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PILGRIM AMERICA PRIME RATE TRUST
STATEMENT OF ADDITIONAL INFORMATION
Pilgrim America Prime Rate Trust (the "Trust") is a diversified, closed-end
management investment company registered under the Investment Company Act of
1940, as amended (the "Investment Company Act"). The Trust's investment
objective is to seek as high a level of current income as is consistent with the
preservation of capital. The Trust seeks to achieve its objective by investing
in variable or floating-rate senior collateralized corporate loans ("Senior
Loans"), the interest rates of which float periodically based upon a benchmark
indicator of prevailing interest rates, such as the prime rate or the London
Inter-Bank Offered Rate ("LIBOR"). Under normal circumstances, at least 80% of
the Trust's net assets are invested in Senior Loans. The Trust is managed by
Pilgrim America Investments, Inc. ("PAII" or the "Investment Manager").
This Statement of Additional Information ("SAI") is not a prospectus, but should
be read in conjunction with the Prospectus for the Trust dated October 18, 1996
(the "Prospectus"). This SAI does not include all information that a prospective
investor should consider before purchasing shares of the Trust, and investors
should obtain and read the Prospectus prior to purchasing shares. A copy of the
Prospectus may be obtained without charge, by calling PAII at (800) 331-1080.
This SAI incorporates by reference the entire Prospectus.
TABLE OF CONTENTS
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PAGE
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Change of Name....................................................................... 2
Additional Information About Investments and Investment Techniques................... 2
Investment Restrictions.............................................................. 8
Trustees and Officers................................................................ 9
Investment Management and Other Services............................................. 12
Portfolio Transactions............................................................... 14
Net Asset Value...................................................................... 15
Methods Available to Reduce Market Value Discount From NAV........................... 15
Dividend Reinvestment and Cash Purchase Plan......................................... 16
Tax Matters.......................................................................... 17
Advertising and Performance Data..................................................... 20
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The Prospectus and this SAI omit certain of the information contained in the
registration statement filed with the Securities and Exchange Commission (the
"Commission"), Washington, D.C. The registration statement may be obtained from
the Commission upon payment of the fee prescribed, or inspected at the
Commission's office at no charge.
This SAI is dated October 18, 1996.
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CHANGE OF NAME
The Trust changed its name from "Pilgrim Prime Rate Trust" to "Pilgrim America
Prime Rate Trust" in April 1996.
ADDITIONAL INFORMATION ABOUT INVESTMENTS
AND INVESTMENT TECHNIQUES
Some of the different types of securities in which the Trust may invest, subject
to its investment objective, policies and restrictions, are described in the
Prospectus under "Investment Objectives and Policies." Additional information
concerning certain of the Trust's investments and investment techniques is set
forth below.
EQUITY SECURITIES
In connection with its purchase or holding of interests in Senior Loans, the
Trust may acquire (and subsequently sell) equity securities or exercise warrants
that it receives. The Trust will acquire such interests only as an incident to
the intended purchase or ownership of Senior Loans or if, in connection with a
reorganization of a borrower, the Trust receives an equity interest in a
reorganized corporation or warrants to acquire such an equity interest. The
Trust normally will not hold more than 20% of its total assets in equity
securities. Equity securities will not be treated as Senior Loans; therefore, an
investment in such securities will not count toward the 80% of the Trust's total
assets that normally will be invested in Senior Loans. Equity securities are
subject to financial and market risks and can be expected to fluctuate in value.
LEASE PARTICIPATIONS
The Trust may invest up to 20% of its assets in participation interests in lease
financings ("Lease Participations"). Investments in Lease Participations will
not be counted toward the 80% of the Trust's assets that under normal market
conditions are invested in Senior Loans.
The Trust will invest in Lease Participations only if they generally meet the
same credit quality standards and general requirements that the Trust applies to
Senior Loans. Thus, the collateral quality, the credit quality of the borrower
and the likelihood of payback for a Lease Participation are the same as those
applied to a Senior Loan. A Lease Participation is also required to have a
floating interest rate that is indexed to the federal funds rate, LIBOR, or
prime rate in order to be eligible for investment.
The Office of the Comptroller of the Currency has established regulations which
set forth circumstances under which national banks may engage in lease
financings. Among other things, the regulation requires that a lease be a
net-full payout lease representing the noncancelable obligation of the lessee,
and that the bank make certain determinations with respect to any estimated
residual value of leased property relied upon by the bank to yield a full return
on the lease. The Trust may invest in lease financings only if the Lease
Participation meets these banking law requirements.
REPURCHASE AGREEMENTS
In general, the Trust does not engage, nor does it intend to engage in the
foreseeable future, in repurchase agreements. The Trust has the ability,
however, pursuant to its investment objective and policies, to enter into
repurchase agreements (a purchase of, and a simultaneous commitment to resell, a
financial instrument at an agreed upon price on an agreed upon date) only with
member banks of the Federal Reserve System, member firms of the New York Stock
Exchange ("NYSE") or other entities determined by PAII to be creditworthy. When
participating in repurchase agreements, the Trust buys securities from a vendor,
e.g., a bank or brokerage firm, with the agreement that the vendor will
repurchase the securities at a higher price at a later date. The Trust may be
subject to various delays and risks of loss if the vendor is unable to meet its
obligation to repurchase. Under the Investment Company Act, repurchase
agreements are deemed to be collateralized loans of money by the Trust to the
seller. In evaluating whether to enter into a repurchase agreement, PAII will
consider carefully the creditworthiness of the vendor. If the member bank or
member firm that is the party to the repurchase agreement petitions for
bankruptcy or otherwise becomes subject to the U.S. Bankruptcy
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Code, the law regarding the rights of the Trust to enforce the terms of the
repurchase agreement is unsettled. The securities underlying a repurchase
agreement will be marked to market every business day so that the value of the
collateral is at least equal to the value of the loan, including the accrued
interest thereon, and PAII will monitor the value of the collateral. No specific
limitation exists as to the percentage of the Trust's assets which may be used
to participate in repurchase agreements.
REVERSE REPURCHASE AGREEMENTS
In general, the Trust does not engage, nor does it intend to engage in the
foreseeable future, in reverse repurchase agreements. The Trust has the ability,
however, pursuant to its investment objective and policies, to enter into
reverse repurchase agreements. A reverse repurchase agreement is an instrument
under which the Trust may sell an underlying debt instrument and simultaneously
obtain the commitment of the purchaser to sell the security back to the Trust at
an agreed upon price on an agreed upon date. Reverse repurchase agreements will
be considered borrowings by the Trust and as such are subject to the
restrictions on borrowing. Borrowings by the Trust create an opportunity for
greater total return, but at the same time, increase exposure to capital risk.
The Trust will maintain in a segregated account with its custodian cash or
liquid high grade portfolio securities in an amount sufficient to cover its
obligations with respect to reverse repurchase agreements. The Trust will
receive payment for such securities only upon physical delivery or evidence of
book entry transfer by its custodian. Regulations of the Commission require
either that securities sold by the Trust under a reverse repurchase agreement be
segregated pending repurchase or that the proceeds be segregated on the Trust's
books and records pending repurchase. Reverse repurchase agreements may involve
certain risks in the event of default or insolvency of the other party,
including possible loss from delays or restrictions upon the Trust's ability to
dispose of the underlying securities. An additional risk is that the market
value of securities sold by the Trust under a reverse repurchase agreement could
decline below the price at which the Trust is obligated to repurchase them.
LENDING SENIOR LOANS AND OTHER PORTFOLIO INSTRUMENTS
To generate additional income, the Trust may lend its portfolio securities,
including an interest in a Senior Loan, in an amount up to 33 1/3% of total
Trust assets to broker-dealers, major banks, or other recognized domestic
institutional borrowers of securities. No lending may be made with any companies
affiliated with PAII. During the time portfolio securities are on loan, the
borrower pays the Trust any dividends or interest paid on such securities, and
the Trust may invest the cash collateral and earn additional income, or it may
receive an agreed-upon amount of interest income from the borrower who has
delivered equivalent collateral or a letter of credit. As with other extensions
of credit, there are risks of delay in recovery or even loss of rights in the
collateral should the borrower fail financially.
The Trust may seek to increase its income by lending financial instruments in
its portfolio in accordance with present regulatory policies, including those of
the Board of Governors of the Federal Reserve System and the Commission. The
lending of financial instruments is a common practice in the securities
industry. The loans are required to be secured continuously by collateral,
consistent with the requirements of the Investment Company Act discussed below,
maintained on a current basis at an amount at least equal to the market value of
the portfolio instruments loaned. The Trust has the right to call a Senior Loan
and obtain the portfolio instruments loaned at any time on such notice as
specified in the transaction documents. For the duration of the Senior Loan, the
Trust will continue to receive the equivalent of the interest paid by the issuer
on the portfolio instruments loaned and may also receive compensation for the
loan of the financial instrument. Any gain or loss in the market price of the
instruments loaned that may occur during the term of the Senior Loan will be for
the account of the Trust.
