<PAGE>
(Hatteras Income
Securities Inc.
Logo appears here)
ANNUAL REPORT
TO SHAREHOLDERS
DECEMBER 31, 1996
<PAGE>
DEAR SHAREHOLDER:
I am pleased to present the Annual Report for Hatteras Income Securities,
Inc. (the "Company") to Shareholders for the year ended December 31, 1996.
INVESTMENT OBJECTIVE
The Company is a closed-end investment company registered under the
Investment Company Act of 1940, as amended, and its shares are traded on the New
York Stock Exchange under the symbol "HAT." The Company's investment objective
is to seek to provide high monthly income consistent with prudent investment
risk.
PERFORMANCE UPDATE*
The calendar-year 1996 was a difficult year for the bond market, with
interest rates rising 0.70% to 0.80% across the yield curve. The Company's total
return of 2.93%, based on its net asset value ("NAV"), lagged its benchmarks.
This underperformance can be traced to the first quarter of the year, when
surprising strength in employment and economic growth led to a rapid increase in
interest rates. Bond market investors began to speculate that the Federal
Reserve Board ("Fed") would have to raise the Federal Funds rate to slow the
economy, or risk having wage pressures lead to broader inflation. Through the
latter half of the year, growth appeared to moderate, allowing yields to come
back down from their highs. As a result, the Company outperformed during the
second half of the year, producing a total return based on NAV of 6.04% versus a
total return of 5.55% for the Lehman Corporate Bond Index.**
Another measure of an investment's success is performance over longer time
horizons. Over the five-year period ended December 31, 1996, the Company
delivered an average NAV annual return of 9.01%, which compares well with the
Lehman Corporate Index at 8.14%, and the Lipper Closed-end Investment Grade Bond
Funds*** NAV average return of 8.51%.
ECONOMIC ENVIRONMENT
Since the beginning of the 1990s, moderate economic growth and low
inflation have resulted in a general decline in interest rates. Since the end of
1989, the yield on the 2-year U.S. Treasury Note has declined from 7.87% to
5.87%, while the yield on the 30-year U.S. Treasury Bond has declined from 7.93%
to 6.64%. This general decline in rates has been accompanied by a decline in the
yield premium available on corporate bonds over U.S. Treasury securities. As an
example, at the end of 1989, a typical BBB-rated industrial corporate bond
yielded 1.53% more than a similar maturity U.S. Treasury security. By the end of
1996, this yield premium had declined to 0.70%. Taken together, these declines
in rates resulted in the reinvestment of portfolio assets at lower yields and
the need for the reduction in the dividend from $0.11 to $0.095 per share.
The current monthly dividend rate of $0.095 equates to an annualized yield
of 7.16%, based on the closing NAV of $15.91 on December 31, 1996. This remains
a very competitive yield, given the current level of interest rates.
MARKET OUTLOOK
Looking ahead to 1997, we are apprehensive over near term economic
momentum, as the economy ended 1996 on a strong note. Jobs, housing and hourly
earnings all point toward a strong economy, which raises the potential for an
acceleration of inflation and a possible tightening of the Fed's policies. While
our longer-term forecast for more benign economic growth, modest inflation and
declining interest rates remains intact, we are concerned that the near-term
outlook for bonds might be less favorable. We have adopted a short-term
defensive posture for the Company's portfolio, while we wait for the economic
evidence to confirm our longer-term view.
2
<PAGE>
We remain confident in pursuing the Company's investment objective of high
monthly income consistent with prudent investment risk, and thank you for your
continued support.
Sincerely,
MARK H. WILLIAMSON
PRESIDENT
DECEMBER 31, 1996
NOT FDIC-INSURED, MAY LOSE VALUE, NO BANK GUARANTEE SHARES
OF HATTERAS INCOME SECURITIES, INC. ARE NOT DEPOSITS OR OTHER
OBLIGATIONS OF, OR ISSUED, ENDORSED OR GUARANTEED BY NATIONSBANK, N.A. OR ANY
OF ITS AFFILIATES. SUCH SHARES ARE NOT INSURED BY THE U.S. GOVERNMENT, THE
FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD OR ANY OTHER
GOVERNMENT AGENCY. AN INVESTMENT IN THE COMPANY INVOLVES CERTAIN RISKS,
INCLUDING POSSIBLE LOSS OF PRINCIPAL.
NATIONSBANK, N.A. AND ITS AFFILIATES PROVIDE ADVISORY AND OTHER SERVICES TO
THE COMPANY, FOR WHICH THEY ARE COMPENSATED.
* The past performance information quoted represents past performance which
is not an indication of future results. All percentages are based upon NAV as of
December 31, 1996.
** The Lehman Corporate Bond Index is an index based on all publicly issued
intermediate fixed-rate, non-convertible investment grade corporate debt.
