UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM N-CSR CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES Investment Company Act file number: 811-02319 --------------------------------------------- FORT DEARBORN INCOME SECURITIES, INC. ------------------------------------------------------------------------------ (Exact name of registrant as specified in charter) One North Wacker Drive, Chicago, Illinois 60606 ------------------------------------------------------------------------------ (Address of principal executive offices) (Zip code) Amy R. Doberman UBS Global Asset Management (Americas) Inc. 51 West 52nd Street New York, NY 10019-6114 (Name and address of agent for service) Copy to: M. Finley Maxson, Esq. Winston & Strawn 35 West Wacker Drive Chicago, Illinois 60606 Registrant's telephone number, including area code: 312-525 7877 Date of fiscal year end: September 30, 2003 Date of reporting period: September 30, 2003 Item 1. Reports to Stockholders. - -------------------------------- November 15, 2003 Dear Shareholder, We present you with the annual report for Fort Dearborn Income Securities, Inc. (the "Fund") for the fiscal year ended September 30, 2003. An Interview with the Portfolio Manager Q. Can you describe the economic environment during the reporting period? A. As the reporting period began in October 2002, there was a great deal of uncertainty surrounding the economy. Fourth quarter 2002 and first quarter 2003 gross domestic product (GDP) growth was a tepid 1.4%. While consumer spending was resilient leading up to the start of the war in Iraq, corporations postponed major purchases as they waited for clearer signs of a sustainable economic upturn. Although the conclusion of major combat in Iraq stimulated the equity markets, its impact on the economy was initially unclear. Despite some indications that the economy was turning a corner; heightened concerns about terrorism, widening turmoil in the Middle East and continued lackluster corporate spending all served to undermine the economy. The following quarter produced more positive news. The combined effects of significantly higher military spending, an increase in exports, and a stronger manufacturing sector fueled an uptick in economic growth that resulted in a second quarter 2003 GDP figure of 3.3%. This was followed by a preliminary third quarter 2003 GDP estimate of 7.2%--far higher than anticipated, and the sharpest recorded advance since 1984. Consumer and business spending provided significant impetus behind this figure; consumer spending rose 6.6%, its highest rate since 1988, while business spending surged to 11.1%, its best posting since the first quarter of 2000. Q. How did the Federal Reserve Board (the "Fed") react in this economic environment? A. The Fed was on hold early in the reporting period, as it waited for more definitive signs regarding the economy's direction. However, by November 2002, it became apparent that the interest rate cuts up to that point had not spurred meaningful growth. Thus, the Fed lowered interest rates by another 50 basis points to 1.25%--a four-decade low. (A basis point is 1/100th of a percent.) Given consumers' and businesses' preoccupation with the situation in Iraq, the economic picture remained murky during the early months of 2003. Fed Chairman Alan Greenspan, in a statement at that time, expressed concerns about deflation. It came as no surprise, then, when, in June 2003, the Fed moved to cut rates an additional 25 basis points to 1.00%--the lowest level since 1958. Since that time, the Fed has remained on hold, although it has made clear its willingness to cut rates further if necessary. At its September 16, 2003 meeting, the Fed rationalized this position, noting, "an accommodative stance on monetary policy, coupled with robust underlying growth in productivity, is providing important ongoing support to economic activity." Q. How did the overall fixed income markets perform during the fiscal year? A. The fixed income markets were extremely volatile during the reporting period. Initially, interest rates fell and bond prices rose as geopolitical concerns and the weak stock market caused investors to flock to the relative safety offered by fixed income securities. 1 In the days leading up to the war and during its initial phases, bond prices generally fell. Based on reports surrounding the progress of the war, investors believed that it would be short-lived and would result in an increase in economic activity. However, following the end of major conflict in Iraq and the absence of a post-war economic bounce, bond prices rallied. The riskier segments of the bond market generated the best returns, as investors searched for incremental yields in the low interest rate environment. Toward the end of the fiscal year, the bond market experienced unprecedented fluctuations. Fed-driven concerns about deflation dominated the market and drove the yield on the 10-year Treasury to a 45-year low of 3.1%. This gave way, however, to a market that began pricing in stronger economic growth prospects for the second half of the year. A selloff ensued, and the yield on the 10-year Treasury surged to 4.60% in a span of 10 weeks, reaching a 14-month high. By period end, this figure fell back to 3.93%, as continued high unemployment eased fears that the Fed would raise rates at its September meeting. Indeed, the Fed did leave rates on hold at that time, citing labor statistics as a significant reason behind its decision to do so. Further, it reiterated its commitment to maintaining low rates. Q. How did you position the Fund's portfolio during the period? A. For much of the reporting period, the Fund's duration was shorter than that of its benchmark, the Investment Grade Bond Index (the "benchmark").* This stance led to mixed results--hurting performance when interest rates declined, helping performance when interest rates rose. Toward the end of the period, we opportunistically increased the Fund's duration to a neutral position, since we believed rates had risen too far, too fast. This benefited results when rates subsequently declined at the end of the reporting period. From a sector standpoint, corporate credit was the best performing segment of the investment grade market. Throughout the period, our long-standing process of utilizing bottom-up credit analysis in this market helped us to identify compelling opportunities that generated positive absolute returns. However, our underweight in credit compared to the benchmark hurt relative results. The Fund also maintained an overweight position in asset-backed and commercial mortgage-backed securities over the period. These sectors underperformed the credit markets, detracting from results. Q. What is your outlook for the economy and how do you anticipate positioning the Fund going forward? A. We are fairly positive regarding the growth prospects for the economy. Consumer spending is solid, the manufacturing sector appears to be gaining momentum, the housing market remains strong, tax cuts are starting to work their way through the system, and the Fed should remain accommodative. One major issue we're following very closely is the job market. Even though the economy appears to be picking up steam, it has not yet triggered an increase in job growth. With approximately 70% of the economy driven by the consumer, continued high unemployment could hurt consumer confidence and temper economic expansion. In terms of the Fund's portfolio, its duration is now in line with the benchmark. To the extent possible, we have added long duration and short duration bonds, as we believe this will be beneficial if the yield curve flattens from its current steep slope. We continue to be underweight investment grade credit, as we feel spreads are too tight relative to their risk. - ------------ *Index composition, 12/31/81 to present: 5% Lehman U.S. Agency Index, 75% Lehman U.S. Credit Index, 10% Lehman U.S. Mortgage Fixed Rate MBS Index, 10% Lehman U.S. Treasury Index. 2 Performance Summary Net investment income for the 12 months was $0.83 per share and net realized and unrealized gains on investments totaled $0.81 per share. On September 30, 2003, the net asset value per share was $16.46 and the stock closed that day at $14.70 per share. During the period, the Board of Directors declared regular quarterly dividends of $0.23 per share, $0.22 per share, $0.20 per share and $0.20 per share payable on December 13, 2002, March 26, 2003, June 13, 2003 and September 12, 2003, respectively. In addition to regular dividends, the Board declared a capital gains distribution of $0.04 per share payable on December 13, 2002. At the end of the period, the 160 issues in the portfolio had an average market yield of 5.02%, an average Moody's quality rating of A1, an average duration of 8.3 years, and an average maturity of 14.9 years. The distribution of the portfolio's expected maturities and quality was as follows: Maturities Quality - -------------------------------- -------------------------------------- 0-1 year 1.0% Treasury, Agency and Aaa 36.6% 1-3 years 3.7 Aa 1.8 3-5 years 1.9 A 28.7 5-10 years 53.6 Baa 30.8 10-20 years 11.3 Below Baa 2.1 20 plus years 28.5 ----- ----- 100.0% 100.0% Our ultimate objective in managing your investments is to help you successfully meet your financial goals. We thank you for your continued support and welcome any comments or questions you may have. Sincerely, Sincerely, /s/ Joseph A. Varnas /s/ Craig G. Ellinger Joseph A. Varnas Craig G. Ellinger President Portfolio Manager This letter is intended to assist shareholders in understanding how the Fund performed during the fiscal year ended September 30, 2003, and reflects our views at the time of its writing. Of course, these views may change in response to changing circumstances, and they do not guarantee the future performance of the markets or the Fund. We encourage you to consult your financial advisor regarding your personal investment program. 