THE BOARD OF DIRECTORS
NORMAN BARKER, JR.*+ Chairman
JOHN E. BRYSON*
RICHARD C. GILMAN+
WILLIAM G. McGAGH
RONALD L. OLSON*
WILLIAM E. B. SIART
LOUIS A. SIMPSON+
OFFICERS
W. CURTIS LIVINGSTON III
President
KENT S. ENGEL
Vice President
& Portfolio Manager
SCOTT F. GRANNIS
Vice President
ILENE S. HARKER
Vice President
DONNA E. BARNES
Secretary
STEVEN T. SARUWATARI
Treasurer
MARIE K. KARPINSKI
Assistant Treasurer
REFERENCES
INVESTMENT ADVISER
Western Asset Management Company
117 East Colorado Boulevard
Pasadena, California 91105
TRANSFER AGENT
Boston EquiServ
P.O. Box 8200
Boston, Massachusetts 02266-8200
*Member of Executive Committee
+Member of Audit Committee
PACIFIC
AMERICAN
INCOME
SHARES, INC.
P.O. BOX 983
PASADENA
CALIFORNIA 91105
PACIFIC
AMERICAN
INCOME
SHARES, INC.
SEMI-ANNUAL
REPORT
1997
<PAGE>
Dear Shareholders:
MARKET REVIEW AND PERFORMANCE
The bond market in the first half of this year continued to experience
relatively volatile yields. The ebbs and flows of the economy accounted for most
of the ups and downs in rates. Investors' concerns have centered mainly around
the belief that excessive growth would eventually generate rising inflation
pressures. Perhaps the most significant event of this year, therefore, has been
the recent acceptance by a majority of market participants that even as growth
has accelerated, inflation has continued to fall, reaching levels today that we
have not seen since the 1950s.
Despite the challenging environment for bonds, there were pockets of
opportunity for which the fund was well positioned. Yield premiums on corporate
issues--both in the investment-grade and particularly in the high-yield
arenas--continued to decline, as strong economic fundamentals bolstered the
outlook for credit quality improvements, and investors hungered for yield
against a global backdrop of generally low interest rates. A modest exposure to
emerging market debt was rewarded as Latin American countries such as Mexico and
Argentina began to evidence signs of resurging economic strength, causing the
sector to again generate very impressive returns. Finally, the fund benefited
from a moderate exposure to mortgage-backed securities, the top-performing
sector of the broad bond market.
With the impact of low inflation beginning to overcome concerns about
economic growth, interest rates have declined in recent months and demand for
higher yielding securities has improved, allowing Pacific American's (PAI) share
price to trend higher, from 14 3/8 at the end of 1996 to 15 1/4 by the end of
June. And, as an apparent result of increased demand for yield in an environment
of gradually narrowing credit spreads, the fund's discount to net asset value
narrowed from 9% to 4% over this period. For the first half of 1997 the fund
performed quite well, continuing to deliver a high level of income to
shareholders. On a total return basis, the fund exceeded the returns of the
broad investment grade bond market as measured by the Lehman Brothers Aggregate
Bond Index by a comfortable margin, 5.0% (net) vs. 3.1%, and it performed well
against funds with similar income goals. According to Lipper Analytical
Services, for the year ending June 30, 1997, PAI's return ranked first out of
its universe of 16 competitive closed-end investment grade bond funds. Its
long-term competitive record remains excellent: for periods ending June 30,
1997, PAI ranked first for the past five years, and second for the past ten
years. As we anticipated in our last letter, regular dividends of $0.295 per
share were paid out to shareholders.
ECONOMIC OUTLOOK AND PORTFOLIO STRATEGY
Currently, we are seeing the most benign inflation the economy has had
since the mid-50s and -60s, when bond yields were 4% and mortgages were 5%.
