<PAGE>
FPA New Income, Inc.
ANNUAL REPORT
SEPTEMBER 30, 1998
[LOGO]
DISTRIBUTOR:
FPA FUND DISTRIBUTORS, INC.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, California 90064
<PAGE>
LETTER TO SHAREHOLDERS
Dear Fellow Shareholders:
This Annual Report covers the fiscal year ended September 30, 1998.
Your Fund's net asset value (NAV) per share closed at $11.13. During the
fiscal year, the Fund paid income dividends totaling $0.66 and a $0.02
long-term capital gains distribution.
The following table shows the average annual total return for several
different periods ended September 30 for the Fund and comparative indices.
The data quoted represents past performance, and an investment in the Fund
may fluctuate so that an investor's shares, when redeemed, may be worth more
or less than their original cost.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURN
PERIODS ENDED SEPTEMBER 30, 1998
--------------------------------
1 YEAR 5 YEARS 10 YEARS
------- ------- --------
<S> <C> <C> <C>
FPA New Income, Inc.
(NAV) ................................. 5.24%* 7.04%* 9.51%*
FPA New Income, Inc.
(Net of Sales Charge) ................. 0.50%++ 6.06%++ 9.01%++
Lipper Corporate Debt
A Rated Fund Average .................. 10.40% 6.55% 8.97%
Lehman Brothers Government/
Corporate Bond Index ................... 12.84% 7.21% 9.43%
</TABLE>
The Fund's total rate of return for the fiscal year, which reflects
the change in NAV combined with the reinvestment of dividends and
distributions paid, was 5.24%* versus 10.40% and 12.84% for the Lipper "A"
Rated Bond Fund Average and Lehman Brothers Government/Corporate Bond Index,
respectively. For the second half of the fiscal year, the total returns
were: FPA New Income, Inc., 1.63%*; Lipper Average, 5.99%; and the Lehman
Brothers Index, 7.69%. Finally, on a calendar year-to-date basis, the total
returns were: FPA New Income, Inc., 3.65%*; the Lipper Average, 7.47%; and
the Lehman Bothers Index, 9.33%.
COMMENTARY
Your Fund materially underperformed both the Lipper Average and the
Lehman Index this past fiscal year. It was an especially difficult six-month
period ended September 30, when we lost 4.36% and 6.06% of relative
performance to these indices. Your Fund still had positive performance, but
it was less than these comparative indices due to the second-half performance
results. In this shareholder letter, we would like to discuss the reasons we
underperformed, as well as how we expect to position the portfolio going
forward.
We can simply state that the primary cause of underperformance was
that your Fund was positioned with a much shorter average portfolio duration
than that of the Lipper Average or the Lehman Index. As of March 31, 1998,
our average portfolio duration was 2.85 years versus 5.2 years for the Lehman
Index. We do not know what the duration of the Lipper Average is since it is
not published, but we can infer that it was considerably longer by its
performance results. The longer a portfolio's duration, the greater its
portfolio volatility. During the six-month period ended September 30, the
yield on the ten-year Treasury bond fell from 5.65% to 4.41%. This led to a
much greater total return--yield plus the change in the price of the
security--than we could achieve with a shorter average maturity. At these
lower levels of yield, we were unwilling to risk your capital.
A second contributing factor to the underperformance was the drastic
widening of yield spreads of various bond sectors compared to U.S. Treasury
yields. We measure the relative attractiveness of a bond sector by how much
more it yields than a Treasury bond of similar duration (the yield spread).
During the recent financial market chaos, the yield spreads of various
sectors have been quite volatile. Our exposure to mortgage-backed securities
proved to be a negative contribution since their yield spreads widened more
than other high-quality bond sectors. The fear of rapid repayments meant
that investors would not pay much of a premium for a mortgage security for
fear of being refinanced.
Our portfolio of mortgage securities did what we generally expected.
It was our strategy to have a large exposure to mortgages that could be
refinanced, if the interest rate on the ten-year Treasury bond fell below the
5.5% to 6% range. This strategy would automatically increase the portfolio's
defensive characteristics at, what we believed to be, a low interest rate
level. We also added a small portion, 4% of total assets, of interest-only
mortgage securities. Their value actually increases, during periods of rising
interest rates. We added these securities to help hedge a portion of the
portfolio that
_______________
* Does not reflect deduction of the sales charge which, if reflected, would
reduce the performance shown
++ Reflects deduction of the current maximum sales charge of 4.50% of the
offering price
1
<PAGE>
potentially can have very long durations. As it turned out, interest rates
fell much further than we ever imagined. This caused some of these
potentially very long duration securities to rapidly pay down while our
interest-only securities fell in price. Our estimates of the prepayment
characteristics for these interest-only securities have been fairly accurate.
It is the market that is penalizing their price currently. If our estimates
remain fairly accurate from a longer-term perspective, their prices should
return to a more favorable level. The underlying mortgage rates for these
securities are 6.5% to 6.75%, currently a rate too low to be refinanced.
Their valuation is also being negatively influenced by the unraveling of
several aggressive investment strategies deployed by financially leveraged
managers who are being forced to sell mortgage securities in order to meet
margin calls. Over time, these transitory problems should pass.
Other areas that have been negatively impacted by this yield spread
expansion trend are the high-yield and convertible bond sectors. For almost
two years, we have expressed our concern that one was not being sufficiently
compensated through additional yield for the incremental credit risk being
assumed. Our exposure has been relatively conservative with higher quality,
shorter maturity high-yield and convertible bonds being emphasized. Yield
spreads in the high-yield sector doubled in less than three months: the
fastest we have ever witnessed in twenty-five years. Despite our small
exposure to this area, these holdings reduced your Fund's total return.
