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: 811-02684
| T. Rowe Price Tax-Free Income Fund, Inc. |
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| (Exact name of registrant as specified in charter) |
| 100 East Pratt Street, Baltimore, MD 21202 |
|
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| (Address of principal executive offices) |
| David Oestreicher |
| 100 East Pratt Street, Baltimore, MD 21202 |
|
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| (Name and address of agent for service) |
Registrant’s telephone number, including area
code: (410) 345-2000
Date of fiscal year end: February
28
Date of reporting period: August 31, 2015
Item 1. Report to Shareholders
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|
Tax-Free
Income Fund |
August
31, 2015 |
The views and opinions in this report were current as of August 31, 2015. They are not guarantees of performance or investment results and should not be taken as investment advice. Investment decisions reflect a variety of factors, and the managers reserve the right to change their views about individual stocks, sectors, and the markets at any time. As a result, the views expressed should not be relied upon as a forecast of the fund’s future investment intent. The report is certified under the Sarbanes-Oxley Act, which requires mutual funds and other public companies to affirm that, to the best of their knowledge, the information in their financial reports is fairly and accurately stated in all material respects.
REPORTS ON THE WEB
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Manager’s Letter
Fellow Shareholders
Tax-free municipal bonds posted modestly positive results in the six-month period ended August 31, 2015, outperforming taxable bonds. Munis are one of the best-performing asset classes for the year to date, as global markets and other higher-risk assets have fallen sharply in recent months in response to China’s economic deceleration and tumbling commodity prices. Tax-free and taxable money market rates remained close to 0.00%, as the Federal Reserve prepared to begin raising short-term rates. While there was little performance difference among short-, intermediate-, and long-term securities, higher-quality municipals outpaced lower-quality issues. The T. Rowe Price Tax-Free Funds generally performed in line with or better than their benchmarks in the last six months, and the funds’ longer-term relative performance records remained favorable.
ECONOMY AND INTEREST RATES
The economy improved from sluggish first-quarter growth, expanding at an annualized pace of 3.7% in the second quarter of 2015 according to the most recent estimates. The labor market continued to improve, with solid job gains driving the national unemployment rate down to 5.1% in August, its lowest level since 2008. Inflation is likely to remain very low in the near term due to recent declines in oil and other commodity prices. Lower energy costs bode well for consumer spending in the second half of the year. Despite the recent global financial market volatility, the Federal Reserve still seems to be on track to begin raising short-term U.S. interest rates at some point in the months ahead. Subsequent rate hikes are expected to be very gradual.
There were large fluctuations in U.S. Treasury and municipal yields during the reporting period in anticipation of the onset of tighter Fed monetary policy and in response to turmoil in global markets. Both the U.S. Treasury and municipal yield curves steepened over the period, though long-term municipal yields did not rise as much as their Treasury counterparts with similar maturities. At the end of the reporting period, 30-year municipal bonds yielded more than comparable-maturity Treasuries, making them attractive versus taxable bonds as an alternative for taxable fixed income investors.
As an illustration of their relative attractiveness, on August 31, 2015, the 3.10% yield offered by a 30-year tax-free general obligation (GO) bond rated AAA was about 105% of the 2.95% pretax yield offered by a 30-year Treasury bond. Including the 3.8% net investment income tax that took effect in 2013 as part of the Affordable Care Act, the top marginal federal tax rate currently stands at 43.4%. An investor in this tax bracket would need to invest in a taxable bond yielding about 5.48% to receive the same after-tax income as that generated by the municipal bond. (To calculate a municipal bond’s taxable-equivalent yield, divide the yield by the quantity of 1.00 minus your federal tax bracket expressed as a decimal—in this case, 1.00 – 0.434, or 0.566.)
MUNICIPAL MARKET NEWS
In the first eight months of 2015, total municipal bond issuance was $289 billion, according to The Bond Buyer, a substantial year-over-year increase. Refunding debt has been rising significantly, as muni issuers have been taking advantage of cheap borrowing costs to refinance older, higher-cost debt. Inflows into the muni market in the first quarter of the year transitioned into a slow but steady pace of outflows during the summer months, though demand from individual investors has been picking up in response to higher muni yields. Overall, flows remain positive for the year to date.
With a few exceptions, fundamentals for municipal issuers remain solid overall. The overwhelming number of issuers in the $3.7 trillion municipal bond market are acting responsibly—raising revenues, reducing expenses, balancing budgets, and taking steps to address long-term liability issues. Most state and local governments have been very cautious about adding to indebtedness since the financial crisis, and a strengthening economy has helped tax revenues rebound. Over 60% of the market is AAA or AA rated, as measured by the Barclays Municipal Bond Index.
Although the market is overwhelmingly high quality, many states and municipalities are grappling with underfunded pensions and other post-employment benefit (OPEB) obligations. Investors often overlooked this long-term risk in the past. We believe that the market will price in higher pension risks over time as the magnitude of unfunded liabilities becomes more conspicuous. New reporting rules from the Governmental Accounting Standards Board will bring greater transparency to state and local governments’ pension funding gaps.
In the last six months, Chicago’s financial problems, highlighted by an underfunded pension system and other considerations, drew increasing attention after the city’s GO debt was downgraded to below investment-grade status by Moody’s in May. The timing of the move by Moody’s came just as the Illinois Supreme Court had reversed steps toward pension reform that had recently been introduced in the state. In July, Chicago’s plan to reform a portion of its underfunded pension system was similarly struck down by an Illinois Circuit Court judge, who ruled that the proposed changes diminish pension benefits for individual workers and violate the state constitution, which led to further credit spread widening for both the city and the state. Most of our municipal portfolios have no exposure to GO debt issued by Chicago, and the recent developments in the city reinforce our bias for revenue bonds that are more insulated from the pension funding risks faced by GO debt.
Puerto Rico was also in the headlines during our reporting period. In late June, Governor Alejandro García Padilla conceded that the U.S. territory could not continue servicing its roughly $72 billion in public debt. The commonwealth subsequently experienced its first official default when it failed to make the full payment due on its Public Finance Corporation bonds at the beginning of August; while this event weighed on the high yield muni index, contagion in the broad muni market has been limited. After our reporting period ended, the commonwealth released a fiscal and economic growth plan that will likely entail a debt restructuring, as the priority of paying debt service as scheduled was notably absent from the plan. T. Rowe Price’s municipal team has long maintained that Puerto Rico’s debt burden is unsustainable and would eventually need to be restructured, and our municipal bond portfolios have had very little exposure to the commonwealth’s bonds for some time.
In terms of sector performance, revenue bonds outperformed GOs over the last six months. We continue to favor bonds backed by a dedicated revenue stream over GOs, with a preference for higher-yielding health care and transportation debt. Among revenue bonds, housing, hospital, and water and sewer bonds posted the strongest performance, while leasing was the only revenue sector to post negative returns. High yield tobacco performed particularly well over the period, outpacing the broad municipal market by a wide margin.
PORTFOLIO STRATEGY
TAX-EXEMPT MONEY FUND
The fund returned 0.01% during the six months ended August 31, 2015, compared with the 0.00% return of the Lipper Tax-Exempt Money Market Funds Index. All money market rates continue to be closely tied to the Federal Reserve’s fed funds target rate of 0.00% to 0.25%.
