DEAR SHAREHOLDERS:
- --------------------------------------------------------------------------------
The second half of 1997 was good to fixed income investors. Sliding
inflation levels in the U.S. plus falling asset and currency values throughout
Asia helped lower yields and raise bond prices.The Lexington GNMA Income Fund,
which invests both in government-guaranteed mortgages and U.S. Treasury
securities, was well positioned to participate in the rally. The Fund's share
price increased from $8.12 on June 30th to $8.40 by year end. Moreover, the Fund
paid out 25.7 cents in dividends during the period. For all of 1997, Lexington
GNMA Income Fund shareholders enjoyed a 10.2%* total rate of return which ranked
it as the number one GNMA fund as measured by Lipper Analytical Services, Inc.
The party in the U.S. bond market has continued into 1998. The problems in
Asia are worsening despite considerable efforts by the International Monetary
Fund (IMF) to pump some liquidity into those economies. Meanwhile, the news on
inflation just keeps getting better. A sub-2% annual rate of increase in the
Consumer Price Index is now likely for some time to come. That makes sub-6% U.S.
Treasury bond yields and sub-7% GNMA mortgage rates look attractive.
We look for the Federal Reserve to lower short term interest rates in the
months ahead. As the keeper of the world's reserve currency, the Fed has an
obligation to assure liquidity in times of crisis. One way to do that would be
to lower the Federal Funds Rate and that would spur bond prices to new heights.
Accordingly, we are keeping the Fund's average maturity relatively long. So, the
Fund's share price will be quite sensitive to interest rate changes. That is, if
interest rates fall further, the share price will rise and, if interest rates
rise, the share price will fall.
At the close of 1997, about 7% of the Fund's assets were invested in U.S.
Treasury bonds with an average maturity in excess of twenty years. The remainder
of the portfolio consisted of lower coupon single family mortgages and
multi-family mortgage loans with varying degrees of call protection.
Accordingly, we think the portfolio is better structured than most to withstand
the imminent increase in mortgage prepayments. Since loans are refinanced at par
rather than the higher market quotes used to determine a fund's net asset value,
high mortgage prepayments usually have a negative impact on the relative
performance of a mortgage fund. Also, prepayments tend to be reinvested at the
lower current market yields. This tends to reduce dividend per share payouts.
1
<PAGE>
We have a positive outlook for the bond market through the first half of
1998 and the Fund is positioned to perform well in a rally. We wish to thank all
our shareholders for their continued loyalty. The management of your Fund will
continue to strive to earn your support.
Sincerely,
/s/ Denis P. Jamison /s/ Robert M. DeMichele
- -------------------- -----------------------
Denis P. Jamison Robert M. DeMichele
Portfolio Manager President
February, 1998 February, 1998
- --------------------------------------------------------------------------------
[The following table represents a line chart in the printed piece.]
COMPARISON OF CHANGE IN VALUE OF A $10,000 INVESTMENT IN
LEXINGTON GNMA INCOME FUND, INC., AND
THE UNMANAGED LEHMAN BROTHERS MORTGAGE-BACKED SECURITIES INDEX
Year Lexington GNMA LBMBSI
=========================================================
12/31/87 $10,000 $10,000
12/30/88 $10,690 $10,872
12/31/89 $12,357 $12,541
12/31/90 $13,498 $13,885
12/31/91 $15,623 $16,068
12/30/92 $16,433 $17,188
12/31/93 $17,758 $18,364
12/31/94 $17,390 $18,068
12/31/95 $20,158 $21,103
12/30/96 $21,309 $22,232
12/31/97 $23,484 $24,342
AVERAGE ANNUAL STANDARD TOTAL RETURNS
FOR THE PERIOD ENDED 12/31/97
- --------------------------------------------------------------------------------
FUND NAME 1 YEAR 5 YEAR 10 YEAR
- --------------------------------------------------------------------------------
LEXINGTON GNMA 10.20% 7.40% 8.91%
INCOME FUND
- --------------------------------------------------------------------------------
LEHMAN BROTHERS 9.49% 7.21% 9.30%
MORTGAGE-BACKED
SECURITIES INDEX
- --------------------------------------------------------------------------------
This graph, prepared in accordance with SEC regulations, compares a $10,000
investment in the Fund with a similar investment in the Lehman Brothers
Mortgage-Backed Securities Index. Results for the Fund and the Lehman Brothers
Mortgage-Backed Securities Index include the reinvestment of all dividend and
capital gain distributions. Investment return and principal value of an
investment will fluctuate so that an investor's shares when redeemed may be
worth more or less than at their original cost. Total return represents past
performance and it is not predictive of future results.
