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The information in this statement of additional information is not complete
and may be changed. This statement of additional information and the
accompanying prospectus are not an offer to sell these securities and we
are not soliciting an offer to buy these securities in any jurisdiction
where the offer or sale is not permitted.
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JPMORGAN FUNDS
STATEMENT OF
ADDITIONAL INFORMATION
AUGUST __, 2001
(SUBJECT TO COMPLETION, DATED MAY 8, 2001)
JPMORGAN INTERMEDIATE TAX FREE INCOME FUND
JPMORGAN NEW YORK INTERMEDIATE TAX FREE INCOME FUND
JPMORGAN FLEMING EUROPEAN FUND
522 FIFTH AVENUE, NEW YORK, NEW YORK 10036
This Statement of Additional Information sets forth information which
may be of interest to investors but which is not necessarily included in the
Prospectuses offering shares of the Funds. This Statement of Additional
Information should be read in conjunction with the Prospectus dated August
__, 2001, offering shares of JPMorgan Intermediate Tax Free Income Fund,
JPMorgan New York Intermediate Tax Free Income Fund and JPMorgan Fleming
European Fund. Any reference to a "Prospectus" in this Statement of
Additional Information is a reference to the foregoing Prospectuses. Copies
of the Prospectus may be obtained by an investor without charge by contacting
J.P. Morgan Fund Distributors, Inc., the Funds' distributor (the
"Distributor"), at the above-listed address.
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS AND IS AUTHORIZED
FOR DISTRIBUTION TO PROSPECTIVE INVESTORS ONLY IF PRECEDED OR ACCOMPANIED BY AN
EFFECTIVE PROSPECTUS.
For more information about the Funds, simply call or write the JPMorgan Funds
Service Center at:
1-800-622-4273
JPMORGAN FUNDS SERVICE CENTER
P.O. BOX 219392
KANSAS CITY, MO 64121
MFST-SAI-401
TABLE OF CONTENTS PAGE
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The Funds.................................................................. 3
Investment Policies and Restrictions....................................... 3
Performance Information.................................................... 17
Determination of Net Asset Value........................................... 21
Purchases and Redemptions.................................................. 22
Tax Matters................................................................ 27
Management of the Trust and the Funds...................................... 32
Independent Accountants.................................................... 42
Certain Regulatory Matters................................................. 42
General Information........................................................ 42
Appendix A--Description of Certain Obligations Issued or Guaranteed by
U.S. Government Agencies or Instrumentalities............................ A-1
Appendix B--Description of Ratings......................................... B-1
Appendix C--Special Investment Considerations Relating to
New York Municipal Obligations........................................... C-1
2
THE FUNDS
Mutual Fund Select Trust and Mutual Fund Group (collectively, the
"Trust") are open-end management investment companies which were organized as
business trusts under the laws of the Commonwealth of Massachusetts on
October 1, 1996 and May 11, 1987 respectively. Each Trust presently consists
of separate series, including the JPMorgan Intermediate Tax Free Income Fund,
JPMorgan New York Intermediate Tax Free Income Fund and JPMorgan Fleming
European Fund (collectively, the "Funds"). Certain of the Funds are
non-diversified, as such term is defined in the Investment Company Act of
1940, as amended (the "1940 Act"). The shares of the Funds are collectively
referred to in this Statement of Additional Information as the "Shares."
The Board of Trustees of the Trust provides broad supervision over the
affairs of the Trust including the Funds. J.P. Morgan Fleming Asset
Management (USA) Inc. ("JPMFAM") is the investment adviser for the Funds. The
Chase Manhattan Bank ("Chase") serves as the Trusts' administrator (the
"Administrator") and supervises the overall administration of the Trusts,
including the Funds. A majority of the Trustees of the Trust are not
affiliated with the investment adviser or sub-advisers.
Effective as of December 29, 1997, New York Tax Free Income Fund changed
its name to New York Intermediate Tax Free Income Fund.
Effective February 28, 2001, the following Funds were renamed with the
approval of the Board of Trustees of the Trust:
NEW NAME FORMER NAME
- -------- -----------
JPMorgan Intermediate Tax Free Income Fund Chase Vista Select Intermediate Tax Free
(Intermediate Tax Free Income Fund) Income Fund
JPMorgan New York Intermediate Tax Free Income Fund Chase Vista Select New York Intermediate
(New York Intermediate Tax Free Income Fund) Tax Free Income Fund
JPMorgan Fleming European Fund (European Fund) Chase Vista European Fund
INVESTMENT POLICIES AND RESTRICTIONS
INVESTMENT POLICIES
The Prospectuses set forth the various investment policies applicable to
each Fund. The following information supplements and should be read in
conjunction with the related sections of each Prospectus. As used in this
Statement of Additional Information, with respect to those Funds and policies
for which they apply, the terms "Municipal Obligations" and "tax-exempt
securities" have the meanings given to them in the relevant Fund's Prospectus.
For descriptions of the securities ratings of Moody's Investors Service, Inc.
("Moody's"), Standard & Poor's Corporation ("S&P") and Fitch Investors Service,
Inc. ("Fitch"), see Appendix B. For a general discussion of special investment
considerations relating to investing in New York Municipal Obligations, see
Appendix C.
The management style used for the Funds emphasizes several key factors.
Portfolio managers consider the security quality--that is, the ability of the
debt issuer to make timely payments of principal and interest. Also important in
the analysis is the relationship of a bond's yield and its maturity, in which
the managers evaluate the risks of investing in long-term higher-yielding
securities. Managers also use a computer model to simulate possible fluctuations
in prices and yields if interest rates change. Another step in the analysis is
comparing yields on different types of securities to determine relative
risk/reward profiles.
U.S. GOVERNMENT SECURITIES. U.S. government securities include (1) U.S.
Treasury obligations, which generally differ only in their interest rates,
maturities and times of issuance, including U.S. Treasury bills
3
(maturities of one year or less), U.S. Treasury notes (maturities of one to
ten years) and U.S. Treasury bonds (generally maturities of greater than ten
years); and (2) obligations issued or guaranteed by U.S. government agencies
and instrumentalities which are supported by any of the following: (a) the
full faith and credit of the U.S. Treasury, (b) the right of the issuer to
borrow any amount listed to a specific line of credit from the U.S. Treasury,
(c) discretionary authority of the U.S. government to purchase certain
obligations of the U.S. government agency or instrumentality or (d) the
credit of the agency or instrumentality. Agencies and instrumentalities of
the U.S. government include but are not limited to: Federal Land Banks,
Federal Financing Banks, Banks for Cooperatives, Federal Intermediate Credit
Banks, Farm Credit Banks, Federal Home Loan Banks, Federal Home Loan Mortgage
Corporation, Federal National Mortgage Association, Student Loan Marketing
Association, United States Postal Service, Chrysler Corporate Loan Guarantee
Board, Small Business Administration, Tennessee Valley Authority and any
other enterprise established or sponsored by the U.S. government. Certain
U.S. government securities, including U.S. Treasury bills, notes and bonds,
Government National Mortgage Association certificates and Federal Housing
Administration debentures, are supported by the full faith and credit of the
United States. Other U.S. government securities are issued or guaranteed by
federal agencies or government sponsored enterprises and are not supported by
the full faith and credit of the United States. These securities include
obligations that are supported by the right of the issuer to borrow from the
U.S. Treasury, such as obligations of Federal Home Loan Banks, and
obligations that are supported by the creditworthiness of the particular
instrumentality, such as obligations of the Federal National Mortgage
Association or Federal Home Loan Mortgage Corporation. Agencies and
instrumentalities issuing such obligations include the Farm Credit System
Financial Assistance Corporation, the Federal Financing Bank, The General
Services Administration, Federal Home Loan Banks, the Tennessee Valley
Authority and the Student Loan Marketing Association. For a description of
certain obligations issued or guaranteed by U.S. government agencies and
instrumentalities, see Appendix A.
In addition, certain U.S. government agencies and instrumentalities issue
specialized types of securities, such as guaranteed notes of the Small Business
Administration, Federal Aviation Administration, Department of Defense, Bureau
of Indian Affairs and Private Export Funding Corporation, which often provide
higher yields than are available from the more common types of government-backed
instruments. However, such specialized instruments may only be available from a
few sources, in limited amounts, or only in very large denominations; they may
also require specialized capability in portfolio servicing and in legal matters
related to government guarantees. While they may frequently offer attractive
yields, the limited-activity markets of many of these securities means that, if
a Fund were required to liquidate any of them, it might not be able to do so
advantageously; accordingly, each Fund investing in such securities intends
normally to hold such securities to maturity or pursuant to repurchase
agreements, and would treat such securities (including repurchase agreements
maturing in more than seven days) as illiquid for purposes of its limitation on
investment in illiquid securities.
BANK OBLIGATIONS. Investments in bank obligations are limited to those
of U.S. banks (including their foreign branches) which have total assets at
the time of purchase in excess of $1 billion and the deposits of which are
insured by either the Bank Insurance Fund or the Savings and Loan Insurance
Fund of the Federal Deposit Insurance Corporation, and foreign banks
(including their U.S. branches) having total assets in excess of $10 billion
(or the equivalent in other currencies), and such other U.S. and foreign
commercial banks which are judged by the advisers to meet comparable credit
standing criteria.
Bank obligations include negotiable certificates of deposit, bankers'
acceptances, fixed time deposits and deposit notes. A certificate of deposit is
a short-term negotiable certificate issued by a commercial bank against funds
deposited in the bank and is either interest-bearing or purchased on a discount
basis. A bankers' acceptance is a short-term draft drawn on a commercial bank by
a borrower, usually in connection with an international commercial transaction.
The borrower is liable for payment as is the bank, which unconditionally
guarantees to pay the draft at its face amount on the maturity date. Fixed time
deposits are obligations of branches of United States banks or foreign banks
which are payable at a stated maturity date and bear a fixed rate of interest.
Although fixed time deposits do not have a market, there are no contractual
4
restrictions on the right to transfer a beneficial interest in the deposit to a
third party. Fixed time deposits subject to withdrawal penalties and with
respect to which a Fund cannot realize the proceeds thereon within seven days
are deemed "illiquid" for the purposes of its restriction on investments in
illiquid securities. Deposit notes are notes issued by commercial banks which
generally bear fixed rates of interest and typically have original maturities
ranging from eighteen months to five years.
Banks are subject to extensive governmental regulations that may limit
both the amounts and types of loans and other financial commitments that may
be made and the interest rates and fees that may be charged. The
profitability of this industry is largely dependent upon the availability and
cost of capital funds for the purpose of financing lending operations under
prevailing money market conditions. Also, general economic conditions play an
important part in the operations of this industry and exposure to credit
losses arising from possible financial difficulties of borrowers might affect
a bank's ability to meet its obligations. Bank obligations may be general
obligations of the parent bank or may be limited to the issuing branch by the
terms of the specific obligations or by government regulation. Investors
should also be aware that securities of foreign banks and foreign branches of
United States banks may involve foreign investment risks in addition to those
relating to domestic bank obligations. These investment risks may involve,
among other considerations, risks relating to future political and economic
developments, more limited liquidity of foreign obligations than comparable
domestic obligations, the possible imposition of withholding taxes on
interest income, the possible seizure or nationalization of foreign assets
and the possible establishment of exchange controls or other restrictions.
There also may be less publicly available information concerning foreign
issuers, difficulties in obtaining or enforcing a judgment against a foreign
issuer (including branches) and differences in accounting, auditing and
financial reporting standards and practices from those applicable to U.S.
issuers. In addition, foreign banks are also not subject to regulations
comparable to U.S. banking regulations. Certain national policies may also
impede the investment opportunities of the Funds in other ways, including
restrictions on investing in issuers or industries deemed sensitive to
relevant national interests.
FOREIGN SECURITIES. For purposes of a Fund's investment policies, an
issuer of a security may be deemed to be located in a particular country if
(i) the principal trading market for the security is in such country, (ii)
the issuer is organized under the laws of such country or (iii) the issuer
derives at least 50 percent of its revenue or profits from such country or
has at least 50 percent of its assets situated in such country.
DEPOSITARY RECEIPTS. Each Fund may invest its assets in securities of
multinational companies in the form of American Depositary Receipts or other
similar securities representing securities of foreign issuers, such as
European Depositary Receipts, Global Depositary Receipts and other similar
securities representing securities of foreign issuers (collectively,
"Depositary Receipts"). The Funds treat Depositary Receipts as interests in
the underlying securities for purposes of their investment policies.
Unsponsored Depositary Receipts may not carry comparable voting rights to
sponsored Depositary Receipts, and a purchaser of unsponsored Depositary
Receipts may not receive as much information about the issuer of the
underlying securities as with a sponsored Depositary Receipt.
COMMERCIAL PAPER. Commercial paper consists of short-term (usually from
1 to 270 days) unsecured promissory notes issued by corporations in order to
finance their current operations. A variable amount master demand note (which
is a type of commercial paper) represents a direct borrowing arrangement
involving periodically fluctuating rates of interest under a letter agreement
between a commercial paper issuer and an institutional lender pursuant to
which the lender may determine to invest varying amounts.
SUPRANATIONAL OBLIGATIONS. The Fleming European Fund may invest in
supranational obligations. Supranational organizations include organizations
such as The World Bank, which was chartered to finance development projects
in developing member countries; the European Union, which is a fifteen-nation
organization engaged in cooperative economic activities; and the Asian
Development Bank, which is an international development bank established to
lend funds, promote investment and provide technical assistance to member
nations of the Asian and Pacific regions.
MONEY MARKET INSTRUMENTS. Each Fund may invest in cash or high-quality,
short-term money market instruments. These may include U.S. government
securities, commercial paper of domestic and foreign issuers and obligations
of domestic and foreign banks. Investments in foreign money market
instruments may involve certain risks associated with foreign investment.
CORPORATE REORGANIZATIONS. In general securities that are subject to a
tender or exchange offer or proposal sell at a premium to their historic
market price immediately prior to the announcement of the offer or proposal.
The increased market price of these securities may also discount what the
stated or appraised value of the security would be if the contemplated action
were approved or consummated. These investments may be advantageous when the
discount significantly overstates the risk of the contingencies involved;
significantly undervalues the securities, assets or cash to be received by
shareholders of the prospective portfolio company as a result of the
contemplated transaction; or fails adequately to recognize the possibility
that the offer or proposal may be replaced or superseded by an offer or
proposal of greater value. The evaluation of these contingencies requires
unusually broad knowledge and experience on the part of the advisers that
must apprise not only the value of the issuer and its component businesses as
well as the assets or securities to be received as a result of the
contemplated transaction, but also the financial resources and business
motivation of the offeror as well as the dynamics of the business climate
when the offer or proposal is in progress. Investments in reorganization
securities may tend to increase the turnover ratio of a Fund and increase its
brokerage and other transaction expenses.
LOAN PARTICIPATIONS. The Funds may invest in participations in fixed
and floating rate loans arranged through private negotiations between a
borrower and one or more financial institutions. The Funds may have
difficulty disposing of participations because to do so it will have to
assign such securities to a third party. Because there is no established
secondary market for such securities, the Funds anticipate that such
securities could be sold only to a limited number of institutional investors.
The lack of an established secondary market may have an adverse impact on the
value of such securities and the Funds' ability to dispose of particular
assignments or participations when necessary to meet the Funds' liquidity
needs or in response to a specific economic event such as a deterioration in
the creditworthiness of the borrower. When investing in a participation, the
Funds will typically have the right to receive payments only from the lender,
and not from the borrower itself, to the extent the lender receives payments
from the borrower. Accordingly, the Funds may be subject to the credit risk
of both the borrower and the lender. The lack of an established secondary
market for assignments and participations also may make it more difficult for
the Funds to assign a value to these securities for purposes of valuing the
Funds' portfolio and calculating its net asset value. The Funds will not
invest more than 15% of the value of their net assets in participations and
assignments that are illiquid, and in other illiquid securities.
BRADY BONDS. The Fleming European Fund may invest in Brady Bonds. The
Brady Plan framework, as it has developed, contemplates the exchange of
external commercial bank debt for newly issued bonds, called Brady Bonds.
Brady Bonds may also be issued in respect of new money being advanced by
existing lenders in connection with the debt restructuring. Brady Bonds
issued to date generally have maturities of between 15 and 30 years from the
date of issuance. The Funds may invest in Brady Bonds of countries that have
been issued to date, as well as those which may be issued in the future.
Agreements implemented under the Brady Plan to date are designed to
achieve debt and debt-service reduction through specific options negotiated
by a debtor nation with its creditors. As a result, the financial packages
offered by each country differ. The types of options have included the
exchange of outstanding commercial bank debt for bonds issued at 100% of face
value of such debt which carry a below-market stated rate of interest
(generally known as par bonds), bonds issued at a discount from the face
value of such debt (generally known as discount bonds), bonds bearing an
interest rate which increases over time and bonds issued in exchange for the
advancement of new money by existing lenders. Regardless of the stated face
amount and stated interest rate of the various types of Brady Bonds, the
Funds will purchase Brady Bonds in secondary markets, as described below, in
which the price and yield to the investor reflect market conditions at the
time of purchase. Brady Bonds issued to date have traded at a deep discount
from their face value. Brady Bonds are often viewed as having three or four
valuation components: (i) the collateralized repayment of principal at final
maturity; (ii) the collateralized interest payments; (iii) the
uncollateralized interest payments; and (iv) any uncollateralized repayment
of principal at maturity (these uncollateralized amounts constitute the
"residual risk"). The Funds may purchase Brady Bonds with no or limited
collateralization and will be relying for payment of interest and (except in
the case of principal collateralized Brady Bonds) principal primarily on the
willingness and ability of the foreign government to make payment in
accordance with the terms of the Brady Bonds. Brady Bonds issued to date are
purchased and sold in secondary markets through U.S. securities dealers and
other financial institutions and are generally maintained through European
transnational securities depositories.
REPURCHASE AGREEMENTS. A Fund will enter into repurchase agreements
only with member banks of the Federal Reserve System and securities dealers
believed creditworthy, and only if fully collateralized by securities in
which such Fund is permitted to invest. Under the terms of a typical
repurchase agreement, a Fund would acquire an underlying debt instrument for
a relatively short period (usually not more than one week) subject to an
obligation of the seller to repurchase the instrument and the Fund to resell
the instrument at a fixed price and time, thereby determining the yield
during the Fund's holding period. This procedure results in a fixed rate of
return insulated from market fluctuations during such period. A repurchase
agreement is subject to the risk that the seller may fail to repurchase the
security. Repurchase agreements are considered under the 1940 Act to be loans
collateralized by the underlying securities. All repurchase agreements
entered into by a Fund will be fully collateralized at all times during the
period of the agreement in that the value of the underlying security will be
at least equal to 100% of the amount of the loan, including the accrued
interest thereon, and the Fund or its custodian or sub-custodian will have
possession of the collateral, which the Board of Trustees believes will give
it a valid, perfected security interest in the collateral. Whether a
repurchase agreement is the purchase and sale of a security or a
collateralized loan has not been conclusively established. This might become
an issue in the event of the bankruptcy of the other party to the
transaction. In the event of default by the seller under a repurchase
agreement construed to be a collateralized loan, the underlying securities
would not be owned by a Fund, but would only constitute collateral for the
seller's obligation to pay the repurchase price. Therefore, a Fund may suffer
time delays and incur costs in connection with the disposition of the
collateral. The Board of Trustees believes that the collateral underlying
repurchase agreements may be more susceptible to claims of the seller's
creditors than would be the case with securities owned by a Fund. Repurchase
agreements will give rise to income which will not qualify as tax-exempt
income when distributed by a Fund. Repurchase agreements maturing in more
than seven days are treated as illiquid for purposes of the Funds'
restrictions on purchases of illiquid securities. Repurchase agreements are
also subject to the risks described below with respect to stand-by
commitments.
REVERSE REPURCHASE AGREEMENTS. Reverse repurchase agreements involve
sales of portfolio securities of a Fund to member banks of the Federal
Reserve System or securities dealers believed creditworthy. Concurrently, a
Fund agrees to repurchase the same securities at a later date at a fixed
price which is generally equal to the original sales price plus interest. A
Fund retains record ownership and the right to receive interest and principal
payments on the portfolio security involved.
FORWARD COMMITMENTS. In order to invest a Fund's assets immediately,
while awaiting delivery of securities purchased on a forward commitment
basis, short-term obligations that offer same-day settlement and earnings
will normally be purchased. Although short-term investments will normally be
in tax-exempt securities or Municipal Obligations, short-term taxable
securities or obligations may be purchased if suitable
5
short-term tax-exempt securities or Municipal Obligations are not available.
When a commitment to purchase a security on a forward commitment basis is
made, procedures are established consistent with the General Statement of
Policy of the Securities and Exchange Commission concerning such purchases.
Since that policy currently recommends that an amount of the respective
Fund's assets equal to the amount of the purchase be held aside or segregated
to be used to pay for the commitment, a separate account of such Fund
consisting of cash, cash equivalents or high quality debt securities equal to
the amount of such Fund's commitments will be established at such Fund's
custodian bank. For the purpose of determining the adequacy of the securities
in the account, the deposited securities will be valued at market value. If
the market value of such securities declines, additional cash, cash
equivalents or highly liquid securities will be placed in the account daily
so that the value of the account will equal the amount of such commitments by
the respective Fund.
Although it is not intended that such purchases would be made for
speculative purposes, purchases of securities on a forward commitment basis
may involve more risk than other types of purchases. Securities purchased on
a forward commitment basis and the securities held in the respective Fund's
portfolio are subject to changes in value based upon the public's perception
of the creditworthiness of the issuer and changes, real or anticipated, in
the level of interest rates. Purchasing securities on a forward commitment
basis can involve the risk that the yields available in the market when the
delivery takes place may actually be higher or lower than those obtained in
the transaction itself. On the settlement date of the forward commitment
transaction, the respective Fund will meet its obligations from then
available cash flow, sale of securities held in the separate account, sale of
other securities or, although it would not normally expect to do so, from
sale of the forward commitment securities themselves (which may have a value
greater or lesser than such Fund's payment obligations). The sale of
securities to meet such obligations may result in the realization of capital
gains or losses, which are not exempt from federal, state or local taxation.
To the extent a Fund engages in forward commitment transactions, it will
do so for the purpose of acquiring securities consistent with its investment
objective and policies and not for the purpose of investment leverage, and
settlement of such transactions will be within 90 days from the trade date.
INVESTMENT GRADE DEBT SECURITIES. Each Fund may invest in investment
grade debt securities. Investment grade debt securities are securities that
are rated in the category BBB or higher by Standard & Poor's Corporation
("S&P"), Baa or higher by Moody's Investors Service, Inc. ("Moody's"), rated
at an equivalent level by another national rating organization or, if
unrated, determined by the advisers to be of comparable quality.
INDEXED INVESTMENTS. The Fleming European Fund may invest in
instruments which are indexed to certain specific foreign currency exchange
rates. The terms of such instruments may provide that their principal amounts
or just their coupon interest rates are adjusted upwards or downwards (but
not below zero) at maturity or on established coupon payment dates to reflect
changes in the exchange rate between two or more currencies while the
obligation is outstanding. Such indexed investments entail the risk of loss
of principal and/or interest paymnents from currency movements in addition to
principal risk, but offer the potential for realizing gains as a result of
changes in foreign currency exchange rates.
WARRANTS AND RIGHTS. Warrants basically are options to purchase equity
securities at a specified price for a specific period of time. Their prices
do not necessarily move parallel to the prices of the underlying securities.
Rights are similar to warrants but normally have a shorter duration and are
distributed directly by the issuer to shareholders. Rights and warrants have
no voting rights, receive no dividends and have no rights with respect to the
assets of the issuer.
SECURITIES LOANS. To the extent specified in the Prospectus, each Fund
is permitted to lend its securities to broker-dealers and other institutional
investors in order to genereate additional income. Such loans of portfolio
securities may not exceed 30% of the value of a Fund's total assets. In
connection with such loans, a Fund will receive collateral consisting of
cash, cash equivalents, U.S. Government securities or irrevocable letters of
credit issued by financial institutions. Such collateral will be maintained
at all times in an amount equal to at least 100% of the current market value
plus accrued interest of the securities loaned. A Fund can increase its
income through the investment of such collateral. A Fund continues to be
entitled to the interest payable or any dividend-equivalent payments received
on a loaned security, and, in addition, to receive interest on the amount of
the loan. However, the receipt of any dividend-equivalent payments by a Fund on
a loaned security from the borrower will not qualify for the dividends-received
deduction. Such loans will be terminable at ay time upon specified notice. A
Fund might experience risk of loss if the institutions with which it has
engaged in portfolio loan transactions breach their agreements with such Fund.
The risks in lending portfolio securities, as with other extensions of secured
credit, consist of possible delays in receiving additional collateral or in the
recovery of the securities or possible loss of rights in the collateral should
the borrower experience financial difficulty. Loans will be made only to firms
deemed by the advisers to be of good standing and will not be made unless, in
the judgment of the advisers, the considerations to be earned from such loans
justifies the risk.
OTHER INVESTMENT COMPANIES. Apart from being able to invest all of
their investable assets in another investment company having substantially
the same investment objectives and policies, each Fund may invest up to 10%
of its total assets in shares of other investment companies when consistent
with its investment objective and policies, subject to applicable regulatory
limitations. For purpose of this restriction, a Mauritius Company will not be
considered an investment company. Additional fees may be charged by other
investment companies.
ILLIQUID SECURITIES. For purposes of its limitation on investments in
illiquid securities, each Fund may elect to treat as liquid, in accordance with
procedures established by the Board of Trustees, certain investments in
restricted securities for which there may be a secondary market of qualified
institutional buyers as contemplated by Rule 144A under the Securities Act of
1933, as amended (the "Securities Act") and commercial obligations issued in
reliance on the so-called "private placement" exemption from registration
afforded by Section 4(2) of the Securities Act ("Section 4(2) paper"). Rule 144A
provides an exemption from the registration requirements of the Securities Act
for the resale of certain restricted securities to qualified institutional
buyers. Section 4(2) paper is restricted as to disposition under the federal
securities laws, and generally is sold to institutional investors such as a Fund
who agree that they are purchasing the paper for investment and not with a view
to public distribution. Any resale of Section 4(2) paper by the purchaser must
be in an exempt transaction.
One effect of Rule 144A and Section 4(2) is that certain restricted
securities may now be liquid, though there is no assurance that a liquid market
for Rule 144A securities or Section 4(2) paper will develop or be maintained.
The Trustees have adopted policies and procedures for the purpose of determining
whether securities that are eligible for resale under Rule 144A and Section 4(2)
paper are liquid or illiquid for purposes of the limitation on investment in
illiquid securities. Pursuant to those policies and procedures, the Trustees
have delegated to the advisers the determination as to whether a particular
instrument is liquid or illiquid, requiring that consideration be given to,
among other things, the frequency of trades and quotes for the security, the
number of dealers willing to sell the security and the number of potential
purchasers, dealer undertakings to make a market in the security, the nature of
the security and the time needed to dispose of the security. The Trustees will
periodically review the Funds' purchases and sales of Rule 144A securities and
Section 4(2) paper.
6
STAND-BY COMMITMENTS. When a Fund purchases securities it may also
acquire stand-by commitments with respect to such securities. Under a
stand-by commitment, a bank, broker-dealer or other financial institution
agrees to purchase at a Fund's option a specified security at a specified
price.
The stand-by commitments that may be entered into by the Funds are
subject to certain risks, which include the ability of the issuer of the
commitment to pay for the securities at the time the commitment is exercised,
the fact that the commitment is not marketable by a Fund, and that the
maturity of the underlying security will generally be different from that of
the commitment.
FLOATING AND VARIABLE RATE SECURITIES; PARTICIPATION CERTIFICATES.
Floating and variable rate demand instruments permit the holder to demand
payment upon a specified number of days' notice of the unpaid principal
balance plus accrued interest either from the issuer or by drawing on a bank
letter of credit, a guarantee or insurance issued with respect to such
instrument. Investments by the Funds in floating or variable rate securities
normally will involve industrial development or revenue bonds that provide
for a periodic adjustment in the interest rate paid on the obligation and
may, but need not, permit the holder to demand payment as described above.
While there is usually no established secondary market for issues of these
types of securities, the dealer that sells an issue of such security
frequently will also offer to repurchase the securities at any time at a
repurchase price which varies and may be more or less than the amount the
holder paid for them.
The terms of these types of securities provide that interest rates are
adjustable at intervals ranging from daily to up to six months and the
adjustments are based upon the prime rate of a bank or other short-term
rates, such as Treasury Bills or LIBOR (London Interbank Offered Rate), as
provided in the respective instruments. The Funds will decide which floating
or variable rate securities to purchase in accordance with procedures
prescribed by Board of Trustees of the Trust in order to minimize credit
risks.
The securities in which the Funds may be invested include participation
certificates, issued by a bank, insurance company or other financial
institution, in securities owned by such institutions or affiliated
organizations ("Participation Certificates"). A Participation Certificate
gives a Fund an undivided interest in the security in the proportion that the
Fund's participation interest bears to the total principal amount of the
security and generally provides the demand feature described below. Each
Participation Certificate is backed by an irrevocable letter of credit or
guaranty of a bank (which may be the bank issuing the Participation
Certificate, a bank issuing a confirming letter of credit to that of the
issuing bank, or a bank serving as agent of the issuing bank with respect to
the possible repurchase of the certificate of participation) or insurance
policy of an insurance company that the Board of Trustees of the Trust has
determined meets the prescribed quality standards for a particular Fund.
A Fund may have the right to sell the Participation Certificate back to
the institution and draw on the letter of credit or insurance on demand after
the prescribed notice period, for all or any part of the full principal
amount of the Fund's participation interest in the security, plus accrued
interest. The institutions issuing the Participation Certificates would
retain a service and letter of credit fee and a fee for providing the demand
feature, in an amount equal to the excess of the interest paid on the
instruments over the negotiated yield at which the Participation Certificates
were purchased by a Fund. The total fees would generally range from 5% to 15%
of the applicable prime rate or other short-term rate index. With respect to
insurance, a Fund will attempt to have the issuer of the Participation
Certificate bear the cost of any such insurance, although the Funds retain
the option to purchase insurance if deemed appropriate. Obligations that have
a demand feature permitting a Fund to tender the obligation to a foreign bank
may involve certain risks associated with foreign investment. A Fund's
ability to receive payment in such circumstances under the demand feature
from such foreign banks may involve certain risks such as future political
and economic developments, the possible establishments of laws or
restrictions that might adversely affect the payment of the bank's
obligations under the demand feature and the difficulty of obtaining or
enforcing a judgment against the bank.
7
The advisers have been instructed by the Board of Trustees to monitor
on an ongoing basis the pricing, quality and liquidity of the floating and
variable rate securities held by the Funds, including Participation
Certificates, on the basis of published financial information and reports of
the rating agencies and other bank analytical services to which the Funds may
subscribe. Although these instruments may be sold by a Fund, it is intended
that they be held until maturity. Participation Certificates will only be
purchased by a Fund if, in the opinion of counsel to the issuer, interest
income on such instruments will be tax-exempt when distributed as dividends
to shareholders of such Fund.
Past periods of high inflation, together with the fiscal measures
adopted to attempt to deal with it, have seen wide fluctuations in interest
rates, particularly "prime rates" charged by banks. While the value of the
underlying floating or variable rate securities may change with changes in
interest rates generally, the floating or variable rate nature of the
underlying floating or variable rate securities should minimize changes in
value of the instruments. Accordingly, as interest rates decrease or
increase, the potential for capital appreciation and the risk of potential
capital depreciation is less than would be the case with a portfolio of fixed
rate securities. A Fund's portfolio may contain floating or variable rate
securities on which stated minimum or maximum rates, or maximum rates set by
state law, limit the degree to which interest on such floating or variable
rate securities may fluctuate; to the extent it does, increases or decreases
in value may be somewhat greater than would be the case without such limits.
Because the adjustment of interest rates on the floating or variable rate
securities is made in relation to movements of the applicable banks' "prime
rates" or other short-term rate adjustment indices, the floating or variable
rate securities are not comparable to long-term fixed rate securities.
Accordingly, interest rates on the floating or variable rate securities may
be higher or lower than current market rates for fixed rate obligations of
comparable quality with similar maturities.
The maturity of variable rate securities is deemed to be the longer of
(i) the notice period required before a Fund is entitled to receive payment
of the principal amount of the security upon demand or (ii) the period
remaining until the security's next interest rate adjustment. If variable
rate securities are not redeemed through the demand feature, they mature on a
specified date which may range up to thirty years from the date of issuance.
ZERO COUPON AND STRIPPED OBLIGATIONS. The principal and interest
components of United States Treasury bonds with remaining maturities of
longer than ten years are eligible to be traded independently under the
Separate Trading of Registered Interest and Principal of Securities
("STRIPS") program. Under the STRIPS program, the principal and interest
components are separately issued by the United States Treasury at the request
of depository financial institutions, which then trade the component parts
separately. The interest component of STRIPS may be more volatile than that
of United States Treasury bills with comparable maturities.
Zero coupon obligations are sold at a substantial discount from their
value at maturity and, when held to maturity, their entire return, which
consists of the amortization of discount, comes from the difference between
their purchase price and maturity value. Because interest on a zero coupon
obligation is not distributed on a current basis, the obligation tends to be
subject to greater price fluctuations in response to changes in interest
rates than are ordinary interest-paying securities with similar maturities.
The value of zero coupon obligations appreciates more than such ordinary
interest-paying securities during periods of declining interest rates and
depreciates more than such ordinary interest-paying securities during periods
of rising interest rates. Under the stripped bond rules of the Internal
Revenue Code of 1986, as amended, investments in zero coupon obligations will
result in the accrual of interest income on such investments in advance of
the receipt of the cash corresponding to such income.
Zero coupon securities may be created when a dealer deposits a U.S.
Treasury or federal agency security with a custodian and then sells the
coupon payments and principal payment that will be generated by this security
separately. Proprietary receipts, such as Certificates of Accrual on Treasury
Securities, Treasury Investment Growth Receipts and generic Treasury
Receipts, are examples of stripped U.S. Treasury securities separated into
their component parts through such custodial arrangements.
8
ADDITIONAL POLICIES REGARDING DERIVATIVE AND RELATED TRANSACTIONS
INTRODUCTION. As explained more fully below, the Funds may employ
derivative and related instruments as tools in the management of portfolio
assets. Put briefly, a "derivative" instrument may be considered a security
or other instrument which derives its value from the value or performance of
other instruments or assets, interest or currency exchange rates, or indexes.
For instance, derivatives include futures, options, forward contracts,
structured notes and various other over-the-counter instruments.
Like other investment tools or techniques, the impact of using
derivatives strategies or similar instruments depends to a great extent on
how they are used. Derivatives are generally used by portfolio managers in
three ways: First, to reduce risk by hedging (offsetting) an investment
position. Second, to substitute for another security particularly where it is
quicker, easier and less expensive to invest in derivatives. Finally, to
speculate or enhance portfolio performance. When used prudently, derivatives
can offer several benefits, including easier and more effective hedging,
lower transaction costs, quicker investment and more profitable use of
portfolio assets. However, derivatives also have the potential to
significantly magnify risks, thereby leading to potentially greater losses
for a Fund.
Each Fund may invest its assets in derivative and related instruments
subject only to the Fund's investment objective and policies and the
requirement that the Fund maintain segregated accounts consisting of liquid
assets, such as cash, U.S. government securities, or other high-grade debt
obligations (or, as permitted by applicable regulation, enter into certain
offsetting positions) to cover its obligations under such instruments with
respect to positions where there is no underlying portfolio asset so as to
avoid leveraging the Fund.
The value of some derivative or similar instruments in which the Funds
invest may be particularly sensitive to changes in prevailing interest rates
or other economic factors, and--like other investments of the Funds--the
ability of a Fund to successfully utilize these instruments may depend in
part upon the ability of the advisers to forecast interest rates and other
economic factors correctly. If the advisers accurately forecast such factors
and have taken positions in derivative or similar instruments contrary to
prevailing market trends, the Funds could be exposed to the risk of a loss.
The Funds might not employ any or all of the strategies described herein, and
no assurance can be given that any strategy used will succeed.
Set forth below is an explanation of the various derivatives strategies
and related instruments the Funds may employ along with risks or special
attributes associated with them. This discussion is intended to supplement
the Funds' current prospectuses as well as provide useful information to
prospective investors.
RISK FACTORS. As explained more fully below and in the discussions of
particular strategies or instruments, there are a number of risks associated
with the use of derivatives and related instruments. There can be no
guarantee that there will be a correlation between price movements in a
hedging vehicle and in the portfolio assets being hedged. An incorrect
correlation could result in a loss on both the hedged assets in a Fund and
the hedging vehicle so that the portfolio return might have been greater had
hedging not been attempted. The advisers may accurately forecast interest
rates, market values or other economic factors in utilizing a derivatives
strategy. In such a case, the Fund may have been in a better position had it
not entered into such strategy. Hedging strategies, while reducing risk of
loss, can also reduce the opportunity for gain. In other words, hedging
usually limits both potential losses as well as potential gains. Strategies
not involving hedging may increase the risk to a Fund. Certain strategies,
such as yield enhancement, can have speculative characteristics and may
result in more risk to a Fund than hedging strategies using the same
instruments. There can be no assurance that a liquid market will exist at a
time when a Fund seeks to close out an option, futures contract or other
derivative or related position. Many exchanges and boards of trade limit the
amount of fluctuation permitted in option or futures contract prices during a
single day; once the daily limit has been reached on particular contract, no
trades may be made that day at a price beyond that limit. In addition,
certain instruments are relatively new and without a significant trading
history. As a
9
result, there is no assurance that an active secondary market will develop or
continue to exist. Finally, over-the-counter instruments typically do not
have a liquid market. Lack of a liquid market for any reason may prevent a
Fund from liquidating an unfavorable position. Activities of large traders in
the futures and securities markets involving arbitrage, "program trading,"
and other investment strategies may cause price distortions in these markets.
