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
KATHRYN L. QUIRK
Vice President and
Assistant Secretary
STEPHEN A. WOHLER
Vice President
INVESTMENT Scudder Kemper Investments, 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 & Rabkin
Three Embarcadero Center
Seventh Floor
San Francisco, CA 94111
INDEPENDENT Ernst & Young LLP
AUDITORS 200 Clarendon Street
Boston, MA 02116
----------
MONTGOMERY
----------
MONTGOMERY
STREET
INCOME
SECURITIES
4
Annual Report
December 31, 1997
SCUDDER (logo)
Investment Adviser
<PAGE>
101 California Street, Suite 4100
San Francisco, CA 94111
(415) 981-8191
Dear Shareholder:
The investments of Montgomery Street Income Securities, Inc. (the Fund) produced
a total return for the quarter ended December 31, 1997 of 3.01%, based on net
asset value (NAV). This reflects an improvement in bond prices and dividends of
$0.36 and $0.37 paid in October and December, respectively. The total return of
the Fund, based on NAV, compared favorably with the unmanaged Lehman Brothers
Aggregate Bond Index, an index we use for comparative purposes, which had a
total return of 2.9% for the quarter. The December 31, 1997 NAV per share was
$20.29, down from $20.45 at the end of the third quarter, primarily because of
the $0.73 of income paid out during the quarter. The market price of the Fund's
shares, which trade on the New York Stock Exchange, was $19.50 on December 31,
versus $18.69 on September 30, 1997.
For the entire year, the Fund returned 12.09% based on NAV, compared to the
Lehman Brothers Aggregate Bond Index's 9.7%. The market price discount of the
shares as a percentage of the NAV narrowed over the year from over 11% to about
4% at year end.
On December 10, 1997, the Board of Directors declared a $0.37 per share dividend
payable on December 31, 1997 to shareholders of record on December 20, 1997.
This dividend is $.01 higher than the prior two dividends and represents the
distribution of excess accumulation at year end. Accordingly, the amount should
not be taken as the norm. The next dividend is expected to be paid in late
April.
The tax loss carry forward the Fund has enjoyed for a number of years is almost
exhausted. Any effect this will have on 1998 distributions will depend on market
levels and specific transactions which occur. It does raise the possibility of
creating net capital gains, which would be distributed to shareholders at year
end.
The Market and Economic Conditions
Certainly the story of the fourth quarter was the disruption in the currency and
securities markets in Southeast Asia. The dislocations felt in these markets
overwhelmed many of the domestic considerations which would normally affect the
fixed-income market, and were severe enough to change fundamental economic
expectations in the United States and around the world. For the Fund it had a
mixed effect, as the flight towards quality brought long interest rates in the
U.S. to the lowest point in almost 20 years. While this was great news for
Treasury bonds, Corporate bonds had a more muted response, reflecting the
concerns about corporate profitability going forward.
The table below gives you some perspective of the havoc wrought over the last
six months of 1997 in the Asian markets. It shows the loss of purchasing power
in dollars that equity holders suffered. The trouble began with a run on the
Thai currency (the baht), and then spread to neighboring economies.
2
<PAGE>
6 Months Ending 12/31/97
Changes in Currency and Stock Market
Local Combined
Currency vs. US$ Stocks Loss in US$
---------------- ------ -----------
Indonesia -55.0% -75.0% -88.8%
Korea -44.7 -72.2 -84.6
Thailand -47.4 -62.9 -80.5
Malaysia -34.8 -64.0 -76.6
Philippines -33.2 -55.6 -70.3
Japan -12.4 -35.0 -43.1
Since year end the Japanese yen has recovered somewhat, but the Indonesian
rupiah is down another 25%, after recovering from an even lower level in
January. Only China has been a pillar of relative stability while the wealth and
financial systems of most countries in the area were severely damaged. As has
been the case more often than not in financial markets, the seeds of destruction
were over-leverage and speculation. For many years these economies, except for
Japan, had enjoyed the fruits of rapid growth and low cost of capital. This led
to non-economic investments based on highly optimistic financial projections.
The surprise was the degree of cross-currency bank lending that caused the
financial unwinding to cross national borders.
The immediate implications of this mess for the U.S. bond market are positive.
