o MUN P-3
SUPPLEMENT DATED JANUARY 1, 2000
TO THE PROSPECTUS OF
FRANKLIN MUNICIPAL SECURITIES TRUST
DATED OCTOBER 1, 1999
The prospectus is amended as follows:
I. The following sentence is added after the minimum investments table on page
29:
Please note that you may only buy shares of a fund eligible for sale in your
state or jurisdiction.
II. The management team for the California High Yield Fund on page 11 is
replaced with the following:
The team responsible for the fund's management is:
SHEILA AMOROSO, SENIOR VICE PRESIDENT OF ADVISERS
Ms. Amoroso has been an analyst or portfolio manager of the fund since its
inception. She is the co-Director of Franklin's Municipal Bond Department.
She joined the Franklin Templeton Group in 1986.
BERNARD SCHROER, SENIOR VICE PRESIDENT OF ADVISERS
Mr. Schroer has been an analyst or portfolio manager of the fund since its
inception. He joined the Franklin Templeton Group in 1987.
JOHN WILEY, VICE PRESIDENT OF ADVISERS
Mr. Wiley has been an analyst or portfolio manager of the fund since its
inception. He joined the Franklin Templeton Group in 1989.
III. The management team for the Tennessee Fund on page 21 is replaced with the
following:
The team responsible for the fund's management is:
SHEILA AMOROSO, SENIOR VICE PRESIDENT OF ADVISERS
Ms. Amoroso has been an analyst or portfolio manager of the fund since its
inception. She is the co-Director of Franklin's Municipal Bond Department.
She joined the Franklin Templeton Group in 1986.
JOHN POMEROY, VICE PRESIDENT OF ADVISERS
Mr. Pomeroy has been an analyst or portfolio manager of the fund since its
inception. He joined the Franklin Templeton Group in 1986.
FRANCISCO RIVERA, PORTFOLIO MANAGER OF ADVISERS
Mr. Rivera has been an analyst or portfolio manager of the fund since 1996.
He joined the Franklin Templeton Group in 1994.
JOHN WILEY, VICE PRESIDENT OF ADVISERS
Mr. Wiley has been an analyst or portfolio manager of the fund since its
inception. He joined the Franklin Templeton Group in 1989.
IV. The section "Sales charge waivers" on page 28 is replaced with the
following:
SALES CHARGE WAIVERS Class A shares may be purchased without an initial sales
charge or CDSC by various individuals and institutions or by investors who
reinvest certain distributions and proceeds within 365 days. Certain investors
also may buy Class C shares without an initial sales charge. The CDSC for each
class may be waived for certain redemptions and distributions. If you would
like information about available sales charge waivers, call your investment
representative or call Shareholder Services at 1-800/632-2301. A list of
available sales charge waivers also may be found in the Statement of
Additional Information (SAI).
V. The section "Dealer compensation" on page 37 is replaced with the following:
DEALER COMPENSATION Qualifying dealers who sell fund shares may receive sales
commissions and other payments. These are paid by Franklin Templeton
Distributors, Inc. (Distributors) from sales charges, distribution and service
(12b-1) fees and its other resources.
Class A Class C
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Commission (%) - 2.00
Investment under $100,000 4.00 -
$100,000 but under $250,000 3.25 -
$250,000 but under $500,000 2.25 -
$500,000 but under $1 million 1.85 -
$1 million or more up to 0.75 1 -
12b-1 fee to dealer 0.10 0.65 2
A dealer commission of up to 1% may be paid on Class C NAV purchases. A dealer
commission of up to 0.25% may be paid on Class A NAV purchases by certain
trust companies and bank trust departments, eligible governmental authorities,
and broker-dealers or others on behalf of clients participating in
comprehensive fee programs.
1. During the first year after purchase, dealers may not be eligible to
receive the 12b-1 fee.
2. Dealers may be eligible to receive up to 0.15% during the first year
after purchase and may be eligible to receive the full 12b-1 fee starting in
the 13th month.
VI. The section "Statements and reports" on page 35 is replaced with the
following:
STATEMENTS AND REPORTS You will receive quarterly account statements that show
all your account transactions during the quarter. You also will receive
written notification after each transaction affecting your account (except for
distributions and transactions made through automatic investment or withdrawal
programs, which will be reported on your quarterly statement). You also will
receive the fund's financial reports every six months. To reduce fund
expenses, we try to identify related shareholders in a household and send only
one copy of the financial reports. If you need additional copies, please call
1-800/DIAL BEN.
If there is a dealer or other investment representative of record on your
account, he or she also will receive copies of all notifications and
statements and other information about your account directly from the fund.
Please keep this supplement for future reference.
FRANKLIN MUNICIPAL
SECURITIES TRUST
FRANKLIN CALIFORNIA HIGH YIELD MUNICIPAL FUND - CLASS A & C
FRANKLIN TENNESSEE MUNICIPAL BOND FUND - CLASS A
STATEMENT OF ADDITIONAL INFORMATION
OCTOBER 1, 1999, AS AMENDED JANUARY 1, 2000
[Insert Franklin Templeton Ben Head]
P.O. Box 997151, Sacramento, CA 95899-9983 1-800/DIAL BEN(R)
This Statement of Additional Information (SAI) is not a prospectus. It contains
information in addition to the information in the funds' prospectus. The funds'
prospectus, dated October 1, 1999, which we may amend from time to time,
contains the basic information you should know before investing in the funds.
You should read this SAI together with the funds' prospectus.
The audited financial statements and auditor's report in the trust's Annual
Report to Shareholders, for the fiscal year ended May 31, 1999, are incorporated
by reference (are legally a part of this SAI).
For a free copy of the current prospectus or annual report, contact your
investment representative or call 1-800/DIAL BEN (1-800/342-5236).
CONTENTS
Goals and Strategies ................................. 2
Risks ................................................ 6
Officers and Trustees ................................ 8
Management and Other Services ........................ 11
Portfolio Transactions ............................... 12
Distributions and Taxes .............................. 13
Organization, Voting Rights
and Principal Holders ............................... 14
Buying and Selling Shares ............................ 15
Pricing Shares ....................................... 20
The Underwriter ...................................... 20
Performance .......................................... 22
Miscellaneous Information ............................ 25
Description of Ratings ............................... 26
State Tax Treatment .................................. 28
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Mutual funds, annuities, and other investment products:
o are not federally insured by the Federal Deposit Insurance Corporation,
the Federal Reserve Board, or any other agency of the U.S. government;
o are not deposits or obligations of, or guaranteed or endorsed by, any
bank;
o are subject to investment risks, including the possible loss of
principal.
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MUN SAI 01/00
Goals and Strategies
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The California High Yield Fund's principal investment goal is to provide
investors with a high level of income exempt from federal and California
personal income taxes. Its secondary goal is capital appreciation to the extent
possible and consistent with its principal investment goal.
The Tennessee Fund's investment goal is to maximize income exempt from federal
income taxes and from the personal income taxes for resident shareholders of
Tennessee to the extent consistent with prudent investing and the preservation
of shareholders' capital.
These goals are fundamental, which means they may
not be changed without shareholder approval. Of course, there is no assurance
that either fund will meet its goal.
As fundamental policies, each fund normally invests at least 80% of its net
assets in securities that pay interest free from regular federal income taxes,
and the Tennessee Fund normally invests at least 80% of its net assets in
securities that pay interest free from Tennessee personal income taxes. As
nonfundamental policies, the California High Yield Fund normally invests at
least 65% of its total assets in securities that pay interest free from
California personal income taxes, and each fund normally invests at least 65% of
its total assets in municipal securities of its state.
Municipal securities issued by a fund's state or that state's counties,
municipalities, authorities, agencies, or other subdivisions, as well as
municipal securities issued by U.S. territories such as Guam, Puerto Rico, the
Mariana Islands or the U.S. Virgin Islands, generally pay interest free from
federal income tax and from state personal income taxes for residents of the
fund's state.
Each fund tries to invest all of its assets in municipal securities whose
interest is free from regular federal income taxes and from the personal income
taxes of its state. The issuer's bond counsel generally gives the issuer an
opinion on the tax-exempt status of a municipal security when the security is
issued.
Below is a description of various types of municipal and other securities that
each fund may buy. Other types of municipal securities may become available that
are similar to those described below and in which each fund also may invest, if
consistent with its investment goals and policies.
Tax anticipation notes are issued to finance short-term working capital needs of
municipalities in anticipation of various seasonal tax revenues, which will be
used to pay the notes. They are usually general obligations of the issuer,
secured by the taxing power for the payment of principal and interest.
Revenue anticipation notes are similar to tax anticipation notes except they are
issued in expectation of the receipt of other kinds of revenue, such as federal
revenues available under the Federal Revenue Sharing Program.
Bond anticipation notes are normally issued to provide interim financing until
long-term financing can be arranged. Proceeds from long-term bond issues then
provide the money for the repayment of the notes.
Tax-exempt commercial paper typically represents a short-term obligation (270
days or less) issued by a municipality to meet working capital needs.
Municipal bonds meet longer-term capital needs and generally have maturities
from one to 30 years when issued. They have two principal classifications:
general obligation bonds and revenue bonds.
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. 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.
Revenue bonds. The full faith, credit and taxing power of the issuer do not
secure revenue bonds. Instead, 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. The principal security behind these bonds may vary. For example,
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. Many bonds
provide additional security in the form of a debt service reserve fund that may
be used to make principal and interest payments. Some authorities have further
security in the form of state assurances (although without obligation) to make
up deficiencies in the debt service reserve fund.
Tax-exempt industrial development revenue bonds are issued by or on behalf of
public authorities to finance various privately operated facilities for
business, manufacturing, housing, sports and pollution control, as well as
public facilities such as airports, mass transit systems, ports and parking. The
payment of principal and interest is solely dependent on the ability of the
facility's user to meet its financial obligations and the pledge, if any, of the
facility or other property as security for payment.
Variable or floating rate securities Each fund may invest in variable or
floating rate securities, including variable rate demand notes, which have
interest rates that change either at specific intervals (variable rate), from
daily up to monthly, or whenever a benchmark rate changes (floating rate). The
interest rate adjustments are designed to help stabilize the security's price.
While this feature helps protect against a decline in the security's market
price when interest rates rise, it lowers the fund's income when interest rates
fall. Of course, the fund's income from its variable rate investments also may
increase if interest rates rise.
Variable or floating rate securities may include a demand feature, which may be
unconditional. The demand feature allows the holder to demand prepayment of the
principal amount before maturity, generally on one to 30 days' notice. The
holder receives the principal amount plus any accrued interest either from the
issuer or by drawing on a bank letter of credit, a guarantee or insurance issued
with respect to the security. Each fund generally uses variable or floating rate
securities as short-term investments while waiting for long-term investment
opportunities.
Municipal lease obligations Each fund may invest in municipal lease obligations,
including certificates of participation. Municipal lease obligations generally
finance the purchase of public property. The property is leased to the state or
a local government, and the lease payments are used to pay the interest on the
obligations. Municipal lease obligations differ from other municipal securities
because the lessee's governing body must appropriate (set aside) the money to
make the lease payments each year. If the money is not appropriated, the issuer
or the lessee can end the lease without penalty. If the lease is cancelled,
investors who own the municipal lease obligations may not be paid. The board of
trustees review each fund's municipal lease obligations to try to assure that
they are liquid investments based on various factors reviewed by the fund's
manager and monitored by the board.
Since annual appropriations are required to make lease payments, municipal lease
obligations generally are not subject to constitutional limitations on the
issuance of debt and may allow an issuer to increase government liabilities
beyond constitutional debt limits. When faced with increasingly tight budgets,
local governments have more discretion to curtail lease payments under a
municipal lease obligation than they do to curtail payments on other municipal
securities. If not enough money is appropriated to make the lease payments, the
leased property may be repossessed as security for holders of the municipal
lease obligations. If this happens, there is no assurance that the property's
private sector or re-leasing value will be enough to make all outstanding
payments on the municipal lease obligations or that the payments will continue
to be tax-free.
While cancellation risk is inherent to municipal lease obligations, the
Tennessee Fund believes that this risk may be reduced, although not eliminated,
by its policies on the quality of securities in which it may invest. The
California High Yield Fund may invest in municipal lease obligations rated below
investment grade.
