FRANKLIN
CALIFORNIA HIGH YIELD
MUNICIPAL FUND
Franklin Municipal Securities Trust
PROSPECTUS October 1, 1995
as amended May 1, 1996
777 Mariners Island Blvd., P.O. Box 7777
San Mateo, CA 94403-7777 1-800/DIAL BEN
Franklin California High Yield Municipal Fund (the "Fund"), a non-diversified
series of Franklin Municipal Securities Trust (the "Trust"), seeks to provide
investors with a high current yield exempt from federal and California personal
income taxes by investing in lower-rated or unrated municipal securities. As a
secondary objective, the Fund will seek capital appreciation to the extent that
this is possible and is consistent with its principal investment objective.
The Fund invests primarily in municipal securities issued by California and its
political subdivisions, agencies and instrumentalities which pay interest
exempt, in the opinion of counsel, from California state and regular federal
income taxes.
Although exempt from regular federal and state personal income tax, interest
paid on certain types of municipal obligations is deemed to be a preference item
under federal income tax law and subject to the federal alternative minimum tax.
It is possible that the Fund's investments could consist entirely of bonds
subject to the federal alternative minimum tax.
THE FUND MAY INVEST UP TO 100% OF ITS PORTFOLIO IN NON-INVESTMENT GRADE BONDS,
COMMONLY KNOWN AS "JUNK BONDS," WHICH ENTAIL DEFAULT AND OTHER RISKS GREATER
THAN THOSE ASSOCIATED WITH HIGHER RATED SECURITIES. YOU SHOULD CAREFULLY ASSESS
THE RISKS ASSOCIATED WITH AN INVESTMENT IN THE FUND IN LIGHT OF THE SECURITIES
IN WHICH THE FUND INVESTS. SEE "WHAT ARE THE FUND'S POTENTIAL RISKS? - HIGH
YIELDING MUNICIPAL SECURITIES."
This prospectus is intended to set forth in a clear and concise manner
information about the Fund that you should know before investing. After reading
this prospectus, you should retain it for future reference; it contains
information about the purchase and sale of shares and other items that you will
find useful.
An SAI concerning the Fund, dated October 1, 1995, as amended May 1, 1996, and
as may be further amended from time to time, provides a further discussion of
certain areas in this prospectus and other matters which may be of interest to
you. It has been filed with the SEC and is incorporated herein by reference. A
copy is available without charge from the Fund or Distributors, at the address
or telephone number shown above.
Shares of the Fund are not deposits or obligations of, or guaranteed or endorsed
by, any bank; further, such shares are not federally insured by the Federal
Deposit Insurance Corporation, the Federal Reserve Board, or any other agency.
Shares of the Fund involve investment risks, including the possible loss of
principal.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SEC OR ANY STATE
SECURITIES COMMISSION NOR HAS THE SEC OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
THIS PROSPECTUS IS NOT AN OFFERING OF THE SECURITIES HEREIN DESCRIBED IN ANY
STATE IN WHICH THE OFFERING IS NOT AUTHORIZED. NO SALES REPRESENTATIVE, DEALER,
OR OTHER PERSON IS AUTHORIZED TO GIVE ANY INFORMATION OR MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS. FURTHER
INFORMATION MAY BE OBTAINED FROM THE UNDERWRITER.
The Fund offers two classes of shares: Franklin California High Yield Municipal
Fund - Class I ("Class I") and Franklin California High Yield Municipal Fund -
Class II ("Class II"). You can choose between Class I shares, which generally
bear a higher front-end sales charge and lower ongoing Rule 12b-1 distribution
fees ("Rule 12b-1 fees"), and Class II shares, which generally have a lower
front-end sales charge and higher ongoing Rule 12b-1 fees. You should consider
the differences between the two classes, including the impact of sales charges
and Rule 12b-1 fees, in choosing the more suitable class given your anticipated
investment amount and time horizon. See "How Do I Buy Shares? - Deciding Which
Class to Buy."
CONTENTS PAGE
Expense Table 3
Financial Highlights - How Has
the Fund Performed? 4
What Is the Franklin California
High Yield Municipal Fund? 5
How Does the Fund Invest Its Assets? 5
What Are the Fund's Potential Risks? 9
How You Participate in the
Results of the Fund's Activities 14
Who Manages the Fund? 14
What Distributions Might I
Receive from the Fund? 17
How Taxation Affects You and the Fund 18
How Do I Buy Shares? 20
What Programs and Privileges Are
Available to Me as a Shareholder? 25
What If My Investment Outlook
Changes? - Exchange Privilege 27
How Do I Sell Shares? 30
Telephone Transactions 33
How Are Fund Shares Valued? 34
How Do I Get More Information
About My Investment? 35
How Does the Fund Measure Performance? 35
General Information 36
Registering Your Account 37
Important Notice Regarding
Taxpayer IRS Certifications 38
Useful Terms and Definitions 39
Appendix - Description of Municipal
Securities Ratings 40
Expense Table
The purpose of this table is to assist you in understanding the various costs
and expenses that you will bear directly or indirectly in connection with an
investment in the Fund. The figures for both classes of shares are based on the
aggregate operating expenses of the Class I shares (except as noted), before fee
waivers and expense reductions, for the fiscal year ended May 31, 1995.
Class I Class II
------------------
SHAREHOLDER TRANSACTION EXPENSES
Maximum Sales Charge Imposed on Purchases
(as a percentage of offering price)...................... 4.25% 1.00%+
Deferred Sales Charge..................................... None++ 1.00%+++
ANNUAL FUND OPERATING EXPENSES
(as a percentage of average net assets)
Management Fees............................................ 0.62%* 0.62%*
Rule 12b-1 Fees............................................ 0.09%** 0.65%**
Other Expenses:
Reports to Shareholders................................... 0.04% 0.04%
Professional Fees......................................... 0.04% 0.04%
Other..................................................... 0.09% 0.09%
---------------
Total Other Expenses....................................... 0.17% 0.17%
---------------
Total Fund Operating Expenses.............................. 0.88% 1.44%
===============
+Although Class II has a lower front-end sales charge than Class I, over time
the higher Rule 12b-1 fees for Class II may cause you to pay more for Class II
shares than for Class I shares. Given the maximum front-end sales charge and the
rate of Rule 12b-1 fees of each class, it is estimated that this will take less
than six years if you maintain total shares valued at less than $100,000 in the
Franklin Templeton Funds. If your investments in the Franklin Templeton Funds
are valued at $100,000 or more, you will reach the crossover point more quickly.
++Class I investments of $1 million or more are not subject to a front-end sales
charge; however, a contingent deferred sales charge of 1% is generally imposed
on certain redemptions within a "contingency period" of 12 months of the
calendar month of such investments. See "How Do I Sell Shares? - Contingent
Deferred Sales Charge."
+++Class II shares redeemed within a "contingency period" of 18 months of the
calendar month of such investments are subject to a 1% contingent deferred sales
charge. See "How Do I Sell Shares? - Contingent Deferred Sales Charge."
*The Manager has agreed in advance to waive all of its management fee and to
make certain payments to reduce expenses of the Fund. With this reduction, the
Fund did not pay a management fee and operating expenses represented 0.20% of
the average net assets of Class I shares.
**The maximum amount of Rule 12b-1 fees allowed pursuant to the distribution
plans is currently 0.10% for Class I and 0.65% pursuant to Class II. See "Who
Manages the Fund? - Plans of Distribution." Consistent with National Association
of Securities Dealers, Inc.'s rules, it is possible that the combination of
front-end sales charges and Rule 12b-1 fees could cause long-term shareholders
to pay more than the economic equivalent of the maximum front-end sales charges
permitted under those same rules.
You should be aware that the above table is not intended to reflect in precise
detail the fees and expenses associated with an investment in the Fund. Rather,
the table has been provided only to assist you in gaining a more complete
understanding of fees, charges and expenses. For a more detailed discussion of
these matters, you should refer to the appropriate sections of this prospectus.
EXAMPLE
As required by SEC regulations, the following example illustrates the expenses,
including the maximum front-end sales charge and applicable contingent deferred
sales charge, that apply to a $1,000 investment in the Fund over various time
periods assuming (1) a 5% annual rate of return and (2) redemption at the end of
each time period.
One Year Three Years Five Years Ten Years
Class I................... $51* $69 $89 $146
Class II.................. $34 $55 $88 $181
*Assumes that a contingent deferred sales charge will not apply to Class I
shares.
You would incur the following expenses on the same investment in Class II
shares, assuming no redemption.
One Year Three Years Five Years Ten Years
Class II.................. $25 $55 $88 $181
This example is based on the aggregate annual operating expenses, before fee
waivers and expense reductions, shown above and should not be considered a
representation of past or future expenses, which may be more or less than those
shown. The operating expenses are borne by the Fund and only indirectly by you
as a result of your investment in the Fund. In addition, federal securities
regulations require the example to assume an annual return of 5%, but the Fund's
actual return may be more or less than 5%.
FINANCIAL HIGHLIGHTS - HOW HAS THE FUND PERFORMED?
Set forth below is a table containing the financial highlights for a Class I
share of the Fund from the effective date of the Fund's registration statement,
as indicated below, through the period ended November 30, 1995. The information
for each of the fiscal years in the period ended May 31, 1995 has been audited
by Coopers & Lybrand L.L.P., independent auditors, whose audit report appears in
the financial statements in the Trust's Annual Report to Shareholders for the
fiscal year ended May 31, 1995. The remaining figures are not audited. See the
discussion "Reports to Shareholders" under "General Information" in this
prospectus.
<TABLE>
<CAPTION>
Distri-
Net Distri- butions
Net Asset Net Realized & Total butions From Net Asset Net Assets Ratio of
Period Value at Invest-Unrealized From From Net Realized Total Value at at End Expenses Net Income Portfolio
Ended Beginning ment Gain(Loss) Investment Investment Capital Distri- End of Total of Period to Average to Average Turnover
May 31 of Period Income on Securities Operations Income Gains butions Period Return+(in 000's) Net Assets Net Assets Rate
- ------------------------------------------------------------------------------------------------------------------------------------
<C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
19931 $10.00 $.03 $(.060) $(.030) $ - $ - $ - $9.97 (3.60)%* $ 2,245 -% 3.85%* 8.89%
1994 9.97 .53 (.199) .331 (.558) (.013) (.571) 9.73 3.22 31,938 .07 6.14 40.74%
1995 9.73 .66 .176 .836 (.636) - (.636) 9.93 9.08 51,102 .20 6.89 57.06
19952 9.93 .328 .150 .478 (.328) - (.328) 10.08 4.93 72,982 .35* 6.77* 7.62
</TABLE>
1For the period May 3, 1993 (effective date of registration) to May 31, 1993.
2For the six months ended November 30, 1995.
+Total return measures the change in value of an investment over the periods
indicated. It does not include the maximum front-end sales charge and assumes
reinvestment of dividends and capital gains, if any, at net asset value.
*Annualized.
**During the periods indicated, Advisers agreed in advance to waive its
management fees and to pay certain other expenses. Had such action not been
taken, the ratio of operating expenses to average net assets would have been as
follows:
19931........................................ 1.42%*
1994......................................... .87
1995......................................... .88
19952........................................ .83*
WHAT IS THE FRANKLIN CALIFORNIA
HIGH YIELD MUNICIPAL FUND?
The Fund is a nondiversified series of the Trust, an open-end management
investment company commonly called a "mutual fund." The Trust was organized as a
Delaware business trust in November 1991 and registered with the SEC under the
1940 Act. The Fund has two classes of shares of beneficial interest
("multiclass" structure) with a par value of $.01: Franklin California High
Yield Municipal Fund - Class I and Franklin California High Yield Municipal Fund
- - Class II. All Fund shares outstanding before May 1, 1996 have been
redesignated as Class I shares and will retain their previous rights and
privileges, except for legally required modifications to shareholder voting
procedures, as discussed in "General Information - Organization and Voting
Rights."
HOW DOES THE FUND INVEST ITS ASSETS?
The Fund's primary investment objective is to provide investors with a high
current yield exempt from federal and California personal income taxes by
investing in lower-rated or unrated municipal securities. As a secondary
objective, the Fund will seek capital appreciation to the extent that this is
possible and is consistent with its principal investment objective. The Fund's
investment objectives and other fundamental policies may not be changed without
shareholder approval. Because of the Fund's policy of seeking high current yield
and its ability to invest in lower-grade municipal obligations, including
defaulted securities, a higher degree of risk accompanies an investment in the
Fund's shares than is the case in a more conservative tax-free, income-type
investment company. Of course, there is no assurance that the Fund's objectives
will be achieved.
The Fund attempts to invest 100% and, as a matter of fundamental policy, will
invest at least 80% of its net assets in municipal securities, the interest on
which is exempt from regular federal income taxes. Although exempt from regular
federal income tax, interest paid on certain types of municipal obligations,
such as "private activity bonds," and the dividends to be paid by the Fund
therefrom, is deemed to be a preference item under the federal alternative
minimum tax system and therefore subject to the federal alternative minimum tax.
As a result, dividends that would otherwise be tax-exempt may not be completely
tax-exempt to an investor who is subject to the federal alternative minimum tax,
and, therefore, an investment in the Fund may not be appropriate for such an
investor. It is possible, although not anticipated, that up to 20% of the Fund's
net assets could be in obligations subject to regular federal taxation.
At least 65% of the Fund's total assets will be invested in municipal securities
issued by the state of California and its political subdivisions, agencies and
instrumentalities, and in non-state issuers that pay interest exempt from
regular federal and California personal income tax. It is possible, although not
anticipated, that up to 35% of the Fund's total assets could be in municipal
securities from other states. In addition, it is possible that the Fund's
investments could consist entirely of bonds subject to the federal alternative
minimum tax.
The interest on bonds issued to finance public purpose state and local
government operations is generally tax-exempt for regular federal income tax
purposes. Interest on certain "private activity bonds" (including those for
housing and student loans) issued after August 7, 1986, while still tax-exempt,
constitutes a preference item for taxpayers in determining the federal
alternative minimum tax under the Internal Revenue Code of 1986, as amended (the
"Code"), and under the income tax provisions of some states. This interest could
subject a shareholder to, or increase liability under, the federal alternative
minimum tax, depending on the shareholder's tax situation. In addition, all
distributions derived from interest exempt from regular federal income tax may
subject a corporate shareholder to, or increase liability under, the federal
alternative minimum tax because such distributions are included in the
corporation's "adjusted current earnings." In states with a corporate franchise
tax, distributions of the Fund may also be fully taxable to a corporate
shareholder under the state franchise tax system.
Consistent with the Fund's investment objectives, the Fund may acquire such
private activity bonds if, in the Manager's opinion, such bonds represent the
most attractive investment opportunity then available to the Fund. As of May 31,
1995, the Fund had derived 7.62% of its income from bonds, the interest on which
constitutes a preference item subject to the federal alternative minimum tax for
certain investors.
Under normal market conditions, the Fund will invest its assets as described
above. For temporary defensive purposes, however, the Fund may invest up to 100%
of its net assets in securities the interest on which is subject to regular
federal income tax. Also for temporary defensive purposes, the Fund may invest
up to 100% of its total assets in (i) municipal securities exempt from regular
federal income taxes but not California personal income tax, (ii) commercial
paper rated at least P-1 by Moody's Investors Service ("Moody's"), A-1 by S&P,
or F-1+ by Fitch Investors Service ("Fitch"), or obligations of domestic banks
with assets of $1 billion or more or (iii) obligations issued or guaranteed by
the full faith and credit of the U.S. government.
DESCRIPTION OF MUNICIPAL SECURITIES
The term "municipal securities," as used in this prospectus, means obligations
issued by or on behalf of the state of California, obligations of non-state
issuers, such as the territories and possessions of the U.S., any state, or the
District of Columbia, and their political subdivisions, agencies, and
instrumentalities, the interest on which is exempt from regular federal income
tax. A portion or all of the interest on such securities may be deemed to be
preference items under the federal alternative minimum tax system and thus
subject to the federal alternative minimum tax. An opinion as to the tax-exempt
status of a municipal security generally is rendered to the issuer by the
issuer's counsel at the time the security is issued.
Municipal securities are used to raise money for various public purposes such as
constructing public facilities and making loans to public institutions. Certain
types of municipal bonds are issued to provide funding for privately operated
facilities. Further information on the maturity and funding classifications of
municipal securities is included in the SAI.
It is possible, from time to time, that the Fund will invest more than 25% of
its assets in a particular segment of the municipal securities market,
including, but not limited to, hospital revenue bonds, housing agency bonds,
tax-exempt industrial development revenue bonds, transportation bonds, or
pollution control revenue bonds. In such circumstances, economic, business,
political, or other changes affecting one bond (such as proposed legislation
affecting the financing of a project; shortages or price increases of needed
materials; or declining markets or need for the projects) might also affect
other bonds in the same segment, thereby potentially increasing market risk.
Yields on municipal securities vary, depending on a variety of factors,
including the general condition of the financial markets and of the municipal
securities market, the size of a particular offering, the maturity of the
obligation and the credit rating of the issuer. Generally, municipal securities
with longer maturities produce higher current yields than municipal securities
with shorter maturities. However, prices of longer term securities typically
fluctuate more than short term securities due to changes in interest rates, tax
laws and other general market conditions. Lower-rated municipal securities
generally produce a higher yield than higher-rated municipal securities due to
the perception of a greater degree of risk as to the ability of the issuer to
make timely payment of principal and interest on its obligations.
The Fund has no restrictions on the maturities of the securities in which it may
invest. The Manager will consider the Fund's investment objectives and current
market conditions in determining which securities to buy or hold.
Variable Rate or Floating Rate Demand Notes ("VRDNs"). The Fund may invest in
VRDNs, which are tax-exempt obligations that bear interest at rates that are not
fixed, but that vary with changes in prevailing market rates on predesignated
dates, and which carry a demand feature that permits the Fund to tender the
obligation back to the issuer or a third party at par value plus accrued
interest prior to maturity, according to the terms of the obligation, which
amount may be more or less than the amount the Fund paid for such obligation.
Frequently, VRDNs are secured by letters of credit or other credit support
arrangements. Because of the demand feature, the prices of VRDNs may be higher
and the yields lower than they otherwise would be for obligations without a
demand feature. The Fund will limit its purchase of municipal securities that
are floating rate and variable rate obligations to those meeting the quality
standards set forth in this prospectus.
"When-Issued" and "Delayed Delivery" transactions. The Fund may buy and sell
municipal securities on a when-issued and delayed delivery basis. The price is
subject to market fluctuation, and the value at delivery may be more or less
than the purchase price. Although the Fund will generally buy municipal
securities on a when-issued basis with the intention of acquiring them, the Fund
may sell the securities before the settlement date if it is considered
advisable. When the Fund is the buyer in such a transaction, it will maintain,
in a segregated account with its custodian bank, cash or high-grade marketable
securities having an aggregate value equal to the amount of such purchase
commitments until payment is made. To the extent the Fund engages in when-issued
and delayed delivery transactions, it will do so for the purpose of acquiring
securities for the Fund's portfolio consistent with its investment objectives
and policies and not for the purpose of investment leverage.
Certificates of Participation ("COPs"). The Fund may also invest in municipal
lease obligations, primarily through COPs, which are widely used by state and
local governments to finance the purchase of property, function much like
installment purchase agreements. For example, COPs may be created when long-term
lease revenue obligations are issued by a governmental corporation to pay for
the acquisition of property or facilities which are then leased to a
municipality. The payments made by the municipality under the lease are used to
repay interest and principal on the obligations issued to buy the property. Once
these lease payments are completed, the municipality gains ownership of the
property for a nominal sum. This lease format is generally not subject to
constitutional limitations on the issuance of state debt, and COPs may enable a
governmental issuer to increase government liabilities beyond constitutional
debt limits.
A feature that distinguishes COPs from municipal debt is that the lease which is
the subject of the transaction contains a "nonappropriation" clause. A
nonappropriation clause provides that while the municipality will use its best
efforts to make lease payments, the municipality may terminate the lease without
penalty if the municipality's appropriating body does not allocate the necessary
funds. Local administrations, when faced with increasingly tight budgets have
more discretion to curtail payments under COPs than they do to curtail payments
on traditionally funded obligations. If the government lessee does not
appropriate sufficient monies to make lease payments, the lessor or its agent is
typically entitled to repossess the property. The private sector value of the
property may be more or less than the amount the government lessee was paying.
The Board reviews the COPs held in the Fund's portfolio to assure that they
constitute liquid investments based on various factors reviewed by the Manager
and monitored by the Board. These factors include (a) the credit quality of such
securities and the extent to which they are rated or, if unrated, comply with
existing criteria and procedures followed to ensure that they are of comparable
quality to the rating required for the Fund's investment, including an
assessment of the likelihood that the leases will not be canceled; (b) the size
of the municipal securities market, both in general and with respect to COPs;
and (c) the extent to which the type of COPs held by the Fund trade on the same
basis and with the same degree of dealer participation as other municipal bonds
of comparable credit rating or quality. While there is no limit as to the amount
of assets which the Fund may invest in COPs, as of May 31, 1995, the Fund held
18.50% of its net assets in COPS and other municipal leases.
Callable bonds. The Fund may buy and hold callable municipal bonds that contain
a provision in the indenture permitting the issuer to redeem the bonds prior to
their maturity dates at a specified price which typically reflects a premium
over the bonds' original issue price. These bonds generally have call protection
(that is, a period of time during which the bonds may not be called) which
usually lasts for 5 to 10 years, after which time such bonds may be called away.
An issuer may generally be expected to call its bonds, or a portion of them,
during periods of declining interest rates, when borrowings may be replaced at
lower rates than those obtained in prior years. If the purchase price of such
bonds included a premium related to the appreciated value of the bonds, some or
all of that premium may not be recovered by bondholders, such as the Fund,
depending on the price at which such bonds were redeemed.
OTHER INVESTMENT POLICIES OF THE FUND
The Fund may borrow from banks for temporary or emergency purposes and pledge up
to 5% of its total assets thereof. The Fund may also, consistent with procedures
approved by the Board, lend its portfolio securities to qualified securities
dealers or other institutional investors, provided that such loans do not exceed
10% of the value of the Fund's total assets at the time of the most recent loan.
The Fund currently intends to limit its lending of securities to no more than 5%
of its total assets.
Illiquid Investments. It is the policy of the Fund that illiquid securities
(securities that cannot be disposed of within seven days in the normal course of
business at approximately the amount at which the Fund has valued the
securities) may not constitute, at the time of purchase, more than 10% of the
value of the net assets of the Fund.
Other. The Fund is subject to a number of additional investment restrictions,
some of which may be changed only with the approval of shareholders, which limit
its activities to some extent. For a list of these restrictions and more
information about the policies discussed herein, please see "How Does the Fund
Invest Its Assets?" and "Investment Restrictions" in the SAI.
WHAT ARE THE FUND'S POTENTIAL RISKS?
While an investment in the Fund is not without risk, certain policies are
followed in managing the Fund that may help to reduce such risk. The Fund is
subject to two categories of risk, credit risk and market risk. Credit risk is
the ability of an issuer of a municipal security to maintain timely interest
payments and to pay the principal of a security upon maturity. It is generally
reflected in a security's underlying credit rating and its stated interest rate
(normally the coupon rate). A change in the credit risk associated with a
municipal security may cause a corresponding change in the security's price.
Market risk is the risk of price fluctuation of a municipal security caused by
changes in general economic and interest rate conditions generally affecting the
market as a whole. A municipal security's maturity length also affects its
price. As with other debt instruments, the price of the securities in which the
Fund invests are likely to decrease in times of rising interest rates.
Conversely, when rates fall, the value of the Fund's investments may rise. Price
changes of securities held by the Fund have a direct impact on the Fund's net
asset value per share. There are also certain specific factors and
considerations concerning California which may affect the credit and market risk
of the these municipal securities. Please see "Risk Factors in California" below
and in "Appendix B" in the SAI.
As a non-diversified investment company, the Fund is not subject to any
statutory restriction under the 1940 Act with respect to the concentration of
its investments in the assets of one or more issuers. This concentration may
present greater risks than in the case of a diversified company. (See the SAI
for the diversification requirements the Fund intends to meet in order to
qualify as a regulated investment company under the Code.)
The Fund seeks to provide California investors with a high current yield exempt
from federal and California personal income taxes by investing primarily in
lower-rated or unrated municipal securities. Higher yields are ordinarily
available from securities in the lower-rated categories of nationally recognized
securities ratings organizations ("NRSROs"). These ratings are Ba, B, Caa and
Ca, by Moody's, BB, B, CCC and CC by Standard & Poor's Corporation ("S&P") or
BB, B, CCC and CC by Fitch. The Fund may also invest in securities that are not
rated, provided that, in the opinion of the Manager, the securities are
comparable in quality to those rated by an NRSRO. These ratings represent the
opinions of the NRSROs with respect to the generally higher risk associated with
the issuer's ability to pay interest and repay principal. They do not purport to
reflect the risk of fluctuations in market value and are not absolute standards
of quality but will be considered in connection with the investment of the
Fund's assets. Securities in the lower-rated categories are regarded, on
balance, as predominantly speculative with respect to the capacity to pay
interest and repay principal in accordance with the terms of the obligation. The
Fund may invest in municipal securities regardless of their rating, including,
from time to time, defaulted debt securities if, in the opinion of the Manager,
the issuer may resume interest payments or other advantageous developments
appear likely, in the near term. The Fund will not invest more than 5% of its
total assets (at the time of purchase) in defaulted securities. A purchase of a
security that is in default carries a high degree of risk and may have the
consequence that interest payments with respect to the security may be reduced,
deferred, suspended, or canceled, causing the loss of the entire amount of the
investment. If the rating on an issue held in the Fund's portfolio is changed by
an NRSRO, the Fund will take it in consideration in its evaluation of the
overall investment merits of that security but will not necessarily result in an
automatic sale of the security. A description of the ratings is contained in
Appendix B of this prospectus. See also the disclosure under "Risk Factors
Relating to High Yielding, Municipal Securities" below.
While it is expected that the portfolio of the Fund will normally consist of
lower-rated, higher yielding bonds, there may be instances when the portfolio
will contain medium grade (BBB or Baa rated), lower yielding bonds because
adequate quantities of attractive lower-rated bonds are not available at that
time. In addition, there may be times when, due to unusual market conditions, or
when the difference in yields on higher and lower-rated bonds is narrowed to the
extent that higher risk is not justified by higher return, the Fund may acquire
higher-rated bonds for its portfolio. It is expected that the Fund's portfolio
will generally consist of longer-term municipal securities as these normally
return higher yields than short-term issues.
