MENTOR INCOME FUND, INC.
ANNUAL REPORT
OCTOBER 31, 1995
THE FUND
( ) A closed-end investment fund that invests primarily in
high-quality fixed-income securities. The Fund is listed on the New York
Stock Exchange with common shares traded under the symbol, MRF.
INVESTMENT OBJECTIVE
( ) To achieve high monthly income consistent with preservation of capital
DIVIDEND OBJECTIVE
( ) To distribute monthly income in excess of that attainable from
investments in U.S. Treasury securities having the same maturity as the
expected average life of the Fund's investments.
REPORT FROM THE CHAIRMAN AND PRESIDENT
It is a pleasure to bring you the Annual Report to Shareholders for Mentor
Income Fund for the year ended October 31, 1995, and to report the 17.48% NAV
total return representing the best fiscal-year performance in the history of the
Fund.
After suffering through the worst bond market in modern history during 1994,
bond investors were compensated in 1995 by a more than 1.50% drop in
intermediate treasury rates. Through both good markets and bad, the Fund has
remained focused on providing attractive income and competitive net asset value
total returns.
During the year ended October 31, 1995, the Fund paid dividends totaling $0.89
per share, which represents an annualized yield of 10.03% based on the Fund's
closing market price of $8.88 on October 31, 1995. These monthly dividends have
provided the Fund's shareholders with a significant income advantage over the
average yield of 6.85% attainable during the period from treasury securities
having the same approximate maturity as the average life of the Fund's
investments.
1
<PAGE>
MENTOR INCOME FUND, INC.
ANNUAL REPORT
OCTOBER 31, 1995
[GRAPH]
U.S. TREASURY CURVE
10/31/94 10/31/95
3 month 5.142 5.494
6 month 5.657 5.548
1 year 6.144 5.541
2 year 6.824 5.608
3 year 7.046 5.681
5 year 7.481 5.805
10 year 7.807 6.018
30 year 7.970 6.332
MARKET CONDITIONS
The bond market experienced a dramatic turn during fiscal-year 1995. Calendar-
year 1994 ended with a series of very aggressive tightening moves by the Federal
Reserve. The Fed.'s restrictive monetary policy prompted a severe sell-off in
the short end of the treasury curve. Between October 31, 1994 and New Year's
Day, the yield on the two-year treasury note jumped nearly a full percentage
point, while the yield on the 30-year long bond was virtually unchanged.
The coming of the new calendar year seemed instantly to dissipate the negative
sentiment in the market; yields fell almost continually for the first six months
of the year. The rally was interrupted by a sharp correction during July and
August, but rates resumed their downward trend in September. As the Fund's
fiscal year drew to a close in October, the rally seemed to be gaining momentum.
Three primary factors have driven the market higher over the past 12 months.
First, the Fed.'s aggressive moves to tighten credit, while painful to the bond
market, appeared to have extinguished any inflationary pressures in the economy.
Virtually every broad-based measure of inflation trended downward during 1995.
Second, expectations of inflationary pressures subsided in response to signs
that economic growth has slowed to a more sustainable 2-2.5% pace during the
year. Finally, despite the predictions of virtually every pundit in Washington,
the members of the Republican majority in Congress acted on their pledge to
propose legislation to balance the budget by the year 2002.
2
<PAGE>
MENTOR INCOME FUND, INC.
ANNUAL REPORT
OCTOBER 31, 1995
While passage remains far from certain, the market found the mere prospect of a
balanced budget sufficient to drive rates lower.
EFFECT ON THE FUND
We are pleased to report that the Fund's portfolio performed well during fiscal
year 1995. The Fund's 17.48% net asset value total return represents the best
fiscal-year total return performance in the history of the Fund.
The Fund's performance was significantly enhanced by the expansion of its
investment policy at the end of 1994. At that time previous restrictions
requiring that at least 65% of the Fund's assets be invested in mortgage-backed
securities were modified to allow diversification across a significantly wider
spectrum of fixed-income sectors, including treasuries, agencies, high-quality
corporates, mortgage- and asset-related securities, and securities of foreign
issuers. This expansion of permissible investments has provided the Fund's
investment manager, Commonwealth Investment Counsel, the opportunity to leverage
more effectively the capabilities of a greater number of its market sector
specialists, and to simultaneously achieve the Fund's objectives of high income,
consistent with preservation of capital.
Partially as a result of this added flexibility, the Fund was able to outperform
the 14.94% and 15.41% returns posted by the Merrill Lynch Mortgage and
Government Bond indexes,** respectively.
The Fund's returns were comparable to the 17.62%* return of its Lipper U.S.
Mortgage Fund peer group, but lagged behind the 18.68%* posted by the Fund's
Morningstar Government Bond Fund peer group. However, these peer groups include
funds that take significantly higher levels of market risk than Mentor Income
Fund. Historically, the Fund's lower risk strategy has served shareholders well;
performance figures for the past two years, a period encompassing both a bull
and a bear market, show the Fund well ahead of its Lipper and Morningstar peers.
