N-CSR 1 y32984nvcsr.txt FORM N-CSR 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: 811-06052 Morgan Stanley Municipal Income Opportunities Trust III (Exact name of registrant as specified in charter) 1221 Avenue of the Americas, New York, New York 10020 (Address of principal executive offices) (Zip code) Ronald E. Robison 1221 Avenue of the Americas, New York, New York 10020 (Name and address of agent for service) Registrant's telephone number, including area code: 212-762-4000 Date of fiscal year end: March 31, 2007 Date of reporting period: March 31, 2007 Item 1 - Report to Shareholders Welcome, Shareholder: In this report, you'll learn about how your investment in Morgan Stanley Municipal Income Opportunities Trust III performed during the annual period. We will provide an overview of the market conditions, and discuss some of the factors that affected performance during the reporting period. In addition, this report includes the Fund's financial statements and a list of Fund investments. MARKET FORECASTS PROVIDED IN THIS REPORT MAY NOT NECESSARILY COME TO PASS. THERE IS NO ASSURANCE THAT THE FUND WILL ACHIEVE ITS INVESTMENT OBJECTIVE. THE FUND IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT MARKET VALUES OF SECURITIES OWNED BY THE FUND WILL DECLINE AND, THEREFORE, THE VALUE OF THE FUND'S SHARES MAY BE LESS THAN WHAT YOU PAID FOR THEM. ACCORDINGLY, YOU CAN LOSE MONEY INVESTING IN THIS FUND. INCOME EARNED BY CERTAIN SECURITIES IN THE PORTFOLIO MAY BE SUBJECT TO THE FEDERAL ALTERNATIVE MINIMUM TAX (AMT). FUND REPORT For the year ended March 31, 2007 MARKET CONDITIONS The economy continued to send mixed signals about its overall strength during the fiscal year. Huge swings in oil prices and ongoing geopolitical uncertainty had a negative impact on the economic outlook, as did the contraction in the residential real estate sector. Turmoil in the sub-prime mortgage market in the latter months of the reporting period intensified concerns about the housing sector and had the greatest impact on the capital markets. In fact, these concerns were the primary contributor to the sharp decline in the equity market in late February, which led to a "flight to quality" that forced yields on U.S. Treasury bonds lower and prices higher. The changing economic and financial picture led to changes in the Federal Open Market Committee's (the "Fed") monetary policy as well. In the first three months of the reporting period, the Fed continued to pursue its monetary tightening campaign, raising the target federal funds rate to 5.25 percent by the end of June 2006. In the months that followed, however, the Fed held the rate steady but still maintained a bias toward tightening until March, when statements released following that month's meeting signaled a more neutral bias. This apparent change in policy led to a firmer equity market and began to move bond yields higher in the final weeks of the period. Long-term municipal bond yields rose modestly at the beginning of the fiscal period, with representative yields on 30-year AAA-rated municipal bonds increasing from 4.40 percent in March to 4.65 percent in July. The subsequent stabilization of Fed monetary policy, coupled with the growing risks to the economy, led long-term municipal rates to reverse course and decline to 3.95 percent in November before ending the fiscal year higher at 4.15 percent. Credit spreads between lower-quality, high-yield municipal bonds -- which comprise the bulk of the Fund's investments -- and higher-rated bonds narrowed during the period. Credit spreads measure the incremental yield investors are willing to accept to assume additional credit risk. When credit spreads have tightened, lower quality issues have typically outperformed high-grade issues. The slope of the municipal yield curve remained relatively flat, with only a 60 basis point yield differential, or "pick-up", between 30-year maturities and one-year maturities. In comparison, the yield pick-up from one to 30 years in March 2006 was over 100 basis points, and has averaged over 170 basis points over the past three years. Although municipal bond issuance in 2006 lagged that of the previous year, declining interest rates in the fourth quarter of the year spurred a rebound that led new issue volume for the year to reach $383 billion, the second highest on record and only 6 percent below 2005's record pace. In the first three months of 2007, new issue municipal volume increased by 49 percent to $104 billion. Municipalities continued to take advantage of lower interest rates to refinance their debt and refundings increased dramatically to an 88 percent share of total volume. The top five issuing states during the period were California (reflecting a 122 percent increase in new issuance for a 20 percent total market share), New York, Texas, Illinois and Florida. Together, these states accounted for 45 percent of total volume. Despite the increase in 2 volume, however, the supply of high-yield municipal bonds remained constrained. Strong demand by institutional investors and non-traditional buyers, including hedge funds and arbitrage accounts, helped long-term municipal bonds perform in line with Treasuries for the period. The 30-year municipal-to-Treasury yield ratio, which measures the relative attractiveness of these two sectors, declined from 92 to 85 percent during the fiscal year. A declining ratio indicates that municipals outperformed Treasuries while at the same time becoming richer (less attractive) on a relative basis. PERFORMANCE ANALYSIS For the 12-month period ended March 31, 2007, Morgan Stanley Municipal Income Opportunities Trust III's (OIC's) net asset value (NAV) increased from $9.77 to $10.08 per share. Based on this change plus reinvestment of tax-free dividends totaling $0.54 per share, and a taxable distribution of approximately $0.01 per share, the Fund's total NAV return was 9.06 percent. OIC's value on the New York Stock Exchange (NYSE) moved from $9.60 to $10.21 per share during the same period. Based on this change plus reinvestment of distributions, the Fund's total market return was 12.42 percent. OIC's NYSE market price was at a 1.29 percent premium to its NAV. Monthly dividends for the second quarter of 2007, declared in March, were unchanged at $0.045 per share. The dividend reflects the current level of the Fund's net investment income. OIC's level of undistributed net investment income was $0.097 per share on March 31, 2007, versus $0.124 per share 12 months earlier.(1) All holdings were accruing interest at fiscal year-end. During the fiscal reporting period, the Fund's interest-rate positioning continued to reflect our anticipation of higher rates. As a result, at the end of March the Fund's option-adjusted duration* stood at 6.9 years. At the beginning of the period this duration strategy helped the Fund's total returns when interest rates rose, but tempered returns later in the fiscal year when rates declined. The Fund invests primarily in higher yielding municipal bonds. During the period, the Fund's exposure to these below investment-grade or non-rated issues was more than three-quarters of its assets. This security mix had a positive impact on performance as lower-rated, high-yield municipal bonds outperformed investment-grade issues. The lower supply of high-yield bonds, coupled with strong demand, served as catalysts to their strong performance. Another boost to the Fund's performance were several holdings that appreciated significantly when they were prerefunded.** Reflecting an ongoing commitment to diversification, the Fund's net assets of approximately $86 million were invested among 11 long-term sectors and 86 credits. OIC's procedure for reinvesting all dividends and distributions in common shares is through purchases in the open market. This method helps support the market value of the Fund's shares. In addition, we would like to remind you that the Trustees have approved a procedure whereby the Fund may, when appropriate, purchase shares in the open market or in 3 privately negotiated transactions at a price not above market value or net asset value, whichever is lower at the time of purchase. ---------------------------------------------------- PERFORMANCE DATA QUOTED REPRESENTS PAST PERFORMANCE, WHICH IS NO GUARANTEE OF FUTURE RESULTS, AND CURRENT PERFORMANCE MAY BE LOWER OR HIGHER THAN THE FIGURES SHOWN. INVESTMENT RETURN, NET ASSET VALUE AND COMMON SHARE MARKET PRICE WILL FLUCTUATE AND FUND SHARES, WHEN SOLD, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. There is no guarantee that any sectors mentioned will continue to perform as discussed herein or that securities in such sectors will be held by the Fund in the future. (1) Income earned by certain securities in the portfolio may be subject to the federal alternative minimum tax (AMT). * A measure of the sensitivity of a bond's price to changes in interest rates, expressed in years. Each year of duration represents an expected 1 percent change in the price of a bond for every 1 percent change in interest rates. The longer a bond's duration, the greater the effect of interest-rate movements on its price. Typically, funds with shorter durations perform better in rising-interest-rate environments, while funds with longer durations perform better when rates decline. ** Prerefunding, or advance refunding, is a financing structure under which new bonds are issued to repay an outstanding bond issue prior to its first call date.
TOP FIVE SECTORS Retirement & Life Care Facilities 24.6% Hospital 13.7 Tax Allocation 13.5 Nursing & Health Related Facilities 7.7 Educational Facilities 7.1
LONG-TERM CREDIT ANALYSIS Aaa/AAA 2.8% Aa/AA 2.0 A/A 1.2 Baa/BBB 16.4 Ba/BB or Less 7.6 NR 70.0
Data as of March 31, 2007. Subject to change daily. All percentages for top five sectors are as a percentage of net assets and all percentages for long-term credit analysis are as a percentage of total long-term investments. These data are provided for informational purposes only and should not be deemed a recommendation to buy or sell the securities mentioned. Morgan Stanley is a full-service securities firm engaged in securities trading and brokerage activities, investment banking, research and analysis, financing and financial advisory services. 4 FOR MORE INFORMATION ABOUT PORTFOLIO HOLDINGS EACH MORGAN STANLEY FUND PROVIDES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS IN ITS SEMIANNUAL AND ANNUAL REPORTS WITHIN 60 DAYS OF THE END OF THE FUND'S SECOND AND FOURTH FISCAL QUARTERS. THE SEMIANNUAL REPORTS AND THE ANNUAL REPORTS ARE FILED ELECTRONICALLY WITH THE SECURITIES AND EXCHANGE COMMISSION (SEC) ON FORM N-CSRS AND FORM N-CSR, RESPECTIVELY. MORGAN STANLEY ALSO DELIVERS THE SEMIANNUAL AND ANNUAL REPORTS TO FUND SHAREHOLDERS AND MAKES THESE REPORTS AVAILABLE ON ITS PUBLIC WEB SITE, WWW.MORGANSTANLEY.COM. EACH MORGAN STANLEY FUND ALSO FILES A COMPLETE SCHEDULE OF PORTFOLIO HOLDINGS WITH THE SEC FOR THE FUND'S FIRST AND THIRD FISCAL QUARTERS ON FORM N-Q. MORGAN STANLEY DOES NOT DELIVER THE REPORTS FOR THE FIRST AND THIRD FISCAL QUARTERS TO SHAREHOLDERS, NOR ARE THE REPORTS POSTED TO THE MORGAN STANLEY PUBLIC WEB SITE. YOU MAY, HOWEVER, OBTAIN THE FORM N-Q FILINGS (AS WELL AS THE FORM N-CSR AND N-CSRS FILINGS) BY ACCESSING THE SEC'S WEB SITE, HTTP://WWW.SEC.GOV. YOU MAY ALSO REVIEW AND COPY THEM AT THE SEC'S PUBLIC REFERENCE ROOM IN WASHINGTON, DC. INFORMATION ON THE OPERATION OF THE SEC'S PUBLIC REFERENCE ROOM MAY BE OBTAINED BY CALLING THE SEC AT (800) SEC-0330. YOU CAN ALSO REQUEST COPIES OF THESE MATERIALS, UPON PAYMENT OF A DUPLICATING FEE, BY ELECTRONIC REQUEST AT THE SEC'S E-MAIL ADDRESS (PUBLICINFO@SEC.GOV) OR BY WRITING THE PUBLIC REFERENCE SECTION OF THE SEC, WASHINGTON, DC 20549-0102. 5 DISTRIBUTION BY MATURITY (% of Long-Term Portfolio) As of March 31, 2007 WEIGHTED AVERAGE MATURITY: 22 YEARS(a) 0-5 10 6-10 3 11-15 6 16-20 16 21-25 26 26-30 32 31+ 7
(a) When applicable maturities reflect mandatory tenders, puts and call dates. Portfolio structure is subject to change. Geographic Summary of Investments Based on Market Value as a Percent of Net Assets Alabama................ 1.2% Alaska................. 1.1 Arizona................ 1.3 California............. 9.4 Colorado............... 3.2 Connecticut............ 3.0 District of Columbia... 1.1 Florida................ 9.4 Georgia................ 1.2 Hawaii................. 2.0 Illinois............... 4.3 Indiana................ 2.9 Iowa................... 1.9% Kansas................. 2.5 Maryland............... 4.0 Massachusetts.......... 3.7 Minnesota.............. 2.1 Missouri............... 4.9 Nevada................. 3.6 New Hampshire.......... 1.2 New Jersey............. 6.7 New York............... 5.0 North Carolina......... 1.2 Oklahoma............... 1.3 Pennsylvania........... 5.1% South Carolina......... 1.0 Tennessee.............. 2.7 Texas.................. 3.1 Utah................... 1.3 Virginia............... 5.8 Washington............. 0.3 Wyoming................ 1.9 Joint exemptions*...... (1.1) ----- Total+................. 98.3% =====
--------------------- * Joint exemptions have been included in each geographic location. + Does not include open short futures contracts with an underlying face amount of $1,621,875 with unrealized appreciation of $4,998 and an open swap contract with unrealized appreciation of $9,804. 2 CALL AND COST (BOOK) YIELD STRUCTURE (Based on Long-Term Portfolio) As of March 31, 2007 YEARS BONDS CALLABLE -- WEIGHTED AVERAGE CALL PROTECTION: 5 YEARS 2007(a) 10 2008 7 2009 10 2010 8 2011 8 2012 8 2013 9 2014 8 2015 7 2016 19 2017+ 6
