Rule 497(c)
Registration No. 33-8982
THE VICTORY PORTFOLIOS
BALANCED FUND
DIVERSIFIED STOCK FUND
VALUE FUND
STOCK INDEX FUND
OHIO REGIONAL STOCK FUND
GROWTH FUND
SPECIAL VALUE FUND
SPECIAL GROWTH FUND
INTERNATIONAL GROWTH FUND
REAL ESTATE INVESTMENT FUND
PROSPECTUS DATED MARCH 1, 1998
EXPLANATORY NOTE
THE REGISTRANT HAS FILED THE PROSPECTUS OF THE BALANCED FUND, DIVERSIFIED STOCK
FUND, VALUE FUND, STOCK INDEX FUND, OHIO REGIONAL STOCK FUND, GROWTH FUND,
SPECIAL VALUE FUND, SPECIAL GROWTH FUND, INTERNATIONAL GROWTH FUND AND REAL
ESTATE INVESTMENT FUND IN THE DEFINITIVE FILING OF THE COMBINED PROSPECTUS
PURSUANT TO RULE 497(C) UNDER THE SECURITIES ACT OF 1933, AS AMENDED, ON MARCH
9, 1998 (ACCESSION NUMBER 0000922423-98-000292) AND SUCH PROSPECTUS IS HEREBY
INCORPORATED BY REFERENCE.
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Rule 497(c)
Registration No. 33-8982
STATEMENT OF ADDITIONAL INFORMATION
THE VICTORY PORTFOLIOS
The Victory Balanced Fund
The Victory Diversified Stock Fund
The Victory Financial Reserves Fund
The Victory Fund For Income
The Victory Government Mortgage Fund
The Victory Growth Fund
The Victory Institutional Money Market Fund
The Victory Intermediate Income Fund
The Victory International Growth Fund
The Victory Investment Quality Bond Fund
The Victory Lakefront Fund
The Victory Limited Term Income Fund
The Victory National Municipal Bond Fund
The Victory New York Tax-Free Fund
The Victory Ohio Municipal Bond Fund
The Victory Ohio Municipal Money Market Fund
The Victory Ohio Regional Stock Fund
The Victory Prime Obligations Fund
The Victory Real Estate Investment Fund
The Victory Special Growth Fund
The Victory Special Value Fund
The Victory Stock Index Fund
The Victory Tax-Free Money Market Fund
The Victory U.S. Government Obligations Fund
The Victory Value Fund
March 1, 1998, as amended June 1. 1998
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This Statement of Additional Information is not a prospectus, but should be read
in conjunction with each prospectus of The Victory Portfolios (individually, a
"Prospectus," and collectively, the "Prospectuses"), each of which is dated the
same date as the date hereof as amended or supplemented from time to time. This
Statement of Additional Information is incorporated by reference in its entirety
into the Prospectuses. Copies of the Prospectuses may be obtained by writing The
Victory Portfolios at P.O Box 8527, Boston, MA 02266-8527, or by calling toll
free 800-KEY FUND(R) or 800-539-3863.
INVESTMENT ADVISER
Key Asset Management Inc.
ADMINISTRATOR
BISYS Fund Services
SUB-ADMINISTRATOR
Key Asset Management Inc.
DISTRIBUTOR
BISYS Fund Services
TRANSFER AGENT
State Street Bank and Trust Company
DIVIDEND DISBURSING AGENT
AND SHAREHOLDER SERVICING AGENT
Boston Financial Data Services, Inc.
CUSTODIAN
Key Trust Company of Ohio, N.A.
INDEPENDENT CERTIFIED ACCOUNTANTS
Coopers & Lybrand L.L.P.
COUNSEL
Kramer, Levin, Naftalis & Frankel
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Table of Contents
INVESTMENT OBJECTIVES AND INVESTMENT POLICIES AND LIMITATIONS.............. 7
FUNDAMENTAL RESTRICTIONS OF THE FUNDS ..................................... 8
NON-FUNDAMENTAL RESTRICTIONS OF THE FUNDS ................................. 17
INSTRUMENTS IN WHICH THE FUNDS CAN INVEST ................................. 19
Eligible Securities for Money Market Funds ....................... 19
U.S. Corporate Debt Obligations .................................. 19
Short-Term Obligations ........................................... 20
Short-Term Corporate Obligations ................................. 20
Demand Features .................................................. 20
Bankers' Acceptances ............................................. 20
Certificates of Deposit .......................................... 20
Eurodollar Certificates of Deposit ............................... 21
Yankee Certificates of Deposit ................................... 21
Eurodollar Time Deposits ......................................... 21
Canadian Time Deposits ........................................... 21
Commercial Paper ................................................. 21
International Bonds .............................................. 21
Foreign Debt Securities .......................................... 21
Repurchase Agreements ............................................ 21
Reverse Repurchase Agreements .................................... 22
Short-Term Funding Agreements .................................... 22
Variable Amount Master Demand Notes .............................. 22
Variable Rate Demand Notes ....................................... 22
Variable and Floating Rate Notes ................................. 22
Extendible Debt Securities ....................................... 23
Receipts ......................................................... 23
Zero-Coupon Bonds ................................................ 23
High-Yield Debt Securities ....................................... 24
Loans and Other Direct Debt Instruments .......................... 24
Securities of Other Investment Companies ......................... 25
U.S. Government Obligations ...................................... 25
Municipal Securities ............................................. 25
Ohio Tax-Exempt Obligations ...................................... 28
Municipal Lease Obligations ...................................... 29
Lower-Rated Municipal Securities ................................. 30
Federally Taxable Obligations .................................... 30
Refunded Municipal Bonds ......................................... 30
When-Issued Securities ........................................... 31
Delayed-Delivery Transactions .................................... 31
Mortgage-Backed Securities ....................................... 31
In General .............................................. 31
U.S. Government Mortgage-Backed Securities .............. 32
GNMA Certificates ....................................... 32
FHLMC Securities ........................................ 32
FNMA Securities ......................................... 33
Collateralized Mortgage Obligations ..................... 33
Non-Government Mortgage-Backed Securities ............... 33
Asset-Backed Securities .......................................... 33
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Futures and Options ............................................. 34
Futures Contracts ...................................... 34
Restrictions on the Use of Futures Contracts ........... 35
Risk Factors in Futures Transactions ................... 36
Options ................................................ 36
Puts ................................................... 37
Illiquid Investments ............................................ 37
Restricted Securities ........................................... 38
Securities Lending Transactions ................................. 38
Short Sales Against-the-Box ..................................... 39
Investment-Grade and High Quality Investments ................... 39
Participation Interests ......................................... 39
Warrants ........................................................ 39
Refunding Contracts ............................................. 39
Standby Commitments ............................................. 39
Foreign Investment .............................................. 40
Miscellaneous Securities ........................................ 40
Additional Information Concerning Ohio Issuers .................. 41
Additional Information Concerning New York Issuers .............. 44
DETERMINING NET ASSET VALUE FOR THE MONEY MARKET FUNDS ................... 64
VALUATION OF PORTFOLIOS SECURITIES FOR THE MONEY MARKET FUNDS ............ 65
VALUATION OF PORTFOLIO SECURITIES FOR THE TAXABLE BOND FUNDS AND THE
TAX-FREE BOND FUNDS ...................................................... 66
VALUATION OF PORTFOLIO SECURITIES FOR THE EQUITY FUNDS ................... 66
PERFORMANCE OF THE MONEY MARKET FUNDS .................................... 67
PERFORMANCE OF THE NON-MONEY MARKET FUNDS ................................ 70
ADDITIONAL PURCHASE, EXCHANGE, AND REDEMPTION INFORMATION ................ 80
DIVIDENDS AND DISTRIBUTIONS ..................................... 83
TAXES ........................................................... 84
TRUSTEES AND OFFICERS ........................................... 92
ADVISORY AND OTHER CONTRACTS .................................... 99
ADDITIONAL INFORMATION .......................................... 112
APPENDIX ........................................................ 121
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STATEMENT OF ADDITIONAL INFORMATION
The Victory Portfolios (the "Victory Portfolios") is an open-end management
investment company. The Victory Portfolios consists of 30 series (each a "Fund,"
and collectively, the "Funds") of units of beneficial interest ("shares"). The
outstanding shares represent interests in the 30 separate investment portfolios.
This Statement of Additional Information (the "SAI") relates to the shares of 25
of the 30 Funds and their respective classes, and are listed below. Much of the
information contained in this Statement of Additional Information expands on
subjects discussed in the Prospectuses. Capitalized terms not defined herein are
used as defined in the Prospectuses. No investment in shares of a Fund should be
made without first reading that Fund's Prospectus.
THE VICTORY PORTFOLIOS:
The Victory Balanced Fund
Class A Shares
Class B Shares
The Victory Diversified Stock Fund
Class A Shares
Class B Shares
The Victory Financial Reserves Fund
The Victory Fund For Income Fund
The Victory Government Mortgage Fund
The Victory Growth Fund
The Victory Institutional Money Market Fund
Select Shares
Investor Shares
The Victory Intermediate Income Fund
The Victory International Growth Fund
Class A Shares
Class B Shares
The Victory Investment Quality Bond Fund
The Victory Lakefront Fund
The Victory Limited Term Income Fund
The Victory National Municipal Bond Fund
Class A Shares
Class B Shares
The Victory New York Tax-Free Fund
Class A Shares
Class B Shares
The Victory Ohio Municipal Bond Fund
The Victory Ohio Municipal Money Market Fund
The Victory Ohio Regional Stock Fund
Class A Shares
Class B Shares
The Victory Prime Obligations Fund
The Victory Real Estate Investment Fund
The Victory Special Growth Fund
The Victory Special Value Fund
Class A Shares
Class B Shares
The Victory Stock Index Fund
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The Victory Tax-Free Money Market Fund
The Victory U.S. Government Obligations Fund
Select Shares
Investor Shares
The Victory Value Fund
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INVESTMENT OBJECTIVES AND INVESTMENT POLICIES AND LIMITATIONS
Each Fund's investment objective is fundamental and may not be changed without a
vote of the holders of a majority of the Fund's outstanding voting securities.
There can be no assurance that a Fund will achieve its investment objective.
ADDITIONAL INFORMATION REGARDING FUND INVESTMENTS.
The following policies and limitations supplement the Funds' investment policies
set forth in the Prospectuses. The Funds' investments in the following
securities and other financial instruments are subject to the other investment
policies and limitations described in the Prospectuses and this SAI.
Unless otherwise noted in the prospectus or this SAI, a Fund may invest no more
than 5% of its total assets in any of the securities or financial instruments
described below (unless the context requires otherwise).
Unless otherwise noted, whenever an investment policy or limitation states a
maximum percentage of a Fund's assets that may be invested in any security or
other asset, or sets forth a policy regarding quality standards, such standard
or percentage limitation will be determined immediately after and as a result of
the Fund's acquisition of such security or other asset except in the case of
borrowing (or other activities that may be deemed to result in the issuance of a
"senior security" under the Investment Company Act of 1940 (the "1940 Act")).
Accordingly, any subsequent change in values, net assets, or other circumstances
will not be considered when determining whether the investment complies with a
Fund's investment policies and limitations. If the value of a Fund's holdings of
illiquid securities at any time exceeds the percentage limitation applicable at
the time of acquisition due to subsequent fluctuations in value or other
reasons, the Trustees will consider what actions, if any, are appropriate to
maintain adequate liquidity.
The investment policies of a Fund may be changed without an affirmative vote of
the holders of a majority of that Fund's outstanding voting securities unless
(1) a policy expressly is deemed to be a fundamental policy of the Fund or (2) a
policy expressly is deemed to be changeable only by such majority vote. A Fund
may, following notice to its shareholders, take advantage of other investment
practices which presently are not contemplated for use by the Fund or which
currently are not available but which may be developed to the extent such
investment practices are both consistent with the Fund's investment objective
and legally permissible for the Fund. Such investment practices, if they arise,
may involve risks which exceed those involved in the activities described in a
Fund's Prospectus.
The following sections list each Fund's investment objective and its investment
policies, limitations, and restrictions. The securities in which the Funds can
invest and the risks associated with these securities are discussed in the
section "Instruments in Which the Funds Can Invest."
DEFINED TERMS. All capitalized terms listed in a Fund's Investment Policies and
Limitations section referring to permissible investments are described in the
section "Instruments in Which the Funds Can Invest."
The following terms are used throughout the Investment Objective and Investment
Policies and Limitations sections.
S&P: Standard & Poor's Ratings Group
Moody's: Moody's Investors Service, Inc.
Fitch: Fitch Investors Service, Inc.
NRSRO: Nationally Recognized Statistical Ratings Organization
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FUNDAMENTAL RESTRICTIONS OF THE FUNDS
1. SENIOR SECURITIES
No fund may:
Issue any senior security (as defined in the Investment Company Act of 1940, as
amended (the "1940 Act")), except that (a) each Fund may engage in transactions
that may result in the issuance of senior securities to the extent permitted
under applicable regulations and interpretations of the 1940 Act or an exemptive
order; (b) each Fund may acquire other securities, the acquisition of which may
result in the issuance of a senior security, to the extent permitted under
applicable regulations or interpretations of the 1940 Act; (c) subject to the
restrictions set forth below, the Fund may borrow money as authorized by the
1940 Act.
2. UNDERWRITING
The Funds may not:
Underwrite securities issued by others, except to the extent that the Fund may
be considered an underwriter within the meaning of the Securities Act of 1933
(the "1933 Act") in the disposition of restricted securities.
3. BORROWING
The Balanced Fund, Diversified Stock Fund, Government Mortgage Fund, Growth
Fund, Intermediate Income Fund, International Growth Fund, Investment Quality
Bond Fund, Lakefront Fund, Limited Term Income Fund, New York Tax-Free Fund,
Ohio Municipal Bond Fund, Ohio Regional Stock Fund, Prime Obligations Fund, Real
Estate Investment Fund, Special Growth Fund, Special Value Fund, Stock Index
Fund, Tax-Free Money Market Fund, U.S. Government Obligations Fund and Value
Fund may not:
Borrow money, except that (a) each Fund may enter into commitments to purchase
securities in accordance with its investment program, including delayed-delivery
and when-issued securities and reverse repurchase agreements, provided that the
total amount of any such borrowing does not exceed 33 1/3 % of the Fund's total
assets; and (b) each Fund may borrow money for temporary or emergency purposes
in an amount not exceeding 5% of the value of its total assets at the time when
the loan is made. Any borrowings representing more than 5% of a Fund's total
assets must be repaid before the Fund may make additional investments.
The Financial Reserves Fund and Institutional Money Market Fund may not:
Borrow money, except (a) from a bank for temporary or emergency purposes (not
for leveraging or investment) or (b) by engaging in reverse repurchase
agreements, provided that (a) and (b) in combination ("borrowings") do not
exceed an amount equal to one third of the current value of its total assets
(including the amount borrowed) less liabilities (not including the amount
borrowed) at the time the borrowing is made. This fundamental limitation is
construed in conformity with the 1940 Act, and if at any time Fund borrowings
exceed an amount equal to 33 1/3 of the current value of the Fund's total assets
(including the amount borrowed) less liabilities (other than borrowings) at the
time the borrowing is made due to a decline in net assets, such borrowings will
be reduced within three days (not including Sundays and holidays) to the extent
necessary to comply with the 33 1/3% limitation.
The Fund for Income may not:
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Borrow money, except for temporary or emergency purposes and not for investment
purposes, and then only in an amount not exceeding 5% of the value of its total
assets at the time of the borrowing.
The National Municipal Bond Fund may not:
Borrow money, except that the Fund may borrow money from banks for temporary or
emergency purposes (not for leveraging or investment) and engage in reverse
repurchase agreements in an amount not exceeding 33 1/3% of the value of its
total assets (including the amount borrowed) less liabilities (other than
borrowings). Any borrowings that come to exceed this amount will be reduced
within three days (exclusive of Sundays and holidays) to the extent necessary to
comply with the 33 1/3% limitation.
The Ohio Municipal Money Market Fund:
(a) May borrow money and engage in reverse repurchase agreements in amounts up
to one-third of the value of the Fund's net assets including the amounts
borrowed, and (b) purchase securities on a when-issued or delayed delivery
basis. The Fund will not borrow money or engage in reverse repurchase agreements
for investment leverage, but rather as a temporary, extraordinary, or emergency
measure or to facilitate management of the Fund by enabling the Fund to meet
redemption requests when the liquidation of Fund securities would be
inconvenient or disadvantageous. The Fund will not purchase any securities while
any such borrowings (including reverse repurchase agreements) are outstanding.
4. REAL ESTATE
The Balanced Fund, Diversified Stock Fund, Government Mortgage Fund, Growth
Fund, Intermediate Income Fund, International Growth Fund, Investment Quality
Bond Fund, Lakefront Fund, Limited Term Income Fund, Ohio Municipal Bond Fund,
Ohio Regional Stock Fund, Prime Obligations Fund, Special Growth Fund, Special
Value Fund, Stock Index Fund, Tax-Free Money Market Fund and Value Fund may not:
Purchase or sell real estate unless acquired as a result of ownership of
securities or other instruments (but this shall not prevent each Fund from
investing in securities or other instruments backed by real estate or securities
of companies engaged in the real estate business). Investments by the Funds in
securities backed by mortgages on real estate or in marketable securities of
companies engaged in such activities are not hereby precluded.
The National Municipal Bond Fund may not:
Purchase or sell real estate unless acquired as a result of ownership of
securities or other instruments (but this shall not prevent each Fund from
investing in securities or other instruments backed by real estate or securities
of companies engaged in the real estate business).
The Financial Reserves Fund may not:
Buy or sell real estate, commodities, or commodities (futures) contracts.
The Institutional Money Market Fund may not:
Buy or sell real estate, commodities, or commodity (futures) contracts or invest
in oil, gas or other mineral exploration or development programs.
The Intermediate Income Fund may not:
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Purchase or sell real estate unless acquired as a result of ownership of
securities or other instruments (but this shall not prevent each Fund from
investing in securities or other instruments backed by real estate or securities
of companies engaged in the real estate business).
The Ohio Municipal Money Market Fund will not:
Purchase or sell real estate, although it may invest in Ohio Municipal
Securities secured by real estate or interests in real estate.
The U.S. Government Obligations Fund may not:
Purchase or sell real estate unless acquired as a result of ownership of
securities or other instruments.
The Real Estate Investment Fund may not:
Purchase or sell real estate, except that the Fund may purchase securities
issued by companies in the real estate industry and will, as a matter of
fundamental policy, concentrate its investments in such securities.
5. LENDING
The Balanced Fund, Diversified Stock Fund, Government Mortgage Fund, Growth
Fund, Intermediate Income Fund, International Growth Fund, Investment Quality
Bond Fund, Lakefront Fund, Limited Term Income Fund, National Municipal Bond
Fund, Ohio Municipal Bond Fund, Ohio Regional Stock Fund, Prime Obligations
Fund, Real Estate Investment Fund, Special Growth Fund, Special Value Fund,
Stock Index Fund, Tax-Free Money Market Fund, U.S. Government Obligations Fund
and Value Fund may not:
Lend any security or make any other loan if, as a result, more than 33 1/3% of
its total assets would be lent to other parties, but this limitation does not
apply to purchases of publicly issued debt securities or to repurchase
agreements.
The Financial Reserves Fund and Institutional Money Market Fund may not:
Make loans to other persons, except (a) by the purchase of debt obligations in
which the Fund is authorized to invest in accordance with its investment
objective, and (b) by engaging in repurchase agreements. In addition, each Fund
may lend its portfolio securities to broker-dealers or other institutional
investors, provided that the borrower delivers cash or cash equivalents as
collateral to the Fund and agrees to maintain such collateral so that it equals
at least 100% of the value of the securities loaned. Any such securities loan
may not be made if, as a result thereof, the aggregate value of all securities
loaned exceeds 33 1/3% of the total assets of the Fund.
The Fund for Income may not:
Make loans to other persons except through the use of repurchase agreements or
the purchase of commercial paper. For these purposes, the purchase of a portion
of an issue of debt securities which is part of an issue to the public shall not
be considered the making of a loan.
The New York Tax-Free Fund may not:
Make loans to other persons except through the use of repurchase agreements, the
purchase of commercial paper or by lending portfolio securities. For these
purposes, the purchase of a portion of an issue of debt securities which is part
of an issue to the public shall not be considered the making of a loan.
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The Ohio Municipal Money Market Fund:
Will not lend any of its assets, except through the purchase of a position of
publicly distributed debt instruments or repurchase agreements and through the
lending of its portfolio securities. The Fund may lend its securities if
collateral values are continuously maintained at no less than 100% of the
current market value of such securities by marking to market daily.
6. COMMODITIES
The Diversified Stock Fund, Government Mortgage Fund, Intermediate Income Fund,
International Growth Fund, Investment Quality Bond Fund, Lakefront Fund, Limited
Term Income Fund, Ohio Municipal Bond Fund, Ohio Regional Stock Fund, Prime
Obligations Fund, Real Estate Investment Fund, Special Growth Fund, Stock Index
Fund and Tax-Free Money Market Fund may not:
Purchase or sell physical commodities unless acquired as a result of ownership
of securities or other instruments (but this shall not prevent the Funds from
purchasing or selling options and futures contracts or from investing in
securities or other instruments backed by physical commodities).
The New York Tax-Free Fund and Ohio Municipal Money Market Fund may not:
Purchase or sell commodities or commodity contracts.
The Balanced Fund, Growth Fund, Special Value Fund, U.S. Government Obligations
Fund and Value Fund may not:
Purchase or sell physical commodities unless acquired as a result of ownership
of securities or other instruments.
The Fund for Income may not:
Purchase or sell commodities or commodity contracts, oil, gas or other mineral
exploration or development programs.
The National Municipal Bond Fund may not:
Purchase or sell physical commodities (but this shall not prevent the Fund from
purchasing or selling futures contracts and options on futures contracts or from
investing in securities or other instruments backed by physical commodities).
7. JOINT TRADING ACCOUNTS
The Balanced Fund, Diversified Stock Fund, Government Mortgage Fund, Growth
Fund, Intermediate Income Fund, International Growth Fund, Investment Quality
Bond Fund, Limited Term Income Fund, Ohio Municipal Bond Fund, Ohio Regional
Stock Fund, Prime Obligations Fund, Special Growth Fund, Special Value Fund,
Stock Index Fund, Tax-Free Money Market Fund and Value Fund may not:
Participate on a joint or joint and several basis in any securities trading
account.
8. DIVERSIFICATION
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The Balanced Fund, Diversified Stock Fund, Government Mortgage Fund, Growth
Fund, Intermediate Income Fund, International Growth Fund, Investment Quality
Bond Fund, Limited Term Income Fund, Ohio Regional Stock Fund, Special Growth
Fund, Special Value Fund, Stock Index Fund and Value Fund may not:
With respect to 75% of a Fund's total assets, purchase the securities of any
issuer (other than securities issued or guaranteed by the U.S. Government or any
of its agencies or instrumentalities) if, as a result, (a) more than 5% of the
Fund's total assets would be invested in the securities of that issuer, or (b)
the Fund would hold more than 10% of the outstanding voting securities of that
issuer.
The Prime Obligations Fund may not:
With respect to 75% of a Fund's total assets, purchase the securities of any
issuer (other than securities issued or guaranteed by the U.S. Government or any
of its agencies or instrumentalities) if, as a result, (a) more than 5% of the
Fund's total assets would be invested in the securities of that issuer, or (b)
the Fund would hold more than 10% of the outstanding voting securities of that
issuer. (Note: In accordance with Rule 2a-7 under the 1940 Act, the Fund may
invest up to 25% of its total assets in securities of a single issuer for a
period of up to three days.)
The New York Tax-Free Fund may not:
Purchase the securities of any issuer (except the United States government, its
agencies and instrumentalities, and the State of New York and its
municipalities) if as a result more than 25% of its total assets are invested in
the securities of a single issuer, and with regard to 50% of total assets, if as
a result more than 5% of its total assets would be invested in the securities of
such issuer. In determining the issuer of a tax-exempt security, each state and
each political subdivision, agency, and instrumentality of each state and each
multi-state agency, of which such state is a member, is a separate issuer. Where
securities are backed only by assets and revenues of a particular
instrumentality, facility or subdivision, such entity is considered the issuer.
With respect to non-municipal bond investments, in addition to the foregoing
limitations, the Fund will not purchase securities (other than securities of the
United States government, its agencies or instrumentalities), if as a result of
such purchase 25% or more of the total Fund's assets would be invested in any
one industry, or enter into a repurchase agreement if, as a result thereof, more
than 10% of its total assets would be subject to repurchase agreements maturing
in more than seven days.
The National Municipal Bond Fund:
To meet federal tax requirements for qualification as a "regulated investment
company," the Fund limits its investments so that at the close of each quarter
of its taxable year: (a) with regard to at least 50% of total assets, no more
than 5% of total assets are invested in the securities of a single issuer, and
(b) no more than 25% of total assets are invested in the securities of a single
issuer. Limitations (a) and (b) do not apply to "Government Securities" as
defined for federal tax purposes. (For such purposes, municipal obligations are
not treated as "Government Securities," and consequently they are subject to
limitations (a) and (b).)
The Ohio Municipal Money Market Fund will limit:
With respect to 75% of the Fund's total assets, investments in one issuer to not
more than 10% of the value of its total assets. The total amount of the
remaining 25% of the value of the Fund's total assets could be invested in a
single issuer if the Adviser believes such a strategy to be prudent. Under Rule
2a-7 under the 1940 Act, the Fund is also subject to certain diversification
requirements.
The Tax-Free Money Market Fund may not:
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Purchase securities of any one issuer, other than obligations issued or
guaranteed by the U.S. Government or its agencies or instrumentalities if,
immediately after such purchase, more than 5% of the value of its total assets
would be invested in such issuer, except that up to 25% of the value of the
Tax-Free Money Market Fund's total assets may be invested without regard to such
5% limitation. For purposes of this limitation, a security is considered to be
issued by the government entity (or entities) whose assets and revenues
guarantee or back the security; with respect to a private activity bond that is
backed only by the assets and revenues of a non-governmental issuer, a security
is considered to be issued by such non-governmental issuer.
The Fund for Income may not:
Purchase the securities of any issuer (except the United States government, its
agencies and instrumentalities), with regard to 75% of total assets, if as a
result more than 5% of its total assets would be invested in the securities of
such issuer. In determining the issuer of a tax-exempt security, each state and
each political subdivision, agency, and instrumentality of each state and each
multi-state agency of which such state is a member is a separate issuer. Where
securities are backed only by assets and revenues of a particular
instrumentality, facility or subdivision, such entity is considered the issuer.
9. CONCENTRATION
The Balanced Fund, Diversified Stock Fund, Growth Fund, Intermediate Income
Fund, International Growth Fund, Investment Quality Bond Fund, Limited Term
Income Fund, Ohio Regional Stock Fund, Special Value Fund, Stock Index Fund and
Value Fund may not:
Purchase the securities of any issuer (other than securities issued or
guaranteed by the U.S. Government or any of its agencies or instrumentalities,
or repurchase agreements secured thereby) if, as a result, more than 25% of the
Fund's total assets would be invested in the securities of companies whose
principal business activities are in the same industry. In the utilities
category, the industry shall be determined according to the service provided.
For example, gas, electric, water and telephone will be considered as separate
industries.
The Prime Obligations Fund may not:
Purchase the securities of any issuer (other than securities issued or
guaranteed by the U.S. Government or any of its agencies or instrumentalities,
or repurchase agreements secured thereby) if, as a result, more than 25% of the
Fund's total assets would be invested in the securities of companies whose
principal business activities are in the same industry. Notwithstanding the
foregoing, there is no limitation with respect to certificates of deposit and
banker's acceptances issued by domestic banks, or repurchase agreements secured
thereby. In the utilities category, the industry shall be determined according
to the service provided. For example, gas, electric, water and telephone will be
considered as separate industries.
The Tax-Free Money Market Fund may not:
Purchase the securities of any issuer (other than securities issued or
guaranteed by the U.S. Government or any of its agencies or instrumentalities,
or repurchase agreements secured thereby) if, as a result, more than 25% of the
Fund's total assets would be invested in the securities of companies whose
principal business activities are in the same industry; provided that this
limitation shall not apply to Municipal Securities or governmental guarantees of
Municipal Securities; but for these purposes only, industrial development bonds
that are backed by the assets and revenues of a non-governmental user shall not
be deemed to be Municipal Securities. Notwithstanding the foregoing, there is no
limitation with respect to certificates of deposit and banker's acceptances
issued by domestic banks, or repurchase agreements secured thereby. In the
utilities category, the industry shall
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be determined according to the service provided. For example, gas, electric,
water and telephone will be considered as separate industries.
The Ohio Municipal Bond Fund may not:
Purchase the securities of any issuer (other than securities issued or
guaranteed by the U.S. government or any of its agencies or instrumentalities,
or repurchase agreements secured thereby) if, as a result, more than 25% of the
Fund's total assets would be invested in the securities of companies whose
principal business activities are in the same industry; provided that this
limitation shall not apply to Municipal Securities or governmental guarantees of
Municipal Securities; but for these purposes only, industrial development bonds
that are backed only by the assets and revenues of a non-governmental user shall
not be deemed to be Municipal Securities. In the utilities category, the
industry shall be determined according to the service provided. For example,
gas, electric, water and telephone will be considered as separate industries.
The National Municipal Bond Fund may not:
Purchase securities (other than those issued or guaranteed by the U.S.
government or any securities of its agencies or instrumentalities or tax-exempt
obligations issued or guaranteed by a U.S. territory or possession or a state or
local government, or a political subdivision of the foregoing) if, as a result,
more than 25% of the Fund's total assets would be invested in securities of
companies whose principal business activities are in the same industry; for the
purpose of this restriction, utility companies will be divided according to
their services, for example, gas, gas transmission, electric and gas and
telephone will each be considered a separate industry. Industrial development
revenue bonds which are issued by nongovernmental entities within the same
industry shall be subject to this industry limitation.
The Ohio Municipal Money Market Fund:
The Fund will not purchase securities (other than securities issued or
guaranteed by the U.S. government, its agencies, or instrumentalities) if, as a
result of such purchase, 25% or more of the value of the Fund's total assets
would be invested in any one industry. The Fund will not invest 25% or more of
its assets in securities, the interest upon which is paid from revenues of
similar type projects. The Fund may invest 25% or more of its assets in
industrial development bonds.
The Financial Reserves Fund and Institutional Money Market Fund may not:
Purchase the securities of any issuer (other than obligations issued or
guaranteed as to principal and interest by the United States government, its
agencies or instrumentalities) if, as a result thereof: (i) more than 5% of its
total assets would be invested in the securities of such issuer, provided,
however, that in the case of certificates of deposit, time deposits and bankers'
acceptances, up to 25% of the Fund's total assets may be invested without regard
to such 5% limitation, but shall instead be subject to a 10% limitation; (ii)
more than 25% of its total assets would be invested in the securities of one or
more issuers having their principal business activities in the same industry,
provided, however, that it may invest more than 25% of its total assets in the
obligations of domestic banks. Neither finance companies as a group nor utility
companies as a group are considered a single industry for purposes of this
policy (i.e., finance companies will be considered a part of the industry they
finance and utilities will be divided according to the types of services they
provide).
The Real Estate Investment Fund may not:
Purchase the securities of any issuer (other than securities issued or
guaranteed by the U.S. Government or any of its agencies or instrumentalities,
or repurchase agreements secured thereby) if, as a result, more than 25% of the
Fund's total assets would be invested in the securities of companies whose
principal business activities are in the
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same industry. In the utilities category, the industry shall be determined
according to the service provided. For example, gas, electric, water and
telephone will be considered as separate industries. Notwithstanding the
foregoing, the Fund will concentrate its investments in securities in the real
estate industry.
The New York Tax-Free Fund may not:
With respect to non-municipal investments, purchase securities (other than
securities of the United States government, its agencies or instrumentalities),
if as a result of such purchase 25% or more of the Fund's total assets would be
invested in any one industry, or enter into a repurchase agreement if, as a
result thereof, more than 10% of its total assets would be subject to repurchase
agreements maturing in more than seven days.
The Special Growth Fund may not:
Purchase the securities of any issuer (other than securities issued or
guaranteed by the U.S. Government or any of its agencies or instrumentalities,
or repurchase agreements secured thereby) if, as a result, more than 25% of the
Fund's total assets would be invested in the securities of companies whose
principal business activities are in the same industry.
The Fund for Income and New York Tax-Free Fund may not:
Invest more than 25% of the Fund's total assets in securities whose interest
payments are derived from revenue from similar projects.
10. MISCELLANEOUS
a. TAX-EXEMPT INCOME
The Ohio Municipal Money Market Fund may not:
Invest its assets so that less than 80% of its annual interest income is exempt
from the federal income tax and Ohio taxes.
b. USE OF ASSETS AS SECURITY
The Fund for Income may not:
Pledge, mortgage, or hypothecate its assets, except that, to secure borrowings
permitted by its fundamental restriction on borrowing, it may pledge securities
having a market value at the time of pledge not exceeding 10% of the value of
its total assets.
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NON-FUNDAMENTAL RESTRICTIONS
1. ILLIQUID SECURITIES
The Balanced Fund, Diversified Stock Fund, Fund for Income, Government Mortgage
Fund, Growth Fund, Intermediate Income Fund, International Growth Fund,
Investment Quality Bond Fund, Lakefront Fund, Limited Term Income Fund, National
Municipal Bond Fund, New York Tax-Free Fund, Ohio Municipal Bond Fund, Ohio
Regional Stock Fund, Real Estate Investment Fund, Special Growth Fund, Special
Value Fund, Stock Index Fund and Value Fund:
Will not invest more than 15% of its net assets in illiquid securities. Illiquid
securities are securities that are not readily marketable or cannot be disposed
of promptly within seven days and in the usual course of business at
approximately the price at which the Fund has valued them. Such securities
include, but are not limited to, time deposits and repurchase agreements with
maturities longer than seven days. Securities that may be resold under Rule
144A, securities offered pursuant to Section 4(2) of, or securities otherwise
subject to restrictions or limitations on resale under the 1933 Act ("Restricted
Securities") shall not be deemed illiquid solely by reason of being
unregistered. Key Asset Management Inc. determines whether a particular security
is deemed to be liquid based on the trading markets for the specific security
and other factors.
The Financial Reserves Fund, Institutional Money Market Fund, Ohio Municipal
Money Market Fund, Prime Obligations Fund, Tax-Free Money Market Fund, and U.S.
Government Obligations Fund:
Will not invest more than 10% of its net assets in illiquid securities. Illiquid
securities are securities that are not readily marketable or cannot be disposed
of promptly within seven days and in the usual course of business at
approximately the price at which the Fund has valued them. Such securities
include, but are not limited to, time deposits and repurchase agreements with
maturities longer than seven days. Securities that may be resold under Rule
144A, securities offered pursuant to Section 4(2) of, or securities otherwise
subject to restrictions or limitations on resale under the 1933 Act ("Restricted
Securities") shall not be deemed illiquid solely by reason of being
unregistered. Key Asset Management Inc. determines whether a particular security
is deemed to be liquid based on the trading markets for the specific security
and other factors.
2. SHORT SALES AND PURCHASES ON MARGIN
The Balanced Fund, Diversified Stock Fund, Government Mortgage Fund, Growth
Fund, Intermediate Income Fund, Investment Quality Bond Fund, Limited Term
Income Fund, Ohio Municipal Bond Fund, Ohio Regional Stock Fund, Prime
Obligations Fund, Special Growth Fund, Special Value Fund, Stock Index Fund,
Tax-Free Money Market Fund, U.S. Government Obligations Fund and Value Fund:
Will not make short sales of securities, other than short sales "against the
box," or purchase securities on margin except for short-term credits necessary
for clearance of portfolio transactions, provided that this restriction will not
be applied to limit the use of options, futures contracts and related options,
in the manner otherwise permitted by the investment restrictions, policies and
investment program of the Fund.
The International Growth Fund may not:
Will not make short sales of securities, other than short sales "against the
box," or purchase securities on margin except for short-term credits necessary
for clearance of portfolio transactions, provided that this restriction will not
be applied to limit the use of options, futures contracts and related options,
in the manner otherwise permitted by the investment restrictions, policies and
investment program of the Fund, and shall not limit the Fund's ability to make
margin payments in connection with transactions in currency future options.
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<PAGE>
The Financial Reserves Fund and Institutional Money Market Fund may not:
1. Purchase securities on margin (but the Fund may obtain such credits as may be
necessary for the clearance of purchases and sales of securities).
2. Make short sales of securities.
The Fund for Income and New York Tax-Free Fund:
Will not make short sales of securities or purchase any securities on margin,
except for such short-term credits as are necessary for the clearance of
transactions.
The National Municipal Bond Fund:
1. May not sell securities short, unless it owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short.
2. May not purchase securities on margin, except that the Fund may obtain such
short-term credits as are necessary for the clearance of transactions.
The Ohio Municipal Money Market Fund:
Will not sell any securities short or purchase any securities on margin but may
obtain such short-term credits as may be necessary for clearance of purchases
and sales of securities.
The Special Growth Fund:
Does not currently intend to purchase securities on margin, except that the Fund
may obtain such short-term credits as are necessary for the clearance of
transactions and provided that margin payments in connection with futures
contracts shall not constitute purchasing securities on margin.
3. OTHER INVESTMENT COMPANIES
The Victory Balanced, Victory Diversified Stock Fund, Victory Financial Reserves
Fund, Victory Fund For Income, Victory Government Mortgage Fund, Victory Growth
Fund, Victory Institutional Money Market Fund, Victory Intermediate Income Fund,
Victory International Growth Fund, Victory Investment Quality Bond Fund, Victory
Lakefront Fund, Victory Limited Term Income Fund, Victory National Municipal
Bond Fund, Victory New York Tax-Free Fund , Victory Ohio Municipal Bond Fund,
Victory Ohio Municipal Money Market Fund, Victory Ohio Regional Stock Fund,
Victory Prime Obligations Fund, Victory Real Estate Investment Fund, Victory
Special Growth Fund, Victory Special Value Fund, Victory Stock Index Fund,
Victory Tax-Free Money Market Fund, Victory U.S. Government Obligations Fund,
Victory Value Fund:
May invest up to 5% of their total assets in the securities of any one
investment company, but may not own more than 3% of the securities of any one
investment company or invest more than 10% of its total assets in the securities
of other investment companies. Pursuant to an exemptive order received by the
Victory Portfolios from the Securities and Exchange Commission (the "SEC"), the
Funds may invest in the other money market funds of the Victory Portfolios. Each
Fund will waive the portion of its fee attributable to the assets of each Fund
invested in such money market funds to the extent required by the laws of any
jurisdiction in which shares of the Funds are registered for sale.
The Funds may not:
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<PAGE>
Purchase the securities of any registered open-end investment company or
registered unit investment trust in reliance on Section 12(d)(1)(G) or Section
12(d)(1)(F) of the 1940 Act, which permits operation as a "fund of funds."
The National Municipal Bond Fund may not:
Purchase securities of other investment companies, except in the open market
where no commission except the ordinary broker's commission is paid. Such
limitation does not apply to securities received as dividends, through offers of
exchange, or as a result of a reorganization, consolidation, or merger.
4. MISCELLANEOUS
a. INVESTMENT GRADE OBLIGATIONS
The National Municipal Bond Fund, New York Tax-Free Fund and Ohio Municipal Bond
Fund may not:
Hold more than five percent of its total assets in securities that have been
downgraded below investment grade.
b. CONCENTRATION
The Fund for Income may not:
With respect to non-municipal bond investments, purchase securities (other than
securities of the United States government, its agencies or instrumentalities),
if as a result of such purchase 25% or more of the total Fund's assets would be
invested in any one industry.
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<PAGE>
INSTRUMENTS IN WHICH THE FUNDS CAN INVEST
The instruments in which the Funds can invest, according to their investment
policies and limitations are described below.
The following paragraphs provide a brief description of some of the types of
securities in which the Funds may invest in accordance with their investment
objective, policies, and limitations, including certain transactions the Funds
may make and strategies they may adopt. The following also contains a brief
description of certain risk factors. The Funds may, following notice to their
shareholders, take advantage of other investment practices which presently are
not contemplated for use by the Funds or which currently are not available but
which may be developed, to the extent such investment practices are both
consistent with a Fund's investment objective and are legally permissible for
the Fund. Such investment practices, if they arise, may involve risks which
exceed those involved in the activities described in a Fund's Prospectus and
this Statement of Additional Information.
ELIGIBLE SECURITIES FOR MONEY MARKET FUNDS. High-quality investments are those
obligations which, at the time of purchase, (i) possess one of the two highest
short-term ratings from an NRSRO or (ii) possess, in the case of multiple-rated
securities, one of the two highest short-term ratings by at least two NRSROs; or
(iii) do not possess a rating (i.e. are unrated) but are determined by the
Adviser to be of comparable quality to the rated instruments described in (i)
and (ii). For purposes of these investment limitations, a security that has not
received a rating will be deemed to possess the rating assigned to an
outstanding class of the issuer's short-term debt obligations if determined by
the Adviser to be comparable in priority and security to the obligation selected
for purchase by a Fund. (The above described securities which may be purchased
by the money market Funds are hereinafter referred to as "Eligible Securities.")
A security subject to a tender or demand feature will be considered an Eligible
Security only if both the demand feature and the underlying security possess a
high quality rating, or, if such do not possess a rating, are determined by the
Adviser to be of comparable quality; provided, however, that where the demand
feature would be readily exercisable in the event of a default in payment of
principal or interest on the underlying security, this obligation may be
acquired based on the rating possessed by the demand feature or, if the demand
feature does not possess a rating, a determination of comparable quality by the
Adviser. A security which at the time of issuance had a maturity exceeding 397
days but, at the time of purchase, has remaining maturity of 397 days or less,
is not considered an Eligible Security if it does not possess a high quality
rating and the long-term rating, if any, is not within the two highest rating
categories.
Pursuant to Rule 2a-7 under the 1940 Act (the "Rule"), the Money Market Funds
maintain a dollar-weighted average portfolio maturity which does not exceed 90
days.
The weighted average maturity of the U.S. Government Obligations Fund will
usually be 60 days or less since rating agencies normally require shorter
maturities. However, the permitted weighted average maturity for the U.S.
Government Obligations Fund is 90 days.
The Appendix of this SAI identifies each NRSRO which may be utilized by the
Adviser with regard to portfolio investments for the Funds and provides a
description of relevant ratings assigned by each such NRSRO. A rating by an
NRSRO may be utilized only where the NRSRO is neither controlling, controlled
by, or under common control with the issuer of, or any issuer, guarantor, or
provider of credit support for, the instrument.
U.S. CORPORATE DEBT OBLIGATIONS. U.S. Corporate Debt Obligations include bonds,
debentures, and notes. Debentures represent unsecured promises to pay, while
notes and bonds may be secured by mortgages on real property or security
interests in personal property. Bonds include, but are not limited to, debt
instruments with maturities of approximately one year or more, debentures,
mortgage-related securities, stripped government
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<PAGE>
securities, and zero coupon obligations. Bonds, notes, and debentures in which
the Funds may invest may differ in interest rates, maturities, and times of
issuance. The market value of a Fund's fixed income investments will change in
response to interest rate changes and other factors. During periods of falling
interest rates, the values of outstanding fixed income securities generally
rise. Conversely, during periods of rising interest rates, the values of such
securities generally decline. Moreover, while securities with longer maturities
tend to produce higher yields, the price of longer maturity securities are also
subject to greater market fluctuations as a result of changes in interest rates.
Changes by recognized agencies in the rating of any fixed income security and in
the ability of an issuer to make payments of interest and principal also affect
the value of these investments. Except under conditions of default, changes in
the value of a Fund's securities will not affect cash income derived from these
securities but will affect the Fund's net asset value.
SHORT-TERM OBLIGATIONS. These include high quality, short-term obligations such
as domestic and foreign commercial paper (including variable-amount master
demand notes), bankers' acceptances, certificates of deposit and demand and time
deposits of domestic and foreign branches of U.S. banks and foreign banks, and
repurchase agreements. (See "Foreign Securities" for a description of risks
associated with investments in foreign securities.)
SHORT-TERM CORPORATE OBLIGATIONS. Corporate obligations are bonds issued by
corporations and other business organizations in order to finance their
long-term credit needs. Corporate bonds in which a Fund may invest generally
consist of those rated in the two highest rating categories of an NRSRO that
possess many favorable investment attributes. In the lower end of this category,
credit quality may be more susceptible to potential future changes in
circumstances.
DEMAND FEATURES. The Fund may acquire securities that are subject to puts and
standby commitments ("demand features") to purchase the securities at their
principal amount (usually with accrued interest) within a fixed period (usually
seven days) following a demand by the Fund. The demand feature may be issued by
the issuer of the underlying securities, a dealer in the securities or by
another third party, and may not be transferred separately from the underlying
security. The Fund uses these arrangements to provide the Fund with liquidity
and not to protect against changes in the market value of the underlying
securities. The bankruptcy, receivership or default by the issuer of the demand
feature, or a default on the underlying security or other event that terminates
the demand feature before its exercise, will adversely affect the liquidity of
the underlying security. Demand features that are exercisable even after a
payment default on the underlying security may be treated as a form of credit
enhancement.
BANKERS' ACCEPTANCES. Bankers' Acceptances are negotiable drafts or bills of
exchange typically drawn by an importer or exporter to pay for specific
merchandise, which are "accepted" by a bank, meaning, in effect, that the bank
unconditionally agrees to pay the face value of the instrument on maturity.
Bankers' Acceptances will be those guaranteed by domestic and foreign banks, if
at the time of purchase such banks have capital, surplus, and undivided profits
in excess of $100,000,000 (as of the date of their most recently published
financial statements).
CERTIFICATES OF DEPOSIT. Certificates of Deposit are negotiable certificates
issued against funds deposited in a commercial bank or a savings and loan
association for a definite period of time and earning a specified return.
Certificates of Deposit and demand and time deposits invested in by a Fund will
be those of domestic and foreign banks and savings and loan associations, if (a)
at the time of purchase such financial institutions have capital, surplus, and
undivided profits in excess of $100,000,000 (as of the date of their most
recently published financial statements) or (b) the principal amount of the
instrument is insured in full by the Federal Deposit Insurance Corporation (the
"FDIC") or the Savings Association Insurance Fund.
EURODOLLAR CERTIFICATES OF DEPOSIT ("ECDs") are U.S. dollar-denominated
certificates of deposit issued by branches of foreign and domestic banks located
outside the United States.
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YANKEE CERTIFICATES OF DEPOSIT ("Yankee CDs") are certificates of deposit issued
by a U.S. branch of a foreign bank denominated in U.S. dollars and held in the
United States.
EURODOLLAR TIME DEPOSITS ("ETDs") are U.S. dollar-denominated deposits in a
foreign branch of a U.S. bank or a foreign bank.
CANADIAN TIME DEPOSITS ("CTDs") are U.S. dollar-denominated certificates of
deposit issued by Canadian offices of major Canadian Banks.
COMMERCIAL PAPER. Commercial paper is unsecured promissory notes issued by
corporations. Except as noted below with respect to variable amount master
demand notes, issues of commercial paper normally have maturities of less than
nine months and fixed rates of return.
The Funds will purchase only commercial paper rated in one of the two highest
categories at the time of purchase by an NRSRO or, if not rated, found by the
Trustees to present minimal credit risks and to be of comparable quality to
instruments that are rated high quality (i.e., in one of the two top ratings
categories) by an NRSRO that is neither controlling, controlled by, or under
common control with the issuer of, or any issuer, guarantor, or provider of
credit support for, the instruments. For a description of the rating symbols of
each NRSRO see the Appendix to this Statement of Additional Information.
INTERNATIONAL BONDS. International Bonds include Euro and Yankee obligations,
which are U.S. dollar-denominated international bonds for which the primary
trading market is in the United States ("Yankee Bonds"), or for which the
primary trading market is abroad ("Eurodollar Bonds"). International Bonds also
include Canadian and Supranational Agency Bonds (e.g., International Monetary
Fund). (See "Foreign Debt Securities" for a description of risks associated with
investments in foreign securities.)
