<PAGE>
USF&G PACHOLDER FUND, INC.
- --------------------------------------------------------------------------------
DEAR STOCKHOLDERS:
Nineteen ninety-six was a strong year for the high yield market and for those
invested in the USF&G Pacholder Fund, Inc. (the "Fund"). For the full year
1996, the Fund reported a total return of 20.40% compared to the CS First Bos-
ton High Yield Index(TM) (the "Index") total return of 12.42%. Based on return
on net asset value, the Fund was the best performing closed-end high yield fund
tracked by Morningstar, Inc. in 1996. During the fourth quarter, the Fund
posted a total return of 6.06%, compared to the Index's total return of 4.41%.
In addition to having a sound core high yield portfolio, the Fund excelled
this year in selecting some of the highest returning securities in the market.
Much of the Fund's performance in 1996 is attributable to securities purchased
at material discounts to par. These investments tend to be in companies that
are either operating in out-of-favor industries, are experiencing some type of
credit difficulties, or are small issues that are not widely followed by the
majority of high yield market participants. Some of these investments, a few of
which depressed the Fund's performance in 1995, had extraordinary returns in
1996. Following are a few examples of the Fund's highest returning securities
for the year: Beatrice Foods, Algoma Steel, GNF Corp., Chattem, Synthetic In-
dustries, and JPS Automotive.
1996 IN REVIEW
Interest rates increased during the first half of 1996 by over 150 basis
points (1.5%) due primarily to concerns about inflation. However, this trend
reversed itself in the second half, recovering more than 60 basis points
(0.6%). The 10-year U. S. Treasury Note began the year yielding 5.52%, peaked
in June at 7.06% and ended the year yielding 6.42%, providing a total return
for the year of only 0.89%.
Demand for high yield debt in 1996 remained consistently strong. The higher
rates of return in the high yield market over the past few years relative to
other fixed income classes has broadened the investor base in our market. High
yield mutual funds received a record amount of net inflows into their funds in
1996, approximately $15.7 billion according to AMG Data Service, Inc. In addi-
tion, many insurance companies, pension funds, investment grade debt mutual
funds and equity income mutual funds have all been increasing their allocation
to the asset class. This increase in demand has allowed more companies access
to the public debt markets, increasing the depth and breadth in the supply of
investment options. CS First Boston estimates that the size of the high yield
market was approximately $385 billion at the end of 1996 compared to $300 bil-
lion at the end of 1994 and $230 billion at the end of 1992.
In addition to strong demand, the high yield market benefited from stable
credit fundamentals in most industry sectors, and default rates remained low on
a historic basis. As a result of these factors, the Index's spread relative to
the comparable U.S. Treasury issues tightened throughout the year, compressing
129 basis points (1.29%) to 355 basis points (3.55%) at the end of December.
OUTLOOK FOR 1997
We believe that many of the factors that contributed to the strength of the
high yield market in 1996 are likely to continue in 1997. The high yield market
has become an integral part of the capital markets in the United States and
will continue to provide investment opportunities in companies not seen in our
market before. However, we are cautious about investing in certain sectors of
the market that are trading at extremely tight spreads on a historic basis
(i.e., energy) and we are selectively moving out of some of these investments.
<PAGE>
USF&G PACHOLDER FUND, INC.
- --------------------------------------------------------------------------------
We continue to feel that the Fund is sufficiently diversified to protect
against negative changes in the market or in any particular investment. Our
strategy is to maintain a solid core portfolio in companies that are industry
leaders and/or have the opportunities to improve their overall credit quality.
In addition, we will seek to add an extra increment of return by investing in
select value opportunities in the high yield market. This has been the strategy
of the Fund since its inception in 1988, and we are confident that it will con-
tinue to provide solid long-term returns in the high yield market going for-
ward.
PERFORMANCE SUMMARY
The performance of the Fund as compared to the Index is illustrated in
the following table.
- --------------------------------------------------------------------------
Performance Comparison*
(For the year ended December 31, 1996)
- --------------------------------------------------------------------------
Since
Twelve Inception
Months (Annualized)**
- --------------------------------------------------------------------------
USF&G Pacholder Fund, Inc. *** 20.40% 12.74%
- --------------------------------------------------------------------------
CS First Boston High Yield Index /(TM)/ 12.42% 11.81%
- --------------------------------------------------------------------------
* The CS First Boston High Yield Index /(TM)/ is an unmanaged index that is
widely used as a measurement of high yield market performance. These figures
assume reinvestment of interest, dividends and capital gains distributions.
Past performance is no guarantee of future results.
** Inception date -- November 11, 1988.
***Return based on Net Asset Value.
We thank you for your support of the Fund and look forward to continuing
to serve your investment needs in the future.
Sincerely,
/s/ Anthony L. Longi, Jr.
Anthony L. Longi, Jr.
President
February 17, 1997
2
<PAGE>
USF&G PACHOLDER FUND, INC.
