| UNITED STATES |
| SECURITIES AND EXCHANGE COMMISSION |
| Washington, D.C. 20549 |
FORM N-CSR |
CERTIFIED SHAREHOLDER REPORT OF REGISTERED |
MANAGEMENT INVESTMENT COMPANIES |
| Investment Company Act File Number: 811-4521 |
| T. Rowe Price State Tax-Free Income Trust |
| (Exact name of registrant as specified in charter) |
| 100 East Pratt Street, Baltimore, MD 21202 |
| (Address of principal executive offices) |
| David Oestreicher |
| 100 East Pratt Street, Baltimore, MD 21202 |
| (Name and address of agent for service) |
| Registrant’s telephone number, including area code: (410) 345-2000 |
| Date of fiscal year end: February 28 |
| Date of reporting period: August 31, 2011 |
Item 1: Report to Shareholders
 |
| New York Tax-Free Bond Fund | August 31, 2011 |
The views and opinions in this report were current as of August 31, 2011. They are not guarantees of performance or investment results and should not be taken as investment advice. Investment decisions reflect a variety of factors, and the managers reserve the right to change their views about individual stocks, sectors, and the markets at any time. As a result, the views expressed should not be relied upon as a forecast of the fund’s future investment intent. The report is certified under the Sarbanes-Oxley Act, which requires mutual funds and other public companies to affirm that, to the best of their knowledge, the information in their financial reports is fairly and accurately stated in all material respects.
REPORTS ON THE WEB
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Manager’s Letter
Fellow Shareholders
Led by long-term and lower-quality issues, New York tax-free municipal bonds produced strong returns and generally outperformed taxable bonds in the six-month period ended August 31, 2011. Performance was driven by several factors, including a significant year-over-year decline in municipal issuance, tumbling Treasury yields tied to sluggish economic growth, and the Federal Reserve’s intention to keep short-term interest rates very low for an additional two years. Investor confidence in municipal securities increased as dire predictions about massive municipal defaults in 2011 proved to be alarmist. New York’s economic picture continued to improve during the period, and the New York Tax-Free Bond Fund posted strong returns. The New York Tax-Free Money Fund return was roughly flat due to the Fed’s accommodative monetary policy, which kept rates near 0%.
MARKET ENVIRONMENT
Economic growth thus far in 2011 has been disappointing. After a strong start to the year, job growth faltered in the spring, and the national unemployment rate remains stuck at around 9%. The housing market also continues to languish at depressed levels. With commodity prices somewhat elevated—though generally lower than they were in the spring—and economic prospects in the U.S. and Europe very uncertain, consumers have been somewhat reluctant to increase their spending, and many businesses have restrained their expansion plans.
Despite the end of the Federal Reserve’s second round of quantitative easing in June 2011 and S&P’s recent downgrade of the U.S. government’s long-term sovereign credit rating, intermediate- and long-term Treasury interest rates fell sharply over the last six months, approaching historic lows amid renewed fears of a double-dip recession. Municipal yields also declined but to a lesser extent. The Fed acknowledged the fragility of the economy and indicated that it would likely keep the fed funds target rate in the 0.00% to 0.25% range—which has been in place since December 2008—until at least mid-2013. As our reporting period ended, Fed Chairman Ben Bernanke indicated that the central bank would contemplate the possible deployment of additional tools to stimulate the economy.
With 30-year municipal yields higher than 30-year Treasury yields, long-term tax-free securities are an attractive alternative, particularly for investors in the highest tax brackets. As of August 31, 2011, the 3.89% yield offered by a 30-year tax-free municipal bond rated AAA was about 108% of the 3.60% pretax yield offered by a 30-year Treasury. An investor in the 28% federal tax bracket would need to invest in a taxable bond yielding about 5.40% in order to receive the same after-tax income. (To calculate a municipal bond’s taxable-equivalent yield, divide the municipal bond’s yield by the quantity of 1.00 minus your federal tax bracket expressed as a decimal—in this case, 1.00 – 0.28, or 0.72.)
MUNICIPAL MARKET NEWS
Nationally, new municipal issuance through August 2011 totaled only about $163 billion, according to The Bond Buyer. This is well below the brisk pace of the last few years. Contributing factors include the expiration last December of the Build America Bond program, which led to increased issuance in 2009–2010, and a pervasive sentiment toward fiscal austerity. While demand for munis has been weak for much of the last six months, it has been improving due to increased interest from individual investors and some nontraditional investors purchasing munis directly. Cash flows into municipal bond funds have been mostly negative throughout our reporting period, reflecting the weakening economic outlook and some concerns about prevailing low yields.
Many states continue to face fiscal difficulties and have been forced to raise taxes and fees and cut spending to close budget deficits. We believe many states deserve the high ratings that they have been given by the major credit rating agencies, and we do not see a near-term threat to their ability to continue servicing their outstanding debts. However, we continue to have longer-term concerns about potentially onerous future pension obligations and other retirement benefits. In any event, the fiscal woes of state governments do not necessarily limit our tax-free investment opportunities. Many municipal market issuers continue to have good credit profiles.