FOREIGN DEBT SECURITIES. Investments in securities of foreign companies
generally involve greater risks than are present in U.S. investments. Compared
to U.S. and Canadian companies, there generally is less publicly available
information about foreign companies and there may be less governmental
regulation and supervision of foreign stock exchanges, brokers and listed
companies. Foreign companies generally are not subject to uniform accounting,
auditing, and financial reporting standards, practices, and requirements
comparable to those applicable to U.S. companies. Securities of some foreign
companies are less liquid, and their prices more volatile, than securities of
comparable U.S. companies. Settlement of transactions in some foreign markets
may be delayed or may be less frequent than in the U.S., which could affect the
liquidity of a Fund's investment. In addition, with respect to some foreign
countries, there is the possibility of nationalization, expropriation, or
confiscatory taxation; limitations on the removal of securities, property, or
other assets of a Fund; there may be political or social instability; there may
be increased difficulty in obtaining legal judgments; or diplomatic developments
which could affect U.S. investments in those countries. The Adviser will take
such factors into consideration in managing a Fund's investments. A Fund will
not hold foreign currency in amounts exceeding 5% of its assets as a result of
such investments.
REPURCHASE AGREEMENTS. Securities held by a Fund may be subject to Repurchase
Agreements. Under the terms of a Repurchase Agreement, a Fund would acquire
securities from financial institutions or registered broker-dealers deemed
creditworthy by the Adviser pursuant to guidelines adopted by the Trustees,
subject to the seller's agreement to repurchase such securities at a mutually
agreed upon date and price. The seller is required to maintain the value of
collateral held pursuant to the agreement at not less than the repurchase price
(including accrued interest).
If the seller were to default on its repurchase obligation or become insolvent,
a Fund would suffer a loss to the extent that the proceeds from a sale of the
underlying portfolio securities were less than the repurchase price, or to the
extent that the disposition of such securities by the Fund is delayed pending
court action.
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<PAGE>
REVERSE REPURCHASE AGREEMENTS. A Fund may borrow funds for temporary purposes by
entering into reverse Repurchase Agreements. Reverse Repurchase Agreements are
considered to be borrowings under the 1940 Act. Pursuant to such agreement, a
Fund would sell a portfolio security to a financial institution such as a bank
and a broker-dealer, and agree to repurchase such security at a mutually
agreed-upon date and price. At the time a Fund enters into a Reverse Repurchase
Agreement, it will place in a segregated custodial account assets (such as cash
or other liquid high-grade securities) consistent with the Fund's investment
restrictions having a value equal to the repurchase price (including accrued
interest). The collateral will be marked-to-market on a daily basis, and will be
monitored continuously to ensure that such equivalent value is maintained.
Reverse Repurchase Agreements involve the risk that the market value of the
securities sold by a Fund may decline below the price at which the Fund is
obligated to repurchase the securities.
SHORT-TERM FUNDING AGREEMENTS. A Fund may invest in Short-Term Funding
Agreements (sometimes referred to as "GICs") issued by insurance companies.
Pursuant to such agreements, a Fund makes cash contributions to a deposit fund
of the insurance company's general account. The insurance company then credits
the Fund, on a monthly basis, guaranteed interest which is based on an index.
The Short-Term Funding Agreement provides that this guaranteed interest will not
be less than a certain minimum rate. Because the principal amount of a
Short-Term Funding Agreement may not be received from the insurance company on
seven days notice or less, the agreement is considered to be an illiquid
investment and, together with other instruments in a Fund which are not readily
marketable, will not exceed, for money market funds, 10% of the Fund's net
assets, and for all other funds, 15% of the Fund's net assets. In determining
dollar-weighted average portfolio maturity, a Short-Term Funding Agreement will
be deemed to have a maturity equal to the period of time remaining until the
next readjustment of the guaranteed interest rate.
VARIABLE AMOUNT MASTER DEMAND NOTES. Variable Amount Master Demand Notes are
unsecured demand notes that permit the indebtedness thereunder to vary and
provide for periodic adjustments in the interest rate according to the terms of
the instrument. Although there is no secondary market for these notes, a Fund
may demand payment of principal and accrued interest at any time and may resell
the notes at any time to a third party. The absence of an active secondary
market, however, could make it difficult for a Fund to dispose of a Variable
Amount Master Demand Note if the issuer defaulted on its payment obligations,
and the Fund could, for this or other reasons, suffer a loss to the extent of
the default. While the notes typically are not rated by credit rating agencies,
issuers of Variable Amount Master Demand Notes must satisfy the same criteria as
set forth above for unrated commercial paper, and the Adviser will monitor
continuously the issuer's financial status and ability to make payments due
under the instrument. Where necessary to ensure that a note is of "high
quality," a Fund will require that the issuer's obligation to pay the principal
of the note be backed by an unconditional bank letter or line of credit,
guarantee or commitment to lend. For purposes of a Fund's investment policies, a
Variable Amount Master Demand Note will be deemed to have a maturity equal to
the longer of the period of time remaining until the next readjustment of its
interest rate or the period of time remaining until the principal amount can be
recovered from the issuer through demand.
VARIABLE RATE DEMAND NOTES. Variable Rate Demand Notes are tax-exempt
obligations containing a floating or variable interest rate adjustment formula,
together with an unconditional right to demand payment of the unpaid principal
balance plus accrued interest upon a short notice period, generally not to
exceed seven days. The Funds also may invest in participation Variable Rate
Demand Notes, which provide a Fund with an undivided interest in underlying
Variable Rate Demand Notes held by major investment banking institutions. Any
purchase of Variable Rate Demand Notes will meet applicable diversification and
concentration requirements.
VARIABLE AND FLOATING RATE NOTES. A Variable Rate Note is one whose terms
provide for the readjustment of its interest rate on set dates and which, upon
such readjustment, reasonably can be expected to have a market value that
approximates its par value. A Floating Rate Note is one whose terms provide for
the readjustment of its interest rate whenever a specified interest rate changes
and which, at any time, reasonably can be expected to have a market
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<PAGE>
value that approximates its par value. Such notes frequently are not rated by
credit rating agencies; however, unrated Variable and Floating Rate Notes
purchased by the Fund will only be those determined by the Adviser, under
guidelines established by the Trustees, to pose minimal credit risks and to be
of comparable quality, at the time of purchase, to rated instruments eligible
for purchase under the Fund's investment policies. In making such
determinations, the Adviser will consider the earning power, cash flow and other
liquidity ratios of the issuers of such notes (such issuers include financial,
merchandising, bank holding and other companies) and will continuously monitor
their financial condition. Although there may be no active secondary market with
respect to a particular Variable or Floating Rate Note purchased by a Fund, the
Fund may resell the note at any time to a third party. The absence of an active
secondary market, however, could make it difficult for a Fund to dispose of a
Variable or Floating Rate Note in the event that the issuer of the note
defaulted on its payment obligations and a Fund could, for this or other
reasons, suffer a loss to the extent of the default. Variable or Floating Rate
Notes may be secured by bank letters of credit.
Variable or Floating Rate Notes may have maturities of more than one year, as
follows:
1. A Variable or Floating Rate Note that is issued or guaranteed by the United
States government or any agency thereof and which has a variable rate of
interest readjusted no less frequently than annually will be deemed to have a
maturity equal to the period remaining until the next readjustment of the
interest rate.
2. A Variable or Floating Rate Note, the principal amount of which is scheduled
on the face of the instrument to be paid in one year or less, will be deemed by
the Fund to have a maturity equal to the period remaining until the next
readjustment of the interest rate.
3. A Variable or Floating Rate Note that is subject to a demand feature
scheduled to be paid in one year or more will be deemed to have a maturity equal
to the longer of the period remaining until the next readjustment of the
interest rate or the period remaining until the principal amount can be
recovered through demand.
4. A Variable or Floating Rate Note that is subject to a demand feature will be
deemed to have a maturity equal to the period remaining until the principal
amount can be recovered through demand.
As used above, a note is "subject to a demand feature" where a Fund is entitled
to receive the principal amount of the note either at any time on no more than
30 days' notice or at specified intervals not exceeding one year and upon no
more than 30 days' notice.
EXTENDIBLE DEBT SECURITIES. Extendible Debt Securities are securities that can
be retired at the option of a Fund at various dates prior to maturity. In
calculating average portfolio maturity, a Fund may treat Extendible Debt
Securities as maturing on the next optional retirement date.
RECEIPTS. Receipts are separately traded interest and principal component parts
of bills, notes, and bonds issued by the U.S. Treasury that are transferable
through the Federal book entry system, known as Separately Traded Registered
Interest and Principal Securities ("STRIPS") and Coupon Under Book Entry
Safekeeping ("CUBES"). These instruments are issued by banks and brokerage firms
and are created by depositing Treasury notes and Treasury bonds into a special
account at a custodian bank; the custodian holds the interest and principal
payments for the benefit of the registered owners of the certificates or
receipts. The custodian arranges for the issuance of the certificates or
receipts evidencing ownership and maintains the register. Receipts include
Treasury Receipts ("TRs"), Treasury Investment Growth Receipts ("TIGRs"), and
Certificates of Accrual on Treasury Securities ("CATS").
ZERO-COUPON BONDS. Zero-Coupon Bonds are purchased at a discount from the face
amount because the buyer receives only the right to a fixed payment on a certain
date in the future and does not receive any periodic interest
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payments. The effect of owning instruments which do not make current interest
payments is that a fixed yield is earned not only on the original investment but
also, in effect, on accretion during the life of the obligations. This implicit
reinvestment of earnings at the same rate eliminates the risk of being unable to
reinvest distributions at a rate as high as the implicit yields on the
Zero-Coupon Bond, but at the same time eliminates the holder's ability to
reinvest at higher rates. For this reason, Zero-Coupon Bonds are subject to
substantially greater price fluctuations during periods of changing market
interest rates than are comparable securities which pay interest currently,
which fluctuation increases in accordance with the length of the period to
maturity.
HIGH-YIELD DEBT SECURITIES. High-Yield Debt Securities are lower-rated debt
securities, commonly referred to as "junk bonds" (those rated Ba to C by Moody's
or BB to C by S&P), that have poor protection with respect to the payment of
interest and repayment of principal, or may be in default. These securities are
often considered to be speculative and involve greater risk of loss or price
changes due to changes in the issuer's capacity to pay. The market prices of
High-Yield Debt Securities may fluctuate more than those of higher-rated debt
securities and may decline significantly in periods of general economic
difficulty, which may follow periods of rising interest rates.
While the market for High-Yield Debt Securities has been in existence for many
years and has weathered previous economic downturns, the 1980s brought a
dramatic increase in the use of such securities to fund highly-leveraged
corporate acquisitions and restructurings. Past experience may not provide an
accurate indication of future performance of the high yield bond market,
especially during periods of economic recession. In fact, from 1989 to 1991, the
percentage of High-Yield Debt Securities that defaulted rose significantly above
prior levels, although the default rate decreased in 1992.
The market for High-Yield Debt Securities may be thinner and less active than
that for higher-rated debt securities, which can adversely affect the prices at
which the former are sold. If market quotations are not available, High-Yield
Debt Securities will be valued in accordance with procedures established by the
Victory Portfolios' Board of Trustees, including the use of outside pricing
services.
Judgment plays a greater role in valuing High-Yield Debt Securities than is the
case for securities for which more external sources for quotations and last-sale
information are available. Adverse publicity and changing investor perceptions
may affect the ability of outside pricing services to value High-Yield Debt
Securities and a Fund's ability to sell these securities.
Since the risk of default is higher for High-Yield Debt Securities, the
Adviser's research and credit analysis are an especially important part of
managing securities of this type held by a Fund. In considering investments for
a Fund, the Adviser will attempt to identify those issuers of high-yielding debt
securities whose financial condition is adequate to meet future obligations, has
improved, or is expected to improve in the future. Analysis of the Adviser
focuses on relative values based on such factors as interest or dividend
coverage, asset coverage, earnings prospects, and the experience and managerial
strength of the issuer.
A Fund may choose, at its expense or in conjunction with others, to pursue
litigation or otherwise exercise its rights as security holder to seek to
protect the interests of security holders if it determines this to be in the
best interest of the Fund's shareholders.
LOANS AND OTHER DIRECT DEBT INSTRUMENTS. Loans and Other Direct Debt Instruments
are interests in amounts owed by a corporate, governmental, or other borrower to
another party. They may represent amounts owed to lenders or lending syndicates
(loans and loan participations), to suppliers of goods or services (trade claims
or other receivables), or to other parties. Direct Debt Instruments involve a
risk of loss in case of default or insolvency of the borrower and may offer less
legal protection to a Fund in the event of fraud or misrepresentation. In
addition, loan participations involve a risk of insolvency of the lending bank
or other financial intermediary. Direct Debt
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Instruments may also include standby financing commitments that obligate a Fund
to supply additional cash to the borrower on demand.
SECURITIES OF OTHER INVESTMENT COMPANIES. A Fund may invest up to 5% of its
total assets in the securities of any one investment company, but may not own
more than 3% of the securities of any one investment company or invest more than
10% of its total assets in the securities of other investment companies.
Pursuant to an exemptive order received by the Victory Portfolios from the SEC,
a Fund may invest in the money market funds of the Victory Portfolios. The
Adviser will waive its investment advisory fee with respect to assets of a Fund
invested in any of the money market funds of the Victory Portfolios, and, to the
extent required by the laws of any state in which a Fund's shares are sold, the
Adviser will waive its investment advisory fee as to all assets invested in
other investment companies.
U.S. GOVERNMENT OBLIGATIONS. U.S. Government Obligations are obligations issued
or guaranteed by the U.S. Government, its agencies, and instrumentalities.
Obligations of certain agencies and instrumentalities of the U.S. Government are
supported by the full faith and credit of the U.S. Treasury; others are
supported by the right of the issuer to borrow from the U.S. Treasury; others
are supported by the discretionary authority of the U.S. Government to purchase
the agency's obligations; and still others are supported only by the credit of
the agency or instrumentality. No assurance can be given that the U.S.
Government will provide financial support to U.S. Government-sponsored agencies
or instrumentalities if it is not obligated to do so by law.
MUNICIPAL SECURITIES. Municipal Securities are obligations, typically bonds and
notes, issued by or on behalf of states, territories, and possessions of the
United States and the District of Columbia and their political subdivisions,
agencies, authorities, and instrumentalities, the interest on which, in the
opinion of the issuer's bond counsel at the time of issuance, is both exempt
from federal income tax and not treated as a preference item for individuals for
purposes of the federal alternative minimum tax.
Two specific types of Municipal Securities are "Ohio Tax-Exempt Obligations" and
"New York Tax-Exempt Obligations." Ohio Tax-Exempt Obligations are Municipal
Securities issued by the State of Ohio and its political subdivisions, the
interest on which is, in the opinion of the issuer's bond counsel at the time of
issuance, excluded from gross income for purposes of both federal income
taxation and Ohio personal income tax. New York Tax-Exempt Obligations are
Municipal Securities issued by the State of New York and its political
subdivisions, the interest on which is, in the opinion of the issuer's bond
counsel at the time of issuance, excluded from gross income for purposes of both
federal income taxation and New York personal income tax.
Generally, Municipal Securities are issued by governmental entities to obtain
funds for various public purposes, such as the construction of a wide range of
public facilities, the refunding of outstanding obligations, the payment of
general operating expenses, and the extension of loans to other public
institutions and facilities. Municipal Securities may include fixed, variable,
or floating rate obligations. Municipal Securities may be purchased on a
when-issued or delayed-delivery basis (including refunding contracts).
The two principal categories of Municipal Securities are "general obligation"
issues and "revenue" issues. Other categories of Municipal Securities are "moral
obligation" issues, private activity bonds, and industrial development bonds.
The prices and yields on Municipal Securities are subject to change from time to
time and depend upon a variety of factors, including general money market
conditions, the financial condition of the issuer (or other entities whose
financial resources are supporting the Municipal Security), general conditions
in the market for tax-exempt obligations, the size of a particular offering, the
maturity of the obligation, and the rating(s) of the issue. There are variations
in the quality of Municipal Securities, both within a particular category of
Municipal Securities and
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between categories. Current information about the financial condition of an
issuer of tax-exempt bonds or notes usually is not as extensive as that which is
made available by corporations whose securities are publicly traded.
The term Municipal Securities, as used in this SAI, includes private activity
bonds issued and industrial development bonds by or on behalf of public
authorities to finance various privately-operated facilities if the interest
paid thereon is both exempt from federal income tax and not treated as a
preference item for individuals for purposes of the federal alternative minimum
tax. The term Municipal Securities also includes short-term instruments issued
in anticipation of the receipt of tax funds, the proceeds of bond placements, or
other revenues, such as short-term general obligation notes, tax anticipation
notes, bond anticipation notes, revenue anticipation notes, tax-exempt
commercial paper, construction loan notes, and other forms of short-term
tax-exempt loans. Additionally, the term Municipal Securities includes project
notes, which are issued by a state or local housing agency and are sold by the
Department of Housing and Urban Development.
An issuer's obligations under its Municipal Securities are subject to the
provisions of bankruptcy, insolvency, and other laws affecting the rights and
remedies of creditors, such as the federal bankruptcy code. Congress or state
legislatures may enact laws extending the time for payment of principal or
interest, or both, or imposing other constraints upon the enforcement of such
obligations or upon the ability of municipalities to levy taxes. The power or
ability of an issuer to meet its obligations for the payment of interest on and
principal of its Municipal Securities may be materially adversely affected by
litigation or other conditions. There is also the possibility that, as a result
of litigation or other conditions, the power or ability of certain issuers to
meet their obligations to pay interest on and principal of their tax-exempt
bonds or notes may be materially impaired or their obligations may be found to
be invalid or unenforceable. Such litigation or conditions may, from time to
time, have the effect of introducing uncertainties in the market for tax-exempt
obligations or certain segments thereof, or may materially affect the credit
risk with respect to particular bonds or notes. Adverse economic, business,
legal, or political developments might affect all or a substantial portion of
the Fund's tax-exempt bonds and notes in the same manner.
From time to time, proposals have been introduced before Congress for the
purpose of restricting or eliminating the federal income tax exemption for
interest on tax-exempt bonds, and similar proposals may be introduced in the
future. The U.S. Supreme Court has held that Congress has the constitutional
authority to enact such legislation. It is not possible to determine what effect
the adoption of such proposals could have on the availability of tax-exempt
bonds for investment by the Fund and the value of its portfolio. Proposals also
may be introduced before state legislatures that would affect the state tax
treatment of Municipal Securities. If such proposals were enacted, the
availability of Municipal Securities and their value would be affected.
The Internal Revenue Code of 1986, as amended (the "Code"), imposes certain
continuing requirements on issuers of tax-exempt bonds regarding the use,
expenditure and investment of bond proceeds and the payment of rebate to the
United States of America. Failure by the issuer to comply with certain of these
requirements subsequent to the issuance of tax-exempt bonds could cause interest
on the bonds to become includable in gross income retroactive to the date of
issuance.
General obligation issues are backed by the full taxing power of a state or
municipality and are payable from the issuer's general unrestricted revenues and
not from any particular fund or source. The characteristics and method of
enforcement of general obligation bonds vary according to the law applicable to
the particular issuer. Revenue issues or special obligation issues are backed
only by the revenues from a specific tax, project, or facility. "Moral
obligation" issues are normally issued by special purpose authorities.
Private activity bonds and industrial development bonds generally are revenue
bonds and not payable from the resources or unrestricted revenues of the issuer.
The credit and quality of industrial development revenue bonds is usually
directly related to the credit of the corporate user of the facilities. Payment
of principal of and interest on industrial development revenue bonds is the
responsibility of the corporate user (and any guarantor).
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Private activity bonds, as discussed above, may constitute Municipal Securities
depending on their tax treatment. The source of payment and security for such
bonds is the financial resources of the private entity involved; the full faith
and credit and the taxing power of the issuer normally will not be pledged. The
payment obligations of the private entity also will be subject to bankruptcy as
well as other exceptions similar to those described above. Certain debt
obligations known as "industrial development bonds" under prior federal tax law
may have been issued by or on behalf of public authorities to obtain funds to
provide certain privately operated housing facilities, sports facilities,
industrial parks, convention or trade show facilities, airport, mass transit,
port or parking facilities, air or water pollution control facilities, sewage or
solid waste disposal facilities, and certain local facilities for water supply
or other heating or cooling facilities. Other private activity bonds and
industrial development bonds issued to fund the construction, improvement or
equipment of privately-operated industrial, distribution, research or commercial
facilities may also be Municipal Securities, but the size of such issues is
limited under current and prior federal tax law. The aggregate amount of most
private activity bonds and industrial development bonds is limited (except in
the case of certain types of facilities) under federal tax law by an annual
"volume cap." The volume cap limits the annual aggregate principal amount of
such obligations issued by or on behalf of all government instrumentalities in
the state. Such obligations are included within the term Municipal Securities if
the interest paid thereon is, in the opinion of bond counsel, at the time of
issuance, excluded from gross income for purposes of both federal income
taxation (including any alternative minimum tax) and state personal income tax.
The Fund may not be a desirable investment for "substantial users" of facilities
financed by private activity bonds or industrial development bonds or for
"related persons" of substantial users.
Project notes are secured by the full faith and credit of the United States
through agreements with the issuing authority which provide that, if required,
the U.S. government will lend the issuer an amount equal to the principal of and
interest on the project notes, although the issuing agency has the primary
obligation with respect to its project notes.
Some municipal securities are insured by private insurance companies, while
others may be supported by letters of credit furnished by domestic or foreign
banks. Insured investments are covered by an insurance policy applicable to a
specific security, either obtained by the issuer of the security or by a third
party from a private insurer. Insurance premiums for the municipal bonds are
paid in advance by the issuer or the third party obtaining such insurance. Such
policies are noncancellable and continue in force as long as the municipal bonds
are outstanding and the respective insurers remain in business.
The insurer unconditionally guarantees the timely payment of the principal of
and interest on the insured municipal bonds when and as such payments become due
but shall not be paid by the issuer, except that in the event of any
acceleration of the due date of the principal by reason of mandatory or optional
redemption (other than acceleration by reason of a mandatory sinking fund
payment), default, or otherwise, the payments guaranteed will be made in such
amounts and at such times as payments of principal would have been due had there
not been such acceleration. The insurer will be responsible for such payments
less any amounts received by the bondholder from any trustee for the municipal
bond issuers or from any other source. The insurance does not guarantee the
payment of any redemption premium, the value of the shares of a Fund, or
payments of any tender purchase price upon the tender of the municipal bonds.
With respect to small issue industrial development municipal bonds and pollution
control revenue municipal bonds, the insurer guarantees the full and complete
payments required to be made by or on behalf of an issuer of such municipal
bonds if there occurs any change in the tax-exempt status of interest on such
municipal bonds, including principal, interest, or premium payments, if any, as
and when required to be made by or on behalf of the issuer pursuant to the terms
of such municipal bonds. This insurance is intended to reduce financial risk,
but the cost thereof will reduce the yield available to shareholders of a Fund.
The ratings of NRSROs represent their opinions as to the quality of Municipal
Securities. In this regard, it should be emphasized that the ratings of any
NRSRO are general and are not absolute standards of quality, and Municipal
Securities with the same maturity, interest rate, and rating may have different
yields, while Municipal Securities of the same maturity and interest rate with
different ratings may have the same yield. Subsequent to purchase by
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a Fund, an issue of Municipal Securities may cease to be rated or its rating may
be reduced below the minimum rating required for purchase by the Fund. The
Adviser will consider such an event in determining whether the Fund should
continue to hold the obligation.
The Adviser believes that it is likely that sufficient Municipal Securities will
be available to satisfy the Fund's investment objective and policies. In meeting
its investment policies, the Fund may invest all or any part of its total assets
in Municipal Securities which are private activity bonds. Moreover, although the
Fund does not presently intend to do so on a regular basis, it may invest more
than 25% of its total assets in Municipal Securities which are related in such a
way that an economic, business or political development or change affecting one
such security would likewise affect the other Municipal Securities. Examples of
such securities are obligations, the repayment of which is dependent upon
similar types of projects or projects located in the same state. Such
investments would be made only if deemed necessary or appropriate by the
Adviser.
OHIO TAX-EXEMPT OBLIGATIONS. As used in the Prospectus and this Statement of
Additional Information, the term "Ohio Tax-Exempt Obligations" refers to debt
obligations issued by the State of Ohio and its political subdivisions, the
interest on which is, in the opinion of the issuer's bond counsel, at the time
of issuance, excluded from gross income for purposes of both federal income
taxation and Ohio personal income tax (as used herein the terms "income tax" and
"taxation" do not include any possible incidence of any alternative minimum
tax). Ohio Tax-Exempt Obligations are issued to obtain funds for various public
purposes, including the construction of a wide range of public facilities such
as bridges, highways, roads, schools, water and sewer works, and other
utilities. Other public purposes for which Ohio Tax-Exempt Obligations may be
issued include refunding outstanding obligations and obtaining funds to lend to
other public institutions and facilities. In addition, certain debt obligations
known as "private activity bonds" may be issued by or on behalf of
municipalities and public authorities to obtain funds to provide certain water,
sewage and solid waste facilities, qualified residential rental projects,
certain local electric, gas and other heating or cooling facilities, qualified
hazardous waste facilities, high-speed inter-city rail facilities,
government-owned airports, docks and wharves and mass commuting facilities,
certain qualified mortgages, student loan and redevelopment bonds and bonds used
for certain organizations exempt from federal income taxation. Certain debt
obligations known as "industrial development bonds" under prior federal tax law
may have been issued by or on behalf of public authorities to obtain funds to
provide certain privately operated housing facilities, sports facilities,
industrial parks, convention or trade show facilities, airport, mass transit,
port or parking facilities, air or water pollution control facilities, sewage or
solid waste disposal facilities, and certain local facilities for water supply
or other heating or cooling facilities. Other private activity bonds and
industrial development bonds issued to fund the construction, improvement or
equipment of privately-operated industrial, distribution, research or commercial
facilities may also be Ohio Tax-Exempt Obligations, but the size of such issues
is limited under current and prior federal tax law. The aggregate amount of most
private activity bonds and industrial development bonds is limited (except in
the case of certain types of facilities) under federal tax law by an annual
"volume cap." The volume cap limits the annual aggregate principal amount of
such obligations issued by or on behalf of all government instrumentalities in
the state. Such obligations are included within the term Ohio Tax-Exempt
Obligations if the interest paid thereon is, in the opinion of bond counsel, at
the time of issuance, excluded from gross income for purposes of both federal
income taxation (including any alternative minimum tax) and Ohio personal income
tax. A Fund which invests in Ohio Tax-Exempt Obligations may not be a desirable
investment for "substantial users" of facilities financed by private activity
bonds or industrial development bonds or for "related persons" of substantial
users. See "Dividends, Distributions, and Taxes" in the Prospectus.
Prices and yields on Ohio Tax-Exempt Obligations are dependent on a variety of
factors, including general money market conditions, the financial condition of
the issuer, general conditions in the market for tax-exempt obligations, the
size of a particular offering, the maturity of the obligation and ratings of
particular issues, and are subject to change from time to time. Current
information about the financial condition of an issuer of tax-exempt bonds or
notes is usually not as extensive as that which is made available by
corporations whose securities are publicly traded.
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Obligations of subdivision issuers of tax-exempt bonds and notes may be subject
to the provisions of bankruptcy, insolvency and other laws, such as the Federal
Bankruptcy Reform Act of 1978, as amended, affecting the rights and remedies of
creditors. Congress or state legislatures may seek to extend the time for
payment of principal or interest, or both, or to impose other constraints upon
enforcement of such obligations. There is also the possibility that, as a result
of litigation or other conditions, the power or ability of certain issuers to
meet their obligations to pay interest on and principal of their tax-exempt
bonds or notes may be materially impaired or their obligations may be found to
be invalid or unenforceable. Such litigation or conditions may, from time to
time, have the effect of introducing uncertainties in the market for tax-exempt
obligations or certain segments thereof, or may materially affect the credit
risk with respect to particular bonds or notes. Adverse economic, business,
legal or political developments might affect all or a substantial portion of the
Funds' tax-exempt bonds and notes in the same manner.
From time to time, proposals have been introduced before Congress for the
purpose of restricting or eliminating the federal income tax exemption for
interest on tax-exempt bonds, and similar proposals may be introduced in the
future. A recent decision of the U.S. Supreme Court has held that Congress has
the constitutional authority to enact such legislation. It is not possible to
determine what effect the adoption of such proposals could have on the
availability of tax-exempt bonds for investment by a Fund and the value of its
portfolio.
The Code imposes certain continuing requirements on issuers of tax-exempt bonds
regarding the use, expenditure and investment of bond proceeds and the payment
of rebate to the United States of America. Failure by the issuer to comply
subsequent to the issuance of tax-exempt bonds with certain of these
requirements could cause interest on the bonds to become includable in gross
income retroactive to the date of issuance.
A Fund may invest in Ohio Tax-Exempt Obligations either by purchasing them
directly or by purchasing certificates of accrual or similar instruments
evidencing direct ownership of interest payments or principal payments, or both,
on Ohio Tax-Exempt Obligations, provided that, in the opinion of counsel to the
initial seller of each such certificate or instrument, any discount accruing on
such certificate or instrument that is purchased at a yield not greater than the
coupon rate of interest on the related Ohio Tax-Exempt Obligations will be
exempt from federal income tax and Ohio personal income tax to the same extent
as interest on such Ohio Tax-Exempt Obligations. A Fund may also invest in Ohio
Tax-Exempt Obligations by purchasing from banks participation interests in all
or part of specific holdings of Ohio Tax-Exempt Obligations. Such participations
may be backed in whole or in part by an irrevocable letter of credit or
guarantee of the selling bank. The selling bank may receive a fee from the Fund
in connection with the arrangement. A Fund will not purchase participation
interests unless it receives an opinion of counsel or a ruling of the Internal
Revenue Service that interest earned by it on Ohio Tax-Exempt Obligations in
which it holds such a participation interest is exempt from federal income tax
and Ohio personal income tax.
MUNICIPAL LEASE OBLIGATIONS. A Fund may invest a portion of its assets in
municipal leases and participation interests therein. These obligations, which
may take the form of a lease, an installment purchase, or a conditional sale
contract, are issued by state and local governments and authorities to acquire
land and a wide variety of equipment and facilities. Generally, Funds will not
hold such obligations directly as a lessor of the property, but will purchase a
participation interest in a municipal obligation from a bank or other third
party. A participation interest gives a Fund a specified, undivided interest in
the obligation in proportion to its purchased interest in the total amount of
the obligation.
Municipal leases frequently have risks distinct from those associated with
general obligation or revenue bonds. State constitutions and statutes set forth
requirements that states or municipalities must meet to incur debt. These may
include voter referenda, interest rate limits, or public sale requirements.
Leases, installment purchases, or conditional sale contracts (which normally
provide for title to the leased asset to pass to the governmental issuer) have
evolved as a means for governmental issuers to acquire property and equipment
without meeting their constitutional and statutory requirements for the issuance
of debt. Many leases and contracts include "non-appropriation clauses" providing
that the governmental issuer has no obligation to make future payments under
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the lease or contract unless money is appropriated for such purposes by the
appropriate legislative body on a yearly or other periodic basis.
Non-appropriation clauses free the issuer from debt issuance limitations.
LOWER-RATED MUNICIPAL SECURITIES. The Funds do not currently intend to invest in
lower-rated municipal securities. However, certain Funds may hold up to 5% of
its assets in municipal securities that have been downgraded below investment
grade. While the market for New York municipal securities is considered to be
substantial, adverse publicity and changing investor perceptions may affect the
ability of outside pricing services used by the Fund to value portfolio
securities, and the Fund's ability to dispose of lower-rated securities. Outside
pricing services are consistently monitored to assure that securities are valued
by a method that the Board of Trustees believes accurately reflects fair value.
The impact of changing investor perceptions may be especially pronounced in
markets where municipal securities are thinly traded.
The Fund may choose, at its expense, or in conjunction with others, to pursue
litigation seeking to protect the interests of security holders if it determines
this to be in the best interest of shareholders.
FEDERALLY TAXABLE OBLIGATIONS. None of the tax-exempt Funds intend to invest in
securities whose interest is federally taxable; however, from time to time,
these Funds may invest a portion of their assets on a temporary basis in
fixed-income obligations whose interest is subject to federal income tax. For
example, these Funds may invest in obligations whose interest is federally
taxable pending the investment or reinvestment in municipal securities of
proceeds from the sale of its shares of portfolio securities.
Should these Funds invest in federally taxable obligations, they would purchase
securities which in the Adviser's judgment are of high quality. This would
include obligations issued or guaranteed by the U.S. Government, its agencies or
instrumentalities; obligations of domestic banks; and repurchase agreements.
These Funds' standards for high quality taxable obligations are essentially the
same as those described by Moody's in rating corporate obligations within its
two highest ratings of Prime-1 and Prime-2, and those described by S&P in rating
corporate obligations within its two highest ratings of A-1 and A-2. In making
high quality determinations the Fund may also consider the comparable ratings of
other nationally recognized rating services.
The Supreme Court has held that Congress may subject the interest on municipal
obligations to federal income tax. Proposals to restrict or eliminate the
federal income tax exemption for interest on municipal obligations are
introduced before Congress from time to time. Proposals also may be introduced
before the New York legislature that would affect the state tax treatment of the
Fund's distributions. If such proposals were enacted, the availability of
municipal obligations and the value of the Fund's holdings would be affected and
the Trustees would reevaluate the Fund's investment objective and policies.
These Funds anticipate being as fully invested as practicable in municipal
securities; however, there may be occasions when, as a result of maturities of
portfolio securities, sales of Fund shares, or in order to meet redemption
requests, the Fund may hold cash that is not earning income. In addition, there
may be occasions when, in order to raise cash to meet redemptions, these Funds
may be required to sell securities at a loss.
REFUNDED MUNICIPAL BONDS. Investments by a Fund in refunded municipal bonds that
are secured by escrowed obligations issued or guaranteed by the U.S. Government
or its agencies or instrumentalities are considered to be investments in U.S.
Government obligations for purposes of the diversification requirements to which
the Funds is subject under the 1940 Act. As a result, more than 5% of a Fund's
total assets may be invested in such refunded bonds issued by a particular
municipal issuer. The escrowed securities securing such refunded municipal bonds
will consist exclusively of U.S. Government obligations, and will be held by an
independent escrow agent or be subject to an irrevocable pledge of the escrow
account to the debt service on the original bonds.
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WHEN-ISSUED SECURITIES. A Fund may purchase securities on a when-issued basis
(i.e., for delivery beyond the normal settlement date at a stated price and
yield). When a Fund agrees to purchase securities on a when issued basis, the
custodian will set aside cash or liquid portfolio securities equal to the amount
of the commitment in a separate account. Normally, the custodian will set aside
portfolio securities to satisfy the purchase commitment, and in such a case, the
Fund may be required subsequently to place additional assets in the separate
account in order to assure that the value of the account remains equal to the
amount of the Fund's commitment. It may be expected that a Fund's net assets
will fluctuate to a greater degree when it sets aside portfolio securities to
cover such purchase commitments than when it sets aside cash. When a Fund
engages in when-issued transactions, it relies on the seller to consummate the
trade. Failure of the seller to do so may result in the Fund incurring a loss or
missing the opportunity to obtain a price considered to be advantageous. The
Funds do not intend to purchase when issued securities for speculative purposes,
but only in furtherance of its investment objective.
DELAYED-DELIVERY TRANSACTIONS. A Fund may buy and sell securities on a
delayed-delivery basis. These transactions involve a commitment by the Fund to
purchase or sell specific securities at a predetermined price or yield, with
payment and delivery taking place after the customary settlement period for that
type of security (and more than seven days in the future). Typically, no
interest accrues to the purchaser until the security is delivered. The Fund may
receive fees for entering into delayed delivery transactions.
When purchasing securities on a delayed-delivery basis, a Fund assumes the
rights and risks of ownership, including the risks of price and yield
fluctuations in addition to the risks associated with the Fund's other
investments. Because a Fund is not required to pay for securities until the
delivery date, these delayed-delivery purchases may result in a form of
leverage. When delayed-delivery purchases are outstanding, the Fund will set
aside cash and appropriate liquid assets in a segregated custodial account to
cover its purchase obligations. When the Fund has sold a security on a
delayed-delivery basis, it does not participate in further gains or losses with
respect to the security. If the other party to a delayed-delivery transaction
fails to deliver or pay for the securities, the Fund could miss a favorable
price or yield opportunity or suffer a loss.
The Fund may renegotiate delayed-delivery transactions after they are entered
into or may sell underlying securities before they are delivered, either of
which may result in capital gains or losses.
MORTGAGE-BACKED SECURITIES--IN GENERAL. Mortgage-Backed Securities are backed by
mortgage obligations including, among others, conventional 30-year fixed rate
mortgage obligations, graduated payment mortgage obligations, 15-year mortgage
obligations, and adjustable-rate mortgage obligations. All of these mortgage
obligations can be used to create pass-through securities. A pass-through
security is created when mortgage obligations are pooled together and undivided
interests in the pool or pools are sold. The cash flow from the mortgage
obligations is passed through to the holders of the securities in the form of
periodic payments of interest, principal, and prepayments (net of a service
fee). Prepayments occur when the holder of an individual mortgage obligation
prepays the remaining principal before the mortgage obligation's scheduled
maturity date. As a result of the pass-through of prepayments of principal on
the underlying securities, Mortgage-Backed Securities are often subject to more
rapid prepayment of principal than their stated maturity indicates. Because the
prepayment characteristics of the underlying mortgage obligations vary, it is
not possible to predict accurately the realized yield or average life of a
particular issue of pass-through certificates. Prepayment rates are important
because of their effect on the yield and price of the securities. Accelerated
prepayments have an adverse impact on yields for pass-throughs purchased at a
premium (i.e., a price in excess of principal amount) and may involve additional
risk of loss of principal because the premium may not have been fully amortized
at the time the obligation is repaid. The opposite is true for pass-throughs
purchased at a discount. A Fund may purchase Mortgage-Backed Securities at a
premium or at a discount. Among the U.S. Government securities in which a Fund
may invest are Government Mortgage-Backed Securities (or government guaranteed
mortgage-related securities). Such guarantees do not extend to the value of
yield of the Mortgage-Backed Securities themselves or of the Fund's shares.
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U.S. GOVERNMENT MORTGAGE-BACKED SECURITIES. Certain obligations of certain
agencies and instrumentalities of the U.S. Government are Mortgage-Backed
Securities. Some such obligations, such as those issued by GNMA are supported by
the full faith and credit of the U.S. Treasury; others, such as those of FNMA,
are supported by the right of the issuer to borrow from the Treasury; others are
supported by the discretionary authority of the U.S. Government to purchase the
agency's obligations; still others, such as those of the Federal Farm Credit
Banks or FHLMC, are supported only by the credit of the instrumentality. No
assurance can be given that the U.S. Government would provide financial support
to U.S. Government-sponsored agencies and instrumentalities if it is not
obligated to do so by law.
The principal governmental (i.e., backed by the full faith and credit of the
U.S. Government) guarantor of Mortgage-Backed Securities is GNMA. GNMA is a
wholly owned U.S. Government corporation within the Department of Housing and
Urban Development. GNMA is authorized to guarantee, with the full faith and
credit of the U.S. Government, the timely payment of principal and interest on
securities issued by institutions approved by GNMA (such as savings and loan
institutions, commercial banks, and mortgage bankers) and pools of FHA-insured
or VA-guaranteed mortgages. Government-related (i.e., not backed by the full
faith and credit of the U.S. Government) guarantors include FNMA and FHLMC. FNMA
and FHLMC are government-sponsored corporations owned entirely by private
stockholders. Pass-through securities issued by FNMA and FHLMC are guaranteed as
to timely payment of principal and interest by FNMA and FHLMC, respectively, but
are not backed by the full faith and credit of the U.S. Government.
GNMA CERTIFICATES. Certificates of the GNMA are mortgage-backed securities which
evidence an undivided interest in a pool or pools of mortgages. GNMA
Certificates that a Fund may purchase are the "modified pass-through" type,
which entitle the holder to receive timely payment of all interest and principal
payments due on the mortgage pool, net of fees paid to the "issuer" and GNMA,
regardless of whether or not the mortgagor actually makes the payment.
The National Housing Act authorizes GNMA to guarantee the timely payment of
principal and interest on securities backed by a pool of mortgages insured by
the Federal Housing Administration ("FHA") or guaranteed by the Veterans
Administration ("VA"). The GNMA guarantee is backed by the full faith and credit
of the U.S. Government. GNMA is also empowered to borrow without limitation from
the U.S. Treasury if necessary to make any payments required under its
guarantee.
The estimated average life of a GNMA Certificate is likely to be substantially
shorter than the original maturity of the mortgages underlying the securities.
Prepayments of principal by mortgagors and mortgage foreclosures usually will
result in the return of the greater part of principal investment long before the
maturity of the mortgages in the pool. Foreclosures impose no risk to principal
investment because of the GNMA guarantee, except to the extent that a Fund has
purchased the certificates above par in the secondary market.
FHLMC SECURITIES. The FHLMC was created in 1970 to promote development of a
nationwide secondary market in conventional residential mortgages. The FHLMC
issues two types of mortgage pass-through securities ("FHLMC Certificates"),
mortgage participation certificates, and collateralized mortgage obligations
("CMOs"). Participation Certificates resemble GNMA Certificates in that each
Participation Certificate represents a pro rata share of all interest and
principal payments made and owed on the underlying pool. The FHLMC guarantees
timely monthly payment of interest on PCs and the ultimate payment of principal.
Recently introduced FHLMC Gold Participation Certificates guarantee the timely
payment of both principal and interest.
FHLMC CMOs are backed by pools of agency mortgage-backed securities and the
timely payment of principal and interest of each tranche is guaranteed by the
FHLMC. The FHLMC guarantee is not backed by the full faith and credit of the
U.S. Government.
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FNMA SECURITIES. The FNMA was established in 1938 to create a secondary market
in mortgages insured by the FHA, but has expanded its activity to the secondary
market for conventional residential mortgages. FNMA primarily issues two types
of mortgage-backed securities, guaranteed mortgage pass-through certificates
("FNMA Certificates") and CMOs. FNMA Certificates resemble GNMA Certificates in
that each FNMA Certificate represents a pro rata share of all interest and
principal payments made and owed on the underlying pool. FNMA guarantees timely
payment of interest and principal on FNMA Certificates and CMOs. The FNMA
guarantee is not backed by the full faith and credit of the U.S. Government.
COLLATERALIZED MORTGAGE OBLIGATIONS. Mortgage-Backed Securities in which a Fund
may invest may also include CMOs. CMOs are securities backed by a pool of
mortgages in which the principal and interest cash flows of the pool are
channeled on a prioritized basis into two or more classes, or tranches, of
bonds.
NON-GOVERNMENTAL MORTGAGE-BACKED SECURITIES. A Fund may invest in
mortgage-related securities issued by non-governmental entities. Commercial
banks, savings and loan institutions, private mortgage insurance companies,
mortgage bankers, and other secondary market issuers also create pass-through
pools of conventional residential mortgage loans. Such issuers also may be the
originators of the underlying mortgage loans as well as the guarantors of the
mortgage-related securities. Pools created by such non-governmental issuers
generally offer a higher rate of interest than government and government-related
pools because there are not direct or indirect government guarantees of payments
in the former pools. However, timely payment of interest and principal of these
pools is supported by various forms of insurance or guarantees, including
individual loan, title, pool, and hazard insurance. The insurance and guarantees
are issued by government entities, private insurers and the mortgage poolers.
Such insurance and guarantees and the creditworthiness of the issuers, thereof
will be considered in determining whether a Non-Governmental Mortgage-Backed
Security meets a Fund's investment quality standards. There can be no assurance
that the private insurers can meet their obligations under the policies. A Fund
may buy NonGovernmental Mortgage-Backed Related Securities without insurance or
guarantees if, through an examination of the loan experience and practices of
the poolers, the Adviser determines that the securities meet the Fund's quality
standards. Although the market for such securities is becoming increasingly
liquid, securities issued by certain private organizations may not be readily
marketable. A Fund will not purchase mortgage-related securities or any other
assets which in the opinion of the Adviser are illiquid if, as a result, more
than 15% of the value of the Fund's net assets will be invested in illiquid
securities.
A Fund may purchase mortgage-related securities with stated maturities in excess
of 10 years. Mortgage-related securities include CMOs and participation
certificates in pools of mortgages. The average life of mortgage-related
securities varies with the maturities of the underlying mortgage instruments,
which have maximum maturities of 40 years. The average life is likely to be
substantially less than the original maturity of the mortgage pools underlying
the securities as the result of mortgage prepayments. The rate of such
prepayments, and hence the average life of the certificates, will be a function
of current market interest rates and current conditions in the relevant housing
markets. The impact of prepayment of mortgages is described under "Government
Mortgage-Backed Securities." Estimated average life will be determined by the
Adviser. Various independent mortgage-related securities dealers publish
estimated average life data using proprietary models, and in making such
determinations, the Adviser will rely on such data except to the extent such
data are deemed unreliable by the Adviser. The Adviser might deem data
unreliable which appeared to present a significantly different estimated average
life for a security than data relating to the estimated average life of
comparable securities as provided by other independent mortgage-related
securities dealers.
ASSET-BACKED SECURITIES. Asset-backed securities are debt securities backed by
pools of automobile or other commercial or consumer finance loans. The
collateral backing asset-backed securities cannot be foreclosed upon. These
issues are normally traded over-the-counter and typically have a short to
intermediate maturity structure, depending on the paydown characteristics of the
underlying financial assets which are passed through to the security holder.
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FUTURES AND OPTIONS
FUTURES CONTRACTS. The Funds may enter into futures contracts, options on
futures contracts, and stock index futures contracts and options thereon for the
purposes of remaining fully invested and reducing transaction costs. Futures
contracts provide for the future sale by one party and purchase by another party
of a specified amount of a specific security, class of securities, or an index
at a specified future time and at a specified price. A stock index futures
contract is a bilateral agreement pursuant to which two parties agree to take or
make delivery of an amount of cash equal to a specified dollar amount times the
difference between the stock index value at the close of trading of the
contracts and the price at which the futures contract is originally struck.
Futures contracts which are standardized as to maturity date and underlying
financial instrument are traded on national futures exchanges. Futures exchanges
and trading are regulated under the Commodity Exchange Act by the Commodity
Futures Trading Commission (the "CFTC"), a U.S. Government agency.
The Funds may enter into contracts for the future delivery of securities and
futures contracts based on a specific security, class of securities or an index,
purchase or sell options on any such futures contracts and engage in related
closing transactions. A futures contract on a securities index is an agreement
obligating either party to pay, and entitling the other party to receive, while
the contract is outstanding, cash payments based on the level of a specified
securities index.
Although futures contracts by their terms call for actual delivery and
acceptance of the underlying securities, in most cases the contracts are closed
out before the settlement date without the making or taking of delivery. Closing
out an open futures position is done by taking an opposite position (buying a
contract which has previously been "sold," or "selling" a contract previously
purchased) in an identical contract to terminate the position. A futures
contract on a securities index is an agreement obligating either party to pay,
and entitling the other party to receive, while the contract is outstanding,
cash payments based on the level of a specified securities index. The
acquisition of put and call options on futures contracts will, respectively,
give a Fund the right (but not the obligation), for a specified price, to sell
or to purchase the underlying futures contract, upon exercise of the option, at
any time during the option period. Brokerage commissions are incurred when a
futures contract is bought or sold.
Futures traders are required to make a good faith margin deposit in cash or
government securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying security)
if it is not terminated prior to the specified delivery date. Minimal initial
margin requirements are established by the futures exchange and may be changed.
Brokers may establish deposit requirements which are higher than the exchange
minimums. Initial margin deposits on futures contracts are customarily set at
levels much lower than the prices at which the underlying securities are
purchased and sold, typically ranging upward from less than 5% of the value of
the contract being traded.
After a futures contract position is opened, the value of the contract is
marked-to-market daily. If the futures contract price changes to the extent that
the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, change in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to and
from the futures broker for as long as the contract remains open. The Funds
expect to earn interest income on its margin deposits.
When interest rates are expected to rise or market values of portfolio
securities are expected to fall, a Fund can seek through the sale of futures
contracts to offset a decline in the value of its portfolio securities. When
interest rates are expected to fall or market values are expected to rise, a
Fund, through the purchase of such contracts, can attempt to secure better rates
or prices for a Fund than might later be available in the market when it effects
anticipated purchases.
