AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 14, 1995
REGISTRATION NO. 33-37730
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------------------
POST-EFFECTIVE AMENDMENT NO. 4
TO
FORM S-6
------------------------------------------
FOR REGISTRATION UNDER THE SECURITIES ACT
OF 1933 OF SECURITIES OF UNIT INVESTMENT
TRUSTS REGISTERED ON FORM N-8B-2
------------------------------------------
A. EXACT NAME OF TRUST:
DEFINED ASSET FUNDS--
MUNICIPAL INVESTMENT TRUST FUND
MONTHLY PAYMENT SERIES--506
B. NAMES OF DEPOSITORS:
MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED
SMITH BARNEY INC.
PRUDENTIAL SECURITIES INCORPORATED
DEAN WITTER REYNOLDS INC.
C. COMPLETE ADDRESSES OF DEPOSITORS' PRINCIPAL EXECUTIVE OFFICES:
MERRILL LYNCH, PIERCE,
FENNER & SMITH
INCORPORATED
DEFINED ASSET FUNDS
POST OFFICE BOX 9051
PRINCETON, N.J.
08543-9051 SMITH BARNEY INC.
388 GREENWICH
STREET--23RD FLOOR
NEW YORK, NY 10013
PRUDENTIAL SECURITIES
INCORPORATED
ONE SEAPORT PLAZA
199 WATER STREET
NEW YORK, N.Y. 10292 DEAN WITTER REYNOLDS INC.
TWO WORLD TRADE
CENTER--59TH FLOOR
NEW YORK, N.Y. 10048
D. NAMES AND COMPLETE ADDRESSES OF AGENTS FOR SERVICE:
TERESA KONCICK, ESQ.
P.O. BOX 9051
PRINCETON, N.J.
08543-9051 THOMAS D. HARMAN, ESQ.
388 GREENWICH ST.
NEW YORK, N.Y. 10013
LEE B. SPENCER, JR. DOUGLAS LOWE, ESQ. COPIES TO:
ONE SEAPORT PLAZA 130 LIBERTY STREET--29TH PIERRE DE SAINT PHALLE,
199 WATER STREET FLOOR ESQ.
NEW YORK, N.Y. 10292 NEW YORK, N.Y. 10006 450 LEXINGTON AVENUE
NEW YORK, N.Y. 10017
The issuer has registered an indefinite number of Units under the Securities Act
of 1933 pursuant to Rule 24f-2 and filed the Rule 24f-2 Notice for the most
recent fiscal year on February 17, 1995.
Check box if it is proposed that this filing will become effective on March 24,
1995 pursuant to paragraph (b) of Rule 485. / x /
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>
DEFINED
ASSET FUNDSSM
MUNICIPAL INVESTMENT
TRUST FUND
------------------------------------------------------------
MONTHLY PAYMENT SERIES--506
(A UNIT INVESTMENT TRUST)
PROSPECTUS, PART A
DATED MARCH 24, 1995
SPONSORS:
Merrill Lynch,
Pierce, Fenner & Smith Incorporated
Smith Barney Inc.
Prudential Securities Incorporated
Dean Witter Reynolds Inc.
MONTHLY INCOME - TAX-FREE
This Defined Fund is a portfolio of preselected Bonds formed for the purpose of
providing interest income which in the opinion of counsel is, with certain
exceptions, exempt from regular Federal income taxes under existing law through
investment in a fixed portfolio consisting primarily of long-term Bonds issued
by states, municipalities, public authorities and similar entities thereof, and
on the initial Date of Deposit rated investment grade by at least one national
rating agency (or having, in the opinion of Defined Asset Funds research
analysts, comparable credit characteristics). There is no assurance that this
objective will be met because it is subject to the continuing ability of issuers
of the Bonds to meet their principal and interest requirements. Furthermore, the
market value of the underlying Bonds, and therefore the value of the Units, will
fluctuate with changes in interest rates and other factors.
Minimum Purchase: One Unit
------------------------------------------------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE COMMISSION OR
ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
------------------------------------------------------------------------
NOTE: PART A OF THIS PROSPECTUS MAY NOT BE DISTRIBUTED
UNLESS ACCOMPANIED BY DEFINED ASSET FUNDS--MUNICIPAL INVESTMENT TRUST FUND
PROSPECTUS, PART B.
This Prospectus consists of two parts. The first includes an Investment Summary
and certified financial statements of the Fund, including the related securities
portfolio; the second contains a general summary of the Fund.
------------------------------------------------------------------------
Read and retain both parts of this Prospectus for future reference.
<PAGE>
DEFINED ASSET FUNDSSM is America's oldest and largest family of unit investment
trusts with over $95 billion sponsored since 1971. Each Defined Fund is a
portfolio of preselected securities. The portfolio is divided into 'units'
representing equal shares of the underlying assets. Each unit receives an equal
share of income and principal distributions.
With Defined Asset Funds you know in advance what you are investing in and that
changes in the portfolio are limited. Most defined bond funds pay interest
monthly and repay principal as bonds are called, redeemed, sold or as they
mature. Defined equity funds offer preselected stock portfolios with defined
termination dates.
Your financial advisor can help you select a Defined Fund to meet your personal
investment objectives. Our size and market presence enable us to offer a wide
variety of investments. Defined Funds are available in the following types of
securities: municipal bonds, corporate bonds, government bonds, utility stocks,
growth stocks, even international securities denominated in foreign currencies.
Termination dates are as short as one year or as long as 30 years. Special funds
are available for investors seeking extra features: insured funds, double and
triple tax-free funds, and funds with 'laddered maturities' to help protect
against rising interest rates. Defined Funds are offered by prospectus only.
--------------------------------------------------------------------------------
CONTENTS
Investment Summary.......................................... A-3
Accountants' Opinion Relating to the Fund................... D-1
Statement of Condition...................................... D-2
Portfolio................................................... D-6
A-2
<PAGE>
DEFINED ASSET FUNDS--MUNICIPAL INVESTMENT TRUST FUND, MONTHLY PAYMENT
SERIES--506
INVESTMENT SUMMARY
AS OF DECEMBER 31, 1994, THE EVALUATION DATE
FACE AMOUNT OF BONDS.....................................$ 29,255,000(a)
NUMBER OF UNITS.......................................... 30,852
FACE AMOUNT OF BONDS PER UNIT............................$ 948.23
FRACTIONAL UNDIVIDED INTEREST IN FUND REPRESENTED BY EACH
UNIT................................................... 1/30,852nd
PUBLIC OFFERING PRICE
Aggregate bid side evaluation of underlying Bonds...$ 29,992,105
-----------------
Divided by Number of Units..........................$ 972.13
Plus sales charge of 4.685% of Public Offering Price
(4.916% of net amount invested in Bonds)(b)....... 47.79
-----------------
Public Offering Price per Unit......................$ 1,019.92
(plus cash
adjustments and
accrued
interest)(c)
SPONSORS' REPURCHASE PRICE AND REDEMPTION PRICE PER
UNIT...................................................$ 972.13
(based on bid side evaluation of Bonds) ($47.79 less (plus cash
than Public Offering Price per Unit) adjustments and
accrued
interest)(c)
PREMIUM AND DISCOUNT ISSUES IN PORTFOLIO
Face amount of Bonds with bid side evaluation:
Over par.......................................... 83%
At a discount from par............................ 17%
CALCULATION OF ESTIMATED NET ANNUAL INTEREST RATE PER
UNIT (based on Face Amount per Unit)
Annual interest rate per Unit....................... 7.351%
Less estimated annual expenses per Unit ($0.90)
expressed as a percentage......................... .094%
-----------------
Estimated net annual interest rate per Unit......... 7.257%
-----------------
-----------------
DAILY RATE AT WHICH ESTIMATED NET INTEREST ACCRUES PER
UNIT................................................... .0201%
MONTHLY INCOME DISTRIBUTIONS
Estimated net annual interest rate per Unit times
the Face Amount per Unit..........................$ 68.82
Divided by 12.......................................$ 5.73
RECORD DAY
The 10th day of each month.
DISTRIBUTION DAY
The 25th day of each month.
MINIMUM CAPITAL DISTRIBUTION
No distribution need be made from Capital Account if balance in Account is
less than $5.00 per Unit.
TRUSTEE'S ANNUAL FEE AND EXPENSES(d)
$0.90 per Unit (see Fund Expenses in Part B).
PORTFOLIO SUPERVISION FEE(e)
Maximum of $0.35 per $1,000 face amount of underlying Bonds (see Fund
Expenses in Part B).
EVALUATOR'S FEE FOR EACH EVALUATION
Maximum of $13 (see Fund Expenses in Part B).
EVALUATION TIME
3:30 P.M. New York Time
MINIMUM VALUE OF FUND
Trust may be terminated if value of Fund is less than 40% of the Face Amount
of Bonds on the date of their deposit. As of the Evaluation Date, the value
of the Fund was 74% of the Face Amount of Bonds on the date of their
deposit.
------------------------------
(a)On the Initial Date of Deposit (January 16, 1991) the Face Amount of
Bonds was $40,000,000. Cost of Bonds is set forth under Portfolio.
(b)This is the maximum Effective Sales Charge on the date stated. The
sales charge will vary depending on the maturities of the underlying
Bonds and will be reduced on a graduated scale for purchases of 250 or
more Units (see How To Buy Units in Part B). Any resulting reduction
in the Public Offering Price will increase the effective returns on a
Unit.
(c)For Units purchased or redeemed on the Evaluation Date, accrued
interest is approximately equal to the undistributed net investment
income of the Fund (see Statement of Condition on p. D-2) divided by
the number of outstanding Units, plus accrued interest per Unit to the
expected date of settlement (5 business days after purchase or
redemption). The amount of the cash adjustment which is added is equal
to the cash per Unit held in the Capital Account (see How To Buy Units
and How To Sell Units in Part B).
(d)Of this figure, the Trustee receives annually for its service as
Trustee, $0.36 per $1,000 face amount of Bonds. The Trustee's Annual
Fee and Expenses also includes the Portfolio Supervision Fee and
Evaluator's Fee set forth herein (see Fund Expenses in Part B).
(e)The Sponsors also may be reimbursed for their costs of bookkeeping and
administrative services to the Fund. Portfolio supervision fees
deducted in excess of portfolio supervision expenses may be used for
this reimbursement. Additional deductions for this purpose are
currently estimated not to exceed an annual rate of $0.10 per Unit
(see Fund Expenses in Part B).
A-3
<PAGE>
DEFINED ASSET FUNDS--MUNICIPAL INVESTMENT TRUST FUND, MONTHLY PAYMENT
SERIES--506
INVESTMENT SUMMARY AS OF THE EVALUATION DATE (CONTINUED)
NUMBER OF ISSUES IN PORTFOLIO............................... 20
NUMBER OF ISSUES RATED BY:(a)
Standard & Poor's Corporation/
rating ............................................. AAA-- 3
AA-- 6
A-- 9
Moody's Investors Service/
rating(b) ....................................... Aaa-- 1
A-- 1
RANGE OF MATURITIES.................................................2009-2030
NUMBER OF ISSUES BY SOURCE OF
REVENUE:
Hospital/Health Care Facility.......................... 6
Housing................................................ 2
University/College..................................... 2
Industrial Development Revenue(c) ..................... 3
Refunded Bonds......................................... 7
CONCENTRATIONS(d) EXPRESSED AS PERCENTAGE OF AGGREGATE FACE
AMOUNT OF BONDS:
Hospital/Health Care Facility.......................... 34%
Refunded Bonds......................................... 31%
Issuers located in Massachusetts (20%), Texas (13%) and
Illinois (12%)....................................... 45%
RETURN CALCULATIONS--
Estimated Current Return shows the estimated annual cash to be received
from interest-bearing Bonds in the Portfolio (net of estimated annual expenses)
divided by the Public Offering Price (including the maximum sales charge).
Estimated Long Term Return is a measure of the estimated return over the
estimated life of the Fund. This represents an average of the yields to maturity
(or in certain cases, to an earlier call date) of the individual Bonds in the
Portfolio, adjusted to reflect the maximum sales charge and estimated expenses.
The average yield for the Portfolio is derived by weighting each Bond's yield by
its market value and the time remaining to the call or maturity date, depending
on how the Bond is priced. Unlike Estimated Current Return, Estimated Long Term
Return takes into account maturities, discounts and premiums of the underlying
Bonds.
No return estimate can be predictive of your actual return because returns
will vary with purchase price (including sales charges), how long units are
held, changes in Portfolio composition, changes in interest income and changes
in fees and expenses. Therefore, Estimated Current Return and Estimated Long
Term Return are designed to be comparative rather than predictive. A yield
calculation which is more comparable to an individual Bond may be higher or
lower than Estimated Current Return or Estimated Long Term Return which are more
comparable to return calculations used by other investment products.
------------------------------
(a) The ratings assigned by the bond rating agencies may change from time
to time. Certain of the ratings may be provisional or conditional. See
Description of Ratings in Part B.
(b) A Moody's rating is included only if Standard & Poor's has not rated
an issue; this rating has been furnished by the Evaluator but not confirmed by
Moody's.
(c) These industrial development revenue bonds are issued on behalf of
corporate utilities.
(d) A Fund is considered to be 'concentrated' in a category when the
Bonds in that category constitute 25% or more of the aggregate face amount of
the Portfolio. See Risk Factors in Part B for a description of certain
investment risks relating to these types of obligations.
A-4
<PAGE>
DEFINED ASSET FUNDS - MUNICIPAL INVESTMENT TRUST FUND,
MONTHLY PAYMENT SERIES - 506
REPORT OF INDEPENDENT ACCOUNTANTS
The Sponsors, Trustee and Holders
of Defined Asset Funds - Municipal Investment Trust Fund,
Monthly Payment Series - 506:
We have audited the accompanying statement of condition of Defined
Asset Funds - Municipal Investment Trust Fund, Monthly Payment Series -
506, including the portfolio, as of December 31, 1994 and the related
statements of operations and of changes in net assets for the years ended
December 31, 1994, 1993 and 1992. These financial statements are the
responsibility of the Trustee. Our responsibility is to express an opinion
on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.
An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. Securities
owned at December 31, 1994, as shown in such portfolio, were
confirmed to us by The Bank of New York, the Trustee. An audit also
includes assessing the accounting principles used and significant
estimates made by the Trustee, as well as evaluating the overall
financial statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Defined
Asset Funds - Municipal Investment Trust Fund, Monthly Payment
Series - 506 at December 31, 1994 and the results of its operations
and changes in its net assets for the above-stated years in conformity
with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
New York, N.Y.
February 9, 1995
D - 1
<PAGE>
DEFINED ASSET FUNDS - MUNICIPAL INVESTMENT TRUST FUND,
MONTHLY PAYMENT SERIES - 506
STATEMENT OF CONDITION
AS OF DECEMBER 31, 1994
TRUST PROPERTY:
Investment in marketable securities - at value
(cost $28,833,272) (Note 1)................... $29,992,105
Securities called for redemption
(cost $185,000) (Note 5)...................... 185,000
Accrued interest receivable..................... 678,370
______________
Total trust property.................. 30,855,475
LESS LIABILITY - Advance from Trustee............. 201,317
______________
NET ASSETS, REPRESENTED BY:
30,852 units of fractional undivided
interest outstanding (Note 3)................. $30,181,653
Undistributed net investment income............. 472,505
____________
$30,654,158
==============
UNIT VALUE ($30,654,158/30,852 units)............. $993.59
==============
See Notes to Financial Statements.
D - 2
<PAGE>
DEFINED ASSET FUNDS - MUNICIPAL INVESTMENT TRUST FUND,
MONTHLY PAYMENT SERIES - 506
<TABLE><CAPTION>
STATEMENTS OF OPERATIONS
.........Years Ended December 31,.........
1994 1993 1992
<S> <C> <C> <C> <C>
INVESTMENT INCOME:
Interest income................................. $2,431,434 $2,681,086 $2,835,632
Trustee's fees and expenses..................... (19,919) (21,343) (22,662)
Sponsors' fees ................................. (9,293) (8,472) (7,094)
__________________________________________
Net investment income........................... 2,402,222 2,651,271 2,805,876
__________________________________________
REALIZED AND UNREALIZED GAIN (LOSS) ON
INVESTMENTS:
Realized gain on securities sold or
redeemed...................................... 373,334 284,331 179,392
Unrealized appreciation (depreciation)
of investments................................ (3,751,926) 1,367,070 1,568,111
__________________________________________
Net realized and unrealized gain (loss) on
investments................................... (3,378,592) 1,651,401 1,747,503
__________________________________________
NET INCREASE (DECREASE) IN NET ASSETS RESULTING
FROM OPERATIONS................................. $ (976,370) $4,302,672 $4,553,379
==========================================
</TABLE>
See Notes to Financial Statements.
D - 3
<PAGE>
DEFINED ASSET FUNDS - MUNICIPAL INVESTMENT TRUST FUND,
MONTHLY PAYMENT SERIES - 506
<TABLE><CAPTION>
STATEMENTS OF CHANGES IN NET ASSETS
.........Years Ended December 31,.........
1994 1993 1992
<S> <C> <C> <C> <C>
OPERATIONS:
Net investment income........................... $ 2,402,222 $ 2,651,271 $ 2,805,876
Realized gain on securities sold
or redeemed.................................. 373,334 284,331 179,392
Unrealized appreciation (depreciation) of
investments.................................. (3,751,926) 1,367,070 1,568,111
__________________________________________
Net increase (decrease)in net assets resulting
from operations.............................. (976,370) 4,302,672 4,553,379
__________________________________________
DISTRIBUTIONS TO HOLDERS (Note 2):
Income.......................................... (2,420,555) (2,657,796) (2,805,534)
Principal....................................... (1,221,837) (192,469) (95,985)
__________________________________________
Total distributions............................. (3,642,392) (2,850,265) (2,901,519)
__________________________________________
CAPITAL SHARE TRANSACTIONS - Redemptions of 4,573,
2,123 and 1,937 units, respectively............. (4,696,254) (2,385,044) (2,074,379)
__________________________________________
NET DECREASE IN NET ASSETS........................ (9,315,016) (932,637) (422,519)
NET ASSETS AT BEGINNING OF YEAR................... 39,969,174 40,901,811 41,324,330
__________________________________________
NET ASSETS AT END OF YEAR......................... $30,654,158 $39,969,174 $40,901,811
==========================================
PER UNIT:
Income distributions during year................ $70.51 $72.00 $72.11
==========================================
Principal distributions during year............. $35.35 $5.33 $2.55
==========================================
Net asset value at end of year.................. $993.59 $1,128.28 $1,089.32
==========================================
TRUST UNITS OUTSTANDING AT END OF YEAR............ 30,852 35,425 37,548
==========================================
</TABLE>
See Notes to Financial Statements.
D - 4
<PAGE>
DEFINED ASSET FUNDS - MUNICIPAL INVESTMENT TRUST FUND,
MONTHLY PAYMENT SERIES - 506
NOTES TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
1. SIGNIFICANT ACCOUNTING POLICIES
The Fund is registered under the Investment Company Act of 1940 as a Unit
Investment Trust. The following is a summary of significant accounting
policies consistently followed by the Fund in the preparation of its
financial statements. The policies are in conformity with generally
accepted accounting principles.
(a) Securities are stated at value as determined by the Evaluator based on
bid side evaluations for the securities. See "Redemption - Computation
of Redemption Price Per Unit" in this Prospectus, Part B.
(b) The Fund is not subject to income taxes. Accordingly, no provision for
such taxes is required.
(c) Interest income is recorded as earned.
2. DISTRIBUTIONS
A distribution of net investment income is made to Holders each month.
Receipts other than interest, after deductions for redemptions and
applicable expenses, are distributed as explained in "Administration of
the Fund - Accounts and Distributions" in this Prospectus, Part B.
</TABLE>
3. NET CAPITAL
<TABLE>
<S> <C>
Cost of 30,852 units at Date of Deposit............................................ $31,729,221
Less sales charge.................................................................. 1,427,831
_______________
Net amount applicable to Holders................................................... 30,301,390
Redemptions of units - net cost of 9,148 units redeemed less redemption
amounts.......................................................................... (575,033)
Realized gain on securities sold or redeemed....................................... 847,029
Principal distributions............................................................ (1,550,566)
Unrealized appreciation of investments............................................. 1,158,833
_______________
Net capital applicable to Holders.................................................. $30,181,653
===============
</TABLE>
<TABLE>
<S> <C>
4. INCOME TAXES
As of December 31, 1994, unrealized appreciation of investments (including
securities called for redemption), based on cost for Federal income tax
purposes, aggregated $1,158,833, all of which related to appreciated
securities. The cost of investment securities for Federal income tax
purposes was $29,018,272 at December 31, 1994.
</TABLE>
D - 5
<PAGE>
DEFINED ASSET FUNDS - MUNICIPAL INVESTMENT TRUST FUND,
MONTHLY PAYMENT SERIES - 506
NOTES TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
5. SECURITIES CALLED FOR REDEMPTION
$50,000 face amount of Utah Housing Financial Agy., Single Family Mortgage
Senior Bonds, 1989 Issue C (Federally Ins. or Guaranteed Mortgage Loans)
and $135,000 face amount of Utah Housing Finance, Single Family Mortgage
Purchase Bonds, 1989 Series D (Federally Ins. or Guaranteed Mortgage
Loans) were called for redemption on January 1, 1995. Such securities are
valued at the amount of the proceeds subsequently received.
</TABLE>
D - 6
<PAGE>
DEFINED ASSET FUNDS - MUNICIPAL INVESTMENT TRUST FUND,
MONTHLY PAYMENT SERIES - 506
PORTFOLIO
AS OF DECEMBER 31, 1994
<TABLE><CAPTION>
Rating Optional
Portfolio No. and Title of of Face Redemption
Securities Issues(1) Amount Coupon Maturities(3) Provisions(3) Cost Value(2)
__________ _________ ______ _______ _____________ _____________ ______ ________
<S> <C> <C> <C> <C> <C> <C> <C>
1 District of Columbia (Washington, D.C.), AA- $ 580,000 7.250% 2020 10/01/00 $ 566,102 $ 579,901
University Revenue Bonds (The Howard @ 102.000
University Issue), Series 1990
2 District of Columbia, University Revenue A+ 1,625,000 7.400 2018 04/01/99 1,636,277 1,636,781
Bonds (Georgetown University Issue), Series @ 102.000
1989A
3 Illinois Health Facility Authority, Revenue A+ 2,560,000 6.000 2011 04/01/99 2,186,828 2,281,498
Bond Financings (Lutheran General Health @ 102.000
Care System), Series 1989C
4 Illinois Development Financial Authority AA 1,000,000 7.600 2013 03/01/00 1,026,290 1,054,770
Pollution Control Revenue Refunding Bonds @ 102.000
(Central Illinois Public Service Company
Project) Series B
5 Indiana Municipal Power Agency, Power Supply A 515,000 7.100 2015(4) 01/01/00 503,396 551,900
Revenue Bonds, 1990 Series A @ 102.000
6 Kentucky Development Finance Authority, A+ 1,395,000 6.250 2019 11/01/99 1,212,156 1,229,414
Sisters of Charity of Nazareth Health @ 100.000
Corporation, Hospital Revenue Bonds, Series
1989
7 City of Boston, Massachusetts, Revenue Aaa(m) 1,810,000 7.625 2021(4) 08/15/00 1,814,525 1,978,927
Bonds, Boston City Hospital (FHA Ins. @ 102.000
Mortgage), Series A
8 Massachusettes Health and Educational A 500,000 8.100 2013 07/01/97 494,875 544,355
Facility Authority Revenue Bonds, Brockton @ 102.000
Hospital Issue, Series B
9 Massachusetts Health and Educational AA 1,120,000 7.750 2018(4) 06/01/98 1,142,232 1,215,682
Facilities Authority Revenue Bonds, @ 102.000
Children's Hospital Issue, Series D
</TABLE>
D - 7
<PAGE>
DEFINED ASSET FUNDS - MUNICIPAL INVESTMENT TRUST FUND,
MONTHLY PAYMENT SERIES - 506
PORTFOLIO
AS OF DECEMBER 31, 1994
<TABLE><CAPTION>
Rating Optional
Portfolio No. and Title of of Face Redemption
Securities Issues(1) Amount Coupon Maturities(3) Provisions(3) Cost Value(2)
__________ _________ ______ _______ _____________ _____________ _______ ________
<S> <C> <C> <C> <C> <C> <C> <C>
10 Massachusetts Water Resources Authority AAA $ 2,485,000 7.625% 2014(4) 04/01/00 $ 2,498,493 $ 2,725,399
General Revenue Bonds, 1990 Series A @ 102.000
11 City of Marquette, MI, Hospital Finance A+ 2,500,000 7.500 2019 04/01/99 2,517,275 2,551,850
Authority, Hospital Revenue Refunding @ 102.000
Bonds(Marquette General Hospital), 1989
Series C
12 North Carolina Municipal Power Agency #1, AAA 20,000 7.875 2019(4) 01/01/98 20,879 21,631
Catawba Electric Revenue Bonds, Series 1988 @ 102.000
13 County of Cuyahoga, Ohio, Hospital Revenue A 455,000 6.500 2012 08/15/00 411,158 429,470
Bonds, Series 1990 (Meridia Health Systems) @ 101.000
1,465,000 7.250 2019 08/15/00 1,421,973 1,478,434
@ 102.000
14 Allegheny County, Pennsylvania, Hospital A- 930,000 7.750 2020 08/01/00 933,450 950,711
Development Authority, Hospital Revenue @ 102.000
Bonds, Series 1990 (Allegheny Valley
Hospital)
15 Brazos River Authority, Texas A 2,650,000 7.625 2019 07/01/99 2,673,585 2,739,464
Collateralized Revenue Refunding Bonds @ 102.000
(Houston Lighting and Power Company
Project) Series 1989A
16 Houston, Texas, Water System Prior Lien AAA 1,130,000 7.400 2017(4) 12/01/97 1,132,824 1,211,089
Revenue Bonds, Series 1987 @ 102.000
17 Utah Housing Finance Agency, Single Family AA 995,000 7.500 2016 07/01/99 995,000 1,018,532
Mortgage Purchase Bonds, 1989 Series D @ 102.000
(Federally Ins. or Guaranteed Mortgage
Loans)
18 Utah Housing Financial Agy., Single Family AA 490,000 7.650 2009 07/01/99 490,000 491,480
Mortgage Senior Bonds, 1989 Issue C @ 102.000
(Federally Ins. or Guaranteed Mortgage
Loans)
</TABLE>
D - 8
<PAGE>
DEFINED ASSET FUNDS - MUNICIPAL INVESTMENT TRUST FUND,
MONTHLY PAYMENT SERIES 506
PORTFOLIO
AS OF DECEMBER 31, 1994
<TABLE><CAPTION>
Rating Optional
Portfolio No. and Title of of Face Redemption
Securities Issues(1) Amount Coupon Maturities(3) Provisions(3) Cost Value(2)
__________ _________ ______ _______ _____________ _____________ _______ ________
<S> <C> <C> <C> <C> <C> <C> <C>
19 Municipality of Metropolitan Seattle, WA, AA- $ 2,030,000 7.375% 2030(4) 01/01/98 $ 2,033,674 $ 2,167,857
Sewer Revenue Bonds, Series S @ 102.000
20 Mason County, West Virginia, Pollution A3(m) 3,000,000 7.875 2013 11/01/00 3,122,280 3,132,960
Control Revenue Bonds (Appalachian Power @ 102.000
Company Project), Series H
_______________ ___________
_____________
TOTAL $29,255,000 $28,833,272 $29,992,105
=============== =========== =============
</TABLE>
See Notes to Portfolio.
D - 9
<PAGE>
DEFINED ASSET FUNDS - MUNICIPAL INVESTMENT TRUST FUND,
MONTHLY PAYMENT SERIES - 506
NOTES TO PORTFOLIO
AS OF DECEMBER 1994
<TABLE>
<S> <C>
(1) A description of the rating symbols and their meanings appears under
"Description of Ratings" in this Prospectus, Part B. Ratings, which have
been provided by the Evaluator, are by Standard & Poor's (when available)
or by Moody's Investors Service (as indicated by "m") when Standard & Poor's
ratings are not available. "NR", if applicable, indicates that this
security is not currently rated by either rating service.
(2) See Notes to Financial Statements.
(3) Optional redemption provisions, which may be exercised in whole or in part,
are initially at prices of par plus a premium, then subsequently at prices
declining to par. Certain securities may provide for redemption at par
prior or in addition to any optional or mandatory redemption dates or
maturity, for example, through the operation of a maintenance and
replacement fund, if proceeds are not able to be used as contemplated, the
project is condemned or sold or the project is destroyed and insurance
proceeds are used to redeem the securities. Many of the securities are
also subject to mandatory sinking fund redemption commencing on dates
which may be prior to the date on which securities may be optionally
redeemed. Sinking fund redemptions are at par and redeem only part of the
issue. Some of the securities have mandatory sinking funds which contain
optional provisions permitting the issuer to increase the principal amount
of securities called on a mandatory redemption date. The sinking fund
redemptions with optional provisions may, and optional refunding
redemptions generally will, occur at times when the redeemed securities
have an offering side evaluation which represents a premium over par.
To the extent that the securities were acquired at a price higher than
the redemption price, this will represent a loss of capital when compared
with the Public Offering Price of the Units when acquired. Distributions
will generally be reduced by the amount of the income which would otherwise
have been paid with respect to redeemed securities and there will be
distributed to Holders any principal amount and premium received on such
redemption after satisfying any redemption requests for Units received by
the Fund. The estimated current return may be affected by redemptions. The
tax effect on Holders of redemptions and related distributions is
described under "Taxes" in this Prospectus, Part B.
(4) Bonds with an aggregate face amount of $9,110,000 have been pre-refunded and
are expected to be called for redemption on the optional redemption provision
dates shown.
</TABLE>
D - 10
<PAGE>
DEFINED ASSET FUNDS--
MUNICIPAL INVESTMENT TRUST FUND
MONTHLY PAYMENT SERIES
I want to learn more about automatic reinvestment in the Investment Accumulation
Program. Please send me information about participation in the Municipal Fund
Accumulation Program, Inc. and a current Prospectus.
My name (please
print) ________________________________________________________________________
My address (please print):
Street and Apt.
No. ___________________________________________________________________________
City, State, Zip
Code __________________________________________________________________________
This page is a self-mailer. Please complete the information above, cut along the
dotted line, fold along the lines on the reverse side, tape, and mail with the
Trustee's address displayed on the outside.
12345678
<PAGE>
BUSINESS REPLY MAIL NO POSTAGE
FIRST CLASS PERMIT NO. 1313 NEW YORK, N.Y. NECESSARY
IF MAILED
POSTAGE WILL BE PAID BY ADDRESSEE IN THE
THE BANK OF NEW YORK UNITED STATES
UNIT INVESTMENT TRUST DEPARTMENT
P.O. BOX 974
WALL STREET STATION
NEW YORK, N.Y. 10268-0974
--------------------------------------------------------------------------------
(Fold along this line.)
--------------------------------------------------------------------------------
(Fold along this line.)
<PAGE>
DEFINED ASSET FUNDSSM
PROSPECTUS--PART B
DEFINED ASSET FUNDS MUNICIPAL SERIES
MUNICIPAL INVESTMENT TRUST FUND
THIS PART B OF THE PROSPECTUS MAY NOT BE DISTRIBUTED UNLESS ACCOMPANIED OR
PRECEDED BY PART A. FURTHER DETAIL REGARDING ANY OF THE INFORMATION
PROVIDED IN THE PROSPECTUS MAY BE OBTAINED WITHIN FIVE DAYS OF WRITTEN
OR TELEPHONIC REQUEST TO THE TRUSTEE, THE ADDRESS AND
TELEPHONE NUMBER OF WHICH ARE SET FORTH IN PART A OF THIS PROSPECTUS.
Index
PAGE
---------
Fund Description...................................... 1
Risk Factors.......................................... 2
How to Buy Units...................................... 7
How to Sell Units..................................... 9
Income, Distributions and Reinvestment................ 9
Fund Expenses......................................... 10
Taxes................................................. 11
Records and Reports................................... 12
PAGE
---------
Trust Indenture....................................... 12
Miscellaneous......................................... 13
Exchange Option....................................... 14
Supplemental Information.............................. 15
Appendix A--Description of Ratings.................... a-1
Appendix B--Sales Charge Schedules for Defined Asset
Funds Municipal Series................................ b-1
Appendix C--Sales Charge Schedules for Municipal
Investment Trust Fund................................. c-1
FUND DESCRIPTION
BOND PORTFOLIO SELECTION
Professional buyers and research analysts for Defined Asset Funds, with
access to extensive research, selected the Bonds for the Portfolio after
considering the Fund's investment objective as well as the quality of the Bonds
(all Bonds in the Portfolio are initially rated in the category A or better by
at least one nationally recognized rating organization or have comparable credit
characteristics), the yield and price of the Bonds compared to similar
securities, the maturities of the Bonds and the diversification of the
Portfolio. Only issues meeting these stringent criteria of the Defined Asset
Funds team of dedicated research analysts are included in the Portfolio. No
leverage or borrowing is used nor does the Portfolio contain other kinds of
securities to enhance yield. A summary of the Bonds in the Portfolio appears in
Part A of the Prospectus.
The deposit of the Bonds in the Fund on the initial date of deposit
established a proportionate relationship among the face amounts of the Bonds.
During the 90-day period following the initial date of deposit the Sponsors may
deposit additional Bonds in order to create new Units, maintaining to the extent
possible that original proportionate relationship. Deposits of additional Bonds
subsequent to the 90-day period must generally replicate exactly the
proportionate relationship among the face amounts of the Bonds at the end of the
initial 90-day period.
Yields on bonds depend on many factors including general conditions of the
bond markets, the size of a particular offering and the maturity and quality
rating of the particular issues. Yields can vary among bonds with similar
maturities, coupons and ratings. Ratings represent opinions of the rating
organizations as to the quality of the bonds rated, based on the credit of the
issuer or any guarantor, insurer or other credit provider, but these ratings are
only general standards of quality (see Appendix A).
After the initial date of deposit, the ratings of some Bonds may be reduced
or withdrawn, or the credit characteristics of the Bonds may no longer be
comparable to bonds rated A or better. Bonds rated BBB or Baa (the lowest
investment grade rating) or lower may have speculative characteristics, and
changes in economic conditions or other circumstances are more likely to lead to
a weakened capacity to make principal and interest payments than is the case
with higher grade bonds. Bonds rated below investment grade or unrated bonds
with
1
<PAGE>
similar credit characteristics are often subject to
greater market fluctuations and risk of loss of principal and income than higher
grade bonds and their value may decline precipitously in response to rising
interest rates.
Because each Defined Asset Fund is a preselected portfolio of bonds, you
know the securities, maturities, call dates and ratings before you invest. Of
course, the Portfolio will change somewhat over time, as Bonds mature, are
redeemed or are sold to meet Unit redemptions or in other limited circumstances.
Because the Portfolio is not actively managed and principal is returned as the
Bonds are disposed of, this principal should be relatively unaffected by changes
in interest rates.
BOND PORTFOLIO SUPERVISION
The Fund follows a buy and hold investment strategy in contrast to the
frequent portfolio changes of a managed fund based on economic, financial and
market analyses. The Fund may retain an issuer's bonds despite adverse financial
developments. Experienced financial analysts regularly review the Portfolio and
a Bond may be sold in certain circumstances including the occurrence of a
default in payment or other default on the Bond, a decline in the projected
income pledged for debt service on a revenue bond, institution of certain legal
proceedings, if the Bond becomes taxable or is otherwise inconsistent with the
Fund's investment objectives, a decline in the price of the Bond or the
occurrence of other market or credit factors (including advance refunding) that,
in the opinion of Defined Asset Funds research analysts, makes retention of the
Bond detrimental to the interests of investors. The Trustee must generally
reject any offer by an issuer of a Bond to exchange another security pursuant to
a refunding or refinancing plan.
The Sponsors and the Trustee are not liable for any default or defect in a
Bond. If a contract to purchase any Bond fails, the Sponsors may generally
deposit a replacement bond so long as it is a tax-exempt bond, has a fixed
maturity or disposition date substantially similar to the failed Bond and is
rated A or better by at least one nationally recognized rating organization or
has comparable credit characteristics. A replacement bond must be deposited
within 110 days after deposit of the failed contract, at a cost that does not
exceed the funds reserved for purchasing the failed Bond and at a yield to
maturity and current return substantially equivalent (considering then current
market conditions and relative creditworthiness) to those of the failed Bond, as
of the date the failed contract was deposited.
RISK FACTORS
An investment in the Fund entails certain risks, including the risk that
the value of your investment will decline with increases in interest rates.
Generally speaking, bonds with longer maturities will fluctuate in value more
than bonds with shorter maturities. In recent years there have been wide
fluctuations in interest rates and in the value of fixed-rate bonds generally.
The Sponsors cannot predict the direction or scope of any future fluctuations.
Certain of the Bonds may have been deposited at a market discount or
premium principally because their interest rates are lower or higher than
prevailing rates on comparable debt securities. The current returns of market
discount bonds are lower than comparably rated bonds selling at par because
discount bonds tend to increase in market value as they approach maturity. The
current returns of market premium bonds are higher than comparably rated bonds
selling at par because premium bonds tend to decrease in market value as they
approach maturity. Because part of the purchase price is returned through
current income payments and not at maturity, an early redemption at par of a
premium bond will result in a reduction in yield to the Fund. Market premium or
discount attributable to interest rate changes does not indicate market
confidence or lack of confidence in the issue.
Certain Bonds deposited into the Fund may have been acquired on a
when-issued or delayed delivery basis. The purchase price for these Bonds is
determined prior to their delivery to the Fund and a gain or loss may result
from fluctuations in the value of the Bonds. Additionally, in any Defined Asset
Funds Municipal Series, if the value of the Bonds reserved for payment of the
periodic deferred sales charge, together with the interest thereon, were to
become insufficient to pay these charges, additional bonds would be required to
be sold.
The Fund may be concentrated in one or more of types of bonds.
Concentration in a State may involve additional risk because of the decreased
diversification of economic, political, financial and market risks. Set forth
below is a brief description of certain risks associated with bonds which may be
held by the Fund. Additional information is contained in the Information
Supplement which is available from the Trustee at no charge to the investor.
2
<PAGE>
GENERAL OBLIGATION BONDS
Certain of the Bonds may be general obligations of a governmental entity.
General obligation bonds are backed by the issuer's pledge of its full faith,
credit and taxing power for the payment of principal and interest. However, the
taxing power of any governmental entity may be limited by provisions of state
constitutions or laws and its credit will depend on many factors, including an
erosion of the tax base resulting from population declines, natural disasters,
declines in the state's industrial base or an inability to attract new
industries, economic limits on the ability to tax without eroding the tax base
and the extent to which the entity relies on federal or state aid, access to
capital markets or other factors beyond the entity's control. In addition,
political restrictions on the ability to tax and budgetary constraints affecting
state governmental aid may have an adverse impact on the creditworthiness of
cities, counties, school districts and other local governmental units.
As a result of the recent recession's adverse impact upon both revenues and
expenditures, as well as other factors, many state and local governments have
confronted deficits which were the most severe in recent years. Many issuers are
facing highly difficult choices about significant tax increases and spending
reductions in order to restore budgetary balance. The failure to implement these
actions on a timely basis could force these issuers to issue additional debt to
finance deficits or cash flow needs and could lead to a reduction of their bond
ratings and the value of their outstanding bonds.
MORAL OBLIGATION BONDS
The Portfolio may include 'moral obligation' bonds. If an issuer of moral
obligation bonds is unable to meet its obligations, the repayment of the bonds
becomes a moral commitment but not a legal obligation of the state or local
government in question. Even though the state or local government may be called
on to restore any deficits in capital reserve funds of the agencies or
authorities which issued the bonds, any restoration generally requires
appropriation by the state or local legislature and does not constitute a
legally enforceable obligation or debt of the state or local government. The
agencies or authorities generally have no taxing power.
REFUNDED BONDS
Refunded bonds are typically secured by direct obligations of the U.S.
Government or in some cases obligations guaranteed by the U.S. Government placed
in an escrow account maintained by an independent trustee until maturity or a
predetermined redemption date. These obligations are generally noncallable prior
to maturity or the predetermined redemption date. In a few isolated instances,
however, bonds which were thought to be escrowed to maturity have been called
for redemption prior to maturity.
MUNICIPAL REVENUE BONDS
Municipal revenue bonds are tax-exempt securities issued by states,
municipalities, public authorities or similar entities to finance the cost of
acquiring, constructing or improving various projects. Municipal revenue bonds
are not general obligations of governmental entities backed by their taxing
power and payment is generally solely dependent upon the creditworthiness of the
public issuer or the financed project or state appropriations. Examples of
municipal revenue bonds are:
Municipal utility bonds, including electrical, water and sewer revenue
bonds, whose payments are dependent on various factors, including the rates
the utilities may charge, the demand for their services and their operating
costs, including expenses to comply with environmental legislation and
other energy and licensing laws and regulations. Utilities are particularly
sensitive to, among other things, the effects of inflation on operating and
construction costs, the unpredictability of future usage requirements, the
costs and availability of fuel and, with certain electric utilities, the
risks associated with the nuclear industry;
Lease rental bonds which are generally issued by governmental financing
authorities with no direct taxing power for the purchase of equipment or
construction of buildings that will be used by a state or local government.
Lease rental bonds are generally subject to an annual risk that the lessee
government might not appropriate funds for the leasing rental payments to
service the bonds and may also be subject to the risk that rental
obligations may terminate in the event of damage to or destruction or
condemnation of the equipment or building;
Multi-family housing revenue bonds and single family mortgage revenue
bonds which are issued to provide financing for various housing projects
and which are payable primarily from the revenues derived from mortgage
loans to housing projects for low to moderate income families or notes
secured by mortgages on residences; repayment of this type of bonds is
therefore dependent upon, among other things, occupancy
3
<PAGE>
levels, rental income, the rate of default on underlying mortgage loans,
the ability of mortgage insurers to pay claims, the continued availability
of federal, state or local housing subsidy programs, economic conditions in
local markets, construction costs, taxes, utility costs and other operating
expenses and the managerial ability of project managers. Housing bonds are
generally prepayable at any time and therefore their average life will
ordinarily be less than their stated maturities;
Hospital and health care facility bonds whose payments are dependent
upon revenues of hospitals and other health care facilities. These revenues
come from private third-party payors and government programs, including the
Medicare and Medicaid programs, which have generally undertaken cost
containment measures to limit payments to health care facilities. Hospitals
and health care facilities are subject to various legal claims by patients
and others and are adversely affected by increasing costs of insurance;
Airport, port, highway and transit authority revenue bonds which are
dependent for payment on revenues from the financed projects, including
user fees from ports and airports, tolls on turnpikes and bridges, rents
from buildings, transit fare revenues and additional financial resources
including federal and state subsidies, lease rentals paid by state or local
governments or a pledge of a special tax such as a sales tax or a property
tax. In the case of the air travel industry, airport income is largely
affected by the airlines' ability to meet their obligations under use
agreements which in turn is affected by increased competition among
airlines, excess capacity and increased fuel costs, among other factors.
Solid waste disposal bonds which are generally payable from dumping and
user fees and from revenues that may be earned by the facility on the sale
of electrical energy generated in the combustion of waste products and
which are therefore dependent upon the ability of municipalities to fully
utilize the facilities, sufficient supply of waste for disposal, economic
or population growth, the level of construction and maintenance costs, the
existence of lower-cost alternative modes of waste processing and
increasing environmental regulation. A recent decision of the U.S. Supreme
Court limiting a municipality's ability to require use of its facilities
may have an adverse affect on the credit quality of various issues of these
bonds;
Special tax bonds which are not secured by general tax revenues but are
only payable from and secured by the revenues derived by a municipality
from a particular tax--for example, a tax on the rental of a hotel room, on
the purchase of food and beverages, on the rental of automobiles or on the
consumption of liquor and may therefore be adversely affected by a
reduction in revenues resulting from a decline in the local economy or
population or a decline in the consumption, use or cost of the goods and
services that are subject to taxation;
Student loan revenue bonds which are typically secured by pledges of new
or existing student loans. The loans, in turn, are generally either
guaranteed by eligible guarantors and reinsured by the Secretary of the
U.S. Department of Education, directly insured by the federal government,
or financed as part of supplemental or alternative loan programs within a
state (e.g., loan repayments are not guaranteed). These bonds often permit
the issuer to enter into interest rate swap agreements with eligible
counterparties in which event the bonds are subject to the additional risk
of the counterparty's ability to fulfill its swap obligation;
University and college bonds, the payments on which are dependent upon
various factors, including the size and diversity of their sources of
revenues, enrollment, reputation, the availability of endowments and other
funds and, in the case of public institutions, the financial condition of
the relevant state or other governmental entity and its policies with
respect to education; and
Tax increment and tax allocation bonds, which are secured by ad valorem
taxes imposed on the incremental increase of taxable assessed valuation of
property within a jurisdiction above an established base of assessed value.
The issuers of these bonds do not have general taxing authority and the tax
assessments on which the taxes used to service the bonds are based may be
subject to devaluation due to market price declines or governmental action.
Puerto Rico. Certain Bonds may be affected by general economic conditions
in the Commonwealth of Puerto Rico. Puerto Rico's economy is largely dependent
for its development on federal programs and current federal budgetary policies
suggest that an expansion of its programs is unlikely. Reductions in federal tax
benefits or incentives or curtailment of spending programs could adversely
affect the Puerto Rican economy.
Industrial Development Revenue Bonds. Industrial development revenue bonds
are municipal obligations issued to finance various privately operated projects
including pollution control and manufacturing facilities. Payment is generally
solely dependent upon the creditworthiness of the corporate operator of the
project and, in
4
<PAGE>
certain cases, an affiliated or third party guarantor and may be affected by
economic factors relating to the particular industry as well as varying degrees
of governmental regulation. In many cases industrial revenue bonds do not have
the benefit of covenants which would prevent the corporations from engaging in
capital restructurings or borrowing transactions which could reduce their
ability to meet their obligations and result in a reduction in the value of the
Portfolio.
BONDS BACKED BY LETTERS OF CREDIT OR INSURANCE
Certain Bonds may be secured by letters of credit issued by commercial
banks or savings banks, savings and loan associations and similar thrift
institutions or are direct obligations of banks or thrifts. The letter of credit
may be drawn upon, and the Bonds redeemed, if an issuer fails to pay amounts due
on the Bonds or, in certain cases, if the interest on the Bond becomes taxable.
Letters of credit are irrevocable obligations of the issuing institutions. The
profitability of a financial institution is largely dependent upon the credit
quality of its loan portfolio which, in turn, is affected by the institution's
underwriting criteria, concentrations within the portfolio and specific industry
and general economic conditions. The operating performance of financial
institutions is also impacted by changes in interest rates, the availability and
cost of funds, the intensity of competition and the degree of governmental
regulation.
Certain Bonds may be insured or guaranteed by insurance companies listed
below. The claims-paying ability of each of these companies, unless otherwise
indicated, was rated AAA by Standard & Poor's or another nationally recognized
rating organization at the time the insured Bonds were purchased by the Fund.
The ratings are subject to change at any time at the discretion of the rating
agencies. In the event that the rating of an Insured Fund is reduced, the
Sponsors are authorized to direct the Trustee to obtain other insurance on
behalf of the Fund. The insurance policies guarantee the timely payment of
principal and interest on the Bonds but do not guarantee their market value or
the value of the Units. The insurance policies generally do not provide for
accelerated payments of principal or cover redemptions resulting from events of
taxability.
The following summary information relating to the listed insurance
companies has been obtained from publicly available information:
<TABLE><CAPTION>
FINANCIAL INFORMATION
AS OF SEPTEMBER 30, 1994
(IN MILLIONS OF DOLLARS)
--------------------------------------
POLICYHOLDERS'
NAME DATE ESTABLISHED ADMITTED ASSETS SURPLUS
---------------------------------------------------- ----------------- --------------- ---------------------
<S> <C> <C> <C>
AMBAC Indemnity Corporation......................... 1970 $ 2,150 $ 779
Asset Guaranty Insurance Co. (AA by S&P) 1988 152 73
Capital Guaranty Insurance Company.................. 1986 293 166
Capital Markets Assurance Corp...................... 1987 198 139
Connie Lee Insurance Company........................ 1987 193 106
Continental Casualty Company........................ 1948 19,220 3,309
Financial Guaranty Insurance Company................ 1984 2,092 872
Financial Security Assurance Inc.................... 1984 776 369
Firemen's Insurance Company of Newark, NJ........... 1855 2,236 383
Industrial Indemnity Co. (HIBI)..................... 1920 1,853 299
Municipal Bond Investors Assurance Corporation...... 1986 3,314 1,083
Insurance companies are subject to extensive regulation and supervision
where they do business by state insurance commissioners who regulate the
standards of solvency which must be maintained, the nature of and limitations on
investments, reports of financial condition, and requirements regarding reserves
for unearned premiums, losses and other matters. A significant portion of the
assets of insurance companies are required by law to be held in reserve against
potential claims on policies and is not available to general creditors. Although
the federal government does not regulate the business of insurance, federal
initiatives including pension regulation, controls on medical care costs,
minimum standards for no-fault automobile insurance, national health insurance,
tax law changes affecting life insurance companies and repeal of the antitrust
exemption for the insurance business can significantly impact the insurance
business.
5
<PAGE>
STATE RISK FACTORS
Investment in a single State Trust, as opposed to a Fund which invests in
the obligations of several states, may involve some additional risk due to the
decreased diversification of economic, political, financial and market risks. A
brief description of the factors which may affect the financial condition of the
applicable State for any State Trust, together with a summary of tax
considerations relating to that State, appear in Part A (or for certain State
Trusts, Part C), of the Prospectus; further information is contained in the
Information Supplement.
LITIGATION AND LEGISLATION
The Sponsors do not know of any pending litigation as of the initial date
of deposit which might reasonably be expected to have a material adverse effect
upon the Fund. At any time after the initial date of deposit, litigation may be
initiated on a variety of grounds, or legislation may be enacted, affecting the
Bonds in the Fund. Litigation, for example, challenging the issuance of
pollution control revenue bonds under environmental protection statutes may
affect the validity of certain Bonds or the tax-free nature of their interest.
While the outcome of litigation of this nature can never be entirely predicted,
opinions of bond counsel are delivered on the date of issuance of each Bond to
the effect that it has been validly issued and that the interest thereon is
exempt from federal income tax. Also, certain proposals, in the form of state
legislative proposals or voter initiatives, seeking to limit real property taxes
have been introduced in various states, and an amendment to the constitution of
the State of California, providing for strict limitations on real property
taxes, has had a significant impact on the taxing powers of local governments
and on the financial condition of school districts and local governments in
California. In addition, other factors may arise from time to time which
potentially may impair the ability of issuers to make payments due on the Bonds.
Under the Federal Bankruptcy Code, for example, municipal bond issuers, as well
as any underlying corporate obligors or guarantors, may proceed to restructure
or otherwise alter the terms of their obligations.
From time to time Congress considers proposals to prospectively and
retroactively tax the interest on state and local obligations, such as the
Bonds. The Supreme Court clarified in South Carolina v. Baker (decided on April
20, 1988) that the U.S. Constitution does not prohibit Congress from passing a
nondiscriminatory tax on interest on state and local obligations. This type of
legislation, if enacted into law, could require investors to pay income tax on
interest from the Bonds and could adversely affect an investment in Units. See
Taxes.
PAYMENT OF THE BONDS AND LIFE OF THE FUND
The size and composition of the Portfolio will change over time. Most of
the Bonds are subject to redemption prior to their stated maturity dates
pursuant to optional refunding or sinking fund redemption provisions or
otherwise. In general, optional refunding redemption provisions are more likely
to be exercised when the value of a Bond is at a premium over par than when it
is at a discount from par. Some Bonds may be subject to sinking fund and
extraordinary redemption provisions which may commence early in the life of the
Fund. Additionally, the size and composition of the Fund will be affected by the
level of redemptions of Units that may occur from time to time. Principally,
this will depend upon the number of investors seeking to sell or redeem their
Units and whether or not the Sponsors are able to sell the Units acquired by
them in the secondary market. As a result, Units offered in the secondary market
may not represent the same face amount of Bonds as on the initial date of
deposit. Factors that the Sponsors will consider in determining whether or not
to sell Units acquired in the secondary market include the diversity of the
Portfolio, the size of the Fund relative to its original size, the ratio of Fund
expenses to income, the Fund's current and long-term returns, the degree to
which Units may be selling at a premium over par and the cost of maintaining a
current prospectus for the Fund. These factors may also lead the Sponsors to
seek to terminate the Fund earlier than its mandatory termination date.
FUND TERMINATION
The Fund will be terminated no later than the mandatory termination date
specified in Part A of the Prospectus. It will terminate earlier upon the
disposition of the last Bond or upon the consent of investors holding 51% of the
Units. The Fund may also be terminated earlier by the Sponsors once the total
assets of the Fund have fallen below the minimum value specified in Part A of
the Prospectus. A decision by the Sponsors to terminate the Fund early will be
based on factors similar to those considered by the Sponsors in determining
whether to continue the sale of Units in the secondary market.
Notice of impending termination will be provided to investors and
thereafter units will no longer be redeemable. On or shortly before termination,
the Fund will seek to dispose of any Bonds remaining in the
6
<PAGE>
Portfolio although any Bond unable to be sold at a reasonable price may continue
to be held by the Trustee in a liquidating trust pending its final disposition.
A proportional share of the expenses associated with termination, including
brokerage costs in disposing of Bonds, will be borne by investors remaining at
that time. This may have the effect of reducing the amount of proceeds those
investors are to receive in any final distribution.
LIQUIDITY
Up to 40% of the value of the Portfolio may be attributable to guarantees
or similar security provided by corporate entities. These guarantees or other
security may constitute restricted securities that cannot be sold publicly by
the Trustee without registration under the Securities Act of 1933, as amended.
The Sponsors nevertheless believe that, should a sale of the Bonds guaranteed or
secured be necessary in order to meet redemption of Units, the Trustee should be
able to consummate a sale with institutional investors.
The principal trading market for the Bonds will generally be in the
over-the-counter market and the existence of a liquid trading market for the
Bonds may depend on whether dealers will make a market in them. There can be no
assurance that a liquid trading market will exist for any of the Bonds,
especially since the Fund may be restricted under the Investment Company Act of
1940 from selling Bonds to any Sponsor. The value of the Portfolio will be
adversely affected if trading markets for the Bonds are limited or absent.
HOW TO BUY UNITS
Units are available from any of the Sponsors, Underwriters and other
broker-dealers at the Public Offering Price plus accrued interest on the Units.
The Public Offering Price varies each Business Day with changes in the value of
the Portfolio and other assets and liabilities of the Fund.
PUBLIC OFFERING PRICE--DEFINED ASSET FUNDS MUNICIPAL SERIES
To allow Units to be priced at $1,000, the Units outstanding as of the
Evaluation Time on the Initial Date of Deposit (all of which are held by the
Sponsors) will be split (or split in reverse).
During the initial offering period for at least the first three months of
the Fund, the Public Offering Price (and the Initial Repurchase Price) is based
on the higher, offer side evaluation of the Bonds at the next Evaluation Time
after the order is received. In the secondary market (after the initial offering
period), the Public Offering Price (and the Sponsors' Repurchase Price and the
Redemption Price) is based on the lower, bid side evaluation of the Bonds.
Investors will be subject to differing types and amounts of sales charge
depending upon the timing of their purchases and redemptions of Units. A
periodic deferred sales charge will be payable quarterly through about the fifth
anniversary of the Fund from a portion of the interest on and principal of Bonds
reserved for that purpose. Commencing on the first anniversary of the Fund, the
Public Offering Price will also include an up-front sales charge applied to the
value of the Bonds in the Portfolio. Lastly, investors redeeming their Units
prior to the fourth anniversary of the Fund will be charged a contingent
deferred sales charge payable out of the redemption proceeds of their Units.
These charges may be less than you would pay to buy and hold a comparable
managed fund. A complete schedule of sales charges appears in Appendix B. The
Sponsors have received an opinion of their counsel that the deferred sales
charge described in this Prospectus is consistent with an exemptive order
received from the SEC.
Because accrued interest on the Bonds is not received by the Fund at a
constant rate throughout the year, any Monthly Income Distribution may be more
or less than the interest actually received by the Fund. To eliminate
fluctuations in the Monthly Income Distribution, a portion of the Public
Offering Price consists of an advance to the Trustee of an amount necessary to
provide approximately equal distributions. Upon the sale or redemption of Units,
investors will receive their proportionate share of the Trustee advance. In
addition, if a Bond is sold, redeemed or otherwise disposed of, the Fund will
periodically distribute the portion of the Trustee advance that is attributable
to the Bond to investors.
The regular Monthly Income Distribution is stated in Part A of the
Prospectus and will change as the composition of the Portfolio changes over
time.
PUBLIC OFFERING PRICE--MUNICIPAL INVESTMENT TRUST FUND
In the initial offering period, the Public Offering Price is based on the
next offer side evaluation of the Bonds, and includes a sales charge based on
the number of Units of a single Fund or Trust purchased on the same or any
7
<PAGE>
preceding day by a single purchaser. See Initial Offering sales charge schedule
in Appendix C. The purchaser or his dealer must notify the Sponsors at the time
of purchase of any previous purchase to be aggregated and supply sufficient
information to permit confirmation of eligibility; acceptance of the purchase
order is subject to confirmation. Purchases of Fund Units may not be aggregated
with purchases of any other unit trust. This procedure may be amended or
terminated at any time without notice.
In the secondary market (after the initial offering period), the Public
Offering Price is based on the bid side evaluation of the Bonds, and includes a
sales charge based (a) on the number of Units of the Fund and any other Series
of Municipal Investment Trust Fund purchased in the secondary market on the same
day by a single purchaser (see Secondary Market sales charge schedule in
Appendix C) and (b) the maturities of the underlying Bonds (see Effective Sales
Charge Schedule in Appendix C). To qualify for a reduced sales charge, the
dealer must confirm that the sale is to a single purchaser or is purchased for
its own account and not for distribution. For these purposes, Units held in the
name of the purchaser's spouse or child under 21 years of age are deemed to be
purchased by a single purchaser. A trustee or other fiduciary purchasing
securities for a single trust estate or single fiduciary account is also
considered a single purchaser.
In the secondary market, the Public Offering Price is further reduced
depending on the maturities of the various Bonds in the Portfolio, by
determining a sales charge percentage for each Bond, as stated in Effective
Sales Charge in Appendix C. The sales charges so determined, multiplied by the
bid side evaluation of the Bonds, are aggregated and the total divided by the
number of Units outstanding to determine the Effective Sales Charge. On any
purchase, the Effective Sales Charge is multiplied by the applicable secondary
market sales charge percentage (depending on the number of Units purchased) in
order to determine the sales charge component of the Public Offering Price.
* * *
Employees of certain Sponsors and Sponsor affiliates and non-employee
directors of Merrill Lynch & Co. Inc. may purchase Units at any time at prices
including a sales charge of not less than $5 per Unit.
Net accrued interest is added to the Public Offering Price, the Sponsors'
Repurchase Price and the Redemption Price per Unit. This represents the interest
accrued on the Bonds, net of Fund expenses, from the initial date of deposit to,
but not including, the settlement date for Units (less any prior distributions
of interest income to investors). Bonds deposited also carry accrued but unpaid
interest up to the initial date of deposit. To avoid having investors pay this
additional accrued interest (which earns no return) when they purchase Units,
the Trustee advances and distributes this amount to the Sponsors; it recovers
this advance from interest received on the Bonds. Because of varying interest
payment dates on the Bonds, accrued interest at any time will exceed the
interest actually received by the Fund.
EVALUATIONS
Evaluations are determined by the independent Evaluator on each Business
Day. This excludes Saturdays, Sundays and the following holidays as observed by
the New York Stock Exchange: New Year's Day, Presidents' Day, Good Friday,
Memorial Day, Independence Day, Labor Day, Thanksgiving and Christmas. Bond
evaluations are based on closing sales prices (unless the Evaluator deems these
prices inappropriate). If closing sales prices are not available, the evaluation
is generally determined on the basis of current bid or offer prices for the
Bonds or comparable securities or by appraisal or by any combination of these
methods. In the past, the bid prices of publicly offered tax-exempt issues have
been lower than the offer prices by as much as 3 1/2% or more of face amount in
the case of inactively traded issues and as little as 1/2 of 1% in the case of
actively traded issues, but the difference between the offer and bid prices has
averaged between 1 and 2% of face amount. Neither the Sponsors, the Trustee or
the Evaluator will be liable for errors in the Evaluator's judgment. The fees of
the Evaluator will be borne by the Fund.
CERTIFICATES
Certificates for Units are issued upon request and may be transferred by
paying any taxes or governmental charges and by complying with the requirements
for redeeming Certificates (see How To Sell Units--Trustee's Redemption of
Units). Certain Sponsors collect additional charges for registering and shipping
Certificates to purchasers. Lost or mutilated Certificates can be replaced upon
delivery of satisfactory indemnity and payment of costs.
8
<PAGE>
HOW TO SELL UNITS
SPONSORS' MARKET FOR UNITS
You can sell your Units at any time without a fee. The Sponsors (although
not obligated to do so) will normally buy any Units offered for sale at the
repurchase price next computed after receipt of the order. The Sponsors have
maintained secondary markets in Defined Asset Funds for over 20 years. Primarily
because of the sales charge and fluctuations in the market value of the Bonds,
the sale price may be less than the cost of your Units. You should consult your
financial professional for current market prices to determine if other broker-
dealers or banks are offering higher prices for Units.
The Sponsors may discontinue this market without prior notice if the supply
of Units exceeds demand or for other business reasons; in that event, the
Sponsors may still purchase Units at the redemption price as a service to
investors. The Sponsors may reoffer or redeem Units repurchased.
TRUSTEE'S REDEMPTION OF UNITS
You may redeem your Units by sending the Trustee a redemption request
together with any certificates you hold. Certificates must be properly endorsed
or accompanied by a written transfer instrument with signatures guaranteed by an
eligible institution. In certain instances, additional documents may be required
such as a certificate of death, trust instrument, certificate of corporate
authority or appointment as executor, administrator or guardian. If the Sponsors
are maintaining a market for Units, they will purchase any Units tendered at the
repurchase price described above. While Defined Asset Funds Municipal Series
have a declining deferred sales charge payable on redemption (see Appendix B),
Municipal Investment Trust Fund has no back-end load or 12b-1 fees, so there is
never a fee for cashing in your investment (see Appendix C). If they do not
purchase Units tendered, the Trustee is authorized in its discretion to sell
Units in the over-the-counter market if it believes it will obtain a higher net
price for the redeeming investor.
By the seventh calendar day after tender you will be mailed an amount equal
to the Redemption Price per Unit. Because of market movements or changes in the
Portfolio, this price may be more or less than the cost of your Units. The
Redemption Price per Unit is computed each Business Day by adding the value of
the Bonds, net accrued interest, cash and the value of any other Fund assets;
deducting unpaid taxes or other governmental charges, accrued but unpaid Fund
expenses, unreimbursed Trustee advances, cash held to redeem Units or for
distribution to investors and the value of any other Fund liabilities; and
dividing the result by the number of outstanding Units.
For Defined Asset Funds Municipal Series, Bonds are evaluated on the offer
side during the initial offering period and for at least the first three months
of the Fund (even in the secondary market) and on the bid side thereafter. For
Municipal Investment Trust Fund, Bonds are evaluated on the offer side during
the initial offering period and on the bid side thereafter.
If cash is not available in the Fund's Income and Capital Accounts to pay
redemptions, the Trustee may sell Bonds selected by the Agent for the Sponsors
based on market and credit factors determined to be in the best interest of the
Fund. These sales are often made at times when the Bonds would not otherwise be
sold and may result in lower prices than might be realized otherwise and will
also reduce the size and diversity of the Fund.
Redemptions may be suspended or payment postponed if the New York Stock
Exchange is closed other than for customary weekend and holiday closings, if the
SEC determines that trading on that Exchange is restricted or that an emergency
exists making disposal or evaluation of the Bonds not reasonably practicable, or
for any other period permitted by the SEC.
INCOME, DISTRIBUTIONS AND REINVESTMENT
INCOME
Some of the Bonds may have been purchased on a when-issued basis or may
have a delayed delivery. Since interest on these Bonds does not begin to accrue
until the date of their delivery to the Fund, the Trustee's annual fee and
expenses may be reduced to provide tax-exempt income to investors for this
non-accrual period. If a when-issued Bond is not delivered until later than
expected and the amount of the Trustee's annual fee and expenses is insufficient
to cover the additional accrued interest, the Sponsors will treat the contracts
as failed Bonds. The Trustee is compensated for its fee reduction by drawing on
the letter of credit deposited by the
9
<PAGE>
Sponsors before the settlement date for these Bonds and depositing the proceeds
in a non-interest bearing account for the Fund.
Interest received is credited to an Income Account and other receipts to a
Capital Account. A Reserve Account may be created by withdrawing from the Income
and Capital Accounts amounts considered appropriate by the Trustee to reserve
for any material amount that may be payable out of the Fund.
DISTRIBUTIONS
Each Unit receives an equal share of monthly distributions of interest
income net of estimated expenses. Interest on the Bonds is generally received by
the Fund on a semi-annual or annual basis. Because interest on the Bonds is not
received at a constant rate throughout the year, any Monthly Income Distribution
may be more or less than the interest actually received. To eliminate
fluctuations in the Monthly Income Distribution, the Trustee will advance
amounts necessary to provide approximately equal interest distributions; it will
be reimbursed, without interest, from interest received on the Bonds, but the
Trustee is compensated, in part, by holding the Fund's cash balances in
non-interest bearing accounts. Along with the Monthly Income Distributions, the
Trustee will distribute the investor's pro rata share of principal received from
any disposition of a Bond to the extent available for distribution. In addition,
for Defined Asset Funds Municipal Series, distributions of amounts necessary to
pay the deferred portion of the sales charge will be made from the Capital and
Income Accounts to an account maintained by the Trustee for purposes of
satisfying investors' sales charge obligations.
The initial estimated annual income per Unit, after deducting estimated
annual Fund expenses (and, for Defined Asset Funds Municipal Series, the portion
of the deferred sales charge payable from interest income) as stated in Part A
of the Prospectus, will change as Bonds mature, are called or sold or otherwise
disposed of, as replacement bonds are deposited and as Fund expenses change.
Because the Portfolio is not actively managed, income distributions will
generally not be affected by changes in interest rates. Depending on the
financial conditions of the issuers of the Bonds, the amount of income should be
substantially maintained as long as the Portfolio remains unchanged; however,
optional bond redemptions or other Portfolio changes may occur more frequently
when interest rates decline, which would result in early returns of principal
and possibly earlier termination of the Fund.
REINVESTMENT
Distributions will be paid in cash unless the investor elects to have
distributions reinvested without sales charge in the Municipal Fund Accumulation
Program, Inc. The Program is an open-end management investment company whose
investment objective is to obtain income exempt from regular federal income
taxes by investing in a diversified portfolio of state, municipal and public
authority bonds rated A or better or with comparable credit characteristics.
Reinvesting compounds earnings free from federal tax. Investors participating in
the Program will be subject to state and local income taxes to the same extent
as if the distributions had been received in cash, and most of the income on the
Program is subject to state and local income taxes. For more complete
information about the Program, including charges and expenses, request the
Program's prospectus from the Trustee. Read it carefully before you decide to
participate. Written notice of election to participate must be received by the
Trustee at least ten days before the Record Day for the first distribution to
which the election is to apply.
FUND EXPENSES
Estimated annual Fund expenses are listed in Part A of the Prospectus; if
actual expenses exceed the estimate, the excess will be borne by the Fund. The
Trustee's annual fee is payable in monthly installments. The Trustee also
benefits when it holds cash for the Fund in non-interest bearing accounts.
Possible additional charges include Trustee fees and expenses for extraordinary
services, costs of indemnifying the Trustee and the Sponsors, costs of action
taken to protect the Fund and other legal fees and expenses, Fund termination
expenses and any governmental charges. The Trustee has a lien on Fund assets to
secure reimbursement of these amounts and may sell Bonds for this purpose if
cash is not available. The Sponsors receive an annual fee of a maximum of $0.35
per $1,000 face amount to reimburse them for the cost of providing Portfolio
supervisory services to the Fund. While the fee may exceed their costs of
providing these services to the Fund, the total supervision fees from all
Defined Asset Funds Municipal Series will not exceed their costs for these
services to all of those Series during any calendar year; and the total
supervision fees from all Series of Municipal Investment Trust Fund will not
exceed their costs for these services to all of those Series during any calendar
year. The Sponsors may also be reimbursed for their costs of providing
bookkeeping and administrative services to the Fund, currently estimated at
$0.10 per Unit. The Trustee's, Sponsors' and Evaluator's fees may be adjusted
for inflation without investors' approval.
10
<PAGE>
All expenses in establishing the Fund will be paid from the Underwriting
Account at no charge to the Fund. Sales charges on Defined Asset Funds range
from under 1.0% to 5.5%. This may be less than you might pay to buy and hold a
comparable managed fund. Defined Asset Funds can be a cost-effective way to
purchase and hold investments. Annual operating expenses are generally lower
than for managed funds. Because Defined Asset Funds have no management fees,
limited transaction costs and no ongoing marketing expenses, operating expenses
are generally less than 0.25% a year. When compounded annually, small
differences in expense ratios can make a big difference in your investment
results.
TAXES
The following discussion addresses only the U.S. federal and certain New
York State and City income tax consequences under current law of Units held as
capital assets and does not address the tax consequences of Units held by
dealers, financial institutions or insurance companies or other investors with
special circumstances.
In the opinion of Davis Polk & Wardwell, special counsel for the Sponsors,
under existing law:
The Fund is not an association taxable as a corporation for federal
income tax purposes. Each investor will be considered the owner of a pro
rata portion of each Bond in the Fund under the grantor trust rules of
Sections 671-679 of the Internal Revenue Code of 1986, as amended (the
'Internal Revenue Code'). Each investor will be considered to have received
the interest and accrued the original issue discount, if any, on his pro
rata portion of each Bond when interest on the Bond is received or original
issue discount is accrued by the Fund. The investor's basis in his Units
will be equal to the cost of his Units, including any up-front sales
charge.
When an investor pays for accrued interest, the investor's confirmation
of purchase will report to him the amount of accrued interest for which he
paid. These investors will receive the accrued interest amount as part of
their first monthly distribution. Accordingly, these investors should
reduce their tax basis by the accrued interest amount after the first
monthly distribution.
An investor will recognize taxable gain or loss when all or part of his
pro rata portion of a Bond is disposed of by the Fund. An investor will
also be considered to have disposed of all or a portion of his pro rata
portion of each Bond when he sells or redeems all or some of his Units. An
investor who is treated as having acquired his pro rata portion of a Bond
at a premium will be required to amortize the premium over the term of the
Bond. The amortization is only a reduction of basis for the investor's pro
rata portion of the Bond and does not result in any deduction against the
investor's income. Therefore, under some circumstances, an investor may
recognize taxable gain when his pro rata portion of a Bond is disposed of
for an amount equal to or less than his original tax basis therefor.
Under Section 265 of the Internal Revenue Code, a non-corporate investor
is not entitled to a deduction for his pro rata share of fees and expenses
of the Fund, because the fees and expenses are incurred in connection with
the production of tax-exempt income. Further, if borrowed funds are used by
an investor to purchase or carry Units of the Fund, interest on this
indebtedness will not be deductible for federal income tax purposes. In
addition, under rules used by the Internal Revenue Service, the purchase of
Units may be considered to have been made with borrowed funds even though
the borrowed funds are not directly traceable to the purchase of Units.
Under the income tax laws of the State and City of New York, the Fund is
not an association taxable as a corporation and income received by the Fund
will be treated as the income of the investors in the same manner as for
federal income tax purposes, but will not necessarily be tax-exempt.
The foregoing discussion relates only to U.S. federal and certain
aspects of New York State and City income taxes. Depending on their state
of residence, investors may be subject to state and local taxation and
should consult their own tax advisers in this regard.
* * *
In the opinion of bond counsel rendered on the date of issuance of each
Bond, the interest on each Bond is excludable from gross income under existing
law for regular federal income tax purposes (except in certain circumstances
depending on the investor) but may be subject to state and local taxes, and
interest on some or all of the Bonds may become subject to regular federal
income tax, perhaps retroactively to their date of issuance, as a result of
changes in federal law or as a result of the failure of issuers (or other users
of the proceeds of the Bonds) to comply with certain ongoing requirements. If
the interest on a Bond should be determined to be taxable, the
11
<PAGE>
Bond would generally have to be sold at a substantial discount. In addition,
investors could be required to pay income tax on interest received prior to the
date on which the interest is determined to be taxable.
Neither the Sponsors nor Davis Polk & Wardwell have made or will make any
review of the proceedings relating to the issuance of the Bonds or the basis for
these opinions and there can be no assurance that the issuer (and other users)
will comply with any ongoing requirements necessary for a Bond to maintain its
tax-exempt character.
RECORDS AND REPORTS
The Trustee keeps a register of the names, addresses and holdings of all
investors. The Trustee also keeps records of the transactions of the Fund,
including a current list of the Bonds and a copy of the Indenture, and
supplemental information on the operations of the Fund and the risks associated
with the Bonds held by the Fund, which may be inspected by investors at
reasonable times during business hours.
With each distribution, the Trustee includes a statement of the interest
and any other receipts being distributed. Within five days after deposit of
Bonds in exchange or substitution for Bonds (or contracts) previously deposited,
the Trustee will send a notice to each investor, identifying both the Bonds
removed and the replacement bonds deposited. The Trustee sends each investor of
record an annual report summarizing transactions in the Fund's accounts and
amounts distributed during the year and Bonds held, the number of Units
outstanding and the Redemption Price at year end, the interest received by the
Fund on the Bonds, the gross proceeds received by the Fund from the disposition
of any Bond (resulting from redemption or payment at maturity or sale of any
Bond), and the fees and expenses paid by the Fund, among other matters. The
Trustee will also furnish annual information returns to each investor and to the
Internal Revenue Service. Investors are required to report to the Internal
Revenue Service the amount of tax-exempt interest received during the year.
Investors may obtain copies of Bond evaluations from the Trustee to enable them
to comply with federal and state tax reporting requirements. Fund accounts are
audited annually by independent accountants selected by the Sponsors. Audited
financial statements are available from the Trustee on request.
TRUST INDENTURE
The Fund is a 'unit investment trust' created under New York law by a Trust
Indenture among the Sponsors, the Trustee and the Evaluator. This Prospectus
summarizes various provisions of the Indenture, but each statement is qualified
in its entirety by reference to the Indenture.
The Indenture may be amended by the Sponsors and the Trustee without
consent by investors to cure ambiguities or to correct or supplement any
defective or inconsistent provision, to make any amendment required by the SEC
or other governmental agency or to make any other change not materially adverse
to the interest of investors (as determined in good faith by the Sponsors). The
Indenture may also generally be amended upon consent of investors holding 51% of
the Units. No amendment may reduce the interest of any investor in the Fund
without the investor's consent or reduce the percentage of Units required to
consent to any amendment without unanimous consent of investors. Investors will
be notified on the substance of any amendment.
The Trustee may resign upon notice to the Sponsors. It may be removed by
investors holding 51% of the Units at any time or by the Sponsors without the
consent of investors if it becomes incapable of acting or bankrupt, its affairs
are taken over by public authorities, or if under certain conditions the
Sponsors determine in good faith that its replacement is in the best interest of
the investors. The Evaluator may resign or be removed by the Sponsors and the
Trustee without the investors' consent. The resignation or removal of either
becomes effective upon acceptance of appointment by a successor; in this case,
the Sponsors will use their best efforts to appoint a successor promptly;
however, if upon resignation no successor has accepted appointment within 30
days after notification, the resigning Trustee or Evaluator may apply to a court
of competent jurisdiction to appoint a successor.
Any Sponsor may resign so long as one Sponsor with a net worth of
$2,000,000 remains and is agreeable to the resignation. A new Sponsor may be
appointed by the remaining Sponsors and the Trustee to assume the duties of the
resigning Sponsor. If there is only one Sponsor and it fails to perform its
duties or becomes incapable of acting or bankrupt or its affairs are taken over
by public authorities, the Trustee may appoint a successor Sponsor at reasonable
rates of compensation, terminate the Indenture and liquidate the Fund or
continue to act as Trustee without a Sponsor. Merrill Lynch, Pierce, Fenner &
Smith Incorporated has been appointed as Agent for the Sponsors by the other
Sponsors.
The Sponsors, the Trustee and the Evaluator are not liable to investors or
any other party for any act or omission in the conduct of their responsibilities
absent bad faith, willful misfeasance, negligence (gross negligence
12
<PAGE>
in the case of a Sponsor or the Evaluator) or reckless disregard of duty. The
Indenture contains customary provisions limiting the liability of the Trustee.
MISCELLANEOUS
LEGAL OPINION
The legality of the Units has been passed upon by Davis Polk & Wardwell,
450 Lexington Avenue, New York, New York 10017, as special counsel for the
Sponsors.
AUDITORS
The Statement of Condition in Part A of the Prospectus was audited by
Deloitte & Touche LLP, independent accountants, as stated in their opinion. It
is included in reliance upon that opinion given on the authority of that firm as
experts in accounting and auditing.
