485APOS 1 a2145436z485apos.txt 485APOS As filed with the Securities and Exchange Commission on October 29, 2004 Securities Act File No. 33-75250 Investment Company Act File No. 811-08358 ================================================================================ U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM N-1A Registration Statement Under The Securities Act of 1933 /X/ Pre-Effective Amendment No. / / Post-Effective Amendment No. 30 /X/ and/or Registration Statement Under The Investment Company Act of 1940 /X/ Amendment No. 30 /X/ (Check appropriate box or boxes) J.P. MORGAN MUTUAL FUND TRUST (Exact Name of Registrant Specified in Charter) 522 Fifth Avenue New York, New York, 10036 (Address of Principal Executive Offices) Registrant's Telephone Number, Including Area Code: (800) 348-4782 George C.W. Gatch With copies to: With copies to: 522 Fifth Avenue Nina O. Shenker, Esq. John E. Baumgardner, Jr., Esq. New York, New York 10036 J.P. Morgan Investment Sullivan & Cromwell LLP (Name and Address of Agent for Service) Management Inc. 125 Broad Street 522 Fifth Avenue New York, NY 10004 New York, NY 10036
---------- It is proposed that this filing will become effective (check appropriate box): / / Immediately upon filing pursuant to paragraph (b) /X/ 60 days after filing pursuant to paragraph (a)(1) / / 75 days after filing pursuant to paragraph (a)(2) / / on (date) pursuant to paragraph (b) / / on (date) pursuant to paragraph (a)(1) / / on (date) pursuant to paragraph (a)(2) of Rule 485 If appropriate, check the following box: / / This post-effective amendment designated a new effective date for a previously filed post-effective amendment. ================================================================================ SUBJECT TO COMPLETION - PRELIMINARY PROSPECTUS DATED OCTOBER 29, 2004 The information contained in this Prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This Prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. PROSPECTUS FEBRUARY 19, 2005 JPMORGAN MONEY MARKET FUNDS CAPITAL CLASS SHARES PRIME MONEY MARKET FUND 100% U.S. TREASURY SECURITIES MONEY MARKET FUND THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. [JPMORGAN FLEMING ASSET MANAGEMENT LOGO] CONTENTS Prime Money Market Fund 1 100% U.S. Treasury Securities Money Market Fund 6 The Funds' Management and Administration 11 How Your Account Works 14 Buying Fund Shares 14 Selling Fund Shares 17 Exchanging Fund Shares 18 Other Information Concerning the Funds 18 Shareholder Information 20 Distributions and Taxes 20 Availability of Proxy Voting Record 20 Portfolio Holdings Disclosure 20 What the Terms Mean 22 Financial Highlights 23 Legal Proceedings Relating to Banc One Investment Advisors Corporation and Certain of its Affiliates 26 How To Reach Us Back cover
JPMORGAN PRIME MONEY MARKET FUND THE FUND'S OBJECTIVE The Fund aims to provide the highest possible level of current income while still maintaining liquidity and preserving capital. THE FUND'S MAIN INVESTMENT STRATEGY The Fund invests in high quality, short-term money market instruments which are issued and payable in U.S. dollars. The Fund principally invests in: - high quality commercial paper and other short-term debt securities, including floating and variable rate demand notes of U.S. and foreign corporations - debt securities issued or guaranteed by qualified U.S. and foreign banks, including certificates of deposit, time deposits and other short-term securities - securities issued or guaranteed by the U.S. government, its agencies or instrumentalities - asset-backed securities - repurchase agreements and reverse repurchase agreements - taxable municipal obligations The dollar weighted average maturity of the Fund generally will be 60 days or less and the Fund will buy only those instruments that have remaining maturities of 397 days or less. All securities purchased by the Fund must meet the requirements of Rule 2a-7 under the Investment Company Act of 1940. The Fund may invest significantly in securities with floating or variable rates of interest. Their yields will vary as interest rates change. The Fund invests only in U.S. dollar denominated securities that have the highest possible short-term rating from at least two nationally recognized statistical rating organizations, or one such rating if only one organization rates that security. Alternatively, some securities may have additional third-party guarantees in order to meet the rating requirements mentioned above. If the security is not rated, it must be considered of comparable quality by the adviser. The Fund's adviser, J.P. Morgan Investment Management Inc. (JPMIM), seeks to develop an appropriate portfolio by considering the differences in yields among securities of different maturities, market sectors and issuers. The Fund seeks to maintain a net asset value of $1.00 per share. The Fund's Board of Trustees may change any of these investment policies (including its investment objective) without shareholder approval. The Fund is diversified as defined in the Investment Company Act of 1940. BEFORE YOU INVEST INVESTORS CONSIDERING THE FUND SHOULD UNDERSTAND THAT: - THERE IS NO ASSURANCE THAT THE FUND WILL MEET ITS INVESTMENT OBJECTIVE. - THE FUND DOES NOT REPRESENT A COMPLETE INVESTMENT PROGRAM. INVESTMENTS IN THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK AND ARE NOT INSURED OR GUARANTEED BY THE FDIC, THE FEDERAL RESERVE BOARD OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH THE FUND SEEKS TO PRESERVE THE VALUE OF YOUR INVESTMENT AT $1.00 PER SHARE, IT IS POSSIBLE TO LOSE MONEY BY INVESTING IN THE FUND. 1 THE FUND'S MAIN INVESTMENT RISKS All mutual funds carry a certain amount of risk. You may lose money on your investment in the Fund. Here are some specific risks of investing in the Fund. The Fund may not achieve its objective if the adviser's expectations regarding particular securities or interest rates are not met. The value of money market investments tends to fall when prevailing interest rates rise, although they are generally less sensitive to interest rate changes than longer-term securities. Repurchase agreements involve some risk to the Fund if the other party does not live up to its obligations under the agreement. Indebtedness of certain issuers identified with the U.S. government whose securities may be held by the Fund, including the well-known Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), is not entitled to the full faith and credit of the United States and is thus subject to the risk of default in the payment of interest and/or principal like the indebtedness of private issuers. The Fund's asset-backed investments involve risk of loss due to prepayments that occur earlier or later than expected, and like any bond, due to default. Some asset-backed securities may have additional risk because they may receive little or no collateral protection from the underlying assets. The Fund's ability to concentrate its investments in the banking industry could increase risks. The profitability of banks depends largely on the availability and cost of funds, which can change depending upon economic conditions. Banks are also exposed to losses if borrowers get into financial trouble and cannot repay their loans. Investments in foreign securities may be riskier than investments in U.S. securities. Foreign securities may be affected by political, social and economic instability. There also may be less public information available. Although the Fund seeks to be fully invested, it may at times hold some of its assets in cash. This could hurt the Fund's performance. Securities in the Fund's portfolio may not earn as high a current income as longer-term or lower-quality securities. If the Fund departs from its investment policies during temporary defensive periods or to meet redemptions, it may not achieve its investment objective. WHO MAY WANT TO INVEST THE FUND IS DESIGNED FOR INVESTORS WHO: - WANT AN INVESTMENT THAT STRIVES TO PRESERVE CAPITAL - WANT REGULAR INCOME FROM A HIGH QUALITY PORTFOLIO - WANT A HIGHLY LIQUID INVESTMENT - ARE LOOKING FOR AN INTERIM INVESTMENT - ARE PURSUING A SHORT-TERM GOAL THE FUND IS NOT DESIGNED FOR INVESTORS WHO: - ARE INVESTING FOR LONG-TERM GROWTH - ARE INVESTING FOR HIGH INCOME - REQUIRE THE ADDED SECURITY OF FDIC INSURANCE 2 THE FUND'S PAST PERFORMANCE This section shows the Fund's performance record with respect to the Fund's Institutional Class Shares.* The bar chart shows how the performance of the Fund's Institutional Class Shares has varied from year to year over the past ten calendar years. This provides some indication of the risks of investing in the Fund. The table shows the average annual total returns for the past one year, five years and ten years. To obtain current yield information call 1-800-766-7722. Past performance is not necessarily an indication of how any class of the Fund will perform in the future. The calculations assume that all dividends and distributions are reinvested in the Fund. Some of the companies that provide services to the Fund have in the past agreed not to collect some expenses and to reimburse others. Without these agreements, the performance figures would have been lower than those shown. [CHART] YEAR-BY-YEAR RETURNS*,(1) 1995 5.84% 1996 5.40% 1997 5.58% 1998 5.53% 1999 5.17% 2000 6.38% 2001 4.12% 2002 1.72% 2003 1.06% 2004 __%
BEST QUARTER 3rd quarter, 2000 1.64% WORST QUARTER 4th quarter, 2003 0.23%
AVERAGE ANNUAL TOTAL RETURNS (%) SHOWS PERFORMANCE OVER TIME, FOR PERIODS ENDED DECEMBER 31, 2004*,(1)
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS -------------------------------------------------------------------------------- INSTITUTIONAL CLASS SHARES [ ] [ ] [ ]