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The Funds will only sell futures contracts to protect securities it owns against
price declines or purchase contracts to protect against an increase in the price
of securities it intends to purchase.
The Funds' ability to use futures trading effectively depends on several
factors. First, it is possible that there will not be a perfect price
correlation between a futures contract and its underlying stock index. Second,
it is possible that a lack of liquidity for futures contracts could exist in the
secondary market, resulting in an inability to close a futures position prior to
its maturity date. Third, the purchase of a futures contract involves the risk
that a Fund could lose more than the original margin deposit required to
initiate a futures transaction.
Futures transactions involve brokerage costs and require a Fund to segregate
assets to cover contracts that would require it to purchase securities or
currencies. A Fund may lose the expected benefit of futures transactions if
interest rates, exchange rates or securities prices move in an unanticipated
manner. Such unanticipated changes may also result in poorer overall performance
than if a Fund had not entered into any futures transactions. In addition, the
value of a Fund's futures positions may not prove to be perfectly or even highly
correlated with the value of its portfolio securities, limiting a Fund's ability
to hedge effectively against interest rate and/or market risk and giving rise to
additional risks. There is no assurance of liquidity in the secondary market for
purposes of closing out futures positions.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS. The Funds will not enter into
futures contract transactions for purposes other than bona fide hedging purposes
or as a substitute for the underlying securities to gain market exposure to the
extent that, immediately thereafter, the sum of its initial margin deposits on
open contracts exceeds 5% of the market value of a Fund's total assets. In
addition, a Fund will not enter into futures contracts to the extent that the
value of the futures contracts held would exceed 1/3 of the Fund's total assets.
Futures transactions will be limited to the extent necessary to maintain a
Fund's qualification as a regulated investment company.
The Victory Portfolios have undertaken to restrict their futures contract
trading as follows: first, the Victory Portfolios will not engage in
transactions in futures contracts for speculative purposes; second, the Victory
Portfolios will not market its funds to the public as commodity pools or
otherwise as vehicles for trading in the commodities futures or commodity
options markets; third, the Victory Portfolios will disclose to all prospective
shareholders the purpose of and limitations on its funds' commodity futures
trading; fourth, the Victory Portfolios will submit to the CFTC special calls
for information. Accordingly, registration as a Commodities Pool Operator with
the CFTC is not required.
In addition to the margin restrictions discussed above, transactions in futures
contracts may involve the segregation of funds pursuant to requirements imposed
by the SEC. Under those requirements, where a Fund has a long position in a
futures contract, it may be required to establish a segregated account (not with
a futures commission merchant or broker) containing cash or certain liquid
assets equal to the purchase price of the contract (less any margin on deposit).
For a short position in futures or forward contracts held by the Fund, those
requirements may mandate the establishment of a segregated account (not with a
futures commission merchant or broker) with cash or certain liquid assets that,
when added to the amounts deposited as margin, equal the market value of the
instruments underlying the futures contracts (but are not less than the price at
which the short positions were established). However, segregation of assets is
not required if a Fund "covers" a long position. For example, instead of
segregating assets, a Fund, when holding a long position in a futures contract,
could purchase a put option on the same futures contract with a strike price as
high or higher than the price of the contract held by a Fund. In addition, where
a Fund takes short positions, or engages in sales of call options, it need not
segregate assets if it "covers" these positions. For example, where a Fund holds
a short position in a futures contract, it may cover by owning the instruments
underlying the contract. A Fund may also cover such a position by holding a call
option permitting it to purchase the same futures contract at a price no higher
than the price at which the short position was established. Where a Fund sells a
call option on a futures contract, it may cover either by entering into a long
position in the same contract at a price no higher than the strike price of the
call option or by owning the
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instruments underlying the futures contract. A Fund could also cover this
position by holding a separate call option permitting it to purchase the same
futures contract at a price no higher than the strike price of the call option
sold by a Fund.
In addition, the extent to which a Fund may enter into transactions involving
futures contracts may be limited by the Code's requirements for qualification as
a registered investment company and a Fund's intention to qualify as such.
RISK FACTORS IN FUTURES TRANSACTIONS. Positions in futures contracts may be
closed out only on an exchange which provides a secondary market for such
futures. However, there can be no assurance that a liquid secondary market will
exist for any particular futures contract at any specific time. Thus, it may not
be possible to close a futures position. In the event of adverse price
movements, a Fund would continue to be required to make daily cash payments to
maintain the required margin. In such situations, if a Fund has insufficient
cash, it may have to sell portfolio securities to meet daily margin requirements
at a time when it may be disadvantageous to do so. In addition, a Fund may be
required to make delivery of the instruments underlying futures contracts it
holds. The inability to close options and futures positions also could have an
adverse impact on the ability to effectively hedge them. A Fund will minimize
the risk that they will be unable to close out a futures contract by only
entering into futures contracts which are traded on national futures exchanges
and for which there appears to be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. Because the deposit
requirements in the futures markets are less onerous than margin requirements in
the securities market, there may be increased participation by speculators in
the futures market which may also cause temporary price distortions. A
relatively small price movement in a futures contract may result in immediate
and substantial loss (as well as gain) to the investor. For example, if at the
time of purchase, 10% of the value of the futures contract is deposited as
margin, a subsequent 10% decrease in the value of the futures contract would
result in a total loss of the margin deposit, before any deduction for the
transaction costs, if the account were then closed out. A 15% decrease would
result in a loss equal to 150% of the original margin deposit if the contract
were closed out. Thus, a purchaser or sale of a futures contract may result in
losses in excess of the amount invested in the contract. However, because the
futures strategies engaged in by the Funds are only for hedging purposes, the
Adviser does not believe that the Funds are subject to the risks of loss
frequently associated with futures transactions. The Funds would presumably have
sustained comparable losses if, instead of the futures contract, it had invested
in the underlying financial instrument and sold it after the decline.
Use of futures transactions by the Funds involve the risk of imperfect or no
correlation where the securities underlying futures contract have different
maturities than the portfolio securities being hedged. It is also possible that
the Funds could both lose money on futures contracts and also experience a
decline in value of its portfolio securities. There is also the risk of loss by
the Funds of margin deposits in the event of bankruptcy of a broker with whom
the Funds have open positions in a futures contract or related option.
OPTIONS. The Funds may sell (write) call options which are traded on national
securities exchanges with respect to common stock in its portfolio. A Fund must
at all times have in its portfolio the securities which it may be obligated to
deliver if the option is exercised, except the Special Growth Fund, which may
write uncovered calls, that is, call options on securities that it does not own.
The risk of writing uncovered call options is that the writer of the option may
be forced to acquire the underlying security at a price in excess of the
exercise price of the option, that is, the price at which the writer has agreed
to sell the underlying security to the purchaser of the option. A Fund may write
call options in an attempt to realize a greater level of current income than
would be realized on the securities alone. A Fund may also write call options as
a partial hedge against a possible stock market decline or to extend a holding
period on a stock which is under consideration for sale in order to create a
long-term capital
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gain. In view of their investment objective, a Fund generally would write call
options only in circumstances where the Adviser does not anticipate significant
appreciation of the underlying security in the near future or has otherwise
determined to dispose of the security. As the writer of a call option, a Fund
receives a premium for undertaking the obligation to sell the underlying
security at a fixed price during the option period, if the option is exercised.
So long as a Fund remains obligated as a writer of a call option, it forgoes the
opportunity to profit from increases in the market price of the underlying
security above the exercise price of the option, except insofar as the premium
represents such a profit. A Fund retains the risk of loss should the value of
the underlying security decline. A Fund may also enter into "closing purchase
transactions" in order to terminate its obligation as a writer of a call option
prior to the expiration of the option. Although the writing of call options only
on national securities exchanges increases the likelihood of a Fund's ability to
make closing purchase transactions, there is no assurance that a Fund will be
able to effect such transactions at any particular time or at any acceptable
price. The writing of call options could result in increases in a Fund's
portfolio turnover rate, especially during periods when market prices of the
underlying securities appreciate.
PUTS. A put is a right to sell a specified security (or securities) within a
specified period of time at a specified exercise price. A Fund may sell,
transfer, or assign a put only in conjunction with the sale, transfer, or
assignment of the underlying security or securities. The amount payable to a
Fund upon its exercise of a "put" is normally (i) a Fund's acquisition cost of
the securities (excluding any accrued interest which a Fund paid on the
acquisition), less any amortized market premium or plus any amortized market or
original issue discount during the period a Fund owned the securities, plus (ii)
all interest accrued on the securities since the last interest payment date
during that period.
Puts may be acquired by a Fund to facilitate the liquidity of its portfolio
assets. Puts may also be used to facilitate the reinvestment of a Fund's assets
at a rate of return more favorable than that of the underlying security. Puts
may, under certain circumstances, also be used to shorten the maturity of
underlying variable rate or floating rate securities for purposes of calculating
the remaining maturity of those securities and the dollar-weighted average
portfolio maturity of a Fund's assets. See "Variable and Floating Rate Notes"
and "Valuation" in this SAI.
A Fund generally will acquire puts only where the puts are available without the
payment of any direct or indirect consideration. However, if necessary or
advisable, a Fund may pay for puts either separately in cash or by paying a
higher price for portfolio securities which are acquired subject to the puts
(thus reducing the yield to maturity otherwise available for the same
securities). The Funds intends to enter into puts only with dealers, banks, and
broker-dealers which, in the Adviser's opinion, present minimal credit risks.
The Special Value Fund may write put options from time to time. Such options may
be listed on a national securities exchange and issued by the Options Clearing
Corporation or traded over-the-counter. The Special Growth Fund may seek to
terminate its position in a put option it writes before exercise by closing out
the option in the secondary market at its current price. If the secondary market
is not liquid for a put option the Special Growth Fund has written, however, the
Special Growth Fund must continue to be prepared to pay the strike price while
the option is outstanding, regardless of price changes, and must continue to set
aside assets to cover its position. Upon the exercise of an option, the Fund is
not entitled to the gains, if any, on securities underlying the options. The
Special Growth Fund also may purchase index put and call options and write index
options. Through the writing or purchase of index options, the Special Growth
Fund can achieve many of the same objectives as through the use of options on
individual securities. Utilizing options is a specialized investment technique
that entails a substantial risk of a complete loss of the amounts paid as
premiums to writers of options.
ILLIQUID INVESTMENTS. Illiquid investments are investments that cannot be sold
or disposed of, within seven business days, in the ordinary course of business
at approximately the prices at which they are valued.
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Under the supervision of the Victory Portfolios' Board of Trustees, the Adviser
determines the liquidity of the Funds' investments and, through reports from the
Adviser, the Trustees monitor investments in illiquid instruments. In
determining the liquidity of a Fund's investments, the Adviser may consider
various factors, including (1) the frequency of trades and quotations, (2) the
number of dealers and prospective purchasers in the marketplace, (3) dealer
undertakings to make a market, (4) the nature of the security (including any
demand or tender features), and (5) the nature of the marketplace for trades
(including the ability to assign or offset the Funds' rights and obligations
relating to the investment).
Investments currently considered by a Fund to be illiquid include repurchase
agreements not entitling the holder to payment of principal and interest within
seven days, over the counter options, non-government stripped fixed-rate
mortgage-backed securities, and Restricted Securities.
Also, the Adviser may determine some securities to be illiquid.
However, with respect to over-the-counter options a Fund writes, all or a
portion of the value of the underlying instrument may be illiquid depending on
the assets held to cover the option and the nature and terms of any agreement a
Fund may have to close out the option before expiration.
In the absence of market quotations, illiquid investments are priced at fair
value as determined in good faith by a committee appointed by the Trustees.
If through a change in values, net assets, or other circumstances, a Fund were
in a position where more than 15% of its net assets were invested in illiquid
securities, it would seek to take appropriate steps to protect liquidity.
RESTRICTED SECURITIES. Restricted securities generally can be sold in privately
negotiated transactions, pursuant to an exemption from registration under the
1933 Act, or in a registered public offering.
Where registration is required, a Fund may be obligated to pay all or part of
the registration expense and a considerable period may elapse between the time
it decides to seek registration and the time the Fund may be permitted to sell a
security under an effective registration statement.
If, during such a period, adverse market conditions were to develop, a Fund
might obtain a less favorable price than prevailed when it decided to seek
registration of the shares.
SECURITIES LENDING TRANSACTIONS. The Funds (with the exception of the tax-exempt
funds) may from time to time lend securities from their portfolio to
broker-dealers, banks, financial institutions and institutional borrowers of
securities and receive collateral in the form of cash or U.S. Government
Obligations. Key Trust Company of Ohio, N.A., an affiliate of the Investment
Adviser, serves as lending agent for the Funds, except the tax-exempt funds,
pursuant to a Securities Lending Agency Agreement that was adopted by the
Trustees of the Funds. Under the Funds' current practices (which are subject to
change), a Fund must receive initial collateral equal to 102% of the market
value of the loaned securities, plus any interest due in the form of cash or
U.S. Government Obligations. The Funds will not lend portfolio securities to:
(a) any "affiliated person" (as that term is defined in the 1940 Act)) of any
Fund; (b) any affiliated person of the Investment Adviser; or (c) any affiliated
person of such an affiliated person. This collateral must be valued daily and
should the market value of the loaned securities increase, the borrower must
furnish additional collateral to a Fund sufficient to maintain the value of the
collateral equal to at least 100% of the value of the loaned securities. During
the time portfolio securities are on loan, the borrower will pay the Fund any
dividends or interest paid on such securities plus any interest negotiated
between the parties to the lending agreement. Loans will be subject to
termination by the Funds or the borrower at any time. While a Fund will not have
the right to vote securities on loan, they intend to terminate loans and regain
the right to vote if that is considered important with respect to the
investment. A Fund will only enter into loan arrangements
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with broker-dealers, banks or other institutions which the Adviser has
determined are creditworthy under guidelines established by the Trustees. The
Funds will limit their securities lending to 33 1/3% of total assets.
SHORT SALES AGAINST-THE-BOX. The Funds will not make short sales of securities,
other than short sales "against-the-box." In a short sale against-the-box, a
Fund sells a security that it owns, or a security equivalent in kind and amount
to the security sold short that the Fund has the right to obtain, for delivery
at a specified date in the future. A Fund will enter into short sales
against-the-box to hedge against unanticipated declines in the market price of
portfolio securities or to defer an unrealized gain. If the value of the
securities sold short increases prior to the scheduled delivery date, a Fund
loses the opportunity to participate in the gain. Any gains realized by a Fund
on such sales will be recognized at the time the Fund enters into the short
sale.
INVESTMENT GRADE AND HIGH QUALITY SECURITIES. The Funds may invest in
"investment grade" obligations, which are those rated at the time of purchase
within the four highest rating categories assigned by an NRSRO or, if unrated,
are obligations that the Adviser determines to be of comparable quality. The
applicable securities ratings are described in the Appendix. "High-quality"
short-term obligations are those obligations which, at the time of purchase, (1)
possess a rating in one of the two highest ratings categories from at least one
NRSRO (for example, commercial paper rated "A-1" or "A-2" by S&P or "P-1" or
"P-2" by Moody's) or (2) are unrated by an NRSRO but are determined by the
Adviser to present minimal credit risks and to be of comparable quality to rated
instruments eligible for purchase by the Funds under guidelines adopted by the
Board of Trustees.
PARTICIPATION INTERESTS. The Funds may purchase interests in securities from
financial institutions such as commercial and investment banks, savings and loan
associations and insurance companies. These interests may take the form of
participation, beneficial interests in a trust, partnership interests or any
other form of indirect ownership. The Funds invest in these participation
interests, in order to obtain credit enhancement or demand features that would
not be available through direct ownership of the underlying securities.
WARRANTS. Warrants are securities that give a Fund the right to purchase equity
securities from the issuer at a specific price (the strike price) for a limited
period of time. The strike price of warrants typically is much lower than the
current market price of the underlying securities, yet they are subject to
greater price fluctuations. As a result, warrants may be more volatile
investments than the underlying securities and may offer greater potential for
capital appreciation as well as capital loss.
REFUNDING CONTRACTS. A Fund generally will not be obligated to pay the full
purchase price if it fails to perform under a refunding contract. Instead,
refunding contracts generally provide for payment of liquidated damages to the
issuer (currently 15-20% of the purchase price). A Fund may secure its
obligations under a refunding contract by depositing collateral or a letter of
credit equal to the liquidated damages provisions of the refunding contract.
When required by SEC guidelines, a Fund will place liquid assets in a segregated
custodial account equal in amount to its obligations under refunding contracts.
STANDBY COMMITMENTS. A Fund may enter into standby commitments, which are puts
that entitle holders to same-day settlement at an exercise price equal to the
amortized cost of the underlying security plus accrued interest, if any, at the
time of exercise. The Funds may acquire standby commitments to enhance the
liquidity of portfolio securities.
Ordinarily, the Funds may not transfer a standby commitment to a third party,
although they could sell the underlying municipal security to a third party at
any time. The Funds may purchase standby commitments separate from or in
conjunction with the purchase of securities subject to such commitments. In the
latter case, the Funds would pay a higher price for the securities acquired,
thus reducing their yield to maturity.
Standby commitments are subject to certain risks, including the ability of
issuers of standby commitments to pay for securities at the time the commitments
are exercised; the fact that standby commitments are not marketable by
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the Funds; and the possibility that the maturities of the underlying securities
may be different from those of the commitments.
FOREIGN INVESTMENTS. A Fund may invest in securities issued by foreign branches
of U.S. banks, foreign banks, or other foreign issuers, including sponsored and
unsponsored American Depository Receipts ("ADRs") and securities purchased on
foreign securities exchanges. Such investment may subject the Fund to
significant investment risks that are different from, and additional to, those
related to investments in obligations of U.S. domestic issuers or in U.S.
securities markets. Unsponsored ADRs may involve additional risks.
The value of securities denominated in or indexed to foreign currencies, and of
dividends and interest from such securities, can change significantly when
foreign currencies strengthen or weaken relative to the U.S. dollar. Foreign
securities markets generally have less trading volume and less liquidity than
U.S. markets, and prices on some foreign markets can be highly volatile. Many
foreign countries lack uniform accounting and disclosure standards comparable to
those applicable to U.S. companies, and it may be more difficult to obtain
reliable information regarding an issuer's financial condition and operations.
In addition, the costs of foreign investing, including withholding taxes,
brokerage commissions, and custodial costs, are generally higher than for U.S.
investments.
Foreign markets may offer less protection to investors than U.S. markets.
Foreign issuers, brokers, and securities markets may be subject to less
government supervision. Foreign security trading practices, including those
involving the release of assets in advance of payment, may involve increased
risks in the event of a failed trade or the insolvency of a broker-dealer, and
may involve substantial delays. It may also be difficult to enforce legal rights
in foreign countries.
Investing abroad also involves different political and economic risks. Foreign
investments may be affected by actions of foreign governments adverse to the
interests of U.S. investors, including the possibility of expropriation or
nationalization of assets, confiscatory taxation, restrictions on U.S.
investment or on the ability to repatriate assets or convert currency into U.S.
dollars, or other government intervention. There may be a greater possibility of
default by foreign governments or foreign government-sponsored enterprises.
Investments in foreign countries also involve a risk of local political,
economic, or social instability, military action or unrest, or adverse
diplomatic developments. There is no assurance that the Advisers will be able to
anticipate these potential events or counter their effects.
The considerations noted above generally are intensified for investments in
developing countries. Developing countries may have relatively unstable
governments, economies based on only a few industries, and securities markets
that trade a small number of securities.
A Fund may invest in foreign securities that impose restrictions on transfer
within the U.S. or to U.S. persons. Although securities subject to transfer
restrictions may be marketable abroad, they may be less liquid than foreign
securities of the same class that are not subject to such restrictions.
The International Growth Fund currently invests in the securities of issuers
based in a number of foreign countries. The Adviser continuously evaluates
issuers based in countries all over the world. Accordingly, the Fund may invest
in the securities of issuers based in any country, subject to approval by the
Trustees, when such securities met the investment criteria of the Adviser and
are consistent with the investment objectives and policies of the Fund.
MISCELLANEOUS SECURITIES. The Funds can invest in various securities issued by
domestic and foreign corporations, including preferred stocks and investment
grade corporate bonds, notes, and warrants. Bonds are long-term corporate debt
instruments secured by some or all of the issuer's assets, debentures are
general corporate debt obligations backed only by the integrity of the borrower,
and warrants are instruments that entitle the holder to
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purchase a certain amount of common stock at a specified price, which price is
usually higher than the current market price at the time of issuance. Preferred
stocks are instruments that combine qualities both of equity and debt
securities. Individual issues of preferred stock will have those rights and
liabilities that are spelled out in the governing document. Preferred stocks
usually pay a fixed dividend per quarter (or annum) and are senior to common
stock in terms of liquidation and dividends rights, and preferred stocks
typically do not have voting rights.
ADDITIONAL INFORMATION CONCERNING OHIO ISSUERS
The Ohio Municipal Bond Fund and Ohio Municipal Money Market Fund will invest
most of their net assets in securities issued by or on behalf of (or in
certificates of participation in lease-purchase obligations of) the State of
Ohio, political subdivisions of the State, or agencies or instrumentalities of
the State or its political subdivisions ("Ohio Obligations"). The Ohio Municipal
Bond Fund and Ohio Municipal Money Market Fund are therefore susceptible to
general or particular economic, political or regulatory factors that may affect
issuers of Ohio Obligations. The following information constitutes only a brief
summary of some of the many complex factors that may have an effect on the
performance of the Funds. The information does not apply to "conduit"
obligations on which the public issuer itself has no financial responsibility.
This information is derived from official statements of certain Ohio issuers
published in connection with their issuance of securities and from other
publicly available information, and is believed to be accurate. No independent
verification has been made of any of the following information.
Generally, the creditworthiness of Ohio Obligations of local issuers is
unrelated to that of obligations of the State itself, and the State has no
responsibility to make payments on those local obligations.
There may be specific factors that at particular times apply in connection with
investment in particular Ohio Obligations or in those obligations of particular
Ohio issuers. It is possible that the investment may be in particular Ohio
Obligations, or in those of particular issuers, as to which those factors apply.
However, the information below is intended only as a general summary, and is not
intended as a discussion of any specific factors that may affect any particular
obligation or issuer.
Ohio is the seventh most populous state. The 1990 Census count of 10,847,000
indicated a 0.5% population increase from 1980. The Census estimate for 1996 is
11,173,000.
While diversifying more into the service and other non-manufacturing areas, the
Ohio economy continues to rely in part on durable goods manufacturing largely
concentrated in motor vehicles and equipment, steel, rubber products and
household appliances. As a result, general economic activity, as in many other
industrially-developed states, tends to be more cyclical than in some other
states and in the nation as a whole. Agriculture is an important segment of the
economy, with over half the State's area devoted to farming and approximately
16% of total employment in agribusiness.
In prior years, the State's overall unemployment rate was commonly somewhat
higher than the national figure. For example, the reported 1990 average monthly
State rate was 5.7%, compared to the 5.5% national figure. However, for the last
six years, the State rates were below the national rates (4.9% versus 5.4% in
1996). The unemployment rate and its effects vary among geographic areas of the
State.
There can be no assurance that future national, regional or state-wide economic
difficulties, and the resulting impact on State or local government finances
generally, will not adversely affect the market value of Ohio Obligations held
in the Ohio Municipal Bond Fund and Ohio Municipal Money Market Fund or the
ability of particular obligors to make timely payments of debt service on (or
lease payments relating to) those Obligations.
The State operates on the basis of a fiscal biennium for its appropriations and
expenditures, and is precluded by law from ending its July 1 to June 30 fiscal
year ("FY") or fiscal biennium in a deficit position. Most State operations are
financed through the General Revenue Fund ("GRF"), for which the personal income
and sales-use taxes are the major sources. Growth and depletion of GRF ending
fund balances show a consistent pattern related to national economic conditions,
with the ending FY balance reduced during less favorable and increased during
more favorable economic periods. The State has well-established procedures for,
and has timely taken, necessary actions to ensure resource/expenditure balances
during less favorable economic periods. Those procedures included general and
selected reductions in appropriations spending.
The 1992-93 biennium presented significant challenges to State finances,
successfully addressed. To allow time to resolve certain budget differences an
interim appropriations act was enacted effective July 1, 1991; it included GRF
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debt service and lease rental appropriations for the entire biennium, while
continuing most other appropriations for a month. Pursuant to the general
appropriations act for the entire biennium, passed on July 11, 1991, $200
million was transferred from the Budget Stabilization Fund ("BSF," a cash and
budgetary management fund) to the GRF in FY 1992.
Based on updated results and forecasts in the course of that FY, both in light
of a continuing uncertain nationwide economic situation, there was projected and
then timely addressed an FY 1992 imbalance in GRF resources and expenditures. In
response, the Governor ordered most State agencies to reduce GRF spending in the
last six months of FY 1992 by a total of approximately $184 million; the $100.4
million BSF balance and additional amounts from certain other funds were
transferred late in the FY to the GRF, and adjustments were made in the timing
of certain tax payments.
A significant GRF shortfall (approximately $520 million) was then projected for
FY 1993. It was addressed by appropriate legislative and administrative actions,
including the Governor's ordering $300 million in selected GRF spending
reductions and subsequent executive and legislative action (a combination of tax
revisions and additional spending reductions). The June 30, 1993 ending GRF fund
balance was approximately $111 million, of which, as a first step to
replenishment, $21 million was deposited in the BSF.
None of the spending reductions were applied to appropriations needed for debt
service or lease rentals relating to any State obligations.
The 1994-95 biennium presented a more affirmative financial picture. Based on
June 30, 1994 balances, an additional $260 million was deposited in the BSF. The
biennium ended June 30, 1995 with a GRF ending fund balance of $928 million, of
which $535.2 million was transferred into the BSF. The significant GRF fund
balance, after leaving in the GRF an unreserved and undesignated balance of $70
million, was transferred to the BSF and other funds including school assistance
funds and, in anticipation of possible federal program changes, a human services
stabilization fund.
From a higher than forecast 1996-97 mid-biennium GRF fund balance, $100 million
was transferred for elementary and secondary school computer network purposes
and $30 million to a new State transportation infrastructure fund. Approximately
$400.8 million served as a basis for temporary 1996 personal income tax
reductions aggregating that amount. The 1996-97 biennium-ending GRF fund balance
was $834.9 million. Of that, $250 million goes to school building construction
and renovation, $94 million to the school computer network, $44.2 million for
school textbooks and instructional materials and a distance learning program,
and $34 million to the BSF (which had a February 6, 1998 balance of $862.7
million), with the $263 million balance to a State income tax reduction fund.
The GRF appropriations act for the 1997-98 biennium was passed on June 25, 1997
and promptly signed (after selective vetoes) by the Governor. All necessary GRF
appropriations for State debt service and lease rental payments then projected
for the biennium were included in that act. Recently passed (but, as of February
16, not yet acted on by the Governor) legislation increases the fiscal year 1999
GRF appropriate on level for elementary and secondary education, with the
increase to be funded in part by mandated small percentage reductions in State
appropriations for various State agencies and institutions. Expressly exempt
from those reductions are all appropriations for debt service, including lease
rental payments.
The State's incurrence or assumption of debt without a vote of the people is,
with limited exceptions, prohibited by current State constitutional provisions.
The State may incur debt, limited in amount to $750,000, to cover casual
deficits or failures in revenues or to meet expenses not otherwise provided for.
The Constitution expressly precludes the State from assuming the debts of any
local government or corporation. (An exception is made in both cases for any
debt incurred to repel invasion, suppress insurrection or defend the State in
war.)
By 14 constitutional amendments approved from 1921 to date (the latest adopted
in 1995) Ohio voters authorized the incurrence of State debt and the pledge of
taxes or excises to its payment. At February 6, 1998, $1.07 billion (excluding
certain highway bonds payable primarily from highway use receipts) of this debt
was outstanding or sold
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and awaiting delivery. The only such State debt at that date still authorized to
be incurred were portions of the highway bonds, and the following: (a) up to
$100 million of obligations for coal research and development may be outstanding
at any one time ($30.9 million outstanding); (b) $240 million of obligations
previously authorized for local infrastructure improvements, no more than $120
million of which may be issued in any calendar year ($946.9 million outstanding
or sold and awaiting delivery), and (c) up to $200 million in general obligation
bonds for parks, recreation and natural resources purposes which may be
outstanding at any one time ($90.9 million outstanding, with no more than $50
million to be issued in any one year).
The electors in 1995 approved a constitutional amendment extending the local
infrastructure bond program (authorizing an additional $1.2 billion of State
full faith and credit obligations to be issued over 10 years for the purpose),
and authorizing additional highway bonds (expected to be payable primarily from
highway use receipts). The latter supersedes the prior $500 million outstanding
authorization, and authorizes not more than $1.2 billion to be outstanding at
any time and not more than $220 million to be issued in a fiscal year.
The Constitution also authorizes the issuance of State obligations for certain
purposes, the owners of which do not have the right to have excises or taxes
levied to pay debt service. Those special obligations include obligations issued
by the Ohio Public Facilities Commission and the Ohio Building Authority, and
certain obligations issued by the State Treasurer, over $4.9 billion of which
were outstanding or sold and awaiting delivery at February 6, 1998.
A 1990 constitutional amendment authorizes greater State and political
subdivision participation (including financing) in the provision of housing. The
General Assembly may for that purpose authorize the issuance of State
obligations secured by a pledge of all or such portion as it authorizes of State
revenues or receipts (but not by a pledge of the State's full faith and credit).
A 1994 constitutional amendment pledges the full faith and credit and taxing
power of the State to meeting certain guarantees under the State's tuition
credit program which provides for purchase of tuition credits, for the benefit
of State residents, guaranteed to cover a specified amount when applied to the
cost of higher education tuition. (A 1965 constitutional provision that
authorized student loan guarantees payable from available State moneys has never
been implemented, apart from a "guarantee fund" approach funded essentially from
program revenues.)
The General Assembly has placed on the May 1998 primary election ballot a
proposed constitutional amendment dealing with State debt. If approved by
voters, it will authorize State general obligation debt to pay costs of
facilities for a system of common schools throughout the State and for state
supported and assisted institutions of higher education. That and other debt
represented by direct obligations of the State (such as that authorized by the
OPFC and OBA) could not be issued if future fiscal year total debt service on
those obligations to be paid from the GRF or net lottery proceeds exceeds 5% of
total State expenditures from the GRF and net lottery proceeds during the then
preceding fiscal year.
State and local agencies issue obligations that are payable from revenues from
or relating to certain facilities (but not from taxes). By judicial
interpretation, these obligations are not "debt" within constitutional
provisions. In general, payment obligations under lease-purchase agreements of
Ohio public agencies (in which certificates of participation may be issued) are
limited in duration to the agency's fiscal period, and are renewable only upon
appropriations being made available for the subsequent fiscal period.
Local school districts in Ohio receive a major portion (state-wide aggregate
approximately 44% in recent years) of their operating moneys from State
subsidies, but are dependent on local property taxes, and in 119 districts from
voter-authorized income taxes, for significant portions of their budgets.
Litigation, similar to that in other states, has been pending questioning the
constitutionality of Ohio's system of school funding. The Ohio Supreme Court has
concluded that aspects of the system (including basic operating assistance and
the loan program referred to below) are unconstitutional, and ordered the State
to provide for and fund a system complying with the Ohio Constitution, staying
its order for a year (to March 1998) to permit time for responsive corrective
actions, some of which to February 16, 1998 are above mentioned. A small number
of the State's 612 local school districts have
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in any year required special assistance to avoid year-end deficits. A program
has provided for school district cash need borrowing directly from commercial
lenders, with diversion of State subsidy distributions to repayment if needed.
Recent borrowings under this program totalled $41.1 million for 28 districts in
FY 1994, $71.1 million for 29 districts in FY 1995 (including $29.5 million for
one), $87.2 million for 20 districts in FY 1996 (including $42.1 million for
one), and $113.2 million for 12 districts in 1997 (including $90 million to one
for restructuring its prior loans).
Ohio's 943 incorporated cities and villages rely primarily on property and
municipal income taxes for their operations. With other subdivisions, they also
receive local government support and property tax relief moneys distributed by
the State.
For those few municipalities and school districts that on occasion have faced
significant financial problems, there are statutory procedures for a joint
State/local commission to monitor the fiscal affairs and for development of a
financial plan to eliminate deficits and cure any defaults. (Similar procedures
have recently been extended to counties and townships.) Since inception for
municipalities in 1979, these "fiscal emergency" procedures have been applied to
24 cities and villages; for 18 of them the fiscal situation was resolved and the
procedures terminated (one village is in preliminary "fiscal watch" status). As
of February 6, 1998, the 1996 school district "fiscal emergency" provision was
applied to four districts, and 12 were on preliminary "fiscal watch" status.
At present the State itself does not levy ad valorem taxes on real or tangible
personal property. Those taxes are levied by political subdivisions and other
local taxing districts. The Constitution has since 1934 limited to 1% of true
value in money the amount of the aggregate levy (including a levy for unvoted
general obligations) of property taxes by all overlapping subdivisions, without
a vote of the electors or a municipal charmer provision, and statutes limit the
amount of that aggregate levy to 10 mills per $1 of assessed valuation (commonly
referred to as the "ten- mill limitation"). Voted general obligations of
subdivisions are payable from property taxes that are unlimited as to amount or
rate.
Additional Information Concerning New York Issuers
The New York Tax-Free Fund will invest substantially all of its assets in New
York municipal securities. In addition, the specific New York municipal
securities in which the New York Tax-Free Fund will invest will change from time
to time. The New York Tax-Free Fund is therefore susceptible to political,
economic, regulatory or other factors affecting issuers of New York municipal
securities. The following information constitutes only a brief summary of a
number of the complex factors which may affect issuers of New York municipal
securities and does not purport to be a complete or exhaustive description of
all adverse conditions to which issuers of New York municipal securities may be
subject. Such information is derived from official statements utilized in
connection with the issuance of New York municipal securities, as well as from
other publicly available documents. Such information has not been independently
verified by the New York Tax-Free Fund, and the New York Tax-Free Fund assumes
no responsibility for the completeness or accuracy of such information.
Additionally, many factors, including national, economic, social and
environmental policies and conditions, which are not within the control of such
issuers, could have a material adverse impact on the financial condition of such
issuers. The New York Tax- Free Fund cannot predict whether or to what extent
such factors or other factors may affect the issuers of New York municipal
securities, the market value or marketability of such securities or the ability
of the respective issuers of such securities acquired by the Fund to pay
interest on or principal of such securities. The creditworthiness of obligations
issued by local New York issuers may be unrelated to the creditworthiness of
obligations issued by the State of New York, and there is no responsibility on
the part of the State of New York to make payments on such local obligations.
There may be specific factors that are applicable in connection with investment
in the obligations of particular issuers located within New York, and it is
possible the Fund will invest in obligations of particular issuers as to which
such specific factors are applicable. However, the information set forth below
is intended only as a general summary and not as a discussion of any specific
factors that may affect any particular issuer of New York municipal securities.
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The New York Tax-Free Fund may invest in municipal securities issued by New York
State (the "State"), by its various public bodies (the "Agencies") and/or by
other entities located within the State, including the City of New York (the
"City") and political subdivisions thereof and/or their agencies.
NEW YORK STATE. The State's current fiscal year commenced on April 1, 1997, and
ends on March 31, 1998, and is referred to herein as the State's 1997-98 fiscal
year. The State's budget for the 1997-98 fiscal year was adopted by the
Legislature on August 4, 1997, more than four months after the start of the
fiscal year. Prior to adoption of the budget, the Legislature enacted
appropriations for disbursements considered to be necessary for State operations
and other purposes, including necessary appropriations for State-supported debt
service. The State Financial Plan for the 1997-98 fiscal year was formulated on
August 11, 1997 and is based on the State's budget as enacted by the
Legislature, as well as actual results for the first quarter of the current
fiscal year. The 1997-98 State Financial Plan is expected to be updated in
October and January.
The adopted 1997-98 budget projects an increase in General Fund disbursements of
$1.7 billion or 5.2 percent over 1996-97 levels. The average annual growth rate
over the last three fiscal years is approximately 1.2 percent. State Funds
disbursements (excluding federal grants) are projected to increase by 5.4
percent from the 1996-97 fiscal year. All Governmental Funds projected
disbursements increase by 7.0 percent over the 1996-97 fiscal year.
The 1997-98 State Financial Plan is projected to be balanced on a cash basis.
The Financial Plan projections include a reserve for future needs of $530
million. As compared to the Governor's Executive Budget as amended in February
1997, the State's adopted budget for 1997-98 increases General Fund spending by
$1.7 billion, primarily from increases for local assistance ($1.3 billion).
Resources used to fund these additional expenditures include increased revenues
projected for the 1997-98 fiscal year, increased resources produced in the
1996-97 fiscal year that will be utilized in 1997-98, reestimates of social
service, fringe benefit and other spending, and certain non-recurring resources.
Total non-recurring resources included in the 1997-98 Financial Plan are
projected by DOB to be $270 million, or 0.7 percent of total General Fund
receipts.
The 1997-98 adopted budget includes multi-year tax reductions, including a State
funded property and local income tax reduction program, estate tax relief,
utility gross receipts tax reductions, permanent reductions in the State sales
tax on clothing, and elimination of assessments on medical providers. These
reductions are intended to reduce the overall level of State and local taxes in
New York and to improve the State's competitive position vis-a-vis other states.
The various elements of the State and local tax and assessment reductions have
little or no impact on the 1997-98 Financial Plan, and do not begin to
materially affect the out year projections until the State's 1999-2000 fiscal
year. The adopted 1997-98 budget also makes significant investments in
education, and proposes a new $2.4 billion general obligation bond proposal for
school facilities to be submitted to the voters in November 1997.
The 1997-98 Financial Plan also includes: a projected General Fund reserve of
$530 million; a projected balance of $332 million in the Tax Stabilization
Reserve Fund; and a projected $65 million balance in the Contingency Reserve
Fund.
The projections do not include any subsequent actions that the Governor may take
to exercise his line item veto (or vetoing any companion legislation) before
signing the 1997-98 budget appropriation bills into law. Under the Constitution,
the Governor may veto any additions to the Executive Budget within 10 days after
the submission of appropriation bills for his approval. If the Governor were to
take such action, the resulting impact on the Financial Plan would be positive.
The economic and financial condition of the State may be affected by various
financial, social, economic and political factors. Those factors can be very
complex, may vary from fiscal year to fiscal year, and are frequently the result
of actions taken not only by the State and its agencies and instrumentalities,
but also by entities, such as the federal government, that are not under the
control of the State. In addition, the State Financial Plan is based upon
forecasts of national and State economic activity. Economic forecasts have
frequently failed to predict accurately the timing and magnitude of changes in
the national and the State economies'. The Division of Budget believes that its
projections of receipts and disbursements relating to the current State
Financial Plan, and the
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assumptions on which they are based, are reasonable. Actual results, however,
could differ materially and adversely from the projections set forth in this
Annual Information Statement, and those projections may be changed materially
and adversely from time to time. See the section entitled "Special
Considerations" below for a discussion of risks and uncertainties faced by the
State.
1997-98 STATE FINANCIAL PLAN. The four governmental fund types that comprise the
State Financial Plan are the General Fund, the Special Revenue Funds, the
Capital Projects Funds, and the Debt Service Funds. This fund structure adheres
to accounting standards of the Governmental Accounting Standards Board. This
section discusses first the General Fund and then the other governmental funds.
Receipts and disbursements trends are presented in tabular form for each
component of the General Fund.
GENERAL FUND. The General Fund is the principal operating fund of the State and
is used to account for all financial transactions, except those required to be
accounted for in another fund. It is the State's largest fund and receives
almost all State taxes and other resources not dedicated to particular purposes.
In the State's 1997-98 fiscal year, the General Fund is expected to account for
approximately 48 percent of total Governmental Funds disbursements and 71
percent of total State Funds disbursements. General Fund moneys are also
transferred to other funds, primarily to support certain capital projects and
debt service payments in other fund types.
Total General Fund receipts and transfers from other funds are projected to be
$35.09 billion, an increase of $2.05 billion from the 1996-97 fiscal year.
General Fund receipts are projected as follows: Personal Income Tax 53.8 %, User
Taxes and Fees 20.0%, Business Taxes 13.8%, Other Taxes 2.8%, Miscellaneous
Receipts/Other 9.7%. Total General Fund disbursements and transfers to other
funds are projected to be $34.60 billion, an increase of $1.70 billion from the
1996-97 fiscal year. General Fund disbursements are projected as follows: Local
Assistance 68.3%, State Operations 18%, Debt Service 6%, General State Charges
6.3%, Capital/Other 1.4%.
Projected General Fund Receipts
Total General Fund receipts and transfers from other funds in the 1997-98 fiscal
year are projected to be $35.09 billion, an increase of over $2 billion or
roughly 6 percent from the $33.04 billion recorded in the 1996-97 fiscal year.
This total includes $31.68 billion in tax receipts, $1.48 billion in
miscellaneous receipts, and $1.94 billion in transfers from other funds.
The projected $2 billion increase in receipts exaggerates the underlying
year-to-year growth in State tax revenues. This increase is largely the result
of actions undertaken by the State to utilize the $1.4 billion 199697 budget
surplus reported by DOB to finance costs in the State's 1997-98 fiscal year.
This transaction reduced reported receipts in the 1996-97 fiscal year and
increased projected receipts in the State's 1997-98 fiscal year. Conversely, the
incremental cost of tax reductions newly effective in 1997-98 and the impact of
new earmarking statutes which divert receipts from the General Fund to other
funds work to depress apparent growth below the underlying growth in the
receipts base attributable to expansion of the State's economy. After adjusting
for these actions, tax receipts are projected to grow by approximately 5 percent
in 1997-98.
The discussion below summarizes the State's projections of General Fund tax
revenues and other receipts for the 1997-98 fiscal year.
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PERSONAL INCOME TAX
($ MILLIONS)
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1994-95 1995-96 1996-97 1997-98 (PROJ.)
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$17,590 $16,998 $16,371 $18,865
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The Personal Income Tax is imposed on the income of individuals, estates and
trusts and is based on federal definitions of income and deductions with certain
modifications. In 1995, the State enacted a tax reduction program
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designed to reduce receipts from the personal income tax by 20 percent over
three years. The maximum rate was reduced from the 7.875 percent rate in effect
in taxable year 1994 to 6.85 percent for taxable year 1997 and thereafter. For
the 1997-98 fiscal year, this tax-reduction program is estimated to reduce
receipts by approximately $4 billion, compared to what tax receipts would have
been under the pre 1995 rate structure. On a current law basis, 1997 income tax
liability is expected to fall slightly, reflecting the tax cut. On a constant
law basis, liability growth during taxable year 1997 would be between 6 and 7
percent.
Net personal income tax collections are projected to reach $18.87 billion, over
half of all General Fund receipts and $2.5 billion above the reported 1996-97
fiscal year total. Virtually all of the projected annual growth in this
category, however, is provided by tax refund and refund reserve transactions
which affect reported receipts levels in the 1995-96 through 1997-98 fiscal
years. Without these transactions between years, income tax receipts in 1997- 98
would be virtually flat.
- -------------------------------------------------------------------------------
USER TAXES AND FEES
($ MILLIONS)
- -------------------------------------------------------------------------------
1994-95 1995-96 1996-97 1997-98 (PROJ.)
- -------------------------------------------------------------------------------
$6,624 $6,631 $6,800 $7,004
- -------------------------------------------------------------------------------
User taxes and fees are comprised of three-quarters of the State four percent
sales and use tax (the balance, one percent, flows to support Local Government
Assistance Corporation ("LGAC") debt service requirements), cigarette, alcoholic
beverage container, and auto rental taxes, and a portion of the motor fuel
excise levies. Also included in this category are receipts from the motor
vehicle registration fees and alcoholic beverage license fees. A portion of the
motor fuel tax and motor vehicle registration fees and all of the highway use
tax are earmarked for dedicated transportation funds.
Receipts from user taxes and fees are projected to total $7 billion in the
1997-98 fiscal year, an increase of $204 million from reported collections in
the prior year. The sales tax component of this category accounts for all of the
projected 1997-98 growth in this category, as receipts from all other sources
are projected to decline by $3 million. The yield of most of the excise taxes in
this category show a long-term declining trend, particularly cigarette and
alcoholic beverage taxes. These declines in the 1997-98 fiscal year are
projected to be offset by an increase in anticipated motor vehicle fees arising,
in large part, from legislative actions that raise additional receipts from this
source.
- -------------------------------------------------------------------------------
BUSINESS TAXES
($ MILLIONS)
- -------------------------------------------------------------------------------
1994-95 1995-96 1996-97 1997-98 (PROJ.)
- -------------------------------------------------------------------------------
$5,069 $4,908 $5,078 $4,825
- -------------------------------------------------------------------------------
Business taxes include franchise taxes based generally on net income of general
business, bank and insurance corporations, as well as gross-receipts-based taxes
on utilities and gallonage-based petroleum business taxes. Beginning in 1994, a
15 percent surcharge on these levies began to be phased out and, for most
taxpayers, there will be no surcharge liability for taxable periods ending in
1997 and thereafter.
Total business tax collections in 1997-98 are now projected to be $4.83 billion,
$253 million less than received in the prior fiscal year. The year-over-year
decline in projected receipts in this category is a function of both statutory
changes between the two years - 1997 is the first "surcharge free" taxable
period in this decade - and a number of essentially one-time transactions that
increased receipts in the base year, including unusually large audit receipts
under the bank tax.
- -------------------------------------------------------------------------------
OTHER TAXES
($ MILLIONS)
- -------------------------------------------------------------------------------
1994-95 1995-96 1996-97 1997-98 (PROJ.)
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- -------------------------------------------------------------------------------
$1,108 $1,099 $1,081 $982
- -------------------------------------------------------------------------------
Other taxes include estate, gift and real estate transfer taxes, a tax on gains
from the sale or transfer of certain real estate (this tax was repealed in
1996), a pari-mutuel tax and other minor levies. This is the first fiscal year
that real estate transfer tax receipts have been diverted from the General Fund
to the Clean Water/Clean Air Fund to provide debt service coverage for general
obligation bonds.
Total receipts from this category in the State's 1997-98 fiscal year are
projected to total $982 million, nearly $100 million below last year's amount.
This figure masks the significant increase in estate tax collections during the
first four months of the fiscal year, and results largely from the dedication of
the proceeds of the real estate transfer tax to meet debt service obligations on
the new Clean Water/Clean Air bond act and from the full-year impact of the
repeal of the real property gains tax.
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MISC. RECEIPTS
($ MILLIONS)
- -------------------------------------------------------------------------------
1994-95 1995-96 1996-97 1997-98 (PROJ.)
- -------------------------------------------------------------------------------
$1,261 $1,420 $2,072 $1,482
- -------------------------------------------------------------------------------
Miscellaneous receipts include investment income, abandoned property receipts,
medical provider assessments, minor federal grants, receipts from public
authorities, and certain other license and fee revenues. Total miscellaneous
receipts are projected to reach $1.48 billion, down almost $600 million from the
prior year. The reduction reflects a significant diminution in the amount of
nonrecurring resources used in the 1997-98 Financial Plan as compared to
1996-97.
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TRANSFERS FROM OTHER FUNDS
($ MILLIONS)
- -------------------------------------------------------------------------------
1994-95 1995-96 1996-97 1997-98 (PROJ.)
- -------------------------------------------------------------------------------
$1,506 $1,680 $1,641 $1,936
- -------------------------------------------------------------------------------
Transfers from other funds to the General Fund consist primarily of tax revenues
in excess of debt service requirements, particularly the one percent sales tax
used to support payments to LGAC. In the 1997-98 fiscal year, tax revenues
transferred in support of debt service are projected to be $1.48 billion, or $58
million more than in the 1996-97 fiscal year. All other transfers are projected
to increase by $237 million, primarily reflecting the nonrecurring transfer of
$200 million for retroactive reimbursement to the State of certain social
services claims from the federal government.
