<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 2, 1996
SECURITIES ACT FILE NO. 33-65521
INVESTMENT COMPANY ACT FILE NO. 811-7456
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-14
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
[_] POST-EFFECTIVE AMENDMENT NO.
[X] PRE-EFFECTIVE AMENDMENT NO. 1
(CHECK APPROPRIATE BOX OR BOXES)
----------------
SENIOR HIGH INCOME PORTFOLIO, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
(609) 282-2000
(AREA CODE AND TELEPHONE NUMBER)
800 SCUDDERS MILL ROAD
PLAINSBORO, NEW JERSEY 08536
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES:
NUMBER, STREET, CITY, STATE, ZIP CODE)
----------------
ARTHUR ZEIKEL
SENIOR HIGH INCOME PORTFOLIO, INC.
800 SCUDDERS MILL ROAD, PLAINSBORO, NEW JERSEY 08536
MAILING ADDRESS: P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011
(NAME AND ADDRESS OF AGENT FOR SERVICE)
----------------
COPIES TO:
FRANK P. BRUNO, ESQ. LAURIN PHILIP L. KIRSTEIN, ESQ.
BLUMENTHAL KLEIMAN, ESQ. PATRICK D. SWEENEY, ESQ.
BROWN & WOOD FUND ASSET MANAGEMENT, L.P.
ONE WORLD TRADE CENTER 800 SCUDDERS MILL ROAD
NEW YORK, NY 10048-0557 PLAINSBORO, NJ 08536
----------------
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING: As soon as practicable after
the Registration Statement becomes effective under the Securities Act of 1933.
----------------
CALCULATION OF THE REGISTRATION FEE UNDER THE SECURITIES ACT OF 1933:
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PROPOSED PROPOSED
TITLE OF SECURITIES AMOUNT BEING MAXIMUM OFFERING MAXIMUM AGGREGATE AMOUNT OF
BEING REGISTERED REGISTERED(1) PRICE PER UNIT(1) OFFERING PRICE(1) REGISTRATION FEE
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock ($.10 par val-
ue) 25,000,000 $9.10 $227,500,000 $78,448.28(2)
- ---------------------------------------------------------------------------------------------------
Common Stock ($.10 par val-
ue) 250,000 $9.18(1) $2,295,000(1) $791.38
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
(1)Estimated solely for the purpose of calculating the registration fee.
(2)Previously paid.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
SENIOR HIGH INCOME PORTFOLIO, INC.
CROSS REFERENCE SHEET
PURSUANT TO RULE 481(a) UNDER THE SECURITIES ACT OF 1933
<TABLE>
<CAPTION>
FORM N-14 ITEM NO. PROXY STATEMENT AND PROSPECTUS CAPTION
------------------ --------------------------------------
<C> <S> <C>
PART A
Item 1. Beginning of
Registration Statement
and Outside Front Cover
Page of Prospectus..... Registration Statement Cover Page;
Prospectus Cover Page
Item 2. Beginning and Outside
Back Cover Page of
Prospectus............. Table of Contents
Item 3. Synopsis Information and
Risk Factors........... Summary; Agreement and Plan of Merger--
Risk Factors and Special Considerations
Item 4. Information About the
Transaction............ Summary; Agreement and Plan of Merger
Item 5. Information About the
Registrant............. Prospectus Cover Page; Summary; Agreement
and Plan of Merger--Comparison of the
Funds; Additional Information
Item 6. Information About the
Company Being Acquired. Prospectus Cover Page; Summary; Agreement
and Plan of Merger--Comparison of the
Funds; Additional Information
Item 7. Voting Information...... Notice of Special Meetings of
Stockholders; Introduction; Summary;
Agreement and Plan of Merger--Comparison
of the Funds; Information Concerning the
Special Meetings; Additional Information
Item 8. Interest of Certain
Persons and Experts.... Not Applicable
Item 9. Additional Information
Required for Reoffering
by Persons Deemed to be
Underwriters........... Not Applicable
PART B
Item 10. Cover Page.............. Not Applicable
Item 11. Table of Contents....... Not Applicable
Item 12. Additional Information
About the Registrant... Agreement and Plan of Merger--Comparison
of the Funds
Item 13. Additional Information
About the Company Being
Acquired............... Agreement and Plan of Merger--Comparison
of the Funds
Item 14. Financial Statements.... Financial Statements
</TABLE>
PART C
Information required to be included in Part C is set forth under the
appropriate Item, so numbered, in Part C to this Registration Statement.
<PAGE>
SENIOR HIGH INCOME PORTFOLIO, INC.
P.O. Box 9011
Princeton, New Jersey 08543-9011
P R O X Y
This proxy is solicited on behalf of the Board of Directors
The undersigned hereby appoints Arthur Zeikel, Terry K. Glenn and Patrick
D. Sweeney as proxies, each with the power to appoint his substitute, and hereby
authorizes each of them to represent and to vote, as designated on the reverse
hereof, all of the shares of common stock of Senior High Income Portfolio II,
Inc. (the "Fund") held of record by the undersigned on January 15, 1996 at the
Special Meeting of stockholders of the Fund to be held on March 14, 1996 or any
adjournment thereof.
This proxy when properly executed will be voted in the manner directed
herein by the undersigned stockholder. If no direction is made, this proxy will
be voted for Proposals 1, 2 and 3.
(Continued and to be signed on the reverse side)
<PAGE>
(Reverse)
- --------------------------------------------------------------------------------
FOR AGAINST ABSTAIN
1. To consider and act upon a proposal to
approve the Agreement and Plan of [ ] [ ] [ ]
Merger among the Fund, Senior High
Income Portfolio, Inc. and Senior
Strategic Income Fund, Inc.
2. To consider and act upon a proposal
to elect the following persons as
Directors of the Fund:
FOR all nominees listed WITHHOLD AUTHORITY
below (except as marked to vote for all
to the contrary below) [ ] Nominees
listed below [ ]
(INSTRUCTION: To withhold authority to vote for any individual nominee, strike a
line through the nominee's name in the list below.) Ronald W. Forbes, Cynthia A.
Montgomery, Charles C. Reilly, Kevin A. Ryan, Richard R. West, Arthur Zeikel
FOR AGAINST ABSTAIN
3. To consider and act upon a proposal
to ratify the selection of Deloitte [ ] [ ] [ ]
& Touche LLP to serve an the independent
auditors of the Fund for
the current fiscal year.
4. In their discretion of such proxies, upon
such other business as properly
may come before the meeting or any
adjournment thereof.
- --------------------------------------------------------------------------------
Please sign exactly as your name appears hereon. When shares are held
by joint tenants, both should sign. When signing as attorney or as executor,
administrator, trustee or guardian, please give full title as such. If a
corporation, please sign in full corporate name by president or either
authorized officer. If a partnership, please sign in partnership name by
authorized persons.
Dated _____________________, 1996
x________________________________
Signature
x________________________________
Signature, if held jointly
Please mark boxes [filled in] or [X] in blue or black ink. Sign,
date and return this proxy card promptly using the
enclosed envelope.
2
<PAGE>
SENIOR HIGH INCOME PORTFOLIO II, INC.
P.O. Box 9011
Princeton, New Jersey 08543-9011
P R O X Y
This proxy is solicited on behalf of the Board of Directors
The undersigned hereby appoints Arthur Zeikel, Terry K. Glenn and Patrick
D. Sweeney as proxies, each with the power to appoint his substitute, and hereby
authorizes each of them to represent and to vote, as designated on the reverse
hereof, all of the shares of common stock of Senior High Income Portfolio II,
Inc. (the "Fund") held of record by the undersigned on January 15, 1996 at the
Special Meeting of stockholders of the Fund to be held on March 14, 1996 or any
adjournment thereof.
This proxy when properly executed will be voted in the manner directed
herein by the undersigned stockholder. If no direction is made, this proxy will
be voted for Proposals 1, 2 and 3.
(Continued and to be signed on the reverse side)
<PAGE>
(Reverse)
- --------------------------------------------------------------------------------
FOR AGAINST ABSTAIN
1. To consider and act upon a proposal to
approve the Agreement and Plan of [ ] [ ] [ ]
Merger among the Fund, Senior High
Income Portfolio, Inc. and Senior
Strategic Income Fund, Inc.
2. To consider and act upon a proposal
to elect the following persons as
Directors of the Fund:
FOR all nominees listed WITHHOLD AUTHORITY
below (except as marked to vote for all
to the contrary below) [ ] Nominees
listed below [ ]
(INSTRUCTION: To withhold authority to vote for any individual nominee, strike a
line through the nominee's name in the list below.) Ronald W. Forbes, Cynthia A.
Montgomery, Charles C. Reilly, Kevin A. Ryan, Richard R. West, Arthur Zeikel
FOR AGAINST ABSTAIN
3. To consider and act upon a proposal
to ratify the selection of Deloitte [ ] [ ] [ ]
& Touche LLP to serve an the independent
auditors of the Fund for
the current fiscal year.
4. In their discretion of such proxies, upon
such other business as properly
may come before the meeting or any
adjournment thereof.
- --------------------------------------------------------------------------------
Please sign exactly as your name appears hereon. When shares are held
by joint tenants, both should sign. When signing as attorney or as executor,
administrator, trustee or guardian, please give full title as such. If a
corporation, please sign in full corporate name by president or either
authorized officer. If a partnership, please sign in partnership name by
authorized persons.
Dated _____________________, 1996
x________________________________
Signature
x________________________________
Signature, if held jointly
Please mark boxes [filled in] or [X] in blue or black ink. Sign,
date and return this proxy card promptly using the
enclosed envelope.
2
<PAGE>
SENIOR STRATEGIC INCOME FUND, INC.
P.O. Box 9011
Princeton, New Jersey 08543-9011
P R O X Y
This proxy is solicited on behalf of the Board of Directors
The undersigned hereby appoints Arthur Zeikel, Terry K. Glenn and Patrick
D. Sweeney as proxies, each with the power to appoint his substitute, and hereby
authorizes each of them to represent and to vote, as designated on the reverse
hereof, all of the shares of common stock of Senior High Income Portfolio II,
Inc. (the "Fund") held of record by the undersigned on January 15, 1996 at the
Special Meeting of stockholders of the Fund to be held on March 14, 1996 or any
adjournment thereof.
This proxy when properly executed will be voted in the manner directed
herein by the undersigned stockholder. If no direction is made, this proxy will
be voted for Proposals 1, 2 and 3.
(Continued and to be signed on the reverse side)
<PAGE>
(Reverse)
- --------------------------------------------------------------------------------
FOR AGAINST ABSTAIN
1. To consider and act upon a proposal to
approve the Agreement and Plan of [ ] [ ] [ ]
Merger among the Fund, Senior High
Income Portfolio, Inc. and Senior
Strategic Income Fund, Inc.
2. To consider and act upon a proposal
to elect the following persons as
Directors of the Fund:
FOR all nominees listed WITHHOLD AUTHORITY
below (except as marked to vote for all
to the contrary below) [ ] Nominees
listed below [ ]
(INSTRUCTION: To withhold authority to vote for any individual nominee, strike a
line through the nominee's name in the list below.) Ronald W. Forbes, Cynthia A.
Montgomery, Charles C. Reilly, Kevin A. Ryan, Richard R. West, Arthur Zeikel
FOR AGAINST ABSTAIN
3. To consider and act upon a proposal
to ratify the selection of Deloitte [ ] [ ] [ ]
& Touche LLP to serve an the independent
auditors of the Fund for
the current fiscal year.
4. In their discretion of such proxies, upon
such other business as properly
may come before the meeting or any
adjournment thereof.
- --------------------------------------------------------------------------------
Please sign exactly as your name appears hereon. When shares are held
by joint tenants, both should sign. When signing as attorney or as executor,
administrator, trustee or guardian, please give full title as such. If a
corporation, please sign in full corporate name by president or either
authorized officer. If a partnership, please sign in partnership name by
authorized persons.
Dated _____________________, 1996
x________________________________
Signature
x________________________________
Signature, if held jointly
Please mark boxes [filled in] or [X] in blue or black ink. Sign,
date and return this proxy card promptly using the
enclosed envelope.
2
<PAGE>
SENIOR HIGH INCOME PORTFOLIO, INC.
SENIOR HIGH INCOME PORTFOLIO II, INC.
SENIOR STRATEGIC INCOME FUND, INC.
P.O. BOX 9011
PRINCETON, NEW JERSEY 08543-9011
NOTICE OF SPECIAL MEETINGS OF STOCKHOLDERS
TO BE HELD ON MARCH 14, 1996
TO THE STOCKHOLDERS OF SENIOR HIGH INCOME PORTFOLIO, INC. SENIOR HIGH INCOME
PORTFOLIO II, INC. SENIOR STRATEGIC INCOME FUND, INC.
NOTICE IS HEREBY GIVEN that special meetings of stockholders (the "Meetings")
of Senior High Income Portfolio, Inc. ("SHIP I"), Senior High Income Portfolio
II, Inc. ("SHIP II") and Senior Strategic Income Fund, Inc. ("Senior
Strategic") will be held at the offices of Merrill Lynch Asset Management,
L.P., 800 Scudders Mill Road, Plainsboro, New Jersey on Thursday, March 14,
1996 at 9:00 A.M., New York time (for SHIP I), 9:30 A.M., New York time (for
SHIP II) and 10:00 A.M., New York time (for Senior Strategic). Each of SHIP I,
SHIP II and Senior Strategic is sometimes individually referred to herein as a
"Fund". The Meetings are called and will be held for the following purposes:
(1) To approve or disapprove an Agreement and Plan of Merger (the
"Agreement and Plan of Merger") contemplating the merger of each of SHIP II
and Senior Strategic with and into SHIP I in accordance with the General
Corporation Law of the State of Maryland, whereupon the separate existence
of each of SHIP II and Senior Strategic will cease and SHIP I will be the
surviving corporation, and each share of common stock of each of SHIP II
and Senior Strategic will be converted into the right to receive an
equivalent dollar amount (to the nearest one ten-thousandth of one cent) of
full shares of common stock of SHIP I, plus cash in lieu of any fractional
shares, computed based on the net asset value per share of each Fund. The
currently issued and outstanding shares of SHIP I will remain issued and
outstanding and in the same number. A vote in favor of this proposal also
will constitute a vote in favor of a termination of the registration under
the Investment Company Act of 1940, as amended, for each of SHIP II and
Senior Strategic;
(2) To elect a Board of Directors of each Fund to serve for the ensuing
year;
(3) To consider and act upon a proposal to ratify the selection of
Deloitte & Touche LLP to serve as independent auditors of each Fund for its
current fiscal year; and
(4) To transact such other business as properly may come before the
Meetings or any adjournment thereof.
The Board of Directors of SHIP I, SHIP II and Senior Strategic have fixed the
close of business on January 15, 1996 as the record date for the determination
of stockholders entitled to notice of, and to vote at, the Meetings or any
adjournment thereof.
A complete list of the stockholders of SHIP I, SHIP II and Senior Strategic
entitled to vote at the Meetings will be available and open to the examination
of any stockholder of SHIP I, SHIP II and Senior Strategic, respectively, for
any purpose germane to the Meetings during ordinary business hours from and
after February 29, 1996, at the offices of SHIP I, SHIP II and Senior
Strategic, 800 Scudders Mill Road, Plainsboro, New Jersey.
You are cordially invited to attend the Meetings. Stockholders who do not
expect to attend the Meetings in person are requested to complete, date and
sign the enclosed form of proxy and return it promptly in the envelope provided
for that purpose. The enclosed proxy is being solicited on behalf of the Board
of Directors of SHIP I, SHIP II and Senior Strategic.
By Order of the Boards of Directors,
Patrick D. Sweeney
Secretary
Plainsboro, New Jersey
Dated: February 2, 1996
<PAGE>
PROXY STATEMENT AND PROSPECTUS
SENIOR HIGH INCOME PORTFOLIO, INC.
SENIOR HIGH INCOME PORTFOLIO II, INC.
SENIOR STRATEGIC INCOME FUND, INC.
P.O. BOX 9011, PRINCETON, NEW JERSEY 08543-9011
(609) 282-2000
SPECIAL MEETINGS OF STOCKHOLDERS
MARCH 14, 1996
This Proxy Statement and Prospectus is furnished in connection with the
solicitation of proxies on behalf of the Boards of Directors of Senior High
Income Portfolio, Inc. ("SHIP I"), Senior High Income Portfolio II, Inc. ("SHIP
II") and Senior Strategic Income Fund, Inc. ("Senior Strategic"), each a
Maryland corporation, for use at Special Meetings of Stockholders (the
"Meetings") called to approve or disapprove the proposed merger whereby (i)
each of SHIP II and Senior Strategic will be merged with and into SHIP I in
accordance with the General Corporation Law of the State of Maryland; (ii) the
separate existence of each of SHIP II and Senior Strategic will cease; (iii)
SHIP I will be the surviving corporation; (iv) each share of common stock
("Common Stock") of each of SHIP II and Senior Strategic will be converted into
the right to receive an equivalent dollar amount (to the nearest one ten-
thousandth of one cent) of full shares of common stock of SHIP I, with a par
value of $.10 per share ("SHIP I Common Stock") plus cash in lieu of any
fractional shares, computed based on the net asset value per share of each Fund
on the Effective Date (as defined below) and (v) the shares of SHIP I
outstanding as of the Effective Date will remain issued and outstanding and in
the same number (collectively, the "Merger"). SHIP I, SHIP II and Senior
Strategic sometimes are referred to herein collectively as the "Funds" and
individually as a "Fund", each as applicable and each as the context requires.
This Proxy Statement and Prospectus also is being furnished in connection with
the election of a Board of Directors of each Fund and the ratification of the
selection of independent auditors for each Fund.
This Proxy Statement and Prospectus serves as a prospectus of SHIP I under
the Securities Act of 1933, as amended (the "Securities Act"), in connection
with the issuance of SHIP I Common Stock in the Merger.
Assuming the stockholders of each of SHIP I, SHIP II and Senior Strategic
approve the Merger, the Funds will collectively file articles of merger (the
"Articles of Merger") with the Department of Assessments and Taxation of the
State of Maryland. The Merger will become effective at such time as the
Articles of Merger are accepted for filing by the Department of Assessments and
Taxation of the State of Maryland or at such later time as is specified in the
Articles of Merger (the "Effective Date"). As promptly as practicable after the
Merger, the registration of each of SHIP II and Senior Strategic under the
Investment Company Act of 1940, as amended (the "Investment Company Act"), will
be terminated.
SHIP I, SHIP II and Senior Strategic are non-diversified, leveraged, closed-
end management investment companies with virtually identical investment
objectives. Each Fund seeks to provide stockholders with as high a level of
current income as is consistent with its investment policies and prudent
investment management. Each Fund seeks to achieve its investment objectives by
investing primarily in senior debt obligations of companies ("Senior Debt"),
including corporate loans made by banks and other financial institutions and
both privately placed and publicly offered corporate bonds and notes. There can
be no assurance that after the Merger SHIP I will achieve the investment
objective of SHIP I, SHIP II or Senior Strategic.
----------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROXY STATEMENT AND
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
----------------
This Proxy Statement and Prospectus sets forth concisely the information
about SHIP I, SHIP II and Senior Strategic that stockholders of these Funds
should know before considering the Merger and should be retained for future
reference. SHIP I, SHIP II and Senior Strategic have authorized the
solicitation of proxies in connection with the Merger solely on the basis of
this Proxy Statement and Prospectus and the accompanying documents.
Common Stock of SHIP I, SHIP II and Senior Strategic are listed on the New
York Stock Exchange (the "NYSE") under the symbols "ARK", "SAL" and "SSN",
respectively. Subsequent to the Merger, shares of Common Stock of SHIP I will
continue to be listed on the NYSE under the symbol "ARK". Reports, proxy
materials and other information concerning each Fund may be inspected at the
offices of the NYSE, 20 Broad Street, New York, New York 10005.
The address of the principal executive offices of each of SHIP I, SHIP II and
Senior Strategic is 800 Scudders Mill Road, Plainsboro, New Jersey 08536, and
the telephone number is (609) 282-2000.
----------------
THE DATE OF THIS PROXY STATEMENT AND PROSPECTUS IS FEBRUARY 2, 1996.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
INTRODUCTION............................................................... 3
AGREEMENT AND PLAN OF MERGER............................................... 4
SUMMARY.................................................................. 4
RISK FACTORS AND SPECIAL CONSIDERATIONS.................................. 11
COMPARISON OF THE FUNDS.................................................. 14
THE MERGER............................................................... 42
ELECTION OF DIRECTORS...................................................... 47
SELECTION OF INDEPENDENT AUDITORS.......................................... 51
INFORMATION CONCERNING THE SPECIAL MEETINGS................................ 51
ADDITIONAL INFORMATION..................................................... 52
CUSTODIAN.................................................................. 53
TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR.................... 53
LEGAL PROCEEDINGS.......................................................... 54
LEGAL OPINIONS............................................................. 54
EXPERTS.................................................................... 54
STOCKHOLDER PROPOSALS...................................................... 54
INDEX TO FINANCIAL STATEMENTS.............................................. 55
FINANCIAL STATEMENTS....................................................... F-1
EXHIBIT I--AGREEMENT AND PLAN OF MERGER ................................... I-1
EXHIBIT II--RATINGS OF CORPORATE BONDS..................................... II-1
</TABLE>
2
<PAGE>
INTRODUCTION
This Proxy Statement and Prospectus is furnished in connection with the
solicitation of proxies on behalf of the Boards of Directors of SHIP I, SHIP II
and Senior Strategic for use at the Meetings to be held at the offices of
Merrill Lynch Asset Management, L.P. ("MLAM"), 800 Scudders Mill Road,
Plainsboro, New Jersey on March 14, 1996, at 9:00 A.M., New York time (for SHIP
I), 9:30 A.M., New York time (for SHIP II) and 10:00 A.M., New York time (for
Senior Strategic). The mailing address for each of SHIP I, SHIP II and Senior
Strategic is P.O. Box 9011, Princeton, New Jersey 08543-9011. The approximate
mailing date of this Proxy Statement and Prospectus is February 8, 1996.
Any person giving a proxy may revoke it at any time prior to its exercise by
executing a superseding proxy, by giving written notice of the revocation to
the Secretary of SHIP I, SHIP II or Senior Strategic, as the case may be, at
the address indicated above or by voting in person at the Meetings. All
properly executed proxies received prior to the Meetings will be voted at the
Meetings in accordance with the instructions marked thereon or otherwise as
provided therein. Unless instructions to the contrary are marked, proxies will
be voted "FOR" each of the following proposals: (1) to approve the Agreement
and Plan of Merger among SHIP I, SHIP II and Senior Strategic (the "Agreement
and Plan of Merger"); (2) to elect a Board of Directors of each Fund to serve
for the ensuing year; and (3) to ratify the selection of Deloitte & Touche LLP
as the independent auditors of each Fund for the current fiscal year.
With respect to proposal 1, approval of the Agreement and Plan of Merger will
require the affirmative vote of stockholders representing more than 50% of the
outstanding shares of Common Stock of each of SHIP I, SHIP II and Senior
Strategic. Because of the requirement that the Agreement and Plan of Merger be
approved by stockholders of all three Funds, the Merger will not take place if
stockholders of any one Fund do not approve the Agreement and Plan of Merger.
With respect to proposal 2, election of Directors of SHIP I, SHIP II and Senior
Strategic will require the affirmative vote of a majority of votes cast by
holders of shares of Common Stock of SHIP I, SHIP II and Senior Strategic,
respectively, represented at the Meetings and entitled to vote, at which a
quorum is duly constituted. With respect to proposal 3, approval of the
ratification of the selection of Deloitte & Touche LLP as the independent
auditors of SHIP I, SHIP II and Senior Strategic will require the affirmative
vote of a majority of votes cast by holders of shares of Common Stock of SHIP
I, SHIP II and Senior Strategic, respectively, represented at the Meetings and
entitled to vote, at which a quorum is duly constituted.
The Boards of Directors of SHIP I, SHIP II and Senior Strategic have fixed
the close of business on January 15, 1996 as the record date for the
determination of stockholders entitled to notice of, and to vote at, the
Meetings or any adjournment thereof. Stockholders on the record date will be
entitled to one vote for each share held, with no shares having cumulative
voting rights. As of January 15, 1996, there were issued and outstanding
25,639,592 shares of Common Stock of SHIP I, 16,652,213 shares of Common Stock
of SHIP II and 7,810,743 shares of Common Stock of Senior Strategic. To the
knowledge of the management of SHIP I, SHIP II and Senior Strategic, no person
owned beneficially more than 5% of the respective outstanding shares of Common
Stock of SHIP I, SHIP II or Senior Strategic at such record date.
The Boards of Directors of SHIP I, SHIP II and Senior Strategic know of no
business other than that discussed in proposals 1, 2 and 3 above which will be
presented for consideration at the Meetings. If any other matter is properly
presented, it is the intention of the persons named in the enclosed proxy to
vote in accordance with their best judgment.
3
<PAGE>
1. AGREEMENT AND PLAN OF MERGER
SUMMARY
The following is a summary of certain information contained elsewhere in this
Proxy Statement and Prospectus and is qualified in its entirety by reference to
the more complete information contained in this Proxy Statement and Prospectus
and in the Agreement and Plan of Merger, attached hereto as Exhibit I.
In this Proxy Statement and Prospectus, the term "Merger" refers collectively
to (i) the merger of each of SHIP II and Senior Strategic with and into SHIP I
in accordance with the General Corporation Law of the State of Maryland,
whereupon the separate existence of each of SHIP II and Senior Strategic will
cease and SHIP I will be the surviving corporation, (ii) the conversion of each
share of Common Stock of each of SHIP II and Senior Strategic into the right to
receive an equivalent dollar amount (to the nearest one ten-thousandth of one
cent) of full shares of SHIP I Common Stock, plus cash in lieu of any
fractional shares, computed based on the net asset value per share of each Fund
on the Effective Date and (iii) the subsequent deregistration of each of SHIP
II and Senior Strategic under the Investment Company Act.
SHIP I, SHIP II and Senior Strategic are non-diversified, leveraged, closed-
end management investment companies registered under the Investment Company
Act. Each of SHIP I, SHIP II and Senior Strategic seeks to provide stockholders
with as high a level of current income as is consistent with its investment
policies and prudent investment management. Each of SHIP I, SHIP II and Senior
Strategic seeks to achieve its investment objectives by investing primarily in
Senior Debt. In addition, each of SHIP I, SHIP II and Senior Strategic seeks to
enhance income by entering into a revolving credit facility and borrowing in
amounts up to 33 1/3% of its total assets (including the amounts borrowed)
under such credit facility. As a condition precedent to the Merger, SHIP I will
enter into an agreement with a financial institution, as agent for the
syndicate of lenders under each credit facility, to refinance the outstanding
credit facilities of each of the Funds and to issue a new credit facility for
SHIP I in an amount approximately equal to the aggregate commitment amount of
the credit facilities currently outstanding for the three Funds. After the
Merger,SHIP I will be the surviving entity, and the total assets of the
combined entities will be invested pursuant to the investment objectives,
policies and restrictions of SHIP I.
At regular meetings of the Boards of Directors of SHIP I, SHIP II and Senior
Strategic held on December 6, 1995, the Boards of Directors of SHIP I, SHIP II
and Senior Strategic declared advisable a proposal that each of SHIP II and
Senior Strategic be merged with and into SHIP I, whereupon the separate
existence of each of SHIP II and Senior Strategic shall cease and SHIP I shall
be the surviving corporation, and each share of Common Stock of each of SHIP II
and Senior Strategic be converted into the right to receive an equivalent
dollar amount (to the nearest one ten-thousandth of one cent) of full shares of
SHIP I Common Stock, plus cash in lieu of any fractional shares, computed based
on the net asset value per share of each Fund on the Effective Date. Subject to
obtaining the necessary approvals from the SHIP I, SHIP II and Senior Strategic
stockholders, the Boards of Directors of SHIP II and Senior Strategic approved
the deregistration of SHIP II and Senior Strategic, respectively, under the
Investment Company Act. The Merger requires the approval of stockholders of
each of SHIP I, SHIP II and Senior Strategic. The Merger will not take place if
stockholders of any one Fund do not approve the Merger. If the SHIP I, SHIP II
and Senior Strategic stockholders approve the Merger at the Meetings, it is
anticipated that the Merger will proceed as described above.
Based upon their evaluation of all relevant information, the Boards of
Directors of SHIP I, SHIP II and Senior Strategic have determined that the
Merger will benefit the holders of Common Stock of SHIP I, SHIP II and Senior
Strategic. Specifically, after the Merger, SHIP II and Senior Strategic
stockholders will remain invested in a closed-end fund that has investment
objectives and policies virtually identical to those of SHIP II and Senior
Strategic and which utilizes the same management personnel. In addition, it is
anticipated that the SHIP I, SHIP II and Senior Strategic stockholders will be
subject to a reduced overall operating expense ratio based on the combined
assets of the surviving fund after the Merger.
4
<PAGE>
In deciding to recommend the Merger, the Boards of Directors of SHIP I, SHIP
II and Senior Strategic took into account the investment objectives and
policies of SHIP I, SHIP II and Senior Strategic, as well as the management
arrangements of each Fund, the expenses incurred both due to the Merger and on
an ongoing basis by the new and existing stockholders of SHIP I and the
potential benefits, including economies of scale, to the SHIP I, SHIP II and
Senior Strategic stockholders as a result of the Merger. The Boards of
Directors of SHIP I, SHIP II and Senior Strategic, including all of the
Directors who are not "interested persons", as defined in the Investment
Company Act, of SHIP I, SHIP II and Senior Strategic, have determined that the
Merger is in the best interests of the stockholders of SHIP I, SHIP II and
Senior Strategic and that the interests of such stockholders will not be
diluted or otherwise adversely affected as a result of the Merger. The Boards
of Directors of SHIP I, SHIP II and Senior Strategic generally considered the
following factors in evaluating whether to approve the Merger: (i) the terms
and conditions of the Merger and the anticipated effect of the Merger on per
share expenses and costs of the Funds; (ii) whether the Merger would achieve
economies of scale for the Funds and benefit stockholders by promoting more
efficient operations; (iii) whether the interests of the Funds' stockholders
will be diluted as a result of the proposed transactions contemplated by the
Merger; (iv) the relative, comparative past investment performance of the
Funds; (v) the future prospects of the Funds if the Merger is effected and if
the Merger is not effected; (vi) whether the investment objectives, policies
and restrictions of the Funds are compatible; (vii) the service features
available to stockholders in the Funds; (viii) whether the Merger will result
in the recognition of any gain or loss for Federal income tax purposes to the
Funds or to the stockholders of the Funds; and (ix) alternatives to the Merger.
If all of the requisite approvals are obtained, it is anticipated that the
Merger will occur on March 15, 1996. The Agreement and Plan of Merger may be
terminated, and the Merger abandoned, whether before or after approval by the
Funds' stockholders, at any time prior to the Effective Date (i) by mutual
consent of the Boards of Directors of SHIP I, SHIP II and Senior Strategic;
(ii) by the Board of Directors of SHIP I if any condition to SHIP I's
obligations has not been fulfilled or waived by such Board; (iii) by the Board
of Directors of SHIP II if any condition to SHIP II's obligations has not been
fulfilled or waived by such Board; or (iv) by the Board of Directors of Senior
Strategic if any condition to Senior Strategic's obligations has not been
fulfilled or waived by such Board.
5
<PAGE>
PRO FORMA FEE TABLE FOR COMMON STOCKHOLDERS OF SHIP I, SHIP II, SENIOR
STRATEGIC AND THE COMBINED FUND AS OF AUGUST 31, 1995 (UNAUDITED)
<TABLE>
<CAPTION>
ACTUAL
------------------------------
SENIOR PRO FORMA FOR
COMMON STOCKHOLDER SHIP I SHIP II STRATEGIC COMBINED FUND
TRANSACTION EXPENSES: ------ ------- --------- -------------
<S> <C> <C> <C> <C>
Maximum Sales Load (as a
percentage of the offering
price) imposed on purchases of
Common Stock................... 5.00%(a) 5.00%(a) 5.00%(a) (b)
Dividend Reinvestment and Cash
Purchase Plan Fees............. None None None None
<CAPTION>
ANNUAL FUND OPERATING EXPENSES
(AS A
PERCENTAGE OF AVERAGE NET
ASSETS ATTRIBUTABLE TO
COMMON STOCK AT AUGUST 31,
1995)(C):
<S> <C> <C> <C> <C>
Investment Advisory Fees....... .65%(d) .69%(d) .59%(d) .65%(d)
Interest Payments on Borrowed
Funds........................... 2.11 2.55(e) 1.93 1.75(f)
Other Expenses
Transfer Agent Fees........... .03 .02 .02 .02
Custodian Fee................. .01 .01 .01 .01
Miscellaneous................. .25 .36 .42 .13
---- ---- ---- ----
Total Other Expenses........ .29 .39 .45 .16
---- ---- ---- ----
Total Annual Operating Expenses
(including interest payments on
borrowed funds)................. 3.05% 3.63% 2.97% 2.56%
==== ==== ==== ====
</TABLE>
- --------
(a) Sales load charged in the Fund's initial offering, subject to reductions
for bulk purchases. Shares of Common Stock purchased on the secondary
market are not subject to sales loads, but may be subject to brokerage
commissions or other charges.
(b) No sales load will be charged on the issuance of shares in the Merger.
Shares of Common Stock are not available for purchase from the Combined
Fund but may be purchased through a broker-dealer subject to individually
negotiated commission rates.
(c) The actual annual fund operating expenses were derived from each Fund's
shareholder report dated as of August 31, 1995. The pro forma annual
operating expenses for the Combined Fund are projections for a 12 month
period. As of August 31, 1995, the total annual operating expenses
(excluding interest payments on borrowed funds) was .94% for SHIP I, 1.08%
for SHIP II and 1.04% for Senior Strategic. If the Merger had taken place
on August 31, 1995, the total annual operating expenses (excluding interest
payments on borrowed funds) for the Combined Fund on a pro forma basis
would have been .81%.
(d) The investment advisory fee for each Fund is computed at an annual rate of
0.50% of such Fund's weekly net assets plus the proceeds of any outstanding
borrowings.
(e) Reflects the cost of borrowed funds under the SHIP II unsecured revolving
credit facility in effect on August 31, 1995. Under such facility, SHIP II
has the option of borrowing at an interest rate of Prime Rate plus 0%,
Eurodollar plus 1% or Fed Funds plus 1%. On August 31, 1995, the interest
rate then in effect under the Fed Funds option was 5.9%. On October 31,
1995, SHIP II renegotiated the cost of its borrowing under such facility
with the new interest rates being Prime Rate plus 0%, Eurodollar plus 0.55%
or Fed Funds plus 0.55%. See "Other Investment Policies--Leverage". If the
reduced interest rates were in effect on August 31, 1995, Interest Payments
on Borrowed Funds and the Total Annual Operating Expenses for SHIP II
(including interest payments on borrowed funds) would have been 1.71% and
2.79%, respectively.
(f) Assumes an annual rate of interest of 5.9%, the interest rate in effect on
August 31, 1995 under the SHIP II unsecured revolving credit facility. This
interest rate was used because, in FAM's judgment, this rate would have
been available to the Combined Fund under the market conditions prevailing
on August 31, 1995.
6
<PAGE>
EXAMPLE:
CUMULATIVE EXPENSES PAID ON SHARES OF COMMON STOCK FOR THE PERIOD OF:
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
An investor would pay the following expenses
on a $1,000 investment, including the maximum
sales load of $50 and assuming (1) an
operating expense ratio of 3.05% (assuming
leverage) and .84% (assuming no leverage) for
SHIP I shares, 3.63% (assuming leverage) and
.97% (assuming no leverage) for SHIP II
shares and 2.97% (assuming leverage) and .96%
(assuming no leverage) for Senior Strategic
shares and (2) a 5% annual return throughout
the periods:
SHIP I (Assuming Leverage).................. $79 $140 $202 $370
SHIP I (Assuming No Leverage)............... $59 $ 78 $ 99 $160
SHIP II (Assuming Leverage)................. $85 $156 $228 $419
SHIP II (Assuming No Leverage).............. $60 $ 83 $107 $175
Senior Strategic (Assuming Leverage)........ $79 $137 $198 $363
Senior Strategic (Assuming No Leverage)..... $60 $ 81 $103 $171
Assuming the Merger had taken place on August
31, 1995, an investor would pay the following
expenses on a $1,000 investment, including
the maximum sales load of $50 and assuming
(1) an operating expense ratio of 2.56%
(assuming leverage and an annual interest
rate of 5.9%) and .81% (assuming no leverage)
and (2) a 5% annual return throughout the
periods:
Combined Fund (Assuming Leverage)........... $75 $126 $179 $325
Combined Fund (Assuming No Leverage)........ $58 $ 75 $ 93 $145
</TABLE>
The foregoing Fee Table is intended to assist investors in understanding the
costs and expenses that a SHIP I, SHIP II or Senior Strategic Common
Stockholder will bear directly or indirectly as compared to the costs and
expenses that would be borne by such investors taking into account the Merger.
The Example set forth above assumes shares of Common Stock were purchased in
the initial offerings and reinvestment of all dividends and distributions and
utilizes a 5% annual rate of return as mandated by Securities and Exchange
Commission (the "Commission") regulations. THE EXAMPLE SHOULD NOT BE CONSIDERED
A REPRESENTATION OF PAST OR FUTURE EXPENSES OR ANNUAL RATES OF RETURN, AND
ACTUAL EXPENSES OR ANNUAL RATES OF RETURN MAY BE MORE OR LESS THAN THOSE
ASSUMED FOR PURPOSES OF THE EXAMPLE. See "Comparison of the Funds" and "The
Merger--Benefits to Stockholders of SHIP I, SHIP II and Senior Strategic as a
Result of the Merger".
7
<PAGE>
<TABLE>
<S> <C>
BUSINESS OF SHIP I SHIP I was incorporated under the laws of the State of
Maryland on January 26, 1993 and commenced operations
on April 30, 1993. Like SHIP II and Senior Strategic,
SHIP I is a non-diversified, leveraged, closed-end
management investment company whose investment
objective is to provide stockholders with as high a
level of current income as is consistent with its
investment policies and prudent investment management.
Furthermore, like SHIP II and Senior Strategic, SHIP I
seeks to achieve its investment objective by investing
primarily in Senior Debt. See "Comparison of the
Funds--Investment Objectives and Policies".
Like SHIP II and Senior Strategic, SHIP I has
outstanding Common Stock. As of August 31, 1995, SHIP I
had net assets of approximately $230 million and total
assets of approximately $300.5 million (including the
proceeds of outstanding borrowings used for leverage).
BUSINESS OF SHIP II SHIP II was incorporated under the laws of the State of
Maryland on July 14, 1993 and commenced operations on
September 24, 1993. Like SHIP I and Senior Strategic,
SHIP II is a non-diversified, leveraged, closed-end
management investment company whose investment
objective is to provide stockholders with as high a
level of current income as is consistent with its
investment policies and prudent investment management.
Furthermore, like SHIP I and Senior Strategic, SHIP II
seeks to achieve its investment objective by investing
primarily in Senior Debt.
Like SHIP I and Senior Strategic, SHIP II has
outstanding Common Stock. As of August 31, 1995, SHIP
II had net assets of approximately $154 million and
total assets of approximately $201.5 million (including
the proceeds of outstanding borrowings used for
leverage).
BUSINESS OF SENIOR STRATEGIC Senior Strategic was incorporated under the laws of the
State of Maryland on November 12, 1993 and commenced
operations on April 8, 1994. Like SHIP I and SHIP II,
Senior Strategic is a non-diversified, leveraged,
closed-end management investment company whose
objective is to provide stockholders with as high a
level of current income as is consistent with its
investment policies and prudent investment management.
Furthermore, like SHIP I and SHIP II, Senior Strategic
seeks to achieve its investment objective by investing
primarily in Senior Debt.
Like SHIP I and SHIP II, Senior Strategic has
outstanding Common Stock. As of August 31, 1995, Senior
Strategic had net assets of approximately $71.8 million
and total assets of approximately $96.6 million
(including the proceeds of outstanding borrowings used
for leverage).
COMPARISON OF THE FUNDS Investment Objectives and Policies. SHIP I, SHIP II and
Senior Strategic have identical investment objectives
and policies, except that Senior Strategic currently
may invest up to 35% of its total assets in debt
obligations other than Senior Debt while SHIP I and
SHIP II currently may invest up to 20% of their
respective total assets in debt instruments not
constituting Senior Debt.
</TABLE>
8
<PAGE>
<TABLE>
<S> <C>
The Directors of SHIP I have approved a proposal that
would result in an increase in SHIP I's limitation on
investment in debt obligations other than Senior Debt
to 35% of its total assets if the Merger takes place.
As of August 31, 1995, 89.38% of SHIP I's total assets,
88.85% of SHIP II's total assets and 85.03% of Senior
Strategic's total assets were invested in Senior Debt.
Senior Debt will include both debt securities bearing
interest at fixed rates and debt instruments which pay
interest at rates which float at a margin above a
generally recognized base lending rate such as the
prime rate ("Prime Rate") of a designated U.S. bank, or
which adjust periodically at a margin above the
Certificate of Deposit ("CD") rate or the London
InterBank Offered Rate ("LIBOR"). Senior Debt
investments of the Fund may be rated in the lower
rating categories of the established rating services
(Baa or lower by Moody's Investors Service, Inc.
("Moody's") and BBB or lower by Standard & Poor's
Ratings Group ("S&P")), or in unrated securities of
comparable quality. Securities rated below Baa by
Moody's or below BBB by S&P, and unrated securities of
comparable quality are commonly known as "junk bonds."
The same investment restrictions apply to SHIP I, SHIP
II and Senior Strategic. See "Comparison of the Funds--
Investment Objectives and Policies".
Capital Stock. SHIP I, SHIP II and Senior Strategic
each has outstanding Common Stock. Common Stock of each
of SHIP I, SHIP II and Senior Strategic is traded on
the NYSE. As of August 31, 1995, the net asset value
per share of the SHIP I Common Stock was $9.06 and the
market price per share was $9.00, the net asset value
per share of the SHIP II Common Stock was $9.27 and the
market price per share was $9.00, and the net asset
value per share of the Senior Strategic Common Stock
was $9.26 and the market price per share was $9.13. See
"Purchases and Sales of Common Stock" and "Comparison
of the Funds--Capital Stock".
Advisory Fees. The investment adviser for each of SHIP
I, SHIP II and Senior Strategic is Fund Asset
Management, L.P. ("FAM"). FAM is an affiliate of MLAM,
and both FAM and MLAM are owned and controlled by
Merrill Lynch & Co., Inc. ("ML & Co."). The principal
business address of FAM is 800 Scudders Mill Road,
Plainsboro, New Jersey 08536. MLAM or FAM acts as the
investment adviser for more than 130 registered
investment companies. FAM also offers portfolio
management and portfolio analysis services to
individuals and institutions.
FAM is responsible for the management of each Fund's
investment portfolio and for providing administrative
services to each Fund. The same personnel manage the
portfolio of each of SHIP I, SHIP II and Senior
Strategic. R. Douglas Henderson serves as the portfolio
manager for each of the Funds.
Pursuant to separate investment advisory agreements
between each Fund and FAM, each Fund pays FAM a monthly
fee at the annual rate of 0.50% of such Fund's average
weekly net assets plus the proceeds of any outstanding
borrowings used for leverage.
</TABLE>
9
<PAGE>
<TABLE>
<S> <C>
Subsequent to the Merger, FAM will continue to receive
a monthly fee at the annual rate of 0.50% of the
surviving Fund's
average weekly net assets plus the proceeds of any
outstanding borrowings used for leverage. See
"Comparison of the Funds--Management of the Funds".
Other Significant Fees. The Bank of New York is the
transfer agent, dividend disbursing agent and registrar
for each of SHIP I, SHIP II and Senior Strategic in
connection with their respective Common Stock, at the
same rate for each Fund. The Bank of New York also is
the custodian for the assets of each of SHIP I, SHIP II
and Senior Strategic, at the same rate for each Fund.
The principal business addresses of The Bank of New
York are 101 Barclay Street, New York, New York 10286
(for its transfer agency services) and 90 Washington
Street, New York, New York 10286 (for its custodial
services).
Overall Expense Ratios. The overall operating expense
ratio as of August 31, 1995 was 3.05% for SHIP I, 3.63%
for SHIP II and 2.97% for Senior Strategic. If the
Merger had taken place on August 31, 1995, the overall
operating expense ratio for the combined fund on a pro
forma basis would have been 2.56% assuming interest on
borrowed funds at an annual rate of 5.9%. Each of the
operating expense ratios set forth in this paragraph
are based on average net assets of the Fund and include
the costs associated with leverage.
Purchases and Sales of Common Stock. Purchase and sale
procedures for Common Stock of each of SHIP I, SHIP II
and Senior Strategic are identical, and investors
typically purchase and sell shares of Common Stock of
such Funds through a registered broker-dealer on the
NYSE, thereby incurring a brokerage commission set by
the broker-dealer. Alternatively, investors may
purchase or sell shares of Common Stock of such Funds
through privately negotiated transactions with existing
stockholders.
Portfolio Transactions. The portfolio transactions in
which each of SHIP I, SHIP II and Senior Strategic may
engage are identical, as are the procedures for such
transactions. See "Comparison of the Funds--Portfolio
Transactions".
Dividends and Distributions. The methods of dividend
payment and distributions are identical for each of
SHIP I, SHIP II and Senior Strategic with respect to
the Common Stock of each Fund, although the amount of
dividends may differ for each Fund depending on
prevailing market conditions at the time dividends are
paid. See "Comparison of the Funds--Dividends and
Distributions".
Voting Rights. The corresponding voting rights of the
holders of shares of Common Stock of each of SHIP I,
SHIP II and Senior Strategic are identical. See
"Comparison of the Funds--Capital Stock".
Stockholder Services. An automatic dividend
reinvestment plan is available to the holders of shares
of Common Stock of each of SHIP I, SHIP II and Senior
Strategic. The plans are identical for the three Funds.
See "Comparison of the Funds--Automatic Dividend
Reinvestment Plan". Other stockholder services,
including the provision of annual and semi-annual
reports, are the same for the three Funds.
</TABLE>
10
<PAGE>
OUTSTANDING SECURITIES OF SHIP I, SHIP II AND SENIOR STRATEGIC AS OF AUGUST 31,
1995
<TABLE>
<CAPTION>
AMOUNT OUTSTANDING EXCLUSIVE
AMOUNT HELD BY REGISTRANT OF AMOUNT SHOWN IN
TITLE OF CLASS AMOUNT AUTHORIZED FOR ITS OWN ACCOUNT PREVIOUS COLUMN
-------------- ----------------- ------------------------- ----------------------------
<S> <C> <C> <C>
SHIP I
Common Stock 200,000,000 0 25,388,292
SHIP II
Common Stock 200,000,000 0 16,610,527
Senior Strategic
Common Stock 200,000,000 0 7,750,527
TAX CONSIDERATIONS The Merger has been structured with the intention that it will qualify
for Federal income tax purposes as a tax-free merger under Section
368(a)(1)(A) of the Internal Revenue Code of 1986, as amended (the
"Code"). Each of the Funds has elected and qualified for the special tax
treatment afforded regulated investment companies under the Code through
the Effective Date, and SHIP I intends to continue to so qualify after
the Merger. The Internal Revenue Service does not issue private letter
rulings in connection with statutory mergers under Section 368(a)(1)(A)
of the Code. Consequently, based on certain representations made by each
Fund, the Funds will receive an opinion of Brown & Wood with respect to
the Merger to the effect that, among other things, no Fund will
recognize taxable gain or loss as a result of the Merger and no SHIP I,
SHIP II or Senior Strategic stockholder will recognize taxable gain or
loss upon the issuance of SHIP I Common Stock in the Merger (except to
the extent that a SHIP II or Senior Strategic stockholder receives cash
representing his or her interest in less than a full share of SHIP I in
the Merger, such stockholder may realize a minimal taxable gain). See
"The Merger--Terms of the Agreement and Plan of Merger" and
"--Tax Consequences of the Merger". The consummation of the Merger is
subject to the receipt of such opinion.
</TABLE>
RISK FACTORS AND SPECIAL CONSIDERATIONS
Because each Fund invests primarily in Senior Debt, any risks inherent in
such investments are equally applicable to all of the Funds and will be
similarly pertinent to the combined fund after the Merger. It is expected that
the Merger itself will not adversely affect the rights of holders of shares of
Common Stock of any one Fund or create additional risks.
NON-DIVERSIFIED STATUS
Each Fund has registered as a "non-diversified" investment company so that it
will be able to invest more than 5% of its assets in the obligations of any
single issuer, subject to the diversification requirements of Subchapter M of
the Code, applicable to the Fund. Since each Fund may invest a relatively high
percentage of its assets in the obligations of a limited number of issuers, the
Fund may be more susceptible than a more widely-diversified fund to any single
economic, political or regulatory occurrence.
CORPORATE LOANS
The Funds may invest in corporate loans ("Corporate Loans") made by banks and
other financial institutions, including highly leveraged loans. Corporate Loans
made in connection with highly leveraged transactions are subject to greater
credit risks than other Corporate Loans in which the Funds may invest.
11
<PAGE>
These credit risks include a greater possibility of default or bankruptcy of
the borrower and the assertion that the pledging of collateral to secure the
loan constituted a fraudulent conveyance or preferential transfer which can be
nullified or subordinated to the rights of other creditors of the borrower
under applicable law. Highly leveraged Corporate Loans also may be less liquid
than other Corporate Loans.
The financial status of the Agent Bank (as defined below) and co-lenders and
participants interposed between each Fund and a borrower may affect the ability
of the Fund to receive payments of interest and repayments of principal. Each
Fund will invest in Corporate Loans only if, at the time of investment, the
outstanding debt obligations of the Agent Bank and intermediate participants
are investment grade, i.e., rated BBB or A-3 or higher by S&P or Baa or P-3 or
higher by Moody's, or determined to be of comparable quality in the judgment of
FAM.
The success of each Fund depends to a great degree, on the skill with which
the Agent Banks administer the terms of the Corporate Loan agreements, monitor
borrower compliance with covenants, collect principal, interest and fee
payments from borrowers and, where necessary, enforce creditor remedies against
borrowers. Typically, the Agent Bank will have broad discretion in enforcing a
Corporate Loan agreement.
LOWER-RATED SECURITIES
Junk bonds are regarded as being predominantly speculative as to the issuer's
ability to make repayments of principal and payments of interest. Investment in
such securities involves substantial risk. Issuers of junk bonds may be highly
leveraged and may not have available to them more traditional methods of
financing. Therefore, the risks associated with acquiring the securities of
such issuers generally are greater than is the case with higher-rated
securities. For example, during an economic downturn or a sustained period of
rising interest rates, issuers of junk bonds may be more likely to experience
financial stress, especially if such issuers are highly leveraged. During such
periods, such issuers may not have sufficient revenues to meet their interest
payment obligations. The issuer's ability to service its debt obligations also
may be adversely affected by specific issuer developments, or the issuer's
inability to meet specific projected business forecasts, or the unavailability
of additional financing.
Junk bonds tend to be more volatile than higher-rated fixed-income
securities, so that adverse economic events may have a greater impact on the
prices of junk bonds than on higher-rated fixed-income securities. Like higher-
rated fixed-income securities, junk bonds are generally purchased and sold
through dealers who make a market in such securities for their own accounts.
There are fewer dealers in the junk bond market, however, which may be less
liquid than the market for higher-rated fixed-income securities, even under
normal economic conditions. Also, there may be significant disparities in the
prices quoted for junk bonds by various dealers. Adverse economic conditions or
investor perceptions (whether or not based on economic fundamentals) may impair
the liquidity of this market, and may cause the prices each Fund receives for
its junk bonds to be reduced, or the Fund may experience difficulty in
liquidating a portion of its portfolio in response to a specific economic event
such as a deterioration in the creditworthiness of the issuer. Under such
conditions, judgment may play a greater role in valuing certain of the Fund's
portfolio securities than is the case with securities trading in a more liquid
market. In addition, the Fund may incur additional expenses to the extent that
it is required to seek recovery upon a default on a portfolio holding or to
participate in the restructuring of the obligation.
LEVERAGE
The use of leverage by each Fund creates an opportunity for increased net
income, but, at the same time, creates special risks. Each Fund intends to
utilize leverage to provide the common shareholders with a potentially higher
rate of return. Leverage creates risks for common stockholders including the
likelihood of greater volatility of net asset value and market price of shares
of the Common Stock, and the risk that fluctuations in interest rates on
borrowings or in the dividend rates on any preferred stock may affect the yield
to common stockholders. To the extent the income derived from securities
purchased with funds
12
<PAGE>
received from leverage exceeds the cost of leverage, the Fund's net income will
be greater than if leverage had not been used. Conversely, if the income from
the securities purchased with such funds is not sufficient to cover the cost of
leverage, the net income of the Fund will be less than if leverage had not been
used, and therefore the amount available for distribution to shareholders as
dividends will be reduced. In the latter case, the Fund may nevertheless
determine to maintain its leveraged position in order to avoid capital losses
on securities purchased with the leverage. Certain types of borrowings may
result in the Fund being subject to covenants in credit agreements relating to
asset coverage and portfolio composition requirements. The Fund may be subject
to certain restrictions on investments imposed by guidelines of one or more
nationally recognized rating agencies which may issue ratings for the short-
term corporate debt securities or preferred stock issued by the Fund. These
guidelines may impose asset coverage or portfolio composition requirements that
are more stringent than those imposed by the Investment Company Act. It is not
anticipated that these covenants or guidelines will impede FAM from managing
the Fund's portfolio in accordance with the Fund's investment objective and
policies.
OTHER INVESTMENT MANAGEMENT TECHNIQUES
Each Fund may use various other investment management techniques that also
involve special considerations including engaging in interest rate
transactions, utilization of options and futures transactions, making forward
commitments, and lending its portfolio securities. For further discussion of
these practices and the associated risks and special considerations, see "Other
Investment Policies".
NON-U.S. SECURITIES
Each Fund may invest in Senior Debt issued by non-U.S. issuers, provided that
the debt instruments are U.S. dollar-denominated or otherwise provide for
payment in U.S. dollars. Investing in securities issued by non-U.S. issuers
involves certain special risks. See "Comparison of the Funds--Description of
Senior Debt".
CONCENTRATION IN FINANCIAL INSTITUTIONS
Each Fund may be deemed to be concentrated in securities of issuers in the
industry group consisting of financial institutions and their holding
companies, including commercial banks, thrift institutions, insurance companies
and finance companies. As a result, each Fund is subject to certain risks
associated with such institutions, including, among other things, changes in
governmental regulation, interest rate levels and general economic conditions.
See "Investment Objective and Policies--Description of Senior Debt Consisting
of Corporate Loans".
ILLIQUID SECURITIES
Each Fund may invest in securities that lack an established secondary trading
market or are otherwise considered illiquid. Some or all of the Corporate Loans
in which each Fund invests will be considered to be illiquid. Liquidity of a
security relates to the ability to easily dispose of the security and the price
to be obtained and does not generally relate to the credit risk or likelihood
of receipt of cash at maturity. Illiquid corporate bonds and notes may trade at
a discount from comparable, more liquid investments.
ANTITAKEOVER PROVISIONS
Each Fund's Articles of Incorporation include provisions that could have the
effect of limiting the ability of other entities or persons to acquire control
of the Fund or to change the composition of its Board of Directors and could
have the effect of depriving shareholders of an opportunity to sell their
shares at a premium over prevailing market prices by discouraging a third party
from seeking to obtain control of the Fund. See "Comparison of the Funds--
Capital Stock--Certain Provisions of the Charter".
13
<PAGE>
COMPARISON OF THE FUNDS
FINANCIAL HIGHLIGHTS
SHIP I
The financial information in the table below, except for the period from
March 1, 1995 through August 31, 1995, which is unaudited and has been provided
by FAM, has been audited in conjunction with the annual audit of the financial
statements of the Fund by Deloitte & Touche LLP, independent auditors.
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE SIX MONTHS ENDED FOR THE FISCAL APRIL 30,
AUGUST 31, 1995++ YEAR ENDED 1993+ TO
(UNAUDITED) FEBRUARY 28, 1995++ FEBRUARY 28, 1994
------------------------ ------------------- -----------------
<S> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value, $ 8.94 $ 9.82 $ 9.50
beginning of period -------- -------- --------
Investment income-net .49 .90 .70
Realized and unrealized
net gain (loss) on .08 (.87)
investments-net -------- -------- .25
--------
Total from investment .57 .03 .95
operations -------- -------- --------
Less dividends and
distributions from:
Investment income-net (.45) (.84) (.61)
Realized gain on
investments-net -- (.07) (.02)
-------- -------- --------
Total dividends and
distributions (.45) (.91) (.63)
-------- -------- --------
Net asset value, end of
period $ 9.06 $ 8.94 $ 9.82
-------- -------- --------
Market price per share;
end of period $ 9.00 $ 8.625 $ 9.375
-------- -------- --------
TOTAL INVESTMENT
RETURN:**
Based on market price
per share 9.85%++ 1.87% .02%++
-------- -------- --------
Based on net asset value
per share 6.69%++ .82% 10.28%++
-------- -------- --------
RATIOS TO AVERAGE NET
ASSETS:
Expenses, net of
reimbursement and
excluding interest
expense .94%* .80% .67%*
-------- -------- --------
Expenses, net of
reimbursement 3.05%* 2.46% 1.61%*
-------- -------- --------
Expenses 3.05%* 2.46% 1.75%*
-------- -------- --------
Investment income-net 10.61%* 7.07% 7.33%*
-------- -------- --------
SUPPLEMENTAL DATA:
Net assets, end of $230,014 $227,007 $248,342
period (in thousands) -------- -------- --------
Portfolio turnover 29.99% 44.81% 52.73%
-------- -------- --------
LEVERAGE:
Amount of borrowings (in $ 67,000 $ 82,000 $ 84,000
thousands) -------- -------- --------
Asset coverage per
$1,000 $ 4,433 $ 3,768 $ 3,956
-------- -------- --------
</TABLE>
- --------
* Annualized.
** Total investment returns based on market value, which can be significantly
greater or lesser than the net asset value, result in substantially different
returns. Total investment returns exclude the effects of sales loads.
+ Commencement of Operations.
++ Based on average shares outstanding during the period.
++ Aggregate total investment return.
14
<PAGE>
SHIP II
The financial information in the table below has been audited in conjunction
with the annual audit of the financial statements of the Fund by Deloitte &
Touche LLP, independent auditors.
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE FISCAL YEAR ENDED SEPTEMBER 24, 1993+
AUGUST 31, 1995 TO AUGUST 31, 1994
------------------------- -------------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period $ 9.25 $ 9.50
-------- --------
Investment income--net .95 .79
Realized and unrealized loss on
investments--net (.04) (.32)
-------- --------
Total from investment operations .91 .47
-------- --------
Less dividends from investment
income--net (.89) (.71)
-------- --------
Capital change resulting from -- (.01)
the issuance of Common Stock -------- --------
Net asset value, end of period $ 9.27 $ 9.25
-------- --------
Market price per share, end of
period $ 9.00 $ 8.875
-------- --------
TOTAL INVESTMENT RETURN:**
Based on market price per share $ 12.09% (4.22%)++
-------- --------
Based on net asset value per $ 10.77% 5.08%++
share -------- --------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement
and excluding interest expense 1.08% 1.51%*
-------- --------
Expenses, net of reimbursement 3.63% 2.17%*
-------- --------
Expenses 3.63% 2.34%*
-------- --------
Investment income--net 10.35% 7.14%*
-------- --------
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands) $153,971 $153,652
-------- --------
Portfolio turnover 51.51% 52.37%
-------- --------
LEVERAGE:
Amount of borrowings (in
thousands) $ 45,000 $ 60,000
-------- --------
Asset coverage per $1000 $ 4,422 $ 3,561
-------- --------
</TABLE>
- --------
*Annualized.
** Total investment returns based on market value, which can be significantly
greater or lesser than the net asset value, result in subsequent value
different returns. Total investment returns exclude the effects of sales
loads.
+ Commencement of operations.
++Aggregate total investment return.
15
<PAGE>
SENIOR STRATEGIC
The financial information in the table below, except for the period from
March 1, 1995 through August 31, 1995 which is unaudited and has been provided
by FAM, has been audited in conjunction with the annual audit of the financial
statements of the Fund by Deloitte & Touche LLP, independent auditors.
<TABLE>
<CAPTION>
FOR THE PERIOD
FOR THE SIX MONTHS ENDED APRIL 8, 1994+ TO
AUGUST 31, 1995 (UNAUDITED) FEBRUARY 28, 1995
--------------------------- -----------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE
Net asset value, beginning of
period $ 9.27 $ 9.50
------- -------
Investment income--net .49 .81
Realized and unrealized loss on
investments--net (.03) (.29)
------- -------
Total from investment operations .46 .52
------- -------
Less dividends and distributions
from:
Investment income--net (.47) (.71)
Realized gain on investments--
net -- (.02)
------- -------
Total dividends and
distributions (.47) (.73)
------- -------
Capital charge resulting from -- (.02)
the issuance of Common Stock ------- -------
Net asset value, end of period $ 9.26 $ 9.27
------- -------
Per share market value, end of
period $ 9.125 $ 9.125
------- -------
TOTAL INVESTMENT RETURN:**
Based on market price per share 5.34%++ (1.13%)++
------- -------
Based on net asset value per
share 5.22%++ 5.73% ++
------- -------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement
and excluding interest expense 1.04%* .65%*
------- -------
Expenses, net of reimbursement 2.97%* 2.15%*
------- -------
Expenses 2.97%* 2.44%*
------- -------
Investment income--net 9.40%* 8.42%*
------- -------
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands) $71,781 $71,852
------- -------
Portfolio turnover 32.79% 33.38%
------- -------
LEVERAGE:
Amount of borrowings (in
thousands) $24,000 $21,000
------- -------
Asset coverage per $1,000 $ 3,991 $ 4,422
------- -------
</TABLE>
- --------
*Annualized.
** Total investment returns based on market value, which can be significantly
greater or lesser than the net asset value, may result in substantially
different returns. Total investment returns exclude the effects of sales
loads.
+ Commencement of Operations.
++Aggregate total investment return.
