund are entitled to an annual fee
based on the average daily net assets of all funds administered by EKIS for
which First Union or its investment advisory subsidiaries is also the investment
adviser. The administration fee is calculated by applying percentage rates,
which start at 0.05% and decline to 0.01% per annum as net assets increase, to
the average daily net asset value of the funds. The sub-administration fee is
calculated by applying percentage rates, which start at 0.01% and decline to
.004% as net assets increase, to the average daily net asset value of the funds.
Evergreen Asset is the investment adviser for the Short-Intermediate Fund and is
paid a management fee that is computed daily and paid monthly at an annual rate
of 0.50% on the average daily net assets. Out of its fee, Evergreen Asset in
turn pays EKIS for its services as administrator, BISYS for its services as
sub-administrator and Lieber & Company, an affiliate of First Union, for its
services as sub-adviser.
Keystone Investment Management Company ("Keystone"), a subsidiary of First
Union, is the investment adviser for the Tax Free Income Fund. In return for
providing investment management and administrative services to the Tax Free
Income Fund, the Fund pays Keystone a management fee that is calculated daily
and paid monthly. The management fee is computed at an annual rate of 2.00% of
Tax Free Income Fund's gross investment income plus an amount determined by
applying percentage rates starting at 0.50% and declining to 0.25% per annum as
net assets increase, to the average daily net asset value of the Fund.
Effective, January 1, 1997, BISYS became the sub-administrator to the Fund and
is paid by Keystone.
During the period ended May 31, 1997, the investment adviser for the High Grade
and Short-Intermediate Funds waived its management fees in the amounts of
$64,199 and $60,003, respectively.
During the period ended May 31, 1997, High Grade Fund and Tax Free Income Fund
paid or accrued $27,577 and $17,396 to EKIS, respectively, for certain
accounting services.
Evergreen Keystone Service Company ("EKSC") (formerly, Keystone Investor
Resource Center, Inc.), a wholly-owned subsidiary of Keystone, serves as the
transfer and dividend disbursing agent for the Funds. Prior to May 5, 1997,
State Street Bank and Trust Company ("State Street") served as the transfer and
dividend disbursing agent for the High Grade and Short-Intermediate Funds. For
certain accounts for the High Grade and Short-Intermediate Funds, First Union
had been sub-contracted by State Street to maintain shareholder sub-account
records, take fund purchase and redemption orders and answer inquiries. For each
account, First Union is entitled a fee which in aggregate totaled $866 and $288
for the High Grade and Short-Intermediate Funds for the period ended May 31,
1997.
Officers of the Funds and affiliated Trustees receive no compensation directly
from the Funds. As sub-administrator, BISYS compensates the officers of the
Funds.
At May 31, 1997, FUNB owned, directly or beneficially, 22.0% of the outstanding
shares of Short-Intermediate Fund.
37
<PAGE>
EVERGREEN KEYSTONE
(logo)
COMBINED NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. EXPENSE OFFSET ARRANGEMENT
The Funds have entered into an expense offset arrangement with their custodian.
The assets deposited with the custodian under this expense offset arrangement
could have been invested in income-producing assets.
7. ACQUISITIONS
On July 7, 1995 the High Grade Fund acquired the net assets of Evergreen
National Tax Free Fund ("National Fund") and on April 30, 1996 the Tax Free
Income Fund acquired the net assets of Keystone Texas Tax Free Fund ("Texas
Fund") in exchange for Class A, B and C or Y shares. Both acquisitions were
accomplished by a tax-free exchange of the respective shares of each respective
Fund. The value of assets acquired, number of shares issued, unrealized
appreciation acquired and aggregate net assets of each Fund immediately after
the acquisition are as follows:
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
ACQUIRING ACQUIRED VALUE OF NET NUMBER OF UNREALIZED NET ASSETS
FUND FUND ASSETS ACQUIRED SHARES ISSUED APPRECIATION AFTER ACQUISITION
High Grade Fund National Fund $28,779,195 2,679,627 $528,003 $ 128,792,690
Tax Free Income Fund Texas Fund 5,119,680 532,628 81,550 140,303,798
</TABLE>
8. DEFERRED TRUSTEES' FEES
Each Independent Trustee of the High Grade and Short-Intermediate Funds may
defer any or all compensation related to their performance of duties as a
Trustee. Each Trustee's deferred balances are allocated to deferral accounts
which are included in the accrued expenses for the Fund. The investment
performance of the deferral accounts are based on the investment performance of
certain Evergreen Keystone Funds. Any gains earned or losses incurred in the
deferral accounts are reported in each Fund's Trustees' fees and expenses.
Trustees will be paid either in one lump sum or in quarterly installments for up
to ten years at their election, not earlier than either the year in which the
Trustee ceases to be a member of the Board of Trustees or January 1, 2000. As of
May 31, 1997, the value of the Trustees deferral account was $3,717 for the High
Grade Fund and $4,985 for the Short-Intermediate Fund.
9. FINANCING AGREEMENT
On October 31, 1996, a financing agreement between all of the Evergreen Funds
and State Street, Societe Generale and ABN Amro Bank N.V. (collectively, the
"Banks") became effective. Under this agreement, the Banks provide an unsecured
credit facility in the aggregate amount of $225 million ($112.5 million
committed and $112.5 million uncommitted) allocated evenly between the Banks.
Borrowings under this facility bear interest at 0.75% per annum above the
Federal Funds rate. A commitment fee of 0.10% per annum will be incurred on the
unused portion of the committed facility which will be allocated to all
participating funds. State Street acts as agent for the Banks, and as agent is
entitled to a fee of $15,000 which is allocated to all of the Evergreen Funds.
During the period ended May 31, 1997, the High Grade and Short-Intermediate
Funds had no borrowings under this agreement.
38
<PAGE>
EVERGREEN KEYSTONE
(logo)
REPORT OF INDEPENDENT ACCOUNTANTS
To the Trustees and Shareholders of
Evergreen High Grade Tax Free Fund
In our opinion, the accompanying statement of assets and liabilities, including
the schedule of investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of Evergreen High Grade Tax Free Fund
(the "Fund"), one of the Evergreen Investment Trust Portfolios, at May 31, 1997,
and the results of its operations, the changes in its net assets and the
financial highlights for the period September 1, 1996 through May 31, 1997, in
conformity with generally accepted accounting principles. These financial
statements and financial highlights (hereafter referred to as "financial
statements") are the responsibility of the Fund's management; our responsibility
is to express an opinion on these financial statements based on our audit. We
conducted our audit of these financial statements in accordance with generally
accepted auditing standards which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit, which included confirmation of securities at May 31, 1997 by
correspondence with the custodian and the application of alternative auditing
procedures, provides a reasonable basis for the opinion expressed above. The
financial statements of the Fund for the year ended, and indicated periods prior
to, August 31, 1996 were audited by other independent accountants whose report
dated October 16, 1996 expressed an unqualified opinion.
Price Waterhouse LLP
1177 Avenue of the Americas
New York, New York
July 8, 1997
39
<PAGE>
EVERGREEN KEYSTONE
(logo)
REPORT OF INDEPENDENT ACCOUNTANTS
To the Trustees and Shareholders of
Evergreen Short-Intermediate Municipal Fund
In our opinion, the accompanying statement of assets and liabilities, including
the schedule of investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of Evergreen Short-Intermediate Fund
(the "Fund"), one of the Evergreen Municipal Trust Portfolios, at May 31, 1997,
and the results of its operations, the changes in its net assets and the
financial highlights for each of the periods indicated, in conformity with
generally accepted accounting principles. These financial statements and
financial highlights (hereafter referred to as "financial statements") are the
responsibility of the Fund's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits, which included confirmation of securities at May 31, 1997 by
correspondence with the custodian, provide a reasonable basis for the opinion
expressed above.
Price Waterhouse LLP
1177 Avenue of the Americas
New York, New York
July 8, 1997
40
<PAGE>
EVERGREEN KEYSTONE
(logo)
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone Tax Free Income Fund
We have audited the accompanying statement of assets and liabilities of Keystone
Tax Free Income Fund, including the schedule of investments, as of May 31, 1997,
and the related statements of operations for the six months ended May 31, 1997
and the year ended November 30, 1996, the statements of changes in net assets
for the six months ended May 31, 1997 and for each of the years in the two-year
period ended November 30, 1996, and the financial highlights for the six months
ended May 31, 1997, each of the years in the nine-year period ended November 30,
1996 and the period from February 13, 1987 (Commencement of Operations) to
November 30, 1987 for Class A Shares and for the six months ended May 31, 1997,
each of the years in the three-year period ended November 30, 1996 and the
period from February 1, 1993 (Date of Initial Public Offering) to November 30,
1993, for Class B and Class C Shares. These financial statements and financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and financial highlights
based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of May
31, 1997 by correspondence with the custodian and brokers. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Keystone Tax Free Income Fund as of May 31, 1997, the results of its operations
for the six months ended May 31, 1997 and the year ended November 30, 1996, the
changes in its net assets and the financial highlights for each of the years or
periods specified in the first paragraph above in conformity with generally
accepted accounting principles.
Boston, Massachusetts KPMG Peat Marwick LLP
June 27, 1997
41
<PAGE>
EVERGREEN KEYSTONE
(logo)
ADDITIONAL INFORMATION (Unaudited)
Shareholders of the Keystone Tax Free Income Fund considered and acted upon the
proposals listed below at a special meeting of shareholders held Monday,
December 9, 1996. In addition, below each proposal are the results of that vote.
1. To elect the following Trustees:
AFFIRMATIVE WITHHELD
Frederick Amling........................... 9,815,069 199,547
Laurence B. Ashkin......................... 9,812,403 202,213
Charles A. Austin III...................... 9,813,238 207,378
Foster Bam................................. 9,812,719 201,897
George S. Bissell.......................... 9,815,312 199,304
Edwin D. Campbell.......................... 9,812,195 202,421
Charles F. Chapin.......................... 9,814,500 200,116
K. Dun Gifford............................. 9,813,609 201,007
James S. Howell............................ 9,811,512 203,104
Leroy Keith, Jr............................ 9,813,609 201,007
F. Ray Keyser.............................. 9,810,159 204,457
Gerald M. McDonnell........................ 9,811,512 203,104
Thomas L. McVerry.......................... 9,811,512 203,104
William Walt Pettit........................ 9,810,932 203,684
David M. Richardson........................ 9,813,609 201,007
Russell A. Salton, III M.D................. 9,811,487 203,129
Michael S. Scofield........................ 9,813,283 201,333
Richard J. Shima........................... 9,808,652 205,964
Andrew J. Simons........................... 9,813,040 201,576
2. To approve an Investment Advisory and Management Agreement between Keystone
Tax Free Income Fund and Keystone Investment Management Company:
Affirmative............................. 9,365,556
Against................................. 146,890
Abstain................................. 502,170
FEDERAL INCOME TAX STATUS OF DIVIDENDS (UNAUDITED)
Of the dividends distributed by High Grade, Short-Intermediate and Tax Free
Income Funds for the period ended May 31, 1997, 99.01%, 99.98% and 99.29%,
respectively, is exempt from federal income tax other than alternative
minimum tax.
42
<PAGE>
This brochure must be preceded or accompanied by a prospectus of an Evergreen
fund contained herein. The prospectus contains more complete information,
including fees and expenses, and should be read carefully before investing
or sending money.
NOT May lose value
FDIC No bank guarantee
INSURED
Evergreen Keystone Distributor, Inc.
<PAGE>
PAGE 1
- --------------------
Keystone Tax Free Fund
Seeks high current income, exempt from federal income taxes, while
preserving capital by investing in high quality municipal bonds.
Dear Shareholder:
We are writing to report to you on the activities of Keystone Tax Free Fund
for the twelve-month period which ended December 31, 1996. Following this
letter, we have included a discussion with your Fund's manager
discussing portfolio strategy.
Performance
For the twelve-month period, your Fund returned 3.15%. These results include
price changes and reinvestment of dividends. The Lehman Municipal Bond
Index--a widely recognized benchmark of municipal bond performance--returned
4.43% for the same twelve-month period.
We were satisfied with your Fund's performance, which showed steady
improvement in the second half of last year.
Municipal bond yields rose by less than 1/4% in 1996. However, this modest
year-over-year increase masks the wide fluctuations that occurred during the
past twelve months.
The municipal bond market experienced a period of adjustment in the first
half of 1996. Interest rates reversed course quickly from the rally that had
characterized much of the prior year, as investors responded to stronger than
expected economic growth and anticipated rising inflation. The possibility of
tax-reform and uncertainty regarding the national elections also caused
municipal bond investors to exercise caution and push prices lower.
Clearer economic and political trends began to emerge by mid-year, causing
the market's tone to improve. Although economic growth was confirmed to be
moderate--stronger than many investors had originally expected--inflation
remained well-contained. Investors also grew more comfortable with political
agendas as the campaign season got underway, and tax-law changes became
increasingly less of a possibility. The municipal bond market rebounded from
its earlier lows to generate a positive performance in the second half of the
year.
Outlook
We enter 1997 with a cautiously optimistic outlook that municipal bond prices
will be relatively stable. We expect the economy to continue to grow at a
moderate rate and inflation to remain well-contained. While we continually
monitor the political environment, currently there appear to be no issues
that would have the impact of last year's potential tax-law changes and the
national elections. Although short periods of price fluctuations could
occasionally occur, for the most part we look for interest rates to move
within a narrow range.
Last year's municipal bond market performance also serves as a reminder that
periods of adjustment are a natural part of the financial markets. As
investors, we need to diversify our personal portfolios to help reduce the
effects of temporary volatility. We also need to maintain a long-term
perspective. Financial markets eventually stabilize; and total return builds
over time.
<PAGE>
PAGE 2
- --------------------
Keystone Tax Free Fund
We appreciate your continued support of Keystone funds. If you have any
questions or comments about your investment, please feel free to write to us.
Sincerely,
/s/ Albert H. Elfner, III
Albert H. Elfner, III
Chairman
Keystone Investment Management Company
/s/ George S. Bissell
George S. Bissell
Chairman of the Board
Keystone Funds
[photo] [photo]
Albert H. Elfner, III George S. Bissell
February 1997
<PAGE>
PAGE 3
- --------------------
A Discussion With
Your Fund's Manager
[photo]
Betsy A. Hutchings is vice president and senior
portfolio manager at Keystone specializing in tax-free municipal
bonds. A professional with 17 years of investment experience, Ms.
Hutchings is the portfolio manager of Keystone Tax Free Fund.
Q What does the Fund offer investors?
A Keystone Tax Free Fund is designed for tax-sensitive investors who seek
capital preservation and a high level of current income that is exempt from
federal income tax. For investors in certain tax situations, a portion of
income may be subject to the federal alternative minimum tax (AMT). The Fund
offers professional management and portfolio diversification. We believe
these are important attributes since many investors do not have the time or
resources to monitor credit quality, the economy and interest rates. Further,
we think that professional management and diversification can reduce credit
risk and enhance price stability.
Q How do you select securities for the Fund?
A Our management team employs an intensive research process, paying careful
attention to credit quality and financial stability. We structure the
portfolio with bonds that meet our high credit standards. Our holdings
typically have the characteristics that we believe are necessary for good
performance in the current and anticipated interest rate environment. We
emphasize diversification and focus on maximizing the Fund's income.
Q What was the environment like for municipal bonds over the past twelve
months?
A Municipal bond rates rose modestly in 1996. The interest rate environment
was volatile in the first half of the year and favorable in the second half
of 1996. The economy grew faster than expected in the first six months of
1996, causing concerns about future inflation. In addition to economic
uncertainties, municipal bond investors prepared for the national elections
and the possibility of tax-reform.
In the second half of last year, the uncertainties became resolved and
municipal bonds staged an impressive turnaround. The economy was confirmed to
be growing at a moderate pace. Inflation remained well-contained. As the
campaign season progressed, investors grew more comfortable with political
agendas; and tax-reform became increasingly less likely.
Other factors also helped shape the environment for municipal bonds.
Although new issuance rose approximately 14% to $183 billion--its highest
level since 1993 and demand from individuals was light, strong demand from
insurance companies helped to create a stable balance in the supply/demand
relationship. From a credit standpoint, upgrades exceeded downgrades and the
yields of lower-rated bonds fell--pushing their prices higher--relative to
higher-rated bonds. Municipal revenues were higher than past years and for
the most part, state fund balances were healthy.
Fund Profile
Objective: Seeks high current income, exempt from federal income taxes, while
preserving capital by investing in high quality municipal bonds.
Inception Date: April 12, 1977
Average Portfolio Quality: AA
Total assets: $1.56 billion
<PAGE>
PAGE 4
- --------------------
Keystone Tax Free Fund
Q How did you manage the Fund during this time?
A We shortened the Fund's average maturity and swapped out of lower yielding
issues into higher yielding issues that we considered to be undervalued. We
later focused on bonds whose primary component in total return, we believed
would be price appreciation, rather than income. These bonds had coupons that
ranged from 5% to 5.50%, and had maturities of 15-20 years. Throughout the
year we emphasized call protection. In fact, as of December 31, 1996,
approximately one-third of the Fund's net assets were non-callable.
The Fund had a longer average maturity early in 1996, which had a negative
effect on performance when interest rates became volatile. We shortened
average maturity modestly as interest rates rose. This change, combined with
the Fund's focus on bonds that emphasized price appreciation, resulted in the
Fund's total return showing solid improvement throughout the rest of the
year. The Fund posted a total return higher than that of the Lipper average
for the fourth quarter. As of December 31, 1996, Keystone Tax Free Fund had
an average maturity of just under 19 years. Average quality stood at AA.
Q What is your outlook for the next six months?
A We anticipate the overall economic and interest rate environment to be
favorable for municipal bonds, but look for periods of volatility as we
expect many investors to over-react to individual pieces of economic data. We
expect the economy to continue on its path of moderate growth with low
inflation. The political climate should also should be supportive. Voters
have approved over $10 billion in new municipal bond issues for 1997 to
improve infrastructures, particularly highways and schools. We believe new
volume will increase at a rate between 8%-10% per year, over the next few
years.
We will continue to emphasize bonds that we believe maximize price
appreciation and will seek to capitalize on situations that are undervalued.
Over the long-term, we believe this strategy can provide investors with solid
total returns and an attractive level of income that is exempt from federal
income tax.
The Benefits of Tax Free Investing
Federal Tax Bracket
--------------- ---------------------------
31%(1) 36%(2) 39.6%(3)
--------------- ------ ------ -------
Tax Free Yield Taxable Equivalent Yield
--------------- ---------------------------
5.0% 7.25% 7.81% 8.28%
6.0% 8.70% 9.38% 9.93%
7.0% 10.14% 10.94% 11.59%
The equivalent yield for a tax free yield of 6.0% is 9.38% for an investor in
the 36% tax bracket. In other words, a tax free yield of 6.0% is equal to a
taxable yield of 9.38% if you are in the 36% federal tax bracket.
(1) Single filers earning $53,501-$115,000; joint filers earning $89,151-
$140,000.
(2) Single filers earning $115,001-$250,000; joint filers earning $140,001-
$250,000.
(3) Single filers earning over $250,000; joint filers earning over $250,000.
[diamond]
This column is intended to answer
questions about your Fund. If you have a question
you would like answered, please write to:
Evergreen Keystone Investment Services, Inc.
Attn: Shareholder Communications, 22nd Floor
200 Berkeley Street, Boston, Massachusetts 02116-5034.
<PAGE>
PAGE 5
- --------------------
Your Fund's Performance
Growth of an investment in
Keystone Tax Free Fund
[mountain chart]
In Thousands
Initial Reinvested
Investment Distributions
12/86 10,000 10,000
9,152 9,986
12/88 9,253 11,074
9,118 12,083
12/90 8,937 12,888
9,129 14,280
12/92 9,095 15,358
9,186 17,072
12/94 8,032 15,819
8,891 18,447
12/96 8,722 19,027
A $10,000 investment in Keystone Tax Free Fund made on December 31, 1986 with
all distributions reinvested was worth $19,027 on December 31, 1996. Past
performance is no guarantee of future results.
Twelve-Month Performance as of December 31, 1996
Total return* 3.15%
Net asset value 12/31/95 $7.86
12/31/96 $7.71
Dividends $0.39
Capital gains None
* Before deduction of any contingent deferred sales charge (CDSC).
Historical Record as of December 31, 1996
If you If you did
Cumulative total return redeemed not redeem
1-year 0.21% 3.15%
5-year 33.24% 33.24%
10-year 90.27% 90.27%
Average annual total return
1-year 0.21% 3.15%
5-year 5.91% 5.91%
10-year 6.64% 6.64%
The "if you redeemed" returns reflect the deduction of the 3% CDSC for those
investors who sold Fund shares after one calendar year. Investors who
retained their fund investment earned the returns reported in the second
column of the table.
The investment return and principal value will fluctuate so that your
shares, when redeemed, may be worth more or less than the original cost.
You may exchange your shares for another Keystone fund by phone or in
writing. You may also exchange funds using Keystone's Automated Response Line
(KARL). The Fund reserves the right to change or terminate the exchange
offer.
<PAGE>
PAGE 6
- --------------------
Keystone Tax Free Fund
Growth of an Investment
Comparison of change in value of a $10,000 investment in Keystone Tax Free
Fund, the Lehman Municipal Bond Index and the Consumer Price Index.
In Thousands December 31, 1986 through December 31, 1996
Fund Average
Annual Total Return
- ---------------------------
1 Year 5 Year 10 Year
0.21% 5.91% 6.64%
[line chart]
Lehman Municipal Consumer
Bond Index Price Index
Fund (LMBI) (CPI)
12/86 10,000 10,000 10,000
9,986 10,150 10,441
12/88 11,074 11,179 10,903
12,083 12,385 11,409
12/90 12,888 13,288 12,105
14,280 14,901 12,476
12/92 15,358 16,215 12,836
17,072 18,206 13,190
12/94 15,819 17,269 13,542
18,447 20,285 13,886
12/96 19,027 21,183 14,348
Past performance is no guarantee of future results. The one-year return
reflects the deduction of the Fund's 3% contingent deferred sales charge for
shares held for at least one year. CPI is through
This chart graphically compares your Fund's performance to certain investment
indexes. It is the result of fund performance guidelines issued by the
Securities and Exchange Commission. The intent is to provide investors with
more information about their investment.
Components of the Chart
The chart is composed of three lines that represent the accumulated value of
an initial $10,000 investment for the period indicated. The lines illustrate
a hypothetical investment in:
1. Keystone Tax Free Fund
Your fund seeks current income, exempt from federal income taxes, while
preserving capital by investing in high quality municipal bonds. The return
is quoted after deducting contingent deferred sales charges (if applicable),
fund expenses, and transaction costs and assumes reinvestment of all
distributions.
2. Lehman Municipal Bond Index (LMBI)
The LMBI is a broad-based, unmanaged market index of securities issued by
state and local governments. It represents the price change and coupon income
of several thousand securities with various maturities and qualities.
Securities are selected and compiled by Lehman Brothers, Inc. according to
criteria that may be unrelated to your Fund's investment objective.
3. Consumer Price Index (CPI)
This index is a widely recognized measure of the cost of goods and services
produced in the U.S. The index contains factors such as prices of services,
housing, food, transportation and electricity which are compiled by the U.S.
Bureau of Labor Statistics. The CPI is generally considered a valuable
benchmark for investors who seek to outperform increases in the cost of
living.
These indexes do not include transaction costs associated with buying and
selling securities, and do not hold cash to meet redemptions. It would be
difficult for most individual investors to duplicate these indexes.
Understanding What the Chart Means
The chart demonstrates your Fund's performance in relation to a well known
investment index and to increases in the cost of living. It is important to
understand what the chart shows and does not show.
This illustration is useful because it charts Fund and index performance
over the same time frame and over a long period. Long-term performance is a
more reliable and useful measure of performance than measurements of
short-term returns or temporary swings in the market. Your financial adviser
can help you evaluate fund performance in conjunction with the other
important financial considerations such as safety, stability and consistency.
<PAGE>
PAGE 7
- --------------------
Limitations of the Chart
The chart, however, limits the evaluation of Fund performance in several
ways. Because the measurement is based on total returns over an extended
period of time, the comparison often favors those funds which emphasize
capital appreciation when the market is rising. Likewise, when the market is
declining, the comparison usually favors those funds which take less risk.
Performance Can Be Distorted
Funds which are more conservative in their orientation and which place an
emphasis on capital preservation will tend to compare less favorably when the
market is rising. In addition, funds which have income as one of their
objectives also will tend to compare less favorably to relevant indexes.
Indexes may also reflect the performance of some securities which a fund may
be prohibited from buying. A bond fund, for example, may be limited to
investments in only high quality bonds, or a stock fund may only be able to
buy stocks that have been traded on a stock exchange for a minimum number of
years or of a certain company size. Indexes usually do not have the same
investment restrictions as your fund.
Indexes Do Not Include Costs of Investing
The comparison is further limited in its utility because the index does not
take into account any deductions for sales charges, transactions costs or
other fund expenses. Your Fund's performance figures do reflect such
deductions. Sales charges--whether up-front or deferred--pay for the cost of
the investment advice of your financial adviser. Transaction costs pay for
the costs of buying and selling securities for your Fund's portfolio. Fund
expenses pay for the costs of investment management and various shareholder
services. None of these costs are reflected in index total returns. The
comparison is not completely realistic because an index cannot be duplicated
by an investor--even an unmanaged index--without incurring some charges and
expenses.