RISK FACTORS IN CALIFORNIA
The following information as to certain California risk factors is given in view
of the Fund's policy of investing primarily in California state and municipal
issuers. The information is based primarily upon information derived from public
documents relating to securities offerings of California state and municipal
issuers, from independent municipal credit reports and historically reliable
sources, but has not been independently verified by the Fund.
California constitutional and other laws affect the ability of California state
and municipal issuers to obtain sufficient revenue to pay their bond
obligations. In 1978, California voters approved an amendment to the California
Constitution known as Proposition 13. Proposition 13 limits ad valorem taxes on
real property and restricts the ability of taxing entities to increase real
property taxes. Legislation passed subsequent to Proposition 13, however,
provided for the redistribution of California's General Fund surplus to local
agencies, the reallocation of revenues to local agencies and the assumption of
certain local obligations by the state so as to help California municipal
issuers raise revenue to pay their bond obligations. It is unknown, however,
whether additional revenue redistribution legislation will be enacted in the
future and whether, if enacted, such legislation would provide sufficient
revenue for California issuers to pay their obligations. The state is also
subject to another constitutional amendment, Article XIIIB, which may have an
adverse impact on California state and municipal issuers. Article XIIIB
restricts the state from spending certain appropriations in excess of an
appropriations limit imposed for each state and local government entity. If
revenues exceed the appropriations limit, those revenues must be returned either
as revisions in the tax rates or fee schedules.
The past four years have challenged California's resiliency, as cyclical and
structural problems have been addressed. The national recession severely
affected California and its effects have lingered. The magnitude of California's
military-industrial complex and effects of the recession have resulted in a loss
of more than 700,000 jobs. Of the approximate 700,000 jobs lost, it is estimated
that more than 240,000 have been restored. Base closures have likewise impacted
state and local economies. California's social welfare and entitlement programs
have strained finances as caseload growth has exceeded resource availability.
The high priority of public safety has resulted in the enactment of strong crime
legislation that is both capital and labor intensive. California has also been
affected by natural catastrophes including earthquakes, wildfires, floods and
droughts.
By the fall of 1993, it had become apparent the California economy had reached a
trough and recovery was underway. During 1994 the state's economy paralleled the
broad-based expansion occurring on the national level. California's economy
continued to gain momentum through 1994 as revenue collections exceeded budget
projections. The state's unemployment rate opened at 10.1% in 1994 and declined
to 7.7% at calendar year-end. California's unemployment rate rose slightly in
January 1995 to 8.2%, perhaps reflecting the effect of seven interest rate
increases over the past year. The number of jobless in January 1995 was
approximately 1.3 million, reflecting a decrease of 300,000 from the prior year.
In early July 1994, both S&P and Moody's lowered the general obligation bond
ratings of the state of California from A+ to A and Aa to A1, respectively.
These revisions reflected the state's heavy reliance on the short-term note
market to finance its cash imbalance and the likelihood that this exposure will
persist for at least another two years. For more information on these ratings
revisions and the state's current budget, please refer to the SAI.
On December 6, 1994, Orange County, California (the "County"), together with its
pooled investment funds (the "Orange County Funds") filed for protection under
Chapter 9 of the federal Bankruptcy Code after reports that the Orange County
Funds had suffered significant market losses in their investments, causing a
liquidity crisis for the Orange County Funds and the County. More than 180 other
public entities, most of which, but not all, are located in the County, were
also depositors in the Orange County Funds. As of mid-January 1995, following a
restructuring of most of the Orange County Funds' assets to increase their
liquidity and reduce their exposure to interest rate increases, the County
estimated the Orange County Funds' loss at about $1.69 billion, or 22% of their
initial deposits of approximately $7.5 billion. Following the bankruptcy filing
many of the entities that deposited money in the Orange County Funds, including
the County, faced cash flow difficulties because of the bankruptcy filing and
would have been required to reduce programs or capital projects. On May 2, 1995,
the bankruptcy court approved a settlement between the County and the Pool
Participants that provides for Pool Participants to receive 100% of their
investment balances. The settlement provides an initial cash distribution of 77%
if their aggregate investment balance followed by a combination of recovery
notes and other claims. The initial 77% distribution was released on May 19,
1995, which greatly reduces the cash flow difficulties faced by depositors. As
of May 31, 1995, the Fund did not own any direct Orange County obligations.
The state has no existing obligation with respect to any outstanding obligations
or securities of the County or any of the other participating entities. However,
in the event the County is unable to maintain county administered state
programsf because of insufficient resources, it may be necessary for the state
to intervene, but the State cannot presently predict what, if any, action may
occur. At this time, it appears that school districts may have collectively lost
up to $230 million from the amounts they had on deposit in the Orange County
Fund. Under existing legal precedent, the state is obligated to intervene when a
school district's fiscal problems would otherwise deny its students basic
educational quality. The state is not presently able to predict whether any
school districts will face insolvency because of their participation in the
Orange County Fund, and if so, the potential amount or form of aid that the
state may have to provide. The Governor has called a special session of the
Legislature which is expected to consider various responses to the Orange County
situation.
RISK FACTORS OF HIGH YIELDING MUNICIPAL SECURITIES
The portfolio of the Fund is subject to greater risks due to its ability to
invest in municipal securities rated below investment grade by the NRSROs, or
which are unrated by an NRSRO but deemed by the Manager to be of comparable
quality. The market values of these securities, commonly known as junk bonds,
tend to reflect individual developments affecting the issuer to a greater extent
than do higher-rated securities, which react primarily to fluctuations in the
general level of interest rates. Such lower-rated securities also tend to be
more sensitive to economic conditions than higher-rated securities. These
lower-rated municipal securities are considered by the NRSROs, on balance, to be
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligation and will
generally involve more credit risk than securities in the higher rating
categories. Even securities rated triple B by the NRSROs, ratings which are
considered investment grade, possess some speculative characteristics.
Projects that are financed by the issuance of high yielding municipal securities
are often highly leveraged and may not have more traditional methods of
financing available to them. Therefore, the risk associated with acquiring the
securities of such issuers is generally greater than is the case with
higher-rated securities. For example, during an economic downturn or a sustained
period of rising interest rates, projects financed by high yielding securities
may experience financial stress. During these periods, such projects may not
have sufficient cash flow to meet their interest payment obligations. The
issuer's ability to service its obligations may also be adversely affected by
specific developments, or the issuer's inability to meet specific projected
revenue forecasts, or by the unavailability of additional financing.
To the extent the secondary trading market for a particular high yielding
municipal security does exist, it is generally not as liquid as the secondary
market for higher-rated securities. Reduced liquidity in the secondary market
may have an adverse impact on market price and the Fund's ability to dispose of
particular issues, when necessary, to meet the Fund's liquidity needs or in
response to a specific economic event, such as the deterioration in the
creditworthiness of the issuer. Reduced liquidity in the secondary market for
certain securities may also make it more difficult for the Fund to obtain market
quotations based on actual trades for purposes of valuing the Fund's portfolio.
Current value for these high yield issues are obtained from pricing services
and/or a limited number of dealers and may be based upon factors other than
actual sales. (See "How Are Fund Shares Valued?")
Factors adversely impacting the market value of high yielding securities may
adversely impact the Fund's net asset value. In addition, the Fund may incur
additional expenses to the extent it is required to seek recovery upon a default
in the payment of principal or interest on its portfolio holdings. The Fund will
rely on the Manager's judgment, analysis and experience in evaluating the
creditworthiness of an issuer. In this evaluation, the Manager will take into
consideration, among other things, the issuer's financial resources, its
sensitivity to economic conditions and trends, its credit history, the quality
of the issuer's management and regulatory matters.
Current prices for defaulted bonds are generally significantly lower than their
purchase price, and the Fund may have unrealized losses on such defaulted
securities which are reflected in the price of the Fund's shares. In general,
securities which default lose much of their value in the time period prior to
the actual default so that the Fund's net assets are impacted prior to the
default. The high yield securities market is relatively new and much of its
growth prior to 1990 paralleled a long economic expansion. The recession that
began in 1990 disrupted the market for high yielding securities and adversely
affected the value of outstanding securities and the ability of issuers of such
securities to meet their obligations. Although the economy has improved
considerably and high yielding securities have performed more consistently since
that time, there is no assurance that the adverse effects previously experienced
will not reoccur. For example, the highly publicized defaults of some high yield
issuers during 1989 and 1990 and concerns regarding a sluggish economy which
continued into 1993, depressed the prices for many of these securities. The Fund
may retain an issue which has defaulted because such issue may present an
opportunity for subsequent price recovery. As previously noted, the Fund may
also, consistent with its investment objectives and policies buy municipal
securities of issuers not currently paying interest as well as issuers that are
in default. Issues that are in default carry a high degree of risk and may have
the consequence that interest payments with respect to such securities may be
reduced, deferred, suspended, eliminated or never begin, and may have the
further consequences that principal payments may likewise be loss of the entire
amount of the investment.
The Fund's investment in lower-rated, unrated, and zero coupon municipal
securities may cause the Fund to recognize income and make distributions to
shareholders prior to the receipt of cash payments by the Fund. For example,
with respect to any non-performing obligations, the Fund may be required to
accrue as income the original amount of interest due on its obligations even
though such interest is not received by the Fund. In order to generate cash to
satisfy the Fund's distribution requirements, it may be required to dispose of
portfolio securities that it otherwise would have continued to hold or to use
cash flows from other sources such as the sale of Fund shares. The SAI contains
more information about zero coupon bonds.
Asset Composition Table. A credit rating by an NRSRO evaluates only the safety
of principal and interest of a bond, and does not consider the market value risk
associated with an investment in such a bond. The table below shows the
percentage of the Fund's assets invested in securities rated in each of the
specific rating categories shown and those that are not rated by the rating
agency but deemed by the Manager to be of comparable credit quality. The
information was prepared based on a dollar weighted average of the Fund's
portfolio composition based on month-end assets for each of the 12 months in the
fiscal year ended May 31, 1995. The Appendix to this prospectus includes a
description of each rating category.
Average Weighted
S&P Rating Percentage of Assets
- ----------------------------------------------------------------
AAA............................................ 1.54%
AA............................................. 4.29
A.............................................. 28.25
A*............................................. 1.41
BBB............................................ 19.66
BBB*........................................... 21.50
BB*............................................ 23.35
*Not rated by the NRSROs. Indicates an internal rating by the Manager.
HOW YOU PARTICIPATE IN THE
RESULTS OF THE FUND'S ACTIVITIES
If the securities owned by the Fund increase in value, the value of the shares
of the Fund which you own will increase. If the securities owned by the Fund
decrease in value, the value of your shares will also decline. In this way, you
participate in any change in the value of the securities owned by the Fund.
In addition to the factors which affect the value of individual securities, as
described in the preceding sections, you may anticipate that the value of Fund
shares will fluctuate with movements in the broader bond markets.
In particular, changes in interest rates will affect the value of the Fund's
portfolio and thus its share price. Increased rates of interest which frequently
accompany higher inflation and/or a growing economy are likely to have a
negative effect on the value of Fund shares. History reflects both increases and
decreases in the prevailing rate of interest and these may reoccur unpredictably
in the future.
WHO MANAGES THE FUND?
The Board has the primary responsibility for the overall management of the Trust
and for electing the officers of the Trust who are responsible for administering
the Fund's day-to-day operations.
The Board has carefully reviewed the multiclass structure to ensure that no
material conflict exists between the two classes of shares. Although the Board
does not expect to encounter material conflicts in the future, the Board will
continue to monitor the Fund and will take appropriate action to resolve such
conflicts if any should arise.
In developing the multiclass structure the Fund has retained the authority to
establish additional classes of shares. It is the Fund's present intention to
offer only two classes of shares, but new classes may be offered in the future.
Advisers serves as the Fund's investment manager. Advisers is a wholly-owned
subsidiary of Resources, a publicly owned holding company, the principal
shareholders of which are Charles B. Johnson and Rupert H. Johnson, Jr., who own
approximately 20% and 16%, respectively, of Resources' outstanding shares.
Resources is engaged in various aspects of the financial services industry
through its subsidiaries. Advisers acts as investment manager or administrator
to 36 U.S. registered investment companies (119 separate series) with aggregate
assets of over $81 billion, $42 billion of which is in the municipal securities
market.
The team responsible for the day-to-day management of the Fund's portfolio is:
Thomas Kenny since 1994, Bernie Schroer since 1987 and Sheila Amoroso since
1994.
Thomas Kenny
Senior Vice President
of Advisers
Mr. Kenny is Director of Franklin's Municipal Bond Department. He received a
Master of Science degree in finance from Golden Gate University and a Bachelor
of Arts degree in business and economics from the University of California at
Santa Barbara. Mr. Kenny joined Franklin in 1986. He is a member of several
municipal securities industry-related committees and associations.
Bernie Schroer
Vice President
of Advisers
Mr. Schroer has a Bachelor degree in finance from Santa Clara University. Prior
to joining Advisers in 1987, he was the manager of trading at Kidder, Peabody
and Company, Inc. He is a member of various municipal securities
industry-related committees and associations.
Sheila Amoroso
Portfolio Manager
of Advisers
Ms. Amoroso joined Franklin in 1986. She holds a Bachelor of Science degree from
San Francisco State University and is a member of municipal securities
industry-related committees and associations.
Pursuant to a management agreement, the Manager supervises and implements the
Fund's investment policies and provides certain administrative services and
facilities which are necessary to conduct the Fund's business. The Manager
performs similar services for other funds and there may be times when the
actions taken with respect to the Fund's portfolio will differ from those taken
by the Manager on behalf of other funds. Neither the Manager (including its
affiliates) nor its officers, directors or employees nor the officers and
trustees of the Fund are prohibited from investing in securities held by the
Fund or other funds which are managed or administered by the Manager to the
extent such transactions comply with the Fund's Code of Ethics. Please see
"Investment Advisory and Other Services" and "General Information" in the SAI
for further information on securities transactions and a summary of the Fund's
Code of Ethics.
During the fiscal year ended May 31, 1995, and the six-month period ended
November 30, 1995, management fees, before any advance waiver, totaled 0.62% and
0.62% (annualized), respectively, of the average monthly net assets of the Fund.
Total operating expenses, including management fees before any advance waiver,
totaled 0.88% and 0.83% (annualized), respectively, of the average monthly net
assets of Class I of the Fund. Pursuant to an agreement by Advisers to waive its
fees, the Fund did not pay a management fee for the fiscal year ended May 31,
1995 and paid an annualized fee totaling 0.15% of the average monthly net assets
of the Fund for the six months ended November 30, 1995. Operating expenses
totaled 0.20% and 0.35% (annualized) for Class I of the Fund for the respective
periods. This arrangement may be terminated by the Manager at any time upon
notice to the Board.
It is not anticipated that the Fund will incur a significant amount of brokerage
expenses because municipal securities are generally traded in principal
transactions that involve the receipt by the broker of a spread between the bid
and ask prices for the securities and not the receipt of commissions. In the
event that the Fund does participate in transactions involving brokerage
commissions, it is the Manager's responsibility to select brokers through whom
such transactions will be effected. The Manager would try to obtain the best
execution on all such transactions. If it is felt that more than one broker
would be able to provide the best execution, the Manager will consider the
furnishing of quotations and of other market services, research, statistical and
other data for the Manager and its affiliates, as well as the sale of shares of
the Fund, as factors in selecting a broker. Further information is included
under "How Does the Fund Purchase Securities For Its Portfolio?" in the SAI.
Shareholder accounting and many of the clerical functions for the Fund are
performed by Investor Services, in its capacity as transfer agent and
dividend-paying agent. Investor Services is a wholly-owned subsidiary of
Resources.
PLANS OF DISTRIBUTION
A separate plan of distribution has been approved and adopted for each class
("Class I Plan" and "Class II Plan," respectively, or "Plan(s)") pursuant to
Rule 12b-1 under the 1940 Act. The Rule 12b-1 fees charged to each class are
based solely on the distribution and, with respect to the Class II Plan,
servicing fees attributable to that particular class. Under either Plan, the
portion of fees remaining after payment to securities dealers or others for
distribution or servicing may be paid to Distributors for routine ongoing
promotion and distribution expenses incurred with respect to such class. Such
expenses may include, but are not limited to, the printing of prospectuses and
reports used for sales purposes, expenses of preparing and distributing sales
literature and related expenses, advertisements, and other distribution-related
expenses, including a prorated portion of Distributors' overhead expenses
attributable to the distribution of Fund shares.
The maximum amount which the Fund may reimburse Distributors or others under the
Class I Plan for distribution expenses is currently 0.10% per annum of Class I's
average daily net assets, payable on a quarterly basis. All expenses of
distribution in excess of 0.10% per annum will be borne by Distributors, or
others who have incurred them, without reimbursement from the Fund.
Under the Class II Plan, the Fund pays Distributors distribution and related
expenses up to 0.50% per annum of Class II's daily net assets, payable
quarterly. Such fees may be used in order to compensate Distributors or others
for providing distribution and related services and bearing certain expenses of
the class. All expenses of distribution, marketing and related services over
that amount will be borne by Distributors or others who have incurred them,
without reimbursement by the Fund. In addition, the Class II Plan provides for
an additional payment by the Fund of up to 0.15% per annum of Class II's average
daily net assets as a servicing fee, payable quarterly. This fee will be used to
pay securities dealers or others for, among other things, assisting in
establishing and maintaining customer accounts and records; assisting with
purchase and redemption requests; receiving and answering correspondence;
monitoring dividend payments from the Fund on behalf of customers, or similar
activities related to furnishing personal services and/or maintaining
shareholder accounts.
Either Distributors or one of its affiliates may pay, from its own resources, a
commission of up to 1% of the purchase price of Class II shares to securities
dealers who initiate and are responsible for such purchases. During the first
year following such purchases, Distributors will retain a portion of Class II's
Rule 12b-1 fees attributable to such shares equal to 0.50% per annum of Class
II's average daily net assets to partially recoup fees Distributors pays to
securities dealers in connection with initial purchases of Class II shares.
Both Plans cover any payments to or by the Fund, Advisers, Distributors, or
other parties on behalf of the Fund, Advisers or Distributors, to the extent
such payments are deemed to be for the financing of any activity primarily
intended to result in the sale of shares issued by the Fund within the context
of Rule 12b-1. The payments under the Plans are included in the maximum
operating expenses which may be borne by each class of the Fund. For more
information, please see "The Fund's Underwriter" in the SAI.
WHAT DISTRIBUTIONS MIGHT I
RECEIVE FROM THE FUND?
You may receive two types of distributions from the Fund:
1. Income dividends. The Fund receives income generally in the form of interest
and other income derived from its investments. This income, less the expenses
incurred in the Fund's operations, is its net investment income from which
income dividends may be distributed. Thus, the amount of dividends paid per
share may vary with each distribution.
2. Capital gain distributions. The Fund may derive capital gains or losses in
connection with sales or other dispositions of its portfolio securities.
Distributions by the Fund derived from net short-term and net long-term capital
gains (after taking into account any net capital loss carryovers) may generally
be made once a year in December to reflect any net short-term and net long-term
capital gains realized by the Fund as of October 31 of the current fiscal year
and any undistributed capital gains from the prior fiscal year. These
distributions, when made, will generally be fully taxable to the Fund's
shareholders. The Fund may make more than one distribution derived from net
short-term and net long-term capital gains in any year or adjust the timing of
these distributions for operational or other reasons.
DISTRIBUTIONS TO EACH CLASS OF SHARES
According to the requirements of the Code, dividends and capital gains will be
calculated and distributed in the same manner for Class I and Class II shares.
The per share amount of any income dividends will generally differ only to the
extent that each class is subject to different Rule 12b-1 fees.
DISTRIBUTION DATE
Although subject to change by the Board without prior notice to or approval by
shareholders, the Fund's current policy is to declare income dividends daily and
pay them monthly on or about the last business day of that month. Daily
allocation of net investment income will begin on the day after the Fund
receives your money or settlement of a wire order trade and will continue to
accrue through the day of receipt of your redemption request or the settlement
of a wire order trade.
The amount of income dividend payments by the Fund is dependent upon the amount
of net income received by the Fund from its portfolio holdings, is not
guaranteed and is subject to the discretion of the Board. The Fund does not pay
"interest" or guarantee any fixed rate of return on an investment in its shares.
DISTRIBUTION OPTIONS
You may choose to receive your distributions from the Fund in any of these ways:
1. Purchase additional shares of the Fund - You may purchase additional shares
of the same class of the Fund (without a sales charge or imposition of a
contingent deferred sales charge) by reinvesting capital gain distributions, or
both dividend and capital gain distributions. If you are a Class II shareholder,
you may also reinvest your distributions in Class I shares of the Fund. This is
a convenient way to accumulate additional shares and maintain or increase your
earnings base.
2. Purchase shares of other Franklin Templeton Funds - You may direct your
distributions to purchase the same class of shares of another Franklin Templeton
Fund (without a sales charge or imposition of a contingent deferred sales
charge). If you are a Class II shareholder, you may also direct your
distributions to purchase Class I shares of another Franklin Templeton Fund.
Many shareholders find this a convenient way to diversify their investments.
3. Receive distributions in cash - You may choose to receive dividends, or both
dividend and capital gain distributions in cash. You may have the money sent
directly to you, to another person, or to a checking account. If you choose to
send the money to a checking account, please see "Electronic Fund Transfers"
under "What Programs and Privileges Are Available to Me as a Shareholder?"
To select one of these options, please complete sections 6 and 7 of the
Shareholder Application included with this prospectus or tell your investment
representative which option you prefer. If no option is selected, dividend and
capital gain distributions will be automatically reinvested in the same class of
the Fund. You may change the distribution option selected at any time by
notifying the Fund by mail or by telephone. Please allow at least seven days
prior to the reinvestment date for the Fund to process the new option.
HOW TAXATION AFFECTS YOU AND THE FUND
The following discussion reflects some of the tax considerations that affect
mutual funds and their shareholders. For additional information on tax matters
relating to the Fund and its shareholders, see "Additional Information Regarding
Taxation" in the SAI.
The Fund intends to continue to qualify as a regulated investment company under
Subchapter M of the Code. By distributing all of its income and meeting certain
other requirements relating to the sources of its income and diversification of
its assets, the Fund will not be liable for federal income or excise taxes.
By meeting certain requirements of the Code, the Fund has qualified and
continues to qualify to pay exempt-interest dividends to its shareholders. Such
exempt-interest dividends are derived from interest income exempt from regular
federal income tax and are not subject to regular federal income tax to you.
To the extent that dividends paid by the Fund are derived from interest income
from debt obligations of California or its political subdivisions or from
interest on U.S. territorial obligations (including Puerto Rico, the U.S. Virgin
Islands or Guam) which are exempt from regular federal and California personal
income tax, they will not be subject to either federal or California personal
income tax when received by you. The pass-through of exempt interest dividends
is allowed only if the Fund meets its federal and California requirements that
at least 50% of its total assets are invested in such exempt obligations at the
end of each quarter of its fiscal year. In addition, to the extent that
dividends are derived from direct obligations of the federal government, they
will also be exempt from California personal income taxes. However, if you are a
corporate taxpayer subject to the California franchise tax, all distributions
will be fully taxable.
To the extent dividends paid by the Fund are derived from taxable income from
temporary investments (including the discount from certain stripped obligations
or their coupons or income from securities loans or other taxable transactions),
from the excess of net short-term capital gain over net long-term capital loss,
or from ordinary income derived from the sale or disposition of bonds purchased
with market discount after April 30, 1993 they are treated as ordinary income
whether you have elected to receive them in cash or in additional shares.
From time to time, the Fund may buy a tax-exempt obligation with market
discount; that is, for a price that is less than the principal amount of the
bond, or for a price that is less than the principal amount of the bond where
the bond was issued with original issue discount and the market discount exceeds
a de minimus amount under the Code. For such obligations purchased after April
30, 1993, a portion of the gain on sale or disposition (not to exceed the
accrued portion of market discount as of the time of sale or disposition) is
treated as ordinary income rather than capital gain. Any distribution to you by
the Fund of such ordinary income will be subject to regular federal and state
income taxes in your hands. In any fiscal year, the Fund may elect not to
distribute to its shareholders its taxable ordinary income and to, instead, pay
federal income or excise taxes on this income at the Fund level. The amount of
such distributions, if any, is expected to be small.
Pursuant to the Code, certain distributions which are declared in October,
November or December but which, for operational reasons, may not be paid to you
until the following January, will be treated, for tax purposes, as if you
received them on December 31 of the calendar year in which they are declared.
Distributions derived from the excess of net long-term capital gain over net
short-term capital loss are treated as long-term capital gain regardless of the
length of time you have owned Fund shares and whether you receive the
distributions in cash or in additional shares.
Redemptions and exchanges of Fund shares are taxable events on which you may
realize a gain or loss. Any loss incurred on a sale or exchange of the Fund's
shares, held for six months or less, will be treated as a long-term capital loss
to the extent of capital gain dividends received with respect to the shares and
will be disallowed to the extent of exempt interest dividends paid with respect
to such shares.
The Fund will inform you of the source of your dividends and distributions at
the time they are paid and will, promptly after the close of each calendar year,
advise you of the tax status for federal income tax purposes, including the
portion of the dividends on an average basis which constitutes taxable income or
interest income that is a tax preference item under the federal alternative
minimum tax. If you have not held the Fund shares for a full calendar year may
have designated as tax-exempt or as tax preference income a percentage of income
which is not equal to the actual amount of tax-exempt or tax preference income
earned during the period of your investment in the Fund.
Exempt-interest dividends of the Fund, although exempt from regular federal
income tax in your hands, are includable in the tax base for determining the
extent to which any social security or railroad retirement benefits you receive
will be subject to regular federal income tax. You are required to disclose the
receipt of tax-exempt interest on your federal income tax returns.
Interest on indebtedness incurred by you (directly or indirectly) to purchase or
carry Fund shares may not be fully deductible for federal income tax purposes.
If you are not an U.S. person for purposes of federal income taxation you should
consult with your financial or tax advisor regarding the applicability of U.S.
withholding or other taxes to distributions you receive from the Fund and the
application of foreign tax laws to these distributions.
The foregoing description relates solely to federal income tax law and to
California personal income tax treatment to the extent indicated. You should
consult your tax advisor with respect to the applicability of other state and
local income taxes to your Fund shares and to distributions and redemption
proceeds you receive from the Fund. Whether you are a corporate, individual or
trust shareholder, you should contact your tax advisor to determine the impact
of Fund dividends and capital gain distributions under the federal alternative
minimum tax that may be applicable to your particular tax situation.
HOW DO I BUY SHARES?
You may buy shares to open a Fund account with as little as $100 and make
additional investments at any time with as little as $25. To open your account,
contact your investment representative or complete and sign the enclosed
Shareholder Application and return it to the Fund with your check. Please
indicate which class of shares you want to buy. If you fail to specify a class,
your purchase will automatically be invested in Class I shares.
