THE OFFITBANK INVESTMENT FUND, INC.
125 West 55th Street
New York, New York 10019
(800) 618-9510
STATEMENT OF ADDITIONAL INFORMATION
January 1, 1997
The OFFITBANK Investment Fund, Inc. (the "Company") is an open-end,
management investment company that currently intends to offer eight
portfolios offering a variety of investment alternatives. This Statement of
Additional Information relates to the following portfolios:
OFFITBANK High Yield Fund
OFFITBANK Emerging Markets Fund
OFFITBANK Investment Grade Global Debt Fund
OFFITBANK Global Convertible Fund
OFFITBANK Latin America Total Return Fund
OFFITBANK National Municipal Fund
OFFITBANK California Municipal Fund
OFFITBANK New York Municipal Fund
(individually, a "Fund", and collectively, the "Funds"). This Statement of
Additional Information sets forth information about the Company applicable to
each of the Funds.
This Statement of Additional Information is not a prospectus and is only
authorized for distribution when preceded or accompanied by the Company's
Prospectus dated November 18, 1996 (the "Prospectus"). This Statement of
Additional Information contains additional information to that set forth in
the Prospectus and should be read in conjunction with the Prospectus,
additional copies of which may be obtained without charge by writing or
calling the Company at the address and telephone number set forth above.
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Table of Contents
Page
ADDITIONAL INFORMATION ON PORTFOLIO INSTRUMENTS . . . . . . . . . . . . . 3
ADDITIONAL RISK CONSIDERATIONS . . . . . . . . . . . . . . . . . . . . . 12
SPECIAL FACTORS AFFECTING THE CALIFORNIA MUNICIPAL FUND . . . . . . . . . 13
SPECIAL FACTORS AFFECTING THE NEW YORK MUNICIPAL FUND . . . . . . . . . . 23
INVESTMENT LIMITATIONS . . . . . . . . . . . . . . . . . . . . . . . . . 51
MANAGEMENT OF THE FUND . . . . . . . . . . . . . . . . . . . . . . . . . 54
DISTRIBUTOR . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
ADMINISTRATION, CUSTODY AND TRANSFER AGENCY SERVICES . . . . . . . . . . 58
PORTFOLIO TRANSACTIONS . . . . . . . . . . . . . . . . . . . . . . . . . 60
PURCHASE OF SHARES . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
REDEMPTION OF SHARES . . . . . . . . . . . . . . . . . . . . . . . . . . 62
PERFORMANCE CALCULATIONS . . . . . . . . . . . . . . . . . . . . . . . . 62
ADDITIONAL INFORMATION CONCERNING TAXES . . . . . . . . . . . . . . . . . 66
SHAREHOLDER SERVICES . . . . . . . . . . . . . . . . . . . . . . . . . . 71
GENERAL INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
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ADDITIONAL INFORMATION ON PORTFOLIO INSTRUMENTS
The following information relates to or supplements the description
of the Funds' investment policies contained in the Prospectus.
Repurchase Agreements
Each Fund may enter into repurchase agreements. A repurchase
agreement is a transaction in which the seller of a security commits itself
at the time of the sale to repurchase that security from the buyer at a
mutually agreed upon time and price. The Funds will enter into repurchase
agreements only with dealers, domestic banks or recognized financial
institutions which, in the opinion of the Adviser based on guidelines
established by the Company's Board of Directors, present minimal credit
risks. The Adviser will monitor the value of the securities underlying the
repurchase agreement at the time the transaction is entered into and at all
times during the term of the repurchase agreement to ensure that the value of
the securities always exceeds the repurchase price. In the event of default
by the seller under the repurchase agreement, the Fund may incur costs and
experience time delays in connection with the disposition of the underlying
securities.
Reverse Repurchase Agreements
Each Fund may enter into reverse repurchase agreements. A reverse
repurchase agreement is a borrowing transaction in which the Fund transfers
possession of a security to another party, such as a bank or broker/dealer,
in return for cash, and agrees to repurchase, the security in the future at
an agreed upon price, which includes an interest component. Whenever the
Funds enter into reverse repurchase agreements as described in the
Prospectus, they will place in a segregated custodian account liquid assets
having a value equal to the repurchase price (including accrued interest) and
will subsequently monitor the account to ensure such equivalent value is
maintained. Reverse repurchase agreements are considered to be borrowings by
the Funds under the Investment Company Act of 1940, as amended (the "1940
Act").
Asset-Backed Securities
Each of the Funds may invest in asset-backed securities. Asset-
backed securities are generally issued as pass through certificates, which
represent undivided fractional ownership interests in the underlying pool of
assets, or as debt instruments, and are generally issued as the debt of a
special purpose entity organized solely for the purpose of owning such assets
and issuing such debt. Asset-backed securities are often backed by a pool of
assets representing the obligations of a number of different parties.
Payments of principal and interest may be guaranteed up to certain amounts
and for a certain time period by a letter of credit or other enhancement
issued by a financial institution unaffiliated with the entities issuing the
securities. Assets which, to date, have been used to back asset-backed
securities include motor vehicle installment sales contracts or installment
loans secured by motor vehicles, and receivables from revolving credit
(credit card) agreements.
Asset-backed securities present certain risks which are, generally,
related to limited interests, if any, in related collateral. Credit card
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receivables are generally unsecured and the debtors are entitled to the
protection of a number of state and federal consumer credit laws, many of
which give such debtors the right to set off certain amounts owed on the
credit cards, thereby reducing the balance due. Most issuers of automobile
receivables permit the servicers to retain possession of the underlying
obligations. If the servicer were to sell these obligations to another party,
there is a risk that the purchaser would acquire an interest superior to that
of the holders of the related automobile receivables. In addition, because of
the large number of vehicles involved in a typical issuance and technical
requirements under state laws, the trustee for the holders of the automobile
receivables may not have a proper security interest in all of the obligations
backing such receivables. Therefore, there is the possibility that recoveries
on repossessed collateral may not, in some cases, be available to support
payments on these securities. If the letter of credit is exhausted, holders
of asset-backed securities may also experience delays in payments or losses
if the full amounts due on underlying sales contracts are not realized.
Because asset-backed securities are relatively new, the market experience in
these securities is limited and the market's ability to sustain liquidity
through all phases of the market cycle has not been tested.
Credit Support. Asset-backed securities often contain elements of
credit support to lessen the effect of the potential failure by obligors to
make timely payments on underlying assets. Credit support falls into two
categories: (i) liquidity protection and (ii) protection against losses
resulting from ultimate default by an obligor on the underlying asset.
Liquidity protection ensures that the pass through of payments due on the
installment sales contracts and installment loans which comprise the
underlying pool occurs in a timely fashion. Protection against losses
resulting from ultimate default enhances the likelihood of ultimate payment
of the obligations on at least a portion of the assets in the pool. Such
protection may be provided through guarantees, insurance policies or letters
of credit obtained by the issuer or sponsor from third parties, through
various means of structuring the transaction or through a combination of such
approaches. The Funds will not pay any additional fees for such credit
support. However, the existence of credit support may increase the market
price of the security.
Depository Receipts
The High Yield, Emerging Markets, Investment Grade Global Debt,
Global Convertible and Latin America Total Return Funds may hold equity
securities of foreign issuers in the form of American Depository Receipts
("ADRs"), American Depository Shares ("ADSs") and European Depository
Receipts ("EDRs"), or other securities convertible into securities of
eligible issuers. These securities may not necessarily be denominated in the
same currency as the securities for which they may be exchanged. ADRs and
ADSs typically are issued by an American bank or trust company which
evidences ownership of underlying securities issued by a foreign corporation.
EDRs, which are sometimes referred to as Continental Depository Receipts
("CDRs"), are receipts issued in Europe typically by foreign banks and trust
companies that evidence ownership of either foreign or domestic securities.
Generally, ADRs and ADSs in registered form are designed for use in United
States securities markets and EDRs and CDRs in bearer form are designed for
use in European securities markets. For purposes of the Fund's investment
policies, the Fund's investments in ADRs, ADSs, EDRs, and CDRs will be deemed
to be investments in the equity securities representing securities of foreign
issuers into which they may be converted.
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Warrants or Rights
Warrants or rights may be acquired by each of the High Yield,
Emerging Markets, Investment Grade Global Debt, Global Convertible and Latin
America Total Return Funds in connection with other securities or separately,
and provide the applicable Fund with the right to purchase at a later date
other securities of the issuer. As a condition of its continuing registration
in a state, each Fund has undertaken that its investment in warrants or
rights, valued at the lower of cost or market, will not exceed 5% of the
value of its net assets and not more than 2% of such assets will be invested
in warrants and rights which are not listed on the American or New York Stock
Exchange. Warrants or rights acquired by a Fund in units or attached to
securities will be deemed to be without value for purpose of this
restriction. These limits are not fundamental policies of the Funds and may
be changed by the Company's Board of Directors without shareholder approval.
Borrowing
The Global Debt, Latin America Total Return, National Municipal,
California Municipal and New York Municipal Funds' borrowings will not exceed
25% of each Fund's respective total assets (including the amount borrowed),
less all liabilities and indebtedness other than the borrowings and may use
the proceeds of such borrowings for investment purposes. These Funds may
borrow for leveraging purposes. The High Yield, Emerging Markets and Global
Convertible Funds borrowings will not exceed 20% of their respective total
assets and is permitted only for temporary or emergency purposes other than
to meet redemptions. Any borrowing by the Funds may cause greater fluctuation
in the value of their shares than would be the case if the Funds did not
borrow. In the event that the Funds employ leverage, they would be subject to
certain additional risks. Use of leverage creates an opportunity for greater
growth of capital but would exaggerate any increases or decreases in the
Funds' net asset values. When the income and gains on securities purchased
with the proceeds of borrowings exceed the costs of such borrowings, the
Funds' earnings or net asset values will increase faster than otherwise would
be the case; conversely, if such income and gains fail to exceed such costs,
the Funds' earnings or net asset values would decline faster than would
otherwise be the case.
Forward Foreign Currency Exchange Contracts
Certain Funds may purchase or sell forward foreign currency exchange
contracts ("forward contracts") as part of its portfolio investment strategy.
A forward contract is an obligation to purchase or sell a specific currency
for an agreed price at a future date which is individually negotiated and
privately traded by currency traders and their customers. A Fund may enter
into a forward contract, for example, when it enters into a contract for the
purchase or sale of a security denominated in a foreign currency in order to
"lock in" the U.S. dollar price of the security ("transaction hedge").
Additionally, for example, when a Fund believes that a foreign currency may
suffer a substantial decline against the U.S. dollar, it may enter into a
forward sale contract to sell an amount of that foreign currency
approximating the value of some or all of such Fund's portfolio securities
denominated in such foreign currency. Conversely, when a Fund believes that
the U.S. dollar may suffer a substantial decline against foreign currency, it
may enter into a forward purchase contract to buy that foreign currency for a
fixed dollar amount ("position hedge"). In this situation, a Fund may, in the
alternative, enter into a forward contract to sell a different foreign
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currency for a fixed U.S. dollar amount where such Fund believes that the
U.S. dollar value of the currency to be sold pursuant to the forward contract
will fall whenever there is a decline in the U.S. dollar value of the
currency in which portfolio securities of the Fund are denominated
("cross-hedge"). Each Fund's custodian will place cash not available for
investment or U.S. government securities or other liquid investments in a
separate account having a value equal to the aggregate amount of such Fund's
commitments under forward contracts entered into with respect to position
hedges, cross-hedges and transaction hedges, to the extent they do not
already own the security subject to the transaction hedge. If the value of
the securities placed in a separate account declines, additional cash or
investments will be placed in the account on a daily basis so that the value
of the account will equal the amount of such Fund's commitments with respect
to such contracts. As an alternative to maintaining all or part of the
separate account, a Fund may purchase a call option permitting such Fund to
purchase the amount of foreign currency being hedged by a forward sale
contract at a price no higher than the forward contract price or a Fund may
purchase a put option permitting such Fund to sell the amount of foreign
currency subject to a forward purchase contract at a price as high or higher
than the forward contract price. Unanticipated changes in currency prices may
result in poorer overall performance for a Fund than if it had not entered
into such contracts. If the party with which a Fund enters into a forward
contract becomes insolvent or breaches its obligation under the contract,
then the Fund may lose the ability to purchase or sell a currency as desired.
Loans of Portfolio Securities
For the purpose of realizing additional income, each Fund may make
secured loans of portfolio securities amounting to not more than 30% of its
total assets. Securities loans are made to broker/dealers or institutional
investors pursuant to agreements requiring that the loans continuously be
secured by collateral at least equal at all times to the value of the
securities lent plus any accrued interest, "marked to market" on a daily
basis. The collateral received will consist of cash, U.S. short-term
government securities, bank letters of credit or such other collateral as may
be permitted under the Fund's investment program and by regulatory agencies
and approved by the Company's Board of Directors. While the securities loan
is outstanding, the Fund will continue to receive the equivalent of the
interest or dividends paid by the issuer on the securities, as well as
interest on the investment of the collateral or a fee from the borrower. The
Fund has a right to call each loan and obtain the securities on five business
days' notice. To the extent applicable, the Fund will not have the right to
vote equity securities while they are being lent, but it will call in a loan
in anticipation of any important vote. The risks in lending portfolio
securities, as with other extensions of secured credit, consist of possible
delay in receiving additional collateral or in the recovery of the securities
or possible loss of rights in the collateral should the borrower fail
financially. Loans only will be made to firms deemed by the Adviser to be of
good standing and will not be made unless, in the judgment of the Adviser,
the consideration to be earned from such loans would justify the risk.
U.S. Government Obligations
Except for temporary defensive purposes, no Fund will invest more
than 25% (35% with respect to the National Municipal, California Municipal
and New York Municipal Funds) of its net assets in securities issued or
guaranteed by the U.S. government or by its agencies or instrumentalities.
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Such securities in general include a wide variety of U.S. Treasury
obligations consisting of bills, notes and bonds, which principally differ
only in their interest rates, maturities and times of issuance. Securities
issued or guaranteed by U.S. government agencies and instrumentalities are
debt securities issued by agencies or instrumentalities established or
sponsored by the U.S. government.
In addition to the U.S. Treasury obligations described above, the
Funds may invest in separately traded interest components of securities
issued or guaranteed by the U.S. Treasury. The interest components of
selected securities are traded independently under the Separate Trading of
Registered Interest and Principal of Securities ("STRIPS") program. Under the
STRIPS program, the interest components are individually numbered and
separately issued by the U.S. Treasury at the request of depository financial
institutions, which then trade the component parts independently.
Securities issued or guaranteed by U.S. government agencies and
instrumentalities include obligations that are supported by (a) the full
faith and credit of the U.S. Treasury (e.g., direct pass-through certificates
of the Government National Mortgage Association); (b) the limited authority
of the issuer or guarantor to borrow from the U.S. Treasury (e.g.,
obligations of Federal Home Loan Banks); or (c) only the credit of the issuer
or guarantor (e.g., obligations of the Federal Home Loan Mortgage
Corporation). In the case of obligations not backed by the full faith and
credit of the U.S. Treasury, the agency issuing or guaranteeing the
obligation is principally responsible for ultimate repayment.
Agencies and instrumentalities that issue or guarantee debt
securities and that have been established or sponsored by the U.S. government
include, in addition to those identified above, the Bank for Cooperatives,
the Export-Import Bank, the Federal Farm Credit System, the Federal
Intermediate Credit Banks, the Federal Land Banks, the Federal National
Mortgage Association and the Student Loan Marketing Association.
Bank Obligations
As stated in the Prospectus, bank obligations that may be purchased
by each Fund include certificates of deposit, bankers' acceptances and fixed
time deposits. A certificate of deposit is a short-term negotiable
certificate issued by a commercial bank against funds deposited in the bank
and is either interest-bearing or purchased on a discount basis. A banker's
acceptance is a short-term draft drawn on a commercial bank by a borrower,
usually in connection with an international commercial transaction. The
borrower is liable for payment as is the bank, which unconditionally
guarantees to pay the draft at its face amount on the maturity date. Fixed
time deposits are obligations of branches of U.S. banks or foreign banks
which are payable at a stated maturity date and bear a fixed rate of
interest. Although fixed time deposits do not have a market, there are no
contractual restrictions on the right to transfer a beneficial interest in
the deposit to a third party. The Funds do not consider fixed time deposits
illiquid for purposes of the restriction on investment in illiquid
securities.
Banks are subject to extensive governmental regulations that may
limit both the amounts and types of loans and other financial commitments
that may be made and the interest rates and fees that may be charged. The
profitability of this industry is largely dependent upon the availability and
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cost of capital funds for the purpose of financing lending operations under
prevailing money market conditions. Also, general economic conditions play an
important part in the operations of this industry and exposure to credit
losses arising from possible financial difficulties of borrowers might affect
a bank's ability to meet its obligations. Bank obligations may be general
obligations of the parent bank or may be limited to the issuing branch by the
terms of the specific obligations or by government regulation.
Investors should also be aware that securities of foreign banks and
foreign branches of U.S. banks may involve investment risks in addition to
those relating to domestic bank obligations. Such investment risks include
future political and economic developments, the possible imposition of
foreign withholding taxes on interest income payable on such securities held
by a Fund, the possible seizure or nationalization of foreign assets and the
possible establishment of exchange controls or other foreign governmental
laws or restrictions which might affect adversely the payment of the
principal of and interest on such securities held by a Fund. In addition,
there may be less publicly-available information about a foreign issuer than
about a U.S. issuer, and foreign issuers may not be subject to the same
accounting, auditing and financial record-keeping standards and requirements
as U.S. issuers.
Variable and Floating Rate Instruments
Securities purchased by each Fund may include variable and floating
rate instruments, which provide for adjustments in the interest rate on
certain reset dates or whenever a specified interest rate index changes,
respectively. Variable and floating rate instruments are subject to the
credit quality standards described in the Prospectus. In some cases the Fund
may require that the obligation to pay the principal of the instrument be
backed by a letter or line of credit or guarantee. Although a particular
variable or floating rate demand instrument might not be actively traded in a
secondary market, in some cases, the Fund may be entitled to principal on
demand and may be able to resell such notes in the dealer market. With
respect to the floating and variable rate notes and demand notes described in
the Prospectus, the Adviser will consider the earning power, cash flows and
other liquidity ratios of the issuers or guarantors of such notes and will
continuously monitor their financial ability to meet payment obligations when
due.
Municipal Leases, Certificates of Participation and Other Participation
Interests
The National Municipal, California Municipal and New York Municipal
Funds may invest in municipal leases, certificates of participation and other
participation interests. A municipal lease is an obligation in the form of a
lease or installment purchase which is issued by a state or local government
to acquire equipment and facilities. Income from such obligations is
generally exempt from state and local taxes in the state of issuance.
Municipal leases frequently involve special risks not normally associated
with general obligations or revenue bonds. Leases and installment purchase
or conditional sale contracts (which normally provide for title to the leased
asset to pass eventually to the governmental issuer) have evolved as a means
for governmental issuers to acquire property and equipment without meeting
the constitutional and statutory requirements for the issuance of debt. The
debt issuance limitations are deemed to be inapplicable because of the
inclusion in many leases or contracts of "non-appropriation" clauses that
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relieve the governmental issuer of any obligation to make future payments
under the lease or contract unless money is appropriated for such purpose by
the appropriate legislative body on a yearly or other periodic basis. In
addition, such leases or contracts may be subject to the temporary abatement
of payments in the event the issuer is prevented from maintaining occupancy
of the leased premises or utilizing the leased equipment. Although the
obligations may be secured by the leased equipment or facilities, the
disposition of the property in the event of nonappropriation or foreclosure
might prove difficult, time consuming and costly, and result in a delay in
recovering or the failure to fully recover a Fund's original investment.
Certificates of participation represent undivided interests in
municipal leases, installment purchase agreements or other instruments. The
certificates are typically issued by a trust or other entity which has
received an assignment of the payments to be made by the state or political
subdivision under such leases or installment purchase agreements.
Certain municipal lease obligations and certificates of participation
may be deemed to be illiquid for the purpose of the Funds' 15% limitation on
investments in illiquid securities. Other municipal lease obligations and
certificates of participation acquired by a Fund may be determined by the
Adviser, pursuant to guidelines adopted by the Trustees of the Trust, to be
liquid securities for the purpose of such limitation. In determining the
liquidity of municipal lease obligations and certificates of participation,
the Adviser will consider a variety of factors including: (1) the
willingness of dealers to bid for the security; (2) the number of dealers
willing to purchase or sell the obligation and the number of other potential
buyers; (3) the frequency of trades or quotes for the obligation; and (4) the
nature of the marketplace trades. In addition, the Adviser will consider
factors unique to particular lease obligations and certificates of
participation affecting the marketability thereof. These include the general
creditworthiness of the issuer, the importance to the issuer of the property
covered by the lease and the likelihood that the marketability of the
obligation will be maintained throughout the time the obligation is held by a
Fund.
Each Fund may purchase participations in Municipal Securities held by
a commercial bank or other financial institution. Such participations
provide a Fund with the right to a pro rata undivided interest in the
underlying Municipal Securities. In addition, such participations generally
provide a Fund with the right to demand payment, on not more than seven days'
notice, of all or any part of such Fund's participation interest in the
underlying Municipal Security, plus accrued interest. Each Fund will only
invest in such participations if, in the opinion of bond counsel, counsel for
the issuers of such participations or counsel selected by the Adviser, the
interest from such participations is exempt from regular federal income tax
and California income tax, in the case of the California Municipal Fund, or
New York State, New York City and City of Yonkers personal income tax, in the
case of the New York Municipal Fund.
Pre-Refunded Municipal Securities
The National Municipal, California Municipal and New York Municipal
Funds may invest in pre-refunded Municipal Securities. The principal of and
interest on pre-refunded Municipal Securities are no longer paid from the
original revenue source for the securities. Instead, the source of such
payments is typically an escrow fund consisting of obligations issued or
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guaranteed by the U.S. Government. The assets in the escrow fund are derived
from the proceeds of refunding bonds issued by the same issuer as the pre-
refunded Municipal Securities. Issuers of Municipal Securities use this
advance refunding technique to obtain more favorable terms with respect to
securities that are not yet subject to call or redemption by the issuer. For
example, advance refunding enables an issuer to refinance debt at lower
market interest rates, restructure debt to improve cash flow or eliminate
restrictive covenants in the indenture or other governing instrument for the
pre-refunded Municipal Securities. However, except for a change in revenue
source from which principal and interest payments are made, the pre-refunded
Municipal Securities remain outstanding on their original terms until they
mature or are redeemed by the Issuer. Pre-refunded Municipal Securities are
usually purchased at a price which represents a premium over their face
value.
Tender Option Bonds
The National Municipal, California Municipal and New York Municipal
Funds may invest in tender option bonds. A tender option bond is a Municipal
Security (generally held pursuant to a custodial arrangement) having a
relatively long maturity and bearing interest at a fixed rate substantially
higher than prevailing short-term-tax-exempt rates. The bond is typically
issued in conjunction with the agreement of a third party, such as a bank,
broker-dealer or other financial institution, pursuant to which such
institution grants the security holders the option, at periodic intervals, to
tender their securities to the institution and receive the face value
thereof. As consideration for providing the option, the financial
institution receives periodic fees equal to the difference between the bond's
fixed coupon rate and the rate, as determined by a remarketing or similar
agent at or near the commencement of such period, that would cause the
securities, coupled with the tender option, to trade at par on the date of
such determination. Thus, after payment of this fee, the security holder
effectively holds a demand obligation that bears interest at the prevailing
short-term, tax-exempt rate. However, an institution will not be obligated
to accept tendered bonds in the event of certain defaults or a significant
downgrade in the credit rating assigned to the issuer of the bond. The
liquidity of a tender option bond is a function of the credit quality of both
the bond issuer and the financial institution providing liquidity. Tender
option bonds are deemed to be liquid unless, in the opinion of the Adviser,
the credit quality of the bond issuer and the financial institution is
deemed, in light of the Fund's credit quality requirements, to be inadequate.
