BAT SUBSIDIARY, INC.
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SEMI-ANNUAL REPORT
JUNE 30, 1999
[LOGO]
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BAT SUBSIDIARY, INC.
PORTFOLIO OF INVESTMENTS
JUNE 30, 1999 (UNAUDITED)
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PRINCIPAL
AMOUNT VALUE
RATING* (000) DESCRIPTION (NOTE 1)
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LONG-TERM INVESTMENTS--114.0%
MORTGAGE PASS-THROUGHS--0.0%
Federal National Mortgage Association,
$ 9 9.50%, 7/1/20 .................................. $ 9,132
MULTIPLE CLASS MORTGAGE
PASS-THROUGHS--14.3%
Federal National Mortgage Association,
REMIC Pass-Through Certificates,
1,580 Trust 1992-43, Class 43-E,
4/25/22 ...................................... 1,594,244
3,683 Trust 1992-129, Class 129-J,
7/25/20 ...................................... 3,517,265
1,444 Trust 1993-193, Class 193-E,
9/25/23 ...................................... 698,015
364 Trust 1993-193, Class 193-PC,
9/25/23 ...................................... 358,932
870 Trust 1993-212, Class 212-SA,
11/25/08, (ARM) .............................. 781,784
2,005+ Trust 1993-214, Class 214-SL,
12/25/08, (ARM) .............................. 1,871,765
1,000 Trust 1994-13, Class 13-SM,
2/25/09, (ARM) ............................... 931,250
329 Trust 1994-37, Class 37-SC,
3/25/24, (ARM) ............................... 322,876
980 Trust 1994-72, Class 72-L,
4/25/24 ...................................... 981,938
AAA 2,000 New York City Mortgage Loan Trust,**
Ser. 1996, Class A-2, 6/25/11 .................. 1,945,000
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13,003,069
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INTEREST ONLY MORTGAGE-BACKED
SECURITIES--14.1%
AAA 28,336 Credit Suisse First Boston Mortgage
Securities Corp.,**
Ser. 1997-C1, Class AX,
6/20/29 ...................................... 2,573,541
1,500 Federal Home Loan Mortgage Corp.,
Multiclass Mortgage
Participation Certificates,
Ser. 1543, Class 1543-VU,
4/15/23 ...................................... 394,327
Federal National Mortgage Association,
REMIC Pass-Through Certificates,
2,500 Trust 1993-163, Class 163-PH,
3/25/22 ...................................... 518,750
2,312 Trust 1993-223, Class 223-PT,
10/25/23 ..................................... 310,847
2,500 Trust 1997-50, Class 50-HK,
8/25/27 ...................................... 816,699
6,755 Trust 1997-84, Class 84-PJ,
1/25/08 ...................................... 1,563,331
3,505 Trust 1998-44, Class 44-JI,
8/20/17 ...................................... 396,461
3,423 Trust 1998-62, Class 62-EI,
11/25/28 ..................................... 526,361
AAA 19,770 First Union-Lehman Brothers-
Bank of America,
Ser. 1998-C2, Class IO,
5/18/28 ...................................... 761,303
2,446 Government National Mortgage
Association,
Trust 1998-24, Class 24-IB,
5/20/23 ...................................... 544,276
AAA 11,794 Merrill Lynch Mortgage Investors Inc.,
Ser. 1997-C2, Class IO,
12/10/29 ..................................... 806,296
AAA 15,741 Morgan (J.P.) Commercial Mortgage
Finance Corp.,**
Ser. 1997-C5, Class X,
9/15/29 ...................................... 1,184,376
AAA 3,494 Morgan Stanley Capital 1 Inc.,**
Ser. 1997-HF1, Class X,
6/15/17 ...................................... 292,910
AAA 135,000 Residential Funding Mortgage
Securities Inc.,
Ser. 1999-S14, Class A5B,
7/25/29 ...................................... 2,109,375
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12,798,853
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PRINCIPAL ONLY MORTGAGE-BACKED
SECURITIES--1.8%
Collateralized Mortgage Obligation Trust,
AAA 630 Trust 26, Class A, 4/23/17 ..................... 525,219
AAA 50 Trust 29, Class A, 5/23/17 ..................... 39,679
469 Federal Home Loan Mortgage Corp.,
Multiclass Mortgage
Participation Certificates,
Ser. 1946, Class 1946-N,
10/15/08 ..................................... 368,040
Federal National Mortgage Association,
REMIC Pass-Through Certificates,
1,406 Trust 1993-225, Class 225-ME,
11/25/23 ..................................... 560,642
137 Trust 1997-85, Class 85-LE,
10/25/23 ..................................... 120,223
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1,613,803
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See Notes to Financial Statements.
