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
EDWARD J. O'CONNELL
Vice President and
Assistant Treasurer
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 8209
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
MONTGOMERY STREET INCOME SECURITIES
ANNUAL REPORT
DECEMBER 31, 1996
SCUDDER
Investment Adviser
<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 based on net asset value (NAV) of 4.15% for the quarter ended
December 31, 1996. The NAV per share at year end was $19.54, a slight increase
from $19.53 at the end of September as a result of a moderate rise in bond
prices, offset by dividend payments of $0.34 per share in October and $0.37 per
share in December. The total return of the Fund for the fourth quarter was
higher than that of the unmanaged Lehman Brothers Aggregate Bond Index, an index
we use for comparative purposes, which had a total return of 3.00%. For the
entire year, the Fund's total return of 6.08% also compares favorably to the
Lehman Brothers Aggregate Bond Index total return of 3.63%. The market price of
the Fund's shares, which trade on the New York Stock Exchange, was $17.375 on
December 31, 1996 compared to $17.25 at the beginning of the quarter, reflecting
a decrease in the discount of the market value to the NAV to 11.1%. As of
January 31, 1997 the discount has further narrowed to 9.0%.
On December 6, 1996 the Board of Directors declared a $0.37 per share dividend
payable on December 31, 1996 to shareholders of record on December 17, 1996. The
amount of this dividend is $0.03 higher than the previous two dividends and
represents the distribution of excess accumulation at year end.
Economic Conditions
During 1996 the Federal Reserve Board made only one target funds rate
adjustment, and that was on January 31, a quarter point reduction. The cut was
made in an effort to jump-start the economy and avoid a recession. Greenspan's
February comments depicting strong economic trends and the stunning surge in
February employment payrolls, reported in early March, changed the perception of
the economic picture entirely. The Fed took on a bias toward a more restrictive
policy in its July meeting and has maintained that bias through the beginning of
1997. Fed members remain concerned about a possible uptick in inflation,
focusing on the labor markets, which appear to have little slack. Wage increases
have been a continued concern but have yet to flow through to bottom line
inflation. CPI for 1996 came in at 3.3%, including food and energy, and 2.6%,
excluding these more volatile commodities.
The fourth quarter saw a resumption of moderate economic growth, from the slower
growth seen during the third quarter. It appears that the slowing economic trend
we questioned in our previous letter has not taken hold. Investors are now
concerned about accelerating economic growth, although in our view any domestic
strength will be tempered by the doldrums overseas. We reiterate that the
economic expansion is mature by any measure, with the consumer overextended, but
it will probably take a crack in the stock market euphoria to alter investor
perceptions. As the dollar has advanced vs. the yen and deutschmark, the
expectations of continued strong foreign central bank purchases of Treasuries
are fading. Although it remains unlikely that the foreign central banks will be
net sellers of Treasuries soon, many feel that the dollar run has gone on long
enough.
Market Conditions
The rally following the third quarter economic respite carried on through
November, but more recent evidence of economic strength caused bonds to finish
the year on a weaker note. With the exception of the negative return registered
in 1994, 1996 ended up being the worst year for the U.S. bond market since 1987.
2
<PAGE>
For the year, broad bond indices underperformed cash investments and were hardly
visible when compared to larger company equity returns. The bulk of the bond
market pain was felt in the first half of the year, as market participants
adjusted from expectations of a weakening global economy and easy Federal
Reserve posture to a more positive economic picture and restrictive Fed. The
latter half of the year saved the bond market from a repeat of 1994. Interest
rates were unchanged over the third quarter, and declined 26 basis points, on
average, over the fourth quarter. A substantial slowing of the economy during
the third quarter, along with expectations for growth continuing at a moderate
pace into 1997 and subdued price inflation readings, brought about the partial
reversal of the first half-year bludgeoning.
The fourth quarter was not all pleasure for bond market participants though. The
first half of December saw rates rise almost 40 basis points as the market
wobbled to the twin punches of Fed Chairman Greenspan's "irrational exuberance"
comment during a dinner speech, referring to rising equity valuations, and a
Wall Street Journal article questioning future substantive Japanese
participation in U.S. Treasury auctions.
The low yield on the long bond for the year was 5.92%, registered on the year's
first trading day, and the high was reached twice around the start of summer at
7.16%. The long bond ended the year with a yield of 6.64% (see table below). In
yield terms, the most volatile maturity range for Treasuries over the year was
in the three to five year area. Peak-to-trough yields covered over 170 basis
points in this maturity range.