TRUSTEE
The Trustee and its address are stated in Part A of the Prospectus. The
Trustee is subject to supervision by the Federal Deposit Insurance Corporation,
the Board of Governors of the Federal Reserve System and either the Comptroller
of the Currency or state banking authorities.
SPONSORS
The Sponsors are listed in Part A of the Prospectus. They may include
Merrill Lynch, Pierce, Fenner & Smith Incorporated, a wholly-owned subsidiary of
Merrill Lynch Co. Inc.; Smith Barney Inc., an indirect wholly-owned subsidiary
of The Travelers Inc.; Prudential Securities Incorporated, an indirect
wholly-owned subsidiary of the Prudential Insurance Company of America; Dean
Witter Reynolds, Inc., a principal operating subsidiary of Dean Witter Discover
& Co. and PaineWebber Incorporated, a wholly-owned subsidiary of PaineWebber
Group Inc. Each Sponsor, or one of its predecessor corporations, has acted as
Sponsor of a number of series of unit investment trusts. Each Sponsor has acted
as principal underwriter and managing underwriter of other investment companies.
The Sponsors, in addition to participating as members of various selling groups
or as agents of other investment companies, execute orders on behalf of
investment companies for the purchase and sale of securities of these companies
and sell securities to these companies in their capacities as brokers or dealers
in securities.
PUBLIC DISTRIBUTION
In the initial offering period Units will be distributed to the public
through the Underwriting Account and dealers who are members of the National
Association of Securities Dealers, Inc. The initial offering period is 30 days
or less if all Units are sold. If some Units initially offered have not been
sold, the Sponsors may extend the initial offering period for up to four
additional successive 30-day periods.
The Sponsors intend to qualify Units for sale in all states in which
qualification is deemed necessary through the Underwriting Account and by
dealers who are members of the National Association of Securities Dealers, Inc.;
however, Units of a State trust will be offered for sale only in the State for
which the trust is named, except that Units of a New Jersey trust will also be
offered in Connecticut, Units of a Florida trust will also be offered in New
York and Units of a New York trust will also be offered in Connecticut, Florida
and Puerto Rico. The Sponsors do not intend to qualify Units for sale in any
foreign countries and this Prospectus does not constitute an offer to sell Units
in any country where Units cannot lawfully be sold. Sales to dealers and to
introducing dealers, if any, will initially be made at prices which represent a
concession from the Public Offering Price, but the Agent for the Sponsors
reserves the right to change the rate of any concession from time to time. Any
dealer or introducing dealer may reallow a concession up to the concession to
dealers.
UNDERWRITERS' AND SPONSORS' PROFITS
Upon sale of the Units, the Underwriters will be entitled to receive sales
charges. The Sponsors also realize a profit or loss on deposit of the Bonds
equal to the difference between the cost of the Bonds to the Fund (based on the
offer side evaluation on the initial date of deposit) and the Sponsors' cost of
the Bonds. In addition, a Sponsor or Underwriter may realize profits or sustain
losses on Bonds it deposits in the Fund which were acquired from underwriting
syndicates of which it was a member. During the initial offering period, the
Underwriting Account also may realize profits or sustain losses as a result of
fluctuations after the initial date of deposit in the Public Offering Price of
the Units. In maintaining a secondary market for Units, the Sponsors will also
realize profits or sustain losses in the amount of any difference between the
prices at which they buy Units and the prices at which they resell these Units
(which include the sales charge) or the prices at which they redeem the Units.
Cash, if any,
13
<PAGE>
made available by buyers of Units to the Sponsors prior to a settlement date for
the purchase of Units may be used in the Sponsors' businesses to the extent
permitted by Rule 15c3-3 under the Securities Exchange Act of 1934 and may be of
benefit to the Sponsors.
FUND PERFORMANCE
Information on the performance of the Fund for various periods, on the
basis of changes in Unit price plus the amount of income and principal
distributions reinvested, may be included from time to time in advertisements,
sales literature, reports and other information furnished to current or
prospective investors. Total return figures are not averaged, and may not
reflect deduction of the sales charge, which would decrease the return. Average
annualized return figures reflect deduction of the maximum sales charge. No
provision is made for any income taxes payable.
Past performance may not be indicative of future results. The Fund is not
actively managed. Unit price and return fluctuate with the value of the Bonds in
the Portfolio, so there may be a gain or loss when Units are sold.
Fund performance may be compared to performance on the same basis (with
distributions reinvested) of Moody's Municipal Bond Averages or performance data
from publications such as Lipper Analytical Services, Inc., Morningstar
Publications, Inc., Money Magazine, The New York Times, U.S. News and World
Report, Barron's Business Week, CDA Investment Technology, Inc., Forbes Magazine
or Fortune Magazine. As with other performance data, performance comparisons
should not be considered representative of the Fund's relative performance for
any future period.
DEFINED ASSET FUNDS
Municipal Investment Trust Funds have provided investors with tax-free
income for more than 30 years. For decades informed investors have purchased
unit investment trusts for dependability and professional selection of
investments. Defined Asset Funds' philosophy is to allow investors to 'buy with
knowledge' (because, unlike managed funds, the portfolio of municipal bonds and
the return are relatively fixed) and 'hold with confidence' (because the
portfolio is professionally selected and regularly reviewed). Defined Asset
Funds offers an array of simple and convenient investment choices, suited to fit
a wide variety of personal financial goals--a buy and hold strategy for capital
accumulation, such as for children's education or retirement, or attractive,
regular current income consistent with the preservation of principal. Tax-exempt
income can help investors keep more today for a more secure financial future. It
can also be important in planning because tax brackets may increase with higher
earnings or changes in tax laws. Unit investment trusts are particularly suited
for the many investors who prefer to seek long-term income by purchasing sound
investments and holding them, rather than through active trading. Few
individuals have the knowledge, resources or capital to buy and hold a
diversified portfolio on their own; it would generally take a considerable sum
of money to obtain the breadth and diversity that Defined Asset Funds offer.
One's investment objectives may call for a combination of Defined Asset Funds.
One of the most important investment decisions you face may be how to
allocate your investments among asset classes. Diversification among different
kinds of investments can balance the risks and rewards of each one. Most
investment experts recommend stocks for long-term capital growth. Long-term
corporate bonds offer relatively high rates of interest income. By purchasing
both defined equity and defined bond funds, investors can receive attractive
current income, as well as growth potential, offering some protection against
inflation. From time to time various advertisements, sales literature, reports
and other information furnished to current or prospective investors may present
the average annual compounded rate of return of selected asset classes over
various periods of time, compared to the rate of inflation over the same
periods.
EXCHANGE OPTION--MUNICIPAL INVESTMENT TRUST FUND ONLY.
You may exchange Fund Units for units of certain other Defined Asset Funds
subject only to a reduced sales charge. You may exchange your units of any
Select Ten Portfolio, of any other Defined Asset Fund with a regular maximum
sales charge of at least 3.50%, or of any unaffiliated unit trust with a regular
maximum sales charge of at least 3.0%, for Units of this Fund at their relative
net asset values, subject only to a reduced sales charge, or to any remaining
Deferred Sales Charge, as applicable.
To make an exchange, you should contact your financial professional to find
out what suitable Exchange Funds are available and to obtain a prospectus. You
may acquire units of only those Exchange Funds in which the Sponsors are
maintaining a secondary market and which are lawfully for sale in the state
where you reside. Except for the reduced sales charge, an exchange is a taxable
event normally requiring recognition of any gain or loss on the units exchanged.
However, the Internal Revenue Service may seek to disallow a loss if the
portfolio of the
14
<PAGE>
units acquired is not materially different from the portfolio of the units
exchanged; you should consult your own tax advisor. If the proceeds of units
exchanged are insufficient to acquire a whole number of Exchange Fund units, you
may pay the difference in cash (not exceeding the price of a single unit
acquired).
As the Sponsors are not obligated to maintain a secondary market in any
series, there can be no assurance that units of a desired series will be
available for exchange. The Exchange Option may be amended or terminated at any
time without notice.
SUPPLEMENTAL INFORMATION
Upon written or telephonic request to the Trustee shown in Part A of this
Prospectus, investors will receive at no cost to the investor supplemental
information about the Fund, which has been filed with the SEC and is hereby
incorporated by reference. The supplemental information includes more detailed
risk factor disclosure about the types of Bonds that may be part of the Fund's
Portfolio, general risk disclosure concerning any letters of credit or insurance
securing certain Bonds, and general information about the structure and
operation of the Fund.
15
<PAGE>
APPENDIX A
DESCRIPTION OF RATINGS (AS DESCRIBED BY THE RATING COMPANIES THEMSELVES)
STANDARD & POOR'S RATINGS GROUP, A DIVISION OF MCGRAW-HILL, INC.
AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's.
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 highest 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.
BB, B, CCC, CC--Debt rated BB, B, CCC and CC 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. BB indicates the
lowest degree of speculation and CC the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major risk exposures to adverse
conditions.
The ratings may be modified by the addition of a plus or minus sign to show
relative standing within the major rating categories.
A provisional rating, indicated by 'p' following a rating, assumes the
successful completion of the project being financed by the issuance of the debt
being rated and indicates that payment of debt service requirements is largely
or entirely dependent upon the successful and timely completion of the project.
This rating, however, while addressing credit quality subsequent to completion
of the project, makes no comment on the likelihood of, or the risk of default
upon failure of, such completion.
NR--Indicates that no rating has been requested, that there is insufficient
information on which to base a rating or that Standard & Poor's does not rate a
particular type of obligation as a matter of policy.
MOODY'S INVESTORS SERVICE, INC.
Aaa--Bonds which are rated Aaa are judged to be the best quality. They
carry the smallest degree of investment risk and are generally referred to as
'gilt edge'. 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 risks 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 sometime 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 over the future. Uncertainty of
position characterizes bonds in this class.
a-1
<PAGE>
B--Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Rating symbols may include numerical modifiers 1, 2 or 3. The numerical
modifier 1 indicates that the security ranks at the high end, 2 in the
mid-range, and 3 nearer the low end, of the generic category. These modifiers of
rating symbols give investors a more precise indication of relative debt quality
in each of the historically defined categories.
Conditional ratings, indicated by 'Con.', are sometimes given when the
security for the bond depends upon the completion of some act or the fulfillment
of some condition. Such bonds are given a conditional rating that denotes their
probable credit stature upon completion of that act or fulfillment of that
condition.
NR--Should no rating be assigned, the reason may be one of the following:
(a) an application for rating was not received or accepted; (b) the issue or
issuer belongs to a group of securities that are not rated as a matter of
policy; (c) there is a lack of essential data pertaining to the issue or issuer
or (d) the issue was privately placed, in which case the rating is not published
in Moody's publications.
FITCH INVESTORS SERVICE, INC.
AAA--These bonds are considered to be investment grade and of the highest
quality. The obligor has an extraordinary ability to pay interest and repay
principal, which is unlikely to be affected by reasonably foreseeable events.
AA--These bonds are considered to be investment grade and of high quality.
The obligor's ability to pay interest and repay principal, while very strong, is
somewhat less than for AAA rated securities or more subject to possible change
over the term of the issue.
A--These bonds are considered to be investment grade and of good quality.
The obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB--These bonds are considered to be investment grade and of satisfactory
quality. The obligor's ability to pay interest and repay principal is considered
to be adequate. Adverse changes in economic conditions and circumstances,
however are more likely to weaken this ability than bonds with higher ratings.
A '+' or a '-' sign after a rating symbol indicates relative standing in
its rating.
DUFF & PHELPS CREDIT RATING CO.
AAA--Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
AA--High credit quality. Protection factors are strong. Risk is modest but
may vary slightly from time to time because of economic condtions.
A--Protection factors are average but adequate. However, risk factors are
more variable and greater in periods of economic stress.
A '+' or a '-' sign after a rating symbol indicates relative standing in
its rating.
a-2
<PAGE>
APPENDIX B
SALES CHARGE SCHEDULES FOR DEFINED ASSET FUNDS, MUNICIPAL SERIES
DEFERRED AND UP-FRONT SALES CHARGES. Units purchased during the first year
of the Fund will be subject to periodic deferred and contingent deferred sales
charges. Units purchased in the second through fifth year will be subject to an
up-front sales charge as well as periodic deferred and contingent deferred sales
charges. Units purchased thereafter will be subject only to an up-front sales
charge. During the first five years of the Fund, a fixed periodic deferred sales
charge of $2.75 per Unit is payable on 20 quarterly payment dates occurring on
the 10th day of February, May, August and November, commencing no earlier than
45 days after the initial date of deposit. Investors purchasing Units on the
initial date of deposit and holding for at least five years, for example, would
incur total periodic deferred sales charges of $55.00 per Unit. Because of the
time value of money, however, as of the initial date of deposit this periodic
deferred sales charge obligation would, at current interest rates, equate to an
up-front sales charge of approximately 4.75%.
On the Fund's initial offering date, the Public Offering Price per Unit
will be $1,000. Subsequently, the Public Offering Price per Unit will fluctuate.
As the periodic deferred sales charge is a fixed dollar amount irrespective of
the Public Offering Price, it will represent a varying percentage of the Public
Offering Price. An up-front sales charge will be imposed on all unit purchases
after the first year of the Fund. The following table illustrates the combined
maximum up-front and periodic deferred sales charges that would be incurred by
an investor who purchases Units at the beginning of each of the first five years
of the Fund (based on a constant Unit price) and holds them through the fifth
year of the Fund:
</TABLE>
<TABLE><CAPTION>
TOTAL
UP-FRONT SALES CHARGE MAXIMUM UP-FRONT AND PERIODIC
----------------------------------------------------------- AMOUNT DEFERRED SALES
YEAR OF UNIT AS PERCENT OF PUBLIC AS PERCENT OF NET AMOUNT PER DEFERRED PER CHARGES
PURCHASE OFFERING PRICE AMOUNT INVESTED $1,000 INVESTED $1,000 INVESTED PER $1,000 INVESTED
------------------- --------------------- ------------------- --------------- --------------- ---------------------
<S> <C> <C> <C> <C> <C>
1 None None None $ 55.00 $ 55.00
2 1.10% 1.11% $ 11.00 44.00 55.00
3 2.20 2.25 22.00 33.00 55.00
4 3.30 3.41 33.00 22.00 55.00
5 4.40 4.60 44.00 11.00 55.00
</TABLE>
CONTINGENT DEFERRED SALES CHARGE. Units redeemed or repurchased within 4
years after the Fund's initial date of deposit will not only incur the periodic
deferred sales charge until the quarter of redemption or repurchase but will
also be subject to a contingent deferred sales charge:
YEAR SINCE FUND'S
INITIAL DATE OF CONTINGENT DEFERRED
DEPOSIT SALES CHARGE PER UNIT
--------------------- ---------------------
1 $ 25.00
2 15.00
3 10.00
4 5.00
5 and thereafter None
The contingent deferred sales charge is waived on any redemption or
repurchase of Units after the death (including the death of a single joint
tenant with rights of survivorship) or disability (as defined in the Internal
Revenue Code) of an investor, provided the redemption or repurchase is requested
within one year of the death or initial determination of disability. The
Sponsors may require receipt of satisfactory proof of disability before
releasing the portion of the proceeds representing the amount of the contingent
deferred sales charge waived.
To assist investors in understanding the total costs of purchasing units
during the first four years of the Fund and disposing of those units by the
fifth year, the following tables set forth the maximum combined up-front,
periodic and contingent deferred sales charges that would be incurred (assuming
a constant Unit price) by an investor:
<TABLE><CAPTION>
UNITS PURCHASED ON INITIAL OFFERING DATE
YEAR OF UNIT DEFERRED SALES CONTINGENT DEFERRED
DISPOSITION UP-FRONT SALES CHARGE CHARGE SALES CHARGE TOTAL SALES CHARGES
------------------- --------------------- ----------------- ------------------- -------------------
<S> <C> <C> <C> <C>
1 None $ 11.00 $ 25.00 $ 36.00
2 None 22.00 15.00 37.00
3 None 33.00 10.00 43.00
4 None 44.00 5.00 49.00
5 None 55.00 0.00 55.00
b-1
<PAGE>
<CAPTION>
UNITS PURCHASED ON FIRST ANNIVERSARY OF FUND
YEAR OF UNIT DEFERRED SALES CONTINGENT DEFERRED
DISPOSITION UP-FRONT SALES CHARGE CHARGE SALES CHARGE TOTAL SALES CHARGES
------------------- --------------------- ----------------- ------------------- -------------------
<S> <C> <C> <C> <C>
2 $ 11.00 $ 11.00 $ 15.00 $ 37.00
3 11.00 22.00 10.00 43.00
4 11.00 33.00 5.00 49.00
5 11.00 44.00 0.00 55.00
<CAPTION>
UNITS PURCHASED ON SECOND ANNIVERSARY OF FUND
YEAR OF UNIT DEFERRED SALES CONTINGENT DEFERRED
DISPOSITION UP-FRONT SALES CHARGE CHARGE SALES CHARGE TOTAL SALES CHARGES
------------------- --------------------- ----------------- ------------------- -------------------
<S> <C> <C> <C> <C>
3 $ 22.00 $ 11.00 $ 10.00 $ 43.00
4 22.00 22.00 5.00 49.00
5 22.00 33.00 0.00 55.00
<CAPTION>
UNITS PURCHASED ON THIRD ANNIVERSARY OF FUND
YEAR OF UNIT DEFERRED SALES CONTINGENT DEFERRED
DISPOSITION UP-FRONT SALES CHARGE CHARGE SALES CHARGE TOTAL SALES CHARGES
------------------- --------------------- ----------------- ------------------- -------------------
<S> <C> <C> <C> <C>
4 $ 33.00 $ 11.00 $ 5.00 $ 49.00
5 33.00 22.00 0.00 55.00
<CAPTION>
UNITS PURCHASED ON FOURTH ANNIVERSARY OF FUND
YEAR OF UNIT DEFERRED SALES CONTINGENT DEFERRED
DISPOSITION UP-FRONT SALES CHARGE CHARGE SALES CHARGE TOTAL SALES CHARGES
------------------- --------------------- ----------------- ------------------- -------------------
<S> <C> <C> <C> <C>
5 $ 44.00 $ 11.00 $ 0.00 $ 55.00
</TABLE>
b-2
<PAGE>
APPENDIX C
SALES CHARGE SCHEDULES FOR MUNICIPAL INVESTMENT TRUST FUND
INITIAL OFFERING
<TABLE><CAPTION>
SALES CHARGE
(GROSS UNDERWRITING PROFIT)
----------------------------------
AS PERCENT OF AS PERCENT OF DEALER CONCESSION AS PRIMARY MARKET
OFFER SIDE PUBLIC NET AMOUNT PERCENT OF PUBLIC CONCESSION TO
NUMBER OF UNITS OFFERING PRICE INVESTED OFFERING PRICE INTRODUCING DEALERS
----------------------------------- ------------------- ------------- --------------------- -------------------
MONTHLY PAYMENT SERIES, MULTISTATE SERIES, INSURED SERIES
<S> <C> <C> <C> <C>
Less than 250...................... 4.50% 4.712% 2.925% $ 32.40
250 - 499.......................... 3.50 3.627 2.275 25.20
500 - 749.......................... 3.00 3.093 1.950 21.60
750 - 999.......................... 2.50 2.564 1.625 18.00
1,000 or more...................... 2.00 2.041 1.300 14.40
<CAPTION>
INTERMEDIATE SERIES (TEN YEAR MATURITIES)
<S> <C> <C> <C> <C>
Less than 250...................... 4.00% 4.167% 2.600% $ 28.80
250 - 499.......................... 3.00 3.093 1.950 21.60
500 - 749.......................... 2.50 2.564 1.625 18.00
750 - 999.......................... 2.00 2.041 1.300 14.40
1,000 or more...................... 1.50 1.523 0.975 10.00
<CAPTION>
INTERMEDIATE SERIES (SHORT INTERMEDIATE MATURITIES)
<S> <C> <C> <C> <C>
Less than 250...................... 2.75% 2.828% 1.788% $ 19.80
250 - 499.......................... 2.25 2.302 1.463 16.20
500 - 749.......................... 1.75 1.781 1.138 12.60
750 - 999.......................... 1.25 1.266 0.813 9.00
1,000 or more...................... 1.00 1.010 0.650 7.20
</TABLE>
SECONDARY MARKET
ACTUAL SALES CHARGE AS DEALER CONCESSION AS
PERCENT OF EFFECTIVE PERCENT OF EFFECTIVE
NUMBER OF UNITS SALES CHARGE SALES CHARGE
----------------- ------------------------- -------------------------
1-249 100% 65%
250-499 80 52
500-749 60 39
750-999 45 29.25
1,000 or more 35 22.75
EFFECTIVE SALES CHARGE
AS PERCENT AS PERCENT
TIME TO OF BID SIDE OF PUBLIC
MATURITY EVALUATION OFFERING PRICE
---------------------------- ------------- -----------------
Less than six months 0% 0%
Six months to 1 year 0.756 0.75
Over 1 year to 2 years 1.523 1.50
Over 2 years to 4 years 2.564 2.50
Over 4 years to 8 years 3.627 3.50
Over 8 years to 15 years 4.712 4.50
Over 15 years 5.820 5.50
For this purpose, a Bond will be considered to mature on its stated
maturity date unless it has been called for redemption or funds or securities
have been placed in escrow to redeem it on an earlier date, or is subject to a
mandatory tender, in which case the earlier date will be considered the maturity
date.
c-1
<PAGE>
DEFINED
ASSET FUNDSSM
SPONSORS: MUNICIPAL INVESTMENT
Merrill Lynch, TRUST FUND
Pierce, Fenner & Smith Incorporated Monthly Payment Series--506
Defined Asset Funds (A Unit Investment Trust)
P.O. Box 9051 PROSPECTUS PART A
Princeton, N.J. 08543-9051 This consists of a Part A and a Part B.
(609) 282-8500 The Prospectus does not contain all of
Smith Barney Inc. the information with respect to the
Unit Trust Department investment company set forth in its
388 Greenwich Street--23rd Floor registration statement and exhibits
New York, NY 10013 relating thereto which have been filed
1-800-223-2532 with the Securities and Exchange
Prudential Securities Incorporated Commission, Washington, D.C. under the
One Seaport Plaza Securities Act of 1933 and the
199 Water Street Investment Company Act of 1940, and to
New York, N.Y. 10292 which reference is hereby made.
(212) 776-1000 No person is authorized to give any
Dean Witter Reynolds Inc. information or to make any
Two World Trade Center--59th Floor representations with respect to this
New York, N.Y. 10048 investment company not contained in this
(212) 392-2222 Prospectus; and any information or
EVALUATOR: representation not contained herein must
Kenny S&P Evaluation Services, not be relied upon as having been
a division of J. J. Kenny Co., Inc. authorized. This Prospectus does not
65 Broadway constitute an offer to sell, or a
New York, N.Y. 10006 solicitation of an offer to buy,
INDEPENDENT ACCOUNTANTS: securities in any state to any person to
Deloitte & Touche LLP whom it is not lawful to make such offer
2 World Financial Center in such state.
9th Floor
New York, N.Y. 10281-1414
TRUSTEE:
The Bank of New York
Unit Investment Trust Department
P.O. Box 974
Wall Street Station
New York, N.Y. 10268-0974
1-800-221-7771
11459--3/95
<PAGE>
DEFINED ASSET FUNDS--
MUNICIPAL INVESTMENT TRUST FUND
CONTENTS OF REGISTRATION STATEMENT
This Post-Effective Amendment to the Registration Statement on Form S-6
comprises the following papers and documents:
The facing sheet of Form S-6.
The cross-reference sheet (incorporated by reference to the Cross-Reference
Sheet to Defined Asset Funds Municipal Insured Series, 1933 Act File No.
33-54565).
The Prospectus.
The Signatures.
The following exhibits:
1.1.1--Form of Standard Terms and Conditions of Trust Effective as of
October 21, 1993 (incorporated by reference to Exhibit 1.1.1 to the
Registration Statement of Municipal Investment Trust Fund, Multi-
state Series--48, 1933 Act File No. 33-50247).
4.1 --Consent of the Evaluator.
5.1 --Consent of independent accountants.
9.1 --Information Supplement.
R-1
<PAGE>
DEFINED ASSET FUNDS--
MUNICIPAL INVESTMENT TRUST FUND
MONTHLY PAYMENT SERIES--506
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT,
DEFINED ASSET FUNDS--MUNICIPAL INVESTMENT TRUST FUND, MONTHLY PAYMENT
SERIES--506, CERTIFIES THAT IT MEETS ALL OF THE REQUIREMENTS FOR EFFECTIVENESS
OF THIS REGISTRATION STATEMENT PURSUANT TO RULE 485(B) UNDER THE SECURITIES ACT
OF 1933 AND HAS DULY CAUSED THIS REGISTRATION STATEMENT OR AMENDMENT TO THE
REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED THEREUNTO
DULY AUTHORIZED IN THE CITY OF NEW YORK AND STATE OF NEW YORK ON THE 14TH DAY OF
MARCH, 1995.
SIGNATURES APPEAR ON PAGES R-3, R-4, R-5 AND R-6.
A majority of the members of the Board of Directors of Merrill Lynch,
Pierce, Fenner & Smith Incorporated has signed this Registration Statement or
Amendment to the Registration Statement pursuant to Powers of Attorney
authorizing the person signing this Registration Statement or Amendment to the
Registration Statement to do so on behalf of such members.
A majority of the members of the Board of Directors of Smith Barney Inc.
has signed this Registration Statement or Amendment to the Registration
Statement pursuant to Powers of Attorney authorizing the person signing this
Registration Statement or Amendment to the Registration Statement to do so on
behalf of such members.
A majority of the members of the Board of Directors of Prudential
Securities Incorporated has signed this Registration Statement or Amendment to
the Registration Statement pursuant to Powers of Attorney authorizing the person
signing this Registration Statement or Amendment to the Registration Statement
to do so on behalf of such members.
A majority of the members of the Board of Directors of Dean Witter Reynolds
Inc. has signed this Registration Statement or Amendment to the Registration
Statement pursuant to Powers of Attorney authorizing the person signing this
Registration Statement or Amendment to the Registration Statement to do so on
behalf of such members.
R-2
<PAGE>
MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED
DEPOSITOR
By the following persons, who constitute a majority of Powers of Attorney
the Board of Directors of Merrill Lynch, Pierce, have been filed
Fenner & Smith Incorporated: under
Form SE and the
following 1933 Act
File
Number: 33-43466
and 33-51607
HERBERT M. ALLISON, JR.
BARRY S. FREIDBERG
EDWARD L. GOLDBERG
STEPHEN L. HAMMERMAN
JEROME P. KENNEY
DAVID H. KOMANSKY
DANIEL T. NAPOLI
THOMAS H. PATRICK
JOHN L. STEFFENS
DANIEL P. TULLY
ROGER M. VASEY
ARTHUR H. ZEIKEL
By
ERNEST V. FABIO
(As authorized signatory for Merrill Lynch, Pierce,
Fenner & Smith Incorporated and
Attorney-in-fact for the persons listed above)
R-3
<PAGE>
PRUDENTIAL SECURITIES INCORPORATED
DEPOSITOR
By the following persons, who constitute a majority of Powers of Attorney
the Board of Directors of Prudential Securities have been filed
Incorporated: under Form SE and
the following 1933
Act File Number:
33-41631
ARTHUR H. BURTON, JR.
JAMES T. GAHAN
ALAN D. HOGAN
HOWARD A. KNIGHT
LELAND B. PATON
HARDWICK SIMMONS
By
WILLIAM W. HUESTIS
(As authorized signatory for Prudential Securities
Incorporated and Attorney-in-fact for the persons
listed above)
R-4
<PAGE>
SMITH BARNEY INC.
DEPOSITOR
By the following persons, who constitute a majority of Powers of Attorney
the Board of Directors of Smith Barney Inc.: have been filed
under the 1933 Act
File Number:
33-49753 and
33-51607
STEVEN D. BLACK
JAMES BOSHART III
ROBERT A. CASE
JAMES DIMON
ROBERT DRUSKIN
ROBERT F. GREENHILL
JEFFREY LANE
JACK L. RIVKIN
By GINA LEMON
(As authorized signatory for
Smith Barney Inc. and
Attorney-in-fact for the persons listed above)
R-5
<PAGE>
DEAN WITTER REYNOLDS INC.
DEPOSITOR
By the following persons, who constitute Powers of Attorney have been filed
a majority of under Form SE and the following 1933
the Board of Directors of Dean Witter Act File Number: 33-17085
Reynolds Inc.:
NANCY DONOVAN
CHARLES A. FIUMEFREDDO
JAMES F. HIGGINS
STEPHEN R. MILLER
PHILIP J. PURCELL
THOMAS C. SCHNEIDER
WILLIAM B. SMITH
By
MICHAEL D. BROWNE
(As authorized signatory for
Dean Witter Reynolds Inc.
and Attorney-in-fact for the persons listed above)
R-6
EXHIBIT 4.1
KENNY S&P EVALUATION SERVICES
A Division of Kenny Information Systems, Inc.
65 BROADWAY
NEW YORK, N.Y. 10006-2511
TELEPHONE (212) 770-4000
March 14, 1995
Merrill Lynch, Pierce, Fenner & Smith
Incorporated
Unit Investment Trust Division
P.O. Box 9051
Princeton, New Jersey 08543-9051
The Bank of New York
101 Barclay Street
New York, New York 10286
RE: DEFINED ASSET FUNDS--MUNICIPAL INVESTMENT TRUST FUND,
MONTHLY PAYMENT SERIES--506
Gentlemen:
We have examined the post-effective Amendment to the Registration Statement
File No. 33-37730 for the above-captioned trust. We hereby acknowledge that
Kenny S&P Evaluation Services, a division of J. J. Kenny Co., Inc. is currently
acting as the evaluator for the trust. We hereby consent to the use in the
Amendment of the reference to Kenny S&P Evaluation Services, a division of J. J.
Kenny Co., Inc. as evaluator.
In addition, we hereby confirm that the ratings indicated in the
above-referenced Amendment to the Registration Statement for the respective
bonds comprising the trust portfolio are the ratings currently indicated in our
KENNYBASE database.
You are hereby authorized to file copies of this letter with the Securities
and Exchange Commission.
Sincerely,
FRANK A. CICCOTTO
Exhibit 5.1
CONSENT OF INDEPENDENT ACCOUNTANTS
The Sponsors and Trustee of
Defined Asset Funds--Municipal Investment Trust Fund--Monthly Payment
Series--506
We consent to the use in this Post-Effective Amendment No. 4 to Registration
Statement No. 33-37730 of our opinion dated February 9, 1995 appearing in the
Prospectus, which is part of such Registration Statement, and to the reference
to us under the heading 'Auditors' in such Prospectus.
DELOITTE & TOUCHE LLP
New York, N.Y.
March 14, 1995
DEFINED ASSET FUNDS
-------------------
INFORMATION SUPPLEMENT
This Information Supplement provides additional information concerning
the structure, operations and risks of municipal bond trusts (each, a
"Fund") of Defined Asset Funds not found in the prospectuses for the
Funds. This Information Supplement is not a prospectus and does not
include all of the information that a prospective investor should
consider before investing in a Fund. This Information Supplement should
be read in conjunction with the prospectus for the Fund in which an
investor is considering investing ("Prospectus"). Copies of the
Prospectus can be obtained by calling or writing the Trustee at the
telephone number and address indicated in Part A of the Prospectus.
This Information Supplement has been incorporated by reference into the
Prospectus.
This Information Supplement is dated March 1, 1995. Capitalized terms
have been defined in the Prospectus.
TABLE OF CONTENTS
-----------------
Description of Fund Investments
Fund Structure . . . . . . . . . . . . . . . . . . . . . . . 2
Portfolio Supervision . . . . . . . . . . . . . . . . . . . . . 2
Risk Factors . . . . . . . . . . . . . . . . . . . . . . . 4
Concentration . . . . . . . . . . . . . . . . . . . . . . . 4
General Obligation Bonds . . . . . . . . . . . . . . . . . . . 4
Moral Obligation Bonds . . . . . . . . . . . . . . . . . . . . 5
Refunded Bonds . . . . . . . . . . . . . . . . . . . . . . . 5
Industrial Development Revenue Bonds . . . . . . . . . . . . . 5
Municipal Revenue Bonds . . . . . . . . . . . . . . . . . . . . 6
Municipal Utility Bonds . . . . . . . . . . . . . . . . . . . 6
Lease Rental Bonds . . . . . . . . . . . . . . . . . . . . . 8
Housing Bonds . . . . . . . . . . . . . . . . . . . . . . . . 8
Hospital and Health Care Bonds . . . . . . . . . . . . . . . 9
Facility Revenue Bonds . . . . . . . . . . . . . . . . . . . 10
Solid Waste Disposal Bonds . . . . . . . . . . . . . . . . . 11
Special Tax Bonds . . . . . . . . . . . . . . . . . . . . . . 11
Student Loan Revenue Bonds . . . . . . . . . . . . . . . . . 12
Transit Authority Bonds . . . . . . . . . . . . . . . . . . . 12
Municipal Water and Sewer Revenue Bonds . . . . . . . . . . . 12
University and College Bonds . . . . . . . . . . . . . . . . 12
Puerto Rico . . . . . . . . . . . . . . . . . . . . . . . 13
Bonds Backed by Letters of Credit or Repurchase Commitments . . 13
Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Bonds Backed by Insurance . . . . . . . . . . . . . . . . . . . 17
State Risk Factors . . . . . . . . . . . . . . . . . . . . . . 22
Payment of Bonds and Life of a Fund . . . . . . . . . . . . . . 22
Redemption . . . . . . . . . . . . . . . . . . . . . . . 22
Tax Exemption . . . . . . . . . . . . . . . . . . . . . . . 23
Income and Returns Income . . . . . . . . . . . . . . . . . . . . 23
State Matters
The Alabama Trust . . . . . . . . . . . . . . . . . . . . . . . 25
The Arizona Trust . . . . . . . . . . . . . . . . . . . . . . . 29
The California Trust . . . . . . . . . . . . . . . . . . . . . 34
The Colorado Trust . . . . . . . . . . . . . . . . . . . . . . 46
<PAGE>
The Connecticut Trust . . . . . . . . . . . . . . . . . . . . . 50
The Florida Trust . . . . . . . . . . . . . . . . . . . . . . . 54
The Georgia Trust . . . . . . . . . . . . . . . . . . . . . . . 60
The Louisiana Trust . . . . . . . . . . . . . . . . . . . . . . 64
The Maine Trust . . . . . . . . . . . . . . . . . . . . . . . . 67
The Maryland Trust . . . . . . . . . . . . . . . . . . . . . . 71
The Massachusetts Trust . . . . . . . . . . . . . . . . . . . . 77
The Michigan Trust . . . . . . . . . . . . . . . . . . . . . . 86
The Minnesota Trust . . . . . . . . . . . . . . . . . . . . . . 90
The Mississippi Trust . . . . . . . . . . . . . . . . . . . . . 93
The Missouri Trust . . . . . . . . . . . . . . . . . . . . . . 96
The New Jersey Trust . . . . . . . . . . . . . . . . . . . . . 100
The New Mexico Trust . . . . . . . . . . . . . . . . . . . . . 104
The New York Trust . . . . . . . . . . . . . . . . . . . . . . 109
The North Carolina Trust . . . . . . . . . . . . . . . . . . . 117
The Ohio Trust . . . . . . . . . . . . . . . . . . . . . . . 123
The Oregon Trust . . . . . . . . . . . . . . . . . . . . . . . 129
The Pennsylvania Trust . . . . . . . . . . . . . . . . . . . . 137
The Tennessee Trust . . . . . . . . . . . . . . . . . . . . . . 142
The Texas Trust . . . . . . . . . . . . . . . . . . . . . . . . 145
The Virginia Trust . . . . . . . . . . . . . . . . . . . . . . 148
2
<PAGE>
DESCRIPTION OF FUND INVESTMENTS
Fund Structure
The Portfolio contains different issues of Bonds with fixed final
maturity or disposition dates. In addition up to 10% of the initial
value of the Portfolio may have consisted of units ("Other Fund Units")
of previously-issued Series of Municipal Investment Trust Fund ("Other
Funds") sponsored and underwritten by certain of the Sponsors and
acquired by the Sponsors in the secondary market. The Other Fund Units
are not bonds as such but represent interests in the securities,
primarily state, municipal and public authority bonds, in the portfolios
of the Other Funds. As used herein, the term "Debt Obligations" means
the bonds deposited in the Fund and described under Portfolio in Part A
and the term "Securities" means the Debt Obligations and any Other Fund
Units. See Investment Summary in Part A for a summary of particular
matters relating to the Portfolio.
The portfolios underlying any Other Fund Units (the units of no one
Other Fund represented more than 5%, and all Other Fund Units
represented less than 10%, of the aggregate offering side evaluation of
the Portfolio on the Date of Deposit) are substantially similar to that
of the Fund. The percentage of the Portfolio, if any, represented by
Other Fund Units on the Evaluation Date is set forth under Investment
Summary in Part A. On their respective dates of deposit, the underlying
bonds in any Other Funds were rated BBB or better by Standard & Poor's
or Baa or better by Moody's. While certain of those bonds may not
currently meet these criteria, they did not represent more than 0.5% of
the face amount of the Portfolio on the Date of Deposit. Bonds in each
Other Fund which do not mature according to their terms within 10 years
after the Date of Deposit had an aggregate bid side evaluation of at
least 40% of the initial face amount of the Other Fund. The investment
objectives of the Other Funds are similar to the investment objective of
the Fund, and the Sponsors, Trustee and Evaluator of the Other Funds
have responsibilities and authority paralleling in most important
respects those described in this Prospectus and receive similar fees.
The names of any Other Funds represented in the Portfolio and the number
of units of each Other Fund in the Fund may be obtained without charge
by writing to the Trustee.
Portfolio Supervision
Each Fund is a unit investment trust which follows a buy and hold
investment strategy. Traditional methods of investment management for
mutual funds typically involve frequent changes in fund holdings based
on economic, financial and market analyses. Because a Fund is not
actively managed, it may retain an issuer's securities despite financial
or economic developments adversely affecting the market value of the
securities held by a Fund. However, Defined Asset Funds' financial
analysts regularly review a Fund's Portfolio, and the Sponsors may
instruct a Trustee to sell securities in a Portfolio in the following
circumstances: (i) default in payment of amounts due on the security;
(ii) institution of certain legal proceedings; (iii) other legal
questions or impediments affecting the security or payments thereon;
(iv) default under certain documents adversely affecting debt service or
in payments on other securities of the same issuer or guarantor; (v)
decline in projected income pledged for debt service on a revenue bond;
(vi) if a security becomes taxable or otherwise inconsistent with a
Fund's investment objectives; (vii) a right to sell or redeem the
security pursuant to a guarantee or other credit support; or (viii)
decline in security price or other market or credit factors (including
advance refunding) that, in the opinion of Defined Asset Funds research,
makes retention of the security detrimental to the interests of Holders.
If there is a payment default on any Bond and the Agent for the Sponsors
fails to instruct the Trustee within 30 days after notice of the
default, the Trustee will sell the Bond.
A Trustee must reject any offer by an issuer of a Bond to exchange
another security pursuant to a refunding or refinancing plan unless (a)
the Bond is in default or (b) in the written opinion of Defined Asset
Funds research analysts, a default is probable in the reasonably
foreseeable future, and
3
<PAGE>
the Sponsors instruct the Trustee to accept the
offer or take any other action with respect to the offer as the Sponsors
consider appropriate.
Units offered in the secondary market may reflect redemptions or
prepayments, in whole or in part, or defaults on, certain of the Bonds
originally deposited in the Fund or the disposition of certain Bonds
originally deposited in the Fund to satisfy redemptions of Units (see
Redemption) or pursuant to the exercise by the Sponsors of their
supervisory role over the Fund (see Risk Factors -- Payment of the Bonds
and Life of the Fund). Accordingly, the face amount of Units may be
less than their original face amount at the time of the creation of the
Fund. A reduced value per Unit does not therefore mean that a Unit is
necessarily valued at a market discount; market discounts, as well as
market premiums, on Units are determined solely by a comparison of a
Unit's outstanding face amount and its evaluated price.
The Portfolio may contain debt obligations rated BBB by Standard &
Poor's and Baa by Moody's, which are the lowest "investment grade"
ratings assigned by the two rating agencies or debt obligations rated
below investment grade. The Portfolio may also contain debt obligations
that have received investment grade ratings from one agency but "junk
Bond" ratings from the other agency. In addition, the Portfolio may
contain debt obligations which are not rated by either agency but have
in the opinion of Merrill Lynch, Pierce, Fenner & Smith Incorporated, as
Agent for the Sponsors, comparable credit characteristics to debt
obligations rated near or below investment grade. Investors should
therefore be aware that these debt obligations may have speculative
characteristics and that changes in economic conditions or other
circumstances are more likely to lead to a weakened capacity to make
principal and interest payments on these debt obligations than is the
case with higher rated bonds. Moreover, conditions may develop with
respect to any of the issuers of debt obligations in the Portfolio which
may cause the rating agencies to lower their ratings below investment
grade on a given security or cause the Agent for the Sponsors to
determine that the credit characteristics of a given security are
comparable to debt obligations rated below investment grade. As a
result of timing lags or a lack of current information, there can be no
assurance that the rating currently assigned to a given debt obligation
by either agency or the credit assessment of the Agent for the Sponsors
actually reflects all current information about the issuer of that debt
obligation.
Subsequent to the Date of Deposit, a Debt Obligation or other
obligations of the issuer or guarantor or bank or other entity issuing a
letter of credit related thereto may cease to be rated, its rating may
be reduced or the credit assessment of the Agent for the Sponsors may
change. Because of the fixed nature of the Portfolio, none of these
events require an elimination of that Debt Obligation from the
Portfolio, but the lowered rating or changed credit assessment may be
considered in the Sponsors' determination to direct the disposal of the
Debt Obligation (see Administration of the Fund -- Portfolio
Supervision).
Because ratings may be lowered or the credit assessment of the Agent
for the Sponsors may change, an investment in Units of the Trust should
be made with an understanding of the risks of investing in "junk bonds"
(bonds rated below investment grade or unrated bonds having similar
credit characteristics), including increased risk of loss of principal
and interest on the underlying debt obligations and the risk that the
value of the Units may decline with increases in interest rates. In
recent years there have been wide fluctuations in interest rates and
thus in the value of fixed-rate debt obligations generally. Debt
obligations which are rated below investment grade or unrated debt
obligations having similar credit characteristics are often subject to
greater market fluctuations and risk of loss of income and principal
than securities rated investment grade, and their value may decline
precipitously in response to rising interest rates. This effect is so
not only because increased interest rates generally lead to decreased
values for fixed-rate instruments, but also because increased interest
rates may indicate a slowdown in the economy generally, which could
result in defaults by less creditworthy issuers. Because investors
generally perceive that there are greater risks associated with lower-
rated securities, the yields and prices of these securities tend to
fluctuate more than higher-rated
4
<PAGE>
securities with changes in the
perceived credit quality of their issuers, whether these changes are
short-term or structural, and during periods of economic uncertainty.
Moreover, issuers whose obligations have been recently downgraded may be
subject to claims by debtholders and suppliers which, if sustained,
would make it more difficult for these issuers to meet payment
obligations.
Debt rated below investment grade or having similar credit
characteristics also tends to be more thinly traded than investment-
grade debt and held primarily by institutions, and this lack of
liquidity can negatively affect the value of the debt. Debt which is
not rated investment grade or having similar credit characteristics may
be subordinated to other obligations of the issuer. Senior debtholders
would be entitled to receive payment in full before subordinated
debtholders receive any payment at all in the event of a bankruptcy or
reorganization. Lower rated debt obligations and debt obligations
having similar credit characteristics may also present payment-
expectation risks. For example, these bonds may contain call or
redemption provisions that would make it attractive for the issuers to
redeem them in periods of declining interest rates, and investors would
therefore not be able to take advantage of the higher yield offered.
The value of Units reflects the value of the underlying debt
obligations, including the value (if any) of any issues which are in
default. In the event of a default in payment of principal or interest,
the Trust may incur additional expenses in seeking payment under the
defaulted debt obligations. Because amounts recovered (if any) in
respect of a defaulted debt obligation may not be reflected in the value
of Units until actually received by the Trust, it is possible that a
Holder who sells Units would bear a portion of the expenses without
receiving a portion of the payments received. It is possible that new
laws could be enacted which could hurt the market for bonds which are
not rated investment grade. For example, federally regulated financial
institutions could be required to divest their holdings of these bonds,
or proposals could be enacted which might limit the use, or tax or other
advantages, of these bonds.
RISK FACTORS
Concentration
A Portfolio may contain or be concentrated in one or more of the types
of Bonds discussed below. An investment in a Fund should be made with
an understanding of the risks that these bonds may entail, certain of
which are described below. Political restrictions on the ability to tax
and budgetary constraints affecting the state or local government may
result in reductions of, or delays in the payment of, state aid to
cities, counties, school districts and other local units of government
which, in turn, may strain the financial operations and have an adverse
impact on the creditworthiness of these entities. State agencies,
colleges and universities and health care organizations, with municipal
debt outstanding, may also be negatively impacted by reductions in state
appropriations.
General Obligation Bonds
General obligation bonds are backed by the issuer's pledge of its full
faith and credit and are secured by its taxing power for the payment of
principal and interest. However, the taxing power of any governmental
entity may be limited by provisions of state constitutions or laws and
an entity's credit will depend on many factors, including an erosion of
the tax base due to population declines, natural disasters, declines in
the state's industrial base or inability to attract new industries,
economic limits on the ability to tax without eroding the tax base and
the extent to which the entity relies on Federal or state aid, access to
capital markets or other factors beyond the entity's control.
Over time, many state and local governments may confront deficits due
to economic or other factors. In addition, a Portfolio may contain
obligations of issuers who rely in whole or in part on ad
<PAGE>
valorem real
property taxes as a source of revenue. Certain proposals, in the form
of state legislative proposals or voter initiatives, to limit ad valorem
real property taxes have been introduced in various states, and an
amendment to the constitution of the State of California, providing for
strict limitations on ad valorem real property taxes, has had a
significant impact on the taxing powers of local governments and on the
financial condition of school districts and local governments in
California. It is not possible at this time to predict the final impact
of such measures, or of similar future legislative or constitutional
measures, on school districts and local governments or on their
abilities to make future payments on their outstanding bonds.
Moral Obligation Bonds
The repayment of a "moral obligation" bond is only a moral commitment,
and not a legal obligation, of the state or municipality in question.
Even though the state may be called on to restore any deficits in
capital reserve funds of the agencies or authorities which issued the
bonds, any restoration generally requires appropriation by the state
legislature and accordingly does not constitute a legally enforceable
obligation or debt of the state. The agencies or authorities generally
have no taxing power.
Refunded Bonds
Refunded Bonds are typically secured by direct obligations of the U.S.
Government, or in some cases obligations guaranteed by the U.S.
Government, placed in an escrow account maintained by an independent
trustee until maturity or a predetermined redemption date. These bonds
are generally noncallable prior to maturity or the predetermined
redemption date. In a few isolated instances, however, bonds which were
thought to be escrowed to maturity have been called for redemption prior
to maturity.
Industrial Development Revenue Bonds
Industrial Development Revenue Bonds, or "IDRs", including pollution
control revenue bonds, are tax-exempt bonds issued by states,
municipalities, public authorities or similar entities to finance the
cost of acquiring, constructing or improving various projects, including
pollution control facilities and certain manufacturing facilities.
These projects are usually operated by private corporations. IDRs are
not general obligations of governmental entities backed by their taxing
power. Municipal issuers are only obligated to pay amounts due on the
IDRs to the extent that funds are available from the unexpended proceeds
of the IDRs or from receipts or revenues under arrangements between the
municipal issuer and the corporate operator of the project. These
arrangements may be in the form of a lease, installment sale agreement,
conditional sale agreement or loan agreement, but in each case the
payments to the issuer are designed to be sufficient to meet the
payments of amounts due on the IDRs.
IDRs are generally issued under bond resolutions, agreements or trust
indentures pursuant to which the revenues and receipts payable to the
issuer by the corporate operator of the project have been assigned and
pledged to the holders of the IDRs or a trustee for the benefit of the
holders of the IDRs. In certain cases, a mortgage on the underlying
project has been assigned to the holders of the IDRs or a trustee as
additional security for the IDRs. In addition, IDRs are frequently
directly guaranteed by the corporate operator of the project or by an
affiliated company. Regardless of the structure, payment of IDRs is
solely dependent upon the creditworthiness of the corporate operator of
the project, corporate guarantor and credit enhancer. Corporate
operators or guarantors that are industrial companies may be affected by
many factors which may have an adverse impact on the credit quality of
the particular company or industry. These include cyclicality of
revenues and earnings, regulatory and environmental restrictions,
litigation resulting from accidents or environmentally-caused illnesses,
extensive competition (including that of low-cost foreign companies),
unfunded pension fund liabilities or off-balance sheet items, and
financial deterioration resulting from leveraged buy-outs or takeovers.
6
<PAGE>
However, certain of the IDRs in the Portfolio may be additionally
insured or secured by letters of credit issued by banks or otherwise
guaranteed or secured to cover amounts due on the IDRs in the event of a
default in payment.
Municipal Revenue Bonds
Municipal Utility Bonds. The ability of utilities to meet their
obligations under revenue bonds issued on their behalf is dependent on
various factors, including the rates they may charge their customers,
the demand for their services and the cost of providing those services.
Utilities, in particular investor-owned utilities, are subject to
extensive regulation relating to the rates which they may charge
customers. Utilities can experience regulatory, political and consumer
resistance to rate increases. Utilities engaged in long-term capital
projects are especially sensitive to regulatory lags in granting rate
increases. Any difficulty in obtaining timely and adequate rate
increases could adversely affect a utility's results of operations.
The demand for a utility's services is influenced by, among other
factors, competition, weather conditions and economic conditions.
Electric utilities, for example, have experienced increased competition
as a result of the availability of other energy sources, the effects of
conservation on the use of electricity, self-generation by industrial
customers and the generation of electricity by co-generators and other
independent power producers. Also, increased competition will result if
federal regulators determine that utilities must open their transmission
lines to competitors. Utilities which distribute natural gas also are
subject to competition from alternative fuels, including fuel oil,
propane and coal.
The utility industry is an increasing cost business making the cost of
generating electricity more expensive and heightening its sensitivity to
regulation. A utility's costs are affected by its cost of capital, the
availability and cost of fuel and other factors. There can be no
assurance that a utility will be able to pass on these increased costs
to customers through increased rates. Utilities incur substantial
capital expenditures for plant and equipment. In the future they will
also incur increasing capital and operating expenses to comply with
environmental legislation such as the Clean Air Act of 1990, and other
energy, licensing and other laws and regulations relating to, among
other things, air emissions, the quality of drinking water, waste water
discharge, solid and hazardous substance handling and disposal, and
citing and licensing of facilities. Environmental legislation and
regulations are changing rapidly and are the subject of current public
policy debate and legislative proposals. It is increasingly likely that
many utilities will be subject to more stringent environmental standards
in the future that could result in significant capital expenditures.
Future legislation and regulation could include, among other things,
regulation of so-called electromagnetic fields associated with electric
transmission and distribution lines as well as emissions of carbon
dioxide and other so-called greenhouse gases associated with the burning
of fossil fuels. Compliance with these requirements may limit a
utility's operations or require substantial investments in new equipment
and, as a result, may adversely affect a utility's results of
operations.
The electric utility industry in general is subject to various
external factors including (a) the effects of inflation upon the costs
of operation and construction, (b) substantially increased capital
outlays and longer construction periods for larger and more complex new
generating units, (c) uncertainties in predicting future load
requirements, (d) increased financing requirements coupled with limited
availability of capital, (e) exposure to cancellation and penalty
charges on new generating units under construction, (f) problems of cost
and availability of fuel, (g) compliance with rapidly changing and
complex environmental, safety and licensing requirements, (h) litigation
and proposed legislation designed to delay or prevent construction of
generating and other facilities, (i) the uncertain effects of
conservation on the use of electric energy, (j) uncertainties associated
with the development of a national energy policy, (k) regulatory,
political and consumer resistance to rate increases and (l) increased
competition as a result of the availability of other energy sources.
These factors may delay the construction and increase the cost of new
facilities, limit the use of, or necessitate costly
7
<PAGE>
modifications to,
existing facilities, impair the access of electric utilities to credit
markets, or substantially increase the cost of credit for electric
generating facilities.
The National Energy Policy Act ("NEPA"), which became law in October,
1992, makes it mandatory for a utility to permit non-utility generators
of electricity access to its transmission system for wholesale
customers, thereby increasing competition for electric utilities. NEPA
also mandated demand-side management policies to be considered by
utilities. NEPA prohibits the Federal Energy Regulatory Commission from
mandating electric utilities to engage in retail wheeling, which is
competition among suppliers of electric generation to provide
electricity to retail customers (particularly industrial retail
customers) of a utility. However, under NEPA, a state can mandate
retail wheeling under certain conditions. California, Michigan, New
Mexico and Ohio have instituted investigations into the possible
introduction of retail wheeling within their respective states, which
could foster competition among the utilities. Retail wheeling might
result in the issue of stranded investment (investment in assets not
being recovered in base rates), thus hampering a utility's ability to
meet its obligations.
There is concern by the public, the scientific community, and the U.S.
Congress regarding environmental damage resulting from the use of fossil
fuels. Congressional support for the increased regulation of air,
water, and soil contaminants is building and there are a number of
pending or recently enacted legislative proposals which may affect the
electric utility industry. In particular, on November 15, 1990,
legislation was signed into law that substantially revises the Clean Air
Act (the "1990 Amendments"). The 1990 Amendments seek to improve the
ambient air quality throughout the United States by the year 2000. A
main feature of the 1990 Amendments is the reduction of sulphur dioxide
and nitrogen oxide emissions caused by electric utility power plants,
particularly those fueled by coal. Under the 1990 Amendments the U.S.
Environmental Protection Agency ("EPA") must develop limits for nitrogen
oxide emissions by 1993. The sulphur dioxide reduction will be achieved
in two phases. Phase I addresses specific generating units named in the
1990 Amendments. In Phase II the total U.S. emissions will be capped at
8.9 million tons by the year 2000. The 1990 Amendments contain
provisions for allocating allowances to power plants based on historical
or calculated levels. An allowance is defined as the authorization to
emit one ton of sulphur dioxide.
The 1990 Amendments also provide for possible further regulation of
toxic air emissions from electric generating units pending the results
of several federal government studies to be presented to Congress by the
end of 1995 with respect to anticipated hazards to public health,
available corrective technologies, and mercury toxicity.
Electric utilities which own or operate nuclear power plants are
exposed to risks inherent in the nuclear industry. These risks include
exposure to new requirements resulting from extensive federal and state
regulatory oversight, public controversy, decommissioning costs, and
spent fuel and radioactive waste disposal issues. While nuclear power
construction risks are no longer of paramount concern, the emerging
issue is radioactive waste disposal. In addition, nuclear plants
typically require substantial capital additions and modifications
throughout their operating lives to meet safety, environmental,
operational and regulatory requirements and to replace and upgrade
various plant systems. The high degree of regulatory monitoring and
controls imposed on nuclear plants could cause a plant to be out of
service or on limited service for long periods. When a nuclear facility
owned by an investor-owned utility or a state or local municipality is
out of service or operating on a limited service basis, the utility
operator or its owners may be liable for the recovery of replacement
power costs. Risks of substantial liability also arise from the
operation of nuclear facilities and from the use, handling, and possible
radioactive emissions associated with nuclear fuel. Insurance may not
cover all types or amounts of loss which may be experienced in
connection with the ownership and operation of a nuclear plant and
severe financial consequences could result from a significant accident
or occurrence. The Nuclear Regulatory Commission has promulgated
regulations mandating the establishment of funded reserves to assure
financial capability for the eventual decommissioning of
8
<PAGE>
licensed
nuclear facilities. These funds are to be accrued from revenues in
amounts currently estimated to be sufficient to pay for decommissioning
costs. Since there have been very few nuclear plants decommissioned to
date, these estimates may be unrealistic.
The ability of state and local joint action power agencies to make
payments on bonds they have issued is dependent in large part on
payments made to them pursuant to power supply or similar agreements.
Courts in Washington, Oregon and Idaho have held that certain agreements
between the Washington Public Power Supply System ("WPPSS") and the
WPPSS participants are unenforceable because the participants did not
have the authority to enter into the agreements. While these decisions
are not specifically applicable to agreements entered into by public
entities in other states, they may cause a reexamination of the legal
structure and economic viability of certain projects financed by joint
action power agencies, which might exacerbate some of the problems
referred to above and possibly lead to legal proceedings questioning the
enforceability of agreements upon which payment of these bonds may
depend.
Lease Rental Bonds. Lease rental bonds are issued for the most part
by governmental authorities that have no taxing power or other means of
directly raising revenues. Rather, the authorities are financing
vehicles created solely for the construction of buildings
(administrative offices, convention centers and prisons, for example) or
the purchase of equipment (police cars and computer systems, for
example) that will be used by a state or local government (the
"lessee"). Thus, the bonds are subject to the ability and willingness
of the lessee government to meet its lease rental payments which include
debt service on the bonds. Willingness to pay may be subject to changes
in the views of citizens and government officials as to the essential
nature of the finance project. Lease rental bonds are subject, in
almost all cases, to the annual appropriation risk, i.e., the lessee
----
government is not legally obligated to budget and appropriate for the
rental payments beyond the current fiscal year. These bonds are also
subject to the risk of abatement in many states--rental obligations
cease in the event that damage, destruction or condemnation of the
project prevents its use by the lessee. (In these cases, insurance
provisions and reserve funds designed to alleviate this risk become
important credit factors). In the event of default by the lessee
government, there may be significant legal and/or practical difficulties
involved in the reletting or sale of the project. Some of these issues,
particularly those for equipment purchase, contain the so-called
"substitution safeguard", which bars the lessee government, in the event
it defaults on its rental payments, from the purchase or use of similar
equipment for a certain period of time. This safeguard is designed to
insure that the lessee government will appropriate the necessary funds
even though it is not legally obligated to do so, but its legality
remains untested in most, if not all, states.
Housing Bonds. Multi-family housing revenue bonds and single family
mortgage revenue bonds are state and local housing issues that have been
issued to provide financing for various housing projects. Multi-family
housing revenue bonds are payable primarily from the revenues derived
from mortgage loans to housing projects for low to moderate income
families. Single-family mortgage revenue bonds are issued for the
purpose of acquiring from originating financial institutions notes
secured by mortgages on residences.
Housing bonds are not general obligations of the issuer although
certain obligations may be supported to some degree by Federal, state or
local housing subsidy programs. Budgetary constraints experienced by
these programs as well as the failure by a state or local housing issuer
to satisfy the qualifications required for coverage under these programs
or any legal or administrative determinations that the coverage of these
programs is not available to a housing issuer, probably will result in a
decrease or elimination of subsidies available for payment of amounts
due on the issuer's bonds. The ability of housing issuers to make debt
service payments on their bonds will also be affected by various
economic and non-economic developments including, among other things,
the achievement and maintenance of sufficient occupancy levels and
adequate rental income in multi-family projects, the rate of default on
mortgage loans underlying single family issues and the ability of
mortgage insurers to pay
9
<PAGE>
claims, employment and income conditions
prevailing in local markets, increases in construction costs, taxes,
utility costs and other operating expenses, the managerial ability of
project managers, changes in laws and governmental regulations and
economic trends generally in the localities in which the projects are
situated. Occupancy of multi-family housing projects may also be
adversely affected by high rent levels and income limitations imposed
under Federal, state or local programs.
All single family mortgage revenue bonds and certain multi-family
housing revenue bonds are prepayable over the life of the underlying
mortgage or mortgage pool, and therefore the average life of housing
obligations cannot be determined. However, the average life of these
obligations will ordinarily be less than their stated maturities.
Single-family issues are subject to mandatory redemption in whole or in
part from prepayments on underlying mortgage loans; mortgage loans are
frequently partially or completely prepaid prior to their final stated
maturities as a result of events such as declining interest rates, sale
of the mortgaged premises, default, condemnation or casualty loss.
Multi-family issues are characterized by mandatory redemption at par
upon the occurrence of monetary defaults or breaches of covenants by the
project operator. Additionally, housing obligations are generally
subject to mandatory partial redemption at par to the extent that
proceeds from the sale of the obligations are not allocated within a
stated period (which may be within a year of the date of issue).
The tax exemption for certain housing revenue bonds depends on
qualification under Section 143 of the Internal Revenue Code of 1986, as
amended (the "Code"), in the case of single family mortgage revenue
bonds or Section 142(a)(7) of the Code or other provisions of Federal
law in the case of certain multi-family housing revenue bonds (including
Section 8 assisted bonds). These sections of the Code or other
provisions of Federal law contain certain ongoing requirements,
including requirements relating to the cost and location of the
residences financed with the proceeds of the single family mortgage
revenue bonds and the income levels of tenants of the rental projects
financed with the proceeds of the multi-family housing revenue bonds.
While the issuers of the bonds and other parties, including the
originators and servicers of the single-family mortgages and the owners
of the rental projects financed with the multi-family housing revenue
bonds, generally covenant to meet these ongoing requirements and
generally agree to institute procedures designed to ensure that these
requirements are met, there can be no assurance that these ongoing
requirements will be consistently met. The failure to meet these
requirements could cause the interest on the bonds to become taxable,
possibly retroactively from the date of issuance, thereby reducing the
value of the bonds, subjecting Holders to unanticipated tax liabilities
and possibly requiring a Trustee to sell these bonds at reduced values.
Furthermore, any failure to meet these ongoing requirements might not
constitute an event of default under the applicable mortgage or permit
the holder to accelerate payment of the bond or require the issuer to
redeem the bond. In any event, where the mortgage is insured by the
Federal Housing Administration, its consent may be required before
insurance proceeds would become payable to redeem the mortgage bonds.
Hospital and Health Care Bonds. The ability of hospitals and other
health care facilities to meet their obligations with respect to revenue
bonds issued on their behalf is dependent on various factors, including
the level of payments received from private third-party payors and
government programs and the cost of providing health care services.
A significant portion of the revenues of hospitals and other health
care facilities is derived from private third-party payors and
government programs, including the Medicare and Medicaid programs. Both
private third-party payors and government programs have undertaken cost
containment measures designed to limit payments made to health care
facilities. Furthermore, government programs are subject to statutory
and regulatory changes, retroactive rate adjustments, administrative
rulings and government funding restrictions, all of which may materially
decrease the rate of program payments for health care facilities.
Certain special revenue obligations (i.e., Medicare or Medicaid
revenues) may be payable subject to appropriations by state
legislatures. There can be no assurance that payments under
governmental programs will remain at levels comparable to present levels
or will, in the future, be
10
<PAGE>
sufficient to cover the costs allocable to
patients participating in these programs. In addition, there can be no
assurance that a particular hospital or other health care facility will
continue to meet the requirements for participation in these programs.
The costs of providing health care services are subject to increase as
a result of, among other factors, changes in medical technology and
increased labor costs. In addition, health care facility construction
and operation is subject to federal, state and local regulation relating
to the adequacy of medical care, equipment, personnel, operating
policies and procedures, rate-setting, and compliance with building
codes and environmental laws. Facilities are subject to periodic
inspection by governmental and other authorities to assure continued
compliance with the various standards necessary for licensing and
accreditation. These regulatory requirements are subject to change and,
to comply, it may be necessary for a hospital or other health care
facility to incur substantial capital expenditures or increased
operating expenses to effect changes in its facilities, equipment,
personnel and services.
Hospitals and other health care facilities are subject to claims and
legal actions by patients and others in the ordinary course of business.
Although these claims are generally covered by insurance, there can be
no assurance that a claim will not exceed the insurance coverage of a
health care facility or that insurance coverage will be available to a
facility. In addition, a substantial increase in the cost of insurance
could adversely affect the results of operations of a hospital or other
health care facility. The Clinton Administration may impose regulations
which could limit price increases for hospitals or the level of
reimbursements for third-party payors or other measures to reduce health
care costs and make health care available to more individuals, which
would reduce profits for hospitals. Some states, such as New Jersey,
have significantly changed their reimbursement systems. If a hospital
cannot adjust to the new system by reducing expenses or raising rates,
financial difficulties may arise. Also, Blue Cross has denied
reimbursement for some hospitals for services other than emergency room
services. The lost volume would reduce revenues unless replacement
patients were found.
Certain hospital bonds provide for redemption at par at any time upon
the sale by the issuer of the hospital facilities to a non-affiliated
entity, if the hospital becomes subject to ad valorem taxation, or in
various other circumstances. For example, certain hospitals may have
the right to call bonds at par if the hospital may be legally required
because of the bonds to perform procedures against specified religious
principles or to disclose information that is considered confidential or
privileged. Certain FHA-insured bonds may provide that all or a portion
of those bonds, otherwise callable at a premium, can be called at par in
certain circumstances. If a hospital defaults upon a bond, the
realization of Medicare and Medicaid receivables may be uncertain and,
if the bond is secured by the hospital facilities, legal restrictions on
the ability to foreclose upon the facilities and the limited alternative
uses to which a hospital can be put may severely reduce its collateral
value.
The Internal Revenue Service is currently engaged in a program of
intensive audits of certain large tax-exempt hospital and health care
facility organizations. Although these audits have not yet been
completed, it has been reported that the tax-exempt status of some of
these organizations may be revoked.
Facility Revenue Bonds. Facility revenue bonds are generally payable
from and secured by the revenues from the ownership and operation of
particular facilities such as airports (including airport terminals and
maintenance facilities), bridges, marine terminals, turnpikes and port
authorities. For example, the major portion of gross airport operating
income is generally derived from fees received from signatory airlines
pursuant to use agreements which consist of annual payments for airport
use, occupancy of certain terminal space, facilities, service fees,
concessions and leases. Airport operating income may therefore be
affected by the ability of the airlines to meet their obligations under
the use agreements. The air transport industry is experiencing
significant variations in earnings and traffic, due to increased
competition, excess capacity, increased aviation fuel, deregulation,
traffic constraints and other factors. As a result, several airlines are
experiencing severe financial difficulties. Several airlines
11
<PAGE>
including
America West Airlines have sought protection from their creditors under
Chapter 11 of the Bankruptcy Code. In addition, other airlines such as
Midway Airlines, Inc., Eastern Airlines, Inc. and Pan American
Corporation have been liquidated. However, Continental Airlines and
Trans World Airlines have emerged from bankruptcy. The Sponsors cannot
predict what effect these industry conditions may have on airport
revenues which are dependent for payment on the financial condition of
the airlines and their usage of the particular airport facility.
Furthermore, proposed legislation would provide the U.S. Secretary of
Transportation with the temporary authority to freeze airport fees upon
the occurrence of disputes between a particular airport facility and the
airlines utilizing that facility.
Similarly, payment on bonds related to other facilities is dependent
on revenues from the projects, such as use fees from ports, tolls on
turnpikes and bridges and rents from buildings. Therefore, payment may
be adversely affected by reduction in revenues due to these factors and
increased cost of maintenance or decreased use of a facility, lower cost
of alternative modes of transportation or scarcity of fuel and reduction
or loss of rents.
Solid Waste Disposal Bonds. Bonds issued for solid waste disposal
facilities are generally payable from dumping fees and from revenues
that may be earned by the facility on the sale of electrical energy
generated in the combustion of waste products. The ability of solid
waste disposal facilities to meet their obligations depends upon the
continued use of the facility, the successful and efficient operation of
the facility and, in the case of waste-to-energy facilities, the
continued ability of the facility to generate electricity on a
commercial basis. All of these factors may be affected by a failure of
municipalities to fully utilize the facilities, an insufficient supply
of waste for disposal due to economic or population decline, rising
construction and maintenance costs, any delays in construction of
facilities, lower-cost alternative modes of waste processing and changes
in environmental regulations. Because of the relatively short history
of this type of financing, there may be technological risks involved in
the satisfactory construction or operation of the projects exceeding
those associated with most municipal enterprise projects. Increasing
environmental regulation on the federal, state and local level has a
significant impact on waste disposal facilities. While regulation
requires more waste producers to use waste disposal facilities, it also
imposes significant costs on the facilities. These costs include
compliance with frequently changing and complex regulatory requirements,
the cost of obtaining construction and operating permits, the cost of
conforming to prescribed and changing equipment standards and required
methods of operation and, for incinerators or waste-to-energy
facilities, the cost of disposing of the waste residue that remains
after the disposal process in an environmentally safe manner. In
addition, waste disposal facilities frequently face substantial
opposition by environmental groups and officials to their location and
operation, to the possible adverse effects upon the public health and
the environment that may be caused by wastes disposed of at the
facilities and to alleged improper operating procedures. Waste disposal
facilities benefit from laws which require waste to be disposed of in a
certain manner but any relaxation of these laws could cause a decline in
demand for the facilities' services. Finally, waste-to-energy
facilities are concerned with many of the same issues facing utilities
insofar as they derive revenues from the sale of energy to local power
utilities.
Special Tax Bonds. Special tax bonds are payable from and secured by
the revenues derived by a municipality from a particular tax such as a
tax on the rental of a hotel room, on the purchase of food and
beverages, on the rental of automobiles or on the consumption of liquor.
Special tax bonds are not secured by the general tax revenues of the
municipality, and they do not represent general obligations of the
municipality. Therefore, payment on special tax bonds may be adversely
affected by a reduction in revenues realized from the underlying special
tax due to a general decline in the local economy or population or due
to a decline in the consumption, use or cost of the goods and services
that are subject to taxation. Also, should spending on the particular
goods or services that are subject to the special tax decline, the
municipality may be under no obligation to increase the rate of the
special tax to ensure that sufficient revenues are raised from the
shrinking taxable base.
12
<PAGE>
Student Loan Revenue Bonds. Student loan revenue bonds are issued by
various authorities to finance the acquisition of student loan
portfolios or to originate new student loans. These bonds are typically
secured by pledged student loans, loan repayments and funds and accounts
established under the indenture. Student loans are generally either
guaranteed by eligible guarantors under the Higher Education Act of
1965, as amended, and reinsured by the Secretary of the U.S. Department
of Education, directly insured by the federal government or financed as
part of supplemental or alternative loan programs with a state (e.g.,
----
loan repayment is not guaranteed).
Certain student loan revenue bonds may permit the issuer to enter into
an "interest rate swap agreement" with a counterparty obligating the
issuer to pay either a fixed or a floating rate on a notional principal
amount of bonds and obligating the counterparty to pay either a fixed or
a floating interest rate on the issuer's bonds. The payment obligations
of the issuer and the counterparty to each other will be netted on each
interest payment date, and only one payment will be made by one party to
the other. Although the choice of counterparty typically requires a
determination from a rating agency that any rating of the bonds will not
be adversely affected by the swap, payment on the bonds may be subject
to the additional risk of the counterparty's ability to fulfill its swap
obligation.
Transit Authority Bonds. Mass transit is generally not
self-supporting from fare revenues. Therefore, additional financial
resources must be made available to ensure operation of mass transit
systems as well as the timely payment of debt service. Often these
financial resources include Federal and state subsidies, lease rentals
paid by funds of the state or local government or a pledge of a special
tax such as a sales tax or a property tax. If fare revenues or the
additional financial resources do not increase appropriately to pay for
rising operating expenses, the ability of the issuer to adequately
service the debt may be adversely affected.
Municipal Water and Sewer Revenue Bonds. Water and sewer bonds are
generally payable from user fees. The ability of state and local water
and sewer authorities to meet their obligations may be affected by
failure of municipalities to utilize fully the facilities constructed by
these authorities, economic or population decline and resulting decline
in revenue from user charges, rising construction and maintenance costs
and delays in construction of facilities, impact of environmental
requirements, failure or inability to raise user charges in response to
increased costs, the difficulty of obtaining or discovering new supplies
of fresh water, the effect of conservation programs and the impact of
"no growth" zoning ordinances. In some cases this ability may be
affected by the continued availability of Federal and state financial
assistance and of municipal bond insurance for future bond issues.
University and College Bonds. The ability of universities and
colleges to meet their obligations is dependent upon various factors,
including the size and diversity of their sources of revenues,
enrollment, reputation, management expertise, the availability and
restrictions on the use of endowments and other funds, the quality and
maintenance costs of campus facilities, and, in the case of public
institutions, the financial condition of the relevant state or other
governmental entity and its policies with respect to education. The
institution's ability to maintain enrollment levels will depend on such
factors as tuition costs, demographic trends, geographic location,
geographic diversity and quality of the student body, quality of the
faculty and the diversity of program offerings.
Legislative or regulatory action in the future at the Federal, state
or local level may directly or indirectly affect eligibility standards
or reduce or eliminate the availability of funds for certain types of
student loans or grant programs, including student aid, research grants
and work-study programs, and may affect indirect assistance for
education.
13
<PAGE>
Puerto Rico
Various Bonds may be affected by general economic conditions in Puerto
Rico. Puerto Rico's unemployment rate remains significantly higher than
the U.S. unemployment rate. Furthermore, the Puerto Rican economy is
largely dependent for its development upon U.S. policies and programs
that are being reviewed and may be eliminated.
The Puerto Rican economy is affected by a number of Commonwealth and
Federal investment incentive programs. For example, Section 936 of the
Code provides for a credit against Federal income taxes for U.S.
companies operating on the island if certain requirements are met. The
Omnibus Budget Reconciliation Act of 1993 imposes limits on this credit,
effective for tax years beginning after 1993. In addition, from time to
time proposals are introduced in Congress which, if enacted into law,
would eliminate some or all of the benefits of Section 936. Although no
assessment can be made at this time of the precise effect of this
limitation, it is expected that the limitation of Section 936 credits
would have a negative impact on Puerto Rico's economy.
Aid for Puerto Rico's economy has traditionally depended heavily on
Federal programs, and current Federal budgetary policies suggest that an
expansion of aid to Puerto Rico is unlikely. An adverse effect on the
Puerto Rican economy could result from other U.S. policies, including a
reduction of tax benefits for distilled products, further reduction in
transfer payment programs such as food stamps, curtailment of military
spending and policies which could lead to a stronger dollar.
In a plebiscite held in November, 1993, the Puerto Rican electorate
chose to continue Puerto Rico's Commonwealth status. Previously
proposed legislation, which was not enacted, would have preserved the
federal tax exempt status of the outstanding debts of Puerto Rico and
its public corporations regardless of the outcome of the referendum, to
the extent that similar obligations issued by states are so treated and
subject to the provisions of the Code currently in effect. There can be
no assurance that any pending or future legislation finally enacted will
include the same or similar protection against loss of tax exemption.
The November 1993 plebiscite can be expected to have both direct and
indirect consequences on such matters as the basic characteristics of
future Puerto Rico debt obligations, the markets for these obligations,
and the types, levels and quality of revenue sources pledged for the
payment of existing and future debt obligations. The possible
consequences include legislative proposals seeking restoration of the
status of Section 936 benefits otherwise subject to the limitations
discussed above. However, no assessment can be made at this time of the
economic and other effects of a change in federal laws affecting Puerto
Rico as a result of the November 1993 plebiscite.
Bonds Backed by Letters of Credit or Repurchase Commitments
In the case of Bonds secured by letters of credit issued by commercial
banks or savings banks, savings and loan associations and similar
institutions ("thrifts"), the letter of credit may be drawn upon, and
the Bonds consequently redeemed, if an issuer fails to pay amounts due
on the Bonds or defaults under its reimbursement agreement with the
issuer of the letter of credit or, in certain cases, if the interest on
the Bonds is deemed to be taxable and full payment of amounts due is not
made by the issuer. The letters of credit are irrevocable obligations
of the issuing institutions, which are subject to extensive governmental
regulations which may limit both the amounts and types of loans and
other financial commitments which may be made and interest rates and
fees which may be charged.
Certain Intermediate Term and Put Series and certain other Series
contain Bonds purchased from one or more commercial banks or thrifts or
other institutions ("Sellers") which have committed under certain
circumstances specified below to repurchase the Bonds from the Fund
("Repurchase Commitments"). The Bonds in these Funds may be secured by
one or more Repurchase Commitments (see Investment Summary in Part A)
which, in turn may be backed by a letter of credit or secured by a
14
<PAGE>
security interest in collateral. A Seller may have committed to
repurchase from the Fund any Bonds sold by it, within a specified period
after receiving notice from the Trustee, to the extent necessary to
satisfy redemptions of Units despite the market-making activity of the
Sponsors (a "Liquidity Repurchase"). The required notice period may be
14 days (a "14 Day Repurchase") or, if a repurchase date is set forth
under Investment Summary in Part A, the Trustee may at any time not
later than two hours after the Evaluation Time on the repurchase date
(or if a repurchase date is not a business day, on the first business
day thereafter), deliver this notice to the Seller. Additionally, if
the Sponsors elect to remarket Units which have been received at or
before the Evaluation Time on any repurchase date (the "Tendered
Units"), a Seller may have committed to repurchase from the Fund on the
date 15 business days after that repurchase date, any Bonds sold by the
Seller to the Fund in order to satisfy any tenders for redemption by the
Sponsors made within 10 business days after the Evaluation Time. A
Seller may also have made any of the following commitments: (i) to
repurchase at any time on 14 calendar days' notice any Bonds if the
issuer thereof shall fail to make any payments of principal thereof and
premium and interest thereon (a "Default Repurchase"); (ii) to
repurchase any Bond on a fixed disposition date (a "Disposition Date")
if the Trustee elects not to sell the Bond in the open market (because a
price in excess of its Put Price (as defined under Investment Summary in
Part A) cannot be obtained) on this date (a "Disposition Repurchase"));
(iii) to repurchase at any time on 14 calendar days' notice any Bond in
the event that the interest thereon should be deemed to be taxable (a
"Tax Repurchase"); and (iv) to repurchase immediately all Bonds if the
Seller becomes or is deemed to be bankrupt or insolvent (an "Insolvency
Repurchase"). (See Investment Summary in Part A.) Any repurchase of a
Bond will be at a price no lower than its original purchase price to the
Fund, plus accrued interest to the date of repurchase, plus any further
adjustments as described under Investment Summary in Part A.