COST (BOOK) YIELD(b) -- WEIGHTED AVERAGE BOOK YIELD: 6.4% 2007(a) 6.40 2008 6.40 2009 6.20 2010 7.30 2011 7.50 2012 6.50 2013 6.50 2014 6.10 2015 5.50 2016 6.00 2017+ 5.80
(a) May include issues initially callable in previous years. (b) Cost or "book" yield is the annual income earned on a portfolio investment based on its original purchase price before the Fund's operating expenses. For example, the Fund is earning a book yield of 6.4% on 10% of the long-term portfolio that is callable in 2007. Portfolio structure is subject to change. 3 Morgan Stanley Municipal Income Opportunities Trust III PORTFOLIO OF INVESTMENTS - MARCH 31, 2007
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE --------------------------------------------------------------------------------------------------------- Tax-Exempt Municipal Bonds (98.6%) General Obligation (1.2%) $ 1,000 Georgetown Special Taxing District, Connecticut, Ser 2006 A (a)................................................... 5.125% 10/01/36 $ 1,002,240 ----------- ------- Educational Facilities Revenue (7.1%) 1,000 Pima County Industrial Development Authority, Arizona, Noah Webster Basic School Ser 2004 A.................... 6.125 12/15/34 1,055,110 495 Bellalago Educational Facilities Benefits District, Florida, Bellalago Charter School Ser 2004 B............ 5.80 05/01/34 513,132 1,500 Upland, Indiana, Taylor University Ser 2002............... 6.25 09/01/28 1,647,900 400 Maryland Health & Higher Educational Facilities Authority, Washington Christian Academy Ser 2006................... 5.50 07/01/38 411,984 420 Maryland Industrial Development Financing Authority, Our Lady of Good Counsel High School Ser 2005 A............. 5.50 05/01/20 443,671 1,000 Harrisburg Authority, Pennsylvania, Harrisburg University of Science & Technology Ser 2007 B...................... 6.00 09/01/36 1,042,020 1,000 Chattanooga Health Educational & Housing Facilities Board, Tennessee, Student Housing Refg Ser 2005 A***........... 5.00 10/01/25 1,019,070 ----------- ------- 6,132,887 5,815 ----------- ------- Hospital Revenue (13.7%) 1,000 Colbert County - Northwest Health Care Authority, Alabama, Helen Keller Hospital Ser 2003.......................... 5.75 06/01/27 1,049,250 500 Salida, Hospital District, Colorado, Heart of the Rockies Regional Medical Center Ser 2006........................ 5.25 10/01/36 508,795 1,500 Hawaii Department of Budget & Finance, Wilcox Memorial Hospital Ser 1998....................................... 5.50 07/01/28 1,539,105 500 Indiana Health Facility Financing Authority, Riverview Hospital Ser 2002....................................... 6.125 08/01/31 539,355 500 Washington County Hospital, Iowa, Ser 2006................ 5.375 07/01/26 516,330 1,250 Aitkin, Minnesota, Riverwood Healthcare Center Ser 2006... 5.60 02/01/32 1,289,700 1,000 Henderson, Nevada, Catholic Health West Ser 1998 A........ 5.125 07/01/28 1,018,080 1,000 New Hampshire Higher Educational & Health Facilities Authority, Littleton Hospital Association Ser 1998 A.... 6.00 05/01/28 1,026,780 1,000 New Jersey Health Care Facilities Financing Authority, Raritan Bay Medical Center Ser 1994..................... 7.25 07/01/27 1,031,650 1,000 Oklahoma Development Finance Authority, Comanche County Hospital 2000 Ser B..................................... 6.60 07/01/31 1,111,170 500 Decatur Hospital Authority, Texas, Wise Regional Health Ser 2004 A.............................................. 7.125 09/01/34 551,000 1,500 Teton County Hospital District, Wyoming, St John's Medical Center Ser 2002......................................... 6.75 12/01/27 1,601,520 ----------- ------- 11,782,735 11,250 ----------- -------
See Notes to Financial Statements 4 Morgan Stanley Municipal Income Opportunities Trust III PORTFOLIO OF INVESTMENTS - MARCH 31, 2007 continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE --------------------------------------------------------------------------------------------------------- Industrial Development/Pollution Control Revenue (6.2%) $ 905 Metropolitan Washington Airports Authority, District of Columbia & Virginia, CaterAir International Corp Ser 1991 (AMT)*............................................. 10.125% 09/01/11 $ 906,421 1,235 Maryland Industrial Development Financing Authority, Medical Waste Associates LP 1989 Ser (AMT).............. 8.75 11/15/10 1,027,718 New York City Industrial Development Agency, New York, 1,000 American Airlines Inc Ser 2005 (AMT).................... 7.75 08/01/31 1,214,050 1,000 7 World Trade Center LLC Ser 2005 A..................... 6.50 03/01/35 1,064,550 425 Carbon County Industrial Development Authority, Pennsylvania, Panther Creek Partners Refg 2000 Ser (AMT)................................................... 6.65 05/01/10 442,705 500 Pennsylvania Economic Development Financing Authority, Reliant Energy Inc Ser 2001 A (AMT)..................... 6.75 12/01/36 551,020 100 Lexington County, South Carolina, Ellett Brothers Inc Refg Ser 1988................................................ 7.50 09/01/08 99,688 ----------- ------- 5,306,152 5,165 ----------- ------- Mortgage Revenue - Multi-Family (0.9%) 500 Buffalo, Minnesota, Central Minnesota Senior Housing Ser 2006 A.................................................. 5.50 09/01/33 504,915 290 Washington Housing Finance Commission, FNMA Collateralized Refg Ser 1990 A......................................... 7.50 07/01/23 290,583 ----------- ------- 795,498 790 ----------- ------- Mortgage Revenue - Single Family (4.0%) 20 Maricopa County Industrial Development Authority, Arizona, Ser 2000-1C (AMT)....................................... 6.25 12/01/30 20,393 California Housing Finance Agency, 500 RITES PA 1417 Ser 2006 (AMT)............................ 5.325** 08/01/31 497,000 500 RITES PA 1417 Ser 2006 (AMT)............................ 5.525** 08/01/36 498,890 180 Colorado Housing Finance Authority, 1998 Ser B-2 (AMT).... 7.25 10/01/31 181,168 245 Chicago, Illinois, GNMA-Collateralized Ser 1998 A-1 (AMT)................................................... 6.45 09/01/29 247,722 Pennsylvania Housing Finance Agency, 880 Ser 2006-96 A (AMT)++................................... 4.65 10/01/31 868,575 1,120 Ser 2006-96 A (AMT)++................................... 4.70 10/01/37 1,105,460 ----------- ------- 3,419,208 3,445 ----------- ------- Nursing & Health Related Facilities Revenue (7.7%) 2,000 Orange County Health Facilities Authority, Florida, Westminister Community Care Services Inc Ser 1999....... 6.75 04/01/34 2,079,880 1,000 Pinellas County Health Facilities Authority, Florida, Oaks of Clearwater Ser 2004.................................. 6.25 06/01/34 1,068,030 Massachusetts Development Finance Agency, 500 Evergreen Center Ser 2005............................... 5.50 01/01/35 514,085 1,205 Kennedy-Donovan Center Inc 1990 Issue................... 7.50 06/01/10 1,249,645
See Notes to Financial Statements 5 Morgan Stanley Municipal Income Opportunities Trust III PORTFOLIO OF INVESTMENTS - MARCH 31, 2007 continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE --------------------------------------------------------------------------------------------------------- $ 695 New Jersey Health Care Facilities Financing Authority, Spectrum for Living - FHA Insured Mortgage Refg Ser B... 6.50% 02/01/22 $ 696,334 1,000 Mount Vernon Industrial Development Agency, New York, Meadowview at the Wartburg Ser 1999..................... 6.20 06/01/29 1,035,830 ----------- ------- 6,643,804 6,400 ----------- ------- Public Facilities Revenue (1.2%) 1,000 Kansas City Industrial Development Authority, Missouri, ------- Plaza Library Ser 2004.................................. 5.90 03/01/24 1,013,300 ----------- Recreational Facilities (6.5%) 1,000 Sacramento Financing Authority, California, Convention Center Hotel 1999 Ser A................................. 6.25 01/01/30 1,040,120 1,300 San Diego County, California, San Diego Natural History Museum COPs............................................. 5.60 02/01/18 1,301,885 1,500 Mohegan Tribe of Indians, Connecticut, Gaming Authority Ser 2001 (a)............................................ 6.25 01/01/31 1,596,135 1,000 Overland Park Development Corporation, Kansas, Convention Center Hotel Ser 2000 A................................. 7.375 01/01/32 1,090,700 500 Austin Convention Enterprises Inc, Texas, Convention Center Hotel Ser 2006 B................................. 5.75 01/01/34 535,720 ----------- ------- 5,564,560 5,300 ----------- ------- Retirement & Life Care Facilities Revenue (24.6%) 1,100 Orange County Health Facilities Authority, Florida, Orlando Lutheran Towers Inc Ser 2005.................... 5.375 07/01/20 1,109,746 1,000 Medical Center Hospital Authority, Georgia, Spring Harbor at Green Island Ser 2007 (WI)........................... 5.25 07/01/27 1,023,820 1,000 Illinois Finance Authority, Friendship Village of Schaumburg Ser 2005 A................................... 5.625 02/15/37 1,032,980 750 Illinois Health Facilities Authority, Villa St Benedict Ser 2003 A-1............................................ 6.90 11/15/33 829,958 275 Saint Joseph County, Indiana, Holy Cross Village at Notre Dame Ser 2006 A......................................... 6.00 05/15/26 293,686 1,000 Olathe, Kansas, Catholic Care Ser 2006 A.................. 6.00 11/15/38 1,070,390 500 Howard County, Maryland, Vantage House Ser 2007 B (WI).... 5.25 04/01/37 511,720 500 Maryland Health & Higher Educational Facilities Authority, King Farm Presbyterian Community Ser 2007 A............. 5.30 01/01/37 514,500 1,425 Massachusetts Development Finance Agency, Loomis Communities Ser 1999 A.................................. 5.625 07/01/15 1,458,887 1,000 Kansas City Industrial Development Authority, Missouri, Bishop Spencer 2004 Ser I............................... 6.25 01/01/24 1,055,750
See Notes to Financial Statements 6 Morgan Stanley Municipal Income Opportunities Trust III PORTFOLIO OF INVESTMENTS - MARCH 31, 2007 continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE --------------------------------------------------------------------------------------------------------- New Jersey Economic Development Authority, $ 1,000 Franciscan Oaks Ser 1997................................ 5.70% 10/01/17 $ 1,020,650 1,000 Franciscan Oaks Ser 1997................................ 5.75 10/01/23 1,020,400 500 Lions Gate Ser 2005 A................................... 5.875 01/01/37 523,960 1,000 North Carolina Medical Care Commission Healthcare Facilities, Presbyterian Homes Ser 2006................. 5.50 10/01/31 1,042,830 750 Bucks County Industrial Development Authority, Pennsylvania, Ann's Choice Ser 2005 A................... 6.25 01/01/35 797,302 500 Montgomery County Industry Development Authority, Pennsylvania, Whitemarsh Community Ser 2005............. 6.25 02/01/35 530,095 750 South Carolina Jobs-Economic Development Authority, Wesley Commons Ser 2006........................................ 5.30 10/01/36 765,945 Shelby County Health, Educational & Housing Facilities Board, Tennessee, 500 Trezevant Manor Ser 2006 A.............................. 5.75 09/01/37 514,250 750 Village at Germantown Ser 2003 A........................ 7.25 12/01/34 761,865 500 HFDC Central Texas Inc, Legacy at Willow Bend, Ser 2006 A....................................................... 5.75 11/01/36 519,265 1,000 Lubbock Health Facilities Development Corporation, Texas, Carillon Ser 2005 A..................................... 6.50 07/01/26 1,049,470 2,580 Chesterfield County Industrial Development Authority, Virginia, Brandermill Woods Ser 1998.................... 6.50 01/01/28 2,684,357 1,000 Peninsula Ports Authority of Virginia, Virginia Baptist Homes Ser 2006 C........................................ 5.40 12/01/33 1,036,510 ----------- ------- 21,168,336 20,380 ----------- ------- Tax Allocation Revenue (13.5%) 475 Carlsbad Community Facility District #3, California, Ser 2006.................................................... 5.30 09/01/36 489,754 1,500 Poway Unified School District, Community Facilities District #14, California, Ser 2006...................... 5.25 09/01/36 1,546,920 1,000 San Marcos Community Facilities District #2002-01, California, University Commons Ser 2004................. 5.90 09/01/28 1,050,140 700 Santa Ana Unified School District Communities Facilities District #2004-1, California, Ser 2005.................. 5.05 09/01/30 708,834 1,000 Copperleaf Metropolitan District #2, Colorado, Ser 2006... 5.95 12/01/36 1,038,930 Elk Valley Public Improvement Corporation, Colorado, 500 Ser 2001 A.............................................. 7.30 09/01/22 531,740 500 Ser 2001 A.............................................. 7.35 09/01/31 530,895 1,000 Midtown Miami Community Development District, Florida, Parking Garage Ser 2004 A............................... 6.25 05/01/37 1,088,370 500 Bolingbrook, Illinois, Sales Tax Ser 2005................. 0.00+++ 01/01/24 499,160 500 Chicago, Illinois, Lake Shore East Ser 2002............... 6.75 12/01/32 542,105 500 Pingree Grove Special Service Area #7, Illinois, Cambridge Lakes Ser 2006.......................................... 6.00 03/01/36 522,590
