[Logo appears here]
HATTERAS
INCOME
SECURITIES,
INC.
Semi-Annual Report
To Shareholders
June 30, 1998
<PAGE>
Dear Shareholder:
We are pleased to present the semi-annual report for Hatteras Income
Securities, Inc. (the "Company") for the six-month period ended June 30, 1998.
Investment Objective
The Company is a closed-end investment company registered under the
Investment Company Act of 1940, 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.
Market Review and Performance Update*
In early 1998, Federal Reserve Board ("Fed") policy makers were uncertain
about whether the magnitude and timing of the weakness resulting from the
economic situation in Asia was going to be sufficient to slow the strong
domestic economy. More recently, the uncertainty seems to have shifted from the
sustainability of strong growth in the face of the Asian crisis, to the extent
of the slowdown in domestic growth despite signs that Asian policies are
becoming more supportive. We expect that the Fed will remain patient, as
uncertainty is high and inflation is low. Interest rates declined modestly
during the second quarter of 1998, as the flight-to-quality trend in the U.S.
Treasury market was supported by slower gross domestic product growth.
The possibility of a domestic slowdown is rooted both in the Asian
financial crisis and a domestic inventory correction. The Purchasing Managers
Index, a commonly cited indicator of manufacturing activity, dropped below 50%
in June for the first time in two years and averaged 51.3% for the second
quarter, down from 53.5% in the first quarter. The key going forward will be if
this slowdown in production will cool job creation and lead to a decline in
income and spending. The Fed has expressed a desire to relieve some of the
strain on tight labor markets, but this will require a sustained period of
below-trend (2.5%) growth, not simply a soft second quarter. Job growth averaged
278,000 in the second quarter, up from 243,000 in the first quarter, and average
hourly earnings are up 4.1% year-over-year. This strength, combined with
modestly lower interest rates, continues to support the consumer sector.
Further, new home sales and motor vehicle sales remain very strong. The consumer
is showing no signs of taking a breather.
The 30 year U.S. Treasury bond yield began the year at 5.92% and rose to as
high as 6.08% before falling to a low of 5.63% at the end of June. In this
relatively stable interest rate environment, the Company posted a positive total
return of 4.10% for the period based on its net asset value ("NAV") which is in
line with the 4.09% return for the Lipper Closed-end Investment Grade Bond Fund
Average for the same period.**
The Company's performance was driven by two primary factors during the
period. The Company suffered from its heavy exposure to corporate bonds, as
concerns over corporate earnings caused the performance of this sector to lag
Treasuries. This was offset, however, by the company's maintaining a longer
duration bias, a strategy that benefited from the decline in interest rates
during the period.
Of course, a better measure of the Company's success is performance over
longer time horizons. Over the five-year period ended June 30, 1998, the Company
delivered an average annual return of 7.68%, based on NAV, which compares well
with the return of the Merrill Lynch Corporate Master Index of 7.74% and the
Lipper Closed-end Investment Grade Bond Fund Average of 7.79% over the same
period.**
In June, the Board of Directors for the Company declared a dividend of
$0.085 per share for shareholders of record on June 15, 1998. This is a
reduction of $0.01 per share from the previous month's dividend and the first
change in the dividend rate since October 1996. The reduced rate reflects the
dramatic decline in interest rates over that time period. For example, the yield
on the 10-year U.S. Treasury note declined from 6.64% to 5.45% from October 1996
to June 1998. Since the Company's dividend is impacted by the prevailing
interest
2
<PAGE>
rate environment, the decline in interest rates has resulted in an adjustment of
the monthly dividend. The Company's shares have an annualized yield of 6.97%
based on the closing market value of $14.625 per share on June 30, 1998. This
remains a very competitive yield on the portfolio compared to the Merrill Lynch
Corporate Master Index at 6.41%, as of the same date.
Market Outlook
Looking ahead, we believe that the fixed income market will continue to
trade in a narrow range, caught between evidence that the economy is slowing and
the fact that dramatically lower rates would be difficult to achieve with the
Fed on hold and the yield curve already very flat. We will focus on seeking
opportunities to add income to the portfolio and wait for a clearer picture to
develop on the ultimate impact of the Asian economic slowdown.
We thank you for your continued support.
