<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
January 29, 1995
SMITH BARNEY
INCOME TRUST [LOGO]
388 GREENWICH STREET NEW YORK, NEW YORK 10013__(212) 723-9218
This Statement of Additional Information supplements the
information contained in the current Prospectuses of Smith Barney
Limited Maturity Municipals Fund (the "Municipal Fund"), Smith
Barney Intermediate Maturity California Municipals Fund (the
"California Fund") and Smith Barney Intermediate Maturity New York
Municipals Fund (the "New York Fund") dated January 29, 1995, as
amended or supplemented from time to time and should be read in
conjunction with the Prospectuses. The Prospectuses may be
obtained by contacting a Smith Barney Financial Consultant, or by
writing or calling Smith Barney Income Trust (the "Trust"), of
which each of the Municipal Fund, California Fund and New York
Fund (individually referred to as a "Fund" and collectively
referred to as the "Funds") is a series, at the address or
telephone number set forth above. This Statement of Additional
Information, although not in itself a prospectus, is incorporated
by reference into each Prospectus in its entirety.
The executive officers of the Funds are employees of certain
of the organizations that provide services to the Fund. These
organizations are as follows:
<TABLE>
<CAPTION>
NAME SERVICE
- --------------------------------------------------------- ---------------------------------------------------------
<S> <C>
Smith Barney Inc.
("Smith Barney")....................................... Distributor
Smith Barney Mutual Funds
Management Inc. ("SBMFM").............................. Investment Adviser and Administrator
The Boston Company Advisors, Inc.
("Boston Advisors").................................... Sub-Administrator
The Boston Safe Deposit and Trust Company
("Boston Safe")........................................ Custodian
The Shareholder Services Group, Inc. ("TSSG"), a
subsidiary of First Data Corporation................... Transfer Agent
</TABLE>
These organizations and the functions that they perform for
the Funds are discussed in the Prospectuses and in this Statement
of Additional Information.
<PAGE>
CONTENTS
For ease of reference, the section headings used in this Statement
of Additional Information are identical to those used in each
Prospectus except as noted in parentheses below.
<TABLE>
<S> <C>
Management of the Trust and the Funds............................ 2
Investment Objectives and Management Policies.................... 5
Purchase of Shares............................................... 30
Redemption of Shares............................................. 31
Distributor...................................................... 32
Valuation of Shares.............................................. 33
Exchange Privilege............................................... 33
Performance Data................................................. 34
(See in the Prospectuses "Performance")
Taxes............................................................ 36
(See in the Prospectuses "Dividends, Distributions and Taxes")
Additional Information........................................... 38
Financial Statements............................................. 38
Appendix......................................................... A-1
</TABLE>
<PAGE>
MANAGEMENT OF THE TRUST AND THE FUNDS
TRUSTEES AND OFFICERS OF THE TRUST
The names of the Trustees of the Trust and executive officers of the Funds,
together with information as to their principal business occupations, are set
forth below. The executive officers of the Funds are employees of organizations
that provide services to the Funds. Each Trustee who is an "interested person"
of the Trust, as defined in the Investment Company Act of 1940, as amended (the
"1940 Act"), is indicated by an asterisk.
Burt N. Dorsett, Trustee (age 64). Managing Partner of Dorsett McCabe
Management,
Inc., an investment counselling firm; Director of Research Corporation
Technologies, Inc., a non-profit patent-clearing and licensing firm. His address
is 201 East 62nd Street, New York, New York 10021.
Elliot S. Jaffe, Trustee (age 68). Chairman of the Board and President
of The Dress
Barn, Inc. His address is 30 Dunnigan Drive, Suffern, New York 10901.
*Heath B. McLendon, Chairman of the Board and Investment Officer. Managing
Director of SBMFM; Executive Vice President and Chairman of Smith Barney
Strategy Advisers Inc.; prior to July 1993, Senior Executive Vice President of
Shearson Lehman Brothers Inc. ("Shearson Lehman Brothers"); Vice Chairman of
Shearson Asset Management; a Director of PanAgora Asset Management, Inc. and
PanAgora Asset Management Limited. His address is 388 Greenwich Street, New
York, New York 10013.
Cornelius C. Rose, Jr., Trustee (age 61). President, Cornelius C.
Rose Associates,
Inc., Financial Consultants, and Chairman and Director of Performance Learning
Systems, an educational consultant. His address is P.O. Box 355, Fair Oaks,
Enfield, New Hampshire 03748.
Stephen J. Treadway, President. Managing Director of Smith Barney; Director
and President of Mutual Management Corp. and SBMFM; and Trustee of Corporate
Income Realty Trust I. His address is 388 Greenwich Street, New York, New York
10013.
____Joseph P. Deane, Vice President and Investment Officer. Investment Officer
of SBMFM; prior to November 7, 1994, Managing Director of Greenwich Street
Advisors; prior to July 1993, Managing Director of Shearson Lehman Advisors. His
address is 388 Greenwich Street, New York, New York 10013.
____Lawrence T. McDermott, Vice President and Investment Officer. Investment
Officer of SBMFM; prior to November 7, 1994, Managing Director of Greenwich
Street Advisors; prior to July 1993, Managing Director of Shearson Lehman
Advisors, the predecessor to Greenwich Street Advisors. His address is 388
Greenwich Street, New York, New York 10013.
____Lewis E. Daidone, Senior Vice President and Treasurer. Managing Director and
Chief Financial Officer of Smith Barney; Director and Senior Vice President of
SBMFM. His address is 388 Greenwich Street, New York, New York 10013.
____Christina T. Sydor, Secretary. Managing Director of Smith Barney; General
Counsel and Secretary of SBMFM. Her address is 388 Greenwich Street, New York,
New York 10013.
____Each of the Trust's Trustees serves as a trustee, general partner and/or
director of other mutual funds for which Smith Barney serves as distributor. As
of January 1, 1995, the Trustees and Officers owned less than 1.00% of each
Fund's outstanding shares.
____No officer, director or employee of Smith Barney or any of its affiliates
receives any compensation from the Trust for serving as an officer or Trustee of
the Trust. The Trust pays each Trustee who is not an officer, director or
employee of Smith Barney or any of its affiliates, a fee of $4,000 per annum
plus $500 per meeting attended, and reimburses them for travel and
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out-of-pocket expenses. For the fiscal year ended November 30, 1994, such fees
and expenses totalled $26,738.
____For the calendar year ended December 31, 1994, the
Trustees of the Trust were paid the following compensation:
<TABLE>
<CAPTION>
AGGREGATE
AGGREGATE COMPENSATION
COMPENSATION FROM THE
FROM THE SMITH BARNEY
TRUSTEE TRUST MUTUAL FUNDS
----------------------------------- --------- ------------
<S> <C> <C>
Burt N. Dorsett................... $ 6,500 $ 34,300
Elliot S. Jaffe....................... 6,500 33,300
Cornelius C. Rose, Jr........... 6,500 33,300
</TABLE>
INVESTMENT ADVISER AND ADMINISTRATOR -- SBMFM
SBMFM serves as investment adviser to the Trust pursuant to a transfer of the
investment advisory agreement effective November 7, 1994 from its affiliate,
Mutual Management Corp. (Mutual Management Corp. and SBMFM are both wholly owned
subsidiaries of Smith Barney Holdings Inc. ("Holdings").) Holdings is a wholly
owned subsidiary of The Travelers Inc. ("Travelers"). The investment advisory
agreement is dated July 30, 1993 (the "Advisory Agreement"), and was first
approved by the Trustees, including a majority of those Trustees who are not
"interested persons" of the Trust or Smith Barney, on April 7, 1993. The
services provided by SBMFM under the Advisory Agreement are described in the
Prospectuses under "Management of the Trust and the Fund." SBMFM pays the salary
of any officer and employee who is employed by both it and the Trust. SBMFM
bears all expenses in connection with the performance of its services.
____For the fiscal period from December 31, 1991 through November 30, 1992, the
Funds paid Shearson Lehman Advisors, the Fund's predecessor investment adviser,
investment advisory fees and Shearson Lehman Advisors waived fees and reimbursed
expenses as follows:
<TABLE>
<CAPTION>
FEES WAIVED
AND EXPENSES
FUND FEES PAID REIMBURSED
----------------------------------- --------- ------------
<S> <C> <C>
Municipal Fund..................... $ 0 $ 67,265
California Fund.................... $ 0 $ 58,703
New York Fund...................... $ 0 $ 46,577
</TABLE>
____For the fiscal year ended November 30, 1993, the Funds paid Shearson Lehman
Advisors and Greenwich Street Advisors investment advisory fees and Shearson
Lehman Advisors and Greenwich Street Advisors waived fees and reimbursed
expenses as follows:
<TABLE>
<CAPTION>
FEES WAIVED
AND EXPENSES
FUND FEES PAID REIMBURSED
----------------------------------- --------- ------------
<S> <C> <C>
Municipal Fund..................... $ 93,010 $135,127
California Fund.................... $ 0 $ 83,727
New York Fund...................... $ 28,605 $130,230
</TABLE>
____For the fiscal year ended November 30, 1994, the Funds paid SBMFM and/or its
predecessor investment adviser, investment advisory fees and SBMFM waived fees
and reimbursed expenses as follows:
<TABLE>
<CAPTION>
FEES WAIVED
AND EXPENSES
FUND FEES PAID REIMBURSED
----------------------------------- --------- ------------
<S> <C> <C>
Municipal Fund..................... $245,303 $ 82,149
California Fund.................... $ 12,828 $ 98,519
New York Fund...................... $ 97,097 $144,592
</TABLE>
____SBMFM also serves as administrator to the Trust pursuant to a written
agreement dated April 20, 1994 (the "Administration Agreement"), which was most
recently approved by the Trustees of the Trust, including a majority of Trustees
who are not "interested persons" of the Trust or SBMFM, on July 20, 1994. The
services provided by SBMFM under the Administration Agreement are described in
the Prospectuses under "Management of the Trust and the Fund." SBMFM pays the
salary of any officer and employee who is employed by both it and the Trust and
bears all expenses in connection with the performance of its services.
____For the fiscal period from December 31, 1991 through November 30, 1992, the
Funds paid Boston Advisors sub-investment advisory and administration fees and
Boston Advisors waived fees as follows:
<TABLE>
<CAPTION>
FUND FEES PAID FEES WAIVED
----------------------------------- --------- ------------
<S> <C> <C>
Municipal Fund..................... $ 0 $ 38,437
California Fund.................... $ 0 $ 10,927
New York Fund...................... $ 0 $ 23,884
</TABLE>
3
<PAGE>
____For the fiscal year ended November 30, 1993 the Funds paid Boston Advisors
administration fees and Boston Advisors waived fees as follows:
<TABLE>
<CAPTION>
FUND FEES PAID FEES WAIVED
----------------------------------- --------- ------------
<S> <C> <C>
Municipal Fund..................... $ 52,571 $ 77,793
California Fund.................... $ 0 $ 39,799
New York Fund...................... $ 16,167 $ 74,596
</TABLE>
____For the fiscal year ended November 30, 1994, the Funds paid administration
fees and fees were waived as follows:
<TABLE>
<CAPTION>
FUND FEES PAID FEES WAIVED
----------------------------------- --------- ------------
<S> <C> <C>
Municipal Fund..................... $140,173 $ 46,942
California Fund.................... $ 7,330 $ 56,297
New York Fund...................... $ 55,483 $ 82,625
</TABLE>
SUB-ADMINISTRATOR -- BOSTON ADVISORS
Boston Advisors serves as sub-administrator to the Trust pursuant to a written
agreement (the "Sub-Administration Agreement") dated April 20, 1994, which was
most recently approved by the Trust's Board of Trustees, including a majority of
Trustees who are not "interested persons" of the Trust or Boston Advisors, on
July 20, 1994. Under the Sub-Administration Agreement, Boston Advisors is paid a
portion of the administration fee paid by the Trust to SBMFM at a rate agreed
upon from time to time between Boston Advisors and SBMFM. Boston Advisors is a
wholly owned subsidiary of The Boston Company, Inc. ("TBC"), a financial
services holding company, which is in turn a wholly owned subsidiary of Mellon
Bank Corporation ("Mellon").
____Certain of the services provided to the Trust by Boston Advisors pursuant to
the Sub-Administration Agreement are described in the Prospectuses under
"Management of the Trust and the Fund." In addition to those services, Boston
Advisors pays the salaries of all officers and employees who are employed by
both it and the Trust, maintains office facilities for the Trust, furnishes the
Trust with statistical and research data, clerical help and accounting, data
processing, bookkeeping, internal auditing and legal services and certain other
services required by the Trust, prepares reports to the Trust's shareholders and
prepares tax returns and reports to and filings with the Securities and Exchange
Commission (the "SEC") and state Blue Sky authorities. Boston Advisors bears all
expenses in connection with the performance of its services.
____The Trust bears expenses incurred in its operation, including: taxes,
interest, brokerage fees and commissions, if any; fees of Trustees who are not
officers, directors, shareholders or employees of Smith Barney, SBMFM or Boston
Advisors; SEC fees and state Blue Sky qualification fees; charges of custodians;
transfer and dividend disbursing agent fees; certain insurance premiums; outside
auditing and legal expenses; costs of maintaining corporate existence; costs of
investor services (including allocated telephone and personnel expenses); costs
of preparing and printing prospectuses for regulatory purposes and for
distribution to existing shareholders; costs of shareholders' reports and
shareholder meetings; and meetings of the officers or Board of Trustees of the
Trust.
____SBMFM and Boston Advisors have agreed that if in any fiscal year the
aggregate expenses of the Trust (including fees pursuant to the Advisory
Agreement, Administration and Sub-Administration Agreements, but excluding
interest, taxes, brokerage fees paid pursuant to the Trust's services and
distribution plan, and, with the prior written consent of the necessary state
securities commissions, extraordinary expenses) exceed the expense limitation of
any state having jurisdiction over the Trust, SBMFM and Boston Advisors will, to
the extent required by state law, reduce their fees by the amount of such excess
expenses, such amount to be allocated between them in the proportion that their
respective fees bear to the aggregate of such fees paid by the Trust. Such fee
reductions, if any, will be reconciled on a monthly basis. The most restrictive
state limitation currently applicable to the Trust would require SBMFM and
Boston Advisors to reduce their fees in any year that such expenses exceed 2.50%
of the first $30 million of average daily net assets, 2.00% of the next $70
million of average daily net assets and 1.50% of the remaining average
4
<PAGE>
daily net assets. No fee reduction was required for the fiscal period ended
November 30, 1992, and the 1993 and 1994 fiscal years.
COUNSEL AND AUDITORS
Willkie Farr & Gallagher serves as legal counsel to the Trust. O'Melveny & Myers
acts as special California counsel for the California Fund and has reviewed
the portions of
the Prospectus and this Statement of Additional Information concerning
California taxes and the description of the special considerations relating to
investments in California municipal securities. The Trustees who are not
"interested persons" of the Trust have selected Stroock & Stroock & Lavan as
their counsel.
____KPMG Peat Marwick LLP, independent accountants, 345 Park Avenue, New York,
New York 10154, have been selected to serve as auditors of the Trust and to
render an opinion on the Trust's financial statements for the fiscal year ended
November 30, 1995. Coopers & Lybrand L.L.P., independent auditors, served as
auditors of the Trust and rendered an opinion on the financial statements for
the fiscal year ended November 30, 1994.
INVESTMENT OBJECTIVES AND MANAGEMENT POLICIES
The Prospectuses discuss the investment objective of each Fund and the principal
policies to be employed to achieve that objective. Supplemental information is
set out below concerning the types of securities and other instruments in which
the Funds may invest, the investment policies and strategies that the Funds may
utilize and certain risks attendant to those investments, policies and
strategies.
UNITED STATES GOVERNMENT SECURITIES
Securities issued or guaranteed by the United States government or one of its
agencies, authorities or instrumentalities ("U.S. government securities") in
which each of the Municipal Fund, the California Fund and the New York Fund may
invest include debt obligations of varying maturities issued by the United
States Treasury or issued or guaranteed by an agency or instrumentality of the
United States government, including the Federal Housing Administration,
Export-Import Bank of the United States, Small Business Administration,
Government National Mortgage Association, General Services Administration,
Federal Home Loan Banks, Federal Home Loan Mortgage Corporation, Federal
Intermediate Credit Banks, Federal National Mortgage Association, Maritime
Administration, Tennessee Valley Authority, District of Columbia Armory Board,
Student Loan Marketing Association, Resolution Trust Corporation and various
institutions that previously were or currently are part of the Farm Credit
System (which has been undergoing a reorganization since 1987). Direct
obligations of the United States Treasury include a variety of securities that
differ in their interest rates, maturities and dates of issuance. Because the
United States government is not obligated by law to provide support to an
instrumentality that it sponsors, none of the Funds will invest in obligations
issued by an instrumentality of the United States government unless SBMFM
determines that the instrumentality's credit risk does not make its securities
unsuitable for investment by the Fund.