3
<PAGE>
MENTOR INCOME FUND, INC.
ANNUAL REPORT
OCTOBER 31, 1995
TOTAL RETURN OF FIXED-INCOME
SECTORS VS. MENTOR INCOME FUND
[GRAPH]
91-Day Treasury Bills +5.92
All-Gov't Securities +15.41
High-Quality Corporates +18.45
Mortgage Securities +14.94
Mentor Income Fund +17.48
PORTFOLIO STRATEGY
Fund strategy evolved in three distinct phases in 1995. Through all phases,
however, common themes remained -- providing attractive income, keeping risk
close to that of intermediate treasuries, and capitalizing on the investment
opportunities provided by our expanded investment policy.
During the first phase the Fund adopted a cautious stance, seeking to preserve
net asset value as rates spiked upward. As we began calendar 1995, we entered a
second, more aggressive phase. Fund duration was lengthened, and securities
expected to perform well in a market rally (treasuries, discount CMOs, and
corporate obligations of brokerage firms) were added to the portfolio. The rally
was interrupted during the late summer by a fairly significant market
correction, which prompted the third phase of our strategy.
During this market pull-back the Fund's portfolio duration was lengthened
somewhat, and additional bonds were acquired that were expected to do well in an
environment of falling interest rates. Although the Fund closed the fiscal year
still postured for additional declines in interest rates, it has subsequently
adopted a more market-neutral stance.
4
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MENTOR INCOME FUND, INC.
ANNUAL REPORT
OCTOBER 31, 1995
PORTFOLIO COMPOSITION
[GRAPH]
U.S. Treasury Securities 8.9%
Adjustable-Rate Mortgage-Backed Securities 17.3%
Corporate Bonds 15.6%
Fixed-Rate Multiple-Class Collateralized Mortgage Obligations 21.9%
Residual Interests 9.0%
Principal-Only Securities 7.3%
Interest-Only Securities 0.5%
Fixed-Rate Single-Class Mortgage-Backed Securities 19.5%
MARKET OUTLOOK
Our long-term outlook for the bond market remains optimistic. As we have said,
low inflation ultimately means low interest rates, and we see little risk of
significant inflationary pressures in the year ahead. Our long-term optimism is
tempered, however, by the rally that has already occurred. At the time of this
writing the long bond's yield is approximately 6.0%, and the two-year note
yields are approximately 0.40% less than overnight cash. At these levels the
market is priced as if the Federal Reserve will be moving quickly and
aggressively to ease credit conditions, and the Republicans will win total
victory in the current budget debate. Should the market be disappointed on
either front, rates will probably re-trace some of their downward move. Should
such a correction occur, we will view it as a buying opportunity.
5
<PAGE>
MENTOR INCOME FUND, INC.
ANNUAL REPORT
OCTOBER 31, 1995
DIVIDEND REINVESTMENT PLAN
Shareholders who wish to purchase additional shares can do so through the Fund's
automatic dividend reinvestment plan. Over 60% of the Fund's shareholders
participate in this plan. If you would like to receive information about the
plan, please call our Plan Agent at (800) 426-5523.
Sincerely,
/s/ WESTON E. EDWARDS
Weston E. Edwards, CFA
CHAIRMAN
/s/ PAUL F. COSTELLO
Paul F. Costello
PRESIDENT
* Lipper Analytical Services and Morningstar, Inc. are independent mutual
fund-rating services. Performance assumes reinvestment of all distributions,
but does not include sales charges.
** The Merrill Lynch Government Bond Index is a composite of 2,347 treasury and
agency issues with maturities ranging from one to thirty years.
The Merrill Lynch Mortgage Index is a composite of fixed-rate mortgage
pass-through securities.
6
<PAGE>
MENTOR INCOME FUND, INC.
PORTFOLIO OF INVESTMENTS
OCTOBER 31, 1995
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
(000) VALUE
<S> <C> <C> <C>
U.S. GOVERNMENT AND AGENCY SECURITIES 45.2%
Federal Home Loan Mortgage Corporation
MBS, 10.50%, 7/1/00 - 2/1/03 $ 4,897 $ 5,175,074
MBS, 10.75%, 9/1/09 679 725,841
MBS, 9.50%, 12/1/09 3,250 3,409,095
REMIC, Series 48 H, 6.00%, 7/15/20 3,500* 3,213,980
REMIC, Series 1130 K, 5.50%, 9/15/21 5,000* 4,443,750
Federal National Mortgage Association
MBS, 10.50%, 11/1/18 8,480* 9,301,106
REMIC, PO, 7/25/20 5,977* 5,343,768
REMIC, PO, 11/25/22 5,000* 4,318,750
REMIC, PO, 11/25/23 3,912 1,559,805
Government National Mortgage Association
MBS, 11.50%, 2/15/13 - 6/15/19 408 456,711
MBS, 7.00%, 9/20/22 2,830 2,894,150
Treasury Securites
U.S. Treasury Note, 5.50%, 2/28/99 9,400* 9,334,388
U.S. Treasury Bond, 7.50%, 11/15/24 3,750* 4,283,100
Total U.S. Government and Agency Securities
(cost $53,920,823) 54,459,518
PRIVATE ISSUES 50.3%
Advanta Mortgage Loan Trust
CMO, 5.55%, 1/25/25 1,883 1,780,265
Bears Stearns Mortgage Securities, Inc.
