o TF1 P-1
SUPPLEMENT DATED JANUARY 1, 2000
TO THE PROSPECTUS OF
FRANKLIN TAX-FREE TRUST
(TF1 - FRANKLIN ARIZONA INSURED, FLORIDA INSURED, INSURED, MASSACHUSETTS
INSURED,
MICHIGAN INSURED, MINNESOTA INSURED AND OHIO INSURED TAX-FREE INCOME FUNDS)
DATED JULY 1, 1999
The prospectus is amended as follows:
I. The following sentence is added after the minimum investments table on page
31:
Please note that you may only buy shares of a fund eligible for sale in your
state or jurisdiction.
II. In the Selling Shares table on page 36 the section "By Wire" is replaced
with the following:
- --------------------------------------------------------------------------------
[Insert graphic of three You can call or write to have redemption proceeds
lightning bolts] BY sent to a bank account. See the policies above for
ELECTRONIC FUNDS selling shares by mail or phone.
TRANSFER (ACH)
Before requesting to have redemption proceeds sent to
a bank account, please make sure we have your bank
account information on file. If we do not have this
information, you will need to send written
instructions with your bank's name and address, a
voided check or savings account deposit slip, and a
signature guarantee if the ownership of the bank and
fund accounts is different.
If we receive your request in proper form by 1:00 p.m.
Pacific time, proceeds sent by ACH generally will be
available within two to three business days.
- --------------------------------------------------------------------------------
III. The management team on page 17 is replaced with the following:
The team responsible for the funds' management is:
SHEILA AMOROSO, SENIOR VICE PRESIDENT OF ADVISERS
Ms. Amoroso has been an analyst or portfolio manager of the Arizona and Florida
Funds since their inception and the Insured, Massachusetts, Michigan, Minnesota
and Ohio Funds since 1987. She is the co-Director of Franklin's Municipal Bond
Department. She joined the Franklin Templeton Group in 1986.
JAMES PATRICK CONN, PORTFOLIO MANAGER OF ADVISERS
Mr. Conn has been an analyst or portfolio manager of the Insured, Massachusetts,
Michigan, Minnesota and Ohio Funds since December 1999. He joined the Franklin
Templeton Group in 1996. Previously, he was a portfolio manager with California
Investment Trust.
CARRIE HIGGINS, PORTFOLIO MANAGER OF ADVISERS
Ms. Higgins has been an analyst or portfolio manager of the Arizona Fund
since its inception. She joined the Franklin Templeton Group in 1990.
JOHN POMEROY, VICE PRESIDENT OF ADVISERS
Mr. Pomeroy has been an analyst or portfolio manager of the Arizona and
Florida Funds since their inception and the Insured, Massachusetts, Michigan,
Minnesota and Ohio Funds since 1989. He joined the Franklin Templeton Group
in 1986.
FRANCISCO RIVERA, PORTFOLIO MANAGER OF ADVISERS
Mr. Rivera has been an analyst or portfolio manager of the Massachusetts Fund
since 1996. He joined the Franklin Templeton Group in 1994.
STELLA WONG, VICE PRESIDENT OF ADVISERS
Ms. Wong has been an analyst or portfolio manager of the Florida Fund since
its inception and the Ohio Fund since 1986. She joined the Franklin Templeton
Group in 1986.
IV. The section "Sales charge waivers" on page 30 is replaced with the
following:
SALES CHARGE WAIVERS Class A shares may be purchased without an initial sales
charge or CDSC by various individuals and institutions or by investors who
reinvest certain distributions and proceeds within 365 days. Certain investors
also may buy Class C shares without an initial sales charge. The CDSC for each
class may be waived for certain redemptions and distributions. If you would like
information about available sales charge waivers, call your investment
representative or call Shareholder Services at 1-800/632-2301. A list of
available sales charge waivers also may be found in the Statement of Additional
Information (SAI).
V. The section "Dealer compensation" on page 39 is replaced with the following:
DEALER COMPENSATION Qualifying dealers who sell fund shares may receive sales
commissions and other payments. These are paid by Franklin Templeton
Distributors, Inc. (Distributors) from sales charges, distribution and service
(12b-1) fees and its other resources.
CLASS A CLASS C
- ------------------------------------------------------------------------------
COMMISSION (%) ........................... - 2.00
Investment under $100,000 ................ 4.00 -
$100,000 but under $250,000 .............. 3.25 -
$250,000 but under $500,000 .............. 2.25 -
$500,000 but under $1 million ............ 1.85 -
$1 million or more ....................... 0.75 1 -
12B-1 FEE TO DEALER ...................... 0.15 (Arizona and 0.65 2
Florida Funds)
0.10 (all other funds)
A dealer commission of up to 1% may be paid on Class C NAV purchases. A dealer
commission of up to 0.25% may be paid on Class A NAV purchases by certain trust
companies and bank trust departments, eligible governmental authorities, and
broker-dealers or others on behalf of clients participating in comprehensive fee
programs.
1. During the first year after purchase, dealers may not be eligible to receive
the 12b-1 fee.
2. Dealers may be eligible to receive up to 0.15% during the first year after
purchase and may be eligible to receive the full 12b-1 fee starting in the 13th
month.
VI. The section "Statements and reports" on page 37 is replaced with the
following:
STATEMENTS AND REPORTS You will receive quarterly account statements that show
all your account transactions during the quarter. You also will receive written
notification after each transaction affecting your account (except for
distributions and transactions made through automatic investment or withdrawal
programs, which will be reported on your quarterly statement). You also will
receive the fund's financial reports every six months. To reduce fund expenses,
we try to identify related shareholders in a household and send only one copy of
the financial reports. If you need additional copies, please call 1-800/DIAL
BEN.
If there is a dealer or other investment representative of record on your
account, he or she also will receive copies of all notifications and statements
and other information about your account directly from the fund.
Please keep this supplement for future reference.
TF1 SAI 01/00
o TF2 P-1
SUPPLEMENT DATED JANUARY 1, 2000
TO THE PROSPECTUS OF
FRANKLIN TAX-FREE TRUST
(TF2 - FRANKLIN ALABAMA, FLORIDA, GEORGIA, KENTUCKY, LOUISIANA, MARYLAND,
MISSOURI,
NORTH CAROLINA, TEXAS AND VIRGINIA TAX-FREE INCOME FUNDS)
DATED JULY 1, 1999
The prospectus is amended as follows:
I. The following sentence is added after the minimum investments table on page
38:
Please note that you may only buy shares of a fund eligible for sale in your
state or jurisdiction.
II. In the Selling Shares table on page 43 the section "By Wire" is replaced
with the following:
- --------------------------------------------------------------------------------
[Insert graphic of three You can call or write to have redemption proceeds
lightning bolts] BY sent to a bank account. See the policies above for
ELECTRONIC FUNDS selling shares by mail or phone.
TRANSFER (ACH)
Before requesting to have redemption proceeds sent to
a bank account, please make sure we have your bank
account information on file. If we do not have this
information, you will need to send written
instructions with your bank's name and address, a
voided check or savings account deposit slip, and a
signature guarantee if the ownership of the bank and
fund accounts is different.
If we receive your request in proper form by 1:00 p.m.
Pacific time, proceeds sent by ACH generally will be
available within two to three business days.
- --------------------------------------------------------------------------------
III. The management team on page 20 is replaced with the following:
The team responsible for the funds' management is:
SHEILA AMOROSO, SENIOR VICE PRESIDENT OF ADVISERS
Ms. Amoroso has been an analyst or portfolio manager of each fund since its
inception. She is the co-Director of Franklin's Municipal Bond Department.
She joined the Franklin Templeton Group in 1986.
JAMES PATRICK CONN, PORTFOLIO MANAGER OF ADVISERS
Mr. Conn has been an analyst or portfolio manager of the Alabama and Maryland
Funds since December 1999. He joined the Franklin Templeton Group in 1996.
Previously, he was a portfolio manager with California Investment Trust.
CARRIE HIGGINS, PORTFOLIO MANAGER OF ADVISERS
Ms. Higgins has been an analyst or portfolio manager of the Missouri Fund
since 1992. She joined the Franklin Templeton Group in 1990.
MARK ORSI, VICE PRESIDENT OF ADVISERS
Mr. Orsi has been an analyst or portfolio manager of the Kentucky Fund since its
inception and the North Carolina and Virginia Funds since 1991. He joined the
Franklin Templeton Group in 1990.
JOHN POMEROY, VICE PRESIDENT OF ADVISERS
Mr. Pomeroy has been an analyst or portfolio manager of the Alabama, Florida,
Georgia and Maryland Funds since 1989. He joined the Franklin Templeton Group
in 1986.
FRANCISCO RIVERA, PORTFOLIO MANAGER OF ADVISERS
Mr. Rivera has been an analyst or portfolio manager of the Georgia, Kentucky,
Louisiana and Texas Funds since 1996. He joined the Franklin Templeton Group
in 1994.
JOHN WILEY, VICE PRESIDENT OF ADVISERS
Mr. Wiley has been an analyst or portfolio manager of the Louisiana and Texas
Funds since 1991. He joined the Franklin Templeton Group in 1989.
STELLA WONG, VICE PRESIDENT OF ADVISERS
Ms. Wong has been an analyst or portfolio manager of the Florida, Maryland,
Missouri, North Carolina and Virginia Funds since their inception. She joined
the Franklin Templeton Group in 1986.
IV. The section "Sales charge waivers" on page 38 is replaced with the
following:
SALES CHARGE WAIVERS Class A shares may be purchased without an initial sales
charge or CDSC by various individuals and institutions or by investors who
reinvest certain distributions and proceeds within 365 days. Certain investors
also may buy Class C shares without an initial sales charge. The CDSC for each
class may be waived for certain redemptions and distributions. If you would like
information about available sales charge waivers, call your investment
representative or call Shareholder Services at 1-800/632-2301. A list of
available sales charge waivers also may be found in the Statement of Additional
Information (SAI).
V. The section "Dealer compensation" on page 46 is replaced with the following:
DEALER COMPENSATION Qualifying dealers who sell fund shares may receive sales
commissions and other payments. These are paid by Franklin Templeton
Distributors, Inc. (Distributors) from sales charges, distribution and service
(12b-1) fees and its other resources.
CLASS A CLASS C
- ------------------------------------------------------------------------------
COMMISSION (%) ................................. - 2.00
Investment under $100,000 ...................... 4.00 -
$100,000 but under $250,000 .................... 3.25 -
$250,000 but under $500,000 .................... 2.25 -
$500,000 but under $1 million .................. 1.85 -
$1 million or more ............................. up to 0.75 1 -
12B-1 FEE TO DEALER ............................ 0.10 0.65 2
A dealer commission of up to 1% may be paid on Class C NAV purchases. A dealer
commission of up to 0.25% may be paid on Class A NAV purchases by certain trust
companies and bank trust departments, eligible governmental authorities, and
broker-dealers or others on behalf of clients participating in comprehensive fee
programs.
1. During the first year after purchase, dealers may not be eligible to receive
the 12b-1 fee.
2. Dealers may be eligible to receive up to 0.15% during the first year after
purchase and may be eligible to receive the full 12b-1 fee starting in the 13th
month.
VI. The section "Statements and reports" on page 44 is replaced with the
following:
STATEMENTS AND REPORTS You will receive quarterly account statements that show
all your account transactions during the quarter. You also will receive written
notification after each transaction affecting your account (except for
distributions and transactions made through automatic investment or withdrawal
programs, which will be reported on your quarterly statement). You also will
receive the fund's financial reports every six months. To reduce fund expenses,
we try to identify related shareholders in a household and send only one copy of
the financial reports. If you need additional copies, please call 1-800/DIAL
BEN.
If there is a dealer or other investment representative of record on your
account, he or she also will receive copies of all notifications and statements
and other information about your account directly from the fund.
Please keep this supplement for future reference.
o TF3 P-1
SUPPLEMENT DATED JANUARY 1, 2000
TO THE PROSPECTUS OF
FRANKLIN TAX-FREE TRUST
(TF3 - FRANKLIN ARIZONA, COLORADO, CONNECTICUT, FEDERAL INTERMEDIATE-TERM,
HIGH YIELD, INDIANA,
MICHIGAN, NEW JERSEY, OREGON, PENNSYLVANIA, AND PUERTO RICO TAX-FREE INCOME
FUNDS)
DATED JULY 1, 1999
The prospectus is amended as follows:
I. On June 23, 1999, shareholders of the Franklin Indiana Tax-Free Income Fund
approved a proposal to merge the Indiana Fund into the Franklin Federal Tax-Free
Income Fund, and shareholders of the Franklin Michigan Tax-Free Income Fund
approved a proposal to merge the Michigan Fund into the Franklin Michigan
Insured Tax-Free Income Fund. The merger of the Franklin Indiana Tax-Free Income
Fund was completed on June 24, 1999. The merger of the Franklin Michigan
Tax-Free Income Fund was completed on August 26, 1999.
Please see below for additional details.
FRANKLIN INDIANA TAX-FREE INCOME FUND
On June 24, 1999, Franklin Federal Tax-Free Income Fund acquired the assets of
Franklin Indiana Tax-Free Income Fund. In exchange, Franklin Indiana Tax-Free
Income Fund received shares of Franklin Federal Tax-Free Income Fund, which it
distributed to its shareholders. All references to the Franklin Indiana Tax-Free
Income Fund in the prospectus are deleted.
FRANKLIN MICHIGAN TAX-FREE INCOME FUND
On August 26, 1999, Franklin Michigan Insured Tax-Free Income Fund acquired the
assets of Franklin Michigan Tax-Free Income Fund. In exchange, Franklin Michigan
Tax-Free Income Fund received shares of Franklin Michigan Insured Tax-Free
Income Fund, which it distributed to its shareholders. All references to the
Franklin Michigan Tax-Free Income Fund in the prospectus are deleted.
II. The following sentence is added after the minimum investments table on page
48:
Please note that you may only buy shares of a fund eligible for sale in your
state or jurisdiction.
III. In the Selling Shares table on page 54 the section "By Wire" is replaced
with the following:
- --------------------------------------------------------------------------------
[Insert graphic of You can call or write to have redemption proceeds sent
three lightning to a bank account. See the policies above for selling
bolts] BY ELECTRONIC shares by mail or phone.
FUNDS TRANSFER (ACH)
Before requesting to have redemption proceeds sent to a
bank account, please make sure we have your bank account
information on file. If we do not have this information,
you will need to send written instructions with your
bank's name and address, a voided check or savings
account deposit slip, and a signature guarantee if the
ownership of the bank and fund accounts is different.
If we receive your request in proper form by 1:00 p.m.
Pacific time, proceeds sent by ACH generally will be
available within two to three business days.
- --------------------------------------------------------------------------------
IV. The management team on pages 26 and 27 is replaced with the following:
The team responsible for the funds' management is:
SHEILA AMOROSO, SENIOR VICE PRESIDENT OF ADVISERS
Ms. Amoroso has been an analyst or portfolio manager of the Arizona, Colorado,
Connecticut, Federal Intermediate, New Jersey and Oregon Funds since their
inception and the High Yield, Pennsylvania and Puerto Rico Funds since 1987. She
is the co-Director of Franklin's Municipal Bond Department.
She joined the Franklin Templeton Group in 1986.
JAMES PATRICK CONN, PORTFOLIO MANAGER OF ADVISERS
Mr. Conn has been an analyst or portfolio manager of the Federal Intermediate
Fund since December 1999. He joined the Franklin Templeton Group in 1996.
Previously, he was a portfolio manager with California Investment Trust.
CARRIE HIGGINS, PORTFOLIO MANAGER OF ADVISERS
Ms. Higgins has been an analyst or portfolio manager of the Arizona, Colorado,
New Jersey, Oregon and Puerto Rico Funds since 1992. She joined the Franklin
Templeton Group in 1990.
JOHN HOPP, VICE PRESIDENT OF ADVISERS
Mr. Hopp has been an analyst or portfolio manager of the High Yield Fund
since 1993. He joined the Franklin Templeton Group in 1991.
MARK ORSI, VICE PRESIDENT OF ADVISERS
Mr. Orsi has been an analyst or portfolio manager of the Federal Intermediate
Fund since its inception and the High Yield Fund since 1991. He joined the
Franklin Templeton Group in 1990.
JOHN POMEROY, VICE PRESIDENT OF ADVISERS
Mr. Pomeroy has been an analyst or portfolio manager of the Federal
Intermediate Fund since its inception and the Connecticut Fund since 1989. He
joined the Franklin Templeton Group in 1986.
JOHN WILEY, VICE PRESIDENT OF ADVISERS
Mr. Wiley has been an analyst or portfolio manager of the Arizona, Oregon and
Pennsylvania Funds since 1991. He joined the Franklin Templeton Group in 1989.
STELLA WONG, VICE PRESIDENT OF ADVISERS
Ms. Wong has been an analyst or portfolio manager of the Colorado, Connecticut,
New Jersey and Pennsylvania Funds since their inception and the Puerto Rico Fund
since 1986. She joined the Franklin Templeton Group in 1986.
V. The section "Sales charge waivers" on page 48 is replaced with the following:
SALES CHARGE WAIVERS Class A shares may be purchased without an initial sales
charge or CDSC by various individuals and institutions or by investors who
reinvest certain distributions and proceeds within 365 days. Certain investors
also may buy Class C shares without an initial sales charge. The CDSC for each
class may be waived for certain redemptions and distributions. If you would like
information about available sales charge waivers, call your investment
representative or call Shareholder Services at 1-800/632-2301. A list of
available sales charge waivers also may be found in the Statement of Additional
Information (SAI).
VI. The section "Dealer compensation" on page 57 is replaced with the following:
DEALER COMPENSATION Qualifying dealers who sell fund shares may receive sales
commissions and other payments. These are paid by Franklin Templeton
Distributors, Inc. (Distributors) from sales charges, distribution and service
(12b-1) fees and its other resources.
CLASS B
(HIGH YIELD
ALL FUNDS (EXCEPT FEDERAL INTERMEDIATE) CLASS A FUND ONLY) CLASS C
- ------------------------------------------------------------------------------
COMMISSION (%) ........................... - 3.00 2.00
Investment under $100,000 ................ 4.00 - -
$100,000 but under $250,000 .............. 3.25 - -
$250,000 but under $500,000 .............. 2.25 - -
$500,000 but under $1 million ............ 1.85 - -
$1 million or more ....................... up to 0.75 1 - -
12B-1 FEE TO DEALER ...................... 0.10 0.15 2 0.65 3
FEDERAL INTERMEDIATE FUND
- ------------------------------------------------------------------------------
COMMISSION (%) ........................... -
Investment under $100,000 ................ 2.00
$100,000 but under $250,000 .............. 1.50
250,000 but under $500,000 ............... 1.00
$500,000 but under $1 million ............ 0.85
$1 million or more ....................... up to 0.75 1
12B-1 FEE TO DEALER ...................... 0.10
A dealer commission of up to 1% may be paid on Class C NAV purchases. A dealer
commission of up to 0.25% may be paid on Class A NAV purchases by certain trust
companies and bank trust departments, eligible governmental authorities, and
broker-dealers or others on behalf of clients participating in comprehensive fee
programs.
1. During the first year after purchase, dealers may not be eligible to receive
the 12b-1 fee.
2. Dealers may be eligible to receive up to 0.15% from the date of purchase.
After 8 years, Class B shares convert to Class A shares and dealers may then
receive the 12b-1 fee applicable to Class A.
3. Dealers may be eligible to receive up to 0.15% during the first year after
purchase and may be eligible to receive the full 12b-1 fee starting in the 13th
month.
VII. The section "Statements and reports" on page 55 is replaced with the
following:
STATEMENTS AND REPORTS You will receive quarterly account statements that show
all your account transactions during the quarter. You also will receive written
notification after each transaction affecting your account (except for
distributions and transactions made through automatic investment or withdrawal
programs, which will be reported on your quarterly statement). You also will
receive the fund's financial reports every six months. To reduce fund expenses,
we try to identify related shareholders in a household and send only one copy of
the financial reports. If you need additional copies, please call 1-800/DIAL
BEN.
If there is a dealer or other investment representative of record on your
account, he or she also will receive copies of all notifications and statements
and other information about your account directly from the fund.
Please keep this supplement for future reference.
FRANKLIN
TAX-FREE TRUST
FRANKLIN ARIZONA INSURED TAX-FREE INCOME FUND FRANKLIN FLORIDA INSURED TAX-FREE
INCOME FUND FRANKLIN INSURED TAX-FREE INCOME FUND FRANKLIN MASSACHUSETTS INSURED
TAX-FREE INCOME FUND FRANKLIN MICHIGAN INSURED TAX-FREE INCOME FUND FRANKLIN
MINNESOTA INSURED TAX-FREE INCOME FUND FRANKLIN OHIO INSURED TAX-FREE INCOME
FUND
STATEMENT OF ADDITIONAL INFORMATION
JULY 1, 1999, AS AMENDED JANUARY 1, 2000
P.O. BOX 997151, SACRAMENTO, CA95899-9983 1-800/DIAL BEN(R)
This Statement of Additional Information (SAI) is not a prospectus. It contains
information in addition to the information in the funds' prospectus. The funds'
prospectus, dated July 1, 1999, which we may amend from time to time, contains
the basic information you should know before investing in the funds. You should
read this SAI together with the funds' prospectus.
The audited financial statements and auditor's report in the trust's Annual
Report to Shareholders, for the fiscal year ended February 28, 1999, are
incorporated by reference (are legally a part of this SAI).
For a free copy of the current prospectus or annual report, contact your
investment representative or call 1-800/DIAL BEN (1-800/342-5236).
CONTENTS
Goals and Strategies ................................. 2
Risks ................................................ 7
Officers and Trustees ................................ 10
Management and Other Services ........................ 13
Portfolio Transactions ............................... 14
Distributions and Taxes .............................. 14
Organization, Voting Rights
and Principal Holders ............................... 16
Buying and Selling Shares ............................ 17
Pricing Shares ....................................... 22
The Underwriter ...................................... 23
Performance .......................................... 25
Miscellaneous Information ............................ 28
Description of Ratings ............................... 29
State Tax Treatment .................................. 31
- ------------------------------------------------------------------------------
MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS:
o ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE
FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT;
o ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK;
o ARE SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL.
- ------------------------------------------------------------------------------
GOALS AND STRATEGIES
Each fund's investment goal is to provide investors with as high a level of
income exempt from federal income taxes as is consistent with prudent investing,
while seeking preservation of shareholders' capital. Each state fund also tries
to provide a maximum level of income exempt from personal income taxes, if any,
for resident shareholders of the fund's state. These goals are fundamental,
which means they may not be changed without shareholder approval. Of course,
there is no assurance that any fund will meet its goal.
As fundamental policies, each fund normally invests at least 80% of its net
assets in securities that pay interest free from federal income taxes, including
the federal alternative minimum tax and, in the case of each state fund, at
least 80% of its net assets in securities that pay interest free from the
personal income taxes, if any, of its state. As a nonfundamental policy, each
state fund also normally invests at least 65% of its total assets in municipal
securities of its state. Unlike the state funds, the Franklin Insured Tax-Free
Income Fund is diversified nationally and will not invest more than 25% of its
total assets in the municipal securities of any one state or territory.
Municipal securities issued by a fund's state or that state's counties,
municipalities, authorities, agencies, or other subdivisions, as well as
municipal securities issued by U.S. territories such as Guam, Puerto Rico, or
the Mariana Islands, generally pay interest free from federal income tax and
from state personal income taxes, if any, for residents of the fund's state.
Each fund tries to invest all of its assets in tax-free municipal securities.
The issuer's bond counsel generally gives the issuer an opinion on the
tax-exempt status of a municipal security when the security is issued.
Some states may require a fund to invest a certain amount of its assets in
securities of that state, or in securities that are otherwise tax-free under the
laws of that state, in order for any portion of the fund's distributions to be
free from the state's personal income taxes. If a fund's state requires this,
the fund will try to invest its assets as required so that its distributions
will be free from personal income taxes for resident shareholder's of the fund's
state.
Below is a description of various types of municipal and other securities that
each fund may buy. Other types of municipal securities may become available that
are similar to those described below and in which each fund also may invest, if
consistent with its investment goals and policies.
TAX ANTICIPATION NOTES are issued to finance short-term working capital needs of
municipalities in anticipation of various seasonal tax revenues, which will be
used to pay the notes. They are usually general obligations of the issuer,
secured by the taxing power for the payment of principal and interest.
REVENUE ANTICIPATION NOTES are similar to tax anticipation notes except they are
issued in expectation of the receipt of other kinds of revenue, such as federal
revenues available under the Federal Revenue Sharing Program.
BOND ANTICIPATION NOTES are normally issued to provide interim financing until
long-term financing can be arranged. Proceeds from long-term bond issues then
provide the money for the repayment of the notes.
TAX-EXEMPT COMMERCIAL PAPER typically represents a short-term obligation (270
days or less) issued by a municipality to meet working capital needs.
MUNICIPAL BONDS meet longer-term capital needs and generally have maturities
from one to 30 years when issued. They have two principal classifications:
general obligation bonds and revenue bonds.
GENERAL OBLIGATION BONDS. Issuers of general obligation bonds include states,
counties, cities, towns and regional districts. The proceeds of these
obligations are used to fund a wide range of public projects, including
construction or improvement of schools, highways and roads. The basic security
behind general obligation bonds is the issuer's pledge of its full faith, credit
and taxing power for the payment of principal and interest. The taxes that can
be levied for the payment of debt service may be limited or unlimited as to the
rate or amount of special assessments.
REVENUE BONDS. The full faith, credit and taxing power of the issuer do not
secure revenue bonds. Instead, the principal security for a revenue bond is
generally the net revenue derived from a particular facility, group of
facilities, or, in some cases, the proceeds of a special excise tax or other
specific revenue source. Revenue bonds are issued to finance a wide variety of
capital projects, including: electric, gas, water and sewer systems; highways,
bridges and tunnels; port and airport facilities; colleges and universities; and
hospitals. The principal security behind these bonds may vary. For example,
housing finance authorities have a wide range of security, including partially
or fully insured mortgages, rent subsidized and/or collateralized mortgages,
and/or the net revenues from housing or other public projects. Many bonds
provide additional security in the form of a debt service reserve fund that may
be used to make principal and interest payments. Some authorities have further
security in the form of state assurances (although without obligation) to make
up deficiencies in the debt service reserve fund.
TAX-EXEMPT INDUSTRIAL DEVELOPMENT REVENUE BONDS are issued by or on behalf of
public authorities to finance various privately operated facilities for
business, manufacturing, housing, sports and pollution control, as well as
public facilities such as airports, mass transit systems, ports and parking. The
payment of principal and interest is solely dependent on the ability of the
facility's user to meet its financial obligations and the pledge, if any, of the
facility or other property as security for payment.
VARIABLE OR FLOATING RATE SECURITIES Each fund may invest in top rated variable
or floating rate securities, including variable rate demand notes, which have
interest rates that change either at specific intervals (variable rate), from
daily up to monthly, or whenever a benchmark rate changes (floating rate). The
interest rate adjustments are designed to help stabilize the security's price.
While this feature helps protect against a decline in the security's market
price when interest rates go up, it lowers the fund's income when interest rates
fall. Variable or floating rate securities may include a demand feature, which
may be unconditional. The demand feature allows the holder to demand prepayment
of the principal amount before maturity, generally on one to 30 days' notice.
The holder receives the principal amount plus any accrued interest either from
the issuer or by drawing on a bank letter of credit, a guarantee or insurance
issued with respect to the security. Each fund generally uses variable or
floating rate securities as short-term investments while waiting for long-term
investment opportunities.
MUNICIPAL LEASE OBLIGATIONS Each fund may invest in municipal lease obligations,
including certificates of participation. Municipal lease obligations generally
finance the purchase of public property. The property is leased to the state or
a local government, and the lease payments are used to pay the interest on the
obligations. Municipal lease obligations differ from other municipal securities
because the lessee's governing body must appropriate (set aside) the money to
make the lease payments each year. If the money is not appropriated, the issuer
or the lessee can end the lease without penalty. If the lease is cancelled,
investors who own the municipal lease obligations may not be paid.
The board of trustees reviews each fund's municipal lease obligations to try to
assure that they are liquid investments based on various factors reviewed by the
fund's manager and monitored by the board. These factors may include (a) the
credit quality of the obligations and the extent to which they are rated or, if
unrated, comply with existing criteria and procedures followed to ensure that
they are comparable in quality to the ratings required for the fund to invest,
including an assessment of the likelihood of the lease being canceled, taking
into account how essential the leased property is and the term of the lease
compared to the useful life of the leased property; (b) the size of the
municipal securities market, both in general and with respect to municipal lease
obligations; and (c) the extent to which the type of municipal lease obligations
held by the fund trade on the same basis and with the same degree of dealer
participation as other municipal securities of comparable credit rating or
quality.
Since annual appropriations are required to make lease payments, municipal lease
obligations generally are not subject to constitutional limitations on the
issuance of debt and may allow an issuer to increase government liabilities
beyond constitutional debt limits. When faced with increasingly tight budgets,
local governments have more discretion to curtail lease payments under a
municipal lease obligation than they do to curtail payments on other municipal
securities. If not enough money is appropriated to make the lease payments, the
leased property may be repossessed as security for holders of the municipal
lease obligations. If this happens, there is no assurance that the property's
private sector or re-leasing value will be enough to make all outstanding
payments on the municipal lease obligations or that the payments will continue
to be tax-free.
While cancellation risk is inherent to municipal lease obligations, each fund
believes that this risk may be reduced, although not eliminated, by its policies
on the quality of securities in which it may invest.
CALLABLE BONDS Each fund may invest in callable bonds, which allow the issuer to
repay some or all of the bonds ahead of schedule. If a bond is called, the fund
will receive the principal amount, the accrued interest, and may receive a small
additional payment as a call premium. The manager may sell a callable bond
before its call date, if it believes the bond is at its maximum premium
potential. When pricing callable bonds, the call feature is factored into the
price of the bonds and may impact the fund's net asset value.
An issuer is more likely to call its bonds when interest rates are falling,
because the issuer can issue new bonds with lower interest payments. If a bond
is called, the fund may have to replace it with a lower-yielding security. A
call of some or all of these securities may lower a fund's income and its
distributions to shareholders. If the fund originally paid a premium for the
bond because it had appreciated in value from its original issue price, the fund
also may not be able to recover the full amount it paid for the bond. One way
for the fund to protect itself from call risk is to buy bonds with call
protection. Call protection is an assurance that the bond will not be called for
a specific time period, typically five to 10 years from when the bond is issued.
ESCROW-SECURED OR DEFEASED BONDS are created when an issuer refunds, before
maturity, an outstanding bond issue that is not immediately callable (or
pre-refunds), and sets aside funds for redemption of the bonds at a future date.
The issuer uses the proceeds from a new bond issue to buy high grade, interest
bearing debt securities, generally direct obligations of the U.S. government.
These securities are then deposited in an irrevocable escrow account held by a
trustee bank to secure all future payments of principal and interest on the
pre-refunded bond. Escrow-secured bonds often receive a triple A or equivalent
rating.
STRIPPED MUNICIPAL SECURITIES Municipal securities may be sold in "stripped"
form. Stripped municipal securities represent separate ownership of principal
and interest payments on municipal securities.
ZERO-COUPON SECURITIES Each fund may invest in zero-coupon and delayed interest
securities. Zero-coupon securities make no periodic interest payments, but are
sold at a deep discount from their face value. The buyer recognizes a rate of
return determined by the gradual appreciation of the security, which is redeemed
at face value on a specified maturity date. The discount varies depending on the
time remaining until maturity, as well as market interest rates, liquidity of
the security, and the issuer's perceived credit quality. The discount, in the
absence of financial difficulties of the issuer, typically decreases as the
final maturity date approaches. If the issuer defaults, the fund may not receive
any return on its investment.
Because zero-coupon securities bear no interest and compound semiannually at the
rate fixed at the time of issuance, their value is generally more volatile than
the value of other fixed-income securities. Since zero-coupon bondholders do not
receive interest payments, zero-coupon securities fall more dramatically than
bonds paying interest on a current basis when interest rates rise. When interest
rates fall, zero-coupon securities rise more rapidly in value, because the bonds
reflect a fixed rate of return.
An investment in zero-coupon and delayed interest securities may cause a fund to
recognize income and make distributions to shareholders before it receives any
cash payments on its investment. To generate cash to satisfy distribution
requirements, a fund may have to sell portfolio securities that it otherwise
would have continued to hold or to use cash flows from other sources such as the
sale of fund shares.
CONVERTIBLE AND STEP COUPON BONDS Each fund may invest a portion of its assets
in convertible and step coupon bonds. Convertible bonds are zero-coupon
securities until a predetermined date, at which time they convert to a specified
coupon security. The coupon on step coupon bonds changes periodically during the
life of the security based on predetermined dates chosen when the security is
issued.
U.S. GOVERNMENT OBLIGATIONS are issued by the U.S. Treasury or by agencies
and instrumentalities of the U.S. government and are backed by the full faith
and credit of the U.S. government. They include Treasury bills, notes and
bonds.
COMMERCIAL PAPER is a promissory note issued by a corporation to finance its
short-term credit needs. Each fund may invest in taxable commercial paper only
for temporary defensive purposes.
WHEN-ISSUED TRANSACTIONS Municipal securities are frequently offered on a
"when-issued" basis. When so offered, the price, which is generally expressed in
yield terms, is fixed at the time the commitment to buy is made, but delivery
and payment take place at a later date. During the time between purchase and
settlement, no payment is made by the fund to the issuer and no interest accrues
to the fund. If the other party to the transaction fails to deliver or pay for
the security, the fund could miss a favorable price or yield opportunity, or
could experience a loss.
When a fund makes the commitment to buy a municipal security on a when-issued
basis, it records the transaction and reflects the value of the security in the
determination of its net asset value. The funds believe their net asset value or
income will not be negatively affected by their purchase of municipal securities
on a when-issued basis. The funds will not engage in when-issued transactions
for investment leverage purposes.
Although a fund will generally buy municipal securities on a when-issued basis
with the intention of acquiring the securities, it may sell the securities
before the settlement date if it is considered advisable. When a fund is the
buyer, it will maintain cash or liquid securities, with an aggregate value equal
to the amount of its purchase commitments, in a segregated account with its
custodian bank until payment is made. If assets of a fund are held in cash
pending the settlement of a purchase of securities, the fund will not earn
income on those assets.
ILLIQUID INVESTMENTS Each fund may invest up to 10% of its net assets in
illiquid securities. Illiquid securities are generally securities that cannot be
sold within seven days in the normal course of business at approximately the
amount at which the fund has valued them.
DIVERSIFICATION All of the funds, except the Arizona and Florida Funds, are
diversified funds. The Arizona and Florida Funds are non-diversified. As a
fundamental policy, none of the diversified funds will buy a security if, with
respect to 75% of its net assets, more than 5% would be in the securities of any
single issuer (with the exception of obligations of the U.S. government). For
this purpose, each political subdivision, agency, or instrumentality, each
multi-state agency of which a state is a member, and each public authority that
issues private activity bonds on behalf of a private entity, is considered a
separate issuer. Escrow-secured or defeased bonds are not generally considered
an obligation of the original municipality when determining diversification.
Each fund, including the Arizona and Florida Funds, intends to meet certain
diversification requirements for tax purposes. Generally, to meet federal tax
requirements at the close of each quarter, a fund may not invest more than 25%
of its total assets in any one issuer and, with respect to 50% of total assets,
may not invest more than 5% of its total assets in any one issuer. These
limitations do not apply to U.S. government securities and may be revised if
applicable federal income tax requirements are revised.
TEMPORARY INVESTMENTS When the manager believes the securities trading markets
or the economy are experiencing excessive volatility or a prolonged general
decline, or other unusual or adverse conditions exist, including the
unavailability of securities that meet a fund's investment criteria, it may
invest each fund's portfolio in a temporary defensive manner. Under these
circumstances, each fund may invest all of its assets in securities that pay
taxable interest, including (i) high quality commercial paper; (ii) securities
issued or guaranteed by the full faith and credit of the U.S. government; or
(iii) for the state funds, municipal securities issued by a state or local
government other than the fund's state. Each fund also may invest all of its
assets in municipal securities issued by a U.S. territory such as Guam, Puerto
Rico or the Mariana Islands.
SECURITIES TRANSACTIONS The frequency of portfolio transactions, usually
referred to as the portfolio turnover rate, varies for each fund from year to
year, depending on market conditions. While short-term trading increases
portfolio turnover and may increase costs, the execution costs for municipal
securities are substantially less than for equivalent dollar values of equity
securities.
CREDIT QUALITY All things being equal, the lower a security's credit quality,
the higher the risk and the higher the yield the security generally must pay as
compensation to investors for the higher risk.
A security's credit quality depends on the issuer's ability to pay interest on
the security and, ultimately, to repay the principal. Independent rating
agencies, such as Fitch Investors Service Inc. (Fitch), Moody's Investors
Service, Inc. (Moody's), and Standard & Poor's Corporation (S&P), often rate
municipal securities based on their opinion of the issuer's credit quality. Most
rating agencies use a descending alphabet scale to rate long-term securities,
and a descending numerical scale to rate short-term securities. These ratings
are described at the end of this SAI under "Description of Ratings."
An insurance company, bank or other foreign or domestic entity may provide
credit support for a municipal security and enhance its credit quality. For
example, some municipal securities are insured, which means they are covered by
an insurance policy that guarantees the timely payment of principal and
interest. Other municipal securities may be backed by letters of credit,
guarantees, or escrow or trust accounts that contain securities backed by the
full faith and credit of the U.S. government to secure the payment of principal
and interest.
As discussed in the prospectus, each fund has limitations on the credit quality
of the securities it may buy. These limitations are generally applied when a
fund makes an investment so that a fund is not required to sell a security
because of a later change in circumstances.
INSURANCE Each fund invests primarily in insured municipal securities. Normally,
the underlying rating of an insured security is one of the top three ratings of
Fitch, Moody's or S&P. An insurer may insure municipal securities that are rated
below the top three ratings or that are unrated if the securities otherwise meet
the insurer's quality standards.
A fund will only enter into a contract to buy an insured municipal security if
either permanent insurance or an irrevocable commitment to insure the municipal
security by a qualified municipal bond insurer is in place. The insurance
feature guarantees the scheduled payment of principal and interest, but does not
guarantee (i) the market value of the insured municipal security, (ii) the value
of a fund's shares, or (iii) a fund's distributions.
TYPES OF INSURANCE. There are three types of insurance: new issue, secondary and
portfolio. A new issue insurance policy is purchased by the issuer when the
security is issued. A secondary insurance policy may be purchased by the fund
after a security is issued. With both new issue and secondary policies, the
insurance continues in force for the life of the security and, thus, may
increase the credit rating of the security, as well as its resale value.
Each fund may buy a secondary insurance policy at any time, if the manager
believes the insurance would be in the best interest of the fund. A fund is
likely to buy a secondary insurance policy if, in the manager's opinion, the
fund could sell a security at a price that exceeds the current value of the
security, without insurance, plus the cost of the insurance. The purchase of a
secondary policy, if available, may enable the fund to sell a defaulted security
at a price similar to that of comparable securities that are not in default. The
fund would value a defaulted security covered by a secondary insurance policy at
its market value.
Each fund also may buy a portfolio insurance policy. Unlike new issue and
secondary insurance, which continue in force for the life of the security,
portfolio insurance only covers securities while they are held by the fund. If
the fund sells a security covered by portfolio insurance, the insurance
protection on that security ends and, thus, cannot affect the resale value of
the security. As a result, the fund may continue to hold any security insured
under a portfolio insurance policy that is in default or in significant risk of
default and, absent any unusual or unforeseen circumstances as a result of the
portfolio insurance policy, would likely value the defaulted security, or
security for which there is a significant risk of default, at the same price as
comparable securities that are not in default. While a defaulted security is
held in the fund's portfolio, the fund continues to pay the insurance premium on
the security but also collects interest payments from the insurer and retains
the right to collect the full amount of principal from the insurer when the
security comes due.
The insurance premium the fund pays for a portfolio insurance policy is a fund
expense. The premium is payable monthly and is adjusted for purchases and sales
of covered securities during the month. If the fund fails to pay its premium,
the insurer may take action against the fund to recover any premium payments
that are due. The insurer may not change premium rates for securities covered by
a portfolio insurance policy, regardless of the issuer's ability or willingness
to meet its obligations.
QUALIFIED MUNICIPAL BOND INSURERS. Insurance policies may be issued by any one
of several qualified municipal bond insurers. Each fund generally buys insured
municipal securities only if they are secured by an insurance policy issued by
an insurer whose claims paying ability is rated triple A or its equivalent by
Fitch, Moody's or S&P. Currently, there are four primary, triple A rated
municipal bond insurers. Each fund, however, may invest a portion of its assets
in insured municipal securities covered by policies issued by insurers with a
rating below tripe A or its equivalent.
The bond insurance industry is a regulated industry. All bond insurers must be
licensed in each state in order to write financial guarantees in that
jurisdiction. Regulations vary from state to state. Most regulators, however,
require minimum standards of solvency and limitations on leverage and investment
of assets. Regulators also place restrictions on the amount an insurer can
guarantee in relation to the insurer's capital base. Neither the funds nor the
manager makes any representations as to the ability of any insurance company to
meet its obligation to a fund if called upon to do so. Currently, to the best of
our knowledge, there are no securities in the funds' portfolios on which an
insurer is paying the principal or interest otherwise payable by the issuer of
the bond.
If an insurer is called upon to pay the principal or interest on an insured
security that is due for payment but that has not been paid by the issuer, the
terms of payment would be governed by the provisions of the insurance policy.
After payment, the insurer becomes the owner of the security, appurtenant
coupon, or right to payment of principal or interest on the security and is
fully subrogated to all of the fund's rights with respect to the security,
including the right to payment. The insurer's rights to the security or to
payment of principal or interest are limited, however, to the amount the insurer
has paid.
INVESTMENT RESTRICTIONS Each fund has adopted the following restrictions as
fundamental policies. This means they may only be changed if the change is
approved by (i) more than 50% of the fund's outstanding shares or (ii) 67% or
more of the fund's shares present at a shareholder meeting if more than 50% of
the fund's outstanding shares are represented at the meeting in person or by
proxy, whichever is less.
Each fund may not:
1. Borrow money or mortgage or pledge any of its assets, except that borrowings
(and a pledge of assets therefore) for temporary or emergency purposes may be
made from banks in any amount up to 5% of the total asset value.
2. Buy any securities on "margin" or sell any securities "short," except that it
may use such short-term credits as are necessary for the clearance of
transactions.
3. Make loans, except through the purchase of readily marketable debt securities
which are either publicly distributed or customarily purchased by institutional
investors. Although such loans are not presently intended, this prohibition will
not preclude the fund from loaning portfolio securities to broker-dealers or
other institutional investors if at least 102% cash collateral is pledged and
maintained by the borrower; provided such portfolio security loans may not be
made if, as a result, the aggregate of such loans exceeds 10% of the value of
the fund's total assets at the time of the most recent loan.
4. Act as underwriter of securities issued by other persons, except insofar as
the fund may be technically deemed an underwriter under the federal securities
laws in connection with the disposition of portfolio securities.
5. Purchase the securities of any issuer which would result in owning more than
10% of the voting securities of such issuer, except with respect to the Arizona
and Florida Funds, each of which will not purchase a security, if as a result:
i) more than 25% of its total assets would be invested in the securities of a
single issuer or ii) with respect to 50% of its total assets, more than 5% of
its assets would be invested in the securities of a single issuer.
6. Purchase securities from or sell to the trust's officers and trustees, or any
firm of which any officer or trustee is a member, as principal, or retain
securities of any issuer if, to the knowledge of the trust, one or more of the
trust's officers, trustees, or investment manager own beneficially more than
one-half of 1% of the securities of such issuer and all such officers and
trustees together own beneficially more than 5% of such securities.
7. Acquire, lease or hold real estate, except such as may be necessary or
advisable for the maintenance of its offices and provided that this limitation
shall not prohibit the purchase of municipal and other debt securities secured
by real estate or interests therein.
8. Invest in commodities and commodity contracts, puts, calls, straddles,
spreads or any combination thereof, or interests in oil, gas, or other mineral
exploration or development programs, except that it may purchase, hold and
dispose of "obligations with puts attached" in accordance with its investment
policies.
9. Invest in companies for the purpose of exercising control or management.
10. Purchase securities of other investment companies, except in connection with
a merger, consolidation, acquisition or reorganization, except to the extent
permitted by exemptions which may be granted under the Investment Company Act of
1940, which allows the fund to invest in shares of one or more investment
companies, of the type generally referred to as money market funds, managed by
Franklin Advisers, Inc. or its affiliates.
11. In the case of the Arizona and Florida Funds, purchase securities, in
private placements or in other transactions, for which there are legal or
contractual restrictions on resale.
12. Invest more than 25% of its assets in securities of any industry; although
for purposes of this limitation, tax-exempt securities and U.S. government
obligations are not considered to be part of any industry.
If a bankruptcy or other extraordinary event occurs concerning a particular
security the fund owns, the fund may receive stock, real estate, or other
investments that the fund would not, or could not, buy. If this happens, the
fund intends to sell such investments as soon as practicable while maximizing
the return to shareholders.
Generally, the policies and restrictions discussed in this SAI and in the
prospectus apply when the fund makes an investment. In most cases, the fund is
not required to sell a security because circumstances change and the security no
longer meets one or more of the fund's policies or restrictions. If a percentage
restriction or limitation is met at the time of investment, a later increase or
decrease in the percentage due to a change in the value or liquidity of
portfolio securities will not be considered a violation of the restriction or
limitation.
RISKS
STATE Since each state fund mainly invests in the municipal securities of its
state, its performance is closely tied to the ability of issuers of municipal
securities in its state to continue to make principal and interest payments on
their securities. The issuers' ability to do this is in turn dependent on
economic, political and other conditions within the state. Below is a discussion
of certain conditions that may affect municipal issuers in the funds' various
states. It is not a complete analysis of every material fact that may affect the
ability of issuers of municipal securities to meet their debt obligations or the
economic or political conditions within any state and is subject to change. The
information below is based on data available to the funds from historically
reliable sources, but the funds have not independently verified it.
The ability of issuers of municipal securities to continue to make principal and
interest payments is dependent in large part on their ability to raise revenues,
primarily through taxes, and to control spending. Many factors can affect a
state's revenues including the rate of population growth, unemployment rates,
personal income growth, federal aid, and the ability to attract and keep
successful businesses. A number of factors can also affect a state's spending
including current debt levels, and the existence of accumulated budget deficits.
The following provides some information on these and other factors.
ARIZONA. Strong overall employment growth, affordable housing, and an attractive
climate have helped Arizona's population grow at a rate four times faster than
the national rate during the 1990s. Although population growth is expected to
remain strong in the near term, the rate of growth has slowed since 1996 as a
result of California's economic recovery and thus less migration from that
state. Competitive wage rates, low energy costs, corporate tax reductions and an
abundance of land also have helped to attract businesses to the state. As a
result, Arizona's unemployment in 1998 was at its lowest level since the early
1970s.
Arizona's economy has continued to diversify, especially in the manufacturing
and services areas. As of August 1998, manufacturing accounted for approximately
10.5% of the state's total employment, trade 24.3%, services 30.4%, government
16.1%, and construction 6.6%. Farming and mining accounted for less than 2% of
the total workforce. Improved diversification may help reduce the state's
economic vulnerability that in the past resulted from Arizona's historical
dependence on its farming, mining and real estate industries. Arizona may be
vulnerable, however, to events affecting high-technology products and to recent
and future economic problems in Asia. Approximately 80% of the state's exports
have been in the area of high-technology products and Asian exports have
supported at least 100,000 jobs in the state.
Under its constitution, Arizona cannot issue general obligation debt. Thus,
gross state debt levels have remained moderate. The state historically has
relied on lease obligations, revenue bonds, and pay-as-you-go financing for its
capital needs.
Arizona's strong economic growth and higher-than-anticipated tax revenues have
allowed the state to post four consecutive operating surpluses and general fund
balance increases. Preliminary 1998 results show another operating surplus.
During fiscal 1999, however, a reduction in the general fund balance is expected
with the implementation of new school capital funding legislation.
FLORIDA. Florida's population has grown rapidly in recent years, with the
fastest growth among 5-17 year-olds and seniors 65 and over. The rapid growth
among these age groups has required increased expenditures for services such as
schools and health care and has placed sustained pressure on the state's budget
for the funding of these services. As a result, Florida is more vulnerable to
increases in the cost of education, Medicaid and other health care services than
many other states. While the population of the young and old has grown rapidly,
the working age population has grown at a much slower rate and is expected to
decline in the coming years.
Because of its substantial retirement age population, investment income and
transfer payments, such as social security and pension benefits, made up more
than 44% of Florida's income distribution in 1997. Wages and salaries were more
than 49%. This income mix historically has led to relatively stable personal
income levels across different economic cycles, although it also has created
some vulnerability to changes in the consumer price index at the federal level.
Florida's tax base has been relatively narrow, with no personal income tax and
60% of its revenues derived from the state's sales and use tax. This reliance on
a cyclical revenue source has created some vulnerability to recession and slower
growth in the tax base. Recent trends also have shown an increase in internet
and mail order sales, which the state has not been able to tax. If this trend
continues, states that rely on sales taxes, like Florida, could be adversely
affected. To help provide some protection against the historically volatile
nature of the sales tax, Florida enacted a constitutional amendment creating a
budget stabilization fund. As of March 1999, Florida projected a balance in the
fund of $787 million by the end of fiscal 1999.
Over the past five years, Florida's debt burden has grown dramatically with the
increased need for schools and health care, as well as environmental protection
programs designed to help protect the state's important tourism industry. The
state's rapidly growing population should continue to place demands on the
state's budget and debt burden to finance infrastructure and other improvements.
While tourism has remained Florida's most important industry, Florida's economy
has continued to diversify from a narrow base of agriculture and seasonal
tourism into a service and trade economy. Job growth has been steady, slightly
higher than the national average, and unemployment has been around the national
rate. Because of its location, much of the state's export sector has relied on
exports to Latin America. Although exports have comprised a relatively small
part of the gross state product, the sector's dependence on Latin America poses
a risk in the event of economic instability in that region.
MASSACHUSETTS. In recent years, Massachusetts' economy has been strong and has
led the northeast region. Since 1996, total employment gains in the commonwealth
have exceeded national levels. Likewise, the commonwealth's unemployment rates
have compared favorably with national rates. In June 1998, the unemployment rate
in Massachusetts was 3.4%, compared to the national rate of 4.5%. Employment
growth of 3% in 1998, together with low unemployment rates and modest population
growth, have begun to cause some concerns of a tight labor market. A labor
shortage may be a potential constraint on the further growth of Massachusetts'
economy.
Although the economy has been strong, the commonwealth's debt levels have
remained among the highest in the nation. Spending disciplines imposed during
the state's severe financial difficulties in the early 1990s have helped and
have resulted in seven consecutive years of balanced financial operations. At
the same time, the state has greatly reduced its reliance on temporary
borrowing.
While the state has regained some control over its budget, continuing
expenditure pressures may present fiscal challenges. After a period of
restrained debt issuance, pressure to increase borrowing has been building.
Funding for routine infrastructure needs and a costly tunnel project have been
the focus of this pressure. Tax cuts, a relatively high unfunded pension
liability, and the substantial reliance of localities on the commonwealth for
financial assistance also may strain the commonwealth's resources and limit its
financial flexibility. With the rate of economic growth expected to slow in
coming years, Massachusetts' biggest challenge is likely to be the long term
management of its capital and debt plans.
MICHIGAN. While Michigan's economy has diversified to some degree, it has
remained dependent on its durable goods manufacturing sector, especially on its
cyclical auto industry. In recent years, manufacturing has accounted for 22% of
the state's employment and 33% of personal income. While this sector has been
strong since the end of the national recession in the early 1990s and has made
improvements that could potentially lessen its historical volatility, the
state's reliance on manufacturing has made its economy potentially more volatile
than the economies of more diverse states and more susceptible to the adverse
effects of another recession.
Since 1992, Michigan's economy has grown at a healthy pace. Unemployment levels
have been below national levels since 1994 and, through September 1998,
employment levels were at an all-time high. With the help of its strong economy,
Michigan's finances also have improved. Tighter budget controls and the positive
effect on revenues of the state's relatively strong economy have allowed the
state to replenish reserves, which had been severely depleted during the early
1990s. The state's budget stabilization fund was at more than $1 billion at
September 30, 1998. Michigan may need the increased stability these reserve
levels provide to offset higher school funding requirements. The state also has
been able to maintain its traditionally low debt levels, although contingent
debt levels issued through school programs and based on the state's credit have
grown rapidly, approaching levels almost double the state's outstanding direct
debt. The state's contingent debt exposure will need to be carefully managed in
the coming years to help maintain the state's financial stability.
MINNESOTA. Minnesota's economy has been well diversified, with only some
concentration in the manufacturing sector. Historically, this diversification
has allowed the state to perform well during economic cycles, compared with the
rest of the nation. The effects of the last national recession were less severe
in Minnesota, and the state was able to recover more quickly than many other
states.
Since late 1994, Minnesota has experienced steady job growth, especially in the
services sector. Much of this growth has occurred in the Minneapolis-St. Paul
metropolitan area and has created labor shortages in some industries. These
shortages have in turn resulted in higher-than-average wage levels. Higher
wages, together with a tight labor market, could limit future job expansion in
the state.
Strong financial management, healthy reserve levels and a moderate debt burden
have allowed the state to maintain its strong credit rating. With the recent
strength of its economy and growth in revenues, Minnesota has increased its
general fund balance to $2.4 billion as of June 30, 1998, with a budgetary
reserve of $1.4 billion. With its balances and reserves at historic levels,
several tax cuts have been proposed.
OHIO. Ohio's financial performance has been strong, aided recently by the
continuing diversification of the state's economy. Although manufacturing has
remained a large part of the economy, the state's overall employment mix has
moved more in line with that of the nation, improving the state's economic
stability. Nonetheless, the state's reliance on manufacturing creates
vulnerability to recession and potential financial volatility. The state's
sizable financial reserves, however, may lend some stability and help protect
the state against future spending pressures and economic cycles.
In recent years, Ohio's employment growth has slowed to below the national
average. For the year ended September 1998, job growth was 1.2%, compared to
2.4% for the nation. Much of this growth has been concentrated in the services
and construction sectors. Unemployment was 4.3% in September 1998, slightly
below the national rate. The state's population growth also has been slow and,
during 1997, was the slowest in the Great Lakes region.
Ohio's direct debt levels have been moderate. As a result, debt service payments
on its general obligation debt and lease obligations have been manageable. The
state has enjoyed large operating surpluses over the last seven fiscal years,
which have allowed the state to restore its reserves to levels above those
before the last recession. A recent court decision requiring major changes to
the state's school funding programs, however, may create some pressure on the
state's ability to maintain a balanced budget, especially in the event of an
economic slowdown.