Economic growth projections were revised downward initially, then revised
downward again as the extent of the damage became better understood. Clearly,
exporting to Southeast Asia will be quite difficult going forward. However, the
major sentiment shift was in the outlook for inflation. Investors have been
worried for quite some while about the prospects for a rebound in inflation,
caused mainly by a very tight labor market. With unemployment near a modern low,
and shortages appearing in the technology industries, wages seemed poised to
advance. In fact, wage costs have bottomed at about a 3% annual growth rate and
have started a slow rise. The new dawning on the financial markets was that
wages might not matter for now, because corporations were not going to be able
to raise prices. Of course, this logically results in a squeeze on corporate
profits unless productivity continues its astounding rate of progress.
So as the U.S. economy ground forward at its 3.5+% rate of growth for the year,
inflation expectations plummeted from over 3% to under 2%, as indicated by the
U.S. Treasury's new inflation indexed notes (which have been very poor
performers, thus far). The CPI for the year was 1.7%, with a reading of 2.2% for
the "core" rate. Clearly the drop in commodity prices has tugged the CPI down
harder than the modest uptrend in wages can offset, at least so far. The
reaction of the bond market has been mostly rational -- interest rates moved to
new lows, and Corporate obligations have done OK, but not great. The High Yield
sector has been surprisingly strong, reacting to flows into higher yielding
mutual funds, and a crossover flight of assets from the nervous Emerging Markets
area.
Looking forward, the positives still outweigh the negatives for domestic bonds.
We expect the economy to slow somewhat from 1997's pace, and experienced the
first evidence of this during a rather blah Christmas shopping season. However,
3
<PAGE>
2% growth with little inflation is a pretty happy picture for bonds. The Federal
Reserve, which has been talking tough, is hog-tied by the Asian meltdown.
Liquidity is needed on the world front, and is likely to be provided, unless
actual domestic inflation turns measurably to the worse. We expect the trade
deficit to head upwards, but all those dollars we export will end up somewhere,
probably the short term Treasury market. Our own budget deficit is essentially
gone for the moment, so the supply/demand equation for dollar assets should be
good. The fly in the ointment is the absolute level of interest rates, which is
low, except in the short term maturities. The table and chart below illustrate
how the yield curve has shifted over the last six months. As you can see, the
flattening has been dramatic.
-------------------------------------------------------------------------------
Treasury Yields 6/30/97 to 12/31/97
Yield Total
6/30/97 9/30/97 12/31/97 Change Return
-------------------------------------------------------------------------------
1 year 5.65% 5.22% 5.48% -0.17% 2.96%
2 years 6.06 5.59 5.64 -0.42 3.75
3 years 6.21 5.81 5.67 -0.54 4.38
5 years 6.37 5.95 5.71 -0.66 5.88
10 years 6.49 6.09 5.74 -0.75 8.67
30 years 6.78 6.39 5.92 -0.86 15.15
-------------------------------------------------------------------------------
THE PRINTED DOCUMENT CONTAINS A LINE CHART HERE
LINE CHART DATA:
------------------------------------------
6/30/97 12/31/97
------------------------------------------
1 Year 15.65% 5.48%
2 Years 6.06 5.64
3 Years 6.21 5.67
5 Years 6.37 5.71
10 Years 6.49 5.74
30 Years 6.78 5.92
The Portfolio
There were no fundamental changes in portfolio strategy during the quarter. We
increased the amount in Corporate bond investments slightly during the quarter
in response to widening yield spreads in that sector. The additions increased
4
<PAGE>
portfolio duration from 5.8 years back to 6.0 years. (Duration is a measure of
the portfolio's sensitivity to interest rates. If interest rates were to rise by
1.0% from present levels, the value of Montgomery Street's portfolio would fall
by about 6.0%, or vice versa.) Portfolio maturity increased from 15.6 years to
16.1 years as some of the short term investments were committed to the long
market. In general, having a maturity greater than that of the market helped
portfolio returns by approximately 1/2 of 1% during the fourth quarter.
Because Corporate yield spreads widened during the quarter, most Corporate bonds
under-performed like maturity Treasuries. However, the Fund's Corporate issues
did better than average for the Corporate sector. Before expenses, the
investment grade portion of the portfolio returned about 3.1%. The below
investment grade portion of the portfolio had a total return of 2.3% for the
quarter, having better income but less maturity exposure in the upward moving
market and suffering from the widening of quality spreads.