Year-to-date through June, the CPI is up at a 1.4% annual pace, and the PPI is
falling at a 3.4% pace; at the end of last year, these indices were registering
3.3% and 2.8%, respectively. With inflation collapsing and interest rates only
moderately lower, real interest rates have risen significantly. In addition,
most commodity and precious metals prices are falling, and the dollar has risen
over 10% in the past year. As if to confirm that
1
<PAGE>
monetary conditions are tight, it appears that the rise in rates earlier this
year was sufficient to produce a substantial economic slowdown in the second
quarter.
This view of the world leads us to the conclusion that interest rates are
still attractive relative to inflation, particularly those offered by longer
maturity securities. Although we plan to continue structuring the portfolio to
benefit from a climate of gradually declining interest rates, we do find some
value in holding a modest exposure to selected mortgage-backed securities which
offer high quality and a minimum of exposure to prepayment risks.
A disinflating and growing economy like we have now should still be
supportive of corporate bonds, but rising deflationary risks and narrow spreads
argue for gradually upgrading the portfolio's overall quality. As global yields
continue to decline, the extra spreads offered by emerging market debt will
continue to be attractive to investors, and we believe that a moderate exposure
to the debt securities of countries such as Mexico and Argentina will continue
to enhance the fund's overall yield.
BOARD OF DIRECTORS
At PAI's annual meeting of shareholders, held on April 8, 1997, all
directors who had served in the previous year were re-elected along with a new
director, William Siart. Mr. Siart is the immediate past Chairman of First
Interstate Bancorp. Ronald Arnault, former Chief Financial Officer for ARCO will
also be joining the Board this fall and will stand for re-election for a full
term at next year's annual meeting.
These changes to Pacific American's Board reflect the retirement of Gordon
Hough this past spring and the scheduled retirement of Norman Barker at the end
of this year.
We are pleased to continue the high standards set by the existing directors
with the addition of these two prominent and capable executives.
It is a pleasure to review our performance and once again note that we have
attained value for our shareholders. We pledge, therefore, to continue our
efforts to avoid excessive risk and to concentrate on strategies which we
believe will benefit the portfolio in the fullness of time. Please let us know
if we can answer any questions for you.
Sincerely,
/s/ W. Curtis Livingston, III
- -----------------------------
W. Curtis Livingston, III
President
2
<PAGE>
PACIFIC AMERICAN INCOME SHARES, INC.
- --------------------------------------------------------------------------------
DIVIDEND REINVESTMENT PLAN
- --------------------------------------------------------------------------------
A Dividend Reinvestment Plan is available to all shareholders of record of the
Company. For participants in the Plan, cash dividends and other distributions
are automatically reinvested in additional shares of the Company's stock. These
shares are purchased on the open market. Interested shareholders may obtain more
information by contacting the Dividend Reinvestment Agent, Boston EquiServ, P.O.
Box 8200, Boston, MA 02266-8200.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
SCHEDULE OF INVESTMENTS June 30, 1997 (Unaudited) (Amounts in Thousands)
- ----------------------------------------------------------------------------------------------------
Market
Par Value
