PACIFIC
AMERICAN
INCOME
SHARES, INC.
ANNUAL
REPORT
1998
THE BOARD OF DIRECTORS
WILLIAM G. McGAGH*, Chairman
RONALD J. ARNAULT+
JOHN E.BRYSON*
Anita L. DeFrantz+
RICHARD C. GILMAN+
RONALD L. OLSON*
WILLIAM E. B. SIART*
LOUIS A. SIMPSON+
OFFICERS
W. CURTIS LIVINGSTON
President
KENT S. ENGEL
Vice President
SCOTT F. GRANNIS
Vice President
ILENE S. HARKER
Vice President
S. KENNETH LEECH
Vice President
STEVEN T. SARUWATARI
Treasurer
MARIE K. KARPINSKI
Assistant Treasurer
INVESTMENT ADVISER
Western Asset Management Company
117 East Colorado Boulevard
Pasadena, California 91105
TRANSFER AGENT
Boston EquiServe
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
PACAM-AR-98
<PAGE>
Dear Shareholders:
Market Review and Performance
Fixed-income markets throughout the world were roiled in the second half of
1998 by both the devaluation of the Russian ruble and Russia's decision to
default on some of its loan obligations. Leveraged hedge funds were severely
impacted, and their unwinding operations magnified a severe shortage of
liquidity and flight to quality. By the time the dust had settled, U.S. Treasury
bond prices had moved up sharply, but most other bond prices were lower, and
emerging market debt prices were significantly so, marking one of the sharpest
and most dramatic divergences in performance in the history of the bond markets.
Following the Federal Reserve's move to ease monetary policy three times in
quick succession, some calm was restored to the markets by year-end,
particularly in the corporate and emerging market sectors. Overall, long-term
Treasury yields fell about one-half of one percent for the period, with
shorter-term yields falling almost one percent, thus continuing the rally that
began in the first half of the year. In the background, the U.S. economy
remained remarkably healthy despite the ongoing global turmoil, and inflation
remained low and stable.
Consistent with the difficult market for non-Treasury securities, the bulk
of the portfolio's holdings experienced either flat or lower prices. This
explains in large part why Pacific American's (PAI) share price eased slightly
from $16.125 at the end of June to close the year at $15.75. The emerging market
sector, where we earlier had established an exposure at what we thought were
extremely attractive levels, experienced the greatest degree of price erosion.
The overall impact on the portfolio was mitigated, however, because we have
taken steps to ensure that exposure is limited to liquid and shorter-dated
issues, and that it is diversified among major countries to minimize systemic
risk should contagion effects persist.
The Fund generated a total return (price gains/losses plus interest income,
net of expenses) of 2.18% for the second half of the year. This is comparable
with the total return of 2.29% for the Lipper Analytical Services group of
competitive closed-end investment grade bond funds, though less so with the
4.57% total return for the broad investment grade bond market (as measured by
the Salomon Brothers Broad Investment Grade Index) which contains a dominant
weighting to better-performing Treasury securities. Its long-term competitive
record remains excellent; however, for periods ending December 31, 1998, PAI
ranked first (of 16 funds) for the past five years and first (of 15 funds) for
the past ten years in the Lipper Analytical Services group of competitive
closed-end investment grade bond funds.
Economic Outlook and Portfolio Strategy
Following numerous moves by the world's central banks to reduce interest
rates in the past several months, a key question today is whether monetary
policy has eased sufficiently to ensure trouble-free economic growth going
forward. The willingness of central banks to relax monetary policy in the face
of serious threats to global financial stability is encouraging, and has clearly
reduced the risk of a serious financial meltdown, deflation or recession.
However, in our view the moves to date do not appear to have eliminated extant
deflationary risks, and they do not rule out the risk of a slowdown in the U.S.
economy.
Whether this slowdown is mild or recessionary is the critical question, as
is the degree to which
1
<PAGE>
deflation persists. If accompanied by Fed ease, mild deflation and a mild
slowdown likely would be fertile ground for all financial assets. If the Fed is
slow to ease, however, a more pronounced deflation or recession is not out of
the question. Since either scenario would imply lower yields, with short-term
rates likely leading the way, we will continue to emphasize longer maturity
bonds in order to lock in their attractive yields.