3 Fort Dearborn Income Securities, Inc. Performance At A Glance Average Annual Return, Periods Ended 9/30/03 Net Asset Value Returns 6 months 1 year 5 years 10 years - ------------------------------------------------------------------------------------------ Fort Dearborn Income Securities, Inc. 5.04% 10.63% 6.87% 7.32% - ------------------------------------------------------------------------------------------ Investment Grade Bond Index 4.82% 10.71% 7.22% 7.63% - ------------------------------------------------------------------------------------------ Market Price Returns - ------------------------------------------------------------------------------------------ Fort Dearborn Income Securities, Inc. 0.61% 3.21% 6.40% 6.80% - ------------------------------------------------------------------------------------------ Investment Grade Bond Index 4.82% 10.71% 7.22% 7.63% - ------------------------------------------------------------------------------------------ Past performance does not predict future performance. The return and principal value of an investment will fluctuate, so that an investor's shares, when sold, may be worth more or less than their original cost. NAV return assumes, for illustration only, that dividends were reinvested at the net asset value on the ex-dividend dates. Market price return assumes dividends were reinvested under the Dividend Reinvestment Plan. NAV and market price returns for periods of less than one year are cumulative. Returns do not include brokerage commissions or taxes paid on realized capital gains. Index composition, 12/31/81 - present: 5% Lehman US Agency Index; 75% Lehman US Credit Index; 10% Lehman US Mortgage Fixed Rate MBS Index; 10% Lehman US Treasury Index. Market Price, Dividend and Yields as of 9/30/03 - ------------------------------------------------------------------------------------------ Market Price $14.70 - ------------------------------------------------------------------------------------------ Net Asset Value (per share applicable to common shareholders) $16.46 - ------------------------------------------------------------------------------------------ 12-Month Net Investment Income Dividend (ended 9/30/03) $0.850 - ------------------------------------------------------------------------------------------ September 2003 Dividend $0.200 - ------------------------------------------------------------------------------------------ Market Yield* 5.44% - ------------------------------------------------------------------------------------------ NAV Yield* 4.86% - ------------------------------------------------------------------------------------------ IPO Yield* 4.27% - ------------------------------------------------------------------------------------------ * Market yield is calculated by multiplying the September dividend by 4 and dividing by the month-end market price. NAV yield is calculated by multiplying the September dividend by 4 and dividing by the month-end net asset value. IPO yield is calculated by multiplying the September dividend by 4 and dividing by the initial public offering price. Prices and yields will vary. 4 STATEMENT OF ASSETS AND LIABILITIES September 30, 2003 ASSETS: Portfolio of investments: Debt securities, at value (cost $132,912,304) ................... $142,506,017 Short-term securities, at cost, which approximates market ....... 1,200,255 ------------ Total portfolio of investments ............................... 143,706,272 Receivable for interest on debt securities ........................ 2,003,737 Other assets ...................................................... 8,055 ------------ Total assets ................................................. 145,718,064 ------------ LIABILITIES: Payable for investments purchased ............................... 1,014,844 Accrued investment advisory and administrative fees ............. 160,155 Accrued professional fees ....................................... 28,000 Accrued custodial and transfer agent fees ....................... 14,053 Accrued other expenses .......................................... 31,743 ------------ Total liabilities ............................................ 1,248,795 ------------ NET ASSETS (equivalent to $16.46 per share for 8,775,665 shares of capital stock outstanding) ............................ $144,469,269 ============ Analysis of Net Assets: Shareholders' capital ........................................... $135,120,133 Accumulated undistributed net investment income ................. 20,394 Accumulated net realized loss on sales of investments ........... (264,971) Unrealized appreciation on investments .......................... 9,593,713 ------------ Net assets applicable to outstanding shares ...................... $144,469,269 ============ See Notes to Financial Statements. 5 STATEMENT OF OPERATIONS For the Year Ended September 30, 2003 Investment income: Interest income earned ................................... $ 8,310,515 ----------- Expenses: Investment advisory and administrative fees .............. 663,376 Directors' fees and expenses ............................. 89,898 Transfer agent and dividend disbursing agent fees ........ 72,212 Stockholders' reports and annual meeting fees ............ 61,929 Professional fees ........................................ 54,444 Custody fees ............................................. 38,434 Franchise taxes .......................................... 15,856 Other expenses ........................................... 43,131 ----------- Total expenses ............................................. 1,039,280 ----------- Net investment income ...................................... 7,271,235 ----------- Net realized and unrealized gain on investments: Net realized gain from investment transactions ........... 186,121 Change in unrealized appreciation ........................ 6,960,588 ----------- Total realized and unrealized gain on investments .......... 7,146,709 ----------- Net increase in net assets from operations ................. $14,417,944 =========== See Notes to Financial Statements. 6 STATEMENT OF CHANGES IN NET ASSETS For the Years Ended September 30, 2003 2002 ------------ ------------ From operations: Net investment income ................................. $ 7,271,235 $ 8,314,247 Net realized gain from investment transactions ........ 186,121 623,636 Change in unrealized appreciation (depreciation) of investments ...................................... 6,960,588 (1,229,377) ------------ ------------ Net increase in net assets from operations ............ 14,417,944 7,708,506 Distributions to shareholders from: Net investment income ................................. (7,459,315) (8,424,638) Net realized gain ..................................... (351,027) (1,404,106) ------------ ------------ Total distributions ................................. (7,810,342) (9,828,744) ------------ ------------ Net increase (decrease) in net assets ............... 6,607,602 (2,120,238) Net Assets: Beginning of period ................................... 137,861,667 139,981,905 ------------ ------------ End of period (including accumulated undistributed net investment income of $20,394 and $133,939, respectively) ................. $144,469,269 $137,861,667 ============ ============ See Notes to Financial Statements. 7 FINANCIAL HIGHLIGHTS Financial highlights for each share of capital stock outstanding through each period: Years Ended September 30, ------------------------------------------------------------------ 2003 2002 2001 2000 1999 ------- ------- ------- ------- ------- Net asset value, beginning of period ........... $ 15.71 $ 15.95 $ 15.05 $ 15.11 $ 16.87 ------- ------- ------- ------- ------- Net investment income .......................... 0.83 0.95 1.04 1.05 1.05 Net realized and unrealized gain (loss) on investments ............................... 0.81 (0.07) 0.90 (0.06) (1.27) ------- ------- ------- ------- ------- Total from investment operations ............... 1.64 0.88 1.94 0.99 (0.22) Less distributions from: Net investment income ...................... (0.85) (0.96) (1.04) (1.04) (1.04) Net realized gain .......................... (0.04) (0.16) -- (0.01) (0.50) ------- ------- ------- ------- ------- Total distributions ............................ (0.89) (1.12) (1.04) (1.05) (1.54) ------- ------- ------- ------- ------- Net asset value, end of period ................. $ 16.46 $ 15.71 $ 15.95 $ 15.05 $ 15.11 ======= ======= ======= ======= ======= Market price per share at end of period ........ $ 14.70 $ 15.10 $ 14.84 $ 13.38 $ 13.88 Total investment return (market value) (1) ..... 3.21% 9.46% 18.98% 4.34% (2.76)% Total return (net asset value) (2) ............. 10.63% 5.82% 13.22% 6.77% (1.48)% Net assets at end of period (in millions) ...... $144.47 $137.86 $139.98 $132.09 $132.81 Ratios of expenses to average net assets ....... 0.74% 0.73% 0.71% 0.74% 0.73% Ratio of net investment income to average net assets ................................... 5.16% 6.07% 6.68% 7.01% 6.61% Portfolio turnover ............................. 62.3% 126.8% 142.7% 73.8% 69.9% Number of shares outstanding at end of period (in thousands) ........................ 8,776 8,776 8,776 8,776 8,789 - --------------------- (1) Total investment return (market value) reflects the market value experiences of a continuous shareholder who made commission-free acquisitions through distributions in accordance with the shareholder reinvestment plan. (2) Total return (net asset value) reflects the Company's portfolio performance and is the combination of reinvested dividend income, reinvested capital gains distributions at NAV, if any, and changes in net asset value per share. See Notes to Financial Statements. 8 PORTFOLIO OF INVESTMENTS September 30, 2003 Moody's Face Value Rating Cost Value - ----------- ------- ----------- ----------- DEBT SECURITIES--(99.2%) [ ] MUNICIPAL SECURITIES--(3.0%) New Jersey Economic Development Authority, $10,000,000 Zero Coupon Revenue Bond, due 02/15/18 .......... Aaa $ 3,421,054 $ 4,307,000 ----------- ----------- [ ] U.S. GOVERNMENT SECURITIES--(16.1%) AGENCY OBLIGATIONS--(5.9%) Fannie Mae, 1,180,000 4.625%, due 05/01/13 ........................... Aa2 1,177,465 1,172,857 430,000 7.125%, due 01/15/30 ........................... Aaa 552,567 528,071 Fannie Mae Grantor Trust, 736,739 5.500%, due 03/01/33 ........................... (a) 759,301 752,049 1,218,237 6.500%, due 07/25/42 ........................... (a) 1,324,452 1,294,758 Federal Home Loan Mortgage Corp., Gold Pool, 587,382 6.500%, due 02/01/17 ........................... (a) 621,157 618,128 Federal National Mortgage Association, 451,514 6.000%, due 06/01/23 ........................... (a) 470,280 467,950 809,182 6.000%, due 11/01/28 ........................... (a) 796,792 835,101 692,770 7.000%, due 03/01/31 ........................... (a) 701,538 735,120 Federal National Mortgage Association, Guaranteed Mortgage Pass Thru Certificates, 154,902 REMIC, 7.000%, due 06/25/13 .................... (a) 144,041 159,147 Freddie Mac, 1,365,000 5.875%, due 03/21/11 ........................... Aa2 1,557,182 1,501,324 Government National Mortgage Association, 398,411 6.500%, due 05/15/29 ........................... (a) 367,596 418,539 ----------- ----------- 8,472,371 8,483,044 ----------- ----------- U.S. TREASURY BONDS--(10.2%) 1,000,000 4.250%, due 08/15/13 ........................... Aaa 1,014,844 1,025,117 830,000 4.375%, due 08/15/12 ........................... Aaa 824,877 865,437 4,195,000 6.250%, due 05/15/30 ........................... Aaa 4,959,933 4,977,795 2,745,000 8.000%, due 11/15/21 ........................... Aaa 3,639,015 3,807,400 13,250,000 Principal Only, due 08/15/26 ................... Aaa 3,583,271 3,899,409 ----------- ----------- 14,021,940 14,575,158 ----------- ----------- Total U.S. Government Securities ................ 22,494,311 23,058,202 ----------- ----------- See Notes to Financial Statements. 9 PORTFOLIO OF INVESTMENTS--(Continued) September 30, 2003 Moody's Face Value Rating Cost Value - ----------- ------- ----------- ----------- [ ] CORPORATE BONDS AND NOTES--(80.1%) FINANCE--(38.8%) $ 195,000 Allstate Corp. (The), 6.750%, due 05/15/18 ........... A1 $ 208,024 $ 225,938 745,000 Anadarko Finance Co., 7.500%, due 05/01/31 ........... Baa1 785,604 900,496 375,000 Avalonbay Communities, Inc., 7.500%, due 08/01/09 ............................................ Baa1 391,385 439,194 1,915,000 Bank of America Corp., 7.400%, due 01/15/11 .......... Aa3 1,978,724 2,274,790 235,000 Bank of New York Co., Inc. (The), 7.300%, due 12/01/09 ............................................ A1 265,450 279,783 815,000 Bank One Corp., 7.875%, due 08/01/10 ................. A1 868,679 991,948 1,655,000 Barclays Bank, PLC, 144A, 8.550%, due 12/31/49 ............................................ Aa3 1,652,733 2,059,138 1,250,000 Bear Stearns Commercial Mortgage Securities, 00-WF2, Class A2, 7.320%, due 10/15/32 .............. AAA* 1,436,084 1,474,095 320,000 Boeing Capital Corp., 7.375%, due 09/27/10 ........... A3 342,837 371,926 140,000 CIT Group, Inc., 7.750%, due 04/02/12 ................ A2 152,833 166,161 2,175,000 Citigroup, Inc., 7.250%, due 10/01/10 ................ Aa2 2,298,256 2,576,242 275,000 Conoco Funding Co., 7.250%, due 10/15/31 ............. A3 314,830 328,164 3,000,000 CPL Transition Funding LLC, 6.250%, due 01/15/17 ............................................ Aaa 3,243,281 3,351,777 1,105,000 Credit Suisse First Boston USA, Inc., 6.500%, due 01/15/12 ........................................ Aa3 1,123,525 1,240,229 2,800,000 CS First Boston Mortgage Securities Corp., 00-C1, Class A2, 7.545%, due 04/15/62 ............... AAA* 3,026,625 3,323,296 1,075,838 CS First Boston Mortgage Securities Corp., 03-8, Class 5A1, 6.500%, due 04/25/33 ..................... Aaa 1,116,182 1,124,989 635,000 DLJ Commercial Mortgage Corp., 00-CKP1, Class A1B, 7.180%, due 08/10/10 ..................... Aaa 638,274 730,142 750,000 DLJ Commercial Mortgage Corp., 99-CG3, Class A1B, 7.340%, due 10/10/32 ..................... Aaa 814,219 881,571 700,000 EOP Operating, 7.250%, due 06/15/28 .................. Baa1 709,188 764,035 590,000 FleetBoston Financial Corp., 7.375%, due 12/01/09 ............................................ A2 623,984 697,604 1,805,000 Ford Motor Co., 7.450%, due 07/16/31 ................. Baa1 1,657,672 1,664,636 1,185,000 Ford Motor Credit Co., 7.375%, due 02/01/11 .......... A3 1,167,864 1,246,436 930,000 General Electric Capital Corp., 6.750%, due 03/15/32 ............................................ Aaa 907,269 1,049,514 See Notes to Financial Statements. 10 PORTFOLIO OF INVESTMENTS--(Continued) September 30, 2003 Moody's Face Value Rating Cost Value - ----------- ------- ----------- ----------- $ 1,730,000 General Electric Capital Corp., 6.000%, due 06/15/12 ............................................. Aaa $ 1,834,482 $ 1,895,933 365,000 General Motors Acceptance Corp., 6.875%, due 09/15/11 ............................................. A3 361,340 378,871 1,000,000 General Motors Acceptance Corp., 8.375%, due 07/15/33 ............................................. Baa1 982,535 1,045,598 1,565,000 General Motors Acceptance Corp., 8.000%, due 11/01/31 ............................................. A3 1,590,689 1,607,537 170,000 Goldman Sachs Group, Inc., 6.125%, due 02/15/33 ............................................. Aa3 170,000 172,723 665,000 Goldman Sachs Group, Inc., 6.875%, due 01/15/11 ............................................. Aa3 664,759 764,647 1,165,000 Household Finance Corp., 6.750%, due 05/15/11 ............................................. A1 1,156,113 1,328,691 260,000 HSBC Holdings PLC, 5.250%, due 12/12/12 ............... A1 259,321 270,788 475,000 Lehman Brothers Holdings, Inc., 6.625%, due 01/18/12 ............................................. A2 472,554 540,325 390,000 Lincoln National Corp., 6.200%, due 12/15/11 .......... A3 388,534 425,619 320,000 Marsh & McClennan Cos., Inc., 6.250%, due 03/15/12 ............................................. A2 354,630 355,924 190,000 MBNA America Bank N.A., 7.125%, due 11/15/12 ............................................. Baa2 194,688 217,928 195,000 Mellon Funding Corp., 5.000%, due 12/01/14 ............ A2 193,366 199,227 1,213,031 Merrill Lynch Mortgage Investors, Inc., 96-C2, Class A3, 6.960%, due 11/21/28 ....................... AAA* 1,287,661 1,319,662 170,000 Morgan Stanley, 7.250%, due 04/01/32 .................. Aa3 170,963 198,584 1,640,000 Morgan Stanley, 6.750%, due 04/15/11 .................. Aa3 1,645,037 1,873,728 360,000 National City Bank, 4.625%, due 05/01/13 .............. A1 359,719 362,759 670,000 Pemex Project Funding Master Trust, 8.000%, due 11/15/11 ......................................... Baa1 732,409 757,100 1,500,000 PNC Mortgage Acceptance Corp., 99-CM1, Class A1B, 7.330%, due 12/10/32 ...................... Aaa 1,608,750 1,757,615 870,000 Prudential Mortgage Capital Funding, LLC, 01-ROCK, Class A2, 6.605%, due 05/10/34 .............. Aaa 874,350 991,558 1,380,000 PSE&G Transition Funding LLC, 6.450%, due 03/15/13 ............................................. Aaa 1,445,766 1,590,418 See Notes to Financial Statements. 