Projectional General Fund Disbursements
General Fund disbursements and transfers to capital, debt service and other
funds are projected at $34.60 billion, an increase of $1.7 billion (5 percent)
from 1996-97 fiscal year levels. Over the last two years, spending growth for
most State agencies and programs has been negative or flat, producing an overall
decline in General Fund spending during that period. The 1997-98 adopted budget
reflects negotiated increases for State employee salaries, increased transfers
for debt service, and other mandated increases, as well as increased investments
in school aid, higher education, mental health, and public protection.
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GRANTS TO LOCAL GOVERNMENTS
($ MILLIONS)
- -------------------------------------------------------------------------------
1994-95 1995-96 1996-97 1997-98 (PROJ.)
- -------------------------------------------------------------------------------
$23,302 $22,537 $22,884 $23,634
- -------------------------------------------------------------------------------
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Grants to local governments is the largest category of General Fund
disbursements, and accounts for approximately 68 percent of overall General Fund
spending. Disbursements from this category are projected to total $23.63 billion
in the 1997-98 State Financial Plan, an increase of $750 million (3.3 percent)
from 1996-97 levels. This includes $11.57 billion in aid for elementary,
secondary, and higher education, accounting for 49 cents of every dollar spent
in this category. On a school year basis, school aid increases by $750 million,
including formula-based elementary and secondary education aid increases of $650
million. This category of the Financial Plan is affected by the reclassification
of costs formerly budgeted as City University local assistance that are now
included in the transfers for debt service category. This has the effect of
decreasing disbursements in this category by a projected $262 million, and
raising projected transfers by the same amount.
General Fund payments for Medicaid are projected to be $5.42 billion, virtually
unchanged from the level of $5.38 billion in 1996-97. This slow growth is due
primarily to continuation of cost containment measures enacted in 1995- 96 and
1996-97, new reforms included in the 1997-98 adopted budget and forecasts for
slower underlying growth. Other social service spending is forecast to increase
by only $115 million to $3.15 billion in 1997-98. This slow growth stems from
continued State efforts to reduce welfare fraud, declining caseloads, and
changes produced by federal welfare legislation enacted in 1996.
Remaining disbursements primarily support community-based mental hygiene
programs, community and public health programs, local transportation programs,
and revenue sharing payments to local governments. Revenue sharing and other
general purpose aid is projected at $802 million, an increase of approximately
$54 million from 1996-97.
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STATE OPERATIONS
($ MILLIONS)
- -------------------------------------------------------------------------------
1994-95 1995-96 1996-97 1997-98 (PROJ.)
- -------------------------------------------------------------------------------
$6,308 $5,953 $5,780 $6,221
- -------------------------------------------------------------------------------
State operations spending reflects the administrative costs of operating the
State's agencies, including the prison system, mental hygiene institutions, the
State University system ("SUNY"), the Legislature, and the court system.
Personal service costs account for approximately 71 percent of this category.
Since January 1995, the State's workforce has been reduced by about 10 percent,
and is projected to reach a level of approximately 191,000 persons by the end of
the 1997-98 fiscal year. Collective bargaining agreements have been ratified by
employee bargaining units representing most State employees subject to such
agreements, and the 1997-98 projections reflect salary increases under these
agreements. For more information on the State's workforce, see the section
entitled "State Organization-State Government Employment."
Disbursements for State operations are projected at $6.22 billion, an increase
of $441 million or 7.6 percent over the 1996-97 fiscal year. About $200 million
of this increase results from approved collective bargaining agreements and the
impact of binding arbitration settlements. Other major increases include growth
in SUNY operations, increased mental hygiene costs resulting from increased
assessments on State operated programs, public protection agency spending, which
is increasing to reflect the impact of sentencing reforms and prison expansion,
and higher spending by the Judiciary and Legislature.
- -------------------------------------------------------------------------------
GENERAL STATE CHARGES
($ MILLIONS)
- -------------------------------------------------------------------------------
1994-95 1995-96 1996-97 1997-98 (PROJ.)
- -------------------------------------------------------------------------------
$2,081 $2,081 $2,184 $2,183
- -------------------------------------------------------------------------------
General State charges primarily reflect the costs of providing fringe benefits
for State employees, including contributions to pension systems, the employer's
share of social security contributions, employer contributions toward the cost
of health insurance, and the costs of providing worker's compensation and
unemployment insurance
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benefits. This category also reflects certain fixed costs such as payments in
lieu of taxes, and payments of judgments against the State or its public
officers.
Disbursements in this category are projected to total $2.18 billion in the
1997-98 State Financial Plan virtually unchanged from 1996-97 levels. Pension
costs are projected to grow moderately year over year, while most of the
projected growth in fixed costs is related to increased payments to localities
for State owned lands. These increases are fully offset by continued savings
from health care and worker's compensation reforms, which account for most of
the cost containment savings in this area.
- -------------------------------------------------------------------------------
DEBT SERVICE
($ MILLIONS)
- -------------------------------------------------------------------------------
1994-95 1995-96 1996-97 1997-98(PROJ)
- -------------------------------------------------------------------------------
$7 $7 $10 $11
- -------------------------------------------------------------------------------
Debt service paid from the General Fund for 1997-98 reflects only the $11
million interest cost of the State's commercial paper program. This is
approximately the same level as last year, reflecting projections for stable
interest rates for the balance of the fiscal year. The State's annual TRAN
borrowing has been eliminated, as discussed in the section entitled "Debt and
Other Financing Activities-Local Government Assistance Corporation." Debt
service on long-term obligations is paid from Debt Service Funds as described
below.
- -------------------------------------------------------------------------------
TRANSFERS TO OTHER FUNDS
($ MILLIONS)
- -------------------------------------------------------------------------------
1994-95 1995-96 1996-97 1997-98 (PROJ.)
- -------------------------------------------------------------------------------
$1,701 $2,101 $2,039 $2,551
- -------------------------------------------------------------------------------
Transfer to other funds from the General Fund are made primarily to finance
certain portions of State capital project spending and debt service on long-term
bonds, where these costs are not funded from other sources. Transfers to other
funds for debt service are projected at $2.07 billion in 1997-98, an increase of
$496 million. This reflects the increased debt service impact of prior year bond
sales (net of refunding savings), the reclassification of City University debt
service costs that had been previously included in grants to local governments,
and the inclusion of costs associated with the 1996-97 bonding of previous
pension liabilities at lower interest rates. This action has the effect of
adding $159 million in costs that would have otherwise been included with
general State charges (for a description of this action, see the section
entitled "Debt and Other Financing - Lease-Purchase and Contractual Obligation
Financing Programs").
Transfers for capital projects provide General Fund support for projects not
otherwise financed through bond proceeds, dedicated taxes and other revenues and
federal grants. These transfers are projected at $184 million for 1997-98, an
increase of $46 million. The 1997-98 State Financial Plan also includes $299
million for subsidies or transfers to other State funds, a decrease of $30
million from last year's level.
NON-RECURRING RESOURCES
The Division of the Budget estimates that the 1997-98 State Financial Plan
contains actions that provide non-recurring resources or savings totaling
approximately $270 million. These include the use of $200 million in federal
reimbursement funds available from retroactive social service claims approved by
the federal government in April 1997. The balance is composed of various other
actions, primarily the transfer of unused special revenue fund balances to the
General Fund.
OUT YEAR PROJECTIONS OF RECEIPTS AND DISBURSEMENTS. The State closed projected
budget gaps of $5.0 billion, $3.9 billion, and $2.3 billion for the 1995-96
through 1997-98 fiscal years, respectively. The 1998-99 budget gap was projected
at $1.68 billion (before the application of any assumed efficiencies) in the
outyear projections submitted to the Legislature in February 1997. As a result
of changes made in the adopted budget, the 1998-99 gap
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is now expected to be about the same or smaller than the amount previously
projected, after application of the $530 million reserve for future needs. The
expected gap is smaller than the three previous budget gaps closed by the State.
The Governor has indicated that he will propose to close any potential imbalance
primarily through General Fund expenditure reductions and without increases in
taxes or deferrals of scheduled tax reductions.
The revised expectations for the 1998-99 fiscal year reflect the loss of $1.4
billion in surplus resources from 1996- 97 operations that are being utilized to
finance current year spending, and an incremental effect of approximately $300
million in legislated State and local tax reductions in the outyear. Other
factors include the annualized costs of certain program increases in the 1997-98
adopted budget, most of which are subject to annual appropriation.
Certain actions taken in the State's 1997-98 fiscal year, such as Medicaid and
welfare reforms, are expected to provide recurring savings in future fiscal
years. Continued controls on State agency spending will also provide recurring
savings. The availability of $530 million in reserves created as a part of the
1997-98 adopted budget and included in the Financial Plan is expected to benefit
the 1998-99 fiscal year. Sustained growth in the State's economy and continued
declines in welfare caseload and health care costs would also produce additional
savings in the 1998-99 Financial Plan. Finally, various federal actions,
including the potential beneficial effect on State tax receipts from changes to
the federal tax treatment of capital gains, could potentially provide
significant benefits to the State over the next several years.
See "Special Considerations" below in this section for a description of other
risks and uncertainties associated with the State Financial Plan process.
FUND BALANCES. The 1997-98 General Fund opening fund balance of $433 million
includes $317 million on deposit in the Tax Stabilization Reserve Fund ("TSRF"),
available for use in the event of an unanticipated General Fund deficit, $41
million on deposit in the Contingency Reserve Fund ("CRF") available for
potential litigation costs against the State, and a $75 million balance in the
Community Projects Fund. The projected closing fund balance in the General Fund
of $927 million reflects a balance of $332 million in the TSRF, following an
additional payment of $15 million at the end of the fiscal year, $65 million in
the CRF, following a deposit of $24 million in 1997-98, and a reserve for future
needs of $530 million.
OTHER GOVERNMENTAL FUNDS. In addition to the General Fund, the State Financial
Plan includes Special Revenue Funds, Capital Projects Funds and Debt Service
Funds which are discussed below. Amounts below do not include other sources and
uses of funds transferred to or from other fund types.
Special Revenue Funds. Special Revenue Funds are used to account for the
proceeds of specific revenue sources such as federal grants that are legally
restricted, either by the Legislature or outside parties, to expenditures for
specified purposes. Although activity in this fund type is expected to comprise
approximately 42 percent of total governmental funds receipts in the 1997-98
fiscal year, three-quarters of that activity relates to federally-funded
programs.
Projected receipts in this fund type total $28.22 billion, an increase of $2.51
billion (9.7 percent) over the prior year. Projected disbursements in this fund
type total $28.45 billion, an increase of $2.43 billion (9.3 percent) over
1996-97 levels. Disbursements from federal funds, primarily the federal share of
Medicaid and other social services programs, are projected to total $21.19
billion in the 1997-98 fiscal year. Remaining projected spending of $7.26
billion primarily reflects aid to SUNY supported by tuition and dormitory fees,
education aid funded from lottery receipts, operating aid payments to the
Metropolitan Transportation Authority funded from the proceeds of dedicated
transportation taxes, and costs of a variety of self-supporting programs which
deliver services financed by user fees.
Capital Projects Funds. Capital Projects Funds account for the financial
resources used for the acquisition, construction, or rehabilitation of major
State capital facilities and for capital assistance grants to certain local
governments or public authorities. This fund type consists of the Capital
Projects Fund, which is supported by tax receipts transferred from the General
Fund, and various other capital funds established to distinguish specific
capital
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construction purposes supported by other revenues. In the 1997-98 fiscal year,
activity in these funds is expected to comprise 5 percent of total governmental
receipts.
Total receipts in this fund type are projected at $3.30 billion. Bond and note
proceeds are expected to provide $605 million in other financing sources.
Disbursements from this fund type are projected to be $3.70 billion, an increase
of $154 million (4.3 percent) over prior-year levels. The Dedicated Highway and
Bridge Trust Fund is the single largest dedicated fund, comprising an estimated
$982 million (27 percent) of the activity in this fund type. Total spending for
capital projects will be financed through a combination of sources: federal
grants (29 percent), public authority bond proceeds (31 percent), general
obligation bond proceeds (15 percent), and pay-as-you-go revenues (25 percent).
Debt Service Funds. Debt Service Funds are used to account for the payment of
principal of, and interest on, long-term debt of the State and to meet
commitments under lease-purchase and other contractual-obligation financing
arrangements (see the section entitled "Debt and Other Financing Activities
outstanding Debt of the State and Certain Authorities" below). This fund type is
expected to comprise 4 percent of total governmental fund receipts and 4.7
percent of total government disbursements in the 1997-98 fiscal year. Receipts
in these funds in excess of debt service requirements may be transferred to the
General Fund and Special Revenue Funds, pursuant to law.
The Debt Service fund type consists of the General Debt Service Fund, which is
supported primarily by tax receipts transferred from the General Fund, and other
funds established to accumulate moneys for the payment of debt service. In the
1997-98 fiscal year, total disbursements in this fund type are projected at
$3.17 billion, an increase of $641 million or 25.3 percent, most of which is
explained by increases in the General Fund transfer as discussed earlier. The
projected transfer from the General Fund of $2.07 billion is expected to finance
65 percent of these payments.
The remaining payments are expected to be financed by pledged revenues,
including $2.03 billion in taxes and $601 million in dedicated fees and other
miscellaneous receipts. After required impoundment for debt service, $3.77
billion is expected to be transferred to the General Fund and other funds in
support of State operations. The largest transfer-$1.86 billion-is made to the
Special Revenue fund type in support of operations of the mental hygiene
agencies. Another $1.47 billion in excess sales taxes is expected to be
transferred to the General Fund, following payment of projected debt service on
LGAC bonds.
GAAP-BASIS UPDATE FOR THE CURRENT FISCAL YEAR. The State issued its first update
to the GAAP-basis Financial Plan for the State's 1997-98 fiscal year on August
11, 1997, in conjunction with the release of the cash-basis 1997- 98 Financial
Plan. A second GAAP basis update will be issued in connection with the
Governor's submission of the 1998-99 Executive Budget.
The major factor affecting the General Fund GAAP-basis results for 1996-97 and
the projections for 1997-98 is the 1996-97 cash-basis surplus, which helped
produce a GAAP-basis surplus in the 1996-97 fiscal year of $1.93 billion. The
use of this cash-basis surplus to fund liabilities in the 1997-98 fiscal year,
offset by the $494 million change in the projected 1997-98 cash-basis fund
balance, is the primary reason for the projected 1997-98 GAAP-basis deficit of
$959 million. This represents an increase of $191 million from the prior
projection, issued in January 1997 as part of the 1997-98 Executive Budget. The
new projection reflects the impact of legislative changes to the Executive
Budget, and the increase in the 1996-97 cash-basis surplus since that time.
Across the two fiscal years, the General Fund accumulated deficit is projected
to be reduced by $974 million to $1.95 billion.
For 1997-98, total revenues in the General Fund are projected at $33.37 billion,
total expenditures are projected at $34.66 billion, and net operating sources
and uses are projected to contribute $331 million. For all governmental funds,
total revenues are projected at $67.48 billion, total expenditures are projected
at $68.24 billion, and financing uses are projected to exceed financing sources
by $220 million. The all governmental funds GAAP-basis Financial Plan
projections show a deficiency of revenues and other financing sources over
expenditures and other financing uses of $979 million, after a reported 1996-97
all funds surplus of $2.1 billion.
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SPECIAL CONSIDERATIONS. The economic and financial condition of the State may be
affected by various financial, social, economic and political factors. These
factors can be very complex, may vary from fiscal year to fiscal year, and are
frequently the result of actions taken not only by the State and its agencies
and instrumentalities, but also by entities, such as the federal government,
that are not under the control of the State. Because of the uncertainty and
unpredictability of the changes, their impact cannot, as a practical matter, be
included in the assumptions underlying the State's projections at this time.
The State Financial Plan is based upon forecasts of national and State economic
activity developed through both internal analysis and review of State and
national economic forecasts prepared by commercial forecasting services and
other public and private forecasters. Economic forecasts have frequently failed
to predict accurately the timing and magnitude of changes in the national and
the State economies. Many uncertainties exist in forecasts of both the national
and State economies, including consumer attitudes toward spending, the extent of
corporate and governmental restructuring, federal fiscal and monetary policies,
the level of interest rates, and the condition of the world economy, which could
have an adverse effect on the State. There can be no assurance that the State
economy will not experience results in the current fiscal year that are worse
than predicted, with corresponding material and adverse effects on the State's
projections of receipts and disbursements.
Projections of total State receipts in the State Financial Plan are based on the
State tax structure in effect during the fiscal year and on assumptions relating
to basic economic factors and their historical relationships to State tax
receipts. In preparing projections of State receipts, economic forecasts
relating to personal income, wages, consumption, profits and employment have
been particularly important. The projection of receipts from most tax or revenue
sources is generally made by estimating the change in yield of such tax or
revenue source caused by economic and other factors, rather than by estimating
the total yield of such tax or revenue source from its estimated tax base. The
forecasting methodology, however, ensures that State fiscal year estimates for
taxes that are based on a computation of annual liability, such as the business
and personal income taxes, are consistent with estimates of total liability
under such taxes.
Projections of total State disbursements are based on assumptions relating to
economic and demographic factors, levels of disbursements for various services
provided by local governments (where the cost is partially reimbursed by the
State), and the results of various administrative and statutory mechanisms in
controlling disbursements for State operations. Factors that may affect the
level of disbursements in the fiscal year include uncertainties relating to the
economy of the nation and the State, the policies of the federal government, and
changes in the demand for and use of State services.
The Division of the Budget believes that its projections of receipts and
disbursements relating to the current State Financial Plan, and the assumptions
on which they are based, are reasonable. Actual results, however, could differ
materially and adversely from the projections set forth in this Annual
Information Statement. In the past, the State has taken management actions and
made use of internal sources to address potential State Financial Plan
shortfalls, and DOB believes it could take similar actions should variances
occur in its projections for the current fiscal year.
In recent years, State actions affecting the level of receipts and
disbursements, the relative strength of the State and regional economy, actions
of the federal government and other factors, have created structural budget gaps
for the State. These gaps resulted from a significant disparity between
recurring revenues and the costs of maintaining or increasing the level of
support for State programs. To address a potential imbalance in any given fiscal
year, the State would be required to take actions to increase receipts and/or
reduce disbursements as it enacts the budget for that year, and under the State
Constitution, the Governor is required to propose a balanced budget each year.
There can be no assurance, however, that the Legislature will enact the
Governor's proposals or that the State's actions will be sufficient to preserve
budgetary balance in a given fiscal year or to align recurring receipts and
disbursements in future fiscal years.
Other actions taken in the 1997-98 adopted budget add further pressure to future
budget balance in New York State. For example, the fiscal effects of tax
reductions adopted in the 1997-98 budget are projected to grow more
substantially beyond the 1998-99 fiscal year, with incremental costs averaging
in excess of $1.3 billion annually
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over the last three years of the tax reduction program. These incremental costs
reflect the phase-in of State-funded school property tax and local income tax
relief, the phase-out of the assessments on medical providers, and reductions in
estate and gift levies, utility gross receipts taxes, and the State sales tax on
clothing. The full annual cost of the enacted tax reduction package is estimated
at approximately $4.8 billion when fully effective in State fiscal year 2001-02.
In addition, the 1997-98 budget included multi-year commitments for school aid
and pre- kindergarten early learning programs which could add as much as $1.4
billion in costs when fully annualized in fiscal year 2001-02. These spending
commitments are subject to annual appropriation.
CASH-BASIS RESULTS FOR PRIOR FISCAL YEARS. The State reports its financial
results on two bases of accounting: the cash basis, showing receipts and
disbursements; and the modified accrual basis, prescribed by Generally Accepted
Accounting Principles ("GAAP"), showing revenues and expenditures.
GENERAL FUND 1994-95 THROUGH 1996-97. The General Fund is the principal
operating fund of the State and is used to account for all financial
transactions, except those required to be accounted for in another fund. It is
the State's largest fund and receives most State taxes and other resources not
dedicated to particular purposes. General Fund moneys are also transferred to
other funds, primarily to support certain capital projects and debt service
payments in other fund types. A narrative description of cash-basis results in
the General Fund is presented below, followed by a tabular presentation of the
actual General Fund results for the prior three fiscal years.
New York State's financial operations have improved during recent fiscal years.
During the period 1989-90 through 1991-92, the State incurred General Fund
operating deficits that were closed with receipts from the issuance of tax and
revenue anticipation notes ("TRANs"). A national recession, followed by the
lingering economic slowdown in New York and the regional economy, resulted in
repeated shortfalls in receipts and three budget deficits during those years.
During its last five fiscal years, however, the State has recorded balanced
budgets on a cash basis, with positive fund balances as described below.
1996-97 Fiscal Year
The State ended its 1996-97 fiscal year on March 31, 1997 in balance on a cash
basis, with a General Fund cash surplus as reported by DOB of approximately $1.4
billion. The cash surplus was derived primarily from higher- than-expected
revenues and lower-than-expected spending for social services programs. The
Governor in his Executive Budget applied $1.05 billion of the cash surplus
amount to finance the 1997-98 Financial Plan, and the additional $373 million is
available for use in financing the 1997-98 Financial Plan when enacted by the
State Legislature.
The General Fund closing fund balance was $433 million. Of that amount, $317
million was in the TSRF, after a required deposit of $15 million and an
additional deposit of $65 million in 1996-97. The TSRF can be used in the event
of any future General Fund deficit, as provided under the State Constitution and
State Finance Law. In addition, $41 million remains on deposit in the CRF. This
fund assists the State in financing any extraordinary litigation costs during
the fiscal year. The remaining $75 million reflects amounts on deposit in the
Community Projects Fund. This fund was created to fund certain legislative
initiatives. The General Fund closing fund balance does not include $1.86
billion in the tax refund reserve account, of which $521 million was made
available as a result of the Local Government Assistance Corporation ("LGAC")
financing program and was required to be on deposit as of March 31, 1997.
General Fund receipts and transfers from other funds for the 1996-97 fiscal year
totaled $33.04 billion, an increase of 0.7 percent from the previous fiscal year
(excluding deposits into the tax refund reserve account). General Fund
disbursements and transfers to other funds totaled $32.90 billion for the
1996-97 fiscal year, an increase of 0.7 percent from the 1995-96 fiscal year.
1995-96 Fiscal Year
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The State ended its 1995-96 fiscal year on March 31, 1996 with a General Fund
cash surplus, as reported by DOB, of $445 million. Of that amount, $65 million
was deposited into the TSRF, and $380 million was used to reduce 1996-97
Financial Plan liabilities.
The General Fund closing fund balance was $287 million, an increase of $129
million from 1994-95 levels. The $129 million change in fund balance is
attributable to the $65 million voluntary deposit to the TSRF, a $15 million
required deposit to the TSRF, a $40 million deposit to the CRF, and a $9 million
deposit to the Revenue Accumulation Fund. The closing fund balance included $237
million on deposit in the TSRF. In addition, $41 million was on deposit in the
CRF. The remaining $9 million reflected amounts then on deposit in the Revenue
Accumulation Fund. The General Fund closing balance does not include $678
million in the tax refund reserve account of which $521 million was made
available as a result of the LGAC financing program and was required to be on
deposit as of March 31, 1996.
General Fund receipts and transfers from other funds totaled $32.81 billion, a
decrease of 1.1 percent from 1994-95 levels. General Fund disbursements and
transfers to other funds totaled $32.68 billion for the 1995-96 fiscal year, a
decrease of 2.2 percent from 1994-95 levels.
1994-95 Fiscal Year
The State ended its 1994-95 fiscal year with the General Fund in balance. There
was a $241 million decline in the fund balance reflecting the planned use of
$264 million from the CRF, partially offset by the required deposit of $23
million to the TSRF. In addition, $278 million was on deposit in the tax refund
reserve account, $250 million of which was deposited to continue the process of
restructuring the State's cash flow as part of the LGAC program. The closing
fund balance of $158 million reflects $157 million in the TSRF and $1 million in
the CRF.
General Fund receipts and transfers from other funds totaled $33.16 billion, an
increase of 2.9 percent from 1993-94 levels. General Fund disbursements and
transfers to other funds totaled $33.40 billion for the 1994-95 fiscal year, an
increase of 4.7 percent from the previous fiscal year.
OTHER GOVERNMENTAL FUNDS (1994-95 THROUGH 1996-97). Activity in the three other
governmental funds has remained relatively stable over the last three fiscal
years, with federally-funded programs comprising approximately two-thirds of
these funds. The most significant change in the structure of these funds has
been the redirection of a portion of transportation related revenues from the
General Fund to two new dedicated funds in the Special Revenue and Capital
Projects fund types. These revenues are used to support the capital programs of
the Department of Transportation and the Metropolitan Transportation Authority
("MTA").
In the Special Revenue Funds, disbursements increased from $24.38 billion to
$26.02 billion over the last three years, primarily as a result of increased
costs for the federal share of Medicaid. Other activity reflected dedication of
taxes to a new fund for mass transportation, new lottery games, and new fees for
criminal justice programs.
Disbursements in the Capital Projects Funds declined from $3.62 billion to $3.54
billion over the last three years, as spending for miscellaneous capital
programs decreased, partially offset by increases for mental hygiene, health and
environmental programs. The composition of this fund type's receipts also
changed as the dedicated transportation taxes began to be deposited, general
obligation bond proceeds declined substantially, federal grants remained stable,
and reimbursements from public authority bonds (primarily transportation
related) increased. The increase in the negative fund balance in 1994-95
resulted from delays in reimbursements caused by delays in the timing of public
authority bond sales.
Activity in the Debt Service Funds reflected increased use of bonds during the
three-year period for improvements to the State's capital facilities and the
continued implementation of the LGAC fiscal reform program. The increases were
moderated by the refunding savings achieved by the State over the last several
years using strict present value savings criteria. The growth in LGAC debt
service was offset by reduced short-term borrowing costs reflected in the
General Fund. (See "Debt and Other Financing Activities Local Government
Assistance Corporation").
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GAAP-BASIS RESULTS FOR PRIOR FISCAL YEARS
The Comptroller prepares a comprehensive annual financial report on the GAAP
basis for governments as promulgated by the Governmental Accounting Standards
Board. The report, generally released in July each year, contains general
purpose financial statements with a Combined Balance Sheet and its Combined
Statement of Revenues, Expenditures and Changes in Fund Balances. These
statements are audited by independent certified public accountants.
1996-97 FISCAL YEAR
The State completed its 1996-97 fiscal year with a combined Governmental Funds
operating surplus of $2.1 billion, which included an operating surplus in the
General Fund of $1.9 billion, in Capital Projects Funds of $98 million and in
the Special Revenue Funds of $65 million, offset in part by an operating deficit
of $37 million in the Debt Service Funds.
General Fund. The State reported a General Fund operating surplus of $1.93
billion for the 1996-97 fiscal year, as compared to an operating surplus of $380
million for the prior fiscal year. The 1996-97 fiscal year GAAP operating
surplus reflects several major factors, including the cash basis operating
surplus, the benefit of bond proceeds which reduced the State's pension
liability, an increase in taxes receivable of $493 million, and a reduction in
tax refund liabilities of $196 million. This was offset by an increased payable
to local governments of $244 million.
Revenues increased $1.91 billion (nearly 6.6 percent) over the prior fiscal year
with increases in all revenue categories. Personal income taxes grew $620
million, an increase of nearly 3.6 percent, despite the implementation of
scheduled tax cuts. The increase in personal income taxes was caused by moderate
employment and wage growth and the strong financial markets during 1996.
Consumption and use taxes increased $179 million or 2.7 percent as a result of
increased consumer confidence. Business taxes grew $268 million, an increase of
5.6 percent, primarily as a result of the strong financial markets during 1996.
Other taxes increased primarily because revenues from estate and gift taxes
increased. Miscellaneous revenues increased $743 million, a 33.1 percent
increase, because of an increase in receipts from the Medical Malpractice
Insurance Association and from medical provider assessments.
Expenditures increased $830 million (2.6 percent) from the prior fiscal year,
with the largest increase occurring in pension contributions and State aid for
education spending. Pension contribution expenditures increased $514 million
(198.2 percent) primarily because the State paid off its 1984-85 and 1985-86
pension amortization liability. Education expenditures grew $351 million (3.4
percent) due mainly to an increase in spending for support for public schools
and physically handicapped children offset by a reduction in spending for
municipal and community colleges. Modest increases in other State aid spending
was offset by a decline in social services expenditures of $157 million (1.7
percent). Social services spending continues to decline because of cost
containment strategies and declining caseloads.
Net other financing sources increased $475 million (62.6 percent) due mainly to
bond proceeds provided by the Dormitory Authority of the State of New York
("DASNY") to pay the outstanding pension amortization, offset by elimination of
prior year LGAC proceeds.
Special Revenue, Debt Service and Capital Projects Fund Types. An operating
surplus of $65 million was reported for the Special Revenue Funds for the
1996-97 fiscal year, increasing the accumulated fund balance to $532 million.
Revenues increased $583 million over the prior fiscal year (2.2 percent) as a
result of increases in tax and lottery revenues. Expenditures increased $384
million (1.6 percent) as a result of increased costs for departmental
operations. Net other financing uses decreased $275 million (8.0 percent)
primarily because of declines in amounts transferred to other funds.
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Debt Service Funds ended the 1996-97 fiscal year with an operating deficit of
$37 million and, as a result, the accumulated fund balance declined to $1.90
billion. Revenues increased $102 million (4.6 percent) because of increases in
both dedicated taxes and mental hygiene patient fees. Debt service expenditures
increased $48 million (2.0 percent). Net other financing sources decreased $22
million (92.6 percent) due primarily to an increase in payments on advance
refundings.
An operating surplus of $98 million was reported in the Capital Projects Funds
for the State's 1996-97 fiscal year and, as a result, the accumulated fund
balance decreased to a deficit of $614 million. Revenues increased $100 million
(5.0 percent) primarily because a larger share of the real estate transfer tax
was shifted to the Environmental Protection Fund and federal grant revenues
increased for transportation and local waste water treatment projects.
Expenditures decreased $359 million (10.0 percent) because of declines in
capital grants for education, housing and regional development programs and
capital construction spending. Net other financing sources decreased by $637
million as a result of a decrease in proceeds from financing arrangements.
1995-96 FISCAL YEAR
The State completed its 1995-96 fiscal year with a combined Governmental Funds
operating surplus of $432 million, which included an operating surplus in the
General Fund of $380 million, in the Capital Projects Funds of $276 million and
in the Debt Service Funds of $185 million, offset in part by an operating
deficit of $409 million in the Special Revenue Funds.
General Fund. The State reported a General Fund operating surplus of $380
million for the 1995-96 fiscal year, as compared to an operating deficit of
$1.43 billion for the prior fiscal year. The 1995-96 fiscal year surplus
reflects several major factors, including the cash-basis surplus and the benefit
of $529 million in LGAC bond proceeds which were used to fund various local
assistance programs. This was offset in part by a $437 million increase in tax
refund liability primarily resulting from the effects of ongoing tax reductions
and (to a lesser extent) changes in accrual measurement policies, and increases
in various other expenditure accruals.
Revenues increased $530 million (nearly 1.7 percent) over the prior fiscal year
with an increase in personal income taxes and miscellaneous revenues offset by
decreases in business and other taxes. Personal income taxes grew $715 million,
an increase of 4.3 percent. The increase in personal income taxes was caused by
moderate employment and wage growth and the strong financial markets during
1995. Business taxes declined $295 million or 5.8 percent, resulting primarily
from changes in the tax law that modified the distribution of taxes between the
General Fund and other fund types, and reduced business tax liability.
Miscellaneous revenues increased primarily because of an increase in receipts
from medical provider assessments.
Expenditures decreased $716 million (2.2 percent) from the prior fiscal year
with the largest decrease occurring in State aid for social services program and
State operations spending. Social services expenditures decreased $739 million
(7.5 percent) due mainly to implementation of cost containment strategies by the
State and local governments, and reduced caseloads. General purpose and health
and environment expenditures grew $139 million (20.2 percent) and $121 million
(33.3 percent), respectively. Health and environment spending increased as a
result of increases enacted with the 1995-96 Budget. In State operations,
personal service costs and fringe benefits declined $241 million (3.8 percent)
and $55 million (3.6 percent), respectively, due to staffing reductions. The
decline in non-personal service costs of $170 million (8.6 percent) was caused
by a decline in the litigation accrual. Pension contributions increased $103
million (66.4 percent) as a result of the return to the aggregate cost method
used to determine employer contributions.
Net other financing sources nearly tripled, increasing $561 million, due
primarily to an increase in bonds issued by LGAC, a transfer from the Mass
Transportation Operating Assistance Fund and transfers from public benefit
corporations.
Special Revenue, Debt Service and Capital Projects Fund Types. An operating
deficit of $409 million was reported for Special Revenue Funds for the 1995-96
fiscal year which decreased the accumulated fund balance to $468
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million. Revenues increased $1.45 billion over the prior fiscal year (5.8
percent) as a result of increases in federal grants and lottery revenues.
Expenditures increased $1.21 billion (5.4 percent) as a result of increased
costs for social services programs and an increase in the distribution of
lottery proceeds to school districts. Other financing uses increased $693
million (25.1 percent) primarily because of an increase in federal
reimbursements transferred to other funds.
Debt Service Funds ended the 1995-96 fiscal year with an operating surplus of
over $185 million and, as a result the accumulated fund balance, increased to
$1.94 billion. Revenues increased $10 million (0.5 percent) because of increases
in both dedicated taxes and mental hygiene patient fees. Debt service
expenditures increased $201 million (9.5 percent). Net other financing sources
increased threefold to $299 million, due primarily to increases in patient
reimbursement revenues.
An operating surplus of $276 million was reported in the Capital Projects Funds
for the State's 1995-96 fiscal year and, as a result, the accumulated deficit
fund balance in this fund type decreased to $712 million. Revenues increased
$260 million (14.9 percent) primarily because a larger share of the petroleum
business tax was shifted from the General Fund to the Dedicated Highway and
Bridge Trust Fund, and by an increase in federal grant revenues for
transportation and local waste water treatment projects. Capital Projects Funds
expenditures increased $194 million (5.7 percent) in State fiscal year 1995-96
because of increased expenditures for education and health and environmental
projects. Net other financing sources increased by $577 million as a result of
an increased in proceeds from financing arrangements.
1994-95 FISCAL YEAR
The State completed its 1994-95 fiscal year with a combined Governmental Funds
operating deficit of $1.79 billion, which included operating deficits in the
General Fund of $1.43 billion, in the Capital Projects Funds of $366 million,
and in the Debt Service Funds of $38 million. There was an operating surplus in
the Special Revenue Funds of $39 million.
General Fund. The State reported a General Fund operating deficit of $1.43
billion for the 1994-95 fiscal year, as compared to an operating surplus of $914
million for the prior fiscal year. The 1994-95 fiscal year deficit was caused by
several factors, including the use of $1.03 billion of the 1993-94 cash-based
surplus to fund operating expenses in 1994-95, and the adoption of changes in
accounting methodologies by the State Comptroller. These factors were offset by
net proceeds of $315 million in bonds issued by LGAC.
Total revenues for 1994-95 were $31.46 billion. Revenues decreased by $173
million over the prior fiscal year, a decrease of less than one percent.
Personal income taxes grew by $103 million, an increase of 0.6 percent.
Similarly, consumption and use taxes increased by $376 million or 6.0 percent.
The increase in personal income and sales taxes was due to modest growth in the
State's economy. Business taxes declined by $751 million or 12.8 percent from
the previous year. The decline in business taxes was caused primarily by a
decline in taxable earnings in the insurance, bank and petroleum industries and
the beginning of the phase-out of the corporate tax surcharges.
Other revenues and miscellaneous receipts showed modest increases.
Total 1994-95 expenditures were $33.08 billion, an increase of $2.08 billion, or
6.7 percent over the prior fiscal year. In Grants to Local Governments, social
service and education expenditures grew by $927 million (10.3 percent) and $727
million (7.6 percent), respectively. Social services spending increased in
Medicaid and Income Maintenance, while education spending grew as a result of
increases enacted with the 1994-95 budget. General purpose local assistance
declined by $205 million (22.9 percent) as a result of prior year spending
reductions. Other local assistance spending showed modest increases. In State
Operations, personal service costs grew by $322 million (5.4 percent) while
non-personal service declined by $70 million (3.4 percent). Pension
contributions more than doubled, increasing by $95 million, while other fringe
benefit costs increased by $151 million (10.9 percent). State Operations growth
was primarily from labor contracts that resulted in salary increases and
retroactive payments.
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Net other financing sources and uses declined from $282 million (as restated) to
$198 million, an $84 million (29.8 percent) decline from the previous year,
primarily because of a reduction in bonds issued by LGAC.
Special Revenue, Debt Service and Capital Projects Fund Types. An operating
surplus of $39 million was reported for Special Revenue Funds for the 1994-95
fiscal year which increased the accumulated fund balance to $877 million.
Revenues increased $1.62 billion over the prior fiscal year (6.9 percent) as a
result of increases in federal grants and lottery revenues. Expenditures
increased $1.89 billion (9.3 percent) as a result of increased costs for social
services programs and an increase in the distribution of lottery proceeds to
school districts. Other financing uses declined $166 million (5.7 percent)
primarily because of a decline in federal reimbursements transferred to other
funds.
Debt Service Funds ended the 1994-95 fiscal year with an operating deficit of
over $38 million and, as a result, the accumulated fund balance declined to
$1.75 billion. Revenues increased $145 million (7.1 percent) because of
increases in both dedicated taxes and mental hygiene patient fees. Debt service
expenditures increased $106 million (5.3 percent). Net other financing uses
increased $101 million, due primarily to a decrease in net operating transfers
of $158 million offset in part by a $57 million increase in proceeds from other
financing arrangements.
An operating deficit of $366 million was reported in the Capital Projects Funds
for the State's 1994-95 fiscal year and, as a result, the accumulated deficit
fund balance in this fund type increased to $988 million. Revenues increased
$256 million (17.3 percent) primarily because a larger share of the petroleum
business tax was shifted from the General Fund to the Dedicated Highway and
Bridge Trust Fund, and by an increase in federal grant revenues for
transportation and local waste water treatment projects. Capital Projects Funds
expenditures increased $585 million (20.7 percent) in State fiscal year 1994-95
because of increased expenditures for transportation and correctional projects.
Net other financing sources (uses) declined by less than $2 million.
ECONOMICS AND DEMOGRAPHICS. This section presents economic information about the
State which may be relevant in evaluating the future prospects of the State.
However, the demographic information and statistical data, which have been
obtained from the sources indicated, do not present all factors which may have a
bearing on the State's fiscal and economic affairs. Further, such information
requires economic and demographic analysis in order to assess the import of the
data presented. The data and analysis may be interpreted differently, according
to the economist or other expert consulted.
CURRENT ECONOMIC OUTLOOK. The State Financial Plan is based upon a July 1997
projection by DOB of national and State economic activity. The information in
this section and in the tables below summarize the national and State economic
situation and outlook upon which projections of receipts and certain
disbursements were made for the 199798 Financial Plan.
The national economy has resumed a more robust rate of growth after a "soft
landing" in 1995, with approximately 14 million jobs added nationally since
early 1992. The State economy has continued to expand, but growth remains
somewhat slower than in the nation. Although the State has added approximately
300,000 jobs since late 1992, employment growth in the State has been hindered
during recent years by significant cutbacks in the computer and instrument
manufacturing, utility, defense, and banking industries. Government downsizing
has also moderated these job gains.
DOB forecasts that national economic growth will be quite strong in the first
half of calendar 1997, but will moderate considerably as the year progresses.
The overall growth rate of the national economy for calendar year 1997 is
expected to be practically identical to the consensus forecast of a widely
followed survey of national economic forecasters. Growth in real Gross Domestic
Product for 1997 is projected to be 3.6 percent, with an anticipated decline in
net exports and continued restraint in Federal spending more than offset by
increases in consumption and investment. Inflation, as measured by the Consumer
Price Index, is projected to remain subdued at about 2.6 percent due to improved
productivity and foreign competition. Personal income and wages are projected to
increase by 6.0 percent and 6.7 percent respectively.
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The forecast of the State's economy shows moderate expansion during the first
half of calendar 1997 with the trend continuing through the year. Although
industries that export goods and services are expected to continue to do well,
growth is expected to be moderated by tight fiscal constraints on the health
care and social services industries. On an average annual basis, employment
growth in the State is expected to be up substantially from the 1996 rate.
Personal income is expected to record moderate gains in 1997. Bonus payments in
the securities industry are expected to increase further from last year's record
level.
THE NEW YORK ECONOMY. New York is the third most populous state in the nation
and has a relatively high level of personal wealth. The State's economy is
diverse, with a comparatively large share of the nation's finance, insurance,
transportation, communications and services employment, and a very small share
of the nation's farming and mining activity. The State's location and its
excellent air transport facilities and natural harbors have made it an important
link in international commerce. Travel and tourism constitute an important part
of the economy. Like the rest of the nation, New York has a declining proportion
of its workforce engaged in manufacturing, and an increasing proportion engaged
in service industries.
Services: The services sector, which includes entertainment, personal services,
such as health care and auto repairs, and business-related services, such as
information processing, law and accounting, is the State's leading economic
sector. The services sector accounts for more than three of every ten
nonagricultural jobs in New York and has a noticeably higher proportion of total
jobs than does the rest of the nation.
Manufacturing: Manufacturing employment continues to decline in importance in
New York, as in most other states, and New York's economy is less reliant on
this sector than is the nation. The principal manufacturing industries in recent
years produced printing and publishing materials, instruments and related
products, machinery, apparel and finished fabric products, electronic and other
electric equipment, food and related products, chemicals and allied products,
and fabricated metal products.
Trade: Wholesale and retail trade is the second largest sector in terms of
nonagricultural jobs in New York but is considerably smaller when measured by
income share. Trade consists of wholesale businesses and retail businesses, such
as department stores and eating and drinking establishments.
Finance, Insurance and Real Estate: New York City is the nation's leading center
of banking and finance and, as a result, this is a far more important sector in
the State than in the nation as a whole. Although this sector accounts for under
one-tenth of all nonagricultural jobs in the State, it contributes over
one-sixth of all non-farm labor and proprietors' income.
Agriculture: Farming is an important part of the economy of large regions of the
State, although it constitutes a very minor part of total State output.
Principal agricultural products of the State include milk and dairy products,
greenhouse and nursery products, apples and other fruits, and fresh vegetables.
New York ranks among the nation's leaders in the production of these
commodities.
Government: Federal, State and local government together are the third largest
sector in terms of nonagricultural jobs, with the bulk of the employment
accounted for by local governments. Public education is the source of nearly
one-half of total state and local government employment.
Relative to the nation, the State has a smaller share of manufacturing and
construction and a larger share of service- related industries. The State's
finance, insurance, and real estate share, as measured by income, is
particularly large relative to the nation. The State is likely to be less
affected than the nation as a whole during an economic recession that is
concentrated in manufacturing and construction, but likely to be more affected
during a recession that is concentrated in the service-producing sector.
DEBT AND OTHER FINANCING ACTIVITIES
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LEGAL CATEGORIES OF STATE DEBT AND OTHER FINANCINGS. State financing activities
include general obligation debt of the State and State-guaranteed debt, to which
the full faith and credit of the State has been pledged, as well as
lease-purchase and contractual-obligation financings, moral obligation
financings and other financings through public authorities and municipalities,
where the State's legal obligation to make payments to those public authorities
and municipalities for their debt service is subject to annual appropriation by
the Legislature. These categories are described in the Glossary of Financial
Terms in Exhibit A to this Annual Information Statement and in more detail
below.
GENERAL OBLIGATION AND STATE-GUARANTEED FINANCING. There are a number of methods
by which the State itself may incur debt. The State may issue general obligation
bonds. Under the State Constitution, the State may not, with limited exceptions
for emergencies, undertake long-term general obligation borrowing (i.e.,
borrowing for more than one year) unless the borrowing is authorized in a
specific amount for a single work or purpose by the Legislature and approved by
the voters. There is no limitation on the amount of long-term general obligation
debt that may be so authorized and subsequently incurred by the State. With the
exception of general obligation housing bonds (which must be paid in equal
annual installments or installments that result in substantially level or
declining debt service payments, within 50 years after issuance, commencing no
more than three years after issuance), general obligation bonds must be paid in
equal annual installments or installments that result in substantially level or
declining debt service payments, within 40 years after issuance, beginning not
more than one year after issuance of such bonds.
The State may undertake short-term borrowings without voter approval (i) in
anticipation of the receipt of taxes and revenues, by issuing tax and revenue
anticipation notes ("TRANs"), and (ii) in anticipation of the receipt of
proceeds from the sale of duly authorized but unissued general obligation bonds,
by issuing bond anticipation notes ("BANs"). TRANs must mature within one year
from their dates of issuance and may not be refunded or refinanced beyond such
period. However, since 1990 the State's ability to issue TRANs has been limited
due to enactment of the fiscal reform program which created LGAC (see "Local
Government Assistance Corporation" below in this section). BANs may only be
issued for the purposes and within the amounts for which bonds may be issued
pursuant to voter authorizations. Such BANs must be paid from the proceeds of
the sale of bonds in anticipation of which they were issued or from other
sources within two years of the date of issuance or, in the case of BANs for
housing purposes, within five years of the date of issuance. In order to provide
flexibility within these maximum term limits, the State has utilized the BANs
authorization to conduct a commercial paper program to fund disbursements
eligible for general obligation bond financing.
Pursuant to specific constitutional authorization, the State may also directly
guarantee certain public authority obligations. The State Constitution provides
for the State guarantee of the repayment of certain borrowings for designated
projects of the New York State Thruway Authority, the Job Development Authority
and the Port Authority of New York and New Jersey. The State has never been
called upon to make any direct payments pursuant to such guarantees. State
guaranteed bonds of the Port Authority of New York and New Jersey were fully
retired on December 31, 1996. State guaranteed bonds issued by the Thruway
Authority were fully retired on July 1, 1995.
In February 1997, the Job Development Authority ("JDA") issued approximately $85
million of State guaranteed bonds to refinance certain of its outstanding bonds
and notes in order to restructure and improve JDA's capital structure. Due to
concerns regarding the economic viability of its programs, JDA's loan and loan
guarantee activities had been suspended since the Governor took office in 1995.
As a result of the structural imbalances in JDA's capital structure, and
defaults in its loan portfolio and loan guarantee program incurred between 1991
and 1996, JDA would have experienced a debt service cash flow shortfall had it
not completed its recent refinancing. JDA anticipates that it will transact
additional refinancings in 1999, 2000 and 2003 to complete its long-term plan of
finance and further alleviate cash flow imbalances which are likely to occur in
future years. The State does not anticipate that it will be called upon to make
any payments pursuant to the State guarantee in the 1997-98 fiscal year. JDA
recently resumed its lending activities under a revised set of lending programs
and underwriting guidelines.
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Payments of debt service on State general obligation and State-guaranteed bonds
and notes are legally enforceable obligations of the State.
LEASE-PURCHASE AND CONTRACTUAL-OBLIGATION FINANCING. The State employs
additional long-term financing mechanisms, lease-purchase and
contractual-obligation financings, which involve obligations of public
authorities or municipalities that are State-supported but not general
obligations of the State. Under these financing arrangements, certain public
authorities and municipalities have issued obligations to finance the
construction and rehabilitation of facilities or the acquisition and
rehabilitation of equipment, and expect to meet their debt service requirements
through the receipt of rental or other contractual payments made by the State.
Although these financing arrangements involve a contractual agreement by the
State to make payments to a public authority, municipality or other entity, the
State's obligation to make such payments is generally expressly made subject to
appropriation by the Legislature and the actual availability of money to the
State for making the payments. The State has also entered into a financing
arrangement with LGAC to restructure the way the State makes certain local aid
payments (see "Local Government Assistance Corporation" below in this section).
The State also participates in the issuance of certificates of participation
("COPs") in a pool of leases entered into by the State's Office of General
Services on behalf of several State departments and agencies interested in
acquiring operational equipment, or in certain cases, real property. Legislation
enacted in 1986 established restrictions upon and centralized State control,
through the Comptroller and the Director of the Budget, over the issuance of
COPs representing the State's contractual obligation, subject to annual
appropriation by the Legislature and availability of money, to make installment
or lease-purchase payments for the State's acquisition of such equipment or real
property.
The State has never defaulted on any of its general obligation indebtedness or
its obligations under lease purchase or contractual-obligation financing
arrangements and has never been called upon to make any direct payments pursuant
to its guarantees.