U.S. TERRITORIES Since each fund may invest a portion of its assets in municipal
securities issued by U.S. territories, the ability of municipal issuers in U.S.
territories to continue to make principal and interest payments also may affect
a fund's performance. As with state municipal issuers, the ability to make these
payments is dependent on economic, political and other conditions. Below is a
discussion of certain conditions within some of the territories where the funds
may be invested. It is not a complete analysis of every material fact that may
affect the ability of issuers of U.S. territory municipal securities to meet
their debt obligations or the economic or political conditions within the
territories and is subject to change. It is based on data available to the funds
from historically reliable sources, but it has not been independently verified
by the funds.
GUAM. Guam's economy has been heavily dependent on tourism. It has been
especially dependent on Japanese tourism, which has made Guam vulnerable to
fluctuations in the relationship between the U.S. dollar and the Japanese yen.
The recent Asian economic crisis and Typhoon Paka, which hit Guam in December
1997, negatively affected both tourism and other economic activities in Guam and
contributed to a decline of 1.8% in gross island product between 1997 and 1998.
In the early to mid-1990s, Guam's financial position deteriorated due to a
series of natural disasters that led to increased spending on top of already
significant budget gaps. As a result, the government introduced a comprehensive
financial plan in June 1995 to help balance the budget and reduce the general
fund deficit by fiscal 1999. For fiscal 1998, however, Guam incurred a $21
million deficit and ended the year with a negative unreserved general fund
balance of $158.9 million. Another deficit is expected in 1999.
While Guam's debt burden has been manageable, Guam's ability to maintain current
debt levels may be challenged in the near future. U.S. military downsizing has
reduced the federal presence on the island and also may reduce federal support
for infrastructure projects. At the same time, Guam has faced increasing
pressure to improve its infrastructure to help generate economic development.
Overall, as of May 1999, S&P's outlook for Guam was negative due to Guam's
continued weak financial position and inability to meet the goals of the
financial plan.
MARIANA ISLANDS. The Mariana Islands became a commonwealth in 1975. At that
time, the U.S. government agreed to exempt the islands from federal minimum wage
and immigration laws in an effort to help stimulate industry and the economy.
The islands' minimum wage has been more than $2 per hour below the U.S. level
and tens of thousands of workers have immigrated from various Asian countries to
provide cheap labor for the islands' industries. Recently, the islands' tourism
and apparel industries combined to help increase gross business receipts from
$224 million in 1985 to $2 billion in 1996.
PUERTO RICO. Overall, Moody's considered Puerto Rico's outlook stable as of
January 1999. In recent years, Puerto Rico's financial performance has improved.
Relatively strong revenue growth and more aggressive tax collection procedures
resulted in a general fund surplus for fiscal 1998 (unaudited). For fiscal 1999,
spending increases of 11% are budgeted, which may create an operating deficit
and deplete the commonwealth's unreserved fund balance.
Puerto Rico's debt levels have been high. Going forward, these levels may
increase as Puerto Rico attempts to finance significant capital and
infrastructure improvements. Puerto Rico also will need to address its large
unfunded pension liability of more than $6 billion.
Despite Puerto Rico's stable outlook, Puerto Rico may face challenges in the
coming years with the 1996 passage of a bill eliminating section 936 of the
Internal Revenue Code. This section has given certain U.S. corporations
operating in Puerto Rico significant tax advantages. These incentives have
helped considerably with Puerto Rico's economic growth, especially with the
development of its manufacturing sector. U.S. firms that have benefited from
these incentives have provided a significant portion of Puerto Rico's revenues,
employment and deposits in local financial institutions. The section 936
incentives will be phased out over a 10-year period ending in 2006. It is hoped
that this long phase-out period will give Puerto Rico sufficient time to lessen
the potentially negative effects of section 936's elimination. Outstanding
issues relating to the potential for a transition to statehood also may have
broad implications for Puerto Rico and its financial and credit position.
OFFICERS AND TRUSTEES
The trust has a board of trustees. The board is responsible for the overall
management of the trust, including general supervision and review of each fund's
investment activities. The board, in turn, elects the officers of the trust who
are responsible for administering the trust's day-to-day operations. The board
also monitors each fund to ensure no material conflicts exist among share
classes. While none is expected, the board will act appropriately to resolve any
material conflict that may arise.
The name, age and address of the officers and board members, as well as their
affiliations, positions held with the trust, and principal occupations during
the past five years are shown below.
Frank H. Abbott, III (78)
1045 Sansome Street, San Francisco, CA 94111
TRUSTEE
President and Director, Abbott Corporation (an investment company); director or
trustee, as the case may be, of 27 of the investment companies in the Franklin
Templeton Group of Funds; and FORMERLY, Director, MotherLode Gold Mines
Consolidated (gold mining) and Vacu-Dry Co. (food processing).
Harris J. Ashton (67)
191 Clapboard Ridge Road, Greenwich, CT 06830
TRUSTEE
Director, RBC Holdings, Inc. (bank holding company) and Bar-S Foods (meat
packing company); director or trustee, as the case may be, of 48 of the
investment companies in the Franklin Templeton Group of Funds; and FORMERLY,
President, Chief Executive Officer and Chairman of the Board, General Host
Corporation (nursery and craft centers).
S. Joseph Fortunato (66)
Park Avenue at Morris County, P.O. Box 1945
Morristown, NJ 07962-1945
TRUSTEE
Member of the law firm of Pitney, Hardin, Kipp & Szuch; director or trustee, as
the case may be, of 50 of the investment companies in the Franklin Templeton
Group of Funds.
Edith E. Holiday (47)
3239 38th Street, N.W., Washington, DC 20016
TRUSTEE
Director, Amerada Hess Corporation (exploration and refining of natural gas)
(1993-present), Hercules Incorporated (chemicals, fibers and resins)
(1993-present), Beverly Enterprises, Inc. (health care) (1995-present) and H.J.
Heinz Company (processed foods and allied products) (1994-present); director or
trustee, as the case may be, of 24 of the investment companies in the Franklin
Templeton Group of Funds; and FORMERLY, Chairman (1995-1997) and Trustee
(1993-1997), National Child Research Center, Assistant to the President of the
United States and Secretary of the Cabinet (1990-1993), General Counsel to the
United States Treasury Department (1989-1990), and Counselor to the Secretary
and Assistant Secretary for Public Affairs and Public Liaison-United States
Treasury Department (1988-1989).
*Charles B. Johnson (66)
777 Mariners Island Blvd., San Mateo, CA 94404
CHAIRMAN OF THE BOARD AND TRUSTEE
President, Chief Executive Officer and Director, Franklin Resources, Inc.;
Chairman of the Board and Director, Franklin Advisers, Inc., Franklin
Investment Advisory Services, Inc. and Franklin Templeton Distributors, Inc.;
Director, Franklin/Templeton Investor Services, Inc. and Franklin Templeton
Services, Inc.; officer and/or director or trustee, as the case may be, of
most of the other subsidiaries of Franklin Resources, Inc. and of 49 of the
investment companies in the Franklin Templeton Group of Funds.
*Rupert H. Johnson, Jr. (58)
777 Mariners Island Blvd., San Mateo, CA 94404
PRESIDENT AND TRUSTEE
Executive Vice President and Director, Franklin Resources, Inc. and Franklin
Templeton Distributors, Inc.; President and Director, Franklin Advisers, Inc.
and Franklin Investment Advisory Services, Inc.; Senior Vice President, Franklin
Advisory Services, LLC; Director, Franklin/Templeton Investor Services, Inc.;
and officer and/or director or trustee, as the case may be, of most of the other
subsidiaries of Franklin Resources, Inc. and of 52 of the investment companies
in the Franklin Templeton Group of Funds.
Frank W.T. LaHaye (70)
20833 Stevens Creek Blvd., Suite 102, Cupertino, CA 95014
TRUSTEE
General Partner, Miller & LaHaye, which is the General Partner of Peregrine
Ventures II (venture capital firm); director or trustee, as the case may be, of
27 of the investment companies in the Franklin Templeton Group of Funds; and
FORMERLY, Director, Fischer Imaging Corporation (medical imaging systems),
Digital Transmission Systems, Inc. (wireless communications) and Quarterdeck
Corporation (software firm), and General Partner, Peregrine Associates, which
was the General Partner of Peregrine Ventures (venture capital firm).
Gordon S. Macklin (71)
8212 Burning Tree Road, Bethesda, MD 20817
TRUSTEE
Director, Fund American Enterprises Holdings, Inc. (holding company), Martek
Biosciences Corporation, MCI WorldCom (information services), MedImmune, Inc.
(biotechnology), Spacehab, Inc. (aerospace services) and Real 3D (software);
director or trustee, as the case may be, of 48 of the investment companies in
the Franklin Templeton Group of Funds; and FORMERLY, Chairman, White River
Corporation (financial services) and Hambrecht and Quist Group (investment
banking), and President, National Association of Securities Dealers, Inc.
Harmon E. Burns (54)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT
Executive Vice President and Director, Franklin Resources, Inc., Franklin
Templeton Distributors, Inc. and Franklin Templeton Services, Inc.; Executive
Vice President, Franklin Advisers, Inc.; Director, Franklin Investment
Advisory Services, Inc. and Franklin/Templeton Investor Services, Inc.; and
officer and/or director or trustee, as the case may be, of most of the other
subsidiaries of Franklin Resources, Inc. and of 52 of the investment
companies in the Franklin Templeton Group of Funds.
Martin L. Flanagan (39)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
Senior Vice President and Chief Financial Officer, Franklin Resources, Inc.,
Franklin/Templeton Investor Services, Inc. and Franklin Mutual Advisers, LLC;
Executive Vice President, Chief Financial Officer and Director, Templeton
Worldwide, Inc.; Executive Vice President, Chief Operating Officer and Director,
Templeton Investment Counsel, Inc.; Executive Vice President and Chief Financial
Officer, Franklin Advisers, Inc.; Chief Financial Officer, Franklin Advisory
Services, LLC and Franklin Investment Advisory Services, Inc.; President and
Director, Franklin Templeton Services, Inc.; officer and/or director of some of
the other subsidiaries of Franklin Resources, Inc.; and officer and/or director
or trustee, as the case may be, of 52 of the investment companies in the
Franklin Templeton Group of Funds.
Deborah R. Gatzek (50)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND SECRETARY
Senior Vice President and General Counsel, Franklin Resources, Inc.; Senior Vice
President, Franklin Templeton Services, Inc. and Franklin Templeton
Distributors, Inc.; Executive Vice President, Franklin Advisers, Inc.; Vice
President, Franklin Advisory Services, LLC and Franklin Mutual Advisers, LLC;
Vice President, Chief Legal Officer and Chief Operating Officer, Franklin
Investment Advisory Services, Inc.; and officer of 53 of the investment
companies in the Franklin Templeton Group of Funds.
Thomas J. Kenny (36)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT
Executive Vice President, Franklin Advisers, Inc.; and officer of eight of the
investment companies in the Franklin Templeton Group of Funds.
Diomedes Loo-Tam (60)
777 Mariners Island Blvd., San Mateo, CA 94404
TREASURER AND PRINCIPAL ACCOUNTING OFFICER
Senior Vice President, Franklin Templeton Services, Inc.; and officer of 32 of
the investment companies in the Franklin Templeton Group of Funds.
Edward V. McVey (61)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT
Senior Vice President and National Sales Manager, Franklin Templeton
Distributors, Inc.; and officer of 28 of the investment companies in the
Franklin Templeton Group of Funds.
*This board member is considered an "interested person" under federal securities
laws.
Note: Charles B. Johnson and Rupert H. Johnson, Jr. are brothers
The trust pays noninterested board members $1,450 per month plus $1,300 per
meeting attended. Board members who serve on the audit committee of the trust
and other funds in the Franklin Templeton Group of Funds receive a flat fee of
$2,000 per committee meeting attended, a portion of which is allocated to the
trust. Members of a committee are not compensated for any committee meeting held
on the day of a board meeting. Noninterested board members also may serve as
directors or trustees of other funds in the Franklin Templeton Group of Funds
and may receive fees from these funds for their services. The fees payable to
noninterested board members by the trust are subject to reductions resulting
from fee caps limiting the amount of fees payable to board members who serve on
other boards within the Franklin Templeton Group of Funds. The following table
provides the total fees paid to noninterested board members by the trust and by
the Franklin Templeton Group of Funds.
NUMBER OF BOARDS IN
TOTAL FEES THE FRANKLIN
TOTAL FEES RECEIVED FROM THE TEMPLETON GROUP
NAME RECEIVED FROM THE FRANKLIN TEMPLETON OF FUNDS ON WHICH
TRUST($)1 GROUP OF FUNDS($)2 EACH SERVES 3
- -------------------------------------------------------------------------------
Frank H. Abbott, III 25,675 159,051 27
Harris J. Ashton 26,390 361,157 48
S. Joseph Fortunato 25,097 367,835 50
Edith E. Holiday 28,650 211,400 24
Frank W.T. LaHaye 26,975 163,753 27
Gordon S. Macklin 26,390 361,157 48
1. For the fiscal year ended February 28, 1999. During the period from March 1,
1998, through May 31, 1998, fees at the rate of $1,300 per month plus $1,300 per
board meeting attended were in effect.
2. For the calendar year ended December 31, 1998.
3. We base the number of boards on the number of registered investment
companies in the Franklin Templeton Group of Funds. This number does not include
the total number of series or funds within each investment company for which the
board members are responsible. The Franklin Templeton Group of Funds currently
includes 54 registered investment companies, with approximately 163 U.S. based
funds or series.
Noninterested board members are reimbursed for expenses incurred in connection
with attending board meetings, paid pro rata by each fund in the Franklin
Templeton Group of Funds for which they serve as director or trustee. No officer
or board member received any other compensation, including pension or retirement
benefits, directly or indirectly from the fund or other funds in the Franklin
Templeton Group of Funds. Certain officers or board members who are shareholders
of Franklin Resources, Inc. may be deemed to receive indirect remuneration by
virtue of their participation, if any, in the fees paid to its subsidiaries.
Board members historically have followed a policy of having substantial
investments in one or more of the funds in the Franklin Templeton Group of
Funds, as is consistent with their individual financial goals. In February 1998,
this policy was formalized through adoption of a requirement that each board
member invest one-third of fees received for serving as a director or trustee of
a Templeton fund in shares of one or more Templeton funds and one-third of fees
received for serving as a director or trustee of a Franklin fund in shares of
one or more Franklin funds until the value of such investments equals or exceeds
five times the annual fees paid such board member. Investments in the name of
family members or entities controlled by a board member constitute fund holdings
of such board member for purposes of this policy, and a three year phase-in
period applies to such investment requirements for newly elected board members.
In implementing such policy, a board member's fund holdings existing on February
27, 1998, are valued as of such date with subsequent investments valued at cost.
MANAGEMENT AND OTHER SERVICES
MANAGER AND SERVICES PROVIDED Each fund's manager is Franklin Advisers, Inc.
The manager is a wholly owned subsidiary of Franklin Resources, Inc.
(Resources), a publicly owned company engaged in the financial services
industry through its subsidiaries. Charles B. Johnson and Rupert H. Johnson,
Jr. are the principal shareholders of Resources.
The manager provides investment research and portfolio management services, and
selects the securities for each fund to buy, hold or sell. The manager's
extensive research activities include, as appropriate, traveling to meet with
issuers and to review project sites. The manager also selects the brokers who
execute the funds' portfolio transactions. The manager provides periodic reports
to the board, which reviews and supervises the manager's investment activities.
To protect the funds, the manager and its officers, directors and employees are
covered by fidelity insurance.
The manager and its affiliates manage numerous other investment companies and
accounts. The manager may give advice and take action with respect to any of the
other funds it manages, or for its own account, that may differ from action
taken by the manager on behalf of each fund. Similarly, with respect to each
fund, the manager is not obligated to recommend, buy or sell, or to refrain from
recommending, buying or selling any security that the manager and access
persons, as defined by applicable federal securities laws, may buy or sell for
its or their own account or for the accounts of any other fund. The manager is
not obligated to refrain from investing in securities held by the funds or other
funds it manages. Of course, any transactions for the accounts of the manager
and other access persons will be made in compliance with the funds' code of
ethics.
Under the funds' code of ethics, employees of the Franklin Templeton Group who
are access persons may engage in personal securities transactions subject to the
following general restrictions and procedures: (i) the trade must receive
advance clearance from a compliance officer and must be completed by the close
of the business day following the day clearance is granted; (ii) copies of all
brokerage confirmations and statements must be sent to a compliance officer;
(iii) all brokerage accounts must be disclosed on an annual basis; and (iv)
access persons involved in preparing and making investment decisions must, in
addition to (i), (ii) and (iii) above, file annual reports of their securities
holdings each January and inform the compliance officer (or other designated
personnel) if they own a security that is being considered for a fund or other
client transaction or if they are recommending a security in which they have an
ownership interest for purchase or sale by a fund or other client.
MANAGEMENT FEES Each fund pays the manager a fee equal to a monthly rate of:
o 5/96 of 1% of the value of its net assets up to and including $100 million;
and
o 1/24 of 1% of the value of its net assets over $100 million up to and
including $250 million; and
o 9/240 of 1% of the value of its net assets in excess of $250 million.
The fee is computed at the close of business on the last business day of each
month according to the terms of the management agreement. Each class of a fund's
shares pays its proportionate share of the fee.
For the last three fiscal years ended February 28, the funds paid the following
management fees:
MANAGEMENT FEES PAID ($)
1999 1998 1997
- ------------------------------------------------------------------
Arizona Fund 1 129,625 53,600 9,209
Florida Fund 2 279,543 164,237 126,611
Insured Fund 8,186,468 7,894,099 7,848,890
Massachusetts Fund 1,842,232 1,792,766 1,649,833
Michigan Fund 5,623,372 5,414,427 5,284,581
Minnesota Fund 2,591,321 2,465,946 2,439,817
Ohio Fund 3,822,228 3,586,169 3,391,314
1. For the fiscal years ended February 28, 1999, 1998 and 1997, management fees,
before any advance waiver, totaled $444,848, $300,020 and $238,269,
respectively. Under an agreement by the manager to limit its fees, the fund paid
the management fees shown.
2. For the fiscal years ended February 28, 1999, 1998 and 1997, management fees,
before any advance waiver, totaled $697,080, $559,377 and $447,534,
respectively. Under an agreement the manager to limit its fees, the fund paid
the management fees shown.
ADMINISTRATOR AND SERVICES PROVIDED Franklin Templeton Services, Inc. (FT
Services) has an agreement with the manager to provide certain administrative
services and facilities for each fund. FT Services is wholly owned by Resources
and is an affiliate of the funds' manager and principal underwriter.
The administrative services FT Services provides include preparing and
maintaining books, records, and tax and financial reports, and monitoring
compliance with regulatory requirements.
ADMINISTRATION FEES The manager pays FT Services a monthly fee equal to an
annual rate of:
o 0.15% of each fund's average daily net assets up to $200 million;
o 0.135% of average daily net assets over $200 million up to $700 million;
o 0.10% of average daily net assets over $700 million up to $1.2 billion; and
o 0.075% of average daily net assets over $1.2 billion.
During the last three fiscal years ended February 28, the manager paid FT
Services the following administration fees:
ADMINISTRATION FEES PAID ($)
1999 1998 1997 1
- ------------------------------------------------------------
Arizona Fund 101,043 70,517 23,726
Florida Fund 169,903 132,554 46,588
Insured Fund 1,895,252 1,847,411 767,504
Massachusetts Fund 506,241 492,589 190,575
Michigan Fund 1,465,757 1,420,284 584,545
Minnesota Fund 730,139 693,518 286,923
Ohio Fund 1,066,391 1,013,556 410,345
1. For the period from October 1, 1996, through February 28, 1997.
SHAREHOLDER SERVICING AND TRANSFER AGENT Franklin/Templeton Investor Services,
Inc. (Investor Services) is each fund's shareholder servicing agent and acts as
the fund's transfer agent and dividend-paying agent. Investor Services is
located at 777 Mariners Island Blvd., San Mateo, CA 94404. Please send all
correspondence to Investor Services to P.O. Box 997151, Sacramento, CA
95899-9983.
For its services, Investor Services receives a fixed fee per account. Each fund
also will reimburse Investor Services for certain out-of-pocket expenses, which
may include payments by Investor Services to entities, including affiliated
entities, that provide sub-shareholder services, recordkeeping and/or transfer
agency services to beneficial owners of the fund. The amount of reimbursements
for these services per benefit plan participant fund account per year will not
exceed the per account fee payable by a fund to Investor Services in connection
with maintaining shareholder accounts.
CUSTODIAN Bank of New York, Mutual Funds Division, 90 Washington Street, New
York, NY 10286, acts as custodian of each fund's securities and other assets.
AUDITOR PricewaterhouseCoopers LLP, 333 Market Street, San Francisco, CA 94105,
is the funds' independent auditor. The auditor gives an opinion on the financial
statements included in the trust's Annual Report to Shareholders and reviews the
trust's registration statement filed with the U.S. Securities and Exchange
Commission (SEC).
PORTFOLIO TRANSACTIONS
Since most purchases by the funds are principal transactions at net prices, the
funds incur little or no brokerage costs. Each fund deals directly with the
selling or buying principal or market maker without incurring charges for the
services of a broker on its behalf, unless it is determined that a better price
or execution may be obtained by using the services of a broker. Purchases of
portfolio securities from underwriters will include a commission or concession
paid by the issuer to the underwriter, and purchases from dealers will include a
spread between the bid and ask prices. As a general rule, the funds do not buy
securities in underwritings where they are given no choice, or only limited
choice, in the designation of dealers to receive the commission. The funds seek
to obtain prompt execution of orders at the most favorable net price.
Transactions may be directed to dealers in return for research and statistical
information, as well as for special services provided by the dealers in the
execution of orders.
It is not possible to place a dollar value on the special executions or on the
research services the manager receives from dealers effecting transactions in
portfolio securities. The allocation of transactions in order to obtain
additional research services allows the manager to supplement its own research
and analysis activities and to receive the views and information of individuals
and research staffs of other securities firms. As long as it is lawful and
appropriate to do so, the manager and its affiliates may use this research and
data in their investment advisory capacities with other clients. If the funds'
officers are satisfied that the best execution is obtained, the sale of fund
shares, as well as shares of other funds in the Franklin Templeton Group of
Funds, also may be considered a factor in the selection of broker-dealers to
execute the funds' portfolio transactions.
If purchases or sales of securities of the funds and one or more other
investment companies or clients supervised by the manager are considered at or
about the same time, transactions in these securities will be allocated among
the several investment companies and clients in a manner deemed equitable to all
by the manager, taking into account the respective sizes of the funds and the
amount of securities to be purchased or sold. In some cases this procedure could
have a detrimental effect on the price or volume of the security so far as the
funds are concerned. In other cases it is possible that the ability to
participate in volume transactions may improve execution and reduce transaction
costs to the funds.
During the fiscal years ended February 28, 1999, 1998 and 1997, the funds did
not pay any brokerage commissions.
As of February 28, 1999, the funds did not own securities of their regular
broker-dealers.
DISTRIBUTIONS AND TAXES
The funds calculate dividends and capital gains the same way for each class. The
amount of any income dividends per share will differ, however, generally due to
the difference in the distribution and service (Rule 12b-1) fees of each class.
The funds do not pay "interest" or guarantee any fixed rate of return on an
investment in their shares.
DISTRIBUTIONS OF NET INVESTMENT INCOME Each fund receives income generally in
the form of interest on its investments. This income, less expenses incurred in
the operation of the fund, constitutes the fund's net investment income from
which dividends may be paid to you.
By meeting certain requirements of the Internal Revenue Code, the funds have
qualified and continue to qualify to pay exempt-interest dividends to you. These
dividends are derived from interest income exempt from regular federal income
tax, and are not subject to regular federal income tax when they are distributed
to you. In addition, to the extent that exempt-interest dividends are derived
from interest on obligations of a state or its political subdivisions, or from
interest on qualifying U.S. territorial obligations (including qualifying
obligations of Puerto Rico, the U.S. Virgin Islands or Guam), they also will be
exempt from that state's personal income taxes. Most states generally do not
grant tax-free treatment to interest on state and municipal securities of other
states.
The funds may earn taxable income on any temporary investments, on the discount
from stripped obligations or their coupons, on income from securities loans or
other taxable transactions, or on ordinary income derived from the sale of
market discount bonds. Any fund distributions from such income will be taxable
to you as ordinary income, whether you receive them in cash or in additional
shares.
DISTRIBUTIONS OF CAPITAL GAINS The funds may derive capital gains and losses in
connection with sales or other dispositions of their portfolio securities.
Distributions from net short-term capital gains will be taxable to you as
ordinary income. Distributions from net long-term capital gains will be taxable
to you as long-term capital gain, regardless of how long you have held your
shares in a fund. Any net capital gains realized by a fund generally will be
distributed once each year, and may be distributed more frequently, if
necessary, in order to reduce or eliminate excise or income taxes on the fund.
INFORMATION ON THE TAX CHARACTER OF DISTRIBUTIONS The funds will inform you of
the amount of your ordinary income dividends and capital gains distributions at
the time they are paid, and will advise you of their tax status for federal
income tax purposes shortly after the close of each calendar year, including the
portion of the distributions that on average comprise taxable income or interest
income that is a tax preference item under the alternative minimum tax. If you
have not held fund shares for a full year, a fund may designate and distribute
to you, as taxable, tax-exempt or tax preference income, a percentage of income
that is not equal to the actual amount of such income earned during the period
of your investment in the fund.
ELECTION TO BE TAXED AS A REGULATED INVESTMENT COMPANY Each fund has elected to
be treated as a regulated investment company under Subchapter M of the Internal
Revenue Code, has qualified as such for its most recent fiscal year, and intends
to so qualify during the current fiscal year. As regulated investment companies,
the funds generally pay no federal income tax on the income and gains they
distribute to you. The board reserves the right not to maintain the
qualification of a fund as a regulated investment company if it determines such
course of action to be beneficial to shareholders. In such case, a fund will be
subject to federal, and possibly state, corporate taxes on its taxable income
and gains, and distributions to you will be taxed as ordinary dividend income to
the extent of the fund's earnings and profits.
EXCISE TAX DISTRIBUTION REQUIREMENTS To avoid federal excise taxes, the Internal
Revenue Code requires each fund to distribute to you by December 31 of each
year, at a minimum, the following amounts: 98% of its taxable ordinary income
earned during the calendar year; 98% of its capital gain net income earned
during the twelve month period ending October 31; and 100% of any undistributed
amounts from the prior year. Each fund intends to declare and pay these amounts
in December (or in January that are treated by you as received in December) to
avoid these excise taxes, but can give no assurances that its distributions will
be sufficient to eliminate all taxes.
REDEMPTION OF FUND SHARES Redemptions and exchanges of fund shares are taxable
transactions for federal and state income tax purposes. If you redeem your fund
shares, or exchange your fund shares for shares of a different Franklin
Templeton Fund, the IRS will require that you report a gain or loss on your
redemption or exchange. If you hold your shares as a capital asset, the gain or
loss that you realize will be capital gain or loss and will be long-term or
short-term, generally depending on how long you hold your shares. Any loss
incurred on the redemption or exchange of shares held for six months or less
will be disallowed to the extent of any exempt-interest dividends distributed to
you with respect to your fund shares and any remaining loss will be treated as a
long-term capital loss to the extent of any long-term capital gains distributed
to you by the fund on those shares.
All or a portion of any loss that you realize upon the redemption of your fund
shares will be disallowed to the extent that you buy other shares in the fund
(through reinvestment of dividends or otherwise) within 30 days before or after
your share redemption. Any loss disallowed under these rules will be added to
your tax basis in the new shares you buy.
DEFERRAL OF BASIS If you redeem some or all of your shares in a fund, and then
reinvest the sales proceeds in the fund or in another Franklin Templeton Fund
within 90 days of buying the original shares, the sales charge that would
otherwise apply to your reinvestment may be reduced or eliminated. The IRS will
require you to report gain or loss on the redemption of your original shares in
a fund. In doing so, all or a portion of the sales charge that you paid for your
original shares in a fund will be excluded from your tax basis in the shares
sold (for the purpose of determining gain or loss upon the sale of such shares).
The portion of the sales charge excluded will equal the amount that the sales
charge is reduced on your reinvestment. Any portion of the sales charge excluded
from your tax basis in the shares sold will be added to the tax basis of the
shares you acquire from your reinvestment.
DIVIDENDS-RECEIVED DEDUCTION FOR CORPORATIONS Because each fund's income
consists of interest rather than dividends, no portion of its distributions
generally will be eligible for the corporate dividends-received deduction. None
of the dividends paid by the funds for the most recent fiscal year qualified for
such deduction, and it is anticipated that none of the current year's dividends
will so qualify.
INVESTMENT IN COMPLEX SECURITIES Each fund may invest in complex securities.
These investments may be subject to numerous special and complex tax rules.
These rules could affect whether gains and losses recognized by a fund are
treated as ordinary income or capital gain, accelerate the recognition of income
to a fund and/or defer a fund's ability to recognize losses. In turn, these
rules may affect the amount, timing or character of the income distributed to
you by a fund.
TREATMENT OF PRIVATE ACTIVITY BOND INTEREST Interest on certain private activity
bonds, while still exempt from regular federal income tax, is a preference item
for taxpayers when determining their alternative minimum tax under the Internal
Revenue Code and under the income tax provisions of several states. Private
activity bond interest could subject you to or increase your liability under
federal and state alternative minimum taxes, depending on your individual or
corporate tax position. Persons who are defined in the Internal Revenue Code as
substantial users (or persons related to such users) of facilities financed by
private activity bonds should consult with their tax advisors before buying fund
shares.
ORGANIZATION, VOTING RIGHTS AND PRINCIPAL HOLDERS
Each fund is a series of Franklin Tax-Free Trust, an open-end management
investment company, commonly called a mutual fund. The trust was organized as a
Massachusetts business trust in September 1984, and is registered with the SEC.
As a shareholder of a Massachusetts business trust, you could, under certain
circumstances, be held personally liable as a partner for its obligations. The
Agreement and Declaration of Trust, however, contains an express disclaimer of
shareholder liability for acts or obligations of the fund. The Declaration of
Trust also provides for indemnification and reimbursement of expenses out of the
fund's assets if you are held personally liable for obligations of the fund. The
Declaration of Trust provides that each fund shall, upon request, assume the
defense of any claim made against you for any act or obligation of the fund and
satisfy any judgment thereon. All such rights are limited to the assets of the
fund. The Declaration of Trust further provides that the fund may maintain
appropriate insurance (for example, fidelity bonding and errors and omissions
insurance) for the protection of the fund, its shareholders, trustees, officers,
employees and agents to cover possible tort and other liabilities. Furthermore,
the activities of the fund as an investment company, as distinguished from an
operating company, would not likely give rise to liabilities in excess of the
fund's total assets. Thus, the risk that you would incur financial loss on
account of shareholder liability is limited to the unlikely circumstance in
which both inadequate insurance exists and the fund itself is unable to meet its
obligations.
Each fund, except the Arizona and Florida Funds, currently offers two classes of
shares, Class A and Class C. Before January 1, 1999, Class A shares were
designated Class I and Class C shares were designated Class II. The full title
of each class is:
o Franklin Insured Tax-Free Income Fund - Class A
o Franklin Insured Tax-Free Income Fund - Class C
o Franklin Massachusetts Insured Tax-Free Income Fund - Class A
o Franklin Massachusetts Insured Tax-Free Income Fund - Class C
o Franklin Michigan Insured Tax-Free Income Fund - Class A
o Franklin Michigan Insured Tax-Free Income Fund - Class C
o Franklin Minnesota Insured Tax-Free Income Fund - Class A
o Franklin Minnesota Insured Tax-Free Income Fund - Class C
o Franklin Ohio Insured Tax-Free Income Fund - Class A
o Franklin Ohio Insured Tax-Free Income Fund - Class C
The Arizona and Florida Funds each offer only one share class. Because their
sales charge structures and Rule 12b-1 plans are similar to those of Class A
shares, shares of the Arizona and Florida Funds are considered Class A shares
for redemption, exchange and other purposes.
The funds may offer additional classes of shares in the future.
Shares of each class represent proportionate interests in the fund's assets. On
matters that affect the fund as a whole, each class has the same voting and
other rights and preferences as any other class. On matters that affect only one
class, only shareholders of that class may vote. Each class votes separately on
matters affecting only that class, or expressly required to be voted on
separately by state or federal law. Shares of each class of a series have the
same voting and other rights and preferences as the other classes and series of
the trust for matters that affect the trust as a whole.
Additional series may be offered in the future.
The trust has noncumulative voting rights. For board member elections, this
gives holders of more than 50% of the shares voting the ability to elect all of
the members of the board. If this happens, holders of the remaining shares
voting will not be able to elect anyone to the board.
The trust does not intend to hold annual shareholder meetings. The trust or a
series of the trust may hold special meetings, however, for matters requiring
shareholder approval. A meeting may be called by the board to consider the
removal of a board member if requested in writing by shareholders holding at
least 10% of the outstanding shares. In certain circumstances, we are required
to help you communicate with other shareholders about the removal of a board
member. A special meeting also may be called by the board in its discretion.
From time to time, the number of fund shares held in the "street name" accounts
of various securities dealers for the benefit of their clients or in centralized
securities depositories may exceed 5% of the total shares outstanding. To the
best knowledge of the fund, no other person holds beneficially or of record more
than 5% of the outstanding shares of any class.
As of April 12, 1999, the officers and board members, as a group, owned of
record and beneficially less than 1% of the outstanding shares of each fund and
class. The board members may own shares in other funds in the Franklin Templeton
Group of Funds.
BUYING AND SELLING SHARES
The fund continuously offers its shares through securities dealers who have an
agreement with Franklin Templeton Distributors, Inc. (Distributors). A
securities dealer includes any financial institution that, either directly or
through affiliates, has an agreement with Distributors to handle customer orders
and accounts with the fund. This reference is for convenience only and does not
indicate a legal conclusion of capacity. Banks and financial institutions that
sell shares of the fund may be required by state law to register as securities
dealers.
For investors outside the U.S., the offering of fund shares may be limited in
many jurisdictions. An investor who wishes to buy shares of the fund should
determine, or have a broker-dealer determine, the applicable laws and
regulations of the relevant jurisdiction. Investors are responsible for
compliance with tax, currency exchange or other regulations applicable to
redemption and purchase transactions in any jurisdiction to which they may be
subject. Investors should consult appropriate tax and legal advisors to obtain
information on the rules applicable to these transactions.
All checks, drafts, wires and other payment mediums used to buy or sell shares
of the fund must be denominated in U.S. dollars. We may, in our sole discretion,
either (a) reject any order to buy or sell shares denominated in any other
currency or (b) honor the transaction or make adjustments to your account for
the transaction as of a date and with a foreign currency exchange factor
determined by the drawee bank.
When you buy shares, if you submit a check or a draft that is returned unpaid to
the fund we may impose a $10 charge against your account for each returned item.
INITIAL SALES CHARGES The maximum initial sales charge is 4.25% for Class A and
1% for Class C.
The initial sales charge for Class A shares may be reduced for certain large
purchases, as described in the prospectus. We offer several ways for you to
combine your purchases in the Franklin Templeton Funds to take advantage of the
lower sales charges for large purchases. The Franklin Templeton Funds include
the U.S. registered mutual funds in the Franklin Group of Funds(R) and the
Templeton Group of Funds except Franklin Valuemark Funds, Templeton Capital
Accumulator Fund, Inc., and Templeton Variable Products Series Fund.
CUMULATIVE QUANTITY DISCOUNT. For purposes of calculating the sales charge on
Class A shares, you may combine the amount of your current purchase with the
cost or current value, whichever is higher, of your existing shares in the
Franklin Templeton Funds. You also may combine the shares of your spouse,
children under the age of 21 or grandchildren under the age of 21. If you are
the sole owner of a company, you also may add any company accounts, including
retirement plan accounts.
LETTER OF INTENT (LOI). You may buy Class A shares at a reduced sales charge by
completing the letter of intent section of your account application. A letter of
intent is a commitment by you to invest a specified dollar amount during a 13
month period. The amount you agree to invest determines the sales charge you
pay. By completing the letter of intent section of the application, you
acknowledge and agree to the following:
o You authorize Distributors to reserve 5% of your total intended purchase in
Class A shares registered in your name until you fulfill your LOI. Your
periodic statements will include the reserved shares in the total shares you
own, and we will pay or reinvest dividend and capital gain distributions on
the reserved shares according to the distribution option you have chosen.
o You give Distributors a security interest in the reserved shares and appoint
Distributors as attorney-in-fact.
o Distributors may sell any or all of the reserved shares to cover any
additional sales charge if you do not fulfill the terms of the LOI.
o Although you may exchange your shares, you may not sell reserved shares until
you complete the LOI or pay the higher sales charge.
After you file your LOI with a fund, you may buy Class A shares at the sales
charge applicable to the amount specified in your LOI. Sales charge reductions
based on purchases in more than one Franklin Templeton Fund will be effective
only after notification to Distributors that the investment qualifies for a
discount. Any Class A purchases you made within 90 days before you filed your
LOI also may qualify for a retroactive reduction in the sales charge. If you
file your LOI with the fund before a change in the fund's sales charge, you may
complete the LOI at the lower of the new sales charge or the sales charge in
effect when the LOI was filed.
Your holdings in the Franklin Templeton Funds acquired more than 90 days before
you filed your LOI will be counted towards the completion of the LOI, but they
will not be entitled to a retroactive reduction in the sales charge. Any
redemptions you make during the 13 month period will be subtracted from the
amount of the purchases for purposes of determining whether the terms of the LOI
have been completed.
If the terms of your LOI are met, the reserved shares will be deposited to an
account in your name or delivered to you or as you direct. If the amount of your
total purchases, less redemptions, is more than the amount specified in your LOI
and is an amount that would qualify for a further sales charge reduction, a
retroactive price adjustment will be made by Distributors and the securities
dealer through whom purchases were made. The price adjustment will be made on
purchases made within 90 days before and on those made after you filed your LOI
and will be applied towards the purchase of additional shares at the offering
price applicable to a single purchase or the dollar amount of the total
purchases.
If the amount of your total purchases, less redemptions, is less than the amount
specified in your LOI, the sales charge will be adjusted upward, depending on
the actual amount purchased (less redemptions) during the period. You will need
to send Distributors an amount equal to the difference in the actual dollar
amount of sales charge paid and the amount of sales charge that would have
applied to the total purchases if the total of the purchases had been made at
one time. Upon payment of this amount, the reserved shares held for your account
will be deposited to an account in your name or delivered to you or as you
direct. If within 20 days after written request the difference in sales charge
is not paid, we will redeem an appropriate number of reserved shares to realize
the difference. If you redeem the total amount in your account before you
fulfill your LOI, we will deduct the additional sales charge due from the sale
proceeds and forward the balance to you.
GROUP PURCHASES. If you are a member of a qualified group, you may buy Class A
shares at a reduced sales charge that applies to the group as a whole. The sales
charge is based on the combined dollar value of the group members' existing
investments, plus the amount of the current purchase.
A qualified group is one that:
o Was formed at least six months ago,
o Has a purpose other than buying fund shares at a discount,
o Has more than 10 members,
o Can arrange for meetings between our representatives and group members,
o Agrees to include Franklin Templeton Fund sales and other materials in
publications and mailings to its members at reduced or no cost to
Distributors,
o Agrees to arrange for payroll deduction or other bulk transmission of
investments to the fund, and
o Meets other uniform criteria that allow Distributors to achieve cost savings
in distributing shares.
WAIVERS FOR INVESTMENTS FROM CERTAIN PAYMENTS. Class A shares may be purchased
without an initial sales charge or contingent deferred sales charge (CDSC) by
investors who reinvest within 365 days:
o Dividend and capital gain distributions from any Franklin Templeton Fund. The
distributions generally must be reinvested in the same share class. Certain
exceptions apply, however, to Class C shareholders who chose to reinvest
their distributions in Class A shares of the fund before November 17, 1997,
and to Advisor Class or Class Z shareholders of a Franklin Templeton Fund who
may reinvest their distributions in the fund's Class A shares. This waiver
category also applies to Class C shares.
o Dividend or capital gain distributions from a real estate investment trust
(REIT) sponsored or advised by Franklin Properties, Inc.
o Annuity payments received under either an annuity option or from death
benefit proceeds, if the annuity contract offers as an investment option the
Franklin Valuemark Funds or the Templeton Variable Products Series Fund. You
should contact your tax advisor for information on any tax consequences that
may apply.
o Redemption proceeds from a repurchase of shares of Franklin Floating Rate
Trust, if the shares were continuously held for at least 12 months.
If you immediately placed your redemption proceeds in a Franklin Bank CD or a
Franklin Templeton money fund, you may reinvest them as described above. The
proceeds must be reinvested within 365 days from the date the CD matures,
including any rollover, or the date you redeem your money fund shares.
o Redemption proceeds from the sale of Class A shares of any of the Templeton
Global Strategy Funds if you are a qualified investor.
If you paid a CDSC when you redeemed your Class A shares from a Templeton
Global Strategy Fund, a new CDSC will apply to your purchase of fund shares
and the CDSC holding period will begin again. We will, however, credit your
fund account with additional shares based on the CDSC you previously paid and
the amount of the redemption proceeds that you reinvest.
If you immediately placed your redemption proceeds in a Franklin Templeton
money fund, you may reinvest them as described above. The proceeds must be
reinvested within 365 days from the date they are redeemed from the money
fund.
WAIVERS FOR CERTAIN INVESTORS. Class A shares also may be purchased without an
initial sales charge or CDSC by various individuals and institutions due to
anticipated economies in sales efforts and expenses, including:
o Trust companies and bank trust departments agreeing to invest in Franklin
Templeton Funds over a 13 month period at least $1 million of assets held in
a fiduciary, agency, advisory, custodial or similar capacity and over which
the trust companies and bank trust departments or other plan fiduciaries or
participants, in the case of certain retirement plans, have full or shared
investment discretion. We will accept orders for these accounts by mail
accompanied by a check or by telephone or other means of electronic data
transfer directly from the bank or trust company, with payment by federal
funds received by the close of business on the next business day following
the order.
o Any state or local government or any instrumentality, department, authority
or agency thereof that has determined the fund is a legally permissible
investment and that can only buy fund shares without paying sales charges.
Please consult your legal and investment advisors to determine if an
investment in the fund is permissible and suitable for you and the effect, if
any, of payments by the fund on arbitrage rebate calculations.
o Broker-dealers, registered investment advisors or certified financial
planners who have entered into an agreement with Distributors for clients
participating in comprehensive fee programs
o Qualified registered investment advisors who buy through a broker-dealer or
service agent who has entered into an agreement with Distributors
o Registered securities dealers and their affiliates, for their investment
accounts only
o Current employees of securities dealers and their affiliates and their family
members, as allowed by the internal policies of their employer
o Officers, trustees, directors and full-time employees of the Franklin
Templeton Funds or the Franklin Templeton Group, and their family members,
consistent with our then-current policies
o Any investor who is currently a Class Z shareholder of Franklin Mutual Series
Fund Inc. (Mutual Series), or who is a former Mutual Series Class Z
shareholder who had an account in any Mutual Series fund on October 31, 1996,
or who sold his or her shares of Mutual Series Class Z within the past 365
days
o Investment companies exchanging shares or selling assets pursuant to a
merger, acquisition or exchange offer
o Accounts managed by the Franklin Templeton Group
o Certain unit investment trusts and their holders reinvesting distributions
from the trusts
In addition, Class C shares may be purchased without an initial sales charge by
any investor who buys Class C shares through an omnibus account with Merrill
Lynch Pierce Fenner & Smith, Inc. A CDSC may apply, however, if the shares are
sold within 18 months of purchase.
SALES IN TAIWAN. Under agreements with certain banks in Taiwan, Republic of
China, each fund's shares are available to these banks' trust accounts without a
sales charge. The banks may charge service fees to their customers who
participate in the trusts. A portion of these service fees may be paid to
Distributors or one of its affiliates to help defray expenses of maintaining a
service office in Taiwan, including expenses related to local literature
fulfillment and communication facilities.
Each fund's Class A shares may be offered to investors in Taiwan through
securities advisory firms known locally as Securities Investment Consulting
Enterprises. In conformity with local business practices in Taiwan, Class A
shares may be offered with the following schedule of sales charges:
SIZE OF PURCHASE - U.S. DOLLARS SALES CHARGE (%)
- --------------------------------------------------------------
Under $30,000 3.0
$30,000 but less than $100,000 2.0
$100,000 but less than $400,000 1.0
$400,000 or more 0
DEALER COMPENSATION Securities dealers may at times receive the entire sales
charge. A securities dealer who receives 90% or more of the sales charge may be
deemed an underwriter under the Securities Act of 1933, as amended. Financial
institutions or their affiliated brokers may receive an agency transaction fee
in the percentages indicated in the dealer compensation table in the funds'
prospectus.
Distributors may pay the following commissions, out of its own resources, to
securities dealers who initiate and are responsible for purchases of Class A
shares of $1 million or more: 0.75% on sales of $1 million to $2 million, plus
0.60% on sales over $2 million to $3 million, plus 0.50% on sales over $3
million to $50 million, plus 0.25% on sales over $50 million to $100 million,
plus 0.15% on sales over $100 million.
These breakpoints are reset every 12 months for purposes of additional
purchases.
Distributors and/or its affiliates provide financial support to various
securities dealers that sell shares of the Franklin Templeton Group of Funds.
This support is based primarily on the amount of sales of fund shares. The
amount of support may be affected by: total sales; net sales; levels of
redemptions; the proportion of a securities dealer's sales and marketing efforts
in the Franklin Templeton Group of Funds; a securities dealer's support of, and
participation in, Distributors' marketing programs; a securities dealer's
compensation programs for its registered representatives; and the extent of a
securities dealer's marketing programs relating to the Franklin Templeton Group
of Funds. Financial support to securities dealers may be made by payments from
Distributors' resources, from Distributors' retention of underwriting
concessions and, in the case of funds that have Rule 12b-1 plans, from payments
to Distributors under such plans. In addition, certain securities dealers may
receive brokerage commissions generated by fund portfolio transactions in
accordance with the rules of the National Association of Securities Dealers,
Inc.
Distributors routinely sponsors due diligence meetings for registered
representatives during which they receive updates on various Franklin Templeton
Funds and are afforded the opportunity to speak with portfolio managers.
Invitation to these meetings is not conditioned on selling a specific number of
shares. Those who have shown an interest in the Franklin Templeton Funds,
however, are more likely to be considered. To the extent permitted by their
firm's policies and procedures, registered representatives' expenses in
attending these meetings may be covered by Distributors.
CONTINGENT DEFERRED SALES CHARGE (CDSC) If you invest $1 million or more in
Class A shares, either as a lump sum or through our cumulative quantity discount
or letter of intent programs, a CDSC may apply on any shares you sell within 12
months of purchase. For Class C shares, a CDSC may apply if you sell your shares
within 18 months of purchase. The CDSC is 1% of the value of the shares sold or
the net asset value at the time of purchase, whichever is less.
CDSC WAIVERS. The CDSC for any share class generally will be waived for:
o Account fees
o Redemptions of Class A shares by investors who purchased $1 million or more
without an initial sales charge if the securities dealer of record waived its
commission in connection with the purchase
o Redemptions by the fund when an account falls below the minimum required
account size
o Redemptions following the death of the shareholder or beneficial owner
o Redemptions through a systematic withdrawal plan set up before February 1,
1995
o Redemptions through a systematic withdrawal plan set up on or after February
1, 1995, up to 1% monthly, 3% quarterly, 6% semiannually or 12% annually of
your account's net asset value depending on the frequency of your plan
EXCHANGE PRIVILEGE If you request the exchange of the total value of your
account, accrued but unpaid income dividends and capital gain distributions will
be reinvested in the fund at net asset value on the date of the exchange, and
then the entire share balance will be exchanged into the new fund. Backup
withholding and information reporting may apply.
If a substantial number of shareholders should, within a short period, sell
their fund shares under the exchange privilege, the fund might have to sell
portfolio securities it might otherwise hold and incur the additional costs
related to such transactions. On the other hand, increased use of the exchange
privilege may result in periodic large inflows of money. If this occurs, it is
each fund's general policy to initially invest this money in short-term,
tax-exempt municipal securities, unless it is believed that attractive
investment opportunities consistent with the fund's investment goals exist
immediately. This money will then be withdrawn from the short-term, tax-exempt
municipal securities and invested in portfolio securities in as orderly a manner
as is possible when attractive investment opportunities arise.
The proceeds from the sale of shares of an investment company are generally not
available until the seventh day following the sale. The funds you are seeking to
exchange into may delay issuing shares pursuant to an exchange until that
seventh day. The sale of fund shares to complete an exchange will be effected at
net asset value at the close of business on the day the request for exchange is
received in proper form.
SYSTEMATIC WITHDRAWAL PLAN Our systematic withdrawal plan allows you to sell
your shares and receive regular payments from your account on a monthly,
quarterly, semiannual or annual basis. The value of your account must be at
least $5,000 and the minimum payment amount for each withdrawal must be at least
$50. There are no service charges for establishing or maintaining a systematic
withdrawal plan. Once your plan is established, any distributions paid by the
fund will be automatically reinvested in your account.
Payments under the plan will be made from the redemption of an equivalent amount
of shares in your account, generally on the 25th day of the month in which a
payment is scheduled. If the 25th falls on a weekend or holiday, we will process
the redemption on the next business day. When you sell your shares under a
systematic withdrawal plan, it is a taxable transaction.
To avoid paying sales charges on money you plan to withdraw within a short
period of time, you may not want to set up a systematic withdrawal plan if you
plan to buy shares on a regular basis. Shares sold under the plan also may be
subject to a CDSC.
Redeeming shares through a systematic withdrawal plan may reduce or exhaust the
shares in your account if payments exceed distributions received from the fund.
This is especially likely to occur if there is a market decline. If a withdrawal
amount exceeds the value of your account, your account will be closed and the
remaining balance in your account will be sent to you. Because the amount
withdrawn under the plan may be more than your actual yield or income, part of
the payment may be a return of your investment.
You may discontinue a systematic withdrawal plan, change the amount and schedule
of withdrawal payments, or suspend one payment by notifying us by mail or by
phone at least seven business days before the end of the month preceding a
scheduled payment. The funds may discontinue a systematic withdrawal plan by
notifying you in writing and will automatically discontinue a systematic
withdrawal plan if all shares in your account are withdrawn or if the fund
receives notification of the shareholder's death or incapacity.
REDEMPTIONS IN KIND Each fund has committed itself to pay in cash (by check) all
requests for redemption by any shareholder of record, limited in amount,
however, during any 90-day period to the lesser of $250,000 or 1% of the value
of the fund's net assets at the beginning of the 90-day period. This commitment
is irrevocable without the prior approval of the U.S. Securities and Exchange
Commission (SEC). In the case of redemption requests in excess of these amounts,
the board reserves the right to make payments in whole or in part in securities
or other assets of the fund, in case of an emergency, or if the payment of such
a redemption in cash would be detrimental to the existing shareholders of the
fund. In these circumstances, the securities distributed would be valued at the
price used to compute the fund's net assets and you may incur brokerage fees in
converting the securities to cash. Redemptions in kind are taxable transactions.
The fund does not intend to redeem illiquid securities in kind. If this happens,
however, you may not be able to recover your investment in a timely manner.
SHARE CERTIFICATES We will credit your shares to your fund account. We do not
issue share certificates unless you specifically request them. This eliminates
the costly problem of replacing lost, stolen or destroyed certificates. If a
certificate is lost, stolen or destroyed, you may have to pay an insurance
premium of up to 2% of the value of the certificate to replace it.
Any outstanding share certificates must be returned to the fund if you want to
sell or exchange those shares or if you would like to start a systematic
withdrawal plan. The certificates should be properly endorsed. You can do this
either by signing the back of the certificate or by completing a share
assignment form. For your protection, you may prefer to complete a share
assignment form and to send the certificate and assignment form in separate
envelopes.
GENERAL INFORMATION If dividend checks are returned to the fund marked "unable
to forward" by the postal service, we will consider this a request by you to
change your dividend option to reinvest all distributions. The proceeds will be
reinvested in additional shares at net asset value until we receive new
instructions.
Distribution or redemption checks sent to you do not earn interest or any other
income during the time the checks remain uncashed. Neither the funds nor their
affiliates will be liable for any loss caused by your failure to cash such
checks. The funds are not responsible for tracking down uncashed checks, unless
a check is returned as undeliverable.
In most cases, if mail is returned as undeliverable we are required to take
certain steps to try to find you free of charge. If these attempts are
unsuccessful, however, we may deduct the costs of any additional efforts to find
you from your account. These costs may include a percentage of the account when
a search company charges a percentage fee in exchange for its location services.
The wiring of redemption proceeds is a special service that we make available
whenever possible. By offering this service to you, the funds are not bound to
meet any redemption request in less than the seven day period prescribed by law.
Neither the funds nor their agents shall be liable to you or any other person
if, for any reason, a redemption request by wire is not processed as described
in the prospectus.
Franklin Templeton Investor Services, Inc. (Investor Services) may pay certain
financial institutions that maintain omnibus accounts with the funds on behalf
of numerous beneficial owners for recordkeeping operations performed with
respect to such owners. For each beneficial owner in the omnibus account, the
fund may reimburse Investor Services an amount not to exceed the per account fee
that the fund normally pays Investor Services. These financial institutions also
may charge a fee for their services directly to their clients.
If you buy or sell shares through your securities dealer, we use the net asset
value next calculated after your securities dealer receives your request, which
is promptly transmitted to the fund. If you sell shares through your securities
dealer, it is your dealer's responsibility to transmit the order to the fund in
a timely fashion. Your redemption proceeds will not earn interest between the
time we receive the order from your dealer and the time we receive any required
documents. Any loss to you resulting from your dealer's failure to transmit your
redemption order to the fund in a timely fashion must be settled between you and
your securities dealer.
Certain shareholder servicing agents may be authorized to accept your
transaction request.
For institutional accounts, there may be additional methods of buying or selling
fund shares than those described in this SAI or in the prospectus.
In the event of disputes involving multiple claims of ownership or authority to
control your account, the fund has the right (but has no obligation) to: (a)
freeze the account and require the written agreement of all persons deemed by
the fund to have a potential property interest in the account, before executing
instructions regarding the account; (b) interplead disputed funds or accounts
with a court of competent jurisdiction; or (c) surrender ownership of all or a
portion of the account to the IRS in response to a notice of levy.
PRICING SHARES
When you buy shares, you pay the offering price. The offering price is the net
asset value (NAV) per share plus any applicable sales charge, calculated to two
decimal places using standard rounding criteria. When you sell shares, you
receive the NAV minus any applicable CDSC.