The portfolio's defensive positioning reflected our cautious attitude
towards the bond market. We were concerned that stronger than anticipated
economic growth, accompanied by gradually rising inflation in employee
compensation and medical costs, would create a floor for interest rates.
Generally, we were correct about the fundamentals but wrong about their
impact on interest rates. Furthermore, we believed the Asian economic
troubles would have only a minimal impact and, therefore, investors would
begin to focus more on the growing challenges to the Federal budget from
Medicare, Social Security and increased defense spending. In this
environment, we believed that the prudent strategy would be one of protecting
principal, while awaiting more attractive yield levels. We were also
skeptical of the widespread "bullishness" on bonds. Currently, surveys of
fixed income managers' and traders' "bullish" sentiments are at their highest
levels in ten years, as measured by International Strategy & Investment and
Market Vane. Portfolio durations are the longest in ten years relative to
their respective benchmarks. As a proponent of the contrarian style of
investing, we view these results with a sense of caution. At the present
level of yields, it does not take much of an interest rate rise to cause a
decline in a high-quality bond's value that will more than offset the
interest earned in a year.
In reviewing the events of the past year, it is obvious that our
attempt last year to quantify the potential impact from the Asian economic
collapse proved to be considerably short of the mark. So far, we have been
reasonably correct in that the economic impact on the U.S. has been
relatively well contained. Where we believe we were wrong is the degree to
which the Asian Contagion has spread throughout the world. Its latest
casualty is Russia, whose economic collapse sent the worldwide financial
markets reeling in a way we have never witnessed before. A massive
"flight-to-quality" by investors led to a spectacular rally in the U.S.
Treasury market. Preservation of purchasing power became far more important
to foreign investors than what the yield was. With this mind-set, Treasury
bond yields fell to levels not seen since the early 1960s. The magnitude of
bond market speculation by highly leveraged investment strategies also became
apparent. Several major hedge funds positioned their portfolios, on a highly
leveraged financial basis, to play the yield spread between Treasury bonds
and mortgage-backed securities. When this "flight-to-quality" trend took
hold, Treasury bonds rallied far more rapidly than these other investments
and this led to significant financial losses. These investors were forced to
sell their mortgage securities, while competing to buy Treasury bonds. We
believe these events were meaningful contributors to the decline in Treasury
bond yields into the 4% range. We also believe that bond mutual fund
managers, not wanting to be left behind, jumped on this runaway train by
shifting their portfolios to a heavier Treasury bond weighting. We did not
want to commit your capital to such a frenzied and speculative market. We
were of the opinion that there was little long-term value, and we would
therefore await a more attractive period for investing your capital.
Over the past month, we have reassessed our fundamental investment
position to see whether it should be modified. Our conclusion is that
long-term Treasury bond yields of 4% to 5% do not provide much in the way of
a margin of safety. We still see threats that could derail this bond market.
The U.S. is now running the largest trade and current account deficits on
record. Historically, when a nation runs these types of deficits, it has not
been good for the value of its currency or its interest rates. Just this past
month, the dollar came under the severest selling pressure against the
Japanese yen since 1971. We are aware that part of this could be the
unwinding of highly leveraged speculative investment strategies. Beginning
January 1, 1999, a new currency, the Euro, comes into being. For the first
time in the modern era, there is the potential of two reserve currencies
existing simultaneously. The Euro could pose
2
<PAGE>
a threat to the dollar, as a portion of international trade now denominated
in dollars will likely be transacted in Euros. Because these Euros will have
to be recycled, just like the dollar, foreign governments will have the
opportunity to choose to what degree they will hold the Euro as a reserve
currency. A higher demand for the Euro means a somewhat lower demand for the
dollar.
Longer term, the Federal government has still not faced the growing
challenges of increased Medicare and Social Security spending. The recent
budgetary surplus is now being viewed for tax cuts and other spending
opportunities. We also see that there is a growing awareness that defense
spending will likely grow in real terms. Primary contributors to the
budgetary surplus have been increased capital gains tax receipts and lower
real defense spending. Without a strong stock market, these tax receipts may
prove to be quite ephemeral. Finally, we see a trend of stimulatory fiscal
policy spending beginning on the part of Europe and Japan. This should
eventually lead to stronger economic growth. Furthermore, with European
monetary integration in 1999, pressures on the new central bank to adopt an
easier monetary policy so as to enhance the economic recovery are likely to
grow. These new trends should help limit the degree to which interest rates
can decline.
In light of these concerns, we expect to maintain our basic portfolio
posture of defensiveness but look for opportunities to take advantage of
investor fear. For example, over the last two months, investment demand has
migrated towards very high-quality liquid securities. U.S. Treasury bonds are
the most liquid and highest-quality securities. Even here, there has been a
differentiation. The yield spread between the "on the run" thirty-year bond
and the "off the run" twenty-nine year bond has grown from 5 basis points to
27 basis points: the widest ever. We believe that investor preference for
quality and liquidity is at an extremely high level and, therefore, we want
to take advantage of it. In October, we increased our high-yield and
convertible bond holdings from 13% to 17% of total assets. We were able to
add securities with yields between 11% and 22%. In many cases, the cash on
the company's balance sheet was almost equal to or greater than its total
debt. We have not seen values like this since 1990, during the last
high-yield debt market collapse. Over the next year, we expect that
high-yield and convertible bonds will be a growing portion of the Fund. We
believe that we are now being compensated for credit risk. The Fund's
high-quality segment will remain relatively unchanged, until we believe we
are being compensated sufficiently by higher yields for the risks we
perceive. We recently expanded our mortgage holdings, in response to the
dislocations in that sector. For example, we added securities with yields of
at least 6%, without much in the way of duration extension risk.
