Mentor Income Fund, Inc.
Semi-Annual Report
April 30, 1998
- --------------------------------------------------------------------------------
The Fund
[]A closed-end investment fund that invests primarily in high-quality fixed-
income securities. The Fund is listed on the New York Stock Exchange with
common shares traded under the symbol, MRF.
Investment Objective
[]To achieve high monthly income consistent with preservation of capital.
Dividend Objective
[]To distribute monthly income in excess of that attainable from investments
in U.S. Treasury securities having the same maturity as the expected
average life of the Fund's investments.
Report from the Chairman and President
We appreciate the opportunity to provide the Semi-Annual Report to shareholders
for Mentor Income Fund for the six months ended April 30, 1998. Regardless of
market environment, the Fund's primary mission remains the same, to provide
attractive income and competitive net asset value total returns to shareholders.
During the six months ended April 30, 1998, the Fund paid dividends totaling
$0.41 per share, which represents an annualized yield of 9.37% based on the
Fund's closing market price of $8.75 on April 30, 1998. These monthly dividends
have provided the Fund's shareholders with a significant income advantage over
the average yield-to-maturity of 5.75%, attainable during the period from
treasury securities having the same approximate maturity as the average life of
the Fund's investments. Of course, treasuries are guaranteed as to principal and
interest, while the Fund's shares are not guaranteed and will fluctuate in
value.
1
<PAGE>
Mentor Income Fund, Inc.
Semi-Annual Report
April 30, 1998
- --------------------------------------------------------------------------------
Market Conditions
Chart I: A Period of Stable Interest Rates
[GRAPH]
10/31/97 4/30/98
3 Mos. 5.19 4.98
6 Mos. 5.31 5.22
1 Yr. 5.35 5.38
2 Yr. 5.61 5.57
3 Yr. 5.68 5.6
5 Yr. 5.72 5.64
10 Yr. 5.83 5.67
30 Yr. 6.15 5.95
Source: Bloomberg
As Chart I indicates, during the six-month period ended April 30, 1998 interest
rates remained stable to moderately lower across the yield curve. Three-month
yields fell 0.22% and 30-year rates fell 0.20%. Two and 10-year treasuries
closed the period at 5.57% and 5.67%, down 0.04% and 0.16% respectively from the
beginning of the period. The Federal Reserve continued to leave the federal
funds rate (the rate member banks charge each other on inter-bank loans and the
primary way in which the Fed influences short-term interest rates) unchanged,
continuing the neutral monetary stance that the Fed has maintained since its
last tightening in March, 1997.
The attractive combination of low inflation and moderate growth, which has
characterized the domestic economy in recent years, remains intact. Annualized
GDP (gross domestic product), the most comprehensive measure of domestic
economic growth, increased at a rate of 3.7% for the fourth quarter of 1997, and
preliminary indications are that first-quarter 1998 growth could be as high as
4.8%.
Despite continued steady economic growth, inflation at both the wholesale and
retail levels remains remarkably subdued. At no time during the past year has
the monthly CPI (consumer price index) increase exceeded 0.2%. The PPI (producer
price index) readings have been even weaker. During five of the last six months
PPI numbers have been negative, resulting in a negative year-to-date annualized
producer price growth rate. That negative growth rate points to an
2
<PAGE>
Mentor Income Fund, Inc.
Semi-Annual Report
April 30, 1998
- --------------------------------------------------------------------------------
emerging deflationary environment for basic industrial commodities such as oil
and metals. Amazingly, falling prices such as these are occurring in a period of
the lowest unemployment rates of the past 30 years. In fact, the 4.3% to 4.7%
unemployment rates experienced during the early months of 1998 represent levels
that were viewed well below "full employment" only a few years ago.
Effect on the Fund
When compared to the indexes which we have traditionally used to assess our
performance, our results for the six-month period ending April 30, 1998 trailed
on a relative basis. As Chart II indicates, the Fund's 1.30% net asset value
total return for the six-months ended April 30, 1998 compares to the 3.58%,
3.59%, and 3.54% returns posted by the Merrill Lynch Mortgage, Government Bond,
and 7-year Treasury indexes, respectively.* The return of the Fund's Lipper U.S.
Mortgage Bond Fund peer group was 2.96%.**
Chart II: Relative Performance
(10/31/97 - 4/30/98)
[GRAPH]
Mentor Income Fund 1.29
Lipper Peer Group 2.96
Mortgage Index 3.58
Gov't Bond Index 3.59
7-Year Treasury 3.54
Source: Lipper Analytical Services, Inc. and Merrill Lynch
Portfolio Strategy
Throughout the six-month period common themes continued to support our strategy
for seeking to fulfill our objectives - to provide attractive income, maintain
risk close to that of intermediate treasuries, and capitalize on the investment
opportunities provided within the guidelines of our investment policy.***
As we had expected, the turmoil in emerging Asian markets and Japan has been
positive for U.S. fixed-income markets, particularly the highest quality sectors
such as U.S. treasuries. The current low interest rate environment has made
3
<PAGE>
Mentor Income Fund, Inc.
Semi-Annual Report
April 30, 1998
- --------------------------------------------------------------------------------
mortgage refinancing particularly attractive for homeowners. As a result, we
reconfigured our portfolio to take advantage of the increased likelihood of
mortgage prepayments. It was our belief that increased prepayment pressure would
inevitably negatively affect the relative attractiveness of mortgage-backed
bonds. Likewise, we felt that the Asian crisis would negatively affect the
earnings of U.S. multi-national corporations that rely on exports to those
countries. The likely consequence of this lack of predictability of corporate
earnings would be a widening of spreads. This anticipated widening of spreads
versus treasuries did in fact occur in both the mortgage and corporate markets.