*** The Lipper Closed-end Investment Grade Bond Funds Universe includes 15
funds. Lipper Analytical Services, Inc. is an independent monitor of closed-end
fund performance.
3
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS
December 31, 1996
<TABLE>
<CAPTION>
PRINCIPAL MOODY'S S&P
AMOUNT RATING RATING COST MARKET
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
CORPORATE BONDS AND NOTES -- 56.31%
BANKING AND FINANCE -- 10.80%
$ 1,150,000 Crestar Financial Inc., 8.160%
12/15/26**.................................... Baa1 BBB+ $ 1,150,000 $ 1,166,675
1,000,000 First Nationwide Escrow, 10.625% 10/01/03**... Ba3 N/R 1,051,250 1,080,000
1,000,000 Leucadia National Corporation, Sr. Sub. Note,
8.250% 06/15/05............................... Ba1 BBB 1,000,000 1,036,975
500,000 Morgan Stanley Finance plc, 8.030% 02/28/17... A2 A- 501,460 504,500
1,000,000 Security Pacific Corporation, Sub Note,
11.000% 03/01/01.............................. A2 A 1,202,730 1,155,030
750,000 Western Financial Savings Bank, Sub. Deb.,
8.500% 07/01/03............................... Ba3 BB+ 801,540 768,256
Total Banking and Finance: 5,706,980 5,711,436
COMPUTER -- 1.96%
1,000,000 Unisys Corporation, Sr. Note, 10.625%
10/01/99...................................... B1 B+ 1,071,250 1,035,000
ENERGY -- 3.29%
500,000 Maxus Energy Corporation, Notes, 9.375%
11/01/03...................................... B1 BB- 497,500 507,500
1,000,000 Occidental Petroleum Corporation,
Sr. Deb., 10.125% 09/15/09.................... Baa2 BBB 1,301,840 1,234,107
Total Energy: 1,799,340 1,741,607
GAS -- 2.03%
1,000,000 Louis Dreyfus Natural Gas Corporation, Sr. Sub
note, 9.250% 06/15/04......................... Ba3 BB+ 1,086,660 1,073,626
HEALTH CARE -- 4.26%
600,000 Genesis Health Ventures Inc., 9.250%
10/01/06...................................... B1 B 606,250 616,500
500,000 HealthSouth Corporation, 9.500% 04/01/01...... Ba3 BB- 528,125 531,250
1,000,000 Tenet Healthcare Corporation, Sr. Sub Note,
10.125% 03/01/05.............................. Ba3 B+ 1,080,000 1,105,000
Total Health Care: 2,214,375 2,252,750
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS -- (CONTINUED)
December 31, 1996
<TABLE>
<CAPTION>
PRINCIPAL MOODY'S S&P
AMOUNT RATING RATING COST MARKET
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
INDUSTRIAL -- 15.53%
$ 1,000,000 Auburn Hills Trust Certificates, Deb., 12.000%
05/01/20...................................... A3 A- $ 1,418,220 $ 1,523,200
500,000 Fisher Scientific International, Sr. Note,
7.125% 12/15/05............................... Ba2 BBB 467,775 485,171
1,400,000 Harris Corporation,
10.375% 12/01/18.............................. A3 A- 1,565,705 1,562,176
500,000 PDV America Inc.,
7.875% 0/8/01/03.............................. Baa3 B 482,055 500,840
1,000,000 Stone Container Corporation, Sr. Note, 11.875%
12/01/98...................................... B1 B+ 1,035,000 1,053,750
1,000,000 United States Can Company, Sr. Sub. Note,
13.500% 01/15/02.............................. B2 B 1,107,500 1,040,000
1,000,000 Valassis Inserts Inc., Sr. Sub. Note, 9.375%
03/15/99...................................... Ba3 BB- 1,033,570 1,025,016
1,000,000 Westpoint Stevens Incorporated,
8.750% 12/15/01............................... Ba3 BB- 1,000,000 1,023,750
Total Industrial: 8,109,825 8,213,903
INSURANCE -- 6.21%
1,000,000 Conseco Inc., Sr. Note, 10.500%
12/15/04...................................... Ba2 BBB- 1,164,810 1,178,310
1,000,000 Liberty Mutual, Note, 8.500%
05/15/25**.................................... A2 A+ 1,039,090 1,074,509
1,000,000 Pacific Mutual Life Insurance, 7.900%
12/30/23**.................................... A2 AA- 1,034,110 1,030,670
Total Insurance: 3,238,010 3,283,489
MEDIA AND CABLE -- 6.85%
1,000,000 Jones Intercable, Inc., Sr. Note, 9.625%
03/15/02...................................... Ba2 BB 1,002,625 1,050,000
1,000,000 Rogers Cablesystems Limited, Deb., 10.000%
12/01/07...................................... Ba3 BB+ 1,000,000 1,055,000
500,000 Time Warner Inc., Deb.,
9.150% 02/01/2023............................. Ba1 BBB- 521,268 541,839
1,000,000 Viacom Inc., Sr. Note, 7.750% 06/01/05........ Ba2 BB+ 1,025,630 979,299
Total Media and Cable: 3,549,523 3,626,138
</TABLE>
See Notes to Financial Statements.