Although the corporate bond market has largely discounted the possibility
of a recession in 1999, the reality of one would likely cause some further
erosion in corporate bond prices even as Treasury bond prices rose. Though we
are cognizant of these risks, we think the inherent dynamism of the U.S. economy
and the Fed's willingness and ability to ease policy make a doomsday scenario
unlikely. Consequently, we continue to place primary emphasis on corporate bonds
and are selectively adding to our overall position, particularly in shorter
maturity below investment grade issues in light of their historically attractive
yield premiums.
In the emerging market area, where extraordinarily high yields appear to
more than compensate for risk given the impressive structural reforms that many
countries have undertaken, our caution continues to take the form of an emphasis
on shorter maturities diversified among major sovereign issuers to minimize
systemic risk. Finally, mortgage-backed securities are still attractive since
they offer the combination of relatively high current yield and very high
quality. They also provide an attractive hedge in the event that inflation picks
up unexpectedly, since their effective yields would then rise.
Year 2000
During 1998, attention increasingly focused on the Year 2000 issue. As you
may know, the Year 2000 issue is a computer programming problem that affects the
ability of computers to correctly process dates of January 1, 2000, and beyond.
The Fund's Year 2000 project is well underway, and is designed to ensure that
the Year 2000 date change will have no adverse impact on our ability to service
our shareholders. The Fund is committed to taking those steps necessary to
protect Fund investors, including efforts to determine that the Year 2000
problem will not affect such vital service functions as shareholder transaction
processing and record keeping. In addition, we are continuously monitoring the
Year 2000 efforts of our vendors, and will perform tests with our critical
vendors throughout 1999. Although the Fund is taking steps to ensure that all of
its systems will function properly before, during, and after the Year 2000, the
Fund could be adversely affected by computer related problems associated with
the Year 2000. Contingency plans to ensure that functions critical to the Fund's
operations will continue without interruption are under development. We are on
target to complete this important project and look forward to continuing
extensive testing (including industry-wide testing) with our industry peers,
regulators and vendors throughout 1999.
Dividend Policy
Our long-term investment program has always sought to balance the twin
objectives of high current income and underlying share value. Over the last few
years, this program has been unusually successful with results that include a
rising market price for our shares, extra capital gains distributions and the
elimination of PAI's historical share price discount. Most notable has been the
stability of our dividend, which has remained the same in each of the last three
years despite large
2
<PAGE>
drops in the level of interest rates generally. U.S. Treasury yields, for
example, are down more than 25% in the last two years alone.
Each January, we set the coming year's dividend rate based on our
projection for future portfolio earnings. For 1999, the reality of lower rates
will finally have an impact larger than can be completely offset by our
investment strategies and the dividend rate will be lowered somewhat from its
recent annual level of $1.18 to $1.10.
As always, we remain dedicated to delivering the highest level of value for
our shareholders. Please let us know if we can answer any questions for you.
Sincerely,
/s/ W. Curtis Livingston
W. Curtis Livingston
President
3
<PAGE>
Pacific American Income Shares, Inc.
- --------------------------------------------------------------------------------
Statistical Highlights (Amounts in Thousands, except per share amounts)
- --------------------------------------------------------------------------------
December 31,
------------
1998 1997
---- ----
Net Asset Value $146,103 $150,139
Per Share $15.56 $16.11
Net Investment Income $9,667 $10,626
Per Share $1.04 $1.14
Dividends Paid $11,012 $10,997
Per Share $1.18 $1.18
Capital Gains Paid $3,273 $3,541
Per Share $.35 $.38
- --------------------------------------------------------------------------------
The Company
- --------------------------------------------------------------------------------
Pacific American Income Shares, Inc. is a closed-end, diversified
management investment company which seeks for its shareholders a high level of
current income through investment in a diversified portfolio of debt securities.
Substantially all of the net investment income is distributed to shareholders. A
Divident Reinvestment Plan is available to those shareholders of record desiring
it. The shares are listed on the New York Stock Exchange where they are traded
under the symbol PAI, and price quotations can be found in publications under
the abbreviation PacAmShrs.
- --------------------------------------------------------------------------------
Investment Policies
- --------------------------------------------------------------------------------
The Company's fundamental investment policies provide that its portfolio be
invested as follows:
[ ] At least 75% in debt securities rated within the four highest grades, and
in government securities, bank debt, commercial paper, cash or cash
equivalents.
[ ] Up to 25% in other fixed income securities, convertible bonds, convertible
preferred and preferred stock.
[ ] Not more than 25% in securities restricted as to resale.