MUNICIPAL OBLIGATIONS
Each of the Funds invests principally in debt obligations issued by, or on
behalf of, states, territories and possessions of the United States and the
District of Columbia and their political subdivisions, agencies and
instrumentalities or multistate agencies or authorities, the interest from which
debt obligations is, in the opinion of bond counsel to the issuer, excluded from
gross income for Federal income tax purposes ("Municipal Obligations").
Municipal Obligations generally are understood to include debt obligations
issued to obtain funds for various public purposes, including the construction
of a wide range of public facilities, refunding of outstanding obligations,
payment of general operating expenses and extensions of loans to public
institutions and facilities. Private activity bonds that are issued by or on
behalf of public authorities to finance privately operated facilities are
considered to be Municipal Obligations if the interest paid on them qualifies as
excluded from gross income
5
<PAGE>
(but not necessarily from alternative minimum taxable income) for Federal income
tax purposes in the opinion of bond counsel to the issuer.
Municipal Obligations may be issued to finance life care facilities, which
are an alternative form of long-term housing for the elderly that offer
residents the independence of a condominium life-style and, if needed, the
comprehensive care of nursing home services. Bonds to finance these facilities
have been issued by various state industrial development authorities. Because
the bonds are secured only by the revenues of each facility and not by state or
local government tax payments, they are subject to a wide variety of risks,
including a drop in occupancy levels, the difficulty of maintaining adequate
financial reserves to secure estimated actuarial liabilities, the possibility of
regulatory cost restrictions applied to health care delivery and competition
from alternative health care or conventional housing facilities.
MUNICIPAL LEASES
Municipal leases are Municipal Obligations that may take the form of a lease or
an installment purchase issued by state and local government authorities to
obtain funds to acquire a wide variety of equipment and facilities such as fire
and sanitation vehicles, computer equipment and other capital assets. These
obligations have evolved to make it possible for state and local government
authorities to acquire property and equipment without meeting constitutional and
statutory requirements for the issuance of debt. Thus, municipal leases have
special risks not normally associated with Municipal Obligations. These
obligations frequently contain "non-appropriation" clauses that provide that the
governmental issuer of the municipal lease has no obligation to make future
payments under the lease or contract unless money is appropriated for such
purposes by the legislative body on a yearly or other periodic basis. In
addition to the non-appropriation risk, municipal leases represent a type of
financing that has not yet developed the depth of marketability associated with
Municipal Obligations; moreover, although the obligations will be secured by the
leased equipment, the disposition of the equipment in the event of foreclosure
might prove difficult. In order to limit the risks, the Fund will purchase
either (a) municipal leases that are rated in the four highest categories by
Moody's Investor Services, Inc. ("Moody's") or Standard & Poor's Corporation
("S&P") or (b) unrated municipal leases that are purchased principally from
domestic banks or other responsible third parties that have entered into an
agreement with the Fund providing the seller will either remarket or repurchase
the municipal leases within a short period after demand by the Fund.
From time to time, proposals to restrict or eliminate the Federal income tax
exemption for interest on Municipal Obligations have been introduced before
Congress. Similar proposals may be introduced in the future. In addition, the
Internal Revenue Code of 1986, as amended, (the "Code") currently provides that
small issue private activity bonds will not be tax-exempt if the bonds were
issued after December 31, 1986, and the proceeds were used to finance projects
other than manufacturing facilities.
SPECIAL CONSIDERATIONS RELATING TO CALIFORNIA
EXEMPT OBLIGATIONS
As indicated in the California Fund's Prospectus, the Fund seeks its objective
by investing principally in a portfolio of Municipal Obligations, the interest
from which is exempt from California State personal income taxes ("California
Exempt Obligations").
Some of the significant financial considerations relating to the Fund's
investments in California Exempt Obligations are summarized below. This summary
information is derived principally from official statements and prospectuses
relating to securities offerings of the State of California and various local
agencies in California, available as of the date of this Statement of Additional
Information and does not purport to be a complete description of any of the
considerations mentioned herein. The accuracy and completeness of the
information contained in such official statements has not been independently
verified.
6
<PAGE>
ECONOMIC FACTORS. The Governor's 1993-1994 Budget, introduced on January 8,
1993, proposed general fund expenditures of $37.3 billion, with projected
revenues of $39.9 billion. To balance the budget in the face of declining
revenues, the Governor proposed a series of revenue shifts from local
government, reliance on increased federal aid, and reductions in state spending.
The Department of Finance of the State of California's May Revision of
General Fund Revenues and Expenditures (the "May Revision"), released on May 20,
1993, projected the State would have an accumulated deficit of about $2.75
billion by June 30, 1993 essentially unchanged from the prior year. The Governor
proposed to eliminate this deficit over an 18-month period. Unlike previous
years, the Governor's Budget and May Revision did not calculate a "gap" to be
closed, but rather set forth revenue and expenditure forecasts and proposals
designed to produce a balanced budget.
The 1993-94 budget act (the "1993-94 Budget Act") was signed by the Governor
on June 30, 1993, along with implementing legislation. The Governor vetoed about
$71 million in spending.
The 1993-94 Budget Act is predicated on general fund revenues and transfers
estimated at $40.6 billion, $400 million below 1992-93 (and the second
consecutive year of actual decline). The principal reasons for declining revenue
are the continued weak economy and the expiration (or repeal) of three fiscal
steps taken in 1991 -- a half cent temporary sales tax, a deferral of operating
loss carryforwards, and repeal by initiative of a sales tax on candy and snack
foods.
The 1993-94 Budget Act also assumes special fund revenues of $11.9 billion,
an increase of 2.9% over 1992-93.
The 1993-94 Budget Act includes general fund expenditures of $38.5 billion
(a 6.3% reduction from projected 1992-93 expenditures of $41.1 billion), in
order to keep a balanced budget within the available revenues. The 1993-94
Budget Act also includes special fund expenditures of $12.1 billion, a 4.2%
increase. The 1993-94 Budget Act reflects the following major adjustments:
1. Changes in local government financing to shift about $2.6 billion in
property taxes from cities, counties, special districts and redevelopment
agencies to school and community college districts, thereby reducing general
fund support by an equal amount. About $2.5 billion would be permanent,
reflecting termination of the State's "bailout" of local governments
following the property tax cuts of Proposition 13 in 1978 (See
"Constitutional, Legislative and Other Factors" below).
The property tax revenue losses for cities and counties are offset in
part by additional sales tax revenues and mandate relief. The temporary 0.5%
sales tax was extended through December 31, 1993, for allocation to counties
for public safety programs. The voters approved Proposition 172 in November
1993 and the 0.5% sales tax was extended permanently for public safety
purposes.
Legislation also has been enacted to eliminate state mandates in order
to provide local governments flexibility in making their programs responsive
to local needs. Legislation provides mandate relief for local justice
systems which affect county audit requirements, court reporter fees, and
court consolidation; health and welfare relief involving advisory boards,
family planning, state audits and realignment maintenance efforts; and
relief in areas such as county welfare department self-evaluations, noise
guidelines and recycling requirements.
2. The 1993-94 Budget Act projected K-12 Proposition 98 funding on a cash
basis at the same per-pupil level as 1992-93 by providing schools a $609
million loan payable from future years' Proposition 98 funds.
3. The 1993-94 Budget Act assumed receipt of about $692 million of aid to
the State from the Federal government to offset health and welfare costs
associated with foreign immigrants living in the
7
<PAGE>
State, which would reduce a like amount of general fund expenditures. About
$411 million of this amount was one-time funding. Congress ultimately
appropriated only $450 million.
4. Reductions of $600 million in health and welfare programs, and $400
million in support for higher education (partly offset by fee increases at
all three units of higher education) and various miscellaneous cuts
(totalling approximately $150 million) in State government services in many
agencies, up to 15%.
5. A 2-year suspension of the renters' tax credit ($390 million expenditure
reduction in 1993-94).
6. Miscellaneous one-time items, including deferral of payment to the
Public Employees Retirement Fund ($339 million) and a change in accounting
for debt service from accrual to cash basis, saving $107 million.
The 1993-94 Budget Act contains no general fund tax/revenue increases other
than a two-year suspension of the renters' tax credit. The 1993-94 Budget Act
suspended the 4% automatic budget reduction "trigger," as was done in 1992-93 so
that cuts could be focused.
Administration reports during the course of the 1993-94 Fiscal Year have
indicated that while economic recovery appears to have started in the second
half of the fiscal year, recessionary conditions continued longer than has been
anticipated when the 1993-94 Budget Act was adopted. Overall, revenues for the
1993-94 Fiscal Year were about $800 million lower than original projections, and
expenditures were about $780 million higher, primarily because of higher health
and welfare caseloads, lower property taxes which require greater State support
for K-14 education to make up the shortfall, and lower than anticipated Federal
government payments for immigration-related costs. The reports in May and June,
1994, indicated that revenues in the second half of the 1993-94 Fiscal Year have
been very close to the projections made in the Governor's Budget of January 10,
1994, which is consistent with a slow turnaround in the economy.
The Department of Finance's July 1994 Bulletin, including the final June
receipts, reported that June revenues were $114 million (2.5%) above projection,
with final end-of-year results at $377 million (about 1%) above the May Revision
projections. Part of this result was due to end-of-year adjustments and
reconciliations. Personal income tax and sales tax continued to track
projections very well. The largest factor in the higher than anticipated
revenues was from bank and corporation taxes, which were $140 million (18.4%)
above projection in June. While the higher June receipts are reflected in the
actual 1993-94 Fiscal Year cash flow results, and help the starting cash balance
for the 1994-95 Fiscal Year, the Department of Finance has not adjusted any of
its revenue projections for the 1994-95 or 1995-96 Fiscal Years.
During the 1993-94 Fiscal Year, the State implemented the deficit retirement
plan, which was part of the 1993-94 Budget Act, by issuing $1.2 billion of
revenue anticipation warrants in February 1994 maturing December 21, 1994. This
borrowing reduced the cash deficit at the end of the 1993-94 Fiscal Year.
Nevertheless, because of the $1.5 billion variance from the original 1993-94
Budget Act assumptions, the General Fund ended the fiscal year at June 30, 1994
carrying forward an accumulated deficit of approximately $2 billion.
Because of the revenue shortfall and the State's reduced internal borrowable
cash resources, in addition to the $1.2 billion of revenue anticipation warrants
issued as part of the deficit retirement plan, the State issued an additional
$2.0 billion of revenue anticipation warrants, maturing July 26, 1994, which
were needed to fund the State's obligations and expenses through the end of the
1993-94 Fiscal Year.
On January 17, 1994, a major earthquake measuring an estimated 6.8 on the
Richter Scale struck Los Angeles. Significant property damage to private and
public facilities occurred in a four-county area including northern Los Angeles
County, Ventura County, and parts of Orange and San Bernardino Counties, which
were
8
<PAGE>
declared as State and Federal disaster areas by January 18. Current estimates of
total property damage (private and public) are in the range of $20 billion but
these estimates still are subject to change.
Despite such damage, on the whole, the vast majority of structures in the
areas, including large manufacturing and commercial buildings and all modern
high-rise offices, survived the earthquake with minimal or no damage, validating
the cumulative effect of strict building codes and thorough preparation for such
an emergency by the State and local agencies.
State-owned facilities, including transportation corridors and facilities
such as Interstate Highways 5 and 10 and State Highways 14, 118 and 210
sustained damage. Most of the major highways (Interstate 5 and 10) have now been
repaired. The campus of California State University at Northridge (very near the
epicenter) suffered an estimated $350 million damage, resulting in temporary
closure of the campus. It has reopened using borrowed facilities elsewhere in
the area and many temporary structures. There was also some damage to the
University of California at Los Angeles and to an office building in Van Nuys
(now open after a temporary closure). Overall, except for the temporary road and
bridge closures, and CSU-Northridge, the earthquake did not and is not expected
to significantly affect State government operations.
The State in conjunction with the Federal government is committed to
providing assistance to local governments, individuals and businesses suffering
damage as a result of the earthquake, as well as to provide for the repair and
replacement of State-owned facilities. The Federal government will provide
substantial earthquake assistance.
The President immediately allocated some available disaster funds, and
Congress has approved additional funds for a total of at least $9.5 billion of
Federal funds for earthquake relief, including assistance to homeowners and
small businesses, and costs for repair of damaged public facilities. The
Governor originally proposed that the State will have to pay about $1.9 billion
for earthquake relief costs, including a 10% match to some of the Federal funds,
and costs for some programs not covered by the Federal aid. The Governor
proposed to cover $1.05 billion of these costs from a general obligation bond
issue which was on the June 1994 ballot, but it was not approved by the voters.
The Governor subsequently announced that the State's share for transportation
projects would come from existing Department of Transportation funds (thereby
delaying other, non-earthquake related projects), that the State's share for
certain other costs (including local school building repairs) would come from
reallocating existing bond funds, and that a proposed program for homeowner and
small business aid supplemental to Federal aid would have to be abandoned. Some
other costs will be borrowed from the Federal government in a manner similar to
that used by the State of Florida after Hurricane Andrew; pursuant to Senate
Bill 2383, repayment will have to be addressed in 1995-96 or beyond.
The 1994-95 Fiscal Year will represent the fourth consecutive year the
Governor and Legislature will be faced with a very difficult budget environment
to produce a balanced budget. Many program cuts and budgetary adjustments have
already been made in the last three years. The Governor's Budget proposal, as
updated in May and June, 1994, recognized that the accumulated deficit could not
be repaid in one year, and proposed a two-year solution. The budget proposal
sets forth revenue and expenditure forecasts and revenue and expenditure
proposals which result in operating surpluses for the budget for both 1994-95
and 1995-96, and lead to the elimination of the accumulated budget deficit,
estimated at about $2.0 billion at June 30, 1994, by June 30, 1996.
The 1994-95 Budget Act, signed by the Governor on July 8, 1994, projects
revenues and transfers of $41.9 billion, $2.1 billion higher than revenues in
1993-94. This reflects the Administration's forecast of an improving economy.
Also included in this figure is a projected receipt of about $360 million from
the Federal government to reimburse the State's cost of incarcerating
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undocumented immigrants. The State will not know how much the Federal government
will actually provide until the Federal fiscal year 1995 Budget is completed.
Completion of the Federal budget is expected by October 1994. The Legislature
took no action on a proposal in the January Governor's Budget to undertake an
expansion of the transfer of certain programs to counties, which would also have
transferred to counties 0.5% of the State's current sales tax.
The Budget Act projects Special Fund revenues of $12.1 billion, a decrease
of 2.4% from 1993-94 estimated revenues.
The 1994-95 Budget Act projects General Fund expenditures of $40.9 billion,
an increase of $1.6 billion over 1993-94. The Budget Act also projects Special
Fund expenditures of $13.7 billion, a 5.4% increase over 1993-94 estimated
expenditures. The principal features of the Budget Act were the following:
1. Receipt of additional Federal aid in 1994-95 of about $400 million for
costs of refugee assistance and medical care for undocumented immigrants,
thereby offsetting a similar General Fund cost. The State will not know how
much of these funds it will receive until the Federal fiscal year 1995
Budget is passed.
2. Reductions of approximately $1.1 billion in health and welfare costs. A
2.3% reduction in Aid to Families with Dependent Children ("AFCD") payments
(equal to about $56 million for the entire fiscal year) has been
suspended by court order.
3. A General Fund increase of approximately $38 million in support for the
University of California and $65 million for California State University. It
is anticipated that student fees for both the U.C. and the C.S.U. will
increase up to 10%.
4. Proposition 98 funding for K-14 schools is increased by $526 million
from 1993-94 levels, representing an increase for enrollment growth and
inflation. Consistent with previous budget agreements, Proposition 98
funding provides approximately $4,217 per student for K-12 schools, equal to
the level in the past three years.
5. Legislation enacted with the Budget clarifies laws passed in 1992 and
1993 which require counties and other local agencies to transfer funds to
local school districts, thereby reducing State aid. Some counties had
implemented a method of making such transfers which provided less money for
schools if there were redevelopment agency projects. The new legislation
bans this method of transfer. If all counties had implemented this method,
General Fund aid to K-12 schools would have been $300 million higher in each
of the 1994-95 and 1995-96 Fiscal Years.
6. The 1994-95 Budget Act provides funding for anticipated growth in the
State's prison inmate population, including provisions for implementing
recent legislation (the so-called "Three Strikes" law) which requires
mandatory life prison terms for certain third-time felony offenders.
7. Additional miscellaneous cuts ($500 million) and fund transfers ($255
million) totalling in the aggregate approximately $755 million.
The 1994-95 Budget Act contains no tax increases. Under legislation enacted
for the 1993-94 Budget, the renters' tax credit was suspended for two years
(1993 and 1994). A ballot proposition to permanently restore the renters' tax
credit after this year failed at the June, 1994 election. The Legislature
enacted a further one-year suspension of the renters' tax credit, for 1995,
saving about $390 million in the 1995-96 Fiscal Year.