THE PRINTED DOCUMENT CONTAINS A PIE CHART HERE
PIE CHART TITLE:
Portfolio Sector Allocation
PIE CHART DATA:
Mortgage 20.3%
Treasury 5.0%
Cash 5.8%
Yankee 5.9%
International 0.9%
Finance 15.3%
Utility 6.6%
Industrial 36.2%
Asset-Backed 4.0%
- ---------------------------
100%
===========================
The pie graph above shows the portfolio's sector weightings at the end of
December. Our Corporate bond position increased to 63.9%, as we reduced
Treasuries and Mortgages to take advantage of the widening Corporate yield
spreads. [Note that "Yankees" are U.S. dollar denominated bonds issued by
foreign corporations or governmental entities.] The portfolio's only foreign
currency exposure was in a long Canadian Government bond, which makes up 0.9% of
the total portfolio. Apache, Cablevision Systems, ENSCO, Hilton Hotels, Royal
Caribbean, Simon DeBartolo, Tenet Healthcare, United Defense, and Viacom were
new holdings at the end of the quarter, while Cole National Group, Fort James,
LASMO, LCI International, Proffitt's, and WorldCom were sold. Once again the
lower grade issues had performed quite well, but during the rally in bonds their
prices had increased to the point where their eventual callability was a factor
that limited their further upward progress. Proffitt's had also done quite well,
but valuation seemed fairly high, especially considering their recent purchase
of Carson Pirie Scott, so we sold. Likewise, we sold WorldCom when they
announced their intention to buy MCI. Neither of these mergers were bad per se
for the credits, but both created uncertainty about results during the
integration process. As you can see, we redeployed these assets into a variety
of industries, maintaining a focus on cable and media, and domestic oil.
The Mortgage component of the portfolio was reduced to 20.3% over the quarter.
As noted in our previous letter, we focused our mortgage position in GNMA 7.5%
5
<PAGE>
securities early in the fourth quarter to help protect against rapid prepayments
due to refinancing activity. These bonds in general did surprisingly well, given
the extent of the drop in interest rates. However, it is difficult to expect
that this favorable price action will continue in the face of the increasing
level of prepayments, unless the bond market retreats and interest rates move up
toward the 6% level.
THE PRINTED DOCUMENT CONTAINS A PIE CHART HERE
PIE CHART TITLE:
Quality Distribution
PIE CHART DATA:
Government 25.5%
Cash 5.8%
B 8.8%
BB 17.4%
BBB 28.3%
A 8.9%
AA 4.4%
AAA 0.9%
- ---------------------------
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 28.2% of its assets in these categories, up from the 25.4% held three
months prior. 26.3% of the portfolio was below investment grade in terms of
credit rating. The largest below investment grade holding remained Borden Inc.,
a packaging company, at 2.2% of the total. Average quality for the overall
portfolio was A, with the quality breakdown shown in the pie graph above.
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 17 years' experience managing fixed-income investments.
Kristin Bradbury, C.F.A., is responsible for quantitative analysis and trading
for the portfolio. Kristin has 12 years of investment related experience. Almond
G. Goduti has replaced Mark Boyadjian as the mortgage specialist on the Fund. Al
has 14 years of industry 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 23 of this report.
Scudder - Zurich Alliance and Special Meeting Results
On December 31, 1997, the Zurich Group ("Zurich") acquired a majority interest
in Scudder, Stevens & Clark, Inc. ("Scudder"), the Fund's investment adviser,
and Zurich Kemper Investments, Inc., an investment subsidiary of Zurich, became
6
<PAGE>
part of Scudder. The Delaware corporation formerly known as Scudder, Stevens &
Clark, Inc. changed its name to "Scudder Kemper Investments, Inc." as of that
date, and will continue to do business with the Fund under its new name on the
same terms and conditions as previously in effect. The new Management and
Investment Advisory Agreement between the Fund and Scudder Kemper Investments,
Inc. was approved by shareholders of the Fund at the Special Meeting held on
October 10, 1997. Please see the table entitled "Stockholders Meeting Results"
on page 22 for more detailed information about the votes cast at the Special
Meeting.
Summary
In summary, 1997 was a volatile year for bonds. Prices declined for the first
one third of the year and then generally rose during the last half as the
economy maintained balanced growth and inflation expectations were lowered. 1998
augurs as a year in which inflation should continue at low levels, but corporate
earnings should begin to grow at slower rates than the last several years.
Normally that is a good environment for bond investments. Great uncertainty
exists regarding the intermediate implications of the Asia situation on the U.S.
Iraq is also a wild card, both politically and from an oil pricing perspective.
Thank you for being a shareholder. We value our relationship with you.