One of Several MeasuresKeystone Tax Free Fund
The chart is one of several tools you can use to understand your investment.
It should be read in conjunction with the Fund's prospectus, and annual and
semiannual reports. Also, your financial adviser, who understands your
personal financial situation, can best explain the features of your Keystone
fund and how it applies to your financial needs.
Future Returns May Be Different
Shareholders also should be mindful that the long-run perfomance of either
the Fund or the indexes is not representative of what shareholders should
expect to receive from their Fund investment in the future; it is presented
to illustrate only past performance and is not a guarantee of future returns.
<PAGE>
PAGE 8
- --------------------
Keystone Tax Free Fund
Glossary of
Mutual Fund Terms
MUTUAL FUND--A company which combines the investment money of many people
whose financial goals are similar, and invests that money in a variety of
securities. A mutual fund allows the smaller investor the benefits of
diversification, professional management and constant supervision usually
available only to large investors.
PORTFOLIO MANAGER--An investment professional who is responsible for
managing a portfolio's assets prudently and making appropriate investment
decisions, such as which securities to buy, hold and sell, based on the
investment objectives of the portfolio.
STOCK--Equity or ownership interest in a corporation, which represents a
claim on the corporation's assets and earnings.
BOND--Security issued by a government or corporation to those from whom it
has borrowed money. A bond usually promises to pay interest income to the
bondholder at regular intervals and to repay the entire amount borrowed at
maturity date.
CONVERTIBLE SECURITY--A corporate security (usually preferred stock or
bonds) that is exchangeable for a set number of another security type
(usually common stocks) at a pre-stated price.
MONEY MARKET FUND--A mutual fund whose assets are invested in a diversified
portfolio of short-term securities, including commercial paper, bankers'
acceptances, certificates of deposit and other short-term instruments. The
fund pays income which can fluctuate daily. Liquidity and safety of principal
are primary objectives.
NET ASSET VALUE (NAV) PER SHARE--The value of one share of a mutual fund.
The NAV per share is determined by subtracting a fund's total liabilities
from its total assets, and dividing that amount by the number of fund shares
outstanding.
DIVIDEND--A per share distribution of the income earned from the fund's
portfolio holdings. When a dividend distribution is made, the fund's net
asset value drops by the amount of the distribution because the distribution
is no longer considered part of the fund's assets.
CAPITAL GAIN--The profit from the sale of securities, less any losses.
Capital gains are paid to fund shareholders on a per share basis. When a
capital gain distribution is made, the fund's net asset value drops by the
amount of the distribution because the distribution is no longer considered
part of the fund's assets.
YIELD--The annualized rate of income as measured against the current net
asset value of fund shares.
TOTAL RETURN--The change in value of a fund investment over a specified
period of time, taking into account the change in a fund's market price and
the reinvestment of all fund distributions.
SHORT-TERM--An investment with a maturity of one year or less.
LONG-TERM--An investment with a maturity of greater than one year.
AVERAGE MATURITY--The average number of days until the notes, drafts,
acceptances, bonds or other debt instruments in a portfolio become due and
payable.
OFFERING PRICE--The offering price of a share of a mutual fund is the price
at which the share is sold to the public.
<PAGE>
PAGE 9
- --------------------
SCHEDULE OF INVESTMENTS--December 31, 1996
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Coupon Maturity Principal Market
Rate Date Amount Value
- ---------------------------------------------------------- ------ ---------- ---------- --------------
MUNICIPAL BONDS (98.0%)
ALABAMA
Alabama Agricultural and Mechanic University (MBIA) 6.500% 11/01/2025 $ 2,035,000 $ 2,208,626
Alabama Housing Finance Authority, Single Family,
Collateralized Home Mortgage, Series D1 6.000 10/01/2016 2,065,000 2,089,945
Mobile, Alabama, Industrial Development Board, Solid
Waste Disposal, Mobile Energy Services Company Project 6.950 01/01/2020 3,500,000 3,681,790
ALASKA
Alaska Energy Authority, Utilities Revenue, Linked
Bulls/Bears Floaters (FGIC) (d) 6.600 07/01/2015 15,000,000 16,346,550
Alaska State Housing Finance Corporation, Collateralized
Home Mortgage, Series A 8.000 12/01/2013 405,000 419,835
North Slope Borough, Alaska, General Obligation, Series
A (MBIA) 5.900 06/30/2003 3,000,000 3,171,030
Valdez, Alaska, Marine Terminal Revenue, Union Alaska
Pipeline Company Project 6.200 05/01/2008 3,000,000 3,007,620
ARIZONA
Central Arizona, Water Conservation District, Contract
Revenue, Central Arizona Project, Series A 5.500 11/01/2008 4,250,000 4,369,467
Central Arizona, Water Conservation District, Contract
Revenue, Central Arizona Project, Series A 5.500 11/01/2009 11,000,000 11,267,190
Chandler, Arizona, Water and Sewer Revenue (FGIC) 6.750 07/01/2006 850,000 920,193
Maricopa County, Arizona, Elementary School District
#008, Osborn Refunding (MBIA) 7.500 07/01/2007 2,000,000 2,410,100
Maricopa County, Arizona, Elementary School District
#068, Series A (AMBAC) 6.750 07/01/2014 3,750,000 4,180,537
Maricopa County, Arizona, Unified School District (MBIA) 8.125 01/01/2010 6,000,000 6,918,060
Northern Arizona University, College and University
Revenue (FGIC) 6.300 06/01/2005 2,770,000 2,980,742
Pima County, Arizona, Industrial Development Authority,
Health Care Corporation Revenue (MBIA) 8.000 07/01/2013 370,000 396,337
Pima County, Arizona, Unified School District, Tucson
Refunding (FGIC) 7.500 07/01/2003 2,030,000 2,356,769
Santa Cruz County, Arizona, Unified School District,
Capital Appreciation (AMBAC) (effective yield 5.95%)
(b) 0.000 01/01/2008 1,100,000 621,115
Santa Cruz County, Arizona, Unified School District,
Capital Appreciation (AMBAC) (effective yield 5.95%)
(b) 0.000 07/01/2008 1,100,000 605,187
ARKANSAS
Arkansas State Development Finance Authority, Single
Family Mortgage Revenue Refunding 8.000 08/15/2011 1,985,000 2,127,920
CALIFORNIA
California Educational Facilities Authority, Stanford
University Project, Series H 5.000 01/01/2015 250,000 234,938
California Health Facilities Financing, St. Francis
Medical Center, Series A 5.500 10/01/2009 200,000 207,158
California Housing Finance Agency, Revenue Bonds, Home
Mortgage, Series H 6.250 08/01/2027 2,000,000 2,019,520
(continued on next page)
<PAGE>
PAGE 10
- --------------------
Keystone Tax Free Fund
SCHEDULE OF INVESTMENTS--December 31, 1996
Coupon Maturity Principal Market
Rate Date Amount Value
- ---------------------------------------------------------- ------ ---------- ---------- --------------
CALIFORNIA (continued)
California State Department of Water Reserves, Series O 5.000% 12/01/2022 $ 6,360,000 $ 5,825,251
California State Public Works Board, Lease Department
Correctional State Prison, Series E 5.500 06/01/2015 3,700,000 3,652,973
California State Public Works Board, Various California
University Projects, Series B 5.500 06/01/2019 350,000 333,515
East Bay, California, Municipal Utility District,
Wastewater Treatment System Revenue (FGIC) 5.000 06/01/2026 3,500,000 3,213,175
Eden Township, California, Hospital District Revenue 7.400 11/01/2019 5,615,000 5,904,509
Los Angeles, California, Transportation Commission,
Series A (MBIA) 6.250 07/01/2013 6,800,000 7,139,184
Metropolitan Water District, Southern California
Waterworks Revenue, Series B 4.750 07/01/2021 6,000,000 5,346,540
Oakland, California, Revenue Refunding, Series A (FGIC) 7.600 08/01/2021 4,265,000 4,565,427
San Francisco, California, City and County Airport
Commission, International Airport Revenue, Second
Series, Issue 12B (FGIC) 5.625 05/01/2021 5,000,000 4,970,300
Southern California Public Power Authority, Transmission
Project Revenue (FGIC) (effective yield 5.93%) (b) 0.000 07/01/2015 10,000,000 3,431,500
Walnut Valley, California, Unified School District,
Series A (MBIA) 6.000 08/01/2014 190,000 202,361
COLORADO
Arapahoe County, Colorado, Single Family Mortgage
Revenue, Capital Appreciation, Series A (effective
yield 6.00%) (b) 0.000 09/01/2010 4,000,000 1,825,240
City and County of Denver, Colorado, Airport System,
Series A 7.000 11/15/1999 2,000,000 2,120,980
City and County of Denver, Colorado, Airport System,
Series A 7.500 11/15/2023 6,625,000 7,376,540
City and County of Denver, Colorado, Airport System,
Series A 8.500 11/15/2023 7,750,000 8,909,943
City and County of Denver, Colorado, Airport System,
Series A 8.750 11/15/2023 23,830,000 28,280,967
City and County of Denver, Colorado, Airport System,
Series A 8.000 11/15/2025 525,000 594,142
City and County of Denver, Colorado, Airport System,
Series B 7.250 11/15/2012 3,500,000 3,829,140
City and County of Denver, Colorado, Airport System,
Series C 6.650 11/15/2005 5,980,000 6,362,840
City and County of Denver, Colorado, Airport System,
Series C 5.600 11/15/2011 5,000,000 4,963,450
City and County of Denver, Colorado, Airport System,
Series C 6.000 12/01/2025 5,000,000 5,019,400
City and County of Denver, Colorado, Airport System,
Series D 7.750 11/15/2013 7,100,000 8,733,000
City and County of Denver, Colorado, Airport System,
Series D 7.750 11/15/2021 12,250,000 13,593,825
Colorado Health Facilities Authority, Sisters Charity
Health Care,
Series A (MBIA) 6.250 05/15/2009 1,880,000 2,061,213
El Paso County, Colorado, School District #11, Colorado
Springs 6.500 12/01/2012 2,310,000 2,588,817
El Paso County, Colorado, School District #11, Colorado
Springs 7.100 12/01/2013 2,000,000 2,371,120
El Paso County, Colorado, School District #11, Colorado
Springs 7.100 12/01/2016 1,000,000 1,190,880
Larimer County, Colorado, School District (MBIA) 7.000 12/15/2016 2,250,000 2,736,923
CONNECTICUT
Connecticut State Special Tax Obligation, Series B 6.500 10/01/2012 1,600,000 1,786,256
Connecticut State Resources Recovery Authority,
Bridgeport Resco Company Project 8.500 01/01/2000 1,375,000 1,424,692
<PAGE>
PAGE 11
- --------------------
SCHEDULE OF INVESTMENTS--December 31, 1996
Coupon Maturity Principal Market
Rate Date Amount Value
- ---------------------------------------------------------- ------ ---------- ---------- --------------
DELAWARE
Delaware State Health Facilities Authority, Medical
Center of Delaware (MBIA) 7.000% 10/01/2015 $ 1,600,000 $ 1,712,064
Delaware State Housing Authority Revenue, Residential
Mortgage, Series A 9.375 06/01/2012 120,000 120,334
FLORIDA
Broward County, Florida, Professional Sports Facilities
Tax Revenue, Series A (MBIA) 5.625 09/01/2028 2,500,000 2,477,075
Broward County, Florida, Resource Recovery, South
Project 7.950 12/01/2008 8,400,000 9,238,572
City of Tarpon Springs Health Facilities Authority,
Florida, Hospital Refunding, Tarpon Springs Hospital
Foundation, Inc., 8.750 05/01/2012 500,000 526,825
Dade County, Florida, General Obligation (FGIC) 5.125 10/01/2016 7,650,000 7,322,886
Dade County, Florida, Solid Waste System, Special
Obligation Revenue (AMBAC) 5.250 10/01/2004 2,025,000 2,074,127
Escambia County, Florida, Pollution Control Revenue,
Champion International Corporation Project 6.400 09/01/2030 2,500,000 2,530,400
Florida Housing Finance Agency, GNMA Collateralized Home
Mortgage 8.000 12/01/2020 640,000 673,856
Florida State, Bond Finance Department, Environmental
Preservation 5.250 07/01/2010 5,925,000 5,914,809
Florida State, Jacksonville Transportation Authority 9.200 01/01/2015 3,580,000 4,859,492
Hillsborough County, Florida, Housing Finance Agency,
Single Family Mortgage Revenue 7.300 04/01/2022 495,000 511,167
Indian River County, Florida, Water and Sewer Revenue
(FGIC) 5.250 09/01/2020 2,860,000 2,758,642
Jacksonville, Florida, Health Facilities Authority, New
Children's Hospital (MBIA) 7.000 06/01/2021 1,800,000 1,971,036
Lakeland, Florida, Electric and Water Revenue 5.625 10/01/2036 4,000,000 3,942,600
Lee County, Florida, Hospital Board of Directors,
Hospital Revenue, Linked RIBs/SAVRs (d) 6.350 03/26/2020 12,500,000 13,028,375
Lee County, Florida, Solid Waste System, Series B 7.000 10/01/2011 300,000 330,732
Martin County, Florida, Industrial Development
Authority, Indiantown Cogeneration Project--Series A 7.875 12/15/2025 9,000,000 10,260,180
Orlando-Orange County, Florida, Expressway Authority 8.250 07/01/2014 3,000,000 3,960,330
Orlando-Orange County, Florida, Expressway Authority
(FGIC) 8.250 07/01/2015 2,960,000 3,918,803
Palm Beach County, Florida, Health Revenue, John F.
Kennedy Hospital 9.500 08/01/2013 2,985,000 3,859,665
Palm Beach County, Florida, Solid Waste Industrial
Development, Okeelanta Power Project 6.700 02/15/2015 3,000,000 2,764,890
Palm Beach County, Florida, Solid Waste Industrial
Development, Okeelanta Power Project 6.850 02/15/2021 7,500,000 6,964,125
Palm Beach County, Florida, Solid Waste, Osceola Power
Project, Series A 6.950 01/01/2022 7,500,000 7,042,575
St. Petersburg, Florida, Health Facilities Authority
(MBIA) 7.000 12/01/2015 3,250,000 3,588,683
Sunrise, Florida, Utility Systems Revenue, Series A
(AMBAC) 5.750 10/01/2026 9,000,000 9,026,640
Tampa, Florida, Allegheny Health Systems 6.500 12/01/2023 500,000 550,155
Tampa, Florida, Guaranteed Entitlement, Series A 8.375 10/01/2008 3,145,000 3,367,760
Tampa, Florida, Subordinate Guaranteed Entitlement,
Series B (Pre-refunded) 8.500 10/01/2018 1,825,000 1,958,042
(continued on next page)
<PAGE>
PAGE 12
- --------------------
Keystone Tax Free Fund
SCHEDULE OF INVESTMENTS--December 31, 1996
Coupon Maturity Principal Market
Rate Date Amount Value
- ---------------------------------------------------------- ------ ---------- ---------- --------------
GEORGIA
Forsyth County, Georgia, School District 6.750% 07/01/2016 $ 3,000,000 $ 3,465,000
Georgia Municipal Electric Authority Power Revenue,
Series B 6.375 01/01/2016 9,800,000 10,716,986
Georgia State, General Obligation, Series B 6.800 03/01/2011 10,000,000 11,595,900
Georgia State, General Obligation, Series C 5.250 04/01/2011 11,700,000 11,763,180
Georgia State, General Obligation, Series D 6.700 08/01/2010 1,500,000 1,725,960
Metropolitan Atlanta Rapid Transit Authority, Georgia,
Sales Tax Revenue, Series P (AMBAC) 6.250 07/01/2011 4,255,000 4,700,371
HAWAII
Hawaii State Department of Budget and Finance, Special
Purpose Revenue, Hawaii Electric Company (MBIA) 7.375 12/01/2020 8,000,000 8,776,560
IDAHO
Idaho Housing Finance Authority, Single Family Mortgage
Bonds, Series D-1 8.000 01/01/2020 1,110,000 1,182,827
ILLINOIS
Chicago, Illinois, Gas Supply Revenue, People's Gas
Light and Coke Company, Series A 8.100 05/01/2020 15,860,000 17,552,421
Cook County, Illinois, General Obligation, District
Number 508, Lease Certificates, Series C (MBIA) 7.700 12/01/2005 5,970,000 7,061,734
Illinois Development Finance Authority, Pollution
Control Revenue Refunding, Commonwealth Edison Company
Project, Series D 6.750 03/01/2015 4,000,000 4,379,280
Illinois State, Sales Tax, Series P 6.500 06/15/2022 9,000,000 10,042,290
Kankakee, Illinois, Sewer Revenue (FGIC) 6.875 05/01/2011 2,965,000 3,260,018
Metropolitan Fair and Exposition Authority, Illinois,
Series A 5.000 06/01/2015 3,000,000 2,717,310
Metropolitan Pier and Exposition Authority, Illinois,
Dedicated State Tax Revenue, McCormick Place Expansion
Project (FGIC) (effective yield 6.70%) (b) 0.000 06/15/2015 19,440,000 6,736,349
Metropolitan Pier and Exposition Authority, Illinois,
Dedicated State Tax Revenue, McCormick Place Expansion
Project (MBIA) (effective yield 6.60%) (b) 0.000 06/15/2013 5,625,000 2,204,212
Metropolitan Pier and Exposition Authority, Illinois,
McCormick Place Expansion Project 7.250 06/15/2005 10,180,000 11,670,352
Quincy, Illinois, Blessing Hospital Revenue 6.000 11/15/2018 4,950,000 4,813,727
INDIANA
Indianapolis, Indiana, Local Public Improvement Bond
Bank, Series 1992D 6.750 02/01/2020 2,000,000 2,142,600
KANSAS
Burlington, Kansas, Pollution Control, Kansas Gas and
Electric Company (MBIA) 7.000 06/01/2031 2,000,000 2,202,580
KENTUCKY
Carroll County, Kentucky, Kentucky Utility Company,
Series A 7.450 09/15/2016 8,000,000 9,073,200
Jefferson County, Kentucky, Hospital Revenue, Linked
ACES/Inverse Floaters (MBIA) (d) 6.435 10/23/2014 6,000,000 6,311,580
<PAGE>
PAGE 13
- --------------------
SCHEDULE OF INVESTMENTS--December 31, 1996
Coupon Maturity Principal Market
Rate Date Amount Value
- ---------------------------------------------------------- ------ ---------- ---------- --------------
KENTUCKY (continued)
Kentucky Housing Corporation, Housing Revenue Bond,
Series C 7.900% 01/01/2021 $ 4,610,000 $ 4,857,050
Trimble County, Kentucky, Pollution Control, Louisville
Gas and Electric Company 7.625 11/01/2020 2,725,000 3,009,735
Trimble County, Kentucky, Pollution Control, Louisville
Gas and Electric Company, Series A (Pre-refunded) 7.625 11/01/2020 545,000 612,275
LOUISIANA
Louisiana Public Facilities Authority, Hospital Revenue,
Woman Hospital Foundation Project 7.250 10/01/2022 1,750,000 1,869,000
New Orleans, Louisiana, Capital Appreciation (AMBAC)
(effective yield 5.77%) (b) 0.000 09/01/2011 5,000,000 2,210,150
New Orleans, Louisiana, Capital Appreciation (AMBAC)
(effective yield 5.82%) (b) 0.000 09/01/2012 4,700,000 1,944,108
New Orleans, Louisiana, Capital Appreciation (AMBAC)
(effective yield 6.05%) (b) 0.000 09/01/2014 6,960,000 2,549,866
Orleans Parish, Louisiana, School Board (ETM) 9.050 02/01/2010 5,175,000 6,870,485
Orleans Parish, Louisiana, School Board, Refunding
Bonds, Series B 5.200 02/01/2014 3,000,000 2,893,530
Ouachita Parish, Louisiana, Louisiana Hospital Service
Revenue, Glenwood Regional Medical Center 7.500 07/01/2021 2,000,000 2,265,280
MAINE
Maine State Housing Authority, Mortgage Purchase,
Series A3 7.800 11/15/2015 2,580,000 2,643,881
Regional Waste System, Maine, Solid Waste Resources
Recovery Revenue 8.150 07/01/2011 2,500,000 2,706,150
MARYLAND
Maryland State Community Development Administration,
Multi-Family Housing 8.750 05/15/2012 3,345,000 3,363,732
Maryland State and Local Facilities Loan, 3rd Series 5.000 10/15/2010 11,250,000 11,055,938
MASSACHUSETTS
Lawrence, Massachusetts, General Obligation (AMBAC) 6.250 02/15/2009 550,000 592,564
Massachusetts Bay Transportation Authority, Refunding,
General Transportation Systems, Series A 7.000 03/01/2008 4,550,000 5,266,625
Massachusetts Bay Transportation Authority, General
Transportation Systems, Series A 7.000 03/01/2007 5,000,000 5,775,650
Massachusetts Bay Transportation Authority, Series A 7.000 03/01/2011 6,110,000 7,105,808
Massachusetts Bay Transportation Authority, Series A 6.250 03/01/2012 7,600,000 8,309,232
Massachusetts Bay Transportation Authority, Series B 6.200 03/01/2016 2,125,000 2,315,506
Massachusetts Bay Transportation Authority, Series B 5.250 03/01/2020 4,500,000 4,302,315
Massachusetts Industrial Finance Agency, Harvard
Community Health Plan, Incorporated, Series B 8.125 10/01/2017 13,750,000 14,602,362
Massachusetts Industrial Finance Agency, Solid Waste
Disposal Revenue, Senior Lien, Massachusetts Recycling
Association, Series A 9.000 08/01/2016 8,000,000 4,000,000
Massachusetts Municipal Wholesale Electric, Power Supply
Systems Revenue, Series B 6.750 07/01/2008 6,050,000 6,465,393
Massachusetts State Consumer Loan, Series B (FGIC) 5.500 06/01/2012 6,385,000 6,438,762
(continued on next page)
<PAGE>
PAGE 14
- --------------------
Keystone Tax Free Fund
SCHEDULE OF INVESTMENTS--December 31, 1996
Coupon Maturity Principal Market
Rate Date Amount Value
- ---------------------------------------------------------- ------ ---------- ---------- --------------
MASSACHUSETTS (continued)
Massachusetts State, General Obligation, Consolidated
Loan, Series C (FGIC) 6.600% 11/01/2008 $ 8,000,000 $ 8,952,960
Massachusetts State Health and Educational Facilities
Authority, Brigham & Women's Hospital (MBIA) 6.750 07/01/2024 2,000,000 2,159,400
Massachusetts State Health and Educational Facilities
Authority, Capital Asset Program (MBIA) 7.300 10/01/2018 2,000,000 2,181,040
Massachusetts State Health and Educational Facilities
Authority, Massachusetts General Hospital, Series F
(AMBAC) 6.250 07/01/2012 5,000,000 5,457,200
Massachusetts State Health and Educational Facilities
Authority, McLean Hospital Issue, Series C 6.500 07/01/2010 500,000 539,710
Massachusetts State Health and Educational Facilities
Authority, Milton Hospital, Series B 7.250 07/01/2005 700,000 767,494
Massachusetts State Health and Educational Facilities
Authority, New England Deaconess Hospital 6.875 04/01/2022 500,000 527,665
Massachusetts State Health and Educational Facilities
Authority, New England Deaconess Hospital (AMBAC) 6.875 04/01/2022 2,980,000 3,252,640
Massachusetts State, Water Pollution Abatement Trust,
Pooled Loan Program, Series 2 6.125 02/01/2008 85,000 92,837
Massachusetts State Water Resources Authority, Series A 7.125 04/01/2000 1,500,000 1,620,480
Massachusetts State Water Resources Authority, Series A
(MBIA) 6.000 08/01/2014 1,500,000 1,549,140
Massachusetts State Water Resources Authority, Series B 4.000 12/01/2018 19,870,000 15,353,748
Massachusetts State Water Resources Authority, Series B
(MBIA) 5.000 12/01/2016 250,000 233,490
MICHIGAN
Monroe County, Michigan, Economic Development
Corporation, Detroit Edison Company (FGIC) 6.950 09/01/2022 9,500,000 11,383,850
Okemos, Michigan, Public School District, Series I
(effective yield 7.35%) (b) 0.000 05/01/2021 51,525,000 11,080,966
Romulus, Michigan, Community Schools, Capital
Appreciation, Series I (effective yield 8.02%) (b) 0.000 05/01/2017 39,490,000 11,206,472
West Ottawa, Michigan, Public School District, Capital
Appreciation (effective yield 7.55%) (b) 0.000 05/01/2015 35,490,000 11,505,148
MINNESOTA
Dakota County, Minnesota, Single Family Mortgage 8.100 09/01/2012 1,285,000 1,344,611
Minnesota State Housing Finance Agency, Single Family
Mortgage, Series D 8.000 01/01/2023 1,385,000 1,434,625
MISSISSIPPI
Harrison County, Mississippi, Wastewater Treatment
Management 8.500 02/01/2013 1,000,000 1,352,510
MISSOURI
Kansas City, Missouri, Municipal Assistance Corporation,
Refunding Leasehold, H Roe Bartle, Revenue Bonds,
Series A 5.000 04/15/2020 11,500,000 10,663,720
Missouri State Health and Educational Facilities
Authority, Barnes Jewish Hospital (MBIA) 5.150 05/15/2010 5,000,000 4,908,150
<PAGE>
PAGE 15
- --------------------
SCHEDULE OF INVESTMENTS--December 31, 1996
Coupon Maturity Principal Market
Rate Date Amount Value
- ---------------------------------------------------------- ------ ---------- ---------- --------------
MISSOURI (continued)
Missouri State Housing Development Commission, Mortgage
Revenue, Single Family, Series B 6.450% 09/01/2027 $ 1,000,000 $ 1,018,750
University of Missouri, University Improvement Systems
Facilities 5.500 11/01/2023 25,000 24,693
NEBRASKA
Nebraska Higher Education Loan Program 6.450 06/01/2018 8,320,000 8,643,981
NEVADA
Clark County, Nevada, School District, Series A (MBIA) 6.750 03/01/2007 3,000,000 3,245,370
Clark County, Nevada, Series A (AMBAC) 7.500 06/01/2009 6,000,000 7,203,780
NEW HAMPSHIRE
New Hampshire Higher Education & Health Facilities
Authority, Frisbie Memorial Hospital, Revenue Bonds 6.125 10/01/2013 8,155,000 8,136,325
NEW JERSEY
Camden County, New Jersey, Municipal Utilities
Authority, Sewer Revenue 5.125 07/15/2017 4,650,000 4,343,890
Gloucester County, New Jersey Improvement Authority,
Solid Waste Resource Recovery Revenue, Gloucester
County Project A 8.125 07/01/2010 1,000,000 1,027,070
New Jersey Health Care Facilities Financing Authority,
Jersey Shore Medical Center (AMBAC) 6.125 07/01/2012 1,000,000 1,036,460
New Jersey Health Care Facilities Financing Authority,
Kimball Medical Center, Series C 8.000 07/01/2013 3,000,000 3,211,530
New Jersey Health Care Facilities Financing Authority,
St. Elizabeth's Hospital, Series B 7.750 07/01/1998 1,200,000 1,227,876
NEW MEXICO
Albuquerque, New Mexico, Joint Water and Sewer System
Revenue, Series A (FGIC) (effective yield 6.90%) (b) 0.000 07/01/2008 2,950,000 1,590,581
City of Albuquerque, New Mexico, Hospital System,
Series A (MBIA) 6.375 08/01/2007 1,500,000 1,613,190
New Mexico Educational Assistance Foundation, Series B 6.300 12/01/2004 2,225,000 2,401,687
University of New Mexico, University Revenues,
Subordinate Lien (MBIA) 5.375 06/01/2026 3,750,000 3,598,012
NEW YORK
Battery Park City Authority, New York, Junior Bonds,
Series A (AMBAC) 5.500 11/01/2029 2,000,000 1,946,920
Metropolitan Transportation Authority, New York,