Persistently low money market rates continue to suppress income for investors in the fund. The Fed has maintained a zero rate monetary policy stance since the 2008 financial crisis and has not raised interest rates since 2006. However, with the U.S. economy continuing to show improvement, many market observers have concluded that the Fed will lift short-term rates sometime this year.
Still, the municipal money market has been quite slow in fully pricing in this view. Over the past six months, overnight yields have stayed largely unchanged at 0.01%. Longer-term money market yields have increased, with the yield on one-year offerings moving higher by about seven basis points to 0.23%. Expectations for higher interest rates within the investment horizon could be one reason for this steepening in the money market yield curve.
The low interest rates over the last few years have contributed to an imbalance between supply and demand as issuers chose to borrow for longer periods to lock in currently favorable financing costs, leading to less short-term issuance to offset maturing debt. We have discussed this concern in prior letters, and at this time, we see no signs of abatement. Variable rate demand note (VRDN) supply is currently around $239 billion, down 57.7% from the high in 2007 of $565 billion. The result has been dramatic—for the first time in many years, total municipal money market assets under management ($247 billion) are higher than VRDN supply outstanding. This imbalance goes a long way toward explaining the near-zero yields that persist on short-dated municipal money market instruments.
Better economic conditions are also having an impact on supply. Municipalities have seen revenues increase over the last couple of years, reducing their need for short-term borrowing. As a result, two of the largest borrowers in the municipal money market—Texas and California—will not be issuers this year. This is good news for municipalities but bad news for money funds because both issuers are well-known, liquid names owned by a large number of portfolios. Other municipalities are also reducing their money market borrowing. The result is a further reduction in money market supply, as overall note issuance is expected to decrease by at least 20% this year.
Credit quality plays a large role in the management of the fund. As a policy, we favor highly rated securities such as state and local GOs as well as hospital and education revenue bonds. Some prominent positions in the portfolio include State of Texas; King County, Washington; Trinity Health; and Duke University. The Fed remains cautious in removing monetary accommodations, and we believe that the path toward rate normalization will be long and slow. As always, we remain committed to managing a high-quality, diversified portfolio focused on liquidity and stability of principal, which we deem of utmost importance to our shareholders. (Please refer to the fund’s portfolio of investments for a complete list of holdings and the amount each represents in the portfolio.)
Finally, as we have discussed previously, the Securities and Exchange Commission rule changes affecting money market funds are expected to become effective in October 2016. T. Rowe Price is currently reviewing these rule changes and their ramifications for shareholders. For most shareholders, there will be no more than a minimal change to their investments. We intend to offer a full range of investing solutions and will write more about this important topic as the situation unfolds.
TAX-FREE SHORT-INTERMEDIATE FUND
The fund returned -0.02% during the six-month reporting period compared with -0.44% for the Lipper Short-Intermediate Municipal Debt Funds Average, which measures the performance of competing funds. (Performance is also shown in the table for the Advisor Class, which has a different fee structure.) While security selection within the revenue bond sector was slightly negative over the reporting period, the fund continues to benefit from our overweight to the sector—particularly to the health care subsector. Our zero exposure to Puerto Rico also aided returns. The fund’s net asset value per share was $5.62 at the end of August, down from $5.66 six months earlier. Dividends per share contributed $0.04 to the fund’s total return during the reporting period.
Over the last six months, we reduced the fund’s duration by about 0.2 years to finish the reporting period about 5% shorter than the duration of the benchmark. This defensive duration positioning results from our expectation for increased volatility in shorter-maturity securities as the Fed moves toward interest rate normalization. However, we do not anticipate that the central bank’s actions will move short-term rates substantially higher. We believe the yield curve will flatten modestly as the Fed raises short-term rates, and we will likely extend the portfolio’s duration to take advantage of the higher rates available on longer-maturity debt.
In terms of yield curve positioning, we maintained a “barbell” strategy that overweights short- and long-maturity securities and underweights intermediate-term debt. Over the last six months, we have invested cash in short-maturity bonds, increasing the fund’s exposure to securities maturing within two years. We also added a few small positions—including several hospital revenue bonds—in the 10- to 15-year part of the yield curve to manage duration and pick up additional yield. While returns were generally flat along the yield curve over the reporting period, the fund’s barbelled curve positioning has aided relative returns over the long term.
The fund’s sector allocations did not change significantly during the reporting period. We continued to emphasize revenue bonds, favoring the relative security of specific claims on revenues versus the generic pledges of taxing power associated with GOs. Within the revenue sector, health care and transportation remain the fund’s largest allocations and overweights relative to the index. We did add to a handful of local GOs, including New York City and Maryland municipalities, which caused our overall allocation to GOs to tick up slightly. We continue to avoid Puerto Rico and have very small holdings of Illinois and New Jersey debt as we generally steer clear of states where we see mounting fiscal pressures from growing pension liabilities. As always, we will continue to focus on the municipal bonds and sectors that our fundamental research-driven investment process uncovers as having superior prospects for long-term returns. (Please refer to the fund’s portfolio of investments for a complete list of holdings and the amount each represents in the portfolio.)
TAX-FREE INCOME FUND
The fund returned 0.33% during the six-month period ended August 31, 2015, compared with -0.13% for the Lipper peer group average, which measures the performance of competing funds. (Performance for the Advisor Class was somewhat lower, reflecting its different fee structure.) The fund’s relative outperformance was driven by our emphasis on revenue bonds over GOs as well as strong security selection coming from the health care and transportation segments of the market. The fund’s net asset value per share was $10.30 at the end of August, down from $10.46 six months earlier. Dividends per share contributed $0.19 to the fund’s total return during the reporting period.
The fund’s duration declined slightly to 4.3 years and was shorter than the duration of the Barclays Municipal Bond Index as well as the peer fund median. The fund’s weighted average maturity also decreased to 16.4 years, yet remained longer than that of the benchmark, reflecting our bias toward bonds with longer maturities. As for yield curve positioning, we maintained an overweight relative to the benchmark in maturities 20 years and longer to earn the additional yield available on longer-maturity securities. Our yield curve emphasis continues to be on the long-maturity end, a positioning that has aided returns over longer time periods. We believe the yield curve will flatten modestly in the coming months as the Fed raises short-term rates. Returns were generally flat across the yield curve during the six-month period.
There was no significant change to the fund’s credit quality profile. We maintained an overweight to A and BBB rated holdings, as we believe they offer greater value than their higher-quality counterparts. Of note, the fund has no exposure to bonds issued by the Commonwealth of Puerto Rico and its agencies, reflecting our view that the U.S. territory’s fiscal deficits and bloated indebtedness are unsustainable.
The fund’s overall sector weightings were also little changed over the course of the reporting period. Our bias toward revenue bonds over GOs remained intact as a result of our longer-term concern that many municipalities will face fiscal challenges related to pension and health care liabilities. Health care and transportation were the two largest sector allocations and overweights relative to the index and generated strong security selection results for the fund over the reporting period. Our allocation to the prerefunded sector increased by three percentage points, as a number of fund holdings were refinanced by their issuers and recategorized into this sector.