Sincerely,
/s/John T. Packard /s/Stephen A. Wohler
- -------------------------- --------------------------
John T. Packard Stephen A. Wohler
President Vice President
Portfolio Manager of the Fund
- --------------------------------------------------------------------------------
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.
- --------------------------------------------------------------------------------
7
<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 that at the time of purchase, the Fund's obligations
under such contracts do 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.
8
<PAGE>
SCHEDULE OF INVESTMENTS
December 31, 1997
<TABLE>
<CAPTION>
Principal Market
Amount ($)* Value ($)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
SHORT-TERM INVESTMENTS -- 5.7%
(under 1 year)
Ford Motor Credit Co., 5.85%, 1/7/98 ................................... 5,500,000 5,500,000
Ford Motor Credit Co., 6.08%, 1/7/98 ................................... 809,000 809,000
Ford Motor Credit Co., 5.96%, 1/8/98 ................................... 748,000 748,000
Household Finance Corp., 5.85%, 1/5/98 ................................. 4,830,000 4,830,000
-----------
TOTAL SHORT-TERM INVESTMENTS (Cost $11,887,000) ........................ 11,887,000
-----------
- ---------------------------------------------------------------------------------------------------------------
INTERMEDIATE-TERM BONDS -- 14.6%
(1 - 8 years)
U.S. TREASURY & AGENCY -- 5.0%
U.S. Treasury Note, 6.5%, 5/31/02 ...................................... 10,000,000 10,292,200
-----------
FINANCIAL -- 3.1%
Banks -- 1.6%
Conti Financial Corp., senior note, 8.375%, 8/15/03 .................... 1,950,000 2,018,250
First Nationwide Holding Corp., 10.625%, 10/1/03 ....................... 1,250,000 1,396,875
-----------
3,415,125
-----------
Real Estate -- 1.5%
Simon Debartolo Group LP, 6.875%, 10/27/05 ............................. 3,000,000 3,032,730
-----------
HEALTH -- 1.0%
Hospital Management
Tenet Healthcare Corp., senior note, 7.875%, 1/15/03 ................... 2,000,000 2,025,000
-----------
MANUFACTURING -- 1.0%
Diversified Manufacturing
Borden Chemicals and Plastics L.P., note, 9.5%, 5/1/05 ................. 2,000,000 2,125,000
-----------
MEDIA -- 2.0%
Broadcasting & Entertainment -- 0.5%
Viacom Inc., senior note, 7.75%, 6/1/05 ................................ 1,000,000 1,017,090
-----------
Cable Television -- 1.5%
Rogers Cablesystems Ltd., senior secured note, 9.63%, 8/1/02 ........... 3,000,000 3,187,500
-----------
TRANSPORTATION -- 1.0%
Airlines
Continental Airlines, Inc., 9.5%, 12/15/01 ............................. 2,000,000 2,070,000
-----------
UTILITIES -- 1.5%
Electric Utilities
Niagara Mohawk Power Corp., 8%, 6/1/04 ................................. 3,000,000 3,178,740
-----------
TOTAL INTERMEDIATE-TERM BONDS (Cost $29,471,895) ....................... 30,343,385
-----------
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
9
<PAGE>
<TABLE>
<CAPTION>
Principal Market
Amount ($)* Value ($)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
LONG-TERM BONDS -- 76.2%
(over 8 years)
U.S. TREASURY & AGENCY -- 20.1%
Government National Mortgage Association, 7.5%, with various
maturities to 11/15/27 (b) ........................................... 40,557,662 41,546,052
-----------
FOREIGN GOVERNMENT -- 0.9%
Government of Canada, 8%, 6/1/23 ....................................... CAD 2,000,000 1,764,109
-----------
METALS & MINERALS -- 0.7%
Steel & Metals
AK Steel Holding Corp., 9.125%, 12/15/06 ............................... 1,500,000 1,533,750
-----------
CONSUMER DISCRETIONARY -- 2.0%
Hotels & Casinos -- 1.0%
Hilton Hotels Corp., senior note, 7.95%, 4/15/07 ....................... 2,000,000 2,121,600
-----------
Miscellaneous -- 1.0%
Royal Caribbean International, senior note, 7%, 10/15/07 ............... 2,000,000 2,014,660
-----------
CONSUMER STAPLES -- 4.0%
Food & Beverage
Borden Inc., debenture, 9.2%, 3/15/21 .................................. 4,000,000 4,395,240
Coca-Cola Co., Inc., debenture, 7.38%, 7/29/2093 ....................... 3,500,000 3,865,505
-----------
8,260,745
-----------
COMMUNICATIONS -- 1.5%