No Fund will purchase tender option bonds unless at the time of such
purchase the Adviser reasonably expects that (i) based upon its assessment of
current and historical interest rate trends, prevailing short-term tax-exempt
rates will not exceed the stated interest rate on the underlying municipal
obligations at the time of the next tender fee adjustment, and (ii) the
circumstances which might entitle the grantor of a tender option to terminate
the tender option would not occur prior to the time of the next tender
opportunity. At the time of each tender opportunity, a Fund will exercise the
tender option with respect to any tender option bonds unless the Adviser
reasonably expects that, (a) based upon its assessment of current and
historical interest rate trends, prevailing short-term tax-exempt rates will
not exceed the stated interest rate on the underlying municipal obligations
at the time of the next tender fee adjustment, and (b) the circumstances
which might entitle the grantor of a tender option to terminate the tender
option would not occur prior to the time of the next tender opportunity. Each
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Fund will exercise the tender feature with respect to tender option bonds, or
otherwise dispose of their tender option bonds, prior to the time the tender
option is scheduled to expire pursuant to the terms of the agreement under
which the tender option is granted. Each Fund will purchase tender option
bonds only when it is satisfied that (a) the custodial and tender option
arrangements, including the fee payment arrangements, will not adversely
affect the tax-exempt status of the underlying municipal obligations and (b)
payment of any tender fees will not have the effect of creating taxable
income for the Funds.
Each Fund intends to invest in tender option bonds the interest on
which will, in the opinion of bond counsel, counsel for the issuer of
interests therein or counsel selected by the Investment Adviser, be exempt
from regular federal income tax and, in the case of the California Municipal
Fund, California state income tax, or in the case of the New York Municipal
Fund, New York State, New York City and City of Yonkers personal income tax.
However, because there can be no assurance that the Internal Revenue Service
(the "Service") will agree with such counsel's opinion in any particular
case, there is a risk that a Fund will not be considered the owner of such
tender option bonds and thus will not be entitled to treat such interest as
exempt from such tax. Additionally, the federal income tax treatment of
certain other aspects of these investments, including the proper tax
treatment of tender option bonds and the associated fees, in relation to
various regulated investment company tax provisions is unclear. Each Fund
intends to manage its portfolio in a manner designed to eliminate or minimize
any adverse impact from the tax rules applicable to these investments.
Auction Rate Securities
The National Municipal, California Municipal and New York Municipal
Funds may invest in auction rate securities. Auction rate securities consist
of auction rate Municipal Securities and auction rate preferred securities
issued by closed-end investment companies that invest primarily in Municipal
Securities. Provided that the auction mechanism is successful, auction rate
securities usually permit the holder to sell the securities in an auction at
par value at specified intervals. The dividend is reset by "Dutch" auction
in which bids are made by broker-dealers and other institutions for a certain
amount of securities at a specified minimum yield. The dividend rate set by
the auction is the lowest interest or dividend rate that covers all
securities offered for sale. While this process is designed to permit
auction rate securities to be traded at par value, there is the risk that an
auction will fail due to insufficient demand for the securities.
Dividends on auction rate preferred securities issued by a closed-end
fund may be designated as exempt from federal income tax to the extent they
are attributable to exempt income earned by the fund on the securities in its
portfolio and distributed to holders of the preferred securities, provided
that the preferred securities are treated as equity securities for federal
income tax purposes and the closed-end fund complies with certain tests under
the Internal Revenue Code. For purposes of complying with the 35% limitation
on each Fund's investments in securities other than Municipal Securities,
auction rate preferred securities will not be treated as Municipal Securities
unless substantially all of the dividends on such securities are expected to
be exempt from regular federal income taxes and, in the case of the
California Fund, California state income tax, or, in the case of the New York
Fund, New York State, New York City and City of Yonkers personal income tax.
<PAGE>
Each Fund's investments in auction rate preferred securities of
closed-end funds are subject to the limitations prescribed by the Investment
Company Act of 1940 (the "Act") and certain state securities regulations.
These limitations include a prohibition against acquiring more than 3% of the
voting securities of any other investment company and investing more than 5%
of such Fund's assets in securities of any one investment company or more
than 10% of its assets in securities of all investment companies. Each Fund
will indirectly bear its proportionate share of any management fees paid by
such closed-end funds in addition to the advisory and administration fees
payable directly by such Fund.
Insurance
The National Municipal, California Municipal and New York Municipal
Funds may invest in "insured" tax-exempt Municipal Securities. Insured
Municipal Securities are those for which scheduled payments of interest and
principal are guaranteed by a private (non-governmental) insurance company.
The insurance only entitles a Fund to receive the face or par value of the
securities held by such Fund. The insurance does not guarantee the market
value of the Municipal Securities or the value of the shares of a Fund.
Each Fund may utilize new issue or secondary market insurance. A new
issue insurance policy is purchased by a bond issuer who wishes to increase
the credit rating of a security. By paying a premium and meeting the
insurer's underwriting standards, the bond issuer is able to obtain a high
credit rating (usually, Aaa from Moody's Investors Service, Inc. ("Moody's")
or AAA from Standard & Poor's Ratings Group ("Standard & Poor's") for the
issued security. Such insurance is likely to increase the purchase price and
resale value of the security. New issue insurance policies are
noncancellable and continue in force as long as the bonds are outstanding.
A secondary market insurance policy is purchased by an investor (such
as a Fund) subsequent to a bond's original issuance and generally insures a
particular bond for the remainder of its term. Each Fund may purchase bonds
which have already been insured under a secondary market insurance policy by
a prior investor, or a Fund may itself purchase such a policy from insurers
for bonds which are currently uninsured.
An insured Municipal Security acquired by a Fund will typically be
covered by only one of the above types of policies. All of the insurance
policies used by the Funds will be obtained only from insurance companies
rated, at the time of purchase, Aaa by Moody's or AAA by Standard & Poor's.
ADDITIONAL RISK CONSIDERATIONS
Illiquid Securities
Each Fund may invest up to 15% of its net assets in illiquid
securities. See "Limiting Investment Risks" in the Prospectus. The sale of
restricted or illiquid securities require more time and result in higher
brokerage charges or dealer discounts and other selling expenses than the
sale of securities eligible for trading on securities exchanges or in the
over-the-counter markets. Restricted securities often sell at a price lower
than similar securities that are not subject to restrictions on resale.
<PAGE>
With respect to liquidity determinations generally, the Company's
Board of Directors has the ultimate responsibility for determining whether
specific securities, including restricted securities pursuant to Rule 144A
under the Securities Act of 1933 and commercial obligations issued in
reliance on the so-called "private placement" exemption from registration
afforded by Section 4(2) of the Securities Act of 1933, are liquid or
illiquid. The Board has delegated the function of making day to day
determinations of liquidity to the Adviser, pursuant to guidelines reviewed
by the Board. The Adviser takes into account a number of factors in reaching
liquidity decisions, including, but not limited to: (i) the frequency of
trading in the security; (ii) the number of dealers who make quotes for the
security; (iii) the number of dealers who have undertaken to make a market in
the security; (iv) the number of other potential purchasers; and (v) the
nature of the security and how trading is effected (e.g., the time needed to
sell the security, how offers are solicited and the mechanics of transfer).
The Adviser will monitor the liquidity of securities in each Fund's portfolio
and report periodically on such decisions to the Board of Directors.
Non-U.S. Withholding Taxes
A Fund's net investment income from foreign issuers may be subject to
non-U.S. withholding taxes, thereby reducing the Fund's net investment
income. See "Additional Information Concerning Taxes".
SPECIAL FACTORS AFFECTING THE CALIFORNIA MUNICIPAL FUND
The California Municipal Fund will invest at least 65% of its assets
in California Municipal Securities. The Fund is therefore susceptible to
political, economic or regulatory factors affecting issuers of California
Municipal Securities. These include the possible adverse effects of certain
California constitutional amendments, legislative measures, voter initiatives
and other matters that are described below.
Overview
The following section provides only a brief summary of the complex
factors affecting the financial condition of California, and is based on
information obtained from California, as publicly available prior to the date
of this Statement of Additional Information. The information contained in
such publicly available documents has not been independently verified. It
should be noted that the creditworthiness of obligations issued by local
issuers may be unrelated to the creditworthiness of California, and that
there is no obligation on the part of California to make payment on such
local obligations in the event of default in the absence of a specific
guarantee or pledge provided by California.
During the early 1990's California experienced significant financial
difficulties, which have reduced its credit standing but the state's finances
have improved since 1995. The ratings of certain related debt of other
issuers for which California has an outstanding lease purchase, guarantee or
other contractual obligation (such as for state-insured hospital bonds) are
generally linked directly to California's rating. Should the financial
condition of California deteriorate again, its credit ratings could be
further reduced, and the market value and marketability of all outstanding
notes and bonds issued by California, its public authorities or local
governments could be adversely affected.
<PAGE>
Economic Factors
California's economy is the largest among the 50 states (accounting
for almost 13% of the nation's output of goods and services) and one of the
largest in the world. California's population of more than 32 million
represents over 12% of the total United States population and grew by 27% in
the 1980s. While California's substantial population growth during the
1980's stimulated local economic growth and diversification and sustained a
real estate boom between 1984 and 1990, it has increased strains on
California's limited water resources and demands for government services and
may impede future economic growth. Population growth slowed since 1991 even
while substantial immigration has continued, due to a significant increase in
outmigration by California residents. Generally, the household incomes of
new residents have been substantially lower (and their education and welfare
utilization higher) than those of departing households, which may have a
major long-term socioeconomic and fiscal impact. However, with the
California economy improving, the recent net outmigration within the
Continental U.S. is expected to decrease or be reversed.
From mid-1990 to late 1993, California's economy suffered its worst
recession since the 1930s, with over 700,000 jobs lost. The largest job
losses have been in Southern California, led by declines in the aerospace and
construction industries. Most of the losses were related to cuts in federal
defense spending.
Since the start of 1994, the California economy has been experiencing
recovery and growth. The State Department of Finance reports net job growth,
particularly in construction and related manufacturing, wholesale and retail
trade, electronics, exports, transportation, recreation and services. This
growth has offset the continuing but slowing job losses in the aerospace
industry and restructuring of the finance and utility sectors. Pre-recession
job levels were reached in early 1996, and job growth is estimated to remain
strong for the next few years.
Constitutional and Statutory Limitations on Taxes, Other Charges and
Appropriations
Limitations on Property Taxes. Certain California instruments may be
obligations of issuers which rely in whole or in part, directly or
indirectly, on ad valorem property taxes as a source of revenue. The taxing
power of California local governments and districts is limited by Article
XIIIA of the California "Proposition 13." Briefly, Article XIIIA limits to
1% of full cash value the rate of ad valorem property taxes on real property
and generally restricts the reassessment of property to 2% per year, except
upon new construction or change of ownership (subject to a number of
exemptions). Taxing entities may, however, raise ad valorem taxes above the
1% limit to pay debt service on voter-approved bonded indebtedness.
Under Article XIIIA, the basic 1% ad valorem tax levy is applied
against the assessed value of property as of the owner's date of acquisition
(or as of March 1, 1975, if acquired earlier), subject to certain
adjustments. This system has resulted in widely varying amounts of tax on
similarly situated properties. Several lawsuits have been filed challenging
the acquisition-based assessment system of Proposition 13, and on June 18,
1992 the U.S. Supreme Court announced a decision upholding Proposition 13.
<PAGE>
Article XIIIA prohibits local governments from raising revenues
through ad valorem property taxes above the 1% limit; it also requires voters
of any governmental unit to give two-thirds approval to levy any "special
tax." Court decisions, however, allowed non-voter approved levy of "general
taxes" which were not dedicated to a specific use.
Limitations on Other Taxes, Fees and Charges. On November 5, 1996,
the voters of the State approved Proposition 218, the so-called "Right to
Vote on Taxes Act." Proposition 218 added Articles XIIIC and XIIID to the
State Constitution, which contain a number of provisions affecting the
ability of local agencies to levy and collect both existing and future taxes,
assessments, fees and charges.
Article XIIIC requires that all new or increased local taxes be
submitted to the electorate before they become effective. Taxes for general
governmental purposes require a majority vote and taxes for specific purposes
require a two-thirds vote. Further, any general purpose tax which was
imposed, extended or increased without voter approval after December 31, 1994
must be approved by a majority vote within two years.
Article XIIID contains several new provisions making it generally
more difficult for local agencies to levy and maintain "assessments" for
municipal services and programs. Article XIIID also contains several new
provisions affecting "fees" and "charges", defined for purposes of Article
XIIID to mean "any levy other than an ad valorem tax, a special tax, or an
assessment, imposed by a local government upon a parcel or upon a person as
an incident of property ownership, including a user fee or charge for a
property related service." All new and existing property related fees and
charges must conform to requirements prohibiting, among other things, fees
and charges which generate revenues exceeding the funds required to provide
the property related service or are used for unrelated purposes. There are
new notice, hearing and protest procedures for levying or increasing property
related fees and charges, and, except for fees or charges for sewer, water
and refuse collection services (or fees for electrical and gas service, which
are not treated as "property related" for purposes of Article XIIID), no
property related fee or charge may be imposed or increased without majority
approval by the property owners subject to the fee or charge or, at the
option of the local agency, two-thirds voter approval by the electorate
residing in the affected area.
In addition to the provisions described above, Article XIIIC removes
limitations on the initiative power in matters of local taxes, assessments,
fees and charges. Consequently, local voters could, by future initiative,
repeal, reduce or prohibit the future imposition or increase of any local
tax, assessment, fee or charge. It is unclear how this right of local
initiative may be used in cases where taxes or charges have been or will be
specifically pledged to secure debt issues.
The interpretation and application of Proposition 218 will ultimately
be determined by the courts with respect to a number of matters, and it is
not possible at this time to predict with certainty the outcome of such
determinations. Proposition 218 is generally viewed as restricting the
fiscal flexibility of local governments, and for this reason, some ratings of
California cities and counties have been, and others may be, reduced.
Appropriation Limits. The State and its local governments are
subject to an annual "appropriations limit" imposed by Article XIIIB of the
<PAGE>
California Constitution, enacted by the voters in 1979 and significantly
amended by Propositions 98 and 111 in 1988 and 1990, respectively. Article
XIIIB prohibits the State or any covered local government from spending
"appropriations subject to limitation" in excess of the appropriations limit
imposed. "Appropriations subject to limitation" are authorizations to spend
"proceeds of taxes," which consist of tax revenues and certain other funds,
including proceeds from regulatory licenses, user charges or other fees, to
the extent that such proceeds exceed the cost of providing the product or
service, but "proceeds of taxes" excludes most State subventions to local
governments. No limit is imposed on appropriations of funds which are not
"proceeds of taxes," such as reasonable user charges or fees, and certain
other non-tax funds, including bond proceeds.
Among the expenditures not included in the Article XIIIB
appropriations limit are (1) the debt service cost of bonds issued or
authorized prior to January 1, 1979, or subsequently authorized by the
voters, (2) appropriations arising from certain emergencies declared by the
Governor, (3) appropriations for certain capital outlay projects, (4)
appropriations by the State of post 1989 increases in gasoline taxes and
vehicle weight fees, and (5) appropriations made in certain cases of
emergency.
The appropriations limit for each year is adjusted annually to
reflect changes in cost of living and populations and any transfer of service
responsibilities between governmental units. The definitions for such
adjustments were liberalized in 1990 to follow more closely growth in the
State's economy.
"Excess" revenues are measured over a two year cycle. Local
governments must return any excess to taxpayers by rate reductions. The
State must refund 50% paid to schools and community colleges. With more
liberal annual adjustment factors since 1988, and depressed revenues for
several years after 1990 because of the recession, few governments, including
the State, are currently operating near their spending limits, but this
condition may change over time. The State's 1996-97 Budget Act provides for
State appropriations more than $7 billion under the Article XIIIB limit.
Local governments may by voter approval exceed their spending limits for up
to four years.
A 1986 initiative statute, called "Proposition 62," imposed
additional limits on local governments, by requiring either majority or 2/3
voter approval for any increases in "general taxes" or "special taxes,"
respectively (other than property taxes, which are unchangeable). Court
decisions had struck down most of Proposition 62 and many local governments,
especially cities, had enacted or raised local "general taxes" without voter
approval. In September, 1995, the California Supreme Court overruled the
prior cases, and upheld the constitutionality of Proposition 62. Many
aspects of this decision remain unclear (such as its impact on charter (home
rule) cities, and whether it will have retroactive effect), but its future
effect will be to further limit the fiscal flexibility of many local
governments.
Because of the complex nature of Articles XIIIA, XIIIB, XIIIC and
XIIID of the California Constitution, the ambiguities and possible
inconsistencies of their terms, and the impossibility of predicting future
appropriations or changes in population and cost of living, and the
probability of continuing legal challenges, it is not currently possible to
<PAGE>
determine fully the impact of these articles on California Instruments. It
is not presently possible to predict the outcome of any pending litigation
with respect to the ultimate scope, impact or constitutionality of either
these articles, or the impact of any such determinations upon State agencies
or local governments, or upon their ability to pay debt service or their
obligations. Future initiatives or legislative changes in laws or the
California Constitution may also affect the ability of the State or local
issuers to repay their obligations.
State Debt
Under the California Constitution, debt service on outstanding
general obligation bonds is the second charge to the General Fund after
support of the public school system and public institutions of higher
education. Total outstanding general obligation bonds and lease purchase
debt of California increased from $9.4 billion at June 30, 1987 to $23.3
billion at October 1, 1996. The State also had outstanding at October 1,
1996 $272 million of general obligation commercial paper notes which will be
refunded into long-term bonds at a later date. In FY1995-96, debt service on
general obligation bonds and lease purchase debt was approximately 5.2% of
General Fund revenues. State voters approved $5.0 billion of new bond
authorizations on the March 26, 1996 ballot, and an additional $2.1 billion
on the November 5, 1996 ballot.
Recent Financial Results
The principal sources of General Fund revenues in 1994-1995 were the
California personal income tax (43% of total revenues), the sales tax (34%),
bank and corporation taxes (13%), and the gross premium tax on insurance
(3%). California maintains a Special Fund for Economic Uncertainties
("SFEU"), derived from General Fund revenues, as a reserve to meet cash needs
of the General Fund. Because of the recession, the SFEU has not been funded
for the past four years.
General. Throughout the 1980s, California state spending increased
rapidly as California's population and economy also grew rapidly, including
increased spending for many assistance programs to local governments, which
were constrained by Proposition 13 and other laws. The largest state program
is assistance to local public school districts. In 1988, an initiative
(Proposition 98) was enacted which (subject to suspension by a two-thirds
vote of the Legislature and the Governor) guarantees local school districts
and community college districts a minimum share of California General Fund
revenues (currently about 35%).
Since the start of 1990-91 Fiscal Year, California has faced adverse
economic, fiscal and budget conditions. The economic recession seriously
affected California's tax revenues. It also caused increased expenditures
for health and welfare programs. California is also facing a structural
imbalance in its budget with the largest programs supported by the General
Fund (education, health, welfare and corrections) growing at rates higher
than the growth rates for the principal revenue sources of the General Fund.
These structural concerns will be exacerbated in coming years by the expected
need to substantially increase capital and operating funds for corrections as
a result of a "Three Strikes" law enacted in 1994.
Recent Budgets. As a result of these factors, among others, from the
late 1980's until 1992-93, the State had a period of nearly chronic budget
<PAGE>
imbalance, with expenditures exceeding revenues in four out of six years, and
the State accumulated and sustained a budget deficit in the budget reserve,
the SFEU approaching $2.8 billion at its peak at June 30, 1993. Starting in
the 1990-91 Fiscal Year and for each year thereafter, each budget required
multibillion dollar actions to bring projected revenues and expenditures into
balance and to close large "budget gaps" which were identified. The
Legislature and Governor eventually agreed on a number of different steps to
produce Budget Acts in the Years 1991-92 to 1994-95, including significant
cuts in health and welfare program expenditures;
transfer of program responsibilities and some funding sources from
the State to local governments, coupled with some reduction in
mandates on local government;
transfer of about $3.6 billion in annual local property tax revenues
from cities, counties, redevelopment agencies and some other
districts to local school districts, thereby reducing state funding
for schools;
reduction in growth of support for higher education programs, coupled
with increases in student fees;
revenue increases (particularly in the 1991-92 Fiscal Year budget),
most of which were for a short duration;
increased reliance on aid from the federal government to offset the
costs of incarcerating, educating and providing health and welfare
services to undocumented aliens (although these efforts have produced
much less federal aid than the State Administration had requested);
and
various one-time adjustment and accounting changes. Despite these
budget actions, the effects of the recession led to large
unanticipated deficits in the SFEU, as compared to projected positive
balances. By the start of the 1993-94 Fiscal Year, the accumulated
deficit was so large (almost $2.8 billion) that it was impractical to
budget to retire it in one year, so a two-year program was
implemented, using the issuance of revenue anticipation warrants to
carry a portion of the deficit over the end of the fiscal year. When
the economy failed to recover sufficiently in 1993-94, a second two-
year plan was implemented in 1994-95, to carry the final retirement
of the deficit into 1995-96.
The combination of stringent budget actions cutting State
expenditures, and the turnaround of the economy by late 1993, finally led to
the restoration of positive financial results. While General Fund revenues
and expenditures were essentially equal in Fiscal Year 1992-93 (following two
years of excess expenditures over revenues), the General Fund had positive
operating results in Fiscal Years 1993-94 through 1995-96, which have reduced
the accumulated budget deficit to less than $100 million as of June 30, 1996.
The State Department of Finance estimated that the General Fund
received revenues of about $46.1 billion in FY 1995-96, about $2 billion
higher than was originally expected, as a result of the strengthening
economy. Expenditures totaled about $45.4 billion, also about $2 billion
higher than budgeted, in part because of the constitutional requirement to
disburse revenues to local school districts, and in part because federal
<PAGE>
actions to reduce welfare costs and to pay for costs of illegal immigrants
were not forthcoming.
A consequence of the accumulated budget deficits in the early 1990's,
together with other factors such as disbursement of funds to local school
districts "borrowed" from future fiscal years and hence not shown in the
annual budget, was to significantly reduce the State's cash resources
available to pay its ongoing obligations. When the Legislature and the
Governor failed to adopt a budget for the 1992-93 Fiscal Year by July 1,
1992, which would have allowed the State to carry out its normal annual cash
flow borrowing to replenish its cash reserves, the State Controller was
forced to issue approximately $3.8 billion of registered warrants ("IOUs")
over a 2-month period to pay a variety of obligations representing prior
years' or continuing appropriations, and mandates from court orders.
Available funds were used to make constitutionally-mandated payments, such as
debt service on bonds and warrants.
The State's cash condition became so serious that from late spring
1992 until 1995, the State had to rely on issuance of short-term notes which
matured in a subsequent fiscal year to finance its ongoing deficit and pay
current obligations. With the repayment of the last of these deficit notes
in April, 1996, the State does not plan to rely further on external borrowing
across fiscal years, but will continue its normal cash flow borrowing during
a fiscal year.
Current Budget. The 1996-97 budget Act was signed by the Governor on
July 15, 1996, along with various implementing bills. The Legislature
rejected the Governor's proposed 15% cut in personal income taxes (to be
phased over three years), but did approve a 5% cut in bank and corporation
taxes, to be effective for income years starting on January 1, 1997. As a
result, revenues for the Fiscal Year are estimated to total $47,643 billion,
a 3.3 percent increase over the final estimated 1995-96 revenues. The Budget
Act contains General Fund appropriations totaling $47,251 billion, a 4.0
percent increase over the final estimated 1995-96 expenditures.
The following are principal features of the 1996-97 Budget Act:
1. Funding for schools and community college districts increased by
$1.65 billion total above revised 1995-96 levels. Almost half of this money
was budgeted to fund class- size reductions in kindergarten and grades 1-3.