Upon the sale of a Bond by the Fund to a third party prior to its
Disposition date, any related Liquidity and Disposition Repurchase
commitments will be transferable, together with an interest in any
collateral or letter of credit backing the repurchase commitments and
the Liquidity Repurchase commitments will be exercisable by the buyer
free from the restriction that the annual repurchase right may only be
exercised to meet redemptions of Units. Any Default Repurchase, Tax
Repurchase and Insolvency Repurchase commitments also will not terminate
upon disposition of the Bond by the Fund but will be transferable,
together with an interest in the collateral or letter of credit backing
the Repurchase Commitments or both, as the case may be.
A Seller's Repurchase Commitments apply only to Bonds which it has
sold to the Fund; consequently, if a particular Seller fails to meet its
commitments, no recourse is available against any other Seller nor
against the collateral or letters of credit of any other Seller. Each
Seller's Repurchase Commitments relating to any Bond terminate (i) upon
repurchase by the Seller of the Bond, (ii) on the Disposition Date of
the Bond if its holder does not elect to have the Seller repurchase the
Bond on that date and (iii) in the event notice of redemption shall have
been given on or prior to the Disposition Date for the entire
outstanding principal amount of the Bond and that redemption or maturity
of the Bond occurs on or prior to the Disposition Date. On the
scheduled Disposition Date of a Bond the Trustee will sell that Bond in
the open market if a price in excess of the Put Price as of the
Disposition Date can be obtained.
An investment in Units of a Fund containing any of these types of
credit-supported Bonds should be made with an understanding of the
characteristics of the commercial banking and thrift industries and of
the risks which an investment in Units may entail. Banks and thrifts
are subject to extensive governmental regulations which may limit both
the amounts and types of loans and other financial commitments which may
be made and interest rates and fees which may be charged. The
profitability of these industries is largely dependent upon the
availability and cost of funds for the purpose of financing lending
operations under prevailing money market conditions. Also, general
economic conditions play an important part in the operations of this
industry and exposure to credit losses arising from possible financial
difficulties of borrowers might affect an institution's ability to
15
<PAGE>
meet
its obligations. These factors also affect bank holding companies and
other financial institutions, which may not be as highly regulated as
banks, and may be more able to expand into other non-financial and non-
traditional businesses.
In December 1991 Congress passed and the President signed into law the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")
and the Resolution Trust Corporation Refinancing, Restructuring, and
Improvement Act of 1991. Those laws imposed many new limitations on the
way in which banks, savings banks, and thrifts may conduct their
business and mandated early and aggressive regulatory intervention for
unhealthy institutions.
The thrift industry has experienced severe strains as demonstrated by
the failure of numerous savings banks and savings and loan associations.
One consequence of this was the insolvency of the deposit insurance fund
of the Federal Savings and Loan Insurance Corporation ("FSLIC"). As a
result, in 1989 Congress enacted the Financial Institutions Reform,
Recovery and Enforcement Act ("FIRREA") which significantly altered the
legal rules and regulations governing banks and thrifts. Among other
things, FIRREA abolished the FSLIC and created a new agency, the
Resolution Trust Corporation ("RTC"), investing it with certain of the
FSLIC's powers. The balance of the FSLIC's powers were transferred to
the Federal Deposit Insurance Corporation ("FDIC"). Under FIRREA, as
subsequently amended, the RTC is normally appointed as receiver or
conservator of thrifts that fail between January 1, 1989 and a date that
may occur as late as July 1, 1995 if their deposits, prior to FIRREA,
were insured by the FSLIC. The FDIC is normally appointed as receiver
or conservator for all thrifts the deposits of which, before FIRREA,
were insured by the FDIC, and those thrifts the deposits of which, prior
to FIRREA, were insured by the FSLIC that fail on or after the end of
the RTC appointment period.
In certain cases, the Sponsors have agreed that the sole recourse in
connection with any default, including insolvency, by thrifts whose
collateralized letter of credit, guarantee or Repurchase Commitments may
back any of the Debt Obligations will be to exercise available remedies
with respect to the collateral pledged by the thrift; should the
collateral be insufficient, the Fund will, therefore, be unable to
pursue any default judgment against that thrift. Certain of these
collateralized letters of credit, guarantees or Repurchase Commitments
may provide that they are to be called upon in the event the thrift
becomes or is deemed to be insolvent. Accordingly, investors should
recognize that they are subject to having the principal amount of their
investment represented by a Debt Obligation secured by a collateralized
letter of credit, guarantee or Repurchase Commitment returned prior to
the termination date of the Fund or the maturity or disposition dates of
the Debt Obligations if the thrift becomes or is deemed to be insolvent,
as well as in any of the situations outlined under Repurchase
Commitments below.
Moreover, FIRREA generally permits the FDIC or the RTC, as the case
may be, to prevent the exercise of a Seller's Insolvency Repurchase
commitment and empowers that agency to repudiate a Seller's contracts,
including a Seller's other Repurchase Commitments. FIRREA also creates
a risk that damages against the FDIC or RTC would be limited and that
investors could be left without the full protections afforded by the
Repurchase Commitments and the Collateral. Policy statements adopted by
the FDIC and the RTC concerning collateralized repurchase commitments
have partially ameliorated these risks for the Funds. According to
these policy statements, the FDIC or the RTC, as conservator or
receiver, will not assert the position that it can repudiate the
repurchase commitments without the payment of damages from the
collateral, and will instead either (i) accelerate the collateralized
repurchase commitments, in which event payment will be made under the
repurchase commitments to the extent of available collateral, or (ii)
enforce the repurchase commitments, except that any insolvency clause
would not be enforceable against the FDIC and the RTC. Should the FDIC
choose to accelerate, however, there is some question whether the
payment made would include interest on the defaulted Debt Obligations
for the period after the appointment of the receiver or conservator
through the payment date.
16
<PAGE>
The RTC has also given similar comfort with respect to collateralized
letters of credit, but the FDIC has not done so at this time.
Consequently, there can be no assurance that collateralized letters of
credit issued by thrifts for which the FDIC would be the receiver or
conservator appointed, as described three paragraphs earlier, will be
available in the event of the failure of any such thrift.
The possibility of early payment has been increased significantly by
the enactment of FDICIA, which requires federal regulators of insured
banks, savings banks and thrifts to act more quickly to address the
problems of undercapitalized institutions than previously, and specifies
in more detail the actions they must take. One requirement virtually
compels the appointment of a receiver for any institution when its ratio
of tangible equity to total assets declines to two percent. Others
force aggressive intervention in the business of an institution at even
earlier stages of deterioration. Upon appointment of a receiver, if the
FDIC or RTC pays as provided, in the policy statements and notwithstanding
the possibility that the institution might not have deteriorated to zero
book net worth (and therefore might not satisfy traditional definitions
of "insolvent"), the payment could therefore come substantially earlier than
might have been the case prior to FDICIA.
Certain letters of credit or guarantees backing Bonds may have been
issued by a foreign bank or corporation or similar entity (a "Foreign
Guarantee"). Foreign Guarantees are subject to the risk that exchange
control regulations might be adopted in the future which might affect
adversely payments to the Fund. Similarly, foreign withholding taxes
could be imposed in the future although provision is made in the
instruments governing any Foreign Guarantee that, in substance, to the
extent permitted by applicable law, additional payments will be made by
the guarantor so that the total amount paid, after deduction of any
applicable tax, will not be less than the amount then due and payable on
the Foreign Guarantee. The adoption of exchange control regulations and
other legal restrictions could have an adverse impact on the
marketability of any Bonds backed by a Foreign Guarantee.
Liquidity.
Certain of the Bonds may have been purchased by the Sponsors from
various banks and thrifts in large denominations and may not have been
issued under bond resolutions or trust indentures providing for issuance
of bonds in small denominations. These Bonds were generally directly
placed with the banks or thrifts and held in their portfolios prior to
sale to the Sponsors. There is no established secondary market for
those Bonds. The Sponsors believe that there should be a readily
available market among institutional investors for the Bonds which were
purchased from these portfolios in the event it is necessary to sell
Bonds to meet redemptions of Units (should redemptions be made despite
the market making activity of the Sponsors) in light of the following
considerations: (i) the credit characteristics of the companies
obligated to make payments on the Bonds; (ii) the fact that these Bonds
may be backed by irrevocable letters of credit or guarantees of banks or
thrifts; and (iii) the fact that banks or thrifts selling these Bonds to
the Sponsors for deposit in the Fund or the placement agent acting in
connection with their sale generally have stated their intentions,
although they are not legally obligated to do so, to remarket or to
repurchase, at the then-current bid side evaluation, any of these Bonds
proposed to be sold by the Trustee. The interest on these Bonds
received by the Fund is net of the fee for the related letter of credit
or guarantee charged by the bank or thrift issuing the letter of credit
or guarantee.
Any Bonds which were purchased from these portfolios are exempt from
the registration provisions of the Federal securities laws, and,
therefore, can be sold free of the registration requirements of the
securities laws. Because there is no established secondary market for
these Bonds, however, there is no assurance that the price realized on
sale of these Bonds will not be adversely affected. Consequently it is
more likely that the sale of these Bonds may cause a decline in the
value of Units than a sale of debt obligations for which an established
secondary market exists. In addition, in certain Intermediate Term and
Put Series and certain other Series, liquidity of the Fund is
additionally augmented by the Sellers' collateralized or letter of
credit-backed Liquidity Repurchase commitment in the event it is
necessary to sell any Bond to meet redemptions of Units. If, upon the
scheduled Disposition Date for any Bond, the Trustee elects not to sell
the Bond scheduled for
17
<PAGE>
disposition on this date in the open market
(because, for example, a price in excess of its Put Price cannot be
obtained), the Seller of the Bond is obligated to repurchase the Bond
pursuant to its collateralized or letter of credit-backed Disposition
Repurchase commitment. There can be no assurance that the prices that
can be obtained for the Bonds at any time in the open market will exceed
the Put Price of the Bonds. In addition, if any Seller should become
unable to honor its repurchase commitments and the Trustee is
consequently forced to sell the Bonds in the open market, there is no
assurance that the price realized on this sale of the Bonds would not be
adversely affected by the absence of an established secondary market for
certain of the Bonds.
In some cases, the Sponsors have entered into an arrangement with the
Trustee whereby certain of the Bonds may be transferred to a trust (a
"Participation Trust") in exchange for certificates of participation in
the Participation Trust which could be sold in order to meet redemptions
of Units. The certificates of participation would be issued in readily
marketable denominations of $5,000 each or any greater multiple thereof
and the holder thereof would be fully entitled to the repayment
protections afforded by collateral arrangements to any holder of the
underlying Bonds. These certificates would be exempt from registration
under the Securities Act of 1933 pursuant to Section 3(a)(2) thereof.
For Bonds that have been guaranteed or similarly secured by insurance
companies or other corporations or entities, the guarantee or similar
commitment may constitute a security (a "Restricted Security") that
cannot, in the opinion of counsel, be sold publicly by the Trustee
without registration under the Securities Act of 1933, as amended, or
similar provisions of law subsequently exacted. The Sponsors
nevertheless believe that, should a sale of these Bonds be necessary in
order to meet redemptions, the Trustee should be able to consummate a
sale with institutional investors. Up to 40% of the Portfolio may
initially have consisted of Bonds purchased from various banks and
thrifts and other Bonds with guarantees which may constitute Restricted
Securities.
The Fund may contain bonds purchased directly from issuers. These
Bonds are generally issued under bond resolutions or trust indentures
providing for the issuance of bonds in publicly saleable denominations
(usually $5,000), may be sold free of the registration requirements of
the Securities Act of 1933 and are otherwise structured in contemplation
of ready marketability. In addition, the Sponsors generally have
obtained letters of intention to repurchase or to use best efforts to
remarket these Debt Obligations from the issuers, the placement agents
acting in connection with their sale or the entities providing the
additional credit support, if any. These letters do not express legal
obligations; however, in the opinion of the Sponsors, these Bonds should
be readily marketable.
Bonds Backed by Insurance
Municipal bond insurance may be provided by one or more of AMBAC
Indemnity Corporation ("AMBAC"), Asset Guaranty Reinsurance Co. ("Asset
Guaranty"), Capital Guaranty Insurance Company ("CGIC"), Capital Markets
Assurance Corp. ("CAPMAC"), Connie Lee Insurance Company ("Connie Lee"),
Continental Casualty Company ("Continental"), Financial Guaranty
Insurance Company ("Financial Guaranty"), Financial Security Assurance
Inc. ("FSA"), Firemen's Insurance Company of Newark, New Jersey
("Firemen's "), Industrial Indemnity Insurance Company ("IIC"), which
operates the Health Industry Bond Insurance ("HIBI") Program or
Municipal Bond Investors Assurance Corporation ("MBIA") (collectively,
the "Insurance Companies"). The claims-paying ability of each of these
companies, unless otherwise indicated, is rated AAA by Standard & Poor's
or another acceptable national rating agency. The ratings are subject
to change at any time at the discretion of the rating agencies. In
determining whether to insure bonds, the Insurance Companies severally
apply their own standards. The cost of this insurance is borne either
by the issuers or previous owners of the bonds or by the Sponsors. The
insurance policies are non-cancellable and will continue in force so
long as the insured Bonds are outstanding and the insurers remain in
business. The insurance policies guarantee the timely payment of
principal and interest on but do not guarantee the market value of the
insured Bonds or the value of the Units. The insurance policies
generally do not provide for
18
<PAGE>
accelerated payments of principal or cover
redemptions resulting from events of taxability. If the issuer of any
insured Bond should fail to make an interest or principal payment, the
insurance policies generally provide that a Trustee or its agent will
give notice of nonpayment to the Insurance Company or its agent and
provide evidence of the Trustee's right to receive payment. The
Insurance Company is then required to disburse the amount of the failed
payment to the Trustee or its agent and is thereafter subrogated to the
Trustee's right to receive payment from the issuer.
Financial information relating to the Insurance Companies has been
obtained from publicly available information. No representation is made
as to the accuracy or adequacy of the information or as to the absence
of material adverse changes since the information was made available to
the public. Standard & Poor's has rated the Units of any Insured Fund
AAA because the Insurance Companies have insured the Bonds. The
assignment of a AAA rating is due to Standard & Poor's assessment of the
creditworthiness of the Insurance Companies and of their ability to pay
claims on their policies of insurance. In the event that Standard &
Poor's reassesses the creditworthiness of any Insurance Company which
would result in the rating of an Insured Fund being reduced, the
Sponsors are authorized to direct the Trustee to obtain other insurance.
Certain Bonds may be entitled to portfolio insurance ("Portfolio
Insurance") that guarantees the scheduled payment of the principal of
and interest on those Bonds ("Portfolio-Insured Bonds") while they are
retained in the Fund. Since the Portfolio Insurance applies to Bonds
only while they are retained in the Fund, the value of Portfolio-Insured
Bonds (and hence the value of the Units) may decline if the credit
quality of any Portfolio-Insured Bonds is reduced. Premiums for
Portfolio Insurance are payable monthly in advance by the Trustee on
behalf of the Fund.
As Portfolio-Insured Bonds are redeemed by their respective issuers or
are sold by the Trustee, the amount of the premium payable for the
Portfolio Insurance will be correspondingly reduced. Nonpayment of
premiums on any policy obtained by the Fund will not result in the
cancellation of insurance but will permit the portfolio insurer to take
action against the Trustee to recover premium payments due it. Upon the
sale of a Portfolio-Insured Bond from the Fund, the Trustee has the
right, pursuant to an irrevocable commitment obtained from the portfolio
insurer, to obtain insurance to maturity ("Permanent Insurance") on the
Bond upon the payment of a single predetermined insurance premium from
the proceeds of the sale. It is expected that the Trustee will exercise
the right to obtain Permanent Insurance only if the Fund would receive
net proceeds from the sale of the Bond (sale proceeds less the insurance
premium attributable to the Permanent Insurance) in excess of the sale
proceeds that would be received if the Bonds were sold on an uninsured
basis. The premiums for Permanent Insurance for each Portfolio-Insured
Bond will decline over the life of the Bond.
The Public Offering Price does not reflect any element of value for
Portfolio Insurance. The Evaluator will attribute a value to the
Portfolio Insurance (including the right to obtain Permanent Insurance)
for the purpose of computing the price or redemption value of Units only
if the Portfolio-Insured Bonds are in default in payment of principal or
interest or, in the opinion of the Agent for the Sponsors, in
significant risk of default. In making this determination the Agent for
the Sponsors has established as a general standard that a Portfolio-
Insured Bond which is rated less than BB by Standard & Poor's or Ba by
Moody's will be deemed in significant risk of default although the Agent
for the Sponsors retains the discretion to conclude that a Portfolio-
Insured Bond is in significant risk of default even though at the time
it has a higher rating, or not to reach that conclusion even if it has a
lower rating. The value of the insurance will be equal to the
difference between (i) the market value of the Portfolio-Insured Bond
assuming the exercise of the right to obtain Permanent Insurance (less
the insurance premium attributable to the purchase of Permanent
Insurance) and (ii) the market value of the Portfolio-Insured Bond not
covered by Permanent Insurance.
19
<PAGE>
In addition, certain Funds may contain Bonds that are insured to
maturity as well as being Portfolio-Insured Bonds.
The following are brief descriptions of the Insurance Companies. The
financial information presented for each company has been determined on
a statutory basis and is unaudited.
AMBAC is a Wisconsin-domiciled stock insurance company, regulated by
the Insurance Department of the State of Wisconsin, and licensed to do
business in various states, with admitted assets of approximately
$2,150,000,000 and policyholders' surplus of approximately $779,000,000
as of September 30, 1994. AMBAC is a wholly-owned subsidiary of AMBAC
Inc., a financial holding company which is publicly owned following a
complete divestiture by Citibank during the first quarter of 1992.
Asset Guaranty is a New York State insurance company licensed to write
financial guarantee, credit, residual value and surety insurance. Asset
Guaranty commenced operations in mid-1988 by providing reinsurance to
several major monoline insurers. The parent holding company of Asset
Guaranty, Asset Guarantee Inc. (AGI), merged with Enhance Financial
Services (EFS) in June, 1990 to form Enhance Financial Services Group
Inc. (EFSG). The two main, 100%-owned subsidiaries of EFSG, Asset
Guaranty and Enhance Reinsurance Company (ERC), share common management
and physical resources. After an initial public offering completed in
February 1992 and the sale by Merrill Lynch & Co. of its state, EFSG is
49.8%-owned by the public, 29.9% by US West Financial Services, 14.1% by
Manufacturers Life Insurance Co. and 6.2% by senior management. Both
ERC and Asset Guaranty are rated "AAA" for claims paying ability by Duff
& Phelps, and ERC is rated triple-A for claims-paying-ability for both
S&P and Moody's. Asset Guaranty received a "AA" claims-paying-ability
rating from S&P during August 1993, but remains unrated by Moody's. As
of September 30, 1994 Asset Guaranty had admitted assets of
approximately $152,000,000 and policyholders' surplus of approximately
$73,000,000.
CGIC, a monoline bond insurer headquartered in San Francisco,
California, was established in November 1986 to assume the financial
guaranty business of United States Fidelity and Guaranty Company
("USF&G"). It is a wholly-owned subsidiary of Capital Guaranty
Corporation ("CGC") whose stock is owned by: Constellation Investments,
Inc., an affiliate of Baltimore Gas & Electric, Fleet/Norstar Financial
Group, Inc., Safeco Corporation, Sibag Finance Corporation, an affiliate
of Siemens AG, USF&G, the eighth largest property/casualty company in
the U.S. as measured by net premiums written, and CGC management. As of
September 30, 1994, CGIC had total admitted assets of approximately
$293,000,000 and policyholders' surplus of approximately $166,000,000.
CAPMAC commenced operations in December 1987, as the second mono-line
financial guaranty insurance company (after FSA) organized solely to
insure non-municipal obligations. CAPMAC, a New York corporation, is a
wholly-owned subsidiary of CAPMAC Holdings, Inc. (CHI), which was sold
in 1992 by Citibank (New York State) to a group of 12 investors led by
the following: Dillon Read's Saratoga Partners II, L.P., an acquisition
fund; Caprock Management, Inc., representing Rockefeller family
interests; Citigrowth Fund, a Citicorp venture capital group; and CAPMAC
senior management and staff. These groups control approximately 70% of
the stock of CHI. CAPMAC had traditionally specialized in guaranteeing
consumer loan and trade receivable asset-backed securities. Under the
new ownership group CAPMAC intends to become involved in the municipal
bond insurance business, as well as their traditional non-municipal
business. As of September 30, 1994 CAPMAC's admitted assets were
approximately $198,000,000 and its policyholders' surplus was
approximately $139,000,000.
Connie Lee is a wholly owned subsidiary of College Construction Loan
Insurance Association ("CCLIA"), a government-sponsored enterprise
established by Congress to provide American academic institutions with
greater access to low-cost capital through credit enhancement. Connie
Lee, the
20
<PAGE>
operating insurance company, was incorporated in 1987 and began
business as a reinsurer of tax-exempt bonds of colleges, universities,
and teaching hospitals with a concentration on the hospital sector.
During the fourth quarter of 1991 Connie Lee began underwriting primary
bond insurance which will focus largely on the college and university
sector. CCLIA's founding shareholders are the U.S. Department of
Education, which owns 36% of CCLIA, and the Student Loan Marketing
Association ("Sallie Mae"), which owns 14%. The other principal owners
are: Pennsylvania Public School Employees' Retirement System,
Metropolitan Life Insurance Company, Kemper Financial Services, Johnson
family funds and trusts, Northwestern University, Rockefeller & Co.,
Inc. administered trusts and funds, and Stanford University. Connie Lee
is domiciled in the state of Wisconsin and has licenses to do business
in 47 states and the District of Columbia. As of September 30, 1994,
its total admitted assets were approximately $193,000,000 and
policyholders' surplus was approximately $106,000,000.
Continental is a wholly-owned subsidiary of CNA Financial Corp. and
was incorporated under the laws of Illinois in 1948. As of September
30, 1994, Continental had policyholders' surplus of approximately
$3,309,000,000 and admitted assets of approximately $19,220,000,000.
Continental is the lead property-casualty company of a fleet of carriers
nationally known as "CNA Insurance Companies". CNA is rated AA+ by
Standard & Poor's.
Financial Guaranty, a New York stock insurance company, is a
wholly-owned subsidiary of FGIC Corporation, which is wholly owned by
General Electric Capital Corporation. The investors in the FGIC
Corporation are not obligated to pay the debts of or the claims against
Financial Guaranty. Financial Guaranty commenced its business of
providing insurance and financial guarantees for a variety of investment
instruments in January 1984 and is currently authorized to provide
insurance in 49 states and the District of Columbia. It files reports
with state regulatory agencies and is subject to audit and review by
those authorities. As of September 30, 1994, its total admitted assets
were approximately $2,092,000,000 and its policyholders' surplus was
approximately $872,000,000.
FSA is a monoline property and casualty insurance company incorporated
in New York in 1984. It is a wholly-owned subsidiary of Financial
Security Assurance Holdings Ltd., which was acquired in December 1989 by
US West, Inc., the regional Bell Telephone Company serving the Rocky
Mountain and Pacific Northwestern states. U.S. West is currently
seeking to sell FSA. FSA is licensed to engage in the surety business
in 42 states and the District of Columbia. FSA is engaged exclusively
in the business of writing financial guaranty insurance, on both
tax-exempt and non-municipal securities. As of September 30, 1994, FSA
had policyholders' surplus of approximately $369,000,000 and total
admitted assets of approximately $776,000,000.
Firemen's, which was incorporated in New Jersey in 1855, is a wholly-
owned subsidiary of The Continental Corporation and a member of The
Continental Insurance Companies, a group of property and casualty
insurance companies the claims paying ability of which is rated AA- by
Standard & Poor's. It provides unconditional and non-cancellable
insurance on industrial development revenue bonds. As of September 30,
1994, the total admitted assets of Firemen's were approximately
$2,236,000,000 and its policyholders' surplus was approximately
$383,000,000.
IIC, which was incorporated in California in 1920, is a wholly-owned
subsidiary of Crum and Forster, Inc., a New Jersey holding company and a
wholly-owned subsidiary of Xerox Corporation. IIC is a property and
casualty insurer which, together with certain other wholly-owned
insurance subsidiaries of Crum and Forster, Inc., operates under a
Reinsurance Participation Agreement whereby all insurance written by
these companies is pooled among them. As of September 30, 1994 the
total admitted assets and policyholders' surplus of IIC on a
consolidated-statutory basis were $1,853,000,000 and $299,000,000
respectively. Standard & Poor's has rated IIC's claims-paying ability
A. Any IIC/HIBI-rated Debt Obligations in an Insured Series are
additionally insured for as long as they remain in the Fund and as long
as IIC/HIBI's rating is below AAA, in order to maintain the AAA-rating
of
21
<PAGE>
Fund Units. The cost of any additional insurance is paid by the Fund
and such insurance would expire on the sale or maturity of the Debt
Obligation.
MBIA is the principal operating subsidiary of MBIA Inc. The principal
shareholders of MBIA Inc. were originally Aetna Casualty and Surety
Company, The Fund American Companies, Inc., subsidiaries of CIGNA
Corporation and Credit Local de France, CAECL, S.A. These principal
shareholders now own approximately 13% of the outstanding common stock
of MBIA Inc. following a series of four public equity offerings over a
five-year period. As of September 30, 1994, MBIA had admitted assets of
approximately $3,314,000,000 and policyholders' surplus of approximately
$1,083,000,000.
Insurance companies are subject to regulation and supervision in the
jurisdictions in which they do business under statutes which delegate
regulatory, supervisory and administrative powers to state insurance
commissioners. This regulation, supervision and administration relate,
among other things, to: the standards of solvency which must be met and
maintained; the licensing of insurers and their agents; the nature of
and limitations on investments; deposits of securities for the benefit
of policyholders; approval of policy forms and premium rates; periodic
examinations of the affairs of insurance companies; annual and other
reports required to be filed on the financial condition of insurers or
for other purposes; and requirements regarding reserves for unearned
premiums, losses and other matters. Regulatory agencies require that
premium rates not be excessive, inadequate or unfairly discriminatory.
Insurance regulation in many states also includes "assigned risk" plans,
reinsurance facilities, and joint underwriting associations, under which
all insurers writing particular lines of insurance within the
jurisdiction must accept, for one or more of those lines, risks that are
otherwise uninsurable. A significant portion of the assets of insurance
companies is required by law to be held in reserve against potential
claims on policies and is not available to general creditors.
Although the Federal government does not regulate the business of
insurance, Federal initiatives can significantly impact the insurance
business. Current and proposed Federal measures which may significantly
affect the insurance business include pension regulation (ERISA),
controls on medical care costs, minimum standards for no-fault
automobile insurance, national health insurance, personal privacy
protection, tax law changes affecting life insurance companies or the
relative desirability of various personal investment vehicles and repeal
of the current antitrust exemption for the insurance business. (If this
exemption is eliminated, it will substantially affect the way premium
rates are set by all property-liability insurers.) In addition, the
Federal government operates in some cases as a co-insurer with the
private sector insurance companies.
Insurance companies are also affected by a variety of state and
Federal regulatory measures and judicial decisions that define and
extend the risks and benefits for which insurance is sought and
provided. These include judicial redefinitions of risk exposure in
areas such as products liability and state and Federal extension and
protection of employee benefits, including pension, workers'
compensation, and disability benefits. These developments may result in
short-term adverse effects on the profitability of various lines of
insurance. Longer-term adverse effects can often be minimized through
prompt repricing of coverages and revision of policy terms. In some
instances these developments may create new opportunities for business
growth. All insurance companies write policies and set premiums based
on actuarial assumptions about mortality, injury, the occurrence of
accidents and other insured events. These assumptions, while well
supported by past experience, necessarily do not take account of future
events. The occurrence in the future of unforeseen circumstances could
affect the financial condition of one or more insurance companies. The
insurance business is highly competitive and with the deregulation of
financial service businesses, it should become more competitive. In
addition, insurance companies may expand into non-traditional lines of
business which may involve different types of risks.
22
<PAGE>
State Risk Factors
Investment in a single State Trust, as opposed to a Fund which invests
in the obligations of several states, may involve some additional risk
due to the decreased diversification of economic, political, financial
and market risks. See Appendix A to this Information Supplement for
brief summaries of some of the factors which may affect the financial
condition of the States represented in various State Trusts of Defined
Asset Funds, together with summaries of tax considerations relating to
those States.
Payment of Bonds and Life of a Fund
Because Bonds from time to time may be redeemed or prepaid or will
mature in accordance with their terms or may be sold under certain
circumstances described herein, no assurance can be given that a
Portfolio will retain for any length of time its present size and
composition. Bonds may be subject to redemption prior to their stated
maturity dates pursuant to optional refunding or sinking fund redemption
provisions or otherwise. In general, optional refunding redemption
provisions are more likely to be exercised when the offer side
evaluation is at a premium over par than when it is at a discount from
par. Generally, the offer side evaluation of Bonds will be at a premium
over par when market interest rates fall below the coupon rate on the
Bonds. Bonds in a Portfolio may be subject to sinking fund provisions
early in the life of a Fund. These provisions are designed to redeem a
significant portion of an issue gradually over the life of the issue;
obligations to be redeemed are generally chosen by lot. Additionally,
the size and composition of a Portfolio will be affected by the level of
redemptions of Units that may occur from time to time and the consequent
sale of Bonds. Principally, this will depend upon the number of Holders
seeking to sell or redeem their Units and whether or not the Sponsors
continue to reoffer Units acquired by them in the secondary market.
Factors that the Sponsors will consider in the future in determining to
cease offering Units acquired in the secondary market include, among
other things, the diversity of a Portfolio remaining at that time, the
size of a Portfolio relative to its original size, the ratio of Fund
expenses to income, a Fund's current and long-term returns, the degree
to which Units may be selling at a premium over par relative to other
funds sponsored by the Sponsors and the cost of maintaining a current
prospectus for a Fund. These factors may also lead the Sponsors to seek
to terminate a Fund earlier than would otherwise be the case.
Redemption
The Trustee is empowered to sell Bonds in order to make funds
available for redemption if funds are not otherwise available in the
Capital and Income Accounts. The Bonds to be sold will be selected from
a list supplied by the Sponsors. Securities will be chosen for this
list by the Sponsors on the basis of those market and credit factors as
they may determine are in the best interests of the Fund. Provision is
made under the Indenture for the Sponsors to specify minimum face
amounts in which blocks of Bonds are to be sold in order to obtain the
best price for the Fund. While these minimum amounts may vary from time
to time in accordance with market conditions, the Sponsors believe that
the minimum face amounts which would be specified would range from
$25,000 for readily marketable Bonds to $250,000 for certain Restricted
Securities which can be distributed on short notice only by private
sale, usually to institutional investors. Provision is also made that
sales of Bonds may not be made so as to (i) result in the Fund owning
less than $250,000 of any Restricted Security or (ii) result in more
than 50% of the Fund consisting of Restricted Securities. In addition,
the Sponsors will use their best efforts to see that these sales of
Bonds are carried out in such a way that no more than 40% in face amount
of the Fund is invested in Restricted Securities, provided that sales of
unrestricted Securities may be made if the Sponsors' best efforts with
regard to timely sales of Restricted Securities at prices they deem
reasonable are unsuccessful and if as a result of these sales more than
50% of the Fund does not consist of Restricted Securities. Thus the
redemption of Units may require the sale of larger amounts of Restricted
Securities than of unrestricted Securities.
23
<PAGE>
Tax Exemption
In the opinion of bond counsel rendered on the date of issuance of
each Bond, the interest on each Bond is excludable from gross income
under existing law for regular Federal income tax purposes (except in
certain circumstances depending on the Holder) but may be subject to
state and local taxes and may be a preference item for purposes of the
Alternative Minimum Tax. Interest on Bonds may become subject to
regular Federal income tax, perhaps retroactively to their date of
issuance, as a result of changes in Federal law or as a result of the
failure of issuers (or other users of the proceeds of the Bonds) to
comply with certain ongoing requirements.
Moreover, the Internal Revenue Service has announced an expansion of
its examination program with respect to tax-exempt bonds. The expanded
examination program will consist of, among other measures, increased
enforcement against abusive transactions, broader audit coverage
(including the expected issuance of audit guidelines) and expanded
compliance achieved by means of expected revisions to the tax-exempt
bond information return forms.
In certain cases, a Bond may provide that if the interest on the Bond
should ultimately be determined to be taxable, the Bond would become due
and payable by its issuer, and, in addition, may provide that any
related letter of credit or other security could be called upon if the
issuer failed to satisfy all or part of its obligation. In other cases,
however, a Bond may not provide for the acceleration or redemption of
the Bond or a call upon the related letter of credit or other security
upon a determination of taxability. In those cases in which a Bond does
not provide for acceleration or redemption or in which both the issuer
and the bank or other entity issuing the letter of credit or other
security are unable to meet their obligations to pay the amounts due on
the Bond as a result of a determination of taxability, a Trustee would
be obligated to sell the Bond and, since it would be sold as a taxable
security, it is expected that it would have to be sold at a substantial
discount from current market price. In addition, as mentioned above,
under certain circumstances Holders could be required to pay income tax
on interest received prior to the date on which the interest is
determined to be taxable.
INCOME AND RETURNS
Income
Because accrued interest on Bonds is not received by a Fund at a
constant rate throughout the year, any monthly income distribution may
be more or less than the interest actually received by the Fund. To
eliminate fluctuations in the monthly income distribution, a portion of
the Public Offering Price consists of an advance to the Trustee of an
amount necessary to provide approximately equal distributions. Upon the
sale or redemption of Units, investors will receive their proportionate
share of the Trustee advance. In addition, if a Bond is sold, redeemed
or otherwise disposed of, a Fund will periodically distribute the
portion of the Trustee advance that is attributable to that Bond to
investors.
The regular monthly income distribution stated in Part A of the
Prospectus is based on a Public Offering Price of $1,000 per Unit after
deducting estimated Fund expenses, and will change as the composition of
the Portfolio changes over time.
Income is received by a Fund upon semi-annual payments of interest on
the Bonds held in a Portfolio. Bonds may sometimes be purchased on a
when, as and if issued basis or may have a delayed delivery. Since
interest on these Bonds does not begin to accrue until the date of
delivery to a Fund, in order to provide tax-exempt income to Holders for
this non-accrual period, the Trustee's Annual Fee and Expenses is
reduced by the interest that would have accrued on these Bonds between
the initial settlement date for Units and the delivery dates of the
Bonds. This eliminates reduction in
24
<PAGE>
Monthly Income Distributions.
Should when-issued Bonds be issued later than expected, the fee
reduction will be increased correspondingly. If the amount of the
Trustee's Annual Fee and Expenses is insufficient to cover the
additional accrued interest, the Sponsors will treat the contracts as
Failed Bonds. As the Trustee is authorized to draw on the letter of
credit deposited by the Sponsors before the settlement date for these
Bonds and deposit the proceeds in an account for the Fund on which it
pays no interest, its use of these funds compensates the Trustee for the
reduction described above.
STATE MATTERS
THE ALABAMA TRUST
RISK FACTORS--During recent years the economy of Alabama has grown at
a slower rate than that of the U.S. The State of Alabama, other
governmental units and agencies, school systems and entities dependent
on government appropriations or economic conditions have, in varying
degrees, suffered budgetary difficulties. These conditions and other
factors described below could adversely affect the Debt Obligations that
the Trust acquires and the value of Units in the Trust. The following
information constitutes only a brief summary, does not purport to be a
complete description of potential adverse economic effects and is based
primarily on material presented in various government documents,
official statements, offering circulars and prospectuses. While the
Sponsors have not independently verified such information, they have no
reason to believe that such information is not correct in all material
respects.
Limitations on State Indebtedness. Section 213 of the Constitution of
Alabama, as amended, requires that annual financial operations of
Alabama must be on a balanced budget and prohibits the State from
incurring general obligation debt unless authorized by an amendment to
the Constitution. Although conventions proposed by the Legislature and
approved by the electorate may be called for the purpose of amending the
Alabama Constitution, amendments to the Constitution have generally been
adopted through a procedure that requires each amendment to be proposed
by a favorable vote of three-fifths of all the members of each house of
the Legislature and thereafter approved by a majority of the voters of
the State voting in a statewide election. The State has statutory
budget provisions which create a proration procedure in the event
estimated budget resources in a fiscal year are insufficient to pay in
full all appropriations for such fiscal year. Proration has a
materially adverse effect on public entities, such as boards of
education, that are substantially dependent on state funds.
Court decisions have indicated that certain State expenses necessary
for essential functions of government are not subject to proration under
applicable law. The Supreme Court of Alabama has held that the debt
prohibition contained in the constitutional amendment does not apply to
obligations incurred for current operating expenses payable during the
current fiscal year, debts incurred by separate public corporations, or
state debt incurred to repel invasion or suppress insurrection. The
State may also make temporary loans not exceeding $300,000 to cover
deficits in the state treasury. Limited obligation debt may be
authorized by the legislature without amendment to the Constitution.
The State has followed the practice of financing certain capital
improvement programs--principally for highways, education and
improvements to the State Docks--through the issuance of limited
obligation bonds payable solely out of certain taxes and other revenues
specifically pledged for their payment and not from the general revenues
of the State.
Medicaid. Because of Alabama's relatively high incidence of poverty,
health care providers in Alabama are more heavily dependent on Medicaid
than are health care providers in other states. Contributions to
Medicaid by the State of Alabama are financed through the General Fund
of the State of Alabama. As discussed above, because deficit spending
is prohibited by the Constitution of Alabama, allocations from the
General Fund, including Medicaid payments, may be subject to proration.
In recent years the General Fund has been subject to proration by virtue
of insufficient tax
25
<PAGE>
revenues and excessive expenditures, and there can
be no assurance that proration of the General Fund budget will not
continue. If continued, such proration may have a materially adverse
effect on Alabama Medicaid payments. Factors such as the increasing
pressure on sources of Medicaid funding, at both the State and the
Federal level, and the expanding number of people covered by this
program, are likely to cause future concern over the Alabama Medicaid
budget.
The State of Alabama Medicaid Agency currently obtains funding through
a Federal matching program in which each dollar contributed to the
Alabama Medicaid budget by the State is matched by the Federal
government on the basis of a formula, provided that the State program
meets federally imposed standards. In recent years the State of Alabama
has relied in part upon revenues raised through a tax on health care
providers to fund its share of the Alabama Medicaid budget. In 1993,
however, the State, acting in response to a projected shortfall of
revenues, instituted a new system to fund Medicaid. This system,
developed with the help of health care providers and the Alabama
Medicaid Agency, diverts funds from State-supported teaching hospitals
to the Alabama Medicaid budget. The new system managed to divert the
shortfall and has resulted in additional matching funds from the federal
government. Reports in the media suggest, however, that the Federal
Health Care Financing Administration ("HCFA") has notified several
states, including Alabama, that their methods of obtaining federal
matching funds may be illegal. Moreover, the reports indicate that HCFA
may seek refunds from those states. Any reduction of the federal
matching program, or any refund requirement, would have a material
adverse effect on the Alabama Medicaid program.
According to reports in the news media, a study by a private consumer
group indicates that the level of benefits available are materially
lower and the eligibility standards significantly more stringent under
the Alabama Medicaid program than in most other states. Although, as
stated above, Alabama health care facilities are dependent on Medicaid
payments, it should be expected that health care facilities in Alabama
will receive substantially less in Medicaid payments than would health
care facilities in most other states.
Health Care Services. In recent years, the importance of service
industries to Alabama's economy has increased significantly. One of the
major service industries in the State is general health care. Because
of cost concerns, health care providers and payors are restructuring and
consolidating. Consolidation resulting in a reduction of services in
the health care industry may have a material adverse effect on the
economy of Alabama in general and, in particular, on the issuers of Debt
Obligations in the Trust secured by revenues of health care facilities.
In addition, there are many possible financial effects that could result
from enactment of any federal or state legislation proposing to regulate
or reform the health care industry, and it is not possible at this time
to predict with assurance the effect of any health care reform proposals
that might be enacted.
In January 1995, Fob James became the new Governor of Alabama.
Governor James has imposed a moratorium on the Alabama State Health
Planning and Development Agency ("SHPDA") that affects all filings with
SHPDA. It is expected that the moratorium will be lifted within the
next six months, but during that time health care providers will be
unable to obtain Certificates of Need for any new or expanded health
services. The moratorium may have a material adverse effect on the
revenues of such providers.
Dependence on Federal Education Funds. Alabama is disproportionately
dependent on federal funds for secondary and higher education,
predominantly because of insufficient state and local support. Recent
federal cutbacks on expenditures for education have had, and if
continued will have, an adverse impact on educational institutions in
Alabama.
On December 30, 1991, the District Court for the Northern District of
Alabama issued an opinion holding Alabama's institutions of higher
learning liable for operating a racially discriminatory dual university
system. The Court ordered several remedies and has maintained
jurisdiction for ten
26
<PAGE>
years to insure compliance. The Circuit Court of
Appeals has since upheld parts of this verdict, in effect maintaining
court control over the institutions. The remedies include changes in
the State's system of funding its universities and colleges. This
change in funding could adversely affect certain educational
institutions in Alabama. If the State and the universities fail to
comply with the Court's orders, the Court may rule that Federal funds
for higher eduction be withheld. In addition, certain funding and
apportionment issues remain unresolved and are the subject of further
litigation. A ruling depriving the State of Federal funds for higher
education would have a materially adverse effect on certain Alabama
colleges and universities.
Challenge to School Funding Mechanism. On April 1, 1993, Montgomery
Circuit Court Judge Gene Reese ruled that an unconstitutional disparity
exists among Alabama's school districts because of inequitable
distribution of tax funds. Judge Reese issued an order calling for a
new design for the distribution of funds for educational purposes as
well as a new system for funding public education.
Several plans for funding were presented, but the Alabama Legislature
decided to allocate a lump sum to be divided among the school systems by
the State Board of Education. The State Board decided to divide this
sum, which represents a 10% increase in the total state education
budget, using the same formula that was used in previous years by the
Alabama Legislature and which had been declared unconstitutional by
Judge Reese.
In response to that action, a mediation was held whereby a new
division of the state education budget was established for the first
seven months of the 1994-1995 school year. Judge Reese has ordered the
parties to reconsider the budget in the spring of 1995. If Judge Reese
orders a new division of the state education budget, or if he orders
that local taxes collected for education be included in the general
education fund, he would reduce the funds provided to certain school
districts. In that case, the ability of those districts to service debt
may be materially, adversely affected. The Alabama Supreme Court has
advised the Legislature that it should abide by Judge Reese's decision.
However, Governor James has indicated that he may challenge Judge
Reese's ruling. It is impossible to predict what form such challenge
may take and what effect such a challenge would have on Alabama
counties, municipalities.
Alabama Industrial Characteristics. Alabama industrial capacity has
traditionally been concentrated in those areas sensitive to cyclical
economic trends, such as textiles and iron and steel production. To the
extent that American iron and steel and textile production continues to
suffer from foreign competition and other factors, the general economy
of the State and the ability of particular issuers, especially
pollution-control and certain IDB issuers, would be materially adversely
affected. The State has recently taken steps to diversify and increase
its industrial capacity. Although these efforts have been somewhat
successful, they include significant tax and other benefits which could
have a mutually adverse effect on the state's tax revenues.
General Obligation Warrants. Municipalities and counties in Alabama
traditionally have issued general obligation warrants to finance various
public improvements. Alabama statutes authorizing the issuance of such
interest-bearing warrants do not require an election prior to issuance.
On the other hand, the Constitution of Alabama (Section 222) provides
that general obligation bonds may not be issued without an election.
The Supreme Court of Alabama has held that general obligation warrants
do not require an election under Section 222 of the Constitution of
Alabama. In so holding, the Court found that warrants are not "bonds"
within the meaning of Section 222. According to the Court, warrants are
not negotiable instruments and transferees of warrants cannot be holders
in due course. Therefore, a transferee of warrants is subject to all
defenses that the issuer of such warrants may have against the
transferor.
27
<PAGE>
Allocation of Local Taxes for Public Education. Under Alabama law, a
city with a population in excess of 5,000 is entitled to establish a
separate public school system within its jurisdiction with its own board
of education, members of which are elected by the governing body of such
city. If a city school system is established within a county, the
county-wide taxes for general educational purposes will, absent specific
law to the contrary, be apportioned among the county board of education
and each city board of education within the county according to a
statutory formula based on the state's uniform minimum educational
program for public school systems. This formula has many factors, but
is based largely on the relative number of students within the
boundaries of each school system.
Local boards of education, whether city board or county board, may
borrow money by issuing interest-bearing warrants payable solely out of
such board's allocated or apportioned share of a specified tax. The
county board's apportioned share of such tax may be diminished upon the
establishment of a city school system, which could jeopardize the
payment of the county board's warrants.
Limited Taxing Authority. Political subdivisions of the State have
limited taxing authority. Ad valorem taxes may be levied only as
authorized by the Alabama Constitution. In order to increase the rate
at which any ad valorem tax is levied above the limit otherwise provided
in the Constitution, the increase must be proposed by the governing body
of the taxing authority after a public hearing, approved by an act of
the Alabama Legislature and approved at an election within the taxing
authority's jurisdiction. In addition, the Alabama Constitution limits
the total amount of state, county, municipal and other ad valorem taxes
that may be imposed on any class of property in any one tax year. This
limitation is expressed in terms of a specified percentage of the market
value of such property. In some jurisdictions in the State this limit
has already been exceeded for one or more classes of property.
Specific authorizing legislation is required for the levy of taxes by
local governments. In addition, the rate at which such taxes are levied
may be limited by the authorizing legislation or judicial precedent.
For example, the Alabama Supreme Court has held that sales and use
taxes, which usually comprise a significant portion of the revenues for
local governments, may not be levied at rates that are confiscatory or
unreasonable. The total sales tax (state and local) in some
jurisdictions is 9%.
Dependence on Certain Taxes. State and local governments in Alabama
are more dependent on general and special sales taxes and user fees than
are state and local governments in many states, and less dependent on
property taxes. Because sales taxes and user fees are less stable
sources of revenue than are property taxes, state and local governments
in Alabama may be subject to shortfalls in revenue due to economic
cycles. Such revenue shortfalls could have a materially adverse effect
on Alabama debt obligations in the Alabama Trust.
Priority for Essential Governmental Functions. Numerous decisions of
the Alabama Supreme Court hold that a governmental unit may first use
its taxes and other revenues to pay the expenses of providing necessary
governmental services before paying debt service on its bonds, warrants
or other indebtedness.
ALABAMA TAXES
In the opinion of Maynard, Cooper & Gale, P.C., Birmingham, Alabama,
special counsel on Alabama tax matters, relying upon the opinion of
Messrs. Davis Polk & Wardwell as to the federal income tax consequences
to the Alabama Trust and the Holders, and assuming that the Alabama
Trust is not an association taxable as a corporation for federal income
tax purposes, under existing Alabama law:
28
<PAGE>
1. The Alabama Trust and the Holders will be treated for purposes of
the Alabama income tax laws in substantially the same manner as they are
for purposes of federal income tax law, as currently enacted.
2. The Alabama Trust will not be treated as an association taxable as
a corporation for Alabama income tax purposes.
3. The income of the Alabama Trust will be treated as the income of
the Holders when distributed or deemed distributed to the Holders.
4. Interest on any Alabama Obligation which is excluded from gross
income for Alabama income tax purposes when received by the Alabama
Trust will be excluded from gross income of the Holders for Alabama
income tax purposes when distributed or deemed distributed to the
Holders.
5. Generally, gain on sale or disposition of an Alabama Obligation
will be subject to Alabama income tax. There may be exceptions to the
general rule of limited application.
6. Distribution to the Holders consisting of gain realized upon the
sale or distribution of an Alabama Obligation by the Alabama Trust will
be subject to Alabama income tax in the same manner as if such Alabama
Obligation was held and sold or otherwise disposed of directly by the
Holders.
7. Gain on the disposition of Units will be subject to Alabama income
tax.
8. Interest on Puerto Rico Obligations will be excluded from gross
income for Alabama income tax purposes and such Puerto Rico Obligations
held by the Alabama Trust will be treated in the same manner as an
Alabama Obligation.
The opinion of Maynard, Cooper & Gale, P.C. does not address the
consequences to foreign or domestic corporations of investment in
Alabama Obligations under the Alabama franchise tax and ad valorem tax
laws.
THE ARIZONA TRUST
RISK FACTORS--The State Economy. The Arizona economy during the last
few years has been described as one of subdued growth, but in 1994
portions of the economy rebounded due in part to a strong single family
home market, new business incorporation, and tourism spending. Sales of
new, single-family homes in Maricopa County reached a several-year high
in 1994, and permits for new home construction increased by 23% from
1992 to 1993 and 17% from 1993 to 1994. Approximately 28,000
residential building permits were issued in Maricopa County during
1994--the highest level of residential construction since 1978. This
improvement was not felt in all sectors of the local economy and it is
uncertain how long the improvement will last. Residential construction
and home sales are expected to decline from these peak levels in 1995.
In the aftermath of the savings and loan crisis, which hit Arizona
hard beginning in the late 1980's, the RTC sold approximately $23.6
billion in Arizona assets as of December 31, 1994 and has $1.16 billion
in assets, mostly real-estate secured loans and real property, still to
be sold. The RTC's Phoenix office closed on January 29, 1993, with
management of the remaining assets shifting to the RTC's Denver office.
The trend in the Arizona banking community continues to be one of
consolidation. In May of 1994, Bank One Arizona purchased the Great
American Federal Savings Association, a San Diego-based thrift that
operates 58 branches in Arizona ("Great American"). Shortly after the
acquisition, Bank One Arizona announced the closure of 12 of Great
American's 22 free-standing
29
<PAGE>
branches in Arizona, and it plans to close
another 10 to 12 Bank One Arizona branches. On August 2, 1993, federal
regulators approved the sale of Citibank Arizona's 59 banking locations
to Norwest Corp. Banc One, the Ohio-based bank, acquired Valley National
Bank of Arizona in March of 1993. Bank of America, which purchased the
assets of MeraBank, Western Savings and Pima Savings, all former savings
and loans under the control of the RTC, merged with Security Pacific,
which had already purchased the assets of Security Savings, another
defunct savings and loan. In a separate transaction, Bank of America
purchased Caliber Bank. Under an agreement with the United States
Justice Department which allowed the Bank of America-Security Pacific
merger, Bank of America had to sell 49 of its branches to keep from
tying up the Arizona market. As a result, Bank of America transferred
approximately thirty branches to Caliber Bank, which it held as a
subsidiary, and then sold Caliber Bank to Independent Bankcorp of
Arizona, an independent bank holding company, in early 1993. In August
1994, Independent Bancorp of Arizona agreed to be bought by Norwest
Corp, which will result in the merger of Caliber Bank and Norwest Corp.
It is likely that some offices will be closed as a result of the merger.
In October 1994 Norwest also acquired Bank of Scottsdale. As financial
institutions within the state consolidate, some branch offices are being
closed, displacing workers. Although more acquisitions are expected,
the pace is expected to slow because there are so few remaining banks
that have expressed a desire to consolidate.
On June 27, 1991, America West Airlines, a Phoenix-based carrier,
filed a Chapter 11 reorganization petition in bankruptcy. At that time,
America West was the sixth largest employer in Maricopa County,
employing approximately 10,000 of its 15,000 employees within the
county. Since the filing, a number of employees have been laid off,
leaving the number of those employed in Maricopa County at approximately
7,500. Before it filed for Bankruptcy Court protection, the carrier
served more than 60 cities with 115 planes; America West now serves
approximately 55 cities with 87 aircraft. America West emerged from
Chapter 11 on August 25, 1994. It has announced its plans to reduce its
work force by another 1,100 positions, partly through attrition and
partly through layoffs. After these reductions in staff, America West
will have about 10,400 employees.
After a turbulent 1992, America West's financial picture improved in
1993 and continued to improve in 1994. The airline lost approximately
$131.8 million in 1992. However, the airline posted a profit of $37.2
million in 1993 and a $62.2 million profit in 1994. The 1994 result was
the airline's best financial result in its 11 years of existence. The
affect of America West's short-term recovery on the state economy and,
more particularly, the Phoenix economy, is uncertain.
Jobs were lost by the closing of Williams Air Force Base in Chandler,
Arizona, on September 30, 1993. Williams Air Force Base was selected as
one of the military installations to be closed as a cost-cutting measure
by the Defense Base Closure and Realignment Commission, whose
recommendations were subsequently approved by the President and the
United States House of Representatives. Williams Air Force Base
injected an estimated $300 million in the local economy annually and
employed approximately 3,800 military and civilian personnel. The base
has been renamed the Williams Gateway Airport, and efforts are underway
to remake the site into a regional civilian airport, including an
aviation, educational and business complex.
Of the state's 10 largest corporate employers, nine reduced their
Arizona-based staffs in 1994. In 1994, American Express Co. announced a
restructuring in which 2,000 Arizona jobs will be cut in the next two
years. McDonnell Douglas Helicopter Systems has cut 2,000 Arizona jobs
over the past three years. Honeywell Inc. will have eliminated a total
of 3,400 Arizona workers by the end of 1994. AT&T Corp. has stated its
intent to sell its wire production plant in Maryvale, Arizona. In 1995
this trend is expected to continue, with large corporations decreasing
their workforce.
Job growth in Arizona, defined as growth of total wage and salary
employment, was consistently in the range of 2.1% to 2.5% for the years
1988 through 1990. Job growth in 1991 declined to 0.6%, with net job
losses in manufacturing, construction, transportation, communication
30
<PAGE>
and
public utilities, and finance, insurance and real estate. Job growth
increased in 1992 to 1.7%. Non-agricultural job growth was 3.6% in
1993, with an increase of 11.2% in construction employment, and 4.2% in
1994, with an increase of about 17% in construction employment. Job
growth is currently forecast to be 4.1% in 1995.
The unemployment rate in Arizona was 5.3% in 1990, which was similar
to the national rate of 5.4%. Arizona's unemployment rate in 1991 was
5.6%, compared to a national rate of 6.7%. Arizona's unemployment rate
in 1992 increased to 7.4%, matching the national rate. The Arizona
unemployment rate decreased in 1993, to 6.2%, compared with the national
figure of 6.8%. In December 1994, Arizona's unemployment rate was 5.9%,
compared to 5.4% nationally.
Current personal income in Arizona has continued to rise, but at
slower rates than in the early to mid-1980's. Personal income grew at a
rate of 5.8% in 1990 and dropped to 4.6% in 1991. Growth in personal
income increased to 6.7% in 1992, 6.3% in 1993, 8.1% in 1994 and is
expected to increase at a rate of 8.3% in 1995.
Bankruptcy filings in the District of Arizona increased dramatically
in the mid-1980's, but percentage increases have decreased over the last
several years, with 1993 resulting in the first drop in bankruptcy
filings since 1984. Bankruptcy filings totalled 15,066 in 1994, 17,381
in 1993, 19,883 in 1992, 19,686 in 1991, and 18,258 in 1990.
The inflation rate, as measured by the consumer price index in the
Phoenix, Arizona area, including all of Maricopa County, has hovered
around the national average for the last several years, increasing from
4.1% in 1988 to 5.6% in 1990. The inflation rate decreased to 2.8% in
1991, compared to 4.2% on a national level, and decreased slightly to
2.7% in 1992, compared to a national rate of 3.0%. The inflation rate
was 4.5% in 1993. In 1994, the Phoenix metropolitan area inflation rate
at 4.1% was higher than the national rate of 2.7%.
The population of Arizona has grown consistently at a rate between
2.2% and 2.4% annually during the years 1988 through 1992. Population
growth remained at 2.4% in 1993, increased slightly to 2.6% in 1994, and
is expected to be 2.7% in 1995. Although significantly greater than the
national average population growth, it is lower than Arizona's
population growth in the mid-1980's. The 1990 census results indicate
that the population of Arizona rose 35% between 1980 and 1990, a rate
exceeded only in Nevada and Alaska. Nearly 950,000 residents were added
during this period.
The State Budget, Revenues and Expenditures. The state operates on a
fiscal year beginning July 1 and ending June 30. Fiscal year 1995
refers to the year ending June 30, 1995.
Total General Fund revenues of $4.235 billion are expected during
fiscal year 1995. Approximately 44% of this expected revenue comes from
sales and use taxes, 38% from income taxes (both individual and
corporate) and 5% from property taxes. All taxes total approximately
$4.09 billion, or 97% of the General Fund revenues. Non-tax revenue
includes items such as income from the state lottery, licenses, fees and
permits, and interest. Lottery income totals approximately 26% of
non-tax revenue.
For fiscal year 1995, General Fund expenditures of $4.191 billion are
expected. Major General Fund appropriations include $1.643 billion to
the Department of Education (primarily for K-12), $486.7 million for the
administration of the AHCCCS program (the State's alternative to
Medicaid), $378.3 million to the Department of Economic Security, and
$338.8 million to the Department of Corrections. The estimated
expenditures for fiscal year 1994 totalled approximately $3.951 billion.
The budget for fiscal year 1993 totalled approximately $3.7 billion.
31
<PAGE>
Most or all of the Debt Obligations of the Arizona Trust are not
obligations of the State of Arizona, and are not supported by the
State's taxing powers. The particular source of payment and security
for each of the Debt Obligations is detailed in the instruments
themselves and in related offering materials. There can be no
assurances, however, with respect to whether the market value or
marketability of any of the Debt Obligations issued by an entity other
than the State of Arizona will be affected by the financial or other
condition of the State or of any entity located within the State. In
addition, it should be noted that the State of Arizona, as well as
counties, municipalities, political subdivisions and other public
authorities of the state, are subject to limitations imposed by
Arizona's constitution with respect to ad valorem taxation, bonded
indebtedness and other matters. For example, the state legislature
cannot appropriate revenues in excess of 7% of the total personal income
of the state in any fiscal year. These limitations may affect the
ability of the issuers to generate revenues to satisfy their debt
obligations.
School Finance. In 1991, the State of Arizona was sued by four school
districts within the state, claiming that the state's funding system for
school buildings, equipment and other capital expenses is
unconstitutional. The lawsuit was filed by the Arizona Center for Law
in the Public Interest and Southern Arizona Legal Aid Inc., but fifty
other school districts helped finance the lawsuit. A state judge
rejected the lawsuit in September of 1992, and the school districts
appealed. In July of 1994, the Supreme Court of Arizona reversed the
lower court ruling and found that the formulas for funding public
schools in Arizona cause "gross disparities" among school districts and
therefore violate the Arizona Constitution. The lawsuit did not seek
damages. It is unclear, at this time, what affect the judgment will
have on state finances or school district budgets.
Health Care Facilities. Arizona does not participate in the federally
administered Medicaid program. Instead, the state administers an
alternative program, the Arizona Health Care Cost Containment System
("AHCCCS"), which provides health care to indigent persons meeting
certain financial eligibility requirements, through managed care
programs. In fiscal year 1995, AHCCCS will be financed approximately
60% by federal funds, 28% by state funds, and 12% by county funds.
Under state law, hospitals retain the authority to raise rates with
notification and review by, but not approval from, the Department of
Health Services. Hospitals in Arizona have experienced profitability
problems along with those in other states. During the first half of
1994, nearly half of Arizona's 101 hospitals filed for rate increases.
The average increase was approximately 8.5%.
Health care firms have been in the process of consolidating. Eli
Lilly and Co. bought prescription- benefits manager PCS Health Systems,
Inc. of Scottsdale for $4 billion - the highest price ever paid for an
Arizona company - in November 1994. Two other large Arizona health-care
organizations were purchased in 1994. Intergroup Healthcare Corp. of
Tucson was purchased by California-based Foundation Health Corp. for
about $720 million in stock, and St. Luke's Health System was bought by
OrNda HealthCorp. for $122 million. Continuing consolidation and merger
activity in the health care industry is expected.
Utilities. Arizona's utilities are subject to regulation by the
Arizona Corporation Commission. This regulation extends to, among other
things, the issuance of certain debt obligations by regulated utilities
and periodic rate increases needed by utilities to cover operating costs
and debt service. The inability of any regulated public utility to
secure necessary rate increases could adversely affect the utility's
ability to pay debt service.
Arizona's largest regulated utility, Arizona Public Service Company
("APS"), serves all or part of 11 of Arizona's 15 counties. APS is a
significant part owner of Arizona's nuclear generator, the Palo Verde
Nuclear Generating Station. APS is owned by Pinnacle West Capital
Corporation ("Pinnacle West"). APS and Pacificorp, an Oregon utility,
entered into a standstill agreement under which Pacificorp agreed not to
attempt a takeover of APS or Pinnacle West through early 1995.
32
<PAGE>
Earlier
offers by Pacificorp to purchase Pinnacle West had been rejected. The
agreement also provides for a seasonal swap of power, allowing
Pacificorp to purchase electricity from APS during the winter in
exchange for selling electricity to APS in the summer. In May 1994 APS
entered into a rate agreement with the Arizona Corporation Commission
which decreased its electric rate by an average of 2.2%. Under the
agreement, neither APS nor the Arizona Corporation Commission can
propose new rates until December 31, 1996. Pinnacle West, APS's parent
company, had 1994 earnings of $173.8 million, compared with $170 million
in 1993. The company announced that it expects 1995 to be a difficult
year in comparison to 1994 due to expected reductions in non-cash income
in 1995 and 1994's hot summer, which bolstered 1994 earnings. APS
employs approximately 6,900 people; since 1988, APS has laid off
approximately 1,100 employees. In April of 1994, APS announced that it
plans to eliminate 690 jobs over the next year as part of its drive to
cut costs.
The Salt River Project Agricultural Improvement and Power District
("SRP") is an agricultural improvement district organized under state
law. For this reason, SRP is not subject to regulation by the Arizona
Corporation Commission. SRP, the nation's third largest public power
utility, provides electric service to approximately 596,000 customers
(consumer, commercial and industrial) within a 2,900 square mile area in
parts of Maricopa, Gila and Pinal Counties in Arizona.
Under Arizona law, SRP's board of directors has the exclusive
authority to establish rates for electricity. SRP must follow certain
procedures, including certain public notice requirements and a special
board of directors meeting, before implementing any changes in standard
electric rates. SRP instituted an average rate increase of 2.9% in
January of 1992 (the actual increases ranged from 2.4% to 3.4%,
depending on the class of customer).
SRP reported a 30% increase in its net income for the fiscal year
ended April 30, 1994, representing its highest net income in seven
years. The previous two fiscal years, which were also profitable,
followed two consecutive years of losses. In July 1993, SRP
renegotiated two key coal contracts, announcing that it expected the new
contracts to cut its production costs by $40 million over the next five
years. SRP has indicated that due to increased earnings and savings it
has cancelled a planned 1994 rate increase, will seek to avoid another
increase until 1999, and is currently considering the possibility of a
rate cut. SRP, along with APS, has laid off about 3,600 employees over
the last seven years. SRP has announced that it does not expect any
growth in its work force through 1996.
The Sponsors believe that the information summarized above describes
some of the more significant matters relating to the Arizona Trust. For
a discussion of the particular risks with each of the Debt Obligations,
and other factors to be considered in connection therewith, reference
should be made to the Official Statements and other offering materials
relating to each of the Debt Obligations included within the Portfolio
of the Arizona Trust. The sources of the information set forth herein
are official statements, other publicly available documents, and
statements of public officials and representatives of the issuers of
certain of the Debt Obligations. While the Sponsors have not
independently verified this information, they have no reason to believe
that such information is incorrect in any material respect.
ARIZONA TAXES
In the opinion of Meyer, Hendricks, Victor, Osborn & Maledon, Phoenix,
Arizona, special counsel on Arizona tax matters, under existing Arizona
law:
Under the income tax laws of the State of Arizona, the Arizona Trust
is not an association taxable as a corporation; the income of the
Arizona Trust will be treated as the income of Holders of Units of
the Arizona Trust and be deemed to be received by them when received by
the Arizona Trust. Interest on the Debt Obligations in the Arizona
Trust which is exempt from Arizona income tax when received
33
<PAGE>
by the
Arizona Trust will retain its status as tax exempt interest for Arizona
income tax purposes to the Holders of Units of the Arizona Trust.
For purposes of the Arizona income tax laws, each Holder of Units of
the Arizona Trust will be considered to have received his pro rata share
of interest on each Debt Obligation in the Arizona Trust when it is
received by the Arizona Trust, and each Holder will have a taxable event
when the Arizona Trust disposes of a Debt Obligation (whether by
sale, exchange, redemption or payment at maturity) or when the Holder
redeems or sells his Unit to the extent the transaction constitutes a
taxable event for Federal income tax purposes. A Holder's tax cost (or
basis) for his pro rata portion of a Debt Obligation will be established
and allocated for purposes of the Arizona income tax laws in the same
manner as such cost is established and allocated for Federal income tax
purposes, except if the Debt Obligation carries bond premium or original
issue discount, in which case it is unclear whether the Federal and
Arizona tax costs are equivalent.
Because Arizona income tax is based upon Federal income tax law, the
foregoing opinions concerning Arizona income tax are based upon the
opinion of Davis Polk & Wardwell concerning Federal income tax aspects
of the Arizona Trust.
With respect to obligations of issuers located in Guam or Puerto Rico,
bond counsel for the issuers has opined that interest on these
obligations is exempt pursuant to Federal law from taxation by any
state. However, special Arizona counsel has advised that, because of a
conflict that exists between Arizona statutes and Federal law, Arizona
taxing authorities might take the position that interest on Guam or
Puerto Rico obligations is subject to tax by Arizona. Special counsel
cannot predict whether this position would be upheld by the courts.
Accordingly, Holders are advised to consult their own tax advisers in
this regard.
THE CALIFORNIA TRUST
RISK FACTORS--Economic Factors. The Governor's 1993-1994 Budget,
introduced on January 8, 1993, proposed general fund expenditures of
$37.3 billion, with projected revenues of $39.9 billion. To balance the
budget in the face of declining revenues, the Governor proposed a series
of revenue shifts from local government, reliance on increased federal
aid, and reductions in state spending.
The Department of Finance of the State of California's May Revision of
General Fund Revenues and Expenditures (the "May Revision"), released on
May 20, 1993, projected the State would have an accumulated deficit of
about $2.75 billion by June 30, 1993, essentially unchanged from the
prior year. The Governor proposed to eliminate this deficit over an
18-month period. Unlike previous years, the Governor's Budget and May
Revision did not calculate a "gap" to be closed, but rather set forth
revenue and expenditure forecasts and proposals designed to produce a
balanced budget.
The 1993-1994 budget act (the "1993-94 Budget Act") was signed by the
Governor on June 30, 1993, along with implementing legislation. The
Governor vetoed about $71 million in spending.
The 1993-94 Budget Act was predicated on general fund revenues and
transfers estimated at $40.6 billion, $400 million below 1992-93 (and
the second consecutive year of actual decline). The principal reasons
for declining revenue were the continued weak economy and the expiration
(or repeal) of three fiscal steps taken in 1991--a half cent temporary
sales tax, a deferral of operating loss carryforwards, and repeal by
initiative of a sales tax on candy and snack foods.
The 1993-94 Budget Act also assumed special fund revenues of $11.9
billion, an increase of 2.9 percent over 1992-93.
34
<PAGE>
The 1993-94 Budget Act included general fund expenditures of $38.5
billion (a 6.3 percent reduction from projected 1992-93 expenditures of
$41.1 billion), in order to keep a balanced budget within the available
revenues. The 1993-94 Budget Act also included special fund
expenditures of $12.1 billion, a 4.2 percent increase. The 1993-94
Budget Act reflected the following major adjustments:
1. Changes in local government financing to shift about $2.6 billion
in property taxes from cities, counties, special districts and
redevelopment agencies to school and community college districts,
thereby reducing general fund support by an equal amount. About $2.5
billion is permanent, reflecting termination of the State's "bailout" of
local governments following the property tax cuts of Proposition 13 in
1978 (See "Constitutional, Legislative and Other Factors" below).
The property tax revenue losses for cities and counties were offset in
part by additional sales tax revenues and mandate relief. The temporary
0.5 percent sales tax was extended through December 31, 1993, for
allocation to counties for public safety programs. The voters approved
Proposition 172 in November 1993 and the 0.5 percent sales tax was
extended permanently for public safety purposes.
Legislation was also enacted to eliminate state mandates in order to
provide local governments flexibility in making their programs
responsive to local needs. Legislation provides mandate relief for local
justice systems which affect county audit requirements, court reporter
fees, and court consolidation; health and welfare relief involving
advisory boards, family planning, state audits and realignment
maintenance efforts; and relief in areas such as county welfare
department self-evaluations, noise guidelines and recycling
requirements.
2. The 1993-94 Budget Act keeps K-12 Proposition 98 funding on a cash
basis at the same per-pupil level as 1992-93 by providing schools a $609
million loan payable from future years" Proposition 98 funds.
3. The 1993-94 Budget Act assumed receipt of about $692 million of
aid to the State from the federal government to offset health and
welfare costs associated with foreign immigrants living in the State,
which would reduce a like amount of General Fund expenditures. About
$411 million of this amount was one-time funding. Congress ultimately
appropriated only $450 million.
4. Reductions of $600 million in health and welfare programs and $400
million in support for higher education, partly offset by fee increases
at all three units of higher education and various miscellaneous cuts
(totalling approximately $150 million) in State government services in
many agencies, up to 15 percent.
5. A 2-year suspension of the renters" tax credit ($390 million
expenditure reduction in 1993-94).
6. Miscellaneous one-time items, including deferral of payment to the
Public Employees Retirement Fund ($339 million) and a change in
accounting for debt service from accrual to cash basis, saving $107
million.
The 1993-94 Budget Act contained no general fund tax/revenue increases
other than a two year suspension of the renters" tax credit. The
1993-94 Budget Act suspended the 4 percent automatic budget reduction
"trigger", as was done in 1992-93, so cuts could be focused.
Administration reports during the course of the 1993-94 Fiscal Year
indicated that while economic recovery appeared to have started in the
second half of the fiscal year, recessionary conditions continued longer
than had been anticipated when the 1993-94 Budget Act was adopted.
Overall, revenues for the 1993-94 Fiscal Year were about $800 million
lower than original projections,
35
<PAGE>
and expenditures were about $780
million higher, primarily because of higher health and welfare
caseloads, lower property taxes which required greater State support for
K-14 education to make up the shortfall, and lower than anticipated
federal government payments for immigration-related costs. The most
recent reports, however, in May and June, 1994, indicated that revenues
in the second half of the 1993-94 Fiscal Year have been very close to
the projections made in the Governor's Budget of January 10, 1994, which
is consistent with a slow turnaround in the economy.
The Department of Finance's July 1994 Bulletin, including the final
June receipts, reported that June revenues were $114 million (2.5
percent) above projection, with final end-of-year results at $377
million (about 1 percent) above the May Revision projections. Part of
this result was due to end-of-year adjustments and reconciliations.
Personal income tax and sales tax continued to track projections very
well. The largest factor in the higher than anticipated revenues was
from bank and corporation taxes, which were $140 million (18.4 percent)
above projection in June. While the higher June receipts are reflected
in the actual 1993-94 Fiscal Year cash flow results, and help the
starting cash balance for the 1994-95 Fiscal Year, the Department of
Finance has not adjusted any of its revenue projections for the 1994-95
or 1995-96 Fiscal Years.
During the 1993-94 Fiscal Year, the State implemented the deficit
retirement plan, which was part of the 1993-94 Budget Act, by issuing
$1.2 billion of revenue anticipation warrants in February 1994 maturing
December 21, 1994. This borrowing reduced the cash deficit at the end
of the 1993-94 Fiscal Year. Nevertheless, because of the $1.5 billion
variance from the original 1993-94 Budget Act assumptions, the General
Fund ended the fiscal year at June 30, 1994 carrying forward an
accumulated deficit of approximately $2 billion.
Because of the revenue shortfall and the State's reduced internal
borrowable cash resources, in addition to the $1.2 billion of revenue
anticipation warrants issued as part of the deficit retirement plan, the
State issued an additional $2.0 billion of revenue anticipation
warrants, maturing July 26, 1994, which were needed to fund the State's
obligations and expenses through the end of the 1993-94 Fiscal Year.
On January 17, 1994, a major earthquake measuring an estimated 6.8 on
the Richter Scale struck Los Angeles. Significant property damage to
private and public facilities occurred in a four-county area including
northern Los Angeles County, Ventura County, and parts of Orange and San
Bernardino Counties, which were declared as State and federal disaster
areas by January 18. Current estimates of total property damage
(private and public) are in the range of $20 billion, but these
estimates are still subject to change.
Despite such damage, on the whole, the vast majority of structures in
the areas, including large manufacturing and commercial buildings and
all modern high-rise offices, survived the earthquake with minimal or no
damage, validating the cumulative effect of strict building codes and
thorough preparation for such an emergency by the State and local
agencies.
State-owned facilities, including transportation corridors and
facilities such as Interstate Highways 5 and 10 and State Highways 14,
118 and 210, sustained damage. Most of the major highways (Interstate
Highways 5 and 10) have now been reopened. The campus of California
State University at Northridge (very near the epicenter) suffered an
estimated $350 million damage, resulting in temporary closure of the
campus. It has reopened using borrowed facilities elsewhere in the area
and many temporary structures. There was also some damage to the
University of California at Los Angeles and to an office building in Van
Nuys (now open after a temporary closure). Overall, except for the
temporary road and bridge closures, and CSU-Northridge, the earthquake
did not and is not expected to significantly affect State government
operations.
36
<PAGE>
The State in conjunction with the federal government is committed to
providing assistance to local governments, individuals and businesses
suffering damage as a result of the earthquake, as well as to provide
for the repair and replacement of State-owned facilities. The federal
government has provided substantial earthquake assistance.
The President immediately allocated some available disaster funds, and
Congress has approved additional funds for a total of at least $9.5
billion of federal funds for earthquake relief, including assistance to
homeowners and small businesses, and costs for repair of damaged public
facilities. The Governor originally proposed that the State will have
to pay about $1.9 billion for earthquake relief costs, including a 10
percent match to some of the federal funds, and costs for some programs
not covered by the federal aid. The Governor proposed to cover $1.05
billion of these costs from a general obligation bond issue which was on
the June, 1994 ballot but it was not approved by the voters. The
Governor subsequently announced that the State's share for
transportation projects would come from existing Department of
Transportation funds (thereby delaying other, non-earthquake related
projects), the State's share for certain other costs (including local
school building repairs) would come from reallocating existing bond
funds, and that a proposed program for homeowner and small business aid
supplemental to federal aid would have to be abandoned. Some other
costs will be borrowed from the federal government in a manner similar
to that used by the State of Florida after Hurricane Andrew; pursuant to
Senate Bill 2383, repayment will have to be addressed in 1995-96 or
beyond.
The 1994-95 Fiscal Year represents the fourth consecutive year the
Governor and Legislature were faced with a very difficult budget
environment to produce a balanced budget. Many program cuts and
budgetary adjustments have already been made in the last three years.
The Governor's Budget proposal, as updated in May and June, 1994,
recognized that the accumulated deficit could not be repaid in one year,
and proposed a two-year solution. The budget proposal sets forth
revenue and expenditure forecasts and revenue and expenditure proposals
which result in operating surpluses for the budget for both 1994-95 and
1995-96, and lead to the elimination of the accumulated budget deficit,
estimated at about $2.0 billion at June 30, 1994, by June 30, 1996.
The 1994-95 Budget Act, signed by the Governor on July 8, 1994,
projects revenues and transfers of $41.9 billion, $2.1 billion higher
than revenues in 1993-94. This reflects the Administration's forecast
of an improving economy. Also included in this figure is a projected
receipt of about $360 million from the Federal Government to reimburse
the State's cost of incarcerating undocumented immigrants. The State
will not know how much the Federal Government will actually provide
until the Federal FY 1995 Budget is completed. Completion of the
Federal Budget is expected by October 1994. The Legislature took no
action on a proposal in the January 1994-95 Governor's Budget to
undertake an expansion of the transfer of certain programs to counties,
which would also have transferred to counties 0.5% of the State's
current sales tax.
The 1994-95 Budget Act projects Special Fund revenues of $12.1
billion, a decrease of 2.4% from 1993-94 estimated revenues.
The 1994-95 Budget Act projects General Fund expenditures of $40.9
billion, an increase of $1.6 billion over 1993-94. The 1994-95 Budget
Act also projects Special Fund expenditures of $12.3 billion, a 4.7%
decrease from 1993-94 estimated expenditures. The principal features of
the 1994-95 Budget Act were the following:
1. Receipt of additional federal aid in 1994-95 of about $400 million
for costs of refugee assistance and medical care for undocumented
immigrants, thereby offsetting a similar General Fund cost. The State
will not know how much of these funds it will receive until the Federal
FY 1995 Budget is passed.