* THE PERFORMANCE FOR THE PERIOD BEFORE CAPITAL CLASS SHARES WERE LAUNCHED ON 2/18/05 IS BASED ON THE PERFORMANCE OF THE INSTITUTIONAL CLASS SHARES OF THE FUND, WHICH INVEST IN THE SAME PORTFOLIO OF SECURITIES, BUT WHOSE SHARES ARE NOT BEING OFFERED IN THIS PROSPECTUS. THE PERFORMANCE FOR THE PERIOD BEFORE INSTITUTIONAL CLASS SHARES WERE LAUNCHED ON 9/10/01 AND THE PERFORMANCE IN THE BAR CHART PRIOR TO 1/1/02 ARE BASED ON THE PERFORMANCE OF AGENCY SHARES OF THE FUND, WHICH INVEST IN THE SAME PORTFOLIO OF SECURITIES, BUT WHOSE SHARES ARE NOT BEING OFFERED IN THIS PROSPECTUS. (1) THE FUND'S FISCAL YEAR END IS 8/31. 3 ESTIMATED INVESTOR EXPENSES FOR CAPITAL CLASS SHARES The estimated expenses of the Capital Class Shares before and after reimbursement are shown below. The table below does not reflect charges or credits which you might incur if you invest through a financial intermediary or service organization. ESTIMATED ANNUAL OPERATING EXPENSES (%) (EXPENSES THAT ARE DEDUCTED FROM CAPITAL CLASS SHARES ASSETS) MANAGEMENT FEES 0.08 DISTRIBUTION (RULE 12b-1) FEES NONE SHAREHOLDER SERVICE FEES 0.05 OTHER EXPENSES(1) TOTAL ANNUAL OPERATING EXPENSES FEE WAIVERS AND EXPENSE REIMBURSEMENTS(2) NET EXPENSES(2) 0.16
(1) "OTHER EXPENSES" ARE BASED ON ACTUAL EXPENSES FOR THE CURRENT FISCAL YEAR. (2) REFLECTS A WRITTEN AGREEMENT PURSUANT TO WHICH JPMIM, THE ADMINISTRATOR AND THE DISTRIBUTOR AGREE THAT THEY WILL WAIVE FEES OR REIMBURSE THE FUND TO THE EXTENT THAT TOTAL ANNUAL OPERATING EXPENSES OF THE INSTITUTIONAL CLASS SHARES (EXCLUDING INTEREST, TAXES AND EXTRAORDINARY EXPENSES AND EXPENSES RELATED TO THE DEFERRED COMPENSATION PLAN) EXCEED 0.16%, OF ITS AVERAGE DAILY NET ASSETS FROM 2/19/05 THROUGH 12/31/06. IN ADDITION, THE FUND'S SERVICE PROVIDERS MAY VOLUNTARILY WAIVE OR REIMBURSE CERTAIN OF THEIR FEES, AS THEY MAY DETERMINE, FROM TIME TO TIME. 4 EXAMPLE The example below is intended to help you compare the cost of investing in the Capital Class Shares with the cost of investing in other mutual funds. The example assumes: - $10,000 initial investment, - 5% return each year, - net expenses through 12/31/06 and total annual operating expenses thereafter. This example is for comparison only; the actual returns of the Capital Class Shares and your actual costs may be higher or lower.
1 YEAR 3 YEARS 5 YEARS 10 YEARS -------------------------------------------------------------------------------- YOUR COST ($) (WITH OR WITHOUT REDEMPTION)
5 JPMORGAN 100% U.S. TREASURY SECURITIES MONEY MARKET FUND THE FUND'S OBJECTIVE The Fund aims to provide the highest possible level of current income while still maintaining liquidity and providing maximum safety of principal. THE FUND'S MAIN INVESTMENT STRATEGY The Fund invests its assets exclusively in obligations of the U.S. Treasury, including Treasury bills, bonds and notes. These investments carry different interest rates, maturities and issue dates. The Fund does not buy securities issued or guaranteed by agencies of the U.S. government. The dollar weighted average maturity of the Fund will be 90 days or less and the Fund will buy only those investments that have remaining maturities of 397 days or less. All securities purchased by the Fund must meet the requirements of Rule 2a-7 under the Investment Company Act of 1940. The Fund's adviser, JPMIM, seeks to develop an appropriate portfolio by considering the differences in yields among securities of different maturities. The Fund seeks to maintain a net asset value of $1.00 per share. The Fund's Board of Trustees may change any of these investment policies (including its investment objective) without shareholder approval. The Fund is diversified as defined in the Investment Company Act of 1940. BEFORE YOU INVEST INVESTORS CONSIDERING THE FUND SHOULD UNDERSTAND THAT: - THERE IS NO ASSURANCE THAT THE FUND WILL MEET ITS INVESTMENT OBJECTIVE. - THE FUND DOES NOT REPRESENT A COMPLETE INVESTMENT PROGRAM. INVESTMENTS IN THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK AND ARE NOT INSURED OR GUARANTEED BY THE FDIC, THE FEDERAL RESERVE BOARD OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH THE FUND SEEKS TO PRESERVE THE VALUE OF YOUR INVESTMENT AT $1.00 PER SHARE, IT IS POSSIBLE TO LOSE MONEY BY INVESTING IN THE FUND. THE FUND'S MAIN INVESTMENT RISKS All mutual funds carry a certain amount of risk. You may lose money on your investment in the Fund. Here are some specific risks of investing in the Fund. The Fund may not achieve its objective if the adviser's expectations regarding particular securities or interest rates are not met. The value of money market investments tends to fall when prevailing interest rates rise, although they are generally less sensitive to interest rate changes than longer-term securities. Although the Fund seeks to be fully invested, it may at times hold some of its assets in cash. This could hurt the Fund's performance. 6 Securities in the Fund's portfolio may not earn as high a current income as longer-term or lower-quality securities. If the Fund departs from its investment policies during temporary defensive periods or to meet redemptions, it may not achieve its investment objective. WHO MAY WANT TO INVEST THE FUND IS DESIGNED FOR INVESTORS WHO: - WANT AN INVESTMENT THAT STRIVES TO PRESERVE CAPITAL - WANT REGULAR INCOME FROM A HIGH QUALITY PORTFOLIO - WANT A HIGHLY LIQUID INVESTMENT - ARE LOOKING FOR AN INTERIM INVESTMENT - ARE PURSUING A SHORT-TERM GOAL THE FUND IS NOT DESIGNED FOR INVESTORS WHO: - ARE INVESTING FOR LONG-TERM GROWTH - ARE INVESTING FOR HIGH INCOME - REQUIRE THE ADDED SECURITY OF FDIC INSURANCE 7 THE FUND'S PAST PERFORMANCE This section shows the Fund's performance record with respect to the Fund's Institutional Class Shares.* The bar chart shows how the performance of the Fund's Institutional Class Shares has varied from year to year over the past ten calendar years. This provides some indication of the risks of investing in the Fund. The table shows the average annual total returns for the past one year, five years and ten years. To obtain current yield information call 1-800-766-7722. Past performance is not necessarily an indication of how any class of the Fund will perform in the future. The calculations assume that all dividends and distributions are reinvested in the Fund. Some of the companies that provide services to the Fund have in the past agreed not to collect some expenses and to reimburse others. Without these agreements, the performance figures would have been lower than those shown. [CHART] YEAR-BY-YEAR RETURNS*,(1) 1995 5.17% 1996 4.94% 1997 5.24% 1998 5.23% 1999 4.62% 2000 5.85% 2001 3.82% 2002 1.57% 2003 0.93% 2004 __%
BEST QUARTER 4th quarter, 2000 1.54% WORST QUARTER 4th quarter, 2003 0.20%
AVERAGE ANNUAL TOTAL RETURNS (%) SHOWS PERFORMANCE OVER TIME, FOR PERIODS ENDED DECEMBER 31, 2004*,(1)
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS -------------------------------------------------------------------------------- INSTITUTIONAL CLASS SHARES [ ] [ ] [ ]
* THE PERFORMANCE FOR THE PERIOD BEFORE CAPITAL CLASS SHARES WERE LAUNCHED ON 2/18/05 IS BASED ON THE PERFORMANCE OF THE INSTITUTIONAL CLASS SHARES OF THE FUND, WHICH INVEST IN THE SAME PORTFOLIO SECURITIES, BUT WHOSE SHARES ARE NOT BEING OFFERED IN THIS PROSPECTUS. THE PERFORMANCE FOR THE PERIOD BEFORE INSTITUTIONAL CLASS SHARES WERE LAUNCHED ON 9/10/01 AND THE PERFORMANCE IN THE BAR CHART PRIOR TO 1/1/02 ARE BASED ON THE PERFORMANCE OF AGENCY SHARES OF THE FUND, WHICH INVEST IN THE SAME PORTFOLIO OF SECURITIES, BUT WHOSE SHARES ARE NOT BEING OFFERED IN THIS PROSPECTUS. (1) THE FUND'S FISCAL YEAR END IS 8/31. 8 ESTIMATED INVESTOR EXPENSES FOR CAPITAL CLASS SHARES The estimated expenses of the Capital Class Shares before and after reimbursement are shown below. The table below does not reflect charges or credits which you might incur if you invest through a financial intermediary or service organization. ESTIMATED ANNUAL OPERATING EXPENSES (%) (EXPENSES THAT ARE DEDUCTED FROM CAPITAL CLASS SHARES ASSETS) MANAGEMENT FEES 0.08 DISTRIBUTION (RULE 12b-1) FEES NONE SHAREHOLDER SERVICE FEES 0.05 OTHER EXPENSES(1) TOTAL ANNUAL OPERATING EXPENSES FEE WAIVERS AND EXPENSE REIMBURSEMENTS(2) NET EXPENSES(2) 0.16
(1) "OTHER EXPENSES" ARE BASED ON ACTUAL EXPENSES FOR THE CURRENT FISCAL YEAR. (2) REFLECTS A WRITTEN AGREEMENT PURSUANT TO WHICH JPMIM, THE ADMINISTRATOR AND THE DISTRIBUTOR AGREE THAT THEY WILL WAIVE FEES OR REIMBURSE THE FUND TO THE EXTENT TOTAL ANNUAL OPERATING EXPENSES OF THE CAPITAL CLASS SHARES (EXCLUDING INTEREST, TAXES AND EXTRAORDINARY EXPENSES AND EXPENSES RELATED TO THE DEFERRED COMPENSATION PLAN) EXCEED 0.16%, OF ITS AVERAGE DAILY NET ASSETS FROM 2/19/05 THROUGH 2/19/06. IN ADDITION, THE FUND'S SERVICE PROVIDERS MAY VOLUNTARILY WAIVE OR REIMBURSE CERTAIN OF THEIR FEES, AS THEY MAY DETERMINE, FROM TIME TO TIME. 9 EXAMPLE The example below is intended to help you compare the cost of investing in the Capital Class Shares with the cost of investing in other mutual funds. The example assumes: - $10,000 initial investment, - 5% return each year, and - net expenses through 2/18/06 and total annual operating expenses thereafter. This example is for comparison only; the actual returns of the Capital Class Shares and your actual costs may be higher or lower.
1 YEAR 3 YEARS 5 YEARS 10 YEARS -------------------------------------------------------------------------------- YOUR COST ($) (WITH OR WITHOUT REDEMPTION)