By quarter-end, however, widened spreads made high-grade mortgage and corporate
product sufficiently attractive to cause us to reverse course and selectively
raise non-treasury allocations within the Fund.
At the end of April we maintained a portfolio duration tilt approximately 5-to-
10% longer than our Merrill Lynch 7-year Treasury Index benchmark, a modest
extension from the portfolio duration at the beginning of the period. During the
period we also sold our international bond positions, replacing them with
domestic holdings.
Market Outlook
The outlook is little changed from what it appeared to be at the beginning of
the year. Prospects for continued low inflation remain good. The likely
long-term consequence is that long rates, which are more sensitive to inflation
than they are to economic growth, are likely to continue to decline over the
course of the year.
Still unknown is the ultimate effect of Pacific Rim dislocations on the rate of
U.S. domestic growth. So far, the effect appears more modest than expected.
Declining exports and surging imports have depressed U.S. growth rates; but
accelerating domestic consumption expenditures driven by the lower rate
environment have offset the damage. It seems clear, however, that the crisis in
Asia has prevented inflationary pressures from emerging in the U.S. economy, as
exhibited by year-to-date inflation trends. Low inflation should continue to
provide an attractive environment for lower interest rates.
4
<PAGE>
Mentor Income Fund, Inc.
Semi-Annual Report
April 30, 1998
- --------------------------------------------------------------------------------
Dividend Reinvestment Plan
Shareholders who wish to purchase additional shares can do so through the Fund's
automatic dividend reinvestment plan. More than 60% of the Fund's shareholders
participate in this plan. If you would like to receive information about the
plan, please call our plan agent at (800) 426-5523.
Sincerely,
/s/ Daniel J. Ludeman
- ---------------------
Daniel J. Ludeman
Chairman
/s/ Paul F. Costello
- --------------------
Paul F. Costello
President
* The Merrill Lynch Mortgage Index is a composite of fixed-rate mortgage
pass-through securities. The Merrill Lynch Government Bond Index is a
composite of 2,347 treasury and agency issues with maturities ranging
from one to 30 years. The Merrill Lynch 7-Year Treasury Index is
adjusted to reflect reinvestment of interest on securities in the index.
It is not adjusted to reflect sales loads, expenses, or other fees that
the SEC requires to be reflected in the Portfolio's performance. Of
course, treasuries are guaranteed as to principal and interest, while
the Fund's shares are not guaranteed and will fluctuate. Performance
does not include sales charges and does include reinvestment of all
distributions.
** Lipper Analytical Services, Inc. is one of the worlds largest providers
of performance and other statistical information on the mutual fund
industry.
*** While the managers seek to fulfill these objectives, there is no
guarantee that their process will be successful.
5
<PAGE>
Mentor Income Fund, Inc.
Portfolio of Investments
April 30, 1998 (Unaudited)
<TABLE>
<CAPTION>
Principal Market
Percent of Net Assets Amount Value
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Long-Term Investments 137.86%
- -----------------------------------------------------------------------------------------------------
Preferred Stock 4.60%
Home Ownership Funding Corporation
(cost $5,287,705) $ 5,650,000 $5,423,339
- -----------------------------------------------------------------------------------------------------
U.S. Government Securities and Agencies 66.66%
- -----------------------------------------------------------------------------------------------------
Federal Home Loan Mortgage Corporation
6.50%, Series 1647 B, 11/15/08 - REMIC 9,386,690 9,308,396
6.00%, Series 1693 Z, 3/15/09 - REMIC 5,965,400 5,650,516
6.00% - 10.75%, 9/01/09 - 1/01/28 (d) 7,533,957 7,519,259
Federal National Mortgage Association
10.50%, 11/01/18 4,709,515 5,227,953
6.00%-6.50%, 12/01/13-3/01/28 (d) 18,322,341 17,871,540
6.50%, Series 98-24, Class JZ, 5/18/98 3,375,000 3,229,453
7.48%, 7/01/27 - ARM 25,412 25,412
Government National Mortgage Association
7.00%, 15-year Platinum, 12/15/08 (d) 4,118,516 4,192,283
6.50% - 11.50%, 2/15/13 - 3/15/28 (d) 5,132,611 5,106,553
4.50% - 7.00%, 12/20/22 - 1/20/28 - ARM (d) 13,794,075 13,881,587
U.S. Treasury Strips, 11/15/21 (d) 27,300,000 6,525,765
- -----------------------------------------------------------------------------------------------------
Total U.S. Government Securities and Agencies
(cost $78,325,823) 78,538,717
- -----------------------------------------------------------------------------------------------------
Corporate Bonds 14.09%
- -----------------------------------------------------------------------------------------------------
Finance 10.48%
Capital One Bank, 7.15%, 9/15/06,
puttable 9/15/99 4,000,000 4,067,936
Lehman Brothers, Inc., 7.50%, 8/01/26,
puttable 8/01/03 1,500,000 1,609,887
NationsBank Corporation, 7.50%, 9/15/06 1,500,000 1,611,766
Salomon, Inc., 7.65%, 6/27/05 2,700,000 2,876,620
Travelers Group, Inc., 9.50%, 3/01/02 1,000,000 1,114,735
United Dominion Realty, 7.25%, 1/15/07 1,050,000 1,071,630
- -----------------------------------------------------------------------------------------------------
12,352,574
- -----------------------------------------------------------------------------------------------------
</TABLE>
6
<PAGE>
Mentor Income Fund, Inc.