Also, for the second year in a row, the full cost of living allowance (3.2
percent) was funded. The funding increases have brought K-12 expenditures to
almost $4,800 per pupil, an almost 15% increase over the level prevailing
during the recession years.
2. Proposed cuts in health and welfare totaling $660 million. All
of these cuts require federal law changes (including welfare reform, which
was enacted), federal waivers, or federal budget appropriations in order to
be achieved. Ultimate federal actions after enactment of the Budget Act will
allow the State to save only about $360 million of this amount.
3. A 4.9 percent increase in funding for the University of
California and the California State University system, with no increases in
student fees for the second consecutive year.
4. The Budget Act assumed the federal government will provide
approximately $700 million in new aid for incarceration and health care costs
<PAGE>
of illegal immigrants. These funds reduce appropriations in these categories
that would otherwise have to be paid from the General Fund.
With signing of the Budget Act, the State implemented its regular
cash flow borrowing program with the issuance of $3.0 billion of Revenue
Anticipation Notes to mature on June 30, 1997. The Budget Act appropriated a
modest budget reserve in the SFEU of $305 million, as of June 30, 1997. The
General Fund fund balance, however, still reflects $1.6 billion of "loans"
which the General Fund made to local schools in the recession years,
representing cash outlays above the mandatory minimum funding level.
Settlement of litigation over these transactions in July 1996 calls for
repayment of these loans over the period ending in 2001-02, about equally
split between outlays from the General Fund and from schools' entitlements.
The 1996-97 Budget Act contained a $150 million appropriation from the
General Fund toward this settlement.
The Department of Finance projected, when the Budget Act was passed,
that, on June 30, 1997, the State's available internal borrowable (cash)
resources will be $2.9 billion, after payment of all obligations due by that
date, so that no external cross-fiscal year borrowing will be needed. The
State will continue to rely on internal borrowing and intra-year external
note borrowing to meet its cash flow requirements.
The Department of Finance has reported that, through the first five
months of the 1996-97 fiscal year, General Fund revenues have been about $460
million (2.7%) above projection, reflecting the continued strength of the
State's economic recovery. This is offset by required increased payments to
schools, and lower than expected savings resulting from federal welfare
reform actions. The State has not yet given any prediction of how the
federal welfare reform law will impact the State's finances, or those of its
local agencies; this State is in the midst of making many decisions
concerning implementation of the new welfare law. A complete update of the
FY 1996-97 budget will be released by the Governor in early January, 1997,
along with his proposed budget for FY 1997-98.
Bond Ratings
The ratings on California's long-term general obligation bonds were
reduced in the early 1990's from "AAA" levels which had existed prior to the
recession. In 1996, Fitch and Standard & Poor's raised their ratings of
California's general obligation bonds, which are currently assigned ratings
of "A+" from Standard & Poor's, "A1" from Moody's and "A+" from Fitch. There
can be no assurance that such ratings will be maintained in the future. It
should be noted that the creditworthiness of obligations issued by local
California issuers may be unrelated to the creditworthiness of obligations
issued by the State of California, and that there is no obligation on the
part of California to make payment on such obligations in the event of
default.
Legal Proceedings
California is involved in certain legal proceedings (described in
California's recent financial statements) that, if decided against
California, may require California to make significant future expenditures or
may substantially impair revenues. Trial courts have recently entered
tentative decisions or injunctions which would overturn several parts of the
state's recent budget compromises. The matters covered by these lawsuits
<PAGE>
include a deferral of payments by California to the Public Employees
Retirement System and reductions in welfare payments. These cases are
subject to further proceedings and appeals, and if California eventually
loses, the final remedies may not have to be implemented in one year.
Obligations of Other Issuers
Other Issuers of California Instruments. There are a number of stat
agencies, instrumentalities and political subdivisions of the State of
California that issue municipal obligations, some of which may be conduit
revenue obligations payable from payments from private borrowers. These
entities are subject to various economic risks and uncertainties, and the
credit quality of the securities issued by them may very considerably from
the credit quality of obligations backed by the full faith and credit of the
State of California.
State Assistance. Property tax revenues received by local
governments declined more than 50% following passage of Proposition 13.
Subsequently, the California Legislature enacted measures to provide for the
redistribution of California's General Fund surplus to local agencies, the
reallocation of certain state revenues to local agencies and the assumption
of certain governmental functions by the State of California to assist
municipal issuers to raise revenues. Through 1990-91, local assistance
(including public schools) accounted for around 75% of General Fund spending.
To reduce California General Fund support for school districts, the 1992-93
and 1993-94 Budget Acts caused local governments to transfer a total of $3.9
billion of property tax revenues to school districts, representing loss of
all the post-Proposition 13 "bailout" aid. The largest share of these
transfers came from counties, and the balance from cities, special districts
and redevelopment agencies. In order to make up part of this shortfall, the
Legislature proposed, and voters approved in 1993, dedicating 0.5% of the
sales tax to counties and cities for public safety purposes. In addition,
the Legislature has changed laws to relieve local governments of certain
mandates, allowing them to reduce costs.
To the extent that California should be constrained by its Article
XIIIB appropriations limit, or its obligation to conform to Proposition 98,
or other fiscal considerations, the absolute level, or the rate of growth, of
state assistance to local governments may continue to be reduced. Any such
reductions in state aid could compound the serious fiscal constraints already
experienced by many local governments, particularly counties. A number of
counties, both rural and urban, have also indicated that their budgetary
condition is extremely serious. At the start of the 1995-96 fiscal year, Los
Angeles County, the largest in the State, had to make significant cuts in
services and personnel, particularly in the health care system, in order to
balance its budget. The County's debt was downgraded by Moody's and S&P in
the summer of 1995. Orange County, which recently emerged from federal
bankruptcy protection, has substantially reduced services and personnel in
order to live within much reduced means.
Assessment Bonds. California instruments which are assessment bonds
may be adversely affected by a general decline in real estate values or a
slowdown in real estate sales activity. In many cases, such bonds are
secured by land which is undeveloped at the time of issuance but anticipated
to be developed within a few years after issuance. In the event of such
reduction or slowdown, such development may not occur or may be delayed,
thereby increasing the risk of a default on the bonds. Because the special
<PAGE>
assessments or taxes securing these bonds are not the personal liability of
the owners of the property assessed, the lien on the property is the only
security for the bonds. Moreover, in most cases the issuer of these bonds is
not required to make payments on the bonds in the event of delinquency in the
payment of assessments or taxes, except from amounts, if any, in a reserve
fund established for the bonds.
California Long-Term Lease Obligations. Certain California long-term
lease obligations, though typically payable from the general fund of the
municipality, are subject to "abatement" in the event the facility being
leased is unavailable for beneficial use and occupancy by the municipality
during the term of the lease. Abatement is not a default, and there may be
no remedies available to the holders of the certificates evidencing the lease
obligation in the event abatement occurs. The most common cases of abatement
are failure to complete construction of the facility before the end of the
period during which lease payments have been capitalized and uninsured
casualty losses to the facility (e.g. due to earthquake). In the event
abatement occurs with respect to a lease obligation, lease payments may be
interrupted (if all available insurance proceeds and reserves are exhausted)
and the certificates may not be paid when due.
Several years ago the Richmond Unified School District (the
"District") entered into a lease transaction in which certain existing
properties of the District were sold and leased back in order to obtain funds
to cover operating deficits. Following a fiscal crisis in which the
District's finances were taken over by a state receiver (including a brief
period under bankruptcy court protection), the District failed to make rental
payments on this lease, resulting in a lawsuit by the Trustee for the
Certificate of Participation holders, in which the State of California was a
named defendant (on the grounds that it controlled the District's finances).
One of the defenses raised in answer to this lawsuit was the invalidity of
the District's lease. The trial court upheld the validity of the lease, and
the case was subsequently settled. Any ultimate judgment in any future case
against the position taken by the Trustee may have adverse implications for
lease transactions of a similar nature by other California entities.
Other Considerations
The repayment of industrial development securities secured by real
property may be affected by California laws limiting foreclosure rights of
creditors. Securities backed by health care and hospital revenues may be
affected by changes in state regulations governing cost reimbursements to
health care providers under Medi-Cal (the State's Medicaid program),
including risks related to the policy of awarding exclusive contracts to
certain hospitals.
Limitations on ad valorem property taxes may particularly affect "tax
allocation" bonds issued by California redevelopment agencies. Such bonds
are secured solely by the increase in assessed valuation of a redevelopment
project area after the start of redevelopment activity. In the event that
assessed values in the redevelopment project decline (e.g. because of major
natural disaster such as an earthquake), the tax increment revenue may be
insufficient to make principal and interest payments on these bonds. Both
Moody's and S&P suspended ratings on California tax allocation bonds after
the enactment of Articles XIIIA and XIIIB, and only resumed such ratings on a
selective basis.
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Proposition 87, approved by California voters in 1988, requires that
all revenues produced by a tax rate increase go directly to the taxing entity
which increased such tax rate to repay that entity's general obligation
indebtedness. As a result, redevelopment agencies (which typically are the
issuers of tax allocation securities) no longer receive an increase in tax
increment when taxes on property in the project area are increased to repay
voter-approved bonded indebtedness.
The effect of these various constitutional and statutory changes upon
the ability of California municipal securities issuers to pay interest and
principal on their obligations remains unclear. Furthermore, other measures
affecting the taxing or spending authority of California or its political
subdivisions may be approved or enacted in the future. Legislation has been
or may be introduced which would modify existing taxes or other revenue
raising measures or which either would further limit or, alternatively, would
increase the abilities of state and local governments to impose new taxes or
increase existing taxes. It is not presently possible to predict the extent
to which any such legislation will be enacted. Nor is it presently possible
to determine the impact of any such legislation on California Municipal
Securities in which the California Municipal Fund may invest, future
allocations of state revenues to local governments or the abilities of state
or local governments to pay the interest on, or repay the principal of, such
California Municipal Securities.
Substantially all of California is within an active geologic region
subject to major seismic activity. Northern California in 1989 and Southern
California in 1994 experienced major earthquakes causing billions of dollars
in damages. The federal government provided more than $13 billion in aid for
both earthquakes, and neither event is expected to have any long-term
negative economic impact. Any security in the California Portfolio could be
affected by an interruption of revenues because of damaged facilities, or,
consequently, income tax deductions for casualty losses or property tax
assessment reductions. Compensatory financial assistance could be
constrained by the inability of (i) an issuer to have obtained earthquake
insurance coverage at reasonable rates; (ii) an insurer to perform on its
contracts of insurance in the event of widespread losses; or (iii) the
federal or state government to appropriate sufficient funds within their
respective budget limitations.
SPECIAL FACTORS AFFECTING THE NEW YORK MUNICIPAL FUND
Some of the significant financial considerations relating to the
investments of the New York Municipal Bond Fund in New York Municipal
Securities are summarized below. The following information constitutes only
a brief summary, does not purport to be a complete description and is largely
based on information drawn from official statements relating to securities
offerings of New York Municipal Securities available as of the date of this
Statement of Additional Information. The accuracy and completeness of the
information contained in such offering statements has not been independently
verified.
<PAGE>
New York State
New York State Financing Activities. There are a number of methods
by which New York State (the "State") may incur debt. Under the State
Constitution, the State may not, with limited exceptions for emergencies,
undertake long-term general obligation borrowing (i.e., borrowing for more
than one year) unless the borrowing is authorized in a specific amount for a
single work or purpose by the New York State Legislature (the "Legislature")
and approved by the voters. There is no limitation on the amount of
long-term general obligation debt that may be so authorized and subsequently
incurred by the State. With the exception of general obligation housing
bonds (which must be paid in equal annual installments or installments that
result in substantially level or declining debt service payments, within 50
years after issuance, commencing no more than three years after issuance),
general obligation bonds must be paid in equal annual installments or
installments that result in substantially level or declining debt service
payments, within 40 years after issuance, beginning not more than one year
after issuance of such bonds.
The State may undertake short-term borrowings without voter approval
(i) in anticipation of the receipt of taxes and revenues, by issuing tax and
revenue anticipation notes ("TRANs"), and (ii) in anticipation of the receipt
of proceeds from the sale of duly authorized but unissued bonds, by issuing
bond anticipation notes ("BANs"). TRANs must mature within one year from
their dates of issuance and may not be refunded or refinanced beyond such
period. BANS may only be issued for the purposes and within the amounts for
which bonds may be issued pursuant to voter authorizations. Such BANs must
be paid from the proceeds of the sale of bonds in anticipation of which they
were issued or from other sources within two years of the date of issuance
or, in the case of BANs for housing purposes, within five years of the date
of issuance.
The State may also, pursuant to specific constitutional
authorization, directly guarantee certain public authority obligations. The
State Constitution provides for the State guarantee of the repayment of
certain borrowings for designated projects of the New York State Thruway
Authority, the Job Development Authority and the Port Authority of New York
and New Jersey. The State has never been called upon to make any direct
payments pursuant to such guarantees. The constitutional provisions allowing
a State-guarantee of certain Port Authority of New York and New Jersey debt
stipulates that no such guaranteed debt may be outstanding after December 31,
1996. State-guaranteed bonds issued by the Thruway Authority were fully
retired on July 1, 1995.
Payments of debt service on State general obligation and
State-guaranteed bonds and notes are legally enforceable obligations of the
State.
The State employs additional long-term financing mechanisms,
lease-purchase and contractual obligation financing, which involve
obligations of public authorities or municipalities that are State-supported
but not general obligations of the State. Under these financing
arrangements, certain public authorities and municipalities have issued
obligations to finance the construction and rehabilitation of facilities or
the acquisition and rehabilitation of equipment and expect to meet their debt
service requirements through the receipt of rental or other contractual
payments made by the State. Although these financing arrangements involve a
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contractual agreement by the State to make payments to a public authority,
municipality or other entity, the State's obligation to make such payments is
generally expressly made subject to appropriation by the Legislature and the
actual availability of money to the State for making the payments. The State
has also entered into a contractual-obligation financing arrangement with the
New York Local Government Assistance Corporation ("LGAC") to restructure the
way the State makes certain local aid payments. The State also participates
in the issuance of certificates of participation ("COPs") in a pool of leases
entered into by the State's Office of General Services on behalf of several
State departments and agencies interested in acquiring operational equipment,
or in certain cases, real property. Legislation enacted in 1986 established
restrictions upon and centralized State control, through the Comptroller and
the Director of the Budget, over the issuance of COPs representing the
State's contractual obligation, subject to annual appropriation by the
Legislature and availability of money, to make installment or lease-purchase
payments for the State's acquisition of such equipment or real property.
The State has never defaulted on any of its general obligation
indebtedness or its obligations under lease-purchase or
contractual-obligation financing arrangements and has never been called upon
to make any direct payments pursuant to its guarantees although there can be
no assurance that such a default or call will not occur in the future.
The State also employs moral obligation financing. Moral obligation
financing generally involves the issuance of debt by a public authority to
finance a revenue-producing project or other activity. The debt is secured
by project revenues and statutory provisions require the State, subject to
appropriation by the Legislature, to make up any deficiencies which may occur
in the issuer's debt service reserve fund. There has never been a default on
any moral obligation debt of any public authority although there can be no
assurance that such a default will not occur in the future.
The State anticipates that its capital programs will be financed, in
part, through borrowings by the State and public authorities in the 1996-97
fiscal year. The State expects to issue $411 million in general obligation
bonds (including $153.6 million for purposes of redeeming outstanding BANs)
and $154 million in general obligation commercial paper. The Legislature has
also authorized the issuance of up to $101 million in COPs during the State's
1996-97 fiscal year for equipment purchases. The projection of the State
regarding its borrowings for the 1996-97 fiscal year may change if
circumstances require.
Borrowings by other public authorities pursuant to lease-purchase and
contractual-obligation financings for capital programs of the State are
projected to total $2.15 billion, including costs of issuances, reserve
funds, and other costs, net of anticipated refundings and other adjustments
for 1996-97 capital projects. Included therein are borrowings by (i) DASNY
for SUNY, The City University of New York ("CUNY"), health facilities, and
mental health facilities; (ii) Thruway Authority for the Dedicated Highway
and Bridge Trust Fund and Consolidated Highway Improvement Program; (iii) UDC
(doing business as the Empire State Development Corporation) for prison and
youth facilities; (iv) the Housing Finance Agency ("HFA") for housing pro-
grams; and (v) borrowings by the Environmental Facilities Corporation ("EFC")
or other authorities. In addition, the Legislature has authorized DASNY to
refinance a $787 million pension obligation of the State.
<PAGE>
In the 1996 legislative session, the Legislature approved the
Governor's proposal to present to the voters in November 1996 a $1.75 billion
State general obligation bond referendum to finance various environmental
improvement and remediation projects. If the Clean Water, Clean Air Bond Act
is approved by the voters, the amount of general obligation bonds issued
during the 1996-97 fiscal year may increase above the $411 million currently
included in the 1996-97 Borrowing Plan to finance a portion of this new
program.
In addition to the arrangements described above, State law provides
for State municipal assistance corporations, which are Authorities authorized
to aid financially troubled localities. The Municipal Assistance Corporation
for The City of New York ("MAC") was created to provide financing assistance
to New York City (the "City"). To enable MAC to pay debt service on its
obligations, MAC receives, subject to annual appropriation by the
Legislature, receipts from the 4% New York State Sales Tax for the Benefit of
New York City, the State-imposed Stock Transfer Tax and, subject to certain
prior liens, certain local assistance payments otherwise payable to the City.
The legislation creating MAC also includes a moral obligation provision.
Under its enabling legislation, MAC's authority to issue bonds and notes
(other than refunding bonds and notes) expired on December 31, 1984.
State Financial Operations. The State has historically been one of
the wealthiest states in the nation. For decades, however, the State economy
has grown more slowly than that of the nation as a whole, gradually eroding
the State's relative economic affluence. Statewide, urban centers have
experienced significant changes involving migration of the more affluent to
the suburbs and an influx of generally less affluent residents. Regionally,
the older Northeast cities have suffered because of the relative success that
the South and the West have had in attracting people and business. The City
has also had to face greater competition as other major cities have developed
financial and business capabilities which make them less dependent on the
specialized services traditionally available almost exclusively in the City.
Although the State ranks 22nd in the nation for its State tax burden,
the State has the second highest combined state and local tax burden in the
United States. In 1991, total State and local taxes in New York were $3,349
per capita, compared with $1,475 per capita in 1980. Between 1980 and 1991,
State and local taxes per capita increased at approximately the same rate in
the State as in the nation as a whole with per capita taxes in the State
increasing by 127% while such taxes increased 111% in the nation. The State
Division of the Budget ("DOB") believes, however, that it is more informative
to describe the state and local tax burden in terms of its relationship to
personal income. In 1992, total State and local taxes in New York were
$154.70 per $1,000 of personal income, compared with $152.70 in 1980.
Between 1980 and 1992, State and local taxes per $1,000 of personal income
increased at a slower rate in the State than in the nation as a whole with
such taxes in the State increasing by 1.3 percent while such taxes increased
4 percent in the nation. The State and its localities have used these taxes
to develop and maintain their respective transportation networks, public
schools and colleges, public health systems, other social services, and
recreational facilities. Despite these benefits, the burden of State and
local taxation, in combination with the many other causes of regional
economic dislocation, may have contributed to the decisions of some
businesses and individuals to relocate outside, or not locate within, the
State.
<PAGE>
The national economy began expanding in 1991 and has added over 7
million jobs since early 1992. However, the recession lasted longer in the
State, and the State's economic recovery has lagged behind the nation's.
Although the State has added approximately 185,000 jobs since November 1992,
employment growth in the State has been hindered during recent years by
significant cutbacks in the computer and instrument manufacturing, utility,
defense, and banking industries. DOB forecasted that national economic
growth would weaken, but not turn negative, during the course of 1995 before
beginning to rebound. This dynamic is often described as a 'soft landing.'
The national economy achieved the desired 'soft landing' in 1995, as
growth slowed from 6.2 percent in 1994 to a rate sufficiently slow to inhibit
the buildup of inflationary pressures. This was achieved without any
material pause in the economic expansion, although recession worries flared
in the late spring and early summer. Growth in the national economy is
expected to moderate during 1996. Real GDP grew only 0.9 percent in the
fourth quarter of 1995, and there were declines in the leading economic
indicators in four of the past five months. It is anticipated that slow
economic growth will continue through the first half of 1996 and inflationary
pressures will be modest in 1996. Economic growth will gradually accelerate
in the second half of 1996 as the lower level of interest rates over the last
year is expected to stimulate economic activity. Economic growth, as
measured by the nation's nominal GDP, is projected to expand by 4.3 percent
in 1996 versus 4.6 in 1995. In 1992 dollars, real GDP is expected to grow
1.8 percent as compared with the 2.1 percent growth in 1995. By either
measure, economic growth is projected to be noticeably slower for 1996 than
1995.
To stimulate economic growth, the State has developed programs,
including the provision of direct financial assistance, designed to assist
businesses to expand existing operations located within the State and to
attract new businesses to the State. In addition, the State has provided
various tax incentives to encourage business relocation and expansion. These
programs include direct tax abatements from local property taxes for new
facilities (subject to locality approval) and investment tax credits that are
applied against the State corporation franchise tax. Furthermore, the State
has created 40 'economic development zones' in economically distressed
regions of the States. Businesses in these zones are provided a variety of
tax and other incentives to create jobs and make investments in the zones.
There can be no assurance that these programs will be successful.
From 1994 to 1995 the annual growth rates of most economic indicators
for the State improved. The pace of private sector employment expansion and
personal income and wage growth all accelerated. Government employment fell
as workforce reductions were implemented at federal, State and local levels.
Similar to the nation, some moderation of growth is expected in the year
ahead. Private sector employment is expected to continue to rise, although
somewhat more slowly than in 1995, while public employment should continue to
fall, reflecting government budget cutbacks. Anticipated continued restraint
in wage settlements, a lower rate of employment growth and falling interest
rates are expected to slow personal income growth significantly.
The State's current fiscal year commenced on April 1, 1996, and ends
on March 31, 1997, and is referred to herein as the State's 1995-96 fiscal
year.
<PAGE>
The State's budget for the State's 1996-97 fiscal year, commencing on
April 1, 1996, was enacted by the Legislature on July 13, 1996. The State
Financial Plan for the 1996-97 fiscal year was formulated on July 25, 1996
and is based on the State's budget as enacted by the Legislature and signed
into law by the Governor, as well as actual results for the first quarter of
the current fiscal year. The 1996-97 State Financial Plan is updated in
October and January. The 1996-97 State Financial Plan is projected to be
balanced on a cash basis. Total General Fund receipts and transfers from
other funds are projected to be $33.17 billion, while total General Fund
disbursements and transfers to other funds are projected to be $33.12
billion. After adjustments for comparability, the adopted 1996-97 budget
projects a year-over-year increase in General Fund disbursements of 0.2
percent. As compared to the Governor's proposed budget as revised on March
20, 1996, the State's adopted budget for 1996-97 increases General Fund
spending by $842 million, primarily from increases for education, special
education and higher education ($563 million). Resources used to fund these
additional expenditures include $540 million in increased revenues projected
for 1996-97 based on higher than projected tax collections during the first
half of calendar 1996, $110 million in projected receipts from a new State
tax amnesty program, and other resources including certain non-recurring
resources.
The economic and financial condition of the State may be affected by
various financial, social, economic and political factors. Those factors can
be very complex, may vary from fiscal year to fiscal year, and are frequently
the result of actions taken not only by the State and its agencies and
instrumentalities, but also by entities, such as the Federal government, that
are not under the control of the State. In addition, the State Financial
Plan is based upon forecasts of national and State economic activity.
Economic forecasts have frequently failed to predict accurately the timing
and magnitude of changes in the national and the State economies. Many
uncertainties exist in forecasts of both the national and State economies,
including consumer attitudes toward spending, the extent of corporate and
governmental restructuring, federal fiscal and monetary policies, the level
of interest rates, and the condition of the world economy, which could have
an adverse effect on the State. Actual results could differ materially and
adversely from projections and those projections may be changed materially
and adversely from time to time.