We sold securities from issuers that we believe may underperform in the future due to growing pension liabilities, such as Chicago and New Jersey state-appropriated debt, as well as various corporate-backed and project-finance securities where we view weakening credit fundamentals and/or relatively high market valuations as causes for potential underperformance.
With municipal market returns close to flat for the reporting period, our holdings that fared best varied in structure and characteristics. A number of lower-rated holdings continued to perform well, as did bonds with near-term issuer prepayment options that were priced at or near par. Illinois-related issuers dominated the list of the fund’s underperformers, including the Metropolitan Pier and Exposition Authority and the Regional Transportation Authority. We believe these issues will do well for the portfolio in the longer run. As always, we will continue to focus on the best long-term prospects in the municipal market, driven by our fundamental research-based investment process. (Please refer to the fund’s portfolio of investments for a complete list of holdings and the amount each represents in the portfolio.)
TAX-FREE HIGH YIELD FUND
The Tax-Free High Yield Fund posted a return of 0.22% for the six-month period ended August 31, 2015, compared with 0.00% for our Lipper peer group. (The result for the Advisor Class, which has a different fee structure, is also shown in the table.) The fund’s net asset value per share was $11.83 at the end of August, down from $12.04 six months earlier, and dividends per share contributed $0.24 to the fund’s total return during the reporting period.
We added to our already significant exposures in the hospital and life care sectors, which were both among the best performers for the reporting period. The financial performance of hospital revenue bonds has improved markedly since the global financial crisis of 2008–2009. Operating margins have generally strengthened under the Affordable Care Act, as a larger percentage of the U.S. population now enjoys some health benefits. Several years of solid returns in the financial markets have further augmented hospital balance sheets. We added holdings in Meritus Medical Center (Maryland), Einstein Healthcare (Pennsylvania), and Owensboro Medical Health (Kentucky) during the reporting period. (Please refer to the fund’s portfolio of investments for a complete list of holdings and the amount each represents in the portfolio.)
Life care bonds, which are issued for continuing care retirement communities (CCRCs), have posted strong returns in recent years. We continue to believe that the demographics of an aging population provide a solid demand tailwind for this sector of the tax-exempt market. The recent recovery in the real estate market, coupled with improved investment returns, has rekindled demand for well-conceived retirement communities in many regions of the country. We participated in the refinancing of several existing CCRC bonds, including White Marsh (Pennsylvania), and initiated a position in Salemtown (North Carolina).
We benefited from our notable underweight position in Puerto Rico-domiciled issuers, particularly the COFINA (Puerto Rico Sales Tax Financing Corporation) bonds backed by sales taxes as well as Puerto Rico GOs. Expectations for full and timely payment on these bonds turned decisively negative following a June address from the governor in which he outlined the commonwealth’s significant fiscal stress and a desire to restructure bond commitments. Our small holdings in PREPA (Puerto Rico Electric Power Authority) recovered as prospects for a restructuring agreement with bondholders improved.
Our conservative positioning in tobacco securitization bonds detracted from relative performance for the six-month period as the sector sharply outpaced the broad municipal market. Cigarette shipments have recently declined at a slower rate, following years of precipitous drops due to taxation and successful cessation initiatives. We continue to anticipate defaults on long-maturity tobacco securitization bonds with highly leveraged structures. Conversely, we believe that select tobacco bonds that are currently paying down principal offer compelling relative value and maintain significant holdings of shorter-maturity bonds issued out of New Jersey and California.
We continue to favor revenue bonds issued by essential service providers such as airports and toll roads over GOs despite recent valuation and credit rating shifts in large, liquid issuers like Chicago and the State of New Jersey. We remain focused on infrastructure investments that have strong state sponsorship, limited competition, and outstanding demand prospects, and we added to our holdings in Ohio River Bridges (Indiana) and Elizabeth River Crossings (Virginia). We believe revenue bonds are largely shielded from the pension and OPEB issues plaguing many state and local GO borrowers. The municipal market is in the early stages of repricing risk in the GO market, long considered a bastion of credit safety. We are watching these developments keenly, particularly how they might affect valuations for medium- and lower-quality borrowers.
Fixed income markets have been gyrating sharply in recent months in anticipation of short-term interest rate hikes and due to significant global crosscurrents. In municipals, the headlines continue to be dominated by the poorest fiscal actors. In this environment, fundamental credit research is crucial. As always, we will continue to search for the best risk-adjusted investment opportunities in the medium- and lower-quality parts of the muni market.
INTERMEDIATE TAX-FREE HIGH YIELD FUND
The Intermediate Tax-Free High Yield Fund returned 0.32% for the six-month period ended August 31, 2015, compared with 0.00% for our Lipper peer group. (The result for the Advisor Class, which has a different fee structure, is also shown in the table.) The fund’s net asset value was $10.15 at the end of August, down from $10.24 six months earlier, and dividends per share contributed $0.12 to the fund’s total return during the reporting period.
Our strong bias toward revenue bonds over GOs remains intact. We have considerable exposure to the health care segment and added to these holdings over the six-month periods. Life care bonds, in particular, have posted strong returns in recent years, outpacing the broad municipal market handily. The recovery in real estate and other investment markets has rekindled demand for well-conceived retirement facilities in many regions. We continue to believe that the demographics of an aging population will favor this sector over the next decade. During the reporting period, we added bonds issued by Amsterdam at Harborside (New York), Redstone Village (Alabama), and Plymouth Place (Illinois). (Please refer to the fund’s portfolio of investments for a complete list of holdings and the amount each represents in the portfolio.)
Hospital revenue bonds also performed well over the reporting period. The financial performance of hospitals has been improving for years. More recently, the Affordable Care Act has aided hospital profitability because a larger percentage of citizens have health insurance. In addition, prudent management and solid investment returns have bolstered health system balance sheets. We added Orange Regional Medical Center (New York) and Meritus Medical Center (Maryland) during the reporting period.
We benefited from our notable underweight position in Puerto Rico-domiciled issuers, particularly the COFINA bonds backed by sales taxes as well as Puerto Rico GOs. Expectations for full and timely payment on these bonds turned decisively negative following a June address from the governor in which he outlined the commonwealth’s significant fiscal stress and a desire to restructure bond commitments. Our holdings of short-maturity bonds backed by the Puerto Rico Government Development Bank detracted from relative performance.
We continue to favor industrial development bonds issued on a tax-exempt basis by corporations. Our holdings of airline bonds backed by Southwest Airlines, United Airlines, and American Airlines posted strong returns as the domestic economy improved and fuel prices dropped significantly. We remain constructive on this sector moving forward.
Our conservative positioning in tobacco securitization bonds detracted from relative performance for the six-month period as the sector sharply outpaced the broad municipal market. Cigarette shipments have recently declined at a slower rate following years of precipitous drops due to taxation and successful cessation initiatives. We continue to anticipate defaults on long-maturity tobacco securitization bonds with highly leveraged structures. Conversely, we believe that select tobacco bonds that are currently paying down principal offer compelling relative value and maintain significant holdings of shorter-maturity bonds issued out of New Jersey and California.
We are enthusiastic about the long-term prospects for the fund, especially for investors who are comfortable with medium- and lower-quality credit exposure but are less at ease with the potential for higher interest rates. We remain committed to utilizing our strong proprietary research to uncover the best investment opportunities in this marketplace.