The value of a mutual fund is determined by deducting the fund's liabilities
from the total assets of the portfolio. The net asset value per share is
determined by dividing the net asset value of the fund by the number of shares
outstanding.
Each fund calculates the NAV per share of each class each business day at the
close of trading on the New York Stock Exchange (normally 1:00 p.m. pacific
time). The funds do not calculate the NAV on days the New York Stock Exchange
(NYSE) is closed for trading, which include New Year's Day, Martin Luther King
Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day and Christmas Day.
When determining its NAV, each fund values cash and receivables at their
realizable amounts, and records interest as accrued. Each fund values
over-the-counter portfolio securities within the range of the most recent quoted
bid and ask prices. If portfolio securities trade both in the over-the-counter
market and on a stock exchange, each fund values them according to the broadest
and most representative market as determined by the manager. Municipal
securities generally trade in the over-the-counter market rather than on a
securities exchange. In the absence of a sale or reported bid and ask prices,
information with respect to bond and note transactions, quotations from bond
dealers, market transactions in comparable securities, and various relationships
between securities are used to determine the value of municipal securities.
Generally, trading in U.S. government securities and money market instruments is
substantially completed each day at various times before the close of the NYSE.
The value of these securities used in computing the NAV is determined as of such
times. Occasionally, events affecting the values of these securities may occur
between the times at which they are determined and the close of the NYSE that
will not be reflected in the computation of the NAV. If events materially
affecting the values of these securities occur during this period, the
securities will be valued at their fair value as determined in good faith by the
board.
Other securities for which market quotations are readily available are valued at
the current market price, which may be obtained from a pricing service, based on
a variety of factors including recent trades, institutional size trading in
similar types of securities (considering yield, risk and maturity) and/or
developments related to specific issues. Securities and other assets for which
market prices are not readily available are valued at fair value as determined
following procedures approved by the board. With the approval of the board, the
funds may use a pricing service, bank or securities dealer to perform any of the
above described functions.
THE UNDERWRITER
Franklin Templeton Distributors, Inc. (Distributors) acts as the principal
underwriter in the continuous public offering of each fund's shares.
Distributors is located at 777 Mariners Island Blvd., San Mateo, CA 94404.
Distributors pays the expenses of the distribution of fund shares, including
advertising expenses and the costs of printing sales material and prospectuses
used to offer shares to the public. Each fund pays the expenses of preparing and
printing amendments to its registration statements and prospectuses (other than
those necessitated by the activities of Distributors) and of sending
prospectuses to existing shareholders.
The table below shows the aggregate underwriting commissions Distributors
received in connection with the offering of the funds' shares, the net
underwriting discounts and commissions Distributors retained after allowances to
dealers, and the amounts Distributors received in connection with redemptions or
repurchases of shares for the last three fiscal years ended February 28:
AMOUNT
RECEIVED IN
TOTAL AMOUNT CONNECTION WITH
COMMISSIONS RETAINED BY REDEMPTIONS AND
RECEIVED ($) DISTRIBUTORS ($) REPURCHASES ($)
- ------------------------------------------------------------------------
1999
Arizona Fund 477,674 32,175 0
Florida Fund 610,778 42,251 85
Insured Fund 3,799,368 242,769 38,597
Massachusetts Fund 1,115,229 66,155 24,083
Michigan Fund 2,630,865 163,572 10,821
Minnesota Fund 1,378,166 80,608 6,400
Ohio Fund 2,308,355 146,830 15,696
1998
Arizona Fund 444,372 30,899 0
Florida Fund 643,277 42,185 0
Insured Fund 3,458,998 223,393 9,982
Massachusetts Fund 971,661 60,293 4,495
Michigan Fund 2,762,586 167,731 18,468
Minnesota Fund 1,114,812 67,354 1,216
Ohio Fund 2,325,085 145,477 6,228
1997
Arizona Fund 325,449 20,962 0
Florida Fund 471,751 30,514 0
Insured Fund 3,651,499 232,191 6,263
Massachusetts Fund 996,784 64,688 1,328
Michigan Fund 3,025,658 186,288 7,786
Minnesota Fund 1,061,069 65,580 2,804
Ohio Fund 2,389,162 144,651 9,688
Distributors may be entitled to reimbursement under the Rule 12b-1 plans, as
discussed below. Except as noted, Distributors received no other compensation
from the funds for acting as underwriter.
DISTRIBUTION AND SERVICE (12B-1) fees Each class has a separate distribution or
"Rule 12b-1" plan. Under each plan, the fund shall pay or may reimburse
Distributors or others for the expenses of activities that are primarily
intended to sell shares of the class. These expenses may include, among others,
distribution or service fees paid to securities dealers or others who have
executed a servicing agreement with the fund, Distributors or its affiliates; a
prorated portion of Distributors' overhead expenses; and the expenses of
printing prospectuses and reports used for sales purposes, and preparing and
distributing sales literature and advertisements.
The distribution and service (12b-1) fees charged to each class are based only
on the fees attributable to that particular class.
THE CLASS A PLAN. Payments by the fund under the Class A plan may not exceed
0.15% per year for the Florida and Arizona Funds, and 0.10% per year for the
remaining funds, of Class A's average daily net assets, payable quarterly. All
distribution expenses over this amount will be borne by those who have incurred
them.
In implementing the Class A plan of each fund, except the Arizona and Florida
Funds, the board has determined that the annual fees payable under the plan will
be equal to the sum of: (i) the amount obtained by multiplying 0.10% by the
average daily net assets represented by the fund's Class A shares that were
acquired by investors on or after May 1, 1994, the effective date of the plan
(new assets), and (ii) the amount obtained by multiplying 0.05% by the average
daily net assets represented by the fund's Class A shares that were acquired
before May 1, 1994 (old assets). These fees will be paid to the current
securities dealer of record on the account. In addition, until such time as the
maximum payment of 0.10% is reached on a yearly basis, up to an additional 0.02%
will be paid to Distributors under the plan. When the fund reaches $4 billion is
assets, the amount to be paid to Distributors will be reduced from 0.02% to
0.01%. The payments made to Distributors will be used by Distributors to defray
other marketing expenses that have been incurred in accordance with the plan,
such as advertising.
The fee is a Class A expense. This means that all Class A shareholders,
regardless of when they purchased their shares, will bear Rule 12b-1 expenses at
the same rate. The initial rate will be at least 0.07% (0.05% plus 0.02%) of the
average daily net assets of Class A and, as Class A shares are sold on or after
May 1, 1994, will increase over time. Thus, as the proportion of Class A shares
purchased on or after May 1, 1994, increases in relation to outstanding Class A
shares, the expenses attributable to payments under the plan also will increase
(but will not exceed 0.10% of average daily net assets). While this is the
currently anticipated calculation for fees payable under the Class A plan, the
plan permits the board to allow the fund to pay a full 0.10% on all assets at
any time. The approval of the board would be required to change the calculation
of the payments to be made under the Class A plan.
The Class A plan for each fund, except the Arizona and Florida Funds, does not
permit unreimbursed expenses incurred in a particular year to be carried over to
or reimbursed in later years.
THE CLASS C PLAN. Under the Class C plan, each fund pays Distributors up to
0.50% per year of the class's average daily net assets, payable quarterly, to
pay Distributors or others for providing distribution and related services and
bearing certain expenses. All distribution expenses over this amount will be
borne by those who have incurred them. The fund also may pay a servicing fee of
up to 0.15% per year of the class's average daily net assets, payable quarterly.
This fee may be used to pay securities dealers or others for, among other
things, helping to establish and maintain customer accounts and records, helping
with requests to buy and sell shares, receiving and answering correspondence,
monitoring dividend payments from the fund on behalf of customers, and similar
servicing and account maintenance activities.
The expenses relating to the Class C plan also are used to pay Distributors for
advancing the commission costs to securities dealers with respect to the initial
sale of Class C shares.
THE CLASS A AND C PLANS. In addition to the payments that Distributors or others
are entitled to under each plan, each plan also provides that to the extent the
fund, the manager or Distributors or other parties on behalf of the fund, the
manager or Distributors make payments that are deemed to be for the financing of
any activity primarily intended to result in the sale of fund shares within the
context of Rule 12b-1 under the Investment Company Act of 1940, as amended, then
such payments shall be deemed to have been made pursuant to the plan. The terms
and provisions of each plan relating to required reports, term, and approval are
consistent with Rule 12b-1.
In no event shall the aggregate asset-based sales charges, which include
payments made under each plan, plus any other payments deemed to be made
pursuant to a plan, exceed the amount permitted to be paid under the rules of
the National Association of Securities Dealers, Inc.
To the extent fees are for distribution or marketing functions, as distinguished
from administrative servicing or agency transactions, certain banks will not be
entitled to participate in the plans as a result of applicable federal law
prohibiting certain banks from engaging in the distribution of mutual fund
shares. These banking institutions, however, are permitted to receive fees under
the plans for administrative servicing or for agency transactions. If you are a
customer of a bank that is prohibited from providing these services, you would
be permitted to remain a shareholder of the fund, and alternate means for
continuing the servicing would be sought. In this event, changes in the services
provided might occur and you might no longer be able to avail yourself of any
automatic investment or other services then being provided by the bank. It is
not expected that you would suffer any adverse financial consequences as a
result of any of these changes.
Each plan has been approved in accordance with the provisions of Rule 12b-1. The
plans are renewable annually by a vote of the board, including a majority vote
of the board members who are not interested persons of the fund and who have no
direct or indirect financial interest in the operation of the plans, cast in
person at a meeting called for that purpose. It is also required that the
selection and nomination of such board members be done by the noninterested
members of the fund's board. The plans and any related agreement may be
terminated at any time, without penalty, by vote of a majority of the
noninterested board members on not more than 60 days' written notice, by
Distributors on not more than 60 days' written notice, by any act that
constitutes an assignment of the management agreement with the manager or by
vote of a majority of the outstanding shares of the class. The Arizona and
Florida plans also may be terminated by any act that constitutes an assignment
of the underwriting agreement with Distributors. Distributors or any dealer or
other firm also may terminate their respective distribution or service agreement
at any time upon written notice.
The plans and any related agreements may not be amended to increase materially
the amount to be spent for distribution expenses without approval by a majority
of the outstanding shares of the class, and all material amendments to the plans
or any related agreements shall be approved by a vote of the noninterested board
members, cast in person at a meeting called for the purpose of voting on any
such amendment.
Distributors is required to report in writing to the board at least quarterly on
the amounts and purpose of any payment made under the plans and any related
agreements, as well as to furnish the board with such other information as may
reasonably be requested in order to enable the board to make an informed
determination of whether the plans should be continued.
For the fiscal year ended February 28, 1999, Distributors' eligible expenditures
for advertising, printing, and payments to underwriters and broker-dealers
pursuant to the plans and the amounts the funds paid Distributors under the
plans were:
DISTRIBUTORS' AMOUNT
ELIGIBLE PAID BY
EXPENSES ($) THE FUND ($)
Arizona Fund 125,733 65,600
Florida Fund 199,058 111,406
Insured Fund - Class A 1,677,988 1,462,142
Insured Fund - Class C 576,359 317,040
Massachusetts Fund - Class A 394,624 296,290
Massachusetts Fund - Class C 226,351 119,178
Michigan Fund - Class A 1,202,034 1,012,546
Michigan Fund - Class C 409,772 260,992
Minnesota Fund - Class A 559,945 438,850
Minnesota Fund - Class C 156,706 94,930
Ohio Fund - Class A 799,316 673,157
Ohio Fund - Class C 339,665 222,379
PERFORMANCE
Performance quotations are subject to SEC rules. These rules require the use of
standardized performance quotations or, alternatively, that every
non-standardized performance quotation furnished by a fund be accompanied by
certain standardized performance information computed as required by the SEC.
Average annual total return and current yield quotations used by the funds are
based on the standardized methods of computing performance mandated by the SEC.
Performance figures reflect Rule 12b-1 fees from the date of the plan's
implementation. An explanation of these and other methods used by the funds to
compute or express performance follows. Regardless of the method used, past
performance does not guarantee future results, and is an indication of the
return to shareholders only for the limited historical period used.
AVERAGE ANNUAL TOTAL RETURN Average annual total return is determined by finding
the average annual rates of return over the periods indicated below that would
equate an initial hypothetical $1,000 investment to its ending redeemable value.
The calculation assumes the maximum initial sales charge is deducted from the
initial $1,000 purchase, and income dividends and capital gain distributions are
reinvested at net asset value. The quotation assumes the account was completely
redeemed at the end of each period and the deduction of all applicable charges
and fees. If a change is made to the sales charge structure, historical
performance information will be restated to reflect the maximum initial sales
charge currently in effect.
When considering the average annual total return quotations, you should keep in
mind that the maximum initial sales charge reflected in each quotation is a one
time fee charged on all direct purchases, which will have its greatest impact
during the early stages of your investment. This charge will affect actual
performance less the longer you retain your investment in the funds. The average
annual total returns for the indicated periods ended February 28, 1999, were:
SINCE
INCEPTION 1 YEAR 5 YEARS 10 YEARS INCEPTION
DATE (%) (%) (%) (%)
CLASS A
Arizona Fund 4/30/93 1.24 5.67 - 5.91
Florida Fund 4/30/93 1.54 5.46 - 5.38
Insured Fund 4/03/85 1.20 4.95 7.11 7.97
Massachusetts Fund 4/03/85 0.89 4.91 6.89 7.30
Michigan Fund 4/03/85 1.73 5.11 7.08 7.68
Minnesota Fund 4/03/85 0.71 4.57 6.61 7.56
Ohio Fund 4/03/85 1.17 4.98 7.03 7.67
SINCE
INCEPTION
1 YEAR (%) (5/1/95) (%)
CLASS C
Insured Fund 3.04 6.09
Massachusetts Fund 2.70 6.04
Michigan Fund 3.70 6.36
Minnesota Fund 2.57 5.53
Ohio Fund 3.03 6.25
The following SEC formula was used to calculate these figures:
n
P(1+T) = ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at the
beginning of each period at the end of each period
CUMULATIVE TOTAL RETURN Like average annual total return, cumulative total
return assumes the maximum initial sales charge is deducted from the initial
$1,000 purchase, and income dividends and capital gain distributions are
reinvested at net asset value. Cumulative total return, however, is based on the
actual return for a specified period rather than on the average return over the
periods indicated above. The cumulative total returns for the indicated periods
ended February 28, 1999, were:
SINCE
INCEPTION 1 YEAR 5 YEARS 10 YEARS INCEPTION
DATE (%) (%) (%) (%)
CLASS A
Arizona Fund 4/30/93 1.24 31.74 - 39.80
Florida Fund 4/30/93 1.54 30.47 - 35.74
Insured Fund 4/03/85 1.20 27.30 98.82 190.59
Massachusetts Fund 4/03/85 0.89 27.11 94.66 166.24
Michigan Fund 4/03/85 1.73 28.32 98.24 179.98
Minnesota Fund 4/03/85 0.71 25.02 89.61 175.48
Ohio Fund 4/03/85 1.17 27.53 97.28 179.58
SINCE
INCEPTION
1 YEAR (%) (5/1/95) (%)
CLASS C
Insured Fund 3.04 25.42
Massachusetts Fund 2.70 25.20
Michigan Fund 3.70 26.63
Minnesota Fund 2.57 22.92
Ohio Fund 3.03 26.12
CURRENT YIELD Current yield shows the income per share earned by a fund. It is
calculated by dividing the net investment income per share earned during a
30-day base period by the applicable maximum offering price per share on the
last day of the period and annualizing the result. Expenses accrued for the
period include any fees charged to all shareholders of the class during the base
period. The yields for the 30-day period ended February 28, 1999, were:
CLASS A (%) CLASS C (%)
Arizona Fund 3.81 -
Florida Fund 3.79 -
Insured Fund 3.83 3.38
Massachusetts Fund 3.75 3.33
Michigan Fund 3.71 3.28
Minnesota Fund 3.83 3.41
Ohio Fund 3.84 3.42
The following SEC formula was used to calculate these figures:
6
Yield = 2 [(a-b + 1) - 1]
---
cd
where:
a = interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the period that were
entitled to receive dividends
d = the maximum offering price per share on the last day of the period
TAXABLE-EQUIVALENT YIELD Each fund also may quote a taxable-equivalent yield
that shows the before-tax yield that would have to be earned from a taxable
investment to equal the yield. Taxable-equivalent yield is computed by dividing
the portion of the yield that is tax-exempt by one minus the highest applicable
federal or combined federal and state income tax rate and adding the product to
the portion of the yield that is not tax-exempt, if any. The taxable-equivalent
yields for the 30-day period ended February 28, 1999, were:
Class A (%) Class C (%)
Arizona Fund 6.64 -
Florida Fund 6.27 -
Insured Fund 6.34 5.60
Massachusetts Fund 6.60 5.86
Michigan Fund 6.43 5.68
Minnesota Fund 6.93 6.17
Ohio Fund 6.82 6.08
As of February 28, 1999, the federal or combined federal and state income tax
rate upon which the taxable-equivalent yield quotations were based were as
follows:
COMBINED RATE (%)
Arizona Fund 42.6
Florida Fund 39.6
Insured Fund 39.6
Massachusetts Fund 43.2
Michigan Fund 42.3
Minnesota Fund 44.7
Ohio Fund 43.7
From time to time, as any changes to the rates become effective,
taxable-equivalent yield quotations advertised by the funds will be updated to
reflect these changes. The funds expect updates may be necessary as tax rates
are changed by federal and state governments. The advantage of tax-free
investments, like the funds, will be enhanced by any tax rate increases.
Therefore, the details of specific tax increases may be used in sales material
for the funds.
CURRENT DISTRIBUTION RATE Current yield and taxable-equivalent yield, which are
calculated according to a formula prescribed by the SEC, are not indicative of
the amounts which were or will be paid to shareholders. Amounts paid to
shareholders are reflected in the quoted current distribution rate or
taxable-equivalent distribution rate. The current distribution rate is usually
computed by annualizing the dividends paid per share by a class during a certain
period and dividing that amount by the current maximum offering price. The
current distribution rate differs from the current yield computation because it
may include distributions to shareholders from sources other than interest, if
any, and is calculated over a different period of time. The current distribution
rates for the 30-day period ended February 28, 1999, were:
CLASS A (%) CLASS C (%)
Arizona Fund 4.45 -
Florida Fund 4.47 -
Insured Fund 4.78 4.31
Massachusetts Fund 4.66 4.22
Michigan Fund 4.63 4.15
Minnesota Fund 4.73 4.31
Ohio Fund 4.69 4.26
A taxable-equivalent distribution rate shows the taxable distribution rate
equivalent to the current distribution rate. The advertised taxable-equivalent
distribution rate will reflect the most current federal and state tax rates
available to the fund. The taxable-equivalent distribution rates for the 30-day
period ended February 28, 1999, were:
CLASS A (%) CLASS C (%)
Arizona Fund 7.76 -
Florida Fund 7.40 -
Insured Fund 7.91 7.14
Massachusetts Fund 8.20 7.43
Michigan Fund 8.02 7.19
Minnesota Fund 8.56 7.80
Ohio Fund 8.33 7.57
VOLATILITY Occasionally statistics may be used to show a fund's volatility or
risk. Measures of volatility or risk are generally used to compare a fund's net
asset value or performance to a market index. One measure of volatility is beta.
Beta is the volatility of a fund relative to the total market, as represented by
an index considered representative of the types of securities in which the fund
invests. A beta of more than 1.00 indicates volatility greater than the market
and a beta of less than 1.00 indicates volatility less than the market. Another
measure of volatility or risk is standard deviation. Standard deviation is used
to measure variability of net asset value or total return around an average over
a specified period of time. The idea is that greater volatility means greater
risk undertaken in achieving performance.
OTHER PERFORMANCE QUOTATIONS Each fund also may quote the performance of shares
without a sales charge. Sales literature and advertising may quote a cumulative
total return, average annual total return and other measures of performance with
the substitution of net asset value for the public offering price.
Each fund may include in its advertising or sales material information relating
to investment goals and performance results of funds belonging to the Franklin
Templeton Group of Funds. Franklin Resources, Inc. is the parent company of the
advisors and underwriter of the Franklin Templeton Group of Funds.
COMPARISONS To help you better evaluate how an investment in the fund may
satisfy your investment goal, advertisements and other materials about the fund
may discuss certain measures of fund performance as reported by various
financial publications. Materials also may compare performance (as calculated
above) to performance as reported by other investments, indices, and averages.
These comparisons may include, but are not limited to, the following examples:
o Salomon Brothers Broad Bond Index or its component indices - measures yield,
price and total return for Treasury, agency, corporate and mortgage bonds.
o Lehman Brothers Aggregate Bond Index or its component indices - measures
yield, price and total return for Treasury, agency, corporate, mortgage and
Yankee bonds.
o Lehman Brothers Municipal Bond Index or its component indices - measures
yield, price and total return for the municipal bond market.
o Bond Buyer 20 Index - an index of municipal bond yields based upon yields of
20 general obligation bonds maturing in 20 years.
o Bond Buyer 40 Index - an index composed of the yield to maturity of 40 bonds.
The index attempts to track the new-issue market as closely as possible, so
it changes bonds twice a month, adding all new bonds that meet certain
requirements and deleting an equivalent number according to their secondary
market trading activity. As a result, the average par call date, average
maturity date, and average coupon rate can and have changed over time. The
average maturity generally has been about 29-30 years.
o Financial publications: THE WALL STREET JOURNAL, AND BUSINESS WEEK, FINANCIAL
WORLD, FORBES, FORTUNE, AND MONEY MAGAZINES - provide performance statistics
over specified time periods.
o Salomon Brothers Composite High Yield Index or its component indices measures
yield, price and total return for the Long-Term High-Yield Index,
Intermediate-Term High-Yield Index, and Long-Term Utility High-Yield Index.
o Historical data supplied by the research departments of CS First Boston
Corporation, the J. P. Morgan companies, Salomon Brothers, Merrill Lynch,
Lehman Brothers and Bloomberg L.P.
o Morningstar - information published by Morningstar, Inc., including
Morningstar proprietary mutual fund ratings. The ratings reflect
Morningstar's assessment of the historical risk-adjusted performance of a
fund over specified time periods relative to other funds within its category.
o Lipper - Mutual Fund Performance Analysis and Lipper - Fixed Income Fund
Performance Analysis - measure total return and average current yield for the
mutual fund industry and rank individual mutual fund performance over
specified time periods, assuming reinvestment of all distributions, exclusive
of any applicable sales charges.
o Savings and Loan Historical Interest Rates - as published in the U.S.
Savings & Loan League Fact Book.
o Consumer Price Index (or Cost of Living Index), published by the U.S. Bureau
of Labor Statistics - a statistical measure of change, over time, in the
price of goods and services in major expenditure groups.
o CDA Mutual Fund Report, published by CDA Investment Technologies, Inc.
analyzes price, current yield, risk, total return, and average rate of return
(average annual compounded growth rate) over specified time periods for the
mutual fund industry.
o Standard & Poor's Bond Indices - measure yield and price of corporate,
municipal, and government bonds.
From time to time, advertisements or information for each fund may include a
discussion of certain attributes or benefits to be derived from an investment in
the fund. The advertisements or information may include symbols, headlines, or
other material that highlights or summarizes the information discussed in more
detail in the communication.
Advertisements or sales material issued by each fund also may discuss or be
based upon information in a recent issue of the Special Report on Tax Freedom
Day published by the Tax Foundation, a Washington, D.C. based nonprofit research
and public education organization. The report illustrates, among other things,
the annual amount of time the average taxpayer works to satisfy his or her tax
obligations to the federal, state and local taxing authorities.
Advertisements or information also may compare each fund's performance to the
return on certificates of deposit (CDs) or other investments. You should be
aware, however, that an investment in the fund involves the risk of fluctuation
of principal value, a risk generally not present in an investment in a CD issued
by a bank. For example, as the general level of interest rates rise, the value
of a fund's fixed-income investments, as well as the value of its shares that
are based upon the value of such portfolio investments, can be expected to
decrease. Conversely, when interest rates decrease, the value of a fund's shares
can be expected to increase. CDs are frequently insured by an agency of the U.S.
government. An investment in a fund is not insured by any federal, state or
private entity.
In assessing comparisons of performance, you should keep in mind that the
composition of the investments in the reported indices and averages is not
identical to any fund's portfolio, the indices and averages are generally
unmanaged, and the items included in the calculations of the averages may not be
identical to the formula used by a fund to calculate its figures. In addition,
there can be no assurance that a fund will continue its performance as compared
to these other averages.
MISCELLANEOUS INFORMATION
The funds may help you achieve various investment goals such as accumulating
money for retirement, saving for a down payment on a home, college costs and
other long-term goals. The Franklin College Costs Planner may help you in
determining how much money must be invested on a monthly basis in order to have
a projected amount available in the future to fund a child's college education.
(Projected college cost estimates are based upon current costs published by the
College Board.) The Franklin Retirement Planning Guide leads you through the
steps to start a retirement savings program. Of course, an investment in the
funds cannot guarantee that these goals will be met.
The funds are members of the Franklin Templeton Group of Funds, one of the
largest mutual fund organizations in the U.S., and may be considered in a
program for diversification of assets. Founded in 1947, Franklin is one of the
oldest mutual fund organizations and now services more than 4 million
shareholder accounts. In 1992, Franklin, a leader in managing fixed-income
mutual funds and an innovator in creating domestic equity funds, joined forces
with Templeton, a pioneer in international investing. The Mutual Series team,
known for its value-driven approach to domestic equity investing, became part of
the organization four years later. Together, the Franklin Templeton Group has
over $217 billion in assets under management for more than 7 million U.S. based
mutual fund shareholder and other accounts. The Franklin Templeton Group of
Funds offers 113 U.S. based open-end investment companies to the public. Each
fund may identify itself by its NASDAQ symbol or CUSIP number.
Franklin is a leader in the tax-free mutual fund industry and manages more than
$51 billion in municipal security assets for over three quarters of a million
investors. According to Research and Ratings Review, Franklin had one of the
largest staffs of municipal securities analysts in the industry, as of June 30,
1998.
Under current tax laws, municipal securities remain one of the few investments
offering the potential for tax-free income. In 1999, taxes could cost almost $47
on every $100 earned from a fully taxable investment (based on the maximum
combined 39.6% federal tax rate and the highest state tax rate of 12% for 1999).
Franklin tax-free funds, however, offer tax relief through a professionally
managed portfolio of tax-free securities selected based on their yield, quality
and maturity. An investment in a Franklin tax-free fund can provide you with the
potential to earn income free of federal taxes and, depending on the fund, state
and local taxes as well, while supporting state and local public projects.
Franklin tax-free funds also may provide tax-free compounding, when dividends
are reinvested. An investment in Franklin's tax-free funds can grow more rapidly
than similar taxable investments.
Municipal securities are generally considered to be creditworthy, second in
quality only to securities issued or guaranteed by the U.S. government and its
agencies. The market price of municipal securities, however, may fluctuate. This
fluctuation will have a direct impact on the net asset value of the fund's
shares.
Currently, there are more mutual funds than there are stocks listed on the New
York Stock Exchange. While many of them have similar investment goals, no two
are exactly alike. Shares of the fund are generally sold through securities
dealers, whose investment representatives are experienced professionals who can
offer advice on the type of investments suitable to your unique goals and needs,
as well as the risks associated with such investments.
The Information Services & Technology division of Franklin Resources, Inc.
(Resources) established a Year 2000 Project Team in 1996. This team has already
begun making necessary software changes to help the computer systems that
service the funds and their shareholders to be Year 2000 compliant. After
completing these modifications, comprehensive tests are conducted in one of
Resources' U.S. test labs to verify their effectiveness. Resources continues to
seek reasonable assurances from all major hardware, software or data-services
suppliers that they will be Year 2000 compliant on a timely basis. Resources is
also beginning to develop a contingency plan, including identification of those
mission critical systems for which it is practical to develop a contingency
plan. However, in an operation as complex and geographically distributed as
Resources' business, the alternatives to use of normal systems, especially
mission critical systems, or supplies of electricity or long distance voice and
data lines are limited.
DESCRIPTION OF RATINGS
MUNICIPAL BOND RATINGS
MOODY'S INVESTORS SERVICE, INC. (MOODY'S)
Aaa: Municipal bonds rated Aaa 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 exceptionally stable
margin, and 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: Municipal bonds rated Aa are judged to be 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, fluctuation of protective elements may be of
greater amplitude, or there may be other elements present that make the
long-term risks appear somewhat larger.
A: Municipal bonds rated A possess many favorable investment attributes and are
considered upper medium-grade obligations. Factors giving security to principal
and interest are considered adequate, but elements may be present that suggest a
susceptibility to impairment sometime in the future.
Baa: Municipal bonds rated Baa are considered medium-grade obligations. 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.
These bonds lack outstanding investment characteristics and, in fact, have
speculative characteristics as well.
Ba: Municipal bonds rated Ba are judged to have predominantly speculative
elements and their future cannot be considered well assured. Often the
protection of interest and principal payments may be very moderate and, thereby,
not well safeguarded during both good and bad times over the future. Uncertainty
of position characterizes bonds in this class.
B: Municipal bonds rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa: Municipal bonds rated Caa are of poor standing. These issues may be in
default or there may be present elements of danger with respect to principal
or interest.
Ca: Municipal bonds rated Ca represent obligations that are speculative to a
high degree. These issues are often in default or have other marked
shortcomings.
C: Municipal bonds rated C are the lowest-rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Con.(-): Municipal 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 that begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon the
completion of construction or the elimination of the basis of the condition.
STANDARD & POOR'S CORPORATION (S&P)
AAA: Municipal bonds rated AAA are the highest-grade obligations. They possess
the ultimate degree of protection as to principal and interest. In the market,
they move with interest rates and, hence, provide the maximum safety on all
counts.
AA: Municipal bonds rated AA also qualify as high-grade obligations, and in the
majority of instances differ from AAA issues only in a small degree. Here, too,
prices move with the long-term money market.
A: Municipal bonds rated A are regarded as upper medium-grade. They have
considerable investment strength but are not entirely free from adverse effects
of changes in economic and trade conditions. Interest and principal are regarded
as safe. They predominantly reflect money rates in their market behavior but
also, to some extent, economic conditions.
BBB: Municipal bonds rated BBB are regarded as having an adequate capacity to
pay principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest for bonds in
this category than for bonds in the A category.
BB, B, CCC, CC: Municipal bonds rated BB, B, CCC and CC are regarded, on
balance, as predominantly speculative with respect to the issuer's capacity to
pay interest and repay principal in accordance with the terms of the
obligations. BB indicates the lowest degree of speculation and CC the highest
degree of speculation. While these bonds will likely have some quality and
protective characteristics, they are outweighed by large uncertainties or major
risk exposures to adverse conditions.
C: This rating is reserved for income bonds on which no interest is being
paid.
D: Debt rated "D" is in default and payment of interest and/or repayment of
principal is in arrears.
Plus (+) or minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
FITCH INVESTORS SERVICE, INC. (FITCH)
AAA: Municipal bonds rated AAA are considered to be investment grade and of the
highest credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal that is unlikely to be affected by reasonably
foreseeable events.
AA: Municipal bonds rated AA are 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 as bonds rated AAA and not
significantly vulnerable to foreseeable future developments.
A: Municipal bonds rated A are 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: Municipal bonds rated BBB are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered 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.
BB: Municipal bonds rated BB are considered speculative. The obligor's ability
to pay interest and repay principal may be affected over time by adverse
economic changes. Business and financial alternatives can be identified,
however, that could assist the obligor in satisfying its debt service
requirements.
B: Municipal bonds rated B are considered highly speculative. While bonds in
this class are currently meeting debt service requirements, the probability of
continued timely payment of principal and interest reflects the obligor's
limited margin of safety and the need for reasonable business and economic
activity throughout the life of the issue.
CCC: Municipal bonds rated CCC have certain identifiable characteristics which,
if not remedied, may lead to default. The ability to meet obligations requires
an advantageous business and economic environment.
CC: Municipal bonds rated CC are minimally protected. Default in payment of
interest and/or principal seems probable over time.
C: Municipal bonds rated C are in imminent default in the payment of interest
or principal.
DDD, DD and D: Municipal bonds rated DDD, DD and D are in default on interest
and/or principal payments. Such bonds are extremely speculative and should be
valued on the basis of their ultimate recovery value in liquidation or
reorganization of the obligor. DDD represents the highest potential for recovery
while D represents the lowest potential for recovery.
Plus (+) or minus (-) signs are used with a rating symbol to indicate the
relative position of a credit within the rating category. Plus or minus signs
are not used with the AAA, DDD, DD or D categories.
MUNICIPAL NOTE RATINGS
MOODY'S
Moody's ratings for state, municipal and other short-term obligations will be
designated Moody's Investment Grade (MIG). This distinction is in recognition of
the differences between short-term credit risk and long-term risk. Factors
affecting the liquidity of the borrower are uppermost in importance in
short-term borrowing; factors of the first importance in long-term borrowing
risk are of lesser importance in the short run. Symbols used will be as follows:
MIG 1: Notes are of the best quality enjoying strong protection from established
cash flows of funds for their servicing or from established and broad-based
access to the market for refinancing, or both.
MIG 2: Notes are of high quality, with margins of protection ample, although not
so large as in the preceding group.
MIG 3: Notes are of favorable quality, with all security elements accounted for,
but lacking the undeniable strength of the preceding grades. Market access for
refinancing, in particular, is likely to be less well established.
MIG 4: Notes are of adequate quality, carrying specific risk but having
protection and not distinctly or predominantly speculative.
S&P
Until June 29, 1984, S&P used the same rating symbols for notes and bonds. After
June 29, 1984, for new municipal note issues due in three years or less, the
ratings below will usually be assigned. Notes maturing beyond three years will
most likely receive a bond rating of the type recited above.
SP-1: Issues carrying this designation have a very strong or strong capacity to
pay principal and interest. Issues determined to possess overwhelming safety
characteristics will be given a "plus" (+) designation.
SP-2: Issues carrying this designation have a satisfactory capacity to pay
principal and interest.
SHORT-TERM DEBT & COMMERCIAL PAPER RATINGS
MOODY'S
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted. Moody's commercial paper
ratings, which are also applicable to municipal paper investments, are opinions
of the ability of issuers to repay punctually their promissory obligations not
having an original maturity in excess of nine months. Moody's employs the
following designations for both short-term debt and commercial paper, all judged
to be investment grade, to indicate the relative repayment capacity of rated
issuers:
P-1 (Prime-1): Superior capacity for repayment.
P-2 (Prime-2): Strong capacity for repayment.
S&P
S&P's ratings are a current assessment of the likelihood of timely payment of
debt having an original maturity of no more than 365 days. Ratings are graded
into four categories, ranging from "A" for the highest quality obligations to
"D" for the lowest. Issues within the "A" category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety, as follows:
A-1: This designation indicates the degree of safety regarding timely payment is
very strong. A "plus" (+) designation indicates an even stronger likelihood of
timely payment.
A-2: Capacity for timely payment on issues with this designation is strong. The
relative degree of safety, however, is not as overwhelming as for issues
designated A-1.
A-3: Issues carrying this designation have a satisfactory capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
FITCH
Fitch's short-term ratings apply to debt obligations that are payable on demand
or have original maturities of generally up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes. The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
F-1+: Exceptionally strong credit quality. Regarded as having the strongest
degree of assurance for timely payment.
F-1: Very strong credit quality. Reflect an assurance of timely payment only
slightly less in degree than issues rated F-1+.
F-2: Good credit quality. A satisfactory degree of assurance for timely payment,
but the margin of safety is not as great as for issues assigned F-1+ and F-1
ratings.
F-3: Fair credit quality. 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-5: Weak credit quality. 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: Default. Actual or imminent payment default.
LOC: The symbol LOC indicates that the rating is based on a letter of credit
issued by a commercial bank.
STATE TAX TREATMENT
The following information on the state income tax treatment of dividends from
the funds is based upon correspondence and sources believed to be reliable.
Except where otherwise noted, the information pertains to individual state
income taxation only. You may be subject to local taxes on dividends or the
value of your shares. Corporations, trusts, estates and other entities may be
subject to other taxes and should consult with their tax advisors or their state
department of revenue. For some investors, a portion of the dividend income may
be subject to the federal and/or state alternative minimum tax.
ARIZONA Sections 43-1021(4) and 43-1121(3) of the Arizona Income Tax Code state
that interest on obligations of the state of Arizona or its political
subdivisions is exempt from personal and corporate income tax. Sections
43-1022(6) and 43-1122(6) provide similar tax-exempt treatment for interest on
obligations of the U.S. or its territories (including Puerto Rico, Guam and the
Virgin Islands). Pursuant to State Income Tax Ruling Number 84-10-5, Arizona
does not tax dividend income from regulated investment companies, such as the
Arizona Fund, to the extent that such income is derived from such exempt
obligations. Dividends paid from interest earned on indirect U.S. government
obligations (GNMAs, FNMAs, etc.), or obligations from other states and their
political subdivisions are fully taxable. To the extent that such taxable
investments are made by the fund for temporary or defensive purposes, the
distributions will be taxable.
Any distributions of net short-term and net long-term capital gain earned by the
fund are included in each shareholder's Arizona taxable income as dividend
income and long-term capital gain, respectively, and are taxed at ordinary
income tax rates.
FLORIDA Although Florida does not impose a personal income tax, it does impose
an intangible personal property tax (intangibles tax) on intangible property
having a taxable situs in Florida. The intangibles tax is imposed on the value
of certain intangible personal property, including shares of a mutual fund.
There is an exemption, however, for shares of a mutual fund, such as the Florida
Fund, that is organized as a business trust, if, on the January 1 assessment
date, at least 90% of the net asset value of the portfolio of assets
corresponding to such shares consists of exempt property. Exempt property
includes notes, bonds and other obligations issued by the state of Florida or
its municipalities, counties and other taxing districts or by the U.S.
government and its agencies. If, on the date of assessment, the 90% threshold is
not met, only that portion, if any, of the value of the mutual fund shares
attributable to notes, bonds and obligations of the U.S.
government and its agencies will be exempt.
MASSACHUSETTS Chapter 62, Section 2, of the Massachusetts General Laws states
that dividends received from a regulated investment company, such as the
Massachusetts Fund, are exempt from state personal income tax to the extent that
such dividends are attributable to interest on obligations of the U.S.
government or its territories (including Puerto Rico, Guam and the Virgin
Islands). Dividends received from the fund, which are either exempt-interest
dividends or capital gain dividends, to the extent that the interest or gains
are attributable to obligations of the Commonwealth of Massachusetts, or any
political subdivision, agency or instrumentality within the commonwealth, also
are exempt from state personal income tax. Dividends paid from interest earned
on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or other
obligations from other states and their political subdivisions are fully
taxable. To the extent that such taxable investments are made by the fund for
temporary or defensive purposes, the distributions will be taxable.
Capital gain dividends attributable to obligations other than of the
Commonwealth of Massachusetts, or any political subdivision, agency or
instrumentality thereof will be taxable as follows: Net short-term capital gain
distributions will be taxable as dividend income while net long-term capital
gain distributions will be taxable at reduced rates ranging from five percent to
two percent based upon the applicable holding period of the asset as determined
under Massachusetts law. By the 2001 tax year, these reduced rates will range
from five percent to zero percent.
In determining the Massachusetts excise tax on corporations subject to state
taxation, distributions from the fund generally will be included in a corporate
shareholder's net income, and in the case of corporations that are defined as
"intangible property corporations," shares of the fund will be included in the
computation of net worth.
MICHIGAN Section 206.30(1) of the Michigan Compiled Laws generally provides that
taxable income, for purposes of the Michigan individual income tax, is
determined by reference to federal adjusted gross income, with certain
modifications. Interest and dividends derived from obligations or securities of
states other than Michigan (less related expenses) must be added back in
determining Michigan taxable income. Interest and dividends derived from
obligations or securities of Michigan (and its political subdivisions) are
exempt and are not, therefore, added back in determining Michigan taxable
income. Further, income derived from obligations of the U.S. government that the
state is prohibited by law from subjecting to a net income tax is subtracted in
determining Michigan taxable income. This includes direct obligations of the
U.S. government, its agencies, instrumentalities, or possessions (including
Puerto Rico, Guam and the Virgin Islands).
Revenue Administrative Bulletin 1986-3, states that a regulated investment
company, such as the Michigan Fund, which invests in tax-free municipal
obligations of the state of Michigan and its political and governmental
subdivisions, is permitted to pass-through the exemption of such interest to its
shareholders to the extent that such interest qualifies as an exempt-interest
dividend of a regulated investment company. The exempt nature of interest from
obligations of the U.S. and its territories and possessions also may be passed
through to shareholders. Dividends paid from interest earned on indirect U.S.
government obligations (GNMAs, FNMAs, etc.) or other obligations from other
states and their political subdivisions are fully taxable. To the extent that
such taxable investments are made by the fund for temporary or defensive
purposes, the distributions will be taxable.
Any distributions of net short-term and net long-term capital gains earned by
the fund generally will be included in each shareholder's Michigan taxable
income as dividend income and long-term capital gain, respectively, and taxed at
ordinary income tax rates.
MINNESOTA Section 290.01 of the Code of Minnesota states that individual
shareholders generally will not be subject to state income taxation on the
exempt-interest dividends distributed by a regulated investment company, such as
the Minnesota Fund, provided that at least 95% of the exempt-interest dividends
are derived from obligations of the state of Minnesota, or its political or
governmental subdivisions. However, such dividends are taken into account in
computing the state's alternative minimum tax to the extent they are derived
from Minnesota private activity bonds. Minnesota Rule 8002.0300 generally states
that dividends paid by the fund, to the extent attributable to interest derived
from obligations of the U.S. government, its authorities, commissions,
instrumentalities or territories (including Puerto Rico, Guam and the Virgin
Islands), also will be exempt from Minnesota's personal income tax. As a matter
of policy, the fund will continue to seek to earn at least 95% of its income
from interest on Minnesota obligations and less than 5% from direct U.S.
government, Puerto Rico or other obligations to try to ensure that the fund
continues to qualify to pay exempt-interest dividends on income from Minnesota
obligations. Dividends paid from interest earned on indirect U.S. government
obligations (GNMAs, FNMAs, etc.) or other obligations from other states and
their political subdivisions are fully taxable. To the extent that such taxable
investments are made by the fund for temporary or defensive purposes, the
distributions will be taxable.
Any distributions of net short-term and net long-term capital gains earned by
the fund are included in each shareholder's Minnesota taxable income as dividend
income and long-term capital gain respectively, and are taxed at ordinary income
tax rates.
OHIO Section 5747.01(A) of the Ohio Revised Code states generally that interest
on obligations of the state of Ohio and its subdivisions and authorities and of
the U.S. and its territories and possessions (to the extent included in federal
adjusted gross income but exempt from state income taxes under U.S. laws) is
exempt from Ohio state personal income tax. Distributions of income attributable
to obligations of the U.S., its territories and possessions by regulated
investment companies, such as the Ohio Fund, also will be exempt from the Ohio
personal income tax and the Ohio corporation franchise tax computed on the net
income basis. In addition, distributions made by the Ohio Fund that are
attributable to interest payments on obligations issued by or on behalf of the
state of Ohio, its political subdivisions or agencies or instrumentalities or
its political subdivisions will be exempt from Ohio personal income tax provided
that at all times at least 50 percent of the value of the total assets of the
Ohio Fund consists of Ohio obligations, or similar obligations of other states
or their subdivisions. Shares of the Ohio Fund will, however, be included in a
shareholder's tax base for purposes of computing the Ohio corporation franchise
tax on the net worth basis. Dividends paid from interest earned on indirect U.S.
government obligations (GNMAs, FNMAs, etc.) or other obligations from other
states and their political subdivisions are fully taxable. To the extent that
such taxable investments are made by the fund for temporary or defensive
purposes, the distributions will be taxable on a pro rata basis.
Shareholders who are subject to the Ohio personal income tax or the Ohio
corporation franchise tax computed on the net income basis will not be subject
to such taxes on distributions of "capital gain dividends" to the extent that
such distributions are attributable to profit made on the sale, exchange or
other disposition by the Ohio Fund of exempt obligations of the state of Ohio
and its subdivisions and authorities.
FRANKLIN
TAX-FREE TRUST
FRANKLIN ALABAMA TAX-FREE INCOME FUND FRANKLIN FLORIDA TAX-FREE INCOME FUND
FRANKLIN GEORGIA TAX-FREE INCOME FUND FRANKLIN KENTUCKY TAX-FREE INCOME FUND
FRANKLIN LOUISIANA TAX-FREE INCOME FUND FRANKLIN MARYLAND TAX-FREE INCOME FUND
FRANKLIN MISSOURI TAX-FREE INCOME FUND FRANKLIN NORTH CAROLINA TAX-FREE INCOME
FUND FRANKLIN TEXAS TAX-FREE INCOME FUND FRANKLIN VIRGINIA TAX-FREE INCOME FUND
STATEMENT OF ADDITIONAL INFORMATION
JULY 1, 1999, AS AMENDED JANUARY 1, 2000
P.O. BOX 997151, SACRAMENTO, CA 95899-9983 1-800/DIAL BEN(R)
This Statement of Additional Information (SAI) is not a prospectus. It contains
information in addition to the information in the funds' prospectus. The funds'
prospectus, dated July 1, 1999, which we may amend from time to time, contains
the basic information you should know before investing in the funds. You should
read this SAI together with the funds' prospectus.
The audited financial statements and auditor's report in the trust's Annual
Report to Shareholders, for the fiscal year ended February 28, 1999, are
incorporated by reference (are legally a part of this SAI).
For a free copy of the current prospectus or annual report, contact your
investment representative or call 1-800/DIAL BEN (1-800/342-5236).
CONTENTS
Goals and Strategies .................................... 2
Risks ................................................... 6
Officers and Trustees ................................... 10
Management and Other Services ........................... 12
Portfolio Transactions .................................. 14
Distributions and Taxes ................................. 14
Organization, Voting Rights
and Principal Holders .................................. 16
Buying and Selling Shares ............................... 17
Pricing Shares .......................................... 22
The Underwriter ......................................... 22
Performance ............................................. 25
Miscellaneous Information ............................... 28
Description of Ratings .................................. 29
State Tax Treatment ..................................... 31
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MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS:
o ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE
FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT;
o ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK;
o ARE SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL.
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GOALS AND STRATEGIES
Each fund's investment goal is to provide investors with as high a level of
income exempt from federal income taxes as is consistent with prudent investing,
while seeking preservation of shareholders' capital. Each fund also tries to
provide a maximum level of income exempt from personal income taxes, if any, for
resident shareholders of the fund's state. These goals are fundamental, which
means they may not be changed without shareholder approval. Of course, there is
no assurance that any fund will meet its goal.
As fundamental policies, each fund normally invests at least 80% of its net
assets in securities that pay interest free from federal income taxes, including
the federal alternative minimum tax, and at least 80% of its net assets in
securities that pay interest free from the personal income taxes, if any, of its
state. As a nonfundamental policy, each fund also normally invests at least 65%
of its total assets in municipal securities of its state.
Municipal securities issued by a fund's state or that state's counties,
municipalities, authorities, agencies, or other subdivisions, as well as
municipal securities issued by U.S. territories such as Guam, Puerto Rico, or
the Mariana Islands, generally pay interest free from federal income tax and
from state personal income taxes, if any, for residents of the fund's state.
Each fund tries to invest all of its assets in tax-free municipal securities.
The issuer's bond counsel generally gives the issuer an opinion on the
tax-exempt status of a municipal security when the security is issued.
Some states may require a fund to invest a certain amount of its assets in
securities of that state, or in securities that are otherwise tax-free under the
laws of that state, in order for any portion of the fund's distributions to be
free from the state's personal income taxes. If a fund's state requires this,
the fund will try to invest its assets as required so that its distributions
will be free from personal income taxes for resident shareholder's of the fund's
state.
Below is a description of various types of municipal and other securities that
each fund may buy. Other types of municipal securities may become available that
are similar to those described below and in which each fund also may invest, if
consistent with its investment goal and policies.
TAX ANTICIPATION NOTES are issued to finance short-term working capital needs of
municipalities in anticipation of various seasonal tax revenues, which will be
used to pay the notes. They are usually general obligations of the issuer,
secured by the taxing power for the payment of principal and interest.
REVENUE ANTICIPATION NOTES are similar to tax anticipation notes except they are
issued in expectation of the receipt of other kinds of revenue, such as federal
revenues available under the Federal Revenue Sharing Program.
BOND ANTICIPATION NOTES are normally issued to provide interim financing until
long-term financing can be arranged. Proceeds from long-term bond issues then
provide the money for the repayment of the notes.
TAX-EXEMPT COMMERCIAL PAPER typically represents a short-term obligation (270
days or less) issued by a municipality to meet working capital needs.
MUNICIPAL BONDS meet longer-term capital needs and generally have maturities
from one to 30 years when issued. They have two principal classifications:
general obligation bonds and revenue bonds.
GENERAL OBLIGATION BONDS. Issuers of general obligation bonds include states,
counties, cities, towns and regional districts. The proceeds of these
obligations are used to fund a wide range of public projects, including
construction or improvement of schools, highways and roads. The basic security
behind general obligation bonds is the issuer's pledge of its full faith, credit
and taxing power for the payment of principal and interest. The taxes that can
be levied for the payment of debt service may be limited or unlimited as to the
rate or amount of special assessments.
REVENUE BONDS. The full faith, credit and taxing power of the issuer do not
secure revenue bonds. Instead, the principal security for a revenue bond is
generally the net revenue derived from a particular facility, group of
facilities, or, in some cases, the proceeds of a special excise tax or other
specific revenue source. Revenue bonds are issued to finance a wide variety of
capital projects, including: electric, gas, water and sewer systems; highways,
bridges and tunnels; port and airport facilities; colleges and universities; and
hospitals. The principal security behind these bonds may vary. For example,
housing finance authorities have a wide range of security, including partially
or fully insured mortgages, rent subsidized and/or collateralized mortgages,
and/or the net revenues from housing or other public projects. Many bonds
provide additional security in the form of a debt service reserve fund that may
be used to make principal and interest payments. Some authorities have further
security in the form of state assurances (although without obligation) to make
up deficiencies in the debt service reserve fund.
TAX-EXEMPT INDUSTRIAL DEVELOPMENT REVENUE BONDS are issued by or on behalf of
public authorities to finance various privately operated facilities for
business, manufacturing, housing, sports and pollution control, as well as
public facilities such as airports, mass transit systems, ports and parking. The
payment of principal and interest is solely dependent on the ability of the
facility's user to meet its financial obligations and the pledge, if any, of the
facility or other property as security for payment.
VARIABLE OR FLOATING RATE SECURITIES Each fund may invest in variable or
floating rate securities, including variable rate demand notes, which have
interest rates that change either at specific intervals (variable rate), from
daily up to monthly, or whenever a benchmark rate changes (floating rate). The
interest rate adjustments are designed to help stabilize the security's price.
While this feature helps protect against a decline in the security's market
price when interest rates go up, it lowers the fund's income when interest rates
fall. Variable or floating rate securities may include a demand feature, which
may be unconditional. The demand feature allows the holder to demand prepayment
of the principal amount before maturity, generally on one to 30 days' notice.
The holder receives the principal amount plus any accrued interest either from
the issuer or by drawing on a bank letter of credit, a guarantee or insurance
issued with respect to the security. Each fund generally uses variable or
floating rate securities as short-term investments while waiting for long-term
investment opportunities.
MUNICIPAL LEASE OBLIGATIONS Each fund may invest in municipal lease obligations,
including certificates of participation. Municipal lease obligations generally
finance the purchase of public property. The property is leased to the state or
a local government, and the lease payments are used to pay the interest on the
obligations. Municipal lease obligations differ from other municipal securities
because the lessee's governing body must appropriate (set aside) the money to
make the lease payments each year. If the money is not appropriated, the issuer
or the lessee can end the lease without penalty. If the lease is cancelled,
investors who own the municipal lease obligations may not be paid.
The board of trustees reviews each fund's municipal lease obligations to try to
assure that they are liquid investments based on various factors reviewed by the
fund's manager and monitored by the board. These factors may include (a) the
credit quality of the obligations and the extent to which they are rated or, if
unrated, comply with existing criteria and procedures followed to ensure that
they are comparable in quality to the ratings required for the fund to invest,
including an assessment of the likelihood of the lease being canceled, taking
into account how essential the leased property is and the term of the lease
compared to the useful life of the leased property; (b) the size of the
municipal securities market, both in general and with respect to municipal lease
obligations; and (c) the extent to which the type of municipal lease obligations
held by the fund trade on the same basis and with the same degree of dealer
participation as other municipal securities of comparable credit rating or
quality.
Since annual appropriations are required to make lease payments, municipal lease
obligations generally are not subject to constitutional limitations on the
issuance of debt and may allow an issuer to increase government liabilities
beyond constitutional debt limits. When faced with increasingly tight budgets,
local governments have more discretion to curtail lease payments under a
municipal lease obligation than they do to curtail payments on other municipal
securities. If not enough money is appropriated to make the lease payments, the
leased property may be repossessed as security for holders of the municipal
lease obligations. If this happens, there is no assurance that the property's
private sector or re-leasing value will be enough to make all outstanding
payments on the municipal lease obligations or that the payments will continue
to be tax-free.
While cancellation risk is inherent to municipal lease obligations, each fund
believes that this risk may be reduced, although not eliminated, by its policies
on the quality of securities in which it may invest.
CALLABLE BONDS Each fund may invest in callable bonds, which allow the issuer to
repay some or all of the bonds ahead of schedule. If a bond is called, the fund
will receive the principal amount, the accrued interest, and may receive a small
additional payment as a call premium. The manager may sell a callable bond
before its call date, if it believes the bond is at its maximum premium
potential. When pricing callable bonds, the call feature is factored into the
price of the bonds and may impact the fund's net asset value.
An issuer is more likely to call its bonds when interest rates are falling,
because the issuer can issue new bonds with lower interest payments. If a bond
is called, the fund may have to replace it with a lower-yielding security. A
call of some or all of these securities may lower a fund's income and its
distributions to shareholders. If the fund originally paid a premium for the
bond because it had appreciated in value from its original issue price, the fund
also may not be able to recover the full amount it paid for the bond. One way
for the fund to protect itself from call risk is to buy bonds with call
protection. Call protection is an assurance that the bond will not be called for
a specific time period, typically five to 10 years from when the bond is issued.
ESCROW-SECURED OR DEFEASED BONDS are created when an issuer refunds, before
maturity, an outstanding bond issue that is not immediately callable (or
pre-refunds), and sets aside funds for redemption of the bonds at a future date.
The issuer uses the proceeds from a new bond issue to buy high grade, interest
bearing debt securities, generally direct obligations of the U.S. government.
These securities are then deposited in an irrevocable escrow account held by a
trustee bank to secure all future payments of principal and interest on the
pre-refunded bond. Escrow-secured bonds often receive a triple A or equivalent
rating.