Mello-Roos bonds The California High Yield Fund may invest in Mello-Roos bonds.
Mello-Roos bonds are issued under the California Mello-Roos Community Facilities
Act to finance the building of roads, sewage treatment plants and other projects
designed to improve the infrastructure of a community. They are not rated and
are not considered obligations of the municipality.
Mello-Roos bonds are primarily secured by real estate taxes levied on property
located in the community. The timely payment of principal and interest on the
bonds depends on the developer's or other property owner's ability to pay the
real estate taxes. This ability could be negatively affected by a declining
economy or real estate market in California.
Callable bonds Each fund may invest in callable bonds, which allow the issuer to
repay some or all of the bonds ahead of schedule. If a bond is called, the fund
will receive the principal amount, the accrued interest, and may receive a small
additional payment as a call premium. The manager may sell a callable bond
before its call date, if it believes the bond is at its maximum premium
potential. When pricing callable bonds, the call feature is factored into the
price of the bonds and may impact the fund's net asset value.
An issuer is more likely to call its bonds when interest rates are falling,
because the issuer can issue new bonds with lower interest payments. If a bond
is called, the fund may have to replace it with a lower-yielding security. A
call of some or all of these securities may lower the fund's income, its yield
and its distributions to shareholders. If the fund originally paid a premium for
the bond because it had appreciated in value from its original issue price, the
fund also may not be able to recover the full amount it paid for the bond. One
way for the fund to protect itself from call risk is to buy bonds with call
protection. Call protection is an assurance that the bond will not be called for
a specific time period, typically five to 10 years from when the bond is issued.
Escrow-secured or defeased bonds are created when an issuer refunds, before
maturity, an outstanding bond issue that is not immediately callable (or
pre-refunds), and sets aside funds for redemption of the bonds at a future date.
The issuer uses the proceeds from a new bond issue to buy high grade, interest
bearing debt securities, generally direct obligations of the U.S. government.
These securities are then deposited in an irrevocable escrow account held by a
trustee bank to secure all future payments of principal and interest on the
pre-refunded bond. Escrow-secured bonds often receive a triple A or equivalent
rating.
Stripped municipal securities Municipal securities may be sold in "stripped"
form. Stripped municipal securities represent separate ownership of principal
and interest payments on municipal securities.
Zero-coupon securities Each fund may invest in zero-coupon and delayed interest
securities. Zero-coupon securities make no periodic interest payments, but are
sold at a deep discount from their face value. The buyer recognizes a rate of
return determined by the gradual appreciation of the security, which is redeemed
at face value on a specified maturity date. The discount varies depending on the
time remaining until maturity, as well as market interest rates, liquidity of
the security, and the issuer's perceived credit quality. The discount, in the
absence of financial difficulties of the issuer, typically decreases as the
final maturity date approaches. If the issuer defaults, the fund may not receive
any return on its investment.
Because zero-coupon securities bear no interest and compound semiannually at the
rate fixed at the time of issuance, their value is generally more volatile than
the value of other fixed-income securities. Since zero-coupon bondholders do not
receive interest payments, zero-coupon securities 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.
An investment in zero-coupon and delayed interest securities may cause the fund
to recognize income and make distributions to shareholders before it receives
any cash payments on its investment. To generate cash to satisfy distribution
requirements, the fund may have to sell 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.
Convertible and step coupon bonds Each fund may invest a portion of its assets
in convertible and step coupon bonds. Convertible bonds are zero-coupon
securities until a predetermined date, at which time they convert to a specified
coupon security. The coupon on step coupon bonds changes periodically during the
life of the security based on predetermined dates chosen when the security is
issued.
U.S. government obligations are issued by the U.S. Treasury or by agencies
and instrumentalities of the U.S. government and are backed by the full faith
and credit of the U.S. government. They include Treasury bills, notes and
bonds.
Commercial paper is a promissory note issued by a corporation to finance its
short-term credit needs. Each fund may invest in taxable commercial paper only
for temporary defensive purposes.
When-issued transactions Municipal securities are frequently offered on a
"when-issued" basis. When so offered, the price, which is generally expressed in
yield terms, is fixed at the time the commitment to buy is made, but delivery
and payment take place at a later date. During the time between purchase and
settlement, no payment is made by the fund to the issuer and no interest accrues
to the fund. If the other party to the transaction fails to deliver or pay for
the security, the fund could miss a favorable price or yield opportunity, or
could experience a loss.
When a fund makes the commitment to buy a municipal security on a when-issued
basis, it records the transaction and reflects the value of the security in the
determination of its net asset value. The funds do not believe their net asset
value or income will be negatively affected by their purchase of municipal
securities on a when-issued basis. Neither fund will engage in when-issued
transactions for investment leverage purposes.
Although a fund generally will buy municipal securities on a when-issued basis
with the intention of acquiring the securities, it may sell the securities
before the settlement date if it is considered advisable. When the fund is the
buyer, it will maintain cash or liquid securities, with an aggregate value equal
to the amount of its purchase commitments, in a segregated account with its
custodian bank until payment is made. If assets of the fund are held in cash
pending the settlement of a purchase of securities, the fund will not earn
income on those assets.
Illiquid investments Each fund may invest up to 10% of its net assets in
illiquid securities. Illiquid securities are generally securities that cannot be
sold within seven days in the normal course of business at approximately the
amount at which the fund has valued them.
Temporary investments When the manager believes the securities trading markets
or the economy are experiencing excessive volatility or a prolonged general
decline, or other unusual or adverse conditions exist, including the
unavailability of securities that meet a fund's investment criteria, it may
invest the fund's portfolio in a temporary defensive manner. Under these
circumstances, each fund may invest all of its assets in securities that pay
taxable interest, including (i) high quality commercial paper and obligations of
U.S. banks with assets of $1 billion or more; (ii) securities issued by or
guaranteed by the full faith and credit of the U.S. government; or (iii)
municipal securities issued by a state or local government other than the fund's
state. Each fund also may invest all of its assets in municipal securities
issued by a U.S. territory such as Guam, Puerto Rico, the Mariana Islands or the
U.S. Virgin Islands.
Securities transactions The frequency of portfolio transactions, usually
referred to as the portfolio turnover rate, varies for each fund from year to
year, depending on market conditions. While short-term trading increases
portfolio turnover and may increase costs, the execution costs for municipal
securities are substantially less than for equivalent dollar values of equity
securities.
Credit quality All things being equal, the lower a security's credit quality,
the higher the risk and the higher the yield the security generally must pay as
compensation to investors for the higher risk.
A security's credit quality depends on the issuer's ability to pay interest on
the security and, ultimately, to repay the principal. Independent rating
agencies, such as Fitch Investors Service Inc. (Fitch), Moody's Investors
Service, Inc. (Moody's), and Standard & Poor's Corporation (S&P), often rate
municipal securities based on their opinion of the issuer's credit quality. Most
rating agencies use a descending alphabet scale to rate long-term securities,
and a descending numerical scale to rate short-term securities. Securities in
the top four ratings are "investment grade," although securities in the fourth
highest rating may have some speculative features. These ratings are described
at the end of this SAI under "Description of Ratings."
An insurance company, bank or other foreign or domestic entity may provide
credit support for a municipal security and enhance its credit quality. For
example, some municipal securities are insured, which means they are covered by
an insurance policy that guarantees the timely payment of principal and
interest. Other municipal securities may be backed by letters of credit,
guarantees, or escrow or trust accounts that contain securities backed by the
full faith and credit of the U.S. government to secure the payment of principal
and interest.
As discussed in the prospectus, each fund has limitations on the credit quality
of the securities it may buy. In addition, the California High Yield Fund may
invest up to 5% of its net assets in defaulted securities if the manager
believes the issuer may resume making interest payments or other favorable
developments seem likely in the near future.
Maturity Municipal securities are issued with a specific maturity date - the
date when the issuer must repay the amount borrowed. Maturities typically range
from less than one year (short term) to 30 years (long term). In general,
securities with longer maturities are more sensitive to price changes, although
they may provide higher yields. Neither fund has any restrictions on the
maturity of the securities it may buy nor on its average portfolio maturity.
Investment restrictions Each fund has adopted the following restrictions as
fundamental policies. This means they may only be changed if the change is
approved by (i) more than 50% of the fund's outstanding shares or (ii) 67% or
more of the fund's shares present at a shareholder meeting if more than 50% of
the fund's outstanding shares are represented at the meeting in person or by
proxy, whichever is less.
Each 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 the 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 Tennessee Fund, all or substantially all of the assets of the
fund may be invested in another registered investment company having the same
investment goal 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 manager own beneficially more than
one-half 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 Tennessee Fund, 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 goal 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 the fund's investment
manager 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 Tennessee Fund, 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
goal 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 Tennessee Fund, all or substantially all of the assets of the fund
may be invested in another registered investment company having the same
investment goal and policies as the fund. To the extent permitted by exemptions
which may be granted under the Investment Company Act of 1940, as amended, the
fund may invest in shares of one or more money market funds managed by the
fund's investment manager or its affiliates.
10. Invest more than 25% of assets in securities of any industry, except that,
in the case of the Tennessee Fund, 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 goal 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.
Municipal securities issued to finance non-governmental business activities
generally are not considered 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.
Each fund presently has the following additional restriction, which is not
fundamental and may be changed without shareholder approval. Each fund may not
invest in real estate limited partnerships.
If a bankruptcy or other extraordinary event occurs concerning a particular
security the fund owns, the fund may receive stock, real estate, or other
investments that the fund would not, or could not, buy. If this happens, the
fund intends to sell such investments as soon as practicable while maximizing
the return to shareholders.
Generally, the policies and restrictions discussed in this SAI and in the
prospectus apply when the fund makes an investment. In most cases, the fund is
not required to sell a security because circumstances change and the security no
longer meets one or more of the fund's policies or restrictions. If a percentage
restriction or limitation is met at the time of investment, a later increase or
decrease in the percentage due to a change in the value or liquidity of
portfolio securities will not be considered a violation of the restriction or
limitation.
Risks
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State Since each fund mainly invests in the municipal securities of its state,
its performance is closely tied to the ability of issuers of municipal
securities in its state to continue to make principal and interest payments on
their securities. The issuers' ability to do this is in turn dependent on
economic, political and other conditions within the state. Below is a discussion
of certain conditions that may affect municipal issuers in each fund's state. It
is not a complete analysis of every material fact that may affect the ability of
issuers of municipal securities to meet their debt obligations or the economic
or political conditions within any state and is subject to change. The
information below is based on data available to the funds from historically
reliable sources, but the funds have not independently verified it.
The ability of issuers of municipal securities to continue to make principal and
interest payments is dependent in large part on their ability to raise revenues,
primarily through taxes, and to control spending. Many factors can affect a
state's revenues including the rate of population growth, unemployment rates,
personal income growth, federal aid, and the ability to attract and keep
successful businesses. A number of factors can also affect a state's spending
including the need for infrastructure improvements, increased costs for
education and other services, current debt levels, and the existence of
accumulated budget deficits. The following provides some information on these
and other factors.
California. California's economy has been the largest of all the states in the
nation. Like many other states, however, California was significantly affected
by the national recession of the early 1990s, especially in the southern portion
of the state. Most of its job losses during its recession resulted from military
cutbacks and the downturn in the construction industry. Downsizing in the
state's aerospace industry, excess office capacity, and slow growth in
California's export market also contributed to the state's recession.
Since mid-1993, California's economic recovery has been fueled by growth in the
export, entertainment, tourism and computer services sectors. In March 1999,
California's employment was up 3%, with growth in construction (8.5%), services
(4.5%), government (3%), finance, insurance and real estate (2.3%) and trade
(2%). Despite strong employment growth, California's unemployment rate has
remained above the national average. Recent economic problems in Asia have
adversely affected the state's high tech manufacturing and related industries,
resulting in slower growth than in previous years. Further weakening of the
economies of California's international trade partners could have a negative
impact on the state.
During the period from 1990 to 1994, California experienced large budget
deficits due to its economic recession, as well as unrealistic budget
assumptions. School expenditures totaling $1.8 billion were recorded as "loan
assets" on the state's books to be repaid by 2002. When adjusted to account for
these loans, California's deficit balance was 10.7% of expenditures in 1992. At
the end of fiscal 1998, general fund balances were a positive $547 million or
1.1% of expenditures on a GAAP basis.