Sincerely,
ROBERT H. GORDON
President
June 30, 1998
* The past performance information quoted is not an indication of future
results.
** The Merrill Lynch Corporate Master Index consists of fixed-rate, coupon
bearing bonds with an outstanding par value greater than or equal to $25
million, a maturity range greater than or equal to one year and bond ratings of
BBB/Baa3 and above. The Lipper Closed-end Investment Grade Bond Funds Universe
includes 16 funds. Lipper Analytical Services, Inc. is an independent monitor of
closed-end fund performance.
3
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS
June 30, 1998 (unaudited)
<TABLE>
<CAPTION>
Moody's S&P
Principal Rating Rating Market
Amount (Unaudited) (Unaudited) Value
<S> <C> <C> <C> <C>
CORPORATE BONDS AND NOTES -- 60.8%
BANKING AND FINANCE -- 11.8%
$ 500,000 Amsouth Bank of Alabama
6.450% 02/01/18 ....................... A1 A- $ 514,602
500,000 FCB/NB Capital Trust I
8.050% 03/01/28 ....................... Baa3 BB+ 524,455
700,000 First Nationwide Escrow,
10.625% 10/01/03** .................... Ba3 N/R 773,500
750,000 Great Western Financial
8.206% 02/01/27 ....................... A3 BBB- 829,072
500,000 Lehman Brothers Inc.
11.625% 05/15/05 ...................... Baa1 A 645,059
1,000,000 Security Pacific Corporation, Sub Note,
11.000% 03/01/01 ...................... A1 A 1,118,184
550,000 Union Planters Trust
6.500% 03/15/18 ....................... Baa1 BBB 551,499
1,000,000 Western Financial Savings Bank, Sub.
Deb., 8.500% 07/01/03 ................. B1 BB+ 979,847
500,000 Wilmington Trust
6.625% 5/1/08 ......................... Baa2 A- 499,390
----------
Total Banking and Finance: 6,435,608
----------
CONTAINERS -- 1.5%
750,000 BWAY Corporation, Sr. Note,
10.250% 04/15/07 ...................... B2 B 817,500
----------
ELECTRIC UTILITY -- 1.4%
750,000 Dominion Capital, Sr. Note,
7.830% 12/01/27 ....................... Baa1 BBB+ 786,494
----------
ENERGY -- 4.7%
800,000 Barrett Resources Corporation, Notes,
7.550% 02/01/07 ....................... Ba1 BB+ 837,140
700,000 Occidental Petroleum Corporation, Sr.
Deb., 10.125% 09/15/09 ................ Baa2 BBB 898,073
800,000 PDV America Inc.,
7.875% 0/8/01/03 ...................... Baa3 BB- 835,257
----------
Total Energy: 2,570,470
----------
See Notes to Financial Statements.
</TABLE>
4
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS -- (Continued)
June 30, 1998 (unaudited)
<TABLE>
<CAPTION>
Moody's S&P
Principal Rating Rating Market
Amount (Unaudited) (Unaudited) Value
<S> <C> <C> <C> <C>
FINANCIAL\BROKERAGE -- 3.3%
$ 775,000 Morgan Stanley Finance plc,
8.030% 02/28/17 .......................... A2 A- $ 876,570
835,000 Paine Webber Group, Inc., Notes,
7.625% 00/00/00 .......................... Baa1 BBB+ 903,918
----------
Total Financial\Brokerage: 1,780,488
----------
GAS -- 2%
1,000,000 Louis Dreyfus Natural Gas Corporation,
Sr. Sub note, 9.250% 06/15/04 ............ Ba3 BB+ 1,110,661
----------
HEALTH CARE -- 3.5%
600,000 Genesis Health Ventures Inc.,
9.250% 10/01/06 .......................... B2 B- 606,000
500,000 Quorum Health Group, Inc.,
8.750% 00/00/00 .......................... Ba3 BB- 515,000
750,000 Tenet Healthcare Corporation:
Sr. Notes, 8.000% 01/15/05 ............... BA1 BB 776,250
----------
Total Health Care: 1,897,250
----------
INDUSTRIAL -- 11.1%
325,000 Alaris Medical Systems
9.750% 12/1/06 ........................... B3 B- 333,125
665,000 Auburn Hills Trust Certificates, Deb.,
12.000% 05/01/20 ......................... A3 A 1,093,915
500,000 Beckman Instruments
7.050% 6/1/26 ............................ Ba1 NR 503,860
500,000 Coltec Industries
7.500% 4/15/08 ........................... Ba2 BB 495,000
500,000 Enterprise Rent A Car
6.625% 2/15/05 ........................... Baa2 BBB 502,045
500,000 Fisher Scientific International, Sr. Note,
7.125% 12/15/05 .......................... B1 B+ 481,781
650,000 Owens Illinois
7.150% 5/15/05 ........................... Ba1 BB+ 655,624
525,000 Raytheon Co.