<TABLE>
<CAPTION>
U.S. Treasury Interest Rates
- -----------------------------------------------------------------------------------------------------------
Yields 4th Quarter 1996 1996
------ ---------------- ----
Total Total
9/30/96 12/31/96 Yield Return Yield Return
Maturity % % Change % Change %
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
3 months 5.03 5.19 .16 1.30 .11 5.31
1 year 5.68 5.49 -.19 1.62 .36 5.50
2 years 6.09 5.87 -.22 2.05 .72 4.50
5 years 6.45 6.21 -.24 2.72 .83 2.83
10 years 6.70 6.42 -.28 3.69 .85 0.34
30 years 6.92 6.64 -.28 5.35 .69 -2.26
Yield Spreads (in basis points)
1 to 30 years 124 115 -9 33
10 to 30 years 22 22 0 -16
- -----------------------------------------------------------------------------------------------------------
</TABLE>
3
<PAGE>
After posting the best return among G-7 country bonds in 1995, when measured in
local currency, the benchmark U.S. Treasury return ranked last in 1996 (see
table below). When measured in dollars, the U.S. benchmark fared better,
outperforming the Japanese and German benchmark bonds.
Ten-Year Government Bond Returns (local currency)
and Yields
----------------------------------------------------------------------
4th Quarter 1996 1996 1996
Country Total Return Total Return Year End Yield
----------------------------------------------------------------------
Italy 10.3% 31.2% 7.55%
France 4.2 13.5 5.74
Canada 7.6 12.4 6.39
Germany 3.6 7.8 5.78
UK 3.1 7.2 7.51
Japan 2.1 7.1 2.75
US 3.7 0.3 6.42
----------------------------------------------------------------------
At present, the U.S. market seems attractive on a yield basis when compared to
many foreign markets, especially as the dollar has shown good strength and
resiliency.
The Portfolio
Fourth quarter activity in the Fund's portfolio centered on relative value
within the Corporate market. Trades extended the maturity of the portfolio as we
sought the better values along the yield curve. The Fund's duration increased
outward from 5.6 years to nearly 6.0 years, while its average maturity increased
to 14.6 years from 14.1 years. Cash was reduced from 2.8% in September to nearly
0% at year end. Because the yield curve improved by about 25 basis points, the
extension to longer Corporates enhanced portfolio value for the quarter.
As in the previous quarter, the positive performance of the portfolio was due
primarily to company selection within the Corporate sector, including a number
of the below investment grade holdings. The graph below shows the sector
weightings at the end of the quarter. Our corporate bond position increased to
66.1% of the portfolio, including the preferred issues. British Sky
Broadcasting, ERP Operating LP (REIT), Celestica, Cole National, Newport New
Shipbuilding, AK Steel, US Bancorp, Rogers Cantel, Walden Residential (REIT),
and BankUnited were new names in the portfolio at quarter end, while Continental
Cable, PT Alatief (Freeport McMoran), Loral, and Seagram were sold. Continental
Cable was an especially successful holding, in that it was bought out by US West
in November 1996, causing a large upgrade in quality. PT Alatief was another
bond that had done its job. Originally purchased in April of 1994 at +300 basis
points above Treasuries when below investment grade, it was sold at +104 basis
points above Treasuries, providing a return of 15.6% above Treasuries for the
holding period (37.8% vs. 22.2%). Both Loral and Seagram had also outperformed
like maturity government bonds.
4
<PAGE>
THE PRINTED DOCUMENT CONTAINS A BAR CHART HERE
BAR CHART TITLE:
Percent of Portfolio as of 12/31/96
BAR CHART DATA:
-----------------------------------------------------
Cash 0%
-----------------------------------------------------
Treasury and Agency (Gov't) 5.9
-----------------------------------------------------
Mortgage 23.2
-----------------------------------------------------
Asset-Backed 4.0
-----------------------------------------------------
Industrial 35.2
-----------------------------------------------------
Communications & Cable 7.0
-----------------------------------------------------
Utility 1.2
-----------------------------------------------------
Finance 22.7
-----------------------------------------------------
Foreign 0.8
-----------------------------------------------------
The mortgage component of the portfolio increased slightly to 23.2% from 21.4%
over the quarter, as we traded down in coupon. During the quarter we traded our
previous mortgage holdings into the 7.5% coupon area, buying a mix of GNMA,
FNMA, and FHLMC, 30-year pass-throughs. This step was taken to avoid prepayment
risk and to improve the upside potential of the mortgage holdings in the
portfolio.