- ----------------------------------------------------------------------------------------------------
<S><C>
INVESTMENT SECURITIES -- 102.0%
FINANCIAL AND LEASING -- 5.3%
Dean Witter Discover, 6.75%, due 10-15-13 $2,700 $ 2,509
J.P. Morgan Capital Trust II, 7.95%, due 2-1-27 300 300
Western Financial Savings Bank, 8.5%, due 7-1-03 5,000 5,001
-------
7,810
-------
FOREIGN AND INTERNATIONAL -- 7.3%
Republic of Argentina, 6.75%, due 3-31-05 1,208 1,134(A,E)
Republic of Argentina, 11.38%, due 1-30-17 600 667(A)
Exide Holdings, 9.13%, due 4-15-04 4,500 2,651
Geberit International SA, 10.13%, due 4-16-07 2,600 1,617
Hydro Quebec, 8.05%, due 7-7-24 1,500 1,626(A)
United Mexican States, 7.88%, due 8-6-01 1,400 1,404(A,E)
United Mexican States, 11.38%, due 9-15-16 1,600 1,798(A)
-------
10,897
-------
INDUSTRIALS AND MISCELLANEOUS -- 27.0%
Auburn Hills Trust, 12%, due 5-1-20 2,094 3,108(E)
Cablevision Industries, 9.25%, due 4-1-08 2,000 2,126
Ford Motor Co., 7.70%, due 5-15-97 1,500 1,512
GMAC Zero Coupon Units, 0%, due 6-15-15 4,300 1,217(F)
Gulf States Utilities, 8.25%, due 4-1-04 3,200 3,362
Harrahs Operations, Inc., 8.75%, due 3-15-00 2,500 2,550
K Mart Corp., 7.95%, due 2-1-23 3,000 2,715
</TABLE>
3
<PAGE>
PACIFIC AMERICAN INCOME SHARES, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS (Continued) (Amounts in Thousands)
- ----------------------------------------------------------------------------------------------------
Market
Par Value
- ----------------------------------------------------------------------------------------------------
<S><C>
Loews Corporation, 7.63%, due 6-1-23 $ 2,242 $ 2,133
MFS Communications, 0%, due 1-15-04 1,100 1,024(F)
News America Holdings Incorporated, 8.88%, due 4-26-23 2,635 2,827
News America Holdings Incorporated, 8.45%, due 8-1-34 930 1,010
Northrop Grumman Corp., 9.38%, due 10-15-24 2,000 2,195
RJR Nabisco, Inc., 8.75%, due 8-15-05 400 406
RJR Nabisco, Inc., 8.75%, due 7-15-07 4,280 4,334
Rogers Cable System, LTD., 10%, due 3-15-05 1,000 1,080
Safeway Inc., 10%, due 12-1-01 1,500 1,660
TCI Communications Inc., 8.75%, due 8-1-15 440 461
Tele Communications, Inc., 9.25%, due 1-15-23 800 834
Time Warner, Inc., 9.15%, due 2-1-23 3,000 3,313
Union Acceptance Corp., 1997-B A2, 6.70%, due 6-10-03 1,500 1,479
US West Capital Funding, Inc., 7.95%, due 2-1-97 700 705
-------
40,051
-------
U.S. GOV'T MORTGAGE-BACKED SECURITIES -- 29.1%
Federal Home Loan Mortgage Corp., 10.75%, due 7-1-00 42 43
Federal Home Loan Mortgage Corp., 10.25%, due 5-1-09 301 325
Federal Home Loan Mortgage Corp., 11.88%, due 6-15-13 413 449
Federal National Mortgage Assoc., 8%, due 4-25-06 3,000 3,070
Federal National Mortgage Assoc., 10.50%, due 7-1-09 265 287
Federal National Mortgage Assoc., 7%, due 12-1-26 14,166 13,891
Federal National Mortgage Assoc., 7%, due 12-1-26 9,900 9,699(B)
Federal National Mortgage Assoc., 7.50%, due 12-1-26 3,000 3,007(B)
Federal National Mortgage Assoc., 7%, due 1-1-27 976 956
Gov't Nat'l Mortgage Assoc., 12.25%, due 3-20-14 203 228
Gov't Nat'l Mortgage Assoc., 9%, due 9-15-19 156 167
Gov't Nat'l Mortgage Assoc., 8%, due 10-15-26 4,581 4,689
Resolution Trust Corporation, 9.40%, due 5-25-24 4,000 4,053
Resolution Trust Corporation, 8%, due 4-25-25 2,415 2,404
-------
43,268
-------
</TABLE>
4
<PAGE>
PACIFIC AMERICAN INCOME SHARES, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS (Continued) (Amounts in Thousands)
- ----------------------------------------------------------------------------------------------------
Market
Par Value
- ----------------------------------------------------------------------------------------------------
<S><C>
MORTGAGE-BACKED SECURITIES -- 4.6%
Asset Securitization Corp., 7.42%, due 4-14-29 $2,400 $ 2,475
