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
primarily in senior floating-rate 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 May 18, 1998
(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 toll-free at (800)
992-0180. This SAI incorporates by reference the entire Prospectus.
TABLE OF CONTENTS
PAGE
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
Tax Matters............................................................. 17
Advertising and Performance Data........................................ 20
Financial Statements.....................................................21
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 May 18, 1998.
<PAGE>
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 Objective 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 other form of business entity 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 net 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 credit quality standards and general requirements that the Trust applies to
Lease Participations including collateral quality, the credit quality of the
borrower and the likelihood of payback are substantially the same as those
applied to conventional Senior Loans. 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 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), (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 the purchase or sale of 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 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 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.
Originating Senior Loans
Although the Trust does not act, nor does it intend to act in the foreseeable
future, 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, it does
have the ability to do so. Senior Loans are typically arranged through private
negotiations between a 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 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 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 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 borrower with the restrictive
covenants in the loan agreement and of notifying the lenders of any adverse
change in the 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 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 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 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 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 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 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 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 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 or other business entities
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 borrower. 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 borrower 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 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 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 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 borrower'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 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 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 & Poor's Ratings Services 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 & Poor's Ratings
Services 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 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
or borrower conditions.
Senior Loans frequently require full or partial prepayment of a loan when there
are asset sales or a securities issuance. Prepayments on Senior Loans may also
be made by the 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 borrower. Prepayment would cause the actual
duration of a Senior Loan to be shorter than its stated maturity. Prepayment may
be deferred by the Trust. 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.
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 borrower generally must pledge as collateral assets
which may include one or more of the following: cash; accounts receivable;
inventory; property, plant and equipment; both common and preferred stock in its
subsidiaries, trademarks, copyrights, patent rights and franchise value. The
Trust may also receive guarantees as a form of collateral. In some instances, a
Senior Loan may be secured only by stock in a borrower or its affiliates. The
market value of the assets serving as collateral will, at the time of
investment, 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 may take action as it deems necessary
for the protection of its own interests and the interests of the other lenders,
including, for example, giving the borrower an opportunity to provide additional
collateral or accelerating the loan. There is no assurance, however, that the
borrower would provide additional collateral or that the liquidation of the
existing collateral would satisfy the 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:
o 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.
o Invest more than 25% of its total assets in any industry.
o 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.
o 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 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 borrower or would not have a direct cause of action against
the 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.
o 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.
o 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.
o Make loans of money or property to any person, except that the Trust
(i) may make loans to corporations or other business entities, or
enter into leases or other arrangements that have the characteristics
of a loan; (ii) may lend portfolio instruments; and (iii) may acquire
securities subject to repurchase agreements.(1)
o Purchase shares of other investment companies, except in connection
with a merger, consolidation, acquisition or reorganization.
o 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 assets (including the amount
borrowed) less all liabilities other than borrowings.
________________________________
1. This investment restriction in the form presented has been approved by the
Board of Trustees, but will not become effective until approved by the
shareholders of the Trust. Until such shareholder approval is obtained,
this restriction is as follows: "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." The proposed change to this investment restriction will be
submitted to shareholders for their approval at the Trust's annual
shareholders meeting currently scheduled for August, 1998.
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 total 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 net
asset value (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 58.) Trustee. Realtor, Coldwell Banker Success Realty
(formerly, The Prudential Arizona Realty) for more than the last five
years. Ms. Baldwin is also Vice President, United States Olympic Committee
(November 1996-Present), and formerly Treasurer, United States Olympic
Committee (November 1992-November 1996). Ms. Baldwin also is a director
and/or trustee of each of the funds managed by the Investment Manager.
John P. Burke, 260 Constitution Plaza, Hartford, Connecticut 06130. (Age
66.) Trustee. Commissioner of Banking, State of Connecticut (January 1995 -
Present). Mr. Burke was formerly President of Bristol Savings Bank (August
1992 - January 1995) and President of Security Savings and Loan (November
1989 - August 1992). Mr. Burke 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
70.) Trustee. President of Al Burton Productions for more than the last
five years; formerly Vice President, First Run Syndication, Castle Rock
Entertainment (July 1992-November 1994). 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 57.) Trustee. President, South Beach Capital Markets Advisory
Corporation (January 1995-Present); Governor, Philadelphia Stock Exchange
(October 1997 - Present); Director of Aurora Capital, Inc. (since February
1995). Mr. Foerster was formerly Director of Mako Marine International
(January 1996 - December 1997) and Managing Director, Equity Syndicate,
Lehman Brothers (June 1992 - December 1994). Mr. Foerster also is a
director and/or trustee of each of the funds managed by the Investment
Manager.
