<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 16, 1998
REGISTRATION NO. 33-54037
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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:
MUNICIPAL INVESTMENT TRUST FUND
INSURED SERIES--207
DEFINED ASSET FUNDS
B. NAMES OF DEPOSITORS:
MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED
SMITH BARNEY INC.
PRUDENTIAL SECURITIES INCORPORATED
DEAN WITTER REYNOLDS INC.
PAINEWEBBER INCORPORATED
C. COMPLETE ADDRESSES OF DEPOSITORS' PRINCIPAL EXECUTIVE OFFICES:
MERRILL LYNCH, PIERCE,
FENNER & SMITH
INCORPORATED
DEFINED ASSET FUNDS
POST OFFICE BOX 9051
PRINCETON, NJ 08543-9051 SMITH BARNEY INC.
388 GREENWICH
STREET--23RD FLOOR
NEW YORK, NY 10013
PRUDENTIAL SECURITIES PAINEWEBBER INCORPORATED DEAN WITTER REYNOLDS INC.
INCORPORATED 1285 AVENUE OF THE TWO WORLD TRADE
ONE NEW YORK PLAZA AMERICAS CENTER--59TH FLOOR
NEW YORK, NY 10292 NEW YORK, NY 10019 NEW YORK, NY 10048
D. NAMES AND COMPLETE ADDRESSES OF AGENTS FOR SERVICE:
TERESA KONCICK, ESQ. ROBERT E. HOLLEY LAURIE A. HESSLEIN
P.O. BOX 9051 1200 HARBOR BLVD. 388 GREENWICH ST.
PRINCETON, NJ 08543-9051 WEEHAWKEN, NJ 07087 NEW YORK, NY 10013
LEE B. SPENCER, JR. COPIES TO: DOUGLAS LOWE, ESQ.
ONE NEW YORK PLAZA PIERRE DE SAINT PHALLE, DEAN WITTER REYNOLDS INC.
NEW YORK, NY 10292 ESQ. TWO WORLD TRADE
450 LEXINGTON AVENUE CENTER--59TH FLOOR
NEW YORK, NY 10017 NEW YORK, NY 10048
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 March 10, 1998.
Check box if it is proposed that this filing will become effective on September
25, 1998 pursuant to paragraph (b) of Rule 485. / x /
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<PAGE>
DEFINED ASSET FUNDSSM
- --------------------------------------------------------------------------------
MUNICIPAL INVESTMENT This Defined Fund is a portfolio of preselected
TRUST FUND bonds formed to provide safety of principal and
INSURED SERIES--207 federally tax-free income by investing in a fixed
(A UNIT INVESTMENT portfolio of insured fixed-rate bonds issued by
TRUST) states and their local governments and
- ------------------------------authorities. In the opinion of bond counsel, your
/ / DESIGNED FOR FEDERALLY interest income is, with certain exceptions,
TAX-FREE INCOME exempt from federal income taxes under existing
/ / DEFINED PORTFOLIO OF law. All bonds are insured as to scheduled
INSURED MUNICIPAL BONDS payments of principal and interest. This insurance
/ / AAA RATED BONDS guarantees the timely payment of principal and
/ / MONTHLY INCOME interest but does not guarantee the market value
of the bonds or the value of the Units. The market
value of the 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 DOCUMENT. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
-------------------------------------------------
SPONSORS: PART A OF THIS PROSPECTUS MAY NOT BE DISTRIBUTED
Merrill Lynch, UNLESS ACCOMPANIED BY MUNICIPAL INVESTMENT TRUST
Pierce, Fenner & Smith FUND PROSPECTUS PART B.
Incorporated INVESTORS SHOULD READ BOTH PARTS OF THIS
Smith Barney Inc. PROSPECTUS CAREFULLY AND RETAIN THEM FOR FUTURE
Prudential Securities REFERENCE.
Incorporated INQUIRIES SHOULD BE DIRECTED TO THE TRUSTEE AT
Dean Witter Reynolds Inc. 1-800-323-1508.
PaineWebber Incorporated PROSPECTUS PART A DATED SEPTEMBER 25, 1998.
<PAGE>
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Defined Asset FundsSM
Defined Asset Funds is America's oldest and largest family of unit investment
trusts, with over $115 billion sponsored over the last 25 years. Each Defined
Asset 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.
Defined Asset Funds offer several defined 'distinctives'. You know in advance
what you are investing in and that changes in the portfolio are limited - a
defined portfolio. Most defined bond funds pay interest monthly - defined
income. The portfolio offers a convenient and simple way to invest - simplicity
defined.
Your financial professional can help you select a Defined Asset Fund to meet
your personal investment objectives. Our size and market presence enable us to
offer a wide variety of investments. The Defined Asset Funds family offers:
o Municipal portfolios
o Corporate portfolios
o Government portfolios
o Equity portfolios
o International portfolios
The terms of Defined Funds are as short as one year or as long as 30 years.
Special defined funds are available including: insured funds, double and triple
tax-free funds and funds with 'laddered maturities' to help protect against
changing interest rates. Defined Asset Funds are offered by prospectus only.
- ----------------------------------------------------------------
Defined Insured Series
- ----------------------------------------------------------------
Our defined portfolio of municipal bonds offers you a simple and convenient way
to earn federally tax-free monthly income. By purchasing Defined Asset Funds,
you not only receive professional selection but also gain the advantage of
reduced risk by investing in bonds of several different issuers.
INVESTMENT OBJECTIVE
To provide interest income exempt from federal income taxes through investment
in a fixed portfolio consisting primarily of insured long-term municipal bonds
issued by or on behalf of states and their local governments and authorities.
The information in this prospectus is as of June 30, 1998, the evaluation date.
DIVERSIFICATION
The Portfolio contains 13 bonds. Spreading your investment among different
issuers reduces your risk, but does not eliminate it. Because of maturities,
sales or other dispositions of bonds, the size, composition and return of the
Portfolio will change over time.
- ----------------------------------------------------------------
Defining Your Portfolio
- ----------------------------------------------------------------
PROFESSIONAL SELECTION AND SUPERVISION
The Portfolio contains a variety of bonds selected by experienced buyers. The
Fund is not actively managed; however, it is regularly reviewed and a bond can
be sold if retaining it is considered detrimental to investors' interests.
TYPES OF BONDS
The Portfolio consists of municipal bonds of the following types:
APPROXIMATE
PORTFOLIO
PERCENTAGE
/ /Hospitals/Nursing Homes/Mental
Health Facilities 31%
/ / Housing 3%
/ / Industrial Development Revenue 8%
/ / Lease Rental Appropriation 13%
/ / Municipal Water/Sewer Utilities 13%
/ / Refunded Bonds 23%
/ / State/Local Municipal Electric
Utilities 9%
INSURANCE
The bonds included in the Portfolio are insured. This insurance guarantees the
timely payment of principal of and interest on the bonds, but does not guarantee
the value of the bonds or the Fund units. Insurance may not cover accelerated
payments of principal or any increase in interest payments or premiums payable
on mandatory redemptions, including if interest on a bond is determined to be
taxable (see Bonds Backed by Letters of Credit or Insurance in Part B.) The
approximate percentage of the aggregate face amount insured by each insurance
company is:
APPROXIMATE
PORTFOLIO
INSURANCE COMPANY PERCENTAGE
AMBAC Indemnity Corporation 31%
Connie Lee Insurance Company 6%
Financial Guaranty Insurance Company 19%
MBIA Insurance Corporation 44%
A-2
<PAGE>
BOND CALL FEATURES
It is possible that during periods of falling interest rates, a bond with a
coupon higher than current market rates will be prepaid or 'called', at the
option of the bond issuer, before its expected maturity. When bonds are
initially callable, the price is usually at a premium to par which then declines
to par over time. Bonds may also be subject to a mandatory sinking fund or have
extraordinary redemption provisions. For example, if the bond's proceeds are not
able to be used as intended the bond may be redeemed. This redemption and the
sinking fund are often at par.
CALL PROTECTION
Although many bonds are subject to optional refunding or call provisions, we
have selected bonds with call protection. This call protection means that any
bond in the Portfolio generally cannot be called for a number of years after the
initial date of deposit (which was July 20, 1994) and thereafter at a declining
premium over par.
TAX INFORMATION
Based on the opinion of bond counsel, interest income from the bonds held by
this Fund is generally 100% exempt under existing laws from federal income tax.
Any gain on a disposition of the underlying bonds or units will be subject to
tax. Non-corporate investors who have held their pro rata portions of bonds for
more than 12 months may be entitled to a 20% maximum federal tax rate for gains
from the sale of these bonds or corresponding units. Investors should consult
their tax advisers in this regard.
- ----------------------------------------------------------------
Defining Your Investment
- ----------------------------------------------------------------
PUBLIC OFFERING PRICE PER UNIT $1,087.61
The Public Offering Price as of June 30, 1998, the evaluation date, is based on
the aggregate bid side value of the underlying bonds in the Portfolio
($6,636,511), divided by the number of units outstanding (6,266) plus a sales
charge of 2.62% of the Public Offering Price (2.689% of the value of the
underlying bonds). The Public Offering Price on any subsequent date will vary.
An amount equal to principal cash, if any, as well as net accrued but
undistributed interest on the unit is added to the Public Offering Price. The
underlying bonds are evaluated by an independent evaluator at 3:30 p.m. Eastern
time on every business day thereafter.
REINVESTMENT OPTION
You can elect to automatically reinvest your distributions into a separate
portfolio of municipal bonds that earn income free from regular federal income
tax. Most or all of the bonds in that portfolio, however, will not be insured.
Reinvesting helps to compound your income tax-free.
PREMIUM AND DISCOUNT ISSUES
On the evaluation date, 87% of the bonds were valued at a premium over par and
13% at a discount from par (see Risk Factors in Part B).
PRINCIPAL DISTRIBUTIONS
Principal from sales, redemptions and maturities of bonds in the Fund will be
distributed to investors periodically when the amount to be distributed is more
than $5.00 per unit.
TERMINATION DATE
The Fund will generally terminate following the maturity date of the last
maturing bond listed in the Portfolio. The Fund may be terminated if the value
of the Portfolio is less than 40% of the face amount of bonds deposited.On the
evaluation date the value of the Fund was 82% of the face amount of bonds
deposited.
- ----------------------------------------------------------------
Defining Your Risks
- ----------------------------------------------------------------
RISK FACTORS
Unit price fluctuates and could be adversely affected by increasing interest
rates as well as the financial condition of the issuers of the bonds and the
insurance companies backing the bonds. Because of the possible maturity, sale or
other disposition of securities, the size, composition and return of the
portfolio may change at any time. Because of sales charges, returns of principal
and fluctuations in unit price, among other reasons, the sale price will
generally be less than the cost of your units. Unit prices could also be
adversely affected if a limited trading market exists in any security to be
sold. There is no guarantee that the Fund will achieve its investment objective.
The Fund is concentrated in Hospital/Nursing Home/Mental Health Facility bonds
and is therefore dependent to a significant extent on revenues generated by
those particular activities, as well as on the financial condition of the
insurers (see Risk Factors in Part B).
A-3
<PAGE>
- ----------------------------------------------------------------
Defining Your Income
- ----------------------------------------------------------------
MONTHLY FEDERALLY TAX-FREE INTEREST INCOME
The Fund pays monthly income, even though the bonds generally pay interest
semi-annually.
WHAT YOU MAY EXPECT
(PAYABLE ON THE 25TH DAY OF THE MONTH TO HOLDERS OF RECORD ON THE 10TH DAY OF
THE MONTH):
Regular Monthly Income per unit: $ 4.75
Annual Income per unit: $ 57.02
These figures are estimates determined as of the evaluation date and actual
payments may vary.
- ----------------------------------------------------------------
Defining Your Costs
- ----------------------------------------------------------------
SALES CHARGES
Although the Fund is a unit investment trust rather than a mutual fund, the
following information is presented to permit a comparison of fees and an
understanding of the direct or indirect costs and expenses that you pay.
As a %
of Secondary
Market
Public
Offering Price
--------------
Maximum Sales Charges 2.90%
ESTIMATED ANNUAL FUND OPERATING EXPENSES
Per Unit
--------------
Trustee's Fee $ 0.70
Portfolio Supervision, Bookkeeping and
Administrative Fees $ 0.45
Evaluator's Fee $ 0.46
Other Operating Expenses $ 0.34
--------------
TOTAL $ 1.95
REDEEMING OR SELLING YOUR INVESTMENT
You may redeem or sell your units at any time. Your price is based on the Fund's
then current net asset value (based on the lower, bid side evaluation of the
bonds, as determined by an independent evaluator), plus principal cash, if any,
as well as accrued interest. The bid side redemption and secondary market
repurchase price as of the evaluation date was $1,059.13 ($28.48 less than the
Public Offering Price). There is no fee for redeeming or selling your units.
- --------------------------------------------------------------------------------
TAX-FREE VS. TAXABLE INCOME: A COMPARISON OF TAXABLE AND TAX-FREE YIELDS
<TABLE><CAPTION>
EFFECTIVE
TAXABLE INCOME 1998* % TAX TAX-FREE YIELD OF
SINGLE RETURN JOINT RETURN BRACKET 3% 3.5% 4% 4.5% 5% 5.5% 6% 6.5%
IS EQUIVALENT TO A TAXABLE YIELD OF
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
$ 0- 25,350 $ 0- 42,350 15.00 3.53 4.12 4.71 5.29 5.88 6.47 7.06 7.65
- ----------------------------------------------------------------------------------------------------------
$ 25,351- 61,400 $ 42,351-102,300 28.00 4.17 4.86 5.56 6.25 6.94 7.64 8.33 9.03
- ----------------------------------------------------------------------------------------------------------
$ 61,401-128,100 $102,301-155,950 31.00 4.35 5.07 5.80 6.52 7.25 7.97 8.70 9.42
- ----------------------------------------------------------------------------------------------------------
$128,101-278,450 $155,951-278,450 36.00 4.69 5.47 6.25 7.03 7.81 8.59 9.38 10.16
- ----------------------------------------------------------------------------------------------------------
OVER $278,450 OVER $278,450 39.60 4.97 5.79 6.62 7.45 8.28 9.11 9.93 10.76
- ----------------------------------------------------------------------------------------------------------
</TABLE>
To compare the yield of a taxable security with the yield of a federally
tax-free security, find your taxable income and read across. The table
incorporates 1998 federal income tax rates and assumes that all income would
otherwise be taxed at U.S. investor's highest tax rate. Yield figures are for
example only.
*Based upon net amount subject to federal income tax after deductions and
exemptions. This table does not reflect the possible effect of other tax
factors, such as alternative minimum tax, personal exemptions, the phase out of
exemptions, itemized deductions, the possible partial disallowance of deductions
or state and local taxation. Consequently, investors are urged to consult their
own tax advisers in this regard.
A-4
<PAGE>
MUNICIPAL INVESTMENT TRUST FUND,
INSURED SERIES - 207,
DEFINED ASSET FUNDS
REPORT OF INDEPENDENT ACCOUNTANTS
The Sponsors, Trustee and Holders
of Municipal Investment Trust Fund,
Insured Series - 207, Defined Asset Funds:
We have audited the accompanying statement of condition of
Municipal Investment Trust Fund, Insured Series - 207,
Defined Asset Funds, including the portfolio, as of June
30, 1998 and the related statements of operations and of
changes in net assets for the years ended June 30, 1998,
1997 and 1996. 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 June 30,
1998, as shown in such portfolio, were confirmed to us by
The Chase Manhattan Bank, 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 Municipal Investment Trust Fund,
Insured Series - 207, Defined Asset Funds at June 30, 1998
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.
August 7, 1998
D - 1.
<PAGE>
MUNICIPAL INVESTMENT TRUST FUND,
INSURED SERIES - 207,
DEFINED ASSET FUNDS
STATEMENT OF CONDITION
As of June 30, 1998
<TABLE>
<S> <C> <C>
TRUST PROPERTY:
Investment in marketable securities -
at value (cost $ 5,965,146 )(Note 1)......... $ 6,636,513
Accrued interest ............................... 154,213
Cash - income .................................. 1,334
Cash - principal ............................... 17,794
-----------
Total trust property ......................... 6,809,854
LESS LIABILITIES:
Income advance from Trustee.....................$ 74,194
Accrued Sponsors' fees ......................... 1,501 75,695
----------- -----------
NET ASSETS, REPRESENTED BY:
6,266 units of fractional undivided
interest outstanding (Note 3)................ 6,654,307
Undistributed net investment income ............ 79,852 $ 6,734,159
----------- ===========
UNIT VALUE ($ 6,734,159 / 6,266 units )........... $ 1,074.71
===========
</TABLE>
See Notes to Financial Statements.
D - 2.
<PAGE>
MUNICIPAL INVESTMENT TRUST FUND,
INSURED SERIES - 207,
DEFINED ASSET FUNDS
STATEMENTS OF OPERATIONS
<TABLE><CAPTION>
Years Ended June 30,
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
INVESTMENT INCOME:
Interest income ........................$ 395,554 $ 431,352 $ 456,814
Trustee's fees and expenses ............ (10,227) (10,460) (11,491)
Sponsors' fees ......................... (3,131) (3,185) (3,345)
------------------------------------------------
Net investment income .................. 382,196 417,707 441,978
------------------------------------------------
REALIZED AND UNREALIZED GAIN
ON INVESTMENTS:
Realized gain on
securities sold or redeemed .......... 63,505 35,847 14,598
Unrealized appreciation
of investments ....................... 189,327 226,048 141,762
------------------------------------------------
Net realized and unrealized
gain on investments ................. 252,832 261,895 156,360
------------------------------------------------
NET INCREASE IN NET ASSETS
RESULTING FROM OPERATIONS ..............$ 635,028 $ 679,602 $ 598,338
================================================
</TABLE>
See Notes to Financial Statements.
D - 3.
<PAGE>
MUNICIPAL INVESTMENT TRUST FUND,
INSURED SERIES - 207,
DEFINED ASSET FUNDS
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE><CAPTION>
Years Ended June 30,
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
OPERATIONS:
Net investment income ..................$ 382,196 $ 417,707 $ 441,978
Realized gain on
securities sold or redeemed .......... 63,505 35,847 14,598
Unrealized appreciation
of investments ....................... 189,327 226,048 141,762
------------------------------------------------
Net increase in net assets
resulting from operations ............ 635,028 679,602 598,338
------------------------------------------------
DISTRIBUTIONS TO HOLDERS (Note 2):
Income ................................ (382,281) (418,817) (442,347)
Principal .............................. (21,914) (18,825) (4,267)
------------------------------------------------
Total distributions .................... (404,195) (437,642) (446,614)
------------------------------------------------
SHARE TRANSACTIONS:
Redemption amounts - income ............ (8,486) (6,776) (3,071)
Redemption amounts - principal ......... (700,379) (617,860) (281,046)
------------------------------------------------
Total share transactions ............... (708,865) (624,636) (284,117)
------------------------------------------------
NET DECREASE IN NET ASSETS ............... (478,032) (382,676) (132,393)
NET ASSETS AT BEGINNING OF YEAR .......... 7,212,191 7,594,867 7,727,260
------------------------------------------------
NET ASSETS AT END OF YEAR ................$ 6,734,159 $ 7,212,191 $ 7,594,867
================================================
PER UNIT:
Income distributions during
year .................................$ 57.25 $ 57.62 $ 57.72
================================================
Principal distributions during
year .................................$ 3.26 $ 2.57 $ 0.55
================================================
Net asset value at end of
year .................................$ 1,074.71 $ 1,041.02 $ 1,007.68
================================================
TRUST UNITS:
Redeemed during year ................... 662 609 273
Outstanding at end of year ............. 6,266 6,928 7,537
================================================
</TABLE>
See Notes to Financial Statements.
D - 4.
<PAGE>
MUNICIPAL INVESTMENT TRUST FUND,
INSURED SERIES - 207,
DEFINED ASSET FUNDS
NOTES TO FINANCIAL STATEMENTS
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 "How to Sell Units - Trustee's Redemption of Units"
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 "Income,
Distributions and Reinvestment - Distributions" in this Prospectus,
Part B.
3. NET CAPITAL
<TABLE>
<S> <C>
Cost of 6,266 units at Date of Deposit .....................$ 6,314,614
Less sales charge .......................................... 284,163
-----------
Net amount applicable to Holders ........................... 6,030,451
Redemptions of units - net cost of 1,734 units redeemed
less redemption amounts (principal)....................... (119,332)
Realized gain on securities sold or redeemed ............... 116,827
Principal distributions .................................... (45,006)
Unrealized appreciation of investments...................... 671,367
-----------
Net capital applicable to Holders ..........................$ 6,654,307
===========
</TABLE>
4. INCOME TAXES
As of June 30, 1998, unrealized appreciation of investments, based on cost
for Federal income tax purposes, aggregated $671,367, all of which related
to appreciated securities. The cost of investment securities for Federal
income tax purposes was $5,965,146 at June 30, 1998.
D - 5.
<PAGE>
MUNICIPAL INVESTMENT TRUST FUND,
INSURED SERIES - 207,
DEFINED ASSET FUNDS
PORTFOLIO
As of June 30, 1998
<TABLE><CAPTION>
Rating of Optional
Portfolio No. and Title of Issues Face Redemption
Securities (1) (4) Amount Coupon Maturities(3) Provisions(3) Cost Value(2)
---------- --------- ----------- ----------- ------------ ------------ ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
1 City of Chicago, IL, Wastewater AAA $ 505,000 6.375 % 2024(5) 01/01/05 $ 508,212 $ 572,170
Transmission Rev. Bonds, Ser. 1994 @ 102.000
(MBIA INS.)
2 Loudon Cnty. Sanit. Auth., VA, Wtr. & AAA 585,000 6.250 2030(5) 01/01/03 585,000 634,737
Swr. Sys. Rev. Bonds, Rfdg. Ser. 1992 @ 100.000
(Financial Guaranty Ins.)
3 North Carolina Eastern Mun. Pwr. Agy., AAA 555,000 6.250 2023 01/01/03 547,707 603,035
Pwr. Sys. Rev. Bonds, Ser. 1993 @ 102.000
(Financial Guaranty Ins.)
4 City of Santa Fe, NM, Rev. Bonds, AAA 305,000 6.300 2024(5) 06/01/04 307,196 337,745
Ser. 1994 A (AMBAC Ins.) @ 100.000
5 Municipality of Metro. Seattle, AAA 800,000 6.300 2033 01/01/03 800,000 869,144
WA, Swr. Rev. Bonds, Ser. W @ 102.000
(MBIA Ins.)
6 Washington Hlth. Care Fac. Auth. Rev. AAA 385,000 5.625 2013 01/01/03 358,851 402,999
Bonds (Franciscan Hlth. Sys. /St. @ 102.000
Joseph Hosp. and Hlth. Care Ctr.,
Tacoma), Rfdg. Ser. 1993 (MBIA Ins.)
7 Wyoming Cmnty. Dev. Auth., Single AAA 155,000 6.100 2033 06/01/03 150,507 160,464
Family Mtge. Bonds, Ser. 1993 A (MBIA @ 102.000
Ins.)
8 City of Henderson, NV, Ins. Hlth. Fac. AAA 800,000 5.000 2020 07/01/04 667,896 773,072
Rfdg. Rev. Bonds (Catholic Healthcare @ 102.000
West), Ser. 1994 A (AMBAC Ins.)
9 Illinois Hlth. Fac. Auth. Rev. Bonds AAA 405,000 6.125 2021 08/15/04 393,267 438,093
(The University of Chicago Hosp. @ 102.000
Proj.), Ser. 1994 (MBIA Ins.)
</TABLE>
D - 6.
<PAGE>
MUNICIPAL INVESTMENT TRUST FUND,
INSURED SERIES - 207,
DEFINED ASSET FUNDS
PORTFOLIO
As of June 30, 1998
<TABLE><CAPTION>
Rating of Optional
Portfolio No. and Title of Issues Face Redemption
Securities (1) (4) Amount Coupon Maturities(3) Provisions(3) Cost Value(2)
---------- --------- ----------- ----------- ------------ ------------ ---------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
10 Indiana State Office Bldg. Comm. AAA $ 805,000 5.250 % 2015 07/01/03 $ 711,644 $ 807,335
Capital Complex Rev. Bonds (Indania @ 102.000
Govt. Ctr. North), Ser. 1993 B (AMBAC
Ins.)
11 Massachusetts Hlth. & Educl. Fac. Auth. AAA 370,000 5.750 2018 07/01/04 342,846 387,372
Rev. Bonds, Valley Regl. Hlth. Sys. @ 102.000
Issue Ser. C (Connie Lee Ins.)
12 Metropolitan Pier and Expo. Auth., IL, AAA 55,000 6.500 2022(5) 06/15/03 55,637 61,608
McCormick Place Expansion Proj. Bonds, @ 102.000
Ser. 1992 A (Financial Guaranty Ins.)
5,000 6.500 2022 06/15/03 5,058 5,506
@ 102.000
13 The Poll. Ctl. Fin. Auth. of Salem AAA 530,000 6.250 2031 06/01/04 531,325 583,233
Cnty., NJ, Poll. Ctl. Rev. Rfdg. Bonds @ 102.000
(Pub. Svc. Elec. & Gas Co. Proj.), 1994
Ser. B (MBIA Ins.)
--------- --------- ---------
TOTAL $ 6,260,000 $ 5,965,146 $ 6,636,513
========= ========= =========
See Notes to Portfolio.
</TABLE>
D - 7.
<PAGE>
MUNICIPAL INVESTMENT TRUST FUND,
INSURED SERIES - 207,
DEFINED ASSET FUNDS
NOTES TO PORTFOLIO
As of June 30, 1998
<TABLE><CAPTION>
<S> <C>
(1) The ratings of the bonds are by Standard & Poor's Ratings Group, or by Moody's
Investors Service, Inc. if followed by "(m)", or by Fitch Investors Service,
Inc. if followed by "(f)"; "NR" indicates that this bond is not currently rated
by any of the above-mentioned rating services. These ratings have been furnished
by the Evaluator but not confirmed with the rating agencies. See
"Description of Ratings" in Part B of this Prospectus.
(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) All securities are insured, either on an individual basis or by portfolio
insurance, by a municipal bond insurance company which has been assigned
"AAA" claims paying ability by Standard & Poor's. Accordingly, Standard &
Poor's has assigned a "AAA" rating to the securities. Securities covered by
portfolio insurance are rated "AAA" only as long as they remain in the Trust.
See "Risk Factors - Bonds Backed by Letters of Credit or Insurance" in this
Prospectus, Part B.
(5) Bonds with an aggregate face amount of $ 1,450,000 have been pre-refunded and are
expected to be called for redemption on the optional redemption provision
dates shown.
</TABLE>
D - 8f
<PAGE>
MUNICIPAL INVESTMENT TRUST FUND
INSURED SERIES
DEFINED ASSET FUNDS
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.
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<PAGE>
BUSINESS REPLY MAIL NO POSTAGE
FIRST CLASS PERMIT NO. 644, NEW YORK, NY NECESSARY
IF MAILED
POSTAGE WILL BE PAID BY ADDRESSEE IN THE
THE CHASE MANHATTAN BANK (MITF) UNITED STATES
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- --------------------------------------------------------------------------------
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<PAGE>
<PAGE>
DEFINED ASSET FUNDSSM
PROSPECTUS--PART B
MUNICIPAL INVESTMENT TRUST FUND
DEFINED ASSET FUNDS MUNICIPAL SERIES
FURTHER DETAIL REGARDING ANY OF THE INFORMATION PROVIDED IN THE PROSPECTUS MAY
BE OBTAINED
WITHIN FIVE DAYS BY WRITING OR CALLING THE TRUSTEE, THE ADDRESS AND
TELEPHONE NUMBER OF WHICH ARE SET FORTH ON THE BACK COVER OF PART A OF THIS
PROSPECTUS.
Index
PAGE
---------
Fund Description...................................... 1
Risk Factors.......................................... 2
How to Buy Units...................................... 8
How to Redeem or Sell Units........................... 10
Income, Distributions and Reinvestment................ 11
Fund Expenses......................................... 12
Taxes................................................. 13
Records and Reports................................... 14
PAGE
---------
Trust Indenture....................................... 14
Miscellaneous......................................... 15
Exchange Option....................................... 17
Appendix A--Description of Ratings.................... a-1
Appendix B--Secondary Market Sales Charge Schedule.... b-1
Appendix C--Sales Charge Schedules for Municipal Asset
Funds, Municipal Series............................... c-1
Supplemental Information...............................Back Cover
FUND DESCRIPTION
BOND PORTFOLIO SELECTION
Professional buyers 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 Defined Asset Funds
were deposited 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. In a Fund that
includes multiple Trusts or Portfolios, the word Fund should be understood to
mean each individual Trust or Portfolio.
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 refundings)
that, in the opinion of the Sponsors 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.
Every investment involves some risk; for example, the market prices of most
fixed-income investments decline when interest rates rise, and this exposure
increases with the remaining life of the investment. Historically, however,
municipal bonds generally have been second only in creditworthiness to U.S.
government obligations. Municipal unit trusts can be an efficient alternative to
investing in actively managed funds. Active management of a portfolio of quality
municipal bonds may not be as important as with other securities. Insured bonds
provide additional assurance of prompt payments of interest and principal (but
not stability of market value). the price of the Bond or the occurrence of other
market or credit factors (including advance refunding) that, in the opinion of
the Sponsors 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 within the 90-day period
following the initial date of deposit, the Sponsors may generally deposit a
replacement bond so long as it is a tax-exempt bond that is not a 'when, as and
if issued' 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 the initial date of
deposit, 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
2
<PAGE>
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, if the value of any
short-term Bonds intended 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.
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. Recent
and significant changes in Federal welfare policy may have substantial negative
impact on certain states, and localities within those states, making their
ability to maintain balanced finances more difficult in the future.
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 revenues of the project,
excise taxes 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. The
3
<PAGE>
movement to introduce competition in the investor-owned electric utility
industry is likely to indirectly affect municipal utility systems by
inducing them to maintain rates as low as possible. In this effort to keep
rates low, municipal utilities may have more trouble raising rates to
completely recover investment in generating plant;
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 bond is
therefore dependent upon, among other things, occupancy 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, mental health, nursing home, retirement community and visiting
nurse bonds whose payments are dependent upon revenues of hospitals and
other health care providers. 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 providers. Hospitals must also deal with
shifting competition resulting from hospital mergers and affiliations and
the need to reduce costs as HMOs increase market penetration. Nursing homes
need to keep residential facilities for the elderly, which are not
reimbursable from Medicare/Medicaid, on a profitable basis. Hospital supply
and drug companies must deal with their need to raise prices in an
environment where hospitals and other health care providers are under
intense pressure to keep their costs low. Hospitals and health care
providers are subject to various legal claims by patients and others and
are adversely affected by increasing costs of insurance. The Internal
Revenue Service has been engaged in a program of intensive audits of
certain large tax-exempt hospital and health care providers. 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. Some
hospitals have been required to pay monetary penalties to the IRS;
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
4
<PAGE>
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 (such as the recently
enacted phased repeal of the Puerto Rico and possession federal tax credit)
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 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 REPURCHASE COMMITMENTS
Certain Funds contain Bonds that were purchased from commercial banks,
savings banks, savings and loan associations or other institutions (thrifts)
that had held the Bonds in their investment portfolios prior to selling the
Bonds to the Fund. These banks or thrifts (the Sellers) have committed to
repurchase the Bonds from the Fund in certain circumstances. In some cases a
Seller's Repurchase Commitments may be backed by a security interest in
collateral or by a letter of credit (see Bonds Backed by Letters or Insurance
below).
A Seller may have committed to repurchase any Bond sold by it if necessary
to satisfy investors' unit redemption requests (a Liquidity Repurchase). A
Seller may also have committed to repurchase any Bonds sold by it if the issuer
of the Bond fails to make payments of interest or principal on the Bond (a
Default Repurchase) or if the issuer becomes or is deemed to be bankup or
insolvent (an Insolvency Repurchase). A Seller may have committed to repurchase
any Bond if the interest on that Bond becomes taxable (a Tax Repurcase).
Investors should realize that they are subject to having all or a portion of the
principal amount of their investment returned prior to termination of the Fund
if any of these situations occurs. A Seller may also have committed to
repurchase the Bonds sold by it on their scheduled disposition dates (as shown
under Portfolio in Part A) (a Disposition Repurchase). The price at which any of
these repurchases will occur (the Put Price) is hown in Part A of the
Prospectus. Any collateral securing any of the Repurchase Commitments may
consist of mortgage-backed securities issued by GNMA (Ginnie Maes), FNMA (Fannie
Maes) or FHLMC (Freddie Macs); mortgages; municipal obligations; corporate
obligations; U.S. government securities; and cash.
Investors in a Fund containing any of these credit-supported Bonds should
be aware that many thrifts have failed in recent years and that the thrift
industry generally has experienced severe strains. New federal legislation has
resulted that imposes new limitations on the ways banks and thrifts may do
business and mandates aggressive, early intervention into unhealthy
institutions. One result of this legislation is an increased possibility of
early payment of the principal amount of an investment in Bonds backed by
collateralized letters of credit or repurchase commitments if a Seller becomes
or is deemed to be insolvent.
5
<PAGE>
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 an Insured Series, in the event that the rating of an insurance
company insuring a bond 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, except at the
sole option of the insurer, 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 DECEMBER 31, 1996
(IN MILLIONS OF DOLLARS)
--------------------------------------
POLICYHOLDERS'
NAME DATE ESTABLISHED ADMITTED ASSETS SURPLUS
- ---------------------------------------------------- ----------------- --------------- ---------------------
<S> <C> <C> <C>
AMBAC Indemnity Corporation......................... 1970 $ 2,585 $ 899
Asset Guaranty Insurance Co. (AA by S&P) 1988 204 87
Capital Markets Assurance Corp. (CAPMAC)............ 1987 321 194
Connie Lee Insurance Company........................ 1987 233 116
Continental Casualty Company (A+ by S&P) 1948 21,168 4,638
Financial Guaranty Insurance Company................ 1984 2,392 1,093
Financial Security Assurance Inc. (FSA) (including
Financial Security Assurance of Maryland Inc.
(FSAM) (formerly Capital Guaranty Insurance
Company).......................................... 1984 1,155 449
Firemen's Insurance Company of Newark, NJ (A-by
S&P).............................................. 1855 1,930 420
Industrial Indemnity Co. (HIBI) (A+ by S&P)......... 1920 1,368 219
MBIA Insurance Corporation.......................... 1986 4,189 1,467
</TABLE>
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.
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 of the Prospectus;
further information is contained in the Information Supplement.