The Trust may lend its portfolio instruments so long as the terms and the
structure of such loans are not inconsistent with the requirements of the
Investment Company Act, which currently require that (a) the borrower pledge and
maintain with the Trust collateral consisting of cash, a letter of credit issued
by a domestic U.S. bank, or securities issued or guaranteed by the U.S.
government having a value at all times not less than 100% of the value of the
instruments loaned, (b) the borrowers add to such collateral whenever the price
of the instruments loaned rises (i.e., the value of the loan is "marked to the
market" on a daily basis),
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(c) the loan be made subject to termination by the Trust at any time, and (d)
the Trust receive reasonable interest on the loan (which may include the Trust's
investing any cash collateral in interest bearing short-term investments), any
distributions on the loaned instruments and any increase in their market value.
The Trust may lend its portfolio instruments to member banks of the Federal
Reserve System, members of the NYSE or other entities determined by PAII to be
creditworthy. All relevant facts and circumstances, including the
creditworthiness of the qualified institution, will be monitored by PAII, and
will be considered in making decisions with respect to the lending of portfolio
instruments.
The Trust may pay reasonable negotiated fees in connection with loaned
instruments. In addition, voting rights may pass with the loaned securities, but
if a material event were to occur affecting such a loan, the Trust will retain
the right to call the loan and vote the securities. If a default occurs by the
other party to such transaction, the Trust will have contractual remedies
pursuant to the agreements related to the transaction but such remedies may be
subject to bankruptcy and insolvency laws which could materially and adversely
affect the Trust's rights as a creditor. However, the loans will be made only to
firms deemed by PAII to be of good financial standing and when, in the judgment
of PAII, the consideration which can be earned currently from loans of this type
justifies the attendant risk.
INTEREST RATE HEDGING TRANSACTIONS
Generally, the Trust does not engage, nor does it intend to engage, in the
foreseeable future, in interest rate swaps, or to purchase or sell interest rate
caps and floors. The Trust has the ability, however, pursuant to its investment
objectives and policies, to engage in certain hedging transactions including
interest rate swaps and the purchase or sale of interest rate caps and floors.
The Trust may undertake these transactions primarily for the following reasons:
to preserve a return on or value of a particular investment or portion of the
Trust's portfolio, to protect against decreases in the anticipated rate of
return on floating or variable rate financial instruments which the Trust owns
or anticipates purchasing at a later date, or for other risk management
strategies such as managing the effective dollar-weighted average duration of
the Trust's portfolio. Market conditions will determine whether and in what
circumstances the Trust would employ any of the hedging techniques described
below.
Interest rate swaps involve the exchange by the Trust with another party of
their respective commitments to pay or receive interest, e.g., an exchange of an
obligation to make floating rate payments on a specified dollar amount referred
to as the "notional" principal amount for an obligation to make fixed rate
payments. For example, the Trust may seek to shorten the effective interest rate
redetermination period of a Senior Loan in its portfolio that has an interest
rate redetermination period of one year. The Trust could exchange its right to
receive fixed income payments for one year from a borrower for the right to
receive payments under an obligation that readjusts monthly. In such event, the
Trust would consider the interest rate redetermination period of such Senior
Loan to be the shorter period. The purchase of an interest rate cap entitles the
purchaser, to the extent that a specified index exceeds a predetermined interest
rate, to receive payments of interest on a notional principal amount from the
party selling such interest rate cap. The purchase of an interest rate floor
entitles the purchaser, to the extent that a specified index falls below a
predetermined interest rate, to receive payments of interest on a notional
principal amount from the party selling such interest rate floor. The Trust will
not enter into swaps, caps or floors if, on a net basis, the aggregate notional
principal amount with respect to such agreements exceeds the net assets of the
Trust or to the extent the purchase of swaps, caps or floors would be
inconsistent with the Trust's other investment restrictions.
The Trust will not treat swaps covered in accordance with applicable regulatory
guidance as senior securities. The Trust will usually enter into interest rate
swaps on a net basis, i.e., where the two parties make net payments with the
Trust receiving or paying, as the case may be, only the net amount of the two
payments. The net amount of the excess, if any, of the Trust's obligations over
its entitlement with respect to each interest rate swap will be accrued and an
amount of cash or liquid securities having an aggregate net asset value ("NAV")
at least equal to the accrued excess will be maintained in a segregated account.
If the Trust enters into a swap on other than a net basis, the Trust will
maintain in the segregated account the full amount of the Trust's obligations
under each such swap. The Trust may enter into swaps, caps and floors with
member banks of the Federal Reserve System, members of the NYSE or other
entities determined by PAII. If a
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default occurs by the other party to such transaction, the Trust will have
contractual remedies pursuant to the agreements related to the transaction but
such remedies may be subject to bankruptcy and insolvency laws which could
materially and adversely affect the Trust's rights as a creditor.
The swap, cap and floor market has grown substantially in recent years with a
large number of banks and financial services firms acting both as principals and
as agents utilizing standardized swap documentation. As a result, this market
has become relatively liquid. There can be no assurance, however, that the Trust
will be able to enter into interest rate swaps or to purchase interest rate caps
or floors at prices or on terms PAII believes are advantageous to the Trust. In
addition, although the terms of interest rate swaps, caps and floors may provide
for termination, there can be no assurance that the Trust will be able to
terminate an interest rate swap or to sell or offset interest rate caps or
floors that it has purchased.
The successful utilization of hedging and risk management transactions requires
skills different from those needed in the selection of the Trust's portfolio
securities and depends on PAII's ability to predict correctly the direction and
degree of movements in interest rates. Although the Trust believes that use of
the hedging and risk management techniques described above will benefit the
Trust, if PAII's judgment about the direction or extent of the movement in
interest rates is incorrect, the Trust's overall performance would be worse than
if it had not entered into any such transactions. The Trust will incur brokerage
and other costs in connection with its hedging transactions.
BORROWING
Under the Investment Company Act, the Trust is not permitted to incur
indebtedness unless immediately after such incurrence the Trust has an asset
coverage of 300% of the aggregate outstanding principal balance of indebtedness.
Additionally, under the Investment Company Act, the Trust may not declare any
dividend or other distribution upon any class of its capital stock, or purchase
any such capital stock, unless the aggregate indebtedness of the Trust has at
the time of the declaration of any such dividend or distribution or at the time
of any such purchase an asset coverage of at least 300% after deducting the
amount of such dividend, distribution, or purchase price, as the case may be.
SUBORDINATED TRANCHES OF SENIOR LOANS
In connection with its purchase or holding of interests in Senior Loans, the
Trust may acquire, with up to 5% of the Trust's total assets, Senior Loans that
are subordinated in some manner as to the payment of interest and/or principal
to other Senior Loans or to other secured lenders (otherwise known as
"subordinated classes" or "subordinated tranches" of Senior Loans). Such
subordinated tranches of Senior Loans may be acquired to provide the Trust
opportunities to enhance Trust performance by obtaining higher interest rates
and/or higher fees.
Subordinated tranches of Senior Loans in an insolvency would bear an increased
share of the ultimate credit losses relative to other senior secured bank
lenders. The primary risk arising from a holder's subordination is the potential
loss in the event of default by the issuer of Senior Loans. The Trust, in this
instance, continues to be a senior, fully secured lender in these Senior Loans.
The Trust will only invest in such subordinated tranches when PAII believes that
the Trust would receive an appropriately higher interest rate and/or higher fees
in connection with its purchase as compensation for assuming this additional
risk.
ORIGINATING SENIOR LOANS
The Trust may act as an "agent" in originating and administering a loan on
behalf of all lenders or as one of a group of "co-agents" in originating Senior
Loans. Senior Loans are typically arranged through private negotiations between
a corporate borrower and several financial institutions ("lenders") represented
in each case by one or more such lenders acting as agent of the several lenders.
On behalf of the several lenders, the agent, which is frequently the entity that
originates the Senior Loan and invites the other parties to join the lending
syndicate, will be primarily responsible for negotiating the Senior Loan
agreements that establish the relative terms, conditions and rights of the
corporate borrower and the several lenders. The co-agents, on the other hand,
are not responsible for administration of a Senior Loan, but are part of the
initial group of lenders
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that commit to providing funding for a Senior Loan. In large transactions, it is
common to have several agents; however, one such agent typically has primary
responsibility for documentation and administration of the Senior Loan. The
agent is required to administer and manage the Senior Loan and to service or
monitor the collateral. The agent is also responsible for the collection of
principal and interest and fee payments from the corporate borrower and the
apportionment of these payments to the credit of all lenders which are parties
to the loan agreement. The agent is charged with the responsibility of
monitoring compliance by the corporate borrower with the restrictive covenants
in the loan agreement and of notifying the lenders of any adverse change in the
corporate borrower's financial condition. In addition, the agent generally is
responsible for determining that the lenders have obtained a perfected security
interest in the collateral securing the Senior Loan.
Lenders generally rely on the agent to collect their portion of the payments on
the Senior Loan and to use appropriate creditor remedies against the corporate
borrower. Typically under loan agreements, the agent is given broad discretion
in enforcing the loan agreement and is obligated to use the same care it would
use in the management of its own property. The corporate borrower compensates
the agent for these services. Such compensation may include special fees paid on
structuring and funding the Senior Loan and other fees paid on a continuing
basis. The precise duties and rights of an agent are defined in the loan
agreement.