The 1996-97 State Financial Plan includes actions that will have an
effect on the budget outlook for State fiscal year 1996-97 and beyond. The
State Division of the Budget estimates that the 1996-97 State Financial Plan
contains actions that provide non-recurring resources or savings totaling
approximately $1.3 billion, or 3.9% of total General Fund receipts. These
include the use of $481 million in surplus funds available from the Medical
Malpractice Insurance Association, $134 million in savings from a refinancing
of certain pension obligations, $88 million in projected savings from bond
refundings, and $36 million in surplus fund transfers. The balance is
composed of $314 million in resources carried forward from the State's
1995-96 fiscal year and various other actions, including that portion of the
proposed tax amnesty program that is projected to be non-recurring.
The State closed projected budget gaps of $5.0 billion and $3.9
billion for its 1995-96 and 1996-97 fiscal years, respectively. The 1997-98
gap was projected at $1.44 billion, based on the Governor's proposed budget
of December 1995. As a result of changes made in the enacted budget, that
gap is now expected to be larger.
<PAGE>
The out-year projection will be impacted by a variety of factors.
Enacted tax reductions, which reduced receipts in the 1996-97 State fiscal
year by an incremental $2.4 billion, are projected to reduce receipts in the
1997-98 State fiscal year by an additional increment of $2.1 billion. The
use of up to $1.3 billion of nonrecurring resources in 1996-97, and the
annualized costs of certain program increases in the 1996-97 enacted budget,
will both add additional pressure in closing the 1997-98 gap. However,
actions undertaken in the State's 1996-97 fiscal year, such as workforce
reductions, health care and education reforms, and strict controls on State
agency spending, are expected to provide larger recurring savings in State
fiscal year 1997-98. Sustained growth in the State's economy and continued
declines in welfare caseload and Medicaid costs would produce additional
savings in the 1997-98 Financial Plan.
In recent years, State actions affecting the level of receipts and
disbursements, the relative strength of the State and regional economy,
actions of the Federal government and other factors have created structural
budget gaps for the State. These gaps resulted from a significant disparity
between recurring revenues and the costs of maintaining or increasing the
level of support for State programs. To address a potential imbalance in any
given fiscal year, the State would be required to take actions to increase
receipts and/or reduce disbursements as it enacts the budget for that year,
and under the State Constitution, the Governor is required to propose a
balanced budget each year. There can be no assurance, however, that the
Legislature will enact the Governor's proposals or that the State's actions
will be sufficient to preserve budgetary balance in a given fiscal year or to
align recurring receipts and disbursements in future fiscal years.
On October 29,1996, the State issued its second quarterly update to
the 1996-97 State Financial Plan based on updated economic forecasts, actual
receipts and disbursements for the first six months of the fiscal year and an
assessment of changing program requirements. The update reflects a balanced
1996-97 State Financial Plan, with a reserve for contingencies in the General
Fund of $300 million, which will be utilized to help offset a variety of
potential risks and other unexpected contingencies that the State may face
during the balance of the 1996-97 fiscal year. Actual receipts through the
first two quarters of the 1996-97 State fiscal year reflect
stronger-than-expected growth in most taxes, with actual receipts exceeding
expectations by $276 million, and, based on the revised economic outlook and
actual receipts for the first six months of 1996-97, projected General Fund
receipts for the 1996-97 State fiscal year have been increased by $420
million.
Uncertainties with regard to the economy, as well as the outcome of
certain litigation now pending against the State, could produce adverse
effects on the State's projections of receipts and disbursements. For
example, changes to current levels of interest rates or deteriorating world
economic conditions could have an adverse effect on the State economy and
produce results in the current fiscal year that are worse than predicted.
Similarly, adverse judgments in legal proceedings against the State could
exceed amounts reserved in the 1996-97 Financial Plan for payment of such
judgments and produce additional unbudgeted costs to the State.
On August 13, 1996, the State Comptroller released a report in which
he identified several risks to the State Financial Plan and estimated that
the State faces a potential imbalance in receipts and disbursements of
approximately $3 billion for the State's 1997-98 fiscal year and
<PAGE>
approximately $3.2 billion for the State's 1998-99 fiscal year. The 1997-98
fiscal year estimate by the State Comptroller is within the range previously
discussed by the State Division of the Budget.
The Governor is required to submit a balanced budget to the State
Legislature and has indicated that he will close any potential imbalance in
the 1997-98 Financial Plan primarily through General Fund expenditure
reductions and without increases in taxes or deferrals of scheduled tax
reductions. It is expected by the State Division of the Budget that the
State's 1997-98 Financial Plan will reflect a continuing strategy of
substantially reduced State spending, including agency consolidations,
reductions in the State workforce, and efficiency and productivity
initiatives. The division of the Budget intends to update the State
Financial Plan and provide an update to the Annual Information Statement upon
release of the 1997-98 Executive Budget.
On August 22,1996, the President signed into law the Personal
Responsibility and Work Opportunity Reconciliation Act of 1996. On October
16,1996, the Governor submitted the State's TANF implementation plan to the
federal government, as required under the new federal welfare law.
Legislation will be required to implement the State's TANF plan. The
Governor has indicated that he plans to introduce legislation necessary to
conform with federal law shortly, and that he may submit amendments to the
State plan if necessary. The Governor's proposals will be available for
consideration by the Legislature either before the end of calendar 1996 or in
the 1997 legislative session. It is expected by the State that funding
levels provided under the federal TANF block grant will be higher than
currently anticipated in the State's financial plan. However, the net fiscal
impact of any changes to the State's welfare programs that are necessary to
conform with federal law will be dependent upon such factors as the ability
of the State to avoid any federal fiscal penalties, the level of additional
resources required to comply with any new State and/or federal requirements,
and the division of non-federal welfare costs between the State and its
localities. States are required to comply with the new federal welfare
reform law no later than July 1,1997. Given the size and scope of the
changes required under federal law, it is likely that these proposals will
produce extensive public discussions. There can be no assurances that the
State Legislature will enact welfare reform proposals as submitted by the
Governor and as required under federal law.
In recent years, the State has failed to adopt a budget prior to the
beginning of its fiscal year. A delay in the adoption of the State's budget
beyond the statutory April 1 deadline could delay the projected receipt by
the City of State aid, and there can be no assurance that State budgets in
future fiscal years will be adopted by the April 1 statutory deadline.
The State's budget for the 1995-96 fiscal year was enacted by the
Legislature on June 7, 1995, more than two months after the start of the
fiscal year. Prior to adoption of the budget, the Legislature enacted
appropriations for disbursements considered to be necessary for State
operations and other purposes, including all necessary appropriations for
debt service. The State Financial Plan for the 1995-96 fiscal year (the
"1995-96 State Financial Plan") was formulated on June 20, 1995 and is based
on the State's budget as enacted by the Legislature and signed into law by
the Governor. The State Financial Plan is updated quarterly pursuant to law
in July, October and January.
<PAGE>
The 1995-96 budget is the first to be enacted in the administration
of Governor George Pataki, who assumed office on January 1, 1995. It is the
first budget in over half a century which proposed and, as enacted, projects
an absolute year-over-year decline in General Fund disbursements. Spending
for State operations is projected to drop even more sharply, by 4.6 percent.
Nominal spending from ail State funding sources (i.e., excluding Federal aid)
is proposed to increase by only 2.5 percent from the prior fiscal year, in
contrast to the prior decade when such spending growth averaged more than 6.0
percent annually.
In his Executive Budget, the Governor indicated that in the 1995-96
fiscal year, the 1995-96 State Financial Plan, based on then-current law
governing spending and revenues, would be out of balance by almost $4.7
billion, as a result of the projected structural deficit resulting from the
ongoing disparity between sluggish growth in receipts, the effect of
prior-year tax changes, and the rapid acceleration of spending growth; the
impact of unfunded 1994-95 initiatives, primarily for local aid programs; and
the use of one-time solutions, primarily surplus funds from the prior year,
to fund recurring spending in the 1994-95 budget. The Governor proposed
additional tax cuts to spur economic growth and provide relief for low and
middle-income tax payers, which were larger than those ultimately adopted,
and which added $240 million to the then projected imbalance or budget gap,
bringing the total to approximately $5 billion.
The 1995-96 State Financial Plan contemplates closing this gap based
on the enacted budget, through a series of actions, mainly spending
reductions and cost containment measures and certain reestimates that are
expected to be recurring, but also through the use of one-time solutions.
The 1995-96 State Financial Plan projects (i) nearly $1.6 billion in savings
from cost containment, disbursement reestimates, and other savings in social
welfare programs, including Medicaid, income maintenance and various child
and family care programs; (ii) $2.2 billion in savings from State agency
actions to reduce spending on the State workforce, SUNY and CUNY, mental
hygiene programs, capital projects, the prison system and fringe benefits;
(iii) $300 million in savings from local assistance reforms, including
actions affecting school aid and revenue sharing while proposing program
legislation to provide relief from certain mandates that increase local
spending; (iv) over $400 million in revenue measures, primarily a new Quick
Draw Lottery game, changes to tax payment schedules, and the sale of assets;
and (v) $300 million from reestimates in receipts. There can be no assurance
that these gap-closing measures can be implemented as planned.
The following discussion summarizes updates to the 1995-96 State
Financial Plan and recent fiscal years with particular emphasis on the
State's General Fund. Pursuant to statute, the State updates the financial
plan at least on a quarterly basis. Due to changing economic conditions and
information, public statements or reports may be released by the Governor,
members of the Legislature, and their respective staffs, as well as others
involved in the budget process from time to time. Those statements or
reports may contain predictions, projections or other items of information
relating to the State's financial condition, including potential operating
results for the current fiscal year and projected baseline gaps for future
fiscal years, that may vary materially and adversely from the information
provided herein.
The General Fund is the principal operating fund of the State and is
used to account for all financial transactions, except those required to be
<PAGE>
accounted for in another fund. It is the State's largest fund and receives
almost all State taxes and other resources not dedicated to particular
purposes. In the State's 1995-96 fiscal year, the General Fund is expected
by the State to account for approximately 49 percent of total
governmental-fund receipts and 71 percent of total governmental-fund
disbursements. General Fund moneys are also transferred to other funds,
primarily to support certain capital projects and debt service payments in
other fund types.
The General Fund is projected to be balanced on a cash basis for the
1995-96 fiscal year. Total receipts are projected to be $33.110 billion, an
increase of $48 million over total receipts in the prior fiscal year. Total
General Fund disbursements are projected to be $33.055 billion, an increase
of $344 million over the total amount disbursed and transferred in the prior
fiscal year.
In addition to the General Fund, the State Financial Plan includes
Special Revenue Funds, Capital Projects Funds and Debt Service Funds.
Special Revenue Funds are used to account for the proceeds of
specific revenue sources such as Federal grants that are legally restricted,
either by the Legislature or outside parties, to expenditures for specified
purposes. Although activity in this fund type is expected to comprise more
than 40 percent of total government funds receipts and disbursements in the
1995-96 fiscal year, about three-quarters of that activity relates to
Federally-funded programs.
Projected receipts in this fund type total $25.547 billion, an
increase of $1.316 billion over the prior year. Projected disbursements in
this fund type total $26.002 billion, an increase of $1.641 billion over
1994-95 levels. Disbursements from Federal funds, primarily the Federal
share of Medicaid and other social services programs, are projected to total
$19.209 billion in the 1995-96 fiscal year. Remaining projected spending of
$6.793 billion primarily reflects aid to SUNY supported by tuition and
dormitory fees, education aid funded from lottery receipts, operating aid
payments to the Metropolitan Transportation Authority (the "MTA") funded from
the proceeds of dedicated transportation taxes, and costs of a variety of
self-supporting programs which deliver services financed by user fees.
Capital Projects Funds are used to account for the
financial-resources used for the acquisition, construction, or rehabilitation
of major State capital facilities and for capital assistance grants to
certain local governments or public authorities. This fund type consists of
the Capital Projects Fund, which is supported by tax dollars transferred from
the General Fund, and 37 other capital funds established to distinguish
specific capital construction purposes supported by other revenues. In the
1996-97 fiscal year, activity in these funds is expected to comprise 6
percent of total governmental receipts and disbursements.
Total receipts in this fund type are projected at $3.58 billion.
Disbursements from this fund type are projected to be $3.85 billion, a
decrease of $120 million (3.1 percent) over prior-year levels, due in part to
a reclassification of economic development projects to the category of grants
to local governments in the General Fund. The Dedicated Highway and Bridge
Trust Fund is the single largest dedicated fund, comprising an estimated $920
million (24 percent) of the activity in this fund type. Total spending for
capital projects will be financed through a combination of sources: federal
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grants (28 percent), public authority bond proceeds (34 percent), general
obligation bond proceeds (12 percent), and pay-as-you-go revenues (26
percent).
Debt Service Funds are used to account for the payment of principal
of, and interest on, long-term debt of the State and to meet commitments
under lease-purchase and other contractual-obligation financing arrangements.
This fund is expected to comprise 4 percent of total governmental fund
receipts and disbursements in the 1996-97 fiscal year. Receipts in these
funds in excess of debt service requirements are transferred to the General
Fund and Special Revenue Funds, pursuant to law.
The Debt Service Fund type consists of the General Debt Service Fund,
which is supported primarily by tax dollars transferred from the General
Fund, and other funds established to accumulate moneys for the payment of
debt service. In the 1996-97 fiscal year, total disbursements in this fund
type are projected at $2.58 billion, an increase of $164 million or 16.8
percent. The projected transfer from the General Fund of $1.59 billion is
expected to finance 62 percent of these payments.
The General Fund is the principal operating fund of the State and is
used to account for all financial transactions, except those required to be
accounted for in another fund. It is the State's largest fund and receives
almost all State taxes and other resources not dedicated to particular
purposes. General Fund moneys are also transferred to other funds, primarily
to support certain capital projects and debt service payments in other fund
types. A narrative description of cash-basis results in the General Fund is
presented below, followed by a tabular presentation of the actual General
Fund results for the prior three fiscal years.
New York State's financial operations have improved during recent
fiscal years. During the period 1989-90 through 1991 -92, the State incurred
General Fund operating deficits that were closed with receipts from the
issuance of TRANs. A national recession, followed by the lingering economic
slowdown in the New York and regional economy, resulted in repeated
shortfalls in receipts and three budget deficits during those years. During
its last four fiscal years, however, the State has recorded balanced budgets
on a cash basis, with positive fund balances as described below.
The State ended its 1995-96 fiscal year on March 31, 1996 with a
General Fund cash surplus. The DOB reported that revenues exceeded
projections by $270 million, while spending for social service programs was
lower than forecast by $120 million and all other spending was lower by $55
million. From the resulting benefit of $445 million, a $65 million voluntary
deposit was made into the TSRF, and $380 million was used to reduce 1996-97
Financial Plan liabilities by accelerating 1996-97 payments, deferring
1995-96 revenues, and making a deposit to the tax refund reserve account.
The General Fund closing fund balance was $287 million, an increase
of $129 million from 1994-95 levels. The $129 million change in fund balance
is attributable to the $65 million voluntary deposit to the TSRF, a $15
million required deposit to the TSRF, a $40 million deposit to the CRF, and a
$9 million deposit to the Revenue Accumulation Fund. The closing fund
balance includes $237 million on deposit in the TSRF, to be used in the event
of any future General Fund deficit as provided under the State Constitution
and State Finance Law. In addition, $41 million is on deposit in the CRF.
The CRF was established in State fiscal year 1993-94 to assist the State in
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financing the costs of extraordinary litigation. The remaining $9 million
reflects amounts on deposit in the Revenue Accumulation Fund. This fund was
created to hold certain tax receipts temporarily before their deposit to
other accounts. In addition, $678 million was on deposit in the tax refund
reserve account, of which $521 million was necessary to complete the
restructuring of the State's cash flow under the LGAC program.
General Fund receipts totaled $32.81 billion, a decrease of 1.1
percent from 1994-95 levels. This decrease reflects the impact of tax
reductions enacted and effective in both 1994 and 1995. General Fund
disbursements totaled $32.68 billion for the 1995-96 fiscal year, a decrease
of 2.2 percent from 1 994-95 levels. Mid-year spending reductions, taken as
part of a management review undertaken in October at the direction of the
Governor, yielded savings from Medicaid utilization controls, office space
consolidation, overtime and contractual expense reductions, and statewide
productivity improvements achieved by State agencies.
Together with decreased social services spending, this management
review accounts for the bulk of the decline in spending.
The State ended its 1994-95 fiscal year with the General Fund in
balance. The $241 million decline in the fund balance reflects the planned
use of $264 million from the CRF, partially offset by the required deposit of
$23 million to the TSRF. In addition, $278 million was on deposit in the tax
refund reserve account, $250 million of which was deposited to continue the
process of restructuring the State's cash flow as part of the LGAC program.
The closing fund balance of $158 million reflects $157 million in the TSRF
and $1 million in the CRF.
General Fund receipts totaled $33.16 billion, an increase of 2.9
percent from 1993-94 levels. General Fund disbursements totaled $33.40
billion for the 1994-95 fiscal year, an increase of 4.7 percent from the
previous fiscal year. The increase in disbursements was primarily the result
of one-time litigation costs for the State, funded by the use of the CRF,
offset by $188 million in spending reductions initiated in January 1995 to
avert a potential gap in the 1994-95 State Financial Plan. These actions
included savings from a hiring freeze, halting the development of certain
services, and the suspension of non-essential capital projects.
The State ended its 1993-94 fiscal year with a General Fund cash
surplus, primarily the result of an improving national economy, State
employment growth, tax collections that exceeded earlier projections and
disbursements that were below expectations. A deposit of $268 million was
made to the CRF, with a withdrawal during the year of $3 million, and a
deposit of $67 million was made to the TSRF. These three transactions result
in the change in fund balance of $332 million. In addition, a deposit of
$1.14 billion was made to the tax refund reserve account, of which $1.03
billion was available for budgetary purposes in the 1994-95 fiscal year.
(For more information on the personal income tax refund reserve account, see
Table 5.) The remaining $114 million was redeposited in the tax refund
reserve account at the end of the State's 1994-95 fiscal year to continue the
process of restructuring the State's cash flow as part of the LGAC program.
The General Fund closing balance was $399 million, of which $265 million was
on deposit in the CRF and $134 million in the TSRF. The CRF was initially
funded with a transfer of $100 million attributable to a positive margin
recorded in the 1992-33 fiscal year.
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General Fund receipts totaled $32.23 billion, an increase of 2.6
percent from 1992-93 levels. General Fund disbursements totaled $31.90
billion for the 1993-94 fiscal year, 3.5 percent higher than the previous
fiscal year. Receipts were higher in part due to improved tax collections
from renewed State economic growth although the State continued to lag behind
the national economic recovery. Disbursements were higher due in part to
increased local assistance costs for school aid and social services,
accelerated payment of certain Medicaid expenses, and the cost of an
additional payroll for State employees.
Activity in the three other governmental funds has remained
relatively stable over the last three fiscal years, with federally-funded
programs comprising approximately two-thirds of these funds. The most
significant change in the structure of these funds has been the redirection,
beginning in the 1993-94 fiscal year, of a portion of transportation-related
revenues from the General Fund to two new dedicated funds in the Special
Revenue and Capital Projects Fund types. These revenues are used to support
the capital programs of the Department of Transportation and the MTA.
In the Special Revenue Funds, disbursements increased from $22.72
billion to $26.26 billion over the last three years, primarily as a result of
increased costs for the federal share of Medicaid. Other activity reflected
dedication of taxes to a new fund for mass transportation, new lottery games,
and new fees for criminal justice programs.
Disbursements in the Capital Projects Funds grew from $3.10 billion
to $3.97 billion over the last three years, as spending for transportation
and mental hygiene programs increased, partially offset by declines for
corrections and environmental programs. The composition of this fund type's
receipts also changed as the dedicated transportation taxes began to be
deposited, general obligation bond proceeds declined substantially, federal
grants remained stable, and reimbursements from public authority bonds
(primarily transportation related) increased. The increase in the negative
fund balance in 1994-95 resulted from delays in reimbursements caused by
delays in the timing of public authority bond sales.
Activity in the Debt Service Funds reflected increased use of bonds
during the three-year period for improvements to the State's capital
facilities and the continued implementation of the LGAC fiscal reform
program. The increases were moderated by the refunding savings achieved by
the State over the last several years using strict present value savings
criteria. The growth in LGAC debt service was offset by reduced short-term
borrowing costs reflected in the General Fund.
The economic and financial condition of the State may be affected by
various financial, social, economic and political factors. These factors can
be very complex, may vary from fiscal year to fiscal year, and are frequently
the result of actions taken not only by the State and its agencies and
instrumentalities, but also by entities, such as the federal government, that
are not under the control of the State. For example, various proposals
relating to federal tax and spending policies that are currently being
publicly discussed and debated could, if enacted, have a significant impact
on the State's financial condition in the current and future fiscal years.
Because of the uncertainty and unpredictability of the changes, their impact
cannot, as a practical matter, be included in the assumptions underlying the
State's projections at this time.
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The State Financial Plan is based upon forecasts of national and
State economic activity developed through both internal analysis and review
of State and national economic forecasts prepared by commercial forecasting
services and other public and private forecasters. Economic forecasts have
frequently failed to predict accurately the timing and magnitude of changes
in the national and the State economies. Many uncertainties exist in
forecasts of both the national and State economies, including consumer
attitudes toward spending, the extent of corporate and governmental
restructuring, federal fiscal and monetary policies, the level of interest
rates, and the condition of the world economy, which could have an adverse
effect on the State. There can be no assurance that the State economy will
not experience results in the current fiscal year that are worse than
predicted, with corresponding material and adverse effects on the State's
projections of receipts and disbursements.
Projections of total State receipts in the State Financial Plan are
based on the State tax structure in effect during the fiscal year and on
assumptions relating to basic economic factors and their historical rela-
tionships to State tax receipts. In preparing projections of State receipts,
economic forecasts relating to personal income, wages, consumption, profits
and employment have been particularly important. The projection of receipts
from most tax or revenue sources is generally made by estimating the change
in yield of such tax or revenue source caused by economic and other factors,
rather than by estimating the total yield of such tax or revenue source from
its estimated tax base. The forecasting methodology, however, ensures that
State fiscal year estimates for taxes that are based on a computation of
annual liability, such as the business and personal income taxes, are
consistent with estimates of total liability under such taxes.
Projections of total State disbursements are based on assumptions
relating to economic and demographic factors, levels of disbursements for
various services provided by local governments (where the cost is partially
reimbursed by the State), and the results of various administrative and
statutory mechanisms in controlling disbursements for State operations.
Factors that may affect the level of disbursements in the fiscal year include
uncertainties relating to the economy of the nation and the State, the
policies of the federal government, and changes in the demand for and use of
State services.
The Division of the Budget believes that its projections of receipts
and disbursements relating to the current State Financial Plan, and the
assumptions on which they are based, are reasonable. Actual results,
however, could differ materially and adversely from the projections set forth
in this Annual Information Statement. In the past, the State has taken
management actions and made use of internal sources to address potential
State Financial Plan shortfalls, and DOB believes it could take similar
actions should variances occur in its projections for the current fiscal
year.
In recent years, State actions affecting the level of receipts and
disbursements, the relative strength of the State and regional economy,
actions of the federal government and other factors, have created structural
budget gaps for the State. These gaps resulted from a significant disparity
between recurring revenues and the costs of maintaining or increasing the
level of support for State programs. To address a potential imbalance in any
given fiscal year, the State would be required to take actions to increase
receipts and/or reduce disbursements as it enacts the budget for that year,
<PAGE>
and under the State Constitution, the Governor is required to propose a
balanced budget each year. There can be no assurance, however, that the Leg-
islature will enact the Governor's proposals or that the State's actions will
be sufficient to preserve budgetary balance in a given fiscal year or to
align recurring receipts and disbursements in future fiscal years.