6
<PAGE>
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. From time to time, proposals are introduced in
Congress to, among other things, reduce federal income tax rates, impose a flat
tax, exempt investment income from tax or abolish the federal income tax and
replace it with another form of tax. Enactment of any such legislation could
adversely affect the value of the Units. The Fund, however, cannot predict what
legislation, if any, in respect of tax rates may be proposed, nor can it predict
which proposals, if any, might be enacted.
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
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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
aasdversely 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.
Net accrued interest and principal cash, if any, are 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.
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 may consist of cash in an amount necessary for the Trustee to
provide approximately equal distributions. Upon the sale or redemption of Units,
investors will receive their proportionate share of this cash. In addition, if a
Bond is sold, redeemed or otherwise disposed of, the Fund will periodically
distribute to investors the portion of this cash that is attributable to the
Bond.
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--THE FOLLOWING SECTIONS APPLY TO TWO DIFFERENT TYPES OF
DEFINED MUNICIPAL FUNDS. INVESTORS SHOULD NOTE THE EXACT NAME OF THE FUND ON THE
COVER OF PART A OF THE PROSPECTUS TO MAKE SURE THEY REFER TO THE CORRECT SECTION
BELOW.
SECTION A--MUNICIPAL INVESTMENT TRUST FUND
Funds Without a Deferred Sales Charge:
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 scheduled in
Appendix B) and (b) the maturities of the underlying Bonds (see Effective Sales
Charge Schedule in Appendix B). 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
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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 B. 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.
Funds with a Deferred Sales Charge:
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 at the next Evaluation Time
after the order is received. Units redeemed or repurchased prior to the accrual
of the final Deferred Sales Charge installment will have the amount of any
remaining installments deducted from the redemption or repurchase proceeds,
although this deduction will be waived in the event of the death or disability
(as defined in the Internal Revenue Code of 1986) of an investor. Units
purchased after the deduction of the first Deferred Sales Charge installment
will be charged the up-front per Unit sales charge indicated in Part A of this
Prospectus based on the Public Offering Price (less the value of the short-term
bonds reserved to pay the deferred sales charge not yet accrued), multiplied by
the number of Deferred Sales Charge installments already deducted. Units
purchased after the deduction of the final Deferred Sales Charge installment
will be subject only to an up-front sales charge based on the maturities of the
bonds in the Portfolio, as set forth in Appendix B.
SECTION B--DEFINED ASSET FUNDS MUNICIPAL SERIES
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 at the next Evaluation Time
after the order is received. 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 C. 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 for the SEC.
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 Redeem or Sell Units--
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Redeeming Units with the Trustee). 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.
HOW TO REDEEM OR SELL UNITS
You can redeem your Units at any time for a price based on net asset value.
In addition, the Sponsors have maintained an uninterrupted secondary market for
Units for over 20 years and will ordinarily buy back Units at the same price.
The following describes these two methods to redeem or sell Units in greater
detail.
REDEEMING UNITS WITH THE TRUSTEE
You can always redeem your Units directly with the Trustee for net asset
value. This can be done by sending the Trustee a redemption request together
with any Unit certificates you hold, which 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 trust instrument, certificate of corporate authority, certificate of
death or appointment as executor, administrator or guardian.
Within seven days after the Trustee's receipt of your request containing
the necessary documents, a check will be mailed to you in an amount based on the
net asset value of your Units. Because of sales charges, market movements or
changes in the Portfolio, net asset value at the time you redeem your Units may
be greater or less than the original cost of your Units. Net asset value is
calculated 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 and any remaining
deferred sales charges, 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 Funds with deferred sales charges, if you redeem or sell your Units
before the final deferred sales charge installment date, the remaining deferred
sales charges will be deducted from the net asset value.
As long as the Sponsors are maintaining a secondary market for Units (as
described below), the Trustee will not actually redeem your Units but will sell
them to the Sponsors for net asset value. If the Sponsors are not maintaining a
secondary market, the Trustee will redeem your Units for net asset value or will
sell your Units in the over-the-counter market if the Trustee believes it will
obtain a higher net price for your Units. If the Trustee is able to sell the
Units for a net price higher than net asset value, you will receive the net
proceeds of the sale.
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 may
also reduce the size and diversity of the Fund. If Bonds are being sold during a
time when additional Units are being created by the purchase of additional Bonds
(as described under Portfolio Selection), Bonds will be sold in a manner
designed to maintain, to the extent practicable, the proportionate relationship
among the face amounts of each Bond in the Portfolio.
The Trustee is authorized, on a redemption request for Units with a value
exceeding $250,000 by any investor who acquired 25% or more of the outstanding
Units of a Trust, to pay part or all of the redemption 'in kind' (by the
distribution of Bonds and cash with an aggregate value equal to the applicable
Redemption Price of the Units tendered for redemption). The Trustee will attempt
to make a pro rata distribution of Bonds in the Portfolio, but reserves the
right to distribute solely one or more Bonds. The distribution will be made to
the distribution agent and either held for the account of the investor or
disposed of in accordance with the instructions of the investor. Any transaction
costs as well as transfer and ongoing custodial fees on sales of the Bonds
distributed in kind will be borne by the redeeming investor.
Redemptions may be suspended or payment postponed (i) if the New York Stock
Exchange is closed (other than customary weekend and holiday closings), (ii) if
the SEC determines that trading on the New York Stock Exchange is restricted or
that an emergency exists making disposal or evaluation of the Bonds not
reasonably practicable or (iii) for any other period permitted by SEC order.
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SPONSORS' SECONDARY MARKET FOR UNITS
The Sponsors, while not obligated to do so, will buy back Units at net
asset value without any other fee or charge as long as they are maintaining a
secondary market for Units. Because of sales charges, market movements or
changes in the portfolio, net asset value at the time you sell your Units may be
greater or less than the original cost of your Units. The Sponsors may resell
the Units to other buyers or redeem the Units by tendering them to the Trustee.
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 the secondary market for Units without prior
notice if the supply of Units exceeds demand or for other business reasons.
Regardless of whether the Sponsors maintain a secondary market, you have the
right to redeem your Units for net asset value with the Trustee at any time, as
described above.
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 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,
distributions of amounts necessary to pay any deferred 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 estimated annual income per Unit, after deducting estimated annual Fund
expenses and the portion of any 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.
RETURN CALCULATIONS
Estimated Current Return shows the estimated annual cash to be received
from interest-bearing bonds in a 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 Trust. This represents an average of the yields to
maturity (or in certain cases, to an earlier call date) of the individual
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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.
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. Advertisements and sales
literature may illustrate the effects of compounding at different hypothetical
interest rates. 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 maintaining
the Fund's registration statement current with Federal and State authorities,
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
currently estimated at $0.35 per $1,000 face amount to reimburse them for the
cost of providing Portfolio supervisory services to the Fund. The Sponsors may
also be reimbursed for their costs of providing bookkeeping and administrative
services to Defined Asset Funds, currently estimated at $0.10 per Unit. While
these fees may exceed their costs of providing services to the Fund, the total
Sponsor 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 Trustee's, Sponsors' and Evaluator's fees may be adjusted for inflation
without investors' approval.
All or a portion of expenses incurred in establishing certain Funds, as
shown in Part A of the Prospectus, including the cost of the initial preparation
of documents relating to the Fund, Federal and State registration fees, the
initial fees and expenses of the Trustee, legal expenses and any other
out-of-pocket expenses will be paid by the Fund and amortized over five years.
Advertising and selling expenses 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. Because our portfolios
rarely hold any significant amount of cash, your money is more fully invested.
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TAXES
The following summary describes some of the important income tax
consequences of holding Units, assuming that the investor is not a dealer,
financial institution or insurance company or other investor with special
circumstances. Investors should consult their tax advisers about an investment
in the Fund.
At the date of issue of each Bond, counsel for the issuer delivered an
opinion to the effect that interest on the Bond is generally exempt from regular
federal income tax. However, interest may be taken into account in determining
alternative minimum tax under certain circumstances and may also be subject to
state and local taxes. Neither the Sponsors nor Davis Polk & Wardwell has
reviewed the issuance of the Bonds, related proceedings or the basis of the
opinions of counsel for the issuers. There can be no assurance, therefore, that
the issuer (or other users) have complied or will comply with any requirements
necessary for a bond to be tax-exempt. If any of the Bonds were determined not
to be tax-exempt, investors may be required to pay income tax for current and
prior years, and if the Fund were to sell the Bond, it might have to sell it at
a substantial discount.
In the opinion of Davis Polk & Wardwell, special counsel for the Sponsors,
under existing law:
GENERAL TREATMENT OF THE FUND
The Fund will not be taxed as a corporation for federal income tax
purposes, and each investor will be considered to own directly a share of each
Bond in the Fund.
INCOME OR LOSS UPON DISPOSITION
Upon a disposition of all or part of an investor's pro rata portion of a
Bond (by sale, exchange or redemption of the Bond or his Units), an investor
will generally recognize capital gain or loss. However, gain from the
disposition will generally be ordinary income to the extent of any accrued
'market discount'. An investor will generally have market discount to the extent
that his basis in a bond when he purchases a Unit is less than its stated
redemption price at maturity (or, if it is an 'original issue discount' bond,
the issue price increased by 'original issue discount' that has accrued to
previous holders). Investors should consult their tax advisers in this regard.
The excess of a non-corporate investor's net long-term capital gains over
his net short-term capital losses may be subject to tax at a lower rate than
ordinary income. A capital gain or loss is long-term if the investment is held
for more than one year and short-term if held for one year or less. Because the
deduction of capital losses is subject to limitations, an investor may not be
able to deduct all of his capital losses.
INVESTOR'S BASIS IN THE BONDS
An investor's aggregate basis in the Bonds will be equal to the cost of his
Units, including any sales charges and the organizational expenses borne by the
investor but excluding any amount paid for accrued interest, and adjusted to
reflect any accruals of 'original issue discount', 'acquisition premium' and
'bond premium'. Investors should consult their tax advisers in this regard.
EXPENSES
A non-corporate investor is not entitled to a deduction for his pro rata
share of fees and expenses of the Fund. Also, if an investor borrowed money in
order to purchase or carry his Units, he will not be able to deduct the interest
on this borrowing. The Internal Revenue Service may treat an investor's purchase
of Units as made with borrowed money even if the borrowed money was not directly
used to purchase the Units.
STATE AND LOCAL TAXES
Under the income tax laws of the State and City of New York, the Fund will
not be taxed as a corporation. The income recognized by investors that are New
York taxpayers will not be tax-exempt in New York except to the extent it is
earned on Bonds that are tax-exempt for New York purposes. Depending on where
investors live, income from the Fund may be subject to state and local taxation.
Investors should consult their tax advisers in this regard.
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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 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.
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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 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 on the back cover 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 New York
State banking authorities.
SPONSORS
The Sponsors are listed on the back cover 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.
CODE OF ETHICS
The Agent for the Sponsors has adopted a code of ethics requiring
preclearance and reporting of personal securities transactions by its personnel
who have access to information on Defined Asset Funds portfolio transactions.
The code is intended to prevent any act, practice or course of conduct which
would operate as a fraud or deceit on any Fund and to provide guidance to these
persons regarding standards of conduct consistent with the Agent's
responsibilities to the Funds.
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.
15
<PAGE>
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, 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 this 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.
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. Average annual compounded rates of return of selected asset
classes over various periods of time may also be compared to the rate of
inflation over the same periods.
DEFINED ASSET FUNDS
Municipal Investment Trust Funds have provided investors with tax-free
income and balance for their portfolios for more than 30 years. As tax reforms
over the years have eliminated many of the ways to reduce individual taxes,
municipal bonds have remained a significant source of tax-free income. 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. Defined equity funds offer growth potential and some
protection against inflation. 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.
Defined Asset Funds reflect a buy and hold strategy that the Sponsors
believe can be more effective and cost-effective than active management. This
strategy is premised on selection criteria and procedures, diversification and
regular monitoring by investment professionals. Various advertisements and sales
literature may summarize the results of economic studies concerning how stock
market movement has tended to be concentrated and how longer-term investments
can tend to reduce risk.
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.
16
<PAGE>
Most investment experts recommend stocks for long-term capital growth. Long-term
corporate bonds offer relatively high rates of interest income.
EXCHANGE OPTION
You may exchange Units of the Fund for units of certain other Defined Asset
Funds subject only to a reduced sales charge.
Upon the deduction of the final Deferred Sales Charge installment for the
Fund, you may exchange your units of any Municipal Investment Trust Fund
Intermediate Term Series with a regular maximum sales charge of at least 3.25%,
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
on the units being exchanged, 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. 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 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.
17
<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 from AA to CCC may be modified by the addition of a plus or
minus sign to show relative standing within the major rating categories.
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.
* Continuance of the rating is contingent upon S&P's receipt of an executed
copy of the escrow agreement or closing documentation confirming investments and
cash flows.
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
a-1
<PAGE>
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
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
MUNICIPAL INVESTMENT TRUST FUND
SECONDARY MARKET SALES CHARGE SCHEDULE
ACTUAL SALES CHARGE AS DEALER CONCESSION AS
PERCENT OF EFFECTIVE PERCENT OF EFFECTIVE
NUMBER OF UNITS SALES CHARGE SALES CHARGE
- ----------------- ------------------------- -------------------------
1-249 100% 65.00%
250-499 80 52.00
500-749 60 39.00
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 less than 1 year 0.503 0.50
1 year to less than 2 years 1.010 1.00
2 years to less than 3 years 1.523 1.50
3 years to less than 4 years 2.302 2.25
4 years to less than 5 years 2.828 2.75
5 years to less than 6 years 3.093 3.00
6 years to less than 7 years 3.359 3.25
7 years to less than 8 years 3.627 3.50
8 years to less than 9 years 4.167 4.00
9 years to less than 12 years 4.439 4.25
12 years to less than 15 years 4.712 4.50
15 years or more 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; (although not called)
its yield to maturity is more than 40 basis points higher than its yield to any
call date; funds or securities have been placed in escrow to redeem it on an
earlier date; or the Bond is subject to a mandatory tender. In each of these
cases the earlier date will be considered the maturity date.
For Funds with a deferred sales charge, Units purchased after the deduction
of the final deferred sales charge installment will be subject only to an
up-front sales charge based on the maturities of the bonds in the Portfolio, as
set forth above. The dealer concession for these funds with a deferred sales
charge will be 65% of the Effective Sales Charge after all deferred charges have
been deducted. Until that time, the dealer concession will be 65% of the
difference between the offer price and the remaining deferred sales charge to be
collected.
b-1
<PAGE>
DEFINED ASSET FUNDS MUNICIPAL SERIES
MUNICIPAL INVESTMENT TRUST FUND
APPENDIX C
SALES CHARGE SCHEDULES FOR DEFINED ASSET FUNDS, MUNICIPAL SERIES
DEFERRED AND UP-FRONT SALES CHARGES. Units purchased in the second through
fifth year of the Fund 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%.
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, but in no event earlier than the
business day following the fourth quarterly payment date.
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><CAPTION>
TOTAL
UP-FRONT SALES CHARGE MAXIMUM UP-FRONT AND PERIODIC
AMOUNT DEFERRED SALES
DEFERRED PER CHARGES
$1,000 INVESTED PER $1,000 INVESTED
----------------------------------------------------------- --------------- ---------------------
YEAR OF UNIT AS PERCENT OF PUBLIC AS PERCENT OF NET AMOUNT PER
PURCHASE OFFERING PRICE AMOUNT INVESTED $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>
To the extent that the initial up-front sales charge does not commence
until the business day following the fourth quarterly payment date (as provided
above), the annual increase in the up-front sales charge will be similarly
delayed.
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
c-1
<PAGE>
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:
UNITS PURCHASED ON INITIAL OFFERING DATE
<TABLE><CAPTION>
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
</TABLE>
UNITS PURCHASED ON FIRST ANNIVERSARY OF FUND
<TABLE><CAPTION>
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
</TABLE>
UNITS PURCHASED ON SECOND ANNIVERSARY OF FUND
<TABLE><CAPTION>
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
</TABLE>
UNITS PURCHASED ON THIRD ANNIVERSARY OF FUND
<TABLE><CAPTION>
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
</TABLE>
UNITS PURCHASED ON FOURTH ANNIVERSARY OF FUND
<TABLE><CAPTION>
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>
c-2
<PAGE>
SUPPLEMENTAL INFORMATION
Upon writing or calling the Trustee shown on the back cover of 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. 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.
PROSPECTUS FORMAT
This prospectus consists of a Part A and this Part B. The Prospectus does
not contain all of the information with respect to the investment company set
forth in its registration statement and exhibits relating thereto which have
been filed with the Securities and Exchange Commission, Washington, D.C. under
the Securities Act of 1933 and the Investment Company Act of 1940, and to which
reference is hereby made. Copies of filed material can be obtained from the
Public Reference Section of the Commission, 450 Fifth Street, N.W., Washington,
D.C. 20549 at prescribed rates. The Commission also maintains a Web site that
contains information statements and other information regarding registrants such
as Defined Asset Funds that file electronically with the Commission at
http://www.sec.gov.
No person is authorized to give any information or to make any
representations with respect to this investment company not contained in the
registration statement and related exhibits; and any information or
representation not contained therein must not be relied upon as having been
authorized. The Prospectus does not constitute an offer to sell, or a
solicitation of any offer to buy, securities in any state to any person to whom
it is not lawful to make such offer in such state.
15900-5/97
<PAGE>
DEFINED
ASSET FUNDSSM
SPONSORS: MUNICIPAL INVESTMENT
Merrill Lynch, TRUST FUND
Pierce, Fenner & Smith Incorporated Insured Series--207
Defined Asset Funds (A Unit Investment Trust)
P.O. Box 9051 PROSPECTUS PART A
Princeton, NJ 08543-9051 This Prospectus consists of a Part A and
(609) 282-8500 a Part B. This Prospectus does not
Smith Barney Inc. contain all of the information with
Unit Trust Department respect to the investment company set
388 Greenwich Street--23rd Floor forth in its registration statement and
New York, NY 10013 exhibits relating thereto which have
(212) 816-4000 been filed with the Securities and
PaineWebber Incorporated Exchange Commission, Washington, D.C.
1200 Harbor Boulevard under the Securities Act of 1933 and the
Weehawken, NJ 07087 Investment Company Act of 1940, and to
(201) 902-3000 which reference is hereby made. Copies
Prudential Securities Incorporated of filed material can be obtained from
One New York Plaza the Public Reference Section of the
New York, NY 10292 Commission, 450 Fifth Street, N.W.,
(212) 778-6164 Washington, D.C. 20549 at prescribed
Dean Witter Reynolds Inc. rates. The Commission also maintains a
Two World Trade Center--59th Floor Web site that contains information
New York, NY 10048 statements and other information
(212) 392-2222 regarding registrants such as Defined
EVALUATOR: Asset Funds that file electronically
Kenny S&P Evaluation Services, with the Commission at
a division of J. J. Kenny Co., Inc. http://www.sec.gov.
65 Broadway No person is authorized to give any
New York, NY 10006 information or to make any
TRUSTEE: representations with respect to this
The Chase Manhattan Bank investment company not contained in its
Customer Service Retail Department registration statement and exhibits
Bowling Green Station relating thereto; and any information or
P.O. Box 5187 representation not contained therein
New York, NY 10274-5187 must not be relied upon as having been
1-800-323-1508 authorized. This Prospectus does not
constitute an offer to sell, or a
solicitation of an offer to buy,
securities in any state to any person to
whom it is not lawful to make such offer
in such state.
14885--9/98
<PAGE>
MUNICIPAL INVESTMENT TRUST FUND
INSURED SERIES
DEFINED ASSET FUNDS
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 the Registration Statement on Form S-6 of Defined Asset Funds,
Municipal Insured Series, 1933 Act File No. 33-54565).
The Prospectus including Part B incorporated by reference, Defined Asset
Funds--Municipal Investment Trust Fund, Insured Series--22, 1933 Act File No.
2-93886.
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>
MUNICIPAL INVESTMENT TRUST FUND
INSURED SERIES--207
DEFINED ASSET FUNDS
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT,
MUNICIPAL INVESTMENT TRUST FUND, INSURED SERIES--207, DEFINED ASSET FUNDS
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 16TH DAY OF
SEPTEMBER, 1998.
SIGNATURES APPEAR ON PAGES R-3, R-4, R-5, R-6 AND R-7.
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 Executive Committee of the Board of
Directors of PaineWebber 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 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
ROGER M. VASEY
ARTHUR H. ZEIKEL
By DANIEL C. TYLER
(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 Numbers:
33-41631 and
333-15919
ROBERT C. GOLDEN
ALAN D. HOGAN
A. LAURENCE NORTON, JR.
LELAND B. PATON
VINCENT T. PICA II
MARTIN PFINSGRAFF
HARDWICK SIMMONS
LEE B. SPENCER, JR.
BRIAN M. STORMS
By RICHARD R. HOFFMANN
(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 Numbers:
33-49753, 33-55073
and 333-10441
JAMES DIMON
DERYCK C. MAUGHAN
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 Numbers: 33-17085 and
Reynolds Inc.: 333-13039
RICHARD M. DeMARTINI
ROBERT J. DWYER
CHRISTINE A. EDWARDS
CHARLES A. FIUMEFREDDO
JAMES F. HIGGINS
MITCHELL M. MERIN
STEPHEN R. MILLER
RICHARD F. POWERS III
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
<PAGE>
PAINEWEBBER INCORPORATED
DEPOSITOR
By the following persons, who constitute Powers of Attorney have been filed
the Board of Directors of PaineWebber under
Incorporated: the following 1933 Act File
Number: 2-61279
MARGO N. ALEXANDER
TERRY L. ATKINSON
BRIAN M. BAREFOOT
STEVEN P. BAUM
MICHAEL CULP
REGINA A. DOLAN
JOSEPH J. GRANO, JR.
EDWARD M. KERSCHNER
JAMES P. MacGILVRAY
DONALD B. MARRON
ROBERT H. SILVER
MARK B. SUTTON
By
ROBERT E. HOLLEY
(As authorized signatory for
PaineWebber Incorporated
and Attorney-in-fact for the persons listed above)
R-7
<PAGE>
EXHIBIT 4.1
STANDARD & POOR'S
A DIVISION OF THE McGRAW-HILL COMPANIES
J. J. KENNY
65 BROADWAY
NEW YORK, N.Y. 10006-2551
TELEPHONE (212) 770-4422
FAX 212/797-8681
September 16, 1998
Frank A. Ciccotto, Jr
Vice President
Tax-Exempt Evaluations
Merrill Lynch, Pierce, Fenner & Smith
Incorporated
Defined Asset Funds
P.O. Box 9051
Princeton, New Jersey 08543-9051
The Chase Manhattan Bank
4 New York Plaza--6th Floor
New York, New York 10004
RE: MUNICIPAL INVESTMENT TRUST FUND,
INSURED SERIES--207, DEFINED ASSET FUNDS
Gentlemen:
We have examined the post-effective Amendment to the Registration Statement
File No. 33-54037 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
Vice President
<PAGE>
Exhibit 5.1
CONSENT OF INDEPENDENT ACCOUNTANTS
The Sponsors and Trustee of
Municipal Investment Trust Fund--Insured Series--207, Defined Asset Fund
We consent to the use in this Post-Effective Amendment No. 4 to Registration
Statement No. 33-54037 of our opinion dated August 7, 1998 appearing in the
Prospectus, which is part of such Registration Statement, and to the reference
to us under the heading 'Miscellaneous--Auditors' in such Prospectus.
DELOITTE & TOUCHE LLP
New York, N.Y.
September 16, 1998
DEFINED ASSET FUNDS
-------------------
MUNICIPAL INVESTMENT TRUST FUND
MUNICIPAL INSURED SERIES
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 is dated September 16, 1998. Capitalized terms have
been defined in the Prospectus.
TABLE OF CONTENTS
Description of Fund Investments..............................................3
Fund Structure.............................................................3
Portfolio Supervision......................................................3
Risk Factors.................................................................5
Concentration..............................................................5
General Obligation Bonds...................................................5
Moral Obligation Bonds.....................................................6
Refunded Bonds.............................................................6
Industrial Development Revenue Bonds.......................................6
Municipal Revenue Bonds....................................................7
Municipal Utility Bonds..................................................7
Lease Rental Bonds.......................................................9
Housing Bonds............................................................9
Hospital and Health Care Bonds..........................................10
Facility Revenue Bonds..................................................11
Solid Waste Disposal Bonds..............................................12
Special Tax Bonds.......................................................12
Student Loan Revenue Bonds..............................................12
Transit Authority Bonds.................................................13
Municipal Water and Sewer Revenue Bonds.................................13
University and College Bonds............................................13
Puerto Rico...............................................................13
Bonds Backed by Letters of Credit or Repurchase Commitments...............14
Liquidity.................................................................17
Bonds Backed by Insurance.................................................18
State Risk Factors........................................................22
Payment of Bonds and Life of a Fund.......................................22
Redemption................................................................23
Tax Exemption.............................................................23
Income and Returns..........................................................24
Income....................................................................24
1
State Matters...............................................................25
Alabama...................................................................25
Arizona ..................................................................28
California................................................................31
Colorado..................................................................41
Connecticut...............................................................44
Florida ..................................................................46
Georgia ..................................................................51
Illinois..................................................................53
Louisiana.................................................................54
Maine ..................................................................56
Maryland..................................................................62
Massachusetts.............................................................67
Michigan..................................................................75
Minnesota.................................................................78
Mississippi...............................................................81
Missouri..................................................................83
New Jersey................................................................85
New Mexico................................................................86
New York..................................................................89
North Carolina............................................................96
Ohio.....................................................................101
Oregon...................................................................105
Pennsylvania.............................................................112
Tennessee................................................................114
Texas....................................................................117
Virginia.................................................................122
2
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. See Investment Summary in Part A
for a summary of particular matters relating to the Portfolio.
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.
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
3
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 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
4
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 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
5
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 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
6
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. 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
7
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 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
8
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 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
9
underlying single family issues and the ability of mortgage insurers to pay
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 financial 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
10
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 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
11
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 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
12
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.
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
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
14
in Part A) which, in turn may be backed by a letter of credit or secured by a
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 meet its obligations. These
factors also affect bank holding
15
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
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'
17
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 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 Insurance 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
18
non-cancelable 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 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
19
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.
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. 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.
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.
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.
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 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
20
college and university sector. CCLIA's founding shareholders are the U.S.
Department of Education, which owns 14% of CCLIA, and the Student Loan Marketing
Association ("Sallie Mae"), which owns 36%. 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.
Continental is a wholly-owned subsidiary of CNA Financial Corp. and
was incorporated under the laws of Illinois in 1948. 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 Insurance Company ("Financial Guaranty") is a
wholly-owned subsidiary of FGIC Corporation ("Corporation"), a Delaware holding
company. The Corporation is a wholly-owned subsidiary of General Electric
Capital Corporation ("GECC"). Neither the Corporation nor GECC is obligated to
pay the debts of or the claims against Financial Guaranty. Financial Guaranty is
domiciled in the State of New York and is subject to regulation by the State of
New York Insurance Department. As of June 30, 1997, the total capital and
surplus of Financial Guaranty was approximately $1,164,694,536. Copies of
Financial Guaranty's financial statements, prepared on the basis of statutory
accounting principles, and the Corporation's financial statements, prepared on
the basis of generally accepted accounting principles, may be obtained by
writing to Financial Guaranty at 115 Broadway, New York, New York 10006,
Attention: Communications Department [telephone number is (212) 312-3000] or to
the New York State Insurance Department at 160 West Broadway, 18th Floor, New
York, New York 10013, Attention: Financial Condition Property/Casualty Bureau
[telephone number: (212) 621-0389].
In addition, Financial Guaranty is currently licensed to write
insurance in all 50 states and the District of Columbia.
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.
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-cancelable insurance on industrial development
revenue bonds.
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. 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 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
21
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.
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.
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"State Matters" 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.
22
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.
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.
23
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 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.
24
STATE MATTERS
ALABAMA
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 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. Recent federal legislation will reduce payments made under the
Federal Medicaid Program and will change the method of calculating the payments
that are due to the states from the Federal government. Material reductions in
Federal Medicaid payments to the State of
25
Alabama are expected in 1998. If such reductions occur, it is unlikely that the
State of Alabama will be able to fund completely any resulting short-falls.
Health care providers in Alabama could be materially adversely affected by these
changes.
In April 1997, the Alabama Supreme Court held that the Alabama Medicaid
program has underpaid providers by limiting certain payments, and the court
enjoined the Medicaid program from any future such limitations. Any increase in
expenses resulting from these holdings could have a materially adverse effect on
other Alabama Medicaid payments. Further, although some health care providers
could benefit from these holdings, many providers will receive no material
benefit. Nevertheless, the General Fund of the State may experience financial
pressures as the result of increased reimbursements.
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. Moreover, a recent study has concluded that, after
cost-of-living adjustments are made, Medicare payments per enrollee in Alabama
are among the highest in the nation. Changes in the Medicare program to reduce
such expenditures could have a materially adverse effect on health care
providers in Alabama. 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.
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 years to insure
compliance. The Circuit Court of Appeals upheld parts of this verdict and
maintained control over the institutions. On August 1, 1995, a new ruling was
issued in this case, requiring additional funding for certain universities and
colleges in Alabama. The new funding requirements may have an adverse impact on
the State budget and could require that future state budgets be prorated. Such
proration would have a materially adverse effect on public entities throughout
the state. In addition, 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
education be withheld. 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
26
for educational purposes as well as a new system for funding public education.
On December 3, 1997, the Alabama Supreme Court issued a new ruling affirming
Judge Reese's determination that the disparity is unconstitutional. The court
stated that the Alabama Legislature must develop a plan within one year to
correct this disparity. Any allocation of funds away from school districts could
impair the ability of such districts to service debt.
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.
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.
27
ARIZONA
The following information is a brief summary of factors affecting the
economy in the State and does not purport to be a complete description of such
factors.
RISK FACTORS--The State Economy. The Arizona economy over the last
several decades has grown faster than in most other regions of the United
States, as measured by population, employment and personal income. Although the
rate of growth slowed considerably during the late 1980's and early 1990's,
growth rates have been increasing in recent years.
Historically, the State economy has been somewhat dependent on the
construction industry and is sensitive to trends in that sector. The
construction and real estate industries have rebounded from their substantial
declines experienced during the late 1980's and early 1990's and are
experiencing positive growth. Other principal economic sectors include services,
manufacturing, mining, tourism and the military.
A substantial amount of overbuilding occurred during the early 1980's
while the State's economy was flourishing, which adversely affected Arizona's
financial-based institutions and caused them to be placed under the control of
the Resolution Trust Corporation ("RTC"). 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, with
$1.16 billion in assets, mostly real-estate secured loans and real property,
still to be sold as of that date. The RTC ceased to exist on December 31, 1995,
with the FDIC taking over any remaining functions of the RTC.
The trend in the Arizona banking community for the past several years
has been one of consolidation. In the early 1980's, 56 banks operated in
Arizona; as of December 1995 there were 34. As financial institutions within the
state consolidate, many branch offices have been closed, displacing workers.
America West Airlines, a Phoenix-based carrier, emerged from Chapter 11
reorganization in August, 1994. Prior to the reorganization, America West was
the sixth largest employer in Maricopa County. The continuation of America
West's recovery and its effect on the state economy and, more particularly, the
Phoenix economy, is uncertain.
More than 1,700 jobs were lost by the closing of Williams Air Force
Base in Chandler, Arizona, on September 30, 1993 when 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 has been converted into a regional civilian airport, including an
aviation, educational and business complex. Further proposed reductions in
federal military expenditures may adversely affect the Arizona economy.
Few of Arizona's largest employers are based entirely in Arizona; many
have headquarters and operations in other states. Therefore, economic factors in
other states could affect the employment situation in Arizona.
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, declined to 0.6% in 1991, then increased to 1.7% in 1992, 3.0% in
1993, and 6.7% in 1994. Job growth was 6.1% in 1995, 5.6% in 1996 and is
estimated at 3.7% for 1997.
28
The unemployment rate in Arizona was 5.3% in 1990, 5.6% in 1991, 7.4%
in 1992, 6.2% in 1993, 6.4% in 1994, 5.1% in 1995 and 5.5% in 1996. Arizona's
unemployment rate is estimated at 5.3% for 1997.
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 at a rate
of 6.7% in 1992, 7.3% in 1993, 8.4% in 1994, 9.4% in 1995 and 7.5% in 1996.
Growth in Arizona personal income is estimated at 6.8% for 1997.
Bankruptcy filings in the District of Arizona increased dramatically in
the mid-1980's, but percentage increases decreased during the early 1990's, with
1993 resulting in the first drop in bankruptcy filings since 1984. Bankruptcy
filings totaled 19,686 in 1991, 19,883 in 1992, 17,381 in 1993, 15,008 in 1994,
15,767 in 1995, and 19,989 in 1996. While Chapter 11 filings were on a decline
during 1997, consumer and wage-earning cases continue to increase. Bankruptcy
filings during 1997 totaled 24,686.
The inflation rate, as measured by the consumer price index in the
Phoenix, Arizona metropolitan area, including all of Maricopa County, hovered
around the national average during the late 1980's and early 1990's, but has
been higher than the national average since 1993. The Phoenix metropolitan area
inflation rate for 1996 was 5.1%, approximately 2% higher than the national
average for 1996. The Phoenix metropolitan area inflation rate remained well
above the national average during the first quarter of 1997, with a rate of
5.2%. The Phoenix metropolitan area inflation rate for 1997 is estimated at
4.9%, compared to an estimated national average rate of 2.9%.
For several decades the population of the State of Arizona has grown at
a substantially higher rate than the population of the United States. Arizona's
population rose 35% between 1980 and 1990, according to the 1990 census, a rate
exceeded only in Nevada and Alaska. Nearly 950,000 residents were added during
this period. Population growth across Arizona between 1990 and 1996 greatly
outpaced the national average; Arizona's population rose more than three times
as fast as the national average during this period. Although significantly
greater than the national average population growth, it is lower than Arizona's
population growth in the mid-1980's. The rate of population growth in Arizona
was expected to drop slightly in 1997. Census data show that in the 1990's,
California has been Arizona's largest source of inmigration. Recent data
concerning 1996 population growth indicates that out-migration from California
has now slowed substantially, which could affect the level of Arizona's net
in-migration.
The State Budget, Revenues and Expenditures. The state operates on a
fiscal year beginning July 1 and ending June 30. Fiscal year 1997 refers to the
year ending June 30, 1997. Fiscal year 1998 refers to the year ending June 30,
1998.
