Smith Barney
Arizona Municipals Fund Inc.
388 Greenwich Street
New York, New York 10013
(800) 451-2010
Statement of Additional Information September 26, 1997
As Amended May 18, 1998
s Amended June 19, 1998
This Statement of Additional Information (the "SAI") expands upon and
supplements the information contained in the current Prospectus of Smith
Barney Arizona Municipals Fund Inc. (the "Fund''), dated September 26, 1997,
as amended or supplemented from time to time, and should be read in
conjunction with the Fund's Prospectus. The Fund's Prospectus may be obtained
from a Smith Barney Financial Consultant or by writing or calling the Fund at
the address or telephone number set forth above. This SAI, although not in
itself a prospectus, is incorporated by reference into the Prospectus in its
entirety.
TABLE OF CONTENTS
For ease of reference the same section headings are used in both the
Prospectus and the SAI, except where shown below:
Management of the
Fund.......................................................................
........ 1
Investment Objective and Management
Policies............................................. 5
Municipal Bonds (See in the Prospectus "Investment Objective and
Management
Policies'')...................................................................
.............. 11
Purchase of
Shares........................................................................
................ 13
Redemption of
Shares........................................................................
............ 14
Distributor (See in the Prospectus "Management of the
Fund")....................... 15
Valuation of
Shares........................................................................
............... 16
Exchange
Privilege.....................................................................
................... 17
Performance Data (See in the Prospectus
"Performance'').............................. 17
Taxes (See in the Prospectus "Dividends, Distributions and
Taxes'').............. 21
Additional
Information................................................................
.................. 24
Financial
Statements.................................................................
.................... 24
Appendix...................................................................
................................... A1
MANAGEMENT OF THE FUND
The executive officers of the Fund are employees of certain of the
organizations that provide services to the Fund. These organizations are as
follows:
Name Service
Smith Barney Inc.
("Smith Barney'').......................................................
Distributor
Mutual Management Corp.
("MMC'')...............................................................
Investment Manager and
PNC Bank, National Association Administrator
("PNC'').....................................................................
Custodian
First Data Investor Services Group, Inc.
("First
Data'')...............................................................
Transfer Agent
These organizations and the functions they perform for the Fund are
discussed in the Prospectus and in this SAI.
Directors and Executive Officers of the Fund
The names of the Directors and executive officers of the Fund, together with
information as to their principal business occupations during the past five
years, are shown below. Each Director who is an "interested person'' of the
Fund, as defined in the Investment Company Act of 1940, as amended (the "1940
Act''), is indicated by an asterisk.
Herbert Barg, Director (Age 74). Private Investor. His address is 273
Montgomery Avenue, Bala Cynwyd, Pennsylvania 19004.
Alfred J. Bianchetti, Director (Age 75). Retired; formerly Senior
Consultant to Dean Witter Reynolds Inc. His address is 19 Circle End Drive,
Ramsey, New Jersey 07446.
Martin Brody, Director (Age 76). Consultant, HMK Associates; Retired Vice
Chairman of the Board of Restaurant Associates Corp.; His address is c/o HMK
Associates, 30 Columbia Turnpike, Florham Park, New Jersey 07932.
Dwight B. Crane, Director (Age 60). Professor, Harvard Business School. His
address is c/o Harvard Business School, Soldiers Field Road, Boston,
Massachusetts 02163.
Burt N. Dorsett, Director (Age 67). Managing Partner of Dorsett McCabe
Management, Inc., an investment counseling firm; Director of Research
Corporation Technologies, Inc., a non-profit patent-clearing and licensing
firm. His address is 201 East 62nd Street, New York, New York 10021.
Elliot S. Jaffe, Director (Age 71). Chairman of the Board and Chief
Executive Officer of The Dress Barn, Inc. His address is 30 Dunnigan Drive,
Suffern, New York 10901.
Stephen E. Kaufman, Director (Age 66). Attorney. His address is 277 Park
Avenue, New York, New York 10172.
Joseph J. McCann, Director (Age 67). Financial Consultant; Retired
Financial Executive of Ryan Homes Inc.. His address is 200 Oak Park Place,
Pittsburgh, Pennsylvania 15243.
*Heath B. McLendon, Chairman of the Board and Investment Officer (Age 64).
Managing Director of Smith Barney and Chairman of Smith Barney Strategy
Advisers Inc.; President of MMC and Travelers Investment Advisor, Inc.
("TIA"); prior to July 1993, Senior Executive Vice President of Shearson
Lehman Brothers Inc. ("SLB''), Vice Chairman of Shearson Asset Management
Division; Mr. McLendon is Chairman of the Board and Investment Officer of 42
Smith Barney Mutual Funds. His address is 388 Greenwich Street, New York, New
York 10013.
Cornelius C. Rose, Jr., Director (Age 64). Chairman of the Board, Cornelius
C. Rose Associates, Inc., financial consultants, and Chairman of Performance
Learning Systems, an educational consultant. His address is P.O. Box 355, Fair
Oaks, Enfield, New Hampshire 03748.
James J. Crisona, Director emeritus (Age 90). Attorney; formerly Justice of
the Supreme Court of the State of New York. His address is 118 East 60th
Street, New York, New York 10022.
Lewis E. Daidone, Senior Vice President and Treasurer (Age 40). Managing
Director of Smith Barney; Director and Senior Vice President of MMC and TIA.
Mr. Daidone serves as Senior Vice President and Treasurer of 42 Smith Barney
Mutual Funds. His address is 388 Greenwich Street, New York, New York 10013.
Lawrence T. McDermott, Vice President and Investment Officer (Age 49).
Investment Officer of MMC; prior to July 1993, Managing Director of SLB. Mr.
McDermott also serves as Investment Officer of 6 Smith Barney Mutual Funds.
His address is 388 Greenwich Street, New York, New York 10013.
Christina T. Sydor, Secretary (Age 46). Managing Director of Smith Barney;
General Counsel and Secretary of MMC and TIA. Ms. Sydor serves as Secretary
of 41 Smith Barney Mutual Funds. Her address is 388 Greenwich Street, New
York, New York 10013.
As of September 5, 1997, the Directors and officers of the Fund as a group
owned less than 1% of the outstanding common stock of the Fund. As of
September 5, 1997, to the knowledge of the Fund and the Board, the following
shareholders or "group" (as that term is used in Section 13(d) of the
Securities Act of 1934) beneficially owned more than 5% of the outstanding
shares of the Fund:
CLASS C SHARES
American Western Trading Co.
6531 N. 3rd Ave. #15
Phoenix, AZ 85013-1258
owned 28,440.238 (35.85%) shares
Rachel Fritch Harris & Richard
Franklin Harris Co. TTEES
FBO Rachel Fritch Harris Trust
U/A/D 5/1/89
7046 N. 59th Place
Scottsdale, AZ 85253-3412
owned 11,355.861(14.29%) shares
Margaret Kane and Nicholas Wyatt
Ten by Ent
Tax Account
PO Box 274
Arivaca, AZ 85601-0274
owned 11,126.832(14.03%) shares
GT Kearney TTEE
FBO Glenn T. Kearney Trust
U/A/D 8/11/93
101 S. Yucca Street, #156
Chandler, AZ 85224-8177
owned 7,524.113(9.49%) shares
Peter Browne
Hilda Browne JTWROS
3031 N. Civic Center
Plaza Apt. 260
Scottsdale, AZ 85251-7910
owned 7,182.432 (9.06%) shares
Kathleen Reardon and
Robert Nichol JTWROS
2925 Ranchero Drive
Lake Havasu City, AZ 86406-6130
owned 6,683.365(8.43%) shares
Each Director also serves as a director, trustee and/or general partner of
certain other mutual funds for which Smith Barney serves as distributor. No
Director, officer or employee of Smith Barney or of any parent or subsidiary
receives any compensation from the Fund for serving as an officer or Director
of the Fund. The Fund pays each Director who is not an officer, director or
employee of Smith Barney or any of its affiliates a fee of $1,000 per annum
plus $100 per in-person meeting and $100 per telephonic meeting. Each
Director emeritus who is not an officer, director or employee of Smith Barney
or any of its affiliates receives a fee of $500 per annum plus $50 per meeting
attended. During the Fund's last fiscal year aggregate compensation paid by
the Fund to Directors achieving emeritus status totaled $800. All Directors
are reimbursed for travel and out-of-pocket expenses incurred to attend such
meetings.
For the fiscal year ended May 31, 1997, the Directors of the Fund were paid
the following compensation:
Total
Pension or Compensation Number of
Retirement from Fund Funds for
Aggregate Benefits Accrued and Fund Which
director
Compensation as part of Complex Serves Within
Name of Person from Fund Fund Expenses Paid to Directors Fund Complex
Herbert Barg $1,700 $0 $100,550 16
Alfred Bianchetti 1,600 0 49,800 11
Martin Brody 1,500 0 119,600 19
Dwight Crane 1,600 0 137,725 22
Burt Dorsett+ 1,600 0 46,900 11
Elliot Jaffe 1,600 0 49,600 11
Stephen Kaufman 1,700 0 86,050 13
Joseph McCann 1,700 0 50,700 11
Heath McLendon++ 0 0 0 41
Cornelius Rose 1,700 0 50,800 11
+ Pursuant to the Fund's deferred compensation plan, Mr. Dorsett has elected
to defer some or all of the compensation due to him from the Fund: $800.
As of January 1, 1997, Mr. Dorsett has elected not to defer his future
compensation.
++ Designates an "interested" Director.