Dedicated Tax Fund, Series A (MBIA) 5.500 04/01/2015 4,500,000 4,493,925
Metropolitan Transportation Authority, New York,
Dedicated Tax Fund, Series A (MBIA) 5.250 04/01/2026 10,250,000 9,751,338
New York City, New York, City Municipal Water Finance
Authority, Water & Sewer System, Revenue Bonds,
Series B (MBIA) 5.750 06/15/2026 10,000,000 10,041,600
New York City, New York, City Municipal Water Finance
Authority, Water and Sewer System Revenue (FGIC) 7.000 06/15/2015 4,270,000 4,672,618
New York City, New York, City Municipal Water Finance
Authority, Water and Sewer System Revenue, Series B 5.875 06/15/2026 7,500,000 7,501,200
New York City, New York, General Obligation, Fiscal
1992, Series A 5.875 03/15/2011 6,000,000 5,881,620
(continued on next page)
<PAGE>
PAGE 16
- --------------------
Keystone Tax Free Fund
SCHEDULE OF INVESTMENTS--December 31, 1996
Coupon Maturity Principal Market
Rate Date Amount Value
- ---------------------------------------------------------- ------ ---------- ---------- --------------
NEW YORK (continued)
New York City, New York, General Obligation, Fiscal
1992, Series A 7.750% 08/15/2014 $ 5,125,000 $ 5,885,038
New York City, New York, General Obligation, Prerefunded
Balance, Series A 7.750 08/15/2008 8,475,000 9,712,774
New York City, New York, General Obligation, Refunding,
Series A (FGIC) 5.750 08/01/2010 400,000 405,104
New York City, New York, General Obligation, Series E
(FGIC) 6.000 08/01/2016 4,500,000 4,620,960
New York City, New York, General Obligation, Unrefunded
Balance, Series A 7.750 08/15/2008 1,525,000 1,705,880
New York City, New York, General Obligation, Unrefunded
Balance, Series A 7.750 08/15/2014 335,000 372,979
New York City, New York, Industrial Special Facility,
Terminal One Group Association Project 6.000 01/01/2015 2,500,000 2,496,825
New York City, New York, Prerefunded, Series A 7.750 08/15/2015 7,980,000 9,163,434
New York State Care Facilities, New York Hospital,
Series A 6.800 08/15/2024 3,800,000 4,181,976
New York State Dormitory Authority Revenue, City
University Educational Facilities 6.000 07/01/2026 9,500,000 9,424,095
New York State Dormitory Authority Revenue, City
University Educational Facilities (FGIC) 7.000 07/01/2009 3,780,000 4,447,019
New York State Dormitory Authority Revenue, City
University Educational Facilities (FGIC) 5.375 07/01/2014 1,000,000 984,810
New York State Dormitory Authority Revenue, Mental
Health Facility (MBIA) 5.125 02/15/2021 7,535,000 7,064,213
New York State Dormitory Authority Revenue, State
University Educational Facilities, Refunding, Series B 7.500 05/15/2011 10,500,000 12,274,815
New York State Dormitory Authority Revenue, State
University Educational Facilities, Series B (FGIC) 5.250 05/15/2013 9,500,000 8,947,385
New York State Dormitory Authority Revenue, State
University Educational Facilities, Series B 5.250 05/15/2019 3,850,000 3,535,956
New York State Dormitory Authority Revenue, State
University Educational Facilities, Series C 7.375 05/15/2010 1,100,000 1,267,805
New York State Energy Research and Development
Authority, Consolidated Edison Project 7.750 01/01/2024 7,400,000 7,721,678
New York State Energy Research and Development
Authority, Gas Facilities Revenue, Brooklyn Union Gas
Company Project, Series A 5.500 01/01/2021 1,000,000 977,880
New York State Environmental Facilities Corporation,
State Water Pollution Control (New York City Water
Finance Authority) Series E 6.875 06/15/2010 5,000,000 5,489,450
New York State Local Government Assistance Corporation,
Series C 5.500 04/01/2017 2,000,000 1,997,220
New York State Local Government Assistance Corporation,
Series D 6.750 04/01/2021 900,000 1,005,462
New York State Medical Care Facilities, Finance Agency
Revenue (AMBAC) 6.375 11/15/2019 2,255,000 2,388,947
New York State Medical Care Facilities, Finance Agency
Revenue (FGIC) 6.375 08/15/2014 2,900,000 3,072,463
New York State Medical Care Facilities, Finance Agency
Revenue, Health Center Projects, Series A 6.375 11/15/2019 1,250,000 1,311,275
<PAGE>
PAGE 17
- --------------------
SCHEDULE OF INVESTMENTS--December 31, 1996
Coupon Maturity Principal Market
Rate Date Amount Value
- ---------------------------------------------------------- ------ ---------- ---------- --------------
NEW YORK (continued)
New York State Medical Care Facilities, Finance Agency
Revenue, New York Hospital, Series A 6.750% 08/15/2014 $ 2,000,000 $ 2,194,560
New York State Medical Care Facilities, Finance Agency
Revenue, Series A 7.700 02/15/2009 5,300,000 5,986,880
New York State Mortgage Agency, Homeowner Mortgage,
Series 27 6.900 04/01/2015 4,500,000 4,792,545
New York State Mortgage Agency, Series A 6.875 04/01/2017 1,565,000 1,580,321
New York State Power Authority Revenue and General
Purpose Revenue 7.000 01/01/2018 1,125,000 1,301,479
New York State Urban Development Corporation Revenue,
Correctional Capital Facilities, Series 6 5.375 01/01/2025 4,690,000 4,289,005
New York State Urban Development Corporation Revenue,
Correctional Facilities, Refunding, Series A 6.500 01/01/2010 15,920,000 17,052,549
New York State Urban Development Corporation Revenue,
Correctional Facilities, Series A 6.500 01/01/2009 575,000 618,821
New York State Urban Development Corporation Revenue,
Correctional Facilities, Series A 7.500 04/01/2011 9,500,000 10,764,165
New York, New York, Unrefunded Balance, Series A 7.750 08/15/2015 270,000 300,375
Niagara Falls, New York, Public Improvement (MBIA) 7.500 03/01/2014 300,000 369,879
Port Authority, New York and New Jersey, Consolidated
104th Series (AMBAC) 4.750 01/15/2026 3,000,000 2,632,500
Port Authority, New York and New Jersey, Special
Obligation Revenue 6.750 10/01/2011 4,500,000 4,641,120
Triborough Bridge and Tunnel Authority, New York,
General Purpose, Series X 6.625 01/01/2012 12,750,000 14,565,855
OHIO
Adams County, Ohio Valley Local School District 7.000 12/01/2015 2,000,000 2,378,960
Cleveland, Ohio, Parking Facilities Revenue (MBIA) 5.500 09/15/2022 7,430,000 7,369,446
Cleveland, Ohio, Public Power Systems, First Mortgage,
Series A (MBIA) 7.000 11/15/2016 7,000,000 8,070,370
Cleveland, Ohio, Public Power Systems, First Mortgage,
Series A (MBIA) 7.000 11/15/2024 1,000,000 1,163,470
Columbus, Ohio, General Obligation 12.375 02/15/2006 1,285,000 1,963,313
Montgomery County, Ohio, Hospital Revenue, Kettering
Medical Center (MBIA) 6.250 04/01/2020 1,500,000 1,642,440
Ohio State Building Authority, State Facilities, Adult
Correctional, Series A (AMBAC) 5.500 04/01/2016 2,000,000 1,998,960
Ohio State Higher Educational Facility Commission (MBIA) 6.125 11/15/2017 1,000,000 1,055,870
Ohio State Housing Finance Agency, Single Family
Mortgage Revenue, Series C (GNMA) 9.000 09/01/2018 10,000,000 11,120,500
Ohio State Turnpike Commission, Turnpike Revenue,
Series A (MBIA) 5.500 02/15/2026 5,000,000 4,914,950
Ohio State Water Development Authority (AMBAC) 9.375 12/01/2018 30,000 30,975
OKLAHOMA
Oklahoma State Industrial Authority, Baptist Medical
Center 7.000 08/15/2014 2,250,000 2,493,495
OREGON
Oregon Health Sciences University, Revenue Bonds,
Series A 5.250 07/01/2025 5,000,000 4,671,900
Western Generation Agency, Oregon, Wauna Cogeneration
Project, Series B (c) 7.400 01/01/2016 3,300,000 3,447,213
(continued on next page)
<PAGE>
PAGE 18
- --------------------
Keystone Tax Free Fund
SCHEDULE OF INVESTMENTS--December 31, 1996
Coupon Maturity Principal Market
Rate Date Amount Value
- ---------------------------------------------------------- ------ ---------- ---------- --------------
PENNSYLVANIA
Allegheny County, Pennsylvania, Sewer Revenue Refunding
(FGIC) (effective yield 6.10%) (b) 0.000% 06/01/2015 $2,500,000 $ 866,700
Beaver County, Pennsylvania, Industrial Development
Authority, Ohio Edison Project, Series A 7.750 09/01/2024 80,000 83,880
Beaver County, Pennsylvania, Ohio Edison (FGIC) 7.000 06/01/2021 4,390,000 4,736,371
Delaware County, Pennsylvania, Hospital Revenue, Crozier
Chester Medical Center (Pre-refunded) 7.500 12/15/2020 2,545,000 2,875,366
Delaware County, Pennsylvania, Industrial Development
Authority 7.375 04/01/2021 500,000 542,225
Delaware County, Pennsylvania, Industrial Development
Authority, Resource Recovery Project, Series A (LOC
Security Pacific) 8.100 12/01/2013 7,500,000 7,843,575
Lebanon County, Pennsylvania, Good Samaritan Hospital
Authority, Project Revenue 6.000 11/15/2018 2,000,000 1,956,640
McKeesport, Pennsylvania, Hospital Authority Revenue,
McKeesport Hospital 6.500 07/01/2008 875,000 877,380
Montgomery County, Pennsylvania, Industrial Development
and Pollution Control, Philadelphia Electric Company 7.600 04/01/2021 900,000 965,151
North Penn, Pennsylvania, Water Authority (FGIC) 6.875 11/01/2019 2,500,000 2,860,700
Pennsylvania Economic Development Financing Authority,
Resources Recovery, Northampton Project (c) 6.400 01/01/2009 9,500,000 9,405,570
Pennsylvania Economic Development Financing Authority,
Resources Recovery, Northampton Project (c) 6.500 01/01/2013 4,000,000 3,954,680
Pennsylvania Economic Development Financing Authority,
Resources Recovery, Northampton Project (c) 6.600 01/01/2019 3,800,000 3,751,322
Pennsylvania Housing Finance Agency, Multi-Family,
Section 8 8.200 07/01/2024 8,000,000 8,547,120
Pennsylvania Housing Finance Agency, Residential
Development, Section 8, Series A 7.600 07/01/2013 5,545,000 5,936,532
Pennsylvania Housing Finance Agency, Single Family
Mortgage, Series P 8.000 04/01/2016 3,000,000 3,081,390
Pennsylvania Housing Finance Agency, Single Family
Mortgage, Series T 7.750 10/01/2009 4,000,000 4,185,920
Pennsylvania Housing Finance Agency, Single Family
Mortgage, Series V 7.800 04/01/2016 3,950,000 4,097,177
Pennsylvania Intergovernmental Cooperative Authority,
Philadelphia Funding (FGIC) 6.750 06/15/2021 1,910,000 2,158,854
Pennsylvania State Higher Educational Facilities
Authority, Allegheny General Hospital, Series A 7.125 09/01/2007 4,000,000 4,355,040
Pennsylvania State Higher Educational Facilities
Authority, Thomas Jefferson University, Series A 6.625 08/15/2009 150,000 163,605
Pennsylvania State Industrial Development Authority 7.000 01/01/2006 500,000 573,780
Philadelphia, Pennsylvania, Hospital and Higher
Education Facilities, Albert Einstein Medical Center 7.625 04/01/2011 2,350,000 2,490,459
Philadelphia, Pennsylvania, Hospital and Higher
Education Facilities, Albert Einstein Medical Center 7.000 10/01/2021 3,000,000 3,181,260
Philadelphia, Pennsylvania, Hospital and Higher
Education Facilities, Community College, Series B
(MBIA) 6.500 05/01/2007 280,000 309,117
<PAGE>
PAGE 19
- --------------------
SCHEDULE OF INVESTMENTS--December 31, 1996
Coupon Maturity Principal Market
Rate Date Amount Value
- ---------------------------------------------------------- ------ ---------- ---------- --------------
PENNSYLVANIA (continued)
Philadelphia, Pennsylvania, Municipal Development
Authority, Criminal Justice Center, Series A (MBIA) 7.100% 11/15/2006 $ 4,095,000 $ 4,575,466
Philadelphia, Pennsylvania, Water and Wastewater, Linked
Bull/Bear Forward BPO (FGIC) (d) 10.000 06/15/2005 10,000,000 13,293,600
Philadelphia, Pennsylvania, Water and Wastewater (MBIA) 6.250 08/01/2012 1,750,000 1,906,887
Pittsburgh, Pennsylvania, Urban Redevelopment Authority,
Multi-Family Housing Mortgage, 1985 Series A 9.250 12/01/2027 3,175,000 3,307,842
Sayre, Pennsylvania, Health Care Facilities Authority,
Guthrie Healthcare, Series A 7.100 03/01/2017 6,350,000 6,849,872
Westmoreland County, Pennsylvania, Municipal Authority,
Capital Appreciation, Series C (effective yield 5.69%)
(b) 0.000 08/15/2015 5,000,000 1,738,050
PUERTO RICO
Puerto Rico Commonwealth Aquaduct and Sewer Authority
Revenue Bond 5.000 07/01/2019 6,000,000 5,463,780
Puerto Rico Commonwealth Highway and Transportation
Authority Revenue, Series Y (FSA) 5.250 07/01/2015 500,000 487,810
Puerto Rico Commonwealth, General Obligation, Linked BPO
(MBIA) (d) 7.000 07/01/2010 13,300,000 15,519,105
Puerto Rico Commonwealth, General Obligation, Linked BPO
(AMBAC) (d) 7.000 07/01/2010 5,000,000 5,834,250
Puerto Rico Commonwealth, General Obligation, Refunding 6.450 07/01/2017 3,000,000 3,206,790
Puerto Rico Electric Power Authority, Refunding,
Series S 7.000 07/01/2007 2,000,000 2,270,040
Puerto Rico Electric Power Authority, Series Y (MBIA) 6.500 07/01/2006 4,000,000 4,509,760
Puerto Rico Industrial, Tourist, Educational, Medical,
Environmental Control Facilities Finance Authority
(MBIA) 6.250 07/01/2024 1,500,000 1,578,945
Puerto Rico Industrial, Tourist, Educational, Medical,
Environmental Control Facilities Finance Authority 5.500 08/01/2024 1,000,000 879,320
Puerto Rico Public Buildings Authority, Guaranteed
Public Education
and Health Facilities, Series M 5.700 07/01/2009 1,800,000 1,857,888
Puerto Rico Public Buildings Authority, Guaranteed
Public Education and Health Facilities, Series M, Step
Bond (effective yield 5.74%) (b) 3.750 07/01/2016 6,250,000 5,779,875
RHODE ISLAND
Rhode Island State Health and Educational Building
Corporation, Hospital Financing Revenue, Roger
Williams General Hospital 9.500 07/01/2016 5,710,000 5,819,575
SOUTH CAROLINA
South Carolina State Ports Authority, Ports Revenue
(AMBAC) 6.750 07/01/2021 9,000,000 9,604,980
South Carolina State Public Services Authority, Fixed
Option Bonds (MBIA) 5.342 06/30/2006 10,400,000 10,508,160
TENNESSEE
Bristol, Tennessee, Health and Education Authority,
Bristol Memorial Hospital (FGIC) 6.750 09/01/2010 4,200,000 4,820,676
Knox County, Tennessee, Health and Educational
Facilities, Fort Sanders Hospital Alliance, Series B
(MBIA) 7.250 01/01/2010 7,000,000 8,253,630
Knox County, Tennessee, Health and Educational
Facilities, Fort Sanders Hospital Alliance, Series C
(MBIA) 5.250 01/01/2015 3,500,000 3,373,195
(continued on next page)
<PAGE>
PAGE 20
- --------------------
Keystone Tax Free Fund
SCHEDULE OF INVESTMENTS--December 31, 1996
Coupon Maturity Principal Market
Rate Date Amount Value
- ---------------------------------------------------------- ------ ---------- ---------- --------------
TENNESSEE (continued)
Metro Government, Nashville & Davidson Counties,
Tennessee, Step Bond (FGIC) (effective yield 4.26%)
(b) 0.000% 01/01/2012 $ 9,000,000 $ 9,716,220
Tennessee Housing Development Authority, Home Ownership
Program, Issue H 7.825 07/01/2015 5,655,000 5,782,860
TEXAS
Alliance Airport Authority Income, Texas, Federal
Express Corporation Project 6.375 04/01/2021 14,500,000 14,525,375
Austin, Texas, Utility Systems Capital Appreciation
(AMBAC) (effective yield 6.80%) (b) 0.000 11/15/2011 12,000,000 5,221,200
Bexar, Texas, Metropolitan Water District Waterworks
Systems, Prerefunded (AMBAC) 6.625 05/01/2014 1,825,000 2,026,133
Bexar, Texas, Metropolitan Water District Waterworks
Systems, Unrefunded Balance (AMBAC) 6.625 05/01/2014 25,000 26,839
Brazos River Authority, Texas Revenue Refunding, Houston
Light and Power Company, Project C 8.100 05/01/2019 8,500,000 9,061,935
Brownsville, Texas, Utility System Revenue (MBIA) 6.250 09/01/2014 2,400,000 2,632,848
Cypress-Fairbanks, Texas, Independent School District,
Capital Appreciation, Series A (effective yield 6.03%)
(b) 0.000 02/15/2013 6,675,000 2,707,981
Fort Bend County, Texas, Levee Improvement (MBIA) 6.900 09/01/2020 1,165,000 1,277,224
Fort Bend County, Texas, Levee Improvement District # 11
(MBIA) 6.900 09/01/2018 1,245,000 1,364,931
Fort Bend County, Texas, Levee Improvement District # 11
(MBIA) 6.900 09/01/2019 1,000,000 1,093,040
Harris County, Texas, Flood Control District (effective
yield 7.20%) (b) 0.000 10/01/2006 7,000,000 3,798,200
Harris County, Texas, Health Facilities Development
Corporation 6.600 06/01/2014 5,000,000 5,225,900
Harris County, Texas, Health Facilities Development
Corporation, Hermann Hospital Project (MBIA) 6.375 10/01/2017 2,480,000 2,623,344
Harris County, Texas, Health Facilities, Memorial
Hospital System 7.125 06/01/2015 2,525,000 2,714,956
Harris County, Texas, Senior Lien, Toll Road, Series A
(MBIA) 6.375 08/15/2024 4,000,000 4,307,080
Harris County, Texas, Toll Road 7.000 08/15/2010 3,000,000 3,504,660
Houston, Texas, Airport System Revenue, Senior Lien 8.200 07/01/2017 4,565,000 4,885,189
Houston, Texas, General Obligation 7.000 03/01/2008 15,000,000 17,460,000
Houston, Texas, Hotel Occupancy Tax, Refunding, Senior
Lien, Revenue Bonds 5.500 07/01/2015 3,000,000 2,982,420
Houston, Texas, Water and Sewer System Revenue,
Refunding, Junior Lien, Series C (effective yield
6.85%) (b) 0.000 12/01/2010 2,700,000 1,257,930
Houston, Texas, Water and Sewer System Revenue, Series C
(effective yield 6.90%) (b) 0.000 12/01/2011 13,000,000 5,699,980
Lower Colorado River Authority, Texas, Series B (AMBAC)
(effective yield 7.05%) (b) 0.000 01/01/2005 2,135,000 1,436,492
Northwest Texas, Independent School District, Capital
Appreciation (AMBAC) (effective yield 7.28%) (b) 0.000 08/15/2010 3,690,000 1,744,853
Rio Grande Valley, Texas, Health Facilities Corporation,
Hospital Revenue, Baptist Medical Center Project
(MBIA) 8.000 08/01/2017 1,085,000 1,159,355
<PAGE>
PAGE 21
- --------------------
SCHEDULE OF INVESTMENTS--December 31, 1996
Coupon Maturity Principal Market
Rate Date Amount Value
- ---------------------------------------------------------- ------ ---------- ---------- --------------
TEXAS (continued)
Tarrant County, Texas, Health Facilities Development
Revenue, Harris Methodist Health System, Series A
(AMBAC) 5.125% 09/01/2018 $ 5,000,000 $ 4,638,300
Tarrant County, Texas, Housing Finance Corporation,
Series A (MBIA) (effective yield 11.00%) (b) 0.000 09/15/2016 6,415,000 2,010,397
Texas Housing Agency, Residential Development, Series D 8.400 01/01/2021 4,085,000 4,260,369
Texas Housing Agency, Single Family Mortgage 8.200 03/01/2016 2,525,000 2,590,423
Texas Municipal Power Agency, Capital Appreciation
(effective yield 9.62%) (b) 0.000 09/01/2008 4,500,000 2,426,670
Texas Municipal Power Agency (effective yield 9.13%) (b) 0.000 09/01/2006 4,455,000 2,721,426
Texas Municipal Power Agency, Refunding Bonds (MBIA) 5.250 09/01/2012 175,000 170,933
Texas Municipal Power Agency, Revenue Bonds 6.100 09/01/2009 130,000 140,574
Texas State, Linked RIBs/SAVRs (d) 6.200 09/30/2011 5,000,000 5,377,350
Titus County, Texas, Water District #1, Southwest
Electric Power 8.200 08/01/2011 9,000,000 10,296,090
Tomball, Texas, Hospital Authority, Tomball Regional
Hospital 6.125 07/01/2023 11,000,000 10,698,270
University of Texas, University Revenues, Prerefunded
Balance, Series B 6.750 08/15/2013 705,000 781,796
University of Texas, University Revenues, Unrefunded
Balance, Series B 6.750 08/15/2013 1,475,000 1,604,240
Waller, Texas, General Obligation, Independent School
District 5.250 02/15/2021 3,450,000 3,278,086
UTAH
Intermountain Power Agency, Utah, Power Supply, Series B 10.375 07/01/2011 3,000,000 3,593,820
Intermountain Power Agency, Utah, Power Supply, Series C
(effective yield 21.29%) (b) 0.000 07/01/2020 6,500,000 1,033,240
Intermountain Power Agency, Utah, Power Supply, Series D 8.375 07/01/2012 3,020,000 3,151,189
Intermountain Power Agency, Utah, Power Supply,
Series G, Step Bond (effective yield 7.65%) (b) 0.000 07/01/2012 24,350,000 24,311,040
Murray City, Utah, Hospital Revenue, Health Services
Incorporated (MBIA) 4.750 05/15/2020 4,145,000 3,605,611
Utah State Housing Finance Agency, Single Family
Mortgage, Series C 2 7.950 07/01/2010 325,000 344,058
VERMONT
Vermont Housing Finance Agency, Single Family, Series 1 8.150 05/01/2025 1,485,000 1,566,526
VIRGINIA
Fairfax County, Virginia, Industrial Development
Authority 5.000 08/15/2023 9,355,000 8,463,375
Fredericksburg, Virginia, Industrial Development
Authority, Hospital Facilities Revenue, Medicorp
Health System Obligation (AMBAC) 5.250 06/15/2023 3,500,000 3,309,075
Hampton Roads, Virginia, Regional Jail Authority,
Regional Jail Facilities Revenue, Series A (MBIA) 5.625 07/01/2016 5,850,000 5,904,288
Pittsylvania County, Virginia, Industrial Development
Authority, Series A (c) 7.450 01/01/2009 2,000,000 2,089,560
Virginia State Housing Development Authority,
Residential Mortgage, Series B (effective yield
10.62%) (b) 0.000 09/01/2014 790,000 126,866
Virginia State Transportation Board Revenue, North
Virginia Transportation District, Series A 5.125 05/15/2016 2,600,000 2,493,270
Winchester, Virginia, Industrial Development Hospital
Revenue, Winchester Medical Center (AMBAC) 6.150 01/01/2015 2,300,000 2,170,303
(continued on next page)
<PAGE>
PAGE 22
- --------------------
Keystone Tax Free Fund
SCHEDULE OF INVESTMENTS--December 31, 1996
Coupon Maturity Principal Market
Rate Date Amount Value
- ---------------------------------------------------------- ------ ---------- ---------- --------------
VIRGINIA (continued)
Winchester, Virginia, Industrial Development Hospital
Revenue, Winchester Medical Center (AMBAC) 6.300% 01/01/2015 $ 3,200,000 $ 3,033,024
WASHINGTON
Tacoma, Washington, Electric Systems Revenue, Linked
RIBs/SAVRs (AMBAC) (d) 6.514 01/02/2015 12,000,000 12,747,480
Washington Public Power Supply System, Nuclear Project
#3 (effective yield 10.09%) (b) 0.000 07/01/2012 4,000,000 1,642,680
Washington State General Obligation, Series A 5.375 07/01/2021 10,000,000 9,664,000
Washington State General Obligation, Series B 5.500 05/01/2018 14,000,000 13,946,240
Washington State Health Care Facilities Authority,
Multi-Care Medical Center of Tacoma (FGIC) 7.875 08/15/2011 1,300,000 1,393,132
WISCONSIN
Wisconsin Health and Education Facilities Authority,
Bellin Memorial Hospital, Incorporated (Pre-refunded) 7.625 04/01/2019 5,000,000 5,452,500
Wisconsin Housing and Economic Development Authority,
Home Ownership 8.000 03/01/2021 1,195,000 1,248,883
Wisconsin State, General Obligation, Series 2 5.125 11/01/2011 5,000,000 4,938,500
WYOMING
Wyoming Community Development Authority, Housing
Revenue, Series 5 6.250 06/01/2027 10,000,000 10,021,300
Wyoming Community Development Authority, Single Family
Mortgage, Series B 8.125 06/01/2021 2,610,000 2,737,759
- ---------------------------------------------------------- ------ ---------- ---------- --------------
TOTAL MUNICIPAL BONDS (Cost--$1,448,532,894) 1,527,775,935
- ---------------------------------------------------------- ------ ---------- ---------- --------------
TEMPORARY TAX-EXEMPT INVESTMENTS (1.0%)
California Health Facilities Financing Authority
Revenue, St. Joseph Health, Series A (a) 5.000 07/01/2013 295,000 295,000
Dade County, Florida, Water & Sewer System Revenue
(FGIC) (a) 4.000 10/05/2022 2,235,000 2,235,000
Los Angeles County, California, Pension, Series C (a) 3.900 06/30/2007 975,000 975,000
Massachusetts State Health and Educational Facilities
Authority Revenue, Capital Assets Program, Series D
(MBIA) (a) 4.900 01/01/2035 2,240,000 2,240,000
Missouri State Health and Educational Facilities
Authority Revenue, Christian Health Services, Series B
(a) 4.050 12/01/2019 1,635,000 1,635,000
New York City, New York, General Obligation, Series B,
Subseries B3 (a) 5.000 08/15/2004 160,000 160,000
New York City, New York, General Obligation, Subseries
A8 (a) 5.000 06/15/2024 5,000 5,000
Peninsula Ports Authority, Virginia, Ports Authority
Revenue (a) 5.000 12/01/2005 2,000,000 2,000,000
Perry County, Mississippi, Pollution Control Revenue,
Leaf River Forest Project (a) 5.000 03/01/2002 2,000,000 2,000,000
Sayre, Pennsylvania, Health Care Facilities Authority
Revenue, Series K (AMBAC) (a) 4.000 12/01/2020 1,495,000 1,495,000
Uinta County, Wyoming, Pollution Control Revenue,
Chevron USA Incorporated Project (a) 5.000 08/15/2020 1,000,000 1,000,000
<PAGE>
PAGE 23
- --------------------
SCHEDULE OF INVESTMENTS--December 31, 1996
Coupon Maturity Principal Market
Rate Date Amount Value
- ---------------------------------------------------------- ------ ---------- ---------- --------------
TEMPORARY TAX-EXEMPT INVESTMENTS (continued)
Washington State Health Care Facilities Authority
Revenue, Sisters of Providence, Series D (a) 5.000% 10/01/2005 $850,000 $ 850,000
- ---------------------------------------------------------- ------ ---------- ---------- --------------
TOTAL TEMPORARY TAX-EXEMPT INVESTMENTS (Cost--$14,890,000) 14,890,000
- ---------------------------------------------------------- ------ ---------- ---------- --------------
TOTAL INVESTMENTS (Cost--$1,463,422,894) (e) 1,542,665,935
OTHER ASSETS AND LIABILITIES--NET (1.0%) 15,219,857
- ---------------------------------------------------------- ------ ---------- ---------- --------------
NET ASSETS (100.0%) $1,557,885,792
- ---------------------------------------------------------- ------ ---------- ---------- --------------
</TABLE>
(a) Security is a variable or floating rate instrument with periodic demand
features. The Fund is entitled to full payment of principal and accrued
interest upon surrendering the security to the issuing agent.