16
<PAGE>
PER SHARE DATA FOR SHIP I COMMON STOCK TRADED ON THE NEW YORK STOCK EXCHANGE
<TABLE>
<CAPTION>
PREMIUM
(DISCOUNT)
NET ASSET TO NET
MARKET PRICE VALUE ASSET VALUE
--------------- ----------- --------------
QUARTER ENDED HIGH LOW HIGH LOW HIGH LOW
------------- ------- ------- ----- ----- ----- ------
<S> <C> <C> <C> <C> <C> <C>
May 31, 1993*...................... $10.125 $10.00 $9.54 $9.48 6.13 % 5.04 %
August 31, 1993.................... 10.125 9.75 9.71 9.56 5.91 1.14
November 30, 1993.................. 10.125 9.50 9.77 9.54 5.25 (2.06)
February 28, 1994.................. 9.875 9.125 9.89 9.70 1.28 (7.74)
May 31, 1994....................... 9.625 8.75 9.80 9.28 0.37 (7.70)
August 31, 1994.................... 9.25 8.50 9.40 9.13 (0.96) (8.41)
November 30, 1994.................. 9.00 7.75 9.17 8.90 (0.28) (14.55)
February 28, 1995.................. 8.875 8.375 8.94 8.74 1.54 (5.58)
May 31, 1995....................... 8.875 8.125 9.16 8.95 (2.47) (9.92)
August 31, 1995.................... 9.125 8.50 9.17 9.04 0.72 (6.90)
November 30, 1995.................. 9.50 8.875 9.15 9.04 3.83 (2.79)
</TABLE>
- --------
* SHIP I commenced operations on April 30, 1993.
PER SHARE DATA FOR SHIP II COMMON STOCK TRADED ON THE NEW YORK STOCK EXCHANGE
<TABLE>
<CAPTION>
PREMIUM
(DISCOUNT)
NET ASSET TO NET
MARKET PRICE VALUE ASSET VALUE
------------- ----------- --------------
QUARTER ENDED HIGH LOW HIGH LOW HIGH LOW
------------- ------ ------ ----- ----- ----- ------
<S> <C> <C> <C> <C> <C> <C>
November 30, 1993*................... $9.75 $9.125 $9.65 $9.50 (1.56)% (5.44)%
February 28, 1994.................... 9.75 9.25 9.80 9.58 0.72 (5.03)
May 31, 1994......................... 9.625 8.50 9.71 9.27 (0.16) (10.15)
August 31, 1994...................... 9.375 8.50 9.39 9.22 0.27 (8.99)
November 30, 1994.................... 8.875 8.125 9.27 9.06 (2.04) (11.49)
February 28, 1995.................... 8.875 8.50 9.18 8.97 (1.83) (6.70)
May 31, 1995......................... 8.875 8.25 9.34 9.17 (4.68) (10.33)
August 31, 1995...................... 9.125 8.75 9.38 9.25 (1.46) (6.32)
November 30, 1995.................... 9.50 9.00 9.33 9.13 3.49 (3.12)
</TABLE>
- --------
* SHIP II commenced operations on September 24, 1993.
PER SHARE DATA FOR SENIOR STRATEGIC COMMON STOCK TRADED ON THE NEW YORK STOCK
EXCHANGE
<TABLE>
<CAPTION>
PREMIUM
(DISCOUNT)
NET ASSET TO NET
MARKET PRICE VALUE ASSET VALUE
------------- ----------- --------------
QUARTER ENDED HIGH LOW HIGH LOW HIGH LOW
------------- ------ ------ ----- ----- ----- ------
<S> <C> <C> <C> <C> <C> <C>
May 31, 1994*........................ $9.875 $9.375 $9.57 $9.47 4.06 % (2.04)%
August 31, 1994...................... 9.50 8.625 9.65 9.44 (0.73) (9.78)
November 30, 1994.................... 9.125 8.00 9.55 9.30 (3.23) (15.25)
February 28, 1995.................... 9.25 8.375 9.28 9.14 (9.07) 0.11
May 31, 1995......................... 9.125 8.375 9.46 9.25 (1.78) (10.14)
August 31, 1995...................... 9.25 8.625 9.25 9.44 (0.11) (7.46)
November 30, 1995.................... 9.50 9.125 9.35 9.15 3.49 (1.78)
</TABLE>
- --------
* Senior Strategic commenced operations on April 8, 1994.
17
<PAGE>
Since the termination of share price stabilization following each Fund's
initial public offering, share prices for SHIP I Common Stock have fluctuated
between a maximum premium of 6.13% and a maximum discount of (14.55%), share
prices for SHIP II Common Stock have fluctuated between a maximum premium of
3.49% and a maximum discount of (11.49%) and share prices for Senior Strategic
Common Stock have fluctuated between a maximum premium of 4.06% and a maximum
discount of (15.25%). It is not possible to state whether shares of the
surviving fund will trade at a premium or discount to net asset value following
the Merger, or what the extent of any such premium or discount might be.
INVESTMENT OBJECTIVES AND POLICIES
The structure, organization and investment policies of SHIP I, SHIP II and
Senior Strategic are virtually identical. Each Fund seeks as a fundamental
investment objective as high a level of current income as is consistent with
the Fund's investment policies and prudent investment management. The sole
difference in the investment policies of the Funds is that Senior Strategic may
invest up to 35% of its total assets in debt obligations other than Senior Debt
while SHIP I and SHIP II may invest up to 20% of their respective total assets
in debt instruments not constituting Senior Debt. The Board of Directors of
SHIP I has approved, as a condition to the Merger, that SHIP I increase its
limitation on investment in debt obligations not constituting Senior Debt to
35% of its total assets.
Except for the difference described in the preceding paragraph, the
investment objectives and policies of SHIP I, SHIP II and Senior Strategic are
identical. Each Fund seeks to achieve its investment objective by investing
primarily in Senior Debt. The investment objective of each Fund is a
fundamental policy that may not be changed without a vote of a majority of the
Fund's outstanding voting securities (as defined in the Investment Company
Act). At times, each Fund may seek to hedge its portfolio against movements in
interest rates through the use of interest rate transactions, the purchase of
call and put options on securities, the sale of covered call and put options on
its portfolio securities and transactions in financial futures and related
options on such futures.
Senior Debt will include both debt securities bearing interest at fixed rates
and debt instruments which pay interest at rates which float at a margin above
a generally recognized base lending rate such as the Prime Rate of a designated
U.S. bank, or which adjust periodically at a margin above the CD rate or LIBOR.
Senior Debt investments of the Funds may be rated in the lower rating
categories of the established rating services (Baa or lower by Moody's and BBB
or lower by S&P), or in unrated securities of comparable quality. Securities
rated below Baa by Moody's or below BBB by S&P, and unrated securities of
comparable quality are commonly known as "junk bonds." See Exhibit II--
"Description of Corporate Bond Ratings" for additional information concerning
rating categories. Although junk bonds can be expected to provide higher
yields, such securities may be subject to greater market fluctuations and risk
of loss of income and principal than lower-yielding, higher rated fixed-income
securities. See "Risk Factors and Special Considerations". The Funds will not
invest in securities in the lowest rating categories (Caa or below for Moody's
and CCC or below for S&P). Securities which are subsequently downgraded may
continue to be held and will be sold only if, in the judgment of FAM, it is
advantageous to do so. To a limited extent, incidental to and in connection
with its portfolio investments, each Fund also may acquire warrants and other
equity securities.
When changing economic conditions and other factors cause the yield
difference between lower-rated and higher-rated securities to narrow, the Funds
may purchase higher-rated securities if FAM believes that the risk of loss of
income and principal may be substantially reduced with only a relatively small
reduction in yield. In addition, under unusual market or economic conditions,
each Fund for temporary defensive purposes may invest up to 100% of its assets
in securities issued or guaranteed by the U.S. Government or its
instrumentalities or agencies, certificates of deposit, bankers' acceptances
and other bank obligations, commercial paper rated in the highest category by
an established rating agency, or other fixed-income securities deemed by FAM to
be consistent with a defensive posture, or may hold its assets in cash. The
yield on such securities may be lower than the yield on lower-rated fixed-
income securities.
18
<PAGE>
The Funds have no restrictions on portfolio maturity, but it is anticipated
that a majority of the Senior Debt in which they will invest will have stated
maturities ranging from four to ten years. As a result of prepayments, however,
it is expected that the actual maturities of many of the Funds' investments
will be shorter. See "--Description of Senior Debt".
Investment in shares of Common Stock of each of the Funds offers several
benefits. Each Fund offers investors the opportunity to receive a high level of
current income by investing in a professionally managed portfolio comprised
primarily of Senior Debt which, to the extent the portfolio is comprised of
Corporate Loans, is a type of investment typically not available to individual
investors. In managing such portfolio, FAM provides each Fund and its
shareholders with professional credit analysis. Each Fund also relieves the
investor of the burdensome administrative details involved in managing a
portfolio of such investments. Additionally, FAM will seek to enhance the yield
on the Common Stock by leveraging each Fund's capital structure through the
borrowing of money or the issuance of preferred stock. The benefits are at
least partially offset by the expenses involved in operating an investment
company. Such expenses primarily consist of the advisory fee and operational
costs. Additionally, the use of leverage involves certain expenses and risk
considerations. See "Other Investment Policies--Leverage".
Each Fund may engage in various portfolio strategies to seek to increase its
return and to hedge its portfolio against movements in interest rates through
the use of interest rate transactions, the purchase of call and put options on
securities, the sale of covered call and put options on its portfolio
securities and transactions in financial futures and related options on such
futures. Each of these portfolio strategies is described below. There can be no
assurance that each Fund's hedging transactions will be effective. Furthermore,
each Fund will only engage in hedging activities from time to time and may not
necessarily be engaging in hedging transactions when movements in interest
rates occur.
Each Fund is classified as non-diversified within the meaning of the
Investment Company Act, which means that the Fund is not limited by such Act in
the proportion of its assets that it may invest in securities of a single
issuer. However, each Fund's investments will be limited so as to qualify the
Fund as a "regulated investment company" for purposes of the Code. See " Tax
Rules Applicable to SHIP I, SHIP II, Senior Strategic and Their Stockholders".
To qualify, among other requirements, each Fund will limit its investments so
that, at the close of each quarter of the taxable year, (i) not more than 25%
of the market value of the Fund's total assets will be invested in the
securities (other than U.S. Government securities) of a single issuer and (ii)
with respect to 50% of the market value of its total assets, not more than 5%
of the market value of its total assets will be invested in the securities
(other than U.S. Government securities) of a single issuer. A fund which elects
to be classified as "diversified" under the Investment Company Act must satisfy
the foregoing 5% requirement with respect to 75% of its total assets. To the
extent that each Fund assumes large positions in the securities of a small
number of issuers, the Fund's yield may fluctuate to a greater extent than that
of a diversified company as a result of changes in the financial condition or
in the market's assessment of the issuers.
DESCRIPTION OF SENIOR DEBT
The Senior Debt in which each Fund invests primarily consist of direct
obligations of a company (a corporation, partnership or trust) undertaken to
finance the growth of the company's business internally or externally, or to
finance a capital restructuring. Senior Debt may also include senior
obligations of a company issued in connection with a restructuring pursuant to
Chapter 11 of the U.S. Bankruptcy Code provided that such senior obligations
meet the credit standards established by FAM. It is anticipated that a
significant portion of such Senior Debt may include obligations of companies
with highly leveraged capital structures (i.e., a large proportion of debt
compared to equity). Such obligations may include leveraged buy-out loans,
leveraged recapitalization loans and other types of acquisition loans. Such
Senior Debt may be structured to include both term loans, which are generally
fully funded at the time of each Fund's investment, and revolving credit
facilities, which would require each Fund to make additional investments in the
Senior Debt as required under the terms of the credit facility. Such Senior
Debt may also include receivables purchase facilities, which are similar to
revolving credit facilities secured by a company's receivables.
19
<PAGE>
The Senior Debt in which each Fund invests will, in many instances, hold the
most senior position in the capitalization structure of the company (i.e., not
subordinated to other debt obligations in right of payment), and, in any case,
will, in the judgment of FAM, be in the category of senior debt of the company.
The Senior Debt in which each Fund invests may be wholly or partially secured
by collateral, or may be unsecured. In the event of a default, the ability of
an investor to have access to any collateral may be limited by bankruptcy and
other insolvency laws. The value of the collateral may also decline subsequent
to each Fund's investment in the Senior Debt. Under certain circumstances, the
collateral may be released with the consent of a majority of the Senior Debt
investors or pursuant to the terms of the debt instrument. There is no
assurance that the liquidation of the collateral would satisfy the company's
obligation in the event of nonpayment of scheduled interest or principal, or
that the collateral could be readily liquidated. As a result, a Fund might not
receive payments to which it is entitled and thereby may experience a decline
in the value of the investment and, possibly, its net asset value.
In the case of highly leveraged senior debt instruments, a company generally
is required to pledge collateral which may include (i) working capital assets,
such as accounts receivable and inventory, (ii) tangible fixed assets, such as
real property, buildings and equipment, (iii) intangible assets, such as
trademarks, copyrights and patent rights and (iv) security interests in
securities of subsidiaries or affiliates. In the case of Senior Debt issued by
privately held companies, the companies' owners may pledge additional security
in the form of guarantees and/or other securities that they own.
The rate of interest payable on floating or variable rate corporate loans and
other debt instruments is established as the sum of a base lending rate plus a
specified margin. These base lending rates generally are the Prime Rate of a
designated U.S. bank, LIBOR, the CD rate or another base lending rate used by
commercial lenders. The interest rate on Prime Rate-based loans floats daily as
the Prime Rate changes, while the interest rate on LIBOR-based and CD-based
loans is reset periodically, typically every 30 days to one year. Investment in
Senior Debt with longer interest rate reset periods or fixed interest rates may
increase fluctuations in each Fund's net asset value as a result of changes in
interest rates. However, to the extent that a substantial portion of each
Fund's investment portfolio is invested in Senior Debt with relatively short
interest rate reset periods, the Fund's net asset value should experience less
fluctuation as a result of changes in interest rates than would a portfolio
comprised primarily of fixed rate debt instruments.
Each Fund will invest in Senior Debt only if, in FAM's judgment, the company
can meet debt service on such debt. In addition, FAM will consider other
factors deemed by it to be appropriate to the analysis of the company and the
Senior Debt. Such factors include financial ratios of the company such as pre-
tax interest coverage, leverage ratios, the ratio of cash flows to total debt
and the ratio of tangible assets to debt. In its analysis of these factors, FAM
also will be influenced by the nature of the industry in which the company is
engaged, the nature of the company's assets and FAM's assessments of the
general quality of the company. The factors utilized have been reviewed and
approved by each Fund's Board of Directors.
The primary consideration in selecting such Senior Debt for investment by
each Fund is the creditworthiness of the company. In evaluating Senior Debt,
the quality ratings assigned to other debt obligations of a company may not be
a determining factor, since they will often be subordinated to the Senior Debt.
Instead, FAM will perform its own independent credit analysis of the company.
FAM's analysis will continue on an ongoing basis for any Senior Debt in which a
Fund has invested. Although FAM will use due care in making such analysis,
there can be no assurance that such analysis will disclose factors which may
impair the value of the Senior Debt.
Senior Debt issued in connection with highly leveraged transactions is
subject to greater credit risks than other Senior Debt in which each Fund may
invest. These credit risks include a greater possibility of default or
bankruptcy of the company and the assertion that the pledging of collateral to
secure the Senior Debt constituted a fraudulent conveyance or preferential
transfer which can be nullified or subordinated to the
20
<PAGE>
rights of other creditors of the company under applicable law. Highly leveraged
Senior Debt also may be less liquid than other debt instruments.
A company also must comply with various restrictive covenants contained in
any Senior Debt instrument. Such covenants, in addition to requiring the
scheduled payment of interest and principal, may include restrictions on
dividend payments and other distributions to stockholders, provisions requiring
the company to maintain specific financial ratios or relationships and limits
on total debt. In addition, the Senior Debt instrument may contain a covenant
requiring the company to prepay the Senior Debt with any excess cash flow.
Excess cash flow generally includes net cash flow after scheduled debt service
payments and permitted capital expenditures, among other things, as well as the
proceeds from asset dispositions or sales of securities. A breach of a covenant
(after giving effect to any cure period) which is not waived by the holders of
the Senior Debt normally is an event of default permitting acceleration of the
maturity of the Senior Debt.
It is expected that a majority of the Senior Debt instruments will have
stated maturities ranging from four to ten years. However, such Senior Debt
instruments may require, in addition to scheduled payments of interest and
principal, the prepayment of the Senior Debt from excess cash flow, as
discussed above, and may permit the company to prepay at its election. The
degree to which companies prepay Senior Debt, whether as a contractual
requirement or at their election, may be affected by general business
conditions, the financial condition of the company and competitive conditions
among lenders, among other factors. Accordingly, prepayments cannot be
predicted with accuracy. Upon a prepayment of a corporate loan, each Fund may
receive both a prepayment penalty fee from the prepaying company and a facility
fee on the purchase of new Senior Debt with the proceeds from the prepayment of
the former. Such fees may mitigate any adverse impact on the yield on each
Fund's portfolio which may arise as a result of prepayments and the
reinvestment of such proceeds in Senior Debt bearing lower interest rates.
Each Fund may invest in Senior Debt issued by non-U.S. companies, provided
that the debt instruments are U.S. dollar-denominated or otherwise provide for
payment in U.S. dollars, and the company meets the credit standards established
by FAM for U.S. companies. Each Fund similarly may invest in Senior Debt issued
by U.S. companies with significant non-dollar denominated revenues, provided
that the debt instruments are U.S. dollar-denominated or otherwise provide for
payment to the Fund in U.S. dollars. In all cases where debt instruments are
not denominated in U.S. dollars, the Senior Debt facility will provide for
payments to the investors, including the Funds, in U.S. dollars pursuant to
foreign currency swap arrangements. Investments in Senior Debt issued by such
non-U.S. companies or U.S. companies may involve risks not typically involved
in domestic investment, including fluctuation in foreign exchange rates, future
foreign political and economic developments, and the possible imposition of
exchange controls or other foreign or U.S. governmental laws or restrictions
applicable to such loans. With respect to certain foreign countries, there is
the possibility of expropriation or confiscatory taxation, political or social
instability, or diplomatic developments which could affect each Fund's
investments in those countries. Moreover, individual foreign economies may
differ favorably or unfavorably from the U.S. economy in such respects as
growth of gross national product, rate of inflation, capital reinvestment,
resource self-sufficiency and balance of payment position. In addition,
information with respect to non-U.S. companies may differ from that available
with respect to U.S. companies, since foreign companies are not generally
subject to uniform accounting, auditing and financial reporting standards,
practices and requirements comparable to those applicable to U.S. companies.
Interest income from foreign securities may be subject to withholding taxes
imposed by the country in which the company is located, and a Fund generally
will not be able to pass through to its shareholders foreign tax credits or
deductions with respect to these taxes.
Senior Debt issued by non-U.S. companies or U.S. companies with significant
non-U.S. dollar-denominated revenues may provide for conversion of all or part
of the debt from a U.S. dollar-denominated obligation into a foreign currency
obligation at the option of the companies. Each Fund may invest in Senior Debt
which has been converted into non-U.S. dollar-denominated obligations only when
the Senior Debt facility provides for payments in U.S. dollars pursuant to
foreign currency swap arrangements. Foreign currency swaps involve the exchange
by the investors, including the Funds, with another party (the
21
<PAGE>
"counterparty") of the right to receive the currency in which the debt is
denominated for the right to receive U.S. dollars. Each Fund will enter into a
transaction subject to a foreign currency swap only if, at the time of entering
into such swap, the outstanding debt obligations of the counterparty are
investment grade, i.e., rated BBB or A-3 or higher by S&P or Baa or P-3 or
higher by Moody's, or determined to be of comparable quality in the judgment of
FAM. The amounts of U.S. dollar payments to be received by the investors and
the foreign currency payments to be received by the counterparty are fixed at
the time the swap arrangement is entered into. Accordingly, the swap protects
the Funds from fluctuations in exchange rates and locks in the right to receive
payments under the debt in a predetermined amount of U.S. dollars. If there is
a default by the counterparty, each Fund will have contractual remedies
pursuant to the swap arrangements; however, the U.S. dollar value of the Fund's
right to foreign currency payments under the debt will be subject to
fluctuations in the applicable exchange rate to the extent that a replacement
swap arrangement is unavailable or the Fund is unable to recover damages from
the defaulting counterparty. If the company defaults on or prepays the Senior
Debt, each Fund may be required pursuant to the swap arrangements to compensate
the counterparty to the extent of fluctuations in exchange rates adverse to the
counterparty. In the event of such a default or prepayment, an amount of cash
or high grade liquid debt securities having an aggregate fair market value at
least equal to the amount of compensation that must be paid to the counterparty
pursuant to the swap arrangements will be maintained in a segregated account by
each Fund's custodian.
DESCRIPTION OF SENIOR DEBT CONSISTING OF CORPORATE LOANS
Each Fund will invest in Senior Debt consisting of Corporate Loans made by
banks and other financial institutions to corporations, partnerships or trusts
(each a "Borrower"). As described in the third paragraph under "Description of
Senior Debt" above, the Corporate Loans may be secured or unsecured. Each Fund
may receive and/or pay certain fees in connection with its lending activities.
These fees are in addition to interest payments received and may include
facility fees, commitment fees, commissions and prepayment penalty fees. When
each Fund buys a loan it may receive a facility fee. In certain circumstances,
each Fund may receive a prepayment penalty fee on the prepayment of a loan by a
Borrower. In connection with the acquisition of loans, each Fund may also
acquire warrants and other equity securities of the Borrower or its affiliates.
The acquisition of such equity securities will only be incidental to each
Fund's purchase of an interest in Senior Debt.
A Corporate Loan in which each Fund may invest typically is originated,
negotiated and structured by a syndicate of lenders ("Co-Lenders") consisting
of commercial banks, thrift institutions, insurance companies, finance
companies or other financial institutions one or more of which administers the
Loan on behalf of the syndicate (the "Agent Bank"). Co-Lenders may sell
Corporate Loans to third parties called "Participants." Each Fund may invest in
a Corporate Loan either by participating as a Co-Lender at the time the loan is
originated or by purchasing an interest in the Corporate Loan from a Co-Lender
or a Participant. Co-Lenders and Participants interposed between each Fund and
a Borrower, together with Agent Banks, are referred to herein as "Intermediate
Participants".
Each Fund may purchase a Corporate Loan from an Intermediate Participant by
means of a novation, an assignment or a participation. In a novation, each Fund
would accept all of the rights of the Intermediate Participants in a Corporate
Loan, including the right to receive repayments of principal and payments of
interest and other amounts directly from the Borrower and to enforce its rights
as a lender directly against the Borrower and would assume all of the
obligations of the Intermediate Participants, including any obligations to make
future advances to the Borrower. As a result, therefore, each Fund would have
the status of a Co-Lender. As an alternative, each Fund may purchase an
assignment of all or a portion of an Intermediate Participant's interest in a
Corporate Loan, in which case the Fund may be required generally to rely on the
assigning lender to demand payment and enforce its rights against the Borrower
but would otherwise be entitled to all of such lender's rights in the Corporate
Loan. Each Fund also may purchase a participation in a portion of the rights of
an Intermediate Participant in a Corporate Loan by means of a participation
agreement with such Intermediate Participant. A participation in the rights of
an Intermediate Participant is similar to an assignment in that the
Intermediate Participant transfers to each Fund all or a
22
<PAGE>
portion of an interest in a Corporate Loan. Unlike an assignment, however, a
participation does not establish any direct relationship between each Fund and
the Borrower. In such case, each Fund would be required to rely on the
Intermediate Participant that sold the participation not only for the
enforcement of the Fund's rights against the Borrower but also for the receipt
and processing of payments due to the Fund under the Corporate Loans. A Fund
will not act as an Agent Bank, guarantor, sole negotiator or sole structuror
with respect to a Corporate Loan.
Because it may be necessary to assert through an Intermediate Participant
such rights as may exist against the Borrower, in the event the Borrower fails
to pay principal and interest when due, each Fund may be subject to delays,
expenses and risks that are greater than those that would be involved if the
Fund could enforce its rights directly against the borrower. Moreover, under
the terms of a participation, each Fund may be regarded as a creditor of the
Intermediate Participant (rather than of the Borrower), so that the Fund may
also be subject to the risk that the Intermediate Participant may become
insolvent. Similar risks may arise with respect to the Agent Bank, as described
below. Further, in the event of the bankruptcy or insolvency of the Borrower,
the obligation of the Borrower to repay the Corporate Loan may be subject to
certain defenses that can be asserted by such Borrower as a result of improper
conduct by the Agent Bank or Intermediate Participant. Each Fund will invest in
Corporate Loans only if, at the time of investment, the outstanding debt
obligations of the Agent Bank and any Intermediate Participant which remains
interposed between the Fund and a Borrower are investment grade, i.e., rated
BBB or A-3 or higher by S&P or Baa or P-3 or higher by Moody's or determined to
be of comparable quality in the judgment of FAM.
Because each Fund will regard the issuer of a Corporate Loan as including the
Borrower under a Corporate Loan Agreement, the Agent Bank and any Intermediate
Participant, each Fund may be deemed to be concentrated in securities of
issuers in the industry group consisting of financial institutions and their
holding companies, including commercial banks, thrift institutions, insurance
companies and finance companies. As a result, each Fund is subject to certain
risks associated with such institutions. Banking and thrift institutions are
subject to extensive governmental regulations which may limit both the amounts
and types of loans and other financial commitments which such institutions may
make and the interest rates and fees which such institutions may charge. The
profitability of these institutions is largely dependent on the availability
and cost of capital funds, and has shown significant recent fluctuation as a
result of volatile interest rate levels. In addition, general economic
conditions are important to the operations of these institutions, with exposure
to credit losses resulting from possible financial difficulties of borrowers
potentially having an adverse effect. Insurance companies are also affected by
economic and financial conditions and are subject to extensive government
regulation, including rate regulation. The property and casualty industry is
cyclical, being subject to dramatic swings in profitability which can be
affected by natural catastrophes and other disasters. Individual companies may
be exposed to material risks, including reserve inadequacy, latent health
exposure and inability to collect from their reinsurance carriers. The
financial services area is currently undergoing relatively rapid change as
existing distinctions between financial service segments become less clear. In
this regard, recent business combinations have included insurance, finance and
securities brokerage under single ownership. Moreover, the Federal laws
generally separating commercial and investment banking are currently being
studied by Congress.
In a typical Corporate Loan, the Agent Bank administers the terms of the
Corporate Loan Agreement and is responsible for the collection of principal and
interest and fee payments from the Borrower and the apportionment of these
payments to the credit of all lenders which are parties to the Corporate Loan
Agreement. Each Fund generally will rely on the Agent Bank or an Intermediate
Participant to collect its portion of the payments on the Corporate Loan.
Furthermore, each Fund will rely on the Agent Bank to use appropriate creditor
remedies against the Borrower. Typically, under Corporate Loan Agreements, the
Agent Bank is given broad discretion in enforcing the Corporate Loan Agreement,
and is obligated to use only the same care it would use in the management of
its own property. The Borrower compensates the Agent Bank of these services.
Such compensation may include special fees paid on structuring and funding the
Corporate Loan and other fees paid on a continuing basis.
23
<PAGE>
In the event that an Agent Bank becomes insolvent, or has a receiver,
conservator, or similar official appointed for it by the appropriate bank
regulatory authority or becomes a debtor in a bankruptcy proceeding, assets
held by the Agent Bank under the Corporate Loan Agreement should remain
available to holders of Corporate Loans. If, however, assets held by the Agent
Bank for the benefit of a Fund were determined by an appropriate regulatory
authority or court to be subject to the claims of the Agent Bank's general or
secured creditors, such Fund might incur certain costs and delays in realizing
payment on a Corporate Loan or suffer a loss of principal and/or interest. In
situations involving Intermediate Participants similar risks may arise, as
described above.
Intermediate Participants may have certain obligations pursuant to a
Corporate Loan Agreement, which may include the obligation to make future
advances to the Borrower in connection with revolving credit facilities in
certain circumstances. Each Fund currently intends to reserve against such
contingent obligations by segregating sufficient investments in high quality,
short-term, liquid instruments. A Fund will not invest in Corporate Loans that
would require the Fund to make any additional investments in connection with
such future advances if such commitments would exceed 20% of the Fund's total
assets or would cause the Fund to fail to meet the diversification requirements
described under "Investment Objectives and Policies".
ILLIQUID SECURITIES
Corporate Loans are, at present, not readily marketable and may be subject to
restrictions on resale. Although Corporate Loans are transferred among certain
financial institutions, as described above, the Corporate Loans in which each
Fund invests do not have the liquidity of conventional debt securities traded
in the secondary market and may be considered illiquid. As the market for
Corporate Loans becomes more seasoned, FAM expects that liquidity will improve.
The Funds have no limitation on the amount of their investments which are not
readily marketable or are subject to restrictions on resale.
OTHER INVESTMENT POLICIES
Each of SHIP I, SHIP II and Senior Strategic has adopted certain other
policies as set forth below:
Leverage. Each Fund is authorized to utilize leverage in amounts up to 33
1/3% of its total assets (including the assets obtained from leverage) to
provide Common Stockholders with a potentially higher rate of return. As of the
date of this proxy statement and prospectus, SHIP I, SHIP II and Senior
Strategic each has entered into a separate agreement with The Bank of New York,
as agent for a syndicate of banks, providing for an unsecured revolving credit
facility under the following terms:
<TABLE>
<CAPTION>
INTEREST RATE
-----------------------
PRIME FED
COMMITMENT EXPIRATION RATE EURODOLLAR FUNDS
AMOUNT DATE PLUS PLUS PLUS
------------ ------------- ----- ---------- -----
<S> <C> <C> <C> <C> <C>
SHIP I $120 million June 7, 1996 0.00% 0.75% 0.75%
SHIP II 80 million Oct. 17, 1996 0.00 0.55 0.55
Senior Strategic 35 million May 22, 1996 0.00 0.75 0.75
</TABLE>
Each Fund renegotiates its credit facility annually. Upon refinancing, a Fund
may enter into a new agreement with a single bank or an agent acting on behalf
of a syndicate of banks. The bank syndicate may include an affiliate of FAM. As
a condition precedent to the Merger, SHIP I will enter into an agreement with a
financial institution to refinance the outstanding credit facilities of all
three Funds in a principal amount approximately equal to the aggregate amount
that SHIP I is permitted to borrow taking into account its total assets as a
result of the Merger. Assuming current market conditions, the aggregate
principal amount of the new credit facility would be approximately $225,000,000
and fees and expenses associated with the refinancing would aggregate
approximately $85,000, which would be paid by SHIP I immediately following the
Merger. The actual amount of the credit facility and the actual fees and
expenses on the Effective Date may be more or less depending on market
conditions on that date; however, because each Fund refinances its credit
facility annually in the ordinary course of business, it is expected that
overall the fees and expenses paid by SHIP I in connection with the credit
facility refinancing after the Merger will be at least as favorable to the
shareholders of SHIP I, SHIP II and Senior Strategic as the fees and expenses
that would be incurred if each credit facility were independently renegotiated.
24
<PAGE>
A Fund generally will not utilize leverage if it anticipates that the Fund's
leveraged capital structure would result in a lower rate of return to holders
of the Common Stock than that obtainable if the Common Stock were unleveraged
for any significant amount of time. Each Fund may also borrow money as a
temporary measure for extraordinary or emergency purposes, including the
payment of dividends and the settlement of securities transactions which may
otherwise require untimely dispositions of Fund securities.
The concept of leveraging is based on the premise that the cost of the assets
to be obtained from leverage will be based on short-term rates which normally
will be lower than the return earned by a Fund on its longer term portfolio
investments. Since the total assets of each Fund (including the assets obtained
from leverage) will be invested in the higher yielding portfolio investments,
the common shareholders will be the beneficiaries of the incremental yield.
Should the differential between the underlying interest rates narrow, the
incremental yield "pick up" will be reduced. Furthermore, if long-term rates
rise, the Common Stock net asset value will reflect the full decline in the
entire portfolio holdings resulting therefrom, since the assets obtained from
leverage do not fluctuate.
Leverage creates risks for common stockholders, including the likelihood of
greater volatility of net asset value and market price of shares of the Common
Stock and the risk that fluctuations in interest rates on borrowings or in the
dividend rates on any preferred stock may affect the yield to common
shareholders. To the extent the income derived from securities purchased with
funds received from leverage exceeds the cost of leverage, the Fund's net
income will be greater than if leverage had not been used. Conversely, if the
income from the securities purchased with such funds is not sufficient to cover
the cost of leverage, the net income of each Fund will be less than if leverage
had not been used, and therefore the amount available for distribution to
shareholders as dividends will be reduced. In the latter case, each Fund may
nevertheless determine to maintain its leveraged position in order to avoid
capital losses on securities purchased with the leverage.
Capital raised through leverage will be subject to interest costs or dividend
payments which may or may not exceed the interest on the assets purchased. Each
Fund also may be required to maintain minimum average balances in connection
with borrowings or to pay a commitment or other fee to maintain a line of
credit; either of these requirements will increase the cost of borrowing over
the stated interest rate. The issuance of additional classes of preferred stock
involves offering expenses and other costs and may limit a Fund's freedom to
pay dividends on shares of Common Stock or to engage in other activities.
Borrowings and the issuance of a class of preferred stock having priority over
each Fund's Common Stock create an opportunity for greater income per share of
Common Stock, but at the same time such borrowing or issuance is a speculative
technique in that it will increase the Fund's exposure to capital risk. Such
risks may be reduced through the use of borrowings and preferred stock that
have floating rates of interest. Unless the income and appreciation, if any, on
assets acquired with borrowed funds or offering proceeds exceeds the cost of
borrowing or issuing additional classes of securities, the use of leverage will
diminish the investment performance of each Fund compared with what it would
have been without leverage.
Certain types of borrowings may result in each Fund being subject to
covenants in credit agreements relating to asset coverage and portfolio
composition requirements. Each Fund may be subject to certain restrictions on
investments imposed by guidelines of one or more nationally recognized rating
agencies which may issue ratings for the short-term corporate debt securities
or preferred stock. These guidelines may impose asset coverage or portfolio
composition requirements that are more stringent than those imposed by the
Investment Company Act. It is not anticipated that these covenants or
guidelines will impede FAM from managing each Fund's portfolio in accordance
with the Fund's investment objective and policies.
Under the Investment Company Act, a Fund is not permitted to incur
indebtedness unless immediately after such incurrence the Fund has an asset
coverage of 300% of the aggregate outstanding principal balance of indebtedness
(i.e., such indebtedness may not exceed 33 1/3% of the Fund's total assets).
Additionally, under the Investment Company Act a Fund may not declare any
dividend or other distribution upon any class of its capital stock, or purchase
any such capital stock, unless the aggregate indebtedness of the Fund has, at
the time of the declaration of any such dividend or distribution or at the time
of any such purchase, an asset
25
<PAGE>
coverage of at least 300% after deducting the amount of such dividend,
distribution, or purchase price, as the case may be. Under the Investment
Company Act, a Fund is not permitted to issue shares of preferred stock unless
immediately after such issuance the net asset value of the Fund's portfolio is
at least 200% of the liquidation value of the outstanding preferred stock
(i.e., such liquidation value may not exceed 50% of the Fund's total assets).
In addition, a Fund is not permitted to declare any cash dividend or other
distribution on its Common Stock unless, at the time of such declaration, the
net asset value of the Fund's portfolio (determined after deducting the amount
of such dividend or distribution) is at least 200% of such liquidation value.
In the event preferred shares are issued, each Fund intends, to the extent
possible, to purchase or redeem shares of preferred stock from time to time to
maintain coverage of any preferred stock of at least 200%.
Each Fund's willingness to borrow money and issue new securities for
investment purposes, and the amount it will borrow, will depend on many
factors, the most important of which are investment outlook, market conditions
and interest rates. Successful use of a leveraging strategy depends on the
Investment Adviser's ability to predict correctly interest rates and market
movements, and there is no assurance that a leveraging strategy will be
successful during any period in which it is employed.
Assuming the utilization by SHIP I of leverage by borrowings in the amount of
33 1/3% of SHIP I's total assets, and an annual interest rate of 6.31% payable
on such leverage based on market rates as of January 26, 1996, the annual
return that SHIP I's portfolio must experience (net of expenses) in order to
cover such interest payments would be 1.58%. Assuming the utilization by SHIP
II of leverage by borrowings in the amount of 33 1/3% of SHIP II's total
assets, and an annual interest rate of 6.11% payable on such leverage based on
market rates as of January 26, 1996, the annual return that SHIP II's portfolio
must experience (net of expenses) in order to cover such interest payments
would be 1.53%. Assuming the utilization by Senior Strategic of leverage by
borrowings in the amount of 33 1/3% of Senior Strategic's total assets, and an
annual interest rate of 6.31% payable on such leverage based on market rates as
of January 26, 1996, the annual return that Senior Strategic's portfolio must
experience (net of expenses) in order to cover such interest payments would be
1.58%. Assuming the utilization by SHIP I of leverage by borrowings in the
amount of 33 1/3% of SHIP I's total assets after the Merger, and an annual
interest rate of 6.11% payable on such leverage based on market rates as of
January 26, 1996, the annual return that SHIP I's portfolio must experience
(net of expenses) in order to cover such interest payments would be 1.53%.
The following table is designed to illustrate the effect on the return to a
holder of SHIP I's Common Stock after the Merger of the leverage obtained by
borrowing, assuming hypothetical annual returns on SHIP I's portfolio of -10%
to +10%. The table also illustrates the effect on the return to a holder of the
Common Stock of each of SHIP I, SHIP II and Senior Strategic of the leverage
obtained by borrowing, assuming hypothetical annual returns on each Fund's
portfolio of -10% to +10%. As the table shows, leverage generally increases the
return to stockholders when portfolio return is positive and greater than the
cost of leverage and decreases the return when the portfolio return is negative
or less than the cost of leverage. In each instance, an annual interest rate of
6.11% payable on such leverage is assumed based on market rates as of January
26, 1996. The figures appearing in the table are hypothetical and actual
returns may be greater or less than those appearing in the table.
<TABLE>
<S> <C> <C> <C> <C> <C>
SHIP I
Assumed Portfolio Return (net of ex-
penses)................................. (10)% (5)% 0 % 5% 10%
Corresponding Common Stock Return........ (15.37)% (8.70)% (2.04)% 4.63% 11.30%
SHIP II
Assumed Portfolio Return (net of ex-
penses)................................. (10)% (5)% 0 % 5% 10%
Corresponding Common Stock Return........ (15.37)% (8.70)% (2.04)% 4.63% 11.30%
SENIOR STRATEGIC
Assumed Portfolio Return (net of ex-
penses)................................. (10)% (5)% 0 % 5% 10%
Corresponding Common Stock Return........ (15.37)% (8.70)% (2.04)% 4.63% 11.30%
PRO FORMA FOR COMBINED FUND
Assumed Portfolio Return (net of ex-
penses)................................. (10)% (5)% 0 % 5% 10%
Corresponding Common Stock Return........ (15.37)% (8.70)% (2.04)% 4.63% 11.30%
</TABLE>
26
<PAGE>
Interest Rate Transactions. In order to hedge the value of each Fund's
portfolio against interest rate fluctuations or to enhance the Fund's income,
each Fund may enter into various interest rate transactions, such as interest
rate swaps and the purchase or sale of interest rate caps and floors. Each Fund
expects to enter into these transactions primarily to preserve a return or
spread on a particular investment or portion of its portfolio or to protect
against any increase in the price of securities the Fund anticipates purchasing
at a later date. Each Fund intends to use these transactions primarily as a
hedge and not as a speculative investment. However, each Fund may also invest
in interest rate swaps to enhance income or to increase the Fund's yield, for
example, during periods of steep interest rate yield curves (i.e., wide
differences between short-term and long-term interest rates).
In an interest rate swap, a Fund exchanges with another party their
respective commitments to pay or receive interest, e.g., an exchange of fixed
rate payments for floating rate payments. For example, if a Fund holds Senior
Debt with an interest rate that is reset only once each year, it may swap the
right to receive interest at this fixed rate for the right to receive interest
at a rate that is reset every week. This would enable the Fund to offset a
decline in the value of the Senior Debt due to rising interest rates but would
also limit its ability to benefit from falling interest rates. Conversely, if a
Fund holds Senior Debt with an interest rate that is reset every week and it
would like to lock in what it believes to be a high interest rate for one year,
it may swap the right to receive interest at this variable weekly rate for the
right to receive interest at a rate that is fixed for one year. Such a swap
would protect the Fund from a reduction in yield due to falling interest rates
and may permit the Fund to enhance its income through the positive differential
between one week and one year interest rates, but would preclude it from taking
full advantage of rising interest rates.
Each Fund usually will enter into interest rate swaps on a net basis, i.e.,
the two payment streams are netted out, with the Fund receiving or paying, as
the case may be, only the net amount of the two payments. The net amount of the
excess, if any, of each Fund's obligations over its entitlements with respect
to each interest rate swap will be accrued on a daily basis, and an amount of
cash or high grade liquid debt securities having an aggregate net asset value
at least equal to the accrued excess will be maintained in a segregated account
by the Fund's custodian. If the interest rate swap transaction is entered into
on other than a net basis, the full amount of each Fund's obligations will be
accrued on a daily basis, and the full amount of the Fund's obligations will be
maintained in a segregated account by the Fund's custodian.
Each Fund may also engage in interest rate transactions in the form of
purchasing or selling interest rate caps or floors. A Fund will not sell
interest rate caps or floors that it does not own. The purchase of an interest
rate cap entitles the purchaser, to the extent that a specified index exceeds a
predetermined interest rate, to receive payments of interest equal to the
difference of the index and the predetermined rate on a notional principal
amount (the reference amount with respect to which interest obligations are
determined although no actual exchange of principal occurs) from the party
selling such interest rate cap. The purchase of an interest rate floor entitles
the purchaser, to the extent that a specified index falls below a predetermined
interest rate, to receive payments of interest at the difference of the index
and the predetermined rate on a notional principal amount from the party
selling such interest rate floor. A Fund will not enter into caps or floors if,
on a net basis, the aggregate notional principal amount with respect to such
agreements exceeds the net assets of the Fund.
Typically, the parties with which each Fund will enter into interest rate
transactions will be broker- dealers and other financial institutions. A Fund
will not enter into any interest rate swap, cap or floor transaction unless the
unsecured senior debt or the claims-paying ability of the other party thereto
is rated investment grade quality by at least one nationally recognized
statistical rating organization at the time of entering into such transaction
or whose creditworthiness is believed by FAM to be equivalent to such rating.
If there is a default by the other party to such a transaction, the Fund will
have contractual remedies pursuant to the agreements related to the
transaction. The swap market has grown substantially in recent years with a
large number of banks and investment banking firms acting both as principals
and as agents utilizing standardized swap documentation. As a result, the swap
market has become relatively liquid in comparison with other similar
instruments traded in the interbank market. Caps and floors, however, are more
recent
27
<PAGE>
innovations and are less liquid than swaps. Certain Federal income tax
requirements may limit each Fund's ability to engage in certain interest rate
transactions. Gains from transactions in interest rate swaps distributed to
shareholders will be taxable as ordinary income or, in certain circumstances,
as long-term capital gains to shareholders. See "Tax Rules Applicable to SHIP
I, SHIP II, Senior Strategic and their Stockholders".
Call Options on Portfolio Securities. Each Fund may purchase call options on
any of the types of securities in which it may invest. A purchased call option
gives each Fund the right to buy, and obligates the seller to sell, the
underlying security at the exercise price at any time during the option period.
Each Fund also is authorized to write (i.e., sell) covered call options on the
securities in which it may invest and to enter into closing purchase
transactions with respect to certain of such options. A covered call option is
an option where a Fund, in return for a premium, gives another party a right to
buy specified securities owned by the Fund at a specified future date and price
set at the time of the contract. The principal reason for writing call options
is an attempt to realize, through the receipt of premiums, a greater return
than would be realized on the securities alone. By writing covered call
options, a Fund gives up the opportunity, while the option is in effect, to
profit from any price increase in the underlying security above the option
exercise price. In addition, a Fund's ability to sell the underlying security
will be limited while the option is in effect unless the Fund effects a closing
purchase transaction. A closing purchase transaction cancels out each Fund's
position as the writer of an option by means of an offsetting purchase of an
identical option prior to the expiration of the option it has written. Covered
call options also serve as a partial hedge against the price of the underlying
security declining. Each Fund may also purchase and sell call options on
indices. Index options are similar to options on securities except that, rather
than taking or making delivery of securities underlying the option at a
specified price upon exercise, an index option gives the holder the right to
receive cash upon exercise of the option if the level of the index upon which
the option is based is greater than the exercise price of the option.
Put Options on Portfolio Securities. Each Fund is authorized to purchase put
options to hedge against a decline in the value of its securities. By buying a
put option, each Fund has a right to sell the underlying security at the
exercise price, thus limiting the Fund's risk of loss through a decline in the
market value of the security until the put option expires. The amount of any
appreciation in the value of the underlying security will be partially offset
by the amount of the premium paid for the put option and any related
transaction costs. Prior to its expiration, a put option may be sold in a
closing sale transaction and profit or loss from the sale will depend on
whether the amount received is more or less than the premium paid for the put
option plus the related transaction costs. A closing sale transaction cancels
out each Fund's position as the purchaser of an option by means of an
offsetting sale of an identical option prior to the expiration of the option it
has purchased. Each Fund also has authority to write (i.e., sell) put options
on the types of securities which may be held by the Fund, provided that such
put options are covered, meaning that such options are secured by segregated,
high grade liquid debt securities. In certain circumstances, each Fund may
purchase call options on securities held in its portfolio on which it has
written call options or which it intends to purchase. Each Fund will receive a
premium for writing a put option, which increases the Fund's return. A Fund
will not sell puts if, as a result, more than 50% of the Fund's assets would be
required to cover its potential obligations under its hedging and other
investment transactions. A Fund may purchase and sell put options on indices.
Index options are similar to options on securities except that, rather than
taking or making delivery of securities underlying the option at a specified
price upon exercise, an index option gives the holder the right to receive cash
upon exercise of the option if the level of the index upon which the option is
based is less than the exercise price of the option.
Financial Futures and Options Thereon. Each Fund is authorized to engage in
transactions in financial futures contracts ("futures contracts") and related
options on such futures contracts either as a hedge against adverse changes in
the market value of its portfolio securities and interest rates or to enhance
the Fund's income. A futures contract is an agreement between two parties which
obligates the purchaser of the futures contract to buy and the seller of a
futures contract to sell a security for a set price on a future date or, in the
case of an index futures contract to make and accept a cash settlement based
upon the difference in value of the index between the time the contract was
entered into and the time of its settlement. A majority of
28
<PAGE>
transactions in futures contracts, however, do not result in the actual
delivery of the underlying instrument or cash settlement, but are settled
through liquidation, i.e., by entering into an offsetting transaction. Futures
contracts have been designed by boards of trade which have been designated
"contract markets" by the Commodity Futures Trading Commission (the "CFTC").
Transactions by each Fund in futures contracts and financial futures are
subject to limitations as described below under "Restrictions on the Use of
Futures Transactions".
Each Fund may sell financial futures contracts in anticipation of an increase
in the general level of interest rates. Generally, as interest rates rise, the
market values of securities which may be held by a Fund will fall, thus
reducing the net asset value of the Fund. However, as interest rates rise, the
value of a Fund's short position in the futures contract will also tend to
increase, thus offsetting all or a portion of the depreciation in the market
value of the Fund's investments which are being hedged. While each Fund will
incur commission expenses in selling and closing out futures positions, these
commissions are generally less than the transaction expenses which the Fund
would have incurred had the Fund sold portfolio securities in order to reduce
its exposure to increases in interest rates. Each Fund also may purchase
financial futures contracts in anticipation of a decline in interest rates when
it is not fully invested in a particular market in which it intends to make
investments to gain market exposure that may in part or entirely offset an
increase in the cost of securities it intends to purchase. It is anticipated
that, in a substantial majority of these transactions, a Fund will purchase
securities upon termination of the futures contract.
Each Fund also has authority to purchase and write call and put options on
futures contracts. Generally, these strategies are utilized under the same
market and market sector conditions (i.e., conditions relating to specific
types of investments) in which a Fund enters into futures transactions. Each
Fund may purchase put options or write call options on futures contracts rather
than selling the underlying futures contract in anticipation of a decrease in
the market value of securities or an increase in interest rates. Similarly,
each Fund may purchase call options, or write put options on futures contracts,
as a substitute for the purchase of such futures to hedge against the increased
cost resulting from an increase in the market value or a decline in interest
rates of securities which the Fund intends to purchase.
Each Fund may engage in options and futures transactions on exchanges and
options in the over-the- counter markets ("OTC options"). In general, exchange-
traded contracts are third-party contracts (i.e., performance of the parties'
obligation is guaranteed by an exchange or clearing corporation) with
standardized strike prices and expiration dates. OTC options transactions are
two-party contracts with price and terms negotiated by the buyer and seller.
See "Restrictions on OTC Options" below for information as to restrictions on
the use of OTC options.
Restrictions on the Use of Futures Transactions. Under regulations of the
CFTC, the futures trading activity described herein will not result in a Fund
being deemed a "commodity pool", as defined under such regulations, provided
that the Fund adheres to certain restrictions. In particular, each Fund may
purchase and sell futures contracts and options thereon (i) for bona fide
hedging purposes, and (ii) for non-hedging purposes, if the aggregate initial
margin and premiums required to establish positions in such contracts and
options does not exceed 5% of the liquidation value of the Fund's portfolio,
after taking into account unrealized profits and unrealized losses on any such
contracts and options. Margin deposits may consist of cash or securities
acceptable to the broker and the relevant contract market.
When a Fund purchases a futures contract or writes a put option or purchases
a call option thereon, an amount of cash and cash equivalents will be deposited
in a segregated account with the Fund's custodian so that the amount so
segregated, plus the amount of variation margin held in the account of its
broker, equals the market value of the futures contract, thereby ensuring that
the use of such futures is unleveraged.
An order has been obtained from the Commission which exempts each Fund from
certain provisions of the Investment Company Act in connection with
transactions involving futures contracts and options thereon.
29
<PAGE>
Restrictions on OTC Options. A Fund will engage in OTC options only with
member banks of the Federal Reserve System and primary dealers in U.S.
government securities or with affiliates of such banks or dealers which have
capital of at least $50 million or whose obligations are guaranteed by an
entity having capital of at least $50 million.
Risk Factors in Interest Rate Transactions and Options and Futures
Transactions. The use of interest rate transactions is a highly specialized
activity which involves investment techniques and risks different from those
associated with ordinary portfolio securities transactions. Interest rate
transactions involve the risk of an imperfect correlation between the index
used in the hedging transaction and that pertaining to the securities which are
the subject of such transaction. If FAM is incorrect in its forecasts of market
values, interest rates and other applicable factors, the investment performance
of a Fund would diminish compared with what it would have been if these
investment techniques were not used. In addition, interest rate transactions
that may be entered into by a Fund do not involve the delivery of securities or
other underlying assets or principal. Accordingly, the risk of loss with
respect to interest rate swaps is limited to the net amount of interest
payments that a Fund is contractually obligated to make. If the security
underlying an interest rate swap is prepaid and a Fund continues to be
obligated to make payments to the other party to the swap, the Fund would have
to make such payments from another source. If the other party to an interest
rate swap defaults, the Fund's risk of loss consists of the net amount of
interest payments that the Fund contractually is entitled to receive. In the
case of a purchase by a Fund of an interest rate cap or floor, the amount of
loss is limited to the fee paid. Since interest rate transactions are
individually negotiated, FAM expects to achieve an acceptable degree of
correlation between a Fund's rights to receive interest on securities and its
rights and obligations to receive and pay interest pursuant to interest rate
swaps.
Utilization of options and futures transactions to hedge the portfolio
involves the risk of imperfect correlation in movements in the price of options
and futures and movements in the prices of the securities which are the subject
of the hedge. If the price of the options or futures moves more or less than
the price of the subject of the hedge, a Fund will experience a gain or loss
which will not be completely offset by movements in the price of the subject of
the hedge. This risk particularly applies to each Fund's use of futures and
options thereon since it will generally use such instruments as a so-called
"cross-hedge", which means that the security that is the subject of the futures
contract is different from the security being hedged by the contract.
Prior to exercise or expiration, an exchange-traded option position can only
be terminated by entering into a closing purchase or sale transaction. This
requires a secondary market on an exchange for call or put options of the same
series. A Fund intends to enter into options and futures transactions, on an
exchange or in the over-the-counter market, only if there appears to be a
liquid secondary market for such options or futures. However, there can be no
assurance that a liquid secondary market will exist at any specific time. Thus,
it may not be possible to close an options or futures position. The inability
to close options and futures positions also could have an adverse impact on a
Fund's ability to effectively hedge its portfolio. There is also the risk of
loss by a Fund of margin deposits or collateral in the event of bankruptcy of a
broker with whom the Fund has an open position in an option, a futures contract
or an option related to a futures contract.
OTHER INVESTMENT STRATEGIES
Repurchase Agreements and Purchase and Sale Contracts. Each Fund may invest
in securities pursuant to repurchase agreements and purchase and sale
contracts. Repurchase agreements and purchase and sale contracts may be entered
into only with a member bank of the Federal Reserve System or primary dealer in
U.S. Government securities or an affiliate thereof. Under such agreements, the
bank or the primary dealer or the affiliate agrees, upon entering into the
contract, to repurchase the security at a mutually agreed upon time and price,
thereby determining the yield during the term of the Agreement. This results in
a fixed rate of return insulated from market fluctuations during such period.
In the case of repurchase agreements, the prices at which the trades are
conducted do not reflect accrued interest on the underlying obligations;
whereas, in the case of purchase and sale contracts, the prices take into
account accrued interest. Such agreements usually cover short periods, such as
under one week. Repurchase agreements may be construed
30
<PAGE>
to be collateralized loans by the purchaser to the seller secured by the
securities transferred to the purchaser. In the case of a repurchase agreement,
each Fund will require the seller to provide additional collateral if the
market value of the securities falls below the repurchase price at any time
during the term of the repurchase agreement; the Fund does not have the right
to seek additional collateral in the case of purchase and sale contracts. In
the event of default by the seller under a repurchase agreement construed to be
a collateralized loan, the underlying securities are not owned by such Fund but
only constitute collateral for the seller's obligation to pay the repurchase
price. Therefore, each Fund may suffer time delays and incur costs or possible
losses in connection with the disposition of the collateral. A purchase and
sale contract differs from a repurchase agreement in that the contract
arrangements stipulate that the securities are owned by each Fund. In the event
of a default under such a repurchase agreement or a purchase and sale contract,
instead of the contractual fixed rate of return, the rate of return to each
Fund shall be dependent upon intervening fluctuations of the market value of
such security and the accrued interest on the security. In such event, each
Fund would have rights against the seller for breach of contract with respect
to any losses arising from market fluctuations following the failure of the
seller to perform.
Lending of Portfolio Securities. Each Fund may from time to time lend
securities from its portfolio, with a value not exceeding 33 1/3% of its total
assets, to banks, brokers and other financial institutions and receive
collateral in cash or securities issued or guaranteed by the U.S. Government,
its agencies or instrumentalities which will be maintained at all times in an
amount equal to at least 100% of the current market value of the loaned
securities. The purpose of such loans is to permit the borrower to use such
securities for delivery to purchasers when such borrower has sold short. If
cash collateral is received by a Fund, it is invested in short-term money
market securities, and a portion of the yield received in respect of such
investment is retained by the Fund. Alternatively, if securities are delivered
to a Fund as collateral, the Fund and the borrower negotiate a rate for the
loan premium to be received by the Fund for lending its portfolio securities.
In either event, the total yield on the Fund's portfolio is increased by loans
of its portfolio securities. Each Fund will have the right to regain record
ownership of loaned securities to exercise beneficial rights such as voting
rights, subscription rights and rights to dividends, interest or other
distributions. Such loans are terminable at any time. Each Fund may pay
reasonable finder's, administrative and custodial fees in connection with such
loans.
When-Issued Securities and Forward Commitments. Each Fund may purchase
securities on a "when- issued" basis and may purchase or sell securities on a
"forward commitment" basis in order to hedge against anticipated changes in
interest rates and prices. When such transactions are negotiated, the price,
which is generally expressed in yield terms, is fixed at the time the
commitment is made, but delivery and payment for the securities take place at a
later date. When-issued securities and forward commitments may be sold prior to
the settlement date, but a Fund will enter into when-issued and forward
commitments only with the intention of actually receiving or delivering the
securities, as the case may be. If a Fund disposes of the right to acquire a
when-issued security prior to its acquisition or disposes of its right to
deliver or receive against a forward commitment, it can incur a gain or loss.
At the time a Fund enters into a transaction on a when-issued or forward
commitment basis, it will segregate with the custodian cash or other liquid
high grade debt securities with a value not less than the value of the when-
issued or forward commitment securities. The value of these assets will be
monitored daily to ensure that their marked to market value will at all times
exceed the corresponding obligations of such Fund. There is always a risk that
the securities may not be delivered, and a Fund may incur a loss. Settlements
in the ordinary course, which may take substantially more than five business
days for mortgage-related securities, are not treated by a Fund as when-issued
or forward commitment transactions and accordingly are not subject to the
foregoing restrictions.
INVESTMENT RESTRICTIONS
Other than as noted above under "Investment Objectives and Policies", SHIP I,
SHIP II and Senior Strategic have identical investment restrictions. The
following are fundamental investment restrictions of each Fund and may not be
changed without the approval of the holders of a majority of the outstanding
shares of Common Stock (which for this purpose and under the Investment Company
Act means the lesser of (i) 67%
31
<PAGE>
of the shares of Common Stock represented at a meeting at which more than 50%
of the outstanding shares of Common Stock are represented or (ii) more than 50%
of the outstanding shares). Each Fund may not:
1. Issue senior securities (including borrowing money) in excess of the
limits set forth in the Investment Company Act; or pledge its assets other than
to secure such issuances or in connection with hedging transactions, when-
issued and forward commitment transactions and similar investment strategies.
The Fund's obligations under interest rate swaps are not treated as senior
securities.
2. Make investments for the purpose of exercising control or management.
3. Purchase securities of other investment companies, except to the extent
that such purchases are permitted by applicable law.
4. Purchase or sell real estate, commodities or commodity contracts; provided
that the Fund may invest in securities secured by real estate or interests
therein or issued by companies that invest in real estate or interests therein,
and the Fund may purchase and sell financial futures contracts and options
thereon.
5. Underwrite securities of other issuers except insofar as the Fund may be
deemed an underwriter under the Securities Act in selling portfolio securities.
6. Make loans to other persons, except (i) to the extent that the Fund may be
deemed to be making loans by purchasing Corporate Loans, as a Co-Lender or
otherwise, and other debt securities and entering into repurchase agreements in
accordance with its investment objective, policies and limitations and (ii) the
Fund may lend its portfolio securities in an amount not in excess of 33 1/3% of
its total assets, taken at market value, provided that such loans shall be made
in accordance with the guidelines set forth in this Proxy Statement and
Prospectus.
7. Invest more than 25% of its total assets in the securities of issuers in
any one industry; provided that this limitation shall not apply with respect to
obligations issued or guaranteed by the U.S. Government or by its agencies or
instrumentalities; and provided further that this limitation shall apply to the
financial institutions industry group as described below. The Fund may not
invest more than 35% of its total assets in securities of issuers in which the
Borrower, in the case of a Corporate Loan, or the issuer, in the case of other
Senior Debt, is in the industry group consisting of financial institutions and
their holding companies, including commercial banks, thrift institutions,
insurance companies and finance companies. The Fund may invest more than 25%
and may invest up to 100% of its assets in securities of issuers in such
financial institutions industry group when, with respect to Corporate Loans,
the term "issuer" is deemed to include not only the Borrower but also the Agent
Bank and any Intermediate Participant. The capitalized terms used herein, are
as defined under "Description of Senior Debt Consisting of Corporate Loans".
8. Purchase any securities on margin, except that the Fund may obtain such
short-term credit as may be necessary for the clearance of purchases and sales
of portfolio securities.
9. Make short sales of securities or maintain a short position or invest in
put, call, straddle or spread options, except as described under "Investment
Objective and Policies" herein.
An additional investment restriction adopted by each Fund, which may be
changed by the Board of Directors, provides that each Fund may not mortgage,
pledge, hypothecate or in any manner transfer, as security for indebtedness,
any securities owned or held by the Fund except as may be necessary in
connection with hedging techniques involving interest rate transactions,
foreign currency swap transactions relating to non-U.S. dollar-denominated
loans and permitted borrowings by the Fund.
If a percentage restriction on investment policies or the investment or use
of assets set forth above is adhered to at the time a transaction is effected,
later changes in percentage resulting from changing values will not be
considered a violation.
Because of the affiliation of Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("Merrill Lynch") with each of the Funds, each Fund is prohibited
from engaging in certain transactions involving Merrill Lynch except pursuant
to an exemptive order or otherwise in compliance with the provisions of the
Investment
32
<PAGE>
Company Act and the rules and regulations thereunder. Included among such
restricted transactions will be purchases from or sales to Merrill Lynch of
securities in transactions in which it acts as principal. See "Portfolio
Transactions".
Each Fund has established procedures for blocking the use of inside
information in securities transactions (commonly referred to as "Chinese Wall
procedures"). As a result, in relation to other funds managed by the same
portfolio manager for the Funds (currently, SHIP I, SHIP II, Senior Strategic
and Merrill Lynch Senior Floating Rate Fund, Inc.), if one fund buys a
security that is publicly traded or privately placed, respectively, the other
funds may be deprived of the opportunity to buy a security of the same issuer
that is privately placed or publicly traded, respectively.
PORTFOLIO COMPOSITION
Although the investment portfolio of each of the Funds must satisfy the same
standards of credit quality, the actual securities owned by each Fund are
different, as a result of which there are certain differences in the
composition of the three investment portfolios. The percentage of total assets
(including the proceeds of borrowings used for leverage) of each Fund invested
in each Moody's rating category as of August 31, 1995 was as follows:
<TABLE>
<CAPTION>
MOODY'S RATING SHIP I SHIP II SENIOR STRATEGIC
-------------- ------ ------- ----------------
<S> <C> <C> <C>
Aaa....................................... 0.07% 0.20% 0.97%
Aa........................................ 0.00 0.00 0.00
A......................................... 0.00 0.00 0.00
Baa....................................... 0.00 0.00 0.00
Ba........................................ 30.65 26.09 27.07
B......................................... 43.58 36.12 49.47
Caa....................................... 0.68 1.48 0.00
Ca........................................ 0.00 0.00 0.00
C......................................... 0.00 0.00 0.00
Not Rated*................................ 25.02 36.11 22.49
</TABLE>
- --------
* With respect to Not Rated investments in each Fund, which consist primarily
of Corporate Loans not rated by any nationally recognized statistical rating
organization, FAM believes that 100% are of comparable quality to securities
rated in the Ba and B categories by Moody's.