10 THE FUNDS' MANAGEMENT AND ADMINISTRATION The Funds are series of J.P. Morgan Mutual Fund Trust, a Massachusetts business trust. The trust is governed by trustees who are responsible for overseeing all business activities of the Funds. Each of the Funds operates in a multiple class structure. A multiple class fund is an open-end investment company that issues two or more classes of shares representing interests in the same investment portfolio. Each class in a multiple class fund can set its own transaction minimums and may vary with respect to expenses for distribution, administration and shareholder services. This means that one class could offer access to a Fund on different terms, and thus would experience different performance, than another class. Certain classes may be more appropriate for a particular investor. Each Fund may also issue other classes of shares that have different expense levels and performance and different requirements for who may invest. Call 1-800-766-7722 to obtain more information concerning the Funds' other share classes. A financial intermediary who receives compensation for selling Fund shares may receive a different amount of compensation for sales of different classes of shares. THE FUNDS' INVESTMENT ADVISER JPMIM is the investment adviser to the Funds and makes the day-to-day investment decisions for the Funds. JPMIM is located at 522 Fifth Avenue, New York, NY 10036. JPMIM is a wholly owned subsidiary of J.P. Morgan Fleming Asset Management Holdings, Inc., which is a wholly owned subsidiary of JPMorgan Chase & Co. (JPMorgan Chase), a bank holding company. During the fiscal year ended 8/31/04, the adviser was paid management fees (net of waivers), as shown below, as a percentage of average daily net assets:
FUND % ----------------------------------------------- PRIME MONEY MARKET FUND 0.10 100% U.S. TREASURY SECURITIES MONEY MARKET FUND 0.10
FUND MANAGER COMPENSATION Portfolio managers and research analysts participate in a highly competitive compensation program that is designed to attract and retain outstanding people and closely link the performance of investment professionals to client investment objectives. The total compensation program includes base salary, cash incentives, the value of stock awards, and, in some cases, mandatory deferred compensation. These elements reflect individual performance and the performance of the business as a whole. Each investment professional's performance is formally evaluated annually based on a variety of factors including the size and performance of the portfolios such professional manages. Individual contribution relative to client goals carries the highest impact. For example: - Portfolio manager compensation is primarily driven by meeting or exceeding clients' risk and return objectives, relative performance to competitors or competitive indices, and compliance with firm policies and regulatory requirements. Investment performance is generally more heavily weighted to the long-term. - Research analyst compensation is primarily driven by the accuracy of their forecasts and rankings with respect to 11 the companies and/or sectors for which they have research responsibility. Stock awards are granted as part of an employee's annual performance bonus and comprise from 0% to 35% of an investment professional's total award. As incentive compensation increases, the percentage of compensation awarded in restricted stock, stock appreciation awards, or stock options also increases. Certain investment professionals may also be subject to a mandatory deferral of a portion of their compensation into proprietary mutual funds based on long-term sustained investment performance. Portfolio managers are encouraged to own shares of the JPMorgan Funds they help manage. THE FUNDS' ADMINISTRATOR One Group Administrative Services, Inc. (the Administrator) provides administrative services and oversees each Fund's other service providers. The Administrator receives a pro-rata portion of the following annual fee on behalf of each Fund for administrative services: 0.10% of the first $100 billion of average daily net assets of all money market funds in the JPMorgan Fund Complex and 0.05% of average daily net assets over $100 billion. THE FUNDS' SHAREHOLDER SERVICING AGENT The Trust, on behalf of the Funds, has entered into a shareholder servicing agreement with One Group Dealer Services, Inc. (OGDS) under which OGDS has agreed to provide certain support services to the Funds' customers. For performing these services, OGDS, as shareholder servicing agent, may receive an annual fee of 0.05% of the average daily net assets of Capital Class Shares of the Fund held by investors serviced by the shareholder servicing agent. OGDS may enter into services contracts with certain entities under which it will pay all or a portion of the 0.05% annual fee to such entities for performing shareholder and administrative services. THE FUNDS' DISTRIBUTOR OGDS (the Distributor) is the distributor for the Funds. The Distributor is an affiliate of JPMIM and the Administrator. ADDITIONAL COMPENSATION TO FINANCIAL INTERMEDIARIES JPMIM, OGDS and, from time to time, other affiliates of JPMorgan Chase may, at their own expense and out of their own legitimate profits, provide additional cash payments to Financial Intermediaries who sell shares of the JPMorgan Funds. For this purpose, Financial Intermediaries include financial advisors, investment advisers, brokers, financial planners, banks, insurance companies, retirement or 401(k) plan administrators and others, including various affiliates of JPMorgan Chase. These additional cash payments are payments over and above the sales charges, Rule 12b-1 fees and shareholder servicing fees which are disclosed elsewhere in this prospectus. These additional cash payments are generally made to Financial Intermediaries that provide shareholder or administrative services or marketing support. Marketing support may include access to sales meetings, sales representatives and Financial Intermediary management representatives, inclusion of the JPMorgan Funds on a sales list, including a preferred or select sales list, or other sales programs. These additional cash payments also may be made as an expense reimbursement in cases where the Financial Intermediary provides shareholder services to 12 JPMorgan Fund shareholders. JPMIM and OGDS may also pay cash compensation in the form of finders' fees that vary depending on the JPMorgan Fund and the dollar amount of shares sold. In addition, OGDS may, on occasion, pay Financial Intermediaries the entire front-end sales charge applicable to the JPMorgan Fund shares sold by the Financial Intermediary or an additional commission on the sale of JPMorgan Fund shares subject to a CDSC. 13 HOW YOUR ACCOUNT WORKS BUYING FUND SHARES You do not pay any sales charge (sometimes called a load) when you buy Capital Class Shares of these Funds. Certain dealers and shareholder servicing agents may receive payments from OGDS or an affiliate. These payments are made at their own expense. The price you pay for your shares is the net asset value (NAV) per share of the class. NAV is the value of everything a class of a Fund owns, minus everything the class owes, divided by the number of shares held by investors. The Funds seek to maintain a stable NAV per share of $1.00. Each Fund uses the amortized cost method to value its portfolio of securities. This method provides more stability in valuations. However, it may also result in periods during which the stated value of a security is different than the price the Fund would receive if it sold the investment. The NAV is generally calculated as of the cut-off time each day the Funds are accepting orders. You will pay the next NAV per share calculated after the JPMorgan Institutional Funds Service Center accepts your order. Capital Class Shares may be purchased by institutional investors such as corporations, pension and profit sharing plans, financial institutions, states, municipalities and foundations. You may purchase Fund shares through your investment representative (Financial Intermediary) or a service organization. Financial Intermediaries may include financial advisors, investment advisers, brokers, financial planners, banks, insurance companies, retirement or 401(k) plan sponsors or other intermediaries, including affiliates of JPMorgan Chase. Shares purchased this way will typically be held for you by the Financial Intermediary or service organization. You may also purchase shares directly from the JPMorgan Institutional Funds Service Center. Shares are available on any business day that the Funds are open for business. The Funds will be closed on weekends and days on which the Federal Reserve Bank of New York (Federal Reserve) or the New York Stock Exchange (NYSE) is closed, including the following holidays: New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Columbus Day, Veterans Day, Thanksgiving Day and Christmas Day. On occasion, the NYSE closes before 4:00 p.m. Eastern Time (ET). When the NYSE closes before a Fund's cut-off time, purchase requests received by the Fund or an authorized agent of the Fund after the NYSE closes will be effective the following business day. Each Fund, however, may elect to remain open following an early close of the NYSE or to open on days when the Federal Reserve is open and the NYSE is closed. If your purchase request is received by the Fund or an authorized agent of the Fund before the Fund's close on a day when the NYSE closes early but the Fund remains open, or on a day when the Fund is open but the NYSE is not, it will be effective the same business day. Purchase requests received after a Fund closes will be effective the following business day. Shareholders will receive notice at www.jpmorganfunds.com if and to what extent a Fund remains open following an early close of the NYSE or if and to what extent a Fund will be open on a day when the Federal Reserve is open and the NYSE is not. The Funds may close earlier a few days each year if the Public Securities 14 Association recommends that the U.S. government securities market close trading early. If the Fund or an authorized agent of the Fund receives your order by the Fund's cut-off time listed below, we will process your purchase order at that day's price and you will be entitled to all dividends declared on that day. If the Fund or an authorized agent of the Fund receives your purchase order after the cut-off time, we will process it at the next day's price. Your Financial Intermediary or service organizations will be responsible for transmitting your purchase order to the Fund or an authorized agent of the Fund by the Fund's cut-off time. Your Financial Intermediary or service organization may have an earlier cut-off time. In addition, your Financial Intermediary or service organization may be closed at times when the Fund is open (for example, when the NYSE is closed and the Fund elects to remain open). Normally, the cut-off time for each Fund is: PRIME MONEY MARKET FUND 5:00 P.M. ET 100% U.S. TREASURY SECURITIES MONEY MARKET FUND 2:00 P.M. ET
