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EXCELSIOR FUNDS, INC.
Money Fund
Government Money Fund
Treasury Money Fund
EXCELSIOR TAX-EXEMPT FUNDS, INC.
Tax-Exempt Money Fund
STATEMENT OF ADDITIONAL INFORMATION
August 1, 1997
This Statement of Additional Information is not a prospectus but should be read
in conjunction with the current prospectus for the Money Fund, Government Money
Fund and Treasury Money Fund of Excelsior Funds, Inc. ("Excelsior Fund") and the
Tax-Exempt Money Fund of Excelsior Tax-Exempt Funds, Inc. ("Excelsior Tax-Exempt
Fund") dated August 1, 1997 (the "Prospectus"). Much of the information
contained in this Statement of Additional Information expands upon the subjects
discussed in the Prospectus. No investment in shares of the portfolios
described herein ("Shares") should be made without reading the Prospectus. A
copy of the Prospectus may be obtained by writing Excelsior Funds c/o Chase
Global Funds Services Company, 73 Tremont Street, Boston, MA 02108-3913 or by
calling (800) 446-1012.
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TABLE OF CONTENTS
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INVESTMENT OBJECTIVES AND POLICIES...................... 1
Additional Information on Portfolio Instruments.... 1
Additional Investment Limitations.................. 6
NET ASSET VALUE AND NET INCOME.......................... 9
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION.......... 10
INVESTOR PROGRAMS....................................... 12
Systematic Withdrawal Plan......................... 12
Exchange Privilege................................. 13
Other Investor Programs............................ 13
DESCRIPTION OF CAPITAL STOCK............................ 14
MANAGEMENT OF THE FUNDS................................. 16
Directors and Officers............................. 16
Investment Advisory and Administration Agreements.. 21
Shareholder Organizations.......................... 23
Expenses........................................... 24
Custodian and Transfer Agent....................... 25
PORTFOLIO TRANSACTIONS.................................. 26
INDEPENDENT AUDITORS.................................... 28
COUNSEL................................................. 28
ADDITIONAL INFORMATION CONCERNING TAXES................. 28
Generally.......................................... 28
Tax-Exempt Money Fund.............................. 29
YIELD INFORMATION....................................... 30
MISCELLANEOUS........................................... 32
FINANCIAL STATEMENTS.................................... 32
APPENDIX A.............................................. A-1
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INVESTMENT OBJECTIVES AND POLICIES
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This Statement of Additional Information contains additional
information with respect to the Money Fund, Government Money Fund and Treasury
Money Fund of Excelsior Fund (collectively, the "Taxable Funds") and the Tax-
Exempt Money Fund of Excelsior Tax-Exempt Fund (the portfolios are referred to
individually as a "Fund" and collectively as the "Funds"; Excelsior Fund and
Excelsior Tax-Exempt Fund are referred to individually as a "Company" and
collectively as the "Companies").
The investment objective of the Money Fund and the Government Money
Fund is to seek as high a level of current income as is consistent with
liquidity and stability of prin cipal. The Money Fund generally invests in
money market instruments; the Government Money Fund generally invests in
obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities and in repurchase agreements collateralized by such
obligations. The investment objective of the Treasury Money Fund is to seek
current income consistent with liquidity and stability of principal. The
Treasury Money Fund invests primarily in direct short-term obligations issued by
the U.S. Treasury and certain agencies or instrumentalities of the U.S.
Government with a view toward providing dividend income that is generally
considered exempt from state and local income taxes. The investment objective
of the Tax-Exempt Money Fund is to seek a moderate level of current interest
income exempt from Federal income taxes consistent with stability of principal.
The Tax-Exempt Money Fund invests substantially all of its assets in high-
quality Municipal Securities (as defined in the Prospectus) and, except during
temporary defensive periods, maintains at least 80% of its assets in tax-exempt
obligations. All Funds invest in instruments that generally have remaining
maturities of not more than 13 months. The following policies supplement the
Funds' investment policies as set forth in the Prospectus.
Additional Information on Portfolio Instruments
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Variable and Floating Rate Instruments
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With respect to variable and floating rate instruments described in
the Prospectus, United States Trust Company of New York ("U.S. Trust New York")
and U.S. Trust Company of Connecticut ("U.S. Trust Connecticut" and,
collectively, with U.S. Trust New York, the "Investment Adviser" or "U.S.
Trust") will consider the earning power, cash flows and other liquidity ratios
of the issuers of such instruments and will continuously monitor their financial
ability to meet payment on demand. In determining dollar-weighted average
portfolio maturity and whether a variable or floating rate instrument has a
remaining maturity of 13 months or less, the maturity of each instrument
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will be computed in accordance with guidelines established by the Securities and
Exchange Commission (the "SEC").
Repurchase Agreements
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The repurchase price under the repurchase agreements described in the
Prospectus generally equals the price paid by a Fund plus interest negotiated on
the basis of current short-term rates (which may be more or less than the rate
on the securities underlying the repurchase agreement). Securities subject to
repurchase agreements are held by the Funds' custodian (or sub-custodian) or in
the Federal Reserve/Treasury Money book-entry system. Repurchase agreements are
considered loans by a Fund under the Investment Company Act of 1940, as amended
(the "1940 Act").
Securities Lending
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When the Money Fund or Government Money Fund lends its portfolio
securities, it continues to receive interest or dividends on the securities lent
and may simultaneously earn interest on the investment of the cash loan
collateral, which will be invested in readily marketable, high-quality, short-
term obligations. Although voting rights, or rights to consent, attendant to
securities lent pass to the borrower, such loans may be called at any time and
will be called so that the securities may be voted by a Fund if a material event
affecting the investment is to occur.
When-Issued and Forward Transactions
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When a Fund agrees to purchase securities on a "when-issued" or
"forward commitment" basis, the custodian will set aside cash or liquid
portfolio securities equal to the amount of the commitment in a separate
account. Normally, the custodian will set aside portfolio securities to satisfy
a purchase commitment and, in such case, the Fund may be required subsequently
to place additional assets in the separate account in order to ensure that the
value of the account remains equal to the amount of the Fund's commitment. It
may be expected that a Fund's net assets will fluctuate to a greater degree when
it sets aside portfolio securities to cover such purchase commitments than when
it sets aside cash. Because a Fund will set aside cash or liquid assets to
satisfy its purchase commitments in the manner described, the Fund's liquidity
and ability to manage its portfolio might be affected in the event its forward
commitments or commitments to purchase "when-issued" securities ever exceed 25%
of the value of its assets.
A Fund will purchase securities on a "when-issued" or "forward
commitment" basis only with the intention of completing the transaction. If
deemed advisable as a matter of investment
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strategy, however, a Fund may dispose of or renegotiate a commitment after it is
entered into, and may sell securities it has committed to purchase before those
securities are delivered to the Fund on the settlement date. In these cases,
the Fund may realize a taxable capital gain or loss.
When a Fund engages in "when-issued" or "forward commitment"
transactions, it relies on the other party to consummate the trade. Failure of
such other party to do so may result in the Funds incurring a loss or missing an
opportunity to obtain a price considered to be advantageous.
The market value of the securities underlying a "when-issued" purchase
or a forward commitment to purchase securities and any subsequent fluctuations
in their market value are taken into account when determining the market value
of a Fund starting on the day the Fund agrees to purchase the securities. The
Fund does not earn interest on the securities it has committed to purchase until
they are paid for and delivered on the settlement date.
Stand-By Commitments
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The Tax-Exempt Money Fund may acquire "stand-by commitments" with
respect to Municipal Securities held by it. Under a "stand-by commitment," a
dealer or bank agrees to purchase from the Tax-Exempt Money Fund, at the Fund's
option, specified Municipal Securities at a specified price. The amount payable
to the Fund upon its exercise of a "stand-by commitment" is normally (i) the
Fund's acquisition cost of the Municipal Securities (excluding any accrued
interest which the Fund paid on their acquisition), less any amortized market
premium or plus any amortized market or original issue discount during the
period the Fund owned the securities, plus (ii) all interest accrued on the
securities since the last interest payment date during that period. "Stand-by
commitments" are exercisable by the Tax-Exempt Money Fund at any time before the
maturity of the underlying Municipal Securities, and may be sold, transferred or
assigned by the Fund only with the underlying instruments.
The Tax-Exempt Money Fund expects that "stand-by commitments" will
generally be available without the payment of any direct or indirect
consideration. However, if necessary or advisable, the Fund may pay for a
"stand-by commitment" either separately in cash or by paying a higher price for
securities which are acquired subject to the commitment (thus reducing the yield
to maturity otherwise available for the same securities). Where the Tax-Exempt
Money Fund has paid any consideration directly or indirectly for a "stand-by
commitment," its cost will be reflected as unrealized depreciation for the
period during which the commitment was held by the Fund.
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The Tax-Exempt Money Fund intends to enter into "stand-by commitments"
only with banks and broker/dealers which, in the Investment Adviser's opinion,
present minimal credit risks. In evaluating the creditworthiness of the issuer
of a "stand-by commitment," the Investment Adviser will review periodically the
issuer's assets, liabilities, contingent claims and other relevant financial
information.
Municipal Securities
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The Tax-Exempt Money Fund invests primarily in Municipal Securities as
defined in the Prospectus. Municipal Securities include debt obligations issued
by governmental entities to obtain funds for various public purposes, including
the construction of a wide range of public facilities, the refunding of
outstanding obligations, the payment of general operating expenses, and the
extension of loans to public institutions and facilities. Private activity
bonds that are issued by or on behalf of public authorities to finance various
privately operated facilities are included within the term "Municipal
Securities" only if the interest paid thereon is exempt from regular Federal
income tax and not treated as a specific tax preference item under the Federal
alternative minimum tax.
The two principal classifications of Municipal Securities are
"general obligations" and "revenue" issues, but the Tax-Exempt Money Fund's
portfolio may also include "moral obliga tion" issues, which are normally issued
by special-purpose authorities. There are, of course, variations in the quality
of Municipal Securities, both within a particular classification and between
classifications, and the yields on Municipal Securities depend upon a variety of
factors, including general money market conditions, the financial condition of
the issuer, general conditions of the municipal bond market, the size of a
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of Moody's Investors Service, Inc. ("Moody's") and Standard
& Poor's Ratings Group ("S&P") described in the Prospectus and Appendix hereto
represent their opinion as to the quality of Municipal Securities. It should be
emphasized that these ratings are general and are not absolute standards of
quality, and Municipal Securities with the same maturity, interest rate, and
rating may have different yields while Municipal Securities of the same maturity
and interest rate with different ratings may have the same yield. Subsequent to
its purchase by the Fund, an issue of Municipal Securities may cease to be
rated, or its rating may be reduced below the minimum rating required for
purchase by the Fund. The Investment Adviser will consider such an event in
determining whether the Tax-Exempt Money Fund should continue to hold the
obligation.
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The payment of principal and interest on most securities purchased by
the Tax-Exempt Money Fund will depend upon the ability of the issuers to meet
their obligations. Each state, the District of Columbia, each of their
political subdivisions, agencies, instrumentalities and authorities, and each
multistate agency of which a state is a member, is a separate "issuer" as that
term is used in this Statement of Additional Information and the Prospectus.
The non-governmental user of facilities financed by private activity bonds is
also considered to be an "issuer." An issuer's obligations under its Municipal
Securities are subject to the provisions of bankruptcy, insolvency, and other
laws affecting the rights and remedies of creditors, such as the Federal
Bankruptcy Code, and laws, if any, which may be enacted by Federal or state
legislatures extending the time for payment of principal or interest, or both,
or imposing other constraints upon enforcement of such obligations or upon the
ability of municipalities to levy taxes. The power or ability of an issuer to
meet its obligations for the payment of interest on and principal of its
Municipal Securities may be materially adversely affected by litigation or other
conditions.
Private activity bonds are or have been issued to obtain funds to
provide, among other things, privately operated housing facilities, pollution
control facilities, convention or trade show facilities, mass transit, airport,
port or parking facilities and certain local facilities for water supply, gas,
electricity or sewage or solid waste disposal. Private activity bonds are also
issued to privately held or publicly owned corporations in the financing of
commercial or industrial facilities. State and local governments are authorized
in most states to issue private activity bonds for such purposes in order to
encourage corporations to locate within their communities. The principal and
interest on these obligations may be payable from the general revenues of the
users of such facilities.
Among other instruments, the Tax-Exempt Money Fund may purchase short-
term General Obligation Notes, Tax Anticipation Notes, Bond Anticipation Notes,
Revenue Anticipation Notes, Tax-Exempt Commercial Paper, Construction Loan Notes
and other forms of short-term loans. Such instruments are issued with a short-
term maturity in anticipation of the receipt of tax funds, the proceeds of bond
placements or other revenues. In addition, the Fund may invest in long-term
tax-exempt instruments, such as municipal bonds and private activity bonds, to
the extent consistent with the maturity restrictions applicable to it.
From time to time, proposals have been introduced before Congress for
the purpose of restricting or eliminating the Federal income tax exemption for
interest on Municipal Securities. For example, under the Tax Reform Act of
1986, interest on certain private activity bonds must be included in an
investor's Federal alternative minimum taxable income, and
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corporate investors must treat all tax-exempt interest as an item of tax
preference. Excelsior Tax-Exempt Fund cannot, of course, predict what
legislation may be proposed in the future regarding the income tax status of
interest on Municipal Securities, or which proposals, if any, might be enacted.
Such proposals, while pending or if enacted, might materially adversely affect
the availability of Municipal Securities for investment by the Tax-Exempt Money
Fund and the liquidity and value of its portfolio. In such an event, Excelsior
Tax-Exempt Fund would re-evaluate the Fund's investment objective and policies
and consider possible changes in its structure or possible dissolution.
Opinions relating to the validity of Municipal Securities and to the
exemption of interest thereon from Federal income tax are rendered by bond
counsel to the respective issuers at the time of issuance. Neither Excelsior
Tax-Exempt Fund nor the Investment Adviser will review the proceedings relating
to the issuance of Municipal Securities or the basis for such opinions.
Miscellaneous
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The Funds may not invest in oil, gas, or mineral leases.
Additional Investment Limitations
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In addition to the investment limitations set forth in the Prospectus,
the Funds are subject to the investment limitations enumerated below, which may
be changed with respect to a particular Fund only by a vote of the holders of a
majority of such Fund's outstanding Shares (as defined under "Miscellaneous" in
the Prospectus).
No Fund may:
1. Purchase securities on margin, make short sales of securities, or
maintain a short position;
2. Act as an underwriter of securities within the meaning of the
Securities Act of 1933, except insofar as the Taxable Funds might be deemed to
be underwriters upon disposition of certain portfolio securities acquired within
the limitation on purchases of restricted securities; and except to the extent
that purchase by the Tax-Exempt Money Fund of Municipal Securities or other
securities directly from the issuer thereof in accordance with the Fund's
investment objective, policies and limitations may be deemed to be underwriting;
3. Purchase or sell real estate, except that each Taxable Fund may
purchase securities of issuers which deal in real estate and may purchase
securities which are secured by
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interests in real estate; and except that the Tax-Exempt Money Fund may invest
in Municipal Securities secured by real estate or interests therein;
4. Purchase or sell commodities or commodity contracts, or invest
in oil, gas, or other mineral exploration or development programs;
5. Invest in or sell puts, calls, straddles, spreads, or any
combination thereof; and
6. Issue any senior securities, except insofar as any borrowing in
accordance with a Fund's investment limitations might be considered to be the
issuance of a senior security.
In addition, the Money, Government Money and Treasury Money Funds may
not:
7. Make loans, except that (i) each Fund may purchase or hold debt
securities in accordance with its investment objective and policies, and the
Money Fund and the Government Money Fund may enter into repurchase agreements
with respect to obligations issued or guaranteed by the U.S. Government, its
agencies or instrumentalities, and (ii) the Money Fund and the Government Money
Fund may lend portfolio securities in an amount not exceeding 30% of their total
assets;
8. Invest in bank obligations having remaining maturities in excess
of one year, except that securities subject to repurchase agreements may bear
longer maturities;
9. Invest in companies for the purpose of exercising management or
control;
10. Invest more than 5% of a Funds's total assets in securities
issued by companies which, together with any pre decessor, have been in
continuous operation for fewer than three years;
11. Purchase foreign securities; except the Money Fund may purchase
certificates of deposit, bankers' acceptances, or other similar obligations
issued by domestic branches of foreign banks and foreign branches of U.S. banks
in an amount not to exceed 20% of its total net assets;
12. Acquire any other investment company or investment company
security, except in connection with a merger, consolidation, reorganization, or
acquisition of assets or where otherwise permitted by the Investment Company Act
of 1940;
13. Invest in obligations of foreign branches of financial
institutions or in domestic branches of foreign banks,
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if immediately after such purchase (i) more than 5% of the value of a Fund's
total assets would be invested in obligations of any one foreign branch of the
financial institution or domestic branch of a foreign bank; or (ii) more than
20% of its total assets would be invested in foreign branches of financial
institutions or in domestic branches of foreign banks;
14. Purchase any securities which would cause more than 25% of the
value of a Fund's total assets at the time of purchase to be invested in the
securities of one or more issuers conducting their principal business activities
in the same industry, provided that (a) there is no limitation with respect to
securities issued or guaranteed by the U.S. Government or domestic bank
obligations, and (b) neither all finance companies, as a group, nor all utility
companies, as a group, are considered a single industry for purposes of this
policy; and
15. Knowingly invest more than 10% of the value of a Fund's total
assets in illiquid securities, including repurchase agreements with remaining
maturities in excess of seven days, restricted securities, and other securities
for which market quotations are not readily available.
In addition, the Tax-Exempt Money Fund may not:
16. Make loans, except that the Fund may purchase or hold debt
obligations in accordance with its investment objective, policies, and
limitations;
17. Invest in industrial revenue bonds where the payment of principal
and interest are the responsibility of a company (including its predecessors)
with less than three years of continuous operation;
18. Knowingly invest more than 10% of the value of its total assets
in securities which may be illiquid in light of legal or contractual
restrictions on resale or the absence of readily available market quotations;
19. Purchase any securities which would cause more than 25% of the
value of its total assets at the time of purchase to be invested in the
securities of one or more issuers conducting their principal business activities
in the same industry, provided that there is no limitation with respect to
domestic bank obligations or securities issued or guaranteed by the United
States; any state or territory; any possession of the U.S. Government; the
District of Columbia; or any of their authorities, agencies, instrumentalities,
or political subdivisions; and
20. Purchase securities of other investment companies (except as part
of a merger, consolidation or reorganization or
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purchase of assets approved by the Fund's shareholders), provided that the Fund
may purchase shares of any registered, open-end investment company, if
immediately after any such purchase, the Fund does not (a) own more than 3% of
the outstanding voting stock of any one investment company, (b) invest more than
5% of the value of its total assets in the securities of any one investment
company, or (c) invest more than 10% of the value of its total assets in the
aggregate in securities of investment companies.
* * *
If a percentage limitation is satisfied at the time of investment, a
later increase or decrease in such percentage resulting from a change in value
of a Fund's portfolio securities will not constitute a violation of such
limitation.
For the purpose of Investment Limitation No. 3, the prohibition of
purchases of real estate includes acquisition of limited partnership interests
in partnerships formed with a view toward investing in real estate, but does not
prohibit purchases of shares in real estate investment trusts.
Notwithstanding Investment Limitations Nos. 15 and 18 above, the
Companies intend to limit the Funds' investments in illiquid securities to 10%
of each Fund's net (rather than total) assets.
Notwithstanding the proviso in Investment Limitation No. 19, to the
extent that the Tax-Exempt Money Fund has invested more than 20% of the value of
its assets in taxable securities on a temporary defensive basis, the industry
diversification limitation in Investment Limitation No. 19 shall apply to
taxable securities issued or guaranteed by any state, territory, or possession
of the U.S. Government; the District of Columbia; or any of their authorities,
agencies, instrumentalities, or political subdivisions.
NET ASSET VALUE AND NET INCOME
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The Companies use the amortized cost method of valuation to value
Shares in the Funds. Pursuant to this method, a security is valued at its cost
initially, and thereafter a constant amortization to maturity of any discount or
premium is assumed, regardless of the impact of fluctuating interest rates on
the market value of the security. This method may result in periods during which
value, as determined by amortized cost, is higher or lower than the price the
Fund involved would receive if it sold the security. The market value of
portfolio securities held by the Funds can be expected to vary inversely with
changes in prevailing interest rates.
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The Funds invest only in high-quality instruments and maintain a
dollar-weighted average portfolio maturity appropriate to their objective of
maintaining a constant net asset value per Share. The Funds will not purchase
any security deemed to have a remaining maturity of more than 13 months within
the meaning of the 1940 Act or maintain a dollar-weighted average portfolio
maturity which exceeds 90 days. The Companies' Boards of Directors have
established procedures that are intended to stabilize the net asset value per
Share of each Fund for purposes of sales and redemptions at $1.00. These
procedures include the determination, at such intervals as the Boards deem
appropriate, of the extent, if any, to which the net asset value per Share of a
Fund calculated by using available market quotations deviates from $1.00 per
Share. In the event such deviation exceeds one half of one percent, the Boards
of Directors will promptly consider what action, if any, should be initiated.
If the Boards of Directors believe that the extent of any deviation from a
Fund's $1.00 amortized cost price per Share may result in material dilution or
other unfair results to new or existing investors, they will take appropriate
steps to eliminate or reduce, to the extent reasonably practicable, any such
dilution or unfair results. These steps may include selling portfolio
instruments prior to maturity; shortening the average portfolio maturity;
withholding or reducing dividends; redeeming Shares in kind; reducing the number
of the Fund's outstanding Shares without monetary consideration; or utilizing a
net asset value per share determined by using available market quotations.
Net income of each of the Funds for dividend purposes consists of (i)
interest accrued and discount earned on a Fund's assets, less (ii) amortization
of market premium on such assets, accrued expenses directly attributable to the
Fund, and the general expenses or the expenses common to more than one portfolio
of a Company (e.g., administrative, legal, accounting, and directors' fees)
prorated to each portfolio of the Company on the basis of their relative net
assets.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
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Shares are continuously offered for sale by Edgewood Services, Inc.
(the "Distributor"), a wholly-owned subsidiary of Federated Investors, and the
Distributor has agreed to use appropriate efforts to solicit all purchase
orders. As described in the Prospectus, Shares may be sold to customers
("Customers") of financial institutions ("Shareholder Organizations"). Shares
are also offered for sale directly to institutional investors and to members of
the general public. Different types of Customer accounts at the Shareholder
Organizations may be used to purchase Shares, including eligible agency and
trust accounts. In addition, Shareholder Organizations may automatically
"sweep" a Customer's account not less frequently than weekly and invest amounts
in excess of a minimum balance agreed to by the
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Shareholder Organization and its Customer in Shares selected by the Customer.
Investors purchasing Shares may include officers, directors, or employees of the
particular Shareholder Organization.
Shares of the Funds are offered for sale at their net asset value per
Share next computed after a purchase order is received by the Companies' sub-
transfer agent.
As stated in the Prospectus, no sales charge is imposed by the
Companies on purchases of Shares. In addition, no sales load is charged on the
reinvestment of dividends or distributions or in connection with certain Share
exchanges as described in the Prospectus under "Investor Programs--Exchange
Privilege."
As described in the Prospectus, Direct Investors may redeem Shares by
writing a check. Checks to redeem Shares are drawn on the Companies' accounts
at The Chase Manhattan Bank ("Chase"). Direct Investors will be subject to the
same rules and regulations that Chase applies to checking accounts and will have
the same rights and duties with respect to stop-payment orders, "stale" checks,
unauthorized signatures, collection of deposits, alterations and unauthorized
endorsements as bank checking account customers do under the New York Uniform
Commercial Code. When a check is presented to Chase for payment, Chase, as the
shareholder's agent, will cause the Fund from which the redemption is requested
to redeem sufficient Shares in the shareholder's account to cover the amount of
the check.
The Companies may suspend the right of redemption or postpone the date
of payment for Shares for more than 7 days during any period when (a) trading on
the New York Stock Exchange (the "Exchange") is restricted by applicable rules
and regulations of the SEC; (b) the Exchange is closed for other than customary
weekend and holiday closings; (c) the SEC has by order permitted such
suspension; or (d) an emergency exists as determined by the SEC.
In the event that Shares are redeemed in cash at their net asset
value, a shareholder may receive in payment for such Shares an amount that is
more or less than his original investment due to changes in the market prices of
that Fund's portfolio securities.
Each Company reserves the right to honor any request for redemption or
repurchase of a Fund's Shares by making payment in whole or in part in
securities chosen by the Company and valued in the same way as they would be
valued for purposes of computing a Fund's net asset value. If payment is made
in securities, a shareholder may incur transaction costs in converting these
securities into cash. Such redemptions in kind will be governed by Rule 18f-1
under the 1940 Act so that a Fund
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is obligated to redeem its Shares solely in cash up to the lesser of $250,000 or
1% of its net asset value during any 90-day period for any one shareholder of a
Fund.
Under limited circumstances, the Companies may accept securities as
payment for Shares. Securities acquired in this manner will be limited to
securities issued in transactions involving a bona fide reorganization or
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statutory merger, or will be limited to other securities (except for municipal
debt securities issued by state political subdivisions or their agencies or
instrumentalities) that: (a) meet the investment objective and policies of any
Fund acquiring such securities; (b) are acquired for investment and not for
resale; (c) are liquid securities that are not restricted as to transfer either
by law or liquidity of market; and (d) have a value that is readily
ascertainable (and not established only by evaluation procedures) as evidenced
by a listing on the American Stock Exchange, New York Stock Exchange or NASDAQ,
or as evidenced by their status as U.S. Government securities, bank certificates
of deposit, banker's acceptances, corporate and other debt securities that are
actively traded, money market securities and other similar securities with a
readily ascertainable value.
INVESTOR PROGRAMS
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Systematic Withdrawal Plan
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An investor who owns Shares with a value of $10,000 or more may begin
a Systematic Withdrawal Plan. The withdrawal can be on a monthly, quarterly,
semiannual or annual basis. There are four options for such systematic
withdrawals. The investor may request:
(1) A fixed-dollar withdrawal;
(2) A fixed-share withdrawal;
(3) A fixed-percentage withdrawal (based on the current value of the
account); or
(4) A declining-balance withdrawal.
Prior to participating in a Systematic Withdrawal Plan, the investor must
deposit any outstanding certificates for Shares with Chase Global Funds Services
Company, the Funds' sub-transfer agent. Under this Plan, dividends and
distributions are automatically reinvested in additional Shares of a Fund.
Amounts paid to investors under this Plan should not be considered as income.
Withdrawal payments represent proceeds from the sale of Shares, and there will
be a reduction of the shareholder's equity in the Fund involved if the amount of
the withdrawal payments
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exceeds the dividends and distributions paid on the Shares and the appreciation
of the investor's investment in the Fund. This in turn may result in a complete
depletion of the shareholder's investment. An investor may not participate in a
program of systematic investing in a Fund while at the same time participating
in the Systematic Withdrawal Plan with respect to an account in the same Fund.
Customers of Shareholder Organizations may obtain information on the
availability of, and the procedures and fees relating to, the Systematic
Withdrawal Plan directly from their Shareholder Organizations.
Exchange Privilege
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Investors and Customers of Shareholder Organizations may exchange
Shares having a value of at least $500 for shares of any other portfolio of the
Companies or for Trust Shares of Excelsior Institutional Trust. Shares may be
exchanged by wire, telephone or mail and must be made to accounts of identical
registration. There is no exchange fee imposed by the Companies or Excelsior
Institutional Trust. In order to prevent abuse of this privilege to the
disadvantage of other shareholders, the Companies and Excelsior Institutional
Trust reserve the right to limit the number of exchange requests of investors to
no more than six per year. The Companies and Excelsior Institutional Trust may
modify or terminate the exchange program at any time upon 60 days' written
notice to shareholders, and may reject any exchange request. Customers of
Shareholder Organizations may obtain information on the availability of, and the
procedures and fees relating to, such program directly from their Shareholder
Organizations.
For Federal income tax purposes, exchanges are treated as sales on
which the shareholder will realize a gain or loss, depending upon whether the
value of the Shares to be given up in exchange is more or less than the basis in
such Shares at the time of the exchange. Generally, a shareholder may include
sales loads incurred upon the purchase of Shares in his or her tax basis for
such Shares for the purpose of determining gain or loss on a redemption,
transfer or exchange of such Shares. However, if the Shareholder effected an
exchange of Shares for shares of another portfolio of the Companies within 90
days of the purchase and was able to reduce the sales load previously applicable
to the new shares (by virtue of the Companies' exchange privilege), the amount
equal to such reduction may not be included in the tax basis of the
shareholder's exchanged Shares but may be included (subject to the limitation)
in the tax basis of the new shares.
Other Investor Programs
- -----------------------
As described in the Prospectus, Shares of the Funds may be purchased
in connection with the Automatic Investment Program.
-13-
<PAGE>
Shares of the Money, Government Money and Treasury Money Funds may also be
purchased in connection with certain Retirement Programs. Customers of
Shareholder Organizations may obtain information on the availability of, and the
procedures and fees relating to, such programs directly from their Shareholder
Organizations.
DESCRIPTION OF CAPITAL STOCK
----------------------------
Excelsior Fund's Charter authorizes its Board of Directors to issue
up to 35 billion full and fractional shares of capital stock; and Excelsior Tax-
Exempt Fund's Charter authorizes its Board of Directors to issue up to 14
billion full and fractional shares of capital stock. Both Charters authorize
the respective Boards of Directors to classify or reclassify any unissued shares
of the respective Companies into one or more additional classes or series by
setting or changing in any one or more respects their respective preferences,
conversion or other rights, voting powers, restrictions, limitations as to
dividends, qualifications, and terms and conditions of redemption. The
Prospectus describes the classes of shares into which the Companies' authorized
capital is currently classified.
Shares have no preemptive rights and only such conversion or exchange
rights as the Boards of Directors may grant in their discretion. When issued
for payment as described in the Prospectus, Shares will be fully paid and non-
assessable. In the event of a liquidation or dissolution of a Fund,
shareholders of that Fund are entitled to receive the assets available for
distribution belonging to that Fund and a proportionate distribution, based upon
the relative asset values of the portfolios of the Company involved, of any
general assets of that Company not belonging to any particular portfolio of that
Company which are available for distribution. In the event of a liquidation or
dissolution of either Company, shareholders of such Company will be entitled to
the same distribution process.
Shareholders of the Companies are entitled to one vote for each full
share held, and fractional votes for fractional shares held, and will vote in
the aggregate and not by class, except as otherwise required by the 1940 Act or
other applicable law or when the matter to be voted upon affects only the
interests of the shareholders of a particular class. Voting rights are not
cumulative and, accordingly, the holders of more than 50% of a Company's
aggregate outstanding shares may elect all of that Company's directors,
regardless of the votes of other shareholders.
Rule 18f-2 under the 1940 Act provides that any matter required to be
submitted to the holders of the outstanding voting securities of an investment
company such as each Company shall
-14-
<PAGE>
not be deemed to have been effectively acted upon unless approved by the holders
of a majority of the outstanding shares of each portfolio affected by the
matter. A portfolio is affected by a matter unless it is clear that the
interests of each portfolio in the matter are substantially identical or that
the matter does not affect any interest of the portfolio. Under the Rule, the
approval of an investment advisory agreement or any change in a fundamental
investment policy would be effectively acted upon with respect to a portfolio
only if approved by a majority of the outstanding shares of such portfolio.
However, the Rule also provides that the ratification of the appointment of
independent public accountants, the approval of principal underwriting
contracts, and the election of directors may be effectively acted upon by
shareholders of each Company voting without regard to class.
The Companies' Charters authorize the Boards of Directors, without
shareholder approval (unless otherwise required by applicable law), to (a) sell
and convey the assets of a Fund to another management investment company for
consideration which may include securities issued by the purchaser and, in
connection therewith, to cause all outstanding Shares of the Fund involved to be
redeemed at a price which is equal to their net asset value and which may be
paid in cash or by distribution of the securities or other consideration
received from the sale and conveyance; (b) sell and convert a Fund's assets into
money and, in connection therewith, to cause all outstanding Shares to be
redeemed at their net asset value; or (c) combine the assets belonging to a Fund
with the assets belonging to another portfolio of the Company involved, if the
Board of Directors reasonably determines that such combination will not have a
material adverse effect on shareholders of any portfolio participating in such
combination, and, in connection therewith, to cause all outstanding shares of
any portfolio to be redeemed at their net asset value or converted into shares
of another class of the Company's capital stock at net asset value. The
exercise of such authority by the Boards of Directors will be subject to the
provisions of the 1940 Act, and the Boards of Directors will not take any action
described in this paragraph unless the proposed action has been disclosed in
writing to the particular Fund's shareholders at least 30 days prior thereto.
Notwithstanding any provision of Maryland law requiring a greater vote
of a Company's Common Stock (or of the Shares of a Fund voting separately as a
class) in connection with any corporate action, unless otherwise provided by law
(for example, by Rule 18f-2, discussed above) or by the Company's Charter, each
Company may take or authorize such action upon the favorable vote of the holders
of more than 50% of its outstanding Common Stock voting without regard to class.
-15-
<PAGE>
MANAGEMENT OF THE FUNDS
-----------------------
Directors and Officers
- ----------------------
The directors and executive officers of the Companies, their
addresses, ages, principal occupations during the past five years, and other
affiliations are as follows:
<TABLE>
<CAPTION>
Position Principal Occupation
with During Past 5 Years and
Name and Address the Companies Other Affiliations
- ---------------- ------------- -----------------------
<S> <C> <C>
Frederick S. Wonham/1/ Chairman of the Retired; Director of
238 June Road Board, President Excelsior Fund and Excelsior
Stamford, CT 06903 and Treasurer Tax-Exempt Fund (since 1995);
Age: 66 Trustee of Excelsior Funds
and Excelsior Institutional Trust
(since 1995); Vice Chairman of U.S.
Trust Corporation and U.S. Trust New
York (from February 1990 until
September 1995); and Chairman, U.S.
Trust Connecticut (from March 1993 to
May 1997).
Donald L. Campbell Director Retired; Director of
333 East 69th Street Excelsior Fund and Excelsior Apt. 10-H
New York, NY 10021 Tax-Exempt Fund (since 1984);
Age: 71 Director of UST Master
Variable Series, Inc.
(from 1994 to June 1997); Trustee of
Excelsior Institutional Trust (since
1995); and Director, Royal Life
Insurance Co. of New York (since 1991).
Rodman L. Drake Director Director, Excelsior Fund
485 Park Avenue and Excelsior Tax-Exempt
New York, NY 10022 Fund (since 1996); Trustee,
Age: 54 Excelsior Institutional
Trust and Excelsior Funds
(since 1994); Director,
Parsons Brinkerhoff Energy Services
Inc. (since 1996); Director, Parsons
Brinkerhoff, Inc. (engineering firm)
(since 1995); President, Mandrake Group
(investment and consulting firm) (since
1994); Director, Hyperion Total Return
Fund, Inc. and four other funds for
which Hyperion Capital Management, Inc.
</TABLE>
- ----------
/1./ This director is considered to be an "interested person" of Excelsior Fund
as defined in the 1940 Act.
-16-
<PAGE>
Position Principal Occupation
with During Past 5 Years and
Name and Address the Companies Other Affiliations
- ---------------- ------------- -----------------------
serves as investment adviser (since
1991); Co-Chairman, KMR Power
Corporation (power plants) (since
1993); Director, The Latin American
Growth Fund (since 1993); Member of
Advisory Board, Argentina Private
Equity Fund L.P. (from 1992 to 1996)
and Garantia L.P. (Brazil) (from 1993
to 1996); and Director, Mueller
Industries, Inc. (from 1992 to 1994).
Joseph H. Dugan Director Retired; Director of
913 Franklin Lakes Road Excelsior Fund and Excelsior
Franklin Lakes, NJ 07417 Tax-Exempt Fund (since 1984);
Age: 72 Director of UST Master
Variable Series, Inc.
(from 1994 to June 1997); and Trustee
of Excelsior Institutional Trust (since
1995).
Wolfe J. Frankl Director Retired; Director of
2320 Cumberland Road Excelsior Fund and Excelsior
Charlottesville, VA 22901 Tax-Exempt Fund (since 1986);
Age: 76 Director of UST Master
Variable Series, Inc. (from 1994 to
June 1997); Trustee of Excelsior
Institutional Trust (since 1995);
Director, Deutsche Bank Financial, Inc.
(since 1989); Director, The Harbus
Corporation (since 1951); and Trustee,
HSBC Funds Trust and HSBC Mutual Funds
Trust (since 1988).
W. Wallace McDowell, Jr. Director Director, Excelsior Fund
c/o Prospect Capital and Excelsior Tax-Exempt
Corp. Fund (since 1996); Trustee,
43 Arch Street Excelsior Institutional Trust
Greenwich, CT 06830 and Excelsior Funds
Age: 60 (since 1994); Private Investor
(since 1994); Managing Director,
Morgan Lewis Githens & Ahn (from 1991
to 1994); and Director, U.S. Homecare
Corporation (since 1992), Grossmans,
Inc. (from 1993 to 1996), Children's
Discovery Centers (since 1984), ITI
Technologies, Inc. (since 1992) and
Jack Morton Productions (since 1987).
-17-
<PAGE>
Position Principal Occupation
with During Past 5 Years and
Name and Address the Companies Other Affiliations
- ---------------- ------------- -----------------------
Jonathan Piel Director Director, Excelsior Fund and
558 E. 87th Street Excelsior Tax-Exempt Fund
New York, NY 10128 (since 1996); Trustee, Excelsior
Age: 58 Institutional Trust and
Excelsior Funds (since 1994);
Vice President and Editor, Scientific
American, Inc. (from 1986 to 1994);
Director, Group for The South Fork,
Bridgehampton, New York (since 1993);
and Member, Advisory Committee, Knight
Journalism Fellowships, Massachusetts
Institute of Technology (since 1984).
Robert A. Robinson Director Director of Excelsior Fund
Church Pension Fund and Excelsior Tax-Exempt Fund
800 Second Avenue (since 1987); Director of UST
New York, NY 10017 Master Variable Series, Inc.
Age: 71 (from 1994 to June 1997); Trustee of
Excelsior Institutional Trust
(since 1995); President Emeritus, The
Church Pension Fund and its affiliated
companies (since 1966); Trustee, H.B.
and F.H. Bugher Foundation and Director
of its wholly owned subsidiaries --
Rosiclear Lead and Flourspar Mining Co.
and The Pigmy Corporation (since 1984);
Director, Morehouse Publishing Co.
(since 1974); Trustee, HSBC Funds Trust
and HSBC Mutual Funds Trust (since
1982); and Director, Infinity Funds,
Inc. (since 1995).
Alfred C. Tannachion/1/ Director Retired; Director of
6549 Pine Meadows Drive Excelsior Fund and
Spring Hill, FL 34606 Excelsior Tax-Exempt Fund
Age: 71 (since 1985); Chairman
of the Board, President and Treasurer
of UST Master Variable Series, Inc.
(from 1994 to June 1997); and Trustee
of Excelsior Institutional Trust (since
1995).
- ----------
/1./ This director is considered to be an "interested person" of Excelsior Fund
as defined in the 1940 Act.
-18-
<PAGE>
Position Principal Occupation
with During Past 5 Years and
Name and Address the Companies Other Affiliations
- ---------------- ------------- -----------------------
W. Bruce McConnel, III Secretary Partner of the law firm of Drinker
Philadelphia National Biddle & Reath LLP.
Bank Building
1345 Chestnut Street
Philadelphia, PA 19107
Age: 54
Gregory Sackos Assistant Second Vice President, Senior
Chase Global Funds Secretary Manager of Blue Sky Compliance
Services Company and Financial Reporting, Chase
73 Tremont Street Global Funds Services Company
Boston, MA 02108-3913 (March 1997 to present); Second
Age: 32 Vice President, Senior Manager of
Financial Reporting, Chase Global Funds
Services Company (September 1996 to
March 1997); and Assistant Vice
President, Assistant Manager of
Financial Reporting, Scudder, Stevens &
Clark Inc. (October 1992 to September
1996).
John M. Corcoran Assistant Vice President, Director of
Chase Global Funds Treasurer Administration Client Group,
Services Company Chase Global Funds Services
73 Tremont Street Company (since July 1996);
Boston, MA 02108-3913 Second Vice President, Manager
Age: 32 of Administration, Chase Global Funds
Services Company (from October 1993
to July 1996); and Audit Manager,
Ernst & Young LLP (from August 1987 to
September 1993).
Each director receives an annual fee of $9,000 with respect to each
Company plus a per-Company meeting fee of $1,500 for each meeting attended and
is reimbursed for expenses incurred in attending meetings. The Chairman of the
Board is entitled to receive an additional $5,000 per annum with respect to each
Company for services in such capacity. Drinker Biddle & Reath LLP, of which Mr.
McConnel is a partner, receives legal fees as counsel to the Companies. The
employees of Chase Global Funds Services Company do not receive any compensation
from the Companies for acting as officers of the Companies. No person who is
currently an officer, director or employee of the Investment Adviser serves as
an officer, director or employee of the Companies. As of July 14, 1997, the
directors and officers of each Company as a group owned beneficially less than
1% of the outstanding shares of each fund of each Company, and less than 1% of
the outstanding shares of all funds of each Company in the aggregate.
-19-
<PAGE>
The following chart provides certain information about the fees
received by the Companies' directors in the most recently completed fiscal year.
Pension or
Retirement Total
Benefits Compensation
Accrued as from the Companies
Aggregate Part of and Fund
Name of Compensation from Fund Complex* Paid
Person/Position the Companies Expenses to Directors
--------------- ----------------- -------- ------------------
Donald L. Campbell $27,000 None $31,750 (4)**
Director
Rodman L. Drake*** $ 7,500 None $12,250 (4)**
Director
Joseph H. Dugan $30,000 None $35,000 (4)**
Director
Wolfe J. Frankl $30,000 None $35,000 (4)**
Director
W. Wallace McDowell, Jr.*** $ 4,500 None $ 9,250 (4)**
Director
Jonathan Piel*** $ 7,500 None $12,500 (4)**
Director
Robert A. Robinson $30,000 None $35,000 (4)**
Director
Alfred C. Tannachion**** $40,000 None $45,000 (4)**
Director
Frederick S. Wonham**** $30,000 None $35,000 (4)**
Chairman of the Board,
President and Treasurer
- ---------------------------
/*/ The "Fund Complex" consists of Excelsior Fund, Excelsior Tax-Exempt
Fund, UST Master Variable Series, Inc., Excelsior Funds and Excelsior
Institutional Trust.
/**/ Number of investment companies in the Fund Complex for which director
served as director or trustee.
/***/ Messrs. Drake, McDowell and Piel were elected to the Board of
Excelsior Fund and Excelsior Tax-Exempt Fund on December 9, 1996.
/****/ Mr. Tannachion served as the Companies' Chairman of the Board,
President and Treasurer until February 13, 1997. On that date, Mr.
Wonham was elected to serve as the
-20-
<PAGE>
Companies' Chairman of the Board, President and Treasurer.
Investment Advisory and Administration Agreements
- -------------------------------------------------
United States Trust Company of New York ("U.S. Trust New York") and
U.S. Trust Company of Connecticut ("U.S. Trust Connecticut" and, collectively
with U.S. Trust New York, "U.S. Trust" or the "Investment Adviser") serve as
Investment Adviser to the Funds. In the Investment Advisory Agreements, U.S.
Trust has agreed to provide the services described in the Prospectus. The
Investment Adviser has also agreed to pay all expenses incurred by it in
connection with its activities under the respective agreements other than the
cost of securities, including brokerage commissions, if any, purchased for the
Funds. See "Expenses" in the Prospectus.
Prior to May 16, 1997, U.S. Trust New York served as investment
adviser to the Funds pursuant to advisory agreements substantially similar to
the Investment Advisory Agreements currently in effect for the Funds.
For the fiscal year ended March 31, 1995, Excelsior Fund paid U.S.
Trust New York $1,781,897, $1,665,344 and $674,259 with respect to the Money,
Government Money and Treasury Money Funds, respectively. For the same period,
Excelsior Tax-Exempt Fund paid U.S. Trust New York $1,698,879 with respect to
the Tax-Exempt Money Fund. For the fiscal year ended March 31, 1995, the U.S.
Trust New York waived fees totalling $204,060, $173,321, $45,366 and $236,867
with respect to the Money, Government Money, Treasury Money and Tax-Exempt Money
Funds, respectively.
For the fiscal year ended March 31, 1996, Excelsior Fund paid U.S.
Trust New York $1,291,496, $1,224,338 and $621,988 with respect to the Money,
Government Money and Treasury Money Funds, respectively. For the same period,
Excelsior Tax-Exempt Fund paid U.S. Trust New York $1,745,649 with respect to
the Tax-Exempt Money Fund. For the fiscal year ended March 31, 1996, U.S. Trust
New York waived fees totalling $227,463, $172,140, $46,887 and $353,419 with
respect to the Money, Government Money, Treasury Money and Tax-Exempt Money
Funds, respectively.
For the fiscal year ended March 31, 1997, Excelsior Fund paid U.S.
Trust New York $810,101, $1,136,936 and $828,277 with respect to the Money,
Government Money and Treasury Money Funds, respectively. For the same period,
Excelsior Tax-Exempt Fund paid U.S. Trust New York $1,891,333 with respect to
the Tax-Exempt Money Fund. For the fiscal year ended March 31, 1997, U.S. Trust
New York waived fees totalling $215,132, $183,979, $79,008 and $502,764 with
respect to the Money, Government Money, Treasury Money and Tax-Exempt Money
Funds, respectively.
-21-
<PAGE>
The Investment Advisory Agreements provide that the Investment Adviser
shall not be liable for any error of judgment or mistake of law or for any loss
suffered by the Funds in connection with the performance of such agreements,
except that the Investment Adviser shall be jointly, but not severally, liable
for a loss resulting from a breach of fiduciary duty with respect to the receipt
of compensation for advisory services or a loss resulting from willful
misfeasance, bad faith or gross negligence on the part of the Investment Adviser
in the performance of its duties or from reckless disregard by it of its duties
and obligations thereunder. In addition, the Investment Adviser has undertaken
in the Investment Advisory Agreements to maintain its policy and practice of
conducting its Asset Management Group independently of its Banking Group.
Chase Global Funds Services Company ("CGFSC"), Federated
Administrative Services, an affiliate of the Distributor, and U.S. Trust
Connecticut (the "Administrators") serve as the Funds' administrators. Under
the Administration Agreements, the Administrators have agreed to maintain office
facilities for the Funds, furnish the Funds with statistical and research data,
clerical, accounting and bookkeeping services, and certain other services
required by the Funds, and to compute the net asset value, net income, "exempt-
interest dividends," and realized capital gains or losses, if any, of the
respective Funds. The Administrators prepare semiannual reports to the SEC,
prepare Federal and state tax returns, prepare filings with state securities
commissions, arrange for and bear the cost of processing Share purchase and
redemption orders, maintain the Funds' financial accounts and records, and
generally assist in the Funds' operations.
Prior to May 16, 1997, CGFSC, Federated Administrative Services and
U.S. Trust New York served as the Funds' administrators pursuant to an
administrative agreement substantially similar to the Administration Agreements
currently in effect for the Funds. Prior to August 1, 1995, administrative
services were provided to the Funds by CGFSC and Concord Holding Corporation
(collectively, the "former administrators") under administration agreements
having substantially the same terms as the Administration Agreements currently
in effect.
For the fiscal year ended March 31, 1995, Excelsior Fund paid the
former administrators $1,223,349, $1,131,530 and $369,056 in the aggregate with
respect to the Money Fund, Government Money Fund and Treasury Money Fund,
respectively. For the same period, Excelsior Tax-Exempt Fund paid the former
administrators $1,193,896 in the aggregate with respect to the Tax-Exempt Money
Fund. For the fiscal year ended March 31, 1995, the former administrators
waived fees totalling $1,087 and $351 with respect to the Government Money and
Treasury Money Funds, respectively.
-22-
<PAGE>
For the period April 1, 1995 through July 31, 1995, Excelsior Fund
paid the former administrators $450,305, $403,443 and $107,685 in the aggregate
with respect to the Money Fund, Government Money Fund and Treasury Money Fund,
respectively. For the same period, Excelsior Tax-Exempt Fund paid the former
administrators $407,281 in the aggregate with respect to the Tax-Exempt Money
Fund. For the period April 1, 1995 through July 31, 1995, the former
administrators waived fees totalling $135 with respect to the Government Money
Fund.
For the period August 1, 1995 through March 31, 1996, Excelsior Fund
paid CGFSC, Federated Administrative Services and U.S. Trust New York $487,151,
$457,681, and $236,672 in the aggregate with respect to the Money Fund,
Government Money Fund and Treasury Money Fund, respectively. For the same
period, Excelsior Tax-Exempt Fund paid CGFSC, Federated Administrative Services
and U.S. Trust New York $889,555 in the aggregate with respect to the Tax-Exempt
Money Fund. For the period August 1, 1995 through March 31, 1996, CGFSC,
Federated Administrative Services and U.S. Trust New York waived fees totalling
$705 with respect to the Government Money Fund.
For the fiscal year ended March 31, 1997, Excelsior Fund paid CGFSC,
Federated Administrative Services and U.S. Trust New York $630,623, $811,988 and
$464,931 in the aggregate with respect to the Money Fund, Government Money Fund
and Treasury Money Fund, respectively. For the same period, Excelsior Tax-
Exempt Fund paid CGFSC, Federated Administrative Services and U.S. Trust New
York $1,472,582 in the aggregate with respect to the Tax-Exempt Money Fund. For
the fiscal year ended March 31, 1997, CGFSC, Federated Administrative Services
and U.S. Trust New York waived fees totalling $8 and $256 with respect to the
Money and Government Money Funds, respectively.
Shareholder Organizations
- -------------------------
As stated in the Prospectus, each Company has entered into agreements
with Shareholder Organizations. Such agreements require the Shareholder
Organizations to provide shareholder administrative services to their Customers
who beneficially own Shares in consideration for a Fund's payment of not more
than the annual rate of .40% of the average daily net assets of the Fund's
Shares beneficially owned by Customers of the Shareholder Organization. Such
services may include: (a) acting as recordholder of Shares; (b) assisting in
processing purchase, exchange and redemption transactions; (c) providing
periodic statements showing a Customer's account balances and confirmations of
transactions by the Customer; (d) providing tax and dividend information to
shareholders as appropriate; (e) transmitting proxy statements, annual reports,
updated prospectuses and other communications from the Companies to
-23-
<PAGE>
Customers; and (f) providing or arranging for the provision of other related
services.
The Companies' agreements with Shareholder Organizations are governed
by Administrative Services Plans (the "Plans") adopted by the Companies.
Pursuant to the Plans, each Company's Board of Directors will review, at least
quarterly, a written report of the amounts expended under the Company's
agreements with Shareholder Organizations and the purposes for which the
expenditures were made. In addition, the arrangements with Shareholder
Organizations will be approved annually by a majority of each Company's
directors, including a majority of the directors who are not "interested
persons" of the Company as defined in the 1940 Act and have no direct or
indirect financial interest in such arrangements (the "Disinterested
Directors").
Any material amendment to a Company's arrangements with Shareholder
Organizations must be approved by a majority of the Company's Board of Directors
(including a majority of the Disinterested Directors). So long as the
Companies' arrangements with Shareholder Organizations are in effect, the
selection and nomination of the members of the Companies' Boards of Directors
who are not "interested persons" (as defined in the 1940 Act) of the Companies
will be committed to the discretion of such Disinterested Directors.
For the fiscal years ended March 31, 1997, 1996 and 1995, payments to
Shareholder Organizations totalled $215,140, $227,463 and $204,060; $184,235,
$172,980 and $174,408; $79,008, $46,887 and $45,717; and $502,764, $353,419 and
$236,867 with respect to the Money, Government Money, Treasury Money and Tax-
Exempt Money Funds, respectively. Of these respective amounts, $215,090,
$227,463 and $203,572; $182,579, $168,064 and $171,257; $79,008, $46,887 and
$44,596; and $502,764, $353,419 and $236,399 were paid to affiliates of U.S.
Trust with respect to the Money, Government Money, Treasury Money and Tax-Exempt
Money Funds, respectively.
Expenses
- --------
Except as otherwise noted, the Investment Adviser and the
Administrators bear all expenses in connection with the performance of their
services. The Funds bear the expenses incurred in their operations. Expenses of
the Funds include taxes; interest; fees (including fees paid to the Companies'
directors and officers who are not affiliated with the Distributor or the
Administrators); SEC fees; state securities qualifications fees; costs of
preparing and printing prospectuses for regulatory purposes and for distribution
to shareholders; advisory, administration and administrative servicing fees;
charges of the custodian, transfer agent, and dividend disbursing agent; certain
insurance premiums; outside auditing and legal
-24-
<PAGE>
expenses; cost of independent pricing services; costs of shareholder reports and
shareholder meetings; and any extraordinary expenses. The Funds also pay for
brokerage fees and commissions in connection with the purchase of portfolio
securities.
Custodian and Transfer Agent
- ----------------------------
The Chase Manhattan Bank ("Chase") serves as custodian of the Funds'
assets. Under the Custodian Agreements, Chase has agreed to (i) maintain a
separate account or accounts in the name of the Funds; (ii) make receipts and
disbursements of money on behalf of the Funds; (iii) collect and receive all
income and other payments and distributions on account of the Funds' portfolio
securities; (iv) respond to correspondence from securities brokers and others
relating to its duties; (v) maintain certain financial accounts and records; and
(vi) make periodic reports to each Company's Board of Directors concerning the
Funds' operations. Chase may, at its own expense, open and maintain custody
accounts with respect to the Funds with other banks or trust companies, provided
that Chase shall remain liable for the performance of all its custodial duties
under the Custodian Agreements, notwithstanding any delegation.
U.S. Trust New York serves as the Funds' transfer agent and dividend
disbursing agent. In such capacity, U.S. Trust New York has agreed to (i) issue
and redeem Shares; (ii) address and mail all communications by the Funds to
their shareholders, including reports to shareholders, dividend and distribution
notices, and proxy materials for its meetings of shareholders; (iii) respond to
correspondence by shareholders and others relating to its duties; (iv) maintain
shareholder accounts; and (v) make periodic reports to each Company's Board of
Directors concerning the Funds' operations. For its transfer agency, dividend
disbursing, and subaccounting services, U.S. Trust New York is entitled to
receive $15.00 per annum per account and subaccount. In addition, U.S. Trust
New York is entitled to be reimbursed for its out-of-pocket expenses for the
cost of forms, postage, processing purchase and redemption orders, handling of
proxies, and other similar expenses in connection with the above services.