37
<PAGE>
2. Reductions of approximately $1.1 billion in health and welfare
costs. A 2.3% reduction in Aid to Family with Dependent Children
payments (equal to about $56 million for the entire fiscal year) has
been suspended by court order.
3. A General Fund increase of approximately $38 million in support
for the University of California and $65 million for California State
University. It is anticipated that student fees for both the U.C. and
the C.S.U. will increase up to 10%.
4. Proposition 98 funding for K-14 schools is increased by $526
million from 1993-94 levels, representing an increase for enrollment
growth and inflation. Consistent with previous budget agreements,
Proposition 98 funding provides approximately $4,217 per student for
K-12 schools, equal to the level in the past three years.
5. Legislation enacted with the Budget clarifies laws passed in 1992
and 1993 which require counties and other local agencies to transfer
funds to local school districts, thereby reducing State aid. Some
counties had implemented a method of making such transfers which
provided less money for schools if there were redevelopment agency
projects. The new legislation bans this method of transfer. If all
counties had implemented this method, General Fund aid to K-12 schools
would have been $300 million higher in each of the 1994-95 and 1995-96
Fiscal Years.
6. The 1994-95 Budget Act provides funding for anticipated growth in
the State's prison inmate population, including provisions for
implementing recent legislation (the so-called "Three Strikes" law)
which requires mandatory life prison terms for certain third-time felony
offenders.
7. Additional miscellaneous cuts ($500 million) and fund transfers
($255 million) totalling in the aggregate approximately $755 million.
The 1994-95 Budget Act contains no tax increases. Under legislation
enacted for the 1993-94 Budget, the renters" tax credit was suspended
for two years (1993 and 1994). A ballot proposition to permanently
restore the renters" tax credit after this year failed at the June, 1994
election. The Legislature enacted a further one-year suspension of the
renters" tax credit, for 1995, saving about $390 million in the 1995-96
Fiscal Year.
The 1994-95 Budget assumes that the State will use a cash flow
borrowing program in 1994-95 which combines one-year notes and two year
warrants which have now been issued. Issuance of warrants allows the
State to defer repayment of approximately $1.0 billion of its
accumulated budget deficit into the 1995-96 Fiscal Year.
The State's cash flow management plan for the 1994-95 fiscal year
included the issuance of $4.0 billion of revenue anticipation warrants
on July 26, 1994, to mature on April 25, 1996, as part of a two-year
plan to retire the accumulated State budget deficit.
Because preparation of cash flow estimates for the 1995-96 Fiscal Year
is necessarily more imprecise than for the current fiscal year and
entails greater risks of variance from assumptions, and because the
Governor's two-year budget plan assumes receipt of a large amount of
federal aid in the 1995-96 Fiscal Year for immigration-related costs
which is uncertain, the Legislature enacted a backup budget adjustment
mechanism to mitigate possible deviations from projected revenues,
expenditures or internal borrowable resources which might reduce
available cash resources during the two-year plan, so as to assure
repayment of the warrants.
Pursuant to Section 12467 of the California Government Code, enacted
by Chapter 135, Statutes of 1994 (the "Budget Adjustment Law"), the
State Controller was required to make a report by November 15, 1994 on
whether the projected cash resources for the General Fund as of June 30,
1995
38
<PAGE>
will decrease more than $430 million from the amount projected by
the State in its Official Statement in July, 1994 for the sale of
$4,000,000,000 of Revenue Anticipation Warrants. On November 15, 1994,
the State Controller issued the report on the State's cash position
required by the Budget Adjustment Law. The report indicated that the
cash position of the General Fund on June 30, 1995 would be $581 million
better than was estimated in the July, 1994 cash flow projections and
therefore, no budget adjustment procedures will be invoked for the
1994-95 Fiscal Year. As explained earlier, the Law would only be
implemented if the State Controller estimated that borrowable resources
on June 30, 1995 would be at least $430 million lower than projected.
The State Controller's report identified a number of factors which
have led to the improved cash position of the State. Estimated revenues
and transfers for the 1994-95 Fiscal Year other than federal
reimbursement for immigration costs were up about $650 million. The
largest portion of this was in higher bank and corporation tax receipts,
but all major tax sources were above original projections. However, most
of the federal immigration aid revenues projected in connection with the
1994-95 Budget Act and in the July, 1994 cash flows will not be
received, as indicated above, leaving a net increase in revenues of $322
million.
On the expenditure side, the State Controller reported that estimated
reduced caseload growth in health and welfare programs, reduced school
enrollment growth, and an accounting adjustment reducing a transfer from
the General Fund to the Special Fund for Economic Uncertainties resulted
in overall General Fund expenditure reductions (again before adjusting
for federal aid) of $672 million. However, the July, 1994 cash flows
projected that General Fund health and welfare and education
expenditures would be offset by the anticipated receipt of $407 million
in federal aid for illegal immigrant costs. The State Controller now
estimates that none of these funds will be received, so the net
reduction in General Fund expenditures is $265 million.
Finally, the State Controller indicated that a review of balances in
special funds available for internal borrowing resulted in an estimated
reduction of such borrowable resources of $6 million. The combination
of these factors results in the estimated improvement of the General
Fund's cash position of $581 million. The State Controller's revised
cash flow projections for 1994-95 have allocated this improvement to two
line items: an increase from $0 to $427 million in the estimated ending
cash balance of the General Fund on June 30, 1995, and an increase in
unused borrowable resources of $154 million.
The State Controller's report indicated that there was no anticipated
cash impact in the 1994-95 Fiscal Year for recent initiatives on "three
strikes" criminal penalties and illegal immigration which were approved
by voters on November 8, 1994. At a hearing before a committee of the
Legislature on November 15, 1994, both the Legislative Analyst and the
Department of Finance concurred in the reasonableness of the State
Controller's report. (The Legislative Analyst had issued a preliminary
analysis on November 1, 1994 which reached a conclusion very close to
that of the State Controller.) The State Controller's report makes no
projections about whether the Law may have to be implemented in 1995-96.
However, both the State Controller and the Legislative Analyst in the
November 15 hearing noted that the July, 1994 cash flows for the 1995-96
Fiscal Year place continued reliance on large amounts of federal
assistance for immigration costs, which did not materialize this year,
indicating significant budget pressures for next year. The Department
of Finance indicated that the budgetary issues identified in the hearing
would be addressed in the Governor's Budget proposal for the 1995-96
Fiscal Year, which will be released in early January, 1995.
The Director of Finance is required to include updated cash-flow
statements for the 1994-95 and 1995-96 Fiscal Years in the May revision
to the 1995-96 Fiscal Year budget proposal. By June 1, 1995, the State
Controller must concur with these updated statements or provide a
revised estimate of the cash condition of the General Fund for the
1994-95 and the 1995-96 Fiscal Years. For the 1995-96 Fiscal Year,
Chapter 135 prohibits any external borrowing as of June 30, 1996,
thereby requiring the
39
<PAGE>
State to rely solely on internal borrowable
resources, expenditure reductions or revenue increases to eliminate any
projected cash flow shortfall.
Commencing on October 15, 1995, the State Controller will, in
conjunction with the Legislative Analyst's Office, review the estimated
cash condition of the General Fund for the 1995-96 Fiscal Year.
The "1996 cash shortfall" shall be the amount necessary to bring the
balance of unused borrowable resources on June 30, 1996 to zero. On or
before December 1, 1995, legislation must be enacted providing for
sufficient General Fund expenditure reductions, revenue increases, or
both, to offset any such 1996 cash shortfall identified by the State
Controller. If such legislation is not enacted, within five days
thereafter the Director of Finance must reduce all General Fund
appropriations for the 1995-96 Fiscal Year, except the Required
Appropriations, by the percentage equal to the ratio of said 1996 cash
shortfall to total remaining General Fund appropriations for the 1995-96
Fiscal Year, excluding the Required Appropriations.
On December 6, 1994, Orange County, California and its Investment Pool
(the "Pool") filed for bankruptcy under Chapter 9 of the United States
Bankruptcy Code. Approximately 187 California public entities,
substantially all of which are public agencies within the County, are
investors in the Pool. Many of the agencies have various bonds, notes
or other forms of indebtedness outstanding, in some instances the
proceeds of which have been invested in the Pool. Such agencies also
have additional funds invested in the Pool. Since the filing, investor
access to monies in the Pool has been by Court order only and severely
limited. Various representatives of the County have indicated that the
Pool expects to lose a substantial amount of its original principal
invested. The County has employed various investment advisors to
restructure the Pool. Such restructuring has resulted in the sale of a
significant amount of the Pool's portfolio resulting in losses estimated
to be in excess of approximately $1.6 billion. The County has indicated
that further losses could be incurred as restructuring continues. It is
anticipated that such losses may result in delays or failures of the
County as well as investors in the Pool to make scheduled debt service
payments. Further, the County expects substantial budget deficits to
occur in Fiscal Year 1995 with possibly similar effects upon operations
of investors in the Pool. The County failed to make certain deposits to
a fund for repayment of $169,000,000 aggregate principal amount of its
short term indebtedness resulting in a technical default under its note
resolution. There has been no default in payment to noteholders.
Principal and interest on such notes is due on June 30, 1995.
Additionally, the County has defaulted in its obligation to accept
tenders of its $110,200,000 aggregate principal amount of its Taxable
Pension Obligation Bonds, Series B used to finance County pension
obligations. Interest at a rate set pursuant to the bond documents has
been timely paid on such Pension Bonds. Principal and interest payments
on other indebtedness of the County and the investors will come due at
various times and amounts throughout 1995. Both Standard & Poors and
Moody's Investors Service have suspended or downgraded ratings on
various debt securities of the County and certain of the investors in
the Pool. Such suspensions or downgradings could affect both price and
liquidity of such securities. The Fund is unable to predict when funds
may be released from the Pool to investors, the amount of such funds, if
any, whether additional technical and payment defaults by the County
and/or investors in the pool and the financial impact upon the value of
securities of the County and the investors in the Pool. Further,
continuing audits of various funds by outside consultants and the State
Auditor have initially identified transfers to and among various funds
as unauthorized and/or inappropriate. Such undertakings could result in
significantly greater or lesser losses among the County and the
investors.
Constitutional, Legislative and Other Factors. Certain California
constitutional amendments, legislative measures, executive orders,
administrative regulations and voter initiatives could result in the
adverse effects described below. The following information constitutes
only a brief summary, does not purport to be a complete description, and
is based on information drawn from official statements and prospectuses
relating to securities offerings of the State of California and various
local agencies in
40
<PAGE>
California, available as of the date of this
Prospectus. While the Sponsors have not independently verified such
information, they have no reason to believe that such information is not
correct in all material respects.
Certain Debt Obligations in the Portfolio may be obligations of
issuers which rely in whole or in part on California State revenues for
payment of these obligations. Property tax revenues and a portion of the
State's general fund surplus are distributed to countries, cities and
their various taxing entities and the State assumes certain obligations
theretofore paid out of local funds. Whether and to what extent a
portion of the State's general fund will be distributed in the future to
counties, cities and their various entities, is unclear.
In 1988, California enacted legislation providing for a water's-edge
combined reporting method if an election fee was paid and other
conditions met. On October 6, 1993, California Governor Pete Wilson
signed Senate Bill 671 (Alquist) which modifies the unitary tax law by
deleting the requirements that a taxpayer electing to determine its
income on a water's-edge basis pay a fee and file a domestic disclosure
spreadsheet and instead requiring an annual information return.
Significantly, the Franchise Tax Board can no longer disregard a
taxpayer's election. The Franchise Tax Board is reported to have
estimated state revenue losses from the Legislation as growing from $27
million in 1993-94 to $616 million in 1999-2000, but others, including
Assembly Speaker Willie Brown, disagree with that estimate and assert
that more revenue will be generated for California, rather than less,
because of an anticipated increase in economic activity and additional
revenue generated by the incentives in the Legislation.
Certain of the Debt Obligations may be obligations of issuers who rely
in whole or in part on ad valorem real property taxes as a source of
revenue. On June 6, 1978, California voters approved an amendment to
the California Constitution known as Proposition 13, which added Article
XIIIA to the California Constitution. The effect of Article XIIIA is to
limit ad valorem taxes on real property and to restrict the ability of
taxing entities to increase real property tax revenues. On November 7,
1978, California voters approved Proposition 8, and on June 3, 1986,
California voters approved Proposition 46, both of which amended Article
XIIIA.
Section 1 of Article XIIIA limits the maximum ad valorem tax on real
property to 1% of full cash value (as defined in Section 2), to be
collected by the counties and apportioned according to law; provided
that the 1% limitation does not apply to ad valorem taxes or special
assessments to pay the interest and redemption charges on (i) any
indebtedness approved by the voters prior to July 1, 1978, or (ii) any
bonded indebtedness for the acquisition or improvement of real property
approved on or after July 1, 1978, by two-thirds of the votes cast by
the voters voting on the proposition. Section 2 of Article XIIIA
defines "full cash value" to mean "the County Assessor's valuation of
real property as shown on the 1975/76 tax bill under "full cash value"
or, thereafter, the appraised value of real property when purchased,
newly constructed, or a change in ownership has occurred after the 1975
assessment." The full cash value may be adjusted annually to reflect
inflation at a rate not to exceed 2% per year, or reduction in the
consumer price index or comparable local data, or reduced in the event
of declining property value caused by damage, destruction or other
factors. The California State Board of Equalization has adopted
regulations, binding on county assessors, interpreting the meaning of
"change in ownership" and "new construction" for purposes of determining
full cash value of property under Article XIIIA.
Legislation enacted by the California Legislature to implement Article
XIIIA (Statutes of 1978, Chapter 292, as amended) provides that
notwithstanding any other law, local agencies may not levy any ad
valorem property tax except to pay debt service on indebtedness approved
by the voters prior to July 1, 1978, and that each county will levy the
maximum tax permitted by Article XIIIA of $4.00 per $100 assessed
valuation (based on the former practice of using 25%, instead of 100%,
of full cash value as the assessed value for tax purposes). The
legislation further provided that, for the 1978/79 fiscal year
41
<PAGE>
only, the
tax levied by each county was to be apportioned among all taxing
agencies within the county in proportion to their average share of taxes
levied in certain previous years. The apportionment of property taxes
for fiscal years after 1978/79 has been revised pursuant to Statutes of
1979, Chapter 282 which provides relief funds from State moneys
beginning in fiscal year 1979/80 and is designed to provide a permanent
system for sharing State taxes and budget funds with local agencies.
Under Chapter 282, cities and counties receive more of the remaining
property tax revenues collected under Proposition 13 instead of direct
State aid. School districts receive a correspondingly reduced amount of
property taxes, but receive compensation directly from the State and are
given additional relief. Chapter 282 does not affect the derivation of
the base levy ($4.00 per $100 assessed valuation) and the bonded debt
tax rate.
On November 6, 1979, an initiative known as "Proposition 4" or the
"Gann Initiative" was approved by the California voters, which added
Article XIIIB to the California Constitution. Under Article XIIIB,
State and local governmental entities have an annual "appropriations
limit" and are not allowed to spend certain moneys called
"appropriations subject to limitation" in an amount higher than the
"appropriations limit." Article XIIIB does not affect the appropriation
of moneys which are excluded from the definition of "appropriations
subject to limitation," including debt service on indebtedness existing
or authorized as of January 1, 1979, or bonded indebtedness subsequently
approved by the voters. In general terms, the "appropriations limit" is
required to be based on certain 1978/79 expenditures, and is to be
adjusted annually to reflect changes in consumer prices, population, and
certain services provided by these entities. Article XIIIB also provides
that if these entities" revenues in any year exceed the amounts
permitted to be spent, the excess is to be returned by revising tax
rates or fee schedules over the subsequent two years.
At the November 8, 1988 general election, California voters approved
an initiative known as Proposition 98. This initiative amends Article
XIIIB to require that (i) the California Legislature establish a prudent
state reserve fund in an amount as it shall deem reasonable and
necessary and (ii) revenues in excess of amounts permitted to be spent
and which would otherwise be returned pursuant to Article XIIIB by
revision of tax rates or fee schedules, be transferred and allocated (up
to a maximum of 4%) to the State School Fund and be expended solely for
purposes of instructional improvement and accountability. No such
transfer or allocation of funds will be required if certain designated
state officials determine that annual student expenditures and class
size meet certain criteria as set forth in Proposition 98. Any funds
allocated to the State School Fund shall cause the appropriation limits
established in Article XIIIB to be annually increased for any such
allocation made in the prior year.
Proposition 98 also amends Article XVI to require that the State of
California provide a minimum level of funding for public schools and
community colleges. Commencing with the 1988-89 fiscal year, state
monies to support school districts and community college districts shall
equal or exceed the lesser of (i) an amount equalling the percentage of
state general revenue bonds for school and community college districts
in fiscal year 1986-87, or (ii) an amount equal to the prior year's
state general fund proceeds of taxes appropriated under Article XIIIB
plus allocated proceeds of local taxes, after adjustment under Article
XIIIB. The initiative permits the enactment of legislation, by a
two-thirds vote, to suspend the minimum funding requirement for one
year.
On June 30, 1989, the California Legislature enacted Senate
Constitutional Amendment 1, a proposed modification of the California
Constitution to alter the spending limit and the education funding
provisions of Proposition 98. Senate Constitutional Amendment 1, on the
June 5, 1990 ballot as Proposition 111, was approved by the voters and
took effect on July 1, 1990. Among a number of important provisions,
Proposition 111 recalculates spending limits for the State and for local
governments, allows greater annual increases in the limits, allows the
averaging of two years" tax revenues before requiring action regarding
excess tax revenues, reduces the amount of the funding guarantee in
recession years for school districts and community college districts
(but with a floor of 40.9 percent of State general fund tax revenues),
removes the provision of Proposition 98 which
42
<PAGE>
included excess moneys
transferred to school districts and community college districts in the
base calculation for the next year, limits the amount of State tax
revenue over the limit which would be transferred to school districts
and community college districts, and exempts increased gasoline taxes
and truck weight fees from the State appropriations limit.
Additionally, Proposition 111 exempts from the State appropriations
limit funding for capital outlays.
Article XIIIB, like Article XIIIA, may require further interpretation
by both the Legislature and the courts to determine its applicability to
specific situations involving the State and local taxing authorities.
Depending upon the interpretation, Article XIIIB may limit significantly
a governmental entity's ability to budget sufficient funds to meet debt
service on bonds and other obligations.
On November 4, 1986, California voters approved an initiative statute
known as Proposition 62. This initiative (i) requires that any tax for
general governmental purposes imposed by local governments be approved
by resolution or ordinance adopted by a two-thirds vote of the
governmental entity's legislative body and by a majority vote of the
electorate of the governmental entity, (ii) requires that any special
tax (defined as taxes levied for other than general governmental
purposes) imposed by a local governmental entity be approved by a
two-thirds vote of the voters within that jurisdiction, (iii) restricts
the use of revenues from a special tax to the purposes or for the
service for which the special tax was imposed, (iv) prohibits the
imposition of ad valorem taxes on real property by local governmental
entities except as permitted by Article XIIIA, (v) prohibits the
imposition of transaction taxes and sales taxes on the sale of real
property by local governments, (vi) requires that any tax imposed by a
local government on or after August 1, 1985 be ratified by a majority
vote of the electorate within two years of the adoption of the
initiative or be terminated by November 15, 1988, (vii) requires that,
in the event a local government fails to comply with the provisions of
this measure, a reduction in the amount of property tax revenue
allocated to such local government occurs in an amount equal to the
revenues received by such entity attributable to the tax levied in
violation of the initiative, and (viii) permits these provisions to be
amended exclusively by the voters of the State of California.
In September 1988, the California Court of Appeal in City of
Westminster v. County of Orange, 204 Cal. App. 3d 623, 215 Cal. Rptr.
511 (Cal. Ct. App. 1988), held that Proposition 62 is unconstitutional
to the extent that it requires a general tax by a general law city,
enacted on or after August 1, 1985 and prior to the effective date of
Proposition 62, to be subject to approval by a majority of voters. The
Court held that the California Constitution prohibits the imposition of
a requirement that local tax measures be submitted to the electorate by
either referendum or initiative. It is not possible to predict the
impact of this decision on charter cities, on special taxes or on new
taxes imposed after the effective date of Proposition 62.
On November 8, 1988, California voters approved Proposition 87.
Proposition 87 amended Article XVI, Section 16, of the California
Constitution by authorizing the California Legislature to prohibit
redevelopment agencies from receiving any of the property tax revenue
raised by increased property tax rates levied to repay bonded
indebtedness of local governments which is approved by voters on or
after January 1, 1989. It is not possible to predict whether the
California Legislature will enact such a prohibition nor is it possible
to predict the impact of Proposition 87 on redevelopment agencies and
their ability to make payments on outstanding debt obligations.
Certain Debt Obligations in the Portfolio may be obligations which are
payable solely from the revenues of health care institutions. Certain
provisions under California law may adversely affect these revenues and,
consequently, payment on those Debt Obligations.
The Federally sponsored Medicaid program for health care services to
eligible welfare beneficiaries in California is known as the Medi-Cal
program. Historically, the Medi-Cal Program has provided for a
cost-based system of reimbursement for inpatient care furnished to
Medi-Cal
43
<PAGE>
beneficiaries by any hospital wanting to participate in the
Medi-Cal program, provided such hospital met applicable requirements for
participation. California law now provides that the State of California
shall selectively contract with hospitals to provide acute inpatient
services to Medi-Cal patients. Medi-Cal contracts currently apply only
to acute inpatient services. Generally, such selective contracting is
made on a flat per diem payment basis for all services to Medi-Cal
beneficiaries, and generally such payment has not increased in relation
to inflation, costs or other factors. Other reductions or limitations
may be imposed on payment for services rendered to Medi-Cal
beneficiaries in the future.
Under this approach, in most geographical areas of California, only
those hospitals which enter into a Medi-Cal contract with the State of
California will be paid for non-emergency acute inpatient services
rendered to Medi-Cal beneficiaries. The State may also terminate these
contracts without notice under certain circumstances and is obligated to
make contractual payments only to the extent the California legislature
appropriates adequate funding therefor.
In February 1987, the Governor of the State of California announced
that payments to Medi-Cal providers for certain services (not including
hospital acute inpatient services) would be decreased by ten percent
through June 1987. However, a federal district court issued a
preliminary injunction preventing application of any cuts until a trial
on the merits can be held. If the injunction is deemed to have been
granted improperly, the State of California would be entitled to
recapture the payment differential for the intended reduction period.
It is not possible to predict at this time whether any decreases will
ultimately be implemented.
California enacted legislation in 1982 that authorizes private health
plans and insurers to contract directly with hospitals for services to
beneficiaries on negotiated terms. Some insurers have introduced plans
known as "preferred provider organizations" ("PPOs"), which offer
financial incentives for subscribers who use only the hospitals which
contract with the plan. Under an exclusive provider plan, which
includes most health maintenance organizations ("HMOs"), private payors
limit coverage to those services provided by selected hospitals.
Discounts offered to HMOs and PPOs may result in payment to the
contracting hospital of less than actual cost and the volume of patients
directed to a hospital under an HMO or PPO contract may vary
significantly from projections. Often, HMO or PPO contracts are
enforceable for a stated term, regardless of provider losses or of
bankruptcy of the respective HMO or PPO. It is expected that failure to
execute and maintain such PPO and HMO contracts would reduce a
hospital's patient base or gross revenues. Conversely, participation may
maintain or increase the patient base, but may result in reduced payment
and lower net income to the contracting hospitals.
These Debt Obligations may also be insured by the State of California
pursuant to an insurance program implemented by the Office of Statewide
Health Planning and Development for health facility construction loans.
If a default occurs on insured Debt Obligations, the State Treasurer
will issue debentures payable out of a reserve fund established under
the insurance program or will pay principal and interest on an
unaccelerated basis from unappropriated State funds. At the request of
the Office of Statewide Health Planning and Development, Arthur D.
Little, Inc. prepared a study in December, 1983, to evaluate the
adequacy of the reserve fund established under the insurance program and
based on certain formulations and assumptions found the reserve fund
substantially underfunded. In September of 1986, Arthur D. Little, Inc.
prepared an update of the study and concluded that an additional 10%
reserve be established for "multi-level" facilities. For the balance of
the reserve fund, the update recommended maintaining the current reserve
calculation method. In March of 1990, Arthur D. Little, Inc. prepared a
further review of the study and recommended that separate reserves
continue to be established for "multi-level" facilities at a reserve
level consistent with those that would be required by an insurance
company.
44
<PAGE>
Certain Debt Obligations in the Portfolio may be obligations which are
secured in whole or in part by a mortgage or deed of trust on real
property. California has five principal statutory provisions which limit
the remedies of a creditor secured by a mortgage or deed of trust. Two
limit the creditor's right to obtain a deficiency judgment, one
limitation being based on the method of foreclosure and the other on the
type of debt secured. Under the former, a deficiency judgment is barred
when the foreclosure is accomplished by means of a nonjudicial trustee's
sale. Under the latter, a deficiency judgment is barred when the
foreclosed mortgage or deed of trust secures certain purchase money
obligations. Another California statute, commonly known as the "one form
of action" rule, requires creditors secured by real property to exhaust
their real property security by foreclosure before bringing a personal
action against the debtor. The fourth statutory provision limits any
deficiency judgment obtained by a creditor secured by real property
following a judicial sale of such property to the excess of the
outstanding debt over the fair value of the property at the time of the
sale, thus preventing the creditor from obtaining a large deficiency
judgment against the debtor as the result of low bids at a judicial
sale. The fifth statutory provision gives the debtor the right to redeem
the real property from any judicial foreclosure sale as to which a
deficiency judgment may be ordered against the debtor.
Upon the default of a mortgage or deed of trust with respect to
California real property, the creditor's nonjudicial foreclosure rights
under the power of sale contained in the mortgage or deed of trust are
subject to the constraints imposed by California law upon transfers of
title to real property by private power of sale. During the three-month
period beginning with the filing of a formal notice of default, the
debtor is entitled to reinstate the mortgage by making any overdue
payments. Under standard loan servicing procedures, the filing of the
formal notice of default does not occur unless at least three full
monthly payments have become due and remain unpaid. The power of sale is
exercised by posting and publishing a notice of sale for at least 20
days after expiration of the three-month reinstatement period.
Therefore, the effective minimum period for foreclosing on a mortgage
could be in excess of seven months after the initial default. Such time
delays in collections could disrupt the flow of revenues available to an
issuer for the payment of debt service on the outstanding obligations if
such defaults occur with respect to a substantial number of mortgages or
deeds of trust securing an issuer's obligations.
In addition, a court could find that there is sufficient involvement
of the issuer in the nonjudicial sale of property securing a mortgage
for such private sale to constitute 'state action," and could hold that
the private-right-of-sale proceedings violate the due process
requirements of the Federal or State Constitutions, consequently
preventing an issuer from using the nonjudicial foreclosure remedy
described above.
Certain Debt Obligations in the Portfolio may be obligations which
finance the acquisition of single family home mortgages for low and
moderate income mortgagors. These obligations may be payable solely
from revenues derived from the home mortgages, and are subject to
California's statutory limitations described above applicable to
obligations secured by real property. Under California antideficiency
legislation, there is no personal recourse against a mortgagor of a
single family residence purchased with the loan secured by the mortgage,
regardless of whether the creditor chooses judicial or nonjudicial
foreclosure.
Under California law, mortgage loans secured by single-family
owner-occupied dwellings may be prepaid at any time. Prepayment charges
on such mortgage loans may be imposed only with respect to voluntary
prepayments made during the first five years during the term of the
mortgage loan, and cannot in any event exceed six months" advance
interest on the amount prepaid in excess of 20% of the original
principal amount of the mortgage loan. This limitation could affect the
flow of revenues available to an issuer for debt service on the
outstanding debt obligations which financed such home mortgages.
45
<PAGE>
CALIFORNIA TAXES
In the opinion of O'Melveny & Myers, Los Angeles, California, special
counsel on California tax matters, under existing California law:
The Trust Fund is not an association taxable as a corporation for
California tax purposes. Each Holder will be considered the owner of a
pro rata portion of the Trust Fund and will be deemed to receive his pro
rata portion of the income therefrom. To the extent interest on the
Debt Obligations is exempt from California personal income taxes, said
interest is similarly exempt from California personal income taxes in
the hands of the Holders, except to the extent such Holders are banks or
corporations subject to the California franchise tax. Holders will be
subject to California income tax on any gain on the disposition of all
or part of his pro rata portion of a Debt Obligation in the Trust Fund.
A Holder will be considered to have disposed of all or part of his pro
rata portion of each Debt Obligation when he sells or redeems all or
some of his Units. A Holder will also be considered to have disposed of
all or part of his pro rata portion of a Debt Obligation when all or
part of the Debt Obligation is sold by the Trust Fund or is redeemed or
paid at maturity. The Debt Obligations and the Units are not taxable
under the California personal property tax law.
THE COLORADO TRUST
RISK FACTORS--Generally. The portfolio of the Colorado Trust consists
primarily of obligations issued by or on behalf of the State of Colorado
and its political subdivisions. The State's political subdivisions
include approximately 1,600 units of local government in Colorado,
including counties, statutory cities and towns, home-rule cities and
counties, school districts and a variety of water, irrigation, and other
special districts and special improvement districts, all with various
constitutional and statutory authority to levy taxes and incur
indebtedness.
Following is a brief summary of some of the factors which may affect
the financial condition of the State of Colorado and its political
subdivisions. It is not a complete or comprehensive description of
these factors or analysis of financial conditions and may not be
indicative of the financial condition of issuers of obligations
contained in the portfolio of the Colorado Trust or any particular
projects financed by those obligations. Many factors not included in
the summary, such as the national economy, social and environmental
policies and conditions, and the national and international markets for
petroleum, minerals and metals, could have an adverse impact on the
financial condition of the State and its political subdivisions,
including the issuers of obligations contained in the portfolio of the
Colorado Trust. It is not possible to predict whether and to what
extent those factors may affect the financial condition of the State and
its political subdivisions, including the issuers of obligations
contained in the portfolio of the Colorado Trust. Prospective investors
should study with care the issues contained in the portfolio of the
Colorado Trust, review carefully the information set out in Part B of
the prospectus under the caption "Risk Factors" and consult with their
investment advisors as to the merits of particular issues in the
portfolio.
The following summary is based on publicly available information which
has not been independently verified by the Sponsor or its legal counsel.
The State Economy. The State's economic growth is estimated to have
surpassed that of the nation's for the past seven consecutive years,
including 1994. Above-average population growth and migration into the
State are helping the State to post better performance in income growth,
homebuilding and job creation. Per-capita income has increased 25.3%
from 1988 through 1992. Retail trade sales has increased 40.4% from
1989 through 1993.
46
<PAGE>
Net migration into the State peaked in 1993 at 70,300 (an increase of
approximately 15.6% over 1992's net migration), with the overall State
population increasing 2.9% in 1993. Net migration into the State is
estimated to be 61,665 in 1994 (a decrease of approximately 12.3% over
1993's net migration), but with the overall State population still
increasing approximately 2.5% in 1994. The State's job growth rate was
4.7% in 1993, compared to 1.8% at the national level, and is estimated
to be 3.5% in 1994, compared to 2.6% at the national level. An
estimated 68,700 net nonfarm new jobs were generated in the State
economy. The State's unemployment rate remained below the national
unemployment rate for 1993.
State Revenues. The State operates on a fiscal year beginning July 1
and ending June 30. Fiscal year 1994 refers to the year ended June 30,
1994, and fiscal year 1995 refers to the year ended June 30, 1995.
The State derives substantially all of its General Fund revenues from
taxes. The two most important sources of these revenues are sales and
use taxes and individual income taxes, which accounted for approximately
31.1% and 57.5%, respectively, of total General Fund revenues during
fiscal year 1994. The Office of State Planning and Budgeting estimates
that, during fiscal year 1995, sales and use taxes will account for
approximately 32.0% of total General Fund revenues and individual income
taxes will account for approximately 58.3% of total General Fund
revenues. The ending General Fund balance for fiscal year 1993 was
$326.7 million and for fiscal year 1994 was 320.4 million. The
estimated ending General Fund balance for fiscal year 1995 is $276.8
million.
The Colorado Constitution contains strict limitations on the ability
of the State to create debt except under certain very limited
circumstances. However, the constitutional provision has been
interpreted not to limit the ability of the State to issue certain
obligations which do not constitute debt, including short-term
obligations which do not extend beyond the fiscal year in which they are
incurred and lease purchase obligations which are subject to annual
appropriation. Nevertheless, following passage by the votes of the
State of a tax and spending limitation amendment, described below, the
General Assembly adopted legislation prohibiting the State from entering
into contracts for the purchase or lease of real or personal property if
such contract involves the issuance of certificates of participation or
other similar instruments, until a court of competent jurisdiction
renders a final decision as to the constitutionality of such
instruments. See the discussion below under "Tax and Spending
Limitation Amendment."
The State is authorized pursuant to State statute to issue short-term
notes to alleviate temporary cash flow shortfalls. The most recent
issue of such notes, issued on July 6, 1994 and maturing June 27, 1995,
were given the highest rating available for short-term obligations by
Moody's Investor's Service, Inc. and Fitch Investors Service, Inc. A
rating on such notes was not requested from, and consequently no rating
was given by Standard & Poor's Corporation. Because of the short-term
nature of such notes, their ratings should not be considered necessarily
indicative of the State's general financial condition. It has not yet
been determined whether the State will issue similar short-term notes
for the beginning of the State's 1996 fiscal year.
Tax and Spending Limitation Amendment. On November 3, 1992, the
Colorado voters approved a State constitutional amendment (the
"Amendment") that restricts the ability of the State and local
governments to increase taxes, revenues, debt and spending. The
Amendment provides that its provisions supersede conflicting State
constitutional, State statutory, charter or other State or local
provisions.
The provisions of the Amendment apply to "districts," which are
defined in the Amendment as the State or any local government, with
certain exclusions. Under the terms of the Amendment, districts must
have prior voter approval to impose any new tax, tax rate increase, mill
levy increase, valuation for assessment ratio increase and extension of
an expiring tax. Prior voter approval is also
47
<PAGE>
required, except in
certain limited circumstances, for the creation of "any multiple-fiscal
year direct or indirect district debt or other financial obligations."
The Amendment prescribes the timing and procedures for any elections
required by the Amendment. Litigation has been filed, and is in various
stages of proceedings, against a number of Colorado municipalities,
counties and school districts, under which the plaintiffs claim various
procedural and substantive violations of the Amendment in the conduct of
the elections held in such municipalities, counties and school districts
on November 2, 1993.
On September 12, 1994, in Bickel v. City of Boulder (Case No.
94SA130), the State Supreme Court, among other things, determined that
(i) ballot questions which authorized the issuance of bonds and the
imposition of taxes to pay such bonds in the same proposition did not
violate the provisions of the Amendment, and (ii) in approving the
ballot questions, the voters could authorize property tax rates to be
adjusted as necessary to repay the specific debt incurred, provided the
tax rate increases are consistent with the 'stated estimate of the final
fiscal year dollar amount of the tax increase" set forth in the ballot
questions. On September 26, 1994, the plaintiffs in the Bickel case
filed a petition for rehearing with the State Supreme Court, which was
denied on October 11, 1994. On January 11, 1995, one of the plaintiffs
filed a petition for a Writ of Certiorari with the United States Supreme
Court, seeking review the State Supreme Court's decision. The plaintiff
argues, among other things, that his constitutional rights as a voter
will be violated if each future mill levy increase to pay debt service
is not approved at future mill levy tax elections, even if the amount of
the increase is within the annual amount authorized in the initial
ballot question. It is not possible to predict whether the United
States Supreme Court will accept jurisdiction of the Certiorari
petition, or the outcome of any such action.
On February 6, 1995, in City of Aurora v. Acosta (Case No. 942C250),
the State Supreme Court further determined that (i) a ballot question
seeking a voter-approved revenue change (i.e., an exception to the
revenue and spending limits of the Amendment) could describe the
proposed revenue change to include all revenue attributable to a stated
tax rate to be imposed, instead of a stated dollar amount, and (ii) in a
mail ballot election, where all relevant information was presented to
the voters in the election ballot and related election notice, the
election materials substantially complied with the Amendment, even
though the ballot omitted certain information required under Bickel.
The State Supreme Court looked to three factors, first announced in
Bickel, to determine substantial compliance. These factors include (i)
the extent of a taxing district's noncompliance with the Amendment
provisions with respect to the challenged ballot issue, (ii) the purpose
of the provision violated and whether that purpose is substantially
achieved despite the taxing district's noncompliance, and (iii) whether
it can be reasonably inferred that the taxing district made a good faith
effort to comply with the Amendment, or attempted to mislead the
electorate.
Other cases are expected to continue proceeding through the appeal
process.
Because the Amendment's voter approval requirements apply to any
"multiple-fiscal year" debt or financial obligation, short-term
obligations which do not extend beyond the fiscal year in which they are
incurred are treated as exempt from the voter approval requirements of
the Amendment. Case law prior to the adoption of the Amendment
determined that lease purchase obligations subject to annual
appropriation do not constitute debt under the Colorado constitution.
On January 6, 1994, in Board of County Commissioners of County of
Boulder v. Dougherty, Dawkins, Strand & Bigelow Incorporated, the
District Court for Boulder County, Colorado held, among other things,
that a lease obligation that is expressly subject to annual
appropriation cannot be characterized as a multiple-fiscal year
obligation, and therefore is not subject to the voter approval
requirements of the Amendment. This holding was affirmed by the State
Court of Appeals on November 3, 1993. The decision of the Court of
Appeals was not appealed to the State Supreme Court.
48
<PAGE>
The Amendment's voter approval requirements and other limitations
(discussed in the following paragraph) do not apply to "enterprises"
which term is defined to include government-owned businesses authorized
to issue their own revenue bonds and receiving under 10% of annual
revenue in grants from all Colorado state and local governments
combined. Enterprise status under the Amendment has been and is likely
to continue to be subject to legislative and judicial interpretation.
Among other provisions, the Amendment requires the establishment of
emergency reserves, limits increases in district revenues and limits
increases in district fiscal year spending. As a general matter, annual
State fiscal year spending may change no more than inflation plus the
percentage change in State population in the prior calendar year.
Annual local district fiscal year spending may change no more than
inflation in the prior calendar year plus annual local growth, as
defined in and subject to the adjustments provided in the Amendment.
The Amendment provides that annual district property tax revenues may
change no more than inflation in the prior calendar year plus annual
local growth, as defined in and subject to the adjustments provided in
the Amendment. District revenues in excess of the limits prescribed by
the Amendment are required, absent voter approval, to be refunded by any
reasonable method, including temporary tax credits or rate reductions.
In addition, the Amendment prohibits new or increased real property
transfer taxes, new State real property taxes and new local district
income taxes. The Amendment also provides that a local district may
reduce or end its subsidies to any program (other than public education
through grade 12 or as required by federal law) delegated to it by the
State General Assembly for administration.
The foregoing is not intended as a complete description of all of the
provisions of the Amendment. Many provisions of the Amendment are
ambiguous and will require judicial interpretation. Several statutes
enacted or proposed during the 1993 and 1994 legislative sessions
attempt to clarify the application of the Amendment with respect to
certain governmental entities and activities. However, many provisions
of the Amendment are likely to continue to be the subject of further
legislation or judicial proceedings. The application of the Amendment
may adversely affect the financial condition and operations of the State
and local governments in the State to an extent which cannot be
predicted. Litigation attempting to apply the provisions of the
Amendment in a manner which would affect general obligations of a school
district issued prior to the approval of the Amendment was commenced in
1993. In December 1993 the District Court before which this litigation
was pending issued its opinion, among others, that the school district
could increase its debt service mill levy to provide for the debt
service on such general obligations without additional, post-Amendment,
voter approval and without decreasing its general revenue mill levy.
This case is scheduled for oral argument before the State Supreme Court
in March 1995.
COLORADO TAXES
In the opinion of Becker Stowe Bowles & Lynch P.C., special counsel on
Colorado tax matters, under existing Colorado law and for Colorado
income tax purposes only:
1. The Colorado Trust will be treated as a trust and will not be
taxable as a corporation. Income of the Colorado Trust will be treated
as income of the Holders of Units of the Colorado Trust in the same
manner as for Federal income tax purposes.
2. Each Holder of Units of the Colorado Trust will be treated as
receiving his or her pro rata share of interest on each Debt Obligation
in the Colorado Trust when it is received by the Colorado Trust.
Interest on Debt Obligations in the Colorado Trust that would be exempt
from Colorado income tax if paid directly to a Holder will be treated as
exempt from Colorado income tax when received by the Colorado Trust and
distributed to the Holders of Units of the Colorado Trust.
3. Each Holder of Units of the Colorado Trust will be treated as
recognizing gain or loss when the Colorado Trust disposes of a Debt
Obligation or when the Holder disposes of all or a portion
49
<PAGE>
of his or her
Units, whether by sale, exchange, redemption or payment at maturity, in
the same manner as for Federal income tax purposes. The amount of such
gain or loss is determined by reference to the amount of such gain or
loss for Federal income tax purposes.
4. Interest on indebtedness incurred or continued by a Holder of
Units of the Colorado Trust to purchase or carry such Units is not
deductible for Colorado income tax purposes to the extent it is not
deductible for Federal income tax purposes.
The foregoing opinions concerning Colorado income tax apply only to
Holders who are individuals and have been made in reliance upon the
opinion of Davis Polk & Wardwell concerning the Federal income tax
treatment of the Colorado Trust and the Holders of its Units.
THE CONNECTICUT TRUST
RISK FACTORS--The State Economy. Manufacturing has historically been
of prime economic importance to Connecticut. The manufacturing industry
is diversified, with transportation equipment (primarily aircraft
engines, helicopters and submarines) the dominant industry, followed by
non-electrical machinery, fabricated metal products, and electrical
machinery. From 1970 to 1993, however, there was a rise in employment
in service-related industries. During this period, manufacturing
employment declined 33.5%, while the number of persons employed in other
non-agricultural establishments (including government) increased 63.3%,
particularly in the service, trade and finance categories. In 1993,
manufacturing accounted for only 19.2% of total non-agricultural
employment in Connecticut. Defense-related business represents a
relatively high proportion of the manufacturing sector. On a per capita
basis, defense awards to Connecticut have traditionally been among the
highest in the nation, and reductions in defense spending have had a
substantial adverse impact on Connecticut's economy. Moreover, the
State's largest defense contractors have announced substantial planned
labor force reductions scheduled to occur over the next four years.
The annual average unemployment rate (seasonally adjusted) in
Connecticut decreased from 6.9% in 1982 to a low of 3.0% in 1988 but
rose to 6.6% in 1993. While these rates were lower than those recorded
for the U.S. as a whole for the same periods, as of May, 1993, the
estimated rate of unemployment in Connecticut on a seasonably adjusted
basis reached 7.4%, compared to 6.0% for the nation as a whole, and
pockets of significant unemployment and poverty exist in some of
Connecticut's cities and towns. Moreover, Connecticut is now in a
recession, the depth and duration of which are uncertain.
State Revenues and Expenditures. The State derives over seventy
percent of its revenues from taxes imposed by the State. The two major
taxes have been the sales and use taxes and the corporation business
tax, each of which is sensitive to changes in the level of economic
activity in the State, but the Connecticut income tax on individuals,
trusts, and estates enacted in 1991 has superseded each of them in
importance.
The State's General Fund budget for the 1986-87 fiscal year
anticipated appropriations and revenues of approximately $4,300,000,000.
The General Fund ended the 1986-87 fiscal year with an operating surplus
of $365,200,000. The General Fund budget for the 1987-88 fiscal year
anticipated appropriations and revenues of approximately $4,915,800,000.
However, the General Fund ended the 1987-88 fiscal year with an
operating deficit of $115,600,000. The General Fund budget for the
1988-89 fiscal year anticipated that General Fund expenditures of
$5,551,000,000 and certain educational expenses of $206,700,000 not
previously paid through the General Fund would be financed in part from
surpluses of prior years and in part from higher tax revenues projected
to result from tax laws in effect for the 1987-88 fiscal year and
stricter enforcement thereof; a substantial deficit was projected during
the third quarter of the 1988-89 fiscal year, but, largely because of
tax law changes
50
<PAGE>
that took effect before the end of the fiscal year, the
operating deficit was kept to $28,000,000. The General Fund budget for
the 1989-90 fiscal year anticipated appropriations of approximately
$6,224,500,000 and, by virtue of tax increases enacted to take effect
generally at the beginning of the fiscal year, revenues slightly
exceeding such amount. However, largely because of tax revenue
shortfalls, the General Fund ended the 1989-90 fiscal year with an
operating deficit for the year of $259,000,000, wiping out reserves for
such events built up in prior years. The General Fund budget for the
1990-91 fiscal year anticipated expenditures of $6,433,000,000, but no
significant new or increased taxes were enacted. Primarily because of
significant declines in tax revenues and unanticipated expenditures
reflective of economic adversity, the General Fund ended the 1990-91
fiscal year alone with a further deficit of $809,000,000. A General
Fund budget was not enacted for the 1991-92 fiscal year until August 22,
1991. This budget anticipated General Fund expenditures of
$7,007,861,328 and revenues of $7,426,390,000. Anticipated decreases in
revenues resulting from a 25% reduction in the sales tax rate effective
October 1, 1991, the repeal of the taxes on the capital gains and
interest and dividend income of resident individuals for years starting
after 1991, and the phase-out of the corporation business tax surcharge
over two years commencing with years starting after 1991 were expected
to be more than offset by a new general personal income tax imposed at
effective rates not to exceed 4.5% on the Connecticut taxable income of
resident and non-resident individuals, trusts, and estates. The General
Fund ended the 1991-92 fiscal year with an operating surplus of
$110,000,000. The General Fund budget for the 1992-93 fiscal year
anticipated General Fund expenditures of $7,372,062,859 and revenues of
$7,372,210,000, and the General Fund ended the 1992-93 fiscal year with
an operating surplus of $113,500,000. Balanced General Fund budgets for
the biennium ending June 30, 1995, were adopted in 1993 appropriating
expenditures of $7,829,000,000 for the 1993-94 fiscal year and
$8,266,000,000 for the 1994-95 fiscal year. The General Fund ended the
1993-94 fiscal year with an operating surplus of $19,700,000. In 1994
the budgeted General Fund appropriations for the 1994-95 fiscal year
were increased to $8,567,200,000.
State Debt. The primary method for financing capital projects by the
State is through the sale of the general obligation bonds of the State.
These bonds are backed by the full faith and credit of the State. As of
November 1, 1994, there was a total legislatively authorized bond
indebtedness of $10,179,811,925, of which $8,431,752,734 had been
approved for issuance by the State Bond Commission and $7,190,061,163
had been issued.
To fund operating cash requirements, prior to the 1991-92 fiscal year
the State borrowed up to $750,000,000 pursuant to authorization to issue
commercial paper and on July 29, 1991, it issued $200,000,000 General
Obligation Temporary Notes, none of which temporary borrowings were
outstanding as of January 14, 1994. To fund the cumulative General Fund
deficit for the 1989-90 and 1990-91 fiscal years, the legislation
enacted August 22, 1991, authorized the State Treasurer to issue
Economic Recovery Notes up to the aggregate amount of such deficit,
which must be payable no later than June 30, 1996; at least $50,000,000
of such Notes, but not more than a cap amount, is to be retired each
fiscal year commencing with the 1991-92 fiscal year, and any
unappropriated surplus up to $205,000,000 in the General Fund at the end
of each of the three fiscal years commencing with the 1991-92 fiscal
year must be applied to retire such Notes as may remain outstanding at
those times. On September 25, 1991 and October 24, 1991, the State
issued $640,710,000 and $325,000,000 respectively, of such Economic
Recovery Notes, of which $555,610,000 were outstanding as of November 1,
1994.
To meet the need for reconstructing, repairing, rehabilitating and
improving the State transportation system (except Bradley International
Airport), the State adopted legislation which provides for, among other
things, the issuance of special tax obligation ("STO") bonds the
proceeds of which will be used to pay for improvements to the State's
transportation system. The STO bonds are special tax obligations of the
State payable solely from specified motor fuel taxes, motor vehicle
receipts, and license, permit and fee revenues pledged therefor and
deposited in the special transportation fund. The cost of the
infrastructure program for the twelve years beginning in 1984, to
51
<PAGE>
be met
from federal, state, and local funds, is currently estimated at $9.4
billion. To finance a portion of the State's $4.1 billion share of such
cost, the State expects to issue $3.7 billion of STO bonds over the
twelve-year period.
As of November 1, 1994, the General Assembly has authorized STO bonds
for the program in the aggregate amount of $3,794,938,104, of which
$3,144,650,752 had been issued. It is anticipated that additional STO
bonds will be authorized by the General Assembly annually in an amount
necessary to finance and to complete the infrastructure program. Such
additional bonds may have equal rank with the outstanding bonds provided
certain pledged revenue coverage requirements of the STO indenture
controlling the issuance of such bonds are met. The State expects to
continue to offer bonds for this program.
The State's budget problems led to the ratings of its general
obligation bonds being reduced by Standard & Poors from AA+ to AA on
March 29, 1990, and by Moody's from Aa1 to Aa on April 9, 1990. Because
of concerns over Connecticut's lack of a plan to deal during the current
fiscal year with the accumulated projected deficits in its General Fund,
on September 13, 1991, Standard & Poors further reduced its ratings of
the State's general obligation bonds and certain other obligations that
depend in part on the creditworthiness of the State to AA-. On March 7,
1991, Moody's downgraded its ratings of the revenue bonds of four
Connecticut hospitals because of the effects of the State's restrictive
controlled reimbursement environment under which they have been
operating.
Litigation. The State, its officers and employees are defendants in
numerous lawsuits. According to the Attorney General's Office, an
adverse decision in any of the cases summarized herein could materially
affect the State's financial position: (i) litigation on behalf of black
and Hispanic school children in the City of Hartford seeking "integrated
education" and a declaratory judgment that the public schools within the
greater Hartford metropolitan area are segregated and inherently
unequal; (ii) litigation involving claims by Indian tribes to monetary
recovery and ownership of portions of the State's land area; (iii)
litigation challenging the State's method of financing elementary and
secondary public schools on the ground that it denies equal access to
education; (iv) an action in which two retarded persons seek placement
outside a State hospital, new programs and damages on behalf of
themselves and all mentally retarded patients at the hospital; (v)
litigation involving claims for refunds of taxes by several cable
television companies; (vi) an action on behalf of all persons with
retardation or traumatic brain injury, claiming that their
constitutional rights are violated by placement in State hospitals
alleged not to provide adequate treatment and training, and seeking
placement in community residential settings with appropriate support
services; (vii) an action by the Connecticut Hospital Association and 33
hospitals seeking to require the State to reimburse hospitals for
in-patient medical services on a basis more favorable to them; (viii) a
class action by the Connecticut Criminal Defense Lawyers Association
claiming a campaign of illegal surveillance activity over a period of
years and seeking damages and injunctive relief; (ix) two actions for
monetary damages brought by a former patient at a State mental hospital
stemming from an attempted suicide that left her brain-damaged; (x) an
action challenging the validity of the State's imposition of surcharges
on hospital charges to finance certain uncompensated care costs incurred
by hospitals; (xi) an action to enforce the spending cap provision of
the State's constitution by seeking to require that the General Assembly
define certain terms used therein and to enjoin certain increases in
"general budget expenditures" until this is done; (xii) an action
challenging the validity of the State's imposition of gross earnings
taxes on hospital revenues to finance certain uncompensated care costs
incurred by hospitals; and (xiii) an action by inmates of the Department
of Correction seeking damages and injunctive relief with respect to
alleged violations of statutory and constitutional rights as a result of
the monitoring and recording of their telephones from the State's
correctional institutions. In addition, a number of corporate taxpayers
have filed refund requests for corporation business tax asserting that
interest on federal obligations may not be included in the measure of
that tax, alleging that to do so violates federal law because interest
on certain State of Connecticut obligations is not included in the
measure of the tax.
52
<PAGE>
Municipal Debt Obligations. General obligation bonds issued by
municipalities are usually payable from ad valorem taxes on property
subject to taxation by the municipality. Certain Connecticut
municipalities have experienced severe fiscal difficulties and have
reported operating and accumulated deficits in recent years. The most
notable of these is the City of Bridgeport, which filed a bankruptcy
petition on June 7, 1991. The State opposed the petition. The United
States Bankruptcy Court for the District of Connecticut has held that
Bridgeport has authority to file such a petition but that its petition
should be dismissed on the grounds that Bridgeport was not insolvent
when the petition was filed.
In addition to general obligation bonds backed by the full faith and
credit of the municipality, certain municipal authorities may issue
bonds that are not considered to be debts of the municipality. Such
bonds may only be repaid from the revenues of projects financed by the
municipal authority, which revenues may be insufficient to service the
authority's debt obligations.
Regional economic difficulties, reductions in revenues, and increased
expenses could lead to further fiscal problems for the State and its
political subdivisions, authorities, and agencies. This could result in
declines in the value of their outstanding obligations, increases in
their future borrowing costs, and impairment of their ability to pay
debt service on their obligations.
CONNECTICUT TAXES
In the Opinion of Day, Berry & Howard, special counsel on Connecticut
tax matters, which is based explicitly on the Opinion of Davis Polk &
Wardwell regarding Federal income tax matters, under existing
Connecticut law:
1. The Connecticut Trust is not liable for any tax on or measured by
net income imposed by the State of Connecticut.
2. Interest income of the Connecticut Trust from Debt Obligations
issued by or on behalf of the State of Connecticut, any political
subdivision thereof, or public instrumentality, state or local
authority, district, or similar public entity created under the laws of
the State of Connecticut ("Connecticut Debt Obligations"), or from Debt
Obligations issued by United States territories or possessions the
interest on which Federal law would prohibit Connecticut from taxing if
received directly by a Holder, is not taxable under the Connecticut tax
on the Connecticut taxable income of individuals, trusts, and estates
(the "Connecticut Income Tax"), when any such interest is received by
the Connecticut Trust or distributed by it to such a Holder.
3. Gains and losses recognized by a Holder for Federal income tax
purposes upon the maturity, redemption, sale, or other disposition by
the Connecticut Trust of a Debt Obligation held by the Connecticut Trust
or upon the redemption, sale, or other disposition of a Unit of the
Connecticut Trust held by a Holder are taken into account as gains or
losses, respectively, for purposes of the Connecticut Income Tax, except
that, in the case of a Holder holding a Unit of the Connecticut Trust as
a capital asset, such gains and losses recognized upon the maturity,
redemption, sale, or exchange of a Connecticut Debt Obligation held by
the Connecticut Trust are excluded from gains and losses taken into
account for purposes of such tax and no opinion is expressed as to the
treatment for purposes of such tax of gains and losses recognized, to
the extent attributable to Connecticut Debt Obligations, upon the
redemption, sale, or other disposition by a Holder of a Unit of the
Connecticut Trust held by him.
4. The portion of any interest income or capital gain of the
Connecticut Trust that is allocable to a Holder that is subject to the
Connecticut corporation business tax is includable in the gross income
of such Holder for purposes of such tax.
53
<PAGE>
5. An interest in a Unit of the Connecticut Trust that is owned by or
attributable to a Connecticut resident at the time of his death is
includable in his gross estate for purposes of the Connecticut
succession tax and the Connecticut estate tax.
The Connecticut Income Tax was enacted in August, 1991. Generally a
Holder recognizes gain or loss for purposes of this tax to the same
extent as he recognizes gain or loss for Federal income tax purposes.
Ordinarily this would mean that gain or loss would be recognized by a
Holder upon the maturity, redemption, sale, or other disposition by the
Connecticut Trust of a Debt Obligation held by it, or upon the
redemption, sale, or other disposition of a Unit of the Connecticut
Trust held by the Holder.
However, on June 19, 1992, Connecticut legislation was adopted that
provides that gains and losses from the sale or exchange of Connecticut
Debt Obligations held as capital assets will not be taken into account
for purposes of the Connecticut Income Tax for taxable years starting on
or after January 1, 1992. Regulations effective for taxable years
starting on or after January 1, 1994, clarify that this provision also
applies to gain or loss recognized by a Holder upon the maturity or
redemption of a Connecticut Debt Obligation held by the Connecticut
Trust. However, it is not clear whether this provision would apply, to
the extent attributable to Connecticut Debt Obligations held by the
Connecticut Trust, to gain or loss recognized by a Holder upon the
redemption, sale, or other disposition of a Unit of the Connecticut
Trust held by the Holder.
By legislation adopted May 19, 1993, as amended by legislation adopted
June 25, 1993 and June 9, 1994, Connecticut enacted the net Connecticut
minimum tax, retroactive to taxable years beginning on or after January
1, 1993, which is applicable to individuals, trusts, and estates that
are subject to the Connecticut Income Tax and required to pay the
Federal alternative minimum tax. Income of the Connecticut Trust that
is subject to the Federal alternative minimum tax in the case of such a
Holder, other than interest from Connecticut Debt Obligations or from
Debt Obligations of United States territories or possessions that
Federal law would prohibit Connecticut from taxing if received directly
by the Holder, could cause the Holder to be liable for the net
Connecticut minimum tax.
Holders are urged to consult their own tax advisors concerning these
matters.
THE FLORIDA TRUST
The Portfolio of the Florida Trust contains different issues of
long-term debt obligations issued by or on behalf of the State of
Florida (the "state") and counties, municipalities and other political
subdivisions and public authorities thereof or by the Government of
Puerto Rico or the Government of Guam or by their respective
authorities, all rated in the category A or better by at least one
national rating organization (See Investment Summary in Part I).
Investment in the Florida Trust should be made with an understanding
that the value of the underlying Portfolio may decline with increases in
interest rates.
RISK FACTORS RELATING TO FLORIDA DEBT OBLIGATIONS--The State Economy.
In 1980 Florida ranked seventh among the fifty states with a population
of 9.7 million people. The State has grown dramatically since then and,
as of April 1, 1993, ranked fourth with an estimated population of 13.6
million, an increase of approximately 44.7% since 1980. Since the
beginning of the eighties, Florida has surpassed Ohio, Illinois and
Pennsylvania in total population. Florida's attraction, as both a
growth and retirement state, has kept net migration fairly steady with
an average of 292,988 new residents each year, from 1982 through 1993.
Since 1983 the prime working age population (18-44) has grown at an
average annual rate of 2.6%. The share of Florida's total working age
population (18-59) to total State population is approximately 54%.
Non-farm employment has grown by approximately 64% since 1980. Total
non-farm employment in Florida is expected to increase 3.6% in
54
<PAGE>
1994-95
and rise 3.3% in 1995-96. The service sector is Florida's largest
employment sector, presently accounting for 32.6% of total non-farm
employment and should experience an increase of 5.4% in 1994-1995 while
growing 4.7% in 1995-96. Manufacturing jobs in Florida are concentrated
in the area of high-tech and value-added sectors, such as electrical and
electronic equipment, as well as printing and publishing. Job gains in
Florida's manufacturing sector have exceeded national averages
increasing by 11.7% between 1980 and 1993. Foreign Trade has
contributed significantly to Florida's employment growth. Florida's
dependence on highly cyclical construction and construction related
manufacturing has declined. Total contract construction employment as a
share of total non-farm employment has fallen from 10% in 1973, to 7% in
1980 to 5% in 1993. Although the job creation rate for the State of
Florida since 1980 is over two times the rate for the nation as a whole,
since 1989 the unemployment rate for the State has risen faster than the
national average. The average rate of unemployment for Florida since
1980 is 6.5%, while the national average is 7.1%. The unemployment rate
is forecasted at 6.1% in 1994-95 and 6.1% in 1995-96. Because Florida
has a proportionately greater retirement age population, property income
(dividends, interest and rent) and transfer payments (Social Security
and pension benefits) are a relatively more important source of income.
In 1993, Florida employment income represented 62% of total personal
income, while nationally, employment income represented 72% of total
personal income. In the ten years ending in 1993, Florida total
personal income grew by nearly 115% and per capita income by
approximately 68.7%. For the nation, total and per capita personal
income increased by roughly 87.9% and 70.3%, respectively.
The ability of the State and its local units of government to satisfy
the Debt Obligations may be affected by numerous factors which impact on
the economic vitality of the State in general and the particular region
of the State in which the issuer of the Debt Obligation is located.
South Florida is particularly susceptible to international trade and
currency imbalances and to economic dislocations in Central and South
America, due to its geographical location and its involvement with
foreign trade, tourism and investment capital. The central and northern
portions of the State are impacted by problems in the agricultural
sector, particularly with regard to the citrus and sugar industries.
Short-term adverse economic conditions may be created in these areas,
and in the State as a whole, due to crop failures, severe weather
conditions or other agriculture-related problems. The State economy
also has historically been somewhat dependent on the tourism and
construction industries and is sensitive to trends in those sectors.
The State Budget. The State operates under a biennial budget which is
formulated in even numbered years and presented for approval to the
Legislature in odd numbered years. A supplemental budget request
process is utilized in the even numbered years for refining and
modifying the primary budget. Under the State Constitution and
applicable statutes, the State budget as a whole, and each separate fund
within the State budget, must be kept in balance from currently
available revenues during each State fiscal year. (The State's fiscal
year runs from July 1 through June 30). The Governor and the
Comptroller of the State are charged with the responsibility of ensuring
that sufficient revenues are collected to meet appropriations and that
no deficit occurs in any State fund.
The financial operations of the State covering all receipts and
expenditures are maintained through the use of three types of funds: the
General Revenue Fund, Trust Funds and Working Capital Fund. The
majority of the State's tax revenues are deposited in the General
Revenue Fund and moneys in the General Revenue Fund are expended
pursuant to appropriations acts. In fiscal year 1993-1994, expenditures
for education, health and welfare and public safety represented
approximately 49%, 32% and 12%, respectively, of expenditures from the
General Revenue Fund. The Trust Funds consist of moneys received by the
State which under law or trust agreement are segregated for a purpose
authorized by law. Revenues in the General Revenue Fund which are in
excess of the amount needed to meet appropriations may be transferred to
the Working Capital Fund.
State Revenues. For fiscal year 1994-1995 the estimated General
Revenue plus Working Capital Fund and Budget Stabilization funds
available total $14,624.4 million, a 5.7% increase over
55
<PAGE>
1993-94. This
amount reflects a transfer of $159 million in non-recurring revenue due
to Hurricane Andrew, to a hurricane relief trust fund. The $13,858.4
million in Estimated Revenues (excluding the Hurricane Andrew impacts)
and recently legislated revenue impacts represent an increase of 7.9%
over revenues for 1993-94. With combined General Revenue, Working
Capital Fund and Budget Stabilization appropriations at $14,311.1
million, unencumbered reserves at the end of 1994-95 are estimated at
$313.3 million. For fiscal year 1995-96, the estimated General Revenue
plus Working Capital and Budget Stabilization funds available total
$15,145.9 million, a 3.6% increase over 1994-95. The $14,647.2 million
in Estimated Revenues represent a 5.7% increase over the analogous
figure in 1994-95.
In fiscal year 1993-1994, the State derived approximately 66% of its
total direct revenues for deposit in the General Revenue Fund, Trust
Funds and Working Capital Fund from State taxes. Federal funds and
other special revenues accounted for the remaining revenues. The
greatest single source of tax receipts in the State is the 6% sales and
use tax. For the fiscal year ended June 30, 1994, receipts from the
sales and use tax totalled $10,012.5 million, an increase of
approximately 6.9% over fiscal year 1992-93. This amount includes
non-recurring increases attributable to the rebuilding and
reconstruction following the hurricane. The second largest source of
State tax receipts is the tax on motor fuels including the tax receipts
distributed to local governments. Receipts from the taxes on motor
fuels are almost entirely dedicated to trust funds for specific purposes
or transferred to local governments and are not included in the General
Revenue Fund. Preliminary data for the fiscal year ended June 30, 1994,
show collections of this tax totalled $1,733.4 million.
The State currently does not impose a personal income tax. However,
the State does impose a corporate income tax on the net income of
corporations, organizations, associations and other artificial entities
for the privilege of conducting business, deriving income or existing
within the State. For the fiscal year ended June 30, 1994, receipts
from the corporate income tax totalled $1,047.4 million, an increase of
23.7% from fiscal year 1992-93. The Documentary Stamp Tax collections
totalled $775 million during fiscal year 1993-94, posting a 21.3%
increase over fiscal year 1992-93. The Alcoholic Beverage Tax, an
excise tax on beer, wine and liquor totalled $439.8 million in fiscal
year 1993-94. The Florida lottery produced sales of $2.15 billion in
fiscal year 1993-94 of which $816.2 million was used for education
purposes.
While the State does not levy ad valorem taxes on real property or
tangible personal property, counties, municipalities and school
districts are authorized by law, and special districts may be authorized
by law, to levy ad valorem taxes. Under the State Constitution, ad
valorem taxes may not be levied by counties, municipalities, school
districts and water management districts in excess of the following
respective millages upon the assessed value of real estate and tangible
personal property: for all county purposes, ten mills; for all municipal
purposes, ten mills; for all school purposes, ten mills; and for water
management purposes, either 0.05 mill or 1.0 mill, depending upon
geographic location. These millage limitations do not apply to taxes
levied for payment of bonds and taxes levied for periods not longer than
two years when authorized by a vote of the electors. (Note: one mill
equals one-tenth of one cent.)
The State Constitution and statutes provide for the exemption of
homesteads from certain taxes. The homestead exemption is an exemption
from all taxation, except for assessments for special benefits, up to a
specific amount of the assessed valuation of the homestead. This
exemption is available to every person who has the legal or equitable
title to real estate and maintains thereon his or her permanent home.
All permanent residents of the State are currently entitled to a $25,000
homestead exemption from levies by all taxing authorities, however, such
exemption is subject to change upon voter approval.
On November 3, 1992, the voters of the State of Florida passed an
amendment to the Florida Constitution establishing a limitation on the
annual increase in assessed valuation of homestead property
56
<PAGE>
commencing
January 1, 1994, of the lesser of 3% or the increase in the Consumer
Price Index during the relevant year, except in the event of a sale
thereof during such year, and except as to improvements thereto during
such year. The amendment did not alter any of the millage rates
described above.
Since municipalities, counties, school districts and other special
purpose units of local governments with power to issue general
obligation bonds have authority to increase the millage levy for voter
approved general obligation debt to the amount necessary to satisfy the
related debt service requirements, the amendment is not expected to
adversely affect the ability of these entities to pay the principal of
or interest on such general obligation bonds. However, in periods of
high inflation, those local government units whose operating millage
levies are approaching the constitutional cap and whose tax base
consists largely of residential real estate, may, as a result of the
above-described amendment, need to place greater reliance on non-ad
valorem revenue sources to meet their operating budget needs.
At the November 1994 general election, voters approved an amendment to
the State Constitution that will limit the amount of taxes, fees,
licenses and charges imposed by the Legislature and collected during any
fiscal year to the amount of revenues allowed for the prior fiscal year,
plus an adjustment for growth. Growth is defined as the amount equal to
the average annual rate of growth in Florida personal income over the
most recent twenty quarters times the state revenues allowed for the
prior fiscal year. The revenues allowed for any fiscal year can be
increased by a two-thirds vote of the Legislature. The limit will be
effective starting with fiscal year 1995-1996. Any excess revenues
generated will be deposited in the budget stabilization fund until it is
fully funded and then refunded to taxpayers. Included among the
categories of revenues which are exempt from the proposed revenue
limitation, however, are revenues pledged to state bonds.
State General Obligation Bonds and State Revenue Bonds. The State
Constitution does not permit the State to issue debt obligations to fund
governmental operations. Generally, the State Constitution authorizes
State bonds pledging the full faith and credit of the State only to
finance or refinance the cost of State fixed capital outlay projects,
upon approval by a vote of the electors, and provided that the total
outstanding principal amount of such bonds does not exceed 50% of the
total tax revenues of the State for the two preceding fiscal years.
Revenue bonds may be issued by the State or its agencies without a vote
of the electors only to finance or refinance the cost of State fixed
capital outlay projects which are payable solely from funds derived
directly from sources other than State tax revenues.
Exceptions to the general provisions regarding the full faith and
credit pledge of the State are contained in specific provisions of the
State Constitution which authorize the pledge of the full faith and
credit of the State, without electorate approval, but subject to
specific coverage requirements, for: certain road projects, county
education projects, State higher education projects, State system of
Public Education and construction of air and water pollution control and
abatement facilities, solid waste disposal facilities and certain other
water facilities.
Local Bonds. The State Constitution provides that counties, school
districts, municipalities, special districts and local governmental
bodies with taxing powers may issue debt obligations payable from ad
valorem taxation and maturing more than 12 months after issuance, only
(i) to finance or refinance capital projects authorized by law, provided
that electorate approval is obtained; or (ii) to refund outstanding debt
obligations and interest and redemption premium thereon at a lower net
average interest cost rate.
Counties, municipalities and special districts are authorized to issue
revenue bonds to finance a variety of self-liquidating projects pursuant
to the laws of the State, such revenue bonds to be secured by and
payable from the rates, fees, tolls, rentals and other charges for the
services and facilities furnished by the financed projects. Under State
law, counties and municipalities are permitted to issue
57
<PAGE>
bonds payable
from special tax sources for a variety of purposes, and municipalities
and special districts may issue special assessment bonds.
Bond Ratings. General obligation bonds of the State are currently
rated Aa by Moody's and AA by Standard & Poor's.
Litigation. Due to its size and its broad range of activities, the
State (and its officers and employees) are involved in numerous routine
lawsuits. The managers of the departments of the State involved in such
routine lawsuits believed that the results of such pending litigation
would not materially affect the State's financial position. In addition
to the routine litigation pending against the State, its officers and
employees, the following lawsuits and claims are also pending:
A. In a suit, plaintiff has sought title to Hugh Taylor Birch State
Recreation Area by virtue of a reverter clause in the deed from Hugh
Taylor Birch to the State. A final judgment at trial was entered in
favor of the State. The case has been appealed to the Fourth District
Court of Appeal. The Department of Natural Resources anticipates the
area will remain in State lands; however, in the event the court should
rule in favor of the plaintiff, the State is subject to a loss of real
property valued at approximately $400 million.
B. A class action suit brought against the Department of Corrections,
alleging race discrimination in hiring and employment practices,
originally went to trial in 1982 with the Department prevailing on all
claims except a partial summary judgment to a plaintiff sub-class
claiming a discriminatory impact on hiring caused by an examination
requirement. Jurisdictional aspects of the testing issue were appealed
to the Eleventh Circuit Court of Appeals which vacated the trial court's
order and was upheld by the United States Supreme Court. The district
court consolidated three successor lawsuits with this case and entered a
final judgment in favor of the State. The judgment, however, has been
appealed to the Eleventh Circuit Court of Appeals. Should the
department fail in future appeals, the liability of the State for back
pay and other monetary relief could exceed $40 million.
C. Complaints were filed in the Second Judicial Circuit seeking a
declaration that Sections 624.509, 624.512 and 624.514, F.S. (1988)
violate various U.S. and Florida Constitutional provisions. Relief was
sought in the form of a tax refund. The Florida Supreme Court reversed
the trial court in favor of the State. Plaintiffs have petitioned for
certiorari with the United States Supreme Court. The State has settled
all outstanding litigation in this area. Similar issues had been raised
in the following cases which were part of the settlement: Ford Motor
Company v. Bill Gunter, Case No. 86-3714, 2nd Judicial Circuit, and
General Motors Corporation v. Tom Gallagher, Case Nos. 90-2045 and
88-2925, 2nd Judicial Circuit, where the plaintiffs are challenging
Section 634.131, F.S., which imposes taxes on the premiums received for
certain motor vehicle service agreements. Current estimates indicate
that the State's potential refund exposure under the remaining refund
application yet to be denied is approximately $150 million. However,
the State hopes that refund exposure will be reduced as these refund
requests begin to be denied based upon the Florida Supreme Court
decision in the instant case.
D. In two cases, plaintiffs have sought approximately $25 million in
intangible tax refunds based partly upon claims that Florida's
intangible tax statutes are unconstitutional.
E. A lawsuit was filed against the Department of Health and
Rehabilitative Services (DHRS) and the Comptroller of the State of
Florida involving a number of issues arising out of the implementation
of a DHRS computer system and seeking declaratory relief and money
damages. The estimated potential liability to the State is in excess of
$40 million.
F. Plaintiffs in a case have sought a declaration that statutory
assessments on certain hospital net revenues are invalid,
unconstitutional, and unenforceable and request temporary and permanent
58
<PAGE>
injunctive relief be granted prohibiting the enforcement or collection
of the assessment and that all monies paid to the State by the
plaintiffs and the class members within the four years preceding the
filing of the action be reimbursed by the defendants with interest. An
unfavorable outcome to this case could result in the possibility of
refunds exceeding $50 million. This case was voluntarily dismissed but
was refiled in the Second Judicial Court. The Court granted final
summary judgment in the State's favor. Awaiting the signed order.
G. In an inverse condemnation suit claiming that the actions of the
State constitute a taking of certain leases for which compensation is
due, the Circuit judge granted the State's motion for summary judgment
finding that the State had not deprived plaintiff of any royalty rights
they might have. Plaintiff has appealed. Additionally, plaintiff's
request for a drilling permit was rejected after administrative
proceedings before the Department of Environmental Protection.
Plaintiff is expected to challenge the decision.
H. In an inverse condemnation suit alleging the regulatory taking of
property without compensation in the Green Swamp Area of Critical State
Concern, discovery is concluding and a motion for a summary judgment
will likely be made. If the judgment should be for the plaintiff,
condemnation procedures would be instituted with costs of $30 million,
plus interest from 1975.
I. In 1990, the Florida Legislature passed an act imposing a $295
impact fee on cars purchased or titled in other states that are then
registered in the State by persons having or establishing permanent
residency in the State. Two separate groups filed suit challenging the
fee. The circuit court consolidated the various cases and entered final
summary judgment finding the fee unconstitutional under the Commerce
Clause of the United States Constitution and ordered an immediate refund
to all persons having paid the fee since the statute came into
existence. The State noticed an appeal of the circuit court ruling
which entitled the State to a stay of the effectiveness of such ruling,
thus, the fee continued to be collected during the period of the pending
appeal. On September 29, 1994, the Supreme Court of Florida reaffirmed
the circuit court's decision by concluding that the statute results in
discrimination against out of state economic interests in contravention
of the Commerce Clause and that the proper remedy for such violation is
a full refund to all persons who have paid the illegal fee. The State's
refund exposure may be in excess of $188 million.
J. Santa Rosa County has filed a complaint for declaratory relief
against the State requesting the Circuit Court to: (1) find that Section
206.60(2)(a), F.S., does not allow the Department to deduct
administrative expenses unrelated to the collection, administration, and
distribution of the county gas tax; and (2) order the department to pay
Santa Rosa County all moneys shown to have been unlawfully deducted from
the motor fuel tax revenues plus interest. Santa Rosa County obtained a
prospective injunction, but was denied the refund it sought. There has
been no appeal by either party. The Legislature changed the statute in
accordance with the Court's decision.
K. Lee Memorial Hospital has contested the calculation of its
disproportionate share payment for the 1992-93 State fiscal year. An
unfavorable outcome to this case could result in a possible settlement
of $20 to $30 million.
L. A lawsuit has challenged the freezing of nursing home
reimbursement rates for the period January 1, 1990 through July 1, 1990.
The First District Court of Appeal ruled against the Agency for Health
Care Administration (AHCA). The AHCA has petitioned the Florida Supreme
Court for review of this decision. An unfavorable outcome to this case
could result in a potential liability of $40 million.
Summary. Many factors including national, economic, social and
environmental policies and conditions, most of which are not within the
control of the State or its local units of government, could affect or
could have an adverse impact on the financial condition of the State.
Additionally, the limitations placed by the State Constitution on the
State and its local units of government with respect
59
<PAGE>
to income taxation,
ad valorem taxation, bond indebtedness and other matters, discussed
above, as well as other applicable statutory limitations, may constrain
the revenue-generating capacity of the State and its local units of
government and, therefore, the ability of the issuers of the Debt
Obligations to satisfy their obligations thereunder.
The Sponsors believe that the information summarized above describes
some of the more significant matters relating to the Florida Trust. For
a discussion of the particular risks with each of the Debt Obligations,
and other factors to be considered in connection therewith, reference
should be made to the Official Statement and other offering materials
relating to each of the Debt Obligations included in the portfolio of
the Florida Trust. The foregoing information regarding the State, its
political subdivisions and its agencies and authorities constitutes only
a brief summary, does not purport to be a complete description of the
matters covered and is based solely upon information drawn from official
statements relating to offerings of certain bonds of the State. The
Sponsors and their counsel have not independently verified this
information, and the Sponsors have no reason to believe that such
information is incorrect in any material respect. None of the
information presented in this summary is relevant to Puerto Rico or Guam
Debt Obligations which may be included in the Florida Trust.
For a general description of the risks associated with the various
types of Debt Obligations comprising the Florida Trust, see the
discussion under "Risk Factors", above.
THE GEORGIA TRUST
RISK FACTORS--Since 1973 the State's long-term debt obligations have
been issued in the form of general obligation debt or guaranteed revenue
debt. Prior to 1973 all of the State's long-term debt obligations were
issued by ten separate State authorities and secured by lease rental
agreements between such authorities and various State departments and
agencies. Currently, Moody's Investors Service, Inc. and Fitch
Investors Service, Inc. rate Georgia general obligation bonds AAA and
Standard & Poor's Corporation rates such bonds AA+. There can be no
assurance that the economic and political conditions on which these
ratings are based will continue or that particular bond issues may not
be adversely affected by changes in economic, political or other
conditions that do not affect the above ratings.