Finally, the municipal market continues to show remarkable resilience in the face of a steady drumbeat of negative publicity, negative cash flow, and political challenges to tax exemption. In the last six months, every major municipal bond sector produced strong gains, led by long-term and lower-quality issues—a remarkable recovery from their poor performance at the end of 2010. Revenue bonds narrowly outperformed both local and state general obligations (GOs). Among revenue bonds, health care was one of the top-performing segments, as hospitals are adjusting to new fiscal realities and last year’s health care reform legislation. We remain cautious and selective on health care due to the likelihood of tighter reimbursement policies and state budget cuts that could affect Medicaid payments to providers. Medicaid and Medicare could also be targets for federal spending cuts. Tobacco bonds performed well due to rumors of a possible legal settlement of a dispute that may result in a significant lump-sum payment from tobacco companies to the states. We continue to underweight this sector due to declining long-term tobacco consumption trends. Solid waste bonds lagged modestly but produced good returns in absolute terms.
NEW YORK MARKET NEWS
The New York state employment picture brightened during the past six months. While the state’s unemployment rate remained elevated, at 8.0% in July 2011, it was below the national average of 9.1%. The state’s nonfarm employment level, which includes private sector and government jobs, increased by 114,200 in the 12 months through July, a net gain of 1.3% compared with 1.0% for the nation. In New York City, the unemployment rate in July was 8.7%. New York maintains above-average wealth levels with 2010 per capita personal income at 120% of the nation, ranking fifth highest among the states.
Moody’s Investors Service rates New York’s GO bonds Aa2, while S&P and Fitch Ratings both rate the bonds AA. All three agencies maintain “stable” outlooks, indicating that a near-term change in the rating is not expected.
The state’s fiscal condition has stabilized due to the slowly recovering private sector, which has boosted tax revenues. The state legislature approved a $132 billion budget for fiscal 2012, which contains about $5.4 billion in spending cuts from the state’s Medicaid program and school aid. Additional savings, including cuts to state agencies and non-school aid to localities helped close an estimated $10 billion budget gap. Audited results for fiscal 2011 were not available by the end of our reporting period, but on a budgetary basis the state ended the year with $1.38 billion in general fund reserves (2.5% of revenues), including $1.2 billion in rainy day reserves.
New York’s debt burden is among the highest in the nation, according to Moody’s. Unlike many other states, however, New York’s pension funds are well funded. The majority of New York’s debt is appropriation-backed, which means that the legislature must approve debt service payments on these obligations annually, but it has no legal obligation to continue to consent to these expenses.
New York City continues to exhibit signs of economic and fiscal improvement and has demonstrated strong fiscal management, including multiyear financial planning and rolling forward its budget surplus from stronger years. Although audited results for fiscal 2011 were not available by the end of our reporting period, the city estimates that it ended the year with a $3.7 billion surplus (5.6% of revenues), which will be rolled forward to help balance fiscal 2012. Property taxes remain the city’s largest revenue source and act as a stabilizing factor given the city’s practice of phasing in tax assessments over five years. Still, the city faces budget gaps of $4.6 billion in fiscal 2013, $4.8 billion in fiscal 2014, and $4.9 billion in fiscal 2015. Agency ratings for New York City are Aa2 from Moody’s, AA from S&P, and AA from Fitch, all with stable outlooks.
PORTFOLIO STRATEGIES
New York Tax-Free Money Fund
The New York Tax-Free Money Fund returned 0.01% for the six-month period ended August 31, 2011. As the Fed kept official shortterm interest rates in the historically low range of 0.00% to 0.25%, the seven-day simple yield remained very low and ended August at 0.01%.
All money market instruments—including Treasuries, agencies, corporates, and municipals—continue to trade in a very narrow range around the fed funds target rate range of 0.00% to 0.25%. With volatile financial markets, the European debt crisis, uncertainty over U.S. debt obligations, and a sputtering economy all serving as a backdrop, investors continue to prefer the safety and quality of money funds despite their meager yields.
A survey of the broader money market shows that, despite concerns over the debt ceiling extension in August, Treasury bill investors continue to demand quality and liquidity. Six-month bills now yield 0.03%, while one-year bills yield 0.09%. In other markets, the benchmark 90-day LIBOR rate moved as low as 0.25% before recovering somewhat to 0.33% as the six-month period ended.
New York municipal money market rates continue to follow the pattern of the broader money markets. Rates across the municipal curve are lower by about 10 basis points compared with six months ago. Overnight rates averaged 0.12% in the most recent six-month period, while seven-day rates averaged 0.17%. Ninety-day commercial paper rates averaged 0.22%, while one-year note yields averaged 0.29%.