When the Trust is an agent, it has, as a party to the loan agreement, a direct
contractual relationship with the corporate borrower and, prior to allocating
portions of the Senior Loan to the lenders, if any, assumes all risks associated
with the Senior Loan. The agent may enforce compliance by the corporate borrower
with the terms of the loan agreement. Agents also have voting and consent rights
under the applicable loan agreement. Action subject to agent vote or consent
generally requires the vote or consent of the holders of some specified
percentage of the outstanding principal amount of the Senior Loan, which
percentage varies depending on the relevant loan agreement. Certain decisions,
such as reducing the amount or increasing the time for payment of interest on or
repayment of principal of a Senior Loan, or releasing collateral therefor,
frequently require the unanimous vote or consent of all lenders affected.
Pursuant to the terms of a loan agreement, the Trust as agent typically has sole
responsibility for servicing and administering a loan on behalf of the other
lenders. Each lender in a Senior Loan is generally responsible for performing
their own credit analysis and their own investigation of the financial condition
of the corporate borrower. Generally, loan agreements will hold the Trust liable
for any action taken or omitted that amounts to gross negligence or willful
misconduct. In the event of a corporate borrower's default on a loan, the loan
agreements provide that the lenders do not have recourse against the Trust for
its activities as agent. Instead, lenders will be required to look to the
corporate borrower for recourse.
Acting in the capacity of an agent in a Senior Loan may subject the Trust to
certain risks in addition to those associated with the Trust's current role as a
lender. An agent is charged with the above described duties and responsibilities
to lenders and corporate borrowers subject to the terms of the loan agreement.
Failure to adequately discharge such responsibilities in accordance with the
standard of care set forth in the loan agreement may expose the Trust to
liability for breach of contract. If a relationship of trust is found between
the agent and the lenders, the agent will be held to a higher standard of
conduct in administering the loan. In consideration of such risks, the Trust
will invest no more than 10% of its total assets in Senior Loans in which it
acts as agent or co-agent and the size of any individual loan will not exceed 5%
of the Trust's total assets.
ADDITIONAL INFORMATION ON SENIOR LOANS
Senior Loans are direct obligations of corporations and are arranged by banks or
other commercial lending institutions and made generally to finance internal
growth, mergers, acquisitions, stock repurchases, and leveraged buyouts. Senior
Loans usually include restrictive covenants which must be maintained by the
borrowing corporation. Such covenants, in addition to the timely payment of
interest and principal, may include mandatory prepayment provisions arising from
free cash flow, restrictions on dividend payments and usually state that a
company must maintain specific minimum financial ratios as well as establishing
limits on total debt. A breach of a covenant, which is not waived by the agent,
is normally an event of acceleration, i.e., the agent has the right to call the
outstanding Senior Loan. In addition, loan covenants may include
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mandatory prepayment provisions stemming from free cash flow. Free cash flow is
cash that is in excess of capital expenditures plus debt service requirements of
principal and interest. The free cash flow shall be applied to prepay the Senior
Loan in an order of maturity described in the loan documents. Under certain
interests in Senior Loans, the Trust may have an obligation to make additional
loans upon demand by the corporate borrower. The Trust intends to reserve
against such contingent obligations by segregating sufficient assets in high
quality short-term liquid investments or borrowing to cover such obligations.
In a typical interest in a Senior Loan, the agent administers the loan and has
the right to monitor the collateral. The agent is also required to segregate the
principal and interest payments received from the corporate borrower and to hold
these payments for the benefit of the lenders. The Trust normally looks to the
agent to collect and distribute principal of and interest on a Senior Loan.
Furthermore, the Trust looks to the agent to use normal credit remedies, such as
to foreclose on collateral; monitor credit loan covenants; and notify the
lenders of any adverse changes in the corporation's financial condition or
declarations of insolvency. At times the Trust may also negotiate with the agent
regarding the agent's exercise of credit remedies under a Senior Loan. The agent
is compensated for these services by the corporate borrower as is set forth in
the loan agreement. Such compensation may take the form of a fee or other amount
paid upon the making of the Senior Loan and/or an ongoing fee or other amount.
The loan agreement in connection with Senior Loans sets forth the standard of
care to be exercised by the agents on behalf of the lenders and usually provides
for the termination of the agent's agency status in the event that it fails to
act properly, becomes insolvent, enters FDIC receivership, or if not FDIC
insured, enters into bankruptcy or if the agent resigns. In the event an agent
is unable to perform its obligations as agent, another lender would generally
serve in that capacity.
The Trust believes that the principal credit risk associated with acquiring
Senior Loans from another lender is the credit risk associated with the
corporate borrower of the underlying Senior Loan. The Trust may incur additional
credit risk, however, when the Trust acquires a participation in a Senior Loan
from another lender because the Trust must assume the risk of insolvency or
bankruptcy of the other lender from which the Senior Loan was acquired. However,
in acquiring Senior Loans, the Trust conducts an analysis and evaluation of the
financial condition of each such lender. In this regard, if the lenders have a
long-term debt rating, the long term debt of all such Participants is rated BBB
or better by Standard and Poor's Corporation or Baa or better by Moody's
Investors Service, Inc., or has received a comparable rating by another
nationally recognized rating service. In the absence of rated long-term debt,
the lenders or, with respect to a bank, the holding company of such lenders have
commercial paper outstanding which is rated at least A-1 by Standard and Poor's
Corporation or P-1 by Moody's Investors Service, Inc. In the absence of such
rated long-term debt or rated commercial paper if a bank, the Trust may acquire
participations in Senior Loans from lenders whose long-term debt and commercial
paper is of comparable quality to the foregoing rating standards as determined
by the Manager under the supervision of the Trustees. The Trust also diversifies
its portfolio with respect to lenders from which the Trust acquires Senior
Loans. See "Investment Restrictions."
Senior Loans, unlike certain bonds, usually do not have call protection. This
means that interests comprising the Trust's portfolio, while having a stated one
to ten-year term, may be prepaid, often without penalty. The weighted average
maturity of Senior Loans purchased is expected to be approximately
two-and-a-half years. The Trust generally holds Senior Loans to maturity unless
it has become necessary to sell them to satisfy any shareholder tender offers or
to adjust the Trust's portfolio in accordance with PAII's view of current or
expected economic or specific industry conditions.
Senior Loans usually require the prepayment of a loan when there are asset sales
or a securities issuance. Prepayments on Senior Loans may also be made by the
corporate borrower at its election. The rate of such prepayments may be affected
by, among other things, general business and economic conditions, as well as the
financial status of the corporate borrower. Prepayment would cause the actual
duration of a Senior Loan to be shorter than its stated maturity. This should,
however, allow the Trust to reinvest in a new loan and recognize as income any
unamortized loan fees. In many cases this will result in a new facility fee
payable to the Trust.
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Because interest rates paid on these Senior Loans periodically fluctuate with
the market, it is expected that the prepayment and a subsequent purchase of a
new Senior Loan by the Trust will not have a material adverse impact on the
yield of the portfolio. See "Portfolio Transactions."
Under a Senior Loan, the corporate borrower generally must pledge as collateral
assets which may include one or more of the following: cash; accounts
receivable; inventory; property, plant and equipment; and both common and
preferred stock in its subsidiaries. The market value of the assets serving as
collateral will, in the opinion of the Investment Manager, equal or exceed the
principal amount of the Senior Loan. The valuations of these assets may be
performed by an independent appraisal. If the agent becomes aware that the value
of the collateral has declined, the agent normally takes such action as it deems
necessary for the protection of its own interests and the interests of the other
lenders, including, for example, giving the corporate borrower an opportunity to
provide additional collateral or accelerating the loan. There is no assurance,
however, that the corporate borrower would provide additional collateral or that
the liquidation of the existing collateral would satisfy the corporate
borrower's obligation in the event of nonpayment of scheduled interest or
principal, or that such collateral could be readily liquidated.
The Trust may be required to pay and may receive various fees and commissions in
the process of purchasing, selling and holding Senior Loans. The fee component
may include any, or a combination of, the following elements: arrangement fees,
non-use fees, facility fees, letter of credit fees and ticking fees. Arrangement
fees are paid at the commencement of a loan as compensation for the initiation
of the transaction. A non-use fee is paid based upon the amount committed but
not used under the loan. Facility fees are on-going annual fees paid in
connection with a loan. Letter of credit fees are paid if a loan involves a
letter of credit. Ticking fees are paid from the initial commitment indication
until loan closing if for an extended period. The amount of fees is negotiated
at the time of transaction.
In order to allow national banks to purchase shares of the Trust for their own
accounts without limitation, the Trust invests only in obligations which are
eligible for purchase by national banks for their own accounts pursuant to the
provisions of paragraph seven of Section 24 of U.S. Code Title 12. National
banks which are contemplating purchasing shares of the Trust for their own
accounts should refer to Banking Circular 220, issued by the U.S. Comptroller of
the Currency on November 21, 1986, for a description of certain considerations
applicable to such purchases.
INVESTMENT RESTRICTIONS
The Trust has adopted the following restrictions relating to its investments and
activities, which may not be changed without a Majority Vote (as defined in the
Investment Company Act). The Trust may not:
- Issue senior securities, except insofar as the Trust may be deemed to
have issued a senior security by reason of (i) entering into certain
interest rate hedging transactions, (ii) entering into reverse repurchase
agreements, or (iii) borrowing money in an amount not exceeding 33 1/3%,
or such other percentage permitted by law, of the Trust's total assets
(including the amount borrowed) less all liabilities other than
borrowings.
- Invest more than 25% of its total assets in any industry.
- Invest in marketable warrants other than those acquired in conjunction
with Senior Loans and such warrants will not constitute more than 5% of
its assets.