The Fund must receive "federal funds" before the Fund's cut-off time shown above (unless the Fund closes early, in which case federal funds must be received by the Fund's close). If the Fund does not receive federal funds by its cut-off time, your order may not be effective until the next business day on which federal funds are timely received by the Fund. If you pay by check before the cut-off time, we will generally process your order the next business day the Fund is open for business. The Funds have the right to refuse any purchase order or to stop offering shares for sale at any time. TO OPEN AN ACCOUNT, BUY OR SELL SHARES OR GET FUND INFORMATION, CALL: JPMORGAN INSTITUTIONAL FUNDS SERVICE CENTER 1-800-766-7722 MINIMUM INVESTMENTS Capital Class shares are subject to a $100,000,000 minimum investment requirement per Fund. Certain institutional investors may meet the minimum though the total amount of Capital Class Shares of the Fund for all such institutional investors with the Financial Intermediaries. There are no minimum levels for subsequent purchases. Former One Group accounts opened on or before October 28, 2004 will be subject to a $1,000,000 minimum. Former JPMorgan accounts opened on or before February 18, 2005 will be subject to a $20,000,000 minimum. The Funds reserve the right to waive any investment minimum. For further information on investment minimum waivers, call 1-800-766-7722. GENERAL The JPMorgan money market funds (including the Funds in this prospectus), are intended for short-term investment horizons and do not monitor for market timers or prohibit short-term trading activity. Although these Funds are managed in a manner that is consistent with their investment objectives, frequent trading by shareholders may disrupt their management and increase their expenses. 15 Federal law requires all financial institutions to obtain, verify and record information that identifies each person who opens an account. When you open an account, we will ask for your name, residential or business street address, date of birth (for an individual) and other information that will allow us to identify you, including your social security number, tax identification number or other identifying number. The Funds cannot waive these requirements. The Funds are required by law to reject your Account Application if the required identifying information is not provided. We will attempt to collect any missing information required on the Account Application by contacting either you or your Financial Intermediary. If we cannot obtain this information within the established time frame, your Account Application will be rejected. Amounts received prior to receipt of the required information will be held uninvested and will be returned to you without interest if your Account Application is rejected. If the required information is obtained, your investment will be accepted and you will receive the NAV per share next calculated after all of the required information is received. Once we have received all of the required information, federal law requires us to verify your identity. After an account is opened, we may restrict your ability to purchase additional shares until your identity is verified. If we are unable to verify your identity within a reasonable time, the Funds reserve the right to close your account at the current day's NAV. If your account is closed for this reason, your shares will be redeemed at the NAV next calculated after the account is closed. Send the completed Account Application and a check to: JPMORGAN INSTITUTIONAL FUNDS SERVICE CENTER 500 STANTON CHRISTIANA ROAD NEWARK, DE 19713 If you choose to pay by wire, please call 1-800-766-7722 to notify the Funds of your purchase and authorize your financial institution to wire funds to: JPMORGAN CHASE BANK, NA ATTN: ______________________ ABA 021 000 021 DDA 323125832 FBO YOUR JPMORGAN FUND (EX: JPMORGAN ABC FUND-CAPITAL) YOUR FUND NUMBER & ACCOUNT NUMBER (EX: FUND 123-ACCOUNT 123456789) YOUR ACCOUNT REGISTRATION (EX: XYZ CORPORATION) All checks must be in U.S. dollars. The Fund does not accept credit cards, cash, starter checks, money orders or credit card checks. The Fund reserves the right to refuse "third-party" checks and checks drawn on non-U.S. financial institutions even if payment may be effected through a U.S. financial institution. Checks made payable to any individual or company and endorsed to the JPMorgan Funds or the Fund are considered third-party checks. ALL CHECKS MUST BE MADE PAYABLE TO ONE OF THE FOLLOWING: - JPMorgan Funds; or - The specific Fund in which you are investing. You can buy shares in one of two ways: THROUGH YOUR FINANCIAL INTERMEDIARY OR SERVICE ORGANIZATION Tell your Financial Intermediary or service organization which Funds you want to buy and they will contact us. Your 16 Financial Intermediary or service organization may charge you a fee and may offer additional services, such as special purchase and redemption programs, "sweep" programs, cash advances and redemption checks. Some Financial Intermediaries and service organizations charge a single fee that covers all services. The Fund or an authorized agent of the Fund must accept your order from your Financial Intermediary or service organization by the Fund's cut-off time in order for us to process your purchase order at that day's price. Your Financial Intermediary or service organization may impose different minimum investments and earlier cut-off times. Your service organization is paid by the Funds to assist you in establishing your account, executing transactions and monitoring your investment. Service organizations may provide the following services in connection with their customers' investments in the Funds: - Acting directly or through an agent, as the sole shareholder of record - Maintaining account records for customers - Processing orders to purchase, redeem or exchange shares for customers - Responding to inquiries from shareholders - Assisting customers with investment procedures. THROUGH THE JPMORGAN INSTITUTIONAL FUNDS SERVICE CENTER Call 1-800-766-7722 Or Complete the application form and mail it along with a check for the amount you want to invest to: JPMORGAN INSTITUTIONAL FUNDS SERVICE CENTER 500 STANTON CHRISTIANA ROAD NEWARK, DE 19713 The JPMorgan Institutional Funds Service Center will accept your order when federal funds, a wire or a check is received together with a completed application or other instructions in proper form. SELLING FUND SHARES You can sell your shares on any day that the JPMorgan Institutional Funds Service Center is accepting purchase orders. You will receive the next NAV per share calculated after the JPMorgan Institutional Funds Service Center accepts your order. We will need the names of the registered shareholders, your account number and other information before we can sell your shares. Your redemption proceeds will be paid within seven days after receipt of the redemption request. However, the Funds will attempt to honor requests for same-day payment if the request is received by the Fund or an authorized agent of the Fund before the Fund's cut-off time. If redemption requests are received by the Fund or an authorized agent of the Fund after a Fund's cut-off time, the Fund will attempt to wire payment the next business day. The Funds also will attempt to honor requests for payment in two business days, if the redemption request is received by the Fund or an authorized agent of the Fund after a Fund's cut-off time. 17 If you have changed your address or payee of record within the previous 30 days, the Funds will not mail your proceeds, but rather will wire them or send them by ACH, and only to a bank account on record with the Funds. The Funds may hold proceeds for shares purchased by ACH or check until the purchase amount has been collected, which may be as long as five (5) business days. You will need to have your signature guaranteed if you want your payment sent to an address other than the one we have in our records. You may also need to have medallion signature guarantees for all registered owners or their legal representatives if: - You want to redeem shares with a value of $50,000 or more and you want to receive your proceeds in the form of a check; or - You want your payment sent to an address, bank account or payee other than the one currently designated on your Fund account. You may sell your shares in one of two ways: THROUGH YOUR FINANCIAL INTERMEDIARY OR SERVICE ORGANIZATION Tell your Financial Intermediary or service organization