-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VIwgM7IPRxI32zUrYiMIIP/F4zx/cR2SFjmudd7Iy0pbkWZ64X4D0+VMLDm/CMxZ AKIcvjIWvHHjIrKwEW3TNA== 0000080249-02-000004.txt : 20020710 0000080249-02-000004.hdr.sgml : 20020710 20020710111540 ACCESSION NUMBER: 0000080249-02-000004 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20020531 FILED AS OF DATE: 20020710 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PRICE T ROWE NEW INCOME FUND INC CENTRAL INDEX KEY: 0000080249 IRS NUMBER: 520980581 FISCAL YEAR END: 0531 FILING VALUES: FORM TYPE: N-30D SEC ACT: 1940 Act SEC FILE NUMBER: 811-02396 FILM NUMBER: 02699420 BUSINESS ADDRESS: STREET 1: 100 EAST PRATT ST CITY: BALTIMORE STATE: MD ZIP: 21202 BUSINESS PHONE: 4105472000 N-30D 1 arnif.txt T. ROWE PRICE NEW INCOME FUND 5/31/2002 Annual Report New IncomeFund May 31, 2002 T. Rowe Price TABLE OF CONTENTS - -------------------------------------------------------------------------------- Highlights 1 Portfolio Manager's Report 2 Interest Rates and Economy 2 Market Activity 3 Performance and Strategy Review 3 Outlook 6 Performance Comparison 7 Financial Highlights 8 Portfolio of Investments 9 Statement of Assets and Liabilities 20 Statement of Operations 21 Statement of Changes in Net Assets 22 Notes to Financial Statements 23 Report of Independent Accountants 30 Tax Information 31 About the Fund's Directors and Officers 32 REPORTS ON THE WEB Sign up for our E-mail Program, and you can begin to receive updated fund reports and prospectuses online rather than through the mail. Log on to your account at www.troweprice.com for more information. Highlights - -------------------------------------------------------------------------------- o After aggressively lowering interest rates in 2001, the Fed kept rates steady through May 31. o Returns on investment-grade bonds were modestly positive for the last six months. o New Income's 6- and 12-month performance surpassed the Lipper peer group average but trailed the Lehman Brothers benchmark. o We expect the economy to grow moderately in coming months, the Fed to nudge up interest rates in the fall, and dividends to generate the bulk of returns going forward. Performance Comparison - -------------------------------------------------------------------------------- Periods Ended 5/31/02 6 Months 12 Months - -------------------------------------------------------------------------------- New Income Fund 1.57% 7.68% Lehman Brothers U.S. Aggregate Index 2.25 8.10 Lipper Average of Corporate Bond Funds A-Rated 1.28 6.49 Price and Yield - -------------------------------------------------------------------------------- 11/30/01 5/31/02 - -------------------------------------------------------------------------------- Price Per Share $ 8.79 $ 8.70 Dividends Per Share For 6 months 0.25 0.22 For 12 months 0.51 0.47 30-Day Dividend Yield* 5.22% 5.00% 30-Day Standardized Yield to Maturity 5.08 5.08 * Dividends earned for the last 30 days of each period indicated are annualized and divided by the fund's net asset value at the end of the period. Portfolio Manager's Report - -------------------------------------------------------------------------------- After aggressively lowering interest rates in 2001, the Fed kept rates steady through May as it waited for signs of an economic recovery. The New Income Fund delivered modest gains from income in the latest six-month period and solid gains from income and capital appreciation during the 12 months ended May 31, 2002, as investor demand for the relative safe haven of high-quality bonds increased. INTEREST RATES AND ECONOMY The economy changed dramatically over the latest six-month period, moving from recession to expansion as signs of recovery emerged early in 2002. GDP growth climbed at an annualized 6.1% clip in the first quarter, driven by an end to the inventory liquidation cycle, which supported production and employment trends. At the same time, corporate cost-cutting and strong productivity gains improved profit margins and prospects for stronger earnings. With inflation subdued, the Federal Reserve reduced the fed funds target rate to 1.75%-a 40-year low-near the end of 2001 and held it steady through the end of the reporting period to encourage recovery. Interest Rate Levels - -------------------------------------------------------------------------------- 10-Year 5-Year 2-Year Treasury Treasury Treasury Note Note Note - -------------------------------------------------------------------------------- 5/31/01 5.38 4.91 4.18 5.41 4.95 4.24 5.05 4.53 3.79 8/31/01 4.83 4.38 3.63 4.59 3.80 2.85 4.23 3.47 2.42 11/30/01 4.75 4.06 2.84 5.05 4.30 3.02 5.03 4.37 3.16 2/28/02 4.88 4.19 3.06 5.40 4.84 3.72 5.09 4.41 3.22 5/31/02 5.04 4.35 3.19 Over the last 12 months, the Treasury yield curve steepened as short-maturity yields fell further than the yields of long-term issues. Falling rates are generally positive for bond prices, and since last May intermediate-term bonds generally outpaced long-maturity issues. During the past six months, however, rates shifted directions several times and ended the period somewhat higher than their trough in late 2001. Except for very low rates in November 2001, yields have remained in a very narrow range in spite of the market's concern about the economy's transition from recession to expansion and the government's budget deficit. Volatile equity markets and investor concerns about accounting standards, a lack of corporate governance, and geopolitical events, however, have dampened the move toward higher rates and fueled demand for high-quality, fixed-income securities with short and intermediate maturities. Bearish developments, including the specter of improving economic prospects, a weakening dollar, and higher interest rates abroad (except in Japan) remain secondary considerations for investors for the time being. MARKET ACTIVITY Bond Market Returns - -------------------------------------------------------------------------------- Periods Ended 5/31/02 6-Month Return 12-Month Return - -------------------------------------------------------------------------------- Treasury 1.15 7.47 Mortgage 3.32 8.38 AAA 2.30 8.42 BBB 0.32 6.06 BBB/BB 4.93 12.25 Source: Salomon Smith Barney Treasury issues struggled during the last six months, with income barely offsetting principal loss. Many lower tier (A, BBB) investment-grade corporate bonds also languished, as investors evaluated the stream of news items about accounting practices and debt burdens. Problems reached far above the Enrons of the world into the ranks of blue chip corporations; even perennial favorites like General Motors Acceptance Corp., Ford, and AT&T were downgraded. Utilities, cable, and telecom companies came under special scrutiny, with the result that many bonds in these sectors lagged the overall investment-grade market. Financial companies, in contrast, performed relatively well, since the steepening yield curve meant they could borrow at low short-term rates and lend at higher long-term rates. Overall, a gap opened up between the performance of top- and lower-tier investment-grade bonds. PERFORMANCE AND STRATEGY REVIEW The improving economic news in recent months was not necessarily good news for bond investors. Bond prices have been mixed in 2002, reflecting uncertainty about economic and political factors, and against a backdrop of stronger economic growth. Your fund's 6- and 12-month returns consisted of steady income and mixed share price appreciation. In both cases, the fund outperformed the Lipper average for similar funds but lagged the Lehman Brothers benchmark. Our investment strategy focuses on fundamental analysis of the companies, sectors, and types of securities in which we invest. We analyze government, mortgage, asset-backed, and corporate bonds, as well as the credit market trends in the U.S. and selected foreign markets, in search of investment-grade (BBB rated and higher) securities that offer relatively high yields and stable or improving credit quality. Several investment themes underpinned our research during the latest period. In the corporate arena, many companies trimmed their debt loads in an effort to improve credit quality and in response to demands from creditors and bondholders. While undertaking this process generates short-term stress, it produces long-term positives for the firm and the credit markets in general. Since the collapse of Enron, Global Crossing, and