1
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PRINCIPAL
AMOUNT VALUE
RATING* (000) DESCRIPTION (NOTE 1)
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COMMERCIAL MORTGAGE-BACKED
SECURITIES--11.0%
A+ $1,000 Credit Suisse First Boston Mortgage
Securities Corp.,
Ser. 1995-AEW 1, Class C,
7.46%, 11/25/27 .............................. $ 998,365
AAA 1,000 Deutsche Mortgage and Asset
Receiving Corp.,
Ser. 1998-C1, Class A2,
6.54%, 2/15/08 ............................... 965,838
BBB 1,000 DLJ Mortgage Acceptance Corp.,**
SER. 1997-CF1, CLASS B1,
7.91%, 4/15/07 ............................... 971,620
AAA 75 GMAC Commercial Mortgage
Securities Inc.,
Ser. 1998-C2, Class A2,
6.42%, 8/15/08 ............................... 72,541
AAA 1,000 Goldman Sachs Mortgage
Securities Corp.,
Ser. 1996-PL, Class A2,
7.41%, 2/15/27 ............................... 1,009,831
AAA 800 LTC Commercial Mortgage Corp.,**
Ser. 1996-1, Class A,
7.06%, 4/15/28 ............................... 798,620
Merrill Lynch Mortgage Investors Inc.,
BBB 1,000 Ser. 1995-C1, Class D,
7.95%, 5/25/15 ............................... 982,881
BBB 500 Series 1996-C1, Class D,
7.42%, 4/25/28 ............................... 481,600
AAA 350 Mortgage Capital Funding Inc.,
Ser. 1998-MC2, Class A2,
6.42%, 5/18/08 ............................... 336,838
Aa2 431 Salomon Brothers Mortgage
Securities Corp.,**
Ser. 1997-TZH, Class A1,
7.15%, 3/25/25 ............................... 438,362
AA 2,635 Sears Mortgage Securities Corp.,
Ser. 1993-7, Class S3,
10.47%, 4/25/08, (ARM) ....................... 2,453,007
AAA 500 Structured Asset Securities Corp.,
Ser. 1996-CFL, Class B,
6.30%, 2/25/28 ............................... 503,279
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10,012,782
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CORPORATE BONDS--16.8%
FINANCE & BANKING--10.6%
A3 1,000 American Savings Bank,**
6.63%, 2/15/06 ................................. 971,360
A 1,452 Equitable Life Assurance Society USA,**
Zero coupon, 12/1/99 - 12/1/05 ................. 998,039
A 1,000 Lehman Brothers Holdings Inc.,
6.75%, 9/24/01 ................................. 998,370
BB+ 1,000 Macsaver Financial Services Inc.,
7.88%, 8/1/03 .................................. 830,000
BBB+ 1,900 PaineWebber Group Inc.,
7.88%, 2/15/03 ................................. 1,957,494
Salomon Smith Barney Holdings Inc.,
Aa3 1,000 6.75%, 1/15/06 ................................. 980,670
Aa3 1,425 7.98%, 3/1/00 .................................. 1,445,463
A- 1,485 Transamerica Finance Corp.,
6.75%, 6/1/00 .................................. 1,489,381
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9,670,777
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INDUSTRIALS--2.8%
AA- 1,000 TCI Communications Inc.,
8.25%, 1/15/03 ................................. 1,054,270
Baa2 2,038 Union Pacific Corp.,**
Zero coupon, 11/1/99 - 5/1/05 .................. 1,455,254
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2,509,524
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UTILITIES--1.1%
A 1,000 ALLTEL CORP.,
7.50%, 3/1/06 .................................. 1,025,980
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YANKEE--2.3%
BBB- 1,000 Empresa Electric Guacolda SA,**
7.95%, 4/30/03 ................................. 908,551
BBB+ 200 Empresa Electric Pehuhuenche,
7.30%, 5/1/03 .................................. 193,219
A- 1,000 Israel Electric Corp. Ltd.,**
7.25%, 12/15/06 ................................ 958,610
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2,060,380
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Total Corporate Bonds ............................ 15,266,661
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ASSET-BACKED SECURITIES--2.6%
AAA 800 Chase Credit Card Master Trust,
Ser. 1997-5, Class A,
6.19%, 8/15/05 ............................... 791,732
NR 422 Global Rated Eligible Asset Trust,**/***
Ser. 1998-A, Class A1,
7.33%, 3/15/06 ............................... 229,843
AA 962 Pegasus Aviation Lease Securitization,**
Ser. 1999-1A, Class A1,
6.30%, 3/25/29 ............................... 940,120
NR 899 Structured Mortgage Asset
Residential Trust,**/***
Ser. 1997-3, 8.57%,
4/15/06 ...................................... 400,000
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2,361,695
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U.S. GOVERNMENT AND
AGENCY SECURITIES--1.6%
1,095 Small Business Administration,
Ser. 1998-P10, Class 10A,
6.12%, 2/1/08 ................................ 1,056,405
400 United States Treasury Notes,
5.50%, 5/15/09 ................................. 390,748
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1,447,153
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See Notes to Financial Statements.