U.S. Trust New York may, at its own expense, delegate its transfer
agency obligations to another transfer agent registered or qualified under
applicable law, provided that U.S. Trust New York shall remain liable for the
performance of all of its transfer agency duties under the Transfer Agency
Agreements, notwithstanding any delegation. Pursuant to this provision in the
agreement, U.S. Trust New York has entered into a sub-transfer agency
arrangement with CGFSC, an affiliate of Chase, with respect to accounts of
shareholders who are not Customers of U.S. Trust New York. For the services
provided by CGFSC, U.S.
-25-
<PAGE>
Trust New York has agreed to pay CGFSC $15.00 per annum per account or
subaccount plus out-of-pocket expenses. CGFSC receives no fee directly from the
Companies for any of its sub-transfer agency services. U.S. Trust New York may,
from time to time, enter into sub-transfer agency arrangements with third party
providers of transfer agency services.
PORTFOLIO TRANSACTIONS
----------------------
Subject to the general control of the Companies' Boards of Directors,
the Investment Adviser is responsible for, makes decisions with respect to, and
places orders for all purchases and sales of all portfolio securities of each of
the Funds.
The Funds do not intend to seek profits from short-term trading.
Their annual portfolio turnover will be relatively high, but brokerage
commissions are not normally paid on money market instruments, and portfolio
turnover is not expected to have a material effect on the net income of the
Funds.
Securities purchased and sold by the Funds are generally traded in the
over-the-counter market on a net basis (i.e., without commission) through
dealers, or otherwise involve transactions directly with the issuer of an
instrument. The cost of securities purchased from underwriters includes an
underwriting commission or concession, and the prices at which securities are
purchased from and sold to dealers include a dealer's mark-up or mark-down.
With respect to over-the-counter transactions, the Funds, where possible, will
deal directly with the dealers who make a market in the securities involved,
except in those circumstances where better prices and execution are available
elsewhere.
The Investment Advisory Agreements between the Companies and the
Investment Adviser provide that, in executing portfolio transactions and
selecting brokers or dealers, the Investment Adviser will seek to obtain the
best net price and the most favorable execution. The Investment Adviser shall
consider factors it deems relevant, including the breadth of the market in the
security, the price of the security, the financial condition and execution
capability of the broker or dealer and whether such broker or dealer is selling
shares of the Companies, and the reasonableness of the commission, if any, for
the specific transaction and on a continuing basis.
In addition, the Investment Advisory Agreements authorize the
Investment Adviser, to the extent permitted by law and subject to the review of
the Companies' Boards of Directors from time to time with respect to the extent
and continuation of the policy, to cause the Funds to pay a broker which
furnishes
-26-
<PAGE>
brokerage and research services a higher commission than that which might be
charged by another broker for effecting the same transaction, provided that the
Investment Adviser determines in good faith that such commission is reasonable
in relation to the value of the brokerage and research services provided by such
broker, viewed in terms of either that particular transaction or the overall
responsibilities of the Investment Adviser to the accounts as to which it
exercises investment discretion. Such brokerage and research services might
consist of reports and statistics on specific companies or industries, general
summaries of groups of stocks and their comparative earnings, or broad overviews
of the stock market and the economy.
Supplementary research information so received is in addition to and
not in lieu of services required to be performed by the Investment Adviser and
does not reduce the investment advisory fees payable by the Funds. Such
information may be useful to the Investment Adviser in serving the Funds and
other clients and, conversely, supplemental information obtained by the
placement of business of other clients may be useful to the Investment Adviser
in carrying out its obligations to the Funds.
Portfolio securities will not be purchased from or sold to the
Investment Adviser, the Distributor, or any affiliated person of either of them
(as such term is defined in the 1940 Act) acting as principal, except to the
extent permitted by the Securities and Exchange Commission.
Investment decisions for the Funds are made independently from those
for other investment companies, common trust funds and other types of funds
managed by the Investment Adviser. Such other investment companies and funds
may also invest in the same securities as the Funds. When a purchase or sale of
the same security is made at substantially the same time on behalf of the Funds
and another investment company or common trust fund, the transaction will be
averaged as to price, and available investments allocated as to amount, in a
manner which the Investment Adviser believes to be equitable to the Funds and
such other investment company or common trust fund. In some instances, this
investment procedure may adversely affect the price paid or received by the
Funds or the size of the position obtained by the Funds. To the extent
permitted by law, the Investment Adviser may aggregate the securities to be sold
or purchased for the Funds with those to be sold or purchased for other
investment companies or common trust funds in order to obtain best execution.
The Companies are required to identify any securities of their regular
brokers or dealers (as defined in Rule 10b-1 under the 1940 Act) or their
parents held by the Funds as of the close of the most recent fiscal year. As of
March 31, 1997, the following Funds held the following securities of Excelsior
Fund's
-27-
<PAGE>
or Excelsior Tax-Exempt Fund's regular brokers or dealers or their parents: (a)
the Money Fund held the following securities: repurchase agreement with Dillon
Read & Co., Inc. in the principal amount of $13,804,749, and commercial paper of
Bear Stearns Co., Inc. in the principal amount of $15,000,000; and (b) the
Government Money Fund held the following security: repurchase agreement with
Dillon Read & Co., Inc. in the principal amount of $14,127,127. Dillon Read &
Co., Inc. and Bear Stearns Co., Inc. are considered to be regular brokers or
dealers of Excelsior Fund.
INDEPENDENT AUDITORS
--------------------
Ernst & Young LLP, independent auditors, 200 Clarendon Street, Boston,
MA 02116, serve as auditors of the Companies. The Funds' Financial Highlights
included in the Prospectus and the financial statements for the period ended
March 31, 1997 incorporated by reference in this Statement of Additional
Information have been audited by Ernst & Young LLP for the periods included in
their reports thereon which appear therein.
COUNSEL
-------
Drinker Biddle & Reath LLP (of which Mr. McConnel, Secretary of the
Companies, is a partner), Philadelphia National Bank Building, 1345 Chestnut
Street, Philadelphia, Pennsylvania 19107, is counsel to the Companies, and will
pass upon the legality of the Shares offered by the Prospectus.
ADDITIONAL INFORMATION CONCERNING TAXES
---------------------------------------
Generally
- ---------
The following supplements the tax information contained in the
Prospectus.
Each of the Funds is treated as a separate corporate entity under the
Internal Revenue Code of 1986, as amended (the "Code"), and intends to qualify
as a regulated investment company. If, for any reason, a Fund does not qualify
for a taxable year for the special Federal tax treatment afforded regulated
investment companies, such Fund would be subject to Federal tax on all of its
taxable income at regular corporate rates, without any deduction for
distributions to shareholders. In such event, dividend distributions (whether
or not derived from interest on Municipal Securities) would be taxable as
ordinary income to shareholders to the extent of the Fund's current and
accumulated earnings and profits and would be
-28-
<PAGE>
eligible for the dividends received deduction in the case of corporate
shareholders.
A 4% non-deductible excise tax is imposed on regulated investment
companies that fail to currently distribute an amount equal to specified
percentages of their ordinary taxable income and capital gain net income (excess
of capital gains over capital losses). The Funds intend to make sufficient
distributions or deemed distributions of their ordinary taxable income and any
capital gain net income prior to the end of each calendar year to avoid
liability for this excise tax.
Each Fund will be required in certain cases to withhold and remit to
the U.S. Treasury 31% of taxable dividends paid to shareholders who have failed
to provide a correct tax identification number in the manner required, who are
subject to withholding by the Internal Revenue Service for failure properly to
include on their return payments of taxable interest or dividends, or who have
failed to certify to the Fund when required to do so either that they are not
subject to backup withholding or that they are "exempt recipients."
Tax-Exempt Money Fund
- ---------------------
The Tax-Exempt Money Fund is not intended to constitute a balanced
investment program and is not designed for investors seeking capital
appreciation or maximum tax-exempt income irrespective of fluctuations in
principal. Shares of the Tax-Exempt Money Fund would not be suitable for tax-
exempt institutions and may not be suitable for retirement plans qualified under
Section 401 of the Code, H.R. 10 plans and individual retirement accounts
because such plans and accounts are generally tax-exempt and, therefore, not
only would not gain any additional benefit from the Tax-Exempt Money Fund
dividends being tax-exempt, but such dividends would be ultimately taxable to
the beneficiaries when distributed to them. In addition, the Tax-Exempt Money
Fund may not be an appropriate investment for entities which are "substantial
users" of facilities financed by private activity bonds or "related persons"
thereof. "Substantial user" is defined under the Treasury Regulations to include
a non-exempt person who regularly uses a part of such facilities in his trade or
business and whose gross revenues derived with respect to the facilities
financed by the issuance of bonds are more than 5% of the total revenues derived
by all users of such facilities, who occupies more than 5% of the usable area of
such facilities or for whom such facilities or a part thereof were specifically
constructed, reconstructed or acquired. "Related persons" include certain
related natural persons, affiliated corporations, a partnership and its partners
and an S Corporation and its shareholders.
-29-
<PAGE>
In order for the Tax-Exempt Money Fund to pay exempt-interest
dividends for any taxable year, at least 50% of the aggregate value of the
Fund's portfolio must consist of exempt-interest obligations at the close of
each quarter of its taxable year. Within 60 days after the close of the taxable
year, the Tax-Exempt Money Fund will notify its shareholders of the portion of
the dividends paid by the Fund which constitutes an exempt-interest dividend
with respect to such taxable year. However, the aggregate amount of dividends
so designated by the Tax-Exempt Money Fund cannot exceed the excess of the
amount of interest exempt from tax under Section 103 of the Code received by the
Tax-Exempt Money Fund during the taxable year over any amounts disallowed as
deductions under Sections 265 and 171(a)(2) of the Code. The percentage of
total dividends paid by the Tax-Exempt Money Fund with respect to any taxable
year which qualifies as exempt-interest dividends will be the same for all
shareholders receiving dividends from the Tax-Exempt Money Fund for such year.
Interest on indebtedness incurred by a shareholder to purchase or
carry the Tax-Exempt Money Fund's Shares generally is not deductible for Federal
income tax purposes.
Excelsior Tax-Exempt Fund intends to distribute to shareholders of the
Tax-Exempt Money Fund any investment company taxable income earned by the Tax-
Exempt Money Fund for each taxable year. In general, the Tax-Exempt Money
Fund's investment company taxable income will be its taxable income (including
taxable interest and short-term capital gains) subject to certain adjustments
and excluding the excess of any net long-term capital gain for the taxable year
over the net short-term capital loss, if any, for such year. Such distributions
will be taxable to the shareholders as ordinary income (whether paid in cash or
additional Shares).
* * *
The foregoing discussion is based on Federal tax laws and regulations
which are in effect on the date of this Statement of Additional Information;
such laws and regulations may be changed by legislative or administrative
action. Shareholders are advised to consult their tax advisers concerning their
specific situations and the application of state and local taxes.
YIELD INFORMATION
-----------------
The standardized annualized seven-day yields for the Shares of the
Funds are computed separately by determining the net change, exclusive of
capital changes, in the value of a hypothetical pre-existing account in the Fund
involved, having a balance of one Share at the beginning of the period, dividing
the
-30-
<PAGE>
net change in account value by the value of the account at the beginning of the
period to obtain the base period return, and multiplying the base period return
by (365/7). The net change in the value of an account in each of the Funds
includes the value of additional Shares purchased with dividends from the
original Share and dividends declared on both the original Share and any such
additional Shares, net of all fees that are charged to all shareholder accounts
and to the particular series of Shares in proportion to the length of the base
period, other than nonrecurring account or any sales charges. For any account
fees that vary with the size of the account, the amount of fees charged is
computed with respect to the Fund's mean (or median) account size. The capital
changes to be excluded from the calculation of the net change in account value
are realized gains and losses from the sale of securities and unrealized
appreciation and depreciation. In addition, each Fund may use effective
compound yield quotations for its Shares computed by adding 1 to the
unannualized base period return (calculated as described above), raising the
sums to a power equal to 365 divided by 7, and subtracting 1 from the results.
From time to time, in advertisements, sales literature or in reports
to shareholders, the yields of each Money Market Fund's Shares may be quoted and
compared to those of other mutual funds with similar investment objectives and
to stock or other relevant indices. For example, the yield of such a Fund's
Shares may be compared to the Donoghue's Money Fund average, which is an average
compiled by Donoghue's MONEY FUND REPORT of Holliston, MA 01746, a widely
recognized independent publication that monitors the performance of money market
funds, or to the data prepared by Lipper Analytical Services, Inc., a widely
recognized independent service that monitors the performance of mutual funds.
Advertisements, sales literature or reports to shareholders may from time to
time also include a discussion and analysis of each Fund's performance,
including without limitation, those factors, strategies and techniques that,
together with market conditions and events, materially affected each Fund's
performance.
The current yields for the Funds' Shares may be obtained by calling
(800) 446-1012. For the seven-day period ended March 31, 1997, the annualized
yields for Shares of the Money Fund, Government Money Fund, Treasury Money Fund
and Tax-Exempt Money Fund were 5.26%, 5.24%, 4.70% and 2.99%, respectively, and
the effective yields for Shares of such respective Funds were 5.39%, 5.38%,
4.81% and 3.03%.
The "tax-equivalent" yield of the Tax-Exempt Money Fund is computed
by: (a) dividing the portion of the yield (calculated as above) that is exempt
from Federal income tax by one minus a stated Federal income tax rate and (b)
adding that figure to that portion, if any of the yield that is not exempt
-31-
<PAGE>
from Federal income tax. Tax-equivalent yields assume the payment of Federal
income taxes at a rate of 31%.
Based on the foregoing calculation, the annualized tax-equivalent
yield of the Tax-Exempt Money Fund for the seven-day period ended March 31, 1997
was 4.39%.
MISCELLANEOUS
-------------
As used in the Prospectus, "assets belonging to a Fund" means the
consideration received upon the issuance of Shares in the Fund, together with
all income, earnings, profits, and proceeds derived from the investment thereof,
including any proceeds from the sale of such investments, any funds or payments
derived from any reinvestment of such proceeds, and a portion of any general
assets of the Company involved not belonging to a particular portfolio of that
Company. In determining the net asset value of a Fund's Shares, assets
belonging to the Fund are charged with the direct liabilities in respect of that
Fund and with a share of the general liabilities of the Company involved which
are normally allocated in proportion to the relative asset values of the
Company's portfolios at the time of allocation. Subject to the provisions of
the Companies' Charters, determinations by the Boards of Directors as to the
direct and allocable liabilities, and the allocable portion of any general
assets with respect to a particular Fund, are conclusive.
As of July 14, 1997, U.S. Trust and its affiliates held of record
substantially all of the Companies' outstanding shares as agent or custodian for
their customers, but did not own such shares beneficially because they did not
have voting or investment discretion with respect to such shares.
As of July 14, 1997, the name, address and percentage ownership of
each person that beneficially owned 5% or more of the outstanding Shares of a
Fund were as follows: (i) Treasury Money Market Fund: Robert F. Mancuso, c/o
--------------------------
United States Trust Company of New York, 114 West 47th Street, New York, New
York 10036, 9.57%; and (ii) Government Money Fund: Sync Corp., c/o United
---------------------
States Trust Company of New York, 114 West 47th Street, New York, New York
10036, 6.42%; H. Peter Dooney, c/o United States Trust Company of New York, 114
West 47th Street, New York, New York 10036, 5.12%; and Siemens Sinking Fund
Account, c/o United States Trust Company of New York, 114 West 47th Street, New
York, New York 10036, 10.60%.
FINANCIAL STATEMENTS
--------------------
The audited financial statements and notes thereto in the Companies'
Annual Reports to Shareholders for the fiscal year
-32-
<PAGE>
ended March 31, 1997 (the "1997 Annual Reports") for the Funds are incorporated
in this Statement of Additional Information by reference. No other parts of the
1997 Annual Reports are incorporated by reference herein. The financial
statements included in the 1997 Annual Reports for the Money, Government Money,
Treasury Money and Tax-Exempt Money Funds have been audited by the Companies'
independent auditors, Ernst & Young LLP, whose reports thereon also appear in
the 1997 Annual Reports and are incorporated herein by reference. Such
financial statements have been incorporated herein in reliance upon such reports
given upon the authority of such firm as experts in accounting and auditing.
Additional copies of the 1997 Annual Reports may be obtained at no charge by
telephoning CGFSC at the telephone number appearing on the front page of this
Statement of Additional Information.
-33-
<PAGE>
APPENDIX A
----------
COMMERCIAL PAPER RATINGS
- ------------------------
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment of debt considered short-term in the relevant
market. The following summarizes the rating categories used by Standard and
Poor's for commercial paper:
"A-1" - The highest category indicates that the degree of safety
regarding timely payment is strong. Those issues determined to possess
extremely strong safety characteristics are denoted with a plus sign (+)
designation.
"A-2" - Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated "A-1."
"A-3" - Issues carrying this designation have adequate capacity for
timely payment. They are, however, more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
"B" - Issues are regarded as having only a speculative capacity for
timely payment.
"C" - This rating is assigned to short-term debt obligations with a
doubtful capacity for payment.
"D" - Issues are in payment default.
Moody's commercial paper ratings are opinions of the ability of
issuers to repay punctually promissory obligations not having an original
maturity in excess of 9 months. The following summarizes the rating categories
used by Moody's for commercial paper:
"Prime-1" - Issuers or related supporting institutions have a superior
capacity for repayment of short-term promissory obligations. Prime-1 repayment
capacity will normally be evidenced by the following characteristics: leading
market positions in well established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on debt
and ample asset protection; broad margins in earning coverage of fixed financial
charges and high internal cash generation; and well established access to a
range of financial markets and assured sources of alternate liquidity.
A-1
<PAGE>
"Prime-2" - Issuers or related supporting institutions have a strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternative liquidity is maintained.
"Prime-3" - Issuers or related supporting institutions have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuers do not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps for investment grade
commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps
employs three designations, "D-1+," "D-1" and "D-1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
"D-1+" - Debt possesses highest certainty of timely payment. Short-
term liquidity, including internal operating factors and/or access to
alternative sources of funds, is outstanding, and safety is just below risk-free
U.S. Treasury short-term obligations.
"D-1" - Debt possesses very high certainty of timely payment.
Liquidity factors are excellent and supported by good fundamental protection
factors. Risk factors are minor.
"D-1-" - Debt possesses high certainty of timely payment. Liquidity
factors are strong and supported by good fundamental protection factors. Risk
factors are very small.
"D-2" - Debt possesses good certainty of timely payment. Liquidity
factors and company fundamentals are sound. Although ongoing funding needs may
enlarge total financing requirements, access to capital markets is good. Risk
factors are small.
"D-3" - Debt possesses satisfactory liquidity and other protection
factors qualify issue as investment grade. Risk
A-2
<PAGE>
factors are larger and subject to more variation. Nevertheless, timely payment
is expected.
"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to ensure against disruption in debt service.
Operating factors and market access may be subject to a high degree of
variation.
"D-5" - Issuer has failed to meet scheduled principal and/or interest
payments.
Fitch short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years. The
following summarizes the rating categories used by Fitch for short-term
obligations:
"F-1+" - Securities possess exceptionally strong credit quality.
Issues assigned this rating are regarded as having the strongest degree of
assurance for timely payment.
"F-1" - Securities possess very strong credit quality. Issues
assigned this rating reflect an assurance of timely payment only slightly less
in degree than issues rated "F-1+."
"F-2" - Securities possess good credit quality. Issues assigned this
rating have a satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as the "F-1+" and "F-1" ratings.
"F-3" - Securities possess fair credit quality. Issues assigned this
rating have characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause these
securities to be rated below investment grade.
"F-S" - Securities possess weak credit quality. Issues assigned this
rating have characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial and
economic conditions.
"D" - Securities are in actual or imminent payment default.
Fitch may also use the symbol "LOC" with its short-term ratings to
indicate that the rating is based upon a letter of credit issued by a commercial
bank.
Thomson BankWatch short-term ratings assess the likelihood of an
untimely or incomplete payment of principal or interest of unsubordinated
instruments having a maturity of one
A-3
<PAGE>
year or less which are issued by United States commercial banks, thrifts and
non-bank banks; non-United States banks; and broker-dealers. The following
summarizes the ratings used by Thomson BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's highest
rating category and indicates a very high degree of likelihood that principal
and interest will be paid on a timely basis.
"TBW-2" - This designation indicates that while the degree of safety
regarding timely payment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated "TBW-1."
"TBW-3" - This designation represents the lowest investment grade
category and indicates that while the debt is more susceptible to adverse
developments (both internal and external) than obligations with higher ratings,
capacity to service principal and interest in a timely fashion is considered
adequate.
"TBW-4" - This designation indicates that the debt is regarded as non-
investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an
original maturity of less than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for short-term debt ratings:
"A1+" - Obligations which posses a particularly strong credit feature
are supported by the highest capacity for timely repayment.
"A1" - Obligations are supported by the highest capacity for timely
repayment.
"A2" - Obligations are supported by a good capacity for timely
repayment.
"A3" - Obligations are supported by a satisfactory capacity for timely
repayment.
"B" - Obligations for which there is an uncertainty as to the capacity
to ensure timely repayment.
"C" - Obligations for which there is a high risk of default or which
are currently in default.
A-4
<PAGE>
CORPORATE AND MUNICIPAL LONG-TERM DEBT RATINGS
- ----------------------------------------------
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"AAA" - This designation represents the highest rating assigned by
Standard & Poor's to a debt obligation and indicates an extremely strong
capacity to pay interest and repay principal.
"AA" - Debt is considered to have a very strong capacity to pay
interest and repay principal and differs from AAA issues only in small degree.
"A" - Debt is considered to have a strong capacity to pay interest and
repay principal although such issues are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher-rated categories.
"BBB" - Debt is regarded as having an adequate capacity to pay
interest and repay principal. Whereas such issues normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher-rated categories.
"BB," "B," "CCC," "CC" and "C" - Debt is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. "BB" indicates the
lowest degree of speculation and "C" the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
"BB" - Debt has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-" rating.
"B" - Debt has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The "B" rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied "BB" or "BB-" rating.
A-5
<PAGE>
"CCC" - Debt has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The "CCC" rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
"B" or "B-" rating.
"CC" - This rating is typically applied to debt subordinated to senior
debt that is assigned an actual or implied "CCC" rating.
"C" - This rating is typically applied to debt subordinated to senior
debt which is assigned an actual or implied "CCC-" debt rating. The "C" rating
may be used to cover a situation where a bankruptcy petition has been filed, but
debt service payments are continued.
"CI" - This rating is reserved for income bonds on which no interest
is being paid.
"D" - Debt is in payment default. This rating is used when interest
payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S & P believes that such
payments will be made during such grace period. "D" rating is also used upon
the filing of a bankruptcy petition if debt service payments are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC" may be
modified by the addition of a plus or minus sign to show relative standing
within the major rating categories.
"r" - This rating is attached to highlight derivative, hybrid, and
certain other obligations that S & P believes may experience high volatility or
high variability in expected returns due to non-credit risks. Examples of such
obligations are: securities whose principal or interest return is indexed to
equities, commodities, or currencies; certain swaps and options; and interest
only and principal only mortgage securities. The absence of an "r" symbol
should not be taken as an indication that an obligation will exhibit no
volatility or variability in total return.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"Aaa" - Bonds are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements
are
A-6
<PAGE>
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
"Aa" - Bonds are judged to be of high quality by all standards.
Together with the "Aaa" group they comprise what are generally known as high-
grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in "Aaa" securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in "Aaa"
securities.
"A" - Bonds possess many favorable investment attributes and are to be
considered as upper medium-grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
"Baa" - Bonds considered medium-grade obligations, i.e., they are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great length of time.
Such bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
"Ba," "B," "Caa," "Ca," and "C" - Bonds that possess one of these
ratings provide questionable protection of interest and principal ("Ba"
indicates some speculative elements; "B" indicates a general lack of
characteristics of desirable investment; "Caa" represents a poor standing; "Ca"
represents obligations which are speculative in a high degree; and "C"
represents the lowest rated class of bonds). "Caa," "Ca" and "C" bonds may be in
default.
Con. (---) - Bonds for which the security depends upon the completion
of some act or the fulfillment of some condition are rated conditionally. These
are bonds secured by (a) earnings of projects under construction, (b) earnings
of projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
(P)... - When applied to forward delivery bonds, indicates that the
rating is provisional pending delivery of the bonds. The rating may be revised
prior to delivery if changes occur in the legal documents or the underlying
credit quality of the bonds.
A-7
<PAGE>
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's
believes possess the strongest investment attributes are designated by the
symbols, Aa1, A1, Baa1, Ba1 and B1.
The following summarizes the long-term debt ratings used by Duff &
Phelps for corporate and municipal long-term debt:
"AAA" - Debt is considered to be of the highest credit quality. The
risk factors are negligible, being only slightly more than for risk-free U.S.
Treasury debt.
"AA" - Debt is considered of high credit quality. Protection factors
are strong. Risk is modest but may vary slightly from time to time because of
economic conditions.
"A" - Debt possesses protection factors which are average but
adequate. However, risk factors are more variable and greater in periods of
economic stress.
"BBB" - Debt possesses below average protection factors but such
protection factors are still considered sufficient for prudent investment.
Considerable variability in risk is present during economic cycles.
"BB," "B," "CCC," "DD," and "DP" - Debt that possesses one of these
ratings is considered to be below investment grade. Although below investment
grade, debt rated "BB" is deemed likely to meet obligations when due. Debt
rated "B" possesses the risk that obligations will not be met when due. Debt
rated "CCC" is well below investment grade and has considerable uncertainty as
to timely payment of principal, interest or preferred dividends. Debt rated
"DD" is a defaulted debt obligation, and the rating "DP" represents preferred
stock with dividend arrearages.
To provide more detailed indications of credit quality, the "AA," "A,"
"BBB," "BB" and "B" ratings may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within these major categories.
The following summarizes the highest four ratings used by Fitch for
corporate and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably foreseeable
events.
"AA" - Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong
A-8
<PAGE>
as bonds rated "AAA." Because bonds rated in the "AAA" and "AA" categories are
not significantly vulnerable to foreseeable future developments, short-term debt
of these issuers is generally rated "F-1+."
"A" - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
To provide more detailed indications of credit quality, the Fitch
ratings from and including "AA" to "BBB" may be modified by the addition of a
plus (+) or minus (-) sign to show relative standing within these major rating
categories.
IBCA assesses the investment quality of unsecured debt with an
original maturity of more than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for long-term debt ratings:
"AAA" - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial, such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk substantially.
"AA" - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial, such that adverse changes in business, economic or financial
conditions may increase investment risk, albeit not very significantly.
"A" - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is strong,
although adverse changes in business, economic or financial conditions may lead
to increased investment risk.
"BBB" - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of
A-9
<PAGE>
principal and interest is adequate, although adverse changes in business,
economic or financial conditions are more likely to lead to increased investment
risk than for obligations in other categories.
"BB," "B," "CCC," "CC," and "C" - Obligations are assigned one of
these ratings where it is considered that speculative characteristics are
present. "BB" represents the lowest degree of speculation and indicates a
possibility of investment risk developing. "C" represents the highest degree of
speculation and indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating below
"AAA" to denote relative status within major rating categories.
Thomson BankWatch assesses the likelihood of an untimely repayment of
principal or interest over the term to maturity of long term debt and preferred
stock which are issued by United States commercial banks, thrifts and non-bank
banks; non-United States banks; and broker-dealers. The following summarizes
the rating categories used by Thomson BankWatch for long-term debt ratings:
"AAA" - This designation represents the highest category assigned by
Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is extremely high.
"AA" - This designation indicates a very strong ability to repay
principal and interest on a timely basis with limited incremental risk compared
to issues rated in the highest category.
"A" - This designation indicates that the ability to repay principal
and interest is strong. Issues rated "A" could be more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
"BBB" - This designation represents Thomson BankWatch's lowest
investment grade category and indicates an acceptable capacity to repay
principal and interest. Issues rated "BBB" are, however, more vulnerable to
adverse developments (both internal and external) than obligations with higher
ratings.
"BB," "B," "CCC," and "CC," - These designations are assigned by
Thomson BankWatch to non-investment grade long-term debt. Such issues are
regarded as having speculative characteristics regarding the likelihood of
timely payment of
A-10
<PAGE>
principal and interest. "BB" indicates the lowest degree of speculation and
"CC" the highest degree of speculation.
"D" - This designation indicates that the long-term debt is in
default.
PLUS (+) OR MINUS (-) - The ratings from "AAA" through "CC" may
include a plus or minus sign designation which indicates where within the
respective category the issue is placed.
MUNICIPAL NOTE RATINGS
- ----------------------
A Standard and Poor's rating reflects the liquidity concerns and
market access risks unique to notes due in three years or less. The following
summarizes the ratings used by Standard & Poor's Ratings Group for municipal
notes:
"SP-1" - The issuers of these municipal notes exhibit very strong or
strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit satisfactory
capacity to pay principal and interest.
"SP-3" - The issuers of these municipal notes exhibit speculative
capacity to pay principal and interest.
Moody's ratings for state and municipal notes and other short-term
loans are designated Moody's Investment Grade ("MIG") and variable rate demand
obligations are designated Variable Moody's Investment Grade ("VMIG"). Such
ratings recognize the differences between short-term credit risk and long-term
risk. The following summarizes the ratings by Moody's Investors Service, Inc.
for short-term notes:
"MIG-1"/"VMIG-1" - Loans bearing this designation are of the best
quality, enjoying strong protection by established cash flows, superior
liquidity support or demonstrated broad-based access to the market for
refinancing.
"MIG-2"/"VMIG-2" - Loans bearing this designation are of high quality,
with margins of protection ample although not so large as in the preceding
group.
"MIG-3"/"VMIG-3" - Loans bearing this designation are of favorable
quality, with all security elements accounted for but lacking the undeniable
strength of the preceding grades. Liquidity and cash flow protection may be
narrow and market access for refinancing is likely to be less well established.
A-11
<PAGE>
"MIG-4"/"VMIG-4" - Loans bearing this designation are of adequate
quality, carrying specific risk but having protection commonly regarded as
required of an investment security and not distinctly or predominantly
speculative.
"SG" - Loans bearing this designation are of speculative quality and
lack margins of protection.
Fitch and Duff & Phelps use the short-term ratings described under
Commercial Paper Ratings for municipal notes.
A-12
<PAGE>
EXCELSIOR FUNDS, INC.
Short-Term Government Securities Fund
Intermediate-Term Managed Income Fund
Managed Income Fund
EXCELSIOR TAX-EXEMPT FUNDS, INC.
Short-Term Tax-Exempt Securities Fund
Intermediate-Term Tax-Exempt Fund
Long-Term Tax-Exempt Fund
STATEMENT OF ADDITIONAL INFORMATION
August 1, 1997
This Statement of Additional Information is not a prospectus but should be read
in conjunction with the current prospectuses for the Short-Term Government
Securities Fund, Intermediate-Term Managed Income Fund and Managed Income Fund
of Excelsior Funds, Inc. ("Excelsior Fund") and the Short-Term Tax-Exempt
Securities Fund, Intermediate-Term Tax-Exempt Fund and Long-Term Tax-Exempt Fund
of Excelsior Tax-Exempt Funds, Inc. ("Excelsior Tax-Exempt Fund") dated August
1, 1997, respectively (the "Fixed-Income Funds Prospectus" and the "Tax-Exempt
Funds Prospectus", respectively; together, the "Prospectuses"). Much of the
information contained in this Statement of Additional Information expands upon
the subjects discussed in the Prospectuses. No investment in shares of the
portfolios described herein ("Shares") should be made without reading the
Prospectuses. A copy of each Prospectus may be obtained by writing Excelsior
Funds c/o Chase Global Funds Services Company, 73 Tremont Street, Boston, MA
02108-3913 or by calling (800) 446-1012.
<PAGE>
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
INVESTMENT OBJECTIVES AND POLICIES.................... 1
Additional Information on Portfolio Instruments.. 1
Additional Investment Limitations................ 10
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION........ 13
INVESTOR PROGRAMS..................................... 16
Systematic Withdrawal Plan....................... 16
Exchange Privilege............................... 16
Other Investor Programs.......................... 17
DESCRIPTION OF CAPITAL STOCK.......................... 17
MANAGEMENT OF THE FUNDS............................... 19
Directors and Officers........................... 19
Shareholder Organizations........................ 28
Expenses 29
Custodian and Transfer Agent..................... 29
PORTFOLIO TRANSACTIONS................................ 30
INDEPENDENT AUDITORS.................................. 32
COUNSEL............................................... 32
ADDITIONAL INFORMATION CONCERNING TAXES............... 33
Generally 33
Tax-Exempt Funds................................. 34
Taxation of Certain Financial Instruments........ 35
PERFORMANCE AND YIELD INFORMATION..................... 37
Yields and Performance........................... 37
MISCELLANEOUS......................................... 41
FINANCIAL STATEMENTS.................................. 42
APPENDIX A............................................ A-1
</TABLE>
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<PAGE>
INVESTMENT OBJECTIVES AND POLICIES
----------------------------------
This Statement of Additional Information contains additional
information with respect to the Short-Term Tax-Exempt Securities Fund,
Intermediate-Term Tax-Exempt Fund and Long-Term Tax-Exempt Fund (collectively,
the "Tax-Exempt Funds") of Excelsior Tax-Exempt Fund and the Short-Term
Government Securities Fund, Intermediate-Term Managed Income Fund and Managed
Income Fund of Excelsior Fund (collectively, the "Fixed-Income Funds"). The
portfolios are referred to individually as a "Fund" and collectively as the
"Funds"; Excelsior Tax-Exempt Fund and Excelsior Fund are referred to
individually as a "Company" and collectively as the "Companies".
For ease of reference, the various Funds are referred to as follows:
Short-Term Tax-Exempt Securities Fund as "Short-Term Tax-Exempt Fund";
Intermediate-Term Tax-Exempt Fund as "IT Tax-Exempt Fund"; Long-Term Tax-Exempt
Fund as "LT Tax-Exempt Fund", Short-Term Government Securities Fund as "ST
Government Fund", and Intermediate-Term Managed Income Fund as "IT Income Fund".
The following policies and disclosures supplement the Funds'
investment objectives and policies as set forth in the Prospectuses.
Additional Information on Portfolio Instruments
- -----------------------------------------------
Municipal Obligations
---------------------
The Tax-Exempt Funds invest substantially all of their assets in
Municipal Obligations as defined in the Prospectus. Municipal Obligations
include debt obligations issued by governmental entities to obtain funds for
various public purposes, including the construction of a wide range of public
facilities, the refunding of outstanding obligations, the payment of general
operating expenses, and the extension of loans to public institutions and
facilities. Private activity bonds that are issued by or on behalf of public
authorities to finance various privately operated facilities are included within
the term "Municipal Obligations" only if the interest paid thereon is exempt
from regular Federal income tax and not treated as a specific tax preference
item under the Federal alternative minimum tax.
The two principal classifications of Municipal Obligations are
"general obligation" and "revenue" issues, but the Tax-Exempt Funds' portfolios
may include "moral obligation" issues, which are normally issued by special-
purpose authorities. There are, of course, variations in the quality of
Municipal Obligations, both within a particular classification and between
<PAGE>
classifications, and the yields on Municipal Obligations depend upon a variety
of factors, including general money market conditions, the financial condition
of the issuer, general conditions of the municipal bond market, the size of a
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of Moody's Investors Service, Inc. ("Moody's") and Standard
& Poor's Ratings Group ("S&P") described in the Prospectus and Appendix A hereto
represent their opinion as to the quality of Municipal Obligations. It should
be emphasized that these ratings are general and are not absolute standards of
quality, and Municipal Obligations with the same maturity, interest rate, and
rating may have different yields while Municipal Obligations of the same
maturity and interest rate with different ratings may have the same yield.
Subsequent to its purchase by a Fund, an issue of Municipal Obligations may
cease to be rated, or its rating may be reduced below the minimum rating
required for purchase by that Fund. United States Trust Company of New York
("U.S. Trust New York") and U.S. Trust Company of Connecticut ("U.S. Trust
Connecticut" and, collectively, with U.S. Trust New York, the "Investment
Adviser" or "U.S. Trust"), will consider such an event in determining whether a
Fund should continue to hold the obligation.
The payment of principal and interest on most securities purchased by
the Tax-Exempt Funds will depend upon the ability of the issuers to meet their
obligations. Each state, the District of Columbia, each of their political
subdivisions, agencies, instrumentalities and authorities, and each multistate
agency of which a state is a member, is a separate "issuer" as that term is used
in this Statement of Additional Information and the Prospectus. The non-
governmental user of facilities financed by private activity bonds is also
considered to be an "issuer." An issuer's obligations under its Municipal
Obligations are subject to the provisions of bankruptcy, insolvency, and other
laws affecting the rights and remedies of creditors, such as the Federal
Bankruptcy Code, and laws, if any, which may be enacted by Federal or state
legislatures extending the time for payment of principal or interest, or both,
or imposing other constraints upon enforcement of such obligations or upon the
ability of municipalities to levy taxes. The power or ability of an issuer to
meet its obligations for the payment of interest on and principal of its
Municipal Obligations may be materially adversely affected by litigation or
other conditions.
Private activity bonds are or have been issued to obtain funds to
provide, among other things, privately operated housing facilities, pollution
control facilities, convention or trade show facilities, mass transit, airport,
port or parking facilities and certain local facilities for water supply, gas,
electricity or sewage or solid waste disposal. Private activity bonds are also
issued to privately held or publicly owned corporations in the financing of
commercial or industrial
-2-
<PAGE>
facilities. State and local governments are authorized in most states to issue
private activity bonds for such purposes in order to encourage corporations to
locate within their communities. The principal and interest on these
obligations may be payable from the general revenues of the users of such
facilities.
Among other instruments, the Tax-Exempt Funds may purchase short-term
General Obligation Notes, Tax Anticipation Notes, Bond Anticipation Notes,
Revenue Anticipation Notes, Tax-Exempt Commercial Paper, Construction Loan Notes
and other forms of short-term loans. Such instruments are issued with a short-
term maturity in anticipation of the receipt of tax funds, the proceeds of bond
placements or other revenues. In addition, each Fund may invest in long-term
tax-exempt instruments, such as municipal bonds and private activity bonds, to
the extent consistent with the maturity restrictions applicable to it.
From time to time, proposals have been introduced before Congress for
the purpose of restricting or eliminating the Federal income tax exemption for
interest on Municipal Obligations. For example, under the Tax Reform Act of
1986, as amended, interest on certain private activity bonds must be included in
an investor's alternative minimum taxable income, and corporate investors must
treat all tax-exempt interest as an item of tax preference. Excelsior Tax-
Exempt Fund cannot, of course, predict what legislation may be proposed in the
future regarding the income tax status of interest on Municipal Obligations, or
which proposals, if any, might be enacted. Such proposals, while pending or if
enacted, might materially adversely affect the availability of Municipal
Obligations for investment by the Tax-Exempt Funds and the liquidity and value
of their portfolios. In such an event, Excelsior Tax-Exempt Fund would
reevaluate the Funds' investment objectives and policies and consider possible
changes in their structure or possible dissolution.
Opinions relating to the validity of Municipal Obligations and to the
exemption of interest thereon from Federal income tax are rendered by bond
counsel to the respective issuers at the time of issuance. Neither Excelsior
Tax-Exempt Fund nor the Investment Adviser will review the proceedings relating
to the issuance of Municipal Obligations or the basis for such opinions.
The IT Income and Managed Income Funds may, when deemed appropriate by
the Investment Adviser in light of the Funds' investment objective, also invest
in Municipal Obligations. Although yields on municipal obligations can
generally be expected under normal market conditions to be lower than yields on
corporate and U.S. Government obligations, from time to time municipal
securities have outperformed, on a total return basis, comparable corporate and
Federal debt obligations as a result of prevailing economic, regulatory or other
circumstances.
-3-
<PAGE>
Dividends paid by the IT Income and Managed Income Funds that are derived from
interest on municipal securities would be taxable to the Funds' shareholders for
Federal income tax purposes.
Insured Municipal Obligations
-----------------------------
The Tax-Exempt Funds may purchase Municipal Obligations which are
insured as to timely payment of principal and interest at the time of purchase.
The insurance policies will usually be obtained by the issuer of the bond at the
time of its original issuance. Bonds of this type will be acquired only if at
the time of purchase they satisfy quality requirements generally applicable to
Municipal Obligations as described in the Prospectus. Although insurance
coverage for the Municipal Obligations held by the Tax-Exempt Funds reduces
credit risk by insuring that the Funds will receive timely payment of principal
and interest, it does not protect against market fluctuations caused by changes
in interest rates and other factors. Each Tax-Exempt Fund may invest more than
25% of its net assets in Municipal Obligations covered by insurance policies.
Repurchase Agreements
---------------------
The repurchase price under the repurchase agreements described in the
Prospectus generally equals the price paid by a Fund plus interest negotiated on
the basis of current short-term rates (which may be more or less than the rate
on the securities underlying the repurchase agreement). Securities subject to
repurchase agreements are held by the Funds' custodian (or sub-custodian) or in
the Federal Reserve/Treasury book-entry system. Repurchase agreements are
considered loans by a Fund under the Investment Company Act of 1940, as amended
(the "1940 Act").
Securities Lending
------------------
When the ST Government Fund, IT Income Fund and Managed Income Fund
lend their portfolio securities, they continue to receive interest or dividends
on the securities lent and may simultaneously earn interest on the investment of
the cash loan collateral, which will be invested in readily marketable, high-
quality, short-term obligations. Although voting rights, or rights to consent,
attendant to securities lent pass to the borrower, such loans may be called at
any time and will be called so that the securities may be voted by the pertinent
Fund if a material event affecting the investment is to occur.
Government Obligations
----------------------
Examples of the types of U.S. Government obligations that may be held
by the Funds include, in addition to U.S. Treasury Bills, the obligations of
Federal Home Loan Banks, Federal Farm Credit Banks, Federal Land Banks, the
Federal
-4-
<PAGE>
Housing Administration, Farmers Home Administration, Export-Import Bank of the
United States, Small Business Administration, Government National Mortgage
Association, Federal National Mortgage Association, General Services
Administration, Student Loan Marketing Association, Central Bank for
Cooperatives, Federal Home Loan Mortgage Corporation, Federal Intermediate
Credit Banks and Maritime Administration.
When-Issued and Forward Transactions
------------------------------------
When a Fund agrees to purchase securities on a "when-issued" or
forward commitment basis, the custodian will set aside cash or liquid portfolio
securities equal to the amount of the commitment in a separate account.
Normally, the custodian will set aside portfolio securities to satisfy a
purchase commitment and, in such case, the Fund may be required subsequently to
place additional assets in the separate account in order to ensure that the
value of the account remains equal to the amount of the Fund's commitment. It
may be expected that a Fund's net assets will fluctuate to a greater degree when
it sets aside portfolio securities to cover such purchase commitments than when
it sets aside cash. Because a Fund will set aside cash or liquid assets to
satisfy its purchase commitments in the manner described, its liquidity and
ability to manage its portfolio might be affected in the event its forward
commitments or commitments to purchase "when-issued" securities ever exceeded
25% of the value of its assets.
A Fund will purchase securities on a "when-issued" or forward
commitment basis only with the intention of completing the transaction. If
deemed advisable as a matter of investment strategy, however, a Fund may dispose
of or renegotiate a commitment after it is entered into, and may sell securities
it has committed to purchase before those securities are delivered to the Fund
on the settlement date. In these cases, the Fund may realize a taxable capital
gain or loss.
When a Fund engages in "when-issued" or forward commitment
transactions, it relies on the other party to consummate the trade. Failure of
such other party to do so may result in the Fund incurring a loss or missing an
opportunity to obtain a price considered to be advantageous.
The market value of the securities underlying a "when-issued" purchase
or a forward commitment to purchase securities and any subsequent fluctuations
in their market value are taken into account when determining the market value
of a Fund starting on the day the Fund agrees to purchase the securities. The
Fund does not earn interest on the securities it has committed to purchase until
they are paid for and delivered on the settlement date.
-5-
<PAGE>
Stand-By Commitments
--------------------
The Managed Income and IT Income Funds and the Tax-Exempt Funds may
acquire "stand-by commitments" with respect to Municipal Obligations held by
them. Under a "stand-by commitment," a dealer or bank agrees to purchase from a
Fund, at the Fund's option, specified Municipal Obligations at a specified
price. The amount payable to a Fund upon its exercise of a "stand-by
commitment" is normally (i) the Fund's acquisition cost of the Municipal
Obligations (excluding any accrued interest which the Fund paid on their
acquisition), less any amortized market premium or plus any amortized market or
original issue discount during the period the Fund owned the securities, plus
(ii) all interest accrued on the securities since the last interest payment date
during that period. "Stand-by commitments" are exercisable by a Fund at any
time before the maturity of the underlying Municipal Obligations, and may be
sold, transferred or assigned by the Fund only with the underlying instruments.
The Managed Income and IT Income Funds and the Tax-Exempt Funds expect
that "stand-by commitments" will generally be available without the payment of
any direct or indirect consideration. However, if necessary or advisable, a
Fund may pay for a "stand-by commitment" either separately in cash or by paying
a higher price for securities which are acquired subject to the commitment (thus
reducing the yield to maturity otherwise available for the same securities).
Where a Fund has paid any consideration directly or indirectly for a "stand-by
commitment," its cost will be reflected as unrealized depreciation for the
period during which the commitment was held by the Fund.
The Managed Income and IT Income Funds and the Tax-Exempt Funds intend
to enter into "stand-by commitments" only with banks and broker/dealers which,
in the Investment Adviser's opinion, present minimal credit risks. In evaluating
the creditworthiness of the issuer of a "stand-by commitment," the Investment
Adviser will review periodically the issuer's assets, liabilities, contingent
claims and other relevant financial information.
Commercial Paper
----------------
Investments by the Funds in commercial paper will consist of issues
that are rated "A-2" or better by S&P or "Prime-2" or better by Moody's. In
addition, each Fund may acquire unrated commercial paper that is determined by
the Investment Adviser at the time of purchase to be of comparable quality to
rated instruments that may be acquired by the particular Fund. Each Fund will
generally limit its investments in such unrated commercial paper to 5% of its
total assets.
-6-
<PAGE>
Futures Contracts
-----------------
Each Fund may invest in futures contracts (interest rate futures
contracts or municipal bond index futures contracts, as applicable). Futures
contracts will not be entered into for speculative purposes, but to hedge risks
associated with a Fund's securities investments. Positions in futures contracts
may be closed out only on an exchange which provides a secondary market for such
futures. However, there can be no assurance that a liquid secondary market will
exist for any particular futures contract at any specific time. Thus, it may
not be possible to close a futures position. In the event of adverse price
movements, a Fund would continue to be required to make daily cash payments to
maintain its required margin. In such situations, if a Fund has insufficient
cash, it may have to sell portfolio securities to meet daily margin requirements
at a time when it may be disadvantageous to do so. In addition, a Fund may be
required to make delivery of the instruments underlying futures contracts it
holds. The inability to close options and futures positions also could have an
adverse impact on a Fund's ability to effectively hedge.
Successful use of futures by a Fund is also subject to the Investment
Adviser's ability to correctly predict movements in the direction of the market.
For example, if a Fund has hedged against the possibility of a decline in the
market adversely affecting securities held by it and securities prices increase
instead, the Fund will lose part or all of the benefit to the increased value of
its securities which it has hedged because it will have approximately equal
offsetting losses in its futures positions. In addition, in some situations, if
a Fund has insufficient cash, it may have to sell securities to meet daily
variation margin requirements. Such sales of securities may be, but will not
necessarily be, at increased prices which reflect the rising market. A Fund may
have to sell securities at a time when it may be disadvantageous to do so.
The risk of loss in trading futures contracts in some strategies can
be substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit, before any deduction for the
transaction costs, if the contract were closed out. Thus, a purchase or sale of
a futures contract may
-7-
<PAGE>
result in losses in excess of the amount invested in the contract.
Utilization of futures transactions by a Fund involves the risk of
loss by a Fund of margin deposits in the event of bankruptcy of a broker with
whom the Fund has an open position in a futures contract or related option.
Most futures exchanges limit the amount of fluctuation permitted in
futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.
The trading of futures contracts is also subject to the risk of
trading halts, suspensions, exchange or clearing house equipment failures,
government intervention, insolvency of a brokerage firm or clearing house or
other disruptions of normal trading activity, which could at times make it
difficult or impossible to liquidate existing positions or to recover excess
variation margin payments.
Forward Currency Transactions
-----------------------------
The Managed Income and IT Income Funds will conduct their currency
exchange transactions either on a spot (i.e., cash) basis at the rate prevailing
in the currency exchange markets, or by entering into forward currency
contracts. A forward foreign currency contract involves an obligation to
purchase or sell a specific currency for a set price at a future date. In this
respect, forward currency contracts are similar to foreign currency futures
contracts; however, unlike futures contracts which are traded on recognized
commodities exchange, forward currency contracts are traded in the interbank
market conducted directly between currency traders (usually large commercial
banks) and their customers. Also, forward currency contracts usually involve
delivery of the currency involved instead of cash payment as in the case of
futures contracts.
A Fund's participation in forward currency contracts will be limited
to hedging involving either specific transactions or portfolio positions.
Transaction hedging involves the
-8-
<PAGE>
purchase or sale of foreign currency with respect to specific receivables or
payables of the Fund generally arising in connection with the purchase or sale
of its portfolio securities. The purpose of transaction hedging is to "lock in"
the U.S. dollar equivalent price of such specific securities. Position hedging
is the sale of foreign currency with respect to portfolio security positions
denominated or quoted in that currency. The Funds will not speculate in foreign
currency exchange transactions. Transaction and position hedging will not be
limited to an overall percentage of a Fund's assets, but will be employed as
necessary to correspond to particular transactions or positions. A Fund may not
hedge its currency positions to an extent greater than the aggregate market
value (at the time of entering into the forward contract) of the securities held
in its portfolio denominated, quoted in, or currently convertible into that
particular currency. When the Funds engage in forward currency transactions,
certain asset segregation requirements must be satisfied to ensure that the use
of foreign currency transactions is unleveraged. When a Fund takes a long
position in a forward currency contract, it must maintain a segregated account
containing liquid assets equal to the purchase price of the contract, less any
margin or deposit. When a Fund takes a short position in a forward currency
contract, the Fund must maintain a segregated account containing liquid assets
in an amount equal to the market value of the currency underlying such contract
(less any margin or deposit), which amount must be at least equal to the market
price at which the short position was established. Asset segregation
requirements are not applicable when a Fund "covers" a forward currency position
generally by entering into an offsetting position.
The transaction costs to the Funds of engaging in forward currency
transactions vary with factors such as the currency involved, the length of the
contract period and prevailing currency market conditions. Because currency
transactions are usually conducted on a principal basis, no fees or commissions
are involved. The use of forward currency contracts does not eliminate
fluctuations in the underlying prices of the securities being hedged, but it
does establish a rate of exchange that can be achieved in the future. Thus,
although forward currency contracts used for transaction or position hedging
purposes may limit the risk of loss due to an increase in the value of the
hedged currency, at the same time they limit potential gain that might result
were the contracts not entered into. Further, the Investment Adviser may be
incorrect in its expectations as to currency fluctuations, and a Fund may incur
losses in connection with its currency transactions that it would not otherwise
incur. If a price movement in a particular currency is generally anticipated, a
Fund may not be able to contract to sell or purchase that currency at an
advantageous price.
-9-
<PAGE>
At or before the maturity of a forward sale contract, a Fund may sell
a portfolio security and make delivery of the currency, or retain the security
and offset its contractual obligation to deliver the currency by purchasing a
second contract pursuant to which the Fund will obtain, on the same maturity
date, the same amount of the currency which it is obligated to deliver. If the
Fund retains the portfolio security and engages in an offsetting transaction,
the Fund, at the time of execution of the offsetting transaction, will incur a
gain or a loss to the extent that movement has occurred in forward contract
prices. Should forward prices decline during the period between a Fund's
entering into a forward contract for the sale of a currency and the date it
enters into an offsetting contract for the purchase of the currency, the Fund
will realize a gain to the extent the price of the currency it has agreed to
sell exceeds the price of the currency it has agreed to purchase. Should
forward prices increase, the Fund will suffer a loss to the extent the price of
the currency it has agreed to sell is less than the price of the currency it has
agreed to purchase in the offsetting contract. The foregoing principles
generally apply also to forward purchase contracts.
Additional Investment Limitations
- ---------------------------------
In addition to the investment limitations disclosed in the Prospectus,
the Funds are subject to the investment limitations enumerated below.
Fundamental investment limitations may be changed with respect to a Fund only by
a vote of the holders of a majority of such Fund's outstanding Shares (as
defined under "Miscellaneous" in the Prospectuses). However, investment
limitations which are "operating policies" with respect to a Fund may be changed
by Excelsior Fund's or Excelsior Tax-Exempt Fund's Board of Directors upon
reasonable notice to investors.
The following investment limitations are fundamental with respect to
each Fund. No Fund may:
1. Act as an underwriter of securities within the meaning of the
Securities Act of 1933, except to the extent that the purchase of Municipal
Obligations or other securities directly from the issuer thereof in accordance
with the Tax-Exempt Funds' investment objectives, policies, and limitations may
be deemed to be underwriting; and except insofar as the Managed Income Fund
might be deemed to be an underwriter upon disposition of certain portfolio
securities acquired within the limitation on purchases of restricted securities;
2. Purchase or sell real estate, except that each Tax-Exempt Fund may
invest in Municipal Obligations secured by real estate or interests therein, and
the Managed Income and Intermediate-Term Managed Income Funds may purchase
securities of
-10-
<PAGE>
issuers which deal in real estate and may purchase securities which are secured
by interests in real estate; and
3. Issue any senior securities, except insofar as any borrowing by
each Fund in accordance with its investment limitations might be considered to
be the issuance of a senior security; provided that each Fund may enter into
futures contracts and futures options.
The following investment limitation is fundamental with respect to the
IT Tax-Exempt, LT Tax-Exempt and Managed Income Funds, but is an operating
policy with respect to the Short-Term Tax-Exempt, ST Government and IT Income
Funds. The Funds may not:
4. Purchase securities on margin, make short sales of securities, or
maintain a short position; provided that each Fund may enter into futures
contracts and futures options.