Cellular Telephone
ComCast Cellular, 9.5%, 5/1/07 ......................................... 2,000,000 2,080,000
Rogers Cantel Mobile Communications Inc., 9.375%, 6/1/08 ............... 1,000,000 1,055,000
-----------
3,135,000
-----------
FINANCIAL -- 15.4%
Banks -- 6.0%
ABN-AMRO Bank NV, subordinated note, 7.13%, 10/15/2093 ................. 5,000,000 5,105,850
Bank United Financial Corp., 10.25%, 12/31/26 .......................... 1,500,000 1,545,000
CoreStates Bank, 8%, 12/15/26 .......................................... 2,500,000 2,638,675
Royal Bank of Scotland, 7.375%, 4/29/49 ................................ 3,000,000 3,127,380
-----------
12,416,905
-----------
Other Financial Companies -- 3.9%
Greentree Financial Corp., asset-backed, senior subordinated pass-thru
certificate, Series 1993-4 B1, 7.2%, 1/15/19 ........................... 8,000,000 8,150,000
-----------
Real Estate -- 5.5%
ERP Operating L.P. Note, 7.57%, 8/15/26 ................................ 3,000,000 3,189,780
Meditrust SBI, 7.82%, 9/10/26 .......................................... 3,000,000 3,150,000
Spieker Properties, Inc., 7.5%, 10/1/27 ................................ 2,000,000 2,024,500
Taubman Realty Group LP, 7%, 8/1/07 .................................... 3,000,000 3,004,200
-----------
11,368,480
-----------
</TABLE>
The accompanying notes are an integral part of the financial statements.
10
<PAGE>
SCHEDULE OF INVESTMENTS (continued)
<TABLE>
<CAPTION>
Principal Market
Amount ($)* Value ($)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
MEDIA -- 7.3%
Broadcasting & Entertainment -- 3.2%
Paramount Communications, Inc., senior debenture, 7.5%, 7/15/23 ........ 2,000,000 1,855,940
Time Warner Inc., debenture, 9.125%, 1/15/13 ........................... 4,000,000 4,763,080
-----------
6,619,020
-----------
Cable Television -- 2.9%
Cablevision Systems Corp., senior note, 7.875%, 12/15/07 ............... 2,500,000 2,550,000
Tele-Communications Inc., 8.75%, 8/1/15 ................................ 3,000,000 3,476,970
-----------
6,026,970
-----------
Print Media -- 1.2%
Harcourt General, Inc., 7.3%, 8/1/2097 ................................. 2,500,000 2,525,375
-----------
DURABLES -- 4.8%
Aerospace -- 3.5%
Argo-Tech Corp., 8.625%, 10/1/07 ....................................... 2,000,000 2,000,000
Lockheed Martin Corp., 7.2%, 5/1/36 .................................... 3,000,000 3,251,160
Tracor, Inc., 8.5%, 3/1/07 ............................................. 2,000,000 2,020,000
-----------
7,271,160
-----------
Miscellaneous -- 1.3%
Newport News Shipbuilding Co., senior note, 9.25%, 12/1/06 ............. 2,500,000 2,643,750
-----------
ENERGY -- 12.2%
Chemicals -- 1.5%
Lyondell Petrochemical Co., note, 7.55%, 2/15/26 ....................... 3,000,000 3,115,860
-----------
Oil & Gas Production-- 10.7%
Apache Corp., debenture, 7.7%, 3/15/26 ................................. 3,310,000 3,607,635
Belden & Blake Corp., 9.875%, 6/15/07 .................................. 2,000,000 2,020,000
Canadian Forest Oil, 8.75%, 9/15/07 .................................... 2,000,000 2,017,500
ENSCO International Inc., note, 6.75%, 11/15/07 ........................ 4,000,000 4,024,400
NGC Corp, 8.316%, 6/1/27 ............................................... 4,000,000 4,552,360
Nuevo Energy Co., senior subordinated note, 9.5%, 4/15/06 .............. 2,000,000 2,115,000
Unocal Corp., debenture, 9.4%, 2/15/11 ................................. 3,000,000 3,715,230
-----------
22,052,125
-----------
MANUFACTURING -- 2.0%
Industrial Specialty -- 1.3%
Hutchison Whampoa, Ltd., 7.5%, 8/1/27 .................................. 3,000,000 2,685,000
-----------
Diversified Manufacturing-- 0.7%
United Defense Inds. Inc., senior subordinate note, 8.75%, 11/15/07 .... 1,500,000 1,509,375
-----------
TECHNOLOGY -- 1.0%
Semiconductors
Fairchild Semiconductor Inc., 10.125%, 3/15/07 ......................... 2,000,000 2,115,000
-----------
TRANSPORTATION -- 1.5%
Airlines
Northwest Airlines Corp., 8.7%, 3/15/07 ................................ 3,000,000 3,185,640
-----------
</TABLE>
The accompanying notes are an integral part of the financial statements.