California's debt levels have grown in recent years. In 1990, the state's debt
per capita was below the median for all states. By 1998, debt per capita had
risen to $675, above the $446 median for all states. California's debt levels
may increase further as the state attempts to address its infrastructure needs
and school improvements.
While the state's financial performance has improved in recent years, its fiscal
operations have remained vulnerable. Increased funding for schools and
infrastructure improvements and various tax cuts have offset some of the growth
in revenues that has resulted from the improving economy. The state's budget
approval process, which requires a two-thirds legislative vote, also has
hampered the state's financial flexibility, as has its lack of a formalized
mid-year budget correction process. The state's relatively low budget reserves
and reduced flexibility make the state vulnerable to a future economic downturn.
Overall, however, S&P considered California's outlook to be positive as of June
14, 1999.
Tennessee. Tennessee's economic recovery from the recession of the early 1990s
has been relatively strong. The state's economy has diversified, with growth in
the services, trade and durable manufacturing sectors offsetting losses in the
textile and apparel manufacturing industries. In 1998, services represented
26.7% of the state's economic base, trade 24% and manufacturing 20%. Despite
slower growth in recent years, growth in durable manufacturing, especially
automobile-related durable manufacturing and the corresponding attraction of
related supply companies, has helped to contribute to the state's personal
income growth with its relatively higher wages. From 1992-1997, the state's per
capita personal income grew by 4.3% annually, exceeding the national average,
and grew by 5.25%, on average, between 1996 and 1998. The state's greater
dependence on auto production, however, may make it more susceptible to a
downturn in the historically cyclical auto industry.
The state's financial management has been historically strong. The state has
shown an ability to react quickly to shortfalls and ended fiscal 1998 with a net
surplus of $238 million, which increased the total general fund balance to $577
million.
The state's finances have been dependent on sales and use taxes. These taxes
have been levied on a wide variety of goods and services, however, and have had
a strong, although slowing, growth trend in recent years. On the other side, the
state's main expenditures have been in the areas of education and health and
social services. The state's commitment to education may help to make the
state's workforce more attractive to prospective employers.
U.S. territories Since each fund may invest up to 35% of its assets in municipal
securities issued by U.S. territories, the ability of municipal issuers in U.S.
territories to continue to make principal and interest payments also may affect
the fund's performance. As with state municipal issuers, the ability to make
these payments is dependent on economic, political and other conditions. Below
is a discussion of certain conditions within some of the territories where each
fund may invest. It is not a complete analysis of every material fact that may
affect the ability of issuers of U.S. territory municipal securities to meet
their debt obligations or the economic or political conditions within the
territories and is subject to change. It is based on data available to the funds
from historically reliable sources, but it has not been independently verified
by the funds.
Guam. Guam's economy has been heavily dependent on tourism. It has been
especially dependent on Japanese tourism, which has made Guam vulnerable to
fluctuations in the relationship between the U.S. dollar and the Japanese yen.
The recent Asian economic crisis and Typhoon Paka, which hit Guam in December
1997, negatively affected both tourism and other economic activities in Guam and
contributed to a decline of 1.8% in gross island product between 1997 and 1998.
In the early to mid-1990s, Guam's financial position deteriorated due to a
series of natural disasters that led to increased spending on top of already
significant budget gaps. As a result, the government introduced a comprehensive
financial plan in June 1995 to help balance the budget and reduce the general
fund deficit by fiscal 1999. For fiscal 1998, however, Guam incurred a $21
million deficit and ended the year with a negative unreserved general fund
balance of $158.9 million. Another deficit is expected in 1999.
While Guam's debt burden has been manageable, Guam's ability to maintain current
debt levels may be challenged in the near future. U.S. military downsizing has
reduced the federal presence on the island and also may reduce federal support
for infrastructure projects. At the same time, Guam has faced increasing
pressure to improve its infrastructure to help generate economic development.
Overall, as of May 20, 1999, S&P's outlook for Guam was negative due to Guam's
continued weak financial position and inability to meet the goals of the
financial plan.
Puerto Rico. Overall, Moody's considered Puerto Rico's outlook stable as of
January 1999. In recent years, Puerto Rico's financial performance has improved.
Relatively strong revenue growth and more aggressive tax collection procedures
resulted in a general fund surplus for fiscal 1998 (unaudited). For fiscal 1999,
spending increases of 11% are budgeted, which may create an operating deficit
and deplete the commonwealth's unreserved fund balance.
Puerto Rico's debt levels have been high. Going forward, these levels may
increase as Puerto Rico attempts to finance significant capital and
infrastructure improvements. Puerto Rico also will need to address its large
unfunded pension liability of more than $6 billion.
Despite Puerto Rico's stable outlook, Puerto Rico may face challenges in the
coming years with the 1996 passage of a bill eliminating section 936 of the
Internal Revenue Code. This section has given certain U.S. corporations
operating in Puerto Rico significant tax advantages. These incentives have
helped considerably with Puerto Rico's economic growth, especially with the
development of its manufacturing sector. U.S. firms that have benefited from
these incentives have provided a significant portion of Puerto Rico's revenues,
employment and deposits in local financial institutions. The section 936
incentives will be phased out over a 10-year period ending in 2006. It is hoped
that this long phase-out period will give Puerto Rico sufficient time to lessen
the potentially negative effects of section 936's elimination. Outstanding
issues relating to the potential for a transition to statehood also may have
broad implications for Puerto Rico and its financial and credit position.
Credit (California High Yield Fund only) Since the California High Yield Fund
may invest in municipal securities rated below investment grade, an investment
in the fund is subject to a higher degree of risk than an investment in a fund
that invests primarily in higher-quality securities.
The market value of high yield, lower-quality municipal securities tends to
reflect individual developments affecting the issuer to a greater degree than
the market value of higher-quality securities, which react primarily to
fluctuations in the general level of interest rates. Lower-quality securities
also tend to be more sensitive to economic conditions than higher-quality
securities. Factors adversely affecting the market value of high yield
securities may lower the fund's net asset value and affect its performance.
Projects financed by high yield municipal securities are often highly leveraged
and may not have more traditional methods of financing available to them.
Therefore, the risk associated with buying these securities is generally greater
than the risk associated with higher-quality securities. For example, during an
economic downturn or a sustained period of rising interest rates, projects
financed by lower-quality securities may experience financial stress and may not
have sufficient cash flow to make interest payments. The issuer's ability to
make timely interest and principal payments also may be adversely affected by
specific developments affecting the issuer, including the issuer's inability to
meet specific projected revenue forecasts or the unavailability of additional
financing.
The risk of loss due to default also may be considerably greater with
lower-quality securities. If the issuer of a security in the fund's portfolio
defaults, the fund may have unrealized losses on the security, which may lower
the fund's net asset value. Defaulted securities tend to lose much of their
value before they default. Thus, the fund's net asset value may be adversely
affected before an issuer defaults. In addition, the fund may incur additional
expenses if it must try to recover principal or interest payments on a defaulted
security.
Lower-quality securities may not be as liquid as higher-quality securities.
Reduced liquidity in the secondary market may have an adverse impact on the
market price of a security and on the fund's ability to sell a security in
response to a specific economic event, such as a deterioration in the
creditworthiness of the issuer, or if necessary to meet the fund's liquidity
needs. Reduced liquidity also may make it more difficult to obtain market
quotations based on actual trades for purposes of valuing the fund's portfolio.
Officers and Trustees
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The trust has a board of trustees. The board is responsible for the overall
management of the trust, including general supervision and review of each fund's
investment activities. The board, in turn, elects the officers of the trust who
are responsible for administering the trust's day-to-day operations. The board
also monitors each fund to ensure no material conflicts exist among share
classes. While none is expected, the board will act appropriately to resolve any
material conflict that may arise.
The name, age and address of the officers and board members, as well as their
affiliations, positions held with the trust, and principal occupations during
the past five years are shown below.
Frank H. Abbott, III (78)
1045 Sansome Street, San Francisco, CA 94111
Trustee
President and Director, Abbott Corporation (an investment company); director or
trustee, as the case may be, of 27 of the investment companies in the Franklin
Templeton Group of Funds; and formerly, Director, MotherLode Gold Mines
Consolidated (gold mining) (until 1996) and Vacu-Dry Co. (food processing)
(until 1996).
Harris J. Ashton (67)
191 Clapboard Ridge Road, Greenwich, CT 06830
Trustee
Director, RBC Holdings, Inc. (bank holding company) and Bar-S Foods (meat
packing company); director or trustee, as the case may be, of 48 of the
investment companies in the Franklin Templeton Group of Funds; and formerly,
President, Chief Executive Officer and Chairman of the Board, General Host
Corporation (nursery and craft centers) (until 1998).
*Harmon E. Burns (54)
777 Mariners Island Blvd., San Mateo, CA 94404
Vice President and Trustee
Executive Vice President and Director, Franklin Resources, Inc., Franklin
Templeton Distributors, Inc. and Franklin Templeton Services, Inc.; Executive
Vice President, Franklin Advisers, Inc.; Director, Franklin Investment
Advisory Services, Inc. and Franklin/Templeton Investor Services, Inc.; and
officer and/or director or trustee, as the case may be, of most of the other
subsidiaries of Franklin Resources, Inc. and of 52 of the investment
companies in the Franklin Templeton Group of Funds.
S. Joseph Fortunato (67)
Park Avenue at Morris County, P.O. Box 1945
Morristown, NJ 07962-1945
Trustee
Member of the law firm of Pitney, Hardin, Kipp & Szuch; and director or trustee,
as the case may be, of 50 of the investment companies in the Franklin Templeton
Group of Funds.
Edith E. Holiday (47)
3239 38th Street, N.W., Washington, DC 20016
Trustee
Director, Amerada Hess Corporation (exploration and refining of natural gas)
(1993-present), Hercules Incorporated (chemicals, fibers and resins)
(1993-present), Beverly Enterprises, Inc. (health care) (1995-present) and H.J.
Heinz Company (processed foods and allied products) (1994-present); director or
trustee, as the case may be, of 24 of the investment companies in the Franklin
Templeton Group of Funds; and formerly, Chairman (1995-1997) and Trustee
(1993-1997), National Child Research Center, Assistant to the President of the
United States and Secretary of the Cabinet (1990-1993), General Counsel to the
United States Treasury Department (1989-1990), and Counselor to the Secretary
and Assistant Secretary for Public Affairs and Public Liaison - United States
Treasury Department (1988-1989).
*Charles B. Johnson (66)
777 Mariners Island Blvd., San Mateo, CA 94404
Chairman of the Board and Trustee
President, Chief Executive Officer and Director, Franklin Resources, Inc.;
Chairman of the Board and Director, Franklin Advisers, Inc., Franklin
Investment Advisory Services, Inc. and Franklin Templeton Distributors, Inc.;
Director, Franklin/Templeton Investor Services, Inc. and Franklin Templeton
Services, Inc.; officer and/or director or trustee, as the case may be, of
most of the other subsidiaries of Franklin Resources, Inc. and of 49 of the
investment companies in the Franklin Templeton Group of Funds.
*Rupert H. Johnson, Jr. (59)
777 Mariners Island Blvd., San Mateo, CA 94404
President and Trustee
Executive Vice President and Director, Franklin Resources, Inc. and Franklin
Templeton Distributors, Inc.; President and Director, Franklin Advisers, Inc.
and Franklin Investment Advisory Services, Inc.; Senior Vice President, Franklin
Advisory Services, LLC; Director, Franklin/Templeton Investor Services, Inc.;
and officer and/or director or trustee, as the case may be, of most of the other
subsidiaries of Franklin Resources, Inc. and of 52 of the investment companies
in the Franklin Templeton Group of Funds.
Frank W.T. LaHaye (70)
20833 Stevens Creek Blvd., Suite 102, Cupertino, CA 95014
Trustee
General Partner, Miller & LaHaye, which is the General Partner of Peregrine
Ventures II (venture capital firm); director or trustee, as the case may be, of
27 of the investment companies in the Franklin Templeton Group of Funds; and
formerly, Director, Fischer Imaging Corporation (medical imaging systems),
Digital Transmission Systems, Inc. (wireless communications) and Quarterdeck
Corporation (software firm), and General Partner, Peregrine Associates, which
was the General Partner of Peregrine Ventures (venture capital firm).