Portfolio of Investments
April 30, 1998 (Unaudited)
<TABLE>
<CAPTION>
Principal Market
Percent of Net Assets Amount Value
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Corporate Bonds (continued)
- -------------------------------------------------------------------------------------------------------
Utilities 3.61%
Mississippi Power & Light Company, 8.80%,
4/01/05, callable 7/06/98 $ 4,250,000 $ 4,250,000
- -------------------------------------------------------------------------------------------------------
Total Corporate Bonds (cost $16,246,666) 16,602,574
- -------------------------------------------------------------------------------------------------------
Private Issues 40.37%
- -------------------------------------------------------------------------------------------------------
Adjustable Rate Mortgages 7.89%
California Federal Bank
Series 1991-2, Class A, 7.38%, 7/15/21 (b) 457,404 457,455
Kidder Peabody Acceptance Corporation Series
1989-3, Class A, 8.91%, 6/20/19 (b) 760,292 764,232
PaineWebber Mortgage Acceptance Corporation
Series 1993-1, Class M-1, 7.82%, 3/25/23 1,044,443 1,049,840
Series 1993-3, Class M-1, 7.70%, 4/25/23 1,446,590 1,454,090
Sears Mortgage Securities Corporation
Series 1992-9, Class A, 7.76%, 10/25/21 (b) 1,251,589 1,275,300
Structured Asset Securities Residential Trust
Series 1990-1, Class A, 7.79%, 4/01/20 4,213,352 4,289,665
- -------------------------------------------------------------------------------------------------------
9,290,582
- -------------------------------------------------------------------------------------------------------
Asset-Backed Securities 6.97%
Advanta Mortgage Loan Trust, Series 1993-3
Class A5, 5.55%, 1/25/25 1,231,938 1,174,261
AFG Receivables Trust, 6.45%, 9/15/00 482,889 482,372
CS First Boston, Series 1996-2 Class A6,
7.18%, 2/25/18 2,750,000 2,793,422
Olympic Automobiles Receivables Trust,
Series 1994-B Class A2 6.85%, 6/15/01 925,848 930,579
Old Stone Credit Corporation Home Equity
Trust, Series 1993-2, 6.20%, 6/15/08 1,201,977 1,190,783
Union Acceptance Corporation Auto Trust,
Series 1996-B, 6.45%, 7/08/03 1,630,382 1,637,249
- -------------------------------------------------------------------------------------------------------
8,208,666
- -------------------------------------------------------------------------------------------------------
</TABLE>
7
<PAGE>
Mentor Income Fund, Inc.
Portfolio of Investments
April 30, 1998 (Unaudited)
<TABLE>
<CAPTION>
Principal Market
Percent of Net Assets Amount Value
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Private Issues (continued)
- ----------------------------------------------------------------------------------------------------------
Collateralized Mortgage Obligation 25.29%
General Electric Capital Mortgage Services
Series 1993-18 Class B1, 6.00%, 2/25/09 (a) $ 1,985,795 $ 1,914,037
Series 1996-4 Class B1, 7.00%, 3/25/26 4,414,150 4,369,837
Series 1998-1, Class M, 6.75%, 1/25/13 743,685 746,637
Series 1998-3, Class M, 7.00%, 1/25/28 2,740,434 2,742,344
NASCOR
Series 1996-2 Class M, 7.00%, 9/25/11 1,789,066 1,803,579
Series 1997-7 Class M, 7.00%, 5/25/27 1,584,728 1,598,595
Prudential Home Mortgage Securities
Series 1993-27 Class M, 7.50%, 5/25/23 3,224,338 3,319,340
Series 1993-22 Class M, 7.00%, 7/25/23 4,743,917 4,791,124
Series 1994-29 Class M, 7.00%, 10/25/24 3,176,198 3,194,214
Series 1995-5 Class M, 7.25%, 9/25/25 2,574,971 2,626,383
Series 1995-5 Class B1, 7.25%, 9/25/25 (a) 2,659,667 2,697,714
- ----------------------------------------------------------------------------------------------------------
29,803,804
- ----------------------------------------------------------------------------------------------------------
Interest Only Securities 0.22%
Contimortgage Home Equity Loan Trust
Series 94-3, A2I0, 0.13%, 3/15/14 (c) 70,280,914 263,553
- ----------------------------------------------------------------------------------------------------------
Total Private Issues (cost $45,834,889) 47,566,605
- ----------------------------------------------------------------------------------------------------------
Residual Interests (a) 12.14%
- ----------------------------------------------------------------------------------------------------------
Capital Mortgage Funding, Inc., 1997-13,
11/20/22 35,545 637,537
Capital Mortgage Funding, Inc., 1998-1,
1/22/27 44,816 711,254
General Mortgage Securities, Inc., 1989-2, 1998,
4/17/19 21,287 1,073,392
General Mortgage Securities II, Inc., 1991-4,
1998, 3/28/20 776 329,198
General Mortgage Securities II, Inc., 1991-7,
1997, 6/28/30 705 394,660
General Mortgage Securities II, Inc., 1995-1,
1998, 6/25/20 18,024 482,070
</TABLE>
8
<PAGE>
Mentor Income Fund, Inc.