See Notes to Financial Statements 7 Morgan Stanley Municipal Income Opportunities Trust III PORTFOLIO OF INVESTMENTS - MARCH 31, 2007 continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE --------------------------------------------------------------------------------------------------------- $ 500 Prince George's County, Maryland, National Harbor Ser 2004.................................................... 5.20% 07/01/34 $ 512,260 1,000 Des Peres, Missouri, West County Center Ser 2002.......... 5.75 04/15/20 1,028,330 500 Clark County Special Improvement District #142, Nevada, Mountain's Edge Ser 2003................................ 6.375 08/01/23 517,145 500 Henderson, Nevada, Local Improvement District # T-18, Ser 2006.................................................... 5.30 09/01/35 507,890 500 Allegheny County Redevelopment Authority, Pennsylvania, Pittsburgh Mills Ser 2004............................... 5.60 07/01/23 531,675 ----------- ------- 11,646,738 11,175 ----------- ------- Tobacco Revenue (5.5%) 1,000 Northern Tobacco Securitization Corporation, Alaska, Asset Backed Ser 2006 A....................................... 5.00 06/01/46 974,780 1,000 California County Tobacco Securitization Agency, Gold County Settlement Funding Corp Ser 2006................. 0.00 06/01/33 223,030 2,000 Golden State Tobacco Securitization Corporation, California, Ser 2007A-1++............................... 5.125 06/01/47 1,986,030 5,000 Silicon Valley Tobacco Securitization Authority, California, Santa Clara Tobacco Securitization Corp Ser 2007 C.................................................. 0.00 06/01/56 239,250 2,000 Tobacco Settlement Financing Corporation, New Jersey, Ser 2007-1B................................................. 0.00 06/01/41 298,640 1,000 Nassau County Tobacco Settlement Corporation, New York, Asset Backed Ser 2006 A-3............................... 5.125 06/01/46 1,019,430 ----------- ------- 4,741,160 12,000 ----------- ------- Transportation Facilities Revenue (1.2%) 1,000 Nevada Department of Business & Industry, Las Vegas ------- Monorail 2nd Tier Ser 2000.............................. 7.375 01/01/40 1,052,190 ----------- Refunded (5.3%) 2,000 St Johns County Industrial Development Authority, Florida, Glenmoor Ser 1999 A..................................... 8.00 01/01/10+ 2,224,180 940 Iowa Health Facilities Development Financing Authority, Care Initiatives Ser 1996............................... 9.25 07/01/11+ 1,147,185 1,000 New Jersey Economic Development Authority, Cedar Crest Village Inc Ser 2001 A.................................. 7.25 11/15/11+ 1,151,800 ----------- ------- 4,523,165 3,940 ----------- ------- 88,660 Total Tax-Exempt Municipal Bonds (Cost $80,534,020)........................... 84,791,973 ----------- ------- Short-Term Tax-Exempt Municipal Obligations (3.2%) 200 Hawaii Department of Budget & Finance, Hawaiian Electric Co Ser 1996 A (AMT) (MBIA) (call for Redemption 05/01/07)............................................... 6.20 05/01/26 200,388 1,100 Missouri Health & Educational Facilities Authority, Saint Louis University Ser 2006 A (MBIA) (Demand 04/02/07).... 3.75@ 10/01/35 1,100,000 1,100 Murray City, Utah, IHC Health Ser 2005 B (Demand 04/02/07)............................................... 3.77@ 05/15/37 1,100,000
See Notes to Financial Statements 8 Morgan Stanley Municipal Income Opportunities Trust III PORTFOLIO OF INVESTMENTS - MARCH 31, 2007 continued
PRINCIPAL AMOUNT IN COUPON MATURITY THOUSANDS RATE DATE VALUE --------------------------------------------------------------------------------------------------------- $ 400 Virginia Commonwealth University, Ser 2006 A (Ambac) (Demand 04/02/07)....................................... 3.80@% 11/01/30 $ 400,000 ----------- ------- 2,800 Total Short-Term Tax-Exempt Municipal Obligations (Cost $2,800,181)........... 2,800,388 ----------- ------- 91,460 Total Investments (Cost $83,334,201).......................................... 87,592,361 ----------- ------- Floating Rate Note Obligation Related to Securities Held (-3.5%) (3,000) Notes with interest rates ranging from 3.68% to 3.75% at March 31, 2007 and contractual maturities of collateral ranging from 10/01/31 to 06/01/47 (See Note 1D)++++ (Cost $(3,000,000))............................................ (3,000,000) ----------- -------
$88,460 Total Net Investments (Cost $80,334,201) (b) (c)................... 98.3% 84,592,361 ======= Other Assets In Excess of Liabilities.............................. 1.7 1,419,799 ----- ----------- Net Assets......................................................... 100.0% $86,012,160 ===== ===========
--------------------- AMT Alternative Minimum Tax. COPs Certificates of Participation. RITES Residual Interest Tax-Exempt Security. WI Security purchased on a when-issued basis. @ Current coupon of variable rate demand obligation. * Joint exemption in locations shown. ** Current coupon rate for inverse floating rate municipal obligations (See Note 7). This rate resets periodically as the auction rate on the related security changes. Positions in inverse floating rate municipal obligations have a total value of $995,890 which represents 1.2% of net assets. *** A portion of this security has been physically segregated in connection with open futures contracts in the amount of $11,250. + Refunded to call date shown. ++ Underlying security related to inverse floater entered into by the Fund. +++ Security is a "step-up" bond where the coupon increases on a predetermined future date. ++++ Floating rate note obligation related to securities held. The interest rate shown reflects the rate in effect at March 31, 2007. (a) Resale is restricted to qualified institutional investors. (b) Securities have been designated as collateral in an amount equal to $3,160,334 in connection with securities purchased on a when-issued basis, open futures contracts and an open swap contract. (c) The aggregate cost for federal income tax purposes is $80,288,425. The aggregate gross unrealized appreciation is $4,610,772 and the aggregate gross unrealized depreciation is $306,836, resulting in net unrealized appreciation of $4,303,936. Bond Insurance: --------------- Ambac Ambac Assurance Corporation. MBIA Municipal Bond Investors Assurance Corporation.
See Notes to Financial Statements 9 Morgan Stanley Municipal Income Opportunities Trust III PORTFOLIO OF INVESTMENTS - MARCH 31, 2007 continued FUTURES CONTRACTS OPEN AT MARCH 31, 2007:
NUMBER OF DESCRIPTION, DELIVERY UNDERLYING FACE UNREALIZED CONTRACTS LONG/SHORT MONTH AND YEAR AMOUNT AT VALUE APPRECIATION ----------------------------------------------------------------------------------------------- 15 Short U.S. Treasury Notes 10 Year $(1,621,875) $4,998 June 2007 ======
INTEREST RATE SWAP CONTRACT OPEN AT MARCH 31, 2007:
NOTIONAL PAYMENTS PAYMENTS TERMINATION UNREALIZED COUNTERPARTY AMOUNT (000) MADE BY FUND RECEIVED BY FUND DATE APPRECIATION ------------------------------------------------------------------------------------------------------------- J.P. Morgan Chase Co. $2,000 Fixed Rate 3.6075% Floating Rate BMA 05/25/17 $9,804 (Bond Market Association) ======
See Notes to Financial Statements 10 Morgan Stanley Municipal Income Opportunities Trust III FINANCIAL STATEMENTS Statement of Assets and Liabilities March 31, 2007 Assets: Investments in securities, at value (cost $83,334,201)................. $87,592,361 Unrealized appreciation on an open swap contract...................... 9,804 Cash................................. 87,900 Receivable for: Investments sold................. 1,678,254 Interest......................... 1,326,895 Variation margin................. 1,875 Prepaid expenses and other assets.... 15,699 ----------- Total Assets..................... 90,712,788 ----------- Liabilities: Floating rate note obligations....... 3,000,000 Payable for: Investments purchased............ 1,534,866 Investment advisory fee.......... 42,593 Administration fee............... 6,815 Transfer agent fee............... 1,323 Accrued expenses and other payables........................... 115,031 ----------- Total Liabilities................ 4,700,628 ----------- Net Assets....................... $86,012,160 =========== Composition of Net Assets: Paid-in-capital...................... $81,402,056 Net unrealized appreciation.......... 4,272,962 Accumulated undistributed net investment income.................. 824,356 Accumulated net realized loss........ (487,214) ----------- Net Assets....................... $86,012,160 ----------- Net Asset Value Per Share 8,532,857 shares outstanding (unlimited shares authorized of $.01 par value)........................... $10.08 ===========
Statement of Operations For the year ended March 31, 2007 Net Investment Income: Interest Income....................... $5,166,452 ---------- Expenses Investment advisory fee............... 427,455 Professional fees..................... 69,172 Administration fee.................... 68,393 Shareholder reports and notices....... 41,153 Listing fees.......................... 22,004 Interest and residual trust expenses............................ 21,097 Transfer agent fees and expenses...... 11,114 Custodian fees........................ 6,151 Trustees' fees and expenses........... 6,069 Other................................. 23,884 ---------- Total Expenses.................... 696,492 Less: expense offset.................. (6,062) ---------- Net Expenses...................... 690,430 ---------- Net Investment Income............. 4,476,022 ---------- Net Realized and Unrealized Gain (Loss): Net Realized Gain (Loss) on: Investments........................... 954,320 Futures contracts..................... (97,793) ---------- Net Realized Gain................. 856,527 ---------- Net Change in Unrealized Appreciation: Investments........................... 1,990,884 Futures contracts..................... 4,998 Swap contract......................... 9,804 ---------- Net Appreciation.................. 2,005,686 ---------- Net Gain.......................... 2,862,213 ---------- Net Increase.......................... $7,338,235 ==========
See Notes to Financial Statements 11 Morgan Stanley Municipal Income Opportunities Trust III FINANCIAL STATEMENTS, continued Statements of Changes in Net Assets
FOR THE YEAR FOR THE YEAR ENDED ENDED MARCH 31, 2007 MARCH 31, 2006 -------------- -------------- Increase (Decrease) in Net Assets: Operations: Net investment income....................................... $ 4,476,022 $ 4,834,759 Net realized gain........................................... 856,527 756,757 Net change in unrealized appreciation....................... 2,005,686 1,140,280 ----------- ----------- Net Increase............................................ 7,338,235 6,731,796 Dividends to shareholders from net investment income........ (4,715,902) (4,574,650) Decrease from transactions in shares of beneficial interest.................................................. (407,092) (2,740,265) ----------- ----------- Net Increase (Decrease)................................. 2,215,241 (583,119) Net Assets: Beginning of period......................................... 83,796,919 84,380,038 ----------- ----------- End of Period (Including accumulated undistributed net investment income of $824,356 and $1,063,894, respectively)................... $86,012,160 $83,796,919 =========== ===========
See Notes to Financial Statements 12 Morgan Stanley Municipal Income Opportunities Trust III NOTES TO FINANCIAL STATEMENTS - MARCH 31, 2007 1. Organization and Accounting Policies Morgan Stanley Municipal Income Opportunities Trust III (the "Fund"), is registered under the Investment Company Act of 1940, as amended, as a diversified, closed-end management investment company. The Fund's investment objective is to provide a high level of current income which is exempt from federal income tax. The Fund was organized as a Massachusetts business trust on February 20, 1990 and commenced operations on April 30, 1990. The following is a summary of significant accounting policies: A. Valuation of Investments -- (1) portfolio securities are valued by an outside independent pricing service approved by the Trustees. The pricing service uses both a computerized grid matrix of tax-exempt securities and evaluations by its staff, in each case based on information concerning market transactions and quotations from dealers which reflect the mean between the last reported bid and asked price. The portfolio securities are thus valued by reference to a combination of transactions and quotations for the same or other securities believed to be comparable in quality, coupon, maturity, type of issue, call provisions, trading characteristics and other features deemed to be relevant. The Trustees believe that timely and reliable market quotations are generally not readily available for purposes of valuing tax-exempt securities and that the valuations supplied by the pricing service are more likely to approximate the fair value of such securities; (2) futures are valued at the latest sale price on the commodities exchange on which they trade unless it is determined that such price does not reflect their market value, in which case they will be valued at their fair value as determined in good faith under procedures established by and under the supervision of the Trustees; (3) interest rate swaps are marked-to-market daily based upon quotations from market makers and the change, if any, is recorded as unrealized appreciation or depreciation in the Statement of Operations; (4) short-term debt securities having a maturity date of more than sixty days at time of purchase are valued on a mark-to-market basis until sixty days prior to maturity and thereafter at