CMO, Series 1993-14, Class B-1, 7.00%, 8/25/24 4,896 4,785,829
California Federal Bank
ARM, Series 1991-2, Class A, 8.75%, 7/25/21 866 866,097
Conti-Mortgage
IO, Series 94-3, A3-1, 0.52%, 5/15/09 91,491 365,963
IO, Series 94-3, A3-1, 0.13%, 3/15/14 73,050 292,200
First Boston Mortgage Securities Corporation
CMO, Series 1993-5 M2, 7.30%, 7/25/23 2,446 2,409,780
First Interstate Bank of California
CMO, 8.90%, 11/15/97 7,000 7,188,160
</TABLE>
7
<PAGE>
MENTOR INCOME FUND, INC.
PORTFOLIO OF INVESTMENTS
OCTOBER 31, 1995
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
(000) VALUE
<S> <C> <C> <C>
PRIVATE ISSUES (CONTINUED)
General Electric Capital Mortgage Services
CMO, Series 1993-18 B1, 6.00%, 2/25/09 $ 2,300 $ 2,151,697
Kidder Peabody Acceptance Corporation
ARM, Series 1989-3, Class A, 9.03%, 6/20/19 1,647 1,662,996
Old Stone Credit Corporation
CMO, 6.20%, 6/15/08 2,983 2,946,705
Paine Webber Mortgage Acceptance Corporation
ARM, Series 1993-1, Class M-1, 7.81%, 3/25/23 2,536 2,557,859
ARM, Series 1993-3, Class M-1, 7.80%, 4/25/23 3,947 3,979,190
Prudential Home Mortgage Securities
CMO, Series 1993-22 M, 7.00%, 7/25/23 4,887 4,721,099
CMO, Series 1993-27 M, 7.50%, 5/25/23 3,312 3,311,383
CMO, Series 1994-29 M, 7.00%, 10/25/24 3,274 3,181,819
Republic Federal Savings & Loan Association
MBS, Series 1988-03, Class A, 9.75%, 6/1/18 178 177,774
Sears Mortgage Securities Corporation
ARM, Series 1992-9, Class A, 7.71%, 10/25/21 2,598 2,572,975
Structured Asset Securities Residential Trust
ARM, Series 1990-1, Class A, 7.94%, 4/1/20 7,572 7,612,207
ARM, Series 1994-5, Class A, 7.00%, 7/25/24 7,395 7,115,060
World Omni, CMO, Series 1993, Class B, 5.05%, 8/15/99 1,057 1,038,567
Total Private Issues (cost $59,447,698) 60,717,625
CORPORATE BONDS 19.7%
Developers Diversified Realty, 7.63%, 5/15/00 2,000 2,021,260
Lehman Brothers Incorporated, 9.88%, 10/15/00 1,770 1,999,551
Missisippi Power & Light, 8.80%, 4/1/05 4,000 4,190,000
Nationsbank, 9.38%, 9/15/09 3,500 4,218,760
Occidental Petroleum, 8.75%, 2/14/03 1,800 1,886,400
Paine Webber, 9.18%, 3/12/99 5,000 5,327,850
Travelers Incorporation, 6.88%, 6/1/25 3,000 3,053,370
Travelers Incorporation, 9.50%, 3/1/02 1,000 1,149,380
Total Corporate Bonds (cost $23,311,932) 23,846,571
</TABLE>
8
<PAGE>
MENTOR INCOME FUND, INC.
PORTFOLIO OF INVESTMENTS
OCTOBER 31, 1995
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
(000) VALUE
<S> <C> <C> <C>
RESIDUAL INTERESTS 11.5%
General Mortgage Securities, Inc., 1989-2, 1995, 4/17/19 $34 $ 1,810,059
General Mortgage Securities II, Inc., 1991-2, 1995, 1/28/30 14 1,034,109
General Mortgage Securities II, Inc., 1991-4, 1995, 3/28/20 1 547,662
General Mortgage Securities II, Inc., 1991-7, 1994, 6/28/30 9 626,916
General Mortgage Securities II, Inc., 1995-1, 1995, 6/25/20 20 206,695
General Mortgage Securities II, Inc., 1995-2, 1995, 6/27/25 38 530,741
General Mortgage Securities II, Inc., 1995-3, 1995, 6/25/20 20 740,707
National Mortgage Funding I, Inc., 1992-4, 1994, 11/27/22 19 1,098,079
National Mortgage Funding I, Inc., 1993-1, 1995, 6/18/14 64 922,944
National Mortgage Funding I, Inc., 1993-3, 1994, 11/28/22 19 474,079
National Mortgage Funding I, Inc., 1995-1, 1995, 4/28/25 39 590,263
National Mortgage Funding I, Inc., 1995-3, 1995, 5/22/25 39 928,691
National Mortgage Funding I, Inc., 1995-4, 1995, 3/20/21 19 295,691
National Mortgage Funding I, Inc., 1995-5, 1995, 3/25/22 17 872,056
National Mortgage Funding I, Inc., 1995-6, 1995, 8/27/25 43 796,184
National Mortgage Funding I, Inc., 1995-7, 1995, 9/17/25 45 812,232
National Mortgage Funding I, Inc., 1995-8, 1995, 8/25/22 45 813,626
National Mortgage Funding I, Inc., 1995-9, 1995, 11/22/25 45 712,328
Total Residual Interests (cost $14,872,218) 13,813,062
TOTAL INVESTMENTS (COST $151,552,671) 126.7% $152,836,776
OTHER ASSETS LESS LIABILITIES (26.7%) (32,220,205)
NET ASSETS 100.0% $120,616,571
</TABLE>
* Certain of these securities are used as collateral for a reverse repurchase
agreement.