The following investment limitation is fundamental with respect to
each Tax-Exempt Fund. A Tax-Exempt Fund may not:
5. Make loans, except that each Tax-Exempt Fund may purchase or hold
debt obligations in accordance with its investment objective, policies, and
limitations.
The following investment limitation is fundamental with respect to the
IT Tax-Exempt and LT Tax-Exempt Funds, but is an operating policy with respect
to the Short-Term Tax-Exempt Fund. A Tax-Exempt Fund may not:
6. Purchase securities of other investment companies (except as part
of a merger, consolidation or reorganization or purchase of assets approved by
the Fund's shareholders), provided that a Fund may purchase shares of any
registered, open-end investment company, if immediately after any such purchase,
the Fund does not (a) own more than 3% of the outstanding voting stock of any
one investment company, (b) invest more than 5% of the value of its total assets
in the securities of any one investment company, or (c) invest more than 10% of
the value of its total assets in the aggregate in securities of investment
companies.
The following investment limitations are fundamental with respect to
the Managed Income Fund, but are operating policies with respect to the IT
Income and ST Government Funds.
A Fixed-Income Fund may not:
7. Invest in companies for the purpose of exercising management or
control;
-11-
<PAGE>
8. Purchase foreign securities; provided that subject to the limit
described below, the IT Income and Managed Income Funds may purchase (a) dollar-
denominated debt obligations issued by foreign issuers, including foreign
corporations and governments, by U.S. corporations outside the United States in
an amount not to exceed 25% of its total assets at time of purchase; and (b)
certificates of deposit, bankers' acceptances, or other similar obligations
issued by domestic branches of foreign banks, or foreign branches of U.S. banks,
in an amount not to exceed 20% of its total net assets; and
9. Acquire any other investment company or investment company
security, except in connection with a merger, consolidation, reorganization, or
acquisition of assets or where otherwise permitted by the 1940 Act.
The following investment limitations are fundamental with respect to
the IT Tax-Exempt, LT Tax-Exempt and Managed Income Funds. The IT Tax-Exempt,
LT Tax-Exempt and Managed Income Funds may not:
10. Write or sell puts, calls, straddles, spreads, or combinations
thereof; provided that each Fund may enter into futures contracts and futures
options; and
11. Purchase or sell commodity futures contracts, or invest in oil,
gas, or mineral exploration or development programs; provided that the Funds may
enter into futures contracts and futures options.
The following investment limitation is fundamental with respect to the
Short-Term Tax-Exempt, ST Government and IT Income Funds. The Short-Term Tax-
Exempt, ST Government and IT Income Funds may not:
12. Purchase or sell commodities or commodity futures contracts, or
invest in oil, gas, or mineral exploration or development programs; provided
that the Funds may enter into futures contracts and futures options.
The following investment limitation is fundamental with respect to the
IT Tax-Exempt and LT Tax-Exempt Funds. The IT Tax-Exempt and LT Tax-Exempt
Funds may not:
13. Invest in industrial revenue bonds where the payment of principal
and interest are the responsibility of a company (including its predecessors)
with less than three years of continuous operation.
The following investment limitation is fundamental with respect to the
Managed Income Fund. The Managed Income Fund may not:
-12-
<PAGE>
14. Invest more than 5% of its total assets in securities issued by
companies which, together with any predecessor, have been in continuous
operation for fewer than three years.
* * *
For the purpose of Investment Limitation No. 2, the prohibition of
purchases of real estate includes acquisition of limited partnership interests
in partnerships formed with a view toward investing in real estate, but does not
prohibit purchases of shares in real estate investment trusts. The Funds do not
currently intend to invest in real estate investment trusts.
In addition to the above investment limitations, Excelsior Fund
currently intends to limit the IT Income and Managed Income Funds' investments
in warrants so that, valued at the lower of cost or market value, they do not
exceed 5% of a Fund's net assets. Included within that amount, but not to
exceed 2% of the value of the IT Income or Managed Income Fund's net assets, may
be warrants which are not listed on the New York or American Stock Exchange.
For the purpose of this limitation, warrants acquired by the IT Income or
Managed Income Fund in units or attached to securities will be deemed to be
without value.
The IT Tax-Exempt, LT Tax-Exempt and Managed Income Funds may not
purchase or sell commodities.
The Funds' transactions in futures contracts and futures options
(including the margin posted by the Funds in connection with such transactions)
are excluded from the Funds' prohibitions: against the purchase of securities
on margin, short sales of securities and the maintenance of a short position;
the issuance of senior securities; writing or selling puts, calls, straddles,
spreads, or combinations thereof; and the mortgage, pledge or hypothecation of
the Funds' assets.
If a percentage limitation is satisfied at the time of investment, a
later increase or decrease in such percentage resulting from a change in value
of a Fund's portfolio securities will not constitute a violation of such
limitation.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
----------------------------------------------
Shares are continuously offered for sale by Edgewood Services, Inc.
(the "Distributor"), a wholly-owned subsidiary of Federated Investors, and the
Distributor has agreed to use appropriate efforts to solicit all purchase
orders. As described in the Prospectus, Shares may be sold to customers
("Customers") of financial institutions ("Shareholder Organizations"). Shares
-13-
<PAGE>
are also offered for sale directly to institutional investors and to members of
the general public. Different types of Customer accounts at the Shareholder
Organizations may be used to purchase Shares, including eligible agency and
trust accounts. In addition, Shareholder Organizations may automatically
"sweep" a Customer's account not less frequently than weekly and invest amounts
in excess of a minimum balance agreed to by the Shareholder Organization and its
Customer in Shares selected by the Customer. Investors purchasing Shares may
include officers, directors, or employees of the particular Shareholder
Organization.
Shares of the Funds are offered for sale at their net asset value per
Share next computed after a purchase order is received by the Companies' sub-
transfer agent.
Prior to February 14, 1997, Shares of the Funds were offered for sale
with a maximum sales charge of 4.50%. For the fiscal years ended March 31,
1997, 1996 and 1995, total sales charges paid by shareholders with respect to
the IT Tax-Exempt Fund were $314, $1,621 and $17,776, respectively; with respect
to the LT Tax-Exempt Fund were $8,085, $15,633 and $4,088, respectively; and
with respect to the Managed Income Fund were $2,072, $727 and $973,
respectively. Of these respective amounts, UST Distributors, Inc., the Funds'
former distributor, retained $341 and $431 with respect to the IT Tax-Exempt
Fund; $1,972 and $3,188 with respect to the LT Tax-Exempt Fund; and $653 and
$973 with respect to the Managed Income Fund for the period from April 1, 1995
through July 31, 1995, and the fiscal year ended March 31, 1995. Edgewood
Services, Inc., the distributor, retained none of the foregoing sales charges
with respect to the IT Tax-Exempt, LT Tax-Exempt and Managed Income Funds for
the fiscal year ended March 31, 1997, and for the period from August 1, 1995
through March 31, 1996. The balance was paid to selling dealers.
Total sales charges paid by shareholders of the Short-Term Tax-Exempt, ST
Government and IT Income Funds for the fiscal years ended March 31, 1997, 1996
and 1995 were $292, $1,523 and $20; $0, $0 and $1; and $0, $299 and $815,
respectively. Of these respective amounts, UST Distributors, Inc., the Funds'
former distributor, retained $1,523 and $20 with respect to the Short-Term Tax-
Exempt Fund; $0 and $1 with respect to the ST Government Fund; and $20 and $815
with respect to the IT Income Fund for the period from April 1, 1995 through
July 31, 1995, and the fiscal year ended March 31, 1995. Edgewood
-14-
<PAGE>
Services, Inc. retained none of the foregoing sales charges with respect to the
Short-Term Tax-Exempt, ST Government and IT Income Funds for the fiscal year
ended March 31, 1997, and for the period August 1, 1995 through March 31, 1996.
The balance was paid to selling dealers.
The Companies may suspend the right of redemption or postpone the date of
payment for Shares for more than 7 days during any period when (a) trading on
the New York Stock Exchange (the "Exchange") is restricted by applicable rules
and regulations of the Securities and Exchange Commission (the "SEC"); (b) the
Exchange is closed for other than customary weekend and holiday closings; (c)
the SEC has by order permitted such suspension; or (d) an emergency exists as
determined by the SEC.
In the event that Shares are redeemed in cash at their net asset
value, a shareholder may receive in payment for such Shares an amount that is
more or less than his original investment due to changes in the market prices of
that Fund's portfolio securities.
Each Company reserves the right to honor any request for redemption or
repurchase of a Fund's Shares by making payment in whole or in part in
securities chosen by the Company and valued in the same way as they would be
valued for purposes of computing a Fund's net asset value. If payment is made
in securities, a shareholder may incur transaction costs in converting these
securities into cash. Such redemptions in kind will be governed by Rule 18f-1
under the 1940 Act so that a Fund is obligated to redeem its Shares solely in
cash up to the lesser of $250,000 or 1% of its net asset value during any 90-day
period for any one shareholder of a Fund.
Under limited circumstances, the Companies may accept securities as
payment for Shares. Securities acquired in this manner will be limited to
securities issued in transactions involving a bona fide reorganization or
---------
statutory merger, or will be limited to other securities (except for municipal
debt securities issued by state political subdivisions or their agencies or
instrumentalities) that: (a) meet the investment objective and policies of any
Fund acquiring such securities; (b) are acquired for investment and not for
resale; (c) are liquid securities that are not restricted as to transfer either
by law or liquidity of market; and (d) have a value that is readily
ascertainable (and not established only by evaluation procedures) as evidenced
by a listing on the American Stock Exchange, New York Stock Exchange or NASDAQ,
or as evidenced by their status as U.S. Government securities, bank certificates
of deposit, banker's acceptances, corporate and other debt securities that are
actively traded, money market securities and other similar securities with a
readily ascertainable value.
-15-
<PAGE>
INVESTOR PROGRAMS
-----------------
Systematic Withdrawal Plan
- --------------------------
An investor who owns Shares with a value of $10,000 or more may begin
a Systematic Withdrawal Plan. The withdrawal can be on a monthly, quarterly,
semiannual or annual basis. There are four options for such systematic
withdrawals. The investor may request:
(1) A fixed-dollar withdrawal;
(2) A fixed-share withdrawal;
(3) A fixed-percentage withdrawal (based on the current value of the
account); or
(4) A declining-balance withdrawal.
Prior to participating in a Systematic Withdrawal Plan, the investor must
deposit any outstanding certificates for Shares with Chase Global Funds Services
Company, the Funds' sub-transfer agent. Under this Plan, dividends and
distributions are automatically reinvested in additional Shares of a Fund.
Amounts paid to investors under this Plan should not be considered as income.
Withdrawal payments represent proceeds from the sale of Shares, and there will
be a reduction of the shareholder's equity in the Fund involved if the amount of
the withdrawal payments exceeds the dividends and distributions paid on the
Shares and the appreciation of the investor's investment in the Fund. This in
turn may result in a complete depletion of the shareholder's investment. An
investor may not participate in a program of systematic investing in a Fund
while at the same time participating in the Systematic Withdrawal Plan with
respect to an account in that Fund. Customers of Shareholder Organizations may
obtain information on the availability of, and procedures and fees relating to,
the Systematic Withdrawal Plan directly from their Shareholder Organizations.
Exchange Privilege
- ------------------
Investors and Customers of Shareholder Organizations may exchange
Shares having a value of at least $500 for shares of any other portfolio of the
Companies or for Trust Shares of Excelsior Institutional Trust. Shares may be
exchanged by wire, telephone or mail and must be made to accounts of identical
registration. There is no exchange fee imposed by the Companies or Excelsior
Institutional Trust. In order to prevent abuse of this privilege to the
disadvantage of other shareholders, the Companies and Excelsior Institutional
Trust reserve the right to limit the number of exchange requests of investors to
no more
-16-
<PAGE>
than six per year. The Companies and Excelsior Institutional Trust may modify
or terminate the exchange program at any time upon 60 days' written notice to
shareholders, and may reject any exchange request. Customers of Shareholder
Organizations may obtain information on the availability of, and the procedures
and fees relating to, such program directly from their Shareholder
Organizations.
For Federal income tax purposes, exchanges are treated as sales on
which the shareholder will realize a gain or loss, depending upon whether the
value of the Shares to be given up in exchange is more or less than the basis in
such Shares at the time of the exchange. Generally, a shareholder may include
sales loads incurred upon the purchase of Shares in his or her tax basis for
such Shares for the purpose of determining gain or loss on a redemption,
transfer or exchange of such Shares. However, if the shareholder effected an
exchange of Shares for shares of another portfolio of the Companies within 90
days of the purchase and was able to reduce the sales load previously applicable
to the new shares (by virtue of the Companies' exchange privilege), the amount
equal to such reduction may not be included in the tax basis of the
shareholder's exchanged Shares but may be included (subject to the limitation)
in the tax basis of the new shares.
Other Investor Programs
- -----------------------
As described in the Prospectuses, Shares of the Funds may be purchased
in connection with the Automatic Investment Program. Shares of the Managed
Income, IT Income and ST Government Funds may also be purchased in connection
with certain Retirement Programs. Customers of Shareholder Organizations may
obtain information on the availability of, and the procedures and fees relating
to, such programs directly from their Shareholder Organizations.
DESCRIPTION OF CAPITAL STOCK
----------------------------
Excelsior Fund's Charter authorizes its Board of Directors to issue up
to thirty-five billion full and fractional shares of capital stock; Excelsior
Tax-Exempt Fund's Charter authorizes its Board of Directors to issue up to
fourteen billion full and fractional shares of capital stock. Both Charters
authorize the respective Boards of Directors to classify or reclassify any
unissued shares of the respective Companies into one or more additional classes
or series by setting or changing in any one or more respects their respective
preferences, conversion or other rights, voting powers, restrictions,
limitations as to dividends, qualifications, and terms and conditions of
redemption. The Prospectuses describe the classes of shares into which the
Companies' authorized capital is currently classified.
-17-
<PAGE>
Shares have no preemptive rights and only such conversion or exchange
rights as the Boards of Directors may grant in their discretion. When issued
for payment as described in the Prospectuses, Shares will be fully paid and non-
assessable. In the event of a liquidation or dissolution of a Fund,
shareholders of that Fund are entitled to receive the assets available for
distribution belonging to that Fund and a proportionate distribution, based upon
the relative asset values of the portfolios of the Company involved, of any
general assets of that Company not belonging to any particular portfolio of that
Company which are available for distribution. In the event of a liquidation or
dissolution of either Company, shareholders of such Company will be entitled to
the same distribution process.
Shareholders of the Companies are entitled to one vote for each full
share held, and fractional votes for fractional shares held, and will vote in
the aggregate and not by class, except as otherwise required by the 1940 Act or
other applicable law or when the matter to be voted upon affects only the
interests of the shareholders of a particular class. Voting rights are not
cumulative and, accordingly, the holders of more than 50% of the aggregate of a
Company's outstanding shares may elect all of that Company's directors,
regardless of the votes of other shareholders.
Rule 18f-2 under the 1940 Act provides that any matter required to be
submitted to the holders of the outstanding voting securities of an investment
company such as each Company shall not be deemed to have been effectively acted
upon unless approved by the holders of a majority of the outstanding shares of
each portfolio affected by the matter. A portfolio is affected by a matter
unless it is clear that the interests of each portfolio in the matter are
substantially identical or that the matter does not affect any interest of the
portfolio. Under the Rule, the approval of an investment advisory agreement or
any change in a fundamental investment policy would be effectively acted upon
with respect to a portfolio only if approved by a majority of the outstanding
shares of such portfolio. However, the Rule also provides that the ratification
of the appointment of independent public accountants, the approval of principal
underwriting contracts, and the election of directors may be effectively acted
upon by shareholders of each Company voting without regard to class.
The Companies' Charters authorize the Boards of Directors, without
shareholder approval (unless otherwise required by applicable law), to (a) sell
and convey the assets of a Fund to another management investment company for
consideration which may include securities issued by the purchaser and, in
connection therewith, to cause all outstanding Shares of the Fund involved to be
redeemed at a price which is equal to their net asset value and which may be
paid in cash or by distribution of
-18-
<PAGE>
the securities or other consideration received from the sale and conveyance; (b)
sell and convert a Fund's assets into money and, in connection therewith, to
cause all outstanding Shares to be redeemed at their net asset value; or (c)
combine the assets belonging to a Fund with the assets belonging to another
portfolio of the Company involved, if the Board of Directors reasonably
determines that such combination will not have a material adverse effect on
shareholders of any portfolio participating in such combination, and, in
connection therewith, to cause all outstanding shares of any portfolio to be
redeemed at their net asset value or converted into shares of another class of
the Company's capital stock at net asset value. The exercise of such authority
by the Boards of Directors will be subject to the provisions of the 1940 Act,
and the Boards of Directors will not take any action described in this paragraph
unless the proposed action has been disclosed in writing to the particular
Fund's shareholders at least 30 days prior thereto.
Notwithstanding any provision of Maryland law requiring a greater vote
of the Companies' Common Stock (or of the Shares of a Fund voting separately as
a class) in connection with any corporate action, unless otherwise provided by
law (for example, by Rule 18f-2, discussed above) or by the Companies' Charters,
the Companies may take or authorize such action upon the favorable vote of the
holders of more than 50% of the outstanding Common Stock of the particular
Company voting without regard to class.
MANAGEMENT OF THE FUNDS
-----------------------
Directors and Officers
- ----------------------
The directors and executive officers of the Companies, their
addresses, ages, principal occupations during the past five years, and other
affiliations are as follows:
<TABLE>
<CAPTION>
Position Principal Occupation
with During Past 5 Years and
Name and Address the Companies Other Affiliations
- ---------------- ------------- -----------------------
<S> <C> <C>
Frederick S. Wonham/1/ Chairman of the Retired; Director of
238 June Road Board, President Excelsior Fund and Excelsior
Stamford, CT 06903 and Treasurer Tax-Exempt Fund (since 1995);
Age: 66 Trustee of Excelsior Funds
and Excelsior Institutional Trust
(since 1995); Vice Chairman of U.S.
Trust
</TABLE>
/1/ This director is considered to be an "interested person" of Excelsior Fund
as defined in the 1940 Act.
-19-
<PAGE>
<TABLE>
<CAPTION>
Position Principal Occupation
with During Past 5 Years and
Name and Address the Companies Other Affiliations
- ---------------- ------------- -----------------------
<S> <C> <C>
Corporation and U.S. Trust New York
(from February 1990 until September
1995); and Chairman, U.S. Trust
Connecticut (from March 1993 to May
1997).
Donald L. Campbell Director Retired; Director of
333 East 69th Street Excelsior Fund and Excelsior
Apt. 10-H Tax-Exempt Fund (since 1984);
New York, NY 10021 Director of UST Master
Age: 71 Variable Series, Inc.
(from 1994 to June 1997); Trustee of
Excelsior Institutional Trust (since
1995); and Director, Royal Life
Insurance Co. of New York (since 1991).
Rodman L. Drake Director Director, Excelsior Fund
485 Park Avenue and Excelsior Tax-Exempt
New York, NY 10022 Fund (since 1996); Trustee,
Age: 54 Excelsior Institutional
Trust and Excelsior Funds
(since 1994); Director, Parsons
Brinkerhoff Energy Services Inc. (since
1996); Director, Parsons Brinkerhoff,
Inc. (engineering firm) (since 1995);
President, Mandrake Group (investment
and consulting firm) (since 1994);
Director, Hyperion Total Return Fund,
Inc. and four other funds for which
Hyperion Capital Management, Inc.
serves as investment adviser (since
1991); Co-Chairman, KMR Power
Corporation (power plants) (from 1993
to 1996); Director, The Latin American
Growth Fund (since 1993); Member of
Advisory Board, Argentina Private
Equity Fund L.P. (from 1992 to 1996)
and Garantia L.P. (Brazil) (from 1993
to 1996); and Director, Mueller
Industries, Inc. (from 1992 to 1994).
</TABLE>
-20-
<PAGE>
<TABLE>
<CAPTION>
Position Principal Occupation
with During Past 5 Years and
Name and Address the Companies Other Affiliations
- ---------------- ------------- -----------------------
<S> <C> <C>
Joseph H. Dugan Director Retired; Director of
913 Franklin Lakes Road Excelsior Fund and Excelsior
Franklin Lakes, NJ 07417 Tax-Exempt Fund (since 1984);
Age: 72 Director of UST Master
Variable Series, Inc.
(from 1994 to June 1997); and Trustee
of Excelsior Institutional Trust (since
1995).
Wolfe J. Frankl Director Retired; Director of
2320 Cumberland Road Excelsior Fund and Excelsior
Charlottesville, VA 22901 Tax-Exempt Fund (since 1986);
Age: 76 Director of UST Master
Variable Series, Inc. (from 1994 to
June 1997); Trustee of Excelsior
Institutional Trust (since 1995);
Director, Deutsche Bank Financial, Inc.
(since 1989); Director, The Harbus
Corporation (since 1951); and Trustee,
HSBC Funds Trust and HSBC Mutual Funds
Trust (since 1988).
W. Wallace
McDowell, Jr. Director Director, Excelsior Fund
c/o Prospect Capital and Excelsior Tax-Exempt
Corp. Fund (since 1996); Trustee,
43 Arch Street Excelsior Institutional Trust
Greenwich, CT 06830 and Excelsior Funds
Age: 60 (since 1994); Private Investor
(since 1994); Managing Director, Morgan
Lewis Githens & Ahn (from 1991 to
1994); and Director, U.S. Homecare
Corporation (since 1992), Grossmans,
Inc. (from 1993 to 1996), Children's
Discovery Centers (since 1984), ITI
Technologies, Inc. (since 1992) and
Jack Morton Productions (since 1987).
Jonathan Piel Director Director, Excelsior Fund and
558 E. 87th Street Excelsior Tax-Exempt Fund
New York, NY 10128 (since 1996); Trustee, Excelsior
Age: 58 Institutional Trust and
Excelsior Funds (since 1994);
Vice President and Editor, Scientific
American, Inc. (from 1986 to 1994);
Director, Group for The South Fork,
Bridgehampton, New York (since 1993);
and Member, Advisory Committee, Knight
Journalism Fellowships, Massachusetts
Institute of Technology (since 1984).
</TABLE>
-21-
<PAGE>
<TABLE>
<CAPTION>
Position Principal Occupation
with During Past 5 Years and
Name and Address the Companies Other Affiliations
- ---------------- ------------- -----------------------
<S> <C> <C>
Robert A. Robinson Director Director of Excelsior Fund
Church Pension Fund and Excelsior Tax-Exempt Fund
800 Second Avenue (since 1987); Director of UST
New York, NY 10017 Master Variable Series, Inc.
Age: 71 (from 1994 to June 1997); Trustee of
Excelsior Institutional Trust (since
1995); President Emeritus, The
Church Pension Fund and its
affiliated companies (since 1966);
Trustee, H.B. and F.H. Bugher
Foundation and Director of its
wholly owned subsidiaries --
Rosiclear Lead and Flourspar Mining
Co. and The Pigmy Corporation (since
1984); Director, Morehouse
Publishing Co. (since 1974);
Trustee, HSBC Funds Trust and HSBC
Mutual Funds Trust (since 1982); and
Director, Infinity Funds, Inc.
(since 1995).
Alfred C. Tannachion/1/Director Retired; Director of
6549 Pine Meadows Drive Excelsior Fund and
Spring Hill, FL 34606 Excelsior Tax-Exempt Fund
Age: 71 (since 1985); Chairman
of the Board, President and Treasurer
of UST Master Variable Series, Inc.
(from 1994 to June 1997); and Trustee
of Excelsior Institutional Trust (since
1995).
W. Bruce McConnel, III Secretary Partner of the law firm of Drinker
Philadelphia National Biddle & Reath LLP.
Bank Building
1345 Chestnut Street
Philadelphia, PA 19107
Age: 54
Gregory Sackos Assistant Second Vice President, Senior
Chase Global Funds Secretary Manager of Blue Sky Compliance
Services Company and Financial Reporting, Chase
73 Tremont Street Global Funds Services Company
Boston, MA 02108-3913 (March 1997 to present); Second
Age: 32 Vice President, Senior Manager of
Financial Reporting, Chase Global
Funds Services Company (September
1996 to March 1997); and Assistant Vice
President, Assistant Manager of
Financial Reporting, Scudder, Stevens &
Clark Inc. (October 1992 to September 1996).
</TABLE>
- ----------
/1/ This director is considered to be an "interested person" of Excelsior Fund
as defined in the 1940 Act.
-22-
<PAGE>
<TABLE>
<CAPTION>
Position Principal Occupation
with During Past 5 Years and
Name and Address the Companies Other Affiliations
- ---------------- ------------- -----------------------
<S> <C> <C>
John M. Corcoran Assistant Vice President, Director of
Chase Global Funds Treasurer Administration Client Group,
Services Company Chase Global Funds Services
73 Tremont Street Company (since July 1996);
Boston, MA 02108-3913 Second Vice President, Manager
Age: 32 of Administration, Chase Global Funds
Services Company (from
October 1993 to July 1996); and Audit
Manager, Ernst & Young LLP (from August
1987 to September 1993).
</TABLE>
Each director receives an annual fee of $9,000 with respect to each
Company plus a per-Company meeting fee of $1,500 for each meeting attended and
is reimbursed for expenses incurred in attending meetings. The Chairman of the
Board is entitled to receive an additional $5,000 per annum for services in such
capacity. Drinker Biddle & Reath LLP, of which Mr. McConnel is a partner,
receives legal fees as counsel to the Companies. The employees of Chase Global
Funds Services Company do not receive any compensation from the Companies for
acting as officers of the Companies. No person who is currently an officer,
director or employee of the Investment Adviser serves as an officer, director or
employee of the Companies. As of July 14, 1997, the directors and officers of
each Company as a group owned beneficially less than 1% of the outstanding
shares of each fund of each Company, and less than 1% of the outstanding shares
of all funds of each Company in the aggregate.
The following chart provides certain information about the fees
received by the Companies' directors in the most recently completed fiscal year.
-23-
<PAGE>
<TABLE>
<CAPTION>
Pension or
Retirement Total
Benefits Compensation
Accrued as from the Companies
Aggregate Part of and Fund
Name of Compensation from Fund Complex* Paid
Person/Position the Companies Expenses to Directors
- --------------- ----------------- ---------- ------------------
<S> <C> <C> <C>
Donald L. Campbell $27,000 None $31,750 (4)**
Director
Rodman L. Drake*** $ 7,500 None $12,250 (4)**
Director
Joseph H. Dugan $30,000 None $35,000 (4)**
Director
Wolfe J. Frankl $30,000 None $35,000 (4)**
Director
W. Wallace McDowell, Jr.*** $ 4,500 None $ 9,250 (4)**
Director
Jonathan Piel*** $ 7,500 None $12,500 (4)**
Director
Robert A. Robinson $30,000 None $35,000 (4)**
Director
Alfred C. Tannachion**** $40,000 None $45,000 (4)**
Director
Frederick S. Wonham**** $30,000 None $35,000 (4)**
Chairman of the Board,
President and Treasurer
</TABLE>
- ---------------------------
/*/ The "Fund Complex" consists of Excelsior Fund, Excelsior Tax-Exempt
Fund, UST Master Variable Series, Inc., Excelsior Funds and Excelsior
Institutional Trust.
/**/ Number of investment companies in the Fund Complex for which director
served as director or trustee.
/***/ Messrs. Drake, McDowell and Piel were elected to the Board of
Excelsior Fund and Excelsior Tax-Exempt Fund on December 9, 1996.
/****/ Mr. Tannachion served as the Companies' Chairman of the Board,
President and Treasurer until February 13, 1997. On that date, Mr.
Wonham was elected to serve as the Companies' Chairman of the Board,
President and Treasurer.
-24-
<PAGE>
Investment Advisory and Administration Agreements
- -------------------------------------------------
United States Trust Company of New York ("U.S. Trust New York") and
U.S. Trust Company of Connecticut ("U.S. Trust Connecticut" and, collectively
with U.S. Trust New York, "U.S. Trust" or the "Investment Adviser") serve as
Investment Adviser to the Funds. In the Investment Advisory Agreements, U.S.
Trust has agreed to provide the services described in the Prospectuses. The
Investment Adviser has also agreed to pay all expenses incurred by it in
connection with its activities under the respective agreements other than the
cost of securities, including brokerage commissions, if any, purchased for the
Funds.
Prior to May 16, 1997, U.S. Trust New York served as investment
adviser to the Funds pursuant to an advisory agreement substantially similar to
the Investment Advisory Agreement currently in effect for the Funds.
For the fiscal year ended March 31, 1995, the particular Company paid
U.S. Trust New York advisory fees of $62,036, $142,883, $634,922, $149,283,
$801,081 and $374,134 with respect to the ST Government, IT Income, Managed
Income, Short-Term Tax-Exempt, IT Tax-Exempt and LT Tax-Exempt Funds,
respectively. For the same period, U.S. Trust New York waived advisory fees
totalling $14,308, $8,255, $121,999, $12,322, $84,360 and advisory $26,819 with
respect to the ST Government, IT Income, Managed Income, Short-Term Tax-Exempt,
IT Tax-Exempt and LT Tax-Exempt Funds, respectively.
For the fiscal year ended March 31, 1996, the particular Company paid
U.S. Trust New York advisory fees of $46,513, $187,185, $602,962, $116,249,
$754,048 and $391,724 with respect to the ST Government, IT Income, Managed
Income, Short-Term Tax-Exempt, IT Tax-Exempt and LT Tax-Exempt Funds,
respectively. For the same period, U.S. Trust New York waived advisory fees
totalling $20,410, $22,783, $46,807, $26,523, $117,024 and advisory $47,791 with
respect to the ST Government, IT Income, Managed Income, Short-Term Tax-Exempt,
IT Tax-Exempt and LT Tax-Exempt Funds, respectively.
For the fiscal year ended March 31, 1997, the particular Company paid
U.S. Trust New York advisory fees of $63,713, $217,254, $1,185,427, $95,564,
$741,452 and $457,137 with respect to the ST Government, IT Income, Managed
Income, Short-Term Tax-Exempt, IT Tax-Exempt and LT Tax-Exempt Funds,
respectively. For the same period, U.S. Trust New York waived advisory fees
totalling $21,478, $35,586, $77,751, $28,208, $140,769 and $69,305 with respect
to the ST Government, IT
-25-
<PAGE>
Income, Managed Income, Short-Term Tax-Exempt, IT Tax-Exempt and LT Tax-Exempt
Funds, respectively.
The Investment Advisory Agreements provide that the Investment Adviser
shall not be liable for any error of judgment or mistake of law or for any loss
suffered by the Funds in connection with the performance of such agreements,
except that the Investment Adviser shall be jointly, but not severally, liable
for a loss resulting from a breach of fiduciary duty with respect to the receipt
of compensation for advisory services or a loss resulting from willful
misfeasance, bad faith or gross negligence on the part of the Investment Adviser
in the performance of its duties or from reckless disregard by it of its duties
and obligations thereunder. In addition, the Investment Adviser has undertaken
in the Investment Advisory Agreement to maintain its policy and practice of
conducting its Asset Management Group independently of its Banking Group.
Chase Global Funds Services Company ("CGFSC"), Federated
Administrative Services, an affiliate of the Distributor, and U.S. Trust
Connecticut (the "Administrators") serve as the Funds' administrators. Under
the Administration Agreements, the Administrators have agreed to maintain office
facilities for the Funds, furnish the Funds with statistical and research data,
clerical, accounting and bookkeeping services, and certain other services
required by the Funds, and to compute the net asset value, net income, "exempt
interest dividends" and realized capital gains or losses, if any, of the
respective Funds. The Administrators prepare semiannual reports to the SEC,
prepare Federal and state tax returns, prepare filings with state securities
commissions, arrange for and bear the cost of processing Share purchase and
redemption orders, maintain the Funds' financial accounts and records, and
generally assist in the Funds' operations.
Prior to May 16, 1997, CGFSC, Federated Administrative Services and
U.S. Trust New York served as the Funds' administrators pursuant to an
administrative agreement substantially similar to the Administration Agreement
currently in effect for the Funds. Prior to August 1, 1995, administrative
services were provided to the Funds by CGFSC and Concord Holding Corporation
(collectively, the "former administrators") under administration agreements
having substantially the same terms as the Administration Agreements currently
in effect.
For the fiscal year ended March 31, 1995, Excelsior Tax-Exempt Fund
paid the former administrators $82,797, $386,614 and $123,173 in the aggregate
with respect to the Short-Term Tax-Exempt Fund, IT Tax-Exempt Fund and the LT
Tax-Exempt Fund, respectively. For the same period, Excelsior Fund paid the
former administrators $39,116, $66,481 and $154,370 in the aggregate with
respect to the ST Government, IT Income and
-26-
<PAGE>
Managed Income Funds, respectively. For the same period, the former
administrators waived administration fees totalling $2,634, $19, $1,051, $356,
$3,455 and $321 with respect to the ST Government, IT Income, Managed Income,
Short-Term Tax-Exempt, IT Tax-Exempt and LT Tax-Exempt Funds, respectively.
For the period April 1, 1995 through July 31, 1995, the Excelsior Tax-
Exempt Fund paid the former administrators $23,993, $124,638 and $41,586 in the
aggregate with respect to the Short-Term Tax-Exempt Fund, IT Tax-Exempt Fund and
the LT Tax-Exempt Fund, respectively. For the same period, Excelsior Fund paid
the former administrators $11,576, $26,526 and $43,727 in the aggregate with
respect to the ST Government, IT Income and Managed Income Funds, respectively.
For the same period, the former administrators waived administration fees
totalling $64, $543, $474, $140, $820 and $160 with respect to the ST
Government, IT Income, Managed Income, Short-Term Tax-Exempt, IT Tax-Exempt and
LT Tax-Exempt Funds, respectively.
For the period August 1, 1995 through March 31, 1996, Excelsior Tax-
Exempt Fund paid CGFSC, Federated Administrative Services and U.S. Trust New
York $33,906, $258,662 and $91,594 in the aggregate with respect to the Short-
Term Tax-Exempt Fund, IT Tax-Exempt Fund and the LT Tax-Exempt Fund,
respectively. For the same period, Excelsior Fund paid CGFSC, Federated
Administrative Services and U.S. Trust New York $38,330, $64,035 and $89,196 in
the aggregate with respect to the ST Government, IT Income and Managed Income
Funds, respectively. For the same period, CGFSC, Federated Administrative
Services and U.S. Trust New York waived administration fees totalling $30,
$1,567, $412, $15,466, $494 and $1,782 with respect to the ST Government, IT
Income, Managed Income, Short-Term Tax-Exempt, IT Tax-Exempt and LT Tax-Exempt
Funds, respectively.
For the fiscal year ended March 31, 1997, Excelsior Tax-Exempt Fund
paid CGFSC, Federated Administrative Services and U.S. Trust New York $63,343,
$387,111 and $160,259 in the aggregate with respect to the Short-Term Tax-Exempt
Fund, IT Tax-Exempt Fund and the LT Tax-Exempt Fund, respectively. For the same
period, Excelsior Fund paid CGFSC, Federated Administrative Services and U.S.
Trust New York $43,657, $110,146 and $258,438 in the aggregate with respect to
the ST Government, IT Income and Managed Income Funds, respectively. For the
same period, CGFSC, Federated Administrative Services and U.S. Trust New York
waived fees totalling $1, $909, $468, $96, $489 and $1,651 with respect to the
ST Government, IT Income, Managed Income, Short-Term Tax-Exempt, IT Tax-Exempt
and LT Tax-Exempt Funds, respectively.
-27-
<PAGE>
Shareholder Organizations
- -------------------------
As stated in the Prospectus, each Company has entered into agreements with
certain Shareholder Organizations. Such agreements require the Shareholder
Organizations to provide shareholder administrative services to their Customers
who beneficially own Shares in consideration for a Fund's payment of not more
than the annual rate of .40% of the average daily net assets of the Fund's
Shares beneficially owned by Customers of the Shareholder Organization. Such
services may include: (a) acting as recordholder of Shares; (b) assisting in
processing purchase, exchange and redemption transactions; (c) providing
periodic statements showing a Customer's account balances and confirmations of
transactions by the Customer; (d) providing tax and dividend information to
shareholders as appropriate; (e) transmitting proxy statements, annual
reports, updated prospec tuses and other communications from the Companies to
Customers; and (f) providing or arranging for the provision of other related
services.
The Companies' agreements with Shareholder Organizations are governed
by Administrative Services Plans (the "Plans") adopted by the Companies.
Pursuant to the Plans, each Company's Board of Directors will review, at least
quarterly, a written report of the amounts expended under the Company's
agreements with Shareholder Organizations and the purposes for which the
expenditures were made. In addition, the arrangements with Shareholder
Organizations will be approved annually by a majority of each Company's
directors, including a majority of the directors who are not "interested
persons" of the Company as defined in the 1940 Act and have no direct or
indirect financial interest in such arrangements (the "Disinterested
Directors").
Any material amendment to a Company's arrangements with Shareholder
Organizations must be approved by a majority of the Company's Board of Directors
(including a majority of the Disinterested Directors). So long as the
Companies' arrangements with Shareholder Organizations are in effect, the
selection and nomination of the members of the Companies' Boards of Directors
who are not "interested persons" (as defined in the 1940 Act) of the Companies
will be committed to the discretion of such Disinterested Directors.
For the fiscal years ended March 31, 1997, 1996 and 1995, payments to
Shareholder Organizations under the Plans totalled $28,304, $26,684 and $12,678;
$141,258, $118,114 and $87,815; $70,956, $22,586 and $27,140; $21,479, $20,504
and $4,466; $36,495, $24,893 and $439; and $78,219, $47,693 and $28,171 with
respect to the Short-Term Tax-Exempt, IT Tax-Exempt, LT Tax-Exempt, ST
Government, IT Income and Managed Income Funds, respectively. Of these
respective amounts, $28,304, $26,684 and $11,475; $139,275, $115,826 and
$74,979; $68,722, $22,586 and
-28-
<PAGE>
$25,075; $21,479, $20,504 and $3,649; $36,495, $21,217 and $8,041; and $77,550,
$46,426 and $20,247 were paid to affiliates of U.S. Trust with respect to the
Short-Term Tax-Exempt, IT Tax-Exempt, LT Tax-Exempt, ST Government, IT Income
and Managed Income Funds, respectively.
Expenses
- --------
Except as otherwise noted, the Investment Adviser and the
Administrators bear all expenses in connection with the performance of their
services. The Funds bear the expenses incurred in their operations. Expenses
of the Funds include: taxes; interest; fees (including fees paid to the
Companies' directors and officers who are not affiliated with the Distributor or
the Administrators); SEC fees; state securities qualification fees; costs of
preparing and printing prospectuses for regulatory purposes and for distribution
to shareholders; advisory, administration and administrative servicing fees;
charges of the custodian, transfer agent and dividend disbursing agent; certain
insurance premiums; outside auditing and legal expenses; cost of independent
pricing service; costs of shareholder reports and meetings; and any
extraordinary expenses. The Funds also pay for any brokerage fees and
commissions in connection with the purchase of portfolio securities.
Custodian and Transfer Agent
- ----------------------------
The Chase Manhattan Bank ("Chase") serves as custodian of the Funds'
assets. Under the Custodian Agreements, Chase has agreed to (i) maintain a
separate account or accounts in the name of the Funds; (ii) make receipts and
disbursements of money on behalf of the Funds; (iii) collect and receive income
and other payments and distributions on account of the Funds' portfolio
securities; (iv) respond to correspondence from securities brokers and others
relating to its duties; (v) maintain certain financial accounts and records; and
(vi) make periodic reports to each Company's Board of Directors concerning the
Funds' operations. Chase may, at its own expense, open and maintain custody
accounts with respect to the Funds with other banks or trust companies, provided
that Chase shall remain liable for the performance of all its custodial duties
under the Custodian Agreements, notwithstanding any delegation.
U.S. Trust New York serves as the Funds' transfer agent and dividend
disbursing agent. In such capacity, U.S. Trust New York has agreed to (i) issue
and redeem Shares; (ii) address and mail all communications by the Funds to
their shareholders, including reports to shareholders, dividend and distribution
notices, and proxy materials for their meetings of shareholders; (iii) respond
to correspondence by shareholders and others relating to its duties; (iv)
maintain shareholder accounts; and (v) make periodic reports to each Company's
Board of Directors
-29-
<PAGE>
concerning the Funds' operations. For its transfer agency, dividend disbursing,
and subaccounting services, U.S. Trust New York is entitled to receive $15.00
per annum per account and subaccount. In addition, U.S. Trust New York is
entitled to be reimbursed for its out-of-pocket expenses for the cost of forms,
postage, processing purchase and redemption orders, handling of proxies, and
other similar expenses in connection with the above services.
U.S. Trust New York may, at its own expense, delegate its transfer
agency obligations to another transfer agent registered or qualified under
applicable law, provided that U.S. Trust New York shall remain liable for the
performance of all of its transfer agency duties under the Transfer Agency
Agreements, notwithstanding any delegation. Pursuant to this provision in the
agreements, U.S. Trust New York has entered into a sub-transfer agency
arrangement with CGFSC, an affiliate of Chase, with respect to accounts of
shareholders who are not Customers of U.S. Trust New York. For the services
provided by CGFSC, U.S. Trust New York has agreed to pay CGFSC $15.00 per annum
per account or subaccount plus out-of-pocket expenses. CGFSC receives no fee
directly from the Companies for any of its sub-transfer agency services. U.S.
Trust New York may, from time to time, enter into sub-transfer agency
arrangements with third party providers of transfer agency services.
PORTFOLIO TRANSACTIONS
----------------------
Subject to the general control of the Companies' Boards of Directors,
the Investment Adviser is responsible for, makes decisions with respect to and
places orders for all purchases and sales of portfolio securities of each of the
Funds. Purchases and sales of portfolio securities will usually be principal
transactions without brokerage commissions.
The Funds may engage in short-term trading to achieve their investment
objectives. Portfolio turnover may vary greatly from year to year as well as
within a particular year. It is expected that the Funds' turnover rates may
remain higher than those of many other investment companies with similar
investment objectives and policies. However, since brokerage commissions are
not normally paid on instruments purchased by the Funds, portfolio turnover is
not expected to have a material effect on the net income of any of the Funds.
The Funds' portfolio turnover rate may also be affected by cash requirements for
redemptions of Shares and by regulatory provisions which enable the Funds to
receive certain favorable tax treatment. Portfolio turnover will not be a
limiting factor in making portfolio decisions. See "Financial Highlights" in
the Funds' prospectuses for the Funds' portfolio turnover rates.
-30-
<PAGE>
Securities purchased and sold by the Funds are generally traded in the
over-the-counter market on a net basis (i.e., without commission) through
dealers, or otherwise involve transactions directly with the issuer of an
instrument. The cost of securities purchased from underwriters includes an
underwriting commission or concession, and the prices at which securities are
purchased from and sold to dealers include a dealer's mark-up or markdown. With
respect to over-the-counter transactions, the Funds, where possible, will deal
directly with dealers who make a market in the securities involved, except in
those situations where better prices and execution are available elsewhere.
The Investment Advisory Agreements between the Companies and the
Investment Adviser provide that, in executing portfolio transactions and
selecting brokers or dealers, the Investment Adviser will seek to obtain the
best net price and the most favorable execution. The Investment Adviser shall
consider factors it deems relevant, including the breadth of the market in the
security, the price of the security, the financial condition and execution
capability of the broker or dealer and whether such broker or dealer is selling
shares of the Companies, and the reasonableness of the commission, if any, for
the specific transaction and on a continuing basis.
In addition, the Investment Advisory Agreements authorize the
Investment Adviser, to the extent permitted by law and subject to the review of
the Companies' Boards of Directors from time to time with respect to the extent
and continuation of the policy, to cause the Funds to pay a broker which
furnishes brokerage and research services a higher commission than that which
might be charged by another broker for effecting the same transaction, provided
that the Investment Adviser determines in good faith that such commission is
reasonable in relation to the value of the brokerage and research services
provided by such broker, viewed in terms of either that particular transaction
or the overall responsibilities of the Investment Adviser to the accounts as to
which it exercises investment discretion. Such brokerage and research services
might consist of reports and statistics on specific companies or industries,
general summaries of groups of stocks and their comparative earnings, or broad
overviews of the stock market and the economy.
Supplementary research information so received is in addition to and
not in lieu of services required to be performed by the Investment Adviser and
does not reduce the investment advisory fee payable by the Funds. Such
information may be useful to the Investment Adviser in serving the Funds and
other clients and, conversely, supplemental information obtained by the
placement of business of other clients may be useful to the Investment Adviser
in carrying out its obligations to the Funds.
-31-
<PAGE>
Portfolio securities will not be purchased from or sold to the
Investment Adviser, the Distributor, or any affiliated person of either of them
(as such term is defined in the 1940 Act) acting as principal, except to the
extent permitted by the SEC.
Investment decisions for the Funds are made independently from those
for other investment companies, common trust funds and other types of funds
managed by the Investment Adviser. Such other investment companies and funds
may also invest in the same securities as the Funds. When a purchase or sale of
the same security is made at substantially the same time on behalf of the Funds
and another investment company or common trust fund, the transaction will be
averaged as to price, and available investments allocated as to amount, in a
manner which the Investment Adviser believes to be equitable to the Funds and
such other investment company or common trust fund. In some instances, this
investment procedure may adversely affect the price paid or received by the
Funds or the size of the position obtained by the Funds. To the extent
permitted by law, the Investment Adviser may aggregate the securities to be sold
or purchased for the Funds with those to be sold or purchased for other
investment companies or common trust funds in order to obtain best execution.
The Companies are required to identify any securities of their regular
brokers or dealers (as defined in Rule 10b-1 under the 1940 Act) or their
parents held by the Funds as of the close of the most recent fiscal year. As of
March 31, 1997, the Funds did not hold any securities issued by the Companies'
regular brokers or dealers or their parents.
INDEPENDENT AUDITORS
--------------------
Ernst & Young LLP, independent auditors, 200 Clarendon Street, Boston,
MA 02116, serve as auditors of the Companies. The Funds' Financial Highlights
included in the Prospectuses and the financial statements for the period ended
March 31, 1997 incorporated by reference in this Statement of Additional
Information have been audited by Ernst & Young LLP for the periods included in
their reports thereon which appear therein.
COUNSEL
-------
Drinker Biddle & Reath LLP (of which Mr. McConnel, Secretary of the
Companies, is a partner), Philadelphia National Bank Building, 1345 Chestnut
Street, Philadelphia, Pennsylvania 19107, is counsel to the Companies and will
pass upon the legality of the Shares offered by the Prospectuses.
-32-
<PAGE>
ADDITIONAL INFORMATION CONCERNING TAXES
---------------------------------------
Generally
- ---------
The following supplements the tax information contained in the
Prospectuses.
Each of the Funds is treated as a separate corporate entity under the
Internal Revenue Code of 1986, as amended (the "Code"), and intends to qualify
as a regulated investment company. If, for any reason, a Fund does not qualify
for a taxable year for the special Federal tax treatment afforded regulated
investment companies, such Fund would be subject to Federal tax on all of its
taxable income at regular corporate rates, without any deduction for
distributions to shareholders. In such event, dividend distributions (whether or
not derived from interest on Municipal Securities) would be taxable as ordinary
income to shareholders to the extent of the Fund's current and accumulated
earnings and profits and would be eligible for the dividends received deduction
in the case of corporate shareholders.
A Fund will designate any distribution of the excess of net long-term
capital gain over net short-term capital loss as a capital gain dividend in a
written notice mailed to shareholders within 60 days after the close of the
Fund's taxable year. Shareholders should note that, upon the sale or exchange
of Shares, if the shareholder has not held such Shares for at least six months,
any loss on the sale or exchange of those Shares will be treated as long-term
capital loss to the extent of the capital gain dividends received with respect
to the Shares.
A 4% non-deductible excise tax is imposed on regulated investment
companies that fail to currently distribute an amount equal to specified
percentages of their ordinary taxable income and capital gain net income (excess
of capital gains over capital losses). Each Fund intends to make sufficient
distributions or deemed distributions of their ordinary taxable income and any
capital gain net income prior to the end of each calendar year to avoid
liability for this excise tax.
Each Fund will be required in certain cases to withhold and remit to
the U.S. Treasury 31% of taxable dividends or gross proceeds realized upon sale
paid to shareholders who have failed to provide a correct tax identification
number in the manner required, who are subject to withholding by the Internal
Revenue Service for failure properly to include on their return payments of
taxable interest or dividends, or who have failed to certify to the Fund when
required to do so either that they are not subject to backup withholding or that
they are "exempt recipients."
-33-
<PAGE>
Tax-Exempt Funds
----------------
As stated in their Prospectus, the Tax-Exempt Funds are not intended
to constitute a balanced investment program and are not designed for investors
seeking capital appreciation or maximum tax-exempt income irrespective of
fluctuations in principal. Shares of the Tax-Exempt Funds would not be suitable
for tax-exempt institutions and may not be suitable for retirement plans
qualified under Section 401 of the Code, H.R. 10 plans and individual retirement
accounts because such plans and accounts are generally tax-exempt and,
therefore, not only would not gain any additional benefit from the Tax-Exempt
Funds' dividends being tax-exempt, but such dividends would be ultimately
taxable to the beneficiaries when distributed to them. In addition, the Tax-
Exempt Funds may not be an appropriate investment for entities which are
"substantial users" of facilities financed by private activity bonds or "related
persons" thereof. "Substantial user" is defined under the Treasury Regulations
to include a non-exempt person who regularly uses a part of such facilities in
his trade or business and whose gross revenues derived with respect to the
facilities financed by the issuance of bonds are more than 5% of the total
revenues derived by all users of such facilities, who occupies more than 5% of
the usable area of such facilities or for whom such facilities or a part thereof
were specifically constructed, reconstructed or acquired. "Related persons"
include certain related natural persons, affiliated corporations, a partnership
and its partners and an S corporation and its shareholders.
In order for a Tax-Exempt Fund to pay exempt-interest dividends for
any taxable year, at least 50% of the aggregate value of such Fund's portfolio
must consist of exempt-interest obligations at the close of each quarter of its
taxable year. Within 60 days after the close of the taxable year, each of the
Tax-Exempt Funds will notify its shareholders of the portion of the dividends
paid by that Fund which constitutes an exempt-interest dividend with respect to
such taxable year. However, the aggregate amount of dividends so designated by
that Fund cannot exceed the excess of the amount of interest exempt from tax
under Section 103 of the Code received by that Fund during the taxable year over
any amounts disallowed as deductions under Sections 265 and 171(a)(2) of the
Code. The percentage of total dividends paid by each of the Tax-Exempt Funds
with respect to any taxable year which qualifies as exempt-interest dividends
will be the same for all shareholders receiving dividends from that Tax-Exempt
Fund for such year.
Interest on indebtedness incurred by a shareholder to purchase or
carry a Tax-Exempt Fund's Shares generally is not deductible for Federal income
tax purposes. In addition, if a shareholder holds Tax-Exempt Fund Shares for
six months or less, any loss on the sale or exchange of those Shares will be
-34-
<PAGE>
disallowed to the extent of the amount of exempt-interest dividends received
with respect to the Shares. The Treasury Department, however, is authorized to
issue regulations reducing the six-month holding requirement to a period of not
less than the greater of 31 days or the period between regular dividend
distributions where the investment company regularly distributes at least 90% of
its net tax-exempt interest. No such regulations had been issued as of the date
of this Statement of Additional Information.
Taxation of Certain Financial Instruments
- -----------------------------------------
Generally, futures contracts held by the Funds at the close of their
taxable year will be treated for Federal income tax purposes as sold for their
fair market value on the last business day of such year, a process known as
"mark-to-market." Forty percent of any gain or loss resulting from such
constructive sale will be treated as short-term capital gain or loss and 60% of
such gain or loss will be treated as long-term capital gain or loss, without
regard to the length of time a Fund has held the futures contract (the "40%-60%
rule"). The amount of any capital gain or loss actually realized by a Fund in a
subsequent sale or other disposition of those futures contracts will be adjusted
to reflect any capital gain or loss taken into account by the Fund in a prior
year as a result of the constructive sale of the contracts. Futures contracts
to sell will be regarded as parts of a "mixed straddle" because their values
fluctuate inversely to the values of specific securities held by a Fund. Losses
as to futures contracts to sell will be subject to certain loss deferral rules
which limit the amount of loss currently deductible on either part of the
straddle to the amount thereof which exceeds the unrecognized gain (if any) with
respect to the other part of the straddle, and to certain wash sales
regulations. Under short sales rules, which also are applicable, the holding
period of the securities forming part of the straddle will (if they have not
been held for the long-term holding period) be deemed not to begin prior to
termination of the straddle. With respect to certain futures contracts,
deductions for interest and carrying charges will not be allowed.
Notwithstanding the rules described above, with respect to futures contracts to
sell which are properly identified as such, a Fund may make an election which
will exempt (in whole or in part) those identified futures contracts from being
treated for Federal income tax purposes as sold on the last business day of the
Fund's taxable year, but gains and losses will be subject to such short sales,
wash sales and loss deferral rules, and the requirement to capitalize interest
and carrying charges. Under temporary regulations, the Fund would be allowed
(in lieu of the foregoing) to elect either (1) to offset gains or losses from
positions which are part of a mixed straddle by separately identifying each
mixed straddle to which such treatment applies, or (2) to establish a mixed
straddle account for which gains and
-35-
<PAGE>
losses would be recognized and offset on a periodic basis during the taxable
year. Under either election, the 40%-60% rule will apply to the net gain or
loss attributable to the futures contracts, but in the case of a mixed straddle
account election, not more than 50 percent of any net gain may be treated as
long term and no more than 40 percent of any net loss may be treated as short
term. Options on futures contracts generally receive Federal tax treatment
similar to that described above.