DECIDING WHICH CLASS TO BUY
When deciding which class of shares to buy, you should consider a number of
factors, including the amount you expect to invest and the length of time you
expect to hold your investment. If you plan to invest $1 million or more in a
single payment or you qualify to buy Class I shares at net asset value, you may
not buy Class II shares.
Generally, you should consider buying Class I shares if:
o you expect to invest in the Fund over the long term;
o you qualify to buy Class I shares at a reduced sales charge; or
o you intend to purchase $1 million or more over time.
You should consider Class II shares if:
o you expect to invest less than $100,000 in Franklin Templeton Funds; and
o you intend to make substantial redemptions within approximately six years or
less of investment.
Class I shares are generally more attractive for long-term investors because of
Class II's higher Rule 12b-1 fees, which accumulate over time to outweigh the
lower Class II front-end sales charge and result in lower income dividends for
Class II shareholders. If you qualify to buy Class I shares at a reduced sales
charge based upon the size of your purchase or through our Letter of Intent or
Rights of Accumulation programs, but intend to hold your shares less than
approximately six years, you should evaluate whether it is more economical for
you to buy Class I or Class II shares.
For purchases of $1 million or more, it is considered more beneficial for you to
buy Class I shares since there is no front-end sales charge, even though these
purchases may be subject to a contingent deferred sales charge. Any purchase of
$1 million or more will therefore be automatically invested in Class I shares.
You may accumulate more than $1 million in Class II shares through purchases
over time, but if you intend to do this you should determine whether it would be
more beneficial for you to buy Class I shares through a Letter of Intent.
Please consider all of these factors before deciding which class of shares to
buy. There are no conversion features attached to either class of shares.
PURCHASE PRICE OF FUND SHARES
You may buy shares at the public offering price of the class you wish to
purchase, unless you qualify to purchase shares at a discount or without a sales
charge as discussed below. The front-end sales charge for Class II shares is 1%
and, unlike Class I shares, does not vary based upon the size of your purchase.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
Total Sales Charge
As a Percentage of
-------------------
Amount Allowed to
Net Amount Dealer as a Percentage
Size of Transaction at Offering Price Offering Price Invested of Offering Price*
<S> <C> <C> <C>
ClassI
Under $100,000.......................... 4.25% 4.44% 4.00%
$100,000 but less than $250,000......... 3.50% 3.63% 3.25%
$250,000 but less than $500,000......... 2.75% 2.83% 2.50%
$500,000 but less than $1,000,000....... 2.15% 2.20% 2.00%
$1,000,000 or more...................... None** None None***
ClassII
Under $100,000+......................... 1.00%** 1.01% 1.00%
</TABLE>
*Financial institutions or their affiliated brokers may receive an agency
transaction fee in the percentages indicated. Distributors may at times reallow
the entire sales charge to the securities dealer. A securities dealer who
receives 90% or more of the sales commission may be deemed an underwriter under
the Securities Act of 1933, as amended.
**A contingent deferred sales charge of 1% may be imposed on: (i) certain
redemptions of all or a part of an investment of $1 million or more in Class I
shares; and (ii) redemptions of Class II shares within 18 months of their
purchase. See "How Do I Sell Shares? - Contingent Deferred Sales Charge."
***Please see "General - Other Payments to Securities Dealers" below for a
discussion of payments Distributors may make to securities dealers out of its
own resources.
+Purchases of Class II shares are limited to purchases below $1 million. See
"Deciding Which Class to Buy."
The offering price for each class will be calculated to two decimal places using
standard rounding criteria.
QUANTITY DISCOUNTS IN SALES CHARGES -
CLASS I SHARES ONLY
As shown in the table above, the sales charge you pay when you buy Class I
shares may be reduced based upon the size of your purchase.
Rights of Accumulation. To determine if you may pay a reduced sales charge, you
may add the cost or current value, whichever is higher, of your Class I and
Class II shares in other Franklin Templeton Funds, as well as those of your
spouse, children under the age of 21 and grandchildren under the age of 21, to
the amount of your current Class I purchase. To receive the reduction, you or
your investment representative must notify Distributors that your investment
qualifies for a discount.
Letter of Intent. You may purchase Class I shares at a reduced sales charge by
completing the Letter of Intent section of the Shareholder Application. A Letter
of Intent is a commitment by you to invest a specified dollar amount during a 13
month period. The amount you agree to invest determines the sales charge you pay
on Class I shares. You or your investment representative must inform us that the
Letter is in effect each time you purchase shares.
BY COMPLETING THE LETTER OF INTENT SECTION OF THE SHAREHOLDER APPLICATION, YOU
ACKNOWLEDGE AND AGREE TO THE FOLLOWING:
o You authorize Distributors to reserve five percent (5%) of the amount of the
total intended purchase in Class I shares registered in your name.
o You grant Distributors a security interest in these shares and appoint
Distributors as attorney-in-fact with full power of substitution to redeem any
or all of these reserved shares to pay any unpaid sales charge if you do not
fulfill the terms of the Letter.
o We will include the reserved shares in the total shares you own as reflected
on your periodic statements.
o You will receive dividend and capital gain distributions on the reserved
shares; we will pay or reinvest these distributions as you direct.
o Although you may exchange your shares, you may not liquidate reserved shares
until you complete the Letter or pay the higher sales charge.
If you would like more information about the Letter of Intent privilege, please
see "How Do I Buy and Sell Shares? - Letter of Intent" in the SAI or call our
Shareholder Services Department.
Group Purchases. If you are a member of a qualified group, you may purchase
Class I shares at the reduced sales charge applicable to the group as a whole.
The sales charge is based on the combined dollar value of the group members'
existing investments, plus the amount of the current purchase. For example, if
group members previously invested and still hold $80,000 of Fund shares and
invest $25,000, the sales charge will be 3.5%
We define a qualified group as one which (i) has been in existence for more than
six months, (ii) has a purpose other than acquiring Fund shares at a discount
and (iii) satisfies uniform criteria which enable Distributors to realize
economies of scale in its costs of distributing shares.
In addition, a qualified group must have more than 10 members, and be available
to arrange for meetings between our representatives and group members. It must
also agree to include sales and other materials related to the Franklin
Templeton Funds in publications and mailings to its members at reduced or no
cost to Distributors, and arrange for payroll deduction or other bulk
transmission of investments to the Fund.
If you select a payroll deduction plan, your investments will continue
automatically until you notify the Fund and your employer to discontinue further
investments. Due to the varying procedures used by employers to handle payroll
deductions, there may be a delay between the time of the payroll deduction and
the time the money reaches the Fund. We invest your purchase at the applicable
offering price per share determined on the day that the Fund receives both the
check and the payroll deduction data in required form.
PURCHASES AT NET ASSET VALUE
You may invest money from the following sources in Class I shares of the Fund
without paying front-end or contingent deferred sales charges. You may also
purchase Class II shares without paying front-end or contingent deferred sales
charges if the source of your investment proceeds is included in paragraph (i)
below:
(i) a distribution that you have received from a Franklin Templeton Fund or a
real estate investment trust ("REIT") sponsored or advised by Franklin
Properties, Inc., if the distribution is returned within 365 days of its payment
date. You may reinvest Class II distributions in either Class I or Class II
shares, but Class I distributions may only be invested in Class I shares under
this privilege. For more information, see "Distribution Options" under "What
Distributions Might I Receive from the Fund?" or call Shareholder Services at
1-800/632-2301; or
(ii) a redemption from a mutual fund with investment objectives similar to those
of the Fund, if (a) your investment in that fund was subject to either a
front-end or contingent deferred sales charge at the time of purchase, (b) the
fund is not part of the Franklin Templeton Funds, and (c) your redemption
occurred within the past 60 days.
You may also reinvest the proceeds from a redemption of any of the Franklin
Templeton Funds in Class I or Class II shares of the Fund at net asset value. To
do so, you must (a) have paid a sales charge on the purchase or sale of the
original shares, (b) reinvest the redemption money in the same class of shares,
and (c) request the reinvestment of the money within 365 days of the redemption
date. You may reinvest up to the total amount of the redemption proceeds under
this privilege. If a different class of shares is purchased, the full front-end
sales charge must be paid at the time of purchase of the new shares. While you
will receive credit for any contingent deferred sales charge paid on the shares
redeemed, a new contingency period will begin. Shares that were no longer
subject to a contingent deferred sales charge will be reinvested at net asset
value and will not be subject to a new contingent deferred sales charge. Shares
exchanged into other Franklin Templeton Funds are not considered "redeemed" for
this privilege (see "What If My Investment Outlook Changes? - Exchange
Privilege").
If you immediately reinvested your redemption proceeds in a Franklin Bank
Certificate of Deposit ("CD") but you would like to reinvest them back into the
Franklin Templeton Funds as described above, you will have 365 days from the
date the CD (including any rollover) matures to do so.
If your securities dealer or another financial institution reinvests your money
in the Fund at net asset value for you, that person or institution may charge
you a fee for this service.
A redemption is a taxable transaction, but reinvestment without a sales charge
may affect the amount of gain or loss you recognize and the tax basis of the
shares reinvested. If you have a loss on the redemption, the loss may be
disallowed if you reinvest in the same fund within a 30-day period. If you would
like more information regarding the possible tax consequences of such a
reinvestment, please see the tax section of this prospectus and the SAI.
Certain categories of investors also qualify to purchase Class I shares of the
Fund at net asset value regardless of the source of the investment proceeds. If
you or your account is included in one of the categories below, none of the
Class I shares you purchase will be subject to front-end or contingent deferred
sales charges:
(i) companies exchanging shares or selling assets pursuant to a merger,
acquisition or exchange offer;
(ii) accounts managed by the Franklin Templeton Group;
(iii) certain unit investment trusts and unit holders of these trusts
reinvesting distributions from the trusts in the Fund;
(iv) registered securities dealers and their affiliates, for their investment
accounts only;
(v) current employees of securities dealers and their affiliates and their
family members, in accordance with the internal policies and procedures of the
employing securities dealer and affiliate;
(vi) broker-dealers who have entered into a supplemental agreement with
Distributors, on behalf of their clients who are participating in comprehensive
fee programs. These programs, sometimes known as wrap fee programs, are
sponsored by the broker-dealer and either advised by the broker-dealer or by
another registered investment advisor affiliated with that broker;
(vii) any state, county, or city, or any instrumentality, department, authority
or agency thereof which has determined that the Fund is a legally permissible
investment and which is prohibited by applicable investment laws from paying a
sales charge or commission in connection with the purchase of shares of any
registered management investment company ("an eligible governmental authority").
IF YOU ARE SUCH AN INVESTOR, PLEASE CONSULT YOUR OWN LEGAL ADVISORS TO DETERMINE
WHETHER AND TO WHAT EXTENT THE SHARES OF THE FUND CONSTITUTE LEGAL INVESTMENTS.
Municipal investors considering investment of proceeds of bond offerings into
the Fund should consult with expert counsel to determine the effect, if any, of
various payments made by the Fund or the Manager on arbitrage rebate
calculations. If you are a securities dealer who has executed a dealer agreement
with Distributors and, through your services, an eligible governmental authority
invests in the Fund at net asset value, Distributors or one of its affiliates
may make a payment, out of its own resources, to you in an amount not to exceed
0.25% of the amount invested. Please contact the Franklin Templeton
Institutional Services Department for additional information;
(viii) officers, trustees, directors and full-time employees of the Franklin
Templeton Funds, or of the Franklin Templeton Group, and their family members.
Although you may pay sales charges on investments in accounts opened after your
association with us has ended, you may continue to invest in accounts opened
while you were with us without paying sales charges; or
(ix) trust companies and bank trust departments that exercise exclusive
discretionary investment authority over funds held in a fiduciary, agency,
advisory, custodial or similar capacity and agree to invest at least $1 million
in Franklin Templeton Funds over a 13 month period. We will accept orders for
such accounts by mail accompanied by a check or by telephone or other means of
electronic data transfer directly from the bank or trust company, with payment
by federal funds received by the close of business on the next business day
following such order.
IF YOU QUALIFY TO BUY SHARES AT NET ASSET VALUE AS DISCUSSED IN THIS SECTION,
PLEASE SPECIFY IN WRITING THE PRIVILEGE THAT APPLIES TO YOUR PURCHASE AND
INCLUDE THAT WRITTEN STATEMENT WITH YOUR PURCHASE ORDER. WE WILL NOT BE
RESPONSIBLE FOR PURCHASES THAT ARE NOT MADE AT NET ASSET VALUE IF THIS WRITTEN
STATEMENT IS NOT INCLUDED WITH YOUR ORDER.
If you would like more information, please see "How Do I Buy and Sell Shares?"
in the SAI.
GENERAL
The Fund continuously offers its shares through securities dealers who have an
agreement with Distributors. The Fund and Distributors may refuse any order for
the purchase of shares. Currently, the Fund does not allow investments by Market
Timers.
Securities laws of states in which the Fund offers its shares may differ from
federal law. Banks and financial institutions that sell shares of the Fund may
be required to register as securities dealers pursuant to state law.
Other Payments to Securities Dealers. Distributors will pay the following
commissions, out of its own resources, to securities dealers who initiate and
are responsible for Class I purchases of $1 million or more: 0.75% on sales of
$1 million but less than $2 million, plus 0.60% on sales of $2 million but less
than $3 million, plus 0.50% on sales of $3 million but less than $50 million,
plus 0.25% on sales of $50 million but less than $100 million, plus 0.15% on
sales of $100 million or more. These breakpoints are reset every 12 months for
purposes of additional purchases.
Distributors or one of its affiliates may also pay up to 1% of the purchase
price to securities dealers who initiate and are responsible for Class I
purchases made at net asset value by any of the entities described in paragraph
(ix) under "Purchases at Net Asset Value" above. Please see "How Do I Buy and
Sell Shares?" in the SAI for the breakpoints applicable to these purchases.
For Class II purchases, either Distributors or one of its affiliates may pay
securities dealers, out of its own resources, up to 1% of the purchase price. To
partially recoup these payments, Distributors will keep part of the Rule 12b-1
fees assessed to the shares during the first year following their purchase.
Either Distributors or one of its affiliates, out of its own resources, may also
provide additional compensation to securities dealers in connection with the
sale of shares of the Franklin Templeton Funds. In some cases, this compensation
may be available only to securities dealers whose representatives have sold or
are expected to sell significant amounts of shares of the Franklin Templeton
Funds. Compensation may include financial assistance and payments made in
connection with conferences, sales or training programs for employees of the
securities dealer, seminars for the public, advertising, sales campaigns and/or
shareholder services, programs regarding one or more of the Franklin Templeton
Funds and other programs or events sponsored by securities dealers, and payment
for travel expenses of invited registered representatives and their families,
including lodging, in connection with business meetings or seminars located
within or outside the U.S. Securities dealers may not use sales of the Fund's
shares to qualify for this compensation if prohibited by the laws of any state
or self-regulatory agency, such as the National Association of Securities
Dealers, Inc. None of this compensation is paid for by the Fund or its
shareholders.
For additional information about shares of the Fund, please see "How Do I Buy
and Sell Shares?" in the SAI. The SAI also includes a listing of the officers
and trustees of the Fund who are affiliated with Distributors. See "Officers and
Trustees."
WHAT PROGRAMS AND PRIVILEGES
ARE AVAILABLE TO ME AS A SHAREHOLDER?
CERTAIN OF THE PROGRAMS AND PRIVILEGES DESCRIBED IN THIS SECTION MAY NOT BE
AVAILABLE DIRECTLY FROM THE FUND IF YOUR SHARES ARE HELD, OF RECORD, BY A
FINANCIAL INSTITUTION OR IN A "STREET NAME" ACCOUNT OR NETWORKED ACCOUNT THROUGH
THE NATIONAL SECURITIES CLEARING CORPORATION ("NSCC") (SEE "REGISTERING YOUR
ACCOUNT" IN THIS PROSPECTUS).
SHARE CERTIFICATES
Shares from an initial investment, as well as subsequent investments, including
the reinvestment of dividends and capital gain distributions, are generally
credited to an account in the name of an investor on the books of the Fund,
without the issuance of a share certificate. Maintaining shares in
uncertificated form (also known as "plan balance") minimizes the risk of loss or
theft of a share certificate. A lost, stolen or destroyed certificate cannot be
replaced without obtaining a sufficient indemnity bond. The cost of such a bond,
which is generally borne by you, can be 2% or more of the value of the lost,
stolen or destroyed certificate. A certificate will be issued if requested by
you or your securities dealer.
CONFIRMATIONS
A confirmation statement will be sent to you quarterly to reflect the dividends
reinvested during the period and after each other transaction which affects your
account. This statement will also show the total number of shares you own,
including the number of shares in "plan balance" for your account.
AUTOMATIC INVESTMENT PLAN
The Automatic Investment Plan offers a convenient way to invest in the Fund.
Under the plan, you can arrange to have money transferred automatically from
your checking account to the Fund each month to buy additional shares. If you
are interested in this program, please refer to the Automatic Investment Plan
Application at the back of this prospectus for the requirements of the program
or contact your investment representative. Of course, the market value of the
Fund's shares may fluctuate and a systematic investment plan such as this will
not assure a profit or protect against a loss. You may terminate the program at
any time by notifying Investor Services by mail or by phone.
SYSTEMATIC WITHDRAWAL PLAN
The Systematic Withdrawal Plan allows you to receive regular payments from your
account on a monthly, quarterly, semiannual or annual basis. To establish a
Systematic Withdrawal Plan, the value of your account must be at least $5,000
and the minimum payment amount for each withdrawal must be at least $50. Please
keep in mind that $50 is merely the minimum amount and is not a recommended
amount.
If you would like to establish a Systematic Withdrawal Plan, please complete the
Systematic Withdrawal Plan section of the Shareholder Application included with
this prospectus and indicate how you would like to receive your payments. You
may choose to receive your payments in any of the following ways:
1. Purchase shares of other Franklin Templeton Funds - You may direct your
payments to purchase the same class of shares of another Franklin Templeton
Fund.
2. Receive payments in cash - You may choose to receive your payments in cash.
You may have the money sent directly to you, to another person, or to a checking
account. If you choose to have the money sent to a checking account, please see
"Electronic Fund Transfers" below.
There are no service charges for establishing or maintaining a Systematic
Withdrawal Plan. Once your plan is established, any distributions paid by the
Fund will be automatically reinvested in your account. Payments under the plan
will be made from the redemption of an equivalent amount of shares in your
account, generally on the first business day of the month in which a payment is
scheduled. You will generally receive your payments within three to five days
after the shares are redeemed.
Redeeming shares through a Systematic Withdrawal Plan may reduce or exhaust the
shares in your account if payments exceed distributions received from the Fund.
This is especially likely to occur if there is a market decline. If a withdrawal
amount exceeds the value of your account, your account will be closed and the
remaining balance in your account will be sent to you. Redemptions under a
Systematic Withdrawal Plan are considered a sale for federal income tax
purposes. Because the amount withdrawn under the plan may be more than your
actual yield or income, part of the payment may be a return of your investment.
While a Systematic Withdrawal Plan is in effect, shares must be held either in
plan balance or, where share certificates are outstanding, deposited with the
Fund. You should ordinarily not make additional investments in the Fund of less
than $5,000 or three times the amount of annual withdrawals under the plan
because of the sales charge on additional purchases. Shares redeemed under the
plan may also be subject to a contingent deferred sales charge. Please see
"Contingent Deferred Sales Charge" under "How Do I Sell Shares?"
You may terminate a Systematic Withdrawal Plan, change the amount and schedule
of withdrawal payments, or suspend one payment by notifying Investor Services in
writing at least seven business days prior to the end of the month preceding a
scheduled payment. The Fund may also terminate a Systematic Withdrawal Plan by
notifying you in writing and will automatically terminate a Systematic
Withdrawal Plan if all shares in your account are withdrawn or if the Fund
receives notification of the shareholder's death or incapacity.
ELECTRONIC FUND TRANSFERS
You may choose to have distributions from the Fund or payments under a
Systematic Withdrawal Plan sent directly to a checking account. If the checking
account is maintained at a bank that is a member of the Automated Clearing
House, the payments may be made automatically by electronic funds transfer. If
you choose this option, please allow at least fifteen days for initial
processing. Any payments made during that time will be sent to the address of
record on your account.
INSTITUTIONAL ACCOUNTS
There may be additional methods of buying, selling or exchanging shares of the
Fund available to institutional accounts. For further information, contact the
Franklin Templeton Institutional Services Department at 1-800/321-8563.
WHAT IF MY INVESTMENT OUTLOOK CHANGES? -
EXCHANGE PRIVILEGE
The Franklin Templeton Funds consist of a number of mutual funds with various
investment objectives and policies. The shares of most of these funds are
offered to the public with a sales charge. If your investment objective or
outlook for the securities markets changes, Fund shares may be exchanged for the
same class of shares of another Franklin Templeton Fund eligible for sale in
your state of residence and in conformity with that fund's stated eligibility
requirements and investment minimums. Some funds, however, may not offer Class
II shares. Class I shares may be exchanged for Class I shares of any of the
other Franklin Templeton Funds. Class II shares may be exchanged for Class II
shares of any of the other Franklin Templeton Funds. No exchanges between
different classes of shares will be allowed. A contingent deferred sales charge
will not be imposed on exchanges. If, however, the exchanged shares were subject
to a contingent deferred sales charge in the original fund purchased and shares
are subsequently redeemed within the contingency period, a contingent deferred
sales charge will be imposed. Before making an exchange, you should review the
prospectus of the fund you wish to exchange from and the fund you wish to
exchange into for all specific requirements or limitations on exercising the
exchange privilege, for example, limitations on a fund's sale of its shares,
minimum holding periods for exchanges at net asset value, or applicable sales
charges.
You may exchange shares in any of the following ways:
BY MAIL
Send written instructions signed by all account owners and accompanied by any
outstanding share certificates properly endorsed. The transaction will be
effective upon receipt of the written instructions together with any outstanding
share certificates.
BY TELEPHONE
You or your investment representative of record, if any, may exchange shares of
the Fund by calling Investor Services at 1-800/632-2301 or the automated
TeleFACTS(R) system (day or night) at 1-800/247-1753. If you do not wish this
privilege extended to a particular account, you should notify the Fund or
Investor Services.
The telephone exchange privilege allows you to effect exchanges from the Fund
into an identically registered account of the same class of shares in one of the
other available Franklin Templeton Funds. The telephone exchange privilege is
available only for uncertificated shares or those which have previously been
deposited in your account. The Fund and Investor Services will employ reasonable
procedures to confirm that instructions communicated by telephone are genuine.
Please see "Telephone Transactions - Verification Procedures."
During periods of drastic economic or market changes, it is possible that the
telephone exchange privilege may be difficult to implement and the TeleFACTS
option may not be available. In this event, you should follow the other exchange
procedures discussed in this section, including the procedures for processing
exchanges through securities dealers.
THROUGH SECURITIES DEALERS
As is the case with all purchases and redemptions of the Fund's shares, Investor
Services will accept exchange orders from securities dealers who execute a
dealer or similar agreement with Distributors. See also "By Telephone" above.
Such a dealer- ordered exchange will be effective only for uncertificated shares
on deposit in your account or for which certificates have previously been
deposited. A securities dealer may charge a fee for handling an exchange.
ADDITIONAL INFORMATION REGARDING EXCHANGES
Exchanges of the same class of shares are made on the basis of the net asset
value of the class involved, except as set forth below. Exchanges of shares of a
class which were purchased without a sales charge will be charged a sales charge
in accordance with the terms of the prospectus of the fund and the class of
shares being purchased, unless the original investment in the Franklin Templeton
Funds was made pursuant to the privilege permitting purchases at net asset
value, as discussed under "How Do I Buy Shares?" Exchanges of Class I shares of
the Fund which were purchased with a lower sales charge into a fund which has a
higher sales charge will be charged the difference, unless the shares were held
in the Fund for at least six months prior to executing the exchange.
If you request the exchange of the total value of your account, accrued but
unpaid income dividends and capital gain distributions will be reinvested in the
Fund at the net asset value on the date of the exchange, and then the entire
share balance will be exchanged into the new fund in accordance with the
procedures set forth above. Because the exchange is considered a redemption and
purchase of shares, you may realize a gain or loss for federal income tax
purposes. Backup withholding and information reporting may also apply.
Information regarding the possible tax consequences of such an exchange is
included in the tax section in this prospectus and under "Additional Information
Regarding Taxation" in the SAI.
If a substantial portion of the Fund's shareholders should, within a short
period, elect to redeem their shares of the Fund pursuant to the exchange
privilege, the Fund might have to liquidate portfolio securities it might
otherwise hold and incur the additional costs related to such transactions. On
the other hand, increased use of the exchange privilege may result in periodic
large inflows of money. If this should occur, it is the general policy of the
Fund to initially invest this money in short-term, tax-exempt municipal
securities, unless it is felt that attractive investment opportunities
consistent with the Fund's investment objectives exist immediately.
Subsequently, this money will be withdrawn from such short-term tax-exempt
municipal securities and invested in portfolio securities in as orderly a manner
as is possible when attractive investment opportunities arise.
The exchange privilege may be modified or discontinued by the Fund at any time
upon 60 days' written notice to shareholders.
EXCHANGES OF CLASS I SHARES
The contingency period during which a contingent deferred sales charge may be
assessed for Class I shares will be tolled (or stopped) for the period such
shares are exchanged into and held in a Franklin or Templeton Class I money
market fund. If a Class I account has shares subject to a contingent deferred
sales charge, Class I shares will be exchanged into the new account on a
"first-in, first-out" basis. See "How Do I Sell Shares? - Contingent Deferred
Sales Charge" for a discussion of investments subject to a contingent deferred
sales charge.
EXCHANGES OF CLASS II SHARES
When an account is composed of Class II shares subject to the contingent
deferred sales charge and Class II shares that are not, the shares will be
transferred proportionately into the new fund. Shares received from reinvestment
of dividends and capital gains are referred to as "free shares," shares which
were originally subject to a contingent deferred sales charge but to which the
contingent deferred sales charge no longer applies are called "matured shares,"
and shares still subject to the contingent deferred sales charge are referred to
as "CDSC liable shares." CDSC liable shares held for different periods of time
are considered different types of CDSC liable shares. For instance, if you have
$1,000 in free shares, $2,000 in matured shares, and $3,000 in CDSC liable
shares and you exchange $3,000 into a new fund, $500 will be exchanged from free
shares, $1,000 from matured shares, and $1,500 from CDSC liable shares.