PORTFOLIO TRANSACTIONS
The procedures for engaging in portfolio transactions are the same for SHIP
I, SHIP II and Senior Strategic. Subject to policies established by the Board
of Directors of each Fund, FAM is primarily responsible for the execution of
each Fund's portfolio transactions. In executing such transactions, FAM seeks
to obtain the best results for each Fund, taking into account such factors as
price (including the applicable brokerage commission or dealer spread), size
of order, difficulty of execution and operational facilities of the firm
involved and the firm's risk in positioning a block of securities. While FAM
generally seeks reasonably competitive commission rates, SHIP I, SHIP II and
Senior Strategic do not necessarily pay the lowest commission or spread
available.
None of the Funds has any obligation to deal with any broker or dealer in
the execution of transactions in portfolio securities. Subject to obtaining
the best price and execution, securities firms which provide supplemental
investment research to FAM, including Merrill Lynch, may receive orders for
transactions by a Fund. Information so received will be in addition to, and
not in lieu of, the services required to be performed by FAM under its
investment advisory agreements with the Funds, and the expenses of FAM will
not necessarily be reduced as a result of the receipt of such supplemental
information.
Each Fund will purchase Corporate Loans in individually negotiated
transactions with commercial banks, thrifts, insurance companies, finance
companies and other financial institutions. In selecting such financial
institutions, FAM may consider, among other factors, the financial strength,
professional ability,
33
<PAGE>
level of service and research capability of the institution. See "Description
of Corporate Loans." While such financial institutions generally are not
required to repurchase Corporate Loans which they have sold, they may act as
principal or on an agency basis in connection with the Fund's disposition of
Corporate Loans.
Other securities in which each Fund may invest, such as publicly traded
corporate bonds and notes, are traded primarily in the over-the-counter
markets, and each Fund intends to deal directly with the dealers who make
markets in the securities involved, except in those circumstances where better
prices and execution are available elsewhere. Under the Investment Company Act,
except as permitted by exemptive order, persons affiliated with a Fund are
prohibited from dealing with the Fund as principal in the purchase and sale of
securities. Since transactions in the over-the-counter market usually involve
transactions with dealers acting as principal for their own account, a Fund
will not deal with affiliated persons, including Merrill Lynch and its
affiliates, in connection with such transactions. In addition, a Fund may not
purchase securities for the Fund during the existence of any underwriting
syndicate of which Merrill Lynch is a member except pursuant to procedures
approved by the Board of Directors of the Fund which comply with rules adopted
by the Commission. An affiliated person of a Fund may serve as the Fund's
broker in over-the-counter transactions conducted on an agency basis.
PORTFOLIO TURNOVER
Generally, neither SHIP I, SHIP II nor Senior Strategic purchases securities
for short-term trading profits. However, a Fund may dispose of securities
without regard to the time that they have been held when such action, for
defensive or other reasons, appears advisable to FAM. For the fiscal year ended
February 28, 1995, the portfolio turnover rate for SHIP I was 44.81%. For the
fiscal year ended August 31, 1995, the portfolio turnover rate for SHIP II was
51.51%. For the period April 8, 1994 (commencement of operations for Senior
Strategic) to February 28, 1995, the portfolio turnover rate for Senior
Strategic was 33.38%. (The portfolio turnover rate is calculated by dividing
the lesser of purchases or sales of portfolio securities for the particular
fiscal year by the monthly average of the value of the portfolio securities
owned by a Fund during the particular fiscal year. For purposes of determining
this rate, all securities whose maturities at the time of acquisition are one
year or less are excluded.)
CAPITAL STOCK
SHIP I, SHIP II and Senior Strategic each has outstanding Common Stock that
is traded on the NYSE. The shares of SHIP I Common Stock commenced trading on
the NYSE on April 30, 1993. As of August 31, 1995, the net asset value per
share of the SHIP I Common Stock was $9.06 and the market price per share was
$9.00. The shares of SHIP II Common Stock commenced trading on the NYSE on
September 24, 1993. As of August 31, 1995, the net asset value per share of the
SHIP II Common Stock was $9.27 and the market price per share was $9.00. The
shares of Senior Strategic Common Stock commenced trading on the NYSE on April
8, 1994. As of August 31, 1995, the net asset value per share of the Senior
Strategic Common Stock was $9.26 and the market price per share was $9.13.
Each Fund is authorized to issue 200,000,000 shares of capital stock, all of
which shares initially were classified as Common Stock. The Board of Directors
of each Fund is authorized to classify or reclassify any unissued shares of
capital stock by setting or changing the preferences, conversion or other
rights, voting powers, restrictions, limitations as to dividends,
qualifications, or terms or conditions of redemption.
Holders of a Fund's Common Stock are entitled to share equally in dividends
declared by the Fund's Board of Directors payable to holders of the Common
Stock and in the net assets of the Fund available for distribution to holders
of the Common Stock. Holders of a Fund's Common Stock do not have preemptive or
conversion rights and shares of a Fund's Common Stock are not redeemable. The
outstanding shares of Common Stock of each Fund are fully paid and
nonassessable.
Certain Provisions of the Charter. Each Fund's Charter includes provisions
that could have the effect of limiting the ability of other entities or persons
to acquire control of the Fund or to change the composition
34
<PAGE>
of its Board of Directors and could have the effect of depriving stockholders
of an opportunity to sell their shares at a premium over prevailing market
prices by discouraging a third party from seeking to obtain control of the
Fund. A Director may be removed from office with or without cause by a vote of
the holders of at least 66 2/3% of the shares entitled to be voted on the
matter.
In addition, the Charter of each Fund requires the affirmative vote of the
holders of at least 66 2/3% of the Fund's shares to approve, adopt or authorize
the following:
(i) a merger or consolidation or statutory share exchange of the Fund
with any other corporation,
(ii) a sale of all or substantially all of the Fund's assets (other than
in the regular course of the Fund's investment activities), or
(iii) a liquidation or dissolution of the Fund,
unless such action has been approved, adopted or authorized by the affirmative
vote of at least two-thirds of the total number of Directors fixed in
accordance with the Fund's by-laws, in which case the affirmative vote of a
majority of the Fund's outstanding shares of capital stock is required.
In addition, conversion of a Fund to an open-end investment company would
require an amendment to the Fund's Charter. The amendment would have to be
declared advisable by the Board of Directors prior to its submission to
stockholders. Such an amendment would require the affirmative vote of the
holders of at least 66 2/3% of the Fund's outstanding shares of Common Stock
entitled to be voted on the matter (or a majority of such shares if the
amendment was previously approved, adopted or authorized by at least two-thirds
of the total number of Directors fixed in accordance with the Fund's by-laws).
Such a vote also would satisfy a separate requirement in the Investment Company
Act that the change be approved by the stockholders. Stockholders of an open-
end investment company may require the company to redeem their shares of common
stock at any time (except in certain circumstances as authorized by or under
the Investment Company Act) at their net asset value, less such redemption
charge, if any, as might be in effect at the time of a redemption. All
redemptions will be made in cash. If the Fund is converted to an open-end
investment company, it could be required to liquidate portfolio securities to
meet requests for redemption and the Common Stock no longer would be listed on
a stock exchange. Conversion to an open-end investment company also would
require changes in certain of the Fund's investment policies and restrictions,
such as those relating to the borrowing of money and the purchase of illiquid
securities.
The Board of Directors of each Fund has determined that the 66 2/3% voting
requirements described above, which are greater than the minimum requirements
under Maryland law or the Investment Company Act, are in the best interests of
stockholders generally. Reference should be made to the Charter of each Fund on
file with the Commission for the full text of these provisions.
MANAGEMENT OF THE FUNDS
Directors and Officers. The Boards of Directors of SHIP I, SHIP II and Senior
Strategic currently consist of the same six persons, five of whom are not
"interested persons", as defined in the Investment Company Act. The Directors
are responsible for the overall supervision of the operations of SHIP I, SHIP
II and Senior Strategic and perform the various duties imposed on the directors
of investment companies by the Investment Company Act and under applicable
Maryland law. SHIP I, SHIP II and Senior Strategic also have the same officers.
For further information regarding the Directors and officers of each Fund, see
"Election of Directors".
Management and Advisory Arrangements. FAM serves as the investment adviser
for SHIP I, SHIP II and Senior Strategic pursuant to separate investment
advisory agreements that, except for their termination dates, are identical.
FAM is an affiliate of MLAM, which is owned and controlled by ML & Co. FAM
provides each Fund with the same investment advisory and management services.
FAM or MLAM acts as the investment adviser for more than 130 registered
investment companies. FAM also offers portfolio management and portfolio
analysis services to individuals and institutions. As of November 30, 1995, FAM
and MLAM had a total of approximately $194.2 billion in investment company and
other portfolio assets
35
<PAGE>
under management, including accounts of certain affiliates of FAM. The
principal business address of FAM is 800 Scudders Mill Road, Plainsboro, New
Jersey 08536. The audited balance sheet of FAM for the fiscal year ended
December 31, 1994 is attached hereto on page F-88.
Each Fund's investment advisory agreement with FAM provides that, subject to
the direction of the Board of Directors of the Fund, FAM is responsible for the
actual management of the Fund's portfolio. The responsibility for making
decisions to buy, sell or hold a particular security for each Fund rests with
FAM, subject to review by the Board of Directors of the Fund.
FAM provides the portfolio management for SHIP I, SHIP II and Senior
Strategic. Such portfolio management considers analyses from various sources
(including brokerage firms with which each Fund does business), makes the
necessary investment decisions, and places orders for transactions accordingly.
FAM also is responsible for the performance of certain administrative and
management services for each Fund.
For the services provided by FAM under each Fund's investment advisory
agreement, the Fund pays a monthly fee at an annual rate of 0.50% of the Fund's
average weekly net assets plus the proceeds of any outstanding borrowings used
for leverage (i.e., the average weekly value of the total assets of the Fund,
minus the sum of accrued liabilities of the Fund, any accrued and unpaid
interest on outstanding borrowings and accumulated dividends on shares of
preferred stock). For purposes of this calculation, average weekly net assets
are determined at the end of each month on the basis of the average net assets
of the Fund for each week during the month. The assets for each weekly period
are determined by averaging the net assets at the last business day of a week
with the net assets at the last business day of the prior week.
Each Fund's investment advisory agreement obligates FAM to provide investment
advisory services and to pay all compensation of and furnish office space for
officers and employees of the Fund connected with investment and economic
research, trading and investment management of the Fund, as well as the
compensation of all Directors of the Fund who are affiliated persons of FAM or
any of its affiliates. Each Fund pays all other expenses incurred in the
operation of the Fund, including, among other things, expenses for legal and
auditing services, taxes, costs of printing proxies, listing fees, stock
certificates and stockholder reports, charges of the custodian and the transfer
agent, dividend disbursing agent and registrar, Securities and Exchange
Commission fees, fees and expenses of unaffiliated Directors, accounting and
pricing costs, insurance, interest, brokerage costs, litigation and other
extraordinary or non-recurring expenses, mailing and other expenses properly
payable by the Fund. FAM provides accounting services to each Fund, and each
Fund reimburses FAM for its respective costs in connection with such services.
Unless earlier terminated as described below, the investment advisory
agreement between SHIP I and FAM will continue from year to year if approved
annually (a) by the Board of Directors of SHIP I or by a majority of the
outstanding shares of SHIP I Common Stock and (b) by a majority of the
Directors of SHIP I who are not parties to such contract or "interested
persons", as defined in the Investment Company Act, of any such party. The
contract is not assignable and it may be terminated without penalty on 60 days'
written notice at the option of either party thereto or by the vote of the
stockholders of SHIP I.
Unless earlier terminated as described below, the investment advisory
agreement between SHIP II and FAM will continue from year to year if approved
annually (a) by the Board of Directors of SHIP II or by a majority of the
outstanding shares of SHIP II Common Stock and (b) by a majority of the
Directors of SHIP II who are not parties to such contract or "interested
persons", as defined in the Investment Company Act, of any such party. The
contract is not assignable and it may be terminated without penalty on 60 days'
written notice at the option of either party thereto or by the vote of the
stockholders of SHIP II.
Unless earlier terminated as described below, the investment advisory
agreement between Senior Strategic and FAM will continue from year to year if
approved annually (a) by the Board of Directors of Senior Strategic or by a
majority of the outstanding shares of Senior Strategic Common Stock and (b) by
a majority of the Directors of Senior Strategic who are not parties to such
contract or "interested persons", as defined in the Investment Company Act, of
any such party. The contract is not assignable and it may be terminated without
penalty on 60 days' written notice at the option of either party thereto or by
the vote of the stockholders of Senior Strategic.
36
<PAGE>
VOTING RIGHTS
Voting rights are identical for the holders of shares of Common Stock of SHIP
I, SHIP II and Senior Strategic. Holders of each Fund's Common Stock are
entitled to one vote for each share held. The shares of each Fund's Common
Stock do not have cumulative voting rights, which means that the holders of
more than 50% of the shares of a Fund's Common Stock voting for the election of
Directors can elect all of the Directors standing for election by such holders,
and, in such event, the holders of the remaining shares of a Fund's Common
Stock will not be able to elect any of such Directors.
STOCKHOLDER INQUIRIES
Stockholder inquiries with respect to SHIP I, SHIP II and Senior Strategic
may be addressed to any Fund by telephone at (609) 282-2000 or at the address
set forth on the cover page of this Proxy Statement and Prospectus.
DIVIDENDS AND DISTRIBUTIONS
Each Fund's current policy with respect to dividends and distributions
relating to shares of Common Stock is identical.
Each Fund will distribute dividends of all or a portion of its net investment
income monthly. Each Fund may at times pay out less than the entire amount of
net investment income earned in any particular period and may at times pay out
such accumulated undistributed income in addition to net investment income
earned in other periods in order to permit the Fund to maintain a more stable
level of distributions. As a result, the distribution paid by a Fund for any
particular period may be more or less than the amount of net investment income
earned by the Fund during such period. For Federal income tax purposes, each
Fund will be required to distribute substantially all of its net investment
income for each calendar year. All net realized long-term and short-term
capital gains, if any, will be distributed to a Fund's shareholders at least
annually.
Under the Investment Company Act, a Fund is not permitted to incur
indebtedness unless immediately after such incurrence the Fund has an asset
coverage of 300% of the aggregate outstanding principal balance of
indebtedness. Additionally, under the Investment Company Act, a Fund may not
declare any dividend or other distribution upon any class of its capital stock,
or purchase any such capital stock, unless the aggregate indebtedness of the
Fund has, at the time of the declaration of any such dividend or distribution
or at the time of any such purchase, an asset coverage of at least 300% after
deducting the amount of such dividend, distribution, or purchase price, as the
case may be.
In addition to the limitations imposed by the Investment Company Act
described in the previous two paragraphs, certain lenders may impose additional
restrictions on the payment of dividends or distributions on each Fund's Common
Stock in the event of a default on the Fund's borrowings. Any limitation on a
Fund's ability to make distributions on its Common Stock could under certain
circumstances impair the ability of the Fund to maintain its qualification for
taxation as a regulated investment company.
See "Automatic Dividend Reinvestment Plan" for information concerning the
manner in which dividends and distributions to holders of Common Stock may be
automatically reinvested in shares of Common Stock of the Funds. Dividends and
distributions will be taxable to shareholders whether they are reinvested in
shares of the Funds or received in cash.
AUTOMATIC DIVIDEND REINVESTMENT PLAN
Pursuant to each Fund's Automatic Dividend Reinvestment Plan (each, the
"Plan"), unless a holder of a Fund's Common Stock elects otherwise, all
dividend and capital gains distributions are reinvested automatically by The
Bank of New York, as agent for stockholders in administering the Plan (the
"Plan Agent"), in additional shares of the Fund's Common Stock. Holders of a
Fund's Common Stock who elect not to participate in the Plan receive all
distributions in cash paid by check mailed directly to the stockholder
37
<PAGE>
of record (or, if the shares are held in street or other nominee name, then to
such nominee) by The Bank of New York, as dividend paying agent. Such
stockholders may elect not to participate in the Plan and to receive all
distributions of dividends and capital gains in cash by sending written
instructions to The Bank of New York, as dividend paying agent, at the address
set forth below. Participation in the Plan is completely voluntary and may be
terminated or resumed at any time without penalty by written notice if received
by the Plan Agent not less than ten days prior to any dividend record date;
otherwise, such termination will be effective with respect to any subsequently
declared dividend or capital gains distribution.
Whenever a Fund declares an ordinary income dividend or a capital gain
dividend (collectively referred to as "dividends") payable either in shares or
in cash, non-participants in the Plan receive cash, and participants in the
Plan receive the equivalent in shares of the Fund's Common Stock. The shares
are acquired by the Plan Agent for the participant's account, depending upon
the circumstances described below, either (i) through receipt of additional
unissued but authorized shares of the Fund's Common Stock from the Fund ("newly
issued shares") or (ii) by purchase of outstanding shares of the Fund's Common
Stock on the open market ("open-market purchases"), on the NYSE or elsewhere.
If on the payment date for the dividend, the net asset value per share of the
Fund's Common Stock is equal to or less than the market price per share of the
Fund's Common Stock plus estimated brokerage commissions (such condition being
referred to herein as "market premium"), the Plan Agent invests the dividend
amount in newly-issued shares on behalf of the participant. The number of
newly-issued shares of the Fund's Common Stock to be credited to the
participant's account is determined by dividing the dollar amount of the
dividend by the net asset value per share on the date the shares are issued,
provided that the maximum discount from the then current market price per share
on the date of issuance may not exceed 5%. If on the dividend payment date, the
net asset value per share is greater than the market value (such condition
being referred to herein as "market discount"), the Plan Agent invests the
dividend amount in shares acquired on behalf of the participant in open-market
purchases.
In the event of a market discount on the dividend payment date, the Plan
Agent has until the last business day before the next date on which the shares
trade on an "ex-dividend" basis or in no event more than 30 days after the
dividend payment date (the "last purchase date") to invest the dividend amount
in shares acquired in open-market purchases. Each Fund intends to pay monthly
income dividends. Therefore, the period during which open-market purchases can
be made exists only from the payment date on the dividend through the date
before the next "ex-dividend" date, which typically is approximately ten days.
If, before the Plan Agent has completed its open-market purchases, the market
price of a share of a Fund's Common Stock exceeds the net asset value per
share, the average per share purchase price paid by the Plan Agent may exceed
the net asset value of the Fund's shares, resulting in the acquisition of fewer
shares than if the dividend had been paid in newly-issued shares on the
dividend payment date. Because of the foregoing difficulty with respect to
open-market purchases, the Plan provides that if the Plan Agent is unable to
invest the full dividend amount in open-market purchases during the purchase
period or if the market discount shifts to a market premium during the purchase
period, the Plan Agent ceases making open-market purchases and invests the
uninvested portion of the dividend amount in newly-issued shares at the close
of business on the last purchase date.
The Plan Agent maintains all stockholders' accounts in the Plan and furnishes
written confirmation of all transactions in the account, including information
needed by stockholders for tax records. Shares in the account of each Plan
participant are held by the Plan Agent in non-certificated form in the name of
the participant, and each stockholder's proxy includes those shares purchased
or received pursuant to the Plan. The Plan Agent will forward all proxy
solicitation materials to participants and vote proxies for shares held
pursuant to the Plan in accordance with the instructions of the participants.
In the case of stockholders such as banks, brokers or nominees which hold
shares for others who are the beneficial owners, the Plan Agent will administer
the Plan on the basis of the number of shares certified from time to time by
the record stockholders as representing the total amount registered in the
record stockholder's name and held for the account of beneficial owners who are
to participate in the Plan.
38
<PAGE>
There are no brokerage charges with respect to shares issued directly by any
Fund as a result of dividends or capital gains distributions payable either in
shares or in cash. However, each participant pays 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.
The automatic reinvestment of dividends and distributions does not relieve
participants of any Federal, state or local income tax that may be payable (or
required to be withheld) on such dividends. See "Tax Rules Applicable to SHIP
I, SHIP II, Senior Strategic and Their Stockholders".
Stockholders participating in the Plan may receive benefits not available to
stockholders not participating in the Plan. If the market price plus
commissions of a Fund's shares of Common Stock is above the net asset value,
participants in the Plan receive shares of the Fund's Common Stock at less than
they otherwise could purchase them and have shares with a cash value greater
than the value of any cash distribution they would have received on their
shares. If the market price plus commissions is below the net asset value,
participants receive distributions in shares with a net asset value greater
than the value of any cash distribution they would have received on their
shares. However, there may be insufficient shares available in the market to
make distributions in shares at prices below the net asset value. Also, since
none of the Funds normally redeems its shares, the price on resale may be more
or less than the net asset value.
Each Fund reserves the right to amend or terminate its Plan. There is no
direct service charge to participants in the Plan; however, each Fund reserves
the right to amend its Plan to include a service charge payable by the
participants.
TAX RULES APPLICABLE TO SHIP I, SHIP II, SENIOR STRATEGIC AND THEIR
STOCKHOLDERS
The tax consequences associated with investment in shares of Common Stock of
SHIP I, SHIP II and Senior Strategic are identical. SHIP I, SHIP II and Senior
Strategic have elected and qualified and SHIP I intends to continue to so
qualify for the special tax treatment afforded regulated investment companies
("RICs") under the Code. As a result, the Funds (but not their stockholders)
are not subject to Federal income tax to the extent that they distribute their
net investment income and net realized capital gains.
Dividends paid by each Fund from its ordinary income or from an excess of net
short-term capital gains over net long-term capital losses (together referred
to hereafter as "ordinary income dividends") are taxable to shareholders as
ordinary income. Distributions made from an excess of net long-term capital
gains over net short-term capital losses including gains or losses from certain
transactions in futures, options and interest rate swaps ("capital gain
dividends") are taxable at long-term capital gains rates for Federal income tax
purposes, regardless of the length of time the shareholder has owned Fund
shares. Any loss upon the sale or exchange of Fund shares held for six months
or less, however, will be treated as long-term capital loss to the extent of
any capital gain dividends received by the shareholder. Distributions in excess
of a Fund's earnings and profits will first reduce the adjusted tax basis of a
holder's Common Stock and, after such adjusted tax basis is reduced to zero,
will constitute capital gains to such holder (assuming such Common Stock is
held as a capital asset).
Dividends are taxable to shareholders even though they are reinvested in
additional shares of a Fund. Distributions attributable to dividend income
earned by a Fund (if any) will be eligible for the dividends received deduction
allowed to corporations under the Code, if certain requirements are met. Not
later than 60 days after the close of its taxable year, each Fund will provide
its shareholders with a written notice designating the amounts of any dividends
eligible for the dividends received deduction (if any), ordinary income
dividends or capital gain dividends. If a Fund pays a dividend in January which
was declared in the previous October, November or December to shareholders of
record on a specified date in one of such months, then such dividend will be
treated for tax purposes as being paid by the Fund and received by its
shareholders on December 31 of the year in which the dividend was declared.
The Internal Revenue Service has taken the position in a revenue ruling that
if a RIC has two classes of shares, it may designate distributions made to each
class in any year as consisting of no more than such class's
39
<PAGE>
proportionate share of particular types of income, including net long-term
capital gains. A class's proportionate share of a particular type of income is
determined according to the percentage of total dividends paid by the RIC
during such year that was paid to such class. Consequently, if both Common
Stock and preferred stock are outstanding, each Fund intends to designate
distributions made to the classes as consisting of particular types of income
in accordance with the classes' proportionate shares of such income. Thus,
capital gain dividends will be allocated between the holders of Common Stock
and any preferred stock in proportion to the total dividends paid to each class
during the taxable year, or otherwise as required by applicable law.
If at any time when shares of preferred stock are outstanding a Fund does not
meet the asset coverage requirements of the Investment Company Act, the Fund
will be required to suspend distributions to holders of Common Stock until the
asset coverage is restored. See "Dividends and Distributions." This may prevent
such Fund from distributing at least 90% of its net income, and may therefore
jeopardize the Fund's qualification for taxation as a RIC or may subject the
Fund to the 4% Federal excise tax described below. Upon any failure to meet the
asset coverage requirement of the Investment Company Act, a Fund may, in its
sole discretion, redeem shares of preferred stock in order to maintain or
restore the requisite asset coverage and avoid the adverse consequences to the
Fund and its shareholders of failing to qualify as a RIC. There can be no
assurance, however, that any such action would achieve these objectives.
As noted above, each Fund must distribute annually at least 90% of its net
investment income. A distribution will only be counted for this purpose if it
qualifies for the dividends paid deduction under the Code. Some types of
preferred stock that each Fund has the authority to issue may raise an issue as
to whether distributions on such preferred stock are "preferential" under the
Code and therefore not eligible for the dividends paid deduction. In the event
a Fund determines to issue preferred stock, the Fund intends to issue preferred
stock that counsel advises will not result in the payment of a preferential
dividend and may seek a private letter ruling from the Internal Revenue Service
to that effect. If a Fund ultimately relies solely on a legal opinion in the
event it issues such preferred stock, there is no assurance that the Internal
Revenue Service would agree that dividends on the preferred stock are not
preferential. If the Internal Revenue Service successfully disallowed the
dividends paid deduction for dividends on the preferred stock, a Fund could be
disqualified as a RIC.
Ordinary income dividends paid to shareholders who are nonresident aliens or
foreign entities will be subject to a 30% United States withholding tax under
existing provisions of the Code applicable to foreign individuals and entities
unless a reduced rate of withholding or a withholding exemption is provided
under applicable treaty law. Nonresident shareholders are urged to consult
their own tax advisers concerning the applicability of the United States
withholding tax.
Interest income from non-U.S. securities may be subject to withholding taxes
imposed by the country in which the issuer is located. Unless more than 50% of
a Fund's assets (by value) consists of stock or securities of foreign
corporations, the Fund will not be able to pass through to its shareholders
foreign tax credits or deductions with respect to these taxes.
Under certain Code provisions, some shareholders may be subject to a 31%
withholding tax on ordinary income dividends, capital gain dividends and
redemption payments ("backup withholding"). Generally, shareholders subject to
backup withholding will be those for whom no certified taxpayer identification
number is on file with the Funds or who, to the Funds' knowledge, have
furnished an incorrect number. When establishing an account, an investor must
certify under penalty of perjury that such number is correct and that such
investor is not otherwise subject to backup withholding.
The Code requires a RIC to pay a nondeductible 4% excise tax to the extent
the RIC does not distribute, during each calendar year, 98% of its ordinary
income, determined on a calendar year basis, and 98% of its capital gains,
determined, in general, on an October 31 year end, plus certain undistributed
amounts from previous years. Each Fund will attempt to make sufficient timely
distributions of income so as to minimize the imposition of the excise tax.
40
<PAGE>
The Funds may invest in securities rated in the medium to lower rating
categories of nationally recognized rating agencies, and in unrated securities
("junk bonds"), as described in this Proxy Statement and Prospectus. Some of
these junk bonds may be purchased at a discount and may therefore cause the
Funds to accrue income before amounts due under the obligations are paid. In
addition, a portion of the interest payments on such junk bonds may be treated
as dividends for Federal income tax purposes; in such case, if the issuer of
such junk bonds is a domestic corporation, dividend payments by the Funds will
be eligible for the dividends received deduction allowed to corporations to the
extent of the deemed dividend portion of such interest payments.
Tax Treatment of Options And Futures Transactions. Each Fund may engage in
interest rate transactions, write (i.e., sell) covered call and covered put
options on its portfolio securities, purchase call and put options on
securities, and engage in transactions in financial futures and related options
on such futures. In general, unless an election is available to a Fund or an
exception applies, such options and futures contracts that are "Section 1256
contracts" will be "marked to market" for Federal income tax purposes at the
end of each taxable year, i.e., each such option or futures contract will be
treated as sold for its fair market value on the last day of the taxable year,
and any gain or loss attributable to such contracts will be 60% long-term and
40% short-term capital gain or loss. Application of these rules to Section 1256
contracts held by a Fund may alter the timing and character of distributions to
shareholders. The mark-to-market rules outlined above, however, will not apply
to certain transactions entered into by the Funds solely to reduce the risk of
changes in price or interest rates with respect to their investments.
The Federal income tax rules governing the taxation of interest rate swaps
are not entirely clear and may require each Fund to treat payments received
under such arrangements as ordinary income and to amortize such payments under
certain circumstances. The Funds do not anticipate that their activity in this
regard will affect their qualification as RICs.
Code Section 1092, which applies to certain "straddles", may affect the
taxation of a Fund's sales of securities, options, futures and interest rate
transactions. Under Section 1092, each Fund may be required to postpone
recognition for tax purposes of losses incurred in certain sales of securities
or certain closing transactions in options, futures and interest rate swaps.
One of the requirements for qualification as a RIC is that less than 30% of a
Fund's gross income be derived from gains from the sale or other disposition of
securities held for less than three months. Accordingly, the Funds may be
restricted in effecting closing transactions within three months after entering
into an options or futures contract.
Special Rules for Certain Foreign Currency Transactions. Code Section 988
provides special rules for certain transactions in a foreign currency other
than the taxpayer's functional currency (i.e., unless certain special rules
apply, currencies other than the U.S. dollar). In general, Code Section 988
gains or losses will increase or decrease the amount of each Fund's investment
company taxable income available to be distributed to shareholders as ordinary
income. Additionally, if Code Section 988 losses exceed other investment
company taxable income during a taxable year, a Fund would not be able to make
any ordinary income dividend distributions, and all or a portion of
distributions made before the losses were realized but in the same taxable year
would be recharacterized as a return of capital to shareholders, thereby
reducing the basis of each shareholder's Fund shares.
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury Regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections
and the Treasury Regulations promulgated thereunder. The Code and the Treasury
Regulations are subject to change by legislative, judicial or administrative
action either prospectively or retroactively.
Shareholders are urged to consult their tax advisers regarding specific
questions as to Federal, foreign, state or local taxes.
41
<PAGE>
MUTUAL FUND INVESTMENT OPTION
Purchasers of shares of each Fund in its initial offering have an investment
option consisting of the right to reinvest the net proceeds from a sale of
such shares (the "Original Shares") in Class A initial sales charge shares of
certain open-end mutual funds sponsored by Merrill Lynch ("Eligible Class A
Shares") at their net asset value, without the imposition of the initial sales
charge, if the conditions set forth below are satisfied. First, the sale of
the Original Shares must be made through Merrill Lynch, and the net proceeds
therefrom must be immediately reinvested in Eligible Class A Shares. Second,
the Original Shares must have been either acquired in the initial offering or
be shares representing reinvested dividends from shares acquired in the
initial offering. Third, the Original Shares must have been continuously
maintained in a Merrill Lynch securities account. Fourth, there must be a
minimum purchase of $250 to be eligible for the investment option. Class A
shares of certain of the mutual funds may be subject to an account maintenance
fee at an annual rate of up to 0.25% of the average daily net asset value of
such mutual fund. The Eligible Class A Shares may be redeemed at any time at
the next determined net asset value, subject in certain cases to a redemption
fee.
THE MERGER
GENERAL
Under the Agreement and Plan of Merger (attached hereto as Exhibit I), each
of SHIP II and Senior Strategic will merge with and into SHIP I on the
Effective Date, whereupon the separate existence of each of SHIP II and Senior
Strategic will cease and SHIP I will be the surviving corporation, and each
share of Common Stock of each of SHIP II and Senior Strategic outstanding will
be converted into the right to receive an equivalent dollar amount (to the
nearest one ten-thousandth of one cent) of full shares of SHIP I Common Stock
plus cash in lieu of any fractional shares, computed based on the net asset
value per share of each Fund on the Effective Date.
No sales charge or fee of any kind will be charged to either SHIP II or
Senior Strategic stockholders in connection with their receipt of SHIP I
Common Stock in the Merger.
Accordingly, as a result of the Merger, every holder of Common Stock of SHIP
II and Senior Strategic would own shares of SHIP I Common Stock (except for
cash payments received in lieu of fractional shares as described below). Since
the SHIP I Common Stock would be issued at net asset value, the net asset
value per share of SHIP I Common Stock should remain virtually unchanged by
the Merger. Thus, the Merger should result in virtually no dilution of net
asset value of the SHIP I Common Stock, other than to reflect the costs of the
Merger. However, as a result of the Merger, a stockholder of a Fund likely
would hold a reduced percentage of ownership in the larger combined entity
than he or she did in any of the constituent Funds.
PROCEDURE
On December 6, 1995, the Boards of Directors of SHIP I, SHIP II and Senior
Strategic, including all of the Directors who are not "interested persons", as
defined by the Investment Company Act, of SHIP I, SHIP II and Senior
Strategic, declared advisable the Agreement and Plan of Merger.
As a result of such Board approvals, SHIP I, SHIP II and Senior Strategic
jointly have filed a proxy statement with the Securities and Exchange
Commission soliciting a vote of the stockholders of SHIP I, SHIP II and Senior
Strategic to approve the Merger. The costs of such solicitation are to be paid
by SHIP I after the Merger so as to be borne equally and exclusively by the
holders of Common Stock of SHIP I, SHIP II and Senior Strategic. It is
anticipated that special meetings of stockholders of SHIP I, SHIP II and
Senior Strategic will be held on or about March 14, 1996. If the stockholders
of SHIP I, SHIP II and Senior Strategic approve the Merger, the Merger will
take place on or about March 15, 1996.
TERMS OF THE AGREEMENT AND PLAN OF MERGER
The following is a summary of the significant terms of the Agreement and
Plan of Merger. This summary is qualified in its entirety by reference to the
Agreement and Plan of Merger, attached hereto as Exhibit I.
42
<PAGE>
Conversion to SHIP I Common Stock. On the Effective Date, each share of
Common Stock of each of SHIP II and Senior Strategic will be converted into the
right to receive an equivalent dollar amount (to the nearest one ten-thousandth
of one cent) of full shares of SHIP I Common Stock plus cash in lieu of any
fractional shares, computed based on the net asset value per share of each Fund
on the Effective Date. Shares of SHIP I Common Stock issued and outstanding as
of the Effective Date will remain issued and outstanding and in the same
number. The net asset value per share of SHIP I, SHIP II and Senior Strategic
shall be determined as of the Effective Date, and no formula will be used to
adjust the net asset value so determined of either SHIP I, SHIP II or Senior
Strategic to take into account differences in realized and unrealized gains and
losses. The value of the assets of SHIP II and Senior Strategic to be
transferred to SHIP I shall be determined by SHIP I pursuant to the procedures
utilized by SHIP I in valuing its own assets and determining its own
liabilities for purposes of the Merger. Such valuation and determination shall
be made by SHIP I in cooperation with SHIP II and Senior Strategic and shall be
confirmed in writing by SHIP I to SHIP II and Senior Strategic. The net asset
value per share of SHIP I Common Stock shall be determined in accordance with
such procedures, and SHIP I shall certify the computations involved. SHIP I
shall issue to the stockholders of SHIP II and Senior Strategic separate
certificates or share deposit receipts for the SHIP I Common Stock by
delivering the certificates or share deposit receipts evidencing ownership of
the SHIP I Common Stock to The Bank of New York, as the transfer agent and
registrar for SHIP I Common Stock. With respect to any SHIP II or Senior
Strategic stockholder holding certificates evidencing ownership of either the
Common Stock of SHIP II or Senior Strategic as of the Effective Date, and
subject to SHIP I being informed thereof in writing by SHIP II or Senior
Strategic, SHIP I will not permit such stockholder to receive new certificates
evidencing ownership of the SHIP I Common Stock, exchange SHIP I Common Stock
credited to such stockholder's account for shares of other investment companies
managed by MLAM or any of its affiliates, or pledge or redeem such SHIP I
Common Stock, in any case, until such stockholder has surrendered his or her
outstanding certificates evidencing ownership of the Common Stock of SHIP II or
Senior Strategic or, in the event of lost certificates, posted adequate bond.
Each of SHIP II and Senior Strategic, at its own expense, will request its
stockholders to surrender their outstanding certificates evidencing ownership
of the Common Stock of SHIP II and Senior Strategic or post adequate bond
therefor.
No fractional shares of SHIP I Common Stock will be issued to SHIP II or
Senior Strategic stockholders. In lieu thereof, SHIP I's transfer agent, The
Bank of New York, will aggregate all fractional shares of SHIP I and sell the
resulting whole shares on the New York Stock Exchange at the current market
price for shares of SHIP I for the account of all holders of fractional
interests, and each such holder will receive such holder's pro rata share of
the proceeds of such sale, without interest, upon surrender of such holder's
SHIP I Common Stock certificates. Although receipt of full shares in the Merger
will not result in taxable gain or loss to the stockholder, his or her receipt
of the proceeds of the sale of fractional shares may result in a small taxable
gain or loss.
Expenses. SHIP I shall pay, subsequent to the Effective Date, all expenses
incurred in connection with the Merger, including, but not limited to, all
costs related to the preparation and distribution of a registration statement
on Form N-14 (the "N-14 Registration Statement") and the fees of special
counsel to the Merger. Such fees and expenses shall include legal, accounting
and state securities or blue sky fees, printing costs, filing fees, stock
exchange fees, rating agency fees, portfolio transfer taxes (if any), and any
similar expenses incurred in connection with the Merger. Neither SHIP I, SHIP
II nor Senior Strategic shall pay any expenses of its respective stockholders
arising out of or in connection with the Merger. If for any reason the Merger
is not consummated, no party shall be liable to any other party for any damages
resulting therefrom, including, without limitation, consequential damages.
Required Approvals. As previously stated, the Board of Directors of each of
SHIP I, SHIP II and Senior Strategic unanimously approved the Merger on
December 6, 1995. Approval of the Agreement and Plan of Merger also requires
the affirmative vote of stockholders representing more than 50% of the
outstanding shares of Common Stock of each of SHIP I, SHIP II and Senior
Strategic. Because of the requirement that the Agreement and Plan of Merger be
approved by stockholders of all three Funds, the Merger will not take place if
stockholders of any one Fund do not approve the Agreement and Plan of Merger.
Deregistration. As promptly as practicable after the Merger, the registration
of each of SHIP II and Senior Strategic under the Investment Company Act shall
be terminated. Moreover, as a result of the Merger,
43
<PAGE>
the separate existence of SHIP II and Senior Strategic will cease. Expenses
incurred in connection with the deregistration and winding up of operations of
SHIP II and Senior Strategic will be deducted from the assets of SHIP I
immediately following the Merger so as to be borne equally on a per share basis
by all Common Stockholders of the three Funds.
Amendments and Conditions. The Agreement and Plan of Merger may be amended at
any time prior to the Effective Date with respect to any of the terms therein
so long as such amendment does not materially adversely affect the stockholders
of any of the Funds. The obligations of SHIP I, SHIP II and Senior Strategic
pursuant to the Agreement and Plan of Merger are subject to various conditions,
including the N-14 Registration Statement being declared effective by the
Commission, approval of the Merger by the requisite number of shares of
stockholders of SHIP I, SHIP II and Senior Strategic being given, an opinion of
counsel as to securities matters being received, the continuing accuracy of
various representations and warranties of SHIP I, SHIP II and Senior Strategic
being confirmed by the respective parties and the refinancing of the
outstanding credit facilities of all three Funds in a principal amount
approximately equal to the aggregate commitment amount of the currently
outstanding credit facilities.
BENEFITS TO STOCKHOLDERS OF SHIP I, SHIP II AND SENIOR STRATEGIC AS A RESULT OF
THE MERGER
In approving the Merger, the Board of Directors of each Fund identified
certain benefits that are likely to result from combining the Funds, including
lower expenses per share of Common Stock and greater efficiency and flexibility
in portfolio management. The Boards also considered the possible risks and
costs of combining the Funds. The Boards noted the many similarities between
the Funds, including their virtually identical investment objectives and
investment policies, their common management and their similar portfolios of
Senior Debt. Based on these factors, the Boards concluded that the Merger (i)
presents no significant risks that would outweigh the benefits discussed above
and (ii) involves minimal costs (including relatively minor legal, accounting
and administrative costs, most of which already have been incurred in
evaluating and analyzing the Merger).
The surviving fund that would result from the Merger would have a much larger
asset base than any Fund has currently. Based on data presented by FAM, the
Board of each Fund believes that administrative expenses for a larger combined
fund would be less than the aggregate expenses for the individual Funds,
resulting in a lower expense ratio for common stockholders of the combined fund
and higher earnings per common share. In particular, certain fixed costs, such
as costs of printing stockholder reports and proxy statements, legal expenses,
audit fees, registration fees, mailing costs and other expenses will be spread
across a larger asset base, thereby lowering the expense ratio for the combined
fund. The following table, which assumes that the Merger took place on August
31, 1995, illustrates the potential economies of scale that may be realized as
a result of the Merger:
<TABLE>
<CAPTION>
AS OF AUGUST 31, 1995
-----------------------------------------
TOTAL ANNUAL TOTAL ANNUAL
OPERATING OPERATING
EXPENSES EXPENSES
NET (EXCLUDING (INCLUDING
ASSETS LEVERAGE) LEVERAGE)
----------- ------------ ------------
(APPROX. IN
MILLIONS)
<S> <C> <C> <C>
SHIP I................................ $230.0 .94% 3.05%
SHIP II............................... $154.0 1.08% 3.63%
Senior Strategic...................... $ 71.8 1.04% 2.97%
Combined Fund......................... $447.1 .81% 2.56%
</TABLE>
In approving the Merger, the Board of Directors of each Fund determined that
the interests of existing stockholders of the Fund would not be diluted as a
result of the Merger. Although the Merger is expected to result in a reduction
in net asset value per share of the SHIP I Common Stock of approximately $.01
as a result of the estimated costs of the Merger, management of each Fund
advised its Board that it expects that such costs would be recovered within 12
months after the Effective Date.
SURRENDER AND EXCHANGE OF STOCK CERTIFICATES OF SHIP II AND SENIOR STRATEGIC
After the Effective Date, each holder of an outstanding certificate or
certificates formerly representing shares of Common Stock of SHIP II and Senior
Strategic, as the case may be, will be entitled to receive,
44
<PAGE>
upon surrender of his or her certificate or certificates, a certificate or
certificates representing the number of full shares of SHIP I Common Stock
distributable with respect to such holder's shares of Common Stock of SHIP II
and Senior Strategic, together with cash in lieu of any fractional shares.
Promptly after the Effective Date, the transfer agent for the SHIP I Common
Stock will mail to each holder of certificates formerly representing shares of
Common Stock of SHIP II and Senior Strategic, as the case may be, a letter of
transmittal for use in surrendering his or her certificates for certificates
representing whole shares of SHIP I Common Stock and cash in lieu of any
fractional shares.
PLEASE DO NOT SEND IN ANY STOCK CERTIFICATES AT THIS TIME. UPON CONSUMMATION
OF THE MERGER, COMMON STOCKHOLDERS OF SHIP II AND SENIOR STRATEGIC WILL BE
FURNISHED WITH INSTRUCTIONS FOR EXCHANGING THEIR STOCK CERTIFICATES OF SHIP II
AND SENIOR STRATEGIC FOR SHIP I STOCK CERTIFICATES AND, IF APPLICABLE, CASH IN
LIEU OF FRACTIONAL SHARES.
From and after the Effective Date, certificates formerly representing shares
of Common Stock of SHIP II and Senior Strategic, as the case may be, will be
deemed for all purposes to evidence ownership of the number of full shares of
SHIP I Common Stock distributable with respect to such shares of SHIP II and
Senior Strategic in the Merger, provided, that until such stock certificates of
SHIP II and Senior Strategic have been so surrendered, no dividends payable to
the holders of record of SHIP I Common Stock as of any date subsequent to the
Effective Date will be paid to the holders of such outstanding stock
certificates of SHIP II and Senior Strategic. Dividends payable to holders of
record of shares of SHIP I Common Stock as of any date after the Effective Date
and prior to the exchange of certificates by any stockholder of SHIP II and
Senior Strategic will be paid to such stockholder, without interest, at the
time such stockholder surrenders his or her stock certificates of SHIP II and
Senior Strategic for exchange.
From and after the Effective Date, there will be no transfers on the stock
transfer books of SHIP II and Senior Strategic. If, after the Effective Date,
certificates representing shares of Common Stock of SHIP II and Senior
Strategic are presented to SHIP I, they will be cancelled and exchanged for
certificates representing SHIP I Common Stock, and the cash in lieu of
fractional shares, if any, distributable with respect to such Common Stock of
SHIP II and Senior Strategic in the Merger.
TAX CONSEQUENCES OF THE MERGER
General. The Merger has been structured with the intention that it qualify
for Federal income tax purposes as a tax-free reorganization under Section
368(a)(1)(A) of the Code. SHIP I, SHIP II and Senior Strategic each has elected
and qualified for the special tax treatment afforded RICs under the Code
through the Effective Date, and SHIP I intends to continue to so qualify after
the Merger. SHIP I, SHIP II and Senior Strategic will each receive an opinion
from counsel to the effect that for Federal income tax purposes: (i) the
Merger, as described, will constitute a reorganization within the meaning of
Section 368(a)(1)(A) of the Code and SHIP I, SHIP II and Senior Strategic will
each be deemed a "party" to a reorganization within the meaning of Section
368(b) of the Code; (ii) in accordance with Section 361(a) of the Code, no gain
or loss will be recognized to either SHIP II or Senior Strategic as a result of
the Merger or on the distribution of SHIP I Common Stock to SHIP II and Senior
Strategic stockholders under Section 361(c)(1) of the Code; (iii) under Section
1032 of the Code, no gain or loss will be recognized to SHIP I as a result of
the Merger; (iv) in accordance with Section 354(a)(1) of the Code, no gain or
loss will be recognized to the stockholders of SHIP II and Senior Strategic on
the conversion of their SHIP II and Senior Strategic shares into SHIP I Common
Stock; (v) in accordance with Section 362(b) of the Code, the tax basis of the
SHIP II and Senior Strategic assets in the hands of SHIP I will be the same as
the tax basis of such assets in the hands of SHIP II and Senior Strategic
immediately prior to the consummation of the Merger; (vi) in accordance with
Section 358 of the Code, immediately after the Merger, the tax basis of the
SHIP I Common Stock received by the stockholders of SHIP II and Senior
Strategic in the Merger will be equal, in the aggregate, to the tax basis of
the shares of SHIP II and Senior Strategic converted pursuant to the Merger;
(vii) in accordance with Section 1223 of the Code, a stockholder's holding
period for the SHIP I Common Stock will be determined by including the period
for which he or she held the Common Stock of SHIP II or Senior Strategic
converted pursuant to the Merger, provided, that such SHIP II or Senior
Strategic shares were held as a capital asset; (viii) in accordance with
Section 1223 of the Code, SHIP I's holding period with respect to the SHIP II
and
45
<PAGE>
Senior Strategic assets transferred will include the period for which such
assets were held by SHIP II and Senior Strategic; (ix) the payment of cash to
SHIP II and Senior Strategic stockholders in lieu of fractional shares of SHIP
I will be treated as though the fractional shares were distributed as part of
the Merger and then redeemed by SHIP I, with the result that each SHIP II and
Senior Strategic stockholder will generally have short- or long-term capital
gain or loss to the extent the cash distribution differs from such
stockholder's basis allocable to the fractional shares; and (x) the taxable
years of SHIP II and Senior Strategic will end on the Effective Date and
pursuant to Section 381(a) of the Code and regulations thereunder, SHIP I will
succeed to and take into account certain tax attributes of SHIP II and Senior
Strategic, such as earnings and profits, capital loss carryovers and method of
accounting.
See "Comparison of the Funds--Tax Rules Applicable to SHIP I, SHIP II, Senior
Strategic and Their Stockholders" for the rules applicable to the Funds as
regulated investment companies generally.
Stockholders should consult their tax advisers regarding the effect of the
Merger in light of their individual circumstances. As the foregoing relates
only to Federal income tax consequences, stockholders also should consult their
tax advisers as to the foreign, state and local tax consequences of the Merger.
Status as a Regulated Investment Company. SHIP I, SHIP II and Senior
Strategic have elected and qualified to be taxed as regulated investment
companies under Section 851-855 of the Code, and after the Merger SHIP I
intends to continue to operate so as to qualify as a regulated investment
company.
CAPITALIZATION
The following table sets forth as of August 31, 1995 (i) the capitalization
of SHIP I, (ii) the capitalization of SHIP II, (iii) the capitalization of
Senior Strategic and (iv) the pro forma capitalization of SHIP I as adjusted to
give effect to the Merger.
<TABLE>
<CAPTION>
PRO FORMA CAPITALIZATION OF SHIP I
AS OF AUGUST 31, 1995
(IN MILLIONS EXCEPT FOR NET ASSET VALUE PER SHARE)
------------------------------------------------------------------
PRO FORMA
SHIP I SHIP II SENIOR STRATEGIC ADJUSTMENTS SHIP I AS ADJUSTED(A)
------ ------- ---------------- ----------- ---------------------
<S> <C> <C> <C> <C> <C>
Net Assets (attributable
to Common Stock):...... $230.0 $154.0 $71.8 ($8.6)(b) $447.1
Total Assets (Net Assets
attributable to Common
Stock plus proceeds of
borrowings used for
leverage).............. $300.5 $201.5 $96.6 ($0.1) $598.5
Shares Outstanding:
Common Stock.......... 25.4 16.6 7.8 -- 50.4(c)
Net Asset Value Per
Share................... $ 9.06 $ 9.27 $9.26 -- $ 8.86(d)
</TABLE>
- --------
(a) Assumes the Merger had been consummated on August 31, 1995. No assurance
can be given as to how many shares of SHIP I Common Stock stockholders of
SHIP II and Senior Strategic will receive on the date the Merger takes
place, and the foregoing should not be relied upon to reflect the number of
shares of SHIP I Common Stock that actually will be received on or after
such date.
(b) The adjusted balances are presented as if the Merger were effective August
31, 1995 and are for informational purposes only. Assumes distributions of
ordinary income and accrual of estimated Merger expenses of $315,000.
(c) Assumes the issuance of 25,048,675 SHIP I shares in exchange for the net
assets of each of SHIP II and Senior Strategic. The number of shares issued
was based on net asset value of each Fund, net of distributions on August
31, 1995.
(d) Net Asset Value Per Share after Merger-related expenses and distribution of
ordinary income.
46
<PAGE>
2. ELECTION OF DIRECTORS
At the Meetings, the same Board of Directors for SHIP I, SHIP II and Senior
Strategic will be elected to serve until the next Annual Meeting of
Stockholders and until their successors are elected and qualified. If the
stockholders of SHIP I, SHIP II and Senior Strategic approve the Merger, then
the Board of Directors elected at the Meetings will serve as the Board of SHIP
I until its next Annual Meeting of Stockholders. If the stockholders of SHIP I,
SHIP II or Senior Strategic vote against the Merger, then the Board of
Directors of each Fund elected at the Meetings will continue to serve until the
next Annual Meeting of Stockholders of each Fund. With respect to each Fund, it
is intended that all properly executed proxies will be voted (unless such
authority has been withheld in the proxy) in favor of the persons designated as
Directors to be elected by holders of Common Stock.
The Boards of Directors of SHIP I, SHIP II and Senior Strategic know of no
reason why any of these nominees will be unable to serve, but in the event of
any such unavailability, the proxies received will be voted for such substitute
nominee or nominees as the Boards of Directors may recommend.
Certain information concerning the nominees is set forth below.
<TABLE>
<CAPTION>
SHARES OF
COMMON STOCK
OF EACH FUND
PRINCIPAL OCCUPATION BENEFICIALLY
DURING PAST FIVE YEARS DIRECTOR OWNED AT
NAME AND ADDRESS AGE AND PUBLIC DIRECTORSHIPS(1) SINCE JANUARY 15, 1996
- ---------------- --- ---------------------------- ----------------------- ----------------
<S> <C> <C> <C> <C>
Ronald W. Forbes(1)(2).. 55 Professor of Finance, School 1993 (SHIP I) 0
1400 Washington Avenue of 1993 (SHIP II)
Albany, New York 12222 Business, State University 1994 (Senior Strategic)
of New
York at Albany since 1989
and
Associate Professor prior
thereto;
Member, Task Force on
Municipal
Securities Markets,
Twentieth
Century Fund.
Cynthia A. 43 Professor, Harvard Business 1994 (SHIP I) 0
Montgomery(1)(2)........ School since 1989; Associate 1994 SHIP II)
Harvard Business School Professor, J.L. Kellogg 1994 (Senior Strategic)
Soldiers Field Road Graduate
Boston, Massachusetts School of Management,
02163 Northwestern University from
1985 to 1989; Assistant
Professor, Graduate School
of Business Administration,
The University of Michigan
from 1979 to 1985; Director,
UNUM Corporation (insurance
holding company) since 1990
and Newell Company (maker of
housewares and other
consumer products) since
1995; Trustee, Mount Auburn
Foundation (Hospital) since
1995.
Charles C. Reilly(1)(2). 64 Self-employed financial 1993 (SHIP I) 14,276 (SHIP I)
9 Hampton Harbor Road consultant 1993 (SHIP II)
Hampton Bays, New York since 1990; President and 1994 (Senior Strategic)
11946 Chief
Investment Officer of Verus
Capital, Inc. from 1979 to
1990;
Senior Vice President of
Arnhold
and S. Bleichroeder, Inc.
from
1973 to 1990; Adjunct
Professor,
Columbia University Graduate
School of Business, 1990;
Adjunct
Professor, Wharton School,
The
University of Pennsylvania,
1990;
Partner, Small Cities Cable
Television since 1986.
</TABLE>
47
<PAGE>
<TABLE>
<CAPTION>
SHARES OF
COMMON STOCK
OF EACH FUND
PRINCIPAL OCCUPATION BENEFICIALLY
DURING PAST FIVE YEARS DIRECTOR OWNED AT
NAME AND ADDRESS AGE AND PUBLIC DIRECTORSHIPS(1) SINCE JANUARY 15, 1996
- ---------------- --- ---------------------------- ----------------------- ----------------
<S> <C> <C> <C> <C>
Kevin A. Ryan(1)(2)..... 63 Founder, current Director 1993 (SHIP I) 765 (SHIP I)
127 Commonwealth Avenue and 1993 (SHIP II)
Chestnut Hill, Professor of The Boston 1994 (Senior Strategic)
Massachusetts 02167 University
Center for the Advancement
of
Ethics and Character;
Professor of
Education at Boston
University
since 1982; formerly
taught on the faculties of
The
University of Chicago,
Stanford
University and The Ohio
State
University.
Richard R. West(1)(2)... 57 Dean Emeritus since 1995, 1993 (SHIP I) 18,000 (SHIP I)
Box 604 and Dean from 1984 to 1993, 1993 (SHIP II) 10,000 (SHIP II)
Genoa, Nevada 89411 New 1994 (Senior Strategic)
York University Leonard N.
Stern
School of Business
Administration;
Professor of Finance at the
Amos
Tuck School of Business
Administration from 1976 to
1984,
and Dean from 1976 to 1983;
Director of Vornado, Inc.
(real
estate investment trust),
Bowne &
Co., Inc. (financial
printer),
Smith-Corona Corporation
(manufacturer of typewriters
and
word processors), and
Alexander's
Inc. (real estate company).
Arthur Zeikel*(1)....... 63 President of FAM (which 1993 (SHIP I) 0
P.O. Box 9011 term as used herein includes 1993 (SHIP II)
Princeton, New Jersey its 1994 (Senior Strategic)
08543-9011 corporate predecessors)
since 1977;
President of MLAM
(which term as used herein
includes
its corporate predecessors)
since
1977; President and Director
of
Princeton Services, Inc.
("Princeton Services") since
1993;
Executive Vice President of
Merrill
Lynch & Co., Inc. ("ML &
Co.")
since 1990; Director of
Merrill
Lynch Funds Distributor,
Inc.
("MLFD").
</TABLE>
- --------
* Interested person, as defined in the Investment Company Act, of the Fund.
(1) Each of the nominees is a director, trustee or member of an advisory board
of certain other investment companies for which FAM or MLAM acts as
investment adviser. See "Compensation of Directors and Officers" below.
(2) Member of the Audit Committee of the Board of Directors.
48
<PAGE>
COMMITTEE AND BOARD MEETINGS
The Board of Directors of each Fund has a standing Audit Committee, which
consists of the Directors who are not "interested persons", as defined in the
Investment Company Act, of the Fund. The principal purpose of the Audit
Committee is to review the scope of the annual audit conducted by each Fund's
independent auditors and the evaluation by such auditors of the accounting
procedures followed by the Fund. The non-interested Directors have retained
independent legal counsel to assist them in connection with these duties. None
of the Board of Directors has a nominating committee. During the fiscal year
ended February 28, 1995, the Board of Directors of SHIP I held ten meetings and
the Audit Committee of SHIP I held four meetings. All of the Directors then in
office attended at least 75% of the total number of meetings of the Board of
Directors and the total number of meetings held by all committees of the Board
on which he/she served during such period. During the fiscal year ended August
31, 1995, the Board of Directors of SHIP II held seven meetings and the Audit
Committee of SHIP II held four meetings. All of the Directors then in office
attended at least 75% of the total number of meetings of the Board of Directors
and the total number of meetings held by all committees of the Board on which
he/she served during such period. During the fiscal year ended February 28,
1995, the Board of Directors of Senior Strategic held nine meetings and the
Audit Committee of Senior Strategic held two meetings. All of the Directors
then in office attended at least 75% of the total number of meetings of the
Board of Directors and the total number of meetings held by all committees of
the Board on which he/she served during such period.
COMPLIANCE WITH SECTION 16 (A) OF THE SECURITIES EXCHANGE ACT OF 1934
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Securities Exchange Act"), requires each Fund's officers, Directors and
persons who own more than ten percent of a registered class of the Fund's
equity securities, to file reports of ownership and changes in ownership on
Forms 3, 4 and 5 with the Commission and the NYSE. Officers, Directors and
greater than ten percent stockholders are required by Commission regulations to
furnish the Fund with copies of all Forms 3, 4 and 5 that they file.
Based solely on each Fund's review of the copies of such forms, and
amendments thereto, furnished to it during or with respect to its most recent
fiscal year, and written representations from certain reporting persons that
they were not required to file Form 5 with respect to the most recent fiscal
year, each Fund believes that all of its officers, Directors, greater than ten
percent beneficial owners and other persons subject to Section 16 of the
Securities Exchange Act because of the requirements of Section 30 of the
Investment Company Act (i.e., any advisory board member, investment adviser or
affiliated person of the Fund's investment adviser), have complied with all
filing requirements applicable to them with respect to transactions during the
Fund's most recent fiscal year.
INTERESTED PERSONS
Each Fund considers Mr. Zeikel to be an "interested person" of the Fund
within the meaning of Section 2(a)(19) of the Investment Company Act as a
result of the position he holds with FAM and its affiliates. Mr. Zeikel is the
President of each Fund, the President of FAM and the President of MLAM.
COMPENSATION OF DIRECTORS
FAM, the investment adviser for both Funds, pays all compensation of all
officers of each Fund and all Directors of each Fund who are affiliated with ML
& Co. or its subsidiaries. Each Fund pays each Director who is not affiliated
with FAM a fee of $2,000 per year plus $400 per meeting attended, together with
such Director's actual out-of-pocket expenses relating to attendance at
meetings. Each Fund also pays each member of its Audit Committee, which
consists of all of the non-affiliated Directors, a fee of $1,000 per year,
together with such Director's out-of-pocket expenses relating to attendance at
meetings. The Chairman of the Audit Committee receives an additional annual fee
of $1,000. These fees and expenses for the fiscal year
49
<PAGE>
ended February 28, 1995 aggregated $24,355 for SHIP I and $26,694 for Senior
Strategic. These fees and expenses for the fiscal year ended August 31, 1995
aggregated $24,544 for SHIP II.
OFFICERS OF THE FUNDS
The Boards of Directors of SHIP I, SHIP II and Senior Strategic have elected
the same eight officers of each Fund. The principal business address of each
officer is 800 Scudders Mill Road, Plainsboro, New Jersey 08536. The following
sets forth information concerning each of these officers:
<TABLE>
<CAPTION>
OFFICER
NAME AND PRINCIPAL OCCUPATION OFFICE AGE SINCE
----------------------------- ------------------------ --- -------------------
<S> <C> <C> <C>
Arthur Zeikel................... President 63 1993 (SHIP I)
President of FAM since 1977; 1993 (SHIP II)
President of MLAM since 1977; 1994 (Senior
President and Director of Strategic)
Princeton Services since
1993; Executive Vice
President of ML & Co. since
1990; Director of MLFD.
Terry K. Glenn.................. Executive Vice President 55 1993 (SHIP I)
Executive Vice President of 1993 (SHIP II)
FAM and of MLAM since 1983; 1994 (Senior
Executive Vice President and Strategic)
Director of Princeton
Services since 1993;
President of MLFD since 1986
and Director since 1991;
President of Princeton
Administrators, L.P. since
1988.
N. John Hewitt.................. Senior Vice President 61 1993 (SHIP I)
Senior Vice President of FAM 1993 (SHIP II)
and of MLAM since 1980 1994 (Senior
and Vice President thereof Strategic)
from 1979 to 1980.
R. Douglas Henderson............ Vice President 38 1993 (SHIP I)
Vice President of MLAM since 1993 (SHIP II)
1989; Vice President, 1994 (Senior
Leveraged Finance Department, Strategic)
Security Pacific
Merchant Bank from 1987 to
1989; Vice President,
Corporate Finance and Banking
Department, Security
Pacific Merchant Bank from
1983 to 1987.
John W. Fraser.................. Vice President 35 1994 (SHIP I)
Vice President of MLAM since 1994 (SHIP II)
1991; Vice President, 1994 (Senior
Corporate Bond Department, Strategic)
Continental Bank from 1988 to
1991; Analyst, Drexel Burnham
Lambert Commercial Paper,
Inc. from 1987 to 1988;
Second Vice President, Chase
Manhattan Bank from 1985 to
1987.
Donald C. Burke................. Vice President 35 1993 (SHIP I)
Vice President and Director 1993 (SHIP II)
of Taxation of MLAM 1994 (Senior
since 1990; Employee at Strategic)
Deloitte & Touche LLP from
1982 to 1990.
Gerald M. Richard............... Treasurer 46 1993 (SHIP I)
Senior Vice President and 1993 (SHIP II)
Treasurer of FAM and MLAM 1994 (Senior
since 1984; Senior Vice Strategic)
President and Treasurer of
Princeton Services since
1993; Treasurer of MLFD since
1984 and Vice President since
1981.
Patrick D. Sweeney.............. Secretary 41 1993 (SHIP I)
Vice President of MLAM since 1993 (SHIP II)
1990; Vice President and 1994 (Senior
Associate Counsel of Security Strategic)
Pacific Merchant Bank from
1988 to 1990; Lawyer in
private practice from 1981 to
1988.