A Fund will not be treated as a regulated investment company under the
Code if 30% or more of the Fund's gross income for a taxable year is derived
from gains realized on the sale or other disposition of the following
investments held for less than three months (the "Short-Short Test"): (1) stock
and securities (as defined in section 2(a)(36) of the 1940 Act); (2) options,
futures and forward contracts other than those on foreign currencies; and (3)
foreign currencies (and options, futures and forward contracts on foreign
currencies) that are not directly related to the Fund's principal business of
investing in stock and securities (and options and futures with respect to
stocks and securities). Interest (including original issue discount and accrued
market discount) received by the Fund upon maturity or disposition of a security
held for less than three months will not be treated as gross income derived from
the sale or other disposition of such security within the meaning of this
requirement. However, any other income which is attributable to realized market
appreciation will be treated as gross income from the sale or other disposition
of securities for this purpose. With respect to forward contracts, futures
contracts, options on futures contracts, and other financial instruments subject
to the mark-to-market rules described above, the Internal Revenue Service has
ruled in private letter rulings that a gain realized from such a contract,
option or financial instrument will be treated as being derived from a security
held for three months or more (regardless of the actual period for which the
contract, option or instrument is held) if the gain arises as a result of a
constructive sale under the mark-to-market rules, and will be treated as being
derived from a security held for less than three months only if the contract,
option or instrument is terminated (or transferred) during the taxable year
(other than by reason of mark-to-market) and less than three months have elapsed
between the date the contract, option or instrument is acquired and the
termination date. Increases and decreases in the value of a Fund's futures
contracts and other investments that qualify as part of a "designated hedge," as
defined in Section 851(g) of the Code, may be netted for purposes of determining
whether the Short-Short Test is met.
* * *
As of the date of this Statement of Additional Information, new
Federal tax legislation--the Taxpayer Relief Act
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<PAGE>
of 1997 (the "TRA")--has been passed by the House of Representatives and the
Senate, and is expected to be signed by the President. The TRA, if enacted as
expected, will repeal the Short-Short Test (effective for each Fund's next
fiscal year) and will change applicable rates and holding period rules for
capital gains.
The foregoing discussion is based on Federal tax laws and regulations
which are in effect on the date of this Statement of Additional Information;
such laws and regulations may be changed by legislative or administrative
action. Shareholders are advised to consult their tax advisers concerning their
specific situations, the application of state and local taxes and changes in
Federal tax rules under the TRA.
PERFORMANCE AND YIELD INFORMATION
---------------------------------
Yields and Performance
- ----------------------
The Funds may advertise the standardized effective 30-day (or one
month) yields calculated in accordance with the method prescribed by the SEC for
mutual funds. Such yield will be calculated separately for each Fund according
to the following formula:
a-b
Yield = 2 [(-------- + 1) to the sixth power - 1]
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of
reimbursements).
c = average daily number of Shares outstanding that were
entitled to receive dividends.
d = maximum offering price per Share on the last day of the
period.
For the purpose of determining interest earned during the period
(variable "a" in the formula), each of the Funds computes the yield to maturity
of any debt obligation held by it based on the market value of the obligation
(including actual accrued interest) at the close of business on the last
business day of each month, or, with respect to obligations purchased during the
month, the purchase price (plus actual accrued interest). Such yield is then
divided by 360, and the quotient is multiplied by the market value of the
obligation (including actual accrued interest) in order to determine the
interest
-37-
<PAGE>
income on the obligation for each day of the subsequent month that the
obligation is in the portfolio. It is assumed in the above calculation that each
month contains 30 days. Also, the maturity of a debt obligation with a call
provision is deemed to be the next call date on which the obligation reasonably
may be expected to be called or, if none, the maturity date. Each of the Funds
calculates interest gained on tax-exempt obligations issued without original
issue discount and having a current market discount by using the coupon rate of
interest instead of the yield to maturity. In the case of tax-exempt obligations
with original issue discount, where the discount based on the current market
value exceeds the then-remaining portion of original issue discount, the yield
to maturity is the imputed rate based on the original issue discount
calculation. Conversely, where the discount based on the current market value is
less than the remaining portion of the original issue discount, the yield to
maturity is based on the market value.
Expenses accrued for the period (variable "b" in the formula) include
all recurring fees charged by each of the Funds to all shareholder accounts and
to the particular series of Shares in proportion to the length of the base
period and that Fund's mean (or median) account size. Undeclared earned income
will be subtracted from the maximum offering price per Share (variable "d" in
the formula).
Based on the foregoing calculations, the effective yields for Shares
of the IT Tax-Exempt, LT Tax-Exempt, Managed Income, Short-Term Tax-Exempt, IT
Income and ST Government Funds for the 30-day period ended March 31, 1997 were
4.10%, 4.91%, 5.96%, 3.53%, 6.08% and 5.26%, respectively.
The "tax-equivalent" yield of the Short-Term Tax-Exempt, IT Tax-Exempt
and LT Tax-Exempt Funds is computed by: (a) dividing the portion of the yield
(calculated as above) that is exempt from Federal income tax by one minus a
stated Federal income tax rate and (b) adding that figure to that portion, if
any, of the yield that is not exempt from Federal income tax. Tax-equivalent
yields assume the payment of Federal income taxes at a rate of 31%. Based on
the foregoing calculations, the tax-equivalent yields of the Short-Term Tax-
Exempt, IT Tax-Exempt and LT Tax-Exempt Funds for the 30-day period ended March
31, 1997 were 5.12%, 5.94% and 7.12%, respectively.
Each Fund's "average annual total return" is computed by determining
the average annual compounded rate of return during specified periods that
equates the initial amount invested to the ending redeemable value of such
investment according to the following formula:
-38-
<PAGE>
ERV
T = [(-----) to the first power divided by n - 1]
P
Where: T = average annual total return.
ERV = ending redeemable value of a hypothetical $1,000
payment made at the beginning of the 1, 5 or 10
year (or other) periods at the end of the
applicable period (or a fractional portion
thereof).
P = hypothetical initial payment of $1,000.
n = period covered by the computation, expressed in
years.
Each Fund may also advertise the "aggregate total return" for its Shares,
which is computed by determining the aggregate compounded rates of return during
specified periods that likewise equate the initial amount invested to the ending
redeemable value of such investment. The formula for calculating aggregate
total return is as follows:
ERV
Aggregate Total Return = [(------)] - 1
P
The above calculations are made assuming that (1) all dividends and
capital gain distributions are reinvested on the reinvestment dates at the price
per Share existing on the reinvestment date, (2) all recurring fees charged to
all shareholder accounts are included, and (3) for any account fees that vary
with the size of the account, a mean (or median) account size in the Fund during
the periods is reflected. The ending redeemable value (variable "ERV', in the
formula) is determined by assuming complete redemption of the hypothetical
investment after deduction of all nonrecurring charges at the end of the
measuring period.
Based on the foregoing calculations, the total returns for Shares of
the Short-Term Tax-Exempt Fund, IT Tax-Exempt Fund, LT Tax-Exempt Fund, ST
Government Fund, IT Income Fund and Managed Income Fund for the one year period
ended March 31, 1997 were 3.55%, 4.58%, 5.47%, 4.77%, 3.25% and 3.17%,
respectively. The average annual total returns for the IT Tax-Exempt Fund, LT
Tax-Exempt Fund and Managed Income Fund for the five year period ended March 31,
1997 were 6.65%, 8.80% and 7.16%, respectively. The average annual total returns
for the IT Tax-Exempt, LT Tax-
-39-
<PAGE>
Exempt and Managed Income Funds for the ten year period ended March 31, 1997
were 6.81%, 9.42% and 8.57%, respectively. The average annual total returns for
the Short-Term Tax-Exempt, IT Income and ST Government Funds for the period from
their commencement of operations (December 31, 1992) to March 31, 1997 were
3.91%, 5.51% and 4.73%, respectively.
The Funds may also from time to time include in advertisements, sales
literature and communications to shareholders a total return figure that is not
calculated according to the formula set forth above in order to compare more
accurately a Fund's performance with other measures of investment return. For
example, in comparing a Fund's total return with data published by Lipper
Analytical Services, Inc., CDA Investment Technologies, Inc. or Weisenberger
Investment Company Service, or with the performance of an index, a Fund may
calculate its aggregate total return for the period of time specified in the
advertisement, sales literature or communication by assuming the investment of
$10,000 in Shares and assuming the reinvestment of each dividend or other
distribution at net asset value on the reinvestment date. Percentage increases
are determined by subtracting the initial value of the investment from the
ending value and by dividing the remainder by the beginning value.
The total return and yield of a Fund may be compared to those of other
mutual funds with similar investment objectives and to other relevant indices or
to ratings prepared by independent services or other financial or industry
publications that monitor the performance of mutual funds. For example, the
total return and/or yield of a Fund may be compared to data prepared by Lipper
Analytical Services, Inc., CDA Investment Technologies, Inc. and Weisenberger
Investment Company Service. Total return and yield data as reported in national
financial publications such as Money Magazine, Forbes, Barron's, The Wall Street
----- -------- ------ -------- --- ---- ------
Journal and The New York Times, or in publications of a local or regional
- ------- --- --- ---- -----
nature, may also be used in comparing the performance of a Fund.
Advertisements, sales literature or reports to shareholders may from time to
time also include a discussion and analysis of each Fund's performance,
including without limitation, those factors, strategies and technologies that
together with market conditions and events, materially affected each Fund's
performance.
The Funds may also from time to time include discussions or illustrations
of the effects of compounding in advertisements. "Compounding" refers to the
fact that, if dividends or other distributions of a Fund investment are
reinvested by being paid in additional Fund shares, any future income or capital
appreciations of a Fund would increase the value, not only of the original Fund
investment, but also of the additional Fund shares received through
reinvestment. As a result, the value of the
-40-
<PAGE>
Fund investment would increase more quickly than if dividends or other
distributions had been paid in cash. The Funds may also include discussions or
illustrations of the potential investment goals of a prospective investor,
investment management techniques, policies or investment suitability of a Fund,
economic conditions, the effects of inflation and historical performance of
various asset classes, including but not limited to, stocks, bonds and Treasury
bills. From time to time advertisements, sales literature or communications to
shareholders may summarize the substance of information contained in shareholder
reports (including the investment composition of a Fund), as well as the views
of the Investment Adviser as to current market, economy, trade and interest rate
trends, legislative, regulatory and monetary developments, investment strategies
and related matters believed to be of relevance to a Fund. The Funds may also
include in advertisements charts, graphs or drawings which illustrate the
potential risks and rewards of investment in various investment vehicles,
including but not limited to, stocks, bonds, Treasury bills and Shares of a
Fund. In addition, advertisement, sales literature or shareholder communications
may include a discussion of certain attributes or benefits to be derived by an
investment in a Fund. Such advertisements or communicators may include symbols,
headlines or other material which highlight or summarize the information
discussed in more detail therein.
MISCELLANEOUS
-------------
As used in the Prospectuses, "assets belonging to a Fund" means the
consideration received upon the issuance of Shares in the Fund, together with
all income, earnings, profits, and proceeds derived from the investment thereof,
including any proceeds from the sale of such investments, any funds or payments
derived from any reinvestment of such proceeds, and a portion of any general
assets of the Company involved not belonging to a particular portfolio of that
Company. In determining the net asset value of a Fund's Shares, assets
belonging to the Fund are charged with the direct liabilities in respect of that
Fund and with a share of the general liabilities of the Company involved which
are normally allocated in proportion to the relative asset values of the
Company's portfolios at the time of allocation. Subject to the provisions of
the Companies' Charters, determinations by the Boards of Directors as to the
direct and allocable liabilities and the allocable portion of any general assets
with respect to a particular Fund are conclusive.
As of July 14, 1997, U.S. Trust and its affiliates held of record
substantially all of the Companies' outstanding shares as agent or custodian for
their customers, but did not own such shares beneficially because they did not
have voting or investment discretion with respect to such shares.
-41-
<PAGE>
As of July 14, 1997, the name, address and percentage ownership of
each person that beneficially owned 5% or more of the outstanding shares of a
Fund were as follows: (i) Short-Term Tax-Exempt Securities Fund: G.L. and J.E.
-------------------------------------
Swenson, c/o United States Trust Company of New York, 114 West 47th Street, New
York, New York 10036, 5.61%; (ii) Short-Term Government Securities Fund: Modern
-------------------------------------
Language Association of America, c/o United States Trust Company of New York,
114 West 47th Street, New York, New York 10036, 5.15%; and (iii) Managed Income
--------------
Fund: U.S. Trust Retirement Fund, c/o United States Trust Company of New York,
- ----
114 West 47th Street, New York, New York 10036, 42.20%.
FINANCIAL STATEMENTS
--------------------
The audited financial statements and notes thereto in the Companies'
Annual Reports to Shareholders for the fiscal year ended March 31, 1997 (the
"1997 Annual Reports") for the Funds are incorporated in this Statement of
Additional Information by reference. No other parts of the 1997 Annual Reports
are incorporated by reference herein. The financial statements included in the
1997 Annual Reports for the ST Government, IT Income, Managed Income, Short-Term
Tax-Exempt, IT Tax-Exempt and LT Tax-Exempt Funds have been audited by the
Companies' independent auditors, Ernst & Young LLP, whose reports thereon also
appear in the 1997 Annual Reports and are incorporated herein by reference.
Such financial statements have been incorporated herein in reliance upon such
reports given upon the authority of such firm as experts in accounting and
auditing. Additional copies of the 1997 Annual Reports may be obtained at no
charge by telephoning CGFSC at the telephone number appearing on the front page
of this Statement of Additional Information.
-42-
<PAGE>
APPENDIX A
----------
COMMERCIAL PAPER RATINGS
- ------------------------
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment of debt considered short-term in the relevant
market. The following summarizes the rating categories used by Standard and
Poor's for commercial paper:
"A-1" - The highest category indicates that the degree of safety
regarding timely payment is strong. Those issues determined to possess
extremely strong safety characteristics are denoted with a plus sign (+)
designation.
"A-2" - Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated "A-1."
"A-3" - Issues carrying this designation have adequate capacity for
timely payment. They are, however, more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
"B" - Issues are regarded as having only a speculative capacity for
timely payment.
"C" - This rating is assigned to short-term debt obligations with a
doubtful capacity for payment.
"D" - Issues are in payment default.
Moody's commercial paper ratings are opinions of the ability of
issuers to repay punctually promissory obligations not having an original
maturity in excess of 9 months. The following summarizes the rating categories
used by Moody's for commercial paper:
"Prime-1" - Issuers or related supporting institutions have a superior
capacity for repayment of short-term promissory obligations. Prime-1 repayment
capacity will normally be evidenced by the following characteristics: leading
market positions in well established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on debt
and ample asset protection; broad margins in earning coverage of fixed financial
charges and high internal cash generation; and well established access to a
range of financial markets and assured sources of alternate liquidity.
A-1
<PAGE>
"Prime-2" - Issuers or related supporting institutions have a strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternative liquidity is maintained.
"Prime-3" - Issuers or related supporting institutions have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuers do not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps for investment grade
commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps
employs three designations, "D-1+," "D-1" and "D-1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
"D-1+" - Debt possesses highest certainty of timely payment. Short-
term liquidity, including internal operating factors and/or access to
alternative sources of funds, is outstanding, and safety is just below risk-free
U.S. Treasury short-term obligations.
"D-1" - Debt possesses very high certainty of timely payment.
Liquidity factors are excellent and supported by good fundamental protection
factors. Risk factors are minor.
"D-1-" - Debt possesses high certainty of timely payment. Liquidity
factors are strong and supported by good fundamental protection factors. Risk
factors are very small.
"D-2" - Debt possesses good certainty of timely payment. Liquidity
factors and company fundamentals are sound. Although ongoing funding needs may
enlarge total financing requirements, access to capital markets is good. Risk
factors are small.
"D-3" - Debt possesses satisfactory liquidity and other protection
factors qualify issue as investment grade. Risk
A-2
<PAGE>
factors are larger and subject to more variation. Nevertheless, timely payment
is expected.
"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to ensure against disruption in debt service.
Operating factors and market access may be subject to a high degree of
variation.
"D-5" - Issuer has failed to meet scheduled principal and/or interest
payments.
Fitch short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years. The
following summarizes the rating categories used by Fitch for short-term
obligations:
"F-1+" - Securities possess exceptionally strong credit quality.
Issues assigned this rating are regarded as having the strongest degree of
assurance for timely payment.
"F-1" - Securities possess very strong credit quality. Issues
assigned this rating reflect an assurance of timely payment only slightly less
in degree than issues rated "F-1+."
"F-2" - Securities possess good credit quality. Issues assigned this
rating have a satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as the "F-1+" and "F-1" ratings.
"F-3" - Securities possess fair credit quality. Issues assigned this
rating have characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause these
securities to be rated below investment grade.
"F-S" - Securities possess weak credit quality. Issues assigned this
rating have characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial and
economic conditions.
"D" - Securities are in actual or imminent payment default.
Fitch may also use the symbol "LOC" with its short-term ratings to
indicate that the rating is based upon a letter of credit issued by a commercial
bank.
Thomson BankWatch short-term ratings assess the likelihood of an
untimely or incomplete payment of principal or
A-3
<PAGE>
interest of unsubordinated instruments having a maturity of one year or less
which are issued by United States commercial banks, thrifts and non-bank banks;
non-United States banks; and broker-dealers. The following summarizes the
ratings used by Thomson BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's highest
rating category and indicates a very high degree of likelihood that principal
and interest will be paid on a timely basis.
"TBW-2" - This designation indicates that while the degree of safety
regarding timely payment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated "TBW-1."
"TBW-3" - This designation represents the lowest investment grade
category and indicates that while the debt is more susceptible to adverse
developments (both internal and external) than obligations with higher ratings,
capacity to service principal and interest in a timely fashion is considered
adequate.
"TBW-4" - This designation indicates that the debt is regarded as non-
investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an
original maturity of less than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for short-term debt ratings:
"A1+" - Obligations which posses a particularly strong credit feature
are supported by the highest capacity for timely repayment.
"A1" - Obligations are supported by the highest capacity for timely
repayment.
"A2" - Obligations are supported by a good capacity for timely
repayment.
"A3" - Obligations are supported by a satisfactory capacity for timely
repayment.
"B" - Obligations for which there is an uncertainty as to the capacity
to ensure timely repayment.
"C" - Obligations for which there is a high risk of default or which
are currently in default.
A-4
<PAGE>
CORPORATE AND MUNICIPAL LONG-TERM DEBT RATINGS
- ----------------------------------------------
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"AAA" - This designation represents the highest rating assigned by
Standard & Poor's to a debt obligation and indicates an extremely strong
capacity to pay interest and repay principal.
"AA" - Debt is considered to have a very strong capacity to pay
interest and repay principal and differs from AAA issues only in small degree.
"A" - Debt is considered to have a strong capacity to pay interest and
repay principal although such issues are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher-rated categories.
"BBB" - Debt is regarded as having an adequate capacity to pay
interest and repay principal. Whereas such issues normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher-rated categories.
"BB," "B," "CCC," "CC" and "C" - Debt is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. "BB" indicates the
lowest degree of speculation and "C" the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
"BB" - Debt has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-" rating.
"B" - Debt has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The "B" rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied "BB" or "BB-" rating.
A-5
<PAGE>
"CCC" - Debt has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The "CCC" rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
"B" or "B-" rating.
"CC" - This rating is typically applied to debt subordinated to senior
debt that is assigned an actual or implied "CCC" rating.
"C" - This rating is typically applied to debt subordinated to senior
debt which is assigned an actual or implied "CCC-" debt rating. The "C" rating
may be used to cover a situation where a bankruptcy petition has been filed, but
debt service payments are continued.
"CI" - This rating is reserved for income bonds on which no interest
is being paid.
"D" - Debt is in payment default. This rating is used when interest
payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S & P believes that such
payments will be made during such grace period. "D" rating is also used upon
the filing of a bankruptcy petition if debt service payments are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC" may be
modified by the addition of a plus or minus sign to show relative standing
within the major rating categories.
"r" - This rating is attached to highlight derivative, hybrid, and
certain other obligations that S & P believes may experience high volatility or
high variability in expected returns due to non-credit risks. Examples of such
obligations are: securities whose principal or interest return is indexed to
equities, commodities, or currencies; certain swaps and options; and interest
only and principal only mortgage securities. The absence of an "r" symbol
should not be taken as an indication that an obligation will exhibit no
volatility or variability in total return.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"Aaa" - Bonds are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally
stable margin and
A-6
<PAGE>
principal is secure. While the various protective elements are likely to
change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
"Aa" - Bonds are judged to be of high quality by all standards.
Together with the "Aaa" group they comprise what are generally known as high-
grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in "Aaa" securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in "Aaa"
securities.
"A" - Bonds possess many favorable investment attributes and are to be
considered as upper medium-grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
"Baa" - Bonds considered medium-grade obligations, i.e., they are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great length of time.
Such bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
"Ba," "B," "Caa," "Ca," and "C" - Bonds that possess one of these
ratings provide questionable protection of interest and principal ("Ba"
indicates some speculative elements; "B" indicates a general lack of
characteristics of desirable investment; "Caa" represents a poor standing; "Ca"
represents obligations which are speculative in a high degree; and "C"
represents the lowest rated class of bonds). "Caa," "Ca" and "C" bonds may be in
default.
Con. (---) - Bonds for which the security depends upon the completion
of some act or the fulfillment of some condition are rated conditionally. These
are bonds secured by (a) earnings of projects under construction, (b) earnings
of projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
(P)... - When applied to forward delivery bonds, indicates that the
rating is provisional pending delivery of the bonds. The rating may be revised
prior to delivery if changes occur in the legal documents or the underlying
credit quality of the bonds.
A-7
<PAGE>
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's
believes possess the strongest investment attributes are designated by the
symbols, Aa1, A1, Baa1, Ba1 and B1.
The following summarizes the long-term debt ratings used by Duff &
Phelps for corporate and municipal long-term debt:
"AAA" - Debt is considered to be of the highest credit quality. The
risk factors are negligible, being only slightly more than for risk-free U.S.
Treasury debt.
"AA" - Debt is considered of high credit quality. Protection factors
are strong. Risk is modest but may vary slightly from time to time because of
economic conditions.
"A" - Debt possesses protection factors which are average but
adequate. However, risk factors are more variable and greater in periods of
economic stress.
"BBB" - Debt possesses below average protection factors but such
protection factors are still considered sufficient for prudent investment.
Considerable variability in risk is present during economic cycles.
"BB," "B," "CCC," "DD," and "DP" - Debt that possesses one of these
ratings is considered to be below investment grade. Although below investment
grade, debt rated "BB" is deemed likely to meet obligations when due. Debt
rated "B" possesses the risk that obligations will not be met when due. Debt
rated "CCC" is well below investment grade and has considerable uncertainty as
to timely payment of principal, interest or preferred dividends. Debt rated
"DD" is a defaulted debt obligation, and the rating "DP" represents preferred
stock with dividend arrearages.
To provide more detailed indications of credit quality, the "AA," "A,"
"BBB," "BB" and "B" ratings may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within these major categories.
The following summarizes the highest four ratings used by Fitch for
corporate and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably foreseeable
events.
"AA" - Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong
A-8
<PAGE>
as bonds rated "AAA." Because bonds rated in the "AAA" and "AA" categories are
not significantly vulnerable to foreseeable future developments, short-term debt
of these issuers is generally rated "F-1+."
"A" - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
To provide more detailed indications of credit quality, the Fitch
ratings from and including "AA" to "BBB" may be modified by the addition of a
plus (+) or minus (-) sign to show relative standing within these major rating
categories.
IBCA assesses the investment quality of unsecured debt with an
original maturity of more than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for long-term debt ratings:
"AAA" - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial, such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk substantially.
"AA" - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial, such that adverse changes in business, economic or financial
conditions may increase investment risk, albeit not very significantly.
"A" - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is strong,
although adverse changes in business, economic or financial conditions may lead
to increased investment risk.
"BBB" - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of
A-9
<PAGE>
principal and interest is adequate, although adverse changes in business,
economic or financial conditions are more likely to lead to increased investment
risk than for obligations in other categories.
"BB," "B," "CCC," "CC," and "C" - Obligations are assigned one of
these ratings where it is considered that speculative characteristics are
present. "BB" represents the lowest degree of speculation and indicates a
possibility of investment risk developing. "C" represents the highest degree of
speculation and indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating below
"AAA" to denote relative status within major rating categories.
Thomson BankWatch assesses the likelihood of an untimely repayment of
principal or interest over the term to maturity of long term debt and preferred
stock which are issued by United States commercial banks, thrifts and non-bank
banks; non-United States banks; and broker-dealers. The following summarizes
the rating categories used by Thomson BankWatch for long-term debt ratings:
"AAA" - This designation represents the highest category assigned by
Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is extremely high.
"AA" - This designation indicates a very strong ability to repay
principal and interest on a timely basis with limited incremental risk compared
to issues rated in the highest category.
"A" - This designation indicates that the ability to repay principal
and interest is strong. Issues rated "A" could be more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
"BBB" - This designation represents Thomson BankWatch's lowest
investment grade category and indicates an acceptable capacity to repay
principal and interest. Issues rated "BBB" are, however, more vulnerable to
adverse developments (both internal and external) than obligations with higher
ratings.
"BB," "B," "CCC," and "CC," - These designations are assigned by
Thomson BankWatch to non-investment grade long-term debt. Such issues are
regarded as having speculative characteristics regarding the likelihood of
timely payment of
A-10
<PAGE>
principal and interest. "BB" indicates the lowest degree of speculation and
"CC" the highest degree of speculation.
"D" - This designation indicates that the long-term debt is in
default.
PLUS (+) OR MINUS (-) - The ratings from "AAA" through "CC" may
include a plus or minus sign designation which indicates where within the
respective category the issue is placed.
MUNICIPAL NOTE RATINGS
- ----------------------
A Standard and Poor's rating reflects the liquidity concerns and
market access risks unique to notes due in three years or less. The following
summarizes the ratings used by Standard & Poor's Ratings Group for municipal
notes:
"SP-1" - The issuers of these municipal notes exhibit very strong or
strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit satisfactory
capacity to pay principal and interest.
"SP-3" - The issuers of these municipal notes exhibit speculative
capacity to pay principal and interest.
Moody's ratings for state and municipal notes and other short-term
loans are designated Moody's Investment Grade ("MIG") and variable rate demand
obligations are designated Variable Moody's Investment Grade ("VMIG"). Such
ratings recognize the differences between short-term credit risk and long-term
risk. The following summarizes the ratings by Moody's Investors Service, Inc.
for short-term notes:
"MIG-1"/"VMIG-1" - Loans bearing this designation are of the best
quality, enjoying strong protection by established cash flows, superior
liquidity support or demonstrated broad-based access to the market for
refinancing.
"MIG-2"/"VMIG-2" - Loans bearing this designation are of high quality,
with margins of protection ample although not so large as in the preceding
group.
"MIG-3"/"VMIG-3" - Loans bearing this designation are of favorable
quality, with all security elements accounted for but lacking the undeniable
strength of the preceding grades. Liquidity and cash flow protection may be
narrow and market access for refinancing is likely to be less well established.
A-11
<PAGE>
"MIG-4"/"VMIG-4" - Loans bearing this designation are of adequate
quality, carrying specific risk but having protection commonly regarded as
required of an investment security and not distinctly or predominantly
speculative.
"SG" - Loans bearing this designation are of speculative quality and
lack margins of protection.
Fitch and Duff & Phelps use the short-term ratings described under
Commercial Paper Ratings for municipal notes.
A-12
<PAGE>
EXCELSIOR TAX-EXEMPT FUNDS, INC.
New York Intermediate-Term Tax-Exempt Fund
STATEMENT OF ADDITIONAL INFORMATION
August 1, 1997
This Statement of Additional Information is not a prospectus but should be read
in conjunction with the current prospectus for the New York Intermediate-Term
Tax-Exempt Fund (the "Fund"), an investment portfolio of Excelsior Tax-Exempt
Funds, Inc. ("Excelsior Tax-Exempt Fund") dated August 1, 1997 (the
"Prospectus"). Much of the information contained in this Statement of
Additional Information expands upon the subjects discussed in the Prospectus.
No investment in shares of the Fund ("Shares") should be made without reading
the Prospectus. A copy of the Prospectus may be obtained by writing Excelsior
Tax-Exempt Fund c/o Chase Global Funds Services Company, 73 Tremont Street,
Boston, MA 02108-3913 or by calling (800) 446-1012.
<PAGE>
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
INVESTMENT OBJECTIVE AND POLICIES............... 1
Additional Information on Portfolio
Instruments.............................. 1
Risk Factors Relating to
New York Municipal Obligations........... 7
Additional Investment Limitations.......... 24
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION.. 25
INVESTOR PROGRAMS............................... 26
Systematic Withdrawal Plan................. 26
Exchange Privilege......................... 27
Other Investor Programs.................... 28
DESCRIPTION OF CAPITAL STOCK.................... 28
MANAGEMENT OF THE FUND.......................... 30
Directors and Officers..................... 30
Investment Advisory and Administration
Agreements............................... 37
Shareholder Organizations.................. 38
Expenses................................... 39
Custodian and Transfer Agent............... 40
PORTFOLIO TRANSACTIONS.......................... 41
INDEPENDENT AUDITORS............................ 43
COUNSEL......................................... 43
ADDITIONAL INFORMATION CONCERNING TAXES......... 43
Federal.................................... 43
Taxation of Certain Financial Instruments.. 45
PERFORMANCE AND YIELD INFORMATION............... 48
MISCELLANEOUS................................... 51
FINANCIAL STATEMENTS............................ 52
APPENDIX A A-1
</TABLE>
-i-
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
---------------------------------
The investment objective of the Fund is to provide New York investors
with as high a level of current interest income exempt from Federal income tax,
and, to the extent possible, from New York state and New York City personal
income taxes, as is consistent with relative stability of principal. Under
normal market conditions, at least 80% of the Fund's assets will be invested in
Municipal Obligations (as defined in the Prospectus), and at least 65% of the
Fund's assets will be invested in New York Municipal Obligations (as defined in
the Prospectus). The following policies supplement the Fund's investment
objective and policies as set forth in the Prospectus.
Additional Information on Portfolio Instruments
- -----------------------------------------------
Municipal Obligations
---------------------
Municipal Obligations include debt obligations issued by governmental
entities to obtain funds for various public purposes, including the construction
of a wide range of public facilities, the refunding of outstanding obligations,
the payment of general operating expenses, and the extension of loans to public
institutions and facilities. Private activity bonds that are issued by or on
behalf of public authorities to finance various privately operated facilities
are included within the term "Municipal Obligations" only if the interest paid
thereon is exempt from general Federal income tax and not treated as a specific
tax preference item under the Federal alternative minimum tax.
The two principal classifications of Municipal Obli gations are
"general obligation" and "revenue" issues, but the Fund's portfolio may also
include "moral obligation" issues, which are normally issued by special-purpose
authorities. There are, of course, variations in the quality of Municipal
Obligations, both within a particular classification and between
classifications, and the yields on Municipal Obligations depend upon a variety
of factors, including general money market conditions, the financial condition
of the issuer, general conditions of the municipal bond market, the size of a
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of Moody's Investors Service, Inc. ("Moody's") and Standard
& Poor's Ratings Group ("S&P") described in the Prospectus and Appendix A hereto
represent their opinion as to the quality of Municipal Obligations. It should
be emphasized that these ratings are general and are not absolute standards of
quality, and Municipal Obligations with the same maturity, interest rate, and
rating may have different yields while Municipal Obligations of the same
maturity and interest rate with different ratings may have the same yield.
Subsequent
-1-
<PAGE>
to its purchase by the Fund, an issue of Municipal Obligations may cease to be
rated, or its rating may be reduced below the minimum rating required for
purchase by the Fund. United States Trust Company of New York ("U.S. Trust New
York") and U.S. Trust Company of Connecticut ("U.S. Trust Connecticut" and,
collectively with U.S. Trust New York, "U.S. Trust" or the "Investment
Adviser"), the Fund's investment adviser ("U.S. Trust" or the "Investment
Adviser"), will consider such an event in determining whether the Fund should
continue to hold the obligation.
The payment of principal and interest on most securi ties purchased by
the Fund will depend upon the ability of the issuers to meet their obligations.
Each state, the District of Columbia, each of their political subdivisions,
agencies, instrumentalities and authorities, and each multistate agency of which
a state is a member, is a separate "issuer" as that term is used in this
Statement of Additional Information and the Fund's Prospectus. The non-
governmental user of facilities financed by private activity bonds is also
considered to be an "issuer." An issuer's obligations under its Municipal
Obligations are subject to the provisions of bankruptcy, insolvency, and other
laws affecting the rights and remedies of creditors, such as the Federal
Bankruptcy Code, and laws, if any, which may be enacted by Federal or state
legislatures extending the time for payment of principal or interest, or both,
or imposing other constraints upon enforcement of such obligations or upon the
ability of municipalities to levy taxes. The power or ability of an issuer to
meet its obligations for the payment of interest on and principal of its
Municipal Obligations may be materially adversely affected by litigation or
other conditions.
Private activity bonds are issued to obtain funds to provide, among
other things, privately operated housing facil ities, pollution control
facilities, convention or trade show facilities, mass transit, airport, port or
parking facilities and certain local facilities for water supply, gas,
electricity or sewage or solid waste disposal. Private activity bonds are also
issued to privately held or publicly owned corporations in the financing of
commercial or industrial facilities. State and local governments are authorized
in most states to issue private activity bonds for such purposes in order to
encourage corporations to locate within their communities. The principal and
interest on these obligations may be payable from the general revenues of the
users of such facilities.
From time to time, proposals have been introduced before Congress for
the purpose of restricting or eliminating the Federal income tax exemption for
interest on Municipal Obligations. For example, under the Tax Reform Act of
1986, as amended, interest on certain private activity bonds must be included in
an investor's alternative minimum taxable income, and
-2-
<PAGE>
corporate investors must treat all tax-exempt interest as an item of tax
preference. Excelsior Tax-Exempt Fund cannot, of course, predict what
legislation may be proposed in the future regarding the income tax status of
interest on Municipal Obligations, or which proposals, if any, might be enacted.
Such proposals, while pending or if enacted, might materially adversely affect
the availability of Municipal Obligations for investment by the Fund and the
liquidity and value of its portfolio. In such an event, the Fund would
reevaluate its investment objective and policies and consider possible changes
in its structure or possible dissolution.
Opinions relating to the validity of Municipal Obli gations and to the
exemption of interest thereon from Federal income tax are rendered by bond
counsel to the respective issuers at the time of issuance. Neither the Fund nor
its Investment Adviser will review the proceedings relating to the issuance of
Municipal Obligations or the basis for such opinions.
Money Market Instruments
------------------------
Certificates of deposit acquired by the Fund within the limits set
forth in the Prospectus will be those of (i) domestic branches of U.S. banks
which are members of the Federal Reserve System or are insured by the Bank
Insurance Fund of the Federal Deposit Insurance Corporation ("FDIC"), or (ii)
savings and loan associations which are insured by the Savings Association
Insurance Fund of the FDIC. (The foregoing limitation does not preclude the Fund
from acquiring Municipal Obligations which are backed by letters of credit
issued by foreign banks.)
Tax-exempt commercial paper purchased by the Fund will consist of
issues rated at the time of purchase "A-2" or higher by S&P or "Prime-2" or
better by Moody's or, if not rated, determined to be of comparable quality by
the Investment Adviser. These rating symbols are described in Appendix A
hereto.
Insured Municipal Obligations
-----------------------------
The Fund may purchase Municipal Obligations which are insured as to
timely payment of principal and interest at the time of purchase. The insurance
policies will usually be obtained by the issuer of the bond at the time of its
original issuance. Bonds of this type will be acquired only if at the time of
purchase they satisfy quality requirements generally applicable to Municipal
Obligations as described in the Prospectus. Although insurance coverage for the
Municipal Obligations held by the Fund reduces credit risk by insuring that the
Fund will receive timely payment of principal and interest, it does not protect
against market fluctuations caused by changes in interest rates and other
factors. The Fund may invest more
-3-
<PAGE>
than 25% of its net assets in Municipal Obligations covered by insurance
policies.
Repurchase Agreements
---------------------
The repurchase price under the repurchase agreements described in the
Prospectus generally equals the price paid by the Fund plus interest negotiated
on the basis of current short-term rates (which may be more or less than the
rate on securities underlying the repurchase agreement). Securities subject to
repurchase agreements are held by the Fund's custodian (or sub-custodian) or in
the Federal Reserve/Treasury book-entry system. Repurchase agreements are
considered loans by the Fund under the Investment Company Act of 1940 (the "1940
Act").
When-Issued and Forward Transactions
------------------------------------
When the Fund agrees to purchase securities on a "when-issued" or
forward commitment basis, the custodian will set aside cash or liquid portfolio
securities equal to the amount of the commitment in a separate account.
Normally, the custodian will set aside portfolio securities to satisfy a
purchase commitment, and, in such case, the Fund may be required subsequently to
place additional assets in the separate account in order to ensure that the
value of the account remains equal to the amount of the Fund's commitment. It
may be expected that the Fund's net assets will fluctuate to a greater degree
when it sets aside portfolio securities to cover such purchase commitments than
when it sets aside cash. Because the Fund will set aside cash or liquid assets
to satisfy its purchase commitments in the manner described, the Fund's
liquidity and ability to manage its portfolio might be affected in the event its
forward commitments or commitments to purchase "when-issued" securities ever
exceeded 25% of the value of its assets.
The Fund will purchase securities on a "when-issued" or forward
commitment basis only with the intention of completing the transaction. If
deemed advisable as a matter of investment strategy, however, the Fund may
dispose of or renegotiate a commitment after it is entered into, and may sell
securities it has committed to purchase before those securities are delivered to
the Fund on the settlement date. In these cases, the Fund may realize a taxable
capital gain or loss.
When the Fund engages in "when-issued" or forward commitment
transactions, it relies on the other party to consummate the trade. Failure of
such other party to do so may result in the Fund incurring a loss or missing an
opportunity to obtain a price considered to be advantageous.
The market value of the securities underlying a "when-issued" purchase
or a forward commitment to purchase securities
-4-
<PAGE>
and any subsequent fluctuations in their market value are taken into account
when determining the market value of the Fund starting on the day the Fund
agrees to purchase the securities. The Fund does not earn interest on the
securities it has committed to purchase until they are paid for and delivered on
the settlement date.
Stand-By Commitments
--------------------
The Fund may acquire "stand-by commitments" with respect to Municipal
Obligations held by it. Under a "stand-by commitment," a dealer or bank agrees
to purchase from the Fund, at the Fund's option, specified Municipal Obligations
at a specified price. The amount payable to the Fund upon its exercise of a
"stand-by commitment" is normally (i) the Fund's acquisition cost of the
Municipal Obligations (excluding any accrued interest which the Fund paid on
their acquisition), less any amortized market premium or plus any amortized
market or original issue discount during the period the Fund owned the
securities, plus (ii) all interest accrued on the securities since the last
interest payment date during that period. "Stand-by commitments" are
exercisable by the Fund at any time before the maturity of the underlying
Municipal Obligations, and may be sold, transferred or assigned by the Fund only
with the underlying instruments.
The Fund expects that "stand-by commitments" will generally be
available without the payment of any direct or indirect consideration. However,
if necessary or advisable, the Fund may pay for a "stand-by commitment" either
separately in cash or by paying a higher price for securities which are acquired
subject to the commitment (thus reducing the yield to maturity otherwise
available for the same securities). Where the Fund has paid any consideration
directly or indirectly for a "stand-by commitment," its cost will be reflected
as unrealized depreciation for the period during which the commitment was held
by the Fund.
The Fund intends to enter into "stand-by commitments" only with banks
and broker/dealers which, in the Investment Adviser's opinion, present minimal
credit risks. In evaluating the creditworthiness of the issuer of a "stand-by
commitment," the Investment Adviser will review periodically the issuer's
assets, liabilities, contingent claims and other relevant financial information.
Futures Contracts
-----------------
The Fund may invest in interest rate futures contracts and municipal
bond index futures contracts. Futures contracts will not be entered into for
speculative purposes, but to hedge risks associated with the Fund's securities
investments.
-5-
<PAGE>
Positions in futures contracts may be closed out only on an exchange which
provides a secondary market for such futures. However, there can be no
assurance that a liquid secondary market will exist for any particular futures
contract at any specific time. Thus, it may not be possible to close a futures
position. In the event of adverse price movements, the Fund would continue to
be required to make daily cash payments to maintain its required margin. In
such situations, if the Fund has insufficient cash, it may have to sell
portfolio securities to meet daily margin requirements at a time when it may be
disadvantageous to do so. In addition, the Fund may be required to make
delivery of the instruments underlying futures contracts it holds. The
inability to close options and futures positions also could have an adverse
impact on the Fund's ability to effectively hedge.
Successful use of futures by the Fund is also subject to the
Investment Adviser's ability to correctly predict movements in the direction of
the market. For example, if the Fund has hedged against the possibility of a
decline in the market adversely affecting securities held by it and securities
prices increase instead, the Fund will lose part or all of the benefit to the
increased value of its securities which it has hedged because it will
approximately equal offsetting losses in its futures positions. In addition, in
some situations, if the Fund has insufficient cash, it may have to sell
securities to meet daily variation margin requirements. Such sale of securities
may be, but will not necessarily be, at increased prices which reflect the
rising market. The Fund may have to sell securities at a time when it may be
disadvantageous to do so.
The risk of loss in trading futures contracts in some strategies can
be substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit, before any deduction for the
transaction costs, if the contract were closed out. Thus, a purchase or sale of
a futures contract may result in losses in excess of the amount invested in the
contract.
Utilization of futures transactions by the Fund involves the risk of
loss by the Fund of margin deposits in the
-6-
<PAGE>
event of bankruptcy of a broker with whom the Fund has an open position in a
futures contract or related option.
Most futures exchanges limit the amount of fluctuation permitted in
futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.
The trading of futures contracts is also subject to the risk of
trading halts, suspensions, exchange or clearing house equipment failures,
government intervention, insolvency of a brokerage firm or clearing house or
other disruptions of normal trading activity, which could at times make it
difficult or impossible to liquidate existing positions or to recover excess
variation margin payments.
Miscellaneous
-------------
The Fund may not invest in oil, gas, or mineral leases.
Risk Factors Relating to New York Municipal Obligations
- -------------------------------------------------------
Some of the significant financial considerations relating to the
Fund's investments in New York Municipal Obligations are summarized below. This
summary information is not intended to be a complete description and is
principally derived from official statements relating to issues of New York
Municipal Obligations that were available prior to the date of this Statement of
Additional Information. The accuracy and completeness of the information
contained in those official statements have not been independently verified.
STATE ECONOMY. New York is the third most populous state in the nation and has
- -------------
a relatively high level of personal wealth. The State's economy is diverse with
a comparatively large share of the nation's finance, insurance, transportation,
communications and services employment, and a very small share of the nation's
farming and mining activity. The State has a declining proportion of its
workforce engaged in manufacturing, and an increasing proportion engaged in
service industries. New York City (the "City"), which is the most populous city
in the State
-7-
<PAGE>
and nation and is the center of the nation's largest metropolitan area, accounts
for a large portion of the State's population and personal income.
The State has historically been one of the wealthiest states in the
nation. For decades, however, the State has grown more slowly than the nation
as a whole, gradually eroding its relative economic position.
There can be no assurance that the State economy will not experience
worse-than-predicted results in the 1997-1998 fiscal year, with corresponding
material and adverse effects on the State's projections of receipts and
disbursements.
State per capita personal income has historically been significantly
higher than the national average, although the ratio has varied substantially.
Between 1975 and 1990, total employment grew by 21.3 percent while the labor
force grew only by 15.7 percent, unemployment fell from 9.5 percent to 5.2
percent of the labor force. In 1991 and 1992, however, total employment in the
State fell by 5.5 percent. As a result, the unemployment rate rose to 8.5
percent reflecting a recession that has had a particularly strong impact on the
entire Northeast. Calendar years 1993 and 1994 saw only a partial recovery,
with the unemployment rate decreasing to 7.8 percent and 6.9 percent,
respectively. The unemployment rate for 1995 was 6.3 percent and was projected
by the Division of Budget to be 6.2 percent for 1996.
STATE BUDGET. The State Constitution requires the governor (the "Governor") to
- ------------
submit to the State legislature (the "Legislature") a balanced executive budget
which contains a complete plan of expenditures for the ensuing fiscal year and
all moneys and revenues estimated to be available therefor, accompanied by bills
containing all proposed appropriations or reappropriations and any new or
modified revenue measures to be enacted in connection with the executive budget.
The entire plan constitutes the proposed State financial plan for that fiscal
year. The Governor is required to submit to the Legislature quarterly budget
updates which include a revised cash-basis state financial plan, and an
explanation of any changes from the previous state financial plan.
The State's budget for the 1996-97 fiscal year was enacted by the
Legislature on July 13, 1996, more than three months after the start of the
fiscal year. Prior to adoption of the budget, the Legislature enacted
appropriations for disbursements considered to be necessary for State operations
and other purposes, including necessary appropriations for all State-supported
debt service. The State Financial Plan for the 1996-97 fiscal year was
formulated on July 25, 1996 and was based on the State's budget as enacted by
the Legislature and signed into law
-8-
<PAGE>
by the Governor, as well as actual results for the first quarter of the current
fiscal year (the "1996-97 State Financial Plan").
The Governor presented his 1997-98 Executive Budget to the Legislature
on January 14, 1997. It is expected that the Governor will prepare amendments
to his Executive Budget as permitted under law. There can be no assurance that
the Legislature will enact the Executive Budget as proposed by the Governor into
law, or that the State's adopted budget projections will not differ materially
and adversely from the projections set forth therein.
The 1997-98 Executive Budget projected balance on a cash basis in the
General Fund. It reflected a continuing strategy of substantially reduced State
spending, including program restructurings, reductions in social welfare
spending, and efficiency and productivity initiatives. Total General Fund
receipts and transfers from other funds were projected to be $32.88 billion, a
decrease of $88 million from total receipts projected in the 1996-97 fiscal
year. Total General Fund disbursements and transfers to other funds were
projected to be $32.84 billion, a decrease of $56 million from spending totals
projected for the 1996-1997 fiscal year. As compared to the 1996-97 State
Financial Plan, the 1997-98 Executive Budget proposed a year-to-year decline in
General Fund spending of 0.2 percent. State funds spending (i.e., General Fund
plus other dedicated funds, with the exception of federal aid) was projected to
grow by 1.2 percent. Spending from all governmental funds (excluding transfers)
was proposed to increase by 2.2 percent from the prior fiscal year.
In the 1997-98 Executive Budget, the Governor indicated that, before
taking action to balance the 1997-98 financial plan, the budget forecast
projected an imbalance of almost $2.3 billion. Before reflecting any actions
proposed by the Governor to restrain spending, General Fund disbursements for
1997-98 were projected to grow by approximately 4 percent. This increase would
have resulted from growth in Medicaid, higher fixed costs such as pensions and
debt service, collective bargaining agreements, inflation, and the loss of non-
recurring resources that offset spending in 1996-97. General Fund receipts were
projected to fall by roughly 3 percent. This reduction would have been
attributable to modest growth in the State's economy and underlying tax base,
the loss of non-recurring revenues available in 1996-97 and implementation of
previously enacted tax reduction programs. The 1997-98 Executive Budget
proposed to close this gap primarily through a series of spending reductions and
Medicaid cost containment measures, the use of a portion of the 1996-97
projected budget surplus, and other actions, with a projected 1997-98 closing
fund balance in the General Fund of $397 million.
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The 1997-98 Executive Budget projected General Fund receipts of $33.02
billion and $33.91 billion for 1998-99 and 1999-2000, respectively. The
receipts projections were prepared on the basis of an economic forecast of a
steadily growing national economy, in an environment of low inflation and slow
employment growth. The forecast for the State's economic performance likewise
was for slow but steady economic growth. The receipt projections reflected tax
reductions proposed in the 1997-98 Executive Budget that will reduce receipts by
an estimated $798 million in 1998-99 and at $1.43 billion in 1999-2000. The
bulk of previously enacted tax reductions are annualized in 1997-98 and their
impact in the out years was largely proportional to projected growth in the
underlying tax liability.
Disbursements from the General Fund are projected at $34.60 billion in
1998-99 and $35.93 billion in 1999-2000, before assuming additional spending
efficiencies and/or additional federal revenue maximization. Assuming
implementation of proposed cost containment and other actions proposed in the
1997-98 Executive Budget, annual disbursements for fiscal years 1998-99 and
1999-2000 grow by $1.77 billion and $1.33 billion, respectively.
The Executive Budget contained projections of a potential imbalance in
the 1998-1999 fiscal year of $988 million and in the 1999-2000 fiscal year of
$1.2 billion, assuming implementation of the 1997-1998 Executive Budget
recommendations and implementation of $600 million and $800 million of
unspecified efficiency initiatives and other actions in the 1998-1999 and 1999-
2000 fiscal years, respectively. The Executive Budget stated that the assumed
unspecified efficiency initiatives and other actions for such fiscal years are
comparable with reductions over the past several years, and that the Governor
plans to make additional proposals to limit State spending in order to address
any potential remaining gap.
It is expected that the 1997-98 financial plan will reflect a
continuing strategy of substantially reduced State spending, including agency
consolidations, reductions in the State workforce, and efficiency and
productivity initiatives.
The Division of the Budget believed that the economic assumptions and
projections of receipts and disbursements accompanying the 1997-98 Executive
Budget were reasonable. However, the economic and financial condition of the
State may be affected by various financial, social, economic and political
factors. Those factors can be very complex, can vary from fiscal year to fiscal
year, and are frequently the result of actions taken not only by the State but
also by entities, such as the federal government, that are outside the State's
control. Because of the uncertainty and unpredictability of changes in
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these factors, their impact cannot be fully included in the assumptions
underlying the State's projections. There can be no assurance that the State
economy will not experience results that are worse than predicted, with
corresponding material and adverse effects on the State's financial projections.
To make progress toward addressing recurring budgetary imbalances, the
1997-98 Executive Budget proposed significant actions to align recurring
receipts and disbursements in future fiscal years. However, there can be no
assurance that the Legislature will enact the Governor's proposals or that the
State's actions will be sufficient to preserve budgetary balance or to align
recurring receipts and disbursements in either 1997-98 or in future fiscal
years. In the State's 1997-98 fiscal year and in certain recent fiscal years,
the State has failed to enact a budget prior to the beginning of the State's
fiscal year.
In addition, there has been discussion of additional tax reductions,
beyond those reflected in the State's current projections for 1997-98 and the
out years that, if enacted, could make it more difficult to achieve budget
balance over this period. In particular, modifying the State's sales tax
treatment of clothing has been discussed. The State now receives approximately
$700 million annually under the current tax statutes from taxation on clothing,
and localities receive a roughly equivalent amount.
Uncertainties with regard to both the economy and potential decisions
at the federal level add further pressure on future budget balance in New York
State. Risks to the financial plan include either a financial market or broader
economic "correction" during the period, a risk heightened by the relatively
lengthy expansions currently underway. In addition, a normal "forecast error"
of one percentage point in the expected growth rate could raise or lower
receipts by $600 million during the last year of the projection period.
Potential changes to federal tax law could alter the federal definitions of
income on which many State taxes rely. Similarly, the financial plan assumed no
significant federal disallowances or other actions which could affect State
finances.
On August 22, 1996, the President signed into law the Personal
Responsibility and Work Opportunity Reconciliation Act of 1996. This federal
legislation fundamentally changed the programmatic and fiscal responsibilities
for administration of welfare programs at the federal, state and local levels.
The new law abolishes the federal Aid to Families with Dependent Children
program (AFDC), and creates a new Temporary Assistance to Needy Families program
(TANF) funded with a fixed federal block grant to states. The new law also
imposes (with certain exceptions) a five-year durational limit on TANF
recipients, requires that virtually all recipients be engaged in work or
community service
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activities within two years of receiving benefits, and limits assistance
provided to certain immigrants and other classes of individuals. States are
required to meet work activity participation targets for their TANF caseload;
these requirements are phased in over time. States that fail to meet these
federally mandated job participation rates, or that fail to conform with certain
other federal standards, face potential sanctions in the form of a reduced
federal block grant.
On October 16, 1996, the Governor submitted the State's TANF
implementation plan to the federal government as required under the new federal
welfare law. On December 13, 1996, the State's plan was approved by the federal
government. Legislation will be required to implement the State's TANF plan,
and the Governor has introduced legislation necessary to conform with federal
law.
States are required to comply with the new federal welfare reform law
no later than July 1, 1997. There can be no assurances that the State
Legislature will enact welfare reform proposals as submitted by the Governor and
as required under federal law.
An additional risk to the financial plan arises from the potential
impact of certain litigation now pending against the State, which could produce
adverse effects on the State's projections of receipts and disbursements.
Specifically, in the case of Tug Buster Bouchard et al. v. Wetzler, the Division
of the Budget believed that the court's decision, as interpreted by the State,
would reduce tax revenues by approximately $5 million in 1997-98 and $2 million
thereafter.
RECENT FINANCIAL RESULTS. The General Fund is the principal operating fund of
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the State and is used to account for all financial transactions, except those
required to be accounted for in another fund. It is the State's largest fund
and receives almost all State taxes and other resources not dedicated to
particular purposes.
The General Fund was projected to be balanced on a cash basis for the
1996-97 fiscal year. Total receipts and transfers from other funds were
projected to be $33.17 billion, an increase of $365 million from the prior
fiscal year. Total General Fund disbursements and transfers to other funds were
projected to be $33.12 billion for the 1996-97 fiscal year, an increase of $444
million from the total in the prior fiscal year.
The State's financial position on a GAAP (generally accepted
accounting principles) basis as of March 31, 1996 showed an accumulated deficit
in its combined governmental funds of $1.23 billion, reflecting liabilities of
$14.59 billion and assets of $13.35 billion.
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DEBT LIMITS AND OUTSTANDING DEBT. There are a number of methods by which the
--------------------------------
State of New York may incur debt. Under the State Constitution, the State may
not, with limited exceptions for emergencies, undertake long-term general
obligation borrowing (i.e., borrowing for more than one year) unless the
----
borrowing is authorized in a specific amount for a single work or purpose by the
Legislature and approved by the voters. There is no limitation on the amount of
long-term general obligation debt that may be so authorized and subsequently
incurred by the State.
The State may undertake short-term borrowings without voter approval
(i) in anticipation of the receipt of taxes and revenues, by issuing tax and
revenue anticipation notes, and (ii) in anticipation of the receipt of proceeds
from the sale of duly authorized but unissued general obligation bonds, by
issuing bond anticipation notes. The State may also, pursuant to specific
constitutional authorization, directly guarantee certain obligations of the
State of New York's authorities and public benefit corporations ("Authorities").
Payments of debt service on New York State general obligation and New York
State-guaranteed bonds and notes are legally enforceable obligations of the
State of New York.
