MONTGOMERY
MONTGOMERY
STREET
INCOME
SECURITIES
4
Annual Report
December 31, 1995
SCUDDER
Investment Adviser
DIRECTORS JOHN C. ATWATER
RICHARD J. BRADSHAW
OTTO W. BUTZ
MARYELLIE K. MOORE
WENDELL G. VAN AUKEN
JAMES C. VAN HORNE
Chairman
OFFICERS JOHN T. PACKARD
President
DANIEL PIERCE
Vice President and
Assistant Treasurer
EDWARD J. O'CONNELL
Vice President
THOMAS F. McDONOUGH
Vice President and
Secretary
PAMELA A. McGRATH
Vice President and
Treasurer
KATHRYN L. QUIRK
Vice President and
Assistant Secretary
STEPHEN A. WOHLER
Vice President
MARK S. BOYADJIAN
Vice President
INVESTMENT Scudder, Stevens & Clark, Inc.
MANAGER 101 California Street, Suite 4100
San Francisco, CA 94111
TRANSFER State Street Bank and Trust
AGENT Company
P.O. Box 8200
Boston, MA 02266-8200
CUSTODIAN Chase Manhattan Bank, N.A.
4 Chase Metro Tech Center
18th Floor
Brooklyn, NY 11245
LEGAL COUNSEL Howard, Rice, Nemerovski,
Canady, Falk & Rabin
Three Embarcadero Center
Seventh Floor
San Francisco, CA 94111
INDEPENDENT Ernst & Young LLP
AUDITORS 200 Clarendon Street
Boston, MA 02116
<PAGE>
101 California Street, Suite 4100
San Francisco, CA 94111
(415) 981-8191
Dear Shareholder:
The portfolio of Montgomery Street Income Securities, Inc. (the Fund) produced a
total return for the quarter ended December 31, 1995 of 4.81%. The net asset
value (NAV) per share was $19.94, a slight increase from $19.79 in September,
reflecting higher bond prices partially offset by the payment of two dividends
in the final quarter of the year. Dividend payments of $0.35 per share were made
on October 31 and $0.36 per share on December 29. The $0.01 higher dividend in
December represented the distribution of excess income accumulation at year end
as opposed to an increase in the earning power of the Fund's portfolio. The
market price of the Fund's shares, which trade on the New York Stock Exchange
(NYSE), was $18.00 on December 31, 1995, compared to $17.75 on September 30. At
quarter end, the annualized dividend yield of the Fund based on market value was
7.8%, approximately 2.2% above the yield of the 10-year U.S. Treasury Note.
For the full year the change in NAV from $17.72 to $19.94 represented an
increase of 12.53%. When the dividend of $1.40 for the year is taken into
consideration, the total return for the Fund was 21.78%. The unmanaged Lehman
Brothers Aggregate Bond Index produced a total return of 18.47% during this same
period. The change in the Lehman Brothers Aggregate Bond Index was the largest
in the last decade and almost double the return the Index had in 1993, which was
another strong year for bonds. The Index posted positive returns for 11 months
in 1995 with only the month of July showing a negative return. The NYSE share
price of the Fund increased to $18.00 from $15.75 per share at the end of 1994,
a gain of 14.29% before taking income into consideration. The market discount to
NAV declined from 11.1% at the end of 1994 to 9.7% on December 31, 1995; the
discount was even lower in early February.
The total return of the Fund based on NAV, which reflects the performance of the
underlying portfolio, has been competitive. Annualized total returns (based on
NAV and dividends) vs. the unmanaged Lehman Brothers Aggregate Bond Index for
the last 5 years are shown below.
-------------------------------------------------------
Montgomery Lehman
Street Brothers
Income Aggregate Return
Securities Bond Index Advantage
-------------------------------------------------------
1 year 21.78% 18.47% 3.31%
2 years 7.84 7.24 0.60
3 years 9.36 8.07 1.29
4 years 9.93 7.90 2.03
5 years 12.30 9.48 2.82
-------------------------------------------------------
We believe that the total return performance of the Fund has been quite good,
especially considering the moderate risk profile that we have maintained in the
face of volatile markets. Duration has been kept in the 5 to 6 year range,
shorter than many other bond funds. A conservative course has been followed in
the use of below investment grade bonds, limiting the size of this commitment to
about 20% of the overall portfolio and using primarily BB rated issues.
Market and Economic Conditions
During the fourth quarter bonds continued to increase in price, reflecting the
increasingly apparent slowdown in the growth of business and the expectation of
another move by the Federal Reserve Board to ease short-term interest rates.
2
<PAGE>
This did occur on December 19 when the Federal Funds target rate was cut by 25
basis points for the second time in 1995. Economic growth continued to show
signs of slowing, especially in the retail sales area. In addition, the cycle in
capital goods may be rolling over, and a weak Europe probably spells weaker
exports. Inflation remains in check and there is nothing apparent on the horizon
which would cause it to increase rapidly from the current level.
The budget impasse has been nothing short of astounding. The potential default
in connection with the January 29 Treasury refinancing was avoided with a last
minute third extension of the national debt ceiling. The inability to reconcile
this situation could lead to a crisis of confidence. On the other hand, the
public may interpret it as politics as usual and, while miffed at the
inconvenience it is causing, may not treat it as a significant problem. There is
risk that the bond market may be disappointed if true resolution must await an
uncertain election in November.
As you can see from the yield curves below, short-term rates have been held up
by the Fed, while longer maturities have come down in yield sharply since last
year. The yield curve has actually rallied to a flatter shape, once again due to
the Fed's reluctance to lower short term rates until the budget deal is done.