</TABLE>
50
<PAGE>
3. SELECTION OF INDEPENDENT AUDITORS
The Boards of Directors of SHIP I, SHIP II and Senior Strategic, including a
majority of the Directors who are not "interested persons", as defined in the
Investment Company Act, of the Funds, have selected the firm of Deloitte &
Touche LLP as independent auditors, to examine the financial statements of each
Fund for the current fiscal year. The Funds know of no direct or indirect
financial interest of such firm in the Funds. Such appointment is subject to
ratification or rejection by the stockholders of the Funds. If the stockholders
of SHIP I, SHIP II and Senior Strategic approve the Merger, then the
independent auditors selected at the Meetings will serve as the independent
auditors of SHIP I until its next Annual Meeting of Stockholders. If the
stockholders of SHIP I, SHIP II or Senior Strategic vote against the Merger,
then the independent auditors of each Fund selected at the Meetings will
continue to serve until the next Annual Meeting of Stockholders of each Fund.
Unless a contrary specification is made, the accompanying proxy will be voted
in favor of ratification of the selection of such auditors.
Deloitte & Touche LLP also acts as independent auditors for ML & Co. and all
of its subsidiaries and for most other investment companies for which FAM or
MLAM acts as investment adviser. The fees received by Deloitte & Touche LLP
from these other entities are substantially greater, in the aggregate, than the
total fees received by it from the Funds. The Boards of Directors of SHIP I,
SHIP II and Senior Strategic considered the fact that Deloitte & Touche LLP has
been retained as the independent auditors of ML & Co. and the other entities
described above in its evaluation of the independence of Deloitte & Touche LLP
with respect to the Funds.
Representatives of Deloitte & Touche LLP are expected to be present at the
Meetings and will have the opportunity to make a statement if they so desire
and to respond to questions from stockholders.
INFORMATION CONCERNING THE SPECIAL MEETINGS
DATE, TIME AND PLACE OF MEETINGS
The Meetings will be held on or about March 14, 1996 at the offices of MLAM,
800 Scudders Mill Road, Plainsboro, New Jersey at 9:00 A.M., New York time (for
SHIP I), 9:30 A.M., New York time (for SHIP II) and 10:00 A.M., New York time
(for Senior Strategic).
SOLICITATION, REVOCATION AND USE OF PROXIES
A stockholder executing and returning a proxy has the power to revoke it at
any time prior to its exercise by executing a superseding proxy or by
submitting a notice of revocation to the Secretary of SHIP I, SHIP II or Senior
Strategic, as the case may be. Although mere attendance at the Meetings will
not revoke a proxy, a stockholder present at the Meetings may withdraw his
proxy and vote in person.
All shares represented by properly executed proxies, unless such proxies
previously have been revoked, will be voted at the Meetings in accordance with
the directions on the proxies; if no direction is indicated, the shares will be
voted "FOR" (i) the approval of the Agreement and Plan of Merger, (ii) the
election of Directors and (iii) the ratification of the selection of Deloitte &
Touche LLP as independent accountants.
It is not anticipated that any matters other than (i) the adoption of the
Agreement and Plan of Merger, (ii) the election of Directors and (iii) the
ratification of the selection of Deloitte & Touche LLP will be brought before
the Meetings. If, however, any other business properly is brought before the
Meetings, proxies will be voted in accordance with the judgment of the persons
designated on such proxies.
RECORD DATE AND OUTSTANDING SHARES
Only holders of record of shares of Common Stock of SHIP I, SHIP II and
Senior Strategic at the close of business on January 15, 1996 (the "Record
Date") are entitled to vote at the Meetings or any adjournment
51
<PAGE>
thereof. At the close of business on the Record Date, there were 25,639,592
shares of Common Stock of SHIP I, 16,652,213 shares of Common Stock of SHIP II
and 7,810,743 shares of Common Stock of Senior Strategic issued and outstanding
and entitled to vote.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT OF SHIP I, SHIP
II AND SENIOR STRATEGIC
To the knowledge of SHIP I, SHIP II and Senior Strategic, at the date hereof,
no person or entity owns beneficially 5% or more of the shares of the Common
Stock of SHIP I, SHIP II or Senior Strategic.
At January 15, 1996, the Directors and officers of SHIP I as a group (13
persons) owned an aggregate of less than 1% of the outstanding shares of Common
Stock of SHIP I.
At January 15, 1996, the Directors and officers of SHIP II as a group (13
persons) owned an aggregate of less than 1% of the outstanding shares of Common
Stock of SHIP II.
At January 15, 1996, the Directors and officers of Senior Strategic as a
group (13 persons) owned an aggregate of less than 1% of the outstanding shares
of Common Stock of Senior Strategic.
At January 15, 1996, the Directors and officers of each Fund owned an
aggregate of less than 1% of the outstanding shares of Common Stock of ML & Co.
VOTING RIGHTS AND REQUIRED VOTE
For purposes of this Proxy Statement and Prospectus, each share of Common
Stock of SHIP I, SHIP II and Senior Strategic is entitled to one vote. Approval
of the Agreement and Plan of Merger requires the affirmative vote of
stockholders representing more than 50% of the outstanding shares of each of
SHIP I, SHIP II and Senior Strategic.
Under Maryland law, stockholders of a corporation whose shares are traded
publicly on a national securities exchange, such as SHIP I, SHIP II and Senior
Strategic, are not entitled to demand the fair value of their shares upon a
merger; therefore, the common stockholders of SHIP I, SHIP II and Senior
Strategic will be bound by the terms of the Merger. However, any common
stockholder of SHIP I, SHIP II or Senior Strategic may sell his or her shares
of Common Stock at any time on the NYSE.
ADDITIONAL INFORMATION
The expenses of preparation, printing and mailing of the enclosed form of
proxy, the accompanying Notice and this Proxy Statement and Prospectus will be
borne by SHIP I, the surviving fund after the Merger, so as to be borne equally
and exclusively by the holders of Common Stock of SHIP I, SHIP II and Senior
Strategic.
SHIP I likewise will reimburse banks, brokers and others for their reasonable
expenses in forwarding proxy solicitation materials to the beneficial owners of
shares of SHIP I, SHIP II and Senior Strategic and certain persons that SHIP I,
SHIP II or Senior Strategic may employ for their reasonable expenses in
assisting in the solicitation of proxies from such beneficial owners of shares
of capital stock of SHIP I, SHIP II or Senior Strategic.
In order to obtain the necessary quorum at the Meetings (i.e., a majority of
the shares of each Fund's securities entitled to vote at the Meetings, present
in person or by proxy), supplementary solicitation may be made by mail,
telephone, telegraph or personal interview by officers of the Fund. The Funds
also may hire proxy solicitors at the expense of SHIP I. It is anticipated that
the cost of such supplementary solicitation, if any, will be nominal. The Funds
have retained, at their expense, Tritech Services, an affiliate of ML & Co.,
52
<PAGE>
with offices at 4 Corporate Place, Piscataway, New Jersey, to aid in the
solicitation of proxies from holders of shares held in nominee or "street" name
at a cost of approximately $2,000 plus out-of-pocket expenses.
Broker-dealer firms, including Merrill Lynch, holding Fund shares in "street
name" for the benefit of their customers and clients will request the
instructions of such customers and clients on how to vote their shares on each
proposal before the Meetings. The Funds understand that, under the rules of the
NYSE, such broker-dealer firms may, without instructions from their customers
and clients, grant authority to the proxies designated to vote on the election
of a Board of Directors of each Fund to serve for the ensuing year (proposal 2)
and the ratification of the selection of Deloitte & Touche LLP as independent
auditors for each Fund for the current fiscal year (proposal 3) if no
instructions have been received prior to the date specified in the broker-
dealer firm's request for voting instructions. Broker-dealer firms, including
Merrill Lynch, will not be permitted to grant voting authority without
instructions with respect to the approval of the Agreement and Plan of Merger
(proposal 1). The Funds will include shares held of record by broker-dealers as
to which such authority has been granted in its tabulation of the total number
of shares present for purposes of determining whether the necessary quorum of
shareholders of each Fund exists. Proxies which are returned but which are
marked "abstain" or on which a broker-dealer has declined to vote on any
proposal ("broker non-votes") will be counted as present for the purposes of
determining a quorum. Merrill Lynch has advised the Funds that it intends to
exercise discretion over shares held in its name for which no instructions have
been received by voting such shares on proposals 2 and 3 in the same proportion
as it has voted such shares for which it has received instructions. However,
abstentions and broker non-votes will not be counted as votes cast. Abstentions
and broker non-votes will not have an effect on the vote on proposals 2 and 3;
however, abstentions and broker non-votes will have the same effect as a vote
against proposal 1.
This Proxy Statement and Prospectus does not contain all of the information
set forth in the registration statements and the exhibits relating thereto
which SHIP I, SHIP II and Senior Strategic, respectively, have filed with the
Commission, under the Securities Act and the Investment Company Act, to which
reference is hereby made.
SHIP I, SHIP II and Senior Strategic are subject to the informational
requirements of the Securities Exchange Act, and in accordance therewith they
file reports and other information with the Commission. Reports, proxy
statements, registration statements and other information filed by SHIP I, SHIP
II and Senior Strategic can be inspected and copied at the public reference
facilities of the Commission in Washington, D.C. and at the New York Regional
Office of the Commission at Seven World Trade Center, New York, New York 10048.
Copies of such materials also can be obtained by mail from the Public Reference
Branch, Office of Consumer Affairs and Information Services, Securities and
Exchange Commission, Washington, D.C. 20549, at prescribed rates.
CUSTODIAN
The Bank of New York acts as the custodian for cash and securities of SHIP I,
SHIP II and Senior Strategic. The principal business address of The Bank of New
York in such capacity is 90 Washington Street, 12th Floor, New York, New York
10286.
TRANSFER AGENT, DIVIDEND DISBURSING AGENT AND REGISTRAR
The Bank of New York serves as the transfer agent, dividend disbursing agent
and registrar with respect to the Common Stock of SHIP I, SHIP II and Senior
Strategic, at the same rate for each Fund, pursuant to separate registrar,
transfer agency and service agreements with each of the Funds. The principal
business addresses of The Bank of New York in such capacity is 101 Barclay
Street, New York, New York 10286.
53
<PAGE>
LEGAL PROCEEDINGS
There are no material legal proceedings to which SHIP I, SHIP II or Senior
Strategic is a party.
LEGAL OPINIONS
Certain legal matters in connection with the Merger will be passed upon for
SHIP I, SHIP II, Senior Strategic and Merrill Lynch by Brown & Wood, New York,
New York. Brown & Wood will rely as to matters of Maryland law on the opinion
of Venable, Baetjer and Howard, LLP, Baltimore, Maryland.
EXPERTS
The financial statements as of February 28, 1995 for SHIP I and Senior
Strategic, the financial statements as of August 31, 1995 for SHIP II and the
balance sheet as of December 30, 1994 for FAM, included in this Proxy Statement
and Prospectus have been so included in reliance on the reports of Deloitte &
Touche LLP, independent auditors, given on their authority as experts in
auditing and accounting. The principal business address of Deloitte & Touche
LLP is 117 Campus Drive, Princeton, New Jersey 08540.
STOCKHOLDER PROPOSALS
If a stockholder of any Fund intends to present a proposal at the 1997
Special Meeting of Stockholders of such Fund, which is anticipated to be held
on March 14, 1997, and desires to have the proposal included in the Fund's
proxy statement and form of proxy for that meeting, the stockholder must
deliver the proposal to the offices of the Fund by October 9, 1996.
By Order of the Boards of Directors
Patrick D. Sweeney
Secretary
54
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Unaudited Financial Statements for SHIP I for the Six-Month Period Ended
August 31, 1995........................................................... F-1
Audited Financial Statements for SHIP I for the Fiscal Year Ended February
28, 1995.................................................................. F-16
Audited Financial Statements for SHIP II for the Fiscal Year Ended August
31, 1995.................................................................. F-33
Unaudited Financial Statements for Senior Strategic for the Six-Month
Period
Ended August 31, 1995..................................................... F-49
Audited Financial Statements for Senior Strategic for the Fiscal Year
Ended
February 28, 1995......................................................... F-63
Unaudited Financial Statements for the Combined Fund on a Pro Forma Basis
as of August 31, 1995..................................................... F-75
Audited Financial Statements for FAM for the Fiscal Year Ended December
30, 1994.................................................................. F-85
</TABLE>
55
<PAGE>
UNAUDITED FINANCIAL STATEMENTS FOR SENIOR HIGH INCOME PORTFOLIO, INC. FOR THE
SIX-MONTH PERIOD ENDED AUGUST 31, 1995
F-1
<PAGE>
SCHEDULE OF INVESTMENTS
<TABLE>
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1b)
<C> <C> <C> <C> <S> <C> <C>
Advertising--2.2% B+ B1 $ 5,000,000 Lamar Advertising Co., Senior Secured
Notes, 11% due 5/15/2003 $ 5,056,250 $ 5,050,000
Aerospace--6.2% Aviall, Inc., Term Loan, Tranche B, due
11/30/2000:*
NR++ NR++ 176,471 9.13% to 9/07/1995 176,471 176,471
NR++ NR++ 1,266,653 9.75% to 9/07/1995 1,266,653 1,266,653
NR++ NR++ 3,529,412 9.25% to 10/10/1995 3,529,412 3,529,412
NR++ NR++ 4,500,000 Gulfstream Delaware Corp., Term Loan,
due 3/31/1998, 9% to 9/08/1995* 4,500,000 4,500,000
B B2 2,000,000 Talley Manufacturing & Technology, Inc.,
Senior Discount Debentures, 10.75% due
10/15/2003 2,030,000 2,020,000
BB- B1 3,000,000 UNC, Inc., Senior Notes, 9.125% due
7/15/2003 3,000,000 2,868,750
------------ ------------
14,502,536 14,361,286
Agricultural B B3 2,000,000 Fresh Del Monte Produce N.V., Series A,
Products--0.7% Senior Notes, 10% due 5/01/2003 2,025,000 1,600,000
Airlines--1.9% NR++ NR++ 4,463,919 Northwest Airlines, Term Loan, due
6/15/1997, 9.125% to 10/20/1995* 4,463,919 4,463,919
Automotive Harvard Industries, Inc., Senior Notes:
Products--2.0% B B2 1,500,000 12% due 7/15/2004 1,500,000 1,578,750
B+ B3 1,000,000 11.125% due 8/01/2005*** 1,000,000 1,012,500
NR++ Ba3 2,000,000 Walbro Corp., Senior Notes, 9.875%
due 7/15/2005*** 1,996,520 1,990,000
------------ ------------
4,496,520 4,581,250
Broadcast/ American Media, Term Loan B, due
Media--9.6% 9/30/2002:*
NR++ Ba2 25,000 10.25% to 9/30/1995 25,000 25,000
NR++ Ba2 4,950,000 8.44% to 11/22/1995 4,950,000 4,950,000
NR++ B2 1,500,000 Benedek Broadcasting, 11.875% due
3/01/2005*** 1,500,000 1,567,500
Continental Cablevision, Inc., Senior
Notes:
BB+ Ba2 2,500,000 8.625% due 8/15/2003 2,500,000 2,500,000
BB- B1 2,500,000 9.125% due 11/01/2004*** 2,500,000 2,500,000
NR++ B3 2,000,000 Granite Broadcasting Corp., 10.375%
due 5/15/2005*** 2,000,000 2,027,500
NR++ NR++ 2,500,000 Marcus Cable Co., Term Loan B, due
4/30/2004, 10.25% to 9/30/1995* 2,500,000 2,500,000
U.S. Radio Inc., Term Loan A, due
12/31/2001:*
NR++ NR++ 865,477 9.4375% to 9/29/1995 865,477 865,477
NR++ NR++ 822,203 8.875% to 10/30/1995 822,203 822,203
U.S. Radio Inc., Term Loan B, due
9/23/2003:*
NR++ NR++ 1,130,109 10.4375% to 9/29/1995 1,130,109 1,130,109
NR++ NR++ 1,138,937 9.875% to 10/30/1995 1,138,937 1,138,937
B B2 2,000,000 Young Broadcasting Corp., 10.125%
due 2/15/2005*** 2,000,000 2,080,000
------------ ------------
21,931,726 22,106,726
Building & B+ Ba3 2,250,000 US Homes Corp., Senior Notes, 9.75%
Construction due 6/15/2003 2,250,000 2,216,250
- --0.9%
</TABLE>
F-2
<PAGE>
<TABLE>
<C> <C> <C> <C> <S> <C> <C>
Building BB- Ba3 1,000,000 Schuller International Group, 10.875%
Products--0.5% due 12/15/2004 1,000,000 1,097,500
Carbon & NR++ NR++ 2,436,892 UCAR International Inc., Term Loan B,
Graphite due 1/31/2003, 8.875% to 9/08/1995* 2,436,892 2,436,892
Products--2.2% NR++ NR++ 1,275,601 UCAR International Inc., Term Loan C,
due 7/31/2003, 9.375% to 9/08/1995* 1,275,601 1,275,601
NR++ NR++ 1,275,601 UCAR International Inc., Term Loan D,
due 2/02/2004, 10.0625% to 11/08/1995* 1,275,601 1,275,601
------------ ------------
4,988,094 4,988,094
Casinos-- 5.0% B+ B2 4,500,000 GB Property Funding Corp., First
Mortgage Notes, 10.875% due 1/15/2004 4,500,000 3,915,000
Harrah's Jazz Co., Term Loan B, due
9/30/1999:*
NR++ NR++ 2,500,000 9.125% to 10/23/1995 2,500,000 2,500,000
NR++ NR++ 5,000,000 9.1875% to 12/21/1995 5,000,000 5,000,000
------------ ------------
12,000,000 11,415,000
Chemicals--2.8% BB+ Ba2 1,000,000 Borden Chemicals and Plastic, L.P.,
9.50% due 5/01/2005 1,000,000 1,005,000
BB- B1 1,000,000 Huntsman Chemical Corp., Senior
Notes, 11% due 4/15/2004 1,015,000 1,082,500
NR++ NR++ 4,311,326 Inspec Chemical Corp., Term Loan B,
due 12/02/2000, 8.50% to 9/29/1995* 4,311,326 4,311,326
------------ ------------
6,326,326 6,398,826
Computers--1.0% BB- Ba3 2,100,000 Dell Computer Corp., Senior Notes,
11% due 8/15/2000 2,118,375 2,304,750
Consumer NR++ NR++ 5,000,000 CHF/Ebel USA Inc., Term Loan B,
Products--3.3% due 9/30/2001, 9.1328% to 10/30/1995* 5,000,000 5,000,000
B+ Ba3 2,000,000 Coty Inc., 10.25% due 5/01/2005 2,000,000 2,060,000
B+ B2 1,000,000 Drypers Corp., Series B, Senior Notes,
12.50% due 11/01/2002 1,050,000 450,000
------------ ------------
8,050,000 7,510,000
Containers--1.7% B+ Ba3 4,000,000 Sweetheart Cup Co., Senior Secured
Notes, 9.625% due 9/01/2000 4,000,000 3,940,000
Diversified--4.7% B+ B1 3,000,000 Essex Group Inc., 10% due 5/01/2003 3,041,250 2,940,000
NR++ NR++ 2,119,370 Figgie International, Fixed Rate Loan,
due 1/01/1996, 10.75% to 9/30/1995* 2,119,370 2,119,370
B+ B2 1,000,000 J.B. Poindexter & Co., 12.50% due
5/15/2004 973,963 940,000
NR++ NR++ 4,813,625 Thermadyne Co., Term Loan B, due
2/01/2001, 8.875% to 9/07/1995* 4,813,625 4,813,625
------------ ------------
10,948,208 10,812,995
Drug NR++ NR++ 4,047,107 Duane Reade Co., Term Loan A, due
Stores--4.6% 9/30/1997, 8.875% to 11/30/1995* 4,047,107 4,047,107
NR++ NR++ 1,500,000 Duane Reade Co., Term Loan B, due
9/30/1999, 9.375% to 11/30/1995* 1,500,000 1,500,000
BA3 Ba3 4,962,312 Thrifty Payless Inc., Term Loan B,
due 9/30/2001, 9.0625% to 9/22/1995* 4,962,312 4,962,312
------------ ------------
10,509,419 10,509,419
Educational B B3 5,000,000 La Petite Holdings Corp., Senior
Services--2.0% Secured Notes, 9.625% due 8/01/2001 5,000,000 4,550,000
</TABLE>
F-3
<PAGE>
SCHEDULE OF INVESTMENTS (continued)
<TABLE>
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1b)
<C> <C> <C> <C> <S> <C> <C>
Electrical Berg Electronics Inc., Term Loan B,
Instruments due 3/31/2001:*
- --0.9% NR++ NR++ $ 8,333 8.94% to 9/29/1995 $ 8,333 $ 8,333
NR++ NR++ 1,966,667 8.94% to 11/27/1995 1,966,667 1,966,667
------------ ------------
1,975,000 1,975,000
Energy--1.1% BB- B1 2,500,000 Ferrellgas Partners, L.P., Series B,
Floating Rate Senior Notes, 9% due
8/01/200 12,489,039 2,493,750
Fertilizer--2.1% BB- B1 3,750,000 Sherritt Gordon Ltd., Senior Notes,
9.75% due 4/01/2003 3,762,500 3,787,500
BB- B1 1,000,000 Sherritt, Inc., USD Debentures, 10.50%
due 3/31/2014 1,000,000 1,015,000
------------ ------------
4,762,500 4,802,500
Food & NR++ NR++ 4,000,000 G. Heileman Brewing Co., Term Loan B,
Beverage--5.9% due 12/31/2000, 9.6875% to 10/13/1995* 4,000,000 4,000,000
B+ B1 5,000,000 Royal Crown Corp., Senior Secured Notes,
9.75% due 8/01/2000 5,000,000 4,650,000
Specialty Foods Corp., Term Loan B,
due 4/30/2001:*
NR++ NR++ 1,666,667 8.1875% to 9/21/1995 1,666,667 1,666,667
NR++ NR++ 1,666,667 8.125% to 10/20/1995 1,666,667 1,666,667
NR++ NR++ 1,666,667 8.0625% to 1/22/1996 1,666,667 1,666,667
------------ ------------
14,000,001 13,650,001
Forest BB- Ba3 1,000,000 Mallette Inc., Senior Secured Notes,
Products--2.3% 12.25% due 7/15/2004 1,000,000 1,110,000
BB- Ba3 2,000,000 Rainy River Forest Products, 10.75%
due 10/15/2001 1,995,574 2,140,000
BB B1 2,000,000 Tembec Finance Corp., 9.875% due
9/30/2005 2,000,000 2,000,000
------------ ------------
4,995,574 5,250,000
Grocery--6.0% B- B3 4,000,000 Bruno's Supermarkets, 10.50% due
8/01/2005 4,000,000 3,890,000
B+ NR++ 1,979,000 Homeland Stores, Inc., Series D,
Floating Rate Senior Secured Notes,
9.062% due 2/28/1997 (1) 1,979,000 1,959,210
NR++ Ba3 4,151,701 Pathmark Stores, Inc., Term Loan B,
due 10/31/1999, 8.9375% to 11/30/1995* 4,151,701 4,151,701
BB- Ba3 1,000,000 The Penn Traffic Company, Senior Notes,
8.625% due 12/15/2003 1,000,000 855,000
B- B2 2,000,000 Pueblo Xtra International, Inc.,
Senior Notes, 9.50% due 8/01/2003 2,000,000 1,860,000
B+ B3 1,000,000 Stater Brothers Holdings, Inc., Senior
Notes, 11% due 3/01/2001 1,000,000 985,000
------------ ------------
14,130,701 13,700,911
Health B B2 2,500,000 Charter Medical Corp., Senior Sub-
Services--3.7% ordinated Notes, 11.25% due 4/15/2004 2,500,000 2,681,250
B B2 1,000,000 Integrated Health Services, Inc., Senior
Subordinated Notes, 10.75% due 7/15/2004 1,000,000 1,065,000
B B1 5,200,000 MEDIQ/PRN Life Support Services, Inc.,
Senior Secured Notes, 11.125% due
7/01/1999 5,409,000 4,836,000
------------ ------------
8,909,000 8,582,250
Hotels--0.8% NR++ NR++ 2,000,000 Four Seasons Hotels Inc., Notes, 9.125%
due 7/01/2000*** 1,934,018 1,940,000
</TABLE>
F-4
<PAGE>
<TABLE>
<C> <C> <C> <C> <S> <C> <C>
Leasing & Rental B- B2 2,000,000 Cort Furniture Rental Corp., Senior
Services--3.9% Notes, 12% due 9/01/2000 1,999,397 1,950,000
Prime Acquisition, Term Loan, due
12/31/2000:*
NR++ NR++ 1,600,000 9.0625% to 9/05/1995 1,600,000 1,600,000
NR++ NR++ 1,780,000 9.0313% to 10/03/1995 1,780,000 1,780,000
NR++ NR++ 1,600,000 8.875% to 11/06/1995 1,600,000 1,600,000
BB- B1 2,000,000 The Scotsman Group, Inc., Senior
Secured Notes, 9.50% due 12/15/2000 2,000,000 1,965,000
------------ ------------
8,979,397 8,895,000
Leisure & B- B3 1,500,000 Alliance Entertainment Corp.,
Entertain- 11.25% due 7/15/2005*** 1,500,000 1,492,500
ment--0.6%
Manufacturing B- B3 1,000,000 Crain Industries Inc., 13.50% due
- --2.0% 8/15/2005*** 1,000,000 1,005,000
B+ B1 3,623,000 Foamex L.P., Senior Secured Notes,
9.50% due 6/01/2000 3,643,000 3,532,425
------------ ------------
4,643,000 4,537,425
Marking B+ B2 1,000,000 Monarch Acquisition Corp., 12.50% due
Devices--0.4% 7/01/2003*** 1,000,000 1,015,000
Metals--8.3% B B1 1,000,000 Algoma Steel, Inc.,12.375% due 7/15/2005 902,167 920,000
B B2 3,000,000 Bayou Steel Corp., First Mortgage Notes,
10.25% due 3/01/2001 3,000,000 2,835,000
B B1 1,000,000 Gulf States Steel Corp., 13.50% due
4/15/2003*** 989,286 970,000
NR++ NR++ 2,000,000 Renco Metals, Inc., 12% due 7/15/2000 1,971,999 2,100,000
B+ B2 2,000,000 Republic Engineered Steel, Inc., First
Mortgage Notes, 9.875% due 12/15/2001 2,000,000 1,860,000
B- B3 5,000,000 Russell Metals, 10.25% due 6/15/2000 5,011,250 4,637,500
B+ B1 3,000,000 WCI Steel Inc., Senior Notes, 10.50%
due 3/01/2002 3,000,000 2,940,000
B B2 3,000,000 Weirton Steel Corp., Senior Notes,
10.75% due 6/01/2005*** 2,955,558 2,760,000
------------ ------------
19,830,260 19,022,500
Musical NR++ B3 1,000,000 Selmer Co. Inc., 11% due 5/15/2005*** 1,000,000 960,000
Instruments
- --0.4%
Paper--16.3% Fort Howard Corp., Term Loan B, due
12/31/2002:*
NR++ Ba3 5,000,000 9% to 9/19/1995 5,000,000 5,000,000
NR++ Ba3 5,000,000 8.88% to 12/19/1995 5,000,000 5,000,000
B B3 1,000,000 Gaylord Container Corp., Senior Notes,
11.50% due 5/15/2001 1,000,000 1,052,500
Jefferson Smurfit/Container Corp. of
America, Term Loan B, due 4/30/2002:*
NR++ B1 375,000 9.4375% to 9/25/1995 375,000 375,000
NR++ B1 1,633,333 8.9375% to 10/20/1995 1,633,333 1,633,333
6,833,333 9.375% to 10/24/1995 6,833,333 6,833,333
Repap New Brunswick Inc.:
BB- Ba3 2,000,000 9.50% due 7/15/2000 2,027,500 1,995,000
BB- Ba3 1,000,000 9.875% due 7/15/2000 1,000,000 1,000,000
NR++ Ba2 7,500,000 S.D. Warren Co., Term Loan B, due
12/19/2002, 8.94% to 9/25/1995* 7,500,000 7,500,000
Stone Container Corp., Canadian Tender
Loan, due 4/01/2000:*
NR++ Ba3 3,450,000 9% to 9/18/1995 3,450,000 3,450,000
NR++ Ba3 3,712,500 9% to 10/16/1995 3,712,500 3,712,500
------------ ------------
37,531,666 37,551,666
</TABLE>
F-5
<PAGE>
SCHEDULE OF INVESTMENTS (concluded)
<TABLE>
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1b)
<C> <C> <C> <C> <S> <C> <C>
Printing & NR++ NR++ $2,496,728 Ziff Davis Acquisition Corp., Term
Publishing--2.1% Loan B, due 12/31/2001, 9.4375% to
9/28/1995* $ 2,496,728 $ 2,496,728
NR++ NR++ 2,351,725 Ziff Davis Acquisition Corp., Term
Loan C, due 12/31/2002, 9.9375% to
9/28/1995* 2,351,725 2,351,725
------------ ------------
4,848,453 4,848,453
Restaurant--1.7% BB- B1 4,000,000 Host Marriott Corp., 9.50% due
5/15/2005*** 3,895,573 3,830,000
Retail-- CCC+ B2 2,500,000 Color Tile Inc., Senior Notes, 10.75%
Specialty--9.9% due 12/15/2001 2,500,000 1,000,000
Federated Department Stores, Inc.,
Term Loan, due 3/31/2000:*
NR++ Ba1 3,125,000 7.4375% to 9/25/1995 3,125,000 3,125,000
NR++ Ba1 1,875,000 7% to 9/29/1995 1,875,000 1,875,000
Music Acquisition Corp., Term Loan B,
due 2/28/2001:*
NR++ NR++ 1,812,500 8.875% to 9/18/1995 1,812,500 1,812,500
NR++ NR++ 3,062,500 8.9375% to 9/21/1995 3,062,500 3,062,500
NR++ NR++ 9,912,700 Saks & Co., Term Loan, Tranche B, due
6/30/2000, 9.25% to 11/09/1995* 9,912,700 9,912,700
B+ B1 2,000,000 Specialty Retailers, Inc., Series A,
Senior Notes, 10% due 8/15/2000 2,000,000 1,930,000
------------ ------------
24,287,700 22,717,700
Security NR++ NR++ 4,194,740 Alert Centre Inc., Term Loan, due
Systems--1.8% 8/01/2001, 8.875% to 9/05/1995* 4,194,740 4,194,740
Shipping--1.0% BB- Ba2 1,000,000 Eletson Holdings, Inc., 9.25% due
11/15/2003 915,978 960,000
B- B3 1,500,000 OMI Corp., Senior Notes, 10.25% due
11/01/2003 1,500,000 1,275,000
------------ ------------
2,415,978 2,235,000
Utilities--2.5% B+ B1 2,000,000 Beaver Valley Funding, 8.625% due
6/01/2007 1,698,283 1,751,080
BB Ba2 2,000,000 Cleveland Electric Illuminating,
Inc., 9.50% due 5/15/2005 1,996,229 2,002,800
B Ba3 2,000,000 Public Service Company of New Mexico,
10.30% due 1/15/2014 2,020,000 2,059,500
------------ ------------
5,714,512 5,813,380
Warehousing & D Caa 2,000,000 Americold Corp., First Mortgage Bonds,
Storage--2.8% Series B, 11.50% due 3/01/2005 2,045,000 1,940,000
NR++ NR++ 4,581,250 Pierce Leahy Corp., Term Loan, Tranche
A, due 6/30/2001, 9.125% to 9/29/1995* 4,581,250 4,581,250
------------ ------------
6,626,250 6,521,250
Total Corporate Debt
Obligations--127.8% 299,329,735 293,935,041
Shares
Held Warrants
Leasing & Rental NR++ NR++ 66,000 Cort Furniture Rental Corp. (a) 760 82,500
Services--0.0%
Metals--0.0% NR++ NR++ 1,000 Gulf States Steel Corp. (a) 11,000 1,500
</TABLE>
F-6
<PAGE>
<TABLE>
<C> <C> <S> <C> <C>
Total Warrants--0.0% 11,760 84,000
<CAPTION>
Face
Amount Short-Term Securities
<C> <C> <S> <C> <C>
Commercial $ 178,000 General Electric Capital Corp.,
Paper**--0.1% 5.82% due 9/01/1995 178,000 178,000
Total Short-Term Securities--0.1% 178,000 178,000
Total Investments--127.9% $299,519,495 294,197,041
============
Liabilities in Excess of Other
Assets--(27.9%) (64,183,003)
------------
Net Assets--100.0% $230,014,038
============
<FN>
(1)Interest rate resets quarterly and is based on the three month
LIBOR (London Interbank Offered Rate), plus an interest rate spread
of three hundred basis points.
(a)Warrants entitle the fund to purchase a predetermined number of
shares of common stock/face amount of bonds. The purchase price and
number of shares/face amount are subject to adjustments under
certain conditions until the expiration date.
++Not Rated.
*Floating or Variable Rate Corporate Loans--The interest rates on
floating or variable rate corporate loans are subject to change
periodically based on the change in the prime rate of a US Bank,
LIBOR (London Interbank Offered Rate), or, in some cases, another
base lending rate. The interest rates shown are those in effect at
August 31, 1994.
**Commercial Paper is traded on a discount basis; the interest rate
shown is the discount rate paid at the time of purchase by the fund.
***Restricted securities as to resale. The value of the fund's
investment in restricted securities was $25,150,000, representing
10.93% of net assets.
<CAPTION>
Acquisition Value
Issue Dates Cost (Note 1b)
<S> <C> <C> <C>
Alliance Entertainment Corp.,
11.25% due 7/15/2005 7/25/1995 $ 1,500,000 $ 1,492,500
Benedek Broadcasting,
11.875% due 3/01/2005 3/03/1995 1,500,000 1,567,500
Continental Cablevision, Inc.,
Senior Notes, 9.125% due
11/01/2004 7/20/1995 2,500,000 2,500,000
Crain Industries Inc.,
13.50% due 8/15/2005 8/29/1995 1,000,000 1,005,000
Four Seasons Hotels Inc., Notes,
9.125% due 7/01/2000 1/25/1994 1,934,018 1,940,000
Granite Broadcasting Corp.,
10.375% due 5/15/2005 5/12/1995 2,000,000 2,027,500
Gulf States Steel Corp.,
13.50% due 4/15/2003 8/08/1995 989,286 970,000
Harvard Industries, Inc., Senior
Notes, 11.125% due 8/01/2005 7/28/1995 1,000,000 1,012,500
Host Marriott Corp., 5/18/1995 to
9.50% due 5/15/2005 7/31/1995 3,895,573 3,830,000
Monarch Acquisition Corp.,
12.50% due 7/01/2003 6/23/1995 1,000,000 1,015,000
Selmer Co. Inc., 11% due
5/15/2005 5/25/1995 1,000,000 960,000
Weirton Steel Corp., Senior Notes,
10.75% due 6/01/2005 6/05/1995 2,955,558 2,760,000
Walbro Corp., Senior Notes, 7/27/1995 to
9.875% due 7/15/2005 8/08/1995 1,996,520 1,990,000
Young Broadcasting Corp.,
10.125% due 2/15/2005 6/07/1995 2,000,000 2,080,000
Total $25,270,955 $25,150,000
=========== ===========
See Notes to Financial Statements.
</TABLE>
F-7
<PAGE>
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<TABLE>
<CAPTION>
As of August 31, 1995
<C> <S> <C> <C>
Assets: Investments, at value (identified cost--$299,519,495) (Note 1b) $294,197,041
Cash 308,236
Receivables:
Interest $ 4,889,035
Securities sold 1,039,632 5,928,667
------------
Deferred facility expenses (Note 6) 43,829
Deferred organization expenses (Note 1f) 69,749
Prepaid expenses and other assets 1,142
------------
Total assets 300,548,664
------------
Liabilities: Payables:
Loans (Note 6) 67,000,000
Dividends to shareholders (Note 1g) 666,472
Interest on loans (Note 6) 318,544
Investment adviser (Note 2) 121,906
Commitment fees 18,910 68,125,832
------------
Deferred income (Note 1e) 2,293,186
Accrued expenses and other liabilities 115,608
Total liabilities 70,534,626
------------
Net Assets: Net assets $230,014,038
============
Capital: Common Stock, par value $.10 per share; 200,000,000 shares
authorized (25,388,292 shares issued and outstanding) $ 2,538,829
Paid-in capital in excess of par 238,288,358
Undistributed investment income--net 4,711,731
Accumulated realized capital losses on investments--net (Note 7) (10,202,426)
Unrealized depreciation on investments--net (5,322,454)
------------
Total capital--Equivalent to $9.06 net asset value per share of
Common Stock (market price--$9.00) $230,014,038
============
See Notes to Financial Statements.
</TABLE>
F-8
<PAGE>
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
For the Six Months Ended August 31, 1995
<C> <S> <C>
Investment Income Interest and discount earned $ 15,412,894
(Note 1e): Facility and other fees 443,347
------------
Total income 15,856,241
------------
Expenses: Loan interest expense fees (Note 6) 2,449,893
Investment advisory fees (Note 2) 753,069
Professional fees 53,399
Accounting services (Note 2) 50,796
Borrowing costs (Note 6) 48,452
Facility fee amortization (Note 6) 43,101
Transfer agent fees (Note 2) 35,688
Printing and shareholder reports 33,690
Amortization of organization expenses (Note 1f) 18,997
Custodian fees 16,716
Directors' fees and expenses 13,241
Pricing services 3,660
Listing fees 136
Other 18,562
------------
Total expenses 3,539,400
------------
Investment income--net 12,316,841
------------
Realized & Realized loss on investments--net (1,408,602)
Unrealized Gain Change in unrealized depreciation on investments--net 3,627,410
(Loss) on ------------
Investments Net Increase in Net Assets Resulting from Operations $ 14,535,649
- --Net (Notes ============
1c, 1e & 3):
See Notes to Financial Statements.
</TABLE>
F-9
<PAGE>
STATEMENTS OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
For the Six For the
Months Ended Year Ended
August 31, February 28,
Increase (Decrease) in Net Assets: 1995 1995
<C> <S> <C> <C>
Operations: Investment income--net $ 12,316,841 $ 22,904,509
Realized loss on investments--net (1,408,602) (8,793,344)
Change in unrealized appreciation(depreciation) on
investments--net 3,627,410 (13,013,937)
------------ ------------
Net increase in net assets resulting from operations 14,535,649 1,097,228
------------ ------------
Dividends & Investment income--net (11,528,645) (21,343,397)
Distributions to Realized gain on investments--net -- (1,784,188)
Shareholders ------------ ------------
(Note 1g):
Net decrease in net assets resulting from dividends and
distributions to shareholders (11,528,645) (23,127,585)
------------ ------------
Capital Share Offering costs resulting from the issuance of Common Stock -- (85,747)
Transactions Value of shares issued to Common Stock shareholders in
(Note 4): reinvestment of dividends and distributions -- 781,304
------------ ------------
Net increase in net assets resulting from capital share
transactions -- 695,557
------------ ------------
Net Assets: Total increase (decrease) in net assets 3,007,004 (21,334,800)
Beginning of period 227,007,034 248,341,834
------------ ------------
End of period* $230,014,038 $227,007,034
============ ============
<FN>
*Undistributed investment income--net $ 4,711,731 $ 3,923,535
============ ============
See Notes to Financial Statements.
</TABLE>
F-10
<PAGE>
<TABLE>
<CAPTION>
STATEMENT OF CASH FLOWS
For the Six Months Ended August 31, 1995
<C> <S> <C>
Cash Provided by Net increase in net assets resulting from operations $ 14,535,649
Operating Adjustments to reconcile net increase in net assets resulting
Activities: from operations to net cash
provided by operating activities:
Decrease in receivables 447,796
Increase in other assets (1,042)
Decrease in other liabilities (138,530)
Realized and unrealized loss on investments--net (2,218,808)
Amortization of premium and discount (638,588)
------------
Net cash provided by operating activities 11,986,477
------------
Cash Provided by Proceeds from sales of long-term investments 99,530,806
Investing Purchases of long-term investments (88,993,018)
Activities: Purchases of short-term investments (114,374,230)
Proceeds from sales and maturities of short-term investments 118,304,000
------------
Net cash provided by investing activities 14,467,558
------------
Cash Used for Short-term borrowings (15,000,000)
Financing Dividends paid to shareholders (11,569,681)
Activities: ------------
Net cash used for financing activities (26,569,681)
------------
Cash: Net increase in cash (115,646)
Cash at beginning of period 423,882
------------
Cash at end of period $ 308,236
============
Cash Flow Cash paid for interest $ 2,566,471
Information: ============
See Notes to Financial Statements.
</TABLE>
F-11
<PAGE>
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
The following per share data and ratios have been
derived from information provided in the financial For the Six For the For the Period
statements. Months Ended Year Ended April 30, 1993++
August 31, Feb. 28, to Feb. 28,
Increase (Decrease) in Net Asset Value: 1995++++ 1995++++ 1994
<C> <S> <C> <C> <C>
Per Share Net asset value, beginning of period $ 8.94 $ 9.82 $ 9.50
Operating ------------ ------------ ------------
Performance: Investment income--net .49 .90 .70
Realized and unrealized gain (loss) on invest-
ments--net .08 (.87) .25
------------ ------------ ------------
Total from investment operations .57 .03 .95
------------ ------------ ------------
Less dividends and distributions from:
Investment income--net (.45) (.84) (.61)
Realized gain on investments--net -- (.07) (.02)
------------ ------------ ------------
Total dividends and distributions (.45) (.91) (.63)
------------ ------------ ------------
Net asset value, end of period $ 9.06 $ 8.94 $ 9.82
============ ============ ============
Market price per share, end of period $ 9.00 $ 8.625 $ 9.375
============ ============ ============
Total Investment Based on net asset value per share 6.69%+++ .82% 10.28%+++
Return:** ============ ============ ============
Based on market price per share 9.85%+++ 1.87% .02%+++
============ ============ ============
Ratios to Average Expenses, net of reimbursement and excluding
Net Assets: interest expense .94%* .80% .67%*
============ ============ ============
Expenses, net of reimbursement 3.05%* 2.46% 1.61%*
============ ============ ============
Expenses 3.05%* 2.46% 1.75%*
============ ============ ============
Investment income--net 10.61%* 7.07% 7.33%*
============ ============ ============
Supplemental Net assets, end of period (in thousands) $ 230,014 $ 227,007 $ 248,342
Data: ============ ============ ============
Portfolio turnover 29.99% 44.81% 52.73%
============ ============ ============
<FN>
*Annualized.
**Total investment returns based on market value, which can be
significantly greater or lesser than the net asset value, result in
substantially different returns. Total investment returns exclude
the effects of sales loads.
++Commencement of Operations.
++++Based on average shares outstanding during the period.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
F-12
<PAGE>
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Senior High Income Portfolio, Inc. (the "Fund") is registered under
the Investment Company Act of 1940 as a non-diversified, closed-end
management investment company. These unaudited financial statements
reflect all adjustments which are, in the opinion of management,
necessary to a fair statement of the results for the interim period
represented. All such adjustments are of a normal recurring nature.
The Fund determines and makes available for publication the net
asset value of its Common Stock on a weekly basis. The Fund's Common
Stock is listed on the New York Stock Exchange under the symbol ARK.
(a) Corporate debt obligations--The Fund invests principally in
senior debt obligations ("Senior Debt") of companies, including
corporate loans made by banks and other financial institutions and
both privately and publicly offered corporate bonds and notes.
Because agents and intermediaries are primarily commercial banks,
the Fund's investment in corporate loans could be considered
concentrated in financial institutions.
(b) Valuation of investments--Portfolio securities are valued on the
basis of prices furnished by one or more pricing services, which
determine prices for normal, institutional-size trading units. In
certain circumstances, portfolio securities are valued at the last
sale price on the exchange that is the primary market for such
securities, or the last quoted bid price for those securities for
which the over-the-counter market is the primary market or for
listed securities in which there were no sales during the day. The
value of interest rate swaps, caps, and floors is determined in
accordance with a formula and then confirmed periodically by
obtaining a bank quotation. Positions in options are valued at the
last sale price on the market where any such option is principally
traded. Securities for which there exist no price quotations or
valuations and all other assets are valued at fair value as
determined in good faith by or on behalf of the Board of Directors
of the Fund. Since corporate loans are purchased and sold primarily
at par value, the Fund values the loans at par, unless Fund Asset
Management, L.P. ("FAM") determines par does not represent fair
value. In the event such a determination is made, fair value will be
determined in accordance with guidelines approved by the Fund's
Board of Directors. Obligations with remaining maturities of sixty
days or less are valued at amortized cost unless this method no
longer produces fair valuations.
(c) Derivative financial instruments--The Fund may engage in various
portfolio strategies to seek to increase its return by hedging its
portfolio against adverse movements in the debt markets. Losses may
arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
* Financial futures contracts--The Fund may purchase or sell
interest rate futures contracts and options on such futures
contracts for the purpose of hedging the market risk on existing
securities or the intended purchase of securities. Futures contracts
are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon entering into a
contract, the Fund deposits and maintains as collateral such initial
margin as required by the exchange on which the transaction is
effected. Pursuant to the contract, the Fund agrees to receive from
or pay to the broker an amount of cash equal to the daily
fluctuation in value of the contract. Such receipts or payments are
known as variation margin and are recorded by the Fund as unrealized
gains or losses. When the contract is closed, the Fund records a
realized gain or loss equal to the difference between the value of
the contract at the time it was opened and the value at the time it
was closed.
* Options--The Fund is authorized to write and purchase call and put
options. When the Fund writes an option, an amount equal to the
premium received by the Fund is reflected as an asset and an
equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option
written. When a security is purchased or sold through an exercise of
an option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from
(or added to) the proceeds of the security sold. When an option
expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums
received or paid (or gain or loss to the extent the cost of the
closing transaction is less than or exceeds the premiums paid or
received).
13
<PAGE>
NOTES TO FINANCIAL STATEMENTS (concluded)
Written and purchased options are non-income producing investments.
* Interest rate transactions--The Fund is authorized to enter into
interest rate swaps and purchase or sell interest rate caps and
floors. In an interest rate swap, the Fund exchanges with another
party their respective commitments to pay or receive interest on a
specified notional principal amount. The purchase of an interest
rate cap (or floor) entitles the purchaser, to the extent that a
specified index exceeds (or falls below), a predetermined interest
rate, to receive payments of interest equal to the difference
between the index and the predetermined rate on a notional principal
amount from the party selling such interest rate cap (or floor).
(d) Income taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required.
(e) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Interest income is recognized on the accrual
basis. Realized gains and losses on security transactions are
determined on the identified cost basis. Facility fees are accreted
to income over the term of the related loan.
(f) Deferred organization expenses--Deferred organization expenses
are amortized on a straight-line basis over a five-year period.
(g) Dividends and distributions--Dividends from net investment
income are declared and paid monthly. Distributions of capital gains
are recorded on the ex-dividend dates. The Fund may at times pay out
less than the entire amount of net investment income earned in any
particular period and may at times pay out such accumulated
undistributed income in other periods to permit the Fund to maintain
a more stable level of distributions.
2. Investment Advisory Agreement with Affiliates:
The Fund has entered into an Investment Advisory Agreement with FAM.
The general partner of FAM is Princeton Services, Inc. ("PSI"), an
indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML &
Co."), which is the limited partner.
FAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund. For such
services, the Fund pays a monthly fee at an annual rate of 0.50% of
the Fund's average weekly net assets plus the proceeds of any
outstanding borrowings used for leverage.
Accounting services are provided to the Fund by FAM at cost.
During the six months ended August 31, 1995, the Fund paid Merrill
Lynch Security Pricing Service, an affiliate of Merrill Lynch,
Pierce, Fenner & Smith Inc. ("MLPF&S"), $719 for security price
quotations to compute the net asset value of the Fund.
Certain officers and/or directors of the Fund are officers and/or
directors of FAM, PSI, MLPF&S, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the six months ended August 31, 1995 were $88,993,018 and
$100,570,438, respectively.
F-14
<PAGE>
Net realized and unrealized losses as of August 31, 1995 were as
follows:
Realized Unrealized
Losses Losses
Long-term investments $(1,408,602) $(5,322,454)
----------- -----------
Total $(1,408,602) $(5,322,454)
=========== ===========
As of August 31, 1995, net unrealized depreciation for financial
reporting and Federal income tax purposes aggregated $5,322,454, of
which $1,676,959 related to appreciated securities and $6,999,413
related to depreciated securities. The aggregate cost of investments
at August 31, 1995 for Federal income tax purposes was $299,519,495.
4. Capital Share Transaction:
The Fund is authorized to issue 200,000,000 shares of capital stock
par value $.10, all of which are initially classified as Common
Stock. The Board of Directors is authorized, however, to classify
and reclassify any unissued shares of capital stock without approval
of the holders of Common Stock.
For the six months ended August 31, 1995, shares issued and
outstanding remained constant at 25,388,292. At August 31, 1995,
total paid-in capital amounted to $240,827,187.
5. Unfunded Loan Interests:
As of August 31, 1995, the Fund had unfunded loan commitments of
$2,500,000, which would be extended at the option of the borrower,
pursuant to the following loan agreements:
Unfunded
Commitment
Borrower (in thousands)
Marcus Cable Co. $2,500
6. Short-Term Borrowings:
On June 16, 1993, the Fund entered into a credit facility with a
syndicate of banks led by The Bank of New York consisting of a one-
year $55,000,000 revolving credit facility bearing interest on
outstanding balances at an alternate base rate plus 0.25% and/or
LIBOR plus 1.25%, and of a two-year $25,000,000 term loan facility
bearing interest on outstanding balances at an alternate base rate
plus 0.50% and/or LIBOR plus 1.375%. On June 10, 1994, this credit
facility and all outstanding balances thereunder were refinanced by
a one-year $120,000,000 revolving credit facility extended by a
syndicate of banks led by The Bank of New York and bearing interest
on outstanding balances at the Federal Funds rate plus 1.125% and/or
an alternate base rate plus 0.125% and/or LIBOR plus 1.125%. On June
9, 1995, the existing credit facility was extended for an additional
year and amended to reduce applicable interest rates on outstanding
balances to Federal Funds rate plus 0.75% and/or alternate base rate
plus 0% and/or LIBOR plus 0.75%. For the six months ended August 31,
1995, the maximum amount borrowed was $86,000,000, the average
amount borrowed was approximately $69,200,000, and the daily
weighted average interest rate was 6.89%. For the year ended August
31, 1995, facility and commitment fees aggregated approximately
$91,553.
7. Capital Loss Carryforward:
At February 28, 1995, the Fund had a net capital loss carryforward
of approximately $5,318,000, all of which expires in 2003. This
amount will be available to offset like amounts of any future
taxable gains.
F-15
<PAGE>
AUDITED FINANCIAL STATEMENTS FOR SENIOR HIGH INCOME PORTFOLIO, INC.
FOR THE FISCAL YEAR ENDED FEBRUARY 28, 1995
F-16
<PAGE>
INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
SENIOR HIGH INCOME PORTFOLIO, INC.:
We have audited the accompanying statement of assets, liabilities and
capital, including the schedule of investments, of Senior High Income
Portfolio, Inc. as of February 28, 1995, the related statements of operations
and cash flows for the year then ended and changes in net assets and the
financial highlights for the year then ended and for the period April 30, 1993
(commencement of operations) to February 28, 1994. These financial statements
and the financial highlights are the responsibility of the Fund's management.
Our responsibility is to express an opinion on these financial statements and
the 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 the 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 securities owned at
February 28, 1995 by correspondence with the custodian and financial
intermediaries. 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, such financial statements and the financial highlights
present fairly, in all material respects, the financial position of Senior High
Income Portfolio, Inc. as of February 28, 1995, the results of its operations
and its cash flows for the year then ended and the changes in its net assets,
and the financial highlights for the year then ended and for the period April
30, 1993 to February 28, 1994 in conformity with generally accepted accounting
principles.
As discussed in Notes 1a and 1b, the financial statements include corporate
loans valued at $169,044,066 (74% of total net assets and 55% of total
investments of the Fund), whose values are fair values as determined by or
under the direction of the Board of Directors in the absence of actual market
values. Determination of fair value involves subjective judgment, as the actual
market value of particular corporate loans can be established only by
negotiation between the parties in a sales transaction. We have reviewed the
procedures established by the Board of Directors and used by the Fund's
investment adviser in determining the fair values of such corporate loans and
have inspected underlying documentation, and under the circumstances, we
believe that the procedures are reasonable and the documentation appropriate.
Deloitte & Touche LLP
Princeton, New Jersey
April 12, 1995
F-17
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1b)
<S> <S> <S> <C> <S> <C> <C>
Advertising-- B B2 $ 5,000,000 Lamar Advertising Co., Senior Secured Notes,
2.1% 11% due 5/15/2003 $ 5,056,250 $ 4,850,000
Aerospace--6.1% Aviall, Inc., Term Loan, Tranche B, due
11/30/2000**:
NR* NR* 882,353 8.57% to 3/07/1995 882,353 882,353
NR* NR* 411,765 9.38% to 3/07/1995 411,765 411,765
NR* NR* 3,705,882 10% to 6/07/1995 3,705,882 3,705,882
NR* NR* 4,500,000 Gulfstream Delaware Corp., Term Loan, due
3/31/1998, 9.88% to 6/08/1995** 4,500,000 4,500,000
B B2 2,000,000 Talley Manufacturing & Technology, Inc.,
Senior Discount Debentures, 10.75% due
10/15/2003 2,030,000 1,810,000
BB- B1 3,000,000 UNC, Inc., Senior Notes, 9.125% due 7/15/2003 3,000,000 2,565,000
------------ ------------
14,530,000 13,875,000
Agricultural BB- B1 2,000,000 Fresh Del Monte Produce N.V., Series A,
Products--0.6% Senior Notes, 10% due 5/01/2003 2,025,000 1,400,000
Airlines--2.0% NR* NR* 4,487,409 Northwest Airlines, Term Loan, due
6/15/1997, 8.562% to 4/20/1995** 4,487,409 4,487,409
Automotive B B2 1,500,000 Harvard Industries, Inc., Senior Notes, 12%
Products-- due 7/15/2004 1,500,000 1,541,250
0.7%
Broadcast/ BB Ba2 2,500,000 Continental Cablevision, Inc., Senior Notes,
Media--5.0% 8.625% due 8/15/2003 2,500,000 2,375,000
Enquirer/Star, Term Loan B, due 9/30/2002**:
NR* NR* 4,950,000 8.75% to 5/22/1995 4,950,000 4,950,000
NR* NR* 50,000 10.50% to 5/22/1995 50,000 50,000
U.S. Radio Inc., Term Loan A, due 12/31/2001**:
NR* NR* 865,477 8.69% to 3/30/1995 865,477 865,477
NR* NR* 865,477 9.313% to 4/28/1995 865,477 865,477
U.S. Radio Inc., Term Loan B, due 9/21/2003**:
NR* NR* 1,130,109 9.69% to 3/30/1995 1,130,109 1,130,109
NR* NR* 1,138,937 10.312% to 4/28/1995 1,138,937 1,138,937
------------ ------------
11,500,000 11,375,000
Building & B- B2 2,500,000 Baldwin Co., Senior Notes, 10.375% due 8/01/2003 2,500,000 1,550,000
Construction B+ Ba3 2,250,000 U.S. Home Corp., Senior Notes, 9.75% due
- --1.6% 6/15/2003 2,250,000 2,047,500
------------ ------------
4,750,000 3,597,500
Building BB- Ba3 1,000,000 Schuller International, 10.875% due 12/15/2004 1,000,000 1,056,250
Products--0.4%
Carbon & NR* NR* 2,442,708 UCAR International Inc., Term Loan B,
Graphite due 1/31/2003**, 9.313% to 5/08/1995 2,442,708 2,442,708
Products--2.2% NR* NR* 1,278,646 UCAR International Inc., Term Loan C,
due 7/31/2003**, 9.8125% to 5/08/1995 1,278,646 1,278,646
</TABLE>
F-18
<PAGE>
<TABLE>
<S> <S> <S> <C> <S> <C> <C>
NR* NR* 1,278,646 UCAR International Inc., Term Loan D,
due 1/31/2004**, 10.0625% to 5/08/1995 1,278,646 1,278,646
------------ ------------
5,000,000 5,000,000
Chemicals--4.0% BB- B1 1,000,000 Huntsman Chemical Corp., Senior Notes,
11% due 4/15/2004 1,015,000 1,065,000
NR* NR* 5,000,000 Indspec Chemical Corp., Term Loan B,
due 12/02/2000, 9.125% to 3/31/1995** 5,000,000 5,000,000
B+ B1 3,000,000 Uniroyal Chemical Company, Inc., 9%
due 9/01/2000 3,000,000 2,865,000
------------ ------------
9,015,000 8,930,000
Computers--1.0% BB- B1 2,100,000 Dell Computer Corp., Senior Notes, 11%
due 8/15/2000 2,118,375 2,231,250
Consumer NR* NR* 5,000,000 CHF/Ebel USA Inc., Term Loan B, due
Products-- 9/30/2001, 9.25% to 4/28/1995** 5,000,000 5,000,000
2.7% B+ B2 1,000,000 Drypers Corp., Series B, Senior Notes,
12.50% due 11/01/2002 1,050,000 1,005,000
6,050,000 6,005,000
Containers--3.9% Silgan Corp., Term Loan B, due 9/15/1996**:
NR* NR* 2,461,967 9.688% to 3/07/1995 2,461,967 2,461,967
NR* NR* 2,500,000 10% to 6/09/1995 2,500,000 2,500,000
B+ Ba3 4,000,000 Sweetheart Cup Co., Senior Secured Notes,
9.625% due 9/01/2000 4,000,000 3,870,000
------------ ------------
8,961,967 8,831,967
Diversified B+ B1 3,000,000 Essex Group Inc., 10% due 5/01/2003 3,041,250 2,910,000
Manufacturing Thermadyne Industries, Term Loan B, due
- --3.4% 2/01/2001**:
NR* NR* 750 10.75% to 3/31/1995 (1) 750 750
NR* NR* 4,225,000 8.3125% to 3/02/1995 4,225,000 4,225,000
NR* NR* 600,000 9.312% to 5/03/1995 600,000 600,000
------------ ------------
7,867,000 7,735,750
Drug Stores-- Duane Reade Co., Term Loan A, due 9/30/1997**:
5.5% NR* NR* 436,980 9.0625% to 3/31/1995 436,980 436,980
NR* NR* 5,626,957 9.25% to 5/30/1995 5,626,957 5,626,957
NR* NR* 1,500,000 Duane Reade Co., Term Loan B, due 9/30/1999,
9.50% to 5/30/1995** 1,500,000 1,500,000
Thrifty Payless Inc., Term Loan B, due
9/30/2001**:
NR* NR* 4,974,874 9.375% to 5/24/1995 4,974,874 4,974,874
NR* NR* 12,563 11% to 5/24/1995 (1) 12,563 12,563
------------ ------------
12,551,374 12,551,374
Educational B B3 5,000,000 La Petite Holdings Corp., Senior Secured
Services--2.1% Notes, 9.625% due 8/01/2001 5,000,000 4,675,000
Electrical Berg Electronics, Inc., Term Loan B, due
Instruments 6/30/2001**:
- --0.9% NR* NR* 8,333 9.07% to 3/30/1995 8,333 8,333
NR* NR* 1,983,333 9.375% to 5/25/1995 1,983,333 1,983,333
------------ ------------
1,991,666 1,991,666
</TABLE>
F-19
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS (continued)
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1b)
<S> <S> <S> <C> <S> <C> <C>
Energy--1.6% BB- B1 $ 2,500,000 Ferrellgas L.P., Series B, Floating Rate
Senior Notes, 9.4375% due 8/01/2001 (2) $ 2,488,332 $ 2,487,500
B- B3 1,500,000 Presidio Oil Company, Senior Secured Notes,
11.50% due 9/15/2000 1,540,000 1,245,000
------------ ------------
4,028,332 3,732,500
Fertilizer--2.0% BB- B1 3,750,000 Sherritt Gordon Ltd., Senior Notes, 9.75%
due 4/01/2003 3,762,500 3,600,000
BB- B1 1,000,000 Sherritt, Inc., USD Debentures, 10.50% due
3/31/2014 1,000,000 986,250
------------ ------------
4,762,500 4,586,250
Food & B+ B1 5,000,000 Royal Crown Corp., Senior Secured Notes,
Beverage 9.75% due 8/01/2000 5,000,000 4,662,500
- --6.3% Specialty Foods Corp., Term Loan B, due
8/31/1999**:
NR* NR* 89,395 10% (1) 89,395 89,395
NR* NR* 4,557,369 9.13% to 4/18/1995 4,557,369 4,557,369
NR* NR* 4,960,000 10% to 7/18/1995 4,960,000 4,960,000
------------ ------------
14,606,764 14,269,264
Forest BB- Ba3 1,000,000 Malette Inc., Senior Secured Notes, 12.25%
Products due 7/15/2004 1,000,000 1,020,000
- --1.4% BB- Ba3 2,000,000 Rainy River Forest Products, 10.75% due
10/15/2001 1,995,321 2,045,000
------------ ------------
2,995,321 3,065,000
Grocery--10.9% NR* NR* 4,966,667 CK Aquisitions Corp., Term Loan B, due
7/31/2001, 8.125% to 3/28/1995** 4,966,667 4,966,667
B+ NR* 2,500,000 Homeland Stores Inc., Series D, Floating Rate
Senior Secured Notes, 9.063% due 2/28/1997 (3) 2,462,968 2,512,707
D Caa 4,950,000 Pathmark Stores, Inc., Term Loan B, due
10/31/1999, 9.25% to 3/31/1995** 4,950,000 4,950,000
BB- Ba3 1,000,000 The Penn Traffic Company, Senior Notes, 8.625%
due 12/15/2003 1,000,000 917,500
B- B2 2,000,000 Pueblo Xtra International, Inc., Senior Notes,
9.50% due 8/01/2003 2,000,000 1,690,000
Ralph's Grocery Co., Primary Term Loan, due
6/30/1998**:
NR* NR* 272,211 9% to 3/06/1995 272,211 272,211
NR* NR* 158,263 8.938% to 3/30/1995 158,263 158,263
NR* NR* 158,263 8.8125% to 3/31/1995 158,263 158,263
NR* NR* 158,263 8.9375% to 3/31/1995 158,263 158,263
NR* NR* 158,263 8.938% to 3/31/1995 158,263 158,263
NR* NR* 6,849,603 8.938% to 4/10/1995 6,849,603 6,849,603
B+ B3 2,000,000 Stater Brothers Holdings, Inc., Senior Notes,
11% due 3/01/2001 2,000,000 1,885,000
------------ ------------
25,134,501 24,676,740
Health B B2 2,500,000 Charter Medical Corp., Senior Subordinated
Services Notes, 11.25% due 4/15/2004 2,500,000 2,600,000
- --3.7% B- B2 1,000,000 Integrated Health Services, Inc., Senior
Subordinated Notes, 10.75% due 7/15/2004 1,000,000 1,030,000
B+ B1 5,200,000 MEDIQ/PRN Life Support Services, Inc., Senior
Secured Notes, 11.125% due 7/01/1999 5,409,000 4,784,000
------------ ------------
8,909,000 8,414,000
</TABLE>
F-20
<PAGE>
<TABLE>
<S> <S> <S> <C> <S> <C> <C>
Hotels & BB- B1 2,000,000 ++Four Seasons Hotels Inc., Notes, 9.125%
Casinos--2.5% due 7/01/2000 1,928,749 1,910,000
B+ B2 4,500,000 GB Property Funding Corp., First Mortgage
Notes, 10.875% due 1/15/2004 4,500,000 3,870,000
------------ ------------
6,428,749 5,780,000
Leasing & B- B2 2,000,000 Cort Furniture Rental Corp., Senior Notes,
Rental 12% due 9/01/2000 1,999,355 1,840,000
Services--3.8% Prime Acquisition, Term Loan, due
12/31/2000**:
NR* NR* 1,600,000 9.25% to 3/06/1995 1,600,000 1,600,000
NR* NR* 1,800,000 9.50% to 4/06/1995 1,800,000 1,800,000
NR* NR* 1,600,000 9.375% to 5/08/1995 1,600,000 1,600,000
BB- B1 2,000,000 The Scotsman Group, Inc., Senior Secured
Notes, 9.50% due 12/15/2000 2,000,000 1,910,000
------------ ------------
8,999,355 8,750,000
Manufacturing B+ B1 3,623,000 Foamex L.P., Senior Secured Notes, 9.50%
- --1.5% due 6/01/2000 3,643,000 3,423,735
Metals--8.8% B B2 1,000,000 AK Steel Holding Corp., Senior Notes,
10.75% due 4/1/2004 l,000,000 1,022,500
B B2 3,000,000 Bayou Steel Corp., First Mortgage Notes,
10.25% due 3/01/2001 3,000,000 2,730,000
B- B3 5,000,000 Federal Industries Ltd., 10.25% due 6/15/2000 5,011,250 4,700,000
B+ B1 3,000,000 Geneva Steel, Senior Notes, 9.50% due 1/15/2004 2,891,238 2,835,000
B B2 2,000,000 Republic Engineered Steel, Inc., First
Mortgage Notes, 9.875% due 12/15/2001 2,000,000 1,850,000
B+ B1 3,000,000 WCI Steel, Inc., Senior Notes, 10.50% due
3/01/2002 3,000,000 2,910,000
Weirton Steel Corp., Senior Notes:
B B2 2,000,000 11.50% due 3/01/1998 2,100,000 2,005,000
B B2 2,000,000 10.875% due 10/15/1999 2,070,000 1,962,500
------------ ------------
21,072,488 20,015,000
Office B+ B1 5,000,000 Bell & Howell Co., 9.25% due 7/15/2000 5,025,000 4,650,000
Machines--3.4% NR* NR* 3,133,532 Lexmark Holdings, US, Term Loan, due
3/27/1998, 8.58594% to 3/31/1995** 3,133,532 3,133,532
------------ ------------
8,158,532 7,783,532
Paper--19.5% NR* NR* 14,125,000 Fort Howard Corp., Primary Term Loan, due
5/01/1997, 10.75% to 3/31/1995** 14,125,000 14,125,000
B B3 5,000,000 Gaylord Container Corp., Senior Notes, 11.50%
due 5/15/2001 5,000,000 5,225,000
Jefferson Smurfit/Container Corp. of America,
Term Loan B, due 12/31/1997**:
NR* NR* 666,667 9.1875% to 3/24/1995 666,667 666,667
NR* NR* 9,333,333 9.3125% to 4/24/1995 9,333,333 9,333,333
NR* NR* 7,500,000 S.D. Warren Co., Term Loan B, due 12/19/2002,
9.50% to 8/23/1995** 7,500,000 7,500,000
Stone Container Corp., Term Loan B, due
4/01/2000**:
NR* NR* 3,750,000 9.25% to 3/17/1995 3,750,000 3,750,000
NR* NR* 3,750,000 9.3125% to 4/14/1995 3,750,000 3,750,000
------------ ------------
44,125,000 44,350,000
</TABLE>
F-21
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS (concluded)
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1b)
<S> <S> <S> <C> <S> <C> <C>
Publishing-- NR* NR* $ 2,573,529 Ziff Davis Acquisition Corp., Term Loan B,
2.2% due 12/31/2001, 9.38% to 3/28/1995** $ 2,573,529 $ 2,573,529
NR* NR* 2,426,471 Ziff Davis Acquisition Corp., Term Loan C,
due 12/31/2002, 9.88% to 3/28/1995** 2,426,471 2,426,471
------------ ------------
5,000,000 5,000,000
Railroad Westinghouse Air Brake Company, Term Loan B,
Equipment--2.2% due 2/15/2003**:
NR* NR* 300,000 9.125% to 3/31/1995** 300,000 300,000
NR* NR* 4,700,000 9.25% to 5/22/1995 4,700,000 4,700,000
------------ ------------
5,000,000 5,000,000
Retail-- B B2 4,000,000 Color Tile, Inc., Senior Notes, 10.75% due
Specialty-- 12/15/2001 4,000,000 3,240,000
8.8% Music Aquisition Corp., Term Loan B, due
8/31/2001**:
NR* NR* 3,125,000 8.875% to 4/19/1995 3,125,000 3,125,000
NR* NR* 1,812,500 9.5625% to 8/17/1995 1,812,500 1,812,500
NR* NR* 9,912,700 Saks & Co., Term Loan, Tranche B, due
6/30/2000, 9.13% to 5/09/1995** 9,912,700 9,912,700
B+ B1 2,000,000 Specialty Retailers, Inc., Series A, Senior
Notes, 10% due 8/15/2000 2,000,000 1,800,000
------------ ------------
20,850,200 19,890,200
Security NR* NR* 4,740,711 Alert Centre Inc., Term Loan, due 8/01/2001,
Systems--2.1% 8.375% to 8/05/1995** 4,740,711 4,740,711
Shipping--1.4% BB Ba2 1,000,000 Eletson Holdings, 9.25% due 11/15/2003 912,820 937,500
B B2 2,500,000 OMI Corp., Senior Notes, 10.25% due 11/01/2003 2,500,000 2,150,000
------------ ------------
3,412,820 3,087,500
Textiles--1.4% BB Ba3 3,500,000 Dominion Textile (USA) Inc., Senior Notes,
8.875% due 11/01/2003 3,484,278 3,220,000
Utilities--2.7% B Ba3 2,000,000 First PV Funding Corp., 10.30% due 1/15/2014 2,020,000 1,990,000
B B1 4,000,000 Texas-New Mexico Power Company, Secured
Debentures, 10.75% due 9/15/2003 4,000,000 4,056,640
------------ ------------
6,020,000 6,046,640
Warehousing & B+ B2 2,000,000 Americold Corp., First Mortgage Bonds, Series
Storage--2.8% B, 11.50% due 3/01/2005 2,045,000 1,840,000
Pierce Leahy Corp., Term Loan, Tranche B,
due 6/30/2001**:
NR* NR* 1,665,909 9.9375% to 4/28/1995 1,665,909 1,665,909
NR* NR* 2,915,341 9.5625% to 4/28/1995 2,915,341 2,915,341
------------ ------------
6,626,250 6,421,250
Total Investments in Corporate Debt
Obligations--133.2% 311,401,842 302,386,738
</TABLE>
F-20
<PAGE>
<TABLE>
<CAPTION>
Shares
Held Warrants
<S> <S> <S> <C> <S> <C> <C>
Leasing & Rental NR* NR* 66,000 Cort Furniture Rental Corp. (a) (b) 760 66,000
Services--0.0%
Total Investments in Warrants--0.0% 760 66,000
<CAPTION>
Face
Amount Short-Term Securities
<S> <S> <S> <C> <S> <C> <C>
Commercial $ 4,084,000 General Electric Capital Corp., 6% due 3/01/1995 4,084,000 4,084,000
Paper***--1.8%
Total Investments in Short-Term Securities--1.8% 4,084,000 4,084,000
Total Investments--135.0% $315,486,602 306,536,738
============
Liabilities in Excess of Other Assets--(35.0%) (79,529,704)
------------
Net Assets--100.0% $227,007,034
============
</TABLE>
[FN]
*Not Rated.