The State employs additional long-term financing mechanisms, lease-
purchase and contractual-obligation financings, which involve obligations of
public authorities or municipalities that are State-supported but are not
general obligations of the State. Under these financing arrangements, certain
public authorities and municipalities have issued obligations to finance the
construction and rehabilitation of facilities or the acquisition and
rehabilitation of equipment, and expect to meet their debt service requirements
through the receipt of rental or other contractual payments made by the State.
Although these financing arrangements involve a contractual agreement by the
State to make payments to a public authority, municipality or other entity, the
State's obligation to make such payments is generally expressly made subject to
appropriation by the Legislature and the actual availability of money to the
State for making the payments. The State has also entered into a contractual-
obligation financing arrangement with the Local Government Assistance
Corporation ("LGAC") to restructure the way the State makes certain local aid
payments.
In 1990, as part of a State fiscal reform program, legislation was
enacted creating LGAC, a public benefit corporation empowered to issue long-term
obligations to fund certain payments to local governments traditionally funded
through New York State's annual seasonal borrowing. The legislation empowered
LGAC to issue its bonds and notes in an amount not in excess of $4.7 billion
(exclusive of certain refunding bonds) plus certain other amounts. Over a
period of years, the issuance of these long-term obligations, which were to
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be amortized over no more than 30 years, was expected to eliminate the need for
continued short-term seasonal borrowing. The legislation also dedicated
revenues equal to one-quarter of the four cent State sales and use tax to pay
debt service on these bonds. The legislation also imposed a cap on the annual
seasonal borrowing of the State at $4.7 billion, less net proceeds of bonds
issued by LGAC and bonds issued to provide for capitalized interest, except in
cases where the Governor and the legislative leaders have certified the need for
additional borrowing and provided a schedule for reducing it to the cap. If
borrowing above the cap was thus permitted in any fiscal year, it was required
by law to be reduced to the cap by the fourth fiscal year after the limit was
first exceeded. As of June 1995, LGAC had issued bonds to provide net proceeds
of $4.7 billion, completing the program.
On January 13, 1992, Standard & Poor's Corporation ("Standard &
Poor's") reduced its ratings on the State's general obligation bonds from A to
A- and, in addition, reduced its ratings on the State's moral obligation, lease
purchase, guaranteed and contractual obligation debt. On January 6, 1992,
Moody's Investors Service, Inc. ("Moody's") reduced its ratings on outstanding
limited-liability State lease purchase and contractual obligations from A to
Baa1. On February 28, 1994, Moody's reconfirmed its A rating on the State's
general obligation long-term indebtedness.
The State had anticipated that its capital programs would be financed,
in part, by State and public authorities borrowings in 1996-97. The State had
expected to issue $411 million in general obligation bonds (including $153.6
million for purposes of redeeming outstanding bond anticipation notes) and $154
million in general obligation commercial paper. The Legislature had also
authorized the issuance of up to $101 million in certificates of participation
during the State's 1996-97 fiscal year for equipment purchases. The projection
of the State regarding its borrowings may change if circumstances require.
In November 1996 voters approved a $1.75 billion State general
obligation bond referendum to finance various environmental improvement and
remediation projects. As a result, the amount of general obligation bonds
issued during the 1996-97 fiscal year may increase above the $411 million
currently included in the 1996-97 borrowing plan to finance a portion of this
new program.
Principal and interest payments on general obligation bonds and
interest payments on bond anticipation notes were $735 million for the 1995-96
fiscal year, and were estimated to be $719 million for the 1996-97 fiscal year.
Principal and interest payments on fixed rate and variable rate bonds issued by
LGAC
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were $340 million for the 1995-96 fiscal year, and were estimated to be $323
million for 1996-97.
New York State has never defaulted on any of its general obligation
indebtedness or its obligations under lease-purchase or contractual-obligation
financing arrangements and has never been called upon to make any direct
payments pursuant to its guarantees.
LITIGATION. Certain litigation pending against New York State or its officers
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or employees could have a substantial or long-term adverse effect on New York
State finances. Among the more significant of these cases are those that
involve (1) the validity of agreements and treaties by which various Indian
tribes transferred title to New York State of certain land in central and
upstate New York; (2) certain aspects of New York State's Medicaid policies,
including its rates, regulations and procedures; (3) action against New York
State and New York City officials alleging inadequate shelter allowances to
maintain proper housing; (4) challenges to the practice of reimbursing certain
Office of Mental Health patient care expenses from the client's Social Security
benefits; (5) alleged responsibility of New York State officials to assist in
remedying racial segre gation in the City of Yonkers; (6) challenges by
commercial insurers, employee welfare benefit plans, and health maintenance
organizations to the imposition of surcharges on inpatient hospital bills; (7)
challenges to certain aspects of petroleum business taxes; (8) action alleging
damages resulting from the failure by the State's Department of Environmental
Conservation to timely provide certain data; (9) a challenge to the
constitutionality of a State lottery game; (10) an action seeking reimbursement
from the State for certain costs arising out of the provision of pre-school
services and programs for children with handicapped conditions; and (ii)
challenges to regulations promulgated by the Superintendent of Insurance
establishing excess malpractice premium rates for the 1986-87 through 1995-96
and 1996-97 fiscal years, respectively.
Several actions challenging the constitutionality of legislation
enacted during the 1990 legislative session which changed actuarial funding
methods for determining state and local contributions to state employee
retirement systems have been decided against the State. As a result, the
Comptroller developed a plan to restore the State's retirement systems to prior
funding levels. Such funding is expected to exceed prior levels by $116 million
in fiscal 1996-97, $193 million in fiscal 1997-98, peaking at $241 million in
fiscal 1998-99. Beginning in fiscal 2001-02, State contributions required under
the Comptroller's plan are projected to be less than that required under the
prior funding method. As a result of the United States Supreme Court decision
in the case of State of Delaware v. State of New York, on January 21, 1994, the
State entered into a
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settlement agreement with various parties. Pursuant to all agreements executed
in connection with the action, the State was required to make aggregate payments
of $351.4 million. Annual payments to the various parties will continue through
the State's 2002-03 fiscal year in amounts which will not exceed $48.4 million
in any fiscal year subsequent to the State's 1994-95 fiscal year. Litigation
challenging the constitutionality of the treatment of certain moneys held in a
reserve fund was settled in June 1996 and certain amounts in a Supplemental
Reserve Fund previously credited by the State against prior State and local
pension contributions will be paid in 1998.
The legal proceedings noted above involve State finances, State
programs and miscellaneous tort, real property and contract claims in which the
State is a defendant and the monetary damages sought are substantial. These
proceedings could affect adversely the financial condition of the State.
Adverse developments in these proceedings or the initiation of new proceedings
could affect the ability of the State to maintain a balanced financial plan. An
adverse decision in any of these proceedings could exceed the amount of the
reserve established in the State's financial plan for the payment of judgments
and, therefore, could affect the ability of the State to maintain a balanced
financial plan. In its audited financial statements for the fiscal year ended
March 31, 1996, the State reported its estimated liability for awarded and
anticipated unfavorable judgments to be $474 million.
Although other litigation is pending against New York State, except as
described herein, no current litigation involves New York State's authority, as
a matter of law, to contract indebtedness, issue its obligations, or pay such
indebtedness when it matures, or affects New York State's power or ability, as a
matter of law, to impose or collect significant amounts of taxes and revenues.
AUTHORITIES. The fiscal stability of New York State is related, in part, to the
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fiscal stability of its Authorities, which generally have responsibility for
financing, constructing and operating revenue-producing public benefit
facilities. Authorities are not subject to the constitutional restrictions on
the incurrence of debt which apply to the State itself, and may issue bonds and
notes within the amounts of, and as otherwise restricted by, their legislative
authorization. The State's access to the public credit markets could be
impaired, and the market price of its outstanding debt may be materially and
adversely affected, if any of the Authorities were to default on their
respective obligations, particularly with respect to debt that are State-
supported or State-related. As of September 30, 1995, date of the latest data
available, there were 17 Authorities that had outstanding debt of $100 million
or more.
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The aggregate outstanding debt, including refunding bonds, of these 17
Authorities was $73.45 billion.
Authorities are generally supported by revenues generated by the
projects financed or operated, such as fares, user fees on bridges, highway
tolls and rentals for dormitory rooms and housing. In recent years, however,
New York State has provided financial assistance through appropriations, in some
cases of a recurring nature, to certain of the Authorities for operating and
other expenses and, in fulfillment of its commit ments on moral obligation
indebtedness or otherwise, for debt service. This operating assistance is
expected to continue to be required in future years. In addition, certain
statutory arrangements provide for State local assistance payments otherwise
payable to localities to be made under certain circumstances to certain
Authorities. The State has no obligation to provide additional assistance to
localities whose local assistance payments have been paid to Authorities under
these arrangements. However, in the event that such local assistance payments
are so diverted, the affected localities could seek additional State funds.
NEW YORK CITY AND OTHER LOCALITIES. The fiscal health of the State of New York
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may also be impacted by the fiscal health of its localities, particularly the
City of New York, which has required and continues to require significant
financial assistance from New York State. The City depends on State aid both to
enable the City to balance its budget and to meet its cash requirements. There
can be no assurance that there will not be reductions in State aid to the City
from amounts currently projected or that State budgets will be adopted by the
April 1 statutory deadline or that any such reductions or delays will not have
adverse effects on the City's cash flow or expenditures. In addition, the
Federal budget negotiation process could result in a reduction in or a delay in
the receipt of Federal grants which could have additional adverse effects on the
City's cash flow or revenues.
For each of the 1981 through 1996 fiscal years, the City achieved
balanced operating results as reported in accordance with then applicable GAAP.
The City was required to close substantial budget gaps in recent years in order
to maintain balanced operating results. There can be no assurance that the City
will continue to maintain a balanced budget as required by State law without
additional tax or other revenue increases or additional reductions in City
services or entitlement programs, which could adversely affect the City's
economic base.
In 1975, New York City suffered a fiscal crisis that impaired the
borrowing ability of both the City and New York State. In that year the City
lost access to the public credit
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markets. The City was not able to sell short-term notes to the public again
until 1979.
In 1975, Standard & Poor's suspended its A rating of City bonds. This
suspension remained in effect until March 1981, at which time the City received
an investment grade rating of BBB from Standard & Poor's. On July 2, 1985,
Standard & Poor's revised its rating of City bonds upward to BBB+ and on
November 19, 1987, to A-. Moody's ratings of City bonds were revised in
November 1981 from B (in effect since 1977) to Ba1, in November 1983 to Baa, in
December 1985 to Baa1, in May 1988 to A and again in February 1991 to Baa1. On
July 10, 1995, Standard & Poor's downgraded its rating on the City's $23 billion
of outstanding general obligation bonds to "BBB+" from "A-", citing the City's
chronic structural budget problems and weak economic outlook. Standard & Poor's
stated that New York City's reliance on one-time revenue measures to close
annual budget gaps, a dependence on unrealized labor savings, overly optimistic
estimates of revenues and state and federal aid and the City's continued high
debt levels also contributed to its decision to lower the rating.
New York City is heavily dependent on New York State and federal
assistance to cover insufficiencies in its revenues. There can be no assurance
that in the future federal and State assistance will enable the City to make up
its budget deficits. To help alleviate the City's financial difficulties, the
Legisla ture created the Municipal Assistance Corporation ("MAC") in 1975.
Since its creation, MAC has provided, among other things, financing assistance
to the City by refunding maturing City short-term debt and transferring to the
City funds received from sales of MAC bonds and notes. MAC is authorized to
issue bonds and notes payable from certain stock transfer tax revenues, from the
City's portion of the State sales tax derived in the City and, subject to
certain prior claims, from State per capita aid otherwise payable by the State
to the City. Failure by the State to continue the imposition of such taxes, the
reduction of the rate of such taxes to rates less than those in effect on July
2, 1975, failure by the State to pay such aid revenues and the reduction of such
aid revenues below a specified level are included among the events of default in
the resolutions authoriz ing MAC's long-term debt. The occurrence of an event
of default may result in the acceleration of the maturity of all or a portion of
MAC's debt. MAC bonds and notes constitute general obligations of MAC and do
not constitute an enforceable obligation or debt of either the State or the
City. As of March 31, 1997, MAC had outstanding an aggregate of approximately
$4.592 billion of its bonds. MAC is authorized to issue bonds and notes to
refunds its outstanding bonds and notes and to fund certain reserves, without
limitation as to principal amount, and to finance certain capital commitments to
the Transit Authority and the New York City School Construction Authority
through the
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1997 fiscal year in the event the City fails to provide such financing.
As of March 31, 1997, the City had received an aggregate of
approximately $4.85 billion from MAC for certain authorized uses by the City
exclusive of capital purposes. In addition, the City had received an aggregate
of approximately $2.352 billion from MAC for capital purposes in exchange for
serial bonds in a like principal amount, of which $191 million was held by MAC
as of March 31, 1997, after $569.1 million was redeemed on January 7, 1997. MAC
has also exchanged $1.839 billion principal amount of MAC bonds for City debt,
of which approximately $57.1 million was redeemed on January 7, 1997. MAC made
the $609.3 million of net redemption proceeds available to the City for capital
financing.
Since 1975, the City's financial condition has been subject to
oversight and review by the New York State Financial Control Board (the "Control
Board") and since 1978 the City's financial statements have been audited by
independent accounting firms. To be eligible for guarantees and assistance, the
City is required during a "control period" to submit annually for Control Board
approval, and when a control period is not in effect for Control Board review, a
financial plan for the next four fiscal years covering the City and certain
agencies showing balanced budgets determined in accordance with GAAP. New York
State also established the Office of the State Deputy Comptroller for New York
City ("OSDC") to assist the Control Board in exercising its powers and
responsibilities. On June 30, 1986, the City satisfied the statutory
requirements for termination of the control period. This means that the Control
Board's powers of approval are suspended, but the Board continues to have
oversight responsibilities.
On May 8, 1997, the City released the Financial Plan for the 1998
through 2001 fiscal years (the "1998-2001 Financial Plan"), which relates to the
City, the Board of Education ("BOE") and the City University of New York
("CUNY") and was based on the Executive Budget and Budget Message for the City's
1998 fiscal year (the "City Executive Budget"). The City Executive Budget and
the 1998-2001 Financial Plan projected revenues and expenditures for the 1998
fiscal year balanced in accordance with GAAP. The City Executive Budget and the
1998-2001 Financial Plan included increased tax revenue projections and
additional expenditures for textbooks, computers, improved education programs
and welfare reform, law enforcement, immigrant naturalization and other
initiatives. In addition, the City Executive Budget and the 1998-2001 Financial
Plan set forth gap-closing actions to eliminate a previously projected gap of
$720 million for the 1998 fiscal year, after taking into account the prepayment
in the 1997 fiscal year of $856 million of debt service due in the 1998 and 1999
fiscal years. The gap-closing
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actions for the 1998 fiscal year included (i) additional agency actions totaling
$660 million; (ii) the prepayment in the 1998 fiscal year of $200 million of
debt service due in the 1999 fiscal year; (iii) the proposed sale of various
assets; (iv) additional State aid of $294 million, including a proposal that the
State accelerate a $142 million revenue sharing payment to the City from March
1999; and (v) entitlement savings of $128 million which would result from
certain of the reductions in Medicaid spending proposed in the Governor's 1997-
1998 Executive Budget and the State making available to the City $77 million of
additional Federal block grant aid, as proposed in the Governor's 1997-1998
Executive Budget. The City Executive Budget is subject to approval by the City
Council, and there can be no assurance that the City Executive Budget will be
adopted in its proposed form. The 1998-2001 Financial Plan also set forth
projections for the 1999 through 2001 fiscal years and projected gaps of $2.0
billion, $2.9 billion and $2.7 billion for the 1999 through 2001 fiscal years,
respectively.
The 1998-2001 Financial Plan included a proposed tax reduction program
totaling $284 million, $651 million, $895 million and $1.2 billion in the 1998
through 2001 fiscal year, respectively. The tax reduction program included a
proposed elimination of the 4% City sales tax on clothing items under $500 as of
December 1, 1997, as well as a proposed reduction in the City property tax and
personal income tax which the 1998-2001 Financial Plan assumed will be offset by
proposed increased State aid totaling $47 million, $254 million, $472 million
and $722 million in the 1998 through 2001 fiscal years, respectively.
The 1998-2001 Financial Plan assumed (i) approval by the Governor and
the State Legislature of the extension of the 14% personal income tax surcharge,
which is scheduled to expire on December 31, 1997 and is projected to provide
revenue (if extended) of $169 million, $501 million and $531 million in the 1998
through 2000 fiscal years, respectively, and of the extension of the 12.5%
personal income tax surcharge, which is scheduled to expire on December 31, 1998
and is projected to provide revenue (if extended) of $190 million and $527
million in the 1999 and 2000 fiscal years, respectively; (ii) collection of the
project rent payments for the City's airports, totalling $270 million and $180
million in the 1998 and 1999 fiscal years, respectively, which may depend on the
successful completion of negotiations with the Port Authority or the enforcement
of the City's rights under the existing leases through pending legal actions;
(iii) the ability of the New York City Health and Hospital Corporation to
identify actions to offset substantial City and State revenue reductions and the
receipt by BOE of additional State aid; and (iv) State approval of the cost
containment initiatives and State aid proposed by the City for the 1998 fiscal
year, and $115 million in State aid which is assumed in the 1998-2001 Financial
Plan but not provided for in
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the Governor's 1997-1998 Executive Budget. The 1998-2001 Financial Plan
reflected the increased costs which the City is prepared to incur as a result of
welfare legislation recently enacted by Congress, but not certain of the costs
resulting from legislation proposed by the Governor, which would, if enacted,
implement such Federal welfare legislation. Moreover, certain of the proposed
entitlement cost containment and other initiatives included in the 1998-2001
Financial Plan have been previously considered and rejected by the Legislature.
The nature and extent of the impact on the City of the State budget, when
adopted, is uncertain, and no assurance can be given that the State actions
included in the State adopted budget may not have a significant adverse impact
on the City's budget and its financial plan.
The projections set forth in the 1998-2001 Financial Plan were based
on various assumptions and contingencies which are uncertain and which may not
materialize. Changes in major assumptions could significantly affect the City's
ability to balance its budget as required by State law and to meet its annual
cash flow and financing requirements. Such assumptions and contingencies
include the condition of the regional and local economies, the impact on real
estate tax revenues of the real estate market, wage increases for City employees
consistent with those assumed in the 1998-2001 Financial Plan, employment
growth, the ability to implement proposed reductions in City personnel and other
cost reduction initiatives, the ability of the HHC and the BOE to take actions
to offset reduced revenues, the ability to complete revenue generating
transactions, provision of State and Federal aid and mandate relief and the
impact on City revenues and expenditures of Federal and State welfare reform and
any future legislation affecting Medicare or other entitlements.
Implementation of the 1998-2001 Financial Plan is also dependent upon
the City's ability to market its securities successfully. The City's financing
program for fiscal years 1998 through 2001 contemplates the issuance of $5.7
billion of general obligation bonds and $5.7 billion of bonds to be issued by
the proposed New York City Transitional Finance Authority (the "Finance
Authority") to finance City capital projects. The Finance Authority, was
created as part of the City's effort to assist in keeping the City's
indebtedness within the forecast level of the constitutional restrictions on the
amount of debt the City is authorized to incur. Indebtedness subject to the
constitutional debt limit includes liability on capital contracts that are
expected to be funded with general obligation bonds, as well as general
obligation bonds. In addition, the City issues revenue and tax anticipation
notes to finance its seasonal working capital requirements. The success of
projected public sales of City bonds and notes, New York City Municipal Water
Finance Authority ("Water Authority") bonds and Finance Authority bonds will be
subject to prevailing market conditions, and no
-21-
<PAGE>
assurance can be given that such sales will be completed. If the City were
unable to sell its general obligation bonds and notes or the Water Authority or
the Finance Authority were unable to sell its bonds, the City would be prevented
from meeting its planned capital and operating expenditures. Future
developments concerning the City and public discussion of such developments, as
well as prevailing market conditions, may affect the market for outstanding City
general obligation bonds and notes.
The City Comptroller and other agencies and public officials have
issued reports and made public statements which, among other things, state that
projected revenues and expenditures may be different from those forecast in the
City's financial plans. It is reasonable to expect that such reports and
statements will continue to be issued and to engender public comment. It is
expected that the City Comptroller and other agencies will issue reports in the
near future commenting on the City Executive Budget and/or the 1998-2001
Financial Plan.
The City since 1981 has fully satisfied its seasonal financing needs
in the public credit markets, repaying all short-term obligations within their
fiscal year of issuance. The City has issued $2.4 billion of short-term
obligations in fiscal year 1997 to finance the City's current estimate of its
seasonal cash flow needs for the 1997 fiscal year. Seasonal financing
requirements for the 1996 fiscal year increased to $2.4 billion from $2.2
billion and $1.75 billion in the 1995 and 1994 fiscal years, respectively.
Seasonal financing requirements were $1.4 billion and $2.25 billion in the 1993
and 1992 fiscal years, respectively. The delay in the adoption of the State's
budget in certain past fiscal years has required the City to issue short-term
notes in amounts exceeding those expected early in such fiscal year.
Certain localities, in addition to the City, could have financial
problems leading to requests for additional New York State assistance. The
potential impact on the State of such requests by localities was not included in
the State's projections of its receipts and disbursements.
Fiscal difficulties experienced by the City of Yonkers ("Yonkers")
resulted in the creation of the Financial Control Board for the City of Yonkers
(the "Yonkers Board") by New York State in 1984. The Yonkers Board is charged
with oversight of the fiscal affairs of Yonkers. Future actions taken by the
Governor or the Legislature to assist Yonkers could result in allocation of New
York State resources in amounts that cannot yet be determined.
Beginning in 1990, the City of Troy experienced a series of budgetary
deficits that resulted in the establishment of a Supervisory Board for the City
of Troy in 1994. The
-22-
<PAGE>
Supervisory Board's powers were increased in 1995, when Troy MAC was created to
help Troy avoid default on certain obligations. The legislation creating Troy
MAC prohibits the city of Troy from seeking federal bankruptcy protection while
Troy MAC bonds are outstanding.
Seventeen municipalities received extraordinary assistance during the
1996 legislative session through $50 million in special appropriations targeted
for distressed cities.
Municipalities and school districts have engaged in substantial short-
term and long-term borrowings. In 1994, the total indebtedness of all
localities in New York State other than New York City was approximately $17.7
billion. A small portion (approximately $82.9 million) of that indebtedness
represented borrowing to finance budgetary deficits and was issued pursuant to
enabling New York State legislation. State law requires the comptroller to
review and make recommendations concerning the budgets of those local government
units other than New York City authorized by State law to issue debt to finance
deficits during the period that such deficit financing is outstanding.
Seventeen localities had outstanding indebtedness for deficit financing at the
close of their fiscal year ending in 1994.
From time to time, federal expenditure reductions could reduce, or in
some cases eliminate, federal funding of some local programs and accordingly
might impose substantial increased expenditure requirements on affected
localities. If New York State, New York City or any of the Authorities were to
suffer serious financial difficulties jeopardizing their respective access to
the public credit markets, the marketability of notes and bonds issued by
localities within New York State could be adversely affected. Localities also
face anticipated and potential problems resulting from certain pending
litigation, judicial decisions and long-range economic trends. Long-range
potential problems of declining urban population, increasing expenditures and
other economic trends could adversely affect localities and require increasing
New York State assistance in the future.
-23-
<PAGE>
Additional Investment Limitations
- ---------------------------------
In addition to the investment limitations disclosed in the Prospectus,
the Fund is subject to the following investment limitations, which may be
changed only by a vote of the holders of a majority of the Fund's outstanding
Shares (as defined under "Miscellaneous" in the Prospectus).
The Fund may not:
1. Make loans, except that the Fund may purchase or hold debt
obligations in accordance with its investment objective, policies, and
limitations;
2. Purchase securities on margin, make short sale of securities, or
maintain a short position; provided that the Fund may enter into futures
contracts and futures options;
3. Act as an underwriter of securities within the meaning of the
Securities Act of 1933, except to the extent that the purchase of Municipal
Obligations or other securities directly from the issuer thereof in accordance
with the Fund's investment objective, policies, and limitations may be deemed to
be underwriting;
4. Purchase or sell real estate, except that the Fund may invest in
Municipal Obligations secured by real estate or interests therein;
5. Purchase or sell commodity futures contracts, or invest in oil,
gas, or mineral exploration or development programs; provided that the Fund may
enter into futures contracts and futures options;
6. Write or sell puts, calls, straddles, spreads, or combinations
thereof; provided that the Fund may enter into futures contracts and futures
options;
7. Invest in industrial revenue bonds where the payment of principal
and interest are the responsibility of a company (including its predecessors)
with less than three years of continuous operation; and
8. Issue any senior securities, except insofar as any borrowing in
accordance with the Fund's investment limitations might be considered to be the
issuance of a senior security; provided that the Fund may enter into futures
contracts and futures options.
-24-
<PAGE>
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
----------------------------------------------
Shares are continuously offered for sale by Edgewood Services, Inc.
(the "Distributor"), a wholly-owned subsidiary of Federated Investors, and the
Distributor has agreed to use appropriate efforts to solicit all purchase
orders. As described in the Prospectus, Shares may be sold to customers
("Customers") of financial institutions ("Shareholder Organizations"). Shares
are also offered for sale directly to institutional investors and members of the
general public. Different types of Customer accounts at the Shareholder
Organizations may be used to purchase Shares, including eligible agency and
trust accounts. In addition, Shareholder Organizations may automatically
"sweep" a Customer's account not less frequently than weekly and invest amounts
in excess of a minimum balance agreed to by the Shareholder Organization and its
Customer in Shares selected by the Customer. Investors purchasing Shares may
include officers, directors, or employees of the particular Shareholder
Organization.
Shares of the Fund are offered for sale at their net asset value per
Share next computed after a purchase order is received by Excelsior Tax-Exempt
Fund's sub-transfer agent.
Prior to February 14, 1997, Shares of the Fund were offered for sale
with a maximum sales charge of 4.50%. No sales charges were imposed in
connection with sales of Shares of the Fund during the fiscal years ended March
31, 1997, 1996 and 1995.
Excelsior Tax-Exempt Fund may suspend the right of redemption or
postpone the date of payment for Shares for more than seven days during any
period when (a) trading on the New York Stock Exchange (the "Exchange") is
restricted by applicable rules and regulations of the Securities and Exchange
Commission (the "SEC"); (b) the Exchange is closed for other than customary
weekend and holiday closings; (c) the SEC has by order permitted such
suspension; or (d) an emergency exists as determined by the SEC.
In the event that Shares are redeemed in cash at their net asset
value, a shareholder may receive in payment for such Shares an amount that is
more or less than his original investment due to changes in the market price of
the Fund's portfolio securities.
Excelsior Tax-Exempt Fund reserves the right to honor any request for
redemption or repurchase of the Fund's Shares by making payment in whole or in
part in securities chosen by Excelsior Tax-Exempt Fund and valued in the same
way as they would be valued for purposes of computing the Fund's net asset
value. If payment is made in securities, a shareholder may incur transaction
costs in converting these securities into cash. Such
-25-
<PAGE>
redemptions in kind will be governed by Rule 18f-1 under the 1940 Act so that
the Fund is obligated to redeem its Shares solely in cash up to the lesser of
$250,000 or 1% of its net asset value during any 90-day period for any one
shareholder of the Fund.
Under limited circumstances, Excelsior Tax-Exempt Fund may accept
securities as payment for Shares. Securities acquired in this manner will be
limited to securities issued in transactions involving a bona fide
---------
reorganization or statutory merger, or will be limited to other securities
(except for municipal debt securities issued by state political subdivisions or
their agencies or instrumentalities) that: (a) meet the investment objective and
policies of the Fund; (b) are acquired for investment and not for resale; (c)
are liquid securities that are not restricted as to transfer either by law or
liquidity of market; and (d) have a value that is readily ascertainable (and not
established only by evaluation procedures) as evidenced by a listing on the
American Stock Exchange, New York Stock Exchange or NASDAQ, or as evidenced by
their status as U.S. Government securities, bank certificates of deposit,
banker's acceptances, corporate and other debt securities that are actively
traded, money market securities and other similar securities with a readily
ascertainable value.
INVESTOR PROGRAMS
-----------------
Systematic Withdrawal Plan
- --------------------------
An investor who owns Shares with a value of $10,000 or more may begin
a Systematic Withdrawal Plan. The withdrawal can be on a monthly, quarterly,
semiannual or annual basis. There are four options for such systematic
withdrawals. The investor may request:
(1) A fixed-dollar withdrawal;
(2) A fixed-share withdrawal;
(3) A fixed-percentage withdrawal (based on the current value of the
account); or
(4) A declining-balance withdrawal.
Prior to participating in a Systematic Withdrawal Plan, the investor must
deposit any outstanding certificates for Shares with Chase Global Funds Services
Company, the Fund's sub-transfer agent. Under this Plan, dividends and
distributions are automatically reinvested in additional Shares of the Fund.
Amounts paid to investors under this Plan should not be considered as income.
Withdrawal payments represent proceeds
-26-
<PAGE>
from the sale of Shares, and there will be a reduction of the shareholder's
equity in the Fund if the amount of the withdrawal payments exceeds the
dividends and distributions paid on the Shares and the appreciation of the
investor's investment in the Fund. This in turn may result in a complete
depletion of the shareholder's investment. An investor may not participate in a
program of systematic investing in the Fund while at the same time participating
in the Systematic Withdrawal Plan with respect to an account in the Fund.
Customers of Shareholder Organizations may obtain information on the
availability of, and the procedures and fees relating to, the Systematic
Withdrawal Plan directly from their Shareholder Organizations.
Exchange Privilege
- ------------------
Investors and Customers of Shareholder Organizations may exchange
Shares having a value of at least $500 for shares of any other portfolio of
Excelsior Tax-Exempt Fund or Excelsior Funds, Inc. ("Excelsior Fund" and,
collectively with Excelsior Tax-Exempt Fund, the "Companies") or for Trust
Shares of Excelsior Institutional Trust. Shares may be exchanged by wire,
telephone or mail and must be made to accounts of identical registration. There
is no exchange fee imposed by the Companies or Excelsior Institutional Trust.
In order to prevent abuse of this privilege to the disadvantage of other
shareholders, the Companies and Excelsior Institutional Trust reserve the right
to limit the number of exchange requests of Investors and Customers of
Shareholder Organizations to no more than six per year. The Companies and
Excelsior Institutional Trust may modify or terminate the exchange program at
any time upon 60 days' written notice to shareholders, and may reject any
exchange request. Customers of Shareholder Organizations may obtain information
on the availability of, and the procedures and fees relating to, such program
directly from their Shareholder Organizations.
For Federal income tax purposes, exchanges are treated as sales on
which the shareholder will realize a gain or loss, depending upon whether the
value of the Shares to be given up in exchange is more or less than the basis in
such Shares at the time of the exchange. Generally, a shareholder may include
sales loads incurred upon the purchase of Shares in his or her tax basis for
such Shares for the purpose of determining gain or loss on a redemption,
transfer or exchange of such Shares. However, if the shareholder effected an
exchange of Shares for shares of another portfolio of the Companies within 90
days of the purchase and was able to reduce the sales load previously applicable
to the new shares (by virtue of the Companies' exchange privilege), the amount
equal to such reduction may not be included in the tax basis of the
shareholder's exchanged Shares but may be included (subject to the limitation)
in the tax basis of the new shares.
-27-
<PAGE>
Other Investor Programs
- -----------------------
As described in the Prospectus, Shares of the Fund may be purchased in
connection with the Automatic Investment Program. Customers of Shareholder
Organizations may obtain information on the availability of, and the procedures
and fees relating to, such program directly from their Shareholder
Organizations.
DESCRIPTION OF CAPITAL STOCK
----------------------------
Excelsior Tax-Exempt Fund's Charter authorizes its Board of Directors
to issue up to 14 billion full and fractional shares of capital stock and to
classify or reclassify any unissued shares of Excelsior Tax-Exempt Fund into one
or more additional classes or series by setting or changing in any one or more
respects their respective preferences, conversion or other rights, voting
powers, restrictions, limitations as to dividends, qualifications, and terms and
conditions of redemption. The Prospectus describes the classes of shares into
which Excelsior Tax-Exempt Fund's authorized capital is currently classified.
Shares have no preemptive rights and only such con version or exchange
rights as the Board of Directors may grant in its discretion. When issued for
payment as described in the Prospectus, Shares will be fully paid and non-
assessable. In the event of a liquidation or dissolution of the Fund, its
shareholders are entitled to receive the assets available for distribution
belonging to the Fund and a proportionate dis tribution, based upon the relative
asset values of Excelsior Tax-Exempt Fund's portfolios, of any general assets of
Excelsior Tax-Exempt Fund not belonging to any particular portfolio of Excelsior
Tax-Exempt Fund which are available for distribution. In the event of a
liquidation or dissolution of Excelsior Tax-Exempt Fund, its shareholders will
be entitled to the same distribution process.
Shareholders of Excelsior Tax-Exempt Fund are entitled to one vote for
each full share held, and fractional votes for fractional shares held, and will
vote in the aggregate and not by class, except as otherwise required by the 1940
Act or other applicable law or when the matter to be voted upon affects only the
interests of the shareholders of a particular class. Voting rights are not
cumulative and, accordingly, the holders of more than 50% of the aggregate of
the outstanding shares of Excelsior Tax-Exempt Fund may elect all of Excelsior
Tax-Exempt Fund's directors, regardless of the votes of other shareholders.
Rule 18f-2 under the 1940 Act provides that any matter required to be
submitted to the holders of the outstanding voting
-28-
<PAGE>
securities of an investment company such as Excelsior Tax-Exempt Fund shall not
be deemed to have been effectively acted upon unless approved by the holders of
a majority of the outstanding shares of each portfolio affected by the matter.
A portfolio is affected by a matter unless it is clear that the interests of
each portfolio in the matter are substantially identical or that the matter does
not affect any interest of the portfolio. Under the Rule, the approval of an
investment advisory agreement or any change in a fundamental investment policy
would be effectively acted upon with respect to a portfolio only if approved by
a majority of the outstanding shares of such portfolio. However, the Rule also
provides that the ratification of the appointment of independent public
accountants, the approval of principal underwriting contracts, and the election
of directors may be effectively acted upon by shareholders of Excelsior Tax-
Exempt Fund voting without regard to class.
Excelsior Tax-Exempt Fund's Charter authorizes its Board of Directors,
without shareholder approval (unless otherwise required by applicable law), to
(a) sell and convey the assets of the Fund to another management investment
company for consideration which may include securities issued by the purchaser
and, in connection therewith, to cause all outstanding Shares of the Fund to be
redeemed at a price which is equal to their net asset value and which may be
paid in cash or by distribution of the securities or other consideration
received from the sale and conveyance; (b) sell and convert the Fund's assets
into money and, in connection therewith, to cause all outstanding Shares to be
redeemed at their net asset value; or (c) combine the assets belonging to the
Fund with the assets belonging to another portfolio of Excelsior Tax-Exempt
Fund, if the Board of Directors reasonably determines that such combination will
not have a material adverse effect on shareholders of any portfolio
participating in such combination, and, in connection therewith, to cause all
outstanding Shares of the Fund to be redeemed at their net asset value or
converted into shares of another class of Excelsior Tax-Exempt Fund's capital
stock at net asset value. The exercise of such authority by the Board of
Directors will be subject to the provisions of the 1940 Act, and the Board of
Directors will not take any action described in this paragraph unless the
proposed action has been disclosed in writing to the Fund's shareholders at
least 30 days prior thereto.
Notwithstanding any provision of Maryland law requiring a greater vote
of Excelsior Tax-Exempt Fund's Common Stock (or of the Shares of the Fund voting
separately as a class) in connection with any corporate action, unless otherwise
provided by law (for example, by Rule 18f-2, discussed above) or by Excelsior
Tax-Exempt Fund's Charter, Excelsior Tax-Exempt Fund may take or authorize such
action upon the favorable vote of the
-29-
<PAGE>
holders of more than 50% of the outstanding Common Stock of Excelsior Tax-Exempt
Fund voting without regard to class.
MANAGEMENT OF THE FUND
----------------------
Directors and Officers
- ----------------------
The directors and executive officers of Excelsior Tax-Exempt Fund,
their addresses, ages, principal occupations during the past five years, and
other affiliations are as follows:
-30-
<PAGE>
Position with Principal Occupation
Excelsior Tax- During Past 5 years and
Name and Address Exempt Fund Other Affiliations
- ---------------- ----------- ------------------
Frederick S. Wonham/1/ Chairman of the Retired; Director of
238 June Road Board, President Excelsior Fund and
Stamford, CT 06903 & Treasurer Excelsior Tax-Exempt
Age: 66 Fund (since 1995);
Trustee of Excelsior
Funds and Excelsior
Institutional Trust
(since 1995); Vice
Chairman of U.S. Trust
Corporation and U.S.
Trust New York (from
February 1990 until
September 1995); and
Chairman, U.S. Trust
Connecticut (from March
1993 to May 1997).
Donald L. Campbell Director Retired; Director of
333 East 69th Street Excelsior Fund and
Apt. 10-H Excelsior Tax-Exempt
New York, NY 10021 Fund (since 1984);
Age: 71 Director of UST Master
Variable Series, Inc.
(from 1994 to June
1997); Trustee of
Excelsior Institutional
and Trust (since 1995);
and Director, Royal Life
Insurance Co. of New
York (since 1991).
- ----------
/1/ This director is considered to be an "interested person" of Excelsior Tax-
Exempt Fund as defined in the 1940 Act.
-31-
<PAGE>
Position with Principal Occupation
Excelsior Tax- During Past 5 years and
Name and Address Exempt Fund Other Affiliations
- ---------------- ----------- ------------------
Rodman L. Drake Director Director, Excelsior Fund
485 Park Avenue and Excelsior Tax-Exempt
New York, New York 10022 Fund (since 1996);
Age: 54 Trustee, Excelsior
Institutional Trust and
Excelsior Funds (since
1994); Director, Parsons
Brinkerhoff Energy
Services Inc. (since
1996); Director, Parsons
Brinkerhoff, Inc.
(engineering firm)
(since 1995); President,
Mandrake Group
(investment and
consulting firm)(since
1994); Director,
Hyperion Total Return
Fund, Inc. and four
other funds for which
Hyperion Capital
Management, Inc. serves
as investment adviser
(since 1991); Co-
Chairman, KMR Power
Corporation (power
plants) (from 1993 to
1996); Director, The
Latin American Growth
Fund (since 1993);
Member of Advisory Board
Argentina Private Equity
Fund L.P. (from 1992 to
1996) and Garantia L.P.
(Brazil) (from 1993 to
1996); and Director,
Mueller Industries, Inc.
(from 1992 to 1994).
Joseph H. Dugan Director Retired; Director of
913 Franklin Lakes Road Excelsior Fund and
Franklin Lakes, NJ 07417 Excelsior Tax-Exempt
Age: 72 Fund (since 1984);
Director of UST Master
Variable Series, Inc.
(from 1994 to June
1997); and Trustee of
Excelsior Institutional
Trust (since 1995).
-32-
<PAGE>
Position with Principal Occupation
Excelsior Tax- During Past 5 years and
Name and Address Exempt Fund Other Affiliations
- ---------------- ----------- ------------------
Wolfe J. Frankl Director Retired; Director of
2320 Cumberland Road Excelsior Fund and
Charlottesville, VA Excelsior Tax-Exempt
22901 Fund (since 1986);
Age: 76 Director of UST Master
Variable Series, Inc.
(from 1994 to June
1997); Trustee of
Excelsior Institutional
Trust (since 1995);
Director, Deutsche Bank
Financial, Inc. (since
1989); Director, The
Harbus Corporation
(since 1951); and
Trustee, HSBC Funds
Trust and HSBC Mutual
Funds Trust (since
1988).
W. Wallace McDowell, Jr. Director Director, Excelsior Fund
c/o Prospect Capital and Excelsior Tax-Exempt
Corp. Fund (since 1996);
43 Arch Street Trustee, Excelsior
Greenwich, CT 06830 Institutional Trust and
Age: 60 Excelsior Funds (since
1994); Private Investor
(since 1994); Managing
Director, Morgan Lewis
Githens & Ahn (from 1991
to 1994); and Director,
U.S. Homecare
Corporation (since
1992), Grossmans, Inc.
(from 1993 to 1996),
Children's Discovery
Centers (since 1984),
ITI Technologies, Inc.
(since 1992) and Jack
Morton Productions
(since 1987).
-33-
<PAGE>
Position with Principal Occupation
Excelsior Tax- During Past 5 years and
Name and Address Exempt Fund Other Affiliations
- ---------------- ----------- ------------------
Jonathan Piel Director Director, Excelsior Fund
558 E. 87th Street and Excelsior Tax-Exempt
New York, New York 10128 Fund (since 1996);
Age: 58 Trustee, Excelsior
Institutional Trust and
Excelsior Funds (since
1994); Vice President
and Editor, Scientific
American, Inc. (from
1986 to 1994); Director,
Group for The South
Fork, Bridgehampton, New
York (since 1993); and
Member, Advisory
Committee, Knight
Journalism Fellowships,
Massachusetts Institute
of Technology (since
1984).
Robert A. Robinson Director Director of Excelsior
Church Pension Fund Fund and Excelsior Tax-
800 Second Avenue Exempt Fund (since
New York, NY 10017 1987); Director of UST
Age: 71 Master Variable Series,
Inc. (from 1994 to June
1997); Trustee of
Excelsior Institutional
Trust (since 1995);
President Emeritus, The
Church Pension Fund and
its affiliated companies
(since 1966); Trustee,
H.B. and F.H. Bugher
Foundation and Director
of its wholly-owned
subsidiaries--Rosiclear
Lead and Flourspar
Mining Co. and The Pigmy
Corporation (since
1984); Director,
Morehouse Publishing Co.
(since 1974); Trustee,
HSBC Funds Trust and
HSBC Mutual Funds Trust
(since 1982); and
Director, Infinity
Funds, Inc. (since
1995).
-34-
<PAGE>
Position with Principal Occupation
Excelsior Tax- During Past 5 years and
Name and Address Exempt Fund Other Affiliations
- ---------------- ----------- ------------------
Alfred C. Tannachion/1/ Director Retired; Director of
6549 Pine Meadows Drive Excelsior Fund and
Spring Hill, FL 34606 Excelsior Tax-Exempt
Age: 71 Fund (since 1985);
Chairman of the Board,
President and Treasurer
of UST Master Variable
Series, Inc. (from 1994
to June 1997); and
Trustee of Excelsior
Institutional Trust
(since 1995).
W. Bruce McConnel, III Secretary Partner of the law firm
Philadelphia National Bank of Drinker Biddle &
Building Reath LLP.
1345 Chestnut Street
Philadelphia, PA 19107-3497
Age: 54
Gregory Sackos Assistant Second Vice President,
Chase Global Funds Secretary Senior Manager of Blue
Services Company Sky Compliance and
73 Tremont Street Financial Reporting,
Boston, MA 02108-3913 Chase Global Funds
Age: 32 Services Company (March
1997 to present); Second
Vice President, Senior
Manager of Financial
Reporting, Chase Global
Funds Services Company
(September 1996 to March
1997); and Assistant
Vice President,
Assistant Manager of
Financial Reporting,
Scudder, Stevens & Clark
Inc. (October 1992 to
September 1996).
- ----------
/1/ This director is considered to be an "interested person" of Excelsior Tax-
Exempt Fund as defined in the 1940 Act.
-35-
<PAGE>
Position with Principal Occupation
Excelsior Tax- During Past 5 years and
Name and Address Exempt Fund Other Affiliations
- ---------------- ----------- ------------------
John M. Corcoran Assistant Vice President, Director
Chase Global Funds Treasurer of Administration Client
Services Company Group, Chase Global
73 Tremont Street Funds Services Company
Boston, MA 02108-3913 (since July 1996);
Age: 32 Second Vice President,
Manager of
Administration, Chase
Global Funds Services
Company (from October
1993 to July 1996); and
Audit Manager, Ernst &
Young LLP (from August
1987 to September 1993).
Each director of Excelsior Tax-Exempt Fund receives an annual fee of $9,000
plus a meeting fee of $1,500 for each meeting attended and is reimbursed for
expenses incurred in attending meetings. The Chairman of the Board is entitled
to receive an additional $5,000 per annum for services in such capacity.
Drinker Biddle & Reath LLP, of which Mr. McConnel is a partner, receives legal
fees as counsel to Excelsior Tax-Exempt Fund. The employees of Chase Global
Funds Services Company do not receive any compensation from Excelsior Tax-Exempt
Fund for acting as officers of Excelsior Tax-Exempt Fund. No person who is
currently an officer, director or employee of the Investment Adviser serves as
an officer, director or employee of Excelsior Tax-Exempt Fund. As of July 14,
1997, the directors and officers of Excelsior Tax-Exempt Fund as a group owned
beneficially less than 1% of the outstanding Shares of Excelsior Tax-Exempt
Fund, and less than 1% of the outstanding shares of all funds of Excelsior Tax-
Exempt Fund in the aggregate.
The following chart provides certain information about the fees
received by Excelsior Tax-Exempt Fund's directors in the most recently completed
fiscal year.
-36-
<PAGE>
<TABLE>
<CAPTION>
Pension or
Retirement Total
Benefits Compensation from
Aggregate Accrued as Excelsior Tax-Exempt
Compensation from Part of Fund and Fund
Name of Excelsior Fund Complex/*/ Paid
Person/Position Tax-Exempt Fund Expenses to Directors
- --------------- ----------------- ---------- --------------------
<S> <C> <C> <C>
Donald L. Campbell $13,500 None $31,750(4)**
Director
Rodman L. Drake $ 3,750 None $12,250(4)**
Director***
Joseph H. Dugan $15,000 None $35,000(4)**
Director
Wolfe J. Frankl $15,000 None $35,000(4)**
Director
W. Wallace McDowell, Jr. $ 2,250 None $ 9,250(4)**
Director***
Jonathan Piel $ 3,750 None $12,500(4)**
Director****
Robert A. Robinson $15,000 None $35,000(4)**
Director
Alfred C. Tannachion $20,000 None $45,000(4)**
Director****
Frederick S. Wonham $15,000 None $35,000(4)**
Chairman of the Board,
President and Treasurer****
</TABLE>
- ---------------------------
* The "Fund Complex" consists of Excelsior Fund, Excelsior Tax-Exempt Fund,
UST Master Variable Series, Inc., Excelsior Funds and Excelsior
Institutional Trust.
** Number of investment companies in the Fund Complex for which director
served as director or trustee.
*** Messrs. Drake, McDowell and Piel were elected to the Board of Excelsior
Fund and Excelsior Tax-Exempt Fund on December 9, 1996.
**** Mr. Tannachion served as Excelsior Tax-Exempt Fund's Chairman of the Board,
President and Treasurer until February 13, 1997. On that date, Mr. Wonham
was elected to serve as Excelsior Tax-Exempt Fund's Chairman of the Board,
President and Treasurer.
-37-
<PAGE>
Investment Advisory and Administration Agreements
- -------------------------------------------------
United States Trust Company of New York ("U.S. Trust New York") and
U.S. Trust Company of Connecticut ("U.S. Trust Connecticut" and, collectively
with U.S. Trust New York, "U.S. Trust" or the "Investment Adviser") serve as
Investment Adviser to the Fund. In the Investment Advisory Agreement, the
Investment Adviser has agreed to provide the services described in the
Prospectus. The Investment Adviser has also agreed to pay all expenses incurred
by it in connection with its activities under the agreement other than the cost
of securities, including brokerage commissions, if any, purchased for the Fund.
Prior to May 16, 1997, U.S. Trust New York served as investment
adviser to the Fund pursuant to an advisory agreement substantially similar to
the Investment Advisory Agreement currently in effect for the Fund.
For the fiscal years ended March 31, 1995, 1996 and 1997, Excelsior
Tax-Exempt Fund paid U.S. Trust New York advisory fees of $449,781, $450,208 and
$451,669, respectively, with respect to the Fund. For the same periods, U.S.
Trust New York waived advisory fees totalling $17,901, $22,385 and $30,358,
respectively, with respect to the Fund.
The Investment Advisory Agreement provides that the Investment Adviser
shall not be liable for any error of judgment or mistake of law or for any loss
suffered by the Fund in connection with the performance of this agreement,
except that the Investment Adviser shall be jointly, but not severally, liable
for a loss resulting from a breach of fiduciary duty with respect to the receipt
of compensation for advisory services or a loss resulting from willful
misfeasance, bad faith or gross negligence on the part of the Investment Adviser
in the performance of its duties or from reckless disregard by it of its duties
and obligations thereunder. In addition, the Investment Adviser has undertaken
in the Investment Advisory Agreement to maintain its policy and practice of
conducting its Asset Management Group independently of its Banking Group.
Chase Global Funds Services Company ("CGFSC"), Federated
Administrative Services, an affiliate of the Distributor, and U.S. Trust
Connecticut (the "Administrators") serve as the Fund's administrators. Under
the Administration Agreement, the Administrators have agreed to maintain office
facilities for the Fund, furnish the Fund with statistical and research data,
clerical, accounting and bookkeeping services, and certain other services
required by the Fund, and to compute the net asset value, net income, "exempt
interest dividends" and realized capital gains or losses, if any, of the Fund.
The Administrators prepare semiannual reports to the SEC, prepare Federal and
state tax returns, prepare filings with state
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securities commissions, arrange for and bear the cost of processing Share
purchase and redemption orders, maintain the Fund's financial accounts and
records, and generally assist in all aspects of the Fund's operations.
Prior to May 16, 1997, CGFSC, Federated Administrative Services and
U.S. Trust New York served as the Fund's administrators pursuant to an
administrative agreement substantially similar to the Administration Agreement
currently in effect for the Fund. Prior to August 1, 1995, administrative
services were provided to the Fund by CGFSC and Concord Holding Corporation
(collectively, the "former administrators") under an administration agreement
having substantially the same terms as the Administration Agreement currently in
effect.
For the fiscal year ended March 31, 1995, Excelsior Tax-Exempt Fund
paid the former administrators $144,024 in the aggregate with respect to the
Fund.
For the period April 1, 1995 through July 31, 1995, Excelsior Tax-
Exempt Fund paid the former administrators $46,815, in the aggregate with
respect to the Fund. For the same period, former administrators waived
administration fees totalling $160 with respect to the Fund.
For the period August 1, 1995 through March 31, 1996, Excelsior Tax-
Exempt Fund paid CGFSC, Federated Administrative Services and U.S. Trust New
York $98,971 in the aggregate with respect to the Fund. For the same period,
CGFSC, Federated Administrative Services and U.S. Trust New York waived
administration fees totalling $41 with respect to the Fund.
For the fiscal year ended March 31, 1997, Excelsior Tax-Exempt Fund
paid CGFSC, Federated Administrative Services and U.S. Trust New York $148,160
in the aggregate with respect to the Fund. For the same period, CGFSC,
Federated Administrative Services and U.S. Trust New York waived administration
fees totalling $50 with respect to the Fund.
Shareholder Organizations
- -------------------------
As stated in the Prospectus, Excelsior Tax-Exempt Fund has entered
into agreements with certain Shareholder Organizations. Such agreements require
the Shareholder Organizations to provide shareholder administrative services to
their Customers who beneficially own Shares in consideration for the Fund's
payment of not more than the annual rate of .40% of the average daily net assets
of the Fund's Shares beneficially owned by Customers of the Shareholder
Organization. Such services may include: (a) acting as recorder of Shares; (b)
assisting in processing purchase, exchange and redemption
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transactions; (c) providing periodic statements showing a Customer's account
balances and confirmations of transactions by the Customer; (d) providing tax
and dividend information to shareholders as appropriate; (e) transmitting proxy
statements, annual reports, updated prospectuses and other communications from
Excelsior Tax-Exempt Fund to Customers; and (f) providing or arranging for the
provision of other related services.
Excelsior Tax-Exempt Fund's agreements with Shareholder Organizations
are governed by an Administrative Services Plan (the "Plan") adopted by
Excelsior Tax-Exempt Fund. Pursuant to the Plan, Excelsior Tax-Exempt Fund's
Board of Directors will review, at least quarterly, a written report of the
amounts expended under Excelsior Tax-Exempt Fund's agreements with Shareholder
Organizations and the purposes for which the expenditures were made. In
addition, the arrangements with Shareholder Organizations will be approved
annually by a majority of Excelsior Tax-Exempt Fund's directors, including a
majority of the directors who are not "interested persons" of Excelsior Tax-
Exempt Fund as defined in the 1940 Act and have no direct or indirect financial
interest in such arrangements (the "Disinterested Directors").
Any material amendment to Excelsior Tax-Exempt Fund's arrangements
with Shareholder Organizations must be approved by a majority of the Board of
Directors (including a majority of the Disinterested Directors). So long as
Excelsior Tax-Exempt Fund's arrangements with Shareholder Organizations are in
effect, the selection and nomination of the members of Excelsior Tax-Exempt
Fund's Board of Directors who are not "interested persons" (as defined in the
1940 Act) of Excelsior Tax-Exempt Fund will be committed to the discretion of
such Disinterested Directors.
For the fiscal years ended March 31, 1997, 1996 and 1995, payments to
Shareholder Organizations totalled $30,408, $22,586 and $17,923, respectively,
with respect to the Fund, of which $30,408, $22,586 and $17,458, respectively,
was paid to affiliates of U.S. Trust.
Expenses
- --------
Except as otherwise noted, the Investment Adviser and the
Administrators bear all expenses in connection with the performance of their
services. The Fund bears the expenses incurred in its operations. Such expenses
include taxes; interest; fees (including fees paid to Excelsior Tax-Exempt
Fund's directors and officers who are not affiliated with the Distributor or the
Administrators); SEC fees; state securities qualification fees; costs of
preparing and printing prospectuses for regulatory purposes and for distribution
to shareholders; advisory, administration and administrative servicing fees;
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charges of the custodian, transfer agent and dividend disbursing agent; certain
insurance premiums; outside auditing and legal expenses; cost of independent
pricing services; costs of shareholder reports and meetings; and any
extraordinary expenses. The Fund also pays for any brokerage fees and
commissions in connection with the purchase of portfolio securities.