2
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PRINCIPAL
AMOUNT VALUE
RATING* (000) DESCRIPTION (NOTE 1)
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ZERO COUPON BONDS--45.1%
$12,407 Aid to Israel,
2/15/05 - 8/15/05 .............................. $8,675,663
Government Trust Certificates,
5,220 Class 2-F, 5/15/05 ............................. 3,651,755
13,760 Class T-1, 5/15/05 ............................. 9,377,578
18,000++ United States Treasury Strips,
11/15/05 ....................................... 12,361,500
10,000 Vanguard Prime Money Market Strip,
12/31/04 ....................................... 7,002,000
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41,068,496
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TAXABLE MUNICIPAL BONDS--6.6%
AAA 1,000 Alameda County California
Pension Obligation,
Zero coupon, 12/1/05 ........................... 653,700
AAA 1,000 Alaska Energy Power Authority Revenue,
Zero coupon, 7/1/05 ............................ 755,090
AAA 1,433 Kern County California
Pension Obligation,
Zero coupon,
8/15/99 - 8/15/05 ............................ 1,014,543
Long Beach California
Pension Obligation,
AAA 1,441 Zero coupon, 9/1/99 - 9/1/05 ................... 1,018,351
AAA 500 7.09%, 9/1/09 .................................. 508,720
Los Angeles County California
Pension Obligation,
AAA 406 Zero coupon, 12/31/99 - 6/30/05 ................ 327,609
AAA 1,000 6.77%, 6/30/05 ................................. 654,170
AAA 1,000 8.62%, 6/30/06 ................................. 1,107,950
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6,040,133
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NOTIONAL
AMOUNT
(000)
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CALL OPTIONS PURCHASED--0.1%
15,000 Interest Rate Swap,
5.60% over 3 month LIBOR,
expires 8/07/00
(cost $206,250) ................................ 80,447
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Total long-term investments
(cost $100,189,976) ............................ 103,702,224
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SHORT-TERM INVESTMENT--1.5%
DISCOUNT NOTES
1,395 Federal Home Loan Mortgage Corp.,
4.60%, 7/1/99
(cost $1,395,000) .............................. 1,395,000
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Total investments before outstanding
call option written--115.5%
(cost $101,584,976) ............................ 105,097,224
NOTIONAL
AMOUNT
(000)
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CALL OPTION WRITTEN--(0.0%)
(24,000) Interest Rate Swap,
3 month LIBOR over 5.50%,
expires 8/10/99
(premium received $147,000) .................... (53)
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Total investments, net of
outstanding call option
written--115.5%
(cost $101,437,976) ......................... 105,097,171
Liabilities in excess of
other assets (15.5)% ......................... (14,108,000)
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NET ASSETS--100% ............................... $90,989,171
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* Using the higher of Standard & Poor's, Moody's or Fitch's rating.
** Restricted securities as to resale.
*** Illiquid securities representing 0.6% of portfolio assets.
+ (Partial) principal amount pledged as collateral for reverse repurchase
agreements.
++ Entire principal amount pledged as collateral for reverse repurchase
agreements.
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KEY TO ABBREVIATIONS
ARM -- Adjustable Rate Mortgage.
LIBOR -- London InterBank Offer Rate.
REMIC -- Real Estate Mortgage Investment Conduit.
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See Notes to Financial Statements.
3
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BAT SUBSIDIARY, INC.
STATEMENT OF ASSETS AND LIABILITIES
JUNE 30, 1999 (UNAUDITED)
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ASSETS
Investments, at value (cost $101,584,976)
(Note 1) ............................................ $105,097,224
Interest receivable ................................... 799,494
Unrealized appreciation on interest rate swaps
(Notes 1 and 3) ..................................... 389
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105,897,107
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LIABILITIES
Reverse repurchase agreements (Note 4) ................ 14,021,000
Due to custodian ...................................... 384,449
Due to parent (Note 2) ................................ 342,865
Interest payable ...................................... 159,569
Call option written, at value
(premium received $147,000) (Notes 1 and 3) ......... 53
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14,907,936
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NET ASSETS ............................................ $ 90,989,171
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Net assets were comprised of:
Common stock, at par (Note 5) ....................... $ 95,107
Paid-in capital in excess of par .................... 82,201,572
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...................................................... 82,296,679
Undistributed net investment income ................. 3,586,093
Accumulated net realized gain ....................... 1,446,815
Net unrealized appreciation ......................... 3,659,584
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Net assets, June 30, 1999 ........................... $ 90,989,171
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Net asset value per share:
($90,989,171 / 9,510,667 shares of
common stock issued and outstanding) ................ $ 9.57
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BAT SUBSIDIARY, INC.