Similarly, if CDSC liable shares have been purchased at different periods, a
proportionate amount will be taken from shares held for each period. If, for
example, you hold $1,000 in shares bought 3 months ago, $1,000 bought 6 months
ago, and $1,000 bought 9 months ago and you exchange $1,500 into the new fund,
$500 from each of these shares will be deemed exchanged into the new fund.
The only money market fund exchange option available to Class II shareholders is
the Franklin Templeton Money Fund II ("Money Fund II"), a series of the Franklin
Templeton Money Fund Trust. No drafts (checks) may be written on Money Fund II
accounts, nor may Class II shareholders purchase shares of Money Fund II
directly. Class II shares exchanged for shares of Money Fund II will continue to
age, for purposes of calculating the contingent deferred sales charge, because
they continue to be subject to Rule 12b-1 fees. The contingent deferred sales
charge will be assessed if CDSC liable shares are redeemed. Class I shares may
be exchanged for shares of any of the money market funds in the Franklin
Templeton Funds except Money Fund II. Draft writing privileges and direct
purchases are allowed on these other money market funds as described in their
respective prospectuses.
To the extent shares are exchanged proportionately, as opposed to another method
such as first-in first-out or free shares followed by CDSC liable shares, the
exchanged shares may, in some instances, be CDSC liable even though a redemption
of such shares, as discussed elsewhere herein, may no longer be subject to a
contingent deferred sales charge. The proportional method is believed by
management to more closely meet and reflect the expectations of Class II
shareholders in the event shares are redeemed during the contingency period. For
federal income tax purposes, the cost basis of shares redeemed or exchanged is
determined under the Code without regard to the method of transferring shares
chosen by the Fund.
MARKET TIMERS
The Fund currently will not accept investments from Market Timers.
TRANSFERS
Transfers between identically registered accounts in the same fund and class are
treated as non-monetary and non-taxable events and are not subject to a
contingent deferred sales charge. The transferred shares will continue to age
from the date of original purchase. Shares of each class will be transferred on
the same basis as described above for exchanges.
CONVERSION RIGHTS
It is not presently anticipated that Class II shares will be convertible to
Class I shares. You may, however, sell Class II shares and use the proceeds to
purchase Class I shares, subject to all applicable sales charges.
HOW DO I SELL SHARES?
You may sell (redeem) your shares at any time and receive from the Fund the
value of the shares. You may sell shares in any of the following ways:
BY MAIL
Send a written request signed by all registered owners to Investor Services, at
the address shown on the back cover of this prospectus, and any share
certificates which have been issued for the shares being redeemed, properly
endorsed and in order for transfer. You will then receive from the Fund the
value of the class of shares redeemed based upon the net asset value per share
(less a contingent deferred sales charge, if applicable) next computed after the
written request in proper form is received by Investor Services. Redemption
requests received after the time at which the net asset value is calculated will
receive the price calculated on the following business day. The net asset value
per share of each class is determined as of the scheduled close of the Exchange
(generally 1:00 p.m. Pacific time) each day that the Exchange is open for
trading. You are requested to provide a telephone number where you may be
reached during business hours, or in the evening if preferred. Investor
Services' ability to contact you promptly when necessary will speed the
processing of the redemption.
TO BE CONSIDERED IN PROPER FORM, SIGNATURES MUST BE GUARANTEED IF THE REDEMPTION
REQUEST INVOLVES ANY OF THE FOLLOWING:
(1) the proceeds of the redemption are over $50,000;
(2) the proceeds (in any amount) are to be paid to someone other than the
registered owners of the account;
(3) the proceeds (in any amount) are to be sent to any address other than the
address of record, preauthorized bank account or brokerage firm account;
(4) share certificates, if the redemption proceeds are in excess of $50,000; or
(5) the Fund or Investor Services believes that a signature guarantee would
protect against potential claims based on the transfer instructions,
including, for example, when (a) the current address of one or more joint
owners of an account cannot be confirmed, (b) multiple owners have a
dispute or give inconsistent instructions to the Fund, (c) the Fund has
been notified of an adverse claim, (d) the instructions received by the
Fund are given by an agent, not the actual registered owner, (e) the Fund
determines that joint owners who are married to each other are separated or
may be the subject of divorce proceedings, or (f) the authority of a
representative of a corporation, partnership, association, or other entity
has not been established to the satisfaction of the Fund.
Signatures must be guaranteed by an "eligible guarantor institution" as defined
under Rule 17Ad-15 under the Securities Exchange Act of 1934. Generally,
eligible guarantor institutions include (1) national or state banks, savings
associations, savings and loan associations, trust companies, savings banks,
industrial loan companies and credit unions; (2) national securities exchanges,
registered securities associations and clearing agencies; (3) securities dealers
that are members of a national securities exchange or a clearing agency or that
have minimum net capital of $100,000; or (4) institutions that participate in
the Securities Transfer Agent Medallion Program ("STAMP") or other recognized
signature guarantee medallion program. A notarized signature will not be
sufficient for the request to be in proper form.
When shares to be redeemed are represented by share certificates, the request
for redemption must be accompanied by the share certificate and a share
assignment form signed by the registered owners exactly as the account is
registered, with the signatures guaranteed as referenced above. You are advised,
for your protection, to send the share certificate and assignment form in
separate envelopes if they are being mailed in for redemption.
Liquidation requests of corporate, partnership, trust and custodianship
accounts, and accounts under court jurisdiction require the following
documentation to be in proper form:
Corporation - (1) Signature guaranteed letter of instruction from the authorized
officers of the corporation and (2) a corporate resolution.
Partnership - (1) Signature guaranteed letter of instruction from a general
partner and (2) pertinent pages from the partnership agreement identifying the
general partners or a certification for a partnership agreement.
Trust - (1) Signature guaranteed letter of instruction from the trustees and (2)
a copy of the pertinent pages of the trust document listing the trustees or a
Certification for Trust if the trustees are not listed on the account
registration.
Custodial - Signature guaranteed letter of instruction from the custodian.
Accounts under court jurisdiction - Check court documents and applicable state
law since these accounts have varying requirements, depending upon the state of
residence.
Payment for redeemed shares will be sent to you within seven days after receipt
of the request in proper form.
BY TELEPHONE
If you complete the Franklin Templeton Telephone Redemption Authorization
Agreement (the "Agreement"), included with this prospectus, you may redeem
shares of the Fund by telephone. You may obtain additional information about
telephone redemptions by writing to the Fund or Investor Services at the address
shown on the cover or by calling 1-800/632-2301. The Fund and Investor Services
will employ reasonable procedures to confirm that instructions given by
telephone are genuine. You, however, bear the risk of loss in certain cases as
described under "Telephone Transactions Verification Procedures."
If your account has a completed Agreement on file, redemptions of uncertificated
shares or shares which have previously been deposited with the Fund or Investor
Services may be made for up to $50,000 per day per Fund account. Telephone
redemption requests received before the scheduled close of the Exchange
(generally 1:00 p.m. Pacific time) on any business day will be processed that
same day. The redemption check will be sent within seven days, made payable to
all the registered owners on the account, and will be sent only to the address
of record.
Redemption requests by telephone will not be accepted within 30 days following
an address change by telephone. In that case, you should follow the other
redemption procedures set forth in this prospectus. Institutional accounts
(certain corporations, bank trust departments and government entities that
qualify to purchase shares at net asset value pursuant to the terms of this
prospectus) that wish to execute redemptions in excess of $50,000 must complete
an Institutional Telephone Privileges Agreement which is available from the
Franklin Templeton Institutional Services Department by calling 1-800/321-8563.
THROUGH SECURITIES DEALERS
The Fund will accept redemption orders from securities dealers who have entered
into an agreement with Distributors. This is known as a repurchase. The only
difference between a normal redemption and a repurchase is that if you redeem
shares through a dealer, the redemption price will be the net asset value next
calculated after your dealer receives the order which is promptly transmitted to
the Fund, rather than on the day the Fund receives your written request in
proper form. The documents described under "By Mail" above, as well as a signed
letter of instruction, are required regardless of whether you redeem shares
directly or submit such shares to a securities dealer for repurchase. Your
letter should reference the Fund and the class, the account number, the fact
that the repurchase was ordered by a dealer and the dealer's name. Details of
the dealer-ordered trade, such as trade date, confirmation number, and the
amount of shares or dollars, will help speed processing of the redemption. The
seven-day period within which the proceeds of your redemption will be sent will
begin when the Fund receives all documents required to complete ("settle") the
repurchase in proper form. Your dealer may charge a fee for handling the order.
See "How Do I Buy and Sell Shares?" in the SAI for more information on the
redemption of shares.
CONTINGENT DEFERRED SALES CHARGE
In order to recover commissions paid to securities dealers, all or a portion of
Class I investments of $1 million or more and any Class II investments redeemed
within the contingency period (12 months for Class I and 18 months for Class II)
will be assessed a contingent deferred sales charge, unless one of the
exceptions described below applies. The charge is 1% of the lesser of the value
of the shares redeemed (exclusive of reinvested dividends and capital gain
distributions) or the net asset value at the time of purchase of such shares,
and is retained by Distributors. The contingent deferred sales charge is waived
in certain instances.
In determining whether a contingent deferred sales charge applies, shares not
subject to a contingent deferred sales charge are deemed to be redeemed first,
in the following order: (i) a calculated number of shares representing amounts
attributable to capital appreciation on shares held less than the contingency
period; (ii) shares purchased with reinvested dividends and capital gain
distributions; and (iii) other shares held longer than the contingency period.
Shares subject to a contingent deferred sales charge will then be redeemed on a
"first-in, first-out" basis. For tax purposes, a contingent deferred sales
charge is treated as either a reduction in redemption proceeds or an adjustment
to the cost basis of the shares redeemed.
The contingent deferred sales charge on each class of shares is waived, as
applicable, for: specified net asset value purchases discussed under "How Do I
Buy Shares? - Purchases at Net Asset Value"; exchanges; any account fees;
redemptions initiated by the Fund due to an account falling below the minimum
specified account size; redemptions following the death of the shareholder or
beneficial owner; and redemptions through a Systematic Withdrawal Plan set up
for shares prior to February 1, 1995, and for Systematic Withdrawal Plans set up
thereafter, redemptions of up to 1% monthly of an account's net asset value (3%
quarterly, 6% semiannually or 12% annually). For example, if a Class I account
maintained an annual balance of $1,000,000, only $120,000 could be withdrawn
through a once-yearly Systematic Withdrawal Plan free of charge. Any amount over
that $120,000 would be assessed a 1% contingent deferred sales charge. Likewise,
if a Class II account maintained an annual balance of $10,000, only $1,200 could
be withdrawn through a once-yearly Systematic Withdrawal Plan free of charge.
All investments made during a calendar month, regardless of when during the
month the investment occurred, will age one month on the last day of that month
and each subsequent month.
Unless otherwise specified, requests for redemptions of a specified dollar
amount will result in additional shares being redeemed to cover any applicable
contingent deferred sales charge, while requests for redemption of a specific
number of shares will result in the applicable contingent deferred sales charge
being deducted from the total dollar amount redeemed.
ADDITIONAL INFORMATION REGARDING REDEMPTIONS
The Fund may delay the mailing of the redemption check, or a portion thereof,
until the clearance of the check used to purchase Fund shares, which may take up
to 15 days or more. Although the use of a certified or cashier's check will
generally reduce this delay, shares purchased with these checks will also be
held pending clearance. Shares purchased by federal funds wire are available for
immediate redemption.
The right of redemption may be suspended or the date of payment postponed if the
Exchange is closed (other than customary closing) or upon the determination of
the SEC that trading on the Exchange is restricted or an emergency exists, or if
the SEC permits it, by order, for the protection of shareholders. Of course, the
amount received may be more or less than the amount you invested, depending on
fluctuations in the market value of securities owned by the Fund.
OTHER INFORMATION
Distribution or redemption checks sent to you do not earn interest or any other
income during the time such checks remain uncashed and neither the Fund nor its
affiliates will be liable for any loss caused by your failure to cash such
checks.
"Cash" payments to or from the Fund may be made by check, draft or wire. The
Fund has no facility to receive, or pay out, cash in the form of currency.
For any information required about a proposed liquidation, you may call
Franklin's Shareholder Services Department. Securities dealers may call
Franklin's Dealer Services Department.
TELEPHONE TRANSACTIONS
By calling Investor Services at 1-800/632-2301, you or your investment
representative of record, if any, may be able to execute various telephone
transactions, including to: (i) effect a change in address, (ii) change a
dividend option (iii) transfer Fund shares in one account to another identically
registered account in the Fund, (iv) request the issuance of certificates (to be
sent to the address of record only) and (v) exchange Fund shares as described in
this prospectus by telephone. In addition, if you complete and file an Agreement
as described under "How Do I Sell Shares? - By Telephone" you will be able to
redeem shares of the Fund.
VERIFICATION PROCEDURES
The Fund and Investor Services will employ reasonable procedures to confirm that
instructions communicated by telephone are genuine. These will include:
recording all telephone calls requesting account activity by telephone,
requiring that the caller provide certain personal and/or account information
requested by the telephone service agent at the time of the call for the purpose
of establishing the caller's identification, and sending a confirmation
statement on redemptions to the address of record each time account activity is
initiated by telephone. So long as the Fund and Investor Services follow
instructions communicated by telephone which were reasonably believed to be
genuine at the time of their receipt, neither they nor their affiliates will be
liable for any loss to you caused by an unauthorized transaction. The Fund and
Investor Services may be liable for any losses due to unauthorized or fraudulent
instructions in the event such reasonable procedures are not followed. You are,
of course, under no obligation to apply for or accept telephone transaction
privileges. In any instance where the Fund or Investor Services is not
reasonably satisfied that instructions received by telephone are genuine, the
requested transaction will not be executed, and neither the Fund nor Investor
Services will be liable for any losses which may occur because of a delay in
implementing a transaction.
GENERAL
During periods of drastic economic or market changes, it is possible that the
telephone transaction privilege will be difficult to execute because of heavy
telephone volume. In these situations, you may wish to contact your investment
representative for assistance or send written instructions to the Fund as
detailed elsewhere in this prospectus.
Neither the Fund nor Investor Services will be liable for any losses resulting
from your inability to execute a telephone transaction.
HOW ARE FUND SHARES VALUED?
The net asset value per share of each class of the Fund is determined as of the
scheduled close of the Exchange (generally 1:00 p.m. Pacific time) each day that
the Exchange is open for trading. Many newspapers carry daily quotations of the
prior trading day's closing "bid" (net asset value) and "ask" (offering price).
The net asset value per share of each class is determined by deducting the
aggregate gross value of all liabilities of each class from the aggregate gross
value of all assets of each class, and then dividing the difference by the
number of shares of the class outstanding. Assets in the Fund's portfolio are
valued as described under "How Are Fund Shares Valued?" in the SAI.
Each class will bear, pro rata, all of the common expenses of the Fund, except
that each class will bear the Rule 12b-1 fees payable under its respective plan.
The net asset value of all outstanding shares of each class of the Fund will be
computed on a pro rata basis based on the proportionate participation in the
Fund represented by the value of shares of such class. Due to the specific
distribution expenses and other costs that will be allocable to each class, the
dividends paid to each class of the Fund may vary.
HOW DO I GET MORE INFORMATION ABOUT MY INVESTMENT?
Any questions or communications regarding your account should be directed to
Investor Services at the address shown on the back cover of this prospectus.
From a touch-tone phone, you may access TeleFACTS(R). By calling the TeleFACTS
system (day or night) at 1-800/247-1753, you may obtain account information,
current price and, if available, yield or other performance information specific
to the Fund or any Franklin Templeton Fund. In addition, you may process an
exchange, within the same class, into an identically registered Franklin account
and request duplicate confirmation or year-end statements and deposit slips.
Class I and Class II share codes for the Fund, which will be needed to access
system information, are 175 and 275, respectively. The system's automated
operator will prompt you with easy to follow step-by-step instructions from the
main menu. Other features may be added in the future.
To assist you and securities dealers wishing to speak directly with a
representative, the following list of Franklin departments, telephone numbers
and hours of operation is provided.
Hours of Operation (Pacific Time)
Department Name Telephone No. (Monday through Friday)
- ------------------------------------------------------------------------------
Shareholder Services 1-800/632-2301 5:30 a.m. to 5:00 p.m.
Dealer Services 1-800/524-4040 5:30 a.m. to 5:00 p.m.
Fund Information 1-800/DIAL BEN 5:30 a.m. to 8:00 p.m.
8:30 a.m. to 5:00 p.m. (Saturday)
Retirement Plans 1-800/527-2020 5:30 a.m. to 5:00 p.m.
TDD (hearing Impaired) 1-800/851-0637 5:30 a.m. to 5:00 p.m.
In order to ensure that the highest quality of service is being provided,
telephone calls placed to or by representatives in Franklin's service
departments may be accessed, recorded and monitored. These calls can be
determined by the presence of a regular beeping tone.
HOW DOES THE FUND MEASURE PERFORMANCE?
Advertisements, sales literature and communications to you may contain several
measures of a class' performance, including current yield, various expressions
of total return tax equivalent yield, taxable equivalent and current
distribution rate. They may also occasionally cite statistics to reflect the
Fund's volatility or risk.
Average annual total return figures as prescribed by the SEC represent the
average annual percentage change in value of $1,000 invested at the maximum
public offering price for one-, five- and ten-year periods, or portion thereof,
to the extent applicable, through the end of the most recent calendar quarter,
assuming reinvestment of all distributions. The Fund may also furnish total
return quotations for each class for other periods or based on investments at
various sales charge levels or at net asset value. For such purposes, total
return equals the total of all income and capital gain paid to shareholders,
assuming reinvestment of all distributions, plus (or minus) the change in the
value of the original investment, expressed as a percentage of the purchase
price.
Current yield for each class reflects the income per share earned by the Fund's
portfolio investments. It is calculated for each class by dividing that class'
net investment income per share during a recent 30-day period by the maximum
public offering price for that class of shares on the last day of that period
and annualizing the result.
Tax equivalent yield demonstrates the yield from a taxable investment necessary
to produce an after-tax yield equivalent to that of a fund which invests in
tax-exempt obligations. It is computed by dividing the tax-exempt portion of
each class' yield (calculated as indicated) by one minus a stated income tax
rate and adding the product to the taxable portion (if any) of the class' yield.
Current yield and tax equivalent yield for each class, which are calculated
according to a formula prescribed by the SEC (see "General Information" in the
SAI), are not indicative of the dividends or distributions which were or will be
paid to the Fund's shareholders. Dividends or distributions paid to shareholders
of a class are reflected in the current distribution rate or taxable equivalent
distribution rate, which may be quoted to you. The current distribution rate is
computed by dividing the total amount of dividends per share paid by a class
during the past 12 months by a current maximum offering price for that class of
shares. A taxable equivalent distribution rate demonstrates the taxable
distribution rate necessary to produce an after tax distribution rate equivalent
to that of a fund which invests in tax-exempt obligations. Under certain
circumstances, such as when there has been a change in the amount of dividend
payout or a fundamental change in investment policies, it might be appropriate
to annualize the dividends paid during the period such policies were in effect,
rather than using the dividends during the past 12 months. The current
distribution rate differs from the current yield computation because it may
include distributions to shareholders from sources other than dividends and
interest, such as short-term capital gain, and is calculated over a different
period of time.
In each case, performance figures are based upon past performance, reflect all
recurring charges against a class' income and will assume the payment of the
maximum sales charge on the purchase of that class of shares. When there has
been a change in the sales charge structure, the historical performance figures
will be restated to reflect the new rate. The investment results of each class,
like all other investment companies, will fluctuate over time; thus, performance
figures should not be considered to represent what an investment may earn in the
future or what a class' performance may be in any future period.
GENERAL INFORMATION
REPORTS TO SHAREHOLDERS
The Fund's fiscal year ends May 31. Annual Reports containing audited financial
statements of the Trust, including the auditors' report, and Semi-Annual Reports
containing unaudited financial statements are automatically sent to
shareholders. To reduce the volume of mail sent to each household, as well as to
reduce Fund expenses, Investor Services will attempt to identify related
shareholders within a household and send only one copy of the report. Additional
copies may be obtained, without charge, upon request to the Trust at the
telephone number or address set forth on the cover page of this prospectus.
Additional information on Fund performance is included in the Trust's Annual
Report to Shareholders and under "General Information" in the SAI.
ORGANIZATION AND VOTING RIGHTS
The Agreement and Declaration of Trust permits the trustees to issue an
unlimited number of full and fractional shares of beneficial interest of $.01
par value, which may be issued in any number of series and classes. Shares
issued will be fully paid and non-assessable and will have no preemptive,
conversion, or sinking rights. Shares of each series have equal and exclusive
rights as to dividends and distributions as declared by such series and the net
assets of such series upon liquidation or dissolution. Shares of each class of a
series have the same voting and other rights and preferences as the other
classes and series of the Trust for matters that affect the Trust as a whole.
Additional series or classes may be added in the future by the Board.
Shares of each class represent proportionate interests in the assets of the Fund
and have the same voting and other rights and preferences as the other class of
the Fund for matters that affect the Fund as a whole. For matters that only
affect a certain class of the Fund's shares, however, only shareholders of that
class will be entitled to vote. Therefore each class of shares will vote
separately on matters (1) affecting only that class, (2) expressly required to
be voted on separately by class by state business trust law, or (3) required to
be voted on separately by class by the 1940 Act, or the rules adopted
thereunder. For instance, if a change to the Rule 12b-1 plan relating to Class I
shares requires shareholder approval, only shareholders of Class I may vote on
the change to the Rule 12b-1 plan affecting that class. Similarly, if a change
to the Rule 12b-1 plan relating to Class II shares requires approval, only
shareholders of Class II may vote on changes to such plan. On the other hand, if
there is a proposed change to the investment objectives of the Fund, the
proposal would affect all shareholders, regardless of which class of shares they
hold and, therefore, each share has the same voting rights.
Voting rights are noncumulative, so that in any election of trustees, the
holders of more than 50% of the shares voting can elect all of the trustees, if
they choose to do so, and in such event the holders of the remaining shares
voting will not be able to elect any person or persons to the Board.
The Trust does not intend to hold annual shareholder meetings. The Trust may,
however, hold a special shareholders' meeting of a series for such purposes as
changing fundamental investment restrictions, approving a new management
agreement or any other matters which are required to be acted on by shareholders
under the 1940 Act. A meeting may also be called by the trustees in their
discretion or by shareholders holding at least ten percent of the outstanding
shares of the Trust. Shareholders will receive assistance in communicating with
other shareholders in connection with the election or removal of trustees such
as that provided in Section 16(c) of the 1940 Act.
REDEMPTIONS BY THE FUND
The Fund reserves the right to redeem your shares, at net asset value, if your
account has a value of less than $50 but only where the value of your account
has been reduced by the prior voluntary redemption of shares and has been
inactive (except for the reinvestment of distributions) for a period of at least
six months, provided you are given advance notice. For more information, see
"How Do I Buy and Sell Shares?" in the SAI.
REGISTERING YOUR ACCOUNT
An account registration should reflect your intentions as to ownership. Where
there are two co-owners on the account, the account will be registered as "Owner
1" and "Owner 2"; the "or" designation is not used except for money market fund
accounts. If co-owners wish to have the ability to redeem or convert on the
signature of only one owner, a limited power of attorney may be used.
Accounts should not be registered in the name of a minor, either as sole or
co-owner of the account. Transfer or redemption for such an account may require
court action to obtain release of the funds until the minor reaches the legal
age of majority. The account should be registered in the name of one "Adult" as
custodian for the benefit of the "Minor" under the Uniform Transfer or Gifts to
Minors Act.
A trust designation such as "trustee" or "in trust for" should only be used if
the account is being established pursuant to a legal, valid trust document. Use
of such a designation in the absence of a legal trust document may cause
difficulties and require court action for transfer or redemption of the funds.
Shares, whether in certificate form or not, registered as joint tenants or "Jt
Ten" shall mean "as joint tenants with rights of survivorship" and not "as
tenants in common."
Except as indicated, you may transfer an account in the Fund carried in "street"
or "nominee" name by your securities dealer to a comparably registered Fund
account maintained by another securities dealer. Both the delivering and
receiving securities dealers must have executed dealer agreements on file with
Distributors. Unless a dealer agreement has been executed and is on file with
Distributors, the Fund will not process the transfer and will so inform your
delivering securities dealer. To effect the transfer, you should instruct the
securities dealer to transfer the account to a receiving securities dealer and
sign any documents required by the securities dealers to evidence consent to the
transfer. Under current procedures, the account transfer may be processed by the
delivering securities dealer and the Fund after the Fund receives authorization
in proper form from your delivering securities dealer. Account transfers may be
effected electronically through the services of the NSCC.
The Fund may conclusively accept instructions from you or your nominee listed in
publicly available nominee lists, regardless of whether the account was
initially registered in the name of or by you, your nominee, or both. If a
securities dealer or other representative is of record on your account, you will
be deemed to have authorized the use of electronic instructions on the account,
including, without limitation, those initiated through the services of the NSCC,
to have adopted as instruction and signature any such electronic instructions
received by the Fund and Investor Services, and to have authorized them to
execute the instructions without further inquiry. At the present time, such
services which are available include the NSCC's "Networking," "Fund/SERV," and
"ACATS" systems.
Any questions regarding an intended registration should be answered by the
securities dealer handling the investment or by calling Franklin's Fund
Information Department.
IMPORTANT NOTICE REGARDING
TAXPAYER IRS CERTIFICATIONS
Pursuant to the Code and U.S. Treasury regulations, the Fund may be required to
report to the IRS any taxable dividend, capital gain distribution, or other
reportable payment (including share redemption proceeds) and withhold 31% of any
such payments made to individuals and other non-exempt shareholders who have not
provided a correct taxpayer identification number ("TIN") and made certain
required certifications that appear in the Shareholder Application. You may also
be subject to backup withholding if the IRS or a securities dealer notifies the
Fund that the number furnished by you is incorrect or that you are subject to
backup withholding for previous under-reporting of interest or dividend income.
The Fund reserves the right to (1) refuse to open an account for any person
failing to provide a TIN along with the required certifications and (2) close an
account by redeeming its shares in full at the then-current net asset value upon
receipt of notice from the IRS that the TIN certified as correct by you is in
fact incorrect or upon the failure of a shareholder who has completed an
"awaiting TIN" certification to provide the Fund with a certified TIN within 60
days after opening the account.
USEFUL TERMS AND DEFINITIONS
1940 Act - Investment Company Act of 1940, as amended.
Advisers - Franklin Advisers, Inc., the Fund's investment manager.
Board - The Board of Trustees of the Trust.
Code - Internal Revenue Code of 1986, as amended.
Distributors - Franklin/Templeton Distributors, Inc., the Fund's principal
underwriter.
Exchange - New York Stock Exchange.