5
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS -- (CONTINUED)
December 31, 1996
<TABLE>
<CAPTION>
PRINCIPAL MOODY'S S&P
AMOUNT RATING RATING COST MARKET
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
PETROLEUM -- DOMESTIC -- 2.17%
$ 900,000 Coastal Corporation, 10.750% 10/01/10......... Baa3 BB+ $ 1,152,981 $ 1,150,378
PUBLISHING -- 1.09%
500,000 News America Holdings Inc., Sr. Deb., 9.700%
10/30/25...................................... Baa3 BBB 575,085 575,528
RETAIL -- 0.98%
500,000 Federated Dept. Stores,
8.500% 06/15/03............................... Ba1 BB- 497,940 519,646
TRANSPORTATION -- 1.14%
500,000 Federal Express Corporation, Note, 9.650%
06/15/12...................................... Baa2 BBB 503,075 605,438
TOTAL CORPORATE BONDS AND NOTES: 29,505,044 29,788,939
MORTGAGE-BACKED SECURITIES -- 29.49%
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION CERTIFICATES -- 5.51%
1,906,978 8.500% 07/15/26............................... 1,946,011 1,974,915
775,964 9.000% 04/15/09 -- 12/15/16................... 723,769 817,672
112,596 9.500% 07/15/09............................... 106,966 121,638
2,776,746 2,914,225
FEDERAL HOME LOAN MORTGAGE CERTIFICATES -- 7.65%
88,229 9.250% 08/01/08............................... 74,663 93,963
3,951,115 7.500% 06/01/26 Gold Pool..................... 3,936,299 3,956,054
4,010,962 4,050,017
</TABLE>
See Notes to Financial Statements.
6
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS -- (CONTINUED)
December 31, 1996
<TABLE>
<CAPTION>
PRINCIPAL MOODY'S S&P
AMOUNT RATING RATING COST MARKET
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
FEDERAL NATIONAL MORTGAGE ASSOCIATION CERTIFICATES -- 16.33%
$ 3,284,422 6.500% 07/01/11 -- 05/01/26................... $ 3,103,510 $ 3,187,917
1,529,055 7.000% 06/01/11............................... 1,501,341 1,527,144
2,179,983 8.000% 05/01/26............................... 2,187,475 2,219,495
1,273,938 8.500% 12/01/25............................... 1,303,000 1,318,923
359,699 9.250% 09/01/10............................... 326,606 383,529
8,421,932 8,637,008
TOTAL MORTGAGE-BACKED SECURITIES: 15,209,640 15,601,250
TREASURY BONDS AND NOTES -- 8.49%
250,000 United States Treasury Notes 6.625%
06/30/01...................................... 254,395 253,984
19,250,000 United States Treasury Strip 02/15/19......... 4,366,642 4,238,273
TOTAL TREASURY BONDS AND NOTES: 4,621,037 4,492,257
FOREIGN BONDS -- 5.71%
1,000,000 Edelnor, S.A. 7.750% 03/15/06**............... Baa1 BBB 994,510 1,012,980
1,000,000 Hydro-Quebec, 9.500% 04/30/27................. A2 A+ 1,258,470 1,227,495
750,000 Mex-Global, 9.750% 02/06/01................... Ba2 BB 750,000 778,125
TOTAL FOREIGN BONDS: 3,002,980 3,018,600
TOTAL INVESTMENTS $52,338,701* $52,901,046
</TABLE>
* Aggregate cost for Federal tax purposes
** Security exempt from registration under Rule 144A of the Securities Act of
1933. These securities may be resold in transactions exempt from
registration, normally to qualified institutional buyers.
See Notes to Financial Statements.
7
<PAGE>
HATTERAS INCOME SECURITIES, INC.
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1996
<TABLE>
<S> <C>
ASSETS:
Investment in securities, at value (Cost $52,338,701), (Note 1).................................. $52,901,046
Cash............................................................................................. 35,519
Interest receivable.............................................................................. 639,722
Prepaid expenses and other assets................................................................ 21,840
Total assets............................................................................. 53,598,127
LIABILITIES:
Management and advisory fees payable (Note 4).................................................... 26,401
Accrued expenses................................................................................. 41,685
Total liabilities........................................................................ 68,086
NET ASSETS (equivalent to $15.91 per share based on 3,363,512 shares of capital stock
outstanding)..................................................................................... $53,530,041
NET ASSETS CONSIST OF
CAPITAL STOCK -- $1.00 par value (shares authorized, 5,000,000).................................... $ 3,363,512
Paid-in capital.................................................................................. 51,120,191
Distributions in excess of net investment income (Note 1)........................................ (30,000)
Accumulated net realized loss on investments (Note 3)............................................ (1,486,007)
Net unrealized appreciation of investments....................................................... 562,345
NET ASSETS......................................................................................... $53,530,041
</TABLE>
See Notes to Financial Statements.