STATEMENT OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1999 (UNAUDITED)
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NET INVESTMENT INCOME
Income
Interest earned (net of premium amortization
of $787,684 and interest
expense of $453,996) .............................. $3,397,416
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Operating expenses
Investment advisory ................................. 227,968
Administration ...................................... 45,594
Custodian ........................................... 26,000
Audit ............................................... 13,000
Legal ............................................... 12,000
Directors ........................................... 10,000
Miscellaneous ....................................... 8,303
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Total operating expenses .......................... 342,865
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Net investment income ................................. 3,054,551
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REALIZED AND UNREALIZED GAIN (LOSS) ON
INVESTMENTS (NOTE 3)
Net realized gain (loss) on:
Investments ......................................... (62,867)
Futures ............................................. 487,973
Short sales ......................................... 211,914
Interest rate swaps ................................. (50,708)
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586,312
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Net change in unrealized appreciation (depreciation) on:
Investments ......................................... (5,304,377)
Options written ..................................... 260,092
Futures ............................................. 7,136
Short sales ......................................... 333,514
Interest rateswaps .................................. (81,267)
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(4,784,902)
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Net loss on investments ............................... (4,198,590)
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NET DECREASE IN NET ASSETS
RESULTING FROM OPERATIONS ........................... $(1,144,039)
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See Notes to Financial Statements.
4
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BAT SUBSIDIARY, INC.
STATEMENT OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 1999 (UNAUDITED)
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RECONCILIATION OF NET DECREASE IN NET ASSETS
RESULTING FROM OPERATIONS TO NET CASH FLOWS
PROVIDED BY OPERATING ACTIVITIES
Net decrease in net assets resulting
from operations .................................... $ (1,144,039)
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Increase in investments .............................. (16,287)
Net realized gain .................................... (586,312)
Decrease in unrealized appreciation .................. 4,784,902
Increase in interest receivable ...................... (106,382)
Decrease in deposits with brokers for
investments sold short ............................. 9,203,750
Decrease in unrealized appreciation of
interest rate swap ................................. 81,267
Decrease in due to broker-variation margin ........... (6,593)
Decrease in payable for investments sold short ....... (9,044,960)
Decrease in call options written ..................... (532,843)
Decrease in interest payable ......................... (77,092)
Increase in accrued expenses and
other liabilities .................................. 562,495
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Total adjustments .................................... 4,261,945
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Net cash flows provided by operating activities ...... $ 3,117,906
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INCREASE (DECREASE) IN CASH
Net cash flows provided by operating activities ...... $ 3,117,906
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Cash flows used for financing activities:
Decrease in reverse repurchase agreements .......... (3,169,000)
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Net decrease in cash ............................... (51,094)
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Cash at beginning of period ........................ 51,094
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Cash at end of period .............................. $ --
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BAT SUBSIDIARY, INC.
STATEMENT OF CHANGES
IN NET ASSETS (UNAUDITED)
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FOR THE PERIOD
OCTOBER 31, 1998*
SIX MONTHS ENDED TO
JUNE 30, DECEMBER 31,
1999 1998
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INCREASE (DECREASE) IN
NET ASSETS
Operations:
Net investment income ........ $ 3,054,551 $ 531,542
Net realized gain on
investments ................ 586,312 860,503
Net change in unrealized
appreciation/(depreciation)
on investments ............. (4,784,902) 8,444,486
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Net increase (decrease) in net
assets resulting from
operations ................. (1,144,039) 9,836,531
Transfer of assets from BAT
in exchange for
shares issued .............. -- 82,296,679
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TOTAL INCREASE (DECREASE) ...... (1,144,039) 92,133,210
NET ASSETS
Beginning of period ............ 92,133,210 --
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End of period .................. $ 90,989,171 $92,133,210
============ ===========
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* Commencement of investment operations.
See Notes to Financial Statements.
5
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BAT SUBSIDIARY, INC.
FINANCIAL HIGHLIGHTS (UNAUDITED)
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<TABLE>
<CAPTION>
FOR THE PERIOD
OCTOBER 31, 1998*
SIX MONTHS ENDED THROUGH
JUNE 30, DECEMBER 31,
1999 1998
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<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period .................................................. $ 9.69 $ 8.65
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Net investment income (net of interest expense of $0.03 and $0.05, respectively) ... 0.32 0.06
Net realized and unrealized gain (loss) ............................................ (0.44) 0.98
------- -------
Net increase (decrease) from investment operations .................................... (0.12) 1.04
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Net asset value, end of period ........................................................ $ 9.57 $ 9.69
======= =======
TOTAL INVESTMENT RETURN:+ ............................................................. (1.24)% 12.02%
======= =======
RATIOS TO AVERAGE NET ASSETS:
Operating expenses** .................................................................. 0.75%++ 0.89%++
Net investment income ................................................................. 6.72%++ 3.50%++
SUPPLEMENTAL DATA:
Average net assets (in thousands) ..................................................... $91,668 $90,986
Portfolio turnover .................................................................... 8% 3%
Net assets, end of period (in thousands) .............................................. $90,989 $92,133
Reverse repurchase agreements outstanding,
end of period (in thousands) ....................................................... $14,021 $17,190
Asset coverage+++ ..................................................................... $ 7,489 $ 6,369
</TABLE>
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* Commencement of investment operations.
** The ratios of operating expenses, including interest expense, to average
net assets was 2.57%++ and 1.75%++ for the period indicated above,
respectively. The ratios of operating expenses, including interest expense
and excise tax, to average net assets was 2.76%++ and 1.75%++, for the
period indicated above, respectively.