Gordon S. Macklin (71)
8212 Burning Tree Road, Bethesda, MD 20817
Trustee
Director, Fund American Enterprises Holdings, Inc. (holding company), Martek
Biosciences Corporation, MCI WorldCom (information services), MedImmune, Inc.
(biotechnology), Spacehab, Inc. (aerospace services) and Real 3D (software);
director or trustee, as the case may be, of 48 of the investment companies in
the Franklin Templeton Group of Funds; and formerly, Chairman, White River
Corporation (financial services) and Hambrecht and Quist Group (investment
banking), and President, National Association of Securities Dealers, Inc.
Hayato Tanaka (82)
277 Haihai Street, Hilo, HI 96720
Trustee
Retired, former owner of The Jewel Box Orchids; and trustee of two of the
investment companies in the Franklin Templeton Group of Funds.
Martin L. Flanagan (39)
777 Mariners Island Blvd., San Mateo, CA 94404
Vice President and Chief Financial Officer
Senior Vice President and Chief Financial Officer, Franklin Resources, Inc.,
Franklin/Templeton Investor Services, Inc. and Franklin Mutual Advisers, LLC;
Executive Vice President, Chief Financial Officer and Director, Templeton
Worldwide, Inc.; Executive Vice President, Chief Operating Officer and Director,
Templeton Investment Counsel, Inc.; Executive Vice President and Chief Financial
Officer, Franklin Advisers, Inc.; Chief Financial Officer, Franklin Advisory
Services, LLC and Franklin Investment Advisory Services, Inc.; President and
Director, Franklin Templeton Services, Inc.; officer and/or director of some of
the other subsidiaries of Franklin Resources, Inc.; and officer and/or director
or trustee, as the case may be, of 52 of the investment companies in the
Franklin Templeton Group of Funds.
Deborah R. Gatzek (50)
777 Mariners Island Blvd., San Mateo, CA 94404
Vice President and Secretary
Senior Vice President and General Counsel, Franklin Resources, Inc.; Senior Vice
President, Franklin Templeton Services, Inc. and Franklin Templeton
Distributors, Inc.; Executive Vice President, Franklin Advisers, Inc.; Vice
President, Franklin Advisory Services, LLC and Franklin Mutual Advisers, LLC;
Vice President, Chief Legal Officer and Chief Operating Officer, Franklin
Investment Advisory Services, Inc.; and officer of 53 of the investment
companies in the Franklin Templeton Group of Funds.
Charles E. Johnson (43)
500 East Broward Blvd., Fort Lauderdale, FL 33394-3091
Vice President
Senior Vice President and Director, Franklin Resources, Inc.; Senior Vice
President, Franklin Templeton Distributors, Inc.; President and Director,
Templeton Worldwide, Inc.; Chairman and Director, Templeton Investment Counsel,
Inc.; Vice President, Franklin Advisers, Inc.; officer and/or director of some
of the other subsidiaries of Franklin Resources, Inc.; and officer and/or
director or trustee, as the case may be, of 33 of the investment companies in
the Franklin Templeton Group of Funds.
Thomas J. Kenny (36)
777 Mariners Island Blvd., San Mateo, CA 94404
Vice President
Executive Vice President, Franklin Advisers, Inc.; and officer of eight of the
investment companies in the Franklin Templeton Group of Funds.
Diomedes Loo-Tam (60)
777 Mariners Island Blvd., San Mateo, CA 94404
Treasurer and Principal Accounting Officer
Senior Vice President, Franklin Templeton Services, Inc.; and officer of 32 of
the investment companies in the Franklin Templeton Group of Funds.
Edward V. McVey (62)
777 Mariners Island Blvd., San Mateo, CA 94404
Vice President
Senior Vice President and National Sales Manager, Franklin Templeton
Distributors, Inc.; and officer of 28 of the investment companies in the
Franklin Templeton Group of Funds.
*This board member is considered an "interested person" under federal securities
laws.
Note: Charles B. Johnson and Rupert H. Johnson, Jr. are brothers and the
father and uncle, respectively, of Charles E. Johnson.
The trust pays noninterested board members $900 per quarter plus $600 per
meeting attended. Board members who serve on the audit committee of the trust
and other funds in the Franklin Templeton Group of Funds receive a flat fee of
$2,000 per committee meeting attended, a portion of which is allocated to the
trust. Members of a committee are not compensated for any committee meeting held
on the day of a board meeting. Noninterested board members also may serve as
directors or trustees of other funds in the Franklin Templeton Group of Funds
and may receive fees from these funds for their services. The fees payable to
certain noninterested board members by the trust are subject to reductions
resulting from fee caps limiting the amount of fees payable to board members who
serve on other boards within the Franklin Templeton Group of Funds. The
following table provides the total fees paid to noninterested board members by
the trust and by the Franklin Templeton Group of Funds.
Number of
Total Fees Boards in
Received from the Franklin
Total Fees the Franklin Templeton
Received Templeton Group
from Group of Funds
the Trust1 of Funds2 on which
Name ($) ($) Each Serves3
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Frank H. Abbott, III 4,587 166,614 27
Harris J. Ashton 5,367 361,157 48
S. Joseph Fortunato 5,043 367,835 50
Edith E. Holiday 6,000 211,400 24
Frank W.T. LaHaye 5,187 171,536 27
Gordon S. Macklin 5,367 361,157 48
Hayato Tanaka 6,600 5,300 2
1. For the fiscal year ended May 31, 1999.
2. For the calendar year ended December 31, 1998.
3. We base the number of boards on the number of registered investment companies
in the Franklin Templeton Group of Funds. This number does not include the total
number of series or funds within each investment company for which the board
members are responsible. The Franklin Templeton Group of Funds currently
includes 54 registered investment companies, with approximately 161 U.S. based
funds or series.
Noninterested board members 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 or trustee. No officer
or board member received any other compensation, including pension or retirement
benefits, directly or indirectly from the fund or other funds in the Franklin
Templeton Group of Funds. Certain officers or board members who are shareholders
of Franklin Resources, Inc. may be deemed to receive indirect remuneration by
virtue of their participation, if any, in the fees paid to its subsidiaries.
Board members historically have followed a policy of having substantial
investments in one or more of the funds in the Franklin Templeton Group of
Funds, as is consistent with their individual financial goals. In February 1998,
this policy was formalized through adoption of a requirement that each board
member invest one-third of fees received for serving as a director or trustee of
a Templeton fund in shares of one or more Templeton funds and one-third of fees
received for serving as a director or trustee of a Franklin fund in shares of
one or more Franklin funds until the value of such investments equals or exceeds
five times the annual fees paid such board member. Investments in the name of
family members or entities controlled by a board member constitute fund holdings
of such board member for purposes of this policy, and a three year phase-in
period applies to such investment requirements for newly elected board members.
In implementing such policy, a board member's fund holdings existing on February
27, 1998, are valued as of such date with subsequent investments valued at cost.
Management and Other Services
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Manager and services provided Each fund's manager is Franklin Advisers, Inc. The
manager is a wholly owned subsidiary ofFranklin Resources, Inc. (Resources), a
publicly owned company engaged in the financial services industry through its
subsidiaries. Charles B. Johnson and Rupert H. Johnson, Jr. are the principal
shareholders of Resources.
The manager provides investment research and portfolio management services, and
selects the securities for each fund to buy, hold or sell. The manager's
extensive research activities include, as appropriate, traveling to meet with
issuers and to review project sites. The manager also selects the brokers who
execute the funds' portfolio transactions. The manager provides periodic reports
to the board, which reviews and supervises the manager's investment activities.
To protect the funds, the manager and its officers, directors and employees are
covered by fidelity insurance.
The manager and its affiliates manage numerous other investment companies and
accounts. The manager may give advice and take action with respect to any of the
other funds it manages, or for its own account, that may differ from action
taken by the manager on behalf of each fund. Similarly, with respect to each
fund, the manager is not obligated to recommend, buy or sell, or to refrain from
recommending, buying or selling any security that the manager and access
persons, as defined by applicable federal securities laws, may buy or sell for
its or their own account or for the accounts of any other fund. The manager is
not obligated to refrain from investing in securities held by the fund or other
funds it manages. Of course, any transactions for the accounts of the manager
and other access persons will be made in compliance with the funds' code of
ethics.
Under the funds' code of ethics, employees of the Franklin Templeton Group who
are access persons may 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 by the close
of the business day following the day clearance is granted; (ii) copies of all
brokerage confirmations and statements must be sent to a compliance officer;
(iii) all brokerage accounts must be disclosed on an annual basis; and (iv)
access persons involved in preparing and making investment decisions must, in
addition to (i), (ii) and (iii) 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.
Management fees Each fund pays the manager a fee equal to an annual rate of:
o 0.625 of 1% of the value of net assets up to and including $100 million;
o 0.50 of 1% of the value of net assets over $100 million up to and
including $250 million; and
o 0.45 of 1% of the value of net assets in excess of $250 million.
The fee is computed daily according to the terms of the management agreement.
Each class of the California High Yield Fund's shares pays its proportionate
share of the fee.
For the last three fiscal years ended May 31, the funds paid the following
management fees:
Management Fees Paid ($)
---------------------------------------
1999 1998 1997
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California High Yield Fund1 1,485,870 607,269 277,913
Tennessee Fund2 125,647 76,507 36,264
1. For the fiscal years ended May 31, 1999, 1998 and 1997, management fees,
before any advance waiver, totaled $3,022,340, $1,729,049 and $985,277,
respectively. Under an agreement by the manager to limit its fees, the fund paid
the management fees shown.
2. For the fiscal years ended May 31, 1999, 1998 and 1997, management fees,
before any advance waiver, totaled $373,934, $227,268 and $120,438,
respectively. Under an agreement by the manager to limit its fees, the fund paid
the management fees shown.
Administrator and services provided Franklin Templeton Services, Inc. (FT
Services) has an agreement with the manager to provide certain administrative
services and facilities for each fund. FT Services is wholly owned by Resources
and is an affiliate of the funds' manager and principal underwriter.
The administrative services FT Services provides include preparing and
maintaining books, records, and tax and financial reports, and monitoring
compliance with regulatory requirements.
Administration fees The manager pays FT Services a monthly fee equal to an
annual rate of:
o 0.15% of each fund's average daily net assets up to $200 million;
o 0.135% of average daily net assets over $200 million up to $700 million;
o 0.10% of average daily net assets over $700 million up to $1.2 billion;
and
o 0.075% of average daily net assets over $1.2 billion.
During the last three fiscal years ended May 31, the manager paid FT Services
the following administration fees:
Administration Fees Paid ($)
----------------------------------------
1999 1998 19971
- --------------------------------------------------------------------------------
California High Yield Fund 792,926 474,252 188,458
Tennessee Fund 89,766 54,548 21,137
1. For the period from October 1, 1996, through May 31, 1997.
Shareholder servicing and transfer agent Franklin/Templeton Investor Services,
Inc. (Investor Services) is each fund's shareholder servicing agent and acts as
the funds' transfer agent and dividend-paying agent. Investor Services is
located at 777 Mariners Island Blvd., San Mateo, CA 94404. Please send all
correspondence to Investor Services to P.O. Box 997151, Sacramento, CA
95899-9983.
For its services, Investor Services receives a fixed fee per account. Each fund
also will reimburse Investor Services for certain out-of-pocket expenses, which
may include payments by Investor Services to entities, including affiliated
entities, that provide sub-shareholder services, recordkeeping and/or transfer
agency services to beneficial owners of the fund. The amount of reimbursements
for these services per benefit plan participant fund account per year will not
exceed the per account fee payable by the fund to Investor Services in
connection with maintaining shareholder accounts.
Custodian Bank of New York, Mutual Funds Division, 90 Washington Street, New
York, NY 10286, acts as custodian of each fund's securities and other assets.