Credit quality remains a primary focus in the portfolio, in terms of the municipal issuers as well as the various bank guarantors that provide liquidity support to municipal debt. While better off than many other states, the fiscal issues New York faces have created a challenging investment landscape. Our portfolio continues to focus on higher-quality issuers in the education, transportation, and health care sectors. As much of the short-term municipal market requires some form of bank support, we are looking to only the highest-quality banks for such backing. The ongoing problems facing some bank guarantors, such as the Belgian bank Dexia, have prompted us to eliminate positions in banks that serve as liquidity providers.
As the Fed has indicated its intent to maintain the current low fed funds target rate until well into 2013, the prospect of higher income for money fund investors continues to be deferred. Nonetheless, investors clearly rely on their fund investments as a source of stability in uncertain markets and as a ready source of liquidity. Our focus on meeting these needs remains unchanged throughout this challenging period.
New York Tax-Free Bond Fund
The New York Tax-Free Bond Fund returned 6.23% for the six-month period ended August 31, 2011. The gain modestly exceeded that of our Lipper peer group average. The fund’s long-term record relative to its competitors also remains favorable. (Based on cumulative total return, Lipper ranked the New York Tax-Free Bond Fund 13 of 92, 30 of 84, 20 of 76, and 16 of 68 New York state municipal debt funds for the 1-, 3-, 5-, and 10-year periods ended August 31, 2011, respectively. Returns will vary for other periods. Past performance cannot guarantee future results.)
The municipal bond market has rebounded following fairly lackluster performance early in the year. Two main factors have driven the municipal market’s strong performance in recent months. A limited supply of new municipal bond issues—combined with steady demand from investors reinvesting proceeds from maturing issues and seeking a higher-yielding alternative for cash—pushed yields down and lifted municipal bond prices by the end of the reporting period. Furthermore, a rally in U.S. Treasuries spurred by renewed recession fears and a global flight to quality amid the spreading European debt crisis also benefited municipal bond prices.
Over the past six months, we positioned the fund to benefit from an overweight to long- and short-term securities. This posture of underweighting intermediate-term bonds relative to the Barclays Capital Municipal Bond Index was based on our concern that securities in the 3- to 10-year range were susceptible to higher rates, which did not come to fruition. While this defensive positioning weighed on performance, the fund outperformed its benchmark due to its allocation of securities with longer maturities that offered higher yields.
The fund’s duration—a measure of its sensitivity to changes in interest rates—was slightly shorter than that of its peers for most of the period and declined from 7.1 years to 5.1 years as rates moved lower late in the period. The fund’s 30-day SEC yield also declined from 3.92% to 3.18% due to falling market rates. However, the fund’s weighted average maturity increased from 16.3 years to 16.6 years over the past six months. Overall quality diversification was relatively unchanged, although we increased the fund’s exposure to AAA rated bonds by five percentage points to 7% of the portfolio and increased AA rated bonds by five percentage points to 49%. The fund remains a high-quality portfolio with 83% of securities rated A and higher. We will continue to ensure that all securities in our portfolio meet the rigorous demands of our in-house research.
Overall trading activity was modest and a reflection of light new issuance. Nevertheless, we were net buyers of bonds, reinvesting cash from coupon income and bond maturities. Additions to the fund were mostly in the 15- to 30-year range as the steep yield curve kept rates in the long end compelling. We slightly decreased exposure to U.S. territory bonds from Puerto Rico and the Virgin Islands near the end of the reporting period due to strong performance. The issuance calendar is expected to pick up throughout the remainder of 2011 and will offer an opportunity for reinvestment as well as to test the market’s appetite for historically low yields.
We increased our allocation to the education sector, which is now the fund’s largest, at 15.5%. The move reflects the state’s abundance of well-regarded higher education institutions—both state and private—that issue tax-exempt debt. Transportation is our second-largest allocation. The fund is overweight versus the benchmark in health care, which offers significantly higher yields relative to other sectors with comparable ratings. However, we remain concerned that curbs on reimbursement costs in Medicaid and potential federal cuts in Medicare could have an adverse effect on health care. Within the sector, we have selectively invested in individual issues that we have deemed appropriate through our in-house analysts’ fundamental credit research. We favor revenue bonds and remain underweight relative to the benchmark in GO debt as both the state and a number of localities may continue to face challenging budget environments.
A rated and BBB rated securities, including the health care and higher education sectors, produced strong results as they bounced back from weak demand and valuations earlier in the year. The fund’s biggest underperformers consisted mostly of short-duration maturities of less than three years.