On January 13, 1992, Standard & Poor's ("S&P") lowered its rating on
the State's general obligation bonds from A to A- and, in addition, reduced
its ratings on the State's moral obligation, lease purchase, guaranteed and
contractual obligation debt. S&P also continued its negative rating outlook
assessment on State general obligation debt. On April 26, 1993 S&P revised
the rating outlook assessment to stable. On February 14, 1994, S&P revised
its outlook to positive and, on August 5, 1996, confirmed its A- rating. On
January 6, 1992, Moody's reduced its ratings on outstanding limited-liability
State lease purchase and contractual obligations from A to Baa1. On July 26,
1996, Moody's reconfirmed its A rating on the State's general obligation
long-term indebtedness.
On June 6, 1990, Moody's changed its ratings on all of the State's
outstanding general obligation bonds from A1 to A, the rating having been A1
since May 27, 1986. On November 12, 1990, Moody's confirmed the A rating.
In 1992, S&P lowered the State's general obligation bond rating to A-, where
it currently remains and was affirmed on July 13, 1995. Prior to this, on
March 26, 1990, S&P lowered its rating of all of the State's outstanding
general obligation bonds from AA- to A. Previous S&P ratings were AA- from
August, 1987 to March, 1990 and A+ from November, 1982 to August, 1987.
Authorities. The fiscal stability of the State is related, in part,
to the fiscal stability of its public authorities, which generally have
responsibility for financing, constructing and operating revenue-producing
public benefit facilities. Public authorities are not subject to the
constitutional restrictions on the incurrence of debt which apply to the
State itself, and may issue bonds and notes within the amounts of, and as
otherwise restricted by, their legislative authorization. The State's access
to the public credit markets could be impaired, and the market price of its
outstanding debt may be materially adversely affected, if any of its public
authorities were to default on their respective obligations. As of September
30, 1995 there were 17 Authorities that had outstanding debt of $100 million
or more each, and the aggregate outstanding debt, including refunding bonds,
of all state public authorities was $73.45 billion.
There are numerous public authorities, with various responsibilities,
including those which finance, construct and/or operate revenue producing
public facilities. Public authority operating expenses and debt service
costs are generally paid by revenues generated by the projects financed or
operated, such as tolls charged for the use of highways, bridges or tunnels,
rentals charged for housing units, and charges for occupancy at medical care
facilities.
In addition, State legislation authorizes several financing
techniques for public authorities. Also, there are statutory arrangements
providing for State local assistance payments otherwise payable to localities
to be made under certain circumstances to public authorities. Although the
State has no obligation to provide additional assistance to localities whose
local assistance payments have been paid to public authorities under these
arrangements if local assistance payments are so diverted, the affected
localities could seek additional State assistance.
<PAGE>
Some authorities also receive monies from State appropriations to pay
for the operating costs of certain of their programs. As described below,
the MTA receives the bulk of this money in order to carry out mass transit
and commuter services.
The State's experience has been that if an Authority suffers serious
financial difficulties, both the ability of the State and the Authorities to
obtain financing in the public credit markets and the market price of the
State's outstanding bonds and notes may be adversely affected. The New York
State HFA, the New York State Urban Development Corporation and certain other
Authorities have in the past required and continue to require substantial
amounts of assistance from the State to meet debt service costs or to pay
operating expenses. Further assistance, possibly in increasing amounts, may
be required for these, or other, Authorities in the future. In addition,
certain other statutory arrangements provide for State local assistance
payments otherwise payable to localities to be made under certain
circumstances to certain Authorities. The State has no obligation to provide
additional assistance to localities whose local assistance payments have been
paid to Authorities under these arrangements. However, in the event that
such local assistance payments are so diverted, the affected localities could
seek additional State funds.
Metropolitan Transportation Authority . The MTA oversees the
operation of the City's subway and bus lines by its affiliates, the New York
City Transit Authority and the Manhattan and Bronx Surface Transit Operating
Authority (collectively, the "TA"). The MTA operates certain commuter rail
and bus lines in the New York Metropolitan area through MTA's subsidiaries,
the Long Island Rail Road Company, the Metro-North Commuter Railroad Company
and the Metropolitan Suburban Bus Authority. In addition, the Staten Island
Rapid Transit Operating Authority, an MTA subsidiary, operates a rapid
transit line on Staten Island. Through its affiliated agency, the Triborough
Bridge and Tunnel Authority (the "TBTA"), the MTA operates certain intrastate
toll bridges and tunnels. Because fare revenues are not sufficient to
finance the mass transit portion of these operations, the MTA has depended,
and will continue to depend for operating support upon a system of State,
local government and TBTA support, and, to the extent available, Federal
operating assistance, including loans, grants and operating subsidies. If
current revenue projections are not realized and/or operating expenses exceed
current projections, the TA or commuter railroads may be required to seek
additional State assistance, raise fares or take other actions.
Since 1980, the State has enacted several taxes--including a
surcharge on the profits of banks, insurance corporations and general
business corporations doing business in the 12-county Metropolitan Trans-
portation Region served by the MTA and a special one-quarter of 1 percent
regional sales and use tax--that provide revenues for mass transit purposes,
including assistance to the MTA. In addition, since 1987, State law has
required that the proceeds of a one quarter of 1% mortgage recording tax paid
on certain mortgages in the Metropolitan Transportation Region be deposited
in a special MTA fund for operating or capital expenses. Further, in 1993
the State dedicated a portion of the State petroleum business tax to fund
operating or capital assistance to the MTA. For the 1996-97 fiscal year,
total State assistance to the MTA is estimated by the State to be
approximately $1.09 billion.
State legislation accompanying the 1996-97 adopted State budget
authorized the MTA, TBTA and TA to issue an aggregate of $6.5 billion in
<PAGE>
bonds to finance a portion of a new $11.98 billion MTA capital plan for the
1995 through 1999 calendar years (the "1995-99 Capital Program"), and
authorized the MTA to submit the 1995-99 Capital Program to the Capital
Program Review Board for approval. This plan will supersede the overlapping
portion of the MTA's 1992-96 Capital Program. This is the fourth capital
plan since the Legislature authorized procedures for the adoption, approval
and amendment of MTA capital programs and is designed to upgrade the
performance of the MTA's transportation systems by investing in new rolling
stock, maintaining replacement schedules for existing assets and bringing the
MTA system into a state of good repair. The 1995-99 Capital Program assumes
the issuance of an estimated $5.1 billion in bonds under this $6.5 billion
aggregate bonding authority. The remainder of the plan is projected to be
financed through assistance from the State, the federal government, and the
City of New York, and from various other revenues generated from actions
taken by the MTA.
There can be no assurance that all the necessary governmental actions
for the 1995-99 Capital Program will be taken, that funding sources currently
identified will not be decreased or eliminated, or that the 1995-99 Capital
Program, or parts thereof, will not be delayed or reduced. If the 1995-99
Capital Program is delayed or reduced, ridership and fare revenues may
decline, which could, among other things, impair the MTA's ability to meet
its operating expenses without additional assistance.cal years and
thereafter. The potential impact on the State of such actions by localities
is not included in the projections of the State receipts and disbursements
for the 1995-96 fiscal year.
Localities. Certain localities outside the City have experienced
financial problems and have requested and received additional State
assistance during the last several State fiscal years. The potential impact
on the State of any future requests by localities for additional assistance
is not included in the projections of the State's receipts and disbursements
for the State's 1996-97 fiscal year.
Fiscal difficulties experienced by the City of Yonkers resulted in
the re-establishment of the Financial Control Board for the City of Yonkers
by the State in 1984. That Board is charged with oversight of the fiscal
affairs of Yonkers. Future actions taken by the State to assist Yonkers
could result in increased State expenditures for extraordinary local
assistance.
Beginning in 1990, the City of Troy experienced a series of budgetary
deficits that resulted in the establishment of a Supervisory Board for the
City of Troy in 1994. The Supervisory Board's powers were increased in 1995,
when Troy MAC was created to help Troy avoid default on certain obligations.
The legislation creating Troy MAC prohibits the City of Troy from seeking
federal bankruptcy protection while Troy MAC bonds are outstanding.
Seventeen municipalities received extraordinary assistance during the
1996 legislative session through $50 million in special appropriations
targeted for distressed cities.
Municipal Indebtedness. Municipalities and school districts have
engaged in substantial short-term and long-term borrowings. In 1994, the
total indebtedness of all localities in the State other than the City was
approximately $17.7 billion. A small portion (approximately $82.9 million)
of that indebtedness represented borrowing to finance budgetary deficits and
<PAGE>
was issued pursuant to State enabling legislation. State law requires the
Comptroller to review and make recommendations concerning the budgets of
those local government units other than the City authorized by State law to
issue debt to finance deficits during the period that such deficit financing
is outstanding. Fifteen localities had outstanding indebtedness for deficit
financing at the close of their fiscal year ending in 1994.
From time to time, proposed Federal expenditure reductions could
reduce, or in some cases eliminate, Federal funding of some local programs
and accordingly might impose substantial increased expenditure requirements
on affected localities. If the State, the City or any of the Authorities
were to suffer serious financial difficulties jeopardizing their respective
access to the public credit markets, the marketability of notes and bonds
issued by localities within the State could be adversely affected.
Localities also face anticipated and potential problems resulting from
certain pending litigation, judicial decisions and long-range economic
trends. Long-range potential problems of declining urban population,
increasing expenditures and other economic trends could adversely affect
certain localities and require increasing State assistance in the future.
Litigation. Certain litigation pending against the State or its
officers or employees could have a substantial or long-term adverse effect on
State finances. Among the more significant of these cases are those that
involve: (i) employee welfare benefit plans seeking a declaratory judgment
nullifying on the ground of federal preemption provisions of Section 2807-c
of the Public Health Law and implementing regulations which impose a bad debt
and charity care allowance on all hospital bills and a 13 percent surcharge
on inpatient bills paid by employee welfare benefit plans; (ii) several
challenges to provisions of Chapter 81 of the Laws of 1995 which alter the
nursing home Medicaid reimbursement methodology; (iii) the validity of agree-
ments and treaties by which various Indian tribes transferred title to the
State of certain land in central and upstate New York; (iv) challenges to the
practice of using patients' Social Security benefits for the costs of care of
patients of State Office of Mental Health facilities; (v) an action against
State and City officials alleging that the present level of shelter allowance
for public assistance recipients is inadequate under statutory standards to
maintain proper housing; (vi) challenges to the practice of reimbursing
certain Office of Mental Health patient care expenses from the client's
Social Security benefits; (vii) alleged responsibility of State officials to
assist in remedying racial segregation in the City of Yonkers; (viii) alleged
responsibility of the State Department of Environmental Conservation for a
plaintiff's inability to complete construction of a cogeneration facility in
a timely fashion and the damages suffered thereby; (ix) challenges to the
promulgation of the State's proposed procedure to determine the eligibility
for and nature of home care services for Medicaid recipients; (x) a challenge
to State implementation of a program which reduces Medicaid benefits to
certain home-relief recipients; (xi) a challenge to the constitutionality of
petroleum business tax assessments authorized by Tax Law SS 301; and (xii) an
action for reimbursement from the State for certain costs arising out of the
provision of preschool services and programs for children with handicapping
conditions, pursuant to Sections 4410 (10) and (11) of the Education Law.
Adverse developments in the proceedings described above or the
initiation of new proceedings could affect the ability of the State to
maintain a balanced 1996-97 State Financial Plan. In its Notes to its
General Purpose Financial Statements for the fiscal year ended March 31,
1996, the State reports its estimated liability for awards and anticipated
<PAGE>
unfavorable judgments at $474 million. There can be no assurance that an
adverse decision in any of the above cited proceedings would not exceed the
amount of the 1996-97 State Financial Plan reserves for the payment of
judgments and, therefore, could affect the ability of the State to maintain a
balanced 1996-97 State Financial Plan.
New York City
The fiscal health of the State may also be impacted by the fiscal
health of its localities, particularly the City, which continues to require
significant financial assistance from the State. The City depends on State
aid both to enable the City to balance its budget and to meet its cash
requirements. The State could also be affected by the ability of the City to
market its securities successfully in the public credit markets. The City
has achieved balanced operating results for each of its fiscal years since
1981 as reported in accordance with the then-applicable GAAP standards. The
City's financial plans are usually prepared quarterly, and the annual
financial report for its most recent completed fiscal year is prepared at the
end of October of each year.
In response to the City's fiscal crisis in 1975, the State took
action to assist the City in returning to fiscal stability. Among these
actions, the State established the Municipal Assistance Corporation for the
City of New York ("MAC") to provide financing assistance to the City. The
State also enacted the New York State Financial Emergency Act for The City of
New York (the "Financial Emergency Act") which, among other things,
established the New York State Financial Control Board (the "Control Board")
to oversee the City's financial affairs. The State also established the
Office of the State Deputy Comptroller for the City of New York ("OSDC") to
assist the Control Board in exercising its powers and responsibilities and a
'Control Period' from 1975 to 1986 during which the City was subject to
certain statutorily-prescribed fiscal-monitoring arrangements. Although the
Control Board terminated the Control Period in 1986 when certain statutory
conditions were met, thus suspending certain Control Board powers, the
Control Board, MAC and OSDC continue to exercise various fiscal-monitoring
functions over the City, and upon the occurrence or 'substantial likelihood
and imminence' of the occurrence of certain events, including, but not
limited to a City operating budget deficit of more than $100 million, the
Control Board is required by law to reimpose a Control Period. Currently,
the City and its "Covered Organizations" (i.e., those which receive or may
receive money from the City directly, indirectly or contingently) operate
under a four-year financial plan, which the City prepares annually and
updates periodically and which includes the City's capital revenue and
expense projections and outlines proposed gap-closing programs for years with
projected budget gaps. The City's current four-year financial plan projects
substantial budget gaps for each of the 1997 through 1999 fiscal years,
before implementation of the proposed gap-closing program contained in the
current financial plan. The City is required to submit its financial plans
to review bodies, including the Control Board.
Although the City has balanced its budget since 1981, estimates of
the City's revenues and expenditures, which are based on numerous
assumptions, are subject to various uncertainties. If, for example, expected
federal or State aid is not forthcoming, if unforeseen developments in the
economy significantly reduce revenues derived from economically sensitive
taxes or necessitate increased expenditures for public assistance, if the
City should negotiate wage increases for its employees greater than the
<PAGE>
amounts provided for in the City's financial plan or if other uncertainties
materialize that reduce expected revenues or increase projected expenditures,
then, to avoid operating deficits, the City may be required to implement
additional actions, including increases in taxes and reductions in essential
City services. The City might also seek additional assistance from the
State. Unforeseen developments and changes in major assumptions could
significantly affect the City's ability to balance its budget as required by
State law and to meet its annual cash flow and financing requirements.
Implementation of the Financial Plan is also dependent upon the
ability of the City and certain Covered Organizations to market their
securities successfully. The City issues securities to finance, refinance
and rehabilitate infrastructure and other capital needs, as well as for
seasonal financing needs. The City currently projects that if no action is
taken, it will exceed its State Constitutional general debt limit beginning
in City fiscal year 1998. The current Financial Plan includes certain
alternative methods of financing a portion of the City's capital program
which require State or other outside approval. Future developments
concerning the City or its Covered Organizations, and public discussion of
such developments, as well as prevailing market conditions and securities
credit ratings, may affect the ability or cost to sell securities issued by
the City or such Covered Organizations and may also affect the market for
their outstanding securities.
The staffs of the Control Board, OSDC and the City Comptroller issue
periodic reports on the City's Financial Plans which analyze the City's
forecasts of revenues and expenditures, cash flow, and debt service
requirements for, and Financial Plan compliance by, the City and its Covered
Organizations. According to recent staff reports, the City's economy has
experienced weak employment and moderate wage and income growth throughout
the mid-1990s. Although this trend is expected to continue for the rest of
the decade, there is the risk of a slowdown in the City's economy in the next
few years, which would depress revenue growth and put further strains on the
City's budget. These reports have also indicated that recent City budgets
have been balanced in part through the use of non-recurring resources; that
the City's Financial Plan tends to rely on actions outside its direct
control; that the City has not yet brought its long-term expenditure growth
in line with recurring revenue growth; and that the City is therefore likely
to continue to face substantial future budget gaps that must be closed with
reduced expenditures and/or increased revenues.
The 1997-2000 Financial Plan projects revenues and expenditures for
the 1997 fiscal year balanced in accordance with GAAP. The projections for
the 1997 fiscal year reflect proposed actions to close a previously projected
gap of approximately $2.6 billion for the 1997 fiscal year. The proposed
actions for the 1997 fiscal year include (i) additional agency actions
totaling $1.2 billion; (ii) a revised tax reduction program which would
increase projected tax revenues by $385 million due to the four year
extension of the 12.5% personal income tax surcharge and other actions; (iii)
savings resulting from cost containment in entitlement programs to reduce
City expenditures and additional proposed State aid of $75 million; (iv) the
assumed receipt of revenues relating to rent payments for the City's airports
totaling $269 million, which are currently the subject of a dispute with the
Port Authority; (v) the sale of the City's television station for $207
million; and (vi) pension cost savings totaling $134 million resulting from a
proposed increase in the earnings assumption for pension assets from 8.5% to
8.75%, $40 million of which the City currently does not expect to be
<PAGE>
achieved. There can be no assurance that these gap-closing measures can be
implemented as planned.
The Financial Plan also sets forth projections for the 1998 through
2000 fiscal years and projects gaps of $1.7 billion, $2.7 billion and $3.4
billion for the 1998, 1999 and 2000 fiscal years, respectively.
The projections for the 1 997 through 2000 fiscal years assume (i)
approval by the Governor and the State Legislature of the extension of the
12.5% personal income tax surcharge, which is projected to provide revenue of
$171 million, $447 million, $478 million and $507 million in the 1997 through
2000 fiscal years, respectively, (ii) collection of the projected rent
payments for the City's airports, which may depend on the successful
completion of negotiations with the Port Authority or the enforcement of the
City's rights under the existing leases thereto through pending legal
actions; (iii) the ability of HHC and BOE to identify actions to offset
substantial City and State revenue reductions and the receipt by BOE of
additional State aid; and (iv) State approval of the cost containment
initiatives and State aid proposed by the City. The Financial Plan does not
reflect any increased costs which the City might incur as a result of welfare
legislation recently enacted by Congress.
The City's financial plans have been the subject of extensive public
comment and criticism. On July 16, 1996, the staff of the City Comptroller
issued a report on the Financial Plan. The report concluded that the City's
fiscal situation remains serious, and that the City faces budgetary risks of
approximately $787 million to $941 million for the 1997 fiscal year, which
increase to $4.1 6 billion to $4.31 billion for fiscal year 2000.
In connection with the Financial Plan, the City has outlined a
gap-closing program for the 1998 through 2000 fiscal years to substantially
reduce the remaining $1.7 billion, $2.7 billion and $3.4 billion projected
budget gaps for such fiscal years. This program, which is not specified in
detail, assumes additional agency programs to reduce expenditures or increase
revenues by $674 million, $959 million and $1.1 billion in the 1998 through
2000 fiscal years, respectively; additional reductions in entitlement cost of
$400 million, $750 million and $1.0 billion in the 1998 through 2000 fiscal
years, respectively; additional savings of $250 million, $300 million and
$500 million in the 1998 through 2000 fiscal years, respectively, resulting
from restructuring City government by consolidating operations, privatization
and mandate management and other initiatives; additional proposed federal and
State aid of $105 million, $200 million and $300 million in the 1998 through
2000 fiscal years, respectively; additional revenue initiatives and asset
sales of $155 million, $350 million and $400 million in the 1998 through 2000
fiscal years, respectively; and the availability in each of the 1998 through
2000 fiscal years of $100 million of the General Reserve.
The City's projected budget gaps for the 1999 and 2000 fiscal years
do not reflect the savings expected to result from prior years' programs to
close the gaps set forth in the Financial Plan. Thus, for example, recurring
savings anticipated from the actions which the City proposes to take to
balance the fiscal year 1998 budget are not taken into account in projecting
the budget gaps for the 1999 and 2000 fiscal years.
Although the City has maintained balanced budgets in each of its last
sixteen fiscal years, and is projected to achieve balanced operating results
for the 1997 fiscal year, there can be no assurance that the gap-closing
<PAGE>
actions proposed in the Financial Plan can be successfully implemented or
that the City will maintain a balanced budget in future years without
additional State aid, revenue increases or expenditure reductions.
Additional tax increases and reductions in essential City services could
adversely affect the City's economic base.
Assumptions
The 1997-2000 Financial Plan is based on numerous assumptions,
including the condition of the City's and the region's economy and a modest
employment recovery and the concomitant receipt of economically sensitive tax
revenues in the amounts projected. The 1997-2000 Financial Plan is subject
to various other uncertainties and contingencies relating to, among other
factors, the extent, if any, to which wage increases for City employees
exceed the annual wage costs assumed for the 1997 through 2000 fiscal years;
continuation of projected interest earnings assumptions for pension fund
assets and current assumptions with respect to wages for City employees
affecting the City's required pension fund contributions; the willingness and
ability of the State, in the context of the State's current financial
condition, to provide the aid contemplated by the Financial Plan and to take
various other actions to assist the City; the ability of HHC, BOE and other
such agencies to maintain balanced budgets; the willingness of the Federal
government to provide the amount of Federal aid contemplated in the Financial
Plan; adoption of the City's budgets by the City Council in substantially the
forms submitted by the Mayor; the ability of the City to implement proposed
reductions in City personnel and other cost reduction initiatives, and the
success with which the City controls expenditures; the impact of conditions
in the real estate market on real estate tax revenues; the City's ability to
market its securities successfully in the public credit markets; and
unanticipated expenditures that may be incurred as a result of the need to
maintain the City's infrastructure. Certain of these assumptions have been
questioned by the City Comptroller and other public officials.
The projections and assumptions contained in the 1997-2000 Financial
Plan are subject to revision which may involve substantial change, and no
assurance can be given that these estimates and projections, which include
actions which the City expects will be taken but which are not within the
City's control, will be realized. The principal projections and assumptions
described below are based on information available in May 1996.
Substantially all of the City's full-time employees are members of
labor unions. The Financial Emergency Act requires that all collective
bargaining agreements entered into by the City and the Covered Organizations
be consistent with the City's current financial plan, except for certain
awards arrived at through impasse procedures. During a Control Period, and
subject to the foregoing exception, the Control Board would be required to
disapprove collective bargaining agreements that are inconsistent with the
City's current financial plan.
Under applicable law, the City may not make unilateral changes in
wages, hours or working conditions under any of the following circumstances:
(i) during the period of negotiations between the City and a union
representing municipal employees concerning a collective bargaining
agreement; (ii) if an impasse panel is appointed, then during the period
commencing on the date on which such panel is appointed and ending sixty days
thereafter or thirty days after it submits its report, whichever is sooner,
subject to extension under certain circumstances to permit completion of
<PAGE>
panel proceedings; or (iii) during the pendency of an appeal to the Board of
Collective Bargaining. Although State law prohibits strikes by municipal
employees, strikes and work stoppages by employees of the City and the
Covered Organizations have occurred.
The 1997-2000 Financial Plan projects that the authorized number of
City-funded employees whose salaries are paid directly from City funds, as
opposed to federal or State funds, will decrease from an estimated level of
206,716 on June 30, 1996 to an estimated level of 203,793 by June 30, 2000,
before implementation of the gap-closing program outlined in the Financial
Plan.
Contracts with all of the City's municipal unions expired in the 1995
and 1996 fiscal years. The City has reached settlements with unions
representing approximately two-thirds of the City's workforce. The Financial
Plan reflects the costs of the settlements and assumes similar increases for
all other City-funded employees.
The terms of wage settlements could be determined through the impasse
procedure in the New York City Collective Bargaining Law, which can impose a
binding settlement. Legislation passed in February 1996 will place
collective bargaining matters relating to police and firefighters, including
impasse proceedings, under the jurisdiction of the State Public Employment
Relations Board ("PERB"), instead of the New York City Office of Collective
Bargaining ("OCB"). OCB considers wage levels of municipal employees in
similar cities in the United States in reaching its determinations, while
PERB's determinations take into account wage levels in both private and
public employment in comparable communities, particularly within the State.