- Make investments in any one issuer other than U.S. Government securities
if, immediately after such purchase or acquisition, more than 5% of the
value of the Trust's total assets would be invested in such issuer, or
the Trust would own more than 25% of any outstanding issue, except that
up to 25% of the Trust's total assets may be invested without regard to
the foregoing restrictions. For the purpose of the foregoing restriction,
the Trust will consider the corporate borrower of a Senior Loan to be the
issuer of such Senior Loan. In addition, with respect to a Senior Loan
under which the Trust does not have privity with the corporate borrower
or would not have a direct cause of action against the corporate
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borrower in the event of the failure of the borrower to pay scheduled
principal or interest, the Trust will also separately meet the foregoing
requirements and consider each interpositioned bank (a lender from which
the Trust acquires a Senior Loan) to be an issuer of the Senior Loan.
- Act as an underwriter of securities, except to the extent that it may be
deemed to act as an underwriter in certain cases when disposing of its
portfolio investments or acting as an agent or one of a group of
Co-Agents in originating Senior Loans.
- Purchase or sell equity securities (except that the Trust may, incidental
to the purchase or ownership of an interest in a Senior Loan, or as part
of a borrower reorganization, acquire, sell and exercise warrants and/or
acquire or sell other equity securities), real estate, real estate
mortgage loans, commodities, commodity futures contracts, or oil or gas
exploration or development programs; or sell short, purchase or sell
straddles, spreads, or combinations thereof, or write put or call
options.
- Make loans of money or property to any person, except that the Trust (i)
may hold Senior Loans in accordance with its investment objectives and
policies; (ii) may lend portfolio instruments; and (iii) may acquire
securities subject to repurchase agreements.
- Purchase shares of other investment companies, except in connection with
a merger, consolidation, acquisition or reorganization.
- Make investments on margin or hypothecate, mortgage or pledge any of its
assets except for the purpose of securing borrowings as described above
in connection with the issuance of senior securities and then only in an
amount up to 33 1/3%, or such other percentage permitted by law, of the
value of the Trust's total net assets (including the amount borrowed)
less all liabilities other than borrowings.
If a percentage restriction is adhered to at the time of investment, a later
increase or decrease in percentage resulting from a change in value of the
Trust's investments or amount of total assets will not be considered a violation
of any of the foregoing restrictions.
There is no limitation on the percentage of the Trust's assets that may be
invested in instruments which are not readily marketable or subject to
restrictions on resale, and to the extent the Trust invests in such instruments,
the Trust's portfolio should be considered illiquid. The extent to which the
Trust invests in such instruments may affect its ability to realize the NAV of
the Trust in the event of the voluntary or involuntary liquidation of its
assets.
TRUSTEES AND OFFICERS
BOARD OF TRUSTEES. The Trust is governed by its Board of Trustees. The Trustees
and Officers of the Trust are listed below. An asterisk (*) has been placed next
to the name of each Trustee who is an "interested person," as that term is
defined in the Investment Company Act, by virtue of that person's affiliation
with the Trust or PAII.
Mary A. Baldwin, Ph.D, 2525 E. Camelback Road, Suite 200, Phoenix, Arizona
85016. (Age 55.) Trustee. Realtor, The Prudential Arizona Realty, for more
than the last five years. Ms. Baldwin is also Treasurer, United States
Olympic Committee, and formerly was on the teaching staff at Arizona State
University. Ms. Baldwin also is a director and/or trustee of each of the
funds managed by the Investment Manager.
Al Burton, 2300 Coldwater Canyon, Beverly Hills, California 90210. (Age
67.) Trustee. President of Al Burton Productions, for more than the last
five years, and Executive Producer, Castle Rock Entertainment. Mr. Burton
also is a director and/or trustee of each of the funds managed by the
Investment Manager.
Bruce S. Foerster, 4045 Sheridan Avenue, Suite 432, Miami Beach, Florida
33140. (Age 55.) Trustee. President, South Beach Capital Markets Advisory
Corporation (since January 1995). Mr. Foerster was formerly Managing
Director, U.S. Equity Syndicate Desk, Lehman Brothers (June 1992-December
1994) and Managing Director, Equity Transactions Group/Equity Syndicate,
PaineWebber Incorporated (September 1984-May 1992). Mr. Foerster also is a
director and/or trustee of each of the funds managed by the Investment
Manager.
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<PAGE> 10
Jock Patton, 100 West Clarendon, Phoenix, Arizona 85013. (Age 49.) Trustee.
President, StockVal, Inc. (1992-present); director and co-owner, StockVal,
Inc. (1982-present); director of Artisoft, Inc. Mr. Patton was formerly a
partner and director of the law firm of Streich, Lang, P.A. (1972-1992).
Mr. Patton is also a director or trustee of each of the funds managed by
the Investment Manager.
*Robert W. Stallings, Two Renaissance Square, 40 North Central Avenue,
Suite 1200, Phoenix, AZ 85004. (Age 47.) Trustee and President. Chairman,
Chief Executive Officer and President of Pilgrim America Group, Inc.
("Pilgrim America Group" or the "Administrator") and PAII, and a director
of Pilgrim America Securities, Inc. ("PASI") since December 1994).
Chairman, Chief Executive Officer and President of Pilgrim America Bank and
Thrift Fund, Inc., Pilgrim Government Securities Income Fund, Inc., Pilgrim
America Investment Funds, Inc. and Pilgrim America Master Series, Inc.
(since April 1995). Chairman and Chief Executive Officer of Express America
Holdings Corporation ("Express America") (since August 1990) and Express
America Mortgage Corporation (since May 1991) and President of Express
America and Express America Mortgage Corporation (since December 1993). Mr.
Stallings formerly was Chairman and Chief Executive Officer of First
Western Partners, Inc., a consulting and management services firm to
financial institutions and private investors (February 1990-December 1991)
and Chairman and Chief Executive Officer of Western Savings & Loan Assoc.
(April 1989-February 1990).
The Board of Trustees has an Audit Committee comprised of the disinterested
Trustees. The Trust pays each Trustee who is not an interested person a pro rata
share, based on all of the investment companies in the Pilgrim America Group, of
(i) an annual retainer of $20,000; (ii) $1,500 per quarterly and special Board
meeting; (iii) $500 per committee meeting; (iv) $100 per special telephonic
meeting; and (v) out-of-pocket expenses. The pro rata share paid by the Trust is
based on the Trust's average net assets for the previous quarter as a percentage
of the average net assets of all the funds managed by PAII for which the
Trustees serve in common as directors/trustees.
COMPENSATION OF TRUSTEES
The following table sets forth information regarding compensation of Trustees by
the Trust and other funds managed by PAII for the fiscal year ended February 29,
1996. Officers of the Trust and Trustees who are interested persons of the Trust
do not receive any compensation from the Trust or any other funds managed by
PAII. In the column headed "Total Compensation From Registrant and Fund Complex
Paid to Trustees," the number in parentheses indicates the total number of
boards in the Pilgrim America family of funds on which the Trustee serves.
<TABLE>
<CAPTION>
TOTAL
COMPENSATION
FROM
AGGREGATE REGISTRANT
COMPENSATION AND FUND
FROM COMPLEX PAID
NAME OF PERSON, POSITION REGISTRANT TO TRUSTEES
- ---------------------------------------------------------------------------------------------
<S> <C> <C>
Mary A. Baldwin(1)(2), Trustee.................... $ 15,788 $24,800 (5 boards)
- ---------------------------------------------------------------------------------------------
Al Burton(2)(3), Trustee.......................... $ 16,288 $25,300 (5 boards)
- ---------------------------------------------------------------------------------------------
Bruce S. Foerster(1)(2), Trustee.................. $ 15,853 $24,900 (5 boards)
- ---------------------------------------------------------------------------------------------
Jock Patton(2)(4), Trustee........................ $ 10,556 $15,300 (5 boards)
- ---------------------------------------------------------------------------------------------
Robert W. Stallings(5), Trustee and Chairman...... $ 0 $ 0 (5 boards)
- ---------------------------------------------------------------------------------------------
</TABLE>
- ---------------
(1) Commenced service as a Trustee on April 7, 1995.
(2) Member of the Audit Committee.
(3) Commenced service as a Trustee in 1988.
(4) Commenced service as a Trustee on August 28, 1995.
(5) "Interested person," as defined in the Investment Company Act, of the Trust
because of the affiliation with the Investment Manager.
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<PAGE> 11
OFFICERS
James R. Reis, Executive Vice President
Two Renaissance Square, 40 North Central Avenue, Suite 1200, Phoenix,
Arizona 85004. (Age 39.) Mr. Reis serves in the capacity of Chief Credit
Officer for the Trust. Mr. Reis reviews each potential portfolio investment
based on the Portfolio Managers' recommendation prior to providing purchase
approval. Vice Chairman (since December 1994) and Executive Vice President
(since April 1995) of Pilgrim America Group and PAII and a director (since
December 1994) and Assistant Secretary (since January 1995) of PASI.
Executive Vice President of Pilgrim Government Securities Income Fund,
Inc., Pilgrim America Investment Funds, Inc., Pilgrim America Masters
Series, Inc., and Pilgrim America Bank and Thrift Fund, Inc. Vice Chairman
and Chief Financial Officer of Express America (since December 1993) and
President and Chief Financial Officer of Express America (May 1991-December
1993). Mr. Reis is also Vice Chairman (since December 1993) of Express
America Mortgage Corporation and formerly was President (May 1991-December
1993), and he was also the President and Chief Financial Officer of First
Western Partners, Inc. (February 1990-December 1991).