OUTLOOK
While we are pleased with the improved performance of and sentiment toward municipal bonds, we acknowledge that the credit and economic environment for municipalities is likely to remain challenging. The slow economic recovery, the housing market downturn, and high unemployment have reduced the tax revenues collected by state and local governments, and municipal bond defaults, which historically have been rare, could increase moderately. Defaults have been mostly limited to the smallest issuers in the riskiest of sectors, such as land-backed, multifamily housing, or hospitals. Income and sales tax revenues have begun to increase, providing some support for state governments. On the other hand, cutbacks in state support and persistent declines in property tax revenues will keep local municipal issuers vulnerable. If the economy slides back into a recession—which we are not predicting—municipalities will face even tougher challenges.
State and local government liabilities such as pension benefits and health care costs are a growing long-term concern. Maintaining balanced budgets and addressing these long-term pressures require careful and dedicated work by state and local officials. Many issuers are trying to make the difficult but necessary fiscal decisions as they adjust to high unemployment, slow economic growth, lower tax revenues, and other tough conditions. These efforts will need to continue—with or without additional federal government assistance.
While it is true that S&P downgraded several thousand municipal issues directly linked to U.S. Treasuries (such as prerefunded bonds) shortly after downgrading the U.S. government’s long-term credit rating, we continue to believe that the municipal bond market is a high-quality market, with good opportunities for long-term investors. While shorter-term securities have unattractive absolute yields and could be vulnerable if the economy picks up unexpectedly, longer-term and lower-rated investment-grade bonds continue to offer a reasonable yield advantage. We expect demand for munis to continue increasing as fears of major municipal defaults wane and investors seek attractive tax-free income in an environment of low interest rates.
We believe T. Rowe Price’s strong credit research capabilities have been and will remain an asset for our investors. We conduct our own thorough research and assign independent credit ratings before making investment decisions. As always, we are on the lookout for attractively valued bonds issued by municipalities with good fundamentals—an investment strategy that has served our investors well in the past.
Respectfully submitted,
Joseph K. Lynagh
Chairman of the Investment Advisory Committee
New York Tax-Free Money Fund
Konstantine B. Mallas
Chairman of the Investment Advisory Committee
New York Tax-Free Bond Fund
September 15, 2011
The committee chairmen have day-to-day responsibility for managing the portfolios and work with committee members in developing and executing the funds’ investment programs.
RISKS OF FIXED INCOME INVESTING
Since money market funds are managed to maintain a constant $1.00 share price, there should be little risk of principal loss. However, there is no assurance the fund will avoid principal losses if fund holdings default or are downgraded or if interest rates rise sharply in an unusually short period. In addition, the fund’s yield will vary; it is not fixed for a specific period like the yield on a bank certificate of deposit. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in it. Bonds are subject to interest rate risk (the decline in bond prices that usually accompanies a rise in interest rates) and credit risk (the chance that any fund holding could have its credit rating downgraded or that a bond issuer will default by failing to make timely payments of interest or principal), potentially reducing the fund’s income level and share price.
GLOSSARY
Barclays Capital Municipal Bond Index: A broadly diversified index of tax-exempt bonds.
Barclays Capital U.S. Aggregate Index: An unmanaged index that tracks domestic investment-grade bonds, including corporate, government, and mortgage-backed securities.
Basis point: One one-hundredth of one percentage point, or 0.01%.
Duration: A measure of a bond fund’s sensitivity to changes in interest rates. For example, a fund with a duration of five years would fall about 5% in price in response to a one-percentage-point rise in interest rates, and vice versa.
Federal funds rate: The interest rate charged on overnight loans of reserves by one financial institution to another in the United States. The Federal Reserve sets a target federal funds rate to affect the direction of interest rates.
General obligation debt: A government’s strongest pledge that obligates its full faith and credit, including, if necessary, its ability to raise taxes.
Gross domestic product (GDP): The total market value of all goods and services produced in a country in a given year.
Investment grade: High-quality bonds as measured by one of the major credit rating agencies. For example, Standard & Poor’s designates the bonds in its top four categories (AAA to BBB) as investment grade.
LIBOR: The London Interbank Offered Rate is a benchmark for short-term taxable rates.
Lipper averages: The averages of available mutual fund performance returns for specified time periods in defined categories as tracked by Lipper Inc.
Prerefunded bond: A bond that originally may have been issued as a general obligation or revenue bond but that is now secured by an escrow fund consisting entirely of direct U.S. government obligations that are sufficient for paying the bondholders.
Revenue (or revenue-backed) bond: A bond issued to fund specific projects, such as airports, bridges, hospitals, and toll roads, where a portion of the revenue generated is used to service the interest payments on the bond.
SEC yield (7-day simple): A method of calculating a money fund’s yield by annualizing the fund’s net investment income for the last seven days of each period divided by the fund’s net asset value at the end of the period. Yield will vary and is not guaranteed.
SEC yield (30-day): A method of calculating a fund’s yield that assumes all securities are held until maturity. Yield will vary and is not guaranteed.
Weighted average life: A measure of a fund’s credit quality risk. In general, the longer the average life, the greater the fund’s credit quality risk. The average life is the dollar-weighted average maturity of a portfolio’s individual securities without taking into account interest rate readjustment dates. Money funds must maintain a weighted average life of less than 120 days.