Franklin Funds - the mutual funds in the Franklin Group of Funds(R) except
Franklin Valuemark Funds and the Franklin Government Securities Trust.
Franklin Templeton Funds - the Franklin Funds and the Templeton Funds.
Franklin Templeton Group - Franklin Resources, Inc., a publicly owned holding
company, and its various subsidiaries.
Investor Services - Franklin/Templeton Investor Services, Inc.
Letter - Letter of Intent.
Manager - Franklin Advisers, Inc., the Fund's investment manager.
Market Timers - Market Timers generally include market timing or allocation
services, accounts administered so as to buy, sell or exchange shares based on
predetermined market indicators, or any person or group whose transactions seem
to follow a timing pattern.
Net asset value (NAV) - the value of a mutual fund is determined by deducting
the fund's liabilities from the total assets of the portfolio. The net asset
value per share is determined by dividing the net asset value of the fund by the
number of shares outstanding. When you buy, sell or exchange shares, we will use
the NAV per share for the applicable class next calculated after we receive your
request in proper form.
Offering price - The public offering price is equal to the net asset value per
share of the class plus the front-end sales charge. The front-end sales charge
is 4.25% for Class I shares and 1% for Class II shares.
Proper Form (Purchases) - generally, the Fund must receive a completed
Shareholder Application accompanied by a negotiable check.
Resources - Franklin Resources, Inc.
SAI - Statement of Additional Information.
SEC - Securities and Exchange Commission.
Securities Dealer - financial institutions which, either directly or through
affiliates, have an agreement with Distributors to handle customer orders and
accounts with the Fund. This reference is for convenience only and does not
indicate a legal conclusion of capacity.
TeleFACTS(R) - Franklin Templeton's automated customer servicing system.
Templeton Funds - the U.S. registered mutual funds in the Templeton Group of
Funds except Templeton Capital Accumulator Fund, Inc., Templeton Variable
Annuity Fund, and Templeton Variable Products Series Fund.
U.S. - United States.
APPENDIX
DESCRIPTION OF MUNICIPAL BOND RATINGS
MOODY'S
Aaa: Municipal bonds rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as
"gilt-edged." Interest payments are protected by a large or 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: Municipal bonds rated Aa are judged to be 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, fluctuation of protective elements may be of
greater amplitude, or there may be other elements present which make the
long-term risks appear somewhat larger.
A: Municipal bonds rated A possess many favorable investment attributes and are
considered upper medium-grade obligations. Factors giving security to principal
and interest are considered adequate, but elements may be present which suggest
a susceptibility to impairment sometime in the future.
Baa: Municipal bonds 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: Municipal bonds rated Ba are judged to have predominantly 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: Municipal bonds 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: Municipal bonds 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: Municipal bonds rated Ca represent obligations which are speculative to a
high degree. Such issues are often in default or have other marked shortcomings.
C: Municipal bonds rated C are the lowest-rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Con.(-): Municipal bonds for which the security depends upon the completion of
some act or the fulfillment of some condition are rated conditionally. These are
bonds secured by (a) earnings of projects under construction, (b) earnings of
projects unseasoned in operation experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon the
completion of construction or the elimination of the basis of the condition.
S&P
AAA: Municipal bonds rated AAA are the highest-grade obligations. They possess
the ultimate degree of protection as to principal and interest. In the market,
they move with interest rates and, hence, provide the maximum safety on all
counts.
AA: Municipal bonds rated AA also qualify as high-grade obligations, and in the
majority of instances differ from AAA issues only in a small degree. Here, too,
prices move with the long-term money market.
A: Municipal bonds rated A are regarded as upper medium-grade. They have
considerable investment strength but are not entirely free from adverse effects
of changes in economic and trade conditions. Interest and principal are regarded
as safe. They predominantly reflect money rates in their market behavior but
also, to some extent, economic conditions.
BBB: Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest for bonds in
this category than for bonds in the A category.
BB, B, CCC, CC: Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligations. BB
indicates the lowest degree of speculation and CC the highest degree of
speculation. While such bonds will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
C: This rating is reserved for income bonds on which no interest is being paid.
D: Debt rated "D" is in default and payment of interest and/or repayment of
principal is in arrears.
Note: The S&P ratings may be modified by the addition of a plus (+) or minus (-)
sign to show relative standing within the major rating categories.
FITCH
AAA: Municipal bonds rated AAA are considered to be of investment grade and of
the highest credit quality. The obligor has an exceptionally strong ability to
pay interest and repay principal which is unlikely to be affected by reasonably
foreseeable events.
AA: Municipal bonds rated AA are considered to be investment grade and of very
high credit quality. The obligor's ability to pay interest and repay principal
is very strong although not quite as strong as bonds rated AAA and not
significantly vulnerable to foreseeable future developments.
A: Municipal bonds rated A are considered to be investment grade and of high
credit quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
BBB: Municipal bonds rated BBB are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered to be adequate. Adverse changes in economic conditions
and circumstances, however, are more likely to have an adverse impact on these
bonds, and therefor impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
BB: Municipal bonds rated BB are considered speculative. The obligor's ability
to pay interest and repay principal may be affected over time by adverse
economic changes. However, business and financial alternatives can be identified
which could assist the obligor in satisfying its debt service requirements.
B: Municipal bonds rated B are considered highly speculative. While bonds in
this class are currently meeting debt service requirements, the probability of
continued timely payment of principal and interest reflects the obligor's
limited margin of safety and the need for reasonable business and economic
activity throughout the life of the issue.
CCC: Municipal bonds rated CCC have certain identifiable characteristics which,
if not remedied, may lead to default. The ability to meet obligations requires
an advantageous business and economic environment.
CC: Municipal bonds rated CC are minimally protected. Default in payment of
interest and/or principal seems probable over time.
C: Municipal bonds rated C are in imminent default in the payment of interest or
principal.
DDD, DD and D: Municipal bonds rated DDD, DD and D are in default on interest
and/or principal payments. Such bonds are extremely speculative and should be
valued on the basis of their ultimate recovery value in liquidation or
reorganization of the obligor. DDD represents the highest potential for recovery
while D represents the lowest potential for recovery.
Plus (+) or minus (-) signs are used with a rating symbol to indicate the
relative position of a credit within the rating category. Plus or minus are not
used for the AAA and the DDD, DD or D categories.
DESCRIPTION OF MUNICIPAL NOTE RATINGS
MOODY'S
Moody's ratings for state, municipal and other short-term obligations will be
designated Moody's Investment Grade ("MIG"). This distinction is in recognition
of the differences between short-term credit risk and long-term risk. Factors
affecting the liquidity of the borrower are uppermost in importance in
short-term borrowing; factors of the first importance in long-term borrowing
risk are of lesser importance in the short run. Symbols used will be as follows:
MIG 1: Notes are of the best quality enjoying strong protection from established
cash flows of funds for their servicing or from established and broad-based
access to the market for refinancing, or both.
MIG 2: Notes are of high quality, with margins of protection ample, although not
so large as in the preceding group.
MIG 3: Notes are of favorable quality, with all security elements accounted for,
but lacking the undeniable strength of the preceding grades. Market access for
refinancing, in particular, is likely to be less well established.
MIG 4: Notes are of adequate quality, carrying specific risk but having
protection and not distinctly or predominantly speculative.
S&P
Until June 29, 1984, S&P used the same rating symbols for notes and bonds. After
June 29, 1984, for new municipal note issues due in three years or less, the
ratings below will usually be assigned. Notes maturing beyond three years will
most likely receive a bond rating of the type recited above.
SP-1: Issues carrying this designation have a very strong or strong capacity to
pay principal and interest. Issues determined to possess overwhelming safety
characteristics will be given a "plus" (+) designation.
SP-2: Issues carrying this designation have a satisfactory capacity to pay
principal and interest.
DESCRIPTION OF COMMERCIAL PAPER RATINGS
MOODY'S
Moody's commercial paper ratings, which are also applicable to municipal paper
investments permitted to be made by the Fund, are opinions of the ability of
issuers to repay punctually their promissory obligations not having an original
maturity in excess of nine months. Moody's employs the following designations,
all judged to be investment grade, to indicate the relative repayment capacity
of rated issuers:
P-1 (Prime-1): Superior capacity for repayment.
P-2 (Prime-2): Strong capacity for repayment.
S&P
S&P's ratings are a current assessment of the likelihood of timely payment of
debt having an original maturity of no more than 365 days. Ratings are graded
into four categories, ranging from "A" for the highest quality obligations to
"D" for the lowest. Issues within the "A" category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety, as follows:
A-1: This designation indicates the degree of safety regarding timely payment is
very strong. A "plus" (+) designation indicates an even stronger likelihood of
timely payment.
A-2: Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as overwhelming as for issues
designated A-1.
A-3: Issues carrying this designation have a satisfactory capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
FITCH'S
Fitch's short-term ratings apply to debt obligations that are payable on demand
or have original maturities of generally up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes. The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
F-1+: Exceptionally strong credit quality. Regarded as having the strongest
degree of assurance for timely payment.
F-1: Very strong credit quality. Reflect on assurance of timely payment only
slightly less in degree than issues rated F-1+.
F-2: Good credit quality. A satisfactory degree of assurance for timely payment,
but the margin of safety is not as great as for issues assigned F-1+ and F-1
ratings.
F-3: Fair credit quality. Have characteristics suggesting that the degree of
assurance for timely payment is adequate; however, near-term adverse changes
could cause these securities to be rated below investment grade.
F-5: Weak credit quality. Have characteristics suggesting a minimal degree of
assurance for timely payment and are vulnerable to near-term adverse changes in
financial and economic conditions.
D: Default. Actual or imminent payment default.
LOC: The symbol LOC indicates that the rating is based on a letter of credit
issued by a commercial bank.
FRANKLIN
MUNICIPAL
SECURITIES TRUST
Franklin Arkansas Municipal Bond Fund
Franklin California High Yield Municipal Fund
Franklin Hawaii Municipal Bond Fund
Franklin Tennessee Municipal Bond Fund
Franklin Washington Municipal Bond Fund
STATEMENT OF
ADDITIONAL INFORMATION
OCTOBER 1, 1995,
AS AMENDED MAY 1, 1996
777 Mariners Island Blvd., P.O. Box 7777
San Mateo, CA 94403-7777 1-800/DIAL BEN
Contents Page
How Do the Funds Invest Their Assets?..................... 2
Investment Restrictions................................... 5
Officers and Trustees..................................... 6
Investment Advisory and Other Services.................... 9
How Do the Funds Purchase
Securities for Their Portfolios?......................... 11
How Do I Buy and Sell Shares?............................. 11
How Are Fund Shares Valued?............................... 13
Additional Information Regarding Taxation................. 14
The Fund's Underwriter.................................... 15
General Information....................................... 17
Financial Statements...................................... 22
Appendix A - Further Information
on Special Factors Affecting
Each State Fund.......................................... 22
Appendix B - Description of
Municipal Securities Ratings............................. 24
MUN SAI 05/96
Franklin Municipal Securities Trust (the "Trust") is an open-end management
investment company consisting of five separate, non-diversified series: Franklin
Arkansas Municipal Bond Fund (the "Arkansas Fund"), Franklin California High
Yield Municipal Fund (the "California Fund"), Franklin Hawaii Municipal Bond
Fund (the "Hawaii Fund"), Franklin Tennessee Municipal Bond Fund (the "Tennessee
Fund") and Franklin Washington Municipal Bond Fund (the "Washington Fund"), each
of which may be referred to collectively or separately as the "Funds" or "Fund."
Each Fund seeks to provide investors with as high a level of income exempt from
regular federal income taxes as is consistent with prudent investing, while
seeking preservation of shareholders' capital. The Arkansas, California, Hawaii
and Tennessee Funds also seek to provide a maximum level of income which is
exempt from state personal income taxes for resident shareholders of each such
state. The state of Washington currently imposes no state income tax. As a
secondary objective the California Fund will seek capital appreciation to the
extent this is possible and is consistent with its principal investment
objective.
Each Fund seeks to accomplish its objective by investing primarily in municipal
securities issued by its respective state and the state's political
subdivisions, agencies and instrumentalities which pay interest exempt from such
state's personal income taxes (if any) and regular federal income taxes.
Each Fund's (except the California Fund) investments in municipal securities
will be limited to investments rated in one of the four highest rating
categories by a nationally recognized statistical rating organization ("NRSRO")
or in securities that are not rated but deemed to be comparable in quality.
In addition, the California High Yield Fund may invest, without percentage
limitation, in lower rated securities or those that are unrated but deemed to be
comparable in quality.
The California Fund offers two classes of shares: Franklin California High Yield
Municipal Fund - Class I ("Class I") and Franklin California High Yield
Municipal Fund - Class II ("Class II"). This multiclass structure allows you to
consider, among other features, the impact of sales charges and distribution
fees ("Rule 12b-1 fees") on your investment in the Fund. The sales charges and
Rule 12b-1 fees for the other series of the Trust are similar to a Class I
structure and are treated herein as Class I.
A prospectus for the California Fund, dated October 1, 1995, as amended May 1,
1996, and a prospectus for Arkansas, Hawaii, Tennessee and Washington Funds,
dated October 1, 1995, each as may be further amended from time to time (the
"Prospectus[es]), provide the basic information you should know before investing
in a Fund and may be obtained without charge from the Trust or the Fund's
principal underwriter, Franklin/Templeton Distributors, Inc. ("Distributors"),
at the address or telephone number shown on the cover.
THIS STATEMENT OF ADDITIONAL INFORMATION ("SAI") IS NOT A PROSPECTUS. IT
CONTAINS INFORMATION IN ADDITION TO AND IN MORE DETAIL THAN SET FORTH IN THE
PROSPECTUSES. THIS SAI IS INTENDED TO PROVIDE YOU WITH ADDITIONAL INFORMATION
REGARDING THE ACTIVITIES AND OPERATIONS OF THE TRUST AND EACH FUND, AND SHOULD
BE READ IN CONJUNCTION WITH THE PROSPECTUSES.
How Do the Funds Invest Their Assets?
As noted in the Prospectuses, each Fund attempts to invest 100% and, as a matter
of fundamental policy, invests at least 80% of the value of its net assets in
municipal securities, the interest on which is exempt from regular federal
income taxes, but which may be deemed to be a preference item under the federal
alternative minimum tax. It is also the policy of each Fund to invest at least
65% of its total assets in municipal securities that pay interest exempt from
personal income tax in its respective state, where such state imposes an income
tax. Interest paid on certain types of municipal obligations, such as "private
activity bonds," and the dividends to be paid by each Fund therefrom, although
exempt from regular federal income tax, may be deemed to be a preference item
under the federal alternative minimum tax, and thus subject to the federal
alternative minimum tax.
It is possible, although not anticipated, that up to 20% of each Fund's net
assets could be in obligations subject to regular federal taxation and/or up to
35% of each Fund's total assets could be in municipal securities from other
states. In addition, it is possible that each Fund's investments could consist
entirely of bonds, the interest on which is subject to the federal alternative
minimum tax.
The Arkansas, Hawaii, Tennessee and Washington Funds may invest, without
percentage limitation, in securities having at the time of purchase one of the
four highest ratings by one or more of an NRSRO. These ratings are: Aaa, Aa, A
and Baa by Moody's Investors Service ("Moody's"); AAA, AA, A and BBB by Standard
& Poor's Corporation ("S&P"); or AAA, AA, A and BBB by Fitch Investors Service,
Inc. ("Fitch"). The Funds may also invest in securities which are not rated,
provided that, in the opinion of the Fund's investment manager, Franklin
Advisers, Inc. ("Advisers" or "Manager"), such securities are comparable in
quality to those within the four highest ratings. These are considered to be
"investment grade" securities, although bonds rated in the fourth highest rating
category by the NRSROs are regarded as having an adequate capacity to pay
principal and interest but with greater vulnerability to adverse economic
conditions, and to have some speculative characteristics. In addition, the
California High Yield Fund may invest, without percentage limitation, in lower
rated securities and may invest up to 5% of its assets (at the time of purchase)
in defaulted securities. Risk considerations of investments in lower rated bonds
are described in the Prospectus for the California Fund. Please see "Appendix B"
for a description of the ratings.
Although each Fund seeks to invest all of its assets in a manner designed to
accomplish its objectives, there may be times where market conditions limit the
availability of appropriate municipal securities or, in the Manager's opinion,
there exist uncertain economic, market, political, or legal conditions which may
jeopardize the value of municipal securities. Accordingly, for temporary
defensive purposes, each Fund may invest more than 20% and up to 100% of its
total assets in taxable, fixed-income obligations, and each Fund may invest more
than 35% and up to 100% of the value of its total assets in instruments, the
interest on which is exempt from regular federal income taxes, but not the
respective state's personal income tax, where such state imposes an income tax.
It is the policy of each Fund that illiquid securities (securities that cannot
be disposed of within seven days in the normal course of business at
approximately the amount at which the Fund has valued the securities) may not
constitute, at the time of purchase, more than 10% of the value of the net
assets of the Fund.
Description of Municipal Securities
Each Prospectusdescribes the general categories and nature of municipal
securities. Discussed below are the major attributes of the various municipal
and other securities in which each Fund may invest.
Tax Anticipation Notes. These are used to finance working capital needs of
municipalities and are issued in anticipation of various seasonal tax revenues
to be payable from these specific future taxes. They are usually general
obligations of the issuer, secured by the taxing power for the payment of
principal and interest.
Revenue Anticipation Notes. These are issued in expectation of receipt of other
kinds of revenue, such as federal revenues available under the Federal Revenue
Sharing Program. They are usually general obligations of the issuer.
Bond Anticipation Notes. These are normallyissued to provide interim financing
until long-term financing can be arranged. The long-term bonds then provide the
money for the repayment of the notes.
Construction Loan Notes. These are sold to provide construction financing for
specific projects. After successful completion and acceptance, many projects
receive permanent financing through the Federal Housing Administration under the
Federal National Mortgage Association or the Government National Mortgage
Association.
Municipal Bonds. Municipal Bonds which meet longer-term capital needs and
generally have maturities of more than one year when issued, have two principal
classifications: general obligation bonds and revenue bonds.
1. General Obligation Bonds. Issuers of general obligation bonds include states,
counties, cities, towns and regional districts. The proceeds of these
obligations are used to fund a wide range of public projects, including
construction or improvement of schools, highways and roads, and water and sewer
systems. The basic security behind general obligation bonds is the issuer's
pledge of its full faith, credit and taxing power for the payment of principal
and interest. The taxes that can be levied for the payment of debt service may
be limited or unlimited as to the rate or amount of special assessments.
2. Revenue Bonds. A revenue bond is not secured by the full faith, credit and
taxing power of an issuer. Rather, the principal security for a revenue bond is
generally the net revenue derived from a particular facility, group of
facilities or, in some cases, the proceeds of a special excise tax or other
specific revenue source. Revenue bonds are issued to finance a wide variety of
capital projects including: electric, gas, water, and sewer systems; highways,
bridges, and tunnels; port and airport facilities; colleges and universities;
and hospitals. Although the principal security behind these bonds may vary, many
provide additional security in the form of a debt service reserve fund, from
which money may be used to make principal and interest payments on the issuer's
obligations. Housing finance authorities have a wide range of security,
including partially or fully insured mortgages, rent subsidized and/or
collateralized mortgages, and/or the net revenues from housing or other public
projects. Some authorities are provided with further security in the form of
state assurance (although without obligation) to make up deficiencies in the
debt service reserve fund.
Tax-Exempt Industrial Development Bonds. These are, in most cases, revenue bonds
and are issued by or on behalf of public authorities to raise money for the
financing of various privately-operated facilities for business manufacturing,
housing, sports, and pollution control. These bonds are also used to finance
public facilities such as airports, mass transit systems, ports, and parking.
The payment of the principal and interest on such bonds is solely dependent on
the ability of the facilities user to meet its financial obligations and the
pledge, if any, of the real and personal property so financed as security for
such payment.
Variable or Floating Rate Demand Notes ("VRDNs"). These are tax-exempt
obligations which contain a floating or variable interest rate and a right of
demand, which may be unconditional, to receive payment of the unpaid principal
balance plus accrued interest upon a short notice period (generally up to 30
days) prior to specified dates, either from the issuer or by drawing on a bank
letter of credit, a guarantee or insurance issued with respect to such
instrument. The interest rates are adjustable at intervals ranging from daily up
to monthly, and are calculated to maintain the market value of the VRDN at
approximately its par value upon the adjustment date.
Zero-Coupon Securities. A Fund's investment in zero coupon and delayed interest
bonds may cause a Fund to recognize income and make distributions to
shareholders prior to the receipt of cash payments. Zero-coupon securities make
no periodic interest payments but instead are sold at a deep discount from their
face value. The buyer receives a rate of return determined by the gradual
appreciation of the security, which is redeemed at face value on a specific
maturity date.
Because zero-coupon securities bear no interest and compound semi-annually at
the rate fixed at the time of issuance, the value of such securities is
generally more volatile than other fixed-income securities. Since zero-coupon
bondholders do not receive interest payments, zeros fall more dramatically than
bonds paying interest on a current basis when interest rates rise. When interest
rates fall, zero-coupon securities rise more rapidly in value, because the bonds
reflect a fixed rate of return. In order to generate cash to satisfy
distribution requirements, a Fund may be required to dispose of portfolio
securities that it otherwise would have continued to hold or to use cash flows
from other sources such as the sale of Fund shares.
When-Issued Purchases. New issues of municipal securities are offered on a
when-issued basis; that is, payment for and delivery of the securities (the
"settlement date") normally takes place after the date that the offer is
accepted. The purchase price and the yield that will be received on the
securities are each fixed at the time the buyer enters into the commitment.
While each Fund will always make commitments to buy such securities with the
intention of actually acquiring the securities, it may nevertheless sell these
securities before the settlement date if it is deemed advisable as a matter of
investment strategy. To the extent that assets of a Fund are held in cash
pending the settlement of a purchase of securities, the Fund would earn no
income; however, it is each Fund's intention to be fully invested to the extent
practicable and subject to the policies stated in the Prospectus. At the time a
Fund makes the commitment to buy a municipal bond on a when-issued basis, it
will record the transaction and reflect the value of the security in determining
each Fund's net asset value. The Funds do not believe that each Fund's net asset
value or income will be adversely affected by the purchase of municipal bonds on
a when-issued basis. Each Fund will establish a segregated account, in which it
will maintain cash and marketable securities equal in value to commitments for
when-issued securities. Escrow Secured Bonds. Escrow secured bonds or defeased
bonds are created when an issuer refunds in advance of maturity (or pre-refunds)
an outstanding bond issue which is not immediately callable, and it becomes
necessary or desirable to set aside funds for redemption of the bonds at a
future date. In an advance refunding, the issuer will use the proceeds of a new
bond issue to buy high grade interest-bearing debt securities which are then
deposited in an irrevocable escrow account held by a trustee bank to secure all
future payments of principal and interest of the advance refunded bond. Escrow
secured bonds will often receive a AAA rating from S&P and Moody's.
Commercial Paper. Commercial Paper refers to promissory notes issued by
corporations in order to finance their short-term credit needs.
Other. There may, of course, be other types of municipal securities that become
available which are similar to the foregoing described municipal securities and
in which each Fund may invest so long as they are consistent with the Fund's
investment objective and policies.
Other Types of Investments
The Funds may invest in all types of United States ("U.S.") government
securities including: (1) U.S. Treasury obligations with varying interest rates,
maturities and dates of issuance, such as U.S. Treasury bills (maturities of one
year or less), U.S. Treasury notes (original maturities of one to ten years) and
U.S. Treasury bonds (generally original maturities of greater than ten years);
and (2) obligations issued or guaranteed by U.S. government agencies and
instrumentalities, such as GNMA, the Export-Import Bank and the Farmers Home
Administration. Some of the Fund's investments will include obligations which
are supported by the full faith and credit pledge of the U.S. government. In the
case of U.S. government obligations which are not backed by the full faith and
credit pledge of the U.S. government (e.g., obligations of FNMA and a Federal
Home Loan Bank), a Fund must look principally to the agency issuing or
guaranteeing the obligation for ultimate repayment and may not be able to assert
a claim against the U.S. itself in the event the agency or instrumentality does
not meet its commitments.
Other Policies
Loans of Portfolio Securities. Consistent with procedures approved by the Board
of Trustees (the "Board") and subject to the following conditions, each Fund may
lend its portfolio securities to qualified securities dealers or other
institutional investors, provided that such loans do not exceed 10% of the value
of the Fund's total assets at the time of the most recent loan. The borrower
must deposit with the Fund's custodian bank collateral with an initial market
value of at least 102% of the initial market value of the securities loaned,
including any accrued interest, with the value of the collateral and loaned
securities marked-to-market daily to maintain collateral coverage of at least
102%. This collateral shall consist of cash. The lending of securities is a
common practice in the securities industry. Each Fund may engage in security
loan arrangements with the primary objective of increasing the Fund's income
either through investing the cash collateral in short-term interest bearing
obligations or by receiving a loan premium from the borrower. Under the
securities loan agreement, the Fund continues to be entitled to all dividends or
interest on any loaned securities. As with any extension of credit, there are
risks of delay in recovery and loss of rights in the collateral should the
borrower of the security fail financially.
Investment Restrictions
Each Fund has adopted the following restrictions as fundamental policies, which
means that they may not be changed without the approval of a majority of the
outstanding voting securities of the Fund. Under the Investment Company Act of
1940, as amended (the "1940 Act"), a "vote of a majority of the outstanding
voting securities" of the Fund means the affirmative vote of the lesser of (i)
more than 50% of the outstanding shares of the Fund or (ii) 67% or more of the
shares of the Fund present at a shareholder meeting if more than 50% of the
outstanding shares of the Fund are represented at the meeting in person or by
proxy. A Fund may not:
1. Borrow money or mortgage or pledge any of its assets, except that borrowing
(and a pledge of assets therefore) for temporary or emergency purposes may be
made from banks in any amount up to 5% of the total asset value.
2. Buy any securities on "margin" or sell any securities "short," except that
it may use such short-term credits as are necessary for the clearance of
transactions.
3. Make loans, except by engaging in repurchase transactions and except through
the purchase of readily marketable debt securities which are either publicly
distributed or customarily purchased by institutional investors. Although such
loans are not presently intended, this prohibition will not preclude a Fund from
loaning portfolio securities to broker-dealers or other institutional investors
if at least 102% cash collateral is pledged and maintained by the borrower,
provided such portfolio security loans may not be made if, as a result, the
aggregate of such loans exceeds 10% of the value of the Fund's total assets at
the time of the most recent loan.
