[HATTERAS INCOME SECURITIES, INC. LOGO HERE]
Annual Report
To Shareholders
December 31, 1998
<PAGE>
NOT FDIC INSURED, MAY LOSE VALUE, NO BANK GUARANTEE
SHARES OF THE COMPANY ARE NOT DEPOSITS OR OTHER OBLIGATIONS OF, OR ISSUED,
ENDORSED OR GUARANTEED BY NATIONSBANK, N.A. ("NATIONSBANK"), BANK OF AMERICA
NATIONAL TRUST AND SAVINGS ASSOCIATION OR ANY OF THEIR 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 INVESTMENT ADVISORY AND OTHER SERVICES TO THE
COMPANY, FOR WHICH THEY ARE COMPENSATED.
- -------------------------------------------------------------------------------
<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, 1998.
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*
One year ago, after a tumultuous ending to 1997, fixed income investors were
hopeful that 1998 would be calmer. After all, the last half of 1997 included
considerable turmoil, mostly centered in Asia. Wishful thinking -- 1998 proved
to be one of the most challenging years in recent history.
The first six months of 1998 did provide a less volatile environment. With
fewer international headlines on which to focus, the financial markets centered
their gaze on the U.S. economy which continued to chug along at an impressive
pace. The strength shown by the economy was particularly striking considering
this was the eighth year of the current economic expansion. The calm ended in
August. August will be remembered as the defining month of 1998 for the fixed
income markets. Investors' attention was refocused on international events as
the dominos began falling with Russia's default on its outstanding debt. Market
psychology turned dour, and liquidity all but disappeared from the market.
Fixed income investors flocked to U.S. Treasuries, in not so much a "flight to
quality" as a "flight to liquidity." Added to the mix were the activities of
hedge funds as they sought to unwind unprofitable positions. The capital
markets had virtually closed.
As a result of the desire for liquidity, the spread in yields between the
current U.S. Treasury and previously issued Treasury bonds rose to extreme
levels. Treasuries were the only sector of the fixed income market to perform
well; all other sectors were pummeled. In August, corporate bonds had their
worst month since 1990, underperforming Treasuries by 266 basis points (100
basis points equals 1%). At the end of August, all spread sectors were badly
underperforming Treasuries for the year. (Spread sectors refer to those sectors
of the bond market which trade at a yield premium over comparable maturity
Treasury bonds. Examples of spread sectors are corporate bonds, mortgage-backed
securities and asset-backed securities.)
The Federal Reserve Board (the "Fed") reacted to the crisis in investor
confidence by reducing the Federal Funds rate by 25 basis points in late
September, and then by another 25 basis points only three weeks later. The
impact of the first cut on market stability was minimal, but the second cut,
which came as a surprise to the markets, eased jittery nerves. The Fed followed
up with a third reduction in rates in mid-November, which reduced the Federal
Funds rate to 4.75%. The markets were much calmer in November and December, and
the spread sectors staged a strong rally. Even with this year-end rally, all
spread sectors underperformed Treasury bonds by substantial amounts for the
year.
During the course of 1998, interest rates declined approximately 100 basis
points across all bond maturities. Much of this decline can be attributed to
the huge downward move in interest rates during the third quarter. Rates
actually moved higher during the fourth quarter, as the Fed's move to provide
liquidity and calm the markets reversed the flight-to-quality bid. Long-term
bond yields began the year at 5.92% before falling to 5.09% at year-end. In
this volatile year, the Company posted a positive return of 7.27% based on its
net asset value ("NAV") compared to 6.58% for the Lipper Closed-end Investment
Grade Bond Funds Average.**
Of course, a true measure of the Company's success is performance over longer
time horizons. Over the five year period ended December 31, 1998, the Fund has
delivered an average annual return of 7.22%, compared with the Lipper
Closed-end Investment Grade Bond Funds average return of 7.43%.