other large icons, we have redoubled our efforts to guard against owning bonds that could be dragged down by negative headlines. SEC investigations and regulatory probes can tarnish entire sectors, marring even solid credits. However, addressing concerns and the loss of trust relating to inadequate accounting and corporate governance, while painful, is also beneficial to the long-term health of the capital markets. Portfolio Characteristics - -------------------------------------------------------------------------------- Periods Ended 11/30/01 5/31/02 - -------------------------------------------------------------------------------- Weighted Average Maturity (years) 7.4 7.6 Weighted Average Effective Duration (years) 4.9 4.6 Weighted Average Quality* AA+ AA+ - -------------------------------------------------------------------------------- * Based on T. Rowe Price research. Overnight lending rates are accomodative, at 1.75%, in light of the prospects for improving economic performance going forward. In the first quarter, the Federal Reserve shifted to a neutral monetary policy outlook, and rising interest rates are now expected. The remaining questions are when and how much rates will rise. Throughout the period we reduced our Treasury holdings and positioned the portfolio for potential rate hikes. Low short-term Treasury rates and the prospect of economic expansion challenged us to focus on sectors and securities that generate additional yield. For much of the six-month period, maintaining a modestly defensive portfolio duration, below that of our benchmark, proved unrewarding. Because the Federal Reserve did not raise rates and the yield curve steepened, we missed opportunities to use lower-yielding cash to purchase higher-yielding intermediate-term securities. Recent adjustments reflect our more neutral interest rate view and our belief that the Fed may not begin to raise rates until the fall. Your portfolio has maintained a strong and growing commitment to mortgage, corporate, and asset-based obligations. The mortgage allocation increased to 36% from 32% during the six-month period, and the sector delivered strong relative returns. Asset-backed securities also remained a reliable source of additional yield. Our positioning in these sectors resulted in strong relative performance compared to our peer group. Security Diversification - -------------------------------------------------------------------------------- Mortgage-Backed Securities 36% Corporate Bonds and Convertibles 30% U.S. Treasuries 17% Asset Backed Securities 6% U.S. Agency Obligations 4% Foreign Gov't & Municipalities 4% Cash and Other 3% Based on net assets as of 5/31/02. Confidence in our research capabilities and a long-term positive fundamental view of the corporate sector kept us actively engaged in the credit market. During the last six months, a general overweighting in the sector was beneficial. High-quality banking and insurance issues performed well, as did several lower-quality securities in the automotive and defense industries. However, evading the downdraft associated with a barrage of negative news relating to the telecom and energy sectors proved difficult. SEC probes, accounting irregularities, and rating agency downgrades brought severe market pressure to several holdings including WorldCom, Qwest, Tyco International, and Williams. Fortunately, modest exposure to these volatile securities, coupled with broad diversification, mitigated the negative impact on performance. Nevertheless, our analysts believe that these and other out-of-favor issues offer opportunity. U.S. equity market volatility and concerns about corporate accounting lead us to question whether foreigners will continue to find U.S. dollar-denominated bonds attractive. Foreign investment is critical for funding the growing U.S. trade deficit, and a more discriminating international investment community could lead to ongoing dollar weakness. Higher yields overseas and in Canada also helped build a compelling case for adding more nondollar securities to the portfolio. At the end of the reporting period, our foreign exposure widened to 4%, divided among assets denominated in the Australian dollar, Canadian dollar, and the euro. OUTLOOK We believe the conditions for an economic recovery are in place. Previous fiscal stimulus programs and low inflation supported consumer strength during the recession. However, the Fed seems likely to maintain the "neutral" stance it recently adopted, meaning it sees the risks of rising inflation and renewed economic weakness as about evenly balanced. If the recovery continues, it is reasonable to anticipate a series of gradual fed funds rate increases-perhaps in the third and fourth quarters. Given the potential for the Fed to start raising short-term rates sometime this year, we expect to maintain a somewhat cautious investment regime. However, since longer-term interest rates did not decline sharply when short-term rates plummeted last year, we do not think they will rise substantially as the recovery proceeds. Rather, we see a flatter yield curve as money market rates return to more normal levels. Apart from interest rate movements, a stronger economy should benefit corporate and other non-Treasury sectors, which have suffered from credit concerns. We trust our research capabilities and our ability to add value through superior sector and credit selection. In summary, we see a relatively good bond environment with returns generated primarily by income. Respectfully submitted, William T. Reynolds President of the fund and chairman of its Investment Advisory Committee June 19, 2002 The committee chairman has day-to-day responsibility for managing the portfolio and works with committee members in developing and executing the fund's investment program. T. Rowe Price New Income Fund - -------------------------------------------------------------------------------- Performance Comparison - -------------------------------------------------------------------------------- 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. NEW INCOME FUND - -------------------------------------------------------------------------------- As of 5/31/02 Lehman Bros. U.S. Aggregate New Income Index Fund - -------------------------------------------------------------------------------- 5/31/92 10000 10000 5/31/93 11130 10946 5/31/94 11210 11099 5/31/95 12497 12334 5/31/96 13044 12790 5/31/97 14129 13774 5/31/98 15671 15267 5/31/99 16354 15422 5/31/00 16698 15597 5/31/01 18888 17553 5/31/02 20419 18901 Average Annual Compound Total Return - -------------------------------------------------------------------------------- This table shows how the fund would have performed each year if its actual (or cumulative) returns for the periods shown had been earned at a constant rate. Periods Ended 5/31/02 1 Year 3 Years 5 Years 10 Years - -------------------------------------------------------------------------------- New Income Fund 7.68% 7.02% 6.53% 6.57% Investment return and principal value represent past performance and will vary. Shares may be worth more or less at redemption than at original purchase. Returns do not reflect taxes that the shareholder may pay on fund distributions or the redemption of fund shares. T. Rowe Price New Income Fund - -------------------------------------------------------------------------------- Financial Highlights For a share outstanding throughout each period - -------------------------------------------------------------------------------- Year Ended 5/31/02 5/31/01 5/31/00 5/31/99 5/31/98 NET ASSET VALUE Beginning of period $ 8.53 $ 8.07 $ 8.50 $ 9.09 $ 8.77 Investment activities Net investment income (loss) 0.47 0.53 0.52 0.54 0.57 Net realized and unrealized gain (loss) 0.17 0.46 (0.43) (0.45) 0.36 Total from investment activities 0.64 0.99 0.09 0.09 0.93 Distributions Net investment income (0.47) (0.53) (0.52) (0.54) (0.57) Net realized gain -- -- -- (0.14) (0.04) Total distributions (0.47) (0.53) (0.52) (0.68) (0.61) NET ASSET VALUE End of period $ 8.70 $ 8.53 $ 8.07 $ 8.50 $ 9.09 - ------------------------------------------------------------------------- Ratios/Supplemental Data Total return (diamond) 7.68% 12.54% 1.13% 1.02% 10.84% Ratio of total expenses to average net assets 0.72% 0.73% 0.73% 0.72% 0.71% Ratio of net investment income (loss) to average net assets 5.38% 6.30% 6.32% 6.16% 6.31% Portfolio turnover rate 