which Fund's shares you want to sell. The Fund or an authorized agent of the Fund must accept an order from your Financial Intermediary or service organization by the Fund's cut-off time in order for us to process your order at that day's price. Your Financial Intermediary or service organization will send the necessary documents to the JPMorgan Institutional Funds Service Center. Your Financial Intermediary or service organization may charge you for this service. THROUGH THE JPMORGAN INSTITUTIONAL FUNDS SERVICE CENTER Call 1-800-766-7722. We will send the proceeds by wire only to the bank account on our records. REDEMPTIONS-IN-KIND Generally, all redemptions will be for cash. However, if you redeem shares worth $250,000 or more of a Fund's assets, the Fund reserves the right to pay part or all of your redemption proceeds in readily marketable securities instead of cash. If payment is made in securities, the Fund will value the securities selected in the same manner in which it computes its NAV. This process minimizes the effect of large redemptions on the Fund and its remaining shareholders. EXCHANGING FUND SHARES You can exchange your Capital Class Shares for shares of the same class in certain other JPMorgan Funds. You will need to meet any minimum investment or eligibility requirement. For tax purposes, an exchange is treated as a sale of Fund shares. Carefully read the prospectus of the Fund you want to buy before making an exchange. Call 1-800-766-7722 for details. We reserve the right to limit the number of exchanges or to refuse an exchange. Your exchange privilege will be revoked if the exchange activity is considered excessive. You can exchange your shares in one of two ways: THROUGH YOUR FINANCIAL INTERMEDIARY OR SERVICE ORGANIZATION Tell your Financial Intermediary or service organization which Funds' shares you want to exchange. They will send the necessary documents to the JPMorgan Institutional Funds Service Center. Your Financial Intermediary or service organization may charge you for this service. 18 THROUGH THE JPMORGAN INSTITUTIONAL FUNDS SERVICE CENTER Call 1-800-766-7722 to ask for details. OTHER INFORMATION CONCERNING THE FUNDS The Funds use reasonable procedures to confirm that instructions given by telephone are genuine. These procedures include recording telephone instructions and asking for personal identification. If these procedures are followed, the Funds will not be responsible for any loss, liability, cost or expense of acting upon unauthorized or fraudulent instructions; you bear the risk of loss. Due to the relatively high cost of maintaining small accounts, if your account value falls below the Funds' minimum investment requirement, the Funds reserve the right to redeem all of the remaining shares in your account and close your account or charge an annual sub-minimum account fee of $10 per Fund. Before either of these actions is taken, you will be given 60 days advance written notice in order to provide you with time to increase your account balance. To collect the $10 sub-minimum account fee, the Funds will redeem $10 worth of shares from your account. You may not always reach the JPMorgan Institutional Funds Service Center by telephone. This may be true at times of unusual market changes and shareholder activity. You can mail us your instructions or contact your Financial Intermediary or service organization. We may modify or cancel the sale of shares by telephone without notice. You may write to: JPMORGAN INSTITUTIONAL FUNDS SERVICE CENTER 500 STANTON CHRISTIANA ROAD NEWARK, DE 19713 The Funds may suspend your ability to redeem when: 1. Trading on the NYSE is restricted; 2. The NYSE is closed (other than weekend and holiday closings); 3. The SEC has permitted a suspension; or 4. An emergency exists, as determined by the SEC. The Statement of Additional Information offers more details about this process. 19 SHAREHOLDER INFORMATION DISTRIBUTIONS AND TAXES The Funds can earn income and can realize capital gain. The Funds deduct any expenses and then pay out these earnings to shareholders as distributions. The Funds declare dividends daily, so your shares can start earning dividends on the day you buy them. The Funds distribute the dividends monthly in the form of additional shares, unless you tell us that you want distributions in cash or as a deposit in a pre-assigned bank account. The taxation of dividends will not be affected by the form in which you receive them. The Funds distribute any short-term capital gain at least annually. The Funds do not expect to realize long-term capital gain. Dividends of net investment income will generally be taxable as ordinary income at the federal, state and local levels. Dividends of tax-exempt interest income paid by the Tax Free Money Market Fund are not subject to federal income taxes, but will generally be subject to state and local taxes. The state or municipality where you live may not charge you state and local taxes on dividends of tax-exempt interest earned on certain bonds. Dividends of interest earned on bonds issued by the U.S. government and its agencies may also be exempt from some types of state and local taxes. It is unlikely that dividends from any of the Funds will qualify to any significant extent for the reduced 15% tax rate applicable to qualified dividend income. If you receive distributions of net capital gain, the tax rate will be based on how long a Fund held a particular asset, not on how long you have owned your shares. The Funds expect substantially all of their distributions of net capital gain to be attributable to short-term capital gain which is taxed at rates applicable to ordinary income. Early in each calendar year, the Funds will send you a notice showing the amount of distributions you received in the preceding year and the tax status of those distributions. Any investor for whom a Fund does not have a valid Taxpayer Identification Number may be subject to backup withholding. The tax considerations described in this section do not apply to tax-deferred accounts or other non-taxable entities. The above is a general summary of the tax implications of investing in the Funds. Because each investor's tax consequences are unique, please consult your tax advisor to see how investing in the Funds will affect your own tax situation. AVAILABILITY OF PROXY VOTING RECORD The Trustees have delegated the authority to vote proxies for securities owned by the Funds to JPMIM. A copy of each Fund's voting record for the most recent twelve-month period ended June 30 is available on the SEC's website at www.sec.gov or on the Funds' website at www.jpmorganfunds.com no later than August 31 of each year. Each Fund's proxy voting record will include, among other things, a brief description of the matter voted on for each portfolio security and state how each vote was cast, for example, for or against the proposal. PORTFOLIO HOLDINGS DISCLOSURE Each business day, each Fund will make available upon request a complete uncertified schedule of its portfolio 20 holdings as of the prior business day. Not later than 60 days after the end of each fiscal quarter, each Fund will make available a complete, certified schedule of its portfolio holdings as of the last day of that quarter. In addition to providing hard copies upon request, the Funds will post these quarterly schedules on the Funds' website at www.jpmorganfunds.com and on the SEC's website at www.sec.gov. The Fund's top ten holdings as of the last day of each month and each calendar quarter are posted on its website at www.jpmorganfunds.com, 15 days after the end of that month or calendar quarter, respectively. Shareholders may request portfolio holdings schedules at no charge by calling 1-800-766-7722. A description of the Funds' policies and procedures with respect to the disclosure of the Funds' portfolio holdings is available in the Statement of Additional Information. 21 WHAT THE TERMS MEAN ASSET-BACKED SECURITIES: Interests in a stream of payments from specific assets, such as auto or credit card receivables. COMMERCIAL PAPER: Short-term securities with maturities of 1 to 270 days which are issued by banks, corporations and others. DEMAND NOTES: A debt security with no set maturity date. The investor can generally demand payment of the principal at any time. DISTRIBUTION FEE: Covers the cost of the distribution system used to sell shares to the public. DOLLAR WEIGHTED AVERAGE MATURITY: The average maturity of the Fund is the average amount of time until the organizations that issued the debt securities in the Fund's portfolio must pay off the principal amount of the debt. "Dollar weighted" means the larger the dollar value of debt security in the Fund, the more weight it gets in calculating this average. FLOATING RATE SECURITIES: Securities whose interest rates adjust automatically whenever a particular interest rate changes. LIQUIDITY: Liquidity is the ability to easily convert investments into cash without losing a significant amount of money in the process. MANAGEMENT FEE: A fee paid to the investment adviser to manage the Fund and make decisions about buying and selling the Fund's investments. MUNICIPAL LEASE OBLIGATIONS: These provide participation in municipal lease agreements and installment purchase contracts, but are not part of the general obligations of the municipality. MUNICIPAL OBLIGATIONS: Debt securities issued by or on behalf of states, territories and possessions or by their agencies or other groups with authority to act for them. For securities to qualify as municipal obligations, the municipality's lawyers must give an opinion that the interest on them is not considered gross income for federal income tax purposes. OTHER