- --------------------------------------------------------------------------------
Dividend Reinvestment Plan
- --------------------------------------------------------------------------------
Pacific American Income Shares Inc. ("PAI" or the "Company") and State
Street Bank and Trust Company ("State Street" or the "Agent"), as the Transfer
Agent and Register of the Company, offer two convenient ways to add shares of
the Company to your account. First, PAI offers to all stockholders a Dividend
Reinvestment Plan ("Plan"). Under the Plan, cash distributions (e.g., dividends
and capital gains) are automatically invested in shares of PAI unless the
stockholder elects otherwise. Second, the Company offers to registered
stockholders (those who own shares in their own name on the Company's records)
the option to purchase additional whole and partial shares of PAI - the Optional
Cash Investment Service ("Optional Cash Investment Service").
As a participant in the Dividend Reinvestment Plan, you will automatically
receive your dividend or net capital gains distribution in newly issued shares
of PAI, if the market price of the shares on the date of the distribution is at
or above the net asset value of the shares. The number of shares
4
<PAGE>
Pacific American Income Shares, Inc.
- --------------------------------------------------------------------------------
to be issued to you will be determined by dividing the amount of the cash
distribution to which you are entitled (net of any applicable withholding taxes)
by the greater of the net asset value ("NAV") per share on such date or 95% of
the market price of a share on such date. If the market price of a share on such
a distribution date is below the NAV, the Agent will, as agent for the
participants, buy shares of PAI stock through a broker on the open market. All
shares of Common Stock acquired on your behalf through the Plan will be
automatically credited to an account maintained on the books of State Street.
Full and fractional shares will be voted by State Street in accordance with your
instructions.
Optional Cash Investment Service
Under the Optional Cash Investment Service (offered to registered
stockholders only), funds received from shareholders for stock purchases will be
pooled once per month. The Agent will then purchase shares of PAI stock through
a broker on the open market. For the purposes of making purchases, the Agent
will commingle each participant's funds with those of all other participants in
the Plan. The price per share of shares purchased for each participant's account
with respect to a particular dividend or other distribution shall be the average
price (including brokerage commissions, transfer taxes and any other costs of
purchase) of all shares purchased with respect to that dividend or other
distribution. The Agent will hold the total shares purchased for all
participants in its name or the name of its nominee and will have no
responsibility for the value of such shares after their purchase.
Beneficial stockholders (those who own shares held in a brokerage, bank or
other financial institution account) are not eligible to participate in this
option because there is no way to make payments through a broker, bank or
nominee. A beneficial stockholder may, however, have their shares taken out of
"street name" and re-register such shares in their own name, becoming a
registered stockholder in order to participate. If you wish to do so, please
contact your broker, bank or nominee.
Additional Information regarding the Plan and the Optional Cash Investment
Service
PAI will pay all costs applicable to the Plan and Optional Cash Investment
Service, with noted exceptions. Brokerage commissions, transfer taxes and any
other costs of purchase or sale by the Agent under the Plan or Optional Cash
Investment Service, will be charged to participants. In the event PAI determines
to no longer pay such costs, the Agent will terminate the Plan and Optional Cash
Investment Service and may, but is not obligated to, offer a new plan under
which it would impose a direct service charge on participants.
All shares acquired through the Plan or the Optional Cash Investment
Service receive voting rights and are eligible for any stock split, stock
dividend, or other rights accruing to stockholders that the Board of Directors
may declare.
You may terminate participation in the Plan or the Optional Cash Investment
Service at any time by giving written notice to the Agent. Such termination
shall be effective prior to the record date next succeeding the receipt of such
instructions or by a later date of termination specified in such instructions.
Upon termination, a participant may request a certificate for the full shares
credited to
5
<PAGE>
Pacific American Income Shares, Inc.
- --------------------------------------------------------------------------------
his or her account or may request the sale of all or part of such shares. If the
participant instructs the Agent to sell the shares credited to the participant's
account, the Agent may accumulate such shares and those of any other terminating
participants for purposes of such sale. Brokerage charges, transfer taxes, and
any other costs of sale will be allocated pro rata among the selling
participants. Any such sale may be made on any securities exchange where such
shares are traded, in the over-the-counter market or in negotiated transactions,
and may be subject to such terms of price, delivery, etc., as the Agent may
agree to. Fractional shares credited to a terminating account will be paid for
in cash at the current market price at the time of termination.