8
<PAGE>
HATTERAS INCOME SECURITIES, INC.
STATEMENT OF OPERATIONS
For the Year Ended December 31, 1996
<TABLE>
<S> <C> <C>
INVESTMENT INCOME:
Interest............................................................................. $ 4,605,947
EXPENSES:
Management and investment advisory (Note 4).......................................... $302,859
Transfer agent....................................................................... 62,739
Director............................................................................. 25,000
Legal and audit...................................................................... 29,618
Custody (Note 4)..................................................................... 13,030
Printing............................................................................. 17,264
New York Stock Exchange Annual Registration.......................................... 17,569
Miscellaneous........................................................................ 13,261
481,340
Fees paid indirectly (Note 4)........................................................ (5,098)
Total expenses.................................................................. 476,242
NET INVESTMENT INCOME.................................................................. 4,129,705
REALIZED AND UNREALIZED GAIN/LOSS
ON INVESTMENTS (NOTE 4):
Net realized gain on investments..................................................... $ 571,972
Net unrealized appreciation/depreciation of investments.............................. (3,371,350)
Net realized and unrealized loss on investments...................................... (2,799,378)
INCREASE IN NET ASSETS RESULTING FROM OPERATIONS....................................... 1,330,327
</TABLE>
See Notes to Financial Statements.
9
<PAGE>
HATTERAS INCOME SECURITIES, INC.
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR YEAR
ENDED ENDED
12/31/96 12/31/95
<S> <C> <C>
Net investment income............................................................ $ 4,129,705 $ 4,448,368
Net realized gain on investments................................................. 571,972 485,661
Change in unrealized appreciation/depreciation of investments.................... (3,371,350) 4,892,545
Net increase in net assets resulting from investment operations.................. 1,330,327 9,826,574
Dividends to shareholders from investment income................................. (4,129,705) (4,448,368)
Distributions to shareholders in excess of net investment income................. (122,932) (103,041)
Net asset value of 21,830 and 36,423 shares, respectively, of capital stock
issued in dividend reinvestment............................................... 342,914 584,429
Net increase/(decrease) in net assets............................................ (2,579,396) 5,859,594
NET ASSETS:
Beginning of period.............................................................. 56,109,437 50,249,843
End of period.................................................................... $53,530,041 $56,109,437
Distributions in excess of net investment income at end of year.................. $ (30,000) $ (30,000)
</TABLE>
See Notes to Financial Statements.
10
<PAGE>
HATTERAS INCOME SECURITIES, INC.
FINANCIAL HIGHLIGHTS
Selected data for each share of capital stock outstanding throughout each
period:
<TABLE>
<CAPTION>
YEAR YEAR YEAR YEAR YEAR YEAR YEAR YEAR YEAR
ENDED ENDED ENDED ENDED ENDED ENDED ENDED ENDED ENDED
12/31/96 1995 1994 1993 1992 1991 1990 1989 1988
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE
Net asset value at beginning
of year.................... $ 16.79 $ 15.20 $ 16.92 $ 16.08 $ 16.03 $ 14.88 $ 15.99 $ 15.99 $ 16.07
Net investment income...... 1.23 1.35 1.44 1.48 1.50 1.54 1.57 1.64 1.61
Net realized and unrealized
gain/(loss) on investment
transactions............. (0.84) 1.61 (1.71) 0.83 0.05 1.17 (1.11) (0.01) (0.07)
Total from investment
operations............... 0.39 2.96 (0.27) 2.31 1.55 2.71 0.46 1.63 1.54
Less distributions
Dividends from net
investment income........ (1.23) (1.34) (1.45) (1.47) (1.50) (1.56) (1.57) (1.63) (1.62)
Dividends in excess of net
investment income........ (0.04) (0.03) -- -- -- -- -- -- --
Total distributions........ (1.27) (1.37) (1.45) (1.47) (1.50) (1.56) (1.57) (1.63) (1.62)
Net asset value at end of
year....................... $ 15.91 $ 16.79 $ 15.20 $ 16.92 $ 16.08 $ 16.03 $ 14.88 $ 15.99 $ 15.99
Per share market value, end
of period.................. $14.375 $ 16.125 $ 14.875 $ 18.000 $ 18.000 $ 17.500 $ 14.875 $ 15.250 $ 15.000
Total Return:
Per share market value..... -3.32% 17.61% -11.09% 8.40% 12.48% 29.57% 7.63% 12.11% -2.45%
RATIOS AND SUPPLEMENTAL DATA
Net assets, end of year
(millions)............... $53,530 $ 56,109 $ 50,250 $ 55,311 $ 51,871 $ 50,964 $ 46,559 $ 49,665 $ 49,518
Ratio of net operating
expenses to average net
assets (%)............... 0.89% 0.86% 0.92% 0.90% 0.97% 0.99% 1.01% 0.97% 1.01%
Ratio of operating expense
before fees paid
indirectly............... 0.90% 0.89% -- -- -- -- -- -- --
Ratio of net investment