4. Act as underwriter of securities issued by other persons, except insofar as
the Fund may be technically deemed an underwriter under the federal securities
laws in connection with the disposition of portfolio securities, except that, in
the case of the Arkansas and Tennessee Funds, all or substantially all of the
assets of either Fund may be invested in another registered investment company
having the same investment objective and policies as the Fund.
5. Purchase securities from or sell to the Trust's officers and trustees, or
any firm of which any officer or trustee is a member, as principal, or retain
securities of any issuer if, to the knowledge of the Trust, one or more of the
Trust's officers, trustees, or investment adviser own beneficially more than 1/2
of 1% of the securities of such issuer and all such officers and trustees
together own beneficially more than 5% of such securities, except that, in the
case of the Arkansas and Tennessee Funds, to the extent this restriction is
applicable, all or substantially all of the assets of the Fund may be invested
in another registered investment company having the same investment objective
and policies as the Fund, or except as permitted under investment restriction
Number 9 regarding the purchase of shares of money market funds managed by
Advisers or its affiliates.
6. Acquire, lease or hold real estate, except such as may be necessary or
advisable for the maintenance of its offices and provided that this limitation
shall not prohibit the purchase of municipal and other debt securities secured
by real estate or interests therein.
7. Invest in commodities and commodity contracts, puts, calls, straddles,
spreads, or any combination thereof, or interests in oil, gas, or other mineral
exploration or development programs, except that it may purchase, hold, and
dispose of obligations with puts attached in accordance with its investment
policies.
8. Invest in companies for the purpose of exercising control or management,
except that, in the case of the Arkansas and Tennessee Funds, to the extent this
restriction is applicable, all or substantially all of the assets of either Fund
may be invested in another registered investment company having the same
investment objective and policies as the Fund.
9. Purchase securities of other investment companies, except in connection with
a merger, consolidation, acquisition, or reorganization, provided that, in the
case of the Arkansas and Tennessee Funds, all or substantially all of the assets
of either Fund may be invested in another registered investment company having
the same investment objective and policies as the Fund. To the extent permitted
by exemptions which may be granted under the 1940 Act, each Fund may invest in
shares of one or more money market funds managed by Advisers or its affiliates.
10. Invest more than 25% of its assets in securities of any industry, except
that, in the case of the Arkansas and Tennessee Funds, to the extent this
restriction is applicable, all or substantially all of the assets of either Fund
may be invested in another registered investment company having the same
investment objective and policies as the Fund. For purposes of this limitation,
municipal securities and U.S. government obligations are not considered to be
part of any industry.
If a percentage restriction contained herein is adhered to at the time of
investment, a later increase or decrease in the percentage resulting from a
change in value of portfolio securities or the amount of net assets will not be
considered a violation of any of the foregoing restrictions.
Municipal securities issued to finance non-governmental business activities are
generally not deemed to be exempt from taxation under federal law. As such,
these securities, if purchased by a Fund, will be subject to the prohibition in
investment restriction number 10 against concentrating in an industry. In
addition, the Funds may not invest in real estate limited partnerships or in
interests in oil, gas or other mineral leases.
Officers and Trustees
The Board has the responsibility for the overall management of the Trust and
each Fund, including general supervision and review of each Fund's investment
activities. The trustees, in turn, elect the officers of the Trust who are
responsible for administering day-to-day operations of the Trust and each Fund.
The affiliations of the officers and trustees and their principal occupations
for the past five years are listed below. Trustees who are deemed to be
"interested persons" of the Trust, as defined in the 1940 Act, are indicated by
an asterisk (*).
Positions and Offices Principal Occupation
Name, Age and Address with the Trust During Past Five Years
- -------------------------------------------------------------------------------
Frank H. Abbott, III (75) Trustee
1045 Sansome St.
San Francisco, CA 94111
President and Director, Abbott Corporation (an investment company); and
director, trustee or managing general partner, as the case may be, of 31 of the
investment companies in the Franklin Group of Funds.
- -------------------------------------------------------------------------------
Harris J. Ashton (63) Trustee
General Host Corporation
Metro Center, 1 Station Place
Stamford, CT 06904-2045
President, Chief Executive Officer and Chairman of the Board, General Host
Corporation (nursery and craft centers); Director, RBC Holdings, Inc. (a bank
holding company) and Bar-S Foods; and director, trustee or managing general
partner, as the case may be, of 56 of the investment companies in the Franklin
Templeton Group of Funds.
- -------------------------------------------------------------------------------
*Harmon E. Burns (51) Vice President
777 Mariners Island Blvd. and Trustee
San Mateo, CA 94404
Executive Vice President, Secretary and Director, Franklin Resources, Inc.;
Executive Vice President and Director, Franklin Templeton Distributors, Inc.;
Executive Vice President, Franklin Advisers, Inc.; Director, Franklin/Templeton
Investor Services, Inc.; officer and/or director, as the case may be, of other
subsidiaries of Franklin Resources, Inc.; and officer and/or director or trustee
of 61 of the investment companies in the Franklin Templeton Group of Funds.
- -------------------------------------------------------------------------------
S. Joseph Fortunato (63) Trustee
Park Avenue at Morris County
P. O. Box 1945
Morristown, NJ 07962-1945
Member of the law firm of Pitney, Hardin, Kipp & Szuch; Director of General Host
Corporation; director, trustee or managing general partner, as the case may be,
of 58 of the investment companies in the Franklin Templeton Group of Funds.
- -------------------------------------------------------------------------------
David W. Garbellano (81) Trustee
111 New Montgomery St., 402
San Francisco, CA 94105
Private Investor; Assistant Secretary/Treasurer and Director, Berkeley Science
Corporation (a venture capital company); and director, trustee or managing
general partner, as the case may be, of 30 of the investment companies in the
Franklin Group of Funds.
- -------------------------------------------------------------------------------
* Charles B. Johnson (63) Chairman
777 Mariners Island Blvd. of the Board
San Mateo, CA 94404 and Trustee
President and Director, Franklin Resources, Inc.; Chairman of the Board and
Director, Franklin Advisers, Inc. and Franklin Templeton Distributors, Inc.;
Director, Franklin/Templeton Investor Services, Inc. and General Host
Corporation; and officer and/or director, trustee or managing general partner,
as the case may be, of most other subsidiaries of Franklin Resources, Inc. and
of 57 of the investment companies in the Franklin Templeton Group of Funds.
- -------------------------------------------------------------------------------
* Rupert H. Johnson, Jr. (55) President
777 Mariners Island Blvd. and Trustee
San Mateo, CA 94404
Executive Vice President and Director, Franklin Resources, Inc. and Franklin
Templeton Distributors, Inc.; President and Director, Franklin Advisers, Inc.;
Director, Franklin/Templeton Investor Services, Inc.; and officer and/or
director, trustee or managing general partner, as the case may be, of most other
subsidiaries of Franklin Resources, Inc. and of 61 of the investment companies
in the Franklin Templeton Group of Funds.
- -------------------------------------------------------------------------------
Frank W. T. LaHaye (67) Trustee
20833 Stevens Creek Blvd.
Suite 102
Cupertino, CA 95014
General Partner, Peregrine Associates and Miller & LaHaye, which are General
Partners of Peregrine Ventures and Peregrine Ventures II (venture capital
firms); Chairman of the Board and Director, Quarterdeck Office Systems, Inc.;
Director, FischerImaging Corporation; and director or trustee or managing
general partner, as the case may be, of 26 of the investment companies in the
Franklin Group of Funds.
- -------------------------------------------------------------------------------
Gordon S. Macklin (67) Trustee
8212 Burning Tree Road
Bethesda, MD 20817
Chairman, White River Corporation (information services); Director, Fund
American Enterprises Holdings, Inc., Lockheed Martin Corporation, MCI
Communications Corporation, MedImmune, Inc. (biotechnology), InfoVest
Corporation (information services), and Fusion Systems Corporation (industrial
technology); and director, trustee or managing general partner, as the case may
be, of 53 of the investment companies in the Franklin Templeton Group of Funds;
and formerly held the following positions: Chairman, Hambrecht and Quist Group;
Director, H & Q Healthcare Investors; and President, National Association of
Securities Dealers, Inc.
- -------------------------------------------------------------------------------
Hayato Tanaka (78) Trustee
277 Haihai Street
Hilo, HI 96720
Retired, former owner of The Jewel Box Orchids; and director or trustee, as the
case may be, of two of the Franklin Group of Funds.
- -------------------------------------------------------------------------------
Kenneth V. Domingues (63) Vice President -
777 Mariners Island Blvd. Financial Reporting
San Mateo, CA 94404 and Accounting Standards
Senior Vice President, Franklin Resources, Inc., Franklin Advisers, Inc., and
Franklin Templeton Distributors, Inc.; officer and/or director, as the case may
be, of other subsidiaries of Franklin Resources, Inc.; and officer and/or
managing general partner, as the case may be, of 37 of the investment companies
in the Franklin Group of Funds.
- -------------------------------------------------------------------------------
Martin L. Flanagan (35) Vice President
777 Mariners Island Blvd. and Chief
San Mateo, CA 94404 Financial Officer
Senior Vice President, Chief Financial Officer and Treasurer, Franklin
Resources, Inc.; Executive Vice President, Templeton Worldwide, Inc.; Senior
Vice President and Treasurer, Franklin Advisers, Inc. and Franklin Templeton
Distributors, Inc.; Senior Vice President, Franklin/Templeton Investor Services,
Inc.; officer of most other subsidiaries of Franklin Resources, Inc.; and
officer, director and/or trustee of 61 of the investment companies in the
Franklin Templeton Group of Funds.
- -------------------------------------------------------------------------------
Deborah R. Gatzek (47) Vice President
777 Mariners Island Blvd. and Secretary
San Mateo, CA 94404
Senior Vice President and General Counsel, Franklin Resources, Inc.; Senior Vice
President, Franklin Templeton Distributors, Inc.; Vice President, Franklin
Advisers, Inc. and officer of 61 of the investment companies in the Franklin
Templeton Group of Funds.
- -------------------------------------------------------------------------------
Charles E. Johnson (39) Vice President
500 East Broward Blvd.
Fort Lauderdale, FL 33394-3091
Senior Vice President and Director, Franklin Resources, Inc.; Senior Vice
President, Franklin Templeton Distributors, Inc.; President and Director,
Templeton Worldwide, Inc. and Franklin Institutional Services Corporation;
officer and/or director, as the case may be, of some of the subsidiaries of
Franklin Resources, Inc. and officer and/or director or trustee, as the case may
be, of 40 of the investment companies in the Franklin Templeton Group of Funds.
- -------------------------------------------------------------------------------
Thomas J. Kenny (33) Vice President
777 Mariners Island Blvd.
San Mateo, CA 94404
Senior Vice President, Franklin Advisers, Inc. and officer of eight of the
investment companies in the Franklin Group of Funds.
- -------------------------------------------------------------------------------
Diomedes Loo-Tam (57) Treasurer
777 Mariners Island Blvd. and Principal
San Mateo, CA 94404 Accounting Officer
Employee of Franklin Advisers, Inc.; and officer of 37 of the investment
companies in the Franklin Group of Funds.
- -------------------------------------------------------------------------------
Edward V. McVey (58) Vice President
777 Mariners Island Blvd.
San Mateo, CA 94404
Senior Vice President/National Sales Manager, Franklin Templeton Distributors,
Inc.; and officer of 32 of the investment companies in the Franklin Group of
Funds.
- -------------------------------------------------------------------------------
The preceding table indicates those officers and trustees who are also
affiliated persons of Distributors and the Manager. Trustees not affiliated with
the investment manager ("nonaffiliated trustees") may in the future, but are not
currently, be paid fees. As indicated above, certain of the Trust's
nonaffiliated trustees also serve as directors, trustees or managing general
partners of other investment companies in the Franklin Group of Funds and the
Templeton Group of Funds (the "Franklin Templeton Group of Funds") from which
they may receive fees for their services. The following table indicates the
total fees paid to nonaffiliated trustees by other funds in the Franklin
Templeton Group of Funds.
Number of Boards
Total Fees in the Franklin
Received from the Templeton Group of
Franklin Templeton Funds* on Which
Name Group of Funds* Each Serves**
- -------------------------------------------------------------------------------
Frank H. Abbott, III.......... $162,420 31
Harris J. Ashton.............. 327,925 56
S. Joseph Fortunato........... 344,745 58
David Garbellano.............. 146,100 30
Frank W.T. LaHaye............. 143,200 26
Gordon S. Macklin............. 321,525 53
Hayato Tanaka................. 500 2
*For the calendar year ended December 31, 1995.
**The number of boards is based on the number of registered investment companies
in the Franklin Templeton Group of Funds and does not include the total number
of series or funds within each investment company for which the trustees are
responsible. The Franklin Templeton Group of Funds currently includes 61
registered investment companies, consisting of approximately 162 U.S. based
funds or series.
Nonaffiliated trustees are reimbursed for expenses incurred in connection with
attending board meetings, paid pro rata by each fund in the Franklin Templeton
Group of Funds for which they serve as director, trustee or managing general
partner. No officer or trustee received any other compensation directly from the
Trust. Certain officers or trustees who are shareholders of Franklin Resources,
Inc. ("Resources") may be deemed to receive indirect remuneration by virtue of
their participation, if any, in the fees paid to its subsidiaries. As of
February 14 1996, the officers and trustees, as a group, owned of record and
beneficially approximately 10,268 shares of the California Fund, or less than 1%
of the total outstanding shares, and owned no shares of the other Funds. Many of
the Trust's trustees also own shares in various of the other funds in the
Franklin Templeton Group of Funds. Charles B. Johnson and Rupert H. Johnson, Jr.
are brothers and the father and uncle, respectively, of Charles E. Johnson.
Investment Advisory and Other Services
- -------------------------------------------------------------------------------
The investment manager of each Fund is Advisers. Advisers is a wholly-owned
subsidiary of Resources, a publicly-owned holding company, whose shares are
listed on the New York Stock Exchange (the "Exchange"). Resources owns several
other subsidiaries that are involved in investment management and shareholder
services.
Pursuant to the management agreement, the Manager provides investment research
and portfolio management services, including the selection of securities for the
Fund to purchase, hold or sell and the selection of brokers through whom the
Fund's portfolio transactions are executed. The Manager's extensive research
activities include, as appropriate, traveling to meet with issuers and to review
project sites. The Manager's activities are subject to the review and
supervision of the Board to whom the Manager renders periodic reports of the
Fund's investment activities. Under the terms of the management agreement, the
Manager provides office space and office furnishings, facilities and equipment
required for managing the business affairs of the Fund; maintains all internal
bookkeeping, clerical, secretarial and administrative personnel and services;
and provides certain telephone and other mechanical services. The Manager is
covered by fidelity insurance on its officers, directors and employees for the
protection of the Fund. Please see the Statement of Operations in the financial
statements included in the Trust's Annual Report to Shareholders for the fiscal
year ended May 31, 1995.
The Manager also provides management services to numerous other investment
companies or funds pursuant to management agreements with each fund. The Manager
may give advice and take action with respect to any of the other funds it
manages, or for its own account, which may differ from action taken by the
Manager on behalf of the Fund. Similarly, with respect to the Fund, the Manager
is not obligated to recommend, purchase or sell, or to refrain from
recommending, purchasing or selling any security that the Manager and access
persons, as defined by the 1940 Act, may purchase or sell for its or their own
account or for the accounts of any other fund. Furthermore, the Manager is not
obligated to refrain from investing in securities held by the Fund or other
funds which it manages or administers. Of course, any transactions for the
accounts of the Manager and other access persons will be made in compliance with
the Fund's Code of Ethics. Pursuant to the management agreement, each Fund is
obligated to pay the Manager a fee equal to a monthly rate of 5/96 of 1%
(approximately 5/8 of 1% per year) for the first $100 million of net assets of
the Fund; 1/24 of 1% (approximately 1/2 of 1% per year) of net assets of the
Fund in excess of $100 million up to $250 million; and 9/240 of 1%
(approximately 45/100 of 1% per year) of net assets of the Fund in excess of
$250 million. The fee is computed and paid monthly based on the average daily
net assets of each Fund during the month. Each class of the California Fund will
pay its share of the management fee, as determined by the proportion of the Fund
that each class represents.
The management agreement specifies that the management fee will be reduced to
the extent necessary to comply with the most stringent limits on the expenses
which may be borne by the Funds as prescribed by any state in which the Funds'
shares are offered for sale. The most stringent current limit requires the
Manager to reduce or eliminate its fee to the extent that aggregate operating
expenses of each Fund (excluding interest, taxes, brokerage commissions and
extraordinary expenses such as litigation costs) would otherwise exceed in any
fiscal year 2.5% of the first $30 million of average net assets of the Fund,
2.0% of the next $70 million of average net assets of the Fund and 1.5% of
average net assets of the Fund in excess of $100 million. Expense reductions
have not been necessary based on state requirements.
The Manager has agreed in advance to waive all of its management fees and make
certain payments to reduce expenses. The table below sets forth on a per Fund
basis the management fees, before any advance waiver, and the management fees
paid for the fiscal years ended May 31, 1993, 1994, and 1995 and for the six
months ended November 30, 1995.
Fees Before Management
Advance Fees Paid
1995* Waiver By the Fund
- -------------------------------------------------------------------------------
Arkansas Fund..................... $ 15,828 $ 0
California Fund................... 181,128 43,361
Hawaii Fund....................... 117,033 24,789
Tennessee Fund.................... 23,617 0
Washington Fund................... 18,258 0
1995
Arkansas Fund..................... 18,634 0
California Fund................... 256,329 0
Hawaii Fund....................... 175,686 0
Tennessee Fund.................... 22,569 0
Washington Fund................... 29,848 0
Fees Before Management
Advance Fees Paid
1994 Waiver By the Fund
Arkansas Fund..................... $ 1,175 $ 0
California Fund................... 111,130 0
Hawaii Fund....................... 152,252 0
Tennessee Fund.................... 1,181 0
Washington Fund................... 22,669 0
1993
Arkansas Fund..................... n/a n/a
California Fund................... 1,175 0
Hawaii Fund....................... 61,202 0
Tennessee Fund.................... n/a n/a
Washington Fund................... 1,167 0
*For the six-month period ended November 30, 1995.
The management agreement is in effect until March 31, 1997. Thereafter, it may
continue in effect for successive annual periods providing such continuance is
specifically approved at least annually by a vote of the Board or by a vote of
the holders of a majority of the Fund's outstanding voting securities, and in
either event by a majority vote of the Fund's trustees who are not parties to
the management agreement or interested persons of any such party (other than as
trustees of the Trust), cast in person at a meeting called for that purpose. The
management agreement may be terminated without penalty at any time by the Board
or, as to each Fund, by a vote of the holders of a majority of the Fund's
outstanding voting securities, or by the Manager on 30 days' written notice and
will automatically terminate in the event of its assignment, as defined in the
1940 Act.
Franklin/Templeton Investor Services, Inc. ("Investor Services"), a wholly-owned
subsidiary of Resources, is the shareholder servicing agent for the Funds and
acts as the Funds' transfer agent and dividend-paying agent. Investor Services
is compensated on the basis of a fixed fee per account.
Bank of New York, Mutual Funds Division, 90 Washington Street, New York, New
York, 10286, acts as custodian of the securities and other assets of the Funds.
Bank of America NT & SA, 555 California Street, 4th Floor, San Francisco,
California 94104, acts as custodian for cash received in connection with the
purchase of Fund shares. Citibank Delaware, One Penn's Way, New Castle, Delaware
19720, acts as custodian in connection with transfer services through bank
automated clearing houses. The custodians do not participate in decisions
relating to the purchase and sale of portfolio securities.
Coopers & Lybrand L.L.P., 333 Market Street, San Francisco, California 94105,
are the Trust's independent auditors. During the fiscal year ended May 31, 1995,
their auditing services consisted of rendering an opinion on the financial
statements of the Trust included in the Trust's Annual Report to Shareholders
for the fiscal year ended May 31, 1995.
How Do the Funds Purchase
Securities For Their Portfolios?
- -------------------------------------------------------------------------------
Since most purchases by the Funds are principal transactions at net prices, the
Funds incur little or no brokerage costs. The Funds deal directly with the
selling or purchasing principal or market maker without incurring charges for
the services of a broker on their behalf, unless it is determined that a better
price or execution may be obtained by utilizing the services of a broker.
Purchases of portfolio securities from underwriters will include a commission or
concession paid by the issuer to the underwriter, and purchases from dealers
will include a spread between the bid and ask prices. As a general rule, the
Fund does not purchase bonds in underwritings where it is given no choice, or
only limited choice, in the designation of dealers to receive the commission.
The Fund seeks to obtain prompt execution of orders at the most favorable net
price. Transactions may be directed to dealers in return for research and
statistical information, as well as for special services rendered by such
dealers in the execution of orders.
It is not possible to place a dollar value on the special executions or on the
research services received by the Manager from dealers effecting transactions in
portfolio securities. The allocation of transactions in order to obtain
additional research services permits the Manager to supplement its own research
and analysis activities and to receive the views and information of individuals
and research staff of other securities firms. As long as it is lawful and
appropriate to do so, the Manager and its affiliates may use this research and
data in their investment advisory capacities with other clients. Provided that
the Trust's officers are satisfied that the best execution is obtained, the sale
of Fund shares may also be considered as a factor in the selection of
broker-dealers to execute the Funds' portfolio transactions.
If purchases or sales of securities of a Fund and one or more other investment
companies or clients supervised by the Manager are considered at or about the
same time, transactions in such securities will be allocated among the several
investment companies and clients in a manner deemed equitable to all by the
Manager, taking into account the respective sizes of the funds and the amount of
securities to be purchased or sold. It is recognized that in some cases this
procedure could possibly have a detrimental effect on the price or volume of the
security so far as the Funds are concerned. In other cases it is possible that
the ability to participate in volume transactions and to negotiate lower
brokerage commissions will be beneficial to the Funds.
During the past three fiscal years ended May 31, 1995, and the six months ended
November 30, 1995 the Funds paid no brokerage commissions. As of May 31 1995,
the Funds did not own securities of their regular broker-dealers.
How Do I Buy and Sell Shares?
- -------------------------------------------------------------------------------
All checks, drafts, wires and other payment mediums used for purchasing or
redeeming shares of the Funds must be denominated in U.S. dollars. Each Fund
reserves the right, in its sole discretion, to either (a) reject any order for
the purchase or sale of shares denominated in any other currency or (b) honor
the transaction or make adjustments to your account for the transaction as of a
date and with a foreign currency exchange factor determined by the drawee bank.
In connection with exchanges, it should be noted that since the proceeds from
the sale of shares of an investment company are generally not available until
the fifth business day following the redemption, the funds into which you are
seeking to exchange reserve the right to delay issuing shares pursuant to an
exchange until said fifth business day. The redemption of shares of a Fund to
complete an exchange will be effected at the close of business on the day the
request for exchange is received in proper form at the net asset value then
effective. Please see "What If My Investment Outlook Changes? - Exchange
Privilege" in the Prospectuses.
If, in connection with the purchase of Fund shares, you submit a check or a
draft that is returned unpaid to a Fund, the Fund may impose a $10 charge
against your account for each returned item.
Dividend checks returned to a Fund marked "unable to forward" by the postal
service will be deemed to be a request to change your dividend option to
reinvest all distributions and the proceeds will be reinvested in additional
shares at net asset value until new instructions are received.
The Funds may deduct from your account the costs of its efforts to locate you if
mail is returned as undeliverable or the Funds are otherwise unable to locate
you or verify your current mailing address. These costs may include a percentage
of the account when a search company charges a percentage fee in exchange for
its location services.
Under agreements with certain banks in Taiwan, Republic of China, the Funds'
shares are available to such banks' discretionary trust funds at net asset
value. The banks may charge service fees to their customers who participate in
the discretionary trusts. Pursuant to agreements, a portion of such service fees
may be paid to Distributors or one of its affiliates to help defray expenses of
maintaining a service office in Taiwan, including expenses related to local
literature fulfillment and communication facilities.
Class I shares of the Funds may be offered to investors in Taiwan through
securities firms known locally as Securities Investment Consulting Enterprises.
In conformity with local business practices in Taiwan, Class I shares may be
offered with the following schedule of sales charges:
Sales
Size of Purchase - U.S. dollars Charge
- -------------------------------------------------------------------------------
Under $30,000......................................... 3%
$30,000 but less than $100,000........................ 2%
$100,000 but less than $400,000....................... 1%
$400,000 or more...................................... 0%
Purchases and Redemptions
through Securities Dealers
Orders for the purchase of shares of a Fund received in proper form prior to the
scheduled close of the Exchange (generally 1:00 p.m. Pacific time) any business
day that the Exchange is open for trading and promptly transmitted to the Fund
will be based upon the public offering price determined that day. Purchase
orders received by securities dealers or other financial institutions after the
scheduled close of the Exchange will be effected at the Fund's public offering
price on the day it is next calculated. The use of the term "securities dealer"
herein shall include other financial institutions which, either directly or
through affiliates, have an agreement with Distributors to handle customer
orders and accounts with the Fund. Such reference, however, is for convenience
only and does not indicate a legal conclusion of capacity.
Orders for the redemption of shares are effected at net asset value subject to
the same conditions concerning time of receipt in proper form. It is the
securities dealer's responsibility to transmit the order in a timely fashion and
any loss to you resulting from the failure to do so must be settled between you
and the securities dealer.
Other Payments to Securities Dealers
As discussed in the Prospectuses under "How Do I Buy Shares? - General," either
Distributors or one of its affiliates may make payments, out of its own
resources, to securities dealers who initiate and are responsible for purchases
of Class I shares made at net asset value by certain trust companies and trust
departments of banks, as described below. Distributors may make these payments
in the form of contingent advance payments, which may be recovered from the
securities dealer or set off against other payments due to the securities dealer
in the event shares are redeemed within 12 months of the calendar month of
purchase. Other conditions may apply. All terms and conditions may be imposed by
an agreement between Distributors, or one of its affiliates, and the securities
dealer. With respect to purchases of Class I shares made at net asset value by
certain trust companies and trust departments of banks, either Distributors or
one of its affiliates, out of its own resources, may pay up to 1% of the amount
invested.
Letter of Intent
You may qualify for a reduced sales charge on the purchase of Class I shares of
the Fund, as described in the Prospectus. At any time within 90 days after the
first investment which you want to qualify for a reduced sales charge, you may
file with the Fund a signed Shareholder Application with the Letter of Intent
(the "Letter") section completed. After the Letter is filed, each additional
investment will be entitled to the sales charge applicable to the level of
investment indicated on the Letter. Sales charge reductions based upon purchases
in more than one of the Franklin Templeton Funds will be effective only after
notification to Distributors that the investment qualifies for a discount. Your
holdings in the Franklin Templeton Funds, including Class II shares, acquired
more than 90 days before the Letter is filed, will be counted towards completion
of the Letter but will not be entitled to a retroactive downward adjustment in
the sales charge. Any redemptions you make during the 13-month period will be
subtracted from the amount of the purchases for purposes of determining whether
the terms of the Letter have been completed. If the Letter is not completed
within the 13-month period, there will be an upward adjustment of the sales
charge, depending upon the amount actually purchased (less redemptions) during
the period. If you execute a Letter prior to a change in the sales charge
structure for the Fund, you will be entitled to complete the Letter at the lower
of the new sales charge structure or the sales charge structure in effect at the
time the Letter was filed.