(b) Effective yield (calculated at date of purchase) is the annual yield at
which the bond accretes until its maturity date.
(c) Securities that may be resold to "qualified institutional buyers" under
Rule 144A or securities offered pursuant to Section 4(2) of the
Securities Act of 1933, as mended. These securities have been determined
to be liquid under guidelines established by the Board of Trustees.
(d) At the discretion of the portfolio manager, these securities may be
separated into securities with interest or principal payments that are
linked to another rate or index and therefore would be considered
derivative securities (see Note 1).
(e) The cost of investments for federal income tax purposes amounted to
$1,463,520,567. Gross unrealized appreciation and unrealized depreciation
of investments, based on identified tax cost, at December 31, 1996 are as
follows:
Gross unrealized appreciation $86,747,523
Gross unrealized depreciation (7,602,155)
-------------
Net unrealized appreciation $79,145,368
-------------
Legend of Portfolio Abbreviations:
AMBAC--American Municipal Bond Assurance Corp.
ETM--Escrowed to Maturity
FGIC--Federal Guaranty Insurance Co.
FSA--Financial Security Assurance
GNMA--Government National Mortgage Association
LOC--Line of Credit
MBIA--Municipal Bond Investors Assurance Corp.
BPO--Bond Payment Obligation
SAVRs--Select Auction Variable Rate Securities
RIBs--Residual Interest Bonds
ACES--Auction Rate Securities
See Notes to Financial Statements.
<PAGE>
PAGE 24
- --------------------
Keystone Tax Free Fund
FINANCIAL HIGHLIGHTS
(For a share outstanding throughout each year)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
Year Ended December 31,
1996 1995 1994 1993 1992 1991
================================ ========= ========= ========= ========= ========= ===========
Net asset value beginning of
year $ 7.86 $ 7.10 $ 8.12 $ 8.04 $ 8.07 $ 7.90
-------------------------------- ------- ------- ------- ------- ------- ---------
Income from investment
operations:
Net investment income 0.41 0.41 0.37 0.39 0.46 0.46
Net realized and unrealized gain
(loss) on investments and
closed futures contracts (0.17) 0.74 (0.96) 0.48 0.12 0.36
-------------------------------- ------- ------- ------- ------- ------- ---------
Total from investment operations 0.24 1.15 (0.59) 0.87 0.58 0.82
-------------------------------- ------- ------- ------- ------- ------- ---------
Less distributions from:
Net investment income (0.39) (0.39) (0.37) (0.39) (0.46) (0.46)
In excess of net investment
income 0.00 0.00 (0.06) (0.06) (0.04) (0.07)
Net realized gain on investments 0.00 0.00 0.00 (0.33) (0.11) (0.12)
In excess of net realized gain
on investments 0.00 0.00 0.00 (0.01) 0.00 0.00
-------------------------------- ------- ------- ------- ------- ------- ---------
Total distributions (0.39) (0.39) (0.43) (0.79) (0.61) (0.65)
-------------------------------- ------- ------- ------- ------- ------- ---------
Net asset value end of year $ 7.71 $ 7.86 $ 7.10 $ 8.12 $ 8.04 $ 8.07
================================ ======= ======= ======= ======= ======= =========
Total Return (b) 3.15% 16.61% (7.34%) 11.15% 7.55% 10.80%
================================ ======= ======= ======= ======= ======= =========
Ratios/supplemental data
Ratios to average net assets:
Total expenses 0.87%(c) 0.95%(c) 1.55% 1.66% 1.38% 1.75%
Net investment income 5.34% 5.41% 4.92% 4.72% 5.71% 5.78%
Portfolio turnover rate 69% 56% 84% 76% 78% 77%
-------------------------------- ------- ------- ------- ------- ------- ---------
Net assets end of year
(thousands) $1,557,886 $1,204,468 $1,197,727 $1,548,503 $1,453,199 $1,146,185
================================ ======= ======= ======= ======= ======= =========
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
Year Ended December 31,
1990 (a) 1989 1988 1987
================================ ========= ========= ========= ===========
Net asset value beginning of
year $ 8.06 $ 8.18 $ 8.09 $ 8.85
-------------------------------- ------- ------- ------- ---------
Income from investment
operations:
Net investment income 0.52 0.57 0.55 0.56
Net realized and unrealized gain
(loss) on investments and
closed futures contracts (0.01) 0.15 0.30 (0.58)
-------------------------------- ------- ------- ------- ---------
Total from investment operations 0.51 0.72 0.85 (0.02)
-------------------------------- ------- ------- ------- ---------
Less distributions from:
Net investment income (0.52) (0.60) (0.63) (0.64)
In excess of net investment
income (0.03) 0.00 0.00 0.00
Net realized gain on investments (0.12) (0.24) (0.13) (0.10)
In excess of net realized gain
on investments 0.00 0.00 0.00 0.00
-------------------------------- ------- ------- ------- ---------
Total distributions (0.67) (0.84) (0.76) (0.74)
-------------------------------- ------- ------- ------- ---------
Net asset value end of year $ 7.90 $ 8.06 $ 8.18 $ 8.09
================================ ======= ======= ======= =========
Total Return (b) 6.66% 9.11% 10.89% (0.14%)
================================ ======= ======= ======= =========
Ratios/supplemental data
Ratios to average net assets:
Total expenses 1.18% 1.23% 1.79% 1.70%
Net investment income 6.54% 6.94% 6.74% 6.80%
Portfolio turnover rate 64% 69% 61% 43%
-------------------------------- ------- ------- ------- ---------
Net assets end of year
(thousands) $1,060,826 $901,912 $903,132 $894,768
================================ ======= ======= ======= =========
</TABLE>
(a) Calculation based on average shares outstanding.
(b) Excluding applicable sales charges.
(c) Ratio of total expenses to average net assets includes indirectly paid
expenses. Excluding indirectly paid expenses, the expense ratio would
have been 0.86% and 0.94% for the years ended December 31, 1996 and 1995,
respectively.
See Notes to Financial Statements.
<PAGE>
PAGE 25
- --------------------
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1996
Assets (Note 2)
Investments at market value
(identified cost--$1,463,422,894) $1,542,665,935
Receivable for:
Investments sold 3,000,875
Fund shares sold 161,661
Interest 25,970,285
Other assets 166,675
- ------------------------------------------------- ----------
Total assets 1,571,965,431
- ------------------------------------------------- ----------
Liabilities (Note 2)
Payable for:
Investments purchased 4,919,751
Fund shares redeemed 2,049,565
Distributions to shareholders 6,333,173
Accrued Trustees' fees and expenses 3,006
Other accrued expenses 774,144
- ------------------------------------------------- ----------
Total liabilities 14,079,639
- ------------------------------------------------- ----------
Net assets $1,557,885,792
- ------------------------------------------------- ----------
Net assets represented by
Paid-in capital $1,489,589,329
Undistributed net investment income 2,957,507
Accumulated net realized loss on investments and
closed futures contracts (13,904,085)
Net unrealized appreciation on investments 79,243,041
- ------------------------------------------------- ----------
Total net assets $1,557,885,792
- ------------------------------------------------- ----------
Net asset value per share (Note 2)
Net asset value of $1,557,885,792 / 201,937,602
outstanding shares of beneficial interest $ 7.71
================================================= ==========
STATEMENT OF OPERATIONS
Year Ended December 31, 1996
Investment income
Interest $ 97,670,668
- ------------------------------------ --------- ----------
Expenses (Notes 4, 5 and 6)
Investment management fee $ 6,642,609
Distribution Plan expenses 4,706,968
Transfer agent fees 1,591,303
Other administrative service fees 666,547
Trustees' fees and expenses 48,506
Reimburseable accounting expenses 19,501
- ------------------------------------ --------- ----------
Total expenses 13,675,434
Less: Expenses paid indirectly (172,145)
- ------------------------------------ --------- ----------
Net expenses 13,503,289
- ------------------------------------ --------- ----------
Net investment income 84,167,379
- ------------------------------------ --------- ----------
Net realized and unrealized loss on
investments (Note 3)
Net realized gain on investments 15,476,735
Net change in unrealized
appreciation or depreciation on
investments (Note 7) (48,955,108)
- ------------------------------------ --------- ----------
Net realized and unrealized loss on
investments (33,478,373)
- ------------------------------------ --------- ----------
Net increase in net assets resulting
from operations $ 50,689,006
==================================== ========= ==========
See Notes to Financial Statements.
<PAGE>
PAGE 26
- --------------------
Keystone Tax Free Fund
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
<S> <C> <C>
Year Ended December
31, 1996 1995
===================================================================== ================ ==================
Operations
Net investment income $ 84,167,379 $ 65,921,672
Net realized gain on investments and closed futures contracts 15,476,735 8,930,765
Net change in unrealized appreciation or depreciation on
investments (48,955,108) 113,250,664
- ------------------------------------------------------------------- ------------ --------------
Net increase in net assets resulting from operations 50,689,006 188,103,101
- ------------------------------------------------------------------- ------------ --------------
Distributions to shareholders from net investment income (Note 1) (79,617,449) (63,827,615)
- ------------------------------------------------------------------- ------------ --------------
Capital share transactions (Notes 2 and 7)
Shares issued in connection with the acquisition of Keystone
Tax Exempt Trust 658,278,376 0
Proceeds from shares sold 107,614,922 133,114,586
Payment for shares redeemed (424,558,360) (283,907,474)
Net asset value of shares issued in reinvestment of dividends and
distributions 41,011,255 33,258,548
- ------------------------------------------------------------------- ------------ --------------
Net increase (decrease) in net assets resulting from capital share
transactions 382,346,193 (117,534,340)
- ------------------------------------------------------------------- ------------ --------------
Total increase in net assets 353,417,750 6,741,146
Net assets
Beginning of year 1,204,468,042 1,197,726,896
- ------------------------------------------------------------------- ------------ --------------
End of year [including undistributed net investment income
(accumulated distributions in excess of net investment income)
as follows: 1996--$2,957,507 and 1995--($1,663,086)] $1,557,885,792 $1,204,468,042
=================================================================== ============ ==============
</TABLE>
See Notes to Financial Statements.
<PAGE>
PAGE 27
- --------------------
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies
Keystone Tax Free Fund (the "Fund") is a Massachusetts business trust for
which Keystone Investment Management Company ("Keystone") is the Investment
Adviser and Manager. Keystone was formerly a wholly-owned subsidiary of
Keystone Investments, Inc. ("KII") and is currently a subsidiary of First
Union Keystone, Inc. First Union Keystone, Inc. is a wholly-owned subsidiary
of First Union National Bank of North Carolina which in turn is a
wholly-owned subsidiary of First Union Corporation ("First Union"). The Fund
is registered under the Investment Company Act of 1940, as amended (the "1940
Act"), as a diversified, open-end investment company. The Fund's investment
objective is to provide shareholders with the highest possible current
income, exempt from federal income taxes, while preserving capital by
investing in high quality municipal bonds.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles,
which require management to make estimates and assumptions that affect
amounts reported herein. Although actual results could differ from these
estimates, any such differences are expected to be immaterial to the net
assets of the Fund.
A. Valuation of Securities
Tax-exempt bonds are valued at prices provided by an independent pricing
service. In determining value for normal institutional-size transactions, the
pricing service uses methods based on market transactions for comparable
securities and various relationships between securities which are generally
recognized by institutional traders. Securities for which valuations are not
available from an independent pricing service (including restricted
securities) are valued at fair value as determined in good faith according to
procedures established by the Board of Trustees.
Short-term investments with remaining maturities of 60 days or less are
carried at amortized cost, which approximates market value. Short-term
securities with greater than 60 days to maturity are valued at market value.
B. Futures Contracts
In order to gain exposure to or protect against changes in security values,
the Fund may buy and sell futures contracts.
The initial margin deposited with a broker when entering into a futures
transaction is subsequently adjusted by daily payments or receipts as the
value of the contract changes. Such changes are recorded as unrealized gains
or losses. Realized gains or losses are recognized on closing the contract.
Risks of entering into futures contracts include (i) the possibility of an
illiquid market for the contract, (ii) the possibility that a change in the
value of the contract may not correlate with changes in the value of the
underlying instrument or index, and (iii) the credit risk that the other
party will not fulfill their obligations under the contract. Futures
contracts also involve elements of market risk in excess of the amount
reflected in the statement of assets and liabilities.
C. Derivative Securities
The Fund may invest in derivative securities. A derivative security is any
investment that derives its value from an underlying security, asset or
market index. Greater market fluctuations may result if these securities are
leveraged. The Fund invests in these
<PAGE>
PAGE 28
- --------------------
Keystone Tax Free Fund
types of securities as it is consistent with its investment objectives.
D. Security Transactions and Investment Income
Securities transactions are accounted for no later than one business day
after the trade date. Realized gains and losses are computed on the
identified cost basis. Interest income is recorded on the accrual basis and
includes amortization of discounts and premiums.
E. Federal Income Taxes
The Fund has qualified and intends to qualify in the future as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code"). Thus, the Fund is relieved of any federal income tax liability by
distributing all of its net taxable investment income and net taxable capital
gains, if any, to its shareholders. The Fund also intends to avoid excise tax
liability by making the required distributions under the Code. Accordingly,
no provision for federal income taxes is required.
F. Distributions
The Fund declares dividends from net investment income daily and distributes
such dividends monthly. The Fund distributes net capital gains, if any, at
least, annually. Distributions to shareholders are recorded at the close of
business on the ex-dividend date.
Income and capital gains distributions to shareholders are determined in
accordance with income tax regulations, which may differ from generally
accepted accounting principles. These differences are primarily due to
differing treatment of market discount on securities.
2. Capital Share Transactions
The Fund's Declaration of Trust authorizes the issuance of an unlimited
number of shares of beneficial interest with no par value. Transactions in
shares of the Fund were as follows:
Year ended December 31,
1996 1995
================================= ============ ==============
Shares issued in connection with
the acquisition of Keystone Tax
Exempt Trust (Note 7) 84,656,452 -0-
Shares sold 14,063,760 17,669,831
Shares redeemed (55,439,349) (37,618,182)
Shares issued in reinvestment of
dividends and distributions 5,361,695 4,437,352
--------------------------------- ------------ --------------
Net increase (decrease) 48,642,558 (15,510,999)
================================= ============ ==============
3. Securities Transactions
Cost of purchases and proceeds from sales of investment securities (excluding
short-term securities and U.S. government securities) for the year ended
December 31, 1996 were $1,379,241,478 and $1,041,052,842, respectively.
As of December 31, 1996, the Fund has a capital loss carryover for federal
income tax purposes of approximately $13,723,000 which expires as follows:
$10,370,000--2002 and $3,353,000--2003.
4. Distribution Plans
The Fund bears some of the costs of selling its shares under a Distribution
Plan adopted pursuant to Rule 12b-1 under the 1940 Act. Under the
Distribution Plan, the Fund pays its principal underwriter amounts which are
calculated and paid monthly.
Prior to December 11, 1996, Evergreen Keystone Investment Services, Inc.
(formerly, Keystone Investment Distributors Company) ("EKIS"), a wholly-owned
subsidiary of Keystone, served as the Fund's principal underwriter. On
December 11, 1996, the Fund entered into a principal underwriting agreement
with Evergreen Keystone Distributor, Inc. (formerly, Evergreen Funds
Distributor, Inc.) ("EKD"), a wholly-owned subsidiary of
<PAGE>
PAGE 29
- --------------------
BISYS Group Inc. At that time, EKD replaced EKIS as the Fund's principal
underwriter.
Under the Distribution Plan, the Fund pays a distribution fee which may not
exceed 1.00% of the Fund's average daily net assets, of which 0.75% is used
to pay distribution expenses and 0.25% may be used to pay shareholder service
fees.
During the year ended December 31, 1996, the Fund received $696,350 in
contingent deferred sales charges. Contingent deferred sales charges paid by
redeeming shareholders may be paid to EKIS and/or EKD.
The Distribution Plan may be terminated at any time by vote of the
Independent Trustees or by vote of a majority of the outstanding voting
shares. However, after the termination of the Distribution Plan, and subject
to the discretion of the Independent Trustees, payments to EKIS and/or EKD
may continue as compensation for services which had been earned while the
Distribution Plan was in effect.
EKD intends, but is not obligated, to continue to pay distribution costs
that exceed the current annual payments from the Fund. EKD intends to seek
full payment of such distribution costs from the Fund at such time in the
future as, and to the extent that, payment thereof by the Fund would be
within permitted limits.
5. Investment Management Agreement and Other Affiliated Transactions
Under an investment advisory agreement dated December 11, 1996, Keystone
serves as the Investment Adviser and Manager to the Fund. Keystone provides
the Fund with investment advisory and management services. In return,
Keystone is paid a management fee, computed and paid daily, at an annual rate
of 2.00% of the Fund's gross investment income plus an amount determined by
applying percentage rates starting at 0.50% and declining as net assets
increase to 0.25% per annum, to the average daily net asset value of the
Fund.
Prior to December 11, 1996, Keystone Management, Inc. ("KMI"), a
wholly-owned subsidiary of Keystone, served as Investment Manager to the Fund
and provided investment management and administrative services. Under an
investment advisory agreement between KMI and Keystone, Keystone served as
the Investment Adviser and provided investment advisory and management
services to the Fund. In return for its services, Keystone received an annual
fee equal to 85% of the management fee received by KMI.
In providing or obtaining additional operating services, facilities and
supplies to the Fund, KMI had incurred administrative expenses of $666,547
which consisted of $533,237 for custodian fees, $18,769 for audit and legal
and $114,541 for printing, registration, insurance and other miscellaneous
expenses. KMI has been reimbursed for these expenses by the Fund.
During the year ended December 31, 1996, the Fund paid or accrued $19,501 to
Keystone for certain accounting services.
Officers of the Fund and affiliated Trustees receive no compensation
directly from the Fund.
6. Expense Offset Arrangement
The Fund has entered into an expense offset arrangement with its custodian.
For the year ended December 31, 1996, the Fund incurred total custody fees of
$533,237 and received a credit of $172,145 pursuant to this expense offset
arrangement, resulting in a net custody expense of $361,092. The assets
deposited with the custodian under this expense offset arrangement could have
been invested in income-producing assets.