OUTLOOK
We believe that the municipal bond market remains a high-quality market that offers good opportunities for long-term investors seeking tax-free income. While fundamentals are sound overall and technical support should persist, there could be hurdles later in 2015. In particular, with the Fed preparing to tighten monetary policy, we are mindful that rising rates would likely weaken the appetite for bonds with higher interest rate risk. However, with the Fed likely to act cautiously, the transition to higher rates may not be as painful as some fear.
While we believe that many states deserve high credit ratings and will be able to continue servicing their debts, we have longer-term concerns about significant funding shortfalls for pensions and OPEB obligations in some jurisdictions. These funding gaps stem from investment losses during the financial crisis, insufficient plan contributions over time, and unrealistic return projections. Although few large plans are at risk of insolvency in the near term, the magnitude of unfunded liabilities is becoming more conspicuous in a few states.
Ultimately, we believe T. Rowe Price’s independent credit research is our greatest strength and will remain an asset for our investors as we navigate the current market environment. As always, we focus on finding attractively valued bonds issued by municipalities with good long-term fundamentals—an investment strategy that we believe will continue to serve our investors well.
Thank you for investing with T. Rowe Price.
Respectfully submitted,
Joseph K. Lynagh
Chairman of the Investment Advisory Committee
Tax-Exempt
Money Fund
Charles B. Hill
Chairman of the Investment Advisory Committee
Tax-Free
Short-Intermediate Fund
Konstantine B. Mallas
Chairman of the Investment Advisory Committee
Tax-Free
Income Fund
James M. Murphy
Chairman of the Investment Advisory
Committee
Tax-Free High Yield Fund and
Intermediate Tax-Free High Yield Fund
September 22, 2015
The committee chairmen have day-to-day responsibility for managing the portfolios and work with committee members in developing and executing the funds’ investment programs.
RISKS OF FIXED INCOME INVESTING
Since money market funds are managed to maintain a constant $1.00 share price, there should be little risk of principal loss. However, there is no assurance the fund will avoid principal losses if fund holdings default or are downgraded, or if interest rates rise sharply in an unusually short period. In addition, the fund’s yield will vary; it is not fixed for a specific period like the yield on a bank certificate of deposit. An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation (FDIC) or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in it.
Bonds are subject to interest rate risk (the decline in bond prices that usually accompanies a rise in interest rates) and credit risk (the chance that any fund holding could have its credit rating downgraded or that a bond issuer will default by failing to make timely payments of interest or principal), potentially reducing the fund’s income level and share price. High yield bonds could have greater price declines than funds that invest primarily in high-quality bonds. Municipalities issuing high yield bonds are not as strong financially as those with higher credit ratings, so the bonds are usually considered speculative investments. Some income may be subject to state and local taxes and the federal alternative minimum tax.
GLOSSARY
Barclays Municipal Bond Index: An unmanaged index that tracks municipal debt instruments.
Barclays 1–5 Year Blend (1–6 Year Maturity) Index: A subindex of the Barclays Municipal Bond Index. It is a rules-based, market value-weighted index of short-term bonds engineered for the tax-exempt bond market.
Barclays 65% High-Grade/35% High-Yield Intermediate Competitive (1–17 Year Maturity) Index: An index that tracks Barclays indexes of both investment-grade and below investment-grade municipal debt instruments.
Basis point: One one-hundredth of one percentage point, or 0.01%.
Credit spread: The additional yield above that of a comparable-maturity Treasury security that investors demand for holding a bond with credit risk.
Duration: A measure of a bond fund’s sensitivity to changes in interest rates. For example, a fund with a duration of five years would fall about 5% in price in response to a one-percentage-point rise in interest rates, and vice versa.
Federal funds rate: The interest rate charged on overnight loans of reserves by one financial institution to another in the United States. The Federal Reserve sets a target federal funds rate to affect the direction of interest rates.
General obligation (GO) debt: A government’s strongest pledge that obligates its full faith and credit, including, if necessary, its ability to raise taxes.
Gross domestic product: The total market value of all goods and services produced in a country in a given year.
Investment grade: High-quality bonds as measured by one of the major credit rating agencies. For example, Standard & Poor’s designates the bonds in its top four categories (AAA to BBB) as investment grade.
Lipper averages: The averages of available mutual fund performance returns for specified time periods in categories defined by Lipper Inc.
Lipper indexes: Fund benchmarks that consist of a small number (10 to 30) of the largest mutual funds in a particular category as tracked by Lipper Inc.
Other post-employment benefits (OPEB): Benefits paid to an employee after retirement, such as premiums for life and health insurance.
Prerefunded bond: A bond that originally may have been issued as a general obligation or revenue bond but that is now secured by an escrow fund consisting entirely of direct U.S. government obligations that are sufficient for paying the bondholders.
SEC yield (7-day simple): A method of calculating a money fund’s yield by annualizing the fund’s net investment income for the last seven days of each period divided by the fund’s net asset value at the end of the period. Yield will vary and is not guaranteed.
SEC yield (30-day): A method of calculating a fund’s yield that assumes all portfolio securities are held until maturity. Yield will vary and is not guaranteed.
Variable rate demand note (VRDN): Generally, a debt security that requires the issuer to redeem at the holder’s discretion on a specified date or dates prior to maturity. Upon redemption, the issuer pays par to the holder who loses future coupon payments that might otherwise be due. The VRDN might be especially attractive at times of rising rates, to protect against interest rate risk by redeeming at par value and reinvesting proceeds in a new bond.
Weighted average life: A measure of a fund’s credit quality risk. In general, the longer the average life, the greater the fund’s credit quality risk. The average life is the dollar-weighted average maturity of a portfolio’s individual securities without taking into account interest rate readjustment dates. Money funds must maintain a weighted average life of less than 120 days.
Weighted average maturity: A measure of a fund’s interest rate sensitivity. In general, the longer the average maturity, the greater the fund’s sensitivity to interest rate changes. The weighted average maturity may take into account the interest rate readjustment dates for certain securities. Money funds must maintain a weighted average maturity of less than 60 days.
Yield curve: A graphic depiction of the relationship between yields and maturity dates for a set of similar securities. A security with a longer maturity usually has a higher yield. If a short-term security offers a higher yield, then the curve is said to be “inverted.” If short- and long-term bonds are offering equivalent yields, then the curve is said to be “flat.”
Performance and Expenses
| Growth of $10,000 |
This chart shows the value of a hypothetical $10,000 investment in the fund over the past 10 fiscal year periods or since inception (for funds lacking 10-year records). The result is compared with benchmarks, which may include a broad-based market index and a peer group average or index. Market indexes do not include expenses, which are deducted from fund returns as well as mutual fund averages and indexes.
| Fund Expense Example |
As a mutual fund shareholder, you may incur two types of costs: (1) transaction costs, such as redemption fees or sales loads, and (2) ongoing costs, including management fees, distribution and service (12b-1) fees, and other fund expenses. The following example is intended to help you understand your ongoing costs (in dollars) of investing in the fund and to compare these costs with the ongoing costs of investing in other mutual funds. The example is based on an investment of $1,000 invested at the beginning of the most recent six-month period and held for the entire period.