The General Fund revenues for fiscal year 1997 are estimated at $4.865
billion. Total General Fund revenues of $4.711 billion are expected during
fiscal year 1998. Approximately 46.2% of this expected revenue comes from sales
and use taxes, 37.6% from income taxes (both individual and corporate) and 0.9%
from property taxes. In addition to taxes, revenue includes non-tax items such
as income from the state lottery, licenses, fees and permits, and interest.
The General Fund expenditures for fiscal year 1997 are estimated at
$4.830 billion. For fiscal year 1998, General Fund expenditures of $5.092
billion are expected. Approximately 41.7% of major General Fund appropriations
are for the Department of Education for K-12, 15.7% is for higher education,
9.8% is for the administration of the AHCCCS program (the State's alternative to
Medicaid), 7.6% is for the Department of Economic Security, 4.2% is for the
Department of Health Services and 9.1% is for the Department of Corrections.
29
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.
The Arizona voters have passed a measure which requires a two-thirds
vote of the legislature to increase State taxes, which could make it more
difficult to reverse tax reduction measures which have been enacted in recent
years. This measure could adversely affect State fund balances and fiscal
conditions. There have also been periodic attempts in the form of voter
initiatives and legislative proposals to further limit the amount of annual
increases in taxes that can be levied by the various taxing jurisdictions
without voter approval. It is impossible to predict whether any such proposals
will ever be enacted or what the effect of any such proposals would be. However,
if such proposals were enacted, there could be an adverse impact on State or
local government financing.
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. The Arizona Supreme
Court upheld a state court decision imposing a deadline of June 30, 1998 to
comply with the Supreme Court mandate. The Arizona legislature recently adopted
a new funding program in response to the judgment, but a state court judge has
ruled that the program fails to meet the requirements of the Arizona Supreme
Court mandate. On October 24, 1997, the Arizona Supreme Court affirmed the trial
court's decision and issued an opinion explaining its reasoning on December 23,
1997. It is not yet known what further action will be taken by the legislature
and whether that action will satisfy the requirements of the judgement. It
remains unclear what effect 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. AHCCCS is financed by a combination
of federal, state and 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.
Health care firms have been in the process of consolidating. Continuing
consolidation and merger activity in the health care industry is expected.
30
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 and provides electric
service to approximately 700,000 customers. 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").
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, one of the nation's five largest locally owned public power
utilities, provides electric service to approximately 600,000 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.
Two special purpose irrigation districts formed for the purpose of
issuing bonds to finance the purchase of Colorado River water from the Central
Arizona Project filed for bankruptcy in 1994 under Chapter 9 of the United
States Bankruptcy Code as a result of the districts' inability to collect tax
revenue sufficient to service their bonded debt. The financial problems arose
from a combination of unexpectedly high costs of constructing the Central
Arizona Project, plummeting land values resulting in a need to increase property
taxes and refusal by many landowners in the districts to shoulder the increased
tax burden. In June 1995 a bankruptcy plan was confirmed for one district, which
returned to bondholders 57 cents on the dollar of their principal and placed an
additional 42 cents on the dollar in new 8% bonds maturing in seven years.
The proceedings with respect to the second district are continuing.
Other Factors. The uncertainty concerning the Mexico economy could have
an impact on Arizona's economy, as trade and tourism in the southern regions of
the state bordering Mexico could be affected by the condition of the Mexico
economy.
CALIFORNIA
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 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.
Economic Factors.
Fiscal Years Prior to 1995-96. Pressures on the State's budget in the
late 1980's and early 1990's were caused by a combination of external economic
conditions and growth of the largest General Fund Programs -- K-4 education,
health, welfare and corrections -- at rates faster than the revenue base. These
pressures could continue as the State's overall population and school age
population continue to grow, and as the State's corrections program responds to
a "Three Strikes" law enacted in 1994, which requires
31
mandatory life prison terms for certain third-time felony offenders. In
addition, the State's health and welfare programs are in a transition period as
a result of recent federal and State welfare reform initiatives.
As a result of these factors and others, and especially because a
severe recession between 1990-94 reduced revenues and increased expenditures for
social welfare programs, from the late 1980's until 1992- 93, the State had
periods of significant budget imbalance. During this period, expenditures
exceeded revenues in four out of six years, and the State accumulated and
sustained a budget deficit in its budget reserve, the Special Fund for Economic
Uncertainties ("SFEU") approaching $2.8 billion at its peak at June 30, 1993.
Between the 1991-92 and 1994-95 Fiscal Years, each budget required multibillion
dollar actions to bring projected revenues and expenditures into balance,
including significant cuts in health and welfare program expenditures; transfers
of program responsibilities and funding from the State to local governments;
transfers of about $3.6 billion in annual local property tax revenues from other
local governments to local school districts, thereby reducing State funding for
schools under Proposition 98; and revenue increases (particularly in the 1991-92
Fiscal Year budget), most of which were for a short duration.
Despite these budget actions, as noted, the effects of the recession
led to large, unanticipated deficits in the SFEU, as compared to projected
positive balances. By the 1993-94 Fiscal Year, the accumulated deficit was so
large that it was impractical to budget to retire such deficits in one year, so
a two-year program was implemented, using the issuance of revenue anticipation
warrants to carry a portion of the deficit over to the end of the fiscal year.
When the economy failed to recover sufficiently in 1993-94, a second two-year
plan was implemented in 1994-95, again using cross-fiscal year revenue
anticipation warrants to partly finance the deficit into the 1995-96 fiscal
year.
Another consequence of the accumulated budget deficits, together with
other factors such as disbursement of funds to local school districts "borrowed"
from future fiscal years and hence not shown in the annual budget, was to
significantly reduce the State's cash resources available to pay its ongoing
obligations. When the Legislature and the Governor failed to adopt a budget for
the 1992-93 Fiscal Year by July 1, 1992, which would have allowed the State to
carry out its normal annual cash flow borrowing to replenish cash reserves, the
State Controller issued registered warrants to pay a variety of obligations
representing prior years' or continuing appropriations, and mandates from court
orders. Available funds were used to make constitutionally-mandated payments,
such as debt service on bonds and warrants. Between July 1 and September 4,
1992, when the budget was adopted, the State Controller issued a total of
approximately $3.8 billion of registered warrants.
For several fiscal years during the recession, the State was forced to
rely on external debt markets to meet its cash needs, as a succession of notes
and revenue anticipation warrants were issued in the period from June 1992 to
July 1994, often needed to pay previously maturing notes or warrants. These
borrowings were used also in part to spread out the repayment of the accumulated
budget deficit over the end of a fiscal year, as noted earlier. The last and
largest of these borrowings was $4.0 billion of revenue anticipation warrants
which were issued in July, 1994 and matured on April 25, 1996.
1995-96 and 1996-97 Fiscal Years. With the end of the recession, and a
growing economy beginning in 1994, the State's financial condition improved
markedly in the last two fiscal years, with a combination of better than
expected revenues, slowdown in growth of social welfare programs, and continued
spending restraint based on the actions taken in earlier years. The last of the
recession-induced budget deficits was repaid, allowing the SFEU to post a
positive cash balance for only the second time in the 1990's, totaling $281
million as of June 30, 1997. The State's cash position also returned to health,
as cash flow borrowing was limited to $3 billion in 1996-97, and no deficit
borrowing has occurred over the end of these last two fiscal years.
In each of these two fiscal years, the State budget contained the
following major features:
32
. Expenditures for K-14 schools grew significantly, as new revenues
were directed to school spending under Proposition 98. This new money allowed
several new education initiatives to be funded, and raised K-12 per-pupil
spending to around $4,900 by Fiscal Year 1996-97. See "STATE FINANCES
Proposition 98" above.
. The budgets restrained health and welfare spending levels,
holding to reduced benefit levels enacted in earlier years, and attempted to
reduce General Fund spending by calling for greater support from the federal
government. The State also attempted to shift to the federal government a larger
share of the cost of incarceration and social services for illegal aliens. Some
of these efforts were successful, and federal welfare reform also helped, but as
a whole the federal support never reached the levels anticipated when the
budgets were enacted. These funding shortfalls were, however, filled by the
strong revenue collections, which exceeded expectations.
. General Fund support for the University of California and the
California State University system grew by an average of 5.2 percent and 3.3
percent per year, respectively, and there were no increases in student fees.
. General Fund support for the Department of Corrections grew as
needed to meet increased prison population. No new prisons were approved for
construction, however.
. There were no tax increases, and starting January 1, 1997, there
was a 5 percent cut in corporate taxes. The suspension of the Renter's Tax
Credit, first taken as a cost-saving measure during the recession, was
continued.
As noted, the economy grew strongly during these fiscal years, and as a
result, the General Fund took in substantially greater tax revenues (about $2.2
billion in 1995-96 and $1.6 billion in 1996-97) than were initially planned when
the budgets were enacted. These additional funds were largely directed to school
spending as mandated by Proposition 98, and to make up shortfalls from reduced
federal health and welfare aid. As a result, there was no dramatic increase in
budget reserves, although the accumulated budget deficit from the recession
years was finally eliminated in the past fiscal year.
1997-98 Fiscal Year.
Background. On January 9, 1997, the Governor released his proposed
budget for the 1997-98 Fiscal Year (the "Proposed Budget"). The Proposed Budget
estimated General Fund revenues and transfers of about $50.7 billion, and
proposed expenditures of $50.3 billion, resulting in an anticipated budget
reserve in the SFEU of about $550 million. The Proposed Budget included
provisions for a further 10% cut in Bank and Corporation Taxes, which ultimately
was not enacted by the Legislature.
At the time of the Department of Finance May Revision, released on May
14, 1997, the Department of Finance increased its revenue estimate for the
upcoming fiscal year by $1.3 billion, in response to the continued strong growth
in the State's economy. Budget negotiations continued into the summer, with
major issues to be resolved including final agreement on State welfare reform,
an increase in State employee salaries and consideration of the tax cut proposed
by the Governor.
In May, 1997, action was taken by the California Supreme Court in an
ongoing lawsuit, PERS v. Wilson, below, which made final a judgment against the
State requiring an immediate payment from the General Fund to the Public
Employees Retirement Fund ("PERF") to make up certain deferrals in annual
retirement fund contributions which had been legislated in earlier years for
budget savings, and which the courts found to be unconstitutional. On July 30,
1997, following a direction from the Governor, the
33
Controller transferred $1.235 billion from the General Fund to the PERF in
satisfaction of the judgment, representing the principal amount of the
improperly deferred payments from 1995-96 and 1996-97.
Fiscal Year 1997-98 Budget Act. Following the transfer of funds to the
PERF, final agreement was reached within a few weeks on the welfare package and
the remainder of the budget. The Legislature passed the Budget Bill on August
11, 1997, along with numerous related bills to implement its provisions.
Agreement was not finally reached at that time on one aspect of the budget plan,
concerning the Governor's proposal for a comprehensive educational testing
program.
On August 18, 1997, the Governor signed the Budget Act, but vetoed
about $314 million of specific spending items, primarily in health and welfare
and education areas from both the General Fund and Special Funds.
The Budget Act anticipates General Fund revenues and transfers of $52.5
billion (a 6.8 percent increase over the final 1996-97 amount), and expenditures
of $52.8 billion (an 8.0 percent increase from the 1996-97 levels). (The
expenditure figure assumes restoration of $48 million of welfare program savings
which were contained in a bill vetoed by the Governor because of other
provisions and also assumes enactment of legislation to restore $203 million of
expenditures associated with education upon agreement by the Legislature and the
Governor of a satisfactory testing program.) On a budgetary basis, SFEU is
projected to decrease from $408 million at June 30, 1997 to $112 million at June
30, 1998. The Budget Act also includes Special Fund expenditures of $14.4
billion (as against estimated Special Fund revenues of $14.0 billion), and $2.1
billion of expenditures from various Bond Funds.
The following are major features of the 1997-98 Budget Act:
. For the second year in a row, the Budget contains a large
increase in funding for K-14 education under Proposition 98, reflecting strong
revenues which have exceeded initial budgeted amounts. Part of the nearly $1.75
billion in increased spending is allocated to prior fiscal years. Funds are
provided to fully pay for the cost-of-living - increase component of Proposition
98, and to extend the class size reduction and reading initiatives. See "STATE
FINANCES - Proposition 98" above.
. The Budget Act reflects the $1.235 billion pension case judgment
payment, and brings funding of the State's pension contribution back to the
quarterly basis which existed prior to the deferral actions which were
invalidated by the courts. There is no provision for any additional payment
relating to this case.
. Continuing the third year of a four-year "compact" which the
Administration has made with higher education units, funding from the General
Fund for the University of California and the California State University system
has increased by approximately 6 percent ($121 million and $107 million,
respectively). There was no increase in student fees.
. Because of the effect of the pension payment, most other State
programs were continued at 1996-97 levels, adjusted for caseload changes.
. Health and welfare costs are contained, continuing generally the
grant levels from prior years, as part of the initial implementation of the new
CalWORKs program.
. Unlike prior years, this budget Act does not depend on uncertain
federal budget actions. About $300 million in general funds, already included in
the federal FY 1997 and 1998 budgets, are included in the Budget Act, to offset
incarceration costs for illegal aliens.
34
. The Budget Act contains no tax increases, and no tax reductions.
The Renters Tax Credit was suspended for another year, saving approximately $500
million. The Legislature has not made any decision on conformity of State tax
laws to the recent federal tax reduction bill; a comprehensive review of this
subject is expected to take place next year.
The Orange County Bankruptcy. 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. The subsequent restructuring led
to the sale of substantially all of the Pool's portfolio and resulted in losses
estimated to be approximately $1.7 billion (or approximately 22% of amounts
deposited by the Pool investors). Approximately 187 California public entities
- -- substantially all of which are public agencies within the county -- had
various bonds, notes or other forms of indebtedness outstanding. In some
instances the proceeds of such indebtedness were invested in the Pool. In April,
1996, the County emerged from bankruptcy after closing on a $900 million
recovery bond transaction. At that time, the County and its financial advisors
stated that the County had emerged from the bankruptcy without any structural
fiscal problems and assured that the County would not slip back into bankruptcy.
However, for many of the cities, schools and special districts that lost money
in the County portfolio, repayment remains contingent on the outcome of
litigation which is pending against investment firms and other finance
professionals. Thus, it is impossible to determine the ultimate impact of the
bankruptcy and its aftermath on these various agencies and their claims.
In May 1996, a taxpayer action was filed against the City of San Diego
("San Diego") and the San Diego Convention Center Expansion Authority (the
"Authority") challenging the validity of a lease revenue financing involving a
lease (the "San Diego Lease") having features similar to the leases commonly
used in California lease-based financings such as certificates of participation
(the "Rider Case"). The Rider Case plaintiffs alleged that voter approval is
required for the San Diego Lease (a) since the lease constituted indebtedness
prohibited by Article XVI, Section 18 of the California Constitution without a
two-thirds vote of the electorate, and (b) since San Diego was prohibited under
its charter from issuing bonds without a two-thirds vote of the electorate, and
the power of the Authority, a joint powers' authority, one of the members of
which is San Diego, to issue bonds is no greater than the power of San Diego. In
response to San Diego's motion for summary judgement, the trial court rejected
the plaintiff's arguments and ruled that the San Diego Lease was
constitutionally valid and that the Authority's related lease revenue bonds did
not require voter approval. The plaintiffs appealed the matter to the Court of
Appeals for the Fourth District, which affirmed the validity of the San Diego
Lease and of the lease revenue bond financing arrangements. The plaintiffs then
filed a petition for review with the California State Supreme Court, and, on
April 2, 1997, the Court granted the plaintiff's petition for review. No
decision from the Supreme Court is expected prior to the Court's 1998 calendar
year.
Constitutional, Legislative and Other Factors.
Certain California constitutional amendments, legislative measures,
executive orders, administrative regulations and voter initiatives could produce
the adverse effects described below.
Revenue Distribution. 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 counties, 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.
35
Health Care Legislation. 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 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.
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.
Mortgages and Deeds. 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
36
statutes 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. The debtor may
reinstate the mortgage in the manner described above, up to five business days
prior to the scheduled sale date. 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 then only
if the borrower prepays an amount in excess of 20% of the original principal
amount of the mortgage loan in a 12-month period; a prepayment charge cannot in
any event exceed six months' advance interest on the amount prepaid during the
12-month period in excess of 20% of the original principal amount of the 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.
Proposition 13. 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
37
approved an amendment to the California Constitution known as Proposition 13,
which added Article XIIIA to the California Constitution. The effect of Article
XIIIA was to limit ad valorem taxes on real property and to restrict the ability
of taxing entities to increase real property tax revenues.
Section 1 of Article XIIIA, as amended, limits the maximum ad valorem
tax on real property to 1% of full cash value, to be collected by the counties
and apportioned according to law. The 1% limitation does not apply to ad valorem
taxes or special assessments to pay the interest and redemption charges on any
bonded indebtedness for the acquisition or improvement of real property
approved, 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.
Legislation enacted by the California Legislature to implement Article
XIIIA 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.
Proposition 9. On November 6, 1979, an initiative known as "Proposition
9" 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.
Proposition 98. On November 8, 1988, voters of the State approved
Proposition 98, a combined initiative constitutional amendment and statute
called the "Classroom Instructional Improvement and Accountability Act."
Proposition 98 changed State funding of public education below the university
level and the operation of the State Appropriations Limit, primarily by
guaranteeing K-14 schools a minimum share of General Fund revenues. Under
Proposition 98 (modified by Proposition 111 as discussed below), K-14 schools
are guaranteed the greater of (a) in general, a fixed percent of General Fund
revenues ("Test 1"), (b) the amount appropriated to K-14 schools in the prior
year, adjusted for changes in the cost of living (measured as in Article XIII B
by reference to State per capita personal income) and enrollment ("Test 2"), or
(c) a third test, which would replace Test 2 in any year when the percentage
growth in per capita General Fund revenues from the prior year plus one half of
one percent is less than the percentage growth in State per capita personal
income ("Test 3"). Under Test 3, schools would receive the amount appropriated
in the prior year adjusted for changes in enrollment and per capita General Fund
revenues, plus an additional small adjustment factor. If Test 3 is used in any
year, the difference between Test 3 and Test 2 would become a "credit" to
schools which would be the basis of payments in future years when per capita
General Fund revenue growth exceeds per capita personal income growth.
Proposition 98 permits the Legislature -- by two-thirds vote of
both houses, with the Governor's concurrence -- to suspend the K-14
schools' minimum funding formula for a one-year period. Proposition
38
98 also contains provisions transferring certain State tax revenues in excess of
the Article XIII B limit to K-14 schools.
During the recession years of the early l990s, General Fund revenues
for several years were less than originally projected, so that the original
Proposition 98 appropriations turned out to be higher than the minimum
percentage provided in the law. The Legislature responded to these developments
by designating the "extra" Proposition 98 payments in one year as a "loan" from
future years' Proposition 98 entitlements, and also intended that the "extra"
payments would not be included in the Proposition 98 "base" for calculating
future years' entitlements. In 1992, a lawsuit was filed, California Teachers'
Association v. Gould, which challenged the validity of these off-budget loans.
During the course of this litigation, a trial court determined that almost $2
billion in "loans" which had been provided to school districts during the
recession violated the constitutional protection of support for public
education. A settlement was reached on April 12, 1996 which ensures that future
school funding will not be in jeopardy over repayment of these so-called loans.
Proposition 111. 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 recalculated spending
limits for the State and for local governments, allowed greater annual increases
in the limits, allowed the averaging of two years' tax revenues before requiring
action regarding excess tax revenues, reduced 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),
removed the provision of Proposition 98 which included excess moneys transferred
to school districts and community college districts in the base calculation for
the next year, limited the amount of State tax revenue over the limit which
would be transferred to school districts and community college districts, and
exempted increased gasoline taxes and truck weight fees from the State
appropriations limit. Additionally, Proposition 111 exempted from the State
appropriations limit funding for capital outlays.
Proposition 62. On November 4, 1986, California voters approved an
initiative statute known as Proposition 62. This initiative provided the
following: (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, (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
39
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.
The California Court of Appeal in City of Woodlake v. Logan, (1991) 230
Cal.App.3d 1058, subsequently held that Proposition 62's popular vote
requirements for future local taxes also provided for an unconstitutional
referenda. The California Supreme Court declined to review both the City of
Westminster and the City of Woodlake decisions.
In Santa Clara Local Transportation Authority v. Guardino, (Sept. 28,
1995) 11 Cal.4th 220, reh'g denied, modified (Dec. 14, 1995) 12 Cal.4th 344e,
the California Supreme Court upheld the constitutionality of Proposition 62's
popular vote requirements for future taxes, and specifically disapproved of the
City of Woodlake decision as erroneous. The Court did not determine the
correctness of the City of Westminster decision, because that case appeared
distinguishable, was not relied on by the parties in Guardino, and involved
taxes not likely to still be at issue. It is impossible to predict the impact of
the Supreme Court's decision on charter cities or on taxes imposed in reliance
on the City of Woodlake case.
Senate Bill 1590 (O'Connell), introduced February 16, 1996, would make
the Guardino decision inapplicable to any tax first imposed or increased by an
ordinance or resolution adopted before December 14, 1995. The California State
Senate passed the Bill on May 16, 1996 and it is currently pending in the
California State Assembly. It is not clear whether the Bill, if enacted, would
be constitutional as a non-voted amendment to Proposition 62 or as a non-voted
change to Proposition 62's operative date.
Proposition 218. On November 5, 1996, the voters of the State approved
Proposition 218, a constitutional initiative, entitled the "Right to Vote on
Taxes Act" ("Proposition 218"). Proposition 218 adds Articles XIII C and XIII D
to the California Constitution and contains a number of interrelated provisions
affecting the ability of local governments to levy and collect both existing and
future taxes, assessments, fees and charges. Proposition 218 became effective on
November 6, 1996. The Sponsors are unable to predict whether and to what extent
Proposition 218 may be held to be constitutional or how its terms will be
interpreted and applied by the courts. However, if upheld, Proposition 218 could
substantially restrict certain local governments' ability to raise future
revenues and could subject certain existing sources of revenue to reduction or
repeal, and increase local government costs to hold elections, calculate fees
and assessments, notify the public and defend local government fees and
assessments in court.
Article XIII C of Proposition 218 requires majority voter approval for
the imposition, extension or increase of general taxes and two-thirds voter
approval for the imposition, extension or increase of special taxes, including
special taxes deposited into a local government's general fund. Proposition 218
also provides that any general tax imposed, extended or increased without voter
approval by any local government on or after January 1, 1995 and prior to
November 6, 1996 shall continue to be imposed only if approved by a majority
vote in an election held within two years of November 6, 1996.
Article XIII C of Proposition 218 also expressly extends the initiative
power to give voters the power to reduce or repeal local taxes, assessments,
fees and charges, regardless of the date such taxes, assessments, fees or
charges were imposed. This extension of the initiative power to some extent
constitutionalizes the March 6, 1995 State Supreme Court decision in Rossi v.
Brown, which upheld an initiative that repealed a local tax and held that the
State constitution does not preclude the repeal, including the prospective
repeal, of a tax ordinance by an initiative, as contrasted with the State
constitutional prohibition on referendum powers regarding statutes and
ordinances which impose a tax. Generally, the initiative process enables
California voters to enact legislation upon obtaining requisite voter approval
at a general election. Proposition 218 extends the authority stated in Rossi v.
Brown by expanding the initiative power to include reducing or repealing
assessments, fees and charges, which had previously been considered
administrative rather than legislative matters and therefore beyond the
initiative power.
40
The initiative power granted under Article XIII C of Proposition 218,
by its terms, applies to all local taxes, assessments, fees and charges and is
not limited to local taxes, assessments, fees and charges that are property
related.
Article XIII D of Proposition 218 adds several new requirements making
it generally more difficult for local agencies to levy and maintain
"assessments" for municipal services and programs. "Assessment" is defined to
mean any levy or charge upon real property for a special benefit conferred upon
the real property.
Article XIII D of Proposition 218 also adds several provisions
affecting "fees" and "charges" which are defined as "any levy other than an ad
valorem tax, a special tax, or an assessment, imposed by a local government upon
a parcel or upon a person as an incident of property ownership, including a user
fee or charge for a property related service." All new and, after June 30, 1997,
existing property related fees and charges must conform to requirements
prohibiting, among other things, fees and charges which (i) generate revenues
exceeding the funds required to provide the property related service, (ii) are
used for any purpose other than those for which the fees and charges are
imposed, (iii) are for a service not actually used by, or immediately available
to, the owner of the property in question, or (iv) are used for general
governmental services, including police, fire or library services, where the
service is available to the public at large in substantially the same manner as
it is to property owners. Further, before any property related fee or charge may
be imposed or increased, written notice must be given to the record owner of
each parcel of land affected by such fee or charges. The local government must
then hold a hearing upon the proposed imposition or increase of such property
based fee, and if written protests against the proposal are presented by a
majority of the owners of the identified parcels, the local government may not
impose or increase the fee or charge. Moreover, except for fees or charges for
sewer, water and refuse collection services, no property related fee or charge
may be imposed or increased without majority approval by the property owners
subject to the fee or charge or, at the option of the local agency, two-thirds
voter approval by the electorate residing in the affected area.
Proposition 87. 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.
COLORADO
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 degrees of 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
41
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 A of the Prospectus under the caption "Colorado 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 for the past nine consecutive years, including
1996. In recent years, above-average population growth and migration into the
State have helped the State to post better performance in income growth,
homebuilding and job creation. Per-capita income increased 21.99% from 1992
through 1996. Retail trade sales increased 36.4% from 1992 through 1996.
Net migration into the State peaked in 1993 at 72,667 (an increase of
approximately 15.7% over 1992's net migration), with the overall State
population increasing 3.0% in 1993. Net migration into the State is estimated to
have been 45,216 in 1996 (a decrease of approximately 19.0% from 1995's net
migration of 55,854, but with the overall State population still increasing
approximately 2.0% in 1996. The State's job growth rate was 4.5% in 1995,
compared to 2.7% at the national level, and 3.4% for 1996, compared to 2.0% at
the national level. 62,500 nonfarm jobs were generated in the State economy in
1996, down from 78,500 in 1995. The State's unemployment rate is estimated to
have remained below the national unemployment rate for 1996 and is estimated to
have remained below the national level in 1997.
State Revenues. The State operates on a fiscal year beginning July 1
and ending June 30. Fiscal year 1997 refers to the year ended June 30, 1997, and
fiscal year 1998 refers to the year ended June 30, 1998.
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 30.5% and 54.9%,
respectively, of total net General Fund revenues during fiscal year 1997. Based
upon Office of State Planning and Budgeting figures it is estimated that, during
fiscal year 1998, sales and use taxes will account for approximately 29.4% of
total General Fund revenues and individual income taxes will account for
approximately 55.4% of total net General Fund revenues. The ending General Fund
balance, before statutory and constitutional reserve requirements, for fiscal
year 1997 was $375.1 million and for fiscal year 1998 is estimated at $325.0
million. After allowances for such reserves the net amounts of fund balance at
such dates were $208.4 million and an estimated $141.1 million respectively.
The Colorado Constitution contains strict limitations on the ability of
the State to create debt except under certain very limited circumstances.
However, the constitutional provisions have been interpreted not to limit the
ability of the State or its political subdivisions to issue certain obligations
which do not constitute debt in the constitutional sense, including short-term
obligations which do not extend beyond the fiscal year in which they are
incurred and lease purchase obligations which are made subject to annual
appropriation.
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 1, 1997 and maturing June 26, 1998, was given the highest
rating available for short-term obligations by Standard & Poor's Ratings Group a
division of The McGraw-Hill Companies, Inc. and Fitch Investors Service, Inc.
Because of the short-term nature of such notes, their ratings should not
necessarily be considered indicative of the State's general financial condition.
It is not known whether the State will issue similar short-term notes in 1998.
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Tax and Spending Limitation Amendment. On November 3, 1992, Colorado
voters approved a State constitutional amendment ("TABOR") that restricts the
ability of the State and local governments to increase taxes, revenues, debt and
spending. TABOR provides that its provisions supersede conflicting State
constitutional, State statutory, charter or other State or local provisions.
The provisions of TABOR apply to "districts," which are defined in
TABOR as the State or any local government, with certain exclusions. Under the
terms of TABOR, districts must have prior voter approval to impose any new tax,
tax rate increase, mill levy increase, valuation for assessment ratio increase
or extension of an expiring tax. Prior voter approval is also required, except
in certain limited circumstances, for the creation of "any multiple-fiscal year
direct or indirect district debt or other financial obligation." TABOR
prescribes the timing and procedures for any elections required by it.
Colorado appellate court cases decided since the adoption of TABOR have
resolved a number of questions concerning the required methods for authorizing
new indebtedness, the treatment of tax levies for existing indebtedness and
other purposes, the procedures for conducting elections under TABOR, the ability
of local governments to obtain voter approval for the exclusion of certain
revenues from the limitations on revenues and spending, the ability of local
governments to enter into annually-appropriated lease purchase obligations
without voter approval, and other interpretive matters.
Because TABOR'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 TABOR. Case law both
prior to and after the adoption of TABOR held that obligations maturing in the
current fiscal year, as well as lease purchase obligations subject to annual
appropriation, do not constitute debt under the Colorado Constitution.
TABOR'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 TABOR has been and is likely
to continue to be subject to legislative and judicial interpretation.
Among other provisions, TABOR 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 TABOR. TABOR 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 TABOR. District revenues in excess of the limits
prescribed by TABOR are required, absent voter approval, to be refunded by any
reasonable method, including temporary tax credits or rate reductions. In
addition, TABOR prohibits new or increased real property transfer taxes, new
State real property taxes and new local district income taxes. TABOR 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 TABOR. Many provisions of TABOR are ambiguous and will require
judicial interpretation. Several statutes enacted or proposed in the State
General Assembly have attempted to clarify the application of TABOR with respect
to certain governmental entities and activities. However, many provisions of
TABOR are likely to continue to be the subject of further legislation or
judicial proceedings. The application of TABOR, particularly in
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periods of slow or negative growth, may adversely affect the financial condition
and operations of the State and local governments in the State to an extent
which cannot be predicted.
CONNECTICUT
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. As a result of a
rise in employment in service-related industries and a decline in manufacturing
employment, manufacturing accounted for only 17.4% of total non-agricultural
employment in Connecticut in 1996. 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.
The annual average unemployment rate (seasonally adjusted) in
Connecticut increased from a low of 3.0% in 1988 to a high of 7.5% in 1992 and,
after a number of important changes in the method of calculation, was reported
to be 5.8% in 1996. However, pockets of significant unemployment and poverty
exist in some of Connecticut's cities and towns.
State Revenues and Expenditures. At the end of the 1990-91 fiscal year,
the General Fund had an accumulated unappropriated deficit of $965,712,000. For
the six fiscal years ended June 30, 1997, the General Fund recorded operating
surpluses, based on the State's budgetary method of accounting, of approximately
$110,200,000, $113,500,000, $19,700,000, $80,500,000, $250,000,000, and
$262,600,000, respectively. General Fund budgets for the biennium ending June
30, 1999, were adopted in 1997. General Fund expenditures and revenues are
budgeted to be approximately $9,550,000,000 and $9,700,000,000 for the 1997-98
and 1998-99 fiscal years, respectively, an increase of more than 35% from the
budgeted expenditures of approximately $7,008,000,000 for the 1991-92 fiscal
year.
State Debt. During 1991 the State issued a total of $965,710,000
Economic Recovery Notes, of which $157,055,000 were outstanding as of December
1, 1997. The notes were to be payable no later than June 30, 1996, but as part
of the budget adopted for the biennium ending June 30, 1997, payment of the
notes scheduled to be paid during the 1995-96 fiscal year was rescheduled to be
made over the four fiscal years ending June 30, 1999.
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 December 1, 1997, there
was a total legislatively authorized bond indebtedness of $11,460,239,000, of
which $10,159,950,000 had been approved for issuance by the State Bond
Commission and $9,181,272,000 had been issued. As of December 1, 1997, State
direct general obligation indebtedness outstanding was $6,475,986,251.
In 1995, the State established the University of Connecticut as a
separate corporate entity to issue bonds and construct certain infrastructure
improvements. The improvements are to be financed by $18 million of general
obligation bonds of the State and $962 million bonds of the University. The
University's bonds will be secured by a State debt service commitment, the
aggregate amount of which is limited to $382 million for the four fiscal years
ending June 30, 1999, and $580 million for the six fiscal years ending June 30,
2005.
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In addition, the State has limited or contingent liability on a
significant amount of other bonds. Such bonds have been issued by the following
quasi-public agencies: the Connecticut Housing Finance Authority, the
Connecticut Development Authority, the Connecticut Higher Education Supplemental
Loan Authority, the Connecticut Resources Recovery Authority and the Connecticut
Health and Educational Facilities Authority. Such bonds have also been issued by
the cities of Bridgeport and West Haven and the Southeastern Connecticut Water
Authority. As of February 4, 1998, the amount of bonds outstanding on which the
State has limited or contingent liability totaled $4,000,900,000.
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, which was
established to budget and account for such revenues.
As of December 1, 1997, the General Assembly had authorized STO bonds
for the program in the aggregate amount of $4,302,700,000, of which
$3,894,700,000 of new money borrowings 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 general obligation bonds are rated AA- by Standard & Poor's
and Aa3 by Moody's. On March 7, 1995, Fitch reduced its rating of the State's
general obligation bonds from AA+ to AA.
Litigation. The State, its officers and its employees are defendants in
numerous lawsuits. Although it is not possible to determine the outcome of these
lawsuits, the Attorney General has opined that an adverse decision in any of the
following cases might have a significant impact on the State's financial
position: (i) a class action by the Connecticut Criminal Defense Lawyers
Association claiming a campaign of illegal surveillance activity and seeking
damages and injunctive relief; (ii) an action on behalf of all persons with
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; and (iii) litigation involving claims by Indian
tribes to a portion of the State's land area.
As a result of litigation on behalf of black and Hispanic school
children in the City of Hartford seeking "integrated education" within the
Greater Hartford metropolitan area, on July 9, 1996, the State Supreme Court
directed the legislature to develop appropriate measures to remedy the racial
and ethnic segregation in the Hartford public schools. The fiscal impact of this
decision might be significant but is not determinable at this time.
Municipal Debt Obligations. General obligation bonds issued by
municipalities are usually payable from ad valorem taxes on property subject to
taxation by the municipality. A municipality's property tax base is subject to
many factors outside the control of the municipality, including the decline in
Connecticut's manufacturing industry. 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
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
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petition was filed. State legislation enacted in 1993 prohibits municipal
bankruptcy filings without the prior written consent of the Governor.