In certain instances, particularly those involving over-the-counter
transactions, forward contracts there is a greater potential that a
counterparty or broker may default or be unable to perform on its
commitments. In the event of such a default, a Fund may experience a loss.
SPECIFIC USES AND STRATEGIES. Set forth below are explanations various
strategies involving derivatives and related instruments which may be used by
the Funds.
OPTIONS ON SECURITIES AND SECURITIES INDEXES. The Funds may PURCHASE,
SELL or EXERCISE call and put options on (i) securities, (ii) securities
indices, and (iii) debt instruments.
Although in most cases these options will be exchange-traded, the Funds
may also purchase, sell or exercise over-the-counter options.
Over-the-counter options differ from exchange-traded options in that they are
two-party contracts with price and other terms negotiated between buyer and
seller. As such, over-the-counter options generally have much less market
liquidity and carry the risk of default or nonperformance by the other party.
One purpose of purchasing put options is to protect holdings in an
underlying or related security against a substantial decline in market value.
One purpose of purchasing call options is to protect against substantial
increases in prices of securities a Fund intends to purchase pending its
ability to invest in such securities in an orderly manner. A Fund may also
use combinations of options to minimize costs, gain exposure to markets or
take advantage of price disparities or market movements. For example, a Fund
may sell put or call options it has previously purchased or purchase put or
call options it has previously sold. These transactions may result in a net
gain or loss depending on whether the amount realized on the sale is more or
less than the premium and other transaction costs paid on the put or call
option which is sold. A Fund may write a call or put option in order to earn
the related premium from such transactions. Prior to exercise or expiration,
an option may be closed out by an offsetting purchase or sale of a similar
option.
In addition to the general risk factors noted above, the purchase and
writing of options involve certain special risks. During the option period, a
fund writing a covered call (i.e., where the underlying securities are held
by the fund) has, in return for the premium on the option, given up the
opportunity to profit from a price increase in the underlying securities
above the exercise price, but has retained the risk of loss should the price
of the underlying securities decline. The writer of an option has no control
over the time when it may be required to fulfill its obligation as a writer
of the option. Once an option writer has received an exercise notice, it
cannot effect a closing purchase transaction in order to terminate its
obligation under the option and must deliver the underlying securities at the
exercise price. The Funds will not write uncovered options.
If a put or call option purchased by a Fund is not sold when it has
remaining value, and if the market price of the underlying security, in the
case of a put, remains equal to or greater than the exercise price or, in the
case of a call, remains less than or equal to the exercise price, such Fund
will lose its entire investment in the option. Also, where a put or call
option on a particular security is purchased to hedge against price movements
in a related security, the price of the put or call option may move more or
less than the price of the related security. There can be no assurance that a
liquid market will exist when a Fund seeks to close out an option position.
Furthermore, if trading restrictions or suspensions are imposed on the
options markets, a Fund may be unable to close out a position.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS. The Funds may
purchase or sell (i) interest-rate futures contracts, (ii) futures contracts
on specified instruments or indices, and (iii) options on these futures
contracts ("futures options").
10
The futures contracts and futures options may be based on various
instruments or indices in which the Funds may invest such as foreign
currencies, certificates of deposit, Eurodollar time deposits, securities
indices and economic indices (such as the Consumer Price Indices compiled by
the U.S. Department of Labor).
Futures contracts and futures options may be used to hedge portfolio
positions and transactions as well as to gain exposure to markets. For
example, a Fund may sell a futures contract--or buy a futures option--to
protect against a decline in value, or reduce the duration, of portfolio
holdings. Likewise, these instruments may be used where a Fund intends to
acquire an instrument or enter into a position. For example, a Fund may
purchase a futures contract--or buy a futures option--to gain immediate
exposure in a market or otherwise offset increases in the purchase price of
securities or currencies to be acquired in the future. Futures options may
also be written to earn the related premiums.
When writing or purchasing options, the Funds may simultaneously enter
into other transactions involving futures contracts or futures options in
order to minimize costs, gain exposure to markets, or take advantage of price
disparities or market movements. Such strategies may entail additional risks
in certain instances. Funds may engage in cross-hedging by purchasing or
selling futures or options on a security different from the security position
being hedged to take advantage of relationships between the two securities.
Investments in futures contracts and options thereon involve risks
similar to those associated with options transactions discussed above. The
Funds will only enter into futures contracts or options on futures contracts
which are traded on a U.S. or foreign exchange or board of trade, or similar
entity, or quoted on an automated quotation system.
FORWARD CONTRACTS. A Fund may also use forward contracts to hedge
against changes in interest-rates, increase exposure to a market or otherwise
take advantage of such changes. An interest-rate forward contract involves
the obligation to purchase or sell a specific debt instrument at a fixed
price at a future date.
INTEREST RATE AND CURRENCY TRANSACTIONS. A Fund may employ currency and
interest rate management techniques, including transactions in options
(including yield curve options), futures, options on futures, forward foreign
currency exchange contracts, currency options and futures and currency and
interest rate swaps. The aggregate amount of a Fund's net currency exposure
will not exceed the total net asset value of its portfolio. However, to the
extent that a Fund is fully invested while also maintaining currency
positions, it may be exposed to greater combined risk.
The Funds will only enter into interest rate and currency swaps on a net
basis, i.e., the two payment streams are netted out, with the Fund receiving
or paying, as the case may be, only the net amount of the two payments.
Interest rate and currency swaps do not involve the delivery of securities,
the underlying currency, other underlying assets or principal. Accordingly,
the risk of loss with respect to interest rate and currency swaps is limited
to the net amount of interest or currency payments that a Fund is
contractually obligated to make. If the other party to an interest rate or
currency swap defaults, a Fund's risk of loss consists of the net amount of
interest or currency payments that the Fund is contractually entitled to
receive. Since interest rate and currency swaps are individually negotiated,
the Funds expect to achieve an acceptable degree of correlation between their
portfolio investments and their interest rate or currency swap positions.
A Fund may hold foreign currency received in connection with investments
in foreign securities when it would be beneficial to convert such currency
into U.S. dollars at a later date, based on anticipated changes in the
relevant exchange rate.
A Fund may purchase or sell without limitation as to a percentage of its
assets forward foreign currency exchange contracts when the advisers
anticipate that the foreign currency will appreciate or depreciate in value,
but securities denominated in that currency do not present attractive
investment opportunities and are not held by such Fund. In addition, a Fund
may enter into forward foreign currency exchange contracts in order to protect
against adverse changes in future foreign currency exchange rates. A Fund may
engage in cross-hedging by using forward contracts in one currency to hedge
against fluctuations in the value of securities denominated in a different
currency if its advisers believe that there is a pattern of correlation
between the two currencies. Forward contracts may reduce the potential gain
from a positive change in the relationship between the U.S. dollar and foreign
currencies. Unanticipated changes in currency prices may result in poorer
overall performance for a Fund than if it had not entered into such contracts.
The use of foreign currency forward contracts will not eliminate fluctuations
in the underlying U.S. dollar equivalent value of the prices of or rates of
return on a Fund's foreign currency denominated portfolio securities and the
use of such techniques will subject the Fund to certain risks.
The matching of the increase in value of a forward contract and the
decline in the U.S. dollar equivalent value of the foreign currency
denominated asset that is the subject of the hedge generally will not be
precise. In addition, a Fund may not always be able to enter into foreign
currency forward contracts at attractive prices, and this will limit a Fund's
ability to use such contract to hedge or cross-hedge its assets. Also, with
regard to a Fund's use of cross-hedges, there can be no assurance that
historical correlations between the movement of certain foreign currencies
relative to the U.S. dollar will continue. Thus, at any time a poor
correlation may exist between movements in the exchange rates of the foreign
currencies underlying a Fund's cross-hedges and the movements in the exchange
rates of the foreign currencies in which the Fund's assets that are the
subject of such cross-hedges are denominated.
A Fund may enter into interest rate and currency swaps to the maximum
allowed limits under applicable law. A Fund will typically use interest rate
swaps to shorten the effective duration of its portfolio. Interest rate swaps
involve the exchange by a Fund with another party of their respective
commitments to pay or receive interest, such as an exchange of fixed rate
payments for floating rate payments. Currency swaps involve the exchange of
their respective rights to make or receive payments in specified currencies.
STRUCTURED PRODUCTS. The Funds may invest in interests in entities
organized and operated solely for the purpose of restructuring the investment
characteristics of certain debt obligations. This type of restructuring
involves the deposit with or purchase by an entity, such as a corporation or
trust, of specified instruments (such as commercial bank loans) and the
issuance by that entity of one or more classes of securities ("structured
products") backed by, or representing interests in, the underlying
instruments. The cash flow on the underlying instruments may be apportioned
among the newly issued structured products to create securities with different
investment characteristics such as varying maturities, payment priorities and
interest
11
rate provisions, and the extent of the payments made with respect to
structured products is dependent on the extent of the cash flow on the
underlying instruments. A Fund may invest in structured products which
represent derived investment positions based on relationships among different
markets or asset classes.
The Funds may also invest in other types of structured products,
including, among others, inverse floaters, spread trades and notes linked by a
formula to the price of an underlying instrument. Inverse floaters have coupon
rates that vary inversely at a multiple of a designated floating rate (which
typically is determined by reference to an index rate, but may also be
determined through a dutch auction or a remarketing agent or by reference to
another security) (the "reference rate"). As an example, inverse floaters may
constitute a class of CMOs with a coupon rate that moves inversely to a
designated index, such as LIBOR (London Interbank Offered Rate) or the cost of
Funds Index. Any rise in the reference rate of an inverse floater (as a
consequence of an increase in interest rates) causes a drop in the coupon rate
while any drop in the reference rate of an inverse floater causes an increase
in the coupon rate. A spread trade is an investment position relating to a
difference in the prices or interest rates of two securities where the value
of the investment position is determined by movements in the difference
between the prices or interest rates, as the case may be, of the respective
securities. When a Fund invests in notes linked to the price of an underlying
instrument, the price of the underlying security is determined by a multiple
(based on a formula) of the price of such underlying security. A structured
product may be considered to be leveraged to the extent its interest rate
varies by a magnitude that exceeds the magnitude of the change in the index
rate of interest. Because they are linked to their underlying markets or
securities, investments in structured products generally are subject to
greater volatility than an investment directly in the underlying market or
security. Total return on the structured product is derived by linking return
to one or more characteristics of the underlying instrument. Because certain
structured products of the type in which the Fund anticipates it will invest
may involve no credit enhancement, the credit risk of those structured
products generally would be equivalent to that of the underlying instruments.
A Fund is permitted to invest in a class of structured products that is either
subordinated or unsubordinated to the right of payment of another class.
Subordinated structured products typically have higher yields and present
greater risks than unsubordinated structured products. Although a Fund's
purchase of subordinated structured products would have similar economic
effect to that of borrowing against the underlying securities, the purchase
will not be deemed to be leverage for purposes of a Fund's fundamental
investment limitation related to borrowing and leverage.
Certain issuers of structured products may be deemed to be "investment
companies" as defined in the 1940 Act. As a result, a Fund's investments in
these structured products may be limited by the restrictions contained in the
1940 Act. Structured products are typically sold in private placement
transactions, and there currently is no active trading market for structured
products. As a result, certain structured products in which the Income Funds
invest may be deemed illiquid and subject to their limitation on illiquid
investments.
Investments in structured products generally are subject to greater
volatility than an investment directly in the underlying market or security.
In addition, because structured products are typically sold in private
placement transactions, there currently is no active trading market for
structured products.
ADDITIONAL RESTRICTIONS ON THE USE OF FUTURES AND OPTION CONTRACTS. None
of the Funds is a "commodity pool" (i.e., a pooled investment vehicle which
trades in commodity futures contracts and options thereon and the operator of
which is registered with the CFTC) and futures contracts and futures options
will be purchased, sold or entered into only for bona fide hedging purposes,
provided that a Fund may enter into such transactions for purposes other than
bona fide hedging if, immediately thereafter, the sum of the amount of its
initial margin and premiums on open contracts and options would not exceed 5%
of the liquidation value of the Fund's portfolio, provided, further, that, in
the case of an option that is in-the-money, the in-the-money amount may be
excluded in calculating the 5% limitation.
When a Fund purchases a futures contract, an amount of cash or liquid
securities will be deposited in a segregated account with such Fund's
custodian so that the amount so segregated, plus the initial deposit and
variation margin held in the account of its broker, will at all times equal
the value of the futures contract, thereby insuring that the use of such
futures is unleveraged.
12
The Funds' ability to engage in the transactions described herein may
be limited by the current federal income tax requirement that a Fund derive
less than 30% of its gross income from the sale or other disposition of
securities held for less than three months.
In addition to the foregoing requirements, the Board of Trustees has
adopted an additional restriction on the use of futures contracts and options
thereon, requiring that the aggregate market value of the futures contracts
held by a Fund not exceed 50% of the market value of its total assets.
Neither this restriction nor any policy with respect to the above-referenced
restrictions, would be changed by the Board of Trustees without considering
the policies and concerns of the various federal and state regulatory
agencies.
INVESTMENT RESTRICTIONS
The Funds have adopted the following investment restrictions, which may
not be changed without approval by a "majority of the outstanding shares" of
a Fund. As used in this Statement of Additional Information, a "majority"
means the vote of the lesser of (i) 67% or more of the shares of a Fund
present at a meeting, if the holders of more than 50% of the outstanding
shares of a Fund are present or represented by proxy, or (ii) more than 50%
of the outstanding shares of a Fund.
Each Fund:
(1) may not borrow money, except that each Fund may borrow money
for temporary or emergency purposes, or by engaging in reverse repurchase
transactions, in an amount not exceeding 33-1/3% of the value of its total
assets at the time when the loan is made and may pledge, mortgage or
hypothecate no more than 1/3 of its net assets to secure such borrowings.
Any borrowings representing more than 5% of a Fund's total assets must be
repaid before the Fund may make additional investments;
(2) may make loans to other persons, in accordance with the
Fund's investment objective and policies and to the extent permitted by
applicable law.
(3) may not purchase the securities of any issuer (other than
securities issued or guaranteed by the U.S. government or any of its
agencies or instrumentalities, or repurchase agreements secured thereby)
if, as a result, more than 25% of the Fund's total assets would be
invested in the securities of companies whose principal business
activities are in the same industry. Notwithstanding the foregoing, with
respect to a Fund's permissible futures and options transactions in U.S.
government securities, positions in options and futures shall not be
subject to this restriction;
(4) may not purchase or sell physical commodities unless acquired
as a result of ownership of securities or other instruments but this
shall not prevent a Fund from (i) purchasing or selling options and
futures contracts or from investing in securities or other instruments
backed by physical commodities or (ii) engaging in forward purchases or
sales of foreign currencies or securities;
(5) may not purchase or sell real estate unless acquired as a
result of ownership of securities or other instruments (but this shall
not prevent a Fund from investing in securities or other instruments
backed by real estate or securities of companies engaged in the real
estate business). Investments by a Fund in securities backed by mortgages
on real estate or in marketable securities of companies engaged in such
activities are not hereby precluded;
13
(6) may not issue any senior security (as defined in the 1940 Act),
except that (a) a Fund may engage in transactions that may result in the
issuance of senior securities to the extent permitted under applicable
regulations and interpretations of the 1940 Act or an exemptive order;
(b) a Fund may acquire other securities, the acquisition of which may
result in the issuance of a senior security, to the extent permitted
under applicable regulations or interpretations of the 1940 Act; and
(c) subject to the restrictions set forth above, a Fund may borrow money
as authorized by the 1940 Act. For purposes of this restriction,
collateral arrangements with respect to a Fund's permissible options and
futures transactions, including deposits of initial and variation margin,
are not considered to be the issuance of a senior security; or
(7) may not underwrite securities issued by other persons except
insofar as a Fund may technically be deemed to be an underwriter under
the Securities Act of 1933 in selling a portfolio security.
In addition, as a matter of fundamental policy, the European Fund:
(8) May not make or guarantee loans to any person or otherwise
become liable for or in connection with any obligation or indebtedness of
any person without the prior written consent of the Trustees, provided
that for purposes of this restriction the acquisition of bonds,
debentures, or other corporate debt securities and investments in
government bonds, short-term commercial paper, certificates of deposit
and bankers' acceptances shall not be deemed to be the making of a loan;
(9) May not invest in securities which are not traded or have not
sought a listing on a stock exchange, over-the-counter market or other
organized securities market that is open to the international public and
on which securities are regularly traded if, regarding all such
securities, more than 10% of its total net assets would be invested in
such securities immediately after and as a result of such transaction;
(10) May not deal in put options, write or purchase call options,
including warrants, unless such options or warrants are covered and are
quoted on a stock exchange or dealt in on a recognized market, and, at
the date of the relevant transaction: (i) call options written do not
involve more than 25%, calculated at the exercise price, of the market
value of the securities within the Fund's portfolio excluding the value
of any outstanding call options purchased, and (ii) the cost of call
options or warrants purchased does not exceed, in terms of premium, 2% of
the value of the net assets of the Fund; or
(11) May not purchase securities of any issuer if such purchase at
the time thereof would cause more than 10% of the voting securities of
such issuer to be held by the Fund.
In addition, as a matter of fundamental policy, notwithstanding any other
investment policy or restriction, a Fund may seek to achieve its investment
objective by investing all of its investable assets in another investment
company having substantially the same investment objective and policies as the
Fund. For purposes of investment restriction (5) above, real estate includes
Real Estate Limited Partnerships. For purposes of investment restriction (3)
above, industrial development bonds, where the payment of principal and interest
is the ultimate responsibility of companies within the same industry, are
grouped together as an "industry." Investment restriction (3) above, however, is
not applicable to investments by a Fund in municipal obligations where the
issuer is regarded as a state, city, municipality or other public authority
since such entities are not members of any "industry."
In addition, each Fund is subject to the following nonfundamental
investment restrictions which may be changed without shareholder approval:
(1) Each Fund may not, with respect to 50% of its assets, hold more
than 10% of the outstanding voting securities of any issuer.
(2) Each Fund may not make short sales of securities, other than
short sales "against the box," or purchase securities on margin except for
short-term credits necessary for clearance of portfolio transactions,
provided that this restriction will not be applied to limit the use of
options, futures contracts and related options, in the manner otherwise
permitted by the investment restrictions, policies and investment program
of a Fund. The Funds have no current intention of making short sales
against the box.
(3) Each Fund may not purchase or sell interests in oil, gas or
mineral leases.
(4) Each Fund may not invest more than 15% of its net assets in
illiquid securities.
(5) Each Fund may not write, purchase or sell any put or call option
or any combination thereof, provided that this shall not prevent (i) the
writing, purchasing or selling of puts, calls or combinations thereof with
respect to portfolio securities or (ii) with respect to a Fund's
permissible futures and options transactions, the writing, purchasing,
ownership, holding or selling of futures and options positions or of puts,
calls or combinations thereof with respect to futures.
(6) Each Fund may invest up to 5% of its total assets in the
securities of any one investment company, but may not own more than 3% of
the securities of any one investment company or invest more than 10% of
its total assets in the securities of other investment companies.
For purposes of the Funds' investment restrictions, the issuer of a
tax-exempt security is deemed to be the entity (public or private) ultimately
responsible for the payment of the principal of and interest on the security.
With respect to the European Fund, as a matter of nonfundamental policy,
to the extent permitted under applicable law, the above restrictions do not
apply to the following investments ("OECD investments"): (i) any security
issued by or the payment of principal and interest on which is guaranteed by
the government of any member state of the Organization for Economic Cooperation
and Development ("OECD country"); (ii) any fixed income security issued in any
OECD country by any public or local authority or nationalized industry or
undertaking of any OECD country or anywhere in the world by the International
Bank for Reconstruction and Development, European Investment Bank, Asian
Development Bank or any body which is, in the Trustees' opinion, of similar
standing. However, no investment may be made in any OECD investment of any one
issue if that would result in the value of a Fund's holding of that issue
exceeding 30% of the net asset value of the Fund and, if the Fund's portfolio
consists only of OECD investments, those OECD investments shall be of at least
six different issues.
14
In order to permit the sale of its shares in certain states, a Fund may
make commitments more restrictive than the investment policies and limitations
described above and in its Prospectus. Should a Fund determine that any such
commitment is no longer in its best interests, it will revoke the commitment by
terminating sales of its shares in the state involved.
If a percentage or rating restriction on investment or use of assets set
forth herein or in a Prospectus is adhered to at the time, later changes in
percentage or ratings resulting from any cause other than actions by a Fund will
not be considered a violation. If the value of a Fund's holdings of illiquid
securities at any time exceeds the percentage limitation applicable at the time
of acquisition due to subsequent fluctuations in value or other reasons, the
Board of Trustees will consider what actions, if any, are appropriate to
maintain adequate liquidity.
SPECIAL CONSIDERATIONS
INVESTING IN EUROPE. Investment in the securities of European countries
may entail risks relating to restrictions on foreign investment and on
repatriation of capital invested as well as risks relating to economic
conditions of the region.
The securities markets of many European countries are relatively small,
with the majority of market capitalization and trading volume concentrated in a
limited number of companies representing a small number of industries.
Consequently, the Fund's investment portfolio may experience greater price
volatility and significantly lower liquidity than a portfolio invested in
equity securities of U.S. companies. These markets may be subject to a greater
influence by adverse events generally affecting the market, and by large
investors trading significant blocks of securities, than is usual in the U.S.
Securities settlements may in some instances be subject to delays and related
administrative uncertainties.
Foreign investment in the securities markets of certain European
countries is restricted or controlled to varying degrees. These restrictions or
controls may at times limit or preclude investment in certain securities and
may increase the cost and expenses of the Fund, As illustrations, certain
countries require governmental approval prior to investments by foreign
persons, or limit the amount of investment by foreign persons in a particular
company, or limit the investment by foreign persons to only a specific class of
securities of a company which may have less advantageous terms than securities
of the company available for purchase by nationals. In addition, the
repatriation of both investment income and capital from certain of the
countries is controlled under regulations, including in some case the need for
certain advance government notification or authority. The Fund could be
adversely affected by delays in, or a refusal to grant, any required
governmental approval for repatriation.
The economies of individual European countries may differ favorably or
unfavorably from the U.S economy in such respects as growth of gross domestic
product or gross national product, as the case may be, rate of inflation,
capital reinvestment, resource self-sufficiency and balance of payments
position. In addition, securities traded in certain emerging European
securities trading markets may be subject to risks due to inexperience of
financial intermediaries, the lack of modern technology, the lack of sufficient
capital base to expand business operations and the possibility of permanent or
temporary termination of trading and greater spreads between bid and asked
prices for securities in such markets.
LOWER RATED SECURITIES. Each Fund is permitted to invest in
non-investment grade securities. Such securities, though higher yielding, are
characterized by risk. Each Fund may invest in debt securities rated as low as
Baa by Moody's or BBB by S&P or, if not rated, are determined to be of
comparable quality. Lower rated securities are securities such as those rated
Ba by Moody's or BB by S&P or as low as the lowest rating assigned by Moody's
or S&P. They generally are not meant for short-term investing and may be
subject to certain risks with respect to the issuing entity and to greater
market fluctuation than certain lower yielding, higher rated fixed income
securities. Obligations rated Ba by Moody's are judged to have speculative
elements; their future cannot be considered well assured and often the
protection of interest and principal payments may be very moderate. Obligations
rated BB by S&P are regarded as having predominantly speculative
characteristics and, while such obligations have less near-term vulnerability
to default than other speculative grade debt, they face major ongoing
uncertainties or exposure to adverse business, financial or economic conditions
which could lead to inadequate capacity to meet timely interest and principal
payments. Obligations rated C by Moody's are regarded as having extremely poor
prospects of ever attaining any real investment standing. Obligations rated D
by S&P are in default and the payment of interest and/or repayments of
principal is in arrears. Such obligations, though high yielding, are
characterized by great risk. See "Appendix B" herein for a general description
of Moody's and S&P ratings.
The ratings of Moody's and S&P represent their opinions as to the quality
of the securities which they undertake to rate. The ratings are relative and
subjective and, although ratings may be useful in evaluating the safety of
interest and principal payments, they do not evaluate the market risk of these
securities. Therefore, although these ratings may be an initial criterion for
selection of portfolio investments, the Investment Adviser will also evaluate
these securities and the ability of the issuers of such securities to pay
interest and principal. Each Fund will rely on the Investment Adviser's
judgment, analysis and experience in evaluating the creditworthiness of an
issuer. In this evaluation, the Investment Adviser will take into
consideration, among other things, the issuer's financial resources, its
sensitivity to economic conditions and trends, its operating history, the
quality of the issuer's management and regulatory matters. The Fund's ability
to achieve its investment objective may be more dependent on the Investment
Adviser's credit analysis than might be the case for funds that invested in
higher rated securities. Once the rating of a security in the Fund's or
Portfolio's portfolio has been changed, the Investment Adviser will consider
all circumstances deemed relevant in determining whether the Fund or Portfolio
should continue to hold the security.
The market price and yield of debt securities rated Ba or lower by
Moody's and BB or lower by S&P are more volatile that those of higher rated
securities. Factors adversely affecting the market price and yield of these
securities will adversely affect a Fund's net asset value. It is likely that
any economic recession could disrupt severely the market for such securities
and may have an adverse impact on the value of such securities. In addition, it
is likely that any such economic downturn could adversely affect the ability of
the issuers of such securities to repay principal and pay interest thereon and
increase the incidence for default for such securities.
The market values of certain lower rated debt securities tend to reflect
individual corporate developments to a greater extent than do higher rated
securities, which react primarily to fluctuations in the general level of
interest rates, and tend to be more sensitive to economic conditions than are
higher rated securities. Companies that issue such securities often are highly
leveraged and may not have available to them more traditional methods of
financing. Therefore the risk associated with acquiring the securities of such
issuers generally is greater than is the case with higher rated securities. For
example, during an economic downturn or a sustained period of rising interest
rates, highly leveraged issuers of these securities may experience financial
stress. During such periods, such issuers may not have sufficient revenues to
meet their interest payment obligations. The issuer's ability to service its
debt obligations also may be affected adversely by specific corporate
developments or the issuer's inability to meet specific projected business
forecasts, or the unavailability of additional financing. The risk of loss
because of default by the issuer is significantly greater for the holders of
these securities because such securities generally are unsecured and often are
subordinated to other creditors of the issuer.
Because there is no established retail secondary market for many of these
securities, the Investment Adviser anticipates that such securities could be
sold only to a limited number of dealers or institutional investors. To the
extent a secondary trading market for these securities does exist, it generally
is not as liquid as the secondary market for higher rated securities. The lack
of a liquid secondary market may have an adverse impact on market price and
yield and a Fund's ability to dispose of particular issues when necessary to
meet that Fund's liquidity needs or in response to a specific economic event
such as a deterioration in the creditworthiness of the issuer. The lack of a
liquid secondary market for certain securities also may make it more difficult
for a Fund or Portfolio to obtain accurate market quotations for purposes of
valuing that Fund's or Portfolio's portfolio and calculating its net asset
value. Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of these
securities. In such cases, judgment may play a greater role in valuation
because less reliable, objective data may be available.
A Fund may acquire these securities during an initial offering. Such
securities may involve special risks because they are new issues. The Funds and
Portfolio have no arrangement with any persons concerning the acquisition of
such securities, and the Investment Adviser will review carefully the credit
and other characteristics pertinent to such new issues.
Each Fund may invest in lower rated zero coupon securities and
pay-in-kind bonds (bonds which pay interest through the issuance of additional
bonds), which involve special considerations. These securities may be subject
to greater fluctuations in value due to changes in interest rates that
interest-bearing securities. These securities carry an additional risk in that,
unlike bonds which may interest throughout the period to maturity, the Funds
will realize no cash until the cash payment date unless a portion of such
securities are sold and, if the issuer defaults, the Funds or Portfolio may
obtain no return at all on their investment. See "Tax Matters."
PORTFOLIO TRANSACTIONS AND BROKERAGE ALLOCATION
Specific decisions to purchase or sell securities for a Fund are made by a
portfolio manager who is an employee of the adviser or sub-adviser to such Fund
and who is appointed and supervised by senior officers of such adviser or
sub-adviser. Changes in the Funds' investments are reviewed by the Board of
Trustees. The Funds' portfolio managers may serve other clients of the adviser
in a similar capacity. Money market instruments are generally purchased in
principal transactions.
The frequency of a Fund's portfolio transactions--the portfolio turnover
rate--will vary from year to year depending upon market conditions. Because a
high turnover rate may increase transaction costs and the possibility of taxable
short-term gains, the advisers will weigh the added costs of short-term
investment against anticipated gains. Each Fund will engage in portfolio trading
if its advisers believe a transaction, net of costs (including custodian
charges), will help it achieve its investment objective.
The Funds' portfolio turnover rates for the three most recent fiscal years
were as follows:
Year Ended August 31,
----------------------------------
1998 1999 2000
---- ---- ----
Intermediate Tax Free Income Fund 71% 62% 60%
New York Intermediate Tax Free Income Fund 66% 39% 46%
JPMorgan Fleming European Fund 183% 149% 161%
Under the advisory agreement and the sub-advisory agreements, the adviser and
sub-advisers shall use their best efforts to seek to execute portfolio
transactions at prices which, under the circumstances, result in total costs or
proceeds being the most favorable to the Funds. In assessing the best overall
terms available for any transaction, the adviser and sub-advisers consider all
factors they deem relevant, including the breadth of the market in the security,
the price of the security, the financial condition and execution capability of
the broker or dealer, research services provided to the adviser or sub-advisers,
and the reasonableness of the commissions, if any, both for the specific
transaction and on a continuing basis. The adviser and sub-advisers are not
required to obtain the lowest commission or the best net price for any Fund on
any particular transaction, and are not required to execute any order in a
fashion either preferential to any Fund relative to other accounts they manage
or otherwise materially adverse to such other accounts.
Debt securities are traded principally in the over-the-counter market
through dealers acting on their own account and not as brokers. In the case of
securities traded in the over-the-counter market (where no stated commissions
are paid but the prices include a dealer's markup or markdown), the adviser or
sub-adviser to a Fund normally seeks to deal directly with the primary market
makers unless, in its opinion, best execution is available elsewhere. In the
case of securities purchased from underwriters, the cost of such securities
generally includes a fixed underwriting commission or concession. From time to
time, soliciting dealer fees are available to the adviser or sub-adviser on the
tender of a Fund's portfolio securities in so-
15
called tender or exchange offers. Such soliciting dealer fees are in effect
recaptured for the Funds by the adviser and sub-advisers. At present, no
other recapture arrangements are in effect.
Under the advisory and sub-advisory agreements and as permitted by
Section 28(e) of the Securities Exchange Act of 1934, the adviser or
sub-advisers may cause the Funds to pay a broker-dealer which provides
brokerage and research services to the adviser or sub-advisers, the Funds
and/or other accounts for which they exercise investment discretion an amount
of commission for effecting a securities transaction for the Funds in excess
of the amount other broker-dealers would have charged for the transaction if
they determine in good faith that the total commission is reasonable in
relation to the value of the brokerage and research services provided by the
executing broker-dealer viewed in terms of either that particular transaction
or their overall responsibilities to accounts over which they exercise
investment discretion. Not all of such services are useful or of value in
advising the Funds. The adviser and sub-advisers report to the Board of
Trustees regarding overall commissions paid by the Funds and their
reasonableness in relation to the benefits to the Funds. The term "brokerage
and research services" includes advice as to the value of securities, the
advisability of investing in, purchasing or selling securities, and the
availability of securities or of purchasers or sellers of securities,
furnishing analyses and reports concerning issues, industries, securities,
economic factors and trends, portfolio strategy and the performance of
accounts, and effecting securities transactions and performing functions
incidental thereto such as clearance and settlement.
The management fees that the Funds pay to the adviser will not be reduced
as a consequence of the adviser's or sub-advisers' receipt of brokerage and
research services. To the extent the Funds' portfolio transactions are used to
obtain such services, the brokerage commissions paid by the Funds will exceed
those that might otherwise be paid by an amount which cannot be presently
determined. Such services would be useful and of value to the adviser or
sub-advisers in serving one or more of their other clients and, conversely, such
services obtained by the placement of brokerage business of other clients would
be useful to the adviser and sub-advisers in carrying out their obligations to
the Funds. While such services are not expected to reduce the expenses of the
adviser or sub-advisers, they would, through use of the services, avoid the
additional expenses that would be incurred if they should attempt to develop
comparable information through their own staff.
In certain instances, there may be securities that are suitable for one or
more of the Funds as well as one or more of the adviser's or sub-advisers' other
clients. Investment decisions for the Funds and for other clients are made with
a view to achieving their respective investment objectives. It may develop that
the same investment decision is made for more than one client or that a
particular security is bought or sold for only one client even though it might
be held by, or bought or sold for, other clients. Likewise, a particular
security may be bought for one or more clients when one or more clients are
selling that same security. Some simultaneous transactions are inevitable when
several clients receive investment advice from the same investment adviser,
particularly when the same security is suitable for the investment objectives of
more than one client. In executing portfolio transactions for a Fund, the
adviser or sub-advisers may, to the extent permitted by applicable laws and
regulations, but shall not be obligated to, aggregate the securities to be sold
or purchased with those of other Funds or their other clients if, in the
adviser's or sub-advisers' reasonable judgment, such aggregation (i) will result
in an overall economic benefit to the Fund, taking into consideration the
advantageous selling or purchase price, brokerage commission and other expenses,
and trading requirements, and (ii) is not inconsistent with the policies set
forth in the Trust's registration statement and the Fund's Prospectus and
Statement of Additional Information. In such event, the adviser or a sub-adviser
will allocate the securities so purchased or sold, and the expenses incurred in
the transaction, in an equitable manner, consistent with its fiduciary
obligations to the Fund and such other clients. It is recognized that in some
cases this system could have a detrimental effect on the price or volume of the
security as far as a Fund is concerned. However, it is believed that the ability
of the Funds to participate in volume transactions will generally produce better
executions for the Funds.
The Funds paid brokerage commissions as detailed below:
YEAR-ENDED YEAR-ENDED YEAR-ENDED
OCTOBER 31, 1998 OCTOBER 31, 1999 OCTOBER 31, 2000
---------------- ---------------- ----------------
Fleming European Fund $315,450 $432,341 $776,639
No portfolio transactions are executed with the advisers or a
Shareholder Servicing Agent, or with any affiliate of the advisers or a
Shareholder Servicing Agent, acting either as principal or as broker.
16
PERFORMANCE INFORMATION
From time to time, a Fund may use hypothetical investment examples and
performance information in advertisements, shareholder reports or other
communications to shareholders. Because such performance information is based
on past investment results, it should not be considered as an indication or
representation of the performance of a Fund in the future. From time to time,
the performance and yield of a Fund may be quoted and compared to those of
other mutual funds with similar investment objectives, unmanaged investment
accounts, including savings accounts, or other similar products and to stock
or other relevant indices or to rankings prepared by independent services or
other financial or industry publications that monitor the performance of
mutual funds. For example, the performance of a Fund may be compared to data
prepared by Lipper Analytical Services, Inc. or Morningstar Mutual Funds on
Disc, widely recognized independent services which monitor the performance of
mutual funds. Performance and yield data as reported in national financial
publications including, but not limited to, Money Magazine, Forbes, Barron's,
The Wall Street Journal and The New York Times, or in local or regional
publications, may also be used in comparing the performance and yield of a
Fund. A Fund's performance may be compared with indices such as the Lehman
Brothers Government/Credit Index, the Lehman Brothers Government Bond Index,
the Lehman Government Bond 1-3 Year Index and the Lehman Aggregate Bond
Index; the S&P 500 Index, the Dow Jones Industrial Average, the Morgan
Stanley Capital International Europe Index or any other commonly quoted index
of common stock prices; and the Russell 2000 Index and the NASDAQ Composite
Index. Additionally, a Fund may, with proper authorization, reprint articles
written about such Fund and provide them to prospective shareholders.
A Fund may provide period and average annual "total rates of return." The
"total rate of return" refers to the change in the value of an investment in a
Fund over a period (which period shall be stated in any advertisement or
communication with a shareholder) based on any change in net asset value per
share including the value of any shares purchased through the reinvestment of
any dividends or capital gains distributions declared during such period. One-,
five-, and ten-year periods will be shown, unless the Fund has been in existence
for a shorter-period.
Unlike some bank deposits or other investments which pay a fixed yield for
a stated period of time, the yields and the net asset values of shares of a Fund
will vary based on market conditions, the current market value of the securities
held by a Fund and changes in the Fund's expenses. The advisers, the
Administrator, the Distributor and other service providers may voluntarily waive
a portion of their fees on a month-to-month basis. In addition, the Distributor
may assume a portion of a Fund's operating expenses on a month-to-month basis.
These actions would have the effect of increasing the net income (and therefore
the yield and total rate of return) of shares of a Fund during the period such
waivers are in effect. These factors and possible differences in the methods
used to calculate the yields and total rates of return should be considered when
comparing the yields or total rates of return of shares of a Fund to yields and
total rates of return published for other investment companies and other
investment vehicles.
Each Fund presents performance information for each class there of since
the commencement of operations of that Fund (or the related predecessor fund, as
described below), rather than the date such class was introduced. Performance
information for each class introduced after the commencement of operations of
the related Fund (or predecessor fund) is therefore based on the performance
history of a predecessor class or classes. Performance information is restated
to reflect the current maximum front-end sales charge (in the case of Class A
Shares) or the maximum applicable contingent deferred sales charge (in the case
of Class B Shares) when presented inclusive of sales charges. Additional
performance information may be presented which does not reflect the deduction of
sales charges. Historical expenses reflected in performance information are
based upon the distribution, shareholder servicing fees and other expenses
actually incurred during the periods presented and have not been restated, for
periods during which the performance information for a particular class is based
upon the performance history of a predecessor class, to reflect the ongoing
expenses currently borne by the particular class.