Portfolio of Investments
April 30, 1998 (Unaudited)
<TABLE>
<CAPTION>
Principal Market
Percent of Net Assets Amount Value
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Residual Interests (a) (continued)
- ---------------------------------------------------------------------------------------------------------
General Mortgage Securities II, Inc., 1995-4,
1997, 6/25/23 $ 11,002 $ 457,424
General Mortgage Securities II, Inc., 1997-4,
5/20/22 18,749 799,032
General Mortgage Securities II, Inc., 1997-5,
7/20/23 27,928 868,161
National Mortgage Funding I, Inc., 1992-4, 1997,
6/01/29 8,348 680,310
National Mortgage Funding I, Inc., 1993-1, 1998,
6/18/14 40,355 586,874
National Mortgage Funding I, Inc., 1995-4, 1997,
3/20/21 9,479 167,784
National Mortgage Funding I, Inc., 1996-1, 1998,
4/25/25 30,473 493,597
National Mortgage Funding I, Inc., 1997-6,
9/20/21 39,311 842,724
National Mortgage Funding I, Inc., 1997-7,
7/20/22 39,997 816,341
National Mortgage Funding I, Inc., 1997-8,
2/20/23 73,660 833,246
National Mortgage Funding I, Inc., 1997-9,
11/20/24 29,924 816,837
National Mortgage Funding I, Inc., 1997-10,
10/20/24 39,873 586,535
National Mortgage Funding I, Inc., 1998-1,
10/20/22 20,700 559,392
National Mortgage Funding I, Inc., 1998-2,
10/20/23 22,988 588,074
National Mortgage Funding I, Inc., 1998-3,
11/20/23 23,244 585,598
National Mortgage Funding I, Inc., 1998-4,
10/25/29 784 530,866
National Mortgage Funding I, Inc., 1998-5,
11/25/22 10,114 465,238
- ---------------------------------------------------------------------------------------------------------
Total Residual Interests (cost $14,706,307) 14,306,144
- ---------------------------------------------------------------------------------------------------------
Total Long-Term Investments (cost $160,401,390) 162,437,379
- ---------------------------------------------------------------------------------------------------------
</TABLE>
9
<PAGE>
Mentor Income Fund, Inc.
Portfolio of Investments
April 30, 1998 (Unaudited)
<TABLE>
<CAPTION>
Principal Market
Percent of Net Assets Amount Value
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Short-Term Investments 1.65%
- -------------------------------------------------------------------------------------------------------
Repurchase Agreement
Goldman Sachs & Company
Dated 4/30/98, 5.54%, due 5/01/98
collateralized by $1,965,560 Federal Home
Loan Mortgage Corporation, 7.00%, 2/01/28,
market value $1,988,900 (cost $1,947,066) $ 1,947,066 $ 1,947,066
- -------------------------------------------------------------------------------------------------------
Total Investments (cost $162,348,456) 139.51% 164,384,445
- -------------------------------------------------------------------------------------------------------
Other Assets less Liabilities (39.51%) (46,556,558)
- -------------------------------------------------------------------------------------------------------
Net Assets 100.00% $ 117,827,887
- -------------------------------------------------------------------------------------------------------
</TABLE>
REMIC - Real Estate Mortgage Investment Conduit
ARM - Adjustable Rate Mortgage
(a) These are securities that may be resold to "qualified institutional buyers"
under Rule 144A or securities offered pursuant to Section 4(2) of the
Securities Act of 1933, as amended. These securities have been determined to
be liquid under guidelines established by the Board of Trustees.
(b) All or a portion of these securities are illiquid securities, and are valued
using market quotations where readily available. In the absence of market
quotations, the securities are valued based upon their fair value determined
under procedures approved by the Board of Directors.
(c) Notional principal amount.
(d) A portion of these securities have been segregated as collateral for reverse
repurchase agreements.
See notes to financial statements.
10
<PAGE>
Mentor Income Fund
Statement of Assets and Liabilities
April 30, 1998 (Unaudited)
- ----------------------------------------------------------------------------
Assets
Investments, at market value (cost $162,348,456) $ 164,384,445
Cash 1,506,837
Receivables
Investments sold 1,772,296
Dividends and interest 1,017,522
Other 180,045
- ----------------------------------------------------------------------------
Total assets 168,861,145
- ----------------------------------------------------------------------------
Liabilities
Payables
Investments purchased 4,830,916
Reverse repurchase agreements 46,000,000
Dividends 153,813
Accrued expenses and other liabilities 48,529
- ----------------------------------------------------------------------------
Total liabilities 51,033,258
- ----------------------------------------------------------------------------
Net Assets $ 117,827,887
============================================================================
Components of Net Assets
Additional paid-in capital $ 131,737,777
Accumulated undistributed net investment income 25,714
Accumulated net realized loss on investment transactions (15,971,593)
Net unrealized appreciation of investments 2,035,989
- ----------------------------------------------------------------------------
Net Assets $ 117,827,887
Shares Outstanding 11,817,776
- ----------------------------------------------------------------------------
Net Asset Value Per Share $ 9.97
============================================================================
See notes to financial statements.