Auditor PricewaterhouseCoopers LLP, 333 Market Street, San Francisco, CA 94105,
is the funds' independent auditor. The auditor gives an opinion on the financial
statements included in the trust's Annual Report to Shareholders and reviews the
trust's registration statement filed with the U.S. Securities and Exchange
Commission (SEC).
Portfolio Transactions
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Since most purchases by the funds are principal transactions at net prices, the
funds incur little or no brokerage costs. Each fund deals directly with the
selling or buying principal or market maker without incurring charges for the
services of a broker on its behalf, unless it is determined that a better price
or execution may be obtained by using 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
funds do not buy securities in underwritings where they are given no choice, or
only limited choice, in the designation of dealers to receive the commission.
The funds seek 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 provided by the dealers
in the execution of orders.
It is not possible to place a dollar value on the special executions or on the
research services the manager receives from dealers effecting transactions in
portfolio securities. The allocation of transactions in order to obtain
additional research services allows the manager to supplement its own research
and analysis activities and to receive the views and information of individuals
and research staffs 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. If the funds'
officers are satisfied that the best execution is obtained, the sale of fund
shares, as well as shares of other funds in the Franklin Templeton Group of
Funds, also may be considered a factor in the selection of broker-dealers to
execute the funds' portfolio transactions.
If purchases or sales of securities of the funds and one or more other
investment companies or clients supervised by the manager are considered at or
about the same time, transactions in these 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. In some cases this procedure could
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 may improve execution and reduce transaction
costs to the funds.
During the fiscal years ended May 31, 1999, 1998 and 1997, the funds did not pay
any brokerage commissions.
As of May 31, 1999, the funds did not own securities of their regular
broker-dealers.
Distributions and Taxes
- --------------------------------------------------------------------------------
The funds calculate dividends and capital gains the same way for each class. The
amount of any income dividends per share will differ, however, generally due to
the difference in the distribution and service (Rule 12b-1) fees of each class.
Distributions are subject to approval by the board. The funds do not pay
"interest" or guarantee any fixed rate of return on an investment in their
shares.
Distributions of net investment income Each fund receives income generally in
the form of interest on its investments. This income, less expenses incurred in
the operation of the fund, constitutes the fund's net investment income from
which dividends may be paid to you.
By meeting certain requirements of the Internal Revenue Code, the funds have
qualified and continue to qualify to pay exempt-interest dividends to you. These
dividends are derived from interest income exempt from regular federal income
tax, and are not subject to regular federal income tax when they are distributed
to you. In addition, to the extent that exempt-interest dividends are derived
from interest on obligations of a state or its political subdivisions, or from
interest on qualifying U.S. territorial obligations (including qualifying
obligations of Puerto Rico, the U.S. Virgin Islands or Guam), they also will be
exempt from that state's personal income taxes. Most states generally do not
grant tax-free treatment to interest on state and municipal securities of other
states.
The funds may earn taxable income on any temporary investments, on the discount
from stripped obligations or their coupons, on income from securities loans or
other taxable transactions, or on ordinary income derived from the sale of
market discount bonds. Any fund distributions from such income will be taxable
to you as ordinary income, whether you receive them in cash or in additional
shares.
Distributions of capital gains The funds may derive capital gains and losses in
connection with sales or other dispositions of their portfolio securities.
Distributions from net short-term capital gains will be taxable to you as
ordinary income. Distributions from net long-term capital gains will be taxable
to you as long-term capital gain, regardless of how long you have held your
shares in a fund. Any net capital gains realized by a fund generally will be
distributed once each year, and may be distributed more frequently, if
necessary, in order to reduce or eliminate excise or income taxes on the fund.
Information on the tax character of distributions The funds will inform you of
the amount of your ordinary income dividends and capital gains distributions at
the time they are paid, and will advise you of their tax status for federal
income tax purposes shortly after the close of each calendar year, including the
portion of the distributions that on average comprise taxable income or interest
income that is a tax preference item under the alternative minimum tax. If you
have not held fund shares for a full year, a fund may designate and distribute
to you, as taxable, tax-exempt or tax preference income, a percentage of income
that is not equal to the actual amount of such income earned during the period
of your investment in the fund.
Election to be taxed as a regulated investment company Each fund has elected to
be treated as a regulated investment company under Subchapter M of the Internal
Revenue Code, has qualified as such for its most recent fiscal year, and intends
to so qualify during the current fiscal year. As regulated investment companies,
the funds generally pay no federal income tax on the income and gains they
distribute to you. The board reserves the right not to maintain the
qualification of a fund as a regulated investment company if it determines such
course of action to be beneficial to shareholders. In such case, a fund will be
subject to federal, and possibly state, corporate taxes on its taxable income
and gains, and distributions to you will be taxed as ordinary dividend income to
the extent of the fund's earnings and profits.
Excise tax distribution requirements To avoid federal excise taxes, the Internal
Revenue Code requires each fund to distribute to you by December 31 of each
year, at a minimum, the following amounts: 98% of its taxable ordinary income
earned during the calendar year; 98% of its capital gain net income earned
during the twelve month period ending October 31; and 100% of any undistributed
amounts from the prior year. Each fund intends to declare and pay these amounts
in December (or in January that are treated by you as received in December) to
avoid these excise taxes, but can give no assurances that its distributions will
be sufficient to eliminate all taxes.
Redemption of fund shares Redemptions and exchanges of fund shares are taxable
transactions for federal and state income tax purposes. If you redeem your fund
shares, or exchange your fund shares for shares of a different Franklin
Templeton Fund, the IRS will require that you report a gain or loss on your
redemption or exchange. If you hold your shares as a capital asset, the gain or
loss that you realize will be capital gain or loss and will be long-term or
short-term, generally depending on how long you hold your shares. Any loss
incurred on the redemption or exchange of shares held for six months or less
will be disallowed to the extent of any exempt-interest dividends distributed to
you with respect to your fund shares and any remaining loss will be treated as a
long-term capital loss to the extent of any long-term capital gains distributed
to you by the fund on those shares.
All or a portion of any loss that you realize upon the redemption of your fund
shares will be disallowed to the extent that you buy other shares in the fund
(through reinvestment of dividends or otherwise) within 30 days before or after
your share redemption. Any loss disallowed under these rules will be added to
your tax basis in the new shares you buy.
Deferral of basis If you redeem some or all of your shares in a fund, and then
reinvest the sales proceeds in the fund or in another Franklin Templeton Fund
within 90 days of buying the original shares, the sales charge that would
otherwise apply to your reinvestment may be reduced or eliminated. The IRS will
require you to report gain or loss on the redemption of your original shares in
a fund. In doing so, all or a portion of the sales charge that you paid for your
original shares in a fund will be excluded from your tax basis in the shares
sold (for the purpose of determining gain or loss upon the sale of such shares).
The portion of the sales charge excluded will equal the amount that the sales
charge is reduced on your reinvestment. Any portion of the sales charge excluded
from your tax basis in the shares sold will be added to the tax basis of the
shares you acquire from your reinvestment.
Dividends-received deduction for corporations Because each fund's income is
derived primarily from interest rather than dividends, no portion of its
distributions generally will be eligible for the corporate dividends-received
deduction. None of the dividends paid by the funds for the most recent fiscal
year qualified for such deduction, and it is anticipated that none of the
current year's dividends will so qualify.
Investment in complex securities Each fund may invest in complex securities.
These investments may be subject to numerous special and complex tax rules.
These rules could affect whether gains and losses recognized by a fund are
treated as ordinary income or capital gain, accelerate the recognition of income
to a fund and/or defer a fund's ability to recognize losses. In turn, these
rules may affect the amount, timing or character of the income distributed to
you by a fund.
Treatment of private activity bond interest Interest on certain private activity
bonds, while still exempt from regular federal income tax, is a preference item
for taxpayers when determining their alternative minimum tax under the Internal
Revenue Code and under the income tax provisions of several states. Private
activity bond interest could subject you to or increase your liability under
federal and state alternative minimum taxes, depending on your individual or
corporate tax position. Persons who are defined in the Internal Revenue Code as
substantial users (or persons related to such users) of facilities financed by
private activity bonds should consult with their tax advisors before buying fund
shares.
Organization, Voting Rights and Principal Holders
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Each fund is a nondiversified series of Franklin Municipal Securities Trust, an
open-end management investment company, commonly called a mutual fund. The trust
was organized as a Delaware business trust on June 15, 1992, and is registered
with the SEC.
The California High Yield Fund currently offers two classes of shares, Class A
and Class C. Before January 1, 1999, Class A shares were designated Class I and
Class C shares were designated Class II. The full title of each class is:
o Franklin California High Yield Municipal Fund - Class A
o Franklin California High Yield Municipal Fund - Class C
The Tennessee Fund offers only one share class. Because its sales charge
structure and Rule 12b-1 plan are similar to those of Class A shares, shares of
the fund are considered Class A shares for redemption, exchange and other
purposes.
The funds may offer additional classes of shares in the future.
Shares of each class of the California High Yield Fund represent proportionate
interests in the fund's assets. On matters that affect the fund as a whole, each
class has the same voting and other rights and preferences as any other class.
On matters that affect only one class, only shareholders of that class may vote.
Each class votes separately on matters affecting only that class, or expressly
required to be voted on separately by state or federal law. 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 may be offered in the future.
The trust has noncumulative voting rights. For board member elections, this
gives holders of more than 50% of the shares voting the ability to elect all of
the members of the board. If this happens, holders of the remaining shares
voting will not be able to elect anyone to the board.
The trust does not intend to hold annual shareholder meetings. The trust or a
series of the trust may hold special meetings, however, for matters requiring
shareholder approval. A meeting may be called by the board to consider the
removal of a board member if requested in writing by shareholders holding at
least 10% of the outstanding shares. In certain circumstances, we are required
to help you communicate with other shareholders about the removal of a board
member. A special meeting also may be called by the board in its discretion.
From time to time, the number of fund shares 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 funds, no other person holds beneficially or of record
more than 5% of the outstanding shares of any class.
As of July 6, 1999, the officers and board members, as a group, owned of record
and beneficially less than 1% of the outstanding shares of each fund and class.
The board members may own shares in other funds in the Franklin Templeton Group
of Funds.
Buying and Selling Shares
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Each fund continuously offers its shares through securities dealers who have an
agreement with Franklin Templeton Distributors, Inc. (Distributors). A
securities dealer includes any financial institution that, either directly or
through affiliates, has 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. Banks and financial institutions that
sell shares of the fund may be required by state law to register as securities
dealers.
For investors outside the U.S., the offering of fund shares may be limited in
many jurisdictions. An investor who wishes to buy shares of the fund should
determine, or have a broker-dealer determine, the applicable laws and
regulations of the relevant jurisdiction. Investors are responsible for
compliance with tax, currency exchange or other regulations applicable to
redemption and purchase transactions in any jurisdiction to which they may be
subject. Investors should consult appropriate tax and legal advisors to obtain
information on the rules applicable to these transactions.
All checks, drafts, wires and other payment mediums used to buy or sell shares
of the fund must be denominated in U.S. dollars. We may, in our sole discretion,
either (a) reject any order to buy or sell 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. We may deduct any applicable banking charges
imposed by the bank from your account.
When you buy shares, if you submit a check or a draft that is returned unpaid to
the fund we may impose a $10 charge against your account for each returned item.
Initial sales charges The maximum initial sales charge is 4.25% for Class A and
1% for Class C.
The initial sales charge for Class A shares may be reduced for certain large
purchases, as described in the prospectus. We offer several ways for you to
combine your purchases in the Franklin Templeton Funds to take advantage of the
lower sales charges for large purchases. The Franklin Templeton Funds include
the U.S. registered mutual funds in the Franklin Group of Funds(R) and the
Templeton Group of Funds except Franklin Templeton Variable Insurance Products
Trust, Templeton Capital Accumulator Fund, Inc., and Templeton Variable Products
Series Fund.
Cumulative quantity discount. For purposes of calculating the sales charge on
Class A shares, you may combine the amount of your current purchase with the
cost or current value, whichever is higher, of your existing shares in the
Franklin Templeton Funds. You also may combine the shares of your spouse,
children under the age of 21 or grandchildren under the age of 21. If you are
the sole owner of a company, you also may add any company accounts, including
retirement plan accounts.
