March 30, 1999
As amended on July 1, 1999
STATEMENT OF ADDITIONAL INFORMATION
SMITH BARNEY INVESTMENT TRUST
Smith Barney Intermediate Maturity California Municipals Fund
Smith Barney Intermediate Maturity New York Municipals Fund
388 Greenwich Street
New York, New York 10013
(800) 451-2010
This Statement of Additional Information ("SAI") is meant to be read in
conjunction with the prospectuses of the Smith Barney Intermediate
Maturity California Municipals Fund (the "California Fund") and the Smith
Barney Intermediate Maturity New York Municipals Fund (the "New York
Fund") dated March 30, 1999, as amended or supplemented from time to time,
and is incorporated by reference in it entirety into the Prospectuses.
Additional information about each fund's investments is available in each
fund's annual and semi-annual reports to shareholders which are
incorporated herein by reference. The prospectuses and copies of the
reports may be obtained free of charge by contacting a Salomon Smith
Barney Financial Consultant, or by writing or calling Salomon Smith Barney
at the address or telephone number above. The funds are separate
investment series of Smith Barney Investment Trust (the "trust").
TABLE OF CONTENTS
Investment Objective and Management Policies 2
Investment Technique................................................9
Risk Factors and Special Considerations Relating to California
and New York Municipal Securities..................... .12
Determination of Net Asset Value ...................................34
Investment Management and Other Services 38
Trustees and Executive Officers of the Fund 48
Investment Restrictions............................................ 51
Investment Management and Other Services............................53
Portfolio Transactions... ..........................................58
Portfolio Turnover...................................................58
Purchase of Shares .............................................59
Redemption of Shares 65
Valuation of Shares 66
Exchange Privilege 67
Performance Data 68
Dividends, Distributions and Taxes 72
Additional Information 77
Financial Statements ...................................................78
Appendix A..............................................................A
INVESTMENT OBJECTIVE AND MANAGEMENT POLICIES FOR THE FUNDS
The prospectuses discuss the investment objective of each fund and the
principal policies employed to achieve those objectives. 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. SSBC Fund Management Inc. ("SSBC"
or the "manager") serves as investment adviser to each fund.
California and New York Fund
Under normal market conditions, each of the California Fund and the New
York Fund attempts to invest 100% of its assets in a portfolio of
investment grade debt obligations issued by or on behalf of the State of
California and the State of New York, respectively, and other states,
territories and possessions of the United States, the District of Columbia
and their respective authorities, agencies, instrumentalities and
political subdivisions ("Municipal Obligations"). For purposes of this
SAI, debt obligations issued by the State of California and the State of
New York, respectively, and its political subdivisions, agencies and
public authorities (together with certain other governmental issuers such
as the Commonwealth of Puerto Rico), 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 and exempt from
California and New York State personal income tax, respectively, are
defined as "California Exempt Obligations." and "New York Exempt
Obligations" Collectively, California Exempt Obligations and New York
Exempt Obligation (defined below) are referred to generally in this SAI
as "Exempt Obligations." The California fund will operate subject to a
fundamental investment policy providing that, under normal market
conditions, the California Fund will invest at least 80% of its net assets
in California Exempt Obligations rated investment grade. Up to 20% of the
fund's total assets may be invested in unrated securities that are deemed
by the manager to be of a quality comparable to investment grade. The fund
will not invest in California Exempt Obligations that are rated lower than
investment grade at the time of purchase. The New York Fund will operate
subject to a fundamental investment policy providing that, under normal
market conditions, the fund will invest at least 80% of its net assets in
New York Exempt Obligations. Up to 20% of the fund's total assets may be
invested in unrated securities that are deemed by the manager to be of a
quality comparable to investment grade. The fund will not invest in New
York Exempt Obligations that are rated lower than Baa by Moody's, BBB by
S&P or BBB by Fitch, at the time of purchase.
Securities Rating Criteria. Exempt Obligations rated no lower than Baa,
MIG 3 or Prime-1 by Moody's Investors Service, Inc. ("Moody's"), BBB, SP-2
or A-1 by Standard & Poor's Ratings Group ("S&P") or BBB or F-1 by Fitch
IBCA, Inc. ("Fitch") are considered investment grade securities. Although
Exempt Obligations rated Baa by Moody's, BBB by S&P or BBB by Fitch are
considered to be investment grade, they may be viewed as being subject to
greater risks than other investment grade securities. Although Exempt
Obligations rated Baa by Moody's, BBB by S&P or BBB by Fitch are
considered to be investment grade, they may be viewed as being subject to
greater risks than other investment grade securities. Exempt Obligations
rated Baa by Moody's, for example, are considered medium grade obligations
that lack outstanding investment characteristics and have speculative
characteristics as well. Exempt Obligations rated BBB by S&P are regarded
as having an adequate capacity to pay principal and interest. Exempt
Obligations rated BBB by Fitch are deemed to be subject to a higher
likelihood that their rating will fall below investment grade than higher
rated bonds.
The ratings of Moody's, S&P and Fitch represent their opinions as to the
quality of the Exempt Obligations that they undertake to rate; the ratings
are relative and subjective and are not absolute standards of quality.
The manager's judgment as to credit quality of an Exempt Obligation, thus,
may differ from that suggested by the ratings published by a rating
service. See Appendix for a description of such organization's ratings.
The policies of the funds as to ratings of portfolio investments will
apply only at the time of the purchase of a security, and neither fund
will be required to dispose of a security in the event Moody's, S&P or
Fitch downgrades its assessment of the credit characteristics of the
security's issuer. 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, the manager
will attempt to use comparable ratings as standards for each fund's
investments.
Maturity of Obligations Held By The Funds. The manager believes that each
fund may offer an attractive investment opportunity for investors seeking
a higher effective tax yield than a tax-exempt money market fund or a tax-
exempt short-term bond fund and less fluctuation in net asset value than a
longer term tax-exempt bond fund. Each fund normally invests in
intermediate maturity securities; the weighted average maturity of each
fund's portfolio will normally be not less than three nor more than 10
years. The maximum remaining maturity of the securities in which the
California Fund and New York Fund normally invest will be no greater than
10 years and 20 years, respectively.
Exempt Obligations. Exempt Obligations are classified as general
obligation bonds, revenue bonds and notes. General obligation bonds are
secured by the issuer's pledge of its full faith, credit and taxing power
for the payment of principal and interest. Revenue bonds are payable from
the revenue derived from a particular facility or class of facilities or,
in some cases, from the proceeds of a special excise or other specific
revenue source, but not from the general taxing power. Notes are short-
term obligations of issuing municipalities or agencies and are sold in
anticipation of a bond sale, collection of taxes or receipt of other
revenues. Exempt Obligations bear fixed, floating and variable rates of
interest, and variations exist in the security of Exempt Obligations, both
within a particular classification and between classifications.
The yields on, and values of, Exempt Obligations depend on a variety of
factors, including general economic and monetary conditions, conditions in
the Exempt Obligation markets, size of a particular offering, maturity of
the obligation and rating of the issue. Consequently, Exempt Obligations
with the same maturity, coupon and rating may have different yields or
values, whereas obligations of the same maturity and coupon with different
ratings may have the same yield or value.
Issuers of Exempt Obligations may be subject to the provisions of
bankruptcy, insolvency and other laws, such as the Federal Bankruptcy
Reform Act of 1978, affecting the rights and remedies of creditors. In
addition, the obligations of those issuers may become subject to laws
enacted in the future by Congress, state legislatures or referenda
extending the time for payment of principal and/or interest, or imposing
other constraints upon enforcement of the obligations or upon the ability
of municipalities to levy taxes. The possibility also exists that, as a
result of litigation or other conditions, the power or ability of any
issuer to pay, when due, the principal of, and interest on, its
obligations may be materially affected.
Private Activity Bonds. Each fund may invest without limit in Exempt
Obligations that are "private activity bonds," as defined in the Internal
Revenue Code of 1986, as amended (the "Code"), which are in most cases
revenue bonds. Private activity bonds generally do not carry the pledge
of the credit of the issuing municipality, but are guaranteed by the
corporate entity on whose behalf they are issued. Interest income on
certain types of private activity bonds issued after August 7, 1986 to
finance non-governmental activities is a specific tax preference item for
purposes of the Federal individual and corporate alternative minimum
taxes. Individual and corporate shareholders may be subject to a federal
alternative minimum tax to the extent the fund's dividends are derived
from interest on these bonds. Dividends derived from interest income on
Exempt Obligations are a "current earnings" adjustment item for purposes
of the Federal corporate alternative minimum tax. See "Taxes." Private
activity bonds held by a fund will be included in the term Exempt
Obligations for purposes of determining compliance with the fund's policy
of investing at least 80% of its total assets in Exempt Obligations.
Related Instruments. The fund may invest without limit in Exempt
Obligations that are repayable out of revenues generated from economically
related projects or facilities or debt obligations whose issuers are
located in the same state. Sizable investments in these obligations could
involve an increased risk to the fund should any of the related projects
or facilities experience financial difficulties.
U.S. Government Securities. Each fund may invest in debt obligations of
varying maturities issued or guaranteed by the United States government,
its agencies or instrumentalities ("U.S. Government Securities"). Direct
obligations of the U.S. Treasury include a variety of securities that
differ in their interest rates, maturities and dates of issuance. U.S.
Government Securities also include securities issued or guaranteed by the
Federal Housing Administration, Farmers Home Loan Administration,
Export-Import Bank of the United States, Small Business Administration,
Government National Mortgage Association ("GNMA"), General Services
Administration, Central Bank for Cooperatives, Federal Farm Credit Banks,
Federal Home Loan Banks, Federal Home Loan Mortgage Corporation ("FHLMC"),
Federal Intermediate Credit Banks, Federal Land Banks, Federal National
Mortgage Association ("FNMA"), Maritime Administration, Tennessee Valley
Authority, District of Columbia Armory Board and Student Loan Marketing
Association. A fund may also invest in instruments that are supported by
the right of the issuer to borrow from the U.S. Treasury and instruments
that are supported by the credit of the instrumentality. Because the U.S.
government is not obligated by law to provide support to an
instrumentality it sponsors, a fund will invest in obligations issued by
such an instrumentality only if the manager determines that the credit
risk with respect to the instrumentality does not make its securities
unsuitable for investment by the fund.
Municipal Obligations. Each fund invests principally in Municipal
Obligations. Municipal Obligations are debt obligations issued to obtain
funds for various public purposes, including 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 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 (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. Each fund may invest without limit in "municipal
leases." Municipal leases may take the form of a lease or an installment
purchase contract issued by state or 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.
Interest payments on qualifying municipal leases are exempt from Federal
income taxes and state income taxes within the state of issuance.
Although lease obligations do not constitute general obligations of the
municipality for which the municipality's taxing power is pledged, a lease
obligation is ordinarily backed by the municipality's covenant to budget
for, appropriate and make the payments due under the lease obligation.
However, certain lease obligations contain "non-appropriation" clauses
which provide that the municipality has no obligation to make lease or
installment purchase payments in future years unless money is appropriated
for such purpose on a yearly basis. In addition to the "non-
appropriation" risk, these securities represent a relatively new type of
financing that has not yet developed the depth of marketability associated
with more conventional bonds. Although "non-appropriation" lease
obligations are often secured by the underlying property, disposition of
the property in the event of foreclosure might prove difficult. Each fund
may invest in municipal leases without non-appropriation clauses only when
the municipality is required to continue the lease under all circumstances
except bankruptcy. There is no limitation on the percentage of a fund's
assets that may be invested in municipal lease obligations. In evaluating
municipal lease obligations, the manager will consider such factors as it
deems appropriate, which my include: (a) whether the lease can be
canceled; (b) the ability of the lease obligee to direct the sale of the
underlying assets; (c) the general creditworthiness of the lease obligor;
(d) the likelihood that the municipality will discontinue appropriating
funding for the leased property in the event such property is no longer
considered essential by the municipality; (e) the legal recourse of the
lease obligee in the event of such a failure to appropriate funding; (f)
whether the security is backed by a credit enhancement such as insurance;
and (g) any limitations which are imposed on the lease obligor's ability
to utilize substitute property or services other than those covered by the
lease obligation.
Municipal leases that a fund may acquire will be both rated and unrated.
Rated leases include those rated investment grade at the time of
investment or those issued by issuers whose senior debt is rated
investment grade at the time of investment. Each fund may acquire unrated
issues that the manager deems to be comparable in quality to rated issues
in which the fund is authorized to invest. A determination that an
unrated lease obligation is comparable in quality to a rated lease
obligation will be subject to oversight and approval by the trust's board
of trustees.
Municipal leases held by a fund will be considered illiquid securities
unless the trust's board of trustees determines on an ongoing basis that
the leases are readily marketable. An unrated municipal lease with a non-
appropriation risk that is backed by an irrevocable bank letter of credit
or an insurance policy issued by a bank or insurer deemed by the manager
to be of high quality and minimal credit risk, will not be deemed to be
illiquid solely because the underlying municipal lease is unrated, if the
manager determines that the lease is readily marketable because it is
backed by the letter of credit or insurance policy.
Zero Coupon Securities. Each fund may invest up to 10% of its assets in
zero coupon Exempt Obligations. Zero coupon Exempt Obligations are
generally divided into two categories: pure zero obligations, which are
those that pay no interest for their entire life and zero/fixed
obligations, which pay no interest for some initial period and thereafter
pay interest currently. In the case of a pure zero obligation, the failure
to pay interest currently may result from the obligation's having no
stated interest rate, in which case the obligation pays only principal at
maturity and is issued at a discount from its stated principal amount. A
pure zero obligation may, in the alternative, carry a stated interest
rate, but provide that no interest is payable until maturity. The value to
the investor of a zero coupon Exempt Obligation consists of the economic
accretion either of the difference between the purchase price and the
nominal principal amount (if no interest is stated to accrue) or of
accrued, unpaid interest during the Exempt Obligation's life or payment
deferral period.
Custodial Receipts. Each fund may acquire custodial receipts or
certificates under-written by securities dealers or banks that evidence
ownership of future interest payments, principal payments, or both, on
certain Exempt Obligations. The underwriter of these certificates or
receipts typically purchases Exempt Obligations and deposits the
obligations in an irrevocable trust or custodial account with a custodian
bank, which then issues receipts or certificates evidencing ownership of
the periodic unmatured coupon payments and the final principal payment on
the obligations. Custodial receipts evidencing specific coupon or
principal payments have the same general attributes as zero coupon Exempt
Obligations described above. Although under the terms of a custodial
receipt a fund would typically be authorized to assert its rights directly
against the issuer of the underlying obligations, the fund could be
required to assert through the custodian bank those rights as may exist
against the underlying issuer. Thus, if the underlying issuer fails to
pay principal and/or interest when due, the fund may be subject to delays,
expenses and risks that are greater than those that would have been
involved if the fund had purchased a direct obligation of the issuer. In
addition, if the trust or custodial account in which the underlying
security has been deposited is determined to be an association taxable as
a corporation, instead of a non-taxable entity, the yield on the
underlying security would be reduced in recognition of any taxes paid.
Exempt Obligation Components. Each fund may invest in Exempt Obligations,
the interest rate on which has been divided by the issuer into two
different and variable components, which together result in a fixed
interest rate. Typically, the first of the components (the "Auction
Component") pays an interest rate that is reset periodically through an
auction process; whereas the second of the components (the "Residual
Component") pays a residual interest rate based on the difference between
the total interest paid by the issuer on the Exempt Obligation and the
auction rate paid on the Auction Component. Each fund may purchase both
Auction and Residual Components.
Because the interest rate paid to holders of Residual Components is
generally determined by subtracting from a fixed amount the interest rate
paid to the holders of Auction Components, the interest rate paid to
Residual Component holders will decrease as the Auction Component's rate
increases and increase as the Auction Component's rate decreases.
Moreover, the magnitude of the increases and decreases in market value of
Residual Components may be larger than comparable changes in the market
value of an equal principal amount of a fixed rate Exempt Obligation
having similar credit quality, redemption provisions and maturity.
Floating and Variable Rate Instruments. Each fund may purchase floating
and variable rate demand notes and bonds, which are Exempt Obligations
normally having a stated maturity in excess of one year, but which permit
their holder to demand payment of principal at any time, or at specified
intervals. The maturity of a floating or variable rate demand note or
bond will be deemed shortened by virtue of a demand feature.
The issuer of floating and variable rate demand obligations normally has a
corresponding right, after a given period, to prepay at its discretion the
outstanding principal amount of the obligations plus accrued interest upon
a specified number of days' notice to the holders of these obligations.
The interest rate on a floating rate demand obligation is based on a known
lending rate, such as a bank's prime rate, and is adjusted automatically
each time that rate is adjusted. The interest rate on a variable rate
demand obligation is adjusted automatically at specified intervals.
Frequently, floating and variable rate obligations are secured by letters
of credit or other credit support arrangements provided by banks. Use of
letters of credit or other credit support arrangements will not adversely
affect the tax-exempt status of these obligations. Because they are
direct lending arrangements between the lender and borrower, floating and
variable rate obligations generally will not be traded. In addition,
generally no secondary market exists for these obligations, although their
holders may demand payment at face value. For these reasons, when
floating and variable rate obligations held by a fund are not secured by
letters of credit or other credit support arrangements, the fund's rights
to demand payment is dependent on the ability of the borrower to pay
principal and interest on demand. The manager, on behalf of the fund,
will consider on an ongoing basis the creditworthiness of the issuers of
floating and variable rate demand obligations held by the fund.
Participation Interests. Each fund may purchase from financial
institutions tax-exempt participation interests in Exempt Obligations. A
participation interest gives the fund an undivided interest in the Exempt
Obligation in the proportion that the fund's participation interest bears
to the total amount of the Exempt Obligation. These instruments may have
floating or variable rates of interest. If the participation interest is
unrated, it will be backed by an irrevocable letter of credit or guarantee
of a bank that the trust's board of trustees has determined meets certain
quality standards, or the payment obligation otherwise will be
collateralized by obligations of the United States government or its
agencies and instrumentalities ("U.S. government securities"). The fund
will have the right, with respect to certain participation interests, to
demand payment, on a specified number of days' notice, for all or any part
of the fund's interest in the Exempt Obligation, plus accrued interest.
Each fund intends to exercise its right with respect to these instruments
to demand payment only upon a default under the terms of the Exempt
Obligation or to maintain or improve the quality of its investment
portfolio.
Taxable Investments. Under normal conditions, each fund may hold up to
20% of its total assets in cash or money market instruments, including
taxable money market instruments (collectively, "Taxable Investments").
In addition, the manager believes that if market conditions warrant, a
fund may take a temporary defensive posture and invest without limitation
in short-term Exempt Obligations and Taxable Investments. To the extent,
a fund holds Taxable Investments and, under certain market conditions,
certain floating and variable rate demand obligations or Auction
Components, the fund may not achieve its investment objective.
Money market instruments in which the fund may invest include: U.S.
government securities; tax-exempt notes of municipal issuers rated, at the
time of purchase, no lower than MIG 1 by Moody's, SP-1 by S&P of F-1 by
Fitch or, if not rated, by issuers having outstanding, unsecured debt then
rated within the three highest rating categories; bank obligations
(including certificates of deposit, time deposits and bankers acceptances
of domestic banks, domestic savings and loan associations and similar
institutions); commercial paper rated no lower than P-1 by Moody's, A-1 by
S&P of F-1 by Fitch or the equivalent from another major rating service
or, if unrated of an issuer having an outstanding, unsecured debt issue
then rated within the three highest rating categories; and repurchase
agreements. At no time will the funds' investments in bank obligations,
including time deposits, exceed 25% of the value of each fund's assets.
U.S. government securities in which the funds may invest include direct
obligations of the United States and obligations issued by U.S. government
agencies and instrumentalities. Included among direct obligations of the
United States are Treasury Bills, Treasury Notes and Treasury Bonds, which
differ principally in terms of their maturities. Included among the
securities issued by U.S. government agencies and instrumentalities are:
securities that are supported by the full faith and credit of the United
States (such as Government National Mortgager Association certificates);
securities that are supported by the right of the issuer to borrow from
the United States Treasury (such as securities of Federal Home Loan
Banks); and securities that are supported by the credit of the
instrumentality (such as Federal National Mortgage Association and Federal
Home Loan Mortgage Corporation bonds).
Investment Techniques
The fund may employ, among others, the investment techniques described
below, which may give rise to taxable income:
Financial Futures and Options Transactions. To hedge against a decline in
the value of Municipal Bonds it owns or an increase in the price of
Municipal Bonds it proposes to purchase, each fund may enter into
financial futures contracts and invest in options on financial futures
contracts that are traded on a domestic exchange or board of trade. The
futures contracts or options on futures contracts that may be entered into
by the fund will be restricted to those that are either based on an index
of Municipal Bonds or relate to debt securities the prices of which are
anticipated by the manager to correlate with the prices of the Municipal
Bonds owned or to be purchased by a fund.
In entering into a financial futures contract, a fund will be required to
deposit with the broker through which it undertakes the transaction an
amount of cash or cash equivalents equal to approximately 5% of the
contract amount. This amount, which is known as "initial margin," is
subject to change by the exchange or board of trade on which the contract
is traded, and members of the exchange or board of trade may charge a
higher amount. Initial margin is in the nature of a performance bond or
good faith deposit on the contract that is returned to the fund upon
termination of the futures contract, assuming all contractual obligations
have been satisfied. In accordance with a process known as "marking-to
market," subsequent payments, known as "variation margin," to and from the
broker will be made daily as the price of the index or securities
underlying the futures contract fluctuates, making the long and short
positions in the futures contract more or less valuable. At any time
prior to the expiration of a futures contract, the fund may elect to close
the position by taking an opposite position, which will operate to
terminate the fund's existing position in the contract.
A financial futures contract provides for the future sale by one party and
the purchase by the other party of a certain amount of a specified
property at a specified price, date, time and place. Unlike the direct
investment in a futures contract, an option on a financial futures
contract gives the purchaser the right, in return for the premium paid, to
assume a position in the financial futures contract at a specified
exercise price at the any time prior to the expiration date of the option.
Upon exercise of an option, the delivery of the futures position by the
writer of the option to the holder of the option will be accompanied by
delivery of the accumulated balance in the writer's futures margin
account, which represents the amount by which the market price of the
futures contract exceeds, in the case of a call, or is less than, in the
case of a put, the exercise price of the option on the futures contract.
The potential loss related to the purchase of an option on financial
futures contracts is limited to the premium paid for the option (plus
transaction costs). The value of the option may change daily and that
change would be reflected in the net asset value of the fund.
Regulations of the Commodity Futures Trading Commission applicable to each
fund require that a fund's transactions in financial futures contracts and
options on financial futures contracts be engaged in for bona fide hedging
purposes, or if a fund enters into futures contracts for speculative
purposes, that the aggregate initial margin deposits and premiums paid by
the fund will not exceed 5% of the market value of its assets. In
addition, the fund will, with respect to its purchases of financial
futures contracts, establish a segregated account on the fund's books
consisting of cash or cash equivalents in an amount equal to the total
market value of the futures contracts, less the amount of initial margin
on deposit for the contracts. Each fund's ability to trade in financial
futures contracts and options on financial futures contracts may be
limited to some extent by the requirements of the Internal Revenue Code of
1986, as amended (the "Code"), applicable to a regulated investment
company that are described below under "Taxes."