The 1994-95 Budget assumes that the State will use a cash flow borrowing
program in 1994-95 which combines one-year notes and two-year warrants, which
have now been issued. Issuance of warrants allows the State to defer repayment
of approximately $1.0 billion of its accumulated budget deficit into the 1995-96
Fiscal Year.
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The State's cash flow management plan for the 1994-95 fiscal year included
the issuance of $4.0 billion of revenue anticipation warrants on July 26, 1994,
to mature on April 25, 1996, as part of a two-year plan to retire the
accumulated State budget deficit.
Because preparation of cash flow estimates for the 1995-96 Fiscal Year is
necessarily more imprecise than for the current fiscal year and entails greater
risks of variance from assumptions, and because the Governor's two-year budget
plan assumes receipt of a large amount of Federal aid in the 1995-96 Fiscal Year
for immigration-related costs which is uncertain, the Legislature enacted a
backup budget adjustment mechanism to mitigate possible deviations from
projected revenues, expenditures or internal borrowable resources which might
reduce available cash resources during the two-year plan, so as to assure
repayment of the warrants.
Pursuant to Section 12467 of the California Government Code, enacted by
Chapter 135, Statutes of 1994 (the "Budget Adjustment Law"), the State
Controller was required to make a report by November 15, 1994 on whether the
projected cash resources for the General Fund as of June 30, 1995 will decrease
more than $430 million from the amount projected by the State in its Official
Statement in July, 1994 for the sale of $4,000,000,000 of Revenue Anticipation
Warrants. On November 15, 1994, the State Controller issued the report on the
State's cash position required by the Budget Adjustment Law. The report
indicated that the cash position of the General Fund on June 30, 1995 would be
$581 million better than was estimated in the July, 1994 cash flow projections
and therefore, no budget adjustment procedures will be invoked for the 1994-95
fiscal year. The Law would only be implemented if the
State Controller estimated that borrowable resources on June 30, 1995 would be
at least $430 million LOWER than projected.
The State Controller's report identified a number of factors which have led
to the improved cash position of the State. Estimated revenues and transfers for
the 1994-95 fiscal year other than Federal reimbursement for immigration costs
were up about $650 million. The largest portion of this was in higher bank and
corporation tax receipts, but all major tax sources were above original
projections. However, most of the Federal immigration aid revenues projected in
connection with the 1994-95 Budget Act and in the July, 1994 cash flows will not
be received, as indicated above, leaving a net increase in revenues of $322
million.
On the expenditure side, the State Controller reported that estimated
reduced caseload growth in health and welfare programs, reduced school
enrollment growth, and an accounting adjustment reducing a transfer from the
General Fund to the Special Fund for Economic Uncertainties resulted in overall
General Fund expenditure reductions (again before adjusting for Federal aid) of
$672 million. However, the July, 1994 cash flows projected that General Fund
health and welfare and education expenditures would be offset by the anticipated
receipt of $407 million in Federal aid for illegal immigrant costs. The State
Controller now estimates that none of these funds will be received, so the net
reduction in General Fund expenditures is $265 million.
Finally, the State Controller indicated that a review of balances in special
funds available for internal borrowing resulted in an estimated reduction of
such borrowable resources of $6 million. The combination of these factors
results in the estimated improvement of the General Fund's cash position of $581
million. The State Controller's revised cash flow projections for 1994-95 have
allocated this improvement to two line items: an increase from $0 to $427
million in the estimated ending cash balance of the General Fund on June 30,
1995, and an increase in unused borrowable resources of $154 million.
The State Controller's report indicated that there was no anticipated cash
impact in the 1994-95 fiscal year for recent initiative on "three strikes"
criminal penalties and illegal immigration which were approved by voters on
November 8, 1994. At a hearing before a committee of the Legislature on November
15, 1994, both the Legislative Analyst and the Department of
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Finance concurred in the reasonableness of the State Controller's report. (The
Legislative Analyst had issued a preliminary analysis on November 1, 1994 which
reached a conclusion very close to that of the State Controller.) The State
Controller's report makes no projections about whether the Law may have to be
implemented in 1995-96. However, both the State Controller and the Legislative
Analyst in the November 15 hearing noted that the July, 1994 cash flows for the
1995-96 fiscal year place continued reliance on large amounts of federal
assistance for immigration costs, which did not materialize this year,
indicating significant budget pressures for next year. The Department of Finance
indicated that the budgetary issues identified in the hearing would be addressed
in the Governor's Budget proposal for the 1995-96 fiscal year, which will be
released in early January, 1995.
The Director of Finance is required to include updated cash-flow statements
for the 1994-95 and 1995-96 Fiscal Years in the May revision to the 1995-96
Fiscal Year budget proposal. By June 1, 1995, the State Controller must concur
with these updated statements or provide a revised estimate of the cash
condition of the General Fund for the 1994-95 and the 1995-96 Fiscal Years. For
the 1995-96 Fiscal Year, Chapter 135 prohibits any external borrowing as of June
30, 1996, thereby requiring the State to rely solely on internal borrowable
resources, expenditure reductions or revenue increases to eliminate any
projected cash flow shortfall.
Commencing on October 15, 1995, the State Controller will, in conjunction
with the Legislative Analyst's Office, review the estimated cash condition of
the General Fund for the 1995-96 Fiscal Year. The "1996 cash shortfall" shall be
the amount necessary to bring the balance of unused borrowable resources on June
30, 1996 to zero. On or before December 1, 1995, legislation must be enacted
providing for sufficient General Fund expenditure reductions, revenue increases,
or both, to offset any such 1996 cash shortfall identified by the State
Controller. If such legislation is not enacted, within five days thereafter the
Director of Finance must reduce all General Fund appropriations for the 1995-96
Fiscal Year, except the Required Appropriations, by the percentage equal to the
ratio of said 1996 cash shortfall to total remaining General Fund appropriations
for the 1995-96 Fiscal Year, excluding the Required Appropriations.
On December 6, 1994, Orange County, California and its Investment Pool (the
"Pool") filed for bankruptcy under Chapter 9 of the United States Bankruptcy
Code. Approximately 187 California public entities, substantially all of which
are public agencies within the County, are investors in the Pool. Many of the
agencies have various bonds, notes or other forms of indebtedness outstanding,
in some instances the proceeds of which have been invested in the Pool. Such
agencies also have additional funds invested in the Pool. Since the filing,
investor access to monies in the Pool has been by Court order only and severely
limited. Various representatives of the County have indicated that the Pool
expects to lose a substantial amount of its original principal invested. The
County has employed various investment advisors to restructure the Pool. Such
restructuring has resulted in the sale of a significant amount of the Pool's
portfolio resulting in losses estimated to be in excess of $2 billion. The
County has indicated that further losses could be incurred as restructuring
continues. It is anticipated that such losses may result in delays or failures
of the County as well as investors in the Pool to make scheduled debt service
payments. Further, the County expects substantial budget deficits to occur in
Fiscal Year 1995 with possibly similar effects upon operations of investors in
the Pool. The County failed to make certain deposits to a fund for repayment of
$169,000,000 aggregate principal amount of its short term indebtedness resulting
in a technical default under its note resolution. There has been no default in
payment to noteholders. Principal and interest on such notes is due on June 30,
1995. Additionally, the County has defaulted in its obligation to accept tenders
of its $110,200,000 aggregate principal amount of its Taxable Pension Obligation
Bonds, Series B used to finance
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County pension obligations. Interest at a rate set pursuant to the bond
documents has been timely paid on such Pension Bonds. Principal and interest
payments on other indebtedness of the County and the investors will come due at
various times and amounts throughout 1995. Both S&P and Moody's have suspended
or downgraded ratings on various debt securities of the County and certain of
the investors in the Pool. Such suspensions or downgradings could affect both
price and liquidity of such securities. The Fund is unable to predict when funds
may be released from the Pool to investors, the amount of such funds, if any,
whether additional technical and payment defaults by the County and/or investors
in the pool and the financial impact upon the value of securities of the County
and the investors in the Pool.
CONSTITUTIONAL, LEGISLATIVE AND OTHER FACTORS. Certain California constitutional
amendments, legislative measures, executive orders, administrative regulations
and voter initiatives could result in the adverse effects described below. The
following information constitutes only a brief summary, does not purport to be a
complete description, and is based on information drawn from official statements
and prospectuses relating to securities offerings of the State of California and
various local agencies in California available as of the date of this Statement
of Additional Information.
Certain of the California Municipal Obligations in which the Fund may invest
may be obligations of issuers which rely in whole or in part on California State
revenues for payment of these obligations. Property tax revenues and a portion
of the State's general fund surplus are distributed to counties, cities and
their various taxing entities and the State assumes certain obligations
theretofore paid out of local funds. Whether and to what extent a portion of the
State's general fund will be distributed in the future to counties, cities and
their various entities, is unclear.
In 1988, California enacted legislation providing for a water's-edge
combined reporting method if an election fee was paid and other conditions met.
On October 6, 1993, California Governor Pete Wilson signed Senate Bill 671
(Alquist) which modifies the unitary tax law by deleting the requirements that a
taxpayer electing to determine its income on a water's-edge basis pay a fee and
file a domestic disclosure spreadsheet and instead requiring an annual
information return. Significantly, the Franchise Tax Board can no longer
disregard a taxpayer's election. The Franchise Tax Board is reported to have
estimated state revenue losses from the Legislation as growing from $27 million
in 1993-94 to $616 million in 1999-2000, but others, including Assembly Speaker
Willie Brown, disagree with that estimate and assert that more revenue will be
generated for California, rather than less, because of an anticipated increase
in economic activity and additional revenue generated by the incentives in the
Legislation.
Certain of the California Municipal Obligations may be obligations of
issuers who rely in whole or in part on ad valorem real property taxes as a
source of revenue. On June 6, 1978, California voters approved an amendment to
the California Constitution known as Proposition 13, which added Article XIIIA
to the California Constitution. The effect of Article XIIIA is to limit ad
valorem taxes on real property and to restrict the ability of taxing entities to
increase real property tax revenues. On November 7, 1978, California voters
approved Proposition 8, and on June 3, 1986, California voters approved
Proposition 46, both of which amended Article XIIIA.
Section 1 of Article XIIIA limits the maximum ad valorem tax on real
property to 1% of full cash value (as defined in Section 2), to be collected by
the counties and apportioned according to law; provided that the 1% limitation
does not apply to ad valorem taxes or special assessments to pay the interest
and redemption charges on (a) any indebtedness approved by the voters prior to
July 1, 1978, or (b) any bonded indebtedness for the acquisition or improvement
of real property approved on or after July 1, 1978, by two-thirds of the votes
cast by the voters voting on the proposition. Section 2 of Article XIIIA defines
"full cash value" to mean "the County Assessor's valuation of real property as
shown on the
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1975/76 tax bill under 'full cash value' or, thereafter, the appraised value of
real property when purchased, newly constructed, or a change in ownership has
occurred after the 1975 assessment." The full cash value may be adjusted
annually to reflect inflation at a rate not to exceed 2% per year, or reduction
in the consumer price index or comparable local data, or reduced in the event of
declining property value caused by damage, destruction or other factors. The
California State Board of Equalization has adopted regulations, binding on
county assessors, interpreting the meaning of "change in ownership" and "new
construction" for purposes of determining full cash value of property under
Article XIIIA.
Legislation enacted by the California Legislature to implement Article XIIIA
(Statutes of 1978, Chapter 292, as amended) provides that notwithstanding any
other law, local agencies may not levy any ad valorem property tax except to pay
debt service on indebtedness approved by the voters prior to July 1, 1978, and
that each county will levy the maximum tax permitted by Article XIIIA of $4.00
per $100 assessed valuation (based on the former practice of using 25%, instead
of 100%, of full cash value as the assessed value for tax purposes). The
legislation further provided that, for the 1978/79 fiscal year only, the tax
levied by each county was to be apportioned among all taxing agencies within the
county in proportion to their average share of taxes levied in certain previous
years. The apportionment of property taxes for fiscal years after 1978/79 has
been revised pursuant to Statutes of 1979, Chapter 282, which provides relief
funds from State moneys beginning in fiscal year 1979/80 and is designed to
provide a permanent system for sharing State taxes and budget funds with local
agencies. Under Chapter 282, cities and counties receive more of the remaining
property tax revenues collected under Proposition 13 instead of direct State
aid. School districts receive a correspondingly reduced amount of property
taxes, but receive compensation directly from the State and are given additional
relief. Chapter 282 does not affect the derivation of the base levy ($4.00 per
$100 of assessed valuation) and the bonded debt tax rate.
On November 6, 1979, an initiative known as "Proposition 4" or the "Gann
Initiative" was approved by the California voters, which added Article XIIIB to
the California Constitution. Under Article XIIIB, State and local governmental
entities have an annual "appropriations limit" and are not allowed to spend
certain monies called "appropriations subject to limitation" in an amount higher
than the "appropriations limit." Article XIIIB does not affect the appropriation
of moneys which are excluded from the definition of "appropriations subject to
limitation," including debt service on indebtedness existing or authorized as of
January 1, 1979, or bonded indebtedness subsequently approved by the voters. In
general terms, the "appropriations limit" is required to be based on certain
1978/79 expenditures, and is to be adjusted annually to reflect changes in
consumer prices, population and certain services provided by these entities.
Article XIIIB also provides that if these entities' revenues in any year exceed
the amounts permitted to be spent, the excess is to be returned by revising tax
rates or fee schedules over the subsequent two years.
At the November 8, 1988 general election, California voters approved an
initiative known as Proposition 98. This initiative amends Article XIIIB to
require that (a) the California Legislature establish a prudent state reserve
fund in an amount as it shall deem reasonable and necessary and (b) revenues in
excess of amounts permitted to be spent and which would otherwise be returned
pursuant to Article XIIIB by revision of tax rates or fee schedules, be
transferred and allocated (up to a maximum of 4%) to the State School Fund and
be expended solely for purposes of instructional improvement and accountability.
No such transfer or allocation of funds will be required if certain designated
state officials determine that annual student expenditures and class size meet
certain criteria as set forth in Proposition 98. Any funds allocated to the
State School Fund shall
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cause the appropriation limits established in Article XIIIB to be annually
increased for any such allocation made in the prior year.
Proposition 98 also amends Article XVI to require that the State of
California provide a minimum level of funding for public schools and community
colleges. Commencing with the 1988-89 fiscal year, state monies to support
school districts and community college districts shall equal or exceed the
lesser of (a) an amount equalling the percentage of state general revenue bonds
for school and community college districts in fiscal year 1986-87, or (b) an
amount equal to the prior year's state general fund proceeds of taxes
appropriated under Article XIIIB plus allocated proceeds of local taxes, after
adjustment under Article XIIIB. The initiative permits the enactment of
legislation, by a two-thirds vote, to suspend the minimum funding requirement
for one year.
On June 30, 1989, the California Legislature enacted Senate Constitutional
Amendment 1, a proposed modification of the California Constitution to alter the
spending limit and the education funding provisions of Proposition 98. Senate
Constitutional Amendment 1, on the June 5, 1990 ballot as Proposition 111, was
approved by the voters and took effect on July 1, 1990. Among a number of
important provisions, Proposition 111 recalculates spending limits for the State
and for local governments, allows greater annual increases in the limits, allows
the averaging of two years' tax revenues before requiring action regarding
excess tax revenues, reduces the amount of the funding guarantee in recession
years for school districts and community college districts (but with a floor of
40.9% of State general fund tax revenues), removes the provision of Proposition
98 which included excess moneys transferred to school districts and community
college districts in the base calculation for the next year, limits the amount
of State tax revenue over the limit which would be transferred to school
districts and community college districts, and exempts increased gasoline taxes
and truck weight fees from the State appropriations limit. Additionally,
Proposition 111 exempts from the State appropriations limit funding for capital
outlays.
Article XIIIB, like Article XIIIA, may require further interpretation by
both the Legislature and the courts to determine its applicability to specific
situations involving the State and local taxing authorities. Depending upon the
interpretation, Article XIIIB may limit significantly a governmental entity's
ability to budget sufficient funds to meet debt service on bonds and other
obligations.
On November 4, 1986, California voters approved an initiative statute known
as Proposition 62. This initiative (a) requires that any tax for general
governmental purposes imposed by local governments be approved by resolution or
ordinance adopted by a two-thirds vote of the governmental entity's legislative
body and by a majority vote of the electorate of the governmental entity, (b)
requires that any special tax (defined as taxes levied for other than general
governmental purposes) imposed by a local governmental entity be approved by a
two-thirds vote of the voters within that jurisdiction, (c) restricts the use of
revenues from a special tax to the purposes or for the service for which the
special tax was imposed, (d) prohibits the imposition of ad valorem taxes on
real property by local governmental entities except as permitted by Article
XIIIA, (e) prohibits the imposition of transaction taxes and sales taxes on the
sale of real property by local governments, (f) requires that any tax imposed by
a local government on or after August 1, 1985 be ratified by a majority vote of
the electorate within two years of the adoption of the initiative or be
terminated by November 15, 1988, (g) requires that, in the event a local
government fails to comply with the provisions of this measure, a reduction in
the amount of property tax revenue allocated to such local government occurs in
an amount equal to the revenues received by such entity attributable to the tax
levied in violation of the initiative, and (h) permits these provisions to be
amended exclusively by the voters of the State of California.