ARM -- Adjustable-Rate Mortgage Pass-Through Security
CMO -- Collateralized Mortgage Obligation (Fixed Rate, Multiple Class)
IO -- Interest-Only Security
MBS -- Mortgage-Backed Security (Fixed Rate, Single Class)
PO -- Principal-Only Security
REMIC -- Real Estate Mortgage Investment Conduit
SEE NOTES TO FINANCIAL STATEMENTS.
9
<PAGE>
MENTOR INCOME FUND, INC.
STATEMENT OF ASSETS AND LIABILITIES
OCTOBER 31, 1995
<TABLE>
<S> <C>
ASSETS
Investments, at value (identified cost $151,552,671) $152,836,776
Cash 1,416,630
Receivables
Investments sold 1,535,389
Interest 1,558,910
Other assets 315,199
Total assets 157,662,904
LIABILITIES
Reverse repurchase agreements 36,000,000
Payable for investments purchased 712,331
Income dividend payable 225,901
Accrued expenses and other liabilities 108,101
Total liabilities 37,046,333
NET ASSETS $120,616,571
ANALYSIS OF NET ASSETS
Common stock at par value $ 118,178
Accumulated paid-in capital 131,619,599
Undistributed net investment income 271,737
Accumulated net realized losses (12,677,048)
Net unrealized appreciation of investments 1,284,105
Net Assets $120,616,571
Shares Outstanding 11,817,776
NET ASSET VALUE PER SHARE $ 10.21
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
10
<PAGE>
MENTOR INCOME FUND, INC.
STATEMENT OF OPERATIONS
YEAR ENDED OCTOBER 31, 1995
<TABLE>
<S> <C>
INVESTMENT INCOME
Interest and net premium earned $12,271,592
EXPENSES
Investment advisory fee 755,201
Administration fee 116,185
Custodian and transfer agent fees 83,882
Directors' fees and expenses 75,389
Legal fees 66,444
Shareholder servicing expenses 62,537
Audit fees 41,170
Reports to shareholders 29,752
Registration and filing fees 25,677
Miscellaneous 3,181
Total operating expenses 1,259,418
Interest expense 1,516,782
Total expenses 2,776,200
Net Investment Income 9,495,392
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
Net realized loss on investments (662,069)
Net realized gain on interest-rate swap 2,309,000
Net realized gain on futures contracts 73,928
Net realized gain on short sales 344,716
Net realized gain on investments 2,065,575
Net unrealized appreciation on investments 6,167,593
Net realized and unrealized gain on investments 8,233,168
Increase in net assets from operations $17,728,560
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
11
<PAGE>
MENTOR INCOME FUND, INC.
STATEMENT OF CASH FLOWS
YEAR ENDED OCTOBER 31, 1995
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Interest received $ 12,943,388
Operating expenses paid (1,382,085)
Net cash provided by operating activities 11,561,303
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of portfolio securities (267,985,083)
Proceeds from disposition of portfolio securities 247,712,591
Variation margin on futures contracts 78,272
Interest paid (1,483,390)
Net cash used in investing activities (21,677,610)
Net cash used in operating and investing activities (10,116,307)
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from reverse repurchase agreements 23,300,000
Net proceeds from dollar roll transactions 6,445
Payment for bank overdraft (1,195,491)
Cash dividends paid (10,578,017)
Net cash provided by financing activities 11,532,937
Net increase in cash 1,416,630
Cash at beginning of year -
Cash at end of year $ 1,416,630
RECONCILIATION OF INCREASE IN NET ASSETS FROM OPERATIONS
TO NET CASH USED IN OPERATING AND INVESTING ACTIVITIES
Increase in net assets from operations $ 17,728,560
Increase in investments-net (21,672,405)
Decrease in receivable for investment securities sold 12,894,435
Decrease in interest receivable 671,796
Decrease in other assets 120,334
Decrease in payable for investments purchased (11,503,192)
Decrease in accrued expenses and other liabilities (122,667)
Net realized gain (2,065,575)
Net unrealized appreciation (6,167,593)
Net cash used in operating and investing activities $ (10,116,307)
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
12
<PAGE>
MENTOR INCOME FUND, INC.