Although each fund intends to enter into financial futures contracts and
options on financial futures contracts that are traded on a domestic
exchange or board of trade only if an active market will exist for them at
any particular time. If closing a futures position in anticipation of
adverse price movements is not possible, the fund would be required to
make daily cash payments of variation margin. In those circumstances, an
increase in the value of the portion of the fund's investments being
hedged, if any, may offset partially or completely losses on the futures
contract. No assurance can be given, however, that the price of the
securities being hedged will correlate with the price movements in a
futures contract and, thus, provide an offset to losses on the futures
contract or option on the futures contract. In addition, in light of the
risk of an imperfect correlation between securities held by the fund that
are the subject of a hedging transaction and the futures or options used
as a hedging device, the hedge may not be fully effective because, for
example, losses on the securities held by the fund may be in excess of
gains on the futures contract or losses on the futures contract may be in
excess of gains on the securities held by the fund that were the subject
of the hedge. In an effort to compensate for the imperfect correlation of
movements in the price of the securities being hedged and movements in the
price of futures contracts, each fund may enter into financial futures
contracts or options on financial futures contracts in a greater or lesser
dollar amount than the dollar amount of the securities being hedged if the
historical volatility of the futures contract has been less or greater
than that of the securities. This "over hedging" or "under hedging" may
adversely affect a fund's net investment results if market movements are
not as anticipated when the hedge is established.
If a fund has hedged against the possibility of an increase in interest
rates adversely affecting the value of securities it holds and rates
decrease instead, the fund will lose part or all of the benefit of the
increased value of securities that it has hedged because it will have
offsetting losses in its futures or options positions. In addition, in
those situations, if the fund has insufficient cash, it may have to sell
securities to meet daily variation margin requirements on the futures
contracts at a time when it may be disadvantageous to do so. These sales
of securities may, but will not necessarily, be at increased prices that
reflect the decline in interest rates.
When-Issued Securities and Delayed-Delivery Transactions. Each fund may
purchase securities on a "when-issued" basis or for delayed delivery
(i.e., payment or delivery occur beyond the normal settlement date at a
stated price and yield). Each fund does not intend to engage in these
transactions for speculative purposes, but only in furtherance of its
investment goal. These transactions occur when securities are purchased
or sold by a fund with payment and delivery taking place in the future to
secure what is considered an advantageous yield and price to a fund at the
time of entering into the transaction. The payment obligation and the
interest rate that will be received on when-issued securities are fixed at
the time the buyer enters into the commitment. Due to fluctuations in the
value of securities purchased or sold on a when-issued or delayed-delivery
basis, the prices obtained on such securities may be higher or lower than
the prices available in the market on the dates when the investments are
actually delivered to the buyers.
When a fund agrees to purchase when-issued or delayed-delivery securities,
the fund will set aside cash or liquid securities equal to the amount of
the commitment in a segregated account on the fund's books. Normally, the
fund will set aside portfolio securities to satisfy a purchase commitment,
and in such a case a fund may be required subsequently to place additional
assets in the segregated account on the fund's books in order to ensure
that the value of the account remains equal to the amount of the fund's
commitment. The assets contained in the segregated account will be
marked-to-market daily. It may be expected that a fund's net assets will
fluctuate to a greater degree when it sets aside portfolio securities to
cover such purchase commitments than when it sets aside cash. When a fund
engages in when-issued or delayed-delivery transactions, it relies 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.
Stand-by Commitments. Each fund may acquire "stand-by commitments" with
respect to Exempt Obligations held in its portfolio. Under a stand-by
commitment, a broker, dealer or bank is obligated to repurchase at the
fund's option specified securities at a specified price and, in this way,
stand-by commitment, therefore, is subject to the ability of the seller to
make payment on demand. A fund will acquire stand-by commitments solely
to facilitate portfolio liquidity and does not intend to exercise the
rights afforded by the commitments for trading purposes. Each fund
anticipates that stand-by commitments will be available from brokers,
dealers and banks without the payment of any direct or indirect
consideration. Each fund may pay for stand-by commitments if payment is
deemed necessary, thus increasing to a degree the cost of the underlying
Exempt Obligations and similarly decreasing the security's yield to the
funds.
Illiquid Securities. Each fund may invest up 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. In addition, up to 5% of the value of each fund's
assets may be invested in securities of entities that have been in
continuous operation for fewer than three years.
Repurchase Agreements. Each fund may agree to purchase securities from a
bank or recognized securities dealer and simultaneously commit to resell
the securities to the bank or dealer at an agreed-upon date and price
reflecting a market rate of interest unrelated to the coupon rate or
maturity of the purchased securities ("repurchase agreements"). A fund
would maintain custody of the underlying securities prior to their
repurchase; thus, the obligation of the bank or dealer to pay the
repurchase price on the date agreed to would be, in effect, secured by
such securities. If the value of such securities were less than the
repurchase price, plus interest, the other party to the agreement would be
required to provide additional collateral so that at all times the
collateral is at least 102% of the repurchase price plus accrued interest.
Default by or bankruptcy of a seller would expose a fund to possible loss
because of adverse market action, expenses and/or delays in connection
with the disposition of the underlying obligations. The financial
institutions with which a fund may enter into repurchase agreements will
be banks and non-bank dealers of U.S. Government securities that are on
the Federal Reserve Bank of New York's list of reporting dealers, if such
banks and non-bank dealers are deemed creditworthy by the fund's manager.
The manager will continue to monitor creditworthiness of the seller under
a repurchase agreement, and will require the seller to maintain during the
term of the agreement the value of the securities subject to the agreement
to equal at least 102% of the repurchase price (including accrued
interest). In addition, the manager will require that the value of this
collateral, after transaction costs (including loss of interest)
reasonably expected to be incurred on a default, be equal to 102% or
greater than the repurchase price (including accrued premium) provided in
the repurchase agreement or the daily amortization of the difference
between the purchase price and the repurchase price specified in the
repurchase agreement. The manager will mark-to-market daily the value of
the securities. Repurchase agreements are considered to be loans by a
Fund under the 1940 Act.
RISK FACTORS AND SPECIAL CONSIDERATIONS RELATING TO CALIFORNIA AND NEW
YORK MUNICIPAL SECURITIES
Investment in the funds involves risk factors and special considerations,
such as those described below:
Exempt Obligations. Even though Exempt Obligations are interest-bearing
investments that promise a stable stream of income, their prices are
inversely affected by changes in interest rates and, therefore, are
subject to the risk of market price fluctuations. The values of Exempt
Obligations with longer remaining maturities typically fluctuate more than
those of similarly rated Exempt Obligations with shorter remaining
maturities such as each fund intends to hold. The values of fixed-income
securities also may be affected by changes in the credit rating or
financial condition of the issuing entities.
Opinions relating to the validity of Municipal Obligations and to the
exemption of interest in them from Federal income taxes (and, with respect
to Exempt Obligations, to the exemption of interest on them from
California or New York, as applicable, state personal income taxes) as
rendered by bond counsel to the respective issuers at the time of
issuance. Neither the funds nor the manager will review the proceedings
relating to the issuance of Exempt Obligations or the basis for opinions
of counsel.
Potential Legislation. In past years, the United States government has
enacted various laws that have restricted or diminished the income tax
exemption on various types of Municipal Obligations and may enact other
similar laws in the future. If any such laws are enacted that would
reduce the availability of Exempt Obligations for investment by the funds
so as to affect a fund's shareholders adversely, the trust will reevaluate
each fund's investment objective and policies and might submit possible
changes in a fund's structure to shareholders for their consideration. If
legislation were enacted that would treat a type of Exempt Obligation as
taxable for Federal income tax purposes, the fund would treat the security
as a permissible Taxable Investment within the applicable limits set forth
in this prospectus.
Unrated Securities. Each fund may invest in unrated securities that the
manager determines to be of comparable quality to the rated securities in
which the fund may invest. Dealers may not maintain daily markets in
unrated securities and retail secondary markets for many of such
securities may not exist. As a result, a fund's ability to sell these
securities when the manager deems it appropriate may be diminished.
Municipal Leases. Municipal leases in which the fund may invest have
special risks not normally associated with Municipal Obligations. These
obligations frequently contain non-appropriation clauses that provide that
the governmental issuer of the obligation need not make future payments
under the lease or contract unless money is appropriated for that purpose
by a legislative body annually or on another periodic basis. Municipal
leases have additional risks because they represent a type of financing
that has not yet developed the depth of marketability generally associated
with other Municipal Obligations. Moreover, although a municipal lease
will be secured by financed equipment or facilities, the disposition of
the equipment or facilities in the event of foreclosure might prove
difficult. In addition, in certain instances the tax-exempt status of the
municipal lease will not be subject to the legal opinion of a nationally
recognized bond counsel, although in all cases a fund will require that a
municipal lease purchased by the fund be covered by a legal opinion to the
effect that, as of each effective date of the municipal lease, the lease
is valid and binding of the government issuer.
Municipal leases are also subject to the risk of non-payment. The ability
of issuers of municipal leases to make timely lease payments may be
adversely impacted in general economic downturns and as relative
governmental cost burdens are allocated and reallocated among Federal,
state and local governmental units. Such non-payments would result in a
reduction of income to a fund, and could result in a reduction in the
value of the municipal lease experiencing non-payment and a decrease in
the net asset value of the fund. Issuers of municipal securities might
seek protection under the bankruptcy laws. In the event of bankruptcy of
such an issuer, a fund could experience delays and limitations with
respect to the collection of principal and interest on such municipal
leases and the fund may not, in all circumstances, be able to collect all
principal and interest to which it is entitled. To enforce its rights in
the event of a default in the lease payments, each fund may take
possession of and manage the assets securing the issuer's obligations on
such securities, which may increase the fund's operating expenses and
adversely affect the net asset value of the fund. Any income derived from
the fund's ownership or operation of such assets may not be tax-exempt.
In addition, each fund's intention to qualify as a "regulated investment
company" under the Code may limit the extent to which the fund may
exercise its rights by taking possession of such assets, because as a
regulated investment company the fund is subject to certain limitations on
its investments and on the nature of its income.
Non-Publicly Traded Securities. As suggested above, each fund may, from
time to time, invest a portion of its assets in non-publicly traded Exempt
Obligations. Non-publicly traded securities may be less liquid than
publicly traded securities. Although non-publicly traded securities may
be resold in privately negotiated transactions, the prices realized from
these sales could be less than those originally paid by the fund.
When-Issued and Delayed-Delivery Transactions. Securities purchased on a
when-issued or delayed-delivery basis may expose a fund to risk because
the securities may experience fluctuations in value prior to their
delivery. Purchasing securities on a when-issued or delayed-delivery
basis can involve the additional risk that the yield available in the
market when the delivery takes place may be higher than that obtained in
the transaction itself.
Non-Diversified Classification. Each fund is classified as a non-
diversified fund under the Investment Company Act of 1940, as amended (the
"1940 Act") which means that the fund is not limited by the Act in the
proportion of its assets that it may invest in the obligations of a single
issuer. Each fund intends to conduct its operations, however, so as to
qualify as a "regulated investment company" for purposes of the Internal
Revenue Code of 1986, as amended (the "Code"), which will relieve the fund
of any liability for Federal income tax and California or New York State
franchise tax, as applicable, to the extent that its earnings are
distributed to shareholders. To qualify as a regulated investment
company, the fund will, among other things, limit its investments so that,
at the close of each quarter of the taxable year (a) not more than 25% of
the market value of the fund's total assets will be invested in the
securities of a single issuer and (b) with respect to 50% of the market
value of its total assets, not more than 5% of the market value of its
total assets will be invested in the securities of a single issuer and the
fund will not own more than 10% of the outstanding voting securities of a
single issuer.
As a result of the funds' non-classified status, an investment in either
fund may present greater risks to investors than an investment in a
diversified fund. The investment return on a non-diversified fund
typically is dependent upon the performance of a smaller number of
securities relative to the number of securities held in a diversified
fund. Each fund's assumption of large positions in the obligations of a
small number of issuers will affect the value of its portfolio to a
greater extent than that of a diversified fund in the event of changes in
the financial condition, or in the market's assessment, of the issuers.
Portfolio Transactions And Turnover. Each fund's portfolio securities
ordinarily are purchased from and sold to parties acting as either
principal or agent. Newly issued securities ordinarily are purchased
directly from the issuer or from an underwriter; other purchases and sales
usually are placed with those dealers from which it appears that the best
price or execution will be obtained. Usually no brokerage commissions, as
such, are paid by the funds for purchases and sales undertaken through
principal transactions, although the price paid usually includes an
undisclosed compensation to the dealer acting as agent.
Special Considerations Relating to Exempt Obligations
The payment of principal and interest on most securities purchased by
either fund will depend on the ability of the issuers to meet their
obligations. A fund's portfolio will be affected by general changes in
interest rates, which will result in increases or decreases in the value
of the obligations held by a fund. The market value of the obligations in
the fund's portfolio can be expected to vary inversely to changes in
prevailing interest rates. During 1996, the ratings of California general
obligations bond was upgraded. S&P Ratings Group upgraded its rating to
A+; the same rating has been assigned to such debt by Fitch. Moody's has
assigned such debt an A1 rating. Certain substantial issuers of New York
Exempt Obligations (including issuers whose obligations may be acquired by
the New York Fund) have experienced serious financial difficulties in
recent years. These difficulties have at times jeopardized the credit
standing and impaired the borrowing abilities of all New York issuers and
have generally contributed to higher interest costs for their borrowing
and fewer markets for their outstanding debt obligations. In recent
years, several different issuers of municipal securities of New York State
and its agencies and instrumentalities and of New York City have been
downgraded by S&P and Moody's. On July 10, 1995, S&P downgraded its
rating of New York City's $23 billion of outstanding general obligation
bonds to "BBB+" from "A-", citing the City's chronic structural budget
problems and weak economic outlook. S&P stated that New York City's
reliance on one-time revenue measures to close annual budget gaps, a
dependence on unrealized labor savings, overly optimistic estimates of
revenues and state and federal aid and City's continued high debt levels
also contributed to its decision to lower the ratings. On the other hand,
strong demand for New York Exempt Obligations has more recently had the
effect of permitting New York Exempt Obligations to be issued with yield
relatively lower, and after issuance, to trade in the market at prices
relatively higher, than comparably rated municipal obligations issued by
other jurisdictions. Moody's rating of City bonds were revised in
November 1981 from B (in effect since 1977) to Bal, in November 1983 to
Baa, in December 1985 to Baal, in 1988 to A and again in February 1991 to
Baal. On July 17, 1997, Moody's changed its outlook on City bonds to
positive from stable. Since July 8, 1997, Fitch has rated City bonds A.
Investors should be aware that certain California or New York
constitutional amendments, legislative measures, executive orders,
administrative regulations and voter initiatives could result in certain
adverse consequences affecting Exempt Obligations. For instance, certain
provisions of the California or New York Constitution and statutes that
limit the taxing and spending authority of California, or New York,
governmental entities may impair the ability of the issuers of some Exempt
Obligations to maintain debt service on their obligations. Other measures
affecting the taxing or spending authority of California, or New York, or
their political sub-divisions may be approved or enacted in the future.
In seeking to achieve its objective, each fund may invest without limit in
Municipal Obligations which are private activity bonds. Moreover,
although each fund does not currently intend to do so on a regular basis,
each fund may invest more than 20% of its assets in Municipal Obligations
which are repayable out of revenue streams generated from economically
related projects or facilities, if such investment is deemed necessary or
appropriate by the manager. To the extent a fund's assets are
concentrated in Municipal Obligations payable from revenues from
economically related projects or facilities, if a fund's assets are
concentrated in Municipal Obligations payable from revenues on
economically related projects and facilities, the fund will be subject to
the particular risks presented by such projects to a greater extent than
it would be if the fund's assets were not so concentrated.
Special Considerations Relating To California Exempt Obligations
Some of the significant financial considerations relating to the
California 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 SAI and does not purport to be a complete
description of any of the considerations mentioned herein. It is also
based on the disclosure statement filed in the County of Orange bankruptcy
case. The accuracy and completeness of the information contained in such
official statements and disclosure statement has not been independently
verified.
Alternative Minimum Tax
Under current federal income tax law, (1) interest on tax-exempt municipal
securities issued after August 7, 1986 which are "specified private
activity bonds," and the proportionate share of any exempt-interest
dividend paid by a regulated investment company which receives interest
from such specified private activity bonds, will be treated as an item of
tax preference for purposes of the alternative minimum tax ("AMT") imposed
on individuals and corporations, though for regular Federal income tax
purposes such interest will remain fully tax-exempt, and (2) interest on
all tax-exempt obligations will be included in "adjusted current earnings"
of corporations for AMT purposes. Such private activity bonds ("AMT-
Subject bonds"), which include industrial development bonds and bonds
issued to finance such projects as airports, housing projects, solid waste
disposal facilities, student loan programs and water and sewage projects,
have provided, and may continue to provide, somewhat higher yields than
other comparable municipal securities.
Investors should consider that, in most instances, no state, municipality
or other governmental unit with taxing power will be obligated with
respect to AMT-Subject bonds. AMT-Subject bonds are in most cases revenue
bonds and do not generally have the pledge of the credit or the taxing
power, if any, of the issuer of such bonds. AMT-Subject bonds are
generally limited obligations of the issuer supported by payments from
private business entities and not by the full faith and credit of a state
or any governmental subdivision. Typically the obligation of the issuer
of AMT-Subject bonds is to make payments to bond holders only out of and
to the extent of, payments made by the private business entity for whose
benefit the AMT-Subject bonds were issued. Payment of the principal and
interest on such revenue bonds depends solely on the ability of the user
of the facilities financed by the bonds to meet its financial obligations
and the pledge, if any, of real and personal property so financed as
security for such payment. It is not possible to provide specific detail
on each of these obligations in which Fund assets may be invested.
Risk of Concentration In a Single State
The primary purpose of investing in a portfolio of a single state's
municipal securities is the special tax treatment accorded the state's
resident individual investors. However, payment of interest and
preservation of principal is dependent upon the continuing ability of the
state's issuers and/or obligors on state, municipal and public authority
debt obligations to meet their obligations thereunder. Investors should be
aware of certain factors that might affect the financial condition of
issuers of municipal securities, consider the greater risk of the
concentration of a fund versus the safety that comes with a less
concentrated investment portfolio and compare yields available in
portfolios of the relevant state's issues with those of more diversified
portfolios, including out-of-state issues, before making an investment
decision.
Municipal securities in which a fund's assets are invested may include
debt obligations of the municipalities and other subdivisions of the
relevant state issued to obtain funds for various public purposes,
including the construction of a wide range of public facilities such as
airports, bridges, highways, schools, streets and water and sewer works.
Other purposes for which municipal securities may be issued include the
obtaining of funds to lend to public or private institutions for the
construction of facilities such as educational, hospital, housing, and
solid waste disposal facilities. The latter, including most AMT-Subject
bonds, are generally payable from private sources which, in varying
degrees, may depend on local economic conditions, but are not necessarily
affected by the ability of the state and its political subdivisions to pay
their debts. It is not possible to provide specific details on each of
these obligations in which fund assets may be invested. However, all such
securities, the payment of which is not a general obligation of an issuer
having general taxing power, must satisfy, at the time of an acquisition
by the fund, the minimum rating(s). See "Appendix A: Bond and Commercial
Paper Ratings" for a description of ratings and rating criteria. Some
municipal securities may be rated based on a "moral obligation" contract
which allows the municipality to terminate its obligation by deciding not
to make an appropriation. Generally, no legal remedy is available against
the municipality that is a party to the "moral obligation" contract in the
event of such non-appropriation.
Municipal Market Volatility Municipal securities can be significantly
affected by political changes as well as uncertainties in the municipal
market related to taxation, legislative changes, or the rights of
municipal security holders. Because many municipal securities are issued
to finance similar projects, especially those relating to education,
health care, transportation and utilities, conditions in those sectors can
affect the overall municipal market. In addition, changes in the financial
condition of an individual municipal insurer can affect the overall
municipal market.
Interest Rate Changes Debt securities have varying levels of sensitivity
to changes in interest rates. In general, the price of a debt security can
fall when interest rates rise and can rise when interest rates fall.
Securities with longer maturities can be more sensitive to interest rate
changes. In other words, the longer the maturity of a security, the
greater the impact a change in interest rates could have on the security's
price. In addition, short-term and long-term interest rates do not
necessarily move in the same amount or the same direction. Short-term
securities tend to react to changes in short-term interest rates, and
long-term securities tend to react to changes in long-term interest rates.
Issuer-Specific Changes Changes in the financial condition of an issuer,
changes in specific economic or political conditions that affect a
particular type of security or issuer, and changes in general economic or
political conditions can affect the credit quality or value of an issuer's
securities. Lower-quality debt securities (those of less than investment-
grade quality) tend to be more sensitive to these changes than higher-
quality debt securities. Entities providing credit support or a maturity-
shortening structure also can be affected by these types of changes.
Municipal securities backed by current or anticipated revenues from a
specific project or specific assets can be negatively affected by the
discontinuance of the taxation supporting the project or assets or the
inability to collect revenues for the project or from the assets. If the
Internal Revenue Service determines an issuer of a municipal security has
not complied with applicable tax requirements, interest from the security
could become taxable and the security could decline significantly in
value. In addition, if the structure of a security fails to function as
intended, interest from the security could become taxable or the security
could decline in value.
Risk Factors
The following brief summaries are included for the purpose of providing
certain information regarding the economic climate and financial condition
of the states of New York and California, and are based primarily on
information from official statements made available in connection with the
issuance of certain securities and other documents and sources and does
not purport to be complete. The trust has not undertaken to verify
independently such information and the trust assumes no responsibility for
the accuracy of such information. These summaries do not provide
information regarding most securities in which the funds are permitted to
invest and in particular do not provide specific information on the
issuers or types of municipal securities in which the fund invests or the
private business entities whose obligations support the payments on AMT-
Subject bonds in which the funds will invest. Therefore, the general risk
factors as to the credit of the state or its political subdivisions
discussed herein may not be relevant to the funds. Although revenue
obligations of a state or its political subdivisions may be payable from a
specific project or source, there can be no assurance that future economic
difficulties and the resulting impact on state and local government
finances will not adversely affect the market value of the funds or the
ability of the respective obligors to make timely payments of principal
and interest on such obligations. In addition, a number of factors may
adversely affect the ability of the issuers of municipal securities to
repay their borrowings that are unrelated to the financial or economic
condition of a state, and that, in some cases, are beyond their control.
Furthermore, issuers of municipal securities are generally not required to
provide ongoing information about their finances and operations to holders
of their debt obligations, although a number of cities, counties and other
issuers prepare annual reports.
NEW YORK FUND
The following is based on information obtained from an Official Statement
of the State of New York, dated December 15, 1998, relating to $85,000,000
Environmental Quality 1986 Variable Interest Rate General Obligation
Bonds, Series 1998G, an Official Statement of the City of New York, dated
December 15, 1998, relating to $117,035,000 Tax-Exempt and $21,835,000
Taxable General Obligation Bonds, Fiscal 1999 Series E, and the Annual
Information Statement of the State of New York dated June 26, 1998.
New York Local Government Assistance Corporation
In 1990, as part of a New York State (the "State") fiscal reform program,
legislation was enacted creating the New York Local Government Assistance
Corporation (the "LGAC"), a public benefit corporation empowered to issue
long-term obligations to fund certain payments to local governments
traditionally funded through the State's annual seasonal borrowing. The
legislation authorized 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 dedicated revenues equal to one-
quarter of the four cent State sales and use tax to pay debt service on
these bonds. The legislation 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. This provision capping the seasonal
borrowing was included as a covenant with LGAC's bondholders in the
resolution authorizing such bonds. Issuance of the entire $4.7 billion
bond authorization as of March 31, 1996 eliminated the need for the
State's annual spring borrowing.
The impact of LGAC's borrowing is that the State is able to meet its cash
flow needs throughout the fiscal year without relying on short-term
seasonal borrowings.
Recent Developments
The national economy has maintained a robust rate of growth during the
past six quarters as the expansion, which is well into its seventh year,
continues. Since early 1992, approximately 16-1/2 million jobs have been
added nationally. The State economy has also continued to expand, but
growth remains somewhat slower than in the nation. Although the State has
added over 400,000 jobs since late 1992, employment growth in the State
has been hindered during recent years by significant cutbacks in the
computer and instrument manufacturing, utility, defense, and banking
industries. Government downsizing has also moderated these job gains.