amortized cost based on their value on the 61st day. Short-term debt securities having a maturity date of sixty days or less at the time of purchase are valued at amortized cost. B. Accounting for Investments -- Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Realized gains and losses on security transactions are determined by the identified cost method. Discounts are accreted and premiums are amortized over the life of the respective securities. Interest income is accrued daily except where collection is not expected. C. Futures Contracts -- A futures contract is an agreement between two parties to buy and sell financial instruments or contracts based on financial indices at a set price on a future date. Upon entering into such a contract, the Fund is required to pledge to the broker cash, U.S. Government 13 Morgan Stanley Municipal Income Opportunities Trust III NOTES TO FINANCIAL STATEMENTS - MARCH 31, 2007 continued securities or other liquid portfolio securities equal to the minimum initial margin requirements of the applicable futures exchange. Pursuant to the contract, the Fund agrees to receive from or pay to the broker an amount of cash equal to the daily fluctuation in the value of the contract. Such receipts or payments known as variation margin are recorded by the Fund as unrealized gains and losses. Upon closing of the contract, the Fund realizes a gain or loss equal to the difference between the value of the contract at the time it was opened and the value at the time it was closed. D. Floating Rate Note Obligations Related to Securities Held -- The Fund enters into transactions in which it transfers to Dealer Trusts ("Dealer Trusts"), fixed rate bonds in exchange for cash and residual interests in the Dealer Trusts' assets and cash flows, which are in the form of inverse floating rate investments. The Dealer Trusts fund the purchases of the fixed rate bonds by issuing floating rate notes to third parties and allowing the Fund to retain residual interest in the bonds. The Fund enters into shortfall agreements with the Dealer Trusts which commit the Fund to pay the Dealer Trusts, in certain circumstances, the difference between the liquidation value of the fixed rate bonds held by the Dealer Trusts and the liquidation value of the floating rate notes held by third parties, as well as any shortfalls in interest cash flows. The residual interests held by the Fund (inverse floating rate investments) include the right of the Fund (1) to cause the holders of the floating rate notes to tender their notes at par at the next interest rate reset date, and (2) to transfer the municipal bond from the Dealer Trusts to the Fund, thereby collapsing the Dealer Trusts. The Fund accounts for the transfer of bonds to the Dealer Trusts as secured borrowings, with the securities transferred remaining in the Fund's investment assets, and the related floating rate notes reflected as Fund liabilities under the caption "floating rate note obligations" on the "Statement of Assets and Liabilities." The Fund records the interest income from the fixed rate bonds under the caption "Interest Income" and records the expenses related to floating rate note obligations and any administrative expenses of the Dealer Trusts under the caption "Interest and residual trust expenses" in the Fund's "Statement of Operations." The notes issued by the Dealer Trusts have interest rates that reset weekly and the floating rate note holders have the option to tender their notes to the Dealer Trusts for redemption at par at each reset date. At March 31, 2007, Fund investments with a value of $3,960,065 are held by the Dealer Trusts and serve as collateral for the $3,000,000 in floating rate note obligations outstanding at that date. Contractual maturities of the floating rate note obligations and interest rates in effect at March 31, 2007 are presented in the "Portfolio of Investments." E. Interest Rate Swaps -- Interest rate swaps involve the exchange of commitments to pay and receive interest based on a notional principal amount. Net periodic interest payments to be received 14 Morgan Stanley Municipal Income Opportunities Trust III NOTES TO FINANCIAL STATEMENTS - MARCH 31, 2007 continued or paid are accrued daily and are recorded as realized gains or losses in the Statement of Operations. F. Federal Income Tax Policy -- It is the Fund's policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute substantially all of its taxable and nontaxable income to its shareholders. Accordingly, no federal income tax provision is required. G. Dividends and Distributions to Shareholders -- Dividends and distributions to shareholders are recorded on the ex-dividend date. H. Use of Estimates -- The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts and disclosures. Actual results could differ from those estimates. 2. Investment Advisory/Administration Agreements Pursuant to an Investment Advisory Agreement with Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") the Fund pays the Investment Adviser an advisory fee, calculated weekly and payable monthly, by applying the annual rate of 0.50% to the Fund's weekly net assets. Pursuant to an Administration Agreement with Morgan Stanley Services Company Inc. (the "Administrator"), an affiliate of the Investment Adviser, the Fund pays an administration fee, calculated weekly and payable monthly, by applying the annual rate of 0.08% to the Fund's weekly net assets. 3. Security Transactions and Transactions with Affiliates The cost of purchases and proceeds from sales of portfolio securities, excluding short-term investments, for the year ended March 31, 2007 aggregated $22,883,162 and $22,864,804, respectively. Included in the aforementioned transactions are purchases and sales of $1,043,750 and $3,071,075, respectively, with other Morgan Stanley funds including net realized gains of $92,236. Morgan Stanley Trust, an affiliate of the Investment Adviser and Administrator, is the Fund's transfer agent. The Fund has an unfunded noncontributory defined benefit pension plan covering certain independent Trustees of the Fund who will have served as independent Trustees for at least five years at the time of retirement. Benefits under this plan are based on factors which include years of service and compensation. The Trustees voted to close the plan to new participants and eliminate the future 15 Morgan Stanley Municipal Income Opportunities Trust III NOTES TO FINANCIAL STATEMENTS - MARCH 31, 2007 continued benefits growth due to increases to compensation after July 31, 2003. Aggregate pension costs for the year ended March 31, 2007 included in Trustees' fees and expenses in the Statement of Operations amounted to $4,537. At March 31, 2007, the Fund had an accrued pension liability of $59,908, which is included in accrued expenses in the Statement of Assets and Liabilities. The Fund has an unfunded Deferred Compensation Plan (the "Compensation Plan") which allows each independent Trustee to defer payment of all, or a portion, of the fees he or she receives for serving on the Board of Trustees. Each eligible Trustee generally may elect to have the deferred amounts credited with a return equal to the total return on one or more of the Morgan Stanley funds that are offered as investment options under the Compensation Plan. Appreciation/depreciation and distributions received from these investments are recorded with an offsetting increase/decrease in the deferred compensation obligation and do not affect the net asset value of the Fund. 4. Shares of Beneficial Interest Transactions in shares of beneficial interest were as follows:
CAPITAL PAID IN PAR VALUE EXCESS OF SHARES OF SHARES PAR VALUE --------- --------- ----------- Balance, March 31, 2005..................................... 8,876,378 $88,764 $84,462,826 Treasury shares purchased and retired (weighted average discount 5.68%)*.......................................... (300,621) (3,006) (2,737,259) Reclassification due to permanent book/tax differences...... -- -- (2,177) --------- ------- ----------- Balance, March 31, 2006..................................... 8,575,757 85,758 81,723,390 Treasury shares purchased and retired (weighted average discount 3.73%)*.......................................... (42,900) (429) (406,663) --------- ------- ----------- Balance, March 31, 2007..................................... 8,532,857 $85,329 $81,316,727 ========= ======= ===========
--------------------- * The Trustees have voted to retire the shares purchased. 5. Dividends On March 26, 2007, the Fund declared the following dividends from net investment income:
AMOUNT RECORD PAYABLE PER SHARE DATE DATE --------- ------------ ------------- April 5, April 20, $0.045 2007 2007 $0.045 May 4, 2007 May 18, 2007 $0.045 June 8, 2007 June 22, 2007
16 Morgan Stanley Municipal Income Opportunities Trust III NOTES TO FINANCIAL STATEMENTS - MARCH 31, 2007 continued 6. Expense Offset The expense offset represents a reduction of the fees and expenses for interest earned on cash balances maintained by the Fund with the transfer agent and custodian. 7. Purposes of and Risks Relating to Certain Financial Instruments The Fund may invest a portion of its assets in inverse floating rate instruments, either through outright purchases of inverse floating rate securities or through the transfer of bonds to a Dealer Trust in exchange for cash and residual interests in the Dealer Trust. These investments are typically used by the Fund in seeking to enhance the yield of the portfolio. These instruments typically involve greater risks than a fixed rate municipal bond. In particular, these instruments are acquired through leverage or may have leverage embedded in them and therefore involve many of the risks associated with leverage. Leverage is a speculative technique that may expose the Fund to greater risk and increased costs. Leverage may cause the Fund's net asset value to be more volatile than if it had not been leveraged because leverage tends to magnify the effect of any increases or decreases in the value of the Fund's portfolio securities. The use of leverage may also cause the Fund to liquidate portfolio positions when it may not be advantageous to do so in order to satisfy its obligations with respect to inverse floating rate instruments. To hedge against adverse interest rate changes, the Fund may invest in financial futures contracts or municipal bond index futures contracts ("futures contracts"). These futures contracts involve elements of market risk in excess of the amount reflected in the Statement of Assets and Liabilities. The Fund bears the risk of an unfavorable change in the value of the underlying securities. Risks may also arise upon entering into these contracts from the potential inability of the counterparties to meet the terms of their contracts. The Fund may enter into interest rate swaps and may purchase or sell interest rate caps, floors and collars. The Fund expects to enter into these transactions primarily to manage interest rate risk, hedge portfolio positions and preserve a return or spread on a particular investment or portion of its portfolio. The Fund may also enter into these transactions to protect against any increase in the price of securities the Fund anticipates purchasing at a later date. Interest rate swap transactions are subject to market risk, risk of default by the other party to the transaction, risk of imperfect correlation and manager risk. Such risks may exceed the related amounts shown in the Statement of Assets and Liabilities. 17 Morgan Stanley Municipal Income Opportunities Trust III NOTES TO FINANCIAL STATEMENTS - MARCH 31, 2007 continued 8. Federal Income Tax Status The amount of dividends and distributions from net investment income and net realized capital gains are determined in accordance with federal income tax regulations which may differ from generally accepted accounting principles. These "book/tax" differences are either considered temporary or permanent in nature. To the extent these differences are permanent in nature, such amounts are reclassified within the capital accounts based on their federal tax-basis treatment; temporary differences do not require reclassification. Dividends and distributions which exceed net investment income and net realized capital gains for tax purposes are reported as distributions of paid-in-capital. The tax character of distributions paid was as follows:
FOR THE YEAR FOR THE YEAR ENDED ENDED MARCH 31, 2007 MARCH 31, 2006 -------------- -------------- Tax-exempt income........................................... $4,614,770 $4,574,650 Ordinary income............................................. 101,132 -- ---------- ---------- Total distributions......................................... $4,715,902 $4,574,650 ========== ==========
As of March 31, 2007, the tax-basis components of accumulated earnings were as follows: Undistributed tax-exempt income............................. $ 838,784 Undistributed long-term gains............................... -- ---------- Net accumulated earnings.................................... 838,784 Capital loss carryforward*.................................. (482,196) Temporary differences....................................... (60,224) Net unrealized appreciation................................. 4,313,740 ---------- Total accumulated earnings.................................. $4,610,104 ==========
