[GRAPHIC OMITTED]
Annual Report
To Shareholders
December 31, 1997
<PAGE>
DEAR SHAREHOLDER:
I am pleased to present the Hatteras Income Securities, Inc. (the
"Company") Annual Report to Shareholders for the year ended December 31, 1997.
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 year 1997 was a volatile period for the fixed-income markets with a
little something for the bulls and the bears -- Federal Reserve Board Chairman
Greenspan's pondering of "irrational exuberance" in the financial markets; 25
basis points of monetary tightening; economic growth well above the most
optimistic expectations of the economy's long-run potential; unemployment rates
at 25 year lows; falling inflation despite strong growth and low unemployment;
declining budget deficits and Treasury supply; and Asian currency and financial
market disasters. In the end, the bulls won with low inflation, declining
supply, robust economic growth and low unemployment dominating. Long-term bond
yields began the year at 6.65% and rose to a high of 7.10% before falling to a
year-end low of 5.92%. In this volatile year, the Company posted a positive
return of 11.18%** based on its market value vs 17.58% for the Lipper Closed-End
Investment Grade Bond Funds.
A true measure of the Company's success is performance over longer time
horizons. Over the five year period ended December 31, 1997, the Company has
delivered an average annual return of 8.67% based on net asset value ("NAV"),
which compares well with the Merrill Lynch Corporate Master Index of 8.55%** and
the Lipper Closed-End Investment Grade Bond Funds average return of 8.66%.
In addition, an important component of total return is income and, with a
monthly dividend rate of $0.095, the Company has an annualized yield of 7.08%
based on the closing NAV of $16.11 on December 31, 1997. This remains a very
competitive yield on the portfolio, given the current level of interest rates.
Market Outlook
Going into 1998, we are optimistic given an absence of inflationary
pressures, slowing economic growth, reduced Treasury borrowing needs, and the
persistence of a "flight-to-quality" trend in the U.S. market. In this
environment, a long average maturity and duration stance is warranted. The
Company will maintain its general overweighting of corporate bonds in order to
capture incremental yield and income. While the near-term picture for corporate
bonds could remain volatile, longer-term values are attractive with overall
credit quality measures at their highest level, in our view, in ten years, and
demand exhibiting no signs of weakness. Caution is warranted in the mortgage
market as volatility and prepayments are expected to rise as interest rates
continue their descent. Investors have been complacent with respect to
volatility and prepayments. These concerns are reflected by the reduced
weighting in the Company's mortgage holdings. In summary, we begin the year with
a positive outlook on interest rates, with guarded optimism for the corporate
sector and with pessimism for the interest-rate and volatility-sensitive
mortgage sector.
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,
/s/ Mark H. Williamson
- -----------------------
MARK H. WILLIAMSON
President
December 31, 1997
NOT FDIC-INSURED, MAY LOSE VALUE, NO BANK GUARANTEE
SHARES OF HATTERAS INCOME SECURITIES, INC. ARE NOT DEPOSITS OR OTHER
OBGLIGATIONS OF, OR ISSUED, ENDORSED OR GUARANTEED BY NATIONSBANK, N.A.
("NATIONSBANK") 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 AFFILIATES PROVIDE ADVISORY AND OTHER SERVICES TO THE COMPANY, FOR
WHICH THEY ARE COMPENSATED.
--------------------------------------------------------------------
* The past performance information quoted is not an indication of future
results.
** 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. 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.
3
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS
December 31, 1997
<TABLE>
<CAPTION>
Principal Moody's S&P Cost Value
Amount Rating Rating (Note 1)
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C>
CORPORATE BONDS AND NOTES -- 54.1%
BANKING AND FINANCE -- 6.0%
$ 700,000 First Nationwide Escrow,
10.625% 10/01/03* .......................... BA3 N/R $ 735,875 $ 784,000
1,000,000 Security Pacific Corporation, Sub Note,
11.000% 03/01/01 ........................... A1 A 1,202,730 1,133,859
500,000 TIG Holdings, Inc., Notes,
8.125% 04/15/05 ............................ Baa1 A- 540,635 539,692
750,000 Western Financial Savings Bank, Sub.