7.375% 07/15/25 .......................... Baa1 BB- 548,438
See Notes to Financial Statements.
</TABLE>
5
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS -- (Continued)
June 30, 1998 (unaudited)
<TABLE>
<CAPTION>
Moody's S&P
Principal Rating Rating Market
Amount (Unaudited) (Unaudited) Value
<S> <C> <C> <C> <C>
INDUSTRIAL -- 11.1% -- (continued)
$ 600,000 USA Waste Services, Inc.,
7.125% 12/15/17 ....................... Baa3 BBB $ 619,676
750,000 Zurich Capital Trust
8.376% 06/01/37 ....................... Aa2 AA 832,514
----------
Total Industrial: 6,065,978
----------
INSURANCE -- 3.6%
750,000 Conseco Inc., Sr. Note,
8.796% 04/01/27 ....................... Ba2 BBB- 852,098
1,000,000 Leucadia National Corporation, Sr. Sub.
Note, 8.250% 06/15/05 ................. Ba1 BBB 1,088,198
----------
Total Insurance: 1,940,296
----------
MEDIA AND CABLE -- 9.1%
700,000 Jones Intercable, Inc., Sr. Note,
9.625% 03/15/02 ....................... Ba2 BB 754,250
750,000 Primedia Inc.
7.625% 04/01/08 ....................... Ba3 BB- 729,375
1,000,000 Rogers Cablesystems Limited, Deb.,
10.000% 12/01/07 ...................... Ba3 BB+ 1,110,000
1,025,000 Time Warner Incorporated
9.125% ................................ Baa3 BBB- 1,237,688
1,000,000 Viacom Inc., Sr. Note,
7.750% 06/01/05 ....................... Ba2 BB+ 1,069,804
----------
Total Media and Cable: 4,901,117
----------
PAPER & FOREST PRODUCTS -- 1.7%
750,000 Georgia-Pacific,
9.500% 12/01/11 ....................... Baa2 BBB- 933,117
----------
PUBLISHING -- 1.6%
750,000 News America Holdings Inc., Sr. Deb.,
10.250% 10/15/12 ...................... Baa3 BBB 880,691
----------
See Notes to Financial Statements.
</TABLE>
6
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS -- (Continued)
June 30, 1998 (unaudited)
<TABLE>
<CAPTION>
Moody's S&P
Principal Rating Rating Market
Amount (Unaudited) (Unaudited) Value
<S> <C> <C> <C> <C>
TELECOMMUNICATIONS -- 3.7%
$1,000,000 GTE Corporation., Sr. Deb.,
7.900% 02/01/27 ......................... Baa1 A $ 1,067,366
650,000 Martin Marietta Technology
7.750% 04/15/23 ......................... A3 BBB+ 692,825
250,000 Paramount Communications
7.500% 07/15/23 ......................... Ba2 BB+ 250,076
-----------
Total Telecommunications: 2,010,267
-----------
TRANSPORTATION -- 1.8%
750,000 Federal Express Corporation, Note,
9.650% 06/15/12 ......................... Baa2 BBB 979,288
-----------
Total Corporate Bonds and Notes:
(Cost $32,222,299)....................... 33,109,225
===========
MUNICIPAL BONDS -- 1.2%
650,000 Massachusetts State Port Authority
6.350% 07/01/07 (Cost $647,316).......... Aa3 AA- 658,884
-----------
FOREIGN BONDS AND NOTES -- 0.9%
525,000 United Mexican States
8.625% 03/12/08 (Cost $524,850).......... Ba2 BB 507,938
-----------
</TABLE>
See Notes to Financial Statements.