Investment Manager and Administrator-MMC
MMC serves as investment manager to the Fund. MMC is a wholly owned subsidiary
of Smith Barney Holdings Inc. ("Holdings'') and Holdings is a wholly owned
subsidiary of Travelers Group Inc. ("Travelers''). The advisory agreement is
dated July 30, 1993 (the "Advisory Agreement'') and was most recently approved
by the Board of Directors, including a majority of those Directors who are not
"interested persons'' of the Fund or MMC ("Independent Directors"), on July
16, 1997. The services provided by MMC under the Advisory Agreement are
described in the Prospectus under "Management of the Fund.'' MMC pays the
salary of any officer or employee who is employed by both it and the Fund and
bears all expenses in connection with the performance of its services.
The Fund pays MMC a fee for investment advisory services at the annual
rate of 0.30% of the value of its daily net assets. Prior to November 17,
1995, as compensation for investment advisory services, the Fund paid MMC a
fee computed daily and paid monthly at the following annual rates of the
Fund's average daily net assets: 0.35% up to $500 million; and 0.32% in excess
of $500 million. For the 1995, 1996 and 1997 fiscal years, the Fund paid
$220,638, $218,249 and $184,078, respectively, in investment advisory fees.
MMC and its predecessors voluntarily waived investment advisory fees for the
fiscal years ended May 31, 1995 and 1996 in the amounts of $73,668 and
$64,184, respectively.
MMC also serves as administrator to the Fund pursuant to a written
agreement dated April 20, 1994 (the "Administration Agreement''), which was
most recently approved by the Fund's Board of Directors, including a majority
of Independent Directors on July 16, 1997. The Boston Company Advisors, Inc.
("Boston Advisors") served as sub-administrator to the Fund from April 21,
1994 through June 16, 1995. Under the sub-administration agreement, Boston
Advisors was paid a portion of the administration fee paid by the Fund to MMC
at a rate agreed upon from time to time between MMC and Boston Advisors. The
services provided by MMC under the Administration Agreement are described in
the Prospectus under "Management of the Fund." MMC pays the salary of any
officer and employee who is employed by both it and the Fund and bears all
expenses in connection with the performance of its services.
As compensation for administrative services rendered to the Fund, MMC
received a fee paid monthly at the following annual percentage of average
daily net assets: 0.20% up to $500 million; and 0.18% thereafter. For the
fiscal years ended May 31, 1995, 1996 and 1997, the Fund paid MMC $83,984,
$88,133 and $122,719, respectively, in administration fees. MMC and its
predecessors voluntarily waived administrative fees for the fiscal years ended
May 31, 1995 and 1996 in the amounts of $42,095 and $46,226, respectively.
The Fund bears expenses incurred in its operations, including: taxes,
interest, brokerage fees and commissions, if any; fees of Directors who are
not officers, directors, shareholders or employees of Smith Barney or MMC; SEC
fees and state Blue Sky qualification fees; charges of custodian; transfer and
dividend disbursing agent's fees; certain insurance premiums; outside auditing
and legal expenses; costs of maintaining corporate existence; costs of
investors services (including allocated telephone and personnel expenses);
costs of preparation and printing of prospectuses for regulatory purposes and
for distribution to existing shareholders; costs of shareholders' reports and
shareholder meetings; and meetings of the officers or Board of Directors of
the Fund.
MMC and the Fund have agreed that if in any fiscal year the aggregate
expenses of the Fund (including fees payable pursuant to the Advisory
Agreement and Administration Agreement, but excluding interest, taxes and
brokerage fees paid pursuant to the Fund's services and distribution plan,
and, with the prior written consent of the necessary state securities
commissions, extraordinary expenses) exceed the expense limitation of any
state having jurisdiction over the Fund, MMC will, to the extent required by
state law, reduce its fees by the amount of such excess expenses. Such fee
reductions, if any, will be reconciled on a monthly basis. No fee reduction
was required for the 1995, 1996 and 1997 fiscal years.
COUNSEL AND AUDITORS
Willkie Farr & Gallagher serves as legal counsel to the Fund. The Independent
Directors have selected Stroock & Stroock & Lavan LLP as their legal counsel.
KPMG Peat Marwick LLP, 345 Park Avenue, New York, New York 10154, has been
selected as the Fund's independent auditor to examine and report on the Fund's
financial statements and highlights for the fiscal year ending May 31, 1998.
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES
The Prospectus discusses the Fund's investment objective and the policies it
employs to achieve that objective. The following discussion supplements the
description of the Fund's investment policies in the Prospectus.
Under normal market conditions, the Fund will invest at least 80% of its
total assets in municipal securities rated no lower that Baa, MIG 3 or Prime-1
by Moody's Investors Service, Inc. ("Moody's") or BBB, SP-2 or A-1 by Standard
& Poor's Ratings Group ("S&P"), or the equivalent of another nationally
recognized statistical ratings organization ("NRSRO") or unrated obligations
of comparable quality. The balance of the Fund's assets may be invested in
securities rated as los as C by Moody's, D by S&P or the equivalent from
another NRSRO. A description of the ratings of Moody's and S&P is contained
in the Appendix to this SAI.
Use of Ratings as Investment Criteria. In general, the ratings of
Moody's, S&P or another NRSRO represent the opinions of those agencies as to
the quality of the securities and short-term investments which they rate. It
should be emphasized, however, that such ratings are relative and subjective,
are not absolute standards of quality and do not evaluate the market risk of
securities. These ratings will be used by the Fund as initial criteria for the
selection of portfolio securities, but the Fund also will rely upon the
independent advice of MMC to evaluate potential investments. Among the factors
which will be considered are the long-term ability of the issuer to pay
principal and interest and general economic trends. To the extent the Fund
invests in lower rated and comparable unrated securities, the Fund's
achievement of its investment objective may be more dependent on MMC's credit
analysis of such securities than would be the case for a portfolio consisting
entirely of higher rated securities.
Subsequent to its purchase by the Fund, an issue of securities may cease
to be rated or its rating may be reduced below the rating given at the time
the securities were acquired by the Fund. Neither event will require the sale
of such securities by the Fund, but MMC will consider such event in its
determination of whether the Fund should continue to hold such securities. In
addition, to the extent the ratings change as a result of changes in such
organizations or their rating systems or due to a corporate restructuring of
Moody's, S&P or another NRSRO, the Fund will attempt to use comparable ratings
as standards for its investments in accordance with its investment objective
and policies.
The Fund generally may invest up to 20% of its total assets in
securities rated below Baa, MIG 3 or Prime-1 (P-1) by Moody's or BBB, SP-2 or
A-1 by S&P, or in unrated securities of comparable quality or the equivalent
from another NRSRO. Such securities (a) will likely have some quality and
protective characteristics that, in the judgment of the rating organization,
are outweighed by large uncertainties or major risk exposures to adverse
conditions and (b) are predominantly speculative with respect to the issuer's
capacity to pay interest and repay principal in accordance with the terms of
the obligations.
Zero coupon securities involve special considerations. Zero coupon
securities are debt obligations which do not entitle the holder to any
periodic payments of interest prior to maturity of a specified cash payment
date when the securities begin paying current interest (the "cash payment
date") and therefore are issued and traded at a discount from their face
amounts or par values. The discount varies depending on the time remaining
until maturity or cash payment date, prevailing interest rates, liquidity of
the security and the perceived credit quality of the issuer. The discount, in
the absence of financial difficulties of the issuer, decreases as the final
maturity or cash payment date of the security approaches. The market prices
of zero coupon securities generally are more volatile than the market prices
of other debt securities that pay interest periodically and are likely to
respond to changes in interest rates to a greater degree than do debt
securities having similar maturities and credit quality. The credit risk
factors pertaining to low-rated securities also apply to low-rated zero coupon
bonds. Such zero coupon bonds carry an additional risk in that, unlike bonds
which pay interest throughout the period to maturity, the Fund will realize no
cash until the cash payment date unless a portfolio of such securities is sold
and, if the issuer defaults, the Fund may obtain no return at all on its
investment.
Current Federal income tax laws may require the holder of a zero coupon
security to accrue income with respect to that security prior to the receipt
of cash payments. To maintain its qualification as a registered investment
company and avoid liability for Federal income taxes, the Fund may be required
to distribute income accrued with respect to zero coupon securities and may
have to dispose of portfolio securities under disadvantageous circumstances in
order to generate cash to satisfy these distribution requirements.
When-Issued Purchases and Firm Commitment Agreements. When the Fund
purchases new issues of municipal securities on a when-issued basis, a
segregated account equal to the amount of the commitment will be established
by the Fund's custodian. The segregated assets may consist of cash, equity
securities or debt securities of any grade having a value equal to or greater
than the Fund's purchase commitments, provided such securities, having a value
equal to or greater than the Fund's purchase commitments, provide such
securities have been determined by MMC to be liquid and unencumbered and
marked to market daily, pursuant to guidelines established by the Directors.
If the value of securities in the account should decline, additional cash or
securities will be placed in the account so that the market value of the
account will equal the amount of such commitments by the Fund on a daily
basis.
Securities purchased on a when-issued basis and the securities held in
the Fund's portfolio are subject to changes in market value based upon various
factors, including changes in the level of market interest rates. Generally,
the value of such securities will fluctuate inversely to changes in interest
rates (i.e., they will appreciate in value when market interest rates decline,
and decrease in value when market interest rates rise). For this reason,
placing securities rather than cash in a segregated account may have a
leveraging effect on the Fund's net assets. That is, to the extent the Fund
remains substantially fully invested in securities at the same time that it
has committed to purchase securities on a when-issued basis, there will be
greater fluctuations in its net assets than if it had set aside cash to
satisfy its purchase commitment.
Upon the settlement date of the when-issued securities, the Fund
ordinarily will meet its obligation to purchase the securities from available
cash flow or from use of the cash (or liquidation of securities) held in the
segregated account or sale of other securities. Although it normally would not
expect to do so, the Fund also may meet its obligation from the sale of the
when-issued securities themselves (which may have a current market value
greater or less than the Fund's payment obligation). Sale of securities to
meet such obligations carries with it a greater potential for the realization
of net capital gains, which are not exempt from Federal income tax.