Custodian and Transfer Agent
- ----------------------------
The Chase Manhattan Bank ("Chase") serves as custodian of the Fund's
assets. Under the Custodian Agreement, Chase has agreed to (i) maintain a
separate account or accounts in the name of the Fund; (ii) make receipts and
disbursements of money on behalf of the Fund; (iii) collect and receive all
income and other payments and distributions on account of the Fund's portfolio
securities; (iv) respond to correspondence from securities brokers and others
relating to its duties; (v) maintain certain financial accounts and records; and
(vi) make periodic reports to Excelsior Tax-Exempt Fund's Board of Directors
concerning the Fund's operations. Chase may, at its own expense, open and
maintain custody accounts with respect to the Fund with other banks or trust
companies, provided that Chase shall remain liable for the performance of all
its custodial duties under the Custodian Agreement, notwithstanding any
delegation.
U.S. Trust New York also serves as the Fund's transfer agent and
dividend disbursing agent. In such capacity, U.S. Trust New York has agreed to
(i) issue and redeem Shares; (ii) address and mail all communications by the
Fund to its shareholders, including reports to shareholders, dividend and
distribution notices, and proxy materials for its meetings of shareholders;
(iii) respond to correspondence by shareholders and others relating to its
duties; (iv) maintain shareholder accounts; and (v) make periodic reports to
Excelsior Tax-Exempt Fund's Board of Directors concerning the Fund's operations.
For its transfer agency, dividend disbursing, and subaccounting services, U.S.
Trust New York is entitled to receive $15.00 per annum per account and
subaccount. In addition, U.S. Trust New York is entitled to be reimbursed for
its out-of-pocket expenses for the cost of forms, postage, processing purchase
and redemption orders, handling of proxies, and other similar expenses in
connection with the above services.
U.S. Trust New York may, at its own expense, delegate its transfer
agency obligations to another transfer agent registered or qualified under
applicable law, provided that U.S. Trust New York shall remain liable for the
performance of all of its transfer agency duties under the Transfer Agency
Agreement, notwithstanding any delegation. Pursuant to this provision in the
agreement, U.S. Trust New York has entered into a sub-
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transfer agency arrangement with CGFSC, an affiliate of Chase, with respect to
accounts of shareholders who are not Customers of U.S. Trust New York. For the
services provided by CGFSC, U.S. Trust New York has agreed to pay CGFSC $15.00
per annum per account or subaccount plus out-of-pocket expenses. CGFSC receives
no fee directly from Excelsior Tax-Exempt Fund for any of its sub-transfer
agency services. U.S. Trust New York may, from time to time, enter into sub-
transfer agency arrangements with third party providers of transfer agency
services.
PORTFOLIO TRANSACTIONS
----------------------
Subject to the general control of Excelsior Tax-Exempt Fund's Board of
Directors, the Investment Adviser is responsible for, makes decisions with
respect to, and places orders for all purchases and sales of portfolio
securities.
The Fund may engage in short-term trading to achieve its investment
objective. Portfolio turnover may vary greatly from year to year as well as
within a particular year. It is expected that the Fund's turnover rate may be
higher than that of many other investment companies with similar investment
objectives and policies. The Fund's portfolio turnover rate may also be
affected by cash requirements for redemptions of Shares and by regulatory
provisions which enable the Fund to receive certain favorable tax treatment.
Portfolio turnover will not be a limiting factor in making portfolio decisions.
See "Financial Highlights" in the Fund's prospectus for the Fund's portfolio
turnover rate.
Securities purchased and sold by the Fund are generally traded in the
over-the-counter market on a net basis (i.e., without commission) through
dealers, or otherwise involve transactions directly with the issuer of an
instrument. The cost of securities purchased from underwriters includes an
underwriting commission or concession, and the prices at which securities are
purchased from and sold to dealers include a dealer's mark-up or mark-down.
With respect to over-the-counter transactions, the Fund, where possible, will
deal directly with dealers who make a market in the securities involved, except
in those situations where better prices and execution are available elsewhere.
The Investment Advisory Agreement provides that, in executing
portfolio transactions and selecting brokers or dealers, the Investment Adviser
will seek to obtain the best net price and the most favorable execution. The
Investment Adviser shall consider factors it deems relevant, including the
breadth of the market in the security, the price of the security, the financial
condition and execution capability of the broker or dealer and whether such
broker or dealer is selling shares of
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Excelsior Tax-Exempt Fund, and the reasonableness of the commission, if any, for
the specific transaction and on a continuing basis.
In addition, the Investment Advisory Agreement authorizes the
Investment Adviser, to the extent permitted by law and subject to the review of
Excelsior Tax-Exempt Fund's Board of Directors from time to time with respect to
the extent and continuation of the policy, to cause the Fund to pay a broker
which furnishes brokerage and research services a higher commission than that
which might be charged by another broker for effecting the same transaction,
provided that the Investment Adviser determines in good faith that such
commission is reasonable in relation to the value of the brokerage and research
services provided by such broker, viewed in terms of either that particular
transaction or the overall responsibilities of the Investment Adviser to the
accounts as to which it exercises investment discretion. Such brokerage and
research services might consist of reports and statistics on specific companies
or industries, general summaries of groups of stocks and their comparative
earnings, or broad overviews of the fixed-income market and the economy.
Supplementary research information so received is in addition to and
not in lieu of services required to be performed by the Investment Adviser and
does not reduce the investment advisory fee payable by the Fund. Such
information may be useful to the Investment Adviser in serving the Fund and
other clients and, conversely, supplemental information obtained by the
placement of business of other clients may be useful to the Investment Adviser
in carrying out its obligations to the Fund.
Portfolio securities will not be purchased from or sold to the
Investment Adviser, Distributor, or any affiliated person of either of them (as
such term is defined in the 1940 Act) acting as principal, except to the extent
permitted by the Securities and Exchange Commission.
Investment decisions for the Fund are made inde pendently from those
for other investment companies, common trust funds and other types of funds
managed by the Investment Adviser. Such other investment companies and funds
may also invest in the same securities as the Fund. When a purchase or sale of
the same security is made at substantially the same time on behalf of the Fund
and another investment company or common trust fund, the transaction will be
averaged as to price, and available investments allocated as to amount, in a
manner which the Investment Adviser believes to be equitable to the Fund and
such other investment company or common trust fund. In some instances, this
investment procedure may adversely affect the price paid or received by the Fund
or the size of the position obtained by the Fund. To the extent permitted by
law, the
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Investment Adviser may aggregate the securities to be sold or purchased for the
Fund with those to be sold or purchased for other investment companies or common
trust funds in order to obtain best execution.
Excelsior Tax-Exempt Fund is required to identify any securities of
its regular brokers or dealers (as defined in Rule 10b-1 under the 1940 Act) or
its parents held by the Fund as of the close of the most recent fiscal year. As
of March 31, 1997, the Fund did not hold any securities of Excelsior Tax-Exempt
Fund's regular brokers or dealers or their parents.
INDEPENDENT AUDITORS
--------------------
Ernst & Young LLP, independent auditors, 200 Clarendon Street, Boston,
MA 02116, serve as auditors of Excelsior Tax-Exempt Fund. The Fund's Financial
Highlights included in the Prospectus and the financial statements for the
period ended March 31, 1997 incorporated by reference in this Statement of
Additional Information have been audited by Ernst & Young LLP for the periods
included in their report thereon which appears therein.
COUNSEL
-------
Drinker Biddle & Reath LLP (of which Mr. McConnel, Secretary of
Excelsior Tax-Exempt Fund, is a partner), Philadelphia National Bank Building,
1345 Chestnut Street, Philadelphia, Pennsylvania 19107, is counsel to Excelsior
Tax-Exempt Fund and will pass upon the legality of the Shares offered by the
Prospectus.
ADDITIONAL INFORMATION CONCERNING TAXES
---------------------------------------
Federal
- -------
The following supplements the tax information contained in the
Prospectus.
The Fund is treated as a separate corporate entity under the Internal
Revenue Code of 1986, as amended (the "Code"), and has qualified and intends to
continue to qualify as a regulated investment company. If, for any reason, the
Fund does not qualify for a taxable year for the special Federal tax treatment
afforded regulated investment companies, the Fund would be subject to Federal
tax on all of its taxable income at regular corporate rates, without any
deduction for distributions to shareholders. In such event, dividend
distributions would be taxable as ordinary income to shareholders to the extent
of the Fund's current and accumulated earnings and profits and would be
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eligible for the dividends received deduction in the case of corporate
shareholders.
As stated in the Prospectus, the Fund is not intended to constitute a
balanced investment program and is not designed for investors seeking capital
appreciation or maximum tax-exempt income irrespective of fluctuations in
principal. Shares of the Fund will not be suitable for tax-exempt institutions
and may not be suitable for retirement plans qualified under Section 401 of the
Code, H.R. 10 plans and individual retirement accounts because such plans and
accounts are generally tax-exempt and, therefore, not only would not gain any
additional benefit from the Fund's dividends being tax-exempt, but such
dividends would be ultimately taxable to the beneficiaries when distributed to
them. In addition, the Fund may not be an appropriate investment for entities
which are "substantial users" of facilities financed by private activity bonds
or "related persons" thereof. "Substantial user" is defined under the Treasury
Regulations to include a non-exempt person who regularly uses a part of such
facilities in his trade or business and whose gross revenues derived with
respect to the facilities financed by the issuance of bonds are more than 5% of
the total revenues derived by all users of such facilities, who occupies more
than 5% of the usable area of such facilities or for whom such facilities or a
part thereof were specifically constructed, reconstructed or acquired. "Related
persons" include certain related natural persons, affiliated corporations, a
partnership and its partners and an S Corporation and its shareholders.
In order for the Fund to pay exempt-interest dividends for any taxable
year, at least 50% of the aggregate value of the Fund's portfolio must consist
of exempt-interest obligations at the close of each quarter of its taxable year.
Within 60 days after the close of the taxable year, the Fund will notify its
shareholders of the portion of the dividends paid by the Fund which constitutes
an exempt-interest dividend with respect to such taxable year. However, the
aggregate amount of dividends so designated by the Fund cannot exceed the excess
of the amount of interest exempt from tax under Section 103 of the Code received
by the Fund during the taxable year over any amounts disallowed as deductions
under Sections 265 and 171(a)(2) of the Code. The percentage of total dividends
paid by the Fund with respect to any taxable year which qualifies as exempt-
interest dividends will be the same for all shareholders receiving dividends
from the Fund for such year.
Interest on indebtedness incurred by a shareholder to purchase or
carry the Shares generally is not deductible for income tax purposes. In
addition, if a shareholder holds Shares for six months or less, any loss on the
sale or exchange of those Shares will be disallowed to the extent of the amount
of exempt-interest dividends received with respect to the Shares.
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<PAGE>
The Treasury Department, however, is authorized to issue regulations reducing
the six-month holding requirement to a period of not less than the greater of 31
days or the period between regular dividend distributions where the investment
company regularly distributes at least 90% of its net tax-exempt interest. No
such regulations had been issued as of the date of this Statement of Additional
Information.
Any net long-term capital gains realized by the Fund will be
distributed at least annually. The Fund will generally have no tax liability
with respect to such gains and the distributions will be taxable to shareholders
as long-term capital gains, regardless of how long a shareholder has held
Shares. Such distributions will be designated as a capital gain dividend in a
written notice mailed by the Fund to shareholders not later than 60 days after
the close of the Fund's taxable year.
A 4% non-deductible excise tax is imposed on regulated investment
companies that fail to currently distribute an amount equal to specified
percentages of their ordinary taxable income and capital gain net income (excess
of capital gains over capital losses). The Fund intends to make sufficient
distributions or deemed distributions of its ordinary taxable income and any
capital gain net income prior to the end of each calendar year to avoid
liability for this excise tax.
The Fund will be required in certain cases to withhold and remit to
the U.S. Treasury 31% of taxable dividends or 31% of gross proceeds realized
upon sale paid to shareholders who have failed to provide a correct tax
identification number in the manner required, who are subject to withholding by
the Internal Revenue Service for failure properly to include on their return
payments of taxable interest or dividends, or who have failed to certify to the
Fund when required to do so either that they are not subject to backup
withholding or that they are "exempt recipients."
Taxation of Certain Financial Instruments
- -----------------------------------------
Generally, futures contracts held by the Fund at the close of the
Fund's taxable year will be treated for Federal income tax purposes as sold for
their fair market value on the last business day of such year, a process known
as "mark-to-market." Forty percent of any gain or loss resulting from such
constructive sale will be treated as short-term capital gain or loss and 60% of
such gain or loss will be treated as long-term capital gain or loss, without
regard to the length of time the Fund has held the futures contract (the "40%-
60% rule"). The amount of any capital gain or loss actually realized by the Fund
in a subsequent sale or other disposition of those futures
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<PAGE>
contracts will be adjusted to reflect any capital gain or loss taken into
account by the Fund in a prior year as a result of the constructive sale of the
contracts. Futures contracts to sell will be regarded as parts of a "mixed
straddle" because their values fluctuate inversely to the values of specific
securities held by the Fund. Losses as to futures contracts to sell will be
subject to certain loss deferral rules which limit the amount of loss currently
deductible on either part of the straddle to the amount thereof which exceeds
the unrecognized gain (if any) with respect to the other part of the straddle,
and to certain wash sales regulations. Under short sales rules, which will also
be applicable, the holding period of the securities forming part of the straddle
will (if they have not been held for the long-term holding period) be deemed not
to begin prior to termination of the straddle. With respect to certain futures
contracts, deductions for interest and carrying charges will not be allowed.
Notwithstanding the rules described above, with respect to futures contracts to
sell which are properly identified as such, the Fund may make an election which
will exempt (in whole or in part) those identified futures contracts from being
treated for Federal income tax purposes as sold on the last business day of the
Fund's taxable year, but gains and losses will be subject to such short sales,
wash sales, and loss deferral rules and the requirement to capitalize interest
and carrying charges. Under temporary regulations, the Fund would be allowed
(in lieu of the foregoing) to elect either (1) to offset gains or losses from
positions which are part of a mixed straddle by separately identifying each
mixed straddle to which such treatment applies, or (2) to establish a mixed
straddle account for which gains and losses would be recognized and offset on a
periodic basis during the taxable year. Under either election, the 40%-60% rule
will apply to the net gain or loss attributable to the futures contracts, but in
the case of a mixed straddle account election, not more than 50 percent of any
net gain may be treated as long-term and no more than 40 percent of any net loss
may be treated as short-term. Options on futures contracts generally receive
Federal tax treatment similar to that described above.
The Fund will not be treated as a regulated investment company under
the Code if 30% or more of the Fund's gross income for a taxable year is derived
from gains realized on the sale or other disposition of the following
investments held for less than three months (the "Short-Short Test"): (1) stock
and securities (as defined in section 2(a)(36) of the 1940 Act); (2) options,
futures and forward contracts other than those on foreign currencies; and (3)
foreign currencies (and options, futures and forward contracts on foreign
currencies) that are not directly related to the Fund's principal business of
investing in stock and securities (and options and futures with respect to
stocks and securities). Interest (including original issue discount and accrued
market discount) received by the Fund upon maturity or disposition of a security
held for less than three months will
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not be treated as gross income derived from the sale or other disposition of
such security within the meaning of this requirement. However, any other income
which is attributable to realized market appreciation will be treated as gross
income from the sale or other disposition of securities for this purpose. With
respect to futures contracts, forward contracts, options on futures contracts,
and other financial instruments subject to the mark-to-market rules described
above, the Internal Revenue Service has ruled in private letter rulings that a
gain realized from such a contract, option, or financial instrument will be
treated as being derived from a security held for three months or more
(regardless of the actual period for which the contract, option or instrument is
held) if the gain arises as a result of a constructive sale under the mark-to-
market rules, and will be treated as being derived from a security held for less
than three months only if the contract, option or instrument is terminated (or
transferred) during the taxable year (other than by reason of mark-to-market)
and less than three months have elapsed between the date the contract, option or
instrument is acquired and the termination date. Increases and decreases in the
value of the Fund's futures contracts and other investments that qualify as part
of a "designated hedge," as defined in Section 851(g) of the Code, may be netted
for purposes of determining whether the Short-Short Test is met.
* * *
As of the date of this Statement of Additional Information, new
Federal tax legislation--the Taxpayer Relief Act of 1997 (the "TRA")--has been
passed by the House of Representatives and the Senate, and is expected to be
signed by the President. The TRA, if enacted as expected, will repeal the
Short-Short Test (effective for each Fund's next fiscal year) and will change
applicable rates and holding period rules for capital gains.
The foregoing discussion is based on Federal tax laws and regulations
which are in effect on the date of this Statement of Additional Information;
such laws and regulations may be changed by legislative or administrative
action. Shareholders are advised to consult their tax advisers concerning their
specific situations, the application of state and local taxes and changes in
Federal tax rules under the TRA.
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<PAGE>
PERFORMANCE AND YIELD INFORMATION
---------------------------------
The Fund may advertise the standardized effective 30-day (or one
month) yields calculated in accordance with the method prescribed by the SEC for
mutual funds. Such yield will be calculated separately for the Fund according
to the following formula:
a-b
Yield = 2 [(----- + 1) to the sixth power - 1]
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = average daily number of Shares outstanding that were entitled to
receive dividends.
d = maximum offering price per Share on the last day of the period.
For the purpose of determining interest earned during the period
(variable "a" in the formula), the Fund computes the yield to maturity of any
debt obligation held by it based on the market value of the obligation
(including actual accrued interest) at the close of business on the last
business day of each month, or, with respect to obligations purchased during the
month, the purchase price (plus actual accrued interest). Such yield is then
divided by 360, and the quotient is multiplied by the market value of the
obligation (including actual accrued interest) in order to determine the
interest income on the obligation for each day of the subsequent month that the
obligation is in the portfolio. It is assumed in the above calculation that
each month contains 30 days. Also, the maturity of a debt obligation with a
call provision is deemed to be the next call date on which the obligation
reasonably may be expected to be called or, if none, the maturity date. The
Fund calculates interest gained on tax-exempt obligations issued without
original issue discount and having a current market discount by using the coupon
rate of interest instead of the yield to maturity. In the case of tax-exempt
obligations with original issue discount, where the discount based on the
current market value exceeds the then-remaining portion of original issue
discount, the yield to maturity is the imputed rate based on the original issue
discount calculation. Conversely, where the discount based on the current
market value is less than the remaining portion of the original
issue discount, the yield to maturity is based on the market value.
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Expenses accrued for the period (variable "b" in the formula) include
all recurring fees charged by the Fund to all shareholder accounts and to the
particular series of Shares in proportion to the length of the base period and
the Fund's mean (or median) account size. Undeclared earned income will be
subtracted from the maximum offering price per Share (variable "d" in the
formula).
Based on the foregoing calculations, the Fund's standardized effective
yield for the 30-day period ended March 31, 1997 was 4.07%.
The "tax-equivalent" yield of the Fund is computed by: (a) dividing
the portion of the yield (calculated as above) that is exempt from Federal
income tax by one minus a stated Federal income tax rate and (b) adding that
figure to that portion, if any, of the yield that is not exempt from Federal
income tax. Tax-equivalent yields assume the payment of Federal income taxes at
a rate of 31%.
Based on the foregoing calculation, the tax-equivalent yield of the
Fund for the 30-day period ended March 31, 1997 was 5.90%.
The Fund's "average annual total return" is computed by determining
the average annual compounded rate of return during specified periods that
equates the initial amount invested to the ending redeemable value of such
investment according to the following formula:
ERV
T = [(-----) to the first power divided by n - 1]
P
Where: T = average annual total return.
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the 1, 5 or 10 year (or other)
periods at the end of the applicable period (or a
fractional portion thereof).
P = hypothetical initial payment of $1,000.
n = period covered by the computation, expressed in years.
The calculation is made assuming that (1) all dividends and capital
gain distributions are reinvested on the reinvestment dates at the price per
Share existing on the reinvestment date, (2) all recurring fees charged to all
shareholder accounts are included, and (3) for any account fees that vary with
the size of
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the account, a mean (or median) account size in the Fund during the periods is
reflected. The ending redeemable value (variable "ERV" in the formula) is
determined by assuming complete redemption of the hypothetical investment after
deduction of all nonrecurring charges at the end of the measuring period. The
average annual total returns for the Fund's Shares for the one year period ended
March 31, 1997, the five year period ended March 31, 1997 and for the period
from commencement of operations (May 31, 1990) to March 31, 1997 were 4.46%,
5.65% and 6.32%, respectively.
The Fund may also from time to time include in advertisements, sales
literature and communications to shareholders a total return figure that is not
calculated according to the formula set forth above in order to compare more
accurately the Fund's performance with other measures of investment return. For
example, in comparing the Fund's total return with data published by Lipper
Analytical Services, Inc., CDA Investment Technologies, Inc. or Weisenberger
Investment Company Service, or with the performance of an index, the Fund may
calculate its aggregate total return for the period of time specified in the
advertisement or communication by assuming the investment of $10,000 in Shares
and assuming the reinvestment of each dividend or other distribution at net
asset value on the reinvestment date. Percentage increases are determined by
subtracting the initial value of the investment from the ending value and by
dividing the remainder by the beginning value.
The total return and yield of the Fund may be compared to that of
other mutual funds with similar investment objectives and to other relevant
indices or to ratings prepared by independent services or other financial or
industry publications that monitor the performance of mutual funds. For
example, the total return and/or yield of the Fund may be compared to data
prepared by Lipper Analytical Services, Inc., CDA Investment Technologies, Inc.
and Weisenberger Investment Company Service. Total return and yield data as
reported in national financial publications such as Money Magazine, Forbes,
----- -------- ------
Barron's, The Wall Street Journal and The New York Times, or in publications of
- -------- --- ---- ------ ------- --- --- ---- -----
a local or regional nature, may also be used in comparing the performance of the
Fund. Advertisements, sales literature or reports to shareholders may from time
to time also include a discussion and analysis of the Fund's performance,
including without limitation, those factors, strategies and technologies that
together with market conditions and events, materially affected the Fund's
performance.
The Fund may also from time to time include discussions or
illustrations of the effects of compounding in advertisements. "Compounding"
refers to the fact that, if dividends or other distributions of the Fund
investment are reinvested by being paid in additional Fund shares, any future
income or capital
-51-
<PAGE>
appreciations of the Fund would increase the value, not only of the original
Fund investment, but also of the additional Fund shares received through
reinvestment. As a result, the value of the Fund investment would increase more
quickly than if dividends or other distributions had been paid in cash. The Fund
may also include discussions or illustrations of the potential investment goals
of a prospective investor, investment management techniques, policies or
investment suitability of the Fund, economic conditions, the effects of
inflation and historical performance of various asset classes, including but not
limited to, stocks, bonds and Treasury bills. From time to time advertisements,
sales literature or communications to shareholders may summarize the substance
of information contained in shareholder reports (including the investment
composition of the Fund), as well as the views of the Investment Adviser as to
current market, economy, trade and interest rate trends, legislative, regulatory
and monetary developments, investment strategies and related matters believed to
be of relevance to the Fund. The Fund may also include in advertisements charts,
graphs or drawings which illustrate the potential risks and rewards of
investment in various investment vehicles, including but not limited to, stocks,
bonds, Treasury bills and Shares of the Fund. In addition, advertisements, sales
literature or shareholder communications may include a discussion of certain
attributes or benefits to be derived by an investment in the Fund. Such
advertisements or communicators may include symbols, headlines or other material
which highlight or summarize the information discussed in more detail therein.
MISCELLANEOUS
-------------
As used in the Prospectus, "assets belonging to the Fund" means the
consideration received upon the issuance of Shares in the Fund, together with
all income, earnings, profits, and proceeds derived from the investment thereof,
including any proceeds from the sale of such investments, any funds or payments
derived from any reinvestment of such proceeds, and a portion of any general
assets of Excelsior Tax-Exempt Fund not belonging to a particular portfolio of
Excelsior Tax-Exempt Fund. In determining the net asset value of the Fund's
Shares, assets belonging to the Fund allocable to Shares are charged with the
direct liabilities of the Fund allocable to Shares and with a share of the
general liabilities of Excelsior Tax-Exempt Fund which are normally allocated in
proportion to the relative asset values of Excelsior Tax-Exempt Fund's
portfolios at the time of allocation. Subject to the provisions of Excelsior
Tax-Exempt Fund's Charter, determinations by the Board of Directors as to the
direct and allocable liabilities, and the allocable portion of any general
assets with respect to the Fund, are conclusive.
-52-
<PAGE>
As of July 14, 1997, U.S. Trust and its affiliates held of record
substantially all of Excelsior Tax-Exempt Fund's outstanding shares as agent or
custodian for their customers, but did not own such shares beneficially because
they did not have voting or investment discretion with respect to such shares.
As of July 14, 1997, no person beneficially owned 5% or more of the
outstanding Shares of the Fund.
FINANCIAL STATEMENTS
--------------------
The audited financial statements and notes thereto in Excelsior Tax-
Exempt Fund's Annual Report to Shareholders for the fiscal year ended March 31,
1997 (the "1997 Annual Report") for the Fund are incorporated in this Statement
of Additional Information by reference. No other parts of the 1997 Annual
Report are incorporated by reference herein. The financial statements included
in the 1997 Annual Report for the Fund have been audited by Excelsior Tax-Exempt
Fund's independent auditors, Ernst & Young LLP, whose reports thereon also
appear in the 1997 Annual Report and are incorporated herein by reference. Such
financial statements have been incorporated herein in reliance upon such reports
given upon the authority of such firm as experts in accounting and auditing.
Additional copies of the 1997 Annual Report may be obtained at no charge by
telephoning CGFSC at the telephone number appearing on the front page of this
Statement of Additional Information.
-53-
<PAGE>
APPENDIX A
----------
COMMERCIAL PAPER RATINGS
- ------------------------
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment of debt considered short-term in the relevant
market. The following summarizes the rating categories used by Standard and
Poor's for commercial paper:
"A-1" - The highest category indicates that the degree of safety
regarding timely payment is strong. Those issues determined to possess
extremely strong safety characteristics are denoted with a plus sign (+)
designation.
"A-2" - Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated "A-1."
"A-3" - Issues carrying this designation have adequate capacity for
timely payment. They are, however, more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
"B" - Issues are regarded as having only a speculative capacity for
timely payment.
"C" - This rating is assigned to short-term debt obligations with a
doubtful capacity for payment.
"D" - Issues are in payment default.
Moody's commercial paper ratings are opinions of the ability of
issuers to repay punctually promissory obligations not having an original
maturity in excess of 9 months. The following summarizes the rating categories
used by Moody's for commercial paper:
"Prime-1" - Issuers or related supporting institutions have a superior
capacity for repayment of short-term promissory obligations. Prime-1 repayment
capacity will normally be evidenced by the following characteristics: leading
market positions in well established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on debt
and ample asset protection; broad margins in earning coverage of fixed financial
charges and high internal cash generation; and well established access to a
range of financial markets and assured sources of alternate liquidity.
A-1
<PAGE>
"Prime-2" - Issuers or related supporting institutions have a strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternative liquidity is maintained.
"Prime-3" - Issuers or related supporting institutions have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuers do not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps for investment grade
commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps
employs three designations, "D-1+," "D-1" and "D-1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
"D-1+" - Debt possesses highest certainty of timely payment. Short-
term liquidity, including internal operating factors and/or access to
alternative sources of funds, is outstanding, and safety is just below risk-free
U.S. Treasury short-term obligations.
"D-1" - Debt possesses very high certainty of timely payment.
Liquidity factors are excellent and supported by good fundamental protection
factors. Risk factors are minor.
"D-1-" - Debt possesses high certainty of timely payment. Liquidity
factors are strong and supported by good fundamental protection factors. Risk
factors are very small.
"D-2" - Debt possesses good certainty of timely payment. Liquidity
factors and company fundamentals are sound. Although ongoing funding needs may
enlarge total financing requirements, access to capital markets is good. Risk
factors are small.
"D-3" - Debt possesses satisfactory liquidity and other protection
factors qualify issue as investment grade. Risk
A-2
<PAGE>
factors are larger and subject to more variation. Nevertheless, timely payment
is expected.
"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to ensure against disruption in debt service.
Operating factors and market access may be subject to a high degree of
variation.
"D-5" - Issuer has failed to meet scheduled principal and/or interest
payments.
Fitch short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years. The
following summarizes the rating categories used by Fitch for short-term
obligations:
"F-1+" - Securities possess exceptionally strong credit quality.
Issues assigned this rating are regarded as having the strongest degree of
assurance for timely payment.
"F-1" - Securities possess very strong credit quality. Issues
assigned this rating reflect an assurance of timely payment only slightly less
in degree than issues rated "F-1+."
"F-2" - Securities possess good credit quality. Issues assigned this
rating have a satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as the "F-1+" and "F-1" ratings.
"F-3" - Securities possess fair credit quality. Issues assigned this
rating have characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause these
securities to be rated below investment grade.
"F-S" - Securities possess weak credit quality. Issues assigned this
rating have characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial and
economic conditions.
"D" - Securities are in actual or imminent payment default.
Fitch may also use the symbol "LOC" with its short-term ratings to
indicate that the rating is based upon a letter of credit issued by a commercial
bank.
Thomson BankWatch short-term ratings assess the likelihood of an
untimely or incomplete payment of principal or interest of unsubordinated
instruments having a maturity of one
A-3
<PAGE>
year or less which are issued by United States commercial banks, thrifts and
non-bank banks; non-United States banks; and broker-dealers. The following
summarizes the ratings used by Thomson BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's highest
rating category and indicates a very high degree of likelihood that principal
and interest will be paid on a timely basis.
"TBW-2" - This designation indicates that while the degree of safety
regarding timely payment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated "TBW-1."
"TBW-3" - This designation represents the lowest investment grade
category and indicates that while the debt is more susceptible to adverse
developments (both internal and external) than obligations with higher ratings,
capacity to service principal and interest in a timely fashion is considered
adequate.
"TBW-4" - This designation indicates that the debt is regarded as non-
investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an
original maturity of less than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for short-term debt ratings:
"A1+" - Obligations which posses a particularly strong credit feature
are supported by the highest capacity for timely repayment.
"A1" - Obligations are supported by the highest capacity for timely
repayment.
"A2" - Obligations are supported by a good capacity for timely
repayment.
"A3" - Obligations are supported by a satisfactory capacity for timely
repayment.
"B" - Obligations for which there is an uncertainty as to the capacity
to ensure timely repayment.
"C" - Obligations for which there is a high risk of default or which
are currently in default.
A-4
<PAGE>
CORPORATE AND MUNICIPAL LONG-TERM DEBT RATINGS
- ----------------------------------------------
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"AAA" - This designation represents the highest rating assigned by
Standard & Poor's to a debt obligation and indicates an extremely strong
capacity to pay interest and repay principal.
"AA" - Debt is considered to have a very strong capacity to pay
interest and repay principal and differs from AAA issues only in small degree.
"A" - Debt is considered to have a strong capacity to pay interest and
repay principal although such issues are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher-rated categories.
"BBB" - Debt is regarded as having an adequate capacity to pay
interest and repay principal. Whereas such issues normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher-rated categories.
"BB," "B," "CCC," "CC" and "C" - Debt is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. "BB" indicates the
lowest degree of speculation and "C" the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
"BB" - Debt has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-" rating.
"B" - Debt has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The "B" rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied "BB" or "BB-" rating.
A-5
<PAGE>
"CCC" - Debt has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The "CCC" rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
"B" or "B-" rating.
"CC" - This rating is typically applied to debt subordinated to senior
debt that is assigned an actual or implied "CCC" rating.
"C" - This rating is typically applied to debt subordinated to senior
debt which is assigned an actual or implied "CCC-" debt rating. The "C" rating
may be used to cover a situation where a bankruptcy petition has been filed, but
debt service payments are continued.
"CI" - This rating is reserved for income bonds on which no interest
is being paid.
"D" - Debt is in payment default. This rating is used when interest
payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S & P believes that such
payments will be made during such grace period. "D" rating is also used upon
the filing of a bankruptcy petition if debt service payments are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC" may be
modified by the addition of a plus or minus sign to show relative standing
within the major rating categories.
"r" - This rating is attached to highlight derivative, hybrid, and
certain other obligations that S & P believes may experience high volatility or
high variability in expected returns due to non-credit risks. Examples of such
obligations are: securities whose principal or interest return is indexed to
equities, commodities, or currencies; certain swaps and options; and interest
only and principal only mortgage securities. The absence of an "r" symbol
should not be taken as an indication that an obligation will exhibit no
volatility or variability in total return.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"Aaa" - Bonds are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements
are
A-6
<PAGE>
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
"Aa" - Bonds are judged to be of high quality by all standards.
Together with the "Aaa" group they comprise what are generally known as high-
grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in "Aaa" securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in "Aaa"
securities.
"A" - Bonds possess many favorable investment attributes and are to be
considered as upper medium-grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
"Baa" - Bonds considered medium-grade obligations, i.e., they are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great length of time.
Such bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
"Ba," "B," "Caa," "Ca," and "C" - Bonds that possess one of these
ratings provide questionable protection of interest and principal ("Ba"
indicates some speculative elements; "B" indicates a general lack of
characteristics of desirable investment; "Caa" represents a poor standing; "Ca"
represents obligations which are speculative in a high degree; and "C"
represents the lowest rated class of bonds). "Caa," "Ca" and "C" bonds may be in
default.
Con. (---) - Bonds for which the security depends upon the completion
of some act or the fulfillment of some condition are rated conditionally. These
are bonds secured by (a) earnings of projects under construction, (b) earnings
of projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
(P)... - When applied to forward delivery bonds, indicates that the
rating is provisional pending delivery of the bonds. The rating may be revised
prior to delivery if changes occur in the legal documents or the underlying
credit quality of the bonds.
A-7
<PAGE>
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's
believes possess the strongest investment attributes are designated by the
symbols, Aa1, A1, Baa1, Ba1 and B1.
The following summarizes the long-term debt ratings used by Duff &
Phelps for corporate and municipal long-term debt:
"AAA" - Debt is considered to be of the highest credit quality. The
risk factors are negligible, being only slightly more than for risk-free U.S.
Treasury debt.
"AA" - Debt is considered of high credit quality. Protection factors
are strong. Risk is modest but may vary slightly from time to time because of
economic conditions.
"A" - Debt possesses protection factors which are average but
adequate. However, risk factors are more variable and greater in periods of
economic stress.
"BBB" - Debt possesses below average protection factors but such
protection factors are still considered sufficient for prudent investment.
Considerable variability in risk is present during economic cycles.
"BB," "B," "CCC," "DD," and "DP" - Debt that possesses one of these
ratings is considered to be below investment grade. Although below investment
grade, debt rated "BB" is deemed likely to meet obligations when due. Debt
rated "B" possesses the risk that obligations will not be met when due. Debt
rated "CCC" is well below investment grade and has considerable uncertainty as
to timely payment of principal, interest or preferred dividends. Debt rated
"DD" is a defaulted debt obligation, and the rating "DP" represents preferred
stock with dividend arrearages.
To provide more detailed indications of credit quality, the "AA," "A,"
"BBB," "BB" and "B" ratings may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within these major categories.
The following summarizes the highest four ratings used by Fitch for
corporate and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably foreseeable
events.
"AA" - Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong
A-8
<PAGE>
as bonds rated "AAA." Because bonds rated in the "AAA" and "AA" categories are
not significantly vulnerable to foreseeable future developments, short-term debt
of these issuers is generally rated "F-1+."
"A" - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
To provide more detailed indications of credit quality, the Fitch
ratings from and including "AA" to "BBB" may be modified by the addition of a
plus (+) or minus (-) sign to show relative standing within these major rating
categories.
IBCA assesses the investment quality of unsecured debt with an
original maturity of more than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for long-term debt ratings:
"AAA" - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial, such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk substantially.
"AA" - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial, such that adverse changes in business, economic or financial
conditions may increase investment risk, albeit not very significantly.
"A" - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is strong,
although adverse changes in business, economic or financial conditions may lead
to increased investment risk.
"BBB" - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of
A-9
<PAGE>
principal and interest is adequate, although adverse changes in business,
economic or financial conditions are more likely to lead to increased investment
risk than for obligations in other categories.
"BB," "B," "CCC," "CC," and "C" - Obligations are assigned one of
these ratings where it is considered that speculative characteristics are
present. "BB" represents the lowest degree of speculation and indicates a
possibility of investment risk developing. "C" represents the highest degree of
speculation and indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating below
"AAA" to denote relative status within major rating categories.
Thomson BankWatch assesses the likelihood of an untimely repayment of
principal or interest over the term to maturity of long term debt and preferred
stock which are issued by United States commercial banks, thrifts and non-bank
banks; non-United States banks; and broker-dealers. The following summarizes
the rating categories used by Thomson BankWatch for long-term debt ratings:
"AAA" - This designation represents the highest category assigned by
Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is extremely high.
"AA" - This designation indicates a very strong ability to repay
principal and interest on a timely basis with limited incremental risk compared
to issues rated in the highest category.
"A" - This designation indicates that the ability to repay principal
and interest is strong. Issues rated "A" could be more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
"BBB" - This designation represents Thomson BankWatch's lowest
investment grade category and indicates an acceptable capacity to repay
principal and interest. Issues rated "BBB" are, however, more vulnerable to
adverse developments (both internal and external) than obligations with higher
ratings.
"BB," "B," "CCC," and "CC," - These designations are assigned by
Thomson BankWatch to non-investment grade long-term debt. Such issues are
regarded as having speculative characteristics regarding the likelihood of
timely payment of
A-10
<PAGE>
principal and interest. "BB" indicates the lowest degree of speculation and
"CC" the highest degree of speculation.
"D" - This designation indicates that the long-term debt is in
default.
PLUS (+) OR MINUS (-) - The ratings from "AAA" through "CC" may
include a plus or minus sign designation which indicates where within the
respective category the issue is placed.
MUNICIPAL NOTE RATINGS
- ----------------------
A Standard and Poor's rating reflects the liquidity concerns and
market access risks unique to notes due in three years or less. The following
summarizes the ratings used by Standard & Poor's Ratings Group for municipal
notes:
"SP-1" - The issuers of these municipal notes exhibit very strong or
strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit satisfactory
capacity to pay principal and interest.
"SP-3" - The issuers of these municipal notes exhibit speculative
capacity to pay principal and interest.
Moody's ratings for state and municipal notes and other short-term
loans are designated Moody's Investment Grade ("MIG") and variable rate demand
obligations are designated Variable Moody's Investment Grade ("VMIG"). Such
ratings recognize the differences between short-term credit risk and long-term
risk. The following summarizes the ratings by Moody's Investors Service, Inc.
for short-term notes:
"MIG-1"/"VMIG-1" - Loans bearing this designation are of the best
quality, enjoying strong protection by established cash flows, superior
liquidity support or demonstrated broad-based access to the market for
refinancing.
"MIG-2"/"VMIG-2" - Loans bearing this designation are of high quality,
with margins of protection ample although not so large as in the preceding
group.
"MIG-3"/"VMIG-3" - Loans bearing this designation are of favorable
quality, with all security elements accounted for but lacking the undeniable
strength of the preceding grades. Liquidity and cash flow protection may be
narrow and market access for refinancing is likely to be less well established.
A-11
<PAGE>
"MIG-4"/"VMIG-4" - Loans bearing this designation are of adequate
quality, carrying specific risk but having protection commonly regarded as
required of an investment security and not distinctly or predominantly
speculative.
"SG" - Loans bearing this designation are of speculative quality and
lack margins of protection.
Fitch and Duff & Phelps use the short-term ratings described under
Commercial Paper Ratings for municipal notes.
A-12
<PAGE>
EXCELSIOR TAX-EXEMPT FUNDS, INC.
California Tax-Exempt Income Fund
STATEMENT OF ADDITIONAL INFORMATION
August 1, 1997
This Statement of Additional Information is not a prospectus but should be read
in conjunction with the current prospectus for the California Tax-Exempt Income
Fund (the "Fund"), an investment portfolio of Excelsior Tax-Exempt Funds, Inc.
("Excelsior Tax-Exempt Fund") dated August 1, 1997 (the "Prospectus"). Much of
the information contained in this Statement of Additional Information expands
upon the subjects discussed in the Prospectus. No investment in shares of the
Fund ("Shares") should be made without reading the Prospectus. A copy of the
Prospectus may be obtained by writing Excelsior Tax-Exempt Fund c/o Chase Global
Funds Services Company, 73 Tremont Street, Boston, MA 02108-3913 or by calling
(800) 446-1012.
<PAGE>
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
Page
----
<S> <C>
INVESTMENT OBJECTIVE AND POLICIES............... 1
Additional Information on Portfolio
Instruments.............................. 1
Risk Factors Relating to
California Municipal Obligations......... 7
Additional Investment Limitations.......... 22
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION.. 23
INVESTOR PROGRAMS............................... 25
Systematic Withdrawal Plan................. 25
Exchange Privilege......................... 25
Other Investor Programs.................... 26
DESCRIPTION OF CAPITAL STOCK.................... 26
MANAGEMENT OF THE FUND.......................... 29
Directors and Officers..................... 29
Investment Advisory, Sub-Advisory and
Administration Agreements................ 36
Shareholder Organizations.................. 37
Expenses................................... 38
Custodian and Transfer Agent............... 38
PORTFOLIO TRANSACTIONS.......................... 39
INDEPENDENT AUDITORS............................ 42
COUNSEL......................................... 42
ADDITIONAL INFORMATION CONCERNING TAXES......... 42
Federal.................................... 42
Taxation of Certain Financial Instruments.. 44
California................................. 46
PERFORMANCE AND YIELD INFORMATION............... 48
MISCELLANEOUS................................... 52
FINANCIAL STATEMENTS............................ 53
APPENDIX A...................................... A-1
</TABLE>
-i-
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
---------------------------------
The investment objective of the Fund is to provide California
investors with as high a level of current interest income exempt from Federal
income tax and, to the extent possible, from California state personal income
taxes as is consistent with relative stability of principal. Under normal
market conditions, at least 80% of the Fund's assets will be invested in
Municipal Obligations (as defined in the Prospectus), and at least 65% of the
Fund's assets will be invested in California Municipal Obligations (as defined
in the Prospectus). The following policies supplement the Fund's investment
objective and policies as set forth in the Prospectus.
Additional Information on Portfolio Instruments
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Municipal Obligations
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Municipal Obligations include debt obligations issued by governmental
entities to obtain funds for various public purposes, including the construction
of a wide range of public facilities, the refunding of outstanding obligations,
the payment of general operating expenses, and the extension of loans to public
institutions and facilities. Private activity bonds that are issued by or on
behalf of public authorities to finance various privately operated facilities
are included within the term "Municipal Obligations" only if the interest paid
thereon is exempt from general Federal income tax and not treated as a specific
tax preference item under the Federal alternative minimum tax.
The two principal classifications of Municipal Obli gations are
"general obligation" and "revenue" issues, but the Fund's portfolio may also
include "moral obligation" issues, which are normally issued by special-purpose
authorities. There are, of course, variations in the quality of Municipal
Obligations, both within a particular classification and between
classifications, and the yields on Municipal Obligations depend upon a variety
of factors, including general money market conditions, the financial condition
of the issuer, general conditions of the municipal bond market, the size of a
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of Moody's Investors Service, Inc. ("Moody's") and Standard
& Poor's Ratings Group ("S&P") described in the Prospectus and Appendix A hereto
represent their opinion as to the quality of Municipal Obligations. It should
be emphasized that these ratings are general and are not absolute standards of
quality, and Municipal Obligations with the same maturity, interest rate, and
rating may have different yields while Municipal Obligations of the same
maturity and interest rate with different ratings may have the same yield.
Subsequent to its purchase by the Fund, an issue of Municipal Obligations
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may cease to be rated, or its rating may be reduced below the minimum rating
required for purchase by the Fund. United States Trust Company of New York
("U.S. Trust New York"), U.S. Trust Company of Connecticut ("U.S. Trust
Connecticut" and, collectively with U.S. Trust New York, the "Investment
Adviser" or "U.S. Trust") and United States Trust Company of California, the
Fund's sub-adviser (the "Sub-Adviser"), will consider such an event in
determining whether the Fund should continue to hold the obligation.
The payment of principal and interest on most securi ties purchased by
the Fund will depend upon the ability of the issuers to meet their obligations.
Each state, the District of Columbia, each of their political subdivisions,
agencies, instrumentalities and authorities, and each multistate agency of which
a state is a member, is a separate "issuer" as that term is used in this
Statement of Additional Information and the Fund's Prospectus. The non-
governmental user of facilities financed by private activity bonds is also
considered to be an "issuer." An issuer's obligations under its Municipal
Obligations are subject to the provisions of bankruptcy, insolvency, and other
laws affecting the rights and remedies of creditors, such as the Federal
Bankruptcy Code, and laws, if any, which may be enacted by Federal or state
legislatures extending the time for payment of principal or interest, or both,
or imposing other constraints upon enforcement of such obligations or upon the
ability of municipalities to levy taxes. The power or ability of an issuer to
meet its obligations for the payment of interest on and principal of its
Municipal Obligations may be materially adversely affected by litigation or
other conditions.
Private activity bonds are issued to obtain funds to provide, among
other things, privately operated housing facil ities, pollution control
facilities, convention or trade show facilities, mass transit, airport, port or
parking facilities and certain local facilities for water supply, gas,
electricity or sewage or solid waste disposal. Private activity bonds are also
issued to privately held or publicly owned corporations in the financing of
commercial or industrial facilities. State and local governments are authorized
in most states to issue private activity bonds for such purposes in order to
encourage corporations to locate within their communities. The principal and
interest on these obligations may be payable from the general revenues of the
users of such facilities.
From time to time, proposals have been introduced before Congress for
the purpose of restricting or eliminating the Federal income tax exemption for
interest on Municipal Obligations. For example, under the Tax Reform Act of
1986, as amended, interest on certain private activity bonds must be included in
an investor's alternative minimum taxable income, and corporate investors must
treat all tax-exempt interest as an item
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of tax preference. Excelsior Tax-Exempt Fund cannot, of course, predict what
legislation may be proposed in the future regarding the income tax status of
interest on Municipal Obligations, or which proposals, if any, might be enacted.
Such proposals, while pending or if enacted, might materially adversely affect
the availability of Municipal Obligations for investment by the Fund and the
liquidity and value of its portfolio. In such an event, the Fund would
reevaluate its investment objective and policies and consider possible changes
in its structure or possible dissolution.
Opinions relating to the validity of Municipal Obli gations and to the
exemption of interest thereon from Federal income tax are rendered by bond
counsel to the respective issuers at the time of issuance. The Fund, its
Investment Adviser and its Sub-Adviser will not review the proceedings relating
to the issuance of Municipal Obligations or the basis for such opinions.
Money Market Instruments
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Certificates of deposit acquired by the Fund within the limits set
forth in the Prospectus will be those of (i) domestic branches of U.S. banks
which are members of the Federal Reserve System or are insured by the Bank
Insurance Fund of the Federal Deposit Insurance Corporation ("FDIC"), or (ii)
savings and loan associations which are insured by the Savings Association
Insurance Fund of the FDIC. (The foregoing limitation does not preclude the Fund
from acquiring Municipal Obligations which are backed by letters of credit
issued by foreign banks.)
Tax-exempt commercial paper purchased by the Fund will consist of
issues rated at the time of purchase "A-3" or higher by S&P or "Prime-3" or
better by Moody's or, if not rated, determined to be of comparable quality by
the Investment Adviser. These rating symbols are described in Appendix A
hereto.
Insured Municipal Obligations
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The Fund may purchase Municipal Obligations which are insured as to
timely payment of principal and interest at the time of purchase. The insurance
policies will usually be obtained by the issuer of the bond at the time of its
original issuance. Bonds of this type will be acquired only if at the time of
purchase they satisfy quality requirements generally applicable to Municipal
Obligations as described in the Prospectus. Although insurance coverage for the
Municipal Obligations held by the Fund reduces credit risk by insuring that the
Fund will receive timely payment of principal and interest, it does not protect
against market fluctuations caused by changes in interest rates and other
factors. The Fund may invest more
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than 25% of its net assets in Municipal Obligations covered by insurance
policies.
Repurchase Agreements
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The repurchase price under the repurchase agreements described in the
Prospectus generally equals the price paid by the Fund plus interest negotiated
on the basis of current short-term rates (which may be more or less than the
rate on securities underlying the repurchase agreement). Securities subject to
repurchase agreements are held by the Fund's custodian (or sub-custodian) or in
the Federal Reserve/Treasury book-entry system. Repurchase agreements are
considered loans by the Fund under the Investment Company Act of 1940 (the "1940
Act").
When-Issued and Forward Transactions
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When the Fund agrees to purchase securities on a "when-issued" or
forward commitment basis, the custodian will set aside liquid assets equal to
the amount of the commitment in a separate account. Normally, the custodian will
set aside portfolio securities to satisfy a purchase commitment, and, in such
case, the Fund may be required subsequently to place additional assets in the
separate account in order to ensure that the value of the account remains equal
to the amount of the Fund's commitment. It may be expected that the Fund's net
assets will fluctuate to a greater degree when it sets aside portfolio
securities to cover such purchase commitments than when it sets aside cash.
Because the Fund will set aside liquid assets to satisfy its purchase
commitments in the manner described, the Fund's liquidity and ability to manage
its portfolio might be affected in the event its forward commitments or
commitments to purchase "when-issued" securities ever exceeded 25% of the value
of its assets.
The Fund will purchase securities on a "when-issued" or forward
commitment basis only with the intention of completing the transaction. If
deemed advisable as a matter of investment strategy, however, the Fund may
dispose of or renegotiate a commitment after it is entered into, and may sell
securities it has committed to purchase before those securities are delivered to
the Fund on the settlement date. In these cases, the Fund may realize a taxable
capital gain or loss.
When the Fund engages in "when-issued" or forward commitment
transactions, it relies on the other party to consummate the trade. Failure of
such other party to do so may result in the Fund incurring a loss or missing an
opportunity to obtain a price considered to be advantageous.
The market value of the securities underlying a "when-issued" purchase
or a forward commitment to purchase securities
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and any subsequent fluctuations in their market value are taken into account
when determining the market value of the Fund starting on the day the Fund
agrees to purchase the securities. The Fund does not earn interest on the
securities it has committed to purchase until they are paid for and delivered on
the settlement date.
Stand-By Commitments
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The Fund may acquire "stand-by commitments" with respect to Municipal
Obligations held by it. Under a "stand-by commitment," a dealer or bank agrees
to purchase from the Fund, at the Fund's option, specified Municipal Obligations
at a specified price. The amount payable to the Fund upon its exercise of a
"stand-by commitment" is normally (i) the Fund's acquisition cost of the
Municipal Obligations (excluding any accrued interest which the Fund paid on
their acquisition), less any amortized market premium or plus any amortized
market or original issue discount during the period the Fund owned the
securities, plus (ii) all interest accrued on the securities since the last
interest payment date during that period. "Stand-by commitments" are
exercisable by the Fund at any time before the maturity of the underlying
Municipal Obligations, and may be sold, transferred or assigned by the Fund only
with the underlying instruments.
The Fund expects that "stand-by commitments" will generally be
available without the payment of any direct or indirect consideration. However,
if necessary or advisable, the Fund may pay for a "stand-by commitment" either
separately in cash or by paying a higher price for securities which are acquired
subject to the commitment (thus reducing the yield to maturity otherwise
available for the same securities). Where the Fund has paid any consideration
directly or indirectly for a "stand-by commitment," its cost will be reflected
as unrealized depreciation for the period during which the commitment was held
by the Fund.
The Fund intends to enter into "stand-by commitments" only with banks
and broker/dealers which, in the Investment Adviser's or Sub-Adviser's opinion,
present minimal credit risks. In evaluating the creditworthiness of the issuer
of a "stand-by commitment," the Investment Adviser or Sub-Adviser will review
periodically the issuer's assets, liabilities, contingent claims and other
relevant financial information.
Futures Contracts
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The Fund may invest in interest rate futures contracts and municipal
bond index futures contracts. Futures contracts will not be entered into for
speculative purposes, but to hedge risks associated with the Fund's securities
investments.
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Positions in futures contracts may be closed out only on an exchange which
provides a secondary market for such futures. However, there can be no
assurance that a liquid secondary market will exist for any particular futures
contract at any specific time. Thus, it may not be possible to close a futures
position. In the event of adverse price movements, the Fund would continue to
be required to make daily cash payments to maintain its required margin. In
such situations, if the Fund has insufficient cash, it may have to sell
portfolio securities to meet daily margin requirements at a time when it may be
disadvantageous to do so. In addition, the Fund may be required to make
delivery of the instruments underlying futures contracts it holds. The
inability to close options and futures positions also could have an adverse
impact on the Fund's ability to effectively hedge.
Successful use of futures by the Fund is also subject to the
Investment Adviser's or Sub-Adviser's ability to correctly predict movements in
the direction of the market. For example, if the Fund has hedged against the
possibility of a decline in the market adversely affecting securities held by it
and securities prices increase instead, the Fund will lose part or all of the
benefit to the increased value of its securities which it has hedged because it
will approximately equal offsetting losses in its futures positions. In
addition, in some situations, if the Fund has insufficient cash, it may have to
sell securities to meet daily variation margin requirements. Such sale of
securities may be, but will not necessarily be, at increased prices which
reflect the rising market. The Fund may have to sell securities at a time when
it may be disadvantageous to do so.
The risk of loss in trading futures contracts in some strategies can
be substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit, before any deduction for the
transaction costs, if the contract were closed out. Thus, a purchase or sale of
a futures contract may result in losses in excess of the amount invested in the
contract.
Utilization of futures transactions by the Fund involves the risk of
loss by the Fund of margin deposits in the
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event of bankruptcy of a broker with whom the Fund has an open position in a
futures contract or related option.
Most futures exchanges limit the amount of fluctuation permitted in
futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.
The trading of futures contracts is also subject to the risk of
trading halts, suspensions, exchange or clearing house equipment failures,
government intervention, insolvency of a brokerage firm or clearing house or
other disruptions of normal trading activity, which could at times make it
difficult or impossible to liquidate existing positions or to recover excess
variation margin payments.
Miscellaneous
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The Fund may not invest in oil, gas, or mineral leases.
Risk Factors Relating to California Municipal Obligations
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Some of the significant financial considerations relating to the
Fund's investment in California Municipal Obligations are summarized below.
This summary information is not intended to be a complete description and is
principally derived from official statements relating to issues of California
Municipal Obligations that were available prior to the date of this Statement of
Additional Information. The accuracy and completeness of the information
contained in those official statements have not been independently verified.