MORAL OBLIGATION AND OTHER FINANCING. Moral obligation financing generally
involves the issuance of debt by a public authority to finance a
revenue-producing project or other activity. The debt is secured by project
revenues and includes statutory provisions requiring the State, subject to
appropriation by the Legislature, to make up any deficiencies which may occur in
the issuer's debt service reserve fund. There has never been a default on any
moral obligation debt of any public authority. The State does not intend to
increase statutory authorizations for moral obligation bond programs. From 1976
through 1987, the State was called upon to appropriate and make payments
totaling $162.8 million to make up deficiencies in the debt service reserve
funds of the Housing Finance Agency ("HFA") pursuant to moral obligation
provisions. In the same period, the State also expended additional funds to
assist the Project Finance Agency, the Urban Development Corporation ("UDC") and
other public authorities which had moral obligation debt outstanding. The State
has not been called upon to make any payments' Pursuant to any moral obligations
since the 1986-87 fiscal year and no such requirements are anticipated during
the 1997-98 fiscal year.
In addition to the moral obligation financing arrangements described above,
State law provides for the creation of State municipal assistance corporations,
which are public authorities established to aid financially troubled localities.
The Municipal Assistance Corporation for the City of New York ("NYC MAC") was
created in 1975 to provide financing assistance to New York City. To enable NYC
MAC to pay debt service on its obligations, NYC MAC receives, subject to annual
appropriation by the Legislature, receipts from the 4 percent New York State
sales tax for the benefit of New York City, the State-imposed stock transfer tax
and, subject to certain prior liens, certain local assistance payments otherwise
payable to New York City. The legislation creating NYC MAC also includes a moral
obligation provision. Under its enabling legislation, NYC MAC's authority to
issue moral obligation bonds and notes (other than refunding bonds and notes)
expired on December 31, 1984. In 1995, the State created the Municipal
Assistance Corporation for the City of Troy ("Troy MAC"). The bonds issued by
Troy MAC, however, do not include the moral obligation provisions.
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The State also provides for contingent contractual-obligation financing for the
Secured Hospital Program pursuant to legislation enacted in 1985. Under this
financing method, the State entered into service contracts which obligate the
State to pay debt service, subject to annual appropriations, on bonds formerly
issued by the New York State Medical Care Facilities Finance Agency ("MCFFA")
and now included as debt of the DASNY in the event there are shortfalls of
revenues from other sources. The State has never been required to make any
payments pursuant to this financing arrangement, nor does it anticipate being
required to do so during the.1997-98 fiscal year.
LOCAL GOVERNMENT ASSISTANCE CORPORATION. In 1990, as part of a State fiscal
reform program, legislation was enacted creating LGAC, a public benefit
corporation empowered to issue long-term obligations to fund certain payments to
local governments that had been traditionally funded through the State's annual
seasonal borrowing. The legislation authorized LGAC to issue its bonds and notes
in an amount to yield net proceeds not in excess of $4.7 billion (exclusive of
certain refunding bonds). Over a period of years, the issuance of these
long-term obligations, which are to be amortized over no more than 30 years, was
expected to eliminate the need for continued short-term seasonal borrowing. The
legislation also dedicated revenues equal to one-quarter of the four cent State
sales and use tax to pay debt service on these bonds. The legislation also
imposed a cap on the annual seasonal borrowing of the State at $4.7 billion,
less net proceeds of bonds issued by LGAC and bonds issued to provide for
capitalized interest, except in cases where the Governor and the legislative
leaders have certified the need for additional borrowing and provided a schedule
for reducing it to the cap. If borrowing above the cap is thus permitted in any
fiscal year, it is required by law to be reduced to the cap by the fourth fiscal
year after the limit was first exceeded. This provision capping the seasonal
borrowing was included as a covenant with LGAC's bondholders in the resolution
authorizing such bonds.
As of June 1995, LGAC had issued bonds and notes to provide net proceeds of $4.7
billion, completing the program. The impact of LGAC's borrowing is that the
State has been able to meet its cash flow needs throughout the fiscal year
without relying on short-term seasonal borrowings.
1997-98 BORROWING PLAN. The State anticipates that its capital programs will be
financed, in part, through borrowings by the State and its public authorities in
the 1997-98 fiscal year. The State expects to issue $605 million in general
obligation bonds (including $140 million for purposes of redeeming outstanding
BANS) and $140 million in general obligation commercial paper. The Legislature
has also authorized the issuance of $311 million in COPs (including costs of
issuance, reserve funds and other costs) during the State's 1997-98 fiscal year
for equipment purchases. The projection of State borrowings for the 1997-98
fiscal year is subject to change as market conditions, interest rates and other
factors vary throughout the fiscal year.
In the 1997 legislative session, the Legislature approved a proposal to present
to the voters in November, 1997, a $2.4 billion State general obligation bond
referendum to finance major capital improvements in public school facilities. If
the School Facility Health and Safety Bond Act is approved by the voters, the
State does not anticipate any issuance for this program during the 1997-98
fiscal year.
Borrowings by public authorities pursuant to lease-purchase and
contractual-obligation financings for capital programs of the State are
projected to total approximately $1.9 billion, including costs of issuance,
reserve funds, and other costs, net of anticipated refundings and other
adjustments for 1997-98 capital projects. Included therein are borrowings by:
(i) DASNY for the State University of New York ("SUNY"), The City University of
New York ("CUNY"), health facilities, and mental health facilities; (ii) the
Thruway Authority for the Dedicated Highway and Bridge Trust Fund and
Consolidated Highway Improvement Program; (iii) UDC (doing business as the
Empire State Development Corporation) for prison and youth facilities; (iv) HFA
for housing programs; and (v) borrowings by the Environmental Facilities
Corporation ("EFC") and other authorities.
In the 1997 legislative session, the Legislature also approved two new
authorizations for lease-purchase and contractual obligation financings. An
aggregate $425 million was authorized for four public authorities (Thruway
Authority, DASNY, UDC and HFA) for the Community Enhancement Facility Program
for economic development purposes, including sports facilities, cultural
institutions, transportation, infrastructure and other community facility
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projects. DASNY was also authorized to issue up to $40 million to finance the
expansion and improvement of facilities at the Albany County airport.
OUTSTANDING DEBT OF THE STATE AND CERTAIN AUTHORITIES. For purposes of analyzing
the financial condition of the State, debt of the State and of certain public
authorities may be classified as State-supported debt, which includes general
obligation debt of the State and lease-purchase and contractual obligations of
public authorities (and municipalities) where debt service is paid from State
appropriations (including dedicated tax sources, and other revenues such as
patient charges and dormitory facilities rentals). In addition, a broader
classification, referred to as State-related debt, includes State-supported
debt, as well as certain types of contingent obligations, including
moral-obligation financing, certain contingent contractual-obligation financing
arrangements, and State-guaranteed debt described above, where debt service is
expected to be paid from other sources and State appropriations are contingent
in that they may be made and used only under certain circumstances.
STATE-SUPPORTED DEBT OUTSTANDING
General Obligation Bond Programs. The first type of State-supported debt,
general obligation debt, is currently authorized for three programmatic
categories: transportation, environmental and housing. The amount of general
obligation bonds and BANs issued in the 1994-95 through 1996-97 fiscal years
(excluding bonds issued to redeem BANS) were $250 million, $333 million and $439
million, respectively. Transportation-related bonds are issued for State highway
and bridge improvements, aviation, highway and mass transportation projects and
purposes, and rapid transit, rail, canal, port and waterway programs and
projects. Environmental bonds are issued to fund environmentally-sensitive land
acquisitions, air and water quality improvements, municipal nonhazardous waste
landfill closures and hazardous waste site cleanup projects. As of March 31,
1997, the total amount of outstanding general obligation debt was $5.03 billion,
including $294 million in BANS.
Lease-Purchase and Contractual-Obligation Financing Programs
The second type of State-supported debt, lease-purchase and
contractual-obligation financing arrangements with public authorities and
municipalities, has been used primarily by the State to finance the State's
highway and bridge program, SUNY and CUNY buildings, health and mental hygiene
facilities, prison construction and rehabilitation, and various other State
capital projects.
In addition, the State has utilized State-supported debt to refinance a
liability incurred to one of its pension funds as a result of an earlier
deferral (and subsequent amortization) of pension payments otherwise due to that
system. Specifically, under enabling legislation passed in 1986, the State
amortized a defer-red pension liability over a 17- year period at an established
interest rate of 8 percent. In order to achieve savings and refinance this
obligation, the State received legislative authorization in 1996 to issue
taxable pension bonds through DASNY to refinance the remaining pension
obligation for the period March 1, 1997 through March 1, 2003. DASNY issued
pension bonds that refinanced the balance of this obligation at interest rates
below 7 percent, without extending the remaining seven year amortization period,
liquidating the outstanding pension liability of $768.9 million. The refinancing
of this pre-existing pension liability, which was formerly included as a
long-term liability to the New York State and Local Employee Retirement System,
has now been reclassified as a component of State-supported debt. The State has
utilized and expects to continue to utilize lease-purchase and
contractual-obligation financing arrangements to finance its capital programs,
in addition to authorized general obligation bonds. Some of the major capital
programs financed by lease-purchase and contractual obligation agreements are
highlighted below.
Transportation. The State Department of Transportation is primarily responsible
for maintaining and rehabilitating the State's system of highways and bridges,
which includes 40,000 State highway lane miles and 7,500 State bridges. The
Department also oversees and funds programs for rail and aviation projects and
programs that help defray local capital expenses associated with road and bridge
projects.
Legislation enacted in 1991 established the Dedicated Highway and Bridge Trust
Fund to provide for the dedication of a portion of the petroleum business tax
and certain other transportation-related taxes and fees for transportation
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<PAGE>
improvements. Legislation enacted in 1996 authorized a five-year, $12.7 billion
plan for State and local highways and bridges through 1999-2000, to be financed
by a combination of Federal 9 grants, pay-as-you-go capital and bond proceeds
supported by the Dedicated Highway and Bridge Trust Fund, and a small amount of
general obligation bonds remaining under previous authorizations.
The State has supported the capital plans of the MTA in part by entering into
service contracts relating to certain bonds issued by the MTA. Legislation
adopted in 1992 and 1993 also authorized payments, subject to appropriation, of
a portion of the petroleum business tax from the State's Dedicated Mass
Transportation Trust Fund to the MTA and authorized it to be used as a source of
payment for bonds to be sold by the MTA to support its capital program.
Education. The State finances the physical infrastructure of SUNY and CUNY and
their respective community colleges and the State Education Department through
direct State capital spending and through financing arrangements with the DASNY,
paying all capital costs of the senior colleges and sharing equally with local
governments for the community colleges, except that SUNY dormitories are
financed through dormitory fees.
The 34 SUNY campuses include more than 2,300 buildings including classrooms,
dormitories, libraries, athletic and student facilities and other buildings of
which 78 percent are over 20 years of age. Together with the 30 SUNY community
colleges, the SUNY system serves nearly 300,000 full-time students. The CUNY
system is comprised of 11 senior colleges and 6 community colleges that serve
approximately 150,000 full time students.
Health/Mental Hygiene. The State provides care for its citizens with mental
illness, mental retardation, and developmental disabilities, and for those with
chemical dependencies, through the Office of Mental Health ("OMH"), the Office
of Mental Retardation and Developmental Disabilities ("OMRDD") and the Office of
Alcoholism and Substance Abuse Services ("OASAS"). Historically, this care has
been provided at large State institutions, although recently the State adopted
policies that provide institutional care to the neediest and expanded care in
community residences. OMR has closed 11 of its 20 developmental centers, with
one additional facility planned for closure in 1997-98. OMH has reduced its
adult institutional population from 22,000 in 1982 to 6,450 at the end of
1996-97.
In 1997, OMH released a "Statewide Comprehensive Plan for Mental Health Services
1997-2001." The plan presents the programmatic and fiscal strategy of
implementing an integrated community-based system of care, de- emphasizing State
adult inpatient hospitalization. It estimates that the State-operated adult
inpatient census will decline to a range of 3,700 to 4,700 by the end of the
decade. As OMH approaches its long-term census targets and inpatient bed needs
diminish, plans are underway to develop alternative uses for surplus facilities.
Capital investments for these programs are primarily supported by patient
revenues through financing arrangements with DASNY.
Hospital capital programs of the Department of Health (including Roswell Park
Cancer Institute and the David Axelrod Institute for Public Health) have also
been financed by DASNY using contractual-obligation financing arrangements.
Corrections. During the 10-year period 1983-92, the State's prison system more
than doubled in size due to the unprecedented increase in demand for prison
space. Today, the system houses approximately 70,000 inmates in 70 facilities
with 3,000 buildings. Although the Department of Correctional Services ("DOCS")
capital program was focused primarily on rehabilitation of existing facilities
in the early 1990's, continued inmate population growth and projected future
growth indicate the need for both expansion of existing facilities and new
facilities. The 1997- 98 adopted budget authorizes the addition of approximately
3,100 beds over the next two years to accommodate this population growth.
Other Programs. The State also uses lease-purchase and contractual-obligation
financing arrangements for the institutional facilities of the Office of
Children and Family Services (formerly known as the Division for Youth),
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<PAGE>
and Youth Opportunity Centers; the State's housing programs; and various
environmental, economic development, and State building programs.
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DETERMINING NET ASSET VALUE FOR THE MONEY MARKET FUNDS
The Financial Reserves Fund, the Institutional Money Market Fund, the Ohio
Municipal Money Market Fund, the Prime Obligations Fund, the Tax-Free Money
Market Fund, and the U.S. Government Obligations Fund (the "Money Market Funds")
use the amortized cost method to determine their net asset value.
USE OF THE AMORTIZED COST METHOD. The Money Market Funds' use of the amortized
cost method of valuing their instruments depends on their compliance with
certain conditions contained in Rule 2a-7 of the 1940 Act. Under Rule 2a-7, the
Trustees must establish procedures reasonably designed to stabilize the net
asset value per share ("NAV"), as computed for purposes of distribution and
redemption, at $1.00 per share, taking into account current market conditions
and the Money Market Funds' investment objectives.
The Money Market Funds have elected to use the amortized cost method of
valuation pursuant to Rule 2a-7. This involves valuing an instrument at its cost
initially and thereafter assuming a constant amortization to maturity of any
discount or premium, regardless of the impact of fluctuating interest rates on
the market value of the instrument. This method may result in periods during
which value, as determined by amortized cost, is higher or lower than the price
a Money Market Fund would receive if it sold the instrument. The value of
securities in a Money Market Fund can be expected to vary inversely with changes
in prevailing interest rates.
Pursuant to Rule 2a-7, the Money Market Funds will maintain a dollar-weighted
average portfolio maturity appropriate to its objective of maintaining a stable
net asset value per share, provided that a Money Market Fund will not purchase
any security with a remaining maturity of more than 397 days (securities subject
to repurchase agreements may bear longer maturities) nor maintain a
dollar-weighted average portfolio maturity which exceeds 90 days. Should the
disposition of a Money Market Fund's security result in a dollar weighted
average portfolio maturity of more than 90 days, the Money Market Fund will
invest its available cash to reduce the average maturity to 90 days or less as
soon as possible.
The Victory Portfolios' Trustees also have established procedures reasonably
designed, taking into account current market conditions and the Victory
Portfolios' investment objectives, to stabilize the net asset value per share of
the Money Market Funds for purposes of sales and redemptions at $1.00. These
procedures include review by the Trustees, at such intervals as they deem
appropriate, to determine the extent, if any, to which the net asset value per
share of the Money Market Funds calculated by using available market quotations
deviates from $1.00 per share. In the event such deviation exceeds one-half of
one percent, Rule 2a-7 requires that the Board promptly consider what action, if
any, should be initiated. If the Trustees believe that the extent of any
deviation from a Money Market Fund's $1.00 amortized cost price per share may
result in material dilution or other unfair results to new or existing
investors, they will take such steps as they consider appropriate to eliminate
or reduce to the extent reasonably practicable any such dilution or unfair
results. These steps may include selling portfolio instruments prior to
maturity, shortening the dollar-weighted average portfolio maturity, withholding
or reducing dividends, reducing the number of a Money Market Fund's outstanding
shares without monetary consideration, or using a net asset value per share
determined by using available market quotations.
MONITORING PROCEDURES
The Trustee's procedures include monitoring the relationship between the
amortized cost value per share and the net asset value per share based upon
available indications of market value. The Trustees will decide what, if any,
steps should be taken if there is a difference of more than 0.5% between the two
values. The Trustees will take any steps they consider appropriate (such as
redemption in kind or shortening a Money Market Fund's average maturity) to
minimize any material dilution or other unfair results arising from differences
between the two methods of determining net asset value.
INVESTMENT RESTRICTIONS
Rule 2a-7 requires that the Money Market Funds limit their investments to
instruments that, in the opinion of the Trustees, present minimal credit risks
and are "Eligible Securities" as defined in Rule 2a-7. See "Investments in
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<PAGE>
Which the Funds Can Invest." An Eligible Security generally must be rated by at
least one NRSRO. Such rating may be of the particular security or of a class of
debt obligations or a debt obligation in that class that is comparable in
priority and security issued by that issuer. If the instruments are not rated,
the Trustees must determine that they are of comparable quality. The Money
Market Funds will limit the percentage allocation of their investments so as to
comply with Rule 2a-7, which generally (except in the case of the Ohio Municipal
Money Market Fund) limits to 5% of total assets the amount which may be invested
in the securities of any one issuer. Rule 2a-7 provides an exception to this 5%
limit: certain money market funds may invest up to 25% of their total assets in
the First-Tier Securities (as that term is defined by Rule 2a-7 (generally, a
First-Tier Security is a security that has received a rating in the highest
short-term rating category)) of a single issuer for a period of up to three days
after the purchase of such a security. This exception is available to all Money
Market Funds other than the Ohio Municipal Money Market Fund. Additionally,
under Rule 2a-7 the Ohio Municipal Money Market Fund, as a single state money
market fund, must limit the amount which it invests in the securities of any one
issuer to 5% of its total assets only with respect to 75% of its total assets;
provided, however, that no more than 5% of its total assets may be invested in
the securities of any one issuer unless those securities are First-Tier
Securities.
The Money Market Funds will purchase only First-Tier Securities. However, a
Money Market Fund will not necessarily dispose of a security if it ceases to be
a First-Tier Security, although if a First-Tier Security is downgraded to a
Second-Tier Security (as that term is defined by Rule 2a-7) the Adviser will
reassess promptly whether such security continues to present minimal credit
risks and will cause the Money Market Fund to take such action as it determines
is in the best interests of the Money Market Fund and its shareholders.
Rule 2a-7 imposes special diversification requirements on puts. Generally, with
respect to 75% of its total assets, immediately after the acquisition of a put,
a money market fund may have no more than 10% of its total assets invested in
securities issued by, or subject to puts from, the same institution. With
respect to the remaining 75% of its total assets, a money market fund may invest
more than 10% of its assets in puts issued by a non-controlled person so long as
the puts are First-Tier Securities. Where a put is a Second-Tier Security, no
more than 5% of the money market fund's total assets may be invested in
securities issued by, or subject to puts from, the same institution.
The Money Market Funds may attempt to increase yield by trading portfolio
securities to take advantage of short-term market variations. This policy may,
from time to time, result in high portfolio turnover. Under the amortized cost
method of valuation, neither the amount of daily income nor the net asset value
is affected by any unrealized appreciation or depreciation of the portfolio.
In periods of declining interest rates, the indicated daily yield on shares of
the Money Market Funds computed by dividing the annualized daily income on a
Money Market Fund's portfolio by the net asset value computed as above may tend
to be higher than a similar computation made by using a method of valuation
based upon market prices and estimates.
In periods of rising interest rates, the indicated daily yield on shares of the
Money Market Funds computed the same way may tend to be lower than a similar
computation made by using a method of calculation based upon market prices and
estimates.
VALUATION OF PORTFOLIOS SECURITIES FOR THE MONEY MARKET FUNDS
The net asset value of the Money Market Funds is determined and the shares of
each Money Market Fund are priced as of the Valuation Time(s) on each Business
Day. A "Business Day" is a day on which the New York Stock Exchange (the "NYSE")
and the Federal Reserve Bank of Cleveland is open for trading and any other day
(other than a day on which no shares of a Money Market Fund are tendered for
redemption and no order to purchase any shares is received) during which there
is sufficient trading in portfolio instruments that a Money Market Fund's net
assets value per share might be materially affected. The New York Stock Exchange
will not open in observance of the following holidays: New Year's Day, Martin
Luther King, Jr. Day, President's Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving, and Christmas.
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<PAGE>
VALUATION OF PORTFOLIO SECURITIES FOR THE TAXABLE BOND FUNDS AND THE
TAX-FREE BOND FUNDS
Investment securities held by the Fund For Income, the Government Mortgage Fund,
the Intermediate Income Fund, the Investment Quality Bond Fund, and the Limited
Term Income Fund (the "Taxable Bond Funds") and the National Municipal Bond
Fund, the New York Tax-Free Fund, and the Ohio Municipal Bond Fund (the
"Tax-Free Bond Funds") are valued on the basis of security valuations provided
by an independent pricing service, approved by the Trustees, which determines
value by using information with respect to transactions of a security,
quotations from dealers, market transactions in comparable securities, and
various relationships between securities. Specific investment securities which
are not priced by the approved pricing service will be valued according to
quotations obtained from dealers who are market makers in those securities.
Investment securities with less than 60 days to maturity when purchased are
valued at amortized cost which approximates market value. Investment securities
not having readily available market quotations will be priced at fair value
using a methodology approved in good faith by the Trustees.
VALUATION OF PORTFOLIO SECURITIES FOR THE EQUITY FUNDS.
Each equity security held by a Fund is valued at its last sales price on the
exchange where the security is principally traded or, lacking any sales on a
particular day, the security is valued at the mean between the closing bid and
asked prices on that day. Exchange listed convertible debt securities are valued
at the mean between the last bid and asked prices obtained from broker-dealers
or a comparable alternative, such as Bloomberg or Telerate. Each security traded
in the over-the-counter market (but not including securities reported on the
NASDAQ National Market System) is valued at the mean between the last bid and
asked prices based upon quotes furnished by market makers for such securities.
Each security reported on the NASDAQ National Market System is valued at the
sales price on the valuation date or absent a last sales price, at the mean
between the closing bid and asked prices on that day. Non-convertible debt
securities are valued on the basis of prices provided by an independent pricing
service. Prices provided by the pricing service may be determined without
exclusive reliance on quoted prices, and may reflect appropriate factors such as
institution-size trading in similar groups of securities, developments related
to special securities, yield, quality, coupon rate, maturity, type of issue,
individual trading characteristics and other market data. Securities for which
market quotations are not readily available are valued at fair value as
determined in good faith by or under the supervision of the Victory Portfolios'
officers in a manner specifically authorized by the Board of Trustees.
Short-term obligations having 60 days or less to maturity are valued on the
basis of amortized cost. For purposes of determining net asset value per share,
futures and options contracts generally will be valued 15 minutes after the
close of trading of the NYSE.
Generally, trading in foreign securities, corporate bonds, U.S. Government
securities and money market instruments is substantially completed each day at
various times prior to the close of the NYSE. The values of such securities used
in computing the net asset value of each Fund's shares are determined at such
times. Foreign currency exchange rates are also generally determined prior the
close of the NYSE. Occasionally, events affecting the values of such securities
and such exchange rates may occur between the times at which such values are
determined and the close of the NYSE which will not be reflected in the
computation of a Fund's net asset value. If events materially affecting the
value of such securities occur during such period, then these securities will be
valued at their fair value as determined in good faith by or under the
supervision of the Board of Trustees.
PERFORMANCE OF THE MONEY MARKET FUNDS
Performance for a class of shares of a Money Market Fund depends upon such
variables as:
o portfolio quality;
o average portfolio maturity;
o type of instruments in which the portfolio is invested;
o changes in interest rates on money market instruments;
o changes in Fund (class) expenses; and
o the relative amount of Fund (class) cash flow.
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<PAGE>
From time to time the Money Market Funds may advertise the performance of each
class compared to similar funds or portfolios using certain indices, reporting
services, and financial publications.
Yield. The Money Market Funds calculate the yield for a class daily, based upon
the seven days ending on the day of the calculation, called the "base period."
This yield is computed by:
o determining the net change in the value of a hypothetical account
with a balance of one share at the beginning of the base period,
with the net change excluding capital changes but including the
value of any additional shares purchased with dividends earned
from the original one share and all dividends declared on the
original and any purchased shares;
o dividing the net change in the account's value by the value of
the account at the beginning of the base period to determine the
base period return; and
o multiplying the base period return by (365/7).
To the extent that financial institutions and broker/dealers charge fees in
connection with services provided in conjunction with the Money Market Funds,
the yield for a class will be reduced for those shareholders paying those fees.
The seven-day yields of the Money Market Funds for the seven-day period ending
October 31, 1997 are listed in the following table.
<TABLE>
<CAPTION>
==================================================================================================
Yield for the Seven-Day Period Ending
Fund October 31, 1997
- --------------------------------------------------------------------------------------------------
<S> <C>
Financial Reserves Fund 5.03%
- --------------------------------------------------------------------------------------------------
Institutional Money Market Fund: Investor Shares 5.40%
- --------------------------------------------------------------------------------------------------
Institutional Money Market Fund: Select Shares 5.12%
- --------------------------------------------------------------------------------------------------
Ohio Municipal Money Market 3.03%
- --------------------------------------------------------------------------------------------------
Prime Obligations Fund 4.90%
- --------------------------------------------------------------------------------------------------
Tax-Free Money Market 3.12%
- --------------------------------------------------------------------------------------------------
U.S. Government Obligations: Investor Shares 5.11%
- --------------------------------------------------------------------------------------------------
U.S. Government Obligations: Select Shares 4.85%
==================================================================================================
</TABLE>
EFFECTIVE YIELD. The Money Market Funds' effective yields are computed by
compounding the unannualized base period return by:
o adding 1 to the base period return;
o raising the sum to the 365/7th power; and
o subtracting 1 from the result.
The effective yields of Money Market Funds for the seven-day period ending
October 31, 1997 are listed below.
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<PAGE>
<TABLE>
<CAPTION>
==================================================================================================
Effective Yield for the Seven-Day Period
Fund Ending October 31, 1997
- --------------------------------------------------------------------------------------------------
<S> <C>
Financial Reserves Fund 5.16%
- --------------------------------------------------------------------------------------------------
Institutional Money Market Fund: Investor Shares 5.55%
- --------------------------------------------------------------------------------------------------
Institutional Money Market Fund: Select Shares 5.25%
- --------------------------------------------------------------------------------------------------
Ohio Municipal Money Market 3.08%
- --------------------------------------------------------------------------------------------------
Prime Obligations Fund 5.02%
- --------------------------------------------------------------------------------------------------
Tax-Free Money Market 3.17%
- --------------------------------------------------------------------------------------------------
U.S. Government Obligations: Investor Shares 5.24%
- --------------------------------------------------------------------------------------------------
U.S. Government Obligations: Select Shares 4.97%
==================================================================================================
</TABLE>
TOTAL RETURN CALCULATIONS. Total returns quoted in advertising reflect all
aspects of a Fund's return, including the effect of reinvesting dividends and
net capital gain distributions (if any), and any change in the net asset value
per share of a Fund over the period. Average annual total returns are calculated
by determining the growth or decline in value of a hypothetical historical
investment in a Fund over a stated period, and then calculating the annually
compounded percentage rate that would have produced the same result if the rate
of growth or decline in value had been constant over the period. For example, a
cumulative total return of 100% over ten years would produce an average annual
total return of 7.18%, which is the steady annual rate of return that would
equal 100% growth on an annually compounded basis in ten years. While average
annual total returns (or "annualized total return") are a convenient means of
comparing investment alternatives, investors should realize that performance for
a Fund is not constant over time, but changes from year to year, and that
average annual total returns represent averaged figures as opposed to the actual
year-to-year performance of a Fund. When using total return and yield to compare
a Fund with other mutual funds, investors should take into consideration
permitted portfolio composition methods used to value portfolio securities and
computing offering price. The total returns of the Money Market Funds for the
one year, five year, and ten year periods ending October 31, 1997 and the period
since inception of each Money Market Fund are as follows:
<TABLE>
<CAPTION>
==========================================================================================================
For the Period Ending October 31, 1997
---------------------------------------------------------
One-Year Five- Ten- Period Since
Period Year Year Inception
Fund Period Period
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial Reserves Fund 5.04% 4.37% 5.50% 6.19%
- ----------------------------------------------------------------------------------------------------------
Institutional Money Market Fund: Investor Shares 5.46% 4.62% 5.82% 6.57%
- ----------------------------------------------------------------------------------------------------------
Institutional Money Market Fund: Select Shares 5.17% N/A N/A 4.79%
- ----------------------------------------------------------------------------------------------------------
Ohio Municipal Money Market 3.01% 2.76% 3.65% 3.74%
- ----------------------------------------------------------------------------------------------------------
Prime Obligations Fund 4.89% 4.31% 5.56% 5.61%
- ----------------------------------------------------------------------------------------------------------
Tax-Free Money Market 3.07% 2.75% N/A 3.64%
- ----------------------------------------------------------------------------------------------------------
U.S. Government Obligations: Investor Shares N/A N/A N/A 4.19%
- ----------------------------------------------------------------------------------------------------------
</TABLE>
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<PAGE>
<TABLE>
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. Government Obligations: Select Shares 4.75% 4.20% 5.34% 5.38%
==========================================================================================================
</TABLE>
In addition to average annual total returns, the Money Market Funds, on behalf
of a class, may quote unaveraged or cumulative total returns reflecting the
total income over a stated period. Average annual and cumulative total returns
may be quoted as a percentage or as a dollar amount, and may be calculated for a
single investment, a series of investments, or a series of redemptions, over any
time period. Total returns may be broken down into their components of income
and capital (including capital gains and changes in share price) in order to
illustrate the relationship of these factors and their contributions to total
return. Total returns, yields, and other performance information may be quoted
numerically or in a table, graph, or similar illustration. The cumulative total
returns of the Money Market Funds for the five year and ten year periods ending
October 31, 1997 and the period since inception are as follows:
<TABLE>
<CAPTION>
================================================================================================
Cumulative Total Returns for the Periods
Ending October 31, 1997
================================================================================================
Five-Year Ten-Year Period Since
Fund Period Period Inception
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Financial Reserves Fund 23.84% 70.81% 140.04%
- ------------------------------------------------------------------------------------------------
Institutional Money Market Fund: Investor 25.34% 76.07% 156.82%
Shares
- ------------------------------------------------------------------------------------------------
Institutional Money Market Fund: Select N/A N/A 11.95%
Shares
- ------------------------------------------------------------------------------------------------
Ohio Municipal Money Market Fund 14.58% 43.12% 57.36%
- ------------------------------------------------------------------------------------------------
Prime Obligations Fund 23.49% 71.79% 81.87%
- ------------------------------------------------------------------------------------------------
Tax-Free Money Market Fund 14.53% N/A 38.87%
- ------------------------------------------------------------------------------------------------
U.S. Government Obligations Fund: N/A N/A 4.19%
Investor Shares
- ------------------------------------------------------------------------------------------------
U.S. Government Obligations Fund: 22.84% 68.24% 77.56%
Select Shares
================================================================================================
</TABLE>
PERFORMANCE OF THE NON-MONEY MARKET FUNDS
From time to time, the "standardized yield," "distribution return," "dividend
yield," "average annual total return," "total return," and "total return at net
asset value" of an investment in each class of Non-Money Market Fund shares may
be advertised. An explanation of how yields and total returns are calculated for
each class and the components of those calculations are set forth below.
Yield and total return information may be useful to investors in reviewing the
Non-Money Market Fund's performance. A Non-Money Market Fund's advertisement of
its performance must, under applicable SEC rules, include the average annual
total returns for each class of shares of a Non-Money Market Fund for the 1, 5,
and 10- year period (or the life of the class, if less) as of the most recently
ended calendar quarter. This enables an investor to compare the Non-Money Market
Fund's performance to the performance of other funds for the same periods.
However, a number of factors should be considered before using such information
as a basis for comparison with other investments. Investments in a Non-Money
Market Fund are not insured; their yield and total return are not guaranteed and
normally will fluctuate on a daily basis. When redeemed, an investor's shares
may be worth more
- 70 -
<PAGE>
or less than their original cost. Yield and total return for any given past
period are not a prediction or representation by The Victory Portfolios of
future yields or rates of return on its shares. The yield and total returns of
the Class A and Class B shares of the Non-Money Market Funds are affected by
portfolio quality, portfolio maturity, the type of investments the Non-Money
Market Fund holds, and operating expenses.
PERFORMANCE - CLASS B SHARES
Class B shares of the Funds were initially offered on the dates listed below.
The performance figures for Class B shares for periods prior to such dates
represent the performance for Class A shares of the Funds, which have been
restated to reflect the applicable CDSC payable at redemption within 6 years
from purchase. Class B Shares are subject to an asset based sales charge of
0.75% of average daily net assets per year and other class-specific expenses.
Had these fees and expenses been reflected, performances quoted would have been
lower.
============================================================================
Date Class B Shares Were
Fund Initially Offered
- ----------------------------------------------------------------------------
Balanced Fund: Class B 3/1/96
- ----------------------------------------------------------------------------
Diversified Stock Fund: Class B 3/1/96
- ----------------------------------------------------------------------------
International Growth Fund: Class B 3/1/96
- ----------------------------------------------------------------------------
National Municipal Bond Fund: Class B 9/26/94
- ----------------------------------------------------------------------------
New York Tax-Free Fund: Class B 9/26/94
- ----------------------------------------------------------------------------
Ohio Regional Stock Fund: Class B 3/1/96
- ----------------------------------------------------------------------------
Special Value Fund: Class B 3/1/96
============================================================================
STANDARDIZED YIELD. The "yield" (referred to as "standardized yield") of the
Non-Money Market Funds for a given 30-day period for a class of shares is
calculated using the following formula set forth in rules adopted by the SEC
that apply to all funds that quote yields:
Standardized Yield = 2 [(a-b + 1)^6 - 1]
---
cd
The symbols above represent the following factors:
a = dividends and interest earned during the 30-day period.
b = expenses accrued for the period (net of any expense reimbursements).
c = the average daily number of shares of that class outstanding
during the 30-day period that were entitled to receive dividends.
d = the maximum offering price per share of the class on the last day of
the period, adjusted for undistributed net investment income.
The standardized yield of a class of shares for a 30-day period may differ from
its yield for any other period. The SEC formula assumes that the standardized
yield for a 30-day period occurs at a constant rate for a six-month period and
is annualized at the end of the six-month period. This standardized yield is not
based on actual distributions paid by a Fund to shareholders in the 30-day
period, but is a hypothetical yield based upon the net investment income from a
Fund's portfolio investments calculated for that period. The standardized yield
may differ from the "dividend yield" of that class, described below.
Additionally, because each class of shares of a Fund is subject to different
expenses, it is likely that the standardized yields of the share classes of the
Funds will differ. The yields on the Funds for the 30-day period ended October
31, 1997 were as follows.
- 71 -
<PAGE>
==============================================================================
Yield for the 30-Day Period
Fund Ended October 31, 1997
- ------------------------------------------------------------------------------
Balanced Fund: Class A 2.148079%
- ------------------------------------------------------------------------------
Balanced Fund: Class B 1.346746%
- ------------------------------------------------------------------------------
Diversified Stock Fund: Class A 0.599536%
- ------------------------------------------------------------------------------
Diversified Stock Fund: Class B (0.738527)%
- ------------------------------------------------------------------------------
Fund for Income: Class A 7.606851%
- ------------------------------------------------------------------------------
Government Mortgage Fund: Class A 5.4696032%
- ------------------------------------------------------------------------------
Growth Fund: Class A 0.045826%
- ------------------------------------------------------------------------------
Intermediate Income Fund: Class A 5.129954%
- ------------------------------------------------------------------------------
International Growth Fund: Class A 0
- ------------------------------------------------------------------------------
International Growth Fund: Class B 0
- ------------------------------------------------------------------------------
Investment Quality Bond Fund: Class A 5.102010%
- ------------------------------------------------------------------------------
Lakefront Fund 1.382171%
- ------------------------------------------------------------------------------
Limited Term Income Fund: Class A 5.2348022%
- ------------------------------------------------------------------------------
National Municipal Bond Fund: Class 3.789578%
- ------------------------------------------------------------------------------
National Municipal Bond Fund: Class B 2.956791%
- ------------------------------------------------------------------------------
New York Tax-Free Fund: Class A 3.549320%
- ------------------------------------------------------------------------------
New York Tax-Free Fund: Class B 3.011367%
- ------------------------------------------------------------------------------
Ohio Municipal Bond Fund: Class A 3.991590%
- ------------------------------------------------------------------------------
Ohio Regional Stock Fund: Class A 0.629703%
- ------------------------------------------------------------------------------
Ohio Regional Stock Fund: Class B (0.745615)%
- ------------------------------------------------------------------------------
Real Estate Investment Fund 3.939614%*
- ------------------------------------------------------------------------------
Special Growth Fund: Class A (0.861114)%
- ------------------------------------------------------------------------------
Special Value Fund: Class A 0.363240%
- ------------------------------------------------------------------------------
Special Value Fund: Class B (0.540817)%
- ------------------------------------------------------------------------------
Stock Index Fund: Class A 1.589215%
- ------------------------------------------------------------------------------
Value Fund: Class A 0.646333%
==============================================================================
* Yield for the 30-day period ended September 30, 1997.
DIVIDEND YIELD AND DISTRIBUTION RETURNS. From time to time a Non-Money Market
Fund may quote a "dividend yield" or a "distribution return" for each class.
Dividend yield is based on the Class A or Class B share dividends derived from
net investment income during a one-year period. Distribution return includes
dividends derived from net investment income and from net realized capital gains
declared during a one-year period. The "dividend yield" is calculated as
follows:
Dividend Yield = Dividends of the Class for a Period of One-Year
of the Class --------------------------------------------------
Max. Offering Price of the Class (last day of period)
- 72 -
<PAGE>
For Class A shares, the maximum offering price includes the maximum front-end
sales charge. For Class B shares, the maximum offering price is the net asset
value per share, without considering the effect of the CDSC.
- 73 -
<PAGE>
From time to time similar yield or distribution return calculations may also be
made using the Class A net asset value (instead of its respective maximum
offering price) at the end of the period. The dividend yields on Class A shares
at maximum offering price and net asset value, and distribution returns on Class
A shares at maximum offering price and net asset value as of October 31, 1997
were as follows:
<TABLE>
<CAPTION>
==========================================================================================================
For the One-Year Period Ended October 31, 1997
==========================================================================================================
Distribution
Dividend Dividend Return at Distribution
Yield Yield Maximum Return
Fund at Maximum at Net Asset Offering at Net Asset
Offering Price Value Price Value
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balanced Fund: Class A 2.37% 2.51% 4.91% 5.21%
- ----------------------------------------------------------------------------------------------------------
Diversified Stock Fund: Class A 0.85% 0.91% 10.58% 11.23%
- ----------------------------------------------------------------------------------------------------------
Fund for Income: Class A 6.71% 6.84% 6.71% 6.84%
- ----------------------------------------------------------------------------------------------------------
Government Mortgage Fund 5.89% 6.25% 5.89% 6.25%
- ----------------------------------------------------------------------------------------------------------
Growth Fund: Class A 0.21% 0.22% 3.44% 3.65%
- ----------------------------------------------------------------------------------------------------------
Intermediate Income Fund: Class A 5.50% 5.83% 5.50% 5.83%
- ----------------------------------------------------------------------------------------------------------
International Growth Fund: Class A 0.10% 0.10% 3.32% 3.52%
- ----------------------------------------------------------------------------------------------------------
Investment Quality Bond Fund 5.40% 5.74% 5.40% 5.74%
- ----------------------------------------------------------------------------------------------------------
Limited Term Income Fund 6.01% 6.13% 6.01% 6.13%
- ----------------------------------------------------------------------------------------------------------
National Municipal Bond Fund: 4.07% 4.32% 4.07% 4.32%
Class A
- ----------------------------------------------------------------------------------------------------------
New York Tax-Free Fund: Class A 5.32% 5.64% 5.65% 5.99%
- ----------------------------------------------------------------------------------------------------------
Ohio Municipal Bond Fund 4.26% 4.52% 4.26% 4.52%
- ----------------------------------------------------------------------------------------------------------
Ohio Regional Stock Fund: Class A 0.57% 0.61% 1.97% 2.09%
- ----------------------------------------------------------------------------------------------------------
Special Growth Fund 0.00% 0.00% 3.78% 4.01%
- ----------------------------------------------------------------------------------------------------------
Special Value Fund: Class A 0.65% 0.69% 6.03% 6.39%
- ----------------------------------------------------------------------------------------------------------
Stock Index Fund 1.48% 1.57% 3.12% 3.31%
- ----------------------------------------------------------------------------------------------------------
Value Fund 0.87% 0.92% 4.55% 4.82%
==========================================================================================================
</TABLE>
The dividend yield on Class B shares with and without the CDSC, and distribution
returns on Class B shares with and without the CDSC as of October 31, 1997 were
as follows.
- 74 -
<PAGE>
<TABLE>
<CAPTION>
==========================================================================================================
For the One-Year Period Ended October 31, 1997
==========================================================================================================
Dividend
Dividend Yield Distribution Distribution
Yield with without Returns with Returns
Fund CDSC CDSC CDSC without CDSC
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balanced Fund: Class B 1.20% 1.26% 3.76% 3.95%
- ----------------------------------------------------------------------------------------------------------
Diversified Stock Fund: Class B 0.27% 0.28% 10.15% 10.69%
- ----------------------------------------------------------------------------------------------------------
International Growth Fund: Class B 0.00% 0.00% 3.31% 3.48%
- ----------------------------------------------------------------------------------------------------------
National Municipal Bond Fund:
Class B 2.95% 3.08% 2.92% 3.08%
- ----------------------------------------------------------------------------------------------------------
New York Tax-Free Fund: Class B 4.55% 4.79% 4.88% 5.14%
- ----------------------------------------------------------------------------------------------------------
Ohio Regional Stock Fund: Class B 0.00% 0.00% 1.43% 1.50%
- ----------------------------------------------------------------------------------------------------------
Special Value Fund: Class B 0.12% 0.13% 5.60% 5.90%
==========================================================================================================
</TABLE>
Total Returns. The "average annual total return" of a Fund, or of each class of
a Fund, is an average annual compounded rate of return for each year in a
specified number of years. It is the rate of return based on the change in value
of a hypothetical initial investment of $1,000 ("P" in the formula below) held
for a number of years ("n") to achieve an Ending Redeemable Value ("ERV"),
according to the following formula:
(ERV )1/n - 1 = Average Annual Total Return
---
( P )
The cumulative "total return" calculation measures the change in value of a
hypothetical investment of $1,000 over an entire period of years. Its
calculation uses some of the same factors as average annual total return, but it
does not average the rate of return on an annual basis. Total return is
determined as follows:
ERV - P = Total Return
-------
P
In calculating total returns for the Funds, and for Class A shares of the Funds,
the current maximum sales charge (as a percentage of the offering price) is
deducted from the initial investment ("P") (unless the return is shown at net
asset value, as discussed below). For Class B shares, the payment of the
applicable CDSC (5.0% for the first year, 4.0% for second year, 3.0% for the
third and fourth years, 2.0% for the fifth year, 1.0% for the sixth year and
none thereafter) is applied to the investment result for the time period shown
(unless the total return is shown at net asset value, as described below). Total
returns also assume that all dividends and net capital gains distributions
during the period are reinvested to buy additional shares at net asset value per
share, and that the investment is redeemed at the end of the period. The average
annual total return and cumulative total return on Fund shares, and Class A
shares, for the period from the commencement of operations to October 31, 1996
(life of fund) at maximum offering price is shown on the table that follows. The
average annual total return for the one and five year periods (when applicable)
ended October 31, 1997 also are shown on the table that follows.
- 75 -
<PAGE>
<TABLE>
<CAPTION>
============================================================================================================
Average
Annual Average Annual
Total Cumulative Average Annual Total Return at
Return for Total Return Total Return at Maximum
the Life of for the Life Maximum Offering Price*
the Fund at of the Fund at Offering Price* for the Five-
Maximum Maximum for the One-Year Year Period
Maximum Offering Offering Period Ended Ended October
Fund Sales Charge Price* Price* October 31, 31, 1997
1997
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balanced Fund: 5.75% 11.84% 54.64% 12.20% N/A
Class A
- ------------------------------------------------------------------------------------------------------------
Balanced Fund: 5.00% 12.48% 58.14% 13.43% N/A
Class B
- ------------------------------------------------------------------------------------------------------------
Diversified 5.75% 15.23% 212.51% 20.61% 18.32%
Stock Fund:
Class A
- ------------------------------------------------------------------------------------------------------------
Diversified 5.00% 15.85% 226.41% 22.48% 19.25%
Stock Fund:
Class B
- ------------------------------------------------------------------------------------------------------------
Fund for Income 2.00% 8.13% 127.12% 5.42% 5.64%
- ------------------------------------------------------------------------------------------------------------
Government 5.75% 7.45% 71.02% 1.97% 5.27%
Mortgage Fund
- ------------------------------------------------------------------------------------------------------------
Growth Fund 5.75% 17.85% 90.21% 21.65% N/A
- ------------------------------------------------------------------------------------------------------------
Intermediate 5.75% 3.51% 14.40% 0.53% N/A
Income Fund
- ------------------------------------------------------------------------------------------------------------
International 5.75% 5.37% 47.74% (0.03)% 8.97%
Growth Fund:
Class A
- ------------------------------------------------------------------------------------------------------------
International 5.00% 5.93% 53.64% 0.68% 9.67%
Growth Fund:
Class B
- ------------------------------------------------------------------------------------------------------------
Investment 5.75% 4.10% 16.96% 1.45% N/A
Quality Bond
Fund
- ------------------------------------------------------------------------------------------------------------
Lakefront Fund 5.75% 7.32% 7.32% N/A N/A
- ------------------------------------------------------------------------------------------------------------
Limited Term 2.00% 6.13% 61.32% 3.51% 4.54%
Income Fund
- ------------------------------------------------------------------------------------------------------------
National 5.75% 4.34% 17.26% 1.88% N/A
Municipal Bond
Fund: Class A
- ------------------------------------------------------------------------------------------------------------
National 5.00% 4.46% 17.73% 2.74% N/A
Municipal Bond
Fund: Class B
</TABLE>
- 76 -
<PAGE>
<TABLE>
<CAPTION>
============================================================================================================
Average
Annual Average Annual
Total Cumulative Average Annual Total Return at
Return for Total Return Total Return at Maximum
the Life of for the Life Maximum Offering Price*
the Fund at of the Fund at Offering Price* for the Five-
Maximum Maximum for the One-Year Year Period
Maximum Offering Offering Period Ended Ended October
Fund Sales Charge Price* Price* October 31, 31, 1997
1997
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
New York Tax- 5.75% 5.96% 47.62% (0.34)% 5.14%
Free Fund:
Class A
- ------------------------------------------------------------------------------------------------------------
New York Tax- 5.00% 6.50% 52.70% 0.89% 5.69%
Free Fund:
Class B
- ------------------------------------------------------------------------------------------------------------
Ohio Municipal 5.75% 6.96% 65.17% 1.17% 6.29%
Bond Fund
- ------------------------------------------------------------------------------------------------------------
Ohio Regional 5.75% 14.25% 191.89% 26.84% 17.47%
Stock Fund:
Class A
- ------------------------------------------------------------------------------------------------------------
Ohio Regional 5.00% 14.80% 203.13% 28.71% 18.26%
Stock Fund:
Class B
- ------------------------------------------------------------------------------------------------------------
Real Estate 5.75% 15.38% 15.38% N/A N/A
Investment Fund
- ------------------------------------------------------------------------------------------------------------
Special Growth 5.75% 13.32% 61.01% 13.70% N/A
Fund
- ------------------------------------------------------------------------------------------------------------
Special Value 5.75% 16.28% 80.51% 19.77% N/A
Fund: Class A
- ------------------------------------------------------------------------------------------------------------
Special Value 5.00% 17.00% 84.80% 21.41% N/A
Fund: Class B
- ------------------------------------------------------------------------------------------------------------
Stock Index 5.75% 19.18% 98.78% 23.59% N/A
Fund
- ------------------------------------------------------------------------------------------------------------
Value Fund 5.75% 17.62% 88.78% 19.89% N/A
============================================================================================================
</TABLE>
*For Class B Shares, the calculations are made with the CDSC.