* During the year ended March 31, 2007, the Fund utilized $861,195 of its net capital loss carryforward. As of March 31, 2007, the Fund had a net capital loss carryforward of $482,196 which will expire on March 31, 2013 to offset future capital gains to the extent provided by regulations. As of March 31, 2007, the Fund had temporary book/tax differences primarily attributable to book amortization of discounts on debt securities and mark-to-market of open futures contracts. 18 Morgan Stanley Municipal Income Opportunities Trust III NOTES TO FINANCIAL STATEMENTS - MARCH 31, 2007 continued Permanent differences, due to tax adjustments on debt securities sold by the Fund, resulted in the following reclassifications among the Fund's components of net assets at March 31, 2007:
ACCUMULATED UNDISTRIBUTED ACCUMULATED NET INVESTMENT NET REALIZED INCOME LOSS PAID-IN-CAPITAL -------------- ------------ --------------- $342 $(342 ) -- ==== ====== ====
9. New Accounting Pronouncements In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation 48, Accounting for Uncertainty in Income Taxes -- an interpretation of FASB Statement 109 (FIN 48). FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position must meet before being recognized in the financial statements. FIN 48 is effective for fiscal years beginning after December 15, 2006 and is to be applied to all open tax years as of the effective date. The impact to the Fund's financial statements, if any, is currently being assessed. In addition, in September 2006, Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS 157), was issued and is effective for fiscal years beginning after November 15, 2007. SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Management is currently evaluating the impact the adoption of SFAS 157 will have on the Fund's financial statement disclosures. 19 Morgan Stanley Municipal Income Opportunities Trust III FINANCIAL HIGHLIGHTS Selected ratios and per share data for a share of beneficial interest outstanding throughout each period:
FOR THE YEAR ENDED MARCH 31 ---------------------------------------------------------------- 2007 2006 2005 2004 2003 -------- -------- -------- -------- -------- Selected Per Share Data: Net asset value, beginning of period.............. $ 9.77 $9.51 $9.39 $9.33 $9.32 ------ ----- ----- ----- ----- Income from investment operations: Net investment income*........................ 0.52 0.55 0.53 0.52 0.56 Net realized and unrealized gain.............. 0.34 0.22 0.10 0.09 0.01 ------ ----- ----- ----- ----- Total income from investment operations........... 0.86 0.77 0.63 0.61 0.57 ------ ----- ----- ----- ----- Less dividends from net investment income......... (0.55) (0.53) (0.53) (0.56) (0.57) ------ ----- ----- ----- ----- Anti-dilutive effect of acquiring treasury shares*.......................................... 0.00(2) 0.02 0.02 0.01 0.01 ------ ----- ----- ----- ----- Net asset value, end of period.................... $10.08 $9.77 $9.51 $9.39 $9.33 ====== ===== ===== ===== ===== Market value, end of period....................... $10.21 $9.60 $8.27 $8.92 $8.63 ====== ===== ===== ===== ===== Total Return+..................................... 12.42% 22.84% (1.27)% 10.00% 5.58% Ratios to Average Net Assets: Total expenses (before expense offset)............ 0.82%(1) 0.79%(1) 0.93%(1) 1.02%(1) 0.98%(1) Total expenses (before expense offset, exclusive of interest and residual trust expenses)......... 0.79%(1) 0.79%(1) 0.93%(1) 1.02%(1) 0.98%(1) Net investment income............................. 5.25% 5.74% 5.68% 5.59% 5.96% Supplemental Data: Net assets, end of period, in thousands........... $86,012 $83,797 $84,380 $85,549 $86,567 Portfolio turnover rate........................... 28% 20% 17% 12% 8%
--------------------- * The per share amounts were computed using an average number of shares outstanding during the period. + Total return is based upon the current market value on the last day of each period reported. Dividends and distributions are assumed to be reinvested at the prices obtained under the Fund's dividend reinvestment plan. Total return does not reflect brokerage commissions. (1) Does not reflect the effect of expense offset of 0.01%. (2) Includes anti-dilutive effect of acquiring treasury shares of less than $0.01.
See Notes to Financial Statements 20 Morgan Stanley Municipal Income Opportunities Trust III REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and Board of Trustees of Morgan Stanley Municipal Income Opportunities Trust III: We have audited the accompanying statement of assets and liabilities of Morgan Stanley Municipal Income Opportunities Trust III (the "Fund"), including the portfolio of investments, as of March 31, 2007, and the related statements of operations for the year then ended and changes in net assets for each of the two years in the period then ended, and the financial highlights for each of the five years in the period then ended. These financial statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. The Fund is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Fund's internal control over financial reporting. Accordingly, we express no such opinion. An audit also 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, as well as evaluating the overall financial statement presentation. Our procedures included confirmation of securities owned as of March 31, 2007, by correspondence with the custodian. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements and financial highlights referred to above present fairly, in all material respects, the financial position of Morgan Stanley Municipal Income Opportunities Trust III as of March 31, 2007, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the five years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. Deloitte & Touche LLP New York, New York May 22, 2007 21 Morgan Stanley Municipal Income Opportunities Trust III REVISED INVESTMENT POLICY (UNAUDITED) INTEREST RATE TRANSACTIONS. The Fund may enter into interest rate swaps and may purchase or sell interest rate caps, floors and collars. The Fund expects to enter into these transactions primarily to manage interest rate risk, hedge portfolio positions and preserve a return or spread on a particular investment or portion of its portfolio. The Fund may also enter into these transactions to protect against any increase in the price of securities the Fund anticipates purchasing at a later date. The Fund does not intend to use these transactions as speculative investments and will not enter into interest rate swaps or sell interest rate caps or floors where it does not own or have the right to acquire the underlying securities or other instruments providing the income stream the Fund may be obligated to pay. Interest rate swaps involve the exchange by the Fund with another party of their respective commitments to pay or receive interest, e.g., an exchange of floating rate payments for fixed-rate payments. The purchase of an interest rate cap entitles the purchaser, to the extent that a specified index exceeds a predetermined interest rate, to receive payments of interest on a contractually-based principal amount from the party selling the interest rate cap. The purchase of an interest rate floor entitles the purchaser, to the extent that a specified index falls below a predetermined interest rate, to receive payments of interest on a contractually-based principal amount from the party selling the interest rate floor. An interest rate collar combines the elements of purchasing a cap and selling a floor. The collar protects against an interest rate rise above the maximum amount but foregoes the benefit of an interest rate decline below the minimum amount. The Fund may enter into interest rate swaps, caps, floors and collars on either an asset-based or liability-based basis, and will usually enter into interest rate swaps on a net basis, i.e., the two payment streams are netted out, with the Fund receiving or paying, as the case may be, only the net amount of the two payments. The net amount of the excess, if any, of the Fund's obligations over its entitlements with respect to each interest rate swap will be accrued on a daily basis and the Fund segregates an amount of cash and/or liquid securities having an aggregate net asset value at least equal to the accrued excess. If the Fund enters into an interest rate swap on other than a net basis, the Fund would segregate the full amount accrued on a daily basis of the Fund's obligations with respect to the swap. Interest rate transactions do not constitute senior securities under the 1940 Act when the Fund segregates assets to cover the obligations under the transactions. The Fund will enter into interest rate swap, cap or floor transactions only with counterparties approved by the Fund's Board of Trustees. The Adviser will monitor the creditworthiness of counterparties to the Fund's interest rate swap, cap, floor and collar transactions on an ongoing basis. If there is a default by the other party to such a transaction, the Fund will have contractual remedies pursuant to the agreements related to the transaction. To the extent the Fund sells (i.e., writes) caps, floors and collars, it will segregate cash and/or liquid securities having an aggregate net asset value at least equal to the full amount, accrued on a daily basis, of the Fund's net obligations with respect to the 22 Morgan Stanley Municipal Income Opportunities Trust III REVISED INVESTMENT POLICY (UNAUDITED) continued caps, floors or collars. The use of interest rate swaps is a highly specialized activity which involves investment techniques and risks different from those associated with ordinary portfolio securities transactions. If the Adviser is incorrect in its forecasts of the market values, interest rates and other applicable factors, the investment performance of the Fund would diminish compared with what it would have been if these investment techniques were not used. The use of interest rate swaps, caps, collars and floors may also have the effect of shifting the recognition of income between current and future periods. These transactions do not involve the delivery of securities or other underlying assets or principal. Accordingly, the risk of loss with respect to interest rate swaps is limited to the net amount of interest payments that the Fund is contractually obligated to make. If the other party to an interest rate swap defaults, the Fund's risk of loss consists of the net amount of interest payments that the Fund contractually is entitled to receive. 23 Morgan Stanley Municipal Income Opportunities Trust III RESULTS OF ANNUAL SHAREHOLDER MEETING (UNAUDITED) On October 25, 2006, an annual meeting of the Fund's shareholders was held for the purpose of voting on the following matters, the results of which were as follows: Election of Trustees:
# OF SHARES ----------------------------------------------- FOR WITHHELD ABSTAIN ----------------------------------------------- Frank L. Bowman............................................. 7,213,261 42,476 57,765 Kathleen Dennis............................................. 7,216,728 39,009 57,765 Edwin J. Garn............................................... 7,214,451 41,286 57,765 Michael F. Klein............................................ 7,214,451 41,286 57,765 Michael E. Nugent........................................... 7,213,661 42,076 57,765 W. Allen Reed............................................... 7,214,051 41,686 57,765
The following Trustees were not standing for reelection at this meeting: Michael Bozic, James Higgins, Dr. Manuel H. Johnson, Joseph J. Kearns and Fergus Reid. 24 Morgan Stanley Municipal Income Opportunities Trust III TRUSTEE AND OFFICER INFORMATION (UNAUDITED) Independent Trustees:
Number of Portfolios in Fund Complex Position(s) Term of Office Overseen by Name, Age and Address of Held with and Length of Principal Occupation(s) During Independent Independent Trustee Registrant Time Served* Past 5 Years Trustee** --------------------------------------- ----------- -------------- ------------------------------ ------------- Frank L. Bowman (62) Trustee Since August President and Chief Executive 171 c/o Kramer Levin Naftalis & Frankel LLP 2006 Officer of the Nuclear Energy Counsel to the Independent Trustees Institute (policy 1177 Avenue of the Americas organization) (since February New York, NY 10036 2005); Director or Trustee of various Retail Funds and Institutional Funds (since August 2006); Chairperson of the Insurance Sub-Committee of the Valuation, Insurance and Compliance Committee (since February 2007); formerly variously, Admiral in the U.S. Navy, Director of Naval Nuclear Propulsion Program and Deputy Administrator-Naval Reactors in the National Nuclear Security Administration at the U.S. Department of Energy (1996-2004). Honorary Knight Commander of the Most Excellent Order of the British Empire. Michael Bozic (66) Trustee Since April Private investor; Chairperson 173 c/o Kramer Levin Naftalis & Frankel LLP 1994 of the Valuation, Insurance Counsel to the Independent Trustees and Compliance Committee 1177 Avenue of the Americas (since October 2006); Director New York, NY 10036 or Trustee of the Retail Funds (since April 1994) and the Institutional Funds (since July 2003); formerly Chairperson of the Insurance Committee (July 2006-September 2006); Vice Chairman of Kmart Corporation (December 1998-October 2000), Chairman and Chief Executive Officer of Levitz Furniture Corporation (November 1995-November 1998) and President and Chief Executive Officer of Hills Department Stores (May 1991-July 1995); variously Chairman, Chief Executive Officer, President and Chief Operating Officer (1987-1991) of the Sears Merchandise Group of Sears, Roebuck & Co. Name, Age and Address of Other Directorships Held by Independent Trustee Independent Trustee --------------------------------------- ----------------------------- Frank L. Bowman (62) Director of the National c/o Kramer Levin Naftalis & Frankel LLP Energy Foundation, the U.S. Counsel to the Independent Trustees Energy Association, the 1177 Avenue of the Americas American Council for Capital New York, NY 10036 Formation and the Armed Services YMCA of the USA. Michael Bozic (66) Director of various business c/o Kramer Levin Naftalis & Frankel LLP organizations. Counsel to the Independent Trustees 1177 Avenue of the Americas New York, NY 10036