In addition, PERB can approve only two-year contracts, unlike OCB which can
approve longer contracts. For these reasons, among others, PERB jurisdiction
could result in labor settlements which impose higher costs on the City than
those reached under existing procedures. On January 23, 1996, the City
requested the Office of Collective Bargaining to declare an impasse against
the Patrolmen's Benevolent Association ("PBA") and the Uniformed Firefighters
Association ("UFA"). In addition, on February 29, 1996, the City commenced
an action in the State Supreme Court seeking a declaratory judgment
confirming that OCB, rather than PERB, has jurisdiction over collective
bargaining matters relating to police. On April 10, 1996, the Court issued a
decision which found the legislation in violation of the home rule provisions
of the State Constitution, and held that OCB and not PERB had jurisdiction
over collective bargaining matters relating to police. On September 12,
1996, the Appellate Division, First Department affirmed this decision. The
PBA has appealed the Appellate Division decision.
The projections for the 1997 through 2000 fiscal years reflect the
costs of the settlements with the United Federation of Teachers ("UFT") and a
coalition of unions headed by District Council 37 of the American Federation
of State, County and Municipal Employees ("District Council 37"), which
together represent approximately two-thirds of the City's workforce, and
assume that the City will reach agreement with its remaining municipal unions
under terms which are generally consistent with such settlements. The
settlement provides for a wage freeze in the first two years, followed by a
cumulative effective wage increase of 11% by the end of the five year period
covered by the proposed agreements, ending in fiscal years 2000 and 2001.
Additional benefit increases would raise the total cumulative effective
increase to 13% above present costs. Costs associated with similar
settlements for all City-funded employees would total $49 million, $459
<PAGE>
million and $1.2 billion in the 1997, 1998 and 1999 fiscal years,
respectively, and exceed $2 billion in each fiscal year after the 1999 fiscal
year. There can be no assurance that the City will reach an agreement with
the unions that have not yet reached a settlement with the City on the terms
contained in the Financial Plan.
In the event of a collective bargaining impasse, the terms of wage
settlements could be determined through statutory impasse procedures, which
can impose a binding settlement except in the case of collective bargaining
with the UFT, which may be subject to non-binding arbitration. On January
23, 1996, the City requested the Office of Collective Bargaining to declare
an impasse against the PBA and the UFA.
From time to time, the Control Board staff, MAC, OSDC, the City
Comptroller and others issue reports and make public statements regarding the
City's financial condition, commenting on, among other matters, the City's
financial plans, projected revenues and expenditures and actions by the City
to eliminate projected operating deficits. Some of these reports and
statements have warned that the City may have underestimated certain
expenditures and overestimated certain revenues and have suggested that the
City may not have adequately provided for future contingencies. Certain of
these reports have analyzed the City's future economic and social conditions
and have questioned whether the City has the capacity to generate sufficient
revenues in the future to meet the costs of its expenditure increases and to
provide necessary services. It is reasonable to expect that reports and
statements will continue to be issued and to engender public comment.
On July 16, 1996, the City Comptroller issued a report on the
Financial Plan, which concluded that the City's fiscal situation remains
serious. With respect to the 1997 fiscal year, the report identified between
$787 million and $941 million in potential risks, including (i) $319 million
in airport-related payments from the Port Authority that are the subject of
arbitration; (ii) $202 million to $266 million in risks related to BOE
resulting primarily from unidentified expenditure reductions and projected
State aid which has not been appropriated by the State Legislature; (iii)
possible tax revenue shortfalls totaling $69 million, reflecting the
potential impact that rising interest rates may have on the economy; and (iv)
$144 million relating to projected overtime savings. In addition, the report
noted that HHC has not provided any details with respect to assumed
expenditure reductions and revenue enhancements to close a projected deficit
for the 1997 fiscal year, and that HHC faces additional uncertainties,
including the impact of reform of the State's health care reimbursement
methodology, lower Medicaid and Medicare revenues due to proposed reductions
by the Federal Government and the impact of proposals to privatize certain
hospital facilities. The report also noted that the City's capital budget
includes risks in the 1997 fiscal year of $777 million, including $607
million in capital from the proposed sale of the City's water and sewer
system, which the City Comptroller has opposed and which was ruled
unconstitutional in a unanimous decision of the Appellate Division of the
State Supreme Court.
With respect to fiscal years 1998 through 2000, the report identified
total risks of between $2.47 billion and $2.58 billion for the 1998 fiscal
year, $3.38 billion and $3.53 billion for the 1999 fiscal year and $4.16
billion and $4.31 billion for fiscal year 2000, which include the gaps
identified in the Financial Plan and the same categories of risks for fiscal
years 1998 through 2000 that the report identified for the 1997 fiscal year.
<PAGE>
With respect to the City's capital budget for the 1998 through 2000 fiscal
years, the report identified risks of $1.5 billion, $1.7 billion and $1.4
billion, respectively, including the risk that the proposed Infrastructure
Finance Agency may not be approved by the State Legislature. The report also
noted that the City's reliance on $1.5 billion of nonrecurring actions for
the 1997 fiscal year to close current year budget gaps and, therefore, defer
them into future fiscal years, has resulted in a rapid increase in the size
of estimated budget gaps for the later years of the Financial Plan. The
largest of these recent budget actions include City labor contracts, which
defer major costs until the end of the contract period, bond refundings, and
the sale of Mitchell-Lama mortgages. In a subsequent report, the City
Comptroller set forth various proposals to relieve overcrowding in the public
schools, including year-round schooling, double shifts, busing to nearby
schools with available space, and federal funding for new school construction
and renovation projects.
On July 18, 1996, the staff of the OSDC issued a report on the
Financial Plan. The report concluded that, while the City will end the 1996
fiscal year with a balanced budget, the City has made no progress towards
structural budget balance, despite its headcount and entitlement reduction
programs and higher revenue collections. The report noted that the City
relied on $1.4 billion in non-recurring resources to achieve budget balance
in the 1996 fiscal year and, as a result, future projected gaps have
increased to the largest the City has ever faced. The report projected
budget gaps of $74 million, $1.8 billion, $2.7 billion and $3.5 billion, and
identified additional risks of $774 million, $1.3 billion, $1.0 billion and
$1.1 billion, for the 1997 through 2000 fiscal years, respectively. The
principal risks identified in the report relate to (i) uncertain State
education aid and mandate relief, and unspecified expenditure reductions,
relating to BOE, totaling $327 million in the 1997 fiscal year and $402
million in each of the 1998, 1999 and 2000 fiscal years; (ii) the receipt of
Port Authority lease payments totaling $314 million and $226 million in the
1997 and 1998 fiscal years, respectively; (iii) State approval of a four-year
extension to the City's personal income tax surcharge which would generate
revenues of $171 million, $447 million, $478 million and $507 million in the
1997 through 2000 fiscal years, respectively; and (iv) the receipt of $200
million in the 1998 fiscal year in connection with a proposed sale of the New
York Coliseum. The report noted that the large future budget gaps result
primarily from tax cuts and the cost of labor agreements, and that revenues
are projected to increase 1.2% per year during the period covered by the
Financial Plan, while expenditures are projected to increase 6% per year.
The report further noted that the City's economy is heavily dependent on
profits in the securities sector, which are volatile, and that there is a
strong likelihood of a downturn in the national and local economies during
the period of the Financial Plan, which creates a risk to City tax
collections beyond those quantified in the report. In addition, the report
noted that HHC could face a budget gap of approximately $370 million for the
1997 fiscal year, resulting from lower hospital utilization and other
factors, and, with respect to the capital plan, the report noted that the
City anticipates funding over the next four years of approximately $5.7
billion which is uncertain, including financing from the proposed sale of the
water and sewer system, savings from amendments to the Wicks Law and the
proceeds from the sale of bonds issued by the proposed Infrastructure Finance
Authority.
On July 18, 1996, the staff of the Control Board issued a report on
the Financial Plan. The report identified risks totaling $594 million, $1.1
<PAGE>
billion, $851 million and $813 million, for the 1997 fiscal year, the 1998
fiscal year, the 1999 fiscal year and fiscal year 2000, respectively. The
principal risks identified in the report included (i) revenues from the
proposed extension of the 12.5% personal income tax surcharge totaling $171
million, $394 million, $419 million and $445 million in the 1997 through 2000
fiscal years, respectively, which requires State legislation; (ii)
implementation by BOE of various actions, totaling $56 million in the 1997
fiscal year and $334 million in each of the 1998 through 2000 fiscal years,
which include unspecified reductions and uncertain State funding; (iii) the
receipt of $314 million and $226 million from the Port Authority in the 1997
and 1998 fiscal years, respectively, which is the subject of arbitration; and
(iv) the potential for greater than forecast overtime spending totaling
between $71 and $77 million in each of the 1997 through 2000 fiscal years.
Taking into account the risks identified in the report and the unprecedented
gaps projected in the Financial Plan, the Control Board identified projected
gaps of $2.8 billion, $3.5 billion and $4.2 billion for the 1998 fiscal year,
the 1999 fiscal year and fiscal year 2000, respectively. The report
concluded that the City has not addressed its underlying problems, which
include inadequate and unstable revenue growth, high debt service
expenditures and increasing costs of health care and employee fringe
benefits. The report noted that by fiscal year 2000, City-funded revenues
will have grown by only 6.1% since the 1996 fiscal year, which is
substantially below the expected rate of inflation, while expenditures are
expected to grow at about the expected rate of inflation. The report noted
that this problem is increased by the volatility and cyclicality of the
City's tax revenues, which do not grow uniformly from one year to the next
and which are sensitive to fluctuations of the securities industry. The
report further noted that the City is approaching the limit on outstanding
general obligation debt permitted under the State Constitution and, as a
result, has proposed the creation of the Infrastructure Finance Authority.
In addition, the report stated that the City's structural imbalance has led
to insufficient funding for maintaining the existing capital plant through
the expense budget, and questioned whether the current capital plan is
affordable over the long term.
On October 9, 1995, Standard & Poor's issued a report which concluded
that proposals to replace the graduated Federal income tax system with a
'flat' tax could be detrimental to the creditworthiness of certain municipal
bonds. The report noted that the elimination of Federal income tax
deductions currently available, including residential mortgage interest,
property taxes and state and local income taxes, could have a severe impact
on funding methods under which municipalities operate. With respect to
property taxes, the report noted that the total valuation of a municipality's
tax base is affected by the affordability of real estate and that elimination
of mortgage interest deduction would result in a significant reduction in
affordability and, thus, in the demand for, and the valuation of, real
estate. The report noted that rapid losses in property valuations would be
felt by many municipalities, hurting their revenue-raising abilities. In
addition, the report noted that the loss of the current deduction for real
property and state and local income taxes from Federal income tax liability
would make rate increases more difficult and increase pressures to lower
existing rates, and that the cost of borrowing for municipalities could
increase if the tax-exempt status of municipal bond interest is worth less to
investors. Finally, the report noted that tax anticipation notes issued in
anticipation of property taxes could be hurt by the imposition of a flat tax,
if uncertainty is introduced with regard to their repayment revenues, until
<PAGE>
property values fully reflect the loss of mortgage and property tax
deductions.
On December 17, 1996, the Control Board issued a report noting that
the City's general tax revenues are growing much more slowly than the City's
expenditures, which will make it increasingly difficult to balance the
budget. On the same day, the staff of the City Comptroller issued a report
which tended to support the Control Board report, finding that the rate of
growth of personal income in the City was much lower than the national rate.
The City since 1981 has fully satisfied its seasonal financing needs
in the public credit markets, repaying all short-term obligations within
their fiscal year of issuance. The City has issued $2.4 billion of
short-term obligations for fiscal year 1997 to finance the current estimate
of its seasonal cash flow needs for the 1997 fiscal year. Seasonal financing
requirements for the 1996 fiscal year increased to $2.4 billion from $2.2
billion and $1.75 billion in the 1995 and 1994 fiscal years, respectively.
Seasonal financing requirements were $1.4 billion and $2.25 billion in the
1993 and 1992 fiscal years, respectively. The delay in the adoption of the
State's budget in certain past fiscal years has required the City to issue
short-term notes exceeding those expected early in such fiscal years.
The City is a defendant in a significant number of lawsuits. Such
litigation includes, but is not limited to, actions commenced and claims
asserted against the City arising out of alleged constitutional violations,
alleged torts, alleged breaches of contracts and other violations of law and
condemnation proceedings. While the ultimate outcome and fiscal impact, if
any, on the proceedings and claims are not currently predictable, adverse
determinations in certain of them might have a material adverse effect upon
the City's ability to carry out the 1997-2000 Financial Plan. The City is a
party to numerous lawsuits and is the subject of numerous claims and
investigations. The City has estimated that its potential future liability
on account of outstanding claims against it as of June 30, 1996 amounted to
approximately $2.8 billion. This estimate was made by categorizing the
various claims and applying a statistical model, based primarily on actual
settlements by type of claim during the preceding ten fiscal years, and by
supplementing the estimated liability with information supplied by the City's
Corporation Counsel.
On July 10, 1995, S&P revised downward its rating on City general
obligation bonds from A-to BBB+ and removed City bonds from Credit Watch.
S&P stated that 'structural budgetary balance remains elusive because of per-
sistent softness in the City's economy, highlighted by weak job growth and a
growing dependence on the historically volatile financial services sector.'
Other factors identified by S&P's in lowering its rating on City bonds
included a trend of using one-time measures, including debt refinancings, to
close projected budget gaps, dependence on unratified labor savings to help
balance the Financial Plan, optimistic projections of additional federal and
State aid or mandate relief, a history of cash flow difficulties caused by
State budget delays and continued high debt levels.
Fitch Investors Service, Inc. ("Fitch") rates City general obligation
bonds A-. Moody's rating for City general obligation bonds is Baa1. On
March 1, 1996, Moody's stated that the rating for the City's Baa1 general
obligation bonds remains under review for a possible downgrade pending the
outcome of the adoption of the City's budget for the 1997 fiscal year and in
light of the status of the debate on public assistance and Medicaid reform;
<PAGE>
the enactment of a State budget, upon which major assumptions regarding State
aid are dependent, which may be extensively delayed; and the seasoning of the
City's economy with regard to its strength and direction in the face of a
potential national economic slowdown. Since July 15, 1993, Fitch has rated
City bonds A-. On February 28, 1996, Fitch placed the City's general
obligation bonds on Fitch Alert with negative implications. On November 5,
1996, Fitch removed the City's general obligation bonds from Fitch Alert
although Fitch stated that the outlook remains negative. There is no
assurance that such ratings will continue for any given period of time or
that they will not be revised downward or withdrawn entirely. Any such
downward revision or withdrawal could have an adverse effect on the market
prices of the City's general obligation bonds.
In 1975, S&P suspended its A rating of City bonds. This suspension
remained in effect until March 1981, at which time the City received an
investment grade rating of BBB from S&P. On July 2, 1985, S&P revised its
rating of City bonds upward to BBB+ and on November 19, 1987, to A-. On July
10, 1995, SOP revised its rating of City bonds downward to BBB+, as discussed
above. Moody's ratings of City bonds were revised in November 1981 from B
(in effect since 1977) to Ba1, in November 1983 to Baa, in December 1985 to
Baa1, in May 1988 to A and again in February 1991 to Baa1. Since July 15,
1993, Fitch has rated City bonds A-.
Investing in Puerto Rico, the United States Virgin Islands and Guam
Although the economy of Puerto Rico expanded significantly from
fiscal 1984 through fiscal 1990, the rate of this expansion slowed during and
after fiscal 1991. Growth in fiscal 1994 will depend on several factors,
including the state of the U.S. economy, the exchange rate of the U.S.
dollar, the cost of borrowing and the relative stability in the price of oil.
Puerto Rico is required to import all of its oil.
Puerto Rico has a diversified economy dominated by the manufacturing
and service sectors. Manufacturing is the largest sector in terms of gross
domestic product and is more diversified than during earlier phases of Puerto
Rico's industrial development. The service sector, particularly finance,
insurance and real estate, grew significantly in response to the expansion of
the manufacturing sector. However, government layoffs and a recession driven
slowdown in tourism have lead to weakness in these areas and have had a
negative ripple effect on services as well. In addition, legislation was
adopted in August 1993 which will phase out over a number of years certain
tax benefits to U.S. corporations with manufacturing operations in Puerto
Rico. Puerto Rico's unemployment rate tends to be significantly higher than
the average rate for the United States.
Puerto Rico exercises virtually the same control over its internal
affairs as do the fifty states; however, it differs from the states in its
relationship with the federal government. Most federal taxes, except those
such as social security taxes that are imposed by mutual consent, are not
levied in Puerto Rico.
Puerto Rico's financial reporting was first conformed to generally
accepted accounting principles in fiscal 1990. Non-recurring revenues have
been used frequently to balance recent years' budgets. This reliance on non-
recurring revenues and economic weakness led Standard & Poor's to change its
outlook from stable to negative. Standard & Poor's rates Puerto Rico general
obligation debt A, while Moody's rates it Baa1.
<PAGE>
The United States Virgin islands ("USVI") are located approximately
1,100 miles east-southeast of Miami and are made up of St. Croix, St. Thomas
and St. John. The economy is heavily reliant on the tourism industry, with
roughly 43% of non-agricultural employment in tourist-related trade and
services. However, a recession-driven decline in visitors to the Virgin
Islands has caused unemployment to increase.
An important component of the USVI revenue base is the federal excise
tax on rum exports. The preferential tariff treatment the USVI rum industry
currently enjoys could be reduced under the North American Free Trade
Agreement. Increased competition from Mexican rum producers could reduce
USVI rum imported to the U.S., decreasing excise tax revenues generated.
There is currently no rated, unenhanced Virgin Islands debt outstanding.
Guam, an unincorporated U.S. territory, is located 1,500 miles
southeast of Tokyo. Population has grown consistently since 1970. The U.S.
military is a key component of Guam's economy. The federal government
directly comprises more than 10% of the employment base, with a substantial
component of the service sector to support these personnel. Guam is expected
to benefit from the closure of the Subic Bay Naval Base and the Clark Air
Force Base in the Philippines. Guam is also heavily reliant on tourists,
particularly the Japanese. There is currently no rated, unenhanced Guam debt
outstanding.
INVESTMENT LIMITATIONS
In addition to the restrictions described under "Limiting Investment
Risks" in the Prospectus, each Fund may not:
1. purchase or sell commodities or commodity contracts, except
that a Fund may purchase and sell financial and currency
futures contracts and options thereon, and may purchase and
sell currency forward contracts, options on foreign
currencies and may otherwise engage in transactions in
foreign currencies;
2. make loans, except that a Fund may (a) (i) purchase and hold
debt instruments (including bonds, debentures or other
obligations and certificates of deposit and bankers'
acceptances) and (ii) invest in loans and participations in
accordance with its investment objectives and policies, (b)
make loans of portfolio securities and (c) enter into
repurchase agreements with respect to portfolio securities;
3. underwrite the securities of other issuers, except to the
extent that the purchase of investments directly from the
issuer thereof and later disposition of such securities in
accordance with a Fund's investment program may be deemed to
be an underwriting;
4. purchase real estate or real estate limited partnership
interests (other than securities secured by real estate or
interests therein or securities issued by companies that
invest in real estate or interests therein);
<PAGE>
5. purchase more than 3% of the stock of another investment
company, or purchase stock of other investment companies
equal to more than 5% of a Fund's total assets in the case
of any one other investment company and 10% of such total
assets in the case of all other investment companies in the
aggregate. This restriction shall not apply to investment
company securities received or acquired by a Fund pursuant
to a merger or plan of reorganization;
6. sell securities short (except for short positions in a
futures contract or forward contract or short sales against
the box and except in connection with Hedging and
Derivatives);
7. invest directly in interests in oil, gas or other mineral
exploration development programs or mineral leases;
8. pledge, hypothecate, mortgage or otherwise encumber its
assets, except to secure permitted borrowings [and to the
extent related to the deposit of assets in escrow in
connection with the writing of covered put and call options
and the purchase of securities on a forward commitment or
delayed-delivery basis and collateral and initial or
variation margin arrangements with respect to futures
contracts and options on futures contracts, securities or
indices;]
9. investment in stock or bond futures and/or options on
futures unless (i) not more than 5% of a Fund's total assets
are required as deposit to secure obligations under such
futures and/or options on futures contracts, provided,
however, that in the case of an option that is in-the-money
at the time of purchase, the in-the-money amount may be
excluded in computing such 5%;
10. purchase or retain securities of an issuer if those officers
or Directors of the Fund or its investment adviser who own
more than 1/2 of 1% of such issuer's securities together own
more than 5% of the securities of such issuer; and
11. invest more than 5% of its total assets in securities of
issuers (other than securities issued or guaranteed by U.S.
or foreign governments or political subdivisions thereof)
which have (with predecessors) a record of less than three
years' continuous operation.
Investment restrictions (1) through (5) described above, (6) with
respect to the National Municipal, California Municipal and New York
Municipal Funds and those set forth in the Prospectus under "Limiting
Investment Risks" are fundamental policies of the Funds which may be changed
only when permitted by law and approved by the holders of a majority of a
Fund's outstanding voting securities, as described under "General Information
- -- Capital Stock". Restrictions (7) through (11) are nonfundamental policies
of the Funds, and may be changed by a vote of the Company's Board of
Directors.
<PAGE>
In addition, each of the High Yield, Emerging Markets, Investment
Grade Global Debt, Global Convertible and Latin America Total Return Funds
may not:
1. purchase securities on margin (except for delayed delivery
or when-issued transactions or such short-term credits as
are necessary for the clearance of transactions, and except
for initial and variation margin payments in connection with
the use of options, futures contracts, options thereon or
forward currency contracts; a Fund may also make deposits of
margin in connection with futures and forward contracts and
options thereon) (other than Municipal Funds);
2. invest for the purpose of exercising control over management
of any company;
3. invest in puts, call, straddles or spreads, except as
described in (9) above;
4. invest in warrants, valued at the lower of cost or market,
in excess of 5% of the value of its total assets. Included
within that amount, but not to exceed 2% of the value of the
Fund's net assets, may be warrants that are not listed on
the New York Stock Exchange or American Stock Exchange or an
exchange with comparable listing requirements, except that
the limitation in this sentence shall not apply to the Latin
America Total Return Fund;
Investment restriction (1) is a fundamental policy of the High Yield,
Emerging Markets, Investment Grade Global Debt, Global Convertible and Latin
America Total Return Funds, while restrictions (2) through (4) are
nonfundamental.
If a percentage restriction on investment or use of assets set forth
above is adhered to at the time a transaction is effected, later changes in
percentages resulting from changing values will not be considered a
violation.
<PAGE>
MANAGEMENT OF THE FUND
Directors and Officers
The principal occupations of the directors and executive officers of
the Company for the past five years are listed below.
Positions Principal
Held With Occupation(s)
Name and Address the Company Past 5 Years
- ---------------- ------------ -------------
Morris W. Offit<F1> Chairman of the Board, President and Director,
OFFITBANK President and Director OFFITBANK
520 Madison Avenue (1983-present).
New York, NY 10022
Age: 59 Years
Edward J. Landau Director Member, Lowenthal,
Lowenthal, Landau, Fischer Landau, Fischer &
& Bring, P.C. Bring, P.C. (1960 -
250 Park Avenue present); Director,
New York, NY 10177 Revlon Group Inc.
Age: 66 Years (cosmetics), Revlon
Consumer Products Inc.
(cosmetics), Pittsburgh
Annealing Box (metal
fabricating) and Clad
Metals Inc. (cookware).
The Very Reverend James Director Retired; Dean of
Parks Morton Cathedral of St. John
285 Riverside Drive the Divine
New York, NY 10025 (1972 - 1996).
Age: 67 Years
Wallace Mathai-Davis Secretary and Managing Director,
OFFITBANK Treasurer OFFITBANK (1986-
520 Madison Avenue present).
New York, NY 10022
Age: 51 Years
Bruce Treff Assistant Secretary Counsel, BISYS Fund
3435 Stelzer Road Services, Inc. since
Columbus, Ohio 43219 September 1995.