STRIPPED MUNICIPAL SECURITIES Municipal securities may be sold in "stripped"
form. Stripped municipal securities represent separate ownership of principal
and interest payments on municipal securities.
ZERO-COUPON SECURITIES Each fund may invest in zero-coupon and delayed interest
securities. Zero-coupon securities make no periodic interest payments, but are
sold at a deep discount from their face value. The buyer recognizes a rate of
return determined by the gradual appreciation of the security, which is redeemed
at face value on a specified maturity date. The discount varies depending on the
time remaining until maturity, as well as market interest rates, liquidity of
the security, and the issuer's perceived credit quality. The discount, in the
absence of financial difficulties of the issuer, typically decreases as the
final maturity date approaches. If the issuer defaults, the fund may not receive
any return on its investment.
Because zero-coupon securities bear no interest and compound semiannually at the
rate fixed at the time of issuance, their value is generally more volatile than
the value of other fixed-income securities. Since zero-coupon bondholders do not
receive interest payments, zero-coupon securities fall more dramatically than
bonds paying interest on a current basis when interest rates rise. When interest
rates fall, zero-coupon securities rise more rapidly in value, because the bonds
reflect a fixed rate of return.
An investment in zero-coupon and delayed interest securities may cause a fund to
recognize income and make distributions to shareholders before it receives any
cash payments on its investment. To generate cash to satisfy distribution
requirements, a fund may have to sell portfolio securities that it otherwise
would have continued to hold or to use cash flows from other sources such as the
sale of fund shares.
CONVERTIBLE AND STEP COUPON BONDS Each fund may invest a portion of its assets
in convertible and step coupon bonds. Convertible bonds are zero-coupon
securities until a predetermined date, at which time they convert to a specified
coupon security. The coupon on step coupon bonds changes periodically during the
life of the security based on predetermined dates chosen when the security is
issued.
U.S. GOVERNMENT OBLIGATIONS are issued by the U.S. Treasury or by agencies
and instrumentalities of the U.S. government and are backed by the full faith
and credit of the U.S. government. They include Treasury bills, notes and
bonds.
COMMERCIAL PAPER is a promissory note issued by a corporation to finance its
short-term credit needs. Each fund may invest in taxable commercial paper only
for temporary defensive purposes.
WHEN-ISSUED TRANSACTIONS Municipal securities are frequently offered on a
"when-issued" basis. When so offered, the price, which is generally expressed in
yield terms, is fixed at the time the commitment to buy is made, but delivery
and payment take place at a later date. During the time between purchase and
settlement, no payment is made by the fund to the issuer and no interest accrues
to the fund. If the other party to the transaction fails to deliver or pay for
the security, the fund could miss a favorable price or yield opportunity, or
could experience a loss.
When the fund makes the commitment to buy a municipal security on a when-issued
basis, it records the transaction and reflects the value of the security in the
determination of its net asset value. The funds believe their net asset value or
income will not be negatively affected by their purchase of municipal securities
on a when-issued basis. The funds will not engage in when-issued transactions
for investment leverage purposes.
Although a fund will generally buy municipal securities on a when-issued basis
with the intention of acquiring the securities, it may sell the securities
before the settlement date if it is considered advisable. When a fund is the
buyer, it will maintain cash or liquid securities, with an aggregate value equal
to the amount of its purchase commitments, in a segregated account with its
custodian bank until payment is made. If assets of a fund are held in cash
pending the settlement of a purchase of securities, the fund will not earn
income on those assets.
ILLIQUID INVESTMENTS Each fund may invest up to 10% of its net assets in
illiquid securities. Illiquid securities are generally securities that cannot be
sold within seven days in the normal course of business at approximately the
amount at which the fund has valued them.
DIVERSIFICATION All of the funds, except the Maryland Fund, are diversified
funds. The Maryland Fund is non-diversified. As a fundamental policy, none of
the diversified funds will buy a security if, with respect to 75% of its net
assets, more than 5% would be in the securities of any single issuer (with the
exception of obligations of the U.S. government). For this purpose, each
political subdivision, agency, or instrumentality, each multi-state agency of
which a state is a member, and each public authority that issues private
activity bonds on behalf of a private entity, is considered a separate issuer.
Escrow-secured or defeased bonds are not generally considered an obligation of
the original municipality when determining diversification.
Each fund, including the Maryland Fund, intends to meet certain diversification
requirements for tax purposes. Generally, to meet federal tax requirements at
the close of each quarter, a fund may not invest more than 25% of its total
assets in any one issuer and, with respect to 50% of total assets, may not
invest more than 5% of its total assets in any one issuer. These limitations do
not apply to U.S. government securities and may be revised if applicable federal
income tax requirements are revised.
TEMPORARY INVESTMENTS When the manager believes the securities trading markets
or the economy are experiencing excessive volatility or a prolonged general
decline, or other unusual or adverse conditions exist, including the
unavailability of securities that meet a fund's investment criteria, it may
invest each fund's portfolio in a temporary defensive manner. Under these
circumstances, each fund may invest all of its assets in securities that pay
taxable interest, including (i) high quality commercial paper; (ii) securities
issued by or guaranteed by the full faith and credit of the U.S. government; or
(iii) municipal securities issued by a state or local government other than the
fund's state. Each fund also may invest all of its assets in municipal
securities issued by a U.S. territory such as Guam, Puerto Rico or the Mariana
Islands.
SECURITIES TRANSACTIONS The frequency of portfolio transactions, usually
referred to as the portfolio turnover rate, varies for each fund from year to
year, depending on market conditions. While short-term trading increases
portfolio turnover and may increase costs, the execution costs for municipal
securities are substantially less than for equivalent dollar values of equity
securities.
CREDIT QUALITY All things being equal, the lower a security's credit quality,
the higher the risk and the higher the yield the security generally must pay as
compensation to investors for the higher risk.
A security's credit quality depends on the issuer's ability to pay interest on
the security and, ultimately, to repay the principal. Independent rating
agencies, such as Fitch Investors Service Inc. (Fitch), Moody's Investors
Service, Inc. (Moody's), and Standard & Poor's Corporation (S&P), often rate
municipal securities based on their opinion of the issuer's credit quality. Most
rating agencies use a descending alphabet scale to rate long-term securities,
and a descending numerical scale to rate short-term securities. Securities in
the top four ratings are "investment grade," although securities in the fourth
highest rating may have some speculative features. These ratings are described
at the end of this SAI under "Description of Ratings."
An insurance company, bank or other foreign or domestic entity may provide
credit support for a municipal security and enhance its credit quality. For
example, some municipal securities are insured, which means they are covered by
an insurance policy that guarantees the timely payment of principal and
interest. Other municipal securities may be backed by letters of credit,
guarantees, or escrow or trust accounts that contain securities backed by the
full faith and credit of the U.S. government to secure the payment of principal
and interest.
As discussed in the prospectus, each fund has limitations on the credit quality
of the securities it may buy. These limitations are generally applied when a
fund makes an investment so that a fund is not required to sell a security
because of a later change in circumstances.
INVESTMENT RESTRICTIONS Each fund has adopted the following restrictions as
fundamental policies. This means they may only be changed if the change is
approved by (i) more than 50% of the fund's outstanding shares or (ii) 67% or
more of the fund's shares present at a shareholder meeting if more than 50% of
the fund's outstanding shares are represented at the meeting in person or by
proxy, whichever is less.
Each fund may not:
1. Borrow money or mortgage or pledge any of its assets, except that borrowings
(and a pledge of assets therefore) for temporary or emergency purposes may be
made from banks in any amount up to 5% of the total asset value.
2. Buy any securities on "margin" or sell any securities "short," except that it
may use such short-term credits as are necessary for the clearance of
transactions.
3. Make loans, except through the purchase of readily marketable debt securities
which are either publicly distributed or customarily purchased by institutional
investors. Although such loans are not presently intended, this prohibition will
not preclude the fund from loaning portfolio securities to broker-dealers or
other institutional investors if at least 102% cash collateral is pledged and
maintained by the borrower; provided such portfolio security loans may not be
made if, as a result, the aggregate of such loans exceeds 10% of the value of
the fund's total assets at the time of the most recent loan.
4. Act as underwriter of securities issued by other persons, except insofar as
the fund may be technically deemed an underwriter under the federal securities
laws in connection with the disposition of portfolio securities.
5. Purchase the securities of any issuer which would result in owning more than
10% of the voting securities of such issuer, except with respect to the Maryland
Fund, which will not purchase a security, if as a result: i) more than 25% of
its total assets would be invested in the securities of a single issuer or ii)
with respect to 50% of its total assets, more than 5% of its assets would be
invested in the securities of a single issuer.
6. Purchase securities from or sell to the trust's officers and trustees, or any
firm of which any officer or trustee is a member, as principal, or retain
securities of any issuer if, to the knowledge of the trust, one or more of the
trust's officers, trustees, or investment manager own beneficially more than
one-half of 1% of the securities of such issuer and all such officers and
trustees together own beneficially more than 5% of such securities.
7. Acquire, lease or hold real estate, except such as may be necessary or
advisable for the maintenance of its offices and provided that this limitation
shall not prohibit the purchase of municipal and other debt securities secured
by real estate or interests therein.
8. Invest in commodities and commodity contracts, puts, calls, straddles,
spreads or any combination thereof, or interests in oil, gas, or other mineral
exploration or development programs, except that it may purchase, hold and
dispose of "obligations with puts attached" in accordance with its investment
policies.
9. Invest in companies for the purpose of exercising control or management.
10. Purchase securities of other investment companies, except in connection with
a merger, consolidation or reorganization, except to the extent the fund invests
its uninvested daily cash balances in shares of the Franklin Tax-Exempt Money
Fund and other tax-exempt money funds in the Franklin Templeton Group of Funds
provided i) its purchases and redemptions of such money market fund shares may
not be subject to any purchase or redemption fees, ii) its investments may not
be subject to duplication of management fees, nor to any charge related to the
expense of distributing the fund's shares (as determined under Rule 12b-1, as
amended under the federal securities laws) and iii) aggregate investments by the
fund in any such money market fund do not exceed (A) the greater of (i) 5% of
the fund's total net assets or (ii) $2.5 million, or (B) more than 3% of the
outstanding shares of any such money market fund.
11. Invest more than 25% of its assets in securities of any industry; although
for purposes of this limitation, tax-exempt securities and U.S. government
obligations are not considered to be part of any industry.
If a bankruptcy or other extraordinary event occurs concerning a particular
security the fund owns, the fund may receive stock, real estate, or other
investments that the fund would not, or could not, buy. If this happens, the
fund intends to sell such investments as soon as practicable while maximizing
the return to shareholders.
Generally, the policies and restrictions discussed in this SAI and in the
prospectus apply when the fund makes an investment. In most cases, the fund is
not required to sell a security because circumstances change and the security no
longer meets one or more of the fund's policies or restrictions. If a percentage
restriction or limitation is met at the time of investment, a later increase or
decrease in the percentage due to a change in the value or liquidity of
portfolio securities will not be considered a violation of the restriction or
limitation.
RISKS
STATE Since each state fund mainly invests in the municipal securities of its
state, its performance is closely tied to the ability of issuers of municipal
securities in its state to continue to make principal and interest payments on
their securities. The issuers' ability to do this is in turn dependent on
economic, political and other conditions within the state. Below is a discussion
of certain conditions that may affect municipal issuers in the funds' various
states. It is not a complete analysis of every material fact that may affect the
ability of issuers of municipal securities to meet their debt obligations or the
economic or political conditions within any state and is subject to change. The
information below is based on data available to the funds from historically
reliable sources, but the funds have not independently verified it.
The ability of issuers of municipal securities to continue to make principal and
interest payments is dependent in large part on their ability to raise revenues,
primarily through taxes, and to control spending. Many factors can affect a
state's revenues including the rate of population growth, unemployment rates,
personal income growth, federal aid, and the ability to attract and keep
successful businesses. A number of factors can also affect a state's spending
including current debt levels, and the existence of accumulated budget deficits.
The following provides some information on these and other factors.
ALABAMA. Alabama's economic base has continued to expand and diversify. Although
manufacturing has remained an important part of the economy, the trade and
service sectors have supplied almost 75% of the state's recent job growth. The
state's economic diversification has been fueled by growth in high tech
industries, health care and business services, and has centered around the
state's major metropolitan areas. Aggressive economic development and business
recruitment policies have helped to increase growth throughout the state. In
recent years, these policies have brought in significant capital investments,
which may help Alabama offset losses in its textile, apparel and food processing
sectors. Nonetheless, Alabama's economic growth and personal income levels have
continued to lag national and regional averages.
Historically, Alabama has been able to maintain a relatively low overall debt
burden, as well as balanced financial operations. Under the state's
constitution, expenditure reductions are required to prevent deficit spending
should the state experience revenue shortfalls. Since fiscal 1993, across the
board cuts have not been needed due mainly to Alabama's recent economic growth
and strict cost containment measures.
Alabama has been under a court order to remedy constitutional violations of
funding equity and adequacy in its school systems. The Alabama Special
Educational Trust Fund has been the state's largest operating fund and has been
funded primarily by income, sales and use taxes. Although the state's
substantial funding requirements for its school systems may put some pressure on
its budget and financial operations, overall both Moody's and S&P recently
considered the state's financial outlook to be stable.
FLORIDA. Florida's population has grown rapidly in recent years, with the
fastest growth among 5-17 year-olds and seniors 65 and over. The rapid growth
among these age groups has required increased expenditures for services such as
schools and health care and has placed sustained pressure on the state's budget
for the funding of these services. As a result, Florida is more vulnerable to
increases in the cost of education, Medicaid and other health care services than
many other states. While the population of the young and old has grown rapidly,
the working age population has grown at a much slower rate and is expected to
decline in the coming years.
Because of its substantial retirement age population, investment income and
transfer payments, such as social security and pension benefits, made up more
than 44% of Florida's income distribution in 1997. Wages and salaries were more
than 49%. This income mix historically has led to relatively stable personal
income levels across different economic cycles, although it also has created
some vulnerability to changes in the consumer price index at the federal level.
Florida's tax base has been relatively narrow, with no personal income tax and
60% of its revenues derived from the state's sales and use tax. This reliance on
a cyclical revenue source has created some vulnerability to recession and slower
growth in the tax base. Recent trends also have shown an increase in internet
and mail order sales, which the state has not been able to tax. If this trend
continues, states that rely on sales taxes, like Florida, could be adversely
affected. To help provide some protection against the historically volatile
nature of the sales tax, Florida enacted a constitutional amendment creating a
budget stabilization fund. As of March 1999, Florida projected a balance in the
fund of $787 million by the end of fiscal 1999.
Over the past five years, Florida's debt burden has grown dramatically with the
increased need for schools and health care, as well as environmental protection
programs designed to help protect the state's important tourism industry. The
state's rapidly growing population should continue to place demands on the
state's budget and debt burden to finance infrastructure and other improvements.
While tourism has remained Florida's most important industry, Florida's economy
has continued to diversify from a narrow base of agriculture and seasonal
tourism into a service and trade economy. Job growth has been steady, slightly
higher than the national average, and unemployment has been around the national
rate. Because of its location, much of the state's export sector has relied on
exports to Latin America. Although exports have comprised a relatively small
part of the gross state product, the sector's dependence on Latin America poses
a risk in the event of economic instability in that region.
GEORGIA. Georgia has been among the fastest growing states in the U.S. in
population, which has helped fuel employment growth and provide low-cost labor
for economic growth. Its diversified economy has performed well in recent years,
with growth in the services and trade sectors driving the state's overall
employment growth. Other factors that have contributed to Georgia's recent
economic growth have been the state's low cost of doing business, extensive
transportation infrastructure, low unemployment rates, availability of land and
water, and its central location. Atlanta, which has been at the heart of the
state's economic growth, has been a trade, service and transportation center for
much of the southeast region.
Financially, the state's strong economic and revenue growth have so far allowed
the state to meet the needs of its growing population, while maintaining a sound
financial position. The state has generated operating surpluses in each of the
last four fiscal years from 1995 to 1998, and also has fully funded its
reserves. While changes to the state's tax laws are expected to reduce tax
revenues by more than $200 million in fiscal 1999, as of November 1998 it was
not anticipated that these changes would have an adverse effect on the state's
overall financial position.
KENTUCKY. Kentucky's economy has performed at or above national levels in both
employment and personal income growth over the past several years. Its economy
has been moving towards a more modern manufacturing and service-oriented base,
with less emphasis on its traditionally low-wage coal, tobacco, and apparel
industries. Its central location and low cost structure have helped the state's
overall economic growth and have led to seven consecutive years of net
in-migration to the state. The state's per capita personal income levels,
however, have remained consistently below the national average.
Since fiscal 1993, Kentucky's financial management has steadily improved.
Results for fiscal 1998 were positive, with a general fund balance of $428
million. This was the fifth consecutive year of positive financial results for
the state, due in part to the state's economic growth and a strong record of
spending controls. The state's debt ratios, while declining, have remained high
relative to other states. The 1998-2000 budget emphasizes spending for
education, economic development and tax cuts and incentives to help further job
growth and capital investments.
LOUISIANA. Louisiana's economy has been historically cyclical due to its
reliance on oil and gas production and petro-chemical products. The state has
made some improvements towards a more diversified economy, however, with strong
growth in its service sector, especially in healthcare and tourism services.
Nonetheless, much of the state's recent economic growth has come from the upturn
in the oil and gas sector. Gaming and construction have also contributed. Future
growth could be limited by the state's dependence on the cyclical oil and gas
industry, as well as below average wealth and income levels.
Historically, Louisiana's main revenue sources, namely its sales tax, individual
and corporate income tax, and severance and royalty taxes, have fluctuated with
economic cycles and the oil and gas industry. This fluctuation has created
instability and budget problems in the past. During the last several years,
however, the state's financial position has stabilized somewhat. The state has
had operating surpluses for the past five fiscal years ended 1997, a trend that,
as of April 1998, was expected to continue for fiscal years 1998 and 1999. Over
the past two years, the state also has made improvements towards controlling
costs in its large health care system, especially Medicaid spending. The state
remains vulnerable, however, to the volatility of its oil and gas industry. Its
relatively high debt burden, unfunded pension liabilities, generally low
reserves, and unfunded risk management claims for judgments against the state,
which, as of April 1998, totaled $1.3 billion, could affect the state's
performance in future years.
MARYLAND. Maryland's economic base has been well-diversified. The state's
leading employment and income sectors have been services (33%), trade (24%) and
government (19%). Maryland's dependence on government has been larger than most
other states due to its close proximity to Washington D.C., and has made
Maryland vulnerable to federal budget cuts and downsizing. At the same time, the
state's manufacturing sector (8%) has been smaller than most other states. Most
recently, economic growth has come mainly from the business services sector. In
1998, job growth outpaced the national average for the first time in the 1990s.
Maryland's financial performance has been historically strong. Contributing
factors have included high per capita income levels, a well-educated workforce,
an advanced infrastructure, and diversified employment opportunities. In each of
the last five fiscal years, the state has generated operating surpluses while
building its financial reserves. Debt service levels, while high relative to
other states, also have remained manageable.
Going forward, a potential area of financial stress may come from the state's
recent 10% personal income tax reduction, which is to be phased in over five
years. Taking the tax cut into consideration, budget forecasts begin to show an
operating deficit in 2002. The state plans to use its reserves to manage
shortfalls resulting from the tax cut.
MISSOURI. Missouri historically has enjoyed a diversified economy that has
tended to mirror the national economy. Employment and personal income growth,
however, have been at or above the national average. In 1998, 34,000 new jobs
were created in the state, led by government, financial services, insurance,
real estate, service and retail trade sectors, and new businesses were up 55%.
Personal income increased by 5.1% in 1998, equal to the national average. At the
same time, the state's unemployment rate of 3.9% was below the national rate of
4.4%. Foreign exports, however, declined in 1998 for the first time this decade
due to the Asian financial crisis.
Despite declines in its manufacturing sector, trade and services have grown
steadily and have more than offset the state's manufacturing losses. Missouri's
low cost of living and highly skilled workforce have contributed to this growth
and have made the state attractive to computer- and telecommunications-related
companies. It has been estimated that the state's job growth will continue in
the near term, although at a slower pace due to slow population growth and a
tight labor force. These factors could raise wages and deter future economic
growth.
From a financial standpoint, Missouri's reluctance to rely heavily on borrowing
to meet capital needs has resulted in a low debt burden, while sound financial
management has resulted in a steadily improving financial position. The state's
general fund has had a surplus in recent years. For fiscal 1999, increased
expenditures for new prison construction, education and further tax reductions
could reduce the state's future financial flexibility.
NORTH CAROLINA. In recent years, North Carolina's economy has experienced strong
growth. From 1994 to 1998, job growth was 3.3%, equal to the national rate.
Below average business costs, a strong durable manufacturing sector, diverse
agriculture, three prestigious universities, and access to ports for trade and
commerce have all contributed to the state's recent economic strength. The
economy has continued to diversify with less emphasis on textile and apparel
manufacturing and more on services, finance and trade, with strong growth in the
high-tech sector. Manufacturing has remained a significant part of the state's
economy, however, and has created some vulnerability to recession. In 1998,
unemployment was a low 3.3%, well below the national average. The state's low
unemployment rate could create tight labor markets and constrain future economic
growth.
Over the past two years, North Carolina's outstanding debt has doubled due to
new bond issues for highways and schools. Nonetheless, the state's debt burden
has remained among the lowest in the nation. The state also has continued its
recent trend of strong financial performance and conservative budgeting
principles. The state ended fiscal 1998 with a surplus and was able to increase
its reserves. Court ordered tax refunds and the need for increased school
spending may put some pressure on the state's finances and could result in lower
reserves in the near term.
TEXAS. The Texas economy has continued to diversify and to move away from its
dependence on the volatile oil and gas sector. The state's high-tech sector has
become increasingly prominent, and, as of March 1999, was second behind only
California in total jobs and advantages in cost of business. The construction,
government and services industries also have experienced strong growth in recent
years due in part to a relatively high rate of net migration to the state.
Overall, Texas has added more than 1.1 million new jobs since 1994.
While overall job growth has been strong, losses in the state's higher paying
oil and gas and aerospace industries have resulted in slower, although still
positive, personal income growth. On a per capita basis, income levels have
remained below the national level. Further defense cutbacks could affect the
state. Changes in the economic and financial stability of Mexico, the state's
chief trade partner, also could adversely affect Texas, its economy and its
financial performance.
Financially, the state's performance has improved since the budget deficits of
the mid-1980s when the oil and gas sector declined. Revenues have continued to
increase as the state's economy has grown, resulting in a general fund surplus
of $426 million for fiscal 1998. Although the 1998-1999 budget was balanced as
of March 1999, the budget includes the use of almost all of the state's
accumulated general fund surplus for property tax relief. The use of existing
surpluses to fund tax cuts could create budget problems going forward,
especially as the state may encounter spending pressures from its growing
population. Since the state does not have a personal income tax, its reliance on
cyclical sales taxes also could result in some budget instability.
The state's debt burden has been relatively modest. In recent years, however,
the state's debt position has grown. The state also has moved away from issuing
debt designed to be self-supporting and towards issuing debt supported by the
general revenue fund. Nonetheless, the state's debt has remained below the
national average on a per capita basis.
VIRGINIA. Virginia's economy has experienced strong growth in recent years,
especially in the areas of business services, high-technology industries and
retail trade. Growth in these areas has helped to offset federal government job
losses caused by recent federal downsizing and budget cuts. The commonwealth's
unemployment rate has remained one of the nation's lowest, while personal income
levels have continued to exceed the national average.
Historically, Virginia's debt levels have been low, although they have begun to
increase due to some large highway and university construction projects.
Revenues and expenses have likewise grown. Overall, financial results have been
positive with surpluses in four of the past five fiscal years.
Since 1995, the state has had to refund approximately $400 million of income tax
collected on federal retiree benefits as a result of a court case. This amount
was scheduled to be paid in full by fiscal year end 1999. In coming years, the
state also will have to fund increased expenditures for education, as well as
the elimination of its car tax. When fully phased in during fiscal 2003, the
cost to the state of the car tax elimination is expected to be more than $2.6
billion.
U.S. TERRITORIES Since each fund may invest a portion of its assets in municipal
securities issued by U.S. territories, the ability of municipal issuers in U.S.
territories to continue to make principal and interest payments also may affect
a fund's performance. As with state municipal issuers, the ability to make these
payments is dependent on economic, political and other conditions. Below is a
discussion of certain conditions within some of the territories where the funds
may be invested. It is not a complete analysis of every material fact that may
affect the ability of issuers of U.S. territory municipal securities to meet
their debt obligations or the economic or political conditions within the
territories and is subject to change. It is based on data available to the funds
from historically reliable sources, but it has not been independently verified
by the funds.
GUAM. Guam's economy has been heavily dependent on tourism. It has been
especially dependent on Japanese tourism, which has made Guam vulnerable to
fluctuations in the relationship between the U.S. dollar and the Japanese yen.
The recent Asian economic crisis and Typhoon Paka, which hit Guam in December
1997, negatively affected both tourism and other economic activities in Guam and
contributed to a decline of 1.8% in gross island product between 1997 and 1998.
In the early to mid-1990s, Guam's financial position deteriorated due to a
series of natural disasters that led to increased spending on top of already
significant budget gaps. As a result, the government introduced a comprehensive
financial plan in June 1995 to help balance the budget and reduce the general
fund deficit by fiscal 1999. For fiscal 1998, however, Guam incurred a $21
million deficit and ended the year with a negative unreserved general fund
balance of $158.9 million. Another deficit is expected in 1999.
While Guam's debt burden has been manageable, Guam's ability to maintain current
debt levels may be challenged in the near future. U.S. military downsizing has
reduced the federal presence on the island and also may reduce federal support
for infrastructure projects. At the same time, Guam has faced increasing
pressure to improve its infrastructure to help generate economic development.
Overall, as of May 20, 1999, S&P's outlook for Guam was negative due to Guam's
continued weak financial position and inability to meet the goals of the
financial plan.
MARIANA ISLANDS. The Mariana Islands became a commonwealth in 1975. At that
time, the U.S. government agreed to exempt the islands from federal minimum wage
and immigration laws in an effort to help stimulate industry and the economy.
The islands' minimum wage has been more than $2 per hour below the U.S. level
and tens of thousands of workers have immigrated from various Asian countries to
provide cheap labor for the islands' industries. Recently, the islands' tourism
and apparel industries combined to help increase gross business receipts from
$224 million in 1985 to $2 billion in 1996.
PUERTO RICO. Overall, Moody's considered Puerto Rico's outlook stable as of
January 1999. In recent years, Puerto Rico's financial performance has improved.
Relatively strong revenue growth and more aggressive tax collection procedures
resulted in a general fund surplus for fiscal 1998 (unaudited). For fiscal 1999,
spending increases of 11% are budgeted, which may create an operating deficit
and deplete the commonwealth's unreserved fund balance.
Puerto Rico's debt levels have been high. Going forward, these levels may
increase as Puerto Rico attempts to finance significant capital and
infrastructure improvements. Puerto Rico also will need to address its large
unfunded pension liability of more than $6 billion.
Despite Puerto Rico's stable outlook, Puerto Rico may face challenges in the
coming years with the 1996 passage of a bill eliminating section 936 of the
Internal Revenue Code. This section has given certain U.S. corporations
operating in Puerto Rico significant tax advantages. These incentives have
helped considerably with Puerto Rico's economic growth, especially with the
development of its manufacturing sector. U.S. firms that have benefited from
these incentives have provided a significant portion of Puerto Rico's revenues,
employment and deposits in local financial institutions. The section 936
incentives will be phased out over a 10-year period ending in 2006. It is hoped
that this long phase-out period will give Puerto Rico sufficient time to lessen
the potentially negative effects of section 936's elimination. Outstanding
issues relating to the potential for a transition to statehood also may have
broad implications for Puerto Rico and its financial and credit position.
OFFICERS AND TRUSTEES
The trust has a board of trustees. The board is responsible for the overall
management of the trust, including general supervision and review of each fund's
investment activities. The board, in turn, elects the officers of the trust who
are responsible for administering the trust's day-to-day operations. The board
also monitors each fund to ensure no material conflicts exist among share
classes. While none is expected, the board will act appropriately to resolve any
material conflict that may arise.
The name, age and address of the officers and board members, as well as their
affiliations, positions held with the trust, and principal occupations during
the past five years are shown below.
Frank H. Abbott, III (78)
1045 Sansome Street, San Francisco, CA 94111
TRUSTEE
President and Director, Abbott Corporation (an investment company); director or
trustee, as the case may be, of 27 of the investment companies in the Franklin
Templeton Group of Funds; and FORMERLY, Director, MotherLode Gold Mines
Consolidated (gold mining) and Vacu-Dry Co. (food processing).
Harris J. Ashton (67)
191 Clapboard Ridge Road, Greenwich, CT 06830
TRUSTEE
Director, RBC Holdings, Inc. (bank holding company) and Bar-S Foods (meat
packing company); director or trustee, as the case may be, of 48 of the
investment companies in the Franklin Templeton Group of Funds; and FORMERLY,
President, Chief Executive Officer and Chairman of the Board, General Host
Corporation (nursery and craft centers).
S. Joseph Fortunato (66)
Park Avenue at Morris County, P.O. Box 1945
Morristown, NJ 07962-1945
TRUSTEE
Member of the law firm of Pitney, Hardin, Kipp & Szuch; director or trustee, as
the case may be, of 50 of the investment companies in the Franklin Templeton
Group of Funds.
Edith E. Holiday (47)
3239 38th Street, N.W., Washington, DC 20016
TRUSTEE
Director, Amerada Hess Corporation (exploration and refining of natural gas)
(1993-present), Hercules Incorporated (chemicals, fibers and resins)
(1993-present), Beverly Enterprises, Inc. (health care) (1995-present) and H.J.
Heinz Company (processed foods and allied products) (1994-present); director or
trustee, as the case may be, of 24 of the investment companies in the Franklin
Templeton Group of Funds; and FORMERLY, Chairman (1995-1997) and Trustee
(1993-1997), National Child Research Center, Assistant to the President of the
United States and Secretary of the Cabinet (1990-1993), General Counsel to the
United States Treasury Department (1989-1990), and Counselor to the Secretary
and Assistant Secretary for Public Affairs and Public Liaison-United States
Treasury Department (1988-1989).
*Charles B. Johnson (66)
777 Mariners Island Blvd., San Mateo, CA 94404
CHAIRMAN OF THE BOARD AND TRUSTEE
President, Chief Executive Officer and Director, Franklin Resources, Inc.;
Chairman of the Board and Director, Franklin Advisers, Inc., Franklin
Investment Advisory Services, Inc. and Franklin Templeton Distributors, Inc.;
Director, Franklin/Templeton Investor Services, Inc. and Franklin Templeton
Services, Inc.; officer and/or director or trustee, as the case may be, of
most of the other subsidiaries of Franklin Resources, Inc. and of 49 of the
investment companies in the Franklin Templeton Group of Funds.
*Rupert H. Johnson, Jr. (58)
777 Mariners Island Blvd., San Mateo, CA 94404
PRESIDENT AND TRUSTEE
Executive Vice President and Director, Franklin Resources, Inc. and Franklin
Templeton Distributors, Inc.; President and Director, Franklin Advisers, Inc.
and Franklin Investment Advisory Services, Inc.; Senior Vice President, Franklin
Advisory Services, LLC; Director, Franklin/Templeton Investor Services, Inc.;
and officer and/or director or trustee, as the case may be, of most of the other
subsidiaries of Franklin Resources, Inc. and of 52 of the investment companies
in the Franklin Templeton Group of Funds.
Frank W.T. LaHaye (70)
20833 Stevens Creek Blvd., Suite 102, Cupertino, CA 95014
TRUSTEE
General Partner, Miller & LaHaye, which is the General Partner of Peregrine
Ventures II (venture capital firm); director or trustee, as the case may be, of
27 of the investment companies in the Franklin Templeton Group of Funds; and
FORMERLY, Director, Fischer Imaging Corporation (medical imaging systems),
Digital Transmission Systems, Inc. (wireless communications) and Quarterdeck
Corporation (software firm), and General Partner, Peregrine Associates, which
was the General Partner of Peregrine Ventures (venture capital firm).
Gordon S. Macklin (71)
8212 Burning Tree Road, Bethesda, MD 20817
TRUSTEE
Director, Fund American Enterprises Holdings, Inc. (holding company), Martek
Biosciences Corporation, MCI WorldCom (information services), MedImmune, Inc.
(biotechnology), Spacehab, Inc. (aerospace services) and Real 3D (software);
director or trustee, as the case may be, of 48 of the investment companies in
the Franklin Templeton Group of Funds; and FORMERLY, Chairman, White River
Corporation (financial services) and Hambrecht and Quist Group (investment
banking), and President, National Association of Securities Dealers, Inc.
Harmon E. Burns (54)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT
Executive Vice President and Director, Franklin Resources, Inc., Franklin
Templeton Distributors, Inc. and Franklin Templeton Services, Inc.; Executive
Vice President, Franklin Advisers, Inc.; Director, Franklin Investment
Advisory Services, Inc. and Franklin/Templeton Investor Services, Inc.; and
officer and/or director or trustee, as the case may be, of most of the other
subsidiaries of Franklin Resources, Inc. and of 52 of the investment
companies in the Franklin Templeton Group of Funds.
Martin L. Flanagan (39)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
Senior Vice President and Chief Financial Officer, Franklin Resources, Inc.,
Franklin/Templeton Investor Services, Inc. and Franklin Mutual Advisers, LLC;
Executive Vice President, Chief Financial Officer and Director, Templeton
Worldwide, Inc.; Executive Vice President, Chief Operating Officer and Director,
Templeton Investment Counsel, Inc.; Executive Vice President and Chief Financial
Officer, Franklin Advisers, Inc.; Chief Financial Officer, Franklin Advisory
Services, LLC and Franklin Investment Advisory Services, Inc.; President and
Director, Franklin Templeton Services, Inc.; officer and/or director of some of
the other subsidiaries of Franklin Resources, Inc.; and officer and/or director
or trustee, as the case may be, of 52 of the investment companies in the
Franklin Templeton Group of Funds.
Deborah R. Gatzek (50)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND SECRETARY
Senior Vice President and General Counsel, Franklin Resources, Inc.; Senior Vice
President, Franklin Templeton Services, Inc. and Franklin Templeton
Distributors, Inc.; Executive Vice President, Franklin Advisers, Inc.; Vice
President, Franklin Advisory Services, LLC and Franklin Mutual Advisers, LLC;
Vice President, Chief Legal Officer and Chief Operating Officer, Franklin
Investment Advisory Services, Inc.; and officer of 53 of the investment
companies in the Franklin Templeton Group of Funds.
Thomas J. Kenny (36)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT
Executive Vice President, Franklin Advisers, Inc.; and officer of eight of the
investment companies in the Franklin Templeton Group of Funds.
Diomedes Loo-Tam (60)
777 Mariners Island Blvd., San Mateo, CA 94404
TREASURER AND PRINCIPAL ACCOUNTING OFFICER
Senior Vice President, Franklin Templeton Services, Inc.; and officer of 32 of
the investment companies in the Franklin Templeton Group of Funds.
Edward V. McVey (61)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT
Senior Vice President and National Sales Manager, Franklin Templeton
Distributors, Inc.; and officer of 28 of the investment companies in the
Franklin Templeton Group of Funds.
*This board member is considered an "interested person" under federal
securities laws.
Note: Charles B. Johnson and Rupert H. Johnson, Jr. are brothers.
The trust pays noninterested board members $1,450 per month plus $1,300 per
meeting attended. Board members who serve on the audit committee of the trust
and other funds in the Franklin Templeton Group of Funds receive a flat fee of
$2,000 per committee meeting attended, a portion of which is allocated to the
trust. Members of a committee are not compensated for any committee meeting held
on the day of a board meeting. Noninterested board members also may serve as
directors or trustees of other funds in the Franklin Templeton Group of Funds
and may receive fees from these funds for their services. The fees payable to
noninterested board members by the trust are subject to reductions resulting
from fee caps limiting the amount of fees payable to board members who serve on
other boards within the Franklin Templeton Group of Funds. The following table
provides the total fees paid to noninterested board members by the trust and by
the Franklin Templeton Group of Funds.
NUMBER OF
BOARDS IN
TOTAL FEES THE FRANKLIN
RECEIVED FROM TEMPLETON
TOTAL FEES THE FRANKLIN GROUP
RECEIVED TEMPLETON OF FUNDS
FROM GROUP ON WHICH
NAME THE TRUST 1 OF FUNDS 2 EACH SERVES 3
- ---------------------------------------------------------------------------
Frank H. Abbott, III $25,675 $159,051 27
Harris J. Ashton $26,390 $361,157 48
S. Joseph Fortunato $25,097 $367,835 50
Edith E. Holiday $28,650 $211,400 24
Frank W.T. LaHaye $26,975 $163,753 27
Gordon S. Macklin $26,390 $361,157 48
1. For the fiscal year ended February 28, 1999. During the period from March 1,
1998, through May 31, 1998, fees at the rate of $1,300 per month plus $1,300 per
board meeting attended were in effect.
2. For the calendar year ended December 31, 1998.
3. We base the number of boards on the number of registered investment
companies in the Franklin Templeton Group of Funds. This number does not include
the total number of series or funds within each investment company for which the
board members are responsible. The Franklin Templeton Group of Funds currently
includes 54 registered investment companies, with approximately 163 U.S. based
funds or series.
Noninterested board members are reimbursed for expenses incurred in connection
with attending board meetings, paid pro rata by each fund in the Franklin
Templeton Group of Funds for which they serve as director or trustee. No officer
or board member received any other compensation, including pension or retirement
benefits, directly or indirectly from the fund or other funds in the Franklin
Templeton Group of Funds. Certain officers or board members who are shareholders
of Franklin Resources, Inc. may be deemed to receive indirect remuneration by
virtue of their participation, if any, in the fees paid to its subsidiaries.
Board members historically have followed a policy of having substantial
investments in one or more of the funds in the Franklin Templeton Group of
Funds, as is consistent with their individual financial goals. In February 1998,
this policy was formalized through adoption of a requirement that each board
member invest one-third of fees received for serving as a director or trustee of
a Templeton fund in shares of one or more Templeton funds and one-third of fees
received for serving as a director or trustee of a Franklin fund in shares of
one or more Franklin funds until the value of such investments equals or exceeds
five times the annual fees paid such board member. Investments in the name of
family members or entities controlled by a board member constitute fund holdings
of such board member for purposes of this policy, and a three year phase-in
period applies to such investment requirements for newly elected board members.
In implementing such policy, a board member's fund holdings existing on February
27, 1998, are valued as of such date with subsequent investments valued at cost.
MANAGEMENT AND OTHER SERVICES
MANAGER AND SERVICES PROVIDED Each fund's manager is Franklin Advisers, Inc.
The manager is a wholly owned subsidiary of Franklin Resources, Inc.
(Resources), a publicly owned company engaged in the financial services
industry through its subsidiaries. Charles B. Johnson and Rupert H. Johnson,
Jr. are the principal shareholders of Resources.
The manager provides investment research and portfolio management services, and
selects the securities for each fund to buy, hold or sell. The manager's
extensive research activities include, as appropriate, traveling to meet with
issuers and to review project sites. The manager also selects the brokers who
execute the funds' portfolio transactions. The manager provides periodic reports
to the board, which reviews and supervises the manager's investment activities.
To protect the funds, the manager and its officers, directors and employees are
covered by fidelity insurance.
The manager and its affiliates manage numerous other investment companies and
accounts. The manager may give advice and take action with respect to any of the
other funds it manages, or for its own account, that may differ from action
taken by the manager on behalf of each fund. Similarly, with respect to each
fund, the manager is not obligated to recommend, buy or sell, or to refrain from
recommending, buying or selling any security that the manager and access
persons, as defined by applicable federal securities laws, may buy or sell for
its or their own account or for the accounts of any other fund. The manager is
not obligated to refrain from investing in securities held by the fund or other
funds it manages. Of course, any transactions for the accounts of the manager
and other access persons will be made in compliance with the funds' code of
ethics.
Under the funds' code of ethics, employees of the Franklin Templeton Group who
are access persons may engage in personal securities transactions subject to the
following general restrictions and procedures: (i) the trade must receive
advance clearance from a compliance officer and must be completed by the close
of the business day following the day clearance is granted; (ii) copies of all
brokerage confirmations and statements must be sent to a compliance officer;
(iii) all brokerage accounts must be disclosed on an annual basis; and (iv)
access persons involved in preparing and making investment decisions must, in
addition to (i), (ii) and (iii) above, file annual reports of their securities
holdings each January and inform the compliance officer (or other designated
personnel) if they own a security that is being considered for a fund or other
client transaction or if they are recommending a security in which they have an
ownership interest for purchase or sale by a fund or other client.
MANAGEMENT FEES Each fund pays the manager a fee equal to a monthly rate of:
o 5/96 of 1% of the value of its net assets up to and including $100 million;
and
o 1/24 of 1% of the value of its net assets over $100 million up to and
including $250 million; and
o 9/240 of 1% of the value of its net assets in excess of $250 million.
The fee is computed at the close of business on the last business day of each
month according to the terms of the management agreement. Each class of a fund's
shares pays its proportionate share of the fee.
For the last three fiscal years ended February 28, the funds paid the following
management fees:
MANAGEMENT FEES PAID ($)
1999 1998 1997
- ------------------------------------------------------------------------
Alabama Fund 1,332,672 1,189,527 1,079,285
Florida Fund 8,253,117 7,419,693 6,567,507
Georgia Fund 990,149 872,451 812,505
Kentucky Fund1 143,286 81,200 66,255
Louisiana Fund 908,906 758,170 692,158
Maryland Fund 1,369,242 1,166,952 1,033,178
Missouri Fund 1,860,465 1,574,188 1,416,882
North Carolina Fund 1,834,435 1,566,067 1,410,760
Texas Fund 786,294 770,725 762,188
Virginia Fund 1,958,381 1,689,780 1,519,947
1. For the fiscal years ended February 28, 1999, 1998 and 1997, management fees,
before any advance waiver, totaled $377,311, $304,904 and $260,610,
respectively. Under an agreement by the manager to limit its fees, the fund paid
the management fees shown.
ADMINISTRATOR AND SERVICES PROVIDED Franklin Templeton Services, Inc. (FT
Services) has an agreement with the manager to provide certain administrative
services and facilities for each fund. FT Services is wholly owned by Resources
and is an affiliate of the funds' manager and principal underwriter.
The administrative services FT Services provides include preparing and
maintaining books, records, and tax and financial reports, and monitoring
compliance with regulatory requirements.
ADMINISTRATION FEES The manager pays FT Services a monthly fee equal to an
annual rate of:
o 0.15% of each fund's average daily net assets up to $200 million;
o 0.135% of average daily net assets over $200 million up to $700 million;
o 0.10% of average daily net assets over $700 million up to $1.2 billion; and
o 0.075% of average daily net assets over $1.2 billion.
During the last three fiscal years ended February 28, the manager paid FT
Services the following administration fees:
ADMINISTRATION FEES PAID ($)
1999 1998 1997 1
- ------------------------------------------------------------------------
Alabama Fund 353,966 315,821 121,584
Florida Fund 1,902,604 1,761,352 691,407
Georgia Fund 257,705 223,366 88,065
Kentucky Fund 89,842 72,518 26,745
Louisiana Fund 233,010 188,768 72,596
Maryland Fund 362,711 309,059 116,248
Missouri Fund 508,048 424,634 163,365
North Carolina Fund 501,620 422,191 161,088
Texas Fund 198,223 193,355 79,386
Virginia Fund 539,321 458,682 174,841
1. For the period from October 1, 1996, through February 28, 1997.
SHAREHOLDER SERVICING AND TRANSFER AGENT Franklin/Templeton Investor Services,
Inc. (Investor Services) is each fund's shareholder servicing agent and acts as
the fund's transfer agent and dividend-paying agent. Investor Services is
located at 777 Mariners Island Blvd., San Mateo, CA 94404. Please send all
correspondence to Investor Services to P.O. Box 997151, Sacramento, CA
95899-9983.
For its services, Investor Services receives a fixed fee per account. Each fund
also will reimburse Investor Services for certain out-of-pocket expenses, which
may include payments by Investor Services to entities, including affiliated
entities, that provide sub-shareholder services, recordkeeping and/or transfer
agency services to beneficial owners of the fund. The amount of reimbursements
for these services per benefit plan participant fund account per year will not
exceed the per account fee payable by the fund to Investor Services in
connection with maintaining shareholder accounts.
CUSTODIAN Bank of New York, Mutual Funds Division, 90 Washington Street, New
York, NY 10286, acts as custodian of each fund's securities and other assets.
AUDITOR PricewaterhouseCoopers LLP, 333 Market Street, San Francisco, CA 94105,
is the funds' independent auditor. The auditor gives an opinion on the financial
statements included in the trust's Annual Report to Shareholders and reviews the
trust's registration statement filed with the U.S. Securities and Exchange
Commission (SEC).
PORTFOLIO TRANSACTIONS
Since most purchases by the funds are principal transactions at net prices, the
funds incurs little or no brokerage costs. Each fund deals directly with the
selling or buying principal or market maker without incurring charges for the
services of a broker on its behalf, unless it is determined that a better price
or execution may be obtained by using the services of a broker. Purchases of
portfolio securities from underwriters will include a commission or concession
paid by the issuer to the underwriter, and purchases from dealers will include a
spread between the bid and ask prices. As a general rule, the funds do not buy
securities in underwritings where they are given no choice, or only limited
choice, in the designation of dealers to receive the commission. The funds seek
to obtain prompt execution of orders at the most favorable net price.
Transactions may be directed to dealers in return for research and statistical
information, as well as for special services provided by the dealers in the
execution of orders.
It is not possible to place a dollar value on the special executions or on the
research services the manager receives from dealers effecting transactions in
portfolio securities. The allocation of transactions in order to obtain
additional research services allows the manager to supplement its own research
and analysis activities and to receive the views and information of individuals
and research staffs of other securities firms. As long as it is lawful and
appropriate to do so, the manager and its affiliates may use this research and
data in their investment advisory capacities with other clients. If the funds'
officers are satisfied that the best execution is obtained, the sale of fund
shares, as well as shares of other funds in the Franklin Templeton Group of
Funds, also may be considered a factor in the selection of broker-dealers to
execute the funds' portfolio transactions.
If purchases or sales of securities of the funds and one or more other
investment companies or clients supervised by the manager are considered at or
about the same time, transactions in these securities will be allocated among
the several investment companies and clients in a manner deemed equitable to all
by the manager, taking into account the respective sizes of the funds and the
amount of securities to be purchased or sold. In some cases this procedure could
have a detrimental effect on the price or volume of the security so far as the
funds are concerned. In other cases it is possible that the ability to
participate in volume transactions may improve execution and reduce transaction
costs to the funds.
During the fiscal years ended February 28, 1999, 1998 and 1997, the funds did
not pay any brokerage commissions.
As of February 28, 1999, the funds did not own securities of their regular
broker-dealers.
DISTRIBUTIONS AND TAXES
The funds calculate dividends and capital gains the same way for each class. The
amount of any income dividends per share will differ, however, generally due to
the difference in the distribution and service (Rule 12b-1) fees of each class.
The funds do not pay "interest" or guarantee any fixed rate of return on an
investment in their shares.
DISTRIBUTIONS OF NET INVESTMENT INCOME Each fund receives income generally in
the form of interest on its investments. This income, less expenses incurred in
the operation of the fund, constitutes the fund's net investment income from
which dividends may be paid to you.
By meeting certain requirements of the Internal Revenue Code, the funds have
qualified and continue to qualify to pay exempt-interest dividends to you. These
dividends are derived from interest income exempt from regular federal income
tax, and are not subject to regular federal income tax when they are distributed
to you. In addition, to the extent that exempt-interest dividends are derived
from interest on obligations of a state or its political subdivisions, or from
interest on qualifying U.S. territorial obligations (including qualifying
obligations of Puerto Rico, the U.S. Virgin Islands or Guam), they also will be
exempt from that state's personal income taxes. Most states generally do not
grant tax-free treatment to interest on state and municipal securities of other
states.
The funds may earn taxable income on any temporary investments, on the discount
from stripped obligations or their coupons, on income from securities loans or
other taxable transactions, or on ordinary income derived from the sale of
market discount bonds. Any fund distributions from such income will be taxable
to you as ordinary income, whether you receive them in cash or in additional
shares.
DISTRIBUTIONS OF CAPITAL GAINS The funds may derive capital gains and losses in
connection with sales or other dispositions of their portfolio securities.
Distributions from net short-term capital gains will be taxable to you as
ordinary income. Distributions from net long-term capital gains will be taxable
to you as long-term capital gain, regardless of how long you have held your
shares in a fund. Any net capital gains realized by a fund generally will be
distributed once each year, and may be distributed more frequently, if
necessary, in order to reduce or eliminate excise or income taxes on the fund.
INFORMATION ON THE TAX CHARACTER OF DISTRIBUTIONS The funds will inform you of
the amount of your ordinary income dividends and capital gains distributions at
the time they are paid, and will advise you of their tax status for federal
income tax purposes shortly after the close of each calendar year, including the
portion of the distributions that on average comprise taxable income or interest
income that is a tax preference item under the alternative minimum tax. If you
have not held fund shares for a full year, a fund may designate and distribute
to you, as taxable, tax-exempt or tax preference income, a percentage of income
that is not equal to the actual amount of such income earned during the period
of your investment in the fund.
ELECTION TO BE TAXED AS A REGULATED INVESTMENT COMPANY Each fund has elected to
be treated as a regulated investment company under Subchapter M of the Internal
Revenue Code, has qualified as such for its most recent fiscal year, and intends
to so qualify during the current fiscal year. As regulated investment companies,
the funds generally pay no federal income tax on the income and gains they
distribute to you. The board reserves the right not to maintain the
qualification of a fund as a regulated investment company if it determines such
course of action to be beneficial to shareholders. In such case, a fund will be
subject to federal, and possibly state, corporate taxes on its taxable income
and gains, and distributions to you will be taxed as ordinary dividend income to
the extent of the fund's earnings and profits.
EXCISE TAX DISTRIBUTION REQUIREMENTS To avoid federal excise taxes, the Internal
Revenue Code requires each fund to distribute to you by December 31 of each
year, at a minimum, the following amounts: 98% of its taxable ordinary income
earned during the calendar year; 98% of its capital gain net income earned
during the twelve month period ending October 31; and 100% of any undistributed
amounts from the prior year. Each fund intends to declare and pay these amounts
in December (or in January that are treated by you as received in December) to
avoid these excise taxes, but can give no assurances that its distributions will
be sufficient to eliminate all taxes.
REDEMPTION OF FUND SHARES Redemptions and exchanges of fund shares are taxable
transactions for federal and state income tax purposes. If you redeem your fund
shares, or exchange your fund shares for shares of a different Franklin
Templeton Fund, the IRS will require that you report a gain or loss on your
redemption or exchange. If you hold your shares as a capital asset, the gain or
loss that you realize will be capital gain or loss and will be long-term or
short-term, generally depending on how long you hold your shares. Any loss
incurred on the redemption or exchange of shares held for six months or less
will be disallowed to the extent of any exempt-interest dividends distributed to
you with respect to your fund shares and any remaining loss will be treated as a
long-term capital loss to the extent of any long-term capital gains distributed
to you by the fund on those shares.
All or a portion of any loss that you realize upon the redemption of your fund
shares will be disallowed to the extent that you buy other shares in the fund
(through reinvestment of dividends or otherwise) within 30 days before or after
your share redemption. Any loss disallowed under these rules will be added to
your tax basis in the new shares you buy.
DEFERRAL OF BASIS If you redeem some or all of your shares in a fund, and then
reinvest the sales proceeds in the fund or in another Franklin Templeton Fund
within 90 days of buying the original shares, the sales charge that would
otherwise apply to your reinvestment may be reduced or eliminated. The IRS will
require you to report gain or loss on the redemption of your original shares in
a fund. In doing so, all or a portion of the sales charge that you paid for your
original shares in a fund will be excluded from your tax basis in the shares
sold (for the purpose of determining gain or loss upon the sale of such shares).
The portion of the sales charge excluded will equal the amount that the sales
charge is reduced on your reinvestment. Any portion of the sales charge excluded
from your tax basis in the shares sold will be added to the tax basis of the
shares you acquire from your reinvestment.
DIVIDENDS-RECEIVED DEDUCTION FOR CORPORATIONS Because each fund's income
consists of interest rather than dividends, no portion of its distributions
generally will be eligible for the corporate dividends-received deduction. None
of the dividends paid by the funds for the most recent fiscal year qualified for
such deduction, and it is anticipated that none of the current year's dividends
will so qualify.
INVESTMENT IN COMPLEX SECURITIES Each fund may invest in complex securities.
These investments may be subject to numerous special and complex tax rules.
These rules could affect whether gains and losses recognized by a fund are
treated as ordinary income or capital gain, accelerate the recognition of income
to a fund and/or defer a fund's ability to recognize losses. In turn, these
rules may affect the amount, timing or character of the income distributed to
you by a fund.
TREATMENT OF PRIVATE ACTIVITY BOND INTEREST Interest on certain private activity
bonds, while still exempt from regular federal income tax, is a preference item
for taxpayers when determining their alternative minimum tax under the Internal
Revenue Code and under the income tax provisions of several states. Private
activity bond interest could subject you to or increase your liability under
federal and state alternative minimum taxes, depending on your individual or
corporate tax position. Persons who are defined in the Internal Revenue Code as
substantial users (or persons related to such users) of facilities financed by
private activity bonds should consult with their tax advisors before buying fund
shares.
ORGANIZATION, VOTING RIGHTS AND PRINCIPAL HOLDERS
Each fund is a series of Franklin Tax-Free Trust, an open-end management
investment company, commonly called a mutual fund. The trust was organized as a
Massachusetts business trust in September 1984, and is registered with the SEC.
As a shareholder of a Massachusetts business trust, you could, under certain
circumstances, be held personally liable as a partner for its obligations. The
Agreement and Declaration of Trust, however, contains an express disclaimer of
shareholder liability for acts or obligations of the fund. The Declaration of
Trust also provides for indemnification and reimbursement of expenses out of the
fund's assets if you are held personally liable for obligations of the fund. The
Declaration of Trust provides that the fund shall, upon request, assume the
defense of any claim made against you for any act or obligation of the fund and
satisfy any judgment thereon. All such rights are limited to the assets of the
fund. The Declaration of Trust further provides that the fund may maintain
appropriate insurance (for example, fidelity bonding and errors and omissions
insurance) for the protection of the fund, its shareholders, trustees, officers,
employees and agents to cover possible tort and other liabilities. Furthermore,
the activities of the fund as an investment company, as distinguished from an
operating company, would not likely give rise to liabilities in excess of the
fund's total assets. Thus, the risk that you would incur financial loss on
account of shareholder liability is limited to the unlikely circumstance in
which both inadequate insurance exists and the fund itself is unable to meet its
obligations.