25 Morgan Stanley Municipal Income Opportunities Trust III TRUSTEE AND OFFICER INFORMATION (UNAUDITED) continued
Number of Portfolios in Fund Complex Position(s) Term of Office Overseen by Name, Age and Address of Held with and Length of Principal Occupation(s) During Independent Independent Trustee Registrant Time Served* Past 5 Years Trustee** --------------------------------------- ----------- -------------- ------------------------------ ------------- Kathleen A. Dennis (53) Trustee Since August President, Cedarwood 171 c/o Kramer Levin Naftalis & Frankel LLP 2006 Associates (mutual fund Counsel to the Independent Trustees consulting) (since July 2006); 1177 Avenue of the Americas Chairperson of the Money New York, NY 10036 Market and Alternatives Sub- Committee of the Investment Committee (since October 2006) and Director or Trustee of various Retail Funds and Institutional Funds (since August 2006); formerly, Senior Managing Director of Victory Capital Management (1993- 2006). Dr. Manuel H. Johnson (58) Trustee Since July Senior Partner, Johnson Smick 173 c/o Johnson Smick Group, Inc. 1991 International, Inc., 888 16th Street, N.W. (consulting firm); Chairperson Suite 740 of the Investment Committee Washington, D.C. 20006 (since October 2006) and Director or Trustee of the Retail Funds (since July 1991) and the Institutional Funds (since July 2003); Co-Chairman and a founder of the Group of Seven Council (G7C), (international economic commission); formerly Chairperson of the Audit Committee (July 1991- September 2006); Vice Chairman of the Board of Governors of the Federal Reserve System and Assistant Secretary of the U.S. Treasury. Name, Age and Address of Other Directorships Held by Independent Trustee Independent Trustee --------------------------------------- ----------------------------- Kathleen A. Dennis (53) None. c/o Kramer Levin Naftalis & Frankel LLP Counsel to the Independent Trustees 1177 Avenue of the Americas New York, NY 10036 Dr. Manuel H. Johnson (58) Director of NVR, Inc. (home c/o Johnson Smick Group, Inc. construction); Director of 888 16th Street, N.W. Evergreen Energy. Suite 740 Washington, D.C. 20006
26 Morgan Stanley Municipal Income Opportunities Trust III TRUSTEE AND OFFICER INFORMATION (UNAUDITED) continued
Number of Portfolios in Fund Complex Position(s) Term of Office Overseen by Name, Age and Address of Held with and Length of Principal Occupation(s) During Independent Independent Trustee Registrant Time Served* Past 5 Years Trustee** --------------------------------------- ----------- -------------- ------------------------------ ------------- Joseph J. Kearns (64) Trustee Since August President, Kearns & Associates 174 c/o Kearns & Associates LLC 1994 LLC (investment consulting); PMB754 Chairperson of the Audit 23852 Pacific Coast Highway Committee (since October 2006) Malibu, CA 90265 and Director or Trustee of the Retail Funds (since July 2003) and the Institutional Funds (since August 1994); formerly, Deputy Chairperson of the Audit Committee (July 2003- September 2006) and Chairperson of the Audit Committee of the Institutional Funds (October 2001-July 2003); formerly CFO of the J. Paul Getty Trust. Michael F. Klein (48) Trustee Since August Managing Director, Aetos 171 c/o Kramer Levin Naftalis & Frankel LLP 2006 Capital, LLC (since March Counsel to the Independent Trustees 2000) and Co-President, Aetos 1177 Avenue of the Americas Alternatives Management, LLC New York, NY 10036 (since January 2004); Chairperson of the Fixed-Income Sub-Committee of the Investment Committee (since October 2006) and Director or Trustee of various Retail Funds and Institutional Funds (since August 2006); formerly Managing Director, Morgan Stanley & Co. Inc. and Morgan Stanley Dean Witter Investment Management, President, Morgan Stanley Institutional Funds (June 1998-March 2000) and Principal, Morgan Stanley & Co. Inc. and Morgan Stanley Dean Witter Investment Management (August 1997-December 1999). Name, Age and Address of Other Directorships Held by Independent Trustee Independent Trustee --------------------------------------- ----------------------------- Joseph J. Kearns (64) Director of Electro Rent c/o Kearns & Associates LLC Corporation (equipment PMB754 leasing), The Ford Family 23852 Pacific Coast Highway Foundation, and the UCLA Malibu, CA 90265 Foundation. Michael F. Klein (48) Director of certain c/o Kramer Levin Naftalis & Frankel LLP investment funds managed or Counsel to the Independent Trustees sponsored by Aetos Capital, 1177 Avenue of the Americas LLC. Director of Sanitized AG New York, NY 10036 and Sanitized Marketing AG (specialty chemicals).
27 Morgan Stanley Municipal Income Opportunities Trust III TRUSTEE AND OFFICER INFORMATION (UNAUDITED) continued
Number of Portfolios in Fund Complex Position(s) Term of Office Overseen by Name, Age and Address of Held with and Length of Principal Occupation(s) During Independent Independent Trustee Registrant Time Served* Past 5 Years Trustee** --------------------------------------- ----------- -------------- ------------------------------ ------------- Michael E. Nugent (70) Chairperson Chairperson of General Partner of Triumph 173 c/o Triumph Capital, L.P. of the the Boards Capital, L.P. (private 445 Park Avenue Board and since July investment partnership); New York, NY 10022 Trustee 2006 and Chairperson of the Boards of Trustee since the Retail Funds and July 1991 Institutional Funds (since July 2006) and Director or Trustee of the Retail Funds (since July 1991) and the Institutional Funds (since July 2001); formerly Chairperson of the Insurance Committee (until July 2006), and Vice President, Bankers Trust Company and BT Capital Corporation (1984-1988). W. Allen Reed (59) Trustee Since August Chairperson of the Equity Sub- 171 c/o Kramer Levin Naftalis & Frankel LLP 2006 Committee of the Investment Counsel to the Independent Trustees Committee (since October 2006) 1177 Avenue of the Americas and Director or Trustee of New York, NY 10036 various Retail Funds and Institutional Funds (since August 2006); President and CEO of General Motors Asset Management; formerly, Chairman and Chief Executive Officer of the GM Trust Bank and Corporate Vice President of General Motors Corporation (August 1994-December 2005). Fergus Reid (74) Trustee Since June Chairman of Lumelite Plastics 174 c/o Lumelite Plastics Corporation 1992 Corporation; Chairperson of 85 Charles Colman Blvd. the Governance Committee and Pawling, NY 12564 Director or Trustee of the Retail Funds (since July 2003) and the Institutional Funds (since June 1992). Name, Age and Address of Other Directorships Held by Independent Trustee Independent Trustee --------------------------------------- ----------------------------- Michael E. Nugent (70) None. c/o Triumph Capital, L.P. 445 Park Avenue New York, NY 10022 W. Allen Reed (59) Director of GMAC (financial c/o Kramer Levin Naftalis & Frankel LLP services), and Temple-Inland Counsel to the Independent Trustees Industries (packaging, 1177 Avenue of the Americas banking and forest products); New York, NY 10036 Director of Legg Mason, Inc. and Director of the Auburn University Foundation. Fergus Reid (74) Trustee and Director of c/o Lumelite Plastics Corporation certain investment companies 85 Charles Colman Blvd. in the JPMorgan Funds complex Pawling, NY 12564 managed by J.P. Morgan Investment Management Inc.
28 Morgan Stanley Municipal Income Opportunities Trust III TRUSTEE AND OFFICER INFORMATION (UNAUDITED) continued Interested Trustee:
Number of Portfolios in Fund Complex Position(s) Term of Office Overseen by Name, Age and Address of Held with and Length of Principal Occupation(s) During Interested Interested Trustee Registrant Time Served* Past 5 Years Trustee** ------------------------------------- ----------- -------------- ------------------------------ ------------- James F. Higgins (59) Trustee Since June Director or Trustee of the 173 c/o Morgan Stanley Trust 2000 Retail Funds (since June 2000) Harborside Financial Center and the Institutional Funds Plaza Two (since July 2003); Senior Jersey City, NJ 07311 Advisor of Morgan Stanley (since August 2000). Name, Age and Address of Other Directorships Held by Interested Trustee Interested Trustee ------------------------------------- ------------------------------ James F. Higgins (59) Director of AXA Financial, c/o Morgan Stanley Trust Inc. and The Equitable Life Harborside Financial Center Assurance Society of the Plaza Two United States (financial Jersey City, NJ 07311 services).
--------------------- * This is the earliest date the Trustee began serving the funds advised by Morgan Stanley Investment Advisors Inc. (the "Investment Adviser") (the "Retail Funds") or the funds advised by Morgan Stanley Investment Management Inc. and Morgan Stanley AIP GP LP (the "Institutional Funds"). ** The Fund Complex includes all open-end and closed-end funds (including all of their portfolios) advised by the Investment Adviser and any funds that have an investment adviser that is an affiliated person of the Investment Adviser (including, but not limited to, Morgan Stanley Investment Management Inc.) as of March 31, 2007. 29 Morgan Stanley Municipal Income Opportunities Trust III TRUSTEE AND OFFICER INFORMATION (UNAUDITED) continued Executive Officers:
Term of Position(s) Office and Name, Age and Address of Held with Length of Executive Officer Registrant Time Served* Principal Occupation(s) During Past 5 Years ----------------------------- --------------- -------------- ------------------------------------------------------------ Ronald E. Robison (68) President and President President (since September 2005) and Principal Executive 1221 Avenue of the Americas Principal since Officer (since May 2003) of funds in the Fund Complex; New York, NY 10020 Executive September 2005 President (since September 2005) and Principal Executive Officer and Principal Officer (since May 2003) of the Van Kampen Funds; Managing Executive Director, Director and/or Officer of the Investment Adviser Officer since and various entities affiliated with the Investment Adviser; May 2003 Director of Morgan Stanley SICAV (since May 2004). Formerly, Executive Vice President (July 2003 to September 2005) of funds in the Fund Complex and the Van Kampen Funds; President and Director of the Institutional Funds (March 2001 to July 2003); Chief Administrative Officer of the Investment Adviser; Chief Administrative Officer of Morgan Stanley Services Company Inc. J. David Germany (52) Vice President Since February Managing Director and (since December 2005) Chief Investment Morgan Stanley Investment 2006 Officer -- Global Fixed Income of Morgan Stanley Investment Management Limited Management; Managing Director and Director of Morgan Stanley 20 Bank Street Investment Management Limited; Vice President of the Retail Canary Wharf, Funds and Institutional Funds (since February 2006). London, England E144QAD Dennis F. Shea (53) Vice President Since February Managing Director and (since February 2006) Chief Investment 1221 Avenue of the Americas 2006 Officer -- Global Equity of Morgan Stanley Investment New York, NY 10020 Management; Vice President of the Retail and Institutional Funds (since February 2006). Formerly, Managing Director and Director of Global Equity Research at Morgan Stanley. Amy R. Doberman (45) Vice President Since July Managing Director and General Counsel, U.S. Investment 1221 Avenue of the Americas 2004 Management of Morgan Stanley Investment Management (since New York, NY 10020 July 2004); Vice President of the Retail Funds and the Institutional Funds (since July 2004); Vice President of the Van Kampen Funds (since August 2004); Secretary (since February 2006) and Managing Director (since July 2004) of the Investment Adviser and various entities affiliated with the Investment Adviser. Formerly, Managing Director and General Counsel -- Americas, UBS Global Asset Management (July 2000 to July 2004). Carsten Otto (43) Chief Since October Managing Director and U.S. Director of Compliance for Morgan 1221 Avenue of the Americas Compliance 2004 Stanley Investment Management (since October 2004); Managing New York, NY 10020 Officer Director and Chief Compliance Officer of Morgan Stanley Investment Management. Formerly, Assistant Secretary and Assistant General Counsel of the Retail Funds. Stefanie V. Chang Yu (40) Vice President Since December Executive Director of the Investment Adviser and various 1221 Avenue of the Americas 1997 entities affiliated with the Investment Adviser; Vice New York, NY 10020 President of the Retail Funds (since July 2002) and the Institutional Funds (since December 1997). Formerly, Secretary of various entities affiliated with the Investment Adviser.