7. Fund Reorganization
On February 29, 1996, the Fund acquired the net assets of Keystone Tax Exempt
Trust in exchange for
<PAGE>
PAGE 30
- --------------------
Keystone Tax Free Fund
shares of the Fund pursuant to a plan of reorganization approved by the
shareholders of Keystone Tax Exempt Trust on February 29, 1996. The
acquisition was accomplished by a tax-free exchange of shares of the Fund for
the net assets of Keystone Tax Exempt Trust. The net assets of Keystone Tax
Exempt Trust on that date, including $40,609,975 of unrealized appreciation
on investments, were combined with the Fund. The aggregate net assets of the
Fund and Tax Exempt Trust immediately before the acquisition were
$1,142,691,716 and $658,278,376, respectively. The net assets of the Fund
immediately after the acquisition were $1,800,970,092.
<PAGE>
PAGE 31
- --------------------
INDEPENDENT AUDITORS' REPORT
The Trustees and Shareholders
Keystone Tax Free Fund
We have audited the accompanying statement of assets and liabilities of
Keystone Tax Free Fund, including the schedule of investments, as of December
31, 1996, and the related statement of operations for the year then ended,
the statements of changes in net assets for each of the years in the two-year
period then ended and the financial highlights for each of the years in the
ten-year period then ended. These financial statements and financial
highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. Our procedures included confirmation of
securities owned as of December 31, 1996 by correspondence with the custodian
and brokers. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Keystone Tax Free Fund, as of December 31, 1996 the results of its operations
for the year then ended, the changes in its net assets for each of the years
in the two-year period then ended, and the financial highlights for each of
the years in the ten-year period then ended in conformity with generally
accepted accounting principles.
KPMG Peat Marwick LLP
Boston, Massachusetts
January 31, 1997
<PAGE>
PAGE 32
- --------------------
Keystone Tax Free Fund
FEDERAL TAX STATUS-FISCAL 1996 DISTRIBUTIONS
(Unaudited)
The per share distributions paid to you for fiscal 1996, whether taken in
shares or cash, are as follows:
Income Dividends
Tax-exempt Taxable
- ------------ -----------
$0.39 $0.00
============ ===========
In January 1997 complete information on calendar year 1996 distributions was
forwarded to you to assist in completing your 1996 federal income tax return.
<PAGE>
PAGE 33
- --------------------
Additional Information
(Unaudited)
Shareholders of the Fund considered and acted upon the proposals listed below
at a special meeting of shareholders held Monday, December 9, 1996. In
addition, next to each proposal are the results of that vote.
1. To elect the following Trustees:
Affirmative Withheld
============================ =========== ===========
Frederick Amling 144,022,770 4,053,136
Laurence B. Ashkin 143,990,875 4,085,031
Charles A. Austin III 144,085,020 3,990,886
Foster Bam 143,983,688 4,092,218
George S. Bissell 143,979,383 4,096,523
Edwin D. Campbell 144,015,759 4,060,147
Charles F. Chapin 144,037,486 4,038,420
K. Dun Gifford 144,088,419 3,987,487
James S. Howell 143,983,258 4,092,648
Leroy Keith, Jr. 144,096,560 3,979,346
F. Ray Keyser, Jr. 143,988,564 4,087,342
Gerald M. McDonell 144,031,045 4,044,861
Thomas L. McVerry 144,024,241 4,051,665
William Walt Pettit 144,010,323 4,065,583
David M Richardson 144,101,685 3,974,221
Russell A. Salton, III M.D. 144,092,464 3,983,442
Michael S. Scofield 144,026,816 4,049,090
Richard J. Shima 144,066,939 4,008,967
Andrew J. Simons 144,068,774 4,007,132
2. To approve an Investment Advisory and Management Agreement between the
Fund and Keystone Investment Management Company.
Affirmative 139,291,841
Against 3,308,095
Abstain 5,475,971
<PAGE>
PAGE 34
- --------------------
Keystone Tax Free Fund
Keystone's Services
for Shareholders
KEYSTONE AUTOMATED RESPONSE LINE (KARL)--Receive up-to-date account
information on your balance, last transaction and recent Fund distribution.
You may also process transactions such as investments, redemptions and
exchanges using a touch-tone telephone as well as receive quotes on price,
yield, and total return of your Keystone Fund. Call toll-free,
1-800-346-3858.
EASY ACCESS TO INFORMATION ON YOUR ACCOUNT--Information about your
Keystone account is available 24 hours a day through KARL. To speak with a
Shareholder Services representative about your account, call toll-free
1-800-343-2898 between 8:00 A.M. and 6:00 P.M. Eastern time. Retirement Plan
investors should call 1-800-247-4075.
ADDITIONS TO YOUR ACCOUNT--You can buy additional shares for your account
at any time, with no minimum additional investment.
REINVESTMENT OF DISTRIBUTIONS--You can compound the return on your
investment by automatically reinvesting your Fund's distributions at net
asset value with no sales charge.
EXCHANGE PRIVILEGE--You may move your money among funds in the same
Keystone family quickly and easily for a nominal service fee. KARL gives you
the added ability to move your money any time of day, any day of the week.
Keystone offers a variety of funds with different investment objectives for
your changing investment needs.
ELECTRONIC FUNDS TRANSFER (EFT)--Referred to as the "paper-less
transaction," EFT allows you to take advantage of a variety of preauthorized
account transactions, including automatic monthly investments and systematic
monthly or quarterly withdrawals. EFT is a quick, safe and accurate way to
move money between your bank account and your Keystone account.
CHECK WRITING--Shareholders of Keystone Liquid Trust may exercise the
check writing privilege to draw from their accounts.
EASY REDEMPTION--KARL makes redemption services available to you 24 hours
a day, every day of the year. The amount you receive may be more or less than
your original account value depending on the value of fund shares at time of
redemption.
RETIREMENT PLANS--Keystone offers a full range of retirement plans,
including IRA, SEP-IRA, profit sharing, money purchase, and defined
contribution plans. For more information, please call Retirement Plan
Services, toll-free at 1-800-247-4075.
Keystone is committed to providing you with quality, responsive account
service. We will do our best to assist you and your financial adviser in
carrying out your investment plans.
<PAGE>
THIS PAGE INTENTIONALLY LEFT BLANK
<PAGE>
[wrap cover]
KEYSTONE
FAMILY OF FUNDS
[diamond]
Balanced Fund (K-1)
Diversified Bond Fund (B-2)
Growth and Income Fund (S-1)
High Income Bond Fund (B-4)
International Fund Inc.
Liquid Trust
Mid-Cap Growth Fund (S-3)
Precious Metals Holdings, Inc.
Quality Bond Fund (B-1)
Small Company Growth Fund (S-4)
Strategic Growth Fund (K-2)
Tax Free Fund
This report was prepared primarily for the information of the Fund's
shareholders. It is authorized for distribution if preceded or accompanied by
the Fund's current prospectus. The prospectus contains important information
about the Fund including fees and expenses. Read it carefully before you invest
or send money. For a free prospectus on other Evergreen Keystone funds, contact
your financial adviser or call Evergreen Keystone.
[GRAPHIC] Evergreen Keystone Logo
P.O. Box 2121
Boston, Massachusetts 02106-2121
KTF-R-2/97
48M [recycle symbol]
KEYSTONE
[GRAPHIC] U.S. flag
TAX FREE
FUND
[GRAPHIC] Evergreen Keystone Logo
ANNUAL REPORT
DECEMBER 31, 1996
<PAGE>
PAGE 1
KEYSTONE TAX FREE FUND
Dear Shareholder:
We are pleased to report on the performance of Keystone Tax Free Fund for the
six-month fiscal period that ended on June 30, 1997. Following this letter is a
discussion with your Fund's manager, discussing portfolio strategy.
PERFORMANCE
For the six-month period your Fund returned 2.52%; for the twelve months period
it returned 7.07%. These results include price changes and reinvestment of
dividends. The Lehman Municipal Bond Index-- a widely recognized benchmark of
municipal bond performance-- returned 3.20% for the same six-month period and
7.81% for the same twelve-month period.
We believe your Fund performed satisfactorily in a difficult interest rate
environment over the past six months. While interest rates ended the period
relatively unchanged, they rose during much of the first half of 1997 and later
declined. Investors continued to be concerned about stronger-than-expected
economic growth, future inflation and higher interest rates. This created an
atmosphere of uncertainty and gave the market a vigilant tone.
Interest rates declined late in the period as employment growth showed signs
of slowing. Throughout the year's first half, inflation remained well contained.
We managed your Fund conservatively during this changing environment. We
improved the overall quality of the portfolio, primarily by reducing positions
in BBB-rated securities and increasing holdings in AAA-rated bonds. We increased
your Fund's net assets invested in AAA-rated bonds from 46% on December 31, 1996
to 54% on June 30, 1997. Your Fund's average quality was AA+, also as of the end
of the reporting period.
In the last half of this period, we increased your Fund's sensitivity to
interest rate changes, as it appeared interest rates would decline and bond
prices would rise. We did this by selling bonds with 5-10 year maturities and
reinvesting proceeds in bonds with 15-20 year maturities.
We also focused on bonds with lower coupons, as well as some attractively
priced zero-coupon bonds. We believe these changes enhanced your Fund's total
return when interest rates fell.
OUTLOOK
Going forward, we are cautiously optimistic about the municipal bond market.
Supply/demand technicals remain favorable. The stronger economic growth has
benefited many municipalities by increasing tax revenues and strengthening their
credit outlook. Higher revenues also have reduced the need for debt financing,
which has restricted the supply of municipal bonds. Meanwhile, demand has
remained steady. This reduced supply and steady demand has helped support
municipal bond prices.
-- CONTINUED--
<PAGE>
PAGE 2
KEYSTONE TAX FREE FUND
We also expect the economy to grow at a moderate pace and inflation to remain
low, an environment which historically has been favorable for fixed-income
investments. Improvements in productivity have increased efficiency throughout
the world. We believe that, combined with the steadfast efforts of the Federal
Reserve Board to thwart inflation, this will enable the economic expansion to
continue without a resurgence of higher prices.
Thank you for your support of Keystone Tax Free Fund.
Sincerely,
Albert H. Elfner, III
(Signature of Albert H. Elfner, III)
CHAIRMAN AND PRESIDENT
KEYSTONE INVESTMENT MANAGEMENT COMPANY
(Signature of George S. Bissell)
George S. Bissell
CHAIRMAN OF THE BOARD
KEYSTONE FUNDS
<TABLE>
<S> <C>
(Photo of (Photo of George S. Bissell)
Albert H. Elfner,III)
ALBERT H. ELFNER, III GEORGE S. BISSELL
</TABLE>
August 1997
<PAGE>
PAGE 3
A Discussion With
Your Fund's Manager
(Photo of Betsy A. Hutchings)
BETSY A. HUTCHINGS, A SENIOR VICE PRESIDENT AND GROUP LEADER OF THE
MUNICIPAL BOND TEAM OF KEYSTONE INVESTMENT MANAGEMENT COMPANY, IS
PORTFOLIO MANAGER OF THE FUND. A PROFESSIONAL WITH MORE THAN 15 YEARS OF
EXPERIENCE IN INVESTMENT MANAGEMENT, MS. HUTCHINGS ALSO IS PORTFOLIO
MANAGER OF KEYSTONE TAX FREE INCOME FUND. PRIOR TO JOINING KEYSTONE IN
1988, MS. HUTCHINGS SERVED IN PORTFOLIO MANAGER AND RESEARCH POSITIONS AT
SCUDDER, STEVENS & CLARK, NY; AND JOHN NUVEEN & COMPANY, CHICAGO. MS.
HUTCHINGS IS ACTIVE IN BOSTON MUNICIPAL ANALYSTS FORUM AND THE MUNICIPAL
BOND BUYERS CONFERENCE. SHE IS A GRADUATE OF WHEATON COLLEGE.
Q WHY IS THE FUND ATTRACTIVE TO INVESTORS?
A Keystone Tax Free Fund is appropriate for tax-sensitive investors. The Fund is
designed to provide a high level of current income that is exempt from federal
income tax and capital preservation. A portion of income may be subject to the
federal alternative minimum tax (AMT). The Fund offers professional management
and diversification. We believe this is especially important, since many
investors do not have the time or resources to monitor credit quality, the
economy and interest rates. We diversify the Fund by selecting securities with
various maturities from across the nation. We believe this can help reduce the
potential for wide fluctuations in the Fund's share price.
Q HOW DO YOU SELECT THE FUND'S SECURITIES?
A Our management team employs an intensive research process, emphasizing credit
quality and financial stability. The bonds we select must meet our high credit
standards and possess attributes that we believe will enable them to perform
well in our anticipated interest rate and economic environment. We also focus on
diversification and maximizing the Fund's income.
Q WHAT WAS THE INTEREST RATE ENVIRONMENT LIKE OVER THE PAST SIX MONTHS?
A Interest rates rose for much of the first half of 1997 and later declined,
ending the period relatively unchanged. Faster-than-expected economic growth
during the year's first quarter caused investors to become concerned about
future inflation, a trend we witnessed throughout 1996. The Federal Reserve
Board confirmed those concerns in March 1997 by raising the federal funds rate,
the rate at which banks lend to each other overnight, by 1/4%. Interest rates
reversed course as signs of slower employment growth began to appear in early
May. Inflation remained low throughout the first half of the year.
Q HOW DID THAT SPECIFICALLY AFFECT MUNICIPAL BONDS?
A The economy's strength benefited municipal bond investors in several ways.
State and local governments enjoyed higher tax revenues, which helped improve
the fiscal conditions and credit standings of many municipalities. Higher
revenues also enabled these governments to reduce their need for debt financing,
which then restricted supply in the tax-exempt market. During 1996, new
municipal supply issuance stood at $185 billion, compared to $292 billion in
1993. This steady demand and thinner supply gave support to municipal bond
prices.
<PAGE>
PAGE 4
KEYSTONE TAX FREE FUND
Q WHAT STRATEGIES DID YOU USE IN MANAGING THE FUND?
A We used two main strategies. First, we focused on relative value. We did this
by increasing assets in AAA-rated bonds and bonds not subject to the alternative
minimum tax (AMT); and reducing BBB-rated and AMT positions. The yields of
BBB-rated bonds have moved closer to those of AAA-rated bonds, so that we were
able to upgrade the portfolio without giving up much yield. As of June 30, 1997,
approximately 54% of the portfolio's net assets were invested in AAA-rated
securities, versus 46% on December 31, 1996. The Fund's average quality was AA+
also as of June 30, 1997. Similarly, AMT bonds have higher yields than non-AMT
bonds. The yields of the AMT bonds have fallen to the point that they provided
little additional yield compared to non-AMT bonds. We believed that the non-AMT
and higher-rated securities provided better relative value.
We also increased the Fund's sensitivity to interest rate changes. The first
part of this strategy was to invest in bonds with lower coupons. These so-called
"discount" coupons typically generate higher total returns in a declining
interest rate environment. A second part of this strategy was to target new
investments in the 15-20 year maturity range, selling positions that had 5-10
year maturities and buying zero-coupon bonds. As of June 30, 1997, the Fund's
average maturity stood at 18.6 years. We believe these changes enhanced total
return in the latter part of the reporting period.
Q WHAT IS YOUR OUTLOOK OVER THE NEXT SIX MONTHS?
A We are cautiously optimistic in our outlook for municipal bonds, expecting to
see a continuation of many of the trends that have existed over the past six
months. We anticipate steady economic growth, low inflation and a positive
relationship between supply and demand.
We believe that improvements in productivity-- specifically from investment in
computers and information processing-- can enable the economy to grow at a
steady pace without a resurgence in inflation. In our opinion, this type of
environment should continue to benefit municipalities by producing higher tax
revenues, which reduces their need to issue bonds while improving the credit
quality on their outstanding bonds.
Investors also have responded positively to news out of Washington. The
federal deficit continues to decline; and many investors believe that members of
Congress are making progress on settling their differences.
Longer term, we also think demographics could have a favorable effect on
municipal bonds. The first of the baby-boomers have reached fifty and may be
looking for a greater portion of their portfolios to be income-producing,
tax-advantaged investments.
--
THIS COLUMN IS INTENDED TO ANSWER QUESTIONS ABOUT YOUR FUND.
IF YOU HAVE A QUESTION YOU WOULD LIKE ANSWERED, PLEASE WRITE TO:
EVERGREEN KEYSTONE INVESTMENT SERVICES, INC.
ATTN: SHAREHOLDER COMMUNICATIONS
201 SOUTH COLLEGE STREET, SUITE 400
CHARLOTTE, N.C. 28288-1195
<PAGE>
PAGE 5
Your Fund's Performance
(Chart appears below with the following plot points)
Tax Value $19,746
Keystone Tax Free Fund
(In thousands)
Dividend Initial
Reinvestment Investment
6/87 10,000 10,000
6/89 11,859 10,024
6/91 13,484 9,495
6/93 16,588 10,036
6/95 17,478 9,063
6/97 19,746 9,255
The cumulative and average annual total returns with sales charge calculations
reflect the deduction of the 3% contingent deferred sales charge (CDSC) for
those investors who sold Fund shares after one calendar year. Investors who
retained their investment earned the returns in the without sales charge lines.
HISTORICAL RECORD
CUMULATIVE TOTAL RETURN
6 mos w/o sales charge 2.52%
1 yr w/o sales charge 7.07%
1 yr w/ sales charge 4.07%
5 years 31.39%
10 years 97.46%
AVERAGE ANNUAL TOTAL RETURN
1 yr w/o sales charge 7.07%
1 yr w/ sales charge 4.07%
5 years 5.61%
10 years 7.04%
The investment return and principal value will fluctuate so that your shares,
when redeemed, may be worth more or less than the original cost.
You may exchange your shares for another Keystone Classic fund by phone or in
writing. The Fund reserves the right to change or terminate the exchange offer.
<PAGE>
PAGE 6
KEYSTONE TAX FREE FUND
SCHEDULE OF INVESTMENTS-- JUNE 30, 1997 (UNAUDITED)
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- 97.9%
ALABAMA-- 0.9%
$ 2,035,000 Alabama Agricultural and
Mechanic University
6.50%, 11/1/25, (MBIA)...... $ 2,211,211
2,065,000 Alabama Housing Finance
Authority, Single Family,
Collateralized Home
Mortgage, Series D1
6.00%, 10/1/16.............. 2,110,554
4,000,000 Jefferson County, Alabama,
Sewer Revenue, Warrants,
Series D
5.70%, 2/1/18, (FGIC)....... 4,011,600
3,500,000 Mobile, Alabama, Industrial
Development Board, Solid
Waste Disposal, Mobile
Energy Serv. Co. Project
6.95%, 1/1/20............... 3,733,625
12,066,990
ALASKA-- 1.2%
15,000,000 Alaska Energy Authority,
Utilities Revenue, Linked
Bulls/Bears Floaters (c)
6.60%, 7/1/15, (FGIC)....... 16,437,150
265,000 Alaska State Housing Finance
Corporation, Collateralized
Home Mortgage, Series A
8.00%, 12/1/13.............. 273,976
16,711,126
ARIZONA-- 2.3%
11,000,000 Central Arizona, Water
Conservation District,
Contract Revenue, Central
Arizona Project, Series A
5.50%, 11/1/09.............. 11,353,760
850,000 Chandler, Arizona, Water and
Sewer Revenue
6.75%, 7/1/06, (FGIC)....... 916,309
Maricopa County, Arizona,
Elementary School District:
2,000,000 #008, Osborn Refunding
7.50%, 7/1/07, (MBIA)......... 2,420,440
3,750,000 #068, Series A
6.75%, 7/1/14, (AMBAC)........ 4,177,012
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
ARIZONA-- CONTINUED
$ 6,000,000 Maricopa County, Arizona,
Unified School District
8.13%, 1/1/10, (MBIA)....... $ 7,232,220
3,785,000 Northern Arizona University,
College and University
Revenue
5.00%, 6/1/15, (FGIC)....... 3,590,981
370,000 Pima County, Arizona,
Industrial Development
Authority, Health Care
Corporation Revenue
8.00%, 7/1/13, (MBIA)....... 390,613
2,030,000 Pima County, Arizona, Unified
School District, Tucson
Refunding
7.50%, 7/1/03, (FGIC)....... 2,339,717
32,421,052
ARKANSAS-- 0.1%
1,725,000 Arkansas State Development
Finance Authority, Single
Family Mortgage Revenue
Refunding
8.00%, 8/15/11.............. 1,851,753
CALIFORNIA-- 7.6%
California Health Facilities
Financing Authority Revenue:
9,800,000 Children's Hospital
5.38%, 7/1/20, (MBIA)......... 9,443,182
2,500,000 Pomona Valley Hospital,
Series A
5.63%, 7/1/19, (MBIA)......... 2,489,050
200,000 St. Francis Medical Center,
Series A
5.50%, 10/1/09................ 208,434
1,995,000 California Housing Finance
Agency, Revenue Bonds, Home
Mortgage, Series H
6.25%, 8/1/27............... 2,034,681
California State Public Works
Board, Lease Department
Correctional State Prison:
9,000,000 Series A
5.25%, 1/1/21, (AMBAC)........ 8,602,470
3,700,000 Series E
5.50%, 6/1/15................. 3,699,334
<PAGE>
PAGE 7
SCHEDULE OF INVESTMENTS-- JUNE 30, 1997 (UNAUDITED)
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
CALIFORNIA-- CONTINUED
California State Public Works
Board, Various California
University Projects:
$ 4,000,000 Series A
5.35%, 12/1/15................ $ 3,925,840
350,000 Series B
5.50%, 6/1/19................. 346,027
Central Coast Water Authority
California Revenue, State
Water Project, Regional
Facilities, Series A:
6,420,000 5.00%, 10/1/16, (AMBAC)....... 6,004,241
5,000,000 5.00%, 10/1/22, (AMBAC)....... 4,603,100
5,615,000 Eden Township, California,
Hospital District Revenue
7.40%, 11/1/19.............. 5,948,531
5,000,000 Los Angeles County,
California, Public Works
Financing Authority Lease
Revenue, Series A
5.25%, 9/1/13, (MBIA)....... 4,913,150
6,800,000 Los Angeles, California,
Transportation Commission,
Series A
6.25%, 7/1/13, (MBIA)....... 7,164,888
6,015,000 Oakland, California, Revenue
Refunding, Series A
7.60%, 8/1/21, (FGIC)....... 6,346,306
Riverside County, California,
Asset Leasing Corp.,
Leasehold Revenue, Riverside
County Hospital Project:
1,750,000 (effective yield 5.80%) (b)
0.00%, 6/1/15, (MBIA)......... 631,785
1,395,000 (effective yield 5.85%) (b)
0.00%, 6/1/16, (MBIA)......... 471,398
5,000,000 San Diego, California, Public
Facilities Financing
Authority, Sewer Revenue,
Series A
5.25%, 5/15/22, (FGIC)...... 4,760,000
22,500,000 San Francisco, California,
State Building Authority,
Lease Revenue, San Francisco
Civic Center Complex, Series
A
5.25%, 12/1/21, (AMBAC)..... 21,429,450
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
CALIFORNIA-- CONTINUED
$ 7,050,000 San Jose, California,
Redevelopment Agency Tax
Allocation, Merged Area
Redevelopment Project
6.00%, 8/1/09, (MBIA)....... $ 7,687,602
10,000,000 Southern California Public
Power Authority,
Transmission Project Revenue
(effective yield 5.93%) (b)
0.00%, 7/1/15, (FGIC)....... 3,741,200
Victor Valley, California,
Joint Unified High School
District, Capital
Appreciation:
2,635,000 (effective yield 6.20%) (b)
0.00%, 9/1/10, (MBIA)......... 1,306,881
3,780,000 (effective yield 6.25%) (b)
0.00%, 9/1/11, (MBIA)......... 1,753,202
107,510,752
COLORADO-- 6.0%
4,000,000 Araphoe County, Colorado,
Single Family Mortgage
Revenue, Capital
Appreciation, Series A
(effective yield 6.00%) (b)
0.00%, 9/1/10............... 1,963,560
City and County of Denver,
Colorado, Airport System:
Series A:
6,625,000 7.50%, 11/15/23............... 7,507,251
525,000 8.00%, 11/15/25............... 584,740
7,750,000 8.50%, 11/15/23............... 8,729,445
23,830,000 8.75%, 11/15/23............... 27,895,160
3,500,000 Series B
7.25%, 11/15/12............... 3,823,785
Series D:
7,100,000 7.75%, 11/15/13............... 8,729,734
12,250,000 7.75%, 11/15/21............... 13,671,245
1,880,000 Colorado Health Facilities
Authority, Sisters Charity
Health Care, Series A
6.25%, 5/15/09, (MBIA)...... 2,080,596
El Paso County, Colorado,
School District #11,
Colorado Springs:
2,310,000 6.50%, 12/1/12................ 2,612,125
2,000,000 7.10%, 12/1/13................ 2,391,180
1,000,000 7.10%, 12/1/16................ 1,202,940
<PAGE>
PAGE 8
KEYSTONE TAX FREE FUND
SCHEDULE OF INVESTMENTS-- JUNE 30, 1997 (UNAUDITED)
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
COLORADO-- CONTINUED
$ 2,250,000 Larimer County, Colorado,
School District
7.00%, 12/15/16, (MBIA)..... $ 2,748,397
83,940,158
CONNECTICUT-- 0.2%
1,375,000 Connecticut State Resources
Recovery Authority,
Bridgeport Project, Series B
8.50%, 1/1/00............... 1,419,082
1,600,000 Connecticut State Special Tax
Obligation, Series B
6.50%, 10/1/12.............. 1,798,688
3,217,770
DELAWARE-- 0.1%
1,600,000 Delaware State Health
Facilities Authority,
Medical Center of Delaware
7.00%, 10/1/15, (MBIA)...... 1,700,544
110,000 Delaware State Housing
Authority Revenue,
Residential Mortgage, Series
A
9.38%, 6/1/12............... 110,372
1,810,916
FLORIDA-- 6.5%
9,400,000 Broward County, Florida,
Resource Recovery, South
Project
7.95%, 12/1/08.............. 10,231,712
7,440,000 Dade County, Florida, School
District
5.00%, 2/15/15, (MBIA)...... 7,078,416
Dade County, Florida, Water
and Sewer Systems Revenue:
5,000,000 5.25%, 10/1/21, (FGIC)........ 4,794,700
10,000,000 5.25%, 10/1/26, (FGIC)........ 9,527,300
2,500,000 Escambia County, Florida,
Pollution Control Revenue,
Champion International
Corporation Project
6.40%, 9/1/30............... 2,564,825
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
FLORIDA-- CONTINUED
$ 580,000 Florida Housing Finance
Agency, GNMA Collateralized
Home Mortgage
8.00%, 12/1/20.............. $ 608,437
12,000,000 Florida State, Bond Finance
Department, Environmental
Preservation, Series A
5.00%, 7/1/10, (AMBAC)...... 11,726,880
3,580,000 Florida State, Jacksonville
Transportation Authority
9.20%, 1/1/15............... 4,947,918
Gainesville, Florida,
Utilities System Revenue:
7,250,000 Series A
5.20%, 10/1/22................ 6,869,592
435,000 Series B
7.50%, 10/1/08................ 527,503
495,000 Hillsborough County, Florida,
Housing Finance Agency,
Single Family Mortgage
Revenue
7.30%, 4/1/22............... 513,142
1,860,000 Indian River County, Florida,
Water and Sewer Revenue
5.25%, 9/1/20, (FGIC)....... 1,801,782
1,800,000 Jacksonville, Florida, Health
Facilities Authority, New
Children's Hospital
7.00%, 6/1/21, (MBIA)....... 1,959,372
300,000 Lee County, Florida, Solid
Waste System, Series B
7.00%, 10/1/11.............. 330,180
North Broward, Florida,
Hospital District Revenue,
Refunding & Improvement:
4,525,000 5.25%, 1/15/17................ 4,337,756
2,250,000 5.38%, 1/15/24................ 2,165,580
Orlando-Orange County,
Florida, Expressway
Authority:
3,000,000 8.25%, 7/1/14................. 3,979,620
2,960,000 8.25%, 7/1/15, (FGIC)......... 3,940,263
<PAGE>
PAGE 9
SCHEDULE OF INVESTMENTS-- JUNE 30, 1997 (UNAUDITED)
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
FLORIDA-- CONTINUED
$ 2,985,000 Palm Beach County, Florida,
Health Revenue, John F.