Each fund, except for the Kentucky Fund, currently offers two classes of shares,
Class A and Class C. Before January 1, 1999, Class A shares were designated
Class I and Class C shares were designated Class II. The full title of each
class is:
o Franklin Alabama Tax-Free Income Fund - Class A o Franklin Alabama Tax-Free
Income Fund - Class C o Franklin Florida Tax-Free Income Fund - Class A o
Franklin Florida Tax-Free Income Fund - Class C o Franklin Georgia Tax-Free
Income Fund - Class A o Franklin Georgia Tax-Free Income Fund - Class C o
Franklin Louisiana Tax-Free Income Fund - Class A o Franklin Louisiana Tax-Free
Income Fund - Class C o Franklin Maryland Tax-Free Income Fund - Class A o
Franklin Maryland Tax-Free Income Fund - Class C o Franklin Missouri Tax-Free
Income Fund - Class A o Franklin Missouri Tax-Free Income Fund - Class C o
Franklin North Carolina Tax-Free Income Fund - Class A o Franklin North Carolina
Tax-Free Income Fund - Class C o Franklin Texas Tax-Free Income Fund - Class A o
Franklin Texas Tax-Free Income Fund - Class C o Franklin Virginia Tax-Free
Income Fund - Class A o Franklin Virginia Tax-Free Income Fund - Class C
The Kentucky Fund offers only one share class. Because its sales charge
structure and Rule 12b-1 plan are similar to those of Class A shares, shares of
the Kentucky Fund are considered Class A shares for redemption, exchange and
other purposes.
The funds may offer additional classes of shares in the future.
Shares of each class represent proportionate interests in each fund's assets. On
matters that affect the fund as a whole, each class has the same voting and
other rights and preferences as any other class. On matters that affect only one
class, only shareholders of that class may vote. Each class votes separately on
matters affecting only that class, or expressly required to be voted on
separately by state or federal law. Shares of each class of a series have the
same voting and other rights and preferences as the other classes and series of
the trust for matters that affect the trust as a whole.
Additional series may be offered in the future.
The trust has noncumulative voting rights. For board member elections, this
gives holders of more than 50% of the shares voting the ability to elect all of
the members of the board. If this happens, holders of the remaining shares
voting will not be able to elect anyone to the board.
The trust does not intend to hold annual shareholder meetings. The trust or a
series of the trust may hold special meetings, however, for matters requiring
shareholder approval. A meeting may be called by the board to consider the
removal of a board member if requested in writing by shareholders holding at
least 10% of the outstanding shares. In certain circumstances, we are required
to help you communicate with other shareholders about the removal of a board
member. A special meeting also may be called by the board in its discretion.
As of April 12, 1999, the principal shareholders of the funds, beneficial or of
record, were:
NAME AND ADDRESS SHARE CLASS PERCENTAGE (%)
Texas Fund
Family Ltd. Partnership
Alo Family Limited
4512 Teas St.
Bellaire, TX 77401-4223 Class C 6.15
PaineWebber For the Benefit of
Timothy A. Costello
9501 Bell Mountain Dr.
Austin, TX 78730-2712 Class C 5.98
From time to time, the number of fund shares held in the "street name" accounts
of various securities dealers for the benefit of their clients or in centralized
securities depositories may exceed 5% of the total shares outstanding.
As of April 12, 1999, the officers and board members, as a group, owned of
record and beneficially less than 1% of the outstanding shares of each fund and
class. The board members may own shares in other funds in the Franklin Templeton
Group of Funds.
BUYING AND SELLING SHARES
The fund continuously offers its shares through securities dealers who have an
agreement with Franklin Templeton Distributors, Inc. (Distributors). A
securities dealer includes any financial institution that, either directly or
through affiliates, has an agreement with Distributors to handle customer orders
and accounts with the fund. This reference is for convenience only and does not
indicate a legal conclusion of capacity. Banks and financial institutions that
sell shares of the fund may be required by state law to register as securities
dealers.
For investors outside the U.S., the offering of fund shares may be limited in
many jurisdictions. An investor who wishes to buy shares of the fund should
determine, or have a broker-dealer determine, the applicable laws and
regulations of the relevant jurisdiction. Investors are responsible for
compliance with tax, currency exchange or other regulations applicable to
redemption and purchase transactions in any jurisdiction to which they may be
subject. Investors should consult appropriate tax and legal advisors to obtain
information on the rules applicable to these transactions.
All checks, drafts, wires and other payment mediums used to buy or sell shares
of the fund must be denominated in U.S. dollars. We may, in our sole discretion,
either (a) reject any order to buy or sell shares denominated in any other
currency or (b) honor the transaction or make adjustments to your account for
the transaction as of a date and with a foreign currency exchange factor
determined by the drawee bank.
When you buy shares, if you submit a check or a draft that is returned unpaid to
the fund we may impose a $10 charge against your account for each returned item.
INITIAL SALES CHARGES The maximum initial sales charge is 4.25% for Class A and
1% for Class C.
The initial sales charge for Class A shares may be reduced for certain large
purchases, as described in the prospectus. We offer several ways for you to
combine your purchases in the Franklin Templeton Funds to take advantage of the
lower sales charges for large purchases. The Franklin Templeton Funds include
the U.S. registered mutual funds in the Franklin Group of Funds(R) and the
Templeton Group of Funds except Franklin Valuemark Funds, Templeton Capital
Accumulator Fund, Inc., and Templeton Variable Products Series Fund.
CUMULATIVE QUANTITY DISCOUNT. For purposes of calculating the sales charge on
Class A shares, you may combine the amount of your current purchase with the
cost or current value, whichever is higher, of your existing shares in the
Franklin Templeton Funds. You also may combine the shares of your spouse,
children under the age of 21 or grandchildren under the age of 21. If you are
the sole owner of a company, you also may add any company accounts, including
retirement plan accounts.
LETTER OF INTENT (LOI). You may buy Class A shares at a reduced sales charge by
completing the letter of intent section of your account application. A letter of
intent is a commitment by you to invest a specified dollar amount during a 13
month period. The amount you agree to invest determines the sales charge you
pay. By completing the letter of intent section of the application, you
acknowledge and agree to the following:
o You authorize Distributors to reserve 5% of your total intended purchase in
Class A shares registered in your name until you fulfill your LOI. Your
periodic statements will include the reserved shares in the total shares you
own, and we will pay or reinvest dividend and capital gain distributions on
the reserved shares according to the distribution option you have chosen.
o You give Distributors a security interest in the reserved shares and appoint
Distributors as attorney-in-fact.
o Distributors may sell any or all of the reserved shares to cover any
additional sales charge if you do not fulfill the terms of the LOI.
o Although you may exchange your shares, you may not sell reserved shares until
you complete the LOI or pay the higher sales charge.
After you file your LOI with the fund, you may buy Class A shares at the sales
charge applicable to the amount specified in your LOI. Sales charge reductions
based on purchases in more than one Franklin Templeton Fund will be effective
only after notification to Distributors that the investment qualifies for a
discount. Any Class A purchases you made within 90 days before you filed your
LOI also may qualify for a retroactive reduction in the sales charge. If you
file your LOI with the fund before a change in the fund's sales charge, you may
complete the LOI at the lower of the new sales charge or the sales charge in
effect when the LOI was filed.
Your holdings in the Franklin Templeton Funds acquired more than 90 days before
you filed your LOI will be counted towards the completion of the LOI, but they
will not be entitled to a retroactive reduction in the sales charge. Any
redemptions you make during the 13 month period will be subtracted from the
amount of the purchases for purposes of determining whether the terms of the LOI
have been completed.
If the terms of your LOI are met, the reserved shares will be deposited to an
account in your name or delivered to you or as you direct. If the amount of your
total purchases, less redemptions, is more than the amount specified in your LOI
and is an amount that would qualify for a further sales charge reduction, a
retroactive price adjustment will be made by Distributors and the securities
dealer through whom purchases were made. The price adjustment will be made on
purchases made within 90 days before and on those made after you filed your LOI
and will be applied towards the purchase of additional shares at the offering
price applicable to a single purchase or the dollar amount of the total
purchases.
If the amount of your total purchases, less redemptions, is less than the amount
specified in your LOI, the sales charge will be adjusted upward, depending on
the actual amount purchased (less redemptions) during the period. You will need
to send Distributors an amount equal to the difference in the actual dollar
amount of sales charge paid and the amount of sales charge that would have
applied to the total purchases if the total of the purchases had been made at
one time. Upon payment of this amount, the reserved shares held for your account
will be deposited to an account in your name or delivered to you or as you
direct. If within 20 days after written request the difference in sales charge
is not paid, we will redeem an appropriate number of reserved shares to realize
the difference. If you redeem the total amount in your account before you
fulfill your LOI, we will deduct the additional sales charge due from the sale
proceeds and forward the balance to you.
GROUP PURCHASES. If you are a member of a qualified group, you may buy Class A
shares at a reduced sales charge that applies to the group as a whole. The sales
charge is based on the combined dollar value of the group members' existing
investments, plus the amount of the current purchase.
A qualified group is one that:
o Was formed at least six months ago,
o Has a purpose other than buying fund shares at a discount,
o Has more than 10 members,
o Can arrange for meetings between our representatives and group members,
o Agrees to include Franklin Templeton Fund sales and other materials in
publications and mailings to its members at reduced or no cost to
Distributors,
o Agrees to arrange for payroll deduction or other bulk transmission of
investments to the fund, and
o Meets other uniform criteria that allow Distributors to achieve cost savings
in distributing shares.
WAIVERS FOR INVESTMENTS FROM CERTAIN PAYMENTS. Class A shares may be purchased
without an initial sales charge or contingent deferred sales charge (CDSC) by
investors who reinvest within 365 days:
o Dividend and capital gain distributions from any Franklin Templeton Fund. The
distributions generally must be reinvested in the same share class. Certain
exceptions apply, however, to Class C shareholders who chose to reinvest
their distributions in Class A shares of the fund before November 17, 1997,
and to Advisor Class or Class Z shareholders of a Franklin Templeton Fund who
may reinvest their distributions in the fund's Class A shares. This waiver
category also applies to Class C shares.
o Dividend or capital gain distributions from a real estate investment trust
(REIT) sponsored or advised by Franklin Properties, Inc.
o Annuity payments received under either an annuity option or from death
benefit proceeds, if the annuity contract offers as an investment option the
Franklin Valuemark Funds or the Templeton Variable Products Series Fund. You
should contact your tax advisor for information on any tax consequences that
may apply.
o Redemption proceeds from a repurchase of shares of Franklin Floating Rate
Trust, if the shares were continuously held for at least 12 months.
If you immediately placed your redemption proceeds in a Franklin Bank CD or a
Franklin Templeton money fund, you may reinvest them as described above. The
proceeds must be reinvested within 365 days from the date the CD matures,
including any rollover, or the date you redeem your money fund shares.
o Redemption proceeds from the sale of Class A shares of any of the Templeton
Global Strategy Funds if you are a qualified investor.
If you paid a CDSC when you redeemed your Class A shares from a Templeton
Global Strategy Fund, a new CDSC will apply to your purchase of fund shares
and the CDSC holding period will begin again. We will, however, credit your
fund account with additional shares based on the CDSC you previously paid and
the amount of the redemption proceeds that you reinvest.
If you immediately placed your redemption proceeds in a Franklin Templeton
money fund, you may reinvest them as described above. The proceeds must be
reinvested within 365 days from the date they are redeemed from the money
fund.
Waivers for certain investors. Class A shares also may be purchased without an
initial sales charge or CDSC by various individuals and institutions due to
anticipated economies in sales efforts and expenses, including:
o Trust companies and bank trust departments agreeing to invest in Franklin
Templeton Funds over a 13 month period at least $1 million of assets held in
a fiduciary, agency, advisory, custodial or similar capacity and over which
the trust companies and bank trust departments or other plan fiduciaries or
participants, in the case of certain retirement plans, have full or shared
investment discretion. We will accept orders for these accounts by mail
accompanied by a check or by telephone or other means of electronic data
transfer directly from the bank or trust company, with payment by federal
funds received by the close of business on the next business day following
the order.
o Any state or local government or any instrumentality, department, authority
or agency thereof that has determined the fund is a legally permissible
investment and that can only buy fund shares without paying sales charges.
Please consult your legal and investment advisors to determine if an
investment in the fund is permissible and suitable for you and the effect, if
any, of payments by the fund on arbitrage rebate calculations.
o Broker-dealers, registered investment advisors or certified financial
planners who have entered into an agreement with Distributors for clients
participating in comprehensive fee programs
o Qualified registered investment advisors who buy through a broker-dealer or
service agent who has entered into an agreement with Distributors
o Registered securities dealers and their affiliates, for their investment
accounts only
o Current employees of securities dealers and their affiliates and their family
members, as allowed by the internal policies of their employer
o Officers, trustees, directors and full-time employees of the Franklin
Templeton Funds or the Franklin Templeton Group, and their family members,
consistent with our then-current policies
o Any investor who is currently a Class Z shareholder of Franklin Mutual Series
Fund Inc. (Mutual Series), or who is a former Mutual Series Class Z
shareholder who had an account in any Mutual Series fund on October 31, 1996,
or who sold his or her shares of Mutual Series Class Z within the past 365
days
o Investment companies exchanging shares or selling assets pursuant to a
merger, acquisition or exchange offer
o Accounts managed by the Franklin Templeton Group
o Certain unit investment trusts and their holders reinvesting distributions
from the trusts
In addition, Class C shares may be purchased without an initial sales charge by
any investor who buys Class C shares through an omnibus account with Merrill
Lynch Pierce Fenner & Smith, Inc. A CDSC may apply, however, if the shares are
sold within 18 months of purchase.
SALES IN TAIWAN. Under agreements with certain banks in Taiwan, Republic of
China, each fund's shares are available to these banks' trust accounts without a
sales charge. The banks may charge service fees to their customers who
participate in the trusts. A portion of these service fees may be paid to
Distributors or one of its affiliates to help defray expenses of maintaining a
service office in Taiwan, including expenses related to local literature
fulfillment and communication facilities.
Each fund's Class A shares may be offered to investors in Taiwan through
securities advisory firms known locally as Securities Investment Consulting
Enterprises. In conformity with local business practices in Taiwan, Class A
shares may be offered with the following schedule of sales charges:
SIZE OF PURCHASE - U.S. DOLLARS SALES CHARGE (%)
- --------------------------------------------------------------------
Under $30,000 3.0
$30,000 but less than $100,000 2.0
$100,000 but less than $400,000 1.0
$400,000 or more 0
DEALER COMPENSATION Securities dealers may at times receive the entire sales
charge. A securities dealer who receives 90% or more of the sales charge may be
deemed an underwriter under the Securities Act of 1933, as amended. Financial
institutions or their affiliated brokers may receive an agency transaction fee
in the percentages indicated in the dealer compensation table in the funds'
prospectus.
Distributors may pay the following commissions, out of its own resources, to
securities dealers who initiate and are responsible for purchases of Class A
shares of $1 million or more: 0.75% on sales of $1 million to $2 million, plus
0.60% on sales over $2 million to $3 million, plus 0.50% on sales over $3
million to $50 million, plus 0.25% on sales over $50 million to $100 million,
plus 0.15% on sales over $100 million.
These breakpoints are reset every 12 months for purposes of additional
purchases.
Distributors and/or its affiliates provide financial support to various
securities dealers that sell shares of the Franklin Templeton Group of Funds.
This support is based primarily on the amount of sales of fund shares. The
amount of support may be affected by: total sales; net sales; levels of
redemptions; the proportion of a securities dealer's sales and marketing efforts
in the Franklin Templeton Group of Funds; a securities dealer's support of, and
participation in, Distributors' marketing programs; a securities dealer's
compensation programs for its registered representatives; and the extent of a
securities dealer's marketing programs relating to the Franklin Templeton Group
of Funds. Financial support to securities dealers may be made by payments from
Distributors' resources, from Distributors' retention of underwriting
concessions and, in the case of funds that have Rule 12b-1 plans, from payments
to Distributors under such plans. In addition, certain securities dealers may
receive brokerage commissions generated by fund portfolio transactions in
accordance with the rules of the National Association of Securities Dealers,
Inc.
Distributors routinely sponsors due diligence meetings for registered
representatives during which they receive updates on various Franklin Templeton
Funds and are afforded the opportunity to speak with portfolio managers.
Invitation to these meetings is not conditioned on selling a specific number of
shares. Those who have shown an interest in the Franklin Templeton Funds,
however, are more likely to be considered. To the extent permitted by their
firm's policies and procedures, registered representatives' expenses in
attending these meetings may be covered by Distributors.
CONTINGENT DEFERRED SALES CHARGE (CDSC) If you invest $1 million or more in
Class A shares, either as a lump sum or through our cumulative quantity discount
or letter of intent programs, a CDSC may apply on any shares you sell within 12
months of purchase. For Class C shares, a CDSC may apply if you sell your shares
within 18 months of purchase. The CDSC is 1% of the value of the shares sold or
the net asset value at the time of purchase, whichever is less.
CDSC WAIVERS. The CDSC for any share class generally will be waived for:
o Account fees
o Redemptions of Class A shares by investors who purchased $1 million or more
without an initial sales charge if the securities dealer of record waived its
commission in connection with the purchase
o Redemptions by the fund when an account falls below the minimum required
account size
o Redemptions following the death of the shareholder or beneficial owner
o Redemptions through a systematic withdrawal plan set up before February 1,
1995
o Redemptions through a systematic withdrawal plan set up on or after February
1, 1995, up to 1% monthly, 3% quarterly, 6% semiannually or 12% annually of
your account's net asset value depending on the frequency of your plan
EXCHANGE PRIVILEGE If you request the exchange of the total value of your
account, accrued but unpaid income dividends and capital gain distributions will
be reinvested in the fund at net asset value on the date of the exchange, and
then the entire share balance will be exchanged into the new fund. Backup
withholding and information reporting may apply.
If a substantial number of shareholders should, within a short period, sell
their fund shares under the exchange privilege, the fund might have to sell
portfolio securities it might otherwise hold and incur the additional costs
related to such transactions. On the other hand, increased use of the exchange
privilege may result in periodic large inflows of money. If this occurs, it is
each fund's general policy to initially invest this money in short-term,
tax-exempt municipal securities, unless it is believed that attractive
investment opportunities consistent with the fund's investment goals exist
immediately. This money will then be withdrawn from the short-term, tax-exempt
municipal securities and invested in portfolio securities in as orderly a manner
as is possible when attractive investment opportunities arise.
The proceeds from the sale of shares of an investment company are generally not
available until the seventh day following the sale. The funds you are seeking to
exchange into may delay issuing shares pursuant to an exchange until that
seventh day. The sale of fund shares to complete an exchange will be effected at
net asset value at the close of business on the day the request for exchange is
received in proper form.
SYSTEMATIC WITHDRAWAL PLAN Our systematic withdrawal plan allows you to sell
your shares and receive regular payments from your account on a monthly,
quarterly, semiannual or annual basis. The value of your account must be at
least $5,000 and the minimum payment amount for each withdrawal must be at least
$50. There are no service charges for establishing or maintaining a systematic
withdrawal plan. Once your plan is established, any distributions paid by the
fund will be automatically reinvested in your account.
Payments under the plan will be made from the redemption of an equivalent amount
of shares in your account, generally on the 25th day of the month in which a
payment is scheduled. If the 25th falls on a weekend or holiday, we will process
the redemption on the next business day. When you sell your shares under a
systematic withdrawal plan, it is a taxable transaction.
To avoid paying sales charges on money you plan to withdraw within a short
period of time, you may not want to set up a systematic withdrawal plan if you
plan to buy shares on a regular basis. Shares sold under the plan also may be
subject to a CDSC.
Redeeming shares through a systematic withdrawal plan may reduce or exhaust the
shares in your account if payments exceed distributions received from the fund.
This is especially likely to occur if there is a market decline. If a withdrawal
amount exceeds the value of your account, your account will be closed and the
remaining balance in your account will be sent to you. Because the amount
withdrawn under the plan may be more than your actual yield or income, part of
the payment may be a return of your investment.
You may discontinue a systematic withdrawal plan, change the amount and schedule
of withdrawal payments, or suspend one payment by notifying us by mail or by
phone at least seven business days before the end of the month preceding a
scheduled payment. The fund may discontinue a systematic withdrawal plan by
notifying you in writing and will automatically discontinue a systematic
withdrawal plan if all shares in your account are withdrawn or if the fund
receives notification of the shareholder's death or incapacity.
REDEMPTIONS IN KIND Each fund has committed itself to pay in cash (by check) all
requests for redemption by any shareholder of record, limited in amount,
however, during any 90-day period to the lesser of $250,000 or 1% of the value
of the fund's net assets at the beginning of the 90-day period. This commitment
is irrevocable without the prior approval of the U.S. Securities and Exchange
Commission (SEC). In the case of redemption requests in excess of these amounts,
the board reserves the right to make payments in whole or in part in securities
or other assets of the fund, in case of an emergency, or if the payment of such
a redemption in cash would be detrimental to the existing shareholders of the
fund. In these circumstances, the securities distributed would be valued at the
price used to compute the fund's net assets and you may incur brokerage fees in
converting the securities to cash. Redemptions in kind are taxable transactions.
The fund does not intend to redeem illiquid securities in kind. If this happens,
however, you may not be able to recover your investment in a timely manner.
SHARE CERTIFICATES We will credit your shares to your fund account. We do not
issue share certificates unless you specifically request them. This eliminates
the costly problem of replacing lost, stolen or destroyed certificates. If a
certificate is lost, stolen or destroyed, you may have to pay an insurance
premium of up to 2% of the value of the certificate to replace it.
Any outstanding share certificates must be returned to the fund if you want to
sell or exchange those shares or if you would like to start a systematic
withdrawal plan. The certificates should be properly endorsed. You can do this
either by signing the back of the certificate or by completing a share
assignment form. For your protection, you may prefer to complete a share
assignment form and to send the certificate and assignment form in separate
envelopes.
GENERAL INFORMATION If dividend checks are returned to the fund marked "unable
to forward" by the postal service, we will consider this a request by you to
change your dividend option to reinvest all distributions. The proceeds will be
reinvested in additional shares at net asset value until we receive new
instructions.
Distribution or redemption checks sent to you do not earn interest or any other
income during the time the checks remain uncashed. Neither the funds nor their
affiliates will be liable for any loss caused by your failure to cash such
checks. The funds are not responsible for tracking down uncashed checks, unless
a check is returned as undeliverable.
In most cases, if mail is returned as undeliverable we are required to take
certain steps to try to find you free of charge. If these attempts are
unsuccessful, however, we may deduct the costs of any additional efforts to find
you from your account. These costs may include a percentage of the account when
a search company charges a percentage fee in exchange for its location services.
The wiring of redemption proceeds is a special service that we make available
whenever possible. By offering this service to you, the funds are not bound to
meet any redemption request in less than the seven day period prescribed by law.
Neither the funds nor their agents shall be liable to you or any other person
if, for any reason, a redemption request by wire is not processed as described
in the prospectus.
Franklin Templeton Investor Services, Inc. (Investor Services) may pay certain
financial institutions that maintain omnibus accounts with the funds on behalf
of numerous beneficial owners for recordkeeping operations performed with
respect to such owners. For each beneficial owner in the omnibus account, the
fund may reimburse Investor Services an amount not to exceed the per account fee
that the fund normally pays Investor Services. These financial institutions also
may charge a fee for their services directly to their clients.
If you buy or sell shares through your securities dealer, we use the net asset
value next calculated after your securities dealer receives your request, which
is promptly transmitted to the fund. If you sell shares through your securities
dealer, it is your dealer's responsibility to transmit the order to the fund in
a timely fashion. Your redemption proceeds will not earn interest between the
time we receive the order from your dealer and the time we receive any required
documents. Any loss to you resulting from your dealer's failure to transmit your
redemption order to the fund in a timely fashion must be settled between you and
your securities dealer.
Certain shareholder servicing agents may be authorized to accept your
transaction request.
For institutional accounts, there may be additional methods of buying or selling
fund shares than those described in this SAI or in the prospectus.
In the event of disputes involving multiple claims of ownership or authority to
control your account, the fund has the right (but has no obligation) to: (a)
freeze the account and require the written agreement of all persons deemed by
the fund to have a potential property interest in the account, before executing
instructions regarding the account; (b) interplead disputed funds or accounts
with a court of competent jurisdiction; or (c) surrender ownership of all or a
portion of the account to the IRS in response to a notice of levy.
PRICING SHARES
When you buy shares, you pay the offering price. The offering price is the net
asset value (NAV) per share plus any applicable sales charge, calculated to two
decimal places using standard rounding criteria. When you sell shares, you
receive the NAV minus any applicable CDSC.
The value of a mutual fund is determined by deducting the fund's liabilities
from the total assets of the portfolio. The net asset value per share is
determined by dividing the net asset value of the fund by the number of shares
outstanding.
Each fund calculates the NAV per share of each class each business day at the
close of trading on the New York Stock Exchange (normally 1:00 p.m. pacific
time). The funds do not calculate the NAV on days the New York Stock Exchange
(NYSE) is closed for trading, which include New Year's Day, Martin Luther King
Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day and Christmas Day.
When determining its NAV, each fund values cash and receivables at their
realizable amounts, and records interest as accrued. Each fund values
over-the-counter portfolio securities within the range of the most recent quoted
bid and ask prices. If portfolio securities trade both in the over-the-counter
market and on a stock exchange, each fund values them according to the broadest
and most representative market as determined by the manager. Municipal
securities generally trade in the over-the-counter market rather than on a
securities exchange. In the absence of a sale or reported bid and ask prices,
information with respect to bond and note transactions, quotations from bond
dealers, market transactions in comparable securities, and various relationships
between securities are used to determine the value of municipal securities.
Generally, trading in U.S. government securities and money market instruments is
substantially completed each day at various times before the close of the NYSE.
The value of these securities used in computing the NAV is determined as of such
times. Occasionally, events affecting the values of these securities may occur
between the times at which they are determined and the close of the NYSE that
will not be reflected in the computation of the NAV. If events materially
affecting the values of these securities occur during this period, the
securities will be valued at their fair value as determined in good faith by the
board.
Other securities for which market quotations are readily available are valued at
the current market price, which may be obtained from a pricing service, based on
a variety of factors including recent trades, institutional size trading in
similar types of securities (considering yield, risk and maturity) and/or
developments related to specific issues. Securities and other assets for which
market prices are not readily available are valued at fair value as determined
following procedures approved by the board. With the approval of the board, each
fund may use a pricing service, bank or securities dealer to perform any of the
above described functions.
THE UNDERWRITER
Franklin Templeton Distributors, Inc. (Distributors) acts as the principal
underwriter in the continuous public offering of each fund's shares.
Distributors is located at 777 Mariners Island Blvd., San Mateo, CA 94404.
Distributors pays the expenses of the distribution of fund shares, including
advertising expenses and the costs of printing sales material and prospectuses
used to offer shares to the public. Each fund pays the expenses of preparing and
printing amendments to its registration statements and prospectuses (other than
those necessitated by the activities of Distributors) and of sending
prospectuses to existing shareholders.
The table below shows the aggregate underwriting commissions Distributors
received in connection with the offering of the funds' shares, the net
underwriting discounts and commissions Distributors retained after allowances to
dealers, and the amounts Distributors received in connection with redemptions or
repurchases of shares for the last three fiscal years ended February 28:
AMOUNT
RECEIVED IN
CONNECTION
WITH
TOTAL AMOUNT REDEMPTIONS
COMMISSIONS RETAINED BY AND
RECEIVED DISTRIBUTORS REPURCHASES
($) ($) ($)
- ----------------------------------------------------------------------
1999
Alabama Fund 1,184,364 76,087 3,487
Florida Fund 5,317,330 337,465 35,807
Georgia Fund 760,914 42,248 11,492
Kentucky Fund 343,647 22,834 -
Louisiana Fund 716,996 46,235 3,048
Maryland Fund 1,309,307 82,392 10,749
Missouri Fund 1,996,212 120,370 5,859
North Carolina Fund 1,781,352 100,011 14,317
Texas Fund 282,886 17,460 1,125
Virginia Fund 1,754,574 110,385 10,724
1998
Alabama Fund 893,841 55,956 3,262
Florida Fund 6,501,473 424,153 7,601
Georgia Fund 705,553 42,875 1,464
Kentucky Fund 354,892 24,682 -
Louisiana Fund 568,856 37,815 1,321
Maryland Fund 1,009,222 62,026 3,096
Missouri Fund 1,652,316 103,117 3,562
North Carolina Fund 1,557,597 95,165 6,473
Texas Fund 310,914 20,220 1,447
Virginia Fund 1,501,600 93,973 3,561
1997
Alabama Fund 714,659 46,026 859
Florida Fund 4,989,349 320,319 13,709
Georgia Fund 589,639 36,558 688
Kentucky Fund 263,208 16,972 -
Louisiana Fund 503,212 30,444 5,331
Maryland Fund 925,907 55,499 2,211
Missouri Fund 1,133,635 71,462 2,759
North Carolina Fund 1,199,579 73,060 1,322
Texas Fund 254,844 16,652 16
Virginia Fund 1,202,582 76,437 1,039
Distributors may be entitled to reimbursement under the Rule 12b-1 plans, as
discussed below. Except as noted, Distributors received no other compensation
from the fund for acting as underwriter.
DISTRIBUTION AND SERVICE (12B-1) FEES Each class has a separate distribution or
"Rule 12b-1" plan. Under each plan, the fund shall pay or may reimburse
Distributors or others for the expenses of activities that are primarily
intended to sell shares of the class. These expenses may include, among others,
distribution or service fees paid to securities dealers or others who have
executed a servicing agreement with the fund, Distributors or its affiliates; a
prorated portion of Distributors' overhead expenses; and the expenses of
printing prospectuses and reports used for sales purposes, and preparing and
distributing sales literature and advertisements.
The distribution and service (12b-1) fees charged to each class are based only
on the fees attributable to that particular class.
THE CLASS A PLAN. Payments by each fund under the Class A plan may not exceed
0.10% per year of Class A's average daily net assets, payable quarterly. All
distribution expenses over this amount will be borne by those who have incurred
them.
In implementing the Class A plan, the board has determined that the annual fees
payable under the plan will be equal to the sum of: (i) the amount obtained by
multiplying 0.10% by the average daily net assets represented by the fund's
Class A shares that were acquired by investors on or after May 1, 1994, the
effective date of the plan (new assets), and (ii) the amount obtained by
multiplying 0.05% by the average daily net assets represented by the fund's
Class A shares that were acquired before May 1, 1994 (old assets). These fees
will be paid to the current securities dealer of record on the account. In
addition, until such time as the maximum payment of 0.10% is reached on a yearly
basis, up to an additional 0.02% will be paid to Distributors under the plan.
When the fund reaches $4 billion in assets, the amount to be paid to
Distributors will be reduced from 0.02% to 0.01%. The payments made to
Distributors will be used by Distributors to defray other marketing expenses
that have been incurred in accordance with the plan, such as advertising.
The fee is a Class A expense. This means that all Class A shareholders,
regardless of when they purchased their shares, will bear Rule 12b-1 expenses at
the same rate. The initial rate will be at least 0.07% (0.05% plus 0.02%) of the
average daily net assets of Class A and, as Class A shares are sold on or after
May 1, 1994, will increase over time. Thus, as the proportion of Class A shares
purchased on or after May 1, 1994, increases in relation to outstanding Class A
shares, the expenses attributable to payments under the plan also will increase
(but will not exceed 0.10% of average daily net assets). While this is the
currently anticipated calculation for fees payable under the Class A plan, the
plan permits the board to allow the fund to pay a full 0.10% on all assets at
any time. The approval of the board would be required to change the calculation
of the payments to be made under the Class A plan.
The Class A plan does not permit unreimbursed expenses incurred in a particular
year to be carried over to or reimbursed in later years.
THE CLASS C PLAN. Under the Class C plans, the fund pays Distributors up to
0.50% per year of the class's average daily net assets, payable quarterly, to
pay Distributors or others for providing distribution and related services and
bearing certain expenses. All distribution expenses over this amount will be
borne by those who have incurred them. The fund also may pay a servicing fee of
up to 0.15% per year of the class's average daily net assets, payable quarterly.
This fee may be used to pay securities dealers or others for, among other
things, helping to establish and maintain customer accounts and records, helping
with requests to buy and sell shares, receiving and answering correspondence,
monitoring dividend payments from the fund on behalf of customers, and similar
servicing and account maintenance activities.
The expenses relating to the Class C plan also are used to pay Distributors for
advancing the commission costs to securities dealers with respect to the initial
sale of Class C shares.
THE CLASS A AND C PLANS. In addition to the payments that Distributors or others
are entitled to under each plan, each plan also provides that to the extent the
fund, the manager or Distributors or other parties on behalf of the fund, the
manager or Distributors make payments that are deemed to be for the financing of
any activity primarily intended to result in the sale of fund shares within the
context of Rule 12b-1 under the Investment Company Act of 1940, as amended, then
such payments shall be deemed to have been made pursuant to the plan. The terms
and provisions of each plan relating to required reports, term, and approval are
consistent with Rule 12b-1.
In no event shall the aggregate asset-based sales charges, which include
payments made under each plan, plus any other payments deemed to be made
pursuant to a plan, exceed the amount permitted to be paid under the rules of
the National Association of Securities Dealers, Inc.
To the extent fees are for distribution or marketing functions, as distinguished
from administrative servicing or agency transactions, certain banks will not be
entitled to participate in the plans as a result of applicable federal law
prohibiting certain banks from engaging in the distribution of mutual fund
shares. These banking institutions, however, are permitted to receive fees under
the plans for administrative servicing or for agency transactions. If you are a
customer of a bank that is prohibited from providing these services, you would
be permitted to remain a shareholder of the fund, and alternate means for
continuing the servicing would be sought. In this event, changes in the services
provided might occur and you might no longer be able to avail yourself of any
automatic investment or other services then being provided by the bank. It is
not expected that you would suffer any adverse financial consequences as a
result of any of these changes.
Each plan has been approved in accordance with the provisions of Rule 12b-1. The
plans are renewable annually by a vote of the board, including a majority vote
of the board members who are not interested persons of the fund and who have no
direct or indirect financial interest in the operation of the plans, cast in
person at a meeting called for that purpose. It is also required that the
selection and nomination of such board members be done by the noninterested
members of the fund's board. The plans and any related agreement may be
terminated at any time, without penalty, by vote of a majority of the
noninterested board members on not more than 60 days' written notice, by
Distributors on not more than 60 days' written notice, by any act that
constitutes an assignment of the management agreement with the manager or by
vote of a majority of the outstanding shares of the class. Distributors or any
dealer or other firm also may terminate their respective distribution or service
agreement at any time upon written notice.
The plans and any related agreements may not be amended to increase materially
the amount to be spent for distribution expenses without approval by a majority
of the outstanding shares of the class, and all material amendments to the plans
or any related agreements shall be approved by a vote of the noninterested board
members, cast in person at a meeting called for the purpose of voting on any
such amendment.
Distributors is required to report in writing to the board at least quarterly on
the amounts and purpose of any payment made under the plans and any related
agreements, as well as to furnish the board with such other information as may
reasonably be requested in order to enable the board to make an informed
determination of whether the plans should be continued.
For the fiscal year ended February 28, 1999, Distributors' eligible expenditures
for advertising, printing, and payments to underwriters and broker-dealers
pursuant to the plans and the amounts the funds paid Distributors under the
plans were:
DISTRIBUTORS' AMOUNT
ELIGIBLE PAID BY THE
EXPENSES ($) FUND ($)
- ------------------------------------------------------------------
Alabama Fund - Class A 263,806 208,274
Alabama Fund - Class C 117,792 75,909
Florida Fund - Class A 1,923,363 1,556,429
Florida Fund - Class C 647,063 430,592
Georgia Fund - Class A 246,069 150,648
Georgia Fund - Class C 162,210 82,938
DISTRIBUTORS' AMOUNT
ELIGIBLE PAID BY THE
EXPENSES ($) FUND ($)
- ----------------------------------------------------------------
Kentucky Fund 124,230 59,051
Louisiana Fund - Class A 193,708 130,917
Louisiana Fund - Class C 94,882 46,261
Maryland Fund - Class A 314,716 223,888
Maryland Fund - Class C 151,286 88,149
Missouri Fund - Class A 427,164 312,809
Missouri Fund - Class C 175,293 93,317
North Carolina Fund - Class A 388,615 303,507
North Carolina Fund - Class C 332,645 183,005
Texas Fund - Class A 177,070 111,102
Texas Fund - Class C 48,823 21,057
Virginia Fund - Class A 409,989 326,787
Virginia Fund - Class C 180,589 109,653
PERFORMANCE
Performance quotations are subject to SEC rules. These rules require the use of
standardized performance quotations or, alternatively, that every
non-standardized performance quotation furnished by the fund be accompanied by
certain standardized performance information computed as required by the SEC.
Average annual total return and current yield quotations used by the funds are
based on the standardized methods of computing performance mandated by the SEC.
Performance figures reflect Rule 12b-1 fees from the date of the plan's
implementation. An explanation of these and other methods used by the fund to
compute or express performance follows. Regardless of the method used, past
performance does not guarantee future results, and is an indication of the
return to shareholders only for the limited historical period used.
AVERAGE ANNUAL TOTAL RETURN Average annual total return is determined by finding
the average annual rates of return over the periods indicated below that would
equate an initial hypothetical $1,000 investment to its ending redeemable value.
The calculation assumes the maximum initial sales charge is deducted from the
initial $1,000 purchase, and income dividends and capital gain distributions are
reinvested at net asset value. The quotation assumes the account was completely
redeemed at the end of each period and the deduction of all applicable charges
and fees. If a change is made to the sales charge structure, historical
performance information will be restated to reflect the maximum initial sales
charge currently in effect.
When considering the average annual total return quotations, you should keep in
mind that the maximum initial sales charge reflected in each quotation is a one
time fee charged on all direct purchases, which will have its greatest impact
during the early stages of your investment. This charge will affect actual
performance less the longer you retain your investment in the fund. The average
annual total returns for the indicated periods ended February 28, 1999, were:
INCEPTION 1 5 10 SINCE
DATE YEAR YEARS YEARS INCEPTION
- ------------------------------------------------------------------------------
CLASS A
Alabama Fund 09/01/87 -1.17% 4.87% 7.00% 7.28%
Florida Fund 09/01/87 1.23% 5.26% 7.32% 7.67%
Georgia Fund 09/01/87 0.73% 4.91% 7.13% 7.37%
Kentucky Fund 10/12/91 1.01% 5.36% - 6.93%
Louisiana Fund 09/01/87 0.71% 4.96% 7.16% 7.35%
Maryland Fund 10/03/88 1.13% 5.28% 7.23% 7.07%
Missouri Fund 09/01/87 0.67% 5.30% 7.43% 7.53%
North Carolina Fund 09/01/87 1.03% 5.05% 7.10% 7.44%
Texas Fund 09/01/87 0.39% 5.18% 7.22% 7.56%
Virginia Fund 09/01/87 0.90% 5.07% 7.26% 7.49%
SINCE
INCEPTION
1 YEAR (5/1/95)
- ------------------------------------------------------------------------------
CLASS C
Alabama Fund 0.64% 6.02%
Florida Fund 3.18% 6.45%
Georgia Fund 2.69% 6.05%
Louisiana Fund 2.55% 6.42%
Maryland Fund 3.06% 6.65%
Missouri Fund 2.58% 6.62%
North Carolina Fund 3.01% 6.45%
Texas Fund 2.38% 6.62%
Virginia Fund 2.75% 6.37%
The following SEC formula was used to calculate these figures:
n
P(1+T) = ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000
payment made at the beginning of each period at the end of each period
CUMULATIVE TOTAL RETURN Like average annual total return, cumulative total
return assumes the maximum initial sales charge is deducted from the initial
$1,000 purchase, and income dividends and capital gain distributions are
reinvested at net asset value. Cumulative total return, however, is based on the
actual return for a specified period rather than on the average return over the
periods indicated above. The cumulative total returns for the indicated periods
ended February 28, 1999, were:
INCEPTION 1 5 10 SINCE
DATE YEAR YEARS YEARS INCEPTION
- -----------------------------------------------------------------------------
CLASS A
Alabama Fund 09/01/87 -1.17% 26.87% 96.75% 124.27%
Florida Fund 09/01/87 1.23% 29.19% 102.72% 133.89%
Georgia Fund 09/01/87 0.73% 27.08% 99.05% 126.53%
Kentucky Fund 10/12/91 1.01% 29.80% - 64.03%
Louisiana Fund 09/01/87 0.71% 27.41% 99.63% 125.85%
Maryland Fund 10/03/88 1.13% 29.35% 100.93% 103.59%
Missouri Fund 09/01/87 0.67% 29.44% 104.68% 130.29%
North Carolina Fund 09/01/87 1.03% 27.93% 98.56% 128.26%
Texas Fund 09/01/87 0.39% 28.72% 100.73% 131.17%
Virginia Fund 09/01/87 0.90% 28.06% 101.49% 129.29%
SINCE
INCEPTION
1 YEAR (5/1/95)
- -----------------------------------------------------------------------------
CLASS C
Alabama Fund 0.64% 25.09%
Florida Fund 3.18% 27.03%
Georgia Fund 2.69% 25.22%
Louisiana Fund 2.55% 26.92%
Maryland Fund 3.06% 27.95%
Missouri Fund 2.58% 27.84%
North Carolina Fund 3.01% 27.07%
Texas Fund 2.38% 27.83%
Virginia Fund 2.75% 26.66%
CURRENT YIELD Current yield shows the income per share earned by a fund. It is
calculated by dividing the net investment income per share earned during a
30-day base period by the applicable maximum offering price per share on the
last day of the period and annualizing the result. Expenses accrued for the
period include any fees charged to all shareholders of the class during the base
period. The yields for the 30-day period ended February 28, 1999, were:
CLASS A CLASS C
Alabama Fund 4.14% 3.72%
Florida Fund 3.78% 3.35%
Georgia Fund 3.85% 3.43%
Kentucky Fund 3.99% -
Louisiana Fund 4.11% 3.69%
Maryland Fund 3.86% 3.45%
Missouri Fund 3.95% 3.53%
North Carolina Fund 3.83% 3.41%
Texas Fund 3.94% 3.52%
Virginia Fund 3.95% 3.53%
The following SEC formula was used to calculate these figures:
6
Yield = 2 [(a-b + 1) - 1]
---
cd
where:
a = interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the period that were
entitled to receive dividends
d = the maximum offering price per share on the last day of the period
TAXABLE-EQUIVALENT YIELD Each fund also may quote a taxable-equivalent yield
that shows the before-tax yield that would have to be earned from a taxable
investment to equal the yield. Taxable-equivalent yield is computed by dividing
the portion of the yield that is tax-exempt by one minus the highest applicable
combined federal and state income tax rate and adding the product to the portion
of the yield that is not tax-exempt, if any. The taxable-equivalent yields for
the 30-day period ended February 28, 1999, were:
CLASS A CLASS C
- ------------------------------------------------------
Alabama Fund 7.22% 6.48%
Florida Fund 6.26% 5.55%
Georgia Fund 6.78% 6.04%
Kentucky Fund 7.03% -
Louisiana Fund 7.24% 6.50%
Maryland Fund 6.93% 6.19%
Missouri Fund 6.96% 6.22%
North Carolina Fund 6.87% 6.12%
Texas Fund 6.52% 5.83%
Virginia Fund 6.94% 6.20%
As of February 28, 1999, the combined federal and state income tax rate upon
which the taxable-equivalent yield quotations are based were as follows:
COMBINED RATE
- ---------------------------------------
Alabama Fund 42.6%
Florida Fund 39.6%
Georgia Fund 43.2%
Kentucky Fund 43.2%
Louisiana Fund 43.2%
Maryland Fund 44.3%
Missouri Fund 43.2%
North Carolina Fund 44.3%
Texas Fund 39.6%
Virginia Fund 43.1%
From time to time, as any changes to the rate become effective,
taxable-equivalent yield quotations advertised by the funds will be updated to
reflect these changes. The funds expect updates may be necessary as tax rates
are changed by federal and state governments. The advantage of tax-free
investments, like the funds, will be enhanced by any tax rate increases.
Therefore, the details of specific tax increases may be used in sales material
for the funds.
CURRENT DISTRIBUTION RATE Current yield and taxable-equivalent yield, which are
calculated according to a formula prescribed by the SEC, are not indicative of
the amounts which were or will be paid to shareholders. Amounts paid to
shareholders are reflected in the quoted current distribution rate or
taxable-equivalent distribution rate. The current distribution rate is usually
computed by annualizing the dividends paid per share by a class during a certain
period and dividing that amount by the current maximum offering price. The
current distribution rate differs from the current yield computation because it
may include distributions to shareholders from sources other than interest, if
any, and is calculated over a different period of time. The current distribution
rates for the 30-day period ended February 28, 1999, were:
CLASS A CLASS C
- ----------------------------------------------------
Alabama Fund 4.92% 4.47%
Florida Fund 4.82% 4.38%
Georgia Fund 4.71% 4.33%
Kentucky Fund 4.86% -
Louisiana Fund 4.86% 4.41%
Maryland Fund 4.53% 4.08%
Missouri Fund 4.71% 4.29%
North Carolina Fund 4.68% 4.23%
Texas Fund 4.88% 4.39%
Virginia Fund 4.69% 4.27%
A taxable-equivalent distribution rate shows the taxable distribution rate
equivalent to the current distribution rate. The advertised taxable-equivalent
distribution rate will reflect the most current federal and state tax rates
available to the fund. The taxable-equivalent distribution rates for the 30-day
period ended February 28, 1999, were:
CLASS A CLASS C
- -------------------------------------------------------
Alabama Fund 8.57% 7.79%
Florida Fund 7.98% 7.25%
Georgia Fund 8.30% 7.63%
Kentucky Fund 8.56% -
Louisiana Fund 8.56% 7.77%
Maryland Fund 8.13% 7.32%
Missouri Fund 8.30% 7.56%
North Carolina Fund 8.40% 7.59%
Texas Fund 8.08% 7.27%
Virginia Fund 8.24% 7.50%
VOLATILITY Occasionally statistics may be used to show a fund's volatility or
risk. Measures of volatility or risk are generally used to compare a fund's net
asset value or performance to a market index. One measure of volatility is beta.
Beta is the volatility of a fund relative to the total market, as represented by
an index considered representative of the types of securities in which the fund
invests. A beta of more than 1.00 indicates volatility greater than the market
and a beta of less than 1.00 indicates volatility less than the market. Another
measure of volatility or risk is standard deviation. Standard deviation is used
to measure variability of net asset value or total return around an average over
a specified period of time. The idea is that greater volatility means greater
risk undertaken in achieving performance.
OTHER PERFORMANCE QUOTATIONS The funds also may quote the performance of shares
without a sales charge. Sales literature and advertising may quote a cumulative
total return, average annual total return and other measures of performance with
the substitution of net asset value for the public offering price.
Each fund may include in its advertising or sales material information relating
to investment goals and performance results of funds belonging to the Franklin
Templeton Group of Funds. Franklin Resources, Inc. is the parent company of the
advisors and underwriter of the Franklin Templeton Group of Funds.
COMPARISONS To help you better evaluate how an investment in the fund may
satisfy your investment goal, advertisements and other materials about the fund
may discuss certain measures of fund performance as reported by various
financial publications. Materials also may compare performance (as calculated
above) to performance as reported by other investments, indices and averages.
These comparisons may include, but are not limited to, the following examples:
o Salomon Brothers Broad Bond Index or its component indices - measures yield,
price and total return for Treasury, agency, corporate and mortgage bonds.
o Lehman Brothers Aggregate Bond Index or its component indices - measures
yield, price and total return for Treasury, agency, corporate, mortgage and
Yankee bonds.
o Lehman Brothers Municipal Bond Index or its component indices - measures
yield, price and total return for the municipal bond market.
o Bond Buyer 20 Index - an index of municipal bond yields based upon yields of
20 general obligation bonds maturing in 20 years.
o Bond Buyer 40 Index - an index composed of the yield to maturity of 40 bonds.
The index attempts to track the new-issue market as closely as possible, so
it changes bonds twice a month, adding all new bonds that meet certain
requirements and deleting an equivalent number according to their secondary
market trading activity. As a result, the average par call date, average
maturity date, and average coupon rate can and have changed over time. The
average maturity generally has been about 29-30 years.
o Financial publications: THE WALL STREET JOURNAL, AND BUSINESS WEEK, FINANCIAL
WORLD, FORBES, FORTUNE, AND MONEY MAGAZINES - provide performance statistics
over specified time periods.
o Salomon Brothers Composite High Yield Index or its component indices measures
yield, price and total return for the Long-Term High-Yield Index,
Intermediate-Term High-Yield Index, and Long-Term Utility High-Yield Index.
o Historical data supplied by the research departments of CS First Boston
Corporation, the J. P. Morgan companies, Salomon Brothers, Merrill Lynch,
Lehman Brothers and Bloomberg L.P.
o Morningstar - information published by Morningstar, Inc., including
Morningstar proprietary mutual fund ratings. The ratings reflect
Morningstar's assessment of the historical risk-adjusted performance of a
fund over specified time periods relative to other funds within its category.
o Lipper - Mutual Fund Performance Analysis and Lipper - Fixed Income Fund
Performance Analysis - measure total return and average current yield for the
mutual fund industry and rank individual mutual fund performance over
specified time periods, assuming reinvestment of all distributions, exclusive
of any applicable sales charges.
o Savings and Loan Historical Interest Rates - as published in the U.S.
Savings & Loan League Fact Book.
o Consumer Price Index (or Cost of Living Index), published by the U.S. Bureau
of Labor Statistics - a statistical measure of change, over time, in the
price of goods and services in major expenditure groups.
o CDA Mutual Fund Report, published by CDA Investment Technologies, Inc.
analyzes price, current yield, risk, total return, and average rate of return
(average annual compounded growth rate) over specified time periods for the
mutual fund industry.
o Standard & Poor's Bond Indices - measure yield and price of corporate,
municipal, and government bonds.
From time to time, advertisements or information for each fund may include a
discussion of certain attributes or benefits to be derived from an investment in
the fund. The advertisements or information may include symbols, headlines, or
other material that highlights or summarizes the information discussed in more
detail in the communication.
Advertisements or sales material issued by each fund also may discuss or be
based upon information in a recent issue of the Special Report on Tax Freedom
Day published by the Tax Foundation, a Washington, D.C. based nonprofit research
and public education organization. The report illustrates, among other things,
the annual amount of time the average taxpayer works to satisfy his or her tax
obligations to the federal, state and local taxing authorities.
Advertisements or information also may compare each fund's performance to the
return on certificates of deposit (CDs) or other investments. You should be
aware, however, that an investment in the fund involves the risk of fluctuation
of principal value, a risk generally not present in an investment in a CD issued
by a bank. For example, as the general level of interest rates rise, the value
of the fund's fixed-income investments, as well as the value of its shares that
are based upon the value of such portfolio investments, can be expected to
decrease. Conversely, when interest rates decrease, the value of the fund's
shares can be expected to increase. CDs are frequently insured by an agency of
the U.S. government. An investment in a fund is not insured by any federal,
state or private entity.
In assessing comparisons of performance, you should keep in mind that the
composition of the investments in the reported indices and averages is not
identical to any fund's portfolio, the indices and averages are generally
unmanaged, and the items included in the calculations of the averages may not be
identical to the formula used by a fund to calculate its figures. In addition,
there can be no assurance that a fund will continue its performance as compared
to these other averages.
MISCELLANEOUS INFORMATION
The funds may help you achieve various investment goals such as accumulating
money for retirement, saving for a down payment on a home, college costs and
other long-term goals. The Franklin College Costs Planner may help you in
determining how much money must be invested on a monthly basis in order to have
a projected amount available in the future to fund a child's college education.
(Projected college cost estimates are based upon current costs published by the
College Board.) The Franklin Retirement Planning Guide leads you through the
steps to start a retirement savings program. Of course, an investment in the
funds cannot guarantee that these goals will be met.
The funds are members of the Franklin Templeton Group of Funds, one of the
largest mutual fund organizations in the U.S., and may be considered in a
program for diversification of assets. Founded in 1947, Franklin is one of the
oldest mutual fund organizations and now services more than 4 million
shareholder accounts. In 1992, Franklin, a leader in managing fixed-income
mutual funds and an innovator in creating domestic equity funds, joined forces
with Templeton, a pioneer in international investing. The Mutual Series team,
known for its value-driven approach to domestic equity investing, became part of
the organization four years later. Together, the Franklin Templeton Group has
over $227 billion in assets under management for more than 7 million U.S. based
mutual fund shareholder and other accounts. The Franklin Templeton Group of
Funds offers 113 U.S. based open-end investment companies to the public. Each
fund may identify itself by its NASDAQ symbol or CUSIP number.
Franklin is a leader in the tax-free mutual fund industry and manages more than
$51 billion in municipal security assets for over three quarters of a million
investors. According to Research and Ratings Review, Franklin had one of the
largest staffs of municipal securities analysts in the industry, as of June 30,
1998.
Under current tax laws, municipal securities remain one of the few investments
offering the potential for tax-free income. In 1999, taxes could cost almost $47
on every $100 earned from a fully taxable investment (based on the maximum
combined 39.6% federal tax rate and the highest state tax rate of 12% for 1999).
Franklin tax-free funds, however, offer tax relief through a professionally
managed portfolio of tax-free securities selected based on their yield, quality
and maturity. An investment in a Franklin tax-free fund can provide you with the
potential to earn income free of federal taxes and, depending on the fund, state
and local taxes as well, while supporting state and local public projects.
Franklin tax-free funds also may provide tax-free compounding, when dividends
are reinvested. An investment in Franklin's tax-free funds can grow more rapidly
than similar taxable investments.
Municipal securities are generally considered to be creditworthy, second in
quality only to securities issued or guaranteed by the U.S. government and its
agencies. The market price of municipal securities, however, may fluctuate. This
fluctuation will have a direct impact on the net asset value of the fund's
shares.
Currently, there are more mutual funds than there are stocks listed on the New
York Stock Exchange. While many of them have similar investment goals, no two
are exactly alike. Shares of the fund are generally sold through securities
dealers, whose investment representatives are experienced professionals who can
offer advice on the type of investments suitable to your unique goals and needs,
as well as the risks associated with such investments.
The Information Services & Technology division of Franklin Resources, Inc.
(Resources) established a Year 2000 Project Team in 1996. This team has already
begun making necessary software changes to help the computer systems that
service the fund and its shareholders to be Year 2000 compliant. After
completing these modifications, comprehensive tests are conducted in one of
Resources' U.S. test labs to verify their effectiveness. Resources continues to
seek reasonable assurances from all major hardware, software or data-services
suppliers that they will be Year 2000 compliant on a timely basis. Resources is
also beginning to develop a contingency plan, including identification of those
mission critical systems for which it is practical to develop a contingency
plan. However, in an operation as complex and geographically distributed as
Resources' business, the alternatives to use of normal systems, especially
mission critical systems, or supplies of electricity or long distance voice and
data lines are limited.