income to average net
assets (%)............... 7.73% 8.07% 8.76% 8.83% 9.29% 9.93% 10.34% 10.15% 9.91%
Portfolio turnover rate
(%)...................... 166.31% 48.75% 28.28% 35.87% 32.35% 27.17% 24.58% 33.49% 58.57%
<CAPTION>
YEAR
ENDED
1987
<S> <C>
PER SHARE OPERATING
PERFORMANCE
Net asset value at beginning
of year.................... $ 17.94
Net investment income...... 1.66
Net realized and unrealized
gain/(loss) on investment
transactions............. (1.31)
Total from investment
operations............... 0.35
Less distributions
Dividends from net
investment income........ (2.22)
Dividends in excess of net
investment income........ --
Total distributions........ (2.22)
Net asset value at end of
year....................... $ 16.07
Per share market value, end
of period.................. $ 17.000
Total Return:
Per share market value..... -5.67%
RATIOS AND SUPPLEMENTAL DATA
Net assets, end of year
(millions)............... $ 49,377
Ratio of net operating
expenses to average net
assets (%)............... 0.95%
Ratio of operating expense
before fees paid
indirectly............... --
Ratio of net investment
income to average net
assets (%)............... 9.80%
Portfolio turnover rate
(%)...................... 48.59%
</TABLE>
See Notes to Financial Statements.
11
<PAGE>
HATTERAS INCOME SECURITIES, INC.
NOTES TO FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES:
Hatteras Income Securities, Inc. (the "Company") is registered under the
Investment Company Act of 1940, as amended, as a closed-end diversified
investment management company.
A summary of significant accounting policies followed by the Company, all of
which are in conformity with generally accepted accounting principles,
follows. The presentation of financial statements in accordance with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts and disclosures
in the financial statements. Actual results may differ from those estimates.
A. Security Valuation:
Portfolio securities listed on an exchange are valued at the closing
sales price taken from the exchange on which the security is primarily
traded, and listed securities for which there is no sale on the
valuation date and securities traded in only the over-the-counter market
are valued at the closing bid price unless the Company's investment
adviser determines that market quotations are not readily available for
institutional size holdings, in which case such securities are valued in
good faith at fair market value under the direction of the Company's
Board of Directors. Short-term investments that have a remaining
maturity of 60 days or less are valued at amortized cost which
approximates market value. Restricted securities and other debt
obligations purchased in private transactions for which no quotations
are readily available are also valued in good faith at fair market value
by or under the direction of the Company's Board of Directors.
B. Federal Income Tax:
It is the Company's policy to comply with the requirements of the
Internal Revenue Code, as amended, applicable to regulated
investment companies and to distribute substantially all of its
taxable income to shareholders. Therefore, no Federal income or
excise tax provision is required.
C. Investment Policy
At least 70% of the Company's total assets will be invested in:
a) debt securities which are rated at the time of purchase as
Baa (Moody's Investors Service, Inc. ("Moody's")) or BBB
(Standard & Poor's Corporation ("S&P")) or better, b) securities
of, or guaranteed by, the U.S. Government, its agencies or
instrumentalities, c) securities of, or guaranteed by, the
Government of Canada or of a Province of Canada or political
subdivision thereof, such securities not to exceed 25% of the
Company's total assets, d) obligations of, or guaranteed by,
banks, savings and loan institutions or their holding companies,
which obligations, although not rated as a matter of policy by
either Moody's or S&P, either are rated in the four highest
ratings assigned by Fitch Investors Service, Inc. (AAA, AA, A or
BBB), or if not rated are considered by the Company's investment
adviser to be of investment quality comparable to securities
described under item a, e) commercial paper considered by the
Company's investment adviser to be of investment quality
comparable to securities which may be purchased under item a
above, and f) cash or cash equivalents.
12
<PAGE>
HATTERAS INCOME SECURITIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
D. Security Transactions and Investment Income
Security transactions are accounted for on the date
securities are purchased or sold. Dividend income is
recorded on the ex-dividend date. Interest income is
recognized daily on the accrual basis. Original issue
discount is amortized using the effective yield method.
Market discount and premiums on securities are not
amortized. The Company maintains a general allowance for
uncollected interest on the high yield portion of its
Portfolio. At December 31, 1996, this allowance was $30,000.
Interest receivable is shown net of this allowance.