Kennedy Hospital
9.50%, 8/1/13................. $ 3,873,127
3,250,000 St. Petersburg, Florida,
Health Facilities Authority
7.00%, 12/1/15, (MBIA)...... 3,578,315
500,000 Tampa, Florida, Allegheny
Health Systems Revenue
6.50%, 12/1/23.............. 549,310
3,145,000 Tampa, Florida, Guaranteed
Entitlement, Series A
8.38%, 10/1/08.............. 3,305,772
1,825,000 Tampa, Florida, Subordinate
Guaranteed Entitlement,
Series B (Pre-refunded)
8.50%, 10/1/18.............. 1,921,032
500,000 Tarpon Springs, Florida,
Health Facilities Authority,
Hospital Revenue, Tarpon
Springs Hospital
8.75%, 5/1/12............... 522,925
91,655,459
GEORGIA-- 3.5%
3,000,000 Forsyth County, Georgia,
School District
6.75%, 7/1/16............... 3,450,240
9,800,000 Georgia Municipal Electric
Authority Power Revenue,
Series B
6.38%, 1/1/16............... 10,703,168
Georgia State, General
Obligation:
10,000,000 Series B
6.80%, 3/1/11................. 11,676,900
10,700,000 Series C
5.25%, 4/1/11................. 10,874,731
Series D:
1,500,000 6.70%, 8/1/10................. 1,737,540
3,425,000 6.25%, 9/1/08................. 3,823,704
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
GEORGIA-- CONTINUED
$ 4,255,000 Metropolitan Atlanta Rapid
Transit Authority, Georgia,
Sales Tax Revenue, Series P
6.25%, 7/1/11, (AMBAC)...... $ 4,672,118
2,370,000 Private Colleges and
University Facilities
Authority Revenue, Georgia,
Mercer University Project
6.40%, 11/1/11, (MBIA)...... 2,641,412
49,579,813
HAWAII-- 0.6%
8,000,000 Hawaii State Department of
Budget and Finance, Special
Purpose Revenue, Hawaii
Electric Company
7.38%, 12/1/20, (MBIA)...... 8,713,200
IDAHO-- 0.1%
1,055,000 Idaho Housing Finance
Authority, Single Family
Mortgage Bonds, Series D-1
8.00%, 1/1/20............... 1,139,495
ILLINOIS-- 3.0%
15,860,000 Chicago, Illinois, Gas Supply
Revenue, People's Gas Light
and Coke Company, Series A
8.10%, 5/1/20............... 17,402,385
4,000,000 Illinois Development Finance
Authority, Pollution Control
Revenue Refunding,
Commonwealth Edison Company
Project, Series D,
6.75%, 3/1/15............... 4,380,280
9,000,000 Illinois State, Sales Tax,
Series P
6.50%, 6/15/22.............. 10,135,800
2,965,000 Kankakee, Illinois, Sewer
Revenue
6.88%, 5/1/11, (FGIC)....... 3,251,893
<PAGE>
PAGE 10
KEYSTONE TAX FREE FUND
SCHEDULE OF INVESTMENTS-- JUNE 30, 1997 (UNAUDITED)
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
ILLINOIS-- CONTINUED
$ 3,000,000 Metropolitan Fair and
Exposition Authority,
Illinois, Series A
5.00%, 6/1/15............... $ 2,724,660
4,950,000 Quincy, Illinois, Blessing
Hospital Revenue
6.00%, 11/15/18............. 4,878,869
42,773,887
KANSAS-- 0.2%
2,000,000 Burlington, Kansas, Pollution
Control, Kansas Gas and
Electric Company
7.00%, 6/1/31, (MBIA)....... 2,190,560
KENTUCKY-- 1.6%
8,000,000 Carroll County, Kentucky,
Kentucky Utility Company,
Series A
7.45%, 9/15/16.............. 9,020,320
6,000,000 Jefferson County, Kentucky,
Hospital Revenue, Linked
ACES/Inverse Floaters (c)
6.44%, 10/23/14, (MBIA)..... 6,301,200
4,360,000 Kentucky Housing Corporation,
Housing Revenue Bond,
Series C
7.90%, 1/1/21............... 4,590,775
2,725,000 Trimble County, Kentucky,
Pollution Control,
Louisville Gas and Electric
Company
7.63%, 11/1/20.............. 2,990,388
22,902,683
LOUISIANA-- 1.7%
1,750,000 Louisiana Public Facilities
Authority, Hospital Revenue,
Woman's Hospital Foundation
Project
7.25%, 10/1/22.............. 1,986,040
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
LOUISIANA-- CONTINUED
New Orleans, Louisiana,
Capital Appreciation:
$ 6,960,000 (effective yield 6.05%) (b)
0.00%, 9/1/14, (AMBAC)........ $ 2,688,857
2,800,000 (effective yield 7.10%) (b)
0.00%, 9/1/15, (AMBAC)........ 1,014,384
3,755,000 (effective yield 7.15%) (b)
0.00%, 9/1/17, (AMBAC)........ 1,204,491
5,000,000 Orleans Parish, Louisiana,
Parishwide School District
5.38%, 9/1/21, (AMBAC)...... 4,845,300
5,175,000 Orleans Parish, Louisiana,
School Board
9.05%, 2/1/10, (ETM)........ 6,870,796
3,000,000 Orleans Parish, Louisiana,
School Board, Refunding
Bonds, Series B
5.20%, 2/1/14............... 2,914,920
2,000,000 Ouachita Parish, Louisiana,
Louisiana Hospital Service
Revenue, Glenwood Regional
Medical Center
7.50%, 7/1/21............... 2,245,920
23,770,708
MAINE-- 0.7%
Maine State Housing Authority,
Mortgage Purchase:
2,580,000 Series A3
7.80%, 11/15/15............... 2,637,663
4,000,000 Series C2
6.05%, 11/15/28............... 4,019,960
2,500,000 Regional Waste System, Maine,
Solid Waste Resources
Recovery Revenue
8.15%, 7/1/11............... 2,676,800
9,334,423
MARYLAND-- 0.0%
115,000 Maryland State Community
Development Administration,
Multi-Family Housing
8.75%, 5/15/12.............. 115,714
<PAGE>
PAGE 11
SCHEDULE OF INVESTMENTS-- JUNE 30, 1997 (UNAUDITED)
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
MASSACHUSETTS-- 9.2%
$ 225,000 Lawrence, Massachusetts,
General Obligation
6.25%, 2/15/09, (AMBAC)..... $ 243,893
Massachusetts Bay
Transportation Authority:
Series A:
7,550,000 6.25%, 3/1/12................. 8,321,610
6,110,000 7.00%, 3/1/11................. 7,180,961
2,125,000 Series B
6.20%, 3/1/16................. 2,339,030
Massachusetts Bay
Transportation Authority,
General Transportation
Systems, Series A:
8,000,000 5.00%, 3/1/23, (FGIC)......... 7,360,400
7,615,000 5.13%, 3/1/17, (FGIC)......... 7,281,996
5,000,000 7.00%, 3/1/07................. 5,785,400
4,550,000 Massachusetts Bay
Transportation Authority,
General Transportation
Systems, Refunding, Series A
7.00%, 3/1/08............... 5,301,159
13,750,000 Massachusetts Industrial
Finance Agency, Harvard
Community Health Plan,
Incorporated, Series B
8.13%, 10/1/17.............. 14,603,600
8,000,000 Massachusetts Industrial
Finance Agency, Solid Waste
Disposal Revenue, Senior
Lien, Massachusetts
Recycling Association,
Series A
9.00%, 8/1/16............... 3,200,000
26,000,000 Massachusetts Municipal
Wholesale Electric Company
Power Supply Systems
Revenue, Linked PARS and
INFLOS (c)
5.45%, 7/1/18............... 24,895,260
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
MASSACHUSETTS-- CONTINUED
Massachusetts State Health and
Educational Facilities
Authority:
$ 1,700,000 Brigham & Women's Hospital
6.75%, 7/1/24, (MBIA)......... $ 1,833,127
2,000,000 Capital Asset Program
7.30%, 10/1/18, (MBIA)........ 2,188,620
5,000,000 Massachusetts General
Hospital, Series F
6.25%, 7/1/12, (AMBAC)........ 5,546,800
600,000 McLean Hospital Issue,
Series C
6.50%, 7/1/10................. 651,582
400,000 Milton Hospital, Series B
7.25%, 7/1/05................. 435,964
New England Deaconess
Hospital:
1,000,000 6.88%, 4/1/22................. 1,069,960
2,980,000 6.88%, 4/1/22, (AMBAC)........ 3,252,551
Massachusetts State Water
Resources Authority:
1,500,000 Series A
7.13%, 4/1/00................. 1,598,040
5,000,000 Series B
5.00%, 12/1/16, (MBIA)........ 4,697,500
Massachusetts State, General
Obligation:
Consolidated Loan, Series C
8,000,000 6.60%, 11/1/08, (FGIC)........ 8,889,920
Series B
5,000,000 5.25%, 6/1/16, (FGIC)......... 4,859,050
Series C
7,600,000 6.00%, 8/1/09, (FGIC)......... 8,258,540
85,000 Massachusetts State, Water
Pollution Abatement Trust,
Pooled Loan Program,
Series 2
6.13%, 2/1/08............... 93,479
129,888,442
<PAGE>
PAGE 12
KEYSTONE TAX FREE FUND
SCHEDULE OF INVESTMENTS-- JUNE 30, 1997 (UNAUDITED)
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
MICHIGAN-- 2.8%
$ 3,000,000 Detroit, Michigan, Sewage
Disposal Revenue, Series A
5.00%, 7/1/22, (MBIA)....... $ 2,770,800
2,450,000 Michigan State University
Revenues, Series A
5.13%, 2/15/16, (AMBAC)..... 2,326,863
9,500,000 Monroe County, Michigan,
Economic Development
Corporation, Detroit Edison
Company
6.95%, 9/1/22, (FGIC)....... 11,381,570
51,525,000 Okemos, Michigan, Public
School District, Series I
(effective yield 7.35%) (b)
0.00%, 5/1/21............... 11,499,349
35,490,000 West Ottawa, Michigan, Public
School District, Capital
Appreciation (effective
yield 7.55%) (b)
0.00%, 5/1/15............... 11,872,115
39,850,697
MINNESOTA-- 1.0%
1,220,000 Dakota County, Minnesota,
Single Family Mortgage
8.10%, 9/1/12............... 1,272,643
1,330,000 Minnesota State Housing
Finance Agency, Single
Family Mortgage, Series D
8.00%, 1/1/23............... 1,382,176
11,925,000 University of Minnesota,
University Revenue, Series A
5.50%, 7/1/21............... 11,973,415
14,628,234
MISSISSIPPI-- 0.1%
1,000,000 Harrison County, Mississippi,
Wastewater Treatment
Management
8.50%, 2/1/13............... 1,346,750
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
MISSOURI-- 0.6%
$ 4,725,000 Missouri State Health and
Educational Facilities
Authority, Barnes Jewish
Hospital
5.15%, 5/15/10, (MBIA)...... $ 4,701,186
945,000 Missouri State Housing
Development Commission,
Mortgage Revenue, Single
Family, Series B
6.45%, 9/1/27............... 977,546
2,500,000 Sikeston, Missouri, Electric
Revenue
5.00%, 6/1/22, (MBIA)....... 2,309,175
7,987,907
NEVADA-- 0.7%
3,000,000 Clark County, Nevada, School
District, Series A
6.75%, 3/1/07, (MBIA)....... 3,226,560
6,000,000 Clark County, Nevada, Series A
7.50%, 6/1/09, (AMBAC)...... 7,253,760
10,480,320
NEW HAMPSHIRE-- 0.3%
New Hampshire Higher Education
& Health Facilities
Authority, Frisbie Memorial
Hospital, Revenue Bonds:
3,155,000 6.13%, 10/1/13................ 3,171,974
1,000,000 Gloucester County Project,
Series A
8.13%, 7/1/10................. 1,014,080
4,186,054
NEW JERSEY-- 0.8%
8,750,000 New Jersey Economic
Development Authority, Water
Facilities Revenue, New
Jersey American Water
Company Incorporated Project
6.50%, 4/1/22, (FGIC)....... 9,275,875
<PAGE>
PAGE 13
SCHEDULE OF INVESTMENTS-- JUNE 30, 1997 (UNAUDITED)
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
NEW JERSEY-- CONTINUED
New Jersey Health Care
Facilities Financing
Authority:
$ 1,000,000 Jersey Shore Medical Center
6.13%, 7/1/12, (AMBAC)........ $ 1,044,790
1,200,000 St. Elizabeth's Hospital,
Series B
7.75%, 7/1/98................. 1,234,908
11,555,573
NEW MEXICO-- 0.2%
1,500,000 Albuquerque, New Mexico,
Hospital System Revenue,
Series A
6.38%, 8/1/07, (MBIA)....... 1,616,385
1,000,000 Albuquerque, New Mexico, Joint
Water and Sewer System
Revenue, Series A (effective
yield 6.90%) (b)
0.00%, 7/1/08, (FGIC)....... 565,010
1,230,000 New Mexico Educational
Assistance Foundation,
Series B
6.30%, 12/1/04.............. 1,328,781
3,510,176
NEW YORK-- 15.4%
4,500,000 Metropolitan Transportation
Authority, New York,
Dedicated Tax Fund, Series A
5.50%, 4/1/15, (MBIA)....... 4,493,925
3,050,000 Metropolitan Transportation
Authority, New York,
Transportation Facilities
Revenue, Series M
5.50%, 7/1/08, (FGIC)....... 3,192,374
7,980,000 New York City, New York,
General Obligation,
Prerefunded, Series A
7.75%, 8/15/15.............. 9,072,781
400,000 New York City, New York,
General Obligation,
Refunding, Series A
5.75%, 8/1/10, (FGIC)....... 409,512
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
NEW YORK-- CONTINUED
New York City, New York,
General Obligation,
Unrefunded Balance,
Series A :
$ 615,000 7.75%, 8/15/08................ $ 683,443
335,000 7.75%, 8/15/14................ 372,282
270,000 7.75%, 8/15/15................ 299,517
New York City, New York,
Municipal Water Finance
Authority, Water and Sewer
Systems Revenue:
Series A:
10,000,000 5.50%, 6/15/24................ 9,660,000
4,565,000 7.00%, 6/15/15, (FGIC)........ 4,960,146
Series B:
8,000,000 5.50%, 6/15/27, (MBIA)........ 7,783,520
5,000,000 5.75%, 6/15/26................ 4,986,550
New York State Dormitory
Authority Revenue, City
University Educational
Facilities:
1,000,000 5.38%, 7/1/14, (FGIC)......... 991,590
3,780,000 7.00%, 7/1/09, (FGIC)......... 4,421,164
4,535,000 New York State Dormitory
Authority Revenue, Mental
Health Facility
5.13%, 2/15/21, (MBIA)...... 4,254,374
New York State Dormitory
Authority Revenue, State
University Educational
Facilities:
3,000,000 5.25%, 5/15/15, (AMBAC)....... 2,941,500
4,000,000 5.50%, 5/15/13, (FSA)......... 4,062,600
7,000,000 Series A
5.25%, 5/15/15, (FSA)......... 6,887,090
9,500,000 Series B
5.25%, 5/15/13, (FSA)......... 9,446,990
Series C:
1,100,000 7.38%, 5/15/10................ 1,289,167
10,500,000 7.50%, 5/15/11................ 12,436,830
<PAGE>
PAGE 14
KEYSTONE TAX FREE FUND
SCHEDULE OF INVESTMENTS-- JUNE 30, 1997 (UNAUDITED)
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
NEW YORK-- CONTINUED
$ 7,400,000 New York State Energy Research
and Development Authority,
Consolidated Edison Project
7.75%, 1/1/24............... $ 7,628,512
5,000,000 New York State Environmental
Facilities Corporation,
State Water Pollution
Control (New York City Water
Finance Authority), Series E
6.88%, 6/15/10.............. 5,446,350
2,000,000 New York State Local
Government Assistance
Corporation, Series C
5.50%, 4/1/17............... 2,011,720
New York State Medical Care
Facilities, Finance Agency
Revenue:
2,900,000 6.38%, 8/15/14, (FGIC)........ 3,110,569
2,255,000 6.38%, 11/15/19, (AMBAC)...... 2,397,133
1,250,000 Health Center Projects,
Series A
6.38%, 11/15/19............... 1,320,712
3,500,000 New York Hospital, FHA Insured
Mortgage, Series A
6.80%, 8/15/24, (AMBAC)....... 3,891,195
2,000,000 New York Hospital, Series A
6.75%, 8/15/14................ 2,217,320
4,000,000 New York State Mortgage
Agency, Homeowner Mortgage,
Series 27
6.90%, 4/1/15............... 4,317,000
1,565,000 New York State Mortgage
Agency, Series A
6.88%, 4/1/17............... 1,582,857
1,125,000 New York State Power
Authority, General Purpose
Revenue
7.00%, 1/1/18............... 1,305,698
New York State Thruway
Authority, Highway and
Bridge Trust Fund, Series A:
1,500,000 5.25%, 4/1/16, (AMBAC)........ 1,459,590
3,300,000 5.25%, 4/1/17, (AMBAC)........ 3,208,557
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
NEW YORK-- CONTINUED
$10,000,000 New York State Thruway
Authority, General Revenue,
Series D
5.25%, 1/1/21............... $ 9,621,600
New York State Urban
Development Corporation
Revenue, Correctional
Facilities:
15,920,000 Refunding, Series A
6.50%, 1/1/10................. 17,370,312
4,000,000 Series 7
5.70%, 1/1/16................. 3,972,360
Series A:
575,000 6.50%, 1/1/09................. 628,952
9,000,000 7.50%, 4/1/11................. 10,102,230
10,550,000 New York State, General
Obligation
5.25%, 3/1/17............... 10,111,331
500,000 Niagara Falls, New York,
Public Improvement
7.50%, 3/1/14, (MBIA)....... 618,780
3,000,000 Port Authority, New York and
New Jersey, Consolidated
104th Series
4.75%, 1/15/26, (AMBAC)..... 2,642,730
Triborough Bridge and Tunnel
Authority Revenue, New York,
General Purpose Bonds:
14,120,000 Series B
5.30%, 1/1/17................. 13,750,621
6,000,000 Series Q
5.00%, 1/1/17, (MBIA)......... 5,629,560
10,000,000 Series Y
5.50%, 1/1/17................. 10,095,000
217,086,044
OHIO-- 1.4%
2,000,000 Adams County, Ohio Valley
Local School District
7.00%, 12/1/15.............. 2,388,720
Cleveland, Ohio, Public Power
Systems, First Mortgage,
Series A:
7,000,000 7.00%, 11/15/16, (MBIA)....... 8,044,960
1,000,000 7.00%, 11/15/24, (MBIA)....... 1,158,660
<PAGE>
PAGE 15
SCHEDULE OF INVESTMENTS-- JUNE 30, 1997 (UNAUDITED)>
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
OHIO-- CONTINUED
$ 1,285,000 Columbus, Ohio, General
Obligation
12.38%, 2/15/06............. $ 1,936,623
1,500,000 Montgomery County, Ohio,
Hospital Revenue, Kettering
Medical Center
6.25%, 4/1/20, (MBIA)....... 1,642,965
1,000,000 Ohio State Higher Educational
Facility Commission
6.13%, 11/15/17, (MBIA)..... 1,047,670
3,000,000 Ohio State Water Development
Authority Revenue, Safe
Water Series
6.00%, 12/1/07, (AMBAC)..... 3,272,940
19,492,538
OKLAHOMA-- 0.2%
2,250,000 Oklahoma State Industrial
Authority, Baptist Medical
Center
7.00%, 8/15/14.............. 2,463,997
PENNSYLVANIA-- 6.7%
2,500,000 Allegheny County,
Pennsylvania, Sewer Revenue
Refunding (effective yield
6.10%) (b)
0.00%, 6/1/15, (FGIC)....... 907,275
80,000 Beaver County, Pennsylvania,
Industrial Development
Authority, Ohio Edison
Project, Series A
7.75%, 9/1/24............... 84,547
4,390,000 Beaver County, Pennsylvania,
Ohio Edison
7.00%, 6/1/21, (FGIC)....... 4,716,923
500,000 Delaware County, Pennsylvania,
Industrial Development
Authority Pollution Control
Revenue
7.38%, 4/1/21............... 540,675
2,000,000 Lebanon County, Pennsylvania,
Good Samaritan Hospital
Authority, Project Revenue
6.00%, 11/15/18............. 1,998,680
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
PENNSYLVANIA-- CONTINUED
$ 900,000 Montgomery County,
Pennsylvania, Industrial
Development and Pollution
Control, Philadelphia
Electric Company
7.60%, 4/1/21............... $ 963,522
2,500,000 North Penn, Pennsylvania,
Water Authority
6.88%, 11/1/19, (FGIC)...... 2,849,675
7,500,000 Northumberland County,
Pennsylvania, Commonwealth
Lease Revenue, Capital
Appreciation (effective
yield 7.10%) (b)
0.00%, 10/15/10, (MBIA)..... 3,700,425
8,000,000 Pennsylvania Housing Finance
Agency, Multi-Family
Mortgage, Section 8
8.20%, 7/1/24............... 8,579,680
5,545,000 Pennsylvania Housing Finance
Agency, Residential
Development, Section 8,
Series A
7.60%, 7/1/13............... 5,940,691
Pennsylvania Housing Finance
Agency, Single Family
Mortgage:
3,000,000 Series P
8.00%, 4/1/16................. 3,089,310
4,000,000 Series T
7.75%, 10/1/09................ 4,179,200
3,950,000 Series V
7.80%, 4/1/16................. 4,084,695
1,260,000 Pennsylvania Intergovernmental
Cooperative Authority,
Philadelphia Funding
6.75%, 6/15/21, (FGIC)...... 1,424,304
4,000,000 Pennsylvania State Higher
Educational Facilities
Authority, Allegheny General
Hospital, Series A
7.13%, 9/1/07............... 4,345,560
3,750,000 Pennsylvania State Higher
Educational Facilities
Authority, State System
Higher Education, Series O
5.13%, 6/15/24, (AMBAC)..... 3,503,813
<PAGE>
PAGE 16
KEYSTONE TAX FREE FUND
SCHEDULE OF INVESTMENTS-- JUNE 30, 1997 (UNAUDITED)
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
PENNSYLVANIA-- CONTINUED
Philadelphia, Pennsylvania,
Hospital and Higher
Education Facilities:
Albert Einstein Medical Center
$ 3,000,000 7.00%, 10/1/21................ $ 3,184,830
2,350,000 7.63%, 4/1/11................. 2,488,979
280,000 Community College, Series B
6.50%, 5/1/07................. 311,693
2,500,000 Temple University Hospital
5.50%, 11/15/15............... 2,402,125
3,350,000 Philadelphia, Pennsylvania,
School District, Series B
5.25%, 4/1/17............... 3,232,750
15,500,000 Philadelphia, Pennsylvania,
Water and Wastewater Revenue
5.00%, 6/15/16, (FSA)....... 14,368,345
3,175,000 Pittsburgh, Pennsylvania,
Urban Redevelopment
Authority, Multi-Family
Housing Mortgage, 1985
Series A
9.25%, 12/1/27.............. 3,316,923
6,350,000 Sayre, Pennsylvania, Health
Care Facilities Authority,
Guthrie Healthcare, Series A
7.10%, 3/1/17............... 6,896,481
3,000,000 South Fork Municipal
Authority, Pennsylvania,
Hospital Revenue, Good
Samaritan Medical Center,
Series B
5.25%, 7/1/26............... 2,826,060
2,500,000 Southeastern Pennsylvania
Transportation Authority,
Special Revenue
5.38%, 3/1/22, (FGIC)....... 2,428,450
5,000,000 Westmoreland County,
Pennsylvania, Municipal
Authority, Capital
Appreciation, Series C
(effective yield 5.69%) (b)
0.00%, 8/15/15.............. 1,832,050
94,197,661
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
RHODE ISLAND-- 0.4%
$ 5,710,000 Rhode Island State Health and
Educational Building
Corporation, Hospital
Financing Revenue, Roger
Williams General Hospital
9.50%, 7/1/16............... $ 5,848,296
SOUTH CAROLINA-- 1.2%
5,000,000 Piedmont Municipal Power
Agency, South Carolina