In addition, an important component of total return is income and, with a
current monthly dividend rate of $0.085 cents per share, Hatteras Income
Securities has an annualized yield of 6.32% based on the closing NAV of $16.14
on December 31, 1998. This is a very competitive yield on the portfolio, given
the current level of rates.
3
<PAGE>
MARKET OUTLOOK
Going into 1999, we are optimistic that while economic growth may slow, the
Company should benefit from its overweighting of corporate bonds through both
income and capital appreciation. In our view, longer-term values are attractive
in the corporate bond market, with overall credit quality measures remaining
high. In summary, we begin the year with a belief that the economic expansion
will continue, providing a positive backdrop for both the investment grade and
high yield corporate bond markets.
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,
[ROBERT H. GORDON SIGNATURE HERE]
ROBERT H. GORDON
President
December 31, 1998
*The past performance information quoted represents past performance
which is not an indication of future results.
**The Lipper Closed-end Investment Grade Bond Funds Universe includes 16
funds. Lipper Inc. is an independent monitor of closed-end fund performance.
4
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS
December 31, 1998
<TABLE>
<CAPTION>
Principal Moody's S&P Market
Amount Rating Rating Value
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
CORPORATE BONDS AND NOTES -- 56.7%
BANKING AND FINANCE -- 9.0%
$ 500,000 Amsouth Bank of Alabama
6.450% 02/01/18 ........................... A1 A- $ 519,430
500,000 FCB/NB Capital Trust I
8.050% 03/01/28 ........................... Baa3 BB+ 522,532
500,000 Golden State Escrow Corporation
6.750% 08/01/01 ........................... Ba1 BB+ 492,814
750,000 Great Western Financial
8.206% 02/01/27 ........................... A3 BBB- 819,102
500,000 Lehman Brothers Inc.
11.625% 05/15/05 .......................... Baa1 A 630,794
550,000 Union Planters Trust
6.500% 03/15/18 ........................... Baa1 BBB 559,439
1,000,000 Western Financial Savings Bank, Sub. Deb.,
8.500% 07/01/03 ........................... B1 BB+ 818,330
500,000 Wilmington Trust
6.625% 5/1/08 ............................. Baa2 A- 518,047
----------
Total Banking and Finance: 4,880,488
----------
CONTAINERS -- 1.5%
750,000 BWAY Corporation, Sr. Note,
10.250% 04/15/07 .......................... B2 B 787,500
----------
ELECTRIC UTILITY -- 3.3%
750,000 Dominion Capital, Sr. Note,
7.830% 12/01/27 ........................... Baa1 BBB+ 791,881
1,000,000 Niagara Mohawk Power
7.125% 07/01/01 ........................... Ba2 BB+ 1,019,848
----------
Total Electric Utility: 1,811,729
----------
ENERGY -- 4.5%
800,000 Barrett Resources Corporation, Notes,
7.550% 02/01/07 ........................... Ba1 BB+ 769,999
700,000 Occidental Petroleum Corporation, Sr. Deb.,
10.125% 09/15/09 .......................... Baa2 BBB 874,192
800,000 PDV America Inc.,
7.875% 08/01/03 ........................... Baa3 BB- 807,373
----------
Total Energy: 2,451,564
----------
</TABLE>
5
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS -- (Continued)
December 31, 1998
<TABLE>
<CAPTION>
Principal Moody's S&P Market
Amount Rating Rating Value
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
FINANCIAL/BROKERAGE -- 3.3%
$ 775,000 Morgan Stanley Finance plc,
8.030% 02/28/17 .......................... A2 A- $ 879,568
835,000 Paine Webber Group, Inc., Notes,
7.625% 10/15/08 .......................... Baa1 BBB+ 892,471
----------
Total Financial/Brokerage: 1,772,039
----------
GAS -- 2.0%
1,000,000 Louis Dreyfus Natural Gas Corporation,
Sr. Sub note,
9.250% 06/15/04 .......................... Ba3 BB+ 1,081,911
