MENTOR INCOME FUND, INC.
SEMI-ANNUAL REPORT
APRIL 30, 1996
THE FUND
o 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
o To achieve high monthly income consistent with preservation of capital
DIVIDEND OBJECTIVE
o 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
We appreciate the opportunity of providing you the Semi-Annual Report to
Shareholders for Mentor Income Fund for the six months ended April 30, 1996.
After an extremely strong bond market in 1995 which saw intermediate treasury
rates fall approximately 2.50%, the first four months of 1996 (January through
April) have seen rates retrace a full 1.00% of those gains. However, regardless
of market environment, the Fund's primary mission remains the same, to provide
attractive income and competitive net asset value total returns to shareholders.
During the six months ended April 30, 1996, the Fund paid dividends totaling
$0.42 per share, which represents an annualized yield of 9.6% based on the
Fund's closing market price of $8.75 on April 30, 1996. These monthly dividends
have provided the Fund's shareholders with a significant income advantage over
the average yield of 5.90% 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.
SEMI-ANNUAL REPORT
APRIL 30, 1996
[GRAPH]
U.S. TREASURY CURVE
10/31/95 4/30/96
3 Mo. 5.494 5.149
6 Mo. 5.548 5.297
1 Yr. 5.541 5.611
2 Yr. 5.608 6.043
3 Yr. 5.681 6.183
5 Yr. 5.805 6.409
10 Yr. 6.018 6.670
30 Yr. 6.332 6.904
MARKET CONDITIONS
From November, 1995 through January, 1996, the bond market continued its trend
toward lower interest rates built upon continued Federal Reserve monetary
accommodation, generally weak economic statistics and low inflationary
expectations. For 1995 both gross domestic product and consumer price increases
were comfortably under the 3% level (2.1% and 2.5% respectively), and by
year-end 1995 the 30-year treasury was yielding under 6% for the first time
since October, 1993. A December cut in the Fed funds rate by 0.25% was followed
by a further 0.25% reduction in the Fed funds and discount rates (to 5.25% and
5% respectively) in late January. These easing moves reflected the Federal
Reserve Board's concern with a string of weak economic statistics which included
sluggish consumer spending and retail sales growth, a flat housing sector,
moderate price and wage increases, and low unemployment gains. The market
appeared convinced that the desired "soft landing" economic scenario, combining
moderate growth and low inflation, had in fact been achieved by the Fed.
However, late February marked a significant turning point in investor
psychology, the effects of which would reverberate throughout the financial
markets for the remainder of the semi-annual period ending April 30, 1996.
Federal Reserve Chairman Alan Greenspan's February Humphrey-Hawkins testimony
and a February employment number showing the largest monthly job growth in over
twelve years convinced market participants that further interest rate cuts were
not in the cards. Annualized first quarter GDP growth of 2.3% combined with
continued strong employment growth and
2
<PAGE>
MENTOR INCOME FUND, INC.
SEMI-ANNUAL REPORT
APRIL 30, 1996
healthy construction spending gains have served to confirm that perception.
EFFECT ON THE FUND
Coming off fiscal year 1995 during which the net asset value total return of the
Fund was its highest in history, the six months ending in April has proven a
more challenging environment. The Fund's 1.52% net asset value total return for
the six-month period ending April 30 compares to the 1.64% and 0.05% returns
posted by the Merrill Lynch Mortgage and Government Bond indexes,**
respectively. The return of the Fund's Morningstar Government Bond Fund peer
group was 1.11%*.
[GRAPH]
TOTAL RETURN OF
FIXED-INCOME SECTORS VS.
MENTOR INCOME FUND
Morningstar Government Mentor
Mortgage Peer Bond Income
Index Group Index Fund
+1.64 +1.11 +0.05 +1.52
Source: Merrill Lynch Indexes; Morningstar, Inc.
PORTFOLIO STRATEGY
Throughout the six-month period common themes continued to underpin our
strategy -- providing attractive income, maintaining risk close to that of
intermediate treasuries, and capitalizing on the investment opportunities
provided within the guidelines of our investment policy. During the course of
this period the duration of the portfolio was adjusted periodically to try to
take advantage of rapidly changing conditions.