THE PRINTED DOCUMENT CONTAINS A PIE CHART HERE
CHART DATA:
Quality
----------------------------------------------
Cash 6%
----------------------------------------------
Government 23%
----------------------------------------------
AA 5%
----------------------------------------------
A 11%
----------------------------------------------
BBB 31%
----------------------------------------------
BB 16%
----------------------------------------------
B 8%
----------------------------------------------
100%
----
----
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 26.9% of its assets in these categories, up slightly from 26.3% three
months before. 23.5% of the portfolio was below investment grade in terms of
credit rating. The largest below investment grade position remained Borden Inc.,
a dairy and packaging company, at 2.0% of the total. Average quality for the
overall portfolio was 'A-', with the quality breakdown shown in the pie graph
above.
After enjoying a period of sustained recovery from the woes of two years ago, we
sold our 3.5% commitment in U.S. dollar denominated Mexican Corporates. We felt
that the risks entailed in a declining peso made these emerging market
Corporates too risky when compared to their remaining upside potential. Also
reduced was the Fund's only foreign currency exposure, the Canadian Government
long bonds, where we sold over half of our position, leaving just a 0.8%
commitment. These Canadian bonds were a star performer in the portfolio during
1996.
5
<PAGE>
We also sold our remaining structured note holding, the Student Loan Marketing
Association (SLMA) note whose coupon depended inversely on German 5-year rates.
This note was structured to have a minimum coupon of 4%. The coupon was reset to
4.84% and the note's price moved up close to par. Having reached our objective,
we sold.
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 16 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 five years. Mark has nine years'
experience in investment management and focuses on the mortgage sector of the
portfolio. Kristin Bradbury, C.F.A., is responsible for quantitative analysis
and trading for the portfolio. Kristin has 11 years of investment related
experience.
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.
Thank You For Being A Shareholder
In summary, 1996 was a year of rising yields and slightly declining prices in
the bond market, in general, which produced a below average bond market year.
The Fund fared slightly better than its benchmark, turning in a credible
performance and providing a dividend of $1.40 per share to shareholders, the
same amount as the prior year. As we enter a year of slower growth and
anticipated lower inflation, we are relatively optimistic about the outlook for
fixed income securities. We have appreciated having you as a shareholder during
this period and we look forward to working with you again 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 7, 1997
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>
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS
December 31, 1996
Principal Market
Amount($)* Value($)
- -------------------------------------------------------------------------------------------
<S> <C> <C>
INTERMEDIATE-TERM BONDS - 20.0%
(1 - 8 years)
U.S. TREASURY AND AGENCY -- 5.8%
U.S. Treasury Note, 8.875%, 2/15/99 ......................... 8,000,000 8,463,760
U.S. Treasury Note, 9.125%, 5/15/99 ......................... 2,900,000 3,098,911
----------
11,562,671
----------
CONSUMER DISCRETIONARY -- 1.6%
Department and Chain Stores
Federated Department Stores, Inc., senior note, 10%, 2/15/01 2,000,000 2,181,000
Federated Department Stores, Inc., 8.5%, 6/15/03 ............ 1,000,000 1,042,500
----------
3,223,500
----------
FINANCIAL -- 7.1%
Banks -- 4.5%
Conti Financial Corp., senior note, 8.375%, 8/15/03 ......... 1,950,000 2,008,500
First Nationwide Corp., 10.625%, 10/1/03 .................... 1,250,000 1,350,000
Continental Bank, subordinated note, 12.5%, 4/1/01 .......... 3,000,000 3,632,700
First USA Bank, global subordinated note, 7.65%, 8/1/03 ..... 2,000,000 1,999,120
----------
8,990,320
----------
Other Financial Companies -- 2.6%
Olympic Financial Ltd., subordinated note, 13%, 5/1/00 ...... 2,000,000 2,180,000
Taubman Realty Group LP, medium-term note, 7.5%, 6/15/02 .... 3,000,000 3,026,250
----------
5,206,250
----------
SERVICE INDUSTRIES -- 1.1%
Service Industries
ADT Operations, senior subordinated note, 9.25%, 8/1/03 ..... 2,000,000 2,145,000
----------
MEDIA -- 2.6%
Cable Television
Rogers Cablesystems Ltd., senior secured note, 9.63%, 8/1/02 3,000,000 3,127,500
Tele-Communications Inc., 8.25%, 1/15/03 .................... 2,000,000 2,019,660
----------
5,147,160
----------
ENERGY -- 1.8%
Oil & Gas Production
Forest Oil Corp., subordinated note, 11.25%, 9/1/03 ......... 300,000 316,500
Louis Dreyfus Natural Gas Corp., senior note, 9.25%, 6/15/04 3,000,000 3,210,300
----------
3,526,800
----------
TOTAL INTERMEDIATE-TERM BONDS (Cost $38,554,969) ............ 39,801,701
==========
</TABLE>
The accompanying notes are an integral part of the financial statements.