222% 112.1% 83.6% 94.3% 147.3% Net assets, end of period (in millions) $ 1,863 $ 1,684 $ 1,633 $ 1,942 $ 2,076 (diamond) Total return reflects the rate that an investor would have earned on an investment in the fund during each period, assuming reinvestment of all distributions. The accompanying notes are an integral part of these financial statements. T. Rowe Price New Income Fund - -------------------------------------------------------------------------------- May 31, 2002 Portfolio of Investments Par/Shares Value - -------------------------------------------------------------------------------- In thousands CORPORATE BONDS AND NOTES 30.1% Aerospace & Defense 0.4% Northrop Grumman, Sr. Notes, 7.125%, 2/15/11 @ $ 8,000 $ 8,383 8,383 Automobiles and Related 1.6% DaimlerChrysler, Sr. Notes, 7.30%, 1/15/12 5,230 5,481 Ford Motor, Sr. Notes, 7.45%, 7/16/31 12,730 12,338 General Motors Acceptance Corp., Sr. Notes, 8.00%, 11/1/31 @ 11,200 11,949 29,768 Banking 2.5% Banco Generale, Sr. Notes, 144A, 7.70%, 8/1/02 10,000 10,025 Banco Santiago, Sr. Sub. Notes, 7.00%, 7/18/07 @ 9,335 9,548 Bank One, Sr. Notes, 5.50%, 3/26/07 4,350 4,446 Colonial Bank, Sr. Sub. Notes, 9.375%, 6/1/11 7,700 8,294 MBNA America Bank, Sr. Notes, 6.50%, 6/20/06 8,500 8,761 Regions Financial Corporation, Sr. Sub. Notes, 6.375%, 5/15/12 5,300 5,389 46,463 Cable Operators 1.2% Clear Channel Communications, Sr. Notes, 7.875%, 6/15/05 8,500 8,978 Comcast Cable Communications, Sr. Notes, 6.75%, 1/30/11 @ 13,500 13,031 22,009 Canadian Government and Municipalities 1.5% Canada Government, 3.50%, 6/1/04 (CAD) 44,500 28,767 28,767 Conglomerates 0.4% Tyco International, Sr. Notes, 5.80%, 8/1/06 @ 8,275 7,365 7,365 Diversified Chemicals 0.2% Praxair, Sr. Notes, 6.75%, 3/1/03 4,500 4,626 4,626 Electric Utilities 3.9% Allegheny Energy Supply, Sr. Notes, 144A, 8.25%, 4/15/12 8,050 8,324 Constellation Energy Group, Sr. Notes, 6.35%, 4/1/07 @ 8,500 8,727 Consumers Energy Group, 1st Mtg., 6.00%, 3/15/05 5,670 5,740 First Energy, Sr. Notes, 7.375%, 11/15/31 6,410 6,086 Korea Electric Power, Sr. Notes, 7.00%, 10/1/02 5,500 5,556 Mirant Americas Generation, Sr. Notes, 8.30%, 5/1/11 @ 3,500 3,045 NiSource Finance, Sr. Notes, 7.625%, 11/15/05 $ 6,700 $ 6,746 PG&E National Energy, Sr. Notes, 10.375%, 5/16/11 7,590 5,693 PPL Energy, Sr. Notes, 6.40%, 11/1/11 4,870 4,656 Sempra Energy, Sr. Notes, 6.80%, 7/1/04 8,900 9,253 Teco Energy, Sr. Notes, 7.00%, 5/1/12 @ 2,960 3,013 TXU, Sr. Notes, 6.375%, 6/15/06 @ 4,950 5,046 71,885 Electronic Components 0.3% Arrow Electronics, Sr. Notes, 8.20%, 10/1/03 6,200 6,247 6,247 Energy 0.9% PDVSA Finance, Sr. Notes, 6.80%, 11/15/08 8,000 6,984 YPF Sociedad Anonima Sr. Notes 7.25%, 3/15/03 @ 10,000 7,900 10.00%, 11/2/28 4,660 2,563 17,447 Entertainment and Leisure 0.6% International Speedway, Sr. Notes, 7.875%, 10/15/04 10,000 10,415 10,415 Exploration and Production 0.5% Canadian Natural Resources, Sr. Notes, 7.20%, 1/15/32 5,200 5,215 Devon Energy, Sr. Notes, 7.95%, 4/15/32 4,225 4,585 9,800 Finance and Credit 1.8% CIT Group, Sr. Notes, 7.75%, 4/2/12 @ 4,305 4,400 Countrywide Home Loans, Sr. Notes, 5.50%, 2/1/07 @ 8,200 8,254 Household Finance, Sr. Notes, 7.00%, 5/15/12 @ 7,200 7,294 International Lease Finance, Sr. Notes, 6.375%, 3/15/09 5,520 5,609 PHH, Sr. Notes, 8.125%, 2/3/03 7,000 7,207 32,764 Food Processing 0.7% Kraft Foods, Sr. Notes, 6.25%, 6/1/12 @ 6,400 6,530 McCormick, Sr. Notes, 6.40%, 2/1/06 7,300 7,549 14,079 Foreign Government and Municipalities (Excluding Canandian) 2.3% Banco Latinoamericano, Sr. Notes, 6.55%, 4/15/03 7,900 7,978 Bundesobligation, Sr. Notes, 4.00%, 2/16/07 (EUR) 10,000 9,025 Bundesrepublic, Sr. Notes, 5.00%, 1/4/12 (EUR) $ 11,300 $ 10,419 European Investment Bank Sr. Notes, 6.00%, 7/15/05 (AUD) 16,500 9,313 Petroleos Mexicanos, Sr. Notes, 9.25%, 3/30/18 @ 5,000 5,360 42,095 Gas & Gas Transmission 1.9% Coastal Sr. Notes 6.50%, 5/15/06 @ 9,400 9,225 7.50%, 8/15/06 5,000 5,079 Dynegy Holdings, Sr. Notes, 8.75%, 2/15/12 @ 6,565 5,055 Kinder Morgan Energy Partners, Sr. Notes, 7.75%, 3/15/32 6,170 6,531 Noram Energy, Sr. Notes, 6.50%, 2/1/08 2,582 2,342 Southern Natural Gas, Sr. Notes, 8.00%, 3/1/32 2,970 2,924 Williams Companies, Sr. Notes, 7.625%, 7/15/19 4,400 3,740 34,896 Insurance 1.9% AIG Sunamerica Global Financing XII, Sr. Notes, 144A 5.30%, 5/30/07 6,070 6,155 Allstate Financial Global Funding, Sr. Notes, 144A 5.25%, 2/1/07 9,000 9,034 Jefferson Pilot Capital Trust A, Jr. Sub. Notes, 144A 8.14%, 1/15/46 3,000 2,966 Sun Life of Canada U.S. Capital Trust, Jr. Sub. Notes, 144A 8.526%, 5/29/49 7,000 7,453 XL Capital Finance, Sr. Notes, 6.50%, 1/15/12 @ 9,100 9,330 34,938 Investment Dealers 1.2% Credit Suisse First Boston USA, Sr. Notes, 6.50%, 1/15/12 @ 10,000 10,094 Goldman Sachs Group, Sr. Notes, 6.60%, 1/15/12 @ 7,660 7,786 Morgan Stanley Group, Sr. Notes, 5.80%, 4/1/07 @ 4,650 4,732 22,612 Long Distance 0.7% AT&T, Sr. Notes, 144A, 8.00%, 11/15/31 9,825 8,425 Sprint Capital, Sr. Notes, 6.875%, 11/15/28 @ 6,330 4,895 13,320 Media and Communications 1.3% AOL Time Warner, Sr. Notes, 7.625%, 4/15/31 15,000 14,472 Cox Communications Sr. Notes 6.75%, 3/15/11 @ $ 5,000 $ 4,732 7.875%, 8/15/09 4,830 4,929 24,133 Metals and Mining 0.4% Phelps Dodge, Sr. Notes, 8.75%, 6/1/11 @ 8,000 8,085 8,085 Paper and Paper Products 0.9% Celulosa Arauco Y Constitucion, Sr. Notes, 8.625%, 8/15/10 @ 7,500 8,129 Weyerhaeuser, Sr. Notes, 5.95%, 11/1/08 8,900 8,938 17,067 Real Estate 0.3% Simon Debartolo, REIT, Sr. Notes, 6.875%, 11/15/06 4,660 4,845 4,845 Retail 0.9% Federated Department Stores, Sr. Notes, 6.625%, 4/1/11 @ 10,000 10,184 Sears Roebuck Acceptance Corp. Sr. Notes, 6.70%, 4/15/12 7,000 7,152 17,336 Savings and Loan 0.4% Greenpoint Bank, Sr. Sub. Notes, 9.25%, 10/1/10 6,000 6,669 6,669 Telephones 1.1% France Telecom, Sr. Notes, 7.75%, 3/1/11 10,835 10,540 Qwest Communications, Sr. Notes, 7.50%, 11/1/08 @ 12,000 9,480 20,020 Wireline Communications 0.3% Worldcom Sr. Notes 8.00%, 5/15/06 @ 7,590 4,175 8.25%, 5/15/31 @ 4,000 1,740 5,915 Total Corporate Bonds and Notes (Cost $567,225) 561,949 ASSET-BACKED SECURITIES 7.7% Airlines 0.6% Continental Airlines, PTC 7.568%, 12/1/06 3,210 2,841 8.312%, 4/2/11 $ 7,657 $ 7,150 9,991 Auto-Backed 1.2% Capital Auto Receivables Asset Series 2002-2, 4.18%, 10/15/07 12,600 12,710 Chase Manhattan Auto Owner Trust Series 2001-B, Class CTFS 3.75%, 5/15/08 5,353 5,320 Provident Auto Lease Trust, 7.73%, 10/14/07 4,764 4,923 22,953 Credit Card-Backed 2.3% American Express Credit Master Trust Series 2001-5, Class A 2.04%, 11/15/10 14,400 14,440 Citibank Credit Card Issuance Trust Series 2000-C1, Class C1 7.45%, 9/15/07 11,075 11,809 MBNA Master Credit Card Trust II Series 1998-E, Class A, 2.125%, 9/15/10 7,575 7,582 Series 2000-D, Class C, 8.40%, 9/15/09 8,400 9,244 43,075 Motorcycles 0.4% Harley Davidson Motorcycle Trust Series 2002-1, Class B, 4.36%, 1/15/10 7,440 7,528 7,528 Recreational Vehicles 1.3% Chase Manhattan RV Owner Trust Series 1997-A, Class B, 6.54%, 8/15/17 11,795 12,124 CIT RV Trust, 6.35%, 4/15/11 11,914 12,250 24,374 Stranded Asset 0.9% Reliant Energy Transition Bond Series 2001-1, Class A4, 5.63%, 9/15/15 17,147 16,628 16,628 Transportation (excluding Rail Road) 1.0% Atlas Air, 7.63%, 1/2/15 9,172 7,949 Federal Express, 8.25%, 1/15/19 9,674 10,590 18,539 Total Asset-Backed Securities (Cost $143,189) 143,088 EQUITY AND CONVERTIBLE SECURITIES 2.2% Automobiles and Related 0.3% Ford Motor Company Capital Trust II, Cv. Pfd. Stock $ 54 $ 3,275 GM, Series A, Cv. Pfd. Stock @ 54 1,488 4,763 Banking 0.0% Silicon Valley Bancshares, Pfd. Stock 30 714 714 Building and Real Estate 1.0% Equity Office Properties Trust, Series B, Cv. Pfd. Stock 60 2,723 Equity Residential Properties Trust Series G, REIT, Cv. Pfd. Stock 190 4,725 Reckson Associates Realty, Series A, Cv. Pfd. Stock 429 10,413 17,861 Computer Service & Software 0.2% Juniper Networks, Cv. Bonds, 4.75%, 3/15/07 4,125 3,074 3,074 Electric Utilities 0.0% Calpine, Sr. Cv. Bonds, 144A, 4.00%, 12/26/06 775 698 698 Electronic Components 0.1% Analog Devices, Sr. Cv. Bonds, 4.75%, 10/1/05 2,000 1,918 1,918 Media and Communications 0.1% Mediaone Group, Cv. Pfd. Stock 173 2,769 2,769 Telecom Equipment 0.1% Corning, Cv. Bonds, Zero Coupon, 11/8/15 6,006 2,879 2,879 Telecommunications 0.3% Cienna, Cv. Bonds, 3.75%, 2/1/08 7,750 4,904 4,904 Telephones 0.1% Liberty Media/Sprint PCS, Cv. Bonds, 4.00%, 11/15/29 2,750 1,483 1,483 Total