11
<PAGE>
<TABLE>
<CAPTION>
Principal Market
Amount ($)* Value ($)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
UTILITIES -- 2.8%
Natural Gas Distributors -- 1.3%
ANR Pipeline, debenture, 9.625%, 11/1/21 ............................... 2,000,000 2,639,420
-----------
Electric Utilities-- 1.5%
Southern Co. Capital Trust I, 8.19%, 2/1/37 ............................ 3,000,000 3,171,420
-----------
TOTAL LONG-TERM BONDS (Cost $151,405,913) 157,871,416
-----------
- ---------------------------------------------------------------------------------------------------------------
WARRANTS -- 0.1%
Shares
------
Walden Residential Properties, Inc. Warrants (expire 1/1/02) ........... 80,000 90,000
-----------
- ---------------------------------------------------------------------------------------------------------------
PREFERRED STOCK -- 1.0%
Walden Residential Properties, Inc. (Cost $2,000,000) .................. 80,000 2,055,000
-----------
- ---------------------------------------------------------------------------------------------------------------
CONVERTIBLE PREFERRED STOCK -- 1.0%
United Dominion Realty Trust Inc., "A", 4/24/00, 9.25%
(Cost $2,000,000) ...................................................... 80,000 2,095,000
-----------
- ---------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT PORTFOLIO-- 98.6% (Cost $196,764,808) (a) ............. 204,341,801
OTHER ASSETS AND LIABILITIES, NET-- 1.4% ............................... 2,973,901
-----------
NET ASSETS -- 100.0% ................................................... 207,315,702
===========
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
(a) The cost for federal income tax purposes was $196,764,808. At December
31, 1997, net unrealized appreciation for all securities based on tax
cost was $7,576,993. This consisted of aggregate gross unrealized
appreciation for all securities in which there was an excess of market
value over tax cost of $7,871,703 and aggregate gross unrealized
depreciation for all securities in which there was an excess of tax
cost over market value of $294,710.
(b) Effective maturities will be shorter due to prepayments.
* 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, 1997
<TABLE>
<S> <C> <C>
ASSETS
Investments, at market (identified cost $196,764,808) ............... $ 204,341,801
Cash ................................................................ 285,662
Interest and dividends receivable ................................... 2,901,570
Other assets ........................................................ 2,992
--------------
Total Assets 207,532,025
LIABILITIES
Accrued management fee .............................................. $ 86,135
Other payables and accrued expenses ................................. 130,188
-----------
Total Liabilities 216,323
--------------
NET ASSETS, at market value $ 207,315,702
==============
NET ASSETS
Net assets consist of:
Undistributed net investment income .............................. $ 168,202
Net unrealized appreciation (depreciation) on
Investments ................................................... 7,576,993
Foreign currency related transactions ......................... (19)
Accumulated net realized gain (loss) ............................. (162,232)
Paid-in capital .................................................. 199,732,758
--------------
NET ASSETS, at market value ...................................... $ 207,315,702
==============
Net Asset Value Per Share ($207,315,702 / 10,219,267 shares of
common stock outstanding, $.001 par value, 30,000,000
shares authorized) .................................................. $20.29
======
</TABLE>
The accompanying notes are an integral part of the financial statements.