EXPENSES: Miscellaneous items, including transfer agency, administration, custody and registration fees. QUALIFIED BANKS: (i) U.S. banks with more than $1 billion in total assets, and foreign branches of these banks; or (ii) foreign banks with the equivalent of more than $1 billion in total assets and which have branches or agencies in the U.S or (iii) other U.S. or foreign commercial banks which the Fund's adviser judges to have comparable credit standing. REPURCHASE AGREEMENTS: A special type of a short-term investment. A dealer sells securities to a fund and agrees to buy them back later for a set price. This set price includes interest. In effect, the dealer is borrowing the Fund's money for a short time, using the securities as collateral. REVERSE REPURCHASE AGREEMENTS: Contract whereby the Fund sells a security and agrees to repurchase it from the buyer on a particular date and at a specific price. Considered a form of borrowing. SHAREHOLDER SERVICE FEE: A fee to cover the cost of paying shareholder servicing agents to provide certain support services for your account. TAX EXEMPT MUNICIPAL SECURITIES: Securities, generally issued as general obligation and revenue bonds, whose interest is exempt from federal taxation and state and/or local taxes in the state where the securities were issued. U.S. GOVERNMENT SECURITIES: Debt instruments (Treasury bills, notes, and bonds) guaranteed by the U.S. government for the timely payment of principal and interest. VARIABLE RATE SECURITIES: Securities whose interest rates are periodically adjusted. 22 FINANCIAL HIGHLIGHTS The financial highlights tables are intended to help you understand each Fund's financial performance for the past one through five fiscal years or periods, as applicable. Certain information reflects financial results for a single Fund share. Because the Capital Class Shares had not commenced operations as of the end of the last fiscal year, the financial highlights included here are the financial highlights with respect to the Institutional Class Shares, which are not offered in this prospectus. The total returns in the tables represent the rate that an investor would have earned (or lost) on an investment in a Fund (assuming reinvestment of all dividends and distributions). This information has been audited by PricewaterhouseCoopers LLP, whose reports, along with each Fund's financial statements, are included in the Fund's annual report, which is available upon request. 23 JPMORGAN PRIME MONEY MARKET FUND
YEAR YEAR 9/10/01** ENDED ENDED THROUGH PER SHARE OPERATING PERFORMANCE: 8/31/04 8/31/03 8/31/02 ------------------------------------------------------------------------------------------------------------------------------ Net Asset Value, Beginning of Period $ $ 1.00 $ 1.00 ------------------------------------------------------------------------------------------------------------------------------ Income from Investment Operations: Net Investment Income 0.01 0.02 Less Dividends from Net Investment Income 0.01 0.02 ------- -------- --------- Net Asset Value, End of Period $ $ 1.00 $ 1.00 ------------------------------------------------------------------------------------------------------------------------------ TOTAL RETURN(1)(b) % 1.27% 2.02% ============================================================================================================================== RATIOS/SUPPLEMENTAL DATA: Net Assets, End of Period (millions) $ $ 25,075 $ 21,881 ------------------------------------------------------------------------------------------------------------------------------ RATIOS TO AVERAGE NET ASSETS:# Net Expenses % 0.20% 0.19% ------------------------------------------------------------------------------------------------------------------------------ Net Investment Income % 1.24% 2.06% ------------------------------------------------------------------------------------------------------------------------------ Expenses Without Waivers, Reimbursements and Earnings Credits % 0.31% 0.32% ------------------------------------------------------------------------------------------------------------------------------ Net Investment Income Without Waivers, Reimbursements and Earnings Credits % 1.13% 1.93% ------------------------------------------------------------------------------------------------------------------------------
** Commencement of offering of class of shares. (1) Total Return figures do not include the effect of any front-end or deferred sales load. (b) Not annualized for periods less than one year. # Short periods have been annualized. 24 JPMORGAN 100% U.S. TREASURY SECURITIES MONEY MARKET FUND
YEAR YEAR 9/10/01 ENDED ENDED THROUGH PER SHARE OPERATING PERFORMANCE: 8/31/04 8/31/03 8/31/02 ------------------------------------------------------------------------------------------------------------------------------ Net Asset Value, Beginning of Period $ $ 1.00 $ 1.00 ------------------------------------------------------------------------------------------------------------------------------ Income from Investment Operations: Net Investment Income 0.01 0.02 Less Dividends from Net Investment Income 0.01 0.02 ------- -------- --------- Net Asset Value, End of Period $ $ 1.00 $ 1.00 ------------------------------------------------------------------------------------------------------------------------------ TOTAL RETURN(b) % 1.14% 1.85% ============================================================================================================================== RATIOS/SUPPLEMENTAL DATA: Net Assets, End of Period (millions) $ $ 1,126 $ 267 ------------------------------------------------------------------------------------------------------------------------------ RATIOS TO AVERAGE NET ASSETS:# Net Expenses % 0.20% 0.20% ------------------------------------------------------------------------------------------------------------------------------ Net Investment Income % 1.08% 1.67% ------------------------------------------------------------------------------------------------------------------------------ Expenses Without Waivers, Reimbursements and Earnings Credits % 0.32% 0.33% ------------------------------------------------------------------------------------------------------------------------------ Net Investment Income Without Waivers, Reimbursements and Earnings Credits % 0.96% 1.54% ------------------------------------------------------------------------------------------------------------------------------
** Commencement of offering of class of shares. (b) Not annualized for periods less than one year. # Short periods have been annualized. 25 LEGAL PROCEEDINGS RELATING TO BANC ONE INVESTMENT ADVISORS CORPORATION AND CERTAIN OF ITS AFFILIATES None of the actions described below allege that any unlawful activity took place with respect to any Fund whose shares are offered in this prospectus. On July 1, 2004, Bank One Corporation, the former corporate parent of the One Group Dealer Services, Inc., One Group Administrative Services, Inc. and Banc One Investment Advisors Corporation (BOIA), the investment adviser to the former One Group Funds, merged into JPMorgan Chase. As a consequence of the merger, on that date, the Distributor, the Administrator and BOIA became affiliates of both JPMIM and JPMorgan Chase Bank. One Group Dealer Services, Inc. (OGDS) and One Group Administrative Services, Inc. became the distributor and administrator, respectively, of the JPMorgan Funds effective February 19, 2005. Prior to becoming an affiliate of JPMorgan Chase, on June 29, 2004, BOIA entered into agreements with the Securities and Exchange Commission (SEC) and the New York Attorney General (NYAG) in resolution of investigations conducted by the SEC and the NYAG into market timing of certain mutual funds advised by BOIA, possible late trading of certain of these funds and related matters. In this connection, BOIA or its affiliates agreed to pay disgorgement and a civil money penalty in an aggregate amount of $50 million. The settlement agreement with the NYAG also requires BOIA to reduce its management fee for certain series of One Group Mutual Funds, in an aggregate amount of approximately $8 million annually over the next five years. In addition, BOIA has agreed to undertakings relating to, among other things, governance and compliance initiatives. In addition to the matters involving the SEC and NYAG, various lawsuits have been filed against BOIA, the incumbent trustees of One Group Mutual Funds and various affiliates of BOIA, including OGDS. The lawsuits generally relate to the same facts that were the subject of the SEC order and NYAG settlement discussed above. These actions seek, among other things, compensatory damages, restitution, disgorgement of unjustly earned profits, punitive damages, removal of the incumbent trustees of One Group Mutual Funds, removal of the One Group Mutual Funds' investment advisers (e.g., BOIA) and distributor (i.e., OGDS), rescission of the distribution and service plans adopted under Rule 12b-1 of the Investment Company Act of 1940, and attorneys' fees. 26 HOW TO REACH US MORE INFORMATION For investors who want more information on these Funds the following documents are available free upon request: ANNUAL AND SEMI-ANNUAL REPORTS Our annual and semi-annual reports contain more information about each Fund's investments and performance. The annual report also includes details about the market conditions and investment strategies that had a significant effect on each Fund's performance during the last fiscal year. STATEMENT OF ADDITIONAL INFORMATION (SAI) The SAI contains more detailed information about the Funds and their policies. It is incorporated by reference into this