Equity and Convertible Securities (Cost $143,189) 41,063 NON-U.S. GOVERNMENT MORTGAGE- BACKED SECURITIES 9.4% Commercial Mortgage-Backed 2.2% COMM 2000, Series 2000-C1, Class B, CMO 7.494%, 4/15/10 $ 8,400 $ 9,109 JP Morgan Chase Commercial Mortgage Securities, CMO 6.244%, 4/15/35 9,900 10,286 Prudential Securities Secured Financing CMO, 6.074%, 1/15/08 10,200 10,557 Salomon Brothers Mortgage Securities VII, CMO 6.226%, 12/18/35 10,875 11,276 41,228 Home Equity Loans-Backed 3.8% BankBoston Home Equity Loan Trust, Series 1998-1, Class A6 6.35%, 2/25/13 6,286 6,498 Chase Funding Mortgage Loan Series 1998-1, Class IM1, 6.59%, 5/25/28 4,190 4,287 Series 2002-1, Class 1A3, 5.039%, 12/25/2 10,675 10,771 GE Capital Mortgage Services, 6.465%, 6/25/28 11,765 12,281 GSR Mortgage Loan Trust, Series 2001-1, Class A12 4.612%, 10/25/31 18,736 18,812 Mellon Residential Funding, Series 2001-HEIL, Class A3 5.945%, 2/25/11 17,750 18,272 70,921 Whole Loans-Backed 3.4% Countrywide Mortgage Backed Securities CMO, 6.75%, 11/25/23 3,630 3,716 GE Capital Mortgage Services, 6.75%, 8/25/28 13,962 14,322 Norwest Asset Securities, CMO, 6.75%, 10/25/28 11,509 11,568 Residential Accredit Loans CMO 6.75%, 7/25/28 7,500 7,684 7.25%, 11/25/27 9,497 9,701 Residential Funding Mortgage, CMO, 6.50%, 1/25/29 7,512 7,632 Summit Mortgage Trust Series 2002-1, Class A2, CMO 6.138%, 2/26/29 7,600 7,754 62,377 Total Non-U.S. Government Mortgage-Backed Securities (Cost $170,791) 174,526 U.S. GOVERNMENT MORTGAGE- BACKED SECURITIES 26.7% U.S. Government Agency Obligations 17.6% Federal Home Loan Mortgage 5.00%, 1/1/09 $ 12,806 $ 12,778 5.50%, 4/1/29 1,789 1,732 6.50%, 12/21/23 - 6/1/24 5,261 5,407 7.00%, 2/1/24 - 8/1/31 3,687 3,833 7.50%, 5/1 - 6/1/24 1,757 1,859 CMO 6.50%, 7/15/11 - 3/15/23 24,754 25,880 7.00%, 11/15/22 3,621 3,743 Principal Only, 8/1/28 4,770 3,832 PTC 6.50%, 11/1/04 1 1 8.00%, 6/1/08 10 10 10.50%, 7/1/11 - 8/1/20 150 164 11.00%, 11/1/17 - 7/1/20 111 125 TBA, 7.00%, 1/1/32 726 750 Federal National Mortgage Assn. 5.00%, 1/1/09 4,224 4,203 6.00%, 4/1/14 - 1/1/29 11,396 11,455 6.50%, 4/1/15 12,788 13,240 7.00%, 11/1/14 - 11/1/30 11,811 12,358 CMO 6.50%, 7/25/16 - 5/25/28 12,242 12,612 Interest Only, 6.50%, 2/1/32 + 29,410 7,913 TBA 6.00%, 1/1/17 - 1/1/32 43,371 43,404 6.50%, 1/1/17 - 1/1/32 92,905 94,349 7.00%, 1/1/32 66,516 68,220 327,868 U.S. Government Guaranteed Obligations 9.1% Government National Mortgage Assn. I 6.00%, 3/15 - 11/15/31 39,028 38,787 6.50%, 8/15/25 - 5/15/29 15,943 16,326 7.00%, 1/15/24 - 4/15/28 26,616 27,816 7.50%, 8/15/16 - 8/15/28 $ 6,136 $ 6,511 8.00%, 7/15/16 - 10/15/27 18,925 20,386 8.50%, 9/15/16 - 7/15/23 3,824 4,167 9.00%, 1/15/09 - 11/15/19 462 510 9.50%, 6/15/09 - 3/15/25 191 207 11.00%, 12/15/09 - 1/15/21 4,403 4,944 11.50%, 3/15/10 - 10/15/15 578 658 II 7.00%, 12/20/23 - 11/20/28 4,167 4,341 8.50%, 9/20/26 15 16 9.00%, 6/20/16 - 2/20/18 283 310 CMO, Principal Only, 3/16/28 5,014 4,271 GPM, I, 10.25%, 12/15/17 - 11/15/20 625 694 Midget, I, 7.00%, 3/15 - 12/15/13 6,640 7,011 TBA, II 6.00%, 7/1/31 8,623 8,542 6.50%, 7/1/32 23,888 24,311 169,808 Total U.S. Government Mortgage-Backed Securities (Cost $487,679) 497,676 U.S. GOVERNMENT OBLIGATIONS/ AGENCIES 20.7% U.S. Government Agency Obligations 3.9% Federal Home Loan Mortgage 5.75%, 1/15/12 8,900 8,999 6.25%, 7/15/32 3,357 3,331 6.75%, 3/15/31 2,649 2,804 6.875%, 1/15/05 @ 4,750 5,098 7.00%, 3/15/10 14,075 15,510 Federal National Mortgage Assn. 5.75%, 2/15/08 @ 15,045 15,665 6.25%, 2/1/11 8,740 8,993 7.125%, 1/15/30 11,300 12,518 72,918 U.S. Treasury Obligations 16.8% U.S. Treasury Bonds 6.25%, 8/15/23 @ 21,250 22,462 6.50%, 11/15/26 @ 31,550 34,461 7.50%, 11/15/16 @ 25,100 29,801 U.S. Treasury Inflation-Indexed Notes, 3.875%, 1/15/09 @ $ 35,754 $ 37,944 U.S. Treasury Notes 3.50%, 11/15/06 @ 34,550 33,523 4.25%, 11/15/03 @ 4,000 4,084 4.75%, 11/15/08 @ 10,675 10,723 5.00%, 8/15/11 @ 57,480 57,342 6.50%, 8/15/05 @ 66,330 71,739 U.S. Treasury Stripped Interest Payment Zero Coupon, 5/15/20 @ 32,250 11,027 313,106 Total U.S. Government Obligations/Agencies (Cost $385,979) 386,024 OPTIONS PURCHASED 0.1% Cienna, 151 Contracts (for 100 shares each), Put, 1/18/03 @ $20.00 * 15 216 Juniper Networks, 250 Contracts (for 100 shares each), Put, 1/18/03 @ $22.50 * 25 333 Vodafone 375 Contracts (for 100 shares each), Put, 1/18/03 @ $10.00 * 38 19 500 Contracts (for 100 shares each), Put, 1/18/03 @ $25.00 * 50 512 Total Options Purchased (Cost $618) 1,080 OPTIONS WRITTEN 0.0% Vodafone 65 Contracts (for 100 shares each), Call, 10/19/02 @ $15.00 * (7) (11) 270 Contracts (for 100 shares each), Call, 1/18/03 @ $10.00 * (27) (145) 465 Contracts (for 100 shares each), Call, 1/18/03 @ $25.00 * (47) (9) Total Options Written (Cost $(369)) (165) Money Market Funds 16.8% T. Rowe Price Reserve Investment Fund, 1.98%, #! 312,585 312,585 Total Money Market Funds (Cost $312,585) 312,585 Total Investments in Securities 113.7% of Net Assets (Cost $2,111,424) $ 2,117,826 Futures Contracts Contract Unrealized Expiration Value Gain (Loss) ---------- -------- ----------- In thousands Short, 30 ten year U.S. Treasury Notes contracts, $50,000 of U.S. Treasury Notes pledged as initial margin 6/02 $ 3,202 $ (24) Net payments (receipts) of variation margin to date 27 Variation margin receivable (payable) on open futures contracts 3 Other Assets Less Liabilities (254,423) NET ASSETS $ 1,863,406 --------------- # Seven-day yield * Non-income producing + Interest Only security for which the fund receives interest on notional principal (par) @ All or a portion of this security is on loan at May 31, 2002 - See Note 2 ! Affiliated company 144A Security was purchased pursuant to Rule 144A under the Securities Act of 1933 and may not be resold subject to that rule except to qualified institutional buyers - total of such securities at period-end amounts to $53,080 and represents 2.8% of net assets AUD Australian dollar CAD Canadian dollar CMO Collateralized Mortgage Obligation EUR Euro GPM Graduated Payment Mortgage PTC Pass-Through Certificate REIT Real Estate Investment Trust TBA To Be Announced security was purchased on a forward commitment basis The accompanying notes are an integral part of these financial statements. T. Rowe Price New Income Fund - -------------------------------------------------------------------------------- May 31, 2002 Statement of Assets and Liabilities - -------------------------------------------------------------------------------- In thousands Assets Investments in securities, at value Affiliated companies (cost $312,585) $ 312,585 Other companies (cost $1,798,839) 1,805,241 Total investments in securities 2,117,826 Securities lending collateral 383,945 Other assets 84,036 Total assets 2,585,807 Liabilities Payable for investment securities purchased 311,542 Obligation to return securities lending collateral 383,945 Other liabilities 26,914 Total liabilities 722,401 NET ASSETS $1,863,406 ---------- Net Assets Consist of: Undistributed net investment income (loss) $ 2,995 Undistributed net realized gain (loss) (48,956) Net unrealized gain (loss) 6,393 Paid-in-capital applicable to 214,236,323 shares of $1.00 par value capital stock outstanding; 300,000,000 shares authorized 1,902,974 NET ASSETS $1,863,406 ---------- NET ASSET VALUE PER SHARE $ 8.70 ---------- The accompanying notes are an integral part of these financial statements. T. Rowe Price New Income Fund - -------------------------------------------------------------------------------- Statement of Operations - -------------------------------------------------------------------------------- In thousands Year Ended 5/31/02 Investment Income (Loss) Income Interest $ 105,343 Dividend 1,890 Securities lending 1,436 Total income 108,669 Expenses Investment management 8,361 Shareholder servicing 4,089 Custody and accounting 241 Prospectus and shareholder reports 72 Directors 25 Proxy and annual meeting 24 Registration 17 Legal and audit 17 Miscellaneous 24 Total expenses 12,870 Expenses paid indirectly (24) Net expenses 12,846 Net investment income (loss) 95,823 Realized and Unrealized Gain (Loss) Net realized gain (loss) Securities 34,572 Futures (368) Written options 668 Foreign currency transactions (815) Net realized gain (loss) 34,057 Change in net unrealized gain (loss) Securities (2,208) Futures 660 Written options 854 Other assets and liabilities denominated in foreign currencies 19 Change in net unrealized gain (loss) (675) Net realized and unrealized gain (loss) 33,382 INCREASE (DECREASE) IN NET ASSETS FROM OPERATIONS $ 129,205 ---------- The accompanying notes are an integral part of these financial statements. T. Rowe Price New Income Fund - -------------------------------------------------------------------------------- Statement of Changes in Net Assets - -------------------------------------------------------------------------------- In thousands Year Ended 5/31/02 5/31/01 Increase (Decrease) in Net Assets Operations Net investment income (loss) $ 95,823 $ 106,378 Net realized gain (loss) 34,057 6,299 Change in net unrealized gain (loss) (675) 87,117 Increase (decrease) in net assets from operations 129,205 199,794 Distributions to shareholders Net investment income (96,406) (106,306) Capital share transactions * Shares sold 346,902 240,495 Distributions reinvested 90,767 99,203 Shares redeemed (291,357) (381,670) Increase (decrease) in net assets from capital share transactions 146,312 (41,972) Net Assets Increase (decrease) during period 179,111 51,516 Beginning of period 1,684,295 1,632,779 End of period $ 1,863,406 $ 1,684,295 ------------------------------------- *Share information Shares sold 39,834 28,496 Distributions reinvested 10,415 11,807 Shares redeemed (33,537) (45,218) Increase (decrease)in shares outstanding 16,712 (4,915) The accompanying notes are an integral part of these financial statements. T. Rowe Price New Income Fund - -------------------------------------------------------------------------------- May 31, 2002 Notes to Financial Statements - -------------------------------------------------------------------------------- NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES T. Rowe Price New Income Fund, Inc. (the fund) is registered under the Investment Company Act of 1940 as a diversified, open-end management investment company and commenced operations on October 12, 1973. The fund seeks the highest level of income consistent with the preservation of capital over time by investing primarily in marketable debt securities. The accompanying financial statements were prepared in accordance with accounting principles generally accepted in the United States of America, which require the use of estimates made by fund management. Valuation Debt securities are generally traded in the over-the-counter market. Securities with original maturities of one year or more are valued at prices furnished by dealers who make markets in such securities or by an independent pricing service, which considers 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 original maturities less than one year are stated at fair value, which is determined by using a matrix system that establishes a value for each security based on bid-side money market yields. Equity securities listed or regularly traded on a securities exchange are valued at the last quoted sale price, or official closing price for certain markets, at the time the valuations are made. 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 and securities regularly traded in the over-the-counter market are valued at the mean of the latest bid and ask prices. Other equity securities are valued at a price within the limits of the latest bid and ask prices deemed by the Board of Directors, or by persons delegated by the Board, best to reflect fair value. Investments in mutual funds are valued at the closing net asset value per share of the mutual fund on the day of valuation. In the absence of a last sale price, purchased and written options are valued at the mean of the closing bid and ask prices. Financial futures contracts are valued at closing settlement prices. Assets and liabilities 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 or under the supervision of the officers of the fund, as authorized by the Board of Directors. Currency Translation Assets and liabilities denominated in foreign currencies are translated into U.S. dollar values each day at the prevailing exchange rate, using the mean of the bid and ask prices of such currencies against U.S. dollars quoted by a major bank. Purchases and sales of securities, income, and expenses are translated into U.S. dollars at the prevailing exchange rate on the dates of such transactions. The effect of changes in foreign exchange rates on realized and unrealized security gains and losses is reflected as a component of such gains and losses. Premiums and Discounts Premiums and discounts on debt securities are amortized for financial reporting purposes. On June 1, 2001, the fund adopted the provisions of the American Institute of Certified Public Accountants' revised Audit and Accounting Guide - Audits of Investment Companies (the guide). The guide requires all premiums and discounts on debt securities to be amortized, and gain/loss on paydowns of mortgage- and asset-backed securities to be accounted for as interest income. Prior to June 1, 2001, the fund recognized premiums and discounts on mortgage- and asset-backed securities at the time of disposition or principal repayment as gain or loss. Upon adoption, the fund adjusted the cost of its mortgage- and asset-backed securities, and corresponding unrealized gain/loss thereon, in the amount of $190,000, reflecting the cumulative amortization that would have been recognized had amortization been in effect from the purchase date of each holding. For the year ended May 31, 2002, the effect of this change was to decrease net investment income by $653,000 ($0.003 per share), increase net realized gain/loss on securities by $552,000 ($0.003 per share), and increase net unrealized gain/loss on securities by $101,000. This change had no effect on the fund's net assets or total return. Other Income and expenses are recorded on the accrual basis. Investment transactions are accounted for on the trade date. Realized gains and losses are reported on the identified cost basis. Dividend income and distributions to shareholders are recorded by the fund on the ex-dividend date. Expenses paid indirectly reflect credits earned on daily uninvested cash balances at the custodian and are used to reduce the fund's custody charges. Payments ("variation margin") made or received by the fund to settle the daily fluctuations in the value of futures contracts are recorded as unrealized gains or losses until the contracts are closed. Unrealized gains and losses on futures and forward currency exchange contracts are included in Other assets and Other liabilities, respectively, and in Change in net unrealized gain or loss in the accompanying financial statements. NOTE 2 - INVESTMENT TRANSACTIONS Consistent with its investment objective, the fund engages in the following practices to manage exposure to certain risks or 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. Forward Currency Exchange Contracts During the year ended May 31, 2002, the fund was a party to forward currency exchange contracts under which it is obligated to exchange currencies at specified future dates and exchange rates. Risks arise from the possible inability of counterparties to meet the terms of their agreements and from movements in currency values. Futures Contracts During the year ended May 31, 2002, the fund was a party to futures contracts, which provide for the future sale by one party and purchase by another of a specified amount of a specific financial instrument at an agreed upon price, date, time, and place. Risks arise from possible illiquidity of the futures market and from movements in security values. Options Call and put options give the holder the right to purchase or sell, respectively, a security at a specified price until a certain date. Risks arise from possible illiquidity of the options market and from movements in security values. Options are reflected in the accompanying Portfolio of Investments at market value. Transactions in options written and related premiums received during the year ended May 31, 2002, were as follows: - -------------------------------------------------------------------------------- Number of Contracts Premiums Outstanding at beginning of period 175 223,000 Written 2,460 1,545,000 Closed (1,835) (1,399,000) Outstanding at end of period 800 $ 369,000 Securities Lending The fund lends its securities to approved brokers to earn additional income. It receives as collateral cash and U.S. government securities valued at 102% to 105% of the value of the