11
<PAGE>
Mentor Income Fund
Statement of Operations
Six Months Ended April 30, 1998 (Unaudited)
- ---------------------------------------------------------------------
Investment income
Dividends $ 5,990,346
- ---------------------------------------------------------------------
Expenses
Management fee 382,608
Administration fee 58,826
Shareholder reports and postage expenses 40,230
Shareholder service fee 29,753
Transfer agent fee 26,475
Custodian and accounting fees 25,813
Legal fees 18,618
Registration expenses 15,184
Directors' fees and expenses 2,606
Audit fees 1,677
Miscellaneous 1,991
- ---------------------------------------------------------------------
Total operating expenses 603,781
- ---------------------------------------------------------------------
Interest expense 1,375,810
- ---------------------------------------------------------------------
Total expenses 1,979,591
- ---------------------------------------------------------------------
Net investment income 4,010,755
- ---------------------------------------------------------------------
Realized and unrealized gain on investments and
interest-rate swaps
Net realized loss on investments and interest-rate
swaps (Note 2) (1,120,453)
Change in unrealized appreciation on investments (1,529,337)
- ---------------------------------------------------------------------
Net realized and unrealized loss on investments and
interest-rate swaps (2,649,790)
- ---------------------------------------------------------------------
Net increase in net assets resulting from operations $ 1,360,965
=====================================================================
See notes to financial statements.
12
<PAGE>
Mentor Income Fund
Statement of Cash Flows
Six Months Ended April 30, 1998 (Unaudited)
- ----------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net increase in net assets resulting from operations $ 1,360,965
Adjustments to reconcile net increase in net assets from
operations to net cash provided by operating activities:
Purchase of investment securities (108,545,632)
Proceeds from disposition of investments 128,283,912
Sale of short-term investments, net (1,199,335)
Variation margin on interest-rate swaps (45,438)
Decrease in dividends and interest receivable 658,242
Decrease in receivable for investments sold 4,082,567
Decrease in other assets (111,860)
Decrease in payable for investments purchased (17,278,481)
Decrease in accrued expenses and other liabilities (302,710)
Change in unrealized appreciation on investments 1,529,337
Net realized loss on investments and
interest-rate swaps 1,120,453
- ---------------------------------------------------------------------------
Net cash provided by operating activities 9,552,020
- ---------------------------------------------------------------------------
Cash Flows from Financing Activities:
Decrease in reverse repurchase agreements (3,236,231)
Cash distributions paid (4,810,162)
- ---------------------------------------------------------------------------
Net cash used in financing activities (8,046,393)
- ---------------------------------------------------------------------------
Net increase in cash 1,505,627
- ---------------------------------------------------------------------------
Cash:
Beginning of period 1,210
- ---------------------------------------------------------------------------
End of period $ 1,506,837
===========================================================================
See notes to financial statements.
13
<PAGE>
Mentor Income Fund
Statements of Changes in Net Assets
<TABLE>
<CAPTION>
Six Months Ended
April 30, 1998 Year Ended
(Unaudited) October 31, 1997
- ---------------------------------------------------------------------------------------
<S> <C>
Net Increase (Decrease) in Net Assets
Operations
Net investment income $ 4,010,755 $ 9,736,025
Net realized loss on investments and
interest-rate swaps (1,120,453) 602,516
Change in unrealized appreciation on
investments (1,529,337) 2,065,727
- ---------------------------------------------------------------------------------------
Net increase in net assets resulting from
operations 1,360,965 12,404,268
- ---------------------------------------------------------------------------------------
Distributions to Shareholders
From net investment income (4,845,202) (9,930,537)
- ---------------------------------------------------------------------------------------
Increase (Decrease) in net assets (3,484,237) 2,473,731
Net Assets
Beginning of period 121,312,124 118,838,393
- ---------------------------------------------------------------------------------------
End of period (including accumulated
undistributed net investment income of
$25,714 and $860,161, respectively) $ 117,827,887 $ 121,312,124
=======================================================================================
</TABLE>
See notes to financial statements.
14
<PAGE>
Mentor Income Fund, Inc.
Financial Highlights
<TABLE>
<CAPTION>
Six Months
Ended
April 30, Year Ended October 31,
1998 -----------------------------------------------------------------------
(Unaudited) 1997 1996 1995 1994 1993
----------------- ------------- ------------- ------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C>
Per Share Operating Performance
Net asset value, beginning of period $ 10.27 $ 10.06 $ 10.21 $ 9.60 $ 11.29 $ 11.06
Income from investment operations
Net investment income 0.34 0.82 0.83 0.80 1.02 1.05
Net realized and unrealized gain
(loss) on investments ( 0.23) 0.23 (0.14) 0.70 (1.75) 0.23
- --------------------------------------- --------- -------- --------- -------- -------- --------
Total from investment operations 0.11 1.05 0.69 1.50 (0.73) 1.28
Less distributions
Distributions from net investment
income ( 0.41) (0.84) (0.84) (0.89) (0.96) (1.05)
- --------------------------------------- --------- --------- --------- --------- -------- --------
Net asset value, end of period $ 9.97 $ 10.27 $ 10.06 $ 10.21 $ 9.60 $ 11.29
- --------------------------------------- --------- --------- --------- --------- -------- --------
Per share market price, end of period $ 8.75 $ 9.38 $ 9.00 $ 8.88 $ 8.25 $ 10.50
Total Investment Return
Based on market price (2.80%) 13.92% 11.24% 18.83% (13.32%) (6.91%)
Based on net asset value 1.30% 11.65% 8.08% 17.48% (6.19%) 12.00%
- ---------------------------------------------------------------------------------------------------------------------------------
Ratios/Supplemental Data
Net assets, end of period
(in thousands) $ 117,828 $ 121,312 $ 118,838 $ 120,617 $ 113,401 $ 133,077
Ratio of gross investment income to
average net assets 10.04%(a) 10.97% 11.12% 10.58% 12.18% 11.79%
Ratio of total operating expenses to
average net assets 1.01%(a) 1.08% 1.13% 1.09% 1.22% 1.09%
Ratio of total expenses to average
net assets 3.32%(a) 2.78% 2.84% 2.39% 2.38% 2.48%
Ratio of net investment income to
average net assets 6.72%(a) 8.19% 8.28% 8.19% 9.80% 9.31%
Portfolio turnover rate 63.43% 70.50% 189.71% 153.92% 173.71% 269.16%
Shares outstanding at end of period
(in thousands) 11,818 11,818 11,818 11,818 11,818 11,786
=================================================================================================================================
</TABLE>
(a) Annualized.