In addition to general obligation debt, the Georgia Constitution
permits the issuance by the State of certain guaranteed revenue debt.
The State may incur guaranteed revenue debt by guaranteeing the payment
of certain revenue obligations issued by an instrumentality of the
State. The Georgia Constitution prohibits the incurring of any proposed
general obligation debt or guaranteed revenue debt if the highest
aggregate annual debt service requirement for the then current year or
any subsequent fiscal year for outstanding authority debt, guaranteed
revenue debt, and general obligation debt, including the proposed debt,
exceed 10% of the total revenue receipts, less refunds, of the State
treasury in the fiscal year immediately preceding the year in which any
proposed debt is to be incurred. As of November, 1994, the total
indebtedness of the State of Georgia consisting of general obligation
debt, guaranteed revenue debt and remaining authority debt totalled
$4,093,820,000 and the highest aggregate annual payment for such debt
equalled 5.17% of fiscal year 1994 State estimated treasury receipts.
The Georgia Constitution also permits the State to incur public debt
to supply a temporary deficit in the State treasury in any fiscal year
created by a delay in collecting the taxes of that year. Such debt must
not exceed, in the aggregate, 5% of the total revenue receipts, less
refunds, of the State treasury in the fiscal year immediately preceding
the year in which such debt is incurred. The debt incurred must be
repaid on or before the last day of the fiscal year in which it is to be
incurred out of the taxes levied for that fiscal year. No such debt may
be incurred in any fiscal year if there is then outstanding unpaid debt
from any previous fiscal year which was incurred to supply a temporary
deficit
60
<PAGE>
in the State treasury. No such short-term debt has been
incurred under this provision since the inception of the constitutional
authority referred to in this paragraph.
The State operates on a fiscal year beginning July 1 and ending June
30. For example, "fiscal 1994" refers to the year ended June 30, 1994.
Revenue collections of $9,409,526,943 for the fiscal 1994 showed an
increase of 12.74% over collections for the previous fiscal year. In
November, 1994, the State estimated that fiscal 1995 revenue collections
would be $9,813,760,431 with an estimated increase of 4.30% over
collections for the previous fiscal year.
Virtually all of the issues of long-term debt obligations issued by or
on behalf of the State of Georgia and counties, municipalities and other
political subdivisions and public authorities thereof are required by
law to be validated and confirmed in a judicial proceeding prior to
issuance. The legal effect of an approved validation in Georgia is to
render incontestable the validity of the pertinent bond issue and the
security therefor.
Based on data of the Georgia Department of Revenue for fiscal 1994,
income tax receipts and sales tax receipts of the State for fiscal 1994
comprised approximately 43.8% and 34.5%, respectively, of the total
State tax revenues.
The unemployment rate of the civilian labor force in the State as of
August 1994 was 5.9% according to data provided by the Georgia
Department of Labor. The Metropolitan Atlanta area, which is the
largest employment center in the area comprised of Georgia and its five
bordering states and which accounts for approximately 42% of the State's
population, has for some time enjoyed a lower rate of unemployment than
the State considered as a whole. In descending order, wholesale and
retail trade, services, manufacturing, government and transportation
comprise the largest sources of employment within the State.
In March, 1989, the U.S. Supreme Court (in Davis v. Michigan
Department of Treasury) ruled unconstitutional the imposition of state
income taxes on federal retirement benefits when state and local
benefits were not taxed. Related lawsuits were filed against Georgia
seeking refunds for a period beginning in 1980, producing a maximum
potential liability estimated at $591 million. Under the State's
three-year statute of limitations, however, maximum liability is
reported at $100 million. On December 6, 1994, the U.S. Supreme Court
reversed the Georgia Supreme Court's decision in Reich v. Collins
(1993), which had determined that the plaintiff federal retiree was not
entitled to a refund of taxes paid on federal retirement pension
benefits for the tax years before 1989. The U.S. Supreme Court in Reich
remanded the case to the Georgia Supreme Court "for the provision of
meaningful backward-looking relief consistent with due process and the
McKesson line of case." Further proceedings before the Georgia Supreme
Court have not been scheduled.
James B. Beam Distilling Co. v. Collins. Three suits have been filed
against the State of Georgia seeking refunds of liquor taxes in light of
Bacchus Imports, Ltd. v. Dias, 468 U.S. 263 (1984) under Georgia's
pre-Bacchus statute. In the Beam case, 501 U.S. ____ (decided June 20,
1991) the United States Supreme Court indicated that Bacchus was
retroactive, but only within the bounds of State statutes of limitations
and procedural bars, and left State courts to determine any remedy in
light of reliance interests, equitable considerations and other
defenses. Georgia's statute of limitations has run on all pre-Bacchus
claims for refund except five pending claims seeking 31 million dollars
in tax plus interest. On remand, the Fulton County Superior Court has
ruled that procedural bars and other defenses bar any recovery by
taxpayers on Beam's claims for refund. Beam appealed to the Georgia
Supreme Court and received an adverse ruling. Beam has applied to the
United States Supreme Court for a writ of certiorari.
Age International, Inc. v. State and Age International, Inc. v. Miller
are suits (one for refund and one for declaratory and injunctive relief)
which have been filed against the State of Georgia by
61
<PAGE>
foreign producers
of alcoholic beverages seeking $96,000,000 in refunds of alcohol import
taxes imposed under Georgia's post-Bacchus (see previous note) statute.
These claims constitute 99% of all such taxes paid during the preceding
three years. In addition, the claimants have filed administrative
claims for an additional $23,000,000 for apparently later time periods.
The Age refund case is still pending in the trial court. The Age
declaratory/injunctive relief case was dismissed by the District Court
and is on appeal to the Eleventh Circuit Court of Appeals.
Board of Public Education for Savannah/Chatham County v. State of
Georgia is based on the local school board's claim that the State
finance the major portion of the costs of its desegregation program.
The Savannah Board originally requested restitution in the amount of
$30,000,000, but the Federal District Court set forth a formula which
would require a State payment in the amount of approximately $6,000,000.
Plaintiffs, dissatisfied with the apportionment of desegregation costs
between state and county, and an adverse ruling on the state funding
formula for transportation costs, have appealed to the Eleventh Circuit
Court of Appeals. The State has filed a responsive cross-appeal on the
ground that there is no basis for any liability. Subsequently, the
parties agreed to a settlement, which has been submitted to the Court
for approval. The proposed settlement calls for the State to pay the
amount awarded to the plaintiff and to offer an option regarding future
funding methodology for pupil transportation.
A similar complaint has been filed by DeKalb County and there are
approximately five other school districts which potentially might
attempt to file similar claims. In the DeKalb County case alone, the
plaintiffs appear to be seeking approximately $67,500,000 of
restitution. The Federal District Court ruled that the State's funding
formula for pupil transportation (which the District Court in the
Savannah/Chatham County case upheld) was contrary to State law. This
ruling would require a State payment of a State law funding entitlement
in the amount of approximately $34,000,000 computed through June 30,
1994. Motions to reconsider and amend the Court's judgment have been
filed by both parties.
Leslie K. Johnsen v. Collins. Plaintiff in this case has filed suit
in federal district and state superior courts challenging the
Constitutionality of Georgia's transfer fee (often referred to as
"impact fee") by asserting that the fee violates the commerce clause,
due process, equal protection and privilege and immunity provisions of
the United States Constitution. Plaintiff seeks to prohibit the State
from further collections and to require the State to return to her and
those similarly situated all fees previously collected. From May 1992
to June 1994, the State has collected $14,933,725. The State continues
to collect approximately $500,000 to $600,000 per month.
Daniel W. Tedder v. Marcus E. Collins, Sr. is a class action suit
challenging the validity of a Georgia Department of Revenue regulation
issued in July 1992 which resulted in enforcement of sales tax
collections on sales of used transportation equipment, most notably
sales of used cars where neither party is engaged in the regular sale of
used cars. The trial court declared the regulation invalid.
Approximately $30,000,000 of tax on such sales was collected before the
regulation was rescinded and collection ceased. Accordingly, refund
claims of up to $30,000,000 plus interest could be sought.
Approximately $21,500,000 in refunds have been paid.
The Sponsors believe that the information summarized above describes
some of the more significant matters relating to the Georgia Trust. The
sources of the information are the official statements of issuers
located in Georgia, other publicly available documents and oral
statements from various federal and State agencies. The Sponsors and
their counsel have not independently verified any of the information
contained in the official statements, other publicly available documents
or oral statements from various State agencies and counsel have not
expressed any opinion regarding the completeness or materiality of any
matters contained in this Prospectus other than the tax opinions set
forth below relating to the status of certain tax matters in Georgia.
62
<PAGE>
GEORGIA TAXES
In the opinion of King & Spalding, Atlanta, Georgia, special counsel
on Georgia tax matters under existing Georgia laws:
1. The Georgia Trust will not be an association taxable as a
corporation for Georgia income tax purposes.
2. The income received by the Georgia Trust will be treated for
Georgia income tax purposes as the income of the Holders of Units of the
Georgia Trust. Each Holder of Units of the Georgia Trust Each Holder of
Units of the Georgia Trust will be considered as receiving the interest
on his pro rata portion of each Debt Obligation when interest is
received by the Georgia Trust. Interest on a Debt Obligation which
would be exempt from Georgia income tax if paid directly to a Holder
will be exempt from Georgia income tax when received by the Georgia
Trust and distributed to the Holders.
3. A Holder of Units of the Georgia Trust will recognize taxable gain
or loss for Georgia income tax purposes to the extent he recognizes gain
or loss for Federal income tax purposes if he sells or redeems all or
part of his Units or if the Georgia Trust sells or redeems a Debt
Obligation.
4. Obligations of the State of Georgia and its political subdivisions
and public institutions are exempt from the Georgia intangible personal
property tax. Obligations issued by the Government of Puerto Rico or by
the Government of Guam or by their respective authorities are exempt by
Federal statute from taxes such as the Georgia intangible personal
property tax. Accordingly, such obligations held by the Georgia Trust
will not be subject to the Georgia intangible personal property tax.
The Georgia Department of Revenue, however, has taken the position that
interests in unit investment trusts similar to the Georgia Trust are
fully subject to the Georgia intangibles tax (at the rate of 10 cents
per $1,000 in value) even though some or all of the securities held by
the trust are exempt from the tax. Notwithstanding the Georgia
Department of Revenue's position, a strong argument can be made that the
Units of the Georgia Trust should be exempt from the Georgia intangibles
tax to the extent the Securities held by the Georgia Trust are exempt
from such tax. At present, it is impossible to predict how this issue
will be resolved.
5. Units of the Georgia Trust will be subject to Georgia estate tax
if held by an individual who is a Georgia resident at his death or if
held by a nonresident decedent and deemed to have a business situs in
Georgia. The Georgia estate tax is limited to the amount allowable as a
credit against Federal estate tax under Section 2011 of the Internal
Revenue Code or, in the case of a nonresident decedent, a portion of
such amount equal to the portion of the decedent's property taxable in
Georgia.
6. There is no exemption or exclusion for Units of the Georgia Trust
for purposes of the Georgia corporate net worth tax.
The opinions expressed herein are based upon existing statutory,
regulatory, and judicial authority, any of which may be changed at any
time with retroactive effect. In addition, such opinions are based
solely on the documents that we have examined, the additional
information that we have obtained and the representations that have been
made to us (including, in particular, the opinion of Davis Polk &
Wardwell on the Federal income tax treatment of the Georgia Trust and
the Holders of its Units). Our opinions cannot be relied upon if any of
the facts contained in such documents or in such additional information
is, or later becomes, inaccurate or if any of the representations made
to us is or later becomes inaccurate. Finally, our opinions are limited
to the tax matters specifically covered thereby, and we have not been
asked to address, nor have we addressed, any other tax consequences
relating to the Georgia Trust or the Units thereof.
63
<PAGE>
THE LOUISIANA TRUST
Certain Considerations. The following discussion regarding the
financial condition of the State government may not be relevant to
general obligation or revenue bonds issued by political subdivisions of
and other issuers in the State of Louisiana (the "State"). Such
financial information is based upon information about general financial
conditions that may or may not affect issuers of the Louisiana
obligations. The Sponsor has not independently verified any of the
information contained in such publicly available documents, but is not
aware of any facts which would render such information inaccurate.
On December 19, 1990 the State received a rating upgrade on its
general obligation bonds to the current Standard & Poor's rating of A
from BBB+. Standard & Poor's cited improvements in the State's cash
flow and fiscal reforms approved by voters in the fall of 1990. The
current Moody's rating on the State's general obligation bonds was not
upgraded and remains unchanged at Baa1. There can be no assurance that
the economic conditions on which these ratings were based will continue
or that particular bond issues may not be adversely affected by changes
in economic or political conditions.
The Revenue Estimating Conference (the "Conference") was established
by Act No. 814 of the 1987 Regular Session of the State Legislature.
The Conference was established by the Legislature to provide an official
estimate of anticipated State revenues upon which the executive budget
shall be based, to provide for a more stable and accurate method of
financial planning and budgeting and to facilitate the adoption of a
balanced budget as is required by Article VII, Section 10(E) of the
State Constitution. Act No. 814 provides that the Governor shall cause
to be prepared an executive budget presenting a complete financial and
programmatic plan for the ensuing fiscal year based only upon the
official estimate of anticipated State revenues as determined by the
Revenue Estimating Conference. Act No. 814 further provides that at no
time shall appropriations or expenditures for any fiscal year exceed the
official estimate of anticipated State revenues for that fiscal year.
An amendment to the Louisiana Constitution was approved by the Louisiana
Legislature in 1990 and enacted by the electorate which granted
constitutional status to the existence of the Revenue Estimating
Conference.
State General Fund: The State General Fund is the principal operating
fund of the State and was established administratively to provide for
the distribution of funds appropriated by the Louisiana Legislature for
the ordinary expenses of the State government. Revenue is provided from
the direct deposit of federal grants and the transfer of State revenues
from the Bond Security and Redemption Fund after general obligation debt
requirements are met. The beginning accumulated State General Fund
balance for fiscal year 1994-1995 was $212 million.
The Revenue Estimating Conference's official forecast of recurring
State General Fund revenues for the fiscal year ending June 30, 1993
(Revenue Estimating Conference October 1994 is $4.626 billion. The
Revenue Estimating Conference adopted on October 27, 1994 its official
forecast for Fiscal Year 1995-1996 to be $4.758 billion. Based upon
that estimate, and assuring federal government approval of a Medicaid
waiver request submitted by the State, the State Office of Planning and
Budget has estimated a $192 million short fall in the amount needed to
maintain State operations at a level of those for Fiscal Year 1994-95.
Transportation Trust Fund: The Transportation Trust Fund was
established pursuant to (i) Section 27 of Article VII of the State
Constitution and (ii) Act No. 16 of the First Extraordinary Session of
the Louisiana Legislature for the year 1989 (collectively the "Act") for
the purpose of funding construction and maintenance of state and federal
roads and bridges, the statewide flood-control program, ports, airports,
transit and state police traffic control projects and to fund the Parish
Transportation Fund. The Transportation Trust Fund is funded by a levy
of $0.20 per gallon on gasoline and motor fuels and on special fuels
(diesel, propane, butane and compressed natural gas)
64
<PAGE>
used, sold or
consumed in the state (the "Gasoline and Motor Fuels Taxes and Special
Fuels Taxes"). This levy was increased from $0.16 per gallon (the
"Existing Taxes") to the current $0.20 per gallon pursuant to Act No. 16
of the First Extraordinary Session of the Louisiana Legislature for the
year 1989, as amended. The additional tax of $0.04 per gallon (the "Act
16 Taxes") became effective January 1, 1990 and will expire on the
earlier of January 1, 2005 or the date on which obligations secured by
the Act No. 16 taxes are no longer outstanding. The Transportation
Infrastructure Model for Economic Development Account (the "TIME
Account") was established in the Transportation Trust Fund. Moneys in
the TIME account will be expended for certain projects identified in the
Act aggregating $1.4 billion and to fund not exceeding $160 million of
additional capital transportation projects. The State issued
$263,902,639.95 of Gasoline and Fuels Tax Revenue Bonds, 1990 Series A,
dated April 15, 1990 payable from the (i) Act No. 16 Taxes, (ii) any Act
No. 16 Taxes and Existing Taxes deposited in the Transportation Trust
Fund, and (iii) any additional taxes on gasoline and motor fuels and
special fuels pledged for the payment of said Bonds. As of December 31,
1994 the outstanding principal amount of said Bonds was $235,703,000.
Louisiana Recovery District: The Louisiana Recovery District (the
"Recovery District") was created pursuant to Act No. 15 of the First
Extraordinary Session of the Legislature of Louisiana of 1988 to assist
the State in the reduction and elimination of a deficit existing at that
time and the delivery of essential services to its citizens and to
assist parishes, cities and other units of local government experiencing
cash flow difficulties. The Recovery District is a special taxing
district the boundaries of which are coterminous with the State and is a
body politic and corporate and a political subdivision of the State.
The Recovery District issued $979,125,000 of Louisiana Recovery District
Sales Tax Bonds, Series 1988, dated July 1, 1988 ("Series 1988 Bonds"),
secured by (i) the revenues derived from the District's 1% statewide
sales and use tax remaining after the costs of collection and (ii) all
funds and accounts held under the Recovery District's General Bond
Resolution and all investment earnings on such funds and accounts. The
Recovery District issued 80,920,000 of Sales Tax Refunding Bonds, Series
1992 dated June 1, 1992 and 86,130,000 of Sales Tax Junior Lien
Refunding Bonds, Series 1992, dated June 1, 1992 to refund a portion of
the Recovery District's Series 1988 Bonds for the purpose of increasing
cash flow available to the Recovery District and creating debt service
savings. On December 31, 1994 the aggregate principal balance of the
1988 Series Bonds and the Series 1992 Bonds was $348,970,000 and
$137,825,000, respectively.
Ad Valorem Taxation: Only local governmental units presently levy ad
valorem taxes. Under the 1921 State Constitution a $5.75 mills ad
valorem tax was being levied by the State until January 1, 1973 at which
time a constitutional amendment to the 1921 Constitution abolished the
ad valorem tax. Under the 1974 State Constitution a State ad valorem
tax of up to $5.75 mills was provided for but is not presently being
levied. The property tax is underutilized at the parish level due to a
constitutional homestead exemption from the property tax applicable to
the first $75,000 of the full market value of single family residences.
Homestead exemptions do not apply to ad valorem property taxes levied by
municipalities, with the exception of the City of New Orleans. Because
local governments also are prohibited from levying an individual income
tax by the constitution, their reliance on State government is increased
under the existing tax structure.
Litigation: In 1988 the Louisiana legislature created a
Self-Insurance Fund within the Department of Treasury. That Fund
consists of all premiums paid by State agencies under the State's Risk
Management program, the investment earnings on those premiums and
commissions retained. The Self-Insurance Fund may only be used for
payment of losses incurred by State agencies under the Self-Insurance
program, together with insurance premiums, legal expenses and
administration costs. For fiscal year 1991-1992, the sum of
$79,744,126.00 was paid from the Self-Insurance Fund as of December 31,
1991 to satisfy claims and judgments. Because of deletion of agency
premium allocations from the State General Appropriations Bill for
Fiscal Year 1991-1992 and 1992-1993 the Self-Insurance Fund did not
receive full funding in those years. In Fiscal Year 1993-94, a partial
funding (153,000,000) was provided to the Self Insurance Fund. However,
due to the inadequacy of
65
<PAGE>
funding, virtually all claimants' payments,
other than workers compensation payments, were eliminated and claimant
payments were sent to the legislature for direct appropriation from the
General Fund. It is the opinion of the Attorney General for the State
of Louisiana that only a small portion of the dollar amount of potential
liability of the State resulting from litigation which is pending
against the State and is not being handled through the Office of Risk
Management ultimately will be recovered by plaintiffs. It is the
opinion of the Attorney General that the estimated future liability for
existing claims is in excess of $81 million. However, there are other
claims with future possible liabilities for which the Attorney General
cannot make a reasonable estimate.
The foregoing information constitutes only a brief summary of some of
the financial difficulties which may impact certain issuers of Bonds and
does not purport to be a complete or exhaustive description of all
adverse conditions to which the issuers of the Louisiana Trust are
subject. Additionally, many factors including national economic, social
and environmental policies and conditions, which are not within the
control of the issuers of Bonds, could affect or could have an adverse
impact on the financial condition of the State and various agencies and
political subdivisions located in the State. The Sponsor is unable to
predict whether or to what extent such factors may affect the issuers of
Bonds, the market value or marketability of the Bonds or the ability of
the respective issuers of the Bonds acquired by the Louisiana Trust to
pay interest on or principal of the Bonds.
Prospective investors should study with care the Portfolio of Bonds in
the Louisiana Trust and should consult with their investment advisors as
to the merits of particular issues in that Trust's Portfolio.
LOUISIANA TAXES
In the opinion of Wiener, Weiss, Madison & Howell, A Professional
Corporation, Shreveport, Louisiana, special counsel on Louisiana tax
matters, under existing Louisiana law:
1. The Louisiana Trust will be treated as a trust for Louisiana tax
purposes and not as an "association" taxable as a corporation; the
income of the Louisiana Trust which is required to be distributed or
which is actually distributed to the Holders shall not be taxed to the
Louisiana Trust.
2. The Louisiana income tax on resident individuals is imposed upon
the "tax table income" of resident individuals. The "tax table income"
of a resident individual is the individual's federal adjusted gross
income with certain additions and exclusions provided under Louisiana
law. No provision under Louisiana law requires the addition of interest
on obligations of the state of Louisiana and its political subdivisions,
public corporations created by them and constituted authorities thereof
authorized to issue obligations on their behalf ("Louisiana
Obligations") or interest on obligations of the Government of Puerto
Rico or Guam. Accordingly, resident individual Holders will not be
subject to Louisiana income tax with respect to amounts received by the
Louisiana Trust representing interest on such obligations that is
excludable from gross income for federal income tax purposes.
3. With certain exceptions, the State of Louisiana imposes a tax on
the "Louisiana taxable income" of resident corporations. "Louisiana
taxable income" of a resident corporation (other than an insurance
company) is the corporation's federal taxable income with certain
modifications to federal gross income and to the deductions from federal
gross income. No provision under Louisiana law requires the addition of
interest on Louisiana Obligations or interest on obligations of the
Governments of Puerto Rico or Guam to the federal gross income of such
resident corporations. Accordingly, resident corporate Holders (other
than insurance companies) will not be subject to Louisiana income tax
with respect to amounts received by the Louisiana Trust representing
interest on such obligations that is excludable from gross income for
federal income tax purposes.
66
<PAGE>
4. To the extent that gain (or loss) from the sale, exchange or other
disposition of obligations held by the Louisiana Trust (whether as a
result of a sale or exchange of such obligations by the Louisiana Trust
or as a result of a sale or exchange of a Unit by a Holder) is
includible in (or deductible in the calculation of) federal adjusted
gross income of a resident individual or the federal taxable income of a
resident corporation, such gain will be included in (or loss deducted
from) the calculation of the resident individual Holder's Louisiana tax
table income or the resident corporate Holder's Louisiana taxable
income.
5. Gain or loss on the Unit or as to the underlying obligations for
Louisiana income tax purposes would be determined by taking into account
the basis adjustments for federal income tax purposes described in the
Prospectus.
6. The State of Louisiana does not impose an intangibles tax on
investments, and therefore, Holders will not be subject to Louisiana
intangibles tax on their Units of the Louisiana Trust.
No opinion is rendered as to the Louisiana tax consequences of Holders
other than as expressed above with regard to Louisiana resident
individuals and corporations and, therefore, tax counsel should be
consulted by other prospective Holders. In rendering the opinions
expressed above, counsel has relied upon the opinion of Davis Polk and
Wardwell that, for federal income tax purposes, the Louisiana Trust is
not an association taxable as a corporation, each Holder of the
Louisiana Trust will be treated as the owner of a pro rata portion of
the securities held by such Louisiana Trust and the income of the
Louisiana Trust will be treated as income of the Holders.
Tax counsel should be consulted as to the other Louisiana tax
consequences not specifically considered herein and as to the Louisiana
tax status of taxpayers other than as expressed above with regard to
Louisiana resident individuals and corporations who are Holders in the
Louisiana Trust. In addition, no opinion is being rendered as to
Louisiana tax consequences resulting from any proposed or future federal
or state tax legislation.
THE MAINE TRUST
RISK FACTORS--Prospective investors should consider the financial
condition of the State of Maine and the public authorities and municipal
subdivisions issuing the obligations to be purchased with the proceeds
of the sale of units. Certain of the debt obligations to be purchased
by and held in the Maine Trust are not obligations of the State of Maine
and are not supported by its full faith and credit or taxing power. The
type of debt obligation, source of payment and security for such
obligations are detailed in the official statements produced by the
issuers thereof in connection with the offering of such obligations.
Reference should be made to such official statements for detailed
information regarding each of the obligations and the specific risks
associated with such obligations. This summary of risk factors relates
to factors generally applicable to Maine obligations and does not
address the specific risks involved in each of the obligations acquired
by the Maine Trust.
The Maine Economy. The State's economy continues to be based on
natural resources, manufacturing related to natural resources, and
tourism. Gradually the economy has begun to diversify with growth in
relatively new industries such has health and business services and
electronics manufacturing.
Although some of the State's industries are independent from the
regional economy, Maine's economy is, in large part, dependent upon
overall improvements in both the regional and national economy. The
northeast continues to be one of the nation's weakest economic regions.
67
<PAGE>
As is the case throughout the northeast, Maine's economy weakened
significantly from 1989 through 1991. By most measures, however, the
State economy reached bottom by the first quarter of 1992, at the
latest, and has been improving in fits and starts since then.
Indications are that the economy is now entering an extended period of
extremely slow growth. From the latter 3 quarters of 1992 through
August, 1994, most measures of the Maine economy showed improvement. As
of August, 1994, the Maine Economic Growth Index (the "EGI") was up 2.4%
over the first eight months of 1993. The EGI, a seasonally adjusted
composite of resident employment, real consumer retail sales, production
hours worked in manufacturing, and services employment, shows an economy
that through the first three quarters of 1994, experienced a 2.3% rate
of growth. While improved, however, the 2.3% rate of growth has been
well below normal for the beginning of an economic expansion.
Nevertheless, it compares favorably with the 2.1% decline experienced
during 1992. The EGI reached 105 at the end of the third quarter of
1994. Although representing only moderate growth, with this 2.3%
increase, the EGI now approaches its pre-recession high of 105.7
(November 1998).
The State experienced a 1.4% decline in the jobless rate through
September 1994. There has been some modest growth in jobs during 1994,
primarily in the services, retail trade and construction areas.
Unemployment in August 1994 equaled 5.5%, compared with 6.9% a year ago.
The State Planning Office predicts an increase of approximately 1.4% in
payroll employment for 1994 and an increase of 1.6% for 1995.
Despite the continued weakness in the labor market, Maine taxable
retail sales have continued to increase after hitting bottom in the
first quarter of 1991. Taxable consumer retail sales for the third
quarter 1994 increased 6.6% over the same period in 1993.
Unfortunately, the business operating sector was down 22.4% through
August 1994. The State Planning office notes that the substantial
portion of the total retail sales increase was attributable to the
automobile transportation sector (up 14.3% over 1993).
The real estate sector saw significant improvement, but construction
was quite weak. According to the Institute for Real Estate Research and
Education, the number of housing units sold through the third quarter of
1994 increased 10.5% over the same period in 1993. After noting some
growth in 1992 over 1991 levels, the Maine Advancement Program reported
$706,000,000 in total construction awards during the first three
quarters of 1993, a 22.7% decrease from the same period of 1992.
An important unresolved question concerning the State's economy
continues to be how the restructuring of the United States military will
affect defense related industries in Maine. Loring Air Force Base
closed in the fall of 1994. The base closing, coupled with the shutdown
of the Backscatter radar system in Bangor, will mean the loss of several
military and civilian jobs in the region. Recent news has been more
favorable. Mitigating the employment loss is the anticipated
establishment of the Defense Financial Accounting Service Center. In
addition, although it will continue to downsize through 1995, Bath Iron
Works, the State's largest employer, landed a major ship building
contract for the construction of three Aegis Class Destroyers by 1998,
bringing the yard's construction backlog to $2.4 billion. Another major
employer, the Portsmouth Naval Shipyard in Kittery, Maine, has managed
to remain off the list of bases to be closed as part of the military's
downsizing efforts although it continued to downsize throughout 1993.
There can be no assurances that the economic conditions discussed
above will not have an adverse effect upon the market value or
marketability of any of the debt obligations acquired by the Maine Trust
or the financial or other condition of any of the issuers of such
obligations.
State Finances and Budget. The State operates under a biennial budget
which is formulated in even-numbered years and presented for approval to
the Legislature in odd-numbered years. The economic strength evidenced
during the 1980's enabled the State to accumulate high levels of general
68
<PAGE>
fund unappropriated surpluses. These surpluses, however, have been
exhausted during the current downturn. Economic conditions continue to
place financial strain upon the State's budget.
According to the most recently available audited financial statement,
dated July 16, 1993, the State reflected in its General Fund for fiscal
year ended June 30, 1992 a $43 million surplus on a non-GAAP budgetary
basis and a $104 million deficit on a GAAP basis. According to the most
recently available unaudited financial statement, the State has a $10
million deficit in its General Fund for fiscal year ended June 30, 1993.
The budget passed during the summer of 1993 for the 1994-95 biennium
included additional budget balancing measures, including making
permanent the previously temporary 6% sales tax, deferring $102,000,000
in payments to the Maine State Retirement System, and assorted program
cutting and cost shifting. With little growth projected for the Maine
economy in the next few years, additional measures may become necessary
to maintain a balanced budget.
The State of Maine is currently confronted with a projected budget gap
of approximately $375 million through June of 1997. The State Budget
Officer has projected revenues for the two years starting July 1, 1994
at $3.4 billion versus recommended spending for current services at $3.6
billion, creating a shortfall of more than $209,000,000. Other
projected spending, most notably an $110 million item related to
Medicaid reimbursements, would raise the budget gap to $375 million.
The projection does not include $465 million in new spending sought by
the State for expanded service, such as new programs for the mentally
ill required by a court order issued by the United States District Court
for the district of Maine. The projection also does not include any
money to fund a State employee pact when the current contract expires on
June 30, 1995.
Finally, a recent decision of a State Superior Court holding that the
State could not tax chemicals used to control pollution, means that the
State no longer can count on collecting approximately $75 million in
taxes that it had expected to collect from Champion International. That
decision is on appeal to the State Supreme Court but the State Budget
Office has advised against booking the money as revenue.
These deficit numbers are based on current projections and
assumptions. A new administration has assumed governing
responsibilities following the 1994 elections and, although no actual
budget has yet been submitted, the administration has announced a budget
outline. Under this outline, the administration proposes to increase
spending by a cumulative total of $232 million over the next two years
to a total of $3.491 billion. The budget proposal contained no new or
higher taxes. The proposed budget leaves responsibility for the $110
million Medicaid reimbursement shortfall on the hospitals involved. The
proposal also requires that the court ordered payments for the mentally
ill be made within existing resources.
The financial condition of the State is, in large measure, a function
of the state's and the region's economy and no assurances can be given
regarding the future economy or financial condition of the State.
The State of Maine's outstanding general obligations continue to be
rated AA+ by Standard & Poor's. Moody's, however, has dropped Maine's
rating from Aa1 to Aa. Moody's cited the weak status of the State's
economy and the continued reliance on one time cost cutting measures to
deal with budget problems as the reasons for the decision.
As of May 31, 1994, there was outstanding approximately $529,000,000
general obligation bonds of the State and no bond anticipation notes.
As of September 1, 1994, there were outstanding $170,000,000 of tax
anticipation notes of the State, to mature June 30, 1995. As of May 31,
1994, the
69
<PAGE>
aggregate principal amount of bonds of the State authorized by
the Constitution and implementing legislation for certain purposes, but
unissued, is expected to be $103,000,000. Although increasing, the
major rating agencies still consider debt to be at manageable levels.
Maine Municipal Bond Bank. The Portfolio may contain obligations of
the Maine Municipal Bond Bank. All Bond Bank debt is secured by loan
repayments of borrowing municipalities and the State's moral obligation
pledge. The state of the economy in Maine could impact the ability of
municipalities to pay debt service on their obligations. Maine Bond
Bank debt is rated A+ by Standard & Poor's and Aa by Moody's.
Solid Waste Disposal Facilities. The Portfolio may contain
obligations issued by Regional Waste Systems, Inc., a quasi-municipal
corporation organized pursuant to an interlocal agreement among
approximately 20 Southern Maine communities ("RWS") or other
quasi-municipal solid waste disposal facilities. RWS and other similar
solid waste disposal projects operate regional solid waste disposal
facilities and process the solid waste of the participating
municipalities as well as the solid waste of other non-municipal users.
The continued viability of such facilities is dependent, in part, upon
the approach taken by the State of Maine with respect to solid waste
disposal generally. Pursuant to a Public Law 1989 Chapter 585, the
Maine Waste Management Agency is charged with preparation and adoption
by rule of an analysis and a plan for the management, reduction and
recycling of solid waste for the State of Maine. The plan developed by
the Maine Waste Management Agency is based on the waste management
priorities and recycling goals established by State law. Pursuant to
State law, Maine has established minimum goals for recycling and
composting requiring that a minimum of 50% of the municipal solid waste
stream be recycled or composted by 1994. Although RWS may participate
in the mandated recycling activities, its principal existing facility
consists of a mass burn 250 ton per day furnace boiler with associated
equipment for production of electric energy. Thus, the source material
for RWS" primary facility could be substantially reduced as a result of
implementation of the State's recycling goals. Other mass burn solid
waste disposal facilities in the State have experienced seasonal
shortages in waste fuel.
Health Care Facilities. Revenue bonds are issued by the Maine Health
and Higher Education Facilities Authority to finance hospitals and other
health care facilities. The revenues of such facilities consists, in
varying but typically material amounts, of payment from insurers and
third-party reimbursement programs, including Medicaid, Medicare and
Blue Cross. The health care industry in Maine is becoming increasingly
competitive. The utilization of new programs and modified benefits by
third-party reimbursement programs and the advent of alternative health
care delivery systems such as health maintenance organizations
contribute to the increasingly competitive nature of the health care
industry. This increase in competition could adversely impact the
ability of health care facilities in Maine to satisfy their financial
obligations.
Further, health care providers are subject to regulatory actions,
changes in law and policy changes by agencies that administer
third-party reimbursement programs and regulate the health care
industry. Any such changes could adversely impact the financial
condition of such facilities.
MAINE TAXES
In the opinion of Pierce, Atwood, Scribner, Allen, Smith & Lancaster,
Portland, Maine, special counsel on Maine tax matters, under existing
Maine law:
1. Maine resident trusts and Maine resident individuals are each
subject to individual income tax by the State of Maine imposed as a
percentage of the individual's or trust's entire taxable income. The
taxable income of an individual or trust is its federal adjusted gross
income as defined under the laws of the United States, with the
modifications and less the deductions and personal exemptions provided
in Part 8 of Title 36 of the Maine Revised Statutes. Thus, to the
extent the Trust is not an
70
<PAGE>
association taxable as a corporation for
purposes of federal income taxation, and to the extent each Holder will
be essentially treated as the owner of a pro rated portion of the Trust
and the income of such portion of the Trust will be treated as the
income of the Holder for purposes of federal income taxation, the Trust
will not constitute an association taxable as a corporation for purposes
of Maine income tax and each Holder of the Trust will be essentially
treated as the owner of a pro rated portion of the Trust and income of
such portion of the Trust will be treated as the income of the Holder
for Maine income tax purposes.
2. Interest on all Bonds which are exempt from Maine income tax when
received by the Trust, and which would be exempt from Maine income tax
and the Maine minimum tax if received directly by a Holder, will retain
its status as exempt from Maine income tax and the Maine minimum tax
when received by the Trust and distributed to the Holder.
3. Each Holder of Units of the Trust will recognize gain or loss for
Maine income tax purposes if the Trustee disposes of a Bond (whether by
redemption, sale or otherwise) or if the Holder redeems or sells Units
of the Trust to the extent that such a transaction results in a
recognized gain or loss to such Holder for federal income tax purposes.
4. The Maine income tax does not permit a deduction of interest paid
or incurred on indebtedness incurred to purchase or carry Units in the
Trust, the interest on which is exempt from Maine income tax.
5. Prospective Holders of Units of the Trust should be advised that
interest paid on certain Bonds and distributed to Holders may be taken
into account in computing the Maine minimum tax for tax preferences.
Prospective Holders should consult their tax advisors regarding
applicability of the Maine minimum tax. In addition, any Holders of
Units of the Trust which are subject to Maine Franchise Tax should be
advised that for purposes of the Maine Franchise Tax, interest on the
Bonds received by the Trust and distributed to a Holder subject to such
tax will be added to the Holder's federal taxable income and therefore
will be taxable.
Special Maine counsel expresses no opinion as regards the acquisition
or carrying of interest-bearing obligations of the Commonwealth of
Puerto Rico or the Territory of Guam by the Trust or the tax effect of
such investments.
THE MARYLAND TRUST
RISK FACTORS--State Debt. The Public indebtedness of the State of
Maryland and its instrumentalities is divided into three general types.
The State issues general obligation bonds for capital improvements and
for various State projects to the payment of which the State ad valorem
property tax is exclusively pledged. In addition, the Maryland
Department of Transportation issues for transportation purposes its
limited, special obligation bonds payable primarily from specific,
fixed-rate excise taxes and other revenues related mainly to highway
use. Certain authorities issue obligations payable solely from specific
non-tax, enterprise fund revenues and for which the State has no
liability and has given no moral obligation assurance. The State and
certain of its agencies also have entered into a variety of lease
purchase agreements to finance the acquisition of capital assets. These
lease agreements specify that payments thereunder are subject to annual
appropriation by the General Assembly.
General Obligation Bonds. General obligation bonds of the State are
authorized and issued primarily to provide funds for State-owned capital
improvements, including institutions of higher learning, and the
construction of locally owned public schools. Bonds have also been
issued for local government improvements, including grants and loans for
water quality improvement projects and
71
<PAGE>
correctional facilities, and to
provide funds for repayable loans or outright grants to private,
non-profit cultural or educational institutions.
The Maryland Constitution prohibits the contracting of State debt
unless it is authorized by a law levying an annual tax or taxes
sufficient to pay the debt service within 15 years and prohibiting the
repeal of the tax or taxes or their use for another purpose until the
debt is paid. As a uniform practice, each separate enabling act which
authorizes the issuance of general obligation bonds for a given object
or purpose has specifically levied and directed the collection of an ad
valorem property tax on all taxable property in the State. The Board of
Public Works is directed by law to fix by May 1 of each year the precise
rate of such tax necessary to produce revenue sufficient for debt
service requirements of the next fiscal year, which begins July 1.
However, the taxes levied need not be collected if or to the extent that
funds sufficient for debt service requirements in the next fiscal year
have been appropriated in the annual State budget. Accordingly, the
Board, in annually fixing the rate of property tax after the end of the
regular legislative session in April, takes account of appropriations of
general funds for debt service.
In the opinion of counsel, the courts of Maryland have jurisdiction to
entertain proceedings and power to grant mandatory injunctive relief to
(i) require the Governor to include in the annual budget a sufficient
appropriation to pay all general obligation bond debt service for the
ensuing fiscal year; (ii) prohibit the General Assembly from taking
action to reduce any such appropriation below the level required for
that debt service; (iii) require the Board of Public Works to fix and
collect a tax on all property in the State subject to assessment for
State tax purposes at a rate and in an amount sufficient to make such
payments to the extent that adequate funds are not provided in the
annual budget; and (iv) provide such other relief as might be necessary
to enforce the collection of such taxes and payment of the proceeds of
the tax collection to the holders of general obligation bonds, pari
passu, subject to the inherent constitutional limitations referred to
below.
It is also the opinion of counsel that, while the mandatory injunctive
remedies would be available and while the general obligation bonds of
the State are entitled to constitutional protection against the
impairment of the obligation of contracts, such constitutional
protection and the enforcement of such remedies would not be absolute.
Enforcement of a claim for payment of the principal of or interest on
the bonds could be subject to the provisions of any statutes that may be
constitutionally enacted by the United States Congress or the Maryland
General Assembly extending the time for payment or imposing other
constraints upon enforcement.
There is no general debt limit imposed by the Maryland Constitution or
public general laws, but a special committee created by statute annually
submits to the Governor an estimate of the maximum amount of new general
obligation debt that prudently may be authorized. Although the
committee's responsibilities are advisory only, the Governor is required
to give due consideration to the committee's findings in preparing a
preliminary allocation of new general debt authorization for the next
ensuing fiscal year.
Department of Transportation Bonds. Consolidated Transportation Bonds
are limited obligations issued by the Maryland Department of
Transportation, the principal of which must be paid within 15 years from
the date of issue, for highway, port, transit, rail or aviation
facilities or any combination of such facilities. Debt service on
Consolidated Transportation Bonds is payable from those portions of the
excise tax on each gallon of motor vehicle fuel and the motor vehicle
titling tax, all mandatory motor vehicle registration fees, motor
carrier fees, and the corporate income tax as are credited to the
Maryland Department of Transportation, plus all departmental operating
revenues and receipts. Holders of such bonds are not entitled to look
to other sources for payment.
The Maryland Department of Transportation also issues its bonds to
provide financing of local road construction and various other county
transportation projects and facilities. Debt service on these
72
<PAGE>
bonds is
payable from the subdivisions" share of highway user revenues held to
their credit in a special State fund.
The Maryland Transportation Authority operates certain highway, bridge
and tunnel toll facilities in the State. The tolls and other revenues
received from these facilities are pledged as security for revenue bonds
of the Authority issued under and secured by a trust agreement between
the authority and a corporate trustee.
Maryland Stadium Authority Bonds. The Maryland Stadium Authority is
responsible for financing and directing the acquisition and construction
of one or more new professional sports facilities in Maryland.
Currently, the Stadium Authority operates the newly opened Oriole Park
at Camden Yards which opened in 1992.
In connection with the construction of that facility, the Authority
issued $155 million in notes and bonds. These notes and bonds, as well
as any future financing for a football stadium, are lease-backed revenue
obligations, the payment of which is secured by, among other things, an
assignment of revenues received under a lease of the sports facilities
from the Stadium Authority to the State. The Stadium Authority also has
been assigned responsibility for constructing an expansion of the
Convention Center in Baltimore. The Convention Center expansion is
expected to cost $155 million and will be financed through a combination
of funding from Baltimore City, Stadium Authority revenue bonds, and
State general obligation bonds.
Miscellaneous Revenue and Enterprise Financings. Certain other
instrumentalities of the State government are authorized to borrow money
under legislation which expressly provides that the loan obligations
shall not be deemed to constitute a debt or a pledge of the faith and
credit of the State. The Community Development Administration of the
Department of Housing and Community Development, the Board of Trustees
of St. Mary's College of Maryland, the Maryland Environmental Service,
the Board of Regents of the University of Maryland System, the Board of
Regents of Morgan State University, and the Maryland Food Center
Authority have issued and have outstanding bonds of this type. The
principal of and interest on bonds issued by these bodies are payable
solely from various sources, principally fees generated from use of the
facilities or enterprises financed by the bonds.
The Water Quality Revolving Loan Fund is administered by the Water
Quality Financing Administration in the Department of the Environment.
The Fund may be used to provide loans, subsidies and other forms of
financial assistance to local government units for wastewater treatment
projects as contemplated by the 1987 amendments to the federal Water
Pollution Control Act. The Administration is authorized to issue bonds
secured by revenues of the Fund, including loan repayments, federal
capitalization grants, and matching State grants.
The University of Maryland System, Morgan State University, and St.
Mary's College of Maryland are authorized to issue revenue bonds for the
purpose of financing academic and auxiliary facilities. Auxiliary
facilities are any facilities that furnish a service to students,
faculty, or staff, and that generate income. Auxiliary facilities
include housing, eating, recreational, campus, infirmary, parking,
athletic, student union or activity, research laboratory, testing, and
any related facilities.
On August 7, 1989, the Governor issued an Executive Order assigning to
the Department of Budget and Fiscal Planning responsibility to review
certain proposed issuances of revenue and enterprise debt other than
private activity bonds. The Executive Order also provides that the
Governor may establish a ceiling of such debt to be issued during the
fiscal year, which ceiling may be amended by the Governor.
Although the State has authority to make short-term borrowings in
anticipation of taxes and other receipts up to a maximum of $100
million, in the past it has not issued short-term tax anticipation
73
<PAGE>
and
bond anticipation notes or made any other similar short-term borrowings.
However, the State has issued certain obligations in the nature of bond
anticipation notes for the purpose of assisting several savings and loan
associations in qualifying for Federal insurance and in connection with
the assumption by a bank of the deposit liabilities of an insolvent
savings and loan association.
Lease and Conditional Purchase Financings. The State has financed the
construction and acquisition of various facilities through conditional
purchase, sale-leaseback, and similar transactions. All of the lease
payments under these arrangements are subject to annual appropriation by
the Maryland General Assembly. In the event that appropriations are not
made, the State may not be held contractually liable for the payments.
Ratings. The general obligation bonds of the State of Maryland have
been rated by Moody's Investors Service, Inc. as Aaa, by Standard &
Poor's Corporation as AAA, and by Fitch Investors Service, Inc. as AAA.
Local Subdivision Debt. The counties and incorporated municipalities
in Maryland issue general obligation debt for general governmental
purposes. The general obligation debt of the counties and incorporated
municipalities is generally supported by ad valorem taxes on real
estate, tangible personal property and intangible personal property
subject to taxation. The issuer typically pledges its full faith and
credit and unlimited taxing power to the prompt payment of the maturing
principal and interest on the general obligation debt and to the levy
and collection of the ad valorem taxes as and when such taxes become
necessary in order to provide sufficient funds to meet the debt service
requirements. The amount of debt which may be authorized may in some
cases be limited by the requirement that it not exceed a stated
percentage of the assessable base upon which such taxes are levied.
In the opinion of counsel, the issuer may be sued in the event that it
fails to perform its obligations under the general obligation debt to
the holders of the debt, and any judgments resulting from such suits
would be enforceable against the issuer. Nevertheless, a holder of the
debt who has obtained any such judgment may be required to seek
additional relief to compel the issuer to levy and collect such taxes as
may be necessary to provide the funds from which a judgment may be paid.
Although there is no Maryland law on this point, it is the opinion of
counsel that the appropriate courts of Maryland have jurisdiction to
entertain proceedings and power to grant additional relief, such as a
mandatory injunction, if necessary, to enforce the levy and collection
of such taxes and payment of the proceeds of the collection of the taxes
to the holders of general obligation debt, pari passu, subject to the
same constitutional limitations on enforcement, as described above, as
apply to the enforcement of judgments against the State.
Local subdivisions, including counties and municipal corporations, are
also authorized by law to issue special and limited obligation debt for
certain purposes other than general governmental purposes. The source
of payment of that debt is limited to certain revenues of the issuer
derived from commercial activities operated by the issuer, payments made
with respect to certain facilities or loans, and any funds pledged for
the benefit of the holders of the debt. That special and limited
obligation debt does not constitute a debt of the State, the issuer or
any other political subdivision of either within the meaning of any
constitutional or statutory limitation. Neither the State nor the
issuer or any other political subdivision of either is obligated to pay
the debt or the interest on the debt except from the revenues of the
issuer specifically pledged to the payment of the debt. Neither the
faith and credit nor the taxing power of the State, the issuer or any
other political subdivision of either is pledged to the payment of the
debt. The issuance of the debt is not directly or indirectly or
contingently an obligation, moral or other, of the State, the issuer or
any other political subdivision of either to levy any tax for its
payment.
74
<PAGE>
Washington Suburban Sanitary District Debt. The Washington Suburban
Sanitary District operates as a public corporation of the State to
provide, as authorized, water, sewerage and drainage systems, including
water supply, sewage disposal, and storm water drainage facilities for
Montgomery County, Maryland and Prince George's County, Maryland. For
the purpose of paying the principal of and interest on bonds of the
District, Maryland law provides for the levy, annually, against all the
assessable property within the District by the County Council of
Montgomery County and the County Council of Prince George's County of ad
valorem taxes sufficient to pay such principal and interest when due and
payable.
Storm water drainage bonds for specific projects are payable from an
ad valorem tax upon all of the property assessed for county tax purposes
within the portion of the District situated in the county in which the
storm water project was, or is to be, constructed. Storm water drainage
bonds of the District are also guaranteed by such county, which guaranty
operates as a pledge of the full faith and credit of the county to the
payment of the bonds and obligates the county council, to the extent
that the tax revenues referred to above and any other money available or
to become available are inadequate to provide the funds necessary to pay
the principal of and the interest on the bonds, to levy upon all
property subject to taxation within the county ad valorem taxes in rate
and in amount sufficient to make up any such deficiency.
Substantially all of the debt service on the bonds, except storm water
drainage bonds, is being paid from revenues derived by the District from
water consumption charges, front foot benefit charges, and sewage usage
charges. Notwithstanding the payment of principal of and interest on
those bonds from those charges, the underlying security of all bonds of
the District is the levy of ad valorem taxes on the assessable property
as stated above.
Special Authority Debt. The State and local governments have created
several special authorities with the power to issue debt on behalf of
the State or local government for specific purposes, such as providing
facilities for non-profit health care and higher educational
institutions, facilities for the disposal of solid waste, funds to
finance single family and low-to-moderate income housing, and similar
purposes. The Maryland Health and Higher Educational Facilities
Authority, the Northeast Maryland Waste Disposal Authority, the Housing
Opportunities Commission of Montgomery County, and the Housing Authority
of Prince George's County are some of the special authorities which have
issued and have outstanding debt of this type.
The debts of the authorities issuing debt on behalf of the State and
the local governments are limited obligations of the authorities payable
solely from and secured by a pledge of the revenues derived from the
facilities or loans financed with the proceeds of the debt and from any
other funds and receipts pledged under an indenture with a corporate
trustee. The debt does not constitute a debt, liability or pledge of
the faith and credit of the State or of any political subdivision or of
the authorities. Neither the State nor any political subdivision
thereof nor the authorities shall be obligated to pay the debt or the
interest on the debt except from such revenues, funds and receipts.
Neither the faith and credit nor the taxing power of the State or of any
political subdivision of the State or the authorities is pledged to the
payment of the principal of or the interest on such debt. The issuance
of the debt is not directly or indirectly an obligation, moral or other,
of the State or of any political subdivision of the State or of the
authority to levy or to pledge any form of taxation whatsoever, or to
make any appropriation, for their payment. The authorities have no
taxing power.
Hospital Bonds. The rates charged by non-governmental Maryland
hospitals are subject to review and approval by the Maryland Health
Services Cost Review Commission. Maryland hospitals subject to
regulation by the Commission are not permitted to charge for services at
rates other than those established by the Commission. In addition, the
Commission is required to permit any nonprofit institution subject to
its jurisdiction to charge reasonable rates which will permit the
institution to provide, on a solvent basis, effective and efficient
service in the public interest.
75
<PAGE>
Under an agreement between Medicare and the Commission, Medicare
agrees to pay Maryland hospitals on the basis of Commission-approved
rates, less a 6% differential. Under this so-called "Medicare Waiver",
Maryland hospitals are exempt from the Medicare Prospective Payment
System which pays hospitals fixed amounts for specific services based
upon patient diagnosis. No assurance can be given that Maryland will
continue to meet any current or future tests for the continuation of the
Medicare Waiver.
In setting hospital rates, the Commission takes into account each
hospital's budgeted volume of services and cash financial requirements
for the succeeding year. It then establishes the rates of the hospital
for the succeeding year based upon the projected volume and those
financial requirements of the institution which the Commission has
deemed to be reasonable. Financial requirements allowable for inclusion
in rates generally include budgeted operating costs, a "capital
facilities allowance", other financial considerations (such as charity
care and bad debts) and discounts allowed certain payors for prompt
payment. Variations from projected volumes of services are reflected in
the rates for the succeeding year. The Commission, on a selective basis
by the application of established review criteria, grants Maryland
hospitals increases in rates to compensate for inflation experienced by
hospitals and for other factors beyond the hospitals" control.
Regulations of the Commission provide that overcharges will in certain
circumstances be deducted from prospective rates. Similarly,
undercharges will in certain circumstances not be recoverable through
prospective rates.
The Commission has entered into agreements with certain hospitals to
adjust rates in accordance with a prospectively approved, guaranteed
inpatient revenue per admission program. Those agreements are in
addition to the rate adjustment methodology discussed above. Under the
program, a hospital's revenue per admission is compared to the revenue
per admission, as adjusted, for a base year. Variations from the
adjusted base year revenues per admission are added or deducted, as the
case may be, from the hospital's gross revenue and rates for the
following year.
There can be no assurance that the Commission will continue to utilize
its present rate-setting methodology or approve rates which will be
sufficient to ensure payment on an individual hospital's obligations.
Future actions by the Commission or the loss of the Medicare Waiver may
adversely affect the operations of individual hospitals.
Other Risk Factors. The manufacturing sector of Maryland's economy,
which historically has been a significant element of the State's
economic health, has experienced severe financial pressures and an
overall contraction in recent years. This is due in part to the
reduction in defense-related contracts and grants, which has had an
adverse impact that is substantial and is believed to be
disproportionately large compared with the impact on most other states.
The State has endeavored to promote economic growth in other areas, such
as financial services, health care and high technology. Whether the
State can successfully make the transition from an economy reliant on
heavy industries to one based on service-and science-oriented businesses
is uncertain. Moreover, future economic difficulties in the service
sector and high technology industries could have an adverse impact on
the finances of the State and its subdivisions, and could adversely
affect the market value of the Bonds in the Maryland Trust or the
ability of the respective obligors to make payments of interest and
principal due on such Bonds.
The State and its subdivisions, and their respective officers and
employees, are defendants in numerous legal proceedings, including
alleged torts and breaches of contract and other alleged violations of
laws. Adverse decisions in these matters could require extraordinary
appropriations not budgeted for, which could adversely affect the
ability to pay obligations on indebtedness.
76
<PAGE>
MARYLAND TAXES
In the opinion of Weinberg & Green LLC, Baltimore, Maryland, special
counsel on Maryland tax matters, under existing Maryland law:
1. The Maryland Trust will not be recognized as an association
taxable as a corporation, and the income of the Maryland Trust will be
treated as the income of the Holders of Units ("Holder"). The Maryland
Trust is not a "financial institution" subject to the Maryland Franchise
Tax measured by net earnings. The Maryland Trust is not subject to
Maryland property taxes imposed on the intangible personal property of
certain corporations.
2. A Holder will not be required to include the Holder's share of the
earnings of, or distributions from, the Maryland Trust in the Holder's
Maryland taxable income to the extent that such earnings or
distributions represent interest excludable from gross income for
Federal income tax purposes received by the Maryland Trust on
obligations of the State of Maryland, or the Government of Puerto Rico,
or the Government of Guam and their respective political subdivisions
and authorities. Interest on Debt Obligations is subject to the
Maryland Franchise Tax imposed on "financial institutions" and measured
by net earnings.
3. In the case of taxpayers who are individuals, Maryland presently
imposes an income tax on items of tax preference with reference to such
items as defined in the Internal Revenue Code, as amended, for purposes
of calculating the federal alternative minimum tax. Interest paid on
certain private activity bonds is a preference item for purposes of
calculating the federal alternative minimum tax. Accordingly, if the
Maryland Trust holds such bonds, 50% of the interest on such bonds in
excess of a threshold amount is taxable by Maryland.
4. A Holder may recognize taxable gain or loss, which will be capital
gain or loss except in the case of a dealer or a financial institution,
when the Holder disposes of all or part of the Holder's pro rata portion
of the Debt Obligations in the Maryland Trust. A Holder will be
considered to have disposed of all or part of the Holder's pro rata
portion of each Debt Obligation when the Holder sells or redeems all or
some of the Holder's Units. A Holder will also be considered to have
disposed of all or part of the Holder's pro rata portion of a Debt
Obligation when all or part of the Debt Obligation is disposed of by the
Maryland Trust or is redeemed or paid at maturity. Capital gains
included in the gross income of Holders for federal income tax purposes
may be subtracted from income for Maryland income tax purposes only to
the extent that the gain is derived from the disposition of Debt
Obligations issued by the State of Maryland and its political
subdivisions. Profits realized on the sale or exchange of Debt
Obligations are subject to the Maryland Franchise Tax imposed on
"financial institutions" and measured by net earnings.
5. Units of the Maryland Trust will be subject to Maryland
inheritance and estate tax only if held by Maryland residents.
6. Neither the Debt Obligations nor the Units will be subject to
Maryland personal property tax.
7. The sales of Units in Maryland or the holding of Units in Maryland
will not be subject to Maryland Sales or Use Tax.
THE MASSACHUSETTS TRUST
RISK FACTORS--The Commonwealth of Massachusetts and certain of its
cities and towns have at certain times in the recent past undergone
serious financial difficulties which have adversely
77
<PAGE>
affected and, to
some degree, continue to adversely affect their credit standing. These
financial difficulties could adversely affect the market values and
marketability of, or result in default in payment on, outstanding bonds
issued by the Commonwealth or its public authorities or municipalities,
including the Debt Obligations deposited in the Trust. The following
description highlights some of the more significant financial problems
of the Commonwealth and the steps taken to strengthen its financial
condition.
The effect of the factors discussed below upon the ability of
Massachusetts issuers to pay interest and principal on their obligations
remains unclear and in any event may depend on whether the obligation is
a general or revenue obligation bond (revenue obligation bonds being
payable from specific sources and therefore generally less affected by
such factors) and on what type of security is provided for the bond. In
order to constrain future debt service costs, the Executive Office for
Administration and Finance established in November, 1988 an annual
fiscal year limit on capital spending of $925 million, effective fiscal
1990. In January, 1990, legislation was enacted to impose a limit on
debt service in Commonwealth budgets beginning in fiscal 1991. The law
provides that no more than 10% of the total appropriations in any fiscal
year may be expended for payment of interest and principal on general
obligation debt of the Commonwealth (excluding the Fiscal Recovery Bonds
discussed below). It should also be noted that Chapter 62F of the
Massachusetts General Laws establishes a state tax revenue growth limit
for each fiscal year equal to the average positive rate of growth in
total wages and salaries in the Commonwealth, as reported by the federal
government, during the three calendar years immediately preceding the
end of such fiscal year. The limit could affect the Commonwealth's
ability to pay principal and interest on its debt obligations. It is
possible that other measures affecting the taxing or spending authority
of Massachusetts or its political subdivisions may be approved or
enacted in the future.
The Commonwealth has waived its sovereign immunity and consented to be
sued under contractual obligations including bonds and notes issued by
it. However, the property of the Commonwealth is not subject to
attachment or levy to pay a judgment, and the satisfaction of any
judgment generally requires legislative appropriation. Enforcement of a
claim for payment of principal of or interest on bonds and notes of the
Commonwealth may also be subject to provisions of federal or
Commonwealth statutes, if any, hereafter enacted extending the time for
payment or imposing other constraints upon enforcement, insofar as the
same may be constitutionally applied. The United States Bankruptcy Code
is not applicable to states.
Cities and Towns. During recent years limitations were placed on the
taxing authority of certain Massachusetts governmental entities that may
impair the ability of the issuers of some of the Debt Obligations in the
Massachusetts Trust to maintain debt service on their obligations.
Proposition 2 1/2, passed by the voters in 1980, led to large reductions
in property taxes, the major source of income for cities and towns.
Between fiscal 1981 and fiscal 1993, the aggregate property tax levy
grew from $3.347 billion to $5.249 billion, representing an increase of
approximately 56.8%. By contrast, according to federal Bureau of Labor
Statistics, the Consumer price index for all urban consumers in Boston
grew during the same period by approximately 80%.
During the 1980's, the Commonwealth increased payments to its cities,
towns and regional school districts to mitigate the import of
Proposition 2 1/2 on local programs and services. Direct local aid
decreased from $2.937 billion in fiscal 1990 to $2.328 billion in 1992,
increased to $2.547 billion in 1993 and increased to $2.727 billion in
fiscal 1994. It is estimated that fiscal 1995 expenditures for direct
local aid will be $2.984 billion, which is an increase of approximately
9.4% above the 1994 level. The additional amount of indirect local aid
provided over and above the direct local aid was approximately $2.069
billion in fiscal 1994. It is estimated that in fiscal 1995
approximately $2.318 billion of indirect local aid will also be paid.
The Governor's proposed fiscal 1996 budget includes approximately $3.222
billion and $2.585 billion of direct local aid and indirect local aid,
respectively.
78
<PAGE>
Many communities have responded to the limitations imposed by
Proposition 2 1/2 through statutorily permitted overrides and
exclusions. Override activity peaked in fiscal 1991, when 182
communities attempted votes on one of the three types of referenda
questions (override of levy limit, exclusion of debt service, or
exclusion of capital expenditures) and 100 passed at least one question,
adding $58.5 million to their levy limits. In fiscal 1992, 67 of 143
communities had successful votes totalling $31.0 million. In fiscal
1993, 83 communities attempted a vote; two-thirds of them (56) passed
questions aggregating $16.4 million.
A statewide voter initiative petition which would effectively mandate
that, commencing with fiscal 1992, no less than 40% of receipts from
personal income taxes, sales and use taxes, corporate excise taxes and
lottery fund proceeds be distributed to certain cities and towns in
local aid was approved in the general election held November 6, 1990.
Pursuant to this petition, the local aid distribution to each city or
town was to equal no less than 100% of the total local aid received for
fiscal 1989. Distributions in excess of fiscal 1989 levels were to be
based on new formulas that would replace the current local aide
distribution formulas. If implemented in accordance with its terms
(including appropriation of the necessary funds), the petition as
approved would shift several hundred million dollars to direct local
aid. However, local aid payments expressly remain subject to annual
appropriation, and fiscal 1992, fiscal 1993 and fiscal 1994
appropriations for local aid did not meet, and fiscal 1995
appropriations for local aid do not meet, the levels set forth in the
initiative law.
Pension Liabilities. Comprehensive pension funding legislation
approved in January, 1988 requires the Commonwealth to fund future
pension liabilities currently and to amortize the Commonwealth's
accumulated unfunded liabilities over 40 years. The unfunded actuarial
accrued liability, as of January 1, 1993, relative to the state
employees" and teachers" systems and the State-Boston retirement system,
to Boston teachers and to the cost-of-living allowances for local
systems, is reported in the schedule to be approximately $7.445 billion,
$372.6 million and $1.833 billion, respectively, for a total unfunded
actuarial liability of $9.651 billion. As of December 31, 1994 the
Commonwealth's pension reserves had grown to approximately $4.925
billion. Prior to the establishment of the pension program, the
Commonwealth appropriated approximately $680 million to pension reserves
during the mid 1980's, in addition to the pay-as-you-go pension costs
during those years.
Annual payments under the funding schedule through fiscal 1998 must be
at least equal to the total estimated pay-as-you-go benefit cost in such
year. As a result of this requirement, the funding requirements for
fiscal 1995, 1996, 1997 and 1998 are estimated to be increased to
approximately $959.9 million, $1.007 billion, $1.061 billion and $1.128
billion, respectively. Total pension expenditures increased from $671.9
million in fiscal 1990 to $908.9 million in 1994. The pension
expenditures for fiscal 1995 and fiscal 1996 are expected to be
approximately $994.3 million and $1.044 billion, respectively.
State Budget and Revenues. The Commonwealth's Constitution requires,
in effect, that its budget be balanced each year. The Commonwealth's
fiscal year ends June 30. The General Fund is the Commonwealth's
primary operating fund; it also functions as a residuary fund to receive
otherwise unallocated revenues and to provide monies for transfers to
other funds as required. The condition of the General Fund is generally
regarded as the principal indication of whether the Commonwealth's
operating revenues and expenses are in balance; the other principal
operating funds (the Local Aid Fund and the Highway Fund) are
customarily funded to at least a zero balance.
Limitations on Commonwealth tax revenues have been established by
enacted legislation and by public approval of an initiative petition
which has become law. The two measures are inconsistent in several
respects, including the methods of calculating the limits and the
exclusions from the limits. The initiative petition does not exclude
debt service on the Commonwealth's notes and bonds from the limits.
State tax revenues in fiscal 1990 through fiscal 1994 were lower than
the limits. The Executive
79
<PAGE>
Office for Administration and Finance
currently estimates that state tax revenues will not reach the limit
imposed by either the initiative petition or the legislative enactment
in fiscal 1995 and fiscal 1996.
Fiscal year 1990 resulted in total expenditures of approximately
$13.260 billion. Budgeted revenues and other services for fiscal 1990
were approximately $12.008 billion. Tax revenues for fiscal 1990 were
approximately $8.517 billion, a decrease of approximately $314 million
or 3.6% from fiscal 1989. The Commonwealth suffered an operating loss
of approximately $1.25 billion and ended fiscal 1990 with a budgetary
deficit of $1.104 billion. The Commonwealth had a cash surplus of $99.2
million on June 30, 1990 as a result of deferring until fiscal 1991 the
payment of approximately $1.26 billion of local aid due June 30, 1990.
On July 28, 1990, the legislature enacted Chapter 151 which provides,
among other matters, for the Commonwealth Fiscal Recovery Loan Act of
1990 and grants authorization for the Commonwealth to issue bonds in an
aggregate amount up to $1.42 billion for purposes of funding the
Commonwealth's fiscal 1990 deficit and certain prior year Medicaid
reimbursement payments. Chapter 151 also provides for the establishment
of the Commonwealth Fiscal Recovery Fund, deposits for which are derived
from a portion of the Commonwealth's personal income tax receipts, are
dedicated for this purpose and are to be deposited in trust and pledged
to pay the debt service on these bonds. Under Chapter 151, the
Commonwealth issued $1.363 billion of Dedicated Income Tax Bonds to
cover the fiscal 1990 deficit.
Fiscal 1991 budgeted expenditures were $13.655 billion. Total
budgeted revenues and other sources for fiscal 1991 were $13.634
billion, resulting in an estimated $21 million operating loss.
Application of the adjusted fiscal 1990 fund balances of $258.3 million
resulted in a final fiscal 1991 budgetary surplus of $237.1 million.
State finance law required that approximately $59.2 million of the
fiscal year surplus be placed in the Stabilization Fund described above.
Amounts credited to the Stabilization Fund are not generally available
to defray current year expenses without subsequent specific legislative
authorization.
After payment in full of the local aid distribution of $1.018 billion
due on June 28, 1991, retirement of all of the Commonwealth's
outstanding commercial paper and repayment of certain other short-term
borrowings, as of the end of fiscal 1991, the Commonwealth had a cash
balance of $182.3 million. The fiscal 1991 year-end cash position
compared favorably to the Commonwealth's cash position at the end of the
prior fiscal year, June 30, 1990, when the Commonwealth's cash
short-fall would have exceeded $1.1 billion had payment of local aid not
been postponed.
In fiscal 1992, Medicaid accounted for more than half of the
Commonwealth's appropriations for health care. It was the largest item
in the Commonwealth's budget and has been one of the fastest growing
budget items. During fiscal years 1990, 1991, 1992 and 1993, Medicaid
expenditures were $2.121 billion, $2.765 billion, $2.818 billion and
$3.151 billion, respectively. The increase from fiscal 1992 to fiscal
1993 resulted mainly from the one-time start-up costs of a new managed
care program for Medicaid recipients. Prior to fiscal 1994, substantial
Medicaid expenditures were provided through supplemental appropriations
because program requirements exceeded initial appropriation amounts. In
fiscal 1990, payments of approximately $488 million were made to
hospitals and nursing homes for rate settlements dating back as far as
1980, through the Medical Assistance Liability Fund established to fund
certain Medicaid liabilities incurred, but not certified for payment, in
prior years. This amount is not factored into the annual total for
Medicaid expenditures listed above for fiscal year 1991 when
expenditures of $194.2 million were made to fund prior year provider
settlements. Including retroactive provider settlements, Medicaid
expenditures for fiscal 1994 were $3.313 billion, an increase of 5.1%
over fiscal 1993 expenditures. The Executive Office for Administration
and Finance estimates that fiscal 1995 Medicaid expenditures will be
approximately $3.411 billion, an increase of 3.0% over fiscal 1994
expenditures. No supplemental appropriations were required in fiscal
1994 to fund
80
<PAGE>
expenditures related to fiscal 1994 services and none are
currently anticipated in fiscal 1995. The Governor's fiscal 1996 budget
recommends $3.431 billion for Medicaid expenditures.
In fiscal 1992 total revenues and other sources of the budgeted
operating funds totalled $13.728 billion, an increase over fiscal 1991
revenues of .7%. (Actual fiscal 1992 tax revenues exceeded original
estimates and totalled $9.484 billion, an increase over fiscal 1991
collections of 5.4%). Fiscal 1992 expenditures and other uses of
budgeted operating funds totalled approximately $13.420 billion, a
decrease from fiscal 1991 expenditures by 1.7%. Fiscal year 1992
revenues and expenditures resulted in an operating gain of $312.3
million. Through the use of the prior year ending fund balances of
$312.3 million, fiscal 1992 budgetary fund balances totalled $549.4
million. Total fiscal 1992 spending authority continued into fiscal
1993 is $231.0 million.
After payment in full of the quarterly local aid distribution of $514
million due on June 30, 1992, retirement of the Commonwealth's
outstanding commercial paper (except for approximately $50 million of
bond anticipation notes) and certain other short-term borrowings, as of
June 30, 1992, the Commonwealth showed a year-end cash position of
approximately $731 million for fiscal year 1992. The ending balance
compares favorably with the cash balance of $182.3 million at the end of
fiscal 1991. As of June 1993, the Commonwealth showed a year-end cash
position of $622.2 million for fiscal year 1993. As of June 30, 1994,
the Commonwealth showed a 1994 year-end cash position of approximately
$757 million, as compared to a projected position of $599 million. The
most recent cash flow projections by the office of State Treasurer in
December, 1994 estimates the fiscal 1995 year-end cash position to be
approximately $447 million.
The budgeted operating funds of the Commonwealth ended fiscal 1993
with a surplus of revenues and other sources over expenditures and other
uses of $13.1 million and aggregate ending fund balances in the budgeted
operating funds of the Commonwealth of approximately $562.5 million.
Budgeted revenues and other sources for fiscal 1993 totalled
approximately $14.710 billion, including tax revenues of $9.940 billion.
Total revenues and other sources increased by approximately 6.9% from
fiscal 1992 to fiscal 1993, while tax revenues increased by 4.7% for the
same period.
Commonwealth budgeted expenditures and other uses in fiscal 1993
totalled approximately $14.696 billion, which is $1.280 billion or
approximately 9.6% higher than fiscal 1992 expenditures and other uses.
Fiscal year 1994 tax revenue collections were $10.607 billion, $87
million below the Department of Revenue's fiscal year 1994 tax revenue
estimate of $10.694 billion. Budgeted revenues and other sources,
including non-tax revenues, collected in fiscal 1994 totalled
approximately $15.55 billion. Budgeted expenditures and other uses of
funds in fiscal 1994 were approximately $15.523 billion.
In June, 1993, the Legislature adopted and the Governor signed in to
law comprehensive education reform legislation. This legislation
required an increase in expenditures for education purposes above fiscal
1993 base spending of $1.288 billion of approximately $175 million in
fiscal 1994. The Executive Office for Administration and Finance
expects the annual increases in expenditures above the fiscal 1993 base
spending of $1.288 billion to be approximately $396 million in fiscal
1995, $625 million in fiscal 1996 and $868 million in fiscal 1997.
Additional annual increases are also expected in later fiscal years.
The fiscal 1995 budget includes $396 million in appropriations to
satisfy this legislation.
The fiscal 1995 budget, which, together with authorizations contained
in the final fiscal 1994 appropriations bill and expected supplemental
appropriations relating to welfare and certain other programs currently
provides for approximately $16.482 billion in fiscal 1995 expenditures.
81
<PAGE>
Budgeted revenues and other sources to be collected in fiscal 1995 are
estimated by the Executive Office for Administration and Finance to be
approximately $16.36 billion. This amount includes estimated fiscal
1995 tax revenues of $11.179 billion, which is approximately $572
million higher than fiscal 1994 tax revenues of $10.607 billion. The
fiscal 1995 budget is based on numerous spending and revenue estimates,
the achievement of which cannot be assured. The $16.449 billion of
fiscal 1995 expenditures includes a reserve against certain
contingencies currently in the amount of $98.6 million. On January 25,
1995, the Governor filed fiscal 1995 supplemental appropriation
recommendations aggregating approximately $43.6 million, which
expenditures are included in the $98.6 million contingency reserve for
fiscal 1995 expenditures.
On January 24, 1995, the Governor submitted his fiscal 1996 budget
recommendations to the Legislature. The proposal calls for budgeted
expenditures of approximately $16.737 billion. After adjusting for
approximately $147.9 million in higher education revenues and
expenditures that the Governor's budget recommendation proposes moving
to an off-budget trust fund for fiscal 1996, the recommended fiscal 1996
spending level is approximately $436 million, or 2.6%, above currently
estimated fiscal 1995 expenditures of $16.449 billion. Proposed
budgeted revenues for fiscal 1996 are approximately $16.741 billion.
The Governor's recommendation projects a fiscal 1996 ending balance of
approximately $505 million, of which approximately $419 million will be
in the Stabilization Fund.
The Governor's budget recommendation is based on a fiscal 1996 tax
revenue estimate of $11.720 billion, an increase of approximately $542
million, or approximately 4.8%, as compared to currently estimated
fiscal 1995 tax revenues of $11.179 billion. Under the Governor's
fiscal 1996 budget recommendations, non-tax revenues are estimated to
total approximately $5.021 billion in fiscal 1996.
The liabilities of the Commonwealth with respect to outstanding bonds
and notes payable as of January 1, 1995 totalled $12.975 billion. These
liabilities consisted of $8.624 billion of general obligation debt, $831
million of dedicated income tax debt (the Fiscal Recovery Bonds), $404
million of special obligation debt, $2.881 billion of supported debt,
and $235 million of guaranteed debt.
Capital spending by the Commonwealth rose from approximately $600
million in fiscal 1987 to $971 million in fiscal 1989. In November
1988, the Executive Office for Administration and Finance established an
administrative limit on state financed capital spending in the Capital
Projects Funds of $925.0 million per fiscal year. Capital expenditures
were $936 million, $847 million, $694.1 million, $575.9 million and
$760.9 million in fiscal 1990, 1991, 1992, 1993, and fiscal 1994,
respectively. Capital expenditures are projected to increase to $850
million and approximately $908 million in fiscal 1994 and fiscal 1995,
respectively. The growth in capital spending in the 1980's accounts for
a significant rise in debt service expenditures since fiscal 1989.
Payments for the debt service on Commonwealth general obligation bonds
and notes have risen at an average annual rate of 22.2% from $770.9
million in fiscal 1990 to $942.3 million in fiscal 1991. Debt Service
payments in fiscal 1992 were $898.3 million, representing a 4.7%
decrease from fiscal 1991. This decrease resulted from a $261 million
one-time reduction achieved through the issuance of refunding bonds in
September and October of 1991. Debt service expenditures were $1.140
billion for fiscal 1993 and $1.149 billion for fiscal 1994 and are
projected to be $1.242 billion for fiscal 1995 and $1.267 billion for
fiscal 1996. These amounts represent debt service payments on direct
Commonwealth debt and do not include debt service on notes issued to
finance the fiscal 1989 deficit and certain Medicaid-related
liabilities, which were paid in full from non-budgeted funds. Also
excluded are debt service contract assistance to certain state agencies
and the municipal school building assistance program projected to total
of $405.6 million in the aggregate in fiscal 1995. In addition to debt
service on bonds issued for capital purposes, the Commonwealth is
obligated to pay the principal of and interest on the Fiscal Recovery
Bonds described above. The estimated debt service on such Bonds
currently outstanding (a portion of which were issued as variable rate
bonds) ranges from approximately $278 million (interest only) in
82
<PAGE>
fiscal
1995 through fiscal 1997 and approximately $130 million in fiscal 1998,
at which time the entire amount of the Fiscal Recovery Bonds will be
paid.
In January, 1990 legislation was enacted to impose a limit on debt
service in Commonwealth budgets beginning in fiscal 1991. The law
provides that no more than 10% of the total appropriations in any fiscal
year may be expended for payment of interest and principal on general
obligation debt (excluding the Fiscal Recovery Bonds) of the
Commonwealth. This law may be amended or appealed by the legislature or
may be superseded in the General Appropriation Act for any year. From
fiscal year 1990 through fiscal year 1995 estimated, this percentage has
been substantially below the limited established by this law.
Legislation enacted in December, 1989 imposes a limit on the amount of
outstanding direct bonds of the Commonwealth. The limit for fiscal 1995
is $8.265 billion; as of January 1, 1995, there were $7.556 billion of
outstanding direct bonds. The law provides that the limit for each
subsequent fiscal year shall be 105% of the previous fiscal year's
limit. The Fiscal Recovery Bonds will not be included in computing the
amount of bonds subject to this limit. Since this law's inception, the
limit has never been reached.