+ This entity is not publicly traded and therefore total investment return is
calculated assuming a purchase of common stock at the current net asset
value on the first day and a sale at the net asset value on the last day of
the period reported. Total investment return for periods of less than one
full year are not annualized.
++ Annualized.
+++ Per $1,000 of reverse repurchase agreement outstanding.
The information above represents the unaudited operating performance data for a
share of common stock outstanding, total investment return, ratios to average
net assets and other supplemental data, for the periods indicated. This
information has been determined based upon financial information provided in the
financial statements.
See Notes to Financial Statements.
6
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BAT SUBSIDIARY, INC.
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
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NOTE 1. ORGANIZATION & POLICIES
BAT Subsidiary, Inc. (the ACCOUNTING "Trust") was incorporated under the laws of
the state of Maryland on August 10, 1998, and is a diversified, closed-end
management investment company. The Trust was incorporated solely for the purpose
of receiving all or a substantial portion of the assets of The BlackRock
Advantage Term Trust Inc., ("BAT") incorporated under the laws of the state of
Maryland and as such, is a wholly-owned subsidiary of BAT. The Trust's
investment objective is to manage a portfolio of investment grade fixed income
securities while providing cash flow definition to BAT. No assurance can be
given that the Trust's investment objective will be achieved.
The following is a summary of significant accounting policies followed by the
Trust.
SECURITIES VALUATION: The Trust values mortgage-backed, asset-backed and other
debt securities, interest rate swaps, caps, floors and non-exchange traded
options on the basis of current market quotations provided by dealers or pricing
services approved by the Trust's Board of Directors. In determining the value of
a particular security, pricing services may use certain information with respect
to transactions in such securities, quotations from dealers, market transactions
in comparable securities, various relationships observed in the market between
securities, and calculated yield measures based on valuation technology commonly
employed in the market for such securities. Exchange-traded options are valued
at their last sales price as of the close of options trading on the applicable
exchanges. In the absence of a last sale, options are valued at the average of
the quoted bid and asked prices as of the close of business. A futures contract
is valued at the last sale price as of the close of the commodities exchange on
which it trades unless the Trust's Board of Directors determines that such price
does not reflect its fair value, in which case it will be valued at its fair
value as determined by the Trust's Board of Directors. Any securities or other
assets for which such current market quotations are not readily available are
valued at fair value as determined in good faith under procedures established by
and under the general supervision and responsibility of the Trust's Board of
Directors.
Short-term securities which mature in 60 days or less are valued at amortized
cost, if their term to maturity from date of purchase is 60 days or less.
Short-term securities with a term to maturity greater than 60 days from the date
of purchase are valued at current market quotations until maturity.
In connection with transactions in repurchase agreements, the Trust's
custodian takes possession of the underlying collateral securities, the value of
which at least equals the principal amount of the repurchase transaction,
including accrued interest. To the extent that any repurchase transaction
exceeds one business day, the value of the collateral is marked-to-market on a
daily basis to ensure the adequacy of the collateral. If the seller defaults and
the value of the collateral declines or if bankruptcy proceedings are commenced
with respect to the seller of the security, realization of the collateral by the
Trust may be delayed or limited.
OPTION SELLING/PURCHASING: When the Trust sells or purchases an option, an
amount equal to the premium received or paid by the Trust is recorded as a
liability or an asset and is subsequently adjusted to the current market value
of the option written or purchased. Premiums received or paid from writing or
purchasing options which expire unexercised are treated by the Trust on the
expiration date as realized gains or losses. The difference between the premium
and the amount paid or received on effecting a closing purchase or sale
transaction, including brokerage commissions, is also treated as a realized gain
or loss. If an option is exercised, the premium paid or received is added to the
cost of the purchase or proceeds from the sale in determining whether the Trust
has realized a gain or a loss on investment transactions. The Trust, as writer
of an option, may have no control over whether the underlying securities may be
sold (call) or purchased (put) and as a result bears the market risk of an
unfavorable change in the price of the security underlying the written option.
Options, when used by the Trust, help in maintaining a targeted duration.
Duration is a measure of the price sensitivity of a security or a portfolio to
relative changes in interest rates. For instance, a duration of "one" means that
a portfolio's or a security's price would be expected to change by approximately
one percent with a one percent change in interest rates, while a duration of
five would imply that the price would move approximately five percent in
relation to a one percent change in interest rates.
Option selling and purchasing is used by the Trust to effectively hedge
positions, or collections of positions, so that changes in interest rates do not
change the duration of the portfolio unexpectedly. In general, the Trust uses
options to hedge a long or short position or an overall portfolio that is longer
or shorter than the benchmark security. A call option gives the purchaser of the
option the right (but not obligation) to buy, and obligates the seller to sell
(when the option is exercised), the underlying position at the exercise price at
anytime or at a specified time during the option period. A put option gives the
holder the right to sell and obligates the writer to buy the underlying position
at the exercise price at any time or at a specified time during the option
period. Put options can be
7
<PAGE>
purchased to effectively hedge a position or a portfolio against price declines
if a portfolio is long. In the same sense, call options can be purchased to
hedge a portfolio that is shorter than its benchmark against price changes. The
Trust can also sell (or write) covered call options and put options to hedge
portfolio positions.