**Floating or Variable Rate Corporate Loans--The interest rates on
floating or variable rate corporate loans are subject to change
periodically, based on the change in the prime rate of a US Bank,
LIBOR (London Interbank Offered Rate), or, in some cases, another
base lending rate. The interest rates shown are those in effect at
February 28, 1995.
***Commercial Paper is traded on a discount basis; the interest rate
shown is the discount rate paid at the time of purchase by the fund.
(a)Warrants entitle the fund to purchase a predetermined number of
shares of common stock/face amount of bonds. The purchase price and
number of shares/face amount are subject to adjustments under
certain conditions until the expiration date.
(b)Non-income producing security.
(1)Interest rate is based on the prime rate of a US bank, which is
subject to change daily.
(2)Interest rate resets quarterly and is based on the three-month
LIBOR (London Interbank Offered Rate), plus an interest rate spread
of three hundred twelve and one half basis points.
(3)Interest rate resets quarterly and is based on the three-month
LIBOR (London Interbank Offered Rate), plus an interest rate spread
of three hundred basis points.
++Restricted securities. The value of the fund's investment in
restricted securities was approximately $1,910,000, representing
0.84% of net assets.
Acquisition Value
Issue Date Cost (Note 1b)
Four Seasons Hotels Inc.,
Notes, 9.125% due 7/01/2000 1/25/1994 $1,918,200 $1,910,000
---------- ----------
Total $1,918,200 $1,910,000
========== ==========
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
F-23
<PAGE>
<TABLE>
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<CAPTION>
As of February 28, 1995
<S> <S> <C>
Assets: Investments, at value (identified cost--$315,486,602) (Note 1b) $306,536,738
Cash 423,882
Interest receivable 5,336,831
Deferred facility expense (Note 1e) 41,315
Deferred organization expense (Note 1f) 69,749
Prepaid expenses and other assets 2,614
------------
Total assets 312,411,129
------------
Liabilities: Payables:
Loans (Note 5) $ 82,000,000
Dividends to shareholders (Note 1g) 707,508
Interest on loans (Note 5) 435,122
Investment adviser (Note 2) 119,455
Commitment fees 10,000 83,272,085
------------
Deferred income (Note 1e) 1,983,089
Accrued expenses and other liabilities 148,921
------------
Total liabilities 85,404,095
------------
Net Assets: Net assets $227,007,034
============
Capital: Common Stock, par value $.10 per share; 200,000,000
shares authorized (25,388,292 shares issued and outstanding) $ 2,538,829
Paid-in capital in excess of par 238,288,358
Undistributed investment income--net 3,923,535
Accumulated realized capital losses on investments--net (Note 6) (8,793,824)
Unrealized depreciation on investments--net (8,949,864)
------------
Total Capital--Equivalent to $8.94 net asset value per share
of Common Stock (market price--$8.625) $227,007,034
============
See Notes to Financial Statements.
</TABLE>
F-24
<PAGE>
<TABLE>
STATEMENT OF OPERATIONS
<CAPTION>
For the Year Ended February 28, 1995
<S> <S> <C>
Investment Income Interest and discount earned $ 29,920,761
(Note 1e): Facility and other fees 960,351
------------
Total income 30,881,112
------------
Expenses: Loan interest expense (Note 5) 5,370,797
Investment advisory fees (Note 2) 1,614,921
Facility fee amortization (Note 5) 527,168
Professional fees 131,609
Accounting services (Note 2) 98,293
Printing and shareholder reports 68,105
Transfer agent fees (Note 2) 51,535
Amortization of organization expenses (Note 1f) 28,402
Custodian fees 26,885
Directors' fees and expenses 24,355
Pricing services 14,336
Listing fees 250
Other 19,947
------------
Total expenses 7,976,603
------------
Investment income--net 22,904,509
------------
Realized & Realized loss on investments--net (8,793,344)
Unrealized Gain Change in unrealized appreciation/depreciation on investments--net (13,013,937)
(Loss) on ------------
Investments--Net Net Increase in Net Assets Resulting from Operations $ 1,097,228
(Notes 1c, 1e & 3): ============
See Notes to Financial Statements.
</TABLE>
F-25
<PAGE>
<TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
<CAPTION>
For the For the Period
Year Ended April 30, 1993++
Feb. 28, to Feb. 28,
Increase (Decrease) in Net Assets: 1995 1994
<S> <S> <C> <C>
Operations: Investment income--net $ 22,904,509 $ 17,533,097
Realized gain (loss) on investments--net (8,793,344) 2,392,226
Change in unrealized appreciation/depreciation on
investments--net (13,013,937) 4,064,073
------------ ------------
Net increase in net assets resulting from operations 1,097,228 23,989,396
------------ ------------
Dividends & Investment income--net (21,343,397) (15,325,391)
Distributions to Realized gain on investments--net (1,784,188) (453,536)
Shareholders ------------ ------------
(Note 1g): Net decrease in net assets resulting from dividends and
distributions to shareholders (23,127,585) (15,778,927)
------------ ------------
Capital Share Offering costs resulting from the issuance of Common Stock (85,747) (223,215)
Transactions Value of shares issued to Common Stock shareholders in
(Note 4): reinvestment of dividends and distributions 781,304 240,254,573
------------ ------------
Net increase in net assets resulting from capital share
transactions 695,557 240,031,358
------------ ------------
Net Assets: Total increase (decrease) in net assets (21,334,800) 248,241,827
Beginning of period 248,341,834 100,007
------------ ------------
End of period* $227,007,034 $248,341,834
============ ============
<FN>
*Undistributed investment income--net (Note 1h) $ 3,923,535 $ 2,207,706
============ ============
++Commencement of Operations.
See Notes to Financial Statements.
</TABLE>
F-26
<PAGE>
<TABLE>
STATEMENT OF CASH FLOWS
<CAPTION>
For the Year Ended February 28, 1995
<S> <C> <C>
Cash Provided by Net increase in net assets resulting from operations $ 1,097,228
Operating Adjustments to reconcile net increase in net assets
Activities: resulting from operations to net cash provided by
operating activities:
Increase in receivables (581,519)
Decrease in other assets 306,460
Increase in other liabilities 295,449
Realized and unrealized loss on investments--net 21,807,281
Amortization of discount (178,818)
------------
Net cash provided by operating activities 22,746,081
------------
Cash Provided by Proceeds from sales of long-term investments 157,940,628
Investing Purchases of long-term investments (152,194,149)
Activities: Purchases of short-term investments (585,347,129)
Proceeds from sales and maturities of short-term
investments 581,616,000
------------
Net cash provided by investing activities 2,015,350
------------
Cash Used for Offering costs from capital shares sold (85,747)
Financing Proceeds from short-term borrowings 22,000,000
Activities: Payments for short-term borrowings (24,000,000)
Dividends paid to shareholders (22,424,154)
------------
Net cash used for financing activities (24,509,901)
------------
Cash: Net increase in cash 251,530
Cash at beginning of period 172,352
------------
Cash at end of period $ 423,882
============
Cash Flow Cash paid for interest $ 5,171,083
Information: ============
Non-Cash Capital shares issued in reinvestment
Financing of dividends paid to shareholders $ 781,304
Activities: ============
See Notes to Financial Statements.
</TABLE>
F-27
<PAGE>
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
The following per share data and ratios have been derived For the For the Period
from information provided in the financial statements. Year Ended April 30, 1993++
Feb. 28, to Feb. 28,
Increase (Decrease) in Net Asset Value: 1995++++ 1994
<S> <S> <C> <C>
Per Share Net asset value, beginning of period $ 9.82 $ 9.50
Operating ------------ ------------
Performance: Investment income--net .90 .70
Realized and unrealized gain (loss) on
investments--net (.87) .25
------------ ------------
Total from investment operations .03 .95
------------ ------------
Less dividends and distributions from:
Investment income--net (.84) (.61)
Realized gain on investments--net (.07) (.02)
------------ ------------
Total dividends and distributions (.91) (.63)
============ ============
Net asset value, end of period $ 8.94 $ 9.82
============ ============
Market price per share, end of period $ 8.625 $ 9.375
============ ============
Total Investment Based on net asset value per share 0.37% 10.28%+++
Return:** ============ ============
Based on market price per share 1.87% 0.02%+++
============ ============
Ratios to Average Expenses, net of reimbursement and
Net Assets: excluding interest expense .80% .67%*
============ ============
Expenses, net of reimbursement 2.46% 1.61%*
============ ============
Expenses 2.46% 1.75%*
============ ============
Investment income--net 7.07% 7.33%*
============ ============
Supplemental Net assets, end of period (in thousands) $ 227,007 $ 248,342
Data: ============ ============
Portfolio turnover 44.81% 52.73%
============ ============
Leverage: Amount of borrowings (in thousands) $ 82,000 $ 84,000
------------ ------------
Asset coverage per $1,000 $ 3,768 $ 3,956
------------ ------------
<FN>
++Commencement of Operations.
++++Based on average shares outstanding during the period.
+++Aggregate total investment return.
*Annualized.
**Total investment returns based on market value, which can be
significantly greater or lesser than the net asset value, may result
in substantially different returns. Total investment returns exclude
the effects of sales loads.
See Notes to Financial Statements.
</TABLE>
F-28
<PAGE>
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Senior High Income Portfolio, Inc. (the "Fund") is registered under
the Investment Company Act of 1940 as a non-diversified, closed-end
management investment company. The Fund determines and makes
available for publication the net asset value of its Common Stock on
a weekly basis. The Fund's Common Stock is listed on the New York
Stock Exchange under the symbol ARK.
(a) Corporate debt obligations--The Fund invests principally in
senior debt obligations ("Senior Debt") of companies, including
corporate loans made by banks and other financial institutions and
both privately and publicly offered corporate bonds and notes.
Because agents and intermediaries are primarily commercial banks,
the Fund's investment in corporate loans could be considered
concentrated in financial institutions.
(b) Valuation of investments--Portfolio securities are valued on the
basis of prices furnished by one or more pricing services, which
determines prices for normal, institutional-size trading units. In
certain circumstances, portfolio securities are valued at the last
sale price on the exchange that is the primary market for such
securities, or the last quoted bid price for those securities for
which the over-the-counter market is the primary market or for
listed securities in which there were no sales during the day. The
value of interest rate swaps, caps, and floors is determined in
accordance with a formula and then confirmed periodically by
obtaining a bank quotation. Positions in options are valued at the
last sale price on the market where any such option is principally
traded. Securities for which there exist no price quotations or
valuations and all other assets are valued at fair value as
determined in good faith by or on behalf of the Board of Directors
of the Fund. Since corporate loans are purchased and sold primarily
at par value, the Fund values the loans at par, unless Fund Asset
Management, L.P. ("FAM") determines par does not represent fair
value. In the event such a determination is made, fair value will be
determined in accordance with guidelines approved by the Fund's
Board of Directors. Obligations with remaining maturities of sixty
days or less are valued at amortized cost unless this method no
longer produces fair valuations.
(c) Derivative financial instruments--The Fund may engage in various
portfolio strategies to seek to increase its return or to hedge its
portfolio against adverse movements in the debt markets. Losses may
arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
* Financial futures contracts--The Fund may purchase or sell
interest rate futures contracts and options on such futures
contracts for the purpose of hedging the market risk on existing
securities or the intended purchase of securities or to enhance its
income. Futures contracts are contracts for delayed delivery of
securities at a specific future date and at a specific price or
yield. Upon entering into a contract, the Fund deposits and
maintains as collateral such initial margin as required by the
exchange on which the transaction is effected. Pursuant to the
contract, the Fund agrees to receive from or pay to the broker an
amount of cash equal to the daily fluctuation in value of the
contract. Such receipts or payments are known as variation margin
and are recorded by the Fund as unrealized gains or losses. When the
contract is closed, the Fund records a realized gain or loss equal
to the difference between the value of the contract at the time it
was opened and the value at the time it was closed.
* Options--The Fund is authorized to write and purchase call and put
options. When the Fund writes an option, an amount equal to the
premium received by the Fund is reflected as an asset and an
equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option
written.
When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from
(or added to) the proceeds of the security sold. When an option
expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums
received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing
investments.
* Interest rate transactions--The Fund is authorized to enter into
interest rate swaps and purchase or sell interest rate caps and
floors. In an interest rate swap, the Fund exchanges with another
party their respective commitments to pay or receive interest on a
specified notional principal amount. The purchase of an interest
rate cap (or floor) entitles the purchaser, to the extent that a
specified index exceeds (or falls below) a predetermined interest
rate, to receive payments of interest equal to the difference
between the index and the predetermined rate on a notional principal
amount from the party selling such interest rate cap (or floor).
F-29
<PAGE>
NOTES TO FINANCIAL STATEMENTS (concluded)
(d) Income taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required.
(e) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Interest income is recognized on the accrual
basis. Realized gains and losses on security transactions are
determined on the identified cost basis. Facility fees are accreted
to income over the term of the related loan. For income tax
purposes, as of March 1, 1994 the corporate loans are treated as
discount obligations.
(f) Deferred organization expenses--Deferred organization expenses
are amortized on a straight-line basis over a five-year period.
(g) Dividends and distributions--Dividends from net investment
income are declared and paid monthly. Distributions of capital gains
are recorded on the ex-dividend dates. The Fund may at times pay out
less than the entire amount of net investment income earned in any
particular period and may at times pay out such accumulated
undistributed income in other periods to permit the Fund to maintain
a more stable level of distributions.
(h) Reclassifications--Generally accepted accounting principles
require that certain differences between accumulated net realized
capital losses for financial reporting and tax purposes, if
permanent, be reclassified to undistributed net investment income.
Accordingly, current year's permanent book/tax differences of
approximately $155,000 have been reclassified from accumulated net
realized losses to undistributed net investment income. These
reclassifications have no effect on net assets or net asset values
per share.
2. Investment Advisory Agreement with Affiliates:
The Fund has entered into an Investment Advisory Agreement with FAM.
The general partner of FAM is Princeton Services, Inc. ("PSI"), an
indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML &
Co."), which is the limited partner.
FAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund. For such
services, the Fund pays a monthly fee at an annual rate of 0.50% of
the Fund's average weekly net assets.
Financial Data Services, Inc. ("FDS"), a wholly-owned subsidiary of
ML & Co., is the Fund's transfer agent.
Accounting services are provided to the Fund by FAM at cost.
During the period May 25, 1994 to February 28, 1995, the Fund paid
Merrill Lynch Security Pricing Service, an affiliate of Merrill
Lynch, Pierce, Fenner & Smith Inc. ("MLPF&S"), $1,103 for security
price quotations to compute the net asset value of the Fund.
Certain officers and/or directors of the Fund are officers and/or
directors of FAM, PSI, FDS, MLPF&S, and/or ML & Co.
F-30
<PAGE>
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended February 28, 1995 were $142,218,519 and
$157,940,628, respectively.
Net realized and unrealized losses as of February 28, 1995 were as
follows:
Realized Unrealized
Losses Losses
Long-term investments $(8,793,344) $(8,949,864)
----------- -----------
Total $(8,793,344) $(8,949,864)
=========== ===========
As of February 28, 1995, net unrealized depreciation for financial
reporting and Federal income tax purposes aggregated $8,949,864, of
which $903,853 related to appreciated securities and $9,853,717
related to depreciated securities. The aggregate cost of investments
at February 28, 1995 for Federal income tax purposes was
$315,486,602.
4. Capital Share Transaction:
The Fund is authorized to issue 200,000,000 shares of capital stock
par value $.10, all of which are initially classified as Common
Stock. The Board of Directors is authorized, however, to classify
and reclassify any unissued shares of capital stock without approval
of the holders of Common Stock.
For the year ended February 28, 1995, shares issued and outstanding
increased by 87,810 to 25,388,292 as a result of dividend
reinvestment. At February 28, 1995, total paid-in capital amounted
to $240,827,187.
5. Short-Term Borrowings:
On June 16, 1993, the Fund entered into a one-year revolving credit
facility in the amount of $55 million, which was increased to $95
million on February 4, 1994, bearing interest at alternate base rate
plus 0.25% and/or LIBOR plus 1.25%, and a two-year term loan
facility in the amount of $25 million bearing interest at alternate
base rate plus 0.50% and/or LIBOR plus 1.375%. On June 10, 1994, the
Fund's existing credit agreement with The Bank of New York was
refinanced with a one-year revolving credit facility with a
syndicate of banks led by The Bank of New York in the amount of $120
million bearing interest at Federal Funds Rate plus 1.125% and/or
alternate base rate plus 0.125% and/or LIBOR plus 1.125%.
From March 1, 1994 to February 28, 1995, the maximum amount borrowed
was $106 million, the average amount borrowed was approximately $92
million, and the daily weighted average interest rate was 6.1243%.
6. Capital Loss Carryforward:
At February 28, 1995, the Fund had a net capital loss carryforward
of approximately $5,318,000, all of which expires 2003. This amount
will be available to offset like amounts of any future taxable
gains.
F-31
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
F-32
<PAGE>
AUDITED FINANCIAL STATEMENTS FOR SENIOR HIGH INCOME PORTFOLIO II, INC. FOR THE
FISCAL YEAR ENDED AUGUST 31, 1995
F-33
<PAGE>
INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
SENIOR HIGH INCOME PORTFOLIO II, INC.:
We have audited the accompanying statement of assets, liabilities and
capital, including the schedule of investments, of Senior High Income Portfolio
II, Inc. as of August 31, 1995, the related statements of operations and cash
flows for the year then ended and changes in net assets and the financial
highlights for the year then ended and the period September 24, 1993
(commencement of operations) to August 31, 1994. These financial statements and
the financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and the
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 the 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 securities owned at August
31, 1995 by correspondence with the custodian and financial intermediaries. 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, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Senior High Income
Portfolio II, Inc. as of August 31, 1995, the results of its operations, the
changes in its net assets, its cash flows, and the financial highlights for the
respective stated periods in conformity with generally accepted accounting
principles.
As discussed in Notes 1a and 1b, the financial statements include corporate
loans valued at $108,805,993 (71% of total net assets and 55% of total
investments of the Fund), whose values are fair values as determined by or
under the direction of the Board of Directors in the absence of actual market
values. Determination of fair value involves subjective judgment, as the actual
market value of particular corporate loans can be established only by
negotiation between the parties in a sales transaction. We have reviewed the
procedures established by the Board of Directors and used by the Fund's
investment adviser in determining the fair values of such corporate loans and
have inspected underlying documentation, and under the circumstances, we
believe that the procedures are reasonable and the documentation appropriate.
Deloitte & Touche LLP
Princeton, New Jersey
October 17, 1995
F-34
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1b)
<C> <C> <C> <C> <S> <C> <C>
Aerospace--9.6% Aviall, Inc., Term Loan, Tranche B, due
11/30/2000:**
NR* NR* $ 176,471 9.13% to 9/07/1995 $ 176,471 $ 176,471
NR* NR* 1,266,653 9.75% to 9/07/1995 1,266,653 1,266,653
NR* NR* 3,529,412 9.25% to 10/10/1995 3,529,412 3,529,412
BB- Ba3 3,000,000 BE Aerospace, Senior Notes, 9.75%
due 3/01/2003 3,060,000 3,000,000
Gulfstream Delaware Corp., Term Loan A,
due 3/31/1997:**
NR* NR* 372,340 10% to 9/30/1995 372,340 372,340
NR* NR* 2,234,043 7.88% to 10/13/1995 2,234,043 2,234,043
NR* NR* 2,240,000 Gulfstream Delaware Corp., Term Loan B,
due 3/31/1998, 9% to 9/08/1995** 2,240,000 2,240,000
B B2 2,000,000 Talley Manufacturing & Technology, Inc.,
Senior Notes, 10.75% due 10/15/2003 2,000,000 2,020,000
------------ ------------
14,878,919 14,838,919
Automotive B+ B3 1,000,000 Harvard Industries, Inc., Senior Notes,
Products--2.0% 11.125% due 8/01/2005++ 1,000,000 1,012,500
B B2 1,000,000 JPS Automotive Products Corp., Senior
Notes, 11.125% due 6/15/2001 1,000,000 995,000
A A3 1,000,000 Walbro Corp., Senior Notes, 9.875%
due 7/15/2005++ 996,520 995,000
------------ ------------
2,996,520 3,002,500
Broadcast/ Continental Cablevision, Inc., Senior
Media--5.2% Notes:
BB Ba2 1,000,000 8.50% due 9/15/2001 1,052,500 1,005,000
BB- B1 2,500,000 9.125% due 11/01/2004++ 2,500,000 2,500,000
B- B3 1,000,000 Granite Broadcasting Corp., 10.375%
due 5/15/2005++ 1,000,000 1,013,750
NR* NR* 2,500,000 Marcus Cable Co., Term Loan B, due
4/30/2004, 10.25% to 9/30/1995** 2,500,000 2,500,000
NR* NR* 1,000,000 Young Broadcasting Corp., 10.125% due
2/15/2005++ 1,000,000 1,040,000
------------ ------------
8,052,500 8,058,750
Building & B B2 2,000,000 NVR, Inc., Senior Notes, 11% due
Construction 4/15/2003 2,082,500 1,945,000
- --1.8% A A3 1,000,000 The Presley Companies, Senior Notes,
12.50% due 7/01/2001 1,000,000 830,000
------------ ------------
3,082,500 2,775,000
</TABLE>
F-35
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS (continued)
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1b)
<C> <C> <C> <C> <S> <C> <C>
Building BB- Ba3 $1,000,000 Schuller International Group,
Products-- 10.875% due 12/15/2004 $ 1,000,000 $ 1,097,500
0.7%
Casinos--4.2% Harrah's Jazz Co., Term Loan B, due
9/30/1999:**
NR* NR* 2,166,667 9.125% to 10/23/1995 2,166,667 2,166,667
NR* NR* 4,333,333 9.1875% to 12/21/1995 4,333,333 4,333,333
------------ ------------
6,500,000 6,500,000
Chemicals--4.2% BB- B1 2,000,000 Huntsman Chemical Corp., Senior Notes,
11% due 4/15/2004 2,030,000 2,165,000
NR* NR* 4,311,326 Inspec Chemical Corp., Term Loan B,
due 12/02/2000, 8.50% to 9/29/1995** 4,311,326 4,311,326
------------ ------------
6,341,326 6,476,326
Computers--3.2% NR* NR* 4,500,000 Dell Computer Corp., Senior Notes, 11%
due 8/15/2000 4,516,219 4,938,750
Consumer B+ Ba3 1,000,000 Coty Inc., 10.25% due 5/01/2005 1,000,000 1,030,000
Products--0.8% B+ B2 565,000 Drypers Corp., Senior Notes, 12.50%
due 11/01/2002 572,063 254,250
------------ ------------
1,572,063 1,284,250
Diversified--9.6% NR* NR* 4,967,600 Desa International Inc., Term Loan B,
due 11/30/2000, 9.0625% to 12/27/1995** 4,967,600 4,967,600
NR* NR* 1,290,844 Figgie International, Term Loan, due
1/01/1996, 10.75% to 10/01/1995** 1,290,844 1,290,844
B+ B2 1,000,000 J.B. Poindexter & Co., 12.50% due
5/15/2004 973,963 940,000
NR* B2 4,813,625 Thermadyne Co., Term Loan B, due
2/01/2001, 8.875% to 9/07/1995** 4,813,625 4,813,625
B B1 3,000,000 Valcor Inc., Senior Notes, 9.625% due
11/01/2003 3,000,000 2,790,000
------------ ------------
15,046,032 14,802,069
Drug Stores--5.2% NR* NR* 3,089,250 Duane Reade Co., Term Loan A, due
9/30/1997, 8.875% to 11/30/1995** 3,089,250 3,089,250
NR* Ba3 4,962,312 Thrifty Payless, Inc., Term Loan B,
due 9/30/2001, 9.0625% to 9/22/1995** 4,962,312 4,962,312
------------ ------------
8,051,562 8,051,562
Energy--1.2% BB- B1 2,000,000 Maxus Energy Corp., Senior Notes,
9.375% due 11/01/2003 1,917,703 1,880,000
Fertilizers BB- B1 3,750,000 Sherritt Gordon Ltd., Senior Notes,
- --2.5% 9.75% due 4/01/2003 3,762,500 3,787,500
Food & American Italian Pasta, Term Loan B,
Beverage-- due 3/31/1999:**
12.6% NR* NR* 1,300,000 9.125% to 1/29/1996 1,300,000 1,300,000
NR* NR* 1,300,000 9% to 6/28/1996 1,300,000 1,300,000
NR* NR* 4,000,000 G. Heilman Brewing Co., Term Loan B,
due 12/31/2000, 9.125% due 10/13/1995** 4,000,000 4,000,000
President Baking Company, Inc., Term
Loan B, due 9/30/2000:**
</TABLE>
F-36
<PAGE>
<TABLE>
<C> <C> <C> <C> <S> <C> <C>
NR* NR* 8,532 10.25% to 9/30/1995 8,532 8,532
NR* NR* 4,948,806 8.625% to 12/29/1995 4,948,806 4,948,806
B+ B1 3,000,000 Royal Crown Corp., Senior Secured Notes,
9.75% due 8/01/2000 3,079,625 2,790,000
Specialty Foods Corp., Term Loan B, due
4/30/2001:**
NR* B2 1,666,667 8.1875% to 9/21/1995 1,666,667 1,666,667
NR* B2 1,666,667 8.125% to 10/20/1995 1,666,667 1,666,667
NR* B2 1,666,666 8.0625% to 1/22/1996 1,666,666 1,666,666
------------ ------------
19,636,963 19,347,338
Forest BB- Ba3 2,000,000 Rainy River Forest Products, 10.75% due
Products-- 10/15/2001 1,995,574 2,140,000
2.0% BB B1 1,000,000 Tembec Finance Corp., 9.875% due
9/30/2005 1,000,000 1,000,000
------------ ------------
2,995,574 3,140,000
Grocery--7.3% B- B3 4,000,000 Bruno's Supermarkets, 10.50% due
8/01/2005 4,000,000 3,890,000
B+ NR* 3,959,000 Homeland Stores, Inc., Floating Rate
Senior Secured Notes, 9.062% due
2/28/1997 (1) 3,959,000 3,919,410
AAA AAA 4,000,000 The Penn Traffic Company, Senior Notes,
8.625% due 12/15/2003 3,992,712 3,420,000
------------ ------------
11,951,712 11,229,410
Health Services-- B B2 1,000,000 Charter Medical Corp., Senior Sub-
3.8% ordinated Notes, 11.25% due 4/15/2004 1,000,000 1,072,500
B- B2 1,000,000 Integrated Health Services, Senior
Subordinated Notes, 10.75% due 7/15/2004 1,000,000 1,065,000
B+ B1 4,040,000 MEDIQ/PRN Life Support Services Inc.,
Senior Secured Notes, 11.125% due
7/01/1999 4,103,860 3,757,200
------------ ------------
6,103,860 5,894,700
Leasing & Rental BB- B1 2,000,000 The Scotsman Group, Inc., Senior Secured
Services--1.3% Notes, 9.50% due 12/15/2000 2,000,000 1,965,000
Leisure & B- B3 1,000,000 Alliance Entertainment Corp., 11.25% due
Entertainment 7/15/2005++ 1,002,500 995,000
- --0.6%
Manufacturing-- B- B3 1,000,000 Crain Industries Inc., 13.50% due
0.7% 8/15/2005++ 1,000,000 1,005,000
</TABLE>
F-37
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS (continued)
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1b)
<C> <C> <C> <C> <S> <C> <C>
Marking B+ B2 $1,000,000 Monarch Acquisition Corp., 12.50% due
Devices-- 7/01/2003++ $ 1,000,000 $ 1,015,000
0.7%
Metals--5.1% B B1 2,000,000 Algoma Steel, Inc., 12.375% due 7/15/2005 1,804,335 1,840,000
NR* B1 1,000,000 Gulf States Steel Acquisition Corp.,
13.50% due 4/15/2003++ 989,286 970,000
B B2 2,000,000 Jorgensen (Earle M.) Co., New Senior
Notes, 10.75% due 3/01/2000 2,065,000 1,960,000
B+ B1 2,000,000 WCI Steel Inc., Senior Notes, 10.50%
due 3/01/2002 2,000,000 1,960,000
B B2 1,190,000 Weirton Steel Corp., Senior Notes, 10.75%
due 6/01/2005++ 1,172,371 1,094,800
------------ ------------
8,030,992 7,824,800
Musical NR* B3 1,000,000 Selmer Co., Inc., 11% due 5/15/2005++ 1,000,000 960,000
Instruments--0.6%
Nautical Sperry Marine, Inc., Term Loan, due
Systems-- 11/15/2000:**
1.9% NR* NR* 1,212,906 9.6875% to 9/29/1995 1,212,906 1,212,906
NR* NR* 1,648,984 9.125% to 12/29/1995 1,648,984 1,648,984
------------ ------------
2,861,890 2,861,890
Paper--15.4% Fort Howard Corp., Term Loan B, due
12/31/2002:**
NR* Ba3 2,500,000 9% to 9/19/1995 2,500,000 2,500,000
NR* Ba3 2,500,000 8.88% to 12/19/1995 2,500,000 2,500,000
B B3 1,000,000 Gaylord Container Corp., Senior Notes,
11.50% due 5/15/2001 985,583 1,052,500
Jefferson Smurfit/Container Corp. of
America, Term Loan B, due 5/10/2002:**
NR* B1 187,500 9.4375% to 9/25/1995 187,500 187,500
NR* NR* 816,666 8.9375% to 10/20/1995 816,666 816,666
NR* NR* 3,416,667 9.375% to 10/24/1995 3,416,667 3,416,667
BB- Ba3 1,000,000 Repap New Brunswick Inc., 9.875% due
7/15/2000 1,000,000 1,000,000
NR* Ba2 5,000,000 S.D. Warren Co., Term Loan B,
due 12/19/2002, 8.94% to 9/25/1995 ** 5,000,000 5,000,000
Stone Container Corp., Term Loan B,
due 4/01/2000:**
NR* Ba3 3,450,000 9% to 9/08/1995 3,450,000 3,450,000
NR* Ba3 3,712,500 9% to 10/16/1995 3,712,500 3,712,500
------------ ------------
23,568,916 23,635,833
Printing & NR* NR* 2,496,728 Ziff Davis Acquisition Corp., Term
Publishing--3.1% Loan B, due 12/31/2001, 9.4375% to
9/28/1995** 2,496,728 2,496,728
NR* NR* 2,351,725 Ziff Davis Acquisition Corp., Term
Loan C, due 12/31/2002, 9.9375% to
9/28/1995** 2,351,725 2,351,725
------------ ------------
4,848,453 4,848,453
Restaurants-- BB- NR* 3,000,000 Host Marriott Corp., 9.50% due
1.9% 5/15/2005++ 2,911,739 2,872,500
Retail-- Camelot Music, Inc., Term Loan B,
Specialty-- due 2/28/2001:**
13.2% NR* NR* 1,812,500 8.375% to 9/18/1995 1,812,500 1,812,500
</TABLE>
F-38
<PAGE>
<TABLE>
<C> <C> <C> <C> <S> <C> <C>
NR* NR* 3,062,500 8.9375% to 9/21/1995 3,062,500 3,062,500
B B2 2,000,000 Color Tile Inc., Senior Notes, 10.75%
due 12/15/2001 2,000,000 800,000
Federated Department Stores, Term Loan,
due 3/31/2000:**
NR* Ba1 3,125,000 7.4375% to 9/25/1995 3,125,000 3,125,000
NR* Ba1 1,875,000 7% to 9/29/1995 1,875,000 1,875,000
NR* NR* 7,682,343 Saks & Co., Term Loan Tranche B, due
6/30/2000, 9.25% to 11/09/1995** 7,682,343 7,682,343
B+ B1 2,000,000 Specialty Retailers, Inc., Series A,
Senior Notes, 10% due 8/15/2000 2,007,500 1,930,000
------------ ------------
21,564,843 20,287,343
Security NR* NR* 3,143,760 Alert Centre Inc., Term Loan, due
Systems-- 8/01/2001, 8.875% to 9/05/1995** 3,143,760 3,143,760
2.0%
Shipping--2.9% BB- Ba2 2,500,000 Eletson Holdings, Inc., First Preferred
Shipping Mortgage Notes, 9.25% due
11/15/2003 2,525,000 2,400,000
B+ Ba3 2,000,000 Viking Star Shipping, Inc., First
Preferred Shipping Mortgage Notes,
9.625% due 7/15/2003 2,012,500 2,045,000
------------ ------------
4,537,500 4,445,000
Utilities--1.0% BB Ba2 1,000,000 Cleveland Electric Illuminating Co.,
9.50% due 5/15/2005 998,114 1,001,400
B Ba3 460,000 Public Service Company of New Mexico,
10.30% due 1/15/2014 436,328 473,685
------------ ------------
1,434,442 1,475,085
Warehousing & D Caa 3,000,000 Americold Corp., First Mortgage Bonds,
Storage--1.9% Series B, 11.50% due 3/01/2005 3,067,500 2,910,000
Total Corporate Debt Obligations--128.2% 200,378,488 197,349,238
Shares
Held Warrants
Metals--0.0% NR* NR* 1,000 Gulf States Steel Acquisition Corp. (a) 11,000 1,500
Total Warrants--0.0% 11,000 1,500
</TABLE>
F-39
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS (concluded)
<CAPTION>
SHORT-TERM Value
SECURITIES Face Amount Issue Cost (Note 1b)
<C> <C> <S> <C> <C>
Commercial $ 413,000 General Electric Capital Corp., 5.82%
Paper ***--0.2% due 9/01/1995 $ 413,000 $ 413,000
Total Short-Term Securities--0.2% 413,000 413,000
Total Investments--128.4% $200,802,488 197,763,738
============
Liabilities in Excess of Other
Assets--(28.4%) (43,793,233)
------------
Net Assets--100.0% $153,970,505
============
<FN>
*Not Rated.
**Floating or Variable Rate Corporate Loans--The interest rates on
floating or variable rate corporate loans are subject to change
periodically based on the change in the prime rate of a US Bank,
LIBOR (London Interbank Offered Rate), or, in some cases, another
base lending rate. The interest rates shown are those in effect at
August 31, 1995.
***Commercial Paper is traded on a discount basis; the interest rate
shown is the discount rate paid at the time of purchase by the
Portfolio.
(1)Interest rate resets quarterly and is based on the three-month
LIBOR (London Interbank Offered Rate), plus an interest rate spread
of three hundred basis points.
(a)Warrants entitle the Portfolio to purchase a predetermined number
of shares of common stock. The purchase price and the number of
shares are subject to adjustment under certain conditions until the
expiration date.
++Restricted securities as to resale. The value of the Portfolio's
investment in restricted securities was approximately $15,474,000,
representing 10.05% of net assets.
<CAPTION>
Acquisition Value
Issue Dates Cost (Note 1b)
<S> <C> <C> <C>
Alliance Entertainment Corp.,
11.25% due 7/15/2005 7/20/1995 $1,002,500 $ 995,000
Continental Cablevision, Inc.,
Senior Notes, 9.125%
due 11/01/2004 7/17/1995 2,500,000 2,500,000
Crain Industries Inc.,
13.50% due 8/15/2005 8/15/2005 1,000,000 1,005,000
Granite Broadcasting Corp.,
10.375% due 5/15/2005 5/12/1995 1,000,000 1,013,750
Gulf States Steel
Acquisition Corp., 13.50%
due 4/15/2003 4/12/1995 989,286 970,000
Harvard Industries, Inc.,
Senior Notes,
11.125% due 8/01/2005 7/25/1995 1,000,000 1,012,500
Host Marriott Corp., 9.50% 5/18/1995-
due 5/15/2005 7/31/1995 2,911,739 2,872,500
Monarch Acquisition Corp.,
12.50% due 7/01/2003 6/23/1995 1,000,000 1,015,000
Selmer Co., Inc., 11%
due 5/15/2005 5/18/1995 1,000,000 960,000
Walbro Corp., Senior Notes,
9.875% due 7/15/2005 7/21/1995 996,520 995,000
Weirton Steel Corp., Senior
Notes, 10.75% due 6/01/2005 6/05/1995 1,172,371 1,094,800
Young Broadcasting Corp.,
10.125% due 2/15/2005 6/07/1995 1,000,000 1,040,000
Total $15,572,416 $15,473,550
=========== ===========
Ratings of issues shown have not been audited by Deloitte & Touche LLP.
See Notes to Financial Statements.
</TABLE>
F-40
<PAGE>
<TABLE>
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<CAPTION>
As of August 31, 1995
<C> <S> <C> <C>
Assets: Investments, at value (identified cost--$200,802,488)(Note 1b) $197,763,738
Cash 224,051
Interest receivable 3,410,741
Deferred facility expense (Note 6) 11,853
Deferred organization expenses (Note 1f) 48,500
Prepaid expenses and other assets 6,705
------------
Total assets 201,465,588
------------
Liabilities: Payables:
Loans (Note 6) $ 45,000,000
Dividends to shareholders (Note 1g) 412,976
Interest on loans (Note 6) 213,538
Investment adviser (Note 2) 82,817
Commitment fees 13,489 45,722,820
------------
Deferred income (Note 1e) 1,697,866
Accrued expenses and other liabilities 74,397
------------
Total liabilities 47,495,083
------------
Net Assets: Net assets $153,970,505
============
Capital: Common Stock, par value $.10 per share; 200,000,000 shares
authorized (16,610,527 shares issued and outstanding) $ 1,661,053
Paid-in capital in excess of par 155,927,256
Undistributed investment income--net 2,527,660
Accumulated realized capital losses on investments--net (Note 7) (3,106,714)
Unrealized depreciation on investments--net (3,038,750)
------------
Total capital--Equivalent to $9.27 net asset value per share of
Common Stock (market price--$9.00) $153,970,505
============
See Notes to Financial Statements.
</TABLE>
F-41
<PAGE>
<TABLE>
STATEMENT OF OPERATIONS
<CAPTION>
For the Year Ended August 31, 1995
<C> <S> <C>
Investment Income Interest and discount earned $ 21,141,242
(Note 1e): Facility and other fees 225,084
------------
Total income 21,366,326
------------
Expenses: Loan interest expense (Note 6) 3,900,781
Investment advisory fees (Note 2) 1,056,899
Professional fees 101,510
Facility fee amortization (Note 6) 95,378
Accounting services (Note 2) 90,536
Borrowing costs (Note 6) 76,307
Printing and shareholder reports 53,707
Transfer agent fees (Note 2) 26,026
Directors' fees and expenses 24,544
Custodian fees 21,924
Amortization of organization expenses (Note 1f) 15,730
Pricing services 4,853
Listing fees 250
Other 86,317
------------
Total expenses 5,554,762
------------
Investment income--net 15,811,564
------------
Realized & Realized loss on investments--net (1,837,439)
Unrealized Gain Change in unrealized depreciation on investments--net 1,061,216
(Loss) on ------------
Investments Net Increase in Net Assets Resulting from Operations $ 15,035,341
- --Net (Notes 1c, ============
1e & 3):
See Notes to Financial Statements.
</TABLE>
F-42
<PAGE>
<TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
<CAPTION>
For the Period
For the September 24,
Year Ended 1993++ to
August 31, August 31,
Increase (Decrease) in Net Assets: 1995 1994
<C> <S> <C> <C>
Operations: Investment income--net $ 15,811,564 $ 13,177,415
Realized loss on investments--net (1,837,439) (1,269,275)
Change in unrealized depreciation on investments--net 1,061,216 (4,099,966)
------------ ------------
Net increase in net assets resulting from operations 15,035,341 7,808,174
------------ ------------
Dividends to Investment income--net (14,716,379) (11,744,940)
Shareholders ------------ ------------
(Note 1g):
Net decrease in net assets resulting from dividends to
shareholders (14,716,379) (11,744,940)
------------ ------------
Capital Share Value of shares issued to Common Stock shareholders in
Transactions reinvestment of dividends -- 157,700,000
(Note 4): Offering costs resulting from the issuance of Common Stock -- (211,698)
------------ ------------
Net increase in net assets resulting from capital share
transactions -- 157,488,302
------------ ------------
Net Assets: Total increase in net assets 318,962 153,551,536
Beginning of period 153,651,543 100,007
------------ ------------
End of period* $153,970,505 $153,651,543
============ ============
<FN>
*Undistributed investment income--net $ 2,527,660 $ 1,432,475
============ ============
++Commencement of Operations.
See Notes to Financial Statements.
</TABLE>
F-43
<PAGE>
<TABLE>
STATEMENT OF CASH FLOWS
<CAPTION>
For the Year Ended August 31, 1995
<C> <S> <C>
Cash Provided by Net increase in net assets resulting from operations $ 15,035,341
Operating Adjustments to reconcile net increase in net assets
Activities: resulting from operations to net cash provided by
operating activities:
Decrease in receivables 712,133
Decrease in other assets 162,281
Decrease in other liabilities (139,183)
Realized and unrealized loss on investments--net 776,223
Amortization of discount (215,463)
------------
Net cash provided by operating activities 16,331,332
------------
Cash Provided by Proceeds from sales of long-term investments 118,321,987
Investing Purchases of long-term investments (106,101,208)
Activities: Purchases of short-term investments (292,692,792)
Proceeds from sales and maturities of short-term investments 294,143,338
------------
Net cash provided by investing activities 13,671,325
------------
Cash Used for Short-term borrowings (15,000,000)
Financing Dividends paid to shareholders (14,778,606)
Activities: ------------
Net cash used for financing activities (29,778,606)
------------
Cash: Net increase in cash 224,051
Cash at beginning of year --
------------
Cash at end of year $ 224,051
============
Cash Flow Cash paid for interest $ 3,796,492
Information: ============
See Notes to Financial Statements.
</TABLE>
F-44
<PAGE>
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
The following per share data and ratios have been derived
from information provided in the financial statements. For the For the Period
Year Ended Sept. 24, 1993++
Increase (Decrease) in Net Asset Value: Aug. 31, 1995 to Aug. 31, 1994
<S> <S> <C> <C>
Per Share Net asset value, beginning of period $ 9.25 $ 9.50
Operating ------------ ------------
Performance: Investment income--net .95 .79
Realized and unrealized loss on investments--net (.04) (.32)
------------ ------------
Total from investment operations .91 .47
------------ ------------
Less dividends from investment income--net (.89) (.71)
------------ ------------
Capital charge resulting from the issuance of Common Stock -- (.01)
------------ ------------
Net asset value, end of period $ 9.27 $ 9.25
============ ============
Market price per share, end of period $ 9.00 $ 8.875
============ ============
Total Investment Based on net asset value per share 10.77% 5.08%+++
Return:** ============ ============
Based on market price per share 12.09% (4.22%)+++
============ ============
Ratios to Expenses, net of reimbursement and excluding interest expense 1.08% 1.51%*
Average Net ============ ============
Assets: Expenses, net of reimbursement 3.63% 2.17%*
============ ============
Expenses 3.63% 2.34%*
============ ============
Investment income--net 10.35% 7.14%*
============ ============
Supplemental Net assets, end of period (in thousands) $ 153,971 $ 153,652
Data: ============ ============
Portfolio turnover 51.51% 52.37%
============ ============
Leverage: Amount of borrowings (in thousands) $ 45,000 $ 60,000
------------ ------------
Asset coverage per $1,000 $ 4,422 $ 3,561
------------ ------------
<FN>
*Annualized.
**Total investment returns based on market value, which can be
significantly greater or lesser than the net asset value, result in
substantially different returns. Total investment returns exclude
the effects of sales loads.
++Commencement of Operations.
+++Aggregate total investment return.
See Notes to Financial Statements.
</TABLE>
F-45
<PAGE>
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Senior High Income Portfolio II, Inc. (the "Fund") is registered
under the Investment Company Act of 1940 as a non-diversified,
closed-end management investment company. The Fund determines and
makes available for publication the net asset value of its Common
Stock on a weekly basis. The Fund's Common Stock is listed on the
New York Stock Exchange under the symbol SAL.
(a) Corporate debt obligations--The Fund invests principally in
senior debt obligations ("Senior Debt") of companies, including
corporate loans made by banks and other financial institutions and
both privately and publicly offered corporate bonds and notes.
Because agents and intermediaries are primarily commercial banks,
the Fund's investment in corporate loans could be considered
concentrated in financial institutions.
(b) Valuation of investments--Portfolio securities are valued on the
basis of prices furnished by one or more pricing services, which
determine prices for normal, institutional-size trading units. In
certain circumstances, portfolio securities are valued at the last
sale price on the exchange that is the primary market for such
securities, or the last quoted bid price for those securities for
which there were no sales during the day. The value of interest rate
swaps, caps, and floors is determined in accordance with a formula
and then confirmed periodically by obtaining a bank quotation.
Positions in options are valued at the last sale price on the market
where any such option is principally traded. Securities for which
there exist no price quotations or valuations and all other assets
are valued at fair value as determined in good faith by or on behalf
of the Board of Directors of the Fund. Since corporate loans are
purchased and sold primarily at par value, the Fund values the loans
at par, unless Fund Asset Management, L.P. ("FAM") determines par
does not represent fair value. In the event such a determination is
made, fair value will be determined in accordance with guidelines
approved by the Fund's Board of Directors. Obligations with
remaining maturities of sixty days or less are valued at amortized
cost unless this method no longer produces fair valuations.
(c) Derivative financial instruments--The Fund may engage in various
portfolio strategies to seek to increase its return by hedging its
portfolio against adverse movements in the debt markets. Losses may
arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
* Financial futures contracts--The Fund may purchase or sell
interest rate futures contracts and options on such futures
contracts for the purpose of hedging the market risk on existing
securities or the intended purchase of securities. Futures contracts
are contracts for delayed delivery of securities at a specific
future date and at a specific price or yield. Upon entering into a
contract, the Fund deposits and maintains as collateral such initial
margin as required by the exchange on which the transaction is
effected. Pursuant to the contract, the Fund agrees to receive from
or pay to the broker an amount of cash equal to the daily
fluctuation in value of the contract. Such receipts or payments are
known as variation margin and are recorded by the Fund as unrealized
gains or losses. When the contract is closed, the Fund records a
realized gain or loss equal to the difference between the value of
the contract at the time it was opened and the value at the time it
was closed.
* Options--The Fund is authorized to write and purchase call and put
options. When the Fund writes an option, an amount equal to the
premium received by the Fund is reflected as an asset and an
equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current market value of the option
written. When a security is purchased or sold through an exercise of
an option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from
(or added to) the proceeds of the security sold. When an option
expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums
received or paid (or gain or loss to the extent the cost of the
closing transaction is less than or exceeds the premiums paid or
received).
Written and purchased options are non-income producing investments.
* Interest rate transactions--The Fund is authorized to enter into
interest rate swaps and purchase or sell interest rate caps and
floors. In an interest rate swap, the Fund exchanges with another
party their respective commitments to pay or receive interest on a
specified notional principal amount. The purchase of an interest
rate cap (or floor) entitles the purchaser, to the extent that a
specified index exceeds (or falls below) a predetermined interest
rate, to receive payments of interest equal to the difference
between the index and the predetermined rate on a notional principal
amount from the party selling such interest rate cap (or floor).
F-46
<PAGE>
(d) Income taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required.
(e) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Interest income is recognized on the accrual
basis. Realized gains and losses on security transactions are
determined on the identified cost basis. Facility fees are accreted
to income over the term of the related loan. For income tax purposes
as of September 1, 1994, the corporate loans are treated as discount
obligations.
(f) Deferred organization expenses--Deferred organization expenses
are amortized on a straight-line basis over a five-year period.
(g) Dividends and distributions--Dividends from net investment
income are declared and paid monthly. Distributions of capital
gains are recorded on the ex-dividend dates. The Fund may at times
pay out less than the entire amount of net investment income earned
in any particular period and may at times pay out such accumulated
undistributed income in other periods to permit the Fund to maintain
a more stable level of distributions.
2. Investment Advisory Agreement with Affiliates:
The Fund has entered into an Investment Advisory Agreement with FAM.
The general partner of FAM is Princeton Services, Inc. ("PSI"), an
indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML &
Co."), which is the limited partner.
FAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund. For such
services, the Fund pays a monthly fee at an annual rate of 0.50% of
the Fund's average weekly net assets plus the proceeds of any
outstanding borrowings used for leverage.
Accounting services are provided to the Fund by FAM at cost.
During the year ended August 31, 1995, the Fund paid Merrill Lynch
Security Pricing Service, an affiliate of Merrill Lynch, Pierce,
Fenner & Smith Inc. ("MLPF&S"), $2,724 for security price quotations
to compute the net asset value of the Fund.
Certain officers and/or directors of the Fund are officers and/or
directors of FAM, PSI, MLPF&S, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the year ended August 31, 1995 were $106,101,208 and
$118,321,987, respectively.
Net realized and unrealized losses as of August 31, 1995 were as
follows:
Realized Unrealized
Losses Losses
Long-term investments $(1,836,477) $(3,038,750)
Short-term investments (962) --
----------- -----------
Total $(1,837,439) $(3,038,750)
=========== ===========
As of August 31, 1995, net unrealized depreciation for financial
reporting and Federal income tax purposes aggregated $3,038,750, of
which $1,273,932 related to appreciated securities and $4,312,682
related to depreciated securities. The aggregate cost of investments
at August 31, 1995 for Federal income tax purposes was $200,802,488.
4. Capital Share Transaction:
The Fund is authorized to issue 200,000,000 shares of capital stock
par value $.10, all of which are initially classified as Common
Stock. The Board of Directors is authorized, however, to classify
and reclassify any unissued shares of capital stock without approval
of the holders of Common Stock.
For the year ended August 31, 1995, shares issued and outstanding
remained constant at 16,610,527. At August 31, 1995, total paid-in
capital amounted to $157,588,309.
5. Unfunded Loan Interests:
As of August 31, 1995, the Fund had unfunded loan commitments of
$2,500,000, which would be extended at the option of the borrower,
pursuant to the following loan agreements:
Unfunded Commitment
Borrower (in thousands)
Marcus Cable Co. $2,500
F-47
<PAGE>
NOTES TO FINANCIAL STATEMENTS (concluded)
6. Short-Term Borrowings:
On October 26, 1993, the Fund entered into a credit facility with a
syndicate of banks led by The Bank of New York consisting of a one-
year $60,000,000 revolving credit facility bearing interest on
outstanding balances at an alternate base rate plus 0.20% and/or
LIBOR plus 1.20% and a two-year $20,000,000 term loan facility
bearing interest on outstanding balances at an alternate base rate
plus 0.45% and/or LIBOR plus 1.25%. On October 20, 1994, this credit
facility and all outstanding balances thereunder were refinanced by
a one-year $80,000,000 revolving credit facility extended by a
syndicate of banks led by The Bank of New York and bearing interest
on outstanding balances at the Federal Funds rate plus 1.00% and/or
an alternate base rate plus 0% and/or LIBOR plus 1.00%. For the year
ended August 31, 1995, the maximum amount borrowed was $77,000,000,
the average amount borrowed was approximately $58,512,000 and the
daily weighted average interest rate was 6.67%. For the year ended
August 31, 1995, facility and commitment fees aggregated
approximately $171,685.
7. Capital Loss Carryforward:
At August 31, 1995, the Fund had a net capital loss carryforward of
approximately $1,273,000, all of which expires in 2003. This amount
will be available to offset like amounts of any future taxable
gains.