30 Morgan Stanley Municipal Income Opportunities Trust III TRUSTEE AND OFFICER INFORMATION (UNAUDITED) continued
Term of Position(s) Office and Name, Age and Address of Held with Length of Executive Officer Registrant Time Served* Principal Occupation(s) During Past 5 Years ----------------------------- --------------- -------------- ------------------------------------------------------------ Francis J. Smith (41) Treasurer and Treasurer Executive Director of the Investment Adviser and various c/o Morgan Stanley Trust Chief Financial since July entities affiliated with the Investment Adviser; Treasurer Harborside Financial Center Officer 2003 and Chief and Chief Financial Officer of the Retail Funds (since July Plaza Two Financial 2003). Formerly, Vice President of the Retail Funds Jersey City, NJ 07311 Officer since (September 2002 to July 2003). September 2002 Mary E. Mullin (40) Secretary Since June Executive Director of the Investment Adviser and various 1221 Avenue of the Americas 1999 entities affiliated with the Investment Adviser; Secretary New York, NY 10020 of the Retail Funds (since July 2003) and the Institutional Funds (since June 1999).
--------------------- * This is the earliest date the Officer began serving the Retail Funds or the Institutional Funds. In accordance with Section 303A.12(a) of the New York Stock Exchange Listed Company Manual, the Fund's Annual CEO Certification certifying as to compliance with NYSE's Corporate Governance Listing Standards was submitted to the Exchange on November 14, 2006. The Fund's Principal Executive Officer and Principal Financial Officer Certifications required by Section 302 of the Sarbanes-Oxley Act of 2002 were filed with the Fund's N-CSR and are available on the Securities and Exchange Commission's Web site at http://www.sec.gov. 2007 FEDERAL TAX NOTICE (UNAUDITED) During the year ended March 31, 2007, the Fund paid its shareholders $0.54 per share from tax-exempt income. 31 TRUSTEES Frank L. Bowman Michael Bozic Kathleen A. Dennis James F. Higgins Dr. Manuel H. Johnson Joseph J. Kearns Michael F. Klein Michael E. Nugent W. Allen Reed Fergus Reid OFFICERS Michael E. Nugent Chairperson of the Board Ronald E. Robison President and Principal Executive Officer J. David Germany Vice President Dennis F. Shea Vice President Amy R. Doberman Vice President Carsten Otto Chief Compliance Officer Stefanie V. Chang Yu Vice President Francis J. Smith Treasurer and Chief Financial Officer Mary E. Mullin Secretary TRANSFER AGENT Morgan Stanley Trust Harborside Financial Center, Plaza Two Jersey City, New Jersey 07311 INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Deloitte & Touche LLP Two World Financial Center New York, New York 10281 LEGAL COUNSEL Clifford Chance US LLP 31 West 52nd Street New York, New York 10019 COUNSEL TO THE INDEPENDENT TRUSTEE Kramer Levin Naftalis & Frankel LLP 1177 Avenue of the Americas New York, New York 10036 INVESTMENT ADVISER Morgan Stanley Investment Advisors Inc. 1221 Avenue of the Americas New York, New York 10020 (c) 2007 Morgan Stanley [MORGAN STANLEY LOGO] MORGAN STANLEY FUNDS LOGO Morgan Stanley Municipal Income Opportunities Trust III Annual Report March 31, 2007 [MORGAN STANLEY LOGO] OICRPT-IU07-01017P-Y03/07 Item 2. Code of Ethics. (a) The Fund has adopted a code of ethics (the "Code of Ethics") that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, regardless of whether these individuals are employed by the Fund or a third party. (b) No information need be disclosed pursuant to this paragraph. (c) Not applicable. (d) Not applicable. (e) Not applicable. (f) (1) The Fund's Code of Ethics is attached hereto as Exhibit 12 A. (2) Not applicable. (3) Not applicable. Item 3. Audit Committee Financial Expert. The Fund's Board of Trustees has determined that Joseph J. Kearns, an "independent" Trustee, is an "audit committee financial expert" serving on its audit committee. Under applicable securities laws, a person who is determined to be an audit committee financial expert will not be deemed an "expert" for any purpose, including without limitation for the purposes of Section 11 of the Securities Act of 1933, as a result of being designated or identified as an audit committee financial expert. The designation or identification of a person as an audit committee financial expert does not impose on such person any duties, obligations, or liabilities that are greater than the duties, obligations, and liabilities imposed on such person as a member of the audit committee and Board of Trustees in the absence of such designation or identification. 2 Item 4. Principal Accountant Fees and Services. (a)(b)(c)(d) and (g). Based on fees billed for the periods shown: 2007
REGISTRANT COVERED ENTITIES(1) AUDIT FEES............................ $ 31,300 N/A NON-AUDIT FEES AUDIT-RELATED FEES.................. $ 531(2) 6,559,000(2) TAX FEES............................ $ 4,600(3) 623,667(4) ALL OTHER FEES...................... $ - - TOTAL NON-AUDIT FEES.................. $ 5,131 7,182,667 TOTAL................................. $ 36,431 7,182,667
2006
REGISTRANT COVERED ENTITIES(1) AUDIT FEES............................ $ 30,446 N/A NON-AUDIT FEES AUDIT-RELATED FEES.................. $ 540(2) 5,180,378(2) TAX FEES............................ $ 4,448(3) 2,275,787(4) ALL OTHER FEES...................... $ - - TOTAL NON-AUDIT FEES.................. $ 4,988 7,456,165 TOTAL................................. $ 35,434 7,456,165
N/A- Not applicable, as not required by Item 4. (1) Covered Entities include the Adviser (excluding sub-advisors) and any entity controlling, controlled by or under common control with the Adviser that provides ongoing services to the Registrant. (2) Audit-Related Fees represent assurance and related services provided that are reasonably related to the performance of the audit of the financial statements of the Covered Entities' and funds advised by the Adviser or its affiliates, specifically data verification and agreed-upon procedures related to asset securitizations and agreed-upon procedures engagements. (3) Tax Fees represent tax compliance, tax planning and tax advice services provided in connection with the preparation and review of the Registrant's tax returns. (4) Tax Fees represent tax compliance, tax planning and tax advice services provided in connection with the review of Covered Entities' tax returns. 3 (e)(1) The audit committee's pre-approval policies and procedures are as follows: APPENDIX A AUDIT COMMITTEE AUDIT AND NON-AUDIT SERVICES PRE-APPROVAL POLICY AND PROCEDURES OF THE MORGAN STANLEY RETAIL AND INSTITUTIONAL FUNDS AS ADOPTED AND AMENDED JULY 23, 2004,(1) 1. STATEMENT OF PRINCIPLES The Audit Committee of the Board is required to review and, in its sole discretion, pre-approve all Covered Services to be provided by the Independent Auditors to the Fund and Covered Entities in order to assure that services performed by the Independent Auditors do not impair the auditor's independence from the Fund. The SEC has issued rules specifying the types of services that an independent auditor may not provide to its audit client, as well as the audit committee's administration of the engagement of the independent auditor. The SEC's rules establish two different approaches to pre-approving services, which the SEC considers to be equally valid. Proposed services either: may be pre-approved without consideration of specific case-by-case services by the Audit Committee ("general pre-approval"); or require the specific pre-approval of the Audit Committee or its delegate ("specific pre-approval"). The Audit Committee believes that the combination of these two approaches in this Policy will result in an effective and efficient procedure to pre-approve services performed by the Independent Auditors. As set forth in this Policy, unless a type of service has received general pre-approval, it will require specific pre-approval by the Audit Committee (or by any member of the Audit Committee to which pre-approval authority has been delegated) if it is to be provided by the Independent Auditors. Any proposed services exceeding pre-approved cost levels or budgeted amounts will also require specific pre-approval by the Audit Committee. The appendices to this Policy describe the Audit, Audit-related, Tax and All Other services that have the general pre-approval of the Audit Committee. The term of any general pre-approval is 12 months from the date of pre-approval, unless the Audit Committee considers and provides a different period and states otherwise. The Audit Committee will annually review and pre-approve the services that may be provided by the Independent Auditors without obtaining specific pre-approval from the Audit Committee. The Audit Committee will add to or subtract from the list of general pre-approved services from time to time, based on subsequent determinations. ---------- (1) This Audit Committee Audit and Non-Audit Services Pre-Approval Policy and Procedures (the "Policy"), adopted as of the date above, supersedes and replaces all prior versions that may have been adopted from time to time. 4 The purpose of this Policy is to set forth the policy and procedures by which the Audit Committee intends to fulfill its responsibilities. It does not delegate the Audit Committee's responsibilities to pre-approve services performed by the Independent Auditors to management. The Fund's Independent Auditors have reviewed this Policy and believes that implementation of the Policy will not adversely affect the Independent Auditors' independence. 2. DELEGATION As provided in the Act and the SEC's rules, the Audit Committee may delegate either type of pre-approval authority to one or more of its members. The member to whom such authority is delegated must report, for informational purposes only, any pre-approval decisions to the Audit Committee at its next scheduled meeting. 3. AUDIT SERVICES The annual Audit services engagement terms and fees are subject to the specific pre-approval of the Audit Committee. Audit services include the annual financial statement audit and other procedures required to be performed by the Independent Auditors to be able to form an opinion on the Fund's financial statements. These other procedures include information systems and procedural reviews and testing performed in order to understand and place reliance on the systems of internal control, and consultations relating to the audit. The Audit Committee will approve, if necessary, any changes in terms, conditions and fees resulting from changes in audit scope, Fund structure or other items. In addition to the annual Audit services engagement approved by the Audit Committee, the Audit Committee may grant general pre-approval to other Audit services, which are those services that only the Independent Auditors reasonably can provide. Other Audit services may include statutory audits and services associated with SEC registration statements (on Forms N-1A, N-2, N-3, N-4, etc.), periodic reports and other documents filed with the SEC or other documents issued in connection with securities offerings. The Audit Committee has pre-approved the Audit services in Appendix B.1. All other Audit services not listed in Appendix B.1 must be specifically pre-approved by the Audit Committee (or by any member of the Audit Committee to which pre-approval has been delegated). 4. AUDIT-RELATED SERVICES Audit-related services are assurance and related services that are reasonably related to the performance of the audit or review of the Fund's financial statements and, to the extent they are Covered Services, the Covered Entities or that are traditionally performed by the Independent Auditors. Because the Audit Committee believes that the provision of Audit-related services does not impair the independence of the auditor and is consistent with the SEC's rules on auditor independence, the Audit Committee may grant general pre-approval to Audit-related services. Audit-related services include, among others, accounting consultations related to accounting, financial reporting or disclosure matters 5 not classified as "Audit services"; assistance with understanding and implementing new accounting and financial reporting guidance from rulemaking authorities; agreed-upon or expanded audit procedures related to accounting and/or billing records required to respond to or comply with financial, accounting or regulatory reporting matters; and assistance with internal control reporting requirements under Forms N-SAR and/or N-CSR. The Audit Committee has pre-approved the Audit-related services in Appendix B.2. All other Audit-related services not listed in Appendix B.2 must be specifically pre-approved by the Audit Committee (or by any member of the Audit Committee to which pre-approval has been delegated). 5. TAX SERVICES The Audit Committee believes that the Independent Auditors can provide Tax services to the Fund and, to the extent they are Covered Services, the Covered Entities, such as tax compliance, tax planning and tax advice without impairing the auditor's independence, and the SEC has stated that the Independent Auditors may provide such services. Pursuant to the preceding paragraph, the Audit Committee has pre-approved the Tax Services in Appendix B.3. All Tax services in Appendix B.3 must be specifically pre-approved by the Audit Committee (or by any member of the Audit Committee to which pre-approval has been delegated). 6. ALL OTHER SERVICES The Audit Committee believes, based on the SEC's rules prohibiting the Independent Auditors from providing specific non-audit services, that other types of non-audit services are permitted. Accordingly, the Audit Committee believes it may grant general pre-approval to those permissible non-audit services classified as All Other services that it believes are routine and recurring services, would not impair the independence of the auditor and are consistent with the SEC's rules on auditor independence. The Audit Committee has pre-approved the All Other services in Appendix B.4. Permissible All Other services not listed in Appendix B.4 must be specifically pre-approved by the Audit Committee (or by any member of the Audit Committee to which pre-approval has been delegated). 7. PRE-APPROVAL FEE LEVELS OR BUDGETED AMOUNTS Pre-approval fee levels or budgeted amounts for all services to be provided by the Independent Auditors will be established annually by the Audit Committee. Any proposed services exceeding these levels or amounts will require specific pre-approval by the Audit Committee. The Audit Committee is mindful of the overall relationship of fees for audit and non-audit services in determining whether to pre-approve any such services. 