7
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS -- (Continued)
June 30, 1998 (unaudited)
<TABLE>
<CAPTION>
Principal Market
Amount Value
<S> <C> <C> <C>
MORTGAGE-BACKED SECURITIES -- 14.5%
GOVERNMENT NATIONAL MORTGAGE
ASSOCIATION CERTIFICATES -- 3.5%
$ 1,173,476 8.000% 09/15/24 .............................. $ 1,215,650
586,967 9.000% 04/15/09 -- 12/15/16 .................. 628,055
81,119 9.500% 07/15/09 .............................. 87,583
-----------
Total: 1,931,288
-----------
FEDERAL HOME LOAN MORTGAGE
CERTIFICATES -- 0.1%
65,869 9.250% 08/01/08 .............................. 69,770
-----------
FEDERAL NATIONAL MORTGAGE ASSOCIATION
CERTIFICATES -- 10.9%
3,496,396 6.500% 07/01/11 -- 05/01/27 .................. 3,458,177
1,696,172 7.000% 06/01/11 -- 04/01/27 .................. 1,702,537
262,000 8.000% 01/01/28 .............................. 261,212
178,833 9.000% 05/01/27 .............................. 188,645
295,491 9.250% 09/01/10 .............................. 311,767
-----------
Total: 5,922,338
-----------
Total Mortgage-Backed Securities:
(Cost $7,517,983)............................. 7,923,396
===========
TREASURY BONDS AND NOTES --
21% United States Treasury Bonds:
7,700,000 12.000% due 08/15/13
(Cost $11,271,748)............................ 11,434,500
-----------
TOTAL INVESTMENTS (Cost 52,184,195) .......... 98.4% 53,633,943
OTHER ASSETS AND LIABILITIES (Net) ........... 1.6% 851,034
----- -----------
NET ASSETS ................................... 100.0% $54,484,977
===== ===========
</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.
8
<PAGE>
HATTERAS INCOME SECURITIES, INC.
STATEMENT OF ASSETS AND LIABILITIES
June 30, 1998
<TABLE>
<S> <C>
ASSETS:
Investment in securities, at value (Note 1) ......................................... $ 53,633,943
Interest receivable ................................................................. 1,003,858
Prepaid expenses and other assets ................................................... 16,592
------------
Total assets .................................................................... 54,654,393
------------
LIABILITIES:
Due to custodian bank ............................................................... 97,886
Management and advisory fees payable (Note 4) ....................................... 25,341
Accrued expenses .................................................................... 46,189
------------
Total Liabilities ............................................................... 169,416
------------
NET ASSETS (equivalent to $16.20 per share based on 3,363,512 shares of capital stock
outstanding) ........................................................................ $ 54,484,977
============
Investments, at cost .................................................................. $ 52,184,195
============
NET ASSETS CONSIST OF:
CAPITAL STOCK -- $1.00 par value (shares authorized, 5,000,000)........................ $ 3,363,512
Paid-in capital ..................................................................... 51,162,365
Undistributed net investment income (Note 1 ) ....................................... 88,150
Accumulated net realized loss on investments (Note 3) ............................... (1,578,798)
Net unrealized appreciation of investments .......................................... 1,449,748
------------
NET ASSETS ............................................................................ $ 54,484,977
============
</TABLE>
See Notes to Financial Statements.
9
<PAGE>
HATTERAS INCOME SECURITIES, INC.
STATEMENT OF OPERATIONS
For the Period Ended June 30, 1998 (unaudited)
<TABLE>
<S> <C> <C>
INVESTMENT INCOME:
Interest ......................................................... $2,121,354
----------
EXPENSES:
Management and investment advisory (Note 4) ...................... 158,391
Transfer agent ................................................... 30,649
Director ......................................................... 12,397
Legal and audit .................................................. 15,050
Custody (Note 4) ................................................. 6,518
Printing ......................................................... 13,215
New York Stock Exchange Annual Registration ...................... 8,074
Miscellaneous .................................................... 9,329
-------
Total expenses ................................................. 253,623
Fees reduced by credit allowed by custodian (Note 4) ............. (2,777)
-------
Net expenses ................................................... 250,846
-------
NET INVESTMENT INCOME ............................................. 1,870,508
----------
REALIZED AND UNREALIZED GAIN
ON INVESTMENTS (Note 2):
Net realized gain on investments during period ................... 61,593
Net unrealized appreciation of investments during period ......... 235,551
----------
Net realized and unrealized gain on investments .................. 297,144
----------
INCREASE IN NET ASSETS RESULTING FROM OPERATIONS .................. $2,167,652
==========
</TABLE>
See Notes to Financial Statements.