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.
FLORIDA
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 A of the Prospectus). 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--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, 1996, ranked fourth with an
estimated population of 14.4 million. 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 at an average of 224,240 new residents per year, from 1987 through
1996. Since 1987 the prime working age population (18-44) has grown at an
average annual rate of 2.1%. The share of Florida's total working age population
(18-59) to total State population is approximately 54%. Non-farm employment has
grown by over 35.6% since 1987. Total non-farm employment in Florida is expected
to increase 3.9% in 1997-98 and rise 2.6% in 1998-99. By the end of 1997-98,
non-farm employment in the State is expected to reach an average of 6.7 million
jobs. The service sector is Florida's largest employment sector, presently
accounting for nearly 87% of total non-farm employment. Employment in the
service sector should experience an increase of 4.8% in 1997-98, while growing
4.1% in 1998-99. 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. Florida's manufacturing sector has kept pace
with the U.S., at about 2.6% of total U.S. manufacturing employment since the
beginning of the nineties. Foreign trade has contributed significantly to
Florida's employment growth. Trade is expected to expand 3.7% this year and 2.3%
next year. 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 reached a peak of 10% in 1973. In 1980 the
share was roughly 7.5%, and in 1996 the share had edged downward to 5%. Although
the job creation rate for the State of Florida since 1987 is almost twice the
rate for the nation as a whole, throughout most of the 1980's the unemployment
rate for the State has tracked below that of the nation's. In the nineties, the
trend was reversed until 1995 and 1996, when the state's unemployment rate again
tracked below the U.S. The average rate of unemployment for Florida since 1987
is 6.2%, while the national average is also 6.2%. Florida's unemployment rate is
forecasted at 4.6% in 1997-98 and 4.8% in 1998-99. 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 1995, Florida's employment
income represented 60.6% of total personal income, while nationally, employment
income represented 70.8% of
46
total personal income. From 1985 through 1995, Florida's total nominal personal
income grew by 103% and per capita income expanded approximately 62.5%. For the
nation, total and per capital personal income increased by roughly 77.8% and
61.0%, respectively. Real personal income in Florida is estimated to increase
5.2% in 1997-98 and increase 3.7% in 1998-99, while real personal income per
capita in the State is projected to grow at 3.2% in 1997-98 and 1.8% in 1998-99.
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. Florida prepares an annual budget which is formulated
each year and presented to the Governor and Legislature. 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 four types of funds: the General
Revenue Fund, Trust Funds, the Working Capital Fund and the Budget Stabilization
Fund. The majority of the State's tax revenues are deposited in the General
Revenue Fund and monies for all funds are expended pursuant to appropriations
acts. In fiscal year 1996-97, expenditures for education, health and welfare and
public safety represented approximately 53%, 26% and 14%, respectively, of
expenditures from the General Revenue Fund. The Trust Funds consist of monies
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 1997-98 the estimated General Revenue
plus Working Capital Fund and Budget Stabilization funds total $18,150.9
million, an 8.5% increase over 1996-97. The $16,598.5 million in Estimated
Revenues represent an increase of 5.7% over the analogous figure in 1996-1997.
With combined General Revenue, Working Capital Fund and Budget Stabilization
Fund appropriations at $17,114.0 million, unencumbered reserves at the end of
1996-97 are estimated at $1,036.9 million. For fiscal year 1998-99, the
estimated General Revenue plus Working Capital and Budget Stabilization funds
available total $18,644.0 million, a 2.7% increase over 1997-98. The $17,405.5
million in Estimated Revenues represent a 4.9% increase over the analogous
figure in 1997-98.
In fiscal year 1996-97, the State derived approximately 67% of its
total direct revenues for deposit in the General Revenue Fund, Trust Funds,
Working Capital Fund and Budget Stabilization Fund from State taxes and fees.
Federal funds and other special revenues accounted for the remaining revenues.
The largest single source of tax receipts in the State is the 6% sales and use
tax. For the fiscal year ended June 30, 1996, receipts from the sales and use
tax totaled $12,089 million, an increase of 5.5% from fiscal year 1996-97. 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.
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Preliminary data for the fiscal year ended June 30, 1997, show collections of
this tax totaled $2,012.0 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, 1997, receipts from the corporate income tax totaled
$1,362.3 million, an increase of 17.2% from fiscal year 1995-96. The Documentary
Stamp Tax collections totaled $844.2 million during fiscal year 1996-97, posting
a 8.9% increase from the previous fiscal year. The Alcoholic Beverage Tax, an
excise tax on beer, wine and liquor totaled $447.2 million in fiscal year
1996-97 The Florida lottery produced sales of $2.09 billion in fiscal year
1996-97 of which $792.3 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, municipal or school
purposes, ten mills; and for water management districts no more than 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.
As of January 1, 1994, the property valuations for homestead property
are subject to a growth cap of the lesser of 3% or the change 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. If the
property changes ownership or homestead status, it is to be re-valued at full
just value on the next tax roll.
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 property valuation growth cap 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 property valuation growth cap,
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 limits 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. The revenue limit is determined by multiplying the average annual rate
of growth in Florida personal income over the previous five years times the
maximum amount of revenues permitted under the cap 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 was effective starting with fiscal year 1995-96
based on actual revenues from fiscal year 1994-95.
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Any excess revenues generated will be deposited in the Budget Stabilization
Fund. 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 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
Aa2 by Moody's, AA by Standard & Poor's, and AA by Fitch Investors Services,
Inc.
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 believe 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 an inverse condemnation suit, plaintiff claims that the action of
State constitutes a taking of plaintiff's leases for which compensation is due.
The Circuit judge granted the State's motion for summary judgment finding that
as a matter of law, the State had not deprived plaintiff of any royalty rights.
Plaintiff appealed to the First District Court of Appeals, but the case was
remanded to the Circuit Court for trial. Final judgment was made in favor of the
State; however plaintiff has filed for a review by The Florida Supreme Court.
B. In a challenge by plaintiffs to the constitutionality of the $295
impact fee imposed by Florida law on the issuance of certificates of title for
vehicles previously titled outside the State, the Court granted
49
summary judgment to the plaintiff finding the fee violated the commerce clause
of the U.S. Constitution. In an appeal to the State Supreme Court by the State,
the Court ordered full refunds to all those who paid the impact fee since the
Statute came into existence in 1991. Refunds of approximately $188 million were
made. Litigation pertaining to post judgment interest is still active.
C. The Florida Department of Transportation has filed an action against
owners of property adjoining property that is subject to a claim by the U.S.
Environmental Protection Agency, seeking a declaratory judgment that the
Department is not the owner of such property. The case was dismissed and FDOT's
appeal of the order of dismissal is pending in the Third District Court of
Appeal. The EPA has agreed to await the outcome of the Department's declaratory
action before proceeding further. If the Department's action is not successful,
the possible clean-up costs could exceed $25 million.
D. In a class action suit on behalf of clients of residential placement
for the developmentally disabled seeking refunds for services where children
were entitled to free education under the Education for Handicapped Act, the
District court held that the State could not charge maintenance fees for
children between the ages of 5 and 17 based on the Act. All appeals have been
exhausted. The State's potential cost of refunding these charges could exceed
$42 million. However, attorneys are in the process of negotiating a settlement
amount.
E. In an action challenging the constitutionality of the Public Medical
Assistance Trust Fund annual assessment on net operating revenue of
free-standing out-patient facilities offering sophisticated radiology services,
a trial has not been scheduled. If the State does not prevail, the potential
refund liability could be approximately $70 million.
F. In an action against the Florida Department of Corrections,
plaintiffs seek a declaratory judgment that they are not exempt employees under
the Fair Labor Standards Act and that, therefore, they are entitled to certain
overtime compensation. The U.S. District Court entered an order dismissing the
case for lack of jurisdiction. Plaintiffs filed a lawsuit against the Department
at the State level making the same allegations previously made at the federal
level. The State court determined it has jurisdiction over the FLSA claim. The
Court entered final summary judgement. The plaintiffs were not awarded overtime
pay at time and one-half nor liquidated damages; however, they were awarded
attorney's fees and costs.
G. In an action challenging whether Florida's statute for dealer
repossessions authorizes the Department of Revenue to grant a refund to a
financial institution as the assignee of numerous security agreements governing
the sale of automobiles and other property sold by dealers, the question turns
on whether the Legislature intended the statute only to provide a refund or
credit to the dealer who actually sold the tangible personal property and
collected and remitted the tax or intended that right to be assignable. Several
banks have applied for refunds; the potential refund to financial institutions
exceeds $30,000,000.
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 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
50
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.
GEORGIA
RISK FACTORS--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 Georgia (the "State"). Such financial information is based upon information
about general financial conditions that may or may not affect individual issuers
of obligations within the State. 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, as of July 1997,
Standard & Poor's Corporation rates such bonds AAA. 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.
State Treasury Receipts of 11.9 billion for fiscal year 1997 increased over
fiscal year 1996 by 6.62% and estimated State Treasury Receipts for fiscal year
1998 are expected to increase by 5.3% according to the Governor's chief
economist.
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 July 1997, the total principal indebtedness of the
State of Georgia consisting of general obligation debt, guaranteed revenue debt
and remaining authority debt totalled $5,070,895,000 and the highest aggregate
annual payment for such debt equaled 5.39% of fiscal 1997 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 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.
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The State operates on a fiscal year beginning July 1 and ending June
30. For example, "fiscal 1997" refers to the year ended June 30, 1997. In July
1997, the State estimated that fiscal 1998 revenue collections would be
$11,777,578,880 with an estimated increase of 4.01% 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 1997,
income tax receipts and sales tax receipts of the State for fiscal 1997
comprised approximately 46% and 36.4%, respectively, of the total State tax
revenues.
The unemployment rate of the civilian labor force in the State as of
May 1997 was 4.4% 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 46% 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,
services, wholesale and retail trade, manufacturing, government and
transportation comprise the largest sources of employment within the State.
The State from time to time is named as a party in certain lawsuits,
which may or may not have a material adverse impact on the financial position of
the State if decided in a manner adverse to the State's interests. Certain of
such lawsuits which could have a significant impact on the State's financial
position are summarized below.
Age International, Inc. v. State (two cases). Two suits for refund have
been filed in state court against the State of Georgia by out-of-state producers
of alcoholic beverages. The first suit for refund seeks 96 million dollars in
refunds of alcohol taxes, plus interest, imposed under Georgia's post-Bacchus
(468 U.S. 263) statute, O.C.G.A. ss.3-4-60., i.e., as amended in 1985. These
claims constitute 99% of all such taxes paid during the 3 years preceding these
claims. In addition, the claimants have filed a second suit for refund for an
additional 23 million dollars, plus interest, for later time periods. These two
cases encompass all known or anticipated claims for refund of such type within
the apparently applicable statute of limitations for the years in question,
i.e., 1989 through January 1993. The cases are pending in the trial court at the
discovery stage.
DeKalb County v. Schrenko. This suit, originally filed in Federal
District Court for the Northern District of Georgia, against the State School
Superintendent and the State of Georgia is based on a claim that the State's
funding formula for pupil transportation is unconstitutional and a local school
board's claim that the State should finance the major portion of the costs of
its desegregation program. The Plaintiffs are seeking approximately $67,500,000
in restitution. The Federal District Court ruled that the State's funding
formula for pupil transportation is contrary to state law but ruled in the
State's favor on the school desegregation costs issue. Motions to reconsider and
amend the Court's judgment were filed by both parties. The State's motion was
granted, in part, which reduced the required state payment to approximately
$28,000,000, as of the date of decision. Notices of appeal and briefs to the
Eleventh Circuit Court of Appeals were filed by both sides, and oral arguments
on appeal were heard in October, 1996. In April, 1997, a three-judge panel of
the Eleventh Circuit Court of Appeals rendered a decision, affirming the trial
court's decision in the State's favor as to school desegregation costs issue and
reversing the trial court's decision against the State as to the State's funding
formula for pupil transportation being contrary to state law, 109 F.3d 680 (11th
Cir. 1997). Thus, under the Eleventh Circuit panel's decision, the State has no
liability. On
52
April 28, 1997, the Plaintiffs filed a motion for rehearing and en banc
consideration, and that motion is still pending. The State intends to continue
to defend the suit vigorously.
George Jackson, et al. v. Georgia Lottery Corporation. Plaintiffs seek
a court order declaring that two games sponsored by the Georgia Lottery
Corporation, "Quick Cash" and "Cash Three," are unconstitutional and enjoining
the lottery from further offering of these games. Plaintiffs also seek the
return of all monies played on these games during a specified period,
approximately $1,703,462,781. As a preliminary matter, the Court has ruled that
the plaintiffs would not be legally entitled to the monies claimed. The
plaintiffs have attempted to appeal. Any judgment against the Georgia Lottery
Corporation would not be satisfied from the State's general fund. See O.C.G.A.
ss.50-27-32(c).
Pursuant to a review of the Georgia Department of Revenue's revenue
collection information systems by the State Auditor, it was determined that from
April, 1995 to May, 1996 the Department did not maintain an adequate accounting
system to determine the accuracy of the amounts of Local Option Sales Tax,
Special Purpose Local Option Sales Tax and MARTA Sales Tax collected by the
Department on behalf of local governments and the disbursements of those taxes
to local governments imposing the sales-based taxes. The Department of Revenue
during this period estimated collections and disbursements to local governments
by reviewing the payment pattern to the local governments for the previous
twenty-four month period and followed that pattern, adjusting for known growth
in sales tax collections. The Department is working to correct this situation
and has ceased using estimates for making payments to the local governments.
Additionally, during this same period, a review of the Department of Revenue's
computer processing systems revealed significant internal control weaknesses.
Procedures are being studied to correct these problems.
As a result of the findings by the State Auditor, a task force
appointed by the Governor in September 1996 engaged KPMG Peat Marwick to make
recommendations to modernize the Department of Revenue's revenue collection
system. Peat Marwick has completed its study and the implementation of its
recommendations is underway. The Governor requested and the legislature approved
expenditures of $15,000,000 in the Amended Fiscal Year 1997 budget and
$6,000,000 was requested and approved in the Fiscal Year 1998 budget to begin
the process of updating the Revenue Department's computer system.
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.
ILLINOIS
RISK FACTORS--As of the end of fiscal year 1997 the State of Illinois
reported overall a GAAP basis excess of revenues over expenditures of $500
million, the greatest excess reported in over 10 years. Although the State
continued to run a year-end deficit in its General Fund, at June 30, 1997 the
General Fund deficit was reduced to $451 million compared to a deficit of $952
million at June 30, 1996. The State's total assets of over $78 billion was an
increase of about $10.3 billion largely attributable to an $8.7 billion increase
in the State's pension funds due to an accounting change requiring reporting of
those assets at fair value. During fiscal year 1997 the State funded all of its
retirement plans in accordance with the 1996 statute requiring full funding over
a 50-year period with a 15-year phase-in. Although retirement plan funding was
53
in an amount sufficient to comply with statutory requirements, it fell short of
the more stringent 40-year funding required by applicable accounting rules.
The State has traditionally taken the position that the minimum
available General Fund balance necessary to meet the State's daily payout needs
in a timely manner is $200 million. During fiscal year 1996 the end-of-month
General Fund available balances were approximately at or above the $200 million
dollar mark in 11 of the 12 months. The financial community, however, generally
believes that 4%-5% of the State's 15-month budgetary expenditures (taking into
account lapse period spending) is a more adequate working balance. In that
regard, the State's end-of-month General Fund balance for June of 1997 was above
the 4% threshold for the first month since fiscal year 1990. The General Fund
balance of $806 million on June 30, 1997 was the highest in State history.
Certain non-home rule units of government within the State are subject
to a cap on property tax increases. The cap limits increases in property tax
extensions to the lesser of 5% or the rate of inflation as measured by the
Consumers Price Index.
In 1988, the Illinois General Assembly approved the Retail Rate Act
which provided a state subsidy for Illinois waste-to-power incinerators.
Following passage of that legislation, bonds were issued to finance certain
facilities which were expected to be repaid from the revenue of the state
subsidized electricity sales. On March 14, 1996, legislation was enacted to
repeal the Retail Rate Act without transition rules to preserve the state
subsidy for outstanding bond issues. As a result of the loss of the state
subsidy, there may not be sufficient revenues to repay the bonds issued to
finance the waste-to-power incinerators. Lawsuits against the State have been
filed in response to the repeal of the Retail Rate Act.
In May, 1997, a Cook County (Illinois) Circuit Court ruled that the
Illinois State Toll Highway Authority had violated the Illinois State
Constitution by failing to submit its annual budget to the General Assembly for
approval. The court issued a preliminary injunction instructing the Tollway
Authority to submit its current budget to the General Assembly for approval on
or before December 15, 1997. On November 25, 1997, the State Supreme Court
stayed the Circuit Court's order until further notice. When the State General
Assembly adjourned in 1997, no action had been taken to resolve the budget
situation for the Tollway Authority. The trustee for the outstanding bond issues
has stated that requiring General Assembly approval of the Tollway Authority
budget could constitute a technical default under the indenture pursuant to
which the outstanding bonds were issued. Rating agencies have placed the bonds
of the Tollway Authority on a credit watch. Moreover, the rating agencies have
stated that loss of autonomy with respect to its budget could cause a downgrade
in the long-term debt rating issued to the Tollway Authority (the rating is
separate from the rating of Illinois general obligation debt). The decision of
the Cook County Circuit Court is currently on appeal.
General obligation bonds of the State of Illinois are currently rated
Aa3 by Moody's, upgraded from A1 in February, 1997, and AA by Standard & Poor's,
upgraded from AA- in July, 1997.
LOUISIANA
RISK FACTORS. 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 Sponsors have not independently verified any of the
information contained in such publicly available documents, but are not aware of
any facts which would render such information inaccurate.
54
In July, 1995 Standard & Poor's downgraded the rating the State
received for its general obligation bonds from A to A-. Standard & Poor's cited
problems with the State's Medicaid program as the primary factor in its
decision. The current Moody's rating on the State's general obligation bonds was
not downgraded and remains at Baaa1. 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 1996-1997 was
$586 million.
On January 29, 1997 the Revenue Estimating Conference (the
"Conference") adopted its official forecast of revenues for Fiscal Year 1997-98
at $5.489 billion of state general fund monies plus $94.9 million in Lottery
Proceeds, or a total of $5.584 billion, as the basis for legislative enactment
of the operating budget during the 1997 regular session, which commences March
31, 1997. Based upon that estimate, forecasted revenues would be approximately
$192.9 million short of the amount needed to continue state operations in the
fiscal year 1997-1998 at a level equivalent to Fiscal Year 1996-1997. The state
believes it may be possible to close this gap by providing stand-still dollar
recommendations in a number of expenditure categories.
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) 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.
55
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, 1995 the outstanding
principal amount of said Bonds was $193,323,000.00.
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 1995-1996, the sum of $119,946,754.00 was
paid from the Self-Insurance Fund to satisfy claims and judgments. It is the
opinion of the Attorney General for the State of Louisiana that only a 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 $31 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
Sponsors are 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.
MAINE
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
56
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 is based primarily on natural
resources, manufacturing related to natural resources, agriculture and tourism.
Gradually the economy has begun to diversify with growth in the trade and
services sector and in relatively new industries such as health and business
services and electronics manufacturing. Maine's economy has become more
diversified as manufacturing declines in importance. Currently, about 16% of
employment is in manufacturing, mostly non-durable, while trade accounts for 24%
of employment and services accounts for 28% of employment. Recent employment
growth has been in the service sector, and this is expected to continue, as
several of the major employers are expanding in the State. MBNA expects to more
than double employment at its Belfast, Maine facility over the next few years
and National Semiconductor, in addition to an $830 million investment in a new
wafer chip plant in South Portland, Maine, has spun off a new company, Fairchild
Semiconductor, which plans to add some 800-850 employees of its own.
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. Following the severe
economic contraction of the early 1990s, the New England Region returned to 95%
of peak employment levels by the end of 1995. At that time, the northern tier
states of Maine, New Hampshire and Vermont actually recouped the jobs lost in
the downturn. The outlook for the overall New England economy is for continued
slow recovery with the lackluster performance of the Connecticut and Rhode
Island economies clouding the vibrancy of the Massachusetts and New Hampshire
showing. According to the State Planning Office, the fact that Maine is likely
more influenced by our closest neighbors should translate to the State receiving
relatively more benefit than harm from the varied performance of those in the
region.
Since experiencing an economic slide that lasted through much of 1990
and 1991 and eliminated 6% of the employment base, Maine has been on a fairly
fragile growth path. Since that time, by most measures, the State economy has
been in a steady, if slow, recovery. While typical recoveries are marked by a
resurgence in economic activity over the 4-6 quarters following the downturn,
this recovery has been painfully slow and sporadic. Thus, while Maine continues
to demonstrate economic improvement, current economic growth would hardly be
described as robust. After 4 full years, the jobs that had been lost earlier
this decade were finally recouped. In 1995, employment was down only 0.4% from
the 1989 peak. Based on preliminary 1996 information, employment levels will
approximate that peak. Unemployment has also come down and appears to be
returning to its historical position, at or below the national average;
preliminary 1996 information showed a 5.1% unemployment rate, about 94% of the
national figure and 106% of the regional average. The May 1997 unemployment rate
was 4.8%, the same as the national figure. The average annual unemployment rate
forecast for the State prepared by the Maine State Planning Office is 5.2% for
1997 and 5.1% for 1998. There is, however, continued concern over the quality of
the jobs that have replaced those that had been lost. The bulk of all jobs
created through the 1980s came from the nonmanufacturing sector, led by medical
and business services, retail trade, and construction. Manufacturing employment
continued to dwindle through the decade with the exception of a work-force
build-up at Bath Iron Works in 1988 that bolstered the industrial job figures.
As with the rest of the nation, job growth in manufacturing is expected to be
minimal, but productivity gains in this sector will continue to bring wealth to
the State. Overall employment growth will average 0.5%-1.0%, a mere fraction of
the 5%-6% growth that marked the mid-eighties. The upward push on wages brought
about by fairly tight labor market conditions will be somewhat offset by the
service sector's generally lower wage and lower benefit job offerings keeping
real income growth below the 2% mark through the next 5 years.
57
The recession of the early 1990s took its toll on both manufacturing
and non-manufacturing sectors, as a cyclical downturn combined with defense
cutbacks and industry restructuring to eliminate over 34,000 jobs spread fairly
evenly over the services and goods-producing sectors. Two of the State's largest
employers are Bath Iron Works (August 1996 employment 7,800) and Portsmouth
Naval Shipyard (August 1996 employment 3,550). These employment figures reflect
reductions from 1995 peaks of 8,900 and 4,086 respectively. There continues to
be some exposure here to defense cuts. In order to enhance BIW's competitive
position, however, the Maine legislature approved assistance legislation
amounting to about 3 million dollars annually. There is a possibility, however,
that this assistance will be reconsidered by the legislature in light of certain
news stories reporting that BIW's parent company, General Dynamics, may merge
with the parent of BIW's chief rival, Ingalls Shipyard in Mississippi.
Consistent with the trends experienced over the past several decades,
virtually all job growth is expected to be in the nonmanufacturing sector, led
by business and health services, retail trade and construction. In the
manufacturing sector, only the fabricated metals, food, and instrument
industries are projected to see any job gains while the other goods-producing
industries will experience stable employment or minor declines. Given Maine's
comparatively high electricity prices, the restructuring of Maine's electric
utilities to create retail access to electricity supplies could be the single
most important factor in the future vibrancy and direction of the State's
economy. Over the past year, the debate on restructuring shifted to the Public
Utilities Commission as phase II of the Legislatively-mandated process to
develop a plan unfolded. While several State's have moved forward with
deregulation and greater competition in the generation and sale of electricity,
the Maine PUC created a plan for re-regulating Maine's two largest
investor-owned utilities and submitted it to the 118th session of the Maine
Legislature. More of a blueprint than a detailed plan, the PUC proposal calls
for full retail access by the year 2000. Many of the specific steps in the
process are deferred to subsequent Commission decisions, but the Legislature
will ultimately set the direction and pace of utility restructuring in Maine.
The recent decision by the owners of the Maine Yankee Nuclear Power plant to
shut the plant down is the real wild card in the ongoing deregulation trend.
State and economic growth figures often mask important regional
differences in economic activity. For example, the unadjusted State jobless rate
in May 1997 was 4.6%. Cumberland, York, Hancock and Lincoln counties, however,
all had rates of 3% or lower while the western and northern counties had
unemployment rates in the 8% to 10% range. Thus, as the State Planning Office
observes while it appears that the south and midcoast counties might be
straining against labor shortages to grow even faster, the remainder of the
State is still in low gear.
As a result of the slow expansion of the Maine economy, the economic
indicators present a mixed bag, with some increasing and others decreasing. Of
17 economic indicators tracked most closely by the State Planning Office, 8
indicators showed improvement in 1996 while 8 showed a decline. Building permits
showed no change. This indicates an economy that is growing very slowly. Indeed,
most of the indicators, whether positive or negative showed only modest
deviation from this "no change" midpoint. Conversely, of the seven national
indicators looked at by the State Planning Office, five fell into the "better"
column, confirming a faster growing national economy than Maine's. The Maine
Economic Growth Index (the "EGI") is a seasonally adjusted composite of resident
employment, real taxable consumer retail sales, production hours worked in
manufacturing, and services employment designed to measure real
(inflation-adjusted) growth in the overall economy. The EGI rebounded from an
almost 2 1/2 point drop at the end of March 1997, climbing to a new high of
112.1 in April 1997. The Maine economic outlook calls for continued slow growth,
yielding payroll employment growth for 1997 and 1998 of 0.5% and 0.8%
respectively and personal income growth in the same periods of approximately
4.8% and 4.9% respectively. Consumer retail sales are projected to increase only
2.6% in 1997 and 3.6% in 1998, down from the 1996 projections of 5.4%. Major
dampers to Maine economic growth over the near term are expected to include slow
income growth and high family debt loads. According to the State Planning
Office, perhaps the single greatest impediment to faster economic growth in
Maine is the State's very slow population growth.
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Between 1991 and 1996, Maine's population increased by about 8,000. Over the
previous five years, the State's population increased by about 64,000, for a
growth rate eight times as fast as in the latest five year period. Additionally,
migration and aging patterns caused a decline of 11,000 persons in the 16-24 age
group between 1990 and 1995, leaving a dearth of people in the labor force's
entry-level age group. However, this situation may be improving. According to
the U.S. Bureau of the Census, Maine had a net in-migration (2,300) in 1996, for
the first time since 1990, and the Bureau's projections call for continued
modest net in-migration over the next five years.
The seasonally adjusted unemployment rate in Maine rose to 4.8% in May
1997 from a low of 4.3% in February 1997. This still reflects a drop from 5.2% a
year ago in May 1996. Maine continues to rank fairly low when measuring per
capita personal income, tallying 37th in the United States in 1996, 85.9% of the
national average.
Construction contract awards fell approximately 17% comparing the first
2 months of 1997 with the same period in 1996. Unlike a year ago, however, the
principal drag has been extremely weak non-residential construction sector,
which was down approximately 68% between the first 2 months of 1996 and the
first 2 months of 1997. In contrast, the residential sector increased 17% and
the non-building sector (roads, bridges, etc.) increased approximately 69% in
comparing the same periods. According to the Institute for Real Estate Research
and Education, the number of housing units sold in 1996 was up 5% from 1995.
In summary, through the first several months of 1997, the Maine economy
has been growing, but sporadically. Curiously, while economic growth in Maine
has been relatively slow, general fund revenues are well above the forecast,
with a $58 million surplus through May 1997. During this time, a real economic
growth for the first quarter in the US was 5.9%, but only 1.9% in Maine.
Similarly, retail store sales for the year through April were up 5.5%
nationally, but only up 3.1% (through May) in Maine. Also payroll employment for
May was up 2.1% over the previous May in the US, but only up 1.4% in Maine. And,
while national personal income rose 5.4% in 1996, the increase in Maine was only
3.7%.
Yet, while income growth in Maine has been relatively weak (and below
projections), personal income tax revenues have been very strong ($42.8 million
surplus for the fiscal year through May 1997). Personal income growth was weaker
in Maine than in the nation in part because of slower population growth, but the
major factor appears to be that job growth here has been largely in the lower
wage paying industries these vis-a-vis the US. The State Planning Office
surmises that Maine income tax revenues have likely been stronger than expected
(given the slow income growth) in part because the distribution of income gains
have been weighted toward the higher income brackets (capital gains from stock
transfers, etc.) and at higher incomes the marginal tax rates increase
considerably with increasing revenues.
The important question concerning how the restructuring of the United
States military will affect defense related industries in Maine now has at least
a preliminary answer. Loring Air Force Base ("LAFB") officially closed its doors
as a military base on September 30, 1994, although most of the planes and
personnel had been reassigned as much as a year earlier. The base closing,
coupled with the shutdown of the Backscatter radar system in Bangor, meant the
loss of a substantial amount of military and civilian jobs in the region. Base
clean-up operations have begun and are expected to take several years to
complete. In the meantime, the Loring Development Authority has begun the task
of attracting public and private business to the facility. Recent news has been
more favorable as LAFB was selected as a Defense Finance and Accounting Service
Center (the "DFAS Center") and a JOBS Corps site. Currently one million square
feet of approximately 3.2 million square feet of available space has been
leased.
The DFAS Center became operational at Loring on May 3, 1995. To date,
the Center has hired 332 employees with a total employment projection estimated
at 550 when fully operational. In addition, a $6.3
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million renovation project for the JOBS Corps site was completed in the fall of
1996. It is now operational with 269 students and 125 employees. The Loring
Development Authority has also decided to pursue locating a National Airline
Training Center at Loring.
Bath Iron Works ("BIW"), the State's largest employer, was recently
awarded a $108 million ship building contract for the construction of Aegis
Class destroyers. The U.S. Navy also awarded BIW a $7.8 million contract for
other continued work on the AEGIS destroyers. In June 1996, the Navy awarded BIW
a $348 million contract on a second AEGIS destroyer. BIW was also recently
awarded a $33 million contract to provide engineering, design and maintenance on
the Navy's Arliegh Burke destroyer fleet. In August 1995, BIW was acquired for
$300 million by General Dynamics Corp. a larger supplier of both defense and
commercial products. The sale is seen as a stabilizing force for BIW and assures
that BIW will continue to concentrate on the construction of ships for military
use. Recent news stories about a possible merger between BIW's parent company
and the parent company of its chief rival, however, do raise significant
questions about the future of BIW. In January 1996, BIW completed a study about
commercial prospects and concluded that the shipyard could not depend on
commercial shipbuilding to significantly supplement its defense work.
Another major employer, the Portsmouth Naval Shipyard in Kittery, Maine
staffed almost completely by a civilian work force, has taken drastic steps over
the past year to become more competitive and efficient, and is considering
re-focusing its mission and role in submarine repair. After large layoffs in
1994 helped to shrink its staffing level by half from the eight thousand workers
employed in the 1980s the shipyard has now stabilized. The U.S. Base Closure
Commission announced in mid-1995 that the Shipyard would not be on its base
closing list. Thus, though trimmer today, the shipyard is assured stability over
the next few years.
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. On November 8, 1994, Maine citizens elected
an Independent candidate to be Governor of the State. In 1996, the voters also
elected a Democratic controlled Senate and House of Representatives. The State
operates under a biennial budget which is formulated by the Governor and the
State Budget Office in even-numbered years and presented for approval to the
Legislature in odd-numbered years.
On June 30, 1995, the Legislature approved and the Governor signed a
budget for the 1996-97 biennium. The budget proposes, for fiscal year 1996,
General Fund expenditures of $1,713,573,026 and Highway Fund expenditures of
$224,514,277 and, for fiscal year 1997, General Fund expenditures of
$1,785,543,156 and Highway Fund expenditures of $220,551,295. The Legislature
met in special session in November and December 1995 and authorized General Fund
Expenditures of $1,732,041,447 and Highway Fund Expenditures of $257,727,929 for
fiscal year 1996 and General Fund Expenditures of $1,786,060,521 and Highway
Fund Expenditures of $226,708,840 for fiscal year 1997. In the Legislature's
regular session convened January 1996 and adjourned on April 4, 1996, the
Legislature amended the budget again and authorized General Fund Expenditures of
$1,733,842,806 and Highway Fund Expenditures of $260,799,573 for fiscal year
1996 and General Fund Expenditures $1,797,414,117 and Highway Fund Expenditures
of $227,316,195 for fiscal year 1997.
Laws authorizing expenditures for fiscal years 1998 and 1999 were
enacted in the first regular session of the Legislature in 1997 and provide for
fiscal year 1998 General Fund expenditures of $1,825,047,780 and Highway Fund
expenditures of $217,416,987 and, for fiscal year 1999 General Fund expenditures
of $1,984,859,413 and Highway Fund expenditures of $218,026,687.
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There can be no assurance that the budget acts for fiscal years 1998
and 1999 will not be amended from time to time.
Maine's financial operations have recovered from the pressures created
by the recession and a financial cushion has been restored. The State has
anticipated a small-unappropriated surplus at the June 30, 1997, end of the
biennium, as well as a rainy day fund balance of $23 million. In actuality,
revenues were stronger than expected in 1995-1996 allowing for an increase in
the rainy day fund to $38 million. With the trend continuing into the 1996-1997
fiscal year, revenues are now estimated to close the year some $30 million to
$40 million (currently $24 million) over estimates and the rainy day fund is
expected to reach $45 million as of June 30, 1997, equal to approximately 2.5%
of revenues. Revenue collection through March 1997 is about 2% over estimates.
The bulk of the revenue at overage is expected to go into a tax relief fund. The
biennial 1998-1999 budget addressed an expected gap of some $360 million due to
the repeal of the hospital and nursing home taxes and a cap placed on income tax
receipts intended to be effective July 1, 1997. Governmental down sizing and
program cuts of some $244 million were enacted to ease the phase-out of the
hospital taxes and income tax cap was repealed.
Maine has passed legislation phasing out the hospital and nursing home
taxes by 1998-1999 (one year later than initially planned) and has repealed the
cap of $671 million on individual tax collections, which would have become
effective July 1, 1997. The absorption of this structural gap of some $360
million is accomplished by about $244 million of program cuts and spending
reductions, as well as the stronger revenue performance. The rainy day fund is
expected to hold $45 million at the end of 1996-1997, its historical high and
equal to 2.5% of revenues. Revenues through the first 9 months of the year are
currently $24 million or 2% ahead of estimates with expectations of a $30
million-$40 million operating surplus. The excess is expected to be applied to
tax relief to increase the personal exemption.