8. PROCEDURES All requests or applications for services to be provided by the Independent Auditors that do not require specific approval by the Audit Committee will be submitted to the Fund's Chief Financial Officer and must include a detailed description of the services to be 6 rendered. The Fund's Chief Financial Officer will determine whether such services are included within the list of services that have received the general pre-approval of the Audit Committee. The Audit Committee will be informed on a timely basis of any such services rendered by the Independent Auditors. Requests or applications to provide services that require specific approval by the Audit Committee will be submitted to the Audit Committee by both the Independent Auditors and the Fund's Chief Financial Officer, and must include a joint statement as to whether, in their view, the request or application is consistent with the SEC's rules on auditor independence. The Audit Committee has designated the Fund's Chief Financial Officer to monitor the performance of all services provided by the Independent Auditors and to determine whether such services are in compliance with this Policy. The Fund's Chief Financial Officer will report to the Audit Committee on a periodic basis on the results of its monitoring. Both the Fund's Chief Financial Officer and management will immediately report to the chairman of the Audit Committee any breach of this Policy that comes to the attention of the Fund's Chief Financial Officer or any member of management. 9. ADDITIONAL REQUIREMENTS The Audit Committee has determined to take additional measures on an annual basis to meet its responsibility to oversee the work of the Independent Auditors and to assure the auditor's independence from the Fund, such as reviewing a formal written statement from the Independent Auditors delineating all relationships between the Independent Auditors and the Fund, consistent with Independence Standards Board No. 1, and discussing with the Independent Auditors its methods and procedures for ensuring independence. 10. COVERED ENTITIES Covered Entities include the Fund's investment adviser(s) and any entity controlling, controlled by or under common control with the Fund's investment adviser(s) that provides ongoing services to the Fund(s). Beginning with non-audit service contracts entered into on or after May 6, 2003, the Fund's audit committee must pre-approve non-audit services provided not only to the Fund but also to the Covered Entities if the engagements relate directly to the operations and financial reporting of the Fund. This list of Covered Entities would include: Morgan Stanley Retail Funds --------------------------- Morgan Stanley Investment Advisors Inc. Morgan Stanley & Co. Incorporated Morgan Stanley DW Inc. Morgan Stanley Investment Management Inc. Morgan Stanley Investment Management Limited Morgan Stanley Investment Management Private Limited Morgan Stanley Asset & Investment Trust Management Co., Limited Morgan Stanley Investment Management Company Van Kampen Asset Management Morgan Stanley Services Company, Inc. Morgan Stanley Distributors Inc. Morgan Stanley Trust FSB 7 Morgan Stanley Institutional Funds ---------------------------------- Morgan Stanley Investment Management Inc. Morgan Stanley Investment Advisors Inc. Morgan Stanley Investment Management Limited Morgan Stanley Investment Management Private Limited Morgan Stanley Asset & Investment Trust Management Co., Limited Morgan Stanley Investment Management Company Morgan Stanley & Co. Incorporated Morgan Stanley Distribution, Inc. Morgan Stanley AIP GP LP Morgan Stanley Alternative Investment Partners LP (e)(2) Beginning with non-audit service contracts entered into on or after May 6, 2003, the audit committee also is required to pre-approve services to Covered Entities to the extent that the services are determined to have a direct impact on the operations or financial reporting of the Registrant. 100% of such services were pre-approved by the audit committee pursuant to the Audit Committee's pre-approval policies and procedures (attached hereto). (f) Not applicable. (g) See table above. (h) The audit committee of the Board of Trustees has considered whether the provision of services other than audit services performed by the auditors to the Registrant and Covered Entities is compatible with maintaining the auditors' independence in performing audit services. Item 5. Audit Committee of Listed Registrants. (a) The Fund has a separately-designated standing audit committee established in accordance with Section 3(a)(58)(A) of the Exchange Act whose members are: Joseph Kearns, Michael Nugent and Allen Reed. (b) Not applicable. Item 6. See Item 1. Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies. 8 The Fund/Trust invests in exclusively non-voting securities and therefore this item is not applicable. Item 8. Portfolio Managers of Closed-End Management Investment Companies FUND MANAGEMENT PORTFOLIO MANAGEMENT. As of the date of this report, the Fund is managed by members of the Municipal Fixed Income team. The team consists of portfolio managers and analysts. Current members of the team jointly and primarily responsible for the day-to-day management of the Fund's portfolio are James F. Willison, a Managing Director of the Investment Adviser, Gerard J. Lian, an Executive Director of the Investment Adviser and Wayne D. Godlin, a Managing Director of the Investment Adviser. Mr. Willison has been associated with the Investment Adviser in an investment management capacity since January 1980 and began managing the Fund at inception. Mr. Lian has been associated with the Investment Adviser in an investment management capacity since December 1991 and began managing the Fund in February 2003. Mr. Godlin has been associated with the Investment Adviser in an investment management capacity since May 1988 and began managing the Fund in October 2001. The composition of the team may change without notice from time to time. OTHER ACCOUNTS MANAGED BY THE PORTFOLIO MANAGERS The following information is as of March 31, 2007. Mr. Willison managed 22 mutual funds with a total of approximately $7.2 billion in assets; no pooled investment vehicles other than mutual funds; and no other accounts. Mr. Lian managed three mutual funds with a total of approximately $400.5 million in assets; no pooled investment vehicles other than mutual funds; and no other accounts. Mr. Godlin managed five mutual funds with a total of approximately $6.5 billion in assets; no pooled investment vehicles other than mutual funds; and no other accounts. Because the portfolio managers manage assets for other investment companies, pooled investment vehicles and/or other accounts (including institutional clients, pension plans and certain high net worth individuals), there may be an incentive to favor one client over another resulting in conflicts of interest. For instance, the Investment Adviser may receive fees from certain accounts that are higher than the fee it receives from the Fund, or it may receive a performance-based fee on certain accounts. In those instances, the portfolio managers may have an incentive to favor the higher and/or performance-based fee accounts over the Fund. In addition, a conflict of interest could exist to the extent the Investment Adviser has proprietary investments in certain accounts, where portfolio managers have personal investments in certain accounts or when certain accounts are investment options in the Investment Adviser's employee benefits and/or deferred compensation plans. The portfolio manager may have an incentive to favor these accounts over others. If the Investment Adviser manages accounts that engage in short sales of securities of the type in which the Fund invests, the Investment Adviser could be seen as harming the performance of the Fund for the benefit of the accounts engaging in short sales if the short sales cause the market value of the securities to fall. The Investment Adviser has adopted trade allocation and other policies and procedures that it believes are reasonably designed to address these and other conflicts of interest. 9 PORTFOLIO MANAGER COMPENSATION STRUCTURE Portfolio managers receive a combination of base compensation and discretionary compensation, comprising a cash bonus and several deferred compensation programs described below. The methodology used to determine portfolio manager compensation is applied across all funds/accounts managed by the portfolio managers. BASE SALARY COMPENSATION. Generally, portfolio managers receive base salary compensation based on the level of their position with the Investment Adviser. DISCRETIONARY COMPENSATION. In addition to base compensation, portfolio managers may receive discretionary compensation. Discretionary compensation can include: - Cash Bonus. - Morgan Stanley's Long Term Incentive Compensation awards - a mandatory program that defers a portion of discretionary year-end compensation into restricted stock units or other awards based on Morgan Stanley common stock or other investments that are subject to vesting and other conditions; - Investment Management Alignment Plan (IMAP) awards - a mandatory program that defers a portion of discretionary year-end compensation and notionally invests it in designated funds advised by the Adviser and/or Sub-Advisor or its affiliates. The award is subject to vesting and other conditions. Portfolio managers must notionally invest a minimum of 25% to a maximum of 100% of the IMAP deferral into a combination of the designated open-end mutual funds they manage that are included in the IMAP fund menu. - Voluntary Deferred Compensation Plans - voluntary programs that permit certain employees to elect to defer a portion of their discretionary year-end compensation and directly or notionally invest the deferred amount: (1) across a range of designated investment funds, including funds advised by the Adviser and/or Sub-Advisor or its affiliates; and/or (2) in Morgan Stanley stock units. Several factors determine discretionary compensation, which can vary by portfolio management team and circumstances. In order of relative importance, these factors include: - Investment performance. A portfolio manager's compensation is linked to the pre-tax investment performance of the funds/accounts managed by the portfolio manager. Investment performance is calculated for one-, three- and five-year periods measured against a fund's/account's primary benchmark (as set forth in the fund's prospectus), indices and/or peer groups where applicable. Generally, the greatest weight is placed on the three- and five-year periods. - Revenues generated by the investment companies, pooled investment vehicles and other accounts managed by the portfolio manager. - Contribution to the business objectives of the Investment Adviser. - The dollar amount of assets managed by the portfolio manager. - Market compensation survey research by independent third parties. 10 - Other qualitative factors, such as contributions to client objectives. - Performance of Morgan Stanley and Morgan Stanley Investment Management, and the overall performance of the investment team(s) of which the portfolio manager is a member. SECURITIES OWNERSHIP OF PORTFOLIO MANAGERS As of March 31, 2007, the portfolio managers did not own any share of the Fund. 11 Item 9. Closed-End Fund Repurchases REGISTRANT PURCHASE OF EQUITY SECURITIES
(d) Maximum (c)Total Number (or Number of Approximate Shares (or Dollar Value) Units) of Shares (or (a) Total Purchased as Units) that May Number of Part of Publicly Yet Be Shares (or (b) Average Announced Purchased Units) Price Paid per Plans or Under the Plans Period Purchased Share (or Unit) Programs or Programs ------------------ ---------- --------------- ---------------- ----------------- April 1, 2006 - April 30, 2006 19,100 9.5028 N/A N/A May 1, 2006 - May 31, 2006 6,400 9.4178 N/A N/A June 1, 2006 - June 30, 2006 13,200 9.3481 N/A N/A November 1, 2006 - November 30, 2006 4,200 9.9527 N/A N/A Total 42,900 9.5554 N/A N/A
12 Item 10. Submission of Matters to a Vote of Security Holders Not applicable. Item 11. Controls and Procedures a) The Fund's principal executive officer and principal financial officer have concluded that the Fund's disclosure controls and procedures are sufficient to provide reasonable assurance that information required to be disclosed by the Fund in this Form N-CSR was recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's ("SEC") rules and forms, based upon such officers' evaluation of these controls and procedures as of a date within 90 days of the filing date of the report. The Fund's principal executive officer and principal financial officer have also concluded that the Fund's disclosure controls and procedures designed to ensure that information required to be disclosed by the Fund in this Form N-CSR is accumulated and communicated to the Fund's management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure were effective. Management of the Fund has determined that as of and prior to March 31, 2007, the Fund's fiscal annual period, the Fund had a deficiency in its internal control over financial reporting related to the review, analysis and determination of whether certain transfers of municipal securities qualified for sale accounting under the provisions of Statement of Financial Accounting Standards No. 140 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." Since March 31, 2007, and prior to the issuance of the Fund's semiannual report, management has revised its disclosure controls and procedures and its internal control over financial reporting in order to improve the controls' effectiveness to ensure that transactions in transfers of municipal securities are accounted for properly. Management notes that other investment companies investing in similar investments over similar time periods had been accounting for such investments in a similar manner as the Fund. Accordingly, other investment companies are also concluding that there was a material weakness in their internal control over financial reporting of such investments. There was no impact to the net asset value of the Fund's shares or the Fund's total return for any period as a result of the changes in financial reporting of such investments. (b) There were no changes in the Fund's internal control over financial reporting that occurred during the second fiscal quarter of the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Fund's internal control over financial reporting. However, as discussed above, subsequent to March 31, 2007, the Fund's internal control over financial reporting was revised. 13 Item 12. Exhibits (a) The Code of Ethics for Principal Executive and Senior Financial Officers is attached hereto. (b) A separate certification for each principal executive officer and principal financial officer of the registrant are attached hereto as part of EX-99.CERT. 14 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. Morgan Stanley Municipal Income Opportunities Trust III /s/ Ronald E. Robison Ronald E. Robison Principal Executive Officer May 22, 2007 Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ Ronald E. Robison Ronald E. Robison Principal Executive Officer May 22, 2007 /s/ Francis Smith Francis Smith Principal Financial Officer May 22, 2007 15