10
<PAGE>
HATTERAS INCOME SECURITIES, INC.
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Period
Ended Year
6/30/98 Ended
(unaudited) 12/31/97
--------------- ---------------
<S> <C> <C>
Net investment income .................................................. $ 1,870,508 $ 3,827,095
Net realized gain on investments ....................................... 61,593 26,332
Change in unrealized appreciation of investments ....................... 235,551 651,852
------------ ------------
Net increase in net assets resulting from investment operations ........ 2,167,652 4,505,279
Dividends to shareholders from investment income ....................... (1,870,508) (3,827,095)
Distributions to shareholders in excess of net investment income ....... (13,066) (7,326)
------------ ------------
Net decrease in net assets ............................................. 284,078 670,858
NET ASSETS:
Beginning of period .................................................... 54,200,899 53,530,041
------------ ------------
End of period .......................................................... $ 54,484,977 $ 54,200,899
============ ============
Undistributed net investment income at end of period ................... $ 88,150 $ 101,216
============ ============
</TABLE>
See Notes to Financial Statements.
11
<PAGE>
HATTERAS INCOME SECURITIES, INC.
FINANCIAL HIGHLIGHTS
Selected data for each share of capital stock outstanding throughout each
period:
<TABLE>
<CAPTION>
Period
Ended Year Year Year Year
6/30/98 Ended Ended Ended Ended
(unaudited) 12/31/97 1996 1995 1994
---------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Per Share Operating Performance
Net asset value at beginning of year ....... $ 16.11 $ 15.91 $ 16.79 $ 15.20 $ 16.92
Net investment income ..................... 0.56 1.18 1.23 1.35 1.44
Net realized and unrealized gain/(loss)
on investment transactions ............... 0.09 0.16 ( 0.84) 1.61 ( 1.71)
-------- --------- --------- -------- ---------
Total from investment operations .......... 0.65 1.34 0.39 2.96 ( 0.27)
Less distributions
Dividends from net investment
income.................................... ( 0.56) ( 1.14) ( 1.23) ( 1.34) ( 1.45)
Dividends in excess of net investment
income.................................... ( 0.00)(a) --(a) ( 0.04) ( 0.03) --
--------- --------- --------- --------- ---------
Total distributions ....................... ( 0.56) ( 1.14) ( 1.27) ( 1.37) ( 1.45)
--------- --------- --------- --------- ---------
Net asset value at end of period ........... $ 16.20 $ 16.11 $ 15.91 $ 16.79 $ 15.20
========= ========= ========= ========= =========
Per share market value, end of period ...... $ 14.625 $ 14.875 $ 14.375 $ 16.125 $ 14.875
Total Return:
Per share market value .................... 2.89 % 11.03 % -3.32% 17.61 % -11.09%
Ratios and Supplemental Data
Net assets, end of period or year
(millions) ............................... $ 54,485 $ 54,201 $ 53,658 $ 56,109 $ 50,250
Ratio of net operating expenses to
average net assets (%) ................... 0.93 %+ 0.94 % 0.89 % 0.86 % 0.92 %
Ratio of operating expense before fees
paid indirectly .......................... 0.94 %+ 0.95 % 0.90 % 0.89 % --
Ratio of net investment income to
average net assets (%) ................... 6.95 %+ 7.18 % 7.73 % 8.07 % 8.76 %
Portfolio turnover rate (%) ............... 48.34 % 199.52 % 166.30 % 48.75 % 28.28 %
<CAPTION>
Year Year Year Year Year Year
Ended Ended Ended Ended Ended Ended
1993 1992 1991 1990 1989 1988
------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Per Share Operating Performance
Net asset value at beginning of year ....... $ 16.08 $ 16.03 $ 14.88 $ 15.99 $ 15.99 $ 16.07
Net investment income ..................... 1.48 1.50 1.54 1.57 1.64 1.61
Net realized and unrealized gain/(loss)
on investment transactions ............... 0.83 0.05 1.17 ( 1.11) ( 0.01) ( 0.07)
-------- -------- -------- --------- --------- ---------
Total from investment operations .......... 2.31 1.55 2.71 0.46 1.63 1.54
Less distributions
Dividends from net investment