prospectus. This means, by law, it is considered to be part of this prospectus. You can get a free copy of these documents and other information, or ask us any questions, by calling us at 1-800-766-7722 or writing to: JPMORGAN INSTITUTIONAL FUNDS SERVICE CENTER 500 STANTON CHRISTIANA ROAD NEWARK, DE 19713 If you buy your shares through an institution, you should contact that institution directly for more information. You can also find information online at www.jpmorganfunds.com. You can write or e-mail the SEC's Public Reference Room and ask them to mail you information about the Funds, including the SAI. They will charge you a copying fee for this service. You can also visit the Public Reference Room and copy the documents while you are there. PUBLIC REFERENCE ROOM OF THE SEC WASHINGTON, DC 20549-0102 1-202-942-8090 EMAIL: publicinfo@sec.gov Reports, a copy of the SAI and other information about the Funds are also available on the SEC's website at http://www.sec.gov. Investment Company Act File No. 811-8358 (C)JPMorgan Chase & Co. All Rights Reserved. February 2005. ##### PROSPECTUS FEBRUARY 19, 2005 JPMORGAN MONEY MARKET FUNDS RESERVE CLASS SHARES FEDERAL MONEY MARKET FUND 100% U.S. TREASURY SECURITIES MONEY MARKET FUND TAX FREE MONEY MARKET FUND THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. [JPMORGAN FLEMING ASSET MANAGEMENT LOGO] CONTENTS Federal Money Market Fund 1 100% U.S. Treasury Securities Money Market Fund 6 Tax Free Money Market Fund 11 The Funds' Management and Administration 17 How Your Account Works 20 Buying Fund Shares 20 Selling Fund Shares 23 Exchanging Fund Shares 24 Distribution Arrangements Other Information Concerning the Funds 25 Shareholder Information 26 Distributions and Taxes 26 Availability of Proxy Voting Record 26 Portfolio Holdings Disclosure 27 What the Terms Mean 28 Financial Highlights 29 Legal Proceedings Relating to Banc One Investment Advisors Corporation and Certain of its Affiliates 33 How To Reach Us Back cover
JPMORGAN FEDERAL MONEY MARKET FUND THE FUND'S OBJECTIVE The Fund aims to provide current income while still preserving capital and maintaining liquidity. THE FUND'S MAIN INVESTMENT STRATEGY Under normal circumstances, the Fund invests its assets exclusively in: - obligations of the U.S. Treasury, including Treasury bills, bonds and notes and - debt securities that certain U.S. government agencies or instrumentalities have either issued or guaranteed as to principal and interest. The interest on these securities is generally exempt from state and local income taxes. The dollar weighted average maturity of the Fund will be 60 days or less and the Fund will buy only those instruments that have remaining maturities of 397 days or less. All securities purchased by the Fund must meet the requirements of Rule 2a-7 under the Investment Company Act of 1940. The Fund may invest significantly in securities with floating or variable rates of interest. Their yields will vary as interest rates change. The Fund invests only in U.S. dollar denominated securities that have the highest possible short-term rating from at least two nationally recognized statistical rating organizations, or one such rating if only one organization rates that security. Alternatively, some securities may have additional third-party guarantees in order to meet the rating requirements mentioned above. If the security is not rated, it must be considered of comparable quality by the Fund's adviser. The Fund's adviser, JPMIM, seeks to develop an appropriate portfolio by considering the differences in yields among securities of different maturities, market sectors and issuers. The Fund seeks to maintain a net asset value of $1.00 per share. The Fund's Board of Trustees may change any of these investment policies (including its investment objective) without shareholder approval. The Fund is diversified as defined in the Investment Company Act of 1940. BEFORE YOU INVEST INVESTORS CONSIDERING THE FUND SHOULD UNDERSTAND THAT: - THERE IS NO ASSURANCE THAT THE FUND WILL MEET ITS INVESTMENT OBJECTIVE. - THE FUND DOES NOT REPRESENT A COMPLETE INVESTMENT PROGRAM. INVESTMENTS IN THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK AND ARE NOT INSURED BY OR GUARANTEED THE FDIC, THE FEDERAL RESERVE BOARD OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH THE FUND SEEKS TO PRESERVE THE VALUE OF YOUR INVESTMENT AT $1.00 PER SHARE, IT IS POSSIBLE TO LOSE MONEY BY INVESTING IN THE FUND. THE FUND'S MAIN INVESTMENT RISKS All mutual funds carry a certain amount of risk. You may lose money on your investment in the Fund. Here are some specific risks of investing in the Fund. The Fund may not achieve its objective if the adviser's expectations regarding 1 particular securities or interest rates are not met. The value of money market investments tends to fall when prevailing interest rates rise, although they are generally less sensitive to interest rate changes than longer-term securities. Indebtedness of certain issuers identified with the U.S. government whose securities may be held by the Fund, including the well-known Fannie Mae and Freddie Mac, is not entitled to the full faith and credit of the United States and is thus subject to the risk of default in the payment of interest and/or principal like the indebtedness of private issuers. Although the Fund seeks to be fully invested, it may at times hold some of its assets in cash. This could hurt the Fund's performance. Securities in the Fund's portfolio may not earn as high a current income as longer-term or lower-quality securities. If the Fund departs from its investment policies during temporary defensive periods or to meet redemptions, it may not achieve its investment objective. WHO MAY WANT TO INVEST THE FUND IS DESIGNED FOR INVESTORS WHO: - WANT AN INVESTMENT THAT STRIVES TO PRESERVE CAPITAL - WANT REGULAR INCOME FROM A HIGH QUALITY PORTFOLIO - WANT A HIGHLY LIQUID INVESTMENT - ARE LOOKING FOR AN INTERIM INVESTMENT - ARE PURSUING A SHORT-TERM GOAL THE FUND IS NOT DESIGNED FOR INVESTORS WHO: - ARE INVESTING FOR LONG-TERM GROWTH - ARE INVESTING FOR HIGH INCOME - REQUIRE THE ADDED SECURITY OF FDIC INSURANCE 2 THE FUND'S PAST PERFORMANCE This section shows the Fund's performance record with respect to the Fund's Morgan Shares.* The bar chart shows how the performance of the Fund's Morgan Shares has varied from year to year over the past ten calendar years. This provides some indication of the risks of investing in the Fund. The table shows the average annual total returns for the past one year, five years and the life of the Fund. To obtain current yield information call 1-800-480-4111. Past performance is not necessarily an indication of how any class of the Fund will perform in the future. The calculations assume that all dividends and distributions are reinvested in the Fund. Some of the companies that provide services to the Fund have in the past agreed not to collect some expenses and to reimburse others. Without these agreements, the performance figures would have been lower than those shown. [CHART] YEAR-BY-YEAR RETURNS*,(1) 1995 5.31% 1996 4.81% 1997 4.98% 1998 4.87% 1999 4.52% 2000 5.68% 2001 3.56% 2002 1.14% 2003 0.48% 2004 ____%
BEST QUARTER 4th quarter, 2000 1.47% WORST QUARTER 3rd quarter, 2003 0.09% 4th quarter, 2003
AVERAGE ANNUAL TOTAL RETURNS (%) SHOWS PERFORMANCE OVER TIME, FOR PERIODS ENDED DECEMBER 31, 2004*,(1)
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS ------------------------------------------------------------------------------------------------------------------- MORGAN SHARES [ ] [ ] [ ]
* THE PERFORMANCE FOR THE PERIOD BEFORE RESERVE SHARES WERE LAUNCHED ON 2/18/05 IS BASED ON THE PERFORMANCE OF THE MORGAN SHARES OF THE FUND, WHICH INVEST IN THE SAME PORTFOLIO OF SECURITIES, BUT WHOSE SHARES ARE NOT BEING OFFERED IN THIS PROSPECTUS. DURING THIS PERIOD, THE ACTUAL RETURNS OF RESERVE SHARES WOULD HAVE BEEN LOWER THAN SHOWN BECAUSE RESERVE SHARES HAVE HIGHER EXPENSES THAN THE MORGAN SHARES. (1) THE FUND'S FISCAL YEAR END IS 8/31. 3 ESTIMATED INVESTOR EXPENSES FOR RESERVE CLASS SHARES The estimated expenses of the Reserve Class Shares before and after reimbursement are shown below. The table below does not reflect charges or credits which you might incur if you invest through a financial intermediary or service organization. ESTIMATED ANNUAL OPERATING EXPENSES (%) (EXPENSES THAT ARE DEDUCTED FROM RESERVE CLASS SHARES ASSETS) MANAGEMENT FEES 0.08 DISTRIBUTION (RULE 12b-1) FEES 0.25 SHAREHOLDER SERVICE FEES 0.30 OTHER EXPENSES(1) -- TOTAL ANNUAL OPERATING EXPENSES -- FEE WAIVER AND EXPENSE REIMBURSEMENTS(2) -- NET EXPENSES(2) 0.70
(1) "OTHER EXPENSES" ARE BASED ON ACTUAL EXPENSES FOR THE CURRENT FISCAL YEAR. (2) REFLECTS A WRITTEN AGREEMENT PURSUANT TO WHICH JPMIM, THE ADMINISTRATOR AND THE DISTRIBUTOR AGREE THAT THEY WILL WAIVE FEES OR REIMBURSE THE FUND TO THE EXTENT TOTAL ANNUAL OPERATING EXPENSES OF THE RESERVE CLASS SHARES (EXCLUDING INTEREST, TAXES AND EXTRAORDINARY EXPENSES AND EXPENSES RELATED TO THE DEFERRED COMPENSATION PLAN) EXCEED 0.70% OF ITS AVERAGE DAILY NET ASSETS FROM 2/19/05 THROUGH 12/31/06. IN ADDITION, THE FUND'S SERVICE PROVIDERS MAY VOLUNTARILY WAIVE OR REIMBURSE CERTAIN OF THEIR FEES, AS THEY MAY DETERMINE, FROM TIME TO TIME. 4 EXAMPLE The example below is intended to help you compare the cost of investing in the Reserve Class Shares with the cost of investing in other mutual funds. The example assumes: - $10,000 initial investment, - 5% return each year, and - net expenses through 12/31/06 and total annual operating expenses thereafter. This example is for comparison only; the actual returns of the Reserve Class Shares and your actual costs may be higher or lower.