F-48
<PAGE>
UNAUDITED FINANCIAL STATEMENTS FOR SENIOR STRATEGIC INCOME FUND, INC. FOR THE
SIX-MONTH PERIOD ENDED AUGUST 31, 1995
F-49
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1b)
<S> <S> <S> <C> <S> <C> <C>
Aerospace--2.8% BB- Ba3 $2,000,000 BE Aerospace Inc., Senior Notes, 9.75%
due 3/01/2003 $ 1,937,065 $ 2,000,000
Automotive B B2 1,500,000 Harvard Industries, Inc., Senior Notes,
Products--5.0% 12% due 7/15/2004 1,500,000 1,578,750
B B2 1,000,000 JPS Automotive Products Corp., Senior
Notes, 11.125% due 6/15/2001 1,000,000 995,000
NR+++ NR+++ 1,000,000 ++Walbro Corp., Senior Notes, 9.875% due
7/15/2005 996,520 995,000
----------- -----------
3,496,520 3,568,750
Broadcast/ B- B3 1,000,000 ++Granite Broadcasting Corp., Senior Sub
Media--4.3% Notes, 10.375% due 5/15/2005 1,000,000 1,013,750
B Caa 1,000,000 Marcus Cable Co., Term Loan B, due
4/30/2004, 10.25% to 9/30/1995* 1,000,000 1,000,000
NR+++ B2 1,000,000 ++Young Broadcasting Corp., Senior Notes,
10.125% due 2/15/2005 1,000,000 1,040,000
----------- -----------
3,000,000 3,053,750
Building & B B2 1,000,000 NVR, Inc., Senior Notes, 11% due 4/15/2003 990,975 972,500
Construction-- B- B2 2,000,000 Presley Companies, Senior Notes, 12.50%
5.0% due 7/01/2001 2,000,000 1,660,000
B+ Ba3 1,000,000 US Homes Corp., Senior Notes, 9.75% due
6/15/2003 954,505 985,000
----------- -----------
3,945,480 3,617,500
Building BB- Ba3 1,000,000 Schuller International Group, Senior Notes,
Products--1.5% 10.875% due 12/15/2004 1,000,000 1,097,500
Casinos--2.8% Harrah's Jazz Company, Term Loan B, due
9/30/1999:*
NR+++ NR+++ 333,333 9.125% to 10/23/1995 333,333 333,333
NR+++ NR+++ 666,667 9.1875% to 12/21/1995 666,667 666,667
BB Ba3 1,000,000 ++Players International Inc., Senior Notes,
10.875% due 4/15/2005 1,000,000 985,000
----------- -----------
2,000,000 1,985,000
Chemicals--5.8% BB+ Ba2 500,000 Borden Chemicals and Plastic, L.P., Senior
Notes, 9.50% due 5/01/2005 500,000 502,500
NR+++ NR+++ 1,500,000 Freedom Chemical Co., Term Loan B, due
6/30/2002, 9.1875% to 10/27/1995* 1,500,000 1,500,000
BB- B1 2,000,000 Huntsman Chemical Corp., Senior Notes,
11% due 4/15/2004 2,000,000 2,165,000
----------- -----------
4,000,000 4,167,500
Computers--2.3% BB- Ba3 1,500,000 Dell Computer Corp., Senior Notes, 11%
due 8/15/2000 1,528,125 1,646,250
Consumer B+ Ba3 1,000,000 Coty Inc., Senior Sub Notes, 10.25% due
Products--2.1% 5/01/2005 1,000,000 1,030,000
B+ B2 1,000,000 Drypers Corp., Senior Notes, 12.50%
due 11/01/2002 1,055,000 450,000
----------- -----------
2,055,000 1,480,000
Diversified InterMetro Industries, Term Loan B, due
Manufacturing-- 7/02/2001:*
13.3% NR+++ NR+++ 612,072 8.875% to 1/03/1995 612,072 612,072
NR+++ NR+++ 173,904 8.875% to 9/05/1995 173,904 173,904
InterMetro Industries, Term Loan C, due
12/31/2002:*
NR+++ NR+++ 253,026 9.375% to 9/05/1995 253,026 253,026
NR+++ NR+++ 890,552 9.375% to 1/03/1996 890,552 890,552
B+ B2 1,000,000 JB Poindexter & Co., Inc., Senior Notes,
12.50% due 5/15/2004 995,324 940,000
</TABLE>
F-50
<PAGE>
<TABLE>
<S> <S> <S> <C> <S> <C> <C>
NR+++ NR+++ 6,649,750 Thermadyne Company, Term Loan B, due
2/01/2001, 8.875% to 9/07/1995* 6,649,750 6,649,750
----------- -----------
9,574,628 9,519,304
Drug NR+++ Ba3 2,115,698 Thrifty Payless, Inc., Term Loan B,
Stores--2.9% due 9/30/2001,* 9.0625% to 9/22/1995 2,115,698 2,115,698
Electrical Berg Electronics Inc., Term Loan B,
Instruments due 3/31/2001:*
- --4.1% NR+++ NR+++ 12,500 8.94% to 9/25/1995 12,500 12,500
NR+++ NR+++ 2,950,000 8.94% to 11/27/1995 2,950,000 2,950,000
----------- -----------
2,962,500 2,962,500
Energy--6.7% BB- B1 2,500,000 Ferrellgas Partners, L.P., Senior Notes,
Series B, 9% due 8/01/2001*** 2,489,039 2,493,750
B B3 2,500,000 Gerrity Oil Corp., Senior Sub Notes,
11.75% due 7/15/2004 2,500,000 2,300,000
----------- -----------
4,989,039 4,793,750
Forest BB Ba3 1,000,000 Rainy River Forest Products, Senior
Products--2.9% Notes, 10.75% due 10/15/2001 997,787 1,070,000
BB B1 1,000,000 Tembec Finance Corp., Senior Notes,
9.875% due 9/30/2005 1,000,000 1,000,000
----------- -----------
1,997,787 2,070,000
Grocery--5.4% B- B3 2,000,000 Brunos, Inc., Senior Sub Notes, 10.50%
due 8/01/2005 2,000,000 1,945,000
B+ NR+++ 1,979,000 Homeland Stores, Inc., Floating Rate
Notes, 9.0625% due 2/28/1997*** 1,979,000 1,959,210
----------- -----------
3,979,000 3,904,210
Health B B2 2,000,000 Charter Medical Corp., Senior Sub Notes,
Services--7.9% 11.25% due 4/15/2004 2,000,000 2,145,000
B B1 1,000,000 Integrated Health Services, Inc., 10.75%
due 7/15/2004 1,000,000 1,065,000
B B1 2,650,000 MEDIQ/PRN Life Support Services Inc.,
Senior Secured Notes, 11.125% due
7/01/1999 2,659,125 2,464,500
----------- -----------
5,659,125 5,674,500
Leisure & Enter- B B3 1,000,000 Plitt Theatres, Inc., Senior Sub Notes,
tainment--1.4% 10.875% due 6/15/2004 1,000,000 980,000
Manufacturing B- B3 1,000,000 ++Crain Industries, Inc., Senior Sub Notes,
- --1.4% 13.50% due 8/15/2005 1,000,000 1,005,000
Marking B+ B2 1,000,000 ++Monarch Acquisitions Corp., Senior Notes,
Devices--1.4% 12.50% due 7/01/2003 1,000,000 1,015,000
Metals--8.0% B B1 1,000,000 Algoma Steel Inc., Senior Notes, 12.375%
due 7/15/2005 902,167 920,000
B B1 1,000,000 ++Gulf States Steel Corp., Senior Notes,
13.50% due 4/15/2003 989,286 970,000
B+ B3 1,000,000 Renco Metals Inc., Senior Notes, 12% due
7/15/2000 985,999 1,050,000
B- B3 2,000,000 Russel Metals Inc., Senior Notes, 10.25%
due 6/15/2000 1,968,817 1,855,000
B B2 1,000,000 ++Weirton Steel Corp., Senior Notes,
10.75% due 6/01/2005 985,186 920,000
----------- -----------
5,831,455 5,715,000
Musical NR+++ B1 1,000,000 ++Selmer Co., Inc., Senior Notes, 11%
Instruments--1.3% due 5/15/2005 1,000,000 960,000
</TABLE>
F-51
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS (concluded)
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1b)
<S> <S> <S> <C> <S> <C> <C>
Paper--24.0% Fort Howard Corp., Term Loan B, due
12/31/2002:*
NR+++ NR+++ $ 1,500,000 9% to 9/19/1995 $ 1,500,000 $ 1,500,000
NR+++ NR+++ 1,500,000 8.88% to 12/19/1995 1,500,000 1,500,000
B B3 1,000,000 Gaylord Container Corp., Senior Notes,
11.50% due 5/15/2001 1,022,500 1,052,500
Jefferson Smurfit/Container Corp. of
America, Term Loan B, due 4/30/2002:
NR+++ NR+++ 187,500 9.4375% to 9/25/1995 187,500 187,500
NR+++ NR+++ 816,667 8.9375% to 10/20/1995 816,667 816,667
NR+++ NR+++ 3,416,667 9.375% to 10/24/1995 3,416,667 3,416,667
BB- Ba3 1,000,000 Repap New Brunswick, Senior Secured
Notes, 9.875% due 7/15/2000 1,000,000 1,000,000
NR+++ NR+++ 3,000,000 S.D. Warren Co., Term Loan B, due
12/19/2002, 8.94% to 9/25/1995* 3,000,000 3,000,000
Stone Container Corp., Term Loan B,
due 4/01/2000:*
NR+++ NR+++ 2,300,000 9% to 9/18/1995 2,300,000 2,300,000
NR+++ NR+++ 2,475,000 9% to 10/16/1995 2,475,000 2,475,000
----------- -----------
17,218,334 17,248,334
Printing & NR+++ NR+++ 1,498,037 Ziff Davis Acquisition Corp., Term Loan B,
Publishing--4.0% due 12/31/2001, 9.4375% to 9/28/1995* 1,498,037 1,498,037
NR+++ NR+++ 1,411,035 Ziff Davis Acquisition Corp., Term Loan C,
due 12/31/2002, 9.9375% to 9/28/1995* 1,411,035 1,411,035
----------- -----------
2,909,072 2,909,072
Restaurants BB- B1 1,000,000 ++Host Marriott Corp., Senior Secured
- --1.3% Notes, 9.50% due 5/15/2005 963,953 957,500
Retail-- CCC+ B2 2,000,000 Color Tile, Inc., Senior Notes, 10.75%
Specialty--4.6% due 12/15/2001 1,973,760 800,000
NR+++ NR+++ 2,487,778 Saks & Co., Term Loan B, due 6/30/2000,
9.25% to 11/09/1995* 2,487,778 2,487,778
----------- -----------
4,461,538 3,287,778
Security NR+++ NR+++ 838,948 Alert Centre Inc., Term Loan, due 8/01/2001,
Systems--1.2% 8.875% to 9/05/1995* 838,948 838,948
Shipping--1.3% BB- Ba2 1,000,000 Eletson Holdings, Senior Notes, 9.25% due
11/15/2003 920,686 960,000
Utilities--2.1% BB Ba2 1,000,000 Cleveland Electric Illuminating Company,
First Mortgage Notes, 9.50% due 5/15/2005*** 998,114 1,001,400
BB- B1 460,000 First PV Funding Corp., Senior Notes,
10.30% due 1/15/2014 452,137 473,685
----------- -----------
1,450,251 1,475,085
Warehousing & NR+++ NR+++ 3,000,000 Pierce Leahy Corp., Term Loan B, due
Storage--4.2% 6/30/2001, 9.125% to 9/29/1995* 3,000,000 3,000,000
Total Investments in Corporate Debt
Obligations--131.0% 95,834,204 94,007,929
<CAPTION>
Shares
Held Warrants
<S> <S> <S> <C> <S> <C> <C>
Metals--0.0% NR+++ NR+++ 1,000 Gulf States Steel Corp. (a) 11,000 1,500
</TABLE>
F-52
<PAGE>
<TABLE>
<S> <C> <S> <C> <C>
Total Investments in Warrants--0.0% 11,000 1,500
<CAPTION>
Face
Amount Short-Term Securities
<S> <C> <S> <C> <C>
Commercial $ 907,000 General Electric Capital Corp., 5.82%
Paper**--1.2% due 9/01/1995 907,000 907,000
Total Investments in Short-Term Securities
--1.2% 907,000 907,000
Total Investments--132.2% $96,752,204 94,916,429
===========
Liabilities in Excess of Other Assets--
(32.2%) (23,135,519)
-----------
Net Assets--100.0% $71,780,910
===========
<FN>
(a)Warrants entitle the Fund to purchase a predetermined number of
shares of common stock/face amount of bonds. The purchase price and
the number of shares/face amount are subject to adjustment under
certain conditions until the expiration date.
*Floating or Variable Rate Corporate Loans--The interest rates on
floating or variable rate corporate loans are subject to change
periodically based on the change in the prime rate of a US Bank,
LIBOR (London Interbank Offered Rate), or, in some cases, another
base lending rate. The interest rates shown are those in effect at
August 31, 1995.
**Commercial Paper is traded on a discount basis; the interest rate
shown is the discount rate paid at the time of purchase by the Fund.
***Floating or Variable Rate Corporate Bonds--The interest rates on
floating or variable rate corporate bonds are subject to change
periodically based on the change in the prime rate of a US Bank,
LIBOR (London Interbank Offered Rate), or, in some cases, another
base lending rate. The interest rates shown are those in effect at
August 31, 1995.
+++Not Rated.
++Restricted securities as to resale. The value of the Fund's
investment in restricted securities was approximately $8,866,000,
representing 12.4% of net assets.
<CAPTION>
Acquisition Value
Issue Date Cost (Note 1b)
<S> <C> <C> <C>
Crain Industries, Inc.,
Senior Sub Notes, 13.50% due 8/15/2005 8/22/1995 $1,000,000 $1,005,000
Granite Broadcasting Corp.,
Senior Sub Notes, 10.375% due 5/15/2005 5/12/1995 1,000,000 1,013,750
Gulf States Steel Corp.,
Senior Notes, 13.50% due 4/15/2003 4/12/1995 989,286 970,000
Host Marriott Corp.,
Senior Secured Notes, 9.50% due 5/15/2005 5/18/1995 963,953 957,500
Monarch Acquisitions Corp.,
Senior Notes, 12.50% due 7/01/2003 6/23/1995 1,000,000 1,015,000
Players International Inc.,
Senior Notes, 10.875%, due 4/15/2005 4/10/1995 1,000,000 985,000
Selmer Co., Inc., Senior Notes, 11% due 5/15/2005 5/18/1995 1,000,000 960,000
Weirton Steel Corp., Senior Notes, 10.75% due 6/01/2005 6/05/1995 985,186 920,000
Walbro Corp., Senior Notes, 9.875% due 7/15/2005 7/21/1995 996,520 995,000
Young Broadcasting Corp.,
Senior Notes, 10.125% due 2/15/2005 6/07/1995 1,000,000 1,040,000
Total $9,934,945 $9,861,250
========== ==========
See Notes to Financial Statements.
</TABLE>
F-53
<PAGE>
<TABLE>
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<CAPTION>
As of August 31, 1995
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$96,752,204)
(Note 1b) $ 94,916,429
Cash 1,907
Interest receivable 1,614,136
Deferred facility expense (Note 6) 6,247
Deferred organization expense (Note 1f) 83,551
Prepaid expenses and other assets 1,016
------------
Total assets 96,623,286
------------
Liabilities: Payables:
Loans (Note 6) $ 24,000,000
Dividends to shareholders (Note 1g) 198,885
Interest on loans (Note 6) 110,597
Investment adviser (Note 2) 39,023
Commitment fees 4,222 24,352,727
------------
Deferred income (Note 1e) 483,431
Accrued expenses and other liabilities 6,218
------------
Total liabilities 24,842,376
------------
Net Assets: Net assets $ 71,780,910
============
Capital: Common Stock, par value $.10 per share; 200,000,000 shares
authorized (7,750,527 shares issued and outstanding) $ 775,053
Paid-in capital in excess of par 72,670,947
Undistributed investment income--net 935,300
Accumulated realized capital losses on investments--net (764,615)
Unrealized depreciation on investments--net (1,835,775)
------------
Total capital--Equivalent to $9.26 net asset value per share of
Common Stock (market price--$9.125) $ 71,780,910
============
See Notes to Financial Statements.
</TABLE>
F-54
<PAGE>
<TABLE>
STATEMENT OF OPERATIONS
<CAPTION>
For the Six Months Ended August 31, 1995
<S> <S> <C>
Investment Income Interest and discount earned $ 4,977,913
(Note 1e): ------------
Expenses: Loan interest expense (Note 6) 775,868
Investment advisory fees (Note 2) 237,873
Professional fees 54,283
Accounting services (Note 2) 27,547
Printing and shareholder reports 26,645
Facility fee amortization (Note 6) 13,594
Directors' fees and expenses 12,317
Borrowing costs (Note 6) 12,292
Amortization of organization expenses (Note 1f) 9,718
Custodian fees 6,021
Transfer agent fees (Note 2) 5,901
Pricing services 1,509
Listing fees 119
Other 9,978
------------
Total expenses 1,193,665
------------
Investment income--net 3,784,248
------------
Realized & Realized gain on investments--net 79,005
Unrealized Change in unrealized depreciation on investments--net (321,109)
Gain (Loss) on ------------
Investments--Net Net Increase in Net Assets Resulting from Operations $ 3,542,144
(Notes 1c, ============
1e & 3):
See Notes to Financial Statements.
</TABLE>
F-55
<PAGE>
<TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
<CAPTION>
For the Six For the Period
Months Ended April 8, 1994++
August 31, to February 28,
Increase (Decrease) in Net Assets: 1995 1995
<S> <S> <C> <C>
Operations: Investment income--net $ 3,784,248 $ 6,262,806
Realized gain (loss) on investments--net 79,005 (706,692)
Change in unrealized depreciation on investments--net (321,109) (1,514,666)
------------ ------------
Net increase in net assets resulting from operations 3,542,144 4,041,448
------------ ------------
Dividends & Investment income--net (3,612,800) (5,498,954)
Distributions to Realized gain on investments--net -- (136,928)
Shareholders ------------ ------------
(Note 1g):
Net decrease in net assets resulting from dividends and
distributions to shareholders (3,612,800) (5,635,882)
------------ ------------
Capital Share Net proceeds from issuance of Common Stock -- 73,530,000
Transactions Offering costs resulting from the issuance of Common Stock -- (184,007)
(Note 4): ------------ ------------
Net increase in net assets resulting from capital share
transactions -- 73,345,993
------------ ------------
Net Assets: Total increase (decrease) in net assets (70,656) 71,751,559
Beginning of period 71,851,566 100,007
------------ ------------
End of period* $ 71,780,910 $ 71,851,566
============ ============
<FN>
*Undistributed investment income--net $ 935,300 $ 763,852
============ ============
++Commencement of Operations.
See Notes to Financial Statements.
</TABLE>
F-56
<PAGE>
<TABLE>
STATEMENT OF CASH FLOWS
For the Six Months Ended August 31, 1995
<S> <S> <C>
Cash Provided Net increase in net assets resulting from operations $ 3,542,144
by Operating Adjustments to reconcile net increase in net assets resulting from
Activities: operations to net cash provided
by operating activities:
Increase in receivables 115,654
Increase in other liabilities (150,559)
Realized and unrealized loss on investments--net 242,104
Amortization of premium and discount (9,275)
------------
Net cash provided by operating activities 3,740,068
------------
Cash Used for Proceeds from sales of long-term investments 30,403,554
Investing Purchases of long-term investments (32,826,136)
Activities: Purchases of short-term investments (77,542,428)
Proceeds from sales and maturities of short-term investments 76,818,000
------------
Net cash used for investing activities (3,147,010)
------------
Cash Used for Dividends paid to shareholders (3,638,215)
Financing Short-term borrowings 3,000,000
Activities: ------------
Net cash used for financing activities (638,215)
------------
Cash: Net decrease in cash (45,157)
Cash at beginning of period 47,064
------------
Cash at end of period $ 1,907
============
Cash Flow Cash paid for interest $ 779,171
Information: ============
See Notes to Financial Statements.
</TABLE>
F-57
<PAGE>
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
The following per share data and ratios have been derived For the Six For the Period
from information provided in the financial statements. Months Ended April 8, 1994++
Aug. 31, to Feb. 28,
Increase (Decrease) in Net Asset Value: 1995 1995
<S> <S> <C> <C>
Per Share Net asset value, beginning of period $ 9.27 $ 9.50
Operating ------------ ------------
Performance: Investment income--net .49 .81
Realized and unrealized loss on investments--net (.03) (.29)
------------ ------------
Total from investment operations .46 .52
------------ ------------
Less dividends and distributions from:
Investment income--net (.47) (.71)
Realized gain on investments--net -- (.02)
------------ ------------
Total dividends and distributions (.47) (.73)
------------ ------------
Capital charge resulting from the issuance of Common Stock -- (.02)
------------ ------------
Net asset value, end of period $ 9.26 $ 9.27
============ ============
Market price per share, end of period $ 9.125 $ 9.125
============ ============
Total Investment Based on net asset value per share 5.22%+++ 5.73%+++
Return:** ============ ============
Based on market price per share 5.34%+++ (1.13%)+++
============ ============
Ratios to Average Expenses, net of reimbursement and excluding interest expense 1.04%* .65%*
Net Assets: ============ ============
Expenses, net of reimbursement 2.97%* 2.15%*
============ ============
Expenses 2.97%* 2.44%*
============ ============
Investment income--net 9.40%* 8.42%*
============ ============
Supplemental Net assets, end of period (in thousands) $ 71,781 $ 71,852
Data: ============ ============
Portfolio turnover 32.79% 33.38%
============ ============
<FN>
++Commencement of Operations.
+++Aggregate total investment return.
*Annualized.
**Total investment returns based on market value, which can be
significantly greater or lesser than the net asset value, may result
in substantially different returns. Total investment returns exclude
the effects of sales loads.
See Notes to Financial Statements.
</TABLE>
F-58
<PAGE>
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Senior Strategic Income Fund, Inc. (the "Fund") is registered under
the Investment Company Act of 1940 as a non-diversified, closed-end
management investment company. These unaudited financial statements
reflect all adjustments which are, in the opinion of management,
necessary to a fair statement of the results for the interim period
presented. All such adjustments are of a normal recurring nature.
The Fund determines and makes available for publication the net
asset value of its Common Stock on a weekly basis. The Fund's Common
Stock is listed on the New York Stock Exchange under the symbol SSN.
(a) Corporate debt obligations--The Fund invests principally in
senior debt obligations ("Senior Debt") of companies, including
corporate loans made by banks and other financial institutions and
both privately and publicly offered corporate bonds and notes.
(b) Valuation of investments--Portfolio securities are valued on the
basis of prices furnished by one or more pricing services, which
determine prices for normal, institutional-size trading units. In
certain circumstances, portfolio securities are valued at the last
sale price on the exchange that is the primary market for such
securities, or the last quoted bid price for those securities for
which the over-the-counter market is the primary market or for
listed securities in which there were no sales during the day. The
value of interest rate swaps, caps, and floors is determined in
accordance with a formula and then confirmed periodically by
obtaining a bank quotation. Positions in options are valued at the
last sale price on the market where any such option is principally
traded. Securities for which there exist no price quotations or
valuations and all other assets are valued at fair value as
determined in good faith by or on behalf of the Board of Directors
of the Fund. Since corporate loans are purchased and sold primarily
at par value, the Fund values the loans at par, unless Fund Asset
Management, L.P. ("FAM") determines par does not represent fair
value. In the event such a determination is made, fair value will be
determined in accordance with guidelines approved by the Fund's
Board of Directors. Obligations with remaining maturities of sixty
days or less are valued at amortized cost, which approximates market
value, unless this method no longer produces fair valuations.
(c) Derivative financial instruments--The Fund may engage in various
portfolio strategies to seek to increase its return by hedging its
portfolio against adverse movements in the debt markets. Losses may
arise due to changes in the value of the contract or if the
counterparty does not perform under the contract.
* Financial futures contracts--The Fund may purchase or sell stock
index futures contracts and options on such futures contracts for
the purpose of hedging the market risk on existing securities or the
intended purchase of securities. Futures contracts are contracts for
delayed delivery of securities at a specific future date and at a
specific price or yield. Upon entering into a contract, the Fund
deposits and maintains as collateral such initial margin as required
by the exchange on which the transaction is effected. Pursuant to
the contract, the Fund agrees to receive from or pay to the broker
an amount of cash equal to the daily fluctuation in value of the
contract. Such receipts or payments are known as variation margin
and are recorded by the Fund as unrealized gains or losses. When the
contract is closed, the Fund records a realized gain or loss equal
to the difference between the value of the contract at the time it
was opened and the value at the time it was closed.
* Options--The Fund is authorized to write and purchase call and put
options. When the Fund writes an option, an amount equal to the
premium received by the Fund is reflected as an asset and an
equivalent liability. The amount of the liability is subsequently
marked to market to reflect the current value of the option written.
When a security is sold through an exercise of an option, the
related premium paid (or received) is added to (or deducted from)
the basis of the security acquired or deducted from (or added to)
the proceeds of the security sold. When an option expires (or the
Fund enters into a closing transaction), the Fund realizes a gain or
loss on the option to the extent of the premiums received or paid
(or gain or loss to the extent the cost of the closing transaction
exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
F-59
<PAGE>
NOTES TO FINANCIAL STATEMENTS (concluded)
* Interest rate transactions--The Fund is authorized to enter into
interest rate swaps and purchase or sell interest rate caps and
floors. In an interest rate swap, the Fund exchanges with another
party their respective commitments to pay or receive interest on a
specified notional principal amount. The purchase of an interest
rate cap (or floor) entitles the purchaser, to the extent that a
specified index exceeds (or falls below) a predetermined interest
rate, to receive payments of interest equal to the difference
between the index and the predetermined rate on a notional principal
amount from the party selling such interest rate cap (or floor).
(d) Income taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required.
(e) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Interest income is recognized on the accrual
basis. Realized gains and losses on security transactions are
determined on the identified cost basis. Facility fees are accreted
to income over the term of the related loan.
(f) Deferred organization expenses--Deferred organization expenses
are amortized on a straight-line basis over a five-year period.
(g) Dividends and distributions--Dividends from net investment
income are declared and paid monthly. Distributions of capital gains
are recorded on the ex-dividend dates. The Fund may at times pay out
less than the entire amount of net investment income earned in any
particular period and may at times pay out such accumulated
undistributed income in other periods to permit the Fund to maintain
a more stable level of distributions.
2. Investment Advisory Agreement with Affiliates:
The Fund has entered into an Investment Advisory Agreement with FAM.
The general partner of FAM is Princeton Services, Inc. ("PSI"), an
indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML &
Co."), which is the limited partner.
FAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund. For such
services, the Fund pays a monthly fee at an annual rate of 0.50% of
the Fund's average weekly net assets plus the proceeds of any
outstanding borrowings used for leverage.
Accounting services are provided to the Fund by FAM at cost.
During the six months ended August 31, 1995, the Fund paid Merrill
Lynch Security Pricing Service, an affiliate of Merrill Lynch,
Pierce, Fenner & Smith Inc. ("MLPF&S"), $181 for security price
quotations to compute the net asset value of the Fund.
Certain officers and/or directors of the Fund are officers and/or
directors of FAM, PSI, MLPF&S, and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for six months ended August 31, 1995 were $32,826,136 and
$30,403,554, respectively.
F-60
<PAGE>
Net realized and unrealized gains (losses) as of August 31, 1995
were as follows:
Realized Unrealized
Gains Losses
Long-term investments $ 79,005 $(1,835,775)
----------- -----------
Total $ 79,005 $(1,835,775)
=========== ===========
As of August 31, 1995, net unrealized depreciation for financial
reporting and Federal income tax purposes aggregated $1,835,775, of
which $1,121,960 related to appreciated securities and $2,957,735
related to depreciated securities. The aggregate cost of investments
at August 31, 1995 for Federal income tax purposes was $96,752,204.
4. Capital Share Transactions:
The Fund is authorized to issue 200,000,000 shares of capital stock
par value $.10, all of which are initially classified as Common
Stock. The Board of Directors is authorized, however, to classify
and reclassify any unissued shares of capital stock without approval
of the holders of Common Stock.
For the six months ended August 31, 1995, shares issued remained
constant at 7,750,527. At August 31, 1995, total paid-in capital
amounted to $73,446,000.
5. Unfunded Loan Interests:
As of August 31, 1995, the Fund had unfunded loan commitments of
$1,000,000 which would be extended at the option of the borrower,
pursuant to the following loan agreements:
Unfunded
Committment
Borrower (in thousands)
Marcus Cable Co. $1,000
6. Short-Term Borrowings:
On May 25, 1994, the Fund entered into a one-year revolving credit
facility in the amount of $35,000,000 with a syndicate of banks
led by the Bank of New York bearing interest on the outstanding
balance at the Federal Funds rate plus 1.125% and/or at an alternate
base rate plus 0.125% and/or at LIBOR plus 1.125%. On May 24, 1995
this facility was extended for one additional year and amended to
reduce applicable interest rates on outstanding balances to Federal
Funds rate plus 0.75%, alternate base rate plus 0%, and/or LIBOR
plus 0.75%. For the six months ended August 31, 1995, the maximum
amount borrowed was $25,000,000, the average amount borrowed was
approximately $23,000,000, and the daily weighted average interest
rate was 6.87%. For the six months ended August 31, 1995, facility
and commitment fees aggregated approximately $13,000.
7. Subsequent Event:
On September 11, 1995, the Board of Directors of the Fund declared
an ordinary income dividend in the amount of $0.079836 per share,
payable on September 29, 1995 to shareholders of record as of
September 22, 1995.
F-61
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
F-62
<PAGE>
AUDITED FINANCIAL STATEMENTS FOR SENIOR STRATEGIC INCOME FUND, INC. FOR THE
FISCAL YEAR ENDED FEBRUARY 28, 1995
F-63
<PAGE>
INDEPENDENT AUDITORS' REPORT
THE BOARD OF DIRECTORS AND SHAREHOLDERS,
SENIOR STRATEGIC INCOME FUND, INC.:
We have audited the accompanying statement of assets, liabilities and
capital, including the schedule of investments, of Senior Strategic Income
Fund, Inc. as of February 28, 1995, the related statements of operations,
changes in net assets, and cash flows for the period April 8, 1994
(commencement of operations) to February 28, 1995 and the financial highlights
for the period April 8, 1994 (commencement of operations) to February 28, 1995.
These financial statements and the financial highlights are the responsibility
of the Fund's management. Our responsibility is to express an opinion on these
financial statements and the financial highlights based on our audit.
We conducted our audit 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 the 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 securities owned at
February 28, 1995 by correspondence with the custodian. 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 audit provides a reasonable basis for our opinion.
In our opinion, such financial statements and the financial highlights
present fairly, in all material respects, the financial position of Senior
Strategic Income Fund, Inc. as of February 28, 1995, the results of its
operations, the changes in its net assets, its cash flows, and the financial
highlights for the period April 8, 1994 to February 28, 1995 in conformity with
generally accepted accounting principles.
As discussed in Notes 1a and 1b, the financial statements include corporate
loans valued at $46,233,630 (64% of total net assets and 50% of total
investments of the Fund), whose values are fair values as determined by or
under the direction of the Board of Directors in the absence of actual market
values. Determination of fair value involves subjective judgment, as the actual
market value of particular corporate loans can be established only by
negotiation between the parties in a sales transaction. We have reviewed the
procedures established by the Board of Directors and used by the Fund's
investment adviser in determining the fair values of such corporate loans and
have inspected underlying documentation, and under the circumstances, we
believe that the procedures are reasonable and the documentation appropriate.
Deloitte & Touche LLP
Princeton, New Jersey
April 14, 1995
F-64
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1b)
<S> <S> <S> <C> <S> <C> <C>
Aerospace--2.7% BB- Ba3 $2,000,000 BE Aerospace Inc., Senior Notes, 9.75% due
3/01/2003 $ 1,934,331 $ 1,940,000
Automotive B B3 1,000,000 Doehler Jarvis, Inc., Senior Notes, 11.875%
Products-- due 6/01/2002 998,223 1,025,000
5.0% B B2 1,500,000 Harvard Industries, Inc., Senior Notes, 12.00%
due 7/15/2004 1,500,000 1,541,250
B B2 1,000,000 JPS Automotive Products Corp., Senior Notes,
11.125% due 6/15/2001 1,000,000 987,500
----------- -----------
3,498,223 3,553,750
Broadcast/ B Caa 2,650,000 Marcus Cable, Senior Debentures, 11.875% due
Media-- 10/01/2005 2,630,813 2,610,250
3.6%
Building & B B2 1,000,000 NVR, Inc., Senior Notes, 11.00% due 4/15/2003 990,602 895,000
Construction-- B- B2 2,000,000 Presley Companies, Senior Notes, 12.50% due
4.9% 7/01/2001 2,000,000 1,720,000
B+ Ba3 1,000,000 US Homes Corp., Senior Notes, 9.75% due
6/15/2003 952,639 910,000
----------- -----------
3,943,241 3,525,000
Building BB- Ba3 1,000,000 Schuller International Group, Senior Notes,
Products-- 10.875% due 12/15/2004 1,000,000 1,056,250
1.5%
Chemicals--5.0% NR+++ NR+++ 1,500,000 Freedom Chemical, Term Loan B, due 6/30/2002,
9.625% to 4/27/1995* 1,500,000 1,500,000
BB- B1 2,000,000 Huntsman Chemical, Senior Notes, 11.00% due
4/l5/2004 2,000,000 2,130,000
----------- -----------
3,500,000 3,630,000
Computers--2.2% BB- B1 1,500,000 Dell Computer Corp., Senior Notes, 11.00%
due 8/15/2000 1,528,125 1,593,750
Consumer B+ B2 1,000,000 Drypers Corp., Senior Notes, 12.50% due
Products-- 11/01/2002 1,055,000 1,005,000
1.4%
Diversified NR+++ NR+++ 785,976 Intermetro Industries, Term Loan B, due
Manufacturing 6/30/2001, 10.00% to 7/03/1995* 785,976 785,976
- --13.3% NR+++ NR+++ 1,143,578 Intermetro Industries, Term Loan C, due
6/30/2002, 10.50% to 7/03/1995* 1,143,578 1,143,578
B B2 1,000,000 JB Poindexter & Co.,Inc., Senior Notes,
12.50% due 5/15/2004 995,177 950,000
Thermadyne Company, Term Loan B, due
2/01/2001:*
NR+++ NR+++ 1,036 10.75% to 3/31/1995 1,036 1,036
NR+++ NR+++ 5,836,598 8.3125% to 4/03/1995 5,836,598 5,836,598
NR+++ NR+++ 828,866 9.3125% to 5/03/1995 828,866 828,866
----------- -----------
9,591,231 9,546,054
Electrical Berg Electronics Inc., Term Loan B, due
Instruments-- 6/30/2001:*
4.2% NR+++ NR+++ 12,500 9.07% to 3/30/1995 12,500 12,500
NR+++ NR+++ 2,975,000 9.375% to 5/25/1995 2,975,000 2,975,000
----------- -----------
2,987,500 2,987,500
</TABLE>
F-65
<PAGE>
<TABLE>
SCHEDULE OF INVESTMENTS (concluded)
<CAPTION>
S&P Moody's Face Value
INDUSTRIES Rating Rating Amount Corporate Debt Obligations Cost (Note 1b)
<S> <S> <S> <C> <S> <C> <C>
Energy--8.4% BB- B1 $2,500,000 Ferrellgas Partners, L.P., Series B,
Floating Rate Notes, 9.4375% due 8/01/2001*** $ 2,488,332 $ 2,487,500
B B2 2,500,000 Gerrity Oil & Gas Corp., Senior Sub Notes,
11.75% due 7/15/2004 2,500,000 2,100,000
B- B3 1,725,000 Presidio Oil Company, Senior Secured Notes,
11.50% due 9/15/2000 1,727,156 1,431,750
----------- -----------
6,715,488 6,019,250
Food & Specialty Foods Corp., Term Loan B, due
Beverage-- 8/31/1999:*
4.0% NR+++ NR+++ 1,367,211 9.13% to 4/18/1995 1,367,211 1,367,211
NR+++ NR+++ 1,514,818 10.00% to 7/18/1995 1,514,818 1,514,818
----------- -----------
2,882,029 2,882,029
Forest BB Ba3 1,000,000 Rainy River Forest Products, Senior Notes,
Products-- 10.75% due 10/15/2001 997,661 1,022,500
1.4%
Fuel Petrolane Inc., Term Loan, due 3/20/1996:*
Distribution NR+++ NR+++ 2,727,829 8.312% to 3/30/1995 2,727,829 2,727,829
- --4.0% NR+++ NR+++ 104,298 8.312% to 4/03/1995 104,298 104,298
----------- -----------
2,832,127 2,832,127
Grocery--3.5% B+ NR+++ 2,500,000 Homeland Stores, Inc., Floating Rate
Notes, 9.0625% due 2/28/1997*** 2,462,969 2,512,708
Health B B2 2,000,000 Charter Medical Corp., Senior Sub Notes,
Services-- 11.25% due 4/15/2004 2,000,000 2,080,000
7.7% B- B2 1,000,000 Integrated Health Services, 10.75% due
7/15/2004 1,000,000 1,030,000
B+ B1 2,650,000 MEDIQ/PRN Life Support Services Inc.,
Senior Secured Notes, 11.125% due 7/01/1999 2,659,125 2,438,000
----------- -----------
5,659,125 5,548,000
Leisure & Enter- B B3 1,000,000 Plitt Theatres, Inc., Senior Sub Notes,
tainment--1.3% 10.875% due 6/15/2004 1,000,000 950,000
Metals--5.3% B1 B3 2,000,000 Federal Industries Ltd., 10.25% due
6/15/2000 1,966,349 1,880,000
B B2 2,000,000 Weirton Steel Corp., Senior Notes, 10.875%
due 10/15/1999 2,050,000 1,962,500
----------- -----------
4,016,349 3,842,500
Paper--27.9% NR+++ NR+++ 5,000,000 Fort Howard Corp., Term Loan B, due 5/01/1997,
10.75%* 5,000,000 5,000,000
B B3 2,000,000 Gaylord Container Corp., Senior Notes, 11.50%
due 5/15/2001 2,042,500 2,090,000
Jefferson Smurfit/Container Corp. of America,
Term Loan B, due 4/30/2002:*
NR+++ NR+++ 333,333 9.1875% to 3/24/1995 333,333 333,333
NR+++ NR+++ 4,666,667 9.3125% to 4/24/1995 4,666,667 4,666,667
NR+++ NR+++ 3,000,000 S.D. Warren Co., Term Loan B, due 12/19/2002,
9.50% to 8/23/1995* 3,000,000 3,000,000
Stone Container Corp., Term Loan B, due
4/01/2000:*
NR+++ NR+++ 2,500,000 9.25% to 3/17/1995 2,500,000 2,500,000
NR+++ NR+++ 2,500,000 9.3125% to 4/14/1995 2,500,000 2,500,000
----------- -----------
20,042,500 20,090,000
</TABLE>
F-66
<PAGE>
<TABLE>
<S> <S> <S> <C> <S> <C> <C>
Publishing--4.2% NR+++ NR+++ 1,544,118 Ziff Davis Holding Corp., Term Loan B, due
12/31/2001, 9.38% to 3/28/1995* 1,544,118 1,544,118
NR+++ NR+++ 1,455,882 Ziff Davis Holding Corp., Term Loan C, due
12/31/2002, 9.88% to 3/28/1995* 1,455,882 1,455,882
----------- -----------
3,000,000 3,000,000
Retail B B2 2,000,000 Color Tile, Inc., Senior Notes, 10.75% due
Specialty-- 12/15/2001 1,972,327 1,620,000
5.7% NR+++ NR+++ 2,487,778 Saks & Co., Term Loan B, due 6/30/2000, 9.13%
to 5/09/1995* 2,487,778 2,487,778
----------- -----------
4,460,105 4,107,778
Security NR+++ NR+++ 948,142 Alert Centre Inc., Term Loan, due 8/1/2001,
Systems--1.3% 8.375% to 8/05/1995* 948,142 948,142
Shipping--2.3% BB- Ba2 1,000,000 Eleston Holdings, Senior Notes, 9.25% due
11/15/2003 917,692 937,500
B B2 800,000 OMI Corp., Senior Notes, 10.25% due 11/01/2003 756,511 688,000
----------- -----------
1,674,203 1,625,500
Utilities--2.8% B Ba3 1,000,000 First PV Funding Corp., 10.30% due 1/15/2014 982,752 995,000
B B1 1,000,000 Texas--New Mexico Power Company, Secured
Debentures, 10.75% due 9/15/2003 1,010,000 1,014,160
----------- -----------
1,992,752 2,009,160
Warehousing & Pierce Leahy Corp., Term Loan B, due
Storage--4.2% 6/30/2001:*
NR+++ NR+++ 1,909,091 9.562% to 4/28/1995 1,909,091 1,909,091
NR+++ NR+++ 1,090,909 9.937% to 7/31/1995 1,090,909 1,090,909
----------- -----------
3,000,000 3,000,000
Total Investments in Corporate Debt
Obligations--127.8% 93,351,914 91,837,248
<CAPTION>
Short-Term Securities
<S> <C> <S> <C> <C>
Commercial 165,000 General Electric Capital Corp., 6.00% due
Paper**--0.2% 3/01/1995 165,000 165,000
Total Investments in Short-Term Securities--0.2% 165,000 165,000
Total Investments--128.0% $93,516,914 92,002,248
===========
Liabilities in Excess of Other Assets--(28.0%) (20,150,682)
-----------
Net Assets--100.0% $71,851,566
===========
<FN>
*Floating or Variable Rate Corporate Loans--The interest rates on float-
ing or variable rate corporate loans are subject to change periodically
based on the change in the prime rate of a US Bank, LIBOR (London
Interbank Offered Rate), or, in some cases, another base lending rate. The
interest rates shown are those in effect at February 28, 1995.
**Commercial Paper is traded on a discount basis; the interest rate shown
is the discount rate paid at the time of purchase by the Fund.
***Floating or Variable Rate Corporate Bonds--The interest rates on
floating or variable rate corporate bonds are subject to change
periodically based on the change in the prime rate of a US Bank,
LIBOR (London Interbank Offered Rate), or, in some cases, another
base lending rate. The interest rates shown are those in effect at
February 28, 1995.
+++Not Rated.
Ratings of issues shown have not been audited by Deloitte & Touche
LLP.
See Notes to Financial Statements.
</TABLE>
F-67
<PAGE>
<TABLE>
STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
<CAPTION>
As of February 28, 1995
<S> <S> <C> <C>
Assets: Investments, at value (identified cost--$93,516,914) (Note 1b) $ 92,002,248
Cash 47,064
Interest receivable 1,729,790
Deferred facility expense (Note 5) 6,247
Deferred organization expense (Note 1f) 83,551
Prepaid expenses and other assets 1,016
------------
Total assets 93,869,916
------------
Liabilities: Payables:
Loans (Note 5) 21,000,000
Dividends to shareholders (Note 1g) 224,300
Interest on loans (Note 5) 113,900
Investment adviser (Note 2) 36,720
Commitment fees 2,383 21,377,303
------------
Deferred income (Note 1e) 557,497
Accrued expenses and other liabilities 83,550
------------
Total liabilities 22,018,350
------------
Net Assets: Net assets $ 71,851,566
============
Capital: Common stock, par value $.10 per share; 200,000,000 shares
authorized (7,750,527 shares issued and outstanding) $ 775,053
Paid-in capital in excess of par 72,670,947
Undistributed investment income--net 763,852
Accumulated realized capital losses on investments--net (843,620)
Unrealized depreciation on investments--net (Note 3) (1,514,666)
------------
Total Capital--Equivalent to $9.27 net asset value per share of
Common Stock (market price--$9.125) $ 71,851,566
============
See Notes to Financial Statements.
</TABLE>
F-68
<PAGE>
<TABLE>
STATEMENT OF OPERATIONS
<CAPTION>
For the Period April 8, 1994++ to February 28, 1995
<S> <S> <C> <C>
Investment Income Interest and discount earned $ 7,843,533
(Note 1e): Facility and other fees 21,499
------------
Total income 7,865,032
Expenses: Loan interest expenses (Note 5) $ 1,122,572
Investment advisory fees (Note 2) 415,168
Accounting services (Note 2) 56,391
Facility fee amortization (Note 5) 53,753
Professional fees 42,664
Directors' fees and expenses 26,694
Amortization of organization expenses (Note 1f) 18,238
Borrowing costs (Note 5) 17,928
Transfer agent fees (Note 2) 13,129
Printing and shareholder reports 12,337
Custodian fees 11,977
Pricing services 1,255
Other 21,033
------------
Total expenses before reimbursement 1,813,139
Reimbursement of expenses (Note 2) (210,913)
------------
Total expenses after reimbursement 1,602,226
------------
Investment income--net 6,262,806
------------
Realized Realized loss on investments--net (706,692)
& Unrealized Unrealized depreciation on investments--net (1,514,666)
Gain (Loss) on ------------
Investments Net Increase in Net Assets Resulting from Operations $ 4,041,448
(Notes 1c, ============
1e & 3):
<FN>
++Commencement of Operations.
See Notes to Financial Statements.
</TABLE>
F-69
<PAGE>
<TABLE>
STATEMENT OF CHANGES IN NET ASSETS
<CAPTION>
For the Period
April 8, 1994++ to
Increase (Decrease) in Net Assets: February 28, 1995
<S> <S> <C>
Operations: Investment income--net $ 6,262,806
Realized loss on investments--net (706,692)
Unrealized depreciation on investments--net (1,514,666)
------------
Net increase in net assets resulting from operations 4,041,448
------------
Dividends & Investment income--net (5,498,954)
Distributions to Realized gain on investments--net (136,928)
Shareholders ------------
(Note 1g): Net decrease in net assets resulting from dividends and distributions to
shareholders (5,635,882)
------------
Capital Share Net proceeds from issuance of Common Stock 73,530,000
Transactions Offering costs resulting from the issuance of Common Stock (184,007)
(Note 4): ------------
Net increase in net assets resulting from capital share transactions 73,345,993
Net Assets: Total increase in net assets 71,751,559
Beginning of period 100,007
------------
End of period* $ 71,851,566
============
<FN>
*Undistributed investment income--net $ 763,852
============
++Commencement of Operations.
See Notes to Financial Statements.
</TABLE>
F-70
<PAGE>
<TABLE>
STATEMENT OF CASH FLOWS
<CAPTION>
For the Period April 8, 1994++ to February 28, 1995
<S> <S> <C>
Cash Provided by Net increase in net assets resulting from operations $ 4,041,448
Operating Adjustments to reconcile net increase in net assets resulting
Activities: from operations to net cash provided by operating activities:
Increase in receivables (1,729,790)
Increase in other assets (90,814)
Increase in other liabilities 794,050
Realized and unrealized loss on investments--net 2,221,358
Amortization of premium and discount--net 85,944
------------
Net cash provided by operating activities 5,322,196
------------
Cash Used for Proceeds from sales of long-term investments 27,559,187
Investing Purchases of long-term investments (121,911,967)
Activities: Purchases of short-term investments (353,821,336)
Proceeds from sales and maturities of short-term investments 353,864,566
------------
Net cash used for investing activities (94,309,550)
------------
Cash Provided by Cash receipts on capital shares sold 73,345,993
Financing Dividends paid to shareholders (5,411,582)
Activities: Short-term borrowings--net 21,000,000
------------
Net cash provided by financing activities 88,934,411
------------
Cash: Net decrease in cash (52,943)
Cash at beginning of period 100,007
------------
Cash at end of period $ 47,064
============
Cash Flow Cash paid for interest $ 1,008,672
Information: ============
<FN>
++Commencement of Operations.
See Notes to Financial Statements.
</TABLE>
F-71
<PAGE>
<TABLE>
FINANCIAL HIGHLIGHTS
<CAPTION>
The following per share data and ratios have been derived
from information provided in the financial statements. For the Period
April 8, 1994++ to
Increase (Decrease) in Net Asset Value: February 28, 1995
<S> <S> <C>
Per Share Net asset value, beginning of period $ 9.50
Operating ------------
Performance: Investment income--net .81
Realized and unrealized loss on investments--net (.29)
------------
Total from investment operations .52
------------
Less dividends and distributions from:
Investment income--net (.71)
Realized gain on investments--net (.02)
------------
Total dividends and distributions (.73)
------------
Capital charge resulting from the issuance of Common Stock (.02)
------------
Net asset value, end of period $ 9.27
============
Market price per share, end of period $ 9.125
============
Total Investment Based on net asset value per share 5.73%+++
Return:** ============
Based on market price per share (1.13%)+++
============
Ratios to Expenses, net of reimbursement and excluding interest expense .65%*
Average ============
Net Assets: Expenses, net of reimbursement 2.15%*
============
Expenses 2.44%*
============
Investment income--net 8.42%*
============
Supplemental Net assets, end of period (in thousands) $ 71,852
Data: ============
Portfolio turnover 33.38%
============
Leverage: Amount of borrowings (in thousands) $ 21,000
------------
Asset coverage per $1,000 $ 4,422
------------
<FN>
++Commencement of Operations.
+++Aggregate total investment return.
*Annualized.
**Total investment returns based on market value, which can be
significantly greater or lesser than the net asset value, result in
substantially different returns. Total investment returns exclude
the effects of sales loads.
See Notes to Financial Statements.
</TABLE>
F-72
<PAGE>
NOTES TO FINANCIAL STATEMENTS
1. Significant Accounting Policies:
Senior Strategic Income Fund, Inc. (the "Fund") is registered under
the Investment Company Act of 1940 as a non-diversified, closed-end
management investment company. Prior to commencement of operations
on April 8, 1994, the Fund had no operations other than those
relating to organizational matters and the issue of 10,527 capital
shares of the Fund to Fund Asset Management, L.P. ("FAM") for
100,007. The Fund determines and makes available for publication the
net asset value of its Common Stock on a weekly basis. The Fund's
Common Stock is listed on the New York Stock Exchange under the
symbol SSN.
(a) Corporate debt obligations--The Fund invests principally in
senior debt obligations ("Senior Debt") of companies, including
corporate loans made by banks and other financial institutions and
both privately and publicly offered corporate bonds and notes.
(b) Valuation of investments--Portfolio securities are valued on the
basis of prices furnished by one or more pricing services, which
determine prices for normal, institutional-size trading units. In
certain circumstances, portfolio securities are valued at the last
sale price on the exchange that is the primary market for such
securities, or the last quoted bid price for those securities for
which the over-the-counter market is the primary market or for
listed securities in which there were no sales during the day. The
value of interest rate swaps, caps, and floors is determined in
accordance with a formula and then confirmed periodically by
obtaining a bank quotation. Positions in options are valued at the
last sale price on the market where any such option is principally
traded. Securities for which there exist no price quotations or
valuations and all other assets are valued at fair value as
determined in good faith by or on behalf of the Board of Directors
of the Fund. Since corporate loans are purchased and sold primarily
at par value, the Fund values the loans at par, unless Fund Asset
Management, L.P. ("FAM") determines par does not represent fair
value. In the event such a determination is made, fair value will be
determined in accordance with guidelines approved by the Fund's
Board of Directors. Obligations with remaining maturities of sixty
days or less are valued at amortized cost, which approximates
market, unless this method no longer produces fair valuations.
(c) Derivative financial instruments--The Fund may engage in various
portfolio strategies to seek to increase its return by hedging its
portfolio against adverse movements in the equity, debt and currency
markets. Losses may arise due to changes in the value of the
contract or if the counterparty does not perform under the contract.
* Financial futures contracts--The Fund may purchase or sell stock
index futures contracts and options on such futures contracts. Upon
entering into a contract, the Fund deposits and maintains as
collateral such initial margin as required by the exchange on which
the transaction is effected. Pursuant to the contract, the Fund
agrees to receive from or pay to the broker an amount of cash equal
to the daily fluctuation in value of the contract. Such receipts or
payments are known as variation margin and are recorded by the Fund
as unrealized gains or losses.
When the contract is closed, the Fund records a realized gain or
loss equal to the difference between the value of the contract at
the time it was opened.
* Options--The Fund can write and purchase call and put options.
When the Fund writes an option, an amount equal to the premium
received by the Fund is reflected as an asset and an equivalent
liability. The amount of the liability is subsequently marked to
market to reflect the current value of the option written.
When a security is purchased or sold through an exercise of an
option, the related premium paid (or received) is added to (or
deducted from) the basis of the security acquired or deducted from
(or added to) the proceeds of the security sold. When an option
expires (or the Fund enters into a closing transaction), the Fund
realizes a gain or loss on the option to the extent of the premiums
received or paid (or gain or loss to the extent the cost of the
closing transaction exceeds the premium paid or received).
Written and purchased options are non-income producing investments.
* Interest rate transactions--The Fund is authorized to enter into
interest rate swaps and purchase or sell interest rate caps and
floors. In an interest rate swap, the Fund exchanges with another
party their respective commitments to pay or receive interest on a
specified notional principal amount. The purchase of an interest
rate cap (or floor) entitles the purchaser, to the extent that a
specified index exceeds (or falls below) a predetermined interest
rate, to receive payments of interest equal to the difference
between the index and the predetermined rate on a notional principal
amount from the party selling such interest rate cap (or floor).
F-73
<PAGE>
(d) Income taxes--It is the Fund's policy to comply with the
requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute substantially all of its
taxable income to its shareholders. Therefore, no Federal income tax
provision is required.
(e) Security transactions and investment income--Security
transactions are recorded on the dates the transactions are entered
into (the trade dates). Interest income is recognized on the accrual
basis. Realized gains and losses on security transactions are
determined on the identified cost basis. Facility fees are accreted
to income over the term of the related loan.
(f) Deferred organization expenses--Deferred organization expenses
are amortized on a straight-line basis over a five-year period.
(g) Dividends and distributions--Dividends from net investment
income are declared and paid monthly. Distributions of capital gains
are recorded on the ex-dividend dates. The Fund may at times pay out
less than the entire amount of net investment income earned in any
particular period and may at times pay out such accumulated
undistributed income in other periods to permit the Fund to maintain
a more stable level of distributions.
2. Investment Advisory Agreement with Affiliates:
The Fund has entered into an Investment Advisory Agreement with FAM.
The general partner of FAM is Princeton Services, Inc. ("PSI"), an
indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc. ("ML &
Co."), which is the limited partner.
FAM is responsible for the management of the Fund's portfolio and
provides the necessary personnel, facilities, equipment and certain
other services necessary to the operations of the Fund.
For such services, the Fund pays a monthly fee at an annual rate of
0.50% of the Fund's average weekly net assets plus the proceeds of
any outstanding borrowings used for leverage. For the year ended
February 28, 1995, FAM earned fees of $415,168, of which $210,913
was voluntarily waived.
Accounting services are provided to the Fund by FAM at cost.
Certain officers and/or directors of the Fund are officers and/or
directors of FAM, PSI, Merrill Lynch, Pierce, Fenner & Smith Inc.,
and/or ML & Co.
3. Investments:
Purchases and sales of investments, excluding short-term securities,
for the period April 8, 1994 to February 28, 1995 were $121,354,470
and $27,559,187, respectively.
Net realized and unrealized losses as of February 28, 1995 were as
follows:
Realized Unrealized
Losses Losses
Long-term investments $ (705,996) $(1,514,666)
Short-term investments (696) --
---------- -----------
Total $ (706,692) $(1,514,666)
========== ===========
As of February 28, 1995, net unrealized depreciation for financial
reporting and Federal income tax purposes aggregated $1,514,666, of
which $593,866 related to appreciated securities and $2,108,532
related to depreciated securities. The aggregate cost of investments
at February 28, 1995 for Federal income tax purposes was
$93,516,914.
4. Capital Share Transaction:
The Fund is authorized to issue 200,000,000 shares of capital stock
par value $.10, all of which are initially classified as Common
Stock. The Board of Directors is authorized, however, to classify
and reclassify any unissued shares of capital stock without approval
of the holders of Common Stock.
For the period April 8, 1994 to February 28, 1995, shares issued and
outstanding was 7,750,527. At February 28, 1995, total paid-in
capital amounted to $73,446,000.
5. Short-Term Borrowings:
On May 25, 1994, the Fund entered into a one-year revolving credit
facility in the amount of $35,000,000 with a syndicate of banks led
by The Bank of New York bearing interest on the outstanding balance
at Federal Funds rate plus 1.125%, and/or at an alternate base rate
plus 0.125% and/or at LIBOR plus 1.125%. The maximum amount borrowed
was $32,000,000, the average amount borrowed was approximately
$15,000,000, and the daily weighted average interest rate was
6.165%. For the period April 8, 1994 to February 28, 1995, facility
and commitment fees aggregated approximately $72,000.
6. Subsequent Event:
On March 13, 1995, the Board of Directors of the Fund declared an
ordinary income dividend in the amount of $0.072110 per share,
payable on March 31, 1995 to shareholders of record as of March 24,
1995.