C.S. First Boston Mortgage, 7.24%, due 6-20-29 3,000 3,036
Glendale Federal Savings and Loan Assoc., 9.13%, due 1-25-08 155 155
Nomura Asset Securities Corp., 7.12%, due 4-13-36 1,170 1,177
Valley Federal S&L, Manufactured Housing, 13.25%, due 1-15-99 26 26(C)
-------
6,869
-------
UTILITIES - GAS AND ELECTRIC -- 17.6%
Connecticut Light &Power Co., 7.88%, due 6-1-01 3,250 3,268
First PV Funding Corporation, 10.15%, due 1-15-16 1,682 1,773
Long Island Lighting Co., 9.75%, due 5-1-21 5,000 5,067
Niagra Mohawk Power, 7.75%, due 5-15-06 3,000 2,966
Niagra Mohawk Power, 8.75%, due 4-1-22 2,500 2,504
North Atlantic Energy Corp., 9.05%, due 6-1-02 2,024 2,048
PNPP II Funding Corp., 9.12%, due 5-30-16 2,459 2,422(D)
Sithe/Independence Funding Corporation, 9%, due 12-30-13 4,000 4,382
Systems Energy Resources, 7.43%, due 1-15-11 1,818 1,762
-------
26,192
-------
U.S. GOVERNMENT AND AGENCIES -- 10.7%
Resolution Funding Corporation, 8.88%, due 4-15-30 3,175 3,937
U.S. Treasury Bonds, 6.63%, due 2-15-07 3,715 3,635
U.S. Treasury Bonds, 6.50%, due 11-15-26 960 921
U.S. Treasury Notes, 6%, due 6-30-99 5,700 5,692
U.S. Treasury Notes, 6.63%, due 7-31-01 1,450 1,464
U.S. Treasury Notes, 7.5%, due 2-15-05 235 249
-------
15,898
-------
</TABLE>
5
<PAGE>
PACIFIC AMERICAN INCOME SHARES, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SCHEDULE OF INVESTMENTS (Continued) (Amounts in Thousands)
- ----------------------------------------------------------------------------------------------------
Market
Shares Value
- ----------------------------------------------------------------------------------------------------
<S><C>
EQUITIES -- 0.4%
News Corp - Trust Originated Preferred Security, 5%, due 11-12-16 520 $ 345
News Corp - Warrants 5 180(G)
Time Warner Inc., 10.25% Preferred Stock 1 3
--------
528
--------
Total Investment Securities 151,513
--------
Par
---
SHORT-TERM SECURITIES -- 2.0%
Repurchase Agreement -- 2.0%
J.P. Morgan, Inc.
6.05% dated 6-30-97, to be repurchased at $3,041 on 7-1-97
(Collateral $2,880 Federal National Mortgage
Association Mortgage-backed securities,
7.65% due 3-10-05, value $3,185) $3,040 3,040
--------
Total Short-term Securities 3,040
--------
Total Investments-- 104.0% 154,553
Other Assets Less Liabilities-- (4.0%) (6,003)
--------
Net Assets-- 100.0% $148,550
--------
- ----------------------------------------------------------------------------------------------------
</TABLE>
(A) Security is denominated and traded in U.S. dollars.
(B) When-issued security -- Security issued on a delayed delivery basis. Final
settlement and maturity not yet determined.
(C) The Company purchased Valley Federal S&L Manufactured Housing Participation
Certificates at 99.5, in a private placement transaction on January 30,
1984. This investment is restricted as to resale and amounted to
approximately $26 (less than .1% of net assets) at June 30, 1997. Restricted
securities have been valued at fair value in accordance with valuation
methods approved by the Board of Directors. Such approved methods reflect
the Board's consideration of, among other things, the financial condition
of the issuer, current interest rates and the maturity of the security.
The Company will bear the costs incurred, if any, in connection with any
future disposition of these securities.
(D) Rule 144A security -- A security purchased pursuant to Rule 144a under the
Securities Act of 1933 which may not be resold subject to that rule except
to qualified buyers.
(E) Variable rate security--The rate shown is the rate as of June 30, 1997.
(F) Zero-coupon bond -- A bond with no periodic interest payments which is sold
at such a discount as to produce a current yield to maturity.
(G) Non-income producing.