17
In connection with the conversion of various common trust funds maintained
by Chase into the Vista Select funds (the "CTF Conversion"), which occurred on
December 31, 1997, the Intermediate Tax Free Income Fund was established to
receive the assets of The Intermediate-Term Tax-Exempt Bond Fund of Chemical
Bank, the New Jersey Tax Free Income Fund was established to receive the assets
of The New Jersey Municipal Bond Fund of Chemical Bank, the New York
Intermediate Tax Free Income Fund was established to receive the assets of the
New York Tax-Exempt Income Fund of The Chase Manhattan Bank and the Tax Free
Income Fund was established to receive the assets of The Tax-Exempt Bond Fund of
Chemical Bank and the Tax-Exempt Income Fund of The Chase Manhattan Bank.
Advertising or communications to shareholders may contain the views of the
advisers as to current market, economic, trade and interest rate trends, as well
as legislative, regulatory and monetary developments, and may include investment
strategies and related matters believed to be of relevance to a Fund.
Advertisements for the J.P. Morgan Funds may include references to the
asset size of other financial products made available by Chase, such as the
offshore assets of other funds.
TOTAL RATE OF RETURN
A Fund's total rate of return for any period will be calculated by: (a)
dividing (i) the sum of the net asset value per share on the last day of the
period and the net asset value per share on the last day of the period of shares
purchasable with dividends and capital gains declared during such period with
respect to a share held at the beginning of such period and with respect to
shares purchased with such dividends and capital gains distributions, by (ii)
the public offering price per share on the first day of such period; and (b)
subtracting 1 from the result. The average annual rate of return quotation will
be calculated by (x) adding 1 to the period total rate of return quotation as
calculated above, (y) raising such sum to a power which is equal to 365 divided
by the number of days in such period, and (z) subtracting 1 from the result.
AVERAGE ANNUAL TOTAL RETURNS*
(EXCLUDING SALES CHARGES)
The average annual total rates of return for the following Funds,
reflecting the initial investment and assuming the reinvestment of all
distributions (but excluding the effects of any applicable sales charges), for
the one, five, and ten year periods ending August 31, 2000, were as follows:
Date of Date of
One Five Ten Fund Class
Fund Year Years Years Inception Introduction
- ---- ---- ----- ----- --------- ------------
JPMorgan Intermediate Tax Free Income Fund 5.54% 5.35% 6.99% 12/31/79
JPMorgan New York Intermediate Tax Free Income Fund 11/30/83
A Shares** 6.13% 5.42% 6.77% 2/16/01
B Shares** 6.13% 5.42% 6.77% 2/16/01
Institutional Shares 6.13% 5.42% 6.77% 11/30/83
JPMorgan Fleming European Fund 11/2/95
A Shares 10.13% N/A 18.53% 11/2/95
B Shares 9.40% N/A 17.69% 11/3/95
C Shares 9.27% N/A 17.68% 11/1/98
* The ongoing fees and expenses borne by Class B and Class C Shares are
greater than those borne by Class A Shares; the ongoing fees and expenses
borne by a Fund's Class A and Class B Shares are greater than
18
those borne by the Fund's Institutional Shares. As indicated above, the
performance information for each class introduced after the
commencement of operations of the related Fund (or predecessor fund) is
based on the performance history of a predecessor class or classes and
historical expenses have not been restated, for periods during which
the performance information for a particular class is based upon the
performance history of a predecessor class, to reflect the ongoing
expenses currently borne by the particular class. Accordingly, the
performance information presented in the table above and in each table
that follows may be used in assessing each Fund's performance history
but does not reflect how the distinct classes would have performed on a
relative basis prior to the introduction of those classes, which would
require an adjustment to the ongoing expenses. The performance quoted
reflects fee waivers that subsidize and reduce the total operating
expenses of certain Funds (or classes thereof). Returns on these Funds
(or classes) would have been lower if there were not such waivers. With
respect to certain Funds, Chase and/or other service providers are
obligated to waive certain fees and/or reimburse certain expenses for a
stated period of time. In other instances, there is no obligation to
waive fees or to reimburse expenses. Each Fund's Prospectus discloses
the extent of any agreements to waive fees and/or reimburse expenses.
** Performance information presented in the table above and in each table
that follows for this class of this Fund prior to the date this class was
introduced is based on the performance of predecessor classes and does not
reflect the distribution fees and certain other expenses borne by this
class which, if reflected, would reduce the performance quoted.
AVERAGE ANNUAL TOTAL RETURNS*
(INCLUDING SALES CHARGES)
With the current maximum respective sales charges of 5.75% for Class A
shares of the European Fund and 4.50% for A shares of the other Funds, and the
current applicable CDSC for B and Class C Shares for each period length,
reflected, the average annual total rate of return figures would be as follows:
One Five Ten
Fund Year Years Years
- ---- ---- ----- -----
JPMorgan Fleming European Fund
A Shares 3.78% N/A 17.14%
B Shares 4.40% N/A 17.48%
C Shares 8.27% N/A 17.68%
JPMorgan New York Intermediate Tax Free Income Fund
A Shares 1.29% 4.46% 6.28%
B Shares 1.13% 5.10% 6.77%
* See the notes to the preceding table.
The Funds may also from time to time include in advertisements or other
communications a total return figure that is not calculated according to the
formula set forth above in order to compare more accurately the performance of a
Fund with other measures of investment return.
YIELD QUOTATIONS
Any current "yield" quotation for a class of shares of a Fund shall
consist of an annualized hypothetical yield, carried at least to the nearest
hundredth of one percent, based on a thirty calendar day period and shall be
calculated by: (a) raising to the sixth power the sum of 1 plus the quotient
obtained by dividing the Fund's net investment income earned during the period
by the product of the average daily number of shares outstanding during the
period that were entitled to receive dividends and the maximum offering price
per share on the last day of the period, (b) subtracting 1 from the result; and
(c) multiplying the result by 2.
The Funds will not quote yields for periods prior to the consummation of
the CTF Reorganization.
19
Advertisements for the Funds may include references to the asset size of
other financial products made available by Chase, such as offshore assets or
other funds advised by Chase.
The SEC yields of the Funds for the thirty-day period ended August 31,
2000 were as follows:
Thirty-Day Tax Equivalent
Yield Thirty-Day Yield
as of 8/31/00 as of 8/31/00
------------- ----------------
JPMorgan Intermediate Tax Free Income Fund 4.06% 6.72%
JPMorgan New York Intermediate Tax Free
Income Fund Institutional Shares 4.08% 7.56%
JPMorgan Fleming European Fund
A Shares 0.00% 0.00%
B Shares 0.00% 0.00%
C Shares 0.00% 0.00%
Yields are not presented for JPMorgan New York Intermediate Tax Free
Income Fund which were introduced on February 16, 2001.
The tax equivalent yields assume a federal income tax rate of 39.6% for
the JPMorgan Intermediate Tax Free Income Fund, a combined New York State, New
York City and federal income tax rate of 46.05% for the JPMorgan New York
Intermediate Tax Free Income Fund.
NON-STANDARDIZED PERFORMANCE RESULTS*
(EXCLUDING SALES CHARGES)
The table below reflects the net change in the value of an assumed initial
investment of $10,000 in each class of Fund shares in the following Funds,
including the predecessor common trust funds, (excluding the effects of any
applicable sale charges) for the ten-year period ending August 31, 2000. The
values reflect an assumption that capital gain distributions and income
dividends, if any, have been invested in additional shares of the same class.
From time to time, the Funds may provide these performance results in addition
to the total rate of return quotations required by the Securities and Exchange
Commission. As discussed more fully in the Prospectuses, neither these
performance results, nor total rate of return quotations, should be considered
as representative of the performance of the Funds in the future. These factors
and the possible differences in the methods used to calculate performance
results and total rates of return should be considered when comparing such
performance results and total rate of return quotations of the Funds with those
published for other investment companies and other investment vehicles.
Total
Value
--------
JPMorgan Intermediate Tax Free Income Fund $19,649
JPMorgan New York Intermediate Tax Free Income Fund
A Shares 19,259
B Shares 19,259
Institutional Shares 19,259
JPMorgan Fleming European Fund
A Shares 23,398
B Shares 22,579
C Shares 22,565
* See the notes to the table captioned "Average Annual Total Return
(excluding sales charges)" above. The table above assumes an initial
investment of $10,000 in a particular class of a Fund from August 31,
1990, although the particular class may have been introduced at a
subsequent date. As indicated above, performance information for each
class introduced after the commencement of operations of the related Fund
(or predecessor fund) is based on the performance history of a predecessor
class or classes, and historical expenses have not been restated, for
periods during which the performance information for a particular class is
based upon the performance history of a predecessor class, to reflect the
ongoing expenses currently borne by the particular class.
20
NON-STANDARDIZED PERFORMANCE RESULTS*
(INCLUDING SALES CHARGES)
With the current maximum respective sales charges of 4.50% for A shares,
and the current applicable CDSC for B Shares, the total value for the same
periods would be as follows:
Total
Value
-------
JPMorgan Fleming European Fund
A Shares $22,053
B Shares 22,379
C Shares 22,565
JPMorgan New York Intermediate Tax Free Income Fund
A Shares 18,390
B Shares 19,259
* See the notes to the table captioned "Average Annual Total Return
(excluding sales charges)" above. The table above assumes an initial
investment of $10,000 in a particular class of a Fund from August 31,
1990, although the particular class may have been introduced at a
subsequent date. As indicated above, performance information for each
class introduced after the commencement of operations of the related Fund
(or predecessor fund) is based on the performance history of a predecessor
class or classes, and historical expenses have not been restated, for
periods during which the performance information for a particular class is
based upon the performance history of a predecessor class, to reflect the
ongoing expenses currently borne by the particular class.
DETERMINATION OF NET ASSET VALUE
As of the date of this Statement of Additional Information, the New York
Stock Exchange is open for trading every weekday except for the following
holidays: New Year's Day, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day. In addition to
the days listed above (other than Good Friday), Chase is closed for business on
the following holidays: Martin Luther King Day, Columbus Day and Veteran's Day.
Each Fund calculates its NAV once each day at the close of regular trading
on the New York Stock Exchange. Bonds and other fixed income securities (other
than short-term obligations) in a Fund's portfolio are valued on the basis of
valuations furnished by a pricing service, the use of which has been approved by
the Board of Trustees. In making such valuations, the pricing service utilizes
both dealer-supplied valuations and electronic data processing techniques that
take into account appropriate factors such as institutional-size trading in
similar groups of securities, yield, quality, coupon rate, maturity, type of
issue, trading characteristics and other market data, without exclusive reliance
upon quoted prices or exchange or over-the-counter prices, since such valuations
are believed to reflect more accurately the fair value of such securities.
Short-term obligations which mature in 60 days or less are valued at amortized
cost, which constitutes fair value as determined by the Board of Trustees.
Futures and option contracts that are traded on commodities or securities
exchanges are normally valued at the settlement price on the exchange on which
they are traded. Portfolio securities (other than short-term obligations) for
which there are no such quotations or valuations are valued at fair value as
determined in good faith by or at the direction of the Board of Trustees.
Interest income on long-term obligations in a Fund's portfolio is
determined on the basis of coupon interest accrued plus amortization of discount
(the difference between acquisition price and stated redemption price at
maturity) and premiums (the excess of purchase price over stated redemption
price at maturity). Interest income on short-term obligations is determined on
the basis of interest and discount accrued less amortization of premium.
21
PURCHASES AND REDEMPTIONS
The Funds have established certain procedures and restrictions, subject
to change from time to time, for purchase, redemption, and exchange orders,
including procedures for accepting telephone instructions and effecting
automatic investments and redemptions. The Funds' Transfer Agent may defer
acting on a shareholder's instructions until it has received them in proper
form. In addition, the privileges described in the Prospectuses are not
available until a completed and signed account application has been received
by the Transfer Agent. Telephone transaction privileges are made available to
shareholders automatically upon opening an account unless the privilege is
declined in Section 6 of the Account Application. The Telephone Exchange
Privilege is not available if you were issued certificates for shares that
remain outstanding.
Upon receipt of any instructions or inquiries by telephone from a
shareholder or, if held in a joint account, from either party, or from any
person claiming to be the shareholder, a Fund or its agent is authorized,
without notifying the shareholder or joint account parties, to carry out the
instructions or to respond to the inquiries, consistent with the service
options chosen by the shareholder or joint shareholders in his or their
latest account application or other written request for services, including
purchasing, exchanging, or redeeming shares of such Fund and depositing and
withdrawing monies from the bank account specified in the Bank Account
Registration section of the shareholder's latest account application or as
otherwise properly specified to such Fund in writing.
Subject to compliance with applicable regulations, each Fund has
reserved the right to pay the redemption price of its Shares, either totally
or partially, by a distribution in kind of readily marketable portfolio
securities (instead of cash). The securities so distributed would be valued
at the same amount as that assigned to them in calculating the net asset
value for the shares being sold. If a shareholder received a distribution in
kind, the shareholder could incur brokerage or other charges in converting
the securities to cash. The Trust has filed an election under Rule 18f-1
committing to pay in cash all redemptions by a shareholder of record up to
amounts specified by the rule (approximately $250,000).
Each investor in a Fund, may add to or reduce its investment in the Fund
on each day that the New York Stock Exchange is open for business. Once each
such day, based upon prices determined as of the close of regular trading on
the New York Stock Exchange (normally 4:00 p.m., Eastern time, however, options
are priced at 4:15 p.m., Eastern time) the value of each investor's interest in
a Fund will be determined by multiplying the NAV of the Fund by the percentage
representing that investor's share of the aggregate beneficial interests in the
Fund. Any additions or reductions which are to be effected on that day will
then be effected. The investor's percentage of the aggregate beneficial
interests in a Fund will then be recomputed as the percentage equal to the
fraction (i) the numerator of which is the value of such investor's investment
in the Fund as of such time on such day plus or minus, as the case may be, the
amount of net additions to or reductions in the investor's investment in the
Fund effected on such day and (ii) the denominator of which is the aggregate
NAV of the Fund as of such time on such day plus or minus, as the case may be,
the amount of net additions to or reductions in the aggregate investments in
the Fund by all investors in the Fund. The percentage so determined will then
be applied to determine the value of the investor's interest in the Fund as of
such time on the following day the New York Stock Exchange is open for trading.
The public offering price of Class A shares is the NAV plus a sales charge
that varies depending on the size of your purchase. The Fund receives the NAV.
The sales charge is allocated between
22
your broker-dealer and the Fund's distributor as shown in the following
table, except when the Fund's distributor, in its discretion, allocates the
entire amount to your broker-dealer.
The broker-dealer allocation for Funds with a 5.75% sales charge on Class A
shares is set forth below:
AMOUNT OF
SALES CHARGE AS A SALES CHARGE
PERCENTAGE OF: REALLOWED TO
-------------------- DEALERS AS A
AMOUNT OF TRANSACTION AT OFFERING NET AMOUNT PERCENTAGE OF
OFFERING PRICE ($) PRICE INVESTED OFFERING PRICE
- ------------------ -------- ---------- --------------
Under 100,000 5.75 6.10 5.00
100,000 but under 250,000 3.75 3.90 3.25
250,000 but under 500,000 2.50 2.56 2.25
500,000 but under 1,000,000 2.00 2.04 1.75
There is no initial sales charge on purchases of Class A shares of $1
million or more.
The Fund's distributor pays broker-dealers commissions on net sales of
Class A shares of $1 million or more based on an investor's cumulative
purchases. Such commissions are paid at the rate of 1.00% of the amount under
$2.5 million, 0.75% of the next $7.5 million, 0.50% of the next $40 million and
0.20% thereafter. The Fund's distributor may withhold such payments with respect
to short-term investments.
The broker-dealer allocation for Funds with a 4.50% sales charge on Class A
shares is set forth below:
AMOUNT OF
SALES CHARGE AS A SALES CHARGE
PERCENTAGE OF: REALLOWED TO
-------------------- DEALERS AS A
AMOUNT OF TRANSACTION AT OFFERING NET AMOUNT PERCENTAGE OF
OFFERING PRICE ($) PRICE INVESTED OFFERING PRICE
- ------------------ -------- ---------- --------------
Under 100,000 4.50 4.71 4.00
100,000 but under 250,000 3.75 3.90 3.25
250,000 but under 500,000 2.50 2.56 2.25
500,000 but under 1,000,000 2.00 2.04 1.75
There is no initial sales charge on purchases of Class A shares of $1
million or more.
The Fund's distributor pays broker-dealers commissions on net sales of Class
A shares of $1 million or more based on an investor's cumulative purchases. Such
commissions are paid at the rate of 0.75% of the amount under $2.5 million,
0.50% of the next $7.5 million, 0.25% of the next $40 million and 0.15%
thereafter. The Fund's distributor may withhold such payments with respect to
short-term investments.
23
There is no initial sales charge on purchases of Class A shares of $1
million or more.
Investors in Class A shares may qualify for reduced initial sales charges
by signing a statement of intention (the "Statement"). This enables the
investor to aggregate purchases of Class A shares in the Fund with purchases of
Class A shares of any other Fund in the Trust (or if a Fund has only one class,
shares of such Fund), excluding shares of any JPMorgan Money Market Fund,
during a 13-month period. The sales charge is based on the total amount to be
invested in Class A shares during the 13-month period. All Class A or other
qualifying shares of these Funds currently owned by the investor will be
credited as purchases (at their current offering prices on the date the
Statement is signed) toward completion of the Statement. A 90-day back-dating
period can be used to include earlier purchases at the investor's cost. The
13-month period would then begin on the date of the first purchase during the
90-day period. No retroactive adjustment will be made if purchases exceed the
amount indicated in the Statement. A shareholder must notify the Transfer Agent
or Distributor whenever a purchase is being made pursuant to a Statement.
The Statement is not a binding obligation on the investor to purchase the
full amount indicated; however, on the initial purchase, if required (or
subsequent purchases if necessary), 5% of the dollar amount specified in the
Statement will be held in escrow by the Transfer Agent in Class A shares (or if
a Fund has only one class and is subject to an initial sales charge, shares of
such Fund) registered in the shareholder's name in order to assure payment of
the proper sales charge. If total purchases pursuant to the Statement (less any
dispositions and exclusive of any distributions on such shares automatically
reinvested) are less than the amount specified, the investor will be requested
to remit to the Transfer Agent an amount equal to the difference between the
sales charge paid and the sales charge applicable to the aggregate purchases
actually made. If not remitted within 20 days after written request, an
appropriate number of escrowed shares will be redeemed in order to realize the
difference. This privilege is subject to modification or discontinuance at any
time with respect to all shares purchased thereunder. Reinvested dividend and
capital gain distributions are not counted toward satisfying the Statement.
Class A shares of a Fund may also be purchased by any person at a reduced
initial sales charge which is determined by (a) aggregating the dollar amount
of the new purchase and the greater of the purchaser's total (i) NAV or (ii)
cost of any shares acquired and still held in the Fund, or any other JPMorgan
Fund excluding any JPMorgan Money Market Fund, and (b) applying the initial
sales charge applicable to such aggregate dollar value (the "Cumulative
Quantity Discount"). The privilege of the Cumulative Quality Discount is
subject to modification or discontinuance at any time with respect to all Class
A shares (or if a Fund has only one class and is subject to an initial sales
charge, shares of such Fund) purchased thereafter.
An individual who is a member of a qualified group (as hereinafter
defined) may also purchase Class A shares of a Fund (or if a Fund has only one
class and is subject to an initial sales charge, shares of such Fund) at the
reduced sales charge applicable to the group taken as a whole. The reduced
initial sales charge is based upon the aggregate dollar value of Class A shares
(or if a Fund has only one class and is subject to an initial sales charge,
shares of such Fund) previously purchased and still owned by the group plus the
securities currently being purchased and is determined as stated in the
preceding paragraph. In order to obtain such discount, the purchaser or
investment dealer must provide the Transfer Agent with sufficient information,
including the purchaser's total cost, at the time of purchase to permit
verification that the purchaser qualifies for a cumulative quantity discount,
and confirmation of the order is subject to such verification. Information
concerning the current initial sales charge applicable to a group may be
obtained by contacting the Transfer Agent.
24
A "qualified group" is one which (i) has been in existence for more than
six months, (ii) has a purpose other than acquiring Class A shares (or if a
Fund has only one class and is subject to an initial sales charge, shares of
such Fund) at a discount and (iii) satisfies uniform criteria which enables the
Distributor to realize economies of scale in its costs of distributing Class A
shares (or if a Fund has only one class and is subject to an initial sales
charge, shares of such Fund). A qualified group must have more than 10 members,
must be available to arrange for group meetings between representatives of the
Fund and the members must agree to include sales and other materials related to
the Fund in its publications and mailings to members at reduced or no cost to
the Distributor, and must seek to arrange for payroll deduction or other bulk
transmission of investments in the Fund. This privilege is subject to
modification or discontinuance at any time with respect to all Class A shares
(or if a Fund has only one class and is subject to an initial sales charge,
shares of such Fund) purchased thereafter.
Under the Exchange Privilege, shares may be exchanged for shares of
another fund only if shares of the fund exchanged into are registered in the
state where the exchange is to be made. Shares of a Fund may only be exchanged
into another fund if the account registrations are identical. With respect to
exchanges from any JPMorgan money market fund, shareholders must have acquired
their shares in such money market fund by exchange from one of the JPMorgan
non-money market funds or the exchange will be done at relative net asset value
plus the appropriate sales charge. Any such exchange may create a gain or loss
to be recognized for federal income tax purposes. Normally, shares of the fund
to be acquired are purchased on the redemption rate, but such purchase may be
delayed by either fund for up to five business days if a fund determines that
it would be disadvantaged by an immediate transfer of the proceeds.
The Funds' Distributor pays broker-dealers a commission of 4.00% of the
offering price on sales of Class B shares and a commission of 1.00% of the
offering price on sales of Class C shares. The Distributor keeps the entire
amount of any CDSC the investor pays.
The contingent deferred sales charge for Class B and Class C shares will
be waived for certain exchanges and for redemptions in connection with a
Fund's systematic withdrawal plan, subject to the conditions described in the
Prospectuses. In addition, subject to confirmation of a shareholder's status,
the contingent deferred sales charge will be waived for: (i) a total or
partial redemption made within one year of the shareholder's death or initial
qualification for Social Security disability payments; (ii) a redemption in
connection with a Minimum Required Distribution from an IRA, Keogh or
custodial account under section 403(b) of the Internal Revenue Code or a
mandatory distribution from a qualified plan; (iii) redemptions made from an
IRA, Keogh or custodial account under section 403(b) of the Internal Revenue
Code through an established Systematic Redemption Plan; (iv) a redemption
resulting from an over-contribution to an IRA; (v) distributions from a
qualified plan upon retirement; and (vi) an involuntary redemption of an
account balance under $500.
Class B shares automatically convert to Class A shares (and thus are
then subject to the lower expenses borne by Class A shares) after a period of
time specified below has elapsed since the date of purchase (the "CDSC
Period"), together with the pro rata portion of all Class B shares
representing dividends and other distributions paid in additional Class B
shares attributable to the Class B shares then converting. The conversion of
Class B shares purchased on or after May 1, 1996, will be effected at the
relative NAVs per share of the two classes on the first business day of the
month following the eighth anniversary of the original purchase. The
conversion of Class B shares purchased prior to May 1, 1996, will be effected
at the relative net asset values per share of the two classes on the first
business day of the month following the seventh anniversary of the original
purchase. Up to 12% of the value of Class B shares subject to a systematic
withdrawal plan may also be redeemed each year without a CDSC, provided that
the Class B account had a minimum balance of $20,000 at the time the
systematic withdrawal plan was established. If any exchanges of Class B
shares during the CDSC Period occurred, the holding period for the shares
exchanged will be counted toward the CDSC Period. At the time of the
conversion the NAV per share of the Class A shares may be higher or lower
than the NAV per share of the Class B shares; as a result, depending on the
relative NAVs per share, a shareholder may receive fewer or more Class A
shares than the number of Class B shares converted.
25
A Fund may require signature guarantees for changes that shareholders
request be made in Fund records with respect to their accounts, including but
not limited to, changes in bank accounts, for any written requests for
additional account services made after a shareholder has submitted an initial
account application to the Fund, and in certain other circumstances described
in the Prospectuses. A Fund may also refuse to accept or carry out any
transaction that does not satisfy any restrictions then in effect. A
signature guarantee may be obtained from a bank, trust company, broker-dealer
or other member of a national securities exchange. Please note that a notary
public cannot provide a signature guarantee.
Investors may be eligible to buy Class A shares at reduced sales charges.
Interested parties should consult their investment representative or the J.P.
Morgan Funds Service Center for details about J.P. Morgan Funds' combined
purchase privilege, cumulative quantity discount, statement of intention, group
sales plan, employee benefit plans and other plans. Sales charges are waived if
the investor is using redemption proceeds received within the prior ninety days
from non-J.P. Morgan mutual funds to buy his or her shares, and on which he or
she paid a front-end or contingent deferred sales charge.
Some participant-directed employee benefit plans participate in a
"multi-fund" program which offers both JPMorgan and non-JPMorgan mutual funds.
The money that is invested in JPMorgan Funds may be combined with the other
mutual funds in the same program when determining the plan's eligibility to buy
Class A shares for purposes of the discount privileges and programs described
above.
No initial sales charge will apply to the purchase of a Fund's Class A
shares if (i) one is investing proceeds from a qualified retirement plan where
a portion of the plan was invested in the JPMorgan Funds, (ii) one is investing
through any qualified retirement plan with 50 or more participants or (iii) one
is a participant in certain qualified retirement plans and is investing (or
reinvesting) the proceeds from the repayment of a plan loan made to him or her.
Purchases of a Fund's Class A shares may be made with no initial sales
charge through an investment adviser or financial planner that charges a fee
for its services.
Purchases of a Fund's Class A shares may be made with no initial sales
charge (i) by an investment adviser, broker or financial planner, provided
arrangements are preapproved and purchases are placed through an omnibus
account with the Fund or (ii) by clients of such investment adviser or
financial planner who place trades for their own accounts, if such accounts are
linked to a master account of such investment adviser or financial planner on
the books and records of the broker or agent. Such purchases may also be made
for retirement and deferred compensation plans and trusts used to fund those
plans.
Purchases of a Fund's Class A shares may be made with no initial sales
charge in accounts opened by a bank, trust company or thrift institution which
is acting as a fiduciary exercising investment discretion, provided that
appropriate notification of such fiduciary relationship is reported at the time
of the investment to the Fund, the Fund's distributor or the J.P. Morgan Funds
Service Center.
A Fund may sell Class A shares without an initial sales charge to the
current and retired Trustees (and their immediate families), current and
retired employees (and their immediate families) of Chase, the Fund's
distributor and transfer agent or any affiliates or subsidiaries thereof,
registered representatives and other employees (and their immediate families)
of broker-dealers having selected dealer agreements with the Fund's
distributor, employees (and their immediate families) of financial institutions
having selected dealer agreements with the Fund's distributor (or otherwise
having an arrangement with a broker-dealer or financial institution with
respect to sales of JPMorgan Fund shares) and financial institution trust
departments investing an aggregate of $1 million or more in the JPMorgan Funds.
Shareholders of record of any JPMorgan Fund as of November 30, 1990 and
certain immediate family members may purchase a Fund's Class A shares with no
initial sales charge for as long as they continue to own Class A shares of any
JPMorgan Fund, provided there is no change in account registration.
26
Shareholders of other JPMorgan Funds may be entitled to exchange their
shares for, or reinvest distributions from their funds in, shares of the Fund
at net asset value.
The Funds reserve the right to change any of these policies at any time and
may reject any request to purchase shares at a reduced sales charge.
Investors may incur a fee if they effect transactions through a broker
or agent.
TAX MATTERS
The following is only a summary of certain additional tax
considerations generally affecting the Funds and their shareholders that are
not described in the respective Fund's Prospectus. No attempt is made to
present a detailed explanation of the tax treatment of the Funds or their
shareholders, and the discussions here and in each Fund's Prospectus are not
intended as substitutes for careful tax planning.
QUALIFICATION AS A REGULATED INVESTMENT COMPANY
Each Fund has elected to be taxed as a regulated investment company
under Subchapter M of the Internal Revenue Code of 1986, as amended (the
"Code"). As a regulated investment company, each Fund is not subject to
federal income tax on the portion of its net investment income (i.e., its
investment company taxable income, as that term is defined in the Code,
without regard to the deduction for dividends paid), and net capital gain
(i.e., the excess of net long-term capital gain over net short-term capital
loss) that it distributes to shareholders, provided that it distributes at
least 90% of its net investment income and at least 90% of its tax-exempt
income (net of expenses allocable thereto) for the taxable year (the
"Distribution Requirement"), and satisfies certain other requirements of the
Code that are described below. Under the current view of the Internal Revenue
Service, if a Fund invests all of its assets in another open-end management
investment company which is classified as a partnership for federal income
tax purposes, such Fund will be deemed to own a proportionate share of the
income of the portfolio into which it contributes all of its assets for
purposes of determining whether such Fund satisfies the Distribution
Requirement and the other requirements necessary to qualify as a regulated
investment company (e.g., Income Requirement (hereinafter defined), etc.).
In addition to satisfying the Distribution Requirement, a regulated
investment company must derive at least 90% of its gross income from
dividends, interest, certain payments with respect to securities loans, gains
from the sale or other disposition of stock or securities or foreign
currencies (to the extent such currency gains are directly related to the
regulated investment company's principal business of investing in stock or
securities) and other income (including but not limited to gains from
options, futures or forward contracts) derived with respect to its business
of investing in such stock, securities or currencies (the "Income
Requirement").
In addition to satisfying the requirements described above, each Fund
must satisfy an asset diversification test in order to qualify as a regulated
investment company. Under this test, at the close of each quarter of a Fund's
taxable year, at least 50% of the value of the Fund's assets must consist of
cash and cash items, U.S. government securities, securities of other
regulated investment companies, and securities of other issuers (as to which
the Fund has not invested more than 5% of the value of the Fund's total
assets in securities of such issuer and as to which the Fund does not hold
more than 10% of the outstanding voting securities of such issuer), and no
more than 25% of the value of its total assets may be invested in the
securities of any one issuer (other than U.S. government securities and
securities of other regulated investment companies), or in two or more
issuers which the Fund controls and which are engaged in the same or similar
trades or businesses.
Each Fund may engage in hedging or derivatives transactions involving
foreign currencies, forward contracts, options and futures contracts
(including options, futures and forward contracts on foreign currencies) and
27
short sales. See "Additional Policies Regarding Derivative and Related
Transactions." Such transactions will be subject to special provisions of the
Code that, among other things, may affect the character of gains and losses
realized by the Fund (that is, may affect whether gains or losses are
ordinary or capital), accelerate recognition of income of the Fund and defer
recognition of certain of the Fund's losses. These rules could therefore
affect the character, amount and timing of distributions to shareholders. In
addition, these provisions (1) will require a Fund to "mark-to-market"
certain types of positions in its portfolio (that is, treat them as if they
were closed out) and (2) may cause a Fund to recognize income without
receiving cash with which to pay dividends or make distributions in amounts
necessary to satisfy the Distribution Requirement and avoid the 4% excise tax
(described below). Each Fund intends to monitor its transactions, will make
the appropriate tax elections and will make the appropriate entries in its
books and records when it acquires any option, futures contract, forward
contract or hedged investment in order to mitigate the effect of these rules.
If for any taxable year a Fund does not qualify as a regulated
investment company, all of its taxable income (including its net capital
gain) will be subject to tax at regular corporate rates without any deduction
for distributions to shareholders, and such distributions will be taxable to
the shareholders as ordinary dividends to the extent of the Fund's current
and accumulated earnings and profits. Such distributions generally will be
eligible for the dividends-received deduction in the case of corporate
shareholders.
EXCISE TAX ON REGULATED INVESTMENT COMPANIES
A 4% non-deductible excise tax is imposed on a regulated investment
company that fails to distribute in each calendar year an amount equal to 98%
of ordinary taxable income for the calendar year and 98% of capital gain net
income for the one-year period ended on October 31 of such calendar year (or,
at the election of a regulated investment company having a taxable year
ending November 30 or December 31, for its taxable year (a "taxable year
election"))(Tax-exempt interest on municipal obligations is not subject to
the excise tax). The balance of such income must be distributed during the
next calendar year. For the foregoing purposes, a regulated investment
company is treated as having distributed any amount on which it is subject to
income tax for any taxable year ending in such calendar year.
Each Fund intends to make sufficient distributions or deemed
distributions of its ordinary taxable income and capital gain net income
prior to the end of each calendar year to avoid liability for the excise tax.
However, investors should note that a Fund may in certain circumstances be
required to liquidate portfolio investments to make sufficient distributions
to avoid excise tax liability.
FUND DISTRIBUTIONS
Each Fund anticipates distributing substantially all of its net
investment income for each taxable year. Such distributions will be taxable
to shareholders as ordinary income and treated as dividends for federal
income tax purposes, but they will not qualify for the 70% dividends-received
deduction for corporate shareholders of a Fund.
A Fund may either retain or distribute to shareholders its net capital
gain for each taxable year. Each Fund currently intends to distribute any
such amounts. If net capital gain is distributed and designated as a capital
gain dividend, it will be taxable to shareholders as long-term capital gain,
regardless of the length of time the shareholder has held his shares or
whether such gain was recognized by the Fund prior to the date on which the
shareholder acquired his shares.
Under current legislation, the maximum rate of tax on long-term capital
gains of individuals is 20% (10% for gains otherwise taxed at 15%) for
long-term capital gains realized with respect to capital assets held for more
than 12 months. Additionally, beginning after December 31, 2000, the maximum
tax rate for capital assets with a holding period beginning after that date
and held for more than five years will be 18%.
28
Conversely, if a Fund elects to retain its net capital gain, the Fund
will be taxed thereon (except to the extent of any available capital loss
carryovers) at the 35% corporate tax rate. If a Fund elects to retain its net
capital gain, it is expected that the Fund also will elect to have
shareholders of record on the last day of its taxable year treated as if each
received a distribution of his pro rata share of such gain, with the result
that each shareholder will be required to report his pro rata share of such
gain on his tax return as long-term capital gain, will receive a refundable
tax credit for his pro rata share of tax paid by the Fund on the gain, and
will increase the tax basis for his shares by an amount equal to the deemed
distribution less the tax credit.
Each Fund intends to qualify to pay exempt-interest dividends by
satisfying the requirement that at the close of each quarter of the Fund's
taxable year at least 50% of the its total assets consists of tax-exempt
municipal obligations. Distributions from a Fund will constitute
exempt-interest dividends to the extent of its tax-exempt interest income
(net of expenses and amortized bond premium). Exempt-interest dividends
distributed to shareholders of a Fund are excluded from gross income for
federal income tax purposes. However, shareholders required to file a federal
income tax return will be required to report the receipt of exempt-interest
dividends on their returns. Moreover, while exempt-interest dividends are
excluded from gross income for federal income tax purposes, they may be
subject to alternative minimum tax ("AMT") in certain circumstances and may
have other collateral tax consequences as discussed below. Distributions by a
Fund of any investment company taxable income or of any net capital gain will
be taxable to shareholders as discussed above.
AMT is imposed in addition to, but only to the extent it exceeds, the
regular tax and is computed at a maximum marginal rate of 28% for
noncorporate taxpayers and 20% for corporate taxpayers on the excess of the
taxpayer's alternative minimum taxable income ("AMTI") over an exemption
amount. In addition, under the Superfund Amendments and Reauthorization Act
of 1986, a tax is imposed for taxable years beginning after 1986 and before
1996 at the rate of 0.12% on the excess of a corporate taxpayer's AMTI
(determined without regard to the deduction for this tax and the AMT net
operating loss deduction) over $2 million. Exempt-interest dividends derived
from certain "private activity" municipal obligations issued after August 7,
1986 will generally constitute an item of tax preference includable in AMTI
for both corporate and noncorporate taxpayers. In addition, exempt-interest
dividends derived from all municipal obligations, regardless of the date of
issue, must be included in adjusted current earnings, which are used in
computing an additional corporate preference item (i.e., 75% of the excess of
a corporate taxpayer's adjusted current earnings over its AMTI (determined
without regard to this item and the AMT net operating loss deduction))
includable in AMTI.
Exempt-interest dividends must be taken into account in computing the
portion, if any, of social security or railroad retirement benefits that must
be included in an individual shareholder's gross income and subject to
federal income tax. Further, a shareholder of a Fund is denied a deduction
for interest on indebtedness incurred or continued to purchase or carry
shares of the Fund. Moreover, a shareholder who is (or is related to) a
"substantial user" of a facility financed by industrial development bonds
held by a Fund will likely be subject to tax on dividends paid by the Fund
which are derived from interest on such bonds. Receipt of exempt-interest
dividends may result in other collateral federal income tax consequences to
certain taxpayers, including financial institutions, property and casualty
insurance companies and foreign corporations engaged in a trade or business
in the United States. Prospective investors should consult their own tax
advisers as to such consequences.
Distributions by a Fund that do not constitute ordinary income
dividends, exempt-interest dividends or capital gain dividends will be
treated as a return of capital to the extent of (and in reduction of) the
shareholder's tax basis in his shares; any excess will be treated as gain
from the sale of his shares, as discussed below.
Distributions by a Fund will be treated in the manner described above
regardless of whether such distributions are paid in cash or reinvested in
additional shares of the Fund (or of another fund). Shareholders receiving a
distribution in the form of additional shares will be treated as receiving a
distribution in an amount equal to the fair market value of the shares
received, determined as of the reinvestment date.