Dividends and other distributions invested in additional shares under the
Plan are subject to income tax just as if they had been received in cash. After
year-end, dividends paid on the accumulated shares will be included in the Form
1099-DIV information return to the Internal Revenue Service (IRS) and only one
Form 1099-DIV will be sent to participants each year.
Inquiries regarding the Plan and the Optional Cash Investment Service, as
well as notices of termination, should be directed to State Street Bank and
Trust Company, c/o Boston EquiServe, P.O. Box 8200, Boston, MA 02266-8200 -
Investor Relations telephone number (800) 426-5523.
6
<PAGE>
Pacific American Income Shares, Inc.
- --------------------------------------------------------------------------------
Portfolio Diversification December 31, 1998
- --------------------------------------------------------------------------------
BY RATING*
(At Market Value)
(Pie chart appears here. See the table below for plot points.)
AAA 51.5%
AA 1.3%
A 7.7%
BBB 19.5%
BB 11.6%
Short-Term Securities 4.7%
Not Rated 3.7%
BY INDUSTRY*
(At Market Value)
3.9% MORTGAGE-BACKED
4.7% SHORT-TERM SECURITIES
4.9% ASSET-BACKED SECURITIES
5.3% FINANCIAL AND LEASING
9.1% UTILITIES - GAS AND ELECTRIC
14.0% FOREIGN AND INTERNATIONAL
15.7% INDUSTRIALS AND MISCELLANEOUS
17.3% U.S. GOVERNMENT AND AGENCIES
25.1% U.S. GOVERNMENT AGENCY MORTGAGE-BACKED SECURITIES
*EXPRESSED AS A PERCENTAGE OF PORTFOLIO
7
<PAGE>
<TABLE>
<CAPTION>
Pacific American Income Shares, Inc.
- -------------------------------------------------------------------------------------------------------------------
Schedule of Investments December 31, 1998 (Amounts in Thousands)
- -------------------------------------------------------------------------------------------------------------------
Market
Par Value
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Investment Securities -- 111.5%
ASSET-Backed Securities -- 5.7%
Franklin Auto Trust, 5.50%, due 1-15-02 $2,800 $2,801
Keystone Owner Trust, 6.62%, due 11-25-08 585 585
Sallie Mae, 5.35%, due 4-25-06 4,976 4,915(E)
========
8,301
========
Financial and Leasing -- 6.2%
Commercial Mtg. Accep. Corp., 6.53%, due 6-15-07 3,100 3,204
Dean Witter Discover, 6.75%, due 10-15-13 2,700 2,689
IBJ Preferred Cap Co. LLC, 8.79%, due 12-29-49 1,610 1,412(D)
J.P. Morgan Capital Trust II, 7.95%, due 2-1-27 150 163
SBTreasury Co. LLC, 9.40%, due 12-29-49 1,530 1,507(D)
Socgen Real Estate Co. LLC, 7.64%, due 12-29-49 150 138(D)
--------
9,113
--------
Foreign and International -- 16.4%
Export-Import Bank Korea, 6.38%, due 2-15-06 830 706
Geberit International SA, 10.13%, due 4-15-07 2,600 1,771(A)
Hydro Quebec, 8.05%, due 7-7-24 1,500 1,800
Manitoba Province Canada, 9.5%, 9-15-18 730 1,015
Petroleos Mexicanos, 8.85%, due 9-15-07 3,675 3,271(D)
Petroliam Nasional Berhad, 7.13%, due 8-15-05 150 117(D)
Petroliam Nasional Berhad, 7.13%, due 10-18-06 260 203(D)
Petroliam Nasional Berhad, 7.75%, due 8-15-15 1,640 1,148(D)
Petroliam Nasional Berhad, 7.63%, due 10-15-26 2,000 1,369(D)
Republic of Argentina, 11%, due 12-4-05 1,970 1,972(E)
Republic of Brazil, 6.13%, due 4-15-06 3,831 2,467(E)
Republic of Brazil, 8%, due 4-15-14 6,794 4,042(E)
Republic of Korea, 8.88%, due 4-15-08 490 506
Russian Ministry of Finance, 12.75%, due 6-24-28 1,190 381(D)
Tata Electric Company, 8.50%, due 8-19-17 3,000 2,272(D)
United Mexican States, 11.5%, due 5-15-26 250 267
</TABLE>
8
<PAGE>
<TABLE>
<CAPTION>
Pacific American Income Shares, Inc.