Jock Patton, 40 North Central Avenue, Suite 1200, Phoenix, Arizona 85004.
(Age 52.) Trustee. Private Investor. Director of Artisoft, Inc. Mr. Patton
was formerly President and Co-owner, StockVal, Inc. (April 1993 - June,
1997) and a partner and director of the law firm of Streich, Lang, P.A.
(1972 - 1993). Mr. Patton is also a director and/or trustee of each of the
funds managed by the Investment Manager.
*Robert W. Stallings, 40 North Central Avenue, Suite 1200, Phoenix, AZ
85004. (Age 49.) Chairman, Chief Executive Officer, and Trustee. Chairman,
Chief Executive Officer and President of Pilgrim America Group, Inc. (since
December 1994); Chairman, Pilgrim America Investments, Inc. (since December
1994); Director, Pilgrim America Securities, Inc. (since December 1994);
Chairman, Chief Executive Officer and President of each of the other
Pilgrim America Funds (since April 1995). Chairman and Chief Executive
Officer of Pilgrim America Capital Corporation (formerly, Express America
Holdings Corporation) ("Pilgrim America") (since August 1990). Director and
officer of other affiliates of Pilgrim America.
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) $500 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 28,
1998. 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 Trust 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 Trust
Compensation and Fund
from Complex Paid
Name of Person, Position Trust to Trustees
<S> <C> <C>
Mary A. Baldwin (1)(2), Trustee $14, 616 $ 28,300 (5 boards)
John P. Burke (2)(3), Trustee $ 14,667 $ 28,400 (5 boards)
Al Burton (2)(4), Trustee $14,667 $ 28,400 (5 boards)
Bruce S. Foerster (1)(2), Trustee $14,667 $ 28,400 (5 boards)
Jock Patton (2)(5), Trustee $14,667 $ 28,400 (5 boards)
Robert W. Stallings (6), Trustee
and Chairman $ 0 $ 0 (5 boards)
- ----------------------------------
<FN>
(1) Commenced service as a Trustee on April 7, 1995.
(2) Member of the Audit Committee.
(3) Commenced service as Trustee on May 5, 1997.
(4) Commenced service as a Trustee on April 19, 1994.
(5) Commenced service as a Trustee on August 28, 1995.
(6) "Interested person," as defined in the Investment Company Act, of the Trust
because of affiliation with the Investment Manager.
</FN>
</TABLE>
Officers
Howard Tiffen, President, Chief Operating Officer, and Senior Portfolio
Manager
40 North Central Avenue, Suite 1200, Phoenix, Arizona 85004. (Age 50.)
Formerly Managing Director of various divisions of Bank of America (and its
predecessor, Continental Bank) (1982-1995).
James R. Reis, Executive Vice President, Chief Credit Officer, and
Assistant Secretary
40 North Central Avenue, Suite 1200, Phoenix, Arizona 85004. (Age 40.)
Director, Vice Chairman (since December 1994), and Executive Vice President
(since April 1995), Pilgrim America Group and PAII; Director (since
December 1994), Vice Chairman (since November 1995) and Assistant Secretary
(since January 1995) of PASI; Executive Vice President, Treasurer and
Assistant Secretary of each of the other Pilgrim America Funds; Chief
Financial Officer (since December 1993), Vice Chairman and Assistant
Secretary (since April 1993) and former President (May 1991-December 1993),
Pilgrim America. Presently serves or has served as an officer or director
of other affiliates of Pilgrim America.
James M. Hennessy, Executive Vice President, Chief Financial Officer and
Secretary
40 North Central Avenue, Suite 1200, Phoenix, Arizona 85004. (Age 49.)
Executive Vice President (since April 1998) and Secretary (since April
1995), Pilgrim America Capital Corporation (formerly Express America
Holdings Corporation), Executive Vice President and Treasurer, Pilgrim
America Group, PAII; Executive Vice President, PASI, Executive Vice
President, Principal Accounting Officer and Secretary of each of the
Pilgrim America Funds. Presently serves or has served as an officer of
other affiliates of Pilgrim America.
Daniel A. Norman, Senior Vice President, Treasurer, and Assistant Portfolio
Manager
40 North Central Avenue, Suite 1200, Phoenix, Arizona 85004. (Age 40.)
Senior Vice President and Assistant Secretary, Pilgrim America Group and
PAII (since December 1994); Senior Vice President (since November 1995) and
Treasurer and Chief Financial Officer (since April 1997), PASI. Formerly an
officer of other affiliates of Pilgrim America.