Weighted average maturity: A measure of a fund’s interest rate sensitivity. In general, the longer the average maturity, the greater the fund’s sensitivity to interest rate changes. The weighted average maturity may take into account the interest rate readjustment dates for certain securities. Money funds must maintain a weighted average maturity of less than 60 days.
Yield curve: A graph depicting the relationship between yields and maturity dates for a set of similar securities. These curves are in constant flux. One of the key activities in managing any fixed income portfolio is to study the trends reflected by yield curves.
Performance and Expenses
| GROWTH OF $10,000 |
This chart shows the value of a hypothetical $10,000 investment in the fund over the past 10 fiscal year periods or since inception (for funds lacking 10-year records). The result is compared with benchmarks, which may include a broad-based market index and a peer group average or index. Market indexes do not include expenses, which are deducted from fund returns as well as mutual fund averages and indexes.
| GROWTH OF $10,000 |
This chart shows the value of a hypothetical $10,000 investment in the fund over the past 10 fiscal year periods or since inception (for funds lacking 10-year records). The result is compared with benchmarks, which may include a broad-based market index and a peer group average or index. Market indexes do not include expenses, which are deducted from fund returns as well as mutual fund averages and indexes.
| FUND EXPENSE EXAMPLE |
As a mutual fund shareholder, you may incur two types of costs: (1) transaction costs, such as redemption fees or sales loads, and (2) ongoing costs, including management fees, distribution and service (12b-1) fees, and other fund expenses. The following example is intended to help you understand your ongoing costs (in dollars) of investing in the fund and to compare these costs with the ongoing costs of investing in other mutual funds. The example is based on an investment of $1,000 invested at the beginning of the most recent six-month period and held for the entire period.
Actual Expenses
The first line of the following table (“Actual”) provides information about actual account values and expenses based on the fund’s actual returns. You may use the information on this line, together with your account balance, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number on the first line under the heading “Expenses Paid During Period” to estimate the expenses you paid on your account during this period.
Hypothetical Example for Comparison Purposes
The information on the second line of the table (“Hypothetical”) is based on hypothetical account values and expenses derived from the fund’s actual expense ratio and an assumed 5% per year rate of return before expenses (not the fund’s actual return). You may compare the ongoing costs of investing in the fund with other funds by contrasting this 5% hypothetical example and the 5% hypothetical examples that appear in the shareholder reports of the other funds. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period.
Note: T. Rowe Price charges an annual account service fee of $20, generally for accounts with less than $10,000 ($1,000 for UGMA/UTMA). The fee is waived for any investor whose T. Rowe Price mutual fund accounts total $50,000 or more; accounts employing automatic investing; accounts electing to receive electronic delivery of account statements, transaction confirmations, and prospectuses and shareholder reports; accounts of an investor who is a T. Rowe Price Preferred Services, Personal Services, or Enhanced Personal Services client (enrollment in these programs generally requires T. Rowe Price assets of at least $100,000); and IRAs and other retirement plan accounts that utilize a prototype plan sponsored by T. Rowe Price (although a separate custodial or administrative fee may apply to such accounts). This fee is not included in the accompanying table. If you are subject to the fee, keep it in mind when you are estimating the ongoing expenses of investing in the fund and when comparing the expenses of this fund with other funds.
You should also be aware that the expenses shown in the table highlight only your ongoing costs and do not reflect any transaction costs, such as redemption fees or sales loads. Therefore, the second line of the table is useful in comparing ongoing costs only and will not help you determine the relative total costs of owning different funds. To the extent a fund charges transaction costs, however, the total cost of owning that fund is higher.
Unaudited
The accompanying notes are an integral part of these financial statements.
Unaudited
The accompanying notes are an integral part of these financial statements.
Unaudited
The accompanying notes are an integral part of these financial statements.
Unaudited
The accompanying notes are an integral part of these financial statements.
Unaudited
The accompanying notes are an integral part of these financial statements.
Unaudited
| NOTES TO FINANCIAL STATEMENTS |
T. Rowe Price State Tax-Free Income Trust (the trust), is registered under the Investment Company Act of 1940 (the 1940 Act). The New York Tax-Free Bond Fund (the fund), a nondiversified, open-end management investment company, is one portfolio established by the trust. The fund commenced operations on August 28, 1986. The fund seeks to provide, consistent with prudent portfolio management, the highest level of income exempt from federal, New York state, and New York City income taxes by investing primarily in investment-grade New York municipal bonds.
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
Basis of Preparation The accompanying financial statements were prepared in accordance with accounting principles generally accepted in the United States of America (GAAP), which require the use of estimates made by management. Management believes that estimates and valuations are appropriate; however, actual results may differ from those estimates, and the valuations reflected in the accompanying financial statements may differ from the value ultimately realized upon sale or maturity.