The main risk that is associated with purchasing options is that the option
expires without being exercised. In this case, the option expires worthless and
the premium paid for the option is considered the loss. The risk associated with
writing call options is that the Trust may forego the opportunity for a profit
if the market value of the underlying position increases and the option is
exercised. The risk in writing put options is that the Trust may incur a loss if
the market value of the underlying position decreases and the option is
exercised. In addition, as with futures contracts, the Trust risks not being
able to enter into a closing transaction for the written option as the result of
an illiquid market.
INTEREST RATE SWAPS: In a simple interest rate swap, one investor pays a
floating rate of interest on a notional principal amount and receives a fixed
rate of interest on the same notional principal amount for a specified period of
time. Alternatively, an investor may pay a fixed rate and receive a floating
rate. Interest rate swaps were conceived as asset/liability management tools. In
more complex swaps, the notional principal amount may decline (or amortize) over
time.
During the term of the swap, changes in the value of the swap are recognized
as unrealized gains or losses by "marking-to-market" to reflect the market value
of the swap. When the swap is terminated, the Trust will record a realized gain
or loss equal to the difference between the proceeds from (or cost of) the
closing transaction and the Trust's basis in the contract, if any.
The Trust is exposed to credit loss in the event of non-performance by the
other party to the interest rate swap. However, the Trust does not anticipate
non-performance by any counterparty.
SWAP OPTIONS: Swap options are similar to options on securities except that
instead of purchasing the right to buy a security, the purchaser of the swap
option has the right to enter into a previously agreed upon interest rate swap
agreement at any time before the expiration of the option. Premiums received or
paid from writing or purchasing options which expire unexercised are treated by
the Trust on the expiration date as realized gains or losses. The difference
between the premium and the amount paid or received on effecting a closing
purchase or sale transaction, including brokerage commissions, is also treated
as a realized gain or loss. If an option is exercised, the premium paid or
received is added to the proceeds from the sale or cost of the purchase in
determining whether the Trust has realized a gain or a loss on investment
transactions. The Trust, as writer of an option, bears the market risk of an
unfavorable change in the value of the swap contract underlying the written
option. Interest rate swap options may be used as part of an income producing
strategy reflecting the view of the Trust's management on the direction of
interest rates.
The main risk that is associated with purchasing swap options is that the
swap option expires without being exercised. In this case, the option expires
worthless and the premium paid for the swap option is considered the loss. The
main risk that is associated with the writing of a swap option is the market
risk of an unfavorable change in the value of the interest rate swap underlying
the written swap option.
Swap options may be used by the Trust to manage the duration of the Trust's
portfolio in a manner similar to more generic options described above.
FINANCIAL FUTURES CONTRACTS: A futures contract is an agreement between two
parties to buy and sell a financial instrument for a set price on a future date.
Initial margin deposits are made upon entering into futures contracts and can be
either cash or securities. During the period the futures contract is open,
changes in the value of the contract are recognized as unrealized gains or
losses by "marking-to-market" on a daily basis to reflect the market value of
the contract at the end of each day's trading. Variation margin payments are
made or received, depending upon whether unrealized gains or losses are
incurred. When the contract is closed, the Trust records a realized gain or loss
equal to the difference between the proceeds from (or cost of) the closing
transaction and the Trust's basis in the contract.
Financial futures contracts, when used by the Trust, help in maintaining a
targeted duration. Futures contracts can be sold to effectively shorten an
otherwise longer duration portfolio. In the same sense, futures contracts can be
purchased to lengthen a portfolio that is shorter than its duration target.
Thus, by buying or selling futures contracts, the Trust can effectively "hedge"
more volatile positions so that changes in interest rates do not change the
duration of the portfolio unexpectedly.
The Trust may invest in financial futures contracts primarily for the purpose
of hedging its existing portfolio securities or securities the Trust intends to
purchase against fluctuations in value caused by changes in prevailing market
interest rates. Should interest rates move unexpectedly, the Trust may not
achieve the anticipated benefits of the financial futures contracts and may
realize a loss. The use of futures transactions involves the risk of imperfect
correlation in movements in the price of futures contracts, interest rates and
the underlying hedged assets. The Trust is also at risk of not being able to
enter into a closing transaction for the futures contract because of an illiquid
secondary market. In addition, since futures are used to shorten or lengthen a
portfolio's duration, there is a risk that the portfolio may have temporarily
performed better without the hedge or that the Trust may lose the opportunity to
realize appreciation in the market price of the underlying positions. SHORT
SALES: The Trust may make short sales of securities as a method of hedging
potential price declines in similar securities owned. When the Trust makes a
short sale, it may borrow the security sold short and deliver it to the
broker-dealer through which it made the short sale as collateral for its
obligation to deliver the security upon conclusion of the sale. The Trust may
have to pay a fee to borrow the particular securities and may be obligated to
pay over any payments received on such borrowed securities. A gain, limited to
the price at which the Trust sold the security short, or a loss, unlimited as to
dollar amount, will be recognized upon the termination of a short sale if the
market price is less or greater than the proceeds originally received.