The principal operating account for the State is the general fund;
supplementing it is the highway fund. The State is in the process of conversion
to a GAAP accounting system but operations are currently founded on the
budgetary basis. On a budgetary basis, Maine retained an unappropriated surplus
in the general fund through the recession. From a high of $163.1 million in
1989, the balance dropped to $61 million at June 30, 1990, and reached $3.5
million at June 30, 1991. On a GAAP basis, the general fund has been in deficit
(based on undesignated balances) for several years.
The State Controller prepares as soon as possible after the close of
each fiscal year an explanatory report of the financial condition of the State.
This report is the official financial report of the State government. The
financial statements of the State of Maine for the year ended June 30, 1996 have
been prepared by the State controller and have been audited by the Department of
Audit in accordance with generally accepted auditing standards. The Department
of Audit has qualified its most recent audit opinion on these financial
statements because of certain departures from generally accepted accounting
principles.
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 are rated AA+ by
Standard & Poor's Ratings Services, Aa3 by Moody's Investors Services, Inc. and
AA by Fitch Investors Services, L.P.
As of March 31, 1997, there was outstanding approximately $444,157,945
general obligation bonds of the State. As of May 1, 1997, there were authorized
by the voters of the State for certain purposes, but unissued, bonds in the
aggregate principal amount of $96,155,316. As of May 1, 1997, the aggregate
principal amount of bonds of the State authorized by the Constitution and
implementing legislation for certain purposes, but unissued, was $99,000,000.
61
Lease-Purchase Agreements. From time to time, the State enters into
lease-purchase agreements for the purpose of acquiring capital equipment and
buildings. A lease-purchase agreement is secured solely by the equipment or
building which is the subject of such agreement. It is not a pledge of the full
faith and credit of the State. Lease payment and obligations are subject to
appropriation by the Legislature. In certain instances, the State has issued
certificates of participation in the lease payments to be made pursuant to
certain lease-purchase agreements. As of February 28, 1997, the aggregate
principal amount of certificates of participation outstanding was $27,983,635.
Litigation. The State is a party to numerous lawsuits. Such lawsuits
include actions to recover monetary damages from the State, disputes over
individual or corporate income taxes, disputes over sales or use taxes, and
actions to alter the regulations or administrative practices of the State in
such manner as to cause additional costs to the State. The Department of the
Attorney General is not aware of any pending or threatened litigation or claim
against the State, the outcome of which will, in his opinion, have a material
adverse effect on the financial condition of the State.
In 1993 the Maine Legislature amended the laws relating to the benefit
structure of the Maine State Retirement System (the "Amendments"). The
Amendments limited certain retirement benefits which would otherwise have been
available to eligible retirees. Litigation was commenced in federal district
court by affected employees in the Retirement System seeking declaratory and
injunctive relief which, if granted, would, in effect, overturn the Amendments
and oblige the State to increase its annual payments to the Retirement System.
In September 1996, the Federal District Court for the District of Maine entered
an order granting in part and denying in part the relief sought by the affected
employees. The Federal District Court order has been appealed to the First
Circuit Court of Appeals by both the State and the affected employees. Oral
argument of the appeal was heard by the First Circuit Court of Appeals in April
1997, and a decision on the appeal is anticipated in the next several months.
The Department of Attorney General of the State continues to believe that the
State will ultimately prevail in the claims of the Plaintiffs in this
litigation.
Certain public authorities. The portfolio may contain obligations of
certain public authorities and quasi-municipal corporations of the State of
Maine including the Maine Municipal Bond Bank, the Maine Health and Higher
Educational Facilities Authority and Regional Waste Systems, Inc., among others.
These various obligations will generally constitute revenue obligations secured
by loan repayments of the ultimate borrowers of the proceeds or other revenue
streams. The risks associated with these various obligations should be assessed
through reference to the official statements for each of the respective
obligations.
MARYLAND
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
62
improvements, including grants and loans for water quality improvement projects
and 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.
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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 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. On November 9, 1994, the Maryland Transportation Authority
issued $162.6 million of special obligation revenue bonds to fund projects at
the Baltimore/Washington International Airport secured by revenues from the
passenger facility charges received by the Maryland Aviation Administration and
from the general account balance of the Transportation Authority. As of June 30,
1997, $388.7 million of the Transportation Authority's revenue bonds were
outstanding.
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 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 Centers in Baltimore and Ocean City
and construction of a conference center in Montgomery County. The Baltimore
Convention Center expansion is expected to cost $163 million and is being
financed through a combination of funding from Baltimore City, Stadium Authority
revenue bonds, and State general obligation bonds. The Ocean City Convention
Center expansion is expected to cost $35 million and is being financed through a
combination of funding from Ocean City and the Stadium Authority. The Montgomery
County conference center is expected to cost $27.5 million and is being financed
through a combination of funding from Montgomery County and the Stadium
Authority.
In October 1995, the Stadium Authority and the Baltimore Ravens
(formally known as the Cleveland Browns) executed a Memorandum of Agreement
which commits the Ravens to occupy a to be constructed football stadium in
Baltimore City. The Agreement was approved by the Board of Public Works and
constitutes a "long-term lease with a National Football League team" as required
by statute for the issuance of Stadium Authority bonds. The Stadium Authority
sold $87.565 million in lease-backed revenue bonds on May 1, 1996. The proceeds
from the bonds, along with cash available from State lottery proceeds,
investment earnings, and other sources will be used to pay project design and
construction expenses of approximately $200 million. The bonds are solely
secured by an assignment of revenues received under a lease of the project from
the Stadium Authority to the State.
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, higher educational institutions (including St. Mary's
College of Maryland, the University of Maryland System, and Morgan State
University), and the Maryland Environmental Service 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.
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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.
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 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.
65
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.
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.
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.
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MASSACHUSETTS
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 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. Generally, the amounts provided herein are calculated on a
statutory basis which may sometimes differ materially from that reported on a
GAAP basis.
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, if any, 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. This limit has been increased to $1.05 billion.
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 1997, the
aggregate property tax levy grew from $3.346 billion to $6.160 billion,
representing an increase of approximately 84.1%. 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 97.7%.
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. In fiscal 1998, approximately 20.6% of the
Commonwealth's budget is estimated to be allocated to direct Local Aid. In
addition to direct Local Aid, the Commonwealth has provided substantial indirect
aid to local governments, including, for example, payments for MBTA assistance
and debt service, pensions for teachers, pension cost-of-living allowances for
municipal retirees, housing subsidies and the costs of courts and district
attorneys that formerly had been paid by the counties.
Many communities have responded to the limitations imposed by
Proposition 2 1/2 through statutorily permitted overrides and exclusions.
Override activity steadily increased throughout the 1980's before peaking in
fiscal 1991 and decreasing thereafter. In fiscal 1997, 17 communities had
successful override referenda which added an aggregate of $5.4 million to their
levy limits. In fiscal 1997, the impact of successful override referenda, going
back as far as fiscal 1993, was to raise the levy limits of 114 communities by
$48.8 million. Although Proposition 2 1/2 will continue to constrain local
property tax revenues, significant capacity exists for overrides in nearly all
cities and towns.
In addition to overrides, Proposition 2 1/2 allows a community, through
voter approval, to assess taxes in excess of its levy limit for the payment of
certain capital projects (capital outlay expenditure exclusions) and for the
payment of specified debt service costs (debt exclusions). Capital exclusions
were passed by 20 communities in fiscal 1997 and totaled $3.2 million. In fiscal
1997, the impact of successful debt exclusion votes going back as far as fiscal
1993, was to raise the levy limits of 236 communities by $612.9 million.
A statute adopted by voter initiative petition at the November, 1990
statewide election regulates the distribution of local aid to cities and towns.
This statute requires that, subject to annual appropriation, no less than 40% of
collections from personal income taxes, sales and use taxes, corporate excise
taxes and lottery fund proceeds be distributed to cities and towns. Under the
law, the local aid distribution to each city or town would equal no less than
100% of the total local aid received for fiscal 1989. Distributions in excess of
fiscal 1989 levels would be based on new formulas that would replace the current
local aid distribution formulas. By its terms, the new formula would have called
for a substantial increase in direct local aid in fiscal 1992, and would call
for such an increase in fiscal 1993 and in subsequent years. However, local aid
payments expressly remain subject to annual appropriation by Legislature, and
the appropriations for Local Aid since the enactment of the initiative law have
not met 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, 1996,
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 $4.774 billion,
$476.6 million and $1.470 billion, respectively, for a total unfunded actuarial
liability of $6.720 billion. As of December 31, 1996 the Commonwealth's pension
reserves had grown to approximately $7.7 billion. The fiscal 1998 budget of the
Commonwealth adopts a 20-year flat payment schedule which will fund the unfunded
employee pension liability by the year 2018, ten years earlier than the previous
schedule.
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 1998 and
1999 are estimated to be increased to approximately $1.046 billion and $1.059
billion, respectively. Acting Governor Cellucci has proposed overriding the
foregoing requirement relating to the first ten years of the schedule in order
to limit required expenditures in fiscal 1999 to approximately $945.3 million.
Total pension expenditures increased from $868.2 million in fiscal 1993 to
$1.005 billion in 1996 and $1.069 billion in 1997. The estimated pension
expenditures for fiscal 1998 are approximately $1.046 billion.
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Pursuant to legislation enacted as part of the fiscal 1997 budget,
public employees hired on or after July 1, 1996 must contribute 9% of their
regular compensation to their retirement system except for state police hired on
or after such date who must contribute 12%.
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 1993 through fiscal 1997
were lower than the limits. The Executive Office for Administration and Finance
currently estimates that state tax revenues in fiscal 1998 will not reach the
limit imposed by either the initiative petition or the legislative enactment.
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. The Fiscal Recovery
Bonds were retired in December, 1997.
State finance law provides for a Stabilization Fund, a Capital Projects
Fund and a Tax Reduction Fund relating to the use of fiscal year-end surpluses.
A limitation formerly equal to 0.5% of total tax revenues (less the amount of
annual debt service costs) is imposed on the amount of any aggregate surplus in
the Commonwealth's three principal budgeted operating funds which may be carried
forward as a beginning balance for the next fiscal year and creates a reserve of
such excess amounts to be used for specific purposes. Legislation adopted in May
1997 raised the statutory ceiling on the Stabilization Fund to 0.5% of budgeted
revenues for the preceding fiscal year (as opposed to just tax revenues) and
also provided that up to 40% of any fiscal year-end surplus may, prior to any
transfer to the Stabilization Fund, be held in a separate account to be used for
capital expenditures, if there is a negative balance in the state's capital
funds. Amounts credited to the Stabilization Fund are not generally available to
defray current year expenses without subsequent specific legislative
authorization. Amounts in excess of the limit are to be transferred to the Tax
Reduction Fund to be applied to the reduction of personal income taxes. For each
of fiscal years 1995 and 1996, the Legislature overrode the general provisions
governing deposits to or the use of excess balances in the Stabilization Fund by
the enactment of one-time modifications.
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 totaled 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
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uses in fiscal 1993 totaled 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 totaled approximately $15.55 billion.
Budgeted expenditures and other uses of funds in fiscal 1994 were $15.523
billion.
As a result of comprehensive education reform legislation enacted in
June, 1993, a large portion of general revenue sharing funds are earmarked for
public education and are distributed through a formula designed to provide more
aid to the Commonwealth's poorer communities. The legislation established a
fiscal 1993 state spending base of approximately $1.288 billion for local
education purposes and required annual increases in state expenditures for such
purposes above that base, subject to appropriation, estimated to be
approximately $175 million in fiscal 1994, approximately $396 million in fiscal
1995, approximately $629 million in fiscal 1996 and approximately $881 million
in fiscal 1997, with additional annual increases anticipated in later years. The
fiscal 1994, 1995, 1996 and 1997 budgets have fully funded the requirements
imposed by this legislation.
Fiscal 1995 tax revenue collections were approximately $11.163 billion,
approximately $12 million above the Department of Revenue's revised fiscal year
1995 tax revenue estimate of $11.151 billion, approximately $556 million, or
5.2%, above fiscal 1994 tax revenues of $10.607 billion. Budgeted revenues and
other sources, including non-tax revenues, collected in fiscal 1995 were
approximately $16.387 billion, approximately $837 million, or 5.4%, above fiscal
1994 budgeted revenues of $15.550 billion. Budgeted expenditures and other uses
of funds in fiscal 1995 were approximately $16.251 billion, approximately $728
million, or 4.7%, above fiscal 1994 budgeted expenditures and uses of $15.523
billion. The Commonwealth ended fiscal 1995 with an operating gain of $137
million and an ending fund balance of $726 million.
The final fiscal 1995 supplemental budget modified, with respect to the
fiscal 1995 year-end surplus, the provisions of state law governing deposits to
the Stabilization Fund. For fiscal 1995, surplus funds as defined in the law
(the sum of the undesignated fund balances at year-end in the three principal
operating funds) in excess of the amount which can be carried forward as a
beginning balance for fiscal 1996 were to be credited, first, to the
Stabilization Fund, to the extent of 0.25% of total tax revenues, second, to a
newly credited Cost Relief Fund, to the extent of 0.5% of total tax revenues,
and, third to the Stabilization Fund to the extent of any remaining amount.
Amounts in the Cost Relief Fund can be appropriated for environmental and
sanitation purposes as well as for unanticipated obligations, unavoidable
deficiencies or extraordinary expenditures of the Commonwealth. As calculated by
the Comptroller, the amount of surplus funds (as so defined) for fiscal 1995 was
approximately $94.9 million, of which $55.9 million was available to be carried
forward as a beginning balance for fiscal 1996. Of the balance, approximately
$27.9 million was deposited in the Stabilization Fund, and approximately $11.1
million was deposited in the Cost Relief Fund.
Budgeted operating funds of the Commonwealth ended fiscal 1996 with a
surplus of revenues and other sources over expenditures and other uses of $446.4
million, resulting in aggregate ending fund balances in the budgeted operating
funds of the Commonwealth of approximately $1.172 billion. Budgeted revenues and
other sources for fiscal 1996 totaled approximately $17.328 billion, including
tax revenues of approximately $12.049 billion. Budgeted revenues and other
sources increased by approximately 5.7% from fiscal 1995 to fiscal 1996, while
tax revenues increased by approximately 7.9% for the same period. Budgeted
expenditures and other uses in fiscal 1996 totaled approximately $16.881
billion, an increase of approximately $630.6 million, or 3.9% over fiscal 1995.
The fiscal 1996 year-end transfer to the Stabilization Fund amounted to
approximately $177.4 million, bringing its balance to approximately $625
million, which exceeded the maximum then allowed under State law. Under state
finance law, year-end
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surplus amounts (as defined in the law) in excess of the amount that can remain
in the Stabilization Fund are transferred to the Tax Reduction Fund, to be
applied, subject to legislative appropriation, to the reduction of personal
income taxes. The balance in the Tax Reduction Fund, as reflected in the 1996
Comptroller's Audited Financial Report, is approximately $231.7 million.
Legislation approved by the Governor on July 30, 1996 appropriated $150 million
from the Tax Reduction Fund for personal income tax reductions in fiscal 1997,
to be implemented by a temporary increase in the amount of the personal
exemption allowable for the 1996 taxable year. Legislation adopted in May, 1997
authorized the remaining balance of approximately $85 million in the Tax
Reduction Fund to be applied toward an additional temporary personal exemption
increase during the 1997 taxable year.
On October 31, 1997, the Comptroller released the Commonwealth's
statutory basis financial report for 1997. Total fiscal 1997 expenditures were
approximately $17.949 billion. Total fiscal 1997 budgeted revenues were
approximately $18.170 billion. The report indicates that fiscal 1997 tax
collections totaled approximately $12.864 billion, an increase of approximately
$815 million, or 6.8%, over fiscal 1996 and approximately $357 million higher
than the most recent official estimates released by the Secretary of
Administration and Finance on May 20, 1997. The final fiscal 1997 supplemental
appropriation bill established a Capital Investment Trust Fund to be
administered by the Secretary of Administration and Finance and provided for the
transfer of $229.8 million to such fund to be charged to fiscal 1997 in order to
finance certain specified expenditures for equipment purchases, deferred
maintenance and repairs, technology upgrades and capital purchases and
improvements. The spending authorization will expire at the end of fiscal 1999,
and any unexpended balances in this new fund will be transferred at that time to
the Commonwealth Stabilization Fund. The bill also directed the transfer of $100
million to the Stabilization Fund (in addition to the $134.3 million transfer to
the Stabilization Fund required by the general provisions of the state finance
law and a $89.5 million transfer to the Capital Projects Funds for capital
expenditures) and the transfer of $128 million to a Caseload Increase Mitigation
Fund which had been established in the fiscal 1998 budget to fund possible
unanticipated expenditures in the Commonwealth's welfare programs.
On July 10, 1997, the Governor signed an $18.4 billion budget for the
1998 fiscal year, an increase of 2.8% over anticipated fiscal 1997 expenditures.
The budget is based on a consensus tax revenue forecast of $12.85 billion. After
a review of first quarter fiscal 1998 tax receipts, the Executive Office for
Administration and Finance revised the fiscal 1998 tax forecast upward to $13.2
billion. The 1998 tax revenue estimates were revised again on January 16, 1998,
to reflect an increase of $100 million in tax revenues. The budget incorporates
tax cuts valued by the Department of Revenue at $61 million and provides for an
accelerated pension funding schedule. (On July 29, 1997, Governor Weld resigned
in an attempt to secure his appointment as Ambassador to Mexico, and Lieutenant
Governor Cellucci became the Acting Governor of the Commonwealth through the
expiration of Governor Weld's term on January 7, 1999.) On July 30, 1997, the
Acting Governor filed legislation that would reduce the tax rate over three
calendar years. The Executive Office for Administration and Finance estimates
that, should the legislation be adopted as filed, the static revenue impact of
these changes would be a reduction in personal income tax collections of
approximately $196 million in fiscal 1998, $587 million in fiscal 1999, $985
million in fiscal 2000, and $1.229 billion in fiscal 2001, at which time the
rate reduction would be fully implemented. The Legislature has not yet acted on
the proposal. Projected total fiscal 1998 expenditures are approximately $18.848
billion.
Year-to-date tax collections through January, 1998 total approximately
$7.577 billion, approximately $395 million, or 5.5%, higher than collections in
the corresponding period in fiscal 1997 and approximately $102 million higher
than the midpoint of the benchmark range ($7.315 billion to $7.475 billion)
contemplated by the Department of Revenue's January 16, 1998 estimates.
As of June 30, 1997, the Commonwealth had a cash position of
approximately $902 million, not including the Stabilization Fund of $799
million. The most recent quarterly cash flow projections for fiscal
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1998 were released by the State Treasurer and Secretary of Administration and
Finance on December 11, 1997 and estimate the fiscal 1998 year-end cash position
will be approximately $335.1 million. The projected year-end balance does not
include any fiscal 1998 activity that may occur after June 30, 1998 nor the
balance in the Stabilization Fund ($799.3 million at June 30, 1997) or interest
earnings thereon expected during fiscal 1998; it does include $234 million to be
transferred to the Stabilization Fund during fiscal 1998 on account of fiscal
1997. The cash flow statement forecasts, in connection with the Central
Artery/Ted Williams Tunnel Project, that the Commonwealth will issue $350
million of notes in anticipation of future federal highway grants, noting that
funding for such purposes has been extended on an interim basis through March
31, 1998, and that successor federal funding legislation is expected to be
enacted during 1998. What the level of future highway aid will be for the
Commonwealth remains uncertain.
On January 27, 1998, Acting Governor Paul Celucci submitted a $19.06
billion budget for fiscal 1999, or total spending of $19.49 billion after
adjusting for shifts to and from off-budget accounts. The proposed fiscal 1999
spending level represents a $641.7 million, or 3.4%, increase over projected
total fiscal 1998 expenditures of $18.848 billion. Budgeted revenues for fiscal
1999 are projected to be $18.961 billion, or $19.291 billion after adjusting for
shifts to and from off-budget accounts. The Acting Governor's proposal projects
a fiscal 1999 ending balance in the budgeted funds of $906.3 billion, including
a Stabilization Fund Balance of $878.1 million. The Acting Governor's budget
recommendation is based on a tax revenue estimate of $13.665 billion, a $510.7
million, or 3.9%, increase over fiscal 1998 projected tax revenues of $13.154
billion. The budget submission proposes reduction of the state income and
unearned tax rates as well as the elimination of the state capital gains tax on
the sale of homes.
During fiscal years 1993, 1994, 1995, 1996 and 1997, Medicaid
expenditures were $3.151 billion, $3.313 billion, $3.398 billion, $3.416 billion
and $3.456 billion, respectively. The average annual growth rate from fiscal
1993 to fiscal 1997 was 1.9%. The moderate rate of growth is due to a number of
savings and cost control initiatives that the Division of Medical Assistance
continues to implement and refine, including managed care, utilization review
and the identification of third party liabilities. Fiscal 1998 spending for the
current Medicaid program is projected to total $3.616 billion, an increase of
4.6% from fiscal 1997.
The liabilities of the Commonwealth with respect to outstanding bonds
and notes payable as of January 1, 1998 totaled $14.469 billion. These
liabilities consisted of $9.595 billion of general obligation debt, $629 million
of special obligation debt, $3.954 billion of supported debt, and $291 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
million per fiscal year. Capital expenditures were $575.9 million, $760.6
million, $902.2 million, $908.5 million and $956.3 million in fiscal 1993, 1994,
1995, 1996 and 1997, respectively. The growth in capital spending in the 1980's
accounts for a significant rise in debt service expenditures since fiscal 1989.
Debt service expenditures were $1.140 billion, $1.149 billion, $1.231 billion,
$1.183 billion and $1.276 billion for fiscal 1993, fiscal 1994, fiscal 1995,
fiscal 1996 and fiscal 1997, respectively, and are projected to be $1.224
billion for fiscal 1998. 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.
In addition to debt service on bonds issued for capital purposes, the
Commonwealth was obligated to pay the principal of and interest on the Fiscal
Recovery Bonds described above, which were retired in December, 1997.
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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 1991 through fiscal year 1997, this percentage has been
below the limits established by this law. The estimated debt service for fiscal
1998 is estimated to fall below the limit as well.
Legislation enacted in December, 1989 imposes a limit on the amount of
outstanding direct bonds of the Commonwealth. The limit for fiscal 1998 is
$9.568 billion; as of July 1, 1997 there were $8.697 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
were not 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. In
fiscal 1992, the annual limit was set at approximately $825 million. During
fiscal 1995, the limit was raised to approximately $900 million and during
fiscal 1998 to approximately $1.0 billion. For fiscal 1998 through 2002, the
plan forecasts total capital spending to be financed by Commonwealth debt of
approximately $5.05 billion, which is significantly below legislatively
authorized capital spending levels. The current plan assumes that the projected
level of capital spending will leverage additional federal transportation aid of
approximately $4.164 billion for this period and also projects the issuance of
$1.5 billion in grant anticipation notes in anticipation of future federal aid
to be received during fiscal years 2003 to 2007 and beyond. The latter
assumption will require a legislative increase in the authorization for grant
anticipation notes. Up to $900 million of such notes are payable from
Commonwealth bonds if federal grants are not available. Federal aid is uncertain
beyond March 31, 1998, when the Intermodal Surface Transportation Efficiency Act
of 1991 expires. The reauthorization of federal aid being considered by Congress
is expected to run through the year 2002 or 2003, although it may be extended
for shorter interim periods. Federal funds for the complete repayment of the
grant anticipation notes contemplated by the five-year plan would have to be
authorized by subsequently enacted successor legislation. The five-year plan
also assumes that the projected level of payments from third-party agencies,
such as the Massachusetts Turnpike Authority and the Massachusetts Port
Authority, and from other sources will be $1.355 billion, such payments,
however, being subject to certain conditions. In addition, a disputed initiative
petition has been filed, which, if successful, could be expected to have a
materially adverse effect on the ability of certain of such agencies to make
such payments. The five-year plan further assumes the receipt by the
Commonwealth of annual federal highway apportionments of $550 million and that
by the completion of the Central Artery/Ted Williams Tunnel project of 2005, the
project will have required expenditures totaling $11.6 billion, and that
insurance reimbursements and proceeds from real estate disposition related to
the project will be received after project completion. What the level of future
federal highway aid will be for the Commonwealth remains uncertain.
Unemployment. The Massachusetts unemployment rate averaged 6.9%, 6.0%,
5.4%, 4.5% and 4.0% in calendar years 1993, 1994, 1995, 1996 and 1997,
respectively. The Massachusetts unemployment rate in December, 1997 was 3.8% as
compared to 3.9% in November, 1997 and 4.1% in December, 1996. 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.
The assets and liabilities of the Commonwealth Unemployment
Compensation Trust Fund are not assets and liabilities of the Commonwealth.
As of December 31, 1997 the private contributory sector of the
Massachusetts Unemployment Trust Fund had a surplus of $1.356 billion. The
Division of Employment and
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Training's January 1998 quarterly report indicates that the contributions
provided by current law should result in a private contributory account balance
of $1.649 billion in the Unemployment Compensation Trust Fund by December, 1998
and rebuild reserves in the system to $2.318 billion by the end of 2002.
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.
Former residents of a state facility have commenced an action against
the Commonwealth alleging that in the 1950's they were fed radioactive isotopes
without their informed consent. The amount of potential liability is estimated
to be $25 million.
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 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 wastewater facilities required under the court's order not
including costs pursuant to the draft combined sewer outflow plan ("CSO"), will
be approximately $3.142 billion in current dollars, with approximately $601
million to be spent after June 30, 1997. With CSO costs, the MWRA anticipates
spending approximately $901 million after that date. 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.
On February 12, 1998, the U.S. Department of Justice filed a complaint
seeking to compel the MWRA to construct a water filtration plant for water drawn
from the Wachusett Reservoir and, together with the Metropolitan District
Commission, to take certain watershed protection measures. Attorneys for all
parties are negotiating and it is too early to determine the outcome of those
negotiations.
A suit was brought by associations of bottlers challenging the 1990
amendments to the bottle bill which escheat abandoned deposits to the
Commonwealth. 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 has 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. The Commonwealth in February
1996 settled with one group of plaintiffs with settlement payments totaling $7
million. Litigation with the other group of plaintiffs is still pending. The
remaining potential liability is approximately $50 million.
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 class certification. If
plaintiffs were to prevail on their claims, the suit could cost the Commonwealth
as much as $200 million per year. In September 1995, the parties argued cross
motions for summary judgment, which are now under advisement.
There are several large eminent domain cases pending against the
Commonwealth with potential liability aggregating $180 million.
The constitutionality of the former version of the Commonwealth's bank
excise tax has been challenged by a Massachusetts bank. In 1992, several
pre-1992 petitions, which raised the same issues, were settled prior to a board
decision. The petitioner has now filed claims with respect to 1993 and 1994
claiming
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the tax violated the Commerce Clause of the United States Constitution by
including the bank's worldwide income without apportionment. Another
Massachusetts bank has raised the same claims as outlined above.
The Commonwealth's potential aggregate liability is $286 million.
In March 1995, the Supreme Judicial Court held that certain deductions
from the net worth measure of the Massachusetts corporate excise tax violate the
Commerce Clause of the United States Constitution. In October 1995, the United
States Supreme Court denied the Commonwealth's petition for a writ of
certiorari. A partial final judgment for tax years ending prior to January 1,
1995 was subsequently entered by the Supreme Judicial Court. The Department of
Revenue estimates that tax revenues in the amount of $40 million to $55 million
may be abated as a result of this decision. On May 13, 1996, the Supreme
Judicial Court entered an order for judgment for tax years ending on or after
January 1, 1996. A final judgment was entered on June 6, 1996. The Department of
Revenue is estimating the fiscal impact of that ruling; to date it has paid
approximately $15 million in abatements in accordance with the judgement.
The Commonwealth has commenced an action and has been named a defendant
in another action brought as a result of indoor air quality problems in a
building previously leased by the Commonwealth. Potential liability to the
Commonwealth in each case is approximately $25 million.
A putative class action has been brought against the Commonwealth
seeking to invalidate the savings bank life insurance statute. Potential
liability to the Commonwealth is $71 million. On October 16, 1997, the court
dismissed the case on statute-of-limitations grounds. The plaintiff has filed a
notice of appeal.
There are also several other tax matters in litigation which may result
in an aggregate liability in excess of $75 million.
Ratings. The ratings by the three bond rating agencies, Standard &
Poor's, Moody's Investors Service, Inc. and Fitch IBCA, Inc., on Massachusetts
general obligation debt reached lows in 1989-1990 of BBB, Baa and A,
respectively, where they remained until 1992-1993 when they were all increased.
Currently, the Commonwealth's general obligation debt is rated at AA-, A1 and
AA- by Standard & Poor's, Moody's and Fitch IBCA, respectively.
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.
MICHIGAN
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 17.1 percent in 1995, 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. Historically, the average monthly unemployment
rate in the State has been higher than the average figures for the United
States. More recently, the State's unemployment rate has remained below the
national average. During 1996, the average monthly unemployment rate in this
State was 4.9% as compared to a national average of 5.4% in the United States.
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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.
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. To avoid
exceeding the revenue limit in the State's 1994-95 fiscal year the State
refunded approximately $113 million through income tax credits for the 1995
calendar year. 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
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 55% from the payment of State taxes and
45% 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,
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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 each of
the last five fiscal years the State ended the fiscal year with its General Fund
in balance after transfers from the General Fund to the Budget Stabilization
Fund. Those and certain other transfers into and out of the Fund raised the
balance in the Budget Stabilization Fund to $1.15 billion as of September 30,
1996. In all but one of the last five fiscal years the State has borrowed
between $500 million and $900 million for cash flow purposes. It borrowed $900
million in each of the 1996 and 1997 fiscal years.
In January 1998, Standard & Poor's raised its rating on the State's
general obligation bonds to AA+. In July 1995, Moody's raised the State's
general obligation credit rating to Aa. Fitch Investor's Service has issued a
rating of Aa on the State's general obligation bonds.
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.
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, while total State revenue sharing payments have increased
in each of the last five years, the State reduced revenue sharing payments to
municipalities below that level otherwise provided under formulas in each of
those fiscal years.
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%, reduced some
property taxes for school operating purposes and shifted the balance of school
funding sources among 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.
In addition, the State Legislature recently adopted a package of state
tax cuts including a phase-out of the intangibles tax, an increase in exemption
amount for the personal income tax and reductions in the single business tax.
The State is a party to various legal proceedings seeking damages or
injunctive or other relief. In addition to routine litigation, certain of these
proceedings could, if unfavorably resolved from the point of
76
view of the State, substantially affect State or local programs or finances.
These lawsuits involve programs generally in the area of corrections, highway
maintenance, social services, tax collection, commerce and budgetary reductions
to governmental units and court funding.
In November of 1997, the State Legislature adopted legislation to
provide for the funding of claims of local schools districts, some of whom had
alleged in a lawsuit, Durant v State of Michigan, that the State had, over a
period of years, paid less in school aid than required by the State's
Constitution. Under this legislation, the State will be required to pay to
school districts which were plaintiffs in the suit not more than $212 million
from the Budget Stabilization Fund on April 15, 1998, and to other school
districts from the Budget Stabilization Fund (i) an additional $32 million per
year in the fiscal years 1998-99 through 2007-08, and (ii) up to an additional
$40 million per year in the fiscal years 1998-99 through 2012-13.
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 schools' district'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.
MINNESOTA
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 the past, suffered cash deficiencies and
budgetary difficulties due to changing economic conditions. Unfavorable economic
trends, such as a decline in economic activity or 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.
77
In the 1995-1997 biennium, as a consequence of strong economic growth,
additional revenues were realized and expenditures in addition to the original
budget for the biennium were authorized by the legislature.
In its regular and first special session in May and June 1997, the
legislature adopted a budget for the 1997-1999 biennium which provided for
revenues of $20.3 billion, expenditures of $20.9 billion and maintenance of a
cash flow reserve account at $350 million, a budget reserve account at $522
million, a new property tax reserve account at $46 million and an appropriations
carried forward account at $72 million, and projected a budgetary surplus of $32
million at the end of the biennium. The most significant revenue measure enacted
by the legislature was a $500 million property tax rebate in the form of an
income tax credit for taxes filed in 1998. Total budgeted expenditures increased
11.5% over the previous biennium, with significant increases in education
finance, health and human services and anticipated property tax reform.
In November 1997, the Minnesota Department of Finance forecast a $1.3
billion budgetary surplus for the end of the biennium on June 30, 1999. Pursuant
to previously enacted allocations, $81 million of the surplus is dedicated to
education tax credits or deductions, $826 million is credited to the property
tax reform reserve and $421 million is available for general fund use. A variety
of tax reduction, rebate and expenditure proposals to deal with the projected
surplus have been placed before the legislature, which commenced its interim
session in January 1998. In addition, the Governor has proposed a $1.0 billion
capital budget for higher education, economic development, environmental uses
and other purposes, which would be financed by $821 million in general
obligation bonds and general fund and trunk highway fund sources. As of January
1, 1998, the total State general obligation bonds outstanding was approximately
$2.2 billion and the total authorized but unissued was approximately $660
million.
The January 1998 Department of Finance economic update indicated that
tax receipts continued at a rate higher than forecast through the end of 1997
but cautioned that general economic predictions for 1998 were more restrained
than in 1997, principally as a consequence of the economic and financial
difficulties occurring in Asia.
Any 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. Recent forecasts by the Minnesota Department of
Finance have been based on an assumption of continuing economic growth and its
favorable impact on State revenues and expenditures. Concerns have also been
raised regarding the cost of debt service and the capacity of the State to
authorize additional major bonding. 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 and in May 1996 raised its
rating again to
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Aaa. In July 1997, Standard & Poor's announced an upgrading in its rating to
AAA. These improved ratings were applied to the State's issuance of $226 million
in general obligation bonds in August 1997.
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, the State and certain State agencies, such as the Minnesota Housing
Finance Agency, University of Minnesota, Minnesota Higher Education Services
Office, Minnesota State Colleges and 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
are not general obligation debts of the State. The payment of these obligations
is generally subject to revenues generated from prescribed sources or 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 decision of the Minnesota Supreme Court sustained the
legislature's position that no State obligation had been created.
A final decision in a case which held the Minnesota excise tax on banks
to be unconstitutional resulted in an initially estimated judgment, including
interest to the date of judgment in 1994, of $327 million. In 1995 the
legislature authorized the Commissioner of Finance to issue up to $400 million
in State revenue bonds to pay the judgment and related obligations. The State
sold $200 million of the bonds in May 1996. The debt service on the bonds is
secured by and payable from a portion of State lottery proceeds, federal and
third party reimbursements for medical expenses and non-dedicated departmental
receipts, all of which have previously been credited to the State general fund.