The State Division of Budget ("DOB") forecasts that national economic
growth during both 1998 and 1999 will be slower than it was during 1997.
The financial and economic turmoil which started in Asia and has spread to
other parts of the world is expected to continue to negatively affect U.S.
trade balances throughout most of 1999. In addition, growth in domestic
consumption, which has been a major driving force behind the nation's
strong economic performance in recent years, is expected to slow in 1999
as consumer confidence retreats from historic highs and the stock market
ceases to provide large amounts of extra discretionary income.
The forecast of the State's economy shows continued expansion during the
1998 calendar year, with continued growth projected in 1998 for
employment, wages, and personal income, although the growth rates of
personal income and wages are expected to be lower than those in 1997.
The growth of personal income is projected to rise from 4.7 percent in
1997 to 5.0 percent in 1998, but then drop to 3.4 percent in 1999, in part
because growth in bonus payments is expected to moderate significantly.
Overall employment is expected to grow 2.0 percent in 1998, the strongest
growth in a decade, but is expected to drop to 1.0 percent in 1999,
reflecting the slowing growth in the national economy, continued restraint
in governmental spending, less robust profitability in the financial
sector and continued restructuring in the manufacturing, health care, and
banking sectors.
1998-99 Fiscal Year
Total receipts for the 1998-99 fiscal year are projected to reach $37.84
billion on a cash-basis. Personal income tax receipts for 1998-99 are
projected to reach $21.44 billion, nearly $3.7 billion above the amount
reported for 1997-98. This estimate reflects an anticipated slowing in
the growth of financial sector bonuses and the resultant impact on
withholding. Business tax collections, reflecting collection experience in
September and reduced expectations for profits in the balance of the year,
are expected to reach $4.79 billion, approximately $257 million below the
amount recorded for the 1997-98 fiscal year. Receipts from user taxes and
fees are expected to total $7.21 billion, an increase of approximately
$170 million above the amount reported for 1997-98. Collections from
other taxes are projected at $1.07 billion. Miscellaneous receipts are
projected to reach $1.47 billion. Transfers to the General Fund from
other funds are expected to be over $1.86 billion, including $1.54 billion
of sales tax receipts net of the debt service requirements of the LGAC.
Projected General Fund disbursements on a cash-basis are expected to total
$36.78 billion. The State projects disbursements of $25.14 billion in
grants to local governments for the year, an increase of $1.88 billion
over 1997-98. A $830 million increase in cash disbursements for school
aid over the prior year is responsible for nearly half the year-over-year
growth in this category. Other significant increases include Medicaid
($144 million), handicapped education programs ($108 million) and children
and families programs ($66 million). School aid is also the largest
program in terms of total spending in this category, with disbursements of
$9.7 billion expected in 1998-99. It is followed by Medicaid ($5.6
billion), welfare ($1.6 billion), services for children and families ($927
million) and general purpose aid to local governments ($837 million).
State operations, which account for the costs of running State agencies,
are estimated at $6.7 billion for the current fiscal year, $511 million
higher than during 1997-98. This year-to-year growth reflects the
continuing phase-in of wage increases under existing collective bargaining
agreements, the impact of binding arbitration settlements and the costs of
funding an additional payroll cycle in 1998-99. General state charges,
which account primarily for fringe benefits of State employees, are
projected to total $2.22 billion in 1998-99, a modest decrease from 1997-
98. Short- and long-term debt service is projected at $2.14 billion, an
increase of $111 million over 1997-98. For the first time, the State
plans to make a $50 million deposit to the Debt Reduction Reserve Fund.
Capital projects and all other transfers are estimated at $592 million, a
decrease of $61 million from 1997-98, reflecting the non-recurring nature
of certain items included in the prior fiscal year.
The financial plan projects a closing balance, on a cash basis, in the
General Fund of $1.7 billion. The balance consists of the $1.04 billion
reserve for future needs, $400 million in the Tax Stabilization Reserve
Fund, $100 million in the Contingency Reserve Fund (after a planned
deposit of $32 million in 1998-99), and $158 million in the Community
Projects Fund.
Total spending from all governmental funds is projected at $71.54 billion.
Spending is projected at $34.07 billion for the General Fund (excluding
transfers), $29.98 billion for the special revenue funds, $4.14 billion
for the capital projects funds, and $3.36 billion for the debt service
funds. State funds spending is estimated to total $48.58 billion.
1997-98 Fiscal Year
The State ended its 1997-98 fiscal year in balance on a cash basis, with a
General Fund cash surplus as reported by DOB of approximately $2.04
billion. The cash surplus was derived primarily from higher-than-
anticipated receipts and lower spending on welfare, Medicaid, and other
entitlement programs.
The General Fund had a closing balance of $638 million, an increase of
$205 million from the prior fiscal year. The balance is held in three
accounts within the General Fund: the Tax Stabilization Reserve Fund
("TSRF"), the Contingency Reserve Fund ("CRF") and the Community Projects
Fund ("CPF"). The TSRF closing balance was $400 million, following a
required deposit of $15 million (repaying a transfer made in 1991-92) and
an extraordinary deposit of $68 million made from the 1997-98 surplus.
The CRF closing balance was $68 million, following a $27 million deposit
from the surplus. The CPF, which finances legislative initiatives, closed
the fiscal year with a balance of $170 million, an increase of $95
million. The General Fund closing balance did not include $2.39 billion
in the tax refund reserve account, of which $521 million was made
available as a result of the LGAC financing program and was required to be
on deposit on March 31, 1998.
General Fund receipts and transfers from other funds for the 1997-98
fiscal year (including net tax refund reserve account activity) totaled
$34.55 billion, an annual increase of $1.51 billion, or 4.57 percent over
1996-97. General Fund disbursements and transfers to other funds were
$34.35 billion, an annual increase of $1.45 or 4.41 percent.
1996-97 Fiscal Year
The State ended its 1996-97 fiscal year on March 31, 1997 in balance on a
cash basis, with a 1996-97 General Fund cash surplus as reported by DOB of
approximately $1.42 billion. The cash surplus was derived primarily from
higher-than-expected receipts and lower-than-expected spending for social
services programs.
The General Fund closing fund balance was $433 million, an increase of
$146 million from the 1995-96 fiscal year. The balance included $317
million in the TSRF, after a required deposit of $15 million and an
additional deposit of $65 million in 1996-97. The TSRF can be used in the
event of any future General Fund deficit, as provided under the State
Constitution and State Finance Law. In addition, $41 million remains on
deposit in the CRF. This fund assists the State in financing any
extraordinary litigation during the fiscal year. The remaining $75
million reflects amounts then on deposit in the Community Projects Fund.
This fund was created to fund certain legislative initiatives. The
General Fund closing fund balance does not include $1.86 billion in the
tax refund reserve account, of which $521 million was made available as a
result of the LGAC financing program and was required to be on deposit as
of March 31, 1997.
General Fund receipts and transfers from other funds for the 1996-97
fiscal year totaled $33.04 billion, an increase of 0.7 percent from the
previous fiscal year (including net tax refund reserve account activity).
General Fund disbursements and transfers to other funds totaled $32.90
billion for the 1996-97 fiscal year, an increase of 0.7 percent from the
1995-96 fiscal year.
State Financial Practices: GAAP Basis
Historically, the State has accounted for, reported and budgeted its
operations on a cash basis. The State currently formulates a financial
plan on an accrual basis in conformance with generally accepted
accounting principles ("GAAP"). The State, as required by law, continues
to prepare its financial plan and financial reports on the cash basis of
accounting as well.
1998-99 Fiscal Year
On March 31, 1998, the State recorded its first ever accumulated positive
balance in its General Fund on a GAAP basis. This "accumulated surplus"
was $567 million. The improvement in the State's General Fund position is
attributable, in part, to the cash surplus recorded at the end of the
State's 1997-98 fiscal year. Much of that surplus is reserved for future
requirements, but a portion is being used to meet spending needs in 1998-
99. Thus, the State expects some deterioration in its GAAP position, but
expects to maintain a positive General Fund balance through the end of the
current fiscal year.
The 1998-99 GAAP-basis General Fund Financial Plan shows expected tax
revenues of $33.1 billion and miscellaneous revenues of $2.6 billion to
finance expenditures of $36.1 billion and net financing uses of $156
million. The General Fund accumulated surplus is projected to be $27
million at the end of 1998-99.
1997-98 Fiscal Year
The State completed its 1997-98 fiscal year with a combined Governmental
Funds operating surplus of $1.80 billion, which included an operating
surplus in the General Fund of $1.56 billion, in Capital Projects Funds of
$232 million and in Special Revenue Funds of $49 million, offset in part
by an operating deficit of $43 million in Debt Service Funds.
The State reported a General Fund operating surplus of $1.56 billion for
the 1997-98 fiscal year, as compared to an operating surplus of $1.93
billion for the 1996-97 fiscal year. As a result, the State reported an
accumulated surplus of $567 million in the General Fund for the first time
since it began reporting its operations on a GAAP-basis. The 1997-98
fiscal year operating surplus resulted in part from the higher-than-
anticipated personal income tax receipts, an increase in taxes receivable
of $681 million, an increase in other assets of $195 million and a
decrease in pension liabilities of $144 million. These gains were
partially offset by increases in payables to local governments of $270
million and tax refunds payable of $147 million.
Revenues increased $617 million (1.8 percent) over the prior fiscal year,
with increases in personal income, consumption and use, and business
taxes, and decreases reported for other taxes, federal grants and
miscellaneous revenues. Personal income taxes grew $746 million, an
increase of nearly 4.2 percent. The increase in personal income taxes
resulted from strong employment and wage growth and the strong performance
by the financial markets during 1997. Consumption and use taxes increased
$334 million, or 5.0 percent, spurred by increased consumer spending.
Business taxes grew $28 million, an increase of 0.5 percent. Other taxes
fell primarily because revenues for estate and gift taxes decreased.
Miscellaneous revenues decreased $380 million, or 12.7 percent, due to a
decline in receipts from the Medical Malpractice Insurance Association and
medical provider assessments.
Expenditures increased $137 million (0.4 percent) from the prior fiscal
year, with the largest increases occurring in education and social
services. Education expenditures grew $391 million (3.6 percent), mainly
due mainly to an increase in State support for public schools. This
growth was offset, in part, by a reduction in spending for municipal and
community colleges. Social services expenditures increased $233 million
(2.6 percent) to fund growth in these programs. Increases in other State
aid spending were offset by a decline in general purpose aid of $235
million (27.8 percent) due to statutory changes in the payment schedule.
Increases in personal and non-personal service costs were offset by a
decrease in pension contribution of $660 million, a result of the
refinancing of the State's pension amortization that occurred in 1997.
Net other financing sources decreased $841 million (68.2 percent) due to
the nonrecurring use of bond proceeds ($769 million) provided by the
Dormitory Authority of the State of New York to pay the outstanding
pension amortization liability incurred in 1997.
An operating surplus of $49 million was reported for the Special Revenue
Funds for the 1997-98 fiscal year, which increased the accumulated fund
balance to $581 million. Revenues rose by $884 million over the prior
fiscal year (3.3 percent) as a result of increases in tax and federal
grant revenues. Expenditures increased $795 million (3.3 percent) as a
result of increased costs for local assistance grants. Net other
financing uses decreased $105 million (3.3 percent).
Debt Service Funds ended the 1997-98 fiscal year with an operating deficit
of $43 million and, as a result, the accumulated fund balance declined to
$1.86 billion. Revenues increased $246 million (10.6 percent) as a result
of increases in dedicated taxes. Debt service expenditures increased $341
million (14.4 percent). Net other financing sources increased $89 million
(401.3 percent) due primarily to savings achieved through advance
refundings of outstanding bonds.
An operating surplus of $232 million was reported in the Capital Projects
Funds for the State's 1997-98 fiscal year and, as a result, the
accumulated deficit in this fund type decreased to $381 million. Revenues
increased $180 million (8.6 percent) primarily as a result of a $54
million increase in dedicated tax revenues and an increase of $101 million
in federal grants for transportation and local waste water treatment
projects. Expenditures increased $146 million (4.5 percent) primarily as a
result of increased capital construction spending for transportation and
local waste water treatment projects. Net other financing sources
increased by $100 million primarily as a result of a decrease in transfers
to certain public benefit corporations engaged in housing programs.
1996-97 Fiscal Year
The State completed its 1996-97 fiscal year with a combined Governmental
Funds operating surplus of $2.1 billion, which included an operating
surplus in the General Fund of $1.9 billion, in Capital Projects Funds of
$98 million and in the Special Revenue Funds of $65 million, offset in
part by an operating deficit of $37 million in the Debt Service Funds.
The State reported a General Funds operating surplus of $1.93 billion for
the 1996-97 fiscal year, as compared to an operating surplus of $380
million for the prior fiscal year. The 1996-97 fiscal year GAAP operating
surplus reflects several major factors, including the cash basis operating
surplus, the benefit of bond proceeds which reduced the State's pension
liability, an increase in taxes receivable of $493 million, and a
reduction in tax refund liabilities of $196 million. This was offset by
an increased payable to local governments of $244 million.
Revenues increased $1.91 billion (nearly 6.0 percent) over the prior
fiscal year with increases in all revenue categories. Personal income
taxes grew $620 million, an increase of nearly 3.6 percent, despite the
implementation of scheduled tax cuts. The increase in personal income
taxes was caused by moderate employment and wage growth and the strong
financial markets during 1996. Consumption and use taxes increased $179
million or 2.7 percent as a result of increased consumer confidence.
Business taxes grew $268 million, an increase of 5.6 percent, primarily as
a result of the strong financial markets during 1996. Other taxes
increased primarily because revenues from estate and gift taxes increased.
Miscellaneous revenues increased $743 million, a 33.1 percent increase,
because of an increase in receipts from the Medical Malpractice Insurance
Association and from medical provider assessments.
Expenditures increase $830 million (2.6 percent) from the prior fiscal
year, with the largest increase occurring in pension contributions and
State aid for education spending. Pension contribution expenditures
increased $514 million (198.2 percent) primarily because the State paid
off its 1984-85 and 1985-86 pension amortization liability. Education
expenditures grew $351 million (3.4 percent) due mainly to an increase in
spending for support for public schools and physically handicapped
children offset by a reduction in spending for municipal and community
colleges. Modest increases in other State aid spending was offset by a
decline in social services expenditures of $157 million (1.7 percent).
Social services spending continues to decline because of cost containment
strategies and declining caseloads.
Net other financing sources increased $475 million (62.6 percent) due
mainly to bond proceeds provided by the Dormitory Authority of the State
of New York to pay the outstanding pension amortization, offset by
elimination of prior year LGAC proceeds.
An operating surplus of $65 million was reported for the Special Revenue
Funds for the 1996-97 year, increasing the accumulated fund balance to
$532 million. Revenues increased $583 million over the prior fiscal year
(2.2 percent) as a result of increases in tax and lottery revenues.
Expenditures increased $384 million (1.6 percent) as a result of increased
costs for departmental operations. Net other financing uses decreased
$275 million (8.0 percent) primarily because of declines in amounts
transferred to other funds.
Debt Service Funds ended the 1996-97 fiscal year with an operating deficit
of $37 million and, as a result, the accumulated fund balance declined to
$1.90 billion. Revenues increased $102 million (4.6 percent) because of
increases in both dedicated taxes and mental hygiene patient fees. Debt
service expenditures increased $47 million (2.0 percent). Net other
financing sources decreased $277 million (92.6 percent) due primarily to
an increase in payments on advance refunds.
An operating surplus of $98 million was reported to the Capital Projects
Funds for the State's 1996-97 fiscal year and, as a result, the
accumulated fund balance decreased to a deficit of $614 million. Revenues
increased $100 million (5.0 percent) primarily because a larger share of
the real estate transfer tax was shifted to the Environmental Protection
Fund and federal grant revenues increased for transportation and local
waste water treatment projects. Expenditures decreased $359 million (10.0
percent) because of declines in capital grants for education, housing and
regional development programs and capital construction spending. Net
other financing sources decreased by $637 million as a result of a
decrease in proceeds from financing arrangements.
Economic Overview
New York 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 services employment, and a very small
share of the nation's farming and mining activity. The State's location
and its excellent air transport facilities and natural harbors have made
it an important link in international commerce. Travel and tourism
constitute an important part of the economy. Like the rest of the nation,
the State has a declining proportion of its workforce engaged in
manufacturing, and an increasing proportion engaged in service industries.
The services sector, which includes entertainment, personal services, such
as health care and auto repairs, and business-related services, such as
information processing, law and accounting, is the State's leading
economic sector. The service sector accounts for more than three of every
ten nonagricultural jobs in New York and has a higher proportion of total
jobs than does the rest of the nation.
Manufacturing employment continues to decline in importance in New York,
as in most other states, and New York's economy is less reliant on this
sector than is the nation. The principal manufacturing industries in
recent years produced printing and publishing materials, instruments and
related products, machinery, apparel and finished fabric products,
electronic and other electric equipment, food and related products,
chemicals and allied products, and fabricated metal products.
Wholesale and retail trade is the second largest sector in terms of
nonagricultural jobs in New York but is considerably smaller when measured
by income share. Trade consists of wholesale businesses and retail
businesses, such as department stores and eating and drinking
establishments.
New York City is the nation's leading center of banking and finance, and,
as a result, this is a far more important sector in the State than in the
nation as a whole. Although this sector accounts for under one-tenth of
all nonagricultural jobs in the State, it contributes over one-sixth of
all nonfarm labor and proprietors' income.
Farming is an important part of the economy of large regions of the State,
although it constitutes a very minor part of total State output.
Principal agricultural products of the State include milk and dairy
products, greenhouse and nursery products, apples and other fruits, and
fresh vegetables. New York ranks among the nation's leaders in the
production of these commodities.
Federal, State and local government together are the third largest sector
in terms of nonagricultural jobs, with the bulk of the employment
accounted for by local governments. Public education is the source of
nearly one-half of total state and local government employment.
The State is likely to be less affected than the nation as a whole during
an economic recession that is concentrated in manufacturing and
construction, but likely to be more affected during a recession that is
concentrated more in the service-producing section.
In the calendar years 1987 through 1997, the State's rate of economic
growth was somewhat slower than that of the nation. In particular, during
the 1990-91 recession and post-recession period, the economy of the State,
and that of the rest of the Northeast, was more heavily damaged than that
of the nation as a whole and has been slower to recover. The total
employment growth rate in the State has been below the national average
since 1987. The unemployment rate in the State dipped below the national
rate in the second half of 1981 and remained lower until 1991; since then,
it has been higher. According to data published by the U.S. Bureau of
Economic Analysis, total personal income in the State has risen more
slowly than the
national average since 1988.
State per capita personal income has historically been significantly
higher than the national average, although the ratio has varied
substantially. Because New York City (the "City") is a regional employment
center for a multi-state region, State personal income measured on a
residence basis understates the relative importance of the State to the
national economy and the size of the base to which State taxation applies.
The fiscal stability of the State is related, in part, to the fiscal
stability of its public benefit corporations (the "Authorities").
Authorities, which have responsibility for financing, constructing and
operating revenue providing public facilities, 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, and as
otherwise restricted by, their legislative authorizations. The State's
access to the public credit markets could be impaired, and the market
price of its outstanding debt may be materially adversely affected, if any
of its Authorities were to default on their respective obligations,
particularly those using State-supported or State-related financing
techniques. As of December 31, 1997, there were 17 Authorities that had
outstanding debt of $100 million or more, and the aggregate outstanding
debt, including refunding bonds, of all State Authorities was $84 billion,
only a portion of which constitutes State-supported or State-related debt.
Moral obligation financing generally involves the issuance of debt by an
Authority to finance a revenue-producing project or other activity. The
debt is secured by project revenues and includes statutory provisions
requiring the State, subject to appropriation by the Legislature, to make
up any deficiencies which may occur in the issuer's debt service reserve
fund. There has never been a default on any moral obligation debt of any
public authority. The State does not intend to increase statutory
authorizations for moral obligation bond programs. From 1976 through
1987, the State was called upon to appropriate and make payments totaling
$162.8 million to make up deficiencies in the debt service reserve funds
of the Housing Finance Agency pursuant to moral obligation provisions. In
the same period, the State also expended additional funds to assist the
Project Finance Agency, the New York State Urban Development Corporation
and other public authorities which had moral obligation debt outstanding.
The State has not been called upon to make any payments pursuant to any
moral obligations since the 1986-87 fiscal year and no such requirements
are anticipated during the 1998-99 fiscal year.
In addition to the moral obligation financing arrangements described
above, State law provides for the creation of State municipal assistance
corporations, which are public authorities established to aid financially
troubled localities. The Municipal Assistance Corporation For The City of
New York ("NYC MAC") was created in 1975 to provide financing assistance
to the City. To enable NYC MAC to pay debt service on its obligations,
NYC MAC receives, subject to annual appropriation by the Legislature,
receipts from the 4 percent New York State sales tax for the benefit of
the City, the State-imposed stock transfer tax and, subject to certain
prior liens, certain local assistance payments otherwise payable to the
City. The legislation creating NYC MAC also includes a moral obligation
provision. Under its enabling legislation, NYC MAC's authority to issue
moral obligation bonds and notes (other than refunding bonds and notes)
expired on December 31, 1984. In 1995, the State created the Municipal
Assistance Corporation for the City of Troy ("Troy MAC"). The bonds
issued by Troy MAC do not include the moral obligation provisions.
The State also provides for contingent contractual-obligation financing
for the Secured Hospital Program pursuant to legislation enacted in 1985.
Under this financing method, the State entered into service contracts
which obligate the State to pay debt service, subject to annual
appropriations, on bonds issued by the New York State Medical Care
Facilities Finance Agency and now included as debt of the Dormitory
Authority of the State of New York in the event there are shortfalls of
revenues from other sources. The State has never been required to make
any payments pursuant to this financing arrangement, nor does it
anticipate being required to do so during the 1998-99 fiscal year. The
legislative authorization to issue bonds under this program expired on
March 1, 1998.
Authorities' operating expenses and debt service costs are generally paid
by revenues generated by the projects financed or operated, such as tolls
charged for the use of highways, bridges or tunnels, charges for public
power, electric and gas utility services, rentals charged for housing
units, and charges for occupancy at medical care facilities. In addition,
State legislation authorizes several financing techniques for Authorities.
Also, there are statutory arrangements providing for State local
assistance payments, otherwise payable to localities, to be made under
certain circumstances to Authorities. Although the State has no
obligation to provide additional assistance to localities whose local
assistance payments have been paid to Authorities under these
arrangements, if local assistance payments are so diverted, the affected
localities could seek additional State assistance. Some Authorities also
receive moneys from State appropriations to pay for the operating costs of
certain of their programs.
The Metropolitan Transportation Authority (the "MTA") oversees the City's
subway and bus lines by its affiliates, the New York City Transit
Authority and the Manhattan and Bronx Surface Transit Operating Authority
(collectively, the "TA"). The MTA operates certain commuter rail and bus
lines in the New York metropolitan area through the MTA's subsidiaries,
the Long Island Rail Road Company, the Metro-North Commuter Railroad
Company and the Metropolitan Suburban Bus Authority. In addition, the
Staten Island Rapid Transit Operating Authority, an MTA subsidiary,
operates a rapid transit line on Staten Island. Through its affiliated-
agency, the Triborough Bridge and Tunnel Authority (the "TBTA"), the MTA
operates certain intrastate toll bridges and tunnels. Because fare
revenues are not sufficient to finance the mass transit portion of these
operations, the MTA has depended and will continue to depend on operating
support from the State, local government and TBTA, including loans, grants
and subsidies. If current revenue projections are not realized and/or
operating expenses exceed current projections, the TA or commuter
railroads may be required to seek additional state assistance, raise fares
or take other actions.