Investment Transactions, Investment Income, and Distributions Income and expenses are recorded on the accrual basis. Premiums and discounts on debt securities are amortized for financial reporting purposes. Income tax-related interest and penalties, if incurred, would be recorded as income tax expense. Investment transactions are accounted for on the trade date. Realized gains and losses are reported on the identified cost basis. Distributions to shareholders are recorded on the ex-dividend date. Income distributions are declared daily and paid monthly. Capital gain distributions, if any, are generally declared and paid by the fund annually.
Credits The fund earns credits on temporarily uninvested cash balances held at the custodian, which reduce the fund’s custody charges. Custody expense in the accompanying financial statements is presented before reduction for credits.
NOTE 2 - VALUATION
The fund’s financial instruments are reported at fair value as defined by GAAP. The fund determines the values of its assets and liabilities and computes its net asset value per share at the close of the New York Stock Exchange (NYSE), normally 4 p.m. ET, each day that the NYSE is open for business.
Valuation Methods Debt securities are generally traded in the over-the-counter (OTC) market. Securities with remaining maturities of one year or more at the time of acquisition are valued at prices furnished by dealers who make markets in such securities or by an independent pricing service, which considers the yield or price of bonds of comparable quality, coupon, maturity, and type, as well as prices quoted by dealers who make markets in such securities. Securities with remaining maturities of less than one year at the time of acquisition generally use amortized cost in local currency to approximate fair value. However, if amortized cost is deemed not to reflect fair value or the fund holds a significant amount of such securities with remaining maturities of more than 60 days, the securities are valued at prices furnished by dealers who make markets in such securities or by an independent pricing service.
Other investments, including restricted securities, private placements, and those financial instruments for which the above valuation procedures are inappropriate or are deemed not to reflect fair value are stated at fair value as determined in good faith by the T. Rowe Price Valuation Committee, established by the fund’s Board of Trustees. Subject to oversight by the fund’s Board of Trustees, the Valuation Committee develops pricing-related policies and procedures and approves all fair valuation determinations. The Valuation Committee regularly makes good faith judgments, using a wide variety of sources and information, to establish and adjust valuations of certain securities as events occur and circumstances warrant. For instance, in determining the fair value of private equity instruments, the Valuation Committee considers a variety of factors including the company’s business prospects, its financial performance, strategic events impacting the company, relevant valuations of similar companies, new rounds of financing, and any negotiated transactions of significant size between other investors in the company. Because any fair value determinations made for portfolio holdings involve a significant amount of judgment, there is a degree of subjectivity inherent in such pricing decisions.
Valuation Inputs Various inputs are used to determine the value of the fund’s financial instruments. These inputs are summarized in the three broad levels listed below:
Level 1 – quoted prices in active markets for identical financial instruments
Level 2 – observable inputs other than Level 1 quoted prices (including, but not limited to, quoted prices for similar financial instruments, interest rates, prepayment speeds, and credit risk)
Level 3 – unobservable inputs
Observable inputs are those based on market data obtained from sources independent of the fund, and unobservable inputs reflect the fund’s own assumptions based on the best information available. The input levels are not necessarily an indication of the risk or liquidity associated with financial instruments at that level. On August 31, 2011, all of the fund’s financial instruments were classified as Level 2, based on the inputs used to determine their values.
NOTE 3 - OTHER INVESTMENT TRANSACTIONS
Consistent with its investment objective, the fund engages in the following practices to manage exposure to certain risks and/or to enhance performance. The investment objective, policies, program, and risk factors of the fund are described more fully in the fund’s prospectus and Statement of Additional Information.
Restricted Securities The fund may invest in securities that are subject to legal or contractual restrictions on resale. Prompt sale of such securities at an acceptable price may be difficult and may involve substantial delays and additional costs.
Other Purchases and sales of portfolio securities other than short-term securities aggregated $24,711,000 and $14,771,000, respectively, for the six months ended August 31, 2011.
NOTE 4 - FEDERAL INCOME TAXES
No provision for federal income taxes is required since the fund intends to continue to qualify as a regulated investment company under Subchapter M of the Internal Revenue Code and distribute to shareholders all of its income and gains. Distributions determined in accordance with federal income tax regulations may differ in amount or character from net investment income and realized gains for financial reporting purposes. Financial reporting records are adjusted for permanent book/tax differences to reflect tax character but are not adjusted for temporary differences. The amount and character of tax-basis distributions and composition of net assets are finalized at fiscal year-end; accordingly, tax-basis balances have not been determined as of the date of this report.
The fund intends to retain realized gains to the extent of available capital loss carryforwards. As of February 28, 2011, the fund had $1,534,000 of unused capital loss carryforwards, which expire: $1,086,000 in fiscal 2017 and $448,000 in fiscal 2018.