Your Fund may continue to underperform the bond market if bond yields
resume their decline. There is a debate raging in the investment community
over what the true level of inflation is likely to be. The "bulls" argue that
we are in either a disinflationary or a deflationary environment and,
therefore, bond yields have no where to go but lower. We can remember another
time when the consensus was just as confident that inflation had no where to
go but higher. Measuring and forecasting the inflation rate has always been
difficult and heavily influenced by judgment. We have witnessed inflation
expectations collapse, as measured by the ten-year Treasury Inflation-Indexed
bond. Since January 1997, its implied ten-year average annual inflation ratio
rate has fallen from approximately 3.3% to 0.8%. In our opinion, low
inflation expectations are now exceedingly optimistic. Should this prove to
be a correct assessment, we would expect that it will become more difficult
for bond yields to fall significantly from current levels.
The portfolio retains its high-quality asset mix orientation. As of
September 30, Government/Agency securities totaled 60%, 55% of these being
agency mortgage-backed securities. An additional 6% was invested in AAA
mortgage-backed securities. High-yield and convertible securities represented
7% and 6%, respectively. (As of October 22, these two sectors had risen to
17%.) Short-term liquidity totaled 20%. The Fund's average modified duration
was 2.60 years versus 2.85 years at March 31, 1998, and 3.85 years at
September 30, 1997.
We hope this letter provides you with a better understanding of the
portfolio strategy and positioning. We thank you for your continued support.
Respectfully submitted,
/s/ Robert L. Rodriquez
- ---------------------------
Robert L. Rodriguez, C.F.A.
President & Chief Investment Officer
October 24, 1998
3
<PAGE>
HISTORICAL PERFORMANCE
CHANGE IN VALUE OF A $10,000 INVESTMENT IN FPA NEW INCOME, INC. VS. LEHMAN
BROTHERS GOVERNMENT/CORPORATE BOND INDEX AND LIPPER CORPORATE DEBT A RATED
FUND AVERAGE FROM OCTOBER 1, 1988 TO SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
9/30/88 9/30/89 9/30/90 9/30/91 9/30/92 9/30/93 9/30/94 9/30/95 9/30/96 9/30/97 9/30/98
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
FPA New Income, Inc. (NAV) 10,000 11,054 11,507 13,888 15,846 17,656 17,938 20,116 21,524 23,578 24,814
FPA New Income, Inc. 9,550 10,557 10,989 13,263 15,133 16,861 17,131 19,211 20,556 22,517 23,697
Lehman Brothers
Government/Corporate 10,000 11,133 11,888 13,777 15,595 17,386 16,661 19,056 19,910 21,822 24,624
Lipper Corporate Debt A Rated
Fund Average 10,000 11,065 11,608 13,528 15,375 17,189 16,395 18,741 19,510 21,386 23,612
</TABLE>
Past performance is not indicative of future performance. The Lehman Brothers
Government/Corporate Bond Index is a broad-based unmanaged index of all
government and corporate bonds that are investment grade with at least one
year to maturity. The Lehman Brothers Government/Corporate Bond Index does
not reflect any commissions or fees which would be incurred by an investor
purchasing the securities it represents. The Lipper Corporate Debt A Rated
Fund Average provides an additional comparison of how your Fund performed in
relation to other mutual funds with similar objectives. The Lipper data does
not include sales charges. The performance shown for FPA New Income, Inc.,
with an ending value of $23,697, reflects deduction of the current maximum
sales charge of 4.5% of the offering price. In addition, since investors
purchase shares of the Fund with varying sales charges depending primarily on
volume purchased, the Fund's performance at net asset value (NAV) is also
shown, as reflected by the ending value of $24,814. The performance of the
Fund and of the Averages is computed on a total return basis which includes
reinvestment of all distributions.