In August, 1991, the Governor announced a five-year capital spending
plan. The policy objective of the Five-Year Capital Spending Plan is to
limit the debt burden of the Commonwealth by controlling the
relationship between current capital spending and the issuance of bonds
by the Commonwealth. For fiscal 1995 through 1999, the plan forecasts
total capital spending for the Commonwealth of $4.634 billion, which is
significantly below legislatively authorized spending levels.
Unemployment. The Massachusetts unemployment rate averaged 9.0%,
8.5%, 6.9% and 6.0% in calendar year 1991, 1992, 1993 and 1994,
respectively. The Massachusetts unemployment rate in January and
February, 1995 was 6.0% as compared to 6.4% for February, 1994, although
the rate has been volatile throughout this period. The Massachusetts
unemployment rates from and after 1994 are not comparable to prior rates
due to a new procedure for computation which became effective in 1994.
In September 1991 the reserves in the Commonwealth's Unemployment
Compensation Trust fund were exhausted due to the continued high level
of unemployment. Between September 1991 and May 1994, benefit payments
in excess of contributions were financed through repayable advances from
the federal unemployment loan account. Legislation enacted in 1992
significantly increased employer contributions in order to reduce
advances from the federal loan account and 1993 contributions exceeded
benefit outlays by more than $200 million. All federal advances were
paid in May 1994 and since that time, the trust fund has been solvent.
As of November 30, 1994, the Massachusetts Unemployment Trust Fund was
running a surplus of $216 million. Interest on federal advances of $4.7
million was paid in September, 1994.
The Department of Employment and Training's October 1994 quarterly
report indicates that the additional increases in contributions provided
by the 1992 legislation should result in a balance of $90 million in the
Unemployment Compensation Trust Fund by December 1994 and rebuild
reserves in the system to $1.4 billion by the end of 1998, even if the
Legislature acts to keep contribution rates at their current level for
one more year.
Litigation. The Attorney General of the Commonwealth is not aware of
any cases involving the Commonwealth which in his opinion would affect
materially its financial condition. However, certain cases exist
containing substantial claims, among which are the following.
The United States has brought an action on behalf of the U.S.
Environmental Protection Agency alleging violations of the Clean Water
Act and seeking to enforce the clean-up of Boston
83
<PAGE>
Harbor. The
Massachusetts Water Resources Authority (the "MWRA") has assumed primary
responsibility for developing and implementing a court approved plan and
time table for the construction of the treatment facilities necessary to
achieve compliance with the federal requirements. The MWRA currently
projects the total cost of construction of the waste water facilities
required under the court's order as approximately $3.5 billion in
current dollars, with approximately $1.54 billion to be spent on or
after July 1, 1994. Under the Clean Water Act, the Commonwealth may be
liable for any costs of complying with any judgment in this case to the
extent that the MWRA or a municipality is prevented by state law from
raising revenues necessary to comply with such a judgment.
A suit was brought by associations of bottlers challenging the 1990
amendments to the bottle bill which escheat abandoned deposits to the
Commonwealth, a case involving approximately $100 million. In March of
1993, the Supreme Judicial Court upheld the amendments except for the
initial funding requirement, which the Court held severable. The
Superior Court recently ruled that the Commonwealth is liable for a
certain amount, including interest, as a result of the Supreme Judicial
Court's decision, such amount to be determined in further proceedings.
In a suit filed against the Department of Public Welfare, plaintiffs
allege that the Department has unlawfully denied personal care attendant
services to severely disabled Medicaid recipients. The Court has denied
plaintiffs" motion for a preliminary injunction and has not yet acted on
plaintiffs" motion for reconsideration of that decision. If plaintiffs
prevail on their claims, the suit could cost the Commonwealth as much as
$200 million per year.
In a suit filed against the Commissioner of Revenue, plaintiffs
challenge the inclusion of income from tax exempt obligations in the
measure of the bank excise tax. The Appellate Tax Board issued a
finding of fact and report in favor of the Commissioner of Revenue on
September 30, 1993. An appeal has been filed. The Supreme Judicial
Court is expected to hear the appeal in the fall of 1994. Approximately
$1.2 billion is at issue.
In a suit filed against the Commonwealth, plaintiffs challenged two
fees imposed on trucks, arguing that they violate the Commerce Clause of
the Constitution of the United States. In May, 1993, the Supreme
Judicial Court struck down several fees imposed on interstate motor
carriers and remanded the case to the Superior Court to determine the
appropriate remedy. As of August 2, 1994, the Superior Court has
approved the parties" agreement establishing a refund mechanism. The
Commonwealth's total liability equals approximately $30 million.
The Superior Court declared that a line item in the Commonwealth's
general appropriations act for fiscal 1994 that increased the state
employees" percentage share of their group health insurance premiums was
invalid under the contracts clause of the United States Constitution.
The decision has been appealed. If the decision is upheld, the
Commonwealth's aggregate liability is estimated to be approximately $32
million.
There are also several other tax matters in litigation which may
result in an aggregate liability in excess of $150 million.
Ratings. Beginning on May 17, 1989, Standard & Poor's downgraded its
ratings on Massachusetts general obligation bonds and certain agency
issues from AA+ to AA. The ratings were downgraded three additional
times to a low of BBB on December 31, 1989. On July 14, 1989, Standard
& Poor's also downgraded its rating on temporary general obligation
notes and various agency notes from SP-1+ to SP-1 and on general
obligation short-term notes and on short-term agency debt from SP-1 to
SP-2. Bonds rated BBB may have speculative characteristics. The rating
remained at BBB until September 9, 1992 when Standard & Poor's raised
its rating to A. At this same time, such bonds were removed from
CreditWatch. On October 14, 1993, Standard & Poor's raised its rating
from A to A+.
84
<PAGE>
On June 21, 1989, Moody's Investors Service downgraded its rating on
Massachusetts general obligation bonds from Aa to A. The ratings were
further reduced on two occasions to a low on March 19, 1990 of Baa where
it remained until September 10, 1992 when Moody's increased its rating
to A. On November 14, 1994, Moody's again increased its rating to A1.
Fitch Investors Service, Inc. lowered its rating on the Commonwealth's
bonds from AA to A on September 29, 1989. As of December 5, 1991, its
qualification of the bonds changed from Uncertain Trends to Stabilizing
Credit Trend. On October 13, 1993, Fitch Investors raised its rating
from A to A+.
Ratings may be changed at any time and no assurance can be given that
they will not be revised or withdrawn by the rating agencies, if in
their respective judgments, circumstances should warrant such action.
Any downward revision or withdrawal of a rating could have an adverse
effect on market prices of the bonds.
MASSACHUSETTS TAXES
In the opinion of Masterman, Culbert & Tully, Boston, Massachusetts,
special counsel on Massachusetts tax matters, under existing
Massachusetts law and regulations:
1. For Massachusetts income tax purposes, the Massachusetts Trust
will be classified as a fixed investment trust, as that term is defined
in Section 62.8.1 of Title 830 of the Code of Massachusetts Regulations
and, therefore, will not be subject as an entity to Massachusetts income
taxation.
2. Holders who are subject to Massachusetts income taxation under
Chapter 62 of the Massachusetts General Laws will not be required to
include their share of the earnings of the Massachusetts Trust in their
Massachusetts gross income to the extent that such earnings represent
interest received by the Massachusetts Trust on obligations issued by
Massachusetts, its political subdivisions or their agencies or
instrumentalities the interest on which is exempt from taxation under
Massachusetts law, and on obligations issued by the Government of Puerto
Rico or by the Government of Guam.
3. The Massachusetts Trust's gains and losses to the extent included
in the Federal gross income of Holders who are subject to Massachusetts
income taxation under Chapter 62 of the Massachusetts General Laws, will
be included as gains and losses in the Holders" Massachusetts gross
income, except those gains specifically exempted from Massachusetts
income taxation under the statutes authorizing issuance of the
obligations held by the Massachusetts Trust. However, in some cases
losses will not be allowed in the determination of a Holder's
Massachusetts gross income when such losses are realized by the
Massachusetts Trust on the sale of obligations issued pursuant to
statutes specifically exempting gains from Massachusetts income
taxation. No judgment can be made in the abstract.
4. Gains and losses realized upon sale or redemption of Units of the
Massachusetts Trust by Holders who are subject to Massachusetts income
taxation under Chapter 62 to the extent included in the Federal gross
income of such Holders will be included as gains and losses in the
Holders" Massachusetts gross income, except those gains attributable to
obligations held by the Massachusetts Trust which are issued pursuant to
statutes specifically exempting gains from Massachusetts income
taxation. However, in some cases, losses will not be allowed in the
determination of a Holder's Massachusetts gross income when such losses
are attributable to obligations issued pursuant to statutes specifically
exempting gains from Massachusetts income taxation. No judgment can be
made in the abstract.
85
<PAGE>
5. Distributions to Holders who are subject to Massachusetts income
taxation under Chapter 62 of the Massachusetts General Laws will be
subject to tax only to the extent provided in paragraphs 2, 3 and 4
above.
The opinions expressed above apply only to Holders who are
individuals. In addition, these opinions are subject to the opinion of
Davis Polk & Wardwell that the Massachusetts Trust is not an association
taxable as a corporation for Federal income tax purposes and will be
treated as a grantor trust for Federal income tax purposes.
THE MICHIGAN TRUST
RISK FACTORS--Due primarily to the fact that the leading sector of the
State's economy is the manufacturing of durable goods, economic activity
in the State has tended to be more cyclical than in the nation as a
whole. While the State's efforts to diversify its economy have proven
successful, as reflected by the fact that the share of employment in the
State in the durable goods sector has fallen from 33.1 percent in 1960
to 15.1 percent in 1993, durable goods manufacturing still represents a
sizable portion of the State's economy. As a result, any substantial
national economic downturn is likely to have an adverse effect on the
economy of the State and on the revenues of the State and some of its
local governmental units. Recently, as well as historically, the
average monthly unemployment rate in the State has been higher than the
average figures for the United States. For example, for 1993 the
average monthly unemployment rate in this State was 7.0% as compared to
a national average of 6.8% in the United States.
The Michigan Constitution limits the amount of total revenues of the
State raised from taxes and certain other sources to a level for each
fiscal year equal to a percentage of the State's personal income for the
prior calendar year. In the event the State's total revenues exceed the
limit by 1% or more, the Constitution requires that the excess be
refunded to taxpayers. The State Constitution does not prohibit the
increasing of taxes so long as revenues are expected to amount to less
than the revenue limit and authorizes exceeding the limit for
emergencies when deemed necessary by the governor and a two-thirds vote
of the members of each house of the legislature. The State Constitution
further provides that the proportion of State spending paid to all local
units to total spending may not be reduced below the proportion in
effect in the 1978-79 fiscal year. The Constitution requires that if
the spending does not meet the required level in a given year an
additional appropriation for local units is required for the following
fiscal year. The State Constitution also requires the State to finance
any new or expanded activity of local units mandated by State law. Any
expenditures required by this provision would be counted as State
spending for local units for purposes of determining compliance with the
provisions cited above.
The State Constitution limits State general obligation debt to (i)
short-term debt for State operating purposes; (ii) short-and long-term
debt for purposes of making loans to school districts; and (iii)
long-term debt for a voter-approved purpose. Short-term debt for
operating purposes is limited to an amount not in excess of fifteen
(15%) percent of undedicated revenues received by the State during the
preceding fiscal year and must mature in the same fiscal year in which
it is issued. Debt incurred by the State for purposes of making loans
to school districts is recommended by the Superintendent of Public
Instruction who certifies the amounts necessary for loans to school
districts for the ensuing two (2) calendar years. These bonds may be
issued without vote of the electors of the State and in whatever amount
required. There is no limit on the amount of long-term voter-approved
State general obligation debt. In addition to the foregoing, the State
authorizes special purpose agencies and authorities to issue revenue
bonds payable from designated revenues and fees. Revenue bonds are not
obligations of the State and in the event of shortfalls in
self-supporting revenues, the State has no legal obligation to
appropriate money to meet debt service payments. The Michigan State
Housing Development Authority has a capital reserve fund pledged for the
payment of debt service on its bonds
86
<PAGE>
derived from State appropriation.
The act creating this Authority provides that the Governor's proposed
budget include an amount sufficient to replenish any deficiency in the
capital reserve fund. The legislature, however, is not obligated to
appropriate such moneys and any such appropriation would require a
two-thirds vote of the members of the legislature. Obligations of all
other authorities and agencies of the State are payable solely from
designated revenues or fees and no right to certify to the legislature
exists with respect to those authorities or agencies.
The State finances its operations through the State's General Fund and
special revenue funds. The General Fund receives revenues of the State
that are not specifically required to be included in the Special Revenue
Fund. General Fund revenues are obtained approximately 59% from the
payment of State taxes and 41% from federal and non-tax revenue sources.
The majority of the revenues from State taxes are from the State's
personal income tax, single business tax, use tax, sales tax and various
other taxes. Approximately 60% of total General Fund expenditures have
been for State support of public education and for social services
programs. Other significant expenditures from the General Fund provide
funds for law enforcement, general State government, debt service and
capital outlay. The State Constitution requires that any prior year's
surplus or deficit in any fund must be included in the next succeeding
year's budget for that fund.
In recent years, the State of Michigan has reported its financial
results in accordance with generally accepted accounting principles.
For the fiscal years ended September 30, 1990 and 1991, the State
reported negative year-end General Fund balances of $310.3 million and
$169.4 million, respectively, but ended the 1992 fiscal year with its
General Fund in balance. A positive cash balance in the combined
General Fund/School Aid Fund was recorded at September 30, 1990. In
each of the three prior fiscal years the State has undertaken mid-year
actions to address projected year-end budget deficits, including
expenditure cuts and deferrals and one-time expenditures or revenue
recognition adjustments. The State reported a balance in the General
Fund as of September 30, 1993 of $26.0 million after a transfer of $283
million to the Budget Stabilization Fund described below. From 1991
through 1993 the State experienced deteriorating cash balances which
necessitated short-term borrowings and the deferral of certain scheduled
cash payments to local units of government. The State borrowed $700
million for cash flow purposes in the 1992 fiscal year and $900 million
in the 1993 fiscal year. The State has a Budget Stabilization Fund
which had an accrued balance of $20.1 million as of September 30, 1992;
and, after a transfer of $283 million on an accrual basis upon
completion of the State's financial reports, an ending balance of $303
million as of September 30, 1993.
In April, 1986, Moody's upgraded Michigan's general obligation credit
rating from A to A-1 and Standard & Poor's raised its rating on the
State's general obligation bonds from A+ to AA-. In October, 1989,
Standard & Poor's raised its rating again to AA. Early in 1992,
Standard & Poor's maintained this rating.
The State's economy could be affected by changes in the auto industry,
notably consolidation and plant closings resulting from competitive
pressures and over-capacity. The financial impact on the local units of
government in the areas in which plants are or have been closed could be
more severe than on the State as a whole. State appropriations and
State economic conditions in varying degrees affect the cash flow and
budgets of local units and agencies of the State, including school
districts and municipalities, as well as the State of Michigan itself.
Amendments to the Michigan Constitution which place limitations on
increases in State taxes and local ad valorem taxes (including taxes
used to meet debt service commitments on obligations of taxing units)
were approved by the voters of the State of Michigan in November 1978
and became effective on December 23, 1978. To the extent that
obligations in the Portfolio are tax-supported and are for local units
and have not been voted by the taxing unit's electors and have been
issued on or subsequent to December 23, 1978, the ability of the local
units to levy debt service taxes might be affected.
87
<PAGE>
State law provides for distributions of certain State collected taxes
or portions thereof to local units based in part on population as shown
by census figures and authorizes levy of certain local taxes by local
units having a certain level of population as determined by census
figures. Reductions in population in local units resulting from
periodic census could result in a reduction in the amount of State
collected taxes returned to those local units and in reductions in
levels of local tax collections for such local units unless the impact
of the census is changed by State law. No assurance can be given that
any such State law will be enacted. In the 1991 fiscal year, the State
deferred certain scheduled payments to municipalities, school districts,
universities and community colleges. While such deferrals were made up
at later dates, similar future deferrals could have an adverse impact on
the cash position of some local units. Additionally, the State reduced
revenue sharing payments to municipalities below that level provided
under formulas by $10.9 million in the 1991 fiscal year, $34.4 million
in the 1992 fiscal year $45.5 million in the 1993 fiscal year and $64.6
million (budgeted) in the 1994 fiscal year.
On March 15, 1994, the electors of the State voted to amend the
State's Constitution to increase the State sales tax rate from 4% to 6%
and to place an annual cap on property assessment increases for all
property taxes. Companion legislation also cut the State's income tax
rate from 4.6% to 4.4%. In addition, property taxes for school
operating purposes have been reduced and school funding is being
provided from a combination of property taxes and state revenues, some
of which are being provided from new or increased State taxes. The
legislation also contains other provisions that may reduce or alter the
revenues of local units of government and tax increment bonds could be
particularly affected. While the ultimate impact of the constitutional
amendment and related legislation cannot yet be accurately predicted,
investors should be alert to the potential effect of such measures upon
the operations and revenues of Michigan local units of government.
The foregoing financial conditions and constitutional provisions could
adversely affect the State's or local unit's ability to continue
existing services or facilities or finance new services or facilities,
and, as a result, could adversely affect the market value or
marketability of the Michigan obligations in the Portfolio and
indirectly affect the ability of local units to pay debt service on
their obligations, particularly in view of the dependency of local units
upon State aid and reimbursement programs.
The Portfolio may contain obligations of the Michigan State Building
Authority. These obligations are payable from rentals to be paid by the
State as part of the State's general operating budget. The foregoing
financial conditions and constitutional provisions could affect the
ability of the State to pay rentals to the Authority and thus adversely
affect payment of the State Building Authority Bonds.
The Portfolio may contain obligations issued by various school
districts pledging the full faith and credit of the school district.
The ability of the school district to pay debt service may be adversely
affected by those factors described above for general obligation bonds
and, if the obligations were not voted by that school's electors by the
restructuring of school operating funding as described above. The
school district obligations also may be qualified for participation in
the Michigan School Bond Loan Fund. If the bonds are so qualified, then
in the event the school district is for any reason unable to pay its
debt service commitments when due, the school district is required to
borrow the deficiency from the School Bond Loan Fund and the State is
required to make the loan. The School Bond Loan Fund is funded by means
of debt obligations issued by the State. In the event of fiscal and
cash flow difficulties of the State the availability of sufficient cash
or the ability of the State to sell debt obligations to fund the School
Bond Loan Fund may be adversely affected and this could adversely affect
the ability of the State to make loans it is required to make to school
districts issuing qualified school bonds in the event the school
district's tax levies are insufficient therefor.
88
<PAGE>
MICHIGAN TAXES
In the opinion of Miller, Canfield, Paddock and Stone, Detroit,
Michigan, special counsel on Michigan tax matters, under existing
Michigan law:
The Michigan Trust and the owners of Units will be treated for
purposes of the Michigan income tax laws and the Single Business Tax in
substantially the same manner as they are for purposes of Federal income
tax laws, as currently enacted. Accordingly, we have relied upon the
opinion of Messrs. Davis, Polk & Wardwell as to the applicability of
Federal income tax under the Internal Revenue Code of 1986, as amended,
to the Michigan Trust and the Holders of Units.
Under the income tax laws of the State of Michigan, the Michigan Trust
is not an association taxable as a corporation; the income of the
Michigan Trust will be treated as the income of the Holders of Units of
the Michigan Trust and be deemed to have been received by them when
received by the Michigan Trust. Interest on the Debt Obligations in the
Michigan Trust which is exempt from tax under the Michigan income tax
laws when received by the Michigan Trust will retain its status as tax
exempt interest to the Holders of Units of the Michigan Trust.
For purposes of the Michigan income tax laws, each Holder of Units of
the Michigan Trust will be considered to have received his pro rata
share of interest on each Debt Obligation in the Michigan Trust when it
is received by the Michigan Trust, and each Holder will have a taxable
event when the Michigan Trust disposes of a Debt Obligation (whether by
sale, exchange, redemption or payment at maturity) or when the Unit
Holder redeems or sells his Unit, to the extent the transaction
constitutes a taxable event for Federal income tax purposes. The tax
cost of each Unit to a Unit Holder will be established and allocated for
purposes of the Michigan income tax laws in the same manner as such cost
is established and allocated for Federal income tax purposes.
Under the Michigan intangibles tax, the Michigan Trust is not taxable
and the pro rata ownership of the underlying Debt Obligations, as well
as the interest thereon, will be exempt to the Holders of Units to the
extent the Michigan Trust consists of obligations of the State of
Michigan or its political subdivisions or municipalities or obligations
of the Government of Puerto Rico, or of any, other possession, agency or
instrumentality of the United States.
The Michigan Single Business Tax replaced the tax on corporate and
financial institution income under the Michigan Income Tax, and the
intangibles tax with respect to those intangibles of persons subject to
the Single Business Tax the income from which would be considered in
computing the Single Business Tax. Persons are subject to the Single
Business Tax only if they are engaged in "business activity", as defined
in the Act. Under the Single Business Tax, both interest received by the
Michigan Trust on the underlying Debt Obligations and any amount
distributed from the Michigan Trust to a Unit Holder, if not included in
determining taxable income for Federal income tax purposes, is also not
included in the adjusted tax base upon which the Single Business Tax is
computed, of either the Michigan Trust or the Unit Holders. If the
Michigan Trust or the Unit Holders have a taxable event for Federal
income tax purposes, when the Michigan Trust disposes of a Debt
Obligation (whether by sale, exchange, redemption or payment at
maturity) or the Holder redeems or sells his Unit, an amount equal to
any gain realized from such taxable event which was included in the
computation of taxable income for Federal income tax purposes (plus an
amount equal to any capital gain of an individual realized in connection
with such event but deducted in computing that individual's Federal
taxable income) will be included in the tax base against which, after
allocation, apportionment and other adjustments, the Single Business Tax
is computed. The tax base will be reduced by an amount equal to any
capital loss realized from such a taxable event, whether or not the
capital loss was deducted in computing Federal taxable income in the
year the loss occurred. Holders should consult their tax advisor as to
their status under Michigan law.
89
<PAGE>
In rendering the above Opinion, special Michigan counsel also advises
that, as the Tax Reform Act of 1986 eliminates the capital gain
deduction for tax years beginning after December 31, 1986, the Federal
adjusted gross income, the computation base for the Michigan income tax,
of a Unit Holder will be increased accordingly to the extent such
capital gains are realized when the Michigan Trust disposes of a Debt
Obligation or when the Unit Holder redeems or sells a Unit, to the
extent such transaction constitutes a taxable event for Federal income
tax purposes.
THE MINNESOTA TRUST
RISK FACTORS--The State of Minnesota and other governmental units and
agencies, school systems and entities dependent on government
appropriations or economic activity in Minnesota have, in recent years,
suffered cash deficiencies and budgetary difficulties due to changing
economic conditions. Similar unfavorable economic trends, such as a
renewed recession, and other factors described below could adversely
affect the Debt Obligations and the value of the Portfolio.
Recessions in the national economy and other factors have had an
adverse impact on the economy of Minnesota and State budgetary balances.
As a consequence, during the budgetary bienniums ended in 1981, 1983,
1987, 1991 and 1993, the State found it necessary to revise revenue
forecasts downward and the State legislature was required to take
remedial action to bring the State's budget into balance on a number of
occasions. The State is constitutionally required to maintain a
balanced budget.
In 1991 the legislature prepared a budget for the 1991-1993 biennium
which provided for a $15.1 billion general fund budget, including
expenditures of $14.6 billion, with maintenance of a budgetary reserve
at $400 million and a projected unrestricted balance of $100 million.
Primarily as a consequence of the recession, in February 1992 the
Department of Finance projected a budgetary shortfall of $569 million by
the end of the 1991-1993 biennium. In response, the legislature enacted
$262 million in expenditure reductions, $149 million in revenue
increases and a $160 million drawdown of the budgetary reserve to bring
the budget into projected balance at the end of the biennium with a
budgetary reserve of $240 million remaining. Improving revenues in late
1992 and early 1993 led to the adoption of minor budgetary revisions by
the legislature, resulting in an increase in the budgetary reserve to
$360 million and an additional unrestricted balance of $195 million at
the end of the biennium on June 30, 1993.
Addressing the 1993-1995 biennium, the 1993 legislative session,
including a special session called to resolve budgetary differences
between the Governor and legislature following appropriation vetoes,
enacted revenue and expenditure proposals which provided for revenues of
$16.2 billion, expenditures of $16.5 billion and maintenance of the
budgetary reserve at $360 million. The major revenue increase was in
the health care provider tax. The principal expenditure increases were
for elementary and secondary education and health and human services.
During 1993 and 1994 the Department of Finance reported that increased
income tax receipts and lower spending would result in an improvement in
estimates used for budgetary purposes. In November 1994 the Department
estimated that the State would complete the biennium on June 30, 1995
with a budgetary reserve of $500 million and an unrestricted balance of
$268 million.
The Governor's budget proposals for the 1995-1997 biennium contemplate
revenues of $17.7 billion and expenditures of $18.0 billion, resulting
in a balanced budget and a $350 million budgetary reserve at June 30,
1997. Elementary, secondary and higher education account for 42% of
proposed expenditures, and health care and criminal justice account for
23% of expenditures.
Authorizations for bonding to support capital expenditures have raised
concern about the cost of debt service and the capacity of the State to
authorize additional major bonding. The legislature has
90
<PAGE>
directed a
portion of receipts from the State's lottery to assist in servicing
bonded debt. As of October 1, 1994, the total of State general
obligation bonds outstanding was approximately $1.7 billion and the
total authorized but unissued was $1.1 billion.
Economic and budgetary difficulties could require the State, its
agencies, local units of government, schools and other instrumentalities
which depend for operating funds and debt service on State revenues or
appropriations or on other sources of revenue which may be affected by
economic conditions to expand revenue sources or curtail services or
operations in order to meet payments on their obligations. The Sponsors
are unable to predict whether or to what extent adverse economic
conditions may affect the State, other units of government, State
agencies, school districts and other affected entities and the impact
thereof on the ability of issuers of Debt Obligations in the Portfolio
to meet payment obligations. To the extent any difficulties in making
payment are perceived, the market value and marketability of Debt
Obligations in the Portfolio, the asset value of the Minnesota Trust and
interest income to the Minnesota Trust could be adversely affected.
In action related to the budgetary and funding difficulties
experienced by the State during the 1980-1983 recession, Standard &
Poor's reduced its rating on the State's outstanding general obligation
bonds from AAA to AA+ in August 1981 and to AA in March 1982. Moody's
lowered its rating on the State's outstanding general obligation bonds
from Aaa to Aa in April 1982. In January 1985, Standard & Poor's
announced an upgrading in its rating for the State's outstanding general
obligation bonds from AA to AA+. In July 1993, Fitch's raised its
rating for the State's bonds from AA+ to AAA. In March 1994, Moody's
announced an upgrading in its rating from Aa to Aa1. These improved
ratings were applied most recently to the State's issuance of $120
million in general obligation bonds dated October 1, 1994.
Certain issuers of obligations in the State, such as counties, cities
and school districts, rely in part on distribution, aid and
reimbursement programs allocated from State revenues and other
governmental sources for the funds with which to provide services and
pay those obligations. Accordingly, legislative decisions and
appropriations have a major impact on the ability of such governmental
units to make payments on any obligations issued by them. In addition,
certain State agencies, such as the Minnesota Housing Finance Agency,
University of Minnesota, Minnesota Higher Education Coordinating Board,
Minnesota State University Board, Minnesota Higher Education Facilities
Authority, Minnesota State Armory Building Commission, Minnesota State
Zoological Board, Minnesota Rural Finance Authority, Minnesota Public
Facilities Authority, Minnesota Agricultural and Economic Development
Board and Iron Range Resources and Rehabilitation Board, also issue
bonds which generally are not debts of the State. The payment of these
obligations is generally subject to revenues generated by the agencies
themselves, the projects funded or discretionary appropriations of the
legislature. The particular source of payment and security is detailed
in the instruments themselves and related offering materials. In one
instance, after default by the Minnesota State Zoological Society in
installment payments supporting tax-exempt certificates of participation
issued to construct a monorail system, the legislature refused to
appropriate funds to supply the deficiency. A subsequent decision of
the Minnesota Supreme Court sustained the legislature's position that no
State obligation had been created.
The State is also a party to other litigation in which a contrary
decision could adversely affect the State's tax revenues or fund
balances, the most significant of which are as follows. First, the
United States Supreme Court has refused to consider a final appeal by
the State in a case in which a Minnesota District Court held the
Minnesota excise tax on banks, which taxes interest on federal
obligations but exempts interest paid on State political subdivision
obligations, to be unconstitutional. The taxes in suit, for the years
1979-1983, have been estimated to be $188 million. Including interest,
the total budget impact on the State over the 1995-1997 and 1997-1999
bienniums is likely to exceed $350 million. Second, the State's
corporate alternative minimum tax in effect from 1987 to 1989 has been
challenged on constitutional grounds. Taxes collected under the law
amounted to approximately
91
<PAGE>
$160 million. Third, the Minnesota charitable
gambling statutes have also been challenged on constitutional grounds.
If the challenge is successful, charitable gambling could not be
conducted and thus no State revenues would be generated by charitable
gambling-related taxes. In calendar year 1992, a total of about $56
million was collected by the State in charitable gambling-related taxes.
A hearing on the State's motion to dismiss the case for lack of standing
took place in October 1993. The decision is pending. Fourth, thirteen
union-based self-insured ERISA health plans have sued certain State
agencies for declaratory and injunctive relief to the effect that the 2%
gross revenues tax on health providers under the MinnesotaCare law may
not be passed on to such plans due to preemption of the Minnesota law by
ERISA and the Federal Labor-Management Relations Act. The United States
District Court granted summary judgment to the State agencies and the
plaintiffs have appealed to the Eighth Circuit Court of Appeals. The
potential fiscal impact of the suit is unclear but the portion of the
tax that is estimated to come from self-insured ERISA plans is in excess
of $50 million per year. Fifth, a case has been filed claiming a
regulatory taking of property based on a denial of a permit to fill
property for development. The amount sought is $8 million but an
adverse decision could establish a precedent for additional substantial
claims. Sixth, a corporate plaintiff has filed an action seeking
substantial tax refunds, potentially exceeding $10 million, alleging
improprieties in the computation and collection of taxes from 1974
through 1981. Adverse decisions in the foregoing and other cases which
individually or collectively may exceed several million dollars in
amount could require extraordinary appropriations or expenditure
reductions and could have a material adverse effect on the financial
condition of the State, its agencies or subdivisions. The Sponsors are
unable to make any prediction concerning the ultimate outcome or impact
of decisions in these cases.
MINNESOTA TAXES
In the opinion of Doherty, Rumble & Butler Professional Association,
Minneapolis, Minnesota, special counsel on Minnesota tax matters, under
existing Minnesota law:
The Minnesota Trust is not an association taxable as a corporation for
Minnesota income tax purposes. Minnesota imposes its income tax on the
taxable net income of individuals, estates and trusts resident in
Minnesota and on certain nonresident taxpayers having activities or
contacts within Minnesota. Taxable net income is the portion of a
taxpayer's Federal taxable income (subject to certain variations and
determined pursuant to the Internal Revenue Code as amended through
December 31, 1993) which is properly allocable to Minnesota. Exclusion
from "taxable net income" for Minnesota income tax purposes for
individuals, trusts and estates of interest on most obligations of the
State of Minnesota, its political and governmental subdivisions,
municipalities, and governmental agencies and instrumentalities depends
on the availability of a Federal exclusion.
Each Holder of Units in the Minnesota Trust which is an individual,
trust or estate resident in Minnesota will be treated as the owner of a
proportionate, undivided interest in the Minnesota Trust, and the income
of the Minnesota Trust will be treated as the income of such Holders for
Minnesota income tax purposes. Accordingly, interest on Debt
Obligations held by the Minnesota Trust which would be exempt from
Federal and Minnesota income taxation when paid directly to an
individual, trust or estate will be exempt from Minnesota income
taxation with respect to such Holders when received by the Minnesota
Trust and distributions of the proceeds of interest received by the
Minnesota Trust on such Debt Obligations will not be a taxable event
under Minnesota law.
Holders of Units of the Minnesota Trust which are individuals, trusts
or estates resident in Minnesota will be required to recognize any
taxable gain or loss realized on the disposition of a Debt Obligation by
the Minnesota Trust (whether by sale, exchange, redemption or payment at
maturity) or upon the disposition by the Holder of Units.
Taxable income for corporations under Minnesota law is computed on the
basis of Federal law with certain modifications. Interest on bonds
issued by the State of Minnesota and its subdivisions,
92
<PAGE>
municipalities,
agencies and instrumentalities is generally not exempt from Minnesota
taxes measured by corporate income. Accordingly, no opinion is given
with respect to the Minnesota tax effects of an investment in the
Minnesota Trust by corporations.
Units of the Minnesota Trust and any of the Debt Obligations held in
the Minnesota Trust are not subject to any property taxes imposed by
Minnesota or its state and local subdivisions. The Units of the
Minnesota Trust, however, will be subject to the Minnesota estate tax if
held by an individual who is domiciled in Minnesota at death. Investors
should consult with their own personal tax advisors concerning any
potential Minnesota estate tax liability.
THE MISSISSIPPI TRUST
RISK FACTORS--The financial condition of the State may be affected by
international, national and regional economic, political and
environmental conditions beyond the State's control, which in turn could
affect the market value and income of the obligations of the Mississippi
Trust and could result in a default with respect to such obligations.
The following information constitutes a brief summary of certain legal,
governmental, budgetary and economic matters of the State which may or
may not affect the financial situation in Mississippi, but does not
purport to be a complete listing or description of all such factors.
None of the following information is relevant to Puerto Rico or Guam
Debt Obligations which may be included in the Mississippi Trust. Such
information was compiled from publicly available information as well as
from oral statements from various State agencies. Although the Sponsors
and their counsel have not verified the accuracy of the information,
they have no reason to believe that such information is not correct.
Budgetary and Economic Matters. The State operates on a fiscal year
beginning July 1 and ending June 30, with budget preparations beginning
on approximately August 1, when all agencies requesting funds submit
budget requests to the Governor's Budget Office and the Legislative
Budget Office. The budgets, in the form adopted by the legislature, are
implemented by the Department of Finance and Administration.
State operations are funded by General Fund revenues, Educational
Enhancement Fund revenues and Special Fund receipts. For the fiscal
year ending June 30, 1994, $4.27 billion in revenues were collected by
the Special Fund. The major source of such receipts was $2.19 billion
from federal grants-in-aid, including $1.31 billion for public health
and welfare and $366.6 million for public education.
The General Fund revenues are derived principally from sales, income,
corporate and excise taxes, profits from wholesale sales of alcoholic
beverages, interest earned on investments, proceeds from sales of
various supplies and services, and license fees. For the fiscal year
ending June 30, 1994, of the $2.39 billion in General Fund receipts,
sales taxes accounted for 42.3%, individual income taxes for 26.5%, and
corporate income taxes for 9.1%. Sales taxes, the largest source of
General Fund revenues, can be adversely affected by downturns in the
economy. Total sales tax collections for fiscal year 1994 were $100.6
million over 1993 fiscal year collections.
Mississippi's recent legalization of dockside gaming is having a
significant impact on the State's revenues. With 31 casinos operating
in the State as of 12/31/94 fiscal year 1994 gaming license fees and
gaming tax revenues transferred to the General Fund for the State
amounted to $95.03 million as compared to $33.32 million in fiscal year
1993.
Each year the legislature appropriates all General Fund, Educational
Enhancement Fund and most Special Fund expenditures. Those Special
Funds that are not appropriated by the legislature are subject to the
approval of the Department of Finance and Administration. In the fiscal
year ending
93
<PAGE>
June 30, 1994, approximately 56.0% of the General Fund was
expended on public and higher education. The areas of public health and
public works were the two largest areas of expenditures from the Special
Fund. The Education Enhancement Fund collections (funded from the 1%
increase in sales and use taxes) totalled approximately $142.2 million
in fiscal year 1994. These funds are appropriated by the Legislature
for the purpose of providing additional funding for grades K-12,
community colleges and institutions of higher learning.
The Department of Finance and Administration has the authority to
reduce allocations to agencies if revenues fall below the amounts
projected during the budgeting phase and may also, in its discretion,
restrict a particular agency's monthly allotment if it appears that an
agency may deplete its appropriations prior to the close of the fiscal
year. Despite budgetary controls, the State has experienced cash flow
problems in the past. In the 1991 fiscal year, because State revenue
collections fell below projections and due to a General Fund cash
balance on July 1, 1991 below expectations, across-the-board budget
reductions totaling approximately $85.1 million were suffered by State
agencies to avoid a year-end deficit. In fiscal year 1992, total
revenue collections were nearly $48 million below projections. As a
result of this shortfall, State agencies were forced to implement an
estimated 3.5% cut in their respective budgets. However, collections
are improving as fiscal year 1994 revenue collections were nearly $259.2
million or 12.15% above projections. For 1995, revenue collections as
of Feb. 1, 1995 are nearly $52 million or 3.5% above the estimated
revenues. In an effort to prevent agencies from being forced to
implement budget cuts, the Mississippi legislature authorized the
Working Cash-Stabilization Fund in order to provide a safeguard during
stressed economic times. The Working Cash-Stabilization Fund, which
reached its maximum balance of $194.6 million or 7.5% of the General
Fund appropriations in 1994, can be used to meet revenue and cash flow
shortfalls as well as provide funds during times of national disasters
in the State.
Although the population of Mississippi grew by only 2.1% between 1980
and 1990 it increased nearly 2.7% in the three year period between 1990
and 1992. Despite this growth, Mississippi continues to rank 31st among
the 50 states, with a population of 2.64 million people for 1994. In
1994, the average State unemployment rate was 6.5%, slightly up from the
state's 1993 level of 6.2%. The 1994 unemployment rate for the nation
was 6.1%.
As of June 1994 the manufacturing sector of the economy, the largest
employer in the State, employed approximately 254,500 persons or 25.5%
of the total nonagricultural employment. Within the manufacturing
sector, the three leading employers by product category were the apparel
industry, the food products industry, and the furniture industry. For
1994, the average employment for these industries was 35,100, 29,400 and
28,200, respectively. Agriculture contributes significantly to the
State's economy as agriculture-related cash receipts amounted to $4.51
billion for 1994. The average number of persons employed by the
agricultural sector of the State's labor force was 53,500 for 1994. The
State continues to be a large producer of cotton and timber and, as a
result of research and promotion, the agricultural sector has
diversified into the production of poultry, catfish, rice, blueberries
and muscadines.
Mississippi has not been without its setbacks, for instance, the NASA
solid fuel rocket motor plant in Tishomingo County, which was originally
scheduled to open in 1995 and expected to result in approximately 3,500
jobs was closed due to recent federal budget reduction.
Total personal income in Mississippi increased 36.1% from 1988 to 1993
to a level of approximately $39.3 million as compared to a 32.1%
increase for the United States during the same period. However,
Mississippi's per capita income of $14,708 in 1993 was well below the
national average of $19,841. The number of bankruptcies filed in
Mississippi for 1994, was 9,892, which was slightly below the 1993
twelve month level of 10,188.
94
<PAGE>
Bonds. The State, counties, municipalities, school districts, and
various other districts are authorized to issue bonds for certain
purposes. Mississippi has historically issued four types of bonds:
general obligation, revenue, refunding and self-supporting general
obligation. In the 1992 and 1993 fiscal years, the State issued general
obligation and revenue bonds in amounts totaling $127.51 million and
$217.0 million, respectively. In fiscal year 1994, the State issued
bonds totalling approximately $299.6 million. The total bond
indebtedness of the State has increased from a level of $432.5 million
on July 1, 1987 to $851.2 million as of July 1, 1994.
The issuance of bonds must be authorized by legislation governing the
particular project to be financed. Such legislation provides the State
Bond Commission, comprised of the Governor as Chairman, the State
Attorney General as Secretary and the State Treasurer as a member, with
the authority to approve and authorize the issuance of bonds.
The general obligation bonds of the State are currently rated Aa by
Moody's Investors Service, Inc. and AA-by Standard and Poor's
Corporation. There can be no assurance that the conditions such ratings
are based upon will continue or that such ratings will not be revised
downward or withdrawn entirely by either or both agencies.
Litigation. The Attorney General's Office has reviewed the status of
cases in which the State is a defendant wherein the obligations of the
State's financial resources may be materially adversely affected. The
following cases, though not an entire list, are a representative
sampling of the most significant cases which could materially affect the
State's financial position: (1) a suit against the State regarding
conditions at its penal institutions; (2) an action against the State
and certain public officials challenging the constitutionality of the
Statewide system of higher education; and (3) an action against the
State Tax Commission challenging the apportionment formula for taxation
of multi-state corporations.
Summary. The financial condition of the State of Mississippi may be
affected by numerous factors, most of which are not within the control
of the State or its subdivisions. The Sponsors are unable to predict to
what extent, if any, such factors would affect the ability of the
issuers of the Debt Obligations to meet payment requirements.
MISSISSIPPI TAXES
In the opinion of Butler, Snow, O'Mara, Stevens & Canada, Jackson,
Mississippi, special counsel on Mississippi tax matters, under existing
Mississippi law:
1. The Mississippi Trust will be classified, for purposes of the
Mississippi income tax, as a grantor trust, not as an association
taxable as a corporation.
2. The Mississippi Trust will not, itself, be subject to the
Mississippi income tax. All of the interest income, gains, and losses
realized and expenses paid by the Mississippi Trust will be deemed, for
purposes of the Mississippi income tax, to have been realized and paid
directly by the Holders, in proportion to their Units.
3. The Holders will not be subject to the Mississippi income tax on
interest income realized by the Mississippi Trust on obligations of the
United States or its possessions, or on securities issued under the
provisions of the Federal Farm Loan Act of July 17, 1916, or on bonds
issued by the War Finance Corporation, or on obligations of the State of
Mississippi or its political subdivisions.
4. The Holders who are individuals residing within or corporations
organized, located and operating solely within the State of Mississippi
will take into account for Mississippi income tax purposes their
respective proportionate shares of (a) the interest income, other than
that described in
95
<PAGE>
Paragraph 3 above, realized and expenses paid by the
Mississippi Trust and (b) the gains and losses realized by the
Mississippi Trust on the sale or exchange or other disposition of its
assets. The Holders who are individuals or corporations but are not
described in the preceding sentence will take into account for
Mississippi income tax purposes those items of interest income and
expenses and those gains and losses in accordance with the Mississippi
principles of multistate taxation of individuals and corporations.
5. The Holders will not be subject to the Mississippi income tax on
any distribution from the Mississippi Trust, except for a distribution
in redemption or sale of Units. In a redemption or sale of Units, the
Holders will be deemed to have sold, for the amount realized from the
redemption or sale, as the case may be, their proportionate respective
shares of each asset in the Mississippi Trust. The extent to which the
Holders will take into account for the Mississippi income tax purposes
their gains and losses from the redemption or sale of Units will depend
upon whether they are individuals or corporations and upon what nexus
they have with the State of Mississippi, as discussed in Paragraph 4
above.
6. The State of Mississippi imposes no gift tax.
7. The Units of the Holders who are individuals residing within the
State of Mississippi will be subject, upon the deaths of those Holders,
to the Mississippi estate tax.
8. The Units of the Holders who are individuals residing without the
State of Mississippi will not be subject, upon the deaths of those
Holders, to the Mississippi estate tax.
9. No political subdivision of the State of Mississippi imposes any
income, gift, or estate tax.
10. Neither the Units nor the assets of the Mississippi Trust will be
subject to an ad valorem tax imposed by the State of Mississippi or any
of its political subdivisions.
THE MISSOURI TRUST
RISK FACTORS--Hancock Amendment. Article X, Sections 16-24 of the
Constitution of Missouri, often referred to as the Hancock Amendment
(the "Hancock Amendment"), imposes limitations on the amount of State
taxes which may be imposed by the General Assembly of Missouri (the
"General Assembly") as well as on the amount of local taxes, licenses
and fees (including taxes, licenses and fees used to meet debt service
commitments on debt obligations) which may be imposed by local
governmental units (such as cities, counties, school districts, fire
protection districts and other similar bodies) in the State of Missouri
in any fiscal year.
The State limit is tied to total State revenues for fiscal year
1980-81, as defined in the Hancock Amendment, adjusted annually in
accordance with the formula set forth in the amendment, which adjusts
the limit based on increases in the average personal income of Missouri
for certain designated periods. The details of the amendment are
complex and clarification from subsequent legislation and further
judicial decisions may be necessary. If the total State revenues exceed
the State revenue limit imposed by Section 18 of Article X by more than
one percent, the State is required to refund the excess. The Hancock
Amendment does not prohibit the increasing of taxes by the State so long
as State revenues are expected to amount to less than the revenue limit
and authorizes exceeding the limit if, upon the request of the Governor,
the General Assembly declares an emergency by a two thirds vote. Under
the emergency provisions, the revenue limit may be exceeded only in the
fiscal year during which the emergency was declared, and the emergency
must be declared prior to incurring expenses which constitute part of
the emergency request. The State revenue limitation imposed by the
Hancock Amendment also does "not apply to taxes imposed for the payment
of principal and interest on
96
<PAGE>
bonds, approved by the voters" and
authorized by the Missouri Constitution. The revenue limit can also be
exceeded by a constitutional amendment authorizing new or increased
taxes or revenues adopted by the voters of the State of Missouri.
The Hancock Amendment further provides that the state financed
proportion of the costs of any existing activity or service required of
counties and other political subdivisions cannot be reduced. In
addition, State government expenses cannot exceed the sum of the State's
revenues (limited as described above) plus Federal funds and any surplus
from a previous fiscal year.
Section 22(a) of Article X of the Missouri Constitution sets forth the
limitation on new taxes, licenses and fees and increases in taxes,
licenses and fees by local governmental units in Missouri. It prohibits
counties and other political subdivisions (essentially all local
governmental units) from levying new taxes, licenses and fees or
increasing the current levy of an existing tax, license or fee "without
the approval of the required majority of the qualified voters of that
county or other political subdivision voting thereon."
If the required majority of qualified electors voting on the issuance
of debt obligations approves the issuance of the debt obligations and
the levy of taxes or impositions of licenses or fees necessary to meet
the payments of principal and interest on such debt obligations, taxes,
licenses or fees may be imposed or existing taxes, licenses or fees may
be increased to cover the principal and interest on such debt
obligations without violating the Hancock Amendment. Missouri
Constitutional or statutory provisions other than the Hancock Amendment
may require greater than majority voter approval for valid issuance of
certain debt obligations.
Taxes may also be increased by counties and other political
subdivisions (but not by the State), without regard to the limitations
of the Hancock Amendment, for the purpose of paying principal and
interest on bonds, other evidences of indebtedness, and obligations
issued in anticipation of the issuance of bonds if such bonds and other
obligations were authorized to be issued prior to the adoption of the
Hancock Amendment.
When a local governmental unit's tax base with respect to certain fees
or taxes is broadened, the Hancock Amendment requires the tax levy or
fees to be reduced "to yield the same estimated gross revenue as on the
prior base." It also effectively limits any percentage increase in
property tax revenues to the percentage increase in the general price
level (plus the value of new construction and improvements), even if the
assessed valuation of property in the local governmental unit, excluding
the value of new construction and improvements, increases at a rate
exceeding the increase in the general price level.
To the extent that the payment of general obligation bonds issued by
the State of Missouri or a unit of local government in the Portfolio is
dependent on revenues from the levy of taxes and such obligations have
been issued subsequent to the date of the Hancock Amendment's adoption,
November 4, 1980, the ability of the State of Missouri or the
appropriate local unit to levy sufficient taxes to pay the debt service
on such bonds may be affected, unless there has been specific voter
approval of the issuance of such bonds and the levy of such taxes as are
necessary to pay the principal and interest on such bonds and
obligations.
Debt obligations issued by certain State issuers, including those of
the Board of Public Buildings of the State of Missouri and the
Department of Natural Resources of the State of Missouri, are payable
either solely or primarily from the rentals, incomes and revenues of
specific projects financed with the proceeds of the debt obligations and
are not supported by the taxing powers of the State or of the issuer of
the bonds. The Hancock Amendment may most strongly affect state revenue
bonds, since they are dependent in whole or in part on appropriations of
the General Assembly to provide sufficient revenues to pay principal and
interest. Unless such bonds are approved by the voters
97
<PAGE>
of Missouri,
under the Hancock Amendment, taxes cannot be raised to cover the state
appropriations necessary to provide revenues to pay principal and
interest on the bonds. Consequently, there may be insufficient state
revenues available to permit the General Assembly to make appropriations
adequate to enable the issuer to make timely payment of principal and
interest on such State revenue bonds. For example, in the case of the
Board of Public Buildings of the State of Missouri, the payment of
principal and interest on debt obligations is dependent solely on the
appropriation by the General Assembly of sufficient funds to pay the
rentals of State agencies occupying buildings constructed by the Board
of Public Buildings. State park revenue bonds of the Department of
Natural Resources of the State of Missouri are in part dependent on
revenues generated by operations of the particular project and in part
on General Assembly appropriations. Consequently, payment of principal
and interest on such State revenue bonds or other obligations, relating
to specific projects and not supported by the taxing power of the State
of Missouri, may not be made or may not be made in a timely fashion
because of (i) the inability of the General Assembly to appropriate
sufficient funds for the payment of such debt obligations (or to make up
shortfalls therein) due to the limitations on State taxes and
expenditures imposed by the Hancock Amendment, (ii) the inability of the
issuer to generate sufficient income or revenue from the project to make
such payment or (iii) a combination of the above.
As described above, general obligation bonds and revenue bonds of
local governmental units, including counties, cities and similar
municipalities, sewer districts, school districts, junior college
districts and other similar issuers, may also be affected by the tax,
license and fee limitations of the Hancock Amendment. Unless the
required voter approval of such debt obligations and the imposition of
taxes to pay them is obtained prior to their issuance, the Hancock
Amendment imposes limitations on the imposition of new taxes and the
increase of existing taxes which may be necessary to pay principal and
interest on general obligation bonds of local issuers. The limitations
contained in the Hancock Amendment may also affect the payment of
principal and interest on bonds and other obligations issued by local
governmental units and supported by the revenues generated from user
fees, licenses or other fees and charges, unless the requisite voter
approval of the issuance of such bonds or other obligations, and the
approval of the assessment of such fees or other charges as may be
necessary to pay the principal and interest on such bonds or other
obligations, has been obtained prior to their issuance.
Debt obligations of certain other State and local agencies and
authorities are not, by the terms of their respective authorizing
statutes, obligations of the State or any political subdivision, public
instrumentality or authority, county, municipality or other state or
local unit of government. Illustrative of such issuers are the Missouri
Housing Development Commission, the State Environmental Improvement and
Energy Resources Authority, the Health and Educational Facilities
Authority of the State of Missouri, the Missouri Higher Education Loan
Authority, the Industrial Development Board of the State of Missouri,
the Missouri Agricultural and Small Business Development Authority and
other similar bodies organized on a local level under similar state
authorizing statutes such as the various local industrial development
authorities, planned industrial expansion authorities and land clearance
for redevelopment authorities. The debt obligations of such issuers are
payable only from the revenues generated by the project or program
financed from the proceeds of the debt obligations they issue, and the
Hancock Amendment has no application.
School Desegregation Lawsuits. Desegregation lawsuits in St. Louis
and Kansas City, and a U.S. Supreme Court decision continue to require
significant levels of state funding and are sources of uncertainty;
litigation continues on many issues, court orders are unpredictable, and
school district spending patterns have proven difficult to predict. The
State paid $290.0 million for desegregation costs in fiscal 1993 and the
budget for fiscal 1994 provided $374 million. This expense accounts for
close to 10% of total state General Revenue Fund spending.
Industry and Employment. While Missouri has a diverse economy with a
distribution of earnings and employment among manufacturing, trade and
service sectors closely approximating the
98
<PAGE>
average national distribution,
the national economic recession of the early 1980's had a
disproportionately adverse impact on the economy of Missouri. During
the 1970's, Missouri characteristically had a pattern of unemployment
levels well below the national averages. However, since the 1980 to
1983 recession periods Missouri unemployment levels generally
approximated or slightly exceeded the national average. A return to a
pattern of high unemployment could adversely affect the Missouri debt
obligations acquired by the Missouri Trust and, consequently, the value
of the Units in the Trust.
The Missouri portions of the St. Louis and Kansas City metropolitan
areas contain approximately 1,939,500 and 975,241 residents,
respectively, constituting over fifty percent of Missouri's 1994
population census of approximately 5,278,000. St. Louis is an
important site for banking and manufacturing activity, as well as a
distribution and transportation center, with eight Fortune 500
industrial companies (as well as other major educational, financial,
insurance, retail, wholesale and transportation companies and
institutions) headquartered there. Kansas City is a major agribusiness
center and an important center for finance and industry. Economic
reversals in either of these two areas would have a major impact on the
overall economic condition of the State of Missouri. Additionally, the
State of Missouri has a significant agricultural sector which is
experiencing farm-related problems comparable to those which are
occurring in other states. To the extent that these problems were to
intensify, there could possibly be an adverse impact on the overall
economic condition of the State of Missouri.
Defense related business plays an important role in Missouri's
economy. In addition to the large number of civilians employed at the
various military installations and training bases in the State, aircraft
and related businesses in Missouri are the recipients of substantial
annual dollar volumes of defense contract awards. The contractor
receiving the largest dollar volume of defense contracts in the United
States in 1993 was McDonnell Douglas Corporation. McDonnell Douglas
Corporation is the State's largest employer, currently employing
approximately 24,000 employees in Missouri. Recent changes in the
levels of military appropriations and the cancellation of the A-12
program has affected McDonnell Douglas Corporation in Missouri and over
the last three years it has reduced its Missouri work force by
approximately 30%. There can be no assurances there will not be further
changes in the levels of military appropriations, and, to the extent
that further changes in military appropriations are enacted by the
United States Congress, Missouri could be disproportionately affected.
MISSOURI TAXES
In the opinion of Bryan Cave, St. Louis, Missouri, special counsel on
Missouri tax matters, under existing Missouri law:
For Missouri income tax purposes under Chapter 143 of the Missouri
Revised Statutes, the Missouri Trust will be treated as having the same
organizational characteristics as it is accorded for Federal income tax
purposes. In reliance upon the opinion of Davis Polk & Wardwell, New
York, New York, counsel to the Sponsors, the Missouri Trust is not an
association taxable as a corporation under Missouri law, with the result
that the income of the Missouri Trust will be deemed to be income of the
Holders of the Units, and that each Holder of Units in the Missouri
Trust will be treated as the owner of a proportionate, undivided
interest in the Missouri Trust, and the income of the Missouri Trust
will be treated as the income of such Holders.
Income, gains and losses from the Missouri Trust will be required to
be reported as Missouri gross, adjusted gross, distributable or taxable
income, gains or losses of individual, trust or corporate Holders of
Units (and partners in partnerships which are Holders of Units) only
when, and to the extent that such income (i) is included in Federal
gross, adjusted gross or taxable income; (ii) is interest on certain
governmental obligations excluded from Federal gross income by Section
103 of the Internal Revenue Code of 1986, as amended, and is not
interest on obligations of the State of Missouri or any
99
<PAGE>
of its political
subdivisions or authorities or obligations issued by the Government of
Puerto Rico or by its authority or by the Government of Guam or by its
authority; or (iii) is not interest on obligations of the United States
and its territories and possessions or of any authority, commission or
instrumentality of the United States and its territories and possessions
to the extent exempt from Missouri income taxes under the laws of the
United States. Non-resident individual, trust or corporate Holders of
Units (including non-resident partners in partnerships or non-resident
beneficiaries of trusts which are Holders of Units) may also exclude
income, gains and losses from the Missouri Trust from Missouri gross,
adjusted gross, distributable or taxable income to the extent that such
income is not from sources within Missouri.
THE NEW JERSEY TRUST
RISK FACTORS--Prospective investors should consider the recent
financial difficulties and pressures which the State of New Jersey and
certain of its public authorities have undergone.
The State's 1994 Fiscal Year budget became law on June 30, 1993.
The New Jersey State Constitution prohibits the legislature from
making appropriations in any fiscal year in excess of the total revenue
on hand and anticipated, as certified by the Governor. It additionally
prohibits a debt or liability that exceeds 1% of total appropriations
for the year, unless it is in connection with a refinancing to produce a
debt service savings or it is approved at a general election. Such debt
must be authorized by law and applied to a single specified object or
work. Laws authorizing such debt provide the ways and means, exclusive
of loans, to pay as it becomes due and the principal within 35 years
from the time the debt is contracted. These laws may not be repealed
until the principal and interest are fully paid. These Constitutional
provisions do not apply to debt incurred because of war, insurrection or
emergencies caused by disaster.
Pursuant to Article VIII, Section II, par. 2 of the New Jersey
Constitution, no monies may be drawn from the State Treasury except for
appropriations made by law. In addition, the monies for the support of
State government and all State purposes, as far as can be ascertained,
must be provided for in one general appropriation law covering one and
the same fiscal year. The State operates on a fiscal year beginning
July 1 and ending June 30. For example, "fiscal 1994" refers to the
year ended June 30, 1994.
In addition to the Constitutional provisions, the New Jersey statutes
contain provisions concerning the budget and appropriation system.
Under these provisions, each unit of the State requests an appropriation
from the Director of the Division of Budget and Accounting, who reviews
the budget requests and forwards them with his recommendations to the
Governor. The Governor then transmits his recommended expenditures and
sources of anticipated revenue to the legislature, which reviews the
Governor's Budget Message and submits an appropriations bill to the
Governor for his signature by July 1 of each year. At the time of
signing the bill, the Governor may revise appropriations or anticipated
revenues. That action can be reversed by a two-thirds vote of each
House. No supplemental appropriation may be enacted after adoption of
the act, except where there are sufficient revenues on hand or
anticipated, as certified by the Governor, to meet the appropriation.
Finally, the Governor may, during the course of the year, prevent the
expenditure of various appropriations when revenues are below those
anticipated or when he determines that such expenditure is not in the
best interest of the State.
In 1992, employment in services and government turned around in the
State, growing over the year by 0.7% and 0.3%, respectively. These
increases were outweighed by declines in other sectors -- especially in
manufacturing, wholesale and retail trade, and construction -- resulting
in a net decline in non-farm employment of 1.7% in 1992. Non-farm
employment continued to decline in 1993 but the
100
<PAGE>
rate of decline has
tapered off. Employment in the first nine months of 1993 was 1.0% lower
than in the same period in 1992. Gains were recorded in services,
government, finance/insurance/real estate and
transportation/communication/public utilities. Declines continued in
trade, construction and manufacturing.
The economic recovery is likely to be slow and uneven in both New
Jersey and the nation. Some sectors, like commercial and industrial
construction, will undoubtedly lag because of continued excess capacity.
Also, employers in rebounding sectors can be expected to remain cautious
about hiring until they become convinced that improved business will be
sustained. Other firms will continue to merge or downsize to increase
profitability. As a result, job gains will probably come grudgingly and
unemployment will recede at a correspondingly slow pace.
One of the major reasons for cautious optimism is found in the
construction industry. Total construction contracts awarded in New
Jersey have turned around, rising by 7.0% in 1993 compared with 1992.
By far, the largest boost came from residential construction awards
which increased by 26% in 1993 compared with 1992. In addition,
non-residential building construction awards have turned around, posting
a 17% gain.
Nonbuilding construction awards have been at high levels since 1991
due to substantial outlays for roads, bridges and other infrastructure
projects. Although nonbuilding construction awards declined in 1993
compared with 1992, this was due to an unusually large amount of
contracts in the spring of 1992.
Finally, even in the labor market there are signs of recovery. Thanks
to a reduced layoff rate and the reappearance of job opportunities in
some parts of the economy, unemployment in the State has been receding
since July 1992, when it peaked at 9.6% according to U.S. Bureau of
Labor Statistics estimates based on the federal government's monthly
household survey. The same survey showed joblessness dropped to an
average of 6.7% in the fourth quarter of 1993. The unemployment rate
registered an average of 7.8% in the first quarter of 1994, but this
rate cannot be compared with prior date due to the changes in the U.S.
Department of Labor procedures for determining the unemployment rate
that went into effect in January 1994.
For Fiscal Year 1994, the State has made appropriations of $119.9
million for principal and interest payments for general obligation
bonds. For Fiscal Year 1995, the Governor has recommended
appropriations of $103.5 million for principal and interest payments for
general obligation bonds. Of the $15,410.7 million appropriated in
Fiscal Year 1994 from the General Fund, the Property Tax Relief Fund,
the Gubernatorial Elections Fund, the Casino Control Fund and the Casino
Revenue Fund, $5,812.4 million (37.8%) was appropriated for State Aid to
Local Governments, $3,698.9 million (24.0%) is appropriated for
Grants-in-Aid, $5,335.5 million (34.6%) for Direct State Services,
$119.9 million (0.7%) for Debt Service on State general obligation bonds
and $443.9 million (2.9%) for Capital Construction.
State Aid to Local Governments was the largest portion of Fiscal Year
1994 appropriations. In Fiscal Year 1994, $5,812.4 million of the
State's appropriations consisted of funds which are distributed to
municipalities, counties and school districts. The largest State Aid
appropriation, in the amount of $4,044.3 million, is provided for local
elementary and secondary education programs. Of this amount, $2,538.2
million was provided as foundation aid to school districts by formula
based upon the number of students and the ability of a school district
to raise taxes from its own base. In addition, the State provided
$582.5 million for special education programs for children with
disabilities. A $293.0 million program was also funded for pupils at
risk of educational failure, including basic skills improvement. The
State appropriated $776.9 million on behalf of school districts as the
employer share of the teachers" pension and benefits programs, $263.8
million to pay for the cost of pupil
101
<PAGE>
transportation and $57.4 million
for transition aid, which guaranteed school districts a 6.5% increase
over the aid received in Fiscal Year 1991 and is being phased out over
four years.
Appropriations to the State Department of Community Affairs totalled
$650.4 million in State Aid monies for Fiscal Year 1994. The principal
programs funded were the Supplemental Municipal Property Tax Act ($365.7
million); the Municipal Revitalization Program ($165.0 million);
municipal aid to urban communities to maintain and upgrade municipal
services ($40.4 million); and the Safe and Clean Neighborhoods Program
($58.9 million). Appropriations to the State Department of the Treasury
totalled $327.5 million in State Aid monies for Fiscal Year 1994. The
principal programs funded by these appropriations were payments under
the Business Personal Property Tax Replacement Programs ($158.7
million); the cost of senior citizens, disabled and veterans property
tax deductions and exemptions ($41.7 million); aid to densely populated
municipalities ($33.0 million); Municipal Purposes Tax Assistance ($30.0
million); and payments to municipalities for services to state owned
property ($34.9 million); and the Safe and Clean Communities program
($15.0 million).
Other appropriations of State Aid in Fiscal Year 1994 include welfare
programs ($477.4 million); aid to county colleges ($114.6 million); and
aid to county mental hospitals ($88.8 million).
The second largest portion of appropriations in Fiscal Year 1994 is
applied to Direct State Services: the operation of State government's 19
departments, the Executive Office, several commissions, the State
Legislature and the Judiciary. In Fiscal Year 1994, appropriations for
Direct State Services aggregated $5,335.5 million. Some of the major
appropriations for Direct State Services during Fiscal Year 1994 are
detailed below.
$602.3 million was appropriated for programs administered by the State
Department of Human Services. Of that amount, $448.2 million was
appropriated for mental health and mental retardation programs,
including the operation of seven psychiatric institutions and nine
schools for the retarded.
The State Department of Labor is appropriated $51.4 million for the
administration of programs for workers" compensation, unemployment and
disability insurance, manpower development, and health safety
inspection.
The State Department of Health is appropriated $37.6 million for the
prevention and treatment of diseases, alcohol and drug abuse programs,
regulation of health care facilities and the uncompensated care program.
$673.0 million is appropriated to the State Department of Higher
Education for the support of nine State colleges, Rutgers University,
the New Jersey Institute of Technology, and the University of Medicine
and Dentistry.
$932.6 million is appropriated to the State Department of Law and
Public Safety and the State Department of Corrections. Among the
programs funded by this appropriation are the administration of the
State's correctional facilities and parole activities, the registration
and regulation of motor vehicles and licensed drivers and the
investigative and enforcement activities of the State Police.
$99.8 million is appropriated to the State Department of
Transportation for the various programs it administers, such as the
maintenance and improvement of the State highway system.
$156.4 million is appropriated to the State Department of
Environmental Protection for the protection of air, land, water, forest,
wildlife and shellfish resources and for the provision of outdoor
recreational facilities.
102
<PAGE>
The primary method for State financing of capital projects is through
the sale of the general obligation bonds of the State. These bonds are
backed by the full faith and credit of the State. tax revenues and
certain other fees are pledged to meet the principal and interest
payments and if provided, redemption premium payments required to pay
the debt fully. No general obligation debt can be issued by the State
without prior voter approval, except that no voter approval is required
for any law authorizing the creation of a debt for the purpose of
refinancing all or a portion of outstanding debt of the State, so long
as such law requires that the refinancing provide a debt service
savings.
In addition to payment from bond proceeds, capital construction can
also be funded by appropriation of current revenues on a pay-as-you-go
basis. This amount represents 2.9 percent of the total budget for
fiscal year 1994.
The aggregate outstanding general obligation bonded indebtedness of
the State as of June 30, 1993 was $3,594.7 billion. The debt service
obligation for outstanding indebtedness is $119.9 million for fiscal
year 1994.
On January 18, 1994, Christine Todd-Whitman replaced James Florio as
Governor of the State. As a matter of public record, Governor Whitman,
during her campaign, publicized her intention to reduce taxes in the
State. Effective January 1, 1994, the State's personal income tax rates
were reduced by 5% for all taxpayers. Effective January 1, 1995, the
State's personal income tax rates will be reduced by an additional 10%
for most taxpayers. The effect of the tax reductions cannot be
evaluated at this time.
All appropriations for capital projects and all proposals for State
bond authorizations are subject to the review and recommendation of the
New Jersey Commission on Capital Budgeting and Planning. This permanent
commission was established in November, 1975, and is charged with the
preparation of the State Capital Improvement Plan, which contains
proposals for State spending for capital projects.
At any given time, there are various numbers of claims and cases
pending against the State, State agencies and employees, seeking
recovery of monetary damages that are primarily paid out of the fund
created pursuant to the Tort Claims Act N.J.S.A. 59:1-1 et seq. In
addition, at any given time there are various contract claims against
the State and State agencies seeking recovery of monetary damages.
The State is unable to estimate its exposure for these claims and
cases. An independent study estimated an aggregate potential exposure
of $50 million for tort claims pending, as of January 1, 1982. It is
estimated that were a similar study made of claims currently pending the
amount of estimated exposure would be higher. Moreover, New Jersey is
involved in a number of other lawsuits in which adverse decisions could
materially affect revenue or expenditures. Such cases include
challenges to its system of educational funding, the methods by which
the State Department of Human Services shares with county governments
the maintenance recoveries and costs for residents in state psychiatric
hospitals and residential facilities for the developmentally disabled.
Other lawsuits, that could materially affect revenue or expenditures
include a suit by a number of taxpayers seeking refunds of taxes paid to
the Spill Compensation Fund pursuant to NJSA 58:10-23.11, a suit
alleging that unreasonably low Medicaid payment rates have been
implemented for long-term care facilities in New Jersey, a suit alleging
unfair taxation on interstate commerce, a suit by Essex County seeking
to invalidate the State's method of funding the judicial system and a
suit seeking return of moneys paid by various counties for maintenance
of Medicaid or Medicare eligible residents of institutions and
facilities for the developmentally disabled and a suit challenging the
imposition of premium tax surcharges on insurers doing business in New
Jersey, and assessments upon property and casualty liability insurers
pursuant to the Fair Automobile Insurance Reform Act.
103
<PAGE>
Legislation enacted June 30, 1992, which called for revaluation of
several public employee pension funds, authorized an adjustment to the
assumed rate of return on the investment of pension fund assets, and
refunds $773 million in public employer contributions to the State from
various pension funds, reflected as a revenue source for Fiscal Year
1992. It is estimated that savings of $226 million will be effected in
fiscal year 1993 and each fiscal year thereafter. Several labor unions
filed suit seeking a judgment directing the State Treasurer to refund
all monies transferred from the pension funds and paid into the General
Fund. On February 5, 1993, the Superior Court granted the State's
motion for summary judgment as to all claims. An appeal has been filed
with the Appellate Division of the Superior Court. On May 5, 1994, the
Appellate Division affirmed the decision of the trial court dismissing
the complaint. An adverse determination in this matter would have a
significant impact on fiscal year 1993 and subsequent fiscal year fund
balances.
Bond Ratings--Citing a developing pattern of reliance on non-recurring
measures to achieve budgetary balance, four years of financial
operations marked by revenue shortfalls and operating deficits, and the
likelihood that financial pressures will persist, on August 24, 1992
Moody's lowered from Aaa to Aa1 the rating assigned to New Jersey
general obligation bonds. The downgrade reflects Moody's concern that
the state's chronic budgetary problems detract from bondholder security.
The Aa-1 rating from Moody's is equivalent to Standard & Poor's AA
rating. On July 6, 1992, Standard & Poor's affirmed its AA+ ratings on
New Jersey's general obligation and various lease and appropriation
backed debt, but its ratings outlook was revised to negative for the
longer term horizon (beyond four months) for resolution of two items
cited in the Credit Watch listing: (i) the Federal Health Care
Facilities Administration ruling concerning retroactive medicaid
hospital reimbursements and (ii) the state's uncompensated health care
funding system, which is under review by the United States Supreme
Court.
NEW JERSEY TAXES
In the opinion of Shanley & Fisher, P.C., Morristown, New Jersey,
special counsel on New Jersey tax matters, under existing New Jersey
law:
1. The proposed activities of the New Jersey Trust will not cause it
to be subject to the New Jersey Corporation Business Tax Act.
2. The income of the New Jersey Trust will be treated as the income
of individuals, estates and trusts who are the Holders of Units of the
New Jersey Trust for purposes of the New Jersey Gross Income Tax Act,
and interest which is exempt from tax under the New Jersey Gross Income
Tax Act when received by the New Jersey Trust will retain its status as
tax exempt in the hands of such Unit Holders. Gains arising from the
sale or redemption by a Holder of his Units or from the sale or
redemption by the New Jersey Trust of any Debt Obligation are exempt
from taxation under the New Jersey Gross Income Tax Act, as enacted and
construed on the date hereof, to the extent such gains are attributable
to Debt Obligations the interest on which is exempt from tax under the
New Jersey Gross Income Tax Act.
3. Units of the New Jersey Trust may be subject, in the estates of
New Jersey residents, to taxation under the Transfer Inheritance Tax Law
of the State of New Jersey.
THE NEW MEXICO TRUST
The New Mexico state economy and the economy of Albuquerque and its
metropolitan area have enjoyed vigorous growth. The short term outlook
continues to be excellent.
104
<PAGE>
Until early 1995, the favorable economy outlook restrained traditional
concerns about the effects of defense cuts that have been seen as a
possibility for some time. Local media reports published on February
15, 1995, attributed to unidentified members of New Mexico's
congressional delegation, asserted that the Department of Defense may
propose the closure or substantial downsizing of military operations at
Kirtland Air Force Base in Albuquerque to the Defense Base Closure and
Realignment Commission. According to the media, the inclusion of a base
on the list of recommendations submitted to the commission during the
last round of closures in 1993 resulted in a more than an 80%
probability that the base would be closed or downsized. Closure or
substantial downsizing of military operations at Kirtland would likely
have a substantial, adverse impact on Albuquerque's economy. There was
no immediate confirmation that Kirtland, or either of the other two air
force bases in New Mexico, would be included on the list of proposed
closures, or of the timing or magnitude of any action that might be
recommended.
RISK FACTORS--The State Economy.
The Debt Obligations included in the Portfolio of the New Mexico Trust
may include special or general obligations of the State or of the
municipality or authority which is the issuer. Special obligations are
not supported by taxing powers. The risks, particular source of payment
and security for each of the Debt Obligations are detailed in the
instruments themselves and in related offering materials. There can be
no assurance concerning the extent to which the market value or
marketability of any of the Debt Obligations will be affected by the
financial or other condition of the State, or by changes in the
financial condition or operating results of underlying obligors.
Further, there can be no assurance that the discussion of risks
disclosed in related offering materials will not become incomplete or
inaccurate as a result of subsequent events.
According to reports of the Bureau of Business and Economic Research
of the University of New Mexico ("BBER") through December 1994 and
covering reports of economic results for 1993 and estimated results for
the State for 1994, New Mexico's economy performed exceptionally well
during the period, with diversified growth by sector and region
throughout the state. During the twelve months ending October 1994,
employment increased 5.1 percent, the second highest growth rate in the
country. Personal income increased 8.1 percent during the second
quarter of 1994, a rate of increase that was the fourth highest rate in
the country.
New Mexico is benefitting from an influx of new manufacturing and
business services firms into the Rocky Mountain states, drawn by the
region's low wages, productive work force, relatively low tax burden and
quality of life. Although New Mexico is highly dependent on defense
spending, the State has so far escaped any major defense cuts. Indeed,
U.S. Air Force facilities have seen a limited expansion, and the two
national laboratories have gained additional funds for environmental,
arms control and technology transfer research. Job losses in defense
related activities which have occurred to date have been fairly minor
from an overall state perspective.
New Mexico's construction sector returned to employment growth during
early 1992. Construction boomed during 1993, across the board, in
residential construction, non-residential construction other than
buildings and non-residential construction, as well. Construction
employment increased at a 15.8 percent rate, adding more than 4,500
jobs. During 1994, growth in this sector increased at an estimated rate
of 14.6 percent. Part of the boom is attributable to a rebound from the
severe recession in construction which occurred during the 1986-1991
period, part to the favorable impact of lower interest rates which
contributed to a favorable climate for construction of residential
housing and part is attributable to the $1.8 billion expansion of
Intel's electronics manufacturing plant at Rio Rancho. (As of 1993, the
Albuquerque Metropolitan Statistical Area ("MSA") was redefined to
include Sandoval County, the location of Rio Rancho, as well as Valencia
County).
105
<PAGE>
In the mining sector, employment has grown by 1,500 jobs since 1992,
following a loss of one-half of the 16,000 jobs which existed in this
sector in 1981 during the following ten years and a loss in 1992 which
reflected the adverse impact of low oil prices and very low gas prices.
Drilling and production of oil and natural gas have increased and a long
term coal purchase agreement between an out-of-state utility and a mine
in northeast New Mexico has had a favorable impact. Recent developments
continue to be positive, with a further increase in employment during
the first quarter of 1994, the reopening of a copper mine in southern
New Mexico and the expansion of other copper mining facilities,
reflecting higher copper prices.
About 5,000 new jobs have been added by the manufacturing sector since
1990, led by expansion of the Intel plant, Motorola, General Mills,
Philips Semiconductor and Sumitomo in the Albuquerque MSA and numerous
new food processing operations in the eastern part of the State.
RISK FACTORS--The Economy of Albuquerque and its Metropolitan Area.
A significant proportion of the New Mexico Trust's Portfolio may
consist of Debt Obligations of issuers located in, or whose activities
may be affected by economic conditions in, the Albuquerque MSA.
Albuquerque is the largest city in the State of New Mexico, accounting
for roughly one-quarter of the State's population. Located in the
center of the State at the intersection of two major interstate highways
and served by both rail and air, Albuquerque is the major trade,
commercial and financial center of the State.
According to BBER reports through December 1994, covering economic
results for 1993 and the first six months of 1994, the economy of the
Albuquerque MSA outperformed the state as a whole in 1993. BBER
described the Albuquerque economy at the end of 1994's first quarter as
"running at full tilt." The Albuquerque MSA accounts for almost 43% of
the jobs in New Mexico, and in 1993 accounted for 55% of all new jobs
statewide.
Employment. The City's expansion was broad-based during the 1980's,
with all major sectors experiencing employment growth. Growth stalled
in the final quarter of 1990, as the national economy experienced
recession, but resumed in the second half of 1991. During calendar
1993, all sectors in the MSA experienced job growth, with the exception
of transportation/communications/utilities, which suffered a decline in
employment largely as a result of a voluntary separation/retirement
program at a utility.
Non agricultural employment growth in the Albuquerque MSA has exceeded
4 percent for each quarter beginning with the fourth quarter of 1992.
An annual growth rate at this level translates to approximately 12,000
jobs annually. Over half of nonagricultural civilian employment in the
Albuquerque MSA is in the trade and service sectors. Historically, the
service sector has grown at roughly twice the rate of growth of the
trade sector. During 1993, the services sector rate of growth slowed
from historical levels, reflecting the influence of a reduction in the
rate of growth in the health services sector and a decrease in
hotel/lodging employment. These trends continued during the first
quarter of 1994. The importance of trade and services reflects the
continued importance of tourism to the Albuquerque economy. Albuquerque
has benefitted from the recent fascination with the Southwest and from
efforts to promote the City and to attract major conventions to the
expanded Convention Center. Lodgers" tax receipts, hotel occupancy
rates and average room rates all have steadily increased.