Receipts from these sources are to be held in a special reserve fund with the
expected excess over debt service requirements being transferred to the general
fund. The bonds issued for this purpose are not general obligations of the State
and the revenue sources supporting the bonds are subject to risks of adverse
legislative, executive or judicial action and economic conditions. The
Commissioner of Revenue has reduced the estimated total liability to the
plaintiffs to approximately $216 million. Most of the bond proceeds have been
expended to cover the judgment and the legislature has appropriated $16.6
million to pay amounts in excess of the bond proceeds. However, new claims have
been filed against the State by plaintiffs not part of the original litigation,
which claims could aggregate $40 million. The State has contested these claims
as barred by the statute of limitations.
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 St. Paul School District
and several individual plaintiffs have commenced a suit claiming that the State
has failed to provide sufficient resources to the district to enable it to
provide an adequate education to the district's poor and minority students and
students in need of special education and English instruction. The complaint
seeks declaratory relief and an order that the State provide the district with
the resources it needs. The potential costs to the State have not been
quantified. The State's motion to dismiss the district's complaint for failure
to state a claim upon which relief can be granted was denied by the trial court
and the State Court of Appeals denied the State's request for discretionary
review of that decision. The State has filed a petition for discretionary review
by the State Supreme Court and has also brought a motion in the trial court to
dismiss the individual plaintiffs' complaints and for judgment on the pleadings
as to the district's complaint. Second, the Minnesota Branch of the NAACP and
several Minneapolis school children and their parents have brought suit against
the State claiming that the segregation of minority and poor students in the
Minneapolis public schools has deprived the students of an adequate education
equal to that received by students in
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suburban schools. The suit is a class action seeking a mandatory injunction and
attorneys' fees. Injunctive relief could force the State to provide substantial
additional funding for the Minneapolis schools, and if the State were required
to pay the cost of alleviating the causes or effects of segregated housing,
substantial additional expenditures could be required. The district court denied
the State's motion to dismiss the case and denied the plaintiffs' motion for
partial summary judgment. The district court has issued an order certifying
certain legal questions for appeal by the Minnesota Supreme Court. Third, twelve
corporations have filed a claim in the Minnesota Tax Court claiming
unconstitutional treatment under certain provisions of the Minnesota tax law.
The most significant issue involves a provision which provides a special
research and development credit only to domiciliary corporations. The Department
of Revenue has not determined the potential refund liability were the plaintiffs
and all similarly-situated taxpayers to prevail. Fourth, the State has been sued
by plaintiffs seeking certain special education services in private, parochial
schools. Unspecified damages, costs and attorneys' fees are claimed and any
relief granted could result in additional expenditures for education programs.
Adverse decisions in the foregoing and other cases which individually or
collectively may exceed several hundred 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 any litigation affecting the State.
MISSISSIPPI
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 which may or may not affect the financial condition of the
State, 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, 1996, approximately $4.7 billion in revenues were collected by the
Special Fund. The major source of such receipts was $2.24 billion from federal
grants-in-aid, including $1.40 billion for public health and welfare and $358.1
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, 1996, of the
$2.70 billion in General Fund receipts, sales taxes accounted for 40.0%,
individual income taxes for 27.4%, and corporate income taxes for 9.7%. Sales
taxes, the largest source of General Fund revenues, can be adversely affected by
downturns in the economy.
Mississippi's recent legalization of dockside gaming is having a
substantial impact on the State's revenues. With 30 casinos operating in the
State as of June 30, 1996, fiscal year 1996 gaming license fees
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and gaming tax revenues transferred to the General Fund for the State amounted
to $110.4 million as compared to $128.8 million in fiscal year 1995.
Additionally, $34.2 million representing 25% in gaming tax revenues have been
dedicated to repayment of bonds issued for construction of certain
gaming-related highway projects.
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 June 30,
1996, approximately 59.1% 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 a 1% increase in sales and use taxes enacted in 1992)
totaled approximately $159.5 million in fiscal year 1995. 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, fiscal year 1994 revenue collections were
nearly $259.2 million or 12.15% above projections. For 1995, revenue collections
nearly matched the estimated revenues with a 0.01% shortfall. Fiscal year 1996
revenue collections exceeded the budgeted estimates by 0.77%. Commencing with
fiscal year 1994, the aggregate appropriation from the General Fund is limited
to 98% of the sum of the official revenue estimate and the estimated prior year
ending cash balance. 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
$201.0 million or 7.5% of the General Fund appropriations for fiscal year 1996
can be used to meet revenue and cash flow shortfalls as well as provide funds
during times of national disasters in the State.
Despite this growth, Mississippi ranks 31st among the 50 states, with a
population of 2.67 million people for 1995. As of May 1996, Mississippi's
unemployment rate was 6.3%, slightly above the State's 1995 level of 6.1%. The
nation's unemployment rate as of May 1996 was 5.6%.
As of May 1996 the manufacturing sector of the economy, the largest
employer in the State, employed approximately 245,000 persons or 22.6% of the
total nonagricultural employment. Within the manufacturing sector, the four
leading employers by product category were the lumber industry, the apparel
industry, the food products industry, and the furniture industry. For 1995, the
average employment for these industries was 27,800, 26,400, 28,300 and 27,900,
respectively. Agriculture contributes significantly to the State's economy as
agriculture-related cash receipts amounted to $3.15 billion for 1994. The number
of persons employed by the agricultural sector of the State's labor force during
May of 1996 was 45,100. 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
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approximately 3,500 jobs, was closed due to recent federal budget cuts.
Additionally, since the inception of legalized dockside gambling, six casinos
located in Mississippi have sought protection under federal bankruptcy laws.
Total personal income in Mississippi increased 4.7% in 1995 as compared
to a 5.0% increase for the United States. However, Mississippi's per capita
income of $16,531 in 1995 was approximately 73% of the national average. The
number of bankruptcies filed in Mississippi during 1996, on an annualized basis,
is 13,946, a 17.8% increase over the 1995 level of 11,831.
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 1994 and 1995
fiscal years, the State issued general obligation bonds in amounts totaling
$284.6 million and $311.9 million, respectively. In fiscal year 1996, the State
issued bonds totaling approximately $288.7 million. The total bond indebtedness
of the State has increased from a level of $432.5 million on July 1, 1987 to
$1.25 billion as of July 1, 1996.
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 Ratings Group.
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; and (2) 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.
MISSOURI
RISK FACTORS--Revenue and Limitations Thereon. Article X, Sections
16-24 of the Constitution of Missouri (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 on taxes 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
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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. Generally, 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 State revenue limitation imposed by the
Hancock Amendment does not apply to taxes imposed for the payment of principal
and interest on bonds, approved by the voters and authorized by the Missouri
Constitution. The revenue limit also can be exceeded by a constitutional
amendment authorizing new or increased taxes or revenue adopted by the voters of
the State of Missouri.
The Hancock Amendment also limits 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.
When a local government 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.
School Desegregation Lawsuits. Desegregation lawsuits in St. Louis and
Kansas City continue to require significant levels of state funding and are
sources of uncertainty; litigation continues on many issues, notwithstanding a
1995 U.S. Supreme Court decision favorable to the State in the Kansas City
desegregation litigation, court orders are unpredictable, and school district
spending patterns have proven difficult to predict. The State paid $282 million
for desegregation costs in fiscal 1994, $315 million for fiscal 1995 and $274
million for fiscal 1996. This expense accounted for close to 7% of total state
General Revenue Fund spending in fiscal 1994 and 1995, and close to 5% in fiscal
1996.
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 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 1,949,956 and 1,039,241 residents, respectively,
constituting over fifty percent of Missouri's 1997 population census of
approximately 5,387,753. 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.
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Defense related business plays an important role in Missouri's economy.
There are a large number of civilians employed at the various military
installations and training bases in the State and recent action by the Defense
Base Closure and Realignment Commission will result in the loss of a substantial
number of civilian jobs in the St. Louis Metropolitan Area. Further, aircraft
and related businesses in Missouri are the recipients of substantial annual
dollar volumes of defense contract awards. The contractor receiving the second
largest dollar volume of defense contracts in the United States in 1995 and 1996
was McDonnell Douglas Corporation which lost the number one position it held in
1994 by reason of the merger of the Lockheed and Martin companies. McDonnell
Douglas Corporation, which was acquired by The Boeing Company on August 1, 1997,
is the State's largest employer, currently employing approximately 22,900
employees in Missouri. Recent changes in the levels of military appropriations
and the cancellation of the A-12 program has affected such Company in Missouri
and over the last four 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. It is impossible to determine
what effect, if any, the acquisition of McDonnell Douglas Corporation by the
Boeing Company will have on the operations conducted in Missouri by the former
McDonnell Douglas Corporation. However, any shift or loss of production
operations now conducted in Missouri would have a negative impact on the economy
of the state and particularly on the economy of the St. Louis metropolitan area.
NEW JERSEY
RISK FACTORS--Potential purchasers of Units of the New Jersey Trust
should consider the fact that the Trust's portfolio consists primarily of
securities issued by the State of New Jersey, its municipalities and authorities
and should realize the substantial risks associated with an investment in such
securities. The State's General Fund (the fund into which all State revenues not
otherwise restricted by statute are deposited) experienced surpluses for fiscal
years 1994 through 1996, and surpluses are preliminarily estimated for 1997 and
1998. As of June 30, 1996, the General Fund had a surplus of $442.0 million.
The State's diverse economic base consists of a variety of
manufacturing, construction and service industries supplemented by recreational
and tourist attractions and commercial agriculture. The State's overall economy
has slowly improved since the end of the nationwide recession in 1992. Business
investment expenditures and consumer spending have also increased substantially
in the State as well as in the nation. Although employment remains low in the
manufacturing sector, employment gains have been recorded in business services,
construction, and retail sectors. Future economic difficulties in any of these
industries could have an adverse impact on the finances of the State or its
municipalities and could adversely affect the market value of the Bonds in the
New Jersey Trust or the ability of the respective obligors to make payments of
interest and principal due on such Bonds.
Certain litigation is pending against the State that could adversely
affect the ability of the State to pay debt service on its obligations including
suit relating to the following matters: (i) several labor unions have challenged
1994 legislation mandating a revaluation of several public employee pension
funds which resulted in a refund of millions of dollars in public employer
contributions to the State and significant ongoing annual savings to the State;
(ii) several cases filed in the State courts have challenged the basis on which
recoveries of certain costs for residents in State psychiatric hospitals and
other facilities are shared between the State Department of Human Services and
the State's county governments, and certain counties are seeking the recovery
from the Department of costs they have incurred for the maintenance of such
residents; (iii) the County of Passaic and other parties have filed suit
alleging the State violated a 1984 consent order concerning the construction of
a resource recovery facility in that county; (iv) several Medicaid eligible
children and the Association for Children of New Jersey have filed suit claiming
the Medicaid reimbursement rates for services rendered to such children are
inadequate under federal law; (v)
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a coalition of churches and church leaders in Hudson County have filed suit
asserting the State-owned Liberty State Park in Jersey City violates
environmental standards; (vi) representatives of the trucking industry have
filed a constitutional challenge to annual hazardous and solid waste licensure
renewal fees; (vii) the New Jersey Hospital Association has filed a
constitutional challenge to the State's failure to provide funding for charity
care costs, while requiring hospitals to treat all patients regardless of
ability to pay; (viii) the Education Law Center filed a motion compelling the
State to close the spending gap between poor urban school districts and wealthy
rural school districts; (ix) a group of insurance companies have filed a
constitutional challenge to the State's assessment of monies pursuant to the
Fair Automobile Insurance Reform Act of 1990; (x) a class action consisting of
prisoners with serious mental disorders has been filed against officers of the
Department of Corrections, alleging sex discrimination, violation of the
Americans with Disabilities Act of 1990, and constitutional violations; (xi) a
class action has been brought in federal court challenging the State's method of
determining the monthly needs of a spouse of an institutionalized person under
the Medicare Catastrophic Act; (xii) several suits have been filed against the
State in federal court alleging that the State committed securities fraud and
environmental violations in the financing of a new Atlantic City highway and
tunnel; (xiii) a class action has been filed against the State alleging the
State's breach of contract for not paying certain Medicare co-insurance and
deductibles; and (xiv) an action has been filed challenging the State's issuance
of bonds to fund the accrued liability in its pension funds under the Pension
Bond Financing Act of 1997.
Although there can be no assurance that such conditions will continue,
the State's general obligation bonds are currently rated Aa1 by Moody's and AA+
by Standard and Poor's.
NEW MEXICO
RISK FACTORS--Driven by its private sector, the New Mexico state
economy and the economy of Albuquerque and its metropolitan area have enjoyed
vigorous economic growth in recent years. However, the rate of growth slowed
dramatically in 1996 and 1997 from the boom levels of the 1992-1994 period. The
short term outlook continues to be good. However, the strong job growth of the
1990-1995 period has slowed. Jobs lost as a result of Levi Strauss plant
closings in Albuquerque and Roswell and expected losses as a result of a
restructuring of Intel's work force at its Rio Rancho plant, have dampened
prospects for short term growth.
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, 1997 and covering
reports of economic results for 1997, the rate of growth in the economies of the
State of New Mexico and the Albuquerque metropolitan area has slowed. Although
each remains healthy and personal income has continued to increase, as well,
further growth in employment and personal income is expected to be well below
the levels of the recent past.
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
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so far escaped any major defense cuts. Job losses in defense related activities
which have occurred to date have been fairly minor from an overall state
perspective. Employment in the federal government sector is expected to remain
stable during 1998.
Employment in New Mexico's construction sector increased by 15,800
jobs, or by 55.6%, over the 1992-1995 period. Construction employment peaked in
1995 and during the following two years 2,307 jobs were lost, resulting in a
5.2% employment decline in this sector. At present, construction no longer
serves as a major source of job growth, although a favorable interest rate
environment and continued although slow economic growth have sustained a
relatively high level of activity. Single family housing construction fell from
9,231 units in 1994 to approximately 8,200 units in 1997; apartment construction
has remained steady at approximately 2,100 units.
The rate of growth in manufacturing employment slowed during 1996. More
than 5,000 new jobs have been added by the manufacturing sector since 1990, led
by expansion of the Intel plant, Motorola, Philips Semiconductor and Sumitomo,
and the relocation of two significant manufactured housing facilities in the
Albuquerque MSA and numerous new dairy and food processing operations in the
eastern part of the State.
Mining employment has been spotty, with jobs added during 1997 in the
copper industry in the southwestern part of the State while layoffs or furloughs
hit the molybdenum and potash operations in northern and southeastern New
Mexico. The services and trade sectors saw small advances, with trade affected
by a weak tourism year during 1996 and a slower rate of growth in real
disposable income in New Mexico. The government sector grew, with increases at
the local government level offsetting declines at both federal and state levels.
The reclassification during 1996 of employees of enterprises owned by Indian
tribes and tribal government into the local government sector, from the
services, construction and retail sectors, benefitted local government
employment statistics at the expense of the other sectors.
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. (As of January 1, 1994, the Albuquerque
Metropolitan Statistical Area ("MSA") was redefined to include Sandoval County,
the location of Rio Rancho, as well as Valencia County and Bernalillo County).
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, the rate of growth of the economy of the
Albuquerque MSA slowed dramatically during 1996 but was slightly stronger than
the statewide economy in 1997, fueled by moderate expansion in high tech
manufacturing and business services. The Albuquerque MSA accounts for almost 47%
of the jobs in New Mexico.
Non-agricultural employment in the Albuquerque MSA increased at a rate
of 2.1% during 1997, with an increase of 7,000 non-agricultural jobs. The
slowdown in growth during 1996 was evident across all sectors of the economy
other than the local government sector-- for which statistics were impacted by
the reclassification of employees of Indian enterprises noted above -- and the
financial/insurance/real estate sector. 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 1995, services was the fastest growth sector in the
Albuquerque MSA, with employment increasing at a rate of 8.7%. During 1996, the
rate of growth slowed to 0.9%. The importance of trade and services reflects
Albuquerque's continuing role as the trade and service center for the State and
the larger region, which includes southern Colorado and parts of eastern
Arizona. People from these areas continue to come
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to Albuquerque for major purchases and to shop at retail and warehouse stores.
Albuquerque's concentration of health care facilities and medical personnel has
made it a regional medical center, and despite the uncertainty about future
healthcare reforms, employment in the health services industry has continued to
grow. The significance of trade and service also 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.
While it has declined in importance as a direct employer, the
government sector still accounts for 19.1 percent of the Albuquerque MSA's total
nonagricultural employment. Not included in this calculation are about 6,600
service jobs at Sandia National Laboratories and about 5,100 military jobs at
Kirtland Air Force Base. As of June 1997, the Albuquerque Public Schools system,
Sandia, Kirtland and the University of New Mexico are the largest employers in
the Albuquerque area. However, there is considerable uncertainty over future
funding for operations at Kirtland Sandia. At Sandia, employment has remained
steady. However, potential future cuts in spending cast a cloud over the
outlook. Many Sandia employees are at or near retirement age and are believed to
be likely to remain in the Albuquerque area after retirement.
In 1993 and 1994, the construction sector led the Albuquerque economy
spurred by low interest rates, pent up demand for housing and retail and public
works construction projects. During 1995, construction employment continued to
increase, at a rate of approximately 6.4%, following three consecutive years of
annual increases that were close to 20%. A dramatic change occurred during 1996,
which saw construction employment actually decline by 0.9%, largely because of a
weak housing sector. During 1996, authorizations for single family units
declined slightly from prior year levels, but authorizations for multi-family
units saw a sharp reduction, off by 36.8% from the prior year.
The manufacturing employment sector within the Albuquerque MSA has
added more than 5,000 jobs since the first quarter of 1992, a significant
portion of which related to high-tech and electronics manufacturing at Intel,
Motorola, Sumitomo and Philips Semiconductor. Employment in the manufacturing
sector continued to increase during 1996, but at a significantly lesser rate
(1.5%) than the rate achieved during each of the three prior years. 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, to almost 6500. However, a restructuring of
Intel's work force before the close of 1998 is expected to result in a reduction
of approximately 200 jobs from the present level.
Income. According to U.S. Department of Commerce data, Albuquerque MSA
personal income grew at an annual rate of not less than 6.3% from 1986 through
1995, the most recent year for which the statistic is available. In 1994, annual
per capita personal income for the Albuquerque MSA, the State of New Mexico and
the United States was $21,452, $18,161 and $23,348, 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 the Albuquerque MSA is estimated at
670,092 for 1996. (The population of the State is estimated at 1,713,167.)
Outlook. As of December 1997, BBER projected slow, moderate near-term
prospects for the New Mexico state economy and pretty good prospects for the
Albuquerque MSA. At the state level, nonagricultural employment is expected to
increase by approximately 14,000 jobs (1.9%). Services is expected to emerge as
the strongest sector in 1998, as manufacturing is constrained by the Levi
Strauss
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layoffs and the Intel restructuring. Growth in tourist related services is
expected to continue to be strong, with the addition of new hotels and motels
presently under construction, and growth in the business services sector will
reflect recent success in attracting telemarketing firms to the area. Personal
income is forecasted to advance at approximately 4.5%.
For the Albuquerque MSA, the rate of expansion during 1998 is expected
to approximate 2.3%, the strongest in the State, led by services and hightech
manufacturing.
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. Recently, however, New Mexico's job and personal income
growth (respectively, 1.7% and 4.7% statewide during 1997) has fallen far below
the rates in other Western states.
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 YORK
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. For many years, there have been extended delays in
adopting the State's budget, repeated revisions of budget projections and often
significant revenue shortfalls (as well as increased expenses). These
developments reflect faster long-term growth in State spending than revenues and
the sensitivity of State revenues to economic factors, 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 until 1993 issuance
of additional short-term tax and revenue anticipation notes payable out of
impounded revenues in the next fiscal year). The State's general fund realized
surpluses of $671 million, $1.54 billion, $445 million and $1.4 billion for the
1993, 1994, 1996 and 1997 fiscal years and a $241 million deficit for the 1995
fiscal year.
Approximately $5.0 billion of State general obligation debt was
outstanding at March 31, 1997. State supported debt (restated to reflect LGAC's
assumption of $4.7 billion obligations previously funded through issuance of
short-term debt) was $37.1 billion at March 31, 1997, up from $9.8 billion in
1986.
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Standard & Poor's rates the State's general obligation bonds A (raised from A-
in August 1997 but still tied for lowest rating for any state). Moody's rates
State general obligation bonds A2. In July 1997, State officials approved
issuance of $7.3 billion in bonds by the Long Island Power Authority to finance
a partial takeover of the Long Island Lighting Company (including refunding
LILCO obligations from building the decommissioned Shoreham nuclear power plant;
LILCO agreed to invest $1.3 billion of the remainder on Long Island and to drop
property tax refund litigation against various Long Island localities). The
takeover is designed to reduce electric rates by at least 14% over 10 years; an
IRS ruling to waive capital gains tax on LILCO's was issued in March 1998 but
additional approvals are needed. The Legislature in 1997 also increased the
limits on certain appropriation-backed debt for the Dormitory and Urban
Development Authorities.
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 ended March 31, 1995, increased spending
by 3.8% (greater than inflation for the first time in six years). It provided a
tax credit for low income families and increased aid to education, especially in
the poorer districts. The State reduced coverage and placed additional
restrictions on certain health care services. Over $1 billion savings resulted
from postponement of scheduled reductions in personal income taxes for a fifth
year and in taxes on hospital income; another $1.5 billion came from
non-recurring measures. The Governor in January 1995 instituted $188 million in
spending reductions (including a hiring freeze) and $71 million of other
measures to address a widening gap.
More than two months after the beginning of the 1996 fiscal year, the
State adopted a budget to close a projected gap of approximately $5 billion,
including a reduction in income and business taxes. The financial plan projected
nearly $1.6 billion in savings from cost containment, disbursement reestimates
and reduced funding for social welfare programs and $2.2 billion from State
agency actions. Approximately $1 billion of the gap-closing measures were
non-recurring. The State Comptroller sued to prevent reallocation of $110
million of reserves from a special pension fund. In October 1995, the Governor
released a plan to reduce State spending by $148 million to offset risks that
developed, including proposed reductions in Federal aid and possible adverse
court decisions.
To address a $3.9 billion projected budget gap for the fiscal year that
began April 1, 1996, in July 1996 the State adopted a budget that includes $1.3
billion of non-recurring measures. A surplus of $1.4 billion was realized, due
primarily to higher than expected revenue and reduced social service spending.
The financial plan for the 1998 fiscal year, adopted 126 days after it
began, used most of the 1997 surplus to close a budget gap estimated at $2.3
billion. A surplus of $1.8 billion is projected; the Governor has proposed to
use a substantial portion of this to accelerate property tax reductions, and has
also proposed
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current State funding of certain construction projects. $11 billion of spending
increases (5.4% in the current year or twice the rate of inflation), primarily
for local assistance including $2.3 billion for education, and $4.75 billion of
tax cuts will be phased in over the next five years, most after 1998. These
features were sharply criticized by bond raters and fiscal monitors as likely to
create major financial pressures beginning with the 1999 fiscal year (yet S&P
subsequently increased its rating of State general obligation debt as described
earlier). Use of non-recurring resources is estimated at $270 million.
Implementing last year's Federal welfare requirements, recipients under both
State and Federal programs generally will be required to work in exchange for
benefits, and benefits will generally terminate after 5 years. State benefits
will be denied to immigrants for the first year of U.S. residence; Mayor
Giuliani announced that the City will continue to provide benefits to legal new
immigrants (if needed) during this period. $530 million is reserved to help
balance the 1999 fiscal year budget. The Governor proposes to increase spending
by 7.2% for the fiscal year beginning April 1, 1998, and projected remaining
budget gaps of $1.75 billion and $3.75 billion for the 2000 and 2001 fiscal
years. The State Comptroller has projected budget gaps of $2.6 billion and $4.8
billion for these years, including uncertainty about receipt of $250 million
annually assumed from the proposed tobacco settlement. State and other estimates
are subject to uncertainties including the effects of federal legislation and
economic developments.
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 $4.7
billion of 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 prevent State seasonal borrowing until an equal amount of LGAC bonds
are retired. The State's last seasonal borrowing was in May 1993.
Generally accepted accounting principles ("GAAP") for municipal
entities apply modified accrual accounting and give no effect to payment
deferrals. On an audited GAAP basis, reflecting payments by LGAC to local
governments out of proceeds from bond sales, the general fund realized surpluses
of $0.9 billion, $0.4 billion and $1.9 billion for the 1994, 1996 and 1997
fiscal years and a deficit of $1.4 billion for the 1995 fiscal year. The
remaining accumulated deficit at March 31, 1997 was $1.0 billion. The State
asserts that the budget is balanced over the 1997 and 1998 fiscal years, but use
of the 1997 fiscal year surplus to fund 1998 fiscal year expenses is projected
to result in a $959 million deficit for the 1998 fiscal year.
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 among the
highest in the nation. 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, and in 1996 State employment
remained 295,000 jobs lower than 1990.
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
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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.
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. S&P increased its rating of MAC bonds to AA in January
1998. MAC plans to covenant not to issue additional parity or prior lien debt in
the future other than refunding bonds. The State also established the Financial
Control Board ("FCB") to review the City's budget, four-year financial plans,
borrowings and major contracts. The FCB is required to impose a review and
approval process of the proposals if the City were to experience certain adverse
financial circumstances. The City's fiscal condition is also monitored by a
Deputy State Comptroller.
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%. The City's unemployment averaged 10.8%, 10.1%, 8.7% and 8.1% in 1992
through 1995. This is well above the rest of the State and the nation as a
whole. Although the City added more jobs in 1997 than any year since 1987,
unemployment averaged 9.4% for the year. Even with new fraud detection
procedures (including fingerprinting) since January 1995, public assistance
recipients were still over 800,000 in 1998. A report by the Citizens Budget
Commission found that in 1996 most of the applicants were eligible and were
denied benefits due to administrative errors or reasons other than fraud.
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. City expenditures grew 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.
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The City's original Financial Plan for the fiscal year ended June 30,
1995, proposed to eliminate a projected $2.3 billion budget gap through measures
including reduction of the City's workforce (achieved in substantial part
through voluntary severance packages funded by MAC), increased State and Federal
aid, a bond refinancing, reduced contributions to City pension funds and sale of
certain City assets. The Mayor's proposals include efforts toward privatization
of certain City services and agencies, greater control of independent
authorities and agencies, and reducing social service expenditures. He also
sought concessions from labor unions representing City employees. As several of
these measures failed to be implemented, the City experienced lower than
anticipated tax collections and higher than budgeted costs (particularly
overtime and liability claims) during the year, various alternative measures
were implemented, for an aggregate of nearly $3.5 billion of gap closing
measures. $1.9 billion of these were non-recurring and, in the case of a second
bond refinancing, will increase City expenses for future years. Reduced
maintenance of City infrastructure could also lead to increased future expenses.
In December 1994, the City Council rejected the Mayor's recommendations, adopted
its own budget revisions and sued to enforce them; the suit was dismissed and
the Mayor impounded funds to achieve his proposed expense reductions.
The City closed a projected $3.1 billion budget gap for the fiscal year
ended June 30, 1996. The Financial Plan reduced a wide range of City services.
City agency and labor savings were projected at $1.2 billion and $600 million
respectively. During the fiscal year, the Major implemented several additional
spending reductions as various proposals (including projected State and Federal
aid increases) failed to be implemented. An additional debt refinancing was also
made. Non-recurring measures (including a $250 million payment from the MTA in
exchange for an agreement to issue $500 million in bonds over the next four
years for transit improvements and a $300 million sale of tax liens) rose to
$1.3 billion. One of the Mayor's privatization proposals has been to sell or
lease City hospitals. In August 1997 the Mayor announced plans to rebuild rather
than sell the Queens Hospital Center. The Appellate Division of the State
Supreme Court ruled in September 1997 that the Health and Hospitals Corporation
exceeded its authority in entering into a 99-year lease for Coney Island
Hospital. It ruled that the State would have to amend the law authorizing HHC to
sell or lease City hospitals. In October 1995 S&P reduced its rating on Health
and Hospitals Corporation debt to BBB- (its lowest investment-grade rating),
citing City failure to articulate a coherent strategy for the hospital system.
Other proposals including mandatory managed care programs for Medicaid
recipients have been blocked. The City Comptroller predicted that certain
reductions in Medicaid and welfare expenditures may lead to job reductions and
higher costs for other programs. The Board of Education also faced reductions of
$265 million in State aid and $189 million in Federal aid.
For the fiscal year ended June 30, 1997, the City faced a projected
$2.6 billion gap including $1.7 billion of increased operating expenditures,
$800 million of increased debt service and a $150 million decline in revenues.
Gap-closing measures in the Financial Plan included $1.2 billion of agency
spending reductions and extension of the personal income tax surcharge. In
August 1996, the Major directed City agencies to plan for $500 million in
further spending reductions. A surplus of $1.4 billion, in large part because of
the boom in the financial sector, was used to prepay debt service due during the
current and 1999 fiscal years.
For the fiscal year that began July 1, 1997, the City adopted a budget
to close a projected $1.6 billion gap, including $2.0 billion of non-recurring
measures. A surplus of at least $1.2 billion is expected. The City proposes a
discretionary transfer from fiscal 1998 of $920 million for payment of 1999 debt
service and $210 million for 2000 debt service. It also proposes a tax reduction
program totaling $237-$774 million a year for each of the next four years, which
is subject to State legislative approval. Risks for fiscal 1999 include State
failure to extend the personal income tax surcharges (which the Speaker of the
City Council has opposed), additional airport rental payments from the Port
Authority and a projected $450 million of additional State and Federal aid. The
timing of receiving $200 million from sale of the New York Colliseum is also in
doubt. The City is also carrying $914 million of State education aid claims as
receivables, some nearly 10 years old. The State asserts that about 40% of these
claims have not been properly submitted. The
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City Comptroller has begun writing off claims more than 10 years past due. The
City may also be required to pay up to $125 million to MAC because 1998
expenditures exceed a ceiling established in a 1996 agreement. The Health and
Hospitals Corporation faces significant deficits. Board of Education
expenditures are projected to represent 28% of the City's total budget in the
1998 fiscal year; the Stavisky-Goodman Act requires Board agreement to reduce
the allocations below the average for the three preceding fiscal years.
Spending is projected to increase faster than revenue for the next
three years, leaving City-projected future budget gaps of $1.8 billion, $2.0
billion and $1.9 billion, respectively, for the 2000, 2001 and 2002 fiscal
years; fiscal monitors have significantly higher estimates. Fiscal monitors have
commented that the City needs to take significant additional actions to work
toward structural balance.
A major uncertainty is the City's labor costs, which represent about
50% of its total expenditures. Although the City workforce was reduced by over
12,000 workers since January 1994, with wage and benefit increases and overtime,
wage costs continue to grow. Contracts with virtually all of the City's labor
unions expired in 1995. New labor agreements with unions for 86% of the City
employees froze wages until 1997 but commit the City to avoid layoffs until
1998, increase wages by 11% over the next three years and fail to achieve any
significant productivity savings. Costs will increase by $1.2 billion for the
1999 fiscal year and over $2 billion each year thereafter.
Budget balance may also be adversely affected by the effect of the
economy on economically sensitive taxes. The City also faces uncertainty in its
dependence on Federal and State aid. Federal and State welfare reform provisions
may require additional training programs to satisfy workfare guidelines and also
additional City expenditures for immigrants disqualified. The State Supreme
Court recently ruled that the City has failed to determine the number of hours
consistent with the Social Services Law, which could result in fewer hours by
workfare participants in the future. The City filed a notice of appeal. There
can be no assurance that City pension contributions will continue to be reduced
by investment performance exceeding assumptions. Other uncertainties include
additional expenditures to combat deterioration in the City's infrastructure
(such as bridges, schools and water supply), the costs of closing the Fresh
Kills landfill (which may be accelerated by pending litigation), cost of the
AIDS epidemic and problems of drug addiction and homelessness. Elimination of
any additional budget gaps will require various actions, including by the State,
a number of which are beyond the City's control.
The City sold $2.4 billion, $2.4 billion and $1.1 billion of short-term
notes, respectively, during the 1996 1997 and 1998 fiscal years. At December 31,
1997, there were outstanding $26.6 billion of City bonds (not including City
debt held by MAC), $3.6 billion of MAC bonds and $1.2 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 reduced its
rating of the City's general obligation debt to BBB+ on July 10, 1995, citing
the City's economy, substantial retention of non-recurring revenues and
optimistic revenue projections in the budget. Moody's increased its rating of
City bonds to A3 on February 24, 1998. City-related debt doubled since 1987,
although total debt declined as a percentage of estimated full value of real
property. To avoid additional financial demands on the 1997 fiscal year budget,
the Mayor proposed borrowing an additional $1.4 billion over the 1998-2001
fiscal years for school repairs. The City also anticipates spending about $1
billion over the next ten years on its upstate watershed area in an effort to
avoid building a filtration plant, estimated to cost $7 billion; there can be no
assurance that these measures will satisfy Environmental Protection Agency water
purity standards. To prevent the City from reaching the constitutional limit on
its general obligation debt (based on real estate values), the State in 1997
authorized creation of the New York City Transitional Finance Authority, to sell
up to $7.5 billion of additional bonds. Bonds will be backed by City personal
income and sales tax revenues, to fund capital projects. A lawsuit challenging
the constitutionality of the Authority was dismissed; an appeal is pending. The
bonds are rated Aa3 by Moody's
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and AA by S&P. Despite the new authority, City bond issuances may reach the debt
limit in the 2000 fiscal year. The City's financing program projects long-term
financing during fiscal years 1998-2002 to aggregate $25.6 billion, including
$7.5 billion from the Transitional Finance Authority and $6.2 billion of Water
Authority financing. Debt service is expected to reach 20% of City tax revenues
by 2000, up from 12.3% in fiscal year 1990 and 14% in fiscal year 1995. The
City's latest Ten Year Capital Strategy plans capital expenditures of $45.0
billion during 1998-2007 (94% to be City funded). This plan assumes State repeal
of the Wicks law governing City contracting, for a saving of $1.6 billion in
construction costs over the 10-year period.