From time to time the Non-Money Market Funds also may quote an "average annual
total return at net asset value" or a cumulative "total return at net asset
value." It is based on the difference in net asset value per share at the
beginning and the end of the period for a hypothetical investment in that class
of shares (without considering front-end or contingent deferred sales charges)
and takes into consideration the reinvestment of dividends and capital gains
distributions. The average annual total return and cumulative total return on
Fund shares, and Class A shares of the Funds, at net asset value for the period
from the commencement of operations to October 31, 1997 (life of fund) are shown
in the table that follows. The average annual total return and cumulative total
return on Class B shares without the CDSC for the period from the commencement
of operations to October 31, 1997 are also shown below.
- 77 -
<PAGE>
<TABLE>
<CAPTION>
=======================================================================================================
For period from commencement of operations to Average Annual Total
October 31, 1997 Return at Net Asset
Value* For Year Ended
October 31, 1997
Fund
-----------------------------------------------------
Average Annual Total Cumulative Total Return
Return at Net Asset at Net Asset Value*
Value*
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balanced Fund: Class
A 13.55% 64.07% 19.02%
- -------------------------------------------------------------------------------------------------------
Balanced Fund: Class
B 13.03% 61.14% 17.43%
- -------------------------------------------------------------------------------------------------------
Diversified Stock
Fund: Class A 16.08% 231.56% 27.96%
- -------------------------------------------------------------------------------------------------------
Diversified Stock
Fund: Class B 15.85% 226.41% 26.48%
- -------------------------------------------------------------------------------------------------------
Fund for Income 8.34% 131.66% 7.58%
- -------------------------------------------------------------------------------------------------------
Government Mortgage
Fund 8.31% 81.45% 8.22%
- -------------------------------------------------------------------------------------------------------
Growth Fund 19.64% 101.82% 29.08%
- -------------------------------------------------------------------------------------------------------
Intermediate Income
Fund 5.10% 21.38% 6.62%
- -------------------------------------------------------------------------------------------------------
International Growth
Fund: Class A 6.21% 56.75 6.04%
- -------------------------------------------------------------------------------------------------------
International Growth
Fund: Class B 5.93% 53.64% 4.68%
- -------------------------------------------------------------------------------------------------------
Investment Quality
Bond Fund 5.70% 24.10% 7.67%
- -------------------------------------------------------------------------------------------------------
Lakefront Fund 13.87% 13.87% N/A
- -------------------------------------------------------------------------------------------------------
Limited Term Income
Fund 6.39% 64.55 5.75
- -------------------------------------------------------------------------------------------------------
National Municipal
Bond Fund: Class A 6.01% 24.41% 8.10%
- -------------------------------------------------------------------------------------------------------
National Municipal
Bond Fund: Class B 5.16% 20.73% 6.74%
- -------------------------------------------------------------------------------------------------------
New York Tax-Free
Fund: Class A 6.90% 56.60% 5.77%
- -------------------------------------------------------------------------------------------------------
New York Tax-Free
Fund: Class B 6.50% 52.70% 4.88%
- -------------------------------------------------------------------------------------------------------
Ohio Municipal Bond
Fund 7.81% 75.25% 7.37%
- -------------------------------------------------------------------------------------------------------
Ohio Regional Stock
Fund: Class A 15.10% 209.69% 34.61%
- 78 -
<PAGE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Ohio Regional Stock
Fund: Class B 14.80% 203.13% 32.71%
- -------------------------------------------------------------------------------------------------------
Real Estate
Investment Fund 22.42% 22.42% N/A
- -------------------------------------------------------------------------------------------------------
Special Growth Fund 15.10% 70.84% 20.62%
- -------------------------------------------------------------------------------------------------------
Special Value Fund:
Class A 18.06% 91.53 27.05%
- -------------------------------------------------------------------------------------------------------
Special Value Fund:
Class B 17.48% 87.80% 25.41%
- -------------------------------------------------------------------------------------------------------
Stock Index Fund 21.00% 110.91% 31.16%
- -------------------------------------------------------------------------------------------------------
Value Fund 19.41% 100.30% 27.24%
=======================================================================================================
</TABLE>
* For Class B shares, calculations are made without the CDSC.
OTHER PERFORMANCE COMPARISONS.
From time to time a Fund may publish the ranking of its performance or the
performance of its Class A or Class B shares by Lipper Analytical Services, Inc.
("Lipper"), a widely-recognized independent mutual fund monitoring service.
Lipper monitors the performance of regulated investment companies, including the
Non-Money Market Funds, and ranks the performance of the Funds and their classes
against all other funds in similar categories, for both equity and fixed income
funds. The Lipper performance rankings are based on total return that includes
the reinvestment of capital gains distributions and income dividends but does
not take sales charges or taxes into consideration.
From time to time a Fund may publish the ranking of its performance or
performance of its Class A or Class B shares by Morningstar, Inc., an
independent mutual fund monitoring service that ranks mutual funds, including
the Non-Money Market Funds, in broad investment categories (domestic equity,
international equity taxable bond, municipal bond or other) monthly, based upon
each fund's three, five, and ten-year average annual total returns (when
available) and a risk adjustment factor that reflects fund performance relative
to three-month U.S. Treasury bill monthly returns. Such returns are adjusted for
fees and sales loads. There are five ranking categories with a corresponding
number of stars: highest (5), above average (4), neutral (3), below average (2),
and lowest (1). Ten percent of the funds, series or classes in an investment
category receive five stars, 22.5% receive four stars, 35% receive three stars,
22.5% receive two stars, and the bottom 10% receive one star.
The total return on an investment made in a Fund or in Class A or Class B shares
of a Fund may be compared with the performance for the same period of one or
more of the following indices: the Consumer Price Index, the Salomon Brothers
World Government Bond Index, the Standard & Poor's 500 Index, the Shearson
Lehman Government/Corporate Bond Index, the Lehman Aggregate Bond Index, and the
J.P. Morgan Government Bond Index. Other indices may be used from time to time.
The Consumer Price Index generally is considered to be a measure of inflation.
The Salomon Brothers World Government Bond Index generally represents the
performance of government debt securities of various markets throughout the
world, including the United States. The Lehman Government/Corporate Bond Index
generally represents the performance of intermediate and long-term government
and investment grade corporate debt securities. The Lehman Aggregate Bond Index
measures the performance of U.S. corporate bond issues, U.S. government
securities and mortgage-backed securities. The J.P. Morgan Government Bond Index
generally represents the performance of government bonds issued by various
countries including the United States. The S&P 500 Index is a composite index of
500 common stocks generally regarded as an index of U.S. stock market
performance. The foregoing bond indices are unmanaged indices of securities that
do not reflect reinvestment of capital gains or take investment costs into
consideration, as these items are not applicable to indices.
- 79 -
<PAGE>
From time to time, the yields and the total returns of the Funds or Class A or
Class B shares of a Non-Money Market Fund may be quoted in and compared to other
mutual funds with similar investment objectives in advertisements, shareholder
reports or other communications to shareholders. A Fund also may include
calculations in such communications that describe hypothetical investment
results. (Such performance examples are based on an express set of assumptions
and are not indicative of the performance of any Fund.) Such calculations may
from time to time include discussions or illustrations of the effects of
compounding in advertisements. "Compounding" refers to the fact that, if
dividends or other distributions on a Fund's investment are reinvested by being
paid in additional Fund shares, any future income or capital appreciation of a
Fund would increase the value, not only of the original Fund investment, but
also of the additional Fund shares received through reinvestment. As a result,
the value of a Fund investment would increase more quickly than if dividends or
other distributions had been paid in cash. A Fund may also include discussions
or illustrations of the potential investment goals of a prospective investor
(including but not limited to tax and/or retirement planning), investment
management techniques, policies or investment suitability of a Fund, economic
conditions, legislative developments (including pending legislation), the
effects of inflation and historical performance of various asset classes,
including but not limited to stocks, bonds and Treasury bills. From time to time
advertisements or communications to shareholders may summarize the substance of
information contained in shareholder reports (including the investment
composition of a Fund, as well as the views of the investment adviser as to
current market, economic, trade and interest rate trends, legislative,
regulatory and monetary developments, investment strategies and related matters
believed to be of relevance to a Fund.) A Fund may also include in
advertisements, charts, graphs or drawings which illustrate the potential risks
and rewards of investment in various investment vehicles, including but not
limited to stock, bonds, and Treasury bills, as compared to an investment in
shares of a Fund, as well as charts or graphs which illustrate strategies such
as dollar cost averaging, and comparisons of hypothetical yields of investment
in tax-exempt versus taxable investments. In addition, advertisements or
shareholder communications may include a discussion of certain attributes or
benefits to be derived by an investment in a Fund. Such advertisements or
communications may include symbols, headlines or other material which highlight
or summarize the information discussed in more detail therein. With proper
authorization, a Fund may reprint articles (or excerpts) written regarding a
Fund and provide them to prospective shareholders. Performance information with
respect to the Funds is generally available by calling 1-800-KEY-FUND.
Investors may also judge, and a Fund may at times advertise, the performance of
a Fund or of Class A or Class B shares of a Fund by comparing it to the
performance of other mutual funds or mutual fund portfolios with comparable
investment objectives and policies, which performance may be contained in
various unmanaged mutual fund or market indices or rankings such as those
prepared by Dow Jones & Co., Inc., Standard & Poor's Corporation, Lehman
Brothers, Merrill Lynch, and Salomon Brothers, and in publications issued by
Lipper Analytical Services, Inc. and in the following publications: IBC's Money
Fund Reports, Value Line Mutual Fund Survey, Morningstar, CDA/Wiesenberger,
Money Magazine, Forbes, Barron's, The Wall Street Journal, The New York Times,
Business Week, American Banker, Fortune, Institutional Investor, Ibbotson
Associates, and U.S.A. Today. In addition to yield information, general
information about a Fund that appears in a publication such as those mentioned
above may also be quoted or reproduced in advertisements or in reports to
shareholders.
Advertisements and sales literature may include discussions of specifics of a
portfolio manager's investment strategy and process, including, but not limited
to, descriptions of security selection and analysis. Advertisements may also
include descriptive information about the investment adviser, including, but not
limited to, its status within the industry, other services and products it makes
available, total assets under management, and its investment philosophy.
When comparing yield, total return, and investment risk of an investment in
shares of a Fund with other investments, investors should understand that
certain other investments have different risk characteristics than an investment
in shares of a Fund. For example, certificates of deposit may have fixed rates
of return and may be insured as to principal and interest by the FDIC, while a
Fund's returns will fluctuate and its share values and returns are not
guaranteed. Money market accounts offered by banks also may be insured by the
FDIC and may offer stability of principal. U.S. Treasury securities are
guaranteed as to principal and interest by the full faith and credit of the U.S.
Government. Money market mutual funds may seek to maintain a fixed price per
share.
- 80 -
<PAGE>
ADDITIONAL PURCHASE, EXCHANGE, AND REDEMPTION INFORMATION
The New York Stock Exchange ("NYSE") holiday closing schedule indicated in the
SAI under "Valuation of Portfolio Securities for the Money Market Funds" is
subject to change.
When the NYSE or the Federal Reserve Board of Cleveland is closed, or when
trading is restricted for any reason other than its customary weekend or holiday
closings, or under emergency circumstances as determined by the SEC to warrant
such action, the Funds will determine their net asset value at Valuation Time. A
Fund's net asset value may be affected to the extent that its securities are
traded on days that are not Business Days.
The Victory Portfolios has elected, pursuant to Rule 18f-1 under the 1940 Act,
to redeem shares of the Balanced Fund, Diversified Stock Fund, Fund for Income,
Government Mortgage Fund, Growth Fund, Intermediate Income Fund, International
Growth Fund, Investment Quality Bond Fund, Limited Term Income Fund, National
Municipal Bond Fund, New York Tax-Free Fund, Ohio Municipal Bond Fund, Ohio
Regional Stock Fund, Special Growth Fund, Special Value Fund, Stock Index Fund,
and Value Fund solely in cash up to the lesser of $250,000 or 1% of the net
asset value of the Fund during any 90-day period for any one shareholder. The
remaining portion of the redemption may be made in securities or other property,
valued for this purpose as they are valued in computing the net asset value of
each class of the Fund. Shareholders receiving securities or other property on
redemption may realize a gain or loss for tax purposes and may incur additional
costs as well as the associated inconveniences of holding and/or disposing of
such securities or other property.
Pursuant to Rule 11a-3 under the 1940 Act, the Funds are required to give
shareholders at least 60 days' notice prior to terminating or modifying a Fund's
exchange privilege. The 60-day notification requirement may, however, be waived
if (1) the only effect of a modification would be to reduce or eliminate an
administrative fee, redemption fee, or deferred sales charge ordinarily payable
at the time of exchange or (2) a Fund temporarily suspends the offering of
shares as permitted under the 1940 Act or by the SEC or because it is unable to
invest amounts effectively in accordance with its investment objective and
policies.
The Funds reserve the right at any time without prior notice to shareholders to
refuse exchange purchases by any person or group if, in the Adviser's judgment,
a Fund would be unable to invest effectively in accordance with its investment
objective and policies, or would otherwise potentially be adversely affected.
PURCHASING SHARES.
ALTERNATIVE SALES ARRANGEMENTS - CLASS A AND CLASS B SHARES. The alternative
sales arrangements permit an investor to choose the method of purchasing shares
that is more beneficial depending on the amount of the purchase, the length of
time the investor expects to hold shares and other relevant circumstances.
Investors should understand that the purpose and function of the deferred sales
charge and asset-based sales charge with respect to Class B shares are the same
as those of the initial sales charge with respect to Class A shares. Any
salesperson or other person entitled to receive compensation for selling Fund
shares may receive different compensation with respect to one class of shares on
behalf of a single investor (not including dealer "street name" or omnibus
accounts) because generally it will be more advantageous for that investor to
purchase Class A shares of a Fund instead.
The two classes of shares each represent an interest in the same portfolio
investments of a Fund. However, each class has different shareholder privileges
and features. The net income attributable to Class B shares and the dividends
payable on Class B shares will be reduced by incremental expenses borne solely
by that class, including the asset-based sales charge to which Class B shares
are subject.
CLASS B CONVERSION FEATURE. Ninety-six months after an investor's purchase order
for Class B shares is accepted, such "Matured Class B Shares" automatically will
convert to Class A shares, on the basis of the relative net asset value of the
two classes, without the imposition of any sales load or other charge. Each time
any Matured Class B shares convert to Class A shares, any Class B shares
acquired by the reinvestment of dividends or distributions on such Matured Class
B shares that are still held will also convert to Class A shares, on the same
basis. The conversion feature is intended to relieve holders of Matured Class B
shares of the asset-based sales charge under
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the Class B Distribution Plan after such shares have been outstanding long
enough that the Distributor may have been compensated for distribution expenses
related to such shares.
The conversion of Matured Class B shares to Class A shares is subject to the
continuing availability of a private letter ruling from the Internal Revenue
Service, or an opinion of counsel or tax adviser, to the effect that the
conversion of Matured Class B shares does not constitute a taxable event for the
holder under Federal income tax law. If such a revenue ruling or opinion is no
longer available, the automatic conversion feature may be suspended, in which
event no further conversion of Matured Class B shares would occur while such
suspension remained in effect. Although Matured Class B shares could then be
exchanged for Class A shares on the basis of relative net asset value of the two
classes, without the imposition of a sales charge or fee, such exchange could
constitute a taxable event for the holder, and absent such exchange, Class B
shares might continue to be subject to the asset-based sales charge for longer
than six years.
The methodology for calculating the net asset value, dividends and distributions
of the Fund's Class A and Class B shares recognizes two types of expenses.
General expenses that do not pertain specifically to either class are allocated
to the shares of each class, based upon the percentage that the net assets of
such class bears to a Fund's total net assets, and then pro rata to each
outstanding share within a given class. Such general expenses include (1)
management fees, (2) legal, bookkeeping and audit fees, (3) printing and mailing
costs of shareholder reports, prospectuses, statements of additional information
and other materials for current shareholders, (4) fees to the Trustees who are
not affiliated with the Adviser, (5) custodian expenses, (6) share issuance
costs, (7) organization and start-up costs, (8) interest, taxes and brokerage
commissions, and (9) non-recurring expenses, such as litigation costs. Other
expenses that are directly attributable to a class are allocated equally to each
outstanding share within that class. Such expenses include (1) Rule 12b-1
distribution fees and shareholder servicing fees, (2) incremental transfer and
shareholder servicing agent fees and expenses, (3) registration fees, and (4)
shareholder meeting expenses, to the extent that such expenses pertain to a
specific class rather than to a Fund as a whole.
REDUCED SALES CHARGE. Reduced sales charges are available for purchases of
$50,000 or more of Class A shares of a Fund alone or in combination with
purchases of other Class A shares of the Victory Portfolios. To obtain the
reduction of the sales charge, you or your Investment Professional must notify
the Transfer Agent at the time of purchase whenever a quantity discount is
applicable to your purchase.
In addition to investing at one time in any combination of Class A shares of the
Victory Portfolios in an amount entitling you to a reduced sales charge, you may
qualify for a reduction in the sales charge under the following programs:
COMBINED PURCHASES. When you invest in Class A shares of the Victory Portfolios
for several accounts at the same time, you may combine these investments into a
single transaction if purchased through one Investment Professional, and if the
total is $50,000 or more. The following may qualify for this privilege: an
individual, or "company" as defined in Section 2(a)(8) of the 1940 Act; an
individual, spouse, and their children under age 21 purchasing for his, her, or
their own account; a trustee, administrator or other fiduciary purchasing for a
single trust estate or single fiduciary account or for a single or a
parent-subsidiary group of "employee benefit plans" (as defined in Section 3(3)
of ERISA); and tax-exempt organizations under Section 501(c)(3) of the Internal
Revenue Code.
RIGHTS OF ACCUMULATION. "Rights of Accumulation" permit reduced sales charges on
future purchases of Class A shares after you have reached a new breakpoint. You
can add the value of existing Victory Portfolios Class A shares held by you,
your spouse, and your children under age 21, determined at the previous day's
net asset value at the close of business, to the amount of your new purchase
valued at the current offering price to determine your reduced sales charge.
LETTER OF INTENT. If you anticipate purchasing $50,000 or more of shares of a
Fund alone or in combination with Class A shares of certain other Victory
Portfolios within a 13-month period, you may obtain shares of the portfolios at
the same reduced sales charge as though the total quantity were invested in one
lump sum, by filing a non-binding Letter of Intent (the "Letter") within 90 days
of the start of the purchases. You must start with a minimum initial investment
of 5% of the projected purchase amount. Each investment you make after signing
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the Letter will be entitled to the sales charge applicable to the total
investment indicated in the Letter. For example, a $2,500 purchase toward a
$60,000 Letter would receive the same reduced sales charge as if the $60,000 had
been invested at one time. To ensure that the reduced price will be received on
future purchases, you or your Investment Professional must inform the Transfer
Agent that the Letter is in effect each time shares are purchased. Neither
income dividends nor capital gain distributions taken in additional shares will
apply toward the completion of the Letter.
You are not obligated to complete the additional purchases contemplated by a
Letter. If you do not complete your purchase under the Letter within the
13-month period, your sales charge will be adjusted upward, corresponding to the
amount actually purchased, and if after written notice, you do not pay the
increased sales charge, sufficient escrowed shares will be redeemed to pay such
charge.
If you purchase more than the amount specified in the Letter and qualify for a
further sales charge reduction, the sales charge will be adjusted to reflect
your total purchase at the end of 13 months. Surplus funds will be applied to
the purchase of additional shares at the then current offering price applicable
to the total purchase.
EXCHANGING SHARES.
Shares of any Victory Money Market Fund may be exchanged for shares of any of
the Victory Portfolios, including Class A and Class B shares of the Victory
Portfolios. Exchanges for Class A shares of the Victory Portfolios may be
subject to payment of a sales charge.
Shares of a Fund may be exchanged for the same class of shares of any other fund
of the Victory Portfolios. For example, an investor can exchange Class B shares
of a Fund only for Class B shares of another Fund. At present, not all Funds of
the Victory Portfolios offer multiple classes of shares. If a Fund has only one
class of shares that does not have a class designation, that class is "Class A"
for exchange purposes. When Class B shares are redeemed to effect an exchange,
the priorities described in the Prospectuses for the imposition of the Class B
CDSC will be followed in determining the order in which the shares are
exchanged. Shareholders should take into account the effect of any exchange on
the applicability and rate of any CDSC that might be imposed in the subsequent
redemption of remaining shares. Shareholders owning shares of both classes must
specify whether they intend to exchange Class A or Class B shares. If you do not
make a selection, your exchange will be made in Class A shares.
REDEEMING SHARES.
REINSTATEMENT PRIVILEGE. Within 90 days of a redemption, a shareholder may
reinvest all or part of the redemption proceeds of (1) Class A shares, or (2)
Class B shares that were subject to the Class B CDSC when redeemed, in Class A
shares of a Fund or any of the other Victory Portfolios into which shares of the
Fund are exchangeable as described below, at the net asset value next computed
after receipt by the Transfer Agent of the reinvestment order. No service charge
is currently made for reinvestment in shares of the Funds. The shareholder must
ask the Distributor for such privilege at the time of reinvestment. Any capital
gain that was realized when the shares were redeemed is taxable, and
reinvestment will not alter any capital gains tax payable on that gain. If there
has been a capital loss on the redemption, some or all of the loss may not be
tax deductible, depending on the timing and amount of the reinvestment. Under
the Code, if the redemption proceeds of Fund shares on which a sales charge was
paid are reinvested in shares of a Fund or another of the Victory Portfolios
within 90 days of payment of the sales charge, the shareholder's basis in the
shares of the Fund that were redeemed may not include the amount of the sales
charge paid. That would reduce the loss or increase the gain recognized from
redemption. The Funds may amend, suspend, or cease offering this reinvestment
privilege at any time as to shares redeemed after the date of such amendment,
suspension, or cessation. The reinstatement must be into an account bearing the
same registration.
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DIVIDENDS AND DISTRIBUTIONS
The Funds distribute substantially all of their net investment income and net
capital gains, if any, to shareholders within each calendar year as well as on a
fiscal year basis to the extent required for the Funds to qualify for favorable
federal tax treatment. The Funds ordinarily declare and pay dividends,
separately for Class A and Class B shares, from their net investment income as
follows.
<TABLE>
<CAPTION>
Income Capital
Fund Dividends Gains
- -----------------------------------------------------------------------------------------------------
<S> <C> <C>
Balanced Fund Declared and paid Monthly Declared and paid Annually
Diversified Stock Fund Declared and paid Quarterly Declared and paid Annually
Fund for Income Declared and paid Monthly Declared and paid Annually
Government Mortgage Fund Declared and paid Monthly Declared and paid Annually
Growth Fund Declared and paid Quarterly Declared and paid Annually
Intermediate Income Fund Declared and paid Monthly Declared and paid Annually
International Growth Fund Declared and paid Quarterly Declared and paid Annually
Investment Quality Bond Fund Declared and paid Monthly Declared and paid Annually
Lakefront Fund Declared and paid Quarterly Declared and paid Annually
Limited Term Income Fund Declared and paid Monthly Declared and paid Annually
Money Market Funds Declared Daily and paid Monthly Declared and paid Annually
National Municipal Bond Fund Declared and paid Monthly Declared and paid Annually
New York Tax-Free Fund Declared and paid Monthly Declared and paid Annually
Ohio Municipal Bond Fund Declared and paid Monthly Declared and paid Annually
Ohio Regional Stock Fund Declared and paid Quarterly Declared and paid Annually
Real Estate Investment Fund Declared and paid Quarterly Declared and paid Annually
Special Growth Fund Declared and paid Quarterly Declared and paid Annually
Special Value Fund Declared and paid Quarterly Declared and paid Annually
Stock Index Fund Declared and paid Quarterly Declared and paid Annually
Value Fund Declared and paid Quarterly Declared and paid Annually
- -----------------------------------------------------------------------------------------------------
</TABLE>
The amount of a class's distributions may vary from time to time depending on
market conditions, the composition of a Fund's portfolio, and expenses borne by
a Fund or borne separately by a class, as described in "Alternative Sales
Arrangements - Class A and Class B," above. Dividends are calculated in the same
manner, at the same time and on the same day for shares of each class. However,
dividends on Class B shares are expected to be lower as a result of the
asset-based sales charge on Class B shares, and Class B dividends will also
differ in amount as a consequence of any difference in net asset value between
Class A and Class B shares.
For this purpose, the net income of a Fund, from the time of the immediately
preceding determination thereof, shall consist of all interest income accrued on
the portfolio assets of the Fund, dividend income, if any, income from
securities loans, if any, and realized capital gains and losses on the Fund's
assets, less all expenses and liabilities
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of the Fund chargeable against income. Interest income shall include discount
earned, including both original issue and market discount, on discount paper
accrued ratably to the date of maturity. Expenses, including the compensation
payable to the Adviser, are accrued each day. The expenses and liabilities of a
Fund shall include those appropriately allocable to the Fund as well as a share
of the general expenses and liabilities of the Victory Portfolios in proportion
to the Fund's share of the total net assets of the Victory Portfolios.
TAXES
Information set forth in the Prospectuses for the Funds and this SAI that
relates to federal income taxation is only a summary of certain key tax
considerations generally affecting purchasers of shares of the Funds. The
following is only a summary of certain additional federal income tax
considerations generally affecting each Fund and its shareholders that are not
described in the Prospectuses. No attempt is made to present a complete
explanation of the tax treatment of the Funds or the implications to
shareholders, and this discussion is not intended as a substitute for careful
tax planning. Accordingly, potential purchasers of shares of the Funds are urged
to consult their tax advisers with specific reference to their own tax
circumstances.
QUALIFICATION AS A REGULATED INVESTMENT COMPANY
Each Fund has elected to be taxed as a regulated investment company under
Subchapter M of the Code. As a regulated investment company, a Fund is not
subject to federal income tax on the portion of its net investment income (i.e.,
taxable interest, dividends and other taxable ordinary income, net of expenses)
and capital gain net income (i.e., the excess of capital gains over capital
losses) that it distributes to shareholders, provided that it distributes an
amount equal to at least 90% of its investment company taxable income (i.e., net
investment income and the excess of net short-term capital gain over net
long-term capital loss) plus at least 90% of its tax-exempt income (net of
expenses allocable thereto) for the taxable year (the "Distribution
Requirement"), and satisfies certain other requirements of the Code that are
described below. Distributions by a Fund made during the taxable year or, under
specified circumstances, within twelve months after the close of the taxable
year, will be considered distributions of income and gains of the taxable year
and will therefore count towards the satisfaction of the Distribution
Requirement. If a Fund has a net capital loss (i.e., an excess of capital losses
over capital gains) for any year, the amount thereof may be carried forward up
to eight years and treated as a short-term capital loss which can be used to
offset capital gains in such future years. As of October 31, 1997, the U.S.
Government Obligations Fund had capital loss carryforwards of approximately
$22,000, which expire in 2002; the Financial Reserves Fund had capital loss
carryforwards of approximately $13,000 which expire in 2001; the Limited Term
Income Fund had capital loss carryforwards of approximately $1,642,000,
$553,000, and $906,000 which expire in 2002, 2003 and 2005 respectively; the
Intermediate Income Fund had capital loss carryforwards of approximately
$2,498,000, $1,386,000, $869,000 and $521,000 which expire in 2001, 2002, 2003
and 2005, respectively; the Investment Quality Bond Fund had capital loss
carryforwards of approximately $8,729,000 which expire in 2002; the Government
Mortgage Fund had capital loss carryforwards of approximately $1,969,000 and
$109,000 which expire in 2002 and 2005, respectively; the National Municipal
Bond Fund had capital loss carryforwards of approximately $131,000 which expire
in 2004; and the Fund for Income had capital loss carryforwards of approximately
$704,000, $588,000 and $328,000 which expire in 2001, 2002 and 2003,
respectively. The Investment Quality Bond Fund had additional capital loss
carryforwards, subject to limitations on availability, to offset future capital
gains as the successor of a merger with the Government Bond Fund of
approximately $3,523,000, $2,760,000, $755,000 and $6,000 which expire in 2001,
2002, 2003 and 2004, respectively. Under Code Sections 382 and 383, if a Fund
has an "ownership change," then the Fund's use of its capital loss carryforwards
in any year following the ownership change will be limited to an amount equal to
the net asset value of the Fund immediately prior to the ownership change
multiplied by the long-term tax-exempt rate (which is published monthly by the
Internal Revenue Service (the "IRS")) in effect for the month in which the
ownership change occurs (the rate for March, 1997 is 5.10%). The Funds will use
their best efforts to avoid having an ownership change. However, because of
circumstances which may be beyond the control or knowledge of a Fund, there can
be no assurance that a Fund will not have, or has not already had, an ownership
change. If a Fund has or has had an ownership change, then any capital gain net
income for any year following the ownership change in excess of the annual
limitation on the capital loss carryforwards will have to be distributed by the
Fund to avoid tax at the Fund level and will be taxable to shareholders as
described under "Fund Distributions" below.
In addition to satisfying the Distribution Requirement, a regulated investment
company must: derive at least 90% of its gross income from dividends, interest,
certain payments with respect to securities loans, gains from the sale or other
disposition of stock or securities or foreign currencies (to the extent such
currency gains are directly related to the regulated investment company's
principal business of investing in stock or securities) and other income
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(including, but not limited to, gains from options, futures or forward
contracts) derived with respect to its business of investing in such stock,
securities or currencies (the "Income Requirement").
In general, gain or loss recognized by a Fund on the disposition of an asset
will be a capital gain or loss. However, gain recognized on the disposition of a
debt obligation (including municipal obligations) purchased by a Fund at a
market discount (generally, at a price less than its principal amount) will be
treated as ordinary income to the extent of the portion of the market discount
which accrued while the Fund held the debt obligation. In addition, under the
rules of Code section 988, gain or loss recognized on the disposition of a debt
obligation denominated in a foreign currency or an option with respect thereto
(but only to the extent attributable to changes in foreign currency exchange
rates), and gain or loss recognized on the disposition of a foreign currency
forward contract, futures contract, option or similar financial instrument, or
of foreign currency itself, except for regulated futures contracts or non-equity
options subject to Code Section 1256 (unless a Fund elects otherwise), generally
will be treated as ordinary income or loss.
The Code also treats as ordinary income a portion of the capital gain recognized
in a transaction where substantially all of the return realized is attributable
to the time value of a Fund's net investment in the transaction and: (1) the
transaction consists of the acquisition of property by the Fund and a
contemporaneous contract to sell substantially identical property in the future;
(2) the transaction is a straddle within the meaning of section 1092 of the
Code; (3) the transaction is one that was marketed or sold to the Fund on the
basis that it would have the economic characteristics of a loan but the
interest-like return would be taxed as capital gain; or (4) the transaction is
described as a conversion transaction in the Treasury Regulations. The amount of
such gain that is treated as ordinary income generally will not exceed the
amount of the interest that would have accrued on the net investment for the
relevant period at a yield equal to 120% of the applicable federal rate, reduced
by the sum of: (1) prior inclusions of ordinary income items from the conversion
transaction and (2) the capitalized interest on acquisition indebtedness under
Code section 263(g). Built-in losses will be preserved where a Fund has a
built-in loss with respect to property that becomes a part of a conversion
transaction. No authority exists that indicates that the converted character of
the income treated as ordinary under this rule will not be passed through to the
Funds' shareholders.
In general, for purposes of determining whether capital gain or loss recognized
by a Fund on the disposition of an asset is long-term or short-term, the holding
period of the asset may be affected (as applicable, depending on the type of the
Fund involved) if (1) the asset is used to close a "short sale" (which includes
for certain purposes the acquisition of a put option) or is substantially
identical to another asset so used, (2) the asset is otherwise held by the Fund
as part of a "straddle" (which term generally excludes a situation where the
asset is stock and Fund grants a qualified covered call option (which, among
other things, must not be deep-in-the-money) with respect thereto), or (3) the
asset is stock and the Fund grants an in-the-money qualified covered call option
with respect thereto. In addition, a Fund may be required to defer the
recognition of a loss on the disposition of an asset held as part of a straddle
to the extent of any unrecognized gain on the offsetting position.
Any gain recognized by a Fund on the lapse of, or any gain or loss recognized by
a Fund from a closing transaction with respect to, an option written by the Fund
will be treated as a short-term capital gain or loss.
Certain transactions that may be engaged in by a Fund (such as regulated futures
contracts, certain foreign currency contracts, and options on stock indexes and
futures contracts) will be subject to special tax treatment as "Section 1256
Contracts." Section 1256 Contracts are treated as if they are sold for their
fair market value on the last business day of the taxable year, even though a
taxpayer's obligations (or rights) under such Section 1256 Contracts have not
terminated (by delivery, exercise, entering into a closing transaction or
otherwise) as of such date. Any gain or loss recognized as a consequence of the
year-end deemed disposition of Section 1256 Contracts is taken into account for
the taxable year together with any other gain or loss that was previously
recognized upon the termination of Section 1256 Contracts during that taxable
year. Any capital gain or loss for the taxable year with respect to Section 1256
Contracts (including any capital gain or loss arising as a consequence of the
year-end deemed sale of such Section 1256 Contracts) generally is treated as 60%
long-term capital gain or loss and 40% short-term capital gain or loss. A Fund,
however, may elect not to have this special tax treatment apply to Section 1256
Contracts that are part of a "mixed straddle" with other investments of the Fund
that are not Section 1256 Contracts.
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A Fund may enter into notional principal contracts, including interest rate
swaps, caps, floors, and collars. Treasury Regulations provide, in general, that
the net income or net deduction from a notional principal contract for a taxable
year is included in or deducted from gross income for that taxable year. The net
income or deduction from a notional principal contract for a taxable year equals
the total of all of the periodic payments (generally, payments that are payable
or receivable at fixed periodic intervals of one year or less during the entire
term of the contract) that are recognized from that contract for the taxable
year and all of the nonperiodic payments (including premiums for caps, floors,
and collars) that are recognized from that contract for the taxable year. No
portion of a payment by a party to a notional principal contract is recognized
prior to the first year to which any portion of a payment by the counterparty
relates. A periodic payment is recognized ratably over the period to which it
relates. In general, a nonperiodic payment must be recognized over the term of
the notional principal contract in a manner that reflects the economic substance
of the contract. A nonperiodic payment that relates to an interest rate swap,
cap, floor, or collar is recognized over the term of the contract by allocating
it in accordance with the values of a series of cash-settled forward or option
contracts that reflect the specified index and notional principal amount upon
which the notional principal contract is based (or, in the case of a swap, under
an alternative method contained in the proposed regulations and, in the case of
a cap or floor, under an alternative method which the IRS may provide in a
revenue procedure).
A Fund may purchase securities of certain foreign investment funds or trusts
which constitute passive foreign investment companies ("PFICs") for federal
income tax purposes. If a Fund invests in a PFIC, it has three separate options.
First, it may elect to treat the PFIC as a qualifying electing fund (a "QEF"),
in which case it will each year have ordinary income equal to its pro rata share
of the PFIC's ordinary earnings for the year and long-term capital gain equal to
its pro rata share of the PFIC's net capital gain for the year, regardless of
whether the Fund receives distributions of any such ordinary earnings or capital
gains from the PFIC. Second, for tax years beginning after December 31, 1997,
the Fund may make a mark-to-market election with respect to its PFIC stock.
Pursuant to such an election, the Fund will include as ordinary income any
excess of the fair market value of such stock at the close of any taxable year
over its adjusted tax basis in the stock. If the adjusted tax basis of the PFIC
stock exceeds the fair market value of such stock at the end of a given taxable
year, such excess will be deductible as ordinary loss in the amount equal to the
lesser of the amount of such excess or the net mark-to-market gains on the stock
that the Fund included in income in previous years. The Fund's holding period
with respect to its PFIC stock subject to the election will commence on the
first day of the following taxable year. If the Fund makes the mark-to-market
election in the first taxable year it holds PFIC stock, it will not incur the
tax described below under the third option.
Finally, if the Fund does not elect to treat the PFIC as a QEF and does not make
a mark-to-market election, then, in general, (1) any gain recognized by the Fund
upon a sale or other disposition of its interest in the PFIC or any "excess
distribution" (as defined) received by the Fund from the PFIC will be allocated
ratably over the Fund's holding period in the PFIC stock, (2) the portion of
such gain or excess distribution so allocated to the year in which the gain is
recognized or the excess distribution is received shall be included in the
Fund's gross income for such year as ordinary income (and the distribution of
such portion by the Fund to shareholders will be taxable as an ordinary income
dividend, but such portion will not be subject to tax at the Fund level), (3)
the Fund shall be liable for tax on the portions of such gain or excess
distribution so allocated to prior years in an amount equal to, for each such
prior year, (i) the amount of gain or excess distribution allocated to such
prior year multiplied by the highest tax rate (individual or corporate, as the
case may be) in effect for such prior year, plus (ii) interest on the amount
determined under clause (i) for the period from the due date for filing a return
for such prior year until the date for filing a return for the year in which the
gain is recognized or the excess distribution is received, at the rates and
methods applicable to underpayments of tax for such period, and (4) the
distribution by the Fund to shareholders of the portions of such gain or excess
distribution so allocated to prior years (net of the tax payable by the Fund
thereon) will again be taxable to the shareholders as an ordinary income
dividend.
Treasury Regulations permit a regulated investment company, in determining its
investment company taxable income and net capital gain (i.e., the excess of net
long-term capital gain over net short-term capital loss) for any taxable year,
to elect (unless it has made a taxable year election for excise tax purposes as
discussed below) to treat all or any part of any net capital loss, any net
long-term capital loss or any net foreign currency loss (including, to the
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extent provided in Treasury Regulations, losses recognized pursuant to the PFIC
mark-to-market election) incurred after October 31 as if it had been incurred in
the succeeding year.
In addition to satisfying the requirements described above, a Fund must satisfy
an asset diversification test in order to qualify as a regulated investment
company. Under this test, at the close of each quarter of a Fund's taxable year,
at least 50% of the value of the Fund's assets must consist of cash and cash
items, U.S. Government securities, securities of other regulated investment
companies, and securities of other issuers (as to which the Fund has not
invested more than 5% of the value of the Fund's total assets in securities of
each such issuer and the Fund does not hold more than 10% of the outstanding
voting securities of each such issuer), and no more than 25% of the value of its
total assets may be invested in the securities of any one issuer (other than
U.S. Government securities and securities of other regulated investment
companies), or in two or more issuers which the Fund controls and which are
engaged in the same or similar trades or businesses. Generally, an option (call
or put) with respect to a security is treated as issued by the issuer of the
security, not the issuer of the option. For purposes of asset diversification
testing, obligations issued or guaranteed by certain agencies or
instrumentalities of the U.S. Government, such as the Federal Agricultural
Mortgage Corporation, the Farm Credit System Financial Assistance Corporation, a
Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation, the Federal
National Mortgage Association, the Government National Mortgage Corporation, and
the Student Loan Marketing Association, are treated as U.S. Government
securities.
If for any taxable year a Fund does not qualify as a regulated investment
company, all of its taxable income (including its net capital gain) will be
subject to tax at regular corporate rates without any deduction for
distributions to shareholders, and such distributions will be taxable to the
shareholders as ordinary dividends to the extent of the Fund's current and
accumulated earnings and profits. Such distributions may be eligible for the
dividends-received deduction in the case of corporate shareholders.
EXCISE TAX ON REGULATED INVESTMENT COMPANIES
A 4% non-deductible excise tax is imposed on a regulated investment company that
fails to distribute in each calendar year an amount equal to 98% of its ordinary
income for such calendar year and 98% of capital gain net income for the
one-year period ended on October 31 of such calendar year (or, at the election
of a regulated investment company having a taxable year ending November 30 or
December 31, for its taxable year (a "taxable year election")). (Tax-exempt
interest on municipal obligations is not subject to the excise tax.) The balance
of such income must be distributed during the next calendar year. For the
foregoing purposes, a regulated investment company is treated as having
distributed any amount on which it is subject to income tax for any taxable year
ending in such calendar year.
For purposes of calculating the excise tax, a regulated investment company
shall: (1) reduces its capital gain net income (but not below its net capital
gain) by the amount of any net ordinary loss for the calendar year and (2)
excludes foreign currency gains and losses and ordinary gains or losses arising
as a result of a PFIC mark-to-market election (or upon an actual disposition of
the PFIC stock subject to such election) incurred after October 31 of any year
(or after the end of its taxable year if it has made a taxable year election) in
determining the amount of ordinary taxable income for the current calendar year
(which gains and losses are included in determining the company's ordinary
taxable income for the succeeding calendar year).
Each Fund intends to make sufficient distributions or deemed distributions of
its ordinary taxable income and capital gain net income prior to the end of each
calendar year to avoid liability for the excise tax. However, investors should
note that a Fund may in certain circumstances be required to liquidate portfolio
investments to make sufficient distributions to avoid excise tax liability.
FUND DISTRIBUTIONS
Each Fund anticipates distributing substantially all of its investment company
taxable income for each taxable year. Such distributions will be taxable to
shareholders as ordinary income and treated as dividends for federal income tax
purposes. Distributions attributable to dividends received by the Funds from
domestic corporations will qualify
- 88 -
<PAGE>
for the 70% dividends-received deduction for corporate shareholders only to the
extent discussed below. Distributions attributable to interest received by the
Funds will not, and distributions attributable to dividends paid by a foreign
corporation generally should not, qualify for the dividend-received deduction.
In general, the Balanced Fund, Diversified Stock Fund, International Growth
Fund, National Municipal Bond Fund, New York Tax-Free Fund, Ohio Regional Stock
Fund and Special Value Fund dividends paid on Class A and Class B shares are
calculated at the same time and in the same manner. In general, dividends on
Class B shares are expected to be lower than those on Class A shares due to the
higher distribution expenses charged by the Class B shares. Dividends may also
differ between classes as a result of differences in other class specific
expenses.
Ordinary income dividends paid by a Fund with respect to a taxable year will
qualify for the 70% dividends-received deduction generally available to
corporations (other than corporations such as S corporations, which are not
eligible for the deduction because of their special characteristics, and other
than for purposes of special taxes such as the accumulated earnings tax and the
personal holding company tax) to the extent of the amount of qualifying
dividends received by the Fund from domestic corporations for the taxable year.
Generally, a dividend received by a Fund will not be treated as a qualifying
dividend (1) if it has been received with respect to any share of stock that the
Fund has held for less than 46 days (91 days in the case of certain preferred
stock), excluding for this purpose under the rules of Code Section 246(c)(3) and
(4) any period during which the Fund has an option to sell, is under a
contractual obligation to sell, has made and not closed a short sale of, is the
grantor of a deep-in-the-money or otherwise nonqualified option to buy, or has
otherwise diminished its risk of loss by holding other positions with respect
to, such (or substantially identical) stock; (2) to the extent that the Fund is
under an obligation (pursuant to a short sale or otherwise) to make related
payments with respect to positions in substantially similar or related property;
or (3) to the extent that the stock on which the dividend is paid is treated as
debt-financed under the rules of Code Section 246A. The 46-day holding period
must be satisfied during the 90-day period beginning 45 days prior to each
applicable ex-dividend date; the 91-day holding period must be satisfied during
the 180-day period beginning 90 days before each applicable ex-dividend date.
Moreover, the dividends-received deduction for a corporate shareholder may be
disallowed or reduced (1) if the corporate shareholder fails to satisfy the
foregoing requirements with respect to its shares of the Fund or (2) by
application of Code Section 246(b) which in general limits the
dividends-received deduction to 70% of the shareholder's taxable income
(determined without regard to the dividends-received deduction and certain other
items). With respect to the International Growth Fund, only an insignificant
portion of the Fund will be invested in stock of domestic corporations;
therefore the ordinary dividends distributed by the Fund generally will not
qualify for the dividends-received deduction for corporate shareholders.
A Fund may either retain or distribute to shareholders its net capital gain for
each taxable year. Each Fund currently intends to distribute any such amounts.
Net capital gain that is distributed and designated as a capital gain dividend
will be taxable to shareholders as long-term capital gain, regardless of the
length of time the shareholder has held his shares or whether such gain was
recognized by the Fund prior to the date on which the shareholder acquired his
shares. The Code provides, however, that under certain conditions only 50% (58%
for the alternative minimum tax purposes) of the capital gain recognized upon a
Fund's disposition of domestic qualified "small business" stock will be subject
to tax.
Conversely, if a Fund elects to retain its net capital gain, the Fund will be
taxed thereon (except to the extent of any available capital loss carryovers) at
the 35% corporate tax rate. If a Fund elects to retain its net capital gain, it
is expected that the Fund also will elect to have shareholders of record on the
last day of its taxable year treated as if each received a distribution of his
pro rata share of such gain, with the result that each shareholder will be
required to report his pro rata share of such gain on his tax return as
long-term capital gain, will receive a refundable tax credit for his pro rata
share of tax paid by the Fund on the gain, and will increase the tax basis for
his shares by an amount equal to the deemed distribution less the tax credit.
The New York Tax-Free Fund, National Municipal Bond Fund, Ohio Municipal Bond
Fund, Ohio Municipal Money Market Fund, and Tax-Free Money Market Fund (the
"Tax-Exempt Funds") intend to qualify to pay exempt-interest dividends by
satisfying the requirement that at the close of each quarter of the Tax-Exempt
Funds' taxable year at least 50% of each Fund's total assets consists of
tax-exempt municipal obligations. Distributions from a Tax- Exempt Fund will
constitute exempt-interest dividends to the extent of such Fund's tax-exempt
interest income (net of expenses and amortizable bond premium). Exempt-interest
dividends distributed to shareholders of a Tax-Exempt
- 89 -
<PAGE>
Fund are excluded from gross income for federal income tax purposes. However,
shareholders required to file a federal income tax return will be required to
report the receipt of exempt interest dividends on their returns. Moreover,
while exempt-interest dividends are excluded from gross income for federal
income tax purposes, they may be subject to alternative minimum tax ("AMT") in
certain circumstances and may have other collateral tax consequences as
discussed below. Distributions by a Tax-Exempt Fund of any investment company
taxable income or of any net capital gain will be taxable to shareholders as
discussed above.
AMT is imposed in addition to, but only to the extent it exceeds, the regular
tax and is computed at a maximum marginal rate of 28% for noncorporate taxpayers
and 20% for corporate taxpayers on the excess of the taxpayer's alternative
minimum taxable income ("AMTI") over an exemption amount. Exempt-interest
dividends derived from certain "private activity" municipal obligations issued
after August 7, 1986 will generally constitute an item of tax preference
includable in AMTI for both corporate and noncorporate taxpayers. In addition,
exempt-interest dividends derived from all municipal obligations, regardless of
the date of issue, must be included in adjusted current earnings, which are used
in computing an additional corporate preference item (i.e., 75% of the excess of
a corporate taxpayer's adjusted current earnings over its AMTI (determined
without regard to this item and the AMT net operating loss deduction))
includable in AMTI. For purposes of the corporate AMT, the corporate dividends-
received deduction is not itself an item of tax preference that must be added
back to taxable income or is otherwise disallowed in determining a corporation's
AMTI. However, corporate shareholders will generally be required to take the
full amount of any dividend received from the Fund into account (without a
dividends-received deduction) in determining their adjusted current earnings.
Exempt-interest dividends must be taken into account in computing the portion,
if any, of social security or railroad retirement benefits that must be included
in an individual shareholder's gross income and subject to federal income tax.
Further, a shareholder of a Tax-Exempt Fund is denied a deduction for interest
on indebtedness incurred or continued to purchase or carry shares of a
Tax-Exempt Fund. Moreover, a shareholder who is (or is related to) a
"substantial user" of a facility financed by industrial development bonds held
by a Tax-Exempt Fund will likely be subject to tax on dividends paid by the
Tax-Exempt Fund which are derived from interest on such bonds. Receipt of
exempt-interest dividends may result in other collateral federal income tax
consequences to certain taxpayers, including financial institutions, property
and casualty insurance companies, and foreign corporations engaged in a trade or
business in the United States. Prospective investors should consult their own
advisers as to such consequences.