Since 1980, the State has enacted several taxes--including a surcharge on
the profits of banks, insurance corporations and general business
corporations doing business in the 12-county Metropolitan Transportation
Region served by the MTA and a special one-quarter of 1 percent regional
sales and use tax--that provide revenues for mass transit purposes,
including assistance to the MTA. In addition, since 1987, state law has
required that the proceeds of a one-quarter of 1 percent mortgage
recording tax paid on certain mortgages in the Metropolitan Transportation
Region be deposited in a special MTA fund for operating or capital
expenses. Further, in 1993, the State dedicated a portion of the State
petroleum business tax receipts to fund operating or capital assistance to
the MTA. For the 1998-99 fiscal year, total State assistance to the MTA
is estimated at approximately $1.3 billion, an increase of $133 million
over the 1997-98 fiscal year.
State legislation accompanying the 1996-97 adopted State budget authorized
the MTA, TBTA and TA to issue an aggregate of $6.5 billion in bonds to
finance a portion of the $12.17 billion MTA capital plan for the 1995
through 1999 calendar years (the "1995-99 Capital Program"). In July
1997, the Capital Program Review Board approved the 1995-99 Capital
Program (subsequently amended in August 1997), which supersedes the
overlapping portion of the MTA's 1992-96 Capital Program. The 1995-99
Capital Program is the fourth capital plan since the Legislature
authorized procedures for the adoption, approval and amendment of MTA
capital programs and is designed to upgrade the performance of the MTA's
transportation systems by investing in new rolling stock, maintaining
replacement schedules for existing assets and bringing the MTA system to a
state of good repair. The 1995-99 Capital Program assumes the issuance of
an estimated $5.2 billion in bonds under this $6.5 billion aggregate
bonding authority. The remainder of the plan is projected to be financed
through assistance from the State, the federal government, and the City of
New York, and from various other revenues generated from actions taken by
the MTA.
There can be no assurance that all the necessary governmental actions for
future capital programs will be taken, that funding sources currently
identified will not be decreased or eliminated, or that the 1995-99
Capital Program, or parts thereof, will not be delayed or reduced. Should
funding levels fall below current projections, the MTA would have to
revise its 1995-99 Capital Program accordingly. If the 1995-99 Capital
Program is delayed or reduced, ridership and fare revenues may decline,
which could, among other things, impair the MTA's ability to meet its
operating expenses without additional State assistance.
Certificates of Participation
The State also participates in the issuance of certificates of
participation ("COPs") in a pool of leases entered into by the State's
Office of General Services on behalf of several State departments and
agencies interested in acquiring operational equipment, or in certain
cases, real property. Legislation enacted in 1986 established restrictions
upon and centralized State control, through the Comptroller and the
Director of the Budget, over the issuance of COPs representing the State's
contractual obligation, subject to annual appropriation by the
Legislature and availability of money, to make installment or lease-
purchase payments for the State's acquisition of such equipment or real
property.
New York City
The fiscal health of the State may also be affected by the fiscal health
of New York City (the "City"), which continues to require significant
financial assistance from the State. State aid contributes to the City's
ability to balance its budget and meet its cash requirements. The State
may also be affected by the ability of the City and certain entities
issuing debt for the City to market their securities successfully in the
public credit markets. The City has achieved balanced operating results
from each of its fiscal years since 1981 as reported in accordance with
the then-applicable GAAP standards.
In response to the City's fiscal crisis in 1975, the State took action to
assist the City in returning to fiscal stability. Among those actions,
the State established the NYC MAC to provide financing assistance to the
City; the New York State Financial Control Board (the "Control Board") to
oversee the City's financial affairs; the Office of the State Deputy
Comptroller for the City of New York ("OSDC") to assist the Control Board
in exercising its powers and responsibilities. A "Control Period" existed
from 1975 to 1986, during which the City was subject to certain
statutorily-prescribed fiscal controls. The Control Board terminated the
Control Period in 1986 when certain statutory conditions were met. State
law requires the Control Board to reimpose a Control Period upon the
occurrence, or "substantial likelihood and imminence" of the occurrence,
of certain events, including, but not limited to, a City operating budget
deficit of more than $100 million or impaired access to the public credit
markets.
Currently, the City and its Covered Organizations (i.e., those which
receive or may receive moneys from the City directly, indirectly or
contingently) operate under a four-year financial plan (the "Financial
Plan") which the City prepares annually and periodically updates. The
City's Financial Plan summarizes its capital, revenue and expense
projections and outlines proposed gap-closing programs for years with
projected budget gaps. The City's projections set forth in the Financial
Plan are based on various assumptions and contingencies, some of which are
uncertain and may not materialize. Unforeseen developments and changes in
major assumptions could significantly affect the City's ability to balance
its budget as required by State law and to meet its annual cash flow and
financing requirements.
To successfully implement its Financial Plan, the City and certain
entities issuing debt for the benefit of the City must market their
securities successfully. The City issues securities to finance, refinance
and rehabilitate infrastructure and other capital needs, as well as for
seasonal financing needs. In 1997, the State created the New York City
Transitional Finance Authority ("TFA") to finance a portion of the City's
capital program because the City was approaching its State Constitutional
general debt limit. Without the additional financial capacity of the TFA,
projected contracts for City capital projects would have exceeded the
City's debt limit during City fiscal year 1997-98. Despite this additional
financing mechanism, the City currently projects that, if no further
action is taken, it will reach its debt limit in City fiscal year 1999-
2000. On June 2, 1997, an action was commenced seeking a declaratory
judgment declaring the legislation establishing the TFA to be
unconstitutional. On November 25, 1997, the State Supreme Court found the
legislation establishing the TFA to be constitutional and granted the
defendants' motion for summary judgment. The plaintiffs have appealed the
decision. Future developments concerning the City or entities issuing
debt for the benefit of the City, and public discussion of such
developments, as well as prevailing market conditions and securities
credit ratings, may affect the ability or cost to sell securities issued
by the City or such entities and may also affect the market for their
outstanding securities.
OSDC and Control Board Reports
The staffs of the Control Board, OSDC and the City Comptroller issue
periodic reports on the City's Financial Plans. The reports analyze the
City's forecasts of revenues and expenditures, cash flow, and debt service
requirements, as well as evaluate compliance by the City and its Covered
Organizations with the Financial Plan. Some of these reports have warned
that the City may have underestimated certain expenditures and
overestimated certain revenues and have suggested that the City may not
have adequately provided for future contingencies. Certain of these
reports have analyzed the City's future economic and social conditions and
have questioned whether the City has the capacity to generate sufficient
revenues in the future to meet the costs of its expenditure increases to
provide necessary services.
On July 20, 1998, the staff of the Control Board issued a report reviewing
the June 1998 Financial Plan. The report noted that the City is likely to
end the 1999 fiscal year in balance. However, the report identified risks
of $510 million, $291 million and $637 million for fiscal years 2000
through 2002, respectively, which, when combined with the City's projected
gaps, result in estimated gaps of $2.8 billion, $3.4 billion and $3.3
billion for fiscal years 2000 through 2002, respectively, before making
provision for any increased labor costs which may occur when the current
contracts with City employees expire in calendar year 2000. With respect
to the 1999 fiscal year, the report noted the possibility that non-
property tax receipts could be $400 million greater than forecast in the
June 1998 Financial Plan, but that gap-closing actions assumed in the June
Financial Plan totaling $402 million have not yet been specified by the
City. Finally, the report noted that because of the sensitivity of the
City's tax base to the health of the financial services sector, the City
needs to be cautious about the outlook of the securities industry.
Financing Requirements
The City requires significant amounts of financing for seasonal and
capital purposes. Since 1981, the City has fully satisfied its seasonal
financing needs in the public credit markets, repaying all short-term
obligations within their fiscal year of issuance. The City issued $500
million of short-term obligations in the 1998-99 fiscal year to finance
the its projected cash flow needs for that year. The City issued $1.075
billion of short-term obligations in fiscal year 1998 to finance the
City's projected cash flow needs for the 1998 fiscal year. The City issued
$2.4 billion of short-term obligations in fiscal year 1997. The delay in
the adoption of the States budget in certain past fiscal years has
required the City to issue short-term notes in amounts exceeding those
expected early in such fiscal years.
The City makes substantial capital expenditures to reconstruct and
rehabilitate its infrastructure and physical assets, including mass
transit facilities, sewers, streets, bridges and tunnels, and to make
capital investments that will improve productivity in City operations.
City-funded commitments, which were $344 million in 1979, are projected to
reach $4.8 billion in 1999, and City-funded expenditures, which more than
tripled between fiscal years 1980 and 1985, are forecast at $3.3 billion
in the 1999 fiscal year; total expenditures are forecast at $3.8 billion
in 1999.
In connection with the June 1998 Financial Plan, the City has outlined a
gap-closing program for the fiscal years 2000, 2001 and 2002 to eliminate
the respective $2.2 billion, $2.9 billion and $2.4 billion projected
remaining budget deficits for such fiscal years. The City has not
specified this program in detail.
The City's projected budget gaps for the 2001 and 2002 fiscal years do not
reflect the savings expected to result from the prior years programs to
close the gaps set forth in the Financial Plan. Thus, for example,
recurring savings anticipated from the actions which the City proposes to
take to balance the fiscal year 2000 budget are not taken into account in
projecting the budget gaps for the 2001 and 2002 fiscal years.
Although the City has maintained balanced budgets in each of its last
eighteen fiscal years and is projected to achieve balanced operating
results for the 1999 fiscal year, there can be no assurance that the gap-
closing actions proposed in the Financial Plan can be successfully
implemented or that the City will maintain a balanced budge in future
years without additional State aid, revenue increases or expenditure
reductions. Additional tax increases and reductions in essential City
services could adversely affect the City's economic base.
Other Localities
Certain localities outside the City have experienced financial problems
and have requested and received additional State assistance during the
last several State fiscal years. The cities of Yonkers and Troy continue
to operate under State-ordered control agencies. The potential impact on
the State of any future requests by localities for additional oversight or
financial assistance is not included in the projections of the State's
receipts and disbursements for the State's 1997-98 fiscal year.
Eighteen municipalities received extraordinary assistance during the 1996
legislative session through $50 million in special appropriations targeted
for distressed cities, and twenty-eight municipalities received more than
$32 million in targeted unrestricted aid in the 1997-98 budget. The State
also dispersed an additional $21 million among all cities, towns and
villages after enacting a 3.97 percent increase in General Purpose State
Aid in 1997-98 and continued this increase in 1998-99.
The 1998-99 budget includes an additional $29.4 million in unrestricted
aid targeted to 57 municipalities across the State. Other assistance for
municipalities with special needs totals more than $25.6 million. Twelve
upstate cities will receive $24.2 million in one-time assistance from a
cash flow acceleration of State aid.
The appropriation and allocation of general purpose local government aid
among localities, including the City, is currently the subject of
investigation by a State commission. While the distribution on general
purpose local government aid was originally based on a statutory formula,
in recent years both the total amount appropriated and the amounts
appropriated to localities have been determined by the Legislature. A
State commission was established to study the distribution and amounts of
general purpose local government aid and recommend a new formula by June
30, 1999, which may change the way aid is allocated.
Certain Municipal Indebtedness
Municipalities and school districts have engaged in substantial short-term
and long-term borrowings. In 1996, the total indebtedness of all
localities in the State other than the City was approximately $20.0
billion. A small portion (approximately $77.2 million) of that
indebtedness represented borrowing to finance budgetary deficits and was
issued pursuant to enabling State legislation. State law requires the
Comptroller to review and make recommendations concerning the budgets of
those local government units other than the City that are authorized by
State law to issue debt to finance deficits during the period that such
deficit financing is outstanding. Twenty-one localities had outstanding
indebtedness for deficit financing at the close of their fiscal year
ending in 1996.
Like the State, local governments must respond to changing political,
economic and financial influences over which they have little or no
control. Such changes may adversely affect the financial condition of
certain local governments. For example, the federal government may reduce
(or in some cases eliminate) federal funding of some local programs which,
in turn, may require local governments to fund these expenditures from
their own resources. It is also possible that the State, the City, or any
of their respective public authorities may suffer serious financial
difficulties that could jeopardize local access to the public credit
markets, which may adversely affect the marketability of notes and bonds
issued by localities within the State. Localities may also face
unanticipated problems resulting from certain pending litigation, judicial
decisions and long-range economic trends. Other large scale potential
problems, such as declining urban populations, increasing expenditures,
and the loss of skilled manufacturing jobs, may also adversely affect
localities and necessitate State assistance.
Litigation
The State is a defendant in legal proceedings involving State finances,
State programs and miscellaneous civil rights, tort, real property and
contract claim where the monetary damages sought are substantial,
generally in excess of $100 million. These proceedings could affect
adversely the financial condition of the State in the 1998-99 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
1998-99 State Financial Plan. The State believes that the proposed 1998-
99 State Financial Plan includes sufficient reserves for the payment of
judgments that may be required during the 1998-99 fiscal year. There can
be no assurance, however, that an adverse decision in any of these
proceedings would not exceed the amount of all potential 1998-99 State
Financial Plan resources available for the payment of judgments, and could
therefore affect the ability of the State to maintain a balanced 1998-99
State Financial Plan.
Medicaid
In several cases, plaintiffs seek reimbursement for services provided to
Medicaid recipients who were also eligible for Medicare during the period
January 1, 1987 to June 2, 1992. Included are Matter of New York State
Radiological Society v. Wing, Appel v. Wing, E.F.S. Medical Supplies v.
Dowling, Kellogg v. Wing, Lifshitz v. Wing, New York State Podiatric
Medical Association v. Wing and New York State Psychiatric Association v.
Wing. These cases were commenced after the State's reimbursement
methodology was held invalid in New York City Health and Hospital Corp. v.
Perales. The State contends that these claims are time-barred. In a
judgment dated September 5, 1996, the Supreme Court, Albany County,
dismissed Matter of New York State Radiological Society v. Wing as time-
barred. By order dated November 26, 1997, the Appellate Division, Third
Department, affirmed that judgment. By decision dated June 9, 1998, the
Court of Appeals denied leave to appeal. The time in which to seek
further review has expired in the latter case.
Several cases, including Port Jefferson Health Care Facility et al. v.
Wing (Supreme Court, Suffolk County), challenge the constitutionality of
Public Health Law Section 2807-d, which imposes a tax on the gross
receipts that hospitals and residential health care facilities receive
from patient care services. Plaintiffs allege that the tax assessments
were not uniformly applied, in violation of federal regulations. In a
decision dated June 30, 1997, the Court held that the 1.2 percent and 3.8
percent assessments on gross receipts imposed pursuant to Public Health
Law Section 2807-d(2)(b)(ii) and Section 2807-d(2)(b)(iii), respectively,
are unconstitutional. An order entered August 27, 1997, enforced the
terms of the decision. The state appealed that order. By decision and
order dated August 31, 1998, the Appellate Division, Second Department,
affirmed that order. On September 30, 1998, the State moved for re-
argument or, in the alternative, for a certified question for the Court of
Appeals to review.
Although other litigation is pending against the State, 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.
Year 2000
The State is currently addressing Year 2000 data processing compliance
issues. In 1996, the State created the Office of Technology ("OFT") to
help address statewide technology issues, including the Year 2000 issue.
OFT has estimated that investments of at least $140 million will be
required to bring approximately 350 State mission-critical and high-
priority computer systems not otherwise scheduled for replacement into
Year 2000 compliance. The State is planning to spend $100 million in the
1998-99 fiscal year for this purpose. The State's budget provides funding
for major systems scheduled for replacement, including the State payroll,
civil service, tax and finance and welfare management systems, for which
Year 2000 compliance is included as part of the project.
OFT is monitoring compliance on a quarterly basis and is providing
assistance and assigning resources to accelerate compliance for mission
critical systems, with most compliance testing expected to be completed by
mid-1999. There can be no guarantee, however, that all of the State's
mission-critical and high-priority computer systems will be made Year 2000
compliant in a timely manner and that there will not be an adverse effect
upon State operations or State finances as a result.
CALIFORNIA FUND
The following is based on information obtained from an Official Statement
dated December 9, 1998 relating to $600,000,000 State of California
General Obligation Bonds and the Governor's Budget Summary 1999-2000.
Limits on Spending and Taxes
Under California (the "State") constitutional amendments, the State is
subject to an annual appropriations limit. The limit may be exceeded in
cases of emergency. The State's yearly appropriations limit is based on
the limit for the prior year adjusted annually for changes in California
per capita personal income and population and any transfers of financial
responsibility of providing services to or from another unit of
government.
On November 8, 1988, voters approved Proposition 98, a combined initiative
constitutional amendment and statute, which changed State funding of
public education below the university level and the operation of the State
appropriations limit, primarily by guaranteeing local schools and
community colleges ("K-14 schools") a minimum share of General Fund
revenues. Under Proposition 98, K-14 schools are guaranteed the greater
of a fixed percentage of General Fund revenues and the prior year's
appropriation adjusted for growth.
During the recession, General Fund revenues for several years were less
than originally projected, so that the original Proposition 98
appropriations turned out to be higher than the minimum percentage
provided in the law. The Legislature responded to these developments by
designating the "extra" Proposition 98 payments in one year as a "loan"
from future years' entitlements. By implementing these actions, per-pupil
funding from Proposition 98 sources stayed almost constant at
approximately $4,200 from Fiscal Year 1991-92 to Fiscal Year 1993-94.
In 1992, a lawsuit was filed, called California Teachers' Association v.
Gould, which challenged the validity of these off-budget loans. The
settlement in this case provides, among other things, that both the State
and K-14 schools share in the repayment of prior years' emergency loans to
schools. Of the total $1.76 billion in loans, the State will repay $935
million by forgiveness of the amount owed, while schools will repay $825
million. The State share of the repayment will be reflected as an
appropriation above the current Proposition 98 base calculation. The
schools' share of the repayment will count as appropriations that count
toward satisfying the Proposition 98 guarantee, or from "below" the
current base. Repayments are spread over the eight-year period of 1994-95
through 2001-02 to mitigate any adverse fiscal impact. The 1998-99 Budget
Act appropriated $250 million as repayment of prior years' loans to
schools, as part of the settlement in this case.
Short-Term Borrowing of California
As part of its cash management program, the State has regularly issued
short-term obligations to meet cash flow needs. Between spring 1992 and
summer 1994, the State had depended upon external borrowing, including
borrowings extending into the subsequent fiscal year, to meet its cash
needs, including repayment of maturing Notes and Warrants. The State
issued $1.7 billion of revenue anticipation notes for the 1998-99 Fiscal
Year, which notes are to mature on June 30, 1999.
The State Treasurer is working closely with the State Controller and the
Department of Finance to manage the State's cash flow on a regular basis,
with the goal of reducing the State's external cash flow borrowing. The
three offices are also working to develop programs to use commercial paper
in whole or in part for the State's cash flow borrowing needs, and for
construction period financing for both general obligation bond-funded and
lease-revenue bond-funded projects. As of March 1, 1997 the Finance
Committees had authorized the issuance of approximately $3.356 billion of
commercial paper notes, but as of that date only $367.78 million aggregate
principal amount of general obligation commercial paper notes was actually
issued and outstanding.
The State has always paid the principal of and interest on its general
obligation bonds, general obligation commercial paper, lease-purchase debt
and short-term obligations, including revenue anticipation notes and
revenue anticipation warrants when due.
1998-99 Fiscal Year Budget
When the Governor released his proposed 1998-99 Fiscal Year Budget on
January 9, 1998, he projected General Fund revenues for the 1998-99 Fiscal
Year of $55.4 billion, and proposed expenditures in the same amount.
The Legislature passed the 1998-99 Budget Bill on August 11, 1998, and the
Governor signed it on August 21, 1998. In signing the Budget Bill, the
Governor used his line-item veto power to reduce expenditures by $1.360
billion from the General Fund, and $160 million from Special Funds. Of
this total, the Governor indicated that about $250 million of vetoed funds
were "set aside" to fund programs for education. Vetoed items included
education funds, salary increases and many individual resources and
capital projects.
The 1998-99 Budget Act is based on projected General Fund revenues and
transfers of $57.0 billion (after giving effect to various tax reductions
enacted in 1997 and 1998), a 4.2% increase from revised 1997-98 figures.
Special Fund revenues were estimated at $14.3 billion.
After giving effect to the Governor's vetoes, the Budget Act provides
authority for expenditures of $57.3 billion from the General Fund (a 7.3%
increase from 1997-98), $14.7 billion from Special Funds, and $3.4 billion
from bond funds. The Budget Act projects a balance in the State's budget
reserve (the Special Fund for Economic Uncertainties or SFEU) at June 30,
1999 (but without including the "set aside" veto amount) of $1.255
billion, a little more than 2% of General Fund revenues. The Budget Act
assumes the State will carry out its normal intra-year cash flow borrowing
in the amount of $1.7 billion of revenue anticipation notes, which were
issued on October 1, 1998.
The most significant feature of the 1998-99 budget was agreement on a
total of $1.4 billion of tax cuts. The central element is a bill that
provides for a phased-in reduction of the Vehicle License Fee (VLF).
Since the VLF is currently transferred to cities and counties, the bill
provides for the General Fund to replace the lost revenues. Starting on
January 1, 1999, the VLF will be reduced by 25% at a cost to the General
Fund of approximately $500 million in the 1998-99 Fiscal Year and about $1
billion annually thereafter.
In addition to the cut in VLF, the 1998-99 budget includes both temporary
and permanent increases in the personal income tax dependent credit ($612
million General Fund cost in 1998-99, but less in future years), a
nonrefundable renters' tax credit ($133 million), and various targeted
business tax credits ($106 million).
Other significant elements of the 1998-99 Budget Act are as follows:
1. Proposition 98 funding for K-12 schools is increased by $1.7
billion in General Fund moneys over revised 1997-98 levels, about $300
million higher than the minimum Proposition 98 guaranty. An additional
$600 million was appropriated to "settle up" prior years' Proposition 98
entitlements, and was primarily devoted to one-time uses such as block
grants, deferred maintenance, and computer and laboratory equipment. The
Budget also includes $250 million as repayment of prior years' loans to
schools, as part of the settlement of California Teachers' Association v.
Gould.
2. Funding for higher education increased substantially above
the level called for in the Governor's four-year compact. General Fund
support was increased by $340 million (15.6%) for the University of
California and $267 million (14.1%) for the California State University
system. In addition, Community Colleges received a $300 million (6.6%)
increase under Proposition 98.
3. The Budget includes increased funding for health, welfare
and social services programs. A 4.9% grant increase was included in the
basic welfare grants, the first increase in those grants in 9 years.
4. Funding for the judiciary and criminal justice programs
increased by about 11% over 1997-98, primarily to reflect increased State
support for local trial courts and a rising prison population.
5. The Budget also included new funding for resources projects,
dedication of $376 million of General Fund moneys for capital outlay
projects, funding of a 3% State employee salary increase, funding of 2,000
new Department of Transportation positions to accelerate transportation
construction projects, and funding of the Infrastructure and Economic
Development Bank ($50 million).
6. The State received approximately $167 million of federal
reimbursements to offset costs related to the incarceration of
undocumented alien felons for federal fiscal year 1997. The State
anticipates receiving approximately $195 million in federal reimbursements
for federal fiscal year 1998.
After the Budget Act was signed, and prior to the close of the Legislative
session on August 31, 1998, the Legislature passed a variety of fiscal
bills. The Governor had until September 30, 1998 to sign or veto these
bills. The bills with the most significant fiscal impact that the
Governor signed include $235 million for certain water system improvements
in southern California, $243 million for the State's share of the purchase
of environmentally sensitive forest lands, $178 million for state prisons,
$160 million for housing assistance ($40 million of which was included in
the 1998-99 Budget Act and an additional $120 million reflected in
Proposition 1A), and $125 million for juvenile facilities. The Governor
also signed bills totaling $223 million for educational programs that were
part of his $250 million veto "set aside," and $32 million for local
governments fiscal relief. In addition, he signed a bill reducing by $577
million the State's obligation to contribute to the State Teachers'
Retirement System in the 1998-99 Fiscal Year.