Deb., 8.500% 07/01/03 ...................... B1 BB+ 801,540 723,849
--------- ---------
Total Banking and Finance: 3,280,780 3,181,400
--------- ---------
COMPUTER -- 1.3%
700,000 Unisys Corporation, Sr. Note,
10.625% 10/01/99 ........................... B1 B+ 749,875 714,000
--------- ---------
CONTAINERS -- 1.5%
750,000 BWAY Corporation, Sr. Note,
10.250% 04/15/07 ........................... B2 B 826,875 817,500
--------- ---------
ELECTRIC UTILITY -- 1.4%
750,000 Dominion Capital, Sr. Note,
7.830% 12/01/27 ............................ Baa1 BBB+ 764,160 754,240
--------- ---------
ENERGY -- 4.8%
800,000 Barrett Resources Corporation, Notes,
7.550% 02/01/07 ............................ Ba1 BB+ 803,084 829,723
700,000 Occidental Petroleum Corporation, Sr.
Deb., 10.125% 09/15/09 ..................... Baa2 BBB 911,288 902,755
800,000 PDV America Inc., 7.875% 08/01/03 .......... Baa3 BB- 788,604 827,850
--------- ---------
Total Energy: 2,502,976 2,560,328
--------- ---------
ENTERTAINMENT -- 2.2%
1,000,000 Time Warner, Inc. Note,
8.375% 07/15/33 ............................ Baa3 BBB- 1,144,750 1,144,485
--------- ---------
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS -- (Continued)
December 31, 1997
<TABLE>
<CAPTION>
Principal Moody's S&P Cost Value
Amount Rating Rating (Note 1)
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C>
FINANCIAL/BROKERAGE -- 2.6%
$ 775,000 Morgan Stanley Finance PLC,
8.030% 02/28/17 .......................... A2 A- $ 793,482 $ 847,994
500,000 Paine Webber Group, Inc., Notes,
7.625% 10/15/08 .......................... Baa1 BBB+ 512,785 533,209
--------- ---------
Total Financial/Brokerage: 1,306,267 1,381,203
--------- ---------
GAS -- 2.1%
1,000,000 Louis Dreyfus Natural Gas Corporation,
Sr. Sub note, 9.250% 06/15/04 ............ Ba3 BB+ 1,086,660 1,115,544
--------- ---------
HEALTH CARE -- 6.1%
600,000 Genesis Health Ventures Inc.,
9.250% 10/01/06 .......................... B2 B- 606,250 611,250
750,000 HealthSouth Corporation,
9.500% 04/01/01 .......................... Ba3 BB- 794,375 783,750
Tenet Healthcare Corporation:
250,000 Sr. Notes, 8.000% 01/15/05 ............... BA1 BB 258,750 255,937
1,000,000 Sr. Sub Notes, 10.125% 03/01/05 .......... Ba3 B+ 1,080,000 1,091,250
500,000 Quorum Health Group, Inc.,
8.750% 11/01/05 .......................... Ba3 BB- 518,685 515,625
--------- ---------
Total Health Care: 3,258,060 3,257,812
--------- ---------
INDUSTRIAL -- 10.1%
1,000,000 Auburn Hills Trust Certificates, Deb.,
12.000% 05/01/20 ......................... A3 A 1,418,220 1,610,879
500,000 Fisher Scientific International, Sr. Note,
7.125% 12/15/05 .......................... B1 B+ 467,775 482,117
1,100,000 Harris Corporation,
10.375% 12/01/18 ......................... A3 A- 1,230,196 1,195,117
600,000 USA Waste Services, Inc.,
7.125% 12/15/17 .......................... Baa3 BBB 599,052 598,128
700,000 Valassis Inserts Inc., Sr. Sub. Note,
9.375% 03/15/99 .......................... Ba3 BB- 723,499 718,488
750,000 Westpoint Stevens Incorporated,
8.750% 12/15/01 .......................... Ba3 BB- 752,000 776,250
--------- ---------
Total Industrial: 5,190,742 5,380,979
--------- ---------
</TABLE>
See Notes to Financial Statements.