The following information constitutes only a brief summary, does not
purport to be a complete description, and is based on information available as
of the date of this Prospectus from official statements and prospectuses
relating to securities offerings of the State of California and various local
agencies in California.
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ECONOMIC FACTORS
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FISCAL YEARS PRIOR TO 1996-97. By the close of the 1989-90 Fiscal
Year, California's revenues had fallen below projections so that the State's
budget reserve, the Special Fund for Economic Uncertainties (the "Special
Fund"), was fully depleted by June 30, 1990. A recession which had begun in
mid-1990, combined with higher health and welfare costs driven by the State's
rapid population growth, adversely affected General Fund revenues and raised
expenditures above initial budget appropriations.
As a result of these factors and others, the State confronted a period
of budget imbalance. Beginning with the 1990-91 Fiscal Year and for several
years thereafter, the budget required multibillion dollar actions to bring
projected revenues and expenditures into balance. During this period,
expenditures exceeded revenues in four out of six years, and the State
accumulated and sustained a budget deficit in the Special Fund --approaching
$2.8 billion at its peak on June 30, 1993.
By the 1993-94 Fiscal Year, the accumulated deficit was too large to
be prudently retired in one year and a two-year program was implemented. This
program used revenue anticipation warrants to carry a portion of the deficit
over to the end of the fiscal year.
The 1994-95 Budget Act projected General Fund revenues and transfers
of $41.9 billion. Expenditures were projected to be $40.9 billion -- an
increase of $1.6 billion over the prior year. As a result of the improving
economy, however, the fiscal year ultimately produced revenues and transfers of
$42.7 billion which more than offset expenditures of $42.0 billion and thereby
reduced the accumulated budget deficit.
With strengthening revenues and reduced caseload growth driven by an
improving economy, the State entered the 1995-96 Fiscal Year budget negotiations
with the smallest nominal "budget gap" to be closed in many years. The 1995-96
Budget Act projected General Fund revenues and transfers of $44.1 billion, a 3.5
percent increase from the prior year, and expenditures were budgeted at $43.4
billion. In addition, the Department of Finance projected that after repaying
the last of the carryover budget deficit, there would be a positive balance of
$28 million in the budget reserve as of June 30, 1996.
1996-97 FISCAL YEAR. The 1996-97 Governor's Budget, released January
10, 1996, projected General Fund revenues and transfers of $45.6 billion, a 1.3%
increase over 1995-96. The Governor's budget proposed two major initiatives, a
15% personal
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and corporate income tax cut and a revision of the trial court funding program,
which would have the effect of reducing General Fund revenues. The Governor's
Budget proposed General Fund expenditures of $45.2 billion. The Governor's
Budget also proposed Special Fund revenues equal to expenditures, at a level of
$13.3 billion.
The May Revision of the Governor's Budget, released on May 21, 1996
("The May Revision"), updated revenue estimates for the 1996-97 Fiscal Year,
reflecting stronger economic activity in the State and thus greater revenue
growth. The revised estimate was for $47.1 billion of revenues, still assuming
the Governor's tax cut would be enacted, and $46.5 billion of expenditures.
1996-97 BUDGET ACT. The 1996-97 Budget Act was signed by the Governor
on July 15, 1996, along with various implementing bills. The Governor vetoed
about $82 million of appropriations (both General Fund and Special Fund). With
the signing of the Budget Act, the State implemented its regular cash flow
borrowing program with the issuance of $3.0 billion of Revenue Anticipation
Notes to mature on June 30, 1997. The Budget Act appropriates a budget reserve
in the Special Fund of $305 million, as of June 30, 1997. The Department of
Finance projects that, on June 30, 1997, the State's available borrowable (cash)
resources will be $2.9 billion, after payment of all obligations due by that
date, so that no cross-fiscal year borrowing is anticipated.
Revenues. The Legislature rejected the Governor's proposed 15% cut in
personal income taxes (to be phased in over three years), approved a 5% cut in
bank and corporation taxes, to be effective for income years commencing on
January 1, 1997. As a result of the Legislature's failure to enact the personal
income tax cut, revenues for the Fiscal Year are estimated to be $550 million
higher than projected in the May Revision, and are now estimated to total
$47.643 billion, a 3.3 percent increase over the final estimated 1995-96
revenues. Special Fund revenues are estimated to be $13.3 billion.
Expenditures. The Budget Act contains General Fund appropriations
totaling $47.251 billion, a 4.0 percent increase over the final estimated 1995-
96 expenditures. Special Fund expenditures are budgeted at $12.6 billion.
The following are principal features of the 1996-97 Budget Act:
1. Proposition 98 funding for schools and community college
districts increased by almost $1.6 billion (General Fund) and $1.65 billion
above revised 1995-96 levels. Almost half of this money was budgeted to fund
class-size reductions in kindergarten and grades 1-3. Also, for the second
consecutive year, the full cost of living allowance (3.2 percent) was funded.
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Proposition 98 increases have brought K-12 expenditures to almost $4,800 per
pupil (also called "ADA", or "Average Daily Attendance"), an almost 15% increase
over the level prevailing during the recession years. Out of this $1.6 billion
total, community colleges will receive an increase in funding of $157 million
for 1996-97.
Due to higher than projected revenues in 1995-96, an additional $1.1
billion ($190 per K-12 ADA and $145 million for community colleges) was
appropriated and retroactively applied towards the 1995-96 Proposition 98
guarantee, bringing K-12 expenditures in that year to over $4,600 per ADA.
Similar retroactive increases totaling $230 million, based on final figures on
revenues and State population growth, were made to the 1991-92 and the 1994-95
Proposition 98 guarantees, most of which was allocated to each school site.
2. The Budget Act assumed savings of approximately $660 million in
health and welfare costs which required changes in federal law, including
federal welfare reform. The Budget Act further assumed federal law changes in
August 1996 which would allow welfare cash grant levels to be reduced by October
1, 1996. These cuts totaled approximately $163 million of the anticipated $660
million savings. See "Federal Welfare Reform" below.
3. A 4.9 percent increase in funding for the University of
California ($130 million General Fund) and the California State University
system ($101 million General Fund), with no increases in student fees.
4. The Budget Act assumed the federal government will provide
approximately $700 million in new aid for incarceration and health care costs of
illegal immigrants. These funds reduce appropriations in these categories that
would otherwise have to be paid from the General Fund. (For purposes of cash
flow projections, the Department of Finance expects $540 million of this amount
to be received during the 1996-97 fiscal year.)
5. General Fund support for the Department of Corrections was
increased by about 7 percent over the prior year, reflecting estimates of
increased prison population.
6. With respect to aid to local governments, the principal new
programs included in the Budget Act are $100 million in grants to cities and
counties for law enforcement purposes, and budgeted $50 million for competitive
grants to local governments for programs to combat juvenile crime.
The Budget Act did not contain any tax increases. As noted, there was
a reduction in bank and corporate taxes. In addition, the Legislature approved
another one-year suspension of the Renters' Tax Credit, saving $520 million in
expenditures.
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FEDERAL WELFARE REFORM. Following enactment of the 1996-97 Budget
Act, Congress passed and the President signed (on August 22, 1996) the Personal
Responsibility and Work Opportunity Act of 1996 (P.L. 104-193, the "Law") making
a fundamental reform of the current welfare system. Among many provisions, the
Law includes: (i) conversion of Aid to Families with Dependent Children from an
entitlement program to a block grant titled Temporary Assistance for Needy
Families ("TANF"), with lifetime time limits on TANF recipients, work
requirements and other changes; (ii) provisions denying certain federal welfare
and public benefits to legal noncitizens, allowing states to elect to deny
additional benefits (including TANF) to legal noncitizens, and generally denying
almost all benefits to illegal immigrants; and (iii) changes in the Food Stamp
program, including reducing maximum benefits and imposing work requirements.
The Law requires states to implement the new TANF program not later
than July 1, 1997 and provides California approximately $3.7 billion in block
grant funds for the 1996-97 Fiscal Year. States are allowed to implement TANF
as soon as possible and will receive a prorated block grant effective the date
of application. The California State Plan is to be submitted in time to allow
grant reductions to be implemented effective January 1, 1997 (allowing $92
million of the $163 million referred to in paragraph 2 above to be saved) and to
allow the State to capture approximately $267 million in additional federal
block grant funds over the currently budgeted level. None of the other federal
changes needed to achieve the balance of the $660 million cost savings were
enacted. Thus, in lieu of the $660 million savings initially assumed to be
saved, it is now projected that savings will total approximately $360 million.
A preliminary analysis of the Law by the Legislative Analyst's Office
indicated that an overall assessment of how these changes will affect the
State's General Fund will not be known for some time, and will depend on how the
State implements the Law. There are many choices, including how quickly the
State implements the Law; the degree to which the State elects to make up for
cuts in federal aid, provide more aid to counties or cut some of its own
existing programs for noncitizens; and the State's ability to avoid certain
penalties written into the Law.
1997-98 FISCAL YEAR PROPOSED BUDGET.
On January 9, 1997, the Governor released his proposed budget for the
1997-98 Fiscal Year (the "Governor's Budget"). The Governor's Budget projects
General Fund revenues and transfers in 1997-98 of $50.7 billion, a 4.6% increase
from revised 1996-97 figures. The Governor proposes expenditures of $50.3
billion, a 3.9% increase from 1996-97. The Governor's Budget projects a balance
in the SPEU of $553 million on June 30,
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1998. The Governor's Budget also anticipates about $3 billion of external
borrowing for cash flow purposes during the year, with no requirement for cross-
fiscal year borrowing.
Among the major initiatives and features of the Governor's Budget are
the following:
1. A proposed 10% cut in the Bank and Corporation Tax rate, to be
phased in over two years.
2. Proposition 98 funding for K-14 schools will be increased again,
as a result of stronger revenues. Per-pupil funding for K-12 schools will reach
$5,010, compared to $4,220 as recently as the 1993-94 Fiscal Year. Part of the
new funding is proposed to be dedicated to the completion of the current program
to reduce class size to 20 pupils in lower elementary grades, and to expand the
program by one grade, so that it will cover K-3rd grade.
3. Funding for higher education will be increased consistent with a
four-year "compact" established in 1995-96. There is not projected to be any
increase in student fees at any of the three levels of the State higher
education system.
4. The 1997-98 proposed Governor's Budget assumes approximately $500
million in savings contingent upon federal action. The Budget assumes that
federal law will be enacted to remove the maintenance-of-effect requirement for
Supplemental Security Income (SSI) payments, thereby enabling the state to
reduce grant levels pursuant to previously enacted state law ($279 million).
The Budget also assumes the federal government will fund $216 million in costs
of health care for illegal immigrants.
THE ORANGE COUNTY BANKRUPTCY. On December 6, 1994, Orange County,
California and its Investment Pool (the "Pool") filed for bankruptcy under
Chapter 9 of the United States Bankruptcy Code. The subsequent restructuring
led to the sale of substantially all of the Pool's portfolio and resulted in
losses estimated to be approximately $1.7 billion (or approximately 22% of
amounts deposited by the Pool investors). Approximately 187 California public
entities -- substantially all of which are public agencies within the county --
had various bonds, notes or other forms of indebtedness outstanding. In some
instances the proceeds of such indebtedness were invested in the Pool.
In April, 1996, the County emerged from bankruptcy after closing on a
$900 million recovery bond transaction. At that time, the County and its
financial advisors stated that the County had emerged from the bankruptcy
without any structural fiscal problems and assured that the County would not
slip back into bankruptcy. However, for many of the cities, schools and
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special districts that lost money in the County portfolio, repayment remains
contingent on the outcome of litigation which is pending against investment
firms and other finance professionals. Thus, it is impossible to determine the
ultimate impact of the bankruptcy and its aftermath on these various agencies
and their claims.
CONSTITUTIONAL, LEGISLATIVE AND OTHER FACTORS.
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Certain California constitutional amendments, legislative measures,
executive orders, administrative regulations and voter initiatives could produce
the adverse effects described below, among others.
REVENUE DISTRIBUTION. Certain Municipal Obligations held by the Fund
may be obligations of issuers which rely in whole or in part on California State
revenues for payment of these obligations. Property tax revenues and a portion
of the State's general fund surplus are distributed to counties, cities and
their various taxing entities and the State assumes certain obligations
theretofore paid out of local funds. Whether and to what extent a portion of
the State's general fund will be distributed in the future to counties, cities
and their various entities is unclear.
HEALTH CARE LEGISLATION. Certain Municipal Obligations held by the
Fund may be obligations which are payable solely from the revenues of health
care institutions. Certain provisions under California law may adversely affect
these revenues and, consequently, payment on those Municipal Obligations.
The Federally sponsored Medicaid program for health care services to
eligible welfare beneficiaries in California is known as the Medi-Cal program.
Historically, the Medi-Cal program has provided for a cost-based system of
reimbursement for inpatient care furnished to Medi-Cal beneficiaries by any
hospital wanting to participate in the Medi-Cal program, provided such hospital
met applicable requirements for participation. California law now provides that
the State of California shall selectively contract with hospitals to provide
acute inpatient services to Medi-Cal patients. Medi-Cal contracts currently
apply only to acute inpatient services. Generally, such selective contracting
is made on a flat per diem payment basis for all services to Medi-Cal
beneficiaries, and generally such payment has not increased in relation to
inflation, costs or other factors. Other reductions or limitations may be
imposed on payment for services rendered to Medi-Cal beneficiaries in the
future.
Under this approach, in most geographical areas of California, only
those hospitals which enter into a Medi-Cal
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contract with the State of California will be paid for non-emergency acute
inpatient services rendered to Medi-Cal beneficiaries. The State may also
terminate these contracts without notice under certain circumstances and is
obligated to make contractual payments only to the extent the California
legislature appropriates adequate funding therefor.
California enacted legislation in 1982 that authorizes private health
plans and insurers to contract directly with hospitals for services to
beneficiaries on negotiated terms. Some insurers have introduced plans known as
"preferred provider organizations" ("PPOs"), which offer financial incentives
for subscribers who use only the hospitals which contract with the plan. Under
an exclusive provider plan, which includes most health maintenance organizations
("HMOs"), private payors limit coverage to those services provided by selected
hospitals. Discounts offered to HMOs and PPOs may result in payment to the
contracting hospital of less than actual cost and the volume of patients
directed to a hospital under an HMO or PPO contract may vary significantly from
projections. Often, HMO or PPO contracts are enforceable for a stated term,
regardless of provider losses or of bankruptcy of the respective HMO or PPO. It
is expected that failure to execute and maintain such PPO and HMO contracts
would reduce a hospital's patient base or gross revenues. Conversely,
participation may maintain or increase the patient base, but may result in
reduced payment and lower net income to the contracting hospitals.
These Municipal Obligations may also be insured by the State of
California pursuant to an insurance program implemented by the Office of
Statewide Health Planning and Development for health facility construction
loans. If a default occurs on insured Municipal Obligations, the State
Treasurer will issue debentures payable out of a reserve fund established under
the insurance program or will pay principal and interest on an unaccelerated
basis from unappropriated State funds. At the request of the Office of
Statewide Health Planning and Development, Arthur D. Little, Inc. prepared a
study in December 1983, to evaluate the adequacy of the reserve fund established
under the insurance program and based on certain formulations and assumptions
found the reserve fund substantially underfunded. In September of 1986, Arthur
D. Little, Inc. prepared an update of the study and recommended that an
additional 10% reserve be established for "multi-level" facilities. For the
balance of the reserve fund, the update recommended maintaining the current
reserve calculation method. In March of 1990, Arthur D. Little, Inc. prepared a
further review of the study and recommended that separate reserves continue to
be established for "multi-level" facilities at a reserve level consistent with
those that would be required by an insurance company.
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<PAGE>
MORTGAGES AND DEEDS. Certain Municipal Obligations held by the Fund
may be obligations which are secured in whole or in part by a mortgage or deed
of trust on real property. California has five principal statutory provisions
which limit the remedies of a creditor secured by a mortgage or deed of trust.
Two statutes limit the creditor's right to obtain a deficiency judgment, one
limitation being based on the method of foreclosure and the other on the type of
debt secured. Under the former, a deficiency judgment is barred when the
foreclosure is accomplished by means of a nonjudicial trustee's sale. Under the
latter, a deficiency judgment is barred when the foreclosed mortgage or deed of
trust secures certain purchase money obligations. Another California statute,
commonly known as the "one form of action" rule, requires creditors secured by
real property to exhaust their real property security by foreclosure before
bringing a personal action against the debtor. The fourth statutory provision
limits any deficiency judgment obtained by a creditor secured by real property
following a judicial sale of such property to the excess of the outstanding debt
over the fair value of the property at the time of the sale, thus preventing the
creditor from obtaining a large deficiency judgment against the debtor as the
result of low bids at a judicial sale. The fifth statutory provision gives the
debtor the right to redeem the real property from any judicial foreclosure sale
as to which a deficiency judgment may be ordered against the debtor.
Upon the default of a mortgage or deed of trust with respect to
California real property, the creditor's nonjudicial foreclosure rights under
the power of sale contained in the mortgage or deed of trust are subject to the
constraints imposed by California law upon transfers of title to real property
by private power of sale. During the three-month period beginning with the
filing of a formal notice of default, the debtor is entitled to reinstate the
mortgage by making any overdue payments. Under standard loan servicing
procedures, the filing of the formal notice of default does not occur unless at
least three full monthly payments have become due and remain unpaid. The power
of sale is exercised by posting and publishing a notice of sale for at least 20
days after expiration of the three-month reinstatement period. The debtor may
reinstate the mortgage, in the manner described above, up to five business days
prior to the scheduled sale date. Therefore, the effective minimum period for
foreclosing on a mortgage could be in excess of seven months after the initial
default. Such time delays in collections could disrupt the flow of revenues
available to an issuer for the payment of debt service on the outstanding
obligations if such defaults occur with respect to a substantial number of
mortgages or deeds of trust securing an issuer's obligations.
In addition, a court could find that there is sufficient involvement
of the issuer in the nonjudicial sale of property securing a mortgage for such
private sale to constitute
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<PAGE>
"state action," and could hold that the private-right-of-sale proceedings
violate the due process requirements of the Federal or State Constitutions,
consequently preventing an issuer from using the nonjudicial foreclosure remedy
described above.
Certain Municipal Obligations held by the Fund may be obligations
which finance the acquisition of single family home mortgages for low and
moderate income mortgagors. These obligations may be payable solely from
revenues derived from the home mortgages, and are subject to California's
statutory limitations described above applicable to obligations secured by real
property. Under California antideficiency legislation, there is no personal
recourse against a mortgagor of a single family residence purchased with the
loan secured by the mortgage, regardless of whether the creditor chooses
judicial or nonjudicial foreclosure.
Under California law, mortgage loans secured by single-family owner-
occupied dwellings may be prepaid at any time. Prepayment charges on such
mortgage loans may be imposed only with respect to voluntary prepayments made
during the first five years during the term of the mortgage loan, and then only
if the borrower prepays an amount in excess of 20% of the original principal
amount of the mortgage loan in a 12-month period; a prepayment charge cannot in
any event exceed six months' advance interest on the amount prepaid during the
12-month period in excess of 20% of the original principal amount of the loan.
This limitation could affect the flow of revenues available to an issuer for
debt service on the outstanding debt obligations which financed such home
mortgages.
PROPOSITION 13. Certain Municipal Obligations may be obligations of
issuers who rely in whole or in part on ad valorem real property taxes as a
source of revenue. On June 6, 1978, California voters approved an amendment to
the California Constitution known as Proposition 13, which added Article XIIIA
to the California Constitution. The effect of Article XIIIA was to limit ad
valorem taxes on real property and to restrict the ability of taxing entities to
increase real property tax revenues.
Section 1 of Article XIIIA, as amended, limits the maximum ad valorem
tax on real property to 1% of full cash value to be collected by the counties
and apportioned according to law. The 1% limitation does not apply to ad
valorem taxes or special assessments to pay the interest and redemption charges
on any bonded indebtedness for the acquisition or improvement of real property
approved by two-thirds of the votes cast by the voters voting on the
proposition. Section 2 of Article XIIIA defines "full cash value" to mean "the
County Assessor's valuation of real property as shown on the 1975/76 tax bill
under `full cash value' or, thereafter, the appraised value of real property
when
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<PAGE>
purchased, newly constructed, or a change in ownership has occurred after the
1975 assessment." The full cash value may be adjusted annually to reflect
inflation at a rate not to exceed 2% per year, or reduction in the consumer
price index or comparable local data, or reduced in the event of declining
property value caused by damage, destruction or other factors.
Legislation enacted by the California Legislature to implement Article
XIIIA provides that notwithstanding any other law, local agencies may not levy
any ad valorem property tax except to pay debt service on indebtedness approved
by the voters prior to July 1, 1978, and that each county will levy the maximum
tax permitted by Article XIIIA.
PROPOSITION 9. On November 6, 1979, an initiative known as
"Proposition 9" or the "Gann Initiative" was approved by the California voters,
which added Article XIIIB to the California Constitution. Under Article XIIIB,
State and local governmental entities have an annual "appropriations limit" and
are not allowed to spend certain moneys called "appropriations subject to
limitation" in an amount higher than the "appropriations limit." Article XIIIB
does not affect the appropriation of moneys which are excluded from the
definition of "appropriations subject to limitation," including debt service on
indebtedness existing or authorized as of January 1, 1979, or bonded
indebtedness subsequently approved by the voters. In general terms, the
"appropriations limit" is required to be based on certain 1978/79 expenditures,
and is to be adjusted annually to reflect changes in consumer prices,
population, and certain services provided by these entities. Article XIIIB also
provides that if these entities' revenues in any year exceed the amounts
permitted to be spent, the excess is to be returned by revising tax rates or fee
schedules over the subsequent two years.
PROPOSITION 98. On November 8, 1988, voters of the State approved
Proposition 98, a combined initiative constitutional amendment and statute
called the "Classroom Instructional Improvement and Accountability Act."
Proposition 98 changed State funding of public education below the university
level and the operation of the State Appropriations Limit, primarily by
guaranteeing K-14 schools a minimum share of General Fund revenues. Under
Proposition 98 (modified by Proposition 111 as discussed below), K-14 schools
are guaranteed the greater of (a) in general, a fixed percent of General Fund
revenues ("Test 1"), (b) the amount appropriated to K-14 schools in the prior
year, adjusted for changes in the cost of living (measured as in Article XIII B
by reference to State per capita personal income) and enrollment ("Test 2"), or
(c) a third test, which would replace Test 2 in any year when the percentage
growth in per capita General Fund revenues from the prior year plus one half of
one percent is less than the percentage growth in State per capita personal
income ("Test 3"). Under Test 3, schools would
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<PAGE>
receive the amount appropriated in the prior year adjusted for changes in
enrollment and per capita General Fund revenues, plus an additional small
adjustment factor. If Test 3 is used in any year, the difference between Test 3
and Test 2 would become a "credit" to schools which would be the basis of
payments in future years when per capita General Fund revenue growth exceeds per
capita personal income growth.
Proposition 98 permits the Legislature -- by two-thirds vote of both
houses, with the Governor's concurrence -- to suspend the K-14 schools' minimum
funding formula for a one-year period. Proposition 98 also contains provisions
transferring certain State tax revenues in excess of the Article XIII B limit to
K-14 schools.
During the recession years of the early 1990s, General Fund revenues
for several years were less than originally projected, so that the original
Proposition 98 appropriations turned out to be higher than the minimum
percentage provided in the law. The Legislature responded to these developments
by designating the "extra" Proposition 98 payments in one year as a "loan" from
future years' Proposition 98 entitlements, and also intended that the "extra"
payments would not be included in the Proposition 98 "base" for calculating
future years' entitlements. In 1992, a lawsuit was filed, California Teachers'
--------------------
Association v. Gould, which challenged the validity of these off-budget loans.
- --------------------
During the course of this litigation, a trial court determined that almost $2
billion in "loans" which had been provided to school districts during the
recession violated the constitutional protection of support for public
education. A settlement was reached on April 12, 1996 which ensures that future
school funding will not be in jeopardy over repayment of these so-called loans.
PROPOSITION 111. On June 30, 1989, the California Legislature enacted
Senate Constitutional Amendment 1, a proposed modification of the California
Constitution to alter the spending limit and the education funding provisions of
Proposition 98. Senate Constitutional Amendment 1 -- on the June 5, 1990 ballot
as Proposition 111 -- was approved by the voters and took effect on July 1,
1990. Among a number of important provisions, Proposition 111 recalculated
spending limits for the State and for local governments, allowed greater annual
increases in the limits, allowed the averaging of two years' tax revenues before
requiring action regarding excess tax revenues, reduced the amount of the
funding guarantee in recession years for school districts and community college
districts (but with a floor of 40.9 percent of State general fund tax revenues),
removed the provision of Proposition 98 which included excess moneys transferred
to school districts and community college districts in the base calculation for
the next year, limited the amount of State tax revenue over the limit which
would be transferred to
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<PAGE>
school districts and community college districts, and exempted increased
gasoline taxes and truck weight fees from the State appropriations limit.
Additionally, Proposition 111 exempted from the State appropriations limit
funding for capital outlays.
PROPOSITION 62. On November 4, 1986, California voters approved an
initiative statute known as Proposition 62. This initiative provided the
following:
1. Requires that any tax for general governmental purposes imposed by
local governments be approved by resolution or ordinance adopted by a two-
thirds vote of the governmental entity's legislative body and by a majority
vote of the electorate of the governmental entity;
2. Requires that any special tax (defined as taxes levied for other
than general governmental purposes) imposed by a local governmental entity
be approved by a two-thirds vote of the voters within that jurisdiction;
3. Restricts the use of revenues from a special tax to the purposes
or for the service for which the special tax was imposed;
4. Prohibits the imposition of ad valorem taxes on real property by
local governmental entities except as permitted by Article XIIIA;
5. Prohibits the imposition of transaction taxes and sales taxes on
the sale of real property by local governments;
6. Requires that any tax imposed by a local government on or after
August 1, 1985 be ratified by a majority vote of the electorate within two
years of the adoption of the initiative;
7. Requires that, in the event a local government fails to comply
with the provisions of this measure, a reduction in the amount of property
tax revenue allocated to such local government occurs in an amount equal to
the revenues received by such entity attributable to the tax levied in
violation of the initiative; and
8. Permits these provisions to be amended exclusively by the voters
of the State of California.
In September 1988, the California Court of Appeal in City of
-------
Westminster v. County of Orange, 204 Cal.App. 3d 623, 215 Cal.Rptr. 511
- -------------------------------
(Cal.Ct.App. 1988), held that Proposition 62 is unconstitutional to the extent
that it requires a general tax by a general law city, enacted on or after August
1, 1985 and prior
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<PAGE>
to the effective date of Proposition 62, to be subject to approval by a majority
of voters. The Court held that the California Constitution prohibits the
imposition of a requirement that local tax measures be submitted to the
electorate by either referendum or initiative. It is impossible to predict the
impact of this decision on charter cities, on special taxes or on new taxes
imposed after the effective date of Proposition 62. The California Court of
Appeal in City of Woodlake v. Logan, (1991) 230 Cal.App.3d 1058, subsequently
-------------------------
held that Proposition 62's popular vote requirements for future local taxes also
provided for an unconstitutional referenda. The California Supreme Court
declined to review both the City of Westminster and the City of Woodlake
------------------- ----------------
decisions.
In Santa Clara Local Transportation Authority v. Guardino, (Sept. 28,
------------------------------------------------------
1995) 11 Cal.4th 220, reh'g denied, modified (Dec. 14, 1995) 12 Cal.4th 344e,
----- ------ --------
the California Supreme Court upheld the constitutionality of Proposition 62's
popular vote requirements for future taxes, and specifically disapproved of the
City of Woodlake decision as erroneous. The Court did not determine the
- ----------------
correctness of the City of Westminster decision, because that case appeared
-------------------
distinguishable, was not relied on by the parties in Guardino, and involved
--------
taxes not likely to still be at issue. It is impossible to predict the impact
of the Supreme Court's decision on charter cities or on taxes imposed in
reliance on the City of Woodlake case.
----------------
Senate Bill 1590 (O'Connell), introduced February 16, 1996, would make
the Guardino decision inapplicable to any tax first imposed or increased by an
--------
ordinance or resolution adopted before December 14, 1995. The California State
Senate passed the Bill on May 16, 1996 and it is currently pending in the
California State Assembly. It is not clear whether the Bill, if enacted, would
be constitutional as a non-voted amendment to Proposition 62 or as a non-voted
change to Proposition 62's operative date.
PROPOSITION 218. On November 5, 1996, the voters of the State
approved Proposition 218, a constitutional initiative, entitled the "Right to
Vote on Taxes Act" ("Proposition 218"). Proposition 218 adds Articles XIII C
and XIII D to the California Constitution and contains a number of interrelated
provisions affecting the ability of local governments to levy and collect both
existing and future taxes, assessments, fees and charges. Proposition 218
became effective on November 6, 1996. The Sponsors are unable to predict
whether and to what extent Proposition 218 may be held to be constitutional or
how its terms will be interpreted and applied by the courts. However, if
upheld, Proposition 218 could substantially restrict certain local governments'
ability to raise future revenues and could subject certain existing sources of
revenue to reduction or repeal, and increase local government costs to hold
elections,
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<PAGE>
calculate fees and assessments, notify the public and defend local government
fees and assessments in court.
Article XIII C of Proposition 218 requires majority voter approval for
the imposition, extension or increase of general taxes and two-thirds voter
approval for the imposition, extension or increase of special taxes, including
special taxes deposited into a local government's general fund. Proposition 218
also provides that any general tax imposed, extended or increased without voter
approval by any local government on or after January 1, 1995 and prior to
November 6, 1996 shall continue to be imposed only if approved by a majority
vote in an election held within two years of November 6, 1996.
Article XIII C of Proposition 218 also expressly extends the
initiative power to give voters the power to reduce or repeal local taxes,
assessments, fees and charges, regardless of the date such taxes, assessments,
fees or charges were imposed. This extension of the initiative power to some
extent constitutionalizes the March 6, 1995 State Supreme Court decision in
Rossi v. Brown, which upheld an initiative that repealed a local tax and held
that the State constitution does not preclude the repeal, including the
prospective repeal, of a tax ordinance by an initiative, as contrasted with the
State constitutional prohibition on referendum powers regarding statutes and
ordinances which impose a tax. Generally, the initiative process enables
California voters to enact legislation upon obtaining requisite voter approval
at a general election. Proposition 218 extends the authority stated in Rossi v.
Brown by expanding the initiative power to include reducing or repealing
assessments, fees and charges, which had previously been considered
administrative rather than legislative matters and therefore beyond the
initiative power.
The initiative power granted under Article XIII C of Proposition 218,
by its terms, applies to all local taxes, assessments, fees and charges and is
not limited to local taxes, assessments, fees and charges that are property
related.
Article XIII D of Proposition 218 adds several new requirements making
it generally more difficult for local agencies to levy and maintain
"assessments" for municipal services and programs. "Assessment" is defined to
mean any levy or charge upon real property for a special benefit conferred upon
the real property.
Article XIII D of Proposition 218 also adds several provisions
affecting "fees" and "charges" which are defined as "any levy other than an ad
valorem tax, a special tax, or an assessment, imposed by a local government upon
a parcel or upon a person as an incident of property ownership, including a user
fee or charge for a property related service." All new and, after
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<PAGE>
June 30, 1997, existing property related fees and charges must conform to
requirements prohibiting, among other things, fees and charges which (i)
generate revenue exceeding the funds required to provide the property related
service, (ii) are used for any purpose other than those for which the fees and
charges are imposed, (iii) are for a service not actually used by, or
immediately available to, the owner of the property in question, or (iv) are
used for general governmental services, including police, fire or library
services, where the service is available to the public at large in substantially
the same manner as it is to property owners. Further, before any property
related fee or charge may be imposed or increased, written notice must be given
to the record owner of each parcel of land affected by such fee or charges. The
local government must then hold a hearing upon the proposed imposition or
increase of such property based fee, and if written protests against the
proposal are presented by a majority of the owners of the identified parcels,
the local government may not impose or increase the fee or charge. Moreover,
except for fees or charges for sewer, water and refuse collection services, no
property related fee or charge may be imposed or increased without majority
approval by the property owners subject to the fee or charge or, at the option
of the local agency, two-thirds voter approval by the electorate residing in the
affected area.
PROPOSITION 87. On November 8, 1988, California voters approved
Proposition 87. Proposition 87 amended Article XVI, Section 16, of the
California Constitution by authorizing the California Legislature to prohibit
redevelopment agencies from receiving any of the property tax revenue raised by
increased property tax rates levied to repay bonded indebtedness of local
governments which is approved by voters on or after January 1, 1989.
Additional Investment Limitations
- ---------------------------------
In addition to the investment limitations disclosed in the Prospectus,
the Fund is subject to the following investment limitations, which may be
changed only by a vote of the holders of a majority of the Fund's outstanding
Shares (as defined under "Miscellaneous" in the Prospectus).
The Fund may not:
1. Make loans, except that the Fund may purchase or hold debt
obligations in accordance with its investment objective, policies, and
limitations;
2. Purchase securities on margin, make short sale of securities, or
maintain a short position; provided that the Fund may enter into futures
contracts and futures options;
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<PAGE>
3. Act as an underwriter of securities within the meaning of the
Securities Act of 1933, except to the extent that the purchase of Municipal
Obligations or other securities directly from the issuer thereof in accordance
with the Fund's investment objective, policies, and limitations may be deemed to
be underwriting;
4. Purchase or sell real estate, except that the Fund may invest in
Municipal Obligations secured by real estate or interests therein;
5. Purchase or sell commodity futures contracts, or invest in oil,
gas, or mineral exploration or development programs; provided that the Fund may
enter into futures contracts and futures options;
6. Write or sell puts, calls, straddles, spreads, or combinations
thereof; provided that the Fund may enter into futures contracts and futures
options;
7. Invest in industrial revenue bonds where the payment of principal
and interest are the responsibility of a company (including its predecessors)
with less than three years of continuous operation; and
8. Issue any senior securities, except insofar as any borrowing in
accordance with the Fund's investment limitations might be considered to be the
issuance of a senior security; provided that the Fund may enter into futures
contracts and futures options.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
----------------------------------------------
Shares are continuously offered for sale by Edgewood Services, Inc.
(the "Distributor"), a wholly-owned subsidiary of Federated Investors, and the
Distributor has agreed to use appropriate efforts to solicit all purchase
orders. As described in the Prospectus, Shares may be sold to customers
("Customers") of financial institutions ("Shareholder Organizations"). Shares
are also offered for sale directly to institutional investors and to members of
the general public. Different types of Customer accounts at the Shareholder
Organizations may be used to purchase Shares, including eligible agency and
trust accounts. In addition, Shareholder Organizations may automatically
"sweep" a Customer's account not less frequently than weekly and invest amounts
in excess of a minimum balance agreed to by the Shareholder Organization and its
Customer in Shares selected by the Customer. Investors purchasing Shares may
include officers, directors, or employees of the particular Shareholder
Organization.
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<PAGE>
Shares of the Fund are offered for sale at their net asset value per
Share next computed after a purchase order is received by Excelsior Tax-Exempt
Fund's sub-transfer agent.
Prior to February 14, 1997, Shares of the Fund were offered for sale
with a maximum sales charge of 4.50%. For the fiscal period ended March 31,
1997, total sales charges paid by shareholders of the Fund were $1,126. All
such sales charges were paid to selling dealers.
Excelsior Tax-Exempt Fund may suspend the right of redemption or
postpone the date of payment for Shares for more than 7 days during any period
when (a) trading on the New York Stock Exchange (the "Exchange") is restricted
by applicable rules and regulations of the Securities and Exchange Commission
(the "SEC"); (b) the Exchange is closed for other than customary weekend and
holiday closings; (c) the SEC has by order permitted such suspension; or (d) an
emergency exists as determined by the SEC.
In the event that Shares are redeemed in cash at their net asset
value, a shareholder may receive in payment for such Shares an amount that is
more or less than his original investment due to changes in the market price of
the Fund's portfolio securities.
Excelsior Tax-Exempt Fund reserves the right to honor any request for
redemption or repurchase of the Fund's Shares by making payment in whole or in
part in securities chosen by Excelsior Tax-Exempt Fund and valued in the same
way as they would be valued for purposes of computing the Fund's net asset
value. If payment is made in securities, a shareholder may incur transaction
costs in converting these securities into cash. Such redemptions in kind will
be governed by Rule 18f-1 under the 1940 Act so that the Fund is obligated to
redeem its Shares solely in cash up to the lesser of $250,000 or 1% of its net
asset value during any 90-day period for any one shareholder of the Fund.
Under limited circumstances, Excelsior Tax-Exempt Fund may accept
securities as payment for Shares. Securities acquired in this manner will be
limited to securities issued in transactions involving a bona fide
---------
reorganization or statutory merger, or will be limited to other securities
(except for municipal debt securities issued by state political subdivisions or
their agencies or instrumentalities) that: (a) meet the investment objective and
policies of the Fund; (b) are acquired for investment and not for resale; (c)
are liquid securities that are not restricted as to transfer either by law or
liquidity of market; and (d) have a value that is readily ascertainable (and not
established only by evaluation procedures) as evidenced by a listing on the
American Stock Exchange, New York Stock Exchange or NASDAQ, or as evidenced by
their status as U.S. Government
-24-
<PAGE>
securities, bank certificates of deposit, banker's acceptances, corporate and
other debt securities that are actively traded, money market securities and
other similar securities with a readily ascertainable value.
INVESTOR PROGRAMS
-----------------
Systematic Withdrawal Plan
- --------------------------
An Investor who owns Shares with a value of $10,000 or more may begin
a Systematic Withdrawal Plan. The withdrawal can be on a monthly, quarterly,
semiannual or annual basis. There are four options for such systematic
withdrawals. The Investor may request:
(1) A fixed-dollar withdrawal;
(2) A fixed-share withdrawal;
(3) A fixed-percentage withdrawal (based on the current value of the
account); or
(4) A declining-balance withdrawal.
Prior to participating in a Systematic Withdrawal Plan, the Investor must
deposit any outstanding certificates for Shares with Chase Global Funds Services
Company, the Fund's sub-transfer agent. Under this Plan, dividends and
distributions are automatically reinvested in additional Shares of the Fund.
Amounts paid to Investors under this Plan should not be considered as income.
Withdrawal payments represent proceeds from the sale of Shares, and there will
be a reduction of the shareholder's equity in the Fund if the amount of the
withdrawal payments exceeds the dividends and distributions paid on the Shares
and the appreciation of the Investor's investment in the Fund. This in turn may
result in a complete depletion of the shareholder's investment. An Investor may
not participate in a program of systematic investing in the Fund while at the
same time participating in the Systematic Withdrawal Plan with respect to an
account in the Fund. Customers of Shareholder Organizations may obtain
information on the availability of, and the procedures and fees relating to, the
Systematic Withdrawal Plan directly from their Shareholder Organizations.
Exchange Privilege
- ------------------
Investors and Customers of Shareholder Organizations may exchange
Shares having a value of at least $500 for shares of any other portfolio of
Excelsior Tax-Exempt Fund or Excelsior Funds, Inc. ("Excelsior Fund" and,
collectively with Excelsior Tax-Exempt Fund, the "Companies") or for Trust
Shares of
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<PAGE>
Excelsior Institutional Trust. Shares may be exchanged by wire, telephone or
mail and must be made to accounts of identical registration. There is no
exchange fee imposed by the Companies or Excelsior Institutional Trust. In
order to prevent abuse of this privilege to the disadvantage of other
shareholders, the Companies and Excelsior Institutional Trust reserve the right
to limit the number of exchange requests of investors to no more than six per
year. The Companies and Excelsior Institutional Trust may modify or terminate
the exchange program at any time upon 60 days' written notice to shareholders,
and may reject any exchange request. Customers of Shareholder Organizations may
obtain information on the availability of, and the procedures and fees relating
to, such program directly from their Shareholder Organizations.
For Federal income tax purposes, exchanges are treated as sales on
which the shareholder will realize a gain or loss, depending upon whether the
value of the Shares to be given up in exchange is more or less than the basis in
such Shares at the time of the exchange. Generally, a shareholder may include
sales loads incurred upon the purchase of Shares in his or her tax basis for
such Shares for the purpose of determining gain or loss on a redemption,
transfer or exchange of such Shares. However, if the shareholder effected an
exchange of Shares for shares of another portfolio of the Companies within 90
days of the purchase and was able to reduce the sales load previously applicable
to the new shares (by virtue of the Companies' exchange privilege), the amount
equal to such reduction may not be included in the tax basis of the
shareholder's exchanged Shares but may be included (subject to the limitation)
in the tax basis of the new shares.
Other Investor Programs
- -----------------------
As described in the Prospectus, Shares of the Fund may be purchased in
connection with the Automatic Investment Program. Customers of Shareholder
Organizations may obtain information on the availability of, and the procedures
and fees relating to, such program directly from their Shareholder
Organizations.
DESCRIPTION OF CAPITAL STOCK
----------------------------
Excelsior Tax-Exempt Fund's Charter authorizes its Board of Directors
to issue up to 14 billion full and fractional shares of capital stock and to
classify or reclassify any unissued shares of Excelsior Tax-Exempt Fund into one
or more additional classes or series by setting or changing in any one or more
respects their respective preferences, conversion or other rights, voting
powers, restrictions, limitations as to dividends, qualifications, and terms and
conditions of redemption. The Prospectus describes the classes of shares into
which Excelsior Tax-Exempt Fund's authorized capital is currently classified.
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<PAGE>
Shares have no preemptive rights and only such con version or exchange
rights as the Board of Directors may grant in its discretion. When issued for
payment as described in the Prospectus, Shares will be fully paid and non-
assessable. In the event of a liquidation or dissolution of the Fund, its
shareholders are entitled to receive the assets available for distribution
belonging to the Fund and a proportionate dis tribution, based upon the relative
asset values of Excelsior Tax-Exempt Fund's portfolios, of any general assets of
Excelsior Tax-Exempt Fund not belonging to any particular portfolio of Excelsior
Tax-Exempt Fund which are available for distribution. In the event of a
liquidation or dissolution of Excelsior Tax-Exempt Fund, its shareholders will
be entitled to the same distribution process.
Shareholders of Excelsior Tax-Exempt Fund are entitled to one vote for
each full share held, and fractional votes for fractional shares held, and will
vote in the aggregate and not by class, except as otherwise required by the 1940
Act or other applicable law or when the matter to be voted upon affects only the
interests of the shareholders of a particular class. Voting rights are not
cumulative and, accordingly, the holders of more than 50% of the aggregate of
the outstanding shares of Excelsior Tax-Exempt Fund may elect all of Excelsior
Tax-Exempt Fund's directors, regardless of the votes of other shareholders.
Rule 18f-2 under the 1940 Act provides that any matter required to be
submitted to the holders of the outstanding voting securities of an investment
company such as Excelsior Tax-Exempt Fund shall not be deemed to have been
effectively acted upon unless approved by the holders of a majority of the
outstanding shares of each portfolio affected by the matter. A portfolio is
affected by a matter unless it is clear that the interests of each portfolio in
the matter are substantially identical or that the matter does not affect any
interest of the portfolio. Under the Rule, the approval of an investment
advisory agreement or any change in a fundamental investment policy would be
effectively acted upon with respect to a portfolio only if approved by a
majority of the outstanding shares of such portfolio. However, the Rule also
provides that the ratification of the appointment of independent public
accountants, the approval of principal underwriting contracts, and the election
of directors may be effectively acted upon by shareholders of Excelsior Tax-
Exempt Fund voting without regard to class.
Excelsior Tax-Exempt Fund's Charter authorizes its Board of Directors,
without shareholder approval (unless otherwise required by applicable law), to
(a) sell and convey the assets of the Fund to another management investment
company for consideration which may include securities issued by the purchaser
and, in connection therewith, to cause all outstanding Shares of the Fund to be
redeemed at a price which is equal to
-27-
<PAGE>
their net asset value and which may be paid in cash or by distribution of the
securities or other consideration received from the sale and conveyance; (b)
sell and convert the Fund's assets into money and, in connection therewith, to
cause all outstanding Shares to be redeemed at their net asset value; or (c)
combine the assets belonging to the Fund with the assets belonging to another
portfolio of Excelsior Tax-Exempt Fund, if the Board of Directors reasonably
determines that such combination will not have a material adverse effect on
shareholders of any portfolio participating in such combination, and, in
connection therewith, to cause all outstanding Shares of the Fund to be redeemed
at their net asset value or converted into shares of another class of Excelsior
Tax-Exempt Fund's capital stock at net asset value. The exercise of such
authority by the Board of Directors will be subject to the provisions of the
1940 Act, and the Board of Directors will not take any action described in this
paragraph unless the proposed action has been disclosed in writing to the Fund's
shareholders at least 30 days prior thereto.
Notwithstanding any provision of Maryland law requiring a greater vote
of Excelsior Tax-Exempt Fund's Common Stock (or of the Shares of the Fund voting
separately as a class) in connection with any corporate action, unless otherwise
provided by law (for example, by Rule 18f-2, discussed above) or by Excelsior
Tax-Exempt Fund's Charter, Excelsior Tax-Exempt Fund may take or authorize such
action upon the favorable vote of the holders of more than 50% of the
outstanding Common Stock of Excelsior Tax-Exempt Fund voting without regard to
class.
-28-
<PAGE>
MANAGEMENT OF THE FUND
----------------------
Directors and Officers
- ----------------------
The directors and executive officers of Excelsior Tax-Exempt Fund,
their addresses, ages, principal occupations during the past five years, and
other affiliations are as follows:
<TABLE>
<CAPTION>
Position with Principal Occupation
Excelsior Tax- During Past 5 years and
Name and Address Exempt Fund Other Affiliations
- ---------------- ----------- ------------------
<S> <C> <C>
Frederick S. Wonham/1/ Chairman of the Retired; Director of
238 June Road Board, President Excelsior Fund and
Stamford, CT 06903 & Treasurer Excelsior Tax-Exempt
Age: 66 Fund (since 1995);
Trustee of Excelsior
Funds and Excelsior
Institutional Trust
(since 1995); Vice
Chairman of U.S. Trust
Corporation and U.S.
Trust New York (from
February 1990 until
September 1995); and
Chairman, U.S. Trust
Connecticut (from March
1993 to May 1997).
Donald L. Campbell Director Retired; Director of
333 East 69th Street Excelsior Fund and
Apt. 10-H Excelsior Tax-Exempt
New York, NY 10021 Fund (since 1984);
Age: 71 Director of UST Master
Variable Series, Inc.
(from 1994 to June
1997); Trustee of
Excelsior Institutional
Trust (since 1995); and
Director, Royal Life
Insurance Co. of New
York (since 1991).
</TABLE>
- ----------
/1/ This director is considered to be an "interested person" of Excelsior
Tax-Exempt Fund as defined in the 1940 Act.
-29-
<PAGE>
<TABLE>
<CAPTION>
Position with Principal Occupation
Excelsior Tax- During Past 5 years and
Name and Address Exempt Fund Other Affiliations
- ---------------- ----------- ------------------
<S> <C> <C>
Rodman L. Drake Director Director, Excelsior Fund
485 Park Avenue and Excelsior Tax-Exempt
New York, New York 10022 Fund (since 1996);
Age: 54 Trustee, Excelsior
Institutional Trust and
Excelsior Funds (since
1994); Director, Parsons
Brinkerhoff Energy
Services Inc. (since
1996); Director, Parsons
Brinkerhoff, Inc.
(engineering firm)
(since 1995); President,
Mandrake Group
(investment and
consulting firm) (since
1994); Director,
Hyperion Total Return
Fund, Inc. and four
other funds for which
Hyperion Capital
Management, Inc. serves
as investment adviser
(since 1991);
Co-Chairman, KMR Power
Corporation (power
plants) (from 1993 to
1996); Director, The
Latin American Growth
Fund (since 1993);
Member of Advisory
Board, Argentina Private
Equity Fund L.P. (from
1992 to 1996) and
Garantia L.P. (Brazil)
(from 1993 to 1996); and
Director, Mueller
Industries, Inc. (from
1992 to 1994).
Joseph H. Dugan Director Retired; Director of
913 Franklin Lakes Road Excelsior Fund and
Franklin Lakes, NJ 07417 Excelsior Tax-Exempt
Age: 72 Fund (since 1984);
Director of UST Master
Variable Series, Inc.
(from 1994 to June
1997); and Trustee of
Excelsior Institutional
Trust (since 1995).
</TABLE>
-30-
<PAGE>
<TABLE>
<CAPTION>
Position with Principal Occupation
Excelsior Tax- During Past 5 years and
Name and Address Exempt Fund Other Affiliations
- ---------------- ----------- ------------------
<S> <C> <C>
Wolfe J. Frankl Director Retired; Director of
2320 Cumberland Road Excelsior Fund and
Charlottesville, VA Excelsior Tax-Exempt
22901 Fund (since 1986);
Age: 76 Director of UST Master
Variable Series, Inc.
(from 1994 to June
1997); Trustee of
Excelsior Institutional
Trust (since 1995);
Director, Deutsche Bank
Financial, Inc. (since
1989); Director, The
Harbus Corporation
(since 1951); and
Trustee, HSBC Funds
Trust and HSBC Mutual
Funds Trust (since
1988).
W. Wallace McDowell, Jr. Director Director, Excelsior Fund
c/o Prospect Capital and Excelsior Tax-Exempt
Corp. Fund (since 1996);
43 Arch Street Trustee of Excelsior
Greenwich, CT 06830 Funds and Excelsior
Age: 60 Institutional Trust
(since 1994); Private
Investor (since 1994);
Managing Director,
Morgan Lewis Githens &
Ahn (from 1991 to 1994);
and Director, U.S.
Homecare Corporation
(since 1992), Grossmans,
Inc. (from 1993 to
1996), Children's
Discovery Centers (since
1984), ITI Technologies,
Inc. (since 1992) and
Jack Morton Productions
(since 1987).
</TABLE>
-31-
<PAGE>
<TABLE>
<CAPTION>
Position with Principal Occupation
Excelsior Tax- During Past 5 years and
Name and Address Exempt Fund Other Affiliations
- ---------------- ----------- ------------------
<S> <C> <C>
Jonathan Piel Director Director, Excelsior Fund
558 E. 87th Street and Excelsior Tax-Exempt
New York, New York 10128 Fund (since 1996);
Age: 58 Trustee, Excelsior Funds
and Excelsior
Institutional Trust
(since 1994); Vice
President and Editor,
Scientific American,
Inc. (from 1986 to
1994); Director, Group
for The South Fork,
Bridgehampton, New York
(since 1993); and
Member, Advisory
Committee, Knight
Journalism Fellowships,
Massachusetts Institute
of Technology (since
1984).
Robert A. Robinson Director Director of Excelsior
Church Pension Fund Fund and Excelsior Tax-
800 Second Avenue Exempt Fund (since
New York, NY 10017 1987); Director of UST
Age: 71 Master Variable Series,
Inc. (from 1994 to June
1997); Trustee of
Excelsior Institutional
Trust (since 1995);
President Emeritus, The
Church Pension Fund and
its affiliated companies
(since 1966); Trustee,
H.B. and F.H. Bugher
Foundation and Director
of its wholly-owned
subsidiaries--Rosiclear
Lead and Flourspar
Mining Co. and The Pigmy
Corporation (since
1984); Director,
Morehouse Publishing Co.
(since 1974); Trustee,
HSBC Funds Trust and
HSBC Mutual Funds Trust
(since 1982); and
Director, Infinity
Funds, Inc. (since
1995).
</TABLE>
-32-
<PAGE>
<TABLE>
<CAPTION>
Position with Principal Occupation
Excelsior Tax- During Past 5 years and
Name and Address Exempt Fund Other Affiliations
- ---------------- ----------- ------------------
<S> <C> <C>
Alfred C. Tannachion/1/ Director Retired; Director of
6549 Pine Meadows Drive Excelsior Fund and
Spring Hill, FL 34606 Excelsior Tax-Exempt
Age: 71 Fund (since 1985);
Chairman of the Board,
President and Treasurer
of UST Master Variable
Series, Inc. (and from
1994 to June 1997); and
Trustee of Excelsior
Institutional Trust
(since 1995).
W. Bruce McConnel, III Secretary Partner of the law firm
Philadelphia National of Drinker Biddle &
Bank Building Reath LLP.
1345 Chestnut Street
Philadelphia, PA 19107-3497
Age: 54
Gregory Sackos Assistant Second Vice President,
Chase Global Funds Secretary Senior Manager of Blue
Services Company Sky Compliance and
73 Tremont Street Financial Reporting,
Boston, MA 02108-3913 Chase Global Funds
Age: 32 Services Company (March
1997 to present); Second
Vice President, Senior
Manager of Financial
Reporting, Chase Global
Funds Services Company
(September 1996 to March
1997); and Assistant
Vice President,
Assistant Manager of
Financial Reporting,
Scudder, Stevens & Clark
Inc. (October 1992 to
September 1996).
</TABLE>
- ----------
/1/ This director is considered to be an "interested person" of Excelsior
Tax-Exempt Fund as defined in the 1940 Act.
-33-
<PAGE>
<TABLE>
<CAPTION>
Position with Principal Occupation
Excelsior Tax- During Past 5 years and
Name and Address Exempt Fund Other Affiliations
- ---------------- ----------- ------------------
<S> <C> <C>
John M. Corcoran Assistant Vice President, Director
Chase Global Funds Treasurer of Administration Client
Services Company Group, Chase Global
73 Tremont Street Funds Services Company
Boston, MA 02108-3913 (since July 1996);
Age: 32 Second Vice President,
Manager of
Administration, Chase
Global Funds Services
Company (from October
1993 to July 1996); and
Audit Manager, Ernst &
Young LLP (from August
1987 to September 1993).
</TABLE>
Each director of Excelsior Tax-Exempt Fund receives an annual fee of $9,000
plus a meeting fee of $1,500 for each meeting attended and is reimbursed for
expenses incurred in attending meetings. The Chairman of the Board is entitled
to receive an additional $5,000 per annum for services in such capacity.
Drinker Biddle & Reath LLP, of which Mr. McConnel is a partner, receives legal
fees as counsel to Excelsior Tax-Exempt Fund. The employees of Chase Global
Funds Services Company do not receive any compensation from Excelsior Tax-Exempt
Fund for acting as officers of Excelsior Tax-Exempt Fund. No person who is
currently an officer, director or employee of the Investment Adviser serves as
an officer, director or employee of Excelsior Tax-Exempt Fund. As of July 14,
1997, the directors and officers of Excelsior Tax-Exempt Fund as a group owned
beneficially less than 1% of the outstanding shares of each fund of Excelsior
Tax-Exempt, and less than 1% of the outstanding shares of all funds of Excelsior
Tax-Exempt Fund in the aggregate.
