March 30, 1999
As amended on July 1, 1999,
As amended on January 12, 2000
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 47
Investment Restrictions..............51
Investment Management and Other
Services..............................52
Portfolio Transactions... ...........57
Portfolio Turnover...................58
Purchase of Shares .............................................59
Redemption of Shares 64
Valuation of Shares 66
Exchange Privilege 66
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 both the California
Fund and New York Fund normally invest will be no greater
than 20 years.
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
Compensat
ion
From
Trust
Total
Pension or
Retirement
Benefits
Accrued
as part of
Trust
Expenses
Compensatio
n
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
Reimburse
d
Fees
Paid
Fees Waived
and
Expenses
Reimbursed
California
Fund
$
0
$
128,361
$
20,278
$
63,087
$47,7
59
$ 46,438
New York
Fund
32,306
122,796
59,523
90,299
98,26
4
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
Reimburse
d
Fees
Paid
Fees
Waived and
Expenses
Reimbursed
Fees
Paid
Fees Waived
and
Expenses
Reimbursed
California
Fund
$
0
$
85,575
$
13,518
$ 42,058
$31,8
40
$ 30,958
New York Fund
10,906
92,495
33,023
66,858
65,50
8
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,
As amended on January 12,
2000
SMITH BARNEY INVESTMENT TRUST
388 Greenwich Street
New York, NY 10013
SALOMON SMITH
BARNEY
A Member of
Citigroup
101