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
10/31/95 10/31/94
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net investment income $ 9,495,392 $ 11,981,106
Net realized gain (loss) on investments 2,065,575 (11,634,659)
Net unrealized appreciation (depreciation) of investments 6,167,593 (9,007,271)
Increase (decrease) in net assets from operations 17,728,560 (8,660,824)
DISTRIBUTIONS TO SHAREHOLDERS
Net investment income (10,513,052) (11,327,395)
CAPITAL SHARE TRANSACTIONS
Income distributions reinvested - 312,709
Increase (decrease) in net assets 7,215,508 (19,675,510)
NET ASSETS
Beginning of year 113,401,063 133,076,573
End of year $120,616,571 $113,401,063
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
13
<PAGE>
MENTOR INCOME FUND, INC.
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
YEAR YEAR YEAR YEAR YEAR
ENDED ENDED ENDED ENDED ENDED
10/31/95 10/31/94 10/31/93 10/31/92 10/31/91
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE
NET ASSET VALUE, BEGINNING OF YEAR $ 9.60 $ 11.29 $ 11.06 $ 11.57 $ 11.12
INCOME FROM INVESTMENT OPERATIONS
Net investment income 0.80 1.02 1.05 1.23 1.32
Net realized and unrealized
gain (loss) on investments 0.70 (1.75) 0.23 (0.46) 0.39
Total from investment operations 1.50 (0.73) 1.28 0.77 1.71
LESS DISTRIBUTIONS AND CAPITALIZED
EXPENSES
Distributions from net investment
income (0.89) (0.96) (1.05) (1.26) (1.26)
Initial and equity rights offering
expenses charged to capital -- -- -- (0.02) --
Total distributions and capitalized
expenses (0.89) (0.96) (1.05) (1.28) (1.26)
NET ASSET VALUE, END OF YEAR $ 10.21 $ 9.60 $ 11.29 $ 11.06 $ 11.57
Per share market price, end of year $ 8.88 $ 8.25 $ 10.50 $ 12.38 $ 12.00
Total Investment Return
Based on market price 18.83% (13.32%) (6.91%) 14.62% 24.66%
Based on net asset value 17.48% (6.19%) 12.00% 6.24% 16.19%
RATIOS / SUPPLEMENTAL DATA
Net assets, end of year
(in thousands) $120,617 $113,401 $133,077 $126,947 $120,051
Ratio of gross investment income to
average net assets 10.58% 12.18% 11.79% 12.84% 14.69%
Ratio of operating expenses to average
net assets 1.09% 1.22% 1.09% 1.13% 1.17%
Ratio of total expenses to average net
assets 2.39% 2.38% 2.48% 2.04% 2.90%
Ratio of net investment income to
average net assets 8.19% 9.80% 9.31% 10.80% 11.79%
Portfolio turnover rate 153.92% 173.71% 269.16% 219.43% 132.44%
Shares outstanding at end of year (in
thousands) 11,818 11,818 11,786 11,478 10,374
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
14
<PAGE>
MENTOR INCOME FUND, INC.
NOTES TO FINANCIAL STATEMENTS
OCTOBER 31, 1995
NOTE 1: ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Mentor Income Fund, Inc. (the "Fund") is registered under the Investment Company
Act of 1940 as a diversified, closed-end management investment company.
The following is a summary of significant accounting policies:
Security Valuation
The Fund values mortgage-backed securities, mortgage-related, asset-backed and
other debt-related securities on the basis of valuations provided by dealers
approved by the Fund's Board of Directors. In determining value, the dealers use
information with respect to transactions in such securities, various
relationships between securities, and yield to maturity. Exchange-traded options
are valued at the closing sales price or the average of the quoted bid and asked
price. Any securities or other assets for which current market quotations are
not readily available are valued at their fair value as determined in good faith
under procedures established by and under the general supervision and
responsibility of the Fund's Board of Directors.
Repurchase Agreements
All repurchase agreements are fully collateralized by U.S. Government Agency
securities and such collateral is in the possession of the Fund's custodian. To
the extent that any repurchase agreement exceeds one business day, the value of
the collateral is marked-to-market on a daily basis to ensure the adequacy of
the collateral.
Options Written or Purchased
When the Fund writes or purchases an option, an amount equal to the premium
received or paid by the Fund is recorded as a liability or an asset and is
subsequently adjusted to the current market value of the option sold or
purchased. The difference between the premium and the amount paid or received on
effecting a closing purchase or sale transaction, including brokerage
commissions, is treated as a realized gain or loss. If an option is exercised,
the premium paid or received is added to the proceeds from the sale or cost of
the purchase of the underlying security in determining whether the Fund has
realized a gain or loss on investment transactions.
15
<PAGE>
MENTOR INCOME FUND, INC.