DESCRIPTION OF RATINGS
MUNICIPAL BOND RATINGS
MOODY'S INVESTORS SERVICE, INC. (MOODY'S)
Aaa: Municipal bonds rated Aaa 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 exceptionally stable
margin, and 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: Municipal bonds rated Aa are judged to be 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, fluctuation of protective elements may be of
greater amplitude, or there may be other elements present that make the
long-term risks appear somewhat larger.
A: Municipal bonds rated A possess many favorable investment attributes and are
considered upper medium-grade obligations. Factors giving security to principal
and interest are considered adequate, but elements may be present that suggest a
susceptibility to impairment sometime in the future.
Baa: Municipal bonds rated Baa are considered medium-grade obligations. 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.
These bonds lack outstanding investment characteristics and, in fact, have
speculative characteristics as well.
Ba: Municipal bonds rated Ba are judged to have predominantly speculative
elements and their future cannot be considered well assured. Often the
protection of interest and principal payments may be very moderate and, thereby,
not well safeguarded during both good and bad times over the future. Uncertainty
of position characterizes bonds in this class.
B: Municipal bonds rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa: Municipal bonds rated Caa are of poor standing. These issues may be in
default or there may be present elements of danger with respect to principal
or interest.
Ca: Municipal bonds rated Ca represent obligations that are speculative to a
high degree. These issues are often in default or have other marked
shortcomings.
C: Municipal bonds rated C are the lowest-rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Con.(-): Municipal 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 that begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon the
completion of construction or the elimination of the basis of the condition.
STANDARD & POOR'S CORPORATION (S&P)
AAA: Municipal bonds rated AAA are the highest-grade obligations. They
possess the ultimate degree of protection as to principal and interest. In
the market, they move with interest rates and, hence, provide the maximum
safety on all counts.
AA: Municipal bonds rated AA also qualify as high-grade obligations, and in the
majority of instances differ from AAA issues only in a small degree. Here, too,
prices move with the long-term money market.
A: Municipal bonds rated A are regarded as upper medium-grade. They have
considerable investment strength but are not entirely free from adverse effects
of changes in economic and trade conditions. Interest and principal are regarded
as safe. They predominantly reflect money rates in their market behavior but
also, to some extent, economic conditions.
BBB: Municipal bonds rated BBB are regarded as having an adequate capacity to
pay principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest for bonds in
this category than for bonds in the A category.
BB, B, CCC, CC: Municipal bonds rated BB, B, CCC and CC are regarded, on
balance, as predominantly speculative with respect to the issuer's capacity to
pay interest and repay principal in accordance with the terms of the
obligations. BB indicates the lowest degree of speculation and CC the highest
degree of speculation. While these bonds will likely have some quality and
protective characteristics, they are outweighed by large uncertainties or major
risk exposures to adverse conditions.
C: This rating is reserved for income bonds on which no interest is being
paid.
D: Debt rated "D" is in default and payment of interest and/or repayment of
principal is in arrears.
Plus (+) or minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
FITCH INVESTORS SERVICE, INC. (FITCH)
AAA: Municipal bonds rated AAA are considered to be investment grade and of the
highest credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal that is unlikely to be affected by reasonably
foreseeable events.
AA: Municipal bonds rated AA are 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 as bonds rated AAA and not
significantly vulnerable to foreseeable future developments.
A: Municipal bonds rated A are 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: Municipal bonds rated BBB are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered 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.
BB: Municipal bonds rated BB are considered speculative. The obligor's ability
to pay interest and repay principal may be affected over time by adverse
economic changes. Business and financial alternatives can be identified,
however, that could assist the obligor in satisfying its debt service
requirements.
B: Municipal bonds rated B are considered highly speculative. While bonds in
this class are currently meeting debt service requirements, the probability of
continued timely payment of principal and interest reflects the obligor's
limited margin of safety and the need for reasonable business and economic
activity throughout the life of the issue.
CCC: Municipal bonds rated CCC have certain identifiable characteristics which,
if not remedied, may lead to default. The ability to meet obligations requires
an advantageous business and economic environment.
CC: Municipal bonds rated CC are minimally protected. Default in payment of
interest and/or principal seems probable over time.
C: Municipal bonds rated C are in imminent default in the payment of interest
or principal.
DDD, DD and D: Municipal bonds rated DDD, DD and D are in default on interest
and/or principal payments. Such bonds are extremely speculative and should be
valued on the basis of their ultimate recovery value in liquidation or
reorganization of the obligor. DDD represents the highest potential for recovery
while D represents the lowest potential for recovery.
Plus (+) or minus (-) signs are used with a rating symbol to indicate the
relative position of a credit within the rating category. Plus or minus signs
are not used with the AAA, DDD, DD or D categories.
MUNICIPAL NOTE RATINGS
MOODY'S
Moody's ratings for state, municipal and other short-term obligations will be
designated Moody's Investment Grade (MIG). This distinction is in recognition of
the differences between short-term credit risk and long-term risk. Factors
affecting the liquidity of the borrower are uppermost in importance in
short-term borrowing; factors of the first importance in long-term borrowing
risk are of lesser importance in the short run. Symbols used will be as follows:
MIG 1: Notes are of the best quality enjoying strong protection from established
cash flows of funds for their servicing or from established and broad-based
access to the market for refinancing, or both.
MIG 2: Notes are of high quality, with margins of protection ample, although not
so large as in the preceding group.
MIG 3: Notes are of favorable quality, with all security elements accounted for,
but lacking the undeniable strength of the preceding grades. Market access for
refinancing, in particular, is likely to be less well established.
MIG 4: Notes are of adequate quality, carrying specific risk but having
protection and not distinctly or predominantly speculative.
S&P
Until June 29, 1984, S&P used the same rating symbols for notes and bonds. After
June 29, 1984, for new municipal note issues due in three years or less, the
ratings below will usually be assigned. Notes maturing beyond three years will
most likely receive a bond rating of the type recited above.
SP-1: Issues carrying this designation have a very strong or strong capacity to
pay principal and interest. Issues determined to possess overwhelming safety
characteristics will be given a "plus" (+) designation.
SP-2: Issues carrying this designation have a satisfactory capacity to pay
principal and interest.
SHORT-TERM DEBT & COMMERCIAL PAPER RATINGS
MOODY'S
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted. Moody's commercial paper
ratings, which are also applicable to municipal paper investments, are opinions
of the ability of issuers to repay punctually their promissory obligations not
having an original maturity in excess of nine months. Moody's employs the
following designations for both short-term debt and commercial paper, all judged
to be investment grade, to indicate the relative repayment capacity of rated
issuers:
P-1 (Prime-1): Superior capacity for repayment.
P-2 (Prime-2): Strong capacity for repayment.
S&P
S&P's ratings are a current assessment of the likelihood of timely payment of
debt having an original maturity of no more than 365 days. Ratings are graded
into four categories, ranging from "A" for the highest quality obligations to
"D" for the lowest. Issues within the "A" category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety, as follows:
A-1: This designation indicates the degree of safety regarding timely payment is
very strong. A "plus" (+) designation indicates an even stronger likelihood of
timely payment.
A-2: Capacity for timely payment on issues with this designation is strong. The
relative degree of safety, however, is not as overwhelming as for issues
designated A-1.
A-3: Issues carrying this designation have a satisfactory capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
FITCH
Fitch's short-term ratings apply to debt obligations that are payable on demand
or have original maturities of generally up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes. The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
F-1+: Exceptionally strong credit quality. Regarded as having the strongest
degree of assurance for timely payment.
F-1: Very strong credit quality. Reflect an assurance of timely payment only
slightly less in degree than issues rated F-1+.
F-2: Good credit quality. A satisfactory degree of assurance for timely payment,
but the margin of safety is not as great as for issues assigned F-1+ and F-1
ratings.
F-3: Fair credit quality. 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-5: Weak credit quality. 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: Default. Actual or imminent payment default.
LOC: The symbol LOC indicates that the rating is based on a letter of credit
issued by a commercial bank.
STATE TAX TREATMENT
The following information on the state income tax treatment of dividends from a
fund is based upon correspondence and sources believed to be reliable. Except
where otherwise noted, the information pertains to individual state income
taxation only. You may be subject to local taxes on dividends or the value of
your shares. Corporations, trusts, estates and other entities may be subject to
other taxes and should consult with their tax advisors or their state department
of revenue. For some investors, a portion of the dividend income may be subject
to the federal and/or state alternative minimum tax.
ALABAMA Under Section 40-18-14(3)f of the Alabama Code, interest on obligations
of the state of Alabama and any of its counties, municipalities or other
political subdivisions is exempt from personal income tax. Section 40-18-14(3)d
provides similar tax-exempt treatment for interest on exempt obligations of the
U.S. government or its possessions including Puerto Rico, Guam and the Virgin
Islands. In addition, Regulation Section 810-3-14-.02(4)(b)2 and an
administrative ruling of the Alabama Department of Revenue, dated March 1, 1990,
both extend the exemption for obligations of the U.S. government or its
possessions to distributions from a regulated investment company, such as the
Alabama Fund, to the extent that the distributions are paid from interest earned
on such exempt obligations. The March 1, 1990, ruling (as well as the
instructions to Alabama Form 40) also indicates that the exemption would apply
to Alabama municipal obligations. Tax-exempt treatment generally is not
available for distributions attributable to income earned on indirect U.S.
government obligations or obligations of other states and their political
subdivisions. To the extent such investments are made by the fund, distributions
from those investments generally will be taxable.
Any distributions of capital gains earned by the fund are fully includable in
each individual shareholder's Alabama taxable income and are currently taxed at
ordinary income tax rates.
FLORIDA Although Florida does not impose a personal income tax, it does impose
an intangible personal property tax (intangibles tax) on intangible property
having a taxable situs in Florida. The intangibles tax is imposed on the value
of certain intangible personal property, including shares of a mutual fund.
There is an exemption, however, for shares of a mutual fund, such as the Florida
Fund, that is organized as a business trust, if, on the January 1 assessment
date, at least 90% of the net asset value of the portfolio of assets
corresponding to such shares consists of exempt property. Exempt property
includes notes, bonds and other obligations issued by the state of Florida or
its municipalities, counties and other taxing districts or by the U.S.
government and its agencies. If, on the date of assessment, the 90% threshold is
not met, only that portion, if any, of the value of the mutual fund shares
attributable to notes, bonds and obligations of the U.S.
government and its agencies will be exempt.
GEORGIA Under Section 48-7-27(b)(1)(A) of the Georgia Code, interest on
obligations of the state of Georgia and its political subdivisions, which is not
otherwise included in federal adjusted gross income, is exempt from the state's
individual income tax. Likewise, under Section 48-7-27(b)(2) interest on exempt
obligations of the U.S. government, its territories and possessions (including
Puerto Rico, Guam and the Virgin Islands), or of any authority, commission, or
instrumentality of the U.S. government also is exempt from the state's
individual income tax. According to the instructions to Georgia's personal
income tax return, distributions from the Georgia Fund attributable to interest
on obligations of the state of Georgia and its political subdivisions and,
apparently, to interest on obligations of the U.S. government, its territories
and possessions will be excluded from the Georgia individual income tax.
Tax-exempt treatment generally is not available for distributions attributable
to income earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or
for obligations of other states and their political subdivisions. To the extent
such investments are made by a fund, such as for temporary or defensive
purposes, such distributions generally will be taxable.
Any distributions of capital gains earned by the fund are fully included in each
individual shareholder's Georgia taxable income as dividend income and capital
gain, respectively, and are currently taxed at ordinary income tax rates.
KENTUCKY Pursuant to Kentucky Revised Statute 141.010(10)(a) and (12)(a),
interest earned on exempt obligations of the U.S. government, its agencies and
instrumentalities, or its territories (including Puerto Rico, Guam and the
Virgin Islands) and obligations issued by the Commonwealth of Kentucky or its
political subdivisions will be exempt from Kentucky's personal income tax. Under
Kentucky Income Tax Revenue Policy 42P161 (as revised December 1, 1990),
dividends from regulated investment companies, such as the Kentucky Fund, which
are derived from such exempt obligations, also will be exempt from state income
tax. Tax-exempt treatment generally is not available for distributions
attributable to income earned on indirect U.S. government obligations (GNMAs,
FNMAs, etc.) or for obligations of other states and their political
subdivisions. To the extent such investments are made by the fund, such as for
temporary or defensive purposes, such distributions generally will be taxable.
Any distributions of net short-term and net long-term capital gains earned by
the fund are includable in each shareholder's Kentucky adjusted gross income and
are taxed at ordinary income tax rates. Kentucky Revenue Circular 40C003 also
states that gain from the sale of some U.S. government and Kentucky obligations
may be exempt from state income tax, but the availability of the exemption
depends upon the specific legislation authorizing the bonds. A specific opinion
may be requested from the Kentucky Revenue Cabinet.
LOUISIANA Under Section 47:293 of Louisiana's individual income tax law,
interest earned on exempt obligations of the state of Louisiana or its political
subdivisions and interest earned on exempt obligations of the U.S. government or
its agencies and possessions (including Puerto Rico, Guam and the Virgin
Islands) is exempt from individual and corporate income tax. Under Section
47:293, distributions from a regulated investment company, such as the Louisiana
Fund, also will be exempt from individual and corporate income tax to the extent
that they are derived from interest earned on such exempt obligations.
Tax-exempt treatment generally is not available for distributions attributable
to income earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or
for obligations of other states and their political subdivisions. To the extent
such investments are made by the fund, such as for temporary or defensive
purposes, such distributions generally will be taxable.
Any distributions of net short-term and net long-term capital gains earned by
the fund are included in each shareholder's Louisiana taxable income and are
currently taxed at ordinary income tax rates.
MARYLAND Distributions from the Maryland Fund attributable to interest on
obligations of the state of Maryland and its political subdivisions are excluded
from Maryland's personal income tax. Under Section 10-207(c) of the Tax General
Article, interest on exempt obligations of the U.S. government and any
authority, commission, instrumentality, possession or territory of the U.S.
(including Puerto Rico, Guam and the Virgin Islands) also is exempt from
Maryland's personal income tax. Under Section 10-207(c-1) and Administrative
Release No. 11, this exemption is extended to distributions from a regulated
investment company, such as the Maryland Fund, to the extent such distributions
are paid out of interest earned on exempt obligations of the U.S. government or
its agencies and possessions (including Puerto Rico, Guam and the U.S. Virgin
Islands). Tax-exempt treatment generally is not available for distributions
attributable to income earned on indirect U.S. government obligations (GNMAs,
FNMAs, etc.) or for obligations of other states and their political
subdivisions. To the extent such investments are made by the fund, such as for
temporary or defensive purposes, such distributions generally will be taxable.
Any distributions of capital gains by the fund derived from gain realized from
the sale or exchange of obligations issued by the state of Maryland or its
political subdivisions also may be tax-exempt to the fund's shareholders.
Distributions of capital gains earned by the fund on non-Maryland obligations
are includable in each shareholder's Maryland adjusted gross income and are
taxed at ordinary income tax rates.
MISSOURI Under Section 143.121 of the Revised Statutes of Missouri, interest
earned on exempt obligations of the U.S. government, its authorities,
commissions, instrumentalities, possessions or territories (including Puerto
Rico, Guam and the Virgin Islands), or the state of Missouri, its political
subdivisions or authorities are exempt from Missouri personal income tax. Under
Missouri's income tax regulations (Title 12, Section 10-2.155), a regulated
investment company such as the Missouri Fund may pass the tax-exempt character
of such interest through to its shareholders. Tax-exempt treatment generally is
not available for distributions attributable to income earned on indirect U.S.
government obligations (GNMAs, FNMAs, etc.) or for obligations of other states
and their political subdivisions. To the extent such investments are made by the
fund, such as for temporary or defensive purposes, such distributions generally
will be taxable.
Any distributions of net short-term and net long-term capital gains earned by
the fund are included in each shareholder's Missouri taxable income and are
currently taxed at ordinary income tax rates.
NORTH CAROLINA Section 105-134.6(b)(1) of the North Carolina General Statutes
provides that interest on exempt obligations of the U.S. government, its
possessions, or its territories (including Puerto Rico, Guam and the Virgin
Islands) and exempt obligations of the state of North Carolina or its political
subdivisions are exempt from state income tax. Pursuant to a North Carolina
Department of Revenue Information Release dated October 4, 1990, dividends
received from a regulated investment company, such as the North Carolina Fund,
are exempt from personal income tax to the extent that the distributions are
derived from interest on such exempt obligations. Tax-exempt treatment generally
is not available for distributions attributable to income earned on indirect
U.S. government obligations (GNMAs, FNMAs, etc.) or for obligations of other
states and their political subdivisions. To the extent such investments are made
by the fund, such as for temporary or defensive purposes, such distributions
generally will be taxable.
Distributions of capital gains attributable from the sale of certain North
Carolina obligations issued before to July 1, 1995, may be exempt from taxation
for the fund's shareholders. Distributions of all net short-term capital gain
and net long-term capital gain earned by the fund on all other North Carolina
obligations and on non-North Carolina obligations are includable in each
shareholder's North Carolina taxable income and are currently taxed at ordinary
income rates.
TEXAS does not presently impose any income tax on individuals, trusts, or
estates.
VIRGINIA Section 58.1-322 of the Code of Virginia provides that interest on
obligations of the state of Virginia, its political subdivisions, and
instrumentalities or direct obligations of the U.S. government or its
authorities, commission, instrumentalities or territories (including Puerto
Rico, Guam and the Virgin Islands) is exempt from personal income tax. Under
Section 23 Virginia Administrative Code 10-110-14, distributions from a
regulated investment company, such as the Virginia Fund, also will be exempt
from personal income tax if the fund invests in such exempt obligations.
Tax-exempt treatment generally is not available for distributions attributable
to income earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or
for obligations of other states and their political subdivisions. To the extent
such investments are made by the fund, such as for temporary or defensive
purposes, such distributions generally will be taxable.
Any distributions of net short-term and net long-term capital gains earned by
the fund are included in each shareholder's Virginia taxable income and are
currently taxed at ordinary income tax rates.
TF2 SAI 01/00
FRANKLIN
TAX-FREE TRUST
FRANKLIN ARIZONA TAX-FREE INCOME FUND
FRANKLIN COLORADO TAX-FREE INCOME FUND
FRANKLIN CONNECTICUT TAX-FREE INCOME FUND
FRANKLIN FEDERAL INTERMEDIATE-TERM TAX-FREE INCOME FUND FRANKLIN HIGH YIELD
TAX-FREE INCOME FUND CLASS FRANKLIN INDIANA TAX-FREE INCOME FUND FRANKLIN
MICHIGAN TAX-FREE INCOME FUND FRANKLIN NEW JERSEY TAX-FREE INCOME FUND FRANKLIN
OREGON TAX-FREE INCOME FUND FRANKLIN PENNSYLVANIA TAX-FREE INCOME FUND FRANKLIN
PUERTO RICO TAX-FREE INCOME FUND
STATEMENT OF ADDITIONAL INFORMATION
JULY 1, 1999, AS AMENDED JANUARY 1, 2000
P.O. BOX 997151, SACRAMENTO, CA 95899-9983 1-800/DIAL BEN(R)
This Statement of Additional Information (SAI) is not a prospectus. It contains
information in addition to the information in the funds' prospectus. The funds'
prospectus, dated July 1, 1999, which we may amend from time to time, contains
the basic information you should know before investing in the funds. You should
read this SAI together with the funds' prospectus.
The audited financial statements and auditor's report in the trust's Annual
Report to Shareholders, for the fiscal year ended February 28, 1999, are
incorporated by reference (are legally a part of this SAI).
For a free copy of the current prospectus or annual report, contact your
investment representative or call 1-800/DIAL BEN (1-800/342-5236).
On June 24, 1999, Franklin Federal Tax-Free Income Fund acquired the assets of
Franklin Indiana Tax-Free Income Fund. In exchange, Franklin Indiana Tax-Free
Income Fund received shares of Franklin Federal Tax-Free Income Fund, which it
distributed to its shareholders. All references to the Franklin Indiana Tax-Free
Income Fund in this SAI are deleted.
On August 26, 1999, Franklin Michigan Insured Tax-Free Income Fund acquired the
assets of Franklin Michigan Tax-Free Income Fund. In exchange, Franklin Michigan
Tax-Free Income Fund received shares of Franklin Michigan Insured Tax-Free
Income Fund, which it distributed to its shareholders. All references to the
Franklin Michigan Tax-Free Income Fund in this SAI are deleted.
CONTENTS
Goals and Strategies ......................................... 2
Risks ........................................................ 7
Officers and Trustees ........................................ 10
Management and Other Services ................................ 13
Portfolio Transactions ....................................... 14
Distributions and Taxes ...................................... 15
Organization, Voting Rights
and Principal Holders ....................................... 16
Buying and Selling Shares .................................... 17
Pricing Shares ............................................... 22
The Underwriter .............................................. 23
Performance .................................................. 25
Miscellaneous Information .................................... 29
Description of Ratings ....................................... 30
State Tax Treatment .......................................... 32
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MUTUAL FUNDS, ANNUITIES, AND OTHER INVESTMENT PRODUCTS:
o ARE NOT FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE
FEDERAL RESERVE BOARD, OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT;
o ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK;
o ARE SUBJECT TO INVESTMENT RISKS, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL.
- ------------------------------------------------------------------------------
GOALS AND STRATEGIES
The Federal Intermediate Fund's investment goal is to provide investors with as
high a level of income exempt from federal income taxes, including the
individual alternative minimum tax, as is consistent with prudent investing,
while seeking preservation of shareholders' capital.
The High Yield Fund's principal investment goal is to provide investors with a
high current yield exempt from federal income taxes. Its secondary goal is
capital appreciation to the extent possible and consistent with the fund's
principal investment goal.
The Puerto Rico Fund's investment goal is to provide investors with as high a
level of income exempt from federal income taxes as is consistent with prudent
investing, while seeking preservation of shareholders' capital. The Puerto Rico
Fund also seeks to provide a maximum level of income that is free from the
personal income taxes of a majority of states, although this policy is not a
fundamental investment goal of the fund and may be changed without shareholder
approval.
Each state fund's investment goal is to provide investors with as high a level
of income exempt from federal income taxes and from personal income taxes for
resident shareholders of the fund's state as is consistent with prudent
investing, while seeking preservation of shareholders' capital.
These goals are fundamental, which means they may not be changed without
shareholder approval. Of course, there is no assurance that any fund will meet
its goal.
As a fundamental policy, each fund normally invests at least 80% of its assets
in securities that pay interest free from federal income taxes, including the
federal alternative minimum tax. Each fund applies this test to its net assets,
except for the Federal Intermediate Fund, which applies this test to its total
assets. Each state fund, as a fundamental policy, also normally invests at least
80% of its net assets in securities that pay interest free from the personal
income taxes, if any, of its state. As a nonfundamental policy, each state fund
and the Puerto Rico Fund also normally invest at least 65% of their total assets
in municipal securities of their state or territory. Unlike the state and Puerto
Rico Funds, the Federal Intermediate and High Yield Funds are diversified
nationally. The High Yield Fund will not invest more than 25% of its total
assets in the municipal securities of any one state or territory.
Municipal securities issued by a fund's state or that state's counties,
municipalities, authorities, agencies, or other subdivisions, generally pay
interest free from federal income tax and from state personal income taxes, if
any, for residents of the fund's state. Municipal securities issued by U.S.
territories such as Guam, Puerto Rico, or the Mariana Islands also generally pay
interest free from state personal income taxes in a majority of states.
Each fund tries to invest all of its assets in tax-free municipal securities.
The issuer's bond counsel generally gives the issuer an opinion on the
tax-exempt status of a municipal security when the security is issued.
Some states may require a fund to invest a certain amount of its assets in
securities of that state, or in securities that are otherwise tax-free under the
laws of that state, in order for any portion of the fund's distributions to be
free from the state's personal income taxes. If a fund's state requires this,
the fund will try to invest its assets as required so that its distributions
will be free from personal income taxes for resident shareholder's of the fund's
state.
As a fundamental policy, the Pennsylvania Fund invests in securities for income
earnings rather than trading for profit. The fund does not vary its investments,
except to (i) eliminate unsafe investments and investments that are not
consistent with the preservation of capital or the tax status of the fund; (ii)
honor redemption requests, meet anticipated redemption requirements and negate
gains from discount purchases; (iii) reinvest the earnings from securities in
like securities; or (iv) defray normal administrative expenses.
Below is a description of various types of municipal and other securities that
each fund may buy. Other types of municipal securities may become available that
are similar to those described below and in which each fund also may invest, if
consistent with its investment goal and policies.
TAX ANTICIPATION NOTES are issued to finance short-term working capital needs of
municipalities in anticipation of various seasonal tax revenues, which will be
used to pay the notes. They are usually general obligations of the issuer,
secured by the taxing power for the payment of principal and interest.
REVENUE ANTICIPATION NOTES are similar to tax anticipation notes except they are
issued in expectation of the receipt of other kinds of revenue, such as federal
revenues available under the Federal Revenue Sharing Program.
BOND ANTICIPATION NOTES are normally issued to provide interim financing until
long-term financing can be arranged. Proceeds from long-term bond issues then
provide the money for the repayment of the notes.
TAX-EXEMPT COMMERCIAL PAPER typically represents a short-term obligation (270
days or less) issued by a municipality to meet working capital needs.
MUNICIPAL BONDS meet longer-term capital needs and generally have maturities
from one to 30 years when issued. They have two principal classifications:
general obligation bonds and revenue bonds.
GENERAL OBLIGATION BONDS. Issuers of general obligation bonds include states,
counties, cities, towns and regional districts. The proceeds of these
obligations are used to fund a wide range of public projects, including
construction or improvement of schools, highways and roads. The basic security
behind general obligation bonds is the issuer's pledge of its full faith, credit
and taxing power for the payment of principal and interest. The taxes that can
be levied for the payment of debt service may be limited or unlimited as to the
rate or amount of special assessments.
REVENUE BONDS. The full faith, credit and taxing power of the issuer do not
secure revenue bonds. Instead, the principal security for a revenue bond is
generally the net revenue derived from a particular facility, group of
facilities, or, in some cases, the proceeds of a special excise tax or other
specific revenue source. Revenue bonds are issued to finance a wide variety of
capital projects, including: electric, gas, water and sewer systems; highways,
bridges and tunnels; port and airport facilities; colleges and universities; and
hospitals. The principal security behind these bonds may vary. For example,
housing finance authorities have a wide range of security, including partially
or fully insured mortgages, rent subsidized and/or collateralized mortgages,
and/or the net revenues from housing or other public projects. Many bonds
provide additional security in the form of a debt service reserve fund that may
be used to make principal and interest payments. Some authorities have further
security in the form of state assurances (although without obligation) to make
up deficiencies in the debt service reserve fund.
TAX-EXEMPT INDUSTRIAL DEVELOPMENT REVENUE BONDS are issued by or on behalf of
public authorities to finance various privately operated facilities for
business, manufacturing, housing, sports and pollution control, as well as
public facilities such as airports, mass transit systems, ports and parking. The
payment of principal and interest is solely dependent on the ability of the
facility's user to meet its financial obligations and the pledge, if any, of the
facility or other property as security for payment.
VARIABLE OR FLOATING RATE SECURITIES Each fund may invest in variable or
floating rate securities, including variable rate demand notes, which have
interest rates that change either at specific intervals (variable rate), from
daily up to monthly, or whenever a benchmark rate changes (floating rate). The
interest rate adjustments are designed to help stabilize the security's price.
While this feature helps protect against a decline in the security's market
price when interest rates go up, it lowers the fund's income when interest rates
fall. Variable or floating rate securities may include a demand feature, which
may be unconditional. The demand feature allows the holder to demand prepayment
of the principal amount before maturity, generally on one to 30 days' notice.
The holder receives the principal amount plus any accrued interest either from
the issuer or by drawing on a bank letter of credit, a guarantee or insurance
issued with respect to the security. Each fund generally uses variable or
floating rate securities as short-term investments while waiting for long-term
investment opportunities.
MUNICIPAL LEASE OBLIGATIONS Each fund may invest in municipal lease obligations,
including certificates of participation. Municipal lease obligations generally
finance the purchase of public property. The property is leased to the state or
a local government, and the lease payments are used to pay the interest on the
obligations. Municipal lease obligations differ from other municipal securities
because the lessee's governing body must appropriate (set aside) the money to
make the lease payments each year. If the money is not appropriated, the issuer
or the lessee can end the lease without penalty. If the lease is cancelled,
investors who own the municipal lease obligations may not be paid.
The board of trustees reviews each fund's municipal lease obligations to try to
assure that they are liquid investments based on various factors reviewed by the
fund's manager and monitored by the board. These factors may include (a) the
credit quality of the obligations and the extent to which they are rated or, if
unrated, comply with existing criteria and procedures followed to ensure that
they are comparable in quality to the ratings required for the fund to invest,
including an assessment of the likelihood of the lease being canceled, taking
into account how essential the leased property is and the term of the lease
compared to the useful life of the leased property; (b) the size of the
municipal securities market, both in general and with respect to municipal lease
obligations; and (c) the extent to which the type of municipal lease obligations
held by the fund trade on the same basis and with the same degree of dealer
participation as other municipal securities of comparable credit rating or
quality.
Since annual appropriations are required to make lease payments, municipal lease
obligations generally are not subject to constitutional limitations on the
issuance of debt and may allow an issuer to increase government liabilities
beyond constitutional debt limits. When faced with increasingly tight budgets,
local governments have more discretion to curtail lease payments under a
municipal lease obligation than they do to curtail payments on other municipal
securities. If not enough money is appropriated to make the lease payments, the
leased property may be repossessed as security for holders of the municipal
lease obligations. If this happens, there is no assurance that the property's
private sector or re-leasing value will be enough to make all outstanding
payments on the municipal lease obligations or that the payments will continue
to be tax-free.
While cancellation risk is inherent to municipal lease obligations, each fund,
except the High Yield Fund, believes that this risk may be reduced, although not
eliminated, by its policies on the quality of securities in which it may invest.
CALLABLE BONDS Each fund may invest in callable bonds, which allow the issuer to
repay some or all of the bonds ahead of schedule. If a bond is called, the fund
will receive the principal amount, the accrued interest, and may receive a small
additional payment as a call premium. The manager may sell a callable bond
before its call date, if it believes the bond is at its maximum premium
potential. When pricing callable bonds, the call feature is factored into the
price of the bonds and may impact the fund's net asset value.
An issuer is more likely to call its bonds when interest rates are falling,
because the issuer can issue new bonds with lower interest payments. If a bond
is called, the fund may have to replace it with a lower-yielding security. A
call of some or all of these securities may lower a fund's income and its
distributions to shareholders. If the fund originally paid a premium for the
bond because it had appreciated in value from its original issue price, the fund
also may not be able to recover the full amount it paid for the bond. One way
for the fund to protect itself from call risk is to buy bonds with call
protection. Call protection is an assurance that the bond will not be called for
a specific time period, typically five to 10 years from when the bond is issued.
ESCROW-SECURED OR DEFEASED BONDS are created when an issuer refunds, before
maturity, an outstanding bond issue that is not immediately callable (or
pre-refunds), and sets aside funds for redemption of the bonds at a future date.
The issuer uses the proceeds from a new bond issue to buy high grade, interest
bearing debt securities, generally direct obligations of the U.S. government.
These securities are then deposited in an irrevocable escrow account held by a
trustee bank to secure all future payments of principal and interest on the
pre-refunded bond. Escrow-secured bonds often receive a triple A or equivalent
rating.
STRIPPED MUNICIPAL SECURITIES Municipal securities may be sold in "stripped"
form. Stripped municipal securities represent separate ownership of principal
and interest payments on municipal securities.
ZERO-COUPON SECURITIES Each fund may invest in zero-coupon and delayed interest
securities. Zero-coupon securities make no periodic interest payments, but are
sold at a deep discount from their face value. The buyer recognizes a rate of
return determined by the gradual appreciation of the security, which is redeemed
at face value on a specified maturity date. The discount varies depending on the
time remaining until maturity, as well as market interest rates, liquidity of
the security, and the issuer's perceived credit quality. The discount, in the
absence of financial difficulties of the issuer, typically decreases as the
final maturity date approaches. If the issuer defaults, the fund may not receive
any return on its investment.
Because zero-coupon securities bear no interest and compound semiannually at the
rate fixed at the time of issuance, their value is generally more volatile than
the value of other fixed-income securities. Since zero-coupon bondholders do not
receive interest payments, zero-coupon securities fall more dramatically than
bonds paying interest on a current basis when interest rates rise. When interest
rates fall, zero-coupon securities rise more rapidly in value, because the bonds
reflect a fixed rate of return.
An investment in zero-coupon and delayed interest securities may cause a fund to
recognize income and make distributions to shareholders before it receives any
cash payments on its investment. To generate cash to satisfy distribution
requirements, a fund may have to sell portfolio securities that it otherwise
would have continued to hold or to use cash flows from other sources such as the
sale of fund shares.
CONVERTIBLE AND STEP COUPON BONDS Each fund may invest a portion of its assets
in convertible and step coupon bonds. Convertible bonds are zero-coupon
securities until a predetermined date, at which time they convert to a specified
coupon security. The coupon on step coupon bonds changes periodically during the
life of the security based on predetermined dates chosen when the security is
issued.
U.S. GOVERNMENT OBLIGATIONS are issued by the U.S. Treasury or by agencies
and instrumentalities of the U.S. government and are backed by the full faith
and credit of the U.S. government. They include Treasury bills, notes and
bonds.
COMMERCIAL PAPER is a promissory note issued by a corporation to finance its
short-term credit needs. Each fund may invest in taxable commercial paper only
for temporary defensive purposes.
WHEN-ISSUED TRANSACTIONS Municipal securities are frequently offered on a
"when-issued" basis. When so offered, the price, which is generally expressed in
yield terms, is fixed at the time the commitment to buy is made, but delivery
and payment take place at a later date. During the time between purchase and
settlement, no payment is made by the fund to the issuer and no interest accrues
to the fund. If the other party to the transaction fails to deliver or pay for
the security, the fund could miss a favorable price or yield opportunity, or
could experience a loss.
When a fund makes the commitment to buy a municipal security on a when-issued
basis, it records the transaction and reflects the value of the security in the
determination of its net asset value. The funds believe their net asset value or
income will not be negatively affected by their purchase of municipal securities
on a when-issued basis. The funds will not engage in when-issued transactions
for investment leverage purposes.
Although a fund will generally buy municipal securities on a when-issued basis
with the intention of acquiring the securities, it may sell the securities
before the settlement date if it is considered advisable. When a fund is the
buyer, it will maintain cash or liquid securities, with an aggregate value equal
to the amount of its purchase commitments, in a segregated account with its
custodian bank until payment is made. If assets of a fund are held in cash
pending the settlement of a purchase of securities, the fund will not earn
income on those assets.
ILLIQUID INVESTMENTS Each fund may invest up to 10% of its net assets in
illiquid securities. Illiquid securities are generally securities that cannot be
sold within seven days in the normal course of business at approximately the
amount at which the fund has valued them.
DIVERSIFICATION All of the funds, except the Connecticut, Federal Intermediate
and Michigan Funds, are diversified funds. The Connecticut, Federal Intermediate
and Michigan Funds are non-diversified. As a fundamental policy, none of the
diversified funds will buy a security if, with respect to 75% of its net assets,
more than 5% would be in the securities of any single issuer (with the exception
of obligations of the U.S. government). For this purpose, each political
subdivision, agency, or instrumentality, each multi-state agency of which a
state is a member, and each public authority that issues private activity bonds
on behalf of a private entity, is considered a separate issuer. Escrow-secured
or defeased bonds are not generally considered an obligation of the original
municipality when determining diversification.
Each fund, including the Connecticut, Federal Intermediate and Michigan Funds,
intends to meet certain diversification requirements for tax purposes.
Generally, to meet federal tax requirements at the close of each quarter, a fund
may not invest more than 25% of its total assets in any one issuer and, with
respect to 50% of total assets, may not invest more than 5% of its total assets
in any one issuer. These limitations do not apply to U.S. government securities
and may be revised if applicable federal income tax requirements are revised.
TEMPORARY INVESTMENTS When the manager believes the securities trading markets
or the economy are experiencing excessive volatility or a prolonged general
decline, or other unusual or adverse conditions exist, including the
unavailability of securities that meet a fund's investment criteria, it may
invest each fund's portfolio in a temporary defensive manner. Under these
circumstances, each fund may invest all of its assets in securities that pay
taxable interest, including (i) high quality commercial paper; (ii) securities
issued or guaranteed by the full faith and credit of the U.S. government; or
(iii) for the state and Puerto Rico Funds, municipal securities issued by a
state, territory or local government other than the fund's state or territory.
Each fund also may invest all of its assets in municipal securities issued by a
U.S. territory such as Guam, Puerto Rico or the Mariana Islands.
SECURITIES TRANSACTIONS The frequency of portfolio transactions, usually
referred to as the portfolio turnover rate, varies for each fund from year to
year, depending on market conditions. While short-term trading increases
portfolio turnover and may increase costs, the execution costs for municipal
securities are substantially less than for equivalent dollar values of equity
securities.
CREDIT QUALITY All things being equal, the lower a security's credit quality,
the higher the risk and the higher the yield the security generally must pay as
compensation to investors for the higher risk.
A security's credit quality depends on the issuer's ability to pay interest on
the security and, ultimately, to repay the principal. Independent rating
agencies, such as Fitch Investors Service Inc. (Fitch), Moody's Investors
Service, Inc. (Moody's), and Standard & Poor's Corporation (S&P), often rate
municipal securities based on their opinion of the issuer's credit quality. Most
rating agencies use a descending alphabet scale to rate long-term securities,
and a descending numerical scale to rate short-term securities. These ratings
are described at the end of this SAI under "Description of Ratings."
An insurance company, bank or other foreign or domestic entity may provide
credit support for a municipal security and enhance its credit quality. For
example, some municipal securities are insured, which means they are covered by
an insurance policy that guarantees the timely payment of principal and
interest. Other municipal securities may be backed by letters of credit,
guarantees, or escrow or trust accounts that contain securities backed by the
full faith and credit of the U.S. government to secure the payment of principal
and interest.
As discussed in the prospectus, each fund has limitations on the credit quality
of the securities it may buy. These limitations are generally applied when a
fund makes an investment so that a fund is not required to sell a security
because of a later change in circumstances.
The High Yield Fund invests at least 65% of its assets in high yield securities.
The High Yield Fund may invest in securities rated in any rating category,
including defaulted securities if the manager believes the issuer may resume
making interest payments or other favorable developments seem likely in the near
future. The High Yield Fund, however, currently does not intend to invest more
than 10% of its assets in defaulted securities. While the fund tries to invest
in lower-rated securities, the manager may consider existing market conditions,
the availability of lower-rated securities, and whether the difference in yields
between higher- and lower-rated securities justifies the higher risk of
lower-rated securities when selecting securities for the High Yield Fund's
portfolio.
INVESTMENT RESTRICTIONS Each fund has adopted the following restrictions as
fundamental policies. This means they may only be changed if the change is
approved by (i) more than 50% of the fund's outstanding shares or (ii) 67% or
more of the fund's shares present at a shareholder meeting if more than 50% of
the fund's outstanding shares are represented at the meeting in person or by
proxy, whichever is less.
Each fund may not:
1. Borrow money or mortgage or pledge any of its assets, except that borrowings
(and a pledge of assets therefore) for temporary or emergency purposes may be
made from banks in any amount up to 5% of the total asset value.
2. Buy any securities on "margin" or sell any securities "short," except that it
may use such short-term credits as are necessary for the clearance of
transactions.
3. Make loans, except through the purchase of readily marketable debt securities
which are either publicly distributed or customarily purchased by institutional
investors. Although such loans are not presently intended, this prohibition will
not preclude the fund from loaning portfolio securities to broker-dealers or
other institutional investors if at least 102% cash collateral is pledged and
maintained by the borrower; provided such portfolio security loans may not be
made if, as a result, the aggregate of such loans exceeds 10% of the value of
the fund's total assets at the time of the most recent loan.
4. Act as underwriter of securities issued by other persons, except insofar as
the fund may be technically deemed an underwriter under the federal securities
laws in connection with the disposition of portfolio securities.
5. Purchase the securities of any issuer which would result in owning more than
10% of the voting securities of such issuer, except with respect to the
Connecticut and Federal Intermediate Funds, each of which will not purchase a
security, if as a result: i) more than 25% of its total assets would be invested
in the securities of a single issuer or ii) with respect to 50% of its total
assets, more than 5% of its assets would be invested in the securities of a
single issuer.
6. Purchase securities from or sell to the trust's officers and trustees, or any
firm of which any officer or trustee is a member, as principal, or retain
securities of any issuer if, to the knowledge of the trust, one or more of the
trust's officers, trustees, or investment manager own beneficially more than
one-half of 1% of the securities of such issuer and all such officers and
trustees together own beneficially more than 5% of such securities.
7. Acquire, lease or hold real estate, except such as may be necessary or
advisable for the maintenance of its offices and provided that this limitation
shall not prohibit the purchase of municipal and other debt securities secured
by real estate or interests therein.
8. Invest in commodities and commodity contracts, puts, calls, straddles,
spreads or any combination thereof, or interests in oil, gas, or other mineral
exploration or development programs, except that it may purchase, hold and
dispose of "obligations with puts attached" in accordance with its investment
policies.
9. Invest in companies for the purpose of exercising control or management.
10. For each fund except the Federal Intermediate Fund, purchase securities of
other investment companies, except in connection with a merger, consolidation or
reorganization, except to the extent the fund invests its uninvested daily cash
balances in shares of the Franklin Tax-Exempt Money Fund and other tax-exempt
money market funds in the Franklin Templeton Group of Funds provided i) its
purchases and redemptions of such money market fund shares may not be subject to
any purchase or redemption fees, ii) its investments may not be subject to
duplication of management fees, nor to any charge related to the expense of
distributing the fund's shares (as determined under Rule 12b-1, as amended under
the federal securities laws) and iii) aggregate investments by the fund in any
such money market fund do not exceed (A) the greater of (i) 5% of the fund's
total net assets or (ii) $2.5 million, or (B) more than 3% of the outstanding
shares of any such money market fund.
11. For each fund except the Federal Intermediate Fund, invest more than 25% of
its assets in securities of any industry; although for purposes of this
limitation, tax-exempt securities and U.S. government obligations are not
considered to be part of any industry.
The following investment restrictions only apply to the Federal Intermediate
Fund:
12. Purchase securities of other investment companies, except in connection with
a merger, consolidation, acquisition or reorganization. To the extent permitted
by exemptions which may be granted under the Investment Company Act of 1940, the
Federal Intermediate Fund may invest in shares of one or more investment
companies, of the type generally referred to as money market funds, managed by
Franklin Advisers, Inc. or its affiliates.
13. Purchase securities, in private placements or in other transactions, for
which there are legal or contractual restrictions on resale.
14. Invest more than 25% of its assets in securities of any industry. For
purposes of this limitation, tax-exempt securities issued by governments or
political subdivisions of governments are not considered to be part of any
industry.
If a bankruptcy or other extraordinary event occurs concerning a particular
security the fund owns, the fund may receive stock, real estate, or other
investments that the fund would not, or could not, buy. If this happens, the
fund intends to sell such investments as soon as practicable while maximizing
the return to shareholders.
Generally, the policies and restrictions discussed in this SAI and in the
prospectus apply when the fund makes an investment. In most cases, the fund is
not required to sell a security because circumstances change and the security no
longer meets one or more of the fund's policies or restrictions. If a percentage
restriction or limitation is met at the time of investment, a later increase or
decrease in the percentage due to a change in the value or liquidity of
portfolio securities will not be considered a violation of the restriction or
limitation.
RISKS
STATE Since each state fund mainly invests in the municipal securities of its
state, its performance is closely tied to the ability of issuers of municipal
securities in its state to continue to make principal and interest payments on
their securities. The issuers' ability to do this is in turn dependent on
economic, political and other conditions within the state. Below is a discussion
of certain conditions that may affect municipal issuers in the funds' various
states. It is not a complete analysis of every material fact that may affect the
ability of issuers of municipal securities to meet their debt obligations or the
economic or political conditions within any state and is subject to change. The
information below is based on data available to the funds from historically
reliable sources, but the funds have not independently verified it.
The ability of issuers of municipal securities to continue to make principal and
interest payments is dependent in large part on their ability to raise revenues,
primarily through taxes, and to control spending. Many factors can affect a
state's revenues including the rate of population growth, unemployment rates,
personal income growth, federal aid, and the ability to attract and keep
successful businesses. A number of factors can also affect a state's spending
including current debt levels, and the existence of accumulated budget deficits.
The following provides some information on these and other factors.
ARIZONA. Strong overall employment growth, affordable housing, and an attractive
climate have helped Arizona's population grow at a rate four times faster than
the national rate during the 1990s. Although population growth is expected to
remain strong in the near term, the rate of growth has slowed since 1996 as a
result of California's economic recovery and thus less migration from that
state. Competitive wage rates, low energy costs, corporate tax reductions and an
abundance of land also have helped to attract businesses to the state. As a
result, Arizona's unemployment in 1998 was at its lowest level since the early
1970s.
Arizona's economy has continued to diversify, especially in the manufacturing
and services areas. As of August 1998, manufacturing accounted for approximately
10.5% of the state's total employment, trade 24.3%, services 30.4%, government
16.1%, and construction 6.6%. Farming and mining accounted for less than 2% of
the total workforce. Improved diversification may help reduce the state's
economic vulnerability that in the past resulted from Arizona's historical
dependence on its farming, mining and real estate industries. Arizona may be
vulnerable, however, to events affecting high-technology products and to recent
and future economic problems in Asia. Approximately 80% of the state's exports
have been in the area of high-technology products and Asian exports have
supported at least 100,000 jobs in the state.
Under its constitution, Arizona cannot issue general obligation debt. Thus,
gross state debt levels have remained moderate. The state historically has
relied on lease obligations, revenue bonds, and pay-as-you-go financing for its
capital needs.
Arizona's strong economic growth and higher-than-anticipated tax revenues have
allowed the state to post four consecutive operating surpluses and general fund
balance increases. Preliminary 1998 results show another operating surplus.
During fiscal 1999, however, a reduction in the general fund balance is expected
with the implementation of new school capital funding legislation.
COLORADO. During the 1980s, Colorado's economy was dependent on its energy
sector. As a result, the state suffered a sharp economic downturn when the
energy sector declined in the mid-to-late 1980s. Since 1991, growth in the
services, trade and government sectors has improved Colorado's economic
diversification. Growth in these areas, as well as in construction and high
technology sectors, also has helped to offset job losses caused by military base
closings and the decline of the state's mining industry. Population and income
levels have also grown since 1991, often exceeding national trends, and
unemployment levels have been below the national average.
The recent strength of Colorado's economy has helped to improve the state's
financial position. Revenue growth has continued to exceed projections,
primarily in the area of income tax collections. Since Colorado's constitution
prohibits the issuance of general obligation debt, the state's debt burden has
been low. The state has relied primarily on pay-as-you-go and lease financing to
meet its capital improvement needs.
CONNECTICUT. Connecticut's recovery from the recession of the early 1990s has
been slower than the rest of the nation. Over the past two years, however, the
state's economic recovery has shown signs of improved strength. Gains in tourism
and business services have led to greater economic diversification as the
economy has continued to move from manufacturing and defense related industries
towards services. Although manufacturing still represented over 16% of the
state's employment base in 1998, the services sector accounted for more than 31%
of employment.
Connecticut has sought to further its economic growth with various business and
tax incentives such as corporate and sales tax rate cuts, corporate tax credits
for research and development and various other business tax credits.
Nonetheless, the state's tight labor market, slow population growth and high
wages may limit future growth.
The state's financial results have been positive in recent years, with budget
surpluses for the past seven years. Connecticut's improved financial performance
has resulted in part from various fiscal reforms including a constitutional
amendment requiring balanced budgets, expenditure caps and the implementation of
a personal income tax. These improvements have allowed the state to fully fund
its rainy day reserve. Potential areas of financial stress may include increased
spending for education, an unfunded pension liability, and a relatively high
debt burden.
INDIANA. Despite some diversification, Indiana's economy has remained dependent
on its durable goods manufacturing sector. As of February 1999, manufacturing
accounted for 24% of all jobs in the state, the highest percentage in the U.S.
The state's reliance on manufacturing makes it more vulnerable to domestic and
international business cycles than more diverse states. The state's employment
growth has been slow in recent years and its already tight labor market could
further constrain future growth.
Financially, the state's performance has been positive. The state ended fiscal
1998 with a surplus and was able to further increase its reserves. At the end of
fiscal 1998, Indiana's reserve levels were among the strongest in the nation.
The state, however, has a significant unfunded pension liability that totaled
$7.2 billion as of January 1999. To address this problem, the state has created
a pension stabilization fund. The state hopes that appropriations to the
stabilization fund will help limit the effect of the liability on the state's
general fund.
MICHIGAN. While Michigan's economy has diversified to some degree, it has
remained dependent on its durable goods manufacturing sector, especially on its
cyclical auto industry. In recent years, manufacturing has accounted for 22% of
the state's employment and 33% of personal income. While this sector has been
strong since the end of the national recession in the early 1990s and has made
improvements that could potentially lessen its historical volatility, the
state's reliance on manufacturing has made its economy potentially more volatile
than the economies of more diverse states and more susceptible to the adverse
effects of another recession.
Since 1992, Michigan's economy has grown at a healthy pace. Unemployment levels
have been below national levels since 1994 and, through September 1998,
employment levels were at an all-time high. With the help of its strong economy,
Michigan's finances also have improved. Tighter budget controls and the positive
effect on revenues of the state's relatively strong economy have allowed the
state to replenish reserves, which had been severely depleted during the early
1990s. The state's budget stabilization fund was at more than $1 billion at
September 30, 1998. Michigan may need the increased stability these reserve
levels provide to offset higher school funding requirements. The state also has
been able to maintain its traditionally low debt levels, although contingent
debt levels issued through school programs and based on the state's credit have
grown rapidly, approaching levels almost double the state's outstanding direct
debt. The state's contingent debt exposure will need to be carefully managed in
the coming years to help maintain the state's financial stability.
NEW JERSEY. Historically, New Jersey's economy has been one of the most diverse
in the nation. Like many other states in the northeast region, New Jersey was
hit especially hard by the recession in the early 1990s and has been slower to
recover than many other states. Over the past two years, however, the state's
performance has improved. Jobs grew at a rate of 2.3% in 1997 and 2% in 1998.
While these rates were below the national rates of 2.5% in 1997 and 2.6% in
1998, they led the region. Unemployment levels also have decreased to 4.8% in
1998, slightly above the national rate of 4.5%.
The state ended fiscal 1998 with a surplus and increased its fund balances to
$1.25 billion. The state's positive financial performance was aided by strong
growth in personal income tax receipts. Much of this growth was from the
high-income taxpayer base, which grew due in part to the recent success of the
financial services sector. The state's increased reliance on high-income
taxpayers and the success of the financial markets may make it more vulnerable
to an economic downturn.
The state's outstanding debt has grown significantly in recent years. As of
January 1999, the state ranked near the top in net tax-supported debt, ratio of
debt to personal income and debt per capita. Nonetheless, debt service has
remained manageable in light of the state's resources.
OREGON. Oregon's economy has experienced strong growth, primarily in its hi-tech
manufacturing and housing construction sectors. Growth has slowed recently,
however, due to economic troubles in Asia. Future growth is likely to be
dependent on the continued strength of the national economy, as well as the
strength of the state's hi-tech industries, and the performance of Pacific Rim
economies. Economic growth may be hampered, however, by the state's rising labor
and housing costs, which have lessened Oregon's competitive position in
attracting new businesses.
The strength of Oregon's economy has helped the state maintain positive
financial results. Recently, however, voter initiatives have limited the state's
financial flexibility. In November 1990, voters approved Measure 5, which
limited local property taxes and required the state to provide replacement
revenues to schools. As of March 1999, the state has been successful in meeting
the requirements of Measure 5, which has increased state spending for schools
from 33% of the general fund budget to more than 40%. On May 20, 1997, voters
passed Measure 50, which has placed some pressure on the state's budget. This
measure could negatively impact the revenue-raising flexibility of the state and
make it more vulnerable to an economic downturn.
PENNSYLVANIA. Although improving, the performance of Pennsylvania's economy has
continued to lag the national average. The largest growth areas have been
business, health care, and consumer services, which have helped to offset
declines in the manufacturing, mining and machinery sectors. Overall, job growth
was 0.9% from April 1998 to April 1999, compared to a national rate of 2.5%.
Population and personal income growth also have remained below national levels.
To try to improve its economic performance, Pennsylvania recently made economic
development a priority. To attract new business, the commonwealth has
implemented various business tax cuts and has attempted to ease its regulatory
environment. These steps, together with the commonwealth's strong education,
health care and transportation systems, could help to provide a positive
environment for attracting businesses.
Historically, Pennsylvania's financial performance has been tied to fluctuations
in both national and regional economic trends. In recent years, improvements in
the commonwealth's economy and higher-than-expected tax revenues have helped
strengthen the commonwealth's financial position. The commonwealth ended fiscal
1998 with an operating surplus and increased its reserve levels. Due to the
cyclical nature of its economy and financial performance, the commonwealth has
been committed to using surpluses to build reserves, rather than to increase
spending, in the hope of providing some security against future economic
downturns or other uncertainties that could affect the state.
U.S. TERRITORIES Since each fund may invest a portion of its assets in municipal
securities issued by U.S. territories, and the Puerto Rico Fund invests mainly
in Puerto Rico municipal securities, the ability of municipal issuers in U.S.
territories to continue to make principal and interest payments also may affect
a fund's performance. As with state municipal issuers, the ability to make these
payments is dependent on economic, political and other conditions. Below is a
discussion of certain conditions within some of the territories where the funds
may be invested. It is not a complete analysis of every material fact that may
affect the ability of issuers of U.S. territory municipal securities to meet
their debt obligations or the economic or political conditions within the
territories and is subject to change. It is based on data available to the funds
from historically reliable sources, but it has not been independently verified
by the funds.
GUAM. Guam's economy has been heavily dependent on tourism. It has been
especially dependent on Japanese tourism, which has made Guam vulnerable to
fluctuations in the relationship between the U.S. dollar and the Japanese yen.
The recent Asian economic crisis and Typhoon Paka, which hit Guam in December
1997, negatively affected both tourism and other economic activities in Guam and
contributed to a decline of 1.8% in gross island product between 1997 and 1998.