James M. Hennessy, Senior Vice President and Secretary
Two Renaissance Square, 40 North Central Avenue, Suite 1200, Phoenix,
Arizona 85004. (Age 47.) Mr. Hennessy serves in the capacity of counsel to
all of the funds in the Pilgrim America family of funds. In this capacity,
Mr. Hennessy monitors all matters relating to regulatory compliance for
Pilgrim America Group. Senior Vice President and Secretary, Express
America, Pilgrim America Group, PAII and PASI (since April 1995). Senior
Vice President and Secretary of Pilgrim Government Securities Income Fund,
Inc., Pilgrim America Investment Funds, Inc., Pilgrim America Masters
Series, Inc. and Pilgrim America Bank and Thrift Fund, Inc. Senior Vice
President, Express America Mortgage Corporation (June 1992-August 1994).
Mr. Hennessy was also the President of Beverly Hills Securities (January
1990-June 1992).
Daniel A. Norman, Senior Vice President and Assistant Portfolio Manager
Two Renaissance Square, 40 North Central Avenue, Suite 1200, Phoenix,
Arizona 85004. (Age 38.) Mr. Norman has served as Senior Vice President and
Assistant Portfolio Manager of the Trust since April 1995 and September
1996, respectively. Mr. Norman is a Senior Vice President of PAGI (since
April 1995), PAII (since April 1995), and PASI (since December 1994). Mr.
Norman was Senior Vice President of Express America (April 1995-July 1996)
and Express America Mortgage Corporation (February 1992-July 1996). Mr.
Norman was Chief Financial Officer of Prime Financial Inc. (December
1985-February 1992) and from 1981 to 1985 was employed by Arthur Andersen &
Co. Mr. Norman received an MBA from the University of Nebraska.
Michael J. Roland, CPA, Senior Vice President, Treasurer and Principal
Accounting Officer
Two Renaissance Square, 40 North Central Avenue, Suite 1200, Phoenix,
Arizona 85004. (Age 38.) Mr. Roland serves as the senior financial
accounting and compliance officer for all of the funds in the Pilgrim
America family of funds. Senior Vice President and Chief Financial Officer
of Pilgrim America Group, PAII and PASI (since April 1995). Senior Vice
President and Treasurer of Pilgrim Government Securities Income Fund, Inc.,
Pilgrim America Bank and Thrift Fund, Inc., Pilgrim America Masters Series,
Inc., and Pilgrim America Investment Funds, Inc. (since January 1995). From
July 1994 through December 1994, Partner at the consulting firm of
Corporate Savings Group in Newport Beach, California. From 1992 to June
1994, Vice President of Pacific Financial Asset Management Corp. Funds in
Newport Beach, California. From 1988 to 1992, Director of Financial
Reporting for Pacific Mutual Life Insurance Company in Newport Beach,
California.
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<PAGE> 12
Howard Tiffen, Senior Vice President and Senior Portfolio Manager
Two Renaissance Square, 40 North Central Avenue, Suite 1200, Phoenix,
Arizona 85004. (Age 47.) Mr. Tiffen is a Senior Vice President of PAII and
Senior Portfolio Manager of the Trust. He has had primary responsibility
for investment management of the Trust since November, 1995. Mr. Tiffen's
banking career spans more than 25 years. Mr. Tiffen served in a series of
positions in the lending and capital market functions at a major United
States bank for 13 years and has served in international investment banking
functions in Hong Kong, Malta, the Caribbean, Singapore, Thailand, and
Japan. From 1982 to November 1995, Mr. Tiffen worked for Bank of America
(and its predecessor, Continental Bank) in the following capacities:
Managing Director, Money Managers Group (1993-1995); Managing Director,
Loan Sales Trading (1990-1993); Managing Director, Distribution (London,
England, 1984-1990); and Vice President and Managing Director, Capital
Markets (1982-1984).
Michael Bacevich, Vice President and Assistant Portfolio Manager
Two Renaissance Square, 40 North Central Avenue, Suite 1200, Phoenix,
Arizona 85004. (Age 37.) Mr. Bacevich has served as Assistant Portfolio
Manager and Vice President of the Trust since December 1995 and September
1996, respectively. Mr. Bacevich is Vice President of PAGI and PAII (since
November 1995). Prior to joining Pilgrim America, Mr. Bacevich was a Vice
President with the Bank of America (and its predecessor, Continental Bank)
in its Leveraged Finance Group (July 1994-November 1995) and prior to that
in Special Assets Administration (July 1990-July 1994). Mr. Bacevich began
his banking career with Chemical Bank in June 1988. Prior to that time, Mr.
Bacevich was in the United States Army where he achieved the rank of
Captain (June 1981-August 1986). Mr. Bacevich is a graduate of West Point
and received an MBA from the University of Chicago.
As of October 18, 1996, the Trustees and Officers of the Trust as a group owned
beneficially less than 1% of the Trust's shares.
INVESTMENT MANAGEMENT AND OTHER SERVICES
INVESTMENT MANAGER. The Investment Manager serves as investment manager to the
Trust and has overall responsibility for the management of the Trust. The
Investment Management Agreement between the Trust and the Investment Manager
requires the Investment Manager to oversee the provision of all investment
advisory services for the Trust. The Investment Manager, which was organized in
December 1994, is registered as an investment adviser with the Commission and
serves as investment adviser to seven other registered investment companies (or
series thereof) and as of October 18, 1996 had total assets under management of
approximately $1.8 billion.
The Investment Manager is a wholly-owned subsidiary of Pilgrim America Group,
which itself is a wholly-owned subsidiary of Express America, a Delaware
corporation, the shares of which are traded on the NASDAQ National Market System
and which is a holding company that through its subsidiaries engages in the
financial services business. On May 16, 1991, Express America acquired a now
discontinued mortgage banking operation from the Resolution Trust Corporation
("RTC") following a competitive bidding process. On December 8, 1995, the RTC
filed a complaint in the United States District Court of Arizona against Express
America, its Chief Executive Officer, who is also Chairman and an officer of the
Trust, its Chief Financial Officer, who is also an officer of the Trust, and
others, including Smith Barney, Harris Upham & Co., Incorporated and Rauscher
Pierce Refsnes, Inc. The RTC's complaint alleges various irregularities in the
bidding process and the closing of the acquisition. The RTC has asked for at
least $20 million in actual damages and at least $60 million in punitive damages
from all defendants.
Express America and the officers have advised the Trust that they believe they
have meritorious defenses to the claims brought by the RTC, and that the
litigation is unlikely to have a material adverse effect on the operations of
the Investment Manager.
The Investment Manager pays all of its expenses arising from the performance of
its obligations under the Investment Management Agreement, including executive
salaries and expenses of the Trustees and Officers of
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<PAGE> 13
the Trust who are employees of the Investment Manager or its affiliates. Other
expenses incurred in the operation of the Trust are borne by the Trust,
including, without limitation, expenses incurred in connection with the sale,
issuance, registration and transfer of its shares; fees of its Custodian,
Transfer and Shareholder Servicing Agent; salaries of officers and fees and
expenses of Trustees or members of any advisory board or committee of the Trust
who are not members of, affiliated with or interested persons of the Investment
Manager; the cost of preparing and printing reports, proxy statements and
prospectuses of the Trust or other communications for distribution to its
shareholders; legal, auditing and accounting fees; the fees of any trade
association of which the Trust is a member; fees and expenses of registering and
maintaining registration of its shares for sale under Federal and applicable
State securities laws; and all other charges and costs of its operation plus any
extraordinary and non-recurring expenses.
For the fiscal years ended February 29, 1996, and February 28, 1995 and 1994,
PAII (or, prior to April 7, 1995, its predecessor) was paid $7,122,089,
$6,196,871, and $6,133,835 for services rendered to the Trust. For further
information on fees, see the Prospectus.
The Investment Management Agreement continues from year to year if specifically
approved at least annually by the Trustees or the Shareholders. But in either
event, the Investment Management Agreement must also be approved by vote of a
majority of the Trustees who are not parties to the Investment Management
Agreement or "interested persons" of any such party, cast in person at a meeting
called for that purpose.
The use of the name "Pilgrim" in the Trust's name is pursuant to a license
granted by PAII, and in the event the Investment Management Agreement is
terminated, the Trust has agreed to amend its Agreement and Declaration of Trust
to remove the reference to "Pilgrim."
THE ADMINISTRATOR. The Administrator of the Trust is Pilgrim America Group,
which is an affiliate of the Investment Manager. In connection with its
administration of the corporate affairs of the Trust, the Administrator bears
the following expenses: the salaries and expenses of all personnel of the Trust
and the Administrator except for the fees and expenses of Trustees not
affiliated with the Administrator or PAII; costs to prepare information for
determination of daily NAV by the recordkeeping and accounting agent; expenses
to maintain certain of the Trust's books and records that are not maintained by
PAII, the custodian, or transfer agent; costs incurred to assist in the
preparation of financial information for the Trust's income tax returns, proxy
statements, quarterly, semi-annual, and annual shareholder reports; costs of
providing shareholder services in connection with any tender offers or to
shareholders proposing to transfer their shares to a third party; providing
shareholder services in connection with the dividend reinvestment plan; and all
expenses incurred by the Administrator or by the Trust in connection with
administering the ordinary course of the Trust's business other than those
assumed by the Trust, as described below.