While it has declined in importance as a direct employer, the
government sector still accounts for 20 percent of the Albuquerque MSA's
total nonagricultural employment. Not included in this calculation are
the 7,500 jobs at Sandia National Laboratories and about 6,200 military
jobs at Kirtland Air Force Base. The University of New Mexico ("UNM"),
the Albuquerque Public Schools system, Sandia and Kirtland are the
largest employers in the Albuquerque area. Discussions of defense
106
<PAGE>
cutbacks have created considerable uncertainty over future funding for
operations at Kirtland and Sandia. At Sandia, employment has remained
steady. However, potential future cuts in military spending cast a
cloud over the outlook. Recent actions by Congress have expanded the
missions of Sandia and other Department of Energy research labs beyond
nuclear weapons to include (1) arms control verification, (2) nuclear
waste clean-up and (3) technology research and development. While this
broadening of the labs" mission is encouraging, the transition to a new
funding base with more reliance on the private sector could result in
workforce reductions at the labs over the next few years. The fact that
many Sandia employees are at or near retirement age and are believed to
be likely to remain in the Albuquerque area would blunt the economic
impact of cutbacks at Sandia.
The finance, insurance and real estate employment sectors experienced
a modest increase in employment in 1992, the first increase seen in this
sector since 1987. The upward trend has continued, with a 4.2 percent
rate of increase during the first quarter of 1994. This sector has seen
major reorganizations and consolidations of local financial
institutions. The reorganization of AT&T and large lay-offs at the
State's major electric utility have contributed to holding down
employment growth in the transportation, communications and public
utilities sector.
The Albuquerque economy experienced a construction boom during the
mid-1980's, but construction employment decreased in every year from
1985 to 1991. A major increase in jobs occurred during 1992 and the
construction sector led the Albuquerque economy in 1993, spurred by low
interest rates, pent up demand for housing and retail and public works
construction projects. In early 1993, this sector received an immense
boost when Intel Corporation began an expansion of its microprocessor
production facility in Rio Rancho, within the Albuquerque MSA, creating
as many as 3,000 construction jobs as of Spring, 1993. During the first
quarter of 1994, construction continued to be the Albuquerque MSA's
fastest growing employment sector with a 24.6 percent increase over the
first quarter of 1993. Growth in this sector exceeded 22 percent for
each of the four quarters beginning with the second quarter of 1993, and
the number of construction jobs increased by 3,700 during that period.
Single family housing construction remained strong and construction
activity for multi-family units saw a rebirth during the second quarter
of 1994.
The manufacturing employment sector within the Albuquerque MSA
returned to overall job growth during 1993, with a net addition of
approximately 1,500 jobs, a significant portion of which related to
electronics manufacturing at Intel, Motorola and Philips Semiconductors.
This increase brought an end to a period of job losses or no job growth
experienced since the first quarter of 1990. Rio Rancho, which is
located approximately 20 miles northwest of downtown Albuquerque in
Sandoval County, has had considerable success in attracting new
manufacturing facilities. Employment at Intel Corporation's Rio Rancho
plant has seen steady, significant increases since 1988, and the current
expansion is expected to add 1,000 new manufacturing jobs. Moderately
strong employment growth continued in this sector during the first
quarter of 1994. Over the seven quarters beginning with the third
quarter of 1992, this sector has seen an average quarterly increase of 6
percent.
Income. According to U.S. Department of Commerce data, Albuquerque
MSA personal income has grown at an annual rate of not less than 6.0%
since 1986. In 1992, annual per capita personal income for the State of
New Mexico and the United States was $15,563 and $20,114, respectively.
According to BBER, New Mexico's average wage in 1993 was 83.9 percent of
the average U.S. wage ($21,703 versus $23,866) a fall from the 93.1
percent level which existed in 1981. This trend shows that with the
exception of the new jobs in the durable manufacturing sector, the new
jobs generated in recent periods have in many cases been low paying ones
and even in sectors such as retail trade and state and local government,
average wages have not kept pace with national averages.
Population. Population in Bernalillo County is estimated at 499,262
for 1992. (The population of the State is estimated at 1,581,830.)
107
<PAGE>
Outlook. The 1994 year has been a strong one economically for New
Mexico and Albuquerque. BBER projects an excellent near-term economic
outlook, based on the income, tax and employment multiplier effect of
recent employment gains at new and expanding manufacturers and business
services, which is expected to continue in 1995; a continued high level
of construction activity following completion of the Intel project
during mid-1995, despite interest rate hikes, with new building of
apartments, hotels and motels, office buildings, streets and highways,
and a major, regional shopping center on the west side of Albuquerque;
and state capital projects funded by the 1994 legislature. Further
increases in employment and personal income are expected in 1995,
although at a lesser rate than during 1994 due to expected reductions in
mining and construction sectors and a weaker national economy. With
strong growth in personal income, in a low inflation environment, retail
trade and consumer services businesses are expected to do well.
According to BBER's analysis, New Mexico has enjoyed a competitive
advantage over other states in attracting manufacturing, business
services and retail trade jobs since 1981, although the sharp declines
in mining throughout the 1980's and construction's bust in the second
half of the 1980's tended to obscure this phenomenon. The State's
recent economic performance in the face of weakness in important sectors
was impressive. This performance provides a basis for optimism with
respect to the longer term, to offset to some extent the apprehension
which resulted the media reports described in the opening paragraph of
this section on The New Mexico Trust.
The Sponsors believe that the information summarized above describes
some of the more significant general considerations relating to Debt
Obligations included in the New Mexico Trust. For a discussion of the
particular risks associated with each of the Debt Obligations and other
factors to be considered in connection therewith, reference should be
made to the Official Statements and other offering materials relating to
each of the Debt Obligations which are included in the portfolio of the
New Mexico Trust. The sources of the information set forth herein are
official statements, other publicly available documents, and statements
of public officials and representatives of the issuers of certain of the
Debt Obligations. While the Sponsors have not independently verified
this information, they have no reason to believe that such information
is incorrect in any material respect.
NEW MEXICO TAXES
In the opinion of Rodey, Dickason, Sloan, Akin & Robb, P.A.,
Albuquerque, New Mexico, special counsel on New Mexico tax matters:
Since New Mexico taxable income is the same as Federal taxable income
with adjustments not pertinent to this discussion, under existing New
Mexico income tax laws, the New Mexico Trust is not an association
taxable as a corporation if it is not treated as an association taxable
as a corporation for Federal income tax purposes; the income of the New
Mexico Trust will be treated as the income of Holders of Units of the
New Mexico Trust and will be deemed to be received by them when received
by the New Mexico Trust. Interest on the Debt Obligations in the New
Mexico Trust which is excludable from net income under the New Mexico
income tax laws when received by the New Mexico Trust will retain such
status with respect to the Holders of Units of the New Mexico Trust for
purposes of New Mexico income tax laws.
For purposes of the New Mexico income tax laws, each Holder of Units
of the New Mexico Trust will be considered to have received his pro rata
share of interest on each Debt Obligation in the New Mexico Trust when
it is received by the New Mexico Trust, and each Holder will recognize
gain or loss for purposes of the New Mexico income tax laws when the New
Mexico Trust disposes of a Debt Obligation (whether by sale, exchange,
redemption or payment at maturity) or when the Holder redeems or sells
his Unit to the extent the transaction constitutes a taxable event for
Federal income tax purposes. A Holder's tax cost (or basis) for his pro
rata portion of a Debt Obligation will be
108
<PAGE>
established and allocated for
purposes of the New Mexico income tax laws in the same manner as such
cost is established and allocated for Federal income tax purposes.
For purposes of the New Mexico income tax laws, a Holder of Units will
not be allowed a deduction for interest paid on any indebtedness
incurred or continued to purchase or hold Units to the extent that the
interest income related to the ownership of the Units is excludable from
net income under the New Mexico income tax laws. Furthermore, under the
New Mexico tax laws, a Holder of Units, other than a corporate Holder,
is not entitled to a deduction for such Holder's share of fees and
expenses of the New Mexico Trust to the extent that the fees and
expenses are incurred in connection with the production of tax-exempt
income.
Because New Mexico income tax laws are based in large part upon
Federal income tax law, the foregoing opinions concerning New Mexico
income taxes are based on the opinion of Davis Polk & Wardwell
concerning Federal income tax aspects of the New Mexico Trust.
Special New Mexico counsel has also advised that Holders should
consult their own tax advisors regarding collateral New Mexico income
tax consequences relating to the ownership of the Units, including, but
not limited to, the inclusion of tax-exempt income attributable to
ownership of Units in "modified gross income", as that term is used in
the New Mexico Income Tax Act, as amended, for purposes of determining
eligibility for and the amount of the New Mexico low income
comprehensive tax rebate, the New Mexico child day care credit, the New
Mexico low income food and medical gross receipts tax rebate and the New
Mexico elderly taxpayers" property tax rebate. Units of the New Mexico
Trust may be subject, in the estates of Holders of Units who are New
Mexico residents, to estate taxation under the New Mexico Estate Tax
Act.
THE NEW YORK TRUST
RISK FACTORS--Prospective investors should consider the financial
difficulties and pressures which the State of New York and several of
its public authorities and municipal subdivisions have undergone. The
following briefly summarizes some of these difficulties and the current
financial situation, based principally on certain official statements
currently available; copies may be obtained without charge from the
issuing entity, or through the Agent for the Sponsors upon payment of a
nominal fee. While the Sponsors have not independently verified this
information, they have no reason to believe that it is not correct in
all material respects.
New York State. In recent fiscal years, there have been extended
delays in adopting the State's budget, repeated revisions of budget
projections, significant revenue shortfalls (as well as increased
expenses) and year-end borrowing to finance deficits. These
developments reflect faster long-term growth in State spending than
revenues and that the State was earlier and more severely affected by
the recent economic recession than most of the rest of the country, as
well as its substantial reliance on non-recurring revenue sources. The
State's general fund incurred cash basis deficits of $775 million,
$1,081 million and $575 million, respectively, for the 1990-1992 fiscal
years. Measures to deal with deteriorating financial conditions
included transfers from reserve funds, recalculating the State's pension
fund obligations (subsequently ruled illegal), hiring freezes and
layoffs, reduced aid to localities, sales of State property to State
authorities, and additional borrowings (including issuance of additional
short-term tax and revenue anticipation notes payable out of impounded
revenues in the next fiscal year). The general fund realized a $671
million surplus for the fiscal year ended March 31, 1993, and a $1.54
billion surplus for the fiscal year ended March 31, 1994.
Approximately $5.4 billion of State general obligation debt was
outstanding at March 31, 1994. The State's net tax-supported debt
(restated to reflect LGAC's assumption of certain obligations previously
funded through issuance of short-term debt) was $27.5 billion at March
31, 1994, up from
109
<PAGE>
$11.7 billion in 1984. A proposed constitutional
amendment passed by the Legislature would limit additional
lease-purchase and contractual obligation financing for State
facilities, but would authorize the State without voter referendum to
issue revenue bonds within a formula-based cap, secured solely by a
pledge of certain State tax receipts. It would also restrict State debt
to capital projects included in a multi-year capital financing plan.
The proposal is subject to approval by the current legislature and by
voters. Standard & Poor's reduced its rating of the State's general
obligation bonds on January 13, 1992 to A-(its lowest rating for any
state). Moody's reduced its ratings of State general obligation bonds
from A1 to A on June 6, 1990 and to Baa1, its rating of $14.2 billion of
appropriation-backed debt of the State and State agencies (over
two-thirds of the total debt) on January 6, 1992.
In May 1991 (nearly 2 months after the beginning of the 1992 fiscal
year), the State Legislature adopted a budget to close a projected $6.5
billion gap (including repayment of $905 million of fiscal 1991 deficit
notes). Measures included $1.2 billion in new taxes and fees, $0.9
billion in non-recurring measures and about $4.5 billion of reduced
spending by State agencies (including layoffs), reduced aid to
localities and school districts, and Medicaid cost containment measures.
After the Governor vetoed $0.9 billion in spending, the State adopted
$0.7 billion in additional spending, together with various measures
including a $100 million increase in personal income taxes and $180
million of additional non-recurring measures. Due primarily to
declining revenues and escalating Medicaid and social service
expenditures, $0.4 billion of administrative actions, $531 million of
year-end short-term borrowing and a $44 million withdrawal from the Tax
Stabilization Reserve Fund were required to meet the State's cash flow
needs.
The State budget to close a projected $4.8 billion gap for the State's
1993 fiscal year (including repayment of the fiscal 1992 short-term
borrowing) contained a combination of $3.5 billion of spending
reductions (including measures to reduce Medicaid and social service
spending, as well as further employee layoffs, reduced aid to
municipalities and schools and reduced support for capital programs),
deferral of scheduled tax reductions, and some new and increased fees.
Nonrecurring measures aggregated $1.18 billion.
To close a projected budget gap of nearly $3 billion for the fiscal
year ended March 31, 1994, the State budget contained various measures
including further deferral of scheduled income tax reductions, some tax
increases, $1.6 billion in spending cuts, especially for Medicaid, and
further reduction of the State's work force. The budget increased aid
to schools, and included a formula to channel more aid to districts with
lower-income students and high property tax burdens. State legislation
requires deposit of receipts from the petroleum business tax and certain
other transportation-related taxes into funds dedicated to
transportation purposes. Nevertheless, $516 million of these monies
were retained in the general fund during this fiscal year. The Division
of the Budget has estimated that non-recurring income items other than
the $671 million surplus from the 1993 fiscal year aggregated, $318
million.
The budget for the fiscal year that began April 1, 1994 increases
spending by 3.8% (greater than inflation for the first time in six
years). Tax revenue projections are based on assumed modest growth in
the State economy. It provides a tax credit for low income families and
increase aid to education, especially the poorer districts. The State
reduced coverage and placed additional restrictions on certain health
care services. Over $1 billion results from postponement of scheduled
reductions in personal income taxes for at of the year and in taxes on
hospital income; another $1 billion comes from rolling over the surplus
from the previous fiscal year. Other non-recurring measures were
reduced to $78 million. The State Legislature passed legislation to
implement a budget agreement more than two months after the beginning of
the year. Taxes (principally business taxes) were reduced by $475
million in the current fiscal year and by $1.6 billion annually after
fully phased in. In November 1993 the State's Court of Appeals ruled
unconstitutional 1990 legislation which postponed employee pension
contributions by the State and localities (other than New York City).
The amounts to be made up, estimated to aggregate $4 billion (half from
the State), will repaid in increasing amounts over 12-20
110
<PAGE>
years and
previous contribution levels will not be exceeded until 1999. The
State's new Governor estimates a deficit of at least $300 million for
the fiscal year ending March 31, 1995 and at least $5 billion for the
next fiscal year. He ordered a partial hiring freeze and reductions in
non-essential expenditures. The new Governor's proposed budget for the
1996 fiscal year seeks significant reductions in expenditures,
particularly on State agencies (by reducing the State workforce) and on
health care and social services, but also across the board including aid
to education and transportation. The proposal includes $650 million in
non-recurring measures. He also proposed reductions aggregating $1
billion in the State income tax. Capital spending in the year would be
substantially reduced. The proposal requires approval by the State
Legislature. However, closing the deficit for that and future years
will be more difficult in view of the Governor's plan to reduce personal
income taxes by 25% during his four-year term and because of potential
decreases in Federal aid. State and other estimates are subject to
uncertainties including the effects of Federal tax legislation and
economic developments. The State in October 1994 cautioned that its
estimates were subject to the risk that further increases in interest
rates could impeded economic growth.
The State normally adjusts its cash basis balance by deferring until
the first quarter of the succeeding fiscal year substantial amounts of
tax refunds and other disbursements. For many years, it also paid in
that quarter more than 40% of its annual assistance to local
governments. Payment of these annual deferred obligations and the
State's accumulated deficit was substantially financed by issuance of
short-term tax and revenue anticipation notes shortly after the
beginning of each fiscal year. The New York Local Government Assistance
Corporation ("LGAC") was established in 1990 to issue long-term bonds
over several years, payable from a portion of the State sales tax, to
fund certain payments to local governments traditionally funded through
the State's annual seasonal borrowing. The legislation will normally
limit the State's short-term borrowing, together with net proceeds of
LGAC bonds, to a total of $4.7 billion. The State's last seasonal
borrowing, in May 1993, was $850 million.
Generally accepted accounting principles ("GAAP") for municipal
entities apply modified accrual accounting and give no effect to payment
deferrals. On an audited GAAP basis, the State's government funds group
recorded operating deficits of $1.2 billion and $1.4 billion for the
1990 and 1991 fiscal years. For the same periods the general fund
recorded deficits (net of transfers from other funds) of $0.7 billion
and $1.0 billion. Reflecting $1.6 billion, $881 million and $875
million of payments by LGAC to local governments out of proceeds from
bond sales, the general fund realized surpluses of $1.7 billion, $2.1
billion and $0.9 billion for the 1992, 1993 and 1994 fiscal years,
respectively. A $0.7 billion deficit has been projected for the fiscal
year ending March 31, 1995.
For decades, the State's economy has grown more slowly than that of
the rest of the nation as a whole. Part of the reason for this decline
has been attributed to the combined State and local tax burden, which is
the second highest in the nation (over 60% above the national average).
The State's dependence on Federal funds and sensitivity to changes in
economic cycles, as well as the high level of taxes, may continue to
make it difficult to balance State and local budgets in the future. The
total employment growth rate in the State has been below the national
average since 1984. The State lost 524,000 jobs in 1990-1992. It
regained approximately 134,000 jobs between November 1992 and July 1994
but has experienced a slight decline since then.
New York City (the "City"). The City is the State's major political
subdivision. In 1975, the City encountered severe financial
difficulties, including inability to refinance $6 billion of short-term
debt incurred to meet prior annual operating deficits. The City lost
access to the public credit markets for several years and depended on a
variety of fiscal rescue measures including commitments by certain
institutions to postpone demands for payment, a moratorium on note
payment (later declared unconstitutional), seasonal loans from the
Federal government under emergency congressional legislation, Federal
guarantees of certain City bonds, and sales and exchanges of bonds by
The Municipal Assistance Corporation for the City of New York ("MAC") to
fund the City's debt.
111
<PAGE>
MAC has no taxing power and pays its obligations out of sales taxes
imposed within the City and per capita State aid to the City. The State
has no legal obligation to back the MAC bonds, although it has a "moral
obligation" to do so. MAC is now authorized to issue bonds only for
refunding outstanding issues and up to $1.5 billion should the City fail
to fund specified transit and school capital programs. The State also
established the Financial Control Board ("FCB") to review the City's
budget, four-year financial plans, borrowings and major contracts.
These were subject to FCB approval until 1986 when the City satisfied
statutory conditions for termination of such review. The FCB is
required to reimpose the review and approval process in the future if
the City were to experience certain adverse financial circumstances.
The City's fiscal condition is also monitored by a Deputy State
Comptroller.
The City projects that it is beginning to emerge from four years of
economic recession. From 1989 through 1993, the gross city product
declined by 10.1% and employment, by almost 11%, while the public
assistance caseload grew by over 25%. Unemployment averaged 10.8% in
1992 and 10.1% in 1993, peaking at 13.4% in January 1993, the highest
level in 25 years. While the City's unemployment rate has declined
substantially since then, it is still above the rest of the State and
the nation as a whole. The number of persons on welfare exceeds 1.1
million, the highest level since 1972, and one in seven residents is
currently receiving some form of public assistance.
While the City, as required by State law, has balanced its budgets in
accordance with GAAP since 1981, this has required exceptional measures
in recent years. The FCB has commented that City expenditures have
grown faster than revenues each year since 1986, masked in part by a
large number of non-recurring gap closing actions. To eliminate
potential budget gaps of $1-$3 billion each year since 1988 the City has
taken a wide variety of measures. In addition to increased taxes and
productivity increases, these have included hiring freezes and layoffs,
reductions in services, reduced pension contributions, and a number of
nonrecurring measures such as bond refundings, transfers of surplus
funds from MAC, sales of City property and tax receivables. The FCB
concluded that the City has neither the economy nor the revenues to do
everything its citizens have been accustomed to expect.
The City closed a budget gap for the 1993 fiscal year (estimated at
$1.2 billion) through actions including service reductions, productivity
initiatives, transfer of $0.5 billion surplus from the 1992 fiscal year
and $100 million from MAC. A November 1992 revision offset an
additional $561 million in projected expenditures through measures
including a refunding to reduce current debt service costs, reduction in
the reserve and an additional $81 million of gap closing measures. Over
half of the City's actions to eliminate the gap were non-recurring.
The Financial Plan for the City's 1994 fiscal year relied on increases
in State and Federal aid, as well as the 1993 $280 million surplus and a
partial hiring freeze, to close a gap resulting primarily from labor
settlements and decline in property tax revenues. The Plan contained
over $1.3 billion of one- time revenue measures including bond
refundings, sale of various City assets and borrowing against future
property tax receipts. Interim expenditure reductions of approximately
$300 million were implemented. The FCB reported that although a $98
million surplus was projected for the year (the surplus was actually $81
million), a $312 million shortfall in budgeted revenues and $904 million
of unanticipated expenses (including an unbudgeted increase of over
3,300 in the number of employees and a record level of overtime), net of
certain increased revenues and other savings, resulted in depleting
prior years" surpluses by $326 million.
The City's Financial Plan for the current fiscal year (that began July
1, 1994), proposed both to eliminate a projected $2.3 billion budget gap
and to stabilize overall spending while beginning to reduce some
business and other taxes. It calls for a reduction of 15,000 in the
City work-force by June 1995 unless equivalent productivity savings are
negotiated with unions; with the aid of $200 million from MAC, the City
induced 11,500 workers to accept voluntary severance, and unions leaders
accepted transfer of remaining employees between agencies. The Plan
projects about $560 million of
112
<PAGE>
increased State and Federal aid, some of
which has not yet been approved. Non-recurring measures include $225
million from refinancing outstanding bonds (which the FCB estimates will
cancel almost 10% of the debt-service savings anticipated from the
recent capital plan reduction), future debt service), extension of the
repayment schedule of a debt to City pension funds, revision of
actuarial assumptions to reduce contribution levels, and sale of a
City-owned hotel. A proposal for City employees to bear $200 million of
their health care costs must be negotiated with the unions, which have
announced their opposition.
Since the current year's Financial Plan was adopted, the City has
experienced lower than anticipated tax collections, higher than budgeted
costs (particularly overtime and liability claims), and increased
likelihood that various revenue measures including certain anticipated
Federal and State aid, will not occur. In July 1994 the Mayor ordered
expenditure reductions of $250 million and a contingency plan for
another $200 million. In late October, the Mayor proposed another $900
million of spending cuts to address a then projected $1.1 billion
additional budget gap. $190 million represents proposed tranfers of
excess reserves in employee health care plans, a non-recurring measure,
and the City's subsidy to the TA was reduced by the $113 million surplus
it realized for 1994. Maintenance of City infrastructure would be
reduced, which could lead to higher expenses in the future. The City
Council rejected the Mayor's proposals and adopted its own plan,
overriding the Mayor's veto and sued the Mayor in State Supreme Court to
enforce that plan. Following the Mayor's withdrawal of his October
proposals and dismissal of the suit, the Mayor impounded $790 million of
funds for previously authorized expenditures. In February 1995 the City
Council approved an additional $647 million deficit-reduction plan,
including a second bond refinancing in the fiscal year as an alternative
to about $120 million of further reductions in subsidies to the Board of
Education.
The Mayor is exploring the possibility of privitizing some of the
City's services. The City Council passed legislation which authorizes
the Council to hold hearings on any significant privitization and
requires submission of a cost-benefit analysis. The City has awarded or
is in the process of awarding contracts to private companies to run more
than twenty separate services. Responding to an impasse in negotiations
to increase the rent the Port Authority pays the City for Kennedy and
LaGuardia airports, the City is studying how the airports might be
privatized. The Mayor has also been seeking greater control over
spending by independent authorities and agencies such as the Board of
Education, the Health and Hospitals Corporation and the TA. The Mayor's
efforts to reduce expenditures by the Board of Education, including
appointment of another fiscal monitor, reduction in City funding of
capital projects and rejection of a tentative labor contract, have
strained relations with the Schools Chancellor at a time of rising
enrollments. In March 1994 the Mayor reduced cash incentives to
landlords renting apartments to the homeless. A program to acquire
able-bodied welfare recipients to render community service started being
phased in January 1995. In February 1995 the Mayor announced that it
would try to sell three of the City's 11 municipal hospitals, and was
appointing an advisory panel to recommend further changes to the
operations of the Health and Hospitals Corporation. It is reported that
the Mayor is considering proposals including eliminating City financing
of a program that creates housing for single homeless people, charging
shelter occupants who refuse offers of treatment or training a modest
rent for use of the shelter, and replacing some of the subsidies to day
care centers with a voucher system. A plan to fingerprint welfare
recipients in the City, could be subject to legal challenge. Budget
gaps of $1.0 billion, $1.5 billion and $2.0 billion were projected for
the 1996 through 1998 fiscal years, respectively, the Mayor's October
1994 proposal, and the City now projects a budget gap of about $2.7
billion for the fiscal year commencing July 1, 1995, attributed to a
$500 million decline in tax revenues and a $265 million shortfall in
anticipated State and Federal aid, as well as higher Medicaid and agency
spending, failure to negotiate increased lease payments for City
airports, additional funding for pensions and State failure to adopt a
tort reform measure. In February 1995 the Mayor announced a preliminary
plan to close this gap by reducing overall spending by $1.3 billion from
the current fiscal year, through savings including $1.2 billion of
reductions in welfare and Medicaid expenditures, $600 million in
spending reductions by City agencies, $230 million by the Board of
Education (proposed State reductions would reduce revenue by
113
<PAGE>
another
$460 million) and $128 million in subsidies to the TA. The plan also
proposes $190 million from revenue and asset sales and $184 million in
tax reductions. The fiscal monitors have suggested that gaps for future
years could reach $2-$4 billion annually. The State Comptroller cited
principally growing Medicaid, employee health insurance and debt service
costs. Even after the recent capital plan reductions, the City
Comptroller recently projected that debt service will consume 19.5% of
tax revenue by the 1998 fiscal year.
A major uncertainty is the City's labor costs, which represent about
50% of its total expenditures. The City's workforce grew by 34% during
the 1980s. A January 1993 agreement covering approximately 44% of City
workers followed negotiations lasting nearly two years. Workers will
receive wage and benefit raises totalling 8.25% over 39 months ending
March 1995. An agreement announced in August 1993 provides wage
increases for City teachers averaging 9% over the 48 1/2 months ending
October 1995. The City is seeking to negotiate workforce productivity
initiatives, savings from which would be shared with the workers
involved. Under a contract reached in September 1994, while sanitation
workers would receive an overall increase of 8.25% in wages and benefits
over 39 months, routes would be lengthened by an average of 20%. The
Financial Plan assumes no further wage increases after the 1995 fiscal
year. Also, costs of some previous wage increases were offset by
reduced contributions to pension funds; if fund performance is less than
the 9% annual earnings projected (as is projected in the current fiscal
year). Although an actuarial audit has not been completed, the January
1995 budget estimate for the 1996 fiscal year anticipates that the City
will need to contribute an additional $300 million in that year.
Budget balance may also be adversely affected by the effect of the
economy on economically sensitive taxes. Reflecting the downturn in
real estate prices and increasing defaults, estimates of property tax
revenues have been reduced. If this trend continues, the City's ability
to issue additional general obligation bonds could be limited by the
1998 fiscal year. The City also faces uncertainty in its dependence on
State aid as the State grapples with its own projected budget gap.
Other uncertainties include additional expenditures to combat
deterioration in the City's infrastructure (such as bridges, schools and
water supply), costs of developing alternatives to ocean dumping of
sewage sludge (which the City expects to defray through increased water
and sewer charges), cost of the AIDS epidemic and problems of drug
addiction and homelessness. For example, the City may be ordered to
spend up to $8 billion to construct water filtration facilities if it is
not successful in implementing measures to prevent pollution of its
watershed upstate. In December 1994 the City submitted for State
approval new pervasive regulations of activities in the area which can
cause pollution. Elimination of any additional budget gaps will require
various actions, including by the State, a number of which are beyond
the City's control. Staten Island voters in 1993 approved a proposed
charter under which Staten Island would secede from the City. Secession
will require enabling legislation by the State Legislature; it would
also be subject to legal challenge by the City. The effects of
secession on the City cannot be determined at this time, but questions
include responsibility for outstanding debt, a diminished tax base, and
continued use of the Fresh Kills landfill, the City's only remaining
garbage dump. A similar measure with respect to Queens was approved by
the New York State Senate.
In December 1993, a report commissioned by the City was released,
describing the nature of the City's structural deficit. It projects
that the City will need to identify and implement $5 billion in annual
gap closing measures by 1998. The report suggests a variety of possible
measures for City consideration. The Mayor rejected out of hand many of
the proposals such as tax increases.
The City sold $1.4 billion, $1.8 billion and $2.2 billion of
short-term notes, respectively, during the 1993, 1994 and current fiscal
years. At September 30, 1994, there were outstanding $21.7 billion of
City bonds (not including City debt held by MAC), $4.1 billion of MAC
bonds and $0.8 billion of City-related public benefit corporation
indebtedness, each net of assets held for debt service. Standard &
Poor's and Moody's during the 1975-80 period either withdrew or reduced
their ratings of the City's bonds. Standard & Poor's currently rates
the City's debt A-while Moody's rates City bonds
114
<PAGE>
Baa1. Following
announcement of the second bond refinancing, in January 1995 S&P put the
City's debt rating on CreditWatch for possible downgrading. In the wake
of the City's current budget difficulties, it has been reported that the
City had to pay higher interest rates on its January 1995 bond sale than
other comparably rated bonds (nearly 0.5% above an average of 30-year
bonds). City-related debt almost doubled since 1987, although total
debt declined as a percentage of estimated full value of real property.
The City's financing program projects long-term financing during fiscal
years 1995-1998 to aggregate $15.3 billion. An addition $2.7 billion is
to be derived from other sources, principally use of restricted cash
balances and advances from the general fund in anticipation of bond
issuances. The City's latest Ten Year Capital Strategy plans capital
expenditures of $45.6 billion during 1994-2003 (93% to be City funded).
Other New York Localities. In 1992, other localities had an aggregate
of approximately $15.7 billion of indebtedness outstanding. In recent
years, several experienced financial difficulties. A March 1993 report
by Moody's Investors Service concluded that the decline in ratings of
most of the State's largest cities in recent years resulted from the
decline in the State's manufacturing economy. Seventeen localities had
outstanding indebtedness for deficit financing at the close of their
respective 1992 fiscal years. Any reductions in State aid to localities
may cause additional localities to experience difficulty in achieving
balanced budgets. If special local assistance were needed from the
State in the future, this could adversely affect the State's as well as
the localities" financial condition. Most localities depend on
substantial annual State appropriations. Legal actions by utilities to
reduce the valuation of their municipal franchises, if successful, could
result in localities becoming liable for substantial tax refunds.
State Public Authorities. In 1975, after the Urban Development
Corporation ("UDC"), with $1 billion of outstanding debt, defaulted on
certain short-term notes, it and several other State authorities became
unable to market their securities. Since 1975 the State has provided
substantial direct and indirect financial assistance to UDC, the Housing
Finance Agency ("HFA"), the Environmental Facilities Corporation and
other authorities. Practical and legal limitations on these agencies"
ability to pass on rising costs through rents and fees could require
further State appropriations. 18 State authorities had an aggregate of
$63.5 billion of debt outstanding at September 30, 1993. At March 31,
1994, approximately $0.4 billion of State public authority obligations
was State-guaranteed, $7.3 billion was moral obligation debt (including
$4.8 billion of MAC debt) and $16.8 billion was financed under
lease-purchase or contractual obligation financing arrangements with the
State. Various authorities continue to depend on State appropriations
or special legislation to meet their budgets.
The Metropolitan Transportation Authority ("MTA"), which oversees
operation of the City's subway and bus system by the City Transit
Authority (the "TA") and operates certain commuter rail lines, has
required substantial State and City subsidies, as well as assistance
from several special State taxes. Measures to balance the TA's 1993
budget included increased funding by the City, increased bridge and
tunnel tolls and allocation of part of the revenues from the Petroleum
Business Tax. While the TA projects a budget surplus for 1994 (which
has been eliminated by reduction of the City subsidy), cash basis gaps
of $300-$800 million are projected for each of the 1995 through 1998
years. Measures proposed to close these gaps include various additional
State aid and possible fare increases. However, both State and City
budget proposals would reduce their subsidies to the MTA. An agreement
with TA workers reached in July 1994, which provides 10.4% wage
increases over 39 months, will cost the MTA $337 million. The MTA
Chairman stated that this cost would be partly offset by savings from
work rule changes and that money for the settlement is available in the
TA's budget. An earlier settlement with Long Island Railroad workers is
expected to cost the MTA $14 million over 26 months. Reacting to the
City's proposed reduction of $112 million in its subsidy for reduced
fares for school children (but not reflecting State and Federal aid
reduction proposals totalling $154 million), the TA in February proposed
a series of draconian service reductions (as well as abandoning proposed
fare restructurings including a rail pass and elimination of two-fare
zones) to an
115
<PAGE>
MTA Committee, in lieu of a fare increase this year.
Substantial claims have been made against the TA and the City for
damages from a 1990 subway fire and a 1991 derailment. The MTA
infrastructure, especially in the City, needs substantial
rehabilitation. In December 1993, a $9.5 billion MTA Capital Plan was
finally approved for 1992-1996, although $500 million was contingent on
increased contributions from the City, which it declined to approve.
The City is seeking State and MAC approval to defer $245 million of
capital contributions to the TA from the City's current fiscal year
until 1998. The Governor has requested the MTA to postpone the $690
million of borrowing for capital spending under the plan for 1995. It
is anticipated that the MTA and the TA will continue to require
significant State and City support. Moody's reduced its rating of
certain MTA obligations to Baa on April 14, 1992.
Litigation. The State and the City are defendants in numerous legal
proceedings, including challenges to the constitutionality and
effectiveness of various welfare programs, alleged torts and breaches of
contract, condemnation proceedings and other alleged violations of laws.
Adverse judgments in these matters could require substantial financing
not currently budgeted. For example, in addition to real estate
certiorari proceedings, claims in excess of $343 billion were
outstanding against the City at June 30, 1993, for which it estimated
its potential future liability at $2.2 billion. Another action seeks a
judgment that, as a result of an overestimate by the State Board of
Equalization and Assessment, the City's 1992 real estate tax levy
exceeded constitutional limits. In March 1993, the U.S. Supreme Court
ruled that if the last known address of a beneficial owner of accounts
held by banks and brokerage firms cannot be ascertained, unclaimed funds
therein belong to the state of the broker's incorporation rather than
where its principal office is located. New York has obtained about $350
million of abandoned funds that could have to be paid to other States.
It has agreed to pay Delaware $200 million over a five-year period and
other States $100 million over a 10-year period.
Final adverse decisions in any of these cases could require
extraordinary appropriations at either the State or City level or both.
NEW YORK TAXES
In the opinion of Davis Polk & Wardwell, special counsel for the
Sponsors, under existing New York law:
Under the income tax laws of the State and City of New York, the Trust
is not an association taxable as a corporation and income received by
the Trust will be treated as the income of the Holders in the same
manner as for Federal income tax purposes. Accordingly, each Holder
will be considered to have received the interest on his pro rata portion
of each Debt Obligation when interest on the Debt Obligation is received
by the Trust. In the opinion of bond counsel delivered on the date of
issuance of the Debt Obligation, such interest will be exempt from New
York State and City personal income taxes except where such interest is
subject to Federal income taxes (see Taxes). A noncorporate Holder of
Units of the Trust who is a New York State (and City) resident will be
subject to New York State (and City) personal income taxes on any gain
recognized when he disposes of all or part of his pro rata portion of a
Debt Obligation. A noncorporate Holder who is not a New York State
resident will not be subject to New York State or City personal income
taxes on any such gain unless such Units are attributable to a business,
trade, profession or occupation carried on in New York. A New York
State (and City) resident should determine his tax basis for his pro
rata portion of each Debt Obligation for New York State (and City)
income tax purposes in the same manner as for Federal income tax
purposes. Interest income on, as well as any gain recognized on the
disposition of, a Holder's pro rata portion of the Debt Obligations is
generally not excludable from income in computing New York State and
City corporate franchise taxes.
116
<PAGE>
THE NORTH CAROLINA TRUST
RISK FACTORS--See Portfolio for a list of the Debt Obligations
included in the North Carolina Trust. The portions of the following
discussion regarding the financial condition of the State government may
not be relevant to general obligation or revenue bonds issued by
political subdivisions of the State. Those portions and the sections
which follow regarding the economy of the State, are included for the
purpose of providing information about general economic conditions that
may or may not affect issuers of the North Carolina Obligations. None
of the information is relevant to any Puerto Rico or Guam Debt
Obligations which may be included in the Portfolio of the North Carolina
Trust.
General obligations of a city, town or county in North Carolina are
payable from the general revenues of the entity, including ad valorem
tax revenues on property within the jurisdiction. Revenue bonds issued
by North Carolina political subdivisions include (1) revenue bonds
payable exclusively from revenue-producing governmental enterprises and
(2) industrial revenue bonds, college and hospital revenue bonds and
other "private activity bonds" which are essentially non-governmental
debt issues and which are payable exclusively by private entities such
as non-profit organizations and business concerns of all sizes. State
and local governments have no obligation to provide for payment of such
private activity bonds and in many cases would be legally prohibited
from doing so. The value of such private activity bonds may be affected
by a wide variety of factors relevant to particular localities or
industries, including economic developments outside of North Carolina.
Section 23-48 of the North Carolina General Statutes appears to permit
any city, town, school district, county or other taxing district to
avail itself of the provisions of Chapter 9 of the United States
Bankruptcy Code, but only with the consent of the Local Government
Commission of the State and of the holders of such percentage or
percentages of the indebtedness of the issuer as may be required by the
Bankruptcy Code (if any such consent is required). Thus, although
limitations apply, in certain circumstances political subdivisions might
be able to seek the protection of the Bankruptcy Code.
State Budget and Revenues. The North Carolina State Constitution
requires that the total expenditures of the State for the fiscal period
covered by each budget not exceed the total of receipts during the
fiscal period and the surplus remaining in the State Treasury at the
beginning of the period. The State's fiscal year runs from July 1st
through June 30th.
In 1990 and 1991 the State had difficulty meeting its budget
projections. The General Assembly responded by enacting a number of new
taxes and fees, to generate additional revenue and reduce allowable
departmental operating expenditures and continuation funding. The
spending reductions were based on recommendations from the Governor, the
Government Performance Audit Committee and selected reductions
identified by the General Assembly.
The State, like the nation, has experienced economic recovery since
1991. Apparently due to both increased tax and fee revenue and the
previously enacted spending reductions, the State had a budget surplus
of approximately $887 million at the end of fiscal 1993-94. After
review of the 1994-95 continuation budget adopted in 1993, the General
Assembly approved spending expansion funds, in part to restore certain
employee salaries to budgeted levels, which amounts had been deferred to
balance the budgets in 1989-1993, and to authorize funding for new
initiatives for economic development, education, human services and
environmental programs. (The cutback in funding for infrastructure and
social development projects had been cited by agencies rating State
obligations, following the 1991 reductions, as cause for concern about
the long-term consequences of those reductions on the economy of the
State and the State's fiscal prospects).
Based on projected growth in State tax and fee revenues, the General
Fund balance forecast for the end of the 1994-95 fiscal year is
approximately $310 million. It is unclear what effect these
developments may have on the value of the Debt Obligations in the North
Carolina Trust.
117
<PAGE>
The State is subject to claims by classes of plaintiffs asserting a
right to a refund of taxes paid under State statutes that allegedly
discriminated against federal retirees and armed services personnel in a
manner that was unconstitutional based on the decision by the United
States Supreme Court in a 1989 Michigan case involving a similar law,
Davis v. Michigan Department of Treasury ("Davis"). At the time of that
decision, State income tax law exempted retirement income paid by North
Carolina State and local governments but did not exempt retirement
income paid by the federal government to its former employees. Also,
State tax law at the time provided a deduction for certain income earned
by members of the North Carolina National Guard, but did not provide a
similar deduction for members of the federal armed services.
Following the Davis decision the North Carolina legislature amended
the tax laws to provide identical retirement income exclusions for
former state and federal employees (effective for 1989), and repealed
the deduction given to members of the State National Guard. In
addition, the amendments authorized a special tax credit for federal
retirees equal to the taxes paid on their nonexcluded federal pensions
in 1988 (to be taken over a three year period beginning with returns for
1990).
Subsequent to Davis, the North Carolina plaintiffs brought an action
in federal court against the North Carolina Department of Revenue and
certain officials of the State alleging that the collection of the taxes
under the prior North Carolina tax statutes was prohibited by the state
and federal constitutions, and also violated civil rights protections
under 42 U.S.C. Section 1983, a federal statute prohibiting
discriminatory taxation of the compensation of certain federal employees
(4 U.S.C. Section 111), and the principle of intergovernmental tax
immunity. The plaintiffs sought injunctive relief requiring the State
to provide refunds of the illegally collected taxes paid on federal
retirement or military pay for the years 1985-88 (covering the asserted
3 year limitations period), plus interest. Swanson, et al. v. Powers,
et al. (United States District Court for the Eastern District of North
Carolina, No. 89-282-CIV-5-H) ("Swanson Federal"). The individual
plaintiffs in Swanson Federal also brought an action in North Carolina
state court seeking refunds of the illegal taxes. Swanson, et al. v.
State of North Carolina, et al. (Wake County, North Carolina Superior
Court, No. 90 CVS 3127) ("Swanson State").
The amounts claimed by federal retirees in the Swanson actions have
not been precisely calculated. Plaintiffs have asserted that the
plaintiff class contains about 100,000 taxpayers; the State estimated
that as of June 30, 1994 that the claims (including interest) would then
aggregate approximately $280 million.
In 1991, the North Carolina Supreme Court in Swanson State affirmed a
decision in favor of the State, holding that the U.S. Supreme Court
decision in Davis was not to have retroactive effect. Review was
granted by the United States Supreme Court and the case subsequently was
remanded to the North Carolina Supreme Court for reconsideration in
light of the U.S. Supreme Court's 1993 holding in Harper v. Virginia
Dept. of Taxation ("Harper"). In Harper, which also involved the
disparate income tax treatment under Virginia law of retired state and
federal employees and the question of retroactive application of Davis,
the U.S. Supreme Court held that the Commonwealth of Virginia must
provide "meaningful backward-looking relief" to the plaintiffs if the
Commonwealth did not have a predeprivation process adequate to satisfy
due process requirements. The case was remanded to the Supreme Court of
Virginia to determine whether a remedy was required and, if so, what
form it would take.
Similarly, Swanson State was remanded for reconsideration of whether
the North Carolina tax laws satisfied the due process requirements of
the federal constitution and, if not, what remedy was to be provided by
the State.
On remand, the North Carolina Supreme Court held in early 1994 that
the plaintiffs in Swanson State were procedurally barred from recovering
refunds because they did not comply with the
118
<PAGE>
State's statutory
postpayment refund demand procedure. The plaintiffs contended
unsuccessfully that the postpayment demand requirement did not meet the
requirements of the federal constitution, in light of the Harper
decision, for "meaningful backward-looking relief". Plaintiffs in
Swanson State have petitioned the U.S. Supreme Court for review of the
most recent North Carolina Supreme Court decision. In December 1994 the
Court denied certiorari to the Swanson State plaintiffs. At the same
time the Court issued a decision in Reich v. Collins, a Georgia case
involving similar claims, finding for the plaintiff taxpayers, but the
effect of the Reich decision on the claims of the Swanson State
plaintiffs is uncertain. It is yet undetermined whether North Carolina
offers pre-deprivation (payment and protest within a specified time
period) or post-deprivation remedies (tax credits especially tailored to
these claims) adequate to satisfy constitutional requirements, and
plaintiffs in Swanson State have petitioned the North Carolina Supreme
Court for a rehearing of its last decision in the case.
Following Harper, the plaintiffs in Swanson Federal again requested an
injunction requiring refunds. (Although the federal and state cases are
independent, the refund claims apparently would lead to only a single
recovery of taxes deemed unlawfully collected.) In May 1994, the U.S.
District Court granted the State's motion to dismiss all but one claim
made by the plaintiffs, declaring that those claims were precluded by
the 1994 North Carolina Supreme Court decision in Swanson State.
Plaintiffs in Swanson Federal asserted that relief should have been
granted because of the effect of the federal District Court's 1990
opinion in Swanson Federal denying the defendants' motion that the
federal Tax Injunction Act precluded the plaintiffs' claims, in which
the court found that the statutory post-payment remedy for refund of
unlawful taxes was not "plain, speedy and efficient", as required by
that law. Swanson Federal, 1990 WL 545 761 (E.D.N.C.), rev"d, 937 F.2d
965 (1991), cert. denied, U.S. , 112 S. Ct. 871 (1992). In its May
1994 decision, the federal court rejected that assertion and held that
its finding regarding the federal Tax Injuction Act was jurisdictional
only and was not a determination that the statutory remedy violated the
due process clause.
The plaintiffs' claim that was not dismissed with prejudice in the
recent District Court order asserts that the State continued an unlawful
discrimination, contrary to the requirements of 4 U.S.C.
Section 111 and the doctrine of intergovernmental tax immunity, by
increasing benefits to State retirees (in order to offset the effect of
the deletion of the preferential State retirement income exemption) as
part of the bill that equalized the income exclusion for State and
federal retirement payments. The claim is based on a holding of similar
effect in Sheehy v. Public Employees Retirement Div., 864 P. 2d 762
(Mont. 1993). In its May 1994 order, the District Court allowed the
plaintiffs to dismiss the Sheehy claim without prejudice. Therefore,
plaintiffs could assert those claims in another action; apparently, the
relief would require providing federal retirees with tax refunds or
other payments equal to the allegedly discriminatory payments made to
State retirees since 1989. The court noted that those claims will be
subject to the statutory post-deprivation procedural requirements, and
that a challenge to the legality of the remedial statute would be
precluded under the scope of the court's order dismissing the other
claims. However, the court granted plaintiffs' motion to dismiss the
Sheehy claims without prejudice because the record did not show whether
the plaintiffs had complied with the statutory requirements. The
plaintiffs in Swanson Federal have appealed the District Court decision
to the United States Court of Appeals and a hearing is currently
scheduled for March, 1995.
Several states involved in similar suits have reached settlements.
Expressions of interest in settlement of the claims in Swanson by both
the plaintiffs and State officials have been reported in the press, but
no prediction can be made of the likelihood or amount of settlement.
Although the recent improvements in the economy and fiscal condition of
the State might better enable the State to satisfy an adverse decision
without significant consequences to the State's fiscal condition or
governmental functions, because the amount of the potential liability
has not been fixed and because of the potential that adverse fiscal or
economic developments could cause a more negative result on the State if
a large amount must be paid, no assurance can be given that the impact
of the Swanson cases, if the plaintiffs ultimately succeed, will not
have an adverse impact on the Debt Obligations.
119
<PAGE>
State and local government retirees also filed a class action suit in
1990 as a result of the repeal of the income tax exemptions for state
and local government retirement benefits. The original suit was
dismissed after the North Carolina Supreme Court ruled in 1991 that the
plaintiffs had failed to comply with state law requirements for
challenging unconstitutional taxes and the United States Supreme Court
denied review. In 1992, many of the same plaintiffs files a new lawsuit
alleging essentially the same claims, including breach of contract,
unconstitutional impairment of contract rights by the State in taxing
benefits that were allegedly promised to be tax-exempt and violation of
several state constitutional provisions. The North Carolina Attorney
General's Office estimates that the amount in controversy is
approximately $40-$45 million annually for the tax years 1989 through
1992. The case is now pending in state court.
Other litigation against the State include the following. None of the
cases, in the reported opinion of the Department of the Treasurer, would
have a material adverse affect on the State's ability to meet its
obligations.
Leandro et al v. State of North Carolina and State Board of
Education--In May, 1994 students and boards of education in five
counties in the State filed suit in state court requesting a declaration
that the public education system of North Carolina, including its system
of funding, violates the State constitution by failing to provide
adequate or substantially equal educational opportunities and denying
due process of law and violates various statutes relating to public
education. The suit is similar to a number of suits in other states,
some of which resulted in holdings that the respective systems of public
education funding were unconstitutional under the applicable state law.
The defendants in such suit have filed a motion to dismiss, but no
answer to the complaint, and no pretrial discovery has taken place.
Francisco Case--In August, 1994 a class action lawsuit was filed in
state court against the Superintendent of Public Instruction and the
State Board of Education on behalf of a class of parents and their
children who are characterized as limited English proficient. The
complaint alleges that the State has failed to provide funding for the
education of these students and has fail to supervise local school
systems in administering programs for them. The complaint does not
allege an amount in controversy, but asks the Court to order the
defendants to fund a comprehensive program to ensure equal educational
opportunities for children with limited English proficiency.
Faulkenburg v. Teachers' and State Employees' Retirement System, Peele
v. Teachers' and State Employees' Retirement System, and Woodard v.
Local Government Employees' Retirement System. Plaintiffs are
disability retirees who brought class actions in state court challenging
changes in the formula for payment of disability retirement benefits and
claiming impairment of contract rights, breach of fiduciary duty,
violation of other federal constitutional rights, and violation of state
constitutional and statutory rights. The State estimates that the cost
in damages and higher prospective benefit payments to plaintiffs and
class members would probably amount to $50 million or more in
Faulkenburg, $50 million or more in Peele, and $15 million or more in
Woodward, all ultimately payable, at least initially, from the
retirement systems funds. Upon review in Faulkenburg, the North
Carolina Court of Appeals and Supreme Court have held that claims made
in Faulkenburg substantially similar to those in Peele and Woodward, for
breach of fiduciary duty and violation of federal constitutional rights
brought under the federal Civil Rights Act either do not state a cause
of action or are otherwise barred by the statute of limitations. In
1994 plaintiffs took voluntary dismissals of their claims for impairment
of contract rights in violation of the United States Constitution and
filed new actions in federal court asserting the same claims along with
claims for violation of constitutional rights in the taxation of
retirement benefits. The remaining state court claims in all cases are
scheduled to be heard in North Carolina in October, 1994.
Fulton Case--The State's intangible personal property tax levied on
certain shares of stock has been challenged by the plaintiff on grounds
that it violates the Commerce Clause of the United States
120
<PAGE>
Constitution
by discriminating against stock issued by corporations that do all or
part of their business outside the State. The plaintiff seeks to
invalidate the tax in its entirety and to recover tax paid on the value
of its shares in other corporations. The North Carolina Court of
Appeals invalidated the taxable percentage deduction and excised it from
the statue beginning with the 1994 tax year. The effect of this ruling
is to increase collections by rendering all stock taxable on 100% of its
value. The State and the plaintiff have sought further appellate
review, and the case is pending before the North Carolina Supreme Court.
Net collections from the tax for the fiscal year ended June 30, 1993
amounted to $120.6 million.
General. The population of the State has increased 13% from 1980,
from 5,880,095 to 6,647,351 as reported by the 1990 federal census and
the State rose from twelfth to tenth in population. The State's
estimate of population as of June 30, 1994 is 7, 023,663.
Notwithstanding its rank in population size, North Carolina is primarily
a rural state, having only five municipalities with populations in
excess of 100,000. The labor force has undergone significant change
during recent years as the State has moved from an agricultural to a
service and goods producing economy. Those persons displaced by farm
mechanization and farm consolidations have, in large measure, sought and
found employment in other pursuits. Due to the wide dispersion of
non-agricultural employment, the people have been able to maintain, to a
large extent, their rural habitation practices. During the period 1980
to 1994, the State labor force grew about 25% (from 2,855,200 to
3,560,000). Per capita income during the period 1980 to 1993 grew from
$7,999 to $18,702, an increase of 133.8%.
The current economic profile of the State consists of a combination of
industry, agriculture and tourism. As of June 1994, the State was
reported to rank tenth among the states in non-agricultural employment
and eighth in manufacturing employment. Employment indicators have
varied somewhat in the annual periods since June of 1990, but have
demonstrated an upward trend since 1991. The following table reflects
the fluctuations in certain key employment categories.
Category (all seasonally adjusted)
June 1990
June 1991
June 1992June 1993June 1994
Civilian Labor Force 3,312,000
3,228,000
3,495,0003,504,0003,560,000
NonagriculturalEmployment 3,129,000
3,059,000
3,135,0003,203,4003,358,700
Goods Producing Occupations
(mining, construction and
manufacturing) 1,023,100973,600 980,800 993,601,021,500
Service Occupations 2,106,300
2,085,400
2,154,2002,209,8002,337,200
Wholesale/Retail Occupations 732,500704,100 715,100 723,200 749,000
Government Employees 496,400496,700 513,400 515,400 554,600
Miscellaneous Services 587,300596,300 638,300 676,900 731,900
Agricultural Employment 58,900 88,700 102,800 88,400 53,000
The seasonally adjusted unemployment rate in January 1995 was 3.8% of
the labor force (down from 4.0% in January 1994), as compared with 5.7%
nationwide (down from 6.7% in January 1994).
As of 1993, the State was tenth in the nation in gross agricultural
income, of which nearly the entire amount (approximately $5.3 billion)
was from commodities. According to the State Commissioner of
Agriculture, in 1993 the State ranked first in the nation in the
production of flue-cured tobacco, total tabacco, turkeys and sweet
potatoes; second in the value of poultry and eggs, hog production, trout
and the production of cucumbers for pickles and in trout production;
fourth in commercial broilers, blueberries and peanuts; sixth in burley
tobacco and net farm income.
The diversity of agriculture in North Carolina and a continuing push
in marketing efforts have protected farm income from some of the wide
variations that have been experienced in other states
121
<PAGE>
where most of the
agricultural economy is dependent on a small number of agricultural
commodities. North Carolina is the third most diversified agricultural
state in the nation.
Tobacco production is the leading source of agricultural income in the
State, accounting for 20% of gross agricultural income. Tobacco farming
in North Carolina has been and is expected to continue to be affected by
major Federal legislation and regulatory measures regarding tobacco
production and marketing and by international competition. Measures
adverse to tobacco farming could have negative effects on farm income
and the North Carolina economy generally. The poultry industry provides
nearly 34% of gross agricultural income. The pork industry has been
expanding and accounted for 17% of gross agricultural income in 1993.
The number of farms has been decreasing; in 1994 there were
approximately 58,000 farms in the State (down from approximately 72,000
in 1987, a decrease of about 19% in seven years). However, a strong
agribusiness sector supports farmers with farm inputs (fertilizer,
insecticide, pesticide and farm machinery) and processing of commodities
produced by farmers (vegetable canning and cigarette manufacturing).
The State Department of Commerce, Travel and Tourism Division,
statistics office, reports that in 1993 approximately $8.3 billion was
spent on tourism in the State. The Department estimates that two-thirds
of total expenditures came from out-of-state travelers and that
approximately 250,000 people were employed in tourism-related jobs.
Bond Ratings. Currently, Moody's rates North Carolina general
obligation bonds as Aaa and Standard & Poor's rates such bonds as AAA.
Standard & Poor's also reaffirmed its stable outlook for the State in
January 1994.
Standard & Poor's reports that North Carolina's rating reflects the
State's strong economic characteristics, sound financial performances,
and low debt levels.
The Sponsor believes the information summarized above describes some
of the more significant events relating to the North Carolina Trust.
The sources of this information are the official statements of issuers
located in North Carolina, State agencies, publicly available documents,
publications of rating agencies and statements by, or news reports of
statements by State officials and employees and by rating agencies. The
Sponsor and its counsel have not independently verified any of the
information contained in the official statements and other sources and
counsel have not expressed any opinion regarding the completeness or
materiality of any matters contained in this Prospectus other than the
tax opinions set forth below under North Carolina Taxes.
NORTH CAROLINA TAXES
In the opinion of Hunton & Williams, Raleigh, North Carolina, special
counsel on North Carolina tax matters, under existing North Carolina
law:
Upon the establishing of the North Carolina Trust and the Units
thereunder:
1. The North Carolina Trust is not an "association" taxable as a
corporation under North Carolina law with the result that income of the
North Carolina Trust will be deemed to be income of the Holders.
2. Interest on the Debt Obligations that is exempt from North
Carolina income tax when received by the North Carolina Trust will
retain its tax-exempt status when received by the Holders.
122
<PAGE>
3. Holders will realize a taxable event when the North Carolina Trust
disposes of a Debt Obligation (whether by sale, exchange, redemption or
payment at maturity) or when a Holder redeems or sells his Units (or any
of them), and taxable gains for Federal income tax purposes may result
in gain taxable as ordinary income for North Carolina income tax
purposes. However, when a Debt Obligation has been issued under an act
of the North Carolina General Assembly that provides that all income
from such Debt Obligation, including any profit made from the sale
thereof, shall be free from all taxation by the State of North Carolina,
any such profit received by the North Carolina Trust will retain its
tax-exempt status in the hands of the Holders.
4. Holders must amortize their proportionate shares of any premium on
a Debt Obligation. Amortization for each taxable year is achieved by
lowering the Holder's basis (as adjusted) in his Units, with no
deduction against gross income for the year.
5. In order for the Units to be exempt from the North Carolina tax on
intangible personal property: (a) at all times either (i) the corpus of
the North Carolina Trust must be composed entirely of North Carolina
Debt Obligations or, pending distribution, amounts received on the sale,
redemption or maturity of the North Carolina Debt Obligations, or (ii)
(if Puerto Rico or Guam Debt Obligations are included in the North
Carolina Trust) at least 80% of the fair market value of the Debt
Obligations, excluding amounts received on the sale, redemption or
maturity of the Debt Obligations, must be attributable to the fair
market value of the North Carolina Debt Obligations; and (b) the Trustee
periodically must supply to the North Carolina Department of Revenue at
such times as required by the Department of Revenue a complete
description of the North Carolina Trust and also the name, description
and value of the obligations held in the corpus of the North Carolina
Trust.
The opinion of Hunton & Williams is based, in part, on the opinion of
Davis Polk & Wardwell regarding Federal tax status and upon current
interpretations and rulings of the North Carolina Department of Revenue,
which are subject to change.
THE OHIO TRUST
RISK FACTORS--The following summary is based on publicly available
information which has not been independently verified by the Sponsors or
their legal counsel.
Employment and Economy. Economic activity in Ohio, as in many other
industrially developed states, tends to be more cyclical than in some
other states and in the nation as a whole. Ohio ranked third in the
nation in 1990 gross state product derived from manufacturing. Although
manufacturing (including auto-related manufacturing) remains an
important part of Ohio's economy, the greatest growth in employment in
Ohio in recent years, consistent with national trends, has been in the
non-manufacturing area. Payroll employment in Ohio showed a steady
upward trend until 1979, then decreased until 1982. It peaked in the
summer of 1993 after a slight decrease in 1992, and then decreased
slightly but, as of January 27, 1995, it has approached a new high.
Growth in recent years has been concentrated among non-manufacturing
industries, with manufacturing tapering off since its 1969 peak.
Approximately 78% of the payroll workers in Ohio are employed by
non-manufacturing industries.
The average monthly unemployment rate in Ohio was 4.2% in December,
1994.
With 15.2 million acres in farm land, agriculture is a very important
segment of the economy in Ohio, providing an estimated 750,000 jobs or
approximately 15.9% of total Ohio employment. By many measures,
agriculture is Ohio's leading industry contributing nearly $5.7 billion
to the state's economy each year.
123
<PAGE>
Ohio continues to be a major "headquarters" state. Of the top 500
industrial corporations (based on 1993 sales) as reported in 1994 by
Fortune magazine, 42 had headquarters in Ohio, placing Ohio fourth as a
"headquarters" state for industrial corporations. Ohio is tied for
fifth as a "headquarters" state for service corporations (24 of the top
500).
The State Budget, Revenues and Expenditures and Cash Flow. Ohio law
effectively precludes the State from ending a fiscal year or a biennium
with a deficit. The State Constitution provides that no appropriation
may be made for more than two years and consistent with that provision
the State operates on a fiscal biennium basis. The current fiscal
biennium runs from July 1, 1993 through June 30, 1995.
Under Ohio law, if the Governor ascertains that the available revenue
receipts and balances for the general revenue fund or other funds for
the then current fiscal year will probably be less than the
appropriations for the year, he must issue orders to the State agencies
to prevent their expenditures and obligations from exceeding the
anticipated receipts and balances. The Governor implemented this
directive in some prior years, including fiscal years 1992 and 1993.
Consistent with national economic conditions, in the 1990-91 biennium,
Ohio experienced an economic slowdown producing some significant changes
in certain general revenue fund revenue and expenditure levels for the
fiscal year 1991. Examples on the revenue side included lower than
previously forecasted revenues from sales and use taxes (including auto)
and corporate franchise and personal income taxes. Increased human
services expenditure requirements developed, such as for Medicaid, Aid
to Dependent Children and general assistance. Several executive and
legislative measures were taken to address the anticipated shortfall in
revenues and increase in expenditures. As a result, the Ohio Office of
Budget and Management (the "OBM") reported a positive general revenue
fund balance of approximately $135.4 million at the end of fiscal year
1991.
State and national fiscal uncertainties during the 1992-93 biennium
required several actions to achieve the ultimate positive general
revenue fund ending balances. OBM projected a fiscal year 1992
imbalance--a receipts shortfall resulting primarily from lower
collection of certain taxes, particularly sales, use and personal income
tax and higher expenditure levels in certain areas, particularly human
services including Medicaid. As an initial action, the Governor ordered
most state agencies to reduce general revenue fund appropriation
spending in the final six months of fiscal year 1992 by a total of
approximately $184 million. Debt service obligations were not affected
by this order. The General Assembly authorized, and the OBM made in
June 1992, a $100.4 million transfer to the general revenue fund from
the budget stabilization fund and certain other funds. Other revenue
and spending actions, legislative and administrative, resolved the
remaining general revenue fund imbalance for fiscal year 1992.
As a first step toward addressing a $520 million general revenue fund
shortfall for fiscal year 1993 then estimated by OBM, the Governor
ordered, effective July 1, 1992, selected general revenue fund
appropriations reductions totalling $300 million (but such reductions
did not include debt service). Subsequent executive and legislative
actions provided for positive biennium-ending general revenue fund
balances for the current biennium. The general revenue fund ended the
1992-93 biennium with a fund balance of approximately $111 million and a
cash balance of approximately $394 million. The general revenue fund
appropriations bill for the current biennium was passed on June 30,
1993. The first year of the current biennium, fiscal year 1994, ended
with a general revenue fund of over $560 million.
Because the schedule of general revenue fund cash receipts and
disbursements do not precisely coincide, temporary general revenue fund
cash flow deficiencies often occur in some months of a fiscal year,
particularly in the middle months. Statutory provisions provide for
effective management of these temporary cash flow deficiencies by
permitting adjustment of payment schedules and the use of total
124
<PAGE>
operating funds. A general revenue fund cash flow deficiency occurred
in two months of fiscal year 1990, with the highest being approximately
$252.4 million. In fiscal year 1991, there were general revenue fund
cash flow deficiencies in nine months, with the highest being $582.5
million; in fiscal year 1992 there were general revenue fund cash flow
deficiencies in ten months, with the highest being approximately $743.1
million. In fiscal year 1993, general revenue fund cash flow
deficiencies occurred in August 1992 through May 1993, with the highest
being approximately $768.6 million in December. General revenue fund
cash flow deficiencies occurred in six months of fiscal year 1994, with
the highest being approximately $500.6 million. In the first six months
of fiscal year 1995, a general revenue fund cash flow deficiency
occurred in four months with the highest being approximately $338
million in November 1994. OBM currently projects cash flow deficiencies
in eight months of the current fiscal year.
State and State Agency Debt. The Ohio Constitution prohibits the
incurrence or assumption of debt by the State without a popular vote
except for the incurrence of debt to cover causal deficits or failures
in revenue or to meet expenses not otherwise provided for which are
limited to $750,000 and to repel invasions, suppress insurrection or
defend the State in war. Under interpretations by Ohio courts, revenue
bonds of the State and State agencies that are payable from net revenues
of or related to revenue producing facilities or categories of such
facilities are not considered "debt" within the meaning of these
constitutional provisions.
At various times since 1921, Ohio voters, by thirteen specific
constitutional amendments (the last adopted in 1993), authorized the
incurrence of up to $4.864 billion in State debt to which taxes or
excises were pledged for payment. Of that amount, $715 million was for
veterans" bonuses. As of January 27, 1995, of the total amount
authorized by the voters, excluding highway obligations and general
obligation park bonds discussed below, approximately $3.375 billion has
been issued, of which approximately $2.581 billion has been retired and
approximately $794.4 million remains outstanding. The only such State
debt still authorized to be incurred are portions of the Highway
Obligation Bonds, the Coal Development Bonds, and the general obligation
bonds for local government infrastructure projects and parks.
No more than $500 million in state highway obligations may be
outstanding at any time. As of January 27, 1995, approximately $446.3
million of highway obligations were outstanding. No more than $100
million in State obligations for coal development may be outstanding at
any one time. As of January 27, 1995, approximately $38.9 million of
such bonds were outstanding. Not more than $1.2 billion of State
general obligation bonds to finance local capital infrastructure
improvements may be issued at any one time, and no more than $120
million can be issued in a calendar year. As of January 27, 1995,
approximately $722.3 million of those bonds were outstanding. The
General Assembly has appropriated sufficient moneys to meet debt service
requirements for the current biennium on all obligations.
The Ohio Constitution authorizes State bonds for certain housing
purposes, but tax moneys may not be obligated or pledged to those bonds.
In addition, the Ohio Constitution authorizes the issuance of
obligations of the State for certain purposes, the owners or holders of
which are not given the right to have excises or taxes levied by the
State legislature to pay principal and interest. Such debt obligations
include the bonds and notes issued by the Ohio Public Facilities
Commission, the Ohio Building Authority and the Treasurer of State.
The general capital appropriations act for the 1995-96 capital
appropriations biennium authorized additional borrowing by the State.
Further, under recent legislation, the State has been authorized to
issue bonds to finance approximately $138.7 million of capital
improvements for local elementary and secondary public school
facilities, and the State building authority has been authorized to
issue $100 million of bonds to provide computer technology and security
systems for local school districts. Debt service on the obligations is
payable from State resources.
125
<PAGE>
A statewide economic development program assists with loans and loan
guarantees, and the financing of facilities for industry, commerce,
research and distribution. The law authorizes the issuance of State
bonds and loan guarantees secured by a pledge of portions of the State
profits from liquor sales. The General Assembly has authorized the
issuance of these bonds by the State Treasurer, with a maximum amount of
$300 million, subject to certain adjustments, currently authorized to be
outstanding at any one time. Of an approximate $148.0 million issue in
1989, approximately $83.2 million is outstanding. The highest future
year annual debt service on those 1989 bonds, which are payable through
2000, is approximately $18.3 million.
An amendment to the Ohio Constitution authorizes revenue bond
financing for certain single and multifamily housing. No State
resources are to be used for the financing. As of February 6, 1995, the
Ohio Housing Financing Agency, pursuant to that constitutional amendment
and implementing legislation, had sold revenue bonds in the aggregate
principal amount of approximately $234.32 million for multifamily
housing and approximately $3.926 billion for single family housing.
A constitutional amendment adopted in 1990 authorizes greater State
and political subdivision participation in the provision of housing for
individuals and families in order to supplement existing State housing
assistance programs. The General Assembly could authorize State
borrowing for the new programs and the issuance of State obligations
secured by a pledge of all or a portion of State revenues or receipts,
although the obligations may not be supported by the State's full faith
and credit. Also, a constitutional amendment approved in November 1994
pledges the full faith and credit and taxing power of the State to meet
certain guarantees under the State's tuition credit program. Under the
amendment, to secure the tuition guarantees, the General Assembly is
required to appropriate moneys sufficient to offset any deficiency that
may occur from time to time in the trust fund that provides for the
guarantee and at any time necessary to make payment of the full amount
of any tuition payment or refund required by a tuition payment contract.
A 1986 act, amended in 1994 (the "Rail Act"), authorizes the Ohio Rail
Development Commission (the "Rail Commission") to issue obligations to
finance the costs of rail service projects within the State either
directly or by loans to other entities. The Rail Commission has
considered financing plan options and the possibility of issuing bonds
or notes. The Rail Act prohibits, without express approval by joint
resolution of the General Assembly, the collapse of any escrow of
financing proceeds for any purpose other than payment of the original
financing, the substitution of any other security, and the application
of any proceeds to loans or grants. The Rail Act authorizes the Rail
Commission, but only with subsequent General Assembly action, to pledge
the full faith and credit of the State but not the State's power to levy
and collect taxes (except ad valorem property taxes if subsequently
authorized by the General Assembly) to secure debt service on any
post-escrow obligations and, provided it obtains the annual consent of
the State Controlling Board, to pledge to and use for the payment of
debt service on any such obligations, all excises, fees, fines and
forfeitures and other revenues (except highway receipts) of the State
after provision for the payment of certain other obligations of the
State.
Schools and Municipalities. The 612 public school districts and 49
joint vocational school districts in the State receive a major portion
(approximately 46%) of their operating funds from State subsidy
appropriations, the primary portion known as the Foundation Program.
They also must rely heavily upon receipts from locally-voted taxes.
Some school districts in recent years have experienced varying degrees
of difficulty in meeting mandatory and discretionary increased costs.
Current law prohibits school closings for financial reasons.
Original State appropriations for the 1992-93 biennium provided for an
increase in school funding over funding for the preceding biennium. The
reduction in appropriations spending for fiscal year 1992 included a
2.5% overall reduction in the annual Foundation Program appropriations
and a 6% reduction in other primary and secondary education programs.
The reductions were in varying
126
<PAGE>
amounts, and had varying effects, with
respect to individual school districts. State appropriations for the
current biennium provide for an increase in State school funding
appropriations over those in the preceding biennium. The $8.9 billion
appropriated for primary and secondary education is intended to provide
for 2.4% and 4.6% increases in basic aid for the two fiscal years of the
biennium.
In previous years school districts facing deficits at year end had to
apply to the State for a loan from the Emergency School Advancement
Fund. This Fund met all the needs of the school districts with
potential deficits in fiscal years 1979 through 1989. New legislation
replaced the Fund with enhanced provisions for individual district local
borrowing, including direct application of Foundation Program
distributions to repayment if needed. As of fiscal year 1993, there
were 27 loans made for an approximate aggregate amount of $94.5 million.
Twenty-eight school districts received loans totalling approximately
$41.1 million in fiscal year 1994. As of January 27, 1995, in fiscal
year 1995, six districts have received approvals for loans totaling
approximately $17.5 million.
Litigation contesting the Ohio system of school funding is pending
with defendants being the State and several State agencies and
officials. The complaints essentially request a declaratory judgment
that the State's statutory system of funding public elementary and
secondary education violates various provisions of the Ohio Constitution
and request the State to devise a constitutionally acceptable system of
school funding. On July 1, 1994, the trial court concluded that certain
provisions of current law violated provisions of the Ohio constitution.
The trial court directed the State to provide for and fund a system of
funding public elementary and secondary education in compliance with the
Ohio Constitution. Defendants have appealed this ruling, and have
applied for a stay until the case is resolved on appeal. On November
14, 1994, the trial court granted a stay of its findings and
conclusions, and certain of its orders. It is not possible at this time
to state whether the suit will be successful or, if plaintiffs should
prevail, the effect on the State's present school funding system,
including the amount of and criteria for State basic aid allocations to
school districts.
Various Ohio municipalities have experienced fiscal difficulties. Due
to these difficulties, the State established an act in 1979 to identify
and assist cities and villages experiencing defined "fiscal
emergencies". A commission appointed by the Governor monitors the
fiscal affairs of municipalities facing substantial financial problems.
To date, this act has been applied to eleven cities and twelve villages.
The situations in nine of the cities and nine of the villages have been
resolved and their commissions terminated.
State Employees and Retirement Systems. The State has established
five public retirement systems, three of which cover both State and
local government employees, one covers State government employees only,
and one covers local government employees only. Those systems provide
retirement, disability retirement and survivor benefits. Federal law
requires newly-hired State employees to participate in the federal
Medicare program, requiring matching employer and employee
contributions, each now 1.45% of the wage base. Otherwise, State
employees covered by a State retirement system are not currently covered
under the federal Social Security Act. The actuarial evaluations
reported by these five systems showed aggregate unfunded accrued
liabilities of approximately $16,801 billion covering both State and
local employees.
The State engages in employee collective bargaining and currently
operates under staggered two-year agreements with all of its 21
bargaining units. The State has a new agreement, expiring March 31,
1997, with its largest bargaining unit representing approximately 37,000
employees. The remaining bargaining units have entered into new
agreements with the State which expire at various times in
Health Care Facilities Debt. Revenue bonds are issued by Ohio
counties and other agencies to finance hospitals and other health care
facilities. The revenues of such facilities consist, in varying but
typically material amounts, of payment from insurers and third-party
reimbursement programs, such as
127
<PAGE>
Medicaid, Medicare and Blue Cross.
Consistent with the national trend, third-party reimbursement programs
in Ohio have begun new programs, and modified benefits, with a goal of
reducing usage of health care facilities. In addition, the number of
alternative health care delivery systems in Ohio has increased over the
past several years. For example, the number of health maintenance
organizations licensed by the Ohio Department of Insurance increased
from 12 on February 14, 1983 to 31 as of February 6, 1994. Due in part
to changes in the third-party reimbursement programs and an increase in
alternative delivery systems, the health care industry in Ohio has
become more competitive. This increased competition may adversely
affect the ability of health care facilities in Ohio to make timely
payments of interest and principal on the indebtedness.
OHIO TAXES
In the opinion of Vorys, Sater, Seymour and Pease, Columbus, Ohio,
special counsel on Ohio tax matters, under existing Ohio law:
The Ohio Trust is not an association subject to the Ohio corporation
franchise tax or the Ohio tax on dealers in intangibles and the Trustees
will not be subject to the Ohio personal income tax.
In calculating a Holder's Ohio personal income tax or the Ohio
corporation franchise tax, a Holder will not be required to include in
the Holder's "adjusted gross income" or "net income," as the case may
be, the Holder's share of interest received by or distributed from the
Ohio Trust on any Debt Obligation in the Ohio Trust, the interest on
which is exempt from Ohio personal income or corporation franchise
taxes, as the case may be.
In calculating a Holder's Ohio personal income tax or the Ohio
corporation franchise tax, a Holder will be required to include in the
Holder's "adjusted gross income" or "net income," as the case may be,
capital gains and losses which the Holder must recognize for Federal
income tax purposes (upon the sale or other disposition of Units by the
Holder or upon the sale or other disposition of Debt Obligations by the
Ohio Trust), except gains and losses attributable to Debt Obligations
specifically exempted from such taxation by the Ohio law authorizing
their issuance. A Holder subject to the Ohio corporation franchise tax
may, in the alternative if it results in a larger amount of tax payable,
be taxed upon its net worth and, for this purpose, is required to
include in its net worth the full value, as shown on the books of the
corporation, of all Units which it owns.
For purposes of Ohio municipal income taxation, the Holder's share of
interest received by or distributed from the Ohio Trust on Debt
Obligations or gains realized by the Holder from the sale, exchange or
other disposition of Units by the Holder or from the sale, exchange or
other disposition of Debt Obligations by the Ohio Trust, as a result of
the repeal of the Ohio tax on intangible personal property, might be
required to be included in a Holder's taxable income if (1) such
interest or gain is not exempt from Ohio municipal income taxes by
virtue of a specific statutory or constitutional exemption from such
taxes (regarding which no blanket opinion is being given), and (2) the
Ohio municipality in which the Holder resides was taxing such income on
or before April 1, 1986 and such tax was submitted to and approved by
the voters of such municipality in an election held on November 8, 1988.
Assuming that the Ohio Trust will not hold any tangible personal
property nor any real property, neither Debt Obligations held by the
Ohio Trust nor Units of the Ohio Trust held by individuals are subject
to any property tax levied by the State of Ohio or any political
subdivision thereof.
128
<PAGE>
THE OREGON TRUST
RISK FACTORS--Introduction. Oregon's public finances were
dramatically altered in November 1990 by the adoption of Ballot Measure
No. 5 by the voters of the State of Oregon. The Measure, which amended
the Oregon Constitution by the addition of a new Article XI, Section
11b, limited property taxes for non-school government operations to $10
per $1,000 of real market value beginning in the 1991-92 fiscal year.
Property taxes for school operations were limited to $15 per $1,000 of
real market value in the 1991-92 fiscal year, while ultimately declining
to $5 per $1,000 of real market value in the 1995-96 fiscal year. The
Measure also required the State of Oregon to use the State General Fund
revenues to pay school districts replacement dollars through the 1995-96
fiscal year for most of the revenues lost by the school districts
because of the Measure's limitations on their tax levies.
The State Legislative Revenue Office reports that, as a result of
Ballot Measure No. 5, non-school districts lost approximately $59.0
million of revenues during the 1993-95 fiscal biennium, and school
districts lost $1.604 billion of tax revenues in the 1993-95 fiscal
biennium.
The Measure contains many confusing and ill-defined terms, which may
ultimately be resolved by litigation in Oregon courts. In an attempt to
define some of these terms, and to provide guidance to Oregon
municipalities, the 1991 Oregon Legislature approved a comprehensive
revision of the statutes applicable to the issuance of municipal debt in
Oregon. A section of the 1991 legislation, which excluded tax increment
financing for urban renewal bonds indebtedness from the limits of Ballot
Measure No. 5, was declared invalid by the Oregon Supreme Court in
September, 1992. The Court, which affirmed an earlier ruling of the
Oregon Tax Court, determined that tax increment financing plans imposed
a "tax" on property subject to the limitations of Ballot Measure No. 5.