See notes to financial statements.
15
<PAGE>
Mentor Income Fund, Inc.
Notes to Financial Statements
April 30, 1998 (Unaudited)
Note 1: Organization
Mentor Income Fund, Inc. ("the Fund") is registered under the Investment Company
Act of 1940 as a diversified, closed-end management investment company.
Note 2: Significant Accounting Policies
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of the financial statements. The
policies are in conformity with generally accepted accounting principles which
require management to make estimates and assumptions that affect amounts
reported therein. Although actual results could differ from these estimates, any
such differences are expected to be immaterial to the net assets of the Fund.
(a) Valuation of Securities
The Fund values mortgage-backed securities, mortgage-related, asset-backed and
other debt-related securities on the basis of valuations provided by dealers
approved by the Fund's Board of Directors. In determining value, the dealers use
information with respect to transactions in such securities, various
relationships between securities, and yield to maturity. Exchange-traded options
are valued at the closing sales price or the average of the quoted bid and asked
price. Any securities or other assets for which current market quotations are
not readily available are valued at their fair value as determined in good faith
under procedures established by and under the general supervision and
responsibility of the Fund's Board of Directors.
(b) Repurchase Agreements
It is the policy of the Fund to require the custodian bank to take possession,
to have legally segregated in the Federal Reserve Book entry system, or to have
segregated within the custodian bank's vault all securities held as collateral
in support of repurchase agreement investments. Additionally, procedures have
been established by the Fund to monitor, on a daily basis, the market value of
each repurchase agreement's underlying securities to ensure the existence of a
proper level of collateral.
The Fund will only enter into repurchase agreements with banks and other
16
<PAGE>
Mentor Income Fund, Inc.
Notes to Financial Statements
(continued)
recognized financial institutions such as broker/dealers which are deemed by the
Fund's advisor to be creditworthy pursuant to guidelines established by the
Fund's Board of Directors. Risks may arise from the potential inability of
counterparties to honor the terms of the repurchase agreement. Accordingly, the
Fund could receive less than the repurchase price on the sale of collateral
securities.
(c) Options
In order to produce incremental earnings or protect against changes in the value
of portfolio securities, the Fund may buy and sell put and call options, write
covered call options on portfolio securities.
The Fund generally purchases put options or writes covered call options to hedge
against adverse movements in the value of portfolio holdings. The Fund may also
use options for speculative purposes, although it does not employ options for
this at the present time. The Fund will segregate assets to cover their
obligations under option contracts.
Options contracts are valued daily based upon the last sales price on the
principal exchange on which the option is traded and unrealized appreciation or
depreciation is recorded. The Fund will realize a gain or loss upon the
expiration or closing of the option transaction. When an option is exercised,
the proceeds on sales for a written call option, the purchase cost for a written
put option, or the cost of the security for a purchased put or call option is
adjusted by the amount of premium received or paid.
The risk in writing a call option is that the Fund gives up the opportunity for
profit if the market price of the security increases and the option is
exercised. The risk in writing a put option is that the Fund may incur a loss if
the market price of the security decreases and the option is exercised. The risk
in buying an option is that the Fund pays a premium whether or not the option is
exercised. The Fund also has the additional risk of not being able to enter into
a closing transaction if a liquid secondary market does not exist. The Fund may
also write over-the-counter options where the completion of the
17
<PAGE>
Mentor Income Fund, Inc.
Notes to Financial Statements
(continued)
obligation is dependent upon the credit standing of the counterparty.
(d) Futures Contracts
In order to gain exposure to or protect against declines in security values, the
Fund may buy and sell futures contracts. The Fund may also buy or write put or
call options on these futures contracts.
The Fund generally sells futures contracts to hedge against declines in the
value of portfolios securities. The Fund may also purchase futures contracts to
gain exposure to market changes as it may be more efficient or cost effective
than actually buying securities. The Fund will segregate assets to cover its
commitments under such speculative futures contracts.
Upon entering into a futures contract, the Fund is required to deposit either
cash or securities in an amount (initial margin) equal to a certain percentage
of the contract value. Subsequent payments (variation margin) are made or
received by the Fund each day. The variation margin payments are equal to the
daily changes in the contract value and are recorded as unrealized gains and
losses. The Fund recognizes a realized gain or loss when the contract is closed.
Risks of entering into futures contracts (and related options) include the
possibility that there may be an illiquid market and that a change in the value
of the contract or option may not correlate with changes in the value of the
underlying securities. At April 30, 1998, the Fund had no open futures
contracts.
(e) Dollar-Rolls
A dollar-roll is a simultaneous agreement to sell a security held in the Fund's
portfolio with a purchase of a similar security at a future date at an
agreed-upon price. The difference between the sale and repurchase price is
recorded as interest income to the Fund. Dollar-rolls are accounted for as
financing transactions by the Fund and no gain or loss is recognized, provided
that the sale and subsequent repurchase involve substantially identical
securities. If the counterparty to the transaction is rendered insolvent, the
ultimate realization of the securities to be
18
<PAGE>
Mentor Income Fund, Inc.