Other New York Localities. In 1995, other localities had an aggregate
of approximately $19.0 billion of indebtedness outstanding. $102.3 million was
for deficit financing. In recent years, several experienced financial
difficulties. A Financial Control Board was established for Yonkers in 1984 and
a Municipal Assistance Corporation for Troy in 1995. In 1996, the State
purchased debt issued by Troy and Utica to avert defaults when those bonds were
not bought by others. Troy, Utica, Newburgh, Cohoes and Niagara Falls general
obligations are rated below investment grade. Buffalo, with a minimum investment
grade rating, is on CreditWatch with negative implications. Pending proposals to
increase State fiscal oversight of local government finances, tax lien
securitization and cash management were not adopted in the 1997 State
legislative session. 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. Any
reductions in State aid to localities may cause additional localities to
experience difficulty in achieving balanced budgets. County executives have
warned that reductions in State aid to localities to fund future State tax
reductions are likely to require increased local taxes. 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. From 1975 through 1987 the State provided substantial direct
and indirect financial assistance to UDC, the Housing Finance Agency ("HFA"),
the Project Finance Agency, 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. In July 1996, the Public Authorities Control Board approved a
$650 million refinancing by the Empire State Development Corp. (formerly the
UDC) to bail out the deficit-ridden Job Development Authority. 17 State
authorities had an aggregate of $73.5 billion of debt outstanding at September
30, 1996, of which approximately $25.7 billion was State-supported. At March 31,
1997, approximately $0.3 billion of State public authority obligations was
State-guaranteed, $3.3 billion was moral obligation debt (including $2.2 billion
of MAC debt) and $22.5 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 ("M.T.A."), 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. The
TA $186.3 million surplus for 1997 was used to balance the 1998 budget. The
Financial Plan forecasts cash-basis gaps of $186 million in 1999, $257 million
in 2000, $279 million in 2001 and $303 million in 2002.
Substantial claims have been made against the TA and the City for
damages from a 1990 subway fire and a 1991 derailment. The M.A. infrastructure,
especially in the City, needs substantial rehabilitation. In July 1996 the State
Legislature approved a $7.3 billion capital plan for 1997-1999, which includes
$3.5
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billion to be raised by bonds backed by fares. The plan does not contemplate
further fare increases until 2000. The plan also projects $2.85 billion in
expense reductions over the five years. Critics have questioned whether many of
the projected labor and other savings can be achieved. It is anticipated that
the M.A. and the TA will continue to require significant State and City support.
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. The State
estimates unfavorable judgments of $364 million, of which $134 million is
expected to be paid during the current fiscal year. Claims in excess of $530
billion were outstanding against the City at June 30, 1997, for which it
estimated its potential future liability at $3.5 billion, in addition to real
estate certiorari proceedings with an estimated liability of $378 million. City
settlements were $327 million in fiscal 1997, up from $175 million in fiscal
1990. Several actions seek judgments that, as a result of an overestimate by the
State Board of Equalization and Assessment, the City's real estate tax levy in
1993-1996 exceeded constitutional limits; if upheld, substantial tax refunds
would be due and this could also adversely affect the City's constitutional debt
limit.
Final adverse decisions in any of these cases could require
extraordinary appropriations at either the State or City level or both.
NORTH CAROLINA
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 Debt
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. In
addition, the Trust is concentrated on Debt Obligations of North Carolina
issuers and is subject to additional risk from decreased diversification as well
as factors that may be particular to North Carolina or, in the case of revenue
bonds payable exclusively from private party revenues or from specific state
non-tax revenue, factors that may be particular to the related activity or
payment party.
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
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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. In
November 1996, the voters of the State approved a constitutional amendment
giving the Governor the power to veto certain legislative matters, including
budgetary matters.
Since 1994, the State has had a budget surplus, in part as a result of
new taxes and fees and spending reductions put into place in the early 1990s. In
addition, the State, like the nation, has experienced economic recovery during
the 1990s. The State budget is based upon estimated revenues and a multitude of
existing and assumed State and non-State factors, including State and national
economic conditions, international activity and federal government policies and
legislation. The unreserved General Fund balance at June 30, 1997, the end of
the 1996-97 fiscal year, was approximately $292.2 million, and the reserved
balance of the General Fund was approximately $880.8 million.
In 1995, the North Carolina General Assembly repealed, effective for
taxable years beginning January 1, 1995, the tax levied on various forms of
intangible personal property. The legislature provided specific appropriations
to counties and municipalities from state to revenues to replace the revenues
those political subdivisions previously received from intangibles tax revenue.
In addition, in the 1996 session the legislature reduced the corporate income
tax rate from 7.75% to 6.9% (phased in over four years), reduced the food tax
from 4% to 3%, and eliminated most privilege license taxes as of January 1,
1997. As a result of the comprehensive tax reductions, General Fund tax
collections for 1995-96 grew by only 1.0% over 1994-95, as opposed to the 6.4%
growth that would have occurred if such measures had not been taken.
In the 1996-97 Budget prepared by the Office of State Budget and
Management, it was projected that General Fund net revenues would increase 3%
over 1995-96. In fact, actual General Fund net revenues for 1996-97 increased
8.3% over 1995-96. This increase resulted primarily from growth in the North
Carolina economy, which resulted in increased personal and corporate income tax
receipts.
It is unclear what effect these developments at the State level may
have on the value of the Debt Obligations in the North Carolina Trust.
Litigation. The following are cases pending in which the State faces
the risk of either a loss of revenue or an unanticipated expenditure. In the
opinion of the Department of State Treasurer, an adverse decision in any of
these cases would not materially adversely affect the State's ability to meet
its financial 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 Superior Court requesting a declaration that the
public education system of North Carolina, including its system of funding,
violates the North Carolina 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.
On July 24, 1997, the North Carolina Supreme Court issued a decision in
the case. The Court upheld the present funding system against the claim that it
unlawfully discriminated against low wealth counties on the basis that the
Constitution does not require substantially equal funding and educational
advantages in all school districts. The Court remanded the case for trial on the
claim for relief based on the Court's conclusion that the Constitution
guarantees every child of the state an opportunity to receive a sound basic
education in North Carolina public schools. Five other counties intervened and
now allege claims for
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relief on behalf of their students' rights to a sound basic education on the
basis of the high proportion of at-risk students in their counties' systems. The
North Carolina Attorney General's Office believes that sound legal arguments
support the State's position on the outstanding claims.
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
failed 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. Discovery is
underway, but no trial date has been set. The North Carolina Attorney General's
Office believes that sound legal arguments support the State's position.
Faulkenbury v. Teachers' and State Employees' Retirement System; Peele
v. Teachers' and State Employees' Retirement System; 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 Superior Court
issued an order ruling in favor of plaintiffs. The Order was affirmed by the
North Carolina Supreme Court. A determination of the actual amount of the
State's liability and the payment process is being determined by the parties.
The plaintiffs have submitted documentation to the court asserting that the cost
in damages and higher prospective benefit payments to the plaintiffs and class
members would amount to $407 million. These amounts would be payable from the
funds of the Retirement systems.
Bailey v. State -- State and local government retirees 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 filed 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. Thereafter, taxpayers also filed additional lawsuits
claiming refunds of income taxes paid for tax years through 1996. In May 1995,
the trial court found that the repeal of the tax exemption for state and local
government retirement benefits that were vested before August 1989 was unlawful
and that such benefits remain exempt from income taxation. The North Carolina
Supreme Court allowed discretionary review, and handed down its decision on May
8, 1998, upholding the decision of the trial court.
Patton v. State -- Federal retirees filed a class action suite in Wake
County Superior Court in 1995 seeking monetary relief for taxes paid since 1989.
This case was brought in anticipation of a favorable outcome for the plaintiffs
in the Bailey case. The federal retirees allege that a result in the Bailey case
that exempts State and local retirement benefits from State income taxes would
require a similar exemption for federal retirement benefits under the United
States Supreme Court's 1989 decision in Davis v. Michigan. In Davis, the United
States Supreme Court ruled that a Michigan income tax statute that taxed federal
retirement benefits while exempting those paid by state and local governments
violated the constitutional doctrine of intergovernmental tax immunity. The
Patton case was held in abeyance pending the outcome in Bailey. On June 10,
1998, the Wake County Superior Court approved a consent order with respect to
the Bailey and Patton cases which the North Carolina General Assembly agreed to
appropriate the sum of $799,000 ($400,000 in fiscal year 1998-1999 and $399,000
in fiscal year 1999-2000) to be paid in the form of cash refunds to State, local
and federal retiree plaintiffs in the Bailey and Patton cases in complete
satisfaction of
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all liability of the State of North Carolina and its officials arising from the
taxation of State, local and federal retirement income and benefits for tax
years 1989 through 1997. The consent order will become final upon enactment of
the necessary legislation by the North Carolina General Assembly appropriating
the funds, and approval by the court following notice to members of the members
of the affected classes. Both the House and Senate versions of the budget
contain the necessary appropriation, although a final budget for fiscal year
1998-1999 has not yet been passed.
Smith, et al. v. Offerman and State of North Carolina, et al. -- This
class action is related to litigation in Fulton Corporation v. Faulkner, 516
U.S. 325, 133 L.Ed.2d 796 (1995), a case filed by a single taxpayer relating to
the State's intangible tax. On July 7, 1995, while the Fulton case was pending
before the United States Supreme Court, the Smith class action was commenced on
behalf of all other taxpayers who had complied with the requirements of the tax
refund statute N.C.G.S. 105-267, and would therefore be entitled to refunds if
Fulton prevailed on its refund claim. These original plaintiffs were later
designated Class A when a second group of plaintiffs were added. The new class,
denominated Class B, consisted of taxpayers who had paid the tax but failed to
comply with the tax refund statute. On February 21, 1996, the United States
Supreme Court held in Fulton that the State's intangibles tax on shares of tax
(by then repealed) violated the Commerce Clause of the United States
Constitution because it discriminated against stock issued by corporations that
do all or part of their business outside of North Carolina. It remanded the case
to the North Carolina Supreme Court to consider remedial issues including
whether the offending provision in the statute (the taxable percentage
deduction) was severable.
On February 10, 1997, the Supreme Court of North Carolina in the Fulton
remand proceeding severed the taxable deduction provision and invited the
General Assembly to determine the appropriate remedy for the discriminatory tax
treatment of eligible taxpayers who paid the tax but did not benefit from the
deduction. While the General Assembly considered the remedial issues raised by
the Fulton remand, the Smith plaintiffs moved for judgment on their refund
claims. On June 11, 1997, the trial judge in Smith ordered refunds to be made
for tax years 1991-1994 to the Class A plaintiffs and dismissed the Class B
claims. Refunds to Class A taxpayers, totaling approximately $120,000,000, have
substantially been paid, with interest. The Class B plaintiffs appealed, and
their appeal is pending in the North Carolina Court of Appeals. The decision in
Bailey that overruled prior decisions requiring a taxpayer to pay the tax and
file a protest within thirty (30) days may have an adverse impact on the outcome
of this case.
Shaver v. Boyles, Refrow, and State of North Carolina-This class action
was filed on January 16, 1998, by intangibles taxpayers who paid intangibles tax
on shares of stock for tax years 1990-1994 and did not receive refunds because
they failed to meet the tax refund statute requirements. These are the same
taxpayers as Class B plaintiffs in Smith, but they claim refund entitlement
under an alleged alternative theory. They claim refunds of approximately
$131,750,000 for tax years 1991-1994 and $80,000,000 for tax year 1990.
In the opinion of the Department of the State Treasurer, the decision
in the Bailey case, if it becomes final, and any adverse decisions in the Patton
and Smith cases, should an adverse decision be rendered, will not materially
adversely affect the State's ability to meet its financial obligations in view
of the State's on-going financial strength and of the current status of its
finances, including its budget stabilization reserve of $500 million. Also, as
of March 31, 1998, in addition to the State's beginning unreserved General Fund
balance of $315 million, the State has realized $585 million in revenues in
excess of expenditures in the General Fund.
The State is involved in numerous other claims and legal proceedings,
many of which normally occur in governmental operations; however, the North
Carolina Attorney General does not expect any of the other outstanding lawsuits
to materially adversely affect the State's ability to meet its financial
obligations.
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General. The population of the State has increased 13% from 1980, from
5,895,195 to 6,656,810 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 July 1997 is 7,436,690. Notwithstanding its rank in population size, North
Carolina is primarily a rural state, having only six 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 1996, the State labor force grew about 33% (from 2,855,200 to
3,796,200). Per capita income during the period 1985 to 1996 grew from $11,870
to $22,010, an increase of 85.4%.
The current economic profile of the State consists of a combination of
industry, agriculture and tourism. As of July 1997, 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.
<TABLE>
<CAPTION>
Category
(all seasonally adjusted) June 1993 June 1994 June 1995 June 1996 June 1997
<S> <C> <C> <C> <C> <C>
Civilian Labor Force 3,504,000 3,560,000 3,578,000 3,704,000 3,797,000
Nonagricultural Employment 3,203,400 3,358,700 3,419,100 3,506,000 3,620,300
Goods Producing Occupations
(mining, construction and
manufacturing) 993,600 1,021,500 1,036,700 1,023,800 1,041,000
Service Occupations 2,209,800 2,337,200 2,382,400 2,482,400 2,579,300
Wholesale/Retail Occupations 723,200 749,000 776,900 809,100 813,500
Government Employees 515,400 554,600 555,300 570,800 579,600
Miscellaneous Services 676,900 731,900 742,200 786,100 852,500
Agricultural Employment 88,400 53,000 53,000 53,000 [not
available]
</TABLE>
The seasonally adjusted unemployment rate in July 1997 was
estimated to be 3.7% of the labor force, as compared with 4.8% nationwide.
North Carolina's economy continues to benefit from a vibrant
manufacturing sector. Manufacturing firms employ approximately 24% of the total
non-agricultural workforce. North Carolina has the second highest percentage of
manufacturing workers in the nation. The State's annual value of manufacturing
shipments totals $142 billion, ranking the State eighth in the nation. The State
leads the nation in the production of textiles, tobacco products, furniture and
fiberoptic cable, and is among the largest producers of pharmaceuticals,
electronics and telecommunications equipment. More than 700 international firms
have established a presence in the State. Charlotte is now the second largest
financial center in the country, based on assets of banks headquartered there.
The strength of the State's manufacturing sector also supports the growth in
exports; the latest annual statistics show $8.76 billion in exports, making
North Carolina one of the few states with an export trade surplus.
In 1996, the State's gross agricultural income of nearly $8.0 billion
placed it eighth in the nation in gross agricultural income. The State ranks
third in the nation in net farm income. According to the State Commissioner of
Agriculture, in 1996 the State ranked first in the nation in the production of
flue-cured
99
tobacco, total tobacco, turkeys and sweet potatoes; second in hog production,
trout, and the production of cucumbers for pickles; third in the value of net
farm income poultry and egg products, and greenhouse and nursery income; fourth
in commercial broilers, peanuts, blueberries and strawberries; and fifth in
burley tobacco.
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 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, which had been the leading source of agricultural
income in the State, declined in 1995. The poultry industry is now the leading
source of gross agricultural income, at 29%, and the pork industry provides 22%
of the total 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. The tobacco industry remains important to North
Carolina providing approximately 13% of gross agricultural income.
The number of farms has been decreasing; in 1997 there were
approximately 57,000 farms in the State down from approximately 72,000 in 1987,
(a decrease of about 20% in ten years). However, a strong agribusiness sector
supports farmers with farm inputs (agricultural chemicals and fertilizer, farm
machinery, and building supplies) and processing of commodities produced by
farmers (vegetable canning and cigarette manufacturing). North Carolina's
agriculture industry, including food, fiber and forest products, contributes
over $45 billion annually to the State's economy.
The North Carolina Department of Commerce, Travel and Tourism Division,
indicates that travel and tourism is increasingly important to the State's
economy. Travel and tourism's $9.8 billion economic impact in 1996 represents a
6.5% increase over 1995. The North Carolina travel and tourism industry directly
supports 167,100 jobs or 4.7% of total non-agricultural employment.
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 June 1996. Standard
& Poor's reports that North Carolina's rating reflects the State's strong
economic characteristics, sound financial performances, and low debt levels.
The Sponsors believe 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 Sponsors and their 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.
OHIO
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 fourth in the
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nation in 1991 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 peaked in the summer of 1993, decreased slightly but then
reached a new high in 1997. Growth in recent years has been concentrated among
non-manufacturing industries, with manufacturing tapering off since its 1969
peak. Over three-fourths of the payroll workers in Ohio are employed by
non-manufacturing industries.
The average monthly unemployment rate in Ohio was 4.3% in November,
1997.
With 14.2 million acres in farm land, agriculture and related sectors
are a very important segment of the economy in Ohio, providing an estimated
935,000 jobs or approximately 15.9% of total Ohio employment.
Ohio continues to be a major "headquarters" state. Of the top 500
corporations (industrial, commercial and service) based on 1995 revenues as
reported in 1996 by Fortune magazine, 30 had headquarters in Ohio, placing Ohio
sixth as a "headquarters" state for corporations.
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, 1997
through June 30, 1999.
Under Ohio law, if the Governor ascertains that the available revenue
receipts and balances for the general revenue fund ("GRF") or other funds for
the then current fiscal year will probably be less than the appropriations for
the year, he must issue orders to State agencies to prevent their expenditures
and obligations from exceeding the anticipated receipts and balances.
State and national fiscal uncertainties during the 1992-93 biennium
required several actions to achieve the ultimate positive GRF ending balances.
As an initial action, to address a subsequently projected fiscal year 1992
imbalance, the Governor ordered most state agencies to reduce GRF appropriation
spending in the final six months of that year by a total of approximately $184
million. Debt service obligations were not affected by this order. Then in June
1992, $100.4 million was transferred to the GRF from the budget stabilization
fund and certain other funds. Other revenue and spending actions, legislative
and administrative, resolved the remaining GRF imbalance for fiscal year 1992.
As a first step toward addressing a then estimated $520 million GRF
shortfall for fiscal year 1993, the Governor ordered, effective July 1, 1992,
selected GRF appropriations reductions totalling $300 million (but such
reductions did not include debt service). Subsequent executive and legislative
actions provided for positive biennium-ending GRF balances. The GRF ended the
1992-93 biennium with a balance of approximately $111 million and a cash balance
of approximately $394 million.
The GRF appropriations act for the 1994-95 biennium provided for total
GRF biennial expenditures of approximately $30.7 billion. The 1994-95 biennium
ending GRF balance was $928 million.
The GRF appropriations act for the 1996-1997 biennium provided for
total GRF biennial expenditures of approximately $33.5 billion. The 1996-1997
biennium GRF ending balance was over $834 million.
The GRF appropriations act for the current biennium provides for total
GRF biennial expenditures of over $36 billion. Necessary GRF debt service was
provided for in the act. Litigation pending in federal District Court and in the
Ohio Court of Claims contests the Ohio Department of Human Services ("ODHS")
prior Medicaid financial eligibility rules for married couples where one spouse
is living in a nursing facility
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and the other spouse resides in the community. ODHS promulgated new eligibility
rules effective January 1, 1996. ODHS is appealing an order of the federal court
directing it to provide notice to persons potentially affected by the former
rules from 1990 to 1995. It is not possible at this time to state whether this
appeal will be successful or, should plaintiffs prevail, the period (beyond the
current fiscal year) during which necessary additional Medicaid expenditures
would have to be made. Plaintiffs have estimated total additional Medicaid
expenditures at $600,000,000 for the retroactive period and, based on current
law, it is estimated that the State's share of those additional expenditures is
approximately $240,000,000. The Court of Claims has certified the action as a
class action.
Because GRF cash receipts and disbursements do not precisely coincide,
temporary GRF 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 operating funds. In fiscal
year 1997, a GRF cash flow deficiency occurred in four months with the highest
being approximately $565 million. The OBM projects GRF cash flow deficiencies
will occur in eight months in fiscal year 1998.
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, but which are limited to $750,000 or
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.
From 1921 to date, Ohio voters approved fifteen constitutional
amendments authorizing the incurrence of State debt to which taxes or excises
were pledged for payment. The only such tax-supported debt still authorized to
be incurred are highway, coal development, local infrastructure and natural
resources general obligation bonds.
Not more than $1.2 billion in certain state highway obligations may be
outstanding at any time and not more than $220 million can be issued in a fiscal
year. As of January 8, 1998, approximately $170 million of such highway
obligations were outstanding. The authority to issue certain other highway
obligations expired in December, 1996; however, as of January 8, 1998
approximately $358 million of such highway obligations were outstanding. Not
more than $100 million in State obligations for coal development may be
outstanding at any one time. As of January 8, 1998, approximately $31 million of
such coal obligations were outstanding. Not more than $2.4 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 8, 1998, approximately $947 million of those bonds
were outstanding. Not more than $200 million of natural resources bonds may be
outstanding at any time, and no more than $50 million can be issued in any year.
As of January 8, 1998, approximately $91 million of those bonds were
outstanding.
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 Treasurer of State has been authorized to issue bonds to finance
approximately $538.6 million of capital improvements for local elementary and
secondary public school facilities (approximately $224 million is issued). Debt
service on the obligations is payable from State resources.
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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. A 1996
issue of approximately $168.7 million of taxable bonds refunded previously
outstanding bonds. The highest future fiscal year debt service on the
outstanding bonds, which are payable through 2022, is approximately $16 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 January 30, 1998, the Ohio Housing Financing Agency,
pursuant to that constitutional amendment and implementing legislation, had sold
revenue bonds in the aggregate principal amount of approximately $309.8 million
for multifamily housing and approximately $4.72 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. The General Assembly could authorize State borrowing for this
purpose by 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.
A constitutional amendment approved in 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.
Schools and Municipalities. The 612 public school districts and 49
joint vocational school districts in the State receive a major portion
(approximately 44%) 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 basic aid appropriations for the 1992-93 biennium
provided for an increase in school funding compared to 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 amounts, and had varying effects, with respect to individual school
districts. State appropriations for primary and secondary education for the
1994-95 biennium provided for 2.4% and 4.6% increases in basic aid for the two
fiscal years of the biennium. State appropriations for primary and secondary
education for the 1996-97 biennium provided for a 13.6% increase in school
funding appropriations over those in the preceding biennium. State
appropriations for the current 1998-99 biennium provide for a 14.5% increase
over the previous biennium.
In years prior to fiscal year 1990, school districts facing deficits at
year end had to apply to the State for a loan from the Emergency School
Advancement Fund. Legislation replaced the Fund with enhanced provisions for
individual district local borrowing, including direct application of Foundation
Program distributions to repayment if needed. In fiscal year 1995, 29 school
districts received loans totaling approximately $71.1 million. In fiscal year
1996, 20 school districts have received loans totaling approximately $87.2
million. In fiscal year 1997, 12 school districts have received loans totaling
approximately $113 million. As of January 8, 1998, one school district has
received approval for a loan of approximately $17.2 million.
103
The Ohio Supreme Court concluded, in a decision released March 24,
1997, that major aspects of the State's system of school funding are
unconstitutional. The Court ordered the State to provide for and fund
sufficiently a system complying with the Ohio Constitution, staying its order
for a year to permit time for responsive corrective actions by the Ohio General
Assembly. In response to a State motion for reconsideration and clarification of
its opinion, the Court, on April 25, 1997, indicated that property taxes may
still play a role in, but can no longer by the primary means of, school funding.
The Court also confirmed that contractual repayment provisions of certain debt
obligations issued for school funding will remain valid until the stay
terminates.
Various Ohio municipalities have experienced fiscal difficulties. Due
to these difficulties, the State established procedures 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. As of January 8, 1998, this act has been applied
to eleven cities and thirteen villages. The situations in nine cities and nine
villages have been resolved and their commissions terminated.
State Employees and Retirement Systems. The State has established five
public retirement systems which 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
$13,816.1 million 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 bargaining unit agreements with the State expire at various times in
1997.
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
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 insuring
corporations licensed by the Ohio Department of Insurance increased from 12 on
February 14, 1983 to 40 as of January 29, 1998. 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.
OREGON
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.
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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
had outstanding $70.6 million in principal amount of urban renewal bonds as of
June 30, 1996. 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.
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.
November 1996 Ballot Measures. Oregon voters will be asked to consider
23 ballot measures at the November 1996 general election. These ballot measures
may have direct and indirect impacts on the finances of the State and its
municipal institutions. The net financial effect of these ballot measures is not
possible to gauge at this time, but the approval of several of these ballot
measures (whether individually or cumulatively, if more than one ballot measure
were approved) could adversely effect the ability of Oregon issuers to service
their outstanding debt and to issue new debt.
105
Ballot Measure 47, for example, would reduce property taxes through the
1997-98 fiscal year based on prior year levels and would limit growth in
property taxes in subsequent years to 3 percent a year, with certain exceptions.
Ballot Measure 47 would also prohibit, without a vote of the people, alternate
local financing of government services or products paid in part or whole
historically by property taxes. Ballot Measure 47 would also require a majority
vote and 50 percent voter turnout to pass new property tax measures on any date
other than a general election. The State Legislative fiscal office estimates
revenue losses to local governments from Ballot Measure 47 at $472 million in
1997-98, $560 million in 1998-99, and increasing thereafter. This reduction in
local government revenues could have a significant impact on the ability of
local governments to service their outstanding debt.
Ballot Measure 46 would require the vote of a majority of registered
voters to pass revenue measures; the current system requires only a majority of
those voting in an election to pass revenue measures. The new requirement would
apply to all proposed tax increases, including property tax operating levies and
levies for general obligation bond issues. If adopted, Ballot Measure 46 would
make the passage of taxation measures much more difficult, and would most likely
lead to fewer tax supported debt and operating levies.
The impact of other ballot measures is more indirect, with some ballot
measures projected by the State to result in net savings for the State and its
municipal institutions, and others projected to require additional expenditures.
The approval by voters of these ballot measures could cause a reduction in the
ratings for debt obligations issued by the State and its political subdivisions,
as well as by Oregon municipalities. Rating changes, if any, may also depend
upon the specific impact of the individual ballot measure or measures on the
revenues of the issuer and the effect of the ballot measures on the revenues
utilized to pay the debt service of the rated indebtedness.
Fiscal Matters. The State Department of Administrative Services expects
some slowing in Oregon's economy due in part to a shortage of skilled labor and
some decrease in the growth rate of the construction sector. The Department
projects job growth to be 4.1 percent in 1996 and 2.4 percent in 1997. The
Department projects that net in-migration should provide some additional skilled
workers, but movement to Oregon from other states is likely to be limited by
higher home prices in Oregon and a continuing economic recovery in California.
The Department projects that expansion of the semiconductor industry will remain
the driving force behind Oregon's economic growth. Strong export activity, broad
base service sector growth and growth in electronic jobs and overall high
technology manufacturing jobs should, according to the Department, also
contribute to Oregon economic growth. The Department expects that income,
population and employment growth will exceed the national average for the
eight-year period between 1995 and 2003.
The Department of Administrative Services reports that Oregon wage and
salary employment for the first quarter of 1996 increased at an annual rate of
4.8 percent, and projects an increase of 7.8 percent in 1996, down from an
estimated 8.1 in 1995. The Department estimates that personal income increased
7.6 percent in 1995 and projects an increase of 6.9 percent in 1996.
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 1995-97 biennium includes a General Fund budget of
$7.375 billion, representing an increase of 15.3% over 1993-95 expenditures.
Total appropriations for all funds in the 1995-97 budget are
106
$22.262 billion, representing an increase of 8.6% over the 1993-95 expenditures.
This total includes, in addition to the General Fund, $10.917 billion in Other
Funds and $3.970 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 $461.0 million during the 1991-93 fiscal
biennium, $1.499 billion during the 1993-95 biennium, and $1.309 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.
Debt Obligations. The State of Oregon issued $658.1 million in bonds,
notes and certificates of participation ("COPs") during the fiscal year ended
June 30, 1996, an increase of 49.3% from the $440.8 million in bonds, notes and
COPs issued in the fiscal year ended June 30, 1995. Of the fiscal year 1995-96
total, $174.6 million were general obligations, $213.6 million were revenue
obligations, and $269.9 million were COPs. During the fiscal year ended June 30,
1996, local Oregon governments issued approximately $1.051 billion in debt, a
decrease of approximately 20.2% from the fiscal year ended June 30, 1995
issuances of $1.317 billion.
The State of Oregon had outstanding $3.697 billion in general
obligations at June 30, 1996 representing a decrease of 12.7% from the total
outstanding of $4.235 billion at June 30, 1995. Oregon local governments had
$7.302 billion in total debt outstanding at June 30, 1995, representing an
increase of 8.7% from the total outstanding of $6.718 billion at June 30, 1995.
At June 30, 1996, the State of Oregon had outstanding approximately
$2.837 billion of Oregon Veterans' Welfare Bonds and Notes, representing a
decrease of 14.9% from the total outstanding of $3.333 billion at June 30, 1995.
The Veterans' Welfare Bonds and Notes, which are utilized to finance the
veterans' mortgage loan program, are administered by the Oregon Department of
Veterans' Affairs, and are general obligations of the State of Oregon.
General obligation bonds of the State of Oregon are currently rated Aa
by Moody's and AA- by Standard & Poor's.
Taxes and Other Revenues. The State relies heavily on the personal
income tax. The personal income tax generated $5.381 billion of the total
1993-95 biennium General Fund revenues of $6.536 billion. The State's Department
of Revenue estimates that the personal income tax will generate $6.024 billion
of the total General Fund revenues of $7.127 billion projected for the 1995-97
biennium. The State corporate income and excise tax generated $575.8 million in
revenues during the 1993-95 biennium, and is projected by the Department of
Revenue to generate $470.9 million in revenues during the 1995-97 biennium.
Revenues generated by the State lottery are currently dedicated to
economic development and education. State lottery officials report that revenues
generated from the regular lottery sales for the 1995-96 fiscal year totaled
$344.2 million, with $75.3 million of that amount having been made available to
the State. State lottery officials also report that the State's video poker
program generated revenues of $355.7 million during the 1995-96 fiscal year,
with $202.7 million of that amount being made available to the State. State
lottery officials currently forecast $354.4 million from regular lottery sales
and $340.6 million from video poker sales for the 1996-97 fiscal year, with
$80.0 million and $187.3 million of those amounts, respectively, projected to be
available to the State. State lottery officials project that revenues for the
1995-1997 biennium from regular lottery sales will be $698.6 million and from
video poker sales will be $696.3 million, with $155.3 million and $390.1 million
of those amounts, respectively, projected to be available to the State. State
Lottery officials expect video poker revenues to remain uncertain due to
increasing competition from tribal gambling casinos.
107
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.
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") that were held in SAIF's
Industrial Accident Fund. The State was sued in litigation challenging the
legality of the transfer of this surplus from SAIF's Industrial Accident Fund to
the General Fund. The Oregon Supreme Court 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.
108
As a result of the decision, a coalition of Oregon businesses filed
companion class action lawsuits in 1988 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.
After a series of appeals, on November 19, 1993, the Oregon Supreme
Court ruled that the State should 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 remand, the trial court ordered the State to return the $81 million to
SAIF, with interest at the rate Industrial Accident Fund investments have earned
since July 1, 1982. In its 1995 session, the Legislative Assembly appropriated
$60 million to the Industrial Accident Fund. To date, the State has repaid $65
million of the $81 million principal amount, but has not yet paid any of the
interest obligation.
The parties drafted a settlement agreement, which the trial court
approved on February 26, 1996. Under the agreement, the State is obligated to
pay a total of $225 million to the Industrial Accident Fund. Of that amount, $65
million has already been paid, $80 million must be paid at the end of the 1997
legislative session, and an additional $80 million must be paid at the end of
the 1999 legislative session. If the State Legislature fails to appropriate the
required amounts, the State will be in breach of the agreement and subject to
additional court action from the plaintiffs.
2. 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.
3. State Employee Claims for Overtime Pay. Two cases have been brought
on behalf of state employees who had been deemed exempt from the federal Fair
Labor Standards Act overtime provisions. In the first case, plaintiffs sought
class status for state employees who claim that they are not salaried employees
exempt from the federal Fair Labor Standards Act overtime provisions. In
November 1995, judgment was entered in this case against the State in the amount
of $705,802, plus $84,801 in prejudgment interest. In the second case, filed on
behalf of all state management service employees, plaintiffs claim that
employees who are subject to disciplinary pay reduction are entitled to payment
for overtime. The plaintiff class consists of approximately 50 individuals. The
State estimates that the amount of damages the plaintiff class could recover
equals approximately $1.5 to $2 million plus attorneys' fees. Based upon a
recent decision by the United States Supreme Court that expands the scope of
Eleventh Amendment immunity of states from suits in federal court, the State has
asked the United States Court of Appeals for the Ninth Circuit to remand one of
these cases for entry of a judgment dismissing the action for lack of subject
matter jurisdiction and anticipates filing a similar motion in the second case.
The State anticipates the Court of Appeals will grant its motion and plaintiffs
will refile their cases in state court.
4. Taxation of Federal Retiree Pension Benefits. Several cases have
been filed in the Oregon Tax Court and the Oregon Circuit Courts alleging that a
1991 increase in the Public Employees' 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 Oregon Supreme Court upheld a ruling by the Oregon
Tax Court in Ragsdale v. Dept. of Revenue that the increase in PERS benefits did
not violate the Davis holding, and is constitutional; the United States Supreme
Court has denied review of this case.
109
Suits involving the same plaintiffs and issues have also been filed in
the state circuit court and in the tax court on behalf of a group of federal
retirees seeking refunds of taxes paid to the State. The case has been stayed in
circuit court and is being litigated in the tax court. In 1995, the Oregon
Legislature enacted House Bill 3349 ("HB 3349"), which provides a remedy to PERS
beneficiaries. The federal retirees are also challenging the provisions of HB
3349. The State has indicated that it is not possible to estimate the potential
impact of liability under any of the PERS cases at this time.
An additional case challenging the PERS benefit increase on the same
grounds that the court ruled against in the Ragsdale case, and seeking to
invalidate HB 3349, was filed in Multnomah County. The court ruled in favor of
the State, but plaintiffs are seeking clarification and reconsideration of the
judge's ruling.
5. Taxation of State Retiree Benefits. 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 of Oregon. 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. The Court in Hughes deferred to the Oregon Legislature
to fashion a remedy; the Oregon Legislature failed to fashion a remedy, however,
in its 1993 session. Plaintiffs filed this action, therefore, to seek to require
public employers to pay breach of contract damages or to increase benefits due
to taxation of previously untaxed pensions.
The 1995 Oregon Legislature enacted HB 3349, which provides a remedy to
PERS beneficiaries by granting PERS members increased benefits as compensation
for damages resulting from the taxation of the PERS benefits. The bill also
prohibits any class action suit for damages based upon such taxation and,
according to the State, effectively renders the claims of the PERS beneficiaries
moot. The fiscal impact statement submitted with this bill indicated that State
agencies will be obligated to pay increased employer contributions of
approximately $27 million in the 1995-97 biennium and approximately $36 million
in the 1997-99 biennium to fund the benefits increase.