At the end of calendar year 1995 the Fund's duration was shortened to a market
neutral stance from the longer-duration posture which had served us so well for
most of the 1995 rally. This reflected our belief that the market had adopted a
very optimistic scenario of slow growth, low inflation, and budgetary restraint
into its fixed-income pricing. However, once the initial market correction in
February had created pricing more reflective of our view of underlying value,
the Fund's duration was lengthened and maintained at an above market-neutral
level through most of the remainder of the period. When the Fund's duration was
lengthened we also added securities to the portfolio like
3
<PAGE>
MENTOR INCOME FUND, INC.
SEMI-ANNUAL REPORT
APRIL 30, 1996
treasuries and discount CMOs which are expected to perform well in a
strengthening markets. However, fixed-income markets continued to weaken in
ensuing months, ultimately convincing us that short-term concerns were
overwhelming longer-term fundamentals. As the period drew to an end we chose to
reduce the duration of our portfolio to a market-neutral posture.
PORTFOLIO COMPOSITION
[GRAPH]
Fixed Rate Single-Class Mortgage Backed Securities 28.70%
U.S. Government Agencies 1.23%
Adjustable-Rate Mortgage Backed Securities 11.32%
Asset-Backed Securities 6.98%
Residual Interests 10.24%
Interest-Only Securities 0.38%
Principal-Only Securities 1.09%
Fixed Rate Multiple Class Collateralized
Mortgage Obligations 28.29%
Corporate Bonds 6.26%
Repurchase Agreement 5.51%
MARKET OUTLOOK
Given the combination of recent stronger than expected economic statistics, an
increase in current market volatility, and a long bond having pierced 7% in a
market with a decidedly negative tone, a market neutral portfolio posture seems
to us the most appropriate current tack.
Our research continues to support the conclusion that present conditions are
demonstrably different from those existing in 1994 when the Fed chose to
aggressively raise rates.
We continue to feel that the long-term prospects for the bond market are very
good. However, the economy's recent strength and the prospect of a presidential
election centered around economic growth strategies rather than fiscal
responsibilities makes the near-term outlook for the market far more risky. This
conflict between our long-term outlook and the short-term risks means that we
will be quite cautious and selective in seeking opportunities to lengthen the
duration of the Fund.
4
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MENTOR INCOME FUND, INC.
SEMI-ANNUAL REPORT
APRIL 30, 1996
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
* Morningstar, Inc. is an independent mutual fund-rating service. 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.
5
<PAGE>
MENTOR INCOME FUND, INC.
PORTFOLIO OF INVESTMENTS
APRIL 30, 1996 (UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL MARKET
AMOUNT VALUE
<S> <C> <C> <C> <C>
LONG-TERM INVESTMENTS 134.71%
U.S. GOVERNMENT SECURITIES AND AGENCIES 60.11%
FEDERAL HOME LOAN MORTGAGE CORPORATION 45.91%
8.19%, 10/6/04 $ 2,000,000 $ 2,058,940
6.50%, Series 1515 J, 5/15/08-REMIC 6,000,000* 5,636,250
6.50%, Series 1647 B, 11/15/08-REMIC 4,259,188* 3,967,702
10.75%, 9/1/09 591,403 632,564
9.50%, 12/1/09 2,862,182* 3,023,179
6.00%, 1/1/11-3/1/11 37,238,563* 35,311,417
6.00%, Series 48 H, 7/15/20-REMIC 3,500,000* 3,066,875
53,696,927
FEDERAL NATIONAL MORTGAGE ASSOCIATION 11.65%
6.50%, Series 1993-18Z,
2/25/08-REMIC 3,906,940 3,456,424
10.50%, 11/1/18 7,588,600* 8,356,946
PO, Class G93-28C, 7/25/22-REMIC 2,500,000 1,814,845
13,628,215
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION 2.55%
11.50%, 2/15/13-6/15/19 337,019 375,507
7.00%, 9/20/22 2,567,148 2,602,446
2,977,953
Total U.S. Government Securities and Agencies (cost
$72,629,510) 70,303,095
CORPORATE BONDS 8.92%
FINANCE 5.40%
Developers Diversified Realty,
7.63%, 5/15/00 2,000,000 1,996,250
Sunamerica Inc., 7.34%, 8/30/05 1,750,000 1,728,650
Travelers Inc., 9.50%, 3/1/02 1,000,000 1,119,300
Travelers Inc., 6.88%, 6/1/25 1,500,000 1,475,595
6,319,795
</TABLE>
6
<PAGE>
MENTOR INCOME FUND, INC.