Actual Expenses
The first line of the following table (Actual) provides
information about actual account values and actual expenses. You may use the
information on this line, together with your account balance, to estimate the
expenses that you paid over the period. Simply divide your account value by
$1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then
multiply the result by the number on the first line under the heading “Expenses
Paid During Period” to estimate the expenses you paid on your account during
this period.
Please note that the Tax-Free Short-Intermediate Fund, Tax-Free Income Fund, Tax-Free High Yield Fund, and Intermediate Tax-Free High Yield Fund have two share classes: The original share class (Investor Class) charges no distribution and service (12b-1) fee, and the Advisor Class shares are offered only through unaffiliated brokers and other financial intermediaries and charge a 0.25% 12b-1 fee. Each share class is presented separately in the table.
Hypothetical Example for Comparison
Purposes
The information on the second
line of the table (Hypothetical) is based on hypothetical account values and
expenses derived from the fund’s actual expense ratio and an assumed 5% per year
rate of return before expenses (not the fund’s actual return). You may compare
the ongoing costs of investing in the fund with other funds by contrasting this
5% hypothetical example and the 5% hypothetical examples that appear in the
shareholder reports of the other funds. The hypothetical account values and
expenses may not be used to estimate the actual ending account balance or
expenses you paid for the period.
Note: T. Rowe Price charges an annual account service fee of $20, generally for accounts with less than $10,000. The fee is waived for any investor whose T. Rowe Price mutual fund accounts total $50,000 or more; accounts electing to receive electronic delivery of account statements, transaction confirmations, prospectuses, and shareholder reports; or accounts of an investor who is a T. Rowe Price Preferred Services, Personal Services, or Enhanced Personal Services client (enrollment in these programs generally requires T. Rowe Price assets of at least $100,000). This fee is not included in the accompanying table. If you are subject to the fee, keep it in mind when you are estimating the ongoing expenses of investing in the fund and when comparing the expenses of this fund with other funds.
You should also be aware that the expenses shown in the table highlight only your ongoing costs and do not reflect any transaction costs, such as redemption fees or sales loads. Therefore, the second line of the table is useful in comparing ongoing costs only and will not help you determine the relative total costs of owning different funds. To the extent a fund charges transaction costs, however, the total cost of owning that fund is higher.
Unaudited
The accompanying notes are an integral part of these financial statements.
Unaudited
The accompanying notes are an integral part of these financial statements.
Unaudited
The accompanying notes are an integral part of these financial statements.
Unaudited
The accompanying notes are an integral part of these financial statements.
Unaudited
The accompanying notes are an integral part of these financial statements.
Unaudited
The accompanying notes are an integral part of these financial statements.
Unaudited
| Notes to Financial Statements |
T. Rowe Price Tax-Free Income Fund, Inc. (the fund), is registered under the Investment Company Act of 1940 (the 1940 Act) as a diversified, open-end management investment company. The fund seeks to provide a high level of income exempt from federal income taxes by investing primarily in long-term investment-grade municipal securities. The fund has two classes of shares: the Tax-Free Income Fund original share class, referred to in this report as the Investor Class, offered since October 26, 1976, and the Tax-Free Income Fund–Advisor Class (Advisor Class), offered since September 30, 2002. Advisor Class shares are sold only through unaffiliated brokers and other unaffiliated financial intermediaries that are compensated by the class for distribution, shareholder servicing, and/or certain administrative services under a Board-approved Rule 12b-1 plan. Each class has exclusive voting rights on matters related solely to that class; separate voting rights on matters that relate to both classes; and, in all other respects, the same rights and obligations as the other class.
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
Basis of Preparation The fund is an investment company and follows accounting and reporting guidance in the Financial Accounting Standards Board (FASB) Accounting Standards Codification Topic 946 (ASC 946). The accompanying financial statements were prepared in accordance with accounting principles generally accepted in the United States of America (GAAP), including but not limited to ASC 946. GAAP requires the use of estimates made by management. Management believes that estimates and valuations are appropriate; however, actual results may differ from those estimates, and the valuations reflected in the accompanying financial statements may differ from the value ultimately realized upon sale or maturity.
Investment Transactions, Investment Income, and Distributions Income and expenses are recorded on the accrual basis. Premiums and discounts on debt securities are amortized for financial reporting purposes. Dividend income and capital gain distributions are recorded on the ex-dividend date. Income tax-related interest and penalties, if incurred, would be recorded as income tax expense. Investment transactions are accounted for on the trade date. Realized gains and losses are reported on the identified cost basis. Distributions to shareholders are recorded on the ex-dividend date. Income distributions are declared by each class daily and paid monthly. Capital gain distributions, if any, are generally declared and paid by the fund annually.
Class Accounting The Advisor Class pays distribution, shareholder servicing, and/or certain administrative expenses in the form of Rule 12b-1 fees, in an amount not exceeding 0.25% of the class’s average daily net assets. Shareholder servicing, prospectus, and shareholder report expenses incurred by each class are charged directly to the class to which they relate. Expenses common to both classes and investment income are allocated to the classes based upon the relative daily net assets of each class’s settled shares; realized and unrealized gains and losses are allocated based upon the relative daily net assets of each class’s outstanding shares.
New Accounting Guidance In May 2015, FASB issued ASU No. 2015-07, Fair Value Measurement (Topic 820), Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent). The ASU removes the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient and amends certain disclosure requirements for such investments. The ASU is effective for interim and annual reporting periods beginning after December 15, 2015. Adoption will have no effect on the fund’s net assets or results of operations.
NOTE 2 - VALUATION
The fund’s financial instruments are valued and each class’s net asset value (NAV) per share is computed at the close of the New York Stock Exchange (NYSE), normally 4 p.m. ET, each day the NYSE is open for business.
Fair Value The fund’s financial instruments are reported at fair value, which GAAP defines as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The T. Rowe Price Valuation Committee (the Valuation Committee) has been established by the fund’s Board of Directors (the Board) to ensure that financial instruments are appropriately priced at fair value in accordance with GAAP and the 1940 Act. Subject to oversight by the Board, the Valuation Committee develops and oversees pricing-related policies and procedures and approves all fair value determinations. Specifically, the Valuation Committee establishes procedures to value securities; determines pricing techniques, sources, and persons eligible to effect fair value pricing actions; oversees the selection, services, and performance of pricing vendors; oversees valuation-related business continuity practices; and provides guidance on internal controls and valuation-related matters. The Valuation Committee reports to the Board and has representation from legal, portfolio management and trading, operations, risk management, and the fund’s treasurer.
Various valuation techniques and inputs are used to determine the fair value of financial instruments. GAAP establishes the following fair value hierarchy that categorizes the inputs used to measure fair value:
Level 1 – quoted prices (unadjusted) in active markets for identical financial instruments that the fund can access at the reporting date
Level 2 – inputs other than Level 1 quoted prices that are observable, either directly or indirectly (including, but not limited to, quoted prices for similar financial instruments in active markets, quoted prices for identical or similar financial instruments in inactive markets, interest rates and yield curves, implied volatilities, and credit spreads)
Level 3 – unobservable inputs
Observable inputs are developed using market data, such as publicly available information about actual events or transactions, and reflect the assumptions that market participants would use to price the financial instrument. Unobservable inputs are those for which market data are not available and are developed using the best information available about the assumptions that market participants would use to price the financial instrument. GAAP requires valuation techniques to maximize the use of relevant observable inputs and minimize the use of unobservable inputs. When multiple inputs are used to derive fair value, the financial instrument is assigned to the level within the fair value hierarchy based on the lowest-level input that is significant to the fair value of the financial instrument. Input levels are not necessarily an indication of the risk or liquidity associated with financial instruments at that level but rather the degree of judgment used in determining those values.