5
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS -- (Continued)
December 31, 1997
<TABLE>
<CAPTION>
Principal Moody's S&P Cost Value
Amount Rating Rating (Note 1)
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C> <C>
INSURANCE -- 3.6%
$ 750,000 Conseco Inc., Sr. Note,
8.796% 04/01/27 ....................... Ba2 BBB- $ 841,203 $ 842,008
1,000,000 Leucadia National Corporation, Sr. Sub.
Note, 8.250% 06/15/05 ................. Ba1 BBB 1,000,000 1,071,376
---------- ----------
Total Insurance: 1,841,203 1,913,384
---------- ----------
MEDIA AND CABLE -- 5.4%
700,000 Jones Intercable, Inc., Sr. Note,
9.625% 03/15/02 ....................... Ba2 BB 700,375 752,500
1,000,000 Rogers Cablesystems Limited, Deb.,
10.000% 12/01/07 ...................... Ba3 BB+ 1,000,000 1,100,000
1,000,000 Viacom Inc., Sr. Note,
7.750% 06/01/05 ....................... Ba2 BB+ 1,025,630 1,020,182
---------- ----------
Total Media and Cable: 2,726,005 2,872,682
---------- ----------
PAPER & FOREST PRODUCTS -- 1.7%
750,000 Georgia-Pacific,
9.500% 12/01/11 ....................... Baa2 BBB- 934,342 930,838
---------- ----------
PUBLISHING -- 1.4%
625,000 News America Holdings Inc., Sr. Deb.,
10.125% 10/15/12 ...................... Baa3 BBB 719,584 739,194
---------- ----------
TELECOMMUNICATIONS -- 2.0%
1,000,000 GTE Corporation, Sr. Deb.,
7.900% 02/01/27 ....................... Baa1 A 1,035,670 1,063,806
---------- ----------
TRANSPORTATION -- 1.8%
750,000 Federal Express Corporation, Note,
9.650% 06/15/12 ....................... Baa2 BBB 816,183 964,415
---------- ----------
Total Corporate Bonds and
Notes: 28,184,132 28,791,810
---------- ----------
</TABLE>
See Notes to Financial Statements.
6
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS -- (Continued)
December 31, 1997
<TABLE>
<CAPTION>
Principal Cost Value
Amount (Note 1)
<S> <C> <C> <C>
MORTGAGE-BACKED SECURITIES -- 17.1%
GOVERNMENT NATIONAL MORTGAGE
ASSOCIATION CERTIFICATES -- 4.2%
$1,398,298 8.000% 09/15/24 ...................... $ 1,435,877 $ 1,449,860
653,471 9.000% 04/15/09 -- 12/15/16 .......... 610,937 698,806
94,089 9.500% 07/15/09 ...................... 89,385 101,793
----------- -----------
2,136,199 2,250,459
----------- -----------
FEDERAL HOME LOAN MORTGAGE
CERTIFICATES -- 0.1%
73,833 9.250% 08/01/08 ...................... 62,482 78,552
----------- -----------
FEDERAL NATIONAL MORTGAGE ASSOCIATION
CERTIFICATES -- 12.8%
3,619,112 6.500% 07/01/11 -- 05/01/27 .......... 3,421,618 3,597,337
1,542,194 7.000% 06/01/11 -- 04/01/27 .......... 1,512,209 1,563,488
1,002,231 8.500% 12/01/25 ...................... 1,025,094 1,046,391
223,974 9.000% 05/01/27 ...................... 235,103 237,973
330,948 9.250% 09/01/10 ...................... 300,501 352,976
----------- -----------
6,494,525 6,798,165
----------- -----------
Total Mortgage-Backed Securities: 8,693,206 9,127,176
----------- -----------
TREASURY BONDS AND NOTES -- 28.8% United States Treasury Notes:
600,000 6.375% due 04/03/99 .................. 605,531 605,437
2,620,000 13.75% due 08/15/04 .................. 3,706,212 3,753,150
----------- -----------
4,311,743 4,358,587
----------- -----------
United States Treasury Bonds:
5,150,000 12.000% due 08/15/13 ................. 7,467,068 7,596,250
3,250,000 6.250% due 08/15/23 .................. 3,353,008 3,349,531
----------- -----------
10,820,076 10,945,781
Total Treasury Bonds and Notes: 15,131,819 15,304,368
----------- -----------
TOTAL INVESTMENTS $52,009,157 $53,223,354
=========== ===========
</TABLE>
- ----------