SECURITIES LENDING: The Trust may lend its portfolio securities to qualified
institutions. The loans are secured by collateral at least equal, at all times,
to the market value of the securities loaned. The Trust may bear the risk of
delay in recovery of, or even loss of rights in, the securities loaned should
the borrower of the securities fail financially. The Trust receives compensation
for lending its securities in the form of interest on the loan. The Trust also
continues to receive interest on the securities loaned, and any gain or loss in
the market price of the securities loaned that may occur during the term of the
loan will be for the account of the Trust. The Trust did not engage in
securities lending during the six months ended June 30, 1999.
INTEREST RATE CAPS: Interest rate caps are similar to interest rate swaps,
except that one party agrees to pay a fee, while the other party pays the
excess, if any, of a floating rate over a specified fixed or floating rate.
Interest rate caps are intended to both manage the duration of the Trust's
portfolio and its exposure to changes in short term rates. Owning interest rate
caps reduces the portfolio's duration, making it less sensitive to changes in
interest rates from a market value perspective. The effect on income invokes
protection from rising short term rates, which the Trust experiences primarily
in the form of leverage.
The Trust is exposed to credit loss in the event of non-performance by the
other party to the interest rate cap. However, the Trust does not anticipate
non-performance by any counterparty.
Transaction fees paid or received by the Trust are recognized as assets or
liabilities and amortized or accreted into interest expense or income over the
life of the interest rate cap. The asset or liability is subsequently adjusted
to the current market value of the interest rate cap purchased or sold. Changes
in the value of the interest rate cap are recognized as unrealized gains and
losses.
INTEREST RATE FLOORS: Interest rate floors are similar to interest rate swaps,
except that one party agrees to pay a fee, while the other party pays the
deficiency, if any, of a floating rate under a specified fixed or floating rate.
Interest rate floors are used by the Trust to both manage the duration of the
portfolio and its exposure to changes in short-term interest rates. Selling
interest rate floors reduces the portfolios duration, making it less sensitive
to changes in interest rates from a market value perspective. The Trust's
leverage provides extra income in a period of falling rates. Selling floors
reduces some of that advantage by partially monetizing it as an up front payment
which the Trust receives.
The Trust is exposed to credit loss in the event of non-performance by the
other party to the interest rate floor. However, the Trust does not anticipate
non-performance by any counterparty.
Transactions fees paid or received by the Trust are recognized as assets or
liabilities and amortized or accreted into interest expense or income over the
life of the interest rate floor. The asset or liability is subsequently adjusted
to the current market value of the interest rate floor purchased or sold.
Changes in the value of the interest rate floor are recognized as unrealized
gains and losses.
SECURITIES TRANSACTIONS AND INVESTMENT INCOME: Securities transactions are
recorded on the trade date. Realized and unrealized gains and losses are
calculated on the identified cost basis. Interest income is recorded on the
accrual basis and the Trust accretes discount and amortizes premium on
securities purchased using the interest method.
TAXES: It is the Trust's intention to continue to meet the requirements of the
Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all taxable income to shareholders. Therefore, no
federal income tax provision is required. As part of its tax planning strategy,
the Trust intends to retain a portion of its taxable income and pay an excise
tax on the undistributed amounts.
Income distributions and capital gain distributions are determined in
accordance with income tax regulations which may differ from generally accepted
accounting principles. ESTIMATES: The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and ex-
9
<PAGE>
penses during the reporting period. Actual results could differ from those
estimates.
NOTE 2. AGREEMENTS
The Trust has an Investment Advisory Agreement with BlackRock Financial
Management, Inc., (the "Adviser"), a wholly owned corporate subsidiary of
BlackRock Advisors, Inc., which is an indirect majority-owned subsidiary of PNC
Bank, N.A., and an Administration Agreement with Prudential Investments Fund
Management, LLC ("PIFM"), an indirect, wholly-owned subsidiary of The Prudential
Insurance Co. of America.
The Trust reimburses the BAT for its pro-rata share of applicable expenses,
including investment advisory and administrative fees, in an amount equal to the
proportionate amount of average net assets which are held by the Trust relative
to the average net assets of the BAT.
NOTE 3. PORTFOLIO SECURITIES
Purchases and sales of invest- ment securities, other than short-term
investments and dollar rolls, for the six months ended June 30, 1999 aggregated
$14,461,394 and $7,808,017, respectively.
The Trust may invest up to 85% of its total assets in securities which are
not readily marketable, including those which are restricted as to disposition
under securities law ("restricted securities"). At June 30, 1999, the Trust held
0.6% of its portfolio assets in illiquid securities.