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS
DECEMBER 31, 1996
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PERCENT
PAR OF NET
DESCRIPTION (000) VALUE ASSETS
- --------------------------------------------------------------------
<S> <C> <C> <C>
CORPORATE DEBT SECURITIES -- 94.0%
AEROSPACE & DEFENSE -- 0.7%
Greenwich Air,
Sr Nt, 10.5%, 6/1/06 $ 750 $ 789,375 0.7%
------------ ---
AUTO PARTS & EQUIPMENT -- 2.1%
APS Inc., Co Gtd,
11.875%, 1/15/06 1,000 1,082,500 0.9
JPS Automotive Products Corp., Sr Nt,
11.125%, 6/15/01 1,350 1,447,875 1.2
------------ ---
2,530,375 2.1
BEVERAGE & TOBACCO -- 0.8%
Cott Corp., Sr Nt,
9.375%, 7/1/05 1,000 1,015,000 0.8
------------ ---
BROADCAST RADIO & TV -- 3.7%
Argyle Television Inc., Sr Sub Nt,
9.75%, 11/1/05 750 757,500 0.6
Granite Broadcasting Corp., Sr Sub Nt,
10.375%, 5/15/05 1,100 1,130,250 0.9
Heritage Media Services, Sr Nt,
11%, 6/15/02 500 530,000 0.5
Sinclair Broadcasting Group, Sr Sub Nt,
10%, 12/15/03 1,000 1,025,000 0.9
Young Broadcasting Inc., Sr Sub Nt,
9%, 1/15/06 1,000 972,500 0.8
------------ ---
4,415,250 3.7
BUILDING -- 3.6%
Atrium Companies Inc., Sr Sub Nt,
10.5%, 11/15/06/2/ 1,000 1,015,000 0.8
Harrow Industries Inc., Sr Sub Deb,
12.375%, 4/15/02 1,378 1,364,220 1.1
Riverside Group Inc., Sub Nt,
13%, 9/30/99/3/ 1,000 900,000 0.8
Triangle Pacific Corp., Sr Nt,
10.5%, 8/1/03 1,000 1,067,500 0.9
------------ ---
4,346,720 3.6
</TABLE>
<TABLE>
<CAPTION>
PERCENT
PAR OF NET
DESCRIPTION (000) VALUE ASSETS
- ----------------------------------------------------------------------------
<S> <C> <C> <C>
BUSINESS SERVICES & EQUIPMENT -- 7.1%
Day International Group Inc., Sr Sub Nt,
11.125%, 6/1/05 $1,000 $ 1,050,000 0.9%
Knoll Inc., Sr Sub Nt,
10.875%, 3/15/06 1,000 1,102,500 0.9
National Fiberstok Corp., Sr Nt,
11.625%, 6/15/02 1,000 1,055,000 0.9
Pierce Leahy Corp., Sr Sub Nt,
11.125%, 7/15/06 1,000 1,092,500 0.9
San Jacinto Holdings, Sr Sub Nt,
12%, 12/31/02 2,823 2,032,272 1.7
Unisys Corp., Sr Nt,
11.75%, 10/15/04 750 799,688 0.6
United Stationer Supply, Sr Nt,
12.75%, 5/1/05 1,250 1,381,250 1.2
------------ ---
8,513,210 7.1
CABLE TELEVISION -- 4.8%
Cablevision Systems Corp., Sr Sub Nt,
9.25%, 11/1/05 500 495,000 0.4
Cablevision Systems Corp.,
Sr Sub Deb, 10.5%, 5/15/16 1,000 1,035,000 0.9
Comcast Corporation, Sr Sub Nt,
9.125%, 10/15/06 1,500 1,022,500 0.8
Fundy Cable Ltd., Sr Nt,
11%, 11/15/05 1,000 1,060,000 0.9
Jones Intercable, Sr Sub Deb,
11.5%, 7/15/04 1,000 1,086,250 0.9
Rifkin Acq. Partners LP, Sr Sub Nt,
11.125%, 1/15/06 1,000 1,042,500 0.9
------------ ---
5,741,250 4.8
CHEMICALS/PLASTIC -- 8.3%
Applied Extrustion Technologies Inc., Sr Unsecd
Nt, 11.5%, 4/1/02 1,500 1,578,750 1.3
Berry Plastics Corp., Sr Sub Nt,
12.25%, 4/15/04 1,400 1,540,000 1.3
Calmar Inc., Sr Sub Nt,
11.5%, 8/15/05 1,500 1,548,750 1.3
Envirodyne Industries, Sr Nt,
12%, 6/15/00 1,500 1,597,500 1.3
Plastic Specialties & Technologies Inc., Sr Nt,
11.25%, 12/1/03 1,250 1,312,500 1.1
Portola Packaging Inc., Sr Nt,
10.75%, 10/1/05 1,250 1,296,875 1.1
Printpack Inc., Sr Sub Nt,
10.625%, 8/15/06/2/ 1,000 1,040,000 0.9
------------ ---
9,914,375 8.3
</TABLE>
3
<PAGE>
USF&G PACHOLDER FUND, INC.