29
In addition, if the net asset value at the time a shareholder purchases
shares of a Fund reflects undistributed net investment income or recognized
capital gain net income, or unrealized appreciation in the value of the
assets of the Fund, distributions of such amounts will be taxable to the
shareholder in the manner described above, although such distributions
economically constitute a return of capital to the shareholder.
Ordinarily, shareholders are required to take distributions by a Fund
into account in the year in which the distributions are made. However,
dividends declared in October, November or December of any year and payable
to shareholders of record on a specified date in such a month will be deemed
to have been received by the shareholders (and made by the Fund) on December
31 of such calendar year if such dividends are actually paid in January of
the following year. Shareholders will be advised annually as to the U.S.
federal income tax consequences of distributions made (or deemed made) during
the year.
A Fund will be required in certain cases to withhold and remit to the
U.S. Treasury 31% of ordinary income dividends and capital gain dividends,
and the proceeds of redemption of shares, paid to any shareholder (1) who has
provided either an incorrect tax identification number or no number at all,
(2) who is subject to backup withholding by the IRS for failure to report the
receipt of interest or dividend income properly, or (3) who has failed to
certify to the Fund that it is not subject to backup withholding or that it
is a corporation or other "exempt recipient."
SALE OR REDEMPTION OF SHARES
A shareholder will recognize gain or loss on the sale or redemption of
shares of a Fund in an amount equal to the difference between the proceeds of
the sale or redemption and the shareholder's adjusted tax basis in the
shares. All or a portion of any loss so recognized may be disallowed if the
shareholder purchases other shares of the Fund within 30 days before or after
the sale or redemption. In general, any gain or loss arising from (or treated
as arising from) the sale or redemption of shares of a Fund will be
considered capital gain or loss and will be long-term capital gain or loss if
the shares were held for longer than one year. However, any capital loss
arising from the sale or redemption of shares held for six months or less
will be disallowed to the extent of the amount of exempt-interest dividends
received on such shares and (to the extent not disallowed) will be treated as
a long-term capital loss to the extent of the amount of capital gain
dividends received on such shares.
FOREIGN SHAREHOLDERS
Taxation of a shareholder who, as to the United States, is a
nonresident alien individual, foreign trust or estate, foreign corporation,
or foreign partnership ("foreign shareholder"), depends on whether the income
from a Fund is "effectively connected" with a U.S. trade or business carried
on by such shareholder.
If the income from a Fund is not effectively connected with a U.S.
trade or business carried on by a foreign shareholder, dividends paid to a
foreign shareholder from net investment income will be subject to U.S.
withholding tax at the rate of 30% (or lower treaty rate) upon the gross
amount of the dividend. Such a foreign shareholder would generally be exempt
from U.S. federal income tax on gains realized on the sale of shares of the
Fund and capital gain dividends and amounts retained by the Fund that are
designated as undistributed capital gains.
If the income from a Fund is effectively connected with a U.S. trade or
business carried on by a foreign shareholder, then ordinary income dividends,
capital gain dividends, and any gains realized upon the sale of shares of the
Fund will be subject to U.S. federal income tax at the rates applicable to
U.S. citizens or domestic corporations.
In the case of foreign noncorporate shareholders, a Fund may be
required to withhold U.S. federal income tax at a rate of 31% on
distributions that are otherwise exempt from withholding tax (or taxable at a
reduced treaty rate) unless such shareholders furnish the Fund with proper
notification of its foreign status.
30
The tax consequences to a foreign shareholder entitled to claim the
benefits of an applicable tax treaty may be different from those described
herein. Foreign shareholders are urged to consult their own tax advisers with
respect to the particular tax consequences to them of an investment in a
Fund, including the applicability of foreign taxes.
STATE AND LOCAL TAX MATTERS
Depending on the residence of the shareholder for tax purposes,
distributions may also be subject to state and local taxes or withholding
taxes. Most states provide that a registered investment company ("RIC") may
pass through (without restriction) to its shareholders state and local income
tax exemptions available to direct owners of certain types of U.S. government
securities (such as U.S. Treasury obligations). Thus, for residents of these
states, distributions derived from a Fund's investment in certain types of
U.S. government securities should be free from state and local income taxes
to the extent that the interest income from such investments would have been
exempt from state and local income taxes if such securities had been held
directly by the respective shareholders themselves. Certain states, however,
do not allow a RIC to pass through to its shareholders the state and local
income tax exemptions available to direct owners of certain types of U.S.
government securities unless the RIC holds at least a required amount of U.S.
government securities. Accordingly, for residents of these states,
distributions derived from a Fund's investment in certain types of U.S.
government securities may not be entitled to the exemptions from state and
local income taxes that would be available if the shareholders had purchased
U.S. government securities directly. Shareholders' dividends attributable to
a Fund's income from repurchase agreements generally are subject to state and
local income taxes, although states and regulations vary in their treatment
of such income. The exemption from state and local income taxes does not
preclude states from asserting other taxes on the ownership of U.S.
government securities. To the extent that a Fund invests to a substantial
degree in U.S. government securities which are subject to favorable state and
local tax treatment, shareholders of such Fund will be notified as to the
extent to which distributions from the Fund are attributable to interest on
such securities. Rules of state and local taxation of ordinary income
dividends and capital gain dividends from RICs may differ from the rules for
U.S. federal income taxation in other respects. Shareholders are urged to
consult their tax advisers as to the consequences of these and other state
and local tax rules affecting investment in a Fund.
EFFECT OF FUTURE LEGISLATION
The foregoing general discussion of U.S. federal income tax
consequences is based on the Code and the Treasury Regulations issued
thereunder as in effect on the date of this Statement of Additional
Information. Future legislative or administrative changes or court decisions
may significantly change the conclusions expressed herein, and any such
changes or decisions may have a retroactive effect with respect to the
transactions contemplated herein.
31
MANAGEMENT OF THE TRUST AND THE FUNDS
TRUSTEES AND OFFICERS
The mailing address of the Trustees and Officers of the Trust, who are
also the Trustees of each of the Funds and the other Master Funds, as defined
below, is 522 Fifth Avenue, New York, New York 10036. Their names, principal
occupations during the past five years and ages are set forth below:
WILLIAM J. ARMSTRONG--Trustee; Retired; formerly Vice President and
Treasurer Ingersoll-Rand Company. Age: 59.
ROLAND R. EPPLEY, JR.--Trustee; Retired; formerly President and Chief
Executive Officer, Eastern States Bankcard Association, Inc. (1971-1988);
Director, Janel Hydraulics, Inc.; formerly Director of The Hanover Funds,
Inc. Age: 68.
ANN MAYNARD GRAY--Trustee; Former President, Diversified Publishing
Group and Vice President, Capital Cities/ABC, Inc. Age: 55.
MATTHEW HEALEY--Trustee; Chief Executive Officer, Chairman, Pierpont
Group, since prior to 1993. Age: 63.
FERGUS REID, III--Trustee; Chairman and Chief Executive Officer,
Lumelite Corporation, since September 1985; Trustee, Morgan Stanley Funds.
Age: 68.
JAMES J. SCHONBACHLER--Trustee; Retired; Prior to September, 1998,
Managing Director, Bankers Trust Company and Chief Executive Officer and
Director, Bankers Trust A.G., Zurich and BT Brokerage Corp. Age: 58.
LEONARD M. SPALDING--Trustee; Retired; formerly Chief Executive Officer
of Chase Mutual Funds Corp.; formerly President and Chief Executive Officer
of Vista Capital Management; and formerly Chief Investment Executive of the
Chase Manhattan Private Bank. Age: 65.
H. RICHARD VARTABEDIAN--Trustee; Investment Management Consultant;
formerly, Senior Investment Officer, Division Executive of the Investment
Management Division of the Chase Manhattan Bank, N.A., 1980-1991. Age: 65.
32
MARTIN R. DEAN--Treasurer. Vice President, Administration Services, BISYS
Fund Services, Inc.; formerly Senior Manager, KPMG Peat Marwick (1987-1994).
Age: 37. Address: 3435 Stelzer Road, Columbus, OH 43219.
LISA HURLEY--Secretary. Executive Vice President and General Counsel,
BISYS Fund Services, Inc.; formerly Counsel to Moore Capital Management and
General Counsel to Global Asset Management and Northstar Investments Management.
Age: 45. Address: 90 Park Avenue, New York, NY 10016.
VICKY M. HAYES--Assistant Secretary. Vice President and Global Marketing
Manager, Vista Fund Distributors, Inc.; formerly Assistant Vice President,
Alliance Capital Management and held various positions with J. & W. Seligman &
Co. Age: 37. Address: 1211 Avenue of the Americas, 41st Floor, New York, NY
10036.
ALAINA METZ--Assistant Secretary. Chief Administrative Officer, BISYS Fund
Services Inc.; formerly Supervisor, Blue Sky Department, Alliance Capital
Management L.P. Age: 33. Address: 3435 Stelzer Road, Columbus, OH 43219.
- ----------
* Asterisks indicate those Trustees that are "interested persons" (as defined in
the 1940 Act). Mr. Reid is not an interested person of the Trust's investment
advisers or principal underwriter, but may be deemed an interested person of the
Trust solely by reason of being an officer of the Trust.
The Board of Trustees of the Trust presently has an Audit Committee. The
members of the Audit Committee are Messrs. Ten Haken (Chairman), Armstrong,
Eppley, MacCallan and Thode. The function of the Audit Committee is to recommend
independent auditors and monitor accounting and financial matters. The Audit
Committee met two times during the fiscal period ended August 31, 2000.
A majority of the disinterested Trustees have adopted written
procedures reasonably appropriate to deal with potential conflicts of
interest arising grom the fact that the same individuals are Trustees of the
Trust, each of the Funds and the J.P. Morgan Institutional Funds up to and
including creating a separate board of trustees.
Each Trustee is currently paid an annual fee of $75,000 (adjusted as of
April 1, 1997) for serving as Trustee of the Trust and the J.P. Morgan Funds.
Each is reimbursed for expenses incurred in connection with service as a
Trustee. The Trustees may hold various other directorships unrelated to these
funds.
The Trustees and officers of the Trust appearing in the table above
also serve in the same capacities with respect to Mutual Fund Trust, Mutual
Fund Variable Annuity Trust, Mutual Fund Group, Mutual Fund Select Group,
Mutual Fund Investment Trust, Mutual Fund Master Investment Trust, Capital
Growth Portfolio, Growth and Income Portfolio and International Equity
Portfolio and other JPMorgan Funds.
REMUNERATION OF TRUSTEES AND CERTAIN EXECUTIVE OFFICERS:
Each Trustee is reimbursed for expenses incurred in attending each meeting
of the Board of Trustees or any committee thereof. Each Trustee who is not an
affiliate of the advisers is compensated for his or her services according to a
fee schedule which recognizes the fact that each Trustee also serves as a
Trustee of other investment companies advised by the advisers. Each Trustee
receives a fee, allocated among all investment companies for which the Trustee
serves, which consists of an annual retainer component and a meeting component.
33
Intermediate New York Intermediate
Tax Free Income Tax Free Income European
Fund Fund Fund
--------------- --------------------- --------
Fergus Reid, III, Trustee $2,684 $1,085 $340.67
H. Richard Vartabedian, Trustee 1,871 757 230.21
William J. Armstrong, Trustee 1,266 512 153.71
Roland R. Eppley, Jr., Trustee 1,250 506 157.58
Leonard M. Spalding, Jr., Trustee 1,266 512 151.91
Matthew Healey N/A N/A N/A
James J. Schonbachler N/A N/A N/A
Ann Maynard Gray N/A N/A N/A
PENSION OR RETIREMENT
COMPENSATION FROM BENEFITS ACCRUED AS FUND TOTAL COMPENSATION FROM
TRUST EXPENSES "FUND COMPLEX"(1)
----------------- ------------------------ -----------------------
William J. Armstrong, Trustee $90,000 $41,781 $131,781 (10)(3)
Roland R. Eppley, Jr., Trustee $91,000 $58,206 $149,206 (10)(3)
Ann Maynard Gray, Member of NA NA $75,000 (17)(3)
Advisory Board of certain
J.P. Morgan Funds
Matthew Healey, Trustee(2) NA NA $75,000 (17)(3)
Fergus Reid, III, Trustee $202,750 $110,091 $312,841 (10)(3)
James J. Schonbachler - NA NA $75,000 (17)(3)
Member of the Advisory Board
of certain J.P. Morgan
Funds
Leonard M. Spalding, Jr., $89,000 $35,335 $124,335 (10)(3)
Trustee
H. Richard Vartabedian, Trustee $134,350 $86,791 $221,141 (10)(3)
1 A Fund Complex means two or more investment companies that hold themselves
out to investors as related companies for purposes of investment and
investment services, or have a common investment adviser or have an
investment adviser that is an affiliated person of the investment adviser of
any of the other investment companies. The Fund Complex for which the
nominees will serve includes 14 investment companies.
2 Pierpont Group, Inc. paid Mr. Healey, in his role as Chairman of Pierpont
Group, Inc., compensation in the amount of $200,000, contributed $25,500 to
a defined contribution plan on his behalf and paid $18,400 in insurance
premiums for his benefit.
3 Total number of investment company boards with respect to Trustees, or
Advisory Boards with respect to Advisory Board members, served on within
the Fund Complex.
34
RETIREMENT PLAN AND DEFERRED COMPENSATION PLAN FOR ELIGIBLE TRUSTEES
Effective August 21, 1995, the Trustees also instituted a Retirement
Plan for Eligible Trustees (the "Plan") pursuant to which each Trustee (who
is not an employee of any of the Funds, the Adviser, the administrator or
distributor or any of their affiliates) may be entitled to certain benefits
upon retirement from the Board of Trustees. Pursuant to the Plan, the normal
retirement date is the date on which the eligible Trustee has attained age 65
and has completed at least five years of continuous service with one or more
of the investment companies advised by the Adviser and its affiliates
(collectively, the "Covered Funds"). Each Eligible Trustee is entitled to
receive from the Covered Fund an annual benefit commencing on the first day
of the calendar quarter coincident with or following his date of retirement
equal to the sum of (1) 8% of the highest annual compensation received from
the Covered Funds multiplied by the number of such Trustee's years of service
(not in excess of 10 years) completed with respect to any Covered Funds and
(ii) 4% of the highest annual compensation received from the Covered Funds
for each year of service in excess of 10 years, provided that no Trustee's
annual benefit will exceed the highest annual compensation received by that
Trustee from the Covered Funds. Such benefit is payable to each eligible
Trustee in monthly installments for the life of the Trustee. On February 22,
2001, the Board of Trustee voted to terminate the Plan and to pay Trustees an
agreed-upon amount of compensation.
Effective August 21, 1995, the Trustees instituted a Deferred
Compensation Plan for Eligible Trustees (the "Deferred Compensation Plan")
pursuant to which each Trustee (who is not an employee of any of the Funds, the
Adviser, the administrator or distributor or any of their affiliates) may enter
into agreements with the Funds whereby payment of the Trustees' fees are
deferred until the payment dated elected by the Trustee (or the Trustee's
termination of service). The deferred amounts are deemed invested in shares of
funds as elected by the Trustee at the time of deferral. If a deferring Trustee
dies prior to the distribution of amounts held in the deferral account, the
balance of the deferral account will be distributed to the Trustee's designated
beneficiary in a single lump sum payment as soon as practicable after such
deferring Trustee's death. Mr. Vartabedian has executed a deferred compensation
agreement for the 2000 calendar year.
35
The Declaration of Trust provides that the Trust will indemnify its
Trustees and officers against liabilities and expenses incurred in connection
with litigation in which they may be involved because of their offices with the
Trust, unless, as to liability to the Trust or its shareholders, it is finally
adjudicated that they engaged in willful misfeasance, bad faith, gross
negligence or reckless disregard of the duties involved in their offices or with
respect to any matter unless it is finally adjudicated that they did not act in
good faith in the reasonable belief that their actions were in the best interest
of the Trust. In the case of settlement, such indemnification will not be
provided unless it has been determined by a court or other body approving the
settlement or other disposition, or by a reasonable determination based upon a
review of readily available facts, by vote of a majority of disinterested
Trustees or in a written opinion of independent counsel, that such officers or
Trustees have not engaged in willful misfeasance, bad faith, gross negligence or
reckless disregard of their duties.
ADVISER AND SUB-ADVISER
Prior to February 28, 2001, the adviser to the funds was the Chase
Manhattan Bank. The day to day management of the Funds was handled by the
sub-adviser, Chase Fleming Asset Management (USA) Inc. Effective February 28,
2001, JPMFAM, acts as investment adviser to the Funds pursuant to an
Investment Advisory Agreement (the "Advisory Agreement"). Subject to such
policies as the Board of Trustees may determine, JPMFAM is responsible for
investment decisions for the Funds. Pursuant to the terms of the Advisory
Agreement, JPMFAM provides the Funds with such investment advice and
supervision as it deems necessary for the proper supervision of the Funds'
investments. The advisers continuously provide investment programs and
determine from time to time what securities shall be purchased, sold or
exchanged and what portion of the Funds' assets shall be held uninvested. The
advisers to the Funds furnish, at their own expense, all services, facilities
and personnel necessary in connection with managing the investments and
effecting portfolio transactions for the Funds. The Advisory Agreement for
the Funds will continue in effect from year to year only if such continuance
is specifically approved at least annually by the Board of Trustees or by
vote of a majority of a Funds' outstanding voting securities and by a
majority of the Trustees who are not parties to the Advisory Agreement or
interested persons of any such party, at a meeting called for the purpose of
voting on such Advisory Agreement.
Under the Advisory Agreement, the adviser may utilize the
specialized portfolio skills of all its various affiliates, thereby providing
the Funds with greater opportunities and flexibility in accessing investment
expertise.
Pursuant to the terms of the Advisory Agreement and the
sub-advisers' agreements with the adviser, the adviser and sub-advisers are
permitted to render services to others. Each advisory agreement is terminable
without penalty by the Trust on behalf of the Funds on not more than 60
days', nor less than 30 days', written notice when authorized either by a
majority vote of a Fund's shareholders or by a vote of a majority of the
Board of Trustees of the Trust, or by the adviser or sub-adviser on not more
than 60 days', nor less than 30 days', written notice, and will automatically
terminate in the event of its "assignment" (as defined in the 1940 Act). The
advisory agreements provide that the adviser or sub-adviser under such
agreement shall not be liable for any error of judgment or mistake of law or
for any loss arising out of any investment or for any act or omission in the
execution of portfolio transactions for the respective Fund, except for
willful misfeasance, bad faith or gross negligence in the performance of its
duties, or by reason of reckless disregard of its obligations and duties
thereunder.
With respect to the Equity Funds, the equity research team of the
adviser looks for two key variables when analyzing stocks for potential
investment by equity portfolios: value and momentum. To uncover these
qualities, the team uses a combination of quantitative analysis, fundamental
research and computer technology to help identify stocks.
In the event the operating expenses of the Funds, including all
investment advisory, administration and sub-administration fees, but excluding
brokerage commissions and fees, taxes, interest and extraordinary expenses such
as litigation, for any fiscal year exceed the most restrictive expense
limitation applicable to the Funds imposed by the securities laws or regulations
thereunder of any state in which the shares of the Funds
36
are qualified for sale, as such limitations may be raised or lowered from
time to time, the adviser shall reduce its advisory fee (which fee is
described below) to the extent of its share of such excess expenses. The
amount of any such reduction to be borne by the adviser shall be deducted
from the monthly advisory fee otherwise payable with respect to the Funds
during such fiscal year; and if such amounts should exceed the monthly fee,
the adviser shall pay to a Fund its share of such excess expenses no later
than the last day of the first month of the next succeeding fiscal year.
Under the Advisory Agreement, JPMFAM may delegate a portion of its
responsibilities to a sub-adviser. In addition, the Advisory Agreement
provides that JPMFAM may render services through its own employees or the
employees of one or more affiliated companies that are qualified to act as an
investment adviser of the Fund and are under the common control of JPMFAM as
long as all such persons are functioning as part of an organized group of
persons, managed by authorized officers of JPMFAM.
JPMFAM, on behalf of the European Fund has entered into an
investment sub-advisory agreement with Chase Fleming Asset Management
(London) Limited ("CFAM London"). With respect to the day-to-day management
of the Funds, under the sub-advisory agreements, the sub-advisers make
decisions concerning, and place all orders for, purchases and sales of
securities and helps maintain the records relating to such purchases and
sales. The sub-advisers may, in their discretion, provide such services
through their own employees or the employees of one or more affiliated
companies that are qualified to act as an investment adviser to the Company
under applicable laws and are under the common control of JPMFAM (USA).;
provided that (i) all persons, when providing services under the sub-advisory
agreement, are functioning as part of an organized group of persons, and (ii)
such organized group of persons is managed at all times by authorized
officers of the sub-advisers. This arrangement will not result in the payment
of additional fees by the Funds.
JPMFAM, a wholly-owned subsidiary of The Chase Manhattan Bank.
JPMFAM is registered with the Securities and Exchange Commission as an
investment adviser. Also included among JPMFAM accounts are commingled trust
funds and a broad spectrum of individual trust and investment management
portfolios. These accounts have varying investment objectives. JPMFAM is
located at 522 Fifth Avenue, New York, New York 10036.
CFAM London is an wholly-owned subsidiary of the Adviser. CFAM London
is registered with the Securities and Exchange Commission and is regulated by
the Investment Management Regulatory Organization (IMRO) as an investment
adviser and provides discretionary investment advisory services to
institutional clients, and the same individuals who serve as portfolio managers
for CFAM London also serve as portfolio managers for Chase. CFAM London is
located at Colvile House, 32 Curzon Street, London W1Y8AL.
In consideration of the services provided by the adviser pursuant to
the Advisory Agreement, the adviser is entitled to receive from each Fund an
investment advisory fee computed daily and paid monthly based on a rate equal
to a percentage of such Fund's average daily net assets specified in the
relevant Prospectuses. However, the adviser may voluntarily agree to waive a
portion of the fees payable to it on a month-to-month basis. For its services
under its sub-advisory agreement, CFAM London in the case of the Funds will be
entitled to receive, with respect to the Funds, such compensation, payable by
the adviser out of its advisory fee, as is described in the relevant
Prospectuses.
For the three most recent fiscal years, the Advisor earned advisory
fees, and voluntarily waived the amounts in parentheses as follows:
YEAR ENDED AUGUST 31,
---------------------------------------------------------------------------------
1998 1999 2000
------------------------- ------------------------ ------------------------
Intermediate
Tax Free Income Fund ...... $1,982,640 $(1,982,640) $2,200,196 $(2,200,196) $2,110,334 $(429,387)
New York Intermediate
Tax Free Income Fund ...... 767,510 (767,510) 879,846 (879,846) 853,972 (173,688)
European Fund ................. 279,521 (166,744) 555,370 (178,633) 933,790 (189,245)
37
ADMINISTRATOR
Pursuant to an Administration Agreement (the "Administration Agreement"),
Chase serves as administrator of the Funds. Chase provides certain
administrative services to the Funds, including, among other responsibilities,
coordinating the negotiation of contracts and fees with, and the monitoring of
performance and billing of, the Funds' independent contractors and agents;
preparation for signature by an officer of the Trust of all documents required
to be filed for compliance by the Trust with applicable laws and regulations
excluding those of the securities laws of various states; arranging for the
computation of performance data, including net asset value and yield; responding
to shareholder inquiries; and arranging for the maintenance of books and records
of the Funds and providing, at its own expense, office facilities, equipment and
personnel necessary to carry out its duties. Chase in its capacity as
administrator does not have any responsibility or authority for the management
of the Funds, the determination of investment policy, or for any matter
pertaining to the distribution of Fund shares.
Under the Administration Agreement Chase is permitted to render
administrative services to others. The Administration Agreement will continue in
effect from year to year with respect to each Fund only if such continuance is
specifically approved at least annually by the Board of Trustees or by vote of a
majority of such Fund's outstanding voting securities and, in either case, by a
majority of the Trustees who are not parties to the Administration Agreement or
"interested persons" (as defined in the 1940 Act) of any such party. The
Administration Agreement is terminable without penalty by the Trust on behalf of
each Fund on 60 days' written notice when authorized either by a majority vote
of such Fund's shareholders or by vote of a majority of the Board of Trustees,
including a majority of the Trustees who are not "interested persons" (as
defined in the 1940 Act) of the Trust, or by Chase on 60 days' written notice,
and will automatically terminate in the event of its "assignment" (as defined in
the 1940 Act). The Administration Agreement also provides that neither Chase nor
its personnel shall be liable for any error of judgment or mistake of law or for
any act or omission in the administration of the Funds, except for willful
misfeasance, bad faith or gross negligence in the performance of its or their
duties or by reason of reckless disregard of its or their obligations and duties
under the Administration Agreement.
In addition, the Administration Agreement provides that, in the event the
operating expenses of any Fund, including all investment advisory,
administration and sub-administration fees, but excluding brokerage commissions
and fees, taxes, interest and extraordinary expenses such as litigation, for any
fiscal year exceed the most restrictive expense limitation applicable to that
Fund imposed by the securities laws or regulations thereunder of any state in
which the shares of such Fund are qualified for sale, as such limitations may be
raised or lowered from time to time, Chase shall reduce its administration fee
(which fee is described below) to the extent of its share of such excess
expenses. The amount of any such reduction to be borne by Chase shall be
deducted from the monthly administration fee otherwise payable to Chase during
such fiscal years; and if such amounts should exceed the monthly fee, Chase
shall pay to such Fund its share of such excess expenses no later than the last
day of the first month of the next succeeding fiscal year.
In consideration of the services provided by Chase pursuant to the
Administration Agreement, Chase receives from each Fund a fee computed daily and
paid monthly at an annual rate equal to 0.10% of each of the Fund's average
daily net assets, on an annualized basis for the Fund's then-current fiscal
year. Chase may voluntarily waive a portion of the fees payable to it with
respect to each Fund on a month-to-month basis.
For the three most recent fiscal years, the Administrator earned
administration fees, and voluntarily waived the amounts in parentheses:
YEAR ENDED AUGUST 31,
---------------------------------------------------------------------------------
1998 1999 2000
------------------------- ------------------------ ------------------------
Intermediate
Tax Free Income Fund ......... $663,008 $(663,008) $733,399 $(733,399) $703,443 $(143,129)
New York Intermediate
Tax Free Income Fund ......... 256,686 (256,686) 293,282 (293,282) 284,657 (57,896)
European Fund ................... 27,109 (6,446) 55,537 -- 93,379 --
38
DISTRIBUTION PLANS
The Trust has adopted separate plans of distribution pursuant to Rule 12b-1
under the 1940 Act (a "Distribution Plan") on behalf of certain classes or
shares of certain Funds as described in the Prospectuses, which provide that
such classes of such Funds shall pay for distribution services a distribution
fee (the "Distribution Fee"), including payments to the Distributor, at annual
rates not to exceed the amounts set forth in their respective Prospectuses. The
Distributor may use all or any portion of such Class A Distribution Fee to pay
for Fund expenses of printing prospectuses and reports used for sales purposes,
expenses of the preparation and printing of sales literature and other such
distribution-related expenses. Promotional activities for the sale of each class
of shares of each Fund will be conducted generally by the J.P. Morgan Funds, and
activities intended to promote one class of shares of a Fund may also benefit
the Fund's other shares and other J.P. Morgan Funds.
Class B and Class C shares pay a Distribution Fee of up to 0.75% of average
daily net assets. The Distributor currently expects to pay sales commissions to
a dealer at the time of sale of Class B and Class C shares of up to 4.00% and
1.00% respectively, of the purchase price of the shares sold by such dealer. The
Distributor will use its own funds (which may be borrowed or otherwise financed)
to pay such amounts. Because the Distributor will receive a maximum Distribution
Fee of 0.75% of average daily net assets with respect to Class B shares, it will
take the Distributor several years to recoup the sales commissions paid to
dealers and other sales expenses.
Some payments under the Distribution Plans may be used to compensate
broker-dealers with trail or maintenance commissions in an amount not to exceed
0.25% annualized of the average net asset value of Class A shares, or 0.25%
annualized of the average net asset value of the Class B shares, or 0.75%
annualized of the average net asset value of the Class C shares, maintained in a
Fund by such broker-dealers' customers. Trail or maintenance commissions on
Class B and Class C shares will be paid to broker-dealers beginning the 13th
month following the purchase of such Class B and Class C shares. Since the
distribution fees are not directly tied to expenses, the amount of distribution
fees paid by a Fund during any year may be more or less than actual expenses
incurred pursuant to the Distribution Plans. For this reason, this type of
distribution fee arrangement is characterized by the staff of the Securities and
Exchange Commission as being of the "compensation variety" (in contrast to
"reimbursement" arrangements by which a distributor's payments are directly
linked to its expenses). With respect to Class B and Class C shares, because of
the 0.75% annual limitation on the compensation paid to the Distributor during a
fiscal year, compensation relating to a large portion of the commissions
attributable to sales of Class B and Class C shares in any one year will be
accrued and paid by a Fund to the Distributor in fiscal years subsequent
thereto. In determining whether to purchase Class B and Class C shares,
investors should consider that compensation payments could continue until the
Distributor has been fully reimbursed for the commissions paid on sales of
Class B and Class C shares. However, the shares are not liable for any
distribution expenses incurred in excess of the Distribution Fee paid.
Each class of shares is entitled to exclusive voting rights with respect to
matters concerning its Distribution Plan.
Each Distribution Plan provides that it will continue in effect
indefinitely if such continuance is specifically approved at least annually
by a vote of both a majority of the Trustees and a majority of the Trustees
who are not "interested persons" (as defined in the 1940 Act) of the Trust
and who have no direct or indirect financial interest in the operation of the
Distribution Plans or in any agreement related to such Plan ("Qualified
Trustees"). The continuance of each Distribution Plan was most recently
approved on October 13, 1995. The Distribution Plans require that the Trust
shall provide to the Board of Trustees, and the Board of Trustees shall
review, at least quarterly, a written report of the amounts expended (and the
purposes therefor) under the Distribution Plans. The Distribution Plans
further provide that the selection and nomination of Qualified Trustees shall
be committed to the discretion of the disinterested Trustees (as defined in
the 1940 Act) then in office. The Distribution Plans may be terminated at any
time by a vote of a majority of the Qualified Trustees or, with respect to a
particular Fund, by vote of a majority of the outstanding voting shares of
the class of such Fund to which it applies (as defined in the 1940 Act). The
Distribution Plans may not be amended to increase materially the amount of
permitted expenses thereunder without the approval of shareholders and may
not be materially amended in any case without a vote of the majority of both
the Trustees and the Qualified Trustees. Each of the Funds will preserve
copies of any plan, agreement or report made pursuant to a Distribution Plan
for a period of not less than six years from the date of the Distribution
Plan, and for the first two years such copies will be preserved in an easily
accessible place.
For the fiscal years ended October 31, 1998, 1999 and 2000, the
Distributor was paid or accrued distribution fees with respect to the Funds,
and voluntarily waived the amount in parentheses following such fees:
FISCAL YEAR ENDED OCTOBER 31,
---------------------------------------------------------------------
1998 1999 2000
--------------------- --------------------- ---------------------
FUND PAID/ACCRUED WAIVED PAID/ACCRUED WAIVED PAID/ACCRUED WAIVED
- ---- ------------ ------ ------------ ------ ------------ ------
European Fund
A Shares $54,193 -- $109,680 -- $182,535 --
B Shares 47,038 -- 81,208 -- 127,726 --
C Shares* N/A N/A 6,279 -- 25,013 --
* Distribution fees are from the period November 1, 1998 (commencement of
operations) through October 31, 1999.
Expenses paid by the Distributor related to the distribution of Trust
shares during the year ended October 31, 2000 were as follows:
TOTAL VALUE
-----------
Advertising and sales literature $ 340,447
Printing, production and mailing of prospectuses and shareholder reports
to other than current Shareholders 137,970
Compensation to dealers 6,122,706
Compensation to sales personnel 5,595,536
B Share financing charges 8,232,922
Equipment, supplies and other indirect distribution-related expenses 29,628
With respect to the Class B shares of the Funds, the Distribution Fee was
paid to FEP Capital L.P. for acting as a finance agent.
39
DISTRIBUTION AND SUB-ADMINISTRATION AGREEMENT
The Trust has entered into a Distribution and Sub-Administration Agreement
(the "Distribution Agreement") with the Distributor, pursuant to which the
Distributor acts as the Funds' exclusive underwriter, provides certain
administration services and promotes and arranges for the sale of Shares. The
Distributor is a wholly-owned subsidiary of BISYS Fund Services, Inc. The
Distribution Agreement provides that the Distributor will bear the expenses of
printing, distributing and filing prospectuses and statements of additional
information and reports used for sales purposes, and of preparing and printing
sales literature and advertisements not paid for by the Distribution Plans. The
Trust pays for all of the expenses for qualification of the shares of each Fund
for sale in connection with the public offering of such shares, and all legal
expenses in connection therewith. In addition, pursuant to the Distribution
Agreement, the Distributor provides certain sub-administration services to the
Trust, including providing officers, clerical staff and office space.
The Distribution Agreement is currently in effect and will continue in
effect with respect to each Fund only if such continuance is specifically
approved at least annually by the Board of Trustees or by vote of a majority of
such Fund's outstanding voting securities and, in either case, by a majority of
the Trustees who are not parties to the Distribution Agreement or "interested
persons" (as defined in the 1940 Act) of any such party. The Distribution
Agreement is terminable without penalty by the Trust on behalf of each Fund on
60 days' written notice when authorized either by a majority vote of such Fund's
shareholders or by vote of a majority of the Board of Trustees of the Trust,
including a majority of the Trustees who are not "interested persons" (as
defined in the 1940 Act) of the Trust, or by the Distributor on 60 days' written
notice, and will automatically terminate in the event of its "assignment" (as
defined in the 1940 Act). The Distribution Agreement also provides that neither
the Distributor nor its personnel shall be liable for any act or omission in the
course of, or connected with, rendering services under the Distribution
Agreement, except for willful misfeasance, bad faith, gross negligence or
reckless disregard of its obligations or duties.
In the event the operating expenses of any Fund, including all investment
advisory, administration and sub-administration fees, but excluding brokerage
commissions and fees, taxes, interest and extraordinary expenses such as
litigation, for any fiscal year exceed the most restrictive expense limitation
applicable to that Fund imposed by the securities laws or regulations thereunder
of any state in which the shares of such Fund are qualified for sale, as such
limitations may be raised or lowered from time to time, the Distributor shall
reduce its sub-administration fee with respect to such Fund (which fee is
described below) to the extent of its share of such excess expenses. The amount
of any such reduction to be borne by the Distributor shall be deducted from the
monthly sub-administration fee otherwise payable with respect to such Fund
during such fiscal year; and if such amounts should exceed the monthly fee, the
Distributor shall pay to such Fund its share of such excess expenses no later
than the last day of the first month of the next succeeding fiscal year.
In consideration of the sub-administration services provided by the
Distributor pursuant to the Distribution Agreement, the Distributor receives
an annual fee, payable monthly, of 0.05% of the net assets of each Fund. The
Distributor may voluntarily agree to from time to time waive a portion of the
fees payable to it under the Distribution Agreement with respect to each Fund
on a month-to-month basis.
For the three most recent fiscal years, the Distributor earned
sub-administration fees, and voluntarily waived the amounts in parentheses:
YEAR ENDED AUGUST 31,
---------------------------------------------------------------------------------
1998 1999 2000
------------------------- ------------------------ ------------------------
Intermediate
Tax Free Income Fund ......... $328,312 $(328,312) $366,699 $(336,565) $351,721 $(61,545)
New York Intermediate
Tax Free Income Fund ......... 127,069 (127,069) 146,641 (134,589) 142,328 (78,737)
European Fund ................... 13,973 (3,223) 27,768 -- 46,690 --
40
Shareholder Servicing Agents, Transfer Agent and Custodian
Effective January 3, 2000, the Trust adopted an Administrative Services
Plan which, among other things, provides that the Trust on behalf of the Funds
may obtain the services of one or more Shareholder Servicing Agents. The Trust
has entered into shareholder servicing agreements (a "Servicing Agreement") with
each Shareholder Servicing Agent to provide certain services including but not
limited to the following: answer customer inquiries regarding account status and
history, the manner in which purchases and redemptions of shares may be effected
for the Fund as to which the Shareholder Servicing Agent is so acting and
certain other matters pertaining to the Fund; assist shareholders in designating
and changing dividend options, account designations and addresses; provide
necessary personnel and facilities to establish and maintain shareholder
accounts and records; assist in processing purchase and redemption transactions;
arrange for the wiring of funds; transmit and receive funds in connection with
customer orders to purchase or redeem shares; verify and guarantee shareholder
signatures in connection with redemption orders and transfers and changes in
shareholder-designated accounts; furnish (either separately or on an integrated
basis with other reports sent to a shareholder by a Shareholder Servicing Agent)
quarterly and year-end statements and confirmations of purchases and
redemptions; transmit, on behalf of the Fund, proxy statements, annual reports,
updated prospectuses and other communications to shareholders of the Fund;
receive, tabulate and transmit to the Fund proxies executed by shareholders with
respect to meetings of shareholders of the Fund; and provide such other related
services as the Fund or a shareholder may request. Shareholder servicing agents
may be required to register pursuant to state securities law. Shareholder
Servicing Agents may subcontract with other parties for the provision of
shareholder support services.