When the Fund engages in when-issued transactions, it relies on the
seller to consummate the trade. Failure of the seller to do so may result in
the Fund's incurring a loss of opportunity to obtain a price considered to be
advantageous.
The Fund also may enter into firm commitment agreements for the purchase
of securities at an agreed-upon price on a specified future date. During the
time that the Fund is obligated to purchase such securities, it will maintain
in a segregated account with the Fund's custodian in an aggregate value
sufficient to make payment for the securities. The segregated assets may
consist of cash, U.S. government securities, equity securities or debt
obligations of any grade so long as such assets are liquid , unencumbered and
marked to market daily.
Puts or Stand-by Commitments. As discussed in the Prospectus, the Fund
may acquire puts or stand-by commitments which will enable the Fund to improve
its portfolio liquidity by providing a ready market for certain municipal
securities in its portfolio at an acceptable price. The price the Fund pays
for municipal securities with puts generally is higher than the price which
otherwise would be paid for the municipal securities alone. The put generally
is for a shorter term than the maturity of the municipal security and does not
restrict in any way the Fund's ability to dispose of (or retain) the municipal
security.
In order to ensure that the interest on municipal securities subject to
puts is tax-exempt for the Fund, the Fund will limit its use of puts in
accordance with current interpretations or rulings of the Internal Revenue
Service (the "IRS"). The IRS has issued a ruling (Rev. Rule. 82-144) in which
it determined that a regulated investment company was the owner for tax
purposes of municipal securities subject to puts (with the result that
interest on those securities would not lose its tax-exempt status when paid to
the company). The IRS position in Rev. Rule. 82-144 relates to a particular
factual situation, including that (a) the municipal securities with puts were
purchased at prices higher than the underlying municipal securities without
puts, (b) a relatively small number of the municipal securities owned by the
company were subject to puts, (c) the puts were nonassignable and terminated
upon disposal of the underlying securities by the company, (d) the puts were
for periods substantially less than the terms of the underlying securities,
(e) the puts did not include call arrangements or restrict the disposal of the
underlying securities by the company and gave the seller no rights in the
underlying securities, and (f) the securities were acquired by the company for
its own account and not as security for a loan from the seller.
Because it is difficult to evaluate the likelihood of exercise or the
potential benefit of a put, it is expected that puts will be determined to
have a "value" of zero, regardless of whether any direct or indirect
consideration was paid. Where the Fund has paid for a put, its cost will be
reflected as unrealized depreciation in the underlying security for the period
during which the commitment is held, and therefore would reduce any potential
gains on the sale of the underlying security by the cost of the put. There is
a risk that the seller of the put may not be able to repurchase the security
upon exercise of the put by the Fund.
Temporary Investments. When the Fund is maintaining a defensive
position, the Fund may invest in short-term investments ("Temporary
Investments") consisting of tax-exempt securities in the form of notes of
municipal issuers having, at the time of purchase, a rating within the three
highest grades of Moody's, S&P or another NRSRO or, if not rated, having an
issue of outstanding municipal bonds of Arizona issuers rated within the three
highest grades by Moody's S&P or the equivalent from another NRSRO and certain
taxable short-term instruments having quality characteristics comparable to
those for tax-exempt investments. The Fund may invest in Temporary
Investments for defensive reasons in anticipation of a market decline. At no
time will more than 20% of the Fund's total assets be invested in Temporary
Investments unless the Fund has adopted a defensive investment policy. The
Fund intends, however, to purchase tax-exempt Temporary Investments pending
the investing of the proceeds of the sale of portfolio securities or shares of
the Fund's common stock, or in order to have highly liquid securities
available to meet anticipated redemptions. For the fiscal year ended May 31,
1997, the Fund did not invest in taxable Temporary Investments.
From time to time on a temporary basis, the Fund may invest in fixed-
income obligations on which the interest is subject to Federal income tax.
Except when the Fund is in a "defensive" investment position, it will not
purchase a taxable security if, as a result, more than 20% of its total assets
would be invested in taxable securities. This limitation is a fundamental
policy of the Fund, that is, it may not be changed without a majority vote of
the shareholders of the outstanding securities of the Fund. Temporary taxable
investments of the Fund may consist of U.S. government securities, commercial
paper rated A-1 by S&P or Prime-1 by Moody's, corporate obligations rated AAA
or AA by S&P or Aaa or Aa by Moody's or the equivalent from another NRSRO,
certificates of deposit or bankers' acceptances of domestic banks or thrift
institutions with at least $1 billion in assets, or repurchase agreements with
certain banks or dealers. Repurchase agreements may be entered into with
respect to any securities eligible for investment by the Fund, including
municipal securities.
Repurchase Agreements. The Fund may enter into repurchase agreements
with banks which are the issuers of instruments acceptable for purchase by the
Fund and with certain dealers on the Federal Reserve Bank of New York's list
of reporting dealers. A repurchase agreement is a contract under which the
buyer of a security simultaneously commits to resell the security to the
seller at an agreed-upon price on an agreed-upon date. Under the terms of a
typical repurchase agreement, the Fund would acquire an underlying debt
obligation for a relatively short period of time (usually not more than seven
days) subject to an obligation of the seller to repurchase, and the Fund to
resell, the obligation at an agreed-upon price and time, thereby determining
the yield during the Fund's holding period. Under each repurchase agreement,
the selling institution will be required to maintain the value of the
securities subject to the repurchase agreement at not less than their
repurchase price. Repurchase agreements could involve certain risks in the
event of default or insolvency of the other party, including possible delays
or restrictions upon the Fund's ability to dispose of the underlying
securities, the risk of a possible decline in the value of the underlying
securities during the period in which the Fund seeks to assert its rights to
them, the risk of incurring expenses associated with asserting those rights
and the risk of losing all or part of the income from the agreement. In
evaluating these potential risks, MMC, acting under the supervision of the
Fund's Board of Directors, reviews on an ongoing basis the value of the
collateral and the creditworthiness of those banks and dealers with which the
Fund enters into repurchase agreements.
Investment Restrictions
The Fund has adopted the following investment restrictions for the protection
of shareholders. Restrictions 1 through 7 below are fundamental policies, and
may not be changed without the approval of the holders of a majority of the
outstanding shares of the Fund, defined as the lesser of (a) 67% of the Fund's
shares present at a meeting, if the holders of more than 50% of the
outstanding shares of the Fund are present or represented by proxy, or (b)
more than 50% of the Fund's outstanding shares. The remaining restrictions may
be changed by the Fund's Board of Directors at any time.
The Fund may not:
1. Invest in a manner that would cause it to fail to be a "diversified
company" under the 1940 Act and the rules, regulations and orders thereunder.
2. Issue "senior securities" as defined in the 1940 Act and the rules,
regulations and orders thereunder, except as permitted under the 1940 Act and
the rules, regulations and orders thereunder
3. Invest more than 25% of its total assets in securities, the issuers of
which are in the same industry. For purposes of this limitation, U.S.
government securities and securities of state or municipal governments and
their political subdivisions are not considered to be issued by members of any
industry.
4. Borrow money, except that (a) the Fund may borrow from banks for temporary
or emergency (not leveraging) purposes, including the meeting of redemption
requests which might otherwise require the untimely disposition of securities,
and (b) the Fund may, to the extent consistent with its investment policies,
enter into reverse repurchase agreements, forward roll transactions and similar
investment strategies and techniques. To the extent that it engages in
transactions described in (a) and (b), the Fund will be limited so that no more
than 33 1/3% of the value of its total assets (including the amount borrowed),
valued at the lesser of cost or market, less liabilities (not including the
amount borrowed) valued at the time the borrowing is made, is derived from such
transactions.
5. Make loans. This restriction does not apply to: (a) the purchase of debt
obligations in which the Fund may invest consistent with its investment
objectives and policies; (b) repurchase agreements; and (c) loans of its
portfolio securities, to the fullest extent permitted under the 1940 Act.
6. Engage in the business of underwriting securities issued by other persons,
except to the extent that the Fund may technically be deemed to be an
underwriter under the Securities Act of 1933, as amended, in disposing of
portfolio securities.
7. Purchase or sell real estate, real estate mortgages, commodities or
commodity contracts, but this restriction shall not prevent the Fund from (a)
investing in securities of issuers engaged in the real estate business or the
business of investing in real estate (including interests in limited
partnerships owning or otherwise engaging in the real estate business or the
business of investing in real estate) and securities which are secured by real
estate or interests therein; (b) holding or selling real estate received in
connection with securities it holds or held; (c) trading in futures contracts
and options on futures contracts (including options on currencies to the extent
consistent with the Funds' investment objective and policies); or (d) investing
in real estate investment trust securities.
8. Purchase any securities on margin (except for such short-term credits as are
necessary for the clearance of purchases and sales of portfolio securities) or
sell any securities short (except "against the box"). For purposes of this
restriction, the deposit or payment by the Fund of underlying securities and
other assets in escrow and collateral agreements with respect to initial or
maintenance margin in connection with futures contracts and related options and
options on securities, indexes or similar items is not considered to be the
purchase of a security on margin.
9. Purchase or otherwise acquire any security if, as a result, more than 15%
of its net assets would be invested in securities that are illiquid.
10. Invest in oil, gas or other mineral exploration or development programs.
Certain restrictions listed above permit the Fund to engage in
investment practices that the Fund does not currently pursue. The Fund has no
present intention of altering its current investment practices as otherwise
described in the Prospectus and this Statement of Additional Information and
any future change in those practices would require Board approval and
appropriate notice to shareholders. If a percentage restriction is complied
with at the time of investment, a later increase or decrease in the percentage
of assets resulting from a change in values of portfolio securities or in the
amount of the Fund's assets will not constitute a violation of such
restriction. In order to permit the sale of the Fund's shares in certain
states, the Fund may make commitments more restrictive than the restrictions
described above. Should the Fund determine that any such commitment is no
longer in the best interests of the Fund and its shareholders it will revoke
the commitment by terminating sales of its shares in the state involved.