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS (CONTINUED)
DECEMBER 31, 1996
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PERCENT
PAR OF NET
DESCRIPTION (000) VALUE ASSETS
- ---------------------------------------------------------------------
<S> <C> <C> <C>
CLOTHING & TEXTILE -- 3.5%
PT Polysindo, Co Gtd,
11.375%, 6/15/06 $1,000 $ 1,076,250 0.9%
Synthetic Industries Inc., Deb,
12.75%, 12/1/02 1,500 1,653,750 1.4
Tultex Corp, Sr Nt,
10.625%, 3/15/05 1,000 1,072,500 0.9
US Leather Inc., Sr Nt,
10.25%, 7/31/03 500 430,000 0.3
------------ ---
4,232,500 3.5
CONGLOMERATE -- 1.4%
Interlake Corp., Sr Sub Deb,
12.125%, 3/1/02 1,150 1,187,375 1.0
Siebe Inc., Sr Sec Nt,
11.22%, 1/29/01 435 434,682 0.4
------------ ---
1,622,057 1.4
CONTAINERS/GLASS PRODUCTS -- 0.3%
U.S. Can Corp., Sr Sub Nt,
10.125%, 10/15/06 350 367,500 0.3
------------ ---
COSMETICS/TOILETRIES -- 2.4%
Chattem Inc., Sr Sub Nt,
12.75%, 6/15/04 1,200 1,248,000 1.1
JB Williams Holdings Inc., Sr Nt,
12%, 3/1/04 1,000 1,015,000 0.8
Remington Product Co. LLC, Sr Sub Nt,
11%, 5/15/06 750 637,500 0.5
------------ ---
2,900,500 2.4
DRUGS -- 0.9%
Twin Laboratories, Inc., Co Gtd,
10.25%, 5/15/06 1,000 1,040,000 0.9
------------ ---
ECOLOGICAL SERVICES & EQUIPMENT -- 2.4%
Allied Waste North America, Sr Sub Nt,
10.25%, 12/1/06 500 524,375 0.5
ICF Kaiser International Inc., Sr Sub Nt
13%, 12/31/03 1,500 1,425,000 1.2
Norcal Waste Systems, Co Gtd,
13%, 11/15/05 750 832,500 0.7
------------ ---
2,781,875 2.4
</TABLE>
<TABLE>
<CAPTION>
PERCENT
PAR OF NET
DESCRIPTION (000) VALUE ASSETS
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
ELECTRONICS/ELECTRIC -- 1.7%
Celestica International, Sr Sub Nt,
10.5%, 12/31/06 $ 500 $ 525,000 0.4%
Communications & Power Industries, Sr Sub Nt, 12%,
8/1/05 1,000 1,112,500 0.9
Plantronics Inc., Sr Nt,
10%, 1/15/01 420 439,950 0.4
------------ ---
2,077,450 1.7
EQUIPMENT LEASING -- 1.1%
Coinmach Corp., Sr Nt,
11.75%, 11/15/05 1,250 1,346,875 1.1
------------ ---
FARMING & AGRICULTURE -- 1.7%
Darling International Inc., Sr Sub Nt,
11%, 7/15/00 2,000 1,995,000 1.7
------------ ---
FINANCIAL INTERMEDIARIES -- 0.8%
Amresco, Inc., Sr Nt,
8.75%, 7/1/99 1,000 1,002,500 0.8
------------ ---
FOOD/DRUG RETAILERS -- 2.8%
Bruno's Inc., Sr Sub Nt,
10.5%, 8/1/05 1,500 1,590,000 1.3
Jitney-Jungle Stores, Co Gtd,
12%, 3/1/06 900 954,000 0.8
P&C Food Markets Inc., Sr Nt,
11.5%, 10/15/01 1,000 885,000 0.7
------------ ---
3,429,000 2.8
FOOD SERVICE -- 3.8%
Beatrice Foods Inc., Sub Nt,
1%, 11/19/26 691 88,102 0.1
Carrols Corp., Sr Nt,
11.5%, 8/15/03 1,500 1,586,250 1.3
Gorges/Quick To Fix Foods, Sr Sub Nt, 11.5%,
12/1/06 1,000 1,036,250 0.8
Great American Cookie Co., Sr Nt,
10.875%, 1/15/01 650 591,500 0.5
Host Marriott Travel Plaza, Sr Nt,
9.5%, 5/15/05 1,250 1,303,125 1.1
------------ ---
4,605,227 3.8
</TABLE>
4
<PAGE>
USF&G PACHOLDER FUND, INC.
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS (CONTINUED)
DECEMBER 31, 1996
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PERCENT
PAR OF NET
DESCRIPTION (000) VALUE ASSETS
- --------------------------------------------------------------------------
<S> <C> <C> <C>
FOREST PRODUCTS -- 4.1%
APP International Finance, Gtd Sec Nt,
11.75%, 10/1/05 $ 500 $ 534,375 0.5%
FSW International, Sr Nt,
12.5%, 11/1/06/2/ 1,000 1,055,000 0.9
Florida Coast Paper, 1st Mtg,
12.75%, 6/1/03 1,000 1,082,500 0.9
Maxxam Group Holdings Inc., Sr Nt,
12%, 8/1/03/2/ 500 506,250 0.4
Stone Container Corp., 1st Mtg,
10.75%, 10/1/02 500 525,625 0.5
Stone Container Corp., Sr Nt,
11.875%, 8/1/16 1,000 1,055,000 0.9
------------ ---
4,758,750 4.1
HEALTH CARE -- 3.2%
Dade International Inc., Sr Sub Nt,
11.125%, 5/1/06 750 810,000 0.7
Grancare Inc., Sr Sub Nt,
9.375%, 9/15/05 1,250 1,340,625 1.1
Maxxim Medical, Co Gtd,
10.5%, 8/1/06 1,000 1,045,000 0.9
Prime Succession Acq. Co., Sr Sub Nt, 10.75%,
8/15/04/2/ 500 541,250 0.5
------------ ---
3,736,875 3.2
HOTEL & CASINOS -- 6.7%
Alliance Gaming Corp., Sr Secd Nt,
12.875%, 6/30/03 900 954,000 0.8
Argosy Gaming Co., 1st Mtg,
13.25%, 6/1/04 1,000 927,500 0.8
Casino Magic-LA, 1st Mtg,
13%, 8/15/03/2/ 900 888,750 0.8
Courtyard by Marriott, Sr Nt,
10.75%, 2/1/08 1,000 1,055,000 0.9
Eldorado Resorts LLC, Sr Sub Nt,
10.5%, 8/15/06/2/ 500 527,500 0.4
HMC Acquisition Properties, Sr Nt,
9%, 12/15/07 750 761,250 0.6
Majestic Star Casino LLC, Sr Nt,
12.75%, 5/15/03 500 537,500 0.4
Santa Fe Hotel Inc., 1st Mtg,
11%, 12/15/00 500 370,000 0.3
Showboat Marina Casino, 1st Mtg,
13.5%, 3/15/03 500 550,000 0.5
Trump Atlantic City, Co Gtd,
11.25%, 5/1/06 1,500 1,485,000 1.2
------------ ---
8,056,500 6.7
</TABLE>
<TABLE>
<CAPTION>
PERCENT
PAR OF NET
DESCRIPTION (000) VALUE ASSETS
- ---------------------------------------------------------------------------
<S> <C> <C> <C>
INDUSTRIAL EQUIPMENT -- 3.5%
Clark Materials, Sr Nt,
10.75%, 11/15/06/2/ $1,000 $ 1,040,000 0.9%
International Knife & Saw, Sr Sub Nt, 11.375%,
11/15/06/2/ 1,000 1,035,000 0.9
Specialty Equipment Co., Sr Sub Nt,
11.375%, 12/1/03 1,750 1,898,750 1.5
Tokheim Corp., Sr Sub Nt,
11.5%, 8/1/06/2/ 250 266,250 0.2
------------ ---
4,240,000 3.5
LEISURE -- 4.6%
E&S Holdings Corp., Sr Sub Nt,
10.375%, 10/1/06/2/ 500 523,125 0.4
Guitar Center Mgmt., Sr Nt,
11%, 7/1/06/2/ 500 527,500 0.4
Hines Horticulture Inc., Sr Sub Nt,
11.75%, 10/15/05 1,500 1,597,500 1.3
Selmer Company Inc., Sr Sub Nt,
11%, 5/15/05 1,500 1,631,250 1.4
Stuart Entertainment, Sr Sub Nt,
12.5%, 11/15/04/2/ 1,250 1,271,875 1.1
------------ ---
5,551,250 4.6
NON-FERROUS METALS -- 2.1%
Easco Corp., Sr Nt,
10%, 3/15/01 1,500 1,515,000 1.2
Renco Metals Inc., Sr Nt,
11.5%, 7/1/03 1,000 1,050,000 0.9
------------ ---
2,565,000 2.1
OIL & GAS -- 4.6%
Giant Industries Inc., Sr Sub Nt,
9.75%, 11/15/03 1,000 1,040,000 0.9
Petro PSC Properties, Sr Nt,
12.5%, 6/1/02 1,500 1,500,000 1.2
Statia Terminals, 1st Mtg,
11.75%, 11/15/03/2/ 1,000 1,040,000 0.9
Transamerican Refining, 1st Mtg,
0/18%, 2/15/02 500 410,000 0.3
Transamerican Refining, 1st Mtg,
16.5%, 2/15/02 650 653,250 0.5
United Refining Corp., Sr Nt w/warrant, 11.5%,
12/31/03 1,000 930,000 0.8
------------ ---
5,573,250 4.6
</TABLE>
5
<PAGE>
USF&G PACHOLDER FUND, INC.
- -------------------------------------------------------------------------------
STATEMENT OF NET ASSETS (CONTINUED)
DECEMBER 31, 1996
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PERCENT
PAR OF NET
DESCRIPTION (000) VALUE ASSETS
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
PUBLISHING -- 2.6%
Adams Outdoor Advertising, Sr Nt,
10.75%, 3/15/06 $ 500 $ 530,000 0.5%
Outdoor Systems Inc., Sr Sub Nt,
9.375%, 10/15/06 500 513,750 0.4
Petersen Publishing, Sr Sub Nt,
11.125%, 11/15/06/2/ 500 522,500 0.4
Universal Outdoor Inc., Sr Sub Nt,
9.75%, 10/15/06 1,000 1,030,000 0.9
Universal Outdoor Inc. Series B, Sr Sub Nt, 9.75%,
10/15/06 500 515,000 0.4
----------- ----
3,111,250 2.6
RETAILERS -- 0.9%
Herff Jones Inc., Sr Sub Nt,
11%, 8/15/05 1,000 1,070,000 0.9
----------- ----
STEEL -- 2.1%
Algoma Steel Inc., 1st Mtg,
12.375%, 7/15/05 1,000 1,075,000 0.9
Gulf States Steel - Alabama, 1st Mtg,
13.5%, 4/15/03 500 472,500 0.4
NS Group Inc., Sr Nt,
13.5%, 7/15/03 1,000 1,022,500 0.8
----------- ----
2,570,000 2.1
TRANSPORTATION -- 3.1%
Moran Transport Co., 1st Mtg,
11.75%, 7/15/04 1,000 1,080,000 0.9
Trism Inc., Sr Sub Nt,
10.75%, 12/15/00 1,400 1,333,500 1.1
Teekay Shipping, Sr Sec Nt,
9.625%, 7/15/03 1,250 1,300,000 1.1
----------- ----
3,713,500 3.1
TELECOMMUNICATIONS/CELLULAR
COMMUNICATION -- 2.7%
Metrocall Inc., Sr Sub Nt,
10.375%, 10/1/07 1,250 1,062,500 0.9
Nextlink Communications, Sr Nt,
12.5%, 4/15/06 1,000 1,072,500 0.9
Western Wireless, Sr Sub Nt,
10.5%, 2/1/07 1,000 1,043,750 0.9
----------- ----
3,178,750 2.6
----------- ----
TOTAL CORPORATE DEBT SECURITIES
(amortized cost $108,104,601) 112,791,164 94.0
----------- ----
</TABLE>
<TABLE>
<CAPTION>
SHARES/ PERCENT
PAR OF NET
DESCRIPTION (000) VALUE ASSETS
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
EQUITY INVESTMENTS -- 2.3%
Beatrice Foods, Conv. Common Stock/1/ 88,252 $ 1,500,284 1.2%
Data Documents, Common Stock/1/ 22,596 245,732 0.2
Fresenius Trust Preferred 9%, 12/1/06 1,000 1,017,500 0.9
Gulf States Steel, Warrants 4/15/03/1/ 500 150 0.0
ICF Kaiser International, Warrants 12/31/98/1/ 7,200 2,700 0.0
Sabreliner Corp., Warrants 4/15/03/1/ 500 2,500 0.0
San Jacinto Holdings, Common Stock/1/ 2,246 6,738 0.0
------------ -----
TOTAL EQUITY INVESTMENTS
(cost $2,613,822) 2,775,604 2.3
------------ -----
COMMERCIAL PAPER -- 1.2%
Ford Motor Credit,
5.47%, 1/16/97 $ 500 498,860 0.4
General Electric Capital Corp.,
5.50%, 1/16/97 500 498,854 0.4
Prudential Funding,
5.50%, 1/16/97 500 498,855 0.4
------------ -----
TOTAL COMMERCIAL PAPER
(at amortized cost) 1,496,569 1.2
------------ -----
TOTAL INVESTMENTS
(amortized cost $112,214,992) $117,063,337 97.5
OTHER ASSETS IN EXCESS OF LIABILITIES 2,990,457 2.5
------------ -----
NET ASSETS $120,053,794 100.0%
LESS: OUTSTANDING PREFERRED STOCK (33,000,000)
------------
NET ASSETS APPLICABLE TO 4,991,642 SHARES OF COMMON
STOCK OUTSTANDING $ 87,053,794
============
NET ASSET VALUE PER COMMON SHARE
($87,053,794 / 4,991,642) $17.44
============
- -----------------------------------------------------------------------------
</TABLE>
/1/ Non-income producing security.
/2/ Security exempt from registration under Rule 144A of the Securities Act of
1933. These securities may be resold in transactions exempt from registration,
normally to qualified institutional buyers. These securities amounted to
$14,253,125 or 11.9% of net assets.
/3/ Board valued security. These securities amounted to $1,334,682 or 1.2% of
net assets.
6
<PAGE>
USF&G PACHOLDER FUND, INC.
- --------------------------------------------------------------------------------
STATEMENT OF OPERATIONS STATEMENTS OF CHANGES IN NET ASSETS
FOR THE YEAR ENDED DECEMBER 31, 1996
- --------------------------------------- ---------------------------------------
<TABLE>
- -------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME:
Interest......................................................... $12,779,536
EXPENSES:
Investment advisory fee (Note 5)................................. 1,624,942
Administrative fee (Note 5)...................................... 148,444
Printing and postage............................................. 72,472
Custodian, transfer agent and accounting fees.................... 68,413
Legal fees....................................................... 58,588
Directors' fees.................................................. 53,603
Audit fee........................................................ 39,350
Insurance........................................................ 14,803
Miscellaneous.................................................... 8,498
-----------
Total Expenses.................................................. 2,089,113
-----------
Net Investment Income........................................... 10,690,423
NET REALIZED AND UNREALIZED GAIN/(LOSS) ON INVESTMENTS:
Net realized gain/(loss) on investments.......................... 1,094,181
Net unrealized appreciation of investments....................... 6,045,554
-----------
Net realized and unrealized gain/(loss) on investments.......... 7,139,735
-----------
Net increase in net assets resulting from operations.............. 17,830,158
DISTRIBUTIONS TO PREFERRED STOCKHOLDERS........................... (2,293,500)
-----------
NET INCREASE IN NET ASSETS APPLICABLE TO COMMON STOCKHOLDERS
RESULTING FROM OPERATIONS AND DISTRIBUTIONS TO PREFERRED
STOCKHOLDERS..................................................... $15,536,658
===========
</TABLE>
- --------------------------------------------------------------------------------
See accompanying Notes to Financial Statements.
<TABLE>
<CAPTION>
FOR THE YEAR FOR THE YEAR
ENDED ENDED
DECEMBER 31, DECEMBER 31,
1996 1995
- -------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS:
OPERATIONS:
Net investment income............................. $ 10,690,423 $ 10,237,987
Net realized gain/(loss) on investments........... 1,094,181 (2,728,589)
Net unrealized appreciation of investments........ 6,045,554 1,562,889
------------ ------------
Net increase in net assets resulting from
operations....................................... 17,830,158 9,072,287
------------ ------------
DISTRIBUTIONS TO STOCKHOLDERS FROM:
Preferred dividends ($1.39 and $2.20 per share,
respectively).................................... (2,293,500) (1,374,239)
Common dividends:
Net investment income and short-term gains of
$1.70 and $1.90 per share, respectively......... (8,465,976) (8,733,897)
------------ ------------
Total decrease in net assets from distributions to
stockholders...................................... (10,759,476) (10,108,136)
------------ ------------
FUND SHARE TRANSACTION
(NOTES 2 AND 3):
Net proceeds from issuance of preferred stock..... -- 32,752,380
Redemption of preferred stock..................... -- (8,922,804)
Value of 23,004 and 15,088 shares issued in
reinvestment of dividends, respectively.......... 386,885 254,686
Net proceeds from 1,457,942 common stock issued in
rights offering after deducting $793,832 of
offering expenses................................ -- 22,022,960
------------ ------------
Total increase in net assets derived from fund
share transactions................................ 386,885 46,107,222
------------ ------------
Total net increase in net assets................... 7,457,567 45,071,373
NET ASSETS:
Beginning of year................................. 112,596,227 67,524,854
------------ ------------
End of year....................................... $120,053,794 $112,596,227
============ ============
</TABLE>
- --------------------------------------------------------------------------------
See accompanying Notes to Financial Statements.
7
<PAGE>
USF&G PACHOLDER FUND, INC.
- -------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
(Contained below is per share operating performance data for a share of common
stock outstanding, total return performance, ratios to average net assets and
other supplemental data. This information has been derived from information
provided in the financial statements and market price data for the Fund's
shares.)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1996 1995 1994 1993 1992
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning of
year........................ $16.02 $16.86 $19.23 $18.52 $17.37
--------- --------- ------- ------- -------
Net investment income........ 2.15 2.19 2.12 2.48 2.37
Net realized and unrealized
gain/(loss) on investments.. 1.42 (0.06) (1.64) 1.42 1.32
--------- --------- ------- ------- -------
Net increase in net asset
value resulting from
operations.................. 3.57 2.13 0.48 3.90 3.69
--------- --------- ------- ------- -------
DISTRIBUTIONS TO STOCKHOLDERS
FROM:
Preferred dividends.......... (0.46) (0.29) (0.24) (0.38) (0.33)
Common:
Net investment income and
short-term gains........... (1.69) (1.90) (1.92) (2.09) (2.08)
Net realized long-term
gains...................... -- -- -- (0.21) --
--------- --------- ------- ------- -------
Total distributions to
preferred and common
stockholders................ (2.15) (2.19) (2.16) (2.68) (2.41)
--------- --------- ------- ------- -------
CAPITAL CHANGE RESULTING FROM
THE ISSUANCE OF FUND SHARES:
Common Shares................ -- (0.67) (0.69) (0.51) --
Preferred Shares............. -- (0.11) -- -- (0.13)
--------- --------- ------- ------- -------
-- (0.78) (0.69) (0.51) (0.13)
--------- --------- ------- ------- -------
Net asset value, end of
year........................ $17.44 $16.02 $16.86 $19.23 $18.52
========= ========= ======= ======= =======
Market value per share, end
of year..................... $17.88 $17.38 $16.75 $21.25 $19.38
========= ========= ======= ======= =======
TOTAL INVESTMENT RETURN:/(1)/
Based on market value per
share....................... 14.37% 16.04% -11.12% 22.41% 25.99%
Based on net asset value per
share....................... 20.40% 10.68% 0.72% 20.27% 18.78%
RATIOS TO AVERAGE NET
ASSETS:/(2)/
Expenses.................... 1.80% 0.86% 1.64% 1.81% 1.90%
Net investment income....... 9.21% 10.45% 10.17% 10.33% 10.32%
SUPPLEMENTAL DATA:
Net assets at end of period,
net of preferred stock
(000)....................... $87,054 $79,596 $58,925 $44,458 $34,001
Average net assets during
period, net of preferred
stock (000)................. $83,074 $79,614 $59,002 $43,275 $34,950
Portfolio turnover rate...... 76% 83% 102% 97% 121%
Number of preferred shares
outstanding at end of
period...................... 1,650,000 1,650,000 8,600 9,400 1,000
Asset coverage per share of
preferred stock outstanding
at end of period............ $73 $66 $7,852 $5,730 $4,400
Liquidation and average
market value per share of
preferred stock............. $20 $20 $1,000 $1,000 $1,000
- -------------------------------------------------------------------------------
</TABLE>
/1/Total investment return excludes the effects of commissions.
/2/Ratios calculated on the basis of expenses and net investment income
applicable to both the common and preferred shares relative to the average
net assets of both the common and preferred shareholders.
See accompanying Notes to Financial Statements.
8
<PAGE>
USF&G PACHOLDER FUND, INC.
- -------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
1. SIGNIFICANT ACCOUNTING POLICIES -- USF&G Pacholder Fund, Inc. (the "Fund")
is a closed-end, diversified management investment company, registered under
the Investment Company Act of 1940. The Fund seeks a high level of total re-
turn through current income and capital appreciation by investing primarily
in high yield, high risk fixed-income securities of domestic companies. The
Fund was incorporated under the laws of the State of Maryland in August,
1988.
The following is a summary of significant accounting policies followed by the
Fund in the preparation of its financial statements.
A. SECURITY VALUATIONS -- Portfolio securities traded primarily on an ex-
change are valued at the closing sale price or, if there have been no sales,
at the last reported bid price on the valuation date. Securities traded pri-
marily in the over-the-counter market are valued at prices provided by an
independent pricing service. Restricted securities and other securities for
which market quotations are not readily available are valued at fair value
as determined under procedures established by the Board of Directors. There
were Board valued securities of $1,334,682 or 1.2% of net assets as of De-
cember 31, 1996. Short-term obligations with remaining maturities of 60 days
or less at the date of purchase are valued at amortized cost.
B. FEDERAL TAXES -- It is the Fund's policy to comply with the requirements
of the Internal Revenue Code applicable to regulated investment companies
and to distribute to its shareholders substantially all of its net invest-
ment income and realized gains on securities transactions. Therefore, no
federal tax provision is required.
C. SECURITIES TRANSACTIONS -- Securities transactions are accounted for on
the date the securities are purchased or sold (trade date). Realized gains
and losses on securities transactions are determined on an identified cost
basis. Interest income is recorded on an accrual basis. The Fund amortizes
discounts or premiums paid on purchases of portfolio securities on the same
basis for both financial reporting and tax purposes. The Fund has elected to
defer the accretion of market discount until disposition of the security.
D. WHEN, AS AND IF ISSUED SECURITIES -- The Fund may engage in "when-issued"
or "delayed delivery" transactions. The Fund records when-issued securities
on the trade date and maintains security positions such that sufficient liq-
uid assets will be available to make payment for the securities purchased.
Securities purchased on a when-issued or delayed delivery basis are marked
to market weekly and begin earning interest on the settlement date. No
"when-issued" or "delayed delivery" purchase commitments were included in
the portfolio of investments as of December 31, 1996.
E. INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS -- Interest income and esti-
mated expenses are accrued daily. Dividends to common stockholders are paid
from net investment income quarterly, and distributions of net realized cap-
ital gains are to be paid at least annually.
F. ESTIMATES -- The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make esti-
mates and assumptions that affect the reported amounts of assets and liabil-
ities and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses dur-
ing the reporting period. Actual results could differ from those estimates.
2. COMMON STOCK -- At December 31, 1996, there were 48,350,000 shares of com-
mon stock with a $.01 par value authorized and 4,991,642 shares outstanding.
During 1996, 23,004 shares of common stock were issued in connection with the
Fund's dividend reinvestment plan.
On March 16, 1995, 1,457,942 shares of common stock were issued at $15.65 per
share as part of a rights offering for the common stockholders of the Fund.
Expenses related to the rights offering totaling $793,832 were recorded as a
reduction to the proceeds from the offering. These expenses included $205,351
paid to Winton Associates, Inc., a wholly-owned subsidiary of Pacholder Asso-
ciates, Inc. (an affiliate of the Fund's Investment Advisor), for financial
and advisory services including advising the Fund regarding the structure of
the rights offering and the materials utilized therewith, coordinating the
distribution arrangements for the rights offering and providing information
and support services to soliciting broker-dealers.
On November 13, 1996, the Fund announced a common stock rights offering
whereby common stockholders are entitled to purchase one newly issued common
share for each three common shares held on the record date of January 24,
1997. Up to 1,663,880 shares of common stock may be purchased at a price per
share of 90% of the net asset value of a share of the Fund's common stock on
February 20, 1997. The Fund may, at its discretion, increase the number of
shares subject to subscription by up to 25% of the shares offered.
9
<PAGE>
USF&G PACHOLDER FUND, INC.
- -------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
3. PREFERRED STOCK -- On August 15, 1995, the Fund issued 1,650,000 shares of
6.95% Cumulative Preferred Stock in a private sale at an offering price of
$20 per share. Dividends on these shares are payable quarterly at an annual
rate of 6.95%. The Fund is required to maintain certain asset coverage, other
financial tests and restrictions as set forth in the Fund's Articles Supple-
mentary Creating and Fixing the Rights of 6.95% Cumulative Preferred Stock.
The preferred stock is subject to mandatory redemption on August 1, 2000, at
a redemption price equal to $20 per share, plus accumulated and unpaid divi-
dends. The preferred stock is also subject to special mandatory redemptions
at a redemption price of $20 per share, plus accumulated and unpaid dividends
and a premium, as defined, if the Fund is not in compliance with the required
coverages, tests and restrictions. In general, the holders of the preferred
stock and the common stock vote together as a single class, except that the
preferred stockholders, as a separate class, vote to elect two members of the
Board of Directors, and separate votes are required on certain matters that
affect the respective interests of the preferred stock and common stock. The
preferred stock has a liquidation preference of $20 per share, plus accumu-
lated and unpaid dividends. The offering expenses of the preferred stock were
$247,620, which were recorded as a reduction in paid-in capital for common
stockholders. These expenses included $123,750 paid to Winton Associates,
Inc. for financial and advisory services including advising the Fund regard-
ing the structure of the preferred stock offering and the materials utilized
therewith, and the coordinating of the arrangements of the preferred stock.
On September 14, 1995, the Fund redeemed the 8,050 outstanding shares of the
8.60% Cumulative Preferred Stock at a redemption price of $1,000 per share
plus accumulated and unpaid dividends and a premium. The redemption was made
in accordance with the Fund's Purchase Agreement and Articles Supplementary.
The premium relating to the redemption was $322,804, which was recorded as a
reduction of paid-in capital for common stockholders.
Upon completion of the common stock rights offering, announced November 13,
1996, to take place after year end, the Fund intends to add incremental lev-
erage by issuing additional preferred stock so that the percentage of the
Fund's assets representing leverage will be approximately the same as it was
prior to the completion of the common stock rights offering.
4. PURCHASES AND SALES OF SECURITIES -- Purchases and sales of securities (ex-
cluding commercial paper and repurchase agreements) for the year ended Decem-
ber 31, 1996 aggregated $86,039,766 and $86,059,136, respectively.
At December 31, 1996, the federal income tax basis of securities was
$112,214,992; unrealized appreciation aggregated $4,848,345, of which
$5,815,039 related to appreciated securities and $966,694 related to depreci-
ated securities.
At December 31, 1996, the Fund had available a capital loss carryforward of
$1,873,839, which expires in 2003, to offset any future net capital gains.
5. TRANSACTIONS WITH INVESTMENT ADVISOR, ADMINISTRATOR AND ACCOUNTING SERVICES
AGENT -- The Fund has an agreement with Pacholder & Company (the "Advisor")
to serve as the Fund's investment advisor. The Fund pays the Advisor a fee
that will increase or decrease based on the total return investment perfor-
mance of the Fund for the prior twelve-month period relative to the percent-
age change in the CS First Boston High Yield Index. The fee ranges from a
maximum of 1.40% to a minimum of 0.40% (on an annualized basis) of the aver-
age net assets. For the year ended December 31, 1996, the Fund's total return
was 20.40%. For the same period, the total return of the CS First Boston High
Yield Index was 12.42%. The 1996 advisory fee is calculated based on 1.40% of
average weekly net assets. Certain officers and directors of the Fund are
also executive committee members of the Advisor. At December 31, 1996, ac-
crued advisory fees were $323,215.
Effective June 5, 1996, the Fund entered into an administrative services
agreement changing from Investment Company Capital Corp. to Kenwood Adminis-
trative Management, L.P. ("KAM") (an affiliate of the Advisor) pursuant to
which KAM provides certain administrative services to the Fund. Under the
agreement, KAM receives from the Fund a fee, calculated and paid monthly, at
the rate of 0.10% of the average net assets. At December 31, 1996, accrued
administrative fees were $10,220.
Effective March 13, 1996 the Fund amended an agreement with Pacholder Associ-
ates, Inc. (an affiliate of the Advisor) to provide portfolio accounting and
pricing services. Pacholder Associates, Inc. receives from the Fund a fee,
calculated and paid monthly, at the annual rate of 0.025% of the first $100
million of the Fund's average net assets and 0.015% of such assets in excess
of $100 million.
10
<PAGE>
USF&G PACHOLDER FUND, INC.
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (CONCLUDED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
6. NET ASSETS CONSIST OF:
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1995
------------ ------------
<S> <C> <C>
Common Stock
($.01 par value)................................. $ 49,916 $ 49,686
Preferred Stock................................... 33,000,000 33,000,000
Paid-in capital................................... 83,926,176 83,539,521
Undistributed net investment income............... 103,196 172,249
Accumulated net realized loss on investments...... (1,873,839) (2,968,020)
Unrealized appreciation/(depreciation) on
investments...................................... 4,848,345 (1,197,209)
------------ ------------
$120,053,794 $112,596,227
============ ============
</TABLE>
11
<PAGE>
USF&G PACHOLDER FUND, INC.
- --------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT ADDITIONAL INFORMATION (UNAUDITED)
- --------------------------------------- ---------------------------------------
- --------------------------------------------------------------------------------
To the Stockholders and Directors
USF&G Pacholder Fund, Inc.
We have audited the accompanying statement of net assets of USF&G Pacholder
Fund, Inc. as of December 31, 1996, and the related statement of operations for
the year then ended, the statements of changes in net assets for each of the
two years in the period then ended, and the financial highlights for each of
the periods presented. These financial statements and financial highlights are
the responsibility of the Fund's management. Our responsibility is to express
an opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing stan-
dards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial high-
lights are free of material misstatements. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of De-
cember 31, 1996, by correspondence with the custodian. An audit also includes
assessing the accounting principles used and significant estimates made by man-
agement, as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
USF&G Pacholder Fund, Inc. at December 31, 1996, and the results of its opera-
tions, changes in net assets and financial highlights for the respective stated
periods, in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Dayton, Ohio
February 18, 1997
DIVIDEND REINVESTMENT PLAN
The Fund's Dividend Reinvestment Plan (the "Plan") offers stockholders a con-
venient way to invest their dividends and capital gains distributions in addi-
tional shares of the Fund's common stock, thereby increasing their holdings of
Fund shares.
To participate in the Plan, stockholders must complete an Authorization Form
and return it to Fifth Third Bank ("Fifth Third"), the Plan Agent. To start the
Plan with a specific dividend, Fifth Third must have received an Authorization
Form prior to the record date.
When a dividend is declared, non-participants will receive cash paid by
check. Plan participants will automatically receive shares of the Fund's common
stock equivalent to the cash distribution. The number of shares will be deter-
mined as follows:
(1) If the shares are trading at net asset value or at a premium above
net asset value at the time of valuation, the Fund will issue new shares at
the greater of net asset value or 95% of the then current market price; or
(2) If the shares are trading at a discount from net asset value at the
time of valuation, Fifth Third will receive the distribution in cash and
apply it to the purchase of shares in the open market, on the American
Stock Exchange or elsewhere, for the participants' accounts. If, before
Fifth Third has completed its purchases, the market price exceeds the net
asset value per share, the Fund will issue new shares at net asset value
for the uninvested portion of the dividend. Fifth Third will use all dis-
tributions received in cash to purchase shares within 30 days of the pay-
ment date. Interest will not be paid on any uninvested cash payments.
There is no charge to participants for reinvesting distributions. Fifth
Third's fee for administering the Plan is paid by the Fund. There will be no
brokerage charges with respect to shares issued directly by the Fund as a re-
sult of distributions payable either in stock or cash. However, each partici-
pant will pay a pro rata share of brokerage commissions incurred with respect
to Fifth Third's open-market purchases in connection with the Plan.
Fifth Third maintains all shareholders' accounts in the Plan and furnishes
written confirmation of all transactions for tax records. Shares in the account
of each Plan participant are held by Fifth Third in non-certificated form in
the name of the participant, and each stockholder's proxy will include shares
received pursuant to the Plan. A participant will be issued a certificate for
shares held in a Plan account only upon request.
12
<PAGE>
USF&G PACHOLDER FUND, INC.
- --------------------------------------------------------------------------------
ADDITIONAL INFORMATION (UNAUDITED AND CONCLUDED)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
A participant may withdraw from the Plan by notifying Fifth Third in writing.
Upon termination, participants can either receive a certificate for the whole
shares credited to their account and a check for fractional shares or have
their shares sold by Fifth Third.
The automatic reinvestment of distributions will not relieve Plan partici-
pants of any income taxes that may be payable (or required to be withheld) on
distributions.
The Fund reserves the right to amend or terminate the Plan and to include a
service charge payable by participants.
Additional information about the Plan and Authorization Forms may be obtained
by writing Fifth Third Bank, Corporate Trust Operations, 38 Fountain Square
Plaza, MD-1090F5, Cincinnati, OH 45263, or by calling Fifth Third toll free at
(800) 837-2755.
---------------
This report is sent to the stockholders of USF&G Pacholder Fund, Inc. for their
information. It is not a prospectus, circular or representation intended for
use in the purchase or sale of shares of the Fund or any securities mentioned
in this report.
13
<PAGE>
USF&G
PACHOLDER FUND, INC.
- --------------------------------------------------------------------------------
DIRECTORS AND OFFICERS
Asher O. Pacholder John C. Sweeney
Chairman Director
Anthony L. Longi, Jr. John F. Williamson
President Director
William J. Morgan George D. Woodward
Director and Treasurer Director
James P. Shanahan, Jr. James E. Gibson
Director and Secretary Senior Vice President
Daniel A. Grant Mark H. Prenger
Director Assistant Treasurer
INVESTMENT OBJECTIVE
A closed-end fund seeking a high level of total return through current income
and capital appreciation by investing primarily in high yield, high risk fixed-
income securities of domestic companies.
INVESTMENT ADVISOR
Pacholder & Company
ADMINISTRATOR
Kenwood Administrative Management, L.P.
CUSTODIAN
Star Bank, N.A.
TRANSFER AGENT
Fifth Third Bank
LEGAL COUNSEL
Piper & Marbury L.L.P.
INDEPENDENT AUDITORS
Deloitte & Touche LLP
EXECUTIVE OFFICES
USF&G Pacholder Fund, Inc.
Bank One Towers
8044 Montgomery Road
Suite 382
Cincinnati, Ohio 45236
(513) 985-3200
==============================================================================
USF&G
PACHOLDER FUND, INC.
ANNUAL REPORT
DECEMBER 31, 1996
===============================================================================