- -------------------------------------------------------------------------------------------------------------------
Schedule of Investments (Continued) (Amounts in Thousands)
- -------------------------------------------------------------------------------------------------------------------
Market
Par Value
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Foreign and International -- CONTINUED
United Mexican States, 11.5%, due 5-15-26 $ 550 $ 591
Vnesheconombank, 5.97%, due 12-15-15 150 10(E)
========
23,908
========
Industrials And Miscellaneous -- 18.4%
Auburn Hills Trust, 12%, due 5-1-20 2,094 3,450
Burlington Northern Sante Fe, 6.38%, due 12-15-05 240 247
CSX Corp., 6.25%, due 10-15-08 460 467
Ford Motor Co., 6.63%, due 10-1-28 120 123
Ford Motor Co., 7.70%, due 5-15-99 1,500 1,730
GMAC Zero Coupon Units, 0%, due 6-15-15 4,300 1,400(F)
Loews Corporation, 7.63%, due 6-1-23 2,242 2,262
MCI WorldCom Inc., 9.38%, due 1-15-04 958 992
News America, Inc., 7.63%, due 11-30-28 1,310 1,402(D)
News America, Inc., 6.75%, due 1-9-38 930 952(D)
News America Holdings Incorporated, 8.88%, due 4-26-23 1,325 1,606
Northrop Grumman Corp., 9.38%, due 10-15-24 2,000 2,283
Raytheon Co., 6.75%, due 8-15-07 420 445
RJR Nabisco, Inc., 8.75%, due 8-15-05 400 404
Rogers Cable System, Ltd., 10%, due 3-15-05 1,000 1,120
Seagram, Joseph & Sons, Inc., 6.40%, due 12-15-03 640 632
Seagram, Joseph & Sons, Inc., 6.80%, due 12-15-08 450 448
Seagram, Joseph & Sons, Inc., 7.50%, due 12-15-18 1,270 1,278
Sprint Capital Corp., 6.13%, due 11-15-08 530 542
TCI Communications Inc., 6.38%, due 5-1-03 930 959
TCI Communications Inc., 8.75%, due 8-1-15 160 199
Time Warner, Inc., 9.15%, due 2-1-23 3,000 3,963
-------
26,904
-------
</TABLE>
9
<PAGE>
<TABLE>
<CAPTION>
Pacific American Income Shares, Inc.
- -------------------------------------------------------------------------------------------------------------------
Schedule of Investments (Continued) (Amounts in Thousands)
- -------------------------------------------------------------------------------------------------------------------
Market
Par Value
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Mortgage-Backed Securities -- 4.6%
Asset Securitization Corp., 7.42%, due 4-14-29 $ 2,400 $ 2,564
Glendale Federal Savings and Loan Assoc., 9.13%, due 1-25-08 98 98
Nomura Asset Securities Corp., 7.12%, due 4-13-36 1,170 1,232
Residential Accredit Loans, Inc., 7.25%, due 9-25-27 1,540 1,574
Resolution Trust Corporation, 9.40%, due 5-25-24 1,290 1,291
-------
6,759
=======
U.S. GOV'T. AGENCY MORTGAGE-BACKED SECURITIES -- 29.4%
Fannie Mae, 8%, due 4-25-06 1,830 1,891
Fannie Mae, 10.50%, due 7-1-09 148 160
Fannie Mae, 7%, due 1-1-14 1,300 1,328(B)
Fannie Mae, 6%, due 1-1-14 1,300 1,303(B)
Fannie Mae, 6.5%, due 1-1-14 7,400 7,504(B)
Freddie Mac, 10.75%, due 7-1-00 12 13
Freddie Mac, 10.25%, due 5-1-09 203 219
Freddie Mac, 11.88%, due 6-15-13 315 357
Freddie Mac, 5.5%, due 1-1-14 8,700 8,700(B)
Gov't Nat'l Mortgage Assoc., 12.25%, due 3-20-14 156 174
Gov't Nat'l Mortgage Assoc., 9%, due 9-15-19 96 103
Gov't Nat'l Mortgage Assoc., 7%, due 8-15-25 227 233
Gov't Nat'l Mortgage Assoc., 7%, due 11-15-27 975 998
Gov't Nat'l Mortgage Assoc., 7%, due 11-15-27 962 984
Gov't Nat'l Mortgage Assoc., 7%, due 12-15-27 944 966
Gov't Nat'l Mortgage Assoc., 7%, due 12-15-27 923 944
Gov't Nat'l Mortgage Assoc., 7%, due 2-15-28 14,349 14,681
Gov't Nat'l Mortgage Assoc., 7%, due 6-15-28 939 961
Gov't Nat'l Mortgage Assoc., 6.5%, due 8-15-28 98 99
Gov't Nat'l Mortgage Assoc., 6%, due 1-1-29 1,270 1,259(B)
-------
42,877
-------
</TABLE>
10
<PAGE>
<TABLE>
<CAPTION>
Pacific American Income Shares, Inc.