Robert S. Naka, Vice President and Assistant Secretary
40 North Central Avenue, Suite 1200, Phoenix, Arizona 85004. (Age 34.) Vice
President, Pilgrim America Investments, Inc. (since April 1997) and Pilgrim
America Group, Inc. (since February 1997). Vice President and Assistant
Secretary of each of the funds in the Pilgrim America Group of Funds.
Formerly Assistant Vice President (August 1995 - February 1997), Pilgrim
America Group, Inc. and Operations Manager (April 1992 - April 1995),
Pilgrim Group, Inc.
As of April 30, 1998, 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), as well as privately managed accounts, and as of the date of
this Statement of Additional Information had total assets under management of
approximately $4 billion.
The Investment Manager is a wholly owned subsidiary of Pilgrim America Group,
which itself is a wholly-owned subsidiary of Pilgrim 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.
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 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 28, 1998, February 28, 1997 and February 29,
1996, PAII (or, prior to April 7, 1995, its predecessor) was paid $369,772
$8,268,263 and $7,122,089, respectively, for services rendered to the Trust.
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 the Investment
Management Agreement between the Trust and PAII, and in the event that 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 28, 1998, February 28, 1997 and February 29,
1996, PAGI (or, prior to April 7, 1995, its predecessor) was paid $1,777,758,
$1,441,271 and $1,264,932, respectively, for services rendered to the Trust.
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 subordinated loans up to a maximum of 5% of the Trust's net
assets, Hybrid Loans, unsecured loans, 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. 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, even if the
specific services were not imputed to the Trust and were useful to the
Investment Manager in advising other clients. 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 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 $0, $0 and $7,400 in brokerage commissions during the fiscal
years ended February 28, 1998, February 28, 1997 and February 29, 1996,
respectively.
Portfolio Turnover Rate
The annual rate of the Trust's total portfolio turnover for the years ended
February 28, 1998 and February 28, 1997, was 90% and 82%, 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 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 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 of the Trust 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.
Generally, Senior Loans are valued at fair value in the absence of readily
ascertainable market values believed to be reliable. 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 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 a
discount from 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 shares in the
open market in accordance with Section 23(c) of the Investment Company Act and
Rule 23c-1 thereunder 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 conducted one
tender offer that expired May 1, 1992. 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, 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
of 1986, as amended (the "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.
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 each year to be taxed as a regulated investment company
under Subchapter M of 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
derive at least 90% of its gross income for each taxable year 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.
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 at a market discount (generally, at a
price less than its principal amount) other than at original issue 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
(discussed below) of its ordinary taxable income and capital gain net income to
avoid liability for the excise tax.
Hedging Transactions
The Trust has the ability, pursuant to its investment objectives and policies,
to hedge its investments in a variety of transactions, including interest rate
swaps and the purchase or sale of interest rate caps and floors. The treatment
of these transactions for federal income tax purposes may in some instances be
unclear, and the regulated investment company qualification requirements may
limit the extent to which the Trust can engage in hedging transactions.
In addition, recently enacted rules may affect the timing and character of gain
if the Trust engages in transactions that reduce or eliminate its risk of loss
with respect to appreciated financial positions. If the Trust enters into
certain transactions in property while holding substantially identical property,
the Trust would be treated as if it had sold and immediately repurchased the
property and would be taxed on any gain (but not loss) from the constructive
sale. The character of gain from a constructive sale would depend upon the
Trust's holding period in the property. Loss from a constructive sale would be
recognized when the property was subsequently disposed of, and its character
would depend on the Trust's holding period and the application of various loss
deferral provisions in the Code.
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 "20% Rate Gain" or "28% Rate
Gain," depending upon the Trust's holding period for the assets sold. "20% Rate
Gains" arise from the sale of assets held by the Trust for more than 18 months
and are subject to a maximum tax rate of 20%; "28% Rate Gains" arise from the
sale of assets held by the Trust for more than one year but not more than 18
months and are subject to a maximum tax rate of 28%. Distributions are subject
to these capital gains rates 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 applicable corporate tax rate. In such event, it
is expected that the Trust also will elect to treat such gain as having been
distributed to 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) if the Internal Revenue Service
notifies the Trust that the shareholder is subject to backup withholding.
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 if the shares are held
as capital assets, and gain or loss will be long-term or short-term, depending
upon the shareholder's holding period for the shares. 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 (including shares acquired though the Dividend
Reinvestment and Cash Purchase Plan) 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.