MAJOR PORTFOLIO CHANGES
For the Six Months Ended September 30, 1998
<TABLE>
<S> <C>
NET PURCHASES
Federal Home Loan Mortgage Corporation (REMIC) --6% 2008 (1) ..... $19,729,661
Federal Home Loan Mortgage Corporation (REMIC) --6% 2009 (1) ..... $22,316,000
Federal Home Loan Mortgage Corporation (REMIC) --8 1/2% 2026 (1).. $11,452,475
Lam Research Corporation --5% 2002 (1) ........................... $10,000,000
U.S. Treasury Inflation-Indexed Notes --3 3/8% 2007 .............. $21,830,180
NET SALES
Federal Home Loan Mortgage Corporation (PAC-REMIC) --7% 2008 ..... $7,132,343
Federal Home Loan Mortgage Corporation (REMIC) --7% 2008 ......... $7,897,529
Federal Home Loan Mortgage Corporation (REMIC) --7% 2010 (2) ..... $16,327,009
Federal National Mortgage Association (REMIC) --7% 2008 .......... $6,377,987
Federal National Mortgage Association (REMIC) --7 1/2% 2010 (2) .. $8,409,399
Province of Ontario --11 3/4% 2013 (2) ........................... $9,000,000
</TABLE>
(1) Indicates new commitment to portfolio
(2) Indicates elimination from portfolio
4
<PAGE>
PORTFOLIO OF INVESTMENTS
September 30, 1998
<TABLE>
<CAPTION>
PRINCIPAL
BONDS & DEBENTURES AMOUNT COST VALUE
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
U.S. GOVERNMENT & AGENCIES
MORTGAGE-BACKED SECURITIES -- 33.0%
Federal Home Loan Bank (Indexed Notes) --6.55% 2003 ..... $ 1,525,775 $ 1,511,105 $ 1,531,020
Federal Home Loan Mortgage Corporation (CMO)
--7 1/2% 2004 ......................................... 6,776,772 6,827,598 6,785,243
--8 1/2% 2024 ......................................... 283,388 285,159 283,386
Federal Home Loan Mortgage Corporation (PAC-REMIC)
--7% 2008 ............................................. 3,842,715 3,781,627 3,842,715
--7 1/2% 2021 ......................................... 2,988,260 3,026,080 3,085,752
--8% 2019 ............................................. 5,000,000 5,151,758 5,050,195
Federal Home Loan Mortgage Corporation (PAC-IO-CMO)
--6 1/2% 2020.......................................... 2,724,685 238,776 243,519
--7% 2020 ............................................. 8,000,000 1,079,497 1,371,248
Federal Home Loan Mortgage Corporation (PAC-IO-REMIC)
--6 1/2% 2007 ......................................... 13,118,393 1,172,196 1,272,891
--6 1/2% 2023 ......................................... 6,001,845 731,698 789,618
Federal Home Loan Mortgage Corporation (REMIC)
--6% 2008 ............................................. 19,729,661 19,724,591 19,748,752
--6% 2009 ............................................. 22,316,000 22,309,026 22,329,948
--7% 2007 ............................................. 6,248,912 6,174,706 6,248,912
--7% 2008 ............................................. 7,783,925 7,716,332 7,795,493
--7% 2023 ............................................. 5,000,000 4,487,500 5,037,500
--7 1/2% 2026 ("Z") ................................... 8,701,316 7,848,488 8,772,014
--8 1/2% 2026 ......................................... 11,452,475 12,103,834 12,110,993
--10.15% 2006 ......................................... 30,829 31,526 31,291
Federal National Mortgage Association (PAC-REMIC)
--7% 2007 ............................................. 139,663 138,092 139,663
Federal National Mortgage Association (PAC-IO-REMIC)
--6% 2027 ............................................. 44,785,634 14,274,914 12,456,004
--6% 2028 ............................................. 27,727,829 9,680,542 7,523,336
--6 1/2% 2009 ......................................... 5,426,145 847,005 903,792
--6 1/2% 2020 ......................................... 6,000,000 764,820 761,250
--7% 2004 ............................................. 1,164,750 159,559 170,345
--7% 2017 ............................................. 5,564,679 -- 315,623
Federal National Mortgage Association (REMIC)
--4.74% 2022 .......................................... 18,500,000 17,897,656 17,875,625
--7% 2008 ............................................. 2,500,710 2,470,037 2,500,711
--7% 2023 ............................................. 2,556,295 2,479,607 2,549,905
--7% 2024 ("Z") ....................................... 10,752,424 8,672,668 10,819,628
</TABLE>
5
<PAGE>
PORTFOLIO OF INVESTMENTS
<TABLE>
<CAPTION>
PRINCIPAL
BONDS & DEBENTURES--Continued AMOUNT COST VALUE
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal National Mortgage Association (REMIC)
--7 1/2% 2024 ("Z") ................................... $ 14,229,639 $ 13,629,302 $ 14,260,766
--7 1/2% 2026 ("Z") ................................... 5,564,317 4,969,963 5,563,610
--8% 2022 ............................................. 3,132,619 3,130,661 3,142,408
Government National Mortgage Association --7 1/2% 2023 .. 603,351 576,955 626,164
Government National Mortgage Association II
--8% 2027 ............................................. 6,590,635 6,687,435 6,841,903
Government National Mortgage Association (MH)
--8 1/4% 2006-7 ....................................... 439,659 461,605 456,147
--8 3/4% 2006 ......................................... 997,968 1,032,088 1,081,391
--8 3/4% 2011 ......................................... 1,061,401 1,097,224 1,105,517
--9% 2010 ............................................. 659,001 687,835 694,011
--9% 2011 ............................................. 1,568,429 1,653,437 1,651,753
--9 1/4% 2010-11 ...................................... 985,568 1,038,702 1,027,763
--9 3/4% 2005-6 ....................................... 2,323,126 2,478,496 2,445,817
--9 3/4% 2012-13 ...................................... 950,404 1,023,813 1,000,596
Government National Mortgage Association (PL)
--10 1/4% 2017 ........................................ 915,669 993,500 940,849
------------ ------------
$201,047,413 $203,185,067
------------ ------------
OTHER U.S. GOVERNMENT & AGENCIES -- 27.2%
Tennessee Valley Authority --8 3/8% 1999 ................ $ 3,400,000 $ 3,222,781 $ 3,514,930
U.S. Treasury Inflation-Indexed Notes --3 3/8% 2007 ..... 145,749,245 142,301,145 143,517,460
U.S. Treasury Notes --8 1/4% 2005 ....................... 1,800,000 1,706,250 1,905,188
U.S. Treasury Notes Strip --0% 2009 ..................... 31,000,000 13,120,721 18,391,990
------------ ------------
$160,350,897 $167,329,568
------------ ------------
TOTAL U.S. GOVERNMENT & AGENCIES -- 60.2% ............... $361,398,310 $370,514,635
------------ ------------
MORTGAGE BONDS
ASSET BACKED -- 3.4%
Green Tree Financial Corporation (CMO)
--6.9% 2004 ........................................... $ 6,327,615 $ 6,294,184 $ 6,365,185
--7 1/4% 2005 ......................................... 13,180,266 13,257,494 13,274,998
Merrill Lynch Mortgage Investors, Inc. Class A
(backed by Manufactured Housing First Mortgages)
--8.3% 2012 ........................................... 1,242,104 1,243,775 1,248,313
--9.2% 2011 ........................................... 9,449 9,405 9,449
------------ ------------
$ 20,804,858 $ 20,897,945
------------ ------------
</TABLE>
6
<PAGE>
PORTFOLIO OF INVESTMENTS
<TABLE>
<CAPTION>
PRINCIPAL
BONDS & DEBENTURES--Continued AMOUNT COST VALUE
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
MORTGAGE BACKED -- 2.6%
Residential Funding Mortgage Securities (REMIC)
--7% 2012 ............................................. $ 4,985,383 $ 4,974,477 $ 4,988,499
--7 3/4% 2026 ......................................... 2,223,105 2,257,841 2,223,105
DLJ Mortgage Acceptance Corp. (Series 1997-E Class "B")
--7.5481% 2026+ ....................................... 5,046,793 4,453,795 4,538,959
Prudential Home Mortgage Securities Corp.