* 10.20%, 7.40% and 8.91% are the one, five and ten year average annual standard
total returns, respectively, for the period ended December 31, 1997. For the
one, five, and ten year periods ended December 31, 1997, the Fund ranked #1
out of 51 funds, #2 out of 29 funds, and #5 out of 24 funds, respectively.
Investment return and principal value of an investment will fluctuate so that
an investor's shares, when redeemed, may be worth more or less than at their
original cost. Total return represents past performance and is not predictive
of future results.
2
<PAGE>
<TABLE>
<CAPTION>
LEXINGTON GNMA INCOME FUND, INC.
STATEMENT OF NET ASSETS
(INCLUDING THE PORTFOLIO OF INVESTMENTS)
December 31, 1997
STATED PRINCIPAL VALUE
COUPON MATURITY AMOUNT (NOTE 1)
- --------------------------------------------------------------------------------------------------------------------
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (GNMA) CERTIFICATES: 93.7%
<C> <C> <C> <C>
10.25% .................................................. 8/2029 $ 1,011,575 $ 1,096,921
9.50 .................................................... 3/2023 1,985,479 2,130,658
9.25 .................................................... 1/2026-8/2029 5,987,318 6,404,224
9.00 .................................................... 5/2020-11/2027 980,774 1,051,751
8.75 .................................................... 9/1998-10/2023 3,368,667 3,576,901
8.50 .................................................... 6/2022-1/2023 1,638,743 1,693,512
8.25 .................................................... 3/2001-10/2038 9,207,601 9,629,590
8.25* ................................................... 5/2038-10/2038 628,257 642,292
8.20 .................................................... 4/2012-5/2017 10,947,263 11,499,852
8.15 .................................................... 12/2011-9/2015 10,431,665 10,945,440
8.125 ................................................... 5/2026-6/2039 11,342,114 11,660,030
8.125* .................................................. 3/2036-6/2039 2,590,140 2,647,622
8.10 .................................................... 6/2012-7/2012 1,840,853 1,929,434
8.00 .................................................... 10/2012-11/2038 5,629,184 5,789,550
8.00* ................................................... 11/2030-11/2038 1,082,424 1,107,814
7.875 ................................................... 6/2021-7/2038 5,184,063 5,235,635
7.875* .................................................. 6/2021-7/2038 2,857,663 2,894,729
7.75 .................................................... 8/2014-3/2032 1,400,895 1,434,995
7.75* ................................................... 8/2014 658,977 671,300
7.70 .................................................... 8/2013 848,986 881,086
7.65 .................................................... 12/2012-4/2031 3,918,324 4,021,218
7.625 ................................................... 8/2032 1,545,588 1,581,322
7.50 .................................................... 4/2013 1,254,457 1,295,616
7.25 .................................................... 8/2022 2,137,196 2,185,284
7.20 .................................................... 6/2014 2,918,300 2,984,866
7.00 .................................................... 5/2026-11/2027 49,450,503 49,889,427
6.75 .................................................... 6/2013-8/2017 746,387 756,461
6.70 .................................................... 12/2014 370,111 374,737
6.65 .................................................... 12/2013-2/2015 1,688,860 1,706,335
6.55 .................................................... 11/2013 6,712 6,763
5.65 .................................................... 7/2029 481,691 418,127
------------
TOTAL GNMA CERTIFICATES (cost $143,665,169) .................................................. 148,143,492
------------
U.S. GOVERNMENT OBLIGATIONS: 10.6%
U.S. Treasury Bills, 5.00%, due 02/26/98 ......................................... 1,400,000 1,389,111
U.S. Treasury Bonds, 6.00%, due 02/15/26 ......................................... 11,000,000 10,977,230
U.S. Treasury Notes, 7.00%, due 07/15/06 ......................................... 4,000,000 4,316,880
------------
TOTAL U.S. GOVERNMENT OBLIGATIONS (cost $16,555,964) .......................................... 16,683,221
------------
TOTAL INVESTMENTS: 104.3% (cost $160,221,133+)(Note 1) ........................................ 164,826,713
Liabilities in excess of other assets: (4.3%) ................................................. (6,755,941)
------------
TOTAL NET ASSETS: 100% (equivalent to $8.40 per share on 18,817,784 shares outstanding) ....... $158,070,772
============
*Construction loan securities (Note 1).
+Aggregate cost for Federal income tax purposes is identical.
The Notes to Financial Statements are an integral part of this statement.