Investment income that may be received by a Fund from sources within foreign
countries may be subject to foreign taxes withheld at the source. The United
States has entered into tax treaties with many foreign countries which entitle a
Fund to a reduced rate of, or exemption from, taxes on such income. It is
impossible to determine the effective rate of foreign tax in advance since the
amount of a Fund's assets to be invested in various countries is not known: If
more than 50% of the value of a Fund's total assets at the close of its taxable
year consist of the stock or securities of foreign corporations, the Fund may
elect to "pass through" to the Fund's shareholders the amount of foreign taxes
paid by the Fund. If the Fund so elects, each shareholder would be required to
include in gross income, even though not actually received, his pro rata share
of the foreign taxes paid by the Fund, but would be treated as having paid his
pro rata share of such foreign taxes and would therefore be allowed to either
deduct such amount in computing taxable income or use such amount (subject to
various Code limitations) as a foreign tax credit against federal income tax
(but not both). For purposes of the foreign tax credit limitation rules of the
Code, each shareholder would treat as foreign source income his pro rata share
of such foreign taxes plus the portion of dividends received from the Fund
representing income derived from foreign sources. No deduction for foreign taxes
could be claimed by an individual shareholder who does not itemize deductions.
Each shareholder should consult his own tax adviser regarding the potential
application of foreign tax credit rules.
Distributions by a Fund that do not constitute ordinary income dividends,
exempt-interest dividends, or capital gain dividends will be treated as a return
of capital to the extent of (and in reduction of) the shareholder's tax basis in
his shares; any excess will be treated as gain from the sale of his shares, as
discussed below.
Distributions by a Fund will be treated in the manner described above regardless
of whether such distributions are paid in cash or reinvested in additional
shares of the Fund (or of another fund). Shareholders receiving a
- 90 -
<PAGE>
distribution in the form of additional shares will be treated as receiving a
distribution in an amount equal to the fair market value of the shares received,
determined as of the reinvestment date. In addition, if the net asset value at
the time a shareholder purchases shares of a Fund reflects undistributed net
investment income, recognized capital gain net income, or unrealized
appreciation in the value of the assets of the Fund, distributions of such
amounts will be taxable to the shareholder in the manner described above,
although such distributions economically constitute a return of capital to the
shareholder.
Ordinarily, shareholders are required to take distributions by a Fund into
account in the year in which the distributions are made. However, dividends
declared in October, November or December of any year and payable to
shareholders of record on a specified date in such a month will be deemed to
have been received by the shareholders (and made by a Fund) on December 31 of
such calendar year if such dividends are actually paid in January of the
following year. Shareholders will be advised annually as to the U.S. federal
income tax consequences of distributions made (or deemed made) during the year.
Each Fund will be required in certain cases to withhold and remit to the U.S.
Treasury 31% of ordinary income dividends and capital gain dividends, and the
proceeds of redemption of shares, paid to any shareholder (1) who has failed to
provide a correct taxpayer identification number (2) who is subject to backup
withholding for failure to report the receipt of interest or dividend income
properly, or (3) who has failed to certify to the Fund that it is not subject to
backup withholding or is an "exempt recipient" (such as a corporation).
SALE OR REDEMPTION OF SHARES
The Money Market Funds seek to maintain a stable net asset value of $1.00 per
share; however, there can be no assurance that the Money Market Funds will do
this. In such a case, and for all the Funds other than the Money Market Funds, a
shareholder will recognize gain or loss on the sale or redemption of shares of a
Fund in an amount equal to the difference between the proceeds of the sale or
redemption and the shareholder's adjusted tax basis in the shares. All or a
portion of any loss so recognized may be disallowed if the shareholder purchases
other shares of a Fund within 30 days before or after the sale or redemption. In
general, any gain or loss arising from (or treated as arising from) the sale or
redemption of shares of a Fund will be considered capital gain or loss and will
be long-term capital gain or loss if the shares were held for longer than one
year. Long-term capital gain recognized by an individual shareholder will be
taxed at the lowest rates applicable to capital gains if the holder has held
such shares for more than 18 months at the time of the sale. However, any
capital loss arising from the sale or redemption of shares held for six months
or less will be disallowed to the extent of the amount of exempt-interest
dividends received on such shares and (to the extent not disallowed) will be
treated as a long-term capital loss to the extent of the amount of capital gain
dividends received on such shares. For this purpose, the special holding period
rules of Code section 246(c)(3) and (4) (discussed above in connection with the
dividends-received deduction for corporations) generally will apply in
determining the holding period of shares. Long-term capital gains of
noncorporate taxpayers are currently taxed at a maximum rate at least 11.6%
lower than the maximum rate applicable to ordinary income. Capital losses in any
year are deductible only to the extent of capital gains plus, in the case of a
noncorporate taxpayer, $3,000 of ordinary income.
If a shareholder (1) incurs a sales load in acquiring shares of a Fund, (2)
disposes of such shares less than 91 days after they are acquired and (3)
subsequently acquires shares of the Fund or another fund at a reduced sales load
pursuant to a right to reinvest at such reduced sales load acquired in
connection with the acquisition of the shares disposed of, then the sales load
on the shares disposed of (to the extent of the reduction in the sales load on
the shares subsequently acquired) shall not be taken into account in determining
gain or loss on such shares but shall be treated as incurred on the acquisition
of the subsequently acquired shares.
FOREIGN SHAREHOLDERS
Taxation of a shareholder who, as to the United States, is a nonresident alien
individual, foreign trust or estate, foreign corporation, or foreign partnership
("foreign shareholder"), depends on whether the income from a Fund is
"effectively connected" with a U.S. trade or business carried on by such
shareholder.
- 91 -
<PAGE>
If the income from a Fund is not effectively connected with a U.S. trade or
business carried on by a foreign shareholder, ordinary income dividends paid to
such foreign shareholder will be subject to U.S. withholding tax at the rate of
30% (or lower treaty rate) upon the gross amount of the dividend. Furthermore,
such foreign shareholder may be subject to U.S. withholding tax at the rate of
30% (or lower applicable treaty rate) on the gross income resulting from a
Fund's election to treat any foreign taxes paid by it as paid by its
shareholders, but may not be allowed a deduction against such gross income or a
credit against the U.S. withholding tax for the foreign shareholder's pro rata
share of such foreign taxes which it is treated as having paid. Such a foreign
shareholder would generally be exempt from U.S. federal income tax on gains
realized on the sale of shares of a Fund, capital gain dividends and
exempt-interest dividends, and amounts retained by the Fund that are designated
as undistributed capital gains.
If the income from a Fund is effectively connected with a U.S. trade or business
carried on by a foreign shareholder, then ordinary income dividends, capital
gain dividends, and any gains realized upon the sale of shares of the Fund will
be subject to U.S. federal income tax at the rates applicable to U.S. citizens
or domestic corporations.
In the case of a foreign shareholder other than a corporation, a Fund may be
required to withhold U.S. federal income tax at a rate of 31% on distributions
that are otherwise exempt from withholding tax (or taxable at a reduced treaty
rate) unless such shareholder furnishes the Fund with proper notification of his
foreign status.
The tax consequences to a foreign shareholder entitled to claim the benefits of
an applicable tax treaty may be different from those described herein. Foreign
shareholders are urged to consult their own tax advisers with respect to the
particular tax consequences to them of an investment in a Fund, including the
applicability of foreign taxes.
EFFECT OF FUTURE LEGISLATION; STATE AND LOCAL TAX CONSIDERATIONS
The foregoing general discussion of U.S. federal income tax consequences is
based on the Code and the Treasury Regulations issued thereunder as in effect on
the date of this Statement of Additional Information. Future legislative or
administrative changes or court decisions may significantly change the
conclusions expressed herein, and any such changes or decisions may have a
retroactive effect.
Rules of state and local taxation of ordinary income dividends, exempt-interest
dividends, and capital gain dividends from regulated investment companies often
differ from the rules for U.S. federal income taxation described above.
Shareholders are urged to consult their tax advisers as to the consequences of
these and other state and local tax rules affecting investment in a Fund.
- 92 -
<PAGE>
TRUSTEES AND OFFICERS
BOARD OF TRUSTEES.
Overall responsibility for management of the Victory Portfolios rests with the
Trustees, who are elected by the shareholders of the Victory Portfolios. The
Victory Portfolios are managed by the Trustees in accordance with the laws of
the State of Delaware. There are currently nine Trustees, seven of whom are not
"interested persons" of the Victory Portfolios within the meaning of that term
under the 1940 Act ("Independent Trustees"). The Trustees, in turn, elect the
officers of the Victory Portfolios to supervise actively its day-to-day
operations.
The Trustees of the Victory Portfolios, their addresses, ages, and their
principal occupations during the past five years are as follows:
<TABLE>
<CAPTION>
Position(s) Held
With the Victory Principal Occupation
Name, Address and Age Portfolios During Past 5 Years
- --------------------- ---------- -------------------
<S> <C> <C>
Roger Noall,* 62 Chairman and Trustee From 1996 to present,
c/o Brighton Apt. 1603 Executive of KeyCorp;
8231 Bay Colony Drive from 1995 to 1996,
Naples, Florida 34108 General Counsel and
Secretary of KeyCorp;
from 1994 to 1996, Senior
Executive Vice President
and Chief Administrative
Officer of KeyCorp; from
1985 to 1994, Vice
Chairman of the Board and
Chief Administrative
Officer of Society
Corporation (now known as
KeyCorp).
Leigh A. Wilson,** 53
New Century Care, Inc. President and Trustee From 1989 to present,
53 Sylvan Road North Chairman and Chief
Westport, CT 06880 Executive Officer,
New Century Care, Inc.
(Merchant bank); from
1995 to present,
Principal of New
Century Living, Inc.;
from 1989 to present,
Director of Chimney Rock
Vineyard and Chimney
Rock Winery; President
and Director, Key Mutual
Funds.
</TABLE>
- -----------------
* Mr. Noall is an "interested person" and an "affiliated person" of the
Company.
** Mr. Wilson is deemed to be an "interested person" of the Victory Portfolios
under the 1940 Act solely by reason of his position as President.
- 93 -
<PAGE>
<TABLE>
<CAPTION>
Position(s) Held
With the Victory Principal Occupation
Name, Address and Age Portfolios During Past 5 Years
- --------------------- ---------- -------------------
<S> <C> <C>
Robert G. Brown, 74 Trustee Executive Vice President
8650 S. Ocean Drive Easton Corporiation -
Singer Island Retired. From October
Jensen Beach, FL 34957 1983 to November 1990,
Founder and President,
Cleveland Advanced
Manufacturing Program,
Inc. Serves on Board of
Directors of CAMP, Inc.
(non-profit corporation
engaged in regional
economic development).
Edward P. Campbell, 48 Trustee From October 1997 to
Nordson Corporation present, President and
28601 Clemens Road Chief Executive Officer
Westlake, OH 44145 of Nordson Corporation
(manufacturer of
application equipment);
July 1996 to October
1997, President and Chief
Operating Officer of
Nordson Corporation; from
March 1994 to July 1996,
Execitive Vice President
and Chief Operating
Officer of Nordson
Corporation; from May
1988 to March 1994, Vice
President of Nordson
Corporation; from 1987 to
December 1994, member of
the Supervisory Committee
of Society's Collective
Investment Retirement
Fund; from May 1991 to
August 1994, Trustee,
Financial Reserves Fund
and from May 1993 to
August 1994, Trustee,
Ohio Municipal Money
Market Fund. Currently,
Director of Key Mutual
Funds and Director of
Nordson Corporation.
Dr. Harry Gazelle, 70 Trustee Retired radiologist, Drs.
17822 Lake Road Hill and Thomas
Lakewood, OH 44107 Corporation.
Eugene J. McDonald, 65 Trustee From 1990 to present,
Duke Management Company Executive Vice President
2200 West Main Street, and Chief Investment
Suite 1000 Officer for Asset
Durham, N.C. 27705 Management of Duke
University and President
and CEO of Duke
Management Company;
Director of CCB Financial
Corporation, Flag Group
of Mutual Funds, DP Mann
Holdings, Key Mutual
Funds, Greater Triangle
Community Foundation, and
NC Bar Association
Investment Committee.
Dr. Thomas F. Morrissey, 64 Trustee 1995 Visiting Scholar,
Weatherhead School of Bond University,
Management Queensland, Australia;
Case Western Reserve Professor, Weatherhead
University School of Management,
10900 Euclid Avenue Case Western Reserve
Cleveland, OH 44106-7235 University; from 1989 to
1995, Associate Dean of
Weatherhead School of
Management; from 1987 to
December 1994, Member of
the Supervisory Committee
of Society's Collective
Investment Retirement
Fund; from May 1991 to
August 1994, Trustee,
Financial Reserves Fund
and from May 1993 to
August 1994, Trustee,
Ohio Municipal Money
Market Fund.
</TABLE>
- 94 -
<PAGE>
<TABLE>
<CAPTION>
Position(s) Held
With the Victory Principal Occupation
Name, Address and Age Portfolios During Past 5 Years
- --------------------- ---------- -------------------
<S> <C> <C>
Dr. H. Patrick Swygert, 54 Trustee President, Howard
Howard University University; formerly
2400 6th Street, N.W. President, State
Suite 402 University of New York at
Washington, D.C. 20059 Albany; formerly,
Executive Vice President,
Temple University;
Trustee, The Victory
Funds.
Frank A. Weil, 66 Trustee Chairman and Chief
Abacus & Associates Executive Officer of
147 E. 47th Street Abacus & Associates, Inc.
New York, N.Y. 10017 (private investment
firm); Director and
President of the Norman
and Hickrill Foundations;
Director of Key Mutual
Funds. Director, Trojan
Industries. Formerly
United States Assistant
Secretary of Commerce for
Industry and Trade.
</TABLE>
The Board presently has an Investment Policy Committee, a Business, Legal, and
Audit Committee, and a Nominating Committee. The members of the Investment
Policy Committee are Messrs. Wilson and Morrissey, who will serve until August
1998. The function of the Investment Policy Committee is to review the existing
investment policies of the Victory Portfolios, including the levels of risk and
types of funds available to shareholders, and make recommendations to the
Trustees regarding the revision of such policies or, if necessary, the
submission of such revisions to the Victory Portfolios' shareholders for their
consideration. The members of the Business, Legal and Audit Committee are
Messrs. Swygert (Chairman), Campbell, and Gazelle who will serve until August
1998. The function of the Business, Legal, and Audit Committee is to recommend
independent auditors and monitor accounting and financial matters; and to review
compliance and contract matters. Mr. Campbell is the Chairman of the Nominating
Committee which nominates persons to serve as Independent Trustees and Trustees
to serve on committees of the Board.
The Investment Policy Committee met four times during the 12 months ended
October 31, 1997. The Business, Legal and Audit Committee met four times during
the 12 months ended October 31, 1997.
REMUNERATION OF TRUSTEES AND CERTAIN EXECUTIVE OFFICERS.
Each Trustee (other than Leigh A. Wilson) receives an annual fee of $27,000 for
serving as Trustee of all the Funds of the Victory Portfolios, and an additional
per meeting fee ($2,400 in person and $1,200 per telephonic meeting). Leigh A.
Wilson receives an annual fee of $33,000 for serving as President and Trustee
for all of the funds of the Victory Portfolios, and an additional per meeting
fee ($3,000 in person and $1,500 per telephonic meeting). The Advisor pays the
fees of Roger Noall.
- 95 -
<PAGE>
The following table indicates the compensation received by each Trustee from the
Victory "Fund Complex"(1) for the 12 month period ended October 31, 1997.
<TABLE>
<CAPTION>
Aggregate
Pension or Retirement Estimated Annual Compensation Total Compensation
Benefits Accrued as Benefits from Victory from Victory
Portfolio Expenses Upon Retirement Portfolios "Fund Complex" (1)
------------------ --------------- ---------- ------------------
<S> <C> <C> <C> <C>
Leigh A. Wilson, Trustee.... -0- -0- $45,000 $56,250
Robert G. Brown, Trustee... -0- -0- 39,000 39,000
Edward P. Campbell, Trustee. -0- -0- 39,000 39,000
Harry Gazelle, Trustee...... -0- -0- 40,200 40,200
Thomas F. Morrissey, -0- -0- 39,000 39,000
Trustee.....................
H. Patrick Swygert, Trustee. -0- -0- 36,600 36,600
</TABLE>
(1) There are presently 33 mutual funds from which the above-named Trustees are
compensated in the Victory "Fund Complex," but not all of the above-named
Trustees serve on the board of each fund in the "Fund Complex."
OFFICERS.
The officers of the Victory Portfolios, their ages, addresses, and principal
occupations during the past five years, are as follows:
<TABLE>
<CAPTION>
Position(s) with the Principal Occupation
Name, Age, and Address Victory Portfolios During Past 5 Years
- ------------------------ ------------------- -------------------
<S> <C> <C>
Roger Noall,* 62 Chairman and Trustee From 1996 to present,
c/o Brighton Apt. 1603 Executive of KeyCorp;
8231 Bay Colony Drive from 1995 to 1996,
Naples, Florida 34108 General Counsel and
Secretary of KeyCorp;
from 1994 to 1996, Senior
Executive Vice President
and Chief Administrative
Officer of KeyCorp; from
1985 to 1994, Vice
Chairman of the Board and
Chief Administrative
Officer of Society
Corporation (now known as
KeyCorp).
Leigh A. Wilson,** 53
New Century Care, Inc. President and Trustee From 1989 to present,
53 Sylvan Road North Chairman and Chief
Westport, CT 06880 Executive Officer,
New Century Care, Inc.
(Merchant bank); from
1995 to present,
Principal of New
Century Living, Inc.;
from 1989 to present,
Director of Chimney Rock
Vineyard and Chimney
Rock Winery; President
and Director, Key Mutual
Funds.
William B. Blundin, 59 Vice President Senior Vice President of
125 West 55th Street BISYS Fund Services
New York, N.Y. 10019 ("BISYS"); officer of
other investment
companies administered
by BISYS Fund Services;
President and Chief
Executive Officer of
Vista Broker- Dealer
Services, Inc., Emerald
Asset Management, Inc.
and BNY Hamilton
Distributors, Inc.,
registered
broker/dealers. - 94
</TABLE>
- 96 -
<PAGE>
<TABLE>
<CAPTION>
Position(s) with the Principal Occupation
Name, Age, and Address Victory Portfolios During Past 5 Years
- ------------------------ ------------------- -------------------
<S> <C> <C>
J. David Huber, 59 Vice President Executive Vice President
3435 Stelzer Road of BISYS.
Columbus, OH 43219-3035
Thomas E. Line, 30 Treasurer From December 1996
3435 Stelzer Road to present, employee
Columbus, OH 43219-3035 of BISYS Funds
Services; from
September 1989 to
November 1996, Audit
Senior Manager at
KPMG Peat Marwick
LLP.
Michael J. Sullivan Secretary From December 1996
to present, Vice
President of BISYS
Fund Services; from
February 1995 to
november 1996,
President,
Performance
Financial Group (a
mutual fund
consulting firm);
from January 1993 to
january 1995, CEO,
Manufacturing
Company.
Alaina V. Metz, Age 30 Assistant Secretary From June 1995 to
3435 Stelzer Road present, Chief
Columbus, OH 43219 Administrative and
Regulatory
Serevices, BISYS
Fund Services
Limited Partnership;
from May 1989 to
June 1995,
Supervisor, Mutual
Fund Legal
Department, Alliance
Capital Management.
Jay G. Baris, 43 Assistant Secretary From 1994 to
Kramer, Levin, Present, Partner,
Naftalis & Frankel; Kramer, Levin,
919 Third Avenue, Naftalis & Frankel;
41st Floor previously, Partner,
Reid & Priest. New
York, NY 10022
</TABLE>
Trustees and officers as a group owned beneficially less than 1% of all classes
of outstanding shares of the Funds.
The mailing address of each of the officers of the Victory Portfolios is 3435
Stelzer Road, Columbus, Ohio 43219- 3035.
The officers of the Victory Portfolios (other than Leigh Wilson) receive no
compensation directly from the Victory Portfolios for performing the duties of
their offices. BISYS receives fees from the Victory Portfolios as Administrator.
As of January 30, 1998, the Trustees and officers as a group owned beneficially
less than 1% of all classes of outstanding shares of the Funds.
ADVISORY AND OTHER CONTRACTS
INVESTMENT ADVISER AND SUB-ADVISER.
One of the Fund's most important contracts is with its investment adviser, Key
Asset Management Inc. ("KAM" or the "Adviser"), a New York corporation
registered as an investment adviser with the Securities and Exchange SEC. KAM is
a wholly owned subsidiary of KeyBank National Association ("KeyBank"), a
wholly-owned subsidiary of KeyCorp. On February 28, 1997, KAM became the
surviving corporation of the reorganization of four indirect investment adviser
subsidiaries of KeyCorp--KeyCorp Mutual Fund Advisers, Inc. ("Key Advisers"),
Society Asset Management, Inc. ("SAM"), Spears, Benzak, Salomon & Farrell, Inc.
("SBSF") and Applied Technologies, Inc. ("ATI"), each registered with the SEC as
an investment adviser. Key Advisers, SAM, and ATI were merged with and into
SBSF, a New York corporation organized on February 22, 1972. Pursuant to the
terms of the reorganization, SBSF changed its name to Key Asset Management Inc.
SAM, SBSF, and ATI will continue to operate under their existing names as
separate divisions of KAM. Affiliates of the Adviser manage approximately $60
billion for numerous clients including large corporate and public retirement
plans, Taft-Hartley plans, foundations and endowments, high net worth
individuals, and mutual funds.
- 97 -
<PAGE>
KeyCorp, a financial services holding company, is headquartered at 127 Public
Square, Cleveland, Ohio 44114. As of September 30, 1997, KeyCorp had an asset
base of $72 billion, with banking offices in 26 states from Maine to Alaska, and
trust and investment offices in 16 states. KeyCorp is the resulting entity of a
merger in 1994 of Society Corporation, the bank holding company of which
KeyBank, formerly Society National Bank was a wholly-owned subsidiary, and
KeyCorp, the former bank holding company. KeyCorp's major business activities
include providing traditional banking and associated financial services to
consumer, business and commercial markets. Its non-bank subsidiaries include
investment advisory, securities brokerage, insurance, bank credit card
processing, and leasing companies. KeyBank is the lead affiliate bank of
KeyCorp.
The following schedule lists the advisory fees for each mutual fund that is
advised by the Adviser.
.25 OF 1% OF AVERAGE DAILY NET ASSETS
Victory Institutional Money Market Fund
.35 OF 1% OF AVERAGE DAILY NET ASSETS
Victory Prime Obligations Fund
Victory U.S. Government Obligations Fund
Victory Tax-Free Money Market Fund
.50 OF 1% OF AVERAGE DAILY NET ASSETS
Victory Ohio Municipal Money Market Fund
Victory Limited Term Income Fund
Victory Government Mortgage Fund
Victory Financial Reserves Fund
Victory Fund for Income
.55 OF 1% OF AVERAGE DAILY NET ASSETS
Victory National Municipal Bond Fund
Victory New York Tax-Free Fund
.60 OF 1% OF AVERAGE DAILY NET ASSETS
Victory Ohio Municipal Bond Fund
Victory Stock Index Fund
.65 OF 1% OF AVERAGE DAILY NET ASSETS
Victory Diversified Stock Fund
.75 OF 1% OF AVERAGE DAILY NET ASSETS
Victory Intermediate Income Fund
Victory Investment Quality Bond Fund
Victory Ohio Regional Stock Fund
1% OF AVERAGE DAILY NET ASSETS
Victory Balanced Fund
Victory Lakefront Fund
Victory Value Fund
Victory Growth Fund
Victory Real Estate Investment Fund
Victory Special Value Fund
Victory Special Growth Fund
- 98 -
<PAGE>
1.10% OF AVERAGE DAILY NET ASSETS
Victory International Growth Fund
Lakefront Capital Investors, Inc. ("Lakefront" or the "Sub-Adviser") serves as
sub-adviser to the Lakefront Fund. For its services under the Investment
Sub-Advisory Agreement, the Adviser pays Lakefront a monthly fee of 0.50% of the
Lakefront Fund's average daily net assets from its advisory fee.
THE INVESTMENT ADVISORY AND INVESTMENT SUB-ADVISORY AGREEMENTS.
Unless sooner terminated, the Investment Advisory Agreement between the Adviser
and the Victory Portfolios, on behalf of the Funds (the "Investment Advisory
Agreement"), provides that it will continue in effect as to the Funds for an
initial two-year term and for consecutive one-year terms thereafter, provided
that such continuance is approved at least annually by the Trustees or by vote
of a majority of the outstanding shares of each Fund (as defined under
"Additional Information - Miscellaneous"), and, in either case, by a majority of
the Trustees who are not parties to the Investment Advisory Agreement or
interested persons (as defined in the 1940 Act) of any party to the Investment
Advisory Agreement, by votes cast in person at a meeting called for such
purpose.
The Investment Advisory Agreement is terminable as to any particular Fund at any
time on 60 days' written notice without penalty by the Trustees, by vote of a
majority of the outstanding shares of the Fund, by vote of the Board of Trustees
of the Victory Portfolios, or by the Adviser. The Investment Advisory Agreement
also terminates automatically in the event of any assignment, as defined in the
1940 Act.
The Investment Advisory Agreement provides that the Adviser shall not be liable
for any error of judgment or mistake of law or for any loss suffered by the
Funds in connection with the performance of services pursuant to the Investment
Advisory Agreement, except a loss resulting from a breach of fiduciary duty with
respect to the receipt of compensation for services or a loss resulting from
willful misfeasance, bad faith, or gross negligence on the part of the Adviser
in the performance of its duties, or from reckless disregard by it of its duties
and obligations thereunder.
From January 1, 1996 until February 28, 1997, Key Advisers served as investment
adviser to the Funds.
From January, 1993 until December 31, 1995, Society Asset Management, Inc.
served as investment adviser to the Funds. For the fiscal years ended October
31, 1997, 1996 and 1995 , the Key Asset Management Inc. (and its predecessors)
earned the following advisory fees with respect to each Fund, the amount of fees
paid to the Adviser is net of the amount of fee reduction:
- 99 -
<PAGE>
<TABLE>
<CAPTION>
1997 1996 1995
Amount of Amount of Amount of Amount of Amount of Amount
Fees Paid Fees Fees Paid Fees Fees Paid of Fee
to Advisor Reduction to Advisor Reduction to Advisor Reduction
---------- --------- ---------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balanced Fund $ 2,810,294 $353,372 $2,006,013 $376,178 $1,024,165 $624,474
Diversified Stock Fund 4,560,843 0 3,147,950 55,678 2,006,479 126,000
Financial Reserves Fund 3,786,668 301,812 3,402,511 582,762 3,125,072 420,213
Fund for Income 5,722 92,630 22,779 87,637 87,483 36,865
Government Mortgage Fund 565,656 0 646,159 3,389 702,724 15,995
Growth Fund 1,709,722 0 1,181,723 70,660 526,613 216,181
Institutional Money Market
Fund (a) 1,638,661 855,791 1,003,395 932,844 314,773 337,327
Intermediate Income Fund 1,622,286 340,846 1,218,106 357,865 692,143 325,544
International Growth Fund 1,317,383 0 1,224,364 30,428 901,337 116,464
Investment Quality Bond
Fund 993,289 208,773 836,655 185,307 546,647 238,865
Lakefront Fund 2,144 5,022
Limited Term Income Fund 418,588 15,636 671,988 46,818 710,323 20,789
National Municipal Bond 812/ 25,316/
Fund (b) 0 239,815 0 206,174 11,825 0
New York Tax-Free Bond 23,901 73,540 7,542 83,068 48,644 45,003
Ohio Municipal Bond Fund 376,962 79,594 298,093 103,079 183,193 163,525
Ohio Municipal Money
Market Fund 2,281,185 833,236 1,129,662 1,706,115 187,594 244,500
Ohio Regional Stock Fund 375,231 0 318,859 4,181 253,943 13,584
Prime Obligations Fund 1,870,850 0 1,628,427 -- 1,907,736 0
Real Estate Investment Trust 0 15,464
Special Growth Fund 920,562 0 711,543 33,521 143,381 296,856
Special Value Fund 3,525,053 0 2,304,543 71,047 1,140,267 405,752
Stock Index Fund 1,715,703 574,290 936,282 382,702 489,171 194,774
Tax-Free Money Market
Fund 1,283,064 37,520 1,092,669 31,987 829,802 34,209
U.S. Government Obligations
Fund 5,387,642 0 4,208,590 0 2,245,705 0
Value Fund 4,396,880 0 3,378,303 62,495 1,771,834 810,820
</TABLE>
(a) Fiscal year ended October 31, 1996 and 1997; fiscal period ended October
31, 1995; fiscal year ended April 30, 1995 and April 30, 1994;
respectively.
- 100 -
<PAGE>
(b) Fiscal year ended October 31, 1996 and 1997; fiscal period ended October
31, 1995 and fiscal year ended April 30, 1995; and fiscal period February
3, 1994 (commencement of operations) to April 30, 1994 respectively.
Under the Investment Advisory Agreement, the Adviser may delegate a portion of
its responsibilities to a sub-adviser. In addition, the Investment Advisory
Agreement provides that the Adviser may render services through its own
employees or the employees of one or more affiliated companies that are
qualified to act as an investment adviser of the Funds and are under the common
control of KeyCorp as long as all such persons are functioning as part of an
organized group of persons, managed by authorized officers of the Adviser.
INTERNATIONAL GROWTH FUND.
Indocam International Investment Services, S.A. ("IIIS") acts as subadviser to
the International Growth Fund under a Portfolio Management Agreement with the
Adviser dated as of June 1, 1998. The Trustees, including a majority of the
Trustees who are not interested persons of the Adviser or IIIS, approved the
Portfolio Management Agreement on February 20, 1998. In addition, the Portfolio
Management Agreement is terminable at any time, without penalty, by the
Trustees, by the Adviser or by a vote of a majority of the International Growth
Fund's outstanding voting securities on 60 days' written notice to the Adviser.
The Portfolio Management Agreement has an initial term of two years and, unless
sooner terminated, this Agreement shall continue in effect from year to year if
approved at least annually by a vote of a majority of the Trustees, including a
majority of the Trustees who are not interested persons of the Adviser or IIIS,
cast in person at a meeting called for the purpose of voting on the Portfolio
Management Agreement.
IIIS is a registered investment adviser with the Securities and Exchange
Commission. As of December 31, 1997, IIIS and its affiliates managed
approximately $124 billion for its clients. IIIS also serves as investment
adviser to the France Growth Fund and subadviser to the BNY Hamilton
International Equity Fund and the John Hancock European Equity Fund.
GLASS-STEAGALL ACT.
In 1971 the United States Supreme Court held in INVESTMENT COMPANY INSTITUTE V.
CAMP that the federal statute commonly referred to as the Glass-Steagall Act
prohibits a national bank from operating a fund for the collective investment of
managing agency accounts. Subsequently, the Board of Governors of the Federal
Reserve System (the "Board") issued a regulation and interpretation to the
effect that the Glass-Steagall Act and such decision: (a) forbid a bank holding
company registered under the Federal Bank Holding Company Act of 1956 (the
"Holding Company Act") or any non-bank affiliate thereof from sponsoring,
organizing, or controlling a registered, open-end investment company
continuously engaged in the issuance of its shares, but (b) do not prohibit such
a holding company or affiliate from acting as investment adviser, transfer
agent, and custodian to such an investment company. In 1981 the United States
Supreme Court held in BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM V.
INVESTMENT COMPANY INSTITUTE that the Board did not exceed its authority under
the Holding Company Act when it adopted its regulation and interpretation
authorizing bank holding companies and their non-bank affiliates to act as
investment advisers to registered closed-end investment companies. IN THE BOARD
OF GOVERNORS case, the Supreme Court also stated that if a national bank
complied with the restrictions imposed by the Board in its regulation and
interpretation authorizing bank holding companies and their non-bank affiliates
to act as investment advisers to investment companies, a national bank
performing investment advisory services for an investment company would not
violate the Glass-Steagall Act.
From time to time, advertisements, supplemental sales literature and information
furnished to present or prospective shareholders of the Funds may include
descriptions of Key Trust Company of Ohio, N.A. and the Adviser including, but
not limited to, (1) descriptions of the operations of Key Trust Company of Ohio,
N.A. and the Adviser; (2) descriptions of certain personnel and their functions;
and (3) statistics and rankings related to the operations of Key Trust Company
of Ohio, N.A. and the Adviser.
PORTFOLIO TRANSACTIONS.
THE MONEY MARKET FUNDS. Pursuant to the Investment Advisory Agreement of the
Victory Portfolios on behalf of the Money Market Funds, the Adviser determines,
subject to the general supervision of the Trustees of the Victory Portfolios,
and in accordance with each Money Market Fund's investment objective, policies
and restrictions, which securities are to be purchased and sold by the Money
Market Funds, and which brokers are to be eligible to execute its portfolio
transactions. Since purchases and sales of portfolio securities by the Money
Market Funds are usually principal transactions, the Money Market Funds incur
little or no brokerage commissions. For the three previous fiscal years ended
October 31, 1997, 1996 and 1995 , the Money Market Funds paid no brokerage
commissions. Securities of the Money Market Funds are normally purchased
directly from the issuer or from a market maker for the securities. The purchase
price paid to dealers serving as market makers may include a spread between the
bid and asked prices. The Money Market Funds may also purchase securities from
- 101 -
<PAGE>
underwriters at prices which include the spread retained by the underwriter from
the proceeds of the offering to the issuer.
The Money Market Funds do not seek to profit from short-term trading, and will
generally (but not always) hold portfolio securities to maturity, but the
Adviser may seek to enhance the yield of the Funds by taking advantage of yield
disparities or other factors that occur in the money markets. For example,
market conditions frequently result in similar securities trading at different
prices. The Adviser may dispose of any portfolio security prior to its maturity
if such disposition and reinvestment of proceeds are expected to enhance yield
consistent with the Adviser's judgment as to desirable portfolio maturity
structure or if such disposition is believed to be advisable due to other
circumstances or conditions. The investment policies of the Money Market Funds
require that investments mature in 90 days or less. Thus, there is likely to be
relatively high portfolio turnover, but since brokerage commissions are not
normally paid on money market instruments, the high rate of portfolio turnover
is not expected to have a material effect on the net income or expenses of the
Money Market Funds.
The Adviser's primary consideration in effecting a security transaction is to
obtain the best net price and the most favorable execution of the order.
Allocation of transactions, including their frequency, among various dealers is
determined by the Adviser in its best judgment and in a manner deemed fair and
reasonable to shareholders.
INCOME AND EQUITY FUNDS. Pursuant to the Investment Advisory Agreement (and for
the Lakefront Fund, the Investment Sub-Advisory Agreement), the Adviser (and the
Sub-Adviser) determine, subject to the general supervision of the Trustees of
the Victory Portfolios, and in accordance with each Fund's investment objective
and restrictions, which securities are to be purchased and sold by the Funds,
and which brokers are to be eligible to execute its portfolio transactions.
Purchases from underwriters and/or broker-dealers of portfolio securities
include a commission or concession paid by the issuer to the underwriter and/or
broker-dealer and purchases from dealers serving as market makers may include
the spread between the bid and asked price. While the Adviser (and the
Sub-Adviser) generally seeks competitive spreads or commissions, each Fund may
not necessarily pay the lowest spread or commission available on each
transaction, for reasons discussed below.
Allocation of transactions to dealers is determined by the Adviser (or the
Sub-Adviser) in their best judgment and in a manner deemed fair and reasonable
to shareholders. The primary consideration is prompt execution of orders in an
effective manner at the most favorable price. Subject to this consideration,
dealers who provide supplemental investment research to the Adviser (or the
Sub-Adviser) may receive orders for transactions by the Victory Portfolios.
Information so received is in addition to and not in lieu of services required
to be performed by the Adviser (or the Sub-Adviser) and does not reduce the
investment advisory fees payable to the Adviser by the Funds. Such information
may be useful to the Adviser (or the Sub-Adviser) in serving both the Victory
Portfolios and other clients and, conversely, such supplemental research
information obtained by the placement of orders on behalf of other clients may
be useful to the Adviser (or the Sub-Adviser) in carrying out its obligations to
the Victory Portfolios. The Trustees have authorized the allocation of brokerage
to affiliated broker-dealers on an agency basis to effect portfolio
transactions. The Trustees have adopted procedures incorporating the standards
of Rule 17e-1 of the 1940 Act, which require that the commission paid to
affiliated broker-dealers must be "reasonable and fair compared to the
commission, fee or other remuneration received, or to be received, by other
brokers in connection with comparable transactions involving similar securities
during a comparable period of time." At times, the Funds may also purchase
portfolio securities directly from dealers acting as principals, underwriters or
market makers. As these transactions are usually conducted on a net basis, no
brokerage commissions are paid by the Funds.
ALL FUNDS. The Victory Portfolios will not execute portfolio transactions
through, acquire portfolio securities issued by, make savings deposits in, or
enter into repurchase or reverse repurchase agreements with the Adviser, the
Sub-Adviser, Key Trust Company of Ohio, N.A. ("Key Trust") or their affiliates,
or BISYS or its affiliates, and will not give preference to Key Trust's
correspondent banks or affiliates, or BISYS with respect to such transactions,
securities, savings deposits, repurchase agreements, and reverse repurchase
agreements.
- 102 -
<PAGE>
Investment decisions for each Fund are made independently from those made for
the other Funds of the Victory Portfolios or any other investment company or
account managed by the Adviser (or the Sub-Adviser). Such other investment
companies or accounts may also invest in the securities in which the Funds
invest, and the Funds may invest in similar securities. When a purchase or sale
of the same security is made at substantially the same time on behalf of a Fund
and any other Fund, investment company or account, the transaction will be
averaged as to price, and available investments allocated as to amount, in a
manner which the Adviser (or the Sub-Adviser) believes to be equitable to such
Funds, investment company or account. In some instances, this investment
procedure may affect the price paid or received by a Fund or the size of the
position obtained by the Fund in an adverse manner relative to the result that
would have been obtained if only that particular Fund had participated in or
been allocated such trades. To the extent permitted by law, the Adviser (or the
Sub-Adviser) may aggregate the securities to be sold or purchased for a Fund
with those to be sold or purchased for the other funds of the Victory Portfolios
or for other investment companies or accounts in order to obtain best execution.
In making investment recommendations for the Victory Portfolios, the Adviser
(and the Sub-Adviser) will not inquire or take into consideration whether an
issuer of securities proposed for purchase or sale by a Fund is a customer of
the Adviser (or the Sub-Adviser), their parents or subsidiaries or affiliates
and, in dealing with their commercial customers, the Advisers (or the
Sub-Adviser), their parents, subsidiaries, and affiliates will not inquire or
take into consideration whether securities of such customers are held by the
Victory Portfolios.
Brokerage commissions paid by each of the Funds listed below were as follows for
the fiscal years ended October 31, 1997, 1996 and 1995.
<TABLE>
<CAPTION>
1997 1996 1995
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balanced Fund $212,666.31 $190,526.34 $125,079
- ------------------------------------------------------------------------------------------------
Diversified Stock Fund 906,124.85 881,427.50 615,260
- ------------------------------------------------------------------------------------------------
Financial Reserves Fund -- -- --
- ------------------------------------------------------------------------------------------------
Fund For Income -- 1,250.00 0
- ------------------------------------------------------------------------------------------------
Government Mortgage Fund -- 542.84 0
- ------------------------------------------------------------------------------------------------
Growth Fund 68,970.96 97,820.00 147,798
- ------------------------------------------------------------------------------------------------
Institutional Money Market Fund -- -- --
- ------------------------------------------------------------------------------------------------
Intermediate Income Fund 3,242.20 61,811.73 1,500
- ------------------------------------------------------------------------------------------------
International Growth Fund 1,103,488.08 -- 333,609
- ------------------------------------------------------------------------------------------------
Investment Quality Bond Fund 1,734.39 12,889.90 1,800
- ------------------------------------------------------------------------------------------------
Lakefront Fund 2,513.90 -- --
- ------------------------------------------------------------------------------------------------
Limited Term Income Fund 468.75 8,580.94 0
- ------------------------------------------------------------------------------------------------
National Municipal Bond Fund -- -- --
- ------------------------------------------------------------------------------------------------
New York Tax-Free Fund -- 0 0
- ------------------------------------------------------------------------------------------------
Ohio Municipal Bond Fund -- 0 0
- ------------------------------------------------------------------------------------------------
Ohio Municipal Money Market Fund -- -- --
- ------------------------------------------------------------------------------------------------
Ohio Regional Stock Fund 21,805.75 6,597.60 15,420
- ------------------------------------------------------------------------------------------------
Prime Obligations Fund -- -- --
- ------------------------------------------------------------------------------------------------
Real Estate Investment Fund -- -- --
- ------------------------------------------------------------------------------------------------
Special Growth Fund 238,533.30 176,980.29 99,980
- ------------------------------------------------------------------------------------------------
Special Value Fund 428,514.23 431,541.97 224,350
- ------------------------------------------------------------------------------------------------
Stock Index Fund 43,190.22 27,553.63 24,243
- ------------------------------------------------------------------------------------------------
Tax-Free Money Market Fund -- -- --
- ------------------------------------------------------------------------------------------------
U.S. Government Obligations Fund -- -- --
- ------------------------------------------------------------------------------------------------
Value Fund 218,946.60 225,799.21 218,770
</TABLE>
- 103 -
<PAGE>
PORTFOLIO TURNOVER.
The turnover rate stated in the Prospectus for a Fund's investment portfolio is
calculated by dividing the lesser of a Fund's purchases or sales of portfolio
securities for the year by the monthly average value of the portfolio
securities. The calculation excludes all securities whose maturities, at the
time of acquisition, were one year or less. The portfolio turnover rates for
each of the Funds listed below were as follows for the fiscal years ended
October 31, 1997 and 1996.
<TABLE>
<CAPTION>
Fund 1997 1996
- ---- ---- ----
<S> <C> <C>
Balanced Fund (a) 109% 80%(b)
Diversified Stock Fund (a) 63% 94%(b)
Fund for Income 26% 25%
Government Mortgage Fund 115% 127%
Growth Fund 21% 27%
Intermediate Income Fund 195% 164%
International Growth Fund (a) 116% 178%(b)
Investment Quality Bond Fund 249% 182%
Lakefront Fund 36% N/A
Limited Term Income Fund 139% 221%
National Municipal Bond Fund (a) 154% 143%
New York Tax-Free Fund (a) 11% 0%
Ohio Municipal Bond Fund 74% 81%
Ohio Regional Stock Fund (a) 8% 6%(b)
Real Estate Invesment Fund 21% N/A
Special Growth Fund (a) 195% 152%
Special Value Fund (a) 39% 55%(b)
Stock Index Fund 11% 4%
Value Fund 26% 28%
</TABLE>
(a) Portfolio turnover is calculated on the basis of the Fund as a whole
without distinguishing between the classes of shares issued.
(b) For year ended October 31, 1996 for Class A shares and for the period March
1, 1996 through October 31, 1996 for Class B shares.
ADMINISTRATOR.
BISYS Fund Services Limited Partnership (d/b/a BISYS Fund Services) ("BISYS" or
the "Administrator") serves as administrator to the Funds pursuant to an
administration agreement dated October 1, 1997 (the "Administration Agreement").
The Administrator assists in supervising all operations of the Funds (other than
those performed by the Adviser or the Sub-Adviser under the Investment Advisory
Agreement and Investment Sub-Advisory Agreement), subject to the supervision of
the Board of Trustees.
For the services rendered to the Funds and related expenses borne by BISYS as
Administrator, each Fund pays BISYS an annual fee, computed daily and paid
monthly, at the following annual rates based on each Fund's average daily net
assets:
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<PAGE>
.15% for portfolio assets of $300 million and less,
.12% for the next $300 million through $600 million of portfolio assets; and
.10% for portfolio assets greater than $600 million.
BISYS may periodically waive all or a portion of its fee with respect to any
Fund in order to increase the net income of one or more of the Funds available
for distribution to shareholders.
Unless sooner terminated, the Administration Agreement will continue in effect
as to each Fund for a period of two years, and for consecutive one-year terms
thereafter, provided that such continuance is ratified at least annually by the
Trustees or by vote of a majority of the outstanding shares of each Fund, and in
either case by a majority of the Trustees who are not parties to the
Administration Agreement or interested persons (as defined in the 1940 Act) of
any party to the Administration Agreement, by votes cast in person at a meeting
called for such purpose.
The Administration Agreement provides that BISYS shall not be liable for any
error of judgment or mistake of law or any loss suffered by the Victory
Portfolios in connection with the matters to which the Administration Agreement
relates, except a loss resulting from willful misfeasance, bad faith, or gross
negligence in the performance of its duties, or from the reckless disregard by
it of its obligations and duties thereunder.
Under the Administration Agreement, BISYS assists in each Fund's administration
and operation, including providing statistical and research data, clerical
services, internal compliance and various other administrative services,
including among other responsibilities, forwarding certain purchase and
redemption requests to the Transfer Agent, participation in the updating of the
prospectus, coordinating the preparation, filing, printing and dissemination of
reports to shareholders, coordinating the preparation of income tax returns,
arranging for the maintenance of books and records and providing the office
facilities necessary to carry out the duties thereunder. Under the
Administration Agreement, BISYS may delegate all or any part of its
responsibilities thereunder.
The following chart reflects the aggregate administration fees earned after fee
reductions by the Administrator in connection with the sale of shares of each
Fund for the fiscal years ended October 31, 1997, 1996 and 1995.
<TABLE>
<CAPTION>
1997 1996 1995
Administration Fee Administration Fee Administration Fee
Fees Reductions Fees Reductions Fees Reductions
---- ---------- ---- ---------- ---- ----------
<S> <C> <C> <C> <C> <C> <C>
Balanced Fund...................... $472,961 $0 $357,125 $0 $246,993 $303
Diversified Stock Fund............. 1,034,997 0 678,848 60,602 490,419 1,612
Financial Reserves Fund............ 1,209,552 0 1,196,089 0 1,063,114 472
Fund for Income.................... 11,799 17,707 13,292 19,833 27,624 9,681
Government Mortgage Fund........... 169,697 0 195,013 0 215,665 0
Growth Fund........................ 256,459 0 187,857 0 63,251 48,168
Institutional Money Market
Fund (a)......................... 340,471 1,156,193 464,863 696,881 134,232 257,028
Intermediate Income Fund........... 392,489 0 314,921 0 203,344 194
International Growth Fund.......... 179,643 0 171,154 0 138,965 0
Investment Quality Bond Fund....... 240,312 0 205,210 0 157,427 0
Lakefront Fund..................... 1,045 0 N/A N/A N/A N/A
Limited Term Income Fund........... 130,222 0 216,263 0 220,396 0
National Municipal Bond
Fund(b)............................ 65,363(b) 0 20,352 35,877 1,046 6,080
New York Tax-Free Bond............. 10,626 15,949 9,888 14,823 18,436 7,104
Ohio Municipal Bond Fund........... 114,083 0 100,340 0 86,670 10
Ohio Municipal Money Market
Fund............................. 548,673(c) 375,708 851,457 0 (c) (c)
Ohio Regional Stock Fund........... 75,046 0 64,609 0 53,484 21
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<PAGE>
Prime Obligations Fund............. 790,839 0 697,897 0 817,341 0
Real Estate Investment Fund........ 0 2,320 N/A N/A N/A N/A
Special Growth Fund................ 138,080 0 112,578 0 33,202 32,831
Special Value Fund................. 525,357 0 356,371 0 231,340 1,000
Stock Index Fund................... 0 567,979 0 329,746 0 171,000
Tax-Free Money Market Fund......... 562,890 0 446,706 35,290 370,209 0
U.S. Government Obligations
Fund............................. 2,258,117 0 1,803,685 0 780,808 88,000
Value Fund......................... 654,663 0 516,120 0 387,398 0
</TABLE>
(a) Fiscal year ended October 31, 1996 and 1997; fiscal period ended October
31, 1995; fiscal year ended April 30, 1995; respectively.