As mentioned in the Prospectus, five percent (5%) of the amount of the total
intended purchase will be reserved in Class I shares of the Fund registered in
your name. If the total purchases, less redemptions, equal the amount specified
under the Letter, the reserved shares will be deposited to an account in your
name or delivered to you or as you direct. If the total purchases, less
redemptions, exceed the amount specified under the Letter and is an amount which
would qualify for a further quantity discount, a retroactive price adjustment
will be made by Distributors and the securities dealer through whom purchases
were made pursuant to the Letter (to reflect such further quantity discount) on
purchases made within 90 days before and on those made after filing the Letter.
The resulting difference in offering price will be applied to the purchase of
additional shares at the offering price applicable to a single purchase or the
dollar amount of the total purchases. If the total purchases, less redemptions,
are less than the amount specified under the Letter, you will remit to
Distributors an amount equal to the difference in the dollar amount of sales
charge actually paid and the amount of sales charge that would have applied to
the aggregate purchases if the total of such purchases had been made at a single
time. Upon such remittance, the reserved shares held for your account will be
deposited to an account in your name or delivered to you or as you direct. If
within 20 days after written request the difference in sales charge is not paid,
the redemption of an appropriate number of reserved shares to realize the
difference will be made. In the event of a total redemption of the account prior
to fulfillment of the Letter, the additional sales charge due will be deducted
from the proceeds of the redemption, and the balance will be forwarded to you.
Redemptions in Kind
Each Fund has committed itself to pay in cash (by check) all requests for
redemption by any shareholder of record, limited in amount, however, during any
90-day period to the lesser of $250,000 or 1% of the value of the Fund's net
assets at the beginning of the 90-day period. This commitment is irrevocable
without the prior approval of the Securities and Exchange Commission ("SEC"). In
the case of redemption requests in excess of these amounts, the trustees reserve
the right to make payments in whole or in part in securities or other assets of
the Fund, in case of an emergency, or if the payment of such a redemption in
cash would be detrimental to the existing shareholders of the Fund. In such
circumstances, the securities distributed would be valued at the price used to
compute the Fund's net assets and you may incur brokerage fees in converting the
securities to cash. The Funds do not intend to redeem illiquid securities in
kind. Should it happen, however, you may not be able to recover your investment
in a timely manner.
Redemptions by the Funds
Due to the relatively high cost of handling small investments, the Funds reserve
the right to involuntarily redeem your shares at net asset value if your account
has a value of less than one-half of your initial required minimum investment,
but only where the value of your account has been reduced by the prior voluntary
redemption of shares. Until further notice, it is the present policy of the
Funds not to exercise this right if your account has a value of $50 or more. In
any event, before the Funds redeem your shares and sends you the proceeds, it
will notify you that the value of the shares in your account is less than the
minimum amount and allow you 30 days to make an additional investment in an
amount which will increase the value of your account to at least $100.
Reports to Shareholders
The Trust sends annual and semiannual reports regarding its performance and
portfolio holdings to shareholders. If you would like to receive an interim
quarterly report, you may phone Fund Information at 1-800/DIAL BEN.
Special Services
The Franklin Templeton Institutional Services Department provides specialized
services, including recordkeeping, for institutional investors of the Fund. The
cost of these services is not borne by the Fund.
Investor Services may pay certain financial institutions that maintain omnibus
accounts with the Funds on behalf of numerous beneficial owners for
recordkeeping operations performed with respect to such owners. For each
beneficial owner in the omnibus account, the Funds may reimburse Investor
Services an amount not to exceed the per account fee which the Fund normally
pays Investor Services. These financial institutions may also charge a fee for
their services directly to their clients.
How Are Fund Shares Valued?
- -------------------------------------------------------------------------------
As noted in the Prospectus, each Fund calculates the net asset value of each
class as of the scheduled close of the Exchange (generally 1:00 p.m. Pacific
time) each day that the Exchange is open for trading. As of the date of this
SAI, the Trust is informed that the Exchange observes the following holidays:
New Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving Day and Christmas Day.
For the purpose of determining the aggregate net assets of the Fund, cash and
receivables are valued at their realizable amounts. Interest is recorded as
accrued. Over-the-counter portfolio securities are valued within the range of
the most recent quoted bid and ask prices. Portfolio securities which are traded
both in the over-the-counter market and on a stock exchange are valued according
to the broadest and most representative market as determined by the Manager.
Municipal securities generally trade in the over-the-counter market rather than
on a securities exchange.
Generally, trading in U.S. government securities and money market instruments is
substantially completed each day at various times prior to the scheduled close
of the Exchange. The value of these securities used in computing the net asset
value of a Fund's shares is determined as of those times. Occasionally, events
affecting the values of these securities may occur between the times at which
they are determined and the scheduled close of the Exchange which will not be
reflected in the computation of the net asset value of each class of the Funds.
If events materially affecting the values of these securities occur during such
period, then the securities will be valued at their fair value as determined in
good faith by the Board.
Other securities for which market quotations are readily available are valued at
the current market price, which may be obtained from a pricing service, based on
a variety of factors including recent trades, institutional size trading in
similar types of securities (considering yield, risk and maturity) and/or
developments related to specific issues. Securities and other assets for which
market prices are not readily available are valued at fair value as determined
following procedures approved by the Board. With the approval of trustees, the
Trust may utilize a pricing service, bank or securities dealer to perform any of
the above described functions.
Additional Information Regarding Taxation
- -------------------------------------------------------------------------------
As stated in the Prospectuses, each fund has elected to be treated as a
regulated investment company under Subchapter M of the Internal Revenue Code of
1986, as amended (the "Code"). The trustees reserve the right not to maintain
the qualification of any Fund as a regulated investment company if they
determine such course of action to be beneficial to the shareholders. In such
case, a Fund will be subject to federal and possibly state corporate taxes on
its taxable income and gains, to the alternative minimum tax on a portion of its
tax-exempt income, and distributions (including tax-exempt interest dividends)
to shareholders will be taxable to the extent of such Fund's available earnings
and profits.
The Code requires all funds to distribute at least 98% of their taxable ordinary
income earned during the calendar year and at least 98% of their capital gain
net income earned during the 12-month period ending October 31 of each year (in
addition to amounts from the prior year that were neither distributed nor taxed
to the Fund) to shareholders by December 31 of each year in order to avoid the
imposition of a federal excise tax. Under these rules, certain distributions
which are declared in October, November or December but which, for operational
reasons, may not be paid to you until the following January, will be treated for
tax purposes as if paid by the Funds and received by you on December 31 of the
calendar year in which they are declared. Each Fund intends as a matter of
policy to declare and pay such dividends, if any, in December to avoid the
imposition of this tax, but does not guarantee that its distributions will be
sufficient to avoid any or all federal excise taxes.
Redemptions and exchanges of Fund shares are taxable transactions for federal
and state income tax purposes. For most shareholders, gain or loss will be
recognized in an amount equal to the difference between your basis in the shares
and the amount received, subject to the rules described below. If such shares
are a capital asset in your hands, gain or loss will be capital gain or loss and
will be long-term for federal income tax purposes if the shares have been held
for more than one year.
Since the Funds' income is derived from interest income and gain on the sale of
portfolio securities rather than dividend income, no portion of the Funds'
distributions will generally be eligible for the corporate dividends-received
deduction. None of the distributions paid by the Funds for the fiscal year ended
May 31, 1995, qualified for this deduction and it is not anticipated that any of
the current year dividends for any of the Funds will so qualify.
All or a portion of a loss realized upon a redemption of shares will be
disallowed to the extent other shares of such Fund are purchased (through
reinvestment of dividends or otherwise) within 30 days before or after such
redemption. Any loss disallowed under these rules will be added to the tax basis
of the shares purchased.
All or a portion of the sales charge incurred in purchasing shares of a Fund
will not be included in the federal tax basis of such shares sold or exchanged
within 90 days of their purchase (for purposes of determining gain or loss with
respect to such shares) if the sales proceeds are reinvested in the Fund or in
another fund in the Franklin Templeton Funds (defined under "How Do I Buy
Shares?" or "How to Buy Shares of Each Fund" in the Prospectuses) and a sales
charge which would otherwise apply to the reinvestment is reduced or eliminated.
Any portion of such sales charge excluded from the tax basis of the shares sold
will be added to your tax basis of the shares acquired in the reinvestment. You
should consult with your tax advisor concerning the tax rules applicable to your
redemption or exchange of Fund shares.
Many states grant tax-free status to dividends paid to shareholders of mutual
funds from interest income earned by a Fund from direct obligations of the U.S.
Government, subject in some states to minimum investment requirements that must
be met by a fund. Investments in GNMA/FNMA securities and repurchase agreements
collateralized by U.S. Government securities do not generally qualify for
tax-free treatment. While it is not the primary investment objective of any Fund
to invest in such obligations, the Funds are authorized to so invest for
temporary or defensive purposes. To the extent such investments are made, any
affected Fund will provide shareholders with the percentage of any dividends
paid which may qualify for such tax-free treatment at the end of each calendar
year. You should consult with your tax advisor with respect to the application
of your state and local laws to these distributions and on the application of
other state and local laws on distributions and redemption proceeds received
from the Fund.
If you are defined in the Code as "a substantial user" (or a related person) of
facilities financed by private activity bonds you should consult with your tax
advisor before purchasing shares of the Funds.
The Trust's Underwriter
- -------------------------------------------------------------------------------
Pursuant to an underwriting agreement in effect until March 31, 1997,
Distributors acts as principal underwriter in a continuous public offering for
both classes of the Trust's shares. The underwriting agreement will continue in
effect for successive annual periods provided that its continuance is
specifically approved at least annually by a vote of the Board or, as to each
Fund, by a vote of the holders of a majority of the Fund's outstanding voting
securities, and in either event by a majority vote of the Trust's trustees who
are not parties to the underwriting agreement or interested persons of any such
party (other than as directors trustees of the Trust), cast in person at a
meeting called for that purpose. The underwriting agreement terminates
automatically in the event of its assignment and may be terminated by either
party on 90 days' written notice.
Distributors pays the expenses of the distribution of Fund shares, including
advertising expenses and the costs of printing sales material and prospectuses
used to offer shares to the public. Each Fund pays the expenses of preparing and
printing amendments to its registration statements and prospectuses (other than
those necessitated by the activities of Distributors) and of sending
prospectuses to existing shareholders.
In connection with the offering of the Funds' shares, aggregate underwriting
commissions for the fiscal years ended May 31, 1993, 1994, and 1995 and for the
six months ended November 30, 1995, and the amounts retained by Distributors in
net underwriting discounts and commissions, after allowances to dealers, were as
follows:
Total Total
Commissions Commissions
1995* Received Retained
- -------------------------------------------------------------------------------
Arkansas Fund.................. $ 49,137 $ 3,066
California Fund................ 698,339 31,585
Hawaii Fund.................... 97,045 626
Tennessee Fund................. 85,104 5,620
Washington Fund................ 9,757 608
1995
Arkansas Fund.................. 62,191 2,536
California Fund................ 475,044 34,733
Hawaii Fund.................... 185,598 12,861
Tennessee Fund................ 98,793 4,642
Washington Fund............... 34,183 2,172
1994
Arkansas Fund.................. 0 0
California Fund................ 847,492 66,225
Hawaii Fund.................... 420,455 51,159
Tennessee Fund................. 0 0
Washington Fund................ 81,291 4,336
1993
Arkansas Fund.................. n/a n/a
California Fund................ 1,801 0
Hawaii Fund.................... 538,200 54,367
Tennessee Fund................. n/a n/a
Washington Fund................ 0 0
*For the six-month period ended November 30, 1995.
Distributors may be entitled to reimbursement under the distribution plans for
each class, as discussed below. Except as noted, Distributors received no other
compensation for acting as underwriter of the Funds' shares.
Distribution Plans
Each class of the Funds has adopted a distribution plan pursuant to Rule 12b-1
under the 1940 Act (the "Class I Plan" and "Class II Plan," respectively, or
"Plan(s)").
The Class I Plan. Under the Class I Plan, the Hawaii Fund may pay up to a
maximum of .10% per annum of its average daily net assets, payable quarterly,
for expenses incurred in the promotion and distribution of Class I shares.
Arkansas, California, Tennessee and Washington may each pay up to a maximum of
.15% per annum of its average daily net assets.
Pursuant to the Class I Plan, Distributors or others will be entitled to be
reimbursed each quarter (up to the maximum stated above) for actual expenses
incurred in the distribution and promotion of Class I shares, including, but not
limited to, the printing of prospectuses and reports used for sales purposes,
expenses of preparing and distributing sales literature and related expenses,
advertisements, and other distribution-related expenses, including a prorated
portion of Distributors' overhead expenses attributable to the distribution of
Class I shares, as well as any distribution or service fees paid to securities
dealers or their firms or others who have executed a servicing agreement with
the Fund, Distributors or its affiliates.
The Class I Plans do not permit unreimbursed expenses incurred in a particular
year to be carried over to or reimbursed in subsequent years.
The Class II Plan. Under Class II Plan for the California Fund, the Fund pays
Distributors up to .50% per annum of the average daily net assets of Class II,
payable quarterly, for distribution and related expenses. These fees may be used
to compensate Distributors or others for providing distribution and related
services and bearing certain Class II expenses. All expenses of distribution and
marketing over this amount will be borne by Distributors or others who have
incurred them without reimbursement by the Fund. Under the Class II Plan, the
Fund also pays an additional .15% per annum of the average daily net assets of
Class II, payable quarterly, as a servicing fee. This fee will be used to pay
dealers or others for, among other things, assisting in establishing and
maintaining customer accounts and records; assisting with purchase and
redemption requests; receiving and answering correspondence; monitoring dividend
payments from the Fund on behalf of customers; and similar activities related to
furnishing personal services and maintaining shareholder accounts. At the time
of investment, Distributors may pay the securities dealer a commission of up to
1% of the amount invested out of its own resources.
Class I and Class II Plans. In addition to the payments that Distributors or
others are entitled to under the Plans, each Plan also provides that to the
extent the Funds, the Manager or Distributors or other parties on behalf of the
Funds, the Manager or Distributors make payments that are deemed to be for the
financing of any activity primarily intended to result in the sale of shares of
each class within the context of Rule 12b-1 under the 1940 Act, then such
payments shall be deemed to have been made pursuant to the Plan. The terms and
provisions of the Plans relating to required reports, term, and approval are
consistent with Rule 12b-1.
In no event shall the aggregate asset-based sales charges, which include
payments made under the Plans, plus any other payments deemed to be made
pursuant to the Plans, exceed the amount permitted to be paid pursuant to the
Rules of Fair Practice of the National Association of Securities Dealers, Inc.,
Article III, Section 26(d)4.
To the extent fees are for distribution or marketing functions, as distinguished
from administrative servicing or agency transactions, certain banks will not be
entitled to participate in the Plans as a result of applicable federal law
prohibiting certain banks from engaging in the distribution of mutual fund
shares. Such banking institutions, however, are permitted to receive fees under
the Plans for administrative servicing or for agency transactions. If you are a
customer of a bank that is prohibited from providing such services, you would be
permitted to remain a shareholder of the Fund, and alternate means for
continuing the servicing would be sought. In such an event, changes in the
services provided might occur and you might no longer be able to avail yourself
of any automatic investment or other services then being provided by the bank.
It is not expected that you would suffer any adverse financial consequences as a
result of any of these changes.
The Plans have been approved in accordance with the provisions of Rule 12b-1.
The Plans are effective through March 31, 1997 for Class I and through April 30,
1997 for Class II, and renewable annually by a vote of the Board, including a
majority vote of the trustees who are non-interested persons of the Trust and
who have no direct or indirect financial interest in the operation of the Plans,
cast in person at a meeting called for that purpose. It is also required that
the selection and nomination of such trustees be done by the non-interested
trustees. The Plans and any related agreement may be terminated at any time,
without penalty, by vote of a majority of the non-interested trustees on not
more than 60 days' written notice, by Distributors on not more than 60 days'
written notice, by any act that constitutes an assignment of the management
agreement with the Manager, or the underwriting agreement with Distributors, or
by vote of a majority of the outstanding shares of the Fund or class.
Distributors or any dealer or other firm may also terminate their respective
distribution or service agreement at any time upon written notice.
The Plans and any related agreements may not be amended to increase materially
the amount to be spent for distribution expenses without approval by a majority
of the outstanding shares of the Fund or class, and all material amendments to
the Plans or any related agreements shall be approved by a vote of the
non-interested trustees, cast in person at a meeting called for the purpose of
voting on any such amendment.
Distributors is required to report in writing to the Board at least quarterly on
the amounts and purpose of any payment made under the Plans and any related
agreements, as well as to furnish the Board with such other information as may
reasonably be requested in order to enable the Board to make an informed
determination of whether the Plans should be continued.
For the fiscal year ended May 31, 1995, and the six months ended November 30,
1995, the total amount paid by each Fund pursuant to the Plans was paid to
broker-dealers in the amounts listed below.
Amount paid
- -------------------------------------------------------------------------------
Fiscal Year Six-Month
ended Period Ended
Fund May 31, 1995 November 30, 1995
- -------------------------------------------------------------------------------
Arkansas Fund............. $ 898 $ 1,458
California Fund........... 35,842 25,054
Hawaii Fund............... 19,175 16,600
Tennessee Fund............ 1,672 2,952
Washington Fund........... 2,286 1,591
General Information
- -------------------------------------------------------------------------------
Performance
As noted in the Prospectus, the Fund may from time to time quote various
performance figures for each class to illustrate past performance and may
occasionally cite statistics to reflect volatility or risk. Performance
quotations by investment companies are subject to rules adopted by the SEC.
These rules require the use of standardized performance quotations or,
alternatively, that every non-standardized performance quotation furnished by
the Fund be accompanied by certain standardized performance information computed
as required by the SEC. Current yield and average annual compounded total return
quotations used by the Fund are based on the standardized methods of computing
performance mandated by the SEC. An explanation of those and other methods used
by the Fund to compute or express performance for each class follows.
Total Return
The average annual total return is determined by finding the average annual
compounded rates of return over one-, five- and ten-year periods, or fractional
portion thereof, that would equate an initial hypothetical $1,000 investment to
its ending redeemable value. The calculation assumes the maximum front-end sales
charge is deducted from the initial $1,000 purchase order, and income dividends
and capital gains are reinvested at net asset value. The quotation assumes the
account was completely redeemed at the end of each one-, five- and ten-year
period and the deduction of all applicable charges and fees. If a change is made
on the sales charge structure, historical performance information will be
restated to reflect the maximum front-end sales charge currently in effect.
In considering the quotations of total return by each Fund, you should remember
that the maximum front-end sales charge reflected in each quotation is a one
time fee (charged on all direct purchases), which will have its greatest impact
during the early stages of your investment in that Fund. This charge will affect
actual performance less the longer you retain your investment in the Fund. The
average annual compounded rates of return for Class I shares for the one-year
period ended on November 30, 1995 and for the period from inception of each
Class I shares to November 30, 1995, were as follows:
Average Annual
Total Return
- -------------------------------------------------------------------------------
Inception One- From
of the Fund Year Inception
- -------------------------------------------------------------------------------
Arkansas Fund.............. 05/10/94 15.51% 5.24%
California Fund............ 05/03/93 13.13% 4.72%
Hawaii Fund................ 02/26/92 15.71% 6.87%
Tennessee Fund............. 05/10/94 15.78% 6.68%
Washington Fund............ 05/03/93 17.96% 4.31%
These figures were calculated according to the SEC formula:
n
P(1+T) = 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 payment made at the
beginning of the one-, five- or ten-year periods at the end of the one-, five-
or ten-year periods (or fractional portion thereof)
As discussed in the Prospectus, the Fund may quote total rates of return for
each class in addition to the average annual total return for each class. These
quotations are computed in the same manner as the average annual compounded
rates, except they will be based on the actual return of a class for a specified
period rather than on the average return over one-, five- and ten-year periods,
or fractional portion thereof. The total rates of return for Class I shares for
the one-year period ended November 30, 1995, and from inception date of each
Class I shares to November 30, 1995 were as follows:
Aggregate Annual
Total Return
- -------------------------------------------------------------------------------
Inception One- From
of the Fund Year Inception
- -------------------------------------------------------------------------------
Arkansas Fund.............. 05/10/94 15.51% 8.30%
California Fund............ 05/03/93 13.13% 12.64%
Hawaii Fund................ 02/26/92 15.71% 28.40%
Tennessee Fund............. 05/10/94 15.78% 10.63%
Washington Fund............ 05/03/93 17.96% 11.50%
Current Yield
The current yield of Class I reflects the income per share earned by each Fund's
portfolio investments and is determined by dividing the net investment income
per share earned during a 30-day base period by the maximum offering price per
share on the last day of the period and annualizing the result. Expenses accrued
for the period include any fees charged to all shareholders of the Funds during
the base period. The yield for Class I shares for the 30-day period ended on
November 30, 1995 was as follows:
Arkansas Fund.......................................... 5.26%
California Fund........................................ 6.05%
Hawaii Fund............................................ 5.29%
Tennessee Fund......................................... 5.23%
Washington Fund........................................ 5.47%
These figures were obtained using the following SEC formula:
6
Yield = 2 [(a-b + 1) - 1]
---
cd
where:
a = 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
Tax Equivalent Yield
The Funds may also quote a tax equivalent yield for each class that demonstrates
the taxable yield necessary to produce an after-tax yield equivalent to that of
a fund which invests in tax-exempt obligations. Tax equivalent yield is computed
by dividing the portion of the class' yield (computed as indicated above) that
is tax-exempt by one minus the highest applicable combined federal and state
income tax rate (and adding the product to the portion of the class' yield that
is not tax-exempt, if any). The tax equivalent yield for Class I shares for the
30-day period ended on November 30, 1995 was as follows:
Arkansas Fund........................................ 9.36%
California Fund...................................... 11.04%
Hawaii Fund.......................................... 9.73%
Tennessee Fund....................................... 9.21%
Washington Fund...................................... 9.06%
As of the date of this SAI, the state and the combined state and federal income
tax rates upon which the tax equivalent yield quotations are based are 10% and
45.64% for the Hawaii Fund, 9.3% and 45.22% for the California High Yield Fund,
7% and 43.83% for the Arkansas Fund, and 6% and 43.22% for the Tennessee Fund.
The Washington Fund currently has no state income tax. Tax equivalent yield
quotations by each Fund will be based upon a 39.6% federal income tax rate.
From time to time, as any changes to the rates become effective, tax equivalent
yield quotations advertised by the Funds will be updated to reflect such
changes. The Funds expect updates may be necessary as tax rates are frequently
changed by federal, state and local governments. The advantage of tax-free
investments, such as the Funds, will be enhanced by any tax rate increases.
Therefore, the details of specific tax increases may be used in sales material
for each Fund.
Current Distribution Rate
Current yield and tax equivalent yield which are calculated according to a
formula prescribed by the SEC are not indicative of the amounts which were or
will be paid to shareholders of a class. Amounts paid to shareholders are
reflected in the quoted current distribution rate or taxable equivalent
distribution rate. The current distribution rate is computed by dividing the
total amount of dividends per share paid by a class during the past 12 months by
a current maximum offering price. A taxable equivalent distribution rate
demonstrates the taxable distribution rate equivalent to the current
distribution rate of a class (calculated as indicated above). The advertised
taxable equivalent distribution rate will reflect the most current federal and
state tax rates available to a Fund. Under certain circumstances, such as when
there has been a change in the amount of dividend payout or a fundamental change
in investment policies, it might be appropriate to annualize the dividends paid
over the period such policies were in effect, rather than using the dividends
during the past 12 months. The current distribution rate differs from the
current yield computation because it may include distributions to shareholders
from sources other than interest, such as short-term capital gains and is
calculated over a different period of time.
Volatility
Occasionally statistics may be used to specify Fund volatility or risk. Measures
of volatility or risk are generally used to compare Fund net asset value or
performance relative to a market index. One measure of volatility is beta. Beta
is the volatility of a fund relative to the total market, as represented by an
index considered representative of the types of securities in which the fund
invests. A beta of more than 1.00 indicates volatility greater than the market
and a beta of less than 1.00 indicates volatility less than the market. Another
measure of volatility or risk is standard deviation. Standard deviation is used
to measure variability of net asset value or total return around an average over
a specified period of time. The idea is that greater volatility means greater
risk undertaken in achieving performance.
Other Performance Quotations
For investors who are permitted to purchase Class I shares of the Funds at net
asset value, sales literature pertaining to Class I may quote a current
distribution rate, yield, total return, average annual total return and other
measures of performance as described elsewhere in this SAI with the substitution
of net asset value for the public offering price.
Regardless of the method used, past performance is not necessarily indicative of
future results, but is an indication of the return to shareholders only for the
limited historical period used.
The Fund may include in its advertising or sales material information relating
to investment objectives and performance results of funds belonging to the
Templeton Group of Funds. Resources is the parent company of the advisors and
underwriter of both the Franklin Group of Funds and Templeton Group of Funds.
Comparisons
To help you better evaluate how an investment in the Funds may satisfy your
investment objective, advertisements and other materials regarding the Funds may
discuss certain measures of performance of each class as reported by various
financial publications. Materials may also compare performance (as calculated
above) to performance as reported by other investments, indices, and averages.