----------
HEALTH CARE -- 3.3%
600,000 Genesis Health Ventures Inc.,
9.250% 10/01/06 .......................... B2 B- 564,000
500,000 Quorum Health Group, Inc.,
8.750% 11/01/05 .......................... Ba3 BB- 477,500
750,000 Tenet Healthcare Corporation, Sr. Notes,
8.000% 01/15/05 .......................... Ba1 BB 774,375
----------
Total Health Care: 1,815,875
----------
INDUSTRIAL -- 9.5%
500,000 Alaris Medical Systems
9.750% 12/1/06 ........................... B3 B- 510,000
500,000 Beckman Instruments
7.050% 6/1/26 ............................ Ba1 NR 499,668
500,000 Coltec Industries
7.500% 4/15/08 ........................... Ba2 BB 530,000
500,000 Enterprise Rent A Car
6.625% 2/15/05 ........................... Baa2 BBB 497,350
500,000 Fisher Scientific International, Sr. Note,
7.125% 12/15/05 .......................... B1 B+ 469,065
650,000 Owens Illinois
7.150% 5/15/05 ........................... Ba1 BB+ 658,938
525,000 Raytheon Co.
7.375% 07/15/25 .......................... Baa1 BB- 543,251
600,000 USA Waste Services, Inc.,
7.125% 12/15/17 .......................... Baa3 BBB 623,766
750,000 Zurich Capital Trust
8.376% 06/01/37 .......................... Aa2 AA 832,327
----------
Total Industrial: 5,164,365
----------
</TABLE>
6
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS -- (Continued)
December 31, 1998
<TABLE>
<CAPTION>
Principal Moody's S&P Market
Amount Rating Rating Value
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
INSURANCE -- 3.2%
$ 800,000 Conseco Inc., Sr. Note,
8.700% 11/15/26 ............................. Ba2 BBB- $ 742,662
1,000,000 Leucadia National Corporation, Sr. Sub. Note,
8.250% 06/15/05 ............................. Ba1 BBB 1,012,873
-----------
Total Insurance: 1,755,535
-----------
MEDIA AND CABLE -- 8.2%
700,000 Jones Intercable, Inc., Sr. Note,
9.625% 03/15/02 ............................. Ba2 BB 752,500
750,000 Primedia Inc
7.625% 04/01/08** ........................... Ba3 BB- 746,250
1,000,000 Rogers Cablesystems Limited, Deb.,
10.000% 12/01/07 ............................ Ba3 BB+ 1,120,000
1,025,000 Time Warner Incorporated
9.125% 01/15/13 ............................. Baa3 BBB- 1,297,874
500,000 Viacom Inc., Sr. Note,
8.250% 08/01/22 ............................. Ba2 BB+ 531,121
-----------
Total Media and Cable: 4,447,745
-----------
PAPER & FOREST PRODUCTS -- 1.7%
750,000 Georgia-Pacific,
9.500% 12/01/11 ............................. Baa2 BBB- 938,730
-----------
PUBLISHING -- 1.7%
750,000 News America Holdings Inc., Sr. Deb.,
10.125% 10/15/12 ............................ Baa3 BBB 893,277
-----------
TELECOMMUNICATIONS -- 3.8%
1,000,000 GTE Corporation, Sr. Deb.,
7.900% 02/01/27 ............................. Baa1 A 1,112,262
650,000 Martin Marietta Technology
7.750% 04/15/23 ............................. A3 BBB+ 692,580
250,000 Paramount Communications
7.500% 07/15/23 ............................. Ba2 BB+ 255,997
-----------
Total Telecommunications: 2,060,839
-----------
TRANSPORTATION -- 1.7%
750,000 Federal Express Corporation, Note,
9.650% 06/15/12 ............................. Baa2 BBB 924,610
-----------
Total Corporate Bonds and Notes:
(Cost $30,502,683)........................... 30,786,207
===========
</TABLE>
7
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS -- (Continued)
December 31, 1998
<TABLE>
<CAPTION>
Principal Moody's S&P Market
Amount Rating Rating Value
(Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
MUNICIPAL BONDS -- 1.2%
$ 650,000 Massachusetts State Port Authority
6.350% 07/01/07 (Cost $647,316).......... Aa3 AA- $ 675,934
-----------
FOREIGN BONDS AND NOTES -- 0.7%
500,000 United Mexican States
6.250% 12/31/19 (Cost $360,000).......... Ba2 BB 388,750
-----------