See notes to financial statements.
6
<PAGE>
PACIFIC AMERICAN INCOME SHARES, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
STATEMENT OF ASSETS AND LIABILITIES June 30, 1997 (Unaudited) (Amounts in Thousands)
- -------------------------------------------------------------------------------------------------
<S><C>
ASSETS
Investment securities at market value (Cost $146,906) $151,513
Short-term securities 3,040
--------
Total investments $154,553
Cash 7,217
Receivable for:
Sales of investments 8,734
Accrued interest 2,204
Appreciation of forward currency contracts 74
--------
11,012
Other assets 14
--------
172,796
LIABILITIES:
Payable for securities purchased 23,856
Accrued expenses 61
Dividend payable 269
Investment advisory fee payable 60
--------
24,246
--------
NET ASSETS -- equivalent to $15.94 per share on
9,319 shares of Common Stock outstanding $148,550
========
SUMMARY OF STOCKHOLDERS' EQUITY:
Common Stock, par value $.01 per share:authorized
10,000 shares; issued and outstanding 9,319
shares 93
Capital surplus 141,491
Overdistributed net investment income (165)
Undistributed net realized gain on investments 2,450
Unrealized appreciation of investments and forward
currency contracts 4,681
--------
Net assets applicable to outstanding Common Stock $148,550
========
See notes to financial statements.
7
<PAGE>
PACIFIC AMERICAN INCOME SHARES, INC.
- --------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
STATEMENT OF OPERATIONS (Unaudited) (Amounts in Thousands)
- -------------------------------------------------------------------------------------------------
For the Six Months
Ended June 30, 1997
-------------------------
<S><C>
INVESTMENT INCOME:
Income:
Interest $5,763
Dividends 105
------
5,868
Expenses:
Advisory fee $383
Transfer agent and shareholder servicing expense 25
Custodian fee 35
Directors' fees and expenses 31
Legal and auditing fees 21
Printing, stationery, and reports to shareholders 19
Taxes, other than federal income taxes 22
Registration fees 8
Other expenses 2
Less fees waived (12)
----
534
------
Net investment income 5,334
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on investments 1,434
Unrealized appreciation of investments 301
------
Net realized and unrealized gain on investments 1,735
------
Increase in net assets resulting from operations $7,069
======
</TABLE>
See notes to financial statements.
8
<PAGE>
PACIFIC AMERICAN INCOME SHARES, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
STATEMENT OF CHANGES IN NET ASSETS (Amounts in Thousands)
- -------------------------------------------------------------------------------------------------
For the Six For the
Months Ended Year Ended
June 30, 1997 Dec. 31, 1996
------------- -------------
(Unaudited)
<S><C>
Operations:
Net investment income $ 5,334 $ 10,641
Net realized gain on investments 1,434 3,370
Increase (decrease) in unrealized appreciation of
investments 301 (4,913)
-------- --------
Change in net assets resulting from operations 7,069 9,098
Distributions to shareholders from:
Net investment income (5,498) (10,997)
Net realized gain on investments -- (2,749)
-------- --------
Total increase (decrease) 1,571 (4,648)
Net Assets:
Beginning of period 146,979 151,627
-------- --------
End of period (including overdistributed net
investment income of $165 and $0, respectively) $148,550 $146,979
======== ========
</TABLE>
See notes to financial statements.
9
<PAGE>
PACIFIC AMERICAN INCOME SHARES, INC.
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
Contained below is per share operating performance data for a share of
common stock outstanding throughout each period, total investment return, ratios
to average net assets and other supplemental data. This information has been
derived from information provided in the financial statements and market price
data for the Company's shares.