11 PORTFOLIO OF INVESTMENTS--(Continued) September 30, 2003 Moody's Face Value Rating Cost Value - ----------- ------- ----------- ----------- $ 3,000,000 PSE&G Transition Funding LLC, 6.610%, due 06/15/15 ......................................... Aaa $ 3,376,875 $ 3,470,699 830,000 Qwest Capital Funding, Inc., 7.900%, due 08/15/10 ......................................... Caa2 862,051 755,300 115,000 SLM Corp., 5.125%, due 08/27/12 ................... A2 114,202 118,478 500,000 U.S. Bank N.A., Minnesota, 6.375%, due 08/01/11 ......................................... Aa3 509,916 567,653 945,000 Unilever Capital Corp., 7.125%, due 11/01/10 ...... A1 1,008,792 1,119,676 1,620,000 Wachovia Bank N.A. (Charlotte), 7.800%, due 08/18/10 ......................................... Aa3 1,709,242 1,980,610 350,000 Washington Mutual Bank, 6.875%, due 06/15/11 ...... A3 377,971 401,081 1,025,000 Wells Fargo Bank, N.A., 6.450%, due 02/01/11 ...... Aa1 1,014,672 1,168,428 ----------- ----------- 51,444,909 55,799,264 ----------- ----------- UTILITIES--(7.0%) 305,000 Apache Corp., 6.250%, due 04/15/12 ................ A3 308,151 345,705 110,000 Boston Edison Co., 4.875%, due 10/15/12 ........... A1 109,227 112,040 370,000 Burlington Resources Finance Co., 6.680%, due 02/15/11 ......................................... Baa1 404,302 421,423 270,000 Commonwealth Edison Co., 6.150%, due 03/15/12 ......................................... A3 270,563 300,127 680,000 ConocoPhillips, 8.750%, due 05/25/10 .............. A3 769,943 863,496 1,400,000 Consolidated Edison Co. of New York, 7.500%, due 09/01/10 ..................................... A1 1,389,332 1,684,367 670,000 Devon Financing Corp., ULC, 6.875%, due 09/30/11 ......................................... Baa2 651,274 769,039 415,000 Dominion Resources, Inc., 5.700%, due 09/17/12 .... Baa1 414,718 440,988 205,000 DTE Energy Co., 7.050%, due 06/01/11 .............. Baa2 222,906 231,040 590,000 Duke Energy Field Services, LLC, 8.125%, due 08/16/30 ......................................... Baa2 637,752 734,237 650,000 FirstEnergy Corp., 6.450%, due 11/15/11 ........... Baa2 642,400 678,275 165,000 Kerr-McGee Corp., 7.875%, due 09/15/31 ............ Baa3 198,145 193,814 345,000 Midamerican Energy Co., 5.125%, due 01/15/13 ...... A3 344,251 356,165 210,000 Praxair, Inc., 6.375%, due 04/01/12 ............... A3 213,065 238,572 520,000 Progress Energy, Inc., 7.000%, due 10/30/31 ....... Baa2 526,487 547,281 290,000 PSEG Power LLC, 8.625%, due 04/15/31 .............. Baa1 206,415 366,856 480,000 Sempra Energy, 7.950%, due 03/01/10 ............... Baa1 478,742 573,468 See Notes to Financial Statements. 12 PORTFOLIO OF INVESTMENTS--(Continued) September 30, 2003 Moody's Face Value Rating Cost Value - ----------- ------- ----------- ----------- $ 325,000 Southern Power Co., 6.250%, due 07/15/12 ............ Baa1 $ 328,821 $ 356,662 300,000 Union Oil Co. of California, 7.500%, due 02/15/29 ........................................... Baa2 316,207 347,899 470,000 Valero Energy Corp., 7.500%, due 04/15/32 ........... Baa3 465,958 523,370 ----------- ----------- 8,898,659 10,084,824 ----------- ----------- INDUSTRIAL--(17.6%) 720,000 Alcoa, Inc., 6.000%, due 01/15/12 ................... A2 718,195 792,890 675,000 Altria Group, Inc., 7.750%, due 01/15/27 ............ Baa2 700,852 704,869 180,000 Amerada Hess Corp., 7.875%, due 10/01/29 ............ Baa3 211,938 204,900 940,000 Anheuser-Busch Cos., Inc., 9.000%, due 12/01/09 ..... A1 1,095,896 1,214,682 1,815,000 AOL Time Warner, Inc., 7.625%, due 04/15/31 ......... Baa1 1,785,641 2,063,065 1,270,000 Avon Products, Inc., 7.150%, due 11/15/09 ........... A2 1,290,827 1,505,850 325,000 Bear Stearns Co., 5.700%, due 11/15/14 .............. A2 340,169 346,626 670,000 Bombardier, Inc.,144A, 6.750%, due 05/01/12 ......... Baa3 633,971 698,475 395,000 Bristol-Myers Squibb Co., 5.750%, due 10/01/11 ...... A1 404,457 429,503 720,000 Caterpillar, Inc., 6.550%, due 05/01/11 ............. A2 720,862 830,188 340,000 Cendant Corp., 7.375%, due 01/15/13 ................. Baa1 405,876 391,975 300,000 Centex Corp., 7.875%, due 02/01/11 .................. Baa2 360,808 355,095 420,000 Conagra Foods, Inc., 6.750%, due 09/15/11 ........... Baa1 466,972 482,966 350,000 Coors Brewing Co., 6.375%, due 05/15/12 ............. Baa2 348,586 390,074 380,000 DaimlerChrysler N.A. Holding Corp., 8.500%, due 01/18/31 ....................................... A3 426,226 444,217 825,000 Deere & Co., 7.125%, due 03/03/31 ................... A3 841,357 969,012 330,000 Dow Chemical Co. (The), 6.125%, due 02/01/11 ........ A3 333,229 352,435 300,000 Federated Department Stores, Inc., 6.625%, due 04/01/11 ........................................... Baa1 333,670 341,894 375,000 First Data Corp., 5.625%, due 11/01/11 .............. A1 373,845 402,367 730,000 General Dynamics Corp., 4.250%, due 05/15/13 ........ A2 728,883 712,509 440,000 Harrah's Operating Co., Inc., 7.500%, due 01/15/09 ........................................... Baa3 480,959 511,521 875,000 International Paper Co., 6.750%, due 09/01/11 ....... Baa2 876,063 987,105 285,000 Kohl's Corp., 6.300%, due 03/01/11 .................. A3 288,605 323,006 760,000 Kraft Foods, Inc., 5.625%, due 11/01/11 ............. A3 790,640 801,023 685,000 Kroger Co., 7.500%, due 04/01/31 .................... Baa3 765,550 807,953 255,000 Lockheed Martin Corp., 8.500%, due 12/01/29 ......... Baa2 351,025 341,099 520,000 Merck & Co., Inc., 6.400%, due 03/01/28 ............. Aaa 563,279 587,865 See Notes to Financial Statements. 13 PORTFOLIO OF INVESTMENTS--(Continued) September 30, 2003 Moody's Face Value Rating Cost Value - ----------- ------- ----------- ----------- $ 350,000 Miller Brewing Co.,144A, 5.500%, due 08/15/13 ...... Baa1 $ 348,651 $ 365,693 235,000 Newell Rubbermaid, Inc., 6.750%, due 03/15/12 ...... Baa1 258,976 266,358 425,000 Northrop Grumman Corp., 7.125%, due 02/15/11 ....... Baa3 493,115 496,826 735,000 Occidental Petroleum Corp., 8.450%, due 02/15/29 .......................................... Baa1 830,325 984,710 275,000 Progressive Corp. (The), 6.250%, due 12/01/32 ...... A1 281,688 292,686 290,000 Rohm & Haas Co., 7.850%, due 07/15/29 .............. A3 319,211 360,348 435,000 Safeway, Inc., 7.250%, due 02/01/31 ................ Baa2 465,047 490,975 525,000 Target Corp., 7.000%, due 07/15/31 ................. A2 567,636 604,488 585,000 Transocean, Inc., 7.500%, due 04/15/31 ............. Baa2 568,129 683,939 125,000 Tyson Foods Inc, 8.250%, due 10/01/11 .............. Baa3 144,464 149,498 430,000 United Technologies Corp., 6.100%, due 05/15/12 .......................................... A2 429,248 481,806 475,000 UST, Inc., 6.625%, due 07/15/12 .................... A3 472,777 531,432 400,000 Walt Disney Co. (The), 6.375%, due 03/01/12 ........ Baa1 406,219 444,156 310,000 Wendy's International, Inc., 6.200%, due 06/15/14 .......................................... Baa1 309,095 344,862 665,000 Weyerhaeuser Co., 7.375%, due 03/15/32 ............. Baa2 658,430 742,355 ----------- ----------- 23,191,392 25,233,296 ----------- ----------- COMMUNICATION--(7.1%) 455,000 AT&T Corp., 8.000%, due 11/15/31 ................... Baa2 397,941 538,707 840,000 AT&T Wireless Services, Inc., 8.750%, due 03/01/31 .......................................... Baa2 927,648 1,038,945 315,000 BellSouth Telecommunications Corp., 6.000%, due 10/15/11 ...................................... A1 321,614 348,566 340,000 British Telecommunications PLC, 8.125%, due 12/15/10 .......................................... Baa1 370,830 418,344 260,000 Cingular Wireless, 6.500%, due 12/15/11 ............ A3 251,534 293,975 520,000 Citizens Communications Co., 9.000%, due 08/15/31 .......................................... Baa2 538,838 684,875 1,005,000 Comcast Corp., 7.050%, due 03/15/33 ................ Baa3 998,869 1,101,453 740,000 International Business Machines Corp., 5.875%, due 11/29/32 ...................................... A1 716,498 756,114 170,000 Motorola, Inc., 7.625%, due 11/15/10 ............... Baa2 158,507 193,800 820,000 News America, Inc., 7.125%, due 04/08/28 ........... Baa3 730,963 907,188 See Notes to Financial Statements. 14 PORTFOLIO OF INVESTMENTS--(Continued) September 30, 2003 Moody's Face Value Rating Cost Value - ----------- ------- ------------ ------------ $ 800,000 SBC Communications, Inc., 5.875%, due 02/01/12 ............................................. A1 $ 807,940 $ 872,160 665,000 Sprint Capital Corp., 8.750%, due 03/15/32 ............ Baa3 721,933 790,175 1,085,000 Verizon New York, Inc., 7.375%, due 04/01/32 .......... A2 992,660 1,264,769 825,000 Viacom, Inc., 6.625%, due 05/15/11 .................... A3 922,592 943,539 ------------ ------------ 8,858,367 10,152,610 ------------ ------------ INTERNATIONAL--(6.4%) 2,500,000 Augusta Funding Ltd., 7.375%, due 04/15/13 ............ Aaa 2,426,113 2,708,700 285,000 Canadian National Railway Co., 6.900%, due 07/15/28 ............................................. Baa1 296,656 322,363 625,000 Deutsche Telekom International Finance BV, 8.250%, due 06/15/30 ................................. Baa3 661,530 792,814 530,000 France Telecom S.A., 8.500%, due 03/01/31 ............. Baa3 605,677 707,623 2,805,000 Mexico Government International Bond, 8.125%, due 12/30/19 ................................. Baa2 2,858,578 3,169,650 385,000 Royal Bank of Scotland, 9.118%, due 03/31/10 .......... A1 472,719 486,357 475,000 State of Qatar, 144A, 9.750%, due 06/15/30 ............ A3 621,807 660,250 365,000 Telus Corp., 8.000%, due 06/01/11 ..................... Ba1 363,095 426,104 ------------ ------------ 8,306,175 9,273,861 ------------ ------------ TRANSPORTATION--(3.2%) 120,000 Burlington Northern Santa Fe Corp., 6.875%, due 12/01/27 ......................................... Baa2 117,860 132,800 740,000 Burlington Northern Santa Fe Corp., 7.082%, due 05/13/29 ......................................... Baa2 733,549 838,732 700,000 Delta Air Lines, Inc., 10.500%, due 04/30/16 .......... B1 853,510 526,918 1,065,000 Erac U.S.A. Finance Co., 144A, 8.000%, due 01/15/11 ............................................. Baa1 1,118,529 1,279,971 470,000 Union Pacific Corp., 6.650%, due 01/15/11 ............. Baa3 473,989 535,019 3,000,000 United Airlines, Inc., 7.870%, due 01/30/19 ........... Ca 3,000,000 1,283,520 ------------ ------------ 6,297,437 4,596,960 ------------ ------------ Total Corporate Bonds and Notes ....................... 106,996,939 115,140,815 ------------ ------------ Total Debt Securities ................................. 132,912,304 142,506,017 ------------ ------------ See Notes to Financial Statements. 15 PORTFOLIO OF INVESTMENTS--(Continued) September 30, 2003 Shares Cost Value - ---------- ------------ ------------ SHORT-TERM INVESTMENTS--(0.8%) 1,200,255 UBS Supplementary Trust U.S. Cash Management Prime Fund .............. $ 1,200,255 $ 1,200,255 ------------ ------------ Total Investments (100.0%) .......... $134,112,559 $143,706,272 ============ ============ - --------------------- (a) Moody's as a matter of policy, does not rate this issue. * Standard & Poor's Corporation rating. Security is not rated by Moody's Investor Service, Inc. 144A Securities exempt from registration under Rule 144A of the Securities Act of 1933. These securities may be resold in transactions exempt from registration, normally to qualified institutional buyers. At September 30, 2003, the value of these securities amounted to $5,063,527 or 3.5% of the total portfolio of investments. REMIC Real Estate Mortgage Investment Conduit See Notes to Financial Statements. 16 NOTES TO FINANCIAL STATEMENTS September 30, 2003 1. SIGNIFICANT ACCOUNTING POLICIES Fort Dearborn Income Securities, Inc. ("the Company") is registered under the Investment Company Act of 1940, as amended, as a diversified closed-end management investment company. The Company invests principally in investment grade long-term fixed income debt securities with the primary objective of providing its shareholders with: o a stable stream of current income consistent with external interest rate conditions, and o a total return over time that is above what they could receive by investing individually in the investment grade and long-term maturity sectors of the bond market. The following is a summary of the significant accounting policies followed by the Company in the preparation of its financial statements. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. A. Valuation of Investments -- The Fund calculates its net asset value based on the current market value, where available, for its portfolio securities. The Fund normally obtains market values for its securities from independent pricing sources and broker-dealers. Independent pricing sources may use reported last sale prices, current market quotations or valuations from computerized "matrix" systems that derive values based on comparable securities. A matrix system incorporates parameters such as security quality, maturity and coupon, and/or research and evaluations by its staff, including review of broker-dealer market price quotations, if available, in determining the valuation of the portfolio securities. If a market value is not available from an independent pricing source for a particular security, that security is valued at fair value as determined in good faith by or under the direction of the Fund's board of directors (the "Board"). The amortized cost method of valuation, which approximates market value, generally is used to value short-term debt instruments with sixty days or less remaining to maturity, unless the Board determines that this does not represent fair value. B. Investment Income and Security Transactions -- Interest income is recorded on the accrual basis. Dividend income is recorded on ex-dividend date. Security transactions are accounted for on the trade date. The Company has elected to amortize market discount and premium on all issues purchased. Realized gains and losses from security transactions and unrealized appreciation and depreciation of investments are reported on a first-in first-out basis. C. Federal Income Taxes -- For federal income tax purposes, the cost of securities owned at September 30, 2003, was substantially the same as the cost of securities for financial statement purposes. 17 NOTES TO FINANCIAL STATEMENTS--(Continued) September 30, 2003 1. SIGNIFICANT ACCOUNTING POLICIES (Continued) At September 30, 2003, the components of net unrealized appreciation of investments were as follows: Gross appreciation (investments having an excess of value over cost) ...... $11,928,084 Gross depreciation (investments having an excess of cost over value) ...... (2,334,371) ----------- Net unrealized appreciation of investments ................................ $ 9,593,713 =========== The Fund intends to distribute substantially all of its taxable income and to comply with the other requirements of the Internal Revenue Code applicable to regulated investment companies. Accordingly, no provision for federal income taxes is required. In addition, by distributing during each calendar year substantially all of its net investment income, capital gains and certain other amounts, if any, the Fund intends not to be subject to a federal excise tax. At September 30, 2003, the components of accumulated earnings on a tax basis were as follows: Accumulated earnings ...................................................... $ 20,394 Undistributed long term capital gains ..................................... -- Accumulated capital and other losses ...................................... (235,576) Unrealized appreciation ................................................... 9,564,317 ---------- Total accumulated earnings ................................................ $9,349,135 ========== The differences between book-basis and tax-basis unrealized appreciation is attributable to the tax deferral of losses on wash sales. Net realized gains or losses may differ for financial and tax reporting purposes as a result of post October 31 losses, which are not recognized for tax purposes until the first day of the following fiscal year along with losses from wash sales. 2. NET ASSET VALUATIONS The net asset value of the Company's shares is determined as of the close of business each day the New York Stock Exchange is open. 3. DISTRIBUTIONS The tax character of distributions paid during the fiscal years ended September 30, 2003 and September 30, 2002 were as follows: Distributions paid from: 2003 2002 - ------------------------ ---------- ---------- Ordinary income ......................................... $7,643,604 $9,828,744 Capital gains ........................................... 166,738 -- ---------- ---------- $7,810,342 $9,828,744 ========== ========== 18 NOTES TO FINANCIAL STATEMENTS--(Continued) September 30, 2003 3. DISTRIBUTIONS (Continued) At September 30, 2003, the Fund had a net capital loss carryforward of $235,576, which is available as a reduction, to the extent provided in the regulations, of future net realized capital gains, and will expire on September 30, 2011. To the extent that such losses are used to offset future net realized capital gains as provided in the regulations, such gains will not be distributed. Dividends and distributions payable to shareholders are recorded by the Company on the ex-date. Net realized gains from the sale of investments, if any, are distributed annually. Net investment income and realized gains and losses for federal income tax purposes may differ from that reported on the financial statements because of permanent and temporary book and tax basis differences. Permanent book and tax differences of $74,535 were reclassified from accumulated net realized gain (loss) on investments to undistributed net investment income due to gains from paydown adjustments related to mortgage-backed securities. Distributions from net realized gains for book purposes may include short-term capital gains, which are included as ordinary income for tax purposes. 4. CAPITAL STOCK At September 30, 2003, there were 12,000,000 shares of $.01 par value capital stock authorized, and shareholder capital of $135,120,133. During the year ended September 30, 2003 no new shares were issued as part of the dividend reinvestment plan and no shares were repurchased in the open market. 