PORTFOLIO OF INVESTMENTS
APRIL 30, 1996 (UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL MARKET
AMOUNT VALUE
<S> <C> <C> <C> <C>
CORPORATE BONDS (CONTINUED)
UTILITIES 3.52%
Mississippi Power & Light, 8.80%, 4/1/05 $4,000,000 $ 4,117,840
Total Corporate Bonds (cost $10,478,189) 10,437,635
PRIVATE ISSUES 51.08%
ADJUSTABLE RATE MORTGAGE 13.92%
California Federal Bank
Series 1991-2, Class A, 8.75%, 7/25/21 710,547 710,547
Kidder Peabody Acceptance Corporation
Series 1989-3, Class A, 8.95%, 6/20/19 1,301,911 1,308,811
PaineWebber Mortgage Acceptance Corporation
Series 1993-1, Class M-1, 7.89%, 3/25/23 2,055,244 2,070,658
Series 1993-3, Class M-1, 7.59%, 4/25/23 3,314,386 3,339,244
Sears Mortgage Securities Corporation
Series 1992-9, Class A, 7.85%, 10/25/21 2,228,114 2,266,883
Structured Asset Securities Residential Trust
Series 1990-1, Class A, 7.92%, 4/1/20 6,509,771 6,578,938
16,275,081
ASSET-BACKED SECURITIES 9.94%
Advanta Mortgage Loan Trust, Series 1993-3 A5, 5.55%,
1/25/25 1,779,019 1,629,471
First Interstate Bank of California,
8.90%, 11/15/97 6,753,470 6,825,226
Old Stone Credit Corporation Home Equity Trust,
Series 1993-2, 6.20%, 6/15/08 2,519,055 2,459,228
World Omni, Series 1993, Class B,
5.05%, 8/15/99 728,498 717,207
11,631,132
COLLATERALIZED MORTGAGE OBLIGATIONS 26.54%
First Boston Mortgage Securities Corporation
Series 1993-5 M2, 7.30%, 7/25/23 2,428,625 2,315,543
</TABLE>
7
<PAGE>
MENTOR INCOME FUND, INC.
PORTFOLIO OF INVESTMENTS
APRIL 30, 1996 (UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL MARKET
AMOUNT VALUE
<S> <C> <C> <C> <C>
COLLATERALIZED MORTGAGE OBLIGATIONS (CONTINUED)
General Electric Capital Mortgage Services
Series 1993-18 B1, 6.00%, 2/25/09 $ 2,241,706 $ 2,038,831
Series 1996-4 B1, 7.00%, 3/25/26 4,501,231 4,093,307
Prudential Home Mortgage Securities
Series 1993-27 M, 7.50%, 5/25/23 3,297,250 3,165,360
Series 1993-22 M, 7.00%, 7/25/23 4,858,126 4,524,887
Series 1994-29 M, 7.00%, 10/25/24 3,256,129 3,030,743
Series 1995-5 M, 7.25%, 9/25/25 2,631,173 2,510,305
Series 1995-5 B1, 7.25%, 9/25/25 2,717,719 2,553,808
Structured Asset Securities Residential Trust
Series 1994-5, Class A, 7.00%, 7/25/24 7,354,034 6,809,380
31,042,164
MORTGAGE BACKED SECURITIES 0.14%
Republic Federal Savings & Loan Association
Series 1988-03, Class A, 9.75%, 6/1/18 154,391 154,391
INTEREST ONLY SECURITIES 0.54%
Conti-Mortgage
Series 94-3, A3-1, 0.52%, 5/15/09 67,131,666 304,743
Series 94-3, A3-1, 0.13%, 3/15/14 73,050,000 330,989
635,732
Total Private Issues (cost $59,786,793) 59,738,500
RESIDUAL INTERESTS 14.60%
General Mortgage Securities, Inc., 1989-2, 1996,
4/17/19 30,061 1,923,575
General Mortgage Securities II, Inc., 1991-2,
1996, 1/28/30 10,252 935,680
General Mortgage Securities II, Inc., 1991-4,
1996, 3/28/20 776 528,419
General Mortgage Securities II, Inc., 1991-7,
1995, 6/28/30 6,605 549,027
General Mortgage Securities II, Inc., 1995-1,
1996, 6/25/20 35,091 759,727
</TABLE>
8
<PAGE>
MENTOR INCOME FUND, INC.