Treasury Yield Curves
0.25 5.682 0.25 5.406 0.25 5.072
0.5 6.495 0.5 5.576 0.5 5.147
1 7.162 1 5.674 1 5.132
2 7.690 2 5.851 2 5.150
3 7.778 3 5.914 3 5.208
5 7.827 5 6.015 5 5.374
10 7.827 10 6.178 10 5.570
30 7.876 30 6.504 30 5.949
Years 12/31/94 9/30/95 12/31/95
to
Maturity
Corporate securities showed very good performance for the year, as financing
needs were relatively light because of excellent corporate cash flow generation
from business operations. This combination of less debt issuance, better credit
fundamentals, and good buying demand, brought the yields on corporates closer to
Treasurys through most of the year. Mortgages, however, generally underperformed
as the market rallied, as they were subjected to rapidly escalating pre-payment
assumptions. Higher prepayments shortened the expected life of mortgage
securities, reducing their price advance as yields moved lower.
The Portfolio
As yields fell in 1995, the portfolio was benefited by the low cash position we
held during the year. Because rates fell more in the intermediate maturities,
that portion of the yield curve had good returns, especially on a duration (or
3
<PAGE>
risk) adjusted basis. During the fourth quarter the portfolio was extended from
an average maturity of 12.5 years to 13.6 years. Duration was moved from 5.1
years to 5.5 years, reflecting our view that the Fed would eventually have to
ease in response to a weakening economy.
Our corporate bond position remained relatively stable at 57.5% of the
portfolio. NationsBank, First Union Corp., and Olympic Financial were added
during the last quarter as we increased our exposure in the financial sector. We
added to mortgage pass-throughs as they lagged the market during the rally since
summer. Mortgages provide a high quality source of income, however, during
volatile periods they tend to underperform. We think the market's recent run has
made selected pass-through securities attractive again. Our mortgage commitment
is currently focused in seasoned higher coupon areas, where we think prepayments
will be below general expectations, and in the 15-year final maturity area,
which should take advantage of a steeper curve as the Fed eases in coming
months. The comparative bar graph below shows the changes that occurred during
the quarter in the sector allocation of the portfolio.
Percent of Portfolio as of 12/31/95
9/30/95 12/31/95
Cash 8.3 0.7
Treasury and Agency (Gov't) 7.5 7
Mortgage 17.7 24.5
Asset-Backed 4. 4.
Industrial 36. 34.
Utility 7.2 6.8
Finance 13. 16.7
Foreign 6.2 5.1
The Fund's investment policy allows the portfolio to hold up to 30% of total
assets in foreign denominated securities, preferreds, convertibles, private
placements, and below investment grade debt securities. As of year end the Fund
held 24.6% of its assets in these categories, 20.1% of which are below
investment grade in terms of credit rating. The single largest below investment
grade holding is Safeway, a supermarket chain, comprising 2.0% of the total
portfolio. Average quality for the portfolio at year end was "A". The PT Alatief
(a subsidiary of Freeport McMoran Resources) holding was upgraded to "BBB" --
from below investment grade during the quarter. We sold our positions in Unisys
due to concerns about credit trends.
4
<PAGE>
The pie chart below shows the quality breakdown of the portfolio.
Quality
-------------------
Cash 0.7%
Government 31.5%
AAA 0.9%
AA 6.5%
A 9.1%
BBB 48.7%
BB 2.6%
-------------------
100.0%
------
------
Our 3.2% commitment in U.S. dollar denominated Mexican corporates performed well
during the quarter, as most emerging markets enjoyed some resurgence of
investment favor. We reduced our only non-dollar position in Government of
Canada bonds to 1.9% from 3.0% prior to the Quebec referendum. Although the
Separatists were defeated, the election was razor close and unsettled the
currency market.
Our position in the structured note area remains unchanged. The General Electric
Capital Corp. inverse floating rate note's coupon was lowered to 2.918% in
November where it provides an expected yield to maturity of 6.04% based on year
end pricing. However, this instrument advanced in price from $89.63 to $93.13
over the quarter as lower European short-term rates have been anticipated by the
market. The Student Loan Marketing Association inverse floater remains at 4.40%,
above its floor of 4.00%. Declining German yields auger well for returns on this
agency credit.
Investment Policy Addendum
During the year, the Board of Directors of the Fund adopted investment
guidelines for a type of mortgage transaction called a "dollar roll". In this
transaction a mortgage security held in the portfolio is sold, and the same type
of security (same issuer, same coupon, same type of underlying mortgage)
purchased for delivery at a later date. At times, technical conditions in the
mortgage market make this type of transaction attractive by enhancing the income
earned by the portfolio. The Board put restrictions in place to help limit the
counterparty and leverage risks which are sometimes associated with this type of
transaction. The Fund will be able to commit no more than 15% of net assets to
dollar rolls at any time, although there were no transactions of this nature in
1995.
Portfolio Management Responsibilities and Team
Stephen A. Wohler, Vice President of the Fund, leads the Fund's portfolio
management team, having assumed responsibility for day-to-day management in
1988. Stephen has over 15 years' experience managing fixed-income investments.
Mark S. Boyadjian, C.F.A., a Vice President of the Fund, has been a member of
the Fund's portfolio management team for over four years. Mark has eight years'
experience in investment management. Kristin Bradbury, C.F.A., is responsible
for quantitative analysis and trading for the portfolio. Ms. Bradbury has 10
years of investment related experience.
5
<PAGE>
Dividend Reinvestment and Cash Purchase Option
The Fund maintains an optional Dividend Reinvestment and Cash Purchase Plan (the
Plan) for the automatic reinvestment of your dividends and capital gains
distributions in the shares of the Fund. This Plan also allows you to make
additional cash investments in Fund shares. We recommend that you consider
enrolling in the Plan to build your investments. State Street Bank and Trust
Company is the Fund's Plan Agent, and the Plan's features are described
beginning on page 22 of this report.