F-74
<PAGE>
UNAUDITED FINANCIAL STATEMENTS FOR THE COMBINED FUND ON A PRO FORMA BASIS AS OF
AUGUST 31, 1995
F-75
<PAGE>
COMBINED SCHEDULE OF INVESTMENTS OF SENIOR HIGH INCOME PORTFOLIO, INC.,
SENIOR HIGH INCOME PORTFOLIO II, INC. AND SENIOR STRATEGIC INCOME FUND, INC. AS
OF AUGUST 31, 1995
(UNAUDITED)
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRIES RATING RATING AMOUNT CORPORATE DEBT OBLIGATIONS COST (NOTE 1B)
- ---------------------------------------------------------------------------------------------------------
<C> <C> <C> <C> <S> <C> <C>
ADVERTISING--1.1%
B+ B1 $ 5,000,000 Lamar Advertising Co.,
Senior Secured Notes,
11% due 5/15/2003...... $ 5,056,250 $ 5,050,000
- ---------------------------------------------------------------------------------------------------------
AEROSPACE--6.9%
Availl, Inc., Term Loan,
Tranche B, due
11/30/2000:**
NR* NR* 352,942 9.13% to 9/07/1995...... 352,942 352,942
NR* NR* 2,533,306 9.75% to 9/07/1995...... 2,533,306 2,533,306
NR* NR* 7,058,824 9.25% to 10/10/1995..... 7,058,824 7,058,824
BB- Ba3 5,000,000 BE Aerospace Inc.,
Senior Notes, 9.75% due
3/01/2003.............. 4,997,065 5,000,000
Gulfstream Delaware
Corp., Term Loan A, due
3/31/1998:**
NR* NR* 372,340 10% to 9/30/1995........ 372,340 372,340
NR* NR* 2,234,043 7.88% to 10/13/1995..... 2,234,043 2,234,043
NR* NR* 6,740,000 Gulfstream Delaware
Corp., Term Loan B, due
3/31/1998, 9% to
9/08/1995**............ 6,740,000 6,740,000
B B2 4,000,000 Talley Manufacturing &
Technology, Inc.,
Senior Discount
Debentures, 10.75% due
10/15/2003............. 4,030,000 4,040,000
BB- B1 3,000,000 UNC, Inc., Senior Notes,
9.125% due 7/15/2003... 3,000,000 2,868,750
------------ -------------
31,318,520 31,200,205
- --------------------------------------------------------------------------------------------------------
AGRICULTURAL PRODUCTS--0.4%
B B3 2,000,000 Fresh Del Monte Produce
N.V., Series A, Senior
Notes, 10% due
5/01/2003.............. 2,025,000 1,600,000
- --------------------------------------------------------------------------------------------------------
AIRLINES--1.0%
NR* NR* 4,463,919 Northwest Airlines, Term
Loan, due 6/15/1997,
9.125% due
10/20/1995***.......... 4,463,919 4,463,919
- --------------------------------------------------------------------------------------------------------
AUTOMOTIVE PRODUCTS--2.4%
Harvard Industries,
Inc., Senior Notes:
B B2 3,000,000 12% due 7/15/2004....... 3,000,000 3,157,500
B+ B3 2,000,000 11.125% due 8/01/2005+.. 2,000,000 2,025,000
B B2 2,000,000 JPS Automotive Products
Corp., Senior Notes,
11.125% due 6/15/2001.. 2,000,000 1,990,000
NR* NR* 4,000,000 Walbro Corp., Senior
Notes, 9.875% due
7/15/2005+............. 3,989,560 3,980,000
------------ -------------
10,989,560 11,152,500
- --------------------------------------------------------------------------------------------------------
BROADCAST/MEDIA--7.3%
American Media, Term
Loan B, due
9/30/2002:**
NR* NR* 25,000 10.25% to 9/30/1995..... 25,000 25,000
NR* NR* 4,950,000 8.44% to 11/22/1995..... 4,950,000 4,950,000
NR* NR* 1,500,000 Benedek Broadcasting,
11.875% due 3/01/2005+. 1,500,000 1,567,500
Continental Cablevision,
Inc., Senior Notes:
BB Ba2 1,000,000 8.50% due 9/15/2001..... 1,052,500 1,005,000
BB+ Ba2 2,500,000 8.625% due 8/15/2003.... 2,500,000 2,500,000
BB- B1 5,000,000 9.125% due 11/01/2004+.. 5,000,000 5,000,000
B- B3 4,000,000 Granite Broadcasting
Corp., Senior Sub
Notes,
10.375% due 5/15/2005+. 4,000,000 4,055,000
NR* NR* 6,000,000 Marcus Cable Co., Term
Loan B, due 4/30/2004,
10.25% to 9/30/1995**.. 6,000,000 6,000,000
U.S. Radio Inc., Term
Loan A, due
12/31/2001:**
NR* NR* 865,477 9.4375% to 9/29/1995.... 865,477 865,477
NR* NR* 822,203 8.875% to 10/30/1995.... 822,203 822,203
U.S. Radio Inc., Term
Loan B, due
9/23/2003:**
NR* NR* 1,130,109 10.4375% to 9/29/1995... 1,130,109 1,130,109
NR* NR* 1,138,937 9.875% to 10/30/1995.... 1,138,937 1,138,937
NR* B2 4,000,000 Young Broadcasting
Corp., Senior Notes,
10.125% due 2/15/2005+. 4,000,000 4,160,000
------------ -------------
32,984,226 33,219,226
- --------------------------------------------------------------------------------------------------------
BUILDING & CONSTRUCTION--1.9%
B B2 3,000,000 NVR, Inc., Senior Notes,
11% due 4/15/2003...... 3,073,475 2,917,500
B- B2 3,000,000 The Presley Companies,
Senior Notes,
12.50% due 7/01/2001... 3,000,000 2,490,000
B+ Ba3 3,250,000 US Home Corp., Senior
Notes, 9.75% due
6/15/2003.............. 3,204,505 3,201,250
------------ -------------
9,277,980 8,608,750
- --------------------------------------------------------------------------------------------------------
</TABLE>
F-76
<PAGE>
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRIES RATING RATING AMOUNT CORPORATE DEBT OBLIGATIONS COST (NOTE 1B)
- ----------------------------------------------------------------------------------------------
<C> <C> <C> <C> <S> <C> <C>
BUILDING PRODUCTS--0.7%
BB- Ba3 $ 3,000,000 Schuller International
Group, Senior Notes,
10.875% due 12/15/2004. $ 3,000,000 $ 3,292,500
- ----------------------------------------------------------------------------------------------
CARBON & GRAPHITE PRODUCTS--1.1%
NR* NR* 2,436,892 UCAR International Inc.,
Term Loan B, due
1/31/2003, 8.875% to
9/08/1995**............ 2,436,892 2,436,892
NR* NR* 1,275,601 UCAR International Inc.,
Term Loan C, due
7/31/2003, 9.375% to
9/08/1995**............ 1,275,601 1,275,601
NR* NR* 1,275,601 UCAR International Inc.,
Term Loan D,
due 2/02/2004, 10.0625%
to 11/08/1995**........ 1,275,601 1,275,601
------------ -------------
4,988,094 4,988,094
- ----------------------------------------------------------------------------------------------
CASINOS--4.4%
B+ B2 4,500,000 GB Property Funding
Corp., First Mortgage
Notes, 10.875% due
1/15/2004.............. 4,500,000 3,915,000
Harrah's Jazz Co., Term
Loan B, due
9/30/1999:**
NR* NR* 5,000,000 9.125% to 10/23/1995.... 5,000,000 5,000,000
NR* NR* 10,000,000 9.1875% to 12/21/1995... 10,000,000 10,000,000
BB Ba3 1,000,000 Players International
Inc., Senior Notes,
10.875% due 4/15/2005+. 1,000,000 985,000
------------ -------------
20,500,000 19,900,000
- ----------------------------------------------------------------------------------------------
CHEMICALS--3.7%
BB+ Ba2 1,500,000 Borden Chemicals and
Plastic, L.P., Senior
Notes
9.50% due 5/01/2005.... 1,500,000 1,507,500
NR* NR* 1,500,000 Freedom Chemical Co.,
Term Loan B,
due 6/30/2002, 9.18755
to 10/27/1995**........ 1,500,000 1,500,000
BB- B1 5,000,000 Huntsman Chemical Corp.,
Senior Notes,
11% due 4/15/2004...... 5,045,000 5,412,500
NR* NR* 8,622,652 Inspec Chemical Corp.,
Term Loan B,
due 12/02/2000, 8.50%
to 9/29/1995**......... 8,622,652 8,622,652
------------ -------------
16,667,652 17,042,652
- ----------------------------------------------------------------------------------------------
COMPUTERS--2.0%
BB- Ba3 8,100,000 Dell Computer Corp.,
Senior Notes, 11% due
8/15/2000.............. 8,162,719 8,889,750
- ----------------------------------------------------------------------------------------------
CONSUMER PRODUCTS--2.3%
NR* NR* 5,000,000 CHF/Ebel USA Inc., Term
Loan B, due 9/30/2001,
9.1328% to
10/30/1995**........... 5,000,000 5,000,000
B+ Ba3 4,000,000 Coty Inc., Senior Sub
Notes, 10.25% due
5/01/2005.............. 4,000,000 4,120,000
B+ B2 2,565,000 Drypers Corp., Series B,
Senior Notes,
12.50% due 11/01/2002.. 2,677,063 1,154,250
------------ -------------
11,677,063 10,274,250
- ----------------------------------------------------------------------------------------------
CONTAINERS--0.9%
B+ Ba3 4,000,000 Sweetheart Cup Co.,
Senior Secured Notes,
9.625% due 9/01/2000... 4,000,000 3,940,000
- ----------------------------------------------------------------------------------------------
DIVERSIFIED--7.7%
NR* NR* 4,967,600 Desa International Inc.,
Term Loan B, due
11/30/2000, 9.0625% to
12/27/1995**........... 4,967,600 4,967,600
B+ B1 3,000,000 Essex Group Inc., 10%
due 5/01/2003.......... 3,041,250 2,940,000
NR* NR* 2,119,370 Figgie International,
Fixed Rate Loan, due
1/01/1996, 10.75% to
9/30/1995**............ 2,119,370 2,119,370
NR* NR* 1,290,844 Figgie International,
Term Loan, due
1/01/1996,
10.75% to 10/01/1995**. 1,290,844 1,290,844
InterMetro Industries,
Term Loan B, due
7/02/2001:**
NR* NR* 612,072 8.875% to 1/03/1995..... 612,072 612,072
NR* NR* 173,904 8.875% to 9/05/1995..... 173,904 173,904
InterMetro Industries,
Term Loan C, due
12/31/2002:**
NR* NR* 253,026 9.375% to 9/05/1995..... 253,026 253,026
NR* NR* 890,552 9.375% to 1/03/1996..... 890,552 890,552
B+ B2 3,000,000 J.B. Poindexter & Co.,
Senior Notes,
12.50% due 5/15/2004... 2,943,250 2,820,000
NR* NR* 16,277,000 Thermadyne Co., Term
Loan B, due 2/01/2001,
8.875% to 9/07/1995**.. 16,277,000 16,277,000
B B1 3,000,000 Valcor Inc., Senior
Notes, 9.625% due
11/01/2003............. 3,000,000 2,790,000
------------ -------------
35,568,868 35,134,368
- ----------------------------------------------------------------------------------------------
</TABLE>
F-77
<PAGE>
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRIES RATING RATING AMOUNT CORPORATE DEBT OBLIGATIONS COST (NOTE 1B)
- -----------------------------------------------------------------------------------------------------
<C> <C> <C> <C> <S> <C> <C>
DRUGSTORES--4.5%
NR* NR* $ 7,136,357 Duane Reade Co., Term
Loan A, due 9/30/1997,
8.875% to 11/30/1995**. $ 7,136,357 $ 7,136,357
NR* NR* 1,500,000 Duane Reade Co., Term
Loan B, due 9/30/1999,
9.375% to 11/30/1995... 1,500,000 1,500,000
NR* Ba3 12,040,322 Thrifty Payless Inc.,
Term Loan B, due
9/30/2001, 9.0625% to
9/22/1995**............ 12,040,322 12,040,322
------------ -------------
20,676,679 20,676,679
- -----------------------------------------------------------------------------------------------------
EDUCATIONAL SERVICES--1.1%
B B3 5,000,000 La Petite Holdings
Corp., Senior Secured
Notes,
9.625% due 8/01/2001... 5,000,000 4,550,000
- -----------------------------------------------------------------------------------------------------
ELECTRICAL INSTRUMENTS--1.1%
Berg Electronics Inc.,
Term Loan B, due
3/31/2001:**
NR* NR* 20,833 8.94% to 9/29/1995...... 20,833 20,833
NR* NR* 4,916,667 8.94% to 11/27/1995..... 4,916,667 4,916,667
------------ -------------
4,937,500 4,937,500
- -----------------------------------------------------------------------------------------------------
ENERGY--2.0%
BB- B1 5,000,000 Ferrellgas Partners,
L.P., Senior Notes,
Series B,
9% due 8/01/2001....... 4,978,078 4,987,500
B B3 2,500,000 Gerrity Oil Corp.,
Senior Sub Notes,
11.75% due 7/15/2004... 2,500,000 2,300,000
BB- B1 2,000,000 Maxus Energy Corp.,
Senior Notes,
9.375% due 11/01/2003.. 1,917,703 1,880,000
------------ -------------
9,395,781 9,167,500
- -----------------------------------------------------------------------------------------------------
BB- B1 Sherritt Gordon Ltd.,
Senior Notes, 9.75% due
FERTILIZERS--1.9% 7,500,000 4/01/2003.............. 7,525,000 7,575,000
BB- B1 Sherritt, Inc., USD
Debentures, 10.50% due
1,000,000 3/31/2014.............. 1,000,000 1,015,000
------------ -------------
8,525,000 8,590,000
- -----------------------------------------------------------------------------------------------------
FOOD & BEVERAGE--7.2%
American Italian Pasta,
Term Loan B, due
3/31/1999:**
NR* NR* 1,300,000 9.125% to 1/29/1996..... 1,300,000 1,300,000
NR* NR* 1,300,000 9% to 6/28/1996......... 1,300,000 1,300,000
G. Heilman Brewing Co.,
Term Loan B, due
12/31/2000:**
NR* NR* 4,000,000 9.125% to 10/13/1995.... 4,000,000 4,000,000
NR* NR* 4,000,000 9.6875% to 10/13/1995... 4,000,000 4,000,000
President Baking
Company, Inc., Term
Loan B, 9/30/2000:**
NR* NR* 8,532 10.25% to 9/30/1995..... 8,532 8,532
NR* NR* 4,948,806 8.625% to 12/29/1995.... 4,948,806 4,948,806
B+ B1 8,000,000 Royal Crown Corp.,
Senior Secured Notes,
9.75% due 8/01/2000.... 8,079,625 7,440,000
Specialty Foods Corp.,
Term Loan B, due
4/30/2001:**
NR* NR* 3,333,334 8.1875% to 9/21/1995.... 3,333,334 3,333,334
NR* NR* 3,333,334 8.125% to 10/20/1995.... 3,333,334 3,333,334
NR* NR* 3,333,333 8.0625% to 1/22/1996.... 3,333,333 3,333,333
------------ -------------
33,636,964 32,997,339
- -----------------------------------------------------------------------------------------------------
FOREST PRODUCTS--2.3%
BB- Ba3 Mallette Inc., Senior
Secured Notes, 12.25%
1,000,000 due 7/15/2004.......... 1,000,000 1,110,000
BB- Ba3 Rainy River Forest
Products, 10.75% due
5,000,000 10/15/2001............. 4,988,935 5,350,000
BB B1 Tembec Finance Corp.,
4,000,000 9.875% due 9/30/2005... 4,000,000 4,000,000
------------ -------------
9,988,935 10,460,000
- -----------------------------------------------------------------------------------------------------
GROCERY--6.3%
B- B3 Bruno's Supermarkets,
10,000,000 10.50% due 8/01/2005... 10,000,000 9,725,000
B+ NR* 7,917,000 Homeland Stores, Inc.,
Floating Rate Senior
Secured Notes, 9.062%
due 2/28/1997(1)....... 7,917,000 7,837,830
NR* Ba3 4,151,701 Pathmark Stores, Inc.,
Term Loan B, due
10/31/1999, 8.9375% to
11/30/1995**........... 4,151,701 4,151,701
BB- Ba3 5,000,000 The Penn Traffic
Company, Senior Notes,
8.625% due 12/15/2003.. 4,992,712 4,275,000
B- B2 2,000,000 Pueblo Xtra
International, Inc.,
Senior Notes,
9.50% due 8/01/2003.... 2,000,000 1,860,000
B+ B3 1,000,000 Stater Brothers
Holdings, Inc., Senior
Notes,
11% due 3/01/2001...... 1,000,000 985,000
------------ -------------
30,061,413 28,834,531
- -----------------------------------------------------------------------------------------------------
</TABLE>
F-78
<PAGE>
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRIES RATING RATING AMOUNT CORPORATE DEBT OBLIGATIONS COST (NOTE 1B)
- ------------------------------------------------------------------------------------------------
<C> <C> <C> <C> <S> <C> <C>
HEALTH SERVICES--4.4%
B B2 $ 5,500,000 Charter Medical Corp.,
Senior Subordinated
Notes,
11.25% due 4/15/2004... $ 5,500,000 $ 5,898,750
B- B2 3,000,000 Integrated Health
Services, Senior
Subordinated Notes,
10.75% due 7/15/2004... 3,000,000 3,195,000
B B1 11,890,000 MEDIQ/PRN Life Support
Services Inc., Senior
Secured Notes,
11.125% due 7/01/1999.. 12,171,985 11,057,700
------------ -------------
20,671,985 20,151,450
- ------------------------------------------------------------------------------------------------
NR* NR* 2,000,000 Four Seasons Hotels
Inc., Notes, 9.125% due
HOTELS--0.4% 7/01/2000+............. 1,934,018 1,940,000
- ------------------------------------------------------------------------------------------------
LEASING & RENTAL SERVICES--2.4%
B- B2 2,000,000 Cort Furniture Rental
Corp., Senior Notes,
12% due 9/01/2000...... 1,999,397 1,950,000
Prime Acquisition, Term
Loan, due 12/31/2000:**
NR* NR* 1,600,000 9.0625% to 9/05/1995.... 1,600,000 1,600,000
NR* NR* 1,780,000 9.0313% to 10/03/1995... 1,780,000 1,780,000
NR* NR* 1,600,000 8.875% to 11/06/1995.... 1,600,000 1,600,000
BB- B1 4,000,000 The Scotsman Group,
Inc., Senior Secured
Notes,
9.50% due 12/15/2000... 4,000,000 3,930,000
------------ -------------
10,979,397 10,860,000
- ------------------------------------------------------------------------------------------------
LEISURE & ENTERTAINMENT--0.7%
B- B3 2,500,000 Alliance Entertainment
Corp., 11.25% due
7/15/2005+............. 2,502,500 2,487,500
B B3 1,000,000 Plitt Theatres, Inc.,
Senior Sub Notes,
10.875% due 6/15/2004.. 1,000,000 980,000
------------ -------------
3,502,500 3,467,500
- ------------------------------------------------------------------------------------------------
MANUFACTURING--1.4%
B- B3 3,000,000 Crain Industries Inc.,
13.50% due 8/15/2005+.. 3,000,000 3,015,000
B+ B1 3,623,000 Foamex L.P., Senior
Secured Notes,
9.50% due 6/01/2000.... 3,643,000 3,532,425
------------ -------------
6,643,000 6,547,425
- ------------------------------------------------------------------------------------------------
MARKING DEVICES--0.7%
B+ B2 3,000,000 Monarch Acquisition
Corp., 12.50% due
7/01/2003+............. 3,000,000 3,045,000
- ------------------------------------------------------------------------------------------------
METALS--7.1%
B B1 4,000,000 Algoma Steel, Inc.,
12.375% due 7/15/2005.. 3,608,669 3,680,000
B B2 3,000,000 Bayou Steel Corp., First
Mortgage Notes,
10.25% due 3/01/2001... 3,000,000 2,835,000
B B1 3,000,000 Gulf States Steel Corp.,
13.50% due 4/15/2003+.. 2,967,858 2,910,000
B B2 2,000,000 Jorgensen (Earle M.)
Co., New Senior Notes,
10.75% due 3/01/2000... 2,065,000 1,960,000
B+ B3 3,000,000 Renco Metals, Inc., 12%
due 7/15/2000........... 2,957,998 3,150,000
B+ B2 2,000,000 Republic Engineered
Steel, Inc., First
Mortgage Notes, 9.875%
due 12/15/2001......... 2,000,000 1,860,000
B- B3 7,000,000 Russell Metals, 10.25%
due 6/15/2000.......... 6,980,067 6,492,500
B+ B1 5,000,000 WCI Steel Inc., Senior
Notes, 10.50% due
3/01/2002.............. 5,000,000 4,900,000
B B2 5,190,000 Weirton Steel Corp.,
Senior Notes,
10.75% due 6/01/2005+.. 5,113,115 4,774,800
------------ -------------
33,692,707 32,562,300
- ------------------------------------------------------------------------------------------------
MUSICAL INSTRUMENTS--0.6%
NR* B3 3,000,000 Selmer Co. Inc., 11% due
5/15/2005+............. 3,000,000 2,880,000
- ------------------------------------------------------------------------------------------------
NAUTICAL SYSTEMS--0.6%
Sperry Marine, Inc.,
Term Loan, due
11/15/2000:**
NR* NR* 1,212,906 9.6875% to 9/29/1995.... 1,212,906 1,212,906
NR* NR* 1,648,984 9.125% to 12/29/1995.... 1,648,984 1,648,984
------------ -------------
2,861,890 2,861,890
- ------------------------------------------------------------------------------------------------
</TABLE>
F-79
<PAGE>
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRIES RATING RATING AMOUNT CORPORATE DEBT OBLIGATIONS COST (NOTE 1B)
- ----------------------------------------------------------------------------------------------
<C> <C> <C> <C> <S> <C> <C>
PAPER--17.2%
Fort Horward Corp., Term
Loan B, due
12/31/2002:**
NR* Ba3 $ 9,000,000 9% to 9/19/1995......... $ 9,000,000 $ 9,000,000
NR* Ba3 9,000,000 8.88% to 12/19/1995..... 9,000,000 9,000,000
B B3 3,000,000 Gaylord Container Corp.,
Senior Notes,
11.50% due 5/15/2001... 3,008,083 3,157,500
Jefferson
Smurfit/Container Corp.
of America,
Term Loan B, due
5/10/2002:**
NR* B1 750,000 9.4375% to 9/25/1995.... 750,000 750,000
NR* NR* 3,266,666 8.9375% to 10/20/1995... 3,266,666 3,266,666
NR* NR* 13,666,667 9.375% to 10/24/1995.... 13,666,667 13,666,667
Repap New Brunswick
Inc.:
BB- Ba3 2,000,000 9.50% due 7/15/2000..... 2,027,500 1,995,000
BB- Ba3 3,000,000 9.875% due 7/15/2000.... 3,000,000 3,000,000
NR* Ba2 15,500,000 S.D. Warren Co., Term
Loan B, due 12/19/2002,
8.94% to 9/25/1995**... 15,500,000 15,500,000
Stone Container Corp.,
Term Loan B, due
4/01/2000:**
NR* Ba3 9,200,000 9% to 9/18/1995......... 9,200,000 9,200,000
NR* Ba3 9,900,000 9% to 10/16/1995........ 9,900,000 9,900,000
------------ -------------
78,318,916 78,435,833
- ----------------------------------------------------------------------------------------------
PRINTING & PUBLISHING--2.8%
NR* NR* 6,491,493 Ziff Davis Acquisition
Corp., Term Loan B, due
12/31/2001, 9.4375% to
9/28/1995**............ 6,491,493 6,491,493
NR* NR* 6,114,485 Ziff Davis Acquisition
Corp., Term Loan C, due
12/31/2002, 9.9375% to
9/28/1995**............ 6,114,485 6,114,485
------------ -------------
12,605,978 12,605,978
- ----------------------------------------------------------------------------------------------
RESTAURANTS--1.7%
BB- B1 8,000,000 Host Marriott Corp.,
9.50% due 5/15/2005+... 7,771,265 7,660,000
- ----------------------------------------------------------------------------------------------
RETAIL-SPECIALTY--10.2%
Camelot Music, Inc.,
Term Loan B, due
2/28/2001:**
NR* NR* 1,812,500 8.375% to 9/18/1995..... 1,812,500 1,812,500
NR* NR* 3,062,500 8.9375% to 9/21/1995.... 3,062,500 3,062,500
CCC+ B2 6,500,000 Color Tile Inc., Senior
Notes, 10.75% due
12/15/2001............. 6,473,760 2,600,000
Federated Department
Stores, Term Loan, due
3/31/2000:**
NR* Ba1 6,250,000 7.4375% to 9/25/1995.... 6,250,000 6,250,000
NR* Ba1 3,750,000 7% to 9/29/1995......... 3,750,000 3,750,000
Music Acquisition Corp.,
Term Loan B, due
2/28/2001:**
NR* NR* 1,812,500 8.875% to 9/18/1995..... 1,812,500 1,812,500
NR* NR* 3,062,500 8.9375% to 9/21/1995.... 3,062,500 3,062,500
NR* NR* 20,082,821 Saks & Co., Term Loan
Tranche B, due
6/30/2000,
9.25% to 11/09/1995**.. 20,082,821 20,082,821
B+ B1 4,000,000 Specialty Retailers,
Inc., Series A, Senior
Notes,
10% due 8/15/2000...... 4,007,500 3,860,000
------------ -------------
50,314,081 46,292,821
- ----------------------------------------------------------------------------------------------
SECURITY SYSTEMS--1.8%
NR* NR* 8,177,448 Alert Centre Inc., Term
Loan, due 8/01/2001,
8.875% to 9/05/1995**.. 8,177,448 8,177,448
- ----------------------------------------------------------------------------------------------
SHIPPING--1.7%
BB- Ba2 4,500,000 Eletson Holdings, Inc.,
9.25% due 11/15/2003... 4,361,664 4,320,000
B- B3 1,500,000 OMI Corp., Senior Notes,
10.25% due 11/01/2003.. 1,500,000 1,275,000
B+ Ba3 2,000,000 Viking Star Shipping,
Inc., First Preferred
Shipping Mortgage
Notes,
9.625% due 7/15/2003... 2,012,500 2,045,000
------------ -------------
7,874,164 7,640,000
- ----------------------------------------------------------------------------------------------
</TABLE>
F-80
<PAGE>
<TABLE>
<CAPTION>
S&P MOODY'S FACE VALUE
INDUSTRIES RATING RATING AMOUNT CORPORATE DEBT OBLIGATIONS COST (NOTE 1B)
- ------------------------------------------------------------------------------------------------
<C> <C> <C> <C> <S> <C> <C>
UTILITIES--1.9%
B+ B1 $ 2,000,000 Beaver Valley Funding,
8.625% due 6/01/2007..... $ 1,698,283 $ 1,751,080
BB Ba2 4,000,000 Cleveland Electric
Illuminating, Inc.,
9.50% due 5/15/2005...... 3,992,457 4,005,600
BB- B1 460,000 First PV Funding Corp.,
Senior Notes,
10.30% due 1/15/2014..... 452,137 473,685
B Ba3 2,460,000 Public Service Company of
New Mexico,
10.30% due 1/15/2014..... 2,456,328 2,533,185
------------ -------------
8,599,205 8,763,550
- ------------------------------------------------------------------------------------------------
WAREHOUSING & STORAGE--2.7%
D Caa 5,000,000 Americold Corp., First
Mortgage Bonds, Series B,
11.50% due 3/01/2005..... 5,112,500 4,850,000
NR* NR* 4,581,250 Pierce Leahy Corp., Term
Loan, Tranche A,
due 6/30/2001,
9.125% to 9/29/1995**.... 4,581,250 4,581,250
NR* NR* 3,000,000 Pierce Leahy Corp., Term
Loan B, due 6/30/2001,
9.125% to 9/29/1995**.... 3,000,000 3,000,000
------------ -------------
12,693,750 12,431,250
- ------------------------------------------------------------------------------------------------
TOTAL CORPORATE DEBT
OBLIGATIONS--128.5%...... 595,542,427 585,292,208
- ------------------------------------------------------------------------------------------------
SHARES
HELD WARRANTS
- ------------------------------------------------------------------------------------------------
LEASING &. RENTAL SERVICES--0.0%
NR* NR* 66,000 Cort Furniture Rental
Corp. (a).................. 760 82,500
- ------------------------------------------------------------------------------------------------
METALS--0.0%
NR* NR* 3,000 Gulf States Steel Corp. (a). 33,000 4,500
- ------------------------------------------------------------------------------------------------
TOTAL WARRANTS--0.0%........ 33,760 87,000
- ------------------------------------------------------------------------------------------------
FACE
AMOUNT SHORT-TERM SECURITIES
- ------------------------------------------------------------------------------------------------
COMMERCIAL PAPER***--0.3%
$ 1,498,000 General Electric Capital
Corp., 5.82% due
9/01/1995................ 1,498,000 1,498,000
- ------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM
SECURITIES--0.3%........... 1,498,000 1,498,000
- ------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS--128.8%. $597,074,187 $ 586,877,208
============ =============
- ------------------------------------------------------------------------------------------------
</TABLE>
(1) Interest rate resets quarterly and is based on the three- month LIBOR
(London Interbank Offered Rate), plus an interest rate spread of three
hundred basis points.
(a) Warrants entitle the Fund to purchase a predetermined number of shares of
common stock/face amount of bonds. The purchase price and number of
shares/face amount are subject to adjustments under certain conditions
until the expiration date.
* Not rated.
** Floating or Vvariable Rate Corporate Loans--The interest rates on floating
or variable rate corporate loans are subject to change periodically based
on the change in the prime rate of a US Bank, LIBOR (London Interbank
Offered Rate), or in some cases, another base lending rate. The interest
rates shown are those in effect at August 31, 1995.
*** Commercial Paper is traded on a discount basis; the interest rate shown is
the discount rate paid at the time of purchase by the Fund.
(footnotes continued on next page)
F-81
<PAGE>
+Restricted securitites as to resale. The value of the Fund's investment in
restricted securities was $50,485,000, representing 11.08% of net assets.
<TABLE>
<CAPTION>
ACQUISITION VALUE
ISSUE DATES COST (NOTE 1B)
----- ----------- ----------- -----------
<S> <C> <C> <C>
Alliance Entertainment Corp., 11.25% due
7/15/2005.............................. 7/20/1995-
7/25/1995 $ 2,502,500 $ 2,487,500
Benedek Broadcasting, 11.875% due
3/01/2005.............................. 3/03/1995 1,500,000 1,567,500
Continental Cablevision, Inc., Senior 7/17/1995-
Notes, 7/20/1995
9.125% due 11/01/2004.................. 5,000,000 5,000,000
Crain Industries Inc., 13.50% due
8/15/2005.............................. 8/22/1995-
8/29/1995 3,000,000 3,015,000
Four Seasons Hotels, Inc., Notes, 9.125%
due 7/01/2000.......................... 1/25/1994 1,934,018 1,940,000
Granite Broadcasting Corp., 10.375% due
5/15/2005.............................. 5/12/1995 4,000,000 4,055,000
Gulf States Steel Corp., 13.50% due
4/15/2003.............................. 4/12/1995-
8/08/1995 2,967,858 2,910,000
Harvard Industries, Inc., Senior Notes, 7/25/1995-
11.125% due 8/01/2005.................. 7/28/1995 2,000,000 2,025,000
Host Marriott Corp., 9.50% due
5/18/2005.............................. 5/18/1995-
7/31/1995 7,771,265 7,660,000
Monarch Acquisition Corp., 12.50% due
7/01/2003.............................. 6/23/1995 3,000,000 3,045,000
Players International Inc., Senior
Notes,
10.875% due 4/15/2005.................. 4/10/1995 1,000,000 985,000
Selmer Co. Inc., 11% due 5/15/2005...... 5/18/1995-
5/25/1995 3,000,000 2,880,000
Walbro Corp., Senior Notes, 9.875% due
7/15/2005.............................. 7/21/1995-
7/27/1995-
8/08/1995 3,989,560 3,980,000
Weirton Steel Corp., Senior Notes,
10.75% due 6/01/2005................... 6/05/1995 5,113,115 4,774,800
Young Broadcasting Corp., 10.125% due
2/15/2005.............................. 6/07/1995 4,000,000 4,160,000
----------- -----------
Total................................... $50,778,316 $50,484,800
=========== ===========
</TABLE>
See Notes to Financial Statements.
F-82
<PAGE>
COMBINED STATEMENT OF ASSETS, LIABILITIES AND CAPITAL
AS OF AUGUST 31, 1995 (UNAUDITED)
<TABLE>
<CAPTION>
SENIOR HIGH INCOME SENIOR HIGH INCOME SENIOR STRATEGIC PRO FORMA
PORTFOLIO, INC. PORTFOLIO II, INC. INCOME FUND, INC. FOR
("SHIP I") ("SHIP II") ("SENIOR STRATEGIC") ADJUSTMENTS COMBINED FUND
------------------ ------------------ -------------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
ASSETS:
Investments, at value
(Note 1b).............. $294,197,041 $197,763,738 $94,916,429 $0 $586,877,208
Cash.................... 308,236 224,051 1,907 0 534,194
Receivables:
Interest receivable.... 4,889,035 3,410,741 1,614,136 0 9,913,912
Securities sold........ 1,039,632 0 0 0 1,039,632
Deferred facility ex-
pense.................. 43,829 11,853 6,247 0 61,929
Deferred organization
expenses (Note 1f)..... 69,749 48,500 83,551 (132,051) 69,749
Prepaid expenses and
other assets........... 1,142 6,705 1,016 0 8,863
------------ ------------ ----------- ----------- ------------
Total assets............ 300,548,664 201,465,588 96,623,286 (132,051) 598,505,487
------------ ------------ ----------- ----------- ------------
LIABILITIES:
Payables:
Loans.................. 67,000,000 45,000,000 24,000,000 0 136,000,000
Dividends to sharehold-
ers (Note 1g)......... 666,472 412,976 198,885 8,174,691 (1) 9,453,024
Interest on loans...... 318,544 213,538 110,597 0 642,679
Investment adviser
(Note 2).............. 121,906 82,817 39,023 0 243,746
Commitment fees........ 18,910 13,489 4,222 0 36,621
Deferred income (Note
1e).................... 2,293,186 1,697,866 483,431 0 4,474,483
Accrued expenses and
other liabilities...... 115,608 74,397 6,218 315,000 (2) 511,223
------------ ------------ ----------- ----------- ------------
Total liabilities....... 70,534,626 47,495,083 24,842,376 8,489,691 151,361,776
------------ ------------ ----------- ----------- ------------
NET ASSETS:
Net assets.............. $230,014,038 $153,970,505 $71,780,910 $(8,621,742) $447,143,711
============ ============ =========== =========== ============
CAPITAL:
Capital Stock
(200,000,000 shares of
each fund authorized;
600,000,000 shares as
adjusted); Common
Stock, par value $.10
per share (25,388,292
shares of SHIP I Common
Stock, 16,610,527
shares of SHIP II
Common Stock and
7,750,527 shares of
Senior Strategic Common
Stock issued and
outstanding; 50,436,967
shares for the combined
Fund as adjusted)...... $ 2,538,829 $ 1,661,053 $ 775,053 $ 68,762 $ 5,043,697
Paid-in capital in ex-
cess of par............ 238,288,358 155,927,256 72,670,947 (515,813) 466,370,748
Undistributed investment
income--net............ 4,711,731 2,527,660 935,300 (8,174,691) --
Accumulated realized
capital losses on in-
vestments--net......... (10,202,426) (3,106,714) (764,615) 0 (14,073,755)
Unrealized depreciation
on investments--net.... (5,322,454) (3,038,750) (1,835,775) 0 (10,196,979)
------------ ------------ ----------- ----------- ------------
Total Capital--
Equivalent to $9.06 net
asset value per share
of SHIP I Common Stock,
$9.27 net asset value
per share of SHIP II
and $9.26 net asset
value per share of
Senior Strategic Common
Stock.................. $230,014,038 $153,970,505 $71,780,910 $(8,621,742) $447,143,711
============ ============ =========== =========== ============
</TABLE>
- --------
(1) Assumes the distribution of undistributed investment income.
(2) Reflects the charge for estimated Merger expenses of $315,000.
See Notes to Financial Statements.
F-83
<PAGE>
COMBINED STATEMENT OF OPERATIONS
FOR THE TWELVE MONTH PERIOD ENDED AUGUST 31, 1995
(UNAUDITED)
<TABLE>
<CAPTION>
SENIOR HIGH
SENIOR HIGH INCOME SENIOR PRO FORMA
INCOME PORTFOLIO STRATEGIC FOR
PORTFOLIO II INCOME ADJUSTMENTS COMBINED FUND
----------- ----------- ---------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Investment Income (Note 1e):
Interest and discount
earned................... $30,816,799 $21,141,242 $9,914,452 $61,872,493
Facility and other fees... 653,090 225,084 0 878,174
----------- ----------- ---------- --------- -----------
Total income.............. 31,469,889 21,366,326 9,914,452 0 62,750,667
----------- ----------- ---------- --------- -----------
Expenses:
Loan interest expense..... 5,272,471 3,900,781 1,624,494 10,797,746
Investment advisory fees
(Note 2)................. 1,534,174 1,056,899 482,594 3,073,667
Facility fee amortization. 250,010 95,378 42,752 388,140
Professional fees......... 97,006 101,510 78,574 277,090
Accounting services (Note
2)....................... 106,061 90,536 59,444 256,041
Printing and shareholder
reports.................. 75,522 53,707 34,759 163,988
Borrowing costs........... 48,452 76,307 30,220 154,979
Transfer agent fees (Note
2)....................... 77,492 26,026 13,561 117,079
Directors' fees and
expenses................. 31,393 24,544 26,770 82,707
Amortization of
organization expenses
(Note 1f)................ 33,198 15,730 20,488 69,416
Custodian fees............ 30,069 21,924 12,910 64,903
Pricing services.......... 5,772 4,853 2,292 12,917
Listing fees.............. 136 250 119 505
Other..................... 11,756 86,317 11,856 315,000(1) 424,929
----------- ----------- ---------- --------- -----------
Total expenses............ 7,573,512 5,554,762 2,440,833 315,000 15,884,107
----------- ----------- ---------- --------- -----------
Investment income--net.... 23,896,377 15,811,564 7,473,619 (315,000) 46,866,560
----------- ----------- ---------- --------- -----------
Realized & Unrealized Gain
(Loss) on Investments--Net
(Notes 1c & 1e):
Realized loss on
investments--net......... (6,059,348) (1,837,439) (660,496) (8,557,283)
Change in unrealized
appreciation/depreciation
on investments--net...... 4,286,776 1,061,216 (1,474,246) 3,873,746
----------- ----------- ---------- --------- -----------
Net Increase in Net Assets
Resulting from
Operations............... $22,123,805 $15,035,341 $5,338,877 $(315,000) $42,183,023
=========== =========== ========== ========= ===========
</TABLE>
- --------
(1)Reflects the charge for estimated Merger expenses of $315,000.
See Notes to Financial Statements.
F-84
<PAGE>
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
1. SIGNIFICANT ACCOUNTING POLICIES:
Senior High Income Portfolio, Inc. ("SHIP I"), Senior High Income Portfolio
II, Inc. ("SHIP II") and Senior Strategic Income Fund, Inc. ("Senior
Strategic") (collectively, the "Funds") are registered under the Investment
Company Act of 1940 as non-diversified, closed-end management investment
companies. The Funds determine and make available for publication the net asset
value of their Common Stock on a weekly basis. The Common Stock of SHIP I, SHIP
II and Senior Strategic are listed on the New York Stock Exchange under the
symbols ARK, SAL and SSN, respectively. The following is a summary of
significant accounting policies followed by the Funds.
(a) Corporate debt obligations--The Funds invest principally in senior debt
obligations ("Senior Debt") of companies, including corporate loans made by
banks and other financial institutions and both privately and publicly offered
corporate bonds and notes. Because agents and intermediaries are primarily
commercial banks, the Funds' investment in corporate loans could be considered
concentrated in financial institutions.
(b) Valuation of investments--Portfolio securities are valued on the basis of
prices furnished by one or more pricing services, which determine prices for
normal, institutional-size trading units. In certain circumstances, portfolio
securities are valued at the last sale price on the exchange that is the
primary market for such securities, or the last quoted bid price for those
securities for which there were no sales during the day. The value of interest
rate swaps, caps, and floors is determined in accordance with a formula and
then confirmed periodically by obtaining a bank quotation. Positions in options
are valued at the last sale price on the market where any such option is
principally traded. Securities for which there exist no price quotations or
valuations and all other assets are valued at fair value as determined in good
faith by or on behalf of the Board of Directors of the Funds. Since corporate
loans are purchased and sold primarily at par value, the Funds value the loans
at par value, unless Fund Asset Management, L.P. ("FAM") determines par does
not represent fair value. In the event such a determination is made, fair value
will be determined in accordance with guidelines approved by the Funds' Board
of Directors. Obligations with remaining maturities of sixty days or less are
valued at amortized cost unless this method no longer produces fair valuations.
(c) Derivative financial instruments--The Funds may engage in various
portfolio strategies to seek to increase its return by hedging its portfolio
against adverse movements in the debt markets. Losses may arise due to changes
in the value of the contract or if the counterparty does not perform under the
contract.
. Financial futures contracts--The Funds may purchase or sell interest rate
futures contracts and options on such futures contracts for the purpose
of hedging the market risk on existing securities or the intended
purchase of securities. Futures contracts are contracts for delayed
delivery of securities at a specific future date and at a specific price
or yield. Upon entering into a contract, a Fund deposits and maintains as
collateral such initial margin as required by the exchange on which the
transaction is effected. Pursuant to the contract, the Fund agrees to
receive from or pay to the broker an amount of cash equal to the daily
fluctuation in value of the contract. Such receipts or payments are known
as variation margin and are recorded by the Fund as unrealized gains or
losses. When the contract is closed, the Fund records a realized gain or
loss equal to the difference between the value of the contract at the
time it was opened and the value at the time it was closed.
. Options--The Funds are authorized to write and purchase call and put
options. When a Fund writes an option, an amount equal to the premium
received by the Fund is reflected as an asset and an equivalent
liability. The amount of the liability is subsequently marked to market
to reflect the current market value of the option written. When a
security is purchased or sold through an exercise of an option, the
related premium paid (or received) is added to (or deducted from) the
basis of the security acquired or deducted from (or added to) the
proceeds of the security sold. When an option expires (or the Fund enters
into a closing transaction), the Fund realizes a gain or loss on the
option to the extent of the premiums received or paid (or gain or loss to
the extent the cost of the closing transaction is less than or exceeds
the premiums paid or received).
F-85
<PAGE>
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Written and purchased options are non-income producing investments.
. Interest rate transactions--The Funds are authorized to enter into
interest rate swaps and purchase or sell interest rate caps and floors.
In an interest rate swap, a Fund exchanges with another party their
respective commitments to pay or receive interest on a specified notional
principal amount. The purchase of an interest rate cap (or floor)
entitles the purchaser, to the extent that a specified index exceeds (or
falls below) a predetermined interest rate, to receive payments of
interest equal to the difference between the index and the predetermined
rate on a notional principal amount from the party selling such interest
rate cap (or floor).
(d) Income taxes--It is the Funds' policy to comply with the requirements of
the Internal Revenue Code applicable to regulated investment companies and to
distribute substantially all of their taxable income to their shareholders.
Therefore, no Federal income tax provision is required.
(e) Security transactions and investment income--Security transactions are
recorded on the dates the transactions are entered into (the trade dates).
Interest income is recognized on the accrual basis. Realized gains and losses
on security transactions are determined on the identified cost basis. Facility
fees are accreted to income over the term of the related loan. For income tax
purposes, as of September 1, 1994, the corporate loans are treated as discount
obligations.
(f) Deferred organization expenses--Deferred organization expenses are
amortized on a straight-line basis over a five-year period. The organization
expenses of SHIP II and Senior Strategic were written off as part of the
adjustments included in the Funds' combined statement of assets, liabilities
and capital.
(g) Dividends and distributions--Dividends from net investment income are
declared and paid monthly. Distributions of capital gains are recorded on the
ex-dividend dates. The Funds may at times pay out less than the entire amount
of net investment income earned in any particular period and may at times pay
out such accumulated undistributed income in other periods to permit the Funds
to maintain a more stable level of distributions.
2. INVESTMENT ADVISORY AGREEMENT WITH AFFILIATES:
Each Fund has entered into an Investment Advisory Agreement with FAM. The
general partner of FAM is Princeton Services, Inc. ("PSI"), an indirect wholly-
owned subsidiary of Merrill Lynch & Co., Inc. ("ML & Co."), which is the
limited partner.
FAM is responsible for the management of each Fund's portfolio and provides
the necessary personnel, facilities, equipment and certain other services
necessary to the operations of the Funds. For such services, each Fund pays a
monthly fee at an annual rate of 0.50% of the Fund's average weekly net assets
plus the proceeds of any outstanding borrowings used for leverage.
Accounting services are provided to the Funds by FAM at cost.
During the period ended August 31, 1995, SHIP I, SHIP II and Senior Strategic
paid Merrill Lynch Securities Pricing Service, an affiliate of Merrill Lynch,
Pierce, Fenner & Smith Incorporated ("MLPF&S"), $719, $2,724 and $181,
respectively, for security price quotations to compute the net asset value of
each Fund.
Certain officers and/or directors of the Funds are officers and/or directors
of FAM, PSI, MLPF&S, and/or ML & Co.
F-86
<PAGE>
AUDITED FINANCIAL STATEMENTS
FOR FUND ASSET MANAGEMENT, L.P.
FOR THE FISCAL YEAR ENDED
DECEMBER 30, 1994
F-87
<PAGE>
INDEPENDENT AUDITORS' REPORT
Fund Asset Management, L.P.:
We have audited the accompanying balance sheet of Fund Asset Management, L.P.
(the "Partnership") as of December 30, 1994 and the related statements of
operations and cash flows for the year then ended. These financial statements
are the responsibility of the Partnership's management. Our responsibility is
to express an opinion on these financial statements based on our audit.
We conducted our audit 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 are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. 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 audit provides a reasonable basis
for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Partnership as of December 30, 1994 and
the results of its operations and its cash flows for the year then ended in
conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Parsippany, New Jersey
March 23, 1995
F-88
<PAGE>
FUND ASSET MANAGEMENT, L.P.
BALANCE SHEET
<TABLE>
<CAPTION>
DECEMBER 30,
1994
------------
<S> <C>
ASSETS
Cash............................................................. $ 65,693
Receivable from affiliate--Merrill Lynch & Co., Inc. ............ 153,541,255
Fund management fees receivable.................................. 27,427,379
Investments in affiliated investment companies--at cost (market
$20,888,184).................................................... 19,802,617
Other assets..................................................... 59,536
------------
TOTAL ASSETS..................................................... $200,896,480
============
LIABILITIES AND PARTNERS' CAPITAL
LIABILITIES
Payable to affiliates............................................ $ 19,876,356
------------
PARTNERS' CAPITAL
Limited partners' capital........................................ 26,550,926
General partner's capital........................................ 11,414,000
Note receivable from affiliate--Merrill Lynch & Co., Inc. ....... (11,414,000)
Retained earnings................................................ 154,469,198
------------
Total partners' capital.......................................... 181,020,124
------------
TOTAL LIABILITIES AND PARTNERS' CAPITAL.......................... $200,896,480
============
</TABLE>
See notes to financial statements.
F-89
<PAGE>
FUND ASSET MANAGEMENT, L.P.
STATEMENT OF OPERATIONS
YEAR ENDED LAST FRIDAY IN DECEMBER
<TABLE>
<CAPTION>
1994
------------
<S> <C>
REVENUES:
Management fees from affiliated companies.......................... $347,757,737
Interest from affiliated companies--(net).......................... 7,959,219
Other.............................................................. 842,305
------------
Total.............................................................. 356,559,261
------------
EXPENSES
Transaction processing costs reimbursed to affiliated company...... 168,206,000
Employee compensation and benefits................................. 16,653,666
Parent company allocation.......................................... 7,764,000
Occupancy and equipment rental..................................... 3,285,842
Professional fees.................................................. 1,630,712
Fund expense reimbursement......................................... 1,237,715
Travel & entertainment............................................. 1,182,182
Communications..................................................... 1,090,338
Advertising........................................................ 410,560
Other expenses..................................................... 629,048
------------
Total.............................................................. 202,090,063
------------
NET EARNINGS....................................................... $154,469,198
============
</TABLE>
See notes to financial statements.
F-90
<PAGE>
FUND ASSET MANAGEMENT, L.P.
STATEMENT OF CASH FLOWS
YEAR ENDED LAST FRIDAY IN DECEMBER
<TABLE>
<CAPTION>
1994
-------------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings................................................... $ 154,469,198
Adjustments to reconcile net earnings to net cash provided by
operating activities:
Decrease in fund management fee receivable................... 1,500,558
Increase in receivable from affiliate--Merrill Lynch & Co.,
Inc. ....................................................... (153,541,255)
Decrease in payable to affiliates............................ (1,678,598)
Increase in other assets..................................... (59,525)
-------------
NET CASH PROVIDED BY OPERATING ACTIVITIES...................... 690,378
-------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Decrease in investments in affiliated companies................ (1,621,365)
-------------
NET CASH USED IN INVESTING ACTIVITIES.......................... (1,621,365)
-------------
NET DECREASE IN CASH........................................... (930,987)
CASH, BEGINNING OF YEAR........................................ 996,680
-------------
CASH, END OF YEAR.............................................. $ 65,693
=============
</TABLE>
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
On January, 1, 1994, Fund Asset Management, Inc. contributed certain net
investment advisory assets and liabilities to the Partnership in exchange for a
99% limited partnership interest. The following is a summary of assets and
liabilities contributed into the Partnership:
<TABLE>
<S> <C>
ASSETS
Investments in affiliated investment companies...................... $18,181,252
Fund management fees receivable..................................... 28,927,937
Cash................................................................ 996,680
Other assets........................................................ 11
-----------
Total assets contributed............................................ $48,105,880
===========
LIABILITIES
Payable to affiliate................................................ $21,554,954
-----------
Total liabilities assumed........................................... $21,554,954
===========
</TABLE>
In addition to the above contribution of assets and liabilities, the
Partnership received a $11,414,000 promissory note receivable from an affiliate
as a capital contribution from its general partner.
See notes to financial statements.
F-91
<PAGE>
FUND ASSET MANAGEMENT, L.P.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEAR ENDED LAST FRIDAY IN DECEMBER 1994
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
Effective January 1, 1994, Fund Asset Management, Inc. ("FAMI") contributed
certain net investment advisory assets to Fund Asset Management, L.P., a newly
formed Delaware limited partnership, in exchange for a 99% limited partnership
interest. The general partner, Princeton Services, Inc., an indirect wholly-
owned subsidiary of Merrill Lynch & Co., Inc. ("ML&Co.") contributed a
promissory note in exchange for its 1% general partnership interest. FAMI then
distributed 49.5% of its limited partnership interest to an affiliate, who in
turn distributed their limited partnership interest to ML&Co. The partnership's
profits and losses are allocated to the partners in proportion to their
ownership percentages.
The Partnership serves as an investment adviser to various registered
investment companies. The basis of the assets and liabilities were recorded on
the opening balance sheet of the Partnership at their net book value
transferred from FAMI.
Investment Advisory Fees
Investment advisory fees are earned based upon a percentage of net assets
under management of affiliated investment companies for which the Partnership
provides investment advisory services.
Income Taxes
For income tax purposes, the Partnership does not incur any income tax
liability. All income tax liabilities are incurred directly by the partners.
Transactions With Affiliates
The Partnership serves as an investment adviser for certain affiliated
investment companies. Management fees are based on a percentage of the net
assets of each investment company. Such fees are generally recognized in the
period earned.
The Partnership maintains investment in certain affiliated investment
companies. Such investments are carried at the lower of cost or market value.
Market value is determined based upon quoted market prices.
In performing the terms of the investment advisory agreements, the
Partnership utilizes employees, office space, and other operating equipment
provided by Merrill Lynch Asset Management, LP ("MLAM"). The Partnership's
reimbursement to MLAM amounted to $24,505,000 in 1994.
The Partnership has an arrangement with Merrill Lynch, Pierce, Fenner & Smith
Incorporated ("MLPF&S") an affiliate which provides that the Partnership, which
receives revenue as investment adviser to certain investment companies
("Funds"), reimburse MLPF&S for certain costs incurred in processing
transactions involving shares of the Funds. This reimbursement amounted to
$168,206,000 in 1994 and is included in "Transaction processing costs
reimbursed to affiliated company".
ML&Co. is the holder of the Partnership's excess cash, which is available on
demand to meet current liabilities. ML&Co. credits the Partnership for
interest, at a floating rate approximating ML&Co.'s average borrowing rate,
based on the Partnership's average daily balances due to/from ML&Co.
Effective January 1, 1994, the general partner contributed a promissory note
of $11,414,000 to the Partnership. This note is payable upon demand and bears
an interest rate equivalent to short-term commercial paper securities. This
note is reflected as a reduction to partners' capital as of December 30, 1994.
F-92
<PAGE>
FUND ASSET MANAGEMENT, L.P.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
FOR THE YEAR ENDED LAST FRIDAY IN DECEMBER 1994
Pension Plan
The Partnership participates in the ML&Co. Comprehensive Retirement Program
(the "Program") consisting of the Retirement Accumulation Plan ("RAP") and the
Employee Stock Ownership Plan (the "ESOP"), and the 401(k) Savings & Investment
Plan ("SIP"). Under the Program, cash contributions made by the Partnership and
the ML&Co. stock held by the ESOP will be allocated quarterly to participants'
accounts. Allocations will be based on years of service, age and eligible
compensation. Actuarial data regarding the Partnership's Plan participants is
not separately available.
Subsequent Events
Effective January 3, 1995, FAMI contributed its 49.5% limited partnership
interest to ML&Co. This contribution had no effect on the Partnership's
financial statements.
On March 10, 1995, the Partnership distributed $175,000,000 of earnings to
the partners.
F-93
<PAGE>
EXHIBIT I
AGREEMENT AND PLAN OF MERGER
THIS AGREEMENT AND PLAN OF MERGER (this "Agreement") is made as of the day
of January , 1996, by and among Senior High Income Portfolio, Inc. ("SHIP
I"), Senior High Income Portfolio II, Inc. ("SHIP II") and Senior Strategic
Income Fund, Inc. ("Senior Strategic"), each a Maryland corporation.
PLAN OF MERGER
The merger will comprise the following: (i) each of SHIP II and Senior
Strategic will be merged with and into SHIP I in accordance with the General
Corporation Law of the State of Maryland ("Maryland Law"); (ii) the separate
existence of each of SHIP II and Senior Strategic will cease; (iii) SHIP I will
be the surviving corporation; and (iv) each share of common stock ("Common
Stock") of each of SHIP II and Senior Strategic will be converted into the
right to receive an equivalent dollar amount (to the nearest one ten-thousandth
of one cent) of full shares of Common Stock of SHIP I, with a par value of $.10
per share ("SHIP I Common Stock"), plus cash in lieu of any fractional shares,
computed based on the net asset value per share of each Fund on the Effective
Date (as defined below), all upon and subject to the terms hereinafter set
forth (the "Merger"). The currently issued and outstanding shares of SHIP I
will remain issued and outstanding and in the same number.
As soon as practicable after satisfaction of all conditions to the Merger,
SHIP I, SHIP II and Senior Strategic will jointly file executed articles of
merger (the "Articles of Merger") with the Department of Assessments and
Taxation of the State of Maryland and make all other filings or recordings
required by Maryland Law in connection with the Merger. The Merger shall become
effective at such time as the Articles of Merger are accepted for filing by the
Department of Assessments and Taxation of the State of Maryland or at such
later time as is specified in the Articles of Merger (the "Effective Date").
From and after the Effective Date, SHIP I will possess all of the rights,
privileges, purposes, powers and franchises and be subject to all of the
restrictions, liabilities, obligations, disabilities and duties of SHIP I, SHIP
II and Senior Strategic, all as provided under Maryland Law.
The parties intend that the Merger qualify as a reorganization under Section
368(a)(1)(A) of the Internal Revenue Code of 1986, as amended ("Code").
As promptly as practicable after the Merger, the registration of each of SHIP
II and Senior Strategic, under the Investment Company Act of 1940, as amended
(the "1940 Act") shall be terminated.
AGREEMENT
In order to consummate the Merger and in consideration of the premises and
the covenants and agreements hereinafter set forth, and intending to be legally
bound, SHIP I, SHIP II and Senior Strategic hereby agree as follows:
1. Representations and Warranties of SHIP I.
SHIP I represents and warrants to, and agrees with, SHIP II and Senior
Strategic that:
(a) SHIP I is a corporation duly organized, validly existing and in good
standing in conformity with Maryland Law, and has the power to own all of
its assets and to carry out this Agreement. SHIP I has all necessary
federal, state and local authorizations to carry on its business as it is
now being conducted and to carry out this Agreement.
(b) SHIP I is duly registered under the 1940 Act as a non-diversified,
closed-end management investment company (File No. 811-7456), and such
registration has not been revoked or rescinded and is in full force and
effect. SHIP I has elected and qualified for the special tax treatment
afforded regulated investment companies ("RICs") under Sections 851-855 of
the Code at all times since its inception, and intends to continue to so
qualify both until consummation of the Merger and thereafter.
I-1
<PAGE>
(c) Each of SHIP II and Senior Strategic has been furnished with a
statement of assets, liabilities and capital and a schedule of investments
of SHIP I, each as of February 28, 1995, said financial statements having
been examined by Deloitte & Touche LLP, independent public accountants.
(d) Each of SHIP II and Senior Strategic has been furnished with an
unaudited statement of assets, liabilities and capital and a schedule of
investments of SHIP I, each as of August 31, 1995.
(e) Each of SHIP II and Senior Strategic has been furnished with SHIP I's
Annual Report to Stockholders for the year ended February 28, 1995, and the
audited financial statements appearing therein fairly present the financial
position of SHIP I as of the respective dates indicated, in conformity with
generally accepted accounting principles applied on a consistent basis.
(f) Each of SHIP II and Senior Strategic has been furnished with SHIP I's
Semi-Annual Report to Stockholders for the six months ended August 31,
1995.
(g) SHIP I has full power and authority to enter into and perform its
obligations under this Agreement. The execution, delivery and performance
of this Agreement has been duly authorized by all necessary action of its
Board of Directors, and this Agreement constitutes a valid and binding
contract enforceable in accordance with its terms, subject to the effects
of bankruptcy, insolvency, moratorium, fraudulent conveyance and similar
laws relating to or affecting creditors' rights generally and court
decisions with respect thereto.
(h) There are no material legal, administrative or other proceedings
pending or, to the knowledge of SHIP I, threatened against SHIP I which
assert liability on the part of SHIP I or which materially affect its
financial condition or its ability to consummate the Merger. SHIP I is not
charged with or, to the best of its knowledge, threatened with any
violation or investigation of any possible violation of any provisions of
any Federal, state or local law or regulation or administrative ruling
relating to any aspect of its business.
(i) SHIP I is not a party to or obligated under any provision of its
Articles of Incorporation, as amended, or its by-laws, as amended, or any
contract or other commitment or obligation, and is not subject to any order
or decree which would be violated by its execution of or performance under
this Agreement, except insofar as SHIP I, SHIP II and Senior Strategic have
mutually agreed to amend such contract or other commitment or obligation to
cure any potential violation as a condition precedent to the Merger.
(j) There are no material contracts outstanding to which SHIP I is a
party that have not been disclosed in the N-14 Registration Statement (as
defined in subsection (n) below) or will not otherwise be disclosed to each
of SHIP II and Senior Strategic prior to the Effective Date.
(k) SHIP I has no known liabilities of a material amount, contingent or
otherwise, other than those shown on SHIP I's statements of assets,
liabilities and capital referred to above, those incurred in the ordinary
course of its business as an investment company since August 31, 1995 and
those incurred in connection with the Merger. Prior to the Effective Date,
SHIP I will advise each of SHIP II and Senior Strategic in writing of all
known liabilities, contingent or otherwise, whether or not incurred in the
ordinary course of business, existing or accrued.
(l) SHIP I has filed, or has obtained extensions to file, all Federal,
state and local tax returns which are required to be filed by it, and has
paid or has obtained extensions to pay, all Federal, state and local taxes
shown on said returns to be due and owing and all assessments received by
it, up to and including the taxable year in which the Effective Date
occurs. All tax liabilities of SHIP I have been adequately provided for on
its books, and no tax deficiency or liability of SHIP I has been asserted
and no question with respect thereto has been raised by the Internal
Revenue Service or by any state or local tax authority for taxes in excess
of those already paid, up to and including the taxable year in which the
Effective Date occurs.
(m) No consent, approval, authorization or order of any court or
governmental authority is required for the consummation by SHIP I of the
Merger, except such as may be required under the
I-2
<PAGE>
Securities Act of 1933, as amended (the "1933 Act"), the Securities
Exchange Act of 1934, as amended (the "1934 Act"), the 1940 Act or state
securities laws (which term as used herein shall include the laws of the
District of Columbia and Puerto Rico) and the laws of the State of
Maryland.
(n) The registration statement filed by SHIP I on Form N-14 relating to
the SHIP I Common Stock to be issued pursuant to this Agreement, and any
supplement or amendment thereto or to the documents therein (as amended,
the "N-14 Registration Statement"), on the effective date of the N-14
Registration Statement, at the time of the stockholders' meetings referred
to in Section 7(a) of this Agreement and at the Effective Date, insofar as
it relates to SHIP I (i) complied or will comply in all material respects
with the provisions of the 1933 Act, the 1934 Act and the 1940 Act and the
rules and regulations thereunder and (ii) did not or will not contain any
untrue statement of a material fact or omit to state any material fact
required to be stated therein or necessary to make the statements therein
not misleading; and the prospectus included therein did not or will not
contain any untrue statement of a material fact or omit to state any
material fact necessary to make the statements therein, in the light of the
circumstances under which they were made, not misleading; provided,
however, that the representations and warranties in this subsection only
shall apply to statements in or omissions from the N-14 Registration
Statement made in reliance upon and in conformity with information
furnished by SHIP I for use in the N-14 Registration Statement as provided
in Section 7 of this Agreement.
(o) SHIP I is authorized to issue 200,000,000 shares of capital stock,
par value $.10 per share, all of which shares are initially classified as
Common Stock and each outstanding share of which is fully paid,
nonassessable and has full voting rights.
(p) All of the issued and outstanding shares of Common Stock of SHIP I
were offered for sale and sold in conformity with all applicable Federal
and state securities laws.
(q) The SHIP I Common Stock to be issued pursuant to this Agreement will
have been duly authorized and, when issued and delivered pursuant to this
Agreement, will be legally and validly issued and will be fully paid and
nonassessable and will have full voting rights, and no stockholder of SHIP
I will have any preemptive right of subscription or purchase in respect
thereof.
(r) At or prior to the Effective Date, the SHIP I Common Stock to be
issued pursuant to this Agreement will be duly qualified for offering to
the public in all states of the United States in which the sale of shares
of SHIP I Common Stock presently are qualified, and there are a sufficient
number of such shares registered under the 1933 Act and with each pertinent
state securities commission to permit the issuance contemplated by this
Agreement.
(s) At or prior to the Effective Date, SHIP I will have obtained any and
all regulatory, Director and stockholder approvals necessary to issue the
SHIP I Common Stock.
(t) The books and records of SHIP I made available to each of SHIP II and
Senior Strategic and/or its counsel are substantially true and correct and
contain no material misstatements or omissions with respect to the
operations of SHIP I.
2. Representations and Warranties of SHIP II.
SHIP II represents and warrants to, and agrees with, SHIP I and Senior
Strategic that:
(a) SHIP II is a corporation duly organized, validly existing and in good
standing in conformity with Maryland Law, and has the power to own all of
its assets and to carry out this Agreement. SHIP II has all necessary
Federal, state and local authorizations to carry on its business as it is
now being conducted and to carry out this Agreement.
(b) SHIP II is duly registered under the 1940 Act as a non-diversified,
closed-end management investment company (File No. 811-7069), and such
registration has not been revoked or rescinded and is in full force and
effect. SHIP II has elected and qualified for the special tax treatment
afforded RICs under Sections 851-855 of the Code at all times since its
inception and intends to continue to so qualify for its taxable year ending
upon the liquidation of SHIP II.
I-3
<PAGE>
(c) SHIP II has full power and authority to enter into and perform its
obligations under this Agreement. The execution, delivery and performance
of this Agreement has been duly authorized by all necessary action of its
Board of Directors, and this Agreement constitutes a valid and binding
contract enforceable in accordance with its terms, subject to the effects
of bankruptcy, insolvency, moratorium, fraudulent conveyance and similar
laws relating to or affecting creditors' rights generally and court
decisions with respect thereto.
(d) Each of SHIP I and Senior Strategic has been furnished with a
statement of assets, liabilities and capital and a schedule of investments
of SHIP II, each as of August 31, 1995, said financial statements having
been examined by Deloitte & Touche LLP, independent public accountants.
(e) Each of SHIP I and Senior Strategic has been furnished with SHIP II's
Annual Report to Stockholders for the year ended August 31, 1995, and the
audited financial statements appearing therein fairly present the financial
position of SHIP II as of the respective dates indicated, in conformity
with generally accepted accounting principles applied on a consistent
basis.
(f) There are no material legal, administrative or other proceedings
pending or, to the knowledge of SHIP II, threatened against SHIP II which
assert liability on the part of SHIP II or which materially affect its
financial condition or its ability to consummate the Merger. SHIP II is not
charged with or, to the best of its knowledge, threatened with any
violation or investigation of any possible violation of any provisions of
any Federal, state or local law or regulation or administrative ruling
relating to any aspect of its business.
(g) There are no material contracts outstanding to which SHIP II is a
party that have not been disclosed in the N-14 Registration Statement or
will not otherwise be disclosed to each of SHIP I and Senior Strategic
prior to the Effective Date.
(h) SHIP II is not a party to or obligated under any provision of its
Articles of Incorporation, as amended, or its by-laws, as amended, or any
contract or other commitment or obligation, and is not subject to any order
or decree which would be violated by its execution of or performance under
this Agreement, except insofar as SHIP I, SHIP II and Senior Strategic have
mutually agreed to amend such contract or other commitment or obligation to
cure any potential violation as a condition precedent to the Merger.
(i) SHIP II has no known liabilities of a material amount, contingent or
otherwise, other than those shown on its statements of assets, liabilities
and capital referred to above, those incurred in the ordinary course of its
business as an investment company since August 31, 1995, and those incurred
in connection with the Merger. Prior to the Effective Date, SHIP II will
advise each of SHIP I and Senior Strategic in writing of all known
liabilities, contingent or otherwise, whether or not incurred in the
ordinary course of business, existing or accrued.
(j) SHIP II has filed, or has obtained extensions to file, all Federal,
state and local tax returns which are required to be filed by it, and has
paid or has obtained extensions to pay, all federal, state and local taxes
shown on said returns to be due and owing and all assessments received by
it, up to and including the taxable year in which the Effective Date
occurs. All tax liabilities of SHIP II have adequately been provided for on
its books, and no tax deficiency or liability of SHIP II has been asserted
and no question with respect thereto has been raised by the Internal
Revenue Service or by any state or local tax authority for taxes in excess
of those already paid, up to and including the taxable year in which the
Effective Date occurs.
(k) No consent, approval, authorization or order of any court or
governmental authority is required for the consummation by SHIP II of the
Merger, except such as may be required under the 1933 Act, the 1934 Act,
the 1940 Act or state securities laws (which term as used herein shall
include the laws of the District of Columbia and Puerto Rico) and the laws
of the State of Maryland.
(l) The N-14 Registration Statement, on its effective date, at the time
of the stockholders' meetings referred to in Section 7(a) of this Agreement
and on the Effective Date, insofar as it relates to SHIP II (i) complied or
will comply in all material respects with the provisions of the 1933 Act,
the 1934 Act and the 1940 Act and the rules and regulations thereunder, and
(ii) did not or will not contain any untrue statement of a material fact or
omit to state any material fact required to be stated therein or necessary
I-4
<PAGE>
to make the statements therein not misleading; and the prospectus included
therein did not or will not contain any untrue statement of a material fact
or omit to state any material fact necessary to make the statements
therein, in the light of the circumstances under which they were made, not
misleading; provided, however, that the representations and warranties in
this subsection shall apply only to statements in or omissions from the N-
14 Registration Statement made in reliance upon and in conformity with
information furnished by SHIP II for use in the N-14 Registration Statement
as provided in Section 7 of this Agreement.
(m) SHIP II is authorized to issue 200,000,000 shares of capital stock,
par value $.10 per share, all of which shares are initially classified as
Common Stock and each outstanding share of which is fully paid,
nonassessable and has full voting rights.
(n) All of the issued and outstanding shares of Common Stock of SHIP II
were offered for sale and sold in conformity with all applicable Federal
and state securities laws.
(o) The books and records of SHIP II made available to each of SHIP I and
Senior Strategic and/or its counsel are substantially true and correct and
contain no material misstatements or omissions with respect to the
operations of SHIP II.
3. Representations and Warranties of Senior Strategic.
Senior Strategic represents and warrants to, and agrees with, SHIP I and SHIP
II that:
(a) Senior Strategic is a corporation duly organized, validly existing
and in good standing in conformity with Maryland Law, and has the power to
own all of its assets and to carry out this Agreement. Senior Strategic has
all necessary Federal, state and local authorizations to carry on its
business as it is now being conducted and to carry out this Agreement.
(b) Senior Strategic is duly registered under the 1940 Act as a non-
diversified, closed-end management investment company (File No. 811-7131),
and such registration has not been revoked or rescinded and is in full
force and effect. Senior Strategic has elected and qualified for the
special tax treatment afforded RICs under Sections 851-855 of the Code at
all times since its inception and intends to continue to so qualify for its
taxable year ending upon the liquidation of Senior Strategic.
(c) Senior Strategic has full power and authority to enter into and
perform its obligations under this Agreement. The execution, delivery and
performance of this Agreement has been duly authorized by all necessary
action of its Board of Directors, and this Agreement constitutes a valid
and binding contract enforceable in accordance with its terms, subject to
the effects of bankruptcy, insolvency, moratorium, fraudulent conveyance
and similar laws relating to or affecting creditors' rights generally and
court decisions with respect thereto.
(d) Each of SHIP I and SHIP II has been furnished with a statement of
assets, liabilities and capital and a schedule of investments of Senior
Strategic, each as of February 28, 1995, said financial statements having
been examined by Deloitte & Touche LLP, independent public accountants.