PORTFOLIO OF INVESTMENTS
APRIL 30, 1996 (UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL MARKET
AMOUNT VALUE
<S> <C> <C>
RESIDUAL INTERESTS (CONTINUED)
General Mortgage Securities II, Inc., 1995-4,
1995, 6/25/23 $ 18,905 $ 629,312
General Mortgage Securities II, Inc., 1996-1,
1996, 11/25/22 18,679 648,872
General Mortgage Securities II, Inc., 1996-3,
1996, 3/29/22 62,015 935,144
National Mortgage Funding I, Inc., 1992-4, 1995,
11/27/22 16,383 1,046,540
National Mortgage Funding I, Inc., 1993-1, 1996,
6/18/14 59,213 903,067
National Mortgage Funding I, Inc., 1995-1, 1996,
4/28/25 30,643 505,454
National Mortgage Funding I, Inc., 1995-4, 1995,
3/20/21 16,560 266,643
National Mortgage Funding I, Inc., 1995-5, 1995,
3/25/22 11,710 676,085
National Mortgage Funding I, Inc., 1995-7, 1995,
9/17/25 42,515 900,713
National Mortgage Funding I, Inc., 1995-8, 1995,
8/25/22 45,000 780,917
National Mortgage Funding I, Inc., 1995-9, 1995,
11/19/25 43,582 598,772
National Mortgage Funding I, Inc., 1996-1, 1996,
4/25/25 66,709 970,376
National Mortgage Funding I, Inc., 1996-3, 1996,
2/17/26 51,960 1,397,281
National Mortgage Funding I, Inc., 1996-4, 1996,
3/29/25 21,081 753,818
National Mortgage Funding I, Inc., 1996-5, 1996,
5/22/26 90,000 1,365,544
Total Residual Interests (cost $17,538,794) 17,074,966
TOTAL LONG-TERM INVESTMENTS
(COST $160,433,286) 157,554,196
</TABLE>
9
<PAGE>
MENTOR INCOME FUND, INC.
PORTFOLIO OF INVESTMENTS
APRIL 30, 1996 (UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL MARKET
AMOUNT VALUE
<S> <C> <C> <C>
SHORT-TERM INVESTMENTS 7.86%
REPURCHASE AGREEMENT
Goldman Sachs & Company
Dated 4/30/96, 5.34%, due 5/1/96 collateralized
by $9,642,000 Federal National Mortgage
Association, 7.50%, 3/1/26 (cost $9,190,123) $ 9,190,123 $ 9,190,123
TOTAL INVESTMENTS (COST $169,623,409) 142.57% 166,744,319
OTHER ASSETS LESS LIABILITIES (42.57%) (49,784,304)
NET ASSETS 100.00% $ 116,960,015
</TABLE>
* Certain of these securities are used as collateral for a reverse repurchase
agreement.
PO - Principal-Only Security
REMIC - Real Estate Mortgage Investment Conduit
SEE NOTES TO FINANCIAL STATEMENTS.
10
<PAGE>
MENTOR INCOME FUND, INC.
STATEMENT OF ASSETS AND LIABILITIES
APRIL 30, 1996 (UNAUDITED)
<TABLE>
<S> <C>
ASSETS
Investments, at value (identified cost $169,623,409) $166,744,319
Cash 216,075
Interest receivable 1,393,589
Other assets 286,455
Total assets 168,640,438
LIABILITIES
Reverse repurchase agreements 50,000,000
Payable for investments purchased 1,391,639
Income dividend payable 214,727
Accrued expenses and other liabilities 74,057
Total liabilities 51,680,423
NET ASSETS $116,960,015
ANALYSIS OF NET ASSETS
Common stock at par value $ 118,178
Accumulated paid-in capital 131,619,599
Undistributed net investment income 211,981
Accumulated net realized losses (12,110,653)
Net unrealized depreciation of investments (2,879,090)
Net Assets $116,960,015
Shares Outstanding 11,817,776
NET ASSET VALUE PER SHARE $ 9.90
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
11
<PAGE>
MENTOR INCOME FUND, INC.