Director Retiring
Mr. John A. White resigned last month from his role as honorary director of
Montgomery Street Income Securities. Mr. White was one of the original directors
of the Fund and guided the Fund as an active director for 18 years through his
leadership and dedication. After his retirement as an active director in 1991,
he continued to provide counsel to the Board as an honorary director until
January 1996. His strong interest in the welfare of the Fund's shareholders and
his sound advice over the years have set a high standard of professionalism
which we will aspire to uphold.
Thank you for being a shareholder this year.
Sincerely,
/s/John T. Packard /s/Stephen A. Wohler
John T. Packard Stephen A. Wohler
President Vice President
Portfolio Manager of the Fund
February 8, 1996
This report is sent to shareholders of Montgomery Street Income Securities, Inc.
for their information. It is not a prospectus, circular, or representation
intended for use in the purchase or sale of shares of the Fund or of any
securities mentioned in the report.
6
<PAGE>
INVESTMENT OBJECTIVES
Your Fund is a closed-end diversified management investment company registered
under the Investment Company Act of 1940, investing and reinvesting its assets
in a portfolio of selected securities. The Fund's primary investment objective
is to seek as high a level of current income as is consistent with prudent
investment risks, from a diversified portfolio primarily of debt securities.
Capital appreciation is a secondary objective.
PRINCIPAL INVESTMENT POLICIES
Investment of your Fund is guided by the following principal investment
policies:
At least 70% of total assets must be invested in: straight debt securities
(other than municipal securities) rated within the four highest grades assigned
by Moody's Investors Service, Inc. or Standard & Poor's; bank debt of comparable
quality; U.S. government or agency securities; commercial paper; cash; cash
equivalents; or Canadian government, provincial, or municipal securities (not in
excess of 25% of total assets).
Up to 30% of total assets (the "30% basket") may be invested in U.S. or foreign
securities that are straight debt securities, whether or not rated, convertible
securities, preferred stocks, or dividend-paying utility company common stock.
Not more than 25% of total assets may be invested in securities of any one
industry (neither utility companies as a whole nor finance companies as a whole
are considered an "industry" for the purposes of this limitation).
Not more than 15% of total assets may be invested in securities which are
restricted as to resale.
Not more than 5% of total assets may be invested in securities of any one
issuer, other than U.S. government or agency securities.
The Fund may invest money pursuant to repurchase agreements so long as the Fund
is initially wholly secured with collateral consisting of securities in which
the Fund can invest under its investment objectives and policies. In addition,
investment in repurchase agreements must not, at the time of any such loan, be
as a whole more than 20%--and be as to any one borrower more than 5%--of the
Fund's total assets.
The Fund may loan portfolio securities so long as the Fund is continuously
secured by collateral at least equal to the market value of the securities
loaned. In addition, loans of securities must not, at the time of any such loan,
be as a whole more than 10% of the Fund's total assets.
The Fund may borrow funds to purchase securities, provided that the aggregate
amount of such borrowings may not exceed 30% of the Fund's assets (including
aggregate borrowings), less liabilities (excluding such borrowings).
The Fund may enter into forward foreign currency sale contracts to hedge
portfolio positions, provided, among other things, that such contracts have a
maturity of one year or less and at the time of purchase, the Fund's obligations
under such contracts may not exceed either the market value of portfolio
securities denominated in the foreign currency or 15% of the Fund's total
assets.
Subject to adoption of Board guidelines, the Fund may enter into interest rate
futures contracts and purchase or write options on interest rate futures
contracts, provided, among other things, that the Fund's obligations under such
instruments may not exceed the market value of the Fund's assets not subject to
the 30% basket.
7
<PAGE>
SCHEDULE OF INVESTMENTS
December 31, 1995
<TABLE>
<CAPTION>
Principal Market
Amount ($)* Value ($)
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
SHORT-TERM INVESTMENTS -- 0.7%
(UNDER 1 YEAR)
American Express Credit Corp., 5.609%, 1/5/96 ................................ 270,000 270,000
Beneficial Corp., 5.929%, 1/5/96 ............................................. 1,204,000 1,204,000
----------
TOTAL SHORT-TERM INVESTMENTS (Cost $1,474,000) ............................... 1,474,000
----------
- -----------------------------------------------------------------------------------------------------------------------
INTERMEDIATE-TERM BONDS -- 29.9%
(1 - 8 YEARS)
U.S. TREASURY AND AGENCY -- 8.6%
Federal Home Loan Mortgage Corp., REMIC, 1724, principal only
certificate, 5/15/01 ................................................. 3,450,198 2,926,739
Federal National Mortgage Association, pass-thru certificate, 8%,
with various maturities to 11/1/01 ................................... 615,798 632,731
Student Loan Marketing Association, floating rate debenture, coupon
inversely indexed to 5 year German Swap Rate, 4.4%, 3/23/98** ........ 2,500,000 2,437,500
U.S. Treasury Note, 8.875%, 2/15/99 .......................................... 8,000,000 8,820,000
U.S. Treasury Note, 9.125%, 5/15/99 .......................................... 2,400,000 2,678,256
----------
17,495,226
----------
FOREIGN GOVERNMENT -- 1.7%
Banco Nacional de Comercio Exterior SNC, 8%, 8/5/03 .......................... 2,000,000 1,590,000
Nacional Financiera SNC, 9.375%, 7/15/02 ..................................... 2,000,000 1,780,000
----------
3,370,000
----------
METALS & MINERALS -- 1.6%
Precious Metals
Alatief Freeport Financial Co., note, 9.75%, 4/15/01 ......................... 3,000,000 3,352,500
----------
CONSUMER DISCRETIONARY -- 3.0%
Department and Chain Stores -- 1.0%
Federated Department Stores, Inc., senior note, 10%, 2/15/01 ................. 2,000,000 2,180,000
----------
Retail -- 2.0%
Safeway Stores Inc., senior subordinated note, 10%, 12/1/01 .................. 3,500,000 3,955,000
----------
CONSUMER STAPLES -- 1.5%
Food & Beverage
Empresa La Moderna S.A., 10.25%, 11/12/97 .................................... 1,000,000 980,000
Fomento Economico Mexicano, S.A. (FEMSA), 9.5%, 7/22/97 ...................... 1,000,000 995,000
Gruma, 9.75%, 3/9/98 ......................................................... 1,000,000 972,500
----------
2,947,500
----------
</TABLE>
The accompanying notes are an integral part of the financial statements.