Based solely on the legislation enacted, on a net basis, the reserve for
June 30, 1999, was reduced by $256 million. On the other hand, 1997-98
revenues have been increased by $160 million. The revised June 30, 1999,
reserve is projected to be $1,159 million or $96 million below the level
projected in the Budget Act. In November 1998, the Legislative Analyst's
Office released a report predicting that General Fund revenues for 1998-
99 would be somewhat lower, and expenditures somewhat higher, than the
Budget Act forecasts, but the net variance would be within the projected
$1.2 billion year-end reserve amount.
1995-96 through 1997-98 Fiscal Years
The State's financial condition improved markedly during the 1995-96,
1996-97 and 1997-98 fiscal years, with a combination of better than
expected revenues, slowdown in growth of social welfare programs, and
continued spending restraint based on the actions taken in earlier years.
The State's cash position also improved, and no external deficit borrowing
has occurred over the end of these three fiscal years.
The economy grew strongly during these fiscal years and, as a result, the
General Fund received substantially greater tax revenues (around $2.2
billion in 1995-96, $1.6 billion in 1996-97 and $2.2 billion in 1997-98)
than initially forecast when the related budgets were enacted. These
additional funds were largely directed to school spending as mandated by
Proposition 98, and to make up shortfalls from reduced federal health and
welfare aid in 1995-96 and 1996-97. The accumulated budget deficit from
the recession years was finally eliminated. The Department of Finance
estimates that the State's budget reserve (the SFEU) totaled $639.8
million as of June 30, 1997 and $1.782 billion at June 30, 1998.
The following were major features of the 1997-98 Budget Act:
1. For the second year in a row, the Budget contained a large
increase in funding for K-14 education under Proposition 98, reflecting
strong revenues that exceeded initial budgeted amounts. Part of the
nearly $1.75 billion of increased spending was allocated to prior fiscal
years.
2. The Budget Act reflected payment of $1.228 billion to
satisfy a court judgment in a lawsuit regarding payments to the State
pension fund, and brought funding of the State's pension contribution back
to the quarterly basis that existed prior to the deferral actions that
were invalidated by the
courts.
3. Funding from the General Fund for the University of
California and the California State University system was increased by
about 6 percent ($121 million and $107 million respectively), and there
was no increase in student fees.
4. Unlike prior years, this Budget Act did not depend on
uncertain federal budget actions. About $300 million in federal funds,
already included in the federal Fiscal Year 1997 and 1998 budgets, was
included in the Budget Act, to offset incarceration costs for illegal
aliens.
5. The Budget Act contained no tax increases, and no tax
reductions. The Renters Tax Credit was suspended for another year, saving
approximately $500 million.
Fiscal Years Prior to 1995-96
Pressures on the State's budget in the late 1980's and early 1990's were
caused by a combination of external economic conditions (including a
recession which began in 1990) and growth of the largest General Fund
programs--K-14 education, health, welfare and corrections--at rates faster
than the revenue base. During this period, expenditures exceeded revenues
in four out of six years up to 1992-93, and the State accumulated and
sustained a budget deficit approaching $2.8 billion at its peak on June
30, 1993. Between the 1991-92 and 1994-95 Fiscal Years, each budget
required multibillion dollar actions to bring projected revenues and
expenditures into balance, including significant cuts in health and
welfare program expenditures; transfers of program responsibilities and
funding from the State to local governments; transfer of about $3.6
billion in annual local property tax revenues from other local governments
to local school districts, thereby reducing State funding for schools
under Proposition 98; and revenue increases (particularly in the 1991-92
Fiscal Year), most of which were for a short duration.
Despite these budget actions, the effects of the recession led to large,
unanticipated budget deficits. By the 1993-94 Fiscal Year, the
accumulated deficit was so large that it was impractical to retire the
deficit in one year, so a two-year program was implemented, using the
issuance of revenue anticipation warrants to carry a portion of the
deficit over the end of the fiscal year. When the economy failed to
recover sufficiently in 1993-94, a second two-year plan was implemented in
1994-95, again using cross-fiscal revenue anticipation warrants to partly
finance the deficit into the 1995-96 fiscal year.
Another consequence of the accumulated budget deficits, together with
other factors such as disbursement of funds to local school districts
"borrowed" from future fiscal years and hence not shown in the annual
budget, was to significantly reduce the State's cash resources available
to pay its ongoing obligations. When the Legislature and the Governor
failed to adopt a budget for the 1992-93 Fiscal Year by July 1, 1992,
which would have allowed the State to carry out its normal annual cash
flow borrowing to replenish its cash reserves, the Controller issued
registered warrants to pay a variety of obligations representing prior
years' or continuing appropriations and mandates from court orders.
Available funds were used to make constitutionally-mandated payments, such
as debt service on bonds and warrants. Between July 1 and September 4,
1992, when the budget was adopted, the State Controller issued a total of
approximately $3.8 billion of registered warrants.
Economic Overview
California's economy is the largest among the 50 states and one of the
largest in the world. Recent economic expansion has been marked by strong
growth in high technology business services (including computer software),
construction, computers and electronic components.
As 1998 unfolded, the impact of Asia's recession on California began to
emerge. Aerospace and electronics manufacturing employment peaked in
March, and by November had lost almost 15,000 jobs, or nearly 3 percent of
the industries' workforce. Total nonfarm employment started 1998 with
annual growth above 3.5 percent, but more recently the year-to-year pace
has slowed to approximately 2.7 percent.
Overall, however, California's economy continued to expand in 1998. Non-
farm employment growth averaged 3.2 percent and personal income was up
more than 6 percent. The jobless rate was below 6 percent most of the
year. Non-residential construction activity remained quite strong, with
building permit value up almost 18 percent. Homebuilding continued on a
moderate recovery path, with permits for new houses reaching 126,000
units, a 13.5 percent increase over 1997.
Litigation
The State is currently involved in certain legal proceedings that, if
decided against the State, may require the State to make significant
future expenditures or may impair future revenue sources. Following are
significant lawsuits involving the State as of December 9, 1998:
On June 24, 1998, plaintiffs in Howard Jarvis Taxpayers Association et al.
v. Kathleen Connell filed a complaint challenging the authority of the
State Controller to make payments from the State Treasury in the absence
of a state budget. On July 21, 1998, the trial court issued a preliminary
injunction prohibiting the State Controller from paying moneys from the
State Treasury for fiscal year 1998-99, with certain limited exceptions,
in the absence of a state budget. The preliminary injunction, among other
things, prohibited the State Controller from making any payments pursuant
to any continuing appropriation.
On July 22, 1998, the State Controller asked the California Supreme Court
to immediately stay the trial court's preliminary injunction and to
overrule the order granting the preliminary injunction on the merits. On
July 29, 1998, the Supreme Court transferred the State Controller's
request to the Court of Appeal. The matters are now pending before the
Court of Appeal.
In Hayes v. Commission on State Mandates, certain local school districts
sought reimbursements for special education programs for handicapped
children. The State Board of Control, which was succeeded by the
Commission on State Mandates (COSM), decided in favor of the local school
districts. The decision was appealed by the Director of Finance in the
trial court and was remanded to the COSM for redetermination. The COSM
expanded the claim to include supplemental claims filed by seven
additional educational institutions. The potential liability to the State
has been estimated at more than $1 billion. A final consolidated decision
was expected to be issued in late 1998.
In State v. Stringfellow, the State is seeking recovery for cleanup costs
of a toxic waste site presently owned by the State. Present estimates of
the cleanup range from $300 million to $800 million.
The State is a defendant in a coordinated action involving 3,000
plaintiffs seeking recovery for damages caused by the Yuba River flood of
1986. The State's potential liability to all plaintiffs in this lawsuit
ranges from $800 million to $1.5 billion.
Year 2000
The State's reliance on information technology in every aspect of its
operations has made Year 2000 related information technology ("IT") issues
a high priority for the State. The Department of Information Technology
("DOIT"), an independent office reporting directly to the Governor, is
responsible for ensuring the State's information technology processes are
fully functional before the year 2000.
In the July Quarterly Report, the DOIT estimates total Year 2000 costs
identified by the departments under its supervision at about $239 million,
of which more than $100 million was projected to be expended in fiscal
years 1998-99 and 1999-2000. The October Quarterly Report indicated the
total costs were then estimated to be at least $290 million, and the
estimate would likely increase in the future. These costs are part of
much larger overall IT costs incurred annually by State departments and do
not include costs for remediation for embedded technology, desktop systems
and additional costs resulting from discoveries in the testing process.
For fiscal year 1998-99, the Legislature created a $20 million fund for
unanticipated Year 2000 costs, which can be increased if necessary.
Although the DOIT reports that State departments are making substantial
progress overall toward the goal of Year 2000 compliance, the task is very
large and will likely encounter unexpected difficulties. The State cannot
predict whether all mission critical systems will be ready and tested by
late 1999 or what impact failure of any particular IT system(s) or of
outside interfaces with State IT systems might have. The State
Treasurer's Office and the State Controller's Office report that they are
both on schedule to complete their Year 2000 remediation projects by
December 31, 1998, allowing full testing during 1999.
SPECIAL CONSIDERATIONS REGARDING PUERTO RICO
The following highlights some of the more significant financial trends and
problems affecting the Commonwealth of Puerto Rico (the "Commonwealth" or
"Puerto Rico"), and is based on information drawn from official statements
and prospectuses relating to the securities offerings of Puerto Rico, its
agencies and instrumentalities, as available on the date of this SAI. SSBC
has not independently verified any of the information contained in such
official statements, prospectuses, and other publicly available documents,
but is not aware of any fact that would render such information materially
inaccurate.
The economy of Puerto Rico is fully integrated with that of the United
States. In fiscal 1997, trade with the United States accounted for
approximately 88% of Puerto Rico's exports and approximately 62% of its
imports. In this regard, in fiscal 1997 Puerto Rico experienced a $2.7
billion positive adjusted merchandise trade balance.
Since fiscal 1985, personal income, both aggregate and per capita, has
increased consistently each fiscal year. In fiscal 1997, aggregate
personal income was $32.1 billion ($30.0 billion in 1992 prices) and
personal per capita income was $8,509 ($7,957 in 1992 prices). Gross
product in fiscal 1993 was $25.1 billion ($24.5 billion in 1992 prices)
and gross product in fiscal 1997 was $32.1 billion ($27.7 billion in 1992
prices). This represents an increase in gross product of 27.7% from fiscal
1993 to 1997 (13.0% in 1992 prices).
Puerto Rico's economic expansion, which has lasted over ten years,
continued throughout the five-year period from fiscal 1993 through fiscal
1997. Almost every sector of the economy participated, and record levels
of employment were achieved. Factors behind the continued expansion
included Government-sponsored economic development programs, periodic
declines in the exchange value of the U.S. dollar, increases in the level
of federal transfers, and the relatively low cost of borrowing funds
during the period.
Average employment increased from 999,000 in fiscal 1993 to 1,128,300 in
fiscal 1997. Unemployment, although at relatively low historical levels,
remains above the U.S. average. Average unemployment decreased from 16.8%
in fiscal 1993 to 13.1% in fiscal 1997.
Manufacturing is the largest sector in the economy accounting for $19.8
billion or 41.2% of gross domestic product in fiscal 1997. The
manufacturing sector employed 153,273 workers as of March 1997.
Manufacturing in Puerto Rico is now more diversified than during earlier
phases of industrial development. In the last two decades industrial
development has tended to be more capital intensive and dependent on
skilled labor. This gradual shift is best exemplified by heavy investment
in pharmaceuticals, scientific instruments, computers, microprocessors,
and electrical products over the last decade. The service sector, which
includes wholesale and retail trade and finance, insurance, real estate,
hotels and related services, and other services, ranks second in its
contribution to gross domestic product and is the sector that employs the
greatest number of people.
In fiscal 1997, the service sector generated $18.4 billion in gross
domestic product or 38.2% of the total. Employment in this sector grew
from 467,000 in fiscal 1993 to 551,000 in fiscal 1997, a cumulative
increase of 17.8%. This increase was greater than the 12.9% cumulative
growth in employment over the same period providing 48% of total
employment. The Government sector of the Commonwealth plays an important
role in the economy of the island. In fiscal year 1997, the Government
accounted for $5.2 billion of Puerto Rico's gross domestic product and
provided 10.9% of the total employment. The construction industry has
experienced real growth since fiscal 1987. In fiscal 1997, investment in
construction rose to $4.7 billion, an increase of 14.7% as compared to
$4.1 billion for fiscal 1996. Tourism also contributes significantly to
the island economy, accounting for $2.0 billion of gross domestic product
in fiscal 1997.
The present administration has developed and is implementing a new
economic development program which is based on the premise that the
private sector should provide the primary impetus for economic development
and growth. This new program, which is referred to as the New Economic
Model, promotes changing the role of the Government from one of being a
provider of most basic services to that of a facilitator for private
sector initiatives and encourages private sector investment by reducing
Government-imposed regulatory restraints.
The New Economic Model contemplates the development of initiatives that
will foster private investment in, and private management of, sectors that
are served more efficiently and effectively by the private enterprise. One
of these initiatives has been the adoption of a new tax code intended to
expand the tax base, reduce top personal and corporate tax rates, and
simplify the tax system. Another initiative is the improvement and
expansion of Puerto Rico's infrastructure to facilitate private sector
development and growth, such as the construction of the water pipeline and
cogeneration facilities described below and the construction of a light
rail system for the San Juan metropolitan area.
The New Economic Model also seeks to identify and promote areas in which
Puerto Rico can compete more effectively in the global markets. Tourism
has been identified as one such area because of its potential for job
creation and contribution to the gross product. In 1993, a new Tourism
Incentives Act and a Tourism Development Fund were implemented in order to
provide special tax incentives and financing for the development of new
hotel projects and the tourism industry. As a result of these initiatives,
new hotels have been constructed or are under construction which have
increased the number of hotel rooms on the island from 8,415 in fiscal
1992 to 10,877 at the end of fiscal 1997 and to a projected 11,972 by the
end of fiscal 1998.
The New Economic Model also seeks to reduce the size of the Government's
direct contribution to gross domestic product. As part of this goal, the
Government has transferred certain Governmental operations and sold a
number of its assets to private parties. Among these are: (i) the
Government sold the assets of the Puerto Rico Maritime Authority; (ii) the
Government executed a five-year management agreement for the operation and
management of the Aqueducts and Sewer Authority by a private company;
(iii) the Aqueducts and Sewer Authority executed a construction and
operating agreement with a private consortium for the design,
construction, and operation of an approximately 75 million gallon per day
water pipeline to the San Juan metropolitan area from the Dos Bocas
reservoir in Utuado; (iv) the Electric Power Authority executed power
purchase contracts with private power producers under which two
cogeneration plants (with a total capacity of 800 megawatts) will be
constructed; (v) the Corrections Administration entered into operating
agreements with two private companies for the operation of three new
correctional facilities; (vi) the Government entered into a definitive
agreement to sell certain assets of a pineapple juice processing business
and sold certain mango growing operations; (vii) the Government is in the
process of transferring to local sugar cane growers certain sugar
processing facilities; (viii) the Government sold two hotel properties and
is currently negotiating the sale of a complex consisting of two hotels
and a convention center; and (ix) the Government has announced its
intention to sell the Puerto Rico Telephone Company and is currently
involved in the sale process.
One of the goals of the Rossello administration is to change Puerto Rico's
public health care system from one in which the Government provides free
health services to low income individuals through public health
facilities owned and administered by the Government to one in which all
medical services are provided by the private sector and the Government
provides comprehensive health insurance coverage for qualifying (generally
low income) Puerto Rico residents. Under this new system, the Government
selects, through a bidding system, one private health insurance company in
each of several designated regions of the island and pays such insurance
company the insurance premium for each eligible beneficiary within such
region. This new health insurance system is now covering 61 municipalities
out of a total of 78 on the island. It is expected that 11 municipalities
will be added by the end of fiscal 1998 and 5 more by the end of fiscal
1999. The total cost of this program will depend on the number of
municipalities included in the program, the number of participants
receiving coverage, and the date coverage commences. As of December 31,
1997, over 1.1 million persons were participating in the program at an
estimated annual cost to Puerto Rico for fiscal 1998 of approximately $672
million. In conjunction with this program, the operation of certain public
health facilities has been transferred to private entities. The
Government's current privatization plan for health facilities provides for
the transfer of ownership of all health
facilities to private entities. The Government sold six health facilities
to private companies and is currently in negotiations with other private
companies for the sale of thirteen health facilities to such companies.
One of the factors assisting the development of the manufacturing sector
in Puerto Rico has been the federal and Commonwealth tax incentives
available, particularly those under the Puerto Rico Industrial Incentives
Program and Sections 30A and 936 of the Internal Revenue Code 1986, as
amended (the "Code").
Since 1948, Puerto Rico has promulgated various industrial incentives laws
designed to stimulate industrial investment. Under these laws, companies
engaged in manufacturing and certain other designated activities were
eligible to receive full or partial exemption from income, property, and
other taxes. The most recent of these laws is Act No. 135 of December 2,
1997 (the "1998 Tax Incentives Law").
The benefits provided by the 1998 Tax Incentives Law are available to new
companies as well as companies currently conducting tax-exempt operations
in Puerto Rico that choose to renegotiate their existing tax exemption
grant. Activities eligible for tax exemption include manufacturing,
certain services performed for markets outside Puerto Rico, the production
of energy from local renewable sources for consumption in Puerto Rico, and
laboratories for scientific and industrial research. For companies
qualifying thereunder, the 1998 Tax Incentives Law imposes income tax
rates ranging from 2% to 7%. In addition, it grants 90% exemption from
property taxes, 100% exemption from municipal license taxes during the
first eighteen months of operation and between 80% and 60% thereafter, and
100% exemption from municipal excise taxes. The 1998 Tax Incentives Law
also provides various special deductions designated to stimulate
employment and productivity, research and development, and capital
investment in Puerto Rico.
Under the 1998 Tax Incentives Law, companies are able to repatriate or
distribute their profits free of tollgate taxes. In addition, passive
income derived from designated investments will continue to be fully
exempt from income and municipal license taxes. Individual shareholders of
an exempted business will be allowed a credit against their Puerto Rico
income taxes equal to 30% of their proportionate share in the exempted
business' income tax liability. Gain from the sale or exchange of shares
of an exempted business by its shareholders during the exemption period
will be subject to a 4% income tax rate.
For many years, U.S. companies operating in Puerto Rico enjoyed a special
tax credit that was available under Section 936 of the Code. Originally,
the credit provided an effective 100% federal tax exemption for operating
and qualifying investment income from Puerto Rico sources. Amendments to
Section 936 made in 1993 (the "1993 Amendments") instituted two
alternative methods for calculating the tax credit and limited the amount
of the credit that a qualifying company could claim. These limitations are
based on a percentage of qualifying income (the "percentage of income
limitation") and on qualifying expenditures on wages and other wage
related benefits (the "economic activity limitation", also known as the
"wage credit limitation"). As a result of amendments incorporated in the
Small Business Job Protection Act of 1996 enacted by the U.S. Congress and
signed into law by President Clinton on August 20, 1996 (the "1996
Amendments"), the tax credit, as described below, is now being phased out
over a ten-year period for existing claimants and is no longer available
for corporations that established operations in Puerto Rico after October
13, 1995 (including existing Section 936 Corporations (as defined below)
to the extent substantially new operations are established in Puerto
Rico). The 1996 Amendments also moved the credit based on the economic
activity limitation to Section 30A of the Code and phased it out over 10
years. In addition, the 1996 Amendments eliminated the credit previously
available for income derived from certain qualified investments in Puerto
Rico. The Section 30A credit and the remaining Section 936 credit are
discussed below.
Section 30A. The 1996 Amendments added a new Section 30A to the Code.
Section 30A permits a "qualifying domestic corporation" ("QDC") that meets
certain gross income tests (which are similar to the 80% and 75% gross
income tests of Section 936 of the Code discussed below) to claim a credit
(the "Section 30A credit") against the federal income tax imposed on
taxable income derived from sources outside the United States from the
active conduct of a trade or business in Puerto Rico or from the sale of
substantially all the assets used in such business ("possession income").
A QDC is a U.S. corporation which (i) was actively conducting a trade or
business in Puerto Rico on October 13, 1995, (ii) had a Section 936
election in effect for its taxable year that included October 13, 1995,
(iii) does not have in effect an election to use the percentage limitation
of Section 936(a)(4)(B) of the Code, and (iv) does not add a "substantial
new line of business."
The Section 30A credit is limited to the sum of (i) 60% of qualified
possession wages as defined in the Code, which includes wages up to 85% of
the maximum earnings subject to the OASDI portion of Social Security taxes
plus an allowance for fringe benefits of 15% of qualified possession
wages, (ii) a specified percentage of depreciation deductions ranging
between 15% and 65%, based on the class life of tangible property, and
(iii) a portion of Puerto Rico income taxes paid by the QDC, up to a 9%
effective tax rate (but only if the QDC does not elect the profit-split
method for allocating income from intangible property).
A QDC electing Section 30A of the Code may compute the amount of its
active business income, eligible for the Section 30A Credit, by using
either the cost sharing formula, the profit-split formula, or the cost-
plus formula, under the same rules and guidelines prescribed for such
formulas as provided under Section 936 (see discussion below). To be
eligible for the first two formulas, the QDC must have a significant
presence in Puerto Rico.
In the case of taxable years beginning after December 31, 2001, the amount
of possession income that would qualify for the Section 30A credit would
be subject to a cap based on the QDC's possession income for an average
adjusted base period ending before October 14, 1995.
Section 30A applies only to taxable years beginning after December 31,
1995 and before January 1, 2006.
Section 936. Under Section 936 of the Code, as amended by the 1996
Amendments, and as an alternative to the Section 30A credit, U.S.
corporations that meet certain requirements and elect its application
("Section 936 Corporations") are entitled to credit against their U.S.
corporate income tax, the portion of such tax attributable to income
derived from the active conduct of a trade or business within Puerto Rico
("active business income") and from the sale or exchange of substantially
all assets used in the active conduct of such trade or business. To
qualify under Section 936 in any given taxable year, a corporation must
derive for the three-year period immediately preceding the end of such
taxable year (i) 80% or more of its gross income from sources within
Puerto Rico and (ii) 75% or more of its gross income from the active
conduct of a trade or business in Puerto Rico.
Under Section 936, a Section 936 Corporation may elect to compute its
active business income, eligible for the Section 936 credit, under one of
three formulas: (A) a cost-sharing formula, whereby it is allowed to claim
all profits attributable to manufacturing intangibles, and other functions
carried out in Puerto Rico, provided it contributes to the research and
development expenses of its affiliated group or pays certain royalties;
(B) a profit-split formula, whereby it is allowed to claim 50% of the net
income of its affiliated group from the sale of products manufactured in
Puerto Rico; or (C) a cost-plus formula, whereby it is allowed to claim a
reasonable profit on the manufacturing costs incurred in Puerto Rico. To
be eligible for the first two formulas, the Section 936 Corporation must
have a significant business presence in Puerto Rico for purposes of the
Section 936 rules.
As a result of the 1993 Amendments and the 1996 Amendments, the Section
936 credit is only available to companies that elect the percentage of
income limitation and is limited in amount to 40% of the credit allowable
prior to the 1993 Amendments, subject to a five-year phase-in period from
1994 to 1998 during which period the percentage of the allowable credit is
reduced from 60% to 40%.
In the case of taxable years beginning on or after 1998, the possession
income subject to the Section 936 credit will be subject to a cap based on
the Section 936 Corporation's possession income for an average adjusted
base period ending on October 14, 1995. The Section 936 credit is
eliminated for taxable years beginning in 2006.