13
<PAGE>
STATEMENT OF OPERATIONS
Year Ended December 31, 1997
<TABLE>
<S> <C> <C>
INVESTMENT INCOME
Income:
Interest .......................................................... $ 15,493,797
Dividends ......................................................... 355,768
-------------
15,849,565
Expenses:
Management and investment advisory fee ............................ $ 991,937
Directors' fees and expenses ...................................... 78,689
Services to shareholders .......................................... 92,054
Reports to shareholders ........................................... 86,261
Auditing .......................................................... 71,550
Legal ............................................................. 23,287
Custodian fees .................................................... 16,012
State franchise tax ............................................... 800
Other ............................................................. 63,403 1,423,993
------------- -------------
Net Investment Income 14,425,572
-------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
Net realized gain (loss) from:
Investment securities ............................................. 3,553,116
Foreign currency related transactions ............................. (2,493)
-------------
3,550,623
Net unrealized appreciation (depreciation) during the period on:
Investment securities ............................................. 4,411,891
Foreign currency related transactions ............................. 33
-------------
4,411,924
-------------
Net gain (loss) on investments ....................................... 7,962,547
-------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING
FROM OPERATIONS ...................................................... $ 22,388,119
=============
</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 1997 1996
<S> <C> <C>
Operations:
Net investment income ................................................. $ 14,425,572 $ 13,940,795
Net realized gain (loss) from investment transactions ................. 3,550,623 2,330,201
Net unrealized appreciation (depreciation) on investment and
foreign currency related transactions during the period ............ 4,411,924 (6,065,303)
--------------- -------------
Net increase (decrease) in net assets resulting from operations ....... 22,388,119 10,205,693
--------------- -------------
Dividends to shareholders from net investment income .................. (14,662,530) (14,163,424)
--------------- -------------
Fund share transactions:
Reinvestment of dividends from net investment income ............... 1,124,291 1,176,267
--------------- -------------
Increase (decrease) in net assets ..................................... 8,849,880 (2,781,464)
Net assets at beginning of period ..................................... 198,465,822 201,247,286
--------------- -------------
Net assets at end of period (including undistributed net invesment
income of $168,202 and $64,006, respectively) ...................... $ 207,315,702 $ 198,465,822
=============== =============
Other Information
Increase in Fund shares
Shares outstanding at beginning of period ............................. 10,158,937 10,091,241
Shares issued to shareholders in reinvestment of dividends
from net investment income ......................................... 60,330 67,696
--------------- -------------
Shares outstanding at end of period ................................... 10,219,267 10,158,937
=============== =============
</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,
-----------------------------------------------------
1997 1996 1995 1994 1993
-----------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period ..... $19.54 $19.94 $17.72 $20.13 $19.30
------ ------ ------ ------ ------
Income from investment operations:
Income ................................. 1.56 1.53 1.57 1.51 1.68
Operating expenses ..................... (.14) (.15) (.14) (.14) (.15)
------ ------ ------ ------ ------
Net investment income .................. 1.42 1.38 1.43 1.37 1.53
Net realized and unrealized
gain (loss) ......................... .77 (.38) 2.19 (2.42) .84
------ ------ ------ ------ ------
Total from investment operations ......... 2.19 1.00 3.62 (1.05) 2.37
------ ------ ------ ------ ------
Less distributions:
From net investment income ............ (1.44) (1.40) (1.40) (1.36) (1.54)
------ ------ ------ ------ ------
Net asset value, end of period ........... $20.29 $19.54 $19.94 $17.72 $20.13
====== ====== ====== ====== ======
Per share market value, end of period .... $19.50 $17.38 $18.00 $15.75 $19.75
====== ====== ====== ====== ======
Price range on New York Stock Exchange
for each share of Common Stock
outstanding during the period
(Unaudited):
High .................................. $19.94 $19.50 $19.13 $20.25 $22.38
Low ................................... $17.25 $16.75 $15.75 $15.25 $19.25
Total Investment Return
Per share market value (%) ............. 21.15 4.54 23.69 (13.54) 2.02
Per share net asset value (%) (b) ...... 12.09 6.08 21.78 (4.51) 12.47
Ratios and Supplemental Data
Net assets, end of period ($ millions) ... 207 198 201 178 200
Ratio of operating expenses to
average daily net assets (%) ........... .71 .76 .73 .71 .73
Ratio of net investment income to
average daily net assets (%) ........... 7.17 7.07 7.45 7.28 7.53
Portfolio turnover rate (%) .............. 162.2(c) 92.1 76.4 137.0 122.8
</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. These percentages are not an
indication of the performance of a shareholder's investment in the Fund
based on market value.
(c) The portfolio turnover rate including mortgage dollar roll transactions
aggregated 218.1% for the year ended December 31, 1997.
16
<PAGE>
NOTES TO FINANCIAL STATEMENTS
December 31, 1997
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.
Significant accounting policies are summarized as follows:
Valuation of Investments--Portfolio debt securities with original
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. Money market investments
purchased with an original 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.