Except as indicated above and under "Investment Management Agreement," the Trust
is responsible for the payment of its other expenses including: the fees payable
to PAII; the fees payable to the Administrator; the fees and expenses of
Trustees who are not affiliated with PAII or the Administrator; the fees and
certain expenses of the Trust's custodian and transfer agent, including the cost
of providing records to the Administrator in connection with its obligation of
maintaining required records of the Trust; the charges and expenses of the
Trust's legal counsel and independent accountants; commissions and any issue or
transfer taxes chargeable to the Trust in connection with its transactions; all
taxes and corporate fees payable by the Trust to governmental agencies; the fees
of any trade association of which the Trust is a member; the cost of share
certificates representing shares of the Trust; organizational and offering
expenses of the Trust and the fees and expenses involved in registering and
maintaining registration of the Trust and of its shares with the Commission
including the preparation and printing of the Trust's registration statement and
prospectuses for such purposes; allocable communications expenses, with respect
to investor services and all expenses of shareholders and Trustees' meetings and
of preparing, printing and mailing reports, proxy statements and prospectuses to
shareholders; and the cost of insurance; and litigation and indemnification
expenses and extraordinary expenses not incurred in the ordinary course of the
Trust's business.
For the fiscal years ended February 29, 1996 and February 28, 1995 and 1994,
PAGI (or, prior to April 7, 1995, its predecessor) was paid $1,264,932,
$1,098,740, and $1,086,767 for services rendered to the Trust. For further
information on fees, see the Prospectus.
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<PAGE> 14
PORTFOLIO TRANSACTIONS
The Trust will generally have at least 80% of its net assets invested in Senior
Loans. The remaining assets of the Trust will generally consist of short-term
debt instruments with remaining maturities of 120 days or less and certain other
instruments such as interest rate swaps, caps and floors, repurchase agreements
and reverse repurchase agreements. The Trust will acquire Senior Loans from and
sell Senior Loans to major money center banks, selected regional banks and
selected non-banks, insurance companies, finance companies and leasing companies
which usually act as lenders on senior collateralized loans. The Trust may also
purchase Senior Loans from and sell Senior Loans to U.S. branches of foreign
banks which are regulated by the Federal Reserve System or appropriate state
regulatory authorities. The Trust's interest in a particular Senior Loan will
terminate when the Trust receives full payment on the loan or sells a Senior
Loan in the secondary market. Costs associated with purchasing or selling Senior
Loans in the secondary market include commissions paid to brokers and processing
fees paid to agents. These costs are allocated between the purchaser and seller
as agreed between the parties.
Purchases and sales of short-term debt and other financial instruments for the
Trust's portfolio usually are principal transactions, and normally the Trust
will deal directly with the underwriters or dealers who make a market in the
securities involved unless better prices and execution are available elsewhere.
Such market makers usually act as principals for their own account. On occasion,
securities may be purchased directly from the issuer. Short-term debt
instruments are generally traded on a net basis and do not normally involve
either brokerage commissions or transfer taxes. The cost of portfolio securities
transactions of the Trust that are not transactions with principals will consist
primarily of brokerage commissions or dealer or underwriter spreads between the
bid and asked price, although purchases from underwriters may involve a
commission or concession paid by the issuer.
While PAII seeks to obtain the most favorable net results in effecting
transactions in the Trust's portfolio securities, brokers or dealers who provide
research services may receive orders for transactions by the Trust. Such
research services ordinarily consist of assessments and analyses of the business
or prospects of a company, industry, or economic sector. If, in the judgment of
PAII, the Trust will benefit from such research services, PAII is authorized to
pay spreads or commissions to brokers or dealers furnishing such services which
are in excess of spreads or commissions that other brokers or dealers not
providing such research may charge for the same transaction. Information so
received will be in addition to, and not in lieu of, the services required to be
performed by PAII under the Investment Management Agreement between PAII and the
Trust. The expenses of PAII will not necessarily be reduced as a result of the
receipt of such supplemental information. PAII may use any research services
obtained for the benefit of the Trust in providing investment advice to its
other investment advisory accounts. Conversely, such information obtained by the
placement of business for PAII or other entities advised by PAII will be
considered by and may be useful to PAII in carrying out its obligations to the
Trust.
The Trust does not intend to effect any brokerage transaction in its portfolio
securities with any broker-dealer affiliated directly or indirectly with the
Investment Manager, except for any sales of portfolio securities pursuant to a
tender offer, in which event the Investment Manager will offset against the
management fee a part of any tender fees which legally may be received by such
affiliated broker-dealer. To the extent certain services which the Trust is
obligated to pay for under the Investment Management Agreement are performed by
the Investment Manager, the Trust will reimburse the Investment Manager for the
costs of personnel involved in placing orders for the execution of portfolio
transactions.
The Trust paid $7,400, $8,544 and $0 in brokerage commissions during the fiscal
years ended February 29, 1996, February 28, 1995 and February 28, 1994,
respectively.
PORTFOLIO TURNOVER RATE
The annual rate of the Trust's total portfolio turnover for the years ended
February 29, 1996 and February 28, 1995 and 1994, was 88%, 108% and 87%,
respectively. The annual turnover rate of the Trust is generally expected to be
between 50% and 100%, although as part of its investment policies, the Trust
places no restrictions on portfolio turnover and the Trust may sell any
portfolio security without regard to the period of
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<PAGE> 15
time it has been held. The annual turnover rate of the Trust also includes
Senior Loans for which the full payment on the Senior Loan has been prepaid by
the corporate borrower. The Investment Manager believes that prepaid Senior
Loans generally comprise approximately 25% to 75% of the Trust's total portfolio
turnover each year.
NET ASSET VALUE
The NAV per share is determined once daily as of the close of trading on the
NYSE on each day it is open, by dividing the value of the Trust's portfolio
securities plus all cash and other assets (including dividends accrued but not
collected) less all liabilities (including accrued expenses but excluding
capital and surplus) by the number of shares outstanding. In accordance with
generally accepted accounting principles for investment companies, dividend
income is accrued on the ex-dividend date. The NAV per share is made available
for publication.
The value of a Senior Loan is determined by obtaining market quotations. Senior
Loans are valued at fair value in the absence of readily ascertainable market
values. Fair value is determined by PAII under procedures established and
monitored by the Trust's Board of Trustees. In valuing a loan, PAII considers,
among other factors: (i) the creditworthiness of the corporate issuer and any
interpositioned bank; (ii) the current interest rate, period until next interest
rate reset and maturity date of the Senior Loan; (iii) recent market prices for
similar loans, if any; and (iv) recent prices in the market for instruments with
similar quality, rate, period until next interest rate reset, maturity, terms
and conditions, if any. PAII may also consider prices or quotations, if any,
provided by banks, dealers or pricing services which may represent the prices at
which secondary market transactions in the loans held by the Trust have or could
have occurred. However, because the secondary market in Senior Loans has not yet
fully developed, PAII will not currently rely solely on such prices or
quotations. Securities for which the primary market is a national securities
exchange or the NASDAQ National Market System are stated at the last reported
sale price on the day of valuation. Debt and equity securities traded in the
over-the-counter market and listed securities for which no sale was reported on
that date are valued at the mean between the last reported bid and asked price.
Securities other than Senior Loans for which reliable quotations are not readily
available and all other assets will be valued at their respective fair values as
determined in good faith by, or under procedures established by, the Board of
Trustees of the Trust. Investments in securities maturing in less than 60 days
are valued at amortized cost, which when combined with accrued interest,
approximates market value.
METHODS AVAILABLE TO REDUCE MARKET VALUE DISCOUNT FROM NAV
In recognition of the possibility that the Trust's shares may trade at discount
to NAV, the Trustees have determined that it would be in the best interest of
Shareholders for the Trust to take action to attempt to reduce or eliminate a
market value discount from NAV. To that end, the Trustees presently contemplate
that the Trust will take action either to repurchase in the open market or to
consider the making of tender offers to purchase its own shares at NAV. Since
Trust shares became listed on the NYSE on March 9, 1992, the Trust has
authorized two repurchase programs and has not conducted any tender offers. The
Trustees presently intend each quarter to consider the making of such tender
offers. The Trustees will at no time be required to make such tender offers.
Moreover, there can be no assurance that tender offers will result in the
Trust's shares trading at a price which is equal to their NAV. The Trust
anticipates that the market price may, among other things, be determined by the
relative demand for and supply of such shares in the market, the Trust's
investment performance, the Trust's yield, and investor perception of the
Trust's overall attractiveness as an investment as compared with other
investment alternatives.
In deciding whether the Trust will entertain tender offers and whether it will
accept shares tendered, the Trustees will consider several factors. One of the
principal factors in the Board's determinations on whether or not to make
quarterly offers will be the strength of the public market for the Trust's
shares. Other factors include the desire to reduce or eliminate a market value
discount from NAV. In addition, the Trustees will take into consideration the
liquidity of its assets in determining whether to make a tender offer or accept
tendered shares. In paying shareholders for tendered shares, the Trust
anticipates that it will use cash on hand,
15
<PAGE> 16
such as proceeds from sales of new Trust shares and specified pay-downs from
Senior Loans, and proceeds from the sale of cash equivalents held by the Trust.