Each Shareholder Servicing Agent may voluntarily agree from time to time to
waive a portion of the fees payable to it under its Servicing Agreement with
respect to each fund on a month-to-month basis. Fees payable to the Shareholder
Servicing Agents (all of which currently are related parties) and the amounts
voluntarily waived for the period from January 3, 2000 through August 31, 2000
with respect to the Intermediate Tax Free Income Fund and the New York
Intermediate Tax Free Income Fund and for the fiscal year ended October 31,
1998, 1999 and 2000 with respect to the European Fund were as follows:
01/03/00
THROUGH
08/31/00
-----------------------
Intermediate
Tax Free Income Fund ............................ $1,155,992 $ --
New York Intermediate
Tax Free Income Fund ............................ 468,231 --
FISCAL YEAR ENDED OCTOBER 31
----------------------------------
1998 1999 2000
-------- -------- --------
European Fund ...............
Shareholder servicing agents may offer additional services to their
customers, including specialized procedures and payment for the purchase and
redemption of Fund shares, such as pre-authorized or systematic purchase and
redemption programs, "sweep" programs, cash advances and redemption checks.
Each Shareholder Servicing Agent may establish its own terms and conditions,
including limitations on the amounts of subsequent transactions, with respect
to such services. Certain Shareholder Servicing Agents may (although they are
not required by the Trust to do so) credit to the accounts of their customers
from whom they are already receiving other fees amounts not exceeding such
other fees or the fees for their services as Shareholder Servicing Agents.
For shareholders that bank with J.P. Morgan Chase, J.P. Morgan Chase may
aggregate investments in the J.P. Morgan Funds with balances held in Chase
bank accounts for purposes of determining eligibility for certain bank
privileges that are based on specified minimum balance requirements, such as
reduced or no fees for certain banking services or preferred rates on loans
and deposits. Chase and certain broker-dealers and other Shareholder Servicing
Agents may, at their own expense, provide gifts such as computer software
packages, guides and books related to investment or additional Fund shares
valued up to $250 to their customers that invest in the J.P. Morgan Funds.
Chase and/or the Distributor may from time to time, at their own expense
out of compensation retained by them from the Fund or other sources available
to them, make additional payments to certain selected dealers or other
Shareholder Servicing Agents for performing administrative services for their
cus-
41
tomers. These services include maintaining account records, processing orders
to purchase, redeem and exchange Fund shares and responding to certain
customer inquiries. The amount of such compensation may be up to an additional
0.10% annually of the average net assets of the Fund attributable to shares or
0.25% in the case of the European Fund if the Fund held by customers of such
Shareholder Servicing Agents. Such compensation does not represent an
additional expense to the Fund or its shareholders, since it will be paid by
Chase and/or the Distributor.
The Trust has also entered into a Transfer Agency Agreement with DST
Systems, Inc. ("DST") pursuant to which DST acts as transfer agent for the
Trust. DST's address is 210 West 10th Street, Kansas City, MO 64105.
Pursuant to a Custodian Agreement, Chase acts as the custodian of the
assets of each Fund for which Chase receives such compensation as is from time
to time agreed upon by the Trust and Chase. As custodian, Chase provides
oversight and record keeping for the assets held in the portfolios of each
Fund. Chase also provides fund accounting services for the income, expenses
and shares outstanding for the Funds. Chase is located at 3 Metrotech Center,
Brooklyn, NY 11245. For additional information, see the Prospectuses.
INDEPENDENT ACCOUNTANTS
The financial statements incorporated herein by reference from the Trust's
Annual Reports to Shareholders for the fiscal year ended August 31, 2000, and
the related financial highlights which appear in the Prospectuses, have been
incorporated herein and included in the Prospectuses in reliance on the
reports of PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York,
New York 10036, independent accountants of the Funds, given on the authority
of said firm as experts in accounting and auditing. PricewaterhouseCoopers LLP
provides the Funds with audit services, tax return preparation and assistance
and consultation with respect to the preparation of filings with the
Securities and Exchange Commission.
CERTAIN REGULATORY MATTERS
Chase and its affiliates may have deposit, loan and other commercial
banking relationships with the issuers of securities purchased on behalf of
any of the Funds, including outstanding loans to such issuers which may be
repaid in whole or in part with the proceeds of securities so purchased. Chase
and its affiliates deal, trade and invest for their own accounts in U.S.
government obligations, municipal obligations and commercial paper and are
among the leading dealers of various types of U.S. government obligations and
municipal obligations. Chase and its affiliates may sell U.S. government
obligations and municipal obligations to, and purchase them from, other
investment companies sponsored by the Funds' distributor or affiliates of the
distributor. Chase will not invest any Fund assets in any U.S. government
obligations, municipal obligations or commercial paper purchased from itself
or any affiliate, although under certain circumstances such securities may be
purchased from other members of an underwriting syndicate in which Chase or an
affiliate is a non-principal member. This restriction my limit the amount or
type of U.S. government obligations, municipal obligations or commercial paper
available to be purchased by any Fund. Chase has informed the Funds that in
making its investment decision, it does not obtain or use material inside
information in the possession of any other division or department of Chase,
including the division that performs services for the Trust as custodian, or
in the possession of any affiliate of Chase. Shareholders of the Funds should
be aware that, subject to applicable legal or regulatory restrictions, Chase
and its affiliates may exchange among themselves certain information about the
shareholder and his account. Transactions with affiliated broker-dealers will
only be executed on an agency basis in accordance with applicable federal
regulations.
GENERAL INFORMATION
DESCRIPTION OF SHARES, VOTING RIGHTS AND LIABILITIES
Mutual Fund Select Trust and Mutual Fund Group are open-end, management
investment companies organized as Massachusetts business trusts under the laws
of the Commonwealth of Massachusetts on October 1, 1996 and May 11, 1987,
respectively. Because certain Funds comprising the Trust are "non-diversified",
more than 5% of any of the assets of such Funds may be invested in the
obligations of any single issuer, which may make the value of the shares in
such a Fund more susceptible to certain risks than shares of a diversified
mutual fund. The fiscal year-end of the Funds in the Trust is August 31.
42
Each share of a series or class represents an equal proportionate
interest in that series or class with each other share of that series or
class. The shares of each series or class participate equally in the
earnings, dividends and assets of the particular series or class. Expenses of
the Trust which are not attributable to a specific series or class are
allocated among all the series in a manner believed by management of the
Trust to be fair and equitable. Shares have no pre-emptive or conversion
rights. Shares when issued are fully paid and non-assessable, except as set
forth below. Shareholders are entitled to one vote for each share held.
Shares of each series or class generally vote together, except when required
under federal securities laws to vote separately on matters that may affect a
particular class, such as the approval of distribution plans for a particular
class.
Each Fund currently issues multiple classes of shares but may, in the
future, offer other classes. The categories of investors that are eligible to
purchase shares may be different for each class of Fund shares. Other classes
of Fund shares may be subject to differences in sales charge arrangements,
ongoing distribution and service fee levels, and levels of certain other
expenses, which will affect the relative performance of the different classes.
Any person entitled to receive compensation for selling or servicing
shares of a Fund may receive different levels of compensation for selling one
particular class of shares rather than another.
The Trust is not required to hold annual meetings of shareholders but will
hold special meetings of shareholders of a series or class when, in the
judgment of the Trustees, it is necessary or desirable to submit matters for a
shareholder vote. Shareholders have, under certain circumstances, the right to
communicate with other shareholders in connection with requesting a meeting of
shareholders for the purpose of removing one or more Trustees. Shareholders
also have, in certain circumstances, the right to remove one or more Trustees
without a meeting. No material amendment may be made to the Trust's
Declaration of Trust without the affirmative vote of the holders of a majority
of the outstanding shares of each portfolio affected by the amendment. Shares
have no preemptive or conversion rights. Shares, when issued, are fully paid
and non-assessable, except as set forth below. Any series or class may be
terminated (i) upon the merger or consolidation with, or the sale or
disposition of all or substantially all of its assets to, another entity, if
approved by the vote of the holders of two-thirds of its outstanding shares,
except that if the Board of Trustees recommends such merger, consolidation or
sale or disposition of assets, the approval by vote of the holders of a
majority of the series' or class' outstanding shares will be sufficient, or
(ii) by the vote of the holders of a majority of its outstanding shares or
(iii) by the Board of Trustees by written notice to the series' or class'
shareholders. Unless each series and class is so terminated, the Trust will
continue indefinitely.
Under Massachusetts law, shareholders of a business trust may, under
certain circumstances, be held personally liable as partners for its
obligations. However, the Trust's Declaration of Trust contains an express
disclaimer of shareholder liability for acts or obligations of the Trust and
provides for indemnification and reimbursement of expenses out of the Trust
property for any shareholder held personally liable for the obligations of the
Trust. The Trust's Declaration of Trust also provides that the Trust shall
maintain appropriate insurance (for example, fidelity bonding and errors and
omissions insurance) for the protection of the Trust, its shareholders,
Trustees, officers, employees and agents covering possible tort and other
liabilities. Thus, the risk of a shareholder incurring financial loss on
account of shareholder liability is limited to circumstances in which both
inadequate insurance existed and the Trust itself was unable to meet its
obligations.
The Trust's Declaration of Trust further provides that obligations of the
Trust are not binding upon the Trustees individually but only upon the
property of the Trust and that the Trustees will not be liable for any action
or failure to act, errors of judgment or mistakes of fact or law, but nothing
in the Declaration of Trust protects a Trustee against any liability to which
he would otherwise be subject by reason of willful misfeasance, bad faith,
gross negligence, or reckless disregard of the duties involved in the conduct
of his office.
The Board of Trustees has adopted a code of ethics addressing personal
securities transactions by investment personnel and access persons and other
related matters. The code has been designated to address potential conflicts
of interest that can arise in connection with personal trading activities of
such persons. Persons subject to the code are generally permitted to engage in
personal securities transactions, subject to certain prohibitions,
pre-clearance requirements and blackout periods.
43
FINANCIAL STATEMENTS
The Annual Report to Shareholders of each Fund, including the report of
independent accountants, financial highlights and financial statements for the
fiscal year-ended August 31, 2000 with respect to the Intermediate Tax Free
Income Fund and the New York Intermediate Tax Free Income Fund and October 31,
2000 with respect to the European Fund contained therein, are incorporated by
reference. With respect to the Intermediate Tax Free Income Fund and the New
York Intermediate Tax Free Income Fund, the Semi-Annual Report to shareholders
for the period ended February 28, 2001, is incorporated by reference.
SPECIMEN COMPUTATIONS OF OFFERING PRICES PER SHARE
INTERMEDIATE TAX FREE INCOME FUND
Net Asset Value and Redemption Price per Share of Beneficial Interest at August 31, 2000 ................ $10.46
NEW YORK INTERMEDIATE TAX FREE INCOME FUND INSTITUTIONAL SHARES
Net Asset Value and Redemption Price per Share of Beneficial Interest at August 31, 2000 ................ $ 7.01
FLEMING EUROPEAN FUND
A SHARES:
Net Asset Value and Redemption Price per Share of Beneficial Interest at October 31, 2000 ............... $17.87
Maximum Offering Price per Share ($17.87 divided by .9425) (reduced on purchases of $100,000 or more) ... $18.96
B SHARES:
Net Asset Value and Redemption Price per Share of Beneficial Interest at October 31, 2000 ............... $17.38
C SHARES:
Net Asset Value and Redemption Price per Share of Beneficial Interest at October 31, 2000 ............... $17.37
44
APPENDIX A
DESCRIPTION OF CERTAIN OBLIGATIONS
ISSUED OR GUARANTEED BY U.S. GOVERNMENT
AGENCIES OR INSTRUMENTALITIES
FEDERAL FARM CREDIT SYSTEM NOTES AND BONDS--are bonds issued by a
cooperatively owned nationwide system of banks and associations supervised by
the Farm Credit Administration, an independent agency of the U.S. government.
These bonds are not guaranteed by the U.S. government.
MARITIME ADMINISTRATION BONDS--are bonds issued and provided by the
Department of Transportation of the U.S. government and are guaranteed by the
U.S. government.
FNMA BONDS--are bonds guaranteed by the Federal National Mortgage
Association. These bonds are not guaranteed by the U.S. government.
FHA DEBENTURES--are debentures issued by the Federal Housing
Administration of the U.S. Government and are guaranteed by the U.S. government.
FHA INSURED NOTES--are bonds issued by the Farmers Home Administration of
the U.S. Government and are guaranteed by the U.S. government.
GNMA CERTIFICATES--are mortgage-backed securities which represent a
partial ownership interest in a pool of mortgage loans issued by lenders such as
mortgage bankers, commercial banks and savings and loan associations. Each
mortgage loan included in the pool is either insured by the Federal Housing
Administration or guaranteed by the Veterans Administration and therefore
guaranteed by the U.S. government. As a consequence of the fees paid to GNMA and
the issuer of GNMA Certificates, the coupon rate of interest of GNMA
Certificates is lower than the interest paid on the VA-guaranteed or FHA-insured
mortgages underlying the Certificates. The average life of a GNMA Certificate is
likely to be substantially less than the original maturity of the mortgage pools
underlying the securities. Prepayments of principal by mortgagors and mortgage
foreclosures may result in the return of the greater part of principal invested
far in advance of the maturity of the mortgages in the pool. Foreclosures impose
no risk to principal investment because of the GNMA guarantee. As the prepayment
rate of individual mortgage pools will vary widely, it is not possible to
accurately predict the average life of a particular issue of GNMA Certificates.
The yield which will be earned on GNMA Certificates may vary form their coupon
rates for the following reasons: (i) Certificates may be issued at a premium or
discount, rather than at par; (ii) Certificates may trade in the secondary
market at a premium or discount after issuance; (iii) interest is earned and
compounded monthly which has the effect of raising the effective yield earned on
the Certificates; and (iv) the actual yield of each Certificate is affected by
the prepayment of mortgages included in the mortgage pool underlying the
Certificates. Principal which is so prepaid will be reinvested, although
possibly at a lower rate. In addition, prepayment of mortgages included in the
mortgage pool underlying a GNMA Certificate purchased at a premium could result
in a loss to a Fund. Due to the large amount of GNMA Certificates outstanding
and active participation in the secondary market by securities dealers and
investors, GNMA Certificates are highly liquid instruments. Prices of GNMA
Certificates are readily available from securities dealers and depend on, among
other things, the level of market rates, the Certificate's coupon rate and the
prepayment experience of the pool of mortgages backing each Certificate. If
agency securities are purchased at a premium above principal, the premium is not
guaranteed by the issuing agency and a decline in the market value to par may
result in a loss of the premium, which may be particularly likely in the event
of a prepayment. When and if available, U.S. government obligations may be
purchased at a discount from face value.
FHLMC CERTIFICATES AND FNMA CERTIFICATES--are mortgage-backed bonds issued
by the Federal Home Loan Mortgage Corporation and the Federal National Mortgage
Association, respectively, and are guaranteed by the U.S. government.
GSA PARTICIPATION CERTIFICATES--are participation certificates issued by
the General Services Administration of the U.S. Government and are guaranteed by
the U.S. government.
A-1
NEW COMMUNITIES DEBENTURES--are debentures issued in accordance with the
provisions of Title IV of the Housing and Urban Development Act of 1968, as
supplemented and extended by Title VII of the Housing and Urban Development Act
of 1970, the payment of which is guaranteed by the U.S. government.
PUBLIC HOUSING BONDS--are bonds issued by public housing and urban renewal
agencies in connection with programs administered by the Department of Housing
and Urban Development of the U.S. Government, the payment of which is secured by
the U.S. government.
PENN CENTRAL TRANSPORTATION CERTIFICATES--are certificates issued by Penn
Central Transportation and guaranteed by the U.S. government.
SBA DEBENTURES--are debentures fully guaranteed as to principal and
interest by the Small Business Administration of the U.S. government.
WASHINGTON METROPOLITAN AREA TRANSIT AUTHORITY BONDS--are bonds issued by
the Washington Metropolitan Area Transit Authority. Some of the bonds issued
prior to 1993 are guaranteed by the U.S. government.
FHLMC BONDS--are bonds issued and guaranteed by the Federal Home Loan
Mortgage Corporation. These bonds are not guaranteed by the U.S. government.
FEDERAL HOME LOAN BANK NOTES AND BONDS--are notes and bonds issued by the
Federal Home Loan Bank System and are not guaranteed by the U.S. government.
STUDENT LOAN MARKETING ASSOCIATION ("SALLIE MAE") NOTES AND BONDS--are
notes and bonds issued by the Student Loan Marketing Association and are not
guaranteed by the U.S. government.
D.C. ARMORY BOARD BONDS--are bonds issued by the District of Columbia
Armory Board and are guaranteed by the U.S. government.
EXPORT-IMPORT BANK CERTIFICATES--are certificates of beneficial interest
and participation certificates issued and guaranteed by the Export-Import Bank
of the U.S. and are guaranteed by the U.S. government.
In the case of securities not backed by the "full faith and credit" of the
U.S. government, the investor must look principally to the agency issuing or
guaranteeing the obligation for ultimate repayment, and may not be able to
assert a claim against the U.S. government itself in the event the agency or
instrumentality does not meet its commitments.
Investments may also be made in obligations of U.S. government agencies or
instrumentalities other than those listed above.
A-2
APPENDIX B
DESCRIPTION OF RATINGS*
The ratings of Moody's and Standard & Poor's represent their opinions as
to the quality of various Municipal Obligations. It should be emphasized,
however, that ratings are not absolute standards of quality. Consequently,
Municipal Obligations with the same maturity, coupon and rating may have
different yields while Municipal Obligations of the same maturity and coupon
with different ratings may have the same yield.
DESCRIPTION OF MOODY'S
FOUR HIGHEST MUNICIPAL BOND RATINGS:
Aaa--Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edge." Interest payments are protected by a large or an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
Aa--Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities, or fluctuation of
protective elements may be of greater amplitude, or there may be other elements
present which make the long-term risks appear somewhat larger than in Aaa
securities.
A--Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may be
present which suggest a susceptibility to impairment sometime in the future.
Baa--Bonds which are rated Baa are considered as medium grade obligations;
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
DESCRIPTION OF MOODY'S THREE HIGHEST RATINGS
OF STATE AND MUNICIPAL NOTES:
Moody's ratings for state and municipal short-term obligations will be
designated Moody's Investment Grade ("MIG"). Such ratings recognize the
differences between short-term credit risk and long-term risk. Factors affecting
the liquidity of the borrower and short-term cyclical elements are critical in
short-term ratings, while other factors of major importance in bond risk,
long-term secular trends for example, may be less important over the short run.
A short-term rating may also be assigned on an issue having a demand
feature-variable rate demand obligation or commercial paper programs; such
ratings will be designated as "VMIG." Short-term ratings on issues with demand
features are differentiated by the use of the VMIG symbol to reflect such
characteristics as payment upon periodic demand rather than fixed maturity dates
and payment relying on external liquidity. Symbols used are as follows:
MIG-1/VMIG-1--Notes bearing this designation are of the best quality,
enjoying strong protection from established cash flows of funds for their
servicing or from established and broad-based access to the market for
refinancing, or both.
MIG-2/VMIG-2--Notes bearing this designation are of high quality, with
margins of protection ample although not so large as in the preceding group.
MIG-3/VMIG-3--Notes bearing this designation are of favorable quality,
where all security elements are accounted for but there is lacking the
undeniable strength of the preceding grade, liquidity and cash flow protection
may be narrow and market access for refinancing is likely to be less well
established.
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* As described by the rating agencies. Ratings are generally given to
securities at the time of issuance. While the rating agencies may from
time to time revise such ratings, they undertake no obligation to do so.
B-1
DESCRIPTION OF STANDARD & POOR'S FOUR HIGHEST MUNICIPAL BOND RATINGS:
- ----------
AAA--Bonds rated AAA have the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
- ----------
AA--Bonds rated AA have a very strong capacity to pay interest and repay
principal and differ from the highest rated issues only in small degree.
- ----------
A--Bonds rated A have a strong capacity to pay interest and repay principal
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
- ----------
BBB--Bonds rated BBB are regarded as having an adequate capacity to pay interest
and repay principal. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
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Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
DESCRIPTION OF STANDARD & POOR'S
RATINGS OF MUNICIPAL NOTES AND TAX-EXEMPT DEMAND BONDS:
A Standard & Poor's note rating reflects the liquidity concerns and market
access risks unique to notes. Notes due in 3 years or less will likely receive a
note rating. Notes maturing beyond 3 years will most likely receive a long-term
debt rating. The following criteria will be used in making that assessment.
--Amortization schedule (the larger the final maturity relative to other
maturities the more likely it will be treated as a note).
--Source of Payment (the more dependent the issue is on the market for its
refinancing, the more likely it will be treated as a note).
Note rating symbols are as follows:
SP-1--Very strong or strong capacity to pay principal and interest. Those
issues determined to possess overwhelming safety characteristics will be given a
plus (+) designation.
SP-2--Satisfactory capacity to pay principal and interest.
SP-3--Speculative capacity to pay principal and interest.
Standard & Poor's assigns "dual" ratings to all long-term debt issues that
have as part of their provisions a demand or double feature.
The first rating addresses the likelihood of repayment of principal and
interest as due, and the second rating addresses only the demand feature. The
long-term debt rating symbols are used for bonds to denote the long-term
maturity and the commercial paper rating symbols are used to denote the put
option (for example, "AAA/B-1+"). For the newer "demand notes," S&P's note
rating symbols, combined with the commercial paper symbols, are used (for
example, "SP-1+/A-1+").
DESCRIPTION OF STANDARD & POOR'S
TWO HIGHEST COMMERCIAL PAPER RATINGS:
A--Issues assigned this highest rating are regarded as having the greatest
capacity for timely payment. Issues in this category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety.
B-2
A-1--This rating indicates a fund has strong capacity to meet its
financial commitments. Standard & Poor's rate it in the highest category. Within
this category, certain obligors are designated with a plus sign (+). This
indicates that the obligor's capacity to meet its financial commitments is
extremely stong.
A-2--This rating indicates a fund has satisfactory capacity to meet its
financial commitments. However it is somewhat more susceptible to the adverse
affects of changes in circumstances and economic conditions than obligors in the
highest rating category.
DESCRIPTION OF MOODY'S
TWO HIGHEST COMMERCIAL PAPER RATINGS:
Moody's Commercial Paper ratings are opinions of the ability of issuers to
repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's employs three designations, all judged to be
investment grade, to indicate the relative repayment capacity of rated issuers:
Prime-1, Prime-2 and Prime-3.
ISSUERS RATED PRIME-1 (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations. Prime-1 repayment
capacity will normally be evidenced by the following characteristics: (1)
leading market positions in well-established industries; (2) high rates of
return on funds employed; (3) conservative capitalization structures with
moderate reliance on debt and ample asset protection; (4) broad margins in
earnings coverage of fixed financial charges and high internal cash generation;
and (5) well-established access to a range of financial markets and assured
sources of alternate liquidity.
ISSUERS RATED PRIME-2 (or related supporting institutions) have a strong
capacity for repayment of short-term promissory obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
DESCRIPTION OF FITCH'S RATINGS OF MUNICIPAL NOTES
AND TAX-EXEMPT DEMAND BONDS
MUNICIPAL BOND RATINGS
The ratings represent Fitch's assessment of the issuer's ability to meet
the obligations of a specific debt issue or class of debt. The ratings take into
consideration special features of the issuer, its relationship to other
obligations of the issuer, the current financial condition and operative
performance of the issuer and of any guarantor, as well as the political and
economic environment that might affect the issuer's financial strength and
credit quality.
AAA--Bonds rated AAA are considered to be investment grade and of the
highest credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by reasonably
foreseeable events.
AA--Bonds rated AA are considered to be investment grade and of very high
credit quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong as bonds rated AAA. Because bonds
rated in the AAA and AA categories are not significantly vulnerable to
foreseeable future developments, short-term debt of these issuers is generally
rated F-1.
A--Bonds rated A are considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is considered
to be strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings.
B-3
BBB--Bonds rated BBB are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered to be adequate. Adverse changes in economic conditions
and circumstances, however, are more likely to have adverse consequences on
these bonds, and therefore impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is higher than for bonds
with higher ratings.
Plus and minus signs are used by Fitch to indicate the relative position
of a credit within a rating category. Plus and minus signs, however, are not
used in the AAA category.
SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable on
demand or have original maturities of up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes.
Although the credit analysis is similar to Fitch's bond rating analysis,
the short-term rating places greater emphasis than bond ratings on the existence
of liquidity necessary to meet the issuer's obligations in a timely manner.
F-1+--Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
F-1--Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated F-1+.
F-2--Good Credit Quality. Issues carrying this rating have satisfactory
degree of assurance for timely payments, but the margin of safety is not as
great as the F-1+ and F-1 categories.
F-3--Fair Credit Quality. Issues assigned this rating have characteristics
suggesting that the degree of assurance for timely payment is adequate, although
near term adverse changes could cause these securities to be rated below
investment grade.
B-4
APPENDIX C
SPECIAL INVESTMENT CONSIDERATIONS RELATING TO
NEW YORK MUNICIPAL OBLIGATIONS
Some of the significant financial considerations relating to the
investments of the New York Intermediate Tax Free Income Fund in New York
municipal securities are summarized below. The following information constitutes
only a brief summary, does not purport to be a complete description and is
largely based on information drawn from official statements relating to
securities offerings of New York municipal obligations available as of the date
of this Statement of Additional Information. The accuracy and completeness of
the information contained in such offering statements has not been independently
verified.
NEW YORK STATE
New York State Financing Activities. There are a number of methods by
which New York State (the "State") may incur debt. Under the State Constitution,
the State may not, with limited exceptions for emergencies, undertake long-term
general obligation borrowing (i.e., borrowing for more than one year) unless the
borrowing is authorized in a specific amount for a single work or purpose by the
New York State Legislature (the "Legislature") and approved by the voters. There
is no limitation on the amount of long-term general obligation debt that may be
so authorized and subsequently incurred by the State. With the exception of
general obligation housing bonds (which must be paid in equal annual
installments or installments that result in substantially level or declining
debt service payments, within 50 years after issuance, commencing no more than
three years after issuance), general obligation bonds must be paid in equal
annual installments or installments that result in substantially level or
declining debt service payments, within 40 years after issuance, beginning not
more than one year after issuance of such bonds.
The State may undertake short-term borrowings without voter approval (i)
in anticipation of the receipt of taxes and revenues, by issuing tax and revenue
anticipation notes ("TRANs"), and (ii) in anticipation of the receipt of
proceeds from the sale of duly authorized but unissued bonds, by issuing bond
anticipation notes ("BANs"). TRANs must mature within one year from their dates
of issuance and may not be refunded or refinanced beyond such period. BANS may
only be issued for the purposes and within the amounts for which bonds may be
issued pursuant to voter authorizations. Such BANs must be paid from the
proceeds of the sale of bonds in anticipation of which they were issued or from
other sources within two years of the date of issuance or, in the case of BANs
for housing purposes, within five years of the date of issuance.
The State may also, pursuant to specific constitutional authorization,
directly guarantee certain public authority obligations. The State Constitution
provides for the State guarantee of the repayment of certain borrowings for
designated projects of the New York State Thruway Authority, the Job Development
Authority and the Port Authority of New York and New Jersey. The State has never
been called upon to make any direct payments pursuant to such guarantees. The
State-guaranteed bonds of the Port Authority of New York and New Jersey were
fully retired on December 31, 1996. State-guaranteed bonds issued by the Thruway
Authority were fully retired on July 1, 1995.
In February 1997, the Job Development Authority ("JDA") issued
approximately $85 million of State-guaranteed bonds to refinance certain of its
outstanding bonds and notes in order to restructure and improve JDA's capital
structure. Due to concerns regarding the economic viability of its programs,
JDA's loan and loan guarantee activities had been suspended since the Governor
took office in 1995. As a result of the structural imbalances in JDA's capital
structure, and defaults in its loan portfolio and loan guarantee program
incurred between 1991 and 1996, JDA would have experienced a debt service cash
flow shortfall had it not completed its recent refinancing. JDA anticipates that
it will transact additional refinancings in 1999, 2000 and 2003 to complete its
long-term plan of finance and further alleviate cash flow imbalances which are
likely to occur in future years. The State does not anticipate that it will be
called upon to make any payments pursuant to the State guarantee in the 1997-98
fiscal year. JDA recently resumed its lending activities under a revised set of
lending programs and underwriting guidelines.
C-1
The State employs additional long-term financing mechanisms,
lease-purchase and contractual-obligation financing, which involve obligations
of public authorities or municipalities that are State-supported but not general
obligations of the State. Under these financing arrangements, certain public
authorities and municipalities have issued obligations to finance the
construction and rehabilitation of facilities or the acquisition and
rehabilitation of equipment and expect to meet their debt service requirements
through the receipt of rental or other contractual payments made by the State.
Although these financing arrangements involve a contractual agreement by the
State to make payments to a public authority, municipality or other entity, the
State's obligation to make such payments is generally expressly made subject to
appropriation by the Legislature and the actual availability of money to the
State for making the payments. The State has also entered into a
contractual-obligation financing arrangement with the New York Local Government
Assistance Corporation ("LGAC") to restructure the way the State makes certain
local aid payments.
The State participates in the issuance of Certificates of Participation
("COPs") in a pool of leases entered into by the State's Office of General
Services on behalf of several State departments and agencies interested in
acquiring operational equipment, or in certain cases, real property. Legislation
enacted in 1986 established restrictions upon and centralized State control,
through the Comptroller and the Director of the Budget, over the issuance of
COPs representing the State's contractual obligation, subject to annual
appropriation by the Legislature and availability of money, to make installment
or lease-purchase payments for the State's acquisition of such equipment or real
property.
The State also employs moral obligation financing. Moral obligation
financing generally involves the issuance of debt by a public authority to
finance a revenue-producing project or other activity. The debt is secured by
project revenues and statutory provisions requiring the State, subject to
appropriation by the Legislature, to make up any deficiencies which may occur in
the issuer's debt service reserve fund. There has never been a default on any
moral obligation debt of any public authority although there can be no assurance
that such a default will not occur in the future.
Payments of debt service on State general obligation and State-guaranteed
bonds and notes are legally enforceable obligations of the State. The State has
never defaulted on any of its general obligation indebtedness or its obligations
under lease-purchase or contractual-obligation financing arrangements and has
never been called upon to make any direct payments pursuant to its guarantees
although there can be no assurance that such a default or call will not occur in
the future.
The proposed 1997-98 through 2002-2003 Capital Program and Financing Plan
was released with the 1998-99 Executive Budget on January 20, 1998. As part of
the Plan, changes were proposed to the State's 1997-98 borrowing plan,
including: delay of the issuance of COPs to finance welfare information systems
through 1998-99 to permit a thorough assessment of needs; and the elimination of
issuances for the CEFAP to reflect the proposed conversion of that bond-financed
program pay-as-you-go financing.
In addition to the arrangements described above, State law provides for
the creation of State municipal assistance corporations, which are public
authorities established to aid financially troubled localities. The Municipal
Assistance Corporation for The City of New York ("MAC") was created to provide
financing assistance to New York City (the "City"). To enable MAC to pay debt
service on its obligations, MAC receives, subject to annual appropriation by the
Legislature, receipts from the 4% New York State Sales Tax for the benefit of
New York City, the State-imposed stock transfer tax and, subject to certain
prior liens, certain local assistance payments otherwise payable to the City.
The legislation creating MAC also includes a moral obligation provision. Under
its enabling legislation, MAC's authority to issue bonds and notes (other than
refunding bonds and notes) expired on December 31, 1984. In 1995, the State
created the Municipal Assistance Corporation for the City of Troy ("Troy MAC").
The bonds issued by Troy MAC, however, do not include moral obligation
provisions.
C-2
THE 1998-99 STATE FINANCIAL PLAN. The State's 1998-99 fiscal year
commenced on April 1, 1998 and ends on March 31, 1999. The debt component of the
State's budget for the 1998-99 fiscal year was adopted by the Legislature on
March 30, 1998, and the remainder of the budget was adopted by the Legislature
on April 18, 1998. The State Financial Plan for the 1998-99 fiscal year (the
"State Financial Plan") was released on June 25, 1998 and was based on the
State's budget as enacted by the Legislature and signed into law by the
Governor. The State Financial Plan is updated in July, October and January. The
State Financial Plan was projected to be balanced on a cash basis; however there
can be no assurance that the State Financial Plan will continue to be in
balance. Total General Fund receipts and transfers from other funds were
projected to be $37.56 billion, while total General Fund disbursements and
transfers to other funds were projected to be $36.78 billion. After adjustments
for comparability, the adopted 1998-99 budget projected a year-over-year
increase in General Fund disbursements of 7.1 percent. General Fund
disbursements in 1998-99 were projected to grow by $2.43 billion over 1997-98
levels, or $690 million more than proposed in the Governor's Executive Budget,
as amended. The change in General Fund disbursements from the Executive Budget
to the enacted budget reflects legislative additions (net of the value of the
Governor's vetoes), actions taken at the end of the regular legislative session
and spending that was originally anticipated to occur in 1997-98 but is now
expected to occur in 1998-99. The 1998-99 increase in General fund spending has
primarily taken the form of additional local assistance ($1.88 billion). The
largest annual increases are for educational programs, Medicaid, other health
and social welfare programs and community projects grants.
Resources used to fund these additional expenditures include increased
revenues projected for 1998-99, increased resources produced in the 1997-98
fiscal year that are to be utilized in 1998-99 reestimates of social service,
fringe benefit and other spending, and certain non-recurring resources.
The State's enacted budget includes several new multi-year tax reduction
initiatives, including acceleration of State-funded property and local income
tax relief for senior citizens under the School Tax Relief Program ("STAR"),
expansion of the child care income tax credit for middle-income families, a
phased-in reduction of the general business tax and reduction of several other
taxes and fees, including an accelerated phase-out of assessments on medical
providers. The enacted budget also provides for significant increases in
spending for public schools, special education programs and the State and City
university systems. It also allocates $50 million for a new Debt Reduction
Reserve Fund ("DRRF") that may eventually be used to pay debt service costs on
or to prepay outstanding State-supported bonds.
The 1998-99 State Financial Plan projects a closing balance in the General
Fund of $1.42 billion that is comprised of a reserve of $761 million available
for future needs, a balance of $400 million in the Tax Stabilization Reserve
Fund ("TSRF"), a balance of $158 million in the Community Projects Fund ("CPF")
and a balance of $100 million in the Contingency Reserve Fund ("CRF"). The TSRF
can be used in the event of an unanticipated General Fund cash operating
deficit, as provided under the State Constitution and State Finance Law. The CPF
is used to finance various legislative and executive initiatives. The CRF
provides resources to help finance any extraordinary litigation costs during the
fiscal year.
Many complex political, social and economic forces influence the State's
economy and finances, which may in turn affect the State's Financial Plan. These
forces may affect the State unpredictably from fiscal year to fiscal year and
are influenced by governments, institutions and organizations that are not
subject to the State's control. The State Financial Plan is also necessarily
based upon forecasts of national and State economic activity. Economic
forecasts, however, have frequently failed to predict accurately the timing and
magnitude of changes in the national and the State economies.
The State Financial Plan included actions that would have an effect on the
budget outlook for State fiscal year 1998-99 and beyond. The DOB estimated that
the 1998-99 State Financial Plan contained actions that provide non-recurring
resources or savings totaling approximately $64 million, the largest of which is
a retroactive reimbursement of federal welfare claims. The balance is composed
of various other actions,primarily the transfer of unused special revenue fund
balances to the General Fund.
C-3
Despite recent budgetary surpluses recorded by the State, State actions
affecting the level of receipts and disbursements, the relative strength of the
State and regional economy, actions of the federal government and other factors
have created structural budget gaps for the State. These gaps resulted from a
significant disparity between recurring revenues and the costs of maintaining or
increasing the level of support for State programs. To address a potential
imbalance in any given fiscal year, the State is required to take actions to
increase receipts and/or reduce disbursements as it enacts the budget for that
year, and under the State Constitution, the Governor is required to propose a
balanced budget each year. There can be no assurance, however, that the
Legislature will enact the Governor's proposals or that the State's actions will
be sufficient to preserve budgetary balance in a given fiscal year or to align
recurring receipts and disbursements in future fiscal years. For example, the
fiscal effects of tax reductions adopted in the last several fiscal years
(including 1998-99) are projected to grow more substantially beyond the 1998-99
fiscal year, with the incremental annual cost of all currently enacted tax
reductions estimated at over $4 billion by the time they are fully effective in
State fiscal year 2002-03. These actions will place pressure on future budget
balance in New York State.
The State Division of Budget ("DOB") believes that its projections of
receipts and disbursements relating to the current State Financial Plan, and the
assumptions on which they are based, are reasonable. Actual results, however,
could differ materially and adversely from the projections set forth in this
Annual Information Statement, and those projections may be changed materially
and adversely from time to time. In the past, the State has taken management
actions and made use of internal sources to address potential State Financial
Plan shortfalls, and DOB believes it could take similar actions should variances
occur in its projections for the current fiscal year.
Outyear Projections of Receipts and Disbursements. In recent years, the
State has closed projected budget gaps of $5.0 billion (1995-96), $3.9 billion
(1996-97), $2.3 billion (1997-98) and less than $1 billion (1998-99). The State,
as a part of the 1998-99 Executive Budget projections submitted to the
Legislature in February 1998, projected a 1999-00 General Fund budget gap of
approximately $1.7 billion and a 2000-01 gap of $3.7 billion. As a result of
changes made in the 1998-99 enacted budget, the 1999-00 gap is now expected to
be roughly $1.3 billion, or about $400 million less than previously projected,
after application of reserves created as part of the 1998-99 budget process.
Such reserves would not be available against subsequent year imbalances.
Sustained growth in the State's economy could contribute to closing
projected budget gaps over the next several years, both in terms of
higher-than-projected tax receipts and in lower-than-expected entitlement
spending. However, the State's projections in 1999-00 currently assume actions
to achieve $600 million in lower disbursements and $250 million in additional
receipts from the settlement of State claims against the tobacco industry.