Portfolio Transactions
Newly issued securities normally are purchased directly from the issuer
or from an underwriter acting as principal. Other purchases and sales usually
are placed with those dealers from which it appears the best price or
execution will be obtained; those dealers may be acting as either agents or
principals. The purchase price paid by the Fund to underwriters of newly
issued securities usually includes a concession paid by the issuer to the
underwriter, and purchases of after-market securities from dealers normally
are executed at a price between the bid and asked prices. The Fund paid no
brokerage commissions for the 1995, 1996 and 1997 fiscal years.
Allocation of transactions, including their frequency, to various
dealers is determined by MMC in its best judgment and in a manner deemed fair
and reasonable to shareholders. The primary considerations are availability
of the desired security and the prompt execution of orders in an effective
manner at the most favorable prices. Subject to these considerations, dealers
that provide supplemental investment research and statistical or other
services to MMC may receive orders for portfolio transactions by the Fund.
Information so received enables MMC to supplement its own research and
analysis with the views and information of other securities firms. Such
information may be useful to MMC in serving both the Fund and other clients,
and conversely, supplement information obtained by the placement of business
of other clients may be useful to MMC in carrying out its obligations to the
Fund.
The Fund will not purchase municipal bonds during the existence of any
underwriting or selling group relating thereto of which Smith Barney is a
member, except to the extent permitted by the Securities and Exchange
Commission ("SEC"). Under certain circumstances, the Fund may be at a
disadvantage because of this limitation in comparison with other investment
companies which have a similar investment objective but which are not subject
to such limitation.
While investment decisions for the Fund are made independently from
those of the other accounts managed by MMC, investments of the type the Fund
may make also may be made by such other accounts. When the Fund and one or
more other accounts managed by MMC are prepared to invest in, or desire to
dispose of, the same security, available investments or opportunities for
sales will be allocated in a manner believed by MMC to be equitable to each.
In some cases, this procedure may adversely affect the price paid or received
by the Fund or the size of the position obtained or disposed of by the Fund.
Portfolio Turnover
The Fund's portfolio turnover rate (the lesser of purchases or sales of
portfolio securities during the year, excluding purchases or sales of short-
term securities, divided by the monthly average value of portfolio securities)
generally is not expected to exceed 100%, but the portfolio turnover rate will
not be a limiting factor whenever the Fund deems it desirable to sell or
purchase securities. Securities may be sold in anticipation of a rise in
interest rates (market decline) or purchased in anticipation of a decline in
interest rates (market rise) and later sold. In addition, a security may be
sold and another security of comparable quality may be purchased at
approximately the same time in order to take advantage of what the Fund
believes to be a temporary disparity in the normal yield relationship between
the two securities. These yield disparities may occur for reasons not directly
related to the investment quality of particular issues or the general movement
of interest rates, such as changes in the overall demand for or supply of
various types of tax-exempt securities. For the fiscal years ending May 31,
1995, 1996 and 1997, the Fund's portfolio turnover rates were 21%, 22% and 27
%, respectively.
MUNICIPAL BONDS
General Information
Municipal bonds generally are understood to include debt obligations
issued to obtain funds for various public purposes, including the construction
of a wide range of public facilities, refunding of outstanding obligations,
payment of general operating expenses and extensions of loans to public
institutions and facilities. Private activity bonds issued by or on behalf of
public authorities to finance privately operated facilities are included
within the term municipal bonds if the interest paid thereon qualifies as
excludable from gross income (but not necessarily from alternative minimum
taxable income) for Federal income tax purposes in the opinion of bond counsel
to the issuer.
The yields on municipal bonds are dependent upon a variety of factors,
including general economic and monetary conditions, general money market
conditions, general conditions of the municipal bond market, the financial
condition of the issuer, the size of a particular offering, the maturity of
the obligation offered and the rating of the issue.
Municipal bonds also are subject to the provisions of bankruptcy,
insolvency and other laws affecting the rights and remedies of creditors, such
as the Federal Bankruptcy Code, and laws, if any, that may be enacted by
Congress or state legislatures extending the time for payment of principal or
interest, or both, or imposing other constraints upon enforcement of the
obligations or upon the ability of municipalities to levy taxes. There is also
the possibility that, as a result of litigation or other conditions, the power
or ability of any one or more issuers to pay, when due, principal of and
interest on its, or their, municipal bonds may be materially affected.
Interest on certain types of private activity bonds (generally small
issues and obligations to finance certain exempt facilities which may be
leased to or used by persons other than the issuer) will not be excluded from
gross income for Federal income tax purposes when received by "substantial
users" or persons related to "substantial users" as defined in the Internal
Revenue Code of 1986, as amended (the "Code"). The term "substantial user"
generally includes any "non-exempt person" who regularly uses in his or her
trade or business as part of a facility financed from the proceeds of private
activity bonds. The Fund may invest periodically in private activity bonds
and, therefore, may not be an appropriate investment for entities which are
substantial users of facilities financed by such bonds or "related persons" of
substantial users. Generally, an individual will not be a related person of a
substantial user under the Code unless the person or his or her immediate
family (spouse, brothers, sisters, ancestors and lineal descendants) owns
directly or indirectly in the aggregate more than 50% in value of the equity
of the substantial user, although special related persons rules apply when the
substantial user is a partnership or Subchapter S corporation.
Special Considerations Relating to Arizona Municipal Securities. Some of
the significant financial considerations relating to the Fund's investments in
Arizona municipal securities are summarized below. This summary information is
derived principally from official statements and prospectuses relating to
securities offerings of the State of Arizona and various local agencies in
Arizona, available as of the date of this SAI and does not purport to be a
complete description of any of the considerations mentioned herein. The
accuracy and completeness of the information contained in such official
statements and documents has not been independently verified and this summary
is qualified by reference to the information from such documents.
As of July 1996, Arizona's population stood at an estimated 4,297,775.
Over the past five years, the population has grown at an average annual rate
of nearly 2.9%. Arizona Department of Economic Security projections call for
a 2.5% increase for 1997 with net migration levels declining from their
currently high rate. Although 73% of the population growth is the result of
net migration, the natural population growth rate of 0.9% still exceeds the
national average of 0.6%.
The State's principal economic sectors include services, manufacturing
dominated by electrical, transportation and military equipment, government,
trade, construction, finance, insurance and real estate, tourism and the
military.
The State's seasonally adjusted unemployment rate as of February 1997,
stood at 5.0%, which is on par with the national rate of 5.0%. Total wage and
salary employment has grown at a3.8% average annual rate from 1990 to 1995,
with annual gains of 6.7% and 5.4% respectively for 1994 and 1995. Major
expansions are presently underway by Microsoft, Charles Schwab, Intel,
Microchip Technology and MCI. However, there are signs that the rate of
employment growth has begun to slow. Total wage and salary employment is
forecast to increase by more moderate rates of 3.3% in 1997 and 2.4% in 1998.
The services sector is projected to experience the highest rate of growth over
the next two years, with increases of 5.5% and 4.8%. Manufacturing employment
is expected to increase 2.9% and 0.9% over the same period while construction
employment is expected to increase 0.2% in 1997 and decline 2.5% in 1998.
This compares with construction employment increases of 21.6% in 1994 and
10.6% in 1995.
Due to the international diversification of Arizona's economy and the
development of expanded tourism opportunities the State's economy is becoming
less seasonal in nature. Exports rose 45.2% from 1993 to 1995 to $9.7 billion.
To further promote Arizona exports, the Arizona Department of Commerce opened
a foreign trade office in London in October 1995. High-tech products account
for about 75% of total exports. This provides better options for both
employers and employees.
Arizona is required by law to maintain a balanced budget. To achieve
this objective, the State has, in the past, utilized a combination of spending
reductions and tax increases. Arizona's top individual income tax rate of
6.9% is moderately high and there is no local income taxes levied by any city
or county. The general sales tax rate matches the US median at 5.0%, although
county and city taxes push combined rates as high as 7.20%. General
governmental revenues totaled about $10.32 billion for June 30,1996, a 7.2%
increase over 1995. The higher sales tax revenues are reflective of statewide
economic growth, while the rise in motor vehicle and fuel taxes resulted from
increases in vehicle registrations and vehicle usage.
The general fund ended the June 30, 1996 fiscal year with a $628.2
million unreserved fund balance, which is about 8.5 % of general fund
revenues. In addition, there is a $309.3 million reserved fund balance that
includes $233.1 million for a "rainy day fund" established by the State
Legislature in 1991. The fund is capped at 15% of general fund revenue and is
funded by a formula comparing real net personal income growth to a seven year
trend.
Arizona's state constitution limits the amount of debt that may be
contracted by the State to $350,000. However, certain other issuers have the
power to issue obligations which affect the whole or large portions of the
State. For example, the Transportation Board of the State of Arizona
Department of Transportation may issue debt for highways which is paid from
revenues generated from state gasoline taxes. Salt River Project Agricultural
& Improvement District, an agricultural improvement district that operates the
Salt River Project (a Federal reclamation project and an electric system which
generates, purchases, and distributes electric power to residential,
commercial, industrial, and agricultural power users in a 2,900 square-mile
service area around Phoenix), may issue debt payable from a number of sources.
Arizona has no general obligation debt. Revenue bonds have been issued
by the Arizona Depaartment of Transportation ("ADOT"), three state
universities, the Arizona Power Authority and the University Medical Center.
The total par value of outstanding revenue bonds is approximately $2.2
billion.