NOTES TO FINANCIAL STATEMENTS
(CONTINUED)
Futures Contracts
A futures contract is an agreement between two parties to buy and sell a
financial instrument for a set price on a future date. Initial margin deposits
are made upon entering into futures contracts and can be either cash or
securities. During the period the futures contract is open, changes in the value
of the contract are recognized as unrealized gains or losses by "marking to
market" on a daily basis to reflect the market value of the contract at the end
of each day's trading. Variation margin payments are made or received, depending
upon whether unrealized gains or losses are incurred. When the contract is
closed, the Fund records a realized gain or loss equal to the difference between
the proceeds from (or cost of) the closing transaction and the Fund's basis in
the contract. The risks of entering into futures contracts arise from the
movements in the value of the investments and interest rates.
Dollar Rolls
A dollar roll is a simultaneous agreement to sell a security held in the Fund's
portfolio with a purchase of a similar security at a future date at an
agreed-upon price. The difference between the sale and repurchase price is
recorded as interest income to the Fund. Dollar rolls are accounted for as
financing transactions by the Fund and no gain or loss is recognized, provided
that the sale and subsequent repurchase involve substantially identical
securities. If the counterparty to the transaction is rendered insolvent, the
ultimate realization of the securities to be repurchased by the Fund may be
delayed or limited.
Short Sales
A short sale is a transaction in which the Fund sells a security it does not own
in anticipation that the market price of the security will decline. If the price
of the security sold short increases between the time of the short sale and the
time the Fund must deliver the security, the Fund realizes a loss.
Interest-Rate Swap
An interest-rate swap is a contract between two parties on a specified principal
amount (referred to as the notional principal) for a specified period. In the
16
<PAGE>
MENTOR INCOME FUND, INC.
NOTES TO FINANCIAL STATEMENTS
(CONTINUED)
most common instance, a swap involves the exchange of streams of variable and
fixed-rate interest payments. During the term of the swap, changes in the value
of the swap are recognized as unrealized gains or losses by "marking-to-market"
to reflect the market value of the swap. When the swap is terminated, the Fund
will record a realized gain or loss.
Interest-Rate Cap
An interest-rate cap is similar to an interest-rate swap, except that one party
agrees to pay a fee, while the other party pays the excess, if any, of a
floating rate over a specified fixed rate. No collateral is provided by the
counterparty to the transaction and as such the Fund is exposed to credit risk
in the event of non-performance by the other party to the interest-rate cap.
Residual Interests
A derivative security is any investment that derives its value from an
underlying security, asset, or market index. The Fund invests in mortgage
security residual interest ("residuals") which are considered derivative
securities. The Fund's investment in residuals has been primarily in securities
issued by proprietary mortgage trusts. While these entities have been highly
leveraged, often having indebtedness of up to 95% of their total value, the Fund
has not incurred any indebtedness in the course of making these residual
investments; nor have the Fund's assets been pledged to secure the indebtedness
of the issuing structure or the Fund's investment in the residuals. In
consideration of the risk associated with investment in residual securities, it
is the Fund's policy to limit its exposure at the time of purchase to no more
than 20% of its total assets. The Fund will continue to invest in residual
securities because, in the opinion of the Investment Manager, these investments
can play a key role in fulfilling the Fund's objective of achieving high monthly
income through providing a means of economic leverage.
Security Transactions and Investment Income
Security transactions are recorded on the trade date. Realized gains and losses
from security transactions are reported on an identified-cost basis. Income and
expenses
17
<PAGE>
MENTOR INCOME FUND, INC.
NOTES TO FINANCIAL STATEMENTS
(CONTINUED)
are recorded on the accrual basis with interest income on principal-only
securities, interest-only securities and residual interests determined using the
effective-yield method based upon estimates of future net cash flows. Estimated
effective yields are periodically updated consistent with changes in interest
rates and prepayment assumptions. Premiums and discounts on mortgage securities
and CMOs are amortized into interest income using the effective-yield method.
Federal Income Taxes
No provision for federal income or excise taxes is required since the Fund
intends to continue to qualify as a regulated investment company and distribute
all of its taxable income to its shareholders.
Reclassification of Capital Accounts
Distributions are determined in accordance with income tax regulations which may
differ from generally accepted accounting principles. Accordingly, periodic
reclassifications are made within the Fund's capital accounts to reflect income
and gains available for distribution under income tax regulations.
Distributions to Shareholders
The Fund declares and distributes dividends monthly from net investment income
and annually from net realized capital gains after offsetting capital-loss
carryovers. Reinvestment of income distribution is a non-cash transaction.
NOTE 2: INVESTMENT TRANSACTIONS
Purchases and sales of investment securities, other than short-term investments,
options, caps, and futures transactions, aggregated $256,481,891 and
$217,418,832 respectively, for the year ended October 31, 1995. At October 31,
1995, the cost of securities for federal income-tax purposes was $152,067,378
and net unrealized appreciation aggregated $769,398 of which $3,608,987 related
to appreciated securities and $2,839,589 related to depreciated securities. The
Fund had an unused realized capital loss carryforward for income-tax purposes of
$12,677,048 at October 31, 1995, which will expire in 2002.