The Trust may also borrow to pay Shareholders for tendered shares. To the extent
more shares are anticipated to be tendered or are tendered than could be paid
for out of such amounts, the liquidity of the Senior Loans held by the Trust may
be a consideration in the Trust's determination whether to make a tender offer
or, if an offer is made, in its determination of whether it will accept shares
tendered. Accepting tendered shares may require the Trust to sell portfolio
investments and incur certain costs which it otherwise would not have. Under
most Senior Loans, it will be necessary for the Trust to obtain the consent of
the agent or lender from whom the Trust purchased the Senior Loan prior to
selling the Senior Loan to a third party. Senior Loans such as those the Trust
intends to invest in have historically been considered by the investment
community to be liquid assets, although in certain instances, the conversion of
such instruments into cash has taken several days or longer. The market for
Senior Loans is relatively new as compared to markets for more established debt
instruments. Accordingly, while PAII does not anticipate any material difficulty
in meeting the liquidity needs for tender offers, there can be no guarantee that
the Trust will be able to liquidate a particular Senior Loan it holds within a
given period of time.
Furthermore, even if a tender offer has been made, it is the Trustees' announced
policy, which may be changed by the Trustees, not to effect tender offers or
accept tenders if: (1) such transactions, if consummated, would impair the
Trust's status as a regulated investment company under the Internal Revenue Code
(which would make the Trust a taxable entity, causing its income to be taxed at
the corporate level in addition to the taxation of shareholders who receive
dividends from the Trust) or (2) there is, in the judgment of the Trustees, any
(a) material legal action or proceeding instituted or threatened challenging
such transactions or otherwise materially adversely affecting the Trust, (b)
declaration of a banking moratorium by federal or state authorities or any
suspension of payment by banks in the United States, (c) limitation affecting
the Trust or the issuers of its portfolio instruments imposed by federal or
state authorities on the extension of credit by lending institutions or on the
exchange of foreign currency, (d) commencement of war, armed hostilities or
other international or national calamity directly or indirectly involving the
United States, or (e) other event or condition which would have a material
adverse effect on the Trust or its shareholders if shares were repurchased. The
Trustees may modify these conditions in light of experience.
Any tender offer made by the Trust will be at a price equal to the NAV of the
shares. Each shareholder will be notified in accordance with the requirements of
the Securities Exchange Act of 1934 and the Investment Company Act, either by
publication or mailing or both. Each offering document will contain such
information as is prescribed by such laws and the rules and regulations
promulgated thereunder. Other procedures to be used in connection with a
particular tender offer will be determined by the Trustees in accordance with
the provisions of applicable law, including the Securities Exchange Act of 1934.
Any tender offer that the Trust makes may have the effect of reducing
shareholder return as a result of the expenses incurred with respect to the
tender offers, the reduced level of interest earned on the money received by the
Trust as payment for shares newly purchased which may be held in cash
equivalents in anticipation of tender offers, and the cost of borrowing money to
fund the tender offers.
DIVIDEND REINVESTMENT AND CASH PURCHASE PLAN
The Trust maintains a Dividend Reinvestment and Cash Purchase Plan (the "Plan"),
which allows participating shareholders to reinvest all dividends and capital
gain distributions in additional shares of the Trust. The Plan also allows
participants to make voluntary purchases monthly through IFTC (the "Plan
Agent"), in amounts ranging from a minimum of $100 to a maximum of $5,000 (such
minimum and maximum may be waived at management's discretion). IFTC establishes
a Dividend Investment Account (the "Account") for each shareholder participating
in the Plan and credits to each participant's Account funds it receives from:
(a) dividends and capital gain distributions paid on Trust shares registered in
the participant's name; and (b) voluntary cash contributions. If on the close of
business on the Trust's dividend valuation date the market price (the average of
sale prices, per share, as reported on the NYSE Composite Transaction Tape) plus
commissions is less than the NAV, funds credited to a participant's Account will
be used to purchase shares. If the market price, plus estimated commissions, of
the shares equals or exceeds their
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NAV at the close of business on such valuation date, the Trust will issue shares
valued at NAV per share to IFTC in the aggregate amount of the distributions
credited to the participants' Accounts.
Shareholders may elect to withdraw from the Plan at any time by giving IFTC
written notice. When a participant withdraws from the Plan, or when the Plan is
terminated or amended, the participant will receive a certificate for full
shares in the Account, plus a check for any fractional shares based on market
price; or if a participant so desires, upon receipt of a request with signature
guaranteed and a properly completed W-9, IFTC will sell such Shares in the Plan
and send the proceeds to the participant less brokerage commissions.
The automatic reinvestment of dividends and capital gain distributions does not
affect the tax characterization of the dividends and capital gains (i.e.,
capital gains and income are realized even though cash is not received). There
are no direct brokerage charges nor service charges to participants for
reinvesting dividends and capital gain distributions or purchases made with
voluntary cash payments. However, each participant will pay a pro rata share of
brokerage commissions with respect to IFTC's open market purchases in connection
with the reinvestment of distributions and voluntary cash contributions.
In accordance with Section 23(c) of the Investment Company Act and Rule 23c-1
thereunder, the Trust may from time to time purchase shares of beneficial
interest of the Trust in the open market in connection with the Plan.
See "Tax Matters -- Distributions" for a discussion of the federal income tax
ramifications of obtaining Shares under the Plan.
TAX MATTERS
The following is only a summary of certain U.S. federal income tax
considerations generally affecting the Trust and its shareholders. No attempt is
made to present a detailed explanation of the tax treatment of the Trust or its
shareholders, and the following discussion is not intended as a substitute for
careful tax planning. Shareholders should consult with their own tax advisers
regarding the specific federal, state, local, foreign and other tax consequences
of investing in the Trust.
QUALIFICATION AS A REGULATED INVESTMENT COMPANY
The Trust has elected to be taxed as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a
regulated investment company, the Trust generally is not subject to federal
income tax on the portion of its investment company taxable income (i.e.,
taxable interest, dividends and other taxable ordinary income, net of expenses,
and net short-term capital gains in excess of net long-term capital losses) and
net capital gains (i.e., the excess of net long-term capital gains over net
short-term capital losses) that it distributes to shareholders, provided that it
distributes at least 90% of its investment company taxable income for the
taxable year (the "Distribution Requirement"), and satisfies certain other
requirements of the Code that are described below.
In addition to satisfying the Distribution Requirement and an asset
diversification requirement discussed below, a regulated investment company must
(1) derive at least 90% of its gross income from dividends, interest, certain
payments with respect to securities loans, gains from the sale or other
disposition of stock or securities or foreign currencies and other income
(including, but not limited to, gains from options, futures or forward
contracts) derived with respect to its business of investing in such stock,
securities or currencies; and (2) derive less than 30% of its gross income from
the sale or other disposition of stock, securities or foreign currencies (or
options, futures or forward contracts thereon) held for less than three months
(the "Short-Short Test"). However, foreign currency gains, including those
derived from options, futures and forwards, will not in any event be
characterized as Short-Short if they are directly related to the regulated
investment company's investment in stock or securities (or options or futures
thereon). Because of the Short-Short Test, the Trust may have to limit the sale
of appreciated securities that it has held for less than three months.
In general, gain or loss recognized by the Trust on the disposition of an asset
will be a capital gain or loss. However, gain recognized on the disposition of a
debt obligation purchased by the Trust other than at original
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issue at a market discount (generally, at a price less than its principal
amount) will be treated as ordinary income to the extent of the portion of the
market discount which accrued during the period of time the Trust held the debt
obligation.
In general, investments by the Trust in zero coupon or other original issue
discount securities will result in income to the Trust equal to a portion of the
excess of the face value of the securities over their issue price (the "original
issue discount") each year that the Trust holds the securities, even though the
Trust receives no cash interest payments. This income is included in determining
the amount of income which the Trust must distribute to maintain its status as a
regulated investment company and to avoid federal income and excise taxes.
In addition to satisfying the requirements described above, the Trust must
satisfy an asset diversification test in order to qualify as a regulated
investment company. Under this test, at the close of each quarter of the Trust's
taxable year, at least 50% of the value of the Trust's assets must consist of
cash and cash items (including receivables), U.S. Government securities,
securities of other regulated investment companies, and securities of other
issuers (as to which the Trust has not invested more than 5% of the value of the
Trust's total assets in securities of any such issuer and as to which the Trust
does not hold more than 10% of the outstanding voting securities of any such
issuer), and no more than 25% of the value of its total assets may be invested
in the securities of any one issuer (other than U.S. Government securities and
securities of other regulated investment companies), or in two or more issuers
which the Trust controls and which are engaged in the same or similar trades or
businesses.
If for any taxable year the Trust does not qualify as a regulated investment
company, all of its taxable income (including its net capital gain) will be
subject to tax at regular corporate rates without any deduction for
distributions to shareholders, and such distributions will be taxable as
ordinary dividends to the extent of the Trust's current and accumulated earnings
and profits. Such distributions generally will be eligible for the
dividends-received deduction in the case of corporate shareholders.