In the early to mid-1990s, Guam's financial position deteriorated due to a
series of natural disasters that led to increased spending on top of already
significant budget gaps. As a result, the government introduced a comprehensive
financial plan in June 1995 to help balance the budget and reduce the general
fund deficit by fiscal 1999. For fiscal 1998, however, Guam incurred a $21
million deficit and ended the year with a negative unreserved general fund
balance of $158.9 million. Another deficit is expected in 1999.
While Guam's debt burden has been manageable, Guam's ability to maintain current
debt levels may be challenged in the near future. U.S. military downsizing has
reduced the federal presence on the island and also may reduce federal support
for infrastructure projects. At the same time, Guam has faced increasing
pressure to improve its infrastructure to help generate economic development.
Overall, as of May 20, 1999, S&P's outlook for Guam was negative due to Guam's
continued weak financial position and inability to meet the goals of the
financial plan.
MARIANA ISLANDS. The Mariana Islands became a commonwealth in 1975. At that
time, the U.S. government agreed to exempt the islands from federal minimum wage
and immigration laws in an effort to help stimulate industry and the economy.
The islands' minimum wage has been more than $2 per hour below the U.S. level
and tens of thousands of workers have immigrated from various Asian countries to
provide cheap labor for the islands' industries. Recently, the islands' tourism
and apparel industries combined to help increase gross business receipts from
$224 million in 1985 to $2 billion in 1996.
PUERTO RICO. Overall, Moody's considered Puerto Rico's outlook stable as of
January 1999. In recent years, Puerto Rico's financial performance has improved.
Relatively strong revenue growth and more aggressive tax collection procedures
resulted in a general fund surplus for fiscal 1998 (unaudited). For fiscal 1999,
spending increases of 11% are budgeted, which may create an operating deficit
and deplete the commonwealth's unreserved fund balance.
Puerto Rico's debt levels have been high. Going forward, these levels may
increase as Puerto Rico attempts to finance significant capital and
infrastructure improvements. Puerto Rico also will need to address its large
unfunded pension liability of more than $6 billion.
Despite Puerto Rico's stable outlook, Puerto Rico may face challenges in the
coming years with the 1996 passage of a bill eliminating section 936 of the
Internal Revenue Code. This section has given certain U.S. corporations
operating in Puerto Rico significant tax advantages. These incentives have
helped considerably with Puerto Rico's economic growth, especially with the
development of its manufacturing sector. U.S. firms that have benefited from
these incentives have provided a significant portion of Puerto Rico's revenues,
employment and deposits in local financial institutions. The section 936
incentives will be phased out over a 10-year period ending in 2006. It is hoped
that this long phase-out period will give Puerto Rico sufficient time to lessen
the potentially negative effects of section 936's elimination. Outstanding
issues relating to the potential for a transition to statehood also may have
broad implications for Puerto Rico and its financial and credit position.
CREDIT (HIGH YIELD FUND ONLY) Since the High Yield Fund may invest in municipal
securities rated below investment grade, an investment in the fund is subject to
a higher degree of risk than an investment in a fund that invests primarily in
higher-quality securities.
The market value of high yield, lower-quality municipal securities tends to
reflect individual developments affecting the issuer to a greater degree than
the market value of higher-quality securities, which react primarily to
fluctuations in the general level of interest rates. Lower-quality securities
also tend to be more sensitive to economic conditions than higher-quality
securities. Factors adversely affecting the market value of high yield
securities may lower the fund's net asset value and affect its performance.
Projects financed by high yield municipal securities are often highly leveraged
and may not have more traditional methods of financing available to them.
Therefore, the risk associated with buying these securities is generally greater
than the risk associated with higher-quality securities. For example, during an
economic downturn or a sustained period of rising interest rates, projects
financed by lower-quality securities may experience financial stress and may not
have sufficient cash flow to make interest payments. The issuer's ability to
make timely interest and principal payments also may be adversely affected by
specific developments affecting the issuer, including the issuer's inability to
meet specific projected revenue forecasts or the unavailability of additional
financing.
The risk of loss due to default also may be considerably greater with
lower-quality securities. If the issuer of a security in the fund's portfolio
defaults, the fund may have unrealized losses on the security, which may lower
the fund's net asset value. Defaulted securities tend to lose much of their
value before they default. Thus, the fund's net asset value may be adversely
affected before an issuer defaults. In addition, the fund may incur additional
expenses if it must try to recover principal or interest payments on a defaulted
security.
Lower-quality securities may not be as liquid as higher-quality securities.
Reduced liquidity in the secondary market may have an adverse impact on the
market price of a security and on the fund's ability to sell a security in
response to a specific economic event, such as a deterioration in the
creditworthiness of the issuer, or if necessary to meet the fund's liquidity
needs. Reduced liquidity also may make it more difficult to obtain market
quotations based on actual trades for purposes of valuing the fund's portfolio.
The following table provides a summary of the credit quality of the High Yield
Fund's portfolio. These figures are dollar-weighted averages of month-end assets
during the fiscal year ended February 28, 1999.
AVERAGE WEIGHTED
S&P RATING PERCENTAGE OF ASSETS
- -----------------------------------------------
AAA 24.0 1
AA 2.2
A 8.5 2
BBB 20.6 3
BB 27.3 4
B 8.7 5
CCC 1.2
Not Rated 7.5 6
1. 9.2% are unrated and have been included in the AAA rating category.
2. 0.4% are unrated and have been included in the A rating category.
3. 7.1% are unrated and have been included in the BBB rating category.
4. 15.8% are unrated and have been included in the BB rating category.
5. 1.1% are unrated and have been included in the B rating category.
6. This figure includes securities that have not been rated by S&P but that
have been rated by another rating agency.
OFFICERS AND TRUSTEES
The trust has a board of trustees. The board is responsible for the overall
management of the trust, including general supervision and review of each fund's
investment activities. The board, in turn, elects the officers of the trust who
are responsible for administering the trust's day-to-day operations. The board
also monitors each fund to ensure no material conflicts exist among share
classes. While none is expected, the board will act appropriately to resolve any
material conflict that may arise.
The name, age and address of the officers and board members, as well as their
affiliations, positions held with the trust, and principal occupations during
the past five years are shown below.
Frank H. Abbott, III (78)
1045 Sansome Street, San Francisco, CA 94111
TRUSTEE
President and Director, Abbott Corporation (an investment company); director or
trustee, as the case may be, of 27 of the investment companies in the Franklin
Templeton Group of Funds; and FORMERLY, Director, MotherLode Gold Mines
Consolidated (gold mining) and Vacu-Dry Co. (food processing).
Harris J. Ashton (67)
191 Clapboard Ridge Road, Greenwich, CT 06830
TRUSTEE
Director, RBC Holdings, Inc. (bank holding company) and Bar-S Foods (meat
packing company); director or trustee, as the case may be, of 48 of the
investment companies in the Franklin Templeton Group of Funds; and FORMERLY,
President, Chief Executive Officer and Chairman of the Board, General Host
Corporation (nursery and craft centers).
S. Joseph Fortunato (66)
Park Avenue at Morris County, P.O. Box 1945
Morristown, NJ 07962-1945
TRUSTEE
Member of the law firm of Pitney, Hardin, Kipp & Szuch; director or trustee, as
the case may be, of 50 of the investment companies in the Franklin Templeton
Group of Funds.
Edith E. Holiday (47)
3239 38th Street, N.W., Washington, DC 20016
TRUSTEE
Director, Amerada Hess Corporation (exploration and refining of natural gas)
(1993-present), Hercules Incorporated (chemicals, fibers and resins)
(1993-present), Beverly Enterprises, Inc. (health care) (1995-present) and H.J.
Heinz Company (processed foods and allied products) (1994-present); director or
trustee, as the case may be, of 24 of the investment companies in the Franklin
Templeton Group of Funds; and FORMERLY, Chairman (1995-1997) and Trustee
(1993-1997), National Child Research Center, Assistant to the President of the
United States and Secretary of the Cabinet (1990-1993), General Counsel to the
United States Treasury Department (1989-1990), and Counselor to the Secretary
and Assistant Secretary for Public Affairs and Public Liaison - United States
Treasury Department (1988-1989).
*Charles B. Johnson (66)
777 Mariners Island Blvd., San Mateo, CA 94404
CHAIRMAN OF THE BOARD AND TRUSTEE
President, Chief Executive Officer and Director, Franklin Resources, Inc.;
Chairman of the Board and Director, Franklin Advisers, Inc., Franklin
Investment Advisory Services, Inc. and Franklin Templeton Distributors, Inc.;
Director, Franklin/Templeton Investor Services, Inc. and Franklin Templeton
Services, Inc.; officer and/or director or trustee, as the case may be, of
most of the other subsidiaries of Franklin Resources, Inc. and of 49 of the
investment companies in the Franklin Templeton Group of Funds.
*Rupert H. Johnson, Jr. (58)
777 Mariners Island Blvd., San Mateo, CA 94404
PRESIDENT AND TRUSTEE
Executive Vice President and Director, Franklin Resources, Inc. and Franklin
Templeton Distributors, Inc.; President and Director, Franklin Advisers, Inc.
and Franklin Investment Advisory Services, Inc.; Senior Vice President, Franklin
Advisory Services, LLC; Director, Franklin/Templeton Investor Services, Inc.;
and officer and/or director or trustee, as the case may be, of most of the other
subsidiaries of Franklin Resources, Inc. and of 52 of the investment companies
in the Franklin Templeton Group of Funds.
Frank W.T. LaHaye (70)
20833 Stevens Creek Blvd., Suite 102, Cupertino, CA 95014
TRUSTEE
General Partner, Miller & LaHaye, which is the General Partner of Peregrine
Ventures II (venture capital firm); director or trustee, as the case may be, of
27 of the investment companies in the Franklin Templeton Group of Funds; and
FORMERLY, Director, Fischer Imaging Corporation (medical imaging systems),
Digital Transmission Systems, Inc. (wireless communications) and Quarterdeck
Corporation (software firm), and General Partner, Peregrine Associates, which
was the General Partner of Peregrine Ventures (venture capital firm).
Gordon S. Macklin (71)
8212 Burning Tree Road, Bethesda, MD 20817
TRUSTEE
Director, Fund American Enterprises Holdings, Inc. (holding company), Martek
Biosciences Corporation, MCI WorldCom (information services), MedImmune, Inc.
(biotechnology), Spacehab, Inc. (aerospace services) and Real 3D (software);
director or trustee, as the case may be, of 48 of the investment companies in
the Franklin Templeton Group of Funds; and FORMERLY, Chairman, White River
Corporation (financial services) and Hambrecht and Quist Group (investment
banking), and President, National Association of Securities Dealers, Inc.
Harmon E. Burns (54)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT
Executive Vice President and Director, Franklin Resources, Inc., Franklin
Templeton Distributors, Inc. and Franklin Templeton Services, Inc.; Executive
Vice President, Franklin Advisers, Inc.; Director, Franklin Investment
Advisory Services, Inc. and Franklin/Templeton Investor Services, Inc.; and
officer and/or director or trustee, as the case may be, of most of the other
subsidiaries of Franklin Resources, Inc. and of 52 of the investment
companies in the Franklin Templeton Group of Funds.
Martin L. Flanagan (39)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
Senior Vice President and Chief Financial Officer, Franklin Resources, Inc.,
Franklin/Templeton Investor Services, Inc. and Franklin Mutual Advisers, LLC;
Executive Vice President, Chief Financial Officer and Director, Templeton
Worldwide, Inc.; Executive Vice President, Chief Operating Officer and Director,
Templeton Investment Counsel, Inc.; Executive Vice President and Chief Financial
Officer, Franklin Advisers, Inc.; Chief Financial Officer, Franklin Advisory
Services, LLC and Franklin Investment Advisory Services, Inc.; President and
Director, Franklin Templeton Services, Inc.; officer and/or director of some of
the other subsidiaries of Franklin Resources, Inc.; and officer and/or director
or trustee, as the case may be, of 52 of the investment companies in the
Franklin Templeton Group of Funds.
Deborah R. Gatzek (50)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT AND SECRETARY
Senior Vice President and General Counsel, Franklin Resources, Inc.; Senior Vice
President, Franklin Templeton Services, Inc. and Franklin Templeton
Distributors, Inc.; Executive Vice President, Franklin Advisers, Inc.; Vice
President, Franklin Advisory Services, LLC and Franklin Mutual Advisers, LLC;
Vice President, Chief Legal Officer and Chief Operating Officer, Franklin
Investment Advisory Services, Inc.; and officer of 53 of the investment
companies in the Franklin Templeton Group of Funds.
Thomas J. Kenny (36)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT
Executive Vice President, Franklin Advisers, Inc.; and officer of eight of the
investment companies in the Franklin Templeton Group of Funds.
Diomedes Loo-Tam (60)
777 Mariners Island Blvd., San Mateo, CA 94404
TREASURER AND PRINCIPAL ACCOUNTING OFFICER
Senior Vice President, Franklin Templeton Services, Inc.; and officer of 32 of
the investment companies in the Franklin Templeton Group of Funds.
Edward V. McVey (61)
777 Mariners Island Blvd., San Mateo, CA 94404
VICE PRESIDENT
Senior Vice President and National Sales Manager, Franklin Templeton
Distributors, Inc.; and officer of 28 of the investment companies in the
Franklin Templeton Group of Funds.
*This board member is considered an "interested person" under federal securities
laws.
Note: Charles B. Johnson and Rupert H. Johnson, Jr. are brothers.
The trust pays noninterested board members $1,450 per month plus $1,300 per
meeting attended. Board members who serve on the audit committee of the trust
and other funds in the Franklin Templeton Group of Funds receive a flat fee of
$2,000 per committee meeting attended, a portion of which is allocated to the
trust. Members of a committee are not compensated for any committee meeting held
on the day of a board meeting. Noninterested board members also may serve as
directors or trustees of other funds in the Franklin Templeton Group of Funds
and may receive fees from these funds for their services. The fees payable to
noninterested board members by the trust are subject to reductions resulting
from fee caps limiting the amount of fees payable to board members who serve on
other boards within the Franklin Templeton Group of Funds. The following table
provides the total fees paid to noninterested board members by the trust and by
the Franklin Templeton Group of Funds.
NUMBER OF
BOARDS IN
TOTAL FEES THE FRANKLIN
RECEIVED FROM TEMPLETON
TOTAL FEES THE FRANKLIN GROUP
RECEIVED TEMPLETON OF FUNDS
FROM THE GROUP ON WHICH
NAME TRUST 1 OF FUNDS 2 EACH SERVES 3
- ------------------------------------------------------------------------------
Frank H. Abbott, III $25,675 $159,051 27
Harris J. Ashton 26,390 361,157 48
S. Joseph Fortunato 25,097 367,835 50
Edith E. Holiday 28,650 211,400 24
Frank W.T. LaHaye 26,975 163,753 27
Gordon S. Macklin 26,390 361,157 48
1. For the fiscal year ended February 28, 1999. During the period from March 1,
1998, through May 31, 1998, fees at the rate of $1,300 per month plus $1,300 per
board meeting attended were in effect.
2. For the calendar year ended December 31, 1998.
3. We base the number of boards on the number of registered investment
companies in the Franklin Templeton Group of Funds. This number does not include
the total number of series or funds within each investment company for which the
board members are responsible. The Franklin Templeton Group of Funds currently
includes 54 registered investment companies, with approximately 163 U.S. based
funds or series.
Noninterested board members are reimbursed for expenses incurred in connection
with attending board meetings, paid pro rata by each fund in the Franklin
Templeton Group of Funds for which they serve as director or trustee. No officer
or board member received any other compensation, including pension or retirement
benefits, directly or indirectly from the fund or other funds in the Franklin
Templeton Group of Funds. Certain officers or board members who are shareholders
of Franklin Resources, Inc. may be deemed to receive indirect remuneration by
virtue of their participation, if any, in the fees paid to its subsidiaries.
Board members historically have followed a policy of having substantial
investments in one or more of the funds in the Franklin Templeton Group of
Funds, as is consistent with their individual financial goals. In February 1998,
this policy was formalized through adoption of a requirement that each board
member invest one-third of fees received for serving as a director or trustee of
a Templeton fund in shares of one or more Templeton funds and one-third of fees
received for serving as a director or trustee of a Franklin fund in shares of
one or more Franklin funds until the value of such investments equals or exceeds
five times the annual fees paid such board member. Investments in the name of
family members or entities controlled by a board member constitute fund holdings
of such board member for purposes of this policy, and a three year phase-in
period applies to such investment requirements for newly elected board members.
In implementing such policy, a board member's fund holdings existing on February
27, 1998, are valued as of such date with subsequent investments valued at cost.
MANAGEMENT AND OTHER SERVICES
MANAGER AND SERVICES PROVIDED Each fund's manager is Franklin Advisers, Inc.
The manager is a wholly owned subsidiary of Franklin Resources, Inc.
(Resources), a publicly owned company engaged in the financial services
industry through its subsidiaries. Charles B. Johnson and Rupert H. Johnson,
Jr. are the principal shareholders of Resources.
The manager provides investment research and portfolio management services, and
selects the securities for each fund to buy, hold or sell. The manager's
extensive research activities include, as appropriate, traveling to meet with
issuers and to review project sites. The manager also selects the brokers who
execute the funds' portfolio transactions. The manager provides periodic reports
to the board, which reviews and supervises the manager's investment activities.
To protect the funds, the manager and its officers, directors and employees are
covered by fidelity insurance.
The manager and its affiliates manage numerous other investment companies and
accounts. The manager may give advice and take action with respect to any of the
other funds it manages, or for its own account, that may differ from action
taken by the manager on behalf of each fund. Similarly, with respect to each
fund, the manager is not obligated to recommend, buy or sell, or to refrain from
recommending, buying or selling any security that the manager and access
persons, as defined by applicable federal securities laws, may buy or sell for
its or their own account or for the accounts of any other fund. The manager is
not obligated to refrain from investing in securities held by the fund or other
funds it manages. Of course, any transactions for the accounts of the manager
and other access persons will be made in compliance with the funds' code of
ethics.
Under the funds' code of ethics, employees of the Franklin Templeton Group who
are access persons may engage in personal securities transactions subject to the
following general restrictions and procedures: (i) the trade must receive
advance clearance from a compliance officer and must be completed by the close
of the business day following the day clearance is granted; (ii) copies of all
brokerage confirmations and statements must be sent to a compliance officer;
(iii) all brokerage accounts must be disclosed on an annual basis; and (iv)
access persons involved in preparing and making investment decisions must, in
addition to (i), (ii) and (iii) above, file annual reports of their securities
holdings each January and inform the compliance officer (or other designated
personnel) if they own a security that is being considered for a fund or other
client transaction or if they are recommending a security in which they have an
ownership interest for purchase or sale by a fund or other client.
MANAGEMENT FEES Each fund pays the manager a fee equal to a monthly rate of:
o 5/96 of 1% of the value of its net assets up to and including $100 million;
and
o 1/24 of 1% of the value of its net assets over $100 million up to and
including $250 million; and
o 9/240 of 1% of the value of its net assets in excess of $250 million.
The fee is computed at the close of business on the last business day of each
month according to the terms of the management agreement. Each class of a funds'
shares pays its proportionate share of the fee.
For the last three fiscal years ended February 28, the funds paid the following
management fees:
MANAGEMENT FEES PAID ($)
1999 1998 1997
- ---------------------------------------------------------------------
Arizona Fund 4,124,084 3,799,811 3,627,685
Colorado Fund 1,615,981 1,432,605 1,259,548
Connecticut Fund 1,313,337 1,126,660 1,012,114
Federal Intermediate Fund 1 901,601 628,115 438,843
High Yield Fund 29,382,074 24,164,691 19,114,157
Indiana Fund 357,518 330,541 311,799
Michigan Fund 2 0 0 0
MANAGEMENT FEES PAID ($)
1999 1998 1997
- ---------------------------------------------------------------------
New Jersey Fund 3,411,855 3,074,915 2,827,318
Oregon Fund 2,429,095 2,119,137 1,964,313
Pennsylvania Fund 3,734,742 3,414,301 3,181,417
Puerto Rico Fund 1,223,542 1,137,320 1,083,818
1. For the fiscal years ended February 28, 1999, 1998 and 1997, management fees
before any advance waiver, totaled $959,067, $718,091, and $586,462,
respectively. Under an agreement by the manager to limit its fees, the fund paid
the management fees shown.
2. For the fiscal years ended February 28, 1999, and 1998, and for the period
from July 1, 1996, through February 28, 1997, management fees before any advance
waiver, totaled $82,747, $44,302, and $12,802, respectively. Under agreements by
the manager to limit its fees, the fund paid the management fees shown.
ADMINISTRATOR AND SERVICES PROVIDED Franklin Templeton Services, Inc. (FT
Services) has an agreement with the manager to provide certain administrative
services and facilities for each fund. FT Services is wholly owned by Resources
and is an affiliate of the funds' manager and principal underwriter.
The administrative services FT Services provides include preparing and
maintaining books, records, and tax and financial reports, and monitoring
compliance with regulatory requirements.
ADMINISTRATION FEES The manager pays FT Services a monthly fee equal to an
annual rate of:
o 0.15% of each fund's average daily net assets up to $200 million;
o 0.135% of average daily net assets over $200 million up to $700 million;
o 0.10% of average daily net assets over $700 million up to $1.2 billion; and
o 0.075% of average daily net assets over $1.2 billion.
During the last three fiscal years ended February 28, the manager paid FT
Services the following administration fees:
ADMINISTRATION FEES PAID ($)
1999 1998 1997 1
- --------------------------------------------------------------
Arizona Fund 1,132,869 1,060,456 430,330
Colorado Fund 436,830 383,050 144,807
Connecticut Fund 347,940 298,352 114,062
Federal Intermediate Fund 246,943 176,069 62,460
High Yield Fund 5,411,515 4,519,848 1,626,344
Indiana Fund 85,406 79,053 31,765
Michigan Fund 19,373 10,238 2,069
New Jersey Fund 970,458 872,308 339,343
Oregon Fund 679,370 587,736 229,705
Pennsylvania Fund 1,046,296 971,653 384,008
Puerto Rico Fund 325,819 301,686 120,593
1. For the period from October 1, 1996, through February 28, 1997.
SHAREHOLDER SERVICING AND TRANSFER AGENT Franklin/ Templeton Investor Services,
Inc. (Investor Services) is each fund's shareholder servicing agent and acts as
the funds' transfer agent and dividend-paying agent. Investor Services is
located at 777 Mariners Island Blvd., San Mateo, CA 94404. Please send all
correspondence to Investor Services to P.O. Box 997151, Sacramento, CA
95899-9983.
For its services, Investor Services receives a fixed fee per account. Each fund
also will reimburse Investor Services for certain out-of-pocket expenses, which
may include payments by Investor Services to entities, including affiliated
entities, that provide sub-shareholder services, recordkeeping and/or transfer
agency services to beneficial owners of the fund. The amount of reimbursements
for these services per benefit plan participant fund account per year will not
exceed the per account fee payable by the fund to Investor Services in
connection with maintaining shareholder accounts.
CUSTODIAN Bank of New York, Mutual Funds Division, 90 Washington Street, New
York, NY 10286, acts as custodian of each fund's securities and other assets.
AUDITOR PricewaterhouseCoopers LLP, 333 Market Street, San Francisco, CA 94105,
is the funds' independent auditor. The auditor gives an opinion on the financial
statements included in the trust's Annual Report to Shareholders and reviews the
trust's registration statement filed with the U.S. Securities and Exchange
Commission (SEC).
PORTFOLIO TRANSACTIONS
Since most purchases by the funds are principal transactions at net prices, the
funds incur little or no brokerage costs. Each fund deals directly with the
selling or buying principal or market maker without incurring charges for the
services of a broker on its behalf, unless it is determined that a better price
or execution may be obtained by using the services of a broker. Purchases of
portfolio securities from underwriters will include a commission or concession
paid by the issuer to the underwriter, and purchases from dealers will include a
spread between the bid and ask prices. As a general rule, the funds do not buy
securities in underwritings where they are given no choice, or only limited
choice, in the designation of dealers to receive the commission. The funds seek
to obtain prompt execution of orders at the most favorable net price.
Transactions may be directed to dealers in return for research and statistical
information, as well as for special services provided by the dealers in the
execution of orders.
It is not possible to place a dollar value on the special executions or on the
research services the manager receives from dealers effecting transactions in
portfolio securities. The allocation of transactions in order to obtain
additional research services allows the manager to supplement its own research
and analysis activities and to receive the views and information of individuals
and research staffs of other securities firms. As long as it is lawful and
appropriate to do so, the manager and its affiliates may use this research and
data in their investment advisory capacities with other clients. If the funds'
officers are satisfied that the best execution is obtained, the sale of fund
shares, as well as shares of other funds in the Franklin Templeton Group of
Funds, also may be considered a factor in the selection of broker-dealers to
execute the funds' portfolio transactions.
If purchases or sales of securities of the funds and one or more other
investment companies or clients supervised by the manager are considered at or
about the same time, transactions in these securities will be allocated among
the several investment companies and clients in a manner deemed equitable to all
by the manager, taking into account the respective sizes of the funds and the
amount of securities to be purchased or sold. In some cases this procedure could
have a detrimental effect on the price or volume of the security so far as the
funds are concerned. In other cases it is possible that the ability to
participate in volume transactions may improve execution and reduce transaction
costs to the funds.
During the fiscal years ended February 28, 1999, 1998 and 1997, the funds did
not pay any brokerage commissions.
As of February 28, 1999, the funds did not own securities of their regular
broker-dealers.
DISTRIBUTIONS AND TAXES
The funds calculate dividends and capital gains the same way for each class. The
amount of any income dividends per share will differ, however, generally due to
the difference in the distribution and service (Rule 12b-1) fees of each class.
The funds do not pay "interest" or guarantee any fixed rate of return on an
investment in their shares.
DISTRIBUTIONS OF NET INVESTMENT INCOME Each fund receives income generally in
the form of interest on its investments. This income, less expenses incurred in
the operation of the fund, constitutes the fund's net investment income from
which dividends may be paid to you.
By meeting certain requirements of the Internal Revenue Code, the funds have
qualified and continue to qualify to pay exempt-interest dividends to you. These
dividends are derived from interest income exempt from regular federal income
tax, and are not subject to regular federal income tax when they are distributed
to you. In addition, to the extent that exempt-interest dividends are derived
from interest on obligations of a state or its political subdivisions, or from
interest on qualifying U.S. territorial obligations (including qualifying
obligations of Puerto Rico, the U.S. Virgin Islands or Guam), they also will be
exempt from that state's personal income taxes. Most states generally do not
grant tax-free treatment to interest on state and municipal securities of other
states.
The funds may earn taxable income on any temporary investments, on the discount
from stripped obligations or their coupons, on income from securities loans or
other taxable transactions, or on ordinary income derived from the sale of
market discount bonds. Any fund distributions from such income will be taxable
to you as ordinary income, whether you receive them in cash or in additional
shares.
DISTRIBUTIONS OF CAPITAL GAINS The funds may derive capital gains and losses in
connection with sales or other dispositions of their portfolio securities.
Distributions from net short-term capital gains will be taxable to you as
ordinary income. Distributions from net long-term capital gains will be taxable
to you as long-term capital gain, regardless of how long you have held your
shares in a fund. Any net capital gains realized by a fund generally will be
distributed once each year, and may be distributed more frequently, if
necessary, in order to reduce or eliminate excise or income taxes on the fund.
INFORMATION ON THE TAX CHARACTER OF DISTRIBUTIONS The funds will inform you of
the amount of your ordinary income dividends and capital gains distributions at
the time they are paid, and will advise you of their tax status for federal
income tax purposes shortly after the close of each calendar year, including the
portion of the distributions that on average comprise taxable income or interest
income that is a tax preference item under the alternative minimum tax. If you
have not held fund shares for a full year, a fund may designate and distribute
to you, as taxable, tax-exempt or tax preference income, a percentage of income
that is not equal to the actual amount of such income earned during the period
of your investment in the fund.
ELECTION TO BE TAXED AS A REGULATED INVESTMENT COMPANY Each fund has elected to
be treated as a regulated investment company under Subchapter M of the Internal
Revenue Code, has qualified as such for its most recent fiscal year, and intends
to so qualify during the current fiscal year. As regulated investment companies,
the funds generally pay no federal income tax on the income and gains they
distribute to you. The board reserves the right not to maintain the
qualification of a fund as a regulated investment company if it determines such
course of action to be beneficial to shareholders. In such case, a fund will be
subject to federal, and possibly state, corporate taxes on its taxable income
and gains, and distributions to you will be taxed as ordinary dividend income to
the extent of the fund's earnings and profits.
EXCISE TAX DISTRIBUTION REQUIREMENTS To avoid federal excise taxes, the Internal
Revenue Code requires each fund to distribute to you by December 31 of each
year, at a minimum, the following amounts: 98% of its taxable ordinary income
earned during the calendar year; 98% of its capital gain net income earned
during the twelve month period ending October 31; and 100% of any undistributed
amounts from the prior year. Each fund intends to declare and pay these amounts
in December (or in January that are treated by you as received in December) to
avoid these excise taxes, but can give no assurances that its distributions will
be sufficient to eliminate all taxes.
REDEMPTION OF FUND SHARES Redemptions and exchanges of fund shares are taxable
transactions for federal and state income tax purposes. If you redeem your fund
shares, or exchange your fund shares for shares of a different Franklin
Templeton Fund, the IRS will require that you report a gain or loss on your
redemption or exchange. If you hold your shares as a capital asset, the gain or
loss that you realize will be capital gain or loss and will be long-term or
short-term, generally depending on how long you hold your shares. Any loss
incurred on the redemption or exchange of shares held for six months or less
will be disallowed to the extent of any exempt-interest dividends distributed to
you with respect to your fund shares and any remaining loss will be treated as a
long-term capital loss to the extent of any long-term capital gains distributed
to you by the fund on those shares.
All or a portion of any loss that you realize upon the redemption of your fund
shares will be disallowed to the extent that you buy other shares in the fund
(through reinvestment of dividends or otherwise) within 30 days before or after
your share redemption. Any loss disallowed under these rules will be added to
your tax basis in the new shares you buy.
DEFERRAL OF BASIS If you redeem some or all of your shares in a fund, and then
reinvest the sales proceeds in the fund or in another Franklin Templeton Fund
within 90 days of buying the original shares, the sales charge that would
otherwise apply to your reinvestment may be reduced or eliminated. The IRS will
require you to report gain or loss on the redemption of your original shares in
a fund. In doing so, all or a portion of the sales charge that you paid for your
original shares in a fund will be excluded from your tax basis in the shares
sold (for the purpose of determining gain or loss upon the sale of such shares).
The portion of the sales charge excluded will equal the amount that the sales
charge is reduced on your reinvestment. Any portion of the sales charge excluded
from your tax basis in the shares sold will be added to the tax basis of the
shares you acquire from your reinvestment.
DIVIDENDS-RECEIVED DEDUCTION FOR CORPORATIONS Because each fund's income
consists of interest rather than dividends, no portion of its distributions
generally will be eligible for the corporate dividends-received deduction. None
of the dividends paid by the funds for the most recent fiscal year qualified for
such deduction, and it is anticipated that none of the current year's dividends
will so qualify.
INVESTMENT IN COMPLEX SECURITIES Each fund may invest in complex securities.
These investments may be subject to numerous special and complex tax rules.
These rules could affect whether gains and losses recognized by a fund are
treated as ordinary income or capital gain, accelerate the recognition of income
to a fund and/or defer a fund's ability to recognize losses. In turn, these
rules may affect the amount, timing or character of the income distributed to
you by a fund.
TREATMENT OF PRIVATE ACTIVITY BOND INTEREST Interest on certain private activity
bonds, while still exempt from regular federal income tax, is a preference item
for taxpayers when determining their alternative minimum tax under the Internal
Revenue Code and under the income tax provisions of several states. Private
activity bond interest could subject you to or increase your liability under
federal and state alternative minimum taxes, depending on your individual or
corporate tax position. Persons who are defined in the Internal Revenue Code as
substantial users (or persons related to such users) of facilities financed by
private activity bonds should consult with their tax advisors before buying fund
shares.
ORGANIZATION, VOTING RIGHTS AND PRINCIPAL HOLDERS
Each fund is a series of Franklin Tax-Free Trust, an open-end management
investment company, commonly called a mutual fund. The trust was organized as a
Massachusetts business trust in September 1984, and is registered with the SEC.
As a shareholder of a Massachusetts business trust, you could, under certain
circumstances, be held personally liable as a partner for its obligations. The
Agreement and Declaration of Trust, however, contains an express disclaimer of
shareholder liability for acts or obligations of the fund. The Declaration of
Trust also provides for indemnification and reimbursement of expenses out of the
fund's assets if you are held personally liable for obligations of the fund. The
Declaration of Trust provides that the fund shall, upon request, assume the
defense of any claim made against you for any act or obligation of the fund and
satisfy any judgment thereon. All such rights are limited to the assets of the
fund. The Declaration of Trust further provides that the fund may maintain
appropriate insurance (for example, fidelity bonding and errors and omissions
insurance) for the protection of the fund, its shareholders, trustees, officers,
employees and agents to cover possible tort and other liabilities. Furthermore,
the activities of the fund as an investment company, as distinguished from an
operating company, would not likely give rise to liabilities in excess of the
fund's total assets. Thus, the risk that you would incur financial loss on
account of shareholder liability is limited to the unlikely circumstance in
which both inadequate insurance exists and the fund itself is unable to meet its
obligations.
The High Yield Fund currently offers three classes of shares, Class A, Class B
and Class C. The Arizona, Colorado, Connecticut, New Jersey, Oregon,
Pennsylvania, and Puerto Rico Funds currently offer two classes of shares, Class
A and Class C. Before January 1, 1999, Class A shares were designated Class I
and Class C shares were designated Class II. The High Yield Fund began offering
Class B shares on January 1, 1999. The full title of each class is:
o Franklin Arizona Tax-Free Income Fund - Class A o Franklin Arizona Tax-Free
Income Fund - Class C o Franklin Colorado Tax-Free Income Fund - Class A o
Franklin Colorado Tax-Free Income Fund - Class C o Franklin Connecticut Tax-Free
Income Fund - Class A o Franklin Connecticut Tax-Free Income Fund - Class C o
Franklin High Yield Tax-Free Income Fund - Class A o Franklin High Yield
Tax-Free Income Fund - Class B o Franklin High Yield Tax-Free Income Fund -
Class C o Franklin New Jersey Tax-Free Income Fund - Class A o Franklin New
Jersey Tax-Free Income Fund - Class C o Franklin Oregon Tax-Free Income Fund -
Class A o Franklin Oregon Tax-Free Income Fund - Class C o Franklin Pennsylvania
Tax-Free Income Fund - Class A o Franklin Pennsylvania Tax-Free Income Fund -
Class C o Franklin Puerto Rico Tax-Free Income Fund - Class A o Franklin Puerto
Rico Tax-Free Income Fund - Class C
The Federal Intermediate, Indiana and Michigan Funds each offer only one share
class. Because their sales charge structures and Rule 12b-1 plans are similar to
those of Class A shares, shares of these funds are considered Class A shares for
redemption, exchange and other purposes.
The funds may offer additional classes of shares in the future.
Shares of each class represent proportionate interests in the fund's assets. On
matters that affect the fund as a whole, each class has the same voting and
other rights and preferences as any other class. On matters that affect only one
class, only shareholders of that class may vote. Each class votes separately on
matters affecting only that class, or expressly required to be voted on
separately by state or federal law. Shares of each class of a series have the
same voting and other rights and preferences as the other classes and series of
the trust for matters that affect the trust as a whole.
Additional series may be offered in the future.
The trust has noncumulative voting rights. For board member elections, this
gives holders of more than 50% of the shares voting the ability to elect all of
the members of the board. If this happens, holders of the remaining shares
voting will not be able to elect anyone to the board.
The trust does not intend to hold annual shareholder meetings. The trust or a
series of the trust may hold special meetings, however, for matters requiring
shareholder approval. A meeting may be called by the board to consider the
removal of a board member if requested in writing by shareholders holding at
least 10% of the outstanding shares. In certain circumstances, we are required
to help you communicate with other shareholders about the removal of a board
member. A special meeting also may be called by the board in its discretion.
As of April 12, 1999, the principal shareholders of the funds, beneficial or of
record, were:
NAME AND ADDRESS SHARE CLASS PERCENTAGE (%)
- ------------------------------------------------------------------------------
MICHIGAN FUND
Franklin Resources Inc. Class A 16.02
Corporate Accounting
555 Airport Boulevard 4th Fl
Burlingame, CA 94010
From time to time, the number of fund shares held in the "street name" accounts
of various securities dealers for the benefit of their clients or in centralized
securities depositories may exceed 5% of the total shares outstanding.
As of April 12, 1999, the officers and board members, as a group, owned of
record and beneficially less than 1% of the outstanding shares of each fund and
class. The board members may own shares in other funds in the Franklin Templeton
Group of Funds.
BUYING AND SELLING SHARES
The fund continuously offers its shares through securities dealers who have an
agreement with Franklin Templeton Distributors, Inc. (Distributors). A
securities dealer includes any financial institution that, either directly or
through affiliates, has an agreement with Distributors to handle customer orders
and accounts with the fund. This reference is for convenience only and does not
indicate a legal conclusion of capacity. Banks and financial institutions that
sell shares of the fund may be required by state law to register as securities
dealers.
For investors outside the U.S., the offering of fund shares may be limited in
many jurisdictions. An investor who wishes to buy shares of the fund should
determine, or have a broker-dealer determine, the applicable laws and
regulations of the relevant jurisdiction. Investors are responsible for
compliance with tax, currency exchange or other regulations applicable to
redemption and purchase transactions in any jurisdiction to which they may be
subject. Investors should consult appropriate tax and legal advisors to obtain
information on the rules applicable to these transactions.
All checks, drafts, wires and other payment mediums used to buy or sell shares
of the fund must be denominated in U.S. dollars. We may, in our sole discretion,
either (a) reject any order to buy or sell shares denominated in any other
currency or (b) honor the transaction or make adjustments to your account for
the transaction as of a date and with a foreign currency exchange factor
determined by the drawee bank.
When you buy shares, if you submit a check or a draft that is returned unpaid to
the fund we may impose a $10 charge against your account for each returned item.
INITIAL SALES CHARGES The maximum initial sales charge is 2.25% for the Federal
Intermediate Fund. For each of the other funds, the maximum initial sales charge
is 4.25% for Class A and 1% for Class C. There is no initial sales charge for
Class B shares of the High Yield Fund.
The initial sales charge for Class A shares may be reduced for certain large
purchases, as described in the prospectus. We offer several ways for you to
combine your purchases in the Franklin Templeton Funds to take advantage of the
lower sales charges for large purchases. The Franklin Templeton Funds include
the U.S. registered mutual funds in the Franklin Group of Funds(R) and the
Templeton Group of Funds except Franklin Valuemark Funds, Templeton Capital
Accumulator Fund, Inc., and Templeton Variable Products Series Fund.
CUMULATIVE QUANTITY DISCOUNT. For purposes of calculating the sales charge on
Class A shares, you may combine the amount of your current purchase with the
cost or current value, whichever is higher, of your existing shares in the
Franklin Templeton Funds. You also may combine the shares of your spouse,
children under the age of 21 or grandchildren under the age of 21. If you are
the sole owner of a company, you also may add any company accounts, including
retirement plan accounts.
LETTER OF INTENT (LOI). You may buy Class A shares at a reduced sales charge by
completing the letter of intent section of your account application. A letter of
intent is a commitment by you to invest a specified dollar amount during a 13
month period. The amount you agree to invest determines the sales charge you
pay. By completing the letter of intent section of the application, you
acknowledge and agree to the following:
o You authorize Distributors to reserve 5% of your total intended purchase in
Class A shares registered in your name until you fulfill your LOI. Your
periodic statements will include the reserved shares in the total shares you
own, and we will pay or reinvest dividend and capital gain distributions on
the reserved shares according to the distribution option you have chosen.
o You give Distributors a security interest in the reserved shares and appoint
Distributors as attorney-in-fact.
o Distributors may sell any or all of the reserved shares to cover any
additional sales charge if you do not fulfill the terms of the LOI.
o Although you may exchange your shares, you may not sell reserved shares until
you complete the LOI or pay the higher sales charge.
After you file your LOI with the fund, you may buy Class A shares at the sales
charge applicable to the amount specified in your LOI. Sales charge reductions
based on purchases in more than one Franklin Templeton Fund will be effective
only after notification to Distributors that the investment qualifies for a
discount. Any Class A purchases you made within 90 days before you filed your
LOI also may qualify for a retroactive reduction in the sales charge. If you
file your LOI with the fund before a change in the fund's sales charge, you may
complete the LOI at the lower of the new sales charge or the sales charge in
effect when the LOI was filed.
Your holdings in the Franklin Templeton Funds acquired more than 90 days before
you filed your LOI will be counted towards the completion of the LOI, but they
will not be entitled to a retroactive reduction in the sales charge. Any
redemptions you make during the 13 month period will be subtracted from the
amount of the purchases for purposes of determining whether the terms of the LOI
have been completed.
If the terms of your LOI are met, the reserved shares will be deposited to an
account in your name or delivered to you or as you direct. If the amount of your
total purchases, less redemptions, is more than the amount specified in your LOI
and is an amount that would qualify for a further sales charge reduction, a
retroactive price adjustment will be made by Distributors and the securities
dealer through whom purchases were made. The price adjustment will be made on
purchases made within 90 days before and on those made after you filed your LOI
and will be applied towards the purchase of additional shares at the offering
price applicable to a single purchase or the dollar amount of the total
purchases.
If the amount of your total purchases, less redemptions, is less than the amount
specified in your LOI, the sales charge will be adjusted upward, depending on
the actual amount purchased (less redemptions) during the period. You will need
to send Distributors an amount equal to the difference in the actual dollar
amount of sales charge paid and the amount of sales charge that would have
applied to the total purchases if the total of the purchases had been made at
one time. Upon payment of this amount, the reserved shares held for your account
will be deposited to an account in your name or delivered to you or as you
direct. If within 20 days after written request the difference in sales charge
is not paid, we will redeem an appropriate number of reserved shares to realize
the difference. If you redeem the total amount in your account before you
fulfill your LOI, we will deduct the additional sales charge due from the sale
proceeds and forward the balance to you.
GROUP PURCHASES. If you are a member of a qualified group, you may buy Class A
shares at a reduced sales charge that applies to the group as a whole. The sales
charge is based on the combined dollar value of the group members' existing
investments, plus the amount of the current purchase.
A qualified group is one that:
o Was formed at least six months ago,
o Has a purpose other than buying fund shares at a discount,
o Has more than 10 members,
o Can arrange for meetings between our representatives and group members,
o Agrees to include Franklin Templeton Fund sales and other materials in
publications and mailings to its members at reduced or no cost to
Distributors,
o Agrees to arrange for payroll deduction or other bulk transmission of
investments to the fund, and
o Meets other uniform criteria that allow Distributors to achieve cost savings
in distributing shares.
WAIVERS FOR INVESTMENTS FROM CERTAIN PAYMENTS. Class A shares may be purchased
without an initial sales charge or contingent deferred sales charge (CDSC) by
investors who reinvest within 365 days:
o Dividend and capital gain distributions from any Franklin Templeton Fund. The
distributions generally must be reinvested in the same share class. Certain
exceptions apply, however, to Class C shareholders who chose to reinvest
their distributions in Class A shares of the fund before November 17, 1997,
and to Advisor Class or Class Z shareholders of a Franklin Templeton Fund who
may reinvest their distributions in the fund's Class A shares. This waiver
category also applies to Class B and C shares.
o Dividend or capital gain distributions from a real estate investment trust
(REIT) sponsored or advised by Franklin Properties, Inc.
o Annuity payments received under either an annuity option or from death
benefit proceeds, if the annuity contract offers as an investment option the
Franklin Valuemark Funds or the Templeton Variable Products Series Fund. You
should contact your tax advisor for information on any tax consequences that
may apply.
o Redemption proceeds from a repurchase of shares of Franklin Floating Rate
Trust, if the shares were continuously held for at least 12 months.
If you immediately placed your redemption proceeds in a Franklin Bank CD or a
Franklin Templeton money fund, you may reinvest them as described above. The
proceeds must be reinvested within 365 days from the date the CD matures,
including any rollover, or the date you redeem your money fund shares.
o Redemption proceeds from the sale of Class A shares of any of the Templeton
Global Strategy Funds if you are a qualified investor.
If you paid a CDSC when you redeemed your Class A shares from a Templeton
Global Strategy Fund, a new CDSC will apply to your purchase of fund shares
and the CDSC holding period will begin again. We will, however, credit your
fund account with additional shares based on the CDSC you previously paid and
the amount of the redemption proceeds that you reinvest.
If you immediately placed your redemption proceeds in a Franklin Templeton
money fund, you may reinvest them as described above. The proceeds must be
reinvested within 365 days from the date they are redeemed from the money
fund.
WAIVERS FOR CERTAIN INVESTORS. Class A shares also may be purchased without an
initial sales charge or CDSC by various individuals and institutions due to
anticipated economies in sales efforts and expenses, including:
o Trust companies and bank trust departments agreeing to invest in Franklin
Templeton Funds over a 13 month period at least $1 million of assets held in
a fiduciary, agency, advisory, custodial or similar capacity and over which
the trust companies and bank trust departments or other plan fiduciaries or
participants, in the case of certain retirement plans, have full or shared
investment discretion. We will accept orders for these accounts by mail
accompanied by a check or by telephone or other means of electronic data
transfer directly from the bank or trust company, with payment by federal
funds received by the close of business on the next business day following
the order.
o Any state or local government or any instrumentality, department, authority
or agency thereof that has determined the fund is a legally permissible
investment and that can only buy fund shares without paying sales charges.
Please consult your legal and investment advisors to determine if an
investment in a fund is permissible and suitable for you and the effect, if
any, of payments by the fund on arbitrage rebate calculations.
o Broker-dealers, registered investment advisors or certified financial
planners who have entered into an agreement with Distributors for clients
participating in comprehensive fee programs
o Qualified registered investment advisors who buy through a broker-dealer or
service agent who has entered into an agreement with Distributors
o Registered securities dealers and their affiliates, for their investment
accounts only
o Current employees of securities dealers and their affiliates and their family
members, as allowed by the internal policies of their employer
o Officers, trustees, directors and full-time employees of the Franklin
Templeton Funds or the Franklin Templeton Group, and their family members,
consistent with our then-current policies
o Any investor who is currently a Class Z shareholder of Franklin Mutual Series
Fund Inc. (Mutual Series), or who is a former Mutual Series Class Z
shareholder who had an account in any Mutual Series fund on October 31, 1996,
or who sold his or her shares of Mutual Series Class Z within the past 365
days
o Investment companies exchanging shares or selling assets pursuant to a
merger, acquisition or exchange offer
o Accounts managed by the Franklin Templeton Group
o Certain unit investment trusts and their holders reinvesting distributions
from the trusts
In addition, Class C shares may be purchased without an initial sales charge by
any investor who buys Class C shares through an omnibus account with Merrill
Lynch Pierce Fenner & Smith, Inc. A CDSC may apply, however, if the shares are
sold within 18 months of purchase.
SALES IN TAIWAN. Under agreements with certain banks in Taiwan, Republic of
China, each fund's shares are available to these banks' trust accounts without a
sales charge. The banks may charge service fees to their customers who
participate in the trusts. A portion of these service fees may be paid to
Distributors or one of its affiliates to help defray expenses of maintaining a
service office in Taiwan, including expenses related to local literature
fulfillment and communication facilities.
Each fund's Class A shares may be offered to investors in Taiwan through
securities advisory firms known locally as Securities Investment Consulting
Enterprises. In conformity with local business practices in Taiwan, Class A
shares may be offered with the following schedule of sales charges:
SIZE OF PURCHASE - U.S. DOLLARS SALES CHARGE (%)
- --------------------------------------------------------------
Under $30,000 3.0
$30,000 but less than $100,000 2.0
$100,000 but less than $400,000 1.0
$400,000 or more 0
DEALER COMPENSATION Securities dealers may at times receive the entire sales
charge. A securities dealer who receives 90% or more of the sales charge may be
deemed an underwriter under the Securities Act of 1933, as amended. Financial
institutions or their affiliated brokers may receive an agency transaction fee
in the percentages indicated in the dealer compensation table in the funds'
prospectus.
Distributors may pay the following commissions, out of its own resources, to
securities dealers who initiate and are responsible for purchases of Class A
shares of $1 million or more: 0.75% on sales of $1 million to $2 million, plus
0.60% on sales over $2 million to $3 million, plus 0.50% on sales over $3
million to $50 million, plus 0.25% on sales over $50 million to $100 million,
plus 0.15% on sales over $100 million.
These breakpoints are reset every 12 months for purposes of additional
purchases.
Distributors and/or its affiliates provide financial support to various
securities dealers that sell shares of the Franklin Templeton Group of Funds.
This support is based primarily on the amount of sales of fund shares. The
amount of support may be affected by: total sales; net sales; levels of
redemptions; the proportion of a securities dealer's sales and marketing efforts
in the Franklin Templeton Group of Funds; a securities dealer's support of, and
participation in, Distributors' marketing programs; a securities dealer's
compensation programs for its registered representatives; and the extent of a
securities dealer's marketing programs relating to the Franklin Templeton Group
of Funds. Financial support to securities dealers may be made by payments from
Distributors' resources, from Distributors' retention of underwriting
concessions and, in the case of funds that have Rule 12b-1 plans, from payments
to Distributors under such plans. In addition, certain securities dealers may
receive brokerage commissions generated by fund portfolio transactions in
accordance with the rules of the National Association of Securities Dealers,
Inc.
Distributors routinely sponsors due diligence meetings for registered
representatives during which they receive updates on various Franklin Templeton
Funds and are afforded the opportunity to speak with portfolio managers.
Invitation to these meetings is not conditioned on selling a specific number of
shares. Those who have shown an interest in the Franklin Templeton Funds,
however, are more likely to be considered. To the extent permitted by their
firm's policies and procedures, registered representatives' expenses in
attending these meetings may be covered by Distributors.
CONTINGENT DEFERRED SALES CHARGE (CDSC) If you invest $1 million or more in
Class A shares, either as a lump sum or through our cumulative quantity discount
or letter of intent programs, a CDSC may apply on any shares you sell within 12
months of purchase. For Class C shares, a CDSC may apply if you sell your shares
within 18 months of purchase. The CDSC is 1% of the value of the shares sold or
the net asset value at the time of purchase, whichever is less. A CDSC will not
apply to Class A purchases over $250 million in the High Yield Fund.
For Class B shares of the High Yield Fund, there is a CDSC if you sell your
shares within six years, as described in the table below. The charge is based on
the value of the shares sold or the net asset value at the time of purchase,
whichever is less.
IF YOU SELL YOUR CLASS B SHARES WITHIN THIS % IS DEDUCTED FROM
THIS MANY YEARS AFTER BUYING THEM YOUR PROCEEDS AS A CDSC
- ------------------------------------------------------------------------------
1 Year 4
2 Years 4
3 Years 3
4 Years 3
5 Years 2
6 Years 1
7 Years 0
CDSC WAIVERS. The CDSC for any share class generally will be waived for:
o Account fees
o Redemptions of Class A shares by investors who purchased $1 million or more
without an initial sales charge if the securities dealer of record waived its
commission in connection with the purchase
o Redemptions by a fund when an account falls below the minimum required
account size
o Redemptions following the death of the shareholder or beneficial owner
o Redemptions through a systematic withdrawal plan set up before February 1,
1995
o Redemptions through a systematic withdrawal plan set up on or after February
1, 1995, up to 1% monthly, 3% quarterly, 6% semiannually or 12% annually of
your account's net asset value depending on the frequency of your plan
EXCHANGE PRIVILEGE If you request the exchange of the total value of your
account, accrued but unpaid income dividends and capital gain distributions will
be reinvested in the fund at net asset value on the date of the exchange, and
then the entire share balance will be exchanged into the new fund. Backup
withholding and information reporting may apply.
If a substantial number of shareholders should, within a short period, sell
their fund shares under the exchange privilege, the fund might have to sell
portfolio securities it might otherwise hold and incur the additional costs
related to such transactions. On the other hand, increased use of the exchange
privilege may result in periodic large inflows of money. If this occurs, it is
each fund's general policy to initially invest this money in short-term,
tax-exempt municipal securities, unless it is believed that attractive
investment opportunities consistent with the fund's investment goals exist
immediately. This money will then be withdrawn from the short-term, tax-exempt
municipal securities and invested in portfolio securities in as orderly a manner
as is possible when attractive investment opportunities arise.
The proceeds from the sale of shares of an investment company are generally not
available until the seventh day following the sale. The funds you are seeking to
exchange into may delay issuing shares pursuant to an exchange until that
seventh day. The sale of fund shares to complete an exchange will be effected at
net asset value at the close of business on the day the request for exchange is
received in proper form.
SYSTEMATIC WITHDRAWAL PLAN Our systematic withdrawal plan allows you to sell
your shares and receive regular payments from your account on a monthly,
quarterly, semiannual or annual basis. The value of your account must be at
least $5,000 and the minimum payment amount for each withdrawal must be at least
$50. There are no service charges for establishing or maintaining a systematic
withdrawal plan. Once your plan is established, any distributions paid by the
fund will be automatically reinvested in your account.
Payments under the plan will be made from the redemption of an equivalent amount
of shares in your account, generally on the 25th day of the month in which a
payment is scheduled. If the 25th falls on a weekend or holiday, we will process
the redemption on the next business day. When you sell your shares under a
systematic withdrawal plan, it is a taxable transaction.
To avoid paying sales charges on money you plan to withdraw within a short
period of time, you may not want to set up a systematic withdrawal plan if you
plan to buy shares on a regular basis. Shares sold under the plan also may be
subject to a CDSC.
Redeeming shares through a systematic withdrawal plan may reduce or exhaust the
shares in your account if payments exceed distributions received from the fund.
This is especially likely to occur if there is a market decline. If a withdrawal
amount exceeds the value of your account, your account will be closed and the
remaining balance in your account will be sent to you. Because the amount
withdrawn under the plan may be more than your actual yield or income, part of
the payment may be a return of your investment.
You may discontinue a systematic withdrawal plan, change the amount and schedule
of withdrawal payments, or suspend one payment by notifying us by mail or by
phone at least seven business days before the end of the month preceding a
scheduled payment. The fund may discontinue a systematic withdrawal plan by
notifying you in writing and will automatically discontinue a systematic
withdrawal plan if all shares in your account are withdrawn or if the fund
receives notification of the shareholder's death or incapacity.
REDEMPTIONS IN KIND Each fund has committed itself to pay in cash (by check) all
requests for redemption by any shareholder of record, limited in amount,
however, during any 90-day period to the lesser of $250,000 or 1% of the value
of the fund's net assets at the beginning of the 90-day period. This commitment
is irrevocable without the prior approval of the U.S. Securities and Exchange
Commission (SEC). In the case of redemption requests in excess of these amounts,
the board reserves the right to make payments in whole or in part in securities
or other assets of the fund, in case of an emergency, or if the payment of such
a redemption in cash would be detrimental to the existing shareholders of the
fund. In these circumstances, the securities distributed would be valued at the
price used to compute the fund's net assets and you may incur brokerage fees in
converting the securities to cash. Redemptions in kind are taxable transactions.