Local governments have asserted defenses that they should not be
required to provide funds for the remedy provided in HB 3349 based upon breach
of contract theories, and are seeking indemnification from the State for any
amounts they must pay toward a remedy. The passage of HB 3349 does not moot the
claims of local governments. If the local governments are successful, liability
would be imposed directly on the General Fund for the amount of increased
benefits that the local governments must pay as a result of HB 3349. According
to the State, the amount of liability imposed on the State as a result of the
local governments' claims is uncertain. The trial court has ruled in favor of
local governments on the breach of contract issues.
In November 1995, the Circuit Court ruled on the State's motions for
reconsideration of the Court's earlier ruling with respect to the local
governments' claims and on HB 3349. The Court upheld its ruling with respect to
local governments. The Court also found that the effect of HB 3349 was to
require local governments to pay breach of contract damages in violation of the
Court's prior ruling, because the local governments would be required to pay
increased contribution amounts to fund the remedy provided in HB 3349. In
addition, because the source of funds for the increased benefit payments was an
integral part of HB 3349, and could not be severed from the rest of the bill,
the Court held that HB 3349 was void in its entirety. The Court enjoined the
payment of increased benefits, scheduled to begin in January 1996, to PERS
retirees under HB 3349. The State has appealed the Circuit Court's ruling.
6. 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 premium 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
110
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 could 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.
The 1995 Oregon Legislative Assembly passed House Bill 2855 ("HB 2855")
which equalizes the taxation of foreign and domestic insurers. Most insurance
companies have dismissed their cases due to the passage of HB 2855. One
insurance company, however, has not dropped its counterclaim on the equal
protection issue. If this case proceeds to trial and succeeds, it could open the
door to recovery by other insurers who are not a party to the present action and
have not allowed the case to be dismissed against them with prejudice. If such
insurers do bring cases, the State could be subject to potential refund
liability of several million dollars per year for each year that must be
refunded. In February 1996, the court ruled on cross motions for summary
judgment. The court ruled in favor of the State on all issues except the years
for which a retaliatory tax could be imposed, with the result that the State
will be unable to collect approximately $750,000. No judgment has been entered
in the case. The parties are pursuing settlement negotiations to arrive at a
consent decree.
7. Liability for PERS Losses. Four separate plaintiffs have filed
lawsuits against the State seeking reimbursement on behalf of the Public
Employees' Retirement Fund (the "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,
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. The Oregon Supreme Court has
granted review of the case on several issues. Upon reconsideration, however, the
Oregon Supreme Court dismissed the review as improvidently granted. The Court of
Appeals ruling that affirmed the trial court's dismissal of the case, therefore,
stands as the final resolution of these cases.
8. Challenge to Oregon Health Plan. A class action suit has been filed
in federal court seeking to add certain Medicare beneficiaries, consisting of
disabled and elderly persons, to the group of persons covered under the Oregon
Health Plan (the "Plan"). The plaintiff class is seeking additional services
offered under the Plan which they do not receive under the Federal Medicare
program. If plaintiffs are successful, the State estimates that costs under the
Plan would increase an additional $30 million per biennium. The Court has ruled
in favor of the State on its motion for summary judgment and dismissed the case.
The plaintiffs have filed an appeal of the court's ruling with the United States
Court of Appeals for the Ninth Circuit.
9. Liability for Radiation Experiments. A class action suit has been
filed in federal court on behalf of inmates and their families for injuries
sustained by inmates in radiation experiments in the 1960s and 1970s. The former
head of the medical services for the Oregon State Police has been named as a
defendant. Plaintiffs seek $250 million in damages. Although the State believes
it is too early to determine the actual amount plaintiffs are likely to recover,
the State believes it is unlikely they will recover the full amount sought.
According to the State, the State intends to assert defenses based on statute of
limitation and ultimate repose.
PENNSYLVANIA
111
RISK FACTORS--Potential purchasers of Units of the Pennsylvania Trust
should consider the fact that the Trust's portfolio consists primarily of
securities issued by the Commonwealth of Pennsylvania (the "Commonwealth"), its
municipalities and authorities and should realize the substantial risks
associated with an investment in such securities. Although the General Fund of
the Commonwealth (the principal operating fund of the Commonwealth) experienced
deficits in fiscal 1990 and 1991, tax increases and spending decreases have
resulted in surpluses the last four years; as of June 30, 1996, the General Fund
had a surplus of $635.2 million.
Pennsylvania's economy historically has been dependent upon heavy
industry, but has diversified recently into various services, particularly into
medical and health services, education and financial services. Agricultural
industries continue to be an important part of the economy, including not only
the production of diversified food and livestock products, but substantial
economic activity in agribusiness and food-related industries. Service
industries currently employ the greatest share of nonagricultural workers,
followed by the categories of trade and manufacturing. Future economic
difficulties in any of these industries could have an adverse impact on the
finances of the Commonwealth or its municipalities and could adversely affect
the market value of the Bonds in the Pennsylvania Trust or the ability of the
respective obligors to make payments of interest and principal due on such
Bonds.
Certain litigation is pending against the Commonwealth that could
adversely affect the ability of the Commonwealth to pay debt service on its
obligations including suit relating to the following matters: (i) the ACLU has
filed suit in federal court demanding additional funding for child welfare
services; the Commonwealth settled a similar suit in the Commonwealth Court of
Pennsylvania and is seeking the dismissal of the federal suit, inter alia
because of that settlement; after its earlier denial of class certification was
reversed by the Third Circuit Court of Appeals, the district court granted class
certification to the ACLU, and the parties are proceeding with discovery (no
available estimate of potential liability); (ii) in 1987, the Supreme Court of
Pennsylvania held the statutory scheme for county funding of the judicial system
to be in conflict with the constitution of the Commonwealth, but stayed judgment
pending enactment by the legislature of funding consistent with the opinion; a
special master appointed by the Court submitted an implementation plan in 1997,
recommending a four phase transition to state funding of a unified judicial
system; the special master recommended that the implementation of the phase
should be effective July 1, 1998, with the completion of the final phase early
next century; objections to the Special Master's report were due by September 1,
1997; the General Assembly has yet to consider legislation implementing the
Court's judgment; (iii) litigation has been filed in both state and federal
court by an association of rural and small schools and several individual school
districts and parents challenging the constitutionality of the Commonwealth's
system for funding local school districts--the federal case has been stayed
pending the resolution of the state case; the state trial, post-trial briefing
and oral arguments have been completed, and the judge has taken the case under
advisement (no available estimate of potential liability); (iv)
Envirotest/Synterra Partners ("Envirotest") filed suit against the Commonwealth
asserting that it sustained damages in excess of $350 million as a result of
investments it made in reliance on a contract to conduct emissions testing
before the emission testing program was suspended. Envirotest has entered into a
Settlement Agreement to resolve Envirotest's claims that will pay Envirotest a
conditional sum of $195 million over four years; (v) in litigation brought by
the Pennsylvania Human Relations Commission to remedy unintentional conditions
of segregation in the Philadelphia public schools, the School District of
Philadelphia filed a third-party complaint against the Commonwealth asking the
Commonwealth Court to require the Commonwealth to supply funding necessary for
the District to comply with orders of the court; the Commonwealth Court found
that the School District was entitled to receive an additional $45.1 million for
the 1996-97 school year, but the Pennsylvania Supreme Court vacated this
decision in September 1996; pursuant to the Court's orders, the parties have
briefed certain issues, but oral argument has not yet been scheduled (no
available estimate of potential liability); (vi) in February 1997, five
residents of the City of Philadelphia, joined by the City, the School District
and others, filed a civil action in the Commonwealth Court for declaratory
judgment against the Commonwealth and certain Commonwealth officers and
officials that the defendants had failed to provide an adequate quality of
education in Philadelphia, as required by the
112
Pennsylvania Constitution; after preliminary objections and briefs were filed,
the Court heard oral argument in September 1997, and has taken the matter under
advisement (no available estimate of potential liability); (vii) in April 1995,
the Commonwealth reached a settlement agreement with Fidelity Bank and certain
other banks with respect to the constitutional validity of the Amended Bank
Shares Act and related legislation; although this settlement agreement did not
require expenditure of Commonwealth funds, the petitions of other banks are
currently pending with the Commonwealth Court (no available estimate of
potential liability); and (viii) suit has been filed in state court against the
State Employees' Retirement Board claiming that the use of gender distinct
actuarial factors to compute benefits received before August 1, 1983 violates
the Pennsylvania Constitution (gender-neutral factors have been used since
August 1, 1983, the date on which the U.S. Supreme Court held in Arizona
Governing Committee v. Norris that the use of such factors violated the Federal
Constitution); in 1996, the Commonwealth Court heard oral argument en banc, and
in 1997 denied the plaintiff's motion for judgement on the pleadings (no
available estimate of potential liability).
Although there can be no assurance that such conditions will continue,
the Commonwealth's general obligation bonds are currently rated AA- by Standard
& Poor's and A1 by Moody's and Philadelphia's general obligation bonds are
currently rated BBB by Standard & Poor's and Baa by Moody's.
The City of Philadelphia (the "City") experienced a series of General
Fund deficits for Fiscal Years 1988 through 1992 and, while its general
financial situation has improved, the City is still seeking a long-term solution
for its economic difficulties. The audited balance of the City's General Fund as
of June 30, 1996 was a surplus of approximately $118.5 million up from
approximately $80.5 million as of June 30, 1995.
In recent years an authority of the Commonwealth, the Pennsylvania
Intergovernmental Cooperation Authority ("PICA"), has issued approximately $1.76
billion of Special Revenue Bonds on behalf of the City to cover budget
shortfalls, to eliminate projected deficits and to fund capital spending. As one
of the conditions of issuing bonds on behalf of the City, PICA exercises
oversight of the City's finances. The City is currently operating under a five
year plan approved by PICA in 1996. PICA's power to issue further bonds to
finance capital projects expired on December 31, 1994. PICA's power to issue
bonds to finance cash flow deficits expired on December 31, 1996, but its
authority to refund outstanding debt is unrestricted. PICA had approximately
$1.1 billion in special revenue bonds outstanding as of June 30, 1997.
THE TENNESSEE TRUST
RISK FACTORS--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.
That amendment also provided that no debt obligation may be authorized for the
current operation of any State service or program unless repaid within the
fiscal year of issuance. The State's fiscal year runs from July 1 through June
30.
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. Although the issue
of instituting a new State income tax scheme remains a matter of discussion
amongst 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 indexes of coincident and leading economic
113
indicators trended downward throughout the period. However, the Tennessee
economy gained strength during the latter part of 1992 and this renewed vitality
steadily continued through 1993, 1994 and into 1995. During the latter half of
1995 and throughout calendar year 1996, the State's economy generally became
inconsistent in its performance. However, many experts believe that the State
will achieve modest economic gains for fiscal year ending June 30, 1997.
The Tennessee index of coincident economic indicators, which gauges
current economic conditions throughout the State, has steadily risen each
quarter beginning the third calendar quarter of 1991 except for the second
quarter of calendar year 1996 where the coincident index declined slightly. For
calendar year 1994 the coincident index rose approximately 6.20% over 1993
figures, while 1993 figures increased approximately 4.27% over 1992 figures, and
1992 figures showed a 2.45% increase over the previous year's figures. In 1995,
figures for the coincident index showed a 2.97% increase over 1994 figures. In
1996, figures for the coincident index were up 2.18% over 1995 annual figures.
No monthly figures for the coincident index are currently available for 1997.
Tennessee taxable sales were approximately $44.16 billion in 1991,
approximately $46.96 billion in 1992, approximately $50.64 billion in 1993,
approximately $55.32 billion in 1994, approximately $59.65 billion in 1995 and
approximately $63.01 billion in 1996, representing percentage increases of 1.4%,
6.4%, 7.8%, 9.3%, 7.8%, and 5.6%, respectively, over the previous year's total.
No Tennessee taxable sales figures are presently confirmed for 1997.
Current data indicate that seasonally-adjusted personal income in
Tennessee has grown approximately $5.34 billion from calendar year 1992 averages
to calendar year 1993 averages, representing an approximate 5.90% increase.
Seasonably-adjusted personal income grew approximately $6.89 billion from
calendar year 1993 averages to calendar year 1994 averages, representing an
approximate 7.03% increase, and grew approximately $6.46 billion from calendar
year 1994 averages to calendar year 1995 averages, representing an approximate
6.42% increase. Comparative figures for calendar year 1996 versus calendar year
1995 are not yet available.
From 1983 to 1993 Tennessee's per capita income 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%. In 1995, the year
for which the most current data is available, per capita income in Tennessee
registered $21,038 which equaled approximately 90.6% of the national level. For
the fiscal year ended June 30, 1996, however, Tennessee remained the leading
state in the nation in household bankruptcy filings (1 in every 45 households)
with a rate more than twice the national average (1 in every 93 households).
Tennessee's unemployment rate stood at 4.0% for December 1994, the
lowest figure since the 1980's. The unemployment rate has slowly risen over the
December 1994 low. At the end of calendar year 1995, the State's unemployment
rate stood at 5.2% with the national rate at 5.6% and at December 1996 the
state's unemployment rate had declined slightly to 5.0% with the national rate
at 5.3%. There currently is no unemployment data for 1997. For the four-year
period beginning 1991 and ending 1994, average annual unemployment in Tennessee
steadily decreased, from 6.6% in 1991, to 6.4% in 1992, to 5.7% in 1993 to 4.8%
in 1994. However, in 1995 the average annual Tennessee unemployment rate rose to
5.2% but has since declined again to 4.9% for calendar year 1996. 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 600,000-700,000 new jobs. These projections for Tennessee compare
favorably to the projections for national employment growth of 20.5% over the
same period.
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, however, has been undergoing a structural change
in the last 20-25 years through increases in service sector and trade sector
employment and
114
manufacturing employment in Tennessee has steadily declined on a percentage of
work force basis. Service sector employment in Tennessee has climbed steadily
since 1973, increasing its share of overall State non-agricultural employment
from 14.5% to 24.7% in 1993. Over the same period, employment in manufacturing
has declined from 33.9% to 22.7%, and employment in the trade sector has
increased in the period from 1973 to 1993 from 20.4% to 23.0% of
non-agricultural employment. Recently, overall Tennessee non-agricultural
employment has grown in the period from 1991 to 1996 from approximately 2.18
million persons to approximately 2.60 million persons, representing percentage
increases of approximately 2.8%, 3.7%, 4.0%, 3.3% and 4.0% for 1992, 1993, 1994,
1995 and 1996, respectively, over the previous year's figure. Accordingly,
non-agricultural employment in Tennessee is relatively uniformly diversified
today with approximately 23% in the manufacturing sector, approximately 25% in
each of the trade and service sectors and approximately 15% in government. No
data is currently available for 1997 non-agricultural employment figures.
Manufacturing employment is one component of non-agricultural
employment. Tennessee manufacturing employment averaged approximately
503,000 persons in 1991; 515,000 persons in 1992; 529,000 persons in 1993,
539,000 persons in 1994, 543,000 persons in 1995, and 531,000 persons in
1996. Comparatively, these figures represent the following percentage
changes from the previous year's figures: approximately 2.4% (1992 vs.
1991), 2.7% (1993 vs. 1992), 1.9% (1994 vs. 1993), 6.5% (1995 vs. 1994) and
- -2.28% (1996 vs. 1995). No manufacturing employment figures are currently
available for 1997.
The Tennessee index of leading economic indicators acts as a signal of
the health of the State's economy four to nine months ahead. In 1994, figures
for the leading index rose approximately 2.40% over 1993 figures, while 1993
figures were up approximately 1.38% over 1992 figures. In 1995, figures for the
leading index rose a very small .02% over 1994 numbers. In this most recent
year, the 1996 leading index average showed an increase of .84% over the 1995
leading index average.
Tennessee Department of Revenue collections for calendar year 1995
increased to approximately $5.91 billion, an increase of approximately $410
million, or 6.84% over 1994 figures. Calendar year 1996 figures are unconfirmed
at the time of this publication. The State's rainy-day fund remained constant
from December 1994 to December 1996 at approximately $101 million.
Tennessee's population increased approximately 6.2% from 1980 to 1990,
less than the national increase of 10.2% for the same period. As of July 1,
1996, the State's population was estimated at approximately 5.4 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 (Memphis, Nashville, Knoxville and Chattanooga) 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, which, in 1995, and for the first time,
passed the Memphis MSA as the largest metropolitan population center in
Tennessee. The largest population decline is expected in the rural counties of
northwest Tennessee.
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 (Shelby, Davidson, Knox and Hamilton) 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.
115
The Sponsors believe that the information summarized above describes
some of the more significant information regarding the Tennessee economy and
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,
however, 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
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.
TEXAS
RISK FACTORS--The State Economy. Over the last decade, the Texas
economy has become more like the national economy, and, as it has done so, the
nature of the Texas work force has also changed. The Texas economy has become
more concentrated in the service and trade industries, with over half of the
Texans working in non-farm jobs being employed in those industries. Texas has,
however, added many new jobs in "high-tech" industries over the past years, with
employment in that segment growing by approximately
116
319,000 jobs from 1983 to 1993. Any major downturns in this industry would
likely hamper further economic growth in Texas in the near future.
As a consequence of the changes in the Texas economy, it has become
more vulnerable to changes in the value of the dollar and the federal budget
deficit. Exports of goods and services to Central and South America, as well as
elsewhere in the world, are becoming an increasingly important factor in the
Texas economy. As is shown by the effect of the economic crisis in Mexico in the
mid-1990's, international economic events and trade policies now have a
heightened effect on the economic activity in Texas. In March, 1995 state
government officials estimated that as much as one-half of a percentage point in
the growth of the Texas economy forecasted for 1996-1997 fiscal biennium by the
state Comptroller of Public Accounts could be lost as a result of the fiscal
crisis in Mexico that has occurred over the past few years. That estimate was
made based on an anticipated decrease in exports to Mexico as well as a slowdown
in retail trade and economic activities in the important region along the
Texas-Mexico border. Trade with Mexico was estimated in March 1995 to support
directly and indirectly more than 464,000 jobs in Texas, about 6% of the total
Texas employment. Texas exports to Mexico in 1995, in fact, are estimated to
have dropped to $21.9 billion, a decrease of $2 billion from the level of
exports to Mexico in 1994. Retail sales and trade in the border region was also
adversely affected. In response to improvement in the Mexican economy after the
crisis in the mid- 1990's, Texas' exports to Mexico rebounded to $27.4 billion
in 1996. Any future economic problems that Mexico encounters in the future could
result in reductions of Texas' exports to Mexico and cross-border trade with
Mexico, as well as increased unemployment, less growth in the Texas gross state
product and reduced tax revenue for the state.
The economic difficulties in Asia during late 1997 and early 1998 may
have an adverse impact on the Texas economy as Japan, Singapore, South Korea and
Taiwan have recently been among the top ten destinations for Texas exports.
The federal Base Closure and Realignment Commission has made decisions
in the recent past that may affect certain regions in Texas significantly. Most
notably, Kelly Air Force Base in San Antonio, Texas, is slated for closure over
the next several years with the resulting direct job loss now estimated to be
between 10,000 and 18,000 jobs. Local officials in San Antonio have asserted
that loss of those jobs would increase unemployment in the significant Hispanic
population of metropolitan San Antonio by 73%. In addition, three other
metropolitan areas in Texas may be affected by the actions of the commission.
State officials and members of the Texas Congressional delegation have been
working to reduce the adverse effect of the Commission's actions, both through
attempts to save jobs and by otherwise reducing community dependence on defense
establishments. There is no way to predict accurately at this time the effect
these closures may ultimately have on the Texas economy generally and economy of
the San Antonio metropolitan region in particular.
The state government of Texas still faces significant financial
challenges as demands for state and social services increase and spending of
state funds for certain purposes is mandated by the courts and federal law and
is required by growing social services caseloads. The population of Texas has
grown significantly in the recent past and is estimated now to be approximately
19 million persons. Illegal immigration into Texas continues to be problematic
for the state, creating additional demand for governmentally provided social
services. In addition, among the ten most populous states, Texas has had the
highest percentage of its population living below the poverty line, with almost
18% of its populace living below that line. Some state officials are concerned
that Texas' growth pattern and the number of persons living in poverty in Texas
are not and will not be recognized properly by programs distributing federal
funds available for social assistance programs to the states, resulting in Texas
having fewer funds than a fair allocation of federal funding would otherwise
provide to Texas. As a result, unless funding is appropriately allocated or
additional sources of funding can be found, the growing need for social services
will further strain the limited state and local resources for these programs.
117
During Texas' 1997 fiscal year ended August 31, 1997, Texas expended
almost $16.1 billion on health and human services compared with spending on
health and human services of approximately $14.7 billion in fiscal 1996. In
fiscal 1997, Texas received over $12.1 billion in federal funding for all
purposes, which constituted 23.2% of all state revenues for that fiscal year, as
compared with federal funding of $11.78 billion in fiscal 1996, which was 23.2%
of all state revenues in that fiscal year. The percentage that the total federal
funds received by Texas was of Texas' total health and human services spending
decreased by 4.7% from fiscal 1996 to fiscal 1997. Generally, over half of the
federal funding received by Texas in any fiscal year is allocated to health and
human services programs provided and administered by Texas. The welfare reform
legislation adopted by the United States Congress and signed into law by
President Clinton in August, 1996, provides for limits on Aid to Dependent
Children benefits, reduces food stamp benefits and prohibits the provision of
food stamps and Supplemental Security Income to legal immigrants. In addition,
certain limits are imposed on the amount of lifetime benefits that can be paid
to any recipients of welfare benefits. The legislation also provides for block
grants of funds from the federal government and for the states to be able to
fashion programs for the use of those funds. Although the ultimate and full
effect of the federal welfare reform law on Texas' public assistance programs
remains unclear, with its high number of legal immigrants and dependence of
poorer Texans on food stamps rather than other types of assistance, the law may
have a disproportionate effect on Texas' public assistance programs. Formulas
for the allocation of block grant funds have typically favored states with
demographics different from those of Texas with its rapidly increasing
population and high incidence of poverty among its population. Texas has
typically provided low levels of assistance for the working poor, with the
assistance given being centered on the provision of food stamps to this group.
In addition, one estimate has concluded that in 1995, Texas had a total of
187,000 legal immigrants who were receiving food stamps and 53,000 who were
receiving Supplemental Security Income. If Texas continues to provide assistance
to these groups at current levels of spending, even with block grants from the
federal government, it is anticipated that such public assistance programs would
adversely affect state finances. The welfare reform initiatives are also
expected to result in additional requirements that Texas provide additional job
training to its residents, while the federal government will provide less aid to
subsidize that job training. The Texas Workforce Commission estimated that in
1997 Texas would be required to provide work activities for an additional 29,000
clients (who are public assistance recipients) beyond the prior federal
requirements. Under the welfare reform law, within five years, Texas must have
50 percent of its welfare recipients working at least 30 hours per week or lose
up to five percent of its federal funds that are used to fund public assistance
programs. Such loss of funds would be required to be made up out of the state's
general revenues. It is possible that under the federal welfare law, Texas will
lose substantial amounts of federal funding of its public assistance programs,
placing even greater strains on Texas' state and local finances if public
assistance is to continue at current levels. However, it is impossible to
predict at this time what the long term effect of this welfare reform
legislation will be on the Texas economy.
Initial steps have been taken to deregulate the electric power
utilities in Texas. Although the major electric utilities in Texas have not been
deregulated, certain electric power cooperatives have been deregulated, and it
is expected that further deregulation will occur. Although the deregulation of
electric utilities is anticipated to lower the cost of electricity to consumers
ultimately, consumers are expected to bear a substantial portion of the costs of
any transition to a deregulated industry. Such costs could have a short term
adverse effect on the ability of Texas to attract new businesses to locate in
Texas and to create the new jobs needed to provide work for the growing Texas
workforce.
Bond Ratings. 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 January 31, 1998, 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.
118
State Finances. In its fiscal year ended August 31, 1997, the Texas
state government's total net revenue exceeded its total net expenditures by
approximately $9.1 billion. The 75th Texas Legislature that concluded in June,
1997 adopted an appropriations bill for the 1998-1999 biennium that provides for
spending of $86.2 billion, including more than $37 billion for education and $26
billion for health and human services during the biennium. The State Comptroller
of Public Accounts has certified that sufficient funds will be available for the
payment of budgeted expenditures. While state government officials have based
the 1998-1999 biennium budget based on forecasts of revenues to be received in
that period, there is no assurance that revenues in the estimated amounts will
be received by the State of Texas during that period or that the state will not
have a budget deficit for that two-year period. The revenue estimates on which
the 1998-1999 budget is based assume aggregate receipts of almost $24.6 billion
from the federal government during the biennium, which will be 28.5% of the
state's budget for the period. As noted above, changes in federal law could
result in the amounts of federal funding being less than those assumed by the
state government for budgeting purposes.
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 sales and rentals taxes
on motor vehicles and interstate carriers, and the franchise tax.
Texas currently has a relatively low state debt burden compared to
other states, ranking thirty-third among all states and ninth among the ten most
populous states in net tax-supported debt per capita, according to reports
published in 1996. However, the debt service of Texas that is payable from
general revenues has grown significantly since 1987. At the end of Texas' fiscal
year 1997, the state debt paid from general revenue was $3 billion. At that
date, the state had an additional $2.45 billion in tax-supported debt that is
considered self-supporting. Total interest payments on all State of Texas bonds
amounted to $553 million during fiscal 1997. Texas has the potential to
substantially increase its debt burden, considering only the bond authorization
that was unused in August, 1997. At August 31, 1997, approximately $721.3
million in bonds payable from general revenue had been authorized by the state
legislature, but not issued. While Texas law limits the amount of tax-supported
debt that Texas may incur to five percent of average annual general revenue fund
revenues, as of August 31, 1997, the outstanding debt-to-limit ratio was only
1.8 percent at that date. If all authorized bonds had been issued as of that
date, the debt-to-limit ratio would have increased to 2.6 percent. The amount of
tax-supported bonds issued by the State of Texas and its instrumentalities did
not materially increase in fiscal 1997 over 1996, reversing a trend of
significant increases in the amount of long-term tax-supported debt obligations
of the State of Texas over the prior two years. On November 4, 1997, a
constitutional amendment that limits the amount of state debt payable from the
general revenue fund was adopted by the voters of Texas. Under this amendment,
the maximum annual debt service in any fiscal year on state debt payable from
the general revenue fund is not permitted to exceed five percent of an amount
equal to the average of the amount of general revenue fund revenues, excluding
revenues constitutionally dedicated for purposes other than payment of state
debt, for the three preceding fiscal years and the legislature may not authorize
additional state debt if the resulting annual debt service exceeds this
limitation.
The State of Texas and all of its political subdivisions and public
agencies, including municipalities, counties, public school districts and other
special districts, had estimated total tax-supported debt of $34.97 billion as
of August 31, 1997, including $29.57 billion of local government debt. In
addition, the State of Texas and all of its political subdivisions and public
agencies had an estimated additional $37.28 billion of revenue debt as of that
date including $31.01 billion of local government debt.
Limitations on Bond Issuances and Ad Valorem Taxation. Although Texas
has few debt limits on the incurrence of public debt, certain tax limitations
imposed on counties and cities are in effect debt limitations. The requirement
that counties and cities in Texas provide for the collection of an annual tax
sufficient to retire
119
any bonded indebtedness they create operates as a limitation on the amount of
indebtedness which may be incurred as 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.
The State of Texas cannot itself impose ad valorem taxes. Although the
state franchise tax system does function as an income tax on corporations,
limited liability companies and certain banks, the State of Texas does not
impose an income tax on personal income. Consequently, the state government must
look to sources of revenue other than state ad valorem taxes and personal income
taxes to fund the operations of the state government and to pay interest and
principal on outstanding obligations of the state and its various agencies.
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 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.
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 and the validity of the bonds issued
questioned.
Property tax revenues are a major source of funding for public
education in Texas. The method for funding public education in Texas has
undergone material changes over the last five years. In 1993, the Texas
legislature adopted legislation that attempts to reduce the disparity of
revenues per student between low-wealth school districts and high-wealth school
districts by causing the high-wealth school districts to share their ad valorem
tax revenues with the low-wealth school districts. In January 1995, the Texas
Supreme Court affirmed the constitutionality of that legislation. Subsequently,
the Texas Legislature created a new $170 million school facilities construction
funding program designed primarily to help property-poor school districts build
and renovate school facilities. The money for this program will come from the
General Revenue Fund of the State
120
of Texas. There is no assurance that further challenges to this method of
funding public education will not be mounted in Texas.
Though the 1997 legislative session began with a proposed overhaul of
the current property tax system, the changes that ultimately were adopted
essentially leave the state's property tax system unchanged. The Texas
legislature adopted a scaled-back property tax relief bill that became effective
September 1, 1997. The most significant form of tax relief adopted is that
school districts will grant an additional state-mandated $10,000 exemption for
each qualified homestead, increasing the total homestead exemption to $15,000 of
assessed valuation, up from the current $5,000 that is allowed. Texas voters
approved a constitutional amendment affirming this change in the law in an
August 9, 1997 election. The additional $10,000 exemption will be effective for
the 1997 tax year. The constitutional amendment also permits homeowners who are
over 65 years of age to transfer the school tax ceiling they enjoy with respect
to a house to a different house if they change primary residences. A $1 billion
budget surplus is to be used to fund the property tax relief. Additionally, the
new law provides for school districts to receive state aid to help pay principal
and interest on eligible new bonds whose proceeds are used to construct
instructional facilities. Moreover, all revenue from the state lottery will now
be dedicated to the foundation school fund. The new legislation also allows
homeowners to defer paying their taxes when the value of their houses increases
by more than five percent a year.
VIRGINIA
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 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
121
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 1996-98 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.
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.
122
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<MULTIPLIER> 1
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<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-END> JUN-30-1998
<INVESTMENTS-AT-COST> 5,965,146
<INVESTMENTS-AT-VALUE> 6,636,513
<RECEIVABLES> 154,213
<ASSETS-OTHER> 19,128
<OTHER-ITEMS-ASSETS> 0
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<OTHER-ITEMS-LIABILITIES> (75,695)
<TOTAL-LIABILITIES> (75,695)
<SENIOR-EQUITY> 0
<PAID-IN-CAPITAL-COMMON> 5,982,940
<SHARES-COMMON-STOCK> 6,266
<SHARES-COMMON-PRIOR> 6,928
<ACCUMULATED-NII-CURRENT> 79,852
<OVERDISTRIBUTION-NII> 0
<ACCUMULATED-NET-GAINS> 0
<OVERDISTRIBUTION-GAINS> 0
<ACCUM-APPREC-OR-DEPREC> 671,367
<NET-ASSETS> 6,734,159
<DIVIDEND-INCOME> 0
<INTEREST-INCOME> 395,554
<OTHER-INCOME> 0
<EXPENSES-NET> (13,358)
<NET-INVESTMENT-INCOME> 382,196
<REALIZED-GAINS-CURRENT> 63,505
<APPREC-INCREASE-CURRENT> 189,327
<NET-CHANGE-FROM-OPS> 635,028
<EQUALIZATION> 0
<DISTRIBUTIONS-OF-INCOME> (382,281)
<DISTRIBUTIONS-OF-GAINS> 0
<DISTRIBUTIONS-OTHER> (21,914)
<NUMBER-OF-SHARES-SOLD> 0
<NUMBER-OF-SHARES-REDEEMED> 662
<SHARES-REINVESTED> 0
<NET-CHANGE-IN-ASSETS> (478,032)
<ACCUMULATED-NII-PRIOR> 88,423
<ACCUMULATED-GAINS-PRIOR> 0
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<PER-SHARE-NAV-BEGIN> 0
<PER-SHARE-NII> 0
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<PAGE>
DAVIS POLK & WARDWELL
450 LEXINGTON AVENUE
NEW YORK, NEW YORK 10017
(212) 450-4000
September 16, 1998
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-- EIF 2 ES-AT&T SHARES 731871 2-87566 811-3044
DEFINED ASSET FUNDS-EIF UCSS-4 318042 2-68397 811-3044
DEFINED ASSET FUNDS-GSIF GNMA SERIES 1I 781299 33-21452 811-2810
DEFINED ASSET FUNDS-GSIF GNMA SERIES 1Y 893062 33-57873 811-2810
DEFINED ASSET FUNDS- IS-207 DAF 803945 33-54037 811-1777
DEFINED ASSET FUNDS- IS-224 DAF 804029 33-59303 811-1777
DEFINED ASSET FUNDS-CIF ITS-38 883649 33-48777 811-2295
DEFINED ASSET FUNDS-MITF ITS-157 780818 33-35574 811-1777
DEFINED ASSET FUNDS- ITS-209 DAF 868116 33-49637 811-1777
DEFINED ASSET FUNDS- ITS-234 DAF 910380 33-54001 811-1777
DEFINED ASSET FUNDS- ITS-257 DAF 924349 33-60599 811-1777
DEFINED ASSET FUNDS- ITS-306 947057 333-2687 811-1777
DEFINED ASSET FUNDS-MPS-313 DAF 781819 33-49449 811-2295
DEFINED ASSET FUNDS-MITF MPS-518 803725 33-47337 811-1777
DEFINED ASSET FUNDS- MPS-529 DAF 892748 33-49611 811-1777
DEFINED ASSET FUNDS- MPS-543 DAF 892766 33-54073 811-1777
DEFINED ASSET FUNDS- MPS-607 947138 333-2453 811-1777
DEFINED ASSET FUNDS-MITF MSS-8 881832 33-48474 811-1777
DEFINED ASSET FUNDS- MSS-210 DAF 924315 333-0406 811-1777
DEFINED ASSET FUNDS- MSS-312 1031543 333-2648 811-1777
DEFINED ASSET FUNDS- MSS-38 DAF 895625 33-49623 811-1777
DEFINED ASSET FUNDS- MSS-39 DAF 895626 33-49657 811-1777
DEFINED ASSET FUNDS- MSS-67 DAF 910017 33-54133 811-1777
DEFINED ASSET FUNDS- MSS-91 DAF 924273 33-59029 811-1777
DEFINED ASSET FUNDS- MSS-92 DAF 924274 33-59537 811-1777
DEFINED ASSET FUNDS-CS Real Estate Income Fund - 2 1012462 333-0269 811-3044
TOTAL: 26 FUNDS
</TABLE>