</TABLE>
3
<PAGE>
LEXINGTON GNMA INCOME FUND, INC.
STATEMENT OF ASSETS AND LIABILITIES
December 31, 1997
ASSETS
Investments, at value
(cost $160,221,133) (Note 1) ........................... $ 164,826,713
Cash ...................................................... 18,386
Receivable for shares sold ................................ 679,041
Interest receivable ....................................... 1,256,853
-------------
Total Assets ....................................... 166,780,993
-------------
LIABILITIES
Due to Lexington Management Corporation
(Note 2) ............................................... 78,813
Payable for investment securities purchased ............... 8,221,559
Payable for shares redeemed ............................... 213,160
Distributions payable ..................................... 106,825
Accrued expenses .......................................... 89,864
-------------
Total Liabilities .................................. 8,710,221
-------------
NET ASSETS (equivalent to $8.40 per share on
18,817,784 shares outstanding) (Note 3) ................. $ 158,070,772
=============
NET ASSETS consist of:
Capital stock--authorized 100,000,000 shares
$.01 par value per share ................................ $ 188,178
Additional paid-in capital (Note 1) ....................... 154,331,238
Undistributed net investment income
(Note 1) ................................................ 404
Accumulated net realized loss on investments
(Notes 1 and 5) ......................................... (1,054,628)
Unrealized appreciation on investments .................... 4,605,580
-------------
$ 158,070,772
=============
LEXINGTON GNMA INCOME FUND, INC.
STATEMENT OF OPERATIONS
Year ended December 31, 1997
INVESTMENT INCOME
Interest income .............................. $ 10,453,919
EXPENSES
Investment advisory fee (Note 2) .......... $ 859,774
Transfer agent and shareholder
servicing expense (Note 2) .............. 274,525
Accounting expenses (Note 2) .............. 104,755
Printing and mailing expenses ............. 40,244
Professional fees ......................... 35,464
Registration fees ......................... 26,835
Custodian expense ......................... 24,764
Computer processing fees .................. 19,556
Directors' fees and expenses .............. 17,398
Other expenses ............................ 48,809
-----------
Total expenses .......................... 1,452,124
--------------
Net investment income ................. 9,001,795
REALIZED AND UNREALIZED GAIN
ON INVESTMENTS (NOTE 4)
Net realized gain on investments .......... 2,716,315
Net change in unrealized
appreciation of investments ............. 2,258,584
--------------
Net realized and
unrealized gain ..................... 4,974,899
--------------
INCREASE IN NET ASSETS RESULTING
FROM OPERATIONS ............................ $ 13,976,694
==============
The Notes to Financial Statements are an integral part of these statements.
4
<PAGE>
LEXINGTON GNMA INCOME FUND, INC.
STATEMENTS OF CHANGES IN NET ASSETS
Years ended December 31, 1997 and 1996
1997 1996
------------- -------------
Net investment income .................... $ 9,001,795 $ 8,297,434
Net realized gain on investments ......... 2,716,315 1,733,533
Net change in unrealized appreciation
of investments ........................ 2,258,584 (3,035,171)
------------- -------------
Increase in net assets
resulting from operations ........... 13,976,694 6,995,796
Distributions to shareholders from
net investment income ................. (9,107,074) (8,115,172)
Increase in net assets from capital
share transactions (Note 3) ........... 19,424,028 4,215,069
------------- -------------
Net increase in net assets .......... 24,293,648 3,095,693
NET ASSETS
Beginning of period ................... 133,777,124 130,681,431
------------- -------------
End of period (including
undistributed net
investment income of
$404 and $9,290,
1997 and 1996, respectively) ........ $ 158,070,772 $ 133,777,124
============= =============
The Notes to Financial Statements are an integral part of these statements.
LEXINGTON GNMA INCOME FUND, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 1997 and 1996
1. SIGNIFICANT ACCOUNTING POLICIES
Lexington GNMA Fund, Inc. (the "Fund") is an open-end diversified management
investment company registered under the Investment Company Act of 1940, as
amended. The Fund's investment objective is to seek a high level of current
income, consistent with liquidity and safety of principal, through investment
primarily in mortgage-backed GNMA ("Ginnie Mae") certificates that are
guaranteed as to the timely payment of principal and interest by the United
States Government. The following is a summary of significant accounting policies
followed by the Fund in the preparation of its financial statements:
INVESTMENTS Security transactions are accounted for on a trade date basis.