At August 31, 2011, the cost of investments for federal income tax purposes was $331,895,000. Net unrealized gain aggregated $12,516,000 at period-end, of which $14,719,000 related to appreciated investments and $2,203,000 related to depreciated investments.
NOTE 5 - RELATED PARTY TRANSACTIONS
The fund is managed by T. Rowe Price Associates, Inc. (Price Associates), a wholly owned subsidiary of T. Rowe Price Group, Inc. (Price Group). The investment management agreement between the fund and Price Associates provides for an annual investment management fee, which is computed daily and paid monthly. The fee consists of an individual fund fee, equal to 0.10% of the fund’s average daily net assets, and a group fee. The group fee rate is calculated based on the combined net assets of certain mutual funds sponsored by Price Associates (the group) applied to a graduated fee schedule, with rates ranging from 0.48% for the first $1 billion of assets to 0.28% for assets in excess of $300 billion. The fund’s group fee is determined by applying the group fee rate to the fund’s average daily net assets. At August 31, 2011, the effective annual group fee rate was 0.30%.
In addition, the fund has entered into service agreements with Price Associates and a wholly owned subsidiary of Price Associates (collectively, Price). Price Associates computes the daily share price and provides certain other administrative services to the fund. T. Rowe Price Services, Inc., provides shareholder and administrative services in its capacity as the fund’s transfer and dividend disbursing agent. For the six months ended August 31, 2011, expenses incurred pursuant to these service agreements were $49,000 for Price Associates and $51,000 for T. Rowe Price Services, Inc. The total amount payable at period-end pursuant to these service agreements is reflected as Due to Affiliates in the accompanying financial statements.
| INFORMATION ON PROXY VOTING POLICIES, PROCEDURES, AND RECORDS |
A description of the policies and procedures used by T. Rowe Price funds and portfolios to determine how to vote proxies relating to portfolio securities is available in each fund’s Statement of Additional Information, which you may request by calling 1-800-225-5132 or by accessing the SEC’s website, sec.gov. The description of our proxy voting policies and procedures is also available on our website, troweprice.com. To access it, click on the words “Our Company” at the top of our corporate homepage. Then, when the next page appears, click on the words “Proxy Voting Policies” on the left side of the page.
Each fund’s most recent annual proxy voting record is available on our website and through the SEC’s website. To access it through our website, follow the directions above, then click on the words “Proxy Voting Records” on the right side of the Proxy Voting Policies page.
| HOW TO OBTAIN QUARTERLY PORTFOLIO HOLDINGS |
The fund files a complete schedule of portfolio holdings with the Securities and Exchange Commission for the first and third quarters of each fiscal year on Form N-Q. The fund’s Form N-Q is available electronically on the SEC’s website (sec.gov); hard copies may be reviewed and copied at the SEC’s Public Reference Room, 450 Fifth St. N.W., Washington, DC 20549. For more information on the Public Reference Room, call 1-800-SEC-0330.
| APPROVAL OF INVESTMENT MANAGEMENT AGREEMENT |
On March 9, 2011, the fund’s Board of Trustees (Board) unanimously approved the continuation of the investment advisory contract (Contract) between the fund and its investment advisor, T. Rowe Price Associates, Inc. (Advisor). The Board considered a variety of factors in connection with its review of the Contract, also taking into account information provided by the Advisor during the course of the year, as discussed below:
Services Provided by the Advisor
The Board considered the nature, quality, and extent of the services provided to the fund by the Advisor. These services included, but were not limited to, management of the fund’s portfolio and a variety of related activities, as well as financial and administrative services, reporting, and communications. The Board also reviewed the background and experience of the Advisor’s senior management team and investment personnel involved in the management of the fund. The Board concluded that it was satisfied with the nature, quality, and extent of the services provided by the Advisor.
Investment Performance of the Fund
The Board reviewed the fund’s average annual total returns over the 1-, 3-, 5-, and 10-year periods, as well as the fund’s year-by-year returns, and compared these returns with a wide variety of previously agreed upon comparable performance measures and market data, including those supplied by Lipper and Morningstar, which are independent providers of mutual fund data. On the basis of this evaluation and the Board’s ongoing review of investment results, and factoring in the relative market conditions during certain of the performance periods, the Board concluded that the fund’s performance was satisfactory.