A proposed State constitutional amendment which would have revalidated
tax increment financing was referred to the Oregon voters in May 1993
and rejected. The City of Portland has outstanding $89 million in
principal amount of urban renewal bonds. The Portland City Council has
committed the City to honor the payment of the urban renewal bonds from
alternative sources.
The Measure defines the term "tax" as "any charge imposed by a
governmental unit upon property or upon a property owner as a direct
consequence of ownership of that property," excepting only from that
definition "incurred charges and assessments for local improvements."
All Oregon issuers are required to analyze the charges they assess to
determine if they constitute "taxes," which are then limited by the
constraints of the Measure. Moreover, debt service payments for revenue
and special assessment bonds are required to be reviewed in the light of
the Measure to determine if the charges made by the municipal issuer for
these debt service payments will constitute "taxes" limited by the
Measure. The comprehensive legislative revision of Oregon municipal
debt contains statutory guidelines to assist a municipality in
determining if the charges assessed are "taxes" limited under the
Measure.
Debt service on bonded indebtedness may be adversely affected by
Ballot Measure No. 5 if the tax levied to provide funds for the
servicing of the debt will be included in the calculation of the maximum
permitted tax levy under the Measure. Taxes levied to pay for bonded
debt will generally be included in the limitations prescribed by the
Measure, unless
* The bonded indebtedness was specifically authorized by the Oregon
Constitution (as, for example, the Oregon Veterans' Bonds), or
* (i) The bonded indebtedness was incurred or will be incurred "for
capital construction or improvements," (ii) the bonds issued for the
capital construction or improvements are general obligation bonds, and
(iii) the bonds were either issued before November 6, 1990, or, if
issued after that date, were approved by the electors of the issuer.
129
<PAGE>
To provide for this limitation on the authority to tax, the Oregon
legislation creates two classifications of bonds secured by the taxing
authority of a municipal issuer: "general obligation bonds," which are
bonds secured by an authority to tax unlimited by the Measure, and
"limited tax bonds," which are bonds secured by an authority to levy
taxes only within the overall limits imposed on a municipal issuer by
the Measure.
Fiscal Matters. The State's Department of Administrative Services
reports that Oregon's economy is expected to slow along with the
national economy in 1995. Higher costs caused by labor shortages and
rising interest rates are expected to moderate the pace of economic
activity in 1995 and 1996. The Department has indicated than another
factor slowing the State's economy is the resumption of declining
activity in the timber industry. According to the Department, lumber
prices have peaked, and industry employment is expected to decrease.
The Department projects that despite the expectation of slower growth,
continuing strength in high technology manufacturing, rising exports and
a steady stream of new residents will cause Oregon income and jobs to
remain above the national average through 1996.
The Department of Services projects, that wage and salary employment
will increase 2.7% in 1995, down from an estimated 3.0% in 1994. The
Department projects that employment growth will slow further to 2% in
1996. The Department projects that Oregon wage and salary income growth
will increase 6.7% in 1995 and 5.6% in 1996 and also projects new jobs
to increase by 35,800 in 1995, compared to 39,800 in 1994. The
Department reports that personal income is projected to increase 7.4% in
1994, the highest growth rate since 1990. The Department projects that
personal income growth will slow to 6.4% in 1995 and 5.8% in 1996.
The Department of Administrative Services expects that the flow of
people moving to Oregon from other states will remain a major
stimulative force for the State economy. The Department projects that
Oregon's population will increase by 61,000 in 1995 and 52,000 in 1996.
A modest deceleration in the rate of migration is anticipated by the
Department due to its assumptions regarding economic recovery in
California.
The Oregon Constitution requires that the State budget be balanced
during each fiscal biennium. Should the State experience budgetary
difficulties similar to the effects of the national recession on Oregon
during the first half of the 1980's, the State, its agencies, local
units of government, schools and private organizations which depend on
State revenues and appropriations for both operating funds and debt
service could be required to expand revenue sources or curtail certain
services or operations in order to meet payments on their obligations.
To the extent any difficulties in making payments are perceived, the
market value and marketability of outstanding debt obligations in the
Oregon Trust, the asset value of the Oregon Trust and interest income to
the Oregon Trust could be adversely affected.
The budget for the 1993-95 biennium includes a General Fund budget of
$6.399 billion, representing an increase of 16.2% over 1991-93
expenditures. Total appropriations for all funds in the 1993-95 budget
are $20.013 billion, representing an increase of 13.6% over the 1991-93
expenditures. This total includes, in addition to the General Fund,
$10.243 billion in Other Funds and $3.370 billion in Federal Funds.
The obligation of the State under Ballot Measure No. 5 to replace most
of the lost revenues of school districts has had an adverse effect on
the State's General Fund. These replacement dollars are estimated by
the State Legislative Revenue Office to total $462.0 million during the
1991-93 fiscal biennium, $1.499 billion during the 1993-95 biennium, and
$2.718 billion during the 1995-96 fiscal year. Under Ballot Measure No.
5, the State's obligation to replace school revenues terminates after
fiscal year 1995-96.
130
<PAGE>
Debt Obligations. The State of Oregon issued $391.1 million in bonds,
notes and certificates of participation ("COPs") during the fiscal year
ended June 30, 1994, an increase of 9.6% from the $357.0 million in
bonds, notes and COPs issued in the fiscal year ended June 30, 1993. Of
the fiscal year 1993-94 total, $147.9 million were general obligations,
$208.7 million were revenue obligations, and $34.5 million were COPs.
During fiscal year 1993-94, local Oregon governments issued
approximately $1.395 billion in debt, a decrease of approximately 14.2%
from the fiscal year 1992-93 issuances of $1.625 billion.
The State of Oregon had outstanding $4.411 billion in general
obligations at December 31, 1994 representing a decrease of 6.4% from
the total outstanding general obligations of $4.713 billion at December
31, 1993. Oregon local governments had $6.468 billion in total debt
outstanding at December 31, 1994, representing an increase of 19.1% from
the total outstanding of $5.432 billion at December 31, 1993.
Veterans' Bond Program. At December 31, 1994, the State of Oregon had
outstanding approximately $3.491 billion of Oregon Veterans' Welfare
Bonds and Notes, representing a decrease of 9.8 percent from the total
outstanding of $3.871 billion at December 31, 1993. The Veterans' Bonds
and Notes are utilized to finance the veterans" mortgage loan program,
administered by the Oregon Department of Veterans' Affairs. The
Veterans' Bonds and Notes are general obligations of the State of
Oregon.
In June 1988 the Oregon Attorney General issued an opinion relating to
periodic transfers dating back to 1951 of surplus monies from the Oregon
War Veterans' Fund to the State's General Fund. The Oregon War
Veterans' Fund, created in 1945 to provide home and farm loans to
veterans, also provides funding for specifically enumerated veterans and
veterans" organizations. The Attorney General opined that the State was
obligated to return the amounts transferred, with interest. The Oregon
Legislature acted on the matter during the 1989 legislative term,
appropriating $77.2 million to the Oregon War Veterans' Fund from the
General Fund. Of the amount appropriated, $58.9 million was transferred
on July 1, 1989, and the balance was transferred in 1990. As a result
of these cash transfers, as well as lower than expected defaults and
other changes in the assumptions underlying the forecasting model of the
Department of Veterans' Affairs, the Department has eliminated its
earlier projected deficits for the Veterans' Bond program's sinking
fund.
These earlier revenue shortfalls and projected deficits in the
Veterans' Bond program had an initial adverse effect on the ratings of
all Oregon general obligation bonds. Standard & Poor's increased its
rating on Oregon general obligations from A+ to AA-, however, after
reviewing the 1989 transfer of monies from the State's General Fund to
the Oregon War Veterans' Fund. Similarly, the Moody's rating of the
State's outstanding general obligation bonds was increased from A1 to Aa
in January 1990.
Taxes and Other Revenues. The State relies heavily on the personal
income tax. The personal income tax generated $4.562 billion of the
total 1991-93 biennium General Fund revenues of $5.477 billion. The
State's Department of Revenue estimates that the personal income tax
will generate $5.346 billion of the total General Fund revenues of
$6.480 billion projected for the 1993-95 biennium. The State corporate
income and excise tax generated $354.9 million in revenues during the
1991-93 biennium, and is projected by the Department of Revenue to
generate $539.5 million in revenues during the 1993-95 biennium.
Revenues generated by the State lottery are currently dedicated to
economic development. State lottery officials report that revenues
generated from the regular lottery sales for the 1993-94 fiscal year
totaled $288.4 million, with $70.7 million of that amount having been
made available to fund economic development in the State. State lottery
officials also report that the State's video poker program, which
commenced operation in March 1992, generated revenues of $247.0 million
during the
131
<PAGE>
1993-94 fiscal year, with $111.2 million of that amount being
made available to fund economic development in the State. State lottery
officials currently forecast $346.3 million from regular lottery sales
and $316.9 million from video poker sales for the 1994-95 fiscal year,
with $80.9 million and $181.4 million of those amounts, respectively,
projected to be available to fund economic development in the State.
State lottery officials project that revenues for the 1995-1997 biennium
from regular lottery sales will be $656.0 million and from video poker
sales will be $848.2 million, with $152.3 million and $467.1 million of
those amounts, respectively, projected to be available to fund economic
development in the State.
Under existing state tax programs, if the actual corporate income and
excise taxes received by the State in a fiscal biennium exceed by two
percent or more the amount estimated to be received from such taxes for
the biennium, the excess must be refunded as a credit to corporate
income and excise taxpayers in a method prescribed by statute.
Similarly, if General Fund revenue sources (other than corporate income
and excise taxes) received in the biennium exceed by two percent or more
the amount estimated to be received from such sources during the
biennium, the excess must be refunded as a credit to personal income
taxpayers.
Authority to levy property taxes is presently vested with the
governing body of each local government unit. In addition to the
restrictions of Ballot Measure No. 5, other constitutional and statutory
provisions exist which limit the amount that a governing body may levy:
1. Levy Within 6 Percent Limitation (Tax Base Levy). A tax base,
approved by a majority of voters at a statewide general or primary
election, represents permanent authority to annually levy a dollar
amount which cannot exceed the highest amount levied in the three most
recent years in which a levy was made, PLUS six percent thereof. A
local unit is permitted to have but one tax base levy and proceeds may
be used for any purpose for which the unit may lawfully expend funds.
2. Levy Outside 6 Percent Limitation (Special, Serial or Continuing
Levy). Special and serial levies are temporary taxing authorities
permitting the levy of a specific dollar amount for one year (Special)
or for two or more years up to ten years (Serial). Continuing levies
are those approved by voters prior to 1953, are permanent in nature and
are limited in amount by the product of the voted tax rate and the
assessed value of the unit. Since 1978 Serial levies may also be
established based on a specified tax rate but the term may not exceed
three years. Not more than four serial levy measures may be proposed in
a given year.
3. Levy Not Subject to 6 Percent Limitation (Debt Levy). Local units
are required to annually levy an amount sufficient to pay principal and
interest costs for a bonded debt. Bond measures to be paid from future
tax levies must first be approved by a majority of those voting unless
otherwise provided by law.
Responding to a number of school closures occurring as a result of tax
levy failures during the last decade, Oregon voters approved a school
'safety Net" measure in 1987 designed to prevent future closures and
maintain schools at the standards required by the State. The law
provides that in the event a school district levy is defeated, upon
making a finding that schools may close for lack of funds, the school
board is authorized to levy property taxes no greater than the amount
levied in the prior year and to adjust the district budget accordingly
for the period through the next date set to vote on the levy.
Litigation. The following summary of litigation relates only to
matters as to which the State of Oregon is a party and as to which the
State of Oregon has indicated that the individual claims against the
State exceed $5 million. Other litigation may exist with respect to
individual municipal issuers as to which the State of Oregon is not a
party, but which, if decided adversely, could have a materially adverse
effect on the financial condition of the individual municipal issuer.
132
<PAGE>
1. SAIF Fund Transfers. During 1983, three special sessions of the
Legislature were convened to balance the previously approved budget for
the 1981-83 fiscal biennium. Among the actions required to balance the
budget were the reduction of expenditures during the biennium by more
than $215 million and the transfer to the State's General Fund in June
1983 of $81 million from the surplus of the State Accident Insurance
Fund ("SAIF"). The State was sued in litigation challenging the
legality of the transfer of this surplus from SAIF to the General Fund.
Although the validity of the action was upheld at the trial and
intermediate appellate levels, the Oregon Supreme Court, affirming the
trial and appellate court decisions in part and reversing them in part,
held that the transfer of the $81 million was not proper. The Court did
not, however, require that the funds be repaid to SAIF, nor did the
Court award the plaintiff any damages.
As a result of the decision, a coalition of Oregon businesses filed a
class action lawsuit against the State seeking the return of the entire
$81 million, plus interest accrued. The lawsuit alleged that 30,000
Oregon businesses were denied potential dividend payments when the
Legislature improperly transferred the SAIF reserves to the General
Fund. The trial court ruled that the plaintiffs could not maintain the
suit as a class action, and dismissed all claims against the State other
than the plaintiffs" claims for breach of contract. Subsequently, the
trial court granted summary judgment, in part, in the State's favor,
dismissing the claims against all but five of the State defendants.
The claims against the remaining defendants were consolidated and
tried in December 1990. The trial court granted a directed verdict for
two of the defendants, and the jury returned a defense verdict for the
remaining three. The plaintiffs appealed the verdicts to the Oregon
Court of Appeals in March 1991. In December 1992, the Oregon Court of
Appeals reversed the trial court's judgment in favor of the State,
holding that the trial court should have heard the case as a class
action, under which the classes of policyholders could have had an
opportunity to offer proof that they sustained damages in the form of
dividends or reduced premiums that the policyholders would have received
if the Legislature had not made the 1983 transfer of surplus reserves
from SAIF. However, in May 1993, the Oregon Supreme Court granted both
the plaintiffs" and the State's petitions for review of the Court of
Appeals" decision and on November 19, 1993, the Oregon Supreme Court
issued an opinion ruling that the State must return to SAIF the $81
million that the Legislature transferred to the General Fund. The
Oregon Supreme Court remanded the case to the trial court to fashion a
decree based upon evidence of what SAIF would have done with the money
if it had not been transferred to the General Fund. On December 28,
1993, the State filed a motion for reconsideration of the Oregon Supreme
Court's opinion. The motion for reconsideration was denied. On remand,
the trial court ordered the State to return the $81 million to SAIF,
with interest, but the trial court did not determine the rate of
interest. Oral arguments were heard by the trial court in December 1994
on the legal issues relating to the calculation of interest that the
State must return. The theory chosen by the court will set the rate and
the amount of interest. According to the State, depending on the trial
court's ruling, the State's repayment obligation could equal or exceed
$150 million.
2. Mental Health Care. Plaintiffs in a lawsuit filed against the
State in May 1992 have challenged the constitutionality of certain
conditions at, and the treatment of, 300 patients in the forensics wards
of the Oregon State Hospital. Although the plaintiffs claim no damage
award, the State has indicated that compliance with the entry of the
injunction that the plaintiffs seek could potentially cost the State
several million dollars annually. If the plaintiffs prevail, the State
could also be liable for the plaintiffs" attorney fees, which the State
believes could amount to several hundred thousand dollars.
In a similar matter, the United States filed a lawsuit against the
State in United States District Court challenging conditions at a
training center for the mentally handicapped. No damages are sought in
the case, but compliance with the injunction sought by the United States
is likely to cost the State several million dollars per year. In April
1989, the District Court approved a consent decree which requires the
State to continue improving conditions at the training center. In May
1991, the United
133
<PAGE>
States filed a contempt motion against the State over
the State's failure to comply with certain consent decree requirements.
Under the contempt motion, additional State program expenditures could
have been required. On September 13, 1991, the District Court entered
an order in favor of the State, dismissing the contempt motion. The
United States appealed the District Court's decision to the United
States Court of Appeals for the Ninth Circuit. The Court of Appeals
heard oral arguments on August 31, 1993, but the court has not yet
issued its decision.
3. Spotted Owl Timber Sale Cases. The State is currently facing
potential claims in connection with twenty-two State timber sales
involving timber lands that spotted owls may be using as habitats.
Although only a few suits have been brought against the State at this
time, the State anticipates that other similar cases will be filed.
While the State has indicated that it is not now possible to estimate
the probable outcome of these claims, it estimates that the total
potential exposure to the State exceeds $11.6 million.
4. State Employee Claims for Overtime Pay. A class action suit has
been commenced in the United States District Court on behalf of all
State employees who have been deemed by the State to be exempt from the
federal Fair Labor Standards Act overtime provisions. Plaintiffs claim
that they are not salaried employees exempt from the overtime payment
requirements of the Fair Labor Standards Act because they are required
to account for hours worked. According to the State, the potential
class totals an estimated 10,000 current and former State employees.
The plaintiffs seek back pay for overtime during the three-year period
preceding filing of the action, plus statutory liquidated damages in an
equal amount, and attorney fees. In June 1993, the federal District
Court granted the State's motion for summary judgment and dismissed the
claim. Plaintiffs appealed the decision to the United States Court of
Appeals for the Ninth Circuit. The Ninth Circuit ruled that certain
employees were not 'salaried" employees because their rate of pay was
subject to reduction as a disciplinary measure for violation of agency
rules that were unrelated to safety concerns. The case was remanded
back to the District Court for a determination of back pay and
liquidated damages. The State has filed a motion with the trial court
for leave to amend the State's answer.
5. Department of Corrections Harassment Litigation. Four former and
current female employees of the Oregon Department of Corrections filed a
civil rights action during September 1992 against that department in the
United States District Court for the District of Oregon. The plaintiffs
claim almost $9 million in damages, plus attorney fees, alleging that
they had been subjected to sexual harassment while working for the
department. At trial, two of the plaintiffs were awarded no damages at
all, one plaintiff was awarded $12,000 and the fourth plaintiff was
awarded $25,000. The time for plaintiffs to appeal has not yet expired.
However, the State has indicated that given the results of the jury
trial, the possibility that the State's exposure will exceed $1 million
is remote.
6. Taxation of Pension Benefits. Several cases have been filed in
the Oregon Tax Court and the State Circuit Courts alleging that a 1991
increase in the Public Employee Retirement System ("PERS") benefits, to
offset State taxation of the PERS benefits, violates a holding by the
United States Supreme Court in Davis v. Michigan Dept. of Treasury.
The Davis case holds that state statutes may not provide disparate tax
treatment of state and federal pension benefits. The State has
indicated that it is not possible to estimate the potential impact of
liability under these cases at this time. The trial court has denied
all of the plaintiff's claims in one of these cases. The plaintiff in
that case has appealed the trial court's ruling to the Oregon Supreme
Court.
Class action certification has been granted in an action filed against
the State and other public entities regarding the taxation of Oregon
public employment retirement benefits. The defendant class is composed
of all employers participating in PERS. The plaintiffs seek enforcement
of the Oregon Supreme Court's decision in Hughes v. State. In Hughes,
the Court ruled that a statutory amendment repealing a tax exemption for
retirement benefits violated the constitutional provision against
impairment of contract for benefits received from work performed prior
to the date of amendment.
134
<PAGE>
The court deferred to the Oregon Legislature
to fashion a remedy; the Legislature failed to provide a remedy,
however, during the 1993 legislative session. Plaintiffs seek to
require public employers to pay breach of contract damages or to
increase benefits due to taxation of previously untaxed pensions.
According to the State, the form and amount of liability which may be
incurred by the State for these cases is uncertain. The State has
indicated that if the court accepts a remedy of increased benefits paid
to the affected retirees, the impact on the General Fund would be
indirect in the form of increased contributions to PERS. The indirect
liability to State agencies under a benefits remedy is estimated by the
State to be $10-13 million per year over a 30-year period, with only
about one-third of that amount payable by agencies funded from the
General Fund.
Local governments have asserted defenses based upon breach of contract
theories and are seeking indemnification from the State. If the local
governments are successful, liability would be imposed directly on the
General Fund. If the court determines that the remedy must be the
direct payment of monetary damages in the amount of tax revenues
generated from the PERS benefits, the State believes that the potential
impact on the General Fund would be much higher than under a remedy of
increased benefit payments.
7. Out-of-State Insurance Company Claims. In August 1993, several
out-of-state insurance companies filed a lawsuit against the State
challenging the State's gross premiums tax on out-of-state insurers.
The lawsuit alleges that the tax violates the Equal Protection Clause of
the 14th Amendment to the United States Constitution because the tax
treats domestic and "foreign" insurers differently. The insurance
companies seek a declaration that the Oregon gross premium tax is
unconstitutional, refunds of all premiums paid from 1982 to date, and
the recovery of their attorney's fees. According to the State, if
claims were brought by all affected foreign insurers, the State's
possible refund liability exposure would probably exceed $30 million.
In hearings before the 1993 Oregon Legislative Assembly concerning the
gross premium tax laws, the estimates of the State's potential refund
liability in such a case ranged from $27.4 million to $174.6 million.
Although the State has indicated that the possibilities of a result
adverse to the State are substantial, on May 19, 1994, the trial court
granted motions by the State that limit the time for which refunds must
be paid to 1993 and subsequent years. According to the State, under the
trial court's ruling, the State's exposure would be limited to
approximately $10-20 million per year covering a two to three year
period. Plaintiffs have filed an amended complaint in response to the
trial court ruling. The State has indicated, however, it is impossible
to predict a probable outcome of this case at this time.
8. State Video Poker Games. Several individuals filed a lawsuit
against the State challenging the legality of video poker games
conducted by the Oregon State Lottery. The challengers contend that the
games violate Oregon's constitutional prohibition against casinos, and
that the 6 percent allocation of revenues from these games to counties
for law enforcement and treatment of gambling disorders does not comply
with the constitutionally mandated application of gambling revenues for
"economic development" purposes.
In October 1991, the trial court granted the State's motion for
judgment on the pleadings in the State's favor, and the plaintiffs
appealed to the Oregon Court of Appeals. The court of appeals reversed
the trial court's decision and remanded the case to the trial court to
take evidence on what constitutes prohibited "casino-type" gambling.
The State appealed the decision of the court of appeals to the Oregon
Supreme Court, which heard oral arguments on January 4, 1994. On April
7, 1994, the Oregon Supreme Court issued its opinion. Although the
court upheld the constitutionality of the video games, it found that the
six percent allocation of revenues to counties for law enforcement and
the treatment of gambling disorders violated the Oregon Constitution.
The plaintiffs" request for reconsideration was denied by the court on
May 11, 1994.
135
<PAGE>
9. Increase in State Medicaid Reimbursement Amounts. An association
of "for profit" nursing homes has filed a lawsuit against the State
alleging that the amount of reimbursement paid by the State to nursing
homes is too low and violates federal law. Under federal law, states
are required to reimburse facilities for costs that must be incurred by
efficient and economic providers. Plaintiffs claim that State
reimbursement costs do not comply with this federal requirement. The
State believes that the potential liability, if plaintiffs are
successful, would be the difference between the amount paid by the State
under its current rules and the greater amount (if any) the court
determines the State should pay. While the State has indicated that it
is not possible to estimate the amount of such increases at this time,
it believes that the liability to the State in terms of future
compliance with any increase for reimbursement rates would likely be
well over $5 million.
10. Discrimination Suit. A former female anesthesiology resident at
the Oregon Health Sciences University filed a suit against the State
claiming discrimination based upon her sex and pregnancy. The plaintiff
is seeking damages totaling $5 million based upon Oregon and federal
law. According to the State, most of plaintiff's damage claims fall
under the limits of the Oregon Tort Claims Act or federal limitations on
damages. At this time, it is impossible to predict the State's actual
exposure in this case. However, the State believes that given the
limits on damages imposed under state and federal law on most of
plaintiff's claims, the possibility that the State's exposure would
equal or exceed $5 million is remote.
11. Liability for PERS Losses. Four separate plaintiffs have filed
lawsuits against the State seeking reimbursement on behalf of the Public
Employees" Retirement Fund for losses in excess of $5 million allegedly
suffered by the Fund as a result of investment actions taken by former
Oregon State Treasury employees. The plaintiffs seek recovery of the
losses from the issuers of certain fidelity bonds or, in the
alternative, a transfer from the State's general fund to the Fund of any
losses that are not recoverable under the fidelity bonds. The State has
now recovered on the fidelity bond an amount that offsets part of the
losses to the Fund. According to the State, those of the plaintiffs"
claims that are based upon recovery under the bond are now moot. The
remaining claims were dismissed by the trial court. In February 1995
the Oregon Court of Appeals upheld the trial court's decision.
According to the State, while many of the plaintiffs" claims are subject
to the limits of the Oregon Tort Claims Act, the plaintiffs" breach of
contract claim would not be subject to Oregon tort claims limits. At
this time, therefore, the State believes that it would be premature to
estimate the actual exposure of the State's General Fund if the
plaintiffs were ultimately to prevail on any of their claims.
12. Change in Foster Care System. An advocacy group for children in
State custody is negotiating with the State's Children's Services
Division (the "Division") over claims by the group that the Division's
program for housing and treating children in foster care is
unconstitutional. The group alleges that the children in foster care do
not get enough or appropriate housing. The Division is working with the
group to implement changes to the system which would resolve these
issues. According to the State, if the negotiations are unsuccessful,
the group has indicated that it intends to file a lawsuit against the
State and the Division seeking changes to the current system. The
State's preliminary estimates regarding the costs to the Division of
implementing such changes is $5 million or more per year over a
four-year period.
13. Potential Construction Delay Claim. The general contractor on a
construction contract for the Oregon Health Sciences University's basic
science building addition has submitted to the University a claim for
additional compensation, in an amount exceeding $4.5 million, based on
alleged delay in the completion of the project. No litigation has yet
been filed, and the parties currently are discussing settlement of the
claim. The State believes that it is premature to attempt an assessment
of the validity or possible defenses to the claim at this time.
136
<PAGE>
OREGON TAXES
In the opinion of Perkins Coie, Portland, Oregon, special counsel on
Oregon tax matters, under existing Oregon law:
1. The Oregon Trust is not an association taxable as a corporation
for Oregon excise tax purposes. The income of the Oregon Trust will be
treated as the income of the Holders of the Units of the Oregon Trust
and be deemed to have been received by them when received by the Oregon
Trust.
2. Holders of Units in the Oregon Trust who are subject to Oregon
personal income taxation under Chapter 316 of the Oregon Revised
Statutes will not be required to include their share of the earnings of,
or distributions from, the Oregon Trust in their Oregon gross income to
the extent that such earnings or distributions represent tax-exempt
interest for Federal income tax purposes received by the Oregon Trust on
obligations issued by Oregon, its political subdivisions or their
agencies or instrumentalities, the interest on which is exempt from
taxation under Oregon law, and on obligations issued by the government
of Puerto Rico or by its authority or by the government of Guam or by
its authority.
3. The Oregon Trust's capital gains and capital losses, included in
the Federal gross income of Holders of Units in the Oregon Trust who are
subject to Oregon personal taxation under Chapter 316 of the Oregon
Revised Statutes, will be included as capital gains and losses in the
Holder's Oregon personal gross income.
4. Gains and losses realized upon the sale or redemption of Units by
Holders who are subject to Oregon personal income taxation under Chapter
316 of the Oregon Revised Statutes will be includable in their Oregon
personal gross income.
5. Corporations subject to the Oregon corporate excise tax under
Chapter 317 of the Oregon Revised Statutes will be subject to the tax on
most or all of the income from the Oregon Trust, depending on the nature
of the obligation held by the Oregon Trust.
THE PENNSYLVANIA TRUST
RISK FACTORS--Prospective investors should consider the financial
difficulties and pressures which the Commonwealth of Pennsylvania and
certain of its municipal subdivisions have undergone. Both the
Commonwealth and the City of Philadelphia have historically experienced
significant revenue shortfalls. There can be no assurance that the
Commonwealth will not experience a further decline in economic
conditions or that portions of the municipal obligations contained in
the Portfolio of the Pennsylvania Trust will not be affected by such a
decline. Without intending to be complete, the following briefly
summarizes some of these difficulties and the current financial
situation, as well as some of the complex factors affecting the
financial situation in the Commonwealth. It is derived from sources
that are generally available to investors and is based in part on
information obtained from various agencies in Pennsylvania. No
independent verification has been made of the following information.
State Economy. Pennsylvania has been historically identified as a
heavy industry state although that reputation has changed recently as
the industrial composition of the Commonwealth diversified when the
coal, steel and railroad industries began to decline. The major new
sources of growth in Pennsylvania are in the service sector, including
trade, medical and health services, education and financial
institutions. Pennsylvania's agricultural industries are also an
important component of the Commonwealth's economic structure, accounting
for more than $3.6 billion in crop and livestock
137
<PAGE>
products annually while
agribusiness and food related industries support $39 billion in economic
activity annually.
Employment within the Commonwealth increased steadily from 1984 to
1990. From 1991 to 1994, employment in the Commonwealth declined 1.2
percent. The growth in employment experienced in the Commonwealth
during such period is comparable to the growth in employment in the
Middle Atlantic region of the United States. Non-manufacturing
employment in the Commonwealth has increased steadily since 1980 to its
1993 level of 81.6 percent of total Commonwealth employment.
Manufacturing, which contributed 18.4 percent of 1993 non- agricultural
employment, has fallen behind both the services sector and the trade
sector as the largest single source of employment within the
Commonwealth. In 1993, the services sector accounted for 29.9 percent
of all non-agricultural employment in the Commonwealth while the trade
sector accounted for 22.4 percent.
The Commonwealth recently experienced a slowdown in its economy.
Moreover, economic strengths and weaknesses vary in different parts of
the Commonwealth. In general, heavy industry and manufacturing have
recently been facing increasing competition from foreign producers.
During 1993, the annual average unemployment rate in Pennsylvania was
7.0 percent compared to 6.8 percent for the United States. For January
1995 the unadjusted unemployment rate was 6.5 percent in Pennsylvania
and 6.2 percent in the United States, while the seasonally adjusted
unemployment rate for the Commonwealth was 5.9 percent and for the
United States was 5.7 percent.
State Budget. The Commonwealth operates under an annual budget that
is formulated and submitted for legislative approval by the governor
each February. The Pennsylvania Constitution requires that the
Governor's budget proposal consist of three parts: (i) a balanced
operating budget setting forth proposed expenditures and estimated
revenues from all sources and, if estimated revenues and available
surplus are less than proposed expenditures, recommending specific
additional sources of revenue sufficient to pay the deficiency; (ii) a
capital budget setting forth proposed expenditures to be financed from
the proceeds of obligations of the Commonwealth or its agencies or from
operating funds; and (iii) a financial plan for not less than the
succeeding five fiscal years, that includes for each year projected
operating expenditures and estimated revenues and projected expenditures
for capital projects. The General Assembly may add, change or delete
any items in the budget prepared by the Governor, but the Governor
retains veto power over the individual appropriations passed by the
legislature. The Commonwealth's fiscal year begins on July 1 and ends
on June 30.
All funds received by the Commonwealth are subject to appropriation in
specific amounts by the General Assembly or by executive authorization
by the Governor. Total appropriations enacted by the General Assembly
may not exceed the ensuing year's estimated revenues, plus (less) the
unappropriated fund balance (deficit) of the preceding year, except for
constitutionally authorized debt service payments. Appropriations from
the principal operating funds of the Commonwealth (the General Fund, the
Motor License Fund and the State Lottery Fund) are generally made for
one fiscal year and are returned to the unappropriated surplus of the
fund if not spent or encumbered by the end of the fiscal year. The
Constitution specifies that a surplus of operating funds at the end of a
fiscal year must be appropriated for the ensuing year.
Pennsylvania uses the "Fund" method of accounting for receipts and
disbursements. For purposes of government accounting, a "fund" is an
independent fiscal and accounting entity with a self-balancing set of
accounts, recording cash and/or other resources together will all
related liabilities and equities. In the Commonwealth, over 150 funds
have been established by legislative enactment or in certain cases by
administrative action for the purpose or recording the receipt and
disbursement of moneys received by the Commonwealth. Annual budgets are
adopted each fiscal year for the principal operating funds of the
Commonwealth and several other special revenue funds. Expenditures and
encumbrances against these funds may only be made pursuant to
appropriation measures enacted by the General Assembly and approved by
the governor. The General Fund, the Commonwealth's largest
138
<PAGE>
fund,
receives all tax revenues, non-tax revenues and federal grants and
entitlements that are not specified by law to be deposited elsewhere.
The majority of the Commonwealth's operating and administrative expenses
are payable from the General Fund. Debt service on all bond
indebtedness of the Commonwealth, except that issued for highway
purposes or for the benefit of other special revenue funds, is payable
from the General Fund.
Financial information for the principal operating funds of the
Commonwealth is maintained on a budgetary basis or accounting, which is
used for the purpose of ensuring compliance with the enacted operating
budget. The Commonwealth also prepares annual financial statements in
accordance with generally accepted accounting principles ("GAAP").
Budgetary basis financial reports are based on a modified cash basis of
accounting as opposed to a modified accrual basis of accounting
prescribed by GAAP. Financial information is adjusted at fiscal
year-end to reflect appropriate accruals for financial reporting in
conformity with GAAP.
Recent Financial Results. Form fiscal 1984, when the Commonwealth
first prepared its financial statements on a GAAP basis, through fiscal
1989, the Commonwealth reported a positive unreserved-undesignated fund
balance for its government fund types (General Fund, Special Revenue
Fund and Capital Projects Fund) at the fiscal year end. Slowing
economic growth during 1990, leading to a national economic recession
beginning in fiscal 1991, reduced revenue growth and increased
expenditures and contributed to negative unreserved-undesignated fund
balances at the end of the 1990 and 1991 fiscal years.
The negative unreserved-undesignated fund balance was due largely to
operating deficits in the General Fund and the State Lottery Fund during
those fiscal years. Actions taken during fiscal 1992 to bring the
General Fund back into balance, including tax increases and expenditure
restraints, resulted in a $1.1 billion reduction to the
unreserved-undesignated fund deficit for combined governmental fund
types at June 30, 1993, as a result of a $420.4 million increase in the
balance. These gains were produced by continued efforts to control
expenditure growth. The Combined Balance Sheet as of June 30, 1993,
showed total fund balance and other credits for the total governmental
fund types of $1,959.9 million, a $732.1 million increase from the
balance at June 30, 1992. During fiscal 1993, total assets increased by
$1,296.7 million to $7,096.4 million, while liabilities increased $564.6
million to $5,136.5 million.
Fiscal 1991 Financial Results. The Commonwealth experienced a $453.6
million general fund deficit as of the end of its 1991 fiscal year. The
deficit reflected higher than budgeted below-estimate economic activity
and growth rates of economic indicators and total tax revenue shortfalls
below those assumed in the enacted budget.
Rising demands on state programs caused by the economic recession,
particularly for medical assistance and cash assistance programs, and
the increased costs of special education programs and correction
facilities and programs, contributed to increased expenditures in fiscal
1991, while tax revenues for the 1991 fiscal year were severely affected
by the economic recession. Total corporation tax receipts and sales and
use tax receipts during fiscal 1991 were, respectively, 7.3 percent and
0.9 percent below amounts collected during fiscal 1990. Personal income
tax receipts also were affected by the recession but not to the extent
of the other major General Fund taxes, increasing only 2.0 percent over
fiscal 1990 collections.
A number of actions were taken throughout the fiscal year by the
Commonwealth to mitigate the effects of the recession on budget revenues
and expenditures. The Commonwealth initiated a number of cost-saving
measures, including the firing of 2,000 state employees, deferral of
paychecks and reduction of funds to state universities, which resulted
in approximately $871 million cost savings.
139
<PAGE>
Fiscal 1992 Financial Results. Actions taken during fiscal 1992 to
bring the General Fund budget back into balance, including tax increases
and expenditure restraints resulted in a $1.1 billion reduction for the
unreserved-undesignated fund deficit for combined governmental fund
types and a return to a positive fund balance. Total General Fund
revenues for fiscal 1992 were $14,516.8 million which is approximately
22 percent higher than fiscal 1991 revenues of $11,877.3 million due in
large part to tax increases. The increases revenues funded substantial
increases in education, social services and corrections programs. As a
result of the tax increases and certain appropriation lapses, fiscal
1992 ended with an $8.8 million surplus after having started the year
with an unappropriated general fund balance deficit of $453.6 million.
Fiscal 1993 Financial Results. Fiscal 1993 closed with revenues
higher than anticipated and expenditures approximately as projected,
resulting in an ending unappropriated balance surplus of $242.3 million.
A reduction in the personal income tax rate in July 1992 and the
one-time receipt of revenues from retroactive corporate tax increases in
fiscal 1992 were responsible, in part, for the low growth in fiscal
1993.
Fiscal 1994 Financial Results. Commonwealth revenues during the 1994
fiscal year totaled $15,210.7 million, $38.6 million above the fiscal
year estimate, and 3.9 percent over commonwealth revenues during the
1993 fiscal year. The sales tax was an important contributor to the
higher than estimated revenues. The strength of collections from the
sales tax offset the lower than budgeted performance of the personal
income tax that ended the 1994 fiscal year $74.4 million below estimate.
The shortfall in the personal income tax was largely due to shortfalls
in income not subject to withholding such as interest, dividends and
other income. Expenditures, excluding pooled financing expenditures,
and net of all fiscal 1994 appropriation lapses, totaled $14, 934.4
million representing a 7.2 percent increase over fiscal 1993
expenditures. Medical assistance and prisons spending contributed to
the rate of spending growth for the 1994 fiscal year. The Commonwealth
maintained an operating balance on a budgetary basis for fiscal 1994
producing a fiscal year ending unappropriated surplus of $335.8 million.
Fiscal 1995 Budget. On June 16, 1994, the Governor signed a $15.7
billion general fund budget, an increase of over five percent from the
fiscal 1994 budget. A substantial amount of the increase is targeted
for medical assistance expenditures, reform of the state-funded public
assistance program and education subsidies to local school districts.
The budget also includes tax reductions totaling an estimated $166.4
million benefiting principally low income families and corporations.
The fiscal 1995 budget projects a $4 million fiscal year-end
unappropriated surplus.
Debt Limits and Outstanding Debt. The Constitution of Pennsylvania
permits the issuance of the following types of debt: (i) debt to
suppress insurrection of rehabilitate areas affected by disaster; (ii)
electorate approved debt; (iii) debt for capital projects subject to an
aggregate debt limit of 1.75 times the annual average tax revenues of
the preceding five fiscal years; and (iv) tax anticipation notes payable
in the fiscal year of issuance.
Under the Pennsylvania Fiscal Code, the Auditor General is required
annually to certify to the Governor and the General Assembly certain
information regarding the Commonwealth's indebtedness. According to the
August 31, 1994 Auditor General Certificate, the average annual tax
revenues deposited in all funds in the five fiscal years ended June 30,
1994 was approximately $16.5 billion, and, therefore, the net debt
limitation for the 1995 fiscal year is approximately $28.8 billion.
Outstanding net debt totalled $4.0 billion at June 30, 1994,
approximately equal to the net debt at June 30, 1993. At August 31,
1994, the amount of debt authorized by law to be issued, but not yet
incurred was $15.0 billion.
Debt Ratings. All outstanding general obligation bonds of the
Commonwealth are rated AA-by Standard and Poor's and Al by Moody's.
140
<PAGE>
City of Philadelphia. The City of Philadelphia (the "City" or
"Philadelphia") is the largest city in the Commonwealth. The City of
Philadelphia experienced a series of general fund deficits for fiscal
years 1988 through 1992, which have culminated in the City's present
serious financial difficulties. In its 1992 Comprehensive Annual
Financial Report, Philadelphia reported a cumulative general fund
deficit of $71.4 million for fiscal year 1992.
In June 1991, the Pennsylvania legislature established the
Pennsylvania Inter-Governmental Cooperation Authority ("PICA"), a
five-member board which would oversee the fiscal affairs of the city of
Philadelphia. The legislation empowers PICA to issue notes and bonds on
behalf of Philadelphia and also authorizes Philadelphia to levy a
one-percent sales tax the proceeds of which would be used to pay off the
bonds. In return for PICA's fiscal assistance, Philadelphia was
required, among other things, to establish a five-year financial plan
that includes balanced annual budgets. Under the legislation, if
Philadelphia does not comply with such requirements, PICA may withhold
bond revenues and certain state funding.
At this time, the City is operating under a five-year fiscal plan
approved by PICA on April 6, 1992. Full implementation of the five-year
plan was delayed due to labor negotiations that were not completed until
October 1992, three months after the expiration of the old labor
contracts. The terms of the new labor contracts are estimated to cost
approximately $144.4 million more than what was budgeted in the original
five-year plan. The Mayor's latest update of the five-year financial
plan was approved by PICA on May 2, 1994.
As of November 17, 1994, PICA has issued $1,296.7 million of its
Special Tax Revenue Bonds. In accordance with the enabling legislation,
PICA was guaranteed a percentage of the wage tax revenue expected to be
collected from Philadelphia residents to permit repayment of the bonds.
In January 1993, Philadelphia anticipated a cumulative general fund
budget deficit of $57 million for fiscal year 1993. In response to the
anticipated deficit, the Mayor unveiled a financial plan eliminating the
budget deficit for fiscal year 1993 through significant service cuts
that included a plan to privatize certain city-provided services. Due
to an upsurge in tax receipts, cost-cutting and additional PICA
borrowings, Philadelphia completed fiscal year 1993 with a balanced
general fund budget. The audited General Fund balance for fiscal year
1993 showed a surplus of approximately $3 million.
In January 1994, the Mayor proposed a $2.3 billion city general fund
budget that included no tax increases, no significant service cuts and a
series of modest health and welfare program increases. At that time,
the Mayor also unveiled a $2.2 billion program (the "Philadelphia
Economic Stimulus Program") designed to stimulate Philadelphia's economy
and stop the loss of 1,000 jobs a month. The preliminary General Fund
balance as of June 30, 1994, estimates a surplus of approximately $15.4
million.
S&P's rating on Philadelphia's general obligation bonds is "BB".
Moody's rating is currently "Ba".
Litigation. The Commonwealth is a party to numerous lawsuits in which
an adverse final decision would materially affect the Commonwealth's
governmental operations and consequently its ability to pay debt service
on its obligations. The Commonwealth also faces tort claims made
possible by the limited waiver of sovereign immunity effected by Act
152, approved September 28, 1978. Damages are limited under such waiver
to $250,000 for each person and $1 million for each accident.
The Sponsors believe that the information summarized above described
some of the more significant matters relating to State Series. For a
discussion of the particular risks with each of the Bonds, and other
factors to be considered in connection therewith, reference should be
made to the
141
<PAGE>
Official Statement and other offering materials relating to
each of the Bonds included in the portfolio of the State Series. The
foregoing information regarding a State, its political subdivisions and
its agencies and authorities constitutes only a brief summary, does not
purport to be a complete description of the matters covered and is based
solely upon information drawn from official statements relating to
offerings of certain bonds of that State. The Sponsors and their
counsel have not independently verified this information and the
Sponsors have no reason to believe that such information is incorrect in
any material respect. None of the information presented in this summary
is relevant to Puerto Rico or Guam Bonds which may be included in the
State Series.
THE TENNESSEE TRUST
In 1978, the voters of the State of Tennessee approved an amendment to
the State Constitution requiring that (1) the total expenditures of the
State for any fiscal year shall not exceed the State's revenues and
reserves, including the proceeds of debt obligations issued to finance
capital expenditures and (2) in no year shall the rate of growth of
appropriations from State tax revenues exceed the estimated rate of
growth of the State's economy. No debt obligation may be authorized for
the current operation of any State service or program unless repaid
within the fiscal year of issuance.
In response to public demand for better public education throughout
the State, the 1992 Tennessee General Assembly temporarily raised the
State sales tax by one-half of one percent to 6%, effective April 1,
1992. This increase became permanent as a result of the 1993
legislative session. This increase establishes the maximum total State
and local sales tax rate at 8.75%. Although the issue of instituting a
State income tax is still being discussed by legislators, most political
observers in Tennessee doubt such a proposal will be passed within the
next two-three years.
The Tennessee economy generally tends to rise and fall in a roughly
parallel manner with the U.S. economy. Like the U.S. economy, the
Tennessee economy entered recession in the last half of 1990 which
continued throughout 1991 and into 1992 as the Tennessee index of
leading economic indicators trended downward throughout the period. The
Tennessee economy gained strength during the latter part of 1992 and
this renewed vitality steadily continued through 1993 and 1994. Current
indicators are for the State to enjoy a year of moderate economic gains
in 1995.
Tennessee Department of Revenue collections for the first six months
of 1994 increased to approximately $2.85 billion, an increase of
approximately $40 million over the comparable period for 1993.
Projected revenue collections for fiscal year ending June 30, 1994 were
approximately $5.28 billion, and actual collections for the fiscal year
were approximately $5.50 billion, approximately $220 million above such
projections and $280 million or 5.3% above 1993 fiscal year end figures.
State revenue collections for the last six months of 1994 were
approximately as follows: July--$488 million, August--$426 million,
September--$441 million, October--$476 million, November--$407 million
and December--$416 million. These figures represent the following
percentage change over figures for the months in 1993: July (7.8%),
August (-3.0%), September (3.0%), October (.2%), November (-1.0%) and
December (-1.0%). By June 30, 1994, the State's rainy-day fund was
approximately $101 million.
Tennessee taxable sales were approximately $44.16 billion in 1991,
approximately $46.97 billion in 1992 and approximately $50.66 billion in
1993, representing percentage increases of 1.4%, 6.4% and 7.9%,
respectively, over the previous year's total. Tennessee taxable sales
for the first ten months of 1994 were as follows: approximately $4.13
billion in January, $4.32 billion in February, $4.74 billion in March,
$4.49 billion in April, $4.52 billion in May, $4.51 billion in June,
$4.56 billion in July, $4.74 billion in August, $4.75 billion in
September and $4.68 billion in October. These figures represent the
following percentage increases over figures for the same months in 1993:
January (3.2%), February (6.8%), March (16.8%), April (7.5%), May
(9.5%), June (8.5%), July (7.0%), August (13.6%), September (6.6%) and
October (9.6%).
142
<PAGE>
The Tennessee index of leading economic indicators acts as a signal of
the health of the State's economy six to nine months ahead. In 1994,
monthly figures for the leading index rose in February (7.4%), March
(30.2%), May (3.7%), June (5.1%), August (15.1%) and September (2.3%),
and declined in January (18.7%), April (15.5%), July (7.0%) and October
(7.1%), as compared to the previous month's figures. Calendar year
figures for 1994 are unavailable at present.
The Tennessee index of coincident economic indicators which gauges
current economic conditions throughout the State has steadily risen each
quarter since the third calendar quarter of 1991. November and December
1993 coincident economic indicators rose approximately 8.3% and 6.1%,
respectively, over the previous month. For calendar year 1993 the
coincident index rose approximately 4.4% over 1992 figures, while 1992
figures increased approximately 2.5% over 1991 figures and 1991 figures
showed a 2.6% decline over the previous year's figures. In 1994,
monthly figures for the coincident index have risen in January (15.5%),
February (.2%), March (11.6%), April (18.6%), Ju (7.3%), August (3.8%)
and October (17.9%), and declined in May (.9%), July (2.5%) and
September (1.7%) as compared to the previous month's figures.
Current data indicate that seasonally-adjusted personal income in
Tennessee has grown approximately $4.6 billion from the fourth calendar
quarter of 1992 to the fourth calendar quarter of 1993 with the
following quarterly changes as compared to the same quarter of the
previous year: first quarter 1993 (6.4%), second quarter 1993 (6.3%),
third quarter 1993 (6.5%), fourth quarter 1993 (5.0%). Personal income
figures for the three years ending December 31, 1991, 1992 and 1993
increased approximately 5.0%, 8.4% and 6.0%, respectively, over personal
income figures for the preceding year. Since 1983 Tennessee's per
capita income has increased approximately 87.1% to $18,434, compared to
the national per capita income of $20,817 which translates into a
ten-year increase of approximately 70.3%. For the year ended June 30,
1993, however, Tennessee still led the nation in household bankruptcy
filings (1 in every 49) with a rate twice the national average (1 in
102). Household bankruptcy filings for the year ended June 30, 1994 are
not yet available.
Historically, the Tennessee economy has been characterized by a
slightly greater concentration in manufacturing employment than the U.S.
as a whole. The Tennessee economy is, however, undergoing a structural
change through the increase in service sector employment. Service
sector employment has climbed steadily since 1960, increasing its share
of overall state employment from 13.0% to 24.3% in 1993. Over the same
period, employment in durable goods manufacturing has been flat, and
employment in the nondurable goods manufacturing sector actually has
declined. Tennessee non-agricultural employment has grown in the period
from 1991 to 1993 from approximately 2.18 million persons to
approximately 2.33 million persons, with percentage increases of
approximately 2.8% and 3.7% for 1992 and 1993, respectively, over the
previous year's figure. Thus far figures for 1994 show non-agricultural
employment having the following percentage changes from the previous
month's figures: January (-1.7%), February (4.4%), March (.8%), April
(2.7%), May (-5.3%), June (2.8%), July (.8%), August (.3%), September
(1.7%) and October (4.3%). Non-agricultural employment in Tennessee is
relatively uniformly diversified with approximately 22% in the
manufacturing sector, approximately 23% in the wholesale and retail
sector, approximately 24% in the service sector and approximately 16% in
government.
Manufacturing employment is one component of non-agricultural
employment. Tennessee manufacturing employment averaged approximately
503,000 persons in 1991; 515,000 persons in 1992 and 529,000 persons in
1993 with the 1992 and 1993 figures representing percentage increases of
approximately 2.4% and 2.7%, respectively, over the previous year's
average.
Tennessee's unemployment rate stood at 5.3% for December 1993, dropped
to 4.6% as of July 1994, and dropped further to 3.8% as of December 1994
which is its lowest level in over six years. By December 1993, only one
Tennessee county had an unemployment rate over 10% for the first time
since 1974. Average annual unemployment in Tennessee has steadily
decreased from 6.6% in 1991 to
143
<PAGE>
6.4% in 1992 to 5.7% in 1993. Average
annual unemployment figures for 1994 are unavailable at the present
time, but it is expected that such 1994 figures will be lower than the
5.7% rate of 1993. The Tennessee Department of Employment Security has
projected minimum growth of approximately 23% in Tennessee's total
employment by the year 2005, with an increase of approximately
550,000-600,000 new jobs as compared to the projection for national
employment growth of 20.5% over the same period.
Tennessee's population increased 6.2% from 1980 to 1990, less than the
national increase of 10.2% for the same period. In December 1994 the
State's population reached approximately 5.2 million. A U.S. census
study projects that Tennessee will be the fifth most popular destination
for new residents coming from other states during the period from
1990-2020. Population growth in Tennessee is expected to come mostly in
the major metropolitan areas over the next 10-15 years. The overall
state population is expected to grow 5.5% between 1990 and 2000, then
4.6% for the period between 2000 and 2010. Greatest growth is expected
to occur in the Nashville MSA, and the largest population decline is
expected in the rural counties of northwest Tennessee. This declining
rate of the rural population, coupled with the structural changes in the
Tennessee economy and the increased competition from domestic and
international trading partners, comprise three trends that are likely to
influence the state's long-term outlook.
Tennessee's general obligation bonds are rated Aaa by Moody's and AA+
by Standard & Poor's. Tennessee's smallest counties have Moody's lower
ratings ranging from Baa to B in part due to these rural counties"
limited economies that make them vulnerable to economic downturns.
Tennessee's four largest counties have the second highest of Moody's
nine investment grades, Aa. There can be no assurance that the economic
conditions on which these ratings are based will continue or that
particular obligations contained in the Portfolio of the Tennessee Trust
may not be adversely affected by changes in economic or political
conditions.
The Sponsors believe that the information summarized above describes
some of the more significant matters relating to the Tennessee Trust.
For a discussion of the particular risks with each of the Debt
Obligations, and other factors to be considered in connection therewith,
reference should be made to the Official Statements and other offering
materials relating to each of the Debt Obligations included in the
portfolio of the Tennessee Trust. The foregoing information regarding
the State does not purport to be a complete description of the matters
covered and is based solely upon information provided by State agencies,
publicly available documents and news reports of statements by State
officials and employees. The Sponsors and their counsel have not
independently verified this information and the Sponsors have no reason
to believe that such information is incorrect in any material respect.
None of the information presented in this summary is relevant to Puerto
Rico or Guam Debt Obligations which may be included in the Tennessee
Trust.
TENNESSEE TAXES
In the opinion of Hunton & Williams, Knoxville, Tennessee, special
counsel on Tennessee tax matters, under existing Tennessee law and
assuming that (i) the Tennessee Trust is a grantor trust under the
grantor trust rules of Sections 671-677 of the Code and (ii) not less
than 75% of the value of the investments of the Tennessee Trust are in
any combination of bonds of the United States, State of Tennessee, or
any county or any municipality or political subdivision of the State,
including any agency, board, authority or commission of the State or its
subdivisions:
1. The Tennessee Trust will not be subject to the Tennessee
individual income tax, also known as the Hall Income Tax; the Tennessee
corporate income tax, also known as the Tennessee Excise Tax, or the
Tennessee Franchise Tax.
2. Tennessee Code Annotated
144
<PAGE>
Section 67-2-104(q) specifically exempts from the Hall Income Tax
distributions from the Tennessee Trust to Holders of Units to the extent
such distributions represent interest on bonds or securities of the
United States government or any agency or instrumentality thereof or on
bonds of the State of Tennessee, or any county, municipality or
political subdivision thereof, including any agency, board, authority or
commission. The Tennessee Department of Revenue has taken the
administrative position that distributions attributable to interest on
obligations issued by Puerto Rico and Guam are exempt from the Hall
Income Tax.
3. The Tennessee Trust will not be subject to any intangible personal
property tax in Tennessee on any Debt Obligation in the Tennessee Trust.
The Units of the Tennessee Trust also will not be subject to any
intangible personal property tax in Tennessee but may be subject to
Tennessee estate and inheritance taxes.
Holders of Units should consult their own tax advisor as to the tax
consequences to them of an investment in and distributions from the
Tennessee Trust.
THE TEXAS TRUST
While the Texas economy continued to improve in many respects through
the fall of 1994, certain traditionally strong segments of the state's
economy have been negatively affected by external market forces. The
Texas oil and gas industry, once the dominant force in the state's
economy, was estimated to constitute only 11% of the Texas economy
during the State's fiscal year ended August 31, 1994 ("Fiscal 1994").
During Fiscal 1994, employment in the Texas oil and gas industry
decreased by 3.1%, a net loss of over 5,000 jobs. Likewise, as a result
of the continuing national defense spending cuts, the Texas aerospace
industry continued to suffer job losses. The aerospace industry lost
approximately 5,000 jobs in Texas during Fiscal 1994. Net job losses in
the Texas aerospace industry have totalled 27,000 since 1989.
Despite the downturn in the oil and gas and aerospace industries in
Texas, the state's economic recovery appeared to strengthen during
Fiscal 1994. After underperforming the national economy during most of
the second half of the 1980's, Texas" economy has either outperformed
the national economy or kept pace with the improving national economy in
recent years. The leading economic indicators for Texas were up 2.9%
over the twelve months ended October, 1994, although this increase is
indicative of a slow down in the state's economic growth from earlier
periods. For example, the same leading indicators were up 3.6% for the
twelve month period ended April, 1994. By way of comparison, for the
twelve months ended October, 1994, the increase in the leading
indicators for the nation as a whole was 3.0%. However, the employment
growth rate in Texas has exceeded the employment growth rate in the
nation for Texas" last five fiscal years, and during Fiscal 1994, Texas
added more jobs than any other state.
The Texas state government still faces financial challenges as demands
for state services increase and spending of state funds is required by
court orders, federal mandates and growing social services caseloads.
In addition, it is unclear what the full effect of the recent Mexican
financial crisis on the Texas economy will be, although it is believed
that retail sales in cities along the Texas-Mexico border have decreased
substantially as a result of the loss of Mexican customers.
The state's credit ratings have been unchanged over recent periods,
although such ratings have caused the state to pay higher interest rates
on state bonds than those historically enjoyed by the state. Some local
governments and other political subdivisions also have had their credit
ratings lowered from their historical levels. As of December 31, 1994,
general obligation bonds issued by the State of Texas were rated AA by
Standard & Poor's, Aa by Moody's and AA+ by Fitch's Investor Services.
145
<PAGE>
Despite the growing demands for governmental services, state
government finances improved during Fiscal 1994 with the state's net
revenue for general and special funds exceeding net expenditures by
approximately $1.1 billion. The state's newly-elected Republican
governor, George W. Bush, took office in January, 1995. It is
uncertain if any of Governor Bush's initiatives and programs will be
adopted by the Texas legislature during its 1995 session or, if adopted,
if such initiatives and programs will result in a overall reduction in
state revenues from taxes or other sources or a net reduction in state
spending.
Although there are indications that the Texas economy is fundamentally
stronger than it has been in the recent past, various economic problems
continue to be experienced throughout the state. While the state's
energy industry had stabilized somewhat in recent years after its
collapse in the early 1980's, during Fiscal 1994, employment in the
state's energy industry decreased to less than 161,000 employees, its
lowest level since 1976. The state has experienced a loss of jobs
attributable to oil companies pursuing more attractive drilling
opportunities overseas, consolidations of the domestic workforce,
declining production and relatively low oil and gas prices. The oil and
gas rig count, an industry barometer, was down by 6.1% in Texas over the
twelve-month period ended September 30, 1994 and is well below
historical highs. Oil and natural gas production have continued to
trend downward further reducing a once important source of revenue to
the state government. Oil and gas remains an important contributor to
the state's economy, but its relative importance is declining as the
state's economy becomes increasingly more diversified.
The Texas economy is continuing to diversify and become more like the
national economy. As a consequence it is vulnerable to changes in the
value of the dollar and increasing federal budget deficits, and is
affected by international events and trade policies more than ever
before. A manifestation of this trend was the downward trend in
industrial production in the state during the early 1990's, which was
triggered by the weak national economy. Industrial production increased
in Texas by 5.4% during the twelve months ending September 30, 1994.
However, job growth in the manufacturing sector of the Texas economy has
been relatively weak (1.2% in Fiscal 1994) and the greatest job growth
in Texas during Fiscal 1994 was in the service sector (4.7% in Fiscal
1994). These growth rates reflect the national trend and indicate that
Texas is continuing to move toward a service-based economy. It is
unclear what effect current national and world events will have on the
state.
Although the banking and thrift industries in Texas have stabilized
and total bank assets, equity capital and retail loans appear to be
increasing, the total amount of business loans made by Texas banks
continues to be at a low level compared to the level of loan activity in
the early 1980's. While the construction sector of the state's economy
remains relatively depressed compared to the boom levels of the early
and mid-1980's, residential construction increased significantly as a
result of the fall in mortgage loan interest rates with housing permits
up 24.3% in September, 1994 compared to their level in September, 1993.
This growth rate is reflective, however, of a slowdown in growth in
housing starts in fiscal 1993, during which period the number of housing
permits issued increased by 43.6%. The continuing rise in mortgage loan
interest rates is expected to be reflected as a slow down in new home
construction. Continuing high vacancy rates in the State's major office
markets have held back the demand for nonresidential construction.
The two major sources of state revenue are state taxes and federal
funds. Other revenue sources include income from licenses, fees and
permits, interest and investment income, the state lottery, income from
sales of goods and services and land income (which includes income from
oil, gas and other mineral royalties as well as from leases on state
lands). The major sources of state government tax collection are the
sales tax, the franchise tax and the motor fuels tax. During 1991, the
Texas Legislature significantly modified the state franchise tax and the
tax on certain motor fuels to raise additional revenues, and made
changes to other tax laws, including some changes to the sales tax.
146
<PAGE>
Limitations on Bond Issuances and Ad Valorem Taxation. Although Texas
has few debt limits, certain tax limitations imposed on counties and
cities are in effect debt limitations. The requirement in Texas that
counties and cities provide for the collection of an annual tax
sufficient to retire any bonded indebtedness they create operates as a
limitation on the amount of indebtedness which may be incurred, since
counties and cities may never incur indebtedness which cannot be
satisfied by revenue received from taxes imposed within the tax limits.
The same requirement is generally applicable to indebtedness of the
State of Texas. However, voters have authorized from time to time, by
constitutional amendment, the issuance of general obligation bonds of
the state for various purposes.
To the extent the Texas Debt Obligations in the Portfolio are payable,
either in whole or in part, from ad valorem taxes levied on taxable
property, the limitations described below may be applicable. The Texas
Constitution prohibits the state from levying ad valorem taxes on
property. The Texas Constitution limits the rate of growth of
appropriations from tax revenues not dedicated to a particular purpose
by the Constitution during any biennium to the estimated rate of growth
for the Texas economy, unless both houses of the Texas Legislature, by a
majority vote in each, find that an emergency exists. In addition, the
Texas Constitution authorizes cities having more than 5,000 inhabitants
to provide further limitations in their city charters regarding the
amount of ad valorem taxes which can be assessed. Furthermore, certain
provisions of the Texas Constitution provide for exemptions from ad
valorem taxes, of which some are mandatory and others are available at
the option of the particular county, city, town, school district or
other political subdivision of the state. The following is only a
summary of certain laws which may be applicable to an issuer of the
Texas Debt Obligations regarding ad valorem taxation.
Counties and political subdivisions are limited in their issuance of
bonds for certain purposes (including construction, maintenance and
improvement of roads, reservoirs, dams, waterways and irrigation works)
to an amount up to one-fourth of the assessed valuation of real
property. No county, city or town may levy a tax in any one year for
general fund, permanent improvement fund, road and bridge fund or jury
fund purposes in excess of $.80 on each $100 assessed valuation. Cities
and towns having a population of 5,000 or less may not levy a tax for
any one year for any purpose in excess of 1 1/2%of the taxable property
($1.50 on each $100 assessed valuation), and a limit of 2 1/2% ($2.50 on
each $100 assessed valuation) is imposed on cities having a population
of more than 5,000. Hospital districts may levy taxes up to $.75 on
each $100 assessed valuation. School districts are subject to certain
restrictions affecting the issuance of bonds and the imposition of
taxes.
The general laws of the State of Texas pertaining to ad valorem
taxation of property by political subdivisions have been codified into
the Property Tax Code. Reference is hereby made thereto for
identification of property subject to taxation; property exempt from
taxation and other exemptions granted and allowed, if claimed; the
appraisal of property for purposes of taxation; and the procedures to be
followed and limitations applicable to the levy and collection of ad
valorem taxes. Governing bodies of taxing units may not adopt tax rates
that exceed certain specified rates until certain procedural
requirements are met (including, in certain cases, holding a public
hearing preceded by a published notice thereof). Certain statutory
requirements exist which set forth the procedures necessary for the
appropriate governmental body to issue and approve bonds and to levy
taxes. To the extent that such procedural requirements are not followed
correctly, the actions taken by such governmental bodies could be
subject to attack and their validity questioned.
In 1989 the Texas Supreme Court declared that the Texas system then in
effect of funding for public schools did not meet the requirements of
the Texas Constitution. The Court found that the prior state funding
system violated the constitutional provision requiring the state to
provide an efficient means of funding public education because the
system resulted in discrimination against low-wealth school districts.
In 1990, the Texas Legislature enacted legislation designed to establish
a constitutional system of financing public education. However, a state
district court subsequently ruled that the funding system effected by
that legislation was also unconstitutional, and the Texas Supreme Court
147
<PAGE>
affirmed the district court's ruling. In 1991, the Governor of Texas
signed into law a public education finance reform bill (the "1991 Public
Education Finance Bill") that dramatically increased revenue for
hundreds of relatively poor school districts, which resulted in
increased property taxes and was expected to increase property taxes in
the future. An important feature of the bill was the creation of new
taxing units called "county education districts".
On January 30, 1992, the Texas Supreme Court declared the public
school finance system enacted in the 1991 Public Education Finance Bill
to be unconstitutional and ordered that a new finance system be adopted
by the Texas Legislature by June 1, 1993. The Court deferred the effect
of its ruling to June 1, 1993 so as not to interfere with the collection
of 1991 and 1992 county education district taxes. Shortly prior to the
June 1 deadline, the Texas Legislature enacted legislation adopting a
new school finance system. The law attempts to reduce the disparity of
revenues per student in low-wealth school districts compared to
high-wealth school districts by providing high-wealth districts with
several options for effectively sharing portions of their ad valorem tax
revenue with low-wealth districts. The 1993 legislation also abolished
county education districts. Certain school districts filed suit in
state court challenging the legislation. The state trial court upheld
the constitutionality of the 1993 school finance legislation, and the
plaintiffs appealed the decision. On January 30, 1995, the Texas
Supreme Court affirmed the constitutionality of the legislation.
TEXAS TAXES--In the opinion of Hughes & Luce, L.L.P., Dallas, Texas,
special counsel, pursuant to Texas law existing as of December 31, 1994,
applicable to individuals who are residents of Texas for Texas tax
purposes:
1. The Texas franchise tax functions as an income tax in certain
respects. The Texas franchise tax is imposed on corporations, limited
liability companies and certain banks, limited banking associations and
savings and loan associations. Assuming that the Texas Trust is not a
corporation, limited liability company, bank, limited banking
association, or savings and loan association (in each case, for Texas
franchise tax purposes), the income of the Texas Trust will not be
subject to an income tax levied by the State of Texas or any political
subdivision thereof.
2. The income derived from the Texas Trust by Holders who are
individuals will not be subject to any income tax levied by the State of
Texas or any political subdivision thereof.
3. Assuming that the Texas Trust will not hold any tangible property,
neither Debt Obligations held by the Texas Trust nor Units of the Texas
Trust held by individuals are subject to any property tax levied by the
State of Texas or any political subdivision thereof.
4. Units of the Texas Trust held by individuals may be subject to
Texas inheritance taxes.
Neither the Sponsors, Davis Polk & Wardwell nor Hughes & Luce, L.L.P.
(except in such cases as Hughes & Luce, L.L.P., has acted or will act as
counsel to such issuing authorities), has made or will make any review
of the proceedings relating to the issuance of the Debt Obligations nor
has Hughes & Luce, L.L.P., made any review of the proceedings relating
to the issuance of the Units.
THE VIRGINIA TRUST
RISK FACTORS--The Constitution of Virginia limits the ability of the
Commonwealth to create debt. An amendment to the Constitution requiring
a balanced budget was approved by the voters on November 6, 1984.
General obligations of cities, towns or counties in Virginia are
payable from the general revenues of the entity, including ad valorem
tax revenues on property within the jurisdiction. The obligation to
levy taxes could be enforced by mandamus, but such a remedy may be
impracticable and difficult to enforce. Under section 15.1--227.61 of
the Code of Virginia, a holder of any general
148
<PAGE>
obligation bond in default
may file an affidavit setting forth such default with the Governor. If,
after investigating, the Governor determines that such default exists,
he is directed to order the State Comptroller to withhold State funds
appropriated and payable to the entity and apply the amount so withheld
to unpaid principal and interest. The Commonwealth, however, has no
obligation to provide any additional funds necessary to pay such
principal and interest.
Revenue bonds issued by Virginia political subdivisions include
(1) revenue bonds payable exclusively from revenue producing
governmental enterprises and (2) industrial revenue bonds, college and
hospital revenue bonds and other "private activity bonds" which are
essentially non-governmental debt issues and which are payable
exclusively by private entities such as non-profit organizations and
business concerns of all sizes. State and local governments have no
obligation to provide for payment of such private activity bonds and in
many cases would be legally prohibited from doing so. The value of such
private activity bonds may be affected by a wide variety of factors
relevant to particular localities or industries, including economic
developments outside of Virginia.
Virginia municipal securities that are lease obligations are
customarily subject to "non-appropriation" clauses. See "Municipal
Revenue Bonds - Lease Rental Bonds." Legal principles may restrict the
enforcement of provisions in lease financing limiting the municipal
issuer's ability to utilize property similar to that leased in the event
that debt service is not appropriated.
No Virginia law expressly authorizes Virginia political subdivisions
to file under Chapter 9 of the United States Bankruptcy Code, but recent
case law suggests that the granting of general powers to such
subdivisions may be sufficient to permit them to file voluntary
petitions under Chapter 9.
Virginia municipal issuers are generally not required to provide
ongoing information about their finances and operations, although a
number of cities, counties and other issuers prepare annual reports.
Although revenue obligations of the Commonwealth or its political
subdivisions may be payable from a specific project or source, including
lease rentals, there can be no assurance that future economic
difficulties and the resulting impact on Commonwealth and local
government finances will not adversely affect the market value of the
Virginia Series portfolio or the ability of the respective obligors to
make timely payments of principal and interest on such obligations.
The Commonwealth has maintained a high level of fiscal stability for
many years due in large part to conservative financial operations and
diverse sources of revenue. The budget for the 1994-96 biennium
submitted by Governor Allen does not contemplate any significant new
taxes or increases in the scope or amount of existing taxes.
The economy of the Commonwealth is based primarily on manufacturing,
the government sector (including defense), agriculture, mining and
tourism. Defense spending is a major component. Defense installations
are concentrated in Northern Virginia, the location of the Pentagon, and
the Hampton Roads area, including the Cities of Newport News, Hampton,
Norfolk and Virginia Beach, the locations of, among other installations,
the Army Transportation Center (Ft. Eustis), the Langley Air Force Base,
Norfolk Naval Base and the Oceana Naval Air Station, respectively. Any
substantial reductions in defense spending generally or in particular
areas, including base closings, could adversely affect the state and
local economies. In addition both residential and non-residential
construction have not fully recovered from recessionary conditions which
caused a major contraction in real estate, construction and related
activities in Northern Virginia and resulted in substantial financial
deterioration for many participants in these activities.
In Davis v. Michigan (decided March 28, 1989), the United States
Supreme Court ruled unconstitutional Michigan's statute exempting from
state income tax the retirement benefits paid by the
149
<PAGE>
state or local
governments and not exempting retirement benefits paid by the federal
government. At the time of this ruling, under legislation subsequently
amended in 1989 to provide uniform exemptions for all pensioners,
Virginia exempted state and local but not federal government benefits.
Several suits for refunds, some with multiple plaintiffs, were filed. A
state trial court ruling in favor of the Commonwealth was affirmed by
the Virginia Supreme Court on March 1, 1991, but on June 28, 1991, the
decision of the Virginia Supreme Court was vacated by the United States
Supreme Court and the case remanded to the Virginia Supreme Court for
reconsideration in light of an intervening United States Supreme Court
decision on retroactive application of decisional constitutional law.
On November 8, 1991, the Virginia Supreme Court affirmed its March 1,
1991, ruling denying refunds. On June 18, 1993, the U.S. Supreme Court
reversed the November 8, 1991, ruling of the Virginia Supreme Court and
remanded the case to the Virginia Supreme Court for further proceedings
consistent with the opinion of the U.S. Supreme Court. On July 30,
1993, the Virginia Supreme Court remanded the case to the trial court
for consideration of means of relief. On January 7, 1994, the trial
court denied refunds and an appeal is currently pending in the Virginia
Supreme Court. The estimated maximum potential financial impact on the
Commonwealth of claims for refunds by all federal pensioners is
approximately $707.5 million, including interest through December 31,
1993.
On July 13, 1994, the Governor signed into law emergency legislation,
reauthorized on February 28, 1995, providing for payments to federal
pensioners totalling $340 million over a five-year period ending March
31, 1999, in settlement of this litigation. Pensioners who accept the
settlement must release the Commonwealth from all claims based on
taxation of federal retirement benefits during 1985-1988 and dismiss all
related lawsuits to which they are parties. Payments for years
subsequent to 1994 are subject to future appropriation. A significant
number of federal pensioners opted out of the settlement proposed by
this legislation, necessitating its reauthorization in 1995, and there
can be no assurance that it will result in release of the pensioner's
claims and dismissal of their lawsuits.
The Commonwealth has a Standard & Poor's rating of AAA and a Moody's
rating of Aaa on its general obligation bonds. There can be no
assurance that the economic conditions on which these ratings are based
will continue or that particular bond issues may not be adversely
affected by changes in economic or political conditions.
VIRGINIA TAXES
In the opinion of Hunton & Williams, Richmond, Virginia, special
counsel on Virginia tax matters, under existing Virginia law and
assuming that the Virginia Trust is a grantor trust under the grantor
trust rules of Sections 671-679 of the Code:
1. The Virginia Trust will be taxable as a grantor trust for Virginia
income tax purposes with the result that income of the Virginia Trust
will be treated as income of the Holders of Units of the Virginia Trust.
Consequently, the Virginia Trust will not be subject to any income or
corporate franchise tax imposed by the Commonwealth of Virginia, or its
subdivisions, agencies or instrumentalities.
2. Interest on the Debt Obligations in the Virginia Trust that is
exempt from Virginia income tax when received by the Virginia Trust will
retain its tax-exempt status in the hands of the Holders of Units of the
Virginia Trust.
3. A Holder of Units of the Virginia Trust will realize a taxable
event when the Virginia Trust disposes of a Debt Obligation (whether by
sale, exchange, redemption or payment at maturity) or when the Holder of
Units redeems or sells his Units, and taxable gain for Federal income
tax purposes may result in taxable gain for Virginia income tax
purposes. Certain Debt Obligations, however, have been issued under Acts
of the Virginia General Assembly that provide that all income from such
Debt Obligations, including any profit from the sale thereof, shall be
free from all taxation by the
150
<PAGE>
Commonwealth of Virginia. To the extent
any such profit is exempt from Virginia income tax, any such profit
received by the Virginia Trust will retain its tax exempt status in the
hands of the Holders of Units of the Virginia Trust.
4. The Virginia Trust will not be subject to any intangible personal
property tax in Virginia on any Debt Obligations in the Virginia Trust.
In addition, Units of the Virginia Trust held for investment purposes
will not be subject to any intangible personal property tax in Virginia.
5. The Units may be subject to Virginia estate tax if held by a
Virginia resident or, in certain cases, by an individual who at the time
of his death was not a resident of the United States.
151
<TABLE> <S> <C>
<ARTICLE> 6
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM MONTHLY PAYMENT SERIES - 506 AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS
</LEGEND>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1994
<PERIOD-END> DEC-31-1994
<INVESTMENTS-AT-COST> 29,018,272
<INVESTMENTS-AT-VALUE> 30,177,105
<RECEIVABLES> 678,370
<ASSETS-OTHER> 0
<OTHER-ITEMS-ASSETS> 0
<TOTAL-ASSETS> 30,855,475
<PAYABLE-FOR-SECURITIES> 0
<SENIOR-LONG-TERM-DEBT> 0
<OTHER-ITEMS-LIABILITIES> (201,317)
<TOTAL-LIABILITIES> (201,317)
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 29,022,820
<SHARES-COMMON-STOCK> 30,852
<SHARES-COMMON-PRIOR> 35,425
<ACCUMULATED-NII-CURRENT> 472,505
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 1,158,833
<NET-ASSETS> 30,654,158
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 2,431,434
<OTHER-INCOME> 0
<EXPENSES-NET> 29,212
<NET-INVESTMENT-INCOME> 2,402,222
<REALIZED-GAINS-CURRENT> 373,334
<APPREC-INCREASE-CURRENT> (3,751,926)
<NET-CHANGE-FROM-OPS> (976,370)
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> 2,420,555
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> 1,221,837
<NUMBER-OF-SHARES-SOLD> 0
<NUMBER-OF-SHARES-REDEEMED> 4,573
<SHARES-REINVESTED> 0
<NET-CHANGE-IN-ASSETS> (9,315,016)
<ACCUMULATED-NII-PRIOR> 550,596
<ACCUMULATED-GAINS-PRIOR> 0
<OVERDISTRIB-NII-PRIOR> 0
<OVERDIST-NET-GAINS-PRIOR> 0
<GROSS-ADVISORY-FEES> 0
<INTEREST-EXPENSE> 0
<GROSS-EXPENSE> 0
<AVERAGE-NET-ASSETS> 0
<PER-SHARE-NAV-BEGIN> 0
<PER-SHARE-NII> 0
<PER-SHARE-GAIN-APPREC> 0
<PER-SHARE-DIVIDEND> 0
<PER-SHARE-DISTRIBUTIONS> 0
<RETURNS-OF-CAPITAL> 0
<PER-SHARE-NAV-END> 0
<EXPENSE-RATIO> 0
<AVG-DEBT-OUTSTANDING> 0
<AVG-DEBT-PER-SHARE> 0
</TABLE>
<PAGE>
DAVIS POLK & WARDWELL
450 LEXINGTON AVENUE
NEW YORK, NEW YORK 10017
(212) 450-4000
March 14, 1995
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Dear Sirs:
We hereby represent that the Post-Effective Amendments to the registered
unit investment trusts described in Exhibit A attached hereto do not contain
disclosures which would render them ineligible to become effective pursuant to
Rule 485(b) under the Securities Act of 1933.
Very truly yours,
Davis Polk & Wardwell
Attachment
<PAGE>
EXHIBIT A
<TABLE>
<CAPTION>
1933 ACT 1940 ACT
FUND NAME CIK FILE NO. FILE NO.
--------- --- -------- --------
<S> <C> <C> <C>
DEFINED ASSET FUNDS-MITF MPS-506 803713 33-37730 811-1777
TOTAL: 1 FUNDS
</TABLE>