Realized gains and losses from investment transactions are reported on the
identified cost basis. Securities are valued at the last reported bid price as
of the last business day of the period or, if no current bid price is available,
by the valuation as determined by the Fund's management in good faith under the
direction of the Fund's Board of Directors. Short-term securities having a
maturity of 60 days or less are stated at amortized cost, which approximates
market value. Dividend income and distributions to shareholders are recorded on
the ex-dividend date. Interest income, adjusted for amortization of premiums and
accretion of discounts, is accrued as earned.
WHEN-ISSUED SECURITIES The Fund, at times, may purchase GNMA certificates
on a delayed delivery, forward or when-issued basis with payment and delivery
often taking place a month or more after the initiation of the transaction. It
is the Fund's policy to record when-issued GNMA certificates (and the
corresponding obligation to pay for the securities) at the time the purchase
commitment becomes fixed--generally on the trade date. It is also the Fund's
policy to segregate assets to cover its commitments for when-issued securities
on trade date.
CONSTRUCTION LOAN SECURITIES The Fund may purchase construction loan
securities which are issued to finance building costs. The funds are disbursed
as needed or in accordance with a prearranged plan. The securities provide for
the timely payment to the registered holder of interest at the specified rate
plus scheduled installments of principal. Upon completion of the construction
phase, the construction loan securities are terminated, and project loan
securities are issued. It is the Fund's policy to record these GNMA certificates
on trade date, and to segregate assets to cover its commitments on trade date as
well.
FEDERAL INCOME TAXES It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to "regulated investment
companies" and to distribute all of its taxable income to its shareholders.
Therefore, no provision for Federal income taxes is required.
DISTRIBUTIONS Dividends from net investment income are normally declared
and paid monthly and dividends from net realized capital gains are normally
declared and paid annually. However, the Fund may make distributions on a more
frequent basis to comply with the distribution requirements of the Internal
Revenue Code. The character of income and gains to be distributed
5
<PAGE>
LEXINGTON GNMA INCOME FUND, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 1997 and 1996 (Continued)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
are determined in accordance with income tax regulations which may differ from
generally accepted accounting principles. At December 31, 1997,
reclassifications were made to the Fund's capital accounts to reflect permanent
book/tax differences and income and gains available for distribution under
income tax regulations. Net investment income, net realized gains and net assets
were not affected by this change.
USE OF ESTIMATES The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of increases and
decreases in net assets from operatons during the reporting period. Actual
results could differ from those estimates.
2. INVESTMENT ADVISORY FEE AND OTHER
TRANSACTIONS WITH AFFILIATE
The Fund pays an investment advisory fee to Lexington Management Corporation
("LMC") at an annual rate of 0.60% of the Fund's average daily net assets up to
$150 million and in decreasing stages to 0.40% of average daily net assets in
excess of $800 million. In accordance with the investment advisory agreement,
LMC is required to reimburse the Fund for any expenses, excluding interest,
taxes and extraordinary expenses which exceed 1.50% of the first $30 million of
the Fund's average daily net assets and 1.00% thereafter. No reimbursement was
required for the year ended December 31, 1997.
The Fund reimbursed LMC for certain expenses, including accounting and
shareholder servicing costs of $223,510, which are incurred by the Fund, but
paid by LMC.
3. CAPITAL STOCK
Transactions in capital stock were as follows:
Year ended Year ended
December 31, 1997 December 31, 1996
----------------------------------------------------------
Shares Amount Shares Amount
---------- ----------- ---------- -----------
Shares sold ....... 5,059,013 $ 41,657,370 4,079,533 $ 33,104,861
Shares issued on
reinvestment
of dividends 916,291 7,517,813 753,267 6,088,504
---------- ----------- ---------- -----------
5,975,304 49,175,183 4,832,800 39,193,365
Shares redeemed ... (3,624,917) (29,751,155) (4,312,315) (34,978,296)
---------- ----------- ---------- -----------
Net increase ...... 2,350,387 $ 19,424,028 520,485 $ 4,215,069
========== =========== ========== ===========
4. PURCHASES AND SALES OF INVESTMENT SECURITIES
The cost of purchases and proceeds from sales of securities for the year ended
December 31, 1997, excluding short-term securities, were $231,217,041 and
$215,860,626, respectively.
At December 31,1997, the aggregate gross unrealized appreciation for all
securities in which there is an excess of value over tax cost amounted to
$4,681,862 and aggregate gross unrealized depreciation for all securities in
which there is an excess of tax cost over value amounted to $76,282.