18
<PAGE>
MENTOR INCOME FUND, INC.
NOTES TO FINANCIAL STATEMENTS
(CONTINUED)
NOTE 3: INVESTMENT MANAGEMENT AND ADMINISTRATION AGREEMENTS
The Mentor Income Fund has entered into an Investment Advisory and Management
Agreement with Commonwealth Investment Counsel, Inc. ("Commonwealth"), a
wholly-owned subsidiary of Mentor Investment Group, Inc. (formerly Investment
Management Group, Inc.), which is a wholly-owned subsidiary of Wheat First
Butcher Singer, Inc. Pursuant to this agreement, the Fund pays Commonwealth a
monthly management fee at the annual rate of 0.65% of average daily net assets.
Mentor Investment Group provides administrative personnel and services to the
Fund at an annual rate of 0.10% of the Fund's average daily net assets.
NOTE 4: BORROWINGS
The Fund enters into reverse repurchase agreements with qualified third-party
broker-dealers as determined by and under the direction of the Fund's Board of
Directors. Interest on the value of reverse repurchase agreements issued and
outstanding is based upon competitive market rates at the time of issuance. At
the time the Fund enters into a reverse repurchase agreements, it will establish
and maintain a segregated account with the lender containing securities having a
value not less than the repurchase price (including accrued interest). If the
counterparty to the transaction is rendered insolvent, the ultimate realization
of the securities to be repurchased by the Fund may be delayed or limited.
The average daily balance of reverse repurchase agreements outstanding during
the year ended October 31, 1995 was approximately $27,443,811, or $2.32 per
share based on average shares outstanding of 11,817,776 during the period at a
weighted average interest rate of 5.91%. The maximum amount of borrowings
outstanding at any week-end during the year was $54,127,983 (including accrued
interest) as of April 6, 1995, at a weighted average interest rate of 6.00%, and
was 26.88% of total assets. The rates on the October 31, 1995, borrowings range
from 5.78% to 5.88% and mature on November 1, 1995.
NOTE 5: CAPITAL
The Fund has authorized 200,000,000 shares of $.01 par value common stock. At
19
<PAGE>
MENTOR INCOME FUND, INC.
NOTES TO FINANCIAL STATEMENTS
(CONTINUED)
October 31, 1995, there were 11,817,776 shares issued and outstanding,
including, 1,151,463 shares issued under the Fund's reinvestment plan and
666,313 from an equity rights offering which occurred from December 23, 1991 to
January 31, 1992. During the year ended October 31, 1995, no shares were issued.
NOTE 6: QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Shown in thousands of dollars and per common share:
<TABLE>
<CAPTION>
Increase
(Decrease)
Investment Net Investment Net Gain (Loss) in Net Assets
Income Income on Investments from Operations
Per Per Per Per
Quarter End Total Share Total Share Total Share Total Share
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1995
October 31, 1995 $3,215 $0.27 $2,439 $0.20 $ 2,867 $ 0.25 $ 5,306 $ 0.45
July 31, 1995 3,366 0.28 2,386 0.20 2,020 0.17 4,406 0.37
April 30, 1995 2,761 0.23 2,030 0.18 5,117 0.43 7,147 0.61
January 31, 1995 2,930 0.25 2,640 0.22 (1,771) (0.15) 869 0.07
1994
October 31, 1994 $3,671 $0.31 $3,126 $0.27 $ (3,003) $ (0.25) $ 123 $ 0.02
July 31, 1994 3,665 0.31 2,912 0.25 (4,443) (0.38) (1,531) (0.13)
April 30, 1994 3,770 0.32 3,038 0.26 (10,589) (0.90) (7,551) (0.64)
January 31, 1994 3,783 0.32 2,905 0.24 (2,607) (0.22) 298 0.02
</TABLE>
20
<PAGE>
MENTOR INCOME FUND, INC.
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE SHAREHOLDERS AND BOARD OF DIRECTORS
OF MENTOR INCOME FUND, INC.
We have audited the accompanying statement of assets and liabilities of Mentor
Income Fund, Inc., including the portfolio of investments, as of October 31,
1995, and the related statements of operations and cash flows for the year then
ended, the statement of changes in net assets for each of the two years in the
period then ended, and the financial highlights for each of the five years in
the period then ended. These financial statements and financial highlights are
the responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of investments owned as of
October 31, 1995, by correspondence with the custodian and brokers. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of Mentor
Income Fund, Inc., as of October 31, 1995, the results of its operations, its
cash flows, the changes in its net assets, and the financial highlights for each
of the respective periods stated in the first paragraph, in conformity with
generally accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Baltimore, Maryland
December 6, 1995
21
<PAGE>
MENTOR INCOME FUND, INC.