* 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, 1997
<TABLE>
<S> <C>
ASSETS:
Investment in securities, at value (Note 1) ......................................... $ 53,223,354
Cash ................................................................................ 47,029
Interest receivable ................................................................. 988,922
Prepaid expenses and other assets ................................................... 3,174
------------
Total assets .................................................................... 54,262,479
------------
LIABILITIES:
Management and advisory fees payable (Note 4) ....................................... 28,073
Transfer agent fees payable ......................................................... 12,139
Accrued legal and audit fees ........................................................ 10,371
Accrued shareholder reports expense ................................................. 8,214
Accrued expenses and other payables ................................................. 2,783
------------
Total Liabilities ............................................................... 61,580
------------
NET ASSETS (equivalent to $16.11 per share based on 3,363,512 shares of capital stock
outstanding) ........................................................................ $ 54,200,899
============
Investments, at cost .................................................................. $ 52,009,157
============
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) ........................................ 101,216
Accumulated net realized loss on investments (Note 3) ............................... (1,640,391)
Net unrealized appreciation of investments .......................................... 1,214,197
------------
NET ASSETS ............................................................................ $ 54,200,899
============
</TABLE>
See Notes to Financial Statements.
8
<PAGE>
HATTERAS INCOME SECURITIES, INC.
STATEMENT OF OPERATIONS
For the Year Ended December 31, 1997
<TABLE>
<S> <C> <C>
INVESTMENT INCOME:
Interest ......................................................... $4,326,859
----------
EXPENSES:
Management and investment advisory (Note 4) ...................... 309,030
Transfer agent ................................................... 52,302
Director ......................................................... 24,999
Legal and audit .................................................. 40,040
Custody (Note 4) ................................................. 15,253
Printing ......................................................... 28,766
New York Stock Exchange Annual Registration ...................... 16,318
Miscellaneous .................................................... 20,820
-------
Total expenses ................................................. 507,528
Fees reduced by credit allowed by custodian (Note 4) ............. 7,764
-------
Net expenses ................................................... 499,764
-------
NET INVESTMENT INCOME ............................................. 3,827,095
----------
REALIZED AND UNREALIZED GAIN
ON INVESTMENTS (Note 2):
Net realized gain on investments during period ................... 26,332
Net unrealized appreciation of investments during period ......... 651,852
----------
Net realized and unrealized gain on investments .................. 678,184
----------
INCREASE IN NET ASSETS RESULTING FROM OPERATIONS .................. $4,505,279
==========
</TABLE>
See Notes to Financial Statements.
9
<PAGE>
HATTERAS INCOME SECURITIES, INC.