Outstanding ADOT issues total approximately $1.5 billion and include
highway revenue bonds secured by a pledge of motor vehicle related fuel fees
of the state highway fund and by transportation excise taxes collected by the
Arizona Department of Revenue on behalf of Maricopa County. Virtually all of
the numerous ADOT issues are insured and carry underlying ratings by S&P
ranging from "A-" on subordinate excise tax issues to "AA-" on senior lien
issues.
Arizona has issued certificates of participation ("COPs") currently
outstanding in the amount of $429 million, to finance construction or
improvements to office buildings, higher education facilities and prisons.
The lease payments are subject to annual appropriation by the State
Legislature. Nearly all of the outstanding COPs are insured and carry S&P's
underlying ratings ranging from "A-" to "A+", depending on a particular
project.
Arizona's state constitution also restricts the debt of certain of the
State's political subdivisions. No county, city, town, school district, or
other municipal corporation of the State may for any purpose become indebted
in any manner in an amount exceeding six percent of the taxable property in
such county, city, town, school district, or other municipal corporation
without the assent of a majority of the qualified electors thereof voting at
an election provided by law to be held for that purpose; provided, however,
that (a) under no circumstances may any county or school district of the State
become indebted in an amount exceeding fifteen percent (or thirty percent in
the case of a unified school district) of such taxable property and (b) any
incorporated city or town of the State with such assent may be allowed to
become indebted up to a twenty percent additional amount for supplying such
city or town with (i) water, artificial light, or sewers, when the works for
supplying such water, light, or sewers are or shall be owned and controlled by
the municipality, (ii) the acquisition and development by the incorporated
city or town of land or interests therein for open space preserves, parks,
playgrounds and recreational facilities, or (iii) the construction,
reconstruction, improvement or acquisition of streets, highways or bridges or
interests in land for rights-of-way for streets, highways or bridges.
Irrigation, power, electrical, agricultural improvement, drainage, flood
control and tax levying public improvement districts are, however, exempt from
such restrictions of the constitution.
Annual property tax levies for the payment of general obligation bonded
indebtedness of political subdivisions are unlimited as to rate or amount.
Other obligations may be issued by such entities, sometimes without an
election, which are payable from, among other sources, project revenues,
special assessments and excise taxes.
Arizona's local governmental entities are subject to certain other
limitations on their ability to assess taxes and levies which could affect
their ability to meet their financial obligations. Subject to certain
exceptions, the maximum amount of property taxes levied by any Arizona county,
city, town or community college district for their operations and maintenance
expenditures cannot exceed the amount levied in a preceding year by more than
two percent. Certain taxes are specifically exempt from this limit, including
taxes levied for debt service payments.
PURCHASE OF SHARES
Volume Discounts
The schedule of sales charges on Class A shares described in the Prospectus
applies to purchases made by any "purchaser,'' which is defined to include the
following: (a) an individual; (b) an individual's spouse and his or her
children purchasing shares for his or her own account; (c) a trustee or other
fiduciary purchasing shares for a single trust estate or single fiduciary
account; (d) a pension, profit-sharing or other employee benefit plan
qualified under Section 401(a) of the Code and qualified employee benefit
plans of employers who are "affiliated persons'' of each other within the
meaning of the 1940 Act; (e) tax-exempt organizations enumerated in Section
501(c)(3) or (13) of the Code; and (f) a trustee or other professional
fiduciary (including a bank, or an investment adviser registered with the SEC
under the Investment Advisers Act of 1940, as amended) purchasing shares of
the Fund for one or more trust estates or fiduciary accounts. Purchasers who
wish to combine purchase orders to take advantage of volume discounts should
contact a Smith Barney Financial Consultant.
Combined Right of Accumulation
Reduced sales charges, in accordance with the schedule in the Prospectus,
apply to any purchase of Class A shares if the aggregate investment in Class A
shares of the Fund and in Class A shares of other Smith Barney Mutual Funds
that are offered with a sales charge, including the purchase being made, of
any purchaser is $25,000 or more. The reduced sales charge is subject to
confirmation of the shareholder's holdings through a check of appropriate
records. The Fund reserves the right to terminate or amend the combined right
of accumulation at any time after written notice to shareholders. For further
information regarding the right of accumulation, shareholders should contact a
Smith Barney Financial Consultant.
Determination of Public Offering Price
The Fund offers its shares to the public on a continuous basis. The public
offering price for a Class A and Class Y share of the Fund is equal to the net
asset value per share at the time of purchase, plus for Class A shares an
initial sales charge based on the aggregate amount of the investment. The
public offering price for a Class B and Class C share (and Class A share
purchases, including applicable rights of accumulation, equaling or exceeding
$500,000), is equal to the net asset value per share at the time of purchase
and no sales charge is imposed at the time of purchase. A contingent deferred
sales charge ("CDSC''), however, is imposed on certain redemptions of Class B
and Class C shares, and Class A shares when purchased in amounts exceeding
$500,000. The method of computation of the public offering price is shown in
the Fund's financial statements, incorporated by reference in their entirety
into this Statement of Additional Information.
REDEMPTION OF SHARES
The right of redemption may be suspended or the date of payment postponed (a)
for any period during which the New York Stock Exchange, Inc. ("NYSE'') is
closed (other than for customary weekend and holiday closings), (b) when
trading in markets the Fund normally utilizes is restricted, or an emergency
exists, as determined by the SEC, so that disposal of the Fund's investments
or determination of net asset value is not reasonably practicable or (c) for
such other periods as the SEC by order may permit for protection of the Fund's
shareholders.
Distribution in Kind
If the Board of Directors of the Fund determines that it would be detrimental
to the best interests of the remaining shareholders to make a redemption
payment wholly in cash, the Fund may pay, in accordance with SEC rules, any
portion of a redemption in excess of the lesser of $250,000 or 1% of the
Fund's net assets by a distribution in kind of portfolio securities in lieu of
cash. Securities issued as a distribution in kind may incur brokerage
commissions when shareholders subsequently sell those securities.
Automatic Cash Withdrawal Plan
An automatic cash withdrawal plan (the "Withdrawal Plan'') is available to
shareholders who own shares with a value of at least $10,000 and who wish to
receive specific amounts of cash monthly or quarterly. Withdrawals of at least
$50 may be made under the Withdrawal Plan by redeeming as many shares of the
Fund as may be necessary to cover the stipulated withdrawal payment. Any
applicable CDSC will not be waived on amounts withdrawn by shareholders that
exceed 1.00% per month of the value of a shareholder's shares at the time the
Withdrawal Plan commences. (With respect to Withdrawal Plans in effect prior
to November 7, 1994, any applicable CDSC will be waived on amounts withdrawn
that do not exceed 2.00% per month of the value of a shareholder's shares that
are subject to a CDSC.) To the extent withdrawals exceed dividends,
distributions and appreciation of a shareholder's investment in the Fund,
there will be a reduction in the value of the shareholder's investment, and
continued withdrawal payments will reduce the shareholder's investment and may
ultimately exhaust it. Withdrawal payments should not be considered as income
from investment in the Fund. Furthermore, as it generally would not be
advantageous to a shareholder to make additional investments in the Fund at
the same time he or she is participating in the Withdrawal Plan, purchases by
such shareholder in amounts of less than $5,000 ordinarily will not be
permitted. All dividends and distributions on shares in the Withdrawal Plan
are reinvested automatically at net asset value in additional shares of the
Fund.
Shareholders who wish to participate in the Withdrawal Plan and who hold
their shares in certificate form must deposit their share certificates with
First Data as agent for Withdrawal Plan members. All other investors should
contact a Smith Barney Financial Consultant. A shareholder who purchases
shares directly through First Data may continue to do so and applications for
participation in the Withdrawal Plan must be received by First Data no later
than the eighth day of the month to be eligible for participation beginning
with that month's withdrawal.
DISTRIBUTOR
Smith Barney serves as the Fund's distributor on a best efforts basis pursuant
to a written agreement (the "Distribution Agreement'') which was most recently
approved by the Fund's Board of Directors on July 16, 1997. For the fiscal
years ended May 31, 1995, 1996 and 1997, Smith Barney received, approximately
$51,000, $62,000 and $32,000, respectively, in sales charges from the sale of
the Fund's Class A shares, and did not reallow any portion thereof to dealers.
For the fiscal years ended May 31, 1995, 1996 and 1997, Smith Barney, received
approximately $29,000, $55,000 and $79,000, respectively, representing CDSC on
redemptions of the Fund's Class B shares.
When payment is made by the investor before settlement date, unless
otherwise noted by the investor, the funds will be held as a free credit
balance in the investor's brokerage account and Smith Barney may benefit from
the temporary use of the funds. The investor may designate another use for the
funds prior to settlement date, such as an investment in a money market fund
(other than Smith Barney Exchange Reserve Fund) of the Smith Barney Mutual
Funds. If the investor instructs Smith Barney to invest in a Smith Barney
money market fund, the amount of the investment will be included as part of
the average daily net assets of both the Fund and the money market fund, and
affiliates of Smith Barney that serve the funds in an investment advisory or
administrative capacity will benefit from the fact they are receiving fees
from both such investment companies for managing these assets, computed on the
basis of their average daily net assets. The Fund's Board of Directors has
been advised of the benefits to Smith Barney resulting from these settlement
procedures and will take such benefits into consideration when reviewing the
Advisory, Administration and Distribution Agreements for continuance.
For the fiscal year ended May 31, 1997, Smith Barney incurred distribution
expenses totaling approximately $154,293, consisting of approximately $13,846
for advertising, $2,309 for printing and mailing of prospectuses, $88,214 for
support services, $49,862 to Smith Barney Financial Consultants, and $62, for
accruals for interest on the excess of Smith Barney expenses incurred in
distribution of the Fund's shares over the sum of the distribution fees and
CDSC received by Smith Barney from the Fund.