5. PURCHASES AND SALES OF SECURITIES Purchases and sales (including maturities) of portfolio securities during the year ended September 30, 2003, were as follows: debt securities and preferred stock, $29,466,887 and $24,256,812, respectively; short-term securities, $34,153,023 and $37,714,853, respectively: and United States government debt obligations, $60,038,752 and $61,351,783, respectively. 6. MANAGEMENT AND OTHER FEES Under an agreement between the Company and UBS Global Asset Management (Americas) Inc. ("the Advisor"), the Advisor manages the Company's investment portfolio, maintains its accounts and records, and furnishes the services of individuals to perform executive and administrative functions for the Company. In return for these services, the Company pays the Advisor 50 basis points (annualized) of the Company's average weekly net assets up to $100,000,000 and 40 basis points (annualized) of average weekly net assets in excess of $100,000,000. The Company pays each of its directors (except the Chairman) at the rate of $9,000 annually to serve as directors and $750 for each Board of Directors meeting attended. The Company pays the Chairman at the rate of $13,000 annually to serve in such capacity and $750 for each Board of Directors meeting attended. 19 NOTES TO FINANCIAL STATEMENTS--(Continued) September 30, 2003 6. MANAGEMENT AND OTHER FEES (Continued) The following table sets forth as to each Director the compensation paid to such Director in the fiscal year ended September 30, 2003 for service on the Board of the Company and, in the case of Messrs. Reilly and Roob, on the boards of three other investment companies for which the Advisor performed investment advisory services. Pension or Retirement Benefits Accrued as Total Compensation Aggregate Part of Estimated from Company and Compensation Company Annual Benefits Fund Complex Name of Director from Company Expenses Upon Retirement (unaudited) - ---------------- ------------ ----------- --------------- ------------------ Adela Cepeda ............... $13,500 -- -- $13,500 C. Roderick O'Neal ......... 16,500 -- -- 16,500 Frank K. Reilly ............ 13,500 -- -- 75,600 Edward M. Roob ............. 13,500 -- -- 75,600 J. Mikesell Thomas ......... 13,500 -- -- 13,500 All Company officers serve without direct compensation from Fort Dearborn. Fort Dearborn Income Securities, Inc. invests in shares of the UBS Supplementary Trust U.S. Cash Management Prime Fund ("Supplementary Trust"). The Supplementary Trust is a business trust managed by the Advisor. The Supplementary Trust is offered as a cash management option only to mutual funds and other accounts managed by the Advisor. The Supplementary Trust pays no management fees. Distributions from the Supplementary Trust are reflected as interest income on the statement of operations. Amounts relating to those investments at September 30, 2003 and for the period ended are summarized as follows: % of Cost of Sales Interest Net Fund Purchase Proceeds Income Value Assets - ---- ----------- ----------- -------- ---------- ------ UBS Supplementary Trust U.S. Cash Management Prime Fund .............. $33,941,563 $37,503,843 $42,474 $1,200,255 0.8% 7. MORTGAGE BACKED SECURITIES AND OTHER INVESTMENTS The Company invests in Mortgage Backed Securities (MBS), representing interests in pools of mortgage loans. These securities provide shareholders with payments consisting of both principal and interest as the mortgages in the underlying mortgage pools are paid. Securities issued by Government National Mortgage Association (GNMA) are backed by the full faith and credit of the U.S. Government. Securities issued by Federal National Mortgage Association (FNMA) or Federal Home Loan Mortgage Corporation (FHLMC) are not backed by the full faith and credit of the U.S. Government, but the issuing agency has the right to borrow from the U.S. Treasury to meet it's obligations. However, some securities may be issued by private, non- 20 NOTES TO FINANCIAL STATEMENTS--(Continued) September 30, 2003 7. MORTGAGE BACKED SECURITIES AND OTHER INVESTMENTS (Continued) governmental corporations. MBS issued by private entities are not government securities and are not directly guaranteed by any government agency. They are secured by the underlying collateral of the private issuer. Yields on privately issued MBS tend to be higher than those of government backed issues. However, risk of loss due to default and sensitivity to interest rate fluctuations is also higher. The Company invests in Collateralized Mortgage Obligations (CMOs). A CMO is a bond that is collateralized by a pool of MBS. The Company also invests in REMICs (Real Estate Mortgage Investment Conduit) which are simply another form of CMO. These MBS pools are divided into classes or tranches with each class having its own characteristics. The different classes are retired in sequence as the underlying mortgages are repaid. For instance, a Planned Amortization Class (PAC) is a specific class of mortgages, which over its life generally has the most stable cash flows and the lowest prepayment risk. A GPM (Graduated Payment Mortgage) is a negative amortization mortgage where the payment amount gradually increases over the life of the mortgage. The early payment amounts are not sufficient to cover the interest due, and therefore, the unpaid interest is added to the principal, thus increasing the borrower's mortgage balance. Prepayment may shorten the stated maturity of the CMO and can result in a loss of premium, if any has been paid. The Company invests in Asset Backed Securities, representing interests in pools of certain types of underlying installment loans or leases or by revolving lines of credit. They often include credit enhancement that help limit investors exposure to the underlying credit. These securities are valued on the basis of timing and certainty of cash flows compared to investments with similar durations. 21 Report of Independent Auditors To the Shareholders and Board of Directors of Fort Dearborn Income Securities, Inc. We have audited the accompanying statement of assets and liabilities, including the portfolio of investments, of Fort Dearborn Income Securities, Inc., (the "Company") as of September 30, 2003, and the related statement of operations for the year then ended, the statement of changes in net assets for each of the two years in the period then ended and the financial highlights for each of the three years in the period then ended. These financial statements and financial highlights are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. The financial highlights for each of the two years in the period ended September 30, 2000, were audited by other auditors whose report dated October 26, 2000, expressed an unqualified opinion on the financial highlights. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and financial highlights. Our procedures included confirmation of securities owned as of September 20, 2003, by correspondence with the custodian and others. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Fort Dearborn Income Securities, Inc. as of September 30, 2003, and the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the three years in the period then ended, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP New York, New York November 3, 2003 22 Report on the Automatic Dividend Investment Plan The Company's Automatic Dividend Investment Plan, operated for the convenience of the shareholders, has been in operation since the dividend payment of May 5, 1973. For the year ended September 30, 2003, 59,608 shares were purchased for the Plan participants. The breakdown of these shares is listed below: Where No. of Shares Dividend Shares Average Were Payment Date Purchased Price Purchased - ----------------------------------------------------------------- December 13, 2002 18,318 $14.83 Open Market March 26, 2003 14,125 $15.50 Open Market June 13, 2003 13,649 $15.70 Open Market September 12, 2003 13,516 $14.55 Open Market As explained in the Plan, shares are purchased at the lower of the market value (including commission) or net asset value, depending upon availability. The expense of maintaining the Plan, $1.35 for each participating account per dividend payment, is borne by the Company. Shareholders who have not elected to participate in the Plan receive all dividends in cash. The Plan had 759 participants on September 12, 2003. Under the terms of the Plan, any shareholder may terminate participation by giving written notice to the Company. Upon termination, a certificate for all full shares, plus a check for the value of any fractional interest in shares, will be sent to the withdrawing shareholders, unless the sale of all or part of such shares is requested. Any registered shareholder who wishes to participate in the Plan may do so by writing to EquiServe Trust Company, N.A., P.O. Box 43081, Providence, RI 02940-3081 or calling them at (800) 446-2617. A copy of the Plan and enrollment card will be mailed to you. Shareholders who own shares in nominee name should contact their brokerage firm. All new shareholders will receive a copy of the Plan and a card, which may be signed to authorize reinvestment of dividends pursuant to the Plan. The investment of dividends does not relieve participants of any income tax which may be payable thereon. The Company strongly recommends that all Automatic Dividend Investment Plan participants retain each year's final statement on their plan participation as a part of their permanent tax record. This will ensure that cost information is available if and when it is needed. - -------------------------------------------------------------------------------- Shareholder Information For the year ended September 30, 2003, there were: (i) no material changes in the Company's investment objectives or policies, (ii) no changes in the Company's charter or by-laws that would delay or prevent a change of control of the Company, (iii) no material changes in the principal risk factors associated with investment in the Company, and (iv) no change in the person primarily responsible for the day-to-day management of the Company's portfolio. 