Letter of intent (LOI). You may buy Class A shares at a reduced sales charge by
completing the letter of intent section of your account 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. By completing the letter of intent section of the application, you
acknowledge and agree to the following:
o You authorize Distributors to reserve 5% of your total intended purchase in
Class A shares registered in your name until you fulfill your LOI. Your
periodic statements will include the reserved shares in the total shares you
own, and we will pay or reinvest dividend and capital gain distributions on
the reserved shares according to the distribution option you have chosen.
o You give Distributors a security interest in the reserved shares and appoint
Distributors as attorney-in-fact.
o Distributors may sell any or all of the reserved shares to cover any
additional sales charge if you do not fulfill the terms of the LOI.
o Although you may exchange your shares, you may not sell reserved shares until
you complete the LOI or pay the higher sales charge.
After you file your LOI with the fund, you may buy Class A shares at the sales
charge applicable to the amount specified in your LOI. Sales charge reductions
based on purchases in more than one Franklin Templeton Fund will be effective
only after notification to Distributors that the investment qualifies for a
discount. Any Class A purchases you made within 90 days before you filed your
LOI also may qualify for a retroactive reduction in the sales charge. If you
file your LOI with the fund before a change in the fund's sales charge, you may
complete the LOI at the lower of the new sales charge or the sales charge in
effect when the LOI was filed.
Your holdings in the Franklin Templeton Funds acquired more than 90 days before
you filed your LOI will be counted towards the completion of the LOI, but they
will not be entitled to a retroactive reduction 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 LOI
have been completed.
If the terms of your LOI are met, the reserved shares will be deposited to an
account in your name or delivered to you or as you direct. If the amount of your
total purchases, less redemptions, is more than the amount specified in your LOI
and is an amount that would qualify for a further sales charge reduction, a
retroactive price adjustment will be made by Distributors and the securities
dealer through whom purchases were made. The price adjustment will be made on
purchases made within 90 days before and on those made after you filed your LOI
and will be applied towards the purchase of additional shares at the offering
price applicable to a single purchase or the dollar amount of the total
purchases.
If the amount of your total purchases, less redemptions, is less than the amount
specified in your LOI, the sales charge will be adjusted upward, depending on
the actual amount purchased (less redemptions) during the period. You will need
to send Distributors an amount equal to the difference in the actual dollar
amount of sales charge paid and the amount of sales charge that would have
applied to the total purchases if the total of the purchases had been made at
one time. Upon payment of this amount, 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, we will redeem an appropriate number of reserved shares to realize
the difference. If you redeem the total amount in your account before you
fulfill your LOI, we will deduct the additional sales charge due from the sale
proceeds and forward the balance to you.
Group purchases. If you are a member of a qualified group, you may buy Class A
shares at a reduced sales charge that applies 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.
A qualified group is one that:
o Was formed at least six months ago,
o Has a purpose other than buying fund shares at a discount,
o Has more than 10 members,
o Can arrange for meetings between our representatives and group members,
o Agrees to include Franklin Templeton Fund sales and other materials in
publications and mailings to its members at reduced or no cost to
Distributors,
o Agrees to arrange for payroll deduction or other bulk transmission of
investments to the fund, and
o Meets other uniform criteria that allow Distributors to achieve cost savings
in distributing shares.
Waivers for investments from certain payments. Class A shares may be purchased
without an initial sales charge or contingent deferred sales charge (CDSC) by
investors who reinvest within 365 days:
o Dividend and capital gain distributions from any Franklin Templeton Fund. The
distributions generally must be reinvested in the same share class. Certain
exceptions apply, however, to Class C shareholders who chose to reinvest
their distributions in Class A shares of the fund before November 17, 1997,
and to Advisor Class or Class Z shareholders of a Franklin Templeton Fund who
may reinvest their distributions in the fund's Class A shares. This waiver
category also applies to Class C shares.
o Dividend or capital gain distributions from a real estate investment trust
(REIT) sponsored or advised by Franklin Properties, Inc.
o Annuity payments received under either an annuity option or from death
benefit proceeds, if the annuity contract offers as an investment option the
Franklin Templeton Variable Insurance Products Trust or the Templeton
Variable Products Series Fund. You should contact your tax advisor for
information on any tax consequences that may apply.
o Redemption proceeds from a repurchase of shares of Franklin Floating Rate
Trust, if the shares were continuously held for at least 12 months.
If you immediately placed your redemption proceeds
in a Franklin Bank CD or a Franklin Templeton money fund, you may reinvest
them as described above. The proceeds must be reinvested within 365 days from
the date the CD matures, including any rollover, or the date you redeem your
money fund shares.
o Redemption proceeds from the sale of Class A shares of any of the Templeton
Global Strategy Funds if you are a qualified investor.
If you paid a CDSC when you redeemed your Class A shares from a Templeton
Global Strategy Fund, a new CDSC will apply to your purchase of fund shares
and the CDSC holding period will begin again. We will, however, credit your
fund account with additional shares based on the CDSC you previously paid and
the amount of the redemption proceeds that you reinvest.
If you immediately placed your redemption proceeds in a Franklin Templeton
money fund, you may reinvest them as described above. The proceeds must be
reinvested within 365 days from the date they are redeemed from the money
fund.
Waivers for certain investors. Class A shares also may be purchased without an
initial sales charge or CDSC by various individuals and institutions due to
anticipated economies in sales efforts and expenses, including:
o Trust companies and bank trust departments agreeing to invest in
Franklin Templeton Funds over a 13 month period at least $1 million of
assets held in a fiduciary, agency, advisory, custodial or similar
capacity and over which the trust companies and bank trust departments or
other plan fiduciaries or participants, in the case of certain retirement
plans, have full or shared investment discretion. We will accept orders
for these 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 the order.
o Any state or local government or any instrumentality, department, authority
or agency thereof that has determined the fund is a legally permissible
investment and that can only buy fund shares without paying sales charges.
Please consult your legal and investment advisors to determine if an
investment in the fund is permissible and suitable for you and the effect, if
any, of payments by the fund on arbitrage rebate calculations.
o Broker-dealers, registered investment advisors or certified financial
planners who have entered into an agreement with Distributors for clients
participating in comprehensive fee programs
o Qualified registered investment advisors who buy through a broker-dealer or
service agent who has entered into an agreement with Distributors
o Registered securities dealers and their affiliates, for their
investment accounts only
o Current employees of securities dealers and their affiliates and their family
members, as allowed by the internal policies of their employer
o Officers, trustees, directors and full-time employees of the Franklin
Templeton Funds or the Franklin Templeton Group, and their family members,
consistent with our then-current policies
o Any investor who is currently a Class Z shareholder of Franklin Mutual Series
Fund Inc. (Mutual Series), or who is a former Mutual Series Class Z
shareholder who had an account in any Mutual Series fund on October 31, 1996,
or who sold his or her shares of Mutual Series Class Z within the past 365
days
o Investment companies exchanging shares or selling assets pursuant to a
merger, acquisition or exchange offer
o Accounts managed by the Franklin Templeton Group
o Certain unit investment trusts and their holders reinvesting
distributions from the trusts
In addition, Class C shares may be purchased without an initial sales charge by
any investor who buys Class C shares through an omnibus account with Merrill
Lynch Pierce Fenner & Smith, Inc. A CDSC may apply, however, if the shares are
sold within 18 months of purchase.
Sales in Taiwan. Under agreements with certain banks in Taiwan, Republic of
China, each fund's shares are available to these banks' trust accounts without a
sales charge. The banks may charge service fees to their customers who
participate in the trusts. A portion of these 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.
Each fund's Class A shares may be offered to investors in Taiwan through
securities advisory firms known locally as Securities Investment Consulting
Enterprises. In conformity with local business practices in Taiwan, Class A
shares may be offered with the following schedule of sales charges:
Size of Purchase - U.S. Dollars Sales Charge (%)
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Under $30,000 3.0
$30,000 but less than $100,000 2.0
$100,000 but less than $400,000 1.0
$400,000 or more 0
Dealer compensation Securities dealers may at times receive the entire sales
charge. A securities dealer who receives 90% or more of the sales charge may be
deemed an underwriter under the Securities Act of 1933, as amended. Financial
institutions or their affiliated brokers may receive an agency transaction fee
in the percentages indicated in the dealer compensation table in the funds'
prospectus.
Distributors may pay the following commissions, out of its own resources, to
securities dealers who initiate and are responsible for purchases of Class A
shares of $1 million or more: 0.75% on sales of $1 million to $2 million, plus
0.60% on sales over $2 million to $3 million, plus 0.50% on sales over $3
million to $50 million, plus 0.25% on sales over $50 million to $100 million,
plus 0.15% on sales over $100 million.
These breakpoints are reset every 12 months for purposes of additional
purchases.
In addition to the payments above, Distributors and/or its affiliates may
provide financial support to securities dealers that sell shares of the Franklin
Templeton Group of Funds. This support is based primarily on the amount of sales
of fund shares and/or total assets with the Franklin Templeton Group of Funds.
The amount of support may be affected by: total sales; net sales; levels of
redemptions; the proportion of a securities dealer's sales and marketing efforts
in the Franklin Templeton Group of Funds; a securities dealer's support of, and
participation in, Distributors' marketing programs; a securities dealer's
compensation programs for its registered representatives; and the extent of a
securities dealer's marketing programs relating to the Franklin Templeton Group
of Funds. Financial support to securities dealers may be made by payments from
Distributors' resources, from Distributors' retention of underwriting
concessions and, in the case of funds that have Rule 12b-1 plans, from payments
to Distributors under such plans. In addition, certain securities dealers may
receive brokerage commissions generated by fund portfolio transactions in
accordance with the rules of the National Association of Securities Dealers,
Inc.
Distributors routinely sponsors due diligence meetings for registered
representatives during which they receive updates on various Franklin Templeton
Funds and are afforded the opportunity to speak with portfolio managers.
Invitation to these meetings is not conditioned on selling a specific number of
shares. Those who have shown an interest in the Franklin Templeton Funds,
however, are more likely to be considered. To the extent permitted by their
firm's policies and procedures, registered representatives' expenses in
attending these meetings may be covered by Distributors.
Contingent deferred sales charge (CDSC) If you invest $1 million or more in
Class A shares, either as a lump sum or through our cumulative quantity discount
or letter of intent programs, a CDSC may apply on any shares you sell within 12
months of purchase. For Class C shares, a CDSC may apply if you sell your shares
within 18 months of purchase. The CDSC is 1% of the value of the shares sold or
the net asset value at the time of purchase, whichever is less.
CDSC waivers. The CDSC for any share class generally will be waived for:
o Account fees
o Redemptions of Class A shares by investors who purchased $1 million or more
without an initial sales charge if the securities dealer of record waived its
commission in connection with the purchase
o Redemptions by the fund when an account falls below the minimum
required account size
o Redemptions following the death of the shareholder or beneficial owner
o Redemptions through a systematic withdrawal plan set up before February
1, 1995
o Redemptions through a systematic withdrawal plan set up on or after February
1, 1995, up to 1% monthly, 3% quarterly, 6% semiannually or 12% annually of
your account's net asset value depending on the frequency of your plan
Exchange privilege 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 net asset value on the date of the exchange, and
then the entire share balance will be exchanged into the new fund. Backup
withholding and information reporting may apply.
If a substantial number of shareholders should, within a short period, sell
their fund shares under the exchange privilege, the fund might have to sell
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 occurs, it is
each fund's general policy to initially invest this money in short-term,
tax-exempt municipal securities, unless it is believed that attractive
investment opportunities consistent with the fund's investment goals exist
immediately. This money will then be withdrawn from the 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 proceeds from the sale of shares of an investment company are generally not
available until the seventh day following the sale. The funds you are seeking to
exchange into may delay issuing shares pursuant to an exchange until that
seventh day. The sale of fund shares to complete an exchange will be effected at
net asset value at the close of business on the day the request for exchange is
received in proper form.
Systematic withdrawal plan Our systematic withdrawal plan allows you to sell
your shares and receive regular payments from your account on a monthly,
quarterly, semiannual or annual basis. The value of your account must be at
least $5,000 and the minimum payment amount for each withdrawal must be at least
$50. There are no service charges for establishing or maintaining a systematic
withdrawal plan.