E. Dividends & Distributions to Shareholders.
Dividends from net investment income, if any, are
declared and paid monthly. Net realized capital gains
(including net short-term capital gains) are distributed
at least annually. The amount and character of income
and gains to be distributed are determined in accordance
with income tax regulations which may differ from
generally accepted accounting principles. These
differences are due primarily to the treatment of market
discount. Reclassifications are made to the Company's
capital accounts to reflect income and gains available
for distribution (or available capital loss carryovers)
under income tax regulations. For the year ended
December 31, 1996, the Company reclassified $121,932 to
increase undistributed net investment income, $51,011 to
increase accumulated net realized loss on investments
and $70,921 to decrease capital surplus.
2. PURCHASES AND SALES OF SECURITIES:
Net realized gains or losses from investment transactions during the period
have been computed using the first-in, first-out method of determining the
cost of securities sold or matured. Purchases and sales (including
maturities) of securities during the year ended December 31, 1996 are
summarized as follows:
<TABLE>
<CAPTION>
SALES AND
PURCHASES MATURITIES
<S> <C> <C>
Corporate Bonds.................................................. $ 35,579,755 $ 52,574,854
U.S. Governments and Agencies (Long-term)........................ 48,199,199 31,819,650
Foreign Municipal Bonds.......................................... 4,663,917 2,815,897
Total..................................................... $ 88,442,871 $ 87,210,401
</TABLE>
At December 31, 1996, net unrealized appreciation for financial reporting and
Federal income tax purposes aggregated $562,345 of which $1,052,056 related
to appreciated securities and $489,711 related to depreciated securities. The
aggregate cost of investment securities owned for financial reporting and
federal income tax purposes was $52,338,701.
3. CAPITAL LOSS CARRYFORWARD:
At December 31, 1996 approximately $1,486,007 is available to offset future
capital gains of which $138,935 expires in 1998, $822,917 expires in 1999,
$47,580 expires in 2000 and $476,575 expires in 2002. Management does not
plan to distribute to shareholders any future net realized gains on
investments until the capital loss carryforwards are used or expired.
13
<PAGE>
HATTERAS INCOME SECURITIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
4. MANAGEMENT AND INVESTMENT ADVISORY FEES AND OTHER RELATED PARTY
TRANSACTIONS:
Effective January 1, 1996, the Company entered into an investment advisory
agreement (the "Advisory Agreement") with NationsBanc Advisors, Inc.
("NBAI") a wholly-owned subsidiary of NationsBank, N.A. ("NationsBank").
Under the terms of the Advisory Agreement, the Company pays NBAI an annual
fee equal to the sum of (i) 0.45% per annum of the first $75,000,000 of the
average weekly net assets and at a reduced rate for net assets in excess of
that amount, and (ii) 1.5% of the gross income. The fee is computed and
accrued weekly and paid monthly. The agreement provides that if certain
recurring expenses, including the advisory and management fee, exceed 1.5%
of the first $30,000,000 in average net assets annually and 1.0% of average
net assets in excess thereof (or pro-rata portion for any fraction of a
year), the investment advisory fee will be reduced by the amount by which
such expenses exceed the limitation. There was no reduction in the fee for
the year ended December 31, 1996. Prior to January 1, 1996, NationsBank
acted as investment advisor to the Company. The investment advisory fees
under the new Advisory Agreement are the same as those paid under the prior
agreement.
The Company and NBAI have entered into a sub-advisory agreement
("Sub-Advisory Agreement") with TradeStreet Investment Associates, Inc.
("TradeStreet") a wholly-owned subsidiary of NationsBank. Under the terms of
the Sub-Advisory Agreement, TradeStreet is entitled to receive from NBAI a
sub-advisory fee equal to an annual rate of 0.15% of the Company's average
weekly net assets.
NationsBank of Texas, N.A. (the "Custodian") serves as the custodian of the
Company's assets. For the nine month period ending December 31, 1996 the
Custodian received $5,932 for its services. Prior to April 1, 1996,
Citibank, N.A. ("Citibank") served as the custodian for the Company. For the
period January 1, 1996 through March 31, 1996 the Company received an
earnings credit totaling $5,098 on daily cash balances held at Citibank,
which was then applied to the custody fee charged by Citibank. On October
18, 1996, The Bank of New York became the sub-custodian for the Company.
No officer, director or employee of NationsBank, NBAI, TradeStreet, or
ChaseMellon, or any affiliate thereof, receives any compensation from the
Company for serving as a Director or Officer of the Company. The Company
pays the Chairman an annual fee of $11,000 and each other director an annual
fee of $7,000.
ChaseMellon serves as transfer agent and dividend disbursing agent for the
Company.
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HATTERAS INCOME SECURITIES, INC.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
of Hatteras Income Securities, Inc.