23 General Information Stock Repurchase Plan On July 28, 1988, the Board of Directors of the Company approved a resolution to repurchase up to 700,000 of its common shares. The Company may repurchase shares, at a price not in excess of market and at a discount from net asset value, if and when such repurchases are deemed appropriate and in the shareholder's best interest. Any repurchases will be made in compliance with applicable requirements of the federal securities law. Under such law, the Company is required to give written notice to all shareholders of its intention to purchase stock within six months of the actual repurchase of shares. This report is to serve as notice to all shareholders with respect to any shares repurchased within the next six months pursuant to the Company's stock repurchase plan. Audited financial statements for the year ended September 30, 2003 and a list of securities owned on that date are included in this report. 24 [THIS PAGE INTENTIONALLY LEFT BLANK] Supplemental Information (Unaudited) Board of Directors & Officers The Company is governed by a Board of Directors which oversees the Company's operations. Each Director serves until the next annual meeting of shareholders or until his or her successor is elected and qualified. Officers are appointed by the Directors and serve at the pleasure of the Board. The table below shows, for each Director and Officer, his or her name, address and age, the position held with the Company, the length of time served as a Director or Officer of the Company, the Director's or Officer's principal occupations during the last five years, other directorships held by the Director or Officer, the number of funds in the Fort Dearborn fund complex overseen by the Director or for which a person served as an Officer, and shares owned by the Director or Officer. Position(s) Term of Office(1) Held with and Length of Name, Address and Age Trust Time Served Principal Occupation(s) During Past 5 Years - --------------------- -------------- ----------------- ---------------------------------------------- DIRECTORS: C. Roderick O'Neil; 71 Director and Since 1992 Mr. O'Neil is chairman of O'Neil Associates, an O'Neil Associates Chairman of investment and financial consulting firm. P.O. Box 405 the Board of South Glastonbury, CT 06073 Directors Adela Cepeda; 44 Director Since 2000 Ms. Cepeda is founder and president of A.C. A.C. Advisory, Inc. Advisory, Inc. (since 1995). 161 No. Clark Street, Suite 4975 Chicago, Illinois 60601 Frank K. Reilly; 67 Director Since 1993 Mr. Reilly is a Professor at the University of College of Business Administration Notre Dame since 1982. Mr. Reilly was a Director University of Notre Dame of Battery Park Funds Inc. (1995-2001). Notre Dame, IN 46556-0399 Edward M. Roob; 69 Director Since 1993 Mr. Roob is retired (since 1993). Mr. Roob was a 841 Woodbine Lane Committee Member of the Chicago Stock Northbrook, IL 60002 Exchange from 1993-1999. J. Mikesell Thomas, 51 Director Since 2002 Mr. Thomas is an independent financial advisor c/o UBS Global Asset Management (since 2001). He was a managing director of (Americas) Inc. Lazard Freres & Co. (1995 to 2001). One N. Wacker Drive Chicago, Illinois 60606 26 Shares Beneficially Owned Directly Number of Portfolios in or Indirectly Fund Complex Overseen Other Directorships September 30, by Trustee Held by Trustee 2003 - ----------------------------------------------------- ------------------------------------------------- -------------- Mr. O'Neil is a director of one investment company Mr. O'Neil is also a director of Beckman Coulter, 3,375 (consisting of one portfolio) for which UBS Global Inc., Cadre Institutional Investors Trust and a AM (Americas) serves as investment advisor trustee of Optimum Qu Fund. Ms. Cepeda is a director of one investment company Ms. Cepeda is a director of Lincoln National 1,000 (consisting of one portfolio) for which UBS Global Income Fund, Inc. and Lincoln National AM (Americas) serves as investment advisor Convertible Securities Fund. Mr. Reilly is a director or trustee of five investment Mr. Reilly is a Director of Discover Bank; Morgan 5,706 companies (consisting of 44 portfolios) for which Stanley Trust, FSB; and NIBCO, Inc. UBS Global AM (Americas) or one of its affiliates serves as investment advisor, sub-advisor or manager. Mr. Roob is a director or trustee of five investment Mr. Roob is a Trustee of the CCM Fund Complex 8,000 companies (consisting of 44 portfolios) for which (9 portfolios). UBS Global AM (Americas) or one of its affiliates serves as investment advisor, sub-advisor or manager. Mr. Thomas is a director of one investment company Mr. Thomas is a director and chairman of the None (consisting of one portfolio) for which UBS Global Finance Committee for Evanston Northwestern AM (Americas) serves as investment advisor Healthcare. He is also a vice president of the Board of Trustees for Mid-Day Club and leadership of Greater Chicago Association. 27 Principal Position(s) Term of Office(1) Occupation(s) Name, Address Held with and Length of During Past and Age Trust Time Served 5 Years - ------- -------------- ----------------- --------------------------------------------------------- OFFICERS: Joseph A. Anderson*; 41 Assistant Since 1992 Mr. Anderson is an executive director of UBS Global AM Treasurer (Americas). (since 1991) and is currently the vice president of UBS Global Asset Management Trust Company (since 1995). Mr. Anderson is assistant treasurer of one investment company (consisting of one portfolio) for which UBS Global AM (Americas) serves as investment advisor. Amy R. Doberman**; 41 Vice President Since 2003 Ms. Doberman is a managing director and general and Assistant counsel of UBS Global AM. From December 1997 Secretary through July 2000, she was general counsel of Aeltus Investment Management, Inc. Ms. Doberman is vice president and assistant secretary of five investment companies (consisting of 44 portfolios) and vice president and secretary of 17 investment companies (consisting of 37 portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. Craig G. Ellinger*; 33 Vice President Since 2001 Mr. Ellinger is a portfolio manager in the Fixed Income Group at UBS Global AM (Americas) (since 2000) He previously served in a similar position at PPM America, Inc. (1997 to 2000). Mr. Ellinger is vice president of one investment company (consisting of one portfolio) for which UBS Global AM (Americas) serves as investment advisor. David M. Goldenberg**; 37 Vice President Since 2003 Mr. Goldenberg is an executive director and deputy and Secretary general counsel of UBS Global AM. From 2000 to 2002 he was director, legal affairs at Lazard Asset Management. Mr. Goldenberg served in various capacities, including most recently as global director of Compliance, at SSB Citi Asset Management Group from 1996 to 2000. Mr. Goldenberg is a vice president and secretary of five investment companies (consisting of 44 portfolios) and a vice president and assistant secretary of 17 investment companies (consisting of 37 portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. 