(e) Each of SHIP I and SHIP II has been furnished with a statement of
assets, liabilities and capital and a schedule of investments of Senior
Strategic, each as of August 31, 1995.
(f) Each of SHIP I and SHIP II has been furnished with Senior Strategic's
Annual Report to Stockholders for the year ended February 28, 1995, and the
audited financial statements appearing therein fairly present the financial
position of Senior Strategic as of the respective dates indicated, in
conformity with generally accepted accounting principles applied on a
consistent basis.
(g) Each of SHIP I and SHIP II has been furnished with Senior Strategic's
Semi-Annual Report to Stockholders for the six months ended August 31,
1995.
(h) There are no material legal, administrative or other proceedings
pending or, to the knowledge of Senior Strategic, threatened against Senior
Strategic which assert liability on the part of Senior Strategic or which
materially affect its financial condition or its ability to consummate the
Merger. Senior Strategic is not charged with or, to the best of its
knowledge, threatened with any violation or
I-5
<PAGE>
investigation of any possible violation of any provisions of any Federal,
state or local law or regulation or administrative ruling relating to any
aspect of its business.
(i) There are no material contracts outstanding to which Senior Strategic
is a party that have not been disclosed in the N-14 Registration Statement
or will not otherwise be disclosed to each of SHIP I and SHIP II prior to
the Effective Date.
(j) Senior Strategic is not a party to or obligated under any provision
of its Articles of Incorporation, as amended, or its by-laws, as amended,
or any contract or other commitment or obligation, and is not subject to
any order or decree which would be violated by its execution of or
performance under this Agreement, except insofar as SHIP I, SHIP II and
Senior Strategic have mutually agreed to amend such contract or other
commitment or obligation to cure any potential violation as a condition
precedent to the Merger.
(k) Senior Strategic has no known liabilities of a material amount,
contingent or otherwise, other than those shown on its statements of
assets, liabilities and capital referred to above, those incurred in the
ordinary course of its business as an investment company since August 31,
1995, and those incurred in connection with the Merger. Prior to the
Effective Date, Senior Strategic will advise each of SHIP I and SHIP II in
writing of all known liabilities, contingent or otherwise, whether or not
incurred in the ordinary course of business, existing or accrued.
(l) Senior Strategic has filed, or has obtained extensions to file, all
federal, state and local tax returns which are required to be filed by it,
and has paid or has obtained extensions to pay, all Federal, state and
local taxes shown on said returns to be due and owing and all assessments
received by it, up to and including the taxable year in which the Effective
Date occurs. All tax liabilities of Senior Strategic have been adequately
provided for on its books, and no tax deficiency or liability of Senior
Strategic has been asserted and no question with respect thereto has been
raised by the Internal Revenue Service or by any state or local tax
authority for taxes in excess of those already paid, up to and including
the taxable year in which the Effective Date occurs.
(m) No consent, approval, authorization or order of any court or
governmental authority is required for the consummation by Senior Strategic
of the Merger, except such as may be required under the 1933 Act, the 1934
Act, the 1940 Act or state securities laws (which term as used herein shall
include the laws of the District of Columbia and Puerto Rico) and the laws
of the State of Maryland.
(n) The N-14 Registration Statement, on its effective date, at the time
of the stockholders' meetings referred to in Section 7(a) of this Agreement
and on the Effective Date, insofar as it relates to Senior Strategic (i)
complied or will comply in all material respects with the provisions of the
1933 Act, the 1934 Act and the 1940 Act and the rules and regulations
thereunder, and (ii) did not or will not contain any untrue statement of a
material fact or omit to state any material fact required to be stated
therein or necessary to make the statements therein not misleading; and the
prospectus included therein did not or will not contain any untrue
statement of a material fact or omit to state any material fact necessary
to make the statements therein, in the light of the circumstances under
which they were made, not misleading; provided, however, that the
representations and warranties in this subsection shall apply only to
statements in or omissions from the N-14 Registration Statement made in
reliance upon and in conformity with information furnished by Senior
Strategic for use in the N-14 Registration Statement as provided in Section
7 of this Agreement.
(o) Senior Strategic is authorized to issue 200,000,000 shares of capital
stock, par value $.10 per share, all of which shares are initially
classified as Common Stock and each outstanding share of which is fully
paid, nonassessable and has full voting rights.
(p) All of the issued and outstanding shares of Common Stock of Senior
Strategic were offered for sale and sold in conformity with all applicable
Federal and state securities laws.
(q) The books and records of Senior Strategic made available to each of
SHIP I and SHIP II and/or its counsel are substantially true and correct
and contain no material misstatements or omissions with respect to the
operations of Senior Strategic.
I-6
<PAGE>
4. The Merger.
(a) Subject to the requisite approvals of the stockholders of each of
SHIP I, SHIP II and Senior Strategic being given, and to the other terms
and conditions contained herein, SHIP I, SHIP II and Senior Strategic agree
that (i) each of SHIP II and Senior Strategic will be merged with and into
SHIP I, (ii) the separate existence of each of SHIP II and Senior Strategic
will cease, (iii) SHIP I will be the surviving corporation, (iv) each share
of Common Stock of each of SHIP II and Senior Strategic outstanding at the
Effective Date will be converted into the right to receive an equivalent
dollar amount (to the nearest one ten-thousandth of one cent) of full
shares of SHIP I Common Stock, plus cash in lieu of fractional shares,
computed based on the net asset value per share of each Fund at the
Effective Date and (v) the shares of SHIP I outstanding as of the Effective
Date will remain issued and outstanding and in the same number.
(b) As soon as practicable after satisfaction of all conditions to the
Merger, SHIP I, SHIP II and Senior Strategic will jointly file the Articles
of Merger with the Department of Assessments and Taxation of the State of
Maryland and make all other filings or recordings required by Maryland Law
in connection with the Merger.
(c) From and after the Effective Date, SHIP I will possess all of the
rights, privileges, purposes, powers and franchises and be subject to all
of the restrictions, liabilities, obligations, disabilities and duties of
SHIP I, SHIP II and Senior Strategic, all as provided under Maryland Law.
5. Conversion to SHIP I Common Stock.
At the Effective Date, each share of Common Stock of each of SHIP II and
Senior Strategic will be converted into the right to receive an equivalent
dollar amount (to the nearest one ten-thousandth of one cent) of full shares of
SHIP I Common Stock, plus cash in lieu of fractional shares, computed based on
the net asset value per share of each Fund at the Effective Date. The net asset
value per share of SHIP I, SHIP II and Senior Strategic shall be determined as
of the Effective Date, and no formula will be used to adjust the net asset
value so determined of either SHIP I, SHIP II or Senior Strategic to take into
account differences in realized and unrealized gains and losses. The value of
the assets of SHIP II and Senior Strategic to be transferred to SHIP I shall be
determined by SHIP I pursuant to the procedures utilized by SHIP I in valuing
its own assets and determining its own liabilities for purposes of the Merger.
Such valuation and determination shall be made by SHIP I in cooperation with
SHIP II and Senior Strategic and shall be confirmed in writing by SHIP I to
SHIP II and Senior Strategic. The net asset value per share of SHIP I Common
Stock shall be determined in accordance with such procedures, and SHIP I shall
certify the computations involved. SHIP I shall issue to the stockholders of
SHIP II and Senior Strategic separate certificates or share deposit receipts
for the SHIP I Common Stock by delivering the certificates or share deposit
receipts evidencing ownership of the SHIP I Common Stock to The Bank of New
York, as the transfer agent and registrar for SHIP I Common Stock. With respect
to any SHIP II or Senior Strategic stockholder holding certificates evidencing
ownership of either the Common Stock of SHIP II or Senior Strategic as of the
Effective Date, and subject to SHIP I being informed thereof in writing by SHIP
II or Senior Strategic, SHIP I will not permit such stockholder to receive new
certificates evidencing ownership of the SHIP I Common Stock, exchange SHIP I
Common Stock credited to such stockholder's account for shares of other
investment companies managed by Merrill Lynch Asset Management, L.P. or any of
its affiliates, or pledge or redeem such SHIP I Common Stock, in any case,
until such stockholder has surrendered his or her outstanding certificates
evidencing ownership of the Common Stock of SHIP II or Senior Strategic or, in
the event of lost certificates, posted adequate bond. Each of SHIP II and
Senior Strategic, at its own expense, will request its stockholders to
surrender their outstanding certificates evidencing ownership of the Common
Stock of SHIP II and Senior Strategic or post adequate bond therefor. Dividends
payable to holders of record of shares of SHIP I Common Stock as of any date
after the Effective Date and prior to the exchange of certificates by any
stockholder of SHIP II and Senior Strategic shall be paid to such stockholder,
without interest; however, such dividends shall not be paid unless and until
such stockholder surrenders his or her stock certificates of SHIP II and Senior
Strategic for exchange.
I-7
<PAGE>
No fractional shares of SHIP I Common Stock will be issued to SHIP II or
Senior Strategic stockholders. In lieu thereof, SHIP I's transfer agent, The
Bank of New York, will aggregate all fractional shares of SHIP I and sell the
resulting full shares on the New York Stock Exchange at the current market
price for shares of SHIP I for the account of all holders of fractional
interests, and each such holder will receive such holder's pro rata share of
the proceeds of such sale, without interest, upon surrender of such holder's
SHIP I Common Stock certificates.
6. Payment of Expenses.
(a) SHIP I shall pay, subsequent to the Effective Date, all expenses
incurred in connection with the Merger, including, but not limited to, all
costs related to the preparation and distribution of the N-14 Registration
Statement and the fees of special counsel to the Merger. Such fees and
expenses shall include legal, accounting and state securities or blue sky
fees, printing costs, filing fees, stock exchange fees, rating agency fees,
portfolio transfer taxes (if any), and any similar expenses incurred in
connection with the Merger. Neither SHIP I, SHIP II nor Senior Strategic
shall pay any expenses of its respective stockholders arising out of or in
connection with the Merger.
(b) If for any reason the Merger is not consummated, no party shall be
liable to any other party for any damages resulting therefrom, including,
without limitation, consequential damages.
7. Covenants of SHIP I, SHIP II and Senior Strategic.
(a) SHIP I, SHIP II and Senior Strategic each agrees to call a special
meeting of its respective stockholders as soon as is practicable after the
effective date of the N-14 Registration Statement for the purpose of
considering the Merger as described in this Agreement.
(b) SHIP I, SHIP II and Senior Strategic each covenants to operate its
respective business as presently conducted between the date hereof and the
Effective Date.
(c) Each of SHIP I, SHIP II and Senior Strategic agrees that, as soon as
practicable after satisfaction of all conditions to the Merger, they will
jointly file executed Articles of Merger with the Department of Assessments
and Taxation of the State of Maryland and make all other filings or
recordings required by Maryland Law in connection with the Merger.
(d) SHIP I undertakes that if the Merger is consummated, it will file, or
cause its agents to file, an application pursuant to Section 8(f) of the
1940 Act for an order declaring that each of SHIP II and Senior Strategic,
respectively, has ceased to be a registered investment company.
(e) SHIP I will file the N-14 Registration Statement with the Securities
and Exchange Commission (the "Commission") and will use its best efforts to
provide that the N-14 Registration Statement becomes effective as promptly
as practicable. Each of SHIP II and Senior Strategic, respectively, agrees
to cooperate fully with SHIP I, and each will furnish to SHIP I the
information relating to itself to be set forth in the N-14 Registration
Statement as required by the 1933 Act, the 1934 Act, the 1940 Act, and the
rules and regulations thereunder and the state securities or blue sky laws.
(f) SHIP I, SHIP II and Senior Strategic each agrees to proceed as
promptly as possible to cause to be made the necessary filings under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the "HSR Act") with
respect to the transactions contemplated by this Agreement and to ensure
that the related waiting period expires or is otherwise terminated at the
earliest possible time.
(g) SHIP I agrees that it has no plan or intention to sell or otherwise
dispose of the assets of SHIP II and Senior Strategic to be acquired in the
Merger, except for dispositions made in the ordinary course of business.
(h) SHIP I, SHIP II and Senior Strategic each agrees that by the
Effective Date all of its federal and other tax returns and reports
required to be filed on or before such date shall have been filed and all
taxes shown as due on said returns either have been paid or adequate
liability reserves have been provided for the payment of such taxes. In
connection with this covenant, SHIP I, SHIP II and Senior Strategic
I-8
<PAGE>
agree to cooperate with each other in filing any tax return, amended return
or claim for refund, determining a liability for taxes or a right to a
refund of taxes or participating in or conducting any audit or other
proceeding in respect of taxes. SHIP I agrees to retain for a period of ten
(10) years following the Effective Date all returns, schedules and work
papers and all material records or other documents relating to tax matters
of SHIP II and Senior Strategic for their respective taxable periods first
ending after the Effective Date and for all prior taxable periods. Any
information obtained under this subsection shall be kept confidential
except as otherwise may be necessary in connection with the filing of
returns or claims for refund or in conducting an audit or other proceeding.
After the Effective Date, SHIP I shall prepare, or cause its agents to
prepare, any Federal, state or local tax returns, including any Forms 1099,
required to be filed by SHIP II or Senior Strategic with respect to their
final taxable years ending with each of SHIP II and Senior Strategic's
complete liquidation and for any prior periods or taxable years and further
shall cause such tax returns and Forms 1099 to be duly filed with the
appropriate taxing authorities. Notwithstanding the aforementioned
provisions of this subsection, any expenses incurred by each of SHIP I
(other than for payment of taxes) in connection with the preparation and
filing of said tax returns and Forms 1099 after the Effective Date shall be
borne by SHIP I.
(i) SHIP I, SHIP II and Senior Strategic each agrees to mail to each of
its respective stockholders of record entitled to vote at the special
meeting of stockholders at which action is to be considered regarding this
Agreement, in sufficient time to comply with requirements as to notice
thereof, a combined Proxy Statement and Prospectus which complies in all
material respects with the applicable provisions of Section 14(a) of the
1934 Act and Section 20(a) of the 1940 Act, and the rules and regulations,
respectively, thereunder.
(j) SHIP I agrees that at the Effective Date it will have entered into an
agreement with a financial institution, in form and substance acceptable to
SHIP I in its sole discretion, providing for an unsecured revolving credit
facility for SHIP I in a principal amount approximately equal to the
aggregate amount that SHIP I is permitted to borrow under Section 18 of the
1940 Act taking into account its total assets as a result of the Merger at
terms no less advantageous to SHIP I, SHIP II and Senior Strategic, taking
into account current market conditions at the Effective Date, than the
terms at which the credit facilities then outstanding for SHIP I, SHIP II
and Senior Strategic (the "Outstanding Credit Facilities") could be renewed
individually at the Effective Date.
(k) Following the consummation of the Merger, SHIP I expects to stay in
existence and continue its business as a closed-end management investment
company registered under the 1940 Act.
8. Effective Date.
(a) The Merger shall become effective at such time as the Articles of
Merger are accepted for filing by the Department of Assessments and
Taxation of the State of Maryland or at such later time as is specified in
the Articles of Merger.
(b) Prior to the Effective Date, each of SHIP II and Senior Strategic
shall have made arrangements with its transfer agent to deliver to SHIP I,
as soon as practicable after the Effective Date, a list of the names and
addresses of all of the stockholders of record of SHIP II and Senior
Strategic on the Effective Date and the number of shares of Common Stock of
SHIP II and Senior Strategic owned by each such stockholder, certified by
its transfer agent or by its President to the best of their knowledge and
belief.
9. SHIP I Conditions.
The obligations of SHIP I hereunder shall be subject to the following
conditions:
(a) That this Agreement shall have been adopted, and the Merger shall
have been approved, by the affirmative vote of the holders of more than
fifty percent of the Common Stock of SHIP I issued and outstanding and
entitled to vote thereon; and that each of SHIP II and Senior Strategic,
respectively, shall have delivered to SHIP I a copy of the resolution
approving this Agreement adopted by its respective Board of Directors and
stockholders, certified by its respective Secretary.
I-9
<PAGE>
(b) That each of SHIP II and Senior Strategic, respectively, shall have
furnished to SHIP I a statement of assets, liabilities and capital,
together with a schedule of investments with their respective dates of
acquisition and tax costs, certified on its behalf by its respective
President (or any Vice President) and its respective Treasurer, and a
certificate of both such officers, dated the Effective Date, certifying
that there has been no material adverse change in its respective financial
position since August 31, 1995, other than changes in its portfolio
securities since that date or changes in the market value of its portfolio
securities.
(c) That each of SHIP II and Senior Strategic, respectively, shall have
furnished to SHIP I a certificate signed by its respective President (or
any Vice President) and its respective Treasurer, dated the Effective Date,
certifying that as of the Effective Date all representations and warranties
made in this Agreement are true and correct in all material respects as if
made at and as of such date and each has complied with all of the
agreements and satisfied all of the conditions on its part to be performed
or satisfied at or prior to such dates.
(d) That each of SHIP II and Senior Strategic, respectively, shall have
delivered to SHIP I a letter from Deloitte & Touche LLP, dated the
Effective Date, stating that such firm has performed a limited review of
the Federal, state and local income tax returns for the period ended August
31, 1995, in the case of SHIP II, or February 28, 1995, in the case of
Senior Strategic (which returns originally were prepared and filed by each
of SHIP II and Senior Strategic, respectively), and that based on such
limited review, nothing came to their attention which caused them to
believe that such returns did not properly reflect, in all material
respects, the Federal, state and local income taxes of each of SHIP II and
Senior Strategic, respectively, for the period covered thereby; and that
for the period from September 1, 1995, in the case of SHIP II, or March 1,
1995, in the case of Senior Strategic, to and including the Effective Date
and for any taxable year ending upon its dissolution, such firm has
performed a limited review to ascertain the amount of applicable Federal,
state and local taxes, and has determined that either such amount has been
paid or reserves established for payment of such taxes, this review to be
based on unaudited financial data; and that based on such limited review,
nothing has come to their attention which caused them to believe that the
taxes paid or reserves set aside for payment of such taxes were not
adequate in all material respects for the satisfaction of Federal, state
and local taxes for the period from September 1, 1995, in the case of SHIP
II, or March 1, 1995, in the case of Senior Strategic, to and including the
Effective Date and for any taxable year ending upon its dissolution or that
either of SHIP II or Senior Strategic would not continue to qualify as a
regulated investment company for Federal income tax purposes.
(e) That there shall not be any material litigation pending with respect
to the matters contemplated by this Agreement.
(f) That SHIP I shall have received an opinion of Brown & Wood, as
counsel to SHIP I, in form and substance satisfactory to SHIP I and dated
the Effective Date, to the effect that (i) each of SHIP I, SHIP II and
Senior Strategic, respectively, is a corporation duly organized, validly
existing and in good standing in conformity with Maryland Law; (ii) the
SHIP I Common Stock to be issued pursuant to this Agreement is duly
authorized and, upon delivery, will be validly issued and outstanding and
fully paid and nonassessable by SHIP I, and no stockholder of SHIP I has
any preemptive right to subscription or purchase in respect thereof
(pursuant to the Articles of Incorporation, as amended, or the by-laws of
SHIP I or, to the best of such counsel's knowledge, otherwise); (iii) this
Agreement has been duly authorized, executed and delivered by each of SHIP
I, SHIP II and Senior Strategic, respectively, and represents a valid and
binding contract, enforceable in accordance with its terms, except as
enforceability may be limited by bankruptcy, insolvency, reorganization or
other similar laws pertaining to the enforcement of creditors' rights
generally and by equitable principles; (iv) to the best of such counsel's
knowledge, no consent, approval, authorization or order of any United
States federal or Maryland state court or governmental authority is
required for the consummation by SHIP I, SHIP II and Senior Strategic of
the Merger, except such as have been obtained under the 1933 Act, the 1934
Act and the 1940 Act and the published rules and regulations of the
Commission thereunder and under Maryland
I-10
<PAGE>
law and such as may be required under state securities or blue sky laws;
(v) the N-14 Registration Statement has become effective under the 1933
Act, no stop order suspending the effectiveness of the N-14 Registration
Statement has been issued and no proceedings for that purpose have been
instituted or are pending or contemplated under the 1933 Act, and the N-14
Registration Statement, and each amendment or supplement thereto, as of
their respective effective dates, appear on their face to be appropriately
responsive in all material respects to the requirements of the 1933 Act,
the 1934 Act and the 1940 Act and the published rules and regulations of
the Commission thereunder; (vi) the descriptions in the N-14 Registration
Statement of statutes, legal and governmental proceedings and contracts and
other documents are accurate and fairly present the information required to
be shown; (vii) such counsel does not know of any statutes, legal or
governmental proceedings or contracts or other documents related to the
Merger of a character required to be described in the N-14 Registration
Statement which are not described therein or, if required to be filed,
filed as required; (viii) the execution and delivery of this Agreement does
not, and the consummation of the Merger will not, violate any material
provision of the Articles of Incorporation, as amended, the by-laws, as
amended, or any agreement (known to such counsel) to which either SHIP I,
SHIP II or Senior Strategic is a party or by which either SHIP I, SHIP II
or Senior Strategic is bound, except insofar as the parties have agreed to
amend such provision as a condition precedent to the Merger; (ix) neither
SHIP I, SHIP II nor Senior Strategic, to the knowledge of such counsel, is
required to qualify to do business as a foreign corporation in any
jurisdiction except as may be required by state securities or blue sky
laws, and except where each has so qualified or the failure so to qualify
would not have a material adverse effect on SHIP I, SHIP II or Senior
Strategic, or their respective stockholders; (x) to the best of such
counsel's knowledge, no material suit, action or legal or administrative
proceeding is pending or threatened against SHIP I, SHIP II or Senior
Strategic, the unfavorable outcome of which would materially adversely
affect SHIP I, SHIP II or Senior Strategic; and (xi) all corporate actions
required to be taken by SHIP I, SHIP II and Senior Strategic to authorize
this Agreement and to effect the Merger have been duly authorized by all
necessary corporate actions on the part of SHIP I, SHIP II and Senior
Strategic. Such opinion also shall state that (x) while such counsel cannot
make any representation as to the accuracy or completeness of statements of
fact in the N-14 Registration Statement or any amendment or supplement
thereto, nothing has come to their attention that would lead them to
believe that, on the respective effective dates of the N-14 Registration
Statement and any amendment or supplement thereto, (1) the N-14
Registration Statement or any amendment or supplement thereto contained any
untrue statement of a material fact or omitted to state any material fact
required to be stated therein or necessary to make the statements therein
not misleading; and (2) the prospectus included in the N-14 Registration
Statement contained any untrue statement of a material fact or omitted to
state any material fact necessary to make the statements therein, in the
light of the circumstances under which they were made, not misleading;
and (y) such counsel does not express any opinion or belief as to the
financial statements, other financial data, statistical data or information
relating to SHIP I, SHIP II or Senior Strategic
contained or incorporated by reference in the N-14 Registration Statement.
In giving the opinion set forth above, Brown & Wood may state that it is
relying on certificates of officers of SHIP I, SHIP II and Senior Strategic
with regard to matters of fact and certain certificates and written
statements of governmental officials with respect to the good standing of
SHIP I, SHIP II and Senior Strategic and on the opinion of Venable, Baetjer
and Howard, LLP as to matters of Maryland Law.
(g) That SHIP I shall have received an opinion from Brown & Wood, as
counsel to SHIP I, in form and substance satisfactory to SHIP I and dated
the Effective Date, to the effect that for Federal income tax purposes (i)
the Merger as provided in this Agreement will constitute a merger within
the meaning of Section 368(a)(1)(A) of the Code and SHIP I, SHIP II and
Senior Strategic will each be deemed a "party" to a reorganization within
the meaning of Section 368(b) of the Code; (ii) in accordance with Section
361(a) of the Code, no gain or loss will be recognized to either SHIP II or
Senior Strategic as a result of the Merger or on the distribution of SHIP I
Common Stock to SHIP II and Senior Strategic stockholders under Section
361(c)(1) of the Code, except to the extent such stockholders are paid cash
in lieu of fractional shares of SHIP I in the Merger; (iii) under Section
1032
I-11
<PAGE>
of the Code, no gain or loss will be recognized to SHIP I as a result of
the Merger; (iv) in accordance with Section 354(a)(1) of the Code, no gain
or loss will be recognized to the stockholders of SHIP II and Senior
Strategic on the conversion of their SHIP II and Senior Strategic shares
into SHIP I Common Stock; (v) in accordance with Section 362(b) of the
Code, the tax basis of the SHIP II and Senior Strategic assets in the hands
of SHIP I will be the same as the tax basis of such assets in the hands of
SHIP II and Senior Strategic immediately prior to the consummation of the
Merger; (vi) in accordance with Section 358 of the Code, immediately after
the Merger, the tax basis of the SHIP I Common Stock received by the
stockholders of SHIP II and Senior Strategic in the Merger will be equal,
in the aggregate, to the tax basis of the shares of SHIP II and Senior
Strategic converted pursuant to the Merger; (vii) in accordance with
Section 1223 of the Code, a stockholder's holding period for the SHIP I
Common Stock will be determined by including the period for which he or she
held the Common Stock of SHIP II or Senior Strategic converted pursuant to
the Merger, provided, that such SHIP II or Senior Strategic shares were
held as a capital asset; (viii) in accordance with Section 1223 of the
Code, SHIP I's holding period with respect to the SHIP II and Senior
Strategic assets transferred will include the period for which such assets
were held by SHIP II and Senior Strategic; (ix) the payment of cash to SHIP
II and Senior Strategic stockholders in lieu of fractional shares of SHIP I
will be treated as though the fractional shares were distributed as part of
the Merger and then redeemed by SHIP I, with the result that each SHIP II
and Senior Strategic stockholder will generally have short- or long-term
capital gain or loss to the extent the cash distribution differs from such
stockholder's basis allocable to the fractional shares; and (x) the taxable
years of SHIP II and Senior Strategic will end on the effective date of the
Merger and pursuant to Section 381(a) of the Code and regulations
thereunder, SHIP I will succeed to and take into account certain tax
attributes of SHIP II and Senior Strategic, such as earnings and profits,
capital loss carryovers and method of accounting.
(h) That SHIP I shall have received from Deloitte & Touche LLP a letter
dated as of the effective date of the N-14 Registration Statement and a
similar letter dated within five days prior to the Effective Date, in form
and substance satisfactory to SHIP I, to the effect that (i) they are
independent public accountants with respect to each of SHIP II and Senior
Strategic within the meaning of the 1933 Act and the applicable published
rules and regulations thereunder; (ii) in their opinion, the financial
statements and supplementary information of each of SHIP II and Senior
Strategic included or incorporated by reference in the N-14 Registration
Statement and reported on by them comply as to form in all material
respects with the applicable accounting requirements of the 1933 Act and
the published rules and regulations thereunder; (iii) on the basis of
limited procedures agreed upon by SHIP I, SHIP II and Senior Strategic and
described in such letter (but not an examination in accordance with
generally accepted auditing standards) consisting of a reading of any
unaudited interim financial statements and unaudited supplementary
information of each of SHIP II and Senior Strategic included in the N-14
Registration Statement, and inquiries of certain officials of each of SHIP
II and Senior Strategic responsible for financial and accounting matters,
nothing came to their attention that caused them to believe that (a) such
unaudited financial statements and related unaudited supplementary
information do not comply as to form in all material respects with the
applicable accounting requirements of the 1933 Act and the published rules
and regulations thereunder, (b) such unaudited financial statements are not
fairly presented in conformity with generally accepted accounting
principles, applied on a basis substantially consistent with that of the
audited financial statements, or (c) such unaudited supplementary
information is not fairly stated in all material respects in relation to
the unaudited financial statements taken as a whole; and (iv) on the basis
of limited procedures agreed upon by SHIP I, SHIP II and Senior Strategic
and described in such letter (but not an examination in accordance with
generally accepted auditing standards), the information relating to each of
SHIP II and Senior Strategic appearing in the N-14 Registration Statement,
which information is expressed in dollars (or percentages derived from such
dollars) concerning each of SHIP II and Senior Strategic (with the
exception of performance comparisons, if any), has been obtained from the
accounting records of each of SHIP II and Senior Strategic or from
schedules prepared by officials of each of SHIP II and Senior
I-12
<PAGE>
Strategic having responsibility for financial and reporting matters and
such information is in agreement with such records, schedules or
computations made therefrom.
(i) That the assets or liabilities of each of SHIP II and Senior
Strategic, respectively, to be transferred to SHIP I shall not include any
assets or liabilities which SHIP I, by reason of charter limitations or
otherwise, may not properly acquire or assume.
(j) That the N-14 Registration Statement shall have become effective
under the 1933 Act and no stop order suspending such effectiveness shall
have been instituted or, to the knowledge of either of SHIP II or Senior
Strategic, contemplated by the Commission.
(k) That the Commission shall not have issued an unfavorable advisory
report under Section 25(b) of the 1940 Act, nor instituted or threatened to
institute any proceeding seeking to enjoin consummation of the Merger under
Section 25(c) of the 1940 Act, no other legal, administrative or other
proceeding shall be instituted or threatened which would materially affect
the financial condition of either of SHIP II or Senior Strategic or would
prohibit the Merger.
(l) That SHIP I shall have received from the Commission such orders or
interpretations as Brown & Wood, as counsel to SHIP I, deems reasonably
necessary or desirable under the 1933 Act and the 1940 Act in connection
with the Merger, provided, that such counsel shall have requested such
orders as promptly as practicable, and all such orders shall be in full
force and effect.
(m) That all proceedings taken by either of SHIP II or Senior Strategic
and its counsel in connection with the Merger and all documents incidental
thereto shall be satisfactory in form and substance to SHIP I.
(n) That prior to the Effective Date, each of SHIP II and Senior
Strategic, respectively, shall have declared a dividend or dividends which,
together with all such previous dividends, shall have the effect of
distributing to its stockholders all of its net investment company taxable
income for the period from September 1, 1995, in the case of SHIP II, or
March 1, 1995, in the case of Senior Strategic, to and including the
Effective Date, if any (computed without regard to any deduction or
dividends paid), and all of its net capital gain, if any, realized for the
period from September 1, 1995, in the case of SHIP II, or March 1, 1995, in
the case of Senior Strategic, to and including the Effective Date.
(o) That any applicable waiting period under the HSR Act relating to the
transactions contemplated hereby shall have expired or been terminated.
(p) That as of the Effective Date, SHIP I will have entered into an
agreement with a financial institution, in form and substance acceptable to
SHIP I in its sole discretion, providing for an unsecured revolving credit
facility for SHIP I in a principal amount approximately equal to the
aggregate amount that SHIP I is permitted to borrow under Section 18 of the
1940 Act taking into account its total assets as a result of the Merger at
terms no less advantageous to SHIP I, SHIP II and Senior Strategic, taking
into account current market conditions at the Effective Date, than the
terms at which the Outstanding Credit Facilities could be renewed
individually at the Effective Date.
10. SHIP II Conditions.
The obligations of SHIP II hereunder shall be subject to the following
conditions:
(a) That this Agreement shall have been adopted, and the Merger shall
have been approved, by the affirmative vote of the holders of more than
fifty percent of the Common Stock of SHIP II issued and outstanding and
entitled to vote thereon; and that each of SHIP I and Senior Strategic,
respectively, shall have delivered to SHIP II a copy of the resolution
approving this Agreement adopted by its respective Board of Directors and
Stockholders, certified by its respective Secretary.
(b) That each of SHIP I and Senior Strategic, respectively, shall have
furnished to SHIP II a statement of assets, liabilities and capital,
together with a schedule of its investments, certified on its behalf by its
respective President (or any Vice President) and its respective Treasurer,
and a certificate of both such officers, dated as of the Effective Date,
certifying that as of the Effective Date there has been no material adverse
change in its respective financial position since August 31, 1995, other
than changes in its portfolio securities since that date or changes in the
market value of its portfolio securities.
I-13
<PAGE>
(c) That each of SHIP I and Senior Strategic, respectively, shall have
furnished to SHIP II a certificate signed by its respective President (or
any Vice President) and its respective Treasurer, dated as of the Effective
Date, certifying that all representations and warranties of each of SHIP I
and Senior Strategic, respectively, made in this Agreement are true and
correct in all material respects with the same effect as if made at and as
of the Effective Date, and that each of SHIP I and Senior Strategic,
respectively, has complied with all of the agreements and satisfied all of
the conditions on its part to be performed or satisfied at or prior to such
date.
(d) That there shall not be any material litigation pending with respect
to the matters contemplated by this Agreement.
(e) That SHIP II shall have received the opinion or opinions of Brown &
Wood, as counsel to SHIP II, in form and substance satisfactory to SHIP II
and dated the Effective Date, with respect to the matters specified in
Sections 9(f) and (g) of this Agreement and such other matters as SHIP II
reasonably may deem necessary or desirable.
(f) That all proceedings taken by both SHIP I or Senior Strategic and its
counsel in connection with the Merger and all documents incidental thereto
shall be satisfactory in form and substance to SHIP II.
(g) That the N-14 Registration Statement shall have become effective
under the 1933 Act, and no stop order suspending such effectiveness shall
have been instituted or, to the knowledge of either of SHIP I or Senior
Strategic, contemplated by the Commission.
(h) That SHIP II shall have received from Deloitte & Touche LLP a letter
dated as of the effective date of the N-14 Registration Statement and a
similar letter dated within five days prior to the Effective Date, in form
and substance satisfactory to SHIP II, to the effect that (i) they are
independent public accountants with respect to each of SHIP I and Senior
Strategic within the meaning of the 1933 Act and the applicable published
rules and regulations thereunder; (ii) in their opinion, the financial
statements and supplementary information of each of SHIP I and Senior
Strategic included or incorporated by reference in the N-14 Registration
Statement and reported on by them comply as to form in all material
respects with the applicable accounting requirements of the 1933 Act and
the published rules and regulations thereunder; (iii) on the basis of
limited procedures agreed upon by SHIP I, SHIP II and Senior Strategic and
described in such letter (but not an examination in accordance with
generally accepted auditing standards) consisting of a reading of any
unaudited interim financial statements and unaudited supplementary
information of each of SHIP I and Senior Strategic included in the N-14
Registration Statement, and inquiries of certain officials of each of SHIP
I and Senior Strategic responsible for financial and accounting matters,
nothing came to their attention that caused them to believe that (a) such
unaudited financial statements and related unaudited supplementary
information do not comply as to form in all material respects with the
applicable accounting requirements of the 1933 Act and the published rules
and regulations thereunder, (b) such unaudited financial statements are not
fairly presented in conformity with generally accepted accounting
principles, applied on a basis substantially consistent with that of the
audited financial statements, or (c) such unaudited supplementary
information is not fairly stated in all material respects in relation to
the unaudited financial statements taken as a whole; and (iv) on the basis
of limited procedures agreed upon by SHIP I, SHIP II and Senior Strategic
and described in such letter (but not an examination in accordance with
generally accepted auditing standards), the information relating to each of
SHIP I and Senior Strategic appearing in the N-14 Registration Statement,
which information is expressed in dollars (or percentages derived from such
dollars) concerning each of SHIP I and Senior Strategic (with the exception
of performance comparisons, if any), if any, has been obtained from the
accounting records of each of SHIP I and Senior Strategic or from schedules
prepared by officials of each of SHIP I and Senior Strategic having
responsibility for financial and reporting matters and such information is
in agreement with such records, schedules or computations made therefrom.
I-14
<PAGE>
(i) That the Commission shall not have issued an unfavorable advisory
report under Section 25(b) of the 1940 Act, nor instituted or threatened to
institute any proceeding seeking to enjoin consummation of the Merger under
Section 25(c) of the 1940 Act, no other legal, administrative or other
proceeding shall be instituted or threatened which would materially affect
the financial condition of either of SHIP I or Senior Strategic or would
prohibit the Merger.
(j) That SHIP II shall have received from the Commission such orders or
interpretations as Brown & Wood, as counsel to SHIP II, deems reasonably
necessary or desirable under the 1933 Act and the 1940 Act in connection
with the Merger, provided, that such counsel shall have requested such
orders as promptly as practicable, and all such orders shall be in full
force and effect.
(k) That any applicable waiting period under the HSR Act relating to the
transactions contemplated hereby shall have expired or been terminated.
(l) That as of the Effective Date, SHIP I will have entered into an
agreement with a financial institution, in form and substance acceptable to
SHIP I in its sole discretion, providing for an unsecured revolving credit
facility for SHIP I in a principal amount approximately equal to the
aggregate amount that SHIP I is permitted to borrow under Section 18 of the
1940 Act taking into account its total assets as a result of the Merger at
terms no less advantageous to SHIP I, SHIP II and Senior Strategic, taking
into account current market conditions at the Effective Date, than the
terms at which the Outstanding Credit Facilities could be renewed
individually at the Effective Date.
11. Senior Strategic Conditions.
The obligations of Senior Strategic hereunder shall be subject to the
following conditions:
(a) That this Agreement shall have been adopted, and the Merger shall
have been approved, by the affirmative vote of the holders of more than
fifty percent of the Common Stock of Senior Strategic issued and
outstanding and entitled to vote thereon; and that each of SHIP I and SHIP
II, respectively, shall have delivered to Senior Strategic a copy of the
resolution approving this Agreement adopted by its respective Board of
Directors and stockholders, certified by its respective Secretary.
(b) That each of SHIP I and SHIP II, respectively, shall have furnished
to Senior Strategic a statement of assets, liabilities and capital,
together with a schedule of its investments, certified on its behalf by its
respective President (or any Vice President) and its respective Treasurer,
and a certificate of both such officers, dated as of the Effective Date,
certifying that as of the Effective Date there has been no material adverse
change in its respective financial position since August 31, 1995, other
than changes in its portfolio securities since that date or changes in the
market value of its portfolio securities.
(c) That each of SHIP I and SHIP II, respectively, shall have furnished
to Senior Strategic a certificate signed by its respective President (or
any Vice President) and its respective Treasurer, dated as of the Effective
Date, certifying that all representations and warranties of each of SHIP I
and SHIP II, respectively, made in this Agreement are true and correct in
all material respects with the same effect as if made at and as of the
Effective Date, and that each of SHIP I and SHIP II, respectively, has
complied with all of the agreements and satisfied all of the conditions on
its part to be performed or satisfied at or prior to such date.
(d) That there shall not be any material litigation pending with respect
to the matters contemplated by this Agreement.
(e) That Senior Strategic shall have received the opinion or opinions of
Brown & Wood, as counsel to Senior Strategic, in form and substance
satisfactory to Senior Strategic and dated the Effective Date, with respect
to matters specified in Sections 9(f) and 9(g) of this Agreement and such
other matters as Senior Strategic reasonably may deem necessary or
desirable.
(f) That all proceedings taken by both SHIP I or SHIP II and its counsel
in connection with the Merger and all documents incidental thereto shall be
satisfactory in form and substance to Senior Strategic.
I-15
<PAGE>
(g) That the N-14 Registration Statement shall have become effective
under the 1933 Act, and no stop order suspending such effectiveness shall
have been instituted or, to the knowledge of both SHIP I or SHIP II,
contemplated by the Commission.
(h) That Senior Strategic shall have received from Deloitte & Touche LLP
a letter dated as of the effective date of the N-14 Registration Statement
and a similar letter dated within five days prior to the Effective Date, in
form and substance satisfactory to Senior Strategic, to the effect that (i)
they are independent public accountants with respect to each of SHIP I and
SHIP II within the meaning of the 1933 Act and the applicable published
rules and regulations thereunder; (ii) in their opinion, the financial
statements and supplementary information of each of SHIP I and SHIP II
included or incorporated by reference in the N-14 Registration Statement
and reported on by them comply as to form in all material respects with the
applicable accounting requirements of the 1933 Act and the published rules
and regulations thereunder; (iii) on the basis of limited procedures agreed
upon by SHIP I, SHIP II and Senior Strategic and described in such letter
(but not an examination in accordance with generally accepted auditing
standards) consisting of a reading of any unaudited interim financial
statements and unaudited supplementary information of each of SHIP I and
SHIP II included in the N-14 Registration Statement, and inquiries of
certain officials of each of SHIP I and SHIP II responsible for financial
and accounting matters, nothing came to their attention that caused them to
believe that (a) such unaudited financial statements and related unaudited
supplementary information do not comply as to form in all material respects
with the applicable accounting requirements of the 1933 Act and the
published rules and regulations thereunder, (b) such unaudited financial
statements are not fairly presented in conformity with generally accepted
accounting principles, applied on a basis substantially consistent with
that of the audited financial statements, or (c) such unaudited
supplementary information is not fairly stated in all material respects in
relation to the unaudited financial statements taken as a whole; and (iv)
on the basis of limited procedures agreed upon by SHIP I, SHIP II and
Senior Strategic and described in such letter (but not an examination in
accordance with generally accepted auditing standards), the information
relating to each of SHIP I and SHIP II appearing in the N-14 Registration
Statement, which information is expressed in dollars (or percentages
derived from such dollars) concerning each of SHIP I and SHIP II (with the
exception of performance comparisons, if any), if any, has been obtained
from the accounting records of each of SHIP I and SHIP II or from schedules
prepared by officials of each of SHIP I and SHIP II having responsibility
for financial and reporting matters and such information is in agreement
with such records, schedules or computations made therefrom.
(i) That the Commission shall not have issued an unfavorable advisory
report under Section 25(b) of the 1940 Act, nor instituted or threatened to
institute any proceeding seeking to enjoin consummation of the Merger under
Section 25(c) of the 1940 Act, no other legal, administrative or other
proceeding shall be instituted or threatened which would materially affect
the financial condition of either of SHIP I or SHIP II or would prohibit
the Merger.
(j) That Senior Strategic shall have received from the Commission such
orders or interpretations as Brown & Wood, as counsel to Senior Strategic,
deems reasonably necessary or desirable under the 1933 Act and the 1940 Act
in connection with the Merger, provided, that such counsel shall have
requested such orders as promptly as practicable, and all such orders shall
be in full force and effect.
(k) That any applicable waiting period under the HSR Act relating to the
transactions contemplated hereby shall have expired or been terminated.
(l) That as of the Effective Date, SHIP I will have entered into an
agreement with a financial institution, in a form acceptable to SHIP I in
its sole discretion, providing for an unsecured revolving credit facility
for SHIP I in a principal amount approximately equal to the aggregate
commitment amount of the Outstanding Credit Facilities at terms no less
advantageous to SHIP I, SHIP II and Senior Strategic than the terms of the
Outstanding Credit Facilities.
12. Termination, Postponement and Waivers.
(a) Notwithstanding anything contained in this Agreement to the contrary,
this Agreement may be terminated and the Merger abandoned at any time
(whether before or after adoption thereof by the
I-16
<PAGE>
stockholders of each of SHIP I, SHIP II and Senior Strategic) prior to the
Effective Date, or the Effective Date may be postponed, (i) by mutual
consent of the Boards of Directors of SHIP I, SHIP II and Senior Strategic;
(ii) by the Board of Directors of SHIP I if any condition of SHIP I's
obligations set forth in Section 9 of this Agreement has not been fulfilled
or waived by such Board; (iii) by the Board of Directors of SHIP II if any
condition of SHIP II's obligations set forth in Section 10 of this
Agreement has not been fulfilled or waived by such Board; or (iv) by the
Board of Directors of Senior Strategic if any condition of Senior
Strategic's obligations set forth in Section 11 of this Agreement has not
been fulfilled or waived by such Board.
(b) If the transactions contemplated by this Agreement have not been
consummated by December 31, 1996, this Agreement automatically shall
terminate on that date, unless a later date is mutually agreed to by the
Boards of Directors of SHIP I, SHIP II and Senior Strategic.
(c) In the event of termination of this Agreement pursuant to the
provisions hereof, the same shall become void and have no further effect,
and there shall not be any liability on the part of either SHIP I, SHIP II
or Senior Strategic or persons who are their directors, trustees, officers,
agents or stockholders in respect of this Agreement.
(d) At any time prior to the Effective Date, any of the terms or
conditions of this Agreement may be waived by the Board of Directors of
either SHIP I, SHIP II or Senior Strategic, respectively (whichever is
entitled to the benefit thereof), if, in the judgment of such Board after
consultation with its counsel, such action or waiver will not have a
material adverse effect on the benefits intended under this Agreement to
the stockholders of their respective fund, on behalf of which such action
is taken. In addition, the Boards of Directors of SHIP I, SHIP II and
Senior Strategic have delegated to FAM the ability to make non-material
changes to the transaction if it deems it to be in the best interests of
SHIP I, SHIP II and Senior Strategic to do so.
(e) The respective representations and warranties contained in Sections
1, 2 and 3 of this Agreement shall expire with, and be terminated by, the
consummation of the Merger, and neither SHIP I, SHIP II nor Senior
Strategic nor any of their officers, directors or trustees, agents or
stockholders shall have any liability with respect to such representations
or warranties after the Effective Date. This provision shall not protect
any officer, director or trustee, agent or stockholder of SHIP I, SHIP II
or Senior Strategic against any liability to the entity for which that
officer, director or trustee, agent or stockholder so acts or to its
stockholders to which that officer, director or trustee, agent or
stockholder otherwise would be subject by reason of willful misfeasance,
bad faith, gross negligence, or reckless disregard of the duties in the
conduct of such office.
(f) If any order or orders of the Commission with respect to this
Agreement shall be issued prior to the Effective Date and shall impose any
terms or conditions which are determined by action of the Boards of
Directors of SHIP I, SHIP II and Senior Strategic to be acceptable, such
terms and conditions shall be binding as if a part of this Agreement
without further vote or approval of the stockholders of SHIP I, SHIP II and
Senior Strategic, unless such terms and conditions shall result in a change
in the method of computing the number of shares of SHIP I Common Stock to
be issued pursuant to this Agreement in which event, unless such terms and
conditions shall have been included in the proxy solicitation materials
furnished to the stockholders of SHIP I, SHIP II and Senior Strategic prior
to the meetings at which the Merger shall have been approved, this
Agreement shall not be consummated and shall terminate unless SHIP I, SHIP
II and Senior Strategic promptly shall call special meetings of
stockholders at which such conditions so imposed shall be submitted for
approval.
13. Other Matters.
(a) Pursuant to Rule 145 under the 1933 Act, and in connection with the
issuance of any shares to any person who at the time of the Merger is, to
its knowledge, an affiliate of a party to the Merger pursuant to Rule
145(c), SHIP I will cause to be affixed upon the certificate(s) issued to
such person (if any) a legend as follows:
THESE SHARES ARE SUBJECT TO RESTRICTIONS ON TRANSFER UNDER THE
SECURITIES ACT OF 1933 AND MAY NOT BE SOLD OR
I-17
<PAGE>
OTHERWISE TRANSFERRED EXCEPT TO SENIOR HIGH INCOME PORTFOLIO,
INC. (OR ITS STATUTORY SUCCESSOR) OR ITS PRINCIPAL UNDERWRITER
UNLESS (I) A REGISTRATION STATEMENT WITH RESPECT THERETO IS
EFFECTIVE UNDER THE SECURITIES ACT OF 1933 OR (II) IN THE
OPINION OF COUNSEL REASONABLY SATISFACTORY TO THE FUND, SUCH
REGISTRATION IS NOT REQUIRED.
and, further, that stop transfer instructions will be issued to SHIP I's
transfer agent with respect to such shares. Each of SHIP II and Senior
Strategic, respectively, will provide SHIP I on the Effective Date with the
name of any SHIP II and Senior Strategic stockholder who is to the respective
knowledge of SHIP II or Senior Strategic an affiliate of it on such date.
(b) All covenants, agreements, representations and warranties made under
this Agreement and any certificates delivered pursuant to this Agreement
shall be deemed to have been material and relied upon by each of the
parties, notwithstanding any investigation made by them or on their behalf.
(c) Any notice, report or demand required or permitted by any provision
of this Agreement shall be in writing and shall be deemed to have been
given if delivered or mailed, first class postage prepaid, addressed to
SHIP I, SHIP II or Senior Strategic, in either case at 800 Scudders Mill
Road, Plainsboro, New Jersey 08536, Attn: Arthur Zeikel, President.
(d) This Agreement supersedes all previous correspondence and oral
communications between the parties regarding the Merger, constitutes the
only understanding with respect to the Merger, may not be changed except by
a letter of agreement signed by each party and shall be governed by and
construed in accordance with the laws of the State of New York applicable
to agreements made and to be performed in said state.
(e) Copies of the Articles of Incorporation, and all amendments, if any,
of SHIP I, SHIP II and Senior Strategic are on file with the State
Department of Assessments and Taxation of Maryland, and notice is hereby
given that this instrument is executed on behalf of the Directors of each
of SHIP I, SHIP II and Senior Strategic.
I-18
<PAGE>
This Agreement may be executed in any number of counterparts, each of which,
when executed and delivered, shall be deemed to be an original but all such
counterparts together shall constitute but one instrument.
Senior High Income Portfolio, Inc.
/s/ Arthur Zeikel
By: _________________________________
Arthur Zeikel, President
Attest:
/s/ Patrick D. Sweeney
_____________________________________
Patrick D. Sweeney, Secretary
Senior High Income Portfolio II,
Inc.
/s/ Arthur Zeikel
By: _________________________________
Arthur Zeikel, President
Attest:
/s/ Patrick D. Sweeney
_____________________________________
Patrick D. Sweeney, Secretary
Senior Strategic Income Fund, Inc.
/s/ Arthur Zeikel
By: _________________________________
Arthur Zeikel, President
Attest:
/s/ Patrick D. Sweeney
_____________________________________
Patrick D. Sweeney, Secretary
I-19
<PAGE>
EXHIBIT II
RATINGS OF CORPORATE BONDS
DESCRIPTION OF CORPORATE BOND RATINGS OF MOODY'S INVESTORS SERVICE, INC.:
AAA--Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt-edge". Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
AA--Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in Aaa
securities.
A--Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium-grade obligations. Factors giving security
to principal and interest are considered adequate but elements may be present
which suggest a susceptibility to impairment sometime in the future.
BAA--Bonds which are rated Baa are considered medium-grade obligations, i.e.,
they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
BA--Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B--Bonds which are rated B generally lack characteristics of a desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
CAA--Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
CA--Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked
shortcomings.
C--Bonds which are rated C are the lowest rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
The modifier 1 indicates that the bond ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its rating category.
DESCRIPTION OF CORPORATE BOND RATINGS OF STANDARD & POOR'S RATINGS GROUP:
AAA--Bonds rated AAA have the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
II-1
<PAGE>
AA--Bonds rated AA have a very strong capacity to pay interest and repay
principal and differ from the higher rated issues only in small degree.
A--Bonds rated A have a strong capacity to pay interest and repay principal
although they are somewhat more susceptible to the adverse effects of changes
in circumstances and economic conditions than bonds in higher rated categories.
BBB--Bonds rated BBB are regarded as having an adequate capacity to pay
interest and repay principal. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
bonds in this category than in higher rated categories.
BB--B--CCC--CC--Bonds rated BB, B, CCC and CC are regarded, on balance, as
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligation. BB
indicates the lowest degree of speculation and CC the highest degree of
speculation. While such bonds will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
C--The C rating is reserved for income bonds on which no interest is being
paid.
D--Bonds rated D are in default, and payment of interest and/or repayment of
principal is in arrears.
NR--Indicates that no rating has been requested, that there is insufficient
information on which to base a rating, or that S&P does not rate a particular
type of bond as a matter of policy.
Plus (+) or Minus (-): The ratings from "AA" to "B" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
II-2
<PAGE>
PART C
OTHER INFORMATION
ITEM 15. INDEMNIFICATION.
Section 2-418 of the General Corporation Law of the State of Maryland,
Article VI of the Registrant's Articles of Incorporation, Article VI of the
Registrant's By-Laws and Article IV of the Registrant's Investment Advisory
Agreement with Fund Asset Management, Inc. (now known as Fund Asset Management,
L.P.; the "Investment Adviser") provide for indemnification.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "Securities Act"), may be provided to directors,
officers and controlling persons of the Registrant, pursuant to the foregoing
provisions or otherwise, the Registrant has been advised that in the opinion of
the Securities and Exchange Commission, such indemnification is against public
policy as expressed in the Securities Act and, therefore, is unenforceable. In
the event that a claim for indemnification against such liabilities (other than
the payment by the Registrant of expenses incurred or paid by a director,
officer or controlling person of the Registrant in connection with any
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant, unless in the opinion of its counsel the matter has
been settled by controlling precedent, will submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
Reference is made to Section Six of the Purchase Agreement relating to the
Registrant's Common Stock, a form of which previously was filed as an exhibit
to the Registrant's Registration Statement, for provisions relating to the
indemnification of the underwriter.
ITEM 16. EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
-------
<C> <S>
1. Articles of Incorporation of the Registrant*
2. By-Laws of the Registrant**
3. Not applicable
4. Form of Agreement and Plan of Merger among the Registrant, Senior High
Income Portfolio II, Inc. and Senior Strategic Income Fund, Inc.+
5.(a) Form of Certificate for Common Stock***
(b) Portions of the Articles of Incorporation and the By-Laws of the
Registrant defining the rights of holders of shares of the
Registrant****
6. Form of Investment Advisory Agreement between the Registrant and Fund
Asset Management, L.P. ( the "Investment Adviser")*
7.(a) Form of Purchase Agreement between the Registrant and the Investment
Adviser and Merrill Lynch, Pierce, Fenner & Smith Incorporated
("Merrill Lynch") relating to the Registrant's Common Stock*
(b) Merrill Lynch Standard Dealer Agreement*
8. Not applicable
9. Custody Agreement between the Registrant and The Bank of New York***
10. Not applicable
11.(a) Opinion and Consent of Brown & Wood, counsel to the Registrant+
Opinion of Brown & Wood, counsel to the Registrant, with respect to
(b) federal tax matters++
(c) Opinion and Consent of Brown & Wood, counsel to the Registrant
</TABLE>
C-1
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- -------
<S> <C>
12. Not applicable
13. Registrar, Transfer Agency and Service Agreement between the Registrant and The Bank of
New York***
14.(a) Consent of Deloitte & Touche LLP, independent auditors for the Registrant
(b) Consent of Deloitte & Touche LLP, independent auditors for Senior High Income Portfolio II, Inc.
(c) Consent of Deloitte & Touche LLP, independent auditors for Senior Strategic Income Fund, Inc.
(d) Consent of Deloitte & Touche LLP, independent auditors for the Investment Adviser
15. Not applicable
16. Power of Attorney+
</TABLE>
- --------
* Incorporated by reference to the Registrant's registration statement
(the "Registration Statement") on Form N-2 relating to the Registrant's
Common Stock (File Nos. 33-57686 and 811-7456), filed with the
Securities and Exchange Commission (the "Commission") on January 29,
1993.
** Incorporated by reference to Pre-Effective Amendment No. 1 to the
Registration Statement, filed with the Commission on March 12, 1993.
*** Incorporated by reference to Pre-Effective Amendment No. 2 to the
Registration Statement, filed with the Commission on April 23, 1993.
**** Reference is made to Article V, Article VI (section 6), Article VII,
Article VIII, Article IX, Article X, Article XI, Article XII and Article
XIII of the Registrant's Articles of Incorporation, filed herewith as
Exhibit 1 to the Registration Statement; and to Article II, Article III
(sections 1, 3, 5 and 17), Article VI, Article VII, Article XII, Article
XIII and Article XIV of the Registrant's By-Laws, filed herewith as
Exhibit 2 to the Registration Statement.
+Previously filed.
++To be filed by an amendment.
ITEM 17. UNDERTAKINGS.
(1) The Registrant agrees that prior to any public reoffering of the securities
registered through the use of a prospectus which is a part of this
Registration Statement by any person or party who is deemed to be an
underwriter within the meaning of Rule 145(c) of the Securities Act, the
reoffering prospectus will contain the information called for by the
applicable registration form for the reofferings by persons who may be
deemed underwriters, in addition to the information called for by the other
items of the applicable form.
(2) The Registrant agrees that every prospectus that is filed under paragraph
(1) above will be filed as a part of an amendment to the Registration
Statement and will not be used until the amendment is effective, and that,
in determining any liability under the Securities Act, each post-effective
amendment shall be deemed to be a new registration statement for the
securities offered therein, and the offering of the securities at that time
shall be deemed to be the initial bona fide offering of them.
(3) The Registrant undertakes to file an opinion of Brown & Wood, counsel to
the Registrant, with respect to U.S. federal income tax matters, as an
exhibit to a post-effective amendment to the Registration Statement.
C-2
<PAGE>
SIGNATURES
As required by the Securities Act of 1933, this Registration Statement has
been signed on behalf of the Registrant, in the Township of Plainsboro and
State of New Jersey, on the 1st day of February, 1996.
SENIOR HIGH INCOME PORTFOLIO, INC.
(Registrant)
/s/ Arthur Zeikel
_____________________________________
(ARTHUR ZEIKEL, PRESIDENT)
As required by the Securities Act of 1933, this Registration Statement has
been signed by the following persons in the capacities and on the dates
indicated.
SIGNATURE TITLE DATE
/s/ Arthur Zeikel President (Principal
- ------------------------------------- Executive Officer) February 1,
(ARTHUR ZEIKEL) and Director 1996
Treasurer (Principal
Gerald M. Richard* Financial and
- ------------------------------------- Accounting Officer)
(GERALD M. RICHARD)
Director
Ronald W. Forbes*
- -------------------------------------
(RONALD W. FORBES)
Director
Cynthia A. Montgomery*
- -------------------------------------
(CYNTHIA A. MONTGOMERY)
Director
Charles C. Reilly*
- -------------------------------------
(CHARLES C. REILLY)
Director
Kevin A. Ryan*
- -------------------------------------
(KEVIN A. RYAN)
Director
Richard R. West*
- -------------------------------------
(RICHARD R. WEST)
*By: /s/ Patrick D. Sweeney February 1,
----------------------------------- 1996
(PATRICK D. SWEENEY, ATTORNEY-IN-
FACT)
C-3
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
ITEM NO. DESCRIPTION
- -------- -----------
<S> <C>
11.(c) Opinion and Consent of Brown & Wood, counsel to the Registrant
14.(a) Consent of Deloitte & Touche LLP, independent auditors for the Registrant
(b) Consent of Deloitte & Touche LLP, independent auditors for Senior High Income
Portfolio II, Inc.
Consent of Deloitte & Touche LLP, independent auditors for Senior Strategic Income
(c) Fund, Inc.
(d) Consent of Deloitte & Touche LLP, independent auditors for the Investment Adviser
</TABLE>
<PAGE>
EXHIBIT 99.11(c)
BROWN & WOOD
ONE WORLD TRADE CENTER
NEW YORK, NEW YORK 10048-0557
TELEPHONE: (212) 839-5300
FACSIMILE: (212) 839-5599
February 1, 1996
Senior High Income Portfolio, Inc.
800 Scudders Mill Road
Plainsboro, New Jersey 08536
Ladies and Gentlemen:
We have acted as counsel for Senior High Income Portfolio, Inc. (the
"Fund") in connection with the proposed merger of Senior High Income Portfolio
II, Inc. ("SHIP II") and Senior Strategic Income Fund, Inc. ("Senior Strategic")
with and into the Fund (the "Merger"), whereby holders of common stock of each
of SHIP II and Senior Strategic will receive newly-issued shares of common stock
of the Fund. This opinion is furnished in connection with the Fund's
Registration Statement on Form N-14 under the Securities Act of 1933, as amended
(the "Registration Statement"), relating to the shares of common stock, par
value $0.10 per share, of the Fund to be issued in the Merger (the "Shares").
As counsel for the Fund, we are familiar with the proceedings taken by it
and to be taken by it in connection with the authorization and issuance of the
Shares. In addition, we have examined and are familiar with the Articles of
Incorporation of the Fund, as amended, the By-Laws of the Fund, as amended, and
<PAGE>
such other documents as we have deemed relevant to the matters referred to in
this opinion.
Based upon the foregoing, we are of the opinion that subsequent to the
approval of the Agreement and Plan of Merger among the Fund, SHIP II and Senior
Strategic set forth in the proxy statement and prospectus constituting a part of
the Registration Statement (the "Proxy Statement and Prospectus"), the Shares,
upon issuance in the manner referred to in the Registration Statement for
consideration not less than the par value thereof, will be legally issued, fully
paid and non-assessable shares of common stock of the Fund.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the use of our name in the Proxy Statement and
Prospectus constituting parts thereof.
Very truly yours,
/s/ Brown & Wood
2
<PAGE>
EXHIBIT 99.14(a)
INDEPENDENT AUDITORS' CONSENT
Senior High Income Portfolio, Inc.:
We consent to the use in this Registration Statement on Form N-14 of our
report dated April 12, 1995 appearing in the Proxy Statement and Prospectus,
which is a part of such Registration Statement, and to the reference to us
under the captions "Agreement and Plan of Merger--Comparison of the Funds--
Financial Highlights" and "Experts" also appearing in such Proxy Statement and
Prospectus.
DELOITTE & TOUCHE LLP
Princeton, New Jersey
February 1, 1996
<PAGE>
EXHIBIT 99.14(b)
INDEPENDENT AUDITORS' CONSENT
Senior High Income Portfolio II, Inc.:
We consent to the use in this Registration Statement on Form N-14 of our
report dated October 17, 1995 appearing in the Proxy Statement and Prospectus,
which is a part of such Registration Statement, and to the reference to us
under the captions "Agreement and Plan of Merger--Comparison of the Funds--
Financial Highlights" and "Experts" also appearing in such Proxy Statement and
Prospectus.
DELOITTE & TOUCHE LLP
Princeton, New Jersey
February 1, 1996
<PAGE>
EXHIBIT 99.14(c)
INDEPENDENT AUDITORS' CONSENT
Senior Strategic Income Fund, Inc.:
We consent to the use in this Registration Statement on Form N-14 of our
report dated April 14, 1995 appearing in the Proxy Statement and Prospectus,
which is a part of such Registration Statement, and to the reference to us
under the captions "Agreement and Plan of Merger--Comparison of the Funds--
Financial Highlights" and "Experts" also appearing in such Proxy Statement and
Prospectus.
DELOITTE & TOUCHE LLP
Princeton, New Jersey
February 1, 1996
<PAGE>
EXHIBIT 99.14(d)
INDEPENDENT AUDITORS' CONSENT
Fund Asset Management, L.P.:
We consent to the use in this Registration Statement on Form N-14 of our report
dated March 23, 1995 appearing in the Proxy Statement and Prospectus, which is a
part of such Registration Statement, and to the reference to us under the
captions "Agreement and Plan of Merger--Comparison of the Funds--Financial
Highlights" and "Experts" also appearing in such Proxy Statement and Prospectus.
DELOITTE & TOUCHE LLP
Parsippany, New Jersey
February 1, 1996