Valuation Techniques Debt securities generally are traded in the over-the-counter (OTC) market. Securities with remaining maturities of one year or more at the time of acquisition are valued at prices furnished by dealers who make markets in such securities or by an independent pricing service, which considers the yield or price of bonds of comparable quality, coupon, maturity, and type, as well as prices quoted by dealers who make markets in such securities. Securities with remaining maturities of less than one year at the time of acquisition generally use amortized cost in local currency to approximate fair value. However, if amortized cost is deemed not to reflect fair value or the fund holds a significant amount of such securities with remaining maturities of more than 60 days, the securities are valued at prices furnished by dealers who make markets in such securities or by an independent pricing service. Generally, debt securities are categorized in Level 2 of the fair value hierarchy; however, to the extent the valuations include significant unobservable inputs, the securities would be categorized in Level 3.
Equity securities listed or regularly traded on a securities exchange or in the OTC market are valued at the last quoted sale price or, for certain markets, the official closing price at the time the valuations are made. OTC Bulletin Board securities are valued at the mean of the closing bid and asked prices. A security that is listed or traded on more than one exchange is valued at the quotation on the exchange determined to be the primary market for such security. Listed securities not traded on a particular day are valued at the mean of the closing bid and asked prices. Actively traded domestic equity securities generally are categorized in Level 1 of the fair value hierarchy. OTC Bulletin Board securities, certain preferred securities, and equity securities traded in inactive markets generally are categorized in Level 2 of the fair value hierarchy.
Financial futures contracts are valued at closing settlement prices and are categorized in Level 1 of the fair value hierarchy. Assets and liabilities other than financial instruments, including short-term receivables and payables, are carried at cost, or estimated realizable value, if less, which approximates fair value.
Thinly traded financial instruments and those for which the above valuation procedures are inappropriate or are deemed not to reflect fair value are stated at fair value as determined in good faith by the Valuation Committee. The objective of any fair value pricing determination is to arrive at a price that could reasonably be expected from a current sale. Financial instruments fair valued by the Valuation Committee are primarily private placements, restricted securities, warrants, rights, and other securities that are not publicly traded.
Subject to oversight by the Board, the Valuation Committee regularly makes good faith judgments to establish and adjust the fair valuations of certain securities as events occur and circumstances warrant. For instance, in determining the fair value of troubled or thinly traded debt instruments, the Valuation Committee considers a variety of factors, which may include, but are not limited to, the issuer’s business prospects, its financial standing and performance, recent investment transactions in the issuer, strategic events affecting the company, market liquidity for the issuer, and general economic conditions and events. In consultation with the investment and pricing teams, the Valuation Committee will determine an appropriate valuation technique based on available information, which may include both observable and unobservable inputs. The Valuation Committee typically will afford greatest weight to actual prices in arm’s length transactions, to the extent they represent orderly transactions between market participants; transaction information can be reliably obtained; and prices are deemed representative of fair value. However, the Valuation Committee may also consider other valuation methods such as a discount or premium from market value of a similar, freely traded security of the same issuer; discounted cash flows; yield to maturity; or some combination. Fair value determinations are reviewed on a regular basis and updated as information becomes available, including actual purchase and sale transactions of the issue. Because any fair value determination involves a significant amount of judgment, there is a degree of subjectivity inherent in such pricing decisions, and fair value prices determined by the Valuation Committee could differ from those of other market participants. Depending on the relative significance of unobservable inputs, including the valuation technique(s) used, fair valued securities may be categorized in Level 2 or 3 of the fair value hierarchy.
Valuation Inputs The following table summarizes the fund’s financial instruments, based on the inputs used to determine their fair values on August 31, 2015:
There were no material transfers between Levels 1 and 2 during the six months ended August 31, 2015.
NOTE 3 - DERIVATIVE INSTRUMENTS
During the six months ended August 31, 2015, the fund invested in derivative instruments. As defined by GAAP, a derivative is a financial instrument whose value is derived from an underlying security price, foreign exchange rate, interest rate, index of prices or rates, or other variable; it requires little or no initial investment and permits or requires net settlement. The fund invests in derivatives only if the expected risks and rewards are consistent with its investment objectives, policies, and overall risk profile, as described in its prospectus and Statement of Additional Information. The fund may use derivatives for a variety of purposes, such as seeking to hedge against declines in principal value, increase yield, invest in an asset with greater efficiency and at a lower cost than is possible through direct investment, or to adjust portfolio duration and credit exposure. The risks associated with the use of derivatives are different from, and potentially much greater than, the risks associated with investing directly in the instruments on which the derivatives are based. The fund at all times maintains sufficient cash reserves, liquid assets, or other SEC-permitted asset types to cover its settlement obligations under open derivative contracts.
The fund values its derivatives at fair value, as described in Note 2, and recognizes changes in fair value currently in its results of operations. Accordingly, the fund does not follow hedge accounting, even for derivatives employed as economic hedges. Generally, the fund accounts for its derivatives on a gross basis. It does not offset the fair value of derivative liabilities against the fair value of derivative assets on its financial statements, nor does it offset the fair value of derivative instruments against the right to reclaim or obligation to return collateral. As of August 31, 2015, the fund held interest rate futures with cumulative unrealized gain of $33,000; the value reflected on the accompanying Statement of Assets and Liabilities is the related unsettled variation margin.
Additionally, during the six months ended August 31, 2015, the fund recognized $105,000 of realized loss on Futures and a $71,000 change in unrealized gain/loss on Futures related to its investments in interest rate derivatives; such amounts are included on the accompanying Statement of Operations.
Counterparty Risk and Collateral The fund invests in exchange-traded or centrally cleared derivative contracts, such as futures, exchange-traded options, and centrally cleared swaps. Counterparty risk on such derivatives is minimal because the clearinghouse provides protection against counterparty defaults. For futures and centrally cleared swaps, the fund is required to deposit collateral in an amount equal to a certain percentage of the contract value (margin requirement), and the margin requirement must be maintained over the life of the contract. Each clearing broker, in its sole discretion, may adjust the margin requirements applicable to the fund.
Collateral may be in the form of cash or debt securities issued by the U.S. government or related agencies. Cash and currencies posted by the fund are reflected as cash deposits in the accompanying financial statements and generally are restricted from withdrawal by the fund; securities posted by the fund are so noted in the accompanying Portfolio of Investments; both remain in the fund’s assets. As of August 31, 2015, cash of $101,000 had been posted by the fund for exchange-traded and/or centrally cleared derivatives.