Notes to Financial Statements
(continued)
repurchased by the Fund may be delayed or limited.
(f) Short Sales
A short sale is a transaction in which the Fund sells a security it does not own
in anticipation that the market price of the security will decline. If the price
of the security sold short increases between the time of the short sale and the
time the Fund must deliver the security, the Fund realizes a loss.
(g) Interest-Rate Swap
An interest-rate swap is a contract between two parties on a specified principal
amount (referred to as the notional principal) for a specified period. In the
most common instance, a swap involves the exchange of streams of variable and
fixed-rate interest payments. During the term of the swap, changes in the value
of the swap are recognized as unrealized gains and losses by marking-to-market
to reflect the market value of the swap. When the swap is terminated, the Fund
will record a realized gain or loss. For the six months ended April 30, 1998,
the Fund had realized losses of $44,201 in connection with closed interest-rate
swap agreements. As of April 30, 1998, the Fund had no outstanding interest-rate
swap contracts.
(h) Interest-Rate Cap
An interest-rate cap is similar to an interest-rate swap, except that one party
agrees to pay a fee, while the other party pays the excess, if any, of a
floating rate over a specified fixed rate. No collateral is provided by the
counterparty to the transaction and as such the Fund is exposed to credit risk
in the event of non-performance by the other party to the interest-rate cap.
(i) Residual Interests
The Fund invests in mortgage security residual interests ("residuals") which are
considered derivative securities. A derivative security is any investment that
derives its value from an underlying security, asset, or market index. The
Fund's investment in residuals has been primarily in securities issued by
proprietary mortgage trusts. While these
19
<PAGE>
Mentor Income Fund, Inc.
Notes to Financial Statements
(continued)
entities have been highly leveraged, often having indebtedness of up to 95% of
their total value, the Fund has not incurred any indebtedness in the course of
making these residual investments; nor have the Fund's assets been pledged to
secure the indebtedness of the issuing structure or the Fund's investment in the
residuals. In consideration of the risk associated with investment in residual
securities, it is the Fund's policy to limit its exposure at the time of
purchase to no more than 20% of its total assets. The Fund will continue to
invest in residual securities because, in the opinion of the Investment Manager,
these investments can play a key role in fulfilling the Fund's objective of
achieving high monthly income through providing a means of economic leverage.
(j) Security Transactions and Investment Income
Security transactions are recorded on the trade date. Realized gains and losses
from security transactions are reported on an identified-cost basis. Income and
expenses are recorded on the accrual basis with interest income on principal-
only securities, interest-only securities and residual interests determined
using the effective-yield method based upon estimates of future net cash flows.
Estimated effective yields are periodically updated consistent with changes in
interest rates and prepayment assumptions. Premiums and discounts on mortgage
securities and collateralized mortgage obligations are amortized into interest
income using the effective-yield method.
(k) Federal Income Taxes
No provision for federal income or excise taxes is required since the Fund
intends to continue to qualify as a regulated investment company and distribute
all of its taxable income to its shareholders.
(l) Reclassification of Capital Accounts
Distributions are determined in accordance with income tax regulations which may
differ from generally accepted accounting principles. Accordingly, periodic
reclassifications are made within the Fund's capital accounts to reflect income
and gains available for distribution under income tax regulations.
20
<PAGE>
Mentor Income Fund, Inc.
Notes to Financial Statements
(continued)
(m) Distributions to Shareholders
The Fund declares and distributes dividends monthly from net investment income
and annually from net realized capital gains after offsetting capital-loss
carryovers. Reinvestment of income distribution is a non-cash transaction.
Note 3: Investment Transactions
Cost of purchases and proceeds from sales of investment securities, other than
short-term investments, options, caps, and futures transactions, aggregated
$108,545,632 and $113,180,921 respectively, for the six months ended April 30,
1998. At April 30, 1998, the cost of securities for federal income-tax purposes
was $160,401,390 and net unrealized appreciation aggregated $2,035,989 of which
$3,493,708 related to appreciated securities and $1,457,719 related to
depreciated securities. The Fund had an unused realized capital loss
carryforward for income-tax purposes of $13,825,362 at October 31, 1997, of
which $170,636 expires in 2000, $11,955,561 expires in 2002 and $1,699,165
expires in 2004.
Note 4: Investment Management and Administration Agreements
Mentor Advisors, LLC ("Mentor Advisors"), the Fund's investment adviser,
receives for its services an annual investment advisory fee of 0.65% based on
Fund's average daily net assets. Mentor Advisors is a wholly-owned subsidiary of
Mentor Investment Group, LLC ("Mentor"), which is in turn a partially owned
subsidiary of Wheat First Union. EVEREN Capital Corporation owns 20% of
outstanding interest in Mentor. Mentor provides administrative personnel and
services to the Fund at an annual rate of 0.10% of the Fund's average daily net
assets.
Note 5: Borrowings
The Fund enters into reverse repurchase agreements with qualified third-party
broker-dealers as determined by and under the direction of the Fund's Board of
Directors. Interest on the value of reverse repurchase agreements issued and
outstanding is based upon competitive market rates at the time of issuance. At
the time the Fund enters into a reverse repurchase agreement, it will establish
and maintain a segregated account with the
21
<PAGE>
Mentor Income Fund, Inc.
Notes to Financial Statements
(continued)
lender containing securities having a value not less than the repurchase price
(including accrued interest). If the counterparty to the transaction is rendered
insolvent, the ultimate realization of the securities to be repurchased by the
Fund may be delayed or limited.