8
<PAGE>
<TABLE>
<CAPTION>
Principal Market
Amount ($)* Value ($)
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
LONG-TERM BONDS -- 75.5%
(over 8 years)
U.S. TREASURY & AGENCY -- 22.8%
Federal Home Loan Mortgage Corp., 7.5%, with various maturities to
12/1/26 ............................................................... 15,150,000 15,164,090
Federal National Mortgage Association,
pass-thru certificate, 7.5%, with various
maturities to 11/1/26 ............................................... 20,199,996 20,187,270
Government National Mortgage Association, pass-thru
certificate, 7.5%, 8/15/26 .......................................... 9,900,010 9,903,079
-----------
45,254,439
-----------
FOREIGN GOVERNMENT -- 0.8%
Government of Canada, 8%, 6/1/23 ...................................... CAD 2,000,000 1,623,042
-----------
METALS & MINERALS -- 0.8%
Steel & Metals
AK Steel Holding Corp., 9.125%, 12/15/06 .............................. 1,500,000 1,541,250
-----------
CONSTRUCTION -- 1.1%
Building Materials
USG Corp., senior note, 8.5%, 8/1/05 .................................. 2,000,000 2,090,000
-----------
CONSUMER DISCRETIONARY -- 1.8%
Hotels & Casinos -- 1.0%
Marriott Corp., debenture, 9.38%, 6/15/07 ............................. 2,000,000 1,985,500
-----------
Specialty Retail -- 0.8%
Cole National Group, 9.875%, 12/31/06 ................................. 1,500,000 1,545,000
-----------
CONSUMER STAPLES -- 3.8%
Food & Beverage
Borden Inc., debenture, 9.2%, 3/15/21 ................................. 4,000,000 3,963,400
Coca Cola Co., Inc., debenture, 7.38%, 7/29/2093 ...................... 3,500,000 3,563,385
-----------
7,526,785
-----------
COMMUNICATIONS -- 2.6%
Cellular Telephone
Rogers Cantel Mobile Communications Inc., 9.375%, 6/1/08 .............. 1,000,000 1,050,000
Teleport Communications Group Inc., senior note, 9.875%, 7/1/06 ....... 2,000,000 2,135,000
360 Communications Co., 7.5%, 3/1/06 .................................. 2,000,000 1,983,820
-----------
5,168,820
-----------
FINANCIAL -- 16.1%
Banks -- 7.2%
ABN-AMRO Bank NV, subordinated note, 7.13%, 10/15/2093 ................ 5,000,000 4,702,250
Bank United Financial Corp., 10.25%, 12/31/26 ......................... 1,500,000 1,503,750
Royal Bank of Scotland, 7.375%, 4/29/49 ............................... 3,000,000 3,002,670
</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>
U.S. Bancorp, 8.27%, 12/15/26 ......................................... 5,000,000 5,120,000
-----------
14,328,670
-----------
Other Financial Companies -- 8.9%
Commercial Credit Corp., debenture, 10%, 5/15/09 ...................... 3,000,000 3,673,230
ERP Operating L.P. Note, 7.57%, 8/15/26 ............................... 3,000,000 3,060,660
Greentree Financial Corp., asset-backed, senior subordinated
pass-thru certificate, Series 1993-4 B1, 7.2%, 1/15/19 .............. 8,000,000 7,893,750
Meditrust SBI, 7.82%, 9/10/26 ......................................... 3,000,000 3,108,510
-----------
17,736,150
-----------
MEDIA -- 6.4%
Broadcasting & Entertainment -- 4.2%
News America Holdings Inc., 10.125%, 10/15/12 ......................... 2,000,000 2,293,620
Paramount Communications, Inc., senior debenture, 7.5%, 7/15/23 ....... 2,000,000 1,708,880
Time Warner Inc., debenture, 9.125%, 1/15/13 .......................... 4,000,000 4,366,800
-----------
8,369,300
-----------
Cable Television -- 2.2%
British Sky Broadcasting Co., 7.3%, 10/15/06 .......................... 1,600,000 1,608,416
Tele-Communications Inc., 7.875%, 2/15/26 ............................. 3,000,000 2,683,380
-----------
4,291,796
-----------
DURABLES -- 2.6%
Aerospace -- 1.6%
Lockheed Martin Corp., 7.2%, 5/1/36 ................................... 3,000,000 3,104,760
-----------
Miscellaneous -- 1.0%
Newport News Shipbuilding Co. senior note, 9.25%, 12/1/06 ............. 1,850,000 1,896,250
-----------
ENERGY -- 11.2%
Chemicals -- 1.5%