Age: 29 Years Previously, Manager,
Alliance Capital
Management, L.P.
<PAGE>
Alaina Metz Assistant Secretary Chief Administrative
3435 Stelzer Road Officer of BISYS Fund
Columbus, Ohio 43219 Services, Inc. from
Age: 29 Years June 1995 to present.
Previously, Supervisor
of Blue Sky Department
at Alliance Capital
Management, May 1989
to June 1995.
Carrie Zuckerman Assistant Secretary Manager of BISYS Fund
3435 Stelzer Services from January
Columbus, Ohio 43219 1997 to present.
Age: 29 Years Previously, Associate
Director at Furman
Selz LLC.
Stephen Brent Wells Assistant Treasurer Managing Director,
520 Madison Avenue OFFITBANK
New York, NY 10022
Vincent M. Rella Assistant Treasurer Controller, OFFITBANK
520 Madison Avenue
New York, NY 10022
[FN]
<F1>"Interested person" as defined in the 1940 Act.
<PAGE>
The Company pays each Director who is not also an officer or
affiliated person an annual fee of $10,000 and a fee of $1,250 for each Board
of Directors and Board committee meeting attended and are reimbursed for all
out-of-pocket expenses relating to attendance at meetings. Directors who are
affiliated with the Adviser do not receive compensation from the Company but
are reimbursed for all out-of-pocket expenses relating to attendance at
meetings.
DIRECTOR COMPENSATION
(for fiscal period ended December 31, 1995)
<TABLE>
<CAPTION>
Pension or Total
Aggregate Retirement Compensation
Name of Compensation Benefits Accrued Estimated Annual From Registrant
Person, from As Part of Fund Benefits Upon and Fund Complex
Position Registrant Expenses Retirement Paid to Directors
_____________________ ____________ ________________ ________________ ______________________
<S> <C> <C> <C> <C>
Morris W. Offit $-0- -0- -0- $-0-
Edward J. Landau $5,500 -0- -0- $5,500
The Very Reverend $5,000 -0- -0- $5,500
James Parks Morton
</TABLE>
As of December 31, 1996, the Directors and officers, as a group, did
not own 1% or more of the Company or of any Fund.
Investment Adviser
The Company has retained OFFITBANK, a New York State chartered trust
company, to act as its investment adviser (the "Adviser"). The advisory
agreements (the "Advisory Agreements") between the Adviser and the Company
provide that the Adviser shall manage the operations of the Company, subject
to policy established by the Board of Directors of the Company. Pursuant to
the Advisory Agreements, the Adviser manages the Company's investment
portfolios, directs purchases and sales of the portfolio securities and
reports thereon to the Company's officers and directors regularly. In
addition, the Adviser pays the compensation of the Company's officers,
employees and directors affiliated with the Adviser. The Company bears all
other costs of its operations, including the compensation of its directors
not affiliated with the Adviser.
<PAGE>
For its services under the Advisory Agreements, the Adviser receives
from each Fund an advisory fee. The fee is payable monthly at an annual rate
of .85% of the first $200,000,000, .75% on the next $400,000,000 and .65% on
amounts in excess of $600,000,000 of OFFITBANK High Yield Fund's average
daily net assets; .90% of the first $200,000,000 and .80% on amounts in
excess thereof of OFFITBANK Emerging Markets Fund's average daily net assets;
.80% of the first $200,000,000 and .70% on amounts in excess thereof of
OFFITBANK Investment Grade Global Debt Fund's average daily net assets; .90%
of OFFITBANK Global Convertible Fund's average daily net assets; 1.00% of
OFFITBANK Latin America Total Return Fund's average daily net assets; .40% of
OFFITBANK National Municipal Fund's average daily net assets; .40% of
OFFITBANK California Municipal Fund's average daily net assets and .40% of
OFFITBANK New York Municipal Fund's average daily net assets. The Adviser may
waive all or part of its fee from time to time in order to increase a Fund's
net investment income available for distribution to shareholders. The Funds
will not be required to reimburse the Adviser for any advisory fees waived.
For the fiscal year ended December 31, 1995, the High Yield Fund paid the
Adviser $2,884,016 in advisory fees, the Adviser earned $312,096, but waived
$52,155, in advisory fees for the Emerging Markets Fund and earned $23,448,
but waived $23,280, in advisory fees for the New York Municipal Fund. For
the fiscal period ended December 31, 1994, the Adviser earned fees of
$1,185,535 for the High Yield Fund and $187,360 for the Emerging Markets
Fund. The Adviser waived fees of $45,799 for the Emerging Markets Fund.
The Advisory Agreement with respect to the High Yield, Global Debt
and Emerging Markets Funds was approved by each Fund's sole shareholder at
the time, Furman Selz LLC ("Furman Selz"), on December 29, 1993. The
Advisory Agreement for these Funds was most recently re-approved by the
Company's Board of Directors on December 18, 1996. The Advisory Agreement
relating to the Latin America Total Return, Global Convertible, National
Municipal, California Municipal and New York Municipal Funds was approved by
such Funds' sole shareholder at the time, Furman Selz, on January 31, 1995,
and was most recently approved by the Company's Board of Directors on
December 18, 1996. Unless sooner terminated, the Advisory Agreements will
continue in effect until February 6, 1998, with respect to the High Yield,
Global Debt and Emerging Markets Funds, and until February 7, 1998 with
respect to the Latin America Total Return, Global Convertible, National
Municipal, California Municipal and New York Municipal Funds, and from year
to year thereafter if such continuance is approved at least annually by the
Company's Board of Directors or by a vote of a majority (as defined under
"General Information -- Capital Stock") of the outstanding shares of each
Fund, and, in either case, by a majority of the directors who are not parties
to the contract or "interested persons" (as defined in the 1940 Act) of any
party by votes cast in person at a meeting called for such purpose. The
Advisory Agreements may each be terminated by the Company or the Adviser on
60 days' written notice, and will terminate immediately in the event of its
assignment.
<PAGE>
DISTRIBUTOR
OFFIT Funds Distributor, Inc., a wholly-owned subsidiary of BISYS
Fund Services (the "Distributor"), with its principal office at 3435 Stelzer
Road, Columbus, Ohio 43219, distributes the shares of the Company. Prior to
January 1, 1997, the Distributor was a wholly-owned subsidiary of Furman
Selz. Under a distribution agreement with the Company (the "Distribution
Agreement"), the Distributor, as agent of the Company, agrees to use its best
efforts as distributor of the Company's shares. Solely for the purpose of
reimbursing the Distributor for its expenses incurred in certain activities
primarily intended to result in the sale of shares of the Funds, the Company
has adopted a Plan of Distribution (the "Plan") under Section 12(b) of the
1940 Act and Rule 12b-1 thereunder. Under the Plan and Distribution
Agreement, each Fund is authorized to spend up to 0.25% of its average daily
net assets annually with respect to each class of the Fund's Shares to
reimburse the Distributor for such activities, which are summarized in the
Prospectus. For the fiscal periods ended December 31, 1995 and December 31,
1994, no distribution costs were incurred by the Funds.
The Plan, together with the Distribution Agreement, continue in
effect with respect to a particular Fund from year to year if such
continuance is approved at least annually by the Company's Board of Directors
and by a majority of the Directors who have no direct or indirect financial
interest in the operation of the Plan or in any agreement related to the Plan
("Qualified Directors") and who are not "interested persons" (as defined in
the 1940 Act) of any party by votes cast in person at a meeting called for
such purpose. In approving the continuance of the Plan and the Distribution
Agreement, the Directors must determine that the Plan is in the best interest
of the shareholders of each Fund. The Plan was approved by Furman Selz, as
sole shareholder of the High Yield, Global Debt and Emerging Markets Funds,
on December 29, 1993 and on October 17, 1994 with respect to the Global
Convertible, Latin America Total Return, National Municipal, California
Municipal and New York Municipal Funds. The Plan, as amended, was most
recently approved by the Company's Board of Directors on September 26, 1996.
On September 26, 1996, the Distribution Agreement with the Distributor was
approved by the Directors.
The Plan requires that, at least quarterly, the Board of Directors
must review a written report prepared by the Treasurer of the Company
enumerating the amounts expended and purposes therefor under the Plan. Rule
12b-1 also requires that the selection and nomination of Directors who are
not "interested persons" of the Company be made by such Qualified Directors.
ADMINISTRATION, CUSTODY AND TRANSFER AGENCY SERVICES
BISYS Fund Services Limited Partnership ("BISYS") provides the
Company with administrative services pursuant to an Administration Agreement
dated as of October 1, 1996 (the "Administration Agreement") with respect to
each of the Funds. The services provided by and the fees payable to BISYS
<PAGE>
for such services are described in the Prospectus. The Administration
Agreement was approved by the Company's Board of Directors on September 26,
1996. The Administration Agreement with BISYS will continue in effect until
January 1, 1998 and from year to year thereafter if such continuance is
approved at least annually by the Company's Board of Directors and by a
majority of the Directors who are not parties to such Agreement or
"interested persons" (as defined in the 1940 Act).
Pursuant to the Administration Agreement, BISYS performs certain
administrative and clerical services. BISYS also furnishes office space and
certain facilities reasonably necessary for the performance of its services
under the Administration Agreement, and provides the office space,
facilities, equipment and personnel necessary to perform the following
services for the Company; Securities and Exchange Commission ("Commission")
compliance, including record keeping, reporting requirements and registration
statements and proxies; supervision of Company operations, including
custodian, accountants and counsel and other parties performing services or
operational functions for the Company. Pursuant to the Administration
Agreement, the Company pays BISYS a monthly fee which on an annualized basis
will not exceed .15% of the average daily net assets of the Company. BISYS
Fund Services, Inc., an affiliate of BISYS, provides accounting services to
the Company pursuant to a separate Fund Accounting Agreement. Under the
Fund Accounting Agreement, each Fund pays BISYS Fund Services, Inc. a fee of
$30,000 each year for the services provided under the Agreement.
For the fiscal year ended December 31, 1995, Furman Selz, which prior
to January 1, 1997 served as the Company's administrator, was entitled to
fees of $536,814 for the High Yield Fund and $52,016 for the Emerging Markets
Fund. Of such fees earned, Furman Selz waived $268,407 and $26,008 for the
High Yield Fund and the Emerging Markets Fund, respectively. For the fiscal
period ended December 31, 1995, Furman Selz waived its entire fee of $8,793
from the New York Municipal Fund. For the fiscal period ended December 31,
1994, Furman Selz was entitled to fees of $209,211 for the High Yield Fund
and $26,454 for the Emerging Markets Fund. Of such fees earned, Furman Selz
waived $104,606 and $15,613 for the High Yield Fund and the Emerging Markets
Fund, respectively.
BISYS Fund Services, Inc. also serves as the Company's Transfer Agent
and Dividend Disbursing Agent pursuant to a Transfer Agency Agreement dated
as of October 1, 1996 (the "Transfer Agency Agreement"). Under the Transfer
Agency Agreement, the Transfer Agent has agreed, among other things, to: (i)
process shareholder purchase and redemption orders; (ii) issue periodic
statements to shareholders; (iii) process transfers, exchanges and dividend
payments; and (iv) maintain all shareholder records for each account in the
Company. Under the Transfer Agency Agreement, the Transfer Agent is entitled
to a fee of $15.00 per account per year. The Transfer Agency Agreement with
BISYS Fund Services, Inc. was approved at the September 26, 1996 Board of
Directors meeting and continues in effect until January 1, 1998 and from year
to year thereafter if such continuance is approved at least annually by the
Company's Board of Directors and by a majority of the Directors who are not
"interested persons" (as defined in the 1940 Act) of any party. For the
fiscal year December 31, 1995, Furman Selz, which previously served as the
Company's transfer agent, was entitled to fees of $21,360 and $4,418 for the
High Yield Fund and the Emerging Markets Fund, respectively. For the fiscal
period ended December 31, 1994, Furman Selz was entitled to fees of $9,110
and $3,407 for the High Yield Fund and the Emerging Markets Fund,
respectively. Of such fees earned in 1994, Furman Selz waived $949 for the
<PAGE>
High Yield Fund and $291 for the Emerging Markets Fund for this period. For
the period ended December 31, 1995, Furman Selz received $1,662 from the New
York Municipal Fund in transfer agency fees.
The Chase Manhattan Bank (the "Chase") serves as the Company's
custodian pursuant to custodian agreements with the Company dated February 7,
1994 with respect to the Global Debt and Emerging Markets Funds, and February
8, 1995 with respect to the Global Convertible and Latin America Total Return
Funds (the "Custodian Agreements"). Chase is located at 4 MetroTech Center,
18th Floor, Brooklyn, New York 11245. The Bank of New York ("BONY") serves as
custodian of the assets of the High Yield, National Municipal, California
Municipal and New York Municipal Funds. The principal business address of
BONY is 48 Wall Street, New York, New York 10286. Under the Custodian
Agreements, each Custodian has agreed to maintain a separate account or
accounts in the name of each applicable Fund; hold and disburse portfolio
securities on account of each Fund; collect and receive all income and other
payments and distributions on account of each Fund's portfolio securities;
and make periodic reports to the Company's Board of Directors concerning the
Funds' operations. Each is authorized under the Custodian Agreements to
establish separate accounts for the Funds' foreign securities with
subcustodians, provided that the custodian remains responsible for the
performance of all of its duties under the Custodian Agreements.
For the fiscal year ended December 31, 1995, Chase received $233,846,
$43,367 and $6,150 from the High Yield, Emerging Markets and New York
Municipal Funds, respectively. Chase received $88,865 from the High Yield
Fund and $40,949 from the Emerging Markets Fund for the fiscal period ended
December 31, 1994.
PORTFOLIO TRANSACTIONS
The Company has no obligation to deal with any dealer or group of
dealers in the execution of transactions in portfolio securities. Subject to
policy established by the Company's Board of Directors, the Adviser is
primarily responsible for the Company's portfolio decisions and the placing
of the Company's portfolio transactions. The High Yield Fund and the Emerging
Markets Fund did not pay any brokerage commissions for the fiscal periods
ended December 31, 1995 and December 31, 1994, and the New York Municipal
Fund did not pay any brokerage commission for the fiscal period ended
December 31, 1995.
Fixed-income and certain short-term securities normally will be
purchased or sold from or to dealers serving as market makers for the
securities at a net price, which may include dealer spreads and underwriting
commissions. Purchases and sales of securities on a stock exchange are
effected through brokers who charge a commission. In the over-the-counter
market, securities are generally traded on a "net" basis with dealers acting
as principal for their own accounts without a stated commission, although the
price of the security usually includes a profit to the dealer. In placing
orders, it is the policy of the Company to obtain the best results taking
into account the dealer's general execution and operational facilities, the
type of transaction involved and other factors such as the dealer's risk in
positioning the securities involved. While the Adviser generally seeks a
competitive price in placing its orders, the Company may not necessarily be
paying the lowest price available.
<PAGE>
Trading practices in certain emerging market and Latin American
countries are significantly different from those in the United States, and
these differences may have adverse consequences on the investment operations
of the Emerging Markets, Global Debt, Global Convertible and Latin America
Total Return Funds. Brokerage commissions and other transaction costs on the
securities exchanges of emerging market and Latin American countries are
generally higher than in the United States. In addition, securities
settlements and clearance procedures in emerging market countries are less
developed and less reliable than those in the United States and the Funds may
be subject to delays or other material difficulties. Delays in settlement
could result in temporary periods when assets of the Funds are uninvested and
no return is earned thereon. The inability of a Fund to make intended
security purchases due to settlement problems could cause such Fund to miss
attractive investment opportunities. The inability to dispose of a portfolio
security due to settlement problems could result either in losses to a Fund
due to subsequent declines in the value of such portfolio security or, if
such Fund has entered into a contract to sell the security, could result in
possible liability to the purchaser.
Factors relating to brokers in emerging market and Latin American
countries may also expose the Funds' to risks in connection with the
execution of portfolio transactions. There may be less government supervision
and regulation of securities exchanges and brokers in these countries than
exists in the United States. Brokers in these countries may not be as well
capitalized as those in the United States, so that they may be more
susceptible to financial failure in times of market, political, or economic
stress, exposing the Funds to a risk of loss in the event of such failure.
Under the 1940 Act, persons affiliated with the Company are
prohibited from dealing with the Company as a principal in the purchase and
sale of securities unless an exemptive order allowing such transactions is
obtained from the Commission. Affiliated persons of the Company, or
affiliated persons of such persons, may from time to time be selected to
execute portfolio transactions for the Company as agent. Subject to the
considerations discussed above and in accordance with procedures expected to
be adopted by the Board of Directors, in order for such an affiliated person
to be permitted to effect any portfolio transactions for the Company, the
commissions, fees or other remuneration received by such affiliated person
must be reasonable and fair compared to the commissions, fees or other
remuneration received by other brokers in connection with comparable
transactions. This standard would allow such an affiliated person to receive
no more than the remuneration which would be expected to be received by an
unaffiliated broker in a commensurate arm's-length agency transaction.
Investment decisions for the Company are made independently from
those for other funds and accounts advised or managed by the Adviser. Such
other funds and accounts may also invest in the same securities as the
Company. If those funds or accounts are prepared to invest in, or desire to
dispose of, the same security at the same time as the Company, however,
transactions in such securities will be made, insofar as feasible, for the
respective funds and accounts in a manner deemed equitable to all. In some
cases, this procedure may adversely affect the size of the position obtained
for or disposed of by the Company or the price paid or received by the
Company. In addition, because of different investment objectives, a
particular security may be purchased for one or more funds or accounts when
one or more funds or accounts are selling the same security. To the extent
permitted by law, the Adviser may aggregate the securities to be sold or
<PAGE>
purchased for the Company with those to be sold or purchased for other funds
or accounts in order to obtain best execution.
PURCHASE OF SHARES
For information pertaining to the manner in which shares of each
class of each Fund are offered to the public, see "Purchase of Shares" in the
Prospectus. The Company reserves the right, in its sole discretion, to (i)
suspend the offering of shares of its Funds, and (ii) reject purchase orders
when, in the judgment of management, such suspension or rejection is in the
best interest of the Company. The officers of the Company may, from time to
time, waive the minimum initial and subsequent investment requirements.
REDEMPTION OF SHARES
For information pertaining to the manner in which each class of each
Fund may be redeemed, see "Redemption of Shares" in the Prospectus. The
Company may suspend redemption privileges or postpone the date of payment (i)
during any period that the New York Stock Exchange (the "NYSE") or the bond
market is closed, or trading on the NYSE is restricted as determined by the
Commission, (ii) during any period when an emergency exists as defined by the
rules of the Commission as a result of which it is not reasonably practicable
for a Fund to dispose of securities owned by it, or fairly to determine the
value of its assets, and (iii) for such other periods as the Commission may
permit.
Furthermore, if the Board of Directors determines that it is in the
best interests of the remaining shareholders of a Fund, such Fund may pay the
redemption price, in whole or in part, by a distribution in kind.
The Company has made an election with the Commission to pay in cash
all redemptions requested by any shareholder of record limited in amount
during any 90-day period to the lesser of $250,000 or 1% of the net assets of
a Fund at the beginning of such period. Such commitment is irrevocable
without the prior approval of the Commission. Redemptions in excess of the
above limits may be paid in whole or in part in investment securities or in
cash, as the Board of Directors may deem advisable; however, payment will be
made wholly in cash unless the Board of Directors believes that economic or
market conditions exist which would make such a practice detrimental to the
best interests of the Company. If redemptions are paid in investment
securities, such securities will be valued as set forth in the Company's
Prospectus under "Net Asset Value" and redeeming shareholders would normally
incur brokerage expenses if they converted these securities to cash.
No charge is made by a Fund for redemptions. Redemption proceeds may
be more or less than the shareholder's cost depending on the market value of
the securities held by a Fund.
PERFORMANCE CALCULATIONS
The Company may from time to time quote various performance figures
to illustrate the past performance of each class of shares of its Funds.
Performance quotations by investment companies are subject to rules adopted
by the Commission, which require the use of standardized performance
<PAGE>
quotations or, alternatively, that every non-standardized performance
quotation furnished by a Fund be accompanied by certain standardized
performance information computed as required by the Commission. An
explanation of the Commission methods for computing performance follows.
Total Return
A Fund's average annual total return is determined by finding the
average annual compounded rates of return over 1, 5 and 10 year periods (or,
if shorter, the period since inception of the Fund) that would equate an
initial hypothetical $1,000 investment to its ending redeemable value. The
calculation assumes that all dividends and distributions are reinvested when
paid. The quotation assumes the amount was completely redeemed at the end of
each 1, 5 and 10 year period (or, if shorter, the period since inception of
the Fund) and the deduction of all applicable Fund expenses on an annual
basis. Average annual total return is calculated according to the following
formula:
P (1+T)n = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment
made at the beginning of the stated period
Each Fund presents performance information for each class of shares
commencing with the Fund's inception (or the inception of the Partnership
with respect to the High Yield Fund). Performance information for each class
of shares may also reflect performance for time periods prior to the
introduction of such class, and the performance for such prior time periods
will not reflect any fees and expenses, payable by such class that were not
borne by the Fund prior to the introduction of such class.
All of the outstanding shares of the Funds were reclassified as
"Select Shares" as of April 29, 1996, and Funds began to offer a new class of
shares, "Advisor Shares." The percentages shown in the tables below are based
on the fees and expenses actually paid by each Fund for the periods
presented, rather than the fees and expenses currently payable by each class
of shares, which in certain cases are different (as indicated in the
footnotes to the tables).
The following tables set forth the average annual total returns for
each class of shares of each of the High Yield Fund, the Emerging Markets
Fund, the Latin America Total Return Fund and the New York Municipal Fund for
certain time periods ended December 31, 1996.
<PAGE>
High Yield Fund
__________________________________
Select Advisor
Shares Shares<F1>
_______________ ________________
1 year 12.46 12.46
5 years 14.87 14.87
10 years 12.74 12.74
Emerging Markets Fund
__________________________________
Select Advisor
Shares Shares<F1>
_______________ ________________
1 year 26.56 26.56
Since inception (March 15.37 15.37
8, 1994)
Latin America Total Return Fund
__________________________________
Select Advisor
Shares Shares<F1>
_______________ ________________
Since inception 23.36 23.36
(February 12, 1996)
New York Municipal Fund
__________________________________
Select Advisor
Shares Shares<F1>
_______________ ________________
1 year -0.34 -0.34
Since inception (April 12.14 12.14
3, 1995)
[FN]
<F1> The return figures do not reflect the distribution and service fees
currently paid with respect to the Advisor Shares of the Fund. At
December 31, 1996, no Advisor Shares had been issued to the public.
As described in the Prospectus under the caption "Expense
Return and New York Municipal Funds have been and still are subject to
certain fee waivers. Absent such waivers, the returns shown above would be
lower.
The Funds may also calculate total return on an aggregate basis which
reflects the cumulative percentage change in value over the measuring period.
The formula for calculating aggregate total return can be expressed as
follows:
Aggregate Total Return = [ ( ERV )- 1 ]
P
<PAGE>
In addition to total return, each Fund may quote performance in terms
of a 30-day yield. The yield figures provided will be calculated according to
a formula prescribed by the Commission and can be expressed as follows:
Yield = 2[( a-b ) + 1)6 -1]
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of
reimbursements).
c = the average daily number of shares outstanding
during the period that were entitled to receive
dividends.
d = the maximum offering price per share on the last day
of the period.
For the purpose of determining the interest earned (variable "a" in
the formula) on debt obligations that were purchased by a Fund at a discount
or premium, the formula generally calls for amortization of the discount or
premium; the amortization schedule will be adjusted monthly to reflect
changes in the market value of the debt obligations.