Such comparisons may include, but are not limited to, the following examples:
a) Salomon Brothers Broad Bond Index or its component indices - measures yield,
price, and total return for Treasury, Agency, Corporate, and Mortgage bonds.
b) Lehman Brothers Aggregate Bond Index or its component indices - measures
yield, price and total return for Treasury, Agency, Corporate, Mortgage, and
Yankee bonds.
c) Lehman Brothers Municipal Bond Index (LBMBI) or its component indices -
measures yield, price and total return for the municipal bond market.
d) Bond Buyer's 20-Bond Index - an index of municipal bond yields based upon
yields of 20 general obligation bonds maturing in 20 years.
e) Bond Buyer's 30-Bond Index - an index of municipal bond yields based upon
yields of 20 revenue bonds maturing in 30 years.
f) Bond Buyers 40 Bond Index - an index based on the yields of 40 long-term
tax-exempt municipal bonds. Designed to be the basis for the Municipal Bond
Index in futures contracts.
g) Financial publications: The Wall Street Journal, Business Week, Financial
World, Forbes, Fortune, and Money magazines - provide performance statistics
over specified time periods.
h) Salomon Brothers Composite High Yield Index or its component indices -
measures yield, price and total return for Long-Term High-Yield Index,
Intermediate-Term High-Yield Index, and Long-Term Utility High-Yield Index.
i) Historical data supplied by the research departments of First Boston
Corporation, the J. P. Morgan companies, Salomon Brothers, Merrill Lynch, Lehman
Brothers and Bloomberg, L.P.
j) Merrill Lynch California Municipal Bond Index - based upon yields from
revenue and general obligation bonds weighted in accordance with their
respective importance to the California municipal market. The index is published
weekly in the Los Angeles Times and the San Francisco Chronicle.
k) Lipper - Mutual Fund Performance Analysis and Lipper - Fixed Income Fund
Performance Analysis - measure total return and average current yield for the
mutual fund industry and rank individual mutual fund performance over specified
time periods, assuming reinvestment of all distributions, exclusive of any
applicable sales charges.
l) Savings & Loan Historical Interest Rates - as published by the U.S. Savings &
Loan League Fact Book.
m) Consumer Price Index (or Cost of Living Index), published by the U.S. Bureau
of Labor Statistics - a statistical measure of change, over time, in the price
of goods and services in major expenditure groups.
From time to time, advertisements or information for the Funds may include a
discussion of certain attributes or benefits to be derived by an investment in
the Funds. Such advertisements or information may include symbols, headlines, or
other material which highlight or summarize the information discussed in more
detail in the communication.
Advertisements or information may also compare the Funds' performance to the
return on certificates of deposit or other investments. You should be aware,
however, that an investment in the Funds involve the risk of fluctuation of
principal value, a risk generally not present in an investment in a certificate
of deposit issued by a bank. For example, as the general level of interest rates
rise, the value of the Funds' fixed-income investments, as well as the value of
their shares which are based upon the value of such portfolio investments, can
be expected to decrease. Conversely, when interest rates decrease, the value of
the Funds' shares can be expected to increase. Certificates of deposit are
frequently insured by an agency of the U.S. government. An investment in the
Funds is not insured by any federal, state or private entity.
In assessing comparisons of performance, you should keep in mind that the
composition of the investments in the reported indices and averages is not
identical to the Funds' portfolios, that the indices and averages are generally
unmanaged, and the items included in the calculations of the averages may not be
identical to the formula used by the Funds to calculate their figures. In
addition there can be no assurance that the Funds will continue their
performance as compared to such other averages.
Other Features and Benefits
Each of the Funds may help you achieve various investment goals such as
accumulating money for retirement, saving for a down payment on a home, college
costs and/or other long-term goals. The Franklin College Costs Planner may
assist you in determining how much money must be invested on a monthly basis in
order to have a projected amount available in the future to fund a child's
college education. (Projected college cost estimates are based upon current
costs published by the College Board.) The Franklin Retirement Planning Guide
leads you through the steps to start a retirement savings program. Of course, an
investment in a Fund cannot guarantee that such goals will be met.
Miscellaneous Information
Each Fund is a member of the Franklin Templeton Group of Funds, one of the
largest mutual fund organizations in the U.S., and may be considered in a
program for diversification of assets. Founded in 1947, Franklin, one of the
oldest mutual fund organizations, has managed mutual funds for over 48 years and
now services more than 2.5 million shareholder accounts. In 1992, Franklin, a
leader in managing fixed-income mutual funds and an innovator in creating
domestic equity funds, joined forces with Templeton Worldwide, Inc., a pioneer
in international investing. Together, the Franklin Templeton Group has over $140
billion in assets under management for more than 4 million U.S. based mutual
fund shareholder and other accounts. The Franklin Group of Funds and the
Templeton Group of Funds offer to the public 115 U.S. based mutual funds. The
Funds may identify themselves by their NASDAQ symbols or CUSIP numbers.
According to Research and Ratings Review, Franklin's municipal research team
ranked number 2 out of 800 investment advisory firms surveyed by TMS Holdings,
Inc., as of March 31, 1996.
The Dalbar Surveys, Inc. broker-dealer survey has ranked Franklin number one in
service quality for five of the past eight years.
From time to time advertisements or sales material issued by the Funds may
discuss or be based upon information in a recent issue of the Special Report on
Tax Freedom Day published by the Tax Foundation, a Washington, D.C. based
nonprofit research and public education organization. The report illustrates,
among other things, the annual amount of time the average taxpayer works to
satisfy his or her tax obligations to the federal, state and local taxing
authorities.
Franklin is one of the largest and oldest managers of municipal bond funds in
the country. Franklin currently offers 42 tax-free and municipal bond funds
(funds whose dividends may be subject to the alternative minimum tax system),
including 32 funds free from both federal and state personal income taxes, and
manages over $42 billion in municipal securities for more than 870,000
investors.
Under current tax laws, municipal securities remain one of the few investments
offering the potential for tax-free income. In 1996, taxes could cost as much as
$47 on every $100 earned from a fully taxable investment (based on the combined
39.6% federal tax rate and the highest state tax rate of 12% for 1994. In
addition, investors subject to the federal or state alternative minimum tax may
find a small portion of their income distribution subject to such tax.) Franklin
municipal securities funds, however, offer tax relief through a professionally
managed portfolio of municipal securities selected based on their yield, quality
and maturity. An investment in a Franklin municipal securities fund can provide
an investor with the potential to earn income exempt from regular federal income
taxes, and depending on the fund, state and local taxes as well, while
supporting state and local public projects. Franklin municipal funds may also
provide potential tax-free compounding, when dividends are reinvested. An
investment in Franklin's municipal securities funds can grow more rapidly than a
similar taxable investment.
General
The Trust will amortize the organizational expenses attributable to each Fund
over a period of five years from the effective date of the registration
statement covering each Fund. New investors purchasing shares of a Fund after
the effective date of such Fund's registration statement under the Securities
Act of 1933 will be bearing such expenses during the amortization period.
From time to time, the number of shares of each Fund held in the "street name"
accounts of various securities dealers for the benefit of their clients or in
centralized securities depositories may exceed 5% of the total shares
outstanding. To the best knowledge of the Trust, as of February 14, 1996 the
principal shareholders of the Funds, beneficial or of record, were as follows:
Name and Address Share Amount Percentage
Arkansas Fund
Franklin Resources, Inc.......... 238,385.908 37.36%
777 Mariners Island Blvd.
San Mateo, CA 94404
Hawaii Fund
Franklin Resources, Inc.......... 248,680.032 6.83%
777 Mariners Island Blvd.
San Mateo, CA 94404
Liu Chang and Lucy C.H. Chang
1525 Wilder Ave. 1108............ 468,603.561 12.87%
Honolulu, HI 96822
777 Mariners Island Blvd.
Tennessee Fund
Franklin Resources, Inc.......... 238,577.114 23.80%
777 Mariners Island Blvd
San Mateo, CA 94404
Washington Municipal Bond Fund
Franklin Resources, Inc.......... 238,385.908 38.34%
777 Mariners Island Blvd.
San Mateo, CA 94404
Employees of Resources or its subsidiaries who are access persons under the 1940
Act are permitted to engage in personal securities transactions subject to the
following general restrictions and procedures: (i) the trade must receive
advance clearance from a compliance officer and must be completed within 24
hours after clearance; (ii) copies of all brokerage confirmations must be sent
to a compliance officer and, within 10 days after the end of each calendar
quarter, a report of all securities transactions must be provided to the
compliance officer; and (iii) access persons involved in preparing and making
investment decisions must, in addition to (i) and (ii) above, file annual
reports of their securities holdings each January and inform the compliance
officer (or other designated personnel) if they own a security that is being
considered for a fund or other client transaction or if they are recommending a
security in which they have an ownership interest for purchase or sale by a fund
or other client.
Ownership and Authority Disputes
In the event of disputes involving multiple claims of ownership or authority to
control your account, the Fund has the right (but has no obligation) to: (a)
freeze the account and require the written agreement of all persons deemed by
the Fund to have a potential property interest in the account, prior to
executing instructions regarding the account; (b) interplead disputed funds or
accounts with a court of competent jurisdiction; or (c) surrender ownership of
all or a portion of the account to the Internal Revenue Service in response to a
Notice of Levy.
Financial Statements
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The audited financial statements contained in the Annual Report to Shareholders
of the Trust for the fiscal year ended May 31, 1995, including the auditors'
report, and the unaudited Semi-Annual Report to Shareholders for the period
ended November 30, 1995, are incorporated herein by reference.
Appendix A -
Further Information on Special Factors
Affecting Each State Fund
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The following information is a summary of special factors affecting each of the
individual state Funds. It does not purport to be a complete description of such
factors and is based primarily upon information derived from public documents
relating to securities offerings of issuers of such states and other
historically reliable sources. The Trust has not independently verified any of
this data. The market value of the shares of any Fund may fluctuate due to
factors such as changes in interest rates, matters affecting a particular state,
or for other reasons.
ARKANSAS
Arkansas has consistently maintained a balanced budget and a conservative
approach to its financial operations. Under the state's Revenue Stabilization
Act and other laws enacted in the early 1970s, all general obligation debt must
be authorized by voters, restrictions are placed on the total amount of debt
that can be issued during any two year budget cycle, and the state is prohibited
from engaging in deficit spending i.e. spending cannot exceed revenues in any
fiscal year. As a result, Arkansas has maintained one of the lowest debt loads
of the states, despite notable increases since 1990, with debt per capita equal
to $293. During fiscal 1994, revenues collected exceeded 1993 levels by 9.3%.
Conservative estimates based on slower employment and income growth project
revenue growth of 4.6% for each of fiscal years 1995 and 1996 and 5.7% for
fiscal 1997. Through February, revenue collections for fiscal 1995 have actually
exceeded projections by 1.8%, with declines in revenues from corporate income
and alcoholic beverage taxes offset by increases in other tax categories.
Despite the state's steady and strong economic growth, many counties in Arkansas
may face financial pressures in the coming years, as a result of the state
Supreme Court's recent ruling declaring a county's one cent sales tax
unconstitutional. The tax was found to be unconstitutional because it exceeded
the half-cent limit on general purpose sales taxes imposed by the state's
constitution. This ruling could affect approximately 63 of the state's 75
counties which have general purpose sales taxes exceeding the half-cent limit,
including Pulaski County, the state's most populous county.
CALIFORNIA
On June 6, 1978, California voters approved Proposition 13, which added Article
XIIIA to the California Constitution. The principal thrust of Article XIIIA is
to limit the amount of ad valorem taxes on real property to one percent of the
full cash value as determined by the county assessor. The assessed valuation of
all real property may be increased, but not in excess of two percent per year,
or decreased to reflect the rate of inflation or deflation as shown by the
consumer price index. Article XIIIA requires a vote of two thirds of the
qualified electorate to impose special taxes, and completely prohibits the
imposition of any additional ad valorem, sales or transaction tax on real
property (other than ad valorem taxes to repay general obligation bonds issued
to acquire or improve real property), and requires the approval of two-thirds of
all members of the State Legislature to change any state tax laws resulting in
increased tax revenues.
On November 6, 1979, California voters approved the initiative seeking to amend
the California Constitution entitled "Limitation of Government Appropriations"
which added Article XIIIB to the California Constitution. Under Article XIIIB
state and local governmental entities have an annual appropriations limit and
may not spend certain monies which are called appropriations subject to
limitations (consisting of tax revenues, state subventions and certain other
funds) in an amount higher than the appropriations limit. Generally, the
appropriations limit is to be based on certain 1978-79 expenditures, and is to
be adjusted annually to reflect changes in consumer prices, population and
services provided by these entities.
Decreases in state and local revenues in future fiscal years as a consequence of
these initiatives may continue to result in reductions in allocations of state
revenues to California municipal issuers or reduce the ability of such
California issuers to pay their obligations.
In its third year of economic recovery, California continues to show gradual
improvement. Although a large portion of the deficit accumulated during the
recession still remains, the state will likely be able to retire its outstanding
short-term borrowing as scheduled in April. Its balance sheet is still weak, but
California's reliance on external cash flow has been reduced from previous
years, and in the fiscal year ended June 30, 1995, the state produced an
operating surplus of approximately $800 million.
The 1995-1996 budget, which was passed on August 3, 1995, calls for an operating
surplus of approximately $600 million. The budget relies on the unlikely
prospect that federal government will provide $500 million in new funding for
incarceration of illegal aliens and other programs, as well as allow California
to cut an additional $500 million from federally mandated programs such as AFDC
and MediCal. At the same time, the temporary top marginal personal income tax
rates have expired, bringing down such rates from 10% and 11% to 9.3%. School
funding will increase by approximately $1 billion over last year, and there will
be an 8% increase in the share of the state budget devoted to prisons.
California's long-term economic difficulties will continue for an extended
period of time despite a gradually improving economy. K-12 education and prison
costs are expected to rise more rapidly than the overall budget, and county
governments are having difficulties resulting from the shift of property taxes
from counties to schools. Even in areas where the growth rates appear to be
decreasing, such as in health and welfare spending, it is likely that California
will encounter the same uncertainties faced by other states as the federal
government leaves more control to the states and as California's population
grows older.
Financial, economic and political factors will continue to have significant
effects on the health of the California economy. Voter initiatives have a strong
impact on the budget, and the budget process has difficulty reconciling spending
needs with a low tolerance for taxes. The constitutional reform commission will
present a final plan to address many of these issues in January, and
California's credit condition is expected to improve at a fairly limited rate
unless such a plan is adopted.
HAWAII
Hawaii has historically enjoyed a strong financial position. Past recessions in
both the U.S. and Asia, however, adversely affected the state's tourism and
construction industries, two of its largest industries, resulting in substantial
reductions in economic growth and tax revenues. Economic recovery has been slow,
creating financial pressures on the state's fiscal position.
Hawaii's debt levels are high and continue to grow, primarily due to the state's
role in delivering services such as education and health care. Debt per capita
is $4,150 and total debt service represents approximately 11% of the state's
operating expenditures. While debt at the state level is high, overall debt is
manageable as counties continue to have relatively low debt burdens.
During fiscal 1994, decreased growth and tax revenues resulted in a reduction of
the state's general fund balance of approximately $25 million, although reserves
remain strong at 8% of current expenditures. Over the next several years, fiscal
pressures are expected to continue. By 1997, the general fund balance is
projected to decline to 2.5% of the state's expenditures and spending cuts of
more than $150 million will be required.
TENNESSEE
Tennessee has historically had a sound financial position, though as in many
states, the recession has had a negative impact on revenues. Although the
recession produced shortfalls in fiscal years 1991 and 1992, renewed economic
growth, increased taxes, and cost controls in fiscal 1993 generated a $132
million general fund surplus and the rainy day revenue fluctuation fund was
restored to $150 million from $75 million in 1992. For fiscal 1994, revenues
growth continued and the Rainy Day Fund has reached $150 million and it is
expected to remain at that level through the fiscal year ended 1995.
In January 1994, TennCare, the state's comprehensive health care program, was
implemented. The program is designed to restructure the health care delivery
system and extends benefits to the uninsured. It is anticipated that the state
should be able to produce sizable savings and limit the growth of Medicaid
spending. The state has received a waiver from the federal government to be free
of the requirements of the Medicaid program. The 1995-1996 budget assumes no new
revenues or taxes and includes reductions in state agency budget. Also included
in the state's budget initiatives for fiscal 1995-1996 is continued
implementation of the Education Improvement Act of 1992, which guarantees a
basic level of service for all primary and secondary school students in the
state under a Basic Education Program formula. A substantial portion of the
capital outlay projects continue to be financed on a current basis. Funds from
general obligation bonds have been used mostly for higher education and
correctional facilities.
Tennessee's financial operations are considerably different than most other
states because there is no state payroll income tax. This factor, together with
the state's reliance on the sales tax for approximately 60% of general fund
receipts, exposes total state tax collections to considerably more volatility
than would otherwise be the case and, in the event of an economic downswing,
could affect the state's ability to pay principal and interest in a timely
manner.
Debt issuance is limited by statute, additional general obligation bonds may
only be issued if pledged special revenues for the preceding fiscal year are at
least 1.5 times the peak annual debt service requirements on both new and
outstanding bonds. In 1994, the debt service limit was $326.2 million and the
peak debt service was $102.4 million. Tennessee's outstanding general obligation
indebtedness is $837 million. Overall debt remains low at $633 per capita.
WASHINGTON
During 1991, in response to economic softening, the state made downward
revisions in its economic and revenue forecasts for the 1991-93 biennium, and
enacted corresponding adjustments on the expenditure side of the budget. As a
result of the adjustments, the 1991-93 biennium closed with an ending unreserved
general fund balance of approximately $234 million, in addition to a $100
million balance in the budget stabilization fund (or "rainy day fund"). These
balances have decreased from the beginning of the 1993-1995 biennium, when the
unreserved fund balance and the rainy day fund stood at $468 million and $260
million, respectively.
The total 1993-95 biennial general fund budget was $16.3 billion, up 6% over the
1991-1993 biennium. On April 6, 1994, the governor signed a supplemental budget,
which included $168 million of additional spending for various one-time items,
including grants to local school districts. The state ended the 1993-1995
biennium with $455 million in the general fund.
In November 1993, voters approved Initiative 601, which will limit state
spending increases to the average of the rate of inflation and population growth
over the previous three years beginning with the 1995-1997 biennium. The impact
of Initiative 601 is expected to be significant but manageable. Since July 1,
1995, tax increases require a two-thirds vote of the legislature but only up to
the spending limit. The total 1995-97 biennial general fund budget is $17.6
billion. The budget successfully closed a gap reflecting new expenditures of
approximately $2 billion necessary to keep up with growth in education
enrollment, prison populations, debt service and health care costs. The state
addressed the $2 billion imbalance through a combination of expenditure
reductions, program restructuring, and increases in revenue, which included an
expansion of the sales tax base to include selected business services and an
increase in the business and occupation tax rate. In May 1995, the governor
signed a supplemental budget, which included revenue and expenditure adjustments
and initiated limits to program growth in anticipation of the July 1, 1995
implementation of Initiative 601. Presently, Washington does not have an income
tax and although from time to time one has been proposed, it was not seriously
considered during the 1995-97 biennial budget debate.
State financial performance is anticipated to be remain positive despite
continued reductions in operations at Boeing, whose employees represent about 4%
of the state's employment and the 1995 implementation of Initiative 601. The
state, in response to earlier Boeing reductions, promptly lowered its revenue
forecasts and enacted a 1993-95 biennial budget aimed at enhancing reserve
levels and bringing spending and revenue back into balance.
Appendix B -
Description of Municipal Bond Ratings
- -------------------------------------------------------------------------------
Moody's
Aaa: Municipal bonds rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as
"gilt-edged." Interest payments are protected by a large or 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: Municipal bonds rated Aa are judged to be 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, fluctuation of protective elements may be of
greater amplitude, or there may be other elements present which make the
long-term risks appear somewhat larger.
A: Municipal bonds rated A possess many favorable investment attributes and are
considered upper medium-grade obligations. Factors giving security to principal
and interest are considered adequate, but elements may be present which suggest
a susceptibility to impairment sometime in the future.
Baa: Municipal bonds 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: Municipal bonds rated Ba are judged to have predominantly 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: Municipal bonds 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: Municipal bonds 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: Municipal bonds rated Ca represent obligations which are speculative to a
high degree. Such issues are often in default or have other marked shortcomings.
C: Municipal bonds rated C are the lowest-rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Con.(-): Municipal bonds for which the security
depends upon the completion of some act or the fulfillment of some condition are
rated conditionally. These are bonds secured by (a) earnings of projects under
construction, (b) earnings of projects unseasoned in operation experience, (c)
rentals which begin when facilities are completed, or (d) payments to which some
other limiting condition attaches. Parenthetical rating denotes probable credit
stature upon the completion of construction or the elimination of the basis of
the condition.
S&P
AAA: Municipal bonds rated AAA are the highest-grade obligations. They possess
the ultimate degree of protection as to principal and interest. In the market,
they move with interest rates and, hence, provide the maximum safety on all
counts.
AA: Municipal bonds rated AA also qualify as high-grade obligations, and in the
majority of instances differ from AAA issues only in a small degree. Here, too,
prices move with the long-term money market.
A: Municipal bonds rated A are regarded as upper medium-grade. They have
considerable investment strength but are not entirely free from adverse effects
of changes in economic and trade conditions. Interest and principal are regarded
as safe. They predominantly reflect money rates in their market behavior but
also, to some extent, economic conditions.
BBB: Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay principal and interest for bonds in
this category than for bonds in the A category.
BB, B, CCC, CC: Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligations. BB
indicates the lowest degree of speculation and CC the highest degree of
speculation. While such bonds will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
C: This rating is reserved for income bonds on which no interest is being paid.
D: Debt rated "D" is in default and payment of interest and/or repayment of
principal is in arrears. Note: The S&P ratings may be modified by the addition
of a plus (+) or minus (-) sign to show relative standing within the major
rating categories.
Fitch
AAA: Municipal bonds rated AAA are considered to be of investment grade and of
the highest credit quality. The obligor has an exceptionally strong ability to
pay interest and repay principal which is unlikely to be affected by reasonably
foreseeable events.
AA: Municipal bonds rated AA are considered to be investment grade and of very
high credit quality. The obligor's ability to pay interest and repay principal
is very strong although not quite as strong as bonds rated AAA and not
significantly vulnerable to foreseeable future developments.
A: Municipal bonds rated A are considered to be investment grade and of high
credit quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
BBB: Municipal bonds rated BBB are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered to be adequate. Adverse changes in economic conditions
and circumstances, however, are more likely to have an adverse impact on these
bonds, and therefor impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
BB: Municipal bonds rated BB are considered speculative. The obligor's ability
to pay interest and repay principal may be affected over time by adverse
economic changes. However, business and financial alternatives can be identified
which could assist the obligor in satisfying its debt service requirements. B:
Municipal bonds rated B are considered highly speculative. While bonds in this
class are currently meeting debt service requirements, the probability of
continued timely payment of principal and interest reflects the obligor's
limited margin of safety and the need for reasonable business and economic
activity throughout the life of the issue.
CCC: Municipal bonds rated CCC have certain identifiable characteristics which,
if not remedied, may lead to default. The ability to meet obligations requires
an advantageous business and economic environment.
CC: Municipal bonds rated CC are minimally protected. Default in payment of
interest and/or principal seems probable over time.
C: Municipal bonds rated C are in imminent default in the payment of interest or
principal.
DDD, DD and D: Municipal bonds rated DDD, DD and D are in default on interest
and/or principal payments. Such bonds are extremely speculative and should be
valued on the basis of their ultimate recovery value in liquidation or
reorganization of the obligor. DDD represents the highest potential for recovery
while D represents the lowest potential for recovery.
Plus (+) or minus (-) signs are used with a rating symbol to indicate the
relative position of a credit within the rating category. Plus or minus are not
used for the AAA and the DDD, DD or D categories.
Description of Municipal Note Ratings
Moody's
Moody's ratings for state, municipal and other short-term obligations will be
designated Moody's Investment Grade ("MIG"). This distinction is in recognition
of the differences between short-term credit risk and long-term risk. Factors
affecting the liquidity of the borrower are uppermost in importance in
short-term borrowing; factors of the first importance in long-term borrowing
risk are of lesser importance in the short run. Symbols used will be as follows:
MIG 1: Notes are of the best quality enjoying strong protection from established
cash flows of funds for their servicing or from established and broad-based
access to the market for refinancing, or both.
MIG 2: Notes are of high quality, with margins of protection ample, although not
so large as in the preceding group.
MIG 3: Notes are of favorable quality, with all security elements accounted for,
but lacking the undeniable strength of the preceding grades. Market access for
refinancing, in particular, is likely to be less well established.
MIG 4: Notes are of adequate quality, carrying specific risk but having
protection and not distinctly or predominantly speculative.
S&P
Until June 29, 1984, S&P used the same rating symbols for notes and bonds. After
June 29, 1984, for new municipal note issues due in three years or less, the
ratings below will usually be assigned. Notes maturing beyond three years will
most likely receive a bond rating of the type recited above.
SP-1: Issues carrying this designation have a very strong or strong capacity to
pay principal and interest. Issues determined to possess overwhelming safety
characteristics will be given a "plus" (+) designation.
SP-2: Issues carrying this designation have a satisfactory capacity to pay
principal and interest.
Description of Commercial Paper Ratings
Moody's
Moody's commercial paper ratings, which are also applicable to municipal paper
investments permitted to be made by the Fund, are opinions of the ability of
issuers to repay punctually their promissory obligations not having an original
maturity in excess of nine months. Moody's employs the following designations,
all judged to be investment grade, to indicate the relative repayment capacity
of rated issuers:
P-1 (Prime-1): Superior capacity for repayment.
P-2 (Prime-2): Strong capacity for repayment.
S&P
S&P's ratings are a current assessment of the likelihood of timely payment of
debt having an original maturity of no more than 365 days. Ratings are graded
into four categories, ranging from "A" for the highest quality obligations to
"D" for the lowest. Issues within the "A" category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety, as follows:
A-1: This designation indicates the degree of safety regarding timely payment is
very strong. A "plus" (+) designation indicates an even stronger likelihood of
timely payment.
A-2: Capacity for timely payment on issues with this designation is strong.
However, the relative degree of safety is not as overwhelming as for issues
designated A-1.
A-3: Issues carrying this designation have a satisfactory capacity for timely
payment. They are, however, somewhat more vulnerable to the adverse effects of
changes in circumstances than obligations carrying the higher designations.
Fitch's
Fitch's short-term ratings apply to debt obligations that are payable on demand
or have original maturities of generally up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes. The short-term rating places greater emphasis than a long-term rating on
the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
F-1+: Exceptionally strong credit quality. Regarded as having the strongest
degree of assurance for timely payment.
F-1: Very strong credit quality. Reflect on assurance of timely payment only
slightly less in degree than issues rated F-1+.
F-2: Good credit quality. A satisfactory degree of assurance for timely payment,
but the margin of safety is not as great as for issues assigned F-1+ and F-1
ratings.
F-3: Fair credit quality. Have characteristics suggesting that the degree of
assurance for timely payment is adequate; however, near-term adverse changes
could cause these securities to be rated below investment grade.
F-5: Weak credit quality. Have characteristics suggesting a minimal degree of
assurance for timely payment and are vulnerable to near-term adverse changes in
financial and economic conditions.
D: Default. Actual or imminent payment default.
LOC: The symbol LOC indicates that the rating is based on a letter of credit
issued by a commercial bank.