5. FEDERAL INCOME TAXES--CAPITAL LOSS CARRYFORWARDS
Capital loss carryforwards available for Federal income tax purposes as of
December 31, 1997 are: $1,054,628 expiring in 2003. To the extent any future
capital gains are offset by these losses, such gains may not be distributed to
shareholders.
FINANCIAL HIGHLIGHTS
Selected per share data for a share outstanding throughout the period:
<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period ............ $ 8.12 $ 8.19 $ 7.60 $ 8.32 $ 8.26
-------- -------- -------- -------- --------
Income from investment operations:
Net investment income ........................ 0.51 0.53 0.58 0.55 0.59
Net realized and unrealized
gain (loss) on investments ................. 0.29 (0.08) 0.59 (0.72) 0.06
-------- -------- -------- -------- --------
Total income (loss) from investment operations .. 0.80 0.45 1.17 (0.17) 0.65
-------- -------- -------- -------- --------
Less distributions:
Distributions from net investment income ..... (0.52) (0.52) (0.58) (0.55) (0.59)
-------- -------- -------- -------- --------
Net asset value, end of period .................. $ 8.40 $ 8.12 $ 8.19 $ 7.60 $ 8.32
======== ======== ======== ======== ========
Total return .................................... 10.20% 5.71% 15.91% (2.07%) 8.06%
Ratio to average net assets:
Expenses ..................................... 1.01% 1.05% 1.01% 0.98% 1.02%
Net investment income ........................ 6.28% 6.56% 7.10% 6.90% 6.96%
Portfolio turnover .............................. 134.28% 128.76% 30.69% 37.15% 52.34%
Net assets at end of period(000's omitted) ...... $158,071 $133,777 $130,681 $132,108 $149,961
</TABLE>
6
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Lexington GNMA Income Fund, Inc.:
We have audited the accompanying statements of net assets (including the
portfolio of investments) and assets and liabilities of Lexington GNMA Income
Fund, Inc. as of December 31, 1997, the related statement of operations for the
year then ended, the statements of changes in net assets for each of the years
in the two-year period then ended, and the financial highlights for each of the
years in the five-year period then ended. These financial statements and
financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
December 31, 1997 by correspondence with the custodian. As to securities
purchased but not yet received, we performed other appropriate auditing
procedures. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Lexington GNMA Income Fund, Inc. as of December 31, 1997, the results of its
operations for the year then ended, the changes in its net assets for each of
the years in the two-year period then ended, and the financial highlights for
each of the years in the five-year period then ended, in conformity with
generally accepted accounting principles.
KPMG Peat Marwick LLP
New York, New York
February 4, 1998
7
<PAGE>
LEXINGTON
GNMA INCOME FUND, INC.
INVESTMENT ADVISER
- --------------------------------------------------------------------------------
LEXINGTON MANAGEMENT CORPORATION
P.O. Box 1515
Park 80 West Plaza Two
Saddle Brook, New Jersey 07663
DISTRIBUTOR
- --------------------------------------------------------------------------------
LEXINGTON FUNDS DISTRIBUTOR, INC.
P.O. Box 1515
Park 80 West Plaza Two
Saddle Brook, New Jersey 07663
------------------------------------------------------------------------------
ALL SHAREHOLDER REQUESTS FOR SERVICES OF
ANY KIND SHOULD BE SENT TO:
TRANSFER AGENT
------------------------------------------------------------------------------
STATE STREET BANK AND
TRUST COMPANY
c/o National Financial Data Services
1004 Baltimore
Kansas City, Missouri 64105
OR CALL TOLL FREE:
SERVICE AND SALES: 1-800-526-0056
24 HOUR ACCOUNT INFORMATION:
1-800-526-0052
------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(800) 526-0052
"LEXLINE"
24 hour toll-free telephone access to your
Lexington Fund account
Price/Yield o Account Balances o Exchanges o
Last Transactions o Total Return o Duplicate Statements
- --------------------------------------------------------------------------------
This report has been prepared for the information of the shareholders of
Lexington GNMA Income Fund, Inc. and is authorized for distribution to the
public only if it is accompanied or preceded by a currently effective prospectus
which sets forth expenses and other material information.
LEXINGTON
- --------------------------------------------------------------------------------
================================================================================
LEXINGTON
GNMA
INCOME
FUND, INC.
- --------------------------------------------------------------------------------
An investment primarily in
mortgage-backed GNMA
Certificates that are guaranteed
as to the timely payment of
principal and interest by the
United States Government.
- --------------------------------------------------------------------------------
ANNUAL REPORT
DECEMBER 31, 1997
The Lexington Group
of No Load
Investment Companies
================================================================================