8
<PAGE>
<TABLE>
<CAPTION>
Principal Market
Amount ($)* Value ($)
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
FINANCIAL -- 8.1%
Banks -- 3.0%
Continental Bank, subordinated note, 12.5%, 4/1/01 ........................... 3,000,000 3,854,100
First USA Bank, global subordinated note, 7.65%, 8/1/03 ...................... 2,000,000 2,085,940
----------
5,940,040
----------
Other Financial Companies -- 3.5%
General Electric Capital Corp., medium-term basket structured note,
coupon inversely indexed to 6 month Italian LIBOR and
Swedish STIBOR, 2.91825%, 5/21/98** ........................................ 2,000,000 1,862,500
Olympic Financial Ltd., 13%, 5/1/00 .......................................... 2,000,000 2,185,000
Taubman Realty Group LP, medium-term note, 7.5%, 6/15/02 ..................... 3,000,000 3,013,500
----------
7,061,000
----------
Real Estate -- 1.6%
Federal Realty Investment Trust, convertible bond, 5.25%, 10/28/03 ........... 2,000,000 1,760,000
Health Care Properties Investors Inc., 6%, 11/8/00 ........................... 1,500,000 1,483,125
----------
3,243,125
----------
SERVICE INDUSTRIES -- 1.1%
Service Industries
ADT Operations, senior subordinated note, 9.25%, 8/1/03 ...................... 2,000,000 2,145,000
----------
MEDIA -- 1.6%
Cable Television
Rogers Cablesystems Ltd., senior secured note, 9.625%, 8/1/02 ................ 3,000,000 3,142,500
----------
ENERGY -- 1.7%
Chemicals
Lyondell Petrochemical Co., note, 10%, 6/1/99 ................................ 3,000,000 3,358,350
----------
TECHNOLOGY -- 1.0%
Electronic Data Processing
Digital Equipment Corp., global note, 7.125%, 10/15/02 ....................... 2,000,000 2,019,780
----------
TOTAL INTERMEDIATE-TERM BONDS (Cost $57,737,018) ............................. 60,210,021
----------
- -----------------------------------------------------------------------------------------------------------------------
LONG-TERM BONDS -- 66.2%
(OVER 8 YEARS)
U.S. TREASURY & AGENCY -- 22.3%
Federal Home Loan Mortgage Corp., 6%, 12/1/10 ................................ 5,100,000 5,044,206
Federal Home Loan Mortgage Corp., 8%, 7/1/25 ................................. 7,816,467 8,099,814
Federal Home Loan Mortgage Corp., REMIC, interest only certificate,
7%, 9/15/23 ................................................................ 2,677,991 1,210,954
Federal National Mortgage Association, pass-thru certificate, 9%,
with various maturities to 10/1/25 ......................................... 1,723,465 1,815,016
</TABLE>
The accompanying notes are an integral part of the financial statements.
9
<PAGE>
SCHEDULE OF INVESTMENTS (CONTINUED)
<TABLE>
<CAPTION>
Principal Market
Amount ($)* Value ($)
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Federal National Mortgage Association, REMIC, interest only
certificate, 7%, 8/25/23 ................................................... 2,307,142 1,155,734
Government National Mortgage Association, pass-thru certificate, 6.5%,
with various maturities to 5/15/09 ......................................... 18,306,171 18,472,024
Government National Mortgage Association, pass-thru certificate, 8%,
with various maturities to 5/20/25 ......................................... 8,806,595 9,169,458
----------
44,967,206
----------
FOREIGN GOVERNMENT -- 1.9%
Government of Canada, 8%, 6/1/23 ............................................. CAD 5,000,000 3,839,846
----------
COMMUNICATIONS -- 1.1%
TCI Communications Inc., senior note, 8%, 8/1/05 ............................. 2,000,000 2,122,980
----------
CONSTRUCTION -- 2.1%
Georgia-Pacific Corp., debenture, 7.7%, 6/15/15 .............................. 2,000,000 2,093,400
USG Corp., senior note, 8.5%, 8/1/05 ......................................... 2,000,000 2,070,000
----------
4,163,400
----------
CONSUMER DISCRETIONARY -- 1.0%
Hotels & Casinos
Marriott Corp., debenture, 9.375%, 6/15/07 ................................... 2,000,000 1,997,500
----------
CONSUMER STAPLES -- 4.1%
Food & Beverage
Borden Inc., debenture, 9.2%, 3/15/21 ........................................ 4,000,000 4,245,640
Coca Cola Co., Inc., debenture, 7.375%, 7/29/2093 ............................ 3,500,000 3,953,110
----------
8,198,750
----------
FINANCIAL -- 11.7%
Banks -- 5.7%
ABN-AMRO Bank N.V., subordinated note, 7.125%, 10/15/2093 .................... 5,000,000 5,141,400
First Union Corp. subordinated note, 6.55%, 10/15/35 ......................... 3,000,000 3,120,090
NationsBank Corp., 7.75%, 8/15/15 ............................................ 3,000,000 3,286,050
----------
11,547,540
----------
Other Financial Companies -- 6.0%
Commercial Credit Corp., debenture, 10%, 5/15/09 ............................. 3,000,000 3,935,970
Greentree Financial Corp., asset-backed, senior subordinated
pass-thru certificate, 7.2%, 1/15/19 ....................................... 8,000,000 8,040,000
----------
11,975,970
----------
MEDIA -- 3.2%
Broadcasting & Entertainment
Paramount Communications, Inc., senior debenture, 7.5%, 7/15/23 .............. 2,000,000 1,921,920
Time Warner Inc., debenture, 9.125%, 1/15/13 ................................. 4,000,000 4,507,800
----------
6,429,720
----------
</TABLE>
The accompanying notes are an integral part of the financial statements.