DIVIDEND REINVESTMENT PLAN
A Dividend Reinvestment Plan (the "Plan") is provided to shareholders of the
Fund pursuant to which they have all distributions of dividends and capital
gains automatically reinvested by State Street Bank and Trust Company (the "Plan
Agent") in additional fund shares. Shareholders who elect not to participate in
the Plan will receive all distributions in cash paid by check mailed directly to
the shareholder of record (or if the shares are held in street or other nominee
name, then to the nominee) by the Fund's Custodian, as Dividend Disbursing
Agent.
The Plan Agent serves as Agent for shareholders in administering the Plan. When
the Fund declares a dividend or determines to make a capital gain distribution,
nonparticipants in the Plan will receive cash. If you participate in the Plan,
you will receive the equivalent in shares of the Fund as follows: (1) if the
market price of the shares on the payment date of the dividend or distribution
is equal to or exceeds the Fund's net asset value, participants will be issued
Fund shares at the higher of net asset value or 95% of the market price; or (2)
if the market price is lower than net asset value, the Plan Agent will receive
the dividend or capital gain distributions in cash and apply them to buy Fund
shares on your behalf in the open market, on the New York Stock Exchange or
elsewhere, for your account. If the market price exceeds the net asset value of
the Fund's shares before the Plan Agent has completed its purchases, the average
per-share purchase price paid by the Plan Agent may exceed the net asset value
of the Fund's shares. This would result in the acquisition of fewer shares than
if the dividend or capital gain distributions had been paid in shares issued by
the Fund.
Participants in the Plan may withdraw from the Plan upon written notice (not
less than 10 business days prior to any dividend record date) to the Plan Agent.
When a participant withdraws from the Plan or upon termination of the Plan by
the Fund, certificates for whole shares credited to his or her account under the
Plan will be issued and a cash payment will be made for any fraction of a share
credited to such account. In lieu of receiving a certificate, you may request
the Plan Agent to sell part or all of your reinvested shares held by the Agent
at market price and remit the proceeds to you, net of any brokerage commissions.
A $2.50 fee is charged by the Plan Agent upon any cash withdrawal or
termination. The Plan may be terminated by the Agent of the Fund upon written
notice mailed to each participant at least 90 days prior to any record date for
the payment of any dividend or capital gain distribution by the Fund.
There is no charge to participants for reinvesting dividends or capital gain
distributions, except for certain brokerage commissions, as described below. The
Plan Agent's fees for the handling of the reinvestment of dividends and
distributions are paid by the Fund. There are no brokerage commissions charged
with respect to shares issued directly by the Fund. However, each participant
will pay a pro-rata share of brokerage commissions incurred with respect to the
Plan Agent's open-market purchases in connection with the reinvestment of
dividends and distributions. It is anticipated that these commissions will be
lower than those would normally incur individually, since these shares are
purchased in large blocks by the Plan Agent.
The automatic reinvestment of dividends and distributions will not relieve
participants of any federal income tax that may be payable on such dividends or
distributions.
If you hold shares of the Fund in your own name, you are an automatic
participant in this Plan unless you elect to withdraw. If your shares are held
in the name of a brokerage firm, bank, or other nominee, you should contact your
nominee to see if it will participate in the Plan on your behalf. If your
nominee is able to participate in the Plan, dividend and capital gain
distributions will be credited to your account. If your nominee is unable to
participate in the Plan on your behalf, you may want to request that your shares
be re-registered in your name so that you can participate in the Plan. If your
shares are registered in your name, and you desire to receive your dividends and
capital gain distributions in cash, you must notify the Plan Agent, State Street
Bank and Trust Company, by calling 1-800-426-5523.
22
<PAGE>
SHAREHOLDER INFORMATION
INVESTMENT MANAGER
CORPORATE OFFICE
Commonwealth Investment Counsel
Riverfront Plaza, 901 East Byrd Street
Richmond, Virginia 23219
INVESTOR RELATIONS OFFICE
1-800-825-5353
OPERATIONS OFFICE
Riverfront Plaza, 901 East Byrd Street
Richmond, Virginia 23219
(804) 782-3747
TRANSFER AGENT AND REGISTRAR
State Street Bank & Trust Company
Post Office Box 366
Boston, Massachusetts 02101
(800) 426-5523
CUSTODIAN
Investor Fiduciary Trust Company
127 West 10th Street
Kansas City, Missouri 64105
INDEPENDENT AUDITORS
Coopers & Lybrand L.L.P.
217 East Redwood Street
Baltimore, Maryland 21202
LEGAL COUNSEL
Dechert Price & Rhoads
1500 K Street, N.W.
Washington, D.C. 20005
DIRECTORS AND OFFICERS
DIRECTORS
Weston E. Edwards, CHAIRMAN
Jerry R. Barrentine
Daniel J. Ludeman
J. Garnett Nelson
OFFICERS
Paul F. Costello, PRESIDENT
Terry L. Perkins, TREASURER
John M. Ivan, SECRETARY
Michael A. Wade, ASSISTANT TREASURER
Sander M. Bieber, ASSISTANT SECRETARY
[LOGO]
MENTOR INCOME FUND, INC.
ANNUAL REPORT
OCTOBER 31, 1995
<PAGE>