17
<PAGE>
Mortgage Dollar Rolls--The Fund may enter into mortgage dollar rolls in
which the Fund sells mortgage securities for delivery in the current month
and simultaneously contracts to repurchase similar, but not identical,
securities at the same price on a fixed date. The Fund receives
compensation as consideration for entering into the commitment to
repurchase. The compensation is recorded as deferred income and amortized
to income over the roll period. The counterparty receives all principal
and interest payments, including prepayments, made in respect of the
security while it is the holder. Mortgage dollar rolls may be renewed with
a new purchase and repurchase price fixed and a cash settlement made at
each renewal without physical delivery of the securities subject to the
contract.
Federal Income Taxes--The Fund's policy is to comply with the requirements
of the Internal Revenue Code, as amended, 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, 1997, the Fund had a net tax basis capital loss
carryforward of approximately $30,000, which may be applied against any
realized net taxable capital gains of each succeeding year until fully
utilized or until December 31, 2003, the expiration date, 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.
18
<PAGE>
NOTES TO FINANCIAL STATEMENTS (continued)
Note B--MANAGEMENT AND INVESTMENT ADVISORY FEE. Effective December 31, 1997,
Scudder, Stevens & Clark, Inc. ("Scudder") and The Zurich Insurance Company
("Zurich"), an international insurance and financial services organization,
formed a new global investment organization by combining Scudder's business with
that of Zurich's subsidiary, Zurich Kemper Investments, Inc. As a result of the
transaction, Scudder changed its name to Scudder Kemper Investments, Inc.
("Scudder Kemper" or the "Adviser"). The transaction between Scudder and Zurich
resulted in the termination of the Fund's Investment Management Agreement with
Scudder. However, a new Investment Management Agreement (the "Management
Agreement") between the Fund and Scudder Kemper was approved by the Fund's Board
of Directors and by the Fund's Stockholders. The Management Agreement, which is
effective December 31, 1997, is the same in all material respects as the
corresponding previous Investment Management Agreement, except that Scudder
Kemper is the new investment adviser to the Fund.
Under the Fund's Management Agreement with Scudder Kemper, 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 Management 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 Management
Agreement exceed 25% of the Fund's annual gross income, the excess will be
reimbursed by the Adviser. For the year ended December 31, 1997, the fee
pursuant to the Management Agreement amounted to $991,937, equivalent to an
effective rate of 0.49% of the Fund's average daily net assets.
None of the Directors are affiliated with the Adviser. For the year ended
December 31, 1997, Directors' fees and expenses aggregated $78,689.
Note C--PURCHASES AND SALES OF INVESTMENTS. For the year ended December 31,
1997, purchases and sales of investment securities (excluding direct U.S.
government obligations, short-term investments, and mortgage dollar roll
transactions) aggregated $284,144,933 and $293,719,249, respectively. Purchases
and sales of direct U.S. Government obligations aggregated $10,063,281 and
$11,326,734, respectively. Purchases and sales of mortgage dollar roll
transactions aggregated $129,253,641 and $129,934,711, respectively.
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, 1997, 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,
1997, 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, 1997, the
results of its operations for the year then ended, the changes in its net
assets for each of the two years in the period then ended, and the
financial highlights for each of the five years in the period then ended,
in conformity with generally accepted accounting principles.
/s/Ernst & Young LLP
Boston, Massachusetts
February 6, 1998
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, 7.68% 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>
STOCKHOLDER MEETING RESULTS
A Special Meeting of Stockholders of Montgomery Street Income Securities, Inc.
(the "Fund") was held on Thursday, October 10, 1997, at the offices of Scudder
Kemper Investments, Inc. (formerly Scudder, Stevens & Clark, Inc.), 101
California Street, Suite 4100, San Francisco, California. The following matter
was voted upon by Stockholders (the resulting votes for this matter are
presented below).
1. To approve the new Investment Management, Advisory and Administration
Agreement between the Fund and Scudder Kemper Investments, Inc.
Number of Votes:
----------------
For Against Abstain Broker Non-Votes*
--- ------- ------- -----------------
7,665,099 117,405 132,774 0
- --------------------------------------------------------------------------------
* Broker non-votes are proxies received by the Company from brokers or
nominees when the broker or nominee neither has received instructions from
the beneficial owner or other persons entitled to vote nor has discretionary
power to vote on a particular matter.
22
<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 $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
23
<PAGE>
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.