Payments under the plan will be made from the redemption of an equivalent amount
of shares in your account, generally on the 25th day of the month in which a
payment is scheduled. If the 25th falls on a weekend or holiday, we will process
the redemption on the next business day. When you sell your shares under a
systematic withdrawal plan, it is a taxable transaction.
To avoid paying sales charges on money you plan to withdraw within a short
period of time, you may not want to set up a systematic withdrawal plan if you
plan to buy shares on a regular basis. Shares sold under the plan also may be
subject to a CDSC.
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. 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.
You may discontinue a systematic withdrawal plan, change the amount and schedule
of withdrawal payments, or suspend one payment by notifying us by mail or by
phone at least seven business days before the end of the month preceding a
scheduled payment. The fund may discontinue a systematic withdrawal plan by
notifying you in writing and will automatically discontinue 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.
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 U.S. Securities and Exchange
Commission (SEC). In the case of redemption requests in excess of these amounts,
the board reserves 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 these 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. Redemptions in kind are taxable transactions.
The fund does not intend to redeem illiquid securities in kind. If this happens,
however, you may not be able to recover your investment in a timely manner.
Share certificates We will credit your shares to your fund account. We do not
issue share certificates unless you specifically request them. This eliminates
the costly problem of replacing lost, stolen or destroyed certificates. If a
certificate is lost, stolen or destroyed, you may have to pay an insurance
premium of up to 2% of the value of the certificate to replace it.
Any outstanding share certificates must be returned to the fund if you want to
sell or exchange those shares or if you would like to start a systematic
withdrawal plan. The certificates should be properly endorsed. You can do this
either by signing the back of the certificate or by completing a share
assignment form. For your protection, you may prefer to complete a share
assignment form and to send the certificate and assignment form in separate
envelopes.
General information If dividend checks are returned to the fund marked "unable
to forward" by the postal service, we will consider this a request by you to
change your dividend option to reinvest all distributions. The proceeds will be
reinvested in additional shares at net asset value until we receive new
instructions.
Distribution or redemption checks sent to you do not earn interest or any other
income during the time the checks remain uncashed. Neither the funds nor their
affiliates will be liable for any loss caused by your failure to cash such
checks. The funds are not responsible for tracking down uncashed checks, unless
a check is returned as undeliverable.
In most cases, if mail is returned as undeliverable we are required to take
certain steps to try to find you free of charge. If these attempts are
unsuccessful, however, we may deduct the costs of any additional efforts to find
you from your account. These costs may include a percentage of the account when
a search company charges a percentage fee in exchange for its location services.
Sending redemption proceeds by wire or electronic funds transfer (ACH) is a
special service that we make available whenever possible. By offering this
service to you, the funds are not bound to meet any redemption request in less
than the seven day period prescribed by law. Neither the funds nor their agents
shall be liable to you or any other person if, for any reason, a redemption
request by wire or ACH is not processed as described in the prospectus.
Franklin Templeton Investor Services, Inc. (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
fund may reimburse Investor Services an amount not to exceed the per account fee
that the fund normally pays Investor Services. These financial institutions also
may charge a fee for their services directly to their clients.
If you buy or sell shares through your securities dealer, we use the net asset
value next calculated after your securities dealer receives your request, which
is promptly transmitted to the fund. If you sell shares through your securities
dealer, it is your dealer's responsibility to transmit the order to the fund in
a timely fashion. Your redemption proceeds will not earn interest between the
time we receive the order from your dealer and the time we receive any required
documents. Any loss to you resulting from your dealer's failure to transmit your
redemption order to the fund in a timely fashion must be settled between you and
your securities dealer.
Certain shareholder servicing agents may be authorized to accept your
transaction request.
For institutional accounts, there may be additional methods of buying or selling
fund shares than those described in this SAI or in the prospectus.
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, before 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 IRS in response to a notice of levy.
Pricing Shares
- --------------------------------------------------------------------------------
When you buy shares, you pay the offering price. The offering price is the net
asset value (NAV) per share plus any applicable sales charge, calculated to two
decimal places using standard rounding criteria. When you sell shares, you
receive the NAV minus any applicable CDSC.
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.
Each fund calculates the NAV per share of each class each business day at the
close of trading on the New York Stock Exchange (normally 1:00 p.m. pacific
time). The funds do not calculate the NAV on days the New York Stock Exchange
(NYSE) is closed for trading, which include New Year's Day, Martin Luther King
Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day and Christmas Day.
When determining its NAV, each fund values cash and receivables at their
realizable amounts, and records interest as accrued. Each fund values
over-the-counter portfolio securities within the range of the most recent quoted
bid and ask prices. If portfolio securities trade both in the over-the-counter
market and on a stock exchange, each fund values them 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. In the absence of a sale or reported bid and ask prices,
information with respect to bond and note transactions, quotations from bond
dealers, market transactions in comparable securities, and various relationships
between securities are used to determine the value of municipal securities.
Generally, trading in U.S. government securities and money market instruments is
substantially completed each day at various times before the close of the NYSE.
The value of these securities used in computing the NAV is determined as of such
times. Occasionally, events affecting the values of these securities may occur
between the times at which they are determined and the close of the NYSE that
will not be reflected in the computation of the NAV. If events materially
affecting the values of these securities occur during this period, 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 the board, each
fund may use a pricing service, bank or securities dealer to perform any of the
above described functions.
The Underwriter
- --------------------------------------------------------------------------------
Franklin Templeton Distributors, Inc. (Distributors) acts
as the principal underwriter in the continuous public offering of each fund's
shares. Distributors is located at 777 Mariners Island Blvd., San Mateo, CA
94404.
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.
The table below shows the aggregate underwriting commissions Distributors
received in connection with the offering of the funds' shares, the net
underwriting discounts and commissions Distributors retained after allowances to
dealers, and the amounts Distributors received in connection with redemptions or
repurchases of shares for the last three fiscal years ended May 31:
Amount
Received in
Connection
with
Total Amount Redemptions
Commissions Retained by and
Received Distributors Repurchases
($) ($) ($)
- --------------------------------------------------------------------------------
1999
California High Yield Fund 3,965,000 247,688 59,344
Tennessee Fund 559,070 36,967 2,120
1998
California High Yield Fund 3,855,645 247,055 4,213
Tennessee Fund 470,161 32,428 -
1997
California High Yield Fund 2,605,176 168,170 6,433
Tennessee Fund 360,982 23,861 -
Distributors may be entitled to reimbursement under the Rule 12b-1 plans, as
discussed below. Except as noted, Distributors received no other compensation
from the funds for acting as underwriter.
Distribution and service (12b-1) fees Each class has a separate distribution or
"Rule 12b-1" plan. Under each plan, the fund shall pay or may reimburse
Distributors or others for the expenses of activities that are primarily
intended to sell shares of the class. These expenses may include, among others,
distribution or service fees paid to securities dealers or others who have
executed a servicing agreement with the fund, Distributors or its affiliates; a
prorated portion of Distributors' overhead expenses; and the expenses of
printing prospectuses and reports used for sales purposes, and preparing and
distributing sales literature and advertisements.
The distribution and service (12b-1) fees charged to each class are based only
on the fees attributable to that particular class.
The Class A plan. Payments by each fund under the Class A plan may not exceed
0.15% per year (although each fund is currently only reimbursing up to 0.10%) of
Class A's average daily net assets, payable quarterly. All distribution expenses
over this amount will be borne by those who have incurred them.
The Class C plan. Under the Class C plan of the California High Yield Fund, the
fund pays Distributors up to 0.50% per year of the class's average daily net
assets, payable monthly, to pay Distributors or others for providing
distribution and related services and bearing certain expenses. All distribution
expenses over this amount will be borne by those who have incurred them. The
fund also may pay a servicing fee of up to 0.15% per year of the class's average
daily net assets, payable monthly. This fee may be used to pay securities
dealers or others for, among other things, helping to establish and maintain
customer accounts and records, helping with requests to buy and sell shares,
receiving and answering correspondence, monitoring dividend payments from the
fund on behalf of customers, and similar servicing and account maintenance
activities.
The expenses relating to the Class C plan also are used to pay Distributors for
advancing the commission costs to securities dealers with respect to the initial
sale of Class C shares.
The Class A and C plans. In addition to the payments that Distributors or others
are entitled to under each plan, each plan also provides that to the extent the
fund, the manager or Distributors or other parties on behalf of the fund, 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 fund shares within the
context of Rule 12b-1 under the Investment Company Act of 1940, as amended, then
such payments shall be deemed to have been made pursuant to the plan. The terms
and provisions of each plan 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 each plan, plus any other payments deemed to be made
pursuant to a plan, exceed the amount permitted to be paid under the rules of
the National Association of Securities Dealers, Inc.
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. These 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 these services, you would
be permitted to remain a shareholder of the fund, and alternate means for
continuing the servicing would be sought. In this 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.
Each plan has been approved in accordance with the provisions of Rule 12b-1. The
plans are renewable annually by a vote of the board, including a majority vote
of the board members who are not interested persons of the fund 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 board members be done by the noninterested
members of the fund's board. The plans and any related agreement may be
terminated at any time, without penalty, by vote of a majority of the
noninterested board members 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 by
vote of a majority of the outstanding shares of the class. The Class A plan for
the California High Yield Fund also may be terminated by any act that
constitutes an assignment of the underwriting agreement with Distributors.
Distributors or any dealer or other firm also may 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 class, and all material amendments to the plans
or any related agreements shall be approved by a vote of the noninterested board
members, 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, 1999, Distributors' eligible expenditures for
advertising, printing, payments to underwriters and broker-dealers and other
expenses pursuant to the plans and the amounts the funds paid Distributors under
the plans were:
Distributors' Amount
Eligible Paid by the
Expenses ($) Fund ($)
- --------------------------------------------------------------------------------
California High Yield Fund - Class A 910,292 489,213
California High Yield Fund - Class C 768,381 372,556
Tennessee Fund 164,095 56,929
Performance
- --------------------------------------------------------------------------------
Performance quotations are subject to SEC rules. 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.
Average annual total return and current yield quotations used by the fund are
based on the standardized methods of computing performance mandated by the SEC.
Performance figures reflect Rule 12b-1 fees from the date of the plan's
implementation. An explanation of these and other methods used by the funds to
compute or express performance follows. Regardless of the method used, past
performance does not guarantee future results, and is an indication of the
return to shareholders only for the limited historical period used.
Average annual total return Average annual total return is determined by finding
the average annual rates of return over the periods indicated below that would
equate an initial hypothetical $1,000 investment to its ending redeemable value.
The calculation assumes the maximum initial sales charge is deducted from the
initial $1,000 purchase, and income dividends and capital gain distributions are
reinvested at net asset value. The quotation assumes the account was completely
redeemed at the end of each period and the deduction of all applicable charges
and fees. If a change is made to the sales charge structure, historical
performance information will be restated to reflect the maximum initial sales
charge currently in effect.