Futures Contracts The fund is subject to interest rate risk in the normal course of pursuing its investment objectives and uses futures contracts to help manage such risk. The fund may enter into futures contracts to manage exposure to interest rate and yield curve movements, security prices, foreign currencies, credit quality, and mortgage prepayments; as an efficient mean of adjusting exposure to all or part of a target market; to enhance income; as a cash management tool; or to adjust portfolio duration and credit exposure. A futures contract provides for the future sale by one party and purchase by another of a specified amount of a specific underlying financial instrument at an agreed-upon price, date, time, and place. The fund currently invests only in exchange-traded futures, which generally are standardized as to maturity date, underlying financial instrument, and other contract terms. Payments are made or received by the fund each day to settle daily fluctuations in the value of the contract (variation margin), which reflect changes in the value of the underlying financial instrument. Variation margin is recorded as unrealized gain or loss until the contract is closed. The value of a futures contract included in net assets is the amount of unsettled variation margin; net variation margin receivable is reflected as an asset and net variation margin payable is reflected as a liability on the accompanying Statement of Assets and Liabilities. Risks related to the use of futures contracts include possible illiquidity of the futures markets, contract prices that can be highly volatile and imperfectly correlated to movements in hedged security values and/or interest rates, and potential losses in excess of the fund’s initial investment. During the year ended August 31, 2015, the volume of the fund’s activity in futures, based on underlying notional amounts, was generally less than 1% of net assets.
NOTE 4 - OTHER INVESTMENT TRANSACTIONS
Consistent with its investment objective, the fund engages in the following practices to manage exposure to certain risks and/or to enhance performance. The investment objective, policies, program, and risk factors of the fund are described more fully in the fund’s prospectus and Statement of Additional Information.
Restricted Securities The fund may invest in securities that are subject to legal or contractual restrictions on resale. Prompt sale of such securities at an acceptable price may be difficult and may involve substantial delays and additional costs.
When-Issued Securities The fund may enter into when-issued purchase or sale commitments, pursuant to which it agrees to purchase or sell, respectively, an authorized but not yet issued security for a fixed unit price, with payment and delivery not due until issuance of the security on a scheduled future date. When-issued securities may be new securities or securities issued through a corporate action, such as a reorganization or restructuring. Until settlement, the fund maintains liquid assets sufficient to settle its commitment to purchase a when-issued security or, in the case of a sale commitment, the fund maintains an entitlement to the security to be sold. Amounts realized on when-issued transactions are included in realized gain/loss on securities in the accompanying financial statements.
Other Purchases and sales of portfolio securities other than short-term securities aggregated $81,956,000 and $173,734,000, respectively, for the six months ended August 31, 2015.
NOTE 5 - FEDERAL INCOME TAXES
No provision for federal income taxes is required since the fund intends to continue to qualify as a regulated investment company under Subchapter M of the Internal Revenue Code and distribute to shareholders all of its income and gains. Distributions determined in accordance with federal income tax regulations may differ in amount or character from net investment income and realized gains for financial reporting purposes. Financial reporting records are adjusted for permanent book/tax differences to reflect tax character but are not adjusted for temporary differences. The amount and character of tax-basis distributions and composition of net assets are finalized at fiscal year-end; accordingly, tax-basis balances have not been determined as of the date of this report.
The fund intends to retain realized gains to the extent of available capital loss carryforwards. Because the fund is required to use capital loss carryforwards that do not expire before those with expiration dates, all or a portion of its capital loss carryforwards subject to expiration could ultimately go unused. As of February 28, 2015, the fund had $39,504,000 of available capital loss carryforwards, which expire as follows: $1,288,000 in fiscal 2016 and $9,481,000 in fiscal 2017; $28,735,000 have no expiration.
At August 31, 2015, the cost of investments for federal income tax purposes was $2,309,197,000. Net unrealized gain aggregated $197,654,000 at period-end, of which $207,868,000 related to appreciated investments and $10,214,000 related to depreciated investments.
NOTE 6 - RELATED PARTY TRANSACTIONS
The fund is managed by T. Rowe Price Associates, Inc. (Price Associates), a wholly owned subsidiary of T. Rowe Price Group, Inc. (Price Group). The investment management agreement between the fund and Price Associates provides for an annual investment management fee, which is computed daily and paid monthly. The fee consists of an individual fund fee, equal to 0.15% of the fund’s average daily net assets, and a group fee. The group fee rate is calculated based on the combined net assets of certain mutual funds sponsored by Price Associates (the group) applied to a graduated fee schedule, with rates ranging from 0.48% for the first $1 billion of assets to 0.275% for assets in excess of $400 billion. The fund’s group fee is determined by applying the group fee rate to the fund’s average daily net assets. At August 31, 2015, the effective annual group fee rate was 0.29%.
In addition, the fund has entered into service agreements with Price Associates and a wholly owned subsidiary of Price Associates (collectively, Price). Price Associates computes the daily share price and provides certain other administrative services to the fund. T. Rowe Price Services, Inc., provides shareholder and administrative services in its capacity as the fund’s transfer and dividend-disbursing agent. For the six months ended August 31, 2015, expenses incurred pursuant to these service agreements were $64,000 for Price Associates and $231,000 for T. Rowe Price Services, Inc. The total amount payable at period-end pursuant to these service agreements is reflected as Due to Affiliates in the accompanying financial statements.
| Information on Proxy Voting Policies, Procedures, and Records |
A description of the policies and procedures used by T. Rowe Price funds and portfolios to determine how to vote proxies relating to portfolio securities is available in each fund’s Statement of Additional Information. You may request this document by calling 1-800-225-5132 or by accessing the SEC’s website, sec.gov.
The description of our proxy voting policies and procedures is also available on our website, troweprice.com. To access it, click on the words “Social Responsibility” at the top of our corporate homepage. Next, click on the words “Conducting Business Responsibly” on the left side of the page that appears. Finally, click on the words “Proxy Voting Policies” on the left side of the page that appears.
Each fund’s most recent annual proxy voting record is available on our website and through the SEC’s website. To access it through our website, follow the above directions to reach the “Conducting Business Responsibly” page. Click on the words “Proxy Voting Records” on the left side of that page, and then click on the “View Proxy Voting Records” link at the bottom of the page that appears.
| How to Obtain Quarterly Portfolio Holdings |
The fund files a complete schedule of portfolio holdings with the Securities and Exchange Commission for the first and third quarters of each fiscal year on Form N-Q. The fund’s Form N-Q is available electronically on the SEC’s website (sec.gov); hard copies may be reviewed and copied at the SEC’s Public Reference Room, 100 F St. N.E., Washington, DC 20549. For more information on the Public Reference Room, call 1-800-SEC-0330.
| Approval of Investment Management Agreement |
On March 13, 2015, the fund’s Board of Directors (Board), including a majority of the fund’s independent directors, approved the continuation of the investment management agreement (Advisory Contract) between the fund and its investment advisor, T. Rowe Price Associates, Inc. (Advisor). In connection with its deliberations, the Board requested, and the Advisor provided, such information as the Board (with advice from independent legal counsel) deemed reasonably necessary. The Board considered a variety of factors in connection with its review of the Advisory Contract, also taking into account information provided by the Advisor during the course of the year, as discussed below:
Services Provided by the Advisor
The Board considered the
nature, quality, and extent of the services provided to the fund by the Advisor.