In our opinion, the accompanying statement of assets and liabilities, including
the portfolio of investments (except bond ratings), 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 Hatteras Income
Securities, Inc. (the "Company") at December 31, 1996, the results of its
operations and the changes in net assets and the financial highlights for 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 Company'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
December 31, 1996 by correspondence with the custodian, provide a reasonable
basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Boston, Massachusetts
February 17, 1997
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HATTERAS INCOME SECURITIES, INC.
DIVIDEND REINVESTMENT PLAN
THE PLAN
The Company's Dividend Reinvestment Plan (the "Plan") offers you an
automatic way to reinvest your dividends and capital gains distributions in
shares of the Company.
PARTICIPATION
Shareholders of record will receive their dividends in cash unless they
have instructed ChaseMellon Shareholder Services (the "Plan Agent") in writing
otherwise. Such a notice must be received by the Plan Agent not less than 5
business days prior to the record date for a dividend or distribution in order
to be effective with respect to that dividend or distribution. A notice which is
not received by that time will be effective only with respect to subsequent
dividends and distributions.
Shareholders who do not participate in the Plan will receive all
distributions by check mailed directly to the shareholder by the Plan Agent, as
the dividend paying agent. For Federal income tax purposes, dividends are
treated as income or capital gains, regardless of whether they are received in
cash or reinvested in additional shares.
Participants may terminate their participation in the Plan by written
notice to the Plan Agent. If the written notice is received at least 5 business
days before the record day of any distribution, it will be effective
immediately. If received after that date, it will be effective as soon as
possible after the reinvestment of the dividend or distribution.
PRICING OF DIVIDENDS AND DISTRIBUTIONS
Whenever the Company's Board of Directors declares a dividend or other
distribution payable in cash or at the option of the Plan Agent, as agent for
all participants, in shares of capital stock issued by the Company, the Plan
Agent will elect on behalf of the participants to receive the dividend in
authorized but unissued shares of capital stock if the net asset value per share
(as determined by the investment adviser of the Company as of the close of
business on the record date for the dividend or distribution) is equal to or
less than 95% of the closing market price per share of the capital stock of the
Company on the New York Stock Exchange (the "Exchange") on such record date plus
estimated brokerage commissions. The number of such authorized but unissued
shares to be credited to a participant's account will be determined as of the
close of business on the record date for the dividend, by valuing such shares at
the greater of the net asset value per share or 95% of the market price per
share. The Plan Agent will credit each participant's account with the number of
shares corresponding in value, as determined under the foregoing formula, to the
amount such participant would have received in cash had such participant not
elected to participate in this Plan.
If the net asset value per share is equal to or less than the closing
market price per share of the capital stock of the Company on the Exchange on
such record date plus estimated brokerage commissions, but exceeds 95% of such
closing market price plus estimated brokerage commissions, the Plan Agent may
elect on behalf of all participants (i) to take the dividend in cash and as soon
as practicable thereafter, consistent with obtaining the best price and
execution, proceed to purchase in one or more transactions the shares of capital
stock in the open market, at the then current price as hereinafter provided, and
will credit each participant's account with the number of shares corresponding
in value, as determined by the price actually paid on the open market for such
shares including brokerage expenses, to the amount such participant would have
received in cash had such participant not elected to participate in this Plan or
(ii) to receive the dividend in authorized but unissued shares of capital stock,
in which case the Plan Agent will credit each participant's
16
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account with the number of shares corresponding in value (determined by valuing
such shares at the greater of the net asset value per share or 95% of the market
price per share, in each case as of the close of business on the record date for
the dividend or distribution) to the amount such participant would have received
in cash had such participant not elected to participate in this Plan.
If the net asset value per share is higher than the closing market price
per share of the capital stock on the New York Stock Exchange plus estimated
brokerage commissions on such record date, the Plan Agent will elect to take the
dividend in cash and as soon as practicable thereafter, consistent with
obtaining the best price and execution, proceed to purchase in one or more
transactions the shares of capital stock in the open market, at the then current
price as hereinafter provided, and will credit each participant's account with
the number of shares corresponding in value, as determined by the price actually
paid on the open market for such shares including brokerage expenses, to the
amount such participant would have received in cash had such participant not
elected to participate in this Plan. Under such circumstances, in anticipation
of receipt of a dividend in cash, the Plan Agent may purchase shares in the open
market during the period between the record date and the payable date for the
dividend or distribution. The Plan has been amended to specifically authorize
such anticipatory purchases.
NO SERVICE FEE TO REINVEST
There is no service fee charged to participants for reinvesting dividends
or distributions from net realized capital gains. The Plan Agent's fees for the
handling of the reinvestment of dividends and capital gains distributions will
be paid by the Company. There will be no brokerage commissions with respect to
shares issued directly by the Company as a result of dividends or capital gains
distributions payable either in stock or in cash. However, participants will pay
a pro rata share of brokerage commissions incurred with respect to the Plan
Agent's open market purchases in connection with the reinvestment of any
dividends or capital gains distributions payable only in cash.