<TABLE>
<CAPTION>
For the Six For the Years Ended December 31,
Months Ended ------------------------------------------------------
June 30, 1997 1996 1995 1994 1993 1992
------------- ------ ------ ------ ------ ------
(Unaudited)
<S><C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning of period $15.77 $16.27 $14.30 $16.25 $15.94 $16.06
------ ------ ------ ------ ------ ------
Net investment income 0.57 1.14 1.18 1.23 1.27 1.38
Net realized and unrealized
gain (loss) on investments 0.19 (.16) 1.99 (1.90) .84 .39
------ ------ ------ ------ ------ ------
Total from investment operations 0.76 .98 3.17 (.67) 2.11 1.77
------ ------ ------ ------ ------ ------
Distributions paid from:
Net investment income (0.59) (1.18) (1.20) (1.20) (1.28) (1.40)
Net realized gain on investments -- (.30) -- (.08) (.52) --
Dilutive effect of stock issuance -- -- -- -- -- (.49)
------ ------ ------ ------ ------ ------
Net asset value, end of period $15.94 $15.77 $16.27 $14.30 $16.25 $15.94
====== ====== ====== ====== ====== ======
Market value per share, end of period $15.25 $14.375 $15.25 $13.125 $16.375 $15.625
====== ======= ====== ======= ======= =======
TOTAL RETURN:
Based on market value per share 10.28%(B) 4.16% 25.92% (12.75%) 16.57% 8.17%
RATIOS TO AVERAGE NET ASSETS:
Expenses 0.73%(A) .72% .81% .76% .72%(C) .79%
Net investment income 7.33%(A) 7.22 7.62% 8.20% 7.71% 8.31%
SUPPLEMENTAL DATA:
Portfolio turnover rate 216.20%(A) 326.30% 131.73% 116.19% 130.25% 83.51%
Net assets at end of period
(in thousands) $148,550 $146,979 $151,627 $133,239 $151,424 $142,311
</TABLE>
- --------------
(A) Annualized
(B) Not annualized
(C) Exclusive of expenses relating to Convertible Notes which were converted in
1993.
See notes to financial statements.
10
<PAGE>
PACIFIC AMERICAN INCOME SHARES, INC.
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (Unaudited) (Amounts in Thousands)
- --------------------------------------------------------------------------------
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
The Company is registered under the Investment Company Act of 1940 as a
diversified, closed-end management investment company. The significant
accounting policies of the Company, which are in accordance with generally
accepted accounting principles for investment companies, include the following:
(a) Cash -- Cash includes demand deposits held with the Company's
custodian and does not include short-term investments.
(b) Investments -- Security transactions are recorded on the trade
date. Investment securities owned at June 30, 1997 are reflected in the
accompanying Schedule of Investments at their value on June 30, 1997. In
valuing portfolio securities, securities listed or traded on a national
securities exchange are valued at the last sales price on the last business
day of the period. Each security traded in the over-the-counter market,
including listed debt securities whose primary market is believed to be
over-the-counter, is generally valued at the mean of the bid prices at the
time of computation. Prices are obtained from at least two dealers
regularly making a market in the security, unless such prices can be
obtained from only a single market maker. The method of valuing restricted
securities is described in Note C to the Schedule of Investments. The
difference between cost and market value is reflected separately as
unrealized appreciation of investments. Short-term securities are generally
stated at cost plus interest earned, which approximates market value.
The net realized gain or loss on investment transactions is determined
for federal income tax and financial reporting purposes on the basis of
identified cost. Purchases and sales of securities other than short-term
and U.S. government securities for the six months ended June 30, 1997
aggregated $32,889 and $37,413, respectively. Purchases and sales of U.S.
government securities were $128,384 and $129,687, respectively, for the six
months ended June 30, 1997. As of June 30, 1997, unrealized appreciation
for federal income tax and financial reporting purposes aggregated $4,607
of which $5,058 related to appreciated securities and $451 related to
depreciated securities. The aggregate cost of investment securities owned
for federal income tax purposes was $146,906 at June 30, 1997.
(c) Recognition of income, expense and distributions to shareholders --
The Company accrues interest income and expenses on a daily basis.
Dividends are recorded on the ex-dividend date.
(d) Federal income taxes -- No provision for federal income or excise
taxes has been made in the accompanying financial statements because the
Company intends to distribute to its shareholders substantially all of its
taxable net income and realized capital gains, and otherwise comply with
the Internal Revenue Code provisions applicable to regulated investment
companies.