Lyondell Petrochemical Co., note, 7.55%, 2/15/26 ...................... 3,000,000 2,898,030
-----------
Oil & Gas Production -- 7.8%
Coastal Corp., debenture, 9.625%, 5/15/12 ............................. 3,000,000 3,577,230
Lasmo U.S.A. Inc., note, 8.375%, 6/1/23 ............................... 3,000,000 3,071,340
Nuevo Energy Co., senior subordinated note, 9.5%, 4/15/06 ............. 2,000,000 2,125,000
Saga Petroleum A.S., note, 9.125%, 7/15/14 ............................ 3,000,000 3,333,960
Unocal Corp., debenture, 9.4%, 2/15/11 ................................ 3,000,000 3,494,490
-----------
15,602,020
-----------
Oil Companies -- 1.9%
Atlantic Richfield, medium-term note, 9.88%, 3/1/16 ................... 3,000,000 3,755,640
-----------
MANUFACTURING -- 3.4%
Diversified Manufacturing -- 2.3%
Borden Chemicals and Plastics L.P., note, 9.5%, 5/1/05 ................ 2,000,000 2,040,000
Tenneco Inc., debenture, 10.2%, 3/15/08 ............................... 2,000,000 2,468,400
-----------
4,508,400
-----------
</TABLE>
The accompanying notes are an integral part of the financial statements.
10
<PAGE>
<TABLE>
<CAPTION>
Principal Market
Amount ($)* Value ($)
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Industrial Specialty -- 1.1%
Celestica International Inc., 10.5%, 12/31/06 ......................... 1,500,000 1,575,000
Pierce Leahy Corp., senior subordinated note, 11.125%, 7/15/06 500,000 546,250
-----------
2,121,250
-----------
TRANSPORTATION -- 0.9%
Airlines
American Airlines, Inc., medium-term note, 10.45%, 3/10/11 ............ 1,500,000 1,813,440
-----------
UTILITIES -- 1.2%
Natural Gas Distributors
ANR Pipeline, debenture, 9.625%, 11/1/21 .............................. 2,000,000 2,424,320
-----------
TOTAL LONG-TERM BONDS (Cost $147,976,867) 149,584,862
-----------
- ----------------------------------------------------------------------------------------------------------------
CONVERTIBLE BONDS -- 0.9%
FINANCIAL
Real Estate
Federal Realty Investment Trust, convertible bond,
5.25%, 10/28/03 (Cost $1,630,625) ................................. 2,000,000 1,825,000
-----------
- ----------------------------------------------------------------------------------------------------------------
WARRANTS -- 0.0%
FINANCIAL
Real Estate
Walden Residential Properties, Inc. Warrants (expire 1/1/02) .......... 80,000 96,000
-----------
- ----------------------------------------------------------------------------------------------------------------
CONVERTIBLE PREFERRED STOCKS -- 1.1%
FINANCIAL
Real Estate
United Dominion Realty Trust Inc., "A", 9.25% (Cost $2,000,000) ....... 80,000 2,110,000
-----------
- ----------------------------------------------------------------------------------------------------------------
PREFERRED STOCK -- 0.9%
FINANCIAL
Real Estate
Walden Residential Properties, Inc. (Cost $2,000,000) ................. 80,000 1,910,000
-----------
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
11
<PAGE>
SCHEDULE OF INVESTMENTS (continued)
<TABLE>
<CAPTION>
Market
Value ($)
- ----------------------------------------------------------------------------------------------------------------
<S> <C>
TOTAL INVESTMENT PORTFOLIO -- 98.4% (Cost $192,162,461) (a) ........... 195,327,563
OTHER ASSETS AND LIABILITIES, NET -- 1.6% ............................. 3,138,259
-----------
NET ASSETS -- 100.0% .................................................. 198,465,822
===========
</TABLE>
- ----------
(a) The cost for federal income tax purposes was $192,162,461. At December
31, 1996, net unrealized appreciation for all securities based on tax
cost was $3,165,102. This consisted of aggregate gross unrealized
appreciation for all securities in which there was an excess of market
value over tax cost of $4,660,620 and aggregate gross unrealized
depreciation for all securities in which there was an excess of tax
cost over market value of $1,495,518.