The following chart provides certain information about the fees
received by Excelsior Tax-Exempt Fund's directors in the most recently completed
fiscal year.
-34-
<PAGE>
<TABLE>
<CAPTION>
Pension or
Retirement Total
Benefits Compensation from
Aggregate Accrued as Excelsior Tax-Exempt
Compensation from Part of Fund and Fund
Name of Excelsior Fund Complex/*/ Paid
Person/Position Tax-Exempt Fund Expenses to Directors
- --------------- ----------------- ---------- --------------------
<S> <C> <C> <C>
Donald L. Campbell $13,500 None $31,750(4)**
Director
Rodman L. Drake $ 3,750 None $12,250(4)**
Director***
Joseph H. Dugan $15,000 None $35,000(4)**
Director
Wolfe J. Frankl $15,000 None $35,000(4)**
Director
W. Wallace McDowell $ 2,250 None $ 9,250(4)**
Director***
Jonathan Piel $ 3,750 None $12,500(4)**
Director***
Robert A. Robinson $15,000 None $35,000(4)**
Director
Alfred C. Tannachion $20,000 None $45,000(4)**
Director****
Frederick S. Wonham $15,000 None $35,000(4)**
Chairman of the Board,
President and Treasurer****
</TABLE>
- ---------------------------
* The "Fund Complex" consists of Excelsior Fund, Excelsior Tax-Exempt Fund,
UST Master Variable Series, Inc., Excelsior Institutional Trust and
Excelsior Funds.
** Number of investment companies in the Fund Complex for which director
served as director or trustee.
*** Messrs. Drake, McDowell and Piel were elected to the Board of Excelsior
Fund and Excelsior Tax-Exempt Fund on December 9, 1996.
**** Mr. Tannachion served as Excelsior Tax-Exempt Fund's Chairman of the Board,
President and Treasurer until February 13, 1997. On that date, Mr. Wonham
was elected to serve as Excelsior Tax-Exempt Fund's Chairman of the Board,
President and Treasurer.
-35-
<PAGE>
Investment Advisory, Sub-Advisory and Administration Agreements
- ---------------------------------------------------------------
United States Trust Company of New York ("U.S. Trust New York") and
U.S. Trust Company of Connecticut ("U.S. Trust Connecticut" and, collectively
with U.S. Trust New York, "U.S. Trust" or the "Investment Adviser") serve as
Investment Adviser to the Fund. United States Trust Company of California (the
"Sub-Adviser") serves as the Fund's Sub-Adviser. In the Investment Advisory and
Sub-Advisory Agreements, U.S. Trust and the Sub-Adviser, respectively, have
agreed to provide the services described in the Prospectus. The Investment
Adviser and Sub-Adviser have also agreed to pay all expenses incurred by them in
connection with their activities under the agreements other than the cost of
securities, including brokerage commissions, if any, purchased for the Fund.
The Investment Adviser and Sub-Adviser may, from time to time, voluntarily waive
a portion of their respective fees, which waivers may be terminated at any time.
Prior to May 16, 1997, U.S. Trust New York served as investment
adviser to the Fund pursuant to an advisory agreement substantially similar to
the Investment Advisory Agreement currently in effect for the Fund.
For the period from October 1, 1996 (commencement of operations)
through March 31, 1997, U.S. Trust New York waived its entire advisory fee
totalling $19,111 and reimbursed expenses totalling $14,586. For the same
period, the Sub-Adviser waived its entire sub-advisory fee totalling $19,111.
The Investment Advisory Agreement and the Sub-Advisory Agreement
provide that the Investment Adviser and the Sub-Adviser shall not be liable for
any error of judgment or mistake of law or for any loss suffered by the Fund in
connection with the performance of such agreements, except that the Investment
Adviser shall be jointly, but not severally, liable for a loss resulting from a
breach of fiduciary duty with respect to the receipt of compensation for
advisory services or a loss resulting from willful misfeasance, bad faith or
gross negligence on the part of the Investment Adviser or Sub-Adviser in the
performance of their duties or from reckless disregard by either of them of
their duties and obligations thereunder. In addition, the Investment Adviser
has undertaken in the Investment Advisory Agreement to maintain its policy and
practice of conducting its Asset Management Group independently of its Banking
Group.
Chase Global Funds Services Company ("CGFSC"), Federated
Administrative Services, an affiliate of the Distributor, and U.S. Trust
Connecticut (the "Administrators") serve as the Fund's Administrators. Under
the Administration Agreement, the Administrators have agreed to maintain office
facilities for the Fund, furnish the Fund with statistical and
-36-
<PAGE>
research data, clerical, accounting and bookkeeping services, and certain other
services required by the Fund, and to compute the net asset value, net income,
"exempt interest dividends" and realized capital gains or losses, if any, of the
Fund. The Administrators prepare semiannual reports to the SEC, prepare Federal
and state tax returns, prepare filings with state securities commissions,
arrange for and bear the cost of processing Share purchase and redemption
orders, maintain the Fund's financial accounts and records, and generally assist
in all aspects of the Fund's operations.
Prior to May 16, 1997, CGFSC, Federated Administrative Services and
U.S. Trust New York served as the Fund's administrators pursuant to an
administrative agreement substantially similar to the Administration Agreement
currently in effect for the Fund.
For the period from October 1, 1996 (commencement of operations)
through March 31, 1997, Excelsior Tax-Exempt Fund paid CGFSC, Federated
Administrative Services and U.S. Trust New York combined administration fees
totalling $5,856 with respect to the Fund.
Shareholder Organizations
- -------------------------
As stated in the Prospectus, Excelsior Tax-Exempt Fund has entered
into agreements with certain Shareholder Organizations. Such agreements require
the Shareholder Organizations to provide shareholder administrative services to
their Customers who beneficially own Shares in consideration for the Fund's
payment of not more than the annual rate of .40% of the average daily net assets
of the Fund's Shares beneficially owned by Customers of the Shareholder
Organization. Such services may include: (a) acting as recordholder of Shares;
(b) assisting in processing purchase, exchange and redemption transactions; (c)
providing periodic statements showing a Customer's account balances and
confirmations of transactions by the Customer; (d) providing tax and dividend
information to shareholders as appropriate; (e) transmitting proxy statements,
annual reports, updated prospectuses and other communications from Excelsior
Tax-Exempt Fund to Customers; and (f) providing or arranging for the provision
of other related services.
Excelsior Tax-Exempt Fund's agreements with Shareholder Organizations
are governed by an Administrative Services Plan (the "Plan") adopted by
Excelsior Tax-Exempt Fund. Pursuant to the Plan, Excelsior Tax-Exempt Fund's
Board of Directors will review, at least quarterly, a written report of the
amounts expended under Excelsior Tax-Exempt Fund's agreements with Shareholder
Organizations and the purposes for which the expenditures were made. In
addition, the arrangements with Shareholder Organizations will be approved
annually by a majority
-37-
<PAGE>
of Excelsior Tax-Exempt Fund's directors, including a majority of the directors
who are not "interested persons" of Excelsior Tax-Exempt Fund as defined in the
1940 Act and have no direct or indirect financial interest in such arrangements
(the "Disinterested Directors").
Any material amendment to Excelsior Tax-Exempt Fund's arrangements
with Shareholder Organizations must be approved by a majority of the Board of
Directors (including a majority of the Disinterested Directors). So long as
Excelsior Tax-Exempt Fund's arrangements with Shareholder Organizations are in
effect, the selection and nomination of the members of Excelsior Tax-Exempt
Fund's Board of Directors who are not "interested persons" (as defined in the
1940 Act) of Excelsior Tax-Exempt Fund will be committed to the discretion of
such Disinterested Directors.
For the period from October 1, 1996 (commencement of operations)
through March 31, 1997, payments to Shareholder Organizations totalled $16,689
with respect to the Fund, all of which was paid to affiliates of U.S. Trust.
Expenses
- --------
Except as otherwise noted, the Investment Adviser, Sub-Adviser and the
Administrators bear all expenses in connection with the performance of their
services. The Fund bears the expenses incurred in its operations. Expenses of
the Fund include taxes; interest; fees (including the Fund's portion of the fees
paid to Excelsior Tax-Exempt Fund's directors and officers who are not
affiliated with the Distributor or the Administrators); SEC fees; state
securities qualification fees; costs of preparing and printing prospectuses for
regulatory purposes and for distribution to shareholders; advisory, sub-
advisory, administration and administrative servicing fees; charges of the
custodian, transfer agent and dividend disbursing agent; certain insurance
premiums; outside auditing and legal expenses; cost of independent pricing
services; costs of shareholder reports and meetings; and any extraordinary
expenses. The Fund also pays for brokerage fees and commissions in connection
with the purchase of portfolio securities.
Custodian and Transfer Agent
- ----------------------------
The Chase Manhattan Bank ("Chase") serves as custodian of the Fund's
assets. Under the Custodian Agreement, Chase has agreed to (i) maintain a
separate account or accounts in the name of the Fund; (ii) make receipts and
disbursements of money on behalf of the Fund; (iii) collect and receive all
income and other payments and distributions on account of the Fund's portfolio
securities; (iv) respond to correspondence from securities brokers and others
relating to its duties; (v) maintain certain financial accounts and records; and
(vi) make
-38-
<PAGE>
periodic reports to Excelsior Tax-Exempt Fund's Board of Directors concerning
the Fund's operations. Chase may, at its own expense, open and maintain custody
accounts with respect to the Fund, with other banks or trust companies, provided
that Chase shall remain liable for the performance of all its custodial duties
under the Custodian Agreement, notwithstanding any delegation.
U.S. Trust New York serves as the Fund's transfer agent and dividend
disbursing agent. In such capacity, U.S. Trust New York has agreed to (i) issue
and redeem Shares; (ii) address and mail all communications by the Fund to its
shareholders, including reports to shareholders, dividend and distribution
notices, and proxy materials for its meetings of shareholders; (iii) respond to
correspondence by shareholders and others relating to its duties; (iv) maintain
shareholder accounts; and (v) make periodic reports to Excelsior Tax-Exempt
Fund's Board of Directors concerning the Fund's operations. For its transfer
agency, dividend disbursing, and subaccounting services, U.S. Trust New York is
entitled to receive $15.00 per annum per account and subaccount. In addition,
U.S. Trust New York is entitled to be reimbursed for its out-of-pocket expenses
for the cost of forms, postage, processing purchase and redemption orders,
handling of proxies, and other similar expenses in connection with the above
services.
U.S. Trust New York may, at its own expense, delegate its transfer
agency obligations to another transfer agent registered or qualified under
applicable law, provided that U.S. Trust New York shall remain liable for the
performance of all of its transfer agency duties under the Transfer Agency
Agreement, notwithstanding any delegation. Pursuant to this provision in the
agreement, U.S. Trust New York has entered into a sub-transfer agency
arrangement with CGFSC, an affiliate of Chase, with respect to accounts of
shareholders who are not Customers of U.S. Trust New York. For the services
provided by CGFSC, U.S. Trust New York has agreed to pay CGFSC $15.00 per annum
per account or subaccount plus out-of-pocket expenses. CGFSC receives no fee
directly from Excelsior Tax-Exempt Fund for any of its sub-transfer agency
services. U.S. Trust New York may, from time to time, enter into sub-transfer
agency arrangements with third party providers of transfer agency services.
PORTFOLIO TRANSACTIONS
----------------------
Subject to the general control of Excelsior Tax-Exempt Fund's Board of
Directors, the Investment Adviser and Sub-Adviser are responsible for, make
decisions with respect to, and place orders for all purchases and sales of
portfolio securities.
-39-
<PAGE>
The Fund may engage in short-term trading to achieve its investment
objective. Portfolio turnover may vary greatly from year to year as well as
within a particular year. It is expected that the Fund's turnover rate may be
higher than that of many other investment companies with similar investment
objectives and policies. The Fund's portfolio turnover rate may also be
affected by cash requirements for redemptions of Shares and by regulatory
provisions which enable the Fund to receive certain favorable tax treatment.
Portfolio turnover will not be a limiting factor in making portfolio decisions.
Securities purchased and sold by the Fund are generally traded in the
over-the-counter market on a net basis (i.e., without commission) through
dealers, or otherwise involve transactions directly with the issuer of an
instrument. The cost of securities purchased from underwriters includes an
underwriting commission or concession, and the prices at which securities are
purchased from and sold to dealers include a dealer's mark-up or mark-down.
With respect to over-the-counter transactions, the Fund, where possible, will
deal directly with dealers who make a market in the securities involved, except
in those situations where better prices and execution are available elsewhere.
The Investment Advisory and Sub-Advisory Agreements provide that, in
executing portfolio transactions and selecting brokers or dealers, the
Investment Adviser and Sub-Adviser will seek to obtain the best net price and
the most favorable execution. The Investment Adviser and Sub-Adviser shall
consider factors they deem relevant, including the breadth of the market in the
security, the price of the security, the financial condition and execution
capability of the broker or dealer and whether such broker or dealer is selling
shares of Excelsior Tax-Exempt Fund, and the reasonableness of the commission,
if any, for the specific transaction and on a continuing basis.
In addition, the Investment Advisory and Sub-Advisory Agreements
authorize the Investment Adviser and Sub-Adviser, to the extent permitted by law
and subject to the review of Excelsior Tax-Exempt Fund's Board of Directors from
time to time with respect to the extent and continuation of the policy, to cause
the Fund to pay a broker which furnishes brokerage and research services a
higher commission than that which might be charged by another broker for
effecting the same transaction, provided that the Investment Adviser or Sub-
Adviser determines in good faith that such commission is reasonable in relation
to the value of the brokerage and research services provided by such broker,
viewed in terms of either that particular transaction or the overall
responsibilities of the Investment Adviser or Sub-Adviser to the accounts as to
which it exercises investment discretion. Such brokerage and research services
might consist of reports and statistics on specific companies or industries,
-40-
<PAGE>
general summaries of groups of stocks and their comparative earnings, or broad
overviews of the fixed-income market and the economy.
Supplementary research information so received is in addition to and
not in lieu of services required to be performed by the Investment Adviser and
the Sub-Adviser and does not reduce the investment advisory fee payable by the
Fund. Such information may be useful to the Investment Adviser or Sub-Adviser
in serving the Fund and other clients and, conversely, supplemental information
obtained by the placement of business of other clients may be useful to the
Investment Adviser or Sub-Adviser in carrying out its obligations to the Fund.
Portfolio securities will not be purchased from or sold to the
Investment Adviser, the Sub-Adviser, the Distributor, or any affiliated person
of any of them (as such term is defined in the 1940 Act) acting as principal,
except to the extent permitted by the SEC.
Investment decisions for the Fund are made inde pendently from those
for other investment companies, common trust funds and other types of funds
managed by the Investment Adviser and the Sub-Adviser. Such other investment
companies and funds may also invest in the same securities as the Fund. When a
purchase or sale of the same security is made at substantially the same time on
behalf of the Fund and another investment company or common trust fund, the
transaction will be averaged as to price, and available investments allocated as
to amount, in a manner which the Investment Adviser or Sub-Adviser believes to
be equitable to the Fund and such other investment company or common trust fund.
In some instances, this investment procedure may ad versely affect the price
paid or received by the Fund or the size of the position obtained by the Fund.
To the extent permitted by law, the Investment Adviser and the Sub-Adviser may
aggregate the securities to be sold or purchased for the Fund with those to be
sold or purchased for other investment companies or common trust funds in order
to obtain best execution.
Excelsior Tax-Exempt Fund is required to identify any securities of
its regular brokers or dealers (as defined in Rule 10b-1 under the 1940 Act) or
their parents held by the Fund as of the close of the most recent fiscal year.
As of March 31, 1997, the Fund did not hold any securities of Excelsior Tax-
Exempt Fund's regular brokers or dealers or their parents.
-41-
<PAGE>
INDEPENDENT AUDITORS
--------------------
Ernst & Young LLP, independent auditors, 200 Clarendon Street, Boston,
MA 02116, serve as auditors of Excelsior Tax-Exempt Fund. The Fund's Financial
Highlights included in the Prospectus and the financial statements for the
period ended March 31, 1997 incorporated by reference in this Statement of
Additional Information have been audited by Ernst & Young LLP for the periods
included in their reports thereon which appear therein.
COUNSEL
-------
Drinker Biddle & Reath LLP (of which Mr. McConnel, Secretary of
Excelsior Tax-Exempt Fund, is a partner), Philadelphia National Bank Building,
1345 Chestnut Street, Philadelphia, Pennsylvania 19107, is counsel to Excelsior
Tax-Exempt Fund and will pass upon the legality of the Shares offered by the
Prospectus.
ADDITIONAL INFORMATION CONCERNING TAXES
---------------------------------------
Federal
- -------
The following supplements the tax information contained in the
Prospectus.
The Fund is treated as a separate corporate entity under the Internal
Revenue Code of 1986, as amended (the "Code"), and has qualified and intends to
continue to qualify as a regulated investment company. If, for any reason, the
Fund does not qualify for a taxable year for the special Federal tax treatment
afforded regulated investment companies, the Fund would be subject to Federal
tax on all of its taxable income at regular corporate rates, without any
deduction for distributions to shareholders. In such event, dividend
distributions would be taxable as ordinary income to shareholders to the extent
of the Fund's current and accumulated earnings and profits and would be eligible
for the dividends received deduction in the case of corporate shareholders.
As stated in the Prospectus, the Fund is not intended to constitute a
balanced investment program and is not designed for investors seeking capital
appreciation or maximum tax-exempt income irrespective of fluctuations in
principal. Shares of the Fund will not be suitable for tax-exempt institutions
and may not be suitable for retirement plans qualified under Section 401 of the
Code, H.R. 10 plans and individual retirement accounts because such plans and
accounts are generally tax-exempt and, therefore, not only would not gain any
additional benefit from
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<PAGE>
the Fund's dividends being tax-exempt, but such dividends would be ultimately
taxable to the beneficiaries when distributed to them. In addition, the Fund
may not be an appropriate investment for entities which are "substantial users"
of facilities financed by private activity bonds or "related persons" thereof.
"Substantial user" is defined under the Treasury Regulations to include a non-
exempt person who regularly uses a part of such facilities in his trade or
business and whose gross revenues derived with respect to the facilities
financed by the issuance of bonds are more than 5% of the total revenues derived
by all users of such facilities, who occupies more than 5% of the usable area of
such facilities or for whom such facilities or a part thereof were specifically
constructed, reconstructed or acquired. "Related persons" include certain
related natural persons, affiliated corporations, a partnership and its partners
and an S Corporation and its shareholders.
In order for the Fund to pay exempt-interest dividends for any taxable
year, at least 50% of the aggregate value of the Fund's portfolio must consist
of exempt-interest obligations at the close of each quarter of its taxable year.
Within 60 days after the close of the taxable year, the Fund will notify its
shareholders of the portion of the dividends paid by the Fund which constitutes
an exempt-interest dividend with respect to such taxable year. However, the
aggregate amount of dividends so designated by the Fund cannot exceed the excess
of the amount of interest exempt from tax under Section 103 of the Code received
by the Fund during the taxable year over any amounts disallowed as deductions
under Sections 265 and 171(a)(2) of the Code. The percentage of total dividends
paid by the Fund with respect to any taxable year which qualifies as exempt-
interest dividends will be the same for all shareholders receiving dividends
from the Fund for such year.
Interest on indebtedness incurred by a shareholder to purchase or
carry the Shares generally is not deductible for income tax purposes. In
addition, if a shareholder holds Shares for six months or less, any loss on the
sale or exchange of those Shares will be disallowed to the extent of the amount
of exempt-interest dividends received with respect to the Shares. The Treasury
Department, however, is authorized to issue regulations reducing the six-month
holding requirement to a period of not less than the greater of 31 days or the
period between regular dividend distributions where the investment company
regularly distributes at least 90% of its net tax-exempt interest. No such
regulations had been issued as of the date of this Statement of Additional
Information.
Any net long-term capital gains realized by the Fund will be
distributed at least annually. The Fund will generally have no tax liability
with respect to such gains and the distributions will be taxable to shareholders
as long-term
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<PAGE>
capital gains, regardless of how long a shareholder has held Shares. Such
distributions will be designated as a capital gain dividend in a written notice
mailed by the Fund to shareholders not later than 60 days after the close of the
Fund's taxable year.
A 4% non-deductible excise tax is imposed on regulated investment
companies that fail to currently distribute an amount equal to specified
percentages of their ordinary taxable income and capital gain net income (excess
of capital gains over capital losses). The Fund intends to make sufficient
distributions or deemed distributions of its ordinary taxable income and any
capital gain net income prior to the end of each calendar year to avoid
liability for this excise tax.
The Fund will be required in certain cases to withhold and remit to
the U.S. Treasury 31% of taxable dividends or 31% of gross proceeds realized
upon sale paid to shareholders who have failed to provide a correct tax
identification number in the manner required, who are subject to withholding by
the Internal Revenue Service for failure properly to include on their return
payments of taxable interest or dividends, or who have failed to certify to the
Fund when required to do so either that they are not subject to backup
withholding or that they are "exempt recipients."
Taxation of Certain Financial Instruments
- -----------------------------------------
Generally, futures contracts held by the Fund at the close of the
Fund's taxable year will be treated for Federal income tax purposes as sold for
their fair market value on the last business day of such year, a process known
as "mark-to-market." Forty percent of any gain or loss resulting from such
constructive sale will be treated as short-term capital gain or loss and 60% of
such gain or loss will be treated as long-term capital gain or loss, without
regard to the length of time the Fund has held the futures contract (the "40-60
rule"). The amount of any capital gain or loss actually realized by the Fund in
a subsequent sale or other disposition of those futures contracts will be
adjusted to reflect any capital gain or loss taken into account by the Fund in a
prior year as a result of the constructive sale of the contracts. With respect
to futures contracts to sell, which will be regarded as parts of a "mixed
straddle" because their values fluctuate inversely to the values of specific
securities held by the Fund, losses as to such contracts to sell will be subject
to certain loss deferral rules which limit the amount of loss currently
deductible on either part of the straddle to the amount thereof which exceeds
the unrecognized gain (if any) with respect to the other part of the straddle,
and to certain wash sales regulations. Under short sales rules, which will also
be applicable, the holding period of the securities forming part of the straddle
will (if they have
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<PAGE>
not been held for the long-term holding period) be deemed not to begin prior to
termination of the straddle. With respect to certain futures contracts,
deductions for interest and carrying charges will not be allowed.
Notwithstanding the rules described above, with respect to futures contracts to
sell which are properly identified as such, the Fund may make an election which
will exempt (in whole or in part) those identified futures contracts from being
treated for Federal income tax purposes as sold on the last business day of the
Fund's taxable year, but gains and losses will be subject to such short sales,
wash sales, and loss deferral rules and the requirement to capitalize interest
and carrying charges. Under temporary regulations, the Fund would be allowed
(in lieu of the foregoing) to elect either (1) to offset gains or losses from
positions which are part of a mixed straddle by separately identifying each
mixed straddle to which such treatment applies, or (2) to establish a mixed
straddle account for which gains and losses would be recognized and offset on a
periodic basis during the taxable year. Under either election, the 40-60 rule
will apply to the net gain or loss attributable to the futures contracts, but in
the case of a mixed straddle account election, not more than 60% of any net gain
may be treated as long-term and no more than 40% of any net loss may be treated
as short-term. Options on futures contracts generally receive Federal tax
treatment similar to that described above.
The Fund will not be treated as a regulated investment company under
the Code if 30% or more of the Fund's gross income for a taxable year is derived
from gains realized on the sale or other disposition of the following
investments held for less than three months (the "Short-Short Test"): (1) stock
and securities (as defined in section 2(a)(36) of the 1940 Act); (2) options,
futures and forward contracts other than those on foreign currencies; and (3)
foreign currencies (and options, futures and forward contracts on foreign
currencies) that are not directly related to the Fund's principal business of
investing in stock and securities (and options and futures with respect to
stocks and securities). Interest (including original issue discount and accrued
market discount) received by the Fund upon maturity or disposition of a security
held for less than three months will not be treated as gross income derived from
the sale or other disposition of such security within the meaning of this
requirement. However, any other income which is attributable to realized market
appreciation will be treated as gross income from the sale or other disposition
of securities for this purpose. With respect to futures contracts, forward
contracts, options on futures contracts, and other financial instruments subject
to the mark-to-market rules described above, the Internal Revenue Service has
ruled in private letter rulings that a gain realized from such a contract,
option, or financial instrument will be treated as being derived from a security
held for three months or more (regardless of the actual period for which the
contract,
-45-
<PAGE>
option or instrument is held) if the gain arises as a result of a constructive
sale under the mark-to-market rules, and will be treated as being derived from a
security held for less than three months only if the contract, option or
instrument is terminated (or transferred) during the taxable year (other than by
reason of mark-to-market) and less than three months have elapsed between the
date the contract, option or instrument is acquired and the termination date.
Increases and decreases in the value of the Fund's futures contracts and other
investments that qualify as part of a "designated hedge," as defined in Section
851(g) of the Code, may be netted for purposes of determining whether the Short-
Short Test is met.
California
- ----------
As a regulated investment company, the Fund will be relieved of
liability for California state franchise and corporate income tax to the extent
its earnings are distributed to its shareholders (including interest income on
California Municipal Obligations for franchise tax purposes). The Fund will be
taxed on its undistributed taxable income. If for any year the Fund does not
qualify for the special tax treatment afforded regulated investment companies,
all of the Fund's taxable income may be subject to California state franchise or
income tax at regular corporate rates.
If, at the close of each quarter of its taxable year, at least 50% of
the value of the total assets of a regulated investment company, or series
thereof, consists of obligations the interest on which, if held by an
individual, is exempt from taxation by California ("California Exempt
Securities"), then a regulated investment company, or series thereof, will be
qualified to pay dividends exempt from California state personal income tax to
its non-corporate shareholders (hereinafter referred to as "California exempt-
interest dividends"). For this purpose, California Exempt Securities are
generally limited to California Municipal Securities and certain U.S. Government
and U.S. Possession obligations. "Series" of a regulated investment company is
defined as a segregated portfolio of assets, the beneficial interest in which is
owned by the holders of an exclusive class or series of stock of the company.
The Fund intends to qualify under the above requirements so that it can pay
California exempt-interest dividends. If the Fund fails to so qualify, no part
of its dividends to shareholders will be exempt from the California state
personal income tax. The Fund may reject purchase orders for shares if it
appears desirable to avoid failing to so qualify.
Within 60 days after the close of its taxable year, the Fund will
notify each shareholder of the portion of the dividends paid by the Fund to the
shareholder with respect to such taxable year which is exempt from California
state personal income tax.
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<PAGE>
The total amount of California exempt-interest dividends paid by the Fund with
respect to any taxable year cannot exceed the excess of the amount of interest
received by the Fund for such year on California Exempt Securities over any
amounts that, if the Fund were treated as an individual, would be considered
expenses related to tax-exempt income or amortizable bond premium and would thus
not be deductible under federal income or California state personal income tax
law. The percentage of total dividends paid by the Fund with respect to any
taxable year which qualifies as California exempt-interest dividends will be the
same for all shareholders receiving dividends from the Fund with respect to such
year.
In cases where shareholders are "substantial users" or "related
persons" with respect to California Exempt Securities held by the Fund, such
shareholders should consult their tax advisers to determine whether California
exempt-interest dividends paid by the Fund with respect to such obligations
retain California state personal income tax exclusion. In this connection rules
similar to those regarding the possible unavailability of federal exempt-
interest dividend treatment to "substantial users" are applicable for California
state tax purposes. See "Additional Information Concerning Taxes -Federal"
above.
To the extent, if any, dividends paid to shareholders are derived from
the excess of net long-term capital gains over net short-term capital losses,
such dividends will not constitute California exempt-interest dividends and will
generally be taxed as long-term capital gains under rules similar to those
regarding the treatment of capital gains dividends for federal income tax
purposes. See "Additional Information Concerning Taxes -Federal" above.
Moreover, interest on indebtedness incurred by a shareholder to purchase or
carry Fund shares is not deductible for California state personal income tax
purposes if the Fund distributes California exempt-interest dividends during the
shareholder's taxable year.
The foregoing is only a summary of some of the important California
state personal income tax considerations generally affecting the Fund and its
shareholders. No attempt is made to present a detailed explanation of the
California state personal income tax treatment of the Fund or its shareholders,
and this discussion is not intended as a substitute for careful planning.
Further, it should be noted that the portion of any Fund dividends constituting
California exempt-interest dividends is excludable from income for California
state personal income tax purposes only. Any dividends paid to shareholders
subject to California state franchise tax or California state corporate income
tax may therefore be taxed as ordinary dividends to such purchasers
notwithstanding that all or a portion of such dividends is exempt from
California state personal income tax.
-47-
<PAGE>
Accordingly, potential investors in the Fund, including, in particular,
corporate investors which may be subject to either California franchise tax or
California corporate income tax, should consult their tax advisers with respect
to the application of such taxes to the receipt of Fund dividends and as to
their own California state tax situation, in general.
* * *
As of the date of this Statement of Additional Information, new Federal tax
legislation--the Taxpayer Relief Act of 1997 (the "TRA")--has been passed by the
House of Representatives and the Senate, and is expected to be signed by the
President. The TRA, if enacted as expected, will repeal the Short-Short Test
(effective for each Fund's next fiscal year) and will change applicable rates
and holding period rules for capital gains.
The foregoing discussion is based on Federal and California state tax
laws and regulations which are in effect on the date of this Statement of
Additional Information; such laws and regulations may be changed by legislative
or administrative action. Shareholders are advised to consult their tax
advisers concerning their specific situations, the application of state and
local taxes and charges in Federal tax rules under the TRA.
PERFORMANCE AND YIELD INFORMATION
---------------------------------
The Fund may advertise the standardized effective 30-day (or one
month) yields calculated in accordance with the method prescribed by the SEC for
mutual funds. Such yield will be calculated separately for the Fund according
to the following formula:
a-b
Yield = 2 [(----- + 1) to the sixth power - 1]
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = average daily number of Shares outstanding that were entitled to
receive dividends.
d = maximum offering price per Share on the last day of the period.
For the purpose of determining interest earned during the period
(variable "a" in the formula), the Fund computes the
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<PAGE>
yield to maturity of any debt obligation held by it based on the market value of
the obligation (including actual accrued interest) at the close of business on
the last business day of each month, or, with respect to obligations purchased
during the month, the purchase price (plus actual accrued interest). Such yield
is then divided by 360, and the quotient is multiplied by the market value of
the obligation (including actual accrued interest) in order to determine the
interest income on the obligation for each day of the subsequent month that the
obligation is in the portfolio. It is assumed in the above calculation that each
month contains 30 days. Also, the maturity of a debt obligation with a call
provision is deemed to be the next call date on which the obligation reasonably
may be expected to be called or, if none, the maturity date. The Fund calculates
interest gained on tax-exempt obligations issued without original issue discount
and having a current market discount by using the coupon rate of interest
instead of the yield to maturity. In the case of tax-exempt obligations with
original issue discount, where the discount based on the current market value
exceeds the then-remaining portion of original issue discount, the yield to
maturity is the imputed rate based on the original issue discount calculation.
Conversely, where the discount based on the current market value is less than
the remaining portion of the original issue discount, the yield to maturity is
based on the market value.
Expenses accrued for the period (variable "b" in the formula) include
all recurring fees charged by the Fund to all shareholder accounts and to the
particular series of Shares in proportion to the length of the base period and
the Fund's mean (or median) account size. Undeclared earned income will be
subtracted from the maximum offering price per Share (variable "d" in the
formula).
Based on the foregoing calculations, the Fund's standardized effective
yield for the 30-day period ended March 31, 1997 was 3.94%.
The "tax-equivalent" yield of the Fund is computed by: (a) dividing
the portion of the yield (calculated as above) that is exempt from Federal
income tax by one minus a stated Federal income tax rate and (b) adding that
figure to that portion, if any, of the yield that is not exempt from Federal
income tax. Tax-equivalent yields assume the payment of Federal income taxes at
a rate of 31%. Based on the foregoing calculation, the tax-equivalent yield of
the Fund for the 30-day period ended March 31, 1997 was 5.71%.
The Fund's "average annual total return" is computed by determining
the average annual compounded rate of return during specified periods that
equates the initial amount invested to the
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<PAGE>
ending redeemable value of such investment according to the following formula:
ERV
T = [(-----) to the first power divided by n - 1]
P
Where: T = average annual total return.
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the 1, 5 or 10 year (or other)
periods at the end of the applicable period (or a
fractional portion thereof).
P = hypothetical initial payment of $1,000.
n = period covered by the computation, expressed in years.
The Fund's "aggregate total return" is computed by determining the
aggregate compounded rates of return during specified periods that likewise
equate the initial amount invested to the ending redeemable value of such
investment. The formula for calculating aggregate total return is as follows:
ERV
T = [(-----)] - 1
P
These calculations are made assuming that (1) all divi dends and
capital gain distributions are reinvested on the reinvestment dates at the price
per Share existing on the reinvestment date, (2) all recurring fees charged to
all share holder accounts are included, and (3) for any account fees that vary
with the size of the account, a mean (or median) account size in the Fund during
the periods is reflected. The ending redeemable value (variable "ERV" in the
formula) is determined by assuming complete redemption of the hypothetical
investment after deduction of all nonrecurring charges at the end of the
measuring period. The Fund's aggregate total return for Shares for the period
from October 1, 1996 (commencement of operations) to March 31, 1997 was 1.05%.
The Fund may also from time to time include in advertisements, sales
literature and communications to shareholders a total return figure that is not
calculated according to the formula set forth above in order to compare more
accurately the Fund's performance with other measures of investment return. For
example, in comparing the Fund's total return with data published by Lipper
Analytical Services, Inc.,
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<PAGE>
CDA Investment Technologies, Inc. or Weisenberger Investment Company Service, or
with the performance of an index, the Fund may calculate its aggregate total
return for the period of time specified in the advertisement or communication by
assuming the investment of $10,000 in Shares and assuming the reinvestment of
each dividend or other distribution at net asset value on the reinvestment date.
Percentage increases are determined by subtracting the initial value of the
investment from the ending value and by dividing the remainder by the beginning
value.
The total return and yield of the Fund may be compared to those of
other mutual funds with similar investment objectives and to other relevant
indices or to ratings prepared by independent services or other financial or
industry publications that monitor the performance of mutual funds. For
example, the total return and/or yield of the Fund may be compared to data
prepared by Lipper Analytical Services, Inc., CDA Investment Technologies, Inc.
and Weisenberger Investment Company Service. Total return and yield data as
reported in national financial publications such as Money Magazine, Forbes,
----- -------- ------
Barron's, The Wall Street Journal and The New York Times, or in publications of
- -------- --- ---- ------ ------- --- --- ---- -----
a local or regional nature, may also be used in comparing the performance of the
Fund. Advertisements, sales literature or reports to shareholders may from time
to time also include a discussion and analysis of the Fund's performance,
including without limitation, those factors, strategies and technologies that
together with market conditions and events, materially affected the Fund's
performance.
The Fund may also from time to time include discussions or
illustrations of the effects of compounding in advertisements. "Compounding"
refers to the fact that, if dividends or other distributions of the Fund
investment are reinvested by being paid in additional Fund shares, any future
income or capital appreciations of the Fund would increase the value, not only
of the original Fund investment, but also of the additional Fund shares received
through reinvestment. As a result, the value of the Fund investment would
increase more quickly than if dividends or other distributions had been paid in
cash. The Fund may also include discussions or illustrations of the potential
investment goals of a prospective investor, investment management techniques,
policies or investment suitability of the Fund, economic conditions, the effects
of inflation and historical performance of various asset classes, including but
not limited to, stocks, bonds and Treasury bills. From time to time
advertisements, sales literature or communications to shareholders may summarize
the substance of information contained in shareholder reports (including the
investment composition of the Fund), as well as the views of the Investment
Adviser as to current market, economy, trade and interest rate trends,
legislative, regulatory and monetary developments, investment strategies and
related matters believed to be of relevance to the
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<PAGE>
Fund. The Fund may also include in advertisements charts, graphs or drawings
which illustrate the potential risks and rewards of investment in various
investment vehicles, including but not limited to, stocks, bonds, treasury bills
and shares of the Fund. In addition, advertisement, sales literature or
shareholder communications may include a discussion of certain attributes or
benefits to be derived by an investment in the Fund. Such advertisements or
communicators may include symbols, headlines or other material which highlight
or summarize the information discussed in more detail therein.
MISCELLANEOUS
-------------
As used in the Prospectus, "assets belonging to the Fund" means the
consideration received upon the issuance of Shares in the Fund, together with
all income, earnings, profits, and proceeds derived from the investment thereof,
including any proceeds from the sale of such investments, any funds or payments
derived from any reinvestment of such proceeds, and a portion of any general
assets of Excelsior Tax-Exempt Fund not belonging to a particular portfolio of
Excelsior Tax-Exempt Fund. In determining the net asset value of the Fund's
Shares, assets belonging to the Fund allocable to Shares are charged with the
direct liabilities of the Fund allocable to Shares and with a share of the
general liabilities of Excelsior Tax-Exempt Fund which are normally allocated in
proportion to the relative asset values of Excelsior Tax-Exempt Fund's
portfolios at the time of allocation. Subject to the provisions of Excelsior
Tax-Exempt Fund's Charter, determinations by the Board of Directors as to the
direct and allocable liabilities, and the allocable portion of any general
assets with respect to the Fund, are conclusive.
As of July 14, 1997, U.S. Trust and its affiliates held of record
substantially all of the outstanding shares of Excelsior Tax-Exempt Fund as
agent or custodian for its customers. In addition, at that date, U.S. Trust and
its affiliates held investment and/or voting power with respect to a majority of
the outstanding Shares of the Fund on behalf of their customers.
As of July 14, 1997, the name, address and percentage ownership of
each person, in addition to U.S. Trust and its affiliates, that beneficially
owned 5% or more of the outstanding Shares of the Fund were as follows:
California Tax-Exempt Income Fund: Donald G. Goodwin, c/o United States Trust
- ---------------------------------
Company of New York, 114 West 47th Street, New York, New York 10036, 6.56%; and
Annette G. Larson, c/o United States Trust Company of New York, 114 West 47th
Street, New York, New York 10036, 6.50%.
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<PAGE>
FINANCIAL STATEMENTS
--------------------
The audited financial statements and notes thereto in Excelsior Tax-
Exempt Fund's Annual Report to Shareholders for the fiscal period ended March
31, 1997 (the "1997 Annual Report") for the Fund are incorporated in this
Statement of Additional Information by reference. No other parts of the 1997
Annual Report are incorporated by reference herein. The financial statements
included in the 1997 Annual Report for the Fund have been audited by Excelsior
Tax-Exempt Fund's independent auditors, Ernst & Young LLP, whose reports thereon
also appear in the 1997 Annual Report and are incorporated herein by reference.
Such financial statements have been incorporated herein in reliance upon such
reports given upon the authority of such firm as experts in accounting and
auditing. Additional copies of the 1997 Annual Report may be obtained at no
charge by telephoning CGFSC at the telephone number appearing on the front page
of this Statement of Additional Information.
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<PAGE>
APPENDIX A
----------
COMMERCIAL PAPER RATINGS
- ------------------------
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment of debt considered short-term in the relevant
market. The following summarizes the rating categories used by Standard and
Poor's for commercial paper:
"A-1" - The highest category indicates that the degree of safety
regarding timely payment is strong. Those issues determined to possess
extremely strong safety characteristics are denoted with a plus sign (+)
designation.
"A-2" - Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated "A-1."
"A-3" - Issues carrying this designation have adequate capacity for
timely payment. They are, however, more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
"B" - Issues are regarded as having only a speculative capacity for
timely payment.
"C" - This rating is assigned to short-term debt obligations with a
doubtful capacity for payment.
"D" - Issues are in payment default.
Moody's commercial paper ratings are opinions of the ability of
issuers to repay punctually promissory obligations not having an original
maturity in excess of 9 months. The following summarizes the rating categories
used by Moody's for commercial paper:
"Prime-1" - Issuers or related supporting institutions have a superior
capacity for repayment of short-term promissory obligations. Prime-1 repayment
capacity will normally be evidenced by the following characteristics: leading
market positions in well established industries; high rates of return on funds
employed; conservative capitalization structures with moderate reliance on debt
and ample asset protection; broad margins in earning coverage of fixed financial
charges and high internal cash generation; and well established access to a
range of financial markets and assured sources of alternate liquidity.
A-1
<PAGE>
"Prime-2" - Issuers or related supporting institutions have a strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternative liquidity is maintained.
"Prime-3" - Issuers or related supporting institutions have an
acceptable capacity for repayment of short-term promissory obligations. The
effects of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
"Not Prime" - Issuers do not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps for investment grade
commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps
employs three designations, "D-1+," "D-1" and "D-1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
"D-1+" - Debt possesses highest certainty of timely payment. Short-
term liquidity, including internal operating factors and/or access to
alternative sources of funds, is outstanding, and safety is just below risk-free
U.S. Treasury short-term obligations.
"D-1" - Debt possesses very high certainty of timely payment.
Liquidity factors are excellent and supported by good fundamental protection
factors. Risk factors are minor.
"D-1-" - Debt possesses high certainty of timely payment. Liquidity
factors are strong and supported by good fundamental protection factors. Risk
factors are very small.
"D-2" - Debt possesses good certainty of timely payment. Liquidity
factors and company fundamentals are sound. Although ongoing funding needs may
enlarge total financing requirements, access to capital markets is good. Risk
factors are small.
"D-3" - Debt possesses satisfactory liquidity and other protection
factors qualify issue as investment grade. Risk
A-2
<PAGE>
factors are larger and subject to more variation. Nevertheless, timely payment
is expected.
"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to ensure against disruption in debt service.
Operating factors and market access may be subject to a high degree of
variation.
"D-5" - Issuer has failed to meet scheduled principal and/or interest
payments.
Fitch short-term ratings apply to debt obligations that are payable on
demand or have original maturities of generally up to three years. The
following summarizes the rating categories used by Fitch for short-term
obligations:
"F-1+" - Securities possess exceptionally strong credit quality.
Issues assigned this rating are regarded as having the strongest degree of
assurance for timely payment.
"F-1" - Securities possess very strong credit quality. Issues
assigned this rating reflect an assurance of timely payment only slightly less
in degree than issues rated "F-1+."
"F-2" - Securities possess good credit quality. Issues assigned this
rating have a satisfactory degree of assurance for timely payment, but the
margin of safety is not as great as the "F-1+" and "F-1" ratings.
"F-3" - Securities possess fair credit quality. Issues assigned this
rating have characteristics suggesting that the degree of assurance for timely
payment is adequate; however, near-term adverse changes could cause these
securities to be rated below investment grade.
"F-S" - Securities possess weak credit quality. Issues assigned this
rating have characteristics suggesting a minimal degree of assurance for timely
payment and are vulnerable to near-term adverse changes in financial and
economic conditions.
"D" - Securities are in actual or imminent payment default.
Fitch may also use the symbol "LOC" with its short-term ratings to
indicate that the rating is based upon a letter of credit issued by a commercial
bank.
Thomson BankWatch short-term ratings assess the likelihood of an
untimely or incomplete payment of principal or interest of unsubordinated
instruments having a maturity of one
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year or less which are issued by United States commercial banks, thrifts and
non-bank banks; non-United States banks; and broker-dealers. The following
summarizes the ratings used by Thomson BankWatch:
"TBW-1" - This designation represents Thomson BankWatch's highest
rating category and indicates a very high degree of likelihood that principal
and interest will be paid on a timely basis.
"TBW-2" - This designation indicates that while the degree of safety
regarding timely payment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated "TBW-1."
"TBW-3" - This designation represents the lowest investment grade
category and indicates that while the debt is more susceptible to adverse
developments (both internal and external) than obligations with higher ratings,
capacity to service principal and interest in a timely fashion is considered
adequate.
"TBW-4" - This designation indicates that the debt is regarded as non-
investment grade and therefore speculative.
IBCA assesses the investment quality of unsecured debt with an
original maturity of less than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for short-term debt ratings:
"A1+" - Obligations which possess a particularly strong credit feature
are supported by the highest capacity for timely repayment.
"A1" - Obligations are supported by the highest capacity for timely
repayment.
"A2" - Obligations are supported by a good capacity for timely
repayment.
"A3" - Obligations are supported by a satisfactory capacity for timely
repayment.
"B" - Obligations for which there is an uncertainty as to the capacity
to ensure timely repayment.
"C" - Obligations for which there is a high risk of default or which
are currently in default.
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CORPORATE AND MUNICIPAL LONG-TERM DEBT RATINGS
- ----------------------------------------------
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"AAA" - This designation represents the highest rating assigned by
Standard & Poor's to a debt obligation and indicates an extremely strong
capacity to pay interest and repay principal.
"AA" - Debt is considered to have a very strong capacity to pay
interest and repay principal and differs from AAA issues only in small degree.
"A" - Debt is considered to have a strong capacity to pay interest and
repay principal although such issues are somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than debt in
higher-rated categories.
"BBB" - Debt is regarded as having an adequate capacity to pay
interest and repay principal. Whereas such issues normally exhibit adequate
protection parameters, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity to pay interest and repay principal
for debt in this category than in higher-rated categories.
"BB," "B," "CCC," "CC" and "C" - Debt is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. "BB" indicates the
lowest degree of speculation and "C" the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
"BB" - Debt has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The "BB"
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied "BBB-" rating.
"B" - Debt has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The "B" rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied "BB" or "BB-" rating.
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"CCC" - Debt has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The "CCC" rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
"B" or "B-" rating.
"CC" - This rating is typically applied to debt subordinated to senior
debt that is assigned an actual or implied "CCC" rating.
"C" - This rating is typically applied to debt subordinated to senior
debt which is assigned an actual or implied "CCC-" debt rating. The "C" rating
may be used to cover a situation where a bankruptcy petition has been filed, but
debt service payments are continued.
"CI" - This rating is reserved for income bonds on which no interest
is being paid.
"D" - Debt is in payment default. This rating is used when interest
payments or principal payments are not made on the date due, even if the
applicable grace period has not expired, unless S & P believes that such
payments will be made during such grace period. "D" rating is also used upon
the filing of a bankruptcy petition if debt service payments are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC" may be
modified by the addition of a plus or minus sign to show relative standing
within the major rating categories.
"r" - This rating is attached to highlight derivative, hybrid, and
certain other obligations that S & P believes may experience high volatility or
high variability in expected returns due to non-credit risks. Examples of such
obligations are: securities whose principal or interest return is indexed to
equities, commodities, or currencies; certain swaps and options; and interest
only and principal only mortgage securities. The absence of an "r" symbol
should not be taken as an indication that an obligation will exhibit no
volatility or variability in total return.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"Aaa" - Bonds are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements
are
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likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
"Aa" - Bonds are judged to be of high quality by all standards.
Together with the "Aaa" group they comprise what are generally known as high-
grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in "Aaa" securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in "Aaa"
securities.
"A" - Bonds possess many favorable investment attributes and are to be
considered as upper medium-grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
"Baa" - Bonds considered medium-grade obligations, i.e., they are
neither highly protected nor poorly secured. Interest payments and principal
security appear adequate for the present but certain protective elements may be
lacking or may be characteristically unreliable over any great length of time.
Such bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
"Ba," "B," "Caa," "Ca," and "C" - Bonds that possess one of these
ratings provide questionable protection of interest and principal ("Ba"
indicates some speculative elements; "B" indicates a general lack of
characteristics of desirable investment; "Caa" represents a poor standing; "Ca"
represents obligations which are speculative in a high degree; and "C"
represents the lowest rated class of bonds). "Caa," "Ca" and "C" bonds may be in
default.
Con. (---) - Bonds for which the security depends upon the completion
of some act or the fulfillment of some condition are rated conditionally. These
are bonds secured by (a) earnings of projects under construction, (b) earnings
of projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
(P)... - When applied to forward delivery bonds, indicates that the
rating is provisional pending delivery of the bonds. The rating may be revised
prior to delivery if changes occur in the legal documents or the underlying
credit quality of the bonds.
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Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's
believes possess the strongest investment attributes are designated by the
symbols, Aa1, A1, Baa1, Ba1 and B1.
The following summarizes the long-term debt ratings used by Duff &
Phelps for corporate and municipal long-term debt:
"AAA" - Debt is considered to be of the highest credit quality. The
risk factors are negligible, being only slightly more than for risk-free U.S.
Treasury debt.
"AA" - Debt is considered of high credit quality. Protection factors
are strong. Risk is modest but may vary slightly from time to time because of
economic conditions.
"A" - Debt possesses protection factors which are average but
adequate. However, risk factors are more variable and greater in periods of
economic stress.
"BBB" - Debt possesses below average protection factors but such
protection factors are still considered sufficient for prudent investment.
Considerable variability in risk is present during economic cycles.
"BB," "B," "CCC," "DD," and "DP" - Debt that possesses one of these
ratings is considered to be below investment grade. Although below investment
grade, debt rated "BB" is deemed likely to meet obligations when due. Debt
rated "B" possesses the risk that obligations will not be met when due. Debt
rated "CCC" is well below investment grade and has considerable uncertainty as
to timely payment of principal, interest or preferred dividends. Debt rated
"DD" is a defaulted debt obligation, and the rating "DP" represents preferred
stock with dividend arrearages.
To provide more detailed indications of credit quality, the "AA," "A,"
"BBB," "BB" and "B" ratings may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within these major categories.
The following summarizes the highest four ratings used by Fitch for
corporate and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay interest
and repay principal, which is unlikely to be affected by reasonably foreseeable
events.
"AA" - Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong
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as bonds rated "AAA." Because bonds rated in the "AAA" and "AA" categories are
not significantly vulnerable to foreseeable future developments, short-term debt
of these issuers is generally rated "F-1+."
"A" - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
"BBB" - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
To provide more detailed indications of credit quality, the Fitch
ratings from and including "AA" to "BBB" may be modified by the addition of a
plus (+) or minus (-) sign to show relative standing within these major rating
categories.
IBCA assesses the investment quality of unsecured debt with an
original maturity of more than one year which is issued by bank holding
companies and their principal bank subsidiaries. The following summarizes the
rating categories used by IBCA for long-term debt ratings:
"AAA" - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial, such that adverse changes in business, economic or financial
conditions are unlikely to increase investment risk substantially.
"AA" - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and interest is
substantial, such that adverse changes in business, economic or financial
conditions may increase investment risk, albeit not very significantly.
"A" - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is strong,
although adverse changes in business, economic or financial conditions may lead
to increased investment risk.
"BBB" - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of
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principal and interest is adequate, although adverse changes in business,
economic or financial conditions are more likely to lead to increased investment
risk than for obligations in other categories.
"BB," "B," "CCC," "CC," and "C" - Obligations are assigned one of
these ratings where it is considered that speculative characteristics are
present. "BB" represents the lowest degree of speculation and indicates a
possibility of investment risk developing. "C" represents the highest degree of
speculation and indicates that the obligations are currently in default.
IBCA may append a rating of plus (+) or minus (-) to a rating below
"AAA" to denote relative status within major rating categories.
Thomson BankWatch assesses the likelihood of an untimely repayment of
principal or interest over the term to maturity of long term debt and preferred
stock which are issued by United States commercial banks, thrifts and non-bank
banks; non-United States banks; and broker-dealers. The following summarizes
the rating categories used by Thomson BankWatch for long-term debt ratings:
"AAA" - This designation represents the highest category assigned by
Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is extremely high.
"AA" - This designation indicates a very strong ability to repay
principal and interest on a timely basis with limited incremental risk compared
to issues rated in the highest category.
"A" - This designation indicates that the ability to repay principal
and interest is strong. Issues rated "A" could be more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
"BBB" - This designation represents Thomson BankWatch's lowest
investment grade category and indicates an acceptable capacity to repay
principal and interest. Issues rated "BBB" are, however, more vulnerable to
adverse developments (both internal and external) than obligations with higher
ratings.
"BB," "B," "CCC," and "CC," - These designations are assigned by
Thomson BankWatch to non-investment grade long-term debt. Such issues are
regarded as having speculative characteristics regarding the likelihood of
timely payment of
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principal and interest. "BB" indicates the lowest degree of speculation and
"CC" the highest degree of speculation.
"D" - This designation indicates that the long-term debt is in
default.
PLUS (+) OR MINUS (-) - The ratings from "AAA" through "CC" may
include a plus or minus sign designation which indicates where within the
respective category the issue is placed.
MUNICIPAL NOTE RATINGS
- ----------------------
A Standard and Poor's rating reflects the liquidity concerns and
market access risks unique to notes due in three years or less. The following
summarizes the ratings used by Standard & Poor's Ratings Group for municipal
notes:
"SP-1" - The issuers of these municipal notes exhibit very strong or
strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit satisfactory
capacity to pay principal and interest.
"SP-3" - The issuers of these municipal notes exhibit speculative
capacity to pay principal and interest.
Moody's ratings for state and municipal notes and other short-term
loans are designated Moody's Investment Grade ("MIG") and variable rate demand
obligations are designated Variable Moody's Investment Grade ("VMIG"). Such
ratings recognize the differences between short-term credit risk and long-term
risk. The following summarizes the ratings by Moody's Investors Service, Inc.
for short-term notes:
"MIG-1"/"VMIG-1" - Loans bearing this designation are of the best
quality, enjoying strong protection by established cash flows, superior
liquidity support or demonstrated broad-based access to the market for
refinancing.
"MIG-2"/"VMIG-2" - Loans bearing this designation are of high quality,
with margins of protection ample although not so large as in the preceding
group.
"MIG-3"/"VMIG-3" - Loans bearing this designation are of favorable
quality, with all security elements accounted for but lacking the undeniable
strength of the preceding grades. Liquidity and cash flow protection may be
narrow and market access for refinancing is likely to be less well established.
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"MIG-4"/"VMIG-4" - Loans bearing this designation are of adequate
quality, carrying specific risk but having protection commonly regarded as
required of an investment security and not distinctly or predominantly
speculative.
"SG" - Loans bearing this designation are of speculative quality and
lack margins of protection.
Fitch and Duff & Phelps use the short-term ratings described under
Commercial Paper Ratings for municipal notes.
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