Proposal to Extend the Phaseout of Section 30A. During 1997, the
Government of Puerto Rico proposed to Congress the enactment of a new
permanent federal incentive program similar to that provided under Section
30A. Such a program would provide U.S. companies a tax credit based on
qualifying wages paid and other wage-related expenses, such as fringe
benefits, as well as depreciation expenses for certain tangible assets and
research and development expenses. Under the Governor's proposal, the
credit granted to qualifying companies would continue in effect until
Puerto Rico shows, among other things, substantial economic improvements
in terms of certain economic parameters. The fiscal 1998 budget submitted
by President Clinton to Congress in February 1997 included a proposal to
modify Section 30A to (i) extend the availability of the Section 30A
credit indefinitely; (ii) make it available to companies establishing
operations in Puerto Rico after October 13, 1995; and (iii) eliminate the
income cap. Although this proposal, was not included in the final fiscal
1998 federal budget, President Clinton's fiscal 1999 budget submitted to
Congress again included these modifications to Section 30A. While the
Government of Puerto Rico plans to continue lobbying for this proposal, it
is not possible at this time to predict whether the Section 30A credit
will be so modified.
Outlook. It is not possible at this time to determine the long-term effect
on the Puerto Rico economy of the enactment of the 1996 Amendments. The
Government of Puerto Rico does not believe there will be short-term or
medium-term material adverse effects on Puerto Rico's economy as a result
of the enactment of the 1996 Amendments. The Government of Puerto Rico
further believes that during the phase-out period sufficient time exists
to implement additional incentive programs to safeguard Puerto Rico's
competitive position.
TRUSTEES OF THE TRUST AND EXECUTIVE OFFICERS OF THE FUND
Overall responsibility for management and supervision of the fund rests
with the trust's board of trustees. The trustees approve all significant
agreements between the fund and the companies that furnish services to the
fund, including agreements with the fund's distributor, investment
manager, custodian and transfer agent. The day-to-day operations of the
fund are delegated to the fund's investment adviser and administrator,
SSBC Fund Management Inc. ("SSBC" or the "manager").
The trustees of the trust and executive officers of the fund, together
with information as to their principal business occupations during the
past five years, are shown below. The executive officers of the fund are
employees of organizations that provide services to the fund. Each trustee
who is an "interested person" of the fund, as defined in the Investment
Company Act of 1940, as amended (the "1940 Act"), is indicated by an
asterisk. The address of the "non-interested" trustees and executive
officers of the fund is 388 Greenwich Street, New York, New York 10013.
Herbert Barg (Age 75). Trustee
Private Investor. Director or trustee of 18 investment companies
associated with Citigroup Inc. ("Citigroup") His address is 273 Montgomery
Avenue, Bala Cynwyd, Pennsylvania 19004.
*Alfred J. Bianchetti (Age 76). Trustee
Retired; formerly Senior Consultant to Dean Witter Reynolds Inc. Director
or trustee of 13 investment companies associated with Citigroup. His
address is 19 Circle End Drive, Ramsey, New Jersey 07466.
Martin Brody (Age 77). Trustee
Consultant, HMK Associates; Retired Vice Chairman of the Board of
Restaurant Associates Corp. Director or trustee of 22 investment companies
associated with Citigroup. His address is c/o HMK Associates, 30 Columbia
Turnpike, Florham Park, New Jersey 07932.
Dwight B. Crane (Age 61). Trustee
Professor, Harvard Business School. Director or trustee of 25 investment
companies associated with Citigroup. His address is c/o Harvard Business
School, Soldiers Field Road, Boston, Massachusetts 02163.
Burt N. Dorsett (Age 68). Trustee
Managing Partner of Dorsett McCabe Management. Inc., an investment
counseling firm; Director of Research Corporation Technologies, Inc., a
nonprofit patent clearing and licensing firm. Director or trustee of 13
investment companies associated with Citigroup.His address is 201 East
62nd Street, New York, New York 10021.
Elliot S. Jaffe (Age 72). Trustee
Chairman of the Board and President of The Dress Barn, Inc. Director or
trustee of 13 investment companies associated with Citigroup.His address
is 30 Dunnigan Drive, Suffern, New York 10901.
Stephen E. Kaufman (Age 67). Trustee
Attorney. Director or trustee of 15 investment companies associated with
Citigroup.His address is 277 Park Avenue, New York, New York 10172.
Joseph J. McCann (Age 68). Trustee
Financial Consultant; Retired Financial Executive, Ryan Homes, Inc.
Director or trustee of 13 investment companies associated with
Citigroup.His address is 200 Oak Park Place, Pittsburgh, Pennsylvania
15243.
*Heath B. McLendon (Age 65). Chairman of the Board and Investment Officer
Managing Director of Salomon Smith Barney, Inc., President of SSBC and
Travelers Investment Adviser, Inc. ("TIA"); Chairman or Co-Chairman of the
Board and director or trustee of 64 investment companies associated with
Citigroup.
Cornelius C. Rose, Jr. (Age 65). Trustee
President, Cornelius C. Rose Associates, Inc., financial consultants, and
Chairman and Director of Performance Learning Systems, an educational
consultant. Director or trustee of 13 investment companies associated with
Citigroup. His address is Meadowbrook Village, Building 4, Apt 6, West
Lebanon, New Hampshire 03784.
Lewis E. Daidone (Age 41) Senior Vice President and Treasurer
Managing Director of Salomon Smith Barney, Chief Financial Officer of the
Smith Barney Mutual funds; Director and Senior Vice President of SSBC and
TIA.
Joseph P. Deane (Age 51) Vice President and Investment Officer
Investment Officer of SSBC; Managing Director of Salomon Smith Barney.
David T. Fare (Age 36) Vice President and Investment Officer
Investment Officer of SSBC; Vice President of Salomon Smith Barney.
Paul Brook (Age 45) Controller
Director of Salomon Smith Barney; from 1997-1998 Managing Director of AMT
Capital Services Inc.; prior to 1997, Partner with Ernst & Young LLP
Christina T. Sydor (Age 48) Secretary
Managing Director of Salomon Smith Barney. General Counsel and Secretary
of SSBC and TIA.
As of March 19, 1999, the trustees and officers owned, in the aggregate,
less than 1% of the outstanding shares of each of the funds. No officer,
director or employee of Salomon Smith Barney or any of its affiliates
receives any compensation from the trust for serving as an officer of the
funds or trustee of the trust. The trust pays each trustee who is not an
officer, director or employee of Salomon Smith Barney or any of its
affiliates a fee of $10,000 per annum plus $1000 per in-person meeting and
$100 per telephonic meeting. Each trustee emeritus who is not an officer,
director or employee of Salomon Smith Barney or its affiliates receives a
fee of $5,000 per annum plus $500 per in-person meeting and $50 per
telephonic meeting. All trustees are reimbursed for travel and out-of-
pocket expenses incurred to attend such meetings and for the last fiscal
year it was $13,594.For the fiscal year ended November 30, 1998, the
trustees of the trust were paid the following compensation:
Name of Person
Aggregate
Compensation
From
Trust
Total
Pension or
Retirement
Benefits
Accrued
as part of
Trust
Expenses
Compensation
From Trust
and Fund
Complex
Paid to
Trustees
Number of
Funds for
Which
Trustees
Serves
Within
Fund
Complex
Herbert Barg**
$11,600
$0
$105,425
18
Alfred
Bianchetti**
11,600
0
51,200
13
Martin Brody**
11,000
0
132,500
21
Dwight B.
Crane**
11,600
0
139,975
24
Burt N.
Dorsett**
11,600
0
51,200
13
Elliot S.
Jaffe**
11,600
0
47,550
13
Stephen E.
Kaufman**
11,600
0
96,400
15
Joseph J.
McCann**
11,600
0
51,200
13
Heath B.
McLendon *
- -
- -
- -
59
Cornelius C.
Rose, Jr.**
11,600
0
51,200
13
* Designates an "interested" trustee.
** Designates member of Audit Committee.
Upon attainment of age 80, fund trustees are required to change to
emeritus status. Trustees Emeritus are entitled to serve in emeritus
status for a maximum of 10 years. Trustees Emeritus may attend meetings
but have no voting rights.
The following table contains a list of shareholders of record or who
beneficially owned at least 5% of the outstanding shares of a particular
class of shares of a fund of the Company as of March 19, 1999.
INTERMEDIATE MATURITY CALIFORNIA MUNICIPALS FUND CLASS Y
PERCENTAGE OF SHARES
Anthony S. Wong & Mandy Tang Wong
TTEES FBO the Amp Wong
Family Trust U/A/D 12/8/89
1071 Piedmont Drive
Sacramento, CA 95822
Owned 35,650.172 (100%) shares
INTERMEDIATE MATURITY NEW YORK MUNICIPAL FUND CLASS L
PERCENTAGE OF SHARES
Muriel S. Kessler
60 East 42nd St.
Suite 1136
New York, New York 10165
Owned 34,145.712 (5.41%) shares
Lynn Kestel
1185 Park Avenue
Apt. 4F
New York, New York 10128
Owned 32,511.741 (5.15%) shares
INVESTMENT RESTRICTIONS
The investment restrictions numbered 1 through 6 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. The remaining restrictions 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: No fund will
1. Invest more than 25% of its total assets in securities, the issuers of
which conduct their principal business activities in the same industry.
For purposes of this limitation, securities of the U.S. government
(including its agencies and instrumentalities) and securities of state
or municipal governments and their political subdivisions are not
considered to be issued by members of any industry.
2. Borrow money, except that (a) the fund may borrow from banks for
temporary or emergency (not leveraging) purposes, including the meeting
of redemption requests which might otherwise require the untimely
disposition of securities, and (b) the fund may, to the extent
consistent with its investment policies, enter into reverse repurchase
agreements, forward roll transactions and similar investment strategies
and techniques. To the extent that it engages in transactions
described in (a) and (b), the fund will be limited so that no more than
33 1/3% of the value of its total assets (including the amount
borrowed), valued at the lesser of cost or market, less liabilities
(not including the amount borrowed) valued at the time the borrowing is
made, is derived from such transactions.
3. Issue "senior securities" as defined in the 1940 Act and the rules,
regulations and orders thereunder, except as permitted under the 1940
Act and the rules, regulations and orders thereunder.
4. Make loans. This restriction does not apply to: (a) the purchase of
debt obligations in which the fund may invest consistent with its
investment objectives and policies; (b) repurchase agreements; and (c)
loans of its portfolio securities, to the fullest extent permitted
under the 1940 Act.
5. Purchase or sell real estate, real estate mortgages, commodities or
commodity contracts, but this restriction shall not prevent the fund
from (a) investing in securities of issuers engaged in the real estate
business or the business of investing in real estate (including
interests in limited partnerships owning or otherwise engaging in the
real estate business or the business of investing in real estate) and
securities which are secured by real estate or interests therein; (b)
holding or selling real estate received in connection with securities
it holds or held; (c) trading in futures contracts and options on
futures contracts (including options on currencies to the extent
consistent with the funds' investment objective and policies); or (d)
investing in real estate investment trust securities.
6. Engage in the business of underwriting securities issued by other
persons, except to the extent that the fund may technically be deemed
to be an underwriter under the Securities Act of 1933, as amended, in
disposing of portfolio securities.
7. Purchase any securities on margin (except for such short-term credits
as are necessary for the clearance of purchases and sales of portfolio
securities) or sell any securities short (except "against the box").
For purposes of this restriction, the deposit or payment by the fund of
underlying securities and other assets in escrow and collateral
agreements with respect to initial or maintenance margin in connection
with futures contracts and related options and options on securities,
indexes or similar items is not considered to be the purchase of a
security on margin.
8. No fund will invest in oil, gas or other mineral leases or exploration
or development programs.
9. 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.
10. 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.
11. No fund may make investments for the purpose of exercising control of
management.
If any percentage restriction described above is complied with at the time
of an investment, a later increase or decrease in percentage resulting
from a change in values or assets will not constitute a violation of such
restriction.
INVESTMENT MANAGEMENT AND OTHER SERVICES
Investment Adviser and Administrator - SSBC (Manager)
SSBC (formerly known as Mutual Management Corp.) serves as investment
adviser to each fund pursuant to an investment advisory agreement (the
"Investment Advisory Agreement") with the trust which was approved by the
board of trustees, including a majority of trustees who are not
"interested persons" of the trust or the manager. The manager is a wholly
owned subsidiary of Salomon Smith Barney Holdings Inc. ("Holdings"), which
in turn, is a wholly owned subsidiary of Citigroup Inc. Subject to the
supervision and direction of the trust's board of trustees, the manager
manages each fund's portfolio in accordance with the fund's stated
investment objective and policies, makes investment decisions for the
fund, places order to purchase and sell securities, and employs
professional portfolio managers and securities analysts who provide
research services to the fund. The manager pays the salary of any officer
and employee who is employed by both it and the Trust. The manager bears
all expenses in connection with the performance of its services.
As compensation for investment advisory services, each fund pays the
manager a fee computed daily and paid monthly at the annual rate of 0.30%
of the fund's average daily net assets.
The funds paid the manager investment advisory fees, and the investment
manager waived fees and reimbursed expenses as follows:
For the fiscal year ended
November 30, 1996
November 30, 1997
November 30, 1998
Fund
Fees
Paid
Fees
Waived and
Expenses
Reimbursed
Fees
Paid
Fees
Waived
and
Expenses
Reimbursed
Fees
Paid
Fees Waived
and
Expenses
Reimbursed
California
Fund
$0
128,361
$20,278
$63,087
$47,759
$ 46,438
New York
Fund
32,306
122,796
59,523
90,299
98,264
63,179
SSBC also serves as administrator to the New York and California Funds
pursuant to a written agreement (the "Administration Agreement"), which
was approved by the trustees of the trust, including a majority of
trustees who are not "interested persons" of the trust or the
administrator. The administrator 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.
As administrator SSBC: (a) assists in supervising all aspects of the
Fund's operations except those performed by the fund's investment manager
under its investment advisory agreement; b) supplies the fund with office
facilities (which may be in SSBC's own offices), statistical and research
data, data processing services, clerical, accounting and bookkeeping
services, including, but not limited to, the calculation of (i) the net
asset value of shares of the fund, (ii) applicable contingent deferred
sales charges and similar fees and charges and (iii) distribution fees,
internal auditing and legal services, internal executive and
administrative services, and stationary and office supplies; and (c)
prepares reports to shareholders of the fund, tax returns and reports to
and filings with the SEC and state blue sky authorities.
As compensation for administrative services rendered to each fund, the
administrator receives a fee computed daily and paid monthly at the annual
rate of 0.20% of each fund's average daily net assets.
The funds paid the administrator administration fees and the administrator
waived fees and reimbursed expenses as follows:
For the fiscal year ended
November 30, 1996
November 30, 1997
November 30, 1998
Fund
Fees
Paid
Fees
Waived
and
Expenses
Reimbursed
Fees
Paid
Fees
Waived and
Expenses
Reimbursed
Fees
Paid
Fees Waived
and
Expenses
Reimbursed
California
Fund
$0
$85,575
$13,518
$42,058
$31,840
$ 30,958
New York Fund
10,906
92,495
33,023
66,858
65,508
42,120
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 Salomon Smith Barney
or SSBC, Securities and Exchange Commission ("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.
Year 2000 - The ability of issuers to make timely payments of interest and
principal or to continue their operations or services may be impaired by
the inadequate preparation of their computer systems for the year 2000.
This may adversely affect the market values of securities of specific
issuers or of securities generally if the inadequacy of preparation is
perceived as widespread or as affecting trading markets.
Auditors
KPMG LLP, independent auditors, 345 Park Avenue, New York, New York 10154,
have been selected to serve as auditors of the trust and to render
opinions on the fund's financial statements for the fiscal year ended
November 30, 1999.
Custodian and Transfer Agent
PNC Bank, National Association ("PNC" or "custodian"), located at 17th and
Chestnut Streets, Philadelphia, Pennsylvania, 19103, serves as the
custodian of the fund. Under its custody agreement with the fund, PNC
holds the fund's securities and keeps all necessary accounts and records.
For its services, PNC receives a monthly fee based upon the month-end
market value of securities held in custody and also receives securities
transactions charges. The assets of the fund are held under bank
custodianship in compliance with the 1940 Act.
First Data Investor Services Group Inc. ("First Data" or "transfer
agent"), located at Exchange Place, Boston, Massachusetts 02109, serves as
the trust's transfer agent. Under the transfer agency agreement, the
transfer agent 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, the transfer agent 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.
Distributor
CFBDS, Inc. serves as the fund's distributor pursuant to a written
agreement dated October 8, 1998 (the "Distribution Agreement") which was
approved by the fund's Board of Directors, including a majority of the
Independent Directors on July 15, 1998. Prior to the merger of Travelers
Group, Inc. and Citicorp Inc. on October 8, 1998, Salomon Smith Barney
served as the fund's distributor. Salomon Smith Barney continues to sell
the funds shares as part of the selling group.
Commissions on Class A Shares. For the 1996 and 1997 fiscal years, the
aggregate dollar amount of commissions on Class A shares, all of which was
paid to Salomon Smith Barney, is as follows:
Class A
Name of Fund
Fiscal Year
Ended
11/30/96
Fiscal Year
Ended 11/30/97
California Fund
$ 39,000
$ 37,000
New York Fund
48,000
46,000
For the period December 1, 1997 through October 7, 1998 and for the period
October 8, 1998 through November 30, 1998, the aggregate dollar amounts of
commissions on Class A shares, are as follows:
Class A
Name of Fund
12/01/97
through
10/07/98*
10/08/98
through
11/30/98**
California Fund
$ 8,000
$ 65,000
New York Fund
27,000
59,000
*The entire amount was paid to Salomon Smith Barney.
** The following amounts were paid to Salomon Smith Barney: $58,500 and
$53,100 with regard to the California Fund and the New York Fund,
respectively.
Commissions on Class L Shares. For the period June 12, 1998 through
October 7, 1998 and for the period October 8, 1998 through November 30,
1998, the aggregate dollar amounts of commission on Class L shares are as
follows:
Class L
(On June 12, 1998, Class
C shares were renamed
Class L Shares)*
Name of Fund
06/12/98
through
10/07/98*
10/08/98
through
11/30/98**
California Fund
$ 4,000
$ 8,000
New York Fund
3,000
16,000
*The entire amount was paid to Salomon Smith Barney.
** The following amounts were paid to Salomon Smith Barney: $7,200 and
14,400 with regard to the California Fund and the New York Fund,
respectively.
Deferred Sales Charges on Class A and L Shares For the 1996, 1997 and
1998 fiscal years, the following deferred sales charges were paid to
Salomon Smith Barney on redemptions of the funds' shares:
Class A
Name of Fund
Fiscal Year
Ended
11/30/96
Fiscal Year
Ended 11/30/97
Fiscal Year
Ended 11/30/98
California Fund
$0
$0
$0
New York Fund
2,000
1,000
3,000
Class L
(On June 12, 1998, Class C shares were
renamed Class L Shares)
Name of Fund
Fiscal Year
Ended
11/30/96
Fiscal Year
Ended 11/30/97
Fiscal Year
Ended 11/30/98
California Fund
$0
$ 1,000
$ 1,000
New York Fund
0
1,000
4,000
When payment is made by the investor before the settlement date, unless
otherwise requested in writing 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 trust's board of
trustees has been advised of the benefits to Salomon Smith Barney
resulting from these settlement procedures and will take such benefits
into consideration when reviewing the Advisory, Administration and
Distribution Agreements for continuance.
California Fund
For the fiscal year ended November 30, 1998, Salomon Smith Barney incurred
distribution expenses totaling approximately $90,984 consisting of
approximately $7,649 for advertising, $296 for printing of prospectuses,
$39,488 for support services, $42,733 to Salomon Smith Barney Financial
Consultants, and $818 in accruals for interest on the excess of Salomon
Smith Barney expenses incurred in distribution of the funds' shares over
the sum of the distribution fees and deferred sales charge received by
Salomon Smith Barney from the fund.
New York Fund
For the fiscal year ended November 30, 1998, Salomon Smith Barney incurred
distribution expenses totaling approximately $139,521 consisting of
approximately $12,196 for advertising, $196 for printing of prospectuses,
$66,418 for support services, $59,786 to Salomon Smith Barney Financial
Consultants, and $925 in accruals for interest on the excess of Salomon
Smith Barney expenses incurred in distribution of the funds' shares over
the sum of the distribution fees and deferred sales charge received by
Salomon Smith Barney from the fund.
Distribution Arrangements for the New York and California Fund
To compensate Salomon Smith Barney for the services it provides and for
the expense it bears, the trust has adopted a services and distribution
plan (the "Plan") pursuant to Rule 12b-1 under the 1940 Act. Under the
Plan, both the New York and California Fund pays Salomon 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 average daily net assets attributable
to the fund's Class A and Class L shares. In addition, each fund pays
Salomon Smith Barney a distribution fee with respect to the Class L 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 L distribution fee is calculated at the annual rate of 0.20% of
the value of each fund's average net assets attributable to the shares of
the Class. The following service and distribution fees were incurred
during the periods indicated:
DISTRIBUTION PLAN FEES
California Fund:
Year Ended
11/30/98
Year Ended
11/30/97
Year Ended
11/30/96
Class A
$39,9
73
$37,151
$37,644
Class L
15,5
64
9,596
8,361
New York Fund:
Class A
76,4
71
72,443
$76,380
Class L
9,91
7
5,758
2,733
*The inception dates for Class L of California Fund and New York
Fund are November 8, 1994 and December 5, 1994, respectively.
PORTFOLIO TRANSACTIONS
Decisions to buy and sell securities for each fund are made by the
manager, 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 the manager, 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 the manager 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 the manager 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 the manager in its best
judgment and in a manner deemed fair and reasonable to the funds'
shareholders. The primary considerations of the manager 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 the manager 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 the manager, and the fees of the manager are not reduced as a
consequence of their receipt of the supplemental information. The
information may be useful to the manager 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 the manager in
carrying out its obligations to a fund.
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 the Adviser 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.
The trust has paid no brokerage commissions for portfolio transactions
since its commencement of operations. Portfolio securities transactions
on behalf of the fund are placed by the manager with a number of brokers
and dealers, including Salomon Smith Barney. Salomon Smith Barney has
advised the fund that in transactions with the fund, Salomon Smith Barney
charges a commission rate at least as favorable as the rate that Salomon
Smith Barney charges its comparable unaffiliated customers in similar
transactions.
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 these 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:
Fund
Year Ended
11/30/98
Year Ended
11/30/97
California Fund
8%
9%
New York Fund
53%
52%
PURCHASE OF SHARES
Sales Charge Alternatives
The following classes of shares are available for purchase. See the
prospectus for a discussion of factors to consider in selecting which
Class of shares to purchase.
Class A Shares. Class A shares are sold to investors at the public
offering price, which is the net asset value plus an initial sales charge
as follows:
Amount of
Investment
Sales Charge as
a %
Of Transaction
Sales Charge as
a %
of Amount
Invested
Dealers'
Reallowance as %
of Offering Price
Less than
$500,000
4.00%
4.17%
3.60%
$500,000 and over
*
*
*
* Purchases of Class A shares of $500,000 or more will be made at net
asset value without any initial sales charge, but will be subject to a
deferred sales charge of 1.00% on redemptions made within 12 months of
purchase. The deferred sales charge on Class A shares is payable to
Salomon Smith Barney, which compensates Salomon Smith Barney Financial
Consultants and other dealers whose clients make purchases of $500,000
or more. The deferred sales charge is waived in the same circumstances
in which the deferred sales charge applicable to Class L shares is
waived. See "Purchase of Shares-Deferred Sales Charge Alternatives" and
"Purchase of Shares-Waivers of Deferred Sales Charge."