MORTGAGE-BACKED SECURITIES -- 14.2%
FEDERAL HOME LOAN MORTGAGE
CERTIFICATES -- 1.2%
568,466 7.000% 07/01/28 ......................... 579,664
55,660 9.250% 08/01/08 ......................... 58,575
-----------
Total: 638,239
-----------
FEDERAL NATIONAL MORTGAGE
ASSOCIATION CERTIFICATES -- 9.8%
3,213,508 6.500% 07/01/11 -- 05/01/27 ............. 3,245,244
1,457,517 7.000% 06/01/11 -- 05/01/28 ............. 1,487,773
197,289 8.000% 01/01/28 ......................... 204,256
109,609 9.000% 05/01/27 ......................... 115,843
259,354 9.250% 09/01/10 ......................... 275,442
-----------
Total: 5,328,558
-----------
GOVERNMENT NATIONAL MORTGAGE
ASSOCIATION CERTIFICATES -- 3.2%
1,029,133 8.000% 09/15/24 ......................... 1,069,012
534,142 9.000% 04/15/09 -- 12/15/16 ............. 569,863
78,524 9.500% 07/15/09 ......................... 84,732
-----------
Total: 1,723,607
-----------
Total Mortgage-Backed Securities:
(Cost $7,283,496)........................ 7,690,404
===========
U.S. TREASURY OBLIGATIONS -- 25.1%
United States Treasury Bonds:
200,000 8.125% 05/15/21 ......................... 270,312
4,965,000 12.000% 08/15/13 ........................ 7,590,244
United States Treasury Notes:
4,000,000 13.750% 08/15/04 ........................ 5,745,000
-----------
Total U.S. Treasury Obligations:
(Cost $13,382,206)....................... 13,605,556
===========
</TABLE>
8
<PAGE>
HATTERAS INCOME SECURITIES, INC.
PORTFOLIO OF INVESTMENTS -- (Continued)
December 31, 1998
<TABLE>
<CAPTION>
Market
Value
--------------
TOTAL INVESTMENTS
(Cost $52,175,701*)......... 97.9% $53,146,851
<S> <C> <C> <C>
OTHER ASSETS AND LIABILITIES
(Net) ...................... 2.1% 1,146,677
---------
NET ASSETS ................. 100.0% $54,293,528
====== ===========
</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.
9
<PAGE>
HATTERAS INCOME SECURITIES, INC.
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1998
<TABLE>
<S> <C>
ASSETS:
Investment in securities, at value (Note 1) ......................................... $ 53,146,851
Cash ................................................................................ 164,348
Interest receivable ................................................................. 1,062,431
Prepaid expenses and other assets ................................................... 19,911
------------
Total assets .................................................................... 54,393,541
------------
LIABILITIES:
Management and advisory fees payable (Note 4) ....................................... 26,717
Accrued legal and audit fees ........................................................ 19,600
Transfer agent fees payable ......................................................... 11,787
Accrued expenses .................................................................... 41,909
------------
Total Liabilities ............................................................... 100,013
------------
NET ASSETS (equivalent to $16.14 per share based on 3,363,512 shares of capital stock
outstanding) ........................................................................ $ 54,293,528
============
Investments, at cost .................................................................. $ 52,175,701
============
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) ........................................ 127,622
Accumulated net realized loss on investments (Note 3) ............................... (1,331,121)
Net unrealized appreciation of investments .......................................... 971,150
------------
NET ASSETS ............................................................................ $ 54,293,528
============
</TABLE>
See Notes to Financial Statements.