Costs, Benefits, Profits, and Economies of Scale
The Board reviewed detailed information regarding the revenues received by the Advisor under the Contract and other benefits that the Advisor (and its affiliates) may have realized from its relationship with the fund, including research received under “soft dollar” agreements and commission-sharing arrangements with broker-dealers. The Board considered that the Advisor may receive some benefit from soft-dollar arrangements pursuant to which research is received from broker-dealers that execute the applicable fund’s portfolio transactions. The Board also received information on the estimated costs incurred and profits realized by the Advisor and its affiliates from advising T. Rowe Price mutual funds, as well as estimates of the gross profits realized from managing the fund in particular. The Board concluded that the Advisor’s profits were reasonable in light of the services provided to the fund. The Board also considered whether the fund or other funds benefit under the fee levels set forth in the Contract from any economies of scale realized by the Advisor. Under the Contract, the fund pays a fee to the Advisor composed of two components—a group fee rate based on the aggregate assets of certain T. Rowe Price mutual funds (including the fund) that declines at certain asset levels and an individual fund fee rate that is assessed on the assets of the fund. The Board determined that it would be appropriate to introduce another breakpoint into the group fee rate, effective May 1, 2011, to allow fund shareholders to participate in additional economies of scale. The Board concluded that the advisory fee structure for the fund continued to provide for a reasonable sharing of benefits from any economies of scale with the fund’s investors.
Fees
The Board reviewed the fund’s management fee rate, operating expenses, and total expense ratio and compared them with fees and expenses of other comparable funds based on information and data supplied by Lipper. The information provided to the Board indicated that the fund’s management fee rate was above the median for certain groups of comparable funds but at or below the median for other groups of comparable funds. The information also indicated that the fund’s total expense ratio was above the median for certain groups of comparable funds but below the median for other groups of comparable funds. The Board also reviewed the fee schedules for institutional accounts of the Advisor and its affiliates with similar mandates. Management provided the Board with information about the Advisor’s responsibilities and services provided to institutional account clients, which are more limited than its responsibilities for the fund and other T. Rowe Price mutual funds that it advises, and showing that the Advisor performs significant additional services and assumes greater risk for the fund and other T. Rowe Price mutual funds that it advises than it does for institutional account clients. On the basis of the information provided, the Board concluded that the fees paid by the fund under the Contract were reasonable.
Approval of the Contract
As noted, the Board approved the continuation of the Contract. No single factor was considered in isolation or to be determinative to the decision. Rather, the Board was assisted by the advice of independent legal counsel and concluded, in light of a weighting and balancing of all factors considered, that it was in the best interests of the fund to approve the continuation of the Contract (including the fees to be charged for services thereunder).
Item 2. Code of Ethics.
A code of ethics, as defined in Item 2 of Form N-CSR, applicable to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions is filed as an exhibit to the registrant’s annual Form N-CSR. No substantive amendments were approved or waivers were granted to this code of ethics during the registrant’s most recent fiscal half-year.
Item 3. Audit Committee Financial Expert.
Disclosure required in registrant’s annual Form N-CSR.
Item 4. Principal Accountant Fees and Services.
Disclosure required in registrant’s annual Form N-CSR.
Item 5. Audit Committee of Listed Registrants.
Not applicable.
Item 6. Investments.
(a) Not applicable. The complete schedule of investments is included in Item 1 of this Form N-CSR.
(b) Not applicable.
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies.
Not applicable.
Item 8. Portfolio Managers of Closed-End Management Investment Companies.
Not applicable.
Item 9. Purchases of Equity Securities by Closed-End Management Investment Company and Affiliated Purchasers.
Not applicable.
Item 10. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 11. Controls and Procedures.
(a) The registrant’s principal executive officer and principal financial officer have evaluated the registrant’s disclosure controls and procedures within 90 days of this filing and have concluded that the registrant’s disclosure controls and procedures were effective, as of that date, in ensuring that information required to be disclosed by the registrant in this Form N-CSR was recorded, processed, summarized, and reported timely.
(b) The registrant’s principal executive officer and principal financial officer are aware of no change in the registrant’s internal control over financial reporting that occurred during the registrant’s second
fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.
Item 12. Exhibits.
(a)(1) The registrant’s code of ethics pursuant to Item 2 of Form N-CSR is filed with the registrant’s annual Form N-CSR.
(2) Separate certifications by the registrant's principal executive officer and principal financial officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 and required by Rule 30a-2(a) under the Investment Company Act of 1940, are attached.
(3) Written solicitation to repurchase securities issued by closed-end companies: not applicable.
(b) A certification by the registrant's principal executive officer and principal financial officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and required by Rule 30a-2(b) under the Investment Company Act of 1940, is attached.
SIGNATURES | |
| Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment | |
| Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the | |
| undersigned, thereunto duly authorized. | |
| T. Rowe Price State Tax-Free Income Trust | |
| By | /s/ Edward C. Bernard |
| Edward C. Bernard | |
| Principal Executive Officer | |
| Date | October 14, 2011 |
| Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment | |
| Company Act of 1940, this report has been signed below by the following persons on behalf of | |
| the registrant and in the capacities and on the dates indicated. | |
| By | /s/ Edward C. Bernard |
| Edward C. Bernard | |
| Principal Executive Officer | |
| Date | October 14, 2011 |
| By | /s/ Gregory K. Hinkle |
| Gregory K. Hinkle | |
| Principal Financial Officer | |
| Date | October 14, 2011 |