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In September 1988, the California Court of Appeals in CITY OF WESTMINSTER V.
COUNTY OF ORANGE 204 Cal. App. 3d 623, 215 Cal. Rptr. 511 (Cal. Ct. App. 1988),
held that Proposition 62 is unconstitutional to the extent that it requires a
general tax by a general law city, enacted on or after August 1, 1985 and prior
to the effective date of Proposition 62, to be subject to approval by a majority
of voters. The Court held that the California Constitution prohibits the
imposition of a requirement that local tax measures be submitted to the
electorate by either referendum or initiative. It is not possible to predict the
impact of this decision on charter cities, on special taxes or on new taxes
imposed after the effective date of Proposition 62.
On November 8, 1988, California voters approved Proposition 87. Proposition
87 amended Article XVI, Section 16, of the California Constitution by
authorizing the California Legislature to prohibit redevelopment agencies from
receiving any of the property tax revenue raised by increased property tax rates
levied to repay bonded indebtedness of local governments which is approved by
voters on or after January 1, 1989. It is not possible to predict whether the
California Legislature will enact such a prohibition nor is it possible to
predict the impact of Proposition 87 on redevelopment agencies and their ability
to make payments on outstanding debt obligations.
Certain California Exempt Obligations in which the Fund may invest may be
obligations that are payable solely from the revenues of health care
institutions. Certain provisions under California law may adversely affect such
revenues and, consequently, payment on those California Exempt Obligations.
The Federally sponsored Medicaid program for health care services to
eligible welfare beneficiaries in California is known as the Medi-Cal program.
Historically, the Medi-Cal program has provided for a cost-based system of
reimbursement for inpatient care furnished to Medi-Cal beneficiaries by any
hospital wanting to participate in the Medi-Cal program, provided such hospital
met applicable requirements for participation. California law now provides that
the State of California shall selectively contract with hospitals to provide
acute inpatient services to Medi-Cal patients. Medi-Cal contracts currently
apply only to acute inpatient services. Generally, such selective contracting is
made on a flat per diem payment basis for all services to Medi-Cal
beneficiaries, and generally such payment has not increased in relation to
inflation, costs or other factors. Other reductions or limitations may be
imposed on payment for services rendered to Medi-Cal beneficiaries in the
future.
Under this approach, in most geographical areas of California, only those
hospitals which enter into a Medi-Cal contract with the State of California will
be paid for non-emergency acute inpatient services rendered to Medi-Cal
beneficiaries. The State may also terminate these contracts without notice under
certain circumstances and is obligated to make contractual payments only to the
extent the California legislature appropriates adequate funding therefor.
In February 1987, the Governor of the State of California announced that
payments to Medi-Cal providers for certain services (not including hospital
acute inpatient services) would be decreased by 10% through June 1987. However,
a Federal district court issued a preliminary injunction preventing application
of any cuts until a trial on the merits can be held. If the injunction is deemed
to have been granted improperly, the State of California would be entitled to
recapture the payment differential for the intended reduction period. It is not
possible to predict at this time whether any decreases will ultimately be
implemented.
California enacted legislation in 1982 that authorizes private health plans
and insurers to contract directly with hospitals for services to beneficiaries
on negotiated terms. Some insurers have introduced plans known as "preferred
provider organizations" ("PPOs"), which offer financial incentives for
subscribers who use only the hospitals which contract with the plan. Under an
exclusive provider plan, which includes most health maintenance organizations
("HMOs"), private payors
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limit coverage to those services provided by selected hospitals. Discounts
offered to HMOs and PPOs may result in payment to the contracting hospital of
less than actual cost and the volume of patients directed to a hospital under an
HMO or PPO contract may vary significantly from projections. Often, HMO or PPO
contracts are enforceable for a stated term, regardless of provider losses or of
bankruptcy of the respective HMO or PPO. It is expected that failure to execute
and maintain such PPO and HMO contracts would reduce a hospital's patient base
or gross revenues. Conversely, participation may maintain or increase the
patient base, but may result in reduced payment and lower net income to the
contracting hospitals.
Such California Exempt Obligations may also be insured by the State of
California pursuant to an insurance program implemented by the Office of
Statewide Health Planning and Development for health facility construction
loans. If a default occurs on insured California Exempt Obligations, the State
Treasurer will issue debentures payable out of a reserve fund established under
the insurance program or will pay principal and interest, on an unaccelerated
basis from unappropriated State funds. At the request of the Office of Statewide
Health Planning and Development, Arthur D. Little, Inc. prepared a study in
December 1983 to evaluate the adequacy of the reserve fund established under the
insurance program and, based on certain formulations and assumptions found the
reserve fund substantially underfunded. In September of 1986, Arthur D. Little,
Inc. prepared an update of the study and concluded that an additional 10%
reserve be established for "multi-level" facilities. For the balance of the
reserve fund, the update recommended maintaining the current reserve calculation
method. In March 1990, Arthur D. Little, Inc. prepared a further review of the
study and recommended that separate reserves continue to be established for
"multi-level" facilities at a reserve level consistent with those that would be
required by an insurance company.
Certain California Exempt Obligations in the Fund may be obligations which
are secured in whole or in part by a mortgage or deed of trust on real property.
California has five principal statutory provisions which limit the remedies of a
creditor secured by a mortgage or deed of trust. Two limit the creditor's right
to obtain a deficiency judgment, one limitation being based on the method of
foreclosure and the other on the type of debt secured. Under the former, a
deficiency judgment is barred when the foreclosure is accomplished by means of a
nonjudicial trustee's sale. Under the latter, a deficiency judgment is barred
when the foreclosed mortgage or deed of trust secures certain purchase money
obligations. Another California statute, commonly known as the "one form of
action" rule, requires creditors secured by real property to exhaust their real
property security by foreclosure before bringing a personal action against the
debtor. The fourth statutory provision limits any deficiency judgment obtained
by a creditor secured by real property following a judicial sale of such
property to the excess of the outstanding debt over the fair value of the
property at the time of the sale, thus preventing the creditor from obtaining a
large deficiency judgment against the debtor as the result of low bids at a
judicial sale. The fifth statutory provision gives the debtor the right to
redeem the real property from any judicial foreclosure sale as to which a
deficiency judgment may be ordered against the debtor.
Upon the default of a mortgage or deed of trust with respect to California
real property, the creditor's nonjudicial foreclosure rights under the power of
sale contained in the mortgage or deed of trust are subject to the constraints
imposed by California law upon transfers of title to real property by private
power of sale. During the three-month period beginning with the filing of a
formal notice of default, the debtor is entitled to reinstate the mortgage by
making any overdue payments. Under standard loan servicing procedures, the
filing of the formal notice of default does not occur unless at least three full
monthly payments have become due and remain unpaid. The power of sale is
exercised by posting
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and publishing a notice of sale for at least 20 days after expiration of the
three-month reinstatement period. Therefore, the effective minimum period for
foreclosing on a mortgage could be in excess of seven months after the initial
default. Such time delays in collections could disrupt the flow of revenues
available to an issuer for the payment of debt service on the outstanding
obligations if such defaults occur with respect to a substantial number of
mortgages or deeds of trust securing an issuer's obligations.
In addition, a court could find that there is sufficient involvement of the
issuer in the nonjudicial sale of property securing a mortgage for such private
sale to constitute "state action," and could hold that the private-right-of-sale
proceedings violate the due process requirements of the Federal or State
Constitutions, consequently preventing an issuer from using the nonjudicial
foreclosure remedy described above.
Certain California Exempt Obligations in the Fund may be obligations which
finance the acquisition of single family home mortgages for low and moderate
income mortgagors. These obligations may be payable solely from revenues derived
from the home mortgages, and are subject to California's statutory limitations
described above applicable to obligations secured by real property. Under
California antideficiency legislation, there is no personal recourse against a
mortgagor of a single family residence purchased with the loan secured by the
mortgage, regardless of whether the creditor chooses judicial or nonjudicial
foreclosure.
Under California law, mortgage loans secured by single-family owner-occupied
dwellings may be prepaid at any time. Prepayment charges on such mortgage loans
may be imposed only with respect to voluntary prepayments made during the first
five years during the term of the mortgage loan, and cannot in any event exceed
six months' advance interest on the amount prepaid in excess of 20% of the
original principal amount of the mortgage loan. This limitation could affect the
flow of revenues available to an issuer for debt service on the outstanding debt
obligations which financed such home mortgages.
ADDITIONAL CONSIDERATIONS. With respect to Municipal Obligations issued by the
State of California and its political sub-divisions, (I.E., California Exempt
Obligations) the Fund cannot predict what legislation, if any, may be proposed
in the California State Legislature as regards the California State personal
income tax status of interest on such obligations, or which proposals, if any,
might be enacted. Such proposals, if enacted, might materially adversely affect
the availability of California Exempt Obligations for investment by the Fund and
the value of the Fund's portfolio. In such an event, the Trustees would
reevaluate the Fund's investment objective and policies and consider changes in
its structure or possible dissolution.
SPECIAL CONSIDERATIONS RELATING TO NEW YORK
EXEMPT OBLIGATIONS
As indicated in the New York Fund's Prospectus, the Fund seeks its objective by
investing principally in a portfolio of Municipal Obligations, the interest from
which is exempt from New York State and New York City personal income taxes
("New York Exempt Obligations").
Some of the significant financial considerations relating to the Fund's
investment in New York Exempt Obligations are summarized below. This summary
information is not intended to be a complete description and is principally
derived from official statements relating to issues of New York Exempt
Obligations that were available prior to the date of this Statement of
Additional Information. The accuracy and completeness of the information
contained in those official statements have not been independently verified.
STATE ECONOMY. New York State (the "State") is the third most populous state in
the nation and has a relatively high level of personal wealth. The State's
economy is diverse with a comparatively large share of the nation's finance,
insurance, transportation, communications and
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services employment, and a very small share of the nation's farming and mining
activity. The State has a declining proportion of its workforce engaged in
manufacturing, and an increasing proportion engaged in service industries. New
York City (the "City"), which is the most populous city in the State and nation
and is the center of the nation's largest metropolitan area, accounts for a
large portion of the State's population and personal income.
The State has historically been one of the wealthiest states in the nation.
For decades, however, the State has grown more slowly than the nation as a
whole, gradually eroding its relative economic position. The recession has been
more severe in the State, owing to a significant retrenchment in the financial
services industry, cutbacks in defense spending, and an overbuilt real estate
market. There can be no assurance that the State economy will not experience
worse-than-predicted results in the 1994-95 fiscal year, with corresponding
material and adverse effects on the State's projections of receipts and
disbursements.
The unemployment rate in the State dipped below the national rate in the
second half of 1981 and remained lower until 1991. It stood at 7.7% in 1993. The
total employment growth rate in the State has been below the national average
since 1984. State per capita personal income remains above the national average.
State per capita income for 1993 was $24,623, which is 18.3% above the 1993
national average of $20,817. During the past ten years, total personal income in
the State rose slightly faster than the national average only in 1986 through
1989.
STATE BUDGET. The State Constitution requires the Governor to submit to the
Legislature a balanced Executive Budget which contains a complete plan of
expenditures for the ensuing fiscal year and all moneys and revenues estimated
to be available therefor, accompanied by bills containing all proposed
appropriations or reappropriations and any new or modified revenue measures to
be enacted in connection with the Executive Budget. The entire plan constitutes
the proposed State financial plan for that fiscal year. The Governor is required
to submit to the Legislature quarterly budget updates which include a revised
cash-basis State financial plan and an explanation of any changes from the
previous State financial plan.
The State's budget for the 1994-95 fiscal year was enacted by the
Legislature on June 7, 1994, more than two months after the start of the fiscal
year. Prior to adoption of the budget, the Legislature enacted appropriations
for disbursements considered to be necessary for State operations and other
purposes, including all necessary appropriations for debt service. The State
financial plan for the 1994-95 fiscal year was formulated on June 16, 1994 and
is based upon the State's budget as enacted by the Legislature and signed into
law by the Governor (the "1994-95 State Financial Plan"). This delay in the
enactment of the State's 1994-95 fiscal year budget may reduce the effectiveness
of several of the actions proposed.
The State issued its second quarterly update to the cash basis 1994-95 State
Financial Plan on October 28, 1994. The update projects a year-end surplus of
$14 million in the General Fund, with estimated receipts reduced by $267 million
and estimated disbursements reduced by $281 million, compared to the 1994-95
State Financial Plan as initially formulated.
The 1994-95 State Financial Plan is based on a number of assumptions and
projections. Because it is not possible to predict accurately the occurrence of
all factors that may affect the 1994-95 State Financial Plan, actual results may
differ and have differed materially in recent years, from projections made at
the outset of a fiscal year. There can be no assurance that the State will not
face substantial potential budget gaps in future years resulting from a
significant disparity between tax revenues projected from a lower recurring
receipts base and the spending required to maintain State programs at current
levels. To address any potential budgetary imbalance, the State may need to take
significant actions to align recurring receipts and disbursements in future
fiscal years.
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RECENT FINANCIAL RESULTS. The General Fund is the general operating fund of the
State and is used to account for all financial transactions, except those
required to be accounted for in another fund. It is the State's largest fund and
receives almost all State taxes and other resources not dedicated to particular
purposes. In the State's 1994-95 fiscal year, the General Fund is expected to
account for approximately 52% of total governmental-fund receipts and 51% of
total governmental-fund disbursements.
The General Fund is projected to be balanced on a cash basis for the 1994-95
fiscal year. Total receipts are projected to be $34.321 billion, an increase of
$2.092 billion over total receipts in the prior fiscal year. Total General Fund
disbursements are projected to be $34.248 billion, an increase of $2.351 billion
over the total amount disbursed and transferred in the prior fiscal year.
The State's financial position on a GAAP (generally accepted accounting
principles) basis as of March 31, 1993 included an 1991-92 accumulated deficit
in its combined governmental funds of $681 million. Liabilities totalled $12.864
billion and assets of $12.183 billion were available to liquidate these
liabilities.
The State's financial operations have improved during recent fiscal years.
During the period 1989-90 through 1991-92, the State incurred General Fund
operating deficits that were closed with receipts from the issuance of tax and
revenue anticipation notes. The national recession and then the lingering
economic slowdown in the New York and regional economy, resulted in repeated
shortfall in receipts and three budget deficits. For its 1992-93 and 1993-94
fiscal years, however, the State recorded balanced budgets on a cash basis, with
substantial fund balances in each year.
DEBT LIMITS AND OUTSTANDING DEBT. There are a number of methods by which the
State of New York may incur debt. Under the State Constitution, the State may
not, with limited exceptions for emergencies, undertake long-term general
obligation borrowing (I.E., borrowing for more than one year) unless the
borrowing is authorized in a specific amount for a single work or purpose by the
Legislature and approved by the voters. There is no limitation on the amount of
long-term general obligation debt that may be so authorized and subsequently
incurred by the State. The total amount of long-term State general obligation
debt authorized but not issued as of December 31, 1993 was approximately $2.273
billion.
The State may undertake short-term borrowings without voter approval (a) in
anticipation of the receipt of taxes and revenues, by issuing tax and revenue
anticipation notes, and (b) in anticipation of the receipt of proceeds from the
sale of duly authorized but unissued bonds, by issuing general obligation bond
anticipation notes. The State may also, pursuant to specific constitutional
authorization, directly guarantee certain obligations of the State's authorities
and public benefit corporations ("Authorities"). Payments of debt service on New
York State general obligation and New York State-guaranteed bonds and notes are
legally enforceable obligations of the State.
The State employs additional long-term financing mechanisms, lease-purchase
and contractual-obligation financings, which involve obligations of public
authorities or municipalities that are State-supported but are not general
obligations of the State. Under these financing arrangements, certain public
authorities and municipalities have issued obligations to finance the
construction and rehabilitation of facilities or the acquisition of equipment,
and expect to meet their debt service requirements through the receipt of rental
or other contractual payments made by the State. Although these financing
arrangements involve a contractual agreement by the State to make payments to a
public authority, municipality or other entity, the State's obligation to make
such payments is generally expressly made subject to appropriation by the
Legislature and the actual availability of money to the State for making the
payments. The State has also entered into a contractual-
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obligation financing arrangement with the Local Government Assistance
Corporation ("LGAC") in an effort to restructure the way the State makes certain
local aid payments.