* Principal amount is stated in U.S. dollars unless otherwise specified.
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, 1996
<TABLE>
<CAPTION>
<S> <C> <C>
ASSETS
Investments, at market (identified cost $192,162,461)
(Note A) ......................................................... $ 195,327,563
Cash ................................................................ 9,568
Receivables:
Interest and dividends receivable ............................. 3,331,768
--------------
Total Assets 198,668,899
LIABILITIES
Accrued management fee (Note B) ..................................... $ 80,558
Other accrued expenses .............................................. 122,519
-----------
Total Liabilities 203,077
--------------
NET ASSETS, at market value ...................................... $ 198,465,822
==============
NET ASSETS Net assets consist of:
Undistributed net investment income .............................. $ 64,006
Net unrealized appreciation (depreciation) on:
Investments ................................................... 3,165,102
Foreign currency related transactions ......................... (52)
Accumulated net realized loss .................................... (3,371,701)
Paid-in capital .................................................. 198,608,467
--------------
NET ASSETS, at market value ...................................... $ 198,465,822
==============
Net Asset Value Per Share ($198,465,822 / 10,158,937 shares of common stock
outstanding, $.001 par value, 30,000,000
shares authorized) .................................................. $19.54
======
</TABLE>
The accompanying notes are an integral part of the financial statements.
13
<PAGE>
STATEMENT OF OPERATIONS
Year Ended December 31, 1996
<TABLE>
<CAPTION>
<S> <C> <C>
INVESTMENT INCOME
Income:
Interest .......................................................... $ 15,155,803
Dividends ......................................................... 292,813
-------------
15,448,616
Expenses:
Management and investment advisory fee (Note B) ................... $ 959,376
Directors' fees and expenses (Note B) ............................. 79,001
Transfer agent and dividend disbursing agent fees ................. 110,388
Reports to shareholders ........................................... 93,315
Reincorporation ................................................... 70,000
Auditing .......................................................... 58,782
State franchise tax ............................................... 26,668
Legal ............................................................. 21,509
Custodian fees .................................................... 19,259
Other ............................................................. 69,523 1,507,821
----------- -------------
Net Investment Income 13,940,795
-------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
Net realized gain from:
Investments ....................................................... 2,327,877
Foreign currency related transactions ............................. 2,324
-------------
2,330,201
-------------
Net unrealized depreciation during the period on:
Investments ....................................................... (6,065,251)
Foreign currency related transactions ............................. (52)
-------------
(6,065,303)
-------------
Net loss on investments .............................................. (3,735,102)
-------------
NET INCREASE IN NET ASSETS RESULTING FROM
OPERATIONS ........................................................... $ 10,205,693
=============
</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,
-------------------------------
INCREASE (DECREASE) IN NET ASSETS 1996 1995
------------ ------------
<S> <C> <C>
Operations:
Net investment income ................................................ $ 13,940,795 $ 14,339,953
Net realized gain from investment transactions ....................... 2,330,201 20,961
Net unrealized appreciation (depreciation) on investment and
foreign currency related transactions during the period ........... (6,065,303) 22,105,681
------------ ------------
Net increase in net assets resulting from operations ................. 10,205,693 36,466,595
------------ ------------
Dividends to shareholders from net investment income ................. (14,163,424) (14,069,861)
------------ ------------
Fund share transactions:
Reinvestment of dividends from net investment income .............. 1,176,267 1,168,280
------------ ------------
Increase (decrease) in net assets .................................... (2,781,464) 23,565,014
Net assets at beginning of period .................................... 201,247,286 177,682,272
------------ ------------
Net assets at end of period (accumulated undistributed net
investment income of $64,006 and $206,477,
respectively) ..................................................... $198,465,822 $201,247,286
============ ============
Other Information
Increase in Fund shares
Shares outstanding at beginning of period ............................ 10,091,241 10,024,589
Shares issued to shareholders in reinvestment of dividends
from net investment income ........................................ 67,696 66,652
------------ ------------
Shares outstanding at end of period .................................. 10,158,937 10,091,241
============ ============
</TABLE>
The accompanying notes are an integral part of the financial statements.