income.................................... ( 1.47) ( 1.50) ( 1.56) ( 1.57) ( 1.63) ( 1.62)
Dividends in excess of net investment
income.................................... -- -- -- -- -- --
--------- --------- --------- --------- --------- ---------
Total distributions ....................... ( 1.47) ( 1.50) ( 1.56) ( 1.57) ( 1.63) ( 1.62)
--------- --------- --------- --------- --------- ---------
Net asset value at end of period ........... $ 16.92 $ 16.08 $ 16.03 $ 14.88 $ 15.99 $ 15.99
========= ========= ========= ========= ========= =========
Per share market value, end of period ...... $ 18.000 $ 18.000 $ 17.500 $ 14.875 $ 15.250 $ 15.000
Total Return:
Per share market value .................... 8.40 % 12.48 % 29.57 % 7.63 % 12.11 % -2.45%
Ratios and Supplemental Data
Net assets, end of period or year
(millions) ............................... $ 55,311 $ 51,871 $ 50,964 $ 46,559 $ 49,665 $ 49,518
Ratio of net operating expenses to
average net assets (%) ................... 0.90 % 0.97 % 0.99 % 1.01 % 0.97 % 1.01 %
Ratio of operating expense before fees
paid indirectly .......................... -- -- -- -- -- --
Ratio of net investment income to
average net assets (%) ................... 8.83 % 9.29 % 9.93 % 10.34 % 10.15 % 9.91 %
Portfolio turnover rate (%) ............... 35.87 % 32.35 % 27.17 % 24.58 % 33.49 % 58.57 %
</TABLE>
+ Annualized
(a) Amount represents less than $0.01 per share.
See Notes to Financial Statements.
12
<PAGE>
HATTERAS INCOME SECURITIES, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited)
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.
1. SIGNIFICANT ACCOUNTING POLICIES:
A summary of significant accounting policies followed by the Company, in
preparation of its financial statements, follows. The preparation of
financial statements in accordance with generally accepted accounting
principles requires management to make estimates and assumptions that affect
the reported amounts and disclosures in the financial statements.
Actual results may differ from those estimates.
Security Valuation: The Company's portfolio securities listed on an exchange
are valued at the closing sales price taken from the exchange on which the
security is primarily traded, or the last sales price on a national
securities market. Securities traded in only the over-the-counter market are
valued on the basis of the closing bid price or, if no sale occurred on such
day, at the mean of the current bid and asked prices. 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 assets
are valued by or under the direction of the Company's Board of Directors.
Investment Policy: At least 70% of the Company's total assets will be
invested in: (i) debt securities which are rated at the time of purchase as
Baa by Moody's Investors Service, Inc. ("Moody's") or BBB by Standard &
Poor's Corporation ("S&P") or better; (ii) securities of, or guaranteed by,
the U.S. Government, its agencies or instrumentalities; (iii) securities of,
or guaranteed by, the Government of Canada or of a Province of Canada or a
political subdivision thereof, such securities not to exceed 25% of the
Company's total assets; (iv) 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 (i); (v) commercial paper considered by the Company's investment adviser
to be of investment quality comparable to securities which may be purchased
under item (i) above; and (vi) cash or cash equivalents.
Securities Transactions and Investment Income: Securities transactions are
accounted for on the trade date. Dividend income is recorded on the
ex-dividend date. Interest income is recognized daily on the accrual basis.
Original issue discount is accreted using the effective yield method. Market
discount and premiums on securities are not amortized or accreted.
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, 1997, the Company reclassified $138,542 to increase
undistributed net investment income, $180,716 to increase accumulated net
realized loss on investments and $42,174 to increase capital surplus.
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 applicable.