Electric Revenue
5.38%, 1/1/25, (MBIA)....... 4,877,950
1,610,000 South Carolina State Housing
Finance and Development
Authority, Homeownership
Mortgage Purchase, Series B
7.90%, 7/1/32, (FHA)........ 1,686,716
9,000,000 South Carolina State Port
Authority, Port Revenue
6.75%, 7/1/21, (AMBAC)...... 9,660,780
16,225,446
TENNESSEE-- 2.4%
5,465,000 Bristol, Tennessee, Health and
Education Authority, Bristol
Memorial Hospital
6.75%, 9/1/10, (FGIC)....... 6,235,237
Knox County, Tennessee, Health
and Educational Facilities,
Fort Sanders Hospital
Alliance:
8,000,000 Series B
7.25%, 1/1/10................. 9,466,880
3,500,000 Series C
5.25%, 1/1/15................. 3,417,295
9,000,000 Metro Government, Nashville
and Davidson Counties,
Tennessee, Step Bond
(effective yield 4.92%) (b)
0.00%, 1/1/12, (FGIC)....... 10,009,170
5,055,000 Tennessee Housing Development
Authority, Home Ownership
Program, Issue H
7.83%, 7/1/15............... 5,184,004
34,312,586
<PAGE>
PAGE 17
SCHEDULE OF INVESTMENTS-- JUNE 30, 1997 (UNAUDITED)
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
TEXAS-- 9.2%
$ 25,000 Bexar, Texas, Metropolitan
Water District Waterworks
Systems, Unrefunded Balance
6.63%, 5/1/14, (AMBAC)...... $ 26,849
8,500,000 Brazos River Authority, Texas
Revenue Refunding, Houston
Light and Power Company,
Project C
8.10%, 5/1/19............... 8,923,895
2,400,000 Brownsville, Texas, Utility
System Revenue
6.25%, 9/1/14, (MBIA)....... 2,645,928
6,675,000 Cypress-Fairbanks, Texas,
Independent School District,
Capital Appreciation, Series
A (effective yield 6.03%)
(b)
0.00%, 2/15/13.............. 2,821,990
Fort Bend County, Texas, Levee
Improvement:
1,165,000 6.90%, 9/1/20, (MBIA)......... 1,280,591
District # 11:
1,245,000 6.90%, 9/1/18, (MBIA)......... 1,364,632
1,000,000 6.90%, 9/1/19, (MBIA)......... 1,096,090
7,000,000 Harris County, Texas, Flood
Control District (effective
yield 7.20%) (b)
0.00%, 10/1/06.............. 3,902,080
Harris County, Texas, Health
Facilities Development
Corporation:
5,000,000 6.60%, 6/1/14................. 5,592,650
2,480,000 Hermann Hospital Project
6.38%, 10/1/17, (MBIA)........ 2,629,222
Memorial Hospital Project:
2,525,000 7.13%, 6/1/15................. 2,819,365
3,215,000 Series A
6.00%, 6/1/09................. 3,469,724
4,000,000 Harris County, Texas, Senior
Lien, Toll Road, Series A
6.38%, 8/15/24, (MBIA)...... 4,326,800
3,000,000 Harris County, Texas, Toll
Road
7.00%, 8/15/10.............. 3,529,980
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
TEXAS-- CONTINUED
$ 4,565,000 Houston, Texas, Airport System
Revenue, Senior Lien
8.20%, 7/1/17............... $ 4,819,134
15,000,000 Houston, Texas, General
Obligation
7.00%, 3/1/08............... 17,544,300
Houston, Texas, Water and
Sewer System Revenue, Junior
Lien:
2,700,000 Refunding, Series C
(effective yield 6.85%) (b)
0.00%, 12/1/10................ 1,311,093
2,000,000 Series C
5.25%, 12/1/22, (FGIC)........ 1,921,440
3,175,000 Port Arthur, Texas, General
Obligation
5.00%, 2/15/21, (MBIA)...... 2,962,339
1,085,000 Rio Grande Valley, Texas,
Health Facilities
Corporation, Hospital
Revenue, Baptist Medical
Project
8.00%, 8/1/17............... 1,143,948
11,250,000 San Antonio, Texas, Electric
and Gas Revenue
5.00%, 2/1/12............... 10,962,562
5,000,000 Tarrant County, Texas, Health
Facilities Development
Revenue, Harris Methodist
Health System, Series A
5.13%, 9/1/18, (AMBAC)...... 4,659,950
6,415,000 Tarrant County, Texas, Housing
Finance Corporation, Series
A (effective yield 11.00%)
(b)
0.00%, 9/15/16, (MBIA)...... 2,148,127
Texas Housing Agency:
3,940,000 Residential Development,
Series D
8.40%, 1/1/21................. 4,102,210
2,310,000 Single Family Mortgage
8.20%, 3/1/16................. 2,365,971
Texas Municipal Power Agency:
175,000 Refunding Bonds
5.25%, 9/1/12, (MBIA)......... 172,786
130,000 Revenue Bonds
6.10%, 9/1/09................. 141,254
<PAGE>
PAGE 18
KEYSTONE TAX FREE FUND
SCHEDULE OF INVESTMENTS-- JUNE 30, 1997 (UNAUDITED)
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
TEXAS-- CONTINUED
$10,800,000 Texas State Turnpike
Authority, Dallas North
Thruway Revenue, President
George Bush Turnpike
5.00%, 1/1/16............... $ 10,285,056
5,000,000 Texas State, Linked
RIBs/SAVRs (c)
6.20%, 9/30/11.............. 5,472,100
9,000,000 Titus County, Texas, Water
District #1, Southwest
Electric Power
8.20%, 8/1/11............... 10,228,860
1,475,000 University of Texas,
University Revenues,
Unrefunded Balance, Series B
6.75%, 8/15/13.............. 1,599,564
3,450,000 Waller, Texas, General
Obligation, Independent
School District
5.25%, 2/15/21.............. 3,310,137
129,580,627
UTAH-- 1.7%
Intermountain Power Agency,
Utah, Power Supply:
6,500,000 Series C (effective yield
6.80%) (b)
0.00%, 7/1/20................. 1,059,695
3,020,000 Series D
8.38%, 7/1/12................. 3,080,400
9,145,000 Murray City, Utah, Hospital
Revenue, Health Services
Incorporated
4.75%, 5/15/20, (MBIA)...... 7,988,066
270,000 Utah State Housing Finance
Agency, Single Family
Mortgage, Series C2
7.95%, 7/1/10............... 285,485
11,350,000 Utah State, General Obligation
5.50%, 7/1/07............... 11,914,549
24,328,195
VERMONT-- 0.1%
1,485,000 Vermont Housing Finance
Agency, Single Family,
Series 1
8.15%, 5/1/25............... 1,530,931
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
VIRGINIA-- 1.0%
$ 9,355,000 Fairfax County, Virginia,
Industrial Development
Authority
5.00%, 8/15/23.............. $ 8,649,633
Winchester, Virginia,
Industrial Development
Hospital Revenue, Winchester
Medical Center:
2,300,000 6.15%, 1/1/15, (AMBAC)........ 2,200,088
3,200,000 6.30%, 1/1/15, (AMBAC)........ 3,059,584
13,909,305
WASHINGTON-- 2.3%
2,595,000 Snohomish County, Washington,
Series A
5.13%, 12/1/16, (MBIA)...... 2,473,424
Tacoma, Washington, Electric
Systems Revenue:
3,000,000 5.25%, 1/1/15, (AMBAC)........ 2,896,290
12,000,000 Linked RIBs/SAVRs (c)
6.51%, 1/2/15, (AMBAC)........ 13,005,000
1,700,000 Tacoma, Washington, Solid
Waste Utilities Revenue,
Series B
5.50%, 12/1/17, (AMBAC)..... 1,677,254
4,000,000 Washington Public Power Supply
System, Nuclear Project #3
(effective yield 10.09%) (b)
0.00%, 7/1/12............... 1,719,640
10,000,000 Washington State General
Obligation, Series A
5.38%, 7/1/21............... 9,769,800
1,300,000 Washington State Health Care
Facilities Authority, Multi-
Care Medical Center of
Tacoma
7.88%, 8/15/11, (FGIC)...... 1,374,841
32,916,249
WISCONSIN-- 0.1%
785,000 Wisconsin Housing and Economic
Development Authority, Home
Ownership
8.00%, 3/1/21............... 822,068
<PAGE>
PAGE 19
SCHEDULE OF INVESTMENTS-- JUNE 30, 1997 (UNAUDITED)
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
PUERTO RICO-- 3.8%
Puerto Rico Commonwealth
Highway and Transportation
Authority Revenue:
$ 400,000 Series Y
5.25%, 7/1/15, (FSA).......... $ 394,004
5,000,000 Series Z
6.00%, 7/1/18, (FSA).......... 5,440,550
Puerto Rico Commonwealth,
General Obligation, Linked
BPO (c):
12,800,000 7.00%, 7/1/10, (MBIA)......... 15,066,240
5,000,000 7.00%, 7/1/10, (AMBAC)........ 5,885,250
3,000,000 Puerto Rico Commonwealth,
General Obligation,
Refunding
6.45%, 7/1/17............... 3,223,230
Puerto Rico Electric Power
Authority Revenue:
2,000,000 Series AA
6.25%, 7/1/10, (MBIA)......... 2,218,100
2,000,000 Series S
7.00%, 7/1/07, (MBIA)......... 2,331,440
Puerto Rico Industrial,
Tourist, Educational,
Medical, Environmental
Control Facilities:
1,400,000 Finance Authority
6.25%, 7/1/24, (MBIA)......... 1,488,942
250,000 Hospital Auxilio Mutuo
Project, Series A
5.50%, 7/1/17, (MBIA)......... 250,338
4,000,000 Puerto Rico Municipal Finance
Agency, Series A
6.00%, 7/1/11, (FSA)........ 4,339,440
Puerto Rico Public Buildings
Authority Revenue,
Government Facilities,
Series B:
5,250,000 5.00%, 7/1/16, (MBIA)......... 4,983,877
2,000,000 5.25%, 7/1/21................. 1,883,560
PRINCIPAL
AMOUNT VALUE
LONG-TERM INVESTMENTS-- CONTINUED
PUERTO RICO-- CONTINUED
$ 6,250,000 Puerto Rico Public Buildings
Authority Revenue,
Guaranteed Public Education
and Health Facilities,
Series M, Step coupon
(effective yield 5.74%) (b)
3.75%, 7/1/16............... $ 5,932,875
53,437,846
TOTAL LONG-TERM INVESTMENTS
(COST $1,323,071,464)..................... 1,381,292,401
SHORT-TERM INVESTMENTS-- 1.3%
CALIFORNIA-- 0.2%
30,000 California Health Facilities
Financing Authority Revenue,
St. Joseph's Health System,
Series A
3.70%, 7/1/13 (a)........... 30,000
2,600,000 Irvine, California,
Improvement Board Act of
1915 Updates, Assessment
District #89-10 3.75%,
9/2/15 (a).................. 2,600,000
2,630,000
FLORIDA-- 0.1%
180,000 Dade County, Florida, Health
Facilities Authority,
Hospital Revenue, Miami
Chidren's Hospital Project
4.15%, 9/1/25, (AMBAC)
(a)......................... 180,000
1,450,000 Dade County, Florida, Water
and Sewer Systems Revenue
4.15%, 10/5/22, (FGIC)
(a)......................... 1,450,003
1,630,003
MASSACHUSETTS-- 0.1%
1,800,000 Massachusetts State Health and
Educational Facilities
Authority, Capital Assets
Program, Series D
3.90%, 1/1/35, (MBIA) (a)... 1,800,000
<PAGE>
PAGE 20
KEYSTONE TAX FREE FUND
SCHEDULE OF INVESTMENTS-- JUNE 30, 1997 (UNAUDITED)
PRINCIPAL
AMOUNT VALUE
SHORT-TERM INVESTMENTS-- CONTINUED
MISSISSIPPI-- 0.2%
$ 3,300,000 Jackson County, Mississippi,
Pollution Control Revenue,
Chevron U.S.A. Incorporated
Project
4.00%, 12/1/16 (a).......... $ 3,300,000
MISSOURI-- 0.1%
895,000 Missouri State Health and
Educational Facilities
Authority, Christian Health
Services, Series B
4.05%, 11/1/19 (a).......... 895,000
NEW YORK-- 0.3%
New York City, New York,
Municipal Water Finance
Authority, Water and Sewer
Systems Revenue:
325,000 Series C
4.15%, 6/15/22, (FGIC) (a).... 325,000
3,700,000 Series G
4.05%, 6/15/24, (FGIC) (a).... 3,700,000
4,025,000
PRINCIPAL
AMOUNT VALUE
SHORT-TERM INVESTMENTS-- CONTINUED
PENNSYLVANIA-- 0.1%
$ 1,160,000 Sayre, Pennsylvania, Health
Care Facilities Authority,
Pennsylvania Capital
Financing Project, Series K
4.15%, 12/1/20,
(AMBAC) (a)................. $ 1,160,000
WYOMING-- 0.2%
3,500,000 Uinta County, Wyoming,
Pollution Control Revenue,
Chevron U. S. A.
Incorporated Project
4.00%, 4/1/10 (a)........... 3,500,000
TOTAL SHORT-TERM
INVESTMENTS--
(COST $18,940,003)..................... 18,940,003
TOTAL INVESTMENTS--
(COST $1,342,011,467) 99.2% 1,400,232,404
OTHER ASSETS AND
LIABILITIES-- NET 0.8 11,335,402
NET ASSETS 100.0% $1,411,567,806
(a) Security is a variable or floating rate instrument with periodic demand
features. The Fund is entitled to full payment of principal and accrued
interest upon surrendering the security to the issuing agent.
(b) Effective yield (calculated at date of purchase) is the annual yield at
which the bond accretes until its maturity date.
(c) At the discretion of the portfolio manager, these securities may be
separated into securities with interest or principal payments that are
linked to another rate or index and therefore would be considered
derivative securities.
LEGEND OF PORTFOLIO ABBREVIATIONS:
ACES-- Auction Rate Securities
AMBAC-- American Municipal Bond Assurance Corp.
BPO-- Bond Payment Obligation
ETM-- Escrowed to Maturity
FGIC-- Federal Guaranty Insurance Co.
FHA-- Federal Housing Authority
FSA-- Federal Security Assurance
GNMA-- Government National Mortgage Association
INFLOs-- Inverse Floating Rate Securities
MBIA-- Municipal Bond Investors Assurance Corp.
PARs-- Periodic Auction Reset Securities
RIBs-- Residual Interest Bonds
SAVRs-- Select Auction Variable Rate Securities
FUTURES CONTRACTS-- SHORT POSITIONS
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
INITIAL CONTRACT UNREALIZED
EXPIRATION NUMBER OF CONTRACTS AMOUNT APPRECIATION
September 1997 195 U.S. Treasury Bond Index $ 429,000 $ 197,320
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 21
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD)
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C> <C>
SIX MONTHS
ENDED
JUNE 30, 1997 YEAR ENDED DECEMBER 31,
(UNAUDITED) 1996 1995 1994 1993 1992
NET ASSET VALUE BEGINNING OF PERIOD $7.71 $7.86 $7.10 $8.12 $8.04 $8.07
INCOME FROM INVESTMENT OPERATIONS:
Net investment income 0.20 0.41 0.41 0.37 0.39 0.46
Net realized and unrealized gain (loss)
on investments and closed futures contracts (0.01) (0.17) 0.74 (0.96) 0.48 0.12
Total from investment operations 0.19 0.24 1.15 (0.59) 0.87 0.58
LESS DISTRIBUTIONS FROM:
Net investment income (0.20) (0.39) (0.39) (0.37) (0.39) (0.46)
In excess of net investment income 0 0 0 (0.06) (0.06) (0.04)
Net realized gain on investments 0 0 0 0 (0.33) (0.11)
In excess of net realized gain on investments 0 0 0 0 (0.01) 0
Total distributions (0.20) (0.39) (0.39) (0.43) (0.79) (0.61)
NET ASSET VALUE END OF PERIOD $7.70 $7.71 $7.86 $7.10 $8.12 $8.04
TOTAL RETURN (B) 2.52% 3.15% 16.61% (7.34%) 11.15% 7.55%
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Expenses 0.92%(c) 0.87% 0.95% 1.55% 1.66% 1.38%
Expenses excluding indirectly paid expenses 0.91%(c) 0.86% 0.94% -- -- --
Net investment income 5.19%(c) 5.34% 5.41% 4.92% 4.72% 5.71%
PORTFOLIO TURNOVER RATE 45% 69% 56% 84% 76% 78%
NET ASSETS END OF PERIOD (THOUSANDS) $ 1,411,568 $1,557,886 $1,204,468 $1,197,727 $1,548,503 $1,453,199
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31,
1991 1990(A) 1989 1988 1987
NET ASSET VALUE BEGINNING OF PERIOD $7.90 $8.06 $8.18 $8.09 $8.85
INCOME FROM INVESTMENT OPERATIONS:
Net investment income 0.46 0.52 0.57 0.55 0.56
Net realized and unrealized gain (loss)
on investments and closed futures contracts 0.36 (0.01) 0.15 0.30 (0.58)
Total from investment operations 0.82 0.51 0.72 0.85 (0.02)
LESS DISTRIBUTIONS FROM:
Net investment income (0.46) (0.52) (0.60) (0.63) (0.64)
In excess of net investment income (0.07) (0.03) 0 0 0
Net realized gain on investments (0.12) (0.12) (0.24) (0.13) (0.10)
In excess of net realized gain on investments 0 0 0 0 0
Total distributions (0.65) (0.67) (0.84) (0.76) (0.74)
NET ASSET VALUE END OF PERIOD $8.07 $7.90 $8.06 $8.18 $8.09
TOTAL RETURN (B) 10.80% 6.66% 9.11% 10.89% (0.14%)
RATIOS/SUPPLEMENTAL DATA
RATIOS TO AVERAGE NET ASSETS:
Expenses 1.75% 1.18% 1.23% 1.79% 1.70%
Expenses excluding indirectly paid expenses -- -- -- -- --
Net investment income 5.78% 6.54% 6.94% 6.74% 6.80%
PORTFOLIO TURNOVER RATE 77% 64% 69% 61% 43%
NET ASSETS END OF PERIOD (THOUSANDS) $1,146,185 $1,060,826 $ 901,912 $903,132 $894,768
</TABLE>
(a) Calculation based on average shares outstanding.
(b) Excluding applicable sales charges.
(c) Annualized.
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 22
KEYSTONE TAX FREE FUND
STATEMENT OF ASSETS AND LIABILITIES
JUNE 30, 1997 (UNAUDITED)
ASSETS
Investments at market value
(identified cost-- $1,342,011,467 $1,400,232,404
Receivable for investments sold 40,051,550
Interest receivable 24,203,183
Receivable for Fund shares sold 484,054
Receivable for daily variation margin
on open futures contracts 118,101
Other assets 166,675
Total assets 1,465,255,967
LIABILITIES
Payable for investments purchased 46,455,680
Dividends payable 3,197,905
Payable for Fund shares redeemed 1,598,482
Due to custodian 1,558,378
Distribution fee payable 314,118
Due to related parties 80,713
Accrued expenses and other liabilities 482,885
Total liabilities 53,688,161
NET ASSETS $1,411,567,806
NET ASSETS REPRESENTED BY
Paid-in capital $1,347,068,254
Undistributed net investment income 2,255,240
Accumulated net realized gain on
investments and closed futures contracts 3,826,055
Net unrealized appreciation on investments
and futures contracts 58,418,257
Total net assets $1,411,567,806
NET ASSET VALUE PER SHARE
Net asset value of
$1,411,567,8064183,328,013 outstanding
shares of beneficial interest $ 7.70
STATEMENT OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1997 (UNAUDITED)
INVESTMENT INCOME
Interest $44,403,380
EXPENSES
Investment management fee $ 3,071,270
Distribution Plan expenses 2,489,761
Transfer agent fees 694,124
Custodian fees 254,748
Administrative services fees 92,109
Other administrative services
fees 81,403
Trustees' fees and expenses 36,813
Total expenses 6,720,228
Less: Expenses paid indirectly (94,355)
Net expenses 6,625,873
Net investment income 37,777,507
NET REALIZED AND UNREALIZED LOSS
ON INVESTMENTS
Net realized gain on investments
and closed futures contracts 17,730,140
Net change in unrealized
appreciation (depreciation) on
investments and futures
contracts (20,824,784)
Net realized and unrealized loss
on investments and futures
contracts (3,094,644)
Net increase in net assets
resulting from operations $34,682,863
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 23
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
<S> <C> <C>
SIX MONTHS
ENDED
JUNE 30, 1997 YEAR ENDED
(UNAUDITED) DECEMBER 31, 1996
OPERATIONS
Net investment income $ 37,777,507 $ 84,167,379
Net realized gain on investments and closed futures contracts 17,730,140 15,476,735
Net change in unrealized appreciation (depreciation) on investments and futures
contracts (20,824,784) (48,955,108)
Net increase in net assets resulting from operations 34,682,863 50,689,006
DISTRIBUTIONS TO SHAREHOLDERS FROM NET INVESTMENT INCOME (38,479,774) (79,617,449)
CAPITAL SHARE TRANSACTIONS
Shares issued in connection with the acquisition of Keystone
Tax Exempt Trust 0 658,278,376
Proceeds from shares sold 16,555,496 107,614,922
Payment for shares redeemed (182,669,241) (424,558,360)
Net asset value of shares issued in reinvestment of dividends
and distributions 23,592,670 41,011,255
Net increase (decrease) in net assets resulting from capital share transactions (142,521,075) 382,346,193
Total increase (decrease) in net assets (146,317,986) 353,417,750
NET ASSETS
Beginning of period 1,557,885,792 1,204,468,042
End of period [including undistributed net investment income as follows:
1997-- $2,255,240 and 1996-- $2,957,507] $1,411,567,806 $ 1,557,885,792
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
<PAGE>
PAGE 24
KEYSTONE TAX FREE FUND
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES
Keystone Tax Free Fund (the "Fund") is a Massachusetts business trust for which
Keystone Investment Management Company ("Keystone"), a subsidiary of First Union
Corporation ("First Union"), is the investment adviser and manager. The Fund is
registered under the Investment Company Act of 1940, as amended (the "1940
Act"), as a diversified, open-end management investment company.
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles, which
require management to make estimates and assumptions that affect amounts
reported herein. Actual results could differ from these estimates.
A. VALUATION OF SECURITIES
An independent pricing service values the Fund's municipal bonds at fair value
using a variety of factors which may include yield, liquidity, interest rate
risk, credit quality, coupon, maturity and type of issue. Securities for which
valuations are not available from an independent pricing service, including
restricted securities, are valued at fair value as determined in good faith
according to procedures established by the Board of Trustees.
Short-term investments with remaining maturities of 60 days or less are
carried at amortized cost, which approximates market value.
B. FUTURES CONTRACTS
In order to gain exposure to or protect against changes in security values, the
Fund may buy and sell futures contracts.
The initial margin deposited with a broker when entering into a futures
transaction is subsequently adjusted by daily payments or receipts as the value
of the contract changes. Such changes are recorded as unrealized gains or
losses. Realized gains or losses are recognized on closing the contract.