15
<PAGE>
FINANCIAL HIGHLIGHTS
The following table includes selected data (a) 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,
----------------------------------------------------
1996 1995 1994 1993 1992
----------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period ............... $19.94 $17.72 $20.13 $19.30 $19.17
------ ------ ------ ------ ------
Income from investment operations:
Income ........................................... 1.53 1.57 1.51 1.68 1.84
Operating expenses ............................... (.15) (.14) (.14) (.15) (.15)
------ ------ ------ ------ ------
Net investment income ............................ 1.38 1.43 1.37 1.53 1.69
Net realized and unrealized
gain (loss) ..................................... (.38) 2.19 (2.42) .84 .47
------ ------ ------ ------ ------
Total from investment operations ................... 1.00 3.62 (1.05) 2.37 2.16
------ ------ ------ ------ ------
Dilution resulting from the rights offering ........ -- -- -- -- (.36)
Less distributions:
From net investment income ....................... (1.40) (1.40) (1.36) (1.54) (1.67)
------ ------ ------ ------ ------
Net asset value, end of period ..................... $19.54 $19.94 $17.72 $20.13 $19.30
====== ====== ====== ====== ======
Per share market value, end of period .............. $17.38 $18.00 $15.75 $19.75 $20.88
====== ====== ====== ====== ======
Price range on New York Stock Exchange for
each share of Common Stock outstanding
during the period (Unaudited):
High ............................................. $19.50 $19.13 $20.25 $22.38 $21.00
Low .............................................. $16.75 $15.75 $15.25 $19.25 $19.00
Total Investment Return
Per share market value (%) ....................... 4.54 23.69 (13.54) 2.02 17.98
Per share net asset value (%) (b) ................ 6.08 21.78 (4.51) 12.47 11.67
Ratios and Supplemental Data
Net assets, end of period ($ millions) ............. 198 201 178 200 191
Ratio of operating expenses to
average net assets (%) ........................... .76 .73 .71 .73 .75
Ratio of net investment income to
average net assets (%) ........................... 7.07 7.45 7.28 7.53 8.69
Portfolio turnover rate (%) ........................ 92.1 76.4 137.0 122.8 137.6
</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, 1996
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. The Fund's
financial statements are prepared in accordance with generally accepted
accounting principles which require the use of management estimates. On July 11,
1996, the shareholders approved the Fund's change of domicile (the
"Reincorporation") from Delaware to Maryland. The Reincorportation became
effective on July 23, 1996 and was done to reduce franchise fees paid by the
Fund.
Significant accounting policies are summarized as follows:
Valuation of Investments-Portfolio debt securities with remaining
maturities greater than sixty days upon purchase 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 upon purchase 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.
17
<PAGE>
NOTES TO FINANCIAL STATEMENTS (continued)
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, 1996, the Fund had a net tax basis capital loss
carryforward of approximately $3,372,000, which may be applied against any
realized net taxable capital gains of each succeeding year until fully
utilized or until December 31, 2002 ($1,124,000) and December 31, 2003
($2,248,000), the respective
expiration dates, whichever occurs first.
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 and foreign denominated 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, 1996, the fee pursuant to the Agreement amounted to $959,376.
None of the Directors are affiliated with the Adviser. For the year ended
December 31, 1996, Directors' fees and expenses aggregated $79,001.
18
<PAGE>
Note C--PURCHASES AND SALES OF INVESTMENTS. For the year ended December 31,
1996, purchases and sales of investment securities other than direct U.S.
government obligations and short-term investments aggregated $177,379,870 and
$174,178,641, respectively. Purchases of direct U.S. government obligations
aggregated $535,703.
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, 1996, 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 and financial highlights. Our procedures
included confirmation of securities owned as of December 31, 1996, 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, 1996, 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.
/s/ Ernst & Young LLP
Boston, Massachusetts
January 20, 1997
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, 6.02% 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. Although subject to change, shareholders
are currently charged $1 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 $2.50 service fee 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