Members of the selling group may receive up to 90% of the sales charge and
may be deemed to be underwriters of the fund as defined in the Securities
Act of 1933. The reduced sales charges shown above apply to the aggregate
of purchases of Class A shares of the fund made at one time by "any
person," which includes an individual and his or her immediate family, or
a trustee or other fiduciary of a single trust estate or single fiduciary
account.
Class L Shares. Class L shares are sold with an initial sales charge of
1.00% (which is equal to 1.01% of the amount invested) and are subject to
a deferred sales charge payable upon certain redemptions. See "Deferred
Sales Charge Provisions" below. Until June 22, 2001 purchases of Class L
shares by investors who were holders of Class C shares of the fund on June
12, 1998 will not be subject to the 1% initial sales charge.
Class Y Shares. Class Y shares are sold without an initial sales charge
or deferred sales charge and are available only to investors investing a
minimum of $15,000,000 (except purchases of Class Y shares by Smith Barney
Concert Allocation Series Inc., for which there is no minimum purchase
amount).
General
Investors may purchase shares from a Salomon Smith Barney Financial
Consultant or a Dealer Representative. In addition, certain investors may
purchase shares directly from the fund. When purchasing shares of the
fund, investors must specify whether the purchase is for Class A, Class L
or Class Y shares. Salomon Smith Barney and Dealer Representatives may
charge their customers an annual account maintenance fee in connection
with a brokerage account through which an investor purchases or holds
shares. Accounts held directly at First Data Investor Services Group,
Inc. ("First Data" or "transfer agent") are not subject to a maintenance
fee.
Investors in Class A and Class L shares may open an account in the fund by
making an initial investment of at least $1,000 for each account, in the
fund. Investors in Class Y shares may open an account by making an initial
investment of $15,000,000. Subsequent investments of at least $50 may be
made for all Classes. For shareholders purchasing shares of the fund
through the Systematic Investment Plan on a monthly basis, the minimum
initial investment requirement for Class A and Class L shares and
subsequent investment requirement for all Classes is $25. For shareholders
purchasing shares of the fund through the Systematic Investment Plan on a
quarterly basis, the minimum initial investment required for Class A and
Class L shares and the subsequent investment requirement for all Classes
is $50. There are no minimum investment requirements for Class A shares
for employees of Citigroup and its subsidiaries, including Salomon Smith
Barney, unitholders who invest distributions from a Unit Investment Trust
("UIT") sponsored by Salomon Smith Barney, and Directors/Trustees of any
of the Smith Barney Mutual Funds, and their spouses and children. The fund
reserves the right to waive or change minimums, to decline any order to
purchase its shares and to suspend the offering of shares from time to
time. Shares purchased will be held in the shareholder's account by First
Data. Share certificates are issued only upon a shareholder's written
request to First Data. It is not recommended that the Fund be used as a
vehicle for Keogh, IRA or other qualified retirement plans.
Purchase orders received by the fund or a Salomon Smith Barney Financial
Consultant prior to the close of regular trading on the NYSE, on any day
the fund calculates its net asset value, are priced according to the net
asset value determined on that day (the ''trade date''). Orders received
by a Dealer Representative prior to the close of regular trading on the
NYSE on any day the fund calculates its net asset value, are priced
according to the net asset value determined on that day, provided the
order is received by the fund or the fund's agent prior to its close of
business. For shares purchased through Salomon Smith Barney or a Dealer
Representative purchasing through Salomon Smith Barney, payment for shares
of the fund is due on the third business day after the trade date. In all
other cases, payment must be made with the purchase order.
Systematic Investment Plan. Shareholders may make additions to their
accounts at any time by purchasing shares through a service known as the
Systematic Investment Plan. Under the Systematic Investment Plan, Salomon
Smith Barney or First Data is authorized through preauthorized transfers
of at least $25 on a monthly basis or at least $50 on a quarterly basis to
charge the shareholder's account held with a bank or other financial
institution on a monthly or quarterly basis as indicated by the
shareholder, to provide for systematic additions to the shareholder's fund
account. A shareholder who has insufficient funds to complete the transfer
will be charged a fee of up to $25 by Salomon Smith Barney or First Data.
The Systematic Investment Plan also authorizes Salomon Smith Barney to
apply cash held in the shareholder's Salomon Smith Barney brokerage
account or redeem the shareholder's shares of a Smith Barney money market
fund to make additions to the account. Additional information is available
from the fund or a Salomon Smith Barney Financial Consultant or a Dealer
Representative.
Sales Charge Waivers and Reductions
Initial Sales Charge Waivers. Purchases of Class A shares may be made at
net asset value without a sales charge in the following circumstances: (a)
sales to (i) Board Members and employees of Citigroup and its subsidiaries
and any Citigroup affiliated funds including the Smith Barney Mutual Funds
(including retired Board Members and employees); the immediate families of
such persons (including the surviving spouse of a deceased Board Member or
employee); and to a pension, profit-sharing or other benefit plan for such
persons and (ii) employees of members of the National Association of
Securities Dealers, Inc., provided such sales are made upon the assurance
of the purchaser that the purchase is made for investment purposes and
that the securities will not be resold except through redemption or
repurchase; (b) offers of Class A shares to any other investment company
to effect the combination of such company with the fund by merger,
acquisition of assets or otherwise; (c) purchases of Class A shares by any
client of a newly employed Salomon Smith Barney Financial Consultant (for
a period up to 90 days from the commencement of the Financial Consultant's
employment with Salomon Smith Barney), on the condition the purchase of
Class A shares is made with the proceeds of the redemption of shares of a
mutual fund which (i) was sponsored by the Financial Consultant's prior
employer, (ii) was sold to the client by the Financial Consultant and
(iii) was subject to a sales charge; (d) purchases by shareholders who
have redeemed Class A shares in the fund (or Class A shares of another
Smith Barney Mutual Fund that is offered with a sales charge) and who wish
to reinvest their redemption proceeds in the fund, provided the
reinvestment is made within 60 calendar days of the redemption; (e)
purchases by accounts managed by registered investment advisory
subsidiaries of Citigroup; (f) investments of distributions from a UIT
sponsored by Salomon Smith Barney; and (g) purchases by investors
participating in a Salomon Smith Barney fee-based arrangement. In order to
obtain such discounts, the purchaser must provide sufficient information
at the time of purchase to permit verification that the purchase would
qualify for the elimination of the sales charge.
Right of Accumulation. Class A shares of the fund may be purchased by
''any person'' (as defined above) at a reduced sales charge or at net
asset value determined by aggregating the dollar amount of the new
purchase and the total net asset value of all Class A shares of the fund
and of other Smith Barney Mutual Funds that are offered with a sales
charge as currently listed under ''Exchange Privilege'' then held by such
person and applying the sales charge applicable to such aggregate. In
order to obtain such discount, the purchaser must provide sufficient
information at the time of purchase to permit verification that the
purchase qualifies for the reduced sales charge. The right of
accumulation is subject to modification or discontinuance at any time with
respect to all shares purchased thereafter.
Letter of Intent - Class A Shares. A Letter of Intent for an amount of
$50,000 or more provides an opportunity for an investor to obtain a
reduced sales charge by aggregating investments over a 13 month period,
provided that the investor refers to such Letter when placing orders. For
purposes of a Letter of Intent, the ''Amount of Investment'' as referred
to in the preceding sales charge table includes (i) all Class A shares of
the fund and other Smith Barney Mutual Funds offered with a sales charge
acquired during the term of the letter plus (ii) the value of all Class A
shares previously purchased and still owned. Each investment made during
the period receives the reduced sales charge applicable to the total
amount of the investment goal. If the goal is not achieved within the
period, the investor must pay the difference between the sales charges
applicable to the purchases made and the charges previously paid, or an
appropriate number of escrowed shares will be redeemed. The term of the
Letter will commence upon the date the Letter is signed, or at the options
of the investor, up to 90 days before such date. Please contact a Salomon
Smith Barney Financial Consultant or First Data to obtain a Letter of
Intent application.
Letter of Intent - Class Y Shares. A Letter of Intent may also be used as
a way for investors to meet the minimum investment requirement for Class Y
shares (except purchases of Class Y shares by Smith Barney Concert
Allocation Series Inc., for which there is no minimum purchase amount).
Such investors must make an initial minimum purchase of $5,000,000 in
Class Y shares of the fund and agree to purchase a total of $15,000,000 of
Class Y shares of the fund within 13 months from the date of the Letter.
If a total investment of $15,000,000 is not made within the 13-month
period, all Class Y shares purchased to date will be transferred to Class
A shares, where they will be subject to all fees (including a service fee
of 0.15%) and expenses applicable to the fund's Class A shares, which may
include a deferred sales charge of 1.00%. Please contact a Salomon Smith
Barney Financial Consultant or First Data for further information.
Deferred Sales Charge Provisions
''Deferred Sales Charge Shares'' are: (a) Class L shares; and (b) Class A
shares that were purchased without an initial sales charge but are subject
to a deferred sales charge. A deferred sales charge may be imposed on
certain redemptions of these shares.
Any applicable deferred sales charge will be assessed on an amount equal
to the lesser of the original cost of the shares being redeemed or their
net asset value at the time of redemption. Deferred Sales Charge Shares
that are redeemed will not be subject to a deferred sales charge to the
extent the value of such shares represents: (a) capital appreciation of
fund assets; (b) reinvestment of dividends or capital gain distributions;
(c) with respect to Class L shares and Class A shares that are Deferred
Sales Charge Shares, shares redeemed more than 12 months after their
purchase.
Class L shares and Class A shares that are Deferred Sales Charge Shares
are subject to a 1.00% deferred sales charge if redeemed within 12 months
of purchase. In circumstances in which the deferred sales charge is
imposed on Class B shares, the amount of the charge will depend on the
number of years since the shareholder made the purchase payment from which
the amount is being redeemed. Solely for purposes of determining the
number of years since a purchase payment, all purchase payments made
during a month will be aggregated and deemed to have been made on the last
day of the preceding Salomon Smith Barney statement month.
The length of time that Deferred Sales Charge Shares acquired through an
exchange have been held will be calculated from the date the shares
exchanged were initially acquired in one of the other Smith Barney Mutual
Funds, and fund shares being redeemed will be considered to represent, as
applicable, capital appreciation or dividend and capital gain distribution
reinvestments in such other funds. For Federal income tax purposes, the
amount of the deferred sales charge will reduce the gain or increase the
loss, as the case may be, on the amount realized on redemption. The amount
of any deferred sales charge will be paid to Salomon Smith Barney. To
provide an example, assume an investor purchased 100 Class B shares of the
fund at $10 per share for a cost of $1,000. Subsequently, the investor
acquired 5 additional shares of the fund through dividend reinvestment.
During the fifteenth month after the purchase, the investor decided to
redeem $500 of his or her investment. Assuming at the time of the
redemption the net asset value had appreciated to $12 per share, the value
of the investor's shares would be $1,260 (105 shares at $12 per share).
The deferred sales charge would not be applied to the amount which
represents appreciation ($200) and the value of the reinvested dividend
shares ($60). Therefore, $240 of the $500 redemption proceeds ($500 minus
$260) would be charged at a rate of 4.00% (the applicable rate for Class B
shares) for a total deferred sales charge of $9.60.
Waivers of Deferred Sales Charge
The deferred sales charge will be waived on: (a) exchanges (see ''Exchange
Privilege''); (b) automatic cash withdrawals in amounts equal to or less
than 1.00% per month of the value of the shareholder's shares at the time
the withdrawal plan commences (see ''Automatic Cash Withdrawal Plan'')
(however, automatic cash withdrawals in amounts equal to or less than
2.00% per month of the value of the shareholder's shares will be permitted
for withdrawal plans established prior to November 7, 1994); (c)
redemptions of shares within 12 months following the death or disability
of the shareholder; (d) involuntary redemptions; and (e) redemptions of
shares to effect a combination of the fund with any investment company by
merger, acquisition of assets or otherwise. In addition, a shareholder who
has redeemed shares from other Smith Barney Mutual Funds may, under
certain circumstances, reinvest all or part of the redemption proceeds
within 60 days and receive pro rata credit for any deferred sales charge
imposed on the prior redemption.
Deferred sales charge waivers will be granted subject to confirmation (by
Salomon Smith Barney in the case of shareholders who are also Salomon
Smith Barney clients or by First Data in the case of all other
shareholders) of the shareholder's status or holdings, as the case may be.
Volume Discounts
The schedule of sales charges on Class A shares described in the
prospectus applies to purchases made by any "purchaser," which is defined
to include the following: (a) an individual; (b) an individual's spouse
and his or her children purchasing shares for their own account; (c) a
trustee or other fiduciary purchasing shares for a single trust estate or
single fiduciary account; and (d) a trustee or other professional
fiduciary (including a bank, or an investment adviser registered with the
SEC under the Investment Advisers Act of 1940, as amended) purchasing
shares of the fund for one or more trust estates or fiduciary accounts.
Purchasers who wish to combine purchase orders to take advantage of volume
discounts on Class A shares should contact a Salomon Smith Barney
Financial Consultant.
Determination of Public Offering Price
Each fund offers its shares to the public on a continuous basis. The
public offering price for a Class A and Class Y share of the 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 L share (and Class A
share purchases, including applicable rights of accumulation, equaling 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
deferred sales charge, however, is imposed on certain redemptions of Class
L 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 SAI.
REDEMPTION OF SHARES
The right of redemption of shares of either 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.
If the shares to be redeemed were issued in certificate form, the
certificates must be endorsed for transfer (or be accompanied by an
endorsed stock power) and must be submitted to First Data together with
the redemption request. Any signature appearing on a share certificate,
stock power or written redemption request in excess of $10,000 must be
guaranteed by an eligible guarantor institution such as a domestic bank,
savings and loan institution, domestic credit union, member bank of the
Federal Reserve System or member firm of a national securities exchange.
Written redemption requests of $10,000 or less do not require a signature
guarantee unless more than one such redemption request is made in any
10-day period or the redemption proceeds are to be sent to an address
other than the address of record. Unless otherwise directed, redemption
proceeds will be mailed to an investor's address of record. First Data
may require additional supporting documents for redemptions made by
corporations, executors, administrators, trustees or guardians. A
redemption request will not be deemed properly received until First Data
receives all required documents in proper form.
If a shareholder holds shares in more than one Class, any request for
redemption must specify the Class being redeemed. In the event of a
failure to specify which Class, or if the investor owns fewer shares of
the Class than specified, the redemption request will be delayed until the
Transfer Agent receives further instructions from Salomon Smith Barney, or
if the shareholder's account is not with Salomon Smith Barney, from the
shareholder directly. The redemption proceeds will be remitted on or
before the third business day following receipt of proper tender, except
on any days on which the NYSE is closed or as permitted under the 1940
Act, in extraordinary circumstances. Generally, if the redemption
proceeds are remitted to a Salomon Smith Barney brokerage account, these
funds will not be invested for the shareholder's benefit without specific
instruction and Salomon Smith Barney will benefit from the use of
temporarily uninvested funds. Redemption proceeds for shares purchased by
check, other than a certified or official bank check, will be remitted
upon clearance of the check, which may take up to ten days or more.
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 $50 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 deferred sales charge
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 deferred sales charge 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 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 the transfer agent 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. A shareholder who purchases shares directly through
the transfer agent may continue to do so and applications for
participation in the Withdrawal Plan must be received by the transfer
agent no later than the eighth day of the month to be eligible for
participation beginning with that month's withdrawal. For additional
information, shareholders should contact a Salomon Smith Barney Financial
Consultant.
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, Martin Luther
King, Jr. 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 for the New York and California Fund, the 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 the manager after consultation with
the Pricing Service. U.S. government securities will be valued at the
mean between the closing bid and asked prices on each day, or, if market
quotations for those securities are not readily available, at fair value,
as determined in good faith by the trust's board of trustees. With
respect to other securities held by the fund, 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 of the Smith Barney Mutual
Funds may exchange all or part of their shares for shares of the same
Class of other 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 the fund may be exchanged without a sales
charge for Class A shares of any of the Smith Barney Mutual Funds.
B. Class L shares of any fund may be exchanged without a sales
charge. For purposes of deferred sales charge applicability, Class
L shares of the fund exchanged for Class L shares of another Smith
Barney Mutual Fund will be deemed to have been owned since the date
the shares being exchanged were deemed to be purchased.
The exchange privilege enables shareholders in any Smith Barney Mutual
Fund 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 Salomon
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 deferred sales charge, 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.
Additional Information Regarding the Exchange Privilege. Although the
exchange privilege is an important benefit, excessive exchange
transactions can be detrimental to either the fund's performance or its
shareholders. The manager may determine that a pattern of frequent
exchanges is excessive and contrary to the best interests of the fund's
other shareholders. In this event, each fund may, at its discretion,
decide to limit additional purchases and/or exchanges by a shareholder.
Upon such a determination, the fund will provide notice in writing or by
telephone to the shareholder at least 15 days prior to suspending the
exchange privilege and during the 15 day period the shareholder will be
required to (a) redeem his or her shares in the fund or (b) remain
invested in the fund or exchange into any of the funds of the Smith Barney
Mutual funds ordinarily available, which position the shareholder would be
expected to maintain for a significant period of time. All relevant
factors will be considered in determining what constitutes an abusive
pattern of exchanges.
Additional Information Regarding Telephone Redemption and Exchange
Program.
Neither the funds nor their agents will be liable for following
instructions communicated by telephone that are reasonably believed to be
genuine. The funds nor their agents will employ procedures designed to
verify the identity of the caller and legitimacy of instructions (for
example, a shareholder's name and account number will be required and
phone calls may be recorded). Each fund reserves the right to suspend,
modify or discontinue the telephone redemption and exchange program or to
impose a charge for this service at any time following at least seven (7)
days prior 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 described in the Prospectuses is calculated
according to a formula prescribed by the SEC, expressed as follows:
Yield = 2[(A - B + 1)6 - 1]
CD
Where: a = Dividends and interest earned during
the period
b = Expenses accrued for the period (net of
reimbursements)
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
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.
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 New York Fund's yield for Class A and Class L shares for the 30-day
period ended November 30, 1998 was 3.41% and 3.26%, respectively. The
equivalent taxable yield for Class A and Class L shares for that same
period was 6.95% and 6.64%, respectively, assuming the payment of Federal
income taxes at a rate of 39.6% and New York taxes at a rate of 11.31%.
The California Fund's yield for Class A, Class L and Class Y shares for
the 30-day period ended November 30, 1998 was 3.04%, 2.87% and 3.29%,
respectively. The equivalent taxable yield for Class A, Class L and Class
Y shares for that same period was 5.95%, 5.62% and 6.44%, respectively,
assuming the payment of Federal income taxes at a rate of 39.6% and
California taxes at a rate of 9.3%.
Average Annual Total Return
A fund's "average annual total return," as described below, is computed
according to a formula prescribed by the SEC. The formula can be
expressed as follows:
P(1 + T)n = ERV
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.
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.
California Fund
Average Annual Total Return
Class of Shares
1-Year
5-Year
10-Year
Life
of fund1
Class A2
4.61%
5.25%
N/A
6.24%
Class L3
4.48%
N/A
N/A
7.65%
Class Y4
7.09%
N/A
N/A
6.66%
___________________
1 Class A commenced operations on December 31, 1991, Class C and L
commenced operations on November 8, 1994, and Class Y commenced
operations on September 8, 1995.
2 The average annual total return figure assumes that the maximum
2.00% sales charge has been deducted from the investment at the time
of purchase. If the maximum sales charge had not been deducted, the
average annual total return for Class A shares for the same period
would have been 6.78%, 5.67% and 6.54% for one year, five years and
life of the fund periods, respectively.
3 The average annual total return figure assumes that the maximum
applicable initial and deferred sales charges have been deducted
from the investment at the time of redemption. If the maximum
initial and deferred sales charge had not been deducted, the average
annual total return for Class L shares for the same period would
have been 6.57% and 7.92% for one year and life of the fund periods,
respectively.
4 Class Y shares do not incur sales charges nor deferred sales
charges.
New York Fund
Average Annual Total Return
Class of Shares
1-Year
5-Year
10-Year
Life
of fund1
Class A2
4.93%
5.11%
N/A
6.32%
Class L3
4.68%
N/A
N/A
7.30%
___________________
1 Class A commenced operations on December 31, 1991. Class C and L
commenced operations on December 2, 1994.
2 The average annual total return figure assumes that the maximum
2.00% sales charge has been deducted from the investment at the time
of purchase. If the maximum sales charge had not been deducted, the
average annual total return for Class A shares for the same period
would have been 7.01%, 5.52% and 6.63% for one year, five years and
life of the fund periods, respectively.
3 The average annual total return figure assumes that the maximum
applicable initial and deferred sales charges have been deducted
from the investment at the time of redemption. If the maximum
initial and deferred sales charges had not been deducted, the
average annual total return for Class L shares for the same period
would have been 6.79% and 7.57% for one year and life of the fund
periods, respectively.
Aggregate Total Return
The fund's "aggregate total return," as described below, represents the
cumulative change in the value of an investment in the fund for the
specified period and is computed by the following formula:
ERV - P
P
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.
The ERV assumes complete redemption of the hypothetical investment at the
end of the measuring period.
California Fund
Aggregate Annual Total Return
Class of Shares
1-Year
5-Year
10-Year
Life
of
fund1
Class A2
4.61%
29.15%
N/A
51.99%
Class L3
4.48%
N/A
N/A
34.92%
Class Y4
7.09%
N/A
N/A
23.17%
_______________________
1 Class A commenced operations on December 31, 1991, Class C and L
commenced operations on November 8, 1994, and Class Y commenced
operations on September 8, 1995.
2 The average annual total return figure assumes that the maximum
2.00% sales charge has been deducted from the investment at the time
of purchase. If the maximum sales charge had not been deducted, the
average annual total return for Class A shares for the same period
would have been 6.78%, 31.74% and 55.07% for one year, five years
and life of the fund periods, respectively.
3 The average annual total return figure assumes that the maximum
applicable initial and deferred sales charges have been deducted
from the investment at the time of redemption. If the maximum
initial and deferred sales charges had not been deducted, the
average annual total return for Class L shares for the same period
would have been 6.57% and 36.31% for one year and life of the fund
periods, respectively.
4 Class Y shares do not incur sales charges nor deferred sales
charges.
New York Fund
Aggregate Annual Total Return
Class of Shares
1-Year
5-Year
10-Year
Life
of
fund1
Class A2
4.93%
28.28%
N/A
52.85%
Class L3
4.68%
N/A
N/A
32.52%
_______________________
1 Class A commenced operations on December 31, 1991. Class C and L
commenced operations on December 2, 1994.
2 The average annual total return figure assumes that the maximum
2.00% sales charge has been deducted from the investment at the time
of purchase. If the maximum sales charge had not been deducted, the
average annual total return for Class A shares for the same period
would have been 7.01%, 30.84% and 55.95% for one year, five years
and life of the fund periods, respectively.
3 The average annual total return figure assumes that the maximum
applicable initial and deferred sales charges have been deducted
from the investment at the time of redemption. If the maximum
initial and deferred sales charges had not been deducted, the
average annual total return for Class L shares for the same period
would have been 6.79% and 33.86% for one year and life of the fund
periods, respectively.
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
fluctuations 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.
DIVIDENDS, DISTRIBUTION AND TAXES
Dividends and Distributions. The fund's policy is to declare and pay
exempt-interest dividends monthly. Dividends from net realized capital
gains, if any, will be distributed annually. The fund may also pay
additional dividends shortly before December 31 from certain amounts of
undistributed ordinary income and capital gains, in order to avoid a
Federal excise tax liability. If a shareholder does not otherwise
instruct, exempt-interest dividends and capital gain distributions will be
reinvested automatically in additional shares of the same Class at net
asset value, with no additional sales charge charge or deferred sales
charge.