Risks of entering into futures contracts include (i) the possibility of an
illiquid market for the contract, (ii) the possibility that a change in the
value of the contract may not correlate with changes in the value of the
underlying instrument or index, and (iii) the credit risk that the other party
will not fulfill their obligations under the contract. Futures contracts also
involve elements of market risk in excess of the amount reflected in the
statement of assets and liabilities.
C. DERIVATIVE SECURITIES
The Fund may invest in derivative securities. A derivative security is any
investment that derives its value from an underlying security, asset or market
index. Greater market fluctuations may result if these securities are leveraged.
The Fund invests in these types of securities as it is consistent with its
investment objectives.
D. SECURITY TRANSACTIONS AND INVESTMENT INCOME
Securities transactions are accounted for no later than one business day after
the trade date. Realized gains and losses are computed on the identified cost
basis. Interest income is recorded on the accrual basis and includes accretion
of discounts (and amortization of premiums).
E. FEDERAL INCOME TAXES
The Fund has qualified and intends to continue to qualify as a regulated
investment company under the Internal Revenue Code of 1986, as amended (the
"Code"). Thus, the Fund will not incur any federal income tax liability since it
is expected to distribute all of its net investment company taxable income, net
tax-exempt income and net capital gains, if any, to its shareholders. The Fund
also intends to avoid any excise tax liability by making the required
distributions under the Code. Accordingly, no provision for federal income taxes
is required. To the extent that realized capital gains can be offset by capital
loss carryforwards, it is the Fund's policy not to distribute such gains.
<PAGE>
PAGE 25
F. DISTRIBUTIONS
Distributions from net investment income for the Fund is declared daily and paid
monthly. Distributions from net realized capital gains, if any, are paid at
least annually. Distributions to shareholders are recorded at the close of
business on the ex-dividend date.
Income and capital gains distributions to shareholders are determined in
accordance with income tax regulations, which may differ from generally accepted
accounting principles. The significant differences between financial statement
amounts available for distributions and distributions made in accordance with
income tax regulations are primarily due to differing treatment of market
discount on securities.
2. CAPITAL SHARE TRANSACTIONS
The Fund has an unlimited number of shares of beneficial interest with no par
value authorized. Transactions in shares of the Fund were as follows:
SIX MONTHS ENDED
JUNE 30, 1997
SHARES AMOUNT
Shares sold 2,159,277 $ 16,555,496
Shares issued in
reinvestment of
distributions 3,077,289 23,592,670
Shares redeemed (23,846,155) (182,669,241)
Net decrease (18,609,589) $(142,521,075)
YEAR ENDED
DECEMBER 31, 1996
SHARES AMOUNT
Shares sold 14,063,760 $ 107,614,922
Shares issued in
connection with the
acquisition of Keystone
Tax Exempt Trust 84,656,452 658,278,376
Shares issued in
reinvestment of
distributions 5,361,695 41,011,255
Shares redeemed (55,439,349) (424,558,360)
Net increase 48,642,558 $ 382,346,193
3. SECURITIES TRANSACTIONS
Cost of purchases and proceeds from sales of investment securities (excluding
short-term securities) for the six months ended June 30, 1997 were $651,620,791
and $796,554,777, respectively.
As of December 31, 1996, the Fund had capital loss carryovers for federal
income tax purposes of approximately $13,723,000 which expires as follows:
$10,370,000 expiring in 2002 and $3,353,000 expiring in 2003.
4. DISTRIBUTION PLAN
Since December 11, 1996, Evergreen Keystone Distributor, Inc. ("EKD"), a
wholly-owned subsidiary of The BISYS Group Inc. ("BISYS"), has served as
principal underwriter to the Fund. Prior to December 11, 1996, Evergreen
Keystone Investment Services, Inc. ("EKIS"), a wholly-owned subsidiary of
Keystone, served as the Fund's principal underwriter.
The Fund has adopted a Distribution Plan as allowed by Rule 12b-1 of the 1940
Act. The Distribution Plan permits the Fund to reimburse its principal
underwriter for costs related to selling shares of the Fund and for various
other services. These costs, which consist primarily of commissions and services
fees to broker-dealers who sell shares of the Fund, are paid by shareholders
through expenses called "Distribution Plan expenses". Under the Distribution
Plan, the Fund pays a distribution fee which may not exceed 1.00% of the Fund's
average daily net assets, of which 0.75% is used to pay distribution expenses
and 0.25% may be used to pay shareholder service fees.
During the six months ended June 30, 1997, the Fund received $194,644 in
contingent deferred sales charges. Contingent deferred sales charges paid by
redeeming shareholders may be paid to EKIS and/or EKD.
The Distribution Plan may be terminated at any time by vote of the Independent
Trustees or by vote of a majority of the outstanding voting shares. However,
after the termination of the Distribution Plan, and subject to the discretion of
the Independent Trustees, payments to EKIS and/or EKD may continue as
compensation for services which had been provided while the Distribution Plan
was in effect.
<PAGE>
PAGE 26
KEYSTONE TAX FREE FUND
EKD intends, but is not obligated, to continue to pay distribution costs that
exceed the current annual payments from the Fund. EKD intends to seek full
payment of such distribution costs from the Fund at such time in the future as,
and to the extent that, payment thereof by the Fund would be within permitted
limits.
5. INVESTMENT ADVISORY AND MANAGEMENT AGREEMENT AND OTHER AFFILIATED
TRANSACTIONS
Keystone serves as the investment advisor and manager to the Fund. In return for
providing investment management and administrative services to the Fund, the
Fund pays Keystone a management fee that is calculated daily and paid monthly.
The management fee is computed at an annual rate of 2.00% of the Fund's gross
investment income plus an amount determined by applying percentage rates
starting at 0.50% and declining to 0.25% per annum as net assets increase, to
the average daily net asset value of the Fund. Effective January 1, 1997, BISYS
became sub-administrator to the Fund and is paid by Keystone for its services.
Prior to December 11, 1996, Keystone Management Inc. ("KMI"), a wholly-owned
subsidiary of Keystone, served as investment manager to the Fund and provided
investment management and administrative services. Under an investment advisory
agreement between KMI and Keystone, Keystone served as the investment adviser
and provided investment advisory and management services to the Fund. In return
for its services, Keystone received an annual fee equal to 85% of the management
fee received by KMI.
In providing or obtaining additional operating services, facilities and
supplies to the Fund, KMI had incurred administrative expenses of $935,920 which
consisted of $694,124 for transfer agent fees, $160,393 for net custodian fees,
$20,500 for audit and legal, $15,695 for printing, $35,039 for registration and
$10,169 for insurance and other miscellaneous expenses. KMI has been reimbursed
for these expenses by the Fund.
During the six months ended June 30, 1997, the Fund paid or accrued to EKIS
$92,109 for certain accounting services.
Evergreen Keystone Service Company ("EKSC"), a wholly-owned subsidiary of
Keystone, serves as the transfer and dividend disbursing agent for the Fund.
Officers of the Funds and affiliated Trustees receive no compensation directly
from the Funds. As sub-administrator, BISYS provides the officers of the Fund.
6. EXPENSE OFFSET ARRANGEMENT
The Fund has entered into an expense offset arrangement with its custodian. The
assets deposited with the custodian under this expense offset arrangement could
have been invested in income-producing assets.
7. FUND REORGANIZATION
On February 29, 1996, the Fund acquired the net assets of Keystone Tax Exempt
Trust in exchange for shares of the Fund pursuant to a plan of reorganization
approved by the shareholders of Keystone Tax Exempt Trust on February 29, 1996.
The acquisition was accomplished by a tax-free exchange of shares of the Fund
for the net assets of Keystone Tax Exempt Trust. The net assets of Keystone Tax
Exempt Trust on that date, including $40,609,975 of unrealized appreciation on
investments, were combined with the Fund. The aggregate net assets of the Fund
and Keystone Tax Exempt Trust immediately before the acquisition were
$1,142,691,716 and $658,278,376, respectively. The net assets of the Fund
immediately after the acquisition were $1,800,970,092.
<PAGE>
(This Page Left Blank Intentionally)
<PAGE>
KEYSTONE
FAMILY OF FUNDS
--
Balanced Fund (K-1)
Diversified Bond Fund (B-2)
Growth and Income Fund (S-1)
High Income Bond Fund (B-4)
International Fund Inc.
Precious Metals Holdings, Inc.
Quality Bond Fund (B-1)
Small Company Growth Fund (S-4)
Strategic Growth Fund (K-2)
Tax Free Fund
This report was prepared primarily for the information of the Fund's
shareholders. It is authorized for distribution if preceded or accompanied by
the Fund's current prospectus. The prospectus contains important information
about the Fund including fees and expenses. Read it carefully before you invest
or send money. For a free prospectus on other Evergreen Keystone funds, contact
your financial adviser or call Evergreen Keystone.
(Evergreen Keystone Funds Logo appears here)
P.O. Box 2121
Boston, Massachusetts 02106-2121
KTFF-R Rev01
KEYSTONE
TAX FREE
FUND
(Evergreen Keystone Funds(SM) Logo appears here)
SEMI-ANNUAL REPORT
JUNE 30, 1997
<PAGE>
EVERGREEN MUNICIPAL TRUST
PART C
OTHER INFORMATION
Item 15. Indemnification.
The response to this item is incorporated by reference to "Liability
and Indemnification of Trustees" under the caption "Comparative Information on
Shareholders' Rights" in Part A of this Registration Statement.
Item 16. Exhibits:
Number Description
1 Declaration of Trust (1)
2 By-Laws (1)
3 Not applicable
4 Agreements and Plans of Reorganization (included as
Exhibits A-1 and A-2 to the Prospectus contained in
Part A to this registration statement)
5 Declaration of Trust Articles II, III.(6)(c), IV.(3),
IV.(8), V, VI, VII, VIII and By-Laws Articles II, III
and VIII
6 Investment Advisory Agreement between Keystone
Investment Management Company and the Registrant (1)
7(A) Distribution Agreement between Evergreen Keystone
Distributor, Inc. and the Registrant (1)
(B) Form of Dealer Agreement for Class A, Class B and Class C shares
used by Evergreen Keystone Distributor, Inc. (1)
8 Deferred Compensation Plan (3)
9 Custody Agreement between State Street Bank and Trust
Company and Registrant (1)
10(A) Rule 12b-1 Distribution Plan (1)
(B) Multiple Class Plan (1)
11 Opinion and consent of counsel as to the legality of
the shares being issued (2)
12 Tax opinion and consent of counsel (3)
13 Not applicable
14 Consent of KPMG Peat Marwick LLP (2)
15 Not applicable
16 Powers of Attorney (2)
17(A) Forms of Proxy Card (2)
(B) Registrant's Rule 24f-2 Declaration (1)
- ----------------------
<PAGE>
(1) Incorporated by reference to Registrant's registration statement (File
Nos. 333-36033/811-08367) (the "Registration Statement") dated October
8, 1997.
(2) Filed herewith.
(3) To be filed by amendment.
Item 17. Undertakings.
(1) The undersigned Registrant agrees that prior to any public
reoffering of the securities registered through the use of a prospectus that is
a part of this Registration Statement by any person or party who is deemed to be
an underwriter within the meaning of Rule 145(c) of the Securities Act of 1933,
the reoffering prospectus will contain the information called for by the
applicable registration form for reofferings by persons who may be deemed
underwriters, in addition to the information called for by the other items of
the applicable form.
(2) The undersigned Registrant agrees that every prospectus that is
filed under paragraph (1) above will be filed as a part of an amendment to the
Registration Statement and will not be used until the amendment is effective,
and that, in determining any liability under the Securities Act of 1933, each
post-effective amendment shall be deemed to be a new Registration Statement for
the securities offered therein, and the offering of the securities at that time
shall be deemed to be the initial bona fide offering of them.
(3) The undersigned Registrant agrees to file, by post-effective
amendment, opinions of counsel or copies of an Internal Revenue Service ruling
supporting the tax consequences of the proposed Reorganizations within a
reasonable time after receipt of such opinions or rulings.
<PAGE>
SIGNATURES
As required by the Securities Act of 1933, this Registration Statement
has been signed on behalf of the Registrant, in the City of New York and State
of New York, on the 9th day of October, 1997.
EVERGREEN MUNICIPAL TRUST
By: /s/ John J. Pileggi
----------------------
Name: John J. Pileggi
Title: President
As required by the Securities Act of 1933, the following persons have
signed this Registration Statement in the capacities on the 9th day of October,
1997.
Signatures Title
- ---------- -----
/s/John J. Pileggi President and
- ------------------ Treasurer
John J. Pileggi
/s/Laurence B. Ashkin* Trustee
- ---------------------
Laurence B. Ashkin
/s/Charles A. Austin III* Trustee
- -------------------------
Charles A. Austin III
/s/K. Dun Gifford* Trustee
- -----------------
K. Dun Gifford
/s/James S. Howell* Trustee
- ------------------
James S. Howell
/s/Leroy Keith, Jr.* Trustee
- -------------------
Leroy Keith, Jr.
/s/Gerald M. McDonnell* Trustee
- ----------------------
Gerald M. McDonnell
<PAGE>
/s/Thomas L. McVerry* Trustee
- --------------------
Thomas L. McVerry
/s/William Walt Pettit* Trustee
- ---------------------
William Walt Pettit
/s/David M. Richardson* Trustee
- ----------------------
David M. Richardson
/s/Russell A. Salton III* Trustee
- -------------------------
Russell A. Salton III
/s/Michael S. Scofield* Trustee
- ----------------------
Michael S. Scofield
/s/Richard J. Shima* Trustee
- -------------------
Richard J. Shima
* By: /s/Martin J. Wolin
------------------
Martin J. Wolin
Attorney-in-Fact
Martin J. Wolin, by signing his name hereto, does hereby sign this
document on behalf of each of the above-named individuals pursuant to powers of
attorney duly executed by such persons and included as Exhibit 16 to this
Registration Statement.
<PAGE>
INDEX TO EXHIBITS
N-14
EXHIBIT NO.
11 Opinion and Consent of Sullivan & Worcester LLP
14 Consent of KPMG Peat Marwick LLP
16 Powers of Attorney
17(a) Forms of Proxy
- --------------------
SULLIVAN & WORCESTER LLP
1025 CONNECTICUT AVENUE, N.W.
WASHINGTON, D.C. 20036
TELEPHONE: 202-775-8190
FACSIMILE: 202-293-2275
767 THIRD AVENUE ONE POST OFFICE SQUARE
NEW YORK, NEW YORK 10017 BOSTON, MASSACHUSETTS 02109
TELEPHONE: 212-486-8200 TELEPHONE: 617-338-2800
FACSIMILE: 212-758-2151 FACSIMILE: 617-338-2880
October 9, 1997
Evergreen Municipal Trust
200 Berkeley Street
Boston, Massachusetts 02116
Ladies and Gentlemen:
We have been requested by the Evergreen Municipal Trust, a Delaware
business trust with transferable shares and currently consisting of two series
(the "Trust") established under an Agreement and Declaration of Trust dated
September 17, 1997, as amended (the "Declaration"), for our opinion with respect
to certain matters relating to Evergreen Tax Free Fund (the "Acquiring Fund"), a
series of the Trust. We understand that the Trust is about to file a
Registration Statement on Form N-14 for the purpose of registering shares of the
Trust under the Securities Act of 1933, as amended (the "1933 Act"), in
connection with the proposed acquisition by the Acquiring Fund of all of the
assets of Keystone Tax Free Income Fund and Keystone Tax Free Fund (the
"Acquired Funds"), each a Massachusetts business trust or a series of a
Massachusetts business trust with transferable shares, in exchange solely for
shares of the Acquiring Fund and the assumption by the Acquiring Fund of certain
identified liabilities of the Acquired Funds pursuant to Agreements and Plans of
Reorganization, forms of which are included in the Form N-1A Registration
Statement (the "Plans").
We have, as counsel, participated in various business and other
proceedings relating to the Trust. We have examined copies, either certified or
otherwise proved to be genuine to our satisfaction, of the Trust's Declaration
and By-Laws, and other documents relating to its organization, operation, and
proposed operation, including the proposed Plans and we have made such other
investigations as, in our judgment, are necessary or appropriate to enable us to
render the opinion expressed below.
<PAGE>
Evergreen Municipal Trust
October 9, 1997
Page 2
Based upon the foregoing, and assuming the approval by shareholders of
each Acquired Fund of certain matters scheduled for their consideration at a
meeting presently anticipated to be held on January 6, 1998, it is our opinion
that the shares of the Acquiring Fund currently being registered, when issued in
accordance with the Plans and the Trust's Declaration and By-Laws, will be
legally issued, fully paid and non-assessable by the Trust, subject to
compliance with the 1933 Act, the Investment Company Act of 1940, as amended and
applicable state laws regulating the offer and sale of securities.
We hereby consent to the filing of this opinion with and as a part of
the Registration Statement on Form N-14 and to the reference to our firm under
the caption "Legal Matters" in the Prospectus/Proxy Statement filed as part of
the Registration Statement. In giving such consent, we do not thereby admit that
we come within the category of persons whose consent is required under Section 7
of the 1933 Act or the rules and regulations promulgated thereunder.
Very truly yours,
/s/SULLIVAN & WORCESTER LLP
---------------------------
SULLIVAN & WORCESTER LLP
<PAGE>
CONSENT OF INDEPENDENT AUDITORS
The Trustees and Shareholders
Evergreen Municipal Trust
We consent to:
1) the use of our report dated January 31, 1997 for Keystone
Tax Free Fund incorporated by reference herein;
2) the use of our report dated June 27, 1997 for Keystone Tax Free Income
Fund incorporated by reference herein; and
3) the reference to our firm under the caption "FINANCIAL
STATEMENTS AND EXPERTS" in the prospectus/proxy
statement.
/s/KPMG Peat Marwick LLP
------------------------
KPMG Peat Marwick LLP
Boston, Massachusetts
October 9, 1997
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/Laurence B. Ashkin Director/Trustee
- ---------------------
Laurence B. Ashkin
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/Charles A. Austin, III Director/Trustee
- -------------------------
Charles A. Austin, III
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/K. Dun Gifford Director/Trustee
- -----------------
K. Dun Gifford
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/James S. Howell Director/Trustee
- ------------------
James S. Howell
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/Leroy Keith, Jr. Director/Trustee
- -------------------
Leroy Keith, Jr.
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/Gerald M. McDonnell Director/Trustee
- ----------------------
Gerald M. McDonnell
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/Thomas L. McVerry Director/Trustee
- --------------------
Thomas L. McVerry
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/William Walt Pettit Director/Trustee
- ----------------------
William Walt Pettit
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/David M. Richardson Director/Trustee
- ----------------------
David M. Richardson
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/Russell A. Salton, III MD Director/Trustee
- ----------------------------
Russell A. Salton, III MD
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/Michael S. Scofield Director/Trustee
- ----------------------
Michael S. Scofield
<PAGE>
POWER OF ATTORNEY
I, the undersigned, hereby constitute Dorothy E. Bourassa, Terrence J.
Cullen, Rosemary D. Van Antwerp, James P. Wallin, Martin J. Wolin and John J.
Pileggi, each of them singly, my true and lawful attorneys, with full power to
them and each of them to sign for me and in my name in the capacity indicated
below any and all registration statements, including, but not limited to, Forms
N-8A, N-8B-1, S-5, N-14 and N-1A, as amended from time to time, and any and all
amendments thereto to be filed with the Securities and Exchange Commission for
the purpose of registering from time to time all investment companies of which I
am now or hereafter a Director or Trustee and for which Keystone Investment
Management Company, Evergreen Asset Management Corp. or First Union National
Bank of North Carolina serves as Adviser or Manager and registering from time to
time the shares of such companies, and generally to do all such things in my
name and on my behalf to enable such investment companies to comply with the
provisions of the Securities Act of 1933, as amended, the Investment Company Act
of 1940, as amended, and all requirements and regulations of the Securities and
Exchange Commission thereunder, hereby ratifying and confirming my signature as
it may be signed by my said attorneys to any and all registration statements and
amendments thereto.
In Witness Whereof, I have executed this Power of Attorney as of June
18, 1997.
Signature Title
- --------- -----
/s/Richard J. Shima Director/Trustee
- -------------------
Richard J. Shima
KEYSTONE TAX FREE INCOME FUND
PROXY FOR THE MEETING OF SHAREHOLDERS
TO BE HELD ON JANUARY 6, 1998
The undersigned, revoking all Proxies heretofore given, hereby appoints
Dorothy E. Bourassa, Terrence J. Cullen, Martin Wolin or Rosemary Van Antwerp or
any of them as Proxies of the undersigned, with full power of substitution, to
vote on behalf of the undersigned all shares of Keystone Tax Free Income Fund
("Keystone Tax Free Income") that the undersigned is entitled to vote at the
special meeting of shareholders of Keystone Tax Free Income to be held at 3:00
p.m. on Tuesday, January 6, 1998 at the offices of the Evergreen Keystone Funds,
26th Floor, 200 Berkeley Street, Boston, Massachusetts 02116 and at any
adjournments thereof, as fully as the undersigned would be entitled to vote if
personally present, as follows:
1. To approve an Agreement and Plan of Reorganization whereby Evergreen
Tax Free Fund, a series of Evergreen Municipal Trust, will (i) acquire all of
the assets of Keystone Tax Free Income in exchange for shares of Evergreen Tax
Free Fund; and (ii) assume certain identified liabilities of Keystone Tax Free
Income, as substantially described in the accompanying Prospectus/Proxy
Statement.
---- FOR ---- AGAINST ---- ABSTAIN
2. To consider and vote upon such other matters as may properly come
before said meeting or any adjournments thereof.
---- FOR ---- AGAINST ---- ABSTAIN
PROXY SOLICITED ON BEHALF OF THE BOARD OF TRUSTEES
OF KEYSTONE TAX FREE INCOME
THE BOARD OF TRUSTEES OF KEYSTONE TAX FREE
INCOME RECOMMENDS A VOTE FOR THE PROPOSALS.
THE SHARES REPRESENTED HEREBY WILL BE VOTED AS
INDICATED OR FOR THE PROPOSALS IF NO CHOICE IS
INDICATED.
-1-
<PAGE>
NOTE: PLEASE SIGN EXACTLY AS YOUR
NAME(S) APPEAR ON THIS CARD.
Dated: , 199
----------------- ---
Signature(s):
Signature (of joint owner, if any):
NOTE: When signing as attorney, executor, administrator, trustee, guardian, or
as custodian for a minor, please sign your name and give your full title as
such. If signing on behalf of a corporation, please sign the full corporate name
and your name and indicate your title. If you are a partner signing for a
partnership, please sign the partnership name and your name. Joint owners should
each sign this proxy.
Please sign, date and return.
-2-
<PAGE>
KEYSTONE TAX FREE FUND
PROXY FOR THE MEETING OF SHAREHOLDERS
TO BE HELD ON JANUARY 6, 1998
The undersigned, revoking all Proxies heretofore given, hereby appoints
Dorothy E. Bourassa, Terrence J. Cullen, Martin Wolin or Rosemary Van Antwerp or
any of them as Proxies of the undersigned, with full power of substitution, to
vote on behalf of the undersigned all shares of Keystone Tax Free Fund
("Keystone Tax Free") that the undersigned is entitled to vote at the special
meeting of shareholders of Keystone Tax Free to be held at 3:00 p.m. on Tuesday,
January 6, 1998 at the offices of the Evergreen Keystone Funds, 26th Floor, 200
Berkeley Street, Boston, Massachusetts 02116 and at any adjournments thereof, as
fully as the undersigned would be entitled to vote if personally present, as
follows:
1. To approve an Agreement and Plan of Reorganization whereby Evergreen
Tax Free Fund, a series of Evergreen Municipal Trust, will (i) acquire all of
the assets of Keystone Tax Free in exchange for shares of Evergreen Tax Free
Fund; and (ii) assume certain identified liabilities of Keystone Tax Free, as
substantially described in the accompanying Prospectus/Proxy Statement.
---- FOR ---- AGAINST ---- ABSTAIN
2. To consider and vote upon such other matters as may properly come
before said meeting or any adjournments thereof.
---- FOR ---- AGAINST ---- ABSTAIN
PROXY SOLICITED ON BEHALF OF THE BOARD OF TRUSTEES
OF KEYSTONE TAX FREE
THEBOARD OF TRUSTEES OF KEYSTONE TAX FREE
RECOMMENDS A VOTE FOR THE PROPOSALS.
THE SHARES REPRESENTED HEREBY WILL BE VOTED AS INDICATED
-3-
<PAGE>
OR FOR THE PROPOSALS IF NO CHOICE IS INDICATED.
NOTE: PLEASE SIGN EXACTLY AS YOUR
NAME(S) APPEAR ON THIS CARD.
Dated: , 199
----------------- ---
Signature(s):
Signature (of joint owner, if any):
NOTE: When signing as attorney, executor, administrator, trustee, guardian, or
as custodian for a minor, please sign your name and give your full title as
such. If signing on behalf of a corporation, please sign the full corporate name
and your name and indicate your title. If you are a partner signing for a
partnership, please sign the partnership name and your name. Joint owners should
each sign this proxy. Please sign, date and return.
-4-
<PAGE>