10
<PAGE>
<TABLE>
<CAPTION>
Principal Market
Amount ($)* Value ($)
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
DURABLES -- 1.4%
Aerospace
McDonnell Douglas, debenture, 9.75%, 4/1/12 .................................. 2,250,000 2,896,740
-----------
ENERGY -- 10.2%
Oil & Gas Production -- 8.2%
Lasmo U.S.A. Inc., note, 8.375%, 6/1/23 ...................................... 3,000,000 3,180,300
Louis Dreyfus Natural Gas Corp., senior note, 9.25%, 6/15/04 ................. 3,000,000 3,245,280
Saga Petroleum A.S., debenture, 9.125%, 7/15/14 .............................. 3,000,000 3,503,760
Seagull Energy, senior subordinated note, 8.625%, 8/1/05 ..................... 3,000,000 2,895,000
Unocal Corp., debenture, 9.4%, 2/15/11 ....................................... 3,000,000 3,768,780
-----------
16,593,120
-----------
Oil Companies -- 2.0%
Atlantic Richfield, medium-term note, 10.875%, 7/15/05 ....................... 3,000,000 3,927,960
-----------
MANUFACTURING -- 2.3%
Diversified Manufacturing
Borden Chemicals and Plastics, Ltd., 9.5%, 5/1/05 ............................ 2,000,000 2,060,000
Tenneco Inc., debenture, 10%, 3/15/08 ........................................ 2,000,000 2,572,220
-----------
4,632,220
-----------
TECHNOLOGY -- 0.9%
Military Electronics
Loral Corp., note, 8.375%, 6/15/24 ........................................... 1,500,000 1,722,495
-----------
TRANSPORTATION -- 0.9%
Airlines
American Airlines, Inc., medium-term note, 10.45%, 3/10/11 ................... 1,500,000 1,865,880
-----------
UTILITIES -- 3.1%
Natural Gas Distributors
ANR Pipeline, debenture, 9.625%, 11/1/21 ..................................... 2,000,000 2,579,740
Coastal Corp., debenture, 9.625%, 5/15/12 .................................... 3,000,000 3,603,870
-----------
6,183,610
-----------
TOTAL LONG-TERM BONDS (Cost $126,530,712) .................................... 133,064,937
-----------
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
11
<PAGE>
SCHEDULE OF INVESTMENTS (CONTINUED)
<TABLE>
<CAPTION>
Market
Shares Value ($)
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
PREFERRED STOCK -- 1.7%
FINANCIAL
Banks -- 0.7%
First Nationwide Bank, non-cumulative 11.5% .................................. 12,500 1,403,125
-----------
Real Estate -- 1.0%
United Dominion Realty Trust Inc., "A", 9.25% ................................ 80,000 2,070,000
-----------
TOTAL PREFERRED STOCK (Cost $3,250,000) ...................................... 3,473,125
-----------
- -----------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT PORTFOLIO -- 98.5% (Cost $188,991,730)(a) ................... 198,222,083
OTHER ASSETS AND LIABILITIES, NET -- 1.5% .................................... 3,025,203
-----------
NET ASSETS -- 100.0% ......................................................... 201,247,286
===========
</TABLE>
- ---------------
(a) The cost for federal income tax purposes was $188,991,730. At December 31,
1995, net unrealized appreciation for all securities based on tax cost was
$9,230,353. This consisted of aggregate gross unrealized appreciation for
all securities in which there was an excess of market value over tax cost of
$10,467,928 and aggregate gross unrealized depreciation for all securities
in which there was an excess of tax cost over market value of $1,237,575.
* Principal amount is stated in U.S. dollars unless otherwise specified.
** Inverse floating rate notes are instruments whose yields have an inverse
relationship to benchmark interest rates. These securities are shown at
their rate as of December 31, 1995.
CURRENCY ABBREVIATIONS USED IN THIS PORTFOLIO:
CAD Canadian Dollar
The accompanying notes are an integral part of the financial statements.
12
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
DECEMBER 31, 1995
<TABLE>
<S> <C> <C>
ASSETS
Investments, at market (identified cost $188,991,730)
(Note A) ............................................................. $ 198,222,083
Cash ......................................................................... 745
Interest and dividends receivable ............................................ 3,210,558
-------------
TOTAL ASSETS 201,433,386
LIABILITIES
Accrued management fee (Note B) .............................................. $ 84,564
Other accrued expenses ....................................................... 101,536
--------
TOTAL LIABILITIES 186,100
-------------
NET ASSETS, at market value .......................................... $ 201,247,286
=============
NET ASSETS
Net assets consist of:
Undistributed net investment income .................................. $ 206,477
Net unrealized appreciation on investments ........................... 9,230,353
Accumulated net realized loss ........................................ (5,621,744)
Common stock ......................................................... 10,091,241
Additional paid-in capital ........................................... 187,340,959
-------------
NET ASSETS, at market value .......................................... $ 201,247,286
=============
NET ASSET VALUE PER SHARE ($201,247,286 divided by 10,091,241 shares
of common stock outstanding, $1.00 par value, 15,000,000
shares authorized) ........................................................... $19.94
======
</TABLE>
The accompanying notes are an integral part of the financial statements.