Consistent with past practice, the projections do not include any costs
associated with new collective bargaining agreements after the expiration of the
current round of contracts at the end of the 1998-99 fiscal year. Sustained
growth in the State's economy and continued declines in welfare case load and
health care costs would also produce additional savings in the State Financial
Plan. Finally, various federal actions, including the potential benefit effect
on State Tax receipts from changes to the federal tax treatment of capital
gains, would potentially provide significant benefits to the State over the next
several years. The State expects that the 1999-00 Financial Plan will achieve
savings from initiatives by State agencies to deliver services more efficiently,
workforce management efforts, maximization of federal and non-General Fund
spending offsets, and other actions necessary to bring projected disbursements
and receipts into balance.
The State will formally update its outyear projections of receipts and
disbursements for the 2000-01 and 2001-02 fiscal years as a part of the 1999-00
Executive Budget process, as required by law. The revised expectations for years
2000-01 and 2001-02 will reflect the cumulative impact of tax reductions and
spending commitments enacted over the last several years as well as new 1999-00
Executive Budget recommendations. The STAR program, which dedicates a portion of
personal income tax receipts to fund school
C-4
tax reductions, has a significant impact on General Fund receipts. STAR is
projected to reduce personal income tax revenues available to the General Fund
by an estimated $1.3 billion in 2000-01. Disbursement projections for the
outyears currently assume additional outlays for school aid, Medicaid, welfare
reform, mental health community reinvestment and other multi-year spending
commitments in law.
Uncertainties with regard to the economy, as well as the outcome of
certain litigation now pending against the State, could produce adverse effects
on the State's projections of receipts and disbursements. For example, changes
to current levels of interest rates or deteriorating world economic conditions
could have an adverse effect on the State economy and produce results in the
current fiscal year that are worse than predicted. Similarly, adverse judgments
in legal proceedings against the State could exceed amounts reserved in the
1998-99 Financial Plan for payment of such judgments and produce additional
unbudgeted costs to the State.
In recent years, the State has failed to adopt a budget prior to the
beginning of its fiscal year. A delay in the adoption of the State's budget
beyond the statutory April 1 deadline could delay the projected receipt by the
City of State aid, and there can be no assurance that State budgets in future
fiscal years will be adopted by the April 1 statutory deadline.
OFT is monitoring compliance on a quarterly basis and is providing
assistance and assigning resources to accelerate compliance for mission critical
systems, with most compliance testing expected to be completed by mid-1999.
There can be no guarantee, however, that all of the State's mission-critical and
high-priority computer systems will be Year 2000 compliant and that there will
not be an adverse impact upon State operations or State finances as a result.
GOVERNMENT FUNDS COMPRISING THE STATE FINANCIAL PLAN. Four governmental
fund types comprise the State Financial Plan: the General fund, the Special
Revenue Funds, the Capital Projects funds and the Debt Service funds.
The General Fund. The General Fund is the principal operating fund of the
State and is used to account for all financial transactions, except those
required to be accounted for in another fund. It is the State's largest fund and
receives almost all State taxes and other resources not dedicated to particular
purposes. General Fund moneys are also transferred to other funds, primarily to
support certain capital projects and debt service payments in other fund types.
In the State's 1998-99 fiscal year, the General Fund was expected by the State
to account for approximately 47.6 percent of all governmental funds
disbursements and 70.1 percent of total State Funds disbursements.
The General Fund was projected to be balanced on a cash basis for the
1998-99 fiscal year, however there can be no assurance that the General Fund
will remain balanced for the entire fiscal year. Total receipts were projected
to be $37.56 billion, an increase of $3.01 billion from the $34.55 billion
recorded in 1997-98. The disbursement total projected for fiscal year 1998-99
included $34.36 billion in tax receipts, $1.40 billion in miscellaneous receipts
and $1.80 billion in transfers from other funds.
The transfer of a portion of the surplus recorded in 1997-98 to 1998-99
exaggerates the "real" growth in State receipts from year to year by depressing
reported 1997-98 figures and inflating 1998-99 projections. Conversely, the
incremental cost of tax reductions newly effective in 1998-99 and the impact of
statutes earmarking certain tax receipts to other funds work to depress apparent
growth below the underlying growth in receipts attributable to expansion of the
State's economy. On an adjusted basis, State tax revenues in the 1998-99 fiscal
year were projected to grow at approximately 7.5 percent, following an adjusted
growth of roughly nine percent in the 1997-98 fiscal year. Fund disbursements
were projected to be $36.78 billion, an increase of $2.43 billion over the total
amount disbursed and transferred in the 1997-98 fiscal year.
C-5
SPECIAL REVENUE FUNDS: Special Revenue Funds are used to account for the
proceeds of specific revenue sources such as federal grants that are legally
restricted, either by the Legislature or outside parties, to expenditures for
specified purposes. Although activity in this fund type was expected to comprise
approximately 41 percent of total governmental funds receipts and disbursements
in the 1998-99 fiscal year, about three-quarters of that activity relates to
federally-funded programs.
Total disbursements for programs supported by Special Revenue Funds were
projected at $29.97 billion, an increase of $2.32 billion or 8.4 percent from
1997-98. Federal grants account for approximately three-quarters of all spending
in the Special Revenue fund type. Disbursements from federal funds were
estimated at $21.78 billion, an increase of $1.12 billion or 5.4 percent. The
single largest program in this Fund group is Medicaid, which was projected at
$13.65 billion, an increase of $465 million or 3.5 percent above last year.
Federal support for welfare programs was projected at $2.53 billion, similar to
1997-98. The remaining growth in federal funds was due primarily to the new
Child Health Plus program, estimated at $197 million in 1998-99. This program
will expand health insurance coverage to children of indigent families.
State special revenue spending was projected to be $8.19 billion, an
increase of $1.20 billion or 17.2 percent from last year's levels. Most of this
projected increase in spending was due to the $704 million cost of the first
phase of the STAR program, as well as $231 million in additional operating
assistance for mass transportation and $113 million for the State share of the
new Child Health Plus program.
CAPITAL PROJECTS FUNDS: Capital Projects Funds account for the financial
resources used in the acquisition, construction or rehabilitation of major State
capital facilities and for capital assistance grants to certain local
governments or public authorities. This fund type consists of the Capital
Projects Fund, which is supported by tax dollars transferred from the General
Fund and various other capital funds established to distinguish specific capital
construction purposes supported by other revenues. In the 1998-99 fiscal year,
activity in these funds was expected to comprise 5.5 percent of total
governmental receipts and disbursements.
Capital Projects Funds spending in fiscal year 1998-99 was projected at
$4.14 billion, an increase of $575 million or 16.1 percent from last year. The
major components of this expected growth were transportation and environmental
programs, including continued increased spending for 1996 Clean Water/Clean Air
Bond Act projects and higher projected disbursements from the Environmental
Protection Fund (EPF). Another significant component of this projected increase
is in the area of public protection, primarily for facility rehabilitation and
construction of additional prison capacity.
DEBT SERVICE FUNDS: Debt Service Funds are used to account for the payment
of principal of, and interest on, long-term debt of the State and to meet
commitments under lease-purchase and other contractual-obligation financing
arrangements. These Funds were expected to comprise 3.8 percent of total
governmental fund receipts and disbursements in the 1998-99 fiscal year.
Receipts in these Funds in excess of debt service requirements are transferred
to the General Fund and Special Revenue Funds, pursuant to law.
The Debt Service Fund type consists of the General Debt Service Fund,
which is supported primarily by tax dollars transferred from the General Fund,
and other funds established to accumulate moneys for the payment of debt
service. Total disbursements from the Debt Service Fund type were estimated at
$3.36 billion in 1998-99, an increase of $275 million or 8.9 percent from
1997-98 levels. Of the increase, $102 million was dedicated to transportation
purposes, including debt service on bonds issued for State and local highway and
bridge programs financed through the New York State Thruway Authority and
supported by the Dedicated Highway and Bridge Trust Fund. Another $45 million
was for education purposes, including State and City University programs
financed through the Dormitory Authority of the State of New York (DASNY). The
remainder was for a variety of programs in such areas as mental health and
corrections and for general obligation financings.
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PRIOR FISCAL YEARS. New York State's financial operations have improved
during recent fiscal years. During the period 1989-90 through 1991-92, the State
incurred General Fund operating deficits that were closed with receipts from the
issuance of TRANs. A national recession, followed by the lingering economic
slowdown in the New York and regional economy, resulted in repeated shortfalls
in receipts and three budget deficits during those years. During its last six
fiscal years, however, the State has recorded balanced budgets on a cash basis,
with positive fund balances as described below. There can be no assurance,
however, that such trends will continue.
FISCAL YEAR 1997-98. The State ended its 1997-98 fiscal year on March 31,
1998 in balance on a cash basis, with a General Fund cash surplus as reported by
DOB of approximately $2.04 billion. The cash surplus was derived primarily from
higher-than-anticipated receipts and lower spending on welfare, Medicaid and
other entitlement programs.
The General Fund had a closing balance of $638 million, an increase of
$205 million from the prior fiscal year. The balance was held in three accounts
within the General Fund: the TSRF, the CRF and the CPF. The TSRF closing balance
was $400 million, following a required deposit of $15 million (repaying a
transfer made in 1991-92) and an extraordinary deposit of $68 million made from
the 1997-98 surplus. The CRF closing balance was $68 million, following a $27
million deposit from the surplus. The CPF, which finances legislative
initiatives, closed the fiscal year with a balance of $170 million, an increase
of $95 million. The General Fund closing balance did not include $2.39 billion
in the tax refund reserve account, of which $521 million was made available as a
result of the LGAC financing program and was required to be on deposit on March
31, 1998.
General Fund receipts and transfers from other funds for the 1997-98
fiscal year (including net tax refund reserve account activity) totaled $34.55
billion, an annual increase of $1.51 billion, or 4.57 percent over 1996-97.
General Fund disbursements and transfers to other funds were $34.35 billion, an
annual increase of $1.45 billion or 4.41 percent.
FISCAL YEAR 1996-97. The State ended its 1996-97 fiscal year on March 31,
1997 in balance on a cash basis, with a General Fund cash surplus as reported by
DOB of approximately $1.42 billion. The cash surplus was derived primarily from
higher-than-expected revenues and lower-than-expected spending for social
services programs.
The General Fund closing fund balance was $433 million, an increase of
$146 million from the 1995-96 fiscal year. Of that amount, $317 million was in
the TSRF, after a required deposit of $15 million and an additional deposit of
$65 million in 1996-97. In addition, $41 million was deposited in the CRF. The
remaining $75 million reflected amounts then on deposit in the Community
Projects Fund. The General Fund closing fund balance did not include $1.86
billion in the tax refund reserve account, of which $521 million was made
available as a result of the LGAC financing program and was required to be on
deposit as of March 31, 1997.
General Fund receipts and transfers from other funds for the 1996-97
fiscal year totaled $33.04 billion, an increase of 0.7 percent from the previous
fiscal year (including net tax refund reserve account activity). General Fund
disbursements and transfers to other funds totaled $32.90 billion for the
1996-97 fiscal year, an increase of 0.7 percent from the 1995-96 fiscal year.
FISCAL YEAR 1995-96. The State ended its 1995-96 fiscal year on March 31,
1996 with a General Fund cash surplus of $445 million, as reported by DOB . The
cash surplus was derived from higher-than expected receipts, savings generated
through agency cost controls and lower-than-expected welfare spending. The DOB
reported that revenues exceeded projections by $270 million, while spending for
social service programs was lower than forecast by $120 million and all other
spending was lower by $55 million. From the resulting benefit of $445 million, a
$65 million voluntary deposit was made into the TSRF, and $380 million was used
to reduce 1996-97 Financial Plan liabilities by accelerating 1996-97 payments,
deferring 1995-96 revenues, and making a deposit to the tax refund reserve
account.
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The General Fund closing Fund balance was $287 million, an increase of
$129 million from 1994-95 levels. The $129 million change in Fund balance is
attributable to a $65 million voluntary deposit to the TSRF, a $15 million
required deposit to the TSRF, a $40 million deposit to the CRF and a $9 million
deposit to the Revenue Accumulation Fund. The closing Fund balance included $237
million on deposit in the TSRF. In addition, $41 million was on deposit in the
CRF. The remaining $9 million reflected amounts then on deposit in the Revenue
Accumulation Fund. That Fund was created to hold certain tax receipts
temporarily before their deposit to other accounts. The General fund closing
balance did not include $678 million in the tax refund reserve account of which
$521 million was made available as a result of the LGAC financing program and
was refinanced to be on deposit as of March 31, 1996.
General Fund receipts and transfers from other funds (including net refund
reserve account activity) totaled $32.81 billion, which is a decrease of 1.1
percent from 1994-95 levels. This decrease reflects the impact of tax reductions
enacted and effective in both 1994 and 1995. General Fund disbursements and
transfers totaled $32.68 billion for the 1995-96 fiscal year, which is a
decrease of 2.2 percent from 1994-95 levels.
CASH-BASIS RESULTS FOR THE NON-GENERAL FUNDS OVER THE LAST 3 YEARS.
Activity in the three other governmental funds has remained relatively stable
over the last three fiscal years, with federally-funded programs comprising
approximately two-thirds of these funds. The most significant change in the
structure of these funds has been the redirection of a portion of
transportation-related revenues from the General Fund to two new dedicated funds
in the Special Revenue and Capital Projects fund types. These revenues are used
to support the capital programs of the Department of Transportation and the MTA.
In the Special Revenue Funds, disbursements increased from $26.26 billion
to $27.65 billion over the last three years, primarily as a result of increased
costs for the federal share of Medicaid. Other activity reflected dedication of
taxes to a new fund for mass transportation, new lottery games, and new fees for
criminal justice programs.
Disbursements in the Capital Projects Funds declined from $3.97 billion to
$3.56 billion over the last three years, as spending for miscellaneous capital
programs decreased, partially offset by increases for mental hygiene, health and
environmental programs. The composition of this Fund type's receipts also
changed as the dedicated transportation taxes began to be deposited, general
obligation bond proceeds declined substantially, federal grants remained stable,
and reimbursements from public authority bonds (primarily transportation
related) increased.
Activity in the Debt Service Funds reflected increased use of bonds during
the three-year period for improvements to the State's capital facilities and the
continued costs of the LGAC fiscal reform program. The increases were moderated
by the refunding savings achieved by the State over the last several years using
strict present value savings criteria. The growth in LGAC debt service was
offset by reduced short-term borrowing costs reflected in the General Fund.
GAAP-BASIS RESULTS. State law requires the State to update its projected
financial results on a GAAP-basis on or before September first of each year.
PROJECTED GAAP-BASIS RESULTS FOR FISCAL YEAR 1998-99. The State based its
GAAP projections on the cash estimates in the First Quarterly Update to the
Financial Plan and the actual results for the 1997-98 fiscal year as reported by
the State Comptroller on July 28, 1998.
On March 31, 1998, the State recorded, on a GAAP-basis, its first-ever,
accumulated positive balance in its General Fund. This "accumulated surplus" was
$567 million. The improvement in the State's GAAP position is attributable, in
part, to the cash surplus recorded at the end of the State's 1997-98 fiscal
year. Much of that surplus is reserved for future requirements, but a portion is
being used to meet spending needs in
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1998-99. Thus, the State expects some deterioration in its GAAP position, but
expects to maintain a positive GAAP balance through the end of the current
fiscal year.
The 1998-99 GAAP-basis General Fund Financial Plan shows expected tax
revenues of $33.1 billion and miscellaneous revenues of $2.6 billion to finance
expenditures of $36.1 billion and net financing uses of $156 million. The
General Fund accumulated surplus is projected to be $27 million at the end of
1998-99.
GAAP-BASIS RESULTS FOR FISCAL YEAR 1997-98. The State completed its
1997-98 fiscal year with a combined Governmental Funds operating surplus of
$1.80 billion, which included an operating surplus in the General Fund of $1.56
billion, in Capital Projects Funds of $232 million and in Special Revenue Funds
of $49 million, offset in part by an operating deficit of $43 million in Debt
Service Funds.
GENERAL FUND. The State reported a General Fund operating surplus of $1.56
billion for the 1997-98 fiscal year, as compared to an operating surplus of
$1.93 billion for the 1996-97 fiscal year. As a result, the State reported an
accumulated surplus of $567 million in the General Fund for the first time since
it began reporting its operations on a GAAP-basis. The 1997-98 fiscal year
operating surplus reflects several major factors, including the cash-basis
operating surplus resulting from the higher-than-anticipated personal income tax
receipts, an increase in taxes receivable of $681 million, an increase in other
assets of $195 million and a decrease in pension liabilities of $144 million.
This was partially offset by an increase in payables to local governments of
$270 million and tax refunds payable of $147 million.
Revenues increased $617 million (1.8 percent) over the prior fiscal year,
with increases in personal income, consumption and use and business taxes.
Decreases were reported for other taxes, federal grants and miscellaneous
revenues. Personal income taxes grew $746 million, an increase of nearly 4.2
percent. The increase in personal income taxes resulted from strong employment
and wage growth and the strong performance by the financial markets during 1997.
Consumption and use taxes increased $334 million or 5.0 percent as a result of
increased consumer confidence. Business taxes grew $28 million, an increase of
0.5 percent. Other taxes fell primarily because revenue for estate and gift
taxes decreased. Miscellaneous revenues decreased $380 million, or 12. 7
percent, due to a decline in receipts from the Medical Malpractice Insurance
Association and medical provider assessments.
Expenditures increased $137 million (0.4 percent) from the prior fiscal
year, with the largest increases occurring in State aid for education and social
services spending. Education expenditures grew $391 million (3.6 percent) due
mainly to an increase in spending for municipal and community colleges. Social
services expenditures increased $233 million (2.6 percent) due mainly to program
growth. Increases in other State aid spending were offset by a decline in
general purpose aid of $235 million (27.8 percent) due to statutory changes in
the payment schedule. Increases in personal and non-personal service costs were
offset by a decrease in pension contribution of $660 million, a result of the
refinancing of the State's pension amortization that occurred in 1997.
Net other financing sources decreased $841 million (68.2 percent) due to
the nonrecurring use of bond proceeds ($769 million) provided by DASNY to pay
the outstanding pension amortization liability incurred in 1997.
SPECIAL REVENUE, DEBT SERVICE AND CAPITAL PROJECTS FUNDS. An operating
surplus of $49 million was reported for the Special Revenue Funds for the
1997-98 fiscal year, which increased the accumulated fund balance to $581
million. Revenues rose by $884 million over the prior fiscal year (3.3 percent)
as a result of increases in tax and federal grant revenues. Expenditures
increased by $795 million (3.3 percent) as a result of increased costs for local
assistance grants. Net other financing uses decreased $105 million (3.3
percent).
Debt Service Funds ended the 1997-98 fiscal year with an operating deficit
of $43 million and, as a result, the accumulated fund balance declined to $1.86
billion. Revenues increased $246 million (10.6 percent) as a result of increases
in dedicated taxes. Debt service expenditures increased $341 million
C-9
(14.4 percent). Net other financing sources increased $89 million (401.3
percent) due primarily to savings achieved through advance refundings of
outstanding bonds.
An operating surplus of $232 million was reported in the Capital Projects
Funds for the State's 1997-98 fiscal year and, as a result, the accumulated
deficit in this fund type decreased to $381 million. Revenues increased $180
million (8.6 percent) primarily as a result of a $54 million increase in
dedicated tax revenues and an increase of $101 million in federal grants for
transportation and local waste water treatment projects. Net other financing
sources increased by $100 million primarily as a result of a decrease in
transfers to certain public benefit corporations engaged in housing programs.
GAAP-BASIS RESULTS FOR FISCAL YEAR 1996-97. The State completed its
1996-97 fiscal year with a combined governmental funds operating surplus of $2.1
billion, which included an operating surplus in the General Fund of $1.9
billion, in the Capital Projects Funds of $98 million and in the Special Revenue
Funds of $65 million, offset in part by an operating deficit of $37 million in
the Debt Service Funds.
GENERAL FUND. The State reported a General Fund operating surplus of $1.93
billion for the 1996-97 fiscal year, as compared to an operating surplus of $380
million for the prior fiscal year. The 1996-97 fiscal year GAAP operating
surplus reflects several major factors, including the cash basis operating
surplus, the benefit of bond proceeds which reduced the State's pension
liability, an increase in taxes receivable of $493 million, and a reduction in
tax refund liabilities of $196 million. This was offset by an increased payable
to local governments of $244 million.
Revenues increased $1.91 billion (nearly 6.0 percent) over the prior
fiscal year with increases in all revenue categories. Personal income taxes grew
$620 million, an increase of nearly 3.6 percent, despite the implementation of
scheduled tax cuts. The increase in personal income taxes was caused by moderate
employment and wage growth and the strong financial markets during 1996.
Consumption and use taxes increased $179 million or 2.7 percent as a result of
increased consumer confidence. Business taxes grew $268 million, an increase of
5.6 percent, primarily as a result of the strong financial markets during 1996.
Other taxes increased primarily because revenues from estate and gift taxes
increased. Miscellaneous revenues increased $743 million, a 33.1 percent
increase, because of legislated increases in receipts from the Medical Local
Practice Insurance Association and from medical provider assessments.
Expenditures increased $830 million (2.6 percent) from the prior fiscal
with the largest increase occurring in pension contributions and State aid for
education spending. Pension contribution expenditures increased $514 million
(198.2 percent), primarily because the State paid off its 1984-85 and 1985-86
pension amortization liability. Education expenditures grew $351 million (3.4
percent), due mainly to an increase in spending for support for public schools
and physically handicapped children, offset by a reduction in spending for
municipal and community colleges. Modest increases in other State aid spending
was offset by a decline in social services expenditures of $157 million (1.7
percent). Social services spending continues to decline because of cost
containment strategies and declining caseloads.
Net other financing sources increased $475 million (62.6 percent), due
mainly to bond proceeds provided by the Documentary Authority of the State of
New York (DASNY) to pay the outstanding pension amortization, offset by
elimination of prior year LGAC proceeds.
SPECIAL REVENUE, DEBT SERVICE AND CAPITAL PROJECTS FUNDS. An operating
surplus of $65 million was reported for the Special Revenue Funds for the
1996-97 fiscal year, increasing the accumulated fund balance to $532 million.
Revenues increased $583 million over the prior fiscal year (2.2 percent) as a
result of increases in tax and lottery revenues. Expenditures increased $384
million (1.6 percent) as a result of increased costs for departmental
operations. Net other financing sources decreased $275 million (8.0 percent),
primarily because of declines in amounts transferred to other funds.
Debt Service Funds ended the 1996-97 fiscal year with an operating deficit
of $37 million and, as a result, the accumulated fund balance declined to $1.90
billion. Revenues increased $102 million (4.6 percent) because of increases in
both dedicated taxes and mental hygiene patient fees. Debt service expenditures
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increased $47 million (2.0 percent). Net other financing sources decreased $277
million (92.6 percent) due primarily to an increase in payments on advance
refundings.
An operating surplus of $98 million was reported in the Capital Projects
Funds for the State's 1996-97 fiscal year, and, as a result, the accumulated
fund deficit decreased to $614 million. Revenues increased $100 million (5.0
percent) primarily because a larger share of the real estate transfer tax was
shifted to the Environmental Protection Fund and federal grant revenues
increased for transportation and local waste water treatment projects.
Expenditures decreased $359 million (10.0 percent) because of declines in
capital grants for education, housing and regional development programs and
capital construction spending. Net other financing sources decreased by $637
million as a result of a decrease in proceeds from financing arrangements.
GAAP-BASIS RESULTS FOR FISCAL YEAR 1995-96. The State completed its
1995-96 fiscal year with a combined Governmental Funds operating surplus of $432
million, which included an operating surplus in the General Fund of $380
million, in the Capital Projects Funds of $276 million and in the Debt Service
Funds of $185 million, offset in part by an operating deficit of $409 million in
the Special Revenue Funds.
GENERAL FUND. The State reported a General Fund operating surplus of $380
million for the 1995-96 fiscal year, as compared to an operating deficit of
$1.43 billion for the prior fiscal year. The 1995-96 fiscal year surplus
reflects several major factors, including the cash-basis surplus and the benefit
of $529 million in LGAC Bond Annual Information Statement June 26, 1998 proceeds
which were used to fund various local assistance programs. This was offset in
part by a $437 million increase in tax refund liability primarily resulting from
the effects of ongoing tax reductions and (to a lesser extent) changes in
accrual measurement policies, and increases in various other expenditure
accruals.
Revenues increased $530 million (nearly 1.7 percent) over the prior fiscal
year with an increase in personal income taxes and miscellaneous revenues offset
by decreases in business and other taxes. Personal income taxes grew $715
million, an increase of 4.3 percent. The increase in personal income taxes was
caused by moderate employment and wage growth and the strong financial markets
during 1995. Business taxes declined $295 million or 5.8 percent, resulting
primarily from changes in the tax law that modified the distribution of taxes
between the General Fund and other fund types, and reduced business tax
liability. Miscellaneous revenues increased primarily because of an increase in
receipts from medical provider assessments.
Expenditures decreased $716 million (2.2 percent) from the prior fiscal
year with the largest decrease Occurring in State aid for social services
program and State operations spending. Social services expenditures decreased
$739 million (7.5 percent) due mainly to implementation of cost containment
strategies by the State and local governments, and reduced caseloads. General
purpose and health and environment expenditures grew $139 million (20.2 percent)
and $121 million (33.3 percent), respectively. Health and environment spending
increased as a result of increases enacted in 1995-96. In State operations,
personal service costs and fringe benefits declined $241 million (3.8 percent)
and $55 million (3.6 percent), respectively, due to staffing reductions. The
decline in non-personal service costs of $170 million (8.6 percent) was caused
by a decline in the litigation accrual. Pension contributions increased $103
million (66.4 percent) as a result of the return to the aggregate cost method
used to determine employer contributions.
Net other financing sources nearly tripled, increasing $561 million, due
primarily to an increase in bonds issued by LGAC, a transfer from the Mass
Transportation Operating Assistance Fund and transfers from public benefit
corporations.
SPECIAL REVENUE, DEBT SERVICE AND CAPITAL PROJECTS FUNDS. An operating
deficit of $409 million was reported for Special Revenue Funds for the 1995-96
fiscal year which deceased the accumulated fund balance to $532 million.
Revenues increased $1.45 billion over the prior fiscal year (5.8 percent) as a
result of increases in federal grants and lottery revenues. Expenditures
increased $1.21 billion (5.4 percent) as a result of increased costs for social
services programs and an increase in the distribution of lottery proceeds
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to school districts. Other financing uses increased $693 million (25.1 percent)
primarily because of an increase in federal reimbursements transferred to other
funds.
Debt Service Funds ended the 1995-96 fiscal year with an operating surplus
of over $185 million and, as a result, the accumulated fund balance increased to
$1.94 billion. Revenues increased $10 million (0.5 percent) because of increases
in both dedicated taxes and mental hygiene patient fees. Debt service
expenditures increased $201 million (9.5 percent). Net other financing sources
increased threefold to $299 million, due primarily to increases in patient
reimbursement revenues.
An operating surplus of $276 million was reported in the Capital Projects
Funds for the State's 1995-96 fiscal year and, as a result, the accumulated
deficit fund balance in this fund type decreased to $712 million. Revenues
increased $260 million (14.9 percent) primarily because a larger share of the
petroleum business tax was shifted from the General Fund to the Dedicated
Highway and Bridge Trust Fund, and due to an increase in federal grant revenues
for transportation and local waste water treatment projects. Capital Projects
Funds expenditures increased $194 million (5.7 percent) in State fiscal year
1995-96 because of increased expenditures for education and health and
environmental projects. Net other financing sources increased by $577 million as
a result of an increased in proceeds from financing arrangements.
Due to changing economic conditions and information, public statements or
reports regarding the State Financial Plan and its constituent funds may be
released by the Governor, members of the Legislature, and their respective
staffs, as well as others involved in the budget process from time to time.
Those statements or reports may contain predictions, projections or other items
of information relating to the State's financial condition, including potential
operating results for the current fiscal year and projected baseline gaps for
future fiscal years, that may vary materially and adversely from the information
provided herein.
STATE FINANCIAL PLAN CONSIDERATIONS. The economic and financial condition
of the State may be affected by various financial, social, economic and
political factors. These factors can be very complex, may vary from fiscal year
to fiscal year, and are frequently the result of actions taken not only by the
State and its agencies and instrumentalities, but also by entities, such as the
federal government, that are not under the control of the State. For example,
various proposals relating to federal tax and spending policies that are
currently being publicly discussed and debated could, if enacted, have a
significant impact on the State's financial condition in the current and future
fiscal years. Because of the uncertainty and unpredictability of the changes,
their impact cannot, as a practical matter, be included in the assumptions
underlying the State's projections at this time.
The State Financial Plan is based upon forecasts of national and State
economic activity developed through both internal analysis and review of State
and national economic forecasts prepared by commercial forecasting services and
other public and private forecasters. Economic forecasts have frequently failed
to predict accurately the timing and magnitude of changes in the national and
the State economies. Many uncertainties exist in forecasts of both the national
and State economies, including consumer attitudes toward spending, the extent of
corporate and governmental restructuring, federal fiscal and monetary policies,
the level of interest rates, and the condition of the world economy, which could
have an adverse effect on the State. There can be no assurance that the State
economy will not experience results in the current fiscal year that are worse
than predicted, with corresponding material and adverse effects on the State's
projections of receipts and disbursements.
Projections of total State receipts in the State Financial Plan are based
on the State tax structure in effect during the fiscal year and on assumptions
relating to basic economic factors and their historical relationships to State
tax receipts. In preparing projections of State receipts, economic forecasts
relating to personal income, wages, consumption, profits and employment have
been particularly important. The projection of receipts from most tax or revenue
sources is generally made by estimating the change in yield of such tax or
revenue source caused by economic and other factors, rather than by estimating
the total yield of such tax or revenue source from its estimated tax base. The
forecasting methodology, however, ensures
C-12
that State fiscal year estimates for taxes that are based on a computation of
annual liability, such as the business and personal income taxes, are consistent
with estimates of total liability under such taxes.
Projections of total State disbursements are based on assumptions relating
to economic and demographic factors, levels of disbursements for various
services provided by local governments (where the cost is partially reimbursed
by the State), and the results of various administrative and statutory
mechanisms in controlling disbursements for State operations. Factors that may
affect the level of disbursements in the fiscal year include uncertainties
relating to the economy of the nation and the State, the policies of the federal
government, and changes in the demand for and use of State services.
NATIONAL AND STATE ECONOMIC OUTLOOKS. The information below summarizes the
national and State economic situation and outlook upon which projections of
receipts and certain disbursements were made for the 1998-99 Financial Plan.
U.S. ECONOMY. The national economy grew strongly during the first quarter
of 1998 but slowed sharply in the second quarter, with the real growth rate
falling from 5.5 percent to 1.8 percent. Although continued moderation is
expected during the second half of the year, the annual growth rate for 1998 is
projected to be 3.4 percent. However, the slowing of growth within the domestic
economy, the contraction of export markets in many parts of the world and the
lack of inflationary pressure has encouraged the Federal Reserve Board ("FRB")
to commence a policy of gradually decreasing short-term interest rates. Nominal
GDP is expected to grow about 4.6 percent in 1998, more than a percentage point
slower than in 1997. Inflation, as measured by the Consumer Price Index, is
expected to be 1.7 percent in 1998. The annual rate of job growth is expected to
be 2.5 percent in 1998. The rate of growth of wages in 1998 will be 6.7 percent.
In line with the general slowdown of the overall economy that has occurred
during the year, personal income growth is projected to decline from 5.6 percent
in 1997 to 5.0 percent in 1998.
The current outlook for the nation has deteriorated modestly from the
Budget Division's July forecast, with weaker real and nominal growth now
anticipated and a general weakening of the business profits picture for the
balance of the fiscal year. There are, however, uncertainties inherent in any
economic forecast. Consumer or business spending could be weaker than expected,
due, perhaps to further significant declines in corporate profits or equity
values. Additionally, the international economic and financial disruptions
currently being felt around the globe could worsen or take longer than
anticipated to subside. The result could be a sharp, additional reduction in
domestic economic growth. Indeed, several private sector forecasters have
indicated a heightened risk of a national recession beginning in 1999. Under
that scenario, the FRB would be likely to lower short-term interest rates faster
and further than expected in an effort to reignite the nation's economic
engines. Alternatively, but less likely, the pace of US economic growth could be
faster if productivity or consumer spending becomes stronger than anticipated,
or if the economies of many of the countries of Asia and Latin America recover
more quickly than expected. If such growth, or a rapid rise in labor, health or
energy costs, awakens long-dormant inflationary pressures, the FRB may reverse
its current position and raise interest rates.
NEW YORK ECONOMY. The healthy growth that has characterized the New York
economy continued during the first three-quarters of 1998. According to
seasonally-adjusted employment data from the State Labor Department, New York
has added over 90,000 private-sector jobs since December 1997 and over 370,000
since December 1994. The service sector accounted for 60,000 of the 1998
increase and trade added about 15,000. The unemployment rate was 5.5 percent in
September and remains above the national rate, as it has since 1991. The State's
current rate, however, is 0.9 percentage points below the level in September
1997.
Compared with the July forecast, the DOB's current employment, income and
wage outlook is slightly higher for 1998. The forecast calls for employment to
increase about 2.0 percent in 1998. Personal income should increase about 5.0
percent in 1998 based on wage growth of around 6.2 percent.
The forecast for New York is subject to the same uncertainties as the
national forecast, as well as some specific to New York. The securities industry
is more important to the New York economy than to the
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national economy and, therefore, a large change in financial market performance
during the forecast horizon could result in wage and employment levels that are
significantly different from those embodied in the forecast.
New York is the third most populous state in the nation and has a
relatively high level of personal wealth. The State's economy is diverse, with a
comparatively large share of the nation's finance, insurance, transportation,
communications and services employment and a very small share of the nation's
farming and mining activity. The State's location and its excellent air
transport facilities and natural harbors have made it an important link in
international commerce. Travel and tourism constitute an important part of the
economy. Like the rest of the nation, New York has a declining proportion of its
work force engaged in manufacturing and an increasing proportion engaged in
service industries. The following paragraphs summarize the state of major
sectors of the New York economy:
SERVICES: The services sector, which includes entertainment,
personal services, such as health care and auto repairs, and
business-related services, such as information processing, law and
accounting, is the State's leading economic sector. The services sector
accounts for more than three of every ten nonagricultural jobs in New York
and has a noticeably higher proportion of total jobs than does the rest of
the nation.
MANUFACTURING: Manufacturing employment continues to decline in
importance in New York, as in most other states, and New York's economy is
less reliant on this sector than is the nation. The principal
manufacturing industries in recent years produced printing and publishing
materials, instruments and related products, machinery, apparel and
finished fabric products, electronic and other electric equipment, food
and related products, chemicals and allied products, and fabricated metal
products.
TRADE: Wholesale and retail trade is the second largest sector in
terms of nonagricultural jobs in New York but is considerably smaller when
measured by income share. Trade consists of wholesale businesses and
retail businesses, such as department stores and eating and drinking
establishments.
FINANCE, INSURANCE AND REAL ESTATE: New York City is the nation's
leading center of banking and finance and, as a result, this is a far more
important sector in the State than in the nation as a whole. Although this
sector accounts for under one-tenth of all nonagricultural jobs in the
State, it contributes over one-sixth of all non-farm labor and
proprietors' income.
AGRICULTURE: Farming is an important part of the economy of large
regions of the State, although it constitutes a very minor part of total
State output. Principal agricultural products of the State include milk
and dairy products, greenhouse and nursery products, apples and other
fruits, and fresh vegetables. New York ranks among the nation's leaders in
the production of these commodities.
GOVERNMENT: Federal, State and local government together are the
third largest sector in terms of nonagricultural jobs, with the bulk of
the employment accounted for by local governments. Public education is the
source of nearly one-half of total state and local government employment.
Relative to the nation, the State has a smaller share of manufacturing and
construction and a larger share of service-related industries. The State's
finance, insurance, and real estate share, as measured by income, is
particularly large relative to the nation. The State is likely to be less
affected than the nation as a whole during an economic recession that is
concentrated in manufacturing and construction, but likely to be more affected
during a recession that is concentrated in the service-producing sector.
In the calendar years 1987 through 1996, the State's rate of economic
growth was somewhat slower than that of the nation. In particular, during the
1990-91 recession and post-recession period, the economy of the State, and that
of the rest of the Northeast, was more heavily damaged than that of the nation
as a whole and has been slower to recover. The total employment growth rate in
the State has been below the national average since 1987. The unemployment rate
in the State dipped below the national rate in the second half of 1981 and
remained lower until 1991; since then, it has been higher. According to data
published
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by the US Bureau of Economic Analysis, total personal income in the State has
risen more slowly than the national average since 1988.
State per capita personal income has historically been significantly
higher than the national average, although the ratio has varied substantially.
Because the City is a regional employment center for a multi-state region, State
personal income measured on a residence basis understates the relative
importance of the State to the national economy and the size of the base to
which State taxation applies.
Financial Plan Updates. The State is required to issue Financial Plan
updates to the cash-basis State Financial Plan in July, October, and January,
respectively. These quarterly updates reflect analysis of actual receipts and
disbursements for each respective period and revised estimates of receipts and
disbursements for the then current fiscal year.