In 1990, as part of a State fiscal reform program, legislation was enacted
creating the New York Local Government Assistance Corporation ("LGAC"), a public
benefit corporation empowered to issue long-term obligations to fund certain
payments to local governments traditionally funded through New York State's
annual seasonal borrowing. The legislation empowered LGAC to issue its bonds and
notes in an amount not in excess of $4.7 billion (exclusive of certain refunding
bonds) plus certain other amounts. Over a period of years, the issuance of these
long-term obligations, which are to be amortized over no more than 30 years, was
expected to eliminate the need for continued short-term seasonal borrowing. The
legislation also imposed a cap on the annual seasonal borrowing of the State at
$4.7 billion, less net proceeds of bonds issued by LGAC and bonds issued to
provide for capitalized interest, except in cases where the Governor and the
legislative leaders have certified the need for additional borrowing and
provided a schedule for reducing it to the cap. If borrowing above the cap is
thus permitted in any fiscal year, it is required by law to be reduced to the
cap by the fourth fiscal year after the limit was first exceeded. As of December
1994, LGAC had issued bonds to provide net proceeds of $3.856 billion and has
been authorized to issue its bonds to provide net proceeds of up to an
additional $315 million during the State's 1994-95 fiscal year. The impact of
this borrowing, together with the availability of certain cash reserves, is
that, for the first time in nearly 35 years, the 1994-95 State Financial Plan
includes no short-term seasonal borrowing.
In April 1993, legislation was enacted proposing significant constitutional
changes to the long-term financing practices of the State and the Authorities.
The Legislature passed a proposed constitutional amendment that would permit
the State, within a formula-based cap, to issue revenue bonds, which would be
debt of the State secured solely by a pledge of certain State tax receipts
(including those allocated to State funds dedicated for transportation
purposes), and not by the full faith and credit of the State. In addition, the
proposed amendment would require that State debt be incurred only for capital
projects included in a multi-year capital financing plan and would prohibit,
after its effective date, lease-purchase and contractual-obligation financing
mechanisms for State facilities. Public hearings were held on the proposed
constitutional amendment during 1993. Following these hearings, in February
1994, the Governor and the State Comptroller recommended a revised
constitutional amendment which would further tighten the ban on lease-purchase
and contractual-obligation financing, incorporate existing lease-purchase and
contractual-obligation debt under the proposed revenue bond cap while
simultaneously reducing the size of the cap. After considering these
recommendations, the Legislature passed a revised constitutional amendment which
tightens the ban, and provides for a phase-in to a lower cap. Before the
approved constitutional amendment or any revised amendment enacted in 1994 can
be presented to the voters for their consideration, it must be passed by a
separately elected legislature. The amendment must therefore be passed by the
newly elected Legislature in 1995 prior to presentation to the voters at the
earliest in November 1995. The amendment could not become effective before
January 1, 1996.
____On January 13, 1992, S&Preduced its ratings on the State's general
obligation bonds from A to A- and, in addition, reduced its ratings on
the State's moral obligation, lease purchase, guaranteed and
contractual obligation debt. S&P also continued its negative rating
outlook assessment on State general obligation debt. On April
26, 1993, S&P revised the rating outlook assessment to stable. On
February 14, 1994, S&P raised its outlook to positive and, on
February 28, 1994, confirmed its A- rating. On January 6, 1992, Moody's
reduced its ratings on outstanding limited-
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liability State lease purchase and contractual obligations from A to Baa1. On
February 28, 1994, Moody's reconfirmed its A rating on the State's general
obligation long-term indebtedness.
____The State anticipates that its capital programs will be financed, in part,
by State and public authorities borrowings in 1994-95. The State expects to
issue $374 million in general obligation bonds (including $140 million for
purposes of redeeming outstanding bond anticipation notes) and $140 million in
general obligation commercial paper. The Legislature has also authorized the
issuance of up to $69 million in certificates of participation during the
State's 1994-95 fiscal year for equipment purchases. The projection of the State
regarding its borrowings for the 1994-95 fiscal year may change if circumstances
require.
____Principal and interest payments on general obligation bonds and interest
payments on bond anticipation notes and on tax and revenue anticipation notes
were $782.5 million for the 1993-94 fiscal year, and are estimated to be $786.3
million for the 1994-95 fiscal year. These figures do not include interest
payable on State General Obligation Refunding Bonds issued in July 1992
("Refunding Bonds") to the extent that such interest was paid from an escrow
fund established with the proceeds of such Refunding Bonds. Principal and
interest payments on fixed rate and variable rate bonds issued by LGAC were
$239.4 million for the 1993-94 fiscal year, and are estimated to be $289.9
million for 1994-95. State lease-purchase rental and contractual obligation
payments for 1993-94, including State installment payments relating to
certificates of participation, were $1.258 billion and are estimated to be
$1.495 billion in 1994-95.
____New York State has never defaulted on any of its general obligation
indebtedness or its obligations under lease-purchase or contractual-obligation
financing arrangements and has never been called upon to make any direct
payments pursuant to its guarantees.
LITIGATION. Certain litigation pending against the State or its officers or
employees could have a substantial or long-term adverse effect on State
finances. Among the more significant of these cases are those that involve: (a)
the validity of agreements and treaties by which various Indian tribes
transferred title to the State of certain land in central and upstate New York;
(b) certain aspects of the State's Medicaid policies, including its rates,
regulations and procedures; (c) contamination in the Love Canal area of Niagara
Falls; (d) action against the State and City officials alleging inadequate
shelter allowances to maintain proper housing; (e) challenges to the practice of
reimbursing certain Office of Mental Health patient care expenses from the
client's Social Security benefits; (f) alleged responsibility of the State's
officials to assist in remedying racial segregation in the City of Yonkers; (g)
action in which the State is a third party defendant, for injunctive or other
appropriate relief, concerning liability for the maintenance of stone groins
constructed along certain areas of Long Island's shoreline; (8) challenges by
commercial insurers, employee welfare benefit plans, and health maintenance
organizations to Section 2807-c of the Public Health Law, which imposes 13%, 11%
and 9% surcharges on inpatient hospital bills and a bad debt and charity care
allowance on all hospital bills and hospital bills paid by such entities; (9)
challenge by a long distance carrier to the constitutionality of Tax Law
Section186-a(2-a) which restricted certain deduction of local access service
fees and (10) challenges to certain aspects of petroleum business taxes.
A number of cases have also been instituted against the State challenging
the constitutionality of various public authority financing programs.
In a proceeding commenced on August 6, 1991 (SCHULZ, ET AL. V. STATE OF NEW
YORK, ET AL., Supreme Court, Albany County), petitioners challenge the
constitutionality of two bonding programs of the New York State Thruway
Authority authorized by Chapters 166 and 410 of the Laws of 1991. In addition,
petitioners challenge the fiscal year 1991-92 judiciary budget as having been
enacted in violation of Sections 1 and 2 of Article VII of the State
Constitution. The defendants' motion to dismiss the action on procedural grounds
was
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denied by order of the Supreme Court dated January 2, 1992. By order dated
November 5, 1992, the Appellate Division, Third Department, reversed the order
of the Supreme Court and granted defendants' motion to dismiss on grounds of
standing and mootness. By order dated September 16, 1993, on motion to
reconsider, the Appellate Division, Third Department, ruled that plaintiffs have
standing to challenge the bonding program authorized by Chapter 166 of the laws
of 1991. The proceeding is presently pending in Supreme Court, Albany County.
In SCHULZ, ET AL. V. STATE OF NEW YORK, ET AL., commenced May 24, 1993,
Supreme Court, Albany County, petitioners challenge, among other things, the
constitutionality of, and seek to enjoin certain highway, bridge and mass
transportation bonding programs of the New York State Thruway Authority and the
Metropolitan Transportation Authority authorized by Chapter 56 of the Laws of
1993. Petitioners contend that the application of State tax receipts held in
dedicated transportation funds to pay debt service on bonds of the Thruway
Authority and of the Metropolitan Transportation Authority violates Sections 8
and 11 of Article VII and Section 5 of Article X of the State Constitution and
due process provisions of the State and Federal Constitutions. By order dated
July 27, 1993, the Supreme Court granted defendants' motions for summary
judgment, dismissed the complaint and vacated the temporary restraining order
previously issued. By decision dated October 21, 1993, the Appellate Division,
Third Department, affirmed the judgment of the Supreme Court. On June 30, 1994,
the Court of Appeals unanimously affirmed the rulings of the trial court and the
Appellate Division in favor of the State.
Several actions challenging the constitutionality of legislation enacted
during the 1990 legislative session which changed actuarial funding methods for
determining state and local contributions to state employee retirement systems
have been decided against the State. As a result, the State's Comptroller has
developed a plan to restore the State's retirement systems to prior funding
levels. Such funding is expected to exceed prior levels by $30 million in fiscal
1994-95, $63 million in fiscal 1995-96, $116 million in fiscal 1996-97, $193
million in fiscal 1997-98, peaking at $241 million in fiscal 1998-99. Beginning
in fiscal 2001-02, State contributions required under the Comptroller's plan are
projected to be less than that required under the prior funding method. As a
result of the United States Supreme Court decision in the case of STATE OF
DELAWARE v. STATE OF NEW YORK, on January 21, 1994, the State entered into a
settlement agreement with Delaware. The State made an immediate $35 million
payment to Delaware and agreed to make annual payments of $33 million in each of
the next five fiscal years. In return, Delaware has agreed to withdraw its
claims and its request for summary judgment. The State and Massachusetts have
also executed a settlement agreement which provides for aggregate payments by
New York State of $23 million, payable over five consecutive years. Litigation
continues with respect to other parties and the State may be required to make
additional payments during the State's 1994-95 fiscal year.
The legal proceedings noted above involve State finances, State programs and
miscellaneous tort, real property and contract claims in which the State is a
defendant and the monetary damages sought are substantial. These proceedings
could affect adversely the financial condition of the State in the 1994-95
fiscal year or thereafter. Adverse developments in these proceedings or the
initiation of new proceedings could affect the ability of the State to maintain
a balanced Revised 1994-95 State Financial Plan. An adverse decision in any of
these proceedings could exceed the amount of the Revised 1994-95 State Financial
Plan reserve for the payment of judgments and, therefore, could affect the
ability of the State to maintain a balanced Revised 1994-95 State Financial
Plan. In its audited financial statements for the fiscal year ended March 31,
1994, the State reported its estimated liability for awarded and anticipated
unfavorable judgments to be $675 million.
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Although other litigation is pending against the State, except as described
above, no current litigation involves the State's authority, as a matter of law,
to contract indebtedness, issue its obligations, or pay such indebtedness when
it matures, or affects the State's power or ability, as a matter of law, to
impose or collect significant amounts of taxes and revenues.
AUTHORITIES. The fiscal stability of the State is related, in part, to the
fiscal stability of its Authorities, which generally have responsibility for
financing, constructing and operating revenue-producing public benefit
facilities. Authorities are not subject to the constitutional restrictions on
the incurrence of debt which apply to the State itself, and may issue bonds and
notes within the amounts of, and as otherwise restricted by, their legislative
authorization. The State's access to the public credit markets could be
impaired, and the market price of its outstanding debt may be materially and
adversely affected, if any of the Authorities were to default on their
respective obligations, particularly with respect to debt that are
State-supported or State-related. As of September 30, 1993, date of the latest
data available, there were 18 Authorities that had outstanding debt of $100
million or more. The aggregate outstanding debt, including refunding bonds, of
these 18 Authorities was $63.5 billion. As of March 31, 1994, aggregate public
authority debt outstanding as State-supported debt was $21.1 billion and as
State-related debt was $29.4 billion.
Authorities are generally supported by revenues generated by the projects
financed or operated, such as fares, user fees on bridges, highway tolls and
rentals for dormitory rooms and housing. In recent years, however, the State has
provided financial assistance through appropriations, in some cases of a
recurring nature, to certain of the 18 Authorities for operating and other
expenses and, in fulfillment of its commitments on moral obligation indebtedness
or otherwise, for debt service. This operating assistance is expected to
continue to be required in future years. In addition, certain statutory
arrangements provide for State local assistance payments otherwise payable to
localities to be made under certain circumstances to certain Authorities. The
State has no obligation to provide additional assistance to localities whose
local assistance payments have been paid to Authorities under these
arrangements. However, in the event that such local assistance payments are so
diverted, the affected localities could seek additional State funds.
NEW YORK CITY AND OTHER LOCALITIES. The fiscal health of the State is closely
related to the fiscal health of its localities, particularly the City, which has
required and continues to require significant financial assistance from the
State. The City's independently audited operating results for each of its 1981
through 1993 fiscal years, which end on June 30, show a General Fund surplus
reported in accordance with GAAP. In addition, the City's financial statements
for the 1993 fiscal year received an unqualified opinion from the City's
independent auditors, the eleventh consecutive year the City has received such
an opinion.
In 1975, the City suffered a fiscal crisis that impaired the borrowing
ability of both the City and the State. In that year the City lost access to
public credit markets. The City was not able to sell short-term notes to the
public again until 1979.
In 1975, S&P suspended its A rating of City bonds. This
suspension remained in effect until March 1981, at which time the City received
an investment grade rating of BBB from S&P. On July 2, 1985,
S&P revised its rating of City bonds upward to BBB+ and on
November 19, 1987, to A-. On July 2, 1993, S&P reconfirmed its A-
rating of City bonds, continued its negative rating outlook assessment and
stated that maintenance of such rating depended upon the City's making further
progress towards reducing budget gaps in the outlying years. Moody's ratings of
City bonds were revised in November 1981 from B (in effect since 1977) to Ba1,
in November 1983 to Baa, in December 1985 to Baa1, in May 1988 to A and again in
February 1991 to Baa1. On January 17, 1995, S&P placed
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the City's general obligation bonds on its CreditWatch list which may portend a
rating downgrade from the agency in the upcoming months.
The City is heavily dependent on State and Federal assistance to cover
insufficiencies in its revenues. There can be no assurance that in the future
Federal and State assistance will enable the City to make up its budget
deficits. To help alleviate the City's financial difficulties, the Legislature
created the Municipal Assistance Corporation ("MAC") in 1975. MAC is authorized
to issue bonds and notes payable from certain stock transfer tax revenues, from
the City's portion of the State sales tax derived in the City and from State per
capita aid otherwise payable by the State to the City. Failure by the State to
continue the imposition of such taxes, the reduction of the rate of such taxes
to rates less than those in effect on July 2, 1975, failure by the State to pay
such aid revenues and the reduction of such aid revenues below a specified level
are included among the events of default in the resolutions authorizing MAC's
long-term debt. The occurrence of an event of default may result in the
acceleration of the maturity of all or a portion of MAC's debt. As of December
31, 1993, MAC had outstanding an aggregate of approximately $5.204 billion of
its bonds. MAC bonds and notes constitute general obligations of MAC and do not
constitute an enforceable obligation or debt of either the State or the City.
Under its enabling legislation, MAC's authority to issue bonds and notes (other
than refunding bonds and notes) expired on December 31, 1984. Legislation has
been passed by the legislature which would, under certain conditions, permit MAC
to issue up to $1.465 billion of additional bonds, which are not subject to a
moral obligation provision.
Since 1975, the City's financial condition has been subject to oversight and
review by the New York State Financial Control Board (the "Control Board") and
since 1978 the City's financial statements have been audited by independent
accounting firms. To be eligible for guarantees and assistance, the City is
required during a "control period" to submit annually for Control Board
approval, and when a control period is not in effect for Control Board review, a
financial plan for the next four fiscal years covering the City and certain
agencies showing balanced budgets determined in accordance with GAAP. The State
also established the Office of the State Deputy Comptroller for New York City
("OSDC") to assist the Control Board in exercising its powers and
responsibilities. On June 30, 1986, the City satisfied the statutory
requirements for termination of the control period. This means that the Control
Board's powers of approval are suspended, but the Board continues to have
oversight responsibilities.
The staffs of OSDC and the Control Board issued periodic reports on the
City's financial plans, as modified, analyzing forecasts of revenues and
expenditures, cash flow, and debt service requirements, as well as compliance
with the financial plan, as modified, by the City and its Covered Organizations
(I.E., those which receive or may receive monies from the City directly,
indirectly or contingently). OSDC staff reports issued during the mid-1980's
noted that the City's budgets benefited from a rapid rise in the City's economy,
which boosted the City's collection of property, business and income taxes.
These resources were used to increase the City's workforce and the scope of
discretionary and mandated City services. Subsequent OSDC staff reports examined
the 1987 stock market crash and the 1989-92 recession, which affected the City's
region more severely than the nation, and attributed an erosion of City revenues
and increasing strain on City expenditures to that recession. According to a
recent OSDC staff report, the City's economy is now slowly recovering, but the
scope of that recovery is uncertain and unlikely, in the foreseeable future, to
match the expansion of the mid-1980's. Also, staff reports of OSDC and the
Control Board have indicated that the City's recent balanced budgets have been
accomplished, in part, through the use of non-recurring resources, tax increases
and additional State assistance; that the City has not yet brought its long-term
expenditures in line with recurring revenues; and that the City is therefore
likely to continue to face
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future projected budget gaps requiring the City to increase revenues and/or
reduce expenditures. According to the most recent staff reports of OSDC and the
Control Board, during the four-year period covered by the current financial
plan, the City is relying on obtaining substantial resources from initiatives
needing approval and cooperation of its municipal labor unions, Covered
Organizations and City Council, as well as the state and Federal governments,
among others.