securities on loan. Cash collateral is invested in a money market pooled account by the fund's lending agent. Collateral is maintained over the life of the loan in an amount not less than the value of loaned securities, as determined at the close of fund business each day; any additional collateral required due to changes in security values is delivered to the fund the next business day. Although risk is mitigated by the collateral, the fund could experience a delay in recovering its securities and a possible loss of income or value if the borrower fails to return the securities. At May 31, 2002, the value of loaned securities was $368,088,000; aggregate collateral consisted of $383,945,000 in the securities lending collateral pool. Other Purchases and sales of portfolio securities, other than short-term and U.S. government securities, aggregated $1,399,848,000 and $1,492,667,000, respectively, for the year ended May 31, 2002. Purchases and sales of U.S. government securities aggregated $2,595,501,000 and $2,377,407,000, respectively, for the year ended May 31, 2002. NOTE 3 - FEDERAL INCOME TAXES No provision for federal income taxes is required since the fund intends to continue to qualify as a regulated investment company and distribute to shareholders all of its taxable income and capital gains. Because federal income tax regulations differ from generally accepted accounting principles, income and capital gain distributions determined in accordance with tax regulations differ from net investment income and realized gains recognized for financial reporting purposes. Accordingly, the character of distributions and composition of net assets for tax purposes differ from those reflected in the accompanying financial statements. Distributions during the year ended May 31, 2002, totaled $96,406,000 and were characterized as ordinary income. At May 31, 2002, the tax-basis components of net assets were as follows: - -------------------------------------------------------------------------------- Unrealized appreciation $36,548,000 Unrealized depreciation (30,453,000) Net unrealized appreciation (depreciation) 6,095,000 Undistributed ordinary income 1,146,000 Capital loss carryforwards (46,809,000) Distributable earnings (39,568,000) Paid-in capital 1,902,974,000 Net assets $1,863,406,000 The fund intends to retain realized capital gains that may be offset against available capital loss carryforwards for federal income tax purposes. In 2002, the fund utilized $29,175,000 of capital loss carryforwards. As of May 31, 2002, the fund had $9,271,000 of capital loss carryforwards that expire in 2008, $37,538,000 that expire in 2009. For financial reporting purposes, capital accounts and distributions to shareholders are adjusted to reflect the tax character of permanent book/tax differences. For the year ended May 31, 2002, the fund recorded the following permanent reclassifications, which relate primarily to the character of market discount at time of sale. Results of operations and net assets were not affected by these reclassifications. - -------------------------------------------------------------------------------- Undistributed net investment income $ 905,000 Undistributed net realized gain (905,000) At May 31, 2002, the cost of investments for federal income tax purposes was $2,111,721,000. NOTE 4 - RELATED PARTY TRANSACTIONS The fund is managed by T. Rowe Price Associates, Inc. (the manager or Price Associates), a wholly owned subsidiary of T. Rowe Price Group. The investment management agreement between the fund and the manager provides for an annual investment management fee, of which $734,000 was payable at May 31, 2002. The fee is computed daily and paid monthly, and consists of an individual fund fee equal to 0.15% of average daily net assets and a group fee. The group fee is based on the combined assets of certain mutual funds sponsored by Price Associates (the group). The group fee rate ranges from 0.48% for the first $1 billion of assets to 0.295% for assets in excess of $120 billion. At May 31, 2002, and for the year then ended, the effective annual group fee rate 0.32%. The fund pays a pro-rata share of the group fee based on the ratio of its net assets to those of the group. In addition, the fund has entered into agreements with Price Associates and two wholly owned subsidiaries of Price Associates, pursuant to which the fund receives certain other services. Price Associates computes the daily share price and maintains the financial records of the fund. T. Rowe Price Services, Inc. is the fund's transfer and dividend disbursing agent and provides shareholder and administrative services to the fund. T. Rowe Price Retirement Plan Services, Inc. provides subaccounting and recordkeeping services for certain retirement accounts invested in the fund. Expenses incurred pursuant to these related party agreements totaled approximately $2,109,000 for the year ended May 31, 2002, of which $183,000 was payable at period-end. Additionally, the fund is one of several mutual funds sponsored by Price Associates (underlying Price funds) in which the T. Rowe Price Spectrum Funds (Spectrum) may invest. Spectrum does not invest in the underlying Price funds for the purpose of exercising management or control. Expenses associated with the operation of Spectrum are borne by each underlying Price fund to the extent of estimated savings to it and in proportion to the average daily value of its shares owned by Spectrum, pursuant to special servicing agreements between and among Spectrum, the underlying Price funds, Price Associates, and, in the case of T. Rowe Price Spectrum International, T. Rowe Price International. For the year ended May 31, 2002, the fund was allocated $1,548,000 of Spectrum expenses, $156,000 of which was payable at period-end. At May 31, 2002, approximately 36% of the outstanding shares of the fund were held by Spectrum. The fund may invest in the T. Rowe Price Reserve Investment Fund and T. Rowe Price Government Reserve Investment Fund (collectively, the Reserve Funds), open-end management investment companies managed by Price Associates. The Reserve Funds are offered as cash management options only to mutual funds and other accounts managed by Price Associates and/or its affiliates, and are not available to the public. The Reserve Funds pay no investment management fees. Distributions from the Reserve Funds to the fund for the year ended May 31, 2002, totaled $3,140,000 and are reflected as interest income in the accompanying Statement of Operations. T. Rowe Price New Income Fund - -------------------------------------------------------------------------------- Report of Independent Accountants - -------------------------------------------------------------------------------- To the Board of Directors and Shareholders of T. Rowe Price New Income Fund, Inc. In our opinion, the accompanying statement of assets and liabilities, including the portfolio of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of T. Rowe Price New Income Fund, Inc. ("the Fund") at May 31, 2002, and the results of its operations, the changes in its net assets and the financial highlights for each of the fiscal periods presented, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at May 31, 2002, by correspondence with custodians and brokers, provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Baltimore, Maryland June 19, 2002 T. Rowe Price New Income Fund - -------------------------------------------------------------------------------- Tax Information (Unaudited) for the Tax Year Ended 5/31/02 - -------------------------------------------------------------------------------- We are providing this information as required by the Internal Revenue Code. The amounts shown may differ from those elsewhere in this report because of differences between tax and financial reporting requirements. For corporate shareholders, $973,000 of the fund's distributed income and short-term capital gains qualified for the dividends-received deduction. T. Rowe Price New Income Fund - -------------------------------------------------------------------------------- About the Fund's Directors and Officers Your fund is governed by a Board of Directors that meets regularly to review investments, performance, expenses, and other business matters, and is responsible for protecting the interests of shareholders. The majority of the fund's directors are