Under this formula, interest earned on debt obligations for purposes
of "a" above, is calculated by (1) computing the yield to maturity of each
obligation held by a Fund based on the market value of the obligation
(including actual accrued interest) at the close of business on the last day
of each month, or, with respect to obligations purchased during the month,
the purchase price (plus actual accrued interest), (2) dividing that figure
by 360 and multiplying the quotient by the market value of the obligation
(including actual accrued interest as referred to above) to determine the
interest income on the obligation in the Fund's portfolio (assuming a month
of 30 days) and (3) computing the total of the interest earned on all debt
obligations during the 30-day or one month period. Undeclared earned income,
computed in accordance with generally accepted accounting principles, may be
subtracted from the maximum offering price calculation required pursuant to
"d" above.
The 30-day yield for the Advisor Shares of the High Yield, Emerging
Markets, Latin America Total Return and New York Municipal Funds for the
period ended December 31, 1996, was 8.51%, 9.73%, 4.41% and 4.32%
respectively.
Each Fund may also advertise tax-equivalent yields which are computed
by dividing that portion of yield that is tax-exempt by one, minus a stated
income tax rate and adding the quotient to that portion, if any, of the yield
that is not tax-exempt.
Each Fund may also advertise its "risk adjusted return," which
reflects the total return of the Fund over time adjusted to reflect
volatility of the Fund.
The performance of a Fund may be compared to data prepared by Lipper
Analytical Services, Inc. or other independent services which monitor the
performance of investment companies, and may be quoted in advertising in
<PAGE>
terms of their rankings in each applicable universe. In addition, the Company
may use performance data reported in financial and industry publications,
including Barron's, Business Week, Forbes, Fortune, Institutional Investor,
Money, Morningstar, Mutual Fund Values, The Wall Street Journal, The New York
Times and U.S.A. Today.
A Fund may include in advertising or sales literature discussions or
illustrations of the potential investment goals of a prospective investor
(including materials that describe general principles of investing, such as
asset allocation, diversification, risk tolerance, and goal setting),
investment management techniques, policies or investment suitability of a
Fund, economic and political conditions and the relationship between sectors
of the economy and the economy as a whole, the effects of inflation and
historical performance of various asset classes, including but not limited
to, stocks and bonds. From time to time advertisements, sales literature,
communications to shareholders or other materials may summarize the substance
of information contained in shareholder reports (including the investment
composition of a Fund), as well as the views of the Adviser as to current
market, economy, trade and interest rate trends, legislative, regulatory and
monetary developments, investment strategies and related matters believed to
be of relevance to a Fund. In addition, selected indices may be used to
illustrate historic performance of select asset classes.
ADDITIONAL INFORMATION CONCERNING TAXES
The following discussion is only a brief summary of certain
additional tax considerations affecting the Company, its Funds and its
shareholders. No attempt is made to present a detailed explanation of all
federal, state and local tax concerns, and the discussion set forth here and
in the Prospectus is not intended as a substitute for careful tax planning.
Investors are urged to consult their own tax advisers with specific questions
relating to federal, state or local taxes.
In General
Each Fund intends to qualify as a regulated investment company (a
"RIC") under Subchapter M of the Internal Revenue Code of 1986, as amended
(the "Code") and to continue to so qualify. Qualification as a RIC requires,
among other things, that each Fund: (a) derive at least 90% of its gross
income in each taxable year from dividends, interest, payments with respect
to securities loans and gains from the sale or other disposition of stock,
securities or foreign currencies, or other income (including gains from
options, futures or forward contracts) derived with respect to its business
of investing in such stocks or securities; (b) derive less than 30% of its
gross income in each taxable year from the sale or other disposition of any
of the following held for less than three months: (i) stock or securities,
(ii) options, futures, or forward contracts, or (iii) foreign currencies (or
foreign currency options, futures or forward contracts) that are not directly
related to its principal business of investing in stock or securities (or
options and futures with respect to stocks or securities) (the "30%
limitation"); and (c) diversify its holdings so that, at the end of each
quarter of each taxable year, (i) at least 50% of the market value of a
Fund's assets is represented by cash, cash items, U.S. government securities,
securities of other regulated investment companies and other securities with
such other securities limited, in respect of any issuer, to an amount not
greater than 5% of the value of a Fund's assets and 10% of the outstanding
<PAGE>
voting securities of such issuer, and (ii) not more than 25% of the value of
its assets is invested in the securities (other than U.S. government
securities or the securities of other regulated investment companies) of any
one issuer.
Investors should consider the tax implications of buying shares just
prior to distribution. Although the price of shares purchased at that time
may reflect the amount of the forthcoming distribution, those purchasing just
prior to a distribution will receive a distribution which will nevertheless
be taxable to them.
Gain or loss, if any, on the sale or other disposition of shares of
each of the Funds will generally result in capital gain or loss to
shareholders. Generally, a shareholder's gain or loss will be a long-term
gain or loss if the shares have been held for more than one year. If a
shareholder sells or otherwise disposes of a share of a Fund before holding
it for more than six months, any loss on the sale or other disposition of
such share shall be treated as a long-term capital loss to the extent of any
capital gain dividends received by the shareholder with respect to such
share, or shall be disallowed to the extent of any exempt-interest dividend.
Currently, the maximum federal income tax rate imposed on individuals with
respect to net realized long-term capital gains is limited to 28%, whereas
the maximum federal income tax rate imposed on individuals with respect to
net realized short-term capital gains (which are taxed at the same rates as
ordinary income) is 39.6%.
Each Fund's investments in options, futures contracts and forward
contracts, options on futures contracts and stock indices and certain other
securities, including transactions involving actual or deemed short sales or
foreign exchange gains or losses are subject to many complex and special tax
rules. For example, over-the-counter options on debt securities and equity
options, including options on stock and on narrow-based stock indexes, will
be subject to tax under Section 1234 of the Code, generally producing a long-
term or short-term capital gain or loss upon exercise, lapse or closing out
of the option or sale of the underlying stock or security. By contrast, each
Fund's treatment of certain other options, futures and forward contracts
entered into by a Fund is generally governed by Section 1256 of the Code.
These "Section 1256" positions generally include listed options on debt
securities, options on broad-based stock indexes, options on securities
indexes, options on futures contracts, regulated futures contracts and
certain foreign currency contracts and options thereon.
Absent a tax election to the contrary, each such Section 1256
position held by the Funds will be marked-to-market (i.e., treated as if it
were sold for fair market value) on the last business day of the Portfolios'
fiscal year, and all gain or loss associated with fiscal year transactions
and mark-to-market positions at fiscal year end (except certain currency gain
or loss covered by Section 988 of the Code) will generally be treated as 60%
long-term capital gain or loss and 40% short-term capital gain or loss. The
effect of Section 1256 mark-to-market rules may be to accelerate income or to
convert what otherwise would have been long-term capital gains into short-
term capital gains or short-term capital losses into long-term capital losses
within the Funds. The acceleration of income on Section 1256 positions may
require the Funds to accrue taxable income without the corresponding receipt
of cash. In order to generate cash to satisfy the distribution requirements
of the Code, the Funds may be required to dispose of portfolio securities
that they otherwise would have continued to hold or to use cash flows from
<PAGE>
other sources such as the sale of Fund shares. In these ways, any or all of
these rules may affect the amount, character and timing of income earned and
in turn distributed to shareholders by the Funds.
When the Funds hold options or contracts which substantially diminish
their risk of loss with respect to other positions (as might occur in some
hedging transactions), this combination of positions could be treated as a
"straddle" for tax purposes, resulting in possible deferral of losses,
adjustments in the holding periods of Fund securities and conversion of
short-term capital losses into long-term capital losses. Certain tax
elections exist for mixed straddles i.e., straddles comprised of at least one
Section 1256 position and at least one non-Section 1256 position which may
reduce or eliminate the operation of these straddle rules.
As a regulated investment company, each Fund is also subject to the
requirement that less than 30% of its annual gross income be derived from the
sale or other disposition of securities and certain other investments held
for less than three months ("short-short income"). This requirement may limit
the Funds' ability to engage in options, spreads, straddles, hedging
transactions, forward or futures contracts or options on any of these
positions because these transactions are often consummated in less than three
months, may require the sale of portfolio securities held less than three
months and may, as in the case of short sales of portfolio securities reduce
the holding periods of certain securities within the Funds, resulting in
additional short-short income for the Funds.
Each Fund will monitor its transactions in such options and contracts
and may make certain other tax elections in order to mitigate the effect of
the above rules and to prevent disqualification of the Fund as a regulated
investment company under Subchapter M of the Code.
Each Fund is likely to make investments that produce income that is
not matched by a corresponding cash distribution to the Fund, such as
investments in certain Brady Bonds or other obligations having original issue
discount (i.e., an amount equal to the excess of the stated redemption price
of the security at maturity over its issue price), or market discount (i.e.,
an amount equal to the excess of the stated redemption price of the security
over the basis of such bond immediately after it was acquired) if the Fund
elects to accrue market discount on a current basis. Each Fund intends to
elect to accrue market discount on a current basis. In addition, income may
continue to accrue for federal income tax purposes with respect to a non-
performing investment. Any such income would be treated as income earned by a
Fund and therefore would be subject to the distribution requirements of the
Code. Because such income may not be matched by a corresponding cash
distribution to a Fund, such Fund may be required to borrow money or dispose
of other securities to be able to make distributions to its investors. The
extent to which a Fund may liquidate securities at a gain may be limited by
the 30% limitation discussed above. In addition, if an election is not made
to currently accrue market discount with respect to a market discount bond,
all or a portion of any deduction for any interest expense incurred to
purchase or hold such bond may be deferred until such bond is sold or
otherwise disposed.
The tax treatment of certain securities in which each Fund may invest
is not free from doubt and it is possible that an Internal Revenue Service
("IRS") examination of the issuers of such securities or of the Fund could
result in adjustments to the income of a Fund. An upward adjustment by the
<PAGE>
IRS to the income of a Fund may result in the failure of such Fund to satisfy
the 90% distribution requirement described in the Prospectus necessary for
such Fund to maintain its status as a regulated investment company under the
Code. In such event, a Fund may be able to make a "deficiency dividend"
distribution to its shareholders with respect to the year under examination
to satisfy this requirement. Such distribution will be taxable as a dividend
to the shareholders receiving the distribution (whether or not a Fund has
sufficient current or accumulated earnings and profits for the year in which
such distribution is made). A downward adjustment by the IRS to the income of
a Fund may cause a portion of the previously made distribution with respect
to the year under examination not to be treated as a dividend. In such event,
the portion of distributions to each shareholder not treated as a dividend
would be recharacterized as a return of capital and reduce the shareholder's
basis in the shares held at the time of the previously made distributions.
Accordingly, this reduction in basis could cause a shareholder to recognize
additional gain upon the sale of such shareholder's shares.
Certain of a Fund's investments in structured products may, for
federal income tax purposes, constitute investments in shares of foreign
corporations. If a Fund purchases shares in certain foreign investment
entities, called "passive foreign investment companies" ("PFICs"), the Fund
may be subject to U.S. federal income tax on a portion of any "excess
distribution" or gain from the disposition of the shares even if the income
is distributed as a taxable dividend by the Fund to its shareholders.
Additional charges in the nature of interest may be imposed on either a Fund
or its shareholders with respect to deferred taxes arising from the
distributions or gains. If a Fund were to invest in a PFIC and (if the Fund
received the necessary information available from the PFIC, which may be
difficult to obtain) elected to treat the PFIC as a "qualified electing fund"
under the Code, in lieu of the foregoing requirements, the Fund might be
required to include in income each year a portion of the ordinary earnings
and net capital gains of the PFIC, even if not distributed to the Fund, and
the amounts would be subject to the 90% and calendar year distribution
requirements described above. Because of the expansive definition of a PFIC,
it is possible that a Fund may invest a portion of its assets in PFICs. It is
not anticipated, however, that the portion of such Fund's assets invested in
PFICs will be material.
Under the Code, gains or losses attributable to fluctuations in
exchange rates which occur between the time a Fund accrues interest or other
receivables or accrues expenses or other liabilities denominated in a foreign
currency and the time a Fund actually collects such receivables or pays such
liabilities are treated as ordinary income or ordinary loss. Similarly, gains
or losses from the disposition of foreign currencies, from the disposition of
debt securities denominated in a foreign currency, or from the disposition of
a forward contract denominated in a foreign currency which are attributable
to fluctuations in the value of the foreign currency between the date of
acquisition of the asset and the date of disposition also are treated as
ordinary gain or loss. These gains or losses, referred to under the Code as
"section 988" gains or losses, increase or decrease the amount of a Fund's
investment company taxable income available to be distributed to its
shareholders as ordinary income, rather than increasing or decreasing the
amount of a Fund's net capital gain. Because section 988 losses reduce the
amount of ordinary dividends a Fund will be allowed to distribute for a
taxable year, such section 988 losses may result in all or a portion of prior
dividends distributions for such year being recharacterized as a non-taxable
return of capital to shareholders, rather than as an ordinary dividend,
<PAGE>
reducing each shareholder's basis in his Fund shares. To the extent that such
distributions exceed such shareholder's basis, each distribution will be
treated as a gain from the sale of shares.
Tax-exempt Dividends
The Funds intend to qualify to pay "exempt-interest dividends," as
that term is defined in the Code, by holding at the end of each quarter of
its taxable year at least 50% of the value of its total assets in the form of
obligations described in section 103(a) of the Code. These Funds' policy is
to pay in each taxable year exempt-interest dividends equal to at least 90%
of each such Fund's interest from tax-exempt obligations net of certain
deductions. Except as discussed below, exempt-interest dividends will be
exempt from regular federal income tax.
Although exempt-interest dividends may be excluded from a
shareholder's gross income for federal income tax purposes, a portion of the
exempt-interest dividends may be a specific preference item for purposes of
determining the shareholder's liability (if any) under the federal individual
and corporate alternative minimum tax provisions of the Code. Exempt-interest
dividends will constitute a specific preference item for purposes of the
federal alternative minimum tax to the extent that such dividends are derived
from certain types of private activity bonds issued after August 7, 1986. In
addition, all exempt-interest dividends will be a component of the "adjusted
current earnings" adjustment item for purposes of the federal corporate
alternative minimum tax. Moreover, the receipt of dividends from the Fund may
increase a corporate shareholder's liability for environmental taxes under
Section 59A of the Code and a foreign corporate shareholder's liability under
the branch profits tax, and may also affect the federal tax liability of
certain Subchapter S corporations and insurance companies. Furthermore, the
receipt of exempt-interest dividends may be a factor in determining the
extent to which a shareholder's Social Security benefits are taxable.
The exemption of interest income for regular federal income tax
purposes may not result in similar exemptions under the tax law of state and
local taxing Authorities. In general, a state exempts from state income tax
only interest earned on obligations issued by that state or its political
subdivisions and instrumentalities.
Interest on indebtedness incurred by a shareholder to purchase or
carry a Fund's shares is not deductible for federal income tax purposes if
such Fund distributes exempt-interest dividends during the shareholder's
taxable year.
Net long-term capital gains realized by the Funds, if any, will be
distributed at least annually. The Funds will generally have no tax liability
with respect to such gains to the extent distributed, and the distributions,
whether paid in cash or reinvested in additional shares, will be taxable to
the Funds' shareholders as long-term capital gains, regardless of how long a
shareholder has held the Funds' shares. Such distributions will be designated
as a capital gain dividend in a written notice mailed by the Funds to their
shareholders not later than 60 days after the close of the Funds' taxable
year.
Similarly, while the Funds do not expect to earn significant
investment company taxable income, taxable income earned by the Funds will be
distributed to their shareholders. In general, the Funds' investment company
<PAGE>
taxable income will be its taxable income (for example, any short-term
capital gains) subject to certain adjustments and excluding the excess of any
net long-term capital gain for the taxable year over the net short-term
capital loss, if any, for such year. The Funds will be taxed on any
undistributed investment company taxable income of each Fund. To the extent
such income is distributed by a Fund, it will be taxable to such Fund's
shareholders as ordinary income, whether paid in cash or reinvested in
additional shares.
Backup Withholding
The Funds may be required to withhold federal income tax at a rate of
31% ("backup withholding") from dividends and redemption proceeds paid to
non-corporate shareholders. This tax may be withheld from dividends if (i)
the payee fails to furnish a Fund with the payee's correct taxpayer
identification number, (ii) the Internal Revenue Service notifies a Fund that
the payee has failed to report properly certain interest and dividend income
to the Internal Revenue Service and to respond to notices to that effect, or
(iii) when required to do so, the payee fails to certify that he or she is
not subject to backup withholding.
Investors should consult their own tax advisers regarding specific
questions as to the federal, state, local and foreign tax consequences of
ownership of shares in any of the Funds.
SHAREHOLDER SERVICES
The following supplements the information regarding shareholder
services set forth in the Company's Prospectus relating to the Funds:
Exchange Privilege
Shares of each class of any Fund of the Company may be exchanged for
shares of the same class of any of the other Funds or any of the Company's
other portfolios provided that, with respect to Select Shares, a shareholder
exchanges shares with a value of at least $50,000. Exchange requests with
respect to Select Shares should be sent to The OFFITBANK Investment Fund,
Inc., 125 West 52nd Street, New York, New York 10020. Any such exchange will
be based on the respective net asset values of the shares involved. There is
no sales commission or charge of any kind. Before making an exchange, a
shareholder should consider the investment objective of the Fund or portfolio
to be purchased. Exchange requests may be made either by mail or telephone.
Telephone exchanges (referred to as "expedited exchanges") will be accepted
only if the certificates for the shares to be exchanged are held by the
Company for the account of the shareholder and the registration of the two
accounts is identical. Requests for expedited exchanges received prior to
4:00 p.m. (New York time) will be processed as of the close of business on
the same day. Requests received after this time will be processed on the next
business day. Expedited exchanges may, upon 60 days' notice to shareholders,
also be subject to limitations as to amounts or frequency, and to other
restrictions established by the Board of Directors to assure that such
exchanges do not disadvantage the Company and its shareholders. A Shareholder
who holds Advisor Shares should consult his/her Shareholder Servicing Agent
to determine the availability of and terms and conditions imposed on
exchanges with the other Funds and portfolios of the Company.
<PAGE>
For federal income tax purposes, an exchange between Funds or
portfolios of the Company is a taxable event, and, accordingly, a capital
gain or loss may be realized. In a revenue ruling relating to circumstances
similar to the Company's, an exchange between a series of a fund was deemed
to be a taxable event. It is likely, therefore, that a capital gain or loss
would be realized on an exchange between Funds or portfolios; shareholders
may want to consult their tax advisers for further information in this
regard. The exchange privilege may be modified or terminated at any time.
Transfer of Shares
Shareholders may transfer shares of the Company's Funds or other
portfolios to another person by written request to The OFFITBANK Investment
Fund, Inc. at the address noted above. The request should clearly identify
the account and number of shares to be transferred and include the signature
of all registered owners and all share certificates, if any, which are
subject to the transfer. The signature on the letter of request, the share
certificate or any stock power must be guaranteed in the same manner as
described under "Redemption of Shares" in the Prospectus. As in the case of
redemptions, the written request must be received in good order before any
transfer can be made.
GENERAL INFORMATION
Capital Stock
All shares of the Company have equal voting rights and will be voted
in the aggregate, and not by class, except where voting by class is required
by law. As used in this Statement of Additional Information, the term
"majority", when referring to the approvals to be obtained from shareholders
in connection with general matters affecting the Fund and all additional
investment portfolios, means the vote of the lesser of (i) 67% of the
Company's shares represented at a meeting if the holders of more than 50% of
the outstanding shares are present in person or by proxy or (ii) more than
50% of the Company's outstanding shares. The term "majority", when referring
to the approvals to be obtained from shareholders in connection with matters
affecting the Company, any other single Fund (e.g., approval of Advisory
Agreements) or any single class of a Fund, means the vote of the lesser of
(i) 67% of the shares of the Fund represented at a meeting if the holders of
more than 50% of the outstanding shares of the Fund, or of the class of
shares of the Fund, if a class vote is required, are present in person or by
proxy or (ii) more than 50% of the outstanding shares of the Fund or of the
class of shares of the Fund, if a class vote is required. Shareholders are
entitled to one vote for each full share held and fractional votes for
fractional shares held.
Each share of each class of a Fund of the Company is entitled to such
dividends and distributions out of the income earned on the assets belonging
to that Fund as are declared in the discretion of the Company's Board of
Directors. In the event of the liquidation or dissolution of the Company,
shares of a class of a Fund are entitled to receive the assets allocable to
that class of shares of such Fund which are available for distribution, and a
proportionate distribution, based upon the relative net assets of the Funds,
of any general assets not belonging to a Fund which are available for
distribution. It is anticipated that expenses incurred by each class of
<PAGE>
shares of each Fund will differ and, accordingly, that the dividends
distributed with respect to each class will differ.
Shareholders are not entitled to any preemptive rights. All shares,
when issued, will be fully paid, non-assessable, fully transferable and
redeemable at the option of the holder.
Certain Owners of Shares of the Company
As of December 5, 1996, the following persons owned of record or
beneficially 5% or more of the outstanding shares of any class of shares of a
Fund of the Company:
EMERGING MARKETS FUND SHARES OWNED PERCENTAGE
_____________________ ____________ __________
GAF Corporation Master 1,096,958.028 10.997%
Retirement Trust (Select)
Trustee-Bankers Trust Co.
Attention: Clare Petosa
Mail Stop 3048
34 Exchange Place
Jersey City, N.J. 07302
Mall Investment LP 1,742,327.314 17.467%
215 Keo Way (Select)
Des Moines, IA 50309
NEW YORK MUNICIPAL FUND SHARES OWNED PERCENTAGE
______________________ ____________ __________
Peter J. Solomon & Abigail 130,577.449 6.710%
F/B/O R. Solomon Trustees (Select)
250 West 88th Street
Abigail R. Solomon 1995 Trust
New York, N.Y. 10024
Kinco & Co. 98,929.938 5.084%
c/o RNB Securities Services (Select)
One Hawson Place
Brooklyn, N.Y. 11243
OFFITBANK Capital 246,739.945 12.680%
Attn: Vincent Rella (Select)
520 Madison Avenue, 27th Floor
New York, N.Y. 10022
Sylvia Slifka 197,214.324 10.135%
870 Fifth Avenue (Select)
New York, N.Y. 10021
<PAGE>
LATIN AMERICA TOTAL RETURN FUND SHARES OWNED PERCENTAGE
_______________________________ ____________ __________
J.N. Taube 88,910.682 8.058%
Trustee, Taube Family Trust No. 2 (Select)
DTD 3/12/82
1050 Ralston Avenue
Belmont, CA 94002
Lighthouse Inc. 24,618.149 20.357%
111 East 59th Street (Select)
New York, N.Y. 10022
Mall Investment L.P. 180,018.839 16.315%
215 Keo Way (Select)
Des Moines, IA 50309
Sheldon H. Solow 99,334.528 9.002%
9 West 57th Street (Select)
New York, N.Y. 10019
[/TABLE]
Price Waterhouse LLP serves as the independent accountants for the
Company. Price Waterhouse LLP is located at 1177 Avenue of the Americas, New
York, New York 10036.
Other Information
The Prospectus and this Statement of Additional Information do not
contain all the information included in the Registration Statement filed with
the Commission under the Securities Act of 1933 with respect to the
securities offered by the Prospectus. Certain portions of the Registration
Statement have been omitted from the Prospectus and this Statement of
Additional Information pursuant to the rules and regulations of the
Commission. The Registration Statement including the exhibits filed therewith
may be examined at the office of the Commission in Washington, D.C.
Statements contained in the Prospectus or in this Statement of
Additional Information as to the contents of any contract or other document
referred to are not necessarily complete, and, in each instance, reference is
made to the copy of such contract or other document filed as an exhibit to
the Registration Statement of which the Prospectus and this Statement of
Additional Information form a part, each such statement being qualified in
all respects by such reference.
Financial Information
The financial statements of the Company are incorporated by reference
to the Annual Report for the year ended December 31, 1995 and the Semi-Annual
Report for the period ended June 30, 1996 filed with the Commission.