THE JULY UPDATE. The State published first update to the cash basis
1998-99 State Financial Plan on July 30, 1998 (the "July Update"). In the
update, the State continued to project that the State Financial Plan for 1998-99
would remain in balance. The State made several revisions to the receipt
estimates in the financial Plan formulated with the enacted budget, which had
the net effect of increasing projected General fund receipts for 1998-99 to a
total of $37.81 billion, up $250 million from its original projection. The State
made no change to the disbursement projections in the 1998-99 financial Plan,
which it estimated at $36.78 billion for the 1998-99 fiscal year. The additional
receipts boosted the State's projected reserve for future needs to $1.01
billion, an increase of $250 million from the June projections. The projected
closing balance in the General fund of $1.67 billion reflected the reserve for
future needs of $1.10 billion, a balance of $400 million in the Tax
Stabilization Reserve fund, a balance of $100 million in the Contingency Reserve
fund (after a deposit of 432 million during the current fiscal year) and $158
million in the Community Projects fund.
THE MID-YEAR UPDATE. The State issued its second update to the cash-basis
1998-99 State Financial Plan (the "Mid-Year Update") on October 30, 1997. The
State ended the first six months of the 1998-99 fiscal year with a General Fund
cash balance of $5.02 billion, some $143 million higher than projected in the
cash flow accompanying te July Update to the Financial Plan.
RECEIPTS: Total receipts, including transfers from other funds, grew to
419.7 billion, through September approximately 452 million higher than expected.
This increase is comprised of additional tax revenues (approximately 422
million) and transfers from other funds ($30 million).
DISBURSEMENTS: Total spending through the first six months of the fiscal
year was $16.27 billion, or $91 million lower than projected. This variance
results primarily from higher spending in Grants to Local Government ($27
million), offset by lower spending in State Operations ($124 million). These
variances are timing-related and should not affect total disbursements for the
fiscal year.
GENERAL FUND RECEIPTS: Total receipts for 1998-99 are projected to reach
$37.84 billion, an increase of $29 million from the amount projected in July. Of
the $37.84 billion in total receipts, taxes are projected at over $34.5 billion,
miscellaneous receipts at over 41.47 billion and transfers from other funds at
over $1.86 billion. Anticipated tax receipts have been reduced slightly, but
expected miscellaneous receipts and transfers from other funds have been
increased by enough to produce the net $29 million increase in overall
collections.
PERSONAL INCOME TAX: Total income tax receipts are projected to reach
$21.44 billion, $29 million above the amount expected in July, and nearly $3.7
billion above the amount reported for 1997-98. The net increase from the July
forecast is attributable to modest upward revisions in estimated 1997 liability
as partially offset by slightly weaker expectations for collections on current
year liability for the balance of the current year. The current estimate
reflects an anticipated deterioration in the growth of financial sector bonuses
and the resultant impact on withholding.
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While gross collections under this tax are expected to grow approximately
10 percent from 1997-98, the exceptional year-to-year change in the estimate of
receipts from this source is still significantly attributable to the movement of
the General Fund surplus available at the end of 1997-98 into the current fiscal
year. The approximately $2.4 billion impact on the year-over-year change that
results from the surplus swing is only partially offset by the planned diversion
of slightly over $700 million in income tax receipts to the School Tax Relief
(STAR) Fund in the current year to fund statewide school property tax relief for
senior citizens.
USER TAXES AND FEES: Receipts from user taxes and fees are expected to
total $7.21 billion, down $3 million fro the amount projected in July, and
approximately $170 million above the amount reported for 1997-98. The reduction
in estimated collections from the July forecast is largely the result of lower
anticipated sales and use tax collections as partially offset by modestly higher
forecasts of receipts from the cigarette, beverage and motor fuel taxes and from
motor vehicle fees.
The modest downward revision in anticipated sales tax receipts is largely
attributable to small reductions in the expected consumption of taxable goods
over the balance of the fiscal year. The small upward revisions in the remaining
sources noted above largely reflect collection experience through the first half
of the year.
BUSINESS TAXES: Business tax collections, reflecting collection experience
in September and reduced expectations for profits in the balance of the year,
are expected to reach $4.79 billion, some $157 million below the amount
anticipated in the July plan. The revised estimate for 1998-99 is some $257
million below the amount recorded for the 1997-99 fiscal year.
The largest revision in this category from the July forecast is a $88
million reduction in anticipated receipts from the bank tax, reflecting both a
lower 1997 liability base than estimated in July as well as lower expected bank
earnings in the current year. Receipts expected under the State's general
business tax, the insurance tax and the corporation and utility tax were also
revised down, reflecting year-to-date collection experience, a weakening profits
outlook and, in the case of the utility levy, continued moderate weather.
OTHER TAXES: Receipts from other taxes are projected at $1,072 million, an
increase of $53 million from the July forecast, largely on the basis of
higher-than-projected estate tax receipts in September. Despite the new, higher
forecast, the revised estimate for the current fiscal year represents a
year-over-year net decline of $22 million from actual results in 1997-98.
Miscellaneous Receipts and Transfers from other Funds: Miscellaneous
receipts are projected to reach $1.47 billion, an increase of some $70 million
from the amount anticipated in July, largely as a result of higher investment
income received during the first six months of the year and expected for the
balance of 1998-99. The revised estimate for the current year is still some $124
million below the amount recorded in the category in the preceding fiscal year.
Transfers from other funds are expected to be over $1.86 billion,
including $1.54 billion as the portion of sales tax receipts that flows to the
General Fund after meeting the debt service requirements of the LGAC. Total
receipts in this category are expected to be some $37 million higher than
projected in July, largely as a result of a $49 million increase in the estimate
of real estate transfer tax receipts available to be transferred to the General
Fund. The upward revision largely reflects the burst of commercial sales in the
New York City real estate market. The estimate of receipts available to be
transferred from LGAC has been reduced by nearly $12 million, mirroring the
reduction expected in the estimate of sales tax received directly in the General
Fund. The estimate of available transfers from other funds is now some $156
million below the amount transferred in 1997-99.
GENERAL FUND DISBURSEMENTS. The State is making no revisions to its July
disbursement estimates, with projected General Fund disbursements for the year
still expected to total $36.78 billion. The State
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believes year-to-date disbursements and the trends underlying its yearly
spending estimates remain consistent with the July update and it does not
anticipate any changes that would alter total projected disbursements for the
year.
GRANTS TO LOCAL GOVERNMENTS: The State continues to project disbursements
of $25.14 billion for the year, an increase of $1.88 billion over 1997-99. An
$830 million increase in cash disbursements for school aid over the prior year
is responsible for nearly half the year-over-year growth in this category. Other
significant increases include Medicaid ($144 million), handicapped education
programs ($108 million) and children and families programs ($66 million).
School aid is the largest program in terms of total spending in this
category, with disbursements of $9.7 billion expected in 1998-99. It is followed
by Medicaid ($5.6 billion), welfare ($1.6 billion), services for children and
families ($927 million) and general purpose aid to local governments ($837
million).
STATE OPERATIONS: This category accounts for the costs of running State
agencies. The State estimates $6.7 billion in spending for State Operations,
$511 million higher than 1997-98. This year-to-year growth reflects the
continuing phase-in of wage increase under existing collective bargaining
agreements, the impact of binding arbitration settlements, and the costs of
funding an extra payroll in 1998-99.
GENERAL STATE CHARGES: spending in this category, which accounts primarily
for fringe benefits of State employees, is projected to total $2.22 billion in
1998-99, a modest decrease from 1997-99.
DEBT SERVICE: Short and long-term debt service is projected at $2.14
billion, an increase of $111 million over 1997-98. For the first time, the State
plans to make a $50 million deposit to the Debt Reduction Reserve Fund.
CAPITAL PROJECTS AND ALL OTHER TRANSFERS: Spending in this category is
estimated at $592 million, a decrease of $61 million over 1997-98, reflecting
the non-recurring nature of certain items included in the prior fiscal year.
FUND BALANCE. The Financial Plan now projects a closing balance in the
General Fund of $1.7 billion. The balance is comprised of the $1.04 billion
reserve for future needs, $400 million in the Tax Stabilization Reserve Fund,
$100 million in the Contingency Reserve Fund (after a planned deposit of $32
million in 1998-99) and $158 million in the Community Projects Funds.
OTHER GOVERNMENTAL FUNDS. Total spending from All Governmental Funds is
projected at $71.54 billion, unchanged from the July estimate. Spending is
projected at $34.07 billion for the General Fund (excluding transfers), $29.98
billion for the Special Revenue Funds, $4.14 billion for the Capital Projects
Funds, and $3.36 billion for the Debt Service Funds.
State Funds spending is estimated to total $48.58 billion. Consistent with
the General Fund and All Governmental Funds, the State is making no change to
the State Funds disbursement estimate in the July update. The State believes
year-to-date disbursements and the trends underlying its yearly spending
estimates remain consistent with the July update and its does not foresee any
changes that would significantly alter total projected disbursements for either
All Funds or State Funds for the year.
RELEVANT NEWS. On August 22, 1996, the President signed the Personal
Responsibility and Work Opportunity Reconciliation Act of 1996 (the "1996
Welfare Act"). This new law made significant changes to welfare and other
benefit programs. Major changes included conversion of AFDC into the TANF block
grant to states, new work requirements and durational limits on recipients of
TANF and limits on assistance provided to immigrants. City expenditures as a
result of welfare reform are estimated in the Financial Plan at $49 million in
fiscal year 1998, $45 million in fiscal year 1999, $38 million in fiscal year
2000 and $44 million in
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fiscal year 2001. In addition, the City's naturalization initiative, CITIZENSHIP
NYC, will assist immigrants made ineligible under Federal law to regain
eligibility for benefits, by helping them through the application process for
citizenship. The Financial Plan assumes that 75% of those immigrants who
otherwise would have lost benefits will become citizens, resulting in projected
savings to the City in public assistance expenditures of $6 million in fiscal
year 1999, $24 million in fiscal year 2000 and $25 million in fiscal year 2001.
Federal legislation enacted August 5, 1997, reinstated eligibility for even more
immigrants currently on the rolls than projected. The outyear estimates made by
OMB are preliminary and depend on a variety of factors, which are impossible to
predict, including the implementation of workfare and child care programs
modified by newly enacted State law, the impact of possible litigation
challenging the law, and the impact of adverse economic developments on welfare
and other benefit programs. In accordance with the Federal welfare reform law,
the Governor submitted a State plan to the Federal government and such plan was
deemed complete as of December 2, 1996. New York State's welfare reform,
bringing the State into compliance with the 1996 Welfare Act and making changes
to the Home Relief program, was signed into law on August 20, 1997. The Governor
submitted an amended State plan to the Federal government, reflecting these
changes, on September 20, 1997. Implementation of the changes at the State level
will in part determine the possible costs or savings to the City. It is expected
that OMB's preliminary estimates of potential costs will change, based on new
policies to be developed by the State and City with respect to benefits no
longer funded as Federal entitlements.
On September 11, 1997, the State Comptroller released a report entitled
"The 1997-98 Budget: Fiscal Review and Analysis" in which he identified several
risks to the State Financial Plan and estimated that the State faces a potential
imbalance in receipts and disbursements of approximately $1.5 billion for the
State's 1998-99 fiscal year and approximately $3.4 billion for the State's
1999-00 fiscal year. The 1998-99 fiscal year estimate by the State Comptroller
is within the range discussed by the Division of the Budget in the section
entitled "Outyear Projections of Receipts and Disbursements" in the Annual
Information Statement of August 15, 1997. Any increase in the 1997-98 reserve
for future needs would reduce this imbalance further and, based upon results to
date, such an outcome is considered possible. In addition, the Comptroller
identified risks in future years from an economic slowdown and from spending and
revenue actions enacted as a part of the 1997-98 budget that will add pressure
to future budget balance. The Governor is required to submit a balanced budget
each year to the State Legislature.
On August 11, 1997 President Clinton exercised his line item veto powers
to cancel a provision in the Federal Balanced Budget Act of 1997 that would have
deemed New York State's health care provider taxes to be approved by the federal
government. New York and several other states have used hospital rate
assessments and other provider tax mechanisms to finance various Medicaid and
health insurance programs since the early 1980s. The State's process of taxation
and redistribution of health care dollars was sanctioned by federal legislation
in 1987 and 1991. However, the federal Health Care Financing Administration
(HCFA) regulations governing the use of provider taxes require the State to seek
waivers from HCFA that would grant explicit approval of the provider taxing
system now in place. The State filed the majority of these waivers with HCFA in
1995 but has yet to receive final approval.
The Balanced Budget Act of 1997 provision passed by Congress was intended
to rectify the uncertainty created by continued inaction on the State's waiver
requests. A federal disallowance of the State's provider tax system could
jeopardize up to $2.6 billion in Medicaid reimbursement received through
December 31, 1998. The President's veto message valued any potential
disallowance at $200 million. The 1997-98 Financial Plan does not anticipate any
provider tax disallowance.
On October 9, 1997 the President offered a corrective amendment to the
HCFA regulations governing such taxes. The Governor has stated that this
proposal does not appear to address all of the State's concerns, and
negotiations are ongoing between the State and HCFA. In addition, the City of
New York and other affected parties in the health care industry have filed a
lawsuit challenging the constitutionality of the President's line item veto.
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On July 31, 1997, the New York State Tax Appeals Tribunal delivered a
decision involving the computation of itemized deductions and personal income
taxes of certain high income taxpayers. By law, the State cannot appeal the
Tribunal's decision. The decision will lower income tax liability attributable
to such taxpayers for the 1997 and earlier open tax years, as well as on a
prospective basis.
RATINGS AGENCIES. On October 6, 1998, Moody's Investors Service, Inc.
("Moody's") confirmed its New York State general obligation bond rating of
single-A2. On April 20, 1998, New York's general obligation bond ratings were
the lowest of any state, except Louisiana. Moody's had rated New York State at
A2, Standard & Poor's ("S&P") had given it an A and Fitch IBCA ("Fitch") had
assigned it an A-plus.
On August 28, 1997, S&P revised its ratings on the State's general
obligation bonds to A from A-, and, in addition, revised its ratings on the
State's moral obligation, lease purchase, guaranteed and contractual obligation
debt. S&P rated the State's general obligation bonds AA- from August 1987 to
March 1990 and A+ from November 1982 to August 1987. In March 1990, S&P lowered
its rating of all of the State's general obligation bonds from AA- to A. On
January 13, 1992, S&P lowered its rating on the State's general obligation bonds
from A to A-, and, in addition, reduced its ratings on the State's moral
obligation, lease purchase, guaranteed and contractual obligation debt. On April
26, 1993 S&P revised the rating outlook assessment to stable. On February 14,
1994, S&P revised its outlook on the State's general obligation bonds to
positive and, on August 5, 1996, confirmed its A- rating.
On February 10, 1997, Moody's confirmed its A2 rating on the State's
general obligation long-term indebtedness. On June 6, 1990, Moody's changed its
ratings on all of the State's outstanding general obligation bonds from A1 to A,
the rating having been A1 since May 27, 1986. On November 12, 1990, Moody's
confirmed the A rating. On January 6, 1992, Moody's reduced its ratings on
outstanding limited-liability State lease purchase and contractual obligations
from A to Baa1.
AUTHORITIES. The fiscal stability of the State is related in part to the
fiscal stability of its public authorities, which generally have responsibility
for financing, constructing and operating revenue-producing public benefit
facilities. Public authorities are not subject to the constitutional
restrictions on the incurrence of debt which apply to the State itself, and may
issue bonds and notes within the amounts of, and as otherwise restricted by,
their legislative authorization. The State's access to the public credit markets
could be impaired, and the market price of its outstanding debt may be
materially adversely affected, if any of its public authorities were to default
on their respective obligations. As of September 30, 1996 there were 17 public
authorities that had outstanding debt of $100 million or more each, and the
aggregate outstanding debt, including refunding bonds, of all state public
authorities was $75.4 billion.
There are numerous public authorities, with various responsibilities,
including those which finance, construct and/or operate revenue producing public
facilities. Public authority operating expenses and debt service costs are
generally paid by revenues generated by the projects financed or operated, such
as tolls charged for the use of highways, bridges or tunnels, rentals charged
for housing units and charges for occupancy at medical care facilities.
In addition, State legislation authorizes several financing techniques for
public authorities. Also, there are statutory arrangements providing for State
local assistance payments otherwise payable to localities to be made under
certain circumstances to public authorities. Although the State has no
obligation to provide additional assistance to localities whose local assistance
payments have been paid to public authorities under these arrangements, if local
assistance payments are so diverted, the affected localities could seek
additional State assistance.
Some authorities also receive monies from State appropriations to pay for
the operating costs of certain of their programs. As described below, the MTA
receives the bulk of this money in order to carry out mass transit and commuter
services.
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The State's experience has been that if an Authority suffers serious
financial difficulties, both the ability of the State and the Authorities to
obtain financing in the public credit markets and the market price of the
State's outstanding bonds and notes may be adversely affected. The New York
State HFA, the New York State Urban Development Corporation and certain other
Authorities have in the past required and continue to require substantial
amounts of assistance from the State to meet debt service costs or to pay
operating expenses. Further assistance, possibly in increasing amounts, may be
required for these, or other, Authorities in the future. In addition, certain
other statutory arrangements provide for State local assistance payments
otherwise payable to localities to be made under certain circumstances to
certain Authorities. The State has no obligation to provide additional
assistance to localities whose local assistance payments have been paid to
Authorities under these arrangements. However, in the event that such local
assistance payments are so diverted, the affected localities could seek
additional State funds.
METROPOLITAN TRANSPORTATION AUTHORITY. The MTA oversees the operation of
the City's subway and bus lines by its affiliates, the New York City Transit
Authority and the Manhattan and Bronx Surface Transit Operating Authority
(collectively, the "TA"). The MTA operates certain commuter rail and bus lines
in the New York Metropolitan area through MTA's subsidiaries, the Long Island
Rail Road Company, the Metro-North Commuter Railroad Company and the
Metropolitan Suburban Bus Authority. In addition, the Staten Island Rapid
Transit Operating Authority, an MTA subsidiary, operates a rapid transit line on
Staten Island. Through its affiliated agency, the Triborough Bridge and Tunnel
Authority (the "TBTA"), the MTA operates certain intrastate toll bridges and
tunnels. Because fare revenues are not sufficient to finance the mass transit
portion of these operations, the MTA has depended, and will continue to depend
for operating support upon a system of State, local government and TBTA support,
and, to the extent available, Federal operating assistance, including loans,
grants and operating subsidies. If current revenue projections are not realized
and/or operating expenses exceed current projections, the TA or commuter
railroads may be required to seek additional State assistance, raise fares or
take other actions.
Since 1980, the State has enacted several taxes--including a surcharge on
the profits of banks, insurance corporations and general business corporations
doing business in the 12-county Metropolitan Transportation Region served by the
MTA and a special one-quarter of 1 percent regional sales and use tax--that
provide revenues for mass transit purposes, including assistance to the MTA. In
addition, since 1987, State law has required that the proceeds of a one quarter
of 1% mortgage recording tax paid on certain mortgages in the Metropolitan
Transportation Region be deposited in a special MTA fund for operating or
capital expenses. Further, in 1993 the State dedicated a portion of the State
petroleum business tax to fund operating or capital assistance to the MTA. For
the 1997-98 fiscal year, total State assistance to the MTA is projected to total
approximately $1.2 billion, an increase of $76 million over the 1996-97 fiscal
year.
State legislation accompanying the 1996-97 adopted State budget authorized
the MTA, TBTA and TA to issue an aggregate of $6.5 billion in bonds to finance a
portion of a new $12.17 billion MTA capital plan for the 1995 through 1999
calendar years (the "1995-99 Capital Program"). In July 1997, the Capital
Program Review Board approved the 1995-99 Capital Program. This plan supersedes
the overlapping portion of the MTA's 1992-96 Capital Program. This is the fourth
capital plan since the Legislature authorized procedures for the adoption,
approval and amendment of MTA capital programs and is designed to upgrade the
performance of the MTA's transportation systems by investing in new rolling
stock, maintaining replacement schedules for existing assets and bringing the
MTA system into a state of good repair. The 1995-99 Capital Program assumes the
issuance of an estimated $5.1 billion in bonds under this $6.5 billion aggregate
bonding authority. The remainder of the plan is projected to be financed through
assistance from the State, the federal government, and the City of New York, and
from various other revenues generated from actions taken by the MTA.
There can be no assurance that all the necessary governmental actions for
future capital programs will be taken, that funding sources currently identified
will not be decreased or eliminated, or that the 1995-99 Capital Program, or
parts thereof, will not be delayed or reduced. If the 1995-99 Capital Program is
delayed
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or reduced, ridership and fare revenues may decline, which could, among other
things, impair the MTA's ability to meet its operating expenses without
additional assistance.
LOCALITIES. Certain localities outside the City have experienced financial
problems and have requested and received additional State assistance during the
last several State fiscal years. The potential impact on the State of any future
requests by localities for additional assistance is not included in the
projections of the State's receipts and disbursements for the State's 1998-99
fiscal year.
Fiscal difficulties experienced by the City of Yonkers resulted in the
re-establishment of the Financial Control Board for the City of Yonkers by the
State in 1984. That Board is charged with oversight of the fiscal affairs of
Yonkers. Future actions taken by the State to assist Yonkers could result in
increased State expenditures for extraordinary local assistance.
Beginning in 1990, the City of Troy experienced a series of budgetary
deficits that resulted in the establishment of a Supervisory Board for the City
of Troy in 1994. The Supervisory Board's powers were increased in 1995, when
Troy MAC was created to help Troy avoid default on certain obligations. The
legislation creating Troy MAC prohibits the City of Troy from seeking federal
bankruptcy protection while Troy MAC bonds are outstanding.
Eighteen municipalities received extraordinary assistance during the 1996
legislative session through $50 million in special appropriations targeted for
distressed cities.
MUNICIPAL INDEBTEDNESS. Municipalities and school districts have engaged
in substantial short-term and long-term borrowings. In 1995, the total
indebtedness of all localities in the State other than the City was
approximately $19.0 billion. A small portion (approximately $102.3 million) of
that indebtedness represented borrowing to finance budgetary deficits and was
issued pursuant to State enabling legislation. State law requires the
Comptroller to review and make recommendations concerning the budgets of those
local government units other than the City authorized by State law to issue debt
to finance deficits during the period that such deficit financing is
outstanding. Eighteen localities had outstanding indebtedness for deficit
financing at the close of their fiscal year ending in 1995.
From time to time, federal expenditure reductions could reduce, or in some
cases eliminate, federal funding of some local programs and accordingly might
impose substantial increased expenditure requirements on affected localities. If
the State, the City or any of the Authorities were to suffer serious financial
difficulties jeopardizing their respective access to the public credit markets,
the marketability of notes and bonds issued by localities within the State could
be adversely affected. Localities also face anticipated and potential problems
resulting from certain pending litigation, judicial decisions and long-range
economic trends. Long-range potential problems of declining urban population,
increasing expenditures and other economic trends could adversely affect certain
localities and require increasing State assistance in the future.
LITIGATION. Certain litigation pending against the State or its officers
or employees could have a substantial or long-term adverse effect on State
finances. Among the more significant of these cases are those that involve: (i)
employee welfare benefit plans where plaintiffs are seeking a declaratory
judgment nullifying on the ground of federal preemption provisions of Section
2807-c of the Public Health Law and implementing regulations which impose a bad
debt and charity care allowance on all hospital bills and a 13 percent surcharge
on inpatient bills paid by employee welfare benefit plans; (ii) several
challenges to provisions of Chapter 81 of the Laws of 1995 which alter the
nursing home Medicaid reimbursement methodology; (iii) the validity of
agreements and treaties by which various Indian tribes transferred title to the
State of certain land in central and upstate New York; (iv) challenges to the
practice of using patients' Social Security benefits for the costs of care of
patients of State Office of Mental Health facilities; (v) an action against
State and City officials alleging that the present level of shelter allowance
for public assistance recipients is inadequate under statutory standards to
maintain proper housing; (vi) alleged responsibility of State officials to
assist in remedying racial segregation in the City of Yonkers; (vii) alleged
responsibility of the State Department of
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Environmental Conservation for a plaintiff's inability to complete construction
of a cogeneration facility in a timely fashion and the damages suffered thereby;
(viii) challenges to the promulgation of the State's proposed procedure to
determine the eligibility for and nature of home care services for Medicaid
recipients; (ix) a challenge to the constitutionality of petroleum business tax
assessments authorized by Tax Law SS 301; (x) an action for reimbursement from
the State for certain costs arising out of the provision of preschool services
and programs for children with handicapping conditions, pursuant to Sections
4410 (10) and (11) of the Education Law; (xi) a challenge to the
constitutionality of the Clean Water/Clean Air Bond Act of 1996 and its
implementing regulations; (xii) two challenges to regulations promulgated by the
Superintendent of Insurance that established excess medical malpractice premium
rates for the 1986-87 through 1996-97 fiscal years; and (xiii) an action to
compel the State to enforce sales and excise taxes imposed on tobacco products
and motor fuel sold to non-Indian customers on Indian reservations.
Adverse developments in the proceedings described above or the initiation
of new proceedings could affect the ability of the State to maintain balanced
1997-98 and 1998-99 State Financial Plans. In its Notes to its General Purpose
Financial Statements for the fiscal year ended March 31, 1997, the State reports
its estimated liability for awards and anticipated unfavorable judgments at $364
million. There can be no assurance that an adverse decision in any of the above
cited proceedings would not exceed the amount that the 1997-98 and 1998-99 State
Financial Plans reserve for the payment of judgments and, therefore, could
affect the ability of the State to maintain balanced plans.
C-22
NEW YORK CITY
The fiscal health of the State may also be particularly affected by the
fiscal health of the City, which continues to require significant financial
assistance from the State. Although the City has maintained balanced budgets in
each of its last seventeen fiscal years and is projected to achieve balances
operating result for the 1998-99 fiscal year, there can be no assurance that the
gap closing actions proposed in the Financial Plan can be successfully
implemented or that the City will maintain a balanced budget in future years
without additional state aid, revenue increases or expenditure reductions.
Additional tax increases and reductions in essential City services could also
adversely affect the City's economic base. The City depends on State aid both to
enable the City to balance its budget and to meet its cash requirements. There
can be no assurance that there will not be reductions in State aid to the City
from amounts currently projected; that State budgets will be adopted by the
April 1st Statutory deadline or interim appropriations enacted; or that any such
reductions or delays will not have adverse effects on the City's cash flow or
revenues. The State could also be affected by the ability of the City to market
its securities successfully in the public credit markets. The City has achieved
balanced operating results for each of its fiscal years since 1981 as reported
in accordance with the then-applicable GAAP standards. Current law requires the
City to prepare four-year annual financial plans, which are reviewed and revised
on a quarterly basis and includes capital, revenue, and expense projections and
outlines proposed gap-closing for the years with projected budget gaps. An
annual financial report for its most recent completed fiscal year is prepared at
the end of October of each year. The City's current financial plan update before
discretionary transfers and budget gaps for each of the 2001 and 2002 fiscal
years.
In response to the City's fiscal crisis in 1975, the State took action to
assist the City in returning to fiscal stability. Among these actions, the State
established the Municipal Assistance Corporation for the City of New York
("MAC") to provide financing assistance to the City. The State also enacted the
New York State Financial Emergency Act for The City of New York (the "Financial
Emergency Act") which, among other things, established the New York State
Financial Control Board (the "Control Board") to oversee the City's financial
affairs. The State also established the Office of the State Deputy Comptroller
for the City of New York ("OSDC") to assist the Control Board in exercising its
powers and responsibilities and a "Control Period" from 1975 to 1986 during
which the City was subject to certain statutorily-prescribed fiscal-monitoring
arrangements. Although the Control Board terminated the Control Period in 1986
when certain statutory conditions were met, thus suspending certain Control
Board powers, the Control Board, MAC and OSDC continue to exercise various
fiscal-monitoring functions over the City, and upon the occurrence or
"substantial likelihood and imminence" of the occurrence of certain events,
including, but not limited to a City operating budget deficit of more than $100
million, the Control Board is required by law to reimpose a Control Period.
Currently, the City and its "Covered Organizations" (i.e., those which
receive or may receive money from the City directly, indirectly or contingently)
operate under a four-year financial plan (the "City Financial Plan"), which the
City prepares annually and updates periodically and which includes the City's
capital revenue and expense projections and outlines proposed gap-closing
programs for years with projected budget gaps. The City's projections set forth
in the City Financial Plan are based on various assumptions and contingencies,
some of which are uncertain and may not materialize. Unforeseen developments and
changes in major assumptions could significantly affect the City's ability to
balance its budget as required by State law and to meet its annual cash flow and
financing requirements.
Although the City has balanced its budget since 1981, estimates of the
City's revenues and expenditures, which are based on numerous assumptions, are
subject to various uncertainties. If, for example, expected federal or State aid
is not forthcoming, if unforeseen developments in the economy significantly
reduce revenues derived from economically sensitive taxes or necessitate
increased expenditures for public assistance, if the City should negotiate wage
increases for its employees greater than the amounts provided for in the City's
financial plan or if other uncertainties materialize that reduce expected
revenues or increase projected expenditures, then, to avoid operating deficits,
the City may be required to implement
C-23
additional actions, including increases in taxes and reductions in essential
City services. The City might also seek additional assistance from the State.
Unforeseen developments and changes in major assumptions could significantly
affect the City's ability to balance its budget as required by State law and to
meet its annual cash flow and financing requirements.
The staffs of the Control Board, OSDC and the City Comptroller issue
periodic reports on the City's financial plans which analyze the City's
forecasts of revenues and expenditures, cash flow, and debt service requirements
for, and financial plan compliance by, the City and its Covered Organizations.
According to recent staff reports, while economic recovery in New York City has
been slower than in other regions of the country, a surge in Wall Street
profitability resulted in increased tax revenues and generated a substantial
surplus for the City in fiscal year 1996-97. Although several sectors of the
City's economy have expanded recently, especially tourism and business and
professional services, City tax revenues remain heavily dependent on the
continued profitability of the securities industries and the course of the
national economy. These reports have also indicated that recent City budgets
have been balanced in part through the use of non-recurring resources; that the
City Financial Plan tends to rely on actions outside its direct control; that
the City has not yet brought its long-term expenditure growth in line with
recurring revenue growth; and that the City is therefore likely to continue to
face substantial gaps between forecast revenues and expenditures in future years
that must be closed with reduced expenditures and/or increased revenues. In
addition to these monitoring agencies, the Independent Budget Office ("IBO") has
been established pursuant to the City Charter to provide analysis to elected
officials and the public on relevant fiscal and budgetary issues affecting the
City.
THE 1999-2002 FINANCIAL PLAN. For the 1997 fiscal year, the City had an
operating surplus, before discretionary transfers, and achieved balanced
operating results, after discretionary transfers, in accordance with GAAP. The
1997 fiscal year is the seventeenth year that the City has achieved an operating
surplus, before discretionary transfers, and balanced operating results, after
discretionary transfers.
The most recent quarterly modification to the City's financial plan for
the 1998 fiscal year, submitted to the Control Board on June 23, 1998 (the "1998
Modification"), projects a balanced budget in accordance with GAAP for the 1998
fiscal year.
One June 26, 1998, the City released the Financial Plan for the 1999-2002
fiscal years, which relates to the City and certain entities which receive funds
from the City. The Financial Plan reflects changes since the June 1997 Financial
Plan, including changes as a result of the City's expense and capital budgets
for the 1999 fiscal year, which were adopted in June, 1998, and changes
subsequent to the adopted budget. The Financial Plan projects revenues and
expenditures for the 1999 fiscal year balanced in accordance with GAAP, and
projects gaps of $1.9 billion, $2.7 billion and $2.3 billion for the 2000
through 2002 fiscal years, respectively, after implementation of a gap closing
program to reduce agency expenditures by approximately $380 million in each of
fiscal years 2000 through 2002.
Changes since the June 1997 Financial Plan include: (i) an increase in
projected tax revenue of $1.1 billion, $955 million, $897 million and $1.7
billion in the 1999 through 2002 fiscal years, respectively; (ii) a reduction in
assumed State aid of between $134 million and $142 million in each of the 1999
through 2002 fiscal years, reflecting the adopted budget for the State's 1998
fiscal year; (iii) a delay in the assumed collection of $350 million of
projected rent payments for the City's airports in the 1999 fiscal year to
fiscal years 2000 through 2002; (iv) a reduction in projected debt service
expenditures totaling $419 million, $204 million and $226 million in the 1999
through 2001 fiscal years, respectively; (v) an increase in the Board of
Education (the "BOE") spending of $345 million, $41 million, $73 million and
$208 million in the 1999 through 2002 fiscal years, respectively; (vi) an
increase in expenditures for the City's proposed drug initiatives totaling
between $167 million and $193 million in each of the 1999 through 2002 fiscal
years; (vii) other agency net spending initiatives totaling $679 million, $487
million, $492 million and $896 million in fiscal years 1999 through 2002,
respectively; and (viii) increased pension costs of $127 million in the 1999
fiscal year and
C-24
reduced pension costs of $254 million in fiscal years from additional agency
actions totaling $1.1 billion, $936 million, $910 million and $962 million in
fiscal years 1999 through 2002, respectively, including the approximately $380
million gap closing program for each of fiscal years 2000 and 2002.
The 1998 Modification and the 1999-2002 Financial Plan include proposed
discretionary transfers in the 1998 fiscal year of approximately $2.0 billion to
pay certain debt service costs and subsidies due in the 1999 fiscal year, and a
proposed discretionary transfer in the 1999 fiscal year of $465 million to pay
debt service due in fiscal year 2000. In addition, the Financial Plan reflects
enacted and proposed tax reduction programs totaling $975 million, $1.172
billion and $1.259 billion in fiscal years 2000 through 2002, respectively,
including the elimination of the City sales tax on all clothing as of December
1, 1999, the expiration of the 12.5% personal income tax surcharge on December
31, 1998, the extension of current tax reductions for owners of cooperative and
condominium apartments starting in fiscal year 2000 and a personal income tax
credit for child care and for resident holders of Subchapter S corporations
starting in fiscal year 2000, which are subject to State legislative approval,
and reduction of the commercial rent tax commencing in fiscal year 2000.
The Financial Plan assumes (i) approval by the Governor and the State
Legislature of the extension of the 14% personal income tax surcharge, which is
scheduled to expire on December 31, 1999, and which is projected to provide
revenue of $172 million, $500 million and $514 million in the 2000, 2001 and
2002 fiscal years, respectively, and the expiration of the 12.5% personal income
tax surcharge on December 31, 1998, the expiration of which is projected to
reduce revenue by $201 million, $546 million, $568 million and $593 million in
the 1999 through 2002 fiscal years, respectively; (ii) collection of the
projected rent payments for the City's airports, totaling $15 million, $365
million, $155 million and $185 million in the 1999 through 2002 fiscal years,
respectively, which may depend on the successful completion of negotiations with
The Port Authority of New York and New Jersey (the "Port Authority") or the
enforcement of the City's rights under the existing leases through pending legal
actions; and (iii) State and Federal approval of the State and Federal
gap-closing actions assumed in the Financial Plan. The Financial Plan provides
no additional wage increases for City employees after their contracts expire in
fiscal years 2000 and 2001. In addition, the economic and financial condition of
the City may be affected by various financial, social, economic and political
factors which could have a material effect on the City.
On June 5, 1998, the City Council adopted a budget which re-allocated
expenditures from those provided in the Executive Budget in the amount of $409
million. The re-allocated expenditures, which include $116 million from the
Budget Stabilization Account, $82 million from debt service, $45 million from
pension contributions, $54 million from social services spending and $112
million from other spending, were re-allocated to uses set forth in the City
Council's adopted budget. Such uses include a revised tax reduction program at a
revenue cost in the 1999 fiscal year of $45 million, additional expenditures for
various programs of $199 million and provision of $165 million to retire high
interest debt. The revised tax reduction program in the City Council's adopted
budget assumes the expiration of the 12.5% personal income tax surcharge, rather
than the implementation of the personal income tax reduction program proposed in
the Executive Budget.
On June 5, 1998, in accordance with the City Charter, the Mayor certified
to the City Council revised estimates of the City's revenues (other than
property tax) for fiscal year 1999. Consistent with this certification, the
property tax levy was estimated by the Mayor to require an increase to realize
sufficient revenue from this source to produce a balanced budget within
generally accepted accounting principles. On June 8, 1998, the City Council
adopted a property tax levy that was $237.7 million lower than the levy
estimated to be required by the Mayor. The City Council, however, maintained
that the revenue to be derived from the levy it adopted would be sufficient to
achieve a balanced budget because the property tax reserve for uncollectibles
could be reduced. Property tax bills for fiscal year 1999 were mailed by the
City's Department of Finance at the rates adopted by the City Council for fiscal
year 1998, subject to later adjustment. The City Charter provides for this
procedure in the event, as is the case this year, that budget adoption has not
been completed by June 5.
C-25
On June 10, 1998, the Mayor vetoed $196 million of spending added in the
expense budget adopted by the City Council and $315 million added in the capital
budget adopted by the City Council. On June 16, 1998, the City Council voted to
override the Mayor's vetoes. For a description of the respective roles of the
Mayor and the City Council in the budget adoption process, see "Section III:
Government and Financial Controls--City Financial Management, Budgeting and
Controls."
COLLECTIVE BARGAINING AGREEMENTS. The Financial Plan reflects the costs of
the settlements and arbitration awards with the United Federation of Teachers
("UFT"), a coalition of unions headed by District Council 37 of the American
Federation of State, County and Municipal Employees ("District Council 37") and
other bargaining units, which together represent approximately 97% of the City's
workforce, and assumes that the City will reach agreement with its remaining
municipal unions under terms which are generally consistent with such
settlements and arbitration awards. These contracts are approximately five years
in length and have a total cumulative net increase of 13%. Assuming the City
reaches similar settlements with its remaining municipal unions, the cost of all
settlements for all City-funded employees, as reflected in the Financial Plan,
would total $459 million and $1.2 billion in the 1998 and 1999 fiscal years,
respectively, and exceed $2 billion in every fiscal year after the 1999 fiscal
year. See "Section VII: 1999-2002 Financial Plan--Assumptions--Expenditure
Assumptions--1. Personal Service Costs". The Financial Plan provides no
additional wage increases for City employees after their contracts expire in
fiscal years 2000 and 2001.