STATEMENT OF OPERATIONS
SIX MONTHS ENDED APRIL 30, 1996 (UNAUDITED)
<TABLE>
<S> <C>
INVESTMENT INCOME
Interest and net premium earned $ 6,801,351
EXPENSES
Investment advisory fee 390,650
Administration fee 60,100
Custodian and transfer agent fees 50,694
Directors' fees and expenses 39,874
Reports to shareholders 32,511
Legal fees 32,161
Shareholder servicing expenses 29,917
Audit fees 22,812
Registration and filing fees 13,764
Miscellaneous 8,795
Total operating expenses 681,278
Interest expense 1,217,139
Total expenses 1,898,417
Net investment income 4,902,934
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
Net realized gain on investments 352,869
Net realized loss on options contracts (56,662)
Net realized loss on futures contracts (34,031)
Net realized gain on short sales 304,219
Net realized gain on investments 566,395
Change in unrealized appreciation
(depreciation) of investments (4,163,195)
Net realized and unrealized loss on investments (3,596,800)
Increase in net assets from operations $ 1,306,134
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
12
<PAGE>
MENTOR INCOME FUND, INC.
STATEMENT OF CASH FLOWS
SIX MONTHS ENDED APRIL 30, 1996 (UNAUDITED)
<TABLE>
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Interest received $ 6,966,672
Operating expenses paid (726,161)
Net cash provided by operating activities 6,240,511
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of portfolio securities (216,330,542)
Proceeds from disposition of portfolio securities 201,160,333
Variation margin on futures and options contracts (90,693)
Interest paid (1,206,300)
Net cash used in investing activities (16,467,202)
Net cash used in operating and investing activities (10,226,691)
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from reverse repurchase agreements 14,000,000
Cash dividends paid (4,973,864)
Net cash provided by financing activities 9,026,136
Net decrease in cash (1,200,555)
Cash at beginning of period 1,416,630
Cash at end of period $ 216,075
RECONCILIATION OF INCREASE IN NET ASSETS FROM OPERATIONS
TO NET CASH USED IN OPERATING AND INVESTING ACTIVITIES
Increase in net assets from operations $ 1,306,134
Increase in investments-net (17,493,504)
Decrease in receivable for investment securities sold 1,535,389
Decrease in interest receivable 165,321
Decrease in other assets 28,744
Increase in payable for investments purchased 679,308
Decrease in accrued expenses and other liabilities (44,883)
Net realized gain (566,395)
Net unrealized depreciation 4,163,195
Net cash used in operating and investing activities $ (10,226,691)
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
13
<PAGE>
MENTOR INCOME FUND, INC.
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
APRIL 30, 1996 YEAR ENDED
(UNAUDITED) OCTOBER 31, 1995
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net investment income $ 4,902,934 $ 9,495,392
Net realized gain on investments 566,395 2,065,575
Change in unrealized appreciation
(depreciation) of investments (4,163,195) 6,167,593
Increase in net assets from operations 1,306,134 17,728,560
DISTRIBUTIONS TO SHAREHOLDERS
Net investment income (4,962,690) (10,513,052)
Increase (decrease) in net assets (3,656,556) 7,215,508
NET ASSETS
Beginning of period 120,616,571 113,401,063
End of period $116,960,015 $120,616,571
</TABLE>
SEE NOTES TO FINANCIAL STATEMENTS.
14
<PAGE>
MENTOR INCOME FUND, INC.