EXCISE TAX ON REGULATED INVESTMENT COMPANIES
A 4% non-deductible excise tax is imposed on a regulated investment company that
fails to distribute in each calendar year an amount equal to at least 98% of
ordinary taxable income for the calendar year, at least 98% of capital gain net
income (i.e., capital gains in excess of capital losses) for the one-year period
ended on October 31 of such calendar year and any ordinary taxable income and
capital gain net income for previous years that was not distributed during those
years. A distribution will be treated as paid on December 31 of the current
calendar year if it is declared by the Trust in October, November or December
with a record date in such a month and paid by the Trust during January of the
following calendar year. Such distributions will be taxable to shareholders in
the calendar year in which the distributions are declared, rather than the
calendar year in which the distributions are received.
The Trust intends to make sufficient distributions or deemed distributions of
its ordinary taxable income and capital gain net income to avoid liability for
the excise tax.
DISTRIBUTIONS
The Trust anticipates distributing substantially all of its investment company
taxable income for each taxable year. Such distributions will be taxable to
shareholders as ordinary income. If a portion of the Trust's income consists of
dividends paid by U.S. corporations, a portion of the dividends paid by the
Trust may be eligible for the corporate dividends received deduction.
The Trust may either retain or distribute to shareholders its net capital gain
for each taxable year. The Trust currently intends to distribute any such
amounts. If net capital gain is distributed and designated as a capital gain
dividend, it will be taxable to shareholders as long-term capital gain,
regardless of the length of time the shareholder has held his shares.
Conversely, if the Trust elects to retain its net capital gain, the Trust will
be taxed thereon (except to the extent of any available capital loss carryovers)
at the 35% corporate tax rate. In such event, it is expected that the Trust also
will elect to treat such gain as having been distributed to
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shareholders. As a result, each shareholder will be required to report his pro
rata share of such gain on his tax return as long-term capital gain, will be
entitled to claim a tax credit for his pro rata share of tax paid by the Trust
on the gain, and will increase the tax basis for his shares by an amount equal
to the deemed distribution less the tax credit.
Distributions by the Trust in excess of the Trust's earnings and profits will be
treated as a return of capital to the extent of (and in reduction of) the
shareholder's tax basis in his shares; any such return of capital distributions
in excess of the shareholder's tax basis will be treated as gain from the sale
of his shares, as discussed below.
Distributions by the Trust will be treated in the manner described above
regardless of whether such distributions are paid in cash or reinvested in
additional shares of the Trust. If the NAV at the time a shareholder purchases
shares of the Trust reflects undistributed income or gain, distributions of such
amounts will be taxable to the shareholder in the manner described above, even
though such distributions economically constitute a return of capital to the
shareholder.
The Trust will be required in certain cases to withhold and remit to the U.S.
Treasury 31% of all taxable distributions payable to any shareholder (1) who
fails to provide the Trust with a certified, correct tax identification number
or other required certifications, or (2) who is notified by the Internal Revenue
Service that he or she is subject to backup withholding for failure to report
the receipt of interest or dividend income properly.
SALE OF SHARES
A shareholder will recognize gain or loss on the sale or exchange of shares of
the Trust in an amount generally equal to the difference between the proceeds of
the sale and the shareholder's adjusted tax basis in the shares. In general, any
such gain or loss will be considered capital gain or loss and will be long-term
capital gain or loss if the shares were held for longer than one year. However,
any capital loss arising from the sale of shares held for six months or less
will be treated as a long-term capital loss to the extent of any long-term
capital gains distributed (or deemed distributed) with respect to such shares.
Also, any loss realized on a sale or exchange of shares will be disallowed to
the extent the shares disposed of are replaced within a period of 61 days
beginning 30 days before and ending 30 days after the shares are disposed of. In
such case, the tax basis of the acquired shares will be adjusted to reflect the
disallowed loss.
FOREIGN SHAREHOLDERS
U.S. taxation of a shareholder who, as to the United States, is a nonresident
alien individual, foreign trust or estate, foreign corporation, or foreign
partnership ("foreign shareholder") depends on whether the income from the Trust
is "effectively connected" with a U.S. trade or business carried on by such
shareholder.
If the income from the Trust is not effectively connected with a U.S. trade or
business carried on by a foreign shareholder, distributions of investment
company taxable income will be subject to U.S. withholding tax at the rate of
30% (or lower treaty rate). Such a foreign shareholder would generally be exempt
from U.S. federal income tax on gains realized on the sale or exchange of shares
of the Trust, capital gain dividends, and amounts retained by the Trust that are
designated as undistributed capital gains.
If the income from the Trust is effectively connected with a U.S. trade or
business carried on by a foreign shareholder, then distributions of investment
company taxable income, capital gain dividends, amounts retained by the Trust
that are designated as undistributed capital gains and any gains realized upon
the sale or exchange of shares of the Trust will be subject to U.S. federal
income tax at the rates applicable to U.S. citizens or domestic corporations.
Such shareholders that are classified as corporations for U.S. tax purposes also
may be subject to a branch profits tax.
In the case of foreign noncorporate shareholders, the Trust may be required to
withhold U.S. federal income tax at a rate of 31% on distributions that are
otherwise exempt from withholding tax (or taxable at a reduced treaty rate)
unless such shareholders furnish the Trust with proper notification of their
foreign status.
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The tax consequences to a foreign shareholder entitled to claim the benefits of
an applicable tax treaty may be different from those described herein. Foreign
shareholders are urged to consult their own tax advisers with respect to the
particular tax consequences to them of an investment in the Trust, including the
applicability of foreign taxes.
EFFECT OF FUTURE LEGISLATION; OTHER TAX CONSIDERATIONS
The foregoing general discussion of U.S. federal income tax consequences is
based on the Code and the Treasury Regulations issued thereunder as in effect on
the date of this SAI. Future legislative or administrative changes or court
decisions may significantly change the conclusions expressed herein, and any
such changes or decisions may have a retroactive effect with respect to the
transactions contemplated herein.
Income received by the Trust from foreign sources may be subject to withholding
and other taxes imposed by such foreign jurisdictions, absent treaty relief.
Distributions to shareholders also may be subject to state, local and foreign
taxes, depending upon each shareholder's particular situation. Shareholders are
urged to consult their tax advisers as to the particular consequences to them of
an investment in the Trust.
ADVERTISING AND PERFORMANCE DATA
ADVERTISING
From time to time advertisements and other sales materials for the Trust may
include information concerning the historical performance of the Trust. Any such
information may include annual total return, aggregate total return,
distribution rate, average compounded distribution rate and yield of the Trust
for specified periods of time. Such information may also include performance
rankings and similar information from independent organizations such as Lipper
Analytical Services, Inc. ("Lipper"), Morningstar, or other industry
publications.
On occasion, the Trust may quote total return calculations published by Lipper,
a widely recognized independent publication that monitors the performance of
both open and closed-end investment companies. The Trust may also cite
investment company rankings published by Lipper based on total return. These
rankings will typically compare the Trust to other Senior Loan funds and also to
taxable closed-end fixed income funds. The Trust may also refer to ratings
received for its overall risk-adjusted performance from Morningstar, another
widely recognized independent publisher of investment company ratings. Any such
use of rankings and ratings in advertisements and sales literature will conform
with the guidelines proposed by the NASD and subsequently approved by the
Commission on July 13, 1994. Ranking comparisons and ratings should not be
considered representative of the Trust's relative performance for any future
period.
In addition, the Trust may compare its yield to (i) the prime rate, quoted daily
in The Wall Street Journal as the base rate on corporate loans at large U.S.
money center commercial banks, (ii) one or more averages compiled by Donoghue's
Money Fund Report, a widely recognized independent publication that monitors the
performance of money market mutual funds, (iii) the average yield reported by
the Bank Rate Monitor National Index for money market deposit accounts offered
by the 100 leading banks and thrift institutions in the ten largest standard
metropolitan statistical areas, (iv) yield data published by Lipper, or (v) the
yield on an investment in 90-day Treasury bills on a rolling basis, assuming
quarterly compounding. Also, the Trust may compare such other yield data
described above to each other. As with yield and total return calculations,
yield comparisons should not be considered representative of the Trust's yield
or relative performance for any future period.
PERFORMANCE DATA
The Trust may quote annual total return and aggregate total return performance
data. Total return quotations for the specified periods will be computed by
finding the rate of return (based on net investment income and
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any capital gains or losses on portfolio investments over such periods) that
would equate the initial amount invested to the value of such investment at the
end of the period.
The Trust's distribution rate generally is determined on a monthly basis with
respect to the immediately preceding monthly distribution period. The
distribution rate is computed by first annualizing the Trust's distributions per
share during such a monthly distribution period and dividing the annualized
distribution by the Trust's maximum offering price per share on the last day of
such period. The Trust calculates the compounded distribution rate by adding one
to the monthly distribution rate, raising the sum to the power of 12, and
subtracting one from the product. In circumstances in which the Trust believes
that, as a result of decreases in market rates of interest, its expected monthly
distributions may be less than the distributions with respect to the immediately
preceding monthly distribution period, the Trust reserves the right to calculate
the distribution rate on the basis of a period of less than one month.
Historical distribution rates on a month to month basis may also be presented.
Total return, distribution rate and compounded distribution rate figures
utilized by the Trust are based on historical performance and are not intended
to indicate future performance. Distribution rate, compounded distribution rate
and NAV per share can be expected to fluctuate over time. Total return will vary
depending on market conditions, the Senior Loans, and other securities
comprising the Trust's portfolio, the Trust's operating expenses and the amount
of net realized and annualized capital gains or losses during the period.
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