13
<PAGE>
STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1995
<TABLE>
<S> <C> <C>
INVESTMENT INCOME
INCOME:
Interest .......................................... $15,472,086
Dividends ......................................... 277,875
-----------
15,749,961
EXPENSES:
Management and investment advisory fee (Note B) ... $946,575
Directors' fees (Note B) .......................... 80,143
Transfer agent and dividend disbursing agent fees.. 92,824
Reports to shareholders ........................... 77,127
Auditing .......................................... 64,479
State franchise tax ............................... 41,034
Legal ............................................. 29,351
Custodian fees .................................... 14,761
Other ............................................. 63,714 1,410,008
-------- -----------
NET INVESTMENT INCOME 14,339,953
-----------
NET REALIZED AND UNREALIZED GAIN ON INVESTMENTS
Net realized gain from investment transactions ............ 20,961
Net unrealized appreciation during the period on:
Investments ....................................... 22,105,285
Foreign currency related transactions ............. 396
-----------
Net gain on investments ................................... 22,126,642
-----------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS .............. $36,466,595
===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
14
<PAGE>
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1995 1994
---- ----
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS:
Net investment income .................................................... $ 14,339,953 $ 13,714,204
Net realized gain (loss) from investment transactions .................... 20,961 (5,045,581)
Net unrealized appreciation (depreciation) on investment
transactions during the period ....................................... 22,105,681 (19,015,182)
------------- ------------
Net increase (decrease) in net assets resulting from operations ............... 36,466,595 (10,346,559)
------------- ------------
Dividends to shareholders from net investment income
($1.40 and $1.36 per share, respectively) ................................ (14,069,861) (13,575,510)
------------- ------------
Fund share transactions:
Reinvestment of dividends from net investment income ..................... 1,168,280 1,106,625
------------- ------------
INCREASE (DECREASE) IN NET ASSETS ............................................. 23,565,014 (22,815,444)
Net assets at beginning of period ............................................. 177,682,272 200,497,716
------------- ------------
NET ASSETS AT END OF PERIOD (including undistributed net
investment income of $206,477 and $93,446, respectively) ................. $ 201,247,286 $177,682,272
============= ============
OTHER INFORMATION
INCREASE IN FUND SHARES
Shares outstanding at beginning of period ..................................... 10,024,589 9,958,150
Shares issued to shareholders in reinvestment of dividends
from net investment income ............................................... 66,652 66,439
------------- ------------
Shares outstanding at end of period ........................................... 10,091,241 10,024,589
============= ============
</TABLE>
The accompanying notes are an integral part of the financial statements.
15
<PAGE>
FINANCIAL HIGHLIGHTS
THE FOLLOWING TABLE INCLUDES SELECTED DATA FOR A SHARE OUTSTANDING THROUGHOUT
EACH PERIOD AND OTHER PERFORMANCE INFORMATION DERIVED FROM THE FINANCIAL
STATEMENTS AND MARKET PRICE DATA.
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------
1995(a) 1994(a) 1993(a) 1992(a) 1991
----------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period ................... $17.72 $20.13 $19.30 $19.17 $17.21
------ ------ ------ ------ ------
Income from investment operations:
Income ......................................... 1.57 1.51 1.68 1.84 1.88
Operating expenses ............................. (.14) (.14) (.15) (.15) (.13)
------ ------ ------ ------ ------
Net investment income .......................... 1.43 1.37 1.53 1.69 1.75
Net realized and unrealized gain (loss) ........ 2.19 (2.42) .84 .47 1.97
------ ------ ------ ------ ------
Total from investment operations ....................... 3.62 (1.05) 2.37 2.16 3.72
------ ------ ------ ------ ------
Dilution resulting from the rights offering ............ -- -- -- (.36) --
Less distributions from net investment
income ......................................... (1.40) (1.36) (1.54) (1.67) (1.76)
------ ------ ------ ------ ------
Net asset value, end of period ......................... $19.94 $17.72 $20.13 $19.30 $19.17
====== ====== ====== ====== ======
Per share market value, end of period .................. $18.00 $15.75 $19.75 $20.88 $19.63
====== ====== ====== ====== ======
Price range on New York Stock Exchange
for each share of Common Stock
outstanding during the period (Unaudited):
High ........................................... $19.13 $20.25 $22.38 $21.00 $20.25
Low ............................................ $15.75 $15.25 $19.25 $19.00 $17.00
TOTAL INVESTMENT RETURN
Per share market value (%) ..................... 23.69 (13.54) 2.02 17.98 23.11
Per share net asset value (%) (b) .............. 21.78 (4.51) 12.47 11.67 22.28
RATIOS AND SUPPLEMENTAL DATA
Net assets, end of period ($ millions) ................. 201 178 200 191 157
Ratio of operating expenses to
average net assets (%) ......................... .73 .71 .73 .75 .69
Ratio of net investment income to
average net assets (%) ......................... 7.45 7.28 7.53 8.69 9.60
Portfolio turnover rate (%) ............................ 76.4 137.0 122.8 137.6 72.0
</TABLE>
- --------------
(a) Based on monthly average shares outstanding during the period.
(b) Total investment returns reflect changes in net asset value per share
during each period and assumes that dividends and capital gains
distributions, if any, were reinvested. The dilution resulting from the
rights offering in 1992 has been treated as a distribution for the total
return calculation. These percentages are not an indication of the
performance of a shareholder's investment in the Fund based on market.