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Year
Ended Ended
12/31/97 12/31/96
--------------- ---------------
<S> <C> <C>
Net investment income .............................................................. $ 3,827,095 $ 4,129,705
Net realized gain on investments ................................................... 26,332 571,972
Change in unrealized appreciation/depreciation of investments ...................... 651,852 (3,371,350)
------------ ------------
Net increase in net assets resulting from investment operations .................... 4,505,279 1,330,327
Dividends to shareholders from investment income ................................... (3,827,095) (4,129,705)
Distributions to shareholders in excess of net investment income ................... (7,326) (122,932)
Net asset value of 0 and 21,830 shares, respectively, of capital stock issued in
dividend reinvestment ............................................................. -- 342,914
------------ ------------
Net increase/decrease in net assets ................................................ 670,858 (2,579,396)
NET ASSETS:
Beginning of year .................................................................. 53,530,041 56,109,437
------------ ------------
End of year ........................................................................ $ 54,200,899 $ 53,530,041
============ ============
Undistributed/(distributions in excess) of net investment income
at end of year .................................................................... $ 101,216 $ (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
Ended Ended Ended Ended
1997 1996 1995 1994
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Per Share Operating Performance ...................
Net asset value at beginning of year .............. $ 15.91 $ 16.79 $ 15.20 $ 16.92
Net investment income ............................ 1.18 1.23 1.35 1.44
Net realized and unrealized gain/(loss) on
investment transactions ......................... 0.16 ( 0.84) 1.61 ( 1.71)
--------- --------- -------- ---------
Total from investment operations ................. 1.34 0.39 2.96 ( 0.27)
Less distributions ................................
Dividends from net investment income ............. ( 1.14) ( 1.23) ( 1.34) ( 1.45)
Dividends in excess of net investment income ..... --(a) ( 0.04) ( 0.03) --
--------- --------- --------- ---------
Total distributions .............................. ( 1.14) ( 1.27) ( 1.37) ( 1.45)
--------- --------- --------- ---------
Net asset value at end of period .................. $ 16.11 $ 15.91 $ 16.79 $ 15.20
========= ========= ========= =========
Per share at market value, end of period .......... $ 14.875 $ 14.375 $ 16.125 $ 14.875
Total Return:
Per share market value ........................... 11.03 % -3.32% 17.61 % -11.09%
Ratios and Supplemental Data
Net assets, end of year (thousands) .............. $ 54,201 $ 53,530 $ 56,109 $ 50,250
Ratio of net operating expenses to average
net assets (%) .................................. .94 % 0.89 % 0.86 % 0.92 %
Ratio of operating expense before fees paid
indirectly ...................................... .95 % 0.90 % 0.89 % --
Ratio of net investment income to average
net assets (%) .................................. 7.18 % 7.73 % 8.07 % 8.76 %
Portfolio turnover rate (%) ...................... 199.52 % 166.30 % 48.75 % 28.28 %
<CAPTION>
Year Year Year Year Year
Ended Ended Ended Ended Ended
1993 1992 1991 1990 1989
------------- ------------- ------------- ------------- -------------
<S> <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
Net investment income ............................ 1.48 1.50 1.54 1.57 1.64
Net realized and unrealized gain/(loss) on
investment transactions ......................... 0.83 0.05 1.17 ( 1.11) ( 0.01)
-------- -------- -------- --------- ---------
Total from investment operations ................. 2.31 1.55 2.71 0.46 1.63
Less distributions ................................
Dividends from net investment income ............. ( 1.47) ( 1.50) ( 1.56) ( 1.57) ( 1.63)
Dividends in excess of net investment income ..... -- -- -- -- --
--------- --------- --------- --------- ---------
Total distributions .............................. ( 1.47) ( 1.50) ( 1.56) ( 1.57) ( 1.63)
--------- --------- --------- --------- ---------
Net asset value at end of period .................. $ 16.92 $ 16.08 $ 16.03 $ 14.88 $ 15.99
========= ========= ========= ========= =========
Per share at market value, end of period .......... $ 18.000 $ 18.000 $ 17.500 $ 14.875 $ 15.250
Total Return:
Per share market value ........................... 8.40 % 12.48 % 29.57 % 7.63 % 12.11 %
Ratios and Supplemental Data
Net assets, end of year (thousands) .............. $ 55,311 $ 51,871 $ 50,964 $ 46,559 $ 49,665
Ratio of net operating expenses to average
net assets (%) .................................. 0.90 % 0.97 % 0.99 % 1.01 % 0.97 %
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 %
Portfolio turnover rate (%) ...................... 35.87 % 32.35 % 27.17 % 24.58 % 33.49 %
<CAPTION>
Year
Ended
1988
-------------
<S> <C>
Per Share Operating Performance ...................