Although the City has balanced its budget since 1981, estimates of the
City's revenues and expenditures, which are based on numerous assumptions, are
subject to various uncertainties. If expected Federal or State aid is not
forthcoming, if unforeseen developments in the economy significantly reduce
revenues derived from economically sensitive taxes or necessitate increased
expenditures for public assistance, if the City should negotiate wage increases
for its employees greater than the amounts provided for in the City's financial
plan or if other uncertainties materialize that reduce expected revenues or
increase projected expenditures, then, to avoid operating deficits, the City may
be required to implement additional actions, including increases in taxes and
reductions in essential City services. The City might also seek additional
assistance from New York State.
The City requires certain amounts of financing for seasonal and capital
spending purposes. The City has issued $1.75 billion of notes for seasonal
financing purposes during fiscal year 1994. The City's capital financing program
projects long-term financing requirements of approximately $17 billion for the
City's fiscal years 1995 through 1998. The major capital requirements include
expenditures for the City's water supply and sewage disposal systems, roads,
bridges, mass transit, schools, hospitals and housing. In addition to financing
for new purposes, the City and the New York City Municipal Water Finance
Authority have issued refunding bonds totalling $1.8 billion in fiscal year
1994.
Certain localities, in addition to the City, could have financial problems
leading to requests for additional New York State assistance during the State's
1994-95 fiscal year and thereafter. The potential impact on the State of such
requests by localities is not included in the projections of the State's
receipts and disbursements in the State's 1994-95 fiscal year.
Fiscal difficulties experienced by the City of Yonkers ("Yonkers") resulted
in the creation of the Financial Control Board for the City of Yonkers (the
"Yonkers Board") by New York State in 1984. The Yonkers Board is charged with
oversight of the fiscal affairs of Yonkers. Future actions taken by the Governor
or the Legislature to assist Yonkers could result in allocation of New York
State resources in amounts that cannot yet be determined.
Municipalities and school districts have engaged in substantial short-term
and long-term borrowings. In 1992, the total indebtedness of all localities in
New York State was approximately $35.2 billion, of which $19.5 billion was debt
of New York City (excluding $5.9 billion in MAC debt); a small portion
(approximately $71.6 million) of the $35.2 billion of indebtedness represented
borrowing to finance budgetary deficits and was issued pursuant to enabling New
York State legislation. State law requires the Comptroller to review and make
recommendations concerning the budgets of those local government units other
than New York City authorized by State law to issue debt to finance deficits
during the period that such deficit financing is outstanding. Seventeen
localities had outstanding indebtedness for deficit financing at the close of
their fiscal year ending in 1992.
From time to time, Federal expenditure reductions could reduce, or in some
cases eliminate, Federal funding of some local programs and accordingly might
impose substantial increased expenditure requirements on affected localities. If
New York State, New York City or any of the Authorities were to suffer serious
financial difficulties jeopardizing their respective access to the public credit
markets, the marketability of notes and bonds issued by localities within New
York State could be adversely affected. Localities also face anticipated and
26
<PAGE>
potential problems resulting from certain pending litigation, judicial decisions
and long-range economic trends. The longer-range problems of declining urban
population, increasing expenditures and other economic trends could adversely
affect localities and require increasing New York State assistance in the
future.
RATINGS AS INVESTMENT CRITERIA
In general, the ratings of Moody's, S&P and Fitch Investors Service, Inc.
("Fitch") represent the opinions of those agencies as to the quality of debt
obligations that they rate. These ratings, however, are relative and subjective,
are not absolute standards of quality and do not evaluate the market risk of
securities. Ratings will be used with respect to the Funds as initial criteria
for the selection of portfolio securities; the Funds will also rely upon the
independent advice of SBMFM to evaluate potential investments. Among the factors
that will be considered by SBMFM are the long-term ability of the issuer to pay
principal and interest and general economic trends. The Appendix to this
Statement of Additional Information contains further information concerning the
ratings of Moody's, S&P and Fitch, together with a brief discussion of the
significance of those ratings.
An issue of debt obligations may, subsequent to its purchase by a Fund,
cease to be rated or its ratings may be reduced below the minimum required for
purchase by the Fund. Neither event will require the sale of the debt obligation
by a Fund, but SBMFM will consider the event in its determination of whether the
Fund should continue to hold the obligation. In addition, to the extent that
ratings change as a result of changes in rating organizations or their rating
systems or as a result of a corporate restructuring of Moody's, S&P or Fitch,
SBMFM will attempt to use comparable ratings as standards for each Fund's
investments.
MISCELLANEOUS INVESTMENT POLICIES
Each Fund may invest up to an aggregate amount equal to 10% of its net assets in
illiquid securities, which term includes securities subject to contractual or
other restrictions on resale and other instruments that lack readily available
markets. None of the Funds will lend its portfolio securities.
REPURCHASE AGREEMENTS
Each Fund may engage in repurchase agreement transactions with banks which are
the issuers of instruments acceptable for purchase by the Fund and certain
dealers on the Federal Reserve Bank of New York's list of reporting dealers. A
repurchase agreement is a contract under which the buyer of a security
simultaneously commits to resell the security to the seller at an agreed-upon
price on an agreed-upon date. Under the terms of a typical repurchase agreement,
a Fund would acquire an underlying debt obligation for a relatively short period
subject to an obligation of the seller to repurchase, and the Fund to resell,
the obligation at an agreed-upon price and time, thereby determining the yield
during the Fund's holding period. This arrangement results in a fixed rate of
return that is not subject to market fluctuations during the Fund's holding
period. Under each repurchase agreement, the selling institution will be
required to maintain the value of the securities subject to the repurchase
agreement at not less than their repurchase price. Although the amount of a
Fund's assets that may be invested in purchase agreements terminable in less
than seven days is not limited, repurchase agreements maturing in more than
seven days, together with other securities lacking readily available markets
held by the Fund, will not exceed 10% of the Fund's net assets.
The value of the securities underlying a repurchase agreement of a Fund will
be monitored on an ongoing basis by SBMFM or Boston Advisors to ensure that the
value is at least equal at all times to the total amount of the repurchase
obligation, including interest. SBMFM or Boston Advisors will also monitor, on
an ongoing basis to evaluate potential risks, the creditworthiness of the banks
and dealers with which a Fund enters into repurchase agreements.
27
<PAGE>
WHEN-ISSUED AND DELAYED-DELIVERY TRANSACTIONS
When a Fund engages in when-issued or delayed-delivery securities transactions,
it will rely on the other party to consummate the trade. Failure of the seller
to do so may result in a Fund's incurring a loss or missing an opportunity to
obtain a price considered to be advantageous.
INVESTMENT RESTRICTIONS
The investment restrictions numbered 1 through 14 below have been adopted by the
Trust as fundamental policies of the Funds. Under the 1940 Act, a fundamental
policy may not be changed with respect to a Fund without the vote of a majority
of the outstanding voting securities of the Fund. Majority is defined in the
1940 Act as the lesser of (a) 67% or more of the shares present at a Fund
meeting, if the holders of more than 50% of the outstanding shares of the Fund
are present or represented by proxy, or (b) more than 50% of outstanding shares.
Investment restrictions 15 through 19 may be changed by a vote of a majority of
the Trust's Board of Trustees at any time.
Under the investment restrictions adopted by the Trust with respect to the
Funds:
1. No Fund will purchase securities other than Municipal Obligations and
Taxable Investments as those terms are defined in the Prospectuses or this
Statement of Additional Information.
2. The Municipal Fund will not purchase securities (other than U.S.
government securities) of any issuer if, as a result of the purchase, more
than 5% of the value of the Fund's total assets would be invested in the
securities of the issuer, except that up to 25% of the value of the Fund's
total assets may be invested without regard to this 5% limitation.
3. The Municipal Fund will not purchase more than 10% of the voting
securities of any one issuer, except that this limitation is not applicable
to a Fund's investments in U.S. government securities, and up to 25% of the
Fund's assets may be invested without regard to this 10% limitation.
4. No Fund will invest more than 25% of the value of its total assets in
securities of issuers in any one industry, except that this limitation is
not applicable to a Fund's investments in U.S. government securities.
5. No Fund will borrow money, except that a Fund may borrow from banks for
temporary or emergency (not leveraging) purposes, including the meeting of
redemption requests that might otherwise require the untimely disposition of
securities, in an amount not to exceed 10% of the value of the Fund's total
assets (including the amount borrowed) valued at market less liabilities
(not including the amount borrowed) at the time the borrowing is made.
Whenever a Fund's borrowings exceed 5% of the value of its total assets, the
Fund will not make any additional investments.
6. No Fund will pledge, hypothecate, mortgage or otherwise encumber its
assets, except to secure permitted borrowings.
7. No Fund will lend money to other persons except through purchasing
Municipal Obligations or Taxable Investments and entering into repurchase
agreements, each in a manner consistent with the Fund's investment objective
and policies.
8. No Fund will purchase securities on margin, except that a Fund may
obtain any short-term credits necessary for the clearance of purchases and
sales of securities.
9. No Fund will make short sales of securities or maintain a short
position.
10. No Fund will purchase or sell real estate or real estate limited
partnership interests.
11. No Fund will purchase or sell commodities or commodity contracts.
12. No Fund will act as an underwriter of securities, except that a Fund may
acquire securities under circumstances in which, if the securities were
sold, the Fund could be deemed to be an underwriter for purposes of the
Securities Act of 1933, as amended.
28
<PAGE>
13. No Fund will invest in oil, gas or other mineral leases or exploration
or development programs.
14. No Fund may write or sell puts, calls, straddles, spreads or
combinations of those transactions, except as permitted under the Fund's
investment objective and policies.
15. No Fund will purchase any security if, as a result (unless the security
is acquired pursuant to a plan of reorganization or an offer of exchange),
the Fund would own any securities of an open-end investment company or more
than 3% of the total outstanding voting stock of any closed-end investment
company, or more than 5% of the value of the Fund's total assets would be
invested in securities of any one or more closed-end investment companies.
16. No Fund will purchase a security if, as a result, the Fund would then
have more than 5% of its total assets invested in securities of issuers
(including predecessors) that have been in continuous operation for fewer
than three years, except that this limitation will be deemed to apply to the
entity supplying the revenues from which the issue is to be paid, in the
case of private activity bonds purchased.
17. No Fund may make investments for the purpose of exercising control of
management.
18. No Fund will purchase or retain securities of any issuer if, to the
knowledge of the Trust, any of the Trust's officers or Trustees or any
officer or director of SBMFM individually owns more than 1/2 of 1% of the
outstanding securities of the issuer and together they own beneficially more
than 5% of the securities.
19. No Fund will lend its portfolio securities.
The Trust may make commitments more restrictive than the restrictions listed
above to enable the sale of shares of any Fund in certain states. Should the
Trust determine that a commitment is no longer in the best interests of a Fund
and its shareholders, the Trust will revoke the commitment by terminating the
sale of shares of the Fund in the state involved. The percentage limitations
contained in the restrictions listed above apply at the time of purchases of
securities.
PORTFOLIO TRANSACTIONS
Decisions to buy and sell securities for each Fund are made by SBMFM, subject to
the overall review of the Trust's Board of Trustees. Although investment
decisions for each Fund are made independently from those of the other accounts
managed by SBMFM, investments of the type that a Fund may make also may be made
by those other accounts. When a Fund and one or more other accounts managed by
SBMFM are prepared to invest in, or desire to dispose of, the same security,
available investments or opportunities for sales will be allocated in a manner
believed by SBMFM to be equitable to each. In some cases, this procedure may
adversely affect the price paid or received by a Fund or the size of the
position obtained or disposed of by a Fund. The Trust has paid no brokerage
commissions since its commencement of operations.
Allocation of transactions on behalf of the Funds, including their
frequency, to various dealers is determined by SBMFM in its best judgment and in
a manner deemed fair and reasonable to the Funds' shareholders. The primary
considerations of SBMFM in allocating transactions are availability of the
desired security and the prompt execution of orders in an effective manner at
the most favorable prices. Subject to these considerations, dealers that provide
supplemental investment research and statistical or other services to SBMFM may
receive orders for portfolio transactions by a Fund. Information so received is
in addition to, and not in lieu of, services required to be performed by SBMFM,
and the fees of SBMFM are not reduced as a consequence of their receipt of the
supplemental information. The information may be useful to SBMFM in serving both
a Fund and other clients, and conversely, supplemental information obtained by
the placement of business of other clients may be useful to SBMFM in carrying
out their obligations to a Fund.
29
<PAGE>
No Fund will purchase U.S. government securities or Municipal Obligations
during the existence of any underwriting or selling group relating to the
securities, of which SBMFM is a member, except to the extent permitted by the
SEC. Under certain circumstances, a Fund may be at a disadvantage because of
this limitation in comparison with other funds that have similar investment
objectives but that are not subject to a similar limitation.
PORTFOLIO TURNOVER
While a Fund's portfolio turnover rate (the lesser of purchases or sales of
portfolio securities during the year, excluding purchases or sales of short-term
securities, divided by the monthly average value of portfolio securities) is
generally not expected to exceed 100%, it has in the past exceeded 100% with
respect to certain funds. The rate of turnover will not be a limiting factor,
however, when a Fund deems it desirable to sell or purchase securities. This
policy should not result in higher brokerage commissions to a Fund, as purchases
and sales of portfolio securities are usually effected as principal
transactions. Securities may be sold in anticipation of a rise in interest rates
(market decline) or purchased in anticipation of a decline in interest rates
(market rise) and later sold. In addition, a security may be sold and another
security of comparable quality purchased at approximately the same time to take
advantage of what the Fund believes to be a temporary disparity in the normal
yield relationship between the two securities. These yield disparities may occur
for reasons not directly related to the investment quality of particular issues
or the general movement of interest rates, such as changes in the overall demand
for, or supply of, various types of tax-exempt securities.
The portfolio turnover rates are as follows:
<TABLE>
<CAPTION>
YEAR YEAR
ENDED ENDED
FUND 11/30/94 11/30/93
- ----------------------------------------- ---------- ----------
<S> <C> <C>
Municipal Fund........................... 28% 4%
California Fund.......................... 39% 16%
New York Fund............................ 68% 22%
</TABLE>
This higher level of turnover for the Funds was due to significant changes
in the portfolio in response to the unusual volatility experienced in municipal
bond markets during this period.
PURCHASE OF SHARES
VOLUME DISCOUNTS
The schedules of sales charges described in the Prospectuses applies to
purchases of shares of each Fund made by any "purchaser," which term is defined
to include the following: (a) an individual; (b) an individual's spouse and his
or her children purchasing shares for his or her own account; (c) a trustee or
other fiduciary purchasing shares for a single trust estate or single fiduciary
account; (d) a pension, profit-sharing or other employee benefit plan qualified
under Section 401(a) of the Code and qualified employee benefit plans of
employers who are "affiliated persons" of each other within the meaning of the
1940 Act; (e) tax-exempt organizations enumerated in Section 501(c)(3) or (13)
of the Code; or (f) any other organized group of persons, provided that the
organization has been in existence for at least six months and was organized for
a purpose other than the purchase of investment company securities at a
discount. Purchasers who wish to combine purchase orders to take advantage of
volume discounts should contact a Smith Barney Financial Consultant.
COMBINED RIGHT OF ACCUMULATION
Reduced sales charges, in accordance with the schedules in the Prospectuses,
apply to any purchase of shares of a Fund by any "purchaser" (as defined above).
The reduced sales charge is subject to confirmation of the shareholder's
holdings through a check of appropriate records. The Trust reserves the right to
terminate or amend the combined right of accumulation at any time after written
notice to shareholders. For further information regarding the right of
accumulation, shareholders should contact a Smith Barney Financial Consultant.
30
<PAGE>
DETERMINATION OF PUBLIC OFFERING PRICE
The Funds offer their shares to the public on a continuous basis. The public
offering price for a Class A and Class Y share of a Fund is equal to the net
asset value per share at the time of purchase, plus for Class A shares an
initial sales charge based on the aggregate amount of the investment. The public
offering price for a Class C share (and Class A share purchases, including
applicable rights of accumulation, equalling or exceeding $500,000) is equal to
the net asset value per share at the time of purchase and no sales charge is
imposed at the time of purchase. A contingent deferred sales charge ("CDSC"),
however, is imposed on certain redemptions of Class C shares, and Class A shares
when purchased in amounts exceeding $500,000. The method of computation of the
public offering price is shown in each Fund's financial statements, incorporated
by reference in their entirety into this Statement of Additional Information.