Tender Offers to Purchase Shares
As described earlier, the Trust will consider making tender offers for its
shares on a quarterly basis. Under current law, a shareholder, who pursuant to a
tender offer, tenders all of his shares and any shares considered owned by such
shareholder under attribution rules contained in the Code, will recognize gain
or loss, taxable as described above (see "Sale of Shares"). Different tax
consequences may apply to shareholders who tender less than all their shares in
connection with a tender offer and possibly to non-tendering shareholders. The
tax consequences to shareholders of a tender offer will be more fully described
in offering documents related to the tender offer.
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.
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 trading volume of the Trust's shares, the number of
Senior Loan investments, annual total return, aggregate total return,
distribution rate, average compounded distribution rate and yield of the Trust
for specified periods of time, and diversification statistics. Such information
may also include performance and risk rankings and similar information from
independent organizations such as Lipper Analytical Services, Inc. ("Lipper"),
Morningstar, Value Line, Inc., CDA Technology, Inc. or other industry
publications. These rankings will typically compare the Trust to all closed-end
funds, to other Senior Loan funds, and/or also to taxable closed-end fixed
income funds. Any such use of rankings and ratings in advertisements and sales
literature will conform with the guidelines of 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.
Reports and promotional literature may also contain the following information:
(i) number of shareholders; (ii) average account size; (iii) identification of
street and registered account holdings; (iv) lists or statistics of certain of
the Trust's holdings including, but not limited to, portfolio composition,
sector weightings, portfolio turnover rates, number of holdings, average market
capitalization and modern portfolio theory statistics alone or in comparison
with itself (over time) and with its peers and industry group; (v) public
information about the asset class; and (vi) discussions concerning coverage of
the Trust by analysts.
In addition, reports and promotional literature may contain information
concerning the Investment Manager, Pilgrim America, the Portfolio Managers,
Pilgrim America Group, Inc. or affiliates of the Trust, the Investment Manager,
Pilgrim America or Pilgrim America Group, Inc. including (i) performance
rankings of other funds managed by the Investment Manager, or the individuals
employed by the Investment Manager who exercise responsibility for the
day-to-day management of the Trust, including rankings of investment companies
published by Lipper Analytical Services, Inc., Morningstar, Inc., Value Line,
Inc., CDA Technologies, Inc., or other rating services, companies, publications
or other persons who rank investment companies or other investment products on
overall performance or other criteria; (ii) lists of clients, the number of
clients, or assets under management; (iii) information regarding the acquisition
of the Pilgrim America Funds by Pilgrim America; (iv) the past performance of
Pilgrim America and Pilgrim America Group, Inc.; (v) the past performance of
other funds managed by the Investment Manager; (vi) quotes from a portfolio
manager of the Trust or industry specialists; and (vii) information regarding
rights offerings conducted by closed-end funds managed by the Investment
Manager.
The Trust may compare the frequency of its reset period to the frequency with
which the London Inter-Bank Offered Rate ("LIBOR") changes. Further, the Trust
may compare its yield to (i) LIBOR, (ii) the federal funds rate, (iii) 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, (iv) 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, (v) 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, (vi) yield data published
by Lipper, or (vii) the yield on an investment in 90-day Treasury bills on a
rolling basis, assuming quarterly compounding. Further, the Trust may compare
such other yield data described above to each other. The Trust may also compare
its total return, NAV stability and yield to other fixed income investments
(such as Certificates of Deposit), open-end mutual funds and Unit Investments
Trusts. 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.
The Trust may provide information designed to help individuals understand their
investment goals and explore various financial strategies. Such information may
include information about current economic, market and political conditions;
materials that describe general principles of investing, such as asset
allocation, diversification, risk tolerance, and goal setting; worksheets used
to project savings needs based on assumed rates of inflation and hypothetical
rates of return; and action plans offering investment alternatives. Materials
may also include discussions of other investment companies in the Pilgrim
America Group of Funds, products and services, and descriptions of the benefits
of working with investment professionals in selecting investments.
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 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. On occasion, the Trust may quote total return calculations published by
Lipper, a widely recognized independent publication that monitors the
performance of both open-end and closed-end investment companies.
The Trust's distribution rate is calculated on a monthly basis by annualizing
the dividend declared in the month and dividing the resulting annualized
dividend amount by the Trust's corresponding month-end net asset value (in the
case of NAV) or the last reported market price (in the case of Market). The
distribution rate is based solely on the actual dividends and distributions,
which are made at the discretion of management. The distribution rate may or may
not include all investment income, and ordinarily will not include capital gains
or losses, if any.
Total return and 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 unrealized capital gains or losses during the period.
FINANCIAL STATEMENTS
The financial statements contained in the Trust's February 28, 1998 Annual
Report to Shareholders are incorporated herein by reference.