28 Principal Position(s) Term of Office(1) Occupation(s) Name, Address Held with and Length of During Past and Age Trust Time Served 5 Years - ------- -------------- ----------------- ----------------------------------------------------------- Rita Rubin**, 33 Assistant Since 2002 Ms. Rubin is a director and associate general counsel of Secretary UBS Global AM. Prior to 2001, she was an attorney with the law firm of Kirkpatrick & Lockhart LLP. Ms. Rubin is an assistant secretary of four investment companies (consisting of 42 portfolios) for which UBS Global AM (Americas) or one of its affiliates serves as investment advisor, sub-advisor or manager. Paul H. Schubert**; 40 Vice President Since 2003 Mr. Schubert is an executive director and head of the and Treasurer mutual fund finance department of UBS Global AM. Mr. Schubert is treasurer and principal accounting officer of three investment companies (consisting of 41 portfolios), a vice president and treasurer of 18 investment companies (consisting of 38 portfolios), and treasurer and chief financial officer of one investment company (consisting of two portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. Joseph A. Varnas**; 35 President Since 2003 Mr. Varnas is a managing director (since March 2003), chief technology officer (since March 2001) and head of product, technology and operations of UBS Global AM (since November 2002). From 2000 to 2001, he was manager of product development in Investment Consulting Services at UBS Financial Services Inc. Mr. Varnas was a senior analyst in the Global Securities Research and Economics Group at Merrill Lynch from 1995 to 1999. Mr. Varnas is president of 21 investment companies (consisting of 79 portfolios) for which UBS Global AM or one of its affiliates serves as investment advisor, sub-advisor or manager. * This person's business address is One North Wacker Drive, Chicago, IL 60606. ** This person's business address is 51 West 52nd Street, New York, New York 10019-6114. (1) Each Director serves until the next annual meeting of shareholders or until his or her successor is elected and qualified, or until he or she resigns or is otherwise removed. Officers of the Fund are appointed by the Directors and serve at the pleasure of the Board. - -------------------------------------------------------------------------------- Fort Dearborn Income Securities, Inc. Legal Counsel One N. Wacker Drive Winston & Strawn 38th Floor 35 West Wacker Drive Chicago, Illinois 60606 Chicago, Illinois 60601 (312) 525-7877 Independent Auditors Ernst & Young LLP 5 Times Square New York, New York 10036 29 EquiServe Trust Company, N.A. P.O. Box 43069 Providence, RI 02940-3069 TELEPHONE: Inside the United States: 1-800-446-2617 Outside the United States 1-781-575-2723 TDD/TTY for hearing impaired: 1-800-952-9245 (Operators are available Monday - Friday, 9:00 a.m. to 5:00 p.m. Eastern time. An interactive automated system is available around the clock every day.) INTERNET: http://www.equiserve.com - ------------------------ CERTIFICATE TRANSFERS BY MAIL: - ------------------------------ EquiServe P.O. Box 43070 Providence, RI 02940-3070 CERTIFICATE TRANSFERS BY OVERNIGHT MAIL OR PRIVATE COURIER: - ----------------------------------------------------------- EquiServe Attn: Transfer Department 150 Royall Street Canton, MA 02021 1-800-446-2617 DIVIDEND REINVESTMENT PLAN INFORMATION: - --------------------------------------- EquiServe Dividend Reinvestment Service P.O. Box 43081 Providence, RI 02940-3081 30 [FORT DEARBORN GRAPHIC] Fort Dearborn Income Securities, Inc. Fort Dearborn Income Securities, Inc. FTD The ANNUAL REPORT - -------- [LOGO] Chicago SEPTEMBER 30, 2003 Listed Stock Exchange - -------- NYSE Item 2. Code of Ethics. - ----------------------- The registrant has adopted a code of ethics that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions pursuant to Section 406 of the Sarbanes-Oxley Act of 2002. (The registrant has designated the code of ethics adopted pursuant to Sarbanes-Oxley as a "Code of Conduct" to lessen the risk of confusion with its separate code of ethics adopted pursuant to Rule 17j-1 under the Investment Company Act of 1940, as amended.) Item 3. Audit Committee Financial Expert. - ----------------------------------------- The registrant's Board of Directors has determined that the following person serving on the registrant's Audit Committee is an "audit committee financial expert" as defined in item 3 of Form N-CSR : J. Mikesell Thomas. Mr. Thomas is independent as defined in item 3 of Form N-CSR. Item 4. Principal Accountant Fees and Services. - ----------------------------------------------- Form N-CSR disclosure requirement not yet effective with respect to the registrant. Item 5. Audit Committee of Listed Registrants. - ---------------------------------------------- Not applicable to the registrant. Item 6. [Reserved by SEC for future use.] - ------------------------------------------ Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed - - ----------------------------------------------------------------------- End Management Investment Companies. - ------------------------------------- The registrant's Board of Directors believes that the voting of proxies on securities held by the registrant is an important element of the overall investment process. As such, the Board has delegated the responsibility to vote such proxies to the registrant's advisor. Following is a summary of the proxy voting policy of the advisor. Corporate Governance Philosophy, Voting Guidelines and Policy Summary The proxy voting policy of UBS Global Asset Management (Americas) Inc. ("UBS Global AM (Americas)") is based on its belief that voting rights have economic value and must be treated accordingly. Generally, UBS Global AM (Americas) expects the boards of directors of companies issuing securities held by its clients to act as stewards of the financial assets of the company, to exercise good judgment and practice diligent oversight with the management of the company. While there is no absolute set of rules that determine appropriate corporate governance under all circumstances and no set of rules will guarantee ethical behavior, there are certain benchmarks, which, if substantial progress is made toward, give evidence of good corporate governance. UBS Global AM (Americas) may delegate to an independent proxy voting and research service the authority to exercise the voting rights associated with certain client holdings. Any such delegation shall be made with the direction that the votes be exercised in accordance with UBS Global AM (Americas)'s proxy voting policy. When UBS Global AM (Americas)'s view of a company's management is favorable, UBS Global AM (Americas) generally supports current management initiatives. When UBS Global AM (Americas)'s view is that changes to the management structure would probably increase shareholder value, UBS Global AM (Americas) may not support existing management proposals. In general, UBS Global AM (Americas) (1) opposes proposals which act to entrench management; (2) believes that boards should be independent of company management and composed of persons with requisite skills, knowledge and experience; (3) opposes structures which impose financial constraints on changes in control; (4) believes remuneration should be commensurate with responsibilities and performance; and (5) believes that appropriate steps should be taken to ensure the independence of auditors. UBS Global AM (Americas) has implemented procedures designed to identify whether it has a conflict of interests in voting a particular proxy proposal, which may arise as a result of its or its affiliates' client relationships, marketing efforts or banking, investment banking and broker/dealer activities. To address such conflicts, UBS Global AM (Americas) has imposed information barriers between it and its affiliates who conduct banking, investment banking, and broker/dealer activities and has implemented procedures to prevent business, sales and marketing issues from influencing our proxy votes. Whenever UBS Global AM (Americas) is aware of a conflict with respect to a particular proxy, its appropriate local corporate governance committee is required to review and agree to the manner in which such proxy is voted. Item 8. [Reserved by SEC for future use.] - ----------------------------------------- Item 9. Controls and Procedures. - --------------------------------- (a) The registrant's principal executive officer and principal financial officer have concluded that the registrant's disclosure controls and procedures (as defined in Rule 30a-3(c) under the Investment Company Act of 1940, as amended) are effective based on their evaluation of these controls and procedures as of a date within 90 days of the filing date of this document. (b) The registrant's principal executive officer and principal financial officer are aware of no changes in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal half-year that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. Item 10. Exhibits. - ------------------- (a) (1) Code of Conduct. (a) (2) Certifications of principal executive officer and principal financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 is attached hereto as Exhibit Ex-99.CERT. (b) Certifications of principal executive officer and principal financial officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 is attached hereto as Exhibit Ex-99.906CERT. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FORT DEARBORN INCOME SECURITIES, INC. By: /s/ Joseph A. Varnas --------------------- Joseph A. Varnas President Date: December 2, 2003 ---------------- Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Joseph A. Varnas --------------------- Joseph A. Varnas President Date: December 2, 2003 ---------------- By: /s/ Paul H. Schubert -------------------- Paul H. Schubert Treasurer Date: December 2, 2003 ----------------