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR YEAR YEAR YEAR YEAR
4/30/96 ENDED ENDED ENDED ENDED ENDED
(UNAUDITED) 10/31/95 10/31/94 10/31/93 10/31/92 10/31/91
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE
NET ASSET VALUE, BEGINNING OF PERIOD $ 10.21 $ 9.60 $ 11.29 $ 11.06 $ 11.57 $ 11.12
INCOME FROM INVESTMENT OPERATIONS
Net investment income 0.41 0.80 1.02 1.05 1.23 1.32
Net realized and unrealized gain
(loss) on investments (0.30) 0.70 (1.75) 0.23 (0.46) 0.39
Total from investment operations 0.11 1.50 (0.73) 1.28 0.77 1.71
LESS DISTRIBUTIONS AND CAPITALIZED
EXPENSES
Distributions from net investment
income (0.42) (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 (0.42) (0.89) (0.96) (1.05) (1.28) (1.26)
NET ASSET VALUE, END OF PERIOD $ 9.90 $ 10.21 $ 9.60 $ 11.29 $ 11.06 $ 11.57
Per share market price, end of period $ 8.75 $ 8.88 $ 8.25 $ 10.50 $ 12.38 $ 12.00
Total Investment Return
Based on market price 3.23% 18.83% (13.32%) (6.91%) 14.62% 24.66%
Based on net asset value 1.52% 17.48% (6.19%) 12.00% 6.24% 16.19%
RATIOS / SUPPLEMENTAL DATA
Net assets, end of period (in
thousands) $ 116,960 $120,617 $113,401 $133,077 $126,947 $120,051
Ratio of gross investment income to
average net assets 11.27%* 10.58% 12.18% 11.79% 12.84% 14.69%
Ratio of operating expenses to average
net assets 1.13%* 1.09% 1.22% 1.09% 1.13% 1.17%
Ratio of total expenses to average net
assets 3.15%* 2.39% 2.38% 2.48% 2.04% 2.90%
Ratio of net investment income to
average net assets 8.13%* 8.19% 9.80% 9.31% 10.80% 11.79%
Portfolio turnover rate 118.20% 153.92% 173.71% 269.16% 219.43% 132.44%
Shares outstanding at end of period
(in thousands) 11,818 11,818 11,818 11,786 11,478 10,374
</TABLE>
* Annualized.
SEE NOTES TO FINANCIAL STATEMENTS.
15
<PAGE>
MENTOR INCOME FUND, INC.
NOTES TO FINANCIAL STATEMENTS
APRIL 30, 1996 (UNAUDITED)
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 consistently
followed by the Fund in the preparation of the financial statements. The
policies are in conformity with generally accepted accounting principles which
required management to make estimates and assumptions that affect amounts
reported therein. Although actual results could differ from these estimates, any
such differences are expected to be immaterial to the net assets of the Fund.
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
16
<PAGE>
MENTOR INCOME FUND, INC.
NOTES TO FINANCIAL STATEMENTS
(CONTINUED)
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.
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
17
<PAGE>
MENTOR INCOME FUND, INC.
NOTES TO FINANCIAL STATEMENTS
(CONTINUED)
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
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
18
<PAGE>
MENTOR INCOME FUND, INC.
NOTES TO FINANCIAL STATEMENTS
(CONTINUED)
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 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 $207,819,727 and
$189,851,985 respectively, for the six months ended April 30, 1996. At April 30,
1996, the cost of securities for federal income-tax purposes was $169,623,409
and net unrealized depreciation aggregated $2,879,090 of which $1,498,806
related to
19
<PAGE>
MENTOR INCOME FUND, INC.
NOTES TO FINANCIAL STATEMENTS
(CONTINUED)
appreciated securities and $4,377,896 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.
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 six months ended April 30, 1996 was approximately $44,134,746 or $3.73 per
share based on average shares outstanding of 11,817,776 during the period at a
weighted average interest rate of 5.46%. The maximum amount of borrowings
outstanding at any week-end during the period was $61,051,153 (including accrued
interest) as of March 1, 1996, at a weighted average interest rate of 5.03%, and
was 27.42% of total assets. The rate
20
<PAGE>
MENTOR INCOME FUND, INC.
NOTES TO FINANCIAL STATEMENTS
(CONTINUED)
on the April 30, 1996, borrowing was 5.32% and matures on May 1, 1996.
NOTE 5: CAPITAL
The Fund has authorized 200,000,000 shares of $.01 par value common stock. At
April 30, 1996, 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 six months ended April 30, 1996, 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>
1996
April 30, 1996 $3,596 $0.30 $2,530 $0.21 $(6,537) $(0.55) $(4,007) $(0.34)
January 31, 1996 3,205 0.27 2,373 0.20 2,940 0.25 5,313 0.45
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
</TABLE>
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
1-800-382-0016
OPERATIONS OFFICE
Riverfront Plaza, 901 East Byrd Street
Richmond, Virginia 23219
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.
SEMI-ANNUAL REPORT
APRIL 30, 1996