10
<PAGE>
HATTERAS INCOME SECURITIES, INC.
STATEMENT OF OPERATIONS
For the Year Ended December 31, 1998
<TABLE>
<S> <C> <C>
INVESTMENT INCOME:
Interest ....................................................................... $4,237,416
----------
EXPENSES:
Management and investment advisory (Note 4) .................................... 309,065
Transfer agent ................................................................. 61,805
Directors ...................................................................... 24,999
Legal and audit ................................................................ 30,350
Custody (Note 4) ............................................................... 12,250
Printing ....................................................................... 26,649
New York Stock Exchange Annual Registration .................................... 16,283
Miscellaneous .................................................................. 19,619
-------
Total expenses ............................................................... 501,020
Fees reduced by credit allowed by custodian (Note 4) ........................... (6,706)
-------
Net expenses ................................................................. 494,314
-------
NET INVESTMENT INCOME ........................................................... 3,743,102
----------
REALIZED AND UNREALIZED GAIN/(LOSS)
ON INVESTMENTS (Note 2):
Net realized gain on investments during year ................................... 309,270
Net change in unrealized appreciation/(depreciation) of investments during year (243,047)
----------
Net realized and unrealized gain on investments ................................ 66,223
----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS ............................ $3,809,325
==========
</TABLE>
See Notes to Financial Statements.
11
<PAGE>
HATTERAS INCOME SECURITIES, INC.
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Year Year
Ended Ended
12/31/98 12/31/97
--------------- ---------------
<S> <C> <C>
Net investment income ................................................... $ 3,743,102 $ 3,827,095
Net realized gain on investments ........................................ 309,270 26,332
Net change in unrealized appreciation/(depreciation) of investments ..... (243,047) 651,852
------------ ------------
Net increase in net assets resulting from operations .................... 3,809,325 4,505,279
Dividends to shareholders from net investment income .................... (3,716,696) (3,827,095)
Distributions to shareholders in excess of net investment income ........ -- (7,326)
------------ ------------
Net increase in net assets .............................................. 92,629 670,858
NET ASSETS:
Beginning of year ....................................................... 54,200,899 53,530,041
------------ ------------
End of year ............................................................. $ 54,293,528 $ 54,200,899
============ ============
Undistributed net investment income at end of year ...................... $ 127,622 $ 101,216
============ ============
</TABLE>
See Notes to Financial Statements.
12
<PAGE>
HATTERAS INCOME SECURITIES, INC.