16
<PAGE>
NOTES TO FINANCIAL STATEMENTS
December 31, 1995
NOTE A--SIGNIFICANT ACCOUNTING POLICIES. Montgomery Street Income Securities,
Inc. (the "Fund") is registered under the Investment Company Act of 1940, as
amended, as a closed-end diversified management investment company.
Significant accounting policies are summarized as follows:
Valuation of Investments--Portfolio debt securities with remaining maturities
greater than sixty days are valued by pricing agents approved by the Officers
of the Fund, which prices reflect broker/dealer-supplied valuations and
electronic data processing techniques. If the pricing agents are unable to
provide such quotations, or if the Adviser does not believe that the value
supplied by the pricing agent represents fair market value, the most recent
bid quotation supplied by a bona fide market maker shall be used. Short-term
investments having a maturity of sixty days or less are valued at amortized
cost. Securities for which market quotations are not available are valued as
determined in good faith by or under the direction of the Board of Directors
of the Fund.
Foreign Currency Translations--The books and records of the Fund are
maintained in U.S. dollars. Foreign currency transactions are translated
into U.S. dollars on the following basis:
(i) market value of investment securities, other assets and liabilities at
the daily rates of exchange, and
(ii) purchases and sales of investment securities, interest income and
certain expenses at the rates of exchange prevailing on the
respective dates of such transactions.
The Fund does not isolate that portion of gains and losses on investments
which is due to changes in foreign exchange rates from that which is due
to changes in market prices of the investments. Such fluctuations are
included with the net realized and unrealized gains and losses from
investments.
Net realized and unrealized gain (loss) from foreign currency related
transactions includes gains and losses between trade and settlement dates on
securities transactions, gains and losses arising from the sales of foreign
currency, and gains and losses between the accrual and payment dates on
interest and foreign withholding taxes.
Federal Income Taxes--The Fund's policy is to comply with the requirements
of the Internal Revenue Code which are applicable to regulated investment
companies and to distribute all of its taxable income to its shareholders.
The Fund, accordingly, paid no federal income taxes and no federal income
tax provision was required.
As of December 31, 1995, the Fund had a net tax basis capital loss
carryforward of approximately $5,622,000, which may be applied against any
realized net taxable capital gains of each succeeding year until fully
utilized or until December 31, 1999 ($61,000), December 31, 2002
($3,313,000), and December 31, 2003 ($2,248,000), the respective expiration
dates, whichever occurs first.
17
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Distribution of Income and Gains--Distributions of net investment income are
made quarterly. During any particular year, net realized gains from
investment transactions, in excess of available capital loss carryforwards,
would be taxable to the Fund if not distributed and, therefore will be
distributed to shareholders. An additional distribution may be made to the
extent necessary to avoid the payment of a four percent federal excise tax.
The Fund uses the specific identification method for determining realized
gain or loss on investments sold for both financial and federal income tax
reporting purposes.
The timing and characterization of certain income and capital gains
distributions are determined annually in accordance with federal tax
regulations which may differ from generally accepted accounting principles
(GAAP). These differences relate primarily to investments in mortgage backed
securities. As a result, net investment income and net realized gain (loss)
on investment transactions for a reporting period may differ significantly
from distributions during such period. Accordingly, the Fund may periodically
make reclassifications among certain of its capital accounts without
impacting the net asset value of the Fund.
Other--Investment security transactions are accounted for on a trade-date
basis. Dividend income and distributions to shareholders are recorded on the
ex-dividend date. Interest income is recorded on the accrual basis.
NOTE B--MANAGEMENT AND INVESTMENT ADVISORY FEE. Under the Fund's Management and
Investment Advisory Agreement (the "Agreement") with Scudder, Stevens & Clark,
Inc. (the "Adviser"), the Fund agrees to pay the Adviser for services rendered,
an annual fee, payable monthly, equal to .50 of 1% of the value of the net
assets of the Fund up to and including $150 million; .45 of 1% of the value of
the net assets of the Fund over $150 million and up to and including $200
million; and .40 of 1% of the value of the net assets of the Fund over $200
million. The Agreement also provides that the Adviser will reimburse the Fund
for all expenses (excluding interest, taxes, brokerage commissions, and
extraordinary expenses) borne by the Fund in any fiscal year in excess of the
sum of one and one-half percent of the first $30 million of average net assets
and one percent of average net assets in excess of $30 million. Further, if
annual expenses as defined in the Agreement exceed 25% of the Fund's annual
gross income, the excess will be reimbursed by the Adviser. For the year ended
December 31, 1995, the fee pursuant to the Agreement amounted to $946,575.
None of the Directors are affiliated with the Adviser. For the year ended
December 31, 1995, Directors' fees aggregated $80,143.
NOTE C--PURCHASES AND SALES OF INVESTMENTS. For the year ended December 31,
1995, purchases and sales of investment securities other than direct U.S.
government obligations and short-term investments aggregated $119,300,033 and
$114,237,705, respectively. Purchases and sales of direct U.S. government
obligations aggregated $19,395,782 and $23,861,953, respectively.
18
<PAGE>
NOTE D -- UNAUDITED QUARTERLY RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
1995
-----------------------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
---------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Total investment income .. $3,950,161 $4,007,202 $3,942,426 $3,850,172 $15,749,961
Net investment income .... 3,615,759 3,653,580 3,567,375 3,503,239 14,339,953
Per share ........ $0.36 $0.36 $0.36 $0.35 $1.43
Net realized gains
(losses) and change in
net unrealized
appreciation
(depreciation) on
investments ............. 5,041,317 9,713,301 2,112,135 5,259,889 22,126,642
<CAPTION>
1994
-----------------------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
---------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C>
Total investment income .. $3,700,348 $3,757,881 $3,732,525 $3,869,078 $15,059,832
Net investment income .... 3,338,823 3,426,127 3,394,951 3,554,303 13,714,204
Per share .............. $0.34 $0.34 $0.34 $0.35 $1.37
Net realized gains
(losses) and change in
net unrealized
appreciation
(depreciation) on
investments ............ (9,979,259) (8,109,555) (1,656,208) (4,315,741) (24,060,763)
</TABLE>
19
<PAGE>
REPORT OF ERNST & YOUNG LLP,
INDEPENDENT AUDITORS
To the Shareholders and Board of Directors
Montgomery Street Income Securities, Inc.