(b) Fiscal year ended October 31, 1996 and 1997; fiscal period ended October
31, 1994 and fiscal year ended April 30, 1995; and fiscal period February
3, 1994 (commencement of operations) to April 30, 1994, respectively. For
the fiscal year ended April 30, 1995, the Fund paid administration fees of
$926 of which Fidelity Distributors Corporation received $717 and Concord
Holding Corporation received $209. During the same period, fees and
expenses of $83,748 were reimbursed to the Predecessor Fund. (c) For the
two month period ended October 31, 1995, Concord Holding Corporation earned
an administration fee of $129,644 after $0 in voluntary fee waivers. For
the period June 5, 1995 to August 31, 1995, Concord Holding Corporation
earned administration fees of $165,282 from the Fund after voluntary fees
waived of $4,709. Prior to that, from August 31, 1994 to June 4, 1995,
Primary Fund Service Corporation earned $433,288 from the Fund after
voluntary fees waived of $500.
Distributor.
BISYS Fund Services serves as distributor (the "Distributor") for the continuous
offering of the shares of the Funds pursuant to a Distribution Agreement between
the Distributor and the Victory Portfolios. Unless otherwise terminated, the
Distribution Agreement will remain in effect with respect to each Fund for two
years, and thereafter for consecutive one-year terms, provided that it is
approved at least annually (1) by the Trustees or by the vote of a majority of
the outstanding shares of each Fund, and (2) by the vote of a majority of the
Trustees of the Victory Portfolios who are not parties to the Distribution
Agreement or interested persons of any such party, cast in person at a meeting
called for the purpose of voting on such approval. The Distribution Agreement
will terminate in the event of its assignment, as defined under the 1940 Act.
The following chart reflects the total underwriting commissions earned and the
amount of those commissions retained by the Distributor in connection with the
sale of shares of each Fund for the fiscal years ended October 31, 1997, 1996
and 1995.
- 106 -
<PAGE>
<TABLE>
<CAPTION>
1997 1996 1995
Underwriting Amount Underwriting Amount Underwriting Amount
Commissions Retained Commissions Retained Commission Retained
<S> <C> <C> <C> <C> <C> <C>
Balanced Fund....................... $96,700 $4,600 $63,000 $60,000 (a) (a)
Diversified Stock Fund.............. 1,412,000 448,000 452,000 430,000 (a) (a)
Financial Reserves Fund............. 0 0 - - (a) (a)
Fund for Income..................... 13,800 3,600 18,000 17,000 (a) (a)
Government Mortgage Fund............ 17,200 2,000 2,000 2,000 (a) (a)
Growth Fund......................... 15,300 2,200 1,000 1,000 (a) (a)
Institutional Money Market Fund..... 0 0 - - (a) (a)
Intermediate Income Fund............ 2,600 300 2,000 2,000 (a) (a)
International Growth Fund........... 11,600 1,300 17,000 17,000 (a) (a)
Investment Quality Bond Fund........ 15,700 2,200 6,000 6,000 (a) (a)
Lakefront Fund . . . . . . . . . .. 3,000 500 - - - -
Limited Term Income Fund............ 400 100 3,000 3,000 (a) (a)
National Municipal Bond Fund........ 30,200 1,300 31,000 31,000 (a) (a)
New York Tax-Free Bond.............. 51,300 3,900 43,000 39,000 (a) (a)
Ohio Municipal Bond Fund............ 26,000 3,500 20,000 20,000 (a) (a)
Ohio Municipal Money Market
Fund.............................. 0 0 - - (a) (a)
Ohio Regional Stock Fund............ 19,800 1,500 21,000 21,000 (a) (a)
Prime Obligations Fund.............. 0 0 - - (a) (a)
Real Estate Investment Fund . .. 16,600 2,300 - - - -
Special Growth Fund................. 18,200 2,800 2,000 2,000 (a) (a)
Special Value Fund.................. 76,000 4,600 22,000 11,000 (a) (a)
Stock Index Fund.................... 91,700 12,800 9,000 9,000 (a) (a)
Tax-Free Money Market Fund.......... 0 0 - - (a) (a)
U.S. Government Obligations
Fund............................. 0 0 - - (a) (a)
Value Fund.......................... 12,800 2,000 1,000 1,000 (a) (a)
</TABLE>
(a) In 1995, the amount of underwriting commissions and the amount retained
for the entire Fund Complex was $721,000 and $107,000, respectively.
TRANSFER AGENT.
State Street Bank and Trust Company ("State Street") serves as transfer agent
for the Funds. Boston Financial Data Services, Inc. ("BFDS") serves as the
dividend disbursing agent and shareholder servicing agent for the Funds,
pursuant to a Transfer Agency and Service Agreement. Under its agreement with
the Victory Portfolios, State Street has agreed (1) to issue and redeem shares
of the Victory Portfolios; (2) to address and mail all communications by the
Victory Portfolios to its shareholders, including reports to shareholders,
dividend and distribution notices, and proxy material for its meetings of
shareholders; (3) to respond to correspondence or inquiries by shareholders and
others relating to its duties; (4) to maintain shareholder accounts and certain
sub-accounts; and (5) to make periodic reports to the Trustees concerning the
Victory Portfolios' operations.
SHAREHOLDER SERVICING PLAN.
Payments made under the Shareholder Servicing Plan to Shareholder Servicing
Agents (which may include affiliates of the Adviser and Sub-Adviser) are for
administrative support services to customers who may from time to time
beneficially own shares, which services may include: (1) aggregating and
processing purchase and redemption requests for shares from customers and
transmitting promptly net purchase and redemption orders to our distributor
- 107 -
<PAGE>
or transfer agent; (2) providing customers with a service that invests the
assets of their accounts in shares pursuant to specific or pre-authorized
instructions; (3) processing dividend and distribution payments on behalf of
customers; (4) providing information periodically to customers showing their
positions in shares; (5) arranging for bank wires; (6) responding to customer
inquiries; (7) providing subaccounting with respect to shares beneficially owned
by customers or providing the information to the Funds as necessary for
subaccounting; (8) if required by law, forwarding shareholder communications
from us (such as proxies, shareholder reports, annual and semi-annual financial
statements and dividend, distribution and tax notices) to customers; (9)
forwarding to customers proxy statements and proxies containing any proposals
which require a shareholder vote; and (10) providing such other similar services
as we may reasonably request to the extent you are permitted to do so under
applicable statutes, rules or regulations.
OTHER SERVICING PLANS.
In connection with certain servicing plans, the Funds had made certain
commitments that provide: (i) for one or more brokers to accept on the Funds'
behalf, purchase and redemption orders; (ii) authorize such brokers to designate
other intermediaries to accept purchase and redemption orders on the Funds'
behalf; (iii) that the Funds will be deemed to have received a purchase or
redemption order when an authorized broker or, if applicable, a broker's
authorized designee, accepts the order; and (iv) that customer orders will be
priced at the Funds' Net Asset Value next computed after they are accepted by an
authorized broker or the broker's authorized designee.
DISTRIBUTION AND SERVICE PLAN.
The Victory Portfolios, on behalf of the Financial Reserves Fund, Fund for
Income, Institutional Money Market Fund (Investor Class and Select Class),
Lakefront Fund, National Municipal Bond Fund, New York Tax-Free Fund, Ohio
Municipal Money Market Fund, Real Estate Investment Fund, and U.S. Obligations
Fund (Investor Shares) has adopted a Distribution and Service Plan (the "Plan")
pursuant to Rule 12b-1 under the 1940 Act (the "Rule 12b- 1"). Rule 12b-1
provides in substance that a mutual fund may not engage directly or indirectly
in financing any activity that is primarily intended to result in the sale of
shares of such mutual fund except pursuant to a plan adopted by the fund under
Rule 12b-1. The Board of Trustees has adopted the Plan to allow the Adviser, the
Sub-Adviser and the Distributor to incur certain expenses that might be
considered to constitute indirect payment by the Funds of distribution expenses.
Under the Plan, if a payment to the Advisers or the Sub-Adviser of management
fees or to the Distributor of administrative fees should be deemed to be
indirect financing by the Victory Portfolios of the distribution of their
shares, such payment is authorized by the Plan.
The Plan specifically recognizes that the Adviser, the Sub-Adviser or the
Distributor, directly or through an affiliate, may use its fee revenue, past
profits, or other resources, without limitation, to pay promotional and
administrative expenses in connection with the offer and sale of shares of the
Funds. In addition, the Plan provides that the Adviser, the Sub-Adviser and the
Distributor may use their respective resources, including fee revenues, to make
payments to third parties that provide assistance in selling the Funds' shares,
or to third parties, including banks, that render shareholder support services.
The Plan has been approved by the Board of Trustees. As required by the Rule,
the Trustees carefully considered all pertinent factors relating to the
implementation of the Plan prior to its approval, and have determined that there
is a reasonable likelihood that the Plan will benefit the Funds and their
shareholders. In particular, the Trustees noted that the Plan does not authorize
payments by the Funds other than the advisory and administrative fees authorized
under the investment advisory and administration agreements. To the extent that
the Plan gives the Adviser, the Sub-Adviser or the Distributor greater
flexibility in connection with the distribution of shares of the Funds,
additional sales of the Funds' shares may result. Additionally, certain
shareholder support services may be provided more effectively under the Plan by
local entities with whom shareholders have other relationships.
CLASS B SHARES DISTRIBUTION PLAN.
The Victory Portfolios has adopted a Distribution Plan for Class B shares of the
Balanced Fund, Diversified Stock Fund, International Growth Fund, National
Municipal Bond Fund, New York Tax-Free Fund, Ohio Regional Stock Fund and
Special Value Fund under the Rule. The Distribution Plan adopted by the Trustees
with respect to the Class B shares of the Funds provides that each Fund will pay
the Distributor a distribution fee under the Distribution Plan at the annual
rate of 0.75% of the average daily net assets of the Fund attributable to the
Class B shares. The distribution fees may be used by the Distributor for: (a)
costs of printing and distributing each Fund's prospectus, statement of
additional information and reports to prospective investors in the Funds; (b)
costs involved in preparing, printing and distributing sales literature
pertaining to the Funds; (c) an allocation of overhead and other branch office
- 108 -
<PAGE>
distribution-related expenses of the Distributor; (d) payments to persons who
provide support services in connection with the distribution of each Fund's
Class B shares, including but not limited to, office space and equipment,
telephone facilities, answering routine inquiries regarding the Funds,
processing shareholder transactions and providing any other shareholder services
not otherwise provided by the Victory Portfolios' transfer agent; (e) accruals
for interest on the amount of the foregoing expenses that exceed the
distribution fee and the CDSCs received by the Distributor; and (f) any other
expense primarily intended to result in the sale of the Funds' Class B shares,
including, without limitation, payments to salesmen and selling dealers at the
time of the sale of Class B shares, if applicable, and continuing fees to each
such salesmen and selling dealers, which fee shall begin to accrue immediately
after the sale of such shares.
The amount of the distribution fees payable by any Fund under the Distribution
Plan is not related directly to expenses incurred by the Distributor and the
Distribution Plan does not obligate the Funds to reimburse the Distributor for
such expenses. The distribution fees set forth in the Distribution Plan will be
paid by each Fund to the Distributor unless and until the Distribution Plan is
terminated or not renewed with respect to such Fund; any distribution or service
expenses incurred by the Distributor on behalf of the Funds in excess of
payments of the distribution fees specified above which the Distributor has
accrued through the termination date are the sole responsibility and liability
of the Distributor and not an obligation of the Funds.
The Distribution Plan for the Class B shares specifically recognizes that either
the Adviser or the Distributor, directly or through an affiliate, may use its
fee revenue, past profits, or other resources, without limitation, to pay
promotional and administrative expenses in connection with the offer and sale of
shares of the Funds. In addition, the Plan provides that the Adviser and the
Distributor may use their respective resources, including fee revenues, to make
payments to third parties that provide assistance in selling the Funds' Class B
shares, or to third parties, including banks, that render shareholder support
services.
The Distribution Plan was approved by the Trustees, including the independent
Trustees, at a meeting called for that purpose. As required by Rule 12b-1, the
Trustees carefully considered all pertinent factors relating to the
implementation of the Distribution Plan prior to its approval, and have
determined that there is a reasonable likelihood that the Distribution Plan will
benefit the Funds and their Class B shareholders. To the extent that the
Distribution Plan gives the Advisers or the Distributor greater flexibility in
connection with the distribution of Class B shares of the Funds, additional
sales of the Funds' Class B shares may result. Additionally, certain Class B
shareholder support services may be provided more effectively under the
Distribution Plan by local entities with whom shareholders have other
relationships.
FUND ACCOUNTANT.
BISYS Fund Services Ohio, Inc. ("BISYS, Inc.") serves as fund accountant for the
all of the Funds pursuant to a fund accounting agreement with the Victory
Portfolios dated May 31, 1995 (the "Fund Accounting Agreement"). As fund
accountant for the Victory Portfolios, BISYS, Inc. calculates each Fund's net
asset value, the dividend and capital gain distribution, if any, and the yield.
BISYS, Inc. also provides a current security position report, a summary report
of transactions and pending maturities, a current cash position report, and
maintains the general ledger accounting records for the Funds. Under the Fund
Accounting Agreement, BISYS, Inc. is entitled to receive annual fees of .03% of
the first $100 million of the Fund's daily average net assets, .02% of the next
$100 million of the Fund's daily average net assets, and .01% of the Fund's
remaining daily average net assets. These annual fees are subject to a minimum
monthly assets charge of $2,500 per taxable fund, $2,917 per tax-free fund and
$3,333 per international fund and does not include out-of-pocket expenses or
multiple class charges of $833 per month assessed for each class of shares after
the first class.
For the fiscal years ended October 31, 1997, 1996, and 1995 the Fund accountant
earned the following fund accounting fees of:
- 109 -
<PAGE>
<TABLE>
<CAPTION>
FUND 1997 1996 1995
- ---- ---- ---- ----
<S> <C> <C> <C>
Balanced Fund $89,610 $93,776 $87,894
Diversified Stock Fund 119,767 159,249 141,598
Financial Reserves Fund 88,998 78,188 100,934
Fund for Income 48,449 57,144 32,288
Government Mortgage Fund 38,396 50,487 83,080
Growth Fund 51,705 35,364 49,945
Institutional Money Market Fund(a) 102,437 86,455 50,238
Intermediate Income Fund 67,260 61,867 71,451
International Growth Fund 70,707 90,570 121,305
Investment Quality Bond Fund 57,053 52,699 70,983
Lakefront Fund 24,280 N/A N/A
Limited Term Income Fund 33,524 39,040 89,012
National Municipal Bond Fund(b) 57,061 65,000 24,041
New York Tax-Free Fund 49,575 51,388 48,533
Ohio Municipal Bond Fund 46,445 51,845 43,204
Ohio Municipal Money Market Fund 99,579 65,058 13,370/
30,071(c)
Ohio Regional Stock Fund 45,783 51,094 30,563
Prime Obligations Fund 92,710 85,261 260,571
Real Estate Investment Fund 15,520 N/A N/A
Special Growth Fund 39,041 57,804 20,897
Special Value Fund 87,704 79,170 75,514
Stock Index Fund 120,844 87,027 22,715
Tax-Free Money Market Fund 79,661 107,911 112,625
U.S. Government Obligation Fund 97,657 85,062 243,249
Value Fund 83,739 71,046 124,400
</TABLE>
(a) Fiscal period ended October 31, 1996; fiscal period ended October 31, 1995;
fiscal year ended April 30, 1995 and April 30, 1994; respectively.
(b) Fiscal year ended October 31, 1996; fiscal period ended October 31, 1995
and fiscal year ended April 30, 1995; and fiscal period February 3, 1994
(commencement of operations) to April 30, 1994, respectively.
(c) For the period ended October 31, 1995 and the period from June 5, 1995
through August 31, 1995.
Key Asset Management Inc. served as fund accountant for the Real Estate
Investment Fund until October 13, 1997.
- 110 -
<PAGE>
CUSTODIAN.
Cash and securities owned by each of the Victory Portfolios are held by Key
Trust as custodian pursuant to a Custodian Agreement dated August 1, 1996. Cash
and securities owned by the Funds are also held by Morgan Stanley Trust Company
("Morgan Stanley") as sub-custodian, and certain foreign sub-custodians,
pursuant to a Sub-Custody Agreement. Under these Agreements, Key Trust and
Morgan Stanley each (1) maintains a separate account or accounts in the name of
each respective fund; (2) makes receipts and disbursements of money on behalf of
each Fund; (3) collects and receives all income and other payments and
distributions on account of portfolio securities; (4) responds to correspondence
from security brokers and others relating to its duties; and (5) makes periodic
reports to the Trustees concerning The Victory Portfolios' operations. Key Trust
may, with the approval of a fund and at the custodian's own expense, open and
maintain a sub-custody account or accounts on behalf of a fund, provided that
Key Trust shall remain liable for the performance of all of its duties under the
Custodian Agreement.
INDEPENDENT ACCOUNTANTS.
The audited financial statements of the Victory Portfolios for the fiscal year
ended October 31, 1997 are incorporated by reference herein. The financial
statements for the fiscal year ended October 31, 1997 have been audited by
Coopers & Lybrand L.L.P. as set forth in their report incorporated by reference
herein, and are included in reliance upon such report and on the authority of
such firm as experts in auditing and accounting. Coopers & Lybrand L.L.P. serves
as The Victory Portfolios' auditors. Coopers & Lybrand L.L.P.'s address is 100
East Broad Street, Columbus, Ohio 43215.
LEGAL COUNSEL.
Kramer, Levin, Naftalis & Frankel, 919 Third Avenue, New York, New York 10022 is
the counsel to the Victory Portfolios.
EXPENSES.
The Funds bear the following expenses relating to its operations: taxes,
interest, brokerage fees and commissions, fees of the Trustees, SEC fees, state
securities qualification fees, costs of preparing and printing prospectuses for
regulatory purposes and for distribution to current shareholders, outside
auditing and legal expenses, advisory and administration fees, fees and
out-of-pocket expenses of the custodian and transfer agent, certain insurance
premiums, costs of maintenance of the fund's existence, costs of shareholders'
reports and meetings, and any extraordinary expenses incurred in the Funds'
operation.
ADDITIONAL INFORMATION
DESCRIPTION OF SHARES.
The Victory Portfolios (sometimes referred to as the "Trust") is a Delaware
business trust. The Delaware Trust Instrument authorizes the Trustees to issue
an unlimited number of shares, which are units of beneficial interest, without
par value. The Victory Portfolios presently has 30 series of shares, which
represent interests in the following funds and their respective classes, if any:
Balanced Fund
Class A Shares
Class B Shares
Diversified Stock Fund
Class A Shares
- 111 -
<PAGE>
Class B Shares
Financial Reserves Fund
Fund For Income
Government Mortgage Fund
Growth Fund
Institutional Money Market Fund
Select Shares
Investor Shares
Intermediate Income Fund
International Growth Fund
Class A Shares
Class B Shares
Investment Quality Bond Fund
Lakefront Fund
Limited Term Income Fund
National Municipal Bond Fund
Class A Shares
Class B Shares
New York Tax-Free Fund
Class A Shares
Class B Shares
Ohio Municipal Bond Fund
Ohio Municipal Money Market Fund
Ohio Regional Stock Fund
Class A Shares
Class B Shares
Prime Obligations Fund
Real Estate Investment Fund
Special Growth Fund
Special Value Fund
Class A Shares
Class B Shares
Stock Index Fund
Tax-Free Money Market Fund
U.S. Government Obligations Fund
Select Shares
Investor Shares
Value Fund
The Victory Portfolios' Trust Instrument authorizes the Trustees to divide or
redivide any unissued shares of the Victory Portfolios into one or more
additional series by setting or changing in any one or more aspects their
respective preferences, conversion or other rights, voting power, restrictions,
limitations as to dividends, qualifications, and terms and conditions of
redemption.
- 112 -
<PAGE>
Shares have no subscription or preemptive rights and only such conversion or
exchange rights as the Trustees may grant in their discretion. When issued for
payment as described in the Prospectus and this Statement of Additional
Information, the Victory Portfolios' shares will be fully paid and
non-assessable. In the event of a liquidation or dissolution of the Victory
Portfolios, shares of a fund are entitled to receive the assets available for
distribution belonging to the fund, and a proportionate distribution, based upon
the relative asset values of the respective funds, of any general assets not
belonging to any particular fund which are available for distribution.
To the best knowledge of the Victory Portfolios, the names and addresses of the
holders of 5% or more of the outstanding shares of each class of the Funds'
equity securities as of January 30, 1998, and the percentage of the outstanding
shares held by such holders are set forth below:
<TABLE>
<CAPTION>
=============================================================================================================================
PERCENT PERCENT
OWNED OWNED
FUND NAME AND ADDRESS OF OWNER OF RECORD BENEFICIALLY
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
BALANCED FUND- SNBOC and Company 96.9% -
CLASS A SHARES 4900 Tiedeman Road
Cleveland, Ohio 44144
- -----------------------------------------------------------------------------------------------------------------------------
DIVERSIFIED STOCK FUND - SNBOC and Company 83.7% -
CLASS A SHARES 4900 Tiedeman Road
Cleveland, Ohio 44144
- -----------------------------------------------------------------------------------------------------------------------------
FINANCIAL RESERVES FUND SNBOC and Company 93.8% -
4900 Tiedeman Road
Cleveland, Ohio 44144
- -----------------------------------------------------------------------------------------------------------------------------
FUND FOR INCOME Key Trust of Cleveland 16.1% -
4900 Tiedeman Road
Cleveland, Ohio 44144
- -----------------------------------------------------------------------------------------------------------------------------
GOVERNMENT MORTGAGE SNBOC and Company 95.5% -
FUND 4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
GROWTH FUND SNBOC and Company 95.4% -
4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
INSTITUTIONAL MONEY BISYS Fund Services Ohio Inc. 98.5% -
MARKET FUND-SELECT Attn: Iris Young
CLASS 3435 Steltzer Rd.
Columbus, Ohio 43219-3035
- -----------------------------------------------------------------------------------------------------------------------------
INVESTOR CLASS Liefke & Co. 67.6% -
c/o KeyCorp Trust Services
4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
KeyCorp Investment Products 8.14% -
127 Public Square
Cleveland, Ohio 44114
- -----------------------------------------------------------------------------------------------------------------------------
Key Clearing Corp. 17.7% -
4900 Tiedeman Road
Cleveland, Ohio 44144
- -----------------------------------------------------------------------------------------------------------------------------
INTERMEDIATE INCOME SNBOC and Company 98.5% -
FUND 4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
INTERNATIONAL GROWTH SNBOC and Company 95.6% -
FUND-CLASS A 4900 Tiedeman Road
Cleveland, Ohio 44144
=============================================================================================================================
</TABLE>
- 113 -
<PAGE>
<TABLE>
<CAPTION>
=============================================================================================================================
PERCENT PERCENT
OWNED OWNED
FUND NAME AND ADDRESS OF OWNER OF RECORD BENEFICIALLY
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CLASS B IRA of Jerry L. Ufford 16.7% 16.7%
22315 Berry Drive
Rocky River, OH 44116
- -----------------------------------------------------------------------------------------------------------------------------
Bruce R. McBroom 5.6% 5.6%
Phyllis E. McBroom
7628 Collins St.
Lowville, NY 13367
- -----------------------------------------------------------------------------------------------------------------------------
A. Buell Arnold 7.7% 7.7%
Doris B. Arnold Trustees
Arnold Family Trust
12 Bartlett Lane
Delmar, NY 12054
- -----------------------------------------------------------------------------------------------------------------------------
Josephine E. Marx 5.5% 5.5%
1 Scott Place
Schenectady, NY 12309
- -----------------------------------------------------------------------------------------------------------------------------
Brandon Bradley 8.1% 8.1%
Box 398
Route 37
Hogansburg, NY 13655
- -----------------------------------------------------------------------------------------------------------------------------
INVESTMENT QUALITY BOND SNBOC and Company 77.6% -
FUND 4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
LAKEFRONT FUND SNBOC and Company 48.9% -
4900 Tiedman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
State Street Bank & Trust Co. - 8.9%
IRA Rollover of C. Maxwell
20563 Rock Hall Avenue
Rock Hall, MD 21661
- -----------------------------------------------------------------------------------------------------------------------------
BISYS Fund Services - 27.1%
3435 Stelzer Road
Columbus, OH 43219
- -----------------------------------------------------------------------------------------------------------------------------
LIMITED TERM INCOME SNBOC and Company 97.4% -
FUND 4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
NATIONAL MUNICIPAL BOND Key Trust of Cleveland 18.7% -
FUND-CLASS A SHARES 4900 Tiedeman Road
Cleveland, Ohio 44144
- -----------------------------------------------------------------------------------------------------------------------------
CLASS B SHARES El Matador Inc. 9.5% 9.5%
2564 Ogden Avenue
Ogden, UT 84401
=============================================================================================================================
</TABLE>
- 114 -
<PAGE>
<TABLE>
<CAPTION>
=============================================================================================================================
PERCENT PERCENT
OWNED OWNED
FUND NAME AND ADDRESS OF OWNER OF RECORD BENEFICIALLY
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Key Bank of Maine, Escrow Agent 13.3% 13.3%
for Robert, Geraldine and Janet Sylvester
and GFS ND Manufacturing Co.
1 Canal Plaza
Portland, ME 04101
- -----------------------------------------------------------------------------------------------------------------------------
Marden Spencer 6.2% 6.2%
958 E. Olympus Park Dr., #A102
Salt Lake City, UT 84117
- -----------------------------------------------------------------------------------------------------------------------------
Ethel F. Robinson 9.6% 9.6%
2716 100th SE
Everett, WA 98208-4338
- -----------------------------------------------------------------------------------------------------------------------------
NEW YORK TAX-FREE Key Trust of Cleveland 11.5% -
FUND-CLASS A SHARES 4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
Philip Morris Companies Inc. - 10.2%
100 Park Avenue - 10th Fl.
New York, NY 10017
- -----------------------------------------------------------------------------------------------------------------------------
SBSF Funds Inc. - 6.2%
45 Rockefeller Plaza
New York, NY 10111
- -----------------------------------------------------------------------------------------------------------------------------
CLASS B SHARES Leon A. Philp 5.7% 5.7%
15 Budd Avenue
Clarence, NY 14031
- -----------------------------------------------------------------------------------------------------------------------------
Richard A. Dudley 17.1% 17.1%
Margaret H. Dudley JTWROS
68 Center Street
Geneseo, NY 14454
- -----------------------------------------------------------------------------------------------------------------------------
Catherine C. Lieb 5.4% 5.4%
19 Park Avenue
Dansville, NY 14437
- -----------------------------------------------------------------------------------------------------------------------------
Anna Maria Desocio 8.5% 8.5%
Colomba Desocio JTWROS
1624 Caleb Avenue
Syracuse, NY 13206
- -----------------------------------------------------------------------------------------------------------------------------
OHIO MUNICIPAL BOND SNBOC and Company 88.8% -
FUND 4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
OHIO MUNICIPAL MONEY SNBOC and Company 18.3% -
MARKET FUND 4900 Tiedeman Road
Cleveland, OH 44144
=============================================================================================================================
</TABLE>
- 115 -
<PAGE>
<TABLE>
<CAPTION>
=============================================================================================================================
PERCENT PERCENT
OWNED OWNED
FUND NAME AND ADDRESS OF OWNER OF RECORD BENEFICIALLY
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
SNBOC and Company 58.6% -
2025 Ontario Street
Cleveland, OH 44115
- -----------------------------------------------------------------------------------------------------------------------------
KeyCorp Investment Products 5.4% -
127 Public Square
Cleveland, OH 44114
- -----------------------------------------------------------------------------------------------------------------------------
Key Clearing Corp. 8.9% -
4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
OHIO REGIONAL STOCK SNBOC and Company 86.3% -
FUND - CLASS A SHARES 4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
CLASS B SHARES IRA of Jerry Ufford 6.8% 6.8%
22315 Berry Drive
Rocky River, OH 44116
- -----------------------------------------------------------------------------------------------------------------------------
IRA of Gerald Mencl 6.4% 6.4%
5899 Canal Road
Valley View, OH 44125
- -----------------------------------------------------------------------------------------------------------------------------
IRA of Stephen A. Worth 5.7% 5.7%
10064 Hunting Dr.
Brecksville, OH 44141
- -----------------------------------------------------------------------------------------------------------------------------
PRIME OBLIGATIONS FUND SNBOC and Company 5.0% -
4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
KeyCorp Investment Products 29.3% -
127 Public Square
Cleveland, OH 44114
- -----------------------------------------------------------------------------------------------------------------------------
Society National Bank-Private Banking 33.1% -
2025 Ontario Street
Cleveland, OH 44115
- -----------------------------------------------------------------------------------------------------------------------------
Key Clearing Corp. 21.9% -
4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
REAL ESTATE INVESTMENT SNBOC and Company 71.4% -
FUND 4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
SPECIAL GROWTH FUND SNBOC and Company 98.1% -
4900 Tiedeman Road
Cleveland, OH 44144
=============================================================================================================================
</TABLE>
- 116 -
<PAGE>
<TABLE>
<CAPTION>
=============================================================================================================================
PERCENT PERCENT
OWNED OWNED
FUND NAME AND ADDRESS OF OWNER OF RECORD BENEFICIALLY
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
SPECIAL VALUE FUND-CLASS SNBOC and Company 88.4% -
A SHARES 4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
STOCK INDEX FUND SNBOC and Company 97.7% -
4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
TAX-FREE MONEY MARKET SNBOC and Company 46.2% -
FUND 4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
Society National Bank-Private Banking 40.5% -
2025 Ontario Street
Cleveland, OH 44115
- -----------------------------------------------------------------------------------------------------------------------------
Key Clearing Corp. 7.5% -
4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
U.S. GOVERNMENT SNBOC and Company 18.2% -
OBLIGATIONS FUND - 4900 Tiedeman Road
SELECT SHARES Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
Key Clearing Corp. 11.1% -
4900 Tiedeman Road
Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
Society National Bank-Private Banking 31.3% -
2025 Ontario Street
Cleveland, OH 44115
- -----------------------------------------------------------------------------------------------------------------------------
Chase Manhattan Bank - 6.0%
FBO Global Trust
450 W. 33rd Street
New York, NY 10001-2603
- -----------------------------------------------------------------------------------------------------------------------------
KeyCorp Investment Products 29.5% -
127 Public Square
Cleveland, OH 44114
- -----------------------------------------------------------------------------------------------------------------------------
U.S. GOVERNMENT Key Clearing Corp. 98.9% -
OBLIGATIONS FUND - 4900 Tiedeman Road
INVESTOR SHARES Cleveland, OH 44144
- -----------------------------------------------------------------------------------------------------------------------------
VALUE FUND SNBOC and Company 99.4% -
4900 Tiedeman Road
Cleveland, OH 44144
=============================================================================================================================
</TABLE>
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<PAGE>
Shares of the Victory Portfolios are entitled to one vote per share (with
proportional voting for fractional shares) on such matters as shareholders are
entitled to vote. Shareholders vote as a single class on all matters except (1)
when required by the 1940 Act, shares shall be voted by individual series, and
(2) when the Trustees have determined that the matter affects only the interests
of one or more series, then only shareholders of such series shall be entitled
to vote thereon. There will normally be no meetings of shareholders for the
purpose of electing Trustees unless and until such time as less than a majority
of the Trustees have been elected by the shareholders, at which time the
Trustees then in office will call a shareholders' meeting for the election of
Trustees. A meeting shall be held for such purpose upon the written request of
the holders of not less than 10% of the outstanding shares. Upon written request
by ten or more shareholders meeting the qualifications of Section 16(c) of the
1940 Act, (i.e., persons who have been shareholders for at least six months, and
who hold shares having a net asset value of at least $25,000 or constituting 1%
of the outstanding shares) stating that such shareholders wish to communicate
with the other shareholders for the purpose of obtaining the signatures
necessary to demand a meeting to consider removal of a Trustee, The Victory
Portfolios will provide a list of shareholders or disseminate appropriate
materials (at the expense of the requesting shareholders). Except as set forth
above, the Trustees shall continue to hold office and may appoint their
successors.
Rule 18f-2 under the 1940 Act provides that any matter required to be submitted
to the holders of the outstanding voting securities of an investment company
such as the Victory Portfolios shall not be deemed to have been effectively
acted upon unless approved by the holders of a majority of the outstanding
shares of each fund of the Victory Portfolios affected by the matter. For
purposes of determining whether the approval of a majority of the outstanding
shares of a fund will be required in connection with a matter, a fund will be
deemed to be affected by a matter unless it is clear that the interests of each
fund in the matter are identical, or that the matter does not affect any
interest of the fund. Under Rule 18f-2, the approval of an investment advisory
agreement or any change in investment policy would be effectively acted upon
with respect to a fund only if approved by a majority of the outstanding shares
of such fund. However, Rule 18f-2 also provides that the ratification of
independent accountants, the approval of principal underwriting contracts, and
the election of Trustees may be effectively acted upon by shareholders of the
Victory Portfolios voting without regard to series.
SHAREHOLDER AND TRUSTEE LIABILITY.
The Victory Portfolios is organized as a Delaware business trust. The Delaware
Business Trust Act provides that a shareholder of a Delaware business trust
shall be entitled to the same limitation of personal liability extended to
shareholders of Delaware corporations, and the Delaware Trust Instrument
provides that shareholders of the Victory Portfolios shall not be liable for the
obligations of the Victory Portfolios. The Delaware Trust Instrument also
provides for indemnification out of the trust property of any shareholder held
personally liable solely by reason of his or her being or having been a
shareholder. The Delaware Trust Instrument also provides that the Victory
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<PAGE>
Portfolios shall, upon request, assume the defense of any claim made against any
shareholder for any act or obligation of the Victory Portfolios, and shall
satisfy any judgment thereon. Thus, the risk of a shareholder incurring
financial loss on account of shareholder liability is considered to be extremely
remote.
The Delaware Trust Instrument states further that no Trustee, officer, or agent
of the Victory Portfolios shall be personally liable in connection with the
administration or preservation of the assets of the funds or the conduct of the
Victory Portfolios' business; nor shall any Trustee, officer, or agent be
personally liable to any person for any action or failure to act except for his
own bad faith, willful misfeasance, gross negligence, or reckless disregard of
his duties. The Declaration of Trust also provides that all persons having any
claim against the Trustees or the Victory Portfolios shall look solely to the
assets of the Victory Portfolios for payment.
MISCELLANEOUS.
As used in the Prospectus and in this SAI, "assets belonging to a fund" (or
"assets belonging to the Fund") means the consideration received by the Victory
Portfolios upon the issuance or sale of shares of a Fund, together with all
income, earnings, profits, and proceeds derived from the investment thereof,
including any proceeds from the sale, exchange, or liquidation of such
investments, and any funds or payments derived from any reinvestment of such
proceeds and any general assets of the Victory Portfolios, which general
liabilities and expenses are not readily identified as belonging to a particular
Fund that are allocated to that Fund by the Trustees. The Trustees may allocate
such general assets in any manner they deem fair and equitable. It is
anticipated that the factor that will be used by the Trustees in making
allocations of general assets to a particular fund of the Victory Portfolios
will be the relative net asset value of each respective fund at the time of
allocation. Assets belonging to a particular Fund are charged with the direct
liabilities and expenses in respect of that Fund, and with a share of the
general liabilities and expenses of each of the Funds not readily identified as
belonging to a particular Fund, which are allocated to each Fund in accordance
with its proportionate share of the net asset values of the Victory Portfolios
at the time of allocation. The timing of allocations of general assets and
general liabilities and expenses of the Victory Portfolios to a particular fund
will be determined by the Trustees and will be in accordance with generally
accepted accounting principles. Determinations by the Trustees as to the timing
of the allocation of general liabilities and expenses and as to the timing and
allocable portion of any general assets with respect to a particular fund are
conclusive.
As used in the Prospectus and in this SAI, a "vote of a majority of the
outstanding shares" of the Fund means the affirmative vote of the lesser of (a)
67% or more of the shares of the Fund present at a meeting at which the holders
of more than 50% of the outstanding shares of the Fund are represented in person
or by proxy, or (b) more than 50% of the outstanding shares of the Fund.
The Victory Portfolios is registered with the SEC as an open-end management
investment company. Such registration does not involve supervision by the SEC of
the management or policies of the Victory Portfolios.
The Prospectus and this SAI omit certain of the information contained in the
Registration Statement filed with the SEC. Copies of such information may be
obtained from the SEC upon payment of the prescribed fee.
The 1997 Annual Report to shareholders of The Victory Portfolios is incorporated
herein in its entirety. This report includes the financial statements for the
fiscal year ended October 31, 1997. The opinion in the Annual Report of Coopers
& Lybrand L.L.P., independent accountants, is incorporated herein in its
entirety to such Annual Report, and such financial statements are incorporated
in their entirety.
THE PROSPECTUS AND THIS STATEMENT OF ADDITIONAL INFORMATION ARE NOT AN OFFERING
OF THE SECURITIES DESCRIBED IN THESE DOCUMENTS IN ANY STATE IN WHICH SUCH
OFFERING MAY NOT LAWFULLY BE MADE. NO SALESMAN, DEALER, OR OTHER PERSON IS
AUTHORIZED TO GIVE ANY INFORMATION OR MAKE ANY REPRESENTATION OTHER THAN THOSE
CONTAINED IN THE PROSPECTUS AND THIS STATEMENT OF ADDITIONAL INFORMATION.
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<PAGE>
APPENDIX
DESCRIPTION OF SECURITY RATINGS.
The nationally recognized statistical rating organizations (individually, an
"NRSRO") that may be utilized by the Adviser or the Sub-Adviser with regard to
portfolio investments for the Funds include Moody's Investors Service, Inc.
("Moody's"), Standard & Poor's Corporation ("S&P"), Duff & Phelps, Inc.
("Duff"), Fitch Investors Service, Inc. ("Fitch"), IBCA Limited and its
affiliate, IBCA Inc. (collectively, "IBCA"), and Thomson BankWatch, Inc.
("Thomson"). Set forth below is a description of the relevant ratings of each
such NRSRO. The NRSROs that may be utilized by the Adviser or the Sub-Adviser
and the description of each NRSRO's ratings is as of the date of this Statement
of Additional Information, and may subsequently change.
LONG-TERM DEBT RATINGS (may be assigned, for example, to corporate and municipal
bonds).
Description of the five highest long-term debt ratings by Moody's (Moody's
applies numerical modifiers (e.g., 1, 2, and 3) in each rating category to
indicate the security's ranking within the category):
Aaa. Bonds which are 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 by an 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. Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risk appear somewhat larger than in Aaa securities.
A. Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper-medium-grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment some time in the future.
Baa. Bonds which are rated Baa are considered as medium grade obligations, i.e.,
they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba. Bonds which are rated Ba are judged to have speculative elements - their
future cannot be considered as 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 in the future. Uncertainty of position
characterizes bonds in this class.
Description of the five highest long-term debt ratings by S&P (S&P may apply a
plus (+) or minus (-) to a particular rating classification to show relative
standing within that classification):
AAA. Debt rated AAA has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.
AA. Debt rated AA has a very strong capacity to pay interest and repay principal
and differs from the higher rated issues only in small degree.
A. Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB. Debt rated BBB is regarded as having an adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
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<PAGE>
BB. Debt rated BB is regarded, on balance, as predominately speculative with
respect to capacity to pay interest and repay principal in accordance with the
terms of the obligation. While such debt will likely have some quality and
protective characteristics, these are outweighed by large uncertainties or major
risk exposure to adverse conditions.
Description of the three highest long-term debt ratings by Duff:
AAA. Highest credit quality. The risk factors are negligible being only slightly
more than for risk-free U.S. Treasury debt.
AA+, AA, AA-. High credit quality Protection factors are strong. Risk is modest
but may vary slightly from time to time because of economic conditions.
A+. Protection factors are average but adequate. However, risk factors are more
variable and greater in periods of economic stress.
Description of the three highest long-term debt ratings by Fitch (plus or minus
signs are used with a rating symbol to indicate the relative position of the
credit within the rating category):
AAA. Bonds considered to be investment grade and of the highest credit quality.
The obligor has an exceptionally strong ability to pay interest and repay
principal, which is unlikely to be affected by reasonably foreseeable events.
AA. Bonds considered to be investment grade and of very high credit quality. The
obligor's ability to pay interest and repay principal is very strong, although
not quite as strong as bonds rated "AAA." Because bonds rated in the "AAA" and
"AA" categories are not significantly vulnerable to foreseeable future
developments, short-term debt of these issues is generally rated "[-]+."
A. Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
IBCA's description of its three highest long-term debt ratings:
AAA. Obligations for which there is the lowest expectation of investment risk.
Capacity for timely repayment of principal and interest is substantial. Adverse
changes in business, economic or financial conditions are unlikely to increase
investment risk significantly.
AA. Obligations for which there is a very low expectation of investment risk.
Capacity for timely repayment of principal and interest is substantial. Adverse
changes in business, economic, or financial conditions may increase investment
risk albeit not very significantly.
A. Obligations for which there is a low expectation of investment risk. Capacity
for timely repayment of principal and interest is strong, although adverse
changes in business, economic or financial conditions may lead to increased
investment risk.
SHORT-TERM DEBT RATINGS (may be assigned, for example, to commercial paper,
master demand notes, bank instruments, and letters of credit).
Moody's description of its three highest short-term debt ratings:
Prime-1. Issuers rated Prime-1 (or supporting institutions) have a superior
capacity for repayment of senior short-term promissory obligations. Prime-1
repayment capacity will normally be evidenced by many of the following
characteristics:
- - Leading market positions in well-established industries.
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<PAGE>
- - High rates of return on funds employed.
- - Conservative capitalization structures with moderate reliance on debt and
ample asset protection.
- - Broad margins in earnings coverage of fixed financial charges and high
internal cash generation.
- - Well-established access to a range of financial markets and assured sources
of alternate liquidity.
Prime-2. Issuers rated Prime-2 (or supporting institutions) have a strong
capacity for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
Prime-3. Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The effect of industry
characteristics and market compositions may be more pronounced. Variability in
earnings and profitability may result in changes in the level of debt protection
measurements and may require relatively high financial leverage. Adequate
alternate liquidity is maintained.
S&P's description of its three highest short-term debt ratings:
A-1. This designation indicates that the degree of safety regarding timely
payment is strong. Those issues determined to have extremely strong safety
characteristics are denoted with a plus sign (+).
A-2. Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated "A-1."
A-3. Issues carrying this designation have adequate capacity for timely payment.
They are, however, more vulnerable to the adverse effects of changes in
circumstances than obligations carrying the higher designations.
Duff's description of its five highest short-term debt ratings (Duff
incorporates gradations of "1+" (one plus) and "1-" (one minus) to assist
investors in recognizing quality differences within the highest rating
category):
Duff 1+. Highest certainty of timely payment. Short-term liquidity, including
internal operating factors and/or access to alternative sources of funds, is
outstanding, and safety is just below risk-free U.S. Treasury short-term
obligations.
Duff 1. Very high certainty of timely payment. Liquidity factors are excellent
and supported by good fundamental protection factors. Risk factors are minor.
Duff 1-. High certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are very small.
Duff 2. Good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge total
financing requirements, access to capital markets is good. Risk factors are
small.
Duff 3. Satisfactory liquidity and other protection factors qualify issue as to
investment grade.
Risk factors are larger and subject to more variation. Nevertheless, timely
payment is expected.
Fitch's description of its four highest short-term debt ratings:
F-1+. Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
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<PAGE>
F-1. Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated F-1+.
F-2. Good Credit Quality. Issues assigned this rating have a satisfactory degree
of assurance for timely payment, but the margin of safety is not as great as for
issues assigned F-1+ or F-1 ratings.
F-3. Fair Credit Quality. Issues assigned this rating have characteristics
suggesting that the degree of assurance for timely payment is adequate, however,
near-term adverse changes could cause these securities to be rated below
investment grade.
IBCA's description of its three highest short-term debt ratings:
A+. Obligations supported by the highest capacity for timely repayment.
A1. Obligations supported by a very strong capacity for timely repayment.
A2. Obligations supported by a strong capacity for timely repayment, although
such capacity may be susceptible to adverse changes in business, economic or
financial conditions.
SHORT-TERM LOAN/MUNICIPAL NOTE RATINGS
Moody's description of its two highest short-term loan/municipal note ratings:
MIG-1/VMIG-1. This designation denotes best quality. There is present strong
protection by established cash flows, superior liquidity support or demonstrated
broad-based access to the market for refinancing.
MIG-2/VMIG-2. This designation denotes high quality. Margins of protection are
ample although not so large as in the preceding group.
S&P's description of its two highest municipal note ratings:
SP-1. Very strong or strong capacity to pay principal and interest. Those issues
determined to possess overwhelming safety characteristics will be given a plus
(+) designation.
SP-2. Satisfactory capacity to pay principal and interest.
SHORT-TERM DEBT RATINGS
Thomson BankWatch, Inc. ("TBW") ratings are based upon a qualitative and
quantitative analysis of all segments of the organization including, where
applicable, holding company and operating subsidiaries.
BankWatch Ratings do not constitute a recommendation to buy or sell securities
of any of these companies. Further, BankWatch does not suggest specific
investment criteria for individual clients.
The TBW Short-Term Ratings apply to commercial paper, other senior short-term
obligations and deposit obligations of the entities to which the rating has been
assigned.
The TBW Short-Term Ratings apply only to unsecured instruments that have a
maturity of one year or less.
The TBW Short-Term Ratings specifically assess the likelihood of an untimely
payment of principal or interest.
TBW-1. The highest category; indicates a very high degree of likelihood that
principal and interest will be paid on a timely basis.
TBW-2. The second highest category; while the degree of safety regarding timely
repayment of principal and interest is strong, the relative degree of safety is
not as high as for issues rated "TBW-1."
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<PAGE>
TBW-3. The lowest investment grade category; indicates that while more
susceptible to adverse developments (both internal and external) than
obligations with higher ratings, capacity to service principal and interest in a
timely fashion is considered adequate.
TBW-4. The lowest rating category; this rating is regarded as non-investment
grade and therefore speculative.
DEFINITIONS OF CERTAIN MONEY MARKET INSTRUMENTS
Commercial Paper. Commercial paper consists of unsecured promissory notes issued
by corporations. Issues of commercial paper normally have maturities of less
than nine months and fixed rates of return.
Certificates of Deposit. Certificates of Deposit are negotiable certificates
issued against funds deposited in a commercial bank or a savings and loan
association for a definite period of time and earning a specified return.
Bankers' Acceptances. Bankers' acceptances are negotiable drafts or bills of
exchange, normally drawn by an importer or exporter to pay for specific
merchandise, which are "accepted" by a bank, meaning, in effect, that the bank
unconditionally agrees to pay the face value of the instrument on maturity.
U.S. Treasury Obligations. U.S. Treasury Obligations are obligations issued or
guaranteed as to payment of principal and interest by the full faith and credit
of the U.S. Government. These obligations may include Treasury bills, notes and
bonds, and issues of agencies and instrumentalities of the U.S. Government,
provided such obligations are guaranteed as to payment of principal and interest
by the full faith and credit of the U.S. Government.
U.S. Government Agency and Instrumentality Obligations. Obligations issued by
agencies and instrumentalities of the U.S. Government include such agencies and
instrumentalities as the Government National Mortgage Association, the
Export-Import Bank of the United States, the Tennessee Valley Authority, the
Farmers Home Administration, the Federal Home Loan Banks, the Federal
Intermediate Credit Banks, the Federal Farm Credit Banks, the Federal Land
Banks, the Federal Housing Administration, the Federal National Mortgage
Association, the Federal Home Loan Mortgage Corporation, and the Student Loan
Marketing Association. Some of these obligations, such as those of the
Government National Mortgage Association are supported by the full faith and
credit of the U.S. Treasury; others, such as those of the Export-Import Bank of
the United States, are supported by the right of the issuer to borrow from the
Treasury; others, such as those of the Federal National Mortgage Association,
are supported by the discretionary authority of the U.S. Government to purchase
the agency's obligations; still others, such as those of the Student Loan
Marketing Association, are supported only by the credit of the instrumentality.
No assurance can be given that the U.S. Government would provide financial
support to U.S. Government-sponsored instrumentalities if it is not obligated to
do so by law. A Fund will invest in the obligations of such instrumentalities
only when the investment adviser believes that the credit risk with respect to
the instrumentality is minimal.
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