FINANCIAL HIGHLIGHTS
Selected data for each share of capital stock outstanding throughout each
year:
<TABLE>
<CAPTION>
Year Year
Ended Ended
1998 1997
------------- -------------
<S> <C> <C>
Per Share Operating Performance
Net asset value at beginning of year ............................ $ 16.11 $ 15.91
Net investment income .......................................... 1.11 1.18
Net realized and unrealized gain/(loss) on investment
transactions ................................................. 0.03 0.16
-------- ---------
Total from investment operations ............................... 1.14 1.34
Less distributions
Dividends from net investment income ........................... ( 1.11) ( 1.14)
Dividends in excess of net investment income ................... -- --(a)
--------- ---------
Total distributions ............................................ ( 1.11) ( 1.14)
--------- ---------
Net asset value at end of year .................................. $ 16.14 $ 16.11
========= =========
Per share market value, end of year ............................. $ 15.125 $ 14.875
Total Return:
Per share market value ......................................... 10.46 % 11.03 %
Ratios and Supplemental Data
Net assets, end of year (thousands) ............................ $ 54,294 $ 54,201
Ratio of net operating expenses to average net assets .......... 0.91 % 0.94 %
Ratio of operating expense before fees paid indirectly ......... 0.92 % 0.95 %
Ratio of net investment income to average net assets ........... 6.86 % 7.18 %
Portfolio turnover rate ........................................ 72.04 % 199.52 %
<CAPTION>
Year Year Year
Ended Ended Ended
1996 1995 1994
------------- ------------- -------------
<S> <C> <C> <C>
Per Share Operating Performance
Net asset value at beginning of year ............................ $ 16.79 $ 15.20 $ 16.92
Net investment income .......................................... 1.23 1.35 1.44
Net realized and unrealized gain/(loss) on investment
transactions ................................................. ( 0.84) 1.61 ( 1.71)
--------- -------- ---------
Total from investment operations ............................... 0.39 2.96 ( 0.27)
Less distributions
Dividends from net investment income ........................... ( 1.23) ( 1.34) ( 1.45)
Dividends in excess of net investment income ................... ( 0.04) ( 0.03) --
--------- --------- ---------
Total distributions ............................................ ( 1.27) ( 1.37) ( 1.45)
--------- --------- ---------
Net asset value at end of year .................................. $ 15.91 $ 16.79 $ 15.20
========= ========= =========
Per share market value, end of year ............................. $ 14.375 $ 16.125 $ 14.875
Total Return:
Per share market value ......................................... -3.32% 17.61 % -11.09%
Ratios and Supplemental Data
Net assets, end of year (thousands) ............................ $ 53,658 $ 56,109 $ 50,250
Ratio of net operating expenses to average net assets .......... 0.89 % 0.86 % 0.92 %
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 %
Portfolio turnover rate ........................................ 166.30 % 48.75 % 28.28 %
</TABLE>
(a) Amount represents less than $0.01 per share.
See Notes to Financial Statements.
13
<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 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.
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.
14
<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 for determining the
cost of securities sold or matured. Purchases and sales (including
maturities) of securities during the year ended December 31, 1998 are
summarized as follows:
<TABLE>
<CAPTION>
Sales and
Purchases Maturities
-------------- --------------
<S> <C> <C>
Corporate Bonds .................................. $16,258,320 $13,541,288
U.S. Government and Agencies (Long-Term) ......... 21,332,478 24,686,342
Foreign Bonds .................................... 884,850 409,500
----------- -----------
Total ....................................... $38,475,648 $38,637,130
=========== ===========
</TABLE>
At December 31, 1998, net unrealized appreciation for Federal income tax
purposes aggregated $971,150 of which $1,508,594 related to appreciated
securities and $537,444 related to depreciated securities. The aggregate
cost of investment securities owned for Federal income tax purposes was
$52,175,701.
3. CAPITAL LOSS CARRYFORWARD:
At December 31, 1998, approximately $1,331,100 was available to offset
future capital gains of which $731,727 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"), which in turn is a wholly
owned banking subsidiary of BankAmerica Corporation, a Delaware
corporation. 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 the 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, 1998.
The Company and NBAI have entered into an investment 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, out of its advisory fee, 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 year ended December 31, 1998,
NationsBank of Texas
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HATTERAS INCOME SECURITIES, INC.
NOTES TO FINANCIAL STATEMENTS -- (Continued)
and NationsBank received $5,061 for their services. The Bank of New York
("BONY") served 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, 1998, the
earnings credit was $6,706.
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.
5. SUBSEQUENT EVENT
On or about February 1, 1999, BONY began serving as the custodian for the
Company's assets and is providing the same services as were previously
provided by NationsBank. There is no longer a sub-custodian for the
Company.
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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, 1998, 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 five 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, 1998 by
correspondence with the custodian, provide a reasonable basis for the opinion
expressed above.
PricewaterhouseCoopers LLP
Boston, Massachusetts
February 5, 1999
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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 date 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
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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 of the Company on the 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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