PLAN AGENT ADDRESS AND TELEPHONE NUMBER
You may obtain more detailed information by requesting a copy of the Plan
from the Plan Agent. All correspondence (including notifications) should be
directed to: ChaseMellon Shareholder Services, Agent for Hatteras Income
Securities, Inc., Dividend Reinvestment Department, P.O. Box 24850, Church
Street Station, New York, New York 10249, (800) 851-9677.
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MEETING OF STOCKHOLDERS
On June 12, 1996, the Company held its Annual Meeting of Stockholders (the
Annual Meeting was originally scheduled to be held on May 24, 1996 but was
adjourned for the purpose of obtaining sufficient votes to achieve a quorum). A
proposal to remove a fundamental investment restriction prohibiting the company
from purchasing securities of other investment companies was approved by the
following votes: 1,707,619 For, 68,629 Against, 63,874 Abstaining. At the Annual
Meeting, the following directors were elected by the following votes: (i)
William H. Grigg 1,805,529 For, 34,593 Against (ii) Thomas F. Keller 1,805,509
For, 34,613 Against, (iii) A. Max Walker 1,801,786 For, 38,336 Against. In the
only other matter voted upon at the Annual Meeting, the selection of Price
Waterhouse LLP as the Company's independent public accountants for the fiscal
year ending December 31, 1996, was ratified by the following votes: 1,707,020
For, 68,629 Against, 63,874 Abstaining.
18
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CHANGE OF NON-FUNDAMENTAL INVESTMENT POLICY
On April 16, 1996, the Board of Directors of the Company unanimously
approved two new investment policies of the Company. Because the new investment
policies were nonfundamental, the approval of the stockholders of the Company
was not required. The first new investment policy permits the Company to invest
in money market instruments, which may include, without limitation: securities
issued or guaranteed by the U.S. Government or its agencies or
instrumentalities; obligations of banks subject to regulation by the U.S.
Government and having total assets of $1 billion or more; Eurodollar
certificates of deposit; obligations of savings banks and savings and loan
associations having total assets of $1 billion or more; fully insured
certificates of deposit; and commercial paper rated within the highest grade by
Moody's Investors Service, Inc. ("Moody's") or Standard & Poor's Corporation
("S&P") or, if not rated, issued by a company having an outstanding long-term
debt issue rated AAA by S&P or Aaa by Moody's. The second new investment policy
expressly authorizes the Company to purchase securities issued by other
investment companies, to the extent that such investments are consistent with
the Company's investment objectives and policies and permissible under the
Investment Company Act of 1940, as amended.
The net effect of these two new investment policies, in combination with
the removal of a fundamental investment restriction prohibiting the Company from
purchasing securities of other investment companies (the removal of such
fundamental investment restriction was approved by the stockholders of the
Company at the Company's Annual Meeting of Stockholders), is to facilitate the
Company's entering into a program in which the Company's available cash would be
"swept" into money market funds of various investment companies on an overnight
basis, significantly supplementing the Company's short-term cash management
activities.
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BOARD OF DIRECTORS
A. MAX WALKER, Chairman
FINANCIAL CONSULTANT
WILLIAM H. GRIGG
CHAIRMAN OF THE BOARD
AND CHIEF EXECUTIVE OFFICER,
DUKE POWER COMPANY
THOMAS F. KELLER
RETIRED DEAN,
FUQUA SCHOOL OF BUSINESS,
DUKE UNIVERSITY
FUND OFFICERS
MARK H. WILLIAMSON
PRESIDENT
EDWARD D. BEDARD
CHIEF FINANCIAL OFFICER
ROBERT B. CARROLL
SECRETARY
RICHARD S. SZAFRAN
TREASURER
MARK S. AHNRUD, CFA
ASSISTANT SECRETARY AND
PORTFOLIO MANAGER
OFFICE OF THE COMPANY
Hatteras Income Securities, Inc.
One NationsBank Plaza -- NC1-002-33-31
Charlotte, North Carolina 28255
INVESTMENT ADVISER
NationsBanc Advisors, Inc.
One NationsBank Plaza
Charlotte, North Carolina 28255
SUB-INVESTMENT ADVISER
TradeStreet Investment Associates, Inc.
One NationsBank Plaza
Charlotte, North Carolina 28255
FUND COUNSEL
Morrison & Foerster LLP
2000 Pennsylvania Avenue, N.W.
Suite 5500
Washington, D.C. 20006
CUSTODIAN
NationsBank of Texas, N.A.
1401 Elm Street -- 11th Floor
Dallas, TX 75202
SUB-CUSTODIAN
The Bank of New York
90 Washington St.
New York, NY 10286
TRANSFER AGENT
ChaseMellon Shareholder Services
450 West 33rd Street 15th Floor
New York, NY 10001
INDEPENDENT ACCOUNTING FIRM
Price Waterhouse LLP
160 Federal Street
Boston, MA 02110