The per share amounts of the exempt-interest dividends on Class L shares
may be lower than on Class A and Class Y shares, mainly as a result of the
distribution fees applicable to Class L shares. Similarly, the per share
amounts of exempt-interest dividends on Class A shares may be lower than
on Class A shares, as a result of the service fee attributable to Class A
shares. Capital gain distributions, if any, will be the same across all
Classes of fund shares (A, L and Y).
Taxes
The following is a summary of the material United States federal income
tax considerations regarding the purchase, ownership and disposition of
shares of a fund. Each prospective shareholder is urged to consult his or
her tax adviser with respect to the specific federal, state and local
consequences of investing in each fund. The summary is based on the laws
in effect on the date of this SAI, which are subject to change.
The Funds and Their Investments
As described in the each fund's Prospectus, each fund is designed to
provide shareholders with current income which is excluded from gross
income for federal income tax purposes and which is exempt from California
or New York State and New York City personal income taxes. Each fund is
not intended to constitute 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 each fund would
not be suitable for tax-exempt institutions, qualified retirement plans,
H.R. 10 plans and individual retirement accounts because such investors
would not gain any additional tax benefit from the receipt of tax-exempt
income.
Each fund intends to continue to qualify to be treated as a regulated
investment company each taxable year under the Code. To so qualify, each
fund must, among other things: (a) derive at least 90% of its gross income
in each taxable year from dividends, interest, payments with respect to
securities loans, and gains from the sale or other disposition of stock or
securities or foreign currencies, or other income (including, but not
limited to, gains from options, futures or forward contracts) derived with
respect to its business of investing in such stock, securities or
currencies; and (b) diversify its holdings so that, at the end of each
quarter of the fund's taxable year, (i) at least 50% of the market value
of the fund's assets is represented by cash, securities of other regulated
investment companies, United States government securities and other
securities, with such other securities limited, in respect of any one
issuer, to an amount not greater than 5% of the fund's assets and not
greater than 10% of the outstanding voting securities of such issuer and
(ii) not more than 25% of the value of its assets is invested in the
securities (other than United States government securities or securities
of other regulated investment companies) of any one issuer or any two or
more issuers that the fund controls and are determined to be engaged in
the same or similar trades or businesses or related trades or businesses.
As a regulated investment company, each fund will not be subject to United
States federal income tax on its net investment income (i.e., income other
than its net realized long- and short-term capital gains) and its net
realized long- and short-term capital gains, if any, that it distributes
to its shareholders, provided that an amount equal to at least 90% of its
investment company taxable income (i.e., 90% of its taxable income minus
the excess, if any, of its net realized long-term capital gains over its
net realized short-term capital losses (including any apital loss
carryovers), plus or minus certain other adjustments as specified in the
Code) and 90% of its net tax-exempt income for the taxable year is
distributed in compliance with the Code's timing and other requirements
but will be subject to tax at regular corporate rates on any taxable
income or gains that it does not distribute.
The Code imposes a 4% nondeductible excise tax on each fund to the extent
it does not distribute by the end of any calendar year at least 98% of its
net investment income for that year and 98% of the net amount of its
capital gains (both long-and short-term) for the one-year period ending,
as a general rule, on October 31 of that year. For this purpose, however,
any income or gain retained by each fund that is subject to corporate
income tax will be considered to have been distributed by year-end. In
addition, the minimum amounts that must be distributed in any year to
avoid the excise tax will be increased or decreased to reflect any
underdistribution or overdistribution, as the case may be, from the
previous year. Each fund anticipates that it will pay such dividends and
will make such distributions as are necessary in order to avoid the
application of this tax.
If, in any taxable year, each fund fails to qualify as a regulated
investment company under the Code or fails to meet the distribution
requirement, it would be taxed in the same manner as an ordinary
corporation and distributions to its shareholders would not be deductible
by each fund in computing its taxable income. In addition, in the event
of a failure to qualify, each fund's distributions, to the extent derived
from each fund's current or accumulated earnings and profits would
constitute dividends (eligible for the corporate dividends-received
deduction) which are taxable to shareholders as ordinary income, even
though those distributions might otherwise (at least in part) have been
treated in the shareholders' hands as tax-exempt interest. If each fund
fails to qualify as a regulated investment company in any year, it must
pay out its earnings and profits accumulated in that year in order to
qualify again as a regulated investment company. In addition, if each
fund failed to qualify as a regulated investment company for a period
greater than one taxable year, each fund may be required to recognize any
net built-in gains (the excess of the aggregate gains, including items of
income, over aggregate losses that would have been realized if it had been
liquidated) in order to qualify as a regulated investment company in a
subsequent year.
Each fund's transactions in municipal bond index and interest rate futures
contracts and options on these futures contracts (collectively "section
1256 contracts") will be subject to special provisions of the Code
(including provisions relating to "hedging transactions" and "straddles")
that, among other things, may affect the character of gains and losses
realized by each fund (i.e., may affect whether gains or losses are
ordinary or capital), accelerate recognition of income to each fund and
defer fund losses. These rules could therefore affect the character,
amount and timing of distributions to shareholders. These provisions also
(a) will require each fund to mark-to-market certain types of the
positions in its portfolio (i.e., treat them as if they were closed out)
and (b) may cause each fund to recognize income without receiving cash
with which to pay dividends or make distributions in amounts necessary to
satisfy the distribution requirements for avoiding income and excise
taxes. Each fund will monitor its transactions, will make the appropriate
tax elections and will make the appropriate entries in its books and
records when it engages in these transactions in order to mitigate the
effect of these rules and prevent disqualification of a fund as a
regulated investment company.
All section 1256 contracts held by each fund at the end of its taxable
year are required to be marked to their market value, and any unrealized
gain or loss on those positions will be included in each fund's income as
if each position had been sold for its fair market value at the end of the
taxable year. The resulting gain or loss will be combined with any gain
or loss realized by each fund from positions in section 1256 contracts
closed during the taxable year. Provided such positions were held as
capital assets and were not part of a "hedging transaction" nor part of a
"straddle," 60% of the resulting net gain or loss will be treated as long-
term capital gain or loss, and 40% of such net gain or loss will be
treated as short-term capital gain or loss, regardless of the period of
time the positions were actually held by each fund.
Taxation of Shareholders
Because each fund will distribute exempt-interest dividends, interest on
indebtedness incurred by a shareholder to purchase or carry fund shares 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 and if such share is held by the shareholder for six months
or less, then, for Federal income tax purposes, any loss on the sale or
exchange of such share may, to the extent of exempt-interest dividends, be
disallowed. In addition, the Code may require a shareholder, if he or she
receives exempt-interest dividends, to treat as Federal taxable income a
portion of certain otherwise non-taxable social security and railroad
retirement benefit payments. Furthermore, that portion of any exempt-
interest dividend paid by each fund which represents income derived from
private activity bonds held by each fund may not retain its Federal tax-
exempt status in the hands of a shareholder who is a "substantial user" of
a facility financed by such bonds or a "related person" thereof.
Moreover, some or all of each fund's 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. In addition,
the receipt of each fund's dividends and distributions may affect a
foreign corporate shareholder's Federal "branch profits" tax liability and
the Federal or California "excess net passive income" tax liability of a
shareholder 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 such users within the meaning of
the Code or (b) subject tot a federal alternative minimum tax, the Federal
branch profits tax or the Federal "excess net passive income" tax.
Each fund does not expect to realize a significant amount of capital
gains. Net realized short-term capital gains are taxable to a United
States shareholder as ordinary income, whether paid in cash or in shares.
Distributions of net-long-term capital gains, if any, that each fund
designates as capital gains dividends are taxable as long-term capital
gains, whether paid in cash or in shares and regardless of how long a
shareholder has held shares of each fund.
Shareholders receiving dividends or distributions in the form of
additional shares should have a cost basis in the shares received equal to
the amount of money that the shareholders receiving cash dividends or
distributions will receive.
Upon the sale or exchange of his shares, a shareholder will realize a
taxable gain or loss equal to the difference between the amount realized
and his basis in his shares. Such gain or loss will be treated as capital
gain or loss, if the shares are capital assets in the shareholder's hands,
and will be long-term capital gain or loss if the shares are held for more
than one year and short-term capital gain or loss if the shares are held
for one year or less. Any loss realized on a sale or exchange will be
disallowed to the extent the shares disposed of are replaced, including
replacement through the reinvesting of dividends and capital gains
distributions in each fund, within a 61-day period beginning 30 days
before and ending 30 days after the disposition of the shares. In such a
case, the basis of the shares acquired will be increased to reflect the
disallowed loss. Any loss realized by a shareholder on the sale of a fund
share held by the shareholder for six months or less(to the extent not
disallowed pursuant to the six-month rule described above relating to
exempt-interest dividends) will be treated for United States federal
income tax purposes as a long-term capital loss to the extent of any
distributions or deemed distributions of long-term capital gains received
by the shareholder with respect to such share.
If a shareholder incurs a sales charge in acquiring shares of a fund,
disposes of those shares within 90 days and then acquires shares in a
mutual fund for which the otherwise applicable sales charge is reduced by
reason of a reinvestment right (e.g., an exchange privilege), the original
sales charge will not be taken into account in computing gain or loss on
the original shares to the extent the subsequent sales charge is reduced.
Instead, the disregarded portion of the original sales charge will be
added to the tax basis in the newly acquired shares. Furthermore, the
same rule also applies to a disposition of the newly acquired shares made
within 90 days of the second acquisition. This provision prevents a
shareholder from immediately deducting the sales charge by shifting his or
her investment in a family of mutual funds.
Backup Withholding. Each fund may be required to withhold, for United
States federal income tax purposes, 31% of (a) taxable dividends and
distributions and (b) redemption proceeds payable to shareholders who fail
to provide each fund with their correct taxpayer identification number or
to make required certifications, or who have been notified by the IRS that
they are subject to backup withholding. Certain shareholders are exempt
from backup withholding. Backup withholding is not an additional tax and
any amount withheld may be credited against a shareholder's United States
federal income tax liabilities.
Notices. Shareholders will be notified annually by a fund as to the
United States federal income tax and California or New York State and New
York City personal income tax status of the dividends and distributions
made by a fund to its shareholders. These statements also will designate
the amount of exempt-interest dividends that is a preference item for
purposes of the Federal individual and corporate alternative minimum
taxes. The dollar amount of dividends excluded or exempt from Federal
income taxation and California or New York State and New York City
personal income taxation and the dollar amount of dividends subject to
Federal income taxation and California or New York State and New York City
personal income taxation, if any, will vary for each shareholder depending
upon the size and duration of each shareholder's investment in a fund. To
the extent each fund earns taxable net investment income, it intends to
designate as taxable dividends the same percentage of each day's dividend
as its taxable net investment income bears to its total net investment
income earned on that day.
The foregoing is only a summary of certain material tax consequences
affecting each fund and its shareholders. Shareholders are advised to
consult their own tax advisers with respect to the particular tax
consequences to them of an investment in each fund.
ADDITIONAL INFORMATION
The trust was organized on October 17, 1991 under the laws of the
Commonwealth of Massachusetts and is a business entity commonly known as a
"Massachusetts business trust." The trust offers shares of beneficial
interest of five separate funds with a par value of $.001 per share. The
fund may offer shares of beneficial interest currently classified into
five Classes - A, B, L ,Y and Z. Each Class of the fund represents an
identical interest in the fund's investment portfolio. As a result, the
Classes have the same rights, privileges and preferences, except with
respect to: (a) the designation of each Class; (b) the effect of the
respective sales charges; if any, for each class; (c) the distribution
and/or service fees borne by each Class pursuant to the Plan; (d) the
expenses allocable exclusively to each Class; (e) voting rights on matters
exclusively affecting a single Class; (f) the exchange privilege of each
Class; and (g) the conversion feature of the Class B shares. The trust's
board of trustees does not anticipate that there will be any conflicts
among the interests of the holders of the different Classes. The trustees,
on an ongoing basis, will consider whether any such conflict exists and,
if so, take appropriate action.
Under Massachusetts's law, shareholders could, under certain
circumstances, be held personally liable for the obligations of the fund.
The Master Trust Agreement disclaims shareholder liability for acts or
obligations of the fund, however, and requires that notice of such
disclaimer be given in each agreement, obligation or instrument entered
into or executed by the fund or a trustee. The Master Trust Agreement
provides for indemnification from fund property for all losses and
expenses of any shareholder held personally liable for the obligations of
the fund. Thus, the risk of a shareholder's incurring financial loss on
account of shareholder liability is limited to circumstances in which the
fund itself would be unable to meet its obligations, a possibility which
management of the fund believes is remote. Upon payment of any liability
incurred by the fund, a shareholder paying such liability will be entitled
to reimbursement from the general assets of the fund. The trustees intend
to conduct the operation of the fund in such a way so as to avoid, as far
as possible, ultimate liability of the shareholders for liabilities of the
fund.
The Master Trust Agreement of the fund permits the trustees of the fund to
issue an unlimited number of full and fractional shares of a single class
and to divide or combine the shares into a greater or lesser number of
shares without thereby changing the proportionate beneficial interests in
the fund. Each share in the fund represents an equal proportional
interest in the fund with each other share. Shareholders of the fund are
entitled upon its liquidation to share pro rata in its net assets
available for distribution. No shareholder of the fund has any preemptive
or conversion rights. Shares of the fund are fully paid and non-
assessable.
Pursuant to the Master Trust Agreement, the fund's trustees may authorize
the creation of additional series of shares (the proceeds of which would
be invested in separate, independently managed portfolios) and additional
classes of shares within any series (which would be used to distinguish
among the rights of different categories of shareholders, as might be
required by future regulations or other unforeseen circumstances).
The fund does not hold annual shareholder meetings. There normally will be
no meetings of shareholders for the purpose of electing trustees unless
and until such time as less than a majority of the trustees holding office
have been elected by shareholders, at which time the trustees then in
office will call a shareholders' meeting for the election of trustees.
Shareholders of record of no less than two-thirds of the outstanding
shares of the trust may remove a trustee through a declaration in writing
or by vote cast in person or by proxy at a meeting called for that
purpose. The trustees will call a meeting for any purpose upon written
request of shareholders holding at least 10% of the trust's outstanding
shares and the trust will assist shareholders in calling such a meeting as
required by the 1940 Act.
When matters are submitted for shareholder vote, shareholders of each
Class will have one vote for each full share owned and a proportionate,
fractional vote for any fractional share held of that Class. Generally,
shares of the fund will be voted on a fund-wide basis on all matters
except matters affecting only the interests of one Class, in which case
only shares of the affected Class would be entitled to vote.
The trust was organized as an unincorporated Massachusetts business trust
on October 17, 1991 under the name Shearson Lehman Brothers Intermediate-
Term Trust. On October 14, 1994 and August 16, 1995, the Trust's name was
changed Smith Barney Income Trust and Smith Barney Investment Trust,
respectively.
Annual and Semi-annual Reports. The fund sends its shareholders a semi-
annual report and an audited annual report, which include listings of
investment securities held by the fund at the end of the period covered.
In an effort to reduce the fund's printing and mailing costs, the fund
consolidates the mailing of its semi-annual and annual reports by
household. This consolidation means that a household having multiple
accounts with the identical address of record will receive a single copy
of each report. In addition, the fund also consolidates the mailing of its
prospectus so that a shareholder having multiple accounts (that is,
individual, IRA and/or Self-Employed Retirement Plan accounts) will
receive a single Prospectus annually. Shareholders who do not want this
consolidation to apply to their accounts should contact their Salomon
Smith Barney Financial Consultant or the transfer agent.
FINANCIAL STATEMENTS
The fund's annual report for the fiscal year ended November 30, 1998 is
incorporated herein by reference in its entirety. The annual report was
filed on February 26, 1999, Accession Number 91155-99-102 .
OTHER INFORMATION
In an industry where the average portfolio manager has seven years of
experience (source: ICI, 1998), the portfolio managers of Smith Barney
Mutual Funds average 21 years in the industry and 15 years with the firm.
Smith Barney Mutual Funds offers more than 60 mutual funds. We understand
that many investors prefer an active role in allocating the mix of funds
in their portfolio, while others want the asset allocation decisions to be
made by experienced managers.
That's why we offer four "styles" of fund management that can be tailored
to suit each investor's unique financial goals.
Style Pure Series
Our Style Pure Series funds stay fully invested within their asset
class and investment style, enabling investors to make asset
allocation decisions in conjunction with their Salomon Smith Barney
Financial Consultant.
Classic Investor Series
Our Classic Investor Series funds offer a range of equity and fixed
income strategies that seek to capture opportunities across asset
classes and investment styles using disciplined investment
approaches.
The Concert Allocation Series
As a fund of funds, investors can select a Concert Portfolio that
may help their investment needs. As needs change, investors can
easily choose another long-term, diversified investment from our
Concert family.
Special Discipline Series
Our Special Discipline Series funds are designed for investors who
are looking beyond more traditional market categories: from natural
resources to a roster of state-specific municipal funds.
APPENDIX
RATINGS ON DEBT OBLIGATIONS
BOND (AND NOTES) RATINGS
Moody's Investors Service, Inc.
Aaa - Bonds that are 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 edged." 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 that are 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 that 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 that suggest a susceptibility to impairment
sometime in the future.
Baa - Bonds that are rated "Baa" are considered as medium grade
obligations, i.e., 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.
Ba - Bonds which are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and
thereby not well safeguarded during both good and bad times over the
future. Uncertainty of position characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time
may be small.
Caa - Bonds which are rated Caa are of poor standing. Such issues may
be in default or there may be present elements of danger with respect to
principal or interest.
Ca - Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have
other marked shortcomings.
C - Bonds which are rated C are the lowest class of bonds and issues
so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Note: 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.
Standard & Poor's
AAA - Debt rated "AAA" has the highest rating assigned by Standard &
Poor's. Capacity to pay interest and repay principal is extremely strong.
AA - Debt rated "AA" has a very strong capacity to pay interest and
repay principal and differs from the highest rated issues only in small
degree.
A - Debt rated "A" has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects
of changes in circumstances and economic conditions than debt in higher
rated categories.
BBB - Debt rated "BBB" is regarded as having an adequate capacity to
pay interest and repay principal. Whereas it normally exhibits 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.
BB, B, CCC, CC, C - Debt rated `BB', `B', `CCC', `CC' or `C' is
regarded, on balance, as predominantly speculative with respect to
capacity to pay interest and repay principal in accordance with the terms
of the obligation. `BB' indicates the lowest degree of speculation and `C'
the highest degree of speculation. While such debt will likely have some
quality and protective characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse conditions.
Plus (+) or Minus (-): The ratings from `AA' to `B' may be modified
by the addition of a plus or minus sign to show relative standing within
the major rating categories.
Provisional Ratings: The letter "p" indicates that the rating is
provisional. A provisional rating assumes the successful completion of the
project being financed by the debt being rated and indicates that payment
of debt service requirements is largely or entirely dependent upon the
successful and timely completion of the project. This rating, however,
while addressing credit quality subsequent to completion of the project,
makes no comment on the likelihood of, or the risk of default upon failure
of, such completion. The investor should exercise judgment with respect to
such likelihood and risk.
L - The letter "L" indicates that the rating pertains to the
principal amount of those bonds where the underlying deposit collateral is
fully insured by the Federal Savings & Loan Insurance Corp. or the Federal
Deposit Insurance Corp.
+ - Continuance of the rating is contingent upon S&P's receipt of
closing documentation confirming investments and cash flow.
* - Continuance of the rating is contingent upon S&P's receipt of an
executed copy of the escrow agreement.
NR - Indicates no rating has been requested, that there is
insufficient information on which to base a rating, or that S&P does not
rate a particular type of obligation as a matter of policy.
Fitch IBCA, Inc.
AAA - Bonds rated AAA by Fitch have the lowest expectation of credit
risk. The obligor has an exceptionally strong capacity for timely payment
of financial commitments which is highly unlikely to be adversely affected
by foreseeable events.
AA - Bonds rated AA by Fitch have a very low expectation of credit
risk. They indicate very strong capacity for timely payment of financial
commitment. This capacity is not significantly vulnerable to foreseeable
events.
A - Bonds rated A by Fitch are considered to have a low expectation
of credit risk. The capacity for timely payment of financial commitments
is considered to be strong, but may be more vulnerable to changes in
economic conditions and circumstances than bonds with higher ratings.
BBB - Bonds rated BBB by Fitch currently have a low expectation of
credit risk. The capacity for timely payment of financial commitments is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to impair this capacity. This is
the lowest investment grade category assigned by Fitch.
BB - Bonds rated BB by Fitch carry the possibility of credit risk
developing, particularly as the result of adverse economic change over
time. Business or financial alternatives may, however, be available to
allow financial commitments to be met. Securities rated in this category
are not considered by Fitch to be investment grade.
B - Bonds rated B by Fitch carry significant credit risk, however, a
limited margin of safety remains. Although financial commitments are
currently being met, capacity for continued payment depends upon a
sustained, favorable business and economic environment.
CCC, CC, C - Default on bonds rated CCC,CC, and C by Fitch is a real
possibility. The capacity to meet financial commitments depends solely on
a sustained, favorable business and economic environment. Default of some
kind on bonds rated CC appears probable, a C rating indicates imminent
default.
Plus and minus signs are used by Fitch to indicate the relative
position of a credit within a rating category. Plus and minus signs
however, are not used in the AAA category.
COMMERCIAL PAPER RATINGS
Moody's Investors Service, Inc.
Issuers rated "Prime-1" (or related supporting institutions) have a
superior capacity for repayment of short-term promissory obligations.
Prime-1 repayment will normally be evidenced by the following
characteristics: leading market positions in well-established industries;
high rates of return on funds employed; conservative capitalization
structures with moderate reliance on debt and ample asset protection;
broad margins in earnings coverage of fixed financial changes and high
internal cash generation; well-established access to a range of financial
markets and assured sources of alternate liquidity.
Issuers rated "Prime-2" (or related supporting institutions) have
strong capacity for repayment of short-term promissory obligations. This
will normally be evidenced by many of the characteristics cited above 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 alternate
liquidity is maintained.
Standard & Poor's
A-1 - This designation indicates that the degree of safety regarding
timely payment is either overwhelming or very strong. Those issuers
determined to possess overwhelming safety characteristics will be denoted
with a plus (+) sign designation.
A-2 - Capacity for timely payment on issues with this designation is
strong. However, the relative degree of safety is not as high as for
issues designated A-1.
Fitch IBCA, Inc.
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 financial commitment in a
timely manner.
Fitch's short-term ratings are as follows:
F1+ - Issues assigned this rating are regarded as having the
strongest capacity for timely payments of financial commitments. The "+"
denotes an exceptionally strong credit feature.
F1 - Issues assigned this rating are regarded as having the strongest
capacity for timely payment of financial commitments.
F2 - Issues assigned this rating have a satisfactory capacity for
timely payment of financial commitments, but the margin of safety is not
as great as in the case of the higher ratings.
F3 - The capacity for the timely payment of financial commitments is
adequate; however, near-term adverse changes could result in a reduction
to non investment grade.
Duff & Phelps Inc.
Duff 1+ - Indicates the highest certainty of timely payment: short-
term liquidity is clearly outstanding, and safety is just below risk-free
United States Treasury short-term obligations.
Duff 1 - Indicates a high certainty of timely payment.
Duff 2 - Indicates a good certainty of timely payment: liquidity
factors and company fundamentals are sound.
The Thomson BankWatch ("TBW")
TBW-1 - Indicates a very high degree of likelihood that principal and
interest will be paid on a timely basis.
TBW-2 - While the degree of safety regarding timely repayment of
principal and interest is strong, the relative degree of safety is not as
high as for issues rated TBW-1.
SMITH BARNEY
INVESTMENT TRUST
Intermediate Maturity
California Municipal Fund
Intermediate Maturity
New York Municipal Fund
March 30, 1999,
As amended on July 1,
1999
SMITH BARNEY INVESTMENT TRUST
388 Greenwich Street
New York, NY 10013
SALOMON SMITH BARNEY
A Member of Citigroup
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