ASSUMPTIONS. The Financial Plan assumes (i) approval by the Governor and
the State Legislature of the extension of the 14% personal income tax surcharge,
which is scheduled to expire on December 31, 1999 and the extension of which is
projected to provide revenue of $168 million, $507 million, and $530 million in
the 2000, 2001, and 2002 fiscal years, respectively, and of the extension of the
12.5% personal income tax surcharge, which is scheduled to expire on December
31, 1998 the extension of which is projected to provide revenue of $187 million,
$531 million and $554 million, and $579 million in the 1999 through 2002 fiscal
years, respectively; (ii) collection of the projected rent payments for the
City's airports, totaling $365 million, $175 million, $170 million, and $70
million in the 1999 through 2002 fiscal years, respectively, which may depend on
the successful completion of negotiations with the Port Authority or the
enforcement of the City's rights under the existing leases through pending legal
actions; and (iii) State approval of the repeal of the Wicks law relating to
contracting requirements for City construction projects and the additional State
funding assumed in the Financial Plan, and State and Federal approval of the
State and Federal gap-closing actions proposed by the City in the Financial
Plan. It is expected that the Financial Plan will engender public debate which
will continue through the time the budget is scheduled to be adopted in June
1998, and that there will be alternative proposals to reduce taxes (including
the 12.5% personal income tax surcharge) and increase in spending. Accordingly,
the Financial Plan may be changed by the time the budget for the 1999 fiscal
year is adopted. Moreover, the Financial Plan provides no additional wage
increases for City employees after their contracts expire in fiscal years 2000
and 2001. In addition, the economic and financial condition of the City may be
affected by various financial, social, economic and political factors which
could have a material effect on the City.
The City's Financial Plan is based on numerous additional assumptions,
including the condition of the City's and the region's economy and a modest
employment recovery and the concomitant receipt of economically sensitive tax
revenues in the amounts projected. The Financial Plan is subject to various
other uncertainties and contingencies relating to, among other factors, the
extent, if any, to which wage increases for City employees exceed the annual
wage costs assumed for the 1998 through 2002 fiscal years; continuation of
projected interest earnings assumptions for pension fund assets and current
assumptions with respect to wages for City employees affecting the City's
required pension fund contributions; the willingness and ability of the State,
in the context of the State's current financial condition, to provide the aid
contemplated by the City Financial Plan and to take various other actions to
assist the City; the ability of HHC, BOE and other such agencies to maintain
balanced budgets; the willingness of the Federal government to provide the
amount of Federal aid contemplated in the City Financial Plan; the impact on the
City revenues and expenditures of Federal and State welfare reform and any
future legislation affecting Mepdicare or other
C-26
entitlement programs; adoption of the City's budgets by the City Council in
substantially the forms submitted by the Mayor; the ability of the City to
implement proposed reductions in City personnel and other cost reduction
initiatives, and the success with which the City controls expenditures; the
impact of conditions in the real estate market on real estate tax revenues; the
City's ability to market its securities successfully in the public credit
markets; and unanticipated expenditures that may be incurred as a result of the
need to maintain the City's infrastructure. Certain of these assumptions have
been questioned by the City Comptroller and other public officials.
The Governor presented his 1998-1999 Executive Budget to the Legislature
on January 20, 1998. In recent years, however, the State has failed to adopt a
budget prior to the beginning of the fiscal year. A prolonged delay in the
adoption of the State's budget beyond the statutory April 1 deadline without
interim appropriations could delay the projected receipt of State aid, and there
can be no assurance that State budgets in future fiscal years will be adopted by
the April 1 statutory deadline.
CITY EMPLOYEES. Substantially all of the City's full-time employees are
members of labor unions. The Financial Emergency Act requires that all
collective bargaining agreements entered into by the City and the Covered
Organizations be consistent with the City's current financial plan, except for
certain awards arrived at through impasse procedures. During a Control Period,
and subject to the foregoing exception, the Control Board would be required to
disapprove collective bargaining agreements that are inconsistent with the
City's current financial plan.
Under applicable law, the City may not make unilateral changes in wages,
hours or working conditions under any of the following circumstances: (i) during
the period of negotiations between the City and a union representing municipal
employees concerning a collective bargaining agreement; (ii) if an impasse panel
is appointed, then during the period commencing on the date on which such panel
is appointed and ending sixty days thereafter or thirty days after it submits
its report, whichever is sooner, subject to extension under certain
circumstances to permit completion of panel proceedings; or (iii) during the
pendency of an appeal to the Board of Collective Bargaining. Although State law
prohibits strikes by municipal employees, strikes and work stoppages by
employees of the City and the Covered Organizations have occurred.
The 1998-2002 Financial Plan projects that the authorized number of
City-funded employees whose salaries are paid directly from City funds, as
opposed to federal or State funds or water and sewer funds, will decrease from
an estimated level of 204,685 on June 30, 1998 to an estimated level of 203,987
by June 30, 2002, before implementation of the gap closing program outlined in
the City Financial Plan.
Contracts with all of the City's municipal unions expired in the 1995 and
1996 fiscal years. The City has reached settlements with unions representing
approximately 86% of the City's work force. The City Financial Plan reflects the
costs of the settlements and assumes similar increases for all other City-funded
employees. The terms of wage settlements could be determined through the impasse
procedure in the New York City Collective Bargaining Law, which can impose a
binding settlement.
The City's pension expenditures for the 1998 fiscal year are expected to
approximate $1.5 billion. In each of fiscal years 1999 through 2002, these
expenditures are expected to approximate $1.4 billion, $1.4 billion, $1.4
billion, and $1.3 billion, respectively. Certain of the systems may provide
pension benefits of 50% to 55% of "final pay" after 20 to 25 years of service
without additional benefits for subsequent years of service. For the 1997 fiscal
year, the City's total annual pension costs, including the City's pension costs
not associated with the five major actuarial systems, plus Federal Social
Security tax payments by the City for the year, were approximately 19.04% of
total payroll costs. In addition, contributions are also made by certain
component units of the City and government units directly to the three cost
sharing multiple employer actuarial systems. The State Constitution provides
that pension rights of public employees are contractual and shall not be
diminished or impaired.
C-27
REPORTS ON THE CITY FINANCIAL PLAN. From time to time, the Control Board
staff, MAC, OSDC, the City Comptroller and others issue reports and make public
statements regarding the City's financial condition, commenting on, among other
matters, the City's financial plans, projected revenues and expenditures and
actions by the City to eliminate projected operating deficits. Some of these
reports and statements have warned that the City may have underestimated certain
expenditures and overestimated certain revenues and have suggested that the City
may not have adequately provided for future contingencies. Certain of these
reports have analyzed the City's future economic and social conditions and have
questioned whether the City has the capacity to generate sufficient revenues in
the future to meet the costs of its expenditure increases and to provide
necessary services. It is reasonable to expect that reports and statements will
continue to be issued and to engender public comment, and it is expected that
the staff of the Control Board will issue a report on the 1998-2002 Financial
Plan in the near future.
On February 26, 1998, the City Comptroller issued a report on the 1998
fiscal year and the preliminary budget for the 1999 fiscal year, as reflected in
the 1997-2001 Financial Plan. With respect to the 1998 fiscal year, the report
identified a possible surplus of between $71 million and $293 million above the
level projected in the City's plan. The report stated that the additional
surplus reflects the possibility of the receipt of an additional $225 million of
tax revenues, and that the size of the possible surplus depends primarily on
whether the sale of the New York Coliseum for $200 million is completed. With
respect to the 1999 fiscal year, the report identified a possible gap of $153
million or a possible surplus of $269 million, depending upon whether the State
approves the extension of 12.5% personal income tax surcharge and the amount of
surplus for the 1998 fiscal year available for debt service in the 1999 fiscal
year.
The potential risks identified in the City Comptroller's report for the
1999 fiscal year include: (i) assumed payments from the Port Authority relating
to the City's claims for back rentals and an increase in future rentals, part of
which are the subject of the arbitration, totaling $335 million; (ii) State
approval of the 12.5% personal income tax surcharge beyond December 1, 1998,
which would generate $188 million in the 1999 fiscal year and which the Speaker
of the City Counsel has opposed; and (iii) the receipt of an additional $450
million of State and Federal aid assumed in the financial plan. The potential
risks are offset by potential additional resources for the 1999 fiscal year,
including the potential for an additional $150 million of State educational aid,
$150 million of additional debt service savings, $176 million in tax revenues if
the proposed sales tax reduction on clothing is not approved, $294 million of
higher than projected tax revenues and the availability in the 1999 fiscal year
of an additional $71 million to $293 million surplus from the 1998 fiscal year.
The report also noted that the City Comptroller will begin writing off
outstanding education-aid receivables that are 10 years past due, which are
estimated to be approximately $4 million in the 1998 fiscal year and $39 million
in the 1999 fiscal year, and which total $914 million for fiscal years 1989
through 1997. In addition, the report noted that City-funded expenditures for
the 1998 fiscal year are expected to exceed the ceiling established in the May
1996 agreement between the City and MAC, which would permit MAC to recover from
the City in the 1999 fiscal year an amount equal to such excess spending, up to
$125 million. Finally, the report noted that, while the City is in a relatively
strong financial position, its reliance on State and Federal aid to close its
budget gap for the 1999 fiscal year raises concerns, and that the City's
spending will again be under pressure in the event of an economic downturn. The
City Comptroller also noted (in a separate report on the City's capital debt)
that debt burden measures, such as annual debt service as a percentage of tax
revenues, debt per capita, and debt assessed value of real property, are
approaching historically high post-fiscal crises levels, which calls for
restraint in the City's capital program, while the City's infrastructure
requires additional resources.
Also on February 26, 1998, the staff of OSDC issued a report on the
Financial Plan. With respect to the 1998 fiscal year, the OSCD report noted that
the City's revenues could be $200 million greater than projected in the
Financial Plan. While noting a potential delay in the receipt of proceeds from
the sale of the New York Coliseum, the report projects that it is not likely
that those resources will be needed in the 1998 fiscal year. The report
projected potential budget gaps of $462 million, $2.6 billion, $2.7 billion, and
$2.3 billion for the 1999 through 2002 fiscal years, respectively, which include
the gaps projected in the Financial
C-28
Plan for fiscal years 2000 through 2002 and the additional net risks identified
in the report totaling $762 million, $1.012 billion, $913 million, and $774
million for the 1999 through 2002 fiscal years, respectively, which are reduced
by the potential for greater than forecast revenues and lower than forecast
pension costs for fiscal years 2000 through 2002. The largest risks identified
in the report relate to (i) the receipt of projected Port Authority lease
payments which are the subject of arbitration and lease negotiations; (ii) City
gap-closing proposals for additional State and Federal assistance; and (iii)
State approval of a three-year extension of the City's 12.5% personal income tax
surcharge. Additional risks identified in the report include unfunded
expenditures for project READ totaling $125 million for each of the 2000 through
2002 fiscal years and the potential for additional funding needs for the City's
labor reserve, which total $104 million in the 1999 fiscal year and exceed $200
million in each of the 2000 through 2002 years, to pay for collective bargaining
increases for the Covered Organizations, which the Plan assumes the Covered
Organizations will pay instead of the City. The report noted that these risks
could be reduced if the Tax Reduction Program proposed in the Financial Plan is
not approved by the City Counsel and the State. The report also noted that: (i)
HHC faces potential budget gaps starting in the 1999 fiscal year and reflecting
the expected loss of revenues associated with the implementation of Medicaid
mandatory managed care; (ii) the Financial Plan assumes that the State will
extend the 14% personal income tax surcharge; (iii) the City faces potential
liability for State education aid owed from prior years which the City could be
required to write off if a plan is not reached to fund these claims; and (iv)
the City might be required to reimburse MAC up to $125 million on the 1999
fiscal year if the City spending limits set forth in the May 1996 agreement with
MAC are exceeded in the 1998 fiscal year. However, the report noted that actual
fiscal year 1998 spending will not be determined until October 1998, and in the
interim, City and MAC officials are discussing solutions to the reimbursement
problem.
The OSDC report noted also that, while the City's financial outlook has
improved because of actions taken by the City, Federal, and State governments
and record securities industry performance, the staff remained concerned about
the City's dependence on the securities industry and whether the City will be
able to sustain a relatively high level of spending. The report noted that
City-funded spending is projected to grow by 7.2% in fiscal year 1998 and by
4.5% in fiscal year 1999, while revenues are projected to grow by only 1.8% in
fiscal year 1999. Moreover, the report noted that while the budget gaps for
fiscal years 2000 through 2002 have been reduced, they are still large by
historical standards, and the budget makes no provisions for wage increases
after the expiration of current contacts, which, at the projected inflation
rate, would increase costs by $375 million in fiscal year 2001 and by $725
million in fiscal year 2002. Finally, the report noted that the Asian financial
and economic crises could intensify and create greater impact on financial
markets in the U.S. economy than currently anticipated, or that the Federal
Reserve Board could raise interest rates, which could adversely affect the
financial markets and the City's financial condition.
On January 13, 1998, the IBO released a report setting forth its forecast
for the City's revenues and expenditures for the 1998 through 2001 fiscal years,
assuming continuation of current spending policies and tax laws. In the report,
the IBO forecasts that the City will end the 1998 fiscal year with a surplus of
$120 million, in addition to $514 million in the Budget Stabilization Account.
Additionally, the report forecasts that the City will face gaps of $1.4 billion,
$2.6 billion, and $2.8 billion in the 1999 through 2001 fiscal years,
respectively, resulting from 4.8% annual growth in spending form 1998 through
2001, compared with 2.2% annual revenue growth. The report noted that slow
revenue growth is attributable to a variety of factors, including a gradual
deceleration in economic growth through the first half of calendar year 1999,
the impact of recently enacted tax cuts and constraints on increases in the real
property tax, as well as uncertain back rent payments from the Port Authority,
while future costs for existing programs will increase to reflect inflation and
scheduled pay increases for the City employees during the term of existing labor
agreements. The report also noted that debt service and education spending will
increase rapidly, while spending for social services rise more slowly due to
lower projected caseloads.
Finally, the report noted that the new welfare law's most significant
fiscal impact is likely to occur in the years 2002 and beyond, reflecting the
full impact of the lifetime limit on welfare participation which only begins to
be felt in 2002 when the first recipients reach the five-year limit and are
assumed to be covered
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by Home Relief. In addition, the report noted that, given the constitutional
requirement to care for the needy, the 1996 Welfare Act might well prompt a
migration of benefit-seekers into the City, thereby increasing City welfare
expenditures in the long run. The report concluded that the impact of the 1996
Welfare Act on the City will ultimately depend on the decisions of State and
City officials, the performance of the local economy and the behavior of
thousands of individuals in response to the new system.
PREVIOUS REPORTS. On September 18, 1997, the City Comptroller issued a
report commenting on developments with respect to the 1998 fiscal year. The
report noted that the City's adopted budget, which is reflected in the City
Financial Plan, had assumed additional State resources of $612 million in the
1998 fiscal year, and that the approved State budget provided resources of only
$216 million for gap-closing purposes. The report further noted that, while the
City will receive $322 million more in education aid in the 1998 fiscal year
than assumed in the City's adopted budget, it is unlikely that the funding will
be entirely available for gap-closing purposes. In addition, the report noted
that the City's financial statements currently contain approximately $643
million in uncollected State education aid receivables from prior years as a
result of the failure of the State to appropriate funds to pay these claims, and
that the staff of BOE has indicated that an additional $302 million in prior
year claims is available for accrual. The report stated that the City
Comptroller maintains the position that no further accrual of prior year aid
will take place, including $75 million in aid assumed in the City's adopted
budget for the 1998 fiscal year, unless the State makes significant progress to
retire the outstanding prior year receivables. On October 28, 1997, the City
Comptroller issued a subsequent report commenting on recent developments. With
respect to the 1997 fiscal year, the report noted that the City ended the 1997
fiscal year with an operating surplus of $1.367 billion, before certain
expenditures and discretionary transfers, of which $1.362 billion was used for
expenditures due in the 1998 fiscal year. With respect to tax revenues for the
1998 fiscal year, the report noted that total tax revenues in the first quarter
of the 1998 fiscal year were $244.3 million above projections in the City
Financial Plan, excluding audit collections which were $31.2 million less than
projected. The report stated that the increased tax revenues included $110.3
million of greater than projected general property tax receipts, which resulted,
in part, from a prepayment discount program, and increased revenues from the
personal income, banking corporation, general corporation and unincorporated
business taxes. The report noted that Wall Street profits exceeded expectations
in the first half of the 1997 calendar year. However, the report noted that the
stock market in the last two weeks of October has declined as a result of
currency turmoil in Southeast Asia. The report noted that, while tax revenues in
the 1998 fiscal year should not be significantly affected by the recent stock
market decline, since there is a lag between activity on Wall Street and City
tax revenues, if the current stock market decline persists, tax revenue
forecasts for subsequent years will have to be revised downward. The report
noted that the City was not affected by the October 1987 stock market crash
until the 1990 fiscal year, when revenues from the City's business and real
estate taxes fell by 20% over the 1989 fiscal year. The report also noted that
expenditures for short-term and long-term debt issued during the first half of
the 1998 fiscal year are estimated to be between approximately $53.9 million and
$58.8 million below levels anticipated in the City's adopted budget for the 1998
fiscal year, approximately $20 million below anticipated levels in the 1999
fiscal year and approximately $30 million below anticipated levels in each of
fiscal years 2000 and 2001 due to less borrowing and lower interest rates than
assumed.
On August 25, 1997, the IBO issued a report relating to recent
developments regarding welfare reform. The report noted that Federal legislation
adopted in August 1997, modified certain aspects of the 1996 Welfare Act, by
reducing SSI eligibility restrictions for certain legal aliens residing in the
country as of August 22, 1996, resulting in the continuation of Federal
benefits, by providing funding to the states to move welfare recipients from
public assistance and into jobs and by providing continued Medicaid Coverage for
those children who lose SSI due to stricter eligibility criteria. In addition,
the report noted that the State had enacted the Welfare Reform Act of 1997
which, among other things, requires the City to achieve work quotas and other
work requirements and requires all able-bodied recipients to work after
receiving assistance for two years. The report noted that this provision could
require the City to spend substantial funds over the next several years for
workfare and day care in addition to the funding reflected in the City Financial
Plan. The report also noted that the State Welfare Reform Act of 1997
established a Food Assistance Program
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designed to replace Federal food stamp benefits for certain classes of legal
aliens denied eligibility for such benefits by the 1996 Welfare Act. The report
noted that if the City elects to participate in the Food Assistance Program, it
will be responsible for 50% of the costs for the elderly and disabled. The IBO
has stated that it will release an updated report to provide a detailed analysis
of these developments and their likely impact on the City.
On July 16, 1997, the City Comptroller issued a report on the City
Financial Plan. With respect to the 1998 fiscal year, the report identified a
possible $112 million surplus or a possible total net budget gap of up to $440
million, depending primarily on whether the tax reduction program proposed in
the City Financial Plan is implemented and the 14% personal income tax surcharge
is extended beyond December 31, 1997. The risks identified in the report for the
1998 fiscal year include (i) $178 million related to BOE, resulting primarily
from unidentified expenditure reductions and prior year State aid receivables;
(ii) State aid totaling $115 million which is assumed in the City Financial Plan
but not provided for in the Governor's Executive Budget; (iii) State approval of
the extension of the 14% personal income tax surcharge beyond December 31, 1997,
which would generate $169 million in the 1998 fiscal year; (iv) City proposals
for State aid totaling $271 million, including the acceleration of $142 million
of State revenue sharing payments from the 1999 fiscal year to the 1998 fiscal
year, which are subject to approval by the Governor and/or the State
Legislature; and (v) the assumed sale of the Coliseum for $200 million, which
may be delayed. The report noted that these risks could be partially offset by
between $597 million and $765 million in potentially available resources,
including $200 million of higher projected tax revenues, $150 million of
possible additional State education aid and the possibility that the proposed
sales tax reduction will not be enacted, which would result in $157 million of
additional tax revenues in the 1998 fiscal year. With respect to the 1998 fiscal
year, the report stated that the City has budgeted $200 million in the General
Reserve and included in the City Financial Plan a $300 million surplus to be
used in the 1999 fiscal year, making the potential $440 million budget gap
manageable. However, the report also expressed concern as to the sustainability
of profits in the securities industry.
With respect to the 1999 and subsequent fiscal years, the report
identified total net budget gaps of between $1.9 billion and $2.8 billion, $2.6
billion and $4.0 billion, and $2.4 billion and $3.8 billion for the 1999 through
2001 fiscal years, respectively, which include the gaps set forth in the City
Financial Plan. The potential risks and potential available resources identified
in the report for the 1999 through 2001 fiscal years include most of the risks
and resources identified for the 1998 fiscal year, except that the additional
risks for the 1999 through 2001 fiscal years include (i) assumed payments from
the Port Authority relating to the City's claim for back rentals and an increase
in future rentals, part of which are the subject of arbitration, totaling $350
million, $140 million and $135 million in the 1999-2001 fiscal years,
respectively; and (ii) State approval of the extension of the 12.5% personal
income tax surcharge beyond December 31, 1998, which would generate $190
million, $527 million and $554 million in the 1999 through 2001 fiscal years,
respectively.
On July 15, 1997, the staff of the Control Board issued a report
commenting on the City Financial Plan. The report stated that, while the City
should end the 1998 fiscal year with its budget in balance, the City Financial
Plan still contains large gaps beginning in the 1999 fiscal year, reflecting
revenues which are not projected to grow during the Financial Plan Period and
expenditures which are projected to grow at about the rate of inflation. The
report identified net risks totaling $485 million, $930 million, $1.2 billion
and $1.4 billion for 1998 through 2001 fiscal years, respectively, in addition
to the gaps projected in the City Financial Plan for fiscal years 1999 through
2001. The principal risks identified in the report included (i) potential tax
revenues shortfalls totaling $150 million, $300 million and $400 million for the
1999 through 2001 fiscal years, respectively, based on historical average
trends; (ii) BOE's structural gap, uncertain State funding of BOE and
implementation by BOE of various unspecified actions, totaling $163 million,
$209 million, $218 million and $218 million in the 1998 through 2001 fiscal
years, respectively; (iii) the proposed sale of certain assets in the 1998
fiscal year totaling $248 million, which could be delayed; (iv) assumed
additional State actions totaling $271 million, $121 million, $125 million and
$129 million in the 1998 through 2001 fiscal years, respectively; (v) revenues
from the extension of the 12.5% personal income tax surcharge beyond December
31, 1998, totaling $188 million, $527 million and $554 million in the 1999
through 2001 fiscal years, respectively, which requires State legislation; and
(vi) the receipt of $350 million, $140 million and $135 million from the
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Port Authority in the 1999 through 2001 fiscal years, respectively, which is the
subject of arbitration. Taking into account the risks identified in the report
and the gaps projected in the City Financial Plan, the report projected a gap of
$485 million for the 1998 fiscal year, which could be offset by available
reserves, and gaps $2.7 billion, $4.1 billion and $4.0 billion for the 1999
through 2001 fiscal years, respectively. The report also noted that (i) if the
securities industry or economy slows down to a greater extent than projected,
the City could face sudden and unpredictable changes to its forecast; (ii) the
City's entitlement reduction assumptions require a decline of historic
proportions in the number of eligible welfare recipients; (iii) the City has not
yet shown how the City's projected debt service, which would consume 20% of tax
revenues by the 1999 fiscal year, can be accommodated on a recurring basis; (iv)
the City is deferring recommended capital maintenance; and (v) continuing growth
in enrollment at BOE has helped create projected gaps of over $100 million
annually at BOE. However, the report noted that if proposed tax reductions are
not approved, additional revenue will be realized, ranging from $272 million in
the 1998 fiscal year to $481 million in the 2001 fiscal year.
On July 2, 1997, the staff of the OSDC issued a report on the City
Financial Plan. The report projected a potential surplus for the 1998 fiscal
year of $190 million, due primarily to the potential for greater than forecast
tax revenues, and projected budget gaps for the 1999 through 2001 fiscal years
which are slightly less than the gaps set forth in the City Financial Plan for
such years. The report also identified risks of $518 million, $1.1 billion, $1.3
billion and $1.4 billion for the 1998 through 2001 fiscal years, respectively.
The additional risks identified in the report relate to: (i) the receipt of Port
Authority lease payments totaling $350 million, $140 million and $135 million in
the 1999 through 2001 fiscal years, respectively; (ii) City proposals for State
aid totaling $271 million, $121 million, $125 million and $129 million in the
1998 through 2001 fiscal years, respectively, including the acceleration of $142
million of State revenue sharing payments from the 1999 fiscal year to the 1998
fiscal year, which are subject to approval by the Governor and/or the State
Legislature; (iii) the receipt of $200 million in the 1998 fiscal year in
connection with the proposed sale of the New York Coliseum; (iv) the receipt of
$47 million in the 1998 fiscal year from the sale of certain other assets; (v)
uncertain State education aid and expenditure reductions relating to BOE
totaling $325 million in each of the 1999 through 2001 fiscal years; (vi) State
approval of a three-year extension to the City's 12.5% personal income tax
surcharge, which is scheduled to expire on December 31, 1998 and which would
generate revenues of $230 million, $525 million and $550 million in the 1999
through 2001 fiscal years, respectively; and (vii) the potential for additional
funding needs for the City's labor reserve totaling $104 million, $225 million
and $231 million in the 1999 through 2001 fiscal years, respectively, to pay for
collective bargaining increases for the Covered Organizations, which the City
Financial Plan assumes will be paid for by the Covered Organizations, rather
than the City. The report also noted that the City Financial Plan assumes that
the State will extend the 14% personal income tax that is scheduled to expire in
December 1997, which would generate revenues of $200 million in the 1998 fiscal
year and $500 million annually in subsequent fiscal years, and that the City
Financial Plan makes no provision for wage increases after the expiration of
current contracts in fiscal year 2000, which would add $430 million to the 2001
fiscal year budget gap if employees receive wage increases at the projected rate
of inflation. The report noted that the City Financial Plan includes an annual
General Reserve of $200 million and sets aside an additional $300 million in the
1998 fiscal year to reduce the budget gap for the 1999 fiscal year if such funds
are not needed in the 1998 fiscal year. With respect to the gap-closing program
for the 1999 through 2001 fiscal years, the report noted that the City has
broadly outlined a program that relies heavily on unspecified agency actions,
savings from reinvention and other unspecified initiatives and uncertain State
aid and entitlement program reductions which depend on the cooperation of
others.
The report concluded that while 1997 was an unexpectedly good fiscal year
for City revenues, the City projects that the rate of spending for the 1998
fiscal year will grow substantially faster than the rate of revenues, reflecting
increasing costs for labor, debt service, Medicaid and education, and that the
gaps for the subsequent fiscal years continue to present a daunting challenge.
With respect to the economy, the report noted that the major risks to the City's
economic and revenue forecasts continue to relate to the pace of both the
national economy and activity on Wall Street, that the potential exists for a
national recession over the next four years, and that Wall Street volatility can
have a negative effect, as was apparent in 1994 when the
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Federal Reserve repeatedly raised interest rates and the profits of securities
firms fell. Other concerns identified in the report include: (i) $76 million in
retroactive claims for State education aid included in the City Financial Plan
for the 1998 fiscal year which may not be realized; (ii) a potential risk of
$698 million in State education aid owed to the City by the State for prior
years, all or a portion of which the City could be forced to write-off if
further delays occur in the State agreeing to fund these claims; and (iii) the
potential adverse impact on HHC over the long-term of the planned expansion of
managed care which emphasizes out-patient services with fixed monthly fees,
uncertainty covering projected savings from a proposal that most Medicaid
recipients be required to enroll in managed care, which is subject to approval
by the Federal Government, and the possibility that the recent Federal budget
agreement could substantially reduce aid to hospitals which serve a large number
of medically indigent patients.
On May 27, 1997, the IBO released a report analyzing the financial plan
published on May 8, 1997 (the "May Financial Plan"). In its report, the IBO
estimated gaps of $27 million, $91 million, $2.1 billion, $2.9 billion and $2.9
billion for the 1997 through 2001 fiscal years, respectively, which include the
gaps set forth in the May Financial Plan for fiscal years 1999 through 2001. The
gaps estimated in the IBO report reflect (i) uncertainty concerning the size and
timing of projected airport rents of $270 million and $215 million in the 1998
and 1999 fiscal years, respectively, which are the subject of an ongoing dispute
between the Port Authority and the City; and (ii) additional funding needs for
the City's labor reserve totaling $104 million, $224 million and $231 million in
the 1999 through 2001 fiscal years, respectively, to pay for collective
bargaining increases for the Covered Organizations, which the May Financial Plan
assumes will be paid for by the Covered Organizations, rather than the City.
These reduced revenues and increased expenditures identified in the IBO report
are substantially offset by tax revenue forecasts which exceed those in the May
Financial Plan. However, the report noted that the May Financial Plan assumes
continued strong revenue growth and that, in the event of an economic downturn,
the City will be required to increase taxes in a slow economy or reduce spending
when it is most needed. With respect to the tax reductions proposed in the May
Financial Plan, the IBO stated that the principal question is whether the City
will be able to afford the tax reductions. In addition, the report discussed
various issues with implications for the City's 1998 budget. These issues
include the reliance in the budget on a number of State legislative actions,
including (i) $294 million from legislation the City has requested to increase
State aid; (ii) $128 million in savings attributable to both a larger City share
of Federal welfare grant funds and State reforms to Medicaid; and (iii) $115
million to restore expenditure reductions proposed in the Governor's Executive
Budget. The report also noted that the City's claim for $900 million of State
reimbursement of prior year education expenditures remains unresolved, that
proposals affecting the MTA, including proposals to eliminate two-fare zones for
bus and subway riders, will result in a significant reduction in revenues for
the MTA, and that the implementation of changes in the City's computer system,
resulting from the inability of the current computer system to recognize the
year 2000, could cost the City up to $150 million to $200 million over the next
three years. In a subsequent report released on June 16, 1997, the IBO noted
that in the City Financial Plan the City had deferred to fiscal years 1999
through 2001 the assumed receipt of back airport rents, and that the tax revenue
forecasts for the 1998 fiscal year in the City Financial Plan are closer than
the forecasts in the May Financial Plan to the IBO's forecast of City tax
revenues in its May report.
On October 31, 1996, the IBO released a report assessing the costs that
could be incurred by the City in response to the 1996 Welfare Act, which, among
other things, replaces the AFDC entitlement program with TANF, imposes a
five-year time limit on TANF assistance, requires 50% of states' TANF caseload
to be employed by 2002, and restricts assistance to legal aliens. The report
noted that if the requirement that all recipients work after two years of
receiving benefits is enforced, these additional costs could be substantial
starting in 1999, reflecting costs for worker training and supervision of new
workers and increased child care costs. The report further noted that, if
economic performance weakened, resulting in an increased number of public
assistance cases, potential costs to the City could substantially increase.
States are required to develop plans during 1997 to implement the new law. The
report noted that decisions to be made by the State which will have a
significant impact on the City budget include the allocation of block grant
funds between the State and New York local governments
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such as the City and the division between the State and its local governments of
welfare costs not funded by the Federal government.
SEASONAL FINANCING. The City since 1981 has fully satisfied its seasonal
financing needs in the public credit markets, repaying all short-term
obligations within their fiscal year of issuance. The City has issued $1.075
billion of short-term obligations for the fiscal year 1998 to finance the City's
projected cash flow needs for the 1998 fiscal year. The City issued $2.4 billion
of short-term obligations in fiscal year 1997. Seasonal financing requirements
for the 1996 fiscal year increased to $2.4 billion from $2.2 billion and $1.75
billion in the 1995 and 1994 fiscal years, respectively. Seasonal financing
requirements were $1.4 billion in the 1993 fiscal year. The delay in the
adoption of the State's budget in certain past fiscal years has required the
City to issue short-term notes in amounts exceeding those expected early in such
fiscal years.
LITIGATION. The City is a defendant in a significant number of lawsuits.
Such litigation includes, but is not limited to, actions commenced and claims
asserted against the City arising out of alleged constitutional violations,
alleged torts, alleged breaches of contracts and other violations of law and
condemnation proceedings. While the ultimate outcome and fiscal impact, if any,
on the proceedings and claims are not currently predictable, adverse
determinations in certain of them might have a material adverse effect upon the
City's ability to carry out the City Financial Plan. The City is a party to
numerous lawsuits and is the subject of numerous claims and investigations. The
City has estimated that its potential future liability on account of outstanding
claims against it as of June 30, 1997 amounted to approximately $3.5 billion.
This estimate was made by categorizing the various claims and applying a
statistical model, based primarily on actual settlements by type of claim during
the preceding ten fiscal years, and by supplementing the estimated liability
with information supplied by the City's Corporation Counsel.
RATINGS AGENCIES. On August 6, 1998, as well as July 2, June 8 and May 27,
Fitch rated New York City's tax-exempt general obligation bonds as "A-". Fitch
qualified that rating, stating that concerns still remained over significant
projected outyear budget funding challenges coupled with sizable reliance on the
securities industry. On July 2, 1998, Moody's revised its rating on the New York
City General Obligation Bonds to Aaa from Baa1.
On July 16, 1998, S&P increased New York City's bond rating to A-, up one
notch from BBB+, but analysts at the agency also cautioned that New York still
had room for improvement and that they were worried about the City's rising
long-term debt and the Council's plan to cut taxes by $200 million this year and
$500 million in future years. On July 7, 1998, S&P had assigned its
triple-B-plus rating to New York City general obligation bonds, stating that the
ratings had been placed on CreditWatch with positive implications.
On February 3, 1998, S&P raised its credit outlook for New York City's
outstanding general obligation bonds from stable to positive but maintained its
BBB-plus rating. The City has held this rating since July 10, 1995, when S&P
lowered its rating from A-to BBB+ and removed City bonds from CreditWatch. S&P
stated that "structural budgetary balance remains elusive because of persistent
softness in the City's economy, highlighted by weak job growth and a growing
dependence on the historically volatile financial services sector." Other
factors identified by S&P's in lowering its rating on City bonds included a
trend of using one-time measures, including debt refinancings, to close
projected budget gaps, dependence on unratified labor savings to help balance
the City Financial Plan, optimistic projections of additional federal and State
aid or mandate relief, a history of cash flow difficulties caused by State
budget delays and continued high debt levels. In 1975, S&P suspended its A
rating of City bonds. This suspension remained in effect until March 1981, at
which time the City received an investment grade rating of BBB from S&P. On July
2, 1985, S&P revised its rating of City bonds upward to BBB+ and on November 19,
1987, to A-. On July 10, 1995, S&P revised its rating of City bonds downward to
BBB+, as discussed above. On November 25, 1996, S&P issued a report which stated
that, if the City reached its debt limit without the ability to issue bonds
through other means, it would cause a deterioration in the City's infrastructure
and significant cutbacks in the capital plan which would eventually impact the
City's economy and revenues, and could have eventual negative credit
implications.
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On February 24, 1998 Moody's raised its rating for City general obligation
bonds from Baa1 to A3, based on improvement in its financial condition and
economy. Previously, on July 17, 1997, Moody's had changed its outlook on City
bonds to positive from stable. On March 1, 1996, Moody's stated that the rating
for the City's Baa1 general obligation bonds remains under review for a possible
downgrade pending the outcome of the adoption of the City's budget for the 1997
fiscal year and in light of the status of the debate on public assistance and
Medicaid reform; the enactment of a State budget, upon which major assumptions
regarding State aid are dependent, which may be extensively delayed; and the
seasoning of the City's economy with regard to its strength and direction in the
face of a potential national economic slowdown. Moody's ratings of City bonds
were revised in November 1981 from B (in effect since 1977) to Ba1, in November
1983 to Baa, in December 1985 to Baa1, in May 1988 to A and again in February
1991 to Baa1.
On February 3, 1998, Fitch Investors Service, Inc. ("Fitch") set its
rating of City general obligation bonds at A-, which it has maintained since
July 15, 1993. On February 28, 1996, Fitch placed the City's general obligation
bonds on FitchAlert with negative implications. On November 5, 1996, Fitch
removed the City's general obligation bonds from FitchAlert although Fitch
stated that the outlook remains negative. Since then Fitch has revised the
outlook to stable. There is no assurance that such ratings will continue for any
given period of time or that they will not be revised downward or withdrawn
entirely. Any such downward revision or withdrawal could have an adverse effect
on the market prices of the City's general obligation bonds.
On October 9, 1995, Standard & Poor's issued a report which concluded that
proposals to replace the graduated Federal income tax system with a "flat" tax
could be detrimental to the creditworthiness of certain municipal bonds. The
report noted that the elimination of Federal income tax deductions currently
available, including residential mortgage interest, property taxes and state and
local income taxes, could have a severe impact on funding methods under which
municipalities operate. With respect to property taxes, the report noted that
the total valuation of a municipality's tax base is affected by the
affordability of real estate and that elimination of mortgage interest deduction
would result in a significant reduction in affordability and, thus, in the
demand for, and the valuation of, real estate. The report noted that rapid
losses in property valuations would be felt by many municipalities, hurting
their revenue raising abilities. In addition, the report noted that the loss of
the current deduction for real property and state and local income taxes from
Federal income tax liability would make rate increases more difficult and
increase pressures to lower existing rates, and that the cost of borrowing for
municipalities could increase if the tax-exempt status of municipal bond
interest is worth less to investors. Finally, the report noted that tax
anticipation notes issued in anticipation of property taxes could be hurt by the
imposition of a flat tax, if uncertainty is introduced with regard to their
repayment revenues, until property values fully reflect the loss of mortgage and
property tax deductions.
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