REDEMPTION OF SHARES
Detailed information on how to redeem shares of the Funds is included in the
Prospectuses. The right of redemption of shares of each Fund may be suspended or
the date of payment postponed (a) for any periods during which the New York
Stock Exchange, Inc. (the "NYSE") is closed (other than for customary weekend
and holiday closings), (b) when trading in the markets the Fund normally
utilizes is restricted, or an emergency exists, as determined by the SEC, so
that disposal of the Fund's investments or determination of its net asset value
is not reasonably practicable or (c) for any other periods as the SEC by order
may permit for the protection of the Fund's shareholders.
DISTRIBUTION IN KIND
If the Board of Trustees of the Trust determines that it would be detrimental to
the best interests of the remaining shareholders to make a redemption payment
wholly in cash, a Fund may pay, in accordance with SEC rules, any portion of a
redemption in excess of the lesser of $250,000 or 1.00% of the Fund's net assets
by a distribution in kind of portfolio securities in lieu of cash. Securities
issued as a distribution in kind may incur brokerage commissions when
shareholders subsequently sell those securities.
AUTOMATIC CASH WITHDRAWAL PLAN
An automatic cash withdrawal plan (the "Withdrawal Plan") is available to
shareholders of any Fund who own shares of the Fund with a value of at least
$10,000 and who wish to receive specific amounts of cash monthly or quarterly.
Withdrawals of at least $100 may be made under the Withdrawal Plan by redeeming
as many shares of the Fund as may be necessary to cover the stipulated
withdrawal payment. Any applicable CDSC will not be waived on amounts withdrawn
by shareholders that exceed 1.00% per month of the value of a shareholder's
shares at the time the Withdrawal Plan commences. (With respect to Withdrawal
Plans in effect prior to November 7, 1994, any applicable CDSC will be waived on
amounts withdrawn that do not exceed 2.00% per month of the value of a
shareholder's shares at the time the Withdrawal Plan commences.) To the extent
that withdrawals exceed dividends, distributions and appreciation of a
shareholder's investment in a Fund, continued withdrawal payments will reduce
the shareholder's investment, and may ultimately exhaust it. Withdrawal payments
should not be considered as income from investment in a Fund. Furthermore, as it
generally would not be advantageous to a shareholder to make additional
investments in the Fund at the same time he or she is participating in the
Withdrawal Plan, purchases by such shareholders in amounts of less than $5,000
ordinarily will not be permitted.
Shareholders of a Fund who wish to participate in the Withdrawal Plan and
who hold their shares of the Fund in certificate form must deposit their share
certificates with TSSG as agent for Withdrawal Plan members. All dividends and
distributions on shares in the Withdrawal Plan are reinvested automatically at
net asset value in additional shares of the Fund involved. Effective November 7,
1994, Withdrawal Plans should be set up with a Smith Barney Financial
Consultant. A shareholder
31
<PAGE>
who purchases shares directly through TSSG may continue to do so and
applications for participation in the Withdrawal Plan must be received by TSSG
no later than the eighth day of the month to be eligibile for participation
beginning with that month's withdrawal. For additional information, shareholders
should contact a Smith Barney Financial Consultant.
DISTRIBUTOR
Smith Barney serves as the Trust's distributor on a best efforts basis pursuant
to a written agreement dated July 30, 1993 (the "Distribution Agreement"), which
was most recently approved by the Trust's Board of Trustees on July 20, 1994.
For the fiscal period ending November 30, 1992 and the 1993 and 1994 fiscal
years, Smith Barney or its predecessor Shearson Lehman Brothers received the
following in sales charges for the sale of each Fund's Class A shares, and did
not reallow any portion thereof to dealers:
<TABLE>
<CAPTION>
YEAR YEAR YEAR
ENDED ENDED ENDED
FUND 11/30/94 11/30/93 11/30/92
- ---------------------------- ----------- ----------- -----------
<S> <C> <C> <C>
Municipal Fund.............. $ 576,872 $ 576,872 $ 343,579
California Fund............. $ 179,329 $ 179,329 $ 242,773
New York Fund............... $ 412,346 $ 412,346 $ 98,334
</TABLE>
For the fiscal period ending November 30, 1992 and the 1993 and 1994 fiscal
years, Smith Barney or Shearson Lehman Brothers received the following
representing CDSC on redemption of each Fund's Class A shares:
<TABLE>
<CAPTION>
YEAR YEAR YEAR
ENDED ENDED ENDED
FUND 11/30/94 11/30/93 11/30/92
- ---------------------------- ----------- ----------- -----------
<S> <C> <C> <C>
Municipal Fund.............. $ 81,916 $ 41,260 $ 4,082
California Fund............. $ 18,705 $ 5,932 $ 3,863
New York Fund............... $ 22,791 $ 26,433 $ 783
</TABLE>
When payment is made by the investor before the settlement date, unless
otherwise noted by the investor, the funds will be held as a free credit balance
in the investor's brokerage account and Smith Barney may benefit from the
temporary use of the funds. The investor may designate another use for the funds
prior to settlement date, such as an investment in a money market fund (other
than Smith Barney Exchange Reserve Fund) of the Smith Barney Mutual Funds. If
the investor instructs Smith Barney to invest the funds in a Smith Barney money
market fund, the amount of the investment will be included as part of the
average daily net assets of both the Fund and the money market fund, and
affiliates of Smith Barney that serve the funds in an investment advisory or
administrative capacity will benefit from the fact that they are receiving fees
from both such investment companies for managing these assets, computed on the
basis of their average daily net assets. The Trust's Board of Trustees has been
advised of the benefits to Smith Barney resulting from these settlement
procedures and will take such benefits into consideration when reviewing the
Advisory, Administration and Distribution Agreements for continuance.
DISTRIBUTION ARRANGEMENTS
To compensate Smith Barney for the services it provides and for the expense it
bears under the Distribution Agreement, the Trust has adopted a services and
distribution plan (the "Plan") pursuant to Rule 12b-1 under the 1940 Act. Under
the Plan, each Fund pays Smith Barney a service fee, accrued daily and paid
monthly, calculated at the annual rate of 0.15% of the value of the Fund's
32
<PAGE>
average daily net assets attributable to the Fund's shares. In addition, each
Fund pays Smith Barney a distribution fee with respect to the Class C shares
primarily intended to compensate Smith Barney for its initial expense of paying
its Financial Consultants a commission upon sales of those shares. The Class C
distribution fee is calculated at the annual rate of 0.20% of the value of the
Funds' average net assets attributable to the shares of the Class.
For the period from December 31, 1991 through November 30, 1992, Shearson
Lehman Brothers, the Trust's distributor prior to Smith Barney, received $90,238
in the aggregate from the Trust under the Plan. For the fiscal years ended
November 30, 1993 and 1994, Smith Barney and/or its predecessor, Shearson Lehman
Brothers, received $269,091 and $291,639, respectively, in the aggregate from
the
Plan.
Under its terms, the Plan continues from year to year, provided such
continuance is approved annually by vote of the Board of Trustees, including a
majority of the Trustees who are not interested persons of the Trust and who
have no direct or indirect financial interest in the operation of the Plan or in
the Distribution Agreement (the "Independent Trustees"). The Plan may not be
amended to increase the amount of the service and distribution fees without
shareholder approval, and all amendments of the Plan also must be approved by
the Trustees including all of the Independent Trustees in the manner described
above. The Plan may be terminated with respect to a Class at any time, without
penalty, by vote of a majority of the Independent Trustees or, with respect to
any Fund, by vote of a majority of the outstanding voting securities of a Fund
(as defined in the 1940 Act). Pursuant to the Plan, Smith Barney will provide
the Board of Trustees with periodic reports of amounts expended under the Plan
and the purpose for which such expenditures were made.
VALUATION OF SHARES
The net asset value per share of each Fund's Classes is calculated on each day,
Monday through Friday, except days on which the NYSE is closed. The NYSE
currently is scheduled to be closed on New Year's Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving and Christmas,
and on the preceding Friday or subsequent Monday when one of these holidays
falls on a Saturday or Sunday, respectively. Because of the differences in
distribution fees and Class-specific expenses, the per share net asset value of
each Class may differ. The following is a description of the procedures used by
the Trust in valuing its assets.
In carrying out valuation policies adopted by the Trust's Board of Trustees,
Boston Advisors, as sub-administrator, may consult with an independent pricing
service (the "Pricing Service") retained by the Trust. Debt securities of
domestic issuers (other than U.S. government securities and short-term
investments), including Municipal Obligations, are valued by Boston Advisors
after consultation with the Pricing Service. When, in the judgment of the
Pricing Service, quoted bid prices for investments are readily available and are
representative of the bid side of the market, these investments are valued at
the mean between the quoted bid prices and asked prices. Investments for which
no readily obtainable market quotations are available, in the judgment of the
Pricing Service, are carried at fair value as determined by the Pricing Service.
The procedures of the Pricing Service are reviewed periodically by the officers
of the Trust under the general supervision and responsibility of the Board of
Trustees.
EXCHANGE PRIVILEGE
Except as noted below, shareholders of any fund of the Smith Barney Mutual
Funds may exchange all or part of their shares for shares of the same Class of
other funds in the Smith Barney Mutual Funds, on the basis of relative net asset
value per share at the time of exchange as follows:
A. Class A shares of any fund purchased with
a sales charge may be exchanged for Class A shares of any of the other
funds, and the sales charge differential, if any, will be applied. Class A
shares of any fund may be exchanged without a sales charge
33
<PAGE>
for shares of the funds that are offered without a sales charge. Class A
shares of any fund purchased without a sales charge may be exchanged for
shares sold with a sales charge, and the appropriate sales charge
differential will be applied.
B. Class A shares of any fund acquired by a
previous exchange of shares purchased with a sales charge may be exchanged
for Class A shares of any of the other funds, and the sales charge
differential, if any, will be applied.
Dealers other than Smith Barney must notify TSSG of the investor's prior
ownership of Class A shares of Smith Barney High Income Fund and the account
number in order to accomplish an exchange of shares of Smith Barney High Income
Fund under paragraph B above.
The exchange privilege enables shareholders in any fund of the Smith Barney
Mutual Funds to acquire shares of the same Class in a fund with different
investment objectives when they believe a shift between funds is an appropriate
investment decision. This privilege is available to shareholders residing in any
state in which the fund shares being acquired may legally be sold. Prior to any
exchange, the shareholder should obtain and review a copy of the current
prospectus of each fund into which an exchange is being considered. Prospectuses
may be obtained from a Smith Barney Financial Consultant.
Upon receipt of proper instructions and all necessary supporting documents,
shares submitted for exchange are redeemed at the then-current net asset value
and, subject to any applicable CDSC, the proceeds are immediately invested, at a
price as described above, in shares of the fund being acquired. Smith Barney
reserves the right to reject any exchange request. The exchange privilege may be
modified or terminated at any time after written notice to shareholders.
PERFORMANCE DATA
From time to time, the Trust may quote a Fund's yield or total return in
advertisements or in reports and other communications to shareholders. The Trust
may include comparative performance information in advertising or marketing each
Fund's shares. Such performance information may include the following industry
and financial publications: BARRON'S, BUSINESS WEEK, CDA INVESTMENT
TECHNOLOGIES, INC., CHANGING TIMES, FORBES, FORTUNE, INSTITUTIONAL INVESTOR,
INVESTORS DAILY, MONEY, MORNINGSTAR MUTUAL FUND VALUES, THE NEW YORK TIMES, USA
TODAY and THE WALL STREET JOURNAL. To the extent any advertisement or sales
literature of a Fund describes the expenses or performance of any Class it will
also disclose such information for the other Classes.
YIELD AND EQUIVALENT TAXABLE YIELD
A Fund's 30-day yield figure described in the Prospectuses is calculated
according to a formula prescribed by the SEC, expressed as follows:
<TABLE>
<S> <C> <C>
YIELD = 2 [(a-b + 1)6 - 1]
cd
</TABLE>
<TABLE>
<S> <C> <C>
Where: a = dividends and interest earned
during the period.
b = expenses accrued for the period
(net of reimbursement).
c = the average daily number of
shares outstanding during the
period that were entitled to
receive dividends.
d = the maximum offering price per
share on the last day of the
period.
</TABLE>
For the purpose of determining the interest earned (variable "a" in the
formula) on debt obligations that were purchased by a Fund at a discount or
premium, the formula generally calls for amortization of the discount or
premium; the amortization schedule will be adjusted monthly to reflect changes
in the market values of the debt obligations.
A Fund's "equivalent taxable 30-day yield" for a Class is computed by
dividing that portion of the Class' 30-day yield which is tax-exempt by one
minus a stated income tax rate and adding the product to that portion, if any of
the Class' yield that is not tax-exempt.
34
<PAGE>
The yield on municipal securities is dependent upon a variety of factors,
including general economic and monetary conditions, conditions of the municipal
securities market, size of a particular offering, maturity of the obligation
offered and rating of the issue. Investors should recognize that, in periods of
declining interest rates, a Fund's yield for each Class of shares will tend to
be somewhat higher than prevailing market rates, and in periods of rising
interest rates a Fund's yield for each Class of shares will tend to be somewhat
lower. In addition, when interest rates are falling, the inflow of net new money
to a Fund from the continuous sale of its shares will likely be invested in
portfolio instruments producing lower yields than the balance of the Fund's
portfolio, thereby reducing the current yield of the Fund. In periods of rising
interest rates, the opposite can be expected to occur.
The yields for the 30-day period ended November 30, 1994 were as follows:
Municipal Fund -- (0.39)%, California Fund -- (1.33)%, and New York Fund --
(1.60)%.
The equivalent taxable yields for the 30-day period ended November 30, 1994
assuming payment of Federal income taxes at the rate of 31.0%; California income
taxes at the rate of 9.3% for the California Fund; and New York State and City
income taxes at a rate of 12.0% for the New York Fund would have been as
follows: Municipal Fund -- (0.57)%; California Fund -- (2.13)%, and New York
Fund -- (2.64)%.
AVERAGE ANNUAL TOTAL RETURN
A Fund's "average annual total return" figures, as described below, are computed
according to a formula prescribed by the SEC. The formula can be expressed as
follows:
P(1 + T)n = ERV
<TABLE>
<S> <C> <C>
Where: P = a hypothetical initial
payment of $1,000.
T = average annual total return.
n = number of years.
ERV = Ending Redeemable Value of a
hypothetical $1,000
investment made at the
beginning of a 1-, 5- or
10-year period at the end of
a 1-, 5- or 10-year period
(or fractional portion
thereof), assuming
reinvestment of all dividends
and distributions.
</TABLE>
The ERV assumes complete redemption of the hypothetical investment at the
end of the measuring period. A Fund's net investment income changes in response
to fluctuations in interest rates and the expenses of the Fund.
The following total return figures assume that the maximum Class A 2.00%
sales charge has been deducted from the investment at the time of purchase and
have been restated to show the change in the maximum sales charge. The Funds'
average annual total return figures for Class A shares were as follows:
<TABLE>
<CAPTION>
ONE YEAR PERIOD
ENDED
NOVEMBER 30, 1994
-------------------------------
TOTAL RETURN TOTAL RETURN
(WITH FEE (WITHOUT FEE
FUND NAME WAIVERS) WAIVERS)
---------------------------- -------------- --------------
<S> <C> <C>
Municipal Fund.............. (1.78)% (1.92)%
California Fund............. (5.57)% (6.06)%
New York Fund............... (5.89)% (6.22)%
</TABLE>
<TABLE>
<CAPTION>
PER ANNUM FOR
THE PERIOD OF
COMMENCEMENT OF
OPERATIONS (DECEMBER 31, 1991)
THROUGH NOVEMBER 30, 1994
-------------------------------
TOTAL RETURN TOTAL RETURN
(WITH FEE (WITHOUT FEE
WAIVERS) WAIVERS)
-------------- --------------
<S> <C> <C>
Municipal Fund.............. 4.06% 3.65%
California Fund............. 3.69% 2.68%
New York Fund............... 4.02% 3.43%
</TABLE>
35
<PAGE>
AGGREGATE TOTAL RETURN
A Fund's "aggregate total return" figures, as described below, represent the
cumulative change in the value of an investment in the Fund for the specified
period and are computed by the following formula:
ERV - P
------------
P
<TABLE>
<S> <C> <C>
Where: P = a hypothetical initial
payment of $10,000.
ERV = Ending Redeemable Value of a
hypothetical $10,000
investment made at the
beginning of the 1-, 5- or
10-year period at the end of
the 1-, 5- or 10-year period
(or fractional portion
thereof), assuming
reinvestment of all dividends
and distributions.
</TABLE>
The ERV assumes complete redemption of the hypothetical investment at the
end of the measuring period.