- -------------------------------------------------------------------------------------------------------------------
Schedule of Investments (Continued) (Amounts in Thousands)
- -------------------------------------------------------------------------------------------------------------------
Market
Par Value
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
U.S. Government and Agencies -- 20.2%
Resolution Funding Corporation, 8.88%, due 4-15-30 $3,175 $ 4,698
U.S. Treasury Bonds, 7.88%, due 2-15-21 1,730 2,275
U.S. Treasury Bonds, 6.38%, due 8-15-27 6,510 7,482
U.S. Treasury Notes, 5.88%, due 9-30-02 1,600 1,663
U.S. Treasury Notes, 5.75%, due 10-31-02 520 539
U.S. Treasury Notes, 5.63%, due 12-31-02 3,140 3,244
U.S. Treasury Notes, 5.25%, due 8-15-03 6,630 6,799
U.S. Treasury Notes, 5.75%, due 8-15-03 370 386
U.S. Treasury Notes, 3.38%, due 1-15-07 911 880(C)
U.S. Treasury Notes, 5.63%, due 5-15-08 150 160
U.S. Treasury Notes, 4.75%, due 11-15-08 1,310 1,320
--------
29,447
--------
Utilities - Gas And Electric -- 10.6%
Gulf States Utilities, 8.25%, due 4-1-04 3,200 3,551
Niagra Mohawk Power, 7.75%, due 5-15-06 1,500 1,647
Niagra Mohawk Power, 8.75%, due 4-1-22 2,500 2,726
PNPP II Funding Corp., 9.12%, due 5-30-16 2,459 2,909(D)
Sithe/Independence Funding Corporation, 9%, due 12-30-13 4,000 4,710
--------
15,543
--------
Warrants -- N.M.
Republic of Argentina Global Bonds, Strike price $93.30, exp. 9-19-27 2 wts 62
========
62
========
Total Investment Securities 162,914
--------
</TABLE>
11
<PAGE>
<TABLE>
<CAPTION>
Pacific American Income Shares, Inc.
- -------------------------------------------------------------------------------------------------------------------
Schedule of Investments (Continued) (Amounts in Thousands)
- -------------------------------------------------------------------------------------------------------------------
Market
Par Value
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
SHORT-TERM SECURITIES -- 5.5%
Repurchase Agreement -- 5.5%
Merrill Lynch Securities Corp.
5.1%, dated 12-31-98, to be repurchased at $7,988 on 1-4-99
(Collateral: $7,905 Fannie Mae Medium-term Notes,
6.56% due 1-28-08, value $8,363) $7,983 $ 7,983
---------
Total Short-term Securities 7,983
---------
Total Investments-- 117.0% 170,897
Other Assets Less Liabilities-- (17.0%) (24,794)
---------
Net Assets-- 100.0% $146,103
=========
</TABLE>
(A) Security is denominated and traded in German Deutschmarks.
(B) When-issued security -- Security issued on a delayed-delivery basis. Final
settlement and maturity not yet determined.
(C) United States Treasury Inflation-Indexed Security--U.S. Treasury security
whose principal value is adjusted daily in accordance with changes in the
Consumer Price Index. Interest is calculated on the basis of the current
adjusted principal value.
(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 institutional buyers. These securities represent 11.7% of net
assets.
(E) Variable rate security--The rate shown is the rate as of December 31,
1998.
(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.
N.M. Not meaningful
See notes to financial statements.
12
<PAGE>
<TABLE>
<CAPTION>
Pacific American Income Shares, Inc.