independent of T. Rowe Price Associates, Inc.; "inside" directors are officers of T. Rowe Price. The Board of Directors elects the fund's officers, who are listed in the final table. The business address of each director and officer is 100 East Pratt Street, Baltimore, MD 21202. Independent Directors Name (Date of Birth) Principal Occupation(s) During Past 5 Years and Year Elected* Other Directorships of Public Companies - -------------------------------------------------------------------------------- Calvin W. Burnett, Ph.D. President, Coppin State College; Director, (3/16/32) Provident Bank of Maryland 1993 - -------------------------------------------------------------------------------- Anthony W. Deering Director, Chairman of the Board, President, and (1/28/45) Chief Executive Officer, The Rouse Company, real 1983 estate developers - -------------------------------------------------------------------------------- Donald W. Dick, Jr. Principal, EuroCapital Advisors, LLC, an (1/27/43) acquisition and management advisory firm 2001 - -------------------------------------------------------------------------------- David K. Fagin Director, Dayton Mining Corp. (6/98 to present), (4/9/38) Golden Star Resources Ltd., and Canyon Resources 2001 Corp. (5/00 to present); Chairman and President, Nye Corp. - -------------------------------------------------------------------------------- F. Pierce Linaweaver President, F. Pierce Linaweaver & Associates, (8/22/34) Inc., consulting environmental and civil 1983 engineers - -------------------------------------------------------------------------------- Hanne M. Merriman Retail Business Consultant; Director, Ann Taylor (11/16/41) Stores Corp., Ameren Corp., Finlay Enterprises, 2001 Inc., The Rouse Company, and US Airways Group, Inc. - -------------------------------------------------------------------------------- John G. Schreiber Owner/President, Centaur Capital Partners, Inc., (10/21/46) a real estate investment company; Senior Advisor 1992 and Partner, Blackstone Real Estate Advisors, L.P.; Director, AMLI Residential Properties Trust, Host Marriott Corp., and The Rouse Company - -------------------------------------------------------------------------------- Hubert D. Vos Owner/President, Stonington Capital Corp., (8/2/33) a private investment company 2001 - -------------------------------------------------------------------------------- Paul M. Wythes Founding Partner, Sutter Hill Ventures, a (6/23/33) venture capital limited partnership, providing 2001 equity capital to young high-technology companies throughout the United States; Director, Teltone Corp. - -------------------------------------------------------------------------------- *Each independent director oversees 98 T. Rowe Price portfolios and serves until the election of a successor. T. Rowe Price New Income Fund - -------------------------------------------------------------------------------- Inside Directors - -------------------------------------------------------------------------------- Name (Date of Birth) Year Elected* [Number of T. Rowe Price Principal Occupation(s) During Past 5 Years and Portfolios Overseen] Other Directorships of Public Companies - -------------------------------------------------------------------------------- William T. Reynolds Director and Managing Director, T. Rowe Price (5/26/48) and T. Rowe Price Group, Inc.; President, 1997 New Income Fund [37] - -------------------------------------------------------------------------------- James S. Riepe Director and Managing Director, T. Rowe Price; (6/25/43) Vice Chairman of the Board, Director, and 1983 Managing Director, T. Rowe Price Group, Inc.; [98] Chairman of the Board and Director, T. Rowe Price Investment Services, Inc., T. Rowe Price Retirement Plan Services, Inc., and T. Rowe Price Services, Inc.; Chairman of the Board, Director, President, and Trust Officer, T. Rowe Price Trust Company; Director, T. Rowe Price International, Inc., and T. Rowe Price Global Investment Services Limited; Vice President, New Income Fund - -------------------------------------------------------------------------------- M. David Testa Vice Chairman of the Board, Chief Investment (4/22/44) Officer, Director, and Managing Director, T. 1997 Rowe Price Group, Inc.; Chief Investment [98] Officer, Director, and Managing Director, T. Rowe Price; Chairman and Director, T. Rowe Price Global Asset Management Limited; Vice President and Director, T. Rowe Price Trust Company; Director, T. Rowe Price Global Investment Services Limited and T. Rowe Price International, Inc. - -------------------------------------------------------------------------------- *Each inside director serves until the election of a successor. Officers Name (Date of Birth) Title and Fund(s) Served Principal Occupation(s) - -------------------------------------------------------------------------------- Connice A. Bavely (3/5/51) Vice President, T. Rowe Price and Vice President, New Income Fund T. Rowe Price Group, Inc. - -------------------------------------------------------------------------------- Brian J. Brennan (7/14/64) Vice President, T. Rowe Price and Vice President, New Income Fund T. Rowe Price Group, Inc. - -------------------------------------------------------------------------------- Jennifer A. Callaghan (5/6/69) Assistant Vice President, T. Rowe Price Assistant Vice President, New Income Fund - -------------------------------------------------------------------------------- Joseph A. Carrier (12/30/60) Vice President, T. Rowe Price, T. Rowe Treasurer, New Income Fund Price Group, Inc., and T. Rowe Price Investment Services, Inc. - -------------------------------------------------------------------------------- Patrick S. Cassidy (8/27/64) Vice President, T. Rowe Price and Vice President, New Income Fund T. Rowe Price Group, Inc. - -------------------------------------------------------------------------------- Henry H. Hopkins (12/23/42) Vice President, New Income Fund Managing Director, T. Rowe Price; Director and Managing Director, T. Rowe Price Group, Inc.; Vice President, T. Rowe Price International, Inc., and T. Rowe Price Retirement Plan Services, Inc.; Vice President and Director, T. Rowe Price Investment Services, Inc., T. Rowe Price Services, Inc., and T. Rowe Price Trust Company - -------------------------------------------------------------------------------- Alan D. Levenson (7/17/58) Vice President, T. Rowe Price and Vice President, New Income Fund T. Rowe Price Group, Inc.; formerly Senior Vice President and Director of Research, Aubrey G. Lanston & Co., Inc. - -------------------------------------------------------------------------------- Patricia B. Lippert (1/12/53) Assistant Vice President, T. Rowe Price Secretary, New Income Fund and T. Rowe Price Investment Services, Inc. - -------------------------------------------------------------------------------- David S. Middleton (1/18/56) Vice President, T. Rowe Price, T. Rowe Controller, New Income Fund Price Group, Inc., and T. Rowe Price Trust Company - -------------------------------------------------------------------------------- Edmund M. Notzon (10/1/45) Managing Director, T. Rowe Price and Vice President, New Income Fund T. Rowe Price Group, Inc.; Vice President, T. Rowe Price Investment Services, Inc., and T. Rowe Price Trust Company - -------------------------------------------------------------------------------- Vernon A. Reid Jr. (5/14/54) Vice President, T. Rowe Price and Vice President, New Income Fund T. Rowe Price Group, Inc. - -------------------------------------------------------------------------------- Robert M. Rubino (8/2/53) Vice President, T. Rowe Price and Vice President, New Income Fund T. Rowe Price Group, Inc. - -------------------------------------------------------------------------------- Daniel O. Shackelford (3/11/58) Vice President, T. Rowe Price and Vice President, New Income Fund T. Rowe Price Group, Inc. - -------------------------------------------------------------------------------- Unless otherwise noted, officers have been employees of T. Rowe Price or T. Rowe Price International for at least five years. T. Rowe Price Investment Services and Information - -------------------------------------------------------------------------------- Investment Services and Information KNOWLEDGEABLE SERVICE REPRESENTATIVES By Phone 1-800-225-5132. Available Monday through Friday