The fund does not intend to redeem illiquid securities in kind. If this happens,
however, you may not be able to recover your investment in a timely manner.
SHARE CERTIFICATES We will credit your shares to your fund account. We do not
issue share certificates unless you specifically request them. This eliminates
the costly problem of replacing lost, stolen or destroyed certificates. If a
certificate is lost, stolen or destroyed, you may have to pay an insurance
premium of up to 2% of the value of the certificate to replace it.
Any outstanding share certificates must be returned to the fund if you want to
sell or exchange those shares or if you would like to start a systematic
withdrawal plan. The certificates should be properly endorsed. You can do this
either by signing the back of the certificate or by completing a share
assignment form. For your protection, you may prefer to complete a share
assignment form and to send the certificate and assignment form in separate
envelopes.
GENERAL INFORMATION If dividend checks are returned to the fund marked "unable
to forward" by the postal service, we will consider this a request by you to
change your dividend option to reinvest all distributions. The proceeds will be
reinvested in additional shares at net asset value until we receive new
instructions.
Distribution or redemption checks sent to you do not earn interest or any other
income during the time the checks remain uncashed. Neither the funds nor their
affiliates will be liable for any loss caused by your failure to cash such
checks. The funds are not responsible for tracking down uncashed checks, unless
a check is returned as undeliverable.
In most cases, if mail is returned as undeliverable we are required to take
certain steps to try to find you free of charge. If these attempts are
unsuccessful, however, we may deduct the costs of any additional efforts to find
you from your account. These costs may include a percentage of the account when
a search company charges a percentage fee in exchange for its location services.
The wiring of redemption proceeds is a special service that we make available
whenever possible. By offering this service to you, the funds are not bound to
meet any redemption request in less than the seven day period prescribed by law.
Neither the funds nor their agents shall be liable to you or any other person
if, for any reason, a redemption request by wire is not processed as described
in the prospectus.
Franklin Templeton Investor Services, Inc. (Investor Services) may pay certain
financial institutions that maintain omnibus accounts with the funds on behalf
of numerous beneficial owners for recordkeeping operations performed with
respect to such owners. For each beneficial owner in the omnibus account, the
fund may reimburse Investor Services an amount not to exceed the per account fee
that the fund normally pays Investor Services. These financial institutions also
may charge a fee for their services directly to their clients.
If you buy or sell shares through your securities dealer, we use the net asset
value next calculated after your securities dealer receives your request, which
is promptly transmitted to the fund. If you sell shares through your securities
dealer, it is your dealer's responsibility to transmit the order to the fund in
a timely fashion. Your redemption proceeds will not earn interest between the
time we receive the order from your dealer and the time we receive any required
documents. Any loss to you resulting from your dealer's failure to transmit your
redemption order to the fund in a timely fashion must be settled between you and
your securities dealer.
Certain shareholder servicing agents may be authorized to accept your
transaction request.
For institutional accounts, there may be additional methods of buying or selling
fund shares than those described in this SAI or in the prospectus.
In the event of disputes involving multiple claims of ownership or authority to
control your account, the fund has the right (but has no obligation) to: (a)
freeze the account and require the written agreement of all persons deemed by
the fund to have a potential property interest in the account, before executing
instructions regarding the account; (b) interplead disputed funds or accounts
with a court of competent jurisdiction; or (c) surrender ownership of all or a
portion of the account to the IRS in response to a notice of levy.
PRICING SHARES
When you buy shares, you pay the offering price. The offering price is the net
asset value (NAV) per share plus any applicable sales charge, calculated to two
decimal places using standard rounding criteria. When you sell shares, you
receive the NAV minus any applicable CDSC.
The value of a mutual fund is determined by deducting the fund's liabilities
from the total assets of the portfolio. The net asset value per share is
determined by dividing the net asset value of the fund by the number of shares
outstanding.
Each fund calculates the NAV per share of each class each business day at the
close of trading on the New York Stock Exchange (normally 1:00 p.m. pacific
time). The funds do not calculate the NAV on days the New York Stock Exchange
(NYSE) is closed for trading, which include New Year's Day, Martin Luther King
Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day and Christmas Day.
When determining its NAV, each fund values cash and receivables at their
realizable amounts, and records interest as accrued. Each fund values
over-the-counter portfolio securities within the range of the most recent quoted
bid and ask prices. If portfolio securities trade both in the over-the-counter
market and on a stock exchange, each fund values them according to the broadest
and most representative market as determined by the manager. Municipal
securities generally trade in the over-the-counter market rather than on a
securities exchange. In the absence of a sale or reported bid and ask prices,
information with respect to bond and note transactions, quotations from bond
dealers, market transactions in comparable securities, and various relationships
between securities are used to determine the value of municipal securities.
Generally, trading in U.S. government securities and money market instruments is
substantially completed each day at various times before the close of the NYSE.
The value of these securities used in computing the NAV is determined as of such
times. Occasionally, events affecting the values of these securities may occur
between the times at which they are determined and the close of the NYSE that
will not be reflected in the computation of the NAV. If events materially
affecting the values of these securities occur during this period, the
securities will be valued at their fair value as determined in good faith by the
board.
Other securities for which market quotations are readily available are valued at
the current market price, which may be obtained from a pricing service, based on
a variety of factors including recent trades, institutional size trading in
similar types of securities (considering yield, risk and maturity) and/or
developments related to specific issues. Securities and other assets for which
market prices are not readily available are valued at fair value as determined
following procedures approved by the board. With the approval of the board, each
fund may use a pricing service, bank or securities dealer to perform any of the
above described functions.
THE UNDERWRITER
Franklin Templeton Distributors, Inc. (Distributors) acts as the principal
underwriter in the continuous public offering of each fund's shares.
Distributors is located at 777 Mariners Island Blvd., San Mateo, CA 94404.
Distributors pays the expenses of the distribution of fund shares, including
advertising expenses and the costs of printing sales material and prospectuses
used to offer shares to the public. Each fund pays the expenses of preparing and
printing amendments to its registration statements and prospectuses (other than
those necessitated by the activities of Distributors) and of sending
prospectuses to existing shareholders.
The table below shows the aggregate underwriting commissions Distributors
received in connection with the offering of the funds' shares, the net
underwriting discounts and commissions Distributors retained after allowances to
dealers, and the amounts Distributors received in connection with redemptions or
repurchases of shares for the last three fiscal years ended February 28:
AMOUNT
RECEIVED IN
CONNECTION
WITH
TOTAL AMOUNT REDEMPTIONS
COMMISSIONS RETAINED BY AND
RECEIVED DISTRIBUTORS REPURCHASES
($) ($) ($)
- ------------------------------------------------------------------------------
1999
Arizona Fund 3,109,731 204,136 12,269
Colorado Fund 1,230,170 75,655 8,464
Connecticut Fund 1,280,521 72,556 7,518
Federal Intermediate Fund 408,916 55,742 4,464
High Yield Fund 24,360,736 1,514,537 283,409
Indiana Fund 206,649 14,009 -
Michigan Fund 208,099 13,810 -
New Jersey Fund 2,838,883 169,312 23,450
Oregon Fund 2,294,919 142,478 13,763
Pennsylvania Fund 2,942,369 186,194 16,329
Puerto Rico Fund 703,085 44,229 5,057
1998
Arizona Fund 2,894,958 189,181 5,073
Colorado Fund 1,099,794 68,871 2,658
Connecticut Fund 1,038,873 64,019 2,066
Federal Intermediate Fund 346,839 47,207 -
High Yield Fund 27,355,789 1,661,281 114,622
Indiana Fund 188,219 12,470 -
Michigan Fund 112,690 7,243 -
New Jersey Fund 2,514,214 152,637 10,997
Oregon Fund 1,645,005 106,236 4,656
Pennsylvania Fund 3,017,041 187,577 5,534
Puerto Rico Fund 748,531 49,128 1,587
1997
Arizona Fund 2,438,719 159,341 2,749
Colorado Fund 838,759 52,237 6,126
Connecticut Fund 958,649 60,427 711
Federal Intermediate Fund 301,298 40,297 -
High Yield Fund 26,688,526 1,654,304 52,856
Indiana Fund 200,618 13,121 -
Michigan Fund 43,942 2,585 -
New Jersey Fund 2,075,332 131,524 4,080
Oregon Fund 1,398,757 89,649 2,950
Pennsylvania Fund 2,594,028 155,077 31,296
Puerto Rico Fund 621,195 39,228 2,964
Distributors may be entitled to reimbursement under the Rule 12b-1 plans, as
discussed below. Except as noted, Distributors received no other compensation
from the fund for acting as underwriter.
DISTRIBUTION AND SERVICE (12B-1) FEES Each class has a separate distribution or
"Rule 12b-1" plan. Under each plan, the fund shall pay or may reimburse
Distributors or others for the expenses of activities that are primarily
intended to sell shares of the class. These expenses may include, among others,
distribution or service fees paid to securities dealers or others who have
executed a servicing agreement with the fund, Distributors or its affiliates; a
prorated portion of Distributors' overhead expenses; and the expenses of
printing prospectuses and reports used for sales purposes, and preparing and
distributing sales literature and advertisements.
The distribution and service (12b-1) fees charged to each class are based only
on the fees attributable to that particular class.
THE CLASS A PLAN. Payments by the fund under the Class A plan may not exceed
0.15 per year for the Michigan Fund (although it is currently only reimbursing
up to 0.10%), and 0.10% per year for the remaining funds, of Class A's average
daily net assets, payable quarterly. All distribution expenses over this amount
will be borne by those who have incurred them.
In implementing the Class A plan, the board has determined that the annual fees
payable under the plan for each fund, except the Federal Intermediate and
Michigan Funds, will be equal to the sum of: (i) the amount obtained by
multiplying 0.10% by the average daily net assets represented by the fund's
Class A shares that were acquired by investors on or after May 1, 1994, the
effective date of the plan (new assets), and (ii) the amount obtained by
multiplying 0.05% by the average daily net assets represented by the fund's
Class A shares that were acquired before May 1, 1994 (old assets). These fees
will be paid to the current securities dealer of record on the account. In
addition, until such time as the maximum payment of 0.10% is reached on a yearly
basis, up to an additional 0.02% will be paid to Distributors under the plan.
When the fund reaches $4 billion in assets, the amount to be paid to
Distributors will be reduced from 0.02% to 0.01%. The payments made to
Distributors will be used by Distributors to defray other marketing expenses
that have been incurred in accordance with the plan, such as advertising.
The fee is a Class A expense. This means that all Class A shareholders,
regardless of when they purchased their shares, will bear Rule 12b-1 expenses at
the same rate. The initial rate for each fund, except the Federal Intermediate
and Michigan Funds, will be at least 0.07% (0.05% plus 0.02%) of the average
daily net assets of Class A and, as Class A shares are sold on or after May 1,
1994, will increase over time. Thus, as the proportion of Class A shares
purchased on or after May 1, 1994, increases in relation to outstanding Class A
shares, the expenses attributable to payments under the plan also will increase
(but will not exceed 0.10% of average daily net assets). While this is the
currently anticipated calculation for fees payable under the Class A plan for
each fund, except the Federal Intermediate and Michigan Funds, the plan permits
the board to allow such funds to pay a full 0.10% on all assets at any time. The
approval of the board would be required to change the calculation of the
payments to be made under the Class A plan.
The Class A plan for each fund, except the Michigan Fund, does not permit
unreimbursed expenses incurred in a particular year to be carried over to or
reimbursed in later years.
THE CLASS B (HIGH YIELD FUND ONLY) AND C PLANS. Under the Class B and C plans,
the fund pays Distributors up to 0.50% per year of the class's average daily net
assets, payable monthly for Class B and quarterly for Class C, to pay
Distributors or others for providing distribution and related services and
bearing certain expenses. All distribution expenses over this amount will be
borne by those who have incurred them. The fund also may pay a servicing fee of
up to 0.15% per year of the class's average daily net assets, payable monthly
for Class B and quarterly for Class C. This fee may be used to pay securities
dealers or others for, among other things, helping to establish and maintain
customer accounts and records, helping with requests to buy and sell shares,
receiving and answering correspondence, monitoring dividend payments from the
fund on behalf of customers, and similar servicing and account maintenance
activities.
The expenses relating to each of the Class B and C plans also are used to pay
Distributors for advancing the commission costs to securities dealers with
respect to the initial sale of Class B and C shares. Further, the expenses
relating to the Class B plan may be used by Distributors to pay third party
financing entities that have provided financing to Distributors in connection
with advancing commission costs to securities dealers.
THE CLASS A, B AND C PLANS. In addition to the payments that Distributors or
others are entitled to under each plan, each plan also provides that to the
extent the fund, the manager or Distributors or other parties on behalf of the
fund, the manager or Distributors make payments that are deemed to be for the
financing of any activity primarily intended to result in the sale of fund
shares within the context of Rule 12b-1 under the Investment Company Act of
1940, as amended, then such payments shall be deemed to have been made pursuant
to the plan. The terms and provisions of each plan relating to required reports,
term, and approval are consistent with Rule 12b-1.
In no event shall the aggregate asset-based sales charges, which include
payments made under each plan, plus any other payments deemed to be made
pursuant to a plan, exceed the amount permitted to be paid under the rules of
the National Association of Securities Dealers, Inc.
To the extent fees are for distribution or marketing functions, as distinguished
from administrative servicing or agency transactions, certain banks will not be
entitled to participate in the plans as a result of applicable federal law
prohibiting certain banks from engaging in the distribution of mutual fund
shares. These banking institutions, however, are permitted to receive fees under
the plans for administrative servicing or for agency transactions. If you are a
customer of a bank that is prohibited from providing these services, you would
be permitted to remain a shareholder of a fund, and alternate means for
continuing the servicing would be sought. In this event, changes in the services
provided might occur and you might no longer be able to avail yourself of any
automatic investment or other services then being provided by the bank. It is
not expected that you would suffer any adverse financial consequences as a
result of any of these changes.
Each plan has been approved in accordance with the provisions of Rule 12b-1. The
plans are renewable annually by a vote of the board, including a majority vote
of the board members who are not interested persons of the fund and who have no
direct or indirect financial interest in the operation of the plans, cast in
person at a meeting called for that purpose. It is also required that the
selection and nomination of such board members be done by the noninterested
members of the fund's board. The plans and any related agreement may be
terminated at any time, without penalty, by vote of a majority of the
noninterested board members on not more than 60 days' written notice, by
Distributors on not more than 60 days' written notice, by any act that
constitutes an assignment of the management agreement with the manager or by
vote of a majority of the outstanding shares of the class. The Federal
Intermediate Fund's plan also may be terminated by any act that constitutes an
assignment of the underwriting agreement with Distributors. Distributors or any
dealer or other firm also may terminate their respective distribution or service
agreement at any time upon written notice.
The plans and any related agreements may not be amended to increase materially
the amount to be spent for distribution expenses without approval by a majority
of the outstanding shares of the class, and all material amendments to the plans
or any related agreements shall be approved by a vote of the noninterested board
members, cast in person at a meeting called for the purpose of voting on any
such amendment.
Distributors is required to report in writing to the board at least quarterly on
the amounts and purpose of any payment made under the plans and any related
agreements, as well as to furnish the board with such other information as may
reasonably be requested in order to enable the board to make an informed
determination of whether the plans should be continued.
For the fiscal year ended February 28, 1999, Distributors' eligible expenditures
for advertising, printing, and payments to underwriters and broker-dealers
pursuant to the plans and the amounts the funds paid Distributors under the
plans were:
DISTRIBUTORS' AMOUNT PAID
ELIGIBLE BY THE
EXPENSES ($) FUND ($)
- ------------------------------------------------------------------------------
Arizona Fund - Class A 905,874 756,099
Arizona Fund - Class C 228,434 118,919
Colorado Fund - Class A 273,334 206,877
Colorado Fund - Class C 201,435 88,879
Connecticut Fund - Class A 401,801 266,061
Connecticut Fund - Class C 189,417 99,834
Federal Intermediate Fund 302,601 160,061
High Yield Fund - Class A 8,022,234 5,149,820
High Yield Fund - Class B1 167,011 1,654
High Yield Fund - Class C 5,282,583 3,431,976
Indiana Fund - Class A 105,872 50,981
Michigan Fund - Class A 44,118 12,261
New Jersey Fund - Class A 740,497 603,991
New Jersey Fund - Class C 409,626 237,210
Oregon Fund - Class A 589,949 412,566
Oregon Fund - Class C 301,399 154,878
Pennsylvania Fund - Class A 812,111 673,325
Pennsylvania Fund - Class C 345,946 208,598
Puerto Rico Fund - Class A 236,743 192,324
Puerto Rico Fund - Class C 65,212 33,042
1. For the period from January 1, 1999, through February 28, 1999.
PERFORMANCE
Performance quotations are subject to SEC rules. These rules require the use of
standardized performance quotations or, alternatively, that every
non-standardized performance quotation furnished by the fund be accompanied by
certain standardized performance information computed as required by the SEC.
Average annual total return and current yield quotations used by the fund are
based on the standardized methods of computing performance mandated by the SEC.
Performance figures reflect Rule 12b-1 fees from the date of the plan's
implementation. An explanation of these and other methods used by the funds to
compute or express performance follows. Regardless of the method used, past
performance does not guarantee future results, and is an indication of the
return to shareholders only for the limited historical period used.
AVERAGE ANNUAL TOTAL RETURN Average annual total return is determined by finding
the average annual rates of return over the periods indicated below that would
equate an initial hypothetical $1,000 investment to its ending redeemable value.
The calculation assumes the maximum initial sales charge is deducted from the
initial $1,000 purchase, and income dividends and capital gain distributions are
reinvested at net asset value. The quotation assumes the account was completely
redeemed at the end of each period and the deduction of all applicable charges
and fees. If a change is made to the sales charge structure, historical
performance information will be restated to reflect the maximum initial sales
charge currently in effect.
When considering the average annual total return quotations you should keep in
mind that the maximum initial sales charge reflected in each quotation is a one
time fee charged on all direct purchases, which will have its greatest impact
during the early stages of your investment. This charge will affect actual
performance less the longer you retain your investment in the fund. The average
annual total returns for the indicated periods ended February 28, 1999, were:
INCEPTION 1 5 10 SINCE
DATE YEAR YEARS YEARS INCEPTION
- ------------------------------------------------------------------------------
CLASS A
Arizona Fund 9/01/87 0.68% 4.99% 7.10% 7.25%
Colorado Fund 9/01/87 0.75% 5.18% 7.34% 7.55%
Connecticut Fund 10/03/88 1.12% 4.95% 6.74% 6.70%
Federal Intermediate
Fund 9/21/92 2.80% 5.56% - 6.54%
High Yield Fund 3/18/86 -0.23% 6.12% 7.85% 8.06%
Indiana Fund 9/01/87 0.74% 4.95% 7.35% 7.58%
Michigan Fund 7/01/96 1.63% - - 7.25%
New Jersey Fund 5/12/88 1.13% 4.99% 7.12% 7.44%
Oregon Fund 9/01/87 0.62% 4.86% 6.86% 6.93%
Pennsylvania Fund 12/01/86 0.63% 5.24% 7.27% 6.77%
Puerto Rico Fund 4/03/85 1.16% 5.20% 7.12% 7.53%
SINCE
INCEPTION
1 YEAR (5/1/95)
- ------------------------------------------------------------
CLASS C
Arizona Fund 2.47% 6.17%
Colorado Fund 2.62% 6.62%
Connecticut Fund 3.02% 6.40%
High Yield Fund 1.67% 7.39%
New Jersey Fund 3.06% 6.39%
Oregon Fund 2.55% 6.18%
Pennsylvania Fund 2.44% 6.39%
Puerto Rico Fund 3.04% 6.44%
The following SEC formula was used to calculate these figures:
n
P(1+T) = ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at the
beginning of each period at the end of each period
CUMULATIVE TOTAL RETURN Like average annual total return, cumulative total
return assumes the maximum initial sales charge is deducted from the initial
$1,000 purchase, and income dividends and capital gain distributions are
reinvested at net asset value. Cumulative total return, however, is based on the
actual return for a specified period rather than on the average return over the
periods indicated above. The cumulative total returns for the indicated periods
ended February 28, 1999, were:
INCEPTION 1 5 10 SINCE
DATE YEAR YEARS YEARS INCEPTION
- ------------------------------------------------------------------------------
CLASS A
Arizona Fund 9/01/87 0.68% 27.54% 98.62% 123.48%
Colorado Fund 9/01/87 0.75% 28.75% 103.11% 130.95%
Connecticut Fund 10/03/88 1.12% 26.89% 92.06% 96.28%
Federal Intermediate
Fund 9/21/92 2.80% 31.04% - 50.36%
High Yield Fund 3/18/86 -0.23% 34.59% 112.92% 172.76%
Indiana Fund 9/01/87 0.74% 27.30% 103.21% 131.60%
Michigan Fund 7/01/96 1.63% - - 20.50%
New Jersey Fund 5/12/88 1.13% 27.58% 98.96% 117.04%
Oregon Fund 9/01/87 0.62% 26.76% 94.17% 116.08%
Pennsylvania Fund 12/01/86 0.63% 29.08% 101.80% 26.78%
Puerto Rico Fund 4/03/85 1.16% 28.87% 99.02% 174.61%
SINCE
INCEPTION
1 YEAR (5/1/95)
- --------------------------------------------------------------
CLASS C
Arizona Fund 2.47% 25.79%
Colorado Fund 2.62% 27.85%
Connecticut Fund 3.02% 26.82%
High Yield Fund 1.67% 31.40%
New Jersey Fund 3.06% 26.77%
Oregon Fund 2.55% 25.84%
Pennsylvania Fund 2.44% 26.78%
Puerto Rico Fund 3.04% 27.02%
CURRENT YIELD Current yield shows the income per share earned by a fund. It is
calculated by dividing the net investment income per share earned during a
30-day base period by the applicable maximum offering price per share on the
last day of the period and annualizing the result. Expenses accrued for the
period include any fees charged to all shareholders of the class during the base
period. The yields for the 30-day period ended February 28, 1999, were:
CLASS A CLASS C
- ---------------------------------------------------
Arizona Fund 3.87% 3.45%
Colorado Fund 3.95% 3.53%
Connecticut Fund 3.81% 3.38%
Federal Intermediate Fund 3.80% -
High Yield Fund 4.71% 4.32%
Indiana Fund 3.89% -
Michigan Fund 4.55% -
New Jersey Fund 3.83% 3.40%
Oregon Fund 3.86% 3.44%
Pennsylvania Fund 4.03% 3.61%
Puerto Rico Fund 3.80% 3.37%
The following SEC formula was used to calculate these figures:
6
Yield = 2 [(a-b + 1) - 1]
---
cd
where:
a = interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = the average daily number of shares outstanding during the period that were
entitled to receive dividends
d = the maximum offering price per share on the last day of the period
TAXABLE-EQUIVALENT YIELD Each fund also may quote a taxable-equivalent yield
that shows the before-tax yield that would have to be earned from a taxable
investment to equal the yield. Taxable-equivalent yield is computed by dividing
the portion of the yield that is tax-exempt by one minus the highest applicable
federal or combined federal and state income tax rate and adding the product to
the portion of the yield that is not tax-exempt, if any. The taxable-equivalent
yields for the 30-day period ended February 28, 1999, were:
CLASS A CLASS C
- ----------------------------------------------------
Arizona Fund 6.75% 6.01%
Colorado Fund 6.88% 6.15%
Connecticut Fund 6.61% 5.86%
Federal Intermediate Fund 6.29% -
High Yield Fund 7.80% 7.15%
Indiana Fund 6.74% -
Michigan Fund 7.88% -
New Jersey Fund 6.77% 6.01%
Oregon Fund 7.02% 6.26%
Pennsylvania Fund 6.86% 6.15%
Puerto Rico Fund 6.29% 5.58%
As of February 28, 1999, the federal or combined federal and state income tax
rates upon which the taxable-equivalent yield quotations were based were as
follows:
COMBINED RATE
- ---------------------------------------------------
Arizona Fund 42.6%
Colorado Fund 42.6%
Connecticut Fund 42.3%
Federal Intermediate Fund 39.6%
High Yield Fund 39.6%
Indiana Fund 42.3%
Michigan Fund 42.3%
New Jersey Fund 43.4%
Oregon Fund 45.0%
Pennsylvania Fund 41.3%
Puerto Rico Fund 39.6%
From time to time, as any changes to the rates become effective,
taxable-equivalent yield quotations advertised by the funds will be updated to
reflect these changes. The funds expect updates may be necessary as tax rates
are changed by federal and state governments. The advantage of tax-free
investments, like the funds, will be enhanced by any tax rate increases.
Therefore, the details of specific tax increases may be used in sales material
for the funds.
CURRENT DISTRIBUTION RATE Current yield and taxable-equivalent yield, which are
calculated according to a formula prescribed by the SEC, are not indicative of
the amounts which were or will be paid to shareholders. Amounts paid to
shareholders are reflected in the quoted current distribution rate or
taxable-equivalent distribution rate. The current distribution rate is usually
computed by annualizing the dividends paid per share by a class during a certain
period and dividing that amount by the current maximum offering price. The
current distribution rate differs from the current yield computation because it
may include distributions to shareholders from sources other than interest, if
any, and is calculated over a different period of time. The current distribution
rates for the 30-day period ended February 28, 1999, were:
CLASS A CLASS C
- -------------------------------------------------------------
Arizona Fund 4.80% 4.23%
Colorado Fund 4.72% 4.30%
Connecticut Fund 4.74% 4.33%
Federal Intermediate Fund 4.31% -
High Yield Fund 5.40% 4.92%
Indiana Fund 4.87% -
Michigan Fund 4.56% -
New Jersey Fund 4.80% 4.38%
Oregon Fund 4.71% 4.27%
Pennsylvania Fund 4.80% 4.37%
Puerto Rico Fund 4.59% 4.18%
A taxable-equivalent distribution rate shows the taxable distribution rate
equivalent to the current distribution rate. The advertised taxable-equivalent
distribution rate will reflect the most current federal and state tax rates
available to the fund. The taxable-equivalent distribution rates for the 30-day
period ended February 28, 1999, were:
CLASS A CLASS C
- --------------------------------------------------------------
Arizona Fund 8.37% 7.72%
Colorado Fund 8.23% 7.49%
Connecticut Fund 8.22% 7.51%
Federal Intermediate Fund 7.14% -
High Yield Fund 8.94% 8.15%
Indiana Fund 8.43% -
Michigan Fund 7.90% -
New Jersey Fund 8.49% 7.75%
Oregon Fund 8.57% 7.77%
Pennsylvania Fund 8.18% 7.44%
Puerto Rico Fund 7.60% 6.92%
VOLATILITY Occasionally statistics may be used to show the a fund's volatility
or risk. Measures of volatility or risk are generally used to compare a fund's
net asset value or performance to a market index. One measure of volatility is
beta. Beta is the volatility of a fund relative to the total market, as
represented by an index considered representative of the types of securities in
which the fund invests. A beta of more than 1.00 indicates volatility greater
than the market and a beta of less than 1.00 indicates volatility less than the
market. Another measure of volatility or risk is standard deviation. Standard
deviation is used to measure variability of net asset value or total return
around an average over a specified period of time. The idea is that greater
volatility means greater risk undertaken in achieving performance.
OTHER PERFORMANCE QUOTATIONS The funds also may quote the performance of shares
without a sales charge. Sales literature and advertising may quote a cumulative
total return, average annual total return and other measures of performance with
the substitution of net asset value for the public offering price.
Each fund may include in its advertising or sales material information relating
to investment goals and performance results of funds belonging to the Franklin
Templeton Group of Funds. Franklin Resources, Inc. is the parent company of the
advisors and underwriter of the Franklin Templeton Group of Funds.
COMPARISONS To help you better evaluate how an investment in the fund may
satisfy your investment goal, advertisements and other materials about the fund
may discuss certain measures of fund performance as reported by various
financial publications. Materials also may compare performance (as calculated
above) to performance as reported by other investments, indices, and averages.
These comparisons may include, but are not limited to, the following examples:
o Salomon Brothers Broad Bond Index or its component indices - measures yield,
price and total return for Treasury, agency, corporate and mortgage bonds.
o Lehman Brothers Aggregate Bond Index or its component indices - measures
yield, price and total return for Treasury, agency, corporate, mortgage and
Yankee bonds.
o Lehman Brothers Municipal Bond Index or its component indices - measures
yield, price and total return for the municipal bond market.
o Bond Buyer 20 Index - an index of municipal bond yields based upon yields of
20 general obligation bonds maturing in 20 years.
o Bond Buyer 40 Index - an index composed of the yield to maturity of 40 bonds.
The index attempts to track the new-issue market as closely as possible, so
it changes bonds twice a month, adding all new bonds that meet certain
requirements and deleting an equivalent number according to their secondary
market trading activity. As a result, the average par call date, average
maturity date, and average coupon rate can and have changed over time. The
average maturity generally has been about 29-30 years.
o Financial publications: THE WALL STREET JOURNAL, AND BUSINESS WEEK, FINANCIAL
WORLD, FORBES, FORTUNE, AND MONEY MAGAZINES - provide performance statistics
over specified time periods.
o Salomon Brothers Composite High Yield Index or its component indices measures
yield, price and total return for the Long-Term High-Yield Index,
Intermediate-Term High-Yield Index, and Long-Term Utility High-Yield Index.
o Historical data supplied by the research departments of CS First Boston
Corporation, the J. P. Morgan companies, Salomon Brothers, Merrill Lynch,
Lehman Brothers and Bloomberg L.P.
o Morningstar - information published by Morningstar, Inc., including
Morningstar proprietary mutual fund ratings. The ratings reflect
Morningstar's assessment of the historical risk-adjusted performance of a
fund over specified time periods relative to other funds within its category.
o Lipper - Mutual Fund Performance Analysis and Lipper - Fixed Income Fund
Performance Analysis - measure total return and average current yield for the
mutual fund industry and rank individual mutual fund performance over
specified time periods, assuming reinvestment of all distributions, exclusive
of any applicable sales charges.
o Savings and Loan Historical Interest Rates - as published in the U.S.
Savings & Loan League Fact Book.
o Consumer Price Index (or Cost of Living Index), published by the U.S. Bureau
of Labor Statistics - a statistical measure of change, over time, in the
price of goods and services in major expenditure groups.
o CDA Mutual Fund Report, published by CDA Investment Technologies, Inc.
analyzes price, current yield, risk, total return, and average rate of return
(average annual compounded growth rate) over specified time periods for the
mutual fund industry.
o Standard & Poor's Bond Indices - measure yield and price of corporate,
municipal, and government bonds.
From time to time, advertisements or information for each fund may include a
discussion of certain attributes or benefits to be derived from an investment in
the fund. The advertisements or information may include symbols, headlines, or
other material that highlights or summarizes the information discussed in more
detail in the communication.
Advertisements or sales material issued by each fund also may discuss or be
based upon information in a recent issue of the Special Report on Tax Freedom
Day published by the Tax Foundation, a Washington, D.C. based nonprofit research
and public education organization. The report illustrates, among other things,
the annual amount of time the average taxpayer works to satisfy his or her tax
obligations to the federal, state and local taxing authorities.
Advertisements or information also may compare each fund's performance to the
return on certificates of deposit (CDs) or other investments. You should be
aware, however, that an investment in the fund involves the risk of fluctuation
of principal value, a risk generally not present in an investment in a CD issued
by a bank. For example, as the general level of interest rates rise, the value
of the fund's fixed-income investments, as well as the value of its shares that
are based upon the value of such portfolio investments, can be expected to
decrease. Conversely, when interest rates decrease, the value of the fund's
shares can be expected to increase. CDs are frequently insured by an agency of
the U.S. government. An investment in a fund is not insured by any federal,
state or private entity.
In assessing comparisons of performance, you should keep in mind that the
composition of the investments in the reported indices and averages is not
identical to any fund's portfolio, the indices and averages are generally
unmanaged, and the items included in the calculations of the averages may not be
identical to the formula used by a fund to calculate its figures. In addition,
there can be no assurance that a fund will continue its performance as compared
to these other averages.
MISCELLANEOUS INFORMATION
The funds may help you achieve various investment goals such as accumulating
money for retirement, saving for a down payment on a home, college costs and
other long-term goals. The Franklin College Costs Planner may help you in
determining how much money must be invested on a monthly basis in order to have
a projected amount available in the future to fund a child's college education.
(Projected college cost estimates are based upon current costs published by the
College Board.) The Franklin Retirement Planning Guide leads you through the
steps to start a retirement savings program. Of course, an investment in the
funds cannot guarantee that these goals will be met.
The funds are members of the Franklin Templeton Group of Funds, one of the
largest mutual fund organizations in the U.S., and may be considered in a
program for diversification of assets. Founded in 1947, Franklin is one of the
oldest mutual fund organizations and now services more than 4 million
shareholder accounts. In 1992, Franklin, a leader in managing fixed-income
mutual funds and an innovator in creating domestic equity funds, joined forces
with Templeton, a pioneer in international investing. The Mutual Series team,
known for its value-driven approach to domestic equity investing, became part of
the organization four years later. Together, the Franklin Templeton Group has
over $227 billion in assets under management for more than 7 million U.S. based
mutual fund shareholder and other accounts. The Franklin Templeton Group of
Funds offers 113 U.S. based open-end investment companies to the public. Each
fund may identify itself by its NASDAQ symbol or CUSIP number.
Franklin is a leader in the tax-free mutual fund industry and manages more than
$51 billion in municipal security assets for over three quarters of a million
investors. According to Research and Ratings Review, Franklin had one of the
largest staffs of municipal securities analysts in the industry, as of June 30,
1998.
Under current tax laws, municipal securities remain one of the few investments
offering the potential for tax-free income. In 1999, taxes could cost almost $47
on every $100 earned from a fully taxable investment (based on the maximum
combined 39.6% federal tax rate and the highest state tax rate of 12% for 1999).
Franklin tax-free funds, however, offer tax relief through a professionally
managed portfolio of tax-free securities selected based on their yield, quality
and maturity. An investment in a Franklin tax-free fund can provide you with the
potential to earn income free of federal taxes and, depending on the fund, state
and local taxes as well, while supporting state and local public projects.
Franklin tax-free funds also may provide tax-free compounding, when dividends
are reinvested. An investment in Franklin's tax-free funds can grow more rapidly
than similar taxable investments.
Municipal securities are generally considered to be creditworthy, second in
quality only to securities issued or guaranteed by the U.S. government and its
agencies. The market price of municipal securities, however, may fluctuate. This
fluctuation will have a direct impact on the net asset value of the fund's
shares.
Currently, there are more mutual funds than there are stocks listed on the New
York Stock Exchange. While many of them have similar investment goals, no two
are exactly alike. Shares of the funds are generally sold through securities
dealers, whose investment representatives are experienced professionals who can
offer advice on the type of investments suitable to your unique goals and needs,
as well as the risks associated with such investments.
The Information Services & Technology division of Franklin Resources, Inc.
(Resources) established a Year 2000 Project Team in 1996. This team has already
begun making necessary software changes to help the computer systems that
service the fund and its shareholders to be Year 2000 compliant. After
completing these modifications, comprehensive tests are conducted in one of
Resources' U.S. test labs to verify their effectiveness. Resources continues to
seek reasonable assurances from all major hardware, software or data-services
suppliers that they will be Year 2000 compliant on a timely basis. Resources is
also beginning to develop a contingency plan, including identification of those
mission critical systems for which it is practical to develop a contingency
plan. However, in an operation as complex and geographically distributed as
Resources' business, the alternatives to use of normal systems, especially
mission critical systems, or supplies of electricity or long distance voice and
data lines are limited.
DESCRIPTION OF RATINGS
MUNICIPAL BOND RATINGS
MOODY'S INVESTORS SERVICE, INC. (MOODY'S)
Aaa: Municipal bonds rated Aaa 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 exceptionally stable
margin, and 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: Municipal bonds rated Aa are judged to be 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, fluctuation of protective elements may be of
greater amplitude, or there may be other elements present that make the
long-term risks appear somewhat larger.
A: Municipal bonds rated A possess many favorable investment attributes and are
considered upper medium-grade obligations. Factors giving security to principal
and interest are considered adequate, but elements may be present that suggest a
susceptibility to impairment sometime in the future.
Baa: Municipal bonds rated Baa are considered medium-grade obligations. 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.
These bonds lack outstanding investment characteristics and, in fact, have
speculative characteristics as well.
Ba: Municipal bonds rated Ba are judged to have predominantly speculative
elements and their future cannot be considered well assured. Often the
protection of interest and principal payments may be very moderate and, thereby,
not well safeguarded during both good and bad times over the future. Uncertainty
of position characterizes bonds in this class.
B: Municipal bonds rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa: Municipal bonds rated Caa are of poor standing. These issues may be in
default or there may be present elements of danger with respect to principal
or interest.
Ca: Municipal bonds rated Ca represent obligations that are speculative to a
high degree. These issues are often in default or have other marked
shortcomings.
C: Municipal bonds rated C are the lowest-rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Con.(-): Municipal 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 that begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon the
completion of construction or the elimination of the basis of the condition.
STANDARD & POOR'S CORPORATION (S&P)
AAA: Municipal bonds rated AAA are the highest-grade obligations. They possess
the ultimate degree of protection as to principal and interest. In the market,
they move with interest rates and, hence, provide the maximum safety on all
counts.
AA: Municipal bonds rated AA also qualify as high-grade obligations, and in the
majority of instances differ from AAA issues only in a small degree. Here, too,
prices move with the long-term money market.
A: Municipal bonds rated A are regarded as upper medium-grade. They have
considerable investment strength but are not entirely free from adverse effects
of changes in economic and trade conditions. Interest and principal are regarded
as safe. They predominantly reflect money rates in their market behavior but
also, to some extent, economic conditions.
BBB: Municipal bonds rated BBB are regarded as having an adequate capacity to
pay principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest for bonds in
this category than for bonds in the A category.
BB, B, CCC, CC: Municipal bonds rated BB, B, CCC and CC are regarded, on
balance, as predominantly speculative with respect to the issuer's capacity to
pay interest and repay principal in accordance with the terms of the
obligations. BB indicates the lowest degree of speculation and CC the highest
degree of speculation. While these bonds will likely have some quality and
protective characteristics, they are outweighed by large uncertainties or major
risk exposures to adverse conditions.
C: This rating is reserved for income bonds on which no interest is being
paid.
D: Debt rated "D" is in default and payment of interest and/or repayment of
principal is in arrears.
Plus (+) or minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
FITCH INVESTORS SERVICE, INC. (FITCH)
AAA: Municipal bonds rated AAA are considered to be investment grade and of the
highest credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal that is unlikely to be affected by reasonably
foreseeable events.
AA: Municipal bonds rated AA are 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 as bonds rated AAA and not
significantly vulnerable to foreseeable future developments.
A: Municipal bonds rated A are 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: Municipal bonds rated BBB are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered 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.
BB: Municipal bonds rated BB are considered speculative. The obligor's ability
to pay interest and repay principal may be affected over time by adverse
economic changes. Business and financial alternatives can be identified,
however, that could assist the obligor in satisfying its debt service
requirements.
B: Municipal bonds rated B are considered highly speculative. While bonds in
this class are currently meeting debt service requirements, the probability of
continued timely payment of principal and interest reflects the obligor's
limited margin of safety and the need for reasonable business and economic
activity throughout the life of the issue.
CCC: Municipal bonds rated CCC have certain identifiable characteristics which,
if not remedied, may lead to default. The ability to meet obligations requires
an advantageous business and economic environment.
CC: Municipal bonds rated CC are minimally protected. Default in payment of
interest and/or principal seems probable over time.
C: Municipal bonds rated C are in imminent default in the payment of interest
or principal.
DDD, DD and D: Municipal bonds rated DDD, DD and D are in default on interest
and/or principal payments. Such bonds are extremely speculative and should be
valued on the basis of their ultimate recovery value in liquidation or
reorganization of the obligor. DDD represents the highest potential for recovery
while D represents the lowest potential for recovery.
Plus (+) or minus (-) signs are used with a rating symbol to indicate the
relative position of a credit within the rating category. Plus or minus signs
are not used with the AAA, DDD, DD or D categories.
MUNICIPAL NOTE RATINGS
MOODY'S
Moody's ratings for state, municipal and other short-term obligations will be
designated Moody's Investment Grade (MIG). This distinction is in recognition of
the differences between short-term credit risk and long-term risk. Factors
affecting the liquidity of the borrower are uppermost in importance in
short-term borrowing; factors of the first importance in long-term borrowing
risk are of lesser importance in the short run. Symbols used will be as follows:
MIG 1: Notes are of the best quality enjoying strong protection from established
cash flows of funds for their servicing or from established and broad-based
access to the market for refinancing, or both.
MIG 2: Notes are of high quality, with margins of protection ample, although not
so large as in the preceding group.
MIG 3: Notes are of favorable quality, with all security elements accounted for,
but lacking the undeniable strength of the preceding grades. Market access for
refinancing, in particular, is likely to be less well established.
MIG 4: Notes are of adequate quality, carrying specific risk but having
protection and not distinctly or predominantly speculative.
S&P
Until June 29, 1984, S&P used the same rating symbols for notes and bonds. After
June 29, 1984, for new municipal note issues due in three years or less, the
ratings below will usually be assigned. Notes maturing beyond three years will
most likely receive a bond rating of the type recited above.
SP-1: Issues carrying this designation have a very strong or strong capacity to
pay principal and interest. Issues determined to possess overwhelming safety
characteristics will be given a "plus" (+) designation.
SP-2: Issues carrying this designation have a satisfactory capacity to pay
principal and interest.
COMMERCIAL PAPER RATINGS
MOODY'S
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted. Moody's commercial paper
ratings, which are also applicable to municipal paper investments, are opinions
of the ability of issuers to repay punctually their promissory obligations not
having an original maturity in excess of nine months. Moody's employs the
following designations for both short-term debt and commercial paper, all judged
to be investment grade, to indicate the relative repayment capacity of rated
issuers:
P-1 (Prime-1): Superior capacity for repayment.
P-2 (Prime-2): Strong capacity for repayment.
S&P
S&P's ratings are a current assessment of the likelihood of timely payment of
debt having an original maturity of no more than 365 days. Ratings are graded
into four categories, ranging from "A" for the highest quality obligations to
"D" for the lowest. Issues within the "A" category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety, as follows:
A-1: This designation indicates the degree of safety regarding timely payment is
very strong. A "plus" (+) designation indicates an even stronger likelihood of
timely payment.
A-2: Capacity for timely payment on issues with this designation is strong. The
relative degree of safety, however, is not as overwhelming as for issues
designated A-1.
A-3: Issues carrying this designation have a satisfactory capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
FITCH
Fitch's short-term ratings apply to debt obligations that are payable on demand
or have original maturities of generally up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes. The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
F-1+: Exceptionally strong credit quality. Regarded as having the strongest
degree of assurance for timely payment.
F-1: Very strong credit quality. Reflect an assurance of timely payment only
slightly less in degree than issues rated F-1+.
F-2: Good credit quality. A satisfactory degree of assurance for timely payment,
but the margin of safety is not as great as for issues assigned F-1+ and F-1
ratings.
F-3: Fair credit quality. 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-5: Weak credit quality. 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: Default. Actual or imminent payment default.
LOC: The symbol LOC indicates that the rating is based on a letter of credit
issued by a commercial bank.
STATE TAX TREATMENT
The following information on the state income tax treatment of dividends from
the funds is based upon correspondence and sources believed to be reliable.
Except where otherwise noted, the information pertains to individual state
income taxation only. You may be subject to local taxes on dividends or the
value of your shares. Corporations, trusts, estates and other entities may be
subject to other taxes and should consult with their tax advisors or their state
department of revenue. For some investors, a portion of the dividend income may
be subject to the federal and/or state alternative minimum tax.
ARIZONA Section 43-1021(4) and 43-1121(3) of the Arizona Income Tax Code states
that interest on obligations of the state of Arizona or its political
subdivisions is exempt from personal and corporate income tax. Sections
43-1022(6) and 43-1122(6) provide similar tax-exempt treatment for interest on
obligations of the U.S. or its territories (including Puerto Rico, Guam and the
Virgin Islands). Pursuant to State Income Tax Ruling Number 84-10-5, Arizona
does not tax dividend income from regulated investment companies, such as the
Arizona Fund, to the extent that such income is derived from such exempt
obligations. Dividends paid from interest earned on indirect U.S. government
obligations (GNMAs, FNMAs, etc.) or obligations from other states and their
political subdivisions are fully taxable. To the extent that such taxable
investments are made by the fund for temporary or defensive purposes, the
distributions will be taxable.
Any distributions of net short-term and net long-term capital gain earned by the
fund are included in each shareholder's Arizona taxable income as dividend
income and long-term capital gain, respectively, and are taxed at ordinary
income tax rates.
COLORADO SECTIONS 39-22-104 and 39-22-304 of the Colorado Revised Statutes state
that interest on obligations of the state of Colorado or its political
subdivisions and direct obligations of the U.S. or its possessions is exempt
from personal and corporate income tax. The Colorado Department of Revenue has
advised in published guidance that distributions from a regulated investment
company, such as the Colorado Fund, also will be exempt from personal and
corporate income tax if the fund invests in such exempt obligations. The
Colorado Department of Revenue has confirmed in guidance dated September 1993
that this exclusion also applies to territorial obligations of the U.S.
(including Puerto Rico, Guam and the Virgin Islands). Dividends paid from
interest earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or
obligations of other states and their political subdivisions do not qualify for
this exemption. To the extent that such taxable investments are made by the fund
for temporary or defensive purposes, the distributions will be taxable.
Any distributions of capital gains earned by the fund are included in each
shareholder's Colorado taxable income as dividend income and capital gain,
respectively, and are taxed at ordinary income tax rates.
CONNECTICUT Section 12-701(a)(20) of the Connecticut General Statutes states
that interest income from obligations issued by or on behalf of the state of
Connecticut, its political subdivisions, public instrumentalities, state or
local authorities, districts, or similar public entities created under the laws
of the state of Connecticut and exempt obligations of the U.S. or its
territories (including Puerto Rico, Guam and the Virgin Islands) is exempt from
state personal income tax. Dividends paid by a regulated investment company,
such as the Connecticut Fund, that are derived from such exempt obligations will
be exempt from state personal income tax, subject to the limitation below for
exempt federal obligations. Corporate shareholders generally are subject to
Connecticut corporation income taxes on distributions from the fund.
Sections 12-701(a)(20) and 12-718 of the Connecticut General Statutes also
states that a fund is qualified to pay exempt dividends derived from exempt U.S.
government obligations to its shareholders if, at the close of each quarter of
its taxable year, at least 50% of the value of its total assets consists of
exempt U.S. government obligations. Dividends paid from interest earned on
indirect U.S. government obligations (GNMAs, FNMAs, etc.) or obligations of
other states and their political subdivisions do not qualify for this exemption.
Any distribution of capital gains earned by the fund that are attributable to
Connecticut obligations are exempt from Connecticut's individual income tax. All
other distributions of capital gains earned by the fund are included in each
shareholder's Connecticut taxable income as dividend income and capital gain,
respectively, and are taxed at ordinary income rates.
INDIANA Corporate taxpayers may be subject to several overlapping Indiana income
taxes on income derived from sources within Indiana. Generally, corporations are
subject to the higher of the adjusted gross income tax or the gross income tax,
plus a supplemental net income tax. Individuals, estates and trusts resident in
Indiana generally are subject only to the adjusted gross income tax.
Gross Income Tax: Information Bulletins 19 and 79 issued by the Indiana
Department of Revenue provide that the proportionate share of dividends received
from a regulated investment company, such as the Indiana Fund, derived from
investments in direct obligations of the U.S. or its possessions (including
Puerto Rico, Guam and the Virgin Islands), will be exempt from the Indiana Gross
Income Tax. An exemption also is provided under Indiana law for exempt interest
dividends derived from interest on obligations of the state of Indiana or its
political subdivisions.
Adjusted Gross Income Tax: All of the obligations referred to in the
foregoing Bulletins are exempt from the Indiana Adjusted Gross Income Tax.
For all taxpayers, dividends paid from interest earned on indirect U.S.
government obligations (GNMAs, FNMAs, etc.) will be taxable on a pro rata basis.
The fund will file all appropriate certification documents with the Indiana
Department of Revenue indicating the exempt portion of distributions to
shareholders.
Any distributions of net short-term and net long-term capital gain earned by the
fund are included in the shareholder's Indiana taxable income as dividend income
and long-term capital gain, respectively, and are taxed at ordinary income tax
rates.
MICHIGAN Section 206.30(1) of the Michigan Compiled Laws generally provides that
taxable income, for purposes of the Michigan individual income tax, is
determined by reference to federal adjusted gross income, with certain
modifications. Interest and dividends derived from obligations or securities of
states other than Michigan (less related expenses) must be added back in
determining Michigan taxable income. Interest and dividends derived from
obligations or securities of Michigan (and its political subdivisions) are
exempt and are not, therefore, added back in determining Michigan taxable
income. Further, income derived from obligations of the U.S. government that the
state is prohibited by law from subjecting to a net income tax is subtracted in
determining Michigan taxable income. This includes direct obligations of the
U.S. government, its agencies, instrumentalities, or possessions (including
Puerto Rico, Guam and the Virgin Islands).
Revenue Administrative Bulletin 1986-3 states that a regulated investment
company, such as the Michigan Fund, which invests in tax-free municipal
obligations of the state of Michigan and its political and governmental
subdivisions is permitted to pass-through the exemption of such interest to its
shareholders to the extent that such interest qualifies as an exempt-interest
dividend of a regulated investment company. The exempt nature of interest from
obligations of the U.S. and its territories and possessions also may be passed
through to shareholders. Dividends paid from interest earned on indirect U.S.
government obligations (GNMAs, FNMAs, etc.) or other obligations from other
states and their political subdivisions are fully taxable. To the extent that
such taxable investments are made by the fund for temporary or defensive
purposes, the distributions will be taxable.
Any distributions of net short-term and net long-term capital gains earned by
the fund generally will be included in each shareholder's Michigan taxable
income as dividend income and long-term capital gain, respectively, and taxed at
ordinary income tax rates.
NEW JERSEY Section 54A:6-14.1 of the New Jersey Statutes provides that
distributions paid by qualified investment funds, such as the New Jersey Fund,
are not included in gross income for purposes of the New Jersey gross income tax
to the extent the distributions are attributable to interest or gain from
obligations issued by or on behalf of the state of New Jersey or its political
subdivisions, or obligations free from state or local taxation by any act of the
state of New Jersey or laws of the U.S. (including obligations of the District
of Columbia, Puerto Rico, Guam and the Virgin Islands). Dividends paid from
interest earned on indirect U.S. government obligations (GNMAs, FNMAs, etc.) or
obligations of other states and their political subdivisions are fully taxable.
To the extent that such taxable investments are made by the fund for temporary
or defensive purposes, the distributions will be taxable.
Any distributions of net short-term and net long-term capital gain earned by the
fund from taxable obligations are included in each shareholder's New Jersey
taxable income as dividend income and long-term capital gain, respectively, and
are taxed at ordinary income tax rates.
OREGON Sections 316.683 and 316-680 of the Oregon Revised Statutes and Oregon
Administrative Rule Section 150-316.680-(B) provide that "state exempt-interest
dividends" that are paid by a regulated investment company, such as the Oregon
Fund, and designated by it as such in a written notice mailed to its
shareholders not later than 60 days after the close of its taxable year will be
excluded from the shareholders' income for purposes of Oregon's personal income
tax. "State exempt-interest dividends" include distributions of interest
attributable both to obligations of the state of Oregon and its political
subdivisions and to obligations of the U.S., its territories (including Puerto
Rico, Guam and the Virgin Islands) and possessions of any U.S. authority,
commission or instrumentality. Corporate shareholders generally are subject to
the Oregon corporation excise and income tax on distributions from the fund.
Dividends paid from interest earned on indirect U.S. government obligations
(GNMAs, FNMAs, etc.) or obligations of other states and their political
subdivisions are fully taxable. To the extent that such taxable investments are
made by the fund for temporary or defensive purposes, the distributions will be
taxable.
Any distributions of capital gain earned by the fund are included in each
shareholder's Oregon taxable income as dividend income and capital gain,
respectively, and are taxed at ordinary income tax rates. However, a shareholder
may defer gain on the sale or other disposition of a capital asset by
reinvesting in a qualified investment fund within six months.
PENNSYLVANIA Sections 301 and 303 of the Tax Reform Code of Pennsylvania states
that interest income derived from obligations that are statutorily free from
state or local taxation under the laws of the Commonwealth of Pennsylvania or
under the laws of the U.S. is exempt from state personal income tax. Such exempt
obligations include obligations issued by the Commonwealth of Pennsylvania, any
public authority, commission, board or other state agency, any political
subdivision of the state or its public authority, and exempt obligations of the
U.S. or its territories (including Puerto Rico, Guam and the Virgin Islands).
Sections 301 and 303 of the Code of Pennsylvania states that interest derived by
an investment trust, such as the Pennsylvania Fund, from such exempt obligations
is not subject to state, personal or corporate net income tax. Fund
distributions and the value of fund shares, however, generally are included in
the tax base in determining the corporation capital stock or foreign franchise
tax. Distributions paid from interest earned on indirect U.S. government
obligations (GNMAs, FNMAs, etc.) or obligations of other states and their
political subdivisions are fully taxable. To the extent that such taxable
investments are made by the fund for temporary or defensive purposes, the
distributions will be taxable. Distributions paid by the fund also are generally
exempt from the Philadelphia School District Investment Income Tax.
Any distributions of net short-term and long-term capital gain earned by the
fund are included in each shareholder's Pennsylvania taxable income and are
taxed at ordinary income tax rates.
Shareholders of the fund who are subject to the Pennsylvania personal property
tax in their county of residence will be exempt from county personal property
tax to the extent that the portfolio of the fund consists of exempt obligations
described above on the annual assessment date of January 1. Information
regarding the portion of the value of the shares, if any, which is subject to
the Pennsylvania personal property tax will be provided to shareholders of the
fund.
PUERTO RICO For U.S. citizens and residents, exempt-interest dividends received
from the Puerto Rico Fund generally are exempt from U.S. federal and state
personal income taxation in all states that impose an income tax, pursuant to
section 103 of the Internal Revenue Code and 31 U.S.C. section 3124. For Puerto
Rico taxpayers, exempt-interest dividends, to the extent derived from Puerto
Rico, Guam and Virgin Island obligations, generally will be exempt from Puerto
Rico taxation pursuant to a ruling received by the fund dated May 24, 1996.