The Trust may from time to time purchase in the secondary market certain
mortgage pass-through securities packaged or master serviced by PNC Mortgage
Securities Corp. (or Sears Mortgage if PNC Mortgage Securities Corp. succeeded
to rights and duties of Sears) or mortgage related securities containing loans
or mortgages originated by PNC Bank or its affiliates, including Midland Loan
Services, Inc. It is possible under certain circumstances, PNC Mortgage
Securities Corp. or its affiliates, including Midland Loan Services, Inc. could
have interests that are in conflict with the holders of these mortgage-backed
securities, and such holders could have rights against PNC Mortgage Securities
Corp. or its affiliates, including Midland Loan Services, Inc.
The federal income tax basis of the Trust's investments at June 30, 1999 was
$101,584,976 and, accordingly, net unrealized appreciation for federal income
tax purposes was $3,512,248 (gross unrealized appreciation--$5,708,039; gross
unrealized depreciation--$2,195,791).
Details of open interest rate swaps at June 30, 1999 are as follows:
NOTIONAL FIXED/
AMOUNT FLOATING FLOATING TERMINATION UNREALIZED
(000) TYPE RATE RATE DATE APPRECIATION
- -------- ----- ------------ ------ ---------- ------------
$5,000 Floating Rate 3 Mo. T-Bill 3 Mo. LIBOR 9/10/03 $209
+ 80.25 bps
5,000 Floating Rate 3 Mo. T-Bill 3 Mo. LIBOR 9/10/03 180
+ 81.75 bps ----
$389
====
NOTE 4. BORROWINGS
REVERSE REPURCHASE AGREEMENTS: The Trust may enter into reverse repurchase
agreements with qualified, third party broker-dealers as determined by and under
the direction of the Trust's Board of Directors. Interest on the value of
reverse repurchase agreements issued and outstanding will be based upon
competitive market rates at the time of issuance. At the time the Trust enters
into a reverse repurchase agreement, it will establish and maintain a segregated
account with the lender, the value of which at least equals the principal amount
of the reverse repurchase transactions including accrued interest.
The average daily balance of reverse repurchase agreements outstanding during
the period ended June 30, 1999 was approximately $15,776,865 at a weighted
average interest rate of approximately 4.82%. The maximum amount of reverse
repurchase agreements outstanding at any month-end during the period ended June
30, 1999 was $20,163,500 as of January 31, 1999 which was 16.4% of total assets.
DOLLAR ROLLS: The Trust may enter into dollar rolls in which the Trust sells
securities for delivery in the current month and simultaneously contracts to
repurchase substantially similar (same type, coupon and maturity) securities on
a specified future date. During the roll period the Trust forgoes principal and
interest paid on the securities. The Trust will be compensated by the interest
earned on the cash proceeds of the initial sale and by the lower repurchase
price at the future date. The Trust did not enter into dollar rolls during the
six months ended June 30, 1999.
NOTE 5. CAPITAL
There are 200 million shares of $.01 par value common stock authorized. BAT
owned all of the 9,510,667 shares outstanding at June 30, 1999.
10
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BlackRock
- --------------------------------------------------------------------------------
DIRECTORS
Laurence D. Fink, CHAIRMAN
Andrew F. Brimmer
Richard E. Cavanagh
Kent Dixon
Frank J. Fabozzi
James Grosfeld
James Clayburn La Force, Jr.
Walter F. Mondale
Ralph L. Schlosstein
OFFICERS
Ralph L. Schlosstein, PRESIDENT
Scott Amero, VICE PRESIDENT
Keith T. Anderson, VICE PRESIDENT
Michael C. Huebsch, VICE PRESIDENT
Robert S. Kapito, VICE PRESIDENT
Richard M. Shea, VICE PRESIDENT/TAX
Henry Gabbay, TREASURER
James Kong, ASSISTANT TREASURER
Karen H. Sabath, SECRETARY
INVESTMENT ADVISER
BlackRock Financial Management, Inc.
345 Park Avenue
New York, NY 10154
(800) 227-7BFM
ADMINISTRATOR
Prudential Investments Fund Management LLC
Gateway Center Three
100 Mulberry Street
Newark, NJ 07102-4077
CUSTODIAN
State Street Bank and Trust Company
One Heritage Drive
North Quincy, MA 02171
(800) 699-1BFM
INDEPENDENT AUDITORS
Deloitte & Touche LLP
Two World Financial Center
New York, NY 10281-1434
LEGAL COUNSEL
Skadden, Arps, Slate, Meagher & Flom LLP
919 Third Avenue
New York, NY 10022
The accompanying financial statements as of June 30, 1999 were not audited
and accordingly, no opinion is expressed on them.
This report is for shareholder information. This is not a prospectus intended
for use in the purchase or sale of any securities.
BAT SUBSIDIARY, INC.
c/o Prudential Investments Fund Management LLC
Gateway Center Three
100 Mulberry Street
Newark, NJ 07102-4077
(800) 227-7BFM
[LOGO] Printed on recycled paper