- -------------------------------------------------------------------------------------------------------------------
Statement of Assets and Liabilities December 31, 1998 (Amounts in Thousands)
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS:
Investment securities at market value (Cost $159,288) $162,914
Short-term securities 7,983
--------
Total investments $170,897
Receivable for:
Sales of investments 10,085
Accrued interest 2,199
--------
12,284
Securities lending collateral 28,093
Other assets 15
--------
211,289
LIABILITIES:
Payable for investments purchased 36,948
Obligation to return securities lending collateral 28,093
Accrued expenses 145
--------
65,186
--------
NET ASSETS -- equivalent to $15.56 per share on
9,389 shares of Common Stock outstanding $146,103
========
SUMMARY OF STOCKHOLDERS' EQUITY:
Common Stock, par value $.01 per share:authorized
20,000 shares; issued and outstanding 9,389
shares $ 94
Additional paid in capital 142,585
Accumulated net realized loss on investments (202)
Unrealized appreciation of investments and forward
currency contracts 3,626
--------
Net assets applicable to outstanding Common Stock $146,103
========
</TABLE>
- ----------
See notes to financial statements.
13
<PAGE>
Pacific American Income Shares, Inc.
- --------------------------------------------------------------------------------
Statement of Operations (Amounts in Thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Year Ended
December 31, 1998
-----------------
INVESTMENT INCOME:
Income:
<S> <C>
Interest $10,795
Expenses:
Advisory fee $778
Custodian fee 81
Directors' fees and expenses 68
Transfer agent and shareholder servicing expense 66
Legal and auditing fees 54
Printing, stationery, and reports to shareholders 49
Taxes, other than federal income taxes 44
Registration fees 12
Less fees waived (24)
----
1,128
-------
Net investment income 9,667
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain (loss) on investments and
foreign currency contracts 3,310
Unrealized depreciation of investments and
foreign currency contracts (3,823)
-------
Net realized and unrealized gain (loss) on investments (513)
-------
Change in net assets resulting from operations $ 9,154
=======
</TABLE>
- ----------
See notes to financial statements.
14
<PAGE>
Pacific American Income Shares, Inc.
- --------------------------------------------------------------------------------
Statement of Changes in Net Assets (Amounts in Thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
For the Years Ended December 31,
1998 1997
---- ----
Operations:
<S> <C> <C>
Net investment income $ 9,667 $ 10,626
Net realized gain (loss) on investments and
foreign currency contracts 3,310 4,002
Increase (decrease) in unrealized appreciation of
investments and foreign currency contracts (3,823) 3,070
------- -------
Change in net assets resulting from operations 9,154 17,698
Distributions to shareholders from:
Net investment income (11,012) (10,997)
Net realized gain on investments (3,273) (3,541)
------- -------
(14,285) (14,538)
Common stock issued in payment of
dividends (representing 70 shares) 1,095 --
------- -------
Total increase (decrease) (4,036) 3,160
Net Assets:
Beginning of year 150,139 146,979
------- -------
End of year $146,103 $150,139
======== ========
</TABLE>
- ----------
See notes to financial statements.
15
<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 year, total investment return, ratios
to average net assets and other supplemental data.
<TABLE>
<CAPTION>
For the Years Ended December 31,
----------------------------------------------
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
PER SHARE OPERATING
PERFORMANCE:
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of year $16.11 $15.77 $16.27 $14.30 $16.25
------ ------ ------ ------ ------
Net investment income 1.04 1.14 1.14 1.18 1.23
Net realized and unrealized gain
(loss) on investments (.06) .76 (.16) 1.99 (1.90)
------ ------ ------ ------ ------
Total from investment operations .98 1.90 .98 3.17 (.67)
------ ------ ------ ------ ------
Distributions paid from:
Net investment income (1.18) (1.18) (1.18) (1.20) (1.20)
Net realized gain on investments (.35) (.38) (.30) -- (.08)
------ ------ ------ ------ ------
Total distributions (1.53) (1.56) (1.48) (1.20) (1.28)
------ ------ ------ ------ ------
Net asset value, end of year $15.56 $16.11 $15.77 $16.27 $14.30
====== ====== ====== ====== ======
Market value per share, end of year $15.75 $16.25 $14.375 $15.25 $13.125
====== ====== ======= ====== =======
TOTAL RETURN:
Based on market value per share 6.61%B 24.73% 4.16% 25.92% (12.75%)
RATIOS TO AVERAGE NET ASSETS:
Expenses .76%A .71% .72% .81% .76%
Net investment income 6.54%A 7.11% 7.22% 7.62% 8.20%
SUPPLEMENTAL DATA:
Portfolio turnover rate 378%A 201% 326% 132% 116%
Net assets at end of year
(in thousands) $146,103 $150,139 $146,979 $151,627 $133,239
</TABLE>
See notes to financial statements.