San Francisco, California
We have audited the accompanying statement of assets and liabilities of
Montgomery Street Income Securities, Inc. (the "Fund"), including the schedule
of investments, as of December 31, 1995, and the related statement of operations
for the year then ended, the statement of changes in 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. 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, 1995, by correspondence with the custodian. 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
Montgomery Street Income Securities, Inc. at December 31, 1995, 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.
Boston, Massachusetts
January 22, 1996
20
<PAGE>
TAX INFORMATION
By now shareholders for whom year-end tax reporting is required by the IRS
should have received their Form 1099-DIV and tax information letter from the
Fund.
In many states the amount of income you received from direct obligations of the
U.S. Government is exempt from your state income taxes. Of the Montgomery Street
Income Securities, Inc.'s dividend from ordinary income, 7.2% was derived from
direct obligations of the U.S. Government.
Please consult a tax adviser if you have questions about federal or state income
tax laws, or on how to prepare your tax returns. If you have specific questions
about your Montgomery Street account, please call 1-800-426-5523.
21
<PAGE>
DIVIDEND REINVESTMENT AND CASH PURCHASE PLAN
All registered shareholders of the Fund's Common Stock are offered the
opportunity of participating in a Dividend Reinvestment and Cash Purchase Plan
(the "Plan"). Registered shareholders, on request or on becoming registered
shareholders, are mailed information regarding the Plan, including a form by
which they may elect to participate in the Plan and thereby cause their future
net investment income dividends and capital gains distributions to be invested
in shares of the Fund's Common Stock. State Street Bank and Trust Company is the
agent (the "Plan Agent") for shareholders who elect to participate in the Plan.
If a shareholder chooses to participate in the Plan, the shareholder's
dividends and capital gains distributions will be promptly invested,
automatically increasing the shareholder's holdings in the Fund. If the Fund
declares a dividend or capital gains distributions payable either in cash or in
stock of the Fund, the shareholder will automatically receive stock. If the
market price per share on the payment date for the dividend (the "Valuation
Date") equals or exceeds the net asset value per share, the Fund will issue new
shares to the shareholder at the greater of the following on the Valuation Date:
(a) net asset value per share or (b) 95% of the market price per share. If the
market price per share on the Valuation Date is less than the net asset value
per share, the Fund will issue new shares to the shareholder at the market price
per share on the Valuation Date. In either case, for federal income tax purposes
the shareholder will be deemed to receive a distribution equal to the market
value on the Valuation Date of the new shares issued. If dividends or capital
gains distributions are payable only in cash, then the shareholder will receive
shares purchased on the New York Stock Exchange or otherwise on the open market.
In this event, for federal income tax purposes the amount of the distribution
will equal the cash distribution paid. State and local taxes may also apply. All
reinvestments are in full and fractional shares, carried to three decimal
places.
Shareholders participating in the Plan can also purchase additional shares
quarterly in any amount from $100 to $3,000 (a "Voluntary Cash Investment") by
sending in a check together with the cash remittance slip which will be sent
with each statement of the shareholder's account. Such additional shares will be
purchased on the open market by the Plan Agent. The purchase price of shares
purchased on the open market, whether pursuant to a reinvestment of dividends
payable only in cash or a Voluntary Cash Investment, will be the average price
(including brokerage commissions) of all shares purchased by the Plan Agent on
the date such purchases are effected. In addition, shareholders may be charged a
service fee in an amount up to 5% of the value of the Voluntary Cash Investment.
Although subject to change, shareholders are currently charged a minimum of $1
and maximum of $3, for each Voluntary Cash Investment.
Shareholders may terminate their participation in the Plan at any time and
elect to receive dividends and other distributions in cash by notifying the Plan
Agent in writing. Such notification must be received not less than 10 days prior
to the record date of any distribution. There is no charge or other penalty for
such termination. The Plan may be terminated by the Fund or the Plan Agent upon
written notice mailed to the shareholders at least 30 days prior to the record
date of any distribution. Upon termination, the Fund will issue certificates for
all full shares held under the Plan and cash for any fractional share.
Alternatively, shareholders may request the Plan Agent to sell any full
shares and remit the proceeds, less a 5% service fee up to $5 and less brokerage
commissions. The sale of shares (including fractional shares) will be a taxable
22
<PAGE>
DIVIDEND REINVESTMENT AND CASH PURCHASE PLAN (continued)
event for federal income tax purposes and may be taxable for state and local tax
purposes.
The Plan may be amended by the Fund or the Plan Agent at any time. Except
when required by law, written notice of any amendment will be mailed to
shareholders at least 30 days prior to its effective date. The amendment will be
deemed accepted unless written notice of termination is received prior to the
effective date.
An investor holding shares in its own name can participate directly in the
Plan. An investor holding shares in the name of a brokerage firm, bank or other
nominee should contact that nominee, or any successor nominee, to determine
whether the nominee can participate in the Plan on the investor's behalf and to
make any necessary arrangements for such participation.
Additional information, including a copy of the Plan and its Terms and
Conditions and an enrollment form, can be obtained from the Plan Agent by
writing State Street Bank and Trust Company, P.O. Box 8209, Boston, MA
02266-8209, or by calling (800) 426-5523.
23