(Series 1993-F Class "1B1") --6.6582% 2000+ ........... 4,548,971 4,543,284 4,551,814
------------ ------------
$ 16,229,397 $ 16,302,377
------------ ------------
TOTAL MORTGAGE BONDS -- 6.0% ............................ $ 37,034,255 $ 37,200,322
------------ ------------
CORPORATE BONDS & DEBENTURES -- 7.4%
Advantica Restaurant Group, Inc. --11 1/4% 2008 ......... $ 10,928,038 $ 11,135,538 $ 10,381,636
Advanta Corporation
--6.0075% 2000 (Floating Rate) ........................ 1,200,000 1,130,160 1,140,000
--6.65% 2000 .......................................... 2,400,000 2,295,350 2,309,676
--6.658% 1999 ......................................... 3,400,000 3,278,076 3,272,500
Busse Broadcasting Corporation --11 5/8% 2000 ........... 3,250,000 3,176,600 3,445,000
Michaels Stores, Inc. --10 7/8% 2006 .................... 5,000,000 4,386,113 5,450,000
Oregon Steel Mills, Inc. --11% 2003 ..................... 8,350,000 8,964,625 8,590,063
Plantronics, Inc. --10% 2001 ............................ 3,248,000 3,299,575 3,248,000
Trump Atlantic City Associates --11 1/4% 2006............ 9,000,000 8,829,875 7,380,000
------------ ------------
$ 46,495,912 $ 45,216,875
------------ ------------
TOTAL NON-CONVERTIBLE
BONDS & DEBENTURES -- 73.6% ........................... $444,928,477 $452,931,832
------------ ------------
CONVERTIBLE SECURITIES
CONVERTIBLE BONDS & DEBENTURES -- 6.0%
Centertrust Retail Properties, Inc.
--7 1/2% 2001 (Class "A") ............................. $ 4,600,000 $ 4,219,838 $ 4,416,000
--7 1/2% 2001 (Class "B") ............................. 5,800,000 5,521,688 5,394,000
Charming Shoppes, Inc. --7 1/2% 2006 .................... 7,000,000 6,853,250 6,580,000
DRS Technologies, Inc. --9% 2003 ........................ 2,000,000 2,000,000 2,285,000
HomeBase, Inc.
--5 1/4% 2004+ ........................................ 2,800,000 2,534,000 2,436,000
--5 1/4% 2004 ......................................... 3,200,000 2,687,112 2,784,000
Lam Research Corporation --5% 2002 ...................... 10,000,000 8,146,769 7,500,000
Offshore Logistics, Inc. --6% 2003 ...................... 500,000 427,500 435,000
Quantum Health Resources, Inc. --4 3/4% 2000 ............ 1,000,000 776,250 940,000
Read-Rite Corporation --6 1/2% 2004 ..................... 8,055,000 5,894,950 4,430,250
------------ ------------
$ 39,061,357 $ 37,200,250
------------ ------------
</TABLE>
7
<PAGE>
PORTFOLIO OF INVESTMENTS
<TABLE>
<CAPTION>
SHARES OR
PRINCIPAL
CONVERTIBLE SECURITIES--Continued AMOUNT COST VALUE
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
CONVERTIBLE PREFERRED STOCK -- 0.1%
Treev Inc. (Series A) ................................... 75,000 $ 1,400,000 $ 684,375
------------ ------------
TOTAL CONVERTIBLE SECURITIES -- 6.1% .................... $ 40,461,357 $ 37,884,625
------------ ------------
OTHER PREFERRED AND COMMON STOCK -- 0.6%
Crown American Realty Trust (Preferred) ................. 78,500 $ 3,926,642 $ 3,861,219
Treev Inc. (Common) ..................................... 15,999 15,750 11,999
------------ ------------
$ 3,942,392 $ 3,873,218
------------ ------------
SHORT-TERM INVESTMENTS -- 8.5%
Federal National Mortgage Association (Floating Rate)
--5.023% 11/3/98 ...................................... $ 11,000,000 $ 11,000,000 $ 11,000,000
--4.723% 5/25/99 ...................................... 5,000,000 4,992,500 4,984,000
--5.540% 6/30/99 ...................................... 10,000,000 10,000,000 10,000,000
Federal Home Loan Bank (Floating Rate)
--5.008% 8/18/99 ...................................... 15,000,000 14,994,600 14,995,500
Private Export Funding Corp. (Floating Rate)
--4.823% 2/28/99 ...................................... 11,250,000 11,248,875 11,216,250
------------ ------------
$ 52,235,975 $ 52,195,750
------------ ------------
TOTAL INVESTMENT SECURITIES -- 88.8% .................... $541,568,201 $546,885,425
------------ ------------
------------ ------------
OTHER SHORT-TERM INVESTMENTS -- 10.2%
Short-term Corporate Notes:
General Electric Capital Services, Inc. --5.51% 10/1/98 $ 18,072,000 $ 18,072,000
American Express Credit Corporation --5.55% 10/2/98 ... 12,047,000 12,045,143
General Electric Capital Corporation --5.55% 10/5/98 .. 21,606,000 21,592,676
General Electric Company --5.36% 10/6/98 .............. 11,080,000 11,071,752
------------
$ 62,781,571
------------
TOTAL INVESTMENTS -- 99.0% .............................. $609,666,996
Other assets less liabilities -- 1.0% ................... 6,079,332
------------
TOTAL NET ASSETS -- 100% ................................ $615,746,328
------------
------------
</TABLE>
+ Restricted security purchased without registration under the Securities Act
of 1933 pursuant to Rule 144A, which generally may be resold only to certain
institutional investors prior to registration. DLJ Mortgage Acceptance Corp.