Distribution Arrangements
To compensate Smith Barney for the services it provides and for the expense it
bears under the Distribution Agreement, the Fund has adopted a services and
distribution plan (the "Plan'') pursuant to Rule 12b-1 under the 1940 Act.
Under the Plan, the Fund pays Smith Barney a service fee, accrued daily and
paid monthly, calculated at the annual rate of 0.15% of the value of the
Fund's average daily net assets attributable to the Class A, Class B and Class
C shares. In addition, the Fund pays Smith Barney a distribution fee primarily
intended to compensate Smith Barney for its initial expense of paying
Financial Consultants a commission upon sales of those shares. The Class B
distribution fee is calculated at the annual rate of 0.50% of the value of the
Fund's average net assets attributable to the shares of the Class. The Class C
distribution fee is calculated at the annual rate of 0.55% of the value of the
Fund's average net assets attributable to the shares of the Class.
For the 1995, 1996 and 1997 fiscal years, Class A shares incurred
$64,130, $65,532 and $59,503, respectively, in services fees. For the 1995,
1996 and 1997 fiscal years, the Class B shares incurred $131,259, $149,271
and $136,271, respectively, in service and distribution fees. For the period
from November 14, 1994 through May 31, 1995, and for the fiscal years ended
May 31, 1996 and 1997, Class C shares incurred $645, $3,655 and $4,702 in
services fees and distribution fees, respectively.
Under its terms, the Plan continues from year to year, provided such
continuance is approved annually by vote of the Fund's Board of Directors,
including a majority of the Independent Directors who have no direct or
indirect financial interest in the operation of the Plan or in the
Distribution Agreement. The Plan may not be amended to increase the amount of
the service and distribution fees without shareholder approval, and all
material amendments of the Plan also must be approved by the Directors and the
Independent Directors in the manner described above. The Plan may be
terminated with respect to a Class at any time, without penalty, by vote of a
majority of the Independent Directors or by a vote of a majority of the
outstanding voting securities of the Class (as defined in the 1940 Act).
Pursuant to the Plan, Smith Barney will provide the Board of Directors with
periodic reports of amounts expended under the Plan and the purpose for which
such expenditures were made.
VALUATION OF SHARES
Each Class' net asset value per share is calculated on each day, Monday
through Friday, except days on which the NYSE is closed. The NYSE currently is
scheduled to be closed on New Year's Day, Martin Luther King, Jr. Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving and Christmas, and on the preceding Friday or subsequent Monday
when one of these holidays falls on a Saturday or Sunday, respectively.
Because of the differences in distribution fees and Class-specific expenses,
the per share net asset value of each Class may differ. The following is a
description of the procedures used by the Fund in valuing its assets.
The valuation of the Fund's assets is made by MMC after consultation with
an independent pricing service (the "Service'') approved by the Board of
Directors. When, in the judgment of the Service, quoted bid prices for
investments are readily available and representative of the bid side of the
market, these investments are valued at the mean between the quoted bid and
asked prices. Investments for which, in the judgment of the Service, there is
no readily obtainable market quotation (which may constitute a majority of the
portfolio securities) are carried at fair value as determined by the Service.
For the most part, such investments are liquid and may be readily sold. The
Service may employ electronic data processing techniques and/or a matrix
system to determine valuations. The procedures of the Service are reviewed
periodically by the officers of the Fund under the general supervision and
responsibility of the Board of Directors, which may replace any such Service
at any time if it determines it to be in the best interest of the Fund to do
so.
EXCHANGE PRIVILEGE
Except as noted below, shareholders of certain Smith Barney Mutual Funds may
exchange all or part of their shares for shares of the same Class of other
Smith Barney Mutual Funds, to the extent such shares are offered for sale in
the shareholder's state of residence, on the basis of relative net asset value
per share at the time of exchange as follows:
A. Class A shares of any fund acquired by a previous exchange of shares
purchased with a sales charge may be exchanged for Class A shares of any
of the other funds.
B. Class B shares of any fund may be exchanged without a sales charge.
Class B shares of the Fund exchanged for Class B shares of another fund
will be subject to the higher applicable CDSC of the two funds and, for
purposes of calculating CDSC rates and conversion periods, will be
deemed to have been held since the date the shares being exchanged were
deemed to be purchased.
C. Class Y and Class A shareholders of the Fund who wish to exchange all or
a portion of their shares of the respective Class in any of the Smith
Barney Mutual Funds listed in the "Exchange Privilege" section of the
Fund's Prospectus may do so without the imposition of any charge.
Dealers other than Smith Barney must notify First Data of the investor's
prior ownership of Class A shares of Smith Barney High Income Fund and the
account number in order to accomplish an exchange of shares of Smith Barney
High Income Fund under paragraph A above.
The exchange privilege enables shareholders to acquire shares of the same
Class in a fund with different investment objectives when they believe that a
shift between funds is an appropriate investment decision. This privilege is
available to shareholders residing in any state in which the fund shares being
acquired may legally be sold. Prior to any exchange, the shareholder should
obtain and review a copy of the current prospectus of each fund into which an
exchange is being considered. Prospectuses may be obtained from a Smith Barney
Financial Consultant.
Upon receipt of proper instructions and all necessary supporting documents,
shares submitted for exchange are redeemed at the then-current net asset value
and, subject to any applicable CDSC, the proceeds are immediately invested, at
a price as described above, in shares of the fund being acquired. Smith Barney
reserves the right to reject any exchange request. The exchange privilege may
be modified or terminated at any time after written notice to shareholders.
PERFORMANCE DATA
From time to time, the Fund may quote yield or total return of a Class in
advertisements or in reports and other communications to shareholders. The
Fund may include comparative performance information in advertising or
marketing the Fund's shares. Such performance information may be included in
the following industry and financial publications: Barron's, Business Week,
CDA Investment Technologies, Inc., Changing Times, Forbes, Fortune,
Institutional Investor, Investors Daily, Money, Morningstar Mutual Fund
Values, The New York Times, USA Today and The Wall Street Journal. To the
extent any advertisement or sales literature of the Fund describes the
expenses or performance of any Class, it will also disclose such information
for the other Classes.
Yield
A Class' 30-day yield figure described below is calculated according to a
formula prescribed by the SEC. The formula can be expressed as follows:
YIELD =2 [(a-b +1)6-1]
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursement).
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends.
d = the maximum offering price per share on the last day of the
period.
For the purpose of determining the interest earned (variable "a'' in the
formula) on debt obligations that were purchased by the Fund at a discount or
premium, the formula generally calls for amortization of the discount or
premium. The amortization schedule will be adjusted monthly to reflect changes
in the market values of the debt obligations.
The Fund's equivalent taxable 30-day yield for a Class of shares is
computed by dividing that portion of the Class' 30-day yield which is tax-
exempt by one minus a stated income tax rate and adding the product to that
portion, if any, of the Class' yield that is not tax-exempt.
The yields on municipal securities are dependent upon a variety of factors,
including general economic and monetary conditions, conditions of the
municipal securities market, size of a particular offering, maturity of the
obligation offered and rating of the issue. Investors should recognize that in
periods of declining interest rates the Fund's yield for each Class of shares
will tend to be somewhat higher than prevailing market rates, and in periods
of rising interest rates the Fund's yield for each Class of shares will tend
to be somewhat lower. Also, when interest rates are falling, the inflow of net
new money to the Fund from the continuous sale of its shares will likely be
invested in portfolio instruments producing lower yields than the balance of
the Fund's portfolio, thereby reducing the current yield of the Fund. In
periods of rising interest rates, the opposite can be expected to occur.
The Fund's yield for Class A, Class B and Class C shares for the 30-day
period ended May 31, 1997 was 4.74%, 4.42% and 4.39%, respectively. The
equivalent taxable yield for Class A, Class B and Class C shares for that same
period was 8.65%, 8.07% and 8.01%, respectively, assuming the payment of
Federal income taxes at a rate of 39.6% and Arizona taxes at a rate of 5.6%.
Average Annual Total Return
"Average annual total return'' figures are computed according to a formula
prescribed by the SEC. The formula can be expressed as follows:
P (1+T) n = ERV
Where: P = a hypothetical initial payment of $1,000.
T = average annual total return.
n = number of years.
ERV = Ending Redeemable Value of a hypothetical $1,000 investment
made at the beginning of a 1-, 5- or 10-year period
at the end of the 1-, 5- or 10-year period (or
fractional portion thereof), assuming reinvestment of all
dividends and distributions.
The average annual total return for Class A shares was as follows for the
periods indicated:
3.78% for the one-year period beginning June 1, 1996 through May 31,
1997.
6.15% per annum during the five-year period beginning June 1, 1992
through May 31, 1997.
7.05% per annum during the period from the Fund's commencement of
operations on June 1, 1987 through May 31, 1997.
These Class A average annual total return figures assume that the maximum
4.00% sales charge has been deducted from the investment at the time of
purchase. [Had the investment advisory, sub-investment advisory and/or
administration fees not been partially waived (and assuming that the maximum
4.00% sales charge had not been deducted),] the Class A's average annual total
return would have been 8.06%, 7.02% and 7.49%, respectively, for those same
periods.
The average annual total return for Class B shares was as follows for the
periods indicated:
3.03% for the one-year period beginning June 1, 1996 through May 31,
1997.
6.08% per annum for the period beginning November 6, 1992 through May 31,
1997.
These average annual total return figures assume that the maximum
applicable CDSC has been deducted from the investment. [Had the investment
advisory and sub-investment advisory and/or administration fees not been
partially waived and the CDSC had not been deducted,] the average annual total
return on the Fund's Class B shares would have been 7.53% and 6.26%,
respectively, for those same periods.
The average annual total return for Class C shares was as follows for the
periods indicated:
6.49% for the one-year period beginning June 1, 1996 through May 31,
1997.
9.21% per annum for the period beginning December 8, 1994 through May 31,
1997.