When considering the average annual total return quotations, you should keep in
mind that the maximum initial 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. This charge will affect actual
performance less the longer you retain your investment in the fund. The average
annual total returns for the indicated periods ended May 31, 1999, were:
Since
Inception 1 Year 5 Years Inception
Date (%) (%) (%)
- --------------------------------------------------------------------------------
California High Yield Fund - 5/3/93 0.63 7.26 6.43
Class A
Tennessee Fund 5/10/94 -0.24 6.49 6.67
Since
Inception
1 Year (5/1/96)
(%) (%)
- --------------------------------------------------------------------------------
California High Yield Fund - Class C 2.43 7.85
The following SEC formula was used to calculate these figures:
P(1+T)n = ERV
where:
P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made at the
beginning of each period at the end of each period
Cumulative total return Like average annual total return, cumulative total
return assumes the maximum initial sales charge is deducted from the initial
$1,000 purchase, income dividends and capital gain distributions are reinvested
at net asset value, the account was completely redeemed at the end of each
period and the deduction of all applicable charges and fees. Cumulative total
return, however, is based on the actual return for a specified period rather
than on the average return over the periods indicated above. The cumulative
total returns for the indicated periods ended May 31, 1999, were:
Since
Inception 1 Year 5 Years Inception
Date (%) (%) (%)
- --------------------------------------------------------------------------------
California High Yield Fund -
Class A 5/3/93 0.63 41.98 46.08
Tennessee Fund 5/10/94 -0.24 36.92 38.63
Since
Inception
1 Year (5/1/96)
(%) (%)
- --------------------------------------------------------------------------------
California High Yield Fund - Class C 2.43 26.25
Current yield Current yield shows the income per share earned by a fund. It is
calculated by dividing the net investment income per share earned during a
30-day base period by the applicable 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 class during the base
period. The yields for the 30-day period ended May 31, 1999, were:
Class A (%) Class C (%)
- --------------------------------------------------------------------------------
California High Yield Fund 4.83 4.45
Tennessee Fund 4.51 --
The following SEC formula was used to calculate these figures:
Yield = 2 [(a-b + 1)6 - 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
Taxable-equivalent yield Each fund also may quote a taxable-equivalent yield
that shows the before-tax yield that would have to be earned from a taxable
investment to equal the yield. Taxable-equivalent yield is computed by dividing
the portion of the yield 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 yield that is not tax-exempt, if any. The taxable-equivalent yields for
the 30-day period ended May 31, 1999, were:
Class A (%) Class C (%)
- --------------------------------------------------------------------------------
California High Yield Fund 8.82 8.12
Tennessee Fund 7.94 --
As of May 31, 1999, the combined federal and state income tax rates upon which
the taxable-equivalent yield quotations were based were 45.2% for the California
High Yield Fund and 43.2% for the Tennessee Fund. From time to time, as any
changes to the rates become effective, taxable-equivalent yield quotations
advertised by the funds will be updated to reflect these changes. The funds
expect updates may be necessary as tax rates are changed by federal and state
governments. The advantage of tax-free investments, like the funds, will be
enhanced by any tax rate increases. Therefore, the details of specific tax
increases may be used in sales material for the funds.
Current distribution rate Current yield and taxable-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. Amounts paid to
shareholders are reflected in the quoted current distribution rate or
taxable-equivalent distribution rate. The current distribution rate is usually
computed by annualizing the dividends paid per share by a class during a certain
period and dividing that amount by the current maximum offering price. The
current distribution rate differs from the current yield computation because it
may include distributions to shareholders from sources other than interest, if
any, and is calculated over a different period of time. The current distribution
rates for the 30-day period ended May 31, 1999, were:
Class A (%) Class C (%)
- --------------------------------------------------------------------------------
California High Yield Fund 5.04 4.59
Tennessee Fund 4.53 --
A taxable-equivalent distribution rate shows the taxable distribution rate
equivalent to the current distribution rate. The advertised taxable-equivalent
distribution rate will reflect the most current federal and state tax rates
available to the fund. The taxable-equivalent distribution rates for the 30-day
period ended May 31, 1999, were:
Class A (%) Class C (%)
- --------------------------------------------------------------------------------
California High Yield Fund 9.20 8.38
Tennessee Fund 7.98 --
Volatility Occasionally statistics may be used to show a fund's volatility or
risk. Measures of volatility or risk are generally used to compare a fund's net
asset value or performance 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 The funds also may quote the performance of shares
without a sales charge. Sales literature and advertising may quote a cumulative
total return, average annual total return and other measures of performance with
the substitution of net asset value for the public offering price.
Each fund may include in its advertising or sales material information relating
to investment goals and performance results of funds belonging to the Franklin
Templeton Group of Funds. Franklin Resources, Inc. is the parent company of the
advisors and underwriter of the Franklin Templeton Group of Funds.
Comparisons To help you better evaluate how an investment in the fund may
satisfy your investment goal, advertisements and other materials about the fund
may discuss certain measures of fund performance as reported by various
financial publications. Materials also may compare performance (as calculated
above) to performance as reported by other investments, indices, and averages.
These comparisons may include, but are not limited to, the following examples:
o Salomon Brothers Broad Bond Index or its component indices - measures yield,
price and total return for Treasury, agency, corporate and mortgage bonds.
o Lehman Brothers Aggregate Bond Index or its component indices measures yield,
price and total return for Treasury, agency, corporate, mortgage and Yankee
bonds.
o Lehman Brothers Municipal Bond Index or its component indices measures yield,
price and total return for the municipal bond market.
o Bond Buyer 20 Index - an index of municipal bond yields based upon yields of
20 general obligation bonds maturing in 20 years.
o Bond Buyer 40 Index - an index composed of the yield to maturity of 40 bonds.
The index attempts to track the new-issue market as closely as possible, so
it changes bonds twice a month, adding all new bonds that meet certain
requirements and deleting an equivalent number according to their secondary
market trading activity. As a result, the average par call date, average
maturity date, and average coupon rate can and have changed over time. The
average maturity generally has been about 29-30 years.
o Financial publications: The Wall Street Journal, and Business Week, Financial
World, Forbes, Fortune, and Money magazines - provide performance statistics
over specified time periods.
o Salomon Brothers Composite High Yield Index or its component indices measures
yield, price and total return for the Long-Term High-Yield Index,
Intermediate-Term High-Yield Index, and Long-Term Utility High-Yield Index.
o Historical data supplied by the research departments of CS First Boston
Corporation, the J.P. Morgan companies, Salomon Brothers, Merrill Lynch,
Lehman Brothers and Bloomberg L.P.
o Morningstar - information published by Morningstar, Inc., including
Morningstar proprietary mutual fund ratings. The ratings reflect
Morningstar's assessment of the historical risk-adjusted performance of a
fund over specified time periods relative to other funds within its category.
o 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.
o 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.
o Savings and Loan Historical Interest Rates - as published in the U.S.
Savings & Loan League Fact Book.
o 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 each fund may include a
discussion of certain attributes or benefits to be derived from an investment in
the fund. The advertisements or information may include symbols, headlines, or
other material that highlights or summarizes the information discussed in more
detail in the communication.
Advertisements or sales material issued by each fund also 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.
Advertisements or information also may compare each fund's performance to the
return on certificates of deposit (CDs) or other investments. You should be
aware, however, that an investment in the fund involves the risk of fluctuation
of principal value, a risk generally not present in an investment in a CD issued
by a bank. For example, as the general level of interest rates rise, the value
of the fund's fixed-income investments, as well as the value of its shares that
are based upon the value of such portfolio investments, can be expected to fall.
Conversely, when interest rates decrease, the value of the fund's shares can be
expected to increase. CDs are frequently insured by an agency of the U.S.
government. An investment in a fund 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 any fund's portfolio, 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 a fund to calculate its figures. In addition,
there can be no assurance that a fund will continue its performance as compared
to these other averages.
Miscellaneous Information
- --------------------------------------------------------------------------------
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
other long-term goals. The Franklin College Costs Planner may help 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 the
funds cannot guarantee that these goals will be met.
The funds are members 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 is one of the
oldest mutual fund organizations and now services more than 4 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, a pioneer in international investing. The Mutual Series team,
known for its value-driven approach to domestic equity investing, became part of
the organization four years later. Together, the Franklin Templeton Group has
over $225 billion in assets under management for more than 7 million U.S. based
mutual fund shareholder and other accounts. The Franklin Templeton Group of
Funds offers 110 U.S. based open-end investment companies to the public. Each
fund may identify itself by its NASDAQ symbol or CUSIP number.
Franklin is a leader in the tax-free mutual fund industry and manages more than
$49 billion in municipal security assets for over three quarters of a million
investors. According to Research and Ratings Review, Franklin had one of the
largest staffs of municipal securities analysts in the industry, as of June 14,
1999.
Under current tax laws, municipal securities remain one of the few investments
offering the potential for tax-free income. In 1999, taxes could cost almost $47
on every $100 earned from a fully taxable investment (based on the maximum
combined 39.6% federal tax rate and the highest state tax rate of 12% for 1999).
Franklin tax-free funds, however, offer tax relief through a professionally
managed portfolio of tax-free securities selected based on their yield, quality
and maturity. An investment in a Franklin tax-free fund can provide you with the
potential to earn income free of federal taxes and, depending on the fund, state
and local taxes as well, while supporting state and local public projects.
Franklin tax-free funds also may provide tax-free compounding, when dividends
are reinvested. An investment in Franklin's tax-free funds can grow more rapidly
than similar taxable investments.
Municipal securities are generally considered to be creditworthy, second in
quality only to securities issued or guaranteed by the U.S. government and its
agencies. The market price of municipal securities, however, may fluctuate. This
fluctuation will have a direct impact on the net asset value of the fund's
shares.
Currently, there are more mutual funds than there are stocks listed on the New
York Stock Exchange. While many of them have similar investment goals, no two
are exactly alike. Shares of the fund are generally sold through securities
dealers, whose investment representatives are experienced professionals who can
offer advice on the type of investments suitable to your unique goals and needs,
as well as the risks associated with such investments.
The Information Services & Technology division of Franklin Resources, Inc.
(Resources) established a Year 2000 Project Team in 1996. This team has already
begun making necessary software changes to help the computer systems that
service the funds and their shareholders to be Year 2000 compliant. After
completing these modifications, comprehensive tests are conducted in one of
Resources' U.S. test labs to verify their effectiveness. Resources continues to
seek reasonable assurances from all major hardware, software or data-services
suppliers that they will be Year 2000 compliant on a timely basis. Resources is
also beginning to develop a contingency plan, including identification of those
mission critical systems for which it is practical to develop a contingency
plan. However, in an operation as complex and geographically distributed as
Resources' business, the alternatives to use of normal systems, especially
mission critical systems, or supplies of electricity or long distance voice and
data lines are limited.
Description of Ratings
- --------------------------------------------------------------------------------
Municipal Bond Ratings
Moody's Investors Service, Inc. (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 that 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 that suggest a
susceptibility to impairment sometime in the future.
Baa: Municipal bonds rated Baa are considered medium-grade obligations. 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.
These 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 and their future cannot be considered 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. These 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 that are speculative to a
high degree. These 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 that 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.
Standard & Poor's Corporation (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: Municipal 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: Municipal 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 these bonds will likely have some quality and
protective characteristics, they 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.
Plus (+) or minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Fitch Investors Service, Inc. (Fitch)
AAA: Municipal bonds rated AAA are considered to be investment grade and of the
highest credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal that 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 adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
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. Business and financial alternatives can be identified,
however, that 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 signs
are not used with the AAA, DDD, DD or D categories.
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.
Short-Term Debt & Commercial Paper Ratings
Moody's
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations. These obligations have an original maturity
not exceeding one year, unless explicitly noted. Moody's commercial paper
ratings, which are also applicable to municipal paper investments, 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 for both short-term debt and commercial paper, 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. The
relative degree of safety, however, 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
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 an 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.
State Tax Treatment
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The following information on the income tax treatment of dividends from each
fund is based upon correspondence and sources believed to be reliable. Except
where otherwise noted, the information pertains to individual state income
taxation only. You may be subject to local taxes on dividends or the value of
your shares. Corporations, trusts, estates and other entities may be subject to
other taxes and should consult with their tax advisors or their state department
of revenue. For some investors, a portion of the dividend income may be subject
to the federal and/or state alternative minimum tax.
California Exempt-interest dividends paid by the fund will not be subject to
federal income taxes or California personal income taxes. An exempt-interest
dividend is any dividend paid by the fund with respect to interest on
obligations of the U.S. government or its territories or possessions and with
respect to obligations of California or certain of its political subdivisions.
In order to qualify, in part, at least 50% of the fund's assets must consist of
such obligations. The fund has qualified and continues to qualify to pay
exempt-interest dividends.
Dividends paid by the fund from interest on obligations exempt from tax in
California generally will be fully taxable to corporate shareholders who are
subject to California's corporate franchise tax.
Tennessee Provided the fund qualifies as a regulated investment company under
the Internal Revenue Code, distributions from the Tennessee Fund will not be
subject to the Tennessee stock and bond income tax, to the extent that such
distributions are attributable to interest on (i) bonds or securities of the
U.S. government, its agencies or instrumentalities, or (ii) bonds of the state
of Tennessee or any of its counties, municipalities or political subdivisions.
Other distributions from the Tennessee Fund, including dividends attributable to
obligations of issuers in states other than Tennessee and capital gains
distributions, will be fully taxable for purposes of the Tennessee stock and
bond income tax.