was purchased on September 8, 1997, HomeBase, Inc. was purchased on
February 3, 1998, and Prudential Home Mortgage Securities Corp. was purchased
on May 20, 1998. These restricted securities constituted 1.9% of total net
assets at September 30, 1998.
See notes to financial statements.
8
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
September 30, 1998
<TABLE>
<S> <C> <C>
ASSETS
Investments at value:
Investment securities -- at market value
(identified cost $541,568,201) ....................... $546,885,425
Short-term investments -- at cost plus interest earned
(maturities of 60 days or less) ..................... 62,781,571 $609,666,996
------------
Cash ..................................................... 828
Receivable for:
Interest ............................................... $ 5,850,904
Capital Stock sold ..................................... 2,220,954 8,071,858
------------ ------------
$617,739,682
LIABILITIES
Payable for:
Investment securities purchased ........................ $ 981,144
Capital Stock repurchased .............................. 635,779
Advisory fees .......................................... 252,220
Accrued expenses and other liabilities ................. 124,211 1,993,354
------------ ------------
NET ASSETS -- equivalent to $11.13 per share on 55,336,651
shares of Capital Stock outstanding ...................... $615,746,328
------------
------------
SUMMARY OF SHAREHOLDERS' EQUITY
Capital Stock -- par value $0.01 per share; authorized
100,000,000 shares; outstanding 55,336,651 shares ...... $ 553,367
Additional Paid-in Capital ............................... 596,773,382
Undistributed net realized gains on investments .......... 2,704,772
Undistributed net investment income ...................... 10,397,583
Unrealized appreciation of investments ................... 5,317,224
------------
Net assets at September 30, 1998 ......................... $615,746,328
------------
------------
</TABLE>
See notes to financial statements.
9
<PAGE>
STATEMENT OF OPERATIONS
For the Year Ended September 30, 1998
<TABLE>
<S> <C> <C>
INVESTMENT INCOME
Interest ...................................................... $39,035,909
Dividends ..................................................... 463,250
-----------
$39,499,159
EXPENSES
Advisory fees ................................................. $ 2,958,785
Transfer agent fees and expenses .............................. 254,685
Registration fees ............................................. 91,413
Custodian fees and expenses ................................... 61,776
Directors' fees and expenses .................................. 34,951
Audit fees .................................................... 22,925
Postage ....................................................... 22,581
Insurance ..................................................... 20,069
Reports to shareholders ....................................... 16,171
Legal fees .................................................... 7,258
Other expenses ................................................ 15,068 3,505,682
------------ -----------
Net investment income ................................... $35,993,477
-----------
NET REALIZED AND UNREALIZED GAIN (LOSS) ON
INVESTMENTS
Net realized gain on investments:
Proceeds from sales of investment securities (excluding
short-term investments with maturities of 60 days or less) .. $222,331,829
Cost of investment securities sold ............................ 219,469,324
------------
Net realized gain on investments .......................... $ 2,862,505
Unrealized appreciation of investments:
Unrealized appreciation at beginning of year .................. $ 14,493,396
Unrealized appreciation at end of year ........................ 5,317,224
------------
Decrease in unrealized appreciation of investments .......... (9,176,172)
-----------
Net realized and unrealized loss on investments ........... $(6,313,667)
-----------
NET INCREASE IN NET ASSETS RESULTING
FROM OPERATIONS ................................................ $29,679,810
-----------
-----------
</TABLE>
See notes to financial statements.
