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
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.
11. Purchase securities of other investment companies, except in
connection with a merger, consolidation, acquisition or
reorganization.
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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