These average annual total return figures assume that the maximum applicable
CDSC has been deducted from the investment. If the CDSC had not been
deducted, the average annual total return on the Fund's Class C shares would
have been 7.49% and 9.21%, respectively for those same periods.
Performance will vary from time to time depending upon market conditions,
the composition of the Fund's portfolio and operating expenses and the
expenses exclusively attributable to the Class. Consequently, any given
performance quotation should not be considered representative of the Class'
performance for any specified period in the future. Because the performance
will vary, it may not provide a basis for comparing an investment in the Class
with certain bank deposits or other investments that pay a fixed yield for a
stated period of time. Investors comparing a Class' performance with that of
other mutual funds should give consideration to the quality and maturity of
the respective investment companies' portfolio securities. It is important to
note that the total return figures set forth above are based on historical
earnings and are not intended to indicate future performance. Each Class' net
investment income changes in response to fluctuation in interest rates and the
expenses of the Fund.
TAXES
The following is a summary of selected Federal income tax considerations that
may affect the Fund and its shareholders. The summary is not intended as a
substitute for individual tax advice and investors are urged to consult their
own tax advisors as to the tax consequences of an investment in the Fund.
As described above and in the Prospectus, the Fund is designed to provide
investors with current income which is excluded from gross income for Federal
income tax purposes and exempt from Arizona personal income taxes. The Fund is
not intended to constitute a balanced investment program and is not designed
for investors seeking capital gains or maximum tax-exempt income irrespective
of fluctuations in principal. Investment in the Fund would not be suitable for
tax-exempt institutions, qualified retirement plans, H.R. 10 plans and
individual retirement accounts since such investors would not gain any
additional tax benefit from the receipt of tax-exempt income.
The Fund has qualified and intends to continue to qualify each year as a
"regulated investment company'' under the Code. Provided that the Fund (a)
qualifies as a regulated investment company and (b) distributes at least 90%
of its taxable net investment income and net realized short-term capital
gains, and 90% of its tax-exempt interest income (reduced by certain
expenses), the Fund will not be liable for Federal and state income taxes to
the extent its taxable net investment income and its net realized short-term
and long-term capital gains, if any, are distributed to shareholders. Any such
taxes paid by the Fund would reduce the amount of income and gains available
for distribution to shareholders.
Because the Fund will distribute exempt-interest dividends, interest on
indebtedness incurred by a shareholder to purchase or carry Fund shares is not
deductible for Federal income and Arizona personal income tax purposes. If a
shareholder receives exempt-interest dividends with respect to any share and
if the share is held by the shareholder for six months or less, then, for
Federal income tax purposes, any loss on the sale or exchange of such share,
to the extent of the exempt-interest dividend, may be disallowed. In addition,
the Code may require a shareholder, if he or she receives exempt-interest
dividends, to treat as taxable income, a portion of certain otherwise non-
taxable social security and railroad retirement benefit payments. Furthermore,
that portion of any dividends paid by the Fund which represent income derived
from private activity bonds held by the Fund may not retain its Federal tax-
exempt status in the hands of a shareholder who is a "substantial user'' of a
facility financed by such bonds, or a "related person'' thereof. Moreover, as
noted in the Fund's Prospectus, some or all of the Fund's dividends and
distributions may be a specific tax preference item, or a component of an
adjustment item, for purposes of the Federal individual and corporate
alternative minimum taxes Shareholders should consult their own tax advisors
as to whether they are (a) "substantial users'' with respect to a facility or
related to such users within the meaning of the Code and (b) subject to a
Federal alternative minimum tax, the Federal "branch profits'' tax or the
Federal "excess net passive income'' tax.
As described above and in the Prospectus, the Fund may invest in municipal
bond index and interest rate futures contracts and options on these futures
contracts. The Fund anticipates that these investment activities would not
prevent the Fund from qualifying as a regulated investment company. As a
general rule, these investment activities will increase or decrease the amount
of long-term and short-term capital gains or losses realized by the Fund and,
accordingly, would affect the amount of capital gains distributed to the
Fund's shareholders.
For Federal income tax purposes, gain or loss on the futures contracts and
options described above (collectively referred to as "section 1256
contracts'') is taxed pursuant to a special "mark-to-market'' system. Under
the mark-to-market system, these instruments are treated as if sold at the
Fund's fiscal year end for their fair market value. As a result, the Fund will
be recognizing gains or losses before they are actually realized. As a general
rule, gain or loss on section 1256 contracts generally is treated as 60% long-
term capital gain or loss and 40% short-term capital gain or loss, and,
accordingly, the mark-to-market system generally will affect the amount of
capital gains or losses taxable to the Fund and the amount of distributions to
a shareholder. Moreover, if the Fund invests in both section 1256 contracts
and offsetting positions in those contracts, which together constitute a
straddle, then the Fund may be required to defer certain realized losses. The
Fund expects that its activities with respect to section 1256 contracts and
offsetting positions in those contracts will not cause it to be treated as
recognizing a materially greater amount of capital gains than actually
realized and will permit it to use substantially all of the losses of the Fund
for the fiscal years in which the losses actually occur.
While the Fund does not expect to realize a significant amount of net long-
term capital gains, any such gains will be distributed annually as described
in the Prospectus. Such distributions ("capital gain dividends''), if any,
will be taxable to shareholders as long-term capital gains, regardless of how
long they have held Fund shares, and will be designated as capital gain
dividends in a written notice mailed to shareholders after the close of the
Fund's taxable year, that will separately identify the portion of capital
gains dividends eligible for the reduced maximum 20% capital gains tax rate
(generally gains on assets other than section 1256 contracts held by the Fund
for more than 18 months). If a shareholder receives a capital gain dividend
with respect to any share and if such share has been held by the shareholder
for six months or less, then any loss (to the extent not disallowed pursuant
to the other six month rule described above relating to exempt-interest
dividends) on the sale or exchange of such share will be treated as a long-
term capital loss to the extent of the capital gain dividend.
If a shareholder incurs a sales charge when acquiring shares of the Fund,
disposes of those shares within 90 days and acquires shares in a mutual fund
for which the otherwise applicable sales charge is reduced by reason of a
reinvestment right (that is, exchange privilege), the original sales charge
will not be taken into account when computing gain or loss on the original
shares to the extent the subsequent sales charge is reduced. The portion of
the original sales charge that does not increase the shareholder's tax basis
in the original shares would be treated as incurred with respect to the second
acquisition and, as a general rule, will increase the shareholder's tax basis
in the newly acquired shares. Furthermore, the same rule also applies to a
disposition of the newly acquired shares made within 90 days of the second
acquisition. This provision prevents a shareholder from immediately deducting
the sales charge by shifting his or her investment in a family of mutual
funds.
Each shareholder will receive after the close of the calendar year an
annual statement as to the Federal income tax and Arizona personal income tax
status of his or her dividends and distributions from the Fund for the prior
calendar year. These statements also will designate the amount of exempt-
interest dividends that is a specific preference item for purposes of the
Federal individual and corporate alternative minimum taxes. Each shareholder
also will receive, if appropriate, various written notices after the close of
the Fund's prior taxable year as to the Federal income tax status of his or
her dividends and distributions which were received from the Fund during the
Fund's prior taxable year. Shareholders should consult their tax advisors as
to any other state and local taxes that may apply to these dividends and
distributions. The dollar amounts of dividends excluded or exempt from Federal
income taxation or Arizona personal income taxation and the dollar amount of
dividends subject to Federal income taxation or Arizona personal income
taxation, if any, will vary for each shareholder depending upon the size and
duration of each shareholder's investment in the Fund. In the event the Fund
earns taxable net investment income, it intends to designate as taxable
dividends the same percentage of each day's dividend as its actual taxable net
investment income bears to its total net investment income earned for that
year.
Investors considering buying shares of the Fund just prior to a record date
for a capital gain distribution should be aware that, regardless of whether
the price of the Fund shares to be purchased reflects the amount of the
forthcoming distribution payment, any such payment will be a taxable
distribution payment.
If a shareholder fails to furnish the Fund with a correct taxpayer
identification number, fails to report fully dividend or interest income, or
fails to certify to the Fund that he or she has provided a correct taxpayer
identification number and that he or she is not subject to "backup
withholding,'' then the shareholder may be subject to a 31% "backup
withholding'' tax with respect to (a) taxable dividends and distributions, if
any, and (b) proceeds of any redemption of Fund shares. An individual's
taxpayer identification number is his or her social security number. The
"backup withholding'' tax is not an additional tax and may be credited against
a shareholder's Federal income tax liability.
Income distributions, including interest income and gains realized by the
Fund upon disposition of investments paid from a "qualified investment fund''
are exempt from the Arizona personal income tax to the extent attributable to
Arizona Municipal Securities or to obligations that are free from state or
local taxation under Arizona or Federal laws ("Tax-Exempt Obligations''). A
"qualified investment fund'' is any investment or trust company, or series of
such investment company or trust registered with the SEC, which for the
calendar year in which a distribution is paid, has no investments other than
interest-bearing obligations, obligations issued at a discount, financial
options, futures, forward contracts or other similar financial instruments
related to interest-bearing obligations, obligations issued at a discount or
related bond indices and cash and cash items, including receivables, and which
has, at the close of each quarter of the taxable year, at least 80% of the
aggregate principal amount of all of its investments, excluding financial
options, futures, forward contracts, or other similar financial instruments
related to interest-bearing obligations, obligations issued at a discount or
bond indices related thereto as authorized under the Code, cash and cash
items, such as receivables, invested in Arizona Municipal Securities or in
Tax-Exempt Obligations. Furthermore, gains resulting from the redemption or
sale of shares of the Fund to the extent attributable to interest or gain from
obligations issued by Arizona or its local government entities or obligations
which are free from state or local taxes under Arizona or Federal law, are
exempt from the Arizona personal income tax.