10
<PAGE>
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
FOR THE YEAR ENDED SEPTEMBER 30,
---------------------------------------------------------
1998 1997
--------------------------- ---------------------------
<S> <C> <C> <C> <C>
INCREASE IN NET ASSETS
Operations:
Net investment income .................. $ 35,993,477 $ 27,558,396
Net realized gain on investments ....... 2,862,505 1,065,224
Increase (decrease) in unrealized
appreciation of investments .......... (9,176,172) 10,242,528
------------ ------------
Increase in net assets resulting
from operations ........................ $ 29,679,810 $ 38,866,148
Distributions to shareholders from:
Net investment income .................. $(33,893,211) $(24,604,952)
Net realized capital gains ............. (1,183,945) (35,077,156) (1,692,535) (26,297,487)
------------ ------------
Capital Stock transactions:
Proceeds from Capital Stock sold ....... $236,277,210 $244,845,762
Proceeds from shares issued to
shareholders upon reinvestment
of dividends and distributions ....... 30,352,091 18,444,941
Cost of Capital Stock repurchased ...... (175,059,444) 91,569,857 (84,582,474) 178,708,229
------------ ------------ ------------ ------------
Total increase in net assets ............. $ 86,172,511 $191,276,890
NET ASSETS
Beginning of year, including
undistributed net investment income
of $8,297,317 and $5,343,873 ........... 529,573,817 338,296,927
------------ ------------
End of year, including
undistributed net investment income
of $10,397,583 and $8,297,317 .......... $615,746,328 $529,573,817
------------ ------------
------------ ------------
CHANGE IN CAPITAL STOCK
OUTSTANDING
Shares of Capital Stock sold ............. 21,199,452 22,283,273
Shares issued to shareholders
upon reinvestment of dividends
and distributions ...................... 2,740,769 1,697,911
Shares of Capital Stock repurchased ...... (15,730,014) (7,684,688)
------------ ------------
Increase in Capital Stock
outstanding ............................ 8,210,207 16,296,496
------------ ------------
------------ ------------
</TABLE>
See notes to financial statements.
11
<PAGE>
FINANCIAL HIGHLIGHTS
SELECTED DATA FOR EACH SHARE OF CAPITAL STOCK OUTSTANDING THROUGHOUT EACH YEAR
<TABLE>
<CAPTION>
FOR THE YEAR ENDED SEPTEMBER 30,
-----------------------------------------------
1998 1997 1996 1995 1994
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Per share operating performance:
Net asset value at beginning of year ....... $11.24 $10.97 $11.05 $10.52 $11.32
------- ------- ------- ------- -------
Net investment income ....................... $ 0.67 $ 0.68 $ 0.68 $ 0.67 $ 0.68
Net realized and unrealized gain (loss)
on investment securities .................. (0.10) 0.32 0.06 0.55 (0.51)
------- ------- ------- ------- -------
Total from investment operations ............ $ 0.57 $ 1.00 $ 0.74 $ 1.22 $ 0.17
------- ------- ------- ------- -------
Less distributions:
Dividends from net investment income ...... $(0.66) $(0.68) $(0.66) $(0.69) $(0.70)
Distributions from net realized
capital gains ........................... (0.02) (0.05) (0.16) -- (0.27)
------- ------- ------- ------- -------
Total distributions ......................... $(0.68) $(0.73) $(0.82) $(0.69) $(0.97)
------- ------- ------- ------- -------
Net asset value at end of year .............. $11.13 $11.24 $10.97 $11.05 $10.52
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Total investment return* .................... 5.24% 9.54% 7.00% 12.14% 1.60%
Ratios/supplemental data:
Net assets at end of year (in $000's) ....... 615,746 529,574 338,297 207,018 122,708
Ratio of expenses to average net assets ..... 0.59% 0.59% 0.63% 0.68% 0.74%
Ratio of net investment income to
average net assets ........................ 6.06% 6.37% 6.44% 6.50% 6.41%
Portfolio turnover rate ..................... 47% 29% 16% 31% 39%
</TABLE>
* Return is based on net asset value per share, adjusted for reinvestment of
distributions, and does not reflect deduction of the sales charge.
- --------------------------------------------------------------------------------
FEDERAL TAX STATUS OF FISCAL YEAR DISTRIBUTIONS TO SHAREHOLDERS (UNAUDITED)
<TABLE>
<CAPTION>
LONG-TERM
PER SHARE ORDINARY INCOME CAPITAL GAIN
PAYABLE DATE AMOUNT QUALIFYING NON-QUALIFYING DISTRIBUTION
- ------------------------------ --------- ---------- -------------- ------------
<S> <C> <C> <C> <C>
October 7, 1997 .............. $0.17 0.7% 99.3% --
January 7, 1998 .............. $0.19+ -- 89.5% 10.5%
April 7, 1998 ................ $0.16 0.1% 99.9% --
July 8, 1998 ................. $0.16 0.1% 99.9% --
</TABLE>
+ This amount includes a $0.02 long-term capital gain distribution taxable as
such. This is in addition to the $0.17 income dividend which is taxable as
ordinary income. Even though payment was made in 1998, this distribution was
taxable to shareholders in 1997 under provisions of the Internal Revenue Code.
Qualifying dividends refers to the amount of dividends which are designated
as qualifying for the 70% dividends received deduction applicable to
corporate shareholders.
A form 1099 will be mailed to each shareholder in January 1999 setting forth
specific amounts to be included in their 1998 tax returns.
12
<PAGE>
NOTES TO FINANCIAL STATEMENTS
September 30, 1998
NOTE 1 -- SIGNIFICANT ACCOUNTING POLICIES
The Fund is registered under the Investment Company Act of 1940 as a
diversified, open-end, management investment company. The Fund's investment
objective is to seek current income and long-term total return. The
following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements.
A. Security Valuation
Securities listed or traded on a national securities exchange or on
the NASDAQ National Market System are valued at the last sale price on the
last business day of the year, or if there was not a sale that day, at the
last bid price. Unlisted securities and securities listed on a national
securities exchange for which the over-the-counter market more accurately
reflects the securities' value in the judgment of the Fund's officers, are
valued at the most recent bid price or other ascertainable market value.