11
<PAGE>
PACIFIC AMERICAN INCOME SHARES, INC.
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (Continued) (Amounts in Thousands)
- --------------------------------------------------------------------------------
NOTE 2 -- INVESTMENT ADVISORY AGREEMENT AND AFFILIATED PERSONS
The Company has entered into an investment advisory agreement with Western
Asset Management Company ("Adviser"), which is a wholly owned subsidiary of Legg
Mason, Inc., pursuant to which the Adviser provides investment advice and
administrative services to the Company. In return for its advisory services, the
Company pays the Adviser a monthly fee at an annual rate of 0.7% of the average
monthly net assets of the Company up to $60,000 and 0.4% of such net assets in
excess of $60,000. If expenses (including the Adviser's fee but excluding
interest, taxes, brokerage fees, the expenses of any offering by the Company of
its securities and extraordinary expenses beyond the control of the Company)
borne by the Company in any fiscal year exceed 1.5% of average net assets up to
$30,000 and 1% of average net assets over $30,000, the Adviser will reimburse
the Company for any excess. No expense reimbursement is due for the six months
ended June 30, 1997.
NOTE 3 -- SECURITIES LOANED
At June 30, 1997, the market value of the securities on loan to
broker-dealers was $21,971, for which the Company received collateral of $22,429
in cash. Such collateral is in the possession of the Company's custodian. As
with other extensions of credit, the Company may bear the risk of delay in
recovery or even loss of rights to the collateral should the borrower of the
securities fail financially.
NOTE 4 -- FORWARD CURRENCY EXCHANGE CONTRACTS
Forward foreign currency contracts are marked-to-market daily using foreign
currency exchange rates supplied by an independent pricing service. The change
in a contract's market value is recorded by the Company as an unrealized gain or
loss. When the contract is closed or delivery is taken, the Company records a
realized gain or loss equal to the difference between the value of the contract
at the time it was opened and the value at the time it was closed.
The use of forward foreign currency contracts does not eliminate
fluctuations in the underlying prices of the Company's securities, but it does
establish a rate of exchange that can be achieved in the future. These forward
foreign currency contracts involve market risk in excess of amounts reflected in
the Financial Statements. Although forward foreign currency contracts used for
hedging purposes limit the risk of loss due to a decline in the value of the
hedged currency, they also limit any potential gain that might result should the
value of the currency increase. In addition, the Company could be exposed to
risks if the counterparties to the contracts are unable to meet the terms of
their contracts. The adviser will enter into forward foreign currency contracts
only with parties approved by the Board of Directors because there is a risk of
loss to the Company if the counterparties do not complete the transaction.
At June 30, 1997, open forward currency exchange contracts were as follows:
Contract to
Settlement -------------------------- Unrealized
Date Receive Deliver Gain/(Loss)
----------------------------------------------------------------
10/17/97 USD 4,179 DEM 7,100 74
12
<PAGE>
NOTE 5 -- QUARTERLY RESULTS OF OPERATIONS:
(Amounts in Thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------------------------
June 30, 1997 March 31, 1997 Dec. 31, 1996 Sept. 30, 1996
============================================================
<S><C>
Investment income Total $3,004 $2,864 $3,034 $2,861
Net investment income Total 2,737 2,597 2,774 2,598
Per Share .294 .279 .298 .279
Net realized and
unrealized gain
(loss) on
investments Total 4,288 (2,553) 3,377 830
Per Share .460 (.274) .362 .089
Three Months Ended
------------------------------------------------------------
June 30, 1996 March 31, 1996 Dec. 31, 1995 Sept. 30, 1995
============================================================
Investment income Total $2,874 $2,940 $2,982 $3 ,072
Net investment income Total 2,605 2,664 2,684 2,737
Per Share .279 .286 .288 .294
Net realized and
unrealized gain
(loss) on
investments Total (1,640) (4,110) 9,609 (4,538)
Per Share (1.75) (.441) 1.031 (.487)
</TABLE>
13