The Arizona personal income tax is not applicable to corporations. For all
corporations subject to the Arizona Corporation Business Tax, dividends and
distributions from a "qualified investment fund'' are included in the net
income tax base for purposes of computing the Corporation Business Tax.
Furthermore, any gain upon the redemption or sale of Fund shares by a
corporate shareholder is also included in the net income tax base for purposes
of computing the Corporation Business Tax.
The foregoing is only a summary of certain tax considerations generally
affecting the Fund and its shareholders, and is not intended as a substitute
for careful tax planning. Shareholders are urged to consult their tax advisors
with specific reference to their own tax situations.
ADDITIONAL INFORMATION
The Fund was incorporated under the laws of the State of Maryland on May 4,
1987 and commenced operations on June 1, 1987 under the name Hutton Municipal
Series Inc. On December 29, 1988, March 31, 1992, July 30, 1993 and October
14, 1994, the Fund changed its name to SLH Municipals Series Fund Inc.,
Shearson Lehman Brothers Arizona Municipals Fund Inc., Smith Barney Shearson
Arizona Municipals Fund Inc. and Smith Barney Arizona Municipals Fund Inc.,
respectively.
PNC, located at Chestnut and 17th Streets, Philadelphia, Pennsylvania
19103, serves as the custodian of the Fund. Under the custody agreement, PNC
holds the Fund's portfolio securities and keeps all necessary accounts and
records. For its services, PNC receives a monthly fee based upon the month-end
market value of securities held in custody and also receives securities
transaction charges. The assets of the Fund are held under bank custodianship
in compliance with the 1940 Act.
First Data, located at Exchange Place, Boston, Massachusetts 02109, serves
as the Fund's transfer agent. Under the transfer agency agreement, First Data
maintains the shareholder account records for the Fund, handles certain
communications between shareholders and the Fund and distributes dividends and
distributions payable by the Fund. For these services, First Data receives a
monthly fee computed on the basis of assets of the Fund during the month and
is reimbursed for out-of-pocket expenses.
FINANCIAL STATEMENTS
The Fund's Annual Report for the fiscal year ended May 31, 1997, accompanies
this Statement of Additional Information and is incorporated herein by
reference in its entirety.
APPENDIX
Description of S&P and Moody's ratings:
S&P Ratings for Municipal Bonds
S&P's Municipal Bond ratings cover obligations of states and political
subdivisions. Ratings are assigned to general obligation and revenue bonds.
General obligation bonds are usually secured by all resources available to the
municipality and the factors outlined in the rating definitions below are
weighed in determining the rating. Because revenue bonds in general are
payable from specifically pledged revenues, the essential element in the
security for a revenue bond is the quantity and quality of the pledged
revenues available to pay debt service.
Although an appraisal of most of the same factors that bear on the quality of
general obligation bond credit is usually appropriate in the rating analysis
of a revenue bond, other factors are important, including particularly the
competitive position of the municipal enterprise under review and the basic
security covenants. Although a rating reflects S&P's judgment as to the
issuer's capacity for the timely payment of debt service, in certain instances
it may also reflect a mechanism or procedure for an assured and prompt cure of
a default, should one occur, i.e., an insurance program, Federal or state
guarantee or the automatic withholding and use of state aid to pay the
defaulted debt service.
AAA
Prime -- These are obligations of the highest quality. They have the strongest
capacity for timely payment of debt service.
General Obligation Bonds -- In a period of economic stress, the issuers will
suffer the smallest declines in income and will be least susceptible to
autonomous decline. Debt burden is moderate. A strong revenue structure
appears more than adequate to meet future expenditure requirements. Quality of
management appears superior.
Revenue Bonds -- Debt service coverage has been, and is expected to remain,
substantial. Stability of the pledged revenues is also exceptionally strong,
due to the competitive position of the municipal enterprise or to the nature
of the revenues. Basic security provisions (including rate covenant, earnings
test for issuance of additional bonds, and debt service reserve requirements)
are rigorous. There is evidence of superior management.
AA
High Grade -- The investment characteristics of general obligation and revenue
bonds in this group are only slightly less marked than those of the prime
quality issues. Bonds rated AA have the second strongest capacity for payment
of debt service.
A
Good Grade -- Principal and interest payments on bonds in this category are
regarded as safe. This rating describes the third strongest capacity for
payment of debt service. It differs from the two higher ratings because:
General Obligation Bonds -- There is some weakness, either in the local
economic base, in debt burden, in the balance between revenues and
expenditures, or in quality of management. Under certain adverse
circumstances, any one such weakness might impair the ability of the issuer to
meet debt obligations at some future date.
Revenue Bonds -- Debt service coverage is good, but not exceptional. Stability
of the pledged revenues could show some variations because of increased
competition or economic influences on revenues. Basic security provisions,
while satisfactory, are less stringent. Management performance appears
adequate.
BBB
Medium Grade -- Of the investment grade ratings, this is the lowest.
General Obligation Bonds -- Under certain adverse conditions, several of the
above factors could contribute to a lesser capacity for payment of debt
service. The difference between "A'' and "BBB'' ratings is that the latter
shows more than one fundamental weakness, or one very substantial fundamental
weakness, whereas the former shows only one deficiency among the factors
considered.
Revenue Bonds -- Debt coverage is only fair. Stability of the pledged revenues
could show substantial variations, with the revenue flow possibly being
subject to erosion over time. Basic security provisions are no more than
adequate. Management performance could be stronger.
BB, B, CCC and CC
Bonds rated BB, B, CCC and CC are 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 bonds will
likely have some quality and protective characteristics, these are outweighed
by large uncertainties or major risk exposures to adverse conditions.
C
The rating C is reserved for income bonds on which no interest is being paid.
D
Bonds rated D are in default, and payment of interest and/or repayment of
principal is in arrears.
S&P's letter ratings may be modified by the addition of a plus or a minus
sign, which is used to show relative standing within the major rating
categories, except in the AAA-Prime Grade category.
S&P Ratings for Municipal Notes
Municipal notes with maturities of three years or less are usually given note
ratings (designated SP-1, -2 or -3) by S&P to distinguish more clearly the
credit quality of notes as compared to bonds. Notes rated SP-1 have a very
strong or strong capacity to pay principal and interest. Those issues
determined to possess overwhelming safety characteristics are given the
designation of SP-1+. Notes rated SP-2 have a satisfactory capacity to pay
principal and interest.
Moody's Ratings for Municipal Bonds
Aaa
Bonds that are Aaa are judged to be of 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 that 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 that 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 that 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 that are rated Ba are judged to have speculative elements; their future
cannot be considered as well assured. Often the protection of interest and
principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B
Bonds that 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.
Moody's applies the numerical modifiers 1, 2 and 3 in each generic rating
classification from Aa through B. The modifier 1 indicates that the security
ranks in the higher end of its generic rating category; the modifier 2
indicates a mid-range ranking; and the modifier 3 indicates that the issue
ranks in the lower end of its generic rating category.
Caa
Bonds that are rated Caa are of poor standing. These issues may be in default
or present elements of danger may exist with respect to principal or interest.
Ca
Bonds that are rated Ca represent obligations that are speculative in a high
degree. These issues are often in default or have other marked short comings.
C
Bonds that are rated C are the lowest rated class of bonds, and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Moody's Ratings for Municipal Notes
Moody's ratings for state and municipal notes and other short-term loans are
designated Moody's Investment Grade ("MIG") and for variable rate demand
obligations are designated Variable Moody's Investment Grade ("VMIG"). This
distinction is in recognition of the differences between short-term credit
risk and long-term credit risk. Loans bearing the designation MIG 1 or VMIG 1
are of the best quality, enjoying strong protection by established cash flows
of funds for their servicing or from established and broad-based access to the
market for refinancing, or both. Loans bearing the designation MIG 2 or VMIG 2
are of high quality, with ample margins of protection although not as large as
the preceding group. Loans bearing the designation MIG 3 or VMIG 3 are of
favorable quality, with all security elements accounted for, but lacking the
undeniable strength of the preceding grades. Liquidity and cash flow may be
tight and market access for refinancing, in particular, is likely to be less
well established.
Description of S&P A-1+ and A-1 Commercial Paper Rating
The rating A-1+ is the highest, and A-1 the second highest, commercial paper
rating assigned by S&P. Paper rated A-1+ must have either the direct credit
support of an issuer or guarantor that possesses excellent long-term operating
and financial strengths combined with strong liquidity characteristics
(typically, such issuers or guarantors would display credit quality
characteristics which would warrant a senior bond rating of AA- or higher), or
the direct credit support of an issuer or guarantor that possesses above
average long-term fundamental operating and financing capabilities combined
with ongoing excellent liquidity characteristics. Paper rated A-1 by S&P has
the following characteristics: liquidity ratios are adequate to meet cash
requirements; long-term senior debt is rated A or better; the issuer has
access to at least two additional channels of borrowing; basic earnings and
cash flow have an upward trend with allowance made for unusual circumstances;
typically, the issuer's industry is well established and the issuer has a
strong position within the industry; and the reliability and quality of
management are unquestioned.
Description of Moody's Prime-1 Commercial Paper Rating
The rating Prime-1 is the highest commercial paper rating assigned by Moody's.
Among the factors considered by Moody's in assigning ratings are the
following: (a) evaluation of the management of the issuer; (b) economic
evaluation of the issuer's industry or industries and an appraisal of
speculative-type risks which may be inherent in certain areas; (c) evaluation
of the issuer's products in relation to competition and customer acceptance;
(d) liquidity; (e) amount and quality of long-term debt; (f) trend of earnings
over a period of ten years; (g) financial strength of a parent company and the
relationships which exist with the issuer; and (h) recognition by the
management of obligations which may be present or may arise as a result of
public interest questions and preparations to meet such obligations.
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