Short-term investments with maturities of 60 days or less are valued at cost
plus interest earned which approximates market value. Securities for which
market quotations are not readily available are valued at fair value as
determined in good faith by, or under the direction of, the Board of
Directors.
B. Federal Income Tax
No provision for federal income tax is required because the Fund has
elected to be taxed as a "regulated investment company" under the Internal
Revenue Code and intends to maintain this qualification and to distribute
each year to its shareholders, in accordance with the minimum distribution
requirements of the Code, all of its taxable net investment income and
taxable net realized gains on investments.
C. Securities Transactions and Related Investment Income
Securities transactions are accounted for on the date the securities
are purchased or sold. Dividend income and distributions to shareholders are
recorded on the ex-dividend date. Interest income and expenses are recorded
on an accrual basis.
D. Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported. Actual results could differ
from these estimates.
NOTE 2 -- PURCHASES OF INVESTMENT SECURITIES
Cost of purchases of investment securities (excluding short-term
investments with maturities of 60 days or less) aggregated $329,296,597 for
the year ended September 30, 1998. Realized gains or losses are based on the
specific-certificate identification method. Cost of investment securities
owned at September 30, 1998 was the same for federal income tax and financial
reporting purposes.
NOTE 3 -- ADVISORY FEES AND OTHER AFFILIATED TRANSACTIONS
Pursuant to an Investment Advisory Agreement, advisory fees were paid
by the Fund to First Pacific Advisors, Inc. (the "Adviser"). Under the terms
of this Agreement, the Fund pays the Adviser a monthly fee calculated at the
annual rate of 0.5% of the average daily net assets of the Fund. The
Agreement obligates the Adviser to reduce its fee to the extent necessary to
reimburse the Fund for any annual expenses (exclusive of interest, taxes, the
cost of any supplemental statistical and research information, and
extraordinary expenses such as litigation) in excess of 1 1/2% of the first
$15 million and 1% of the remaining average net assets of the Fund for the
year.
For the year ended September 30, 1998, the Fund paid aggregate fees
of $34,500 to all Directors who are not affiliated persons of the Adviser.
Legal fees were for services rendered by
13
<PAGE>
O'Melveny & Myers LLP, counsel for the Fund. A Director of the Fund is of
counsel to, and a retired partner of, that firm. Certain officers of the
Fund are also officers of the Adviser and FPA Fund Distributors, Inc.
NOTE 4 -- DISTRIBUTOR
For the year ended September 30, 1998, FPA Fund Distributors, Inc.
("Distributor"), a wholly owned subsidiary of the Adviser, received $129,635
in net Fund share sales commissions after reallowance to other dealers. The
Distributor pays its own overhead and general administrative expenses, the
cost of supplemental sales literature, promotion and advertising.
NOTE 5 -- DISTRIBUTION TO SHAREHOLDERS
On September 30, 1998, the Board of Directors declared a dividend
from net investment income of $0.17 per share payable October 7, 1998 to
shareholders of record on September 30, 1998. For financial statement
purposes, this dividend and distribution was recorded on the ex-dividend
date, October 1, 1998.
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT AUDITORS
TO THE BOARD OF DIRECTORS AND
SHAREHOLDERS OF FPA NEW INCOME, INC.
We have audited the accompanying statement of assets and liabilities
of FPA New Income, Inc., including the portfolio of investments, as of
September 30, 1998, the related statement of operations for the year then
ended, the statement of changes in net assets for each of the two years in
the period then ended, and the financial highlights, for each of the five
years in the period then ended. These financial statements and financial
highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements
and financial highlights are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. Our procedures included
confirmation of securities owned as of September 30, 1998, by correspondence
with the custodian and brokers. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights
referred to above present fairly, in all material respects, the financial
position of FPA New Income, Inc. as of September 30, 1998, the results of its
operations for the year then ended, the changes in its net assets for each of
the two years in the period then ended, and the financial highlights for each
of the five years in the period then ended, in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
Los Angeles, California
November 5, 1998
14
<PAGE>
OFFICERS AND DIRECTORS
DIRECTORS
Willard H. Altman
Donald E. Cantlay
DeWayne W. Moore
Lawrence J. Sheehan
OFFICERS
Robert L. Rodriguez, PRESIDENT AND
CHIEF INVESTMENT OFFICER
Julio J. de Puzo, Jr., EXECUTIVE VICE PRESIDENT
Eric S. Ende, VICE PRESIDENT
Janet M. Pitman, VICE PRESIDENT
J. Richard Atwood, TREASURER
Sherry Sasaki, SECRETARY
Christopher H. Thomas, ASSISTANT TREASURER
INVESTMENT ADVISER
First Pacific Advisors, Inc.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, California 90064
DISTRIBUTOR
FPA Fund Distributors, Inc.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, California 90064
COUNSEL
O'Melveny & Myers LLP
Los Angeles, California
INDEPENDENT AUDITORS
Ernst & Young LLP
Los Angeles, California
CUSTODIAN & TRANSFER AGENT
State Street Bank and Trust Company
Boston, Massachusetts
SHAREHOLDER SERVICE AGENT
Boston Financial Data Services, Inc.
P.O. Box 8500
Boston, Massachusetts 02266-8500
(800) 638-3060
(617) 328-5000
This report has been prepared for the information of shareholders of FPA New
Income, Inc., and is not authorized for distribution to prospective investors
unless preceded or accompanied by a prospectus.