from 7 a.m. until midnight ET and weekends from 8:30 a.m. until 5 p.m. ET. In Person. Available in T. Rowe Price Investor Centers. Please call a service representative at 1-800-225-5132 or visit the Web at www.troweprice.com/investorcenter to locate a center near you. ACCOUNT SERVICES Automated 24-Hour Services Including Tele*Access(registered trademark) and Account Access through the T. Rowe Price Web site on the Internet. Address: www.troweprice.com. Automatic Investing. From your bank account or paycheck. Automatic Withdrawal. Scheduled, automatic redemptions. IRA Rebalancing. Ensuring that your accounts reflect your desired asset allocation. BROKERAGE SERVICES * Individual Investments. Stocks, bonds, options, precious metals, and other securities at a savings over full-service commission rates. INVESTMENT INFORMATION Consolidated Statement. Overview of all of your accounts. Shareholder Reports. Manager reviews of their strategies and results. T. Rowe Price Report. Quarterly investment newsletter. Performance Update. Quarterly review of all T. Rowe Price fund results. Insights. Educational reports on investment strategies and markets. Investment Guides. Asset Mix Worksheet, Diversifying Overseas: A Guide to International Investing, Retirement Planning Kit, Retirement Readiness Guide, and Tax Considerations Guide. * T. Rowe Price Brokerage is a division of T. Rowe Price Investment Services, Inc., Member NASD/SIPC. T. Rowe Price Planning Tools and Services - -------------------------------------------------------------------------------- T. Rowe Price Retirement Services T. Rowe Price offers unique retirement resources that can help you meet a broad variety of planning challenges. Our retirement tools are suitable for individuals, the self-employed, small businesses, corporations, and nonprofit organizations. We also provide recordkeeping, communications, and investment management services. For more information, call us at 1-800-IRA-5000, or visit our Web site at www.troweprice.com. PLANNING TOOLS AND SERVICES T. Rowe Price(registered trademark) Retirement Income Manager* helps retirees or those within two years of retirement determine how much income they can draw down in retirement. The program uses extensive statistical analysis and the input of a T. Rowe Price Advisory Counselor to suggest an income plan that best meets your objectives. Retirement Income Calculator. This free calculator, incorporating the analytic approach of the T. Rowe Price Retirement Income Manager program, simulates 500 potential market scenarios to estimate the probability of maintaining an income strategy throughout retirement. Rollover Investment Service* offers asset allocation and fund selection advice to those planning a 401(k) rollover from a previous employer after changing jobs or retiring. IRA Rebalancing Service. T. Rowe Price will rebalance your IRA at the end of every quarter by exchanging shares between mutual fund accounts. This ensures that your accounts retain your desired asset allocation. Quality Information. Thousands of investors have made their personal choices with the help of our Retirement Readiness Guide, Retirement Planning Kit, IRA Insights, and Retirement Planning Worksheet. INVESTMENT VEHICLES Individual Retirement Accounts (IRAs) No-Load Variable Annuities Small Business Retirement Plans * Services of T. Rowe Price Advisory Services, Inc., a federally registered investment adviser. There are costs associated with these services. T. Rowe Price Web Services - -------------------------------------------------------------------------------- www.troweprice.com ACCOUNT INFORMATION Account Access allows you to access, in a secure environment, all of your T. Rowe Price mutual fund, brokerage, variable annuity, and workplace retirement accounts with a single login. AccountMinder is a personal page, with one password, that gives you access to all your online financial information and other records from the secure T. Rowe Price Account Access site. FINANCIAL TOOLS AND CALCULATORS College Investment Calculator. This interactive tool allows you to estimate simultaneously the college costs for as many as five children. Morningstar(registered trademark) Portfolio Tracker(service mark). See how your investments are performing at any time. After you enter ticker symbols for your stocks and mutual funds, Portfolio Tracker provides information on prices, market value, and any applicable Morningstar ratings. Investment Strategy Planner. This planning tool can help you develop and implement an asset allocation strategy that's appropriate for you. Retirement Income Calculator. This free calculator simulates 500 potential market scenarios to estimate the probability of maintaining an income strategy throughout retirement. INVESTMENT TRACKING AND INFORMATION My TRP e-Updates. This free e-mail service offers timely market reports, important information about investing, and the latest updates on the T. Rowe Price funds and services. Morningstar(registered trademark) Portfolio Watchlist(service mark). Like the Portfolio Tracker, the Watchlist allows you to see how your investments are performing. After entering your ticker symbols, the Watchlist automatically provides you with prices, price changes in dollars and percentages, target highs and lows, and target volume. Morningstar(registered trademark) Portfolio X-Ray(service mark). This comprehensive tool goes below the surface to give you an in-depth examination of all your investments. It analyzes your portfolio by asset allocation, stock sector, fees and expenses, stock statistics, world regions, and top holdings. T. Rowe Price Mutual Funds - -------------------------------------------------------------------------------- STOCK FUNDS Domestic Blue Chip Growth* Capital Appreciation Capital Opportunity Developing Technologies Diversified Small-Cap Growth Dividend Growth Equity Income* Equity Index 500 Extended Equity Market Index Financial Services Growth & Income Growth Stock* Health Sciences Media & Telecommunications Mid-Cap Growth* Mid-Cap Value New America Growth New Era New Horizons Real Estate Science & Technology* Small-Cap Stock* Small-Cap Value*! Spectrum Growth Tax-Efficient Growth Tax-Efficient Multi-Cap Growth Total Equity Market Index Value* BLENDED ASSET FUNDS Balanced Personal Strategy Balanced Personal Strategy Growth Personal Strategy Income Tax-Efficient Balanced BOND FUNDS Domestic Taxable Corporate Income GNMA High Yield* New Income Short-Term Bond Spectrum Income Summit GNMA U.S. Bond Index U.S. Treasury Intermediate U.S. Treasury Long-Term Domestic Tax-Free California Tax-Free Bond Florida Intermediate Tax-Free Georgia Tax-Free Bond Maryland Short-Term Tax-Free Bond Maryland Tax-Free Bond New Jersey Tax-Free Bond New York Tax-Free Bond Summit Municipal Income Summit Municipal Intermediate Tax-Free High Yield Tax-Free Income Tax-Free Intermediate Bond Tax-Free Short-Intermediate Virginia Tax-Free Bond MONEY MARKET FUNDS!! Taxable Prime Reserve Summit Cash Reserves U.S. Treasury Money Tax-Free California Tax-Free Money Maryland Tax-Free Money New York Tax-Free Money Summit Municipal Money Market Tax-Exempt Money INTERNATIONAL/GLOBAL FUNDS Stock Emerging Europe & Mediterranean Emerging Markets Stock European Stock Global Stock Global Technology International Discovery! International Equity Index International Growth & Income International Stock* Japan Latin America New Asia Spectrum International Bond Emerging Markets Bond International Bond* For more information about T. Rowe Price funds or services, please contact us directly at 1-800-225-5132. * T. Rowe Price Advisor Class available for these funds. The T. Rowe Price Advisor Class is offered only through financial intermediaries. For more information about T. Rowe Price Advisor Class funds, contact your financial professional or T. Rowe Price at 1-877-804-2315. ! Closed to new investors. !! Investments in the funds are not insured or guaranteed by the FDIC or any other government agency. Although the funds seek to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the funds. Please call for a prospectus, which contains complete information, including risks, fees, and expenses. Read it carefully before investing. T. Rowe Price(registered trademark) INVEST WITH CONFIDENCE T. Rowe Price Investment Services, Inc. 100 East Pratt Street Baltimore, MD 21202 F43-050 5/31/02 -----END PRIVACY-ENHANCED MESSAGE-----