13
<PAGE>
HATTERAS INCOME SECURITIES, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) -- (Continued)
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 six-month period ended June 30, 1998 are
summarized as follows:
<TABLE>
<CAPTION>
Sales and
Purchases Maturities
------------- -------------
<S> <C> <C>
Corporate Bonds .................................. $ 4,243,280 $ 4,596,491
U.S. Government and Agencies (Long-term) ......... 7,774,770 10,929,923
Foreign Bonds .................................... 827,423 0
----------- -----------
Total ....................................... $12,845,473 $15,526,414
=========== ===========
</TABLE>
At June 30, 1998, net unrealized appreciation for Federal income tax purposes
aggregated $1,449,748 of which $1,679,689 related to appreciated securities
and $229,941 related to depreciated securities. The aggregate cost of
investment securities owned for Federal income tax purposes was $52,184,195.
3. CAPITAL LOSS CARRYFORWARD:
At December 31, 1997 approximately $1,603,400 was available to offset future
capital gains of which $181,110 expires in 1998, $822,917 expires in 1999,
$47,580 expires in 2000, $476,575 expires in 2002 and $75,218 expires in
2005. Management does not plan to distribute to shareholders any future net
realized gains on investments until the capital loss carryforwards are used
or expired.
4. MANAGEMENT AND INVESTMENT ADVISORY FEES AND OTHER RELATED PARTY
TRANSACTIONS:
The Company has entered into an investment advisory agreement ("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 Company's 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
six-month period ended June 30, 1998.
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. ("NationsBank of Texas") served as the custodian
of the Company's assets up to May 6, 1998. On that date, NationsBank of Texas
merged into NationsBank, and NationsBank began serving as the custodian of
the Company's assets. For the six month period ending June 30, 1998,
NationsBank
14
<PAGE>
HATTERAS INCOME SECURITIES, INC.
NOTES TO FINANCIAL STATEMENTS (unaudited) -- (Continued) of Texas
and NationsBank received $3,333 for its services. The Bank of New York
("BONY") serves as sub-custodian for the Company. The Company earns a credit
on daily cash balances held at BONY. The earnings credit is applied to the
monthly custody fee. For the period ended June 30, 1998, the earnings credit
was $2,777.
ChaseMellon Shareholder Services ("ChaseMellon") serves as transfer agent and
dividend disbursing agent for the Company.
No officer, director or employee of NationsBank, NBAI, TradeStreet, BONY, 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.
15
<PAGE>
Annual Meeting of Stockholders (Unaudited)
On April 24, 1998, the Company held its Annual Meeting of Shareholders. At
the Annual Meeting the following directors were elected by the following votes:
(i) A. Max Walker: 2,784,200 For, 37,737 Against; (ii) Thomas F. Keller:
2,784,200 For, 38,737 Against, (iii) William H. Grigg: 2,784,200 For, 38,737
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, 1998, was ratified by the
following votes: 2,778,186 For, 19,320 Against, 25,431 Abstaining.
16
<PAGE>
HATTERAS INCOME SECURITIES, INC.
DIVIDEND REINVESTMENT PLAN
Dividend Reinvestment Plan
The Company's Dividend Reinvestment Plan (the "Plan") offers an automatic
way to reinvest 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 (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 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
17
<PAGE>
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.
18
<PAGE>
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<PAGE>
BOARD OF DIRECTORS
A. MAX WALKER, Chairman
Financial Consultant
WILLIAM H. GRIGG
Chairman Emeritus,
Duke Power Company
THOMAS F. KELLER
Retired Dean,
Fuqua School of Business,
Duke University
FUND OFFICERS
ROBERT H. GORDON
President
EDWARD D. BEDARD
Chief Financial Officer
ROBERT B. CARROLL
Secretary
ANDREW R. PETRUSKI
Assistant 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
101 S. Tryon Street
Charlotte, North Carolina 28255
INVESTMENT ADVISER
NationsBanc Advisors, Inc.
One NationsBank Plaza
101 S. Tryon Street
Charlotte, North Carolina 28255
INVESTMENT SUB-ADVISER
TradeStreet Investment Associates, Inc.
One NationsBank Plaza
101 S. Tryon Street
Charlotte, North Carolina 28255
FUND COUNSEL
Morrison & Foerster LLP
2000 Pennsylvania Avenue, N.W.
Suite 5500
Washington, D.C. 20006
CUSTODIAN
NationsBank, 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 ACCOUNTANTS
PricewaterhouseCoopers LLP
160 Federal Street
Boston, MA 02110