These services included, but were not limited to, directing the fund’s
investments in accordance with its investment program and the overall management
of the fund’s portfolio, as well as a variety of related activities such as
financial, investment operations, and administrative services; compliance;
maintaining the fund’s records and registrations; and shareholder
communications. The Board also reviewed the background and experience of the
Advisor’s senior management team and investment personnel involved in the
management of the fund, as well as the Advisor’s compliance record. The Board
concluded that it was satisfied with the nature, quality, and extent of the
services provided by the Advisor.
Investment Performance of the Fund
The Board reviewed the fund’s
three-month, one-year, and year-by-year returns, as well as the fund’s average
annualized total returns over the 3-, 5-, and 10-year periods, and compared
these returns with a wide variety of previously agreed-upon comparable
performance measures and market data, including those supplied by Lipper and
Morningstar, which are independent providers of mutual fund data.
On the basis of this evaluation and the Board’s ongoing review of investment results, and factoring in the relative market conditions during certain of the performance periods, the Board concluded that the fund’s performance was satisfactory.
Costs, Benefits, Profits, and Economies
of
Scale
The Board reviewed detailed information regarding the revenues received
by the Advisor under the Advisory Contract and other benefits that the Advisor
(and its affiliates) may have realized from its relationship with the fund,
including any research received under “soft dollar” agreements and
commission-sharing arrangements with broker-dealers. The Board considered that
the Advisor may receive some benefit from soft-dollar arrangements pursuant to
which research is received from broker-dealers that execute the applicable
fund’s portfolio transactions. The Board received information on the estimated
costs incurred and profits realized by the Advisor from managing T. Rowe Price
mutual funds. While the Board did not review information regarding profits
realized from managing the fund in particular because the fund had either not
achieved sufficient portfolio asset size or not
recognized sufficient revenues to produce meaningful profit margin percentages,
the Board concluded that the Advisor’s profits were reasonable in light of the
services provided to the T. Rowe Price funds.
The Board also considered whether the fund benefits under the fee levels set forth in the Advisory Contract from any economies of scale realized by the Advisor. Under the Advisory Contract, the fund pays a fee to the Advisor for investment management services composed of two components—a group fee rate based on the combined average net assets of most of the T. Rowe Price mutual funds (including the fund) that declines at certain asset levels and an individual fund fee rate based on the fund’s average daily net assets—and the fund pays its own expenses of operations. At the March 13, 2015, meeting, the Board approved an additional 0.005% breakpoint to the group fee schedule, effective May 1, 2015. With the new breakpoint, the group fee rate will decline to 0.270% when the combined average net assets of the applicable T. Rowe Price funds exceed $500 billion. The Board also noted that there is an arrangement in place whereby the Advisor may voluntarily waive all or a portion of the management fee it is entitled to receive from the fund or pay all or a portion of the fund’s operating expenses in order to maintain a zero or positive net yield for the fund. The Board concluded that the advisory fee structure for the fund continued to provide for a reasonable sharing of benefits from any economies of scale with the fund’s investors.
Fees
The Board was provided with information regarding industry trends in
management fees and expenses, and the Board reviewed the fund’s management fee
rate, operating expenses, and total expense ratio in comparison with fees and
expenses of other comparable funds based on information and data supplied by
Lipper. After including reductions resulting from the voluntary fee waiver
arrangement, the information provided to the Board indicated that the fund’s
management fee rate and total expense ratio were at or below the median for
comparable funds.
The Board also reviewed the fee schedules for institutional accounts and private accounts with similar mandates that are advised or subadvised by the Advisor and its affiliates. Management provided the Board with information about the Advisor’s responsibilities and services provided to institutional account clients, including information about how the requirements and economics of the institutional business are fundamentally different from those of the mutual fund business. The Board considered information showing that the mutual fund business is generally more complex from a business and compliance perspective than the institutional business and that the Advisor generally performs significant additional services and assumes greater risk in managing the fund and other T. Rowe Price mutual funds than it does for institutional account clients.
On the basis of the information provided and the factors considered, the Board concluded that the fees paid by the fund under the Advisory Contract are reasonable.
Approval of the Advisory Contract
As noted, the Board
approved the continuation of the Advisory Contract. No single factor was
considered in isolation or to be determinative to the decision. Rather, the
Board concluded, in light of a weighting and balancing of all factors
considered, that it was in the best interests of the fund and its shareholders
for the Board to approve the continuation of the Advisory Contract (including
the fees to be charged for services thereunder). The independent directors were
advised throughout the process by independent legal
counsel.
Item 2. Code of Ethics.
A code of ethics, as defined in Item 2 of Form N-CSR, applicable to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions is filed as an exhibit to the registrant’s annual Form N-CSR. No substantive amendments were approved or waivers were granted to this code of ethics during the registrant’s most recent fiscal half-year.
Item 3. Audit Committee Financial Expert.
Disclosure required in registrant’s annual Form N-CSR.
Item 4. Principal Accountant Fees and Services.
Disclosure required in registrant’s annual Form N-CSR.
Item 5. Audit Committee of Listed Registrants.
Not applicable.
Item 6. Investments.
(a) Not applicable. The complete schedule of investments is included in Item 1 of this Form N-CSR.
(b) Not applicable.
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies.
Not applicable.
Item 8. Portfolio Managers of Closed-End Management Investment Companies.
Not applicable.
Item 9. Purchases of Equity Securities by Closed-End Management Investment Company and Affiliated Purchasers.
Not applicable.
Item 10. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 11. Controls and Procedures.
(a) The registrant’s principal executive officer and principal financial officer have evaluated the registrant’s disclosure controls and procedures within 90 days of this filing and have concluded that the registrant’s disclosure controls and procedures were effective, as of that date, in ensuring that information required to be disclosed by the registrant in this Form N-CSR was recorded, processed, summarized, and reported timely.
(b) The registrant’s principal executive officer and principal financial officer are aware of no change in the registrant’s internal control over financial reporting that occurred during the registrant’s second fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.
Item 12. Exhibits.
(a)(1) The registrant’s code of ethics pursuant to Item 2 of Form N-CSR is filed with the registrant’s annual Form N-CSR.
(2) Separate certifications by the registrant's principal executive officer and principal financial officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 and required by Rule 30a-2(a) under the Investment Company Act of 1940, are attached.
(3) Written solicitation to repurchase securities issued by closed-end companies: not applicable.
(b) A certification by the registrant's principal executive officer and principal financial officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and required by Rule 30a-2(b) under the Investment Company Act of 1940, is attached.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
T. Rowe Price Tax-Free Income Fund,
Inc.
| By | /s/ Edward C. Bernard | |
| Edward C. Bernard | ||
| Principal Executive Officer | ||
| Date October 15, 2015 | ||
Pursuant to the
requirements of the Securities Exchange Act of 1934 and the Investment Company
Act of 1940, this report has been signed below by the following persons on
behalf of the registrant and in the capacities and on the dates indicated.
| By | /s/ Edward C. Bernard | |
| Edward C. Bernard | ||
| Principal Executive Officer | ||
| Date October 15, 2015 | ||
| By | /s/ Catherine D. Mathews | |
| Catherine D. Mathews | ||
| Principal Financial Officer | ||
| Date October 15, 2015 | ||