Net asset value at beginning of year .............. $ 16.07
Net investment income ............................ 1.61
Net realized and unrealized gain/(loss) on
investment transactions ......................... ( 0.07)
---------
Total from investment operations ................. 1.54
Less distributions ................................
Dividends from net investment income ............. ( 1.62)
Dividends in excess of net investment income ..... --
---------
Total distributions .............................. ( 1.62)
---------
Net asset value at end of period .................. $ 15.99
=========
Per share at market value, end of period .......... $ 15.000
Total Return:
Per share market value ........................... -2.45%
Ratios and Supplemental Data
Net assets, end of year (thousands) .............. $ 49,518
Ratio of net operating expenses to average
net assets (%) .................................. 1.01%
Ratio of operating expense before fees paid
indirectly ...................................... --
Ratio of net investment income to average
net assets (%) .................................. 9.91%
Portfolio turnover rate (%) ...................... 58.57%
</TABLE>
(a) Amount represents less than $0.01 per share.
See Notes to Financial Statements.
11
<PAGE>
HATTERAS INCOME SECURITIES, INC.
NOTES TO FINANCIAL STATEMENTS
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.
12
<PAGE>
HATTERAS INCOME SECURITIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (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 year ended December 31, 1997 are
summarized as follows:
<TABLE>
<CAPTION>
Sales and
Purchases Maturities
-------------- --------------
<S> <C> <C>
Corporate Bonds .................................. $ 13,919,385 $ 15,382,967
U.S. Government and Agencies (Long-term) ......... 90,114,476 86,014,114
Foreign Bonds .................................... 264,063 3,246,730
------------ ------------
Total ........................................ $104,297,924 $104,643,811
============ ============
</TABLE>
At December 31, 1997, net unrealized appreciation for Federal income tax
purposes aggregated $1,177,205 of which $1,458,713 related to appreciated
securities and $281,508 related to depreciated securities. The aggregate cost
of investment securities owned for Federal income tax purposes was
$52,046,149.
3. CAPITAL LOSS CARRYFORWARD:
At December 31, 1997 approximately $1,603,400 is 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 year ended
December 31, 1997.
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 year ending December 31, 1997 the Custodian
received $6,770 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 year ended December 31, 1997 the earnings credit was $7,764.
13
<PAGE>
HATTERAS INCOME SECURITIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued) 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.
14
<PAGE>
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, 1997, the results of its
operations for the year then ended, the changes in its net assets for each of
the two years in the period then ended and the financial highlights for each of
the ten years in the period then ended, 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, 1997 by correspondence with the
custodian, provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Boston, Massachusetts
February 17, 1998
15
<PAGE>
Annual Meeting of Stockholders (Unaudited)
On April 24, 1997, the Company held its Annual Meeting of Stockholders. At
the Annual Meeting, the following directors were elected by the following
votes: (i) William H. Grigg: 2,597,783 For, 55,233 Against; (ii) Thomas F.
Keller: 2,597,388 For, 55,628 Against; and (iii) A. Max Walker: 2,595,983 For,
57,033 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, 1997, was ratified by the
following votes: 2,602,900 For, 24,982 Against, 25,134 Abstaining.
16
<PAGE>
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 (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
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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
MARK H. WILLIAMSON
President
EDWARD D. BEDARD
Chief Financial Officer
ROBERT B. CARROLL
Secretary
RICHARD S. SZAFRAN
Treasurer
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
SUB-INVESTMENT 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 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 ACCOUNTANTS
Price Waterhouse LLP
160 Federal Street
Boston, MA 02110