16
<PAGE>
Pacific American Income Shares, Inc.
- --------------------------------------------------------------------------------
Notes to Financial Statements (Amounts in Thousands)
- --------------------------------------------------------------------------------
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Pacific American Income Shares, Inc. (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 December 31, 1998 are reflected in the
accompanying Schedule of Investments at their value on December 31, 1998.
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 and asked
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 difference between cost
and market value is reflected separately as unrealized appreciation or
depreciation 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 year ended December 31, 1998
aggregated $62,209 and $70,566, respectively. Purchases and sales of U.S.
Government securities were $512,905 and $489,307, respectively, for the
year ended December 31, 1998. As of December 31, 1998, unrealized net
appreciation for federal income tax and financial reporting purposes
aggregated $3,082 of which $7,699 related to appreciated securities and
$4,617 related to depreciated securities. The aggregate cost of investment
securities owned for federal income tax purposes was $159,832 at December
31, 1998.
(c) Recognition of income, expense and distributions to shareholders --
The Company accrues interest income and expenses on a daily basis. Dividend
income and distributions to shareholders are recorded on the ex-dividend
date. Distributions are determined in accordance with income tax
regulations which may differ from generally accepted accounting principles;
accordingly, periodic reclassifications are made within the Fund's capital
accounts to reflect income and gains available for distribution under
income tax regulations.
(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.
17
<PAGE>
Pacific American Income Shares, Inc.
- --------------------------------------------------------------------------------
Notes to Financial Statements (Continued) (Amounts in Thousands)
- --------------------------------------------------------------------------------
(e) Use of estimates -- The preparation of the financial statements in
accordance with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts and disclosures in the financial statements. Actual results could
differ from those estimates.
(f) Foreign Currency Translation -- The books and records of the Funds
are maintained in U.S. dollars. Foreign currency amounts are translated
into U.S. dollars on the following basis: (i) market value of investment
securities, assets and liabilities at the closing daily rate of exchange,
and (ii) purchases and sales of investment securities, interest income and
expenses at the rate of exchange prevailing on the respective date of such
transactions. The effect of changes in foreign exchange rates on realized
and unrealized security gains or losses are reflected as a component of
such gains or losses.
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 year ended
December 31, 1998.
On April 17, 1998, the Adviser entered into an investment subadvisory
agreement with Western Asset Global Management, Limited ("WAGM") to provide the
Company with investment research, advice, management and supervision and a
continuous investment program for the Company's portfolio of non-dollar
securities consistent with the Company's investment objectives and policies. As
compensation, the Adviser will pay WAGM a fee based on the prorata assets of the
Company managed by WAGM during the month.
NOTE 3 -- SECURITIES LOANED
The Company lends its securities to approved brokers to earn additional
income and receives cash and U.S. government securities as collateral against
the loans. Cash collateral received is invested in a money market pooled account
by the fund's lending agent. Collateral is maintained over the life of the loan
in an amount not less than 100% of the value of loaned securities. At December
31, 1998, the market value of the securities on loan to broker-dealers was
$25,466, for which the Company received collateral of $28,093 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.
18
<PAGE>
Pacific American Income Shares, Inc.
- --------------------------------------------------------------------------------
Notes to Financial Statements (Continued) (Amounts in Thousands)
- --------------------------------------------------------------------------------
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 December 31, 1998, there were no open forward currency exchange
contracts.
19
<PAGE>
Pacific American Income Shares, Inc.
- --------------------------------------------------------------------------------
Report of Independent Accountants
- --------------------------------------------------------------------------------
To the Shareholders and Directors of
Pacific American Income Shares, Inc.
In our opinion, the accompanying schedule of investments, statement of assets
and liabilities, including the schedule of investments, and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Pacific American Income Shares, Inc. (hereafter referred to as the "Fund") at
December 31, 1998, and the results of its operations, the changes in its net
assets and the financial highlights for each of the fiscal periods presented, in
conformity with generally accepted accounting principles. These financial
statements and financial highlights (hereafter referred to as "financial
statements") are the responsibility of the Fund's management; our responsibility
is to express an opinion on these financial statements based on our audit. We
conducted our audits of these financial statements in accordance with generally
accepted auditing standards which require that we plan and perform the audits to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statements presentation. We believe that our
audits, which included confirmation of securities at December 31, 1998, by
correspondence with the custodian and brokers, provided a reasonable basis for
the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
Baltimore, Maryland
February 5, 1999
20