The Funds' aggregate total return figures for Class A shares were as
follows:
<TABLE>
<CAPTION>
ONE YEAR PERIOD
ENDED
NOVEMBER 30, 1994
-------------------------------
TOTAL RETURN TOTAL RETURN
(WITH FEE (WITHOUT FEE
FUND NAME WAIVERS) WAIVERS)
---------------------------- -------------- --------------
<S> <C> <C>
Municipal Fund.............. 0.23% (0.09)%
California Fund............. (3.65)% (4.15)%
New York Fund............... (3.97)% (4.31)%
</TABLE>
<TABLE>
<CAPTION>
PER ANNUM FOR
THE PERIOD OF
COMMENCEMENT OF
OPERATIONS (DECEMBER 31,
1991)
THROUGH NOVEMBER 30, 1994
----------------------------
TOTAL RETURN TOTAL RETURN
(WITH FEE (WITHOUT FEE
WAIVERS) WAIVERS)
------------ -------------
<S> <C> <C>
Municipal Fund.............. 14.59% 13.27%
California Fund............. 13.42% 10.21%
New York Fund............... 14.46% 12.59%
</TABLE>
These aggregate total return figures for Class A do not assume that the
maximum 2.00% sales charge has been deducted from the investment at the time of
purchase. If the sales charge had been deducted at the time of purchase, the
aggregate total return for Class A shares for those same periods would have been
as follows in the tables set forth below. The total return figures have been
restated to show the change in the maximum sales charge.
<TABLE>
<CAPTION>
ONE YEAR PERIOD
ENDED
NOVEMBER 30, 1994
-------------------------------
TOTAL RETURN TOTAL RETURN
(WITH FEE (WITHOUT FEE
FUND NAME WAIVERS) WAIVERS)
---------------------------- -------------- --------------
<S> <C> <C>
Municipal Fund.............. (1.78)% (1.92)%
California Fund............. (5.57)% (6.06)%
New York Fund............... (5.89)% (6.22)%
</TABLE>
<TABLE>
<CAPTION>
PER ANNUM FOR
THE PERIOD OF
COMMENCEMENT OF
OPERATIONS (DECEMBER 31, 1991)
THROUGH NOVEMBER 30, 1994
------------------------------
TOTAL RETURN TOTAL RETURN
(WITH FEE (WITHOUT FEE
WAIVERS) WAIVERS)
------------- --------------
<S> <C> <C>
Municipal Fund.............. 12.30% 11.01%
California Fund............. 11.15% 8.00%
New York Fund............... 12.17% 10.34%
</TABLE>
It is important to note that the total return figures set forth above are
based on historical earnings and are not intended to indicate future
performance. Each Class' net investment income changes in response to
fluctuation in interest rates and the expenses of the Fund. Performance will
vary from time to time depending upon market conditions, the composition of the
Fund's portfolio and operating expenses and the expenses exclusively
attributable to the Class. Consequently, any given performance quotation should
not be considered representative of the Class' performance for any specified
period in the future. Because performance will vary, it may not provide a basis
for comparing an investment in the Class with certain bank deposits or other
investments that pay a fixed yield for a stated period of time. Investors
comparing a Class' performance with that of other mutual funds should give
consideration to the quality and maturity of the respective investment
companies' portfolio securities.
TAXES
The following is a summary of selected Federal income tax considerations that
may affect the Trust and its
36
<PAGE>
shareholders. The summary is not intended as a substitute for individual tax
advice and investors are urged to consult their own tax advisors as to the tax
consequences of an investment in the Trust.
As described above and in the Prospectuses, each Fund is designed to provide
investors with current income which is excluded from gross income for Federal
income tax purposes, and the California Fund and the New York Fund are designed
to provide investors with current income exempt from otherwise applicable state
and/or local personal income taxes. The Trust is not intended to be a balanced
investment program and is not designed for investors seeking capital gains or
maximum tax-exempt income irrespective of fluctuations in principal. Investment
in the Trust would not be suitable for tax-exempt institutions, qualified
retirement plans, H.R. 10 plans and individual retirement accounts because those
investors would not gain any additional tax benefit from the receipt of
tax-exempt income.
The Trust has qualified and intends that each Fund continue to qualify each
year as a "regulated investment company" under the Code. Provided that a Fund
(a) is a regulated investment company and (b) distributes to its shareholders at
least 90% of its taxable net investment income (including, for this purpose, its
net realized short-term capital gains) and 90% of its tax-exempt interest income
(reduced by certain expenses), the Fund will not be liable for Federal income
taxes to the extent its taxable net investment income and its net realized
long-term and short-term capital gains, if any, are distributed to its
shareholders. Any such taxes paid by a Fund would reduce the amount of income
and gains available for distribution to shareholders.
Because the Fund may distribute exempt-interest dividends, interest on
indebtedness incurred by a shareholder to purchase or carry shares of a Fund is
not deductible for Federal income tax purposes. In addition, the indebtedness is
not deductible by a shareholder of the California Fund for California State
personal income tax purposes, nor by a New York Fund shareholder for New York
State and New York City personal income tax purposes. If a shareholder receives
exempt-interest dividends with respect to any share of a Fund and if the share
is held by the shareholder for six months or less, then any loss on the sale or
exchange of the share may, to the extent of the exempt-interest dividends, be
disallowed. In addition, the Code may require a shareholder that receives
exempt-interest dividends to treat as taxable income a portion of certain
otherwise non-taxable social security and railroad retirement benefit payments.
Furthermore, the portion of any exempt-interest dividend paid by a Fund that
represents income derived from private activity bonds held by the Fund may not
retain its tax-exempt status in the hands of a shareholder who is a "substantial
user" of a facility financed by the bonds, or a "related person" of the
substantial user. Moreover, as noted in the Prospectuses (a) some or all of a
Fund's exempt-interest dividends may be a specific preference item, or a
component of an adjustment item, for purposes of the Federal individual and
corporate alternative minimum taxes and (b) the receipt of a Fund's dividends
and distributions may affect a corporate shareholder's Federal "environmental"
tax liability. In addition, the receipt of a Fund's dividends and distributions
may affect a foreign corporate shareholder's Federal "branch profits" tax
liability and the Federal and California "excess net passive income" tax
liability of a Subchapter S corporation. Shareholders should consult their own
tax advisors to determine whether they are (a) "substantial users" with respect
to a facility or "related" to those users within the meaning of the Code or (b)
subject to a Federal alternative minimum tax, the Federal "environmental" tax,
the Federal "branch profits" tax, or the Federal or California "excess net
passive income" tax. As a general rule, a Fund's gain or loss on a sale or
exchange of an investment will be a long-term capital gain or loss if the Fund
has held the investment for more than one year and will be a short-term capital
gain or loss if it has held the investment for one year or less. Furthermore, as
a general rule, a shareholder's gain or loss on a sale or redemption of shares
of a Fund will be a long-term capital gain or loss
37
<PAGE>
if the shareholder has held his or her Fund shares for more than one year and
will be a short-term capital gain or loss if he or she has held his or her Fund
shares for one year or less.
Shareholders of each Fund will receive, as more fully described in the
Prospectuses, an annual statement as to the income tax status of his or her
dividends and distributions for the prior calendar year. Each shareholder will
also receive, if appropriate, various written notices after the close of a
Fund's prior taxable year as to the Federal income tax status of certain
dividends or distributions which were received from the Fund during the Fund's
prior taxable year.
The dollar amount of dividends paid by a Fund that is excluded from Federal
income taxation and the dollar amount of dividends paid by a Fund that is
subject to federal income taxation, if any, will vary for each shareholder
depending upon the size and duration of each shareholder's investment in a Fund.
Investors considering buying shares of a Fund on or just prior to the record
date for a capital gain distribution should be aware that the amount of the
forthcoming distribution payment will be a taxable distribution payment.
If a shareholder fails to furnish a correct taxpayer identification number,
fails to report fully dividend or interest income or fails to certify that he or
she has provided a correct taxpayer identification number and that he or she is
not subject to "backup withholding," then the shareholder may be subject to a
31% "backup withholding" tax with respect to (a) taxable dividends and
distributions and (b) the proceeds of any redemptions of shares of a Fund. An
individual's taxpayer identification number is his or her social security
number. The backup withholding tax is not an additional tax and may be credited
against a taxpayer's regular Federal income tax liability.
The discussion above is only a summary of certain tax considerations
generally affecting a Fund and its shareholders, and is not intended as a
substitute for careful tax planning. Shareholders are urged to consult their tax
advisors with specific reference to their own tax situations, including their
state and local tax liabilities.
ADDITIONAL INFORMATION
The Trust was organized as an unincorporated business trust on October 17, 1991
under the name Shearson Lehman Brothers Intermediate-Term Trust. On November 20,
1991, July 30, 1993, and October 14, 1994, the Fund's name was changed to
Shearson Lehman Brothers Income Trust, Smith Barney Shearson Income Trust and
Smith Barney Income Trust, respectively.
Boston Safe, an indirect wholly owned subsidiary of Mellon, is located at
One Boston Place, Boston, Massachusetts 02108, and serves as the custodian for
the Trust. Under the custody agreement, Boston Safe holds the Trust's portfolio
securities and keeps all necessary accounts and records. For its services,
Boston Safe receives a monthly fee based upon the month-end market value of
securities held in custody and also receives securities transaction charges. The
assets of the Trust are held under bank custodianship in compliance with the
1940 Act.
TSSG is located at Exchange Place, Boston, Massachusetts 02109, and serves
as the Trust's transfer agent. Under its transfer agency agreement, TSSG
maintains the shareholder account records for the Trust, handles certain
communications between shareholders and the Trust and distributes dividends and
distributions payable by the Trust. For these services, TSSG receives a monthly
fee computed on the basis of the number of shareholder accounts it maintains for
the Trust during the month, and is reimbursed for out-of-pocket expenses.
FINANCIAL STATEMENTS
The Funds' Annual Reports for the fiscal year ended November 30, 1994, accompany
this Statement of Additional Information and are incorporated herein by
reference in their entirety.
38
<PAGE>
APPENDIX
DESCRIPTION OF MOODY'S, S&P AND FITCH RATINGS
DESCRIPTION OF MOODY'S MUNICIPAL BOND RATINGS:
Aaa -- Bonds rated Aaa are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt edge."
Interest payments are protected by a large or by an exceptionally stable margin
and principal is secure. While the various protective elements are likely to
change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa -- Bonds rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities, or fluctuation of protective elements
may be of greater amplitude, or there may be other elements present that make
the long term risks appear somewhat larger than in Aaa securities.
A -- Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium-grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment sometime in the future.
Baa -- Bonds rated Baa are considered as medium-grade obligations, I.E.,
that is they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Moody's applies the numerical modifiers 1, 2 and 3 in each generic rating
classification below Aaa. The modifier 1 indicates that the security ranks in
the higher end of its generic rating category; the modifier 2 indicates a
mid-range ranking; and the modifier 3 indicates that the issue ranks in the
lower end of its generic rating category.
DESCRIPTION OF MOODY'S MUNICIPAL NOTE RATINGS:
Moody's ratings for state and municipal notes and other short-term loans are
designated Moody's Investment Grade ("MIG")and for variable demand obligations
are designated Variable Moody's Investment Grade "(VMIG)". This distinction is
in recognition of the differences between short-term credit risk and long-term
risk. Loans bearing the designation MIG 1 or VMIG 1 are of the best quality,
enjoying strong protection by established cash flows of funds for their
servicing, superior liquidity support or from established and broad-based access
to the market for refinancing or both. Loans bearing the designation MIG 2 or
VMIG 2 are of high quality, with ample margins of protection, although not as
large as the preceding group. Loans bearing the designation MIG 3 or VMIG 3 are
of favorable quality, with all security elements accounted for, but lacking the
undeniable strength of the preceding grades. Liquidity and cash flow may be
narrow and market access for refinancing, is likely to be less well established.
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS:
The rating Prime-1 is the highest commercial paper rating assigned by Moody's.
Issuers rated Prime-1 (or related supporting institutions) are considered to
have a superior capacity for repayment of short term promissory obligations.
Issuers rated Prime-2 (or related supporting institutions) are considered to
have a strong capacity for repayment of short term promissory obligations. This
will normally be evidenced by many of the characteristics of issuers rated
Prime-1 but to a lesser degree. Earnings trends and coverage ratios, while
sound, will be more subject to variation. Capitalization characteristics, while
still appropriate, may be more affected by external conditions. Ample
alternative liquidity is maintained.
A-1
<PAGE>
DESCRIPTION OF S&P MUNICIPAL BOND RATINGS:
AAA -- These are the obligations of the highest quality. They have the strongest
capacity for timely payment of debt service.
General Obligation Bonds rated AAA -- In a period of economic stress, the
issuers will suffer the smallest declines in income and will be least
susceptible to autonomous decline. Debt burden is moderate. A strong revenue
structure appears more than adequate to meet future expenditure
requirements. Quality of management appears superior.
Revenue Bonds rated AAA -- Debt service coverage has been, and is expected
to remain, substantial. Stability of the pledged revenues is also
exceptionally strong due to the competitive position of the municipal
enterprise or to the nature of the revenues. Basic security provisions
(including rate covenant, earnings test for issuance of additional bonds and
debt service reserve requirements) are rigorous. There is evidence of
superior management.
AA -- The investment characteristics of bonds in this group are only
slightly less marked than those of the prime quality issues. Bonds rated AA have
the second strongest capacity for payment of debt service.
A -- Principal and interest payments on bonds in this category are regarded
as safe, although the bonds are somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than bonds in higher rated
categories. This rating describes the third strongest capacity for payment of
debt service.
General Obligation Bonds rated A -- There is some weakness, either in the
local economic base, in debt burden, in the balance between revenues and
expenditures or in quality of management. Under certain adverse
circumstances, any one such weakness might impair the ability of the issuer
to meet debt obligations at some future date.
Revenue Bonds rated A -- Debt service coverage is good, but not exceptional.
Stability of the pledged revenues could show some variations because of
increased competition or economic influences on revenues. Basic security
provisions, while satisfactory, are less stringent. Management performance
appears adequate.
BBB -- The bonds in this group are regarded as having an adequate capacity
to pay interest and repay principal. Whereas bonds in this group normally
exhibit adequate protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay interest and
repay principal for debt in this category than in higher rated categories. Bonds
rated BBB have the fourth strongest capacity for payment of debt service.
S&P's letter ratings may be modified by the addition of a plus or a minus
sign, which is used to show relative standing within the major rating
categories, except in the AAA category.
DESCRIPTION OF S&P MUNICIPAL NOTE RATINGS:
Municipal notes with maturities of three years or less are usually given note
ratings (designated SP-1, -2 or -3) to distinguish more clearly the credit
quality of notes as compared to bonds. Notes rated SP-1 have a very strong or
strong capacity to pay principal and interest. Those issues determined to
possess overwhelming safety characteristics are given the designation of SP-1+.
Notes rated SP-2 have a satisfactory capacity to pay principal and interest.
DESCRIPTION OF S&P COMMERCIAL PAPER RATINGS:
Commercial paper rated A-1 by S&P indicates that the degree of safety regarding
timely payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics are denoted A-1+. Capacity for
timely payment on commercial paper rated A-2 is strong, but the relative degree
of safety is not as high as for issues designated A-1.
DESCRIPTION OF FITCH MUNICIPAL BOND RATINGS:
AAA -- Bonds rated AAA are considered to be investment grade and of the highest
credit quality. The obligor
A-2
<PAGE>
has an exceptionally strong ability to pay interest and repay principal, which
is unlikely to be affected by reasonably foreseeable events.
AA -- Bonds rated AA are considered to be investment grade and of very high
credit quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong as bonds rated AAA. Because bonds
rated in the AAA and AA categories are not significantly vulnerable to
foreseeable future developments, short term debt of these issues is generally
rated F-1+ by Fitch.
A -- Bonds rated A are considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is considered
to be strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings.
BBB -- Bonds rated BBB are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered to be adequate. Adverse changes in economic conditions
and circumstances, however, are more likely to have adverse impact on these
bonds, and therefore impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
Plus and minus signs are used by Fitch with a rating symbol to indicate the
relative position of a credit within the rating category. Plus and minus signs,
however, are not used in the AAA category.
DESCRIPTION OF FITCH SHORT TERM RATINGS:
Fitch's short term ratings apply to debt obligations that are payable on demand
or have original maturities of generally up to three years, including commercial
paper, certificates of deposit, medium term notes, and municipal and investment
notes.
The short term rating places greater emphasis than a long term rating on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
Fitch's short term ratings are as follows:
F-1+ -- Issues assigned this rating are regarded as having the strongest
degree of assurance for timely payment.
F-1 -- Issues assigned this rating reflect an assurance of timely payment
only slightly less in degree than issues rated F-1+.
F-2 -- Issues assigned this rating have a satisfactory degree of assurance
for timely payment but the margin of safety is not as great as for issues
assigned F-1+ and F-1 ratings.
F-3 -- Issues assigned this rating have characteristics suggesting that the
degree of assurance for timely payment is adequate, however, near term adverse
changes could cause these securities to be rated below investment grade.
LOC -- The symbol LOC indicates that a Fitch rating is based on a letter of
credit issued by a commercial bank.
A-3