1 YEAR 3 YEARS ------------------------------------------------------------------------------ YOUR COST ($) (WITH OR WITHOUT REDEMPTION) -- --
5 JPMORGAN 100% U.S. TREASURY SECURITIES MONEY MARKET FUND THE FUND'S OBJECTIVE The Fund aims to provide the highest possible level of current income while still maintaining liquidity and providing maximum safety of principal. THE FUND'S MAIN INVESTMENT STRATEGY The Fund invests its assets exclusively in obligations of the U.S. Treasury, including Treasury bills, bonds and notes. These investments carry different interest rates, maturities and issue dates. The Fund does not buy securities issued or guaranteed by agencies of the U.S. government. The dollar weighted average maturity of the Fund will be 90 days or less and the Fund will buy only those investments that have remaining maturities of 397 days or less. All securities purchased by the Fund must meet the requirements of Rule 2a-7 under the Investment Company Act of 1940. The Fund's adviser, JPMIM, seeks to develop an appropriate portfolio by considering the differences in yields among securities of different maturities. The Fund seeks to maintain a net asset value of $1.00 per share. The Fund's Board of Trustees may change any of these investment policies (including its investment objective) without shareholder approval. The Fund is diversified as defined in the Investment Company Act of 1940. BEFORE YOU INVEST INVESTORS CONSIDERING THE FUND SHOULD UNDERSTAND THAT: - THERE IS NO ASSURANCE THAT THE FUND WILL MEET ITS INVESTMENT OBJECTIVE. - THE FUND DOES NOT REPRESENT A COMPLETE INVESTMENT PROGRAM. INVESTMENTS IN THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK AND ARE NOT INSURED OR GUARANTEED BY THE FDIC, THE FEDERAL RESERVE BOARD OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH THE FUND SEEKS TO PRESERVE THE VALUE OF YOUR INVESTMENT AT $1.00 PER SHARE, IT IS POSSIBLE TO LOSE MONEY BY INVESTING IN THE FUND. THE FUND'S MAIN INVESTMENT RISKS All mutual funds carry a certain amount of risk. You may lose money on your investment in the Fund. Here are some specific risks of investing in the Fund. The Fund may not achieve its objective if the adviser's expectations regarding particular securities or interest rates are not met. The value of money market investments tends to fall when prevailing interest rates rise, although they are generally less sensitive to interest rate changes than longer-term securities. Although the Fund seeks to be fully invested, it may at times hold some of its assets in cash. This could hurt the Fund's performance. Securities in the Fund's portfolio may not earn as high a current income as longer-term or lower-quality securities. 6 If the Fund departs from its investment policies during temporary defensive periods or to meet redemptions, it may not achieve its investment objective. WHO MAY WANT TO INVEST THE FUND IS DESIGNED FOR INVESTORS WHO: - WANT AN INVESTMENT THAT STRIVES TO PRESERVE CAPITAL - WANT REGULAR INCOME FROM A HIGH-QUALITY PORTFOLIO - WANT A HIGHLY LIQUID INVESTMENT - ARE LOOKING FOR AN INTERIM INVESTMENT - ARE PURSUING A SHORT-TERM GOAL THE FUND IS NOT DESIGNED FOR INVESTORS WHO: - ARE INVESTING FOR LONG-TERM GROWTH - ARE INVESTING FOR HIGH INCOME - REQUIRE THE ADDED SECURITY OF FDIC INSURANCE 7 THE FUND'S PAST PERFORMANCE This section shows the Fund's performance record with respect to the Fund's Morgan Shares.* The bar chart shows how the performance of the Fund's Morgan Shares has varied from year to year over the past ten calendar years. This provides some indication of the risks of investing in the Fund. The table shows the average annual total returns for the past one year, five years and ten years. To obtain current yield information call 1-800-480-4111. Past performance is not necessarily an indication of how any class of the Fund will perform in the future. The calculations assume that all dividends and distributions are reinvested in the Fund. Some of the companies that provide services to the Fund have in the past agreed not to collect some expenses and to reimburse others. Without these agreements, the performance figures would have been lower than those shown. [CHART] YEAR-BY-YEAR RETURNS*,(1) 1995 5.17% 1996 4.73% 1997 4.91% 1998 4.84% 1999 4.26% 2000 5.49% 2001 3.47% 2002 1.18% 2003 0.54% 2004 ____%
BEST QUARTER 4th quarter, 2000 1.46% WORST QUARTER 4th quarter, 2003 0.10%
AVERAGE ANNUAL TOTAL RETURNS (%) SHOWS PERFORMANCE OVER TIME, FOR PERIODS ENDED DECEMBER 31, 2004*,(1)
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS ------------------------------------------------------------------------------------------------------------------- MORGAN SHARES [ ] [ ] [ ]
* THE PERFORMANCE FOR THE PERIOD BEFORE RESERVE SHARES WERE LAUNCHED ON 2/18/05 IS BASED ON THE PERFORMANCE OF THE MORGAN SHARES OF THE FUND, WHICH INVEST IN THE SAME PORTFOLIO OF SECURITIES, BUT WHOSE SHARES ARE NOT BEING OFFERED IN THIS PROSPECTUS. DURING THIS PERIOD, THE ACTUAL RETURNS OF RESERVE SHARES WOULD HAVE BEEN LOWER THAN SHOWN BECAUSE RESERVE SHARES HAVE HIGHER EXPENSES THAN THE MORGAN SHARES. THE PERFORMANCE FOR THE PERIOD BEFORE MORGAN SHARES WERE LAUNCHED ON 5/3/96 IS BASED ON THE PERFORMANCE OF THE FUND'S PREDECESSOR, THE HANOVER 100% TREASURY SECURITIES MONEY MARKET FUND. (1) THE FUND'S FISCAL YEAR END IS 8/31. 8 ESTIMATED INVESTOR EXPENSES FOR RESERVE CLASS SHARES The estimated expenses of the Reserve Class Shares before and after reimbursement are shown below. The table below does not reflect charges or credits which you might incur if you invest through a financial intermediary or service organization. ESTIMATED ANNUAL OPERATING EXPENSES (%) (EXPENSES THAT ARE DEDUCTED FROM RESERVE CLASS SHARES ASSETS) MANAGEMENT FEES 0