The average daily balance of reverse repurchase agreements outstanding during
the six months ended April 30, 1998 was approximately $18,063,202 or $1.53 per
share based on average shares outstanding of 11,817,776 during the period at a
weighted average interest rate of 5.59%. The maximum amount of borrowings
outstanding at any weekend during the period was $58,063,531 (including accrued
interest) as of January 29, 1998, at a weighted average interest rate of 5.63%,
and was 31.59% of total assets. The average rate on the April 30, 1998,
borrowing was 5.57% and matures on May 4, 1998.
Note 6: Capital Share Transactions
The Fund has authorized 200,000,000 shares of $.01 par value common stock. At
April 30, 1998, there were 11,817,776 shares issued and outstanding, including,
1,151,463 shares issued under the Fund's reinvestment plan and 666,313 from an
equity rights offering which occurred from December 23, 1991 to January 31,
1992. During the six months ended April 30, 1998, no shares were issued.
22
<PAGE>
Mentor Income Fund, Inc.
Notes to Financial Statements
(continued)
Note 7: Quarterly Results of Operations (unaudited)
Shown in thousands of dollars and per common share:
<TABLE>
<CAPTION>
Increase(Decrease)
Investment Net Investment Net Gain(Loss) in Net Assets
Income Income on Investment from Operations
---------------------- ---------------------- -------------------------- ----------------------
Per Per Per Per
Quarter End Total Share Total Share Total Share Total Share
- ------------------ ---------- ----------- ---------- ----------- ------------- ------------ ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1998
April 30, 1998 $ 2,233 $ 0.25 $ 1,900 $ 0.16 $ (1,937) $ (0.17) $ (37) $ (0.01)
January 31, 1998 3,757 0.32 2,111 0.17 (713) (0.06) 1,398 0.12
1997
October 31, 1997 $ 3,095 $ 0.26 $ 2,459 $ 0.21 $ (512) $ (0.04) $ 1,947 $ 0.16
July 31, 1997 3,545 0.30 2,551 0.21 4,579 0.39 7,130 0.60
April 30, 1997 3,303 0.28 2,423 0.21 11 - 2,434 0.21
January 31, 1997 3,096 0.26 2,303 0.19 (1,410) (0.12) 893 0.08
</TABLE>
Year 2000
The Fund receives services from a number of providers which rely on the smooth
functioning of their respective systems and the systems of others to perform
those services. It is generally recognized that certain systems in use today may
not perform their intended functions adequately after the Year 1999 because of
the inability of computer software to distinguish the Year 2000 from the Year
1900. Mentor Advisors is taking steps that it believes are reasonably designed
to address this potential "Year 2000" problem and to obtain satisfactory
assurances that comparable steps are being taken by each of the Fund's other
major service providers. There can be no assurance, however, that these steps
will be sufficient to avoid any adverse impact on the Fund from this problem.
23
<PAGE>
Mentor Income Fund, Inc.
Notes to Financial Statements
(continued)
Additional Information (unaudited)
Shareholders of the Fund considered and acted upon the proposals listed below at
a special meeting of shareholders held Monday December 22, 1997. In addition,
below each proposals are the results of that vote.
1. To elect the following Trustees:
Affirmative Withheld
Arch T. Allen, III 10,853,648 245,150
Arnold H. Dreyfuss 10,854,421 244,377
Thomas F. Keller 10,851,187 247,611
Louis W. Moelchert, Jr. 10,856,817 241,981
Troy A. Peery, Jr. 10,854,287 244,511
Peter J. Quinn, Jr. 10,850,559 248,239
2. To approve a new management contract between the Fund and Mentor Investment
Advisors, LLC to take effect upon the merger of Wheat First Butcher Singer,
Inc., with First Union Corporation:
Affirmative 10,736,298
Against 164,378
Abstain 198,122
3. To approve a new management contract between the Fund and Mentor Investment
Advisors, LLC in contemplation of the potential acquisition of an additional
interest in Mentor Investment Group, LLC by EVEREN Securities Holdings,
Inc.:
Affirmative 10,659,171
Against 206,540
Abstain 233,087
24
<PAGE>
Shareholder Information
Investment Manager
Corporate Office
Mentor Investment Advisors, LLC
Riverfront Plaza, 901 East Byrd Street
Richmond, Virginia 23219
Investor Relations Office
1-800-382-0016
Operations Office
Riverfront Plaza, 901 East Byrd Street
Richmond, Virginia 23219
Transfer Agent and Registrar
State Street Bank & Trust Company
Post Office Box 366
Boston, Massachusetts 02101
(800) 426-5523
Custodian
Investor Fiduciary Trust Company
811 Main - 11th Floor
Kansas City, Missouri 64105
Independent Auditors
KPMG Peat Marwick LLP
99 High Street
Boston, Massachuetts 02110
Legal Counsel
Ropes & Gray
One International Place
Boston, Massachusetts 02110
Directors and Officers
Directors
Daniel J. Ludeman, Chairman
Arch T. Allen III
Jerry R. Barrentine
Arnold H. Dreyfuss
Weston E. Edwards
Thomas F. Keller
Louis W. Molechert
J. Garnett Nelson
Troy A. Peery
Peter J. Quinn
Officers
Paul F. Costello, President
Terry L. Perkins, Treasurer
Geoffry B. Sale, Secretary
Michael A. Wade, Assistant Treasurer
Mentor Income Fund, Inc.
------------------------------------
SEMI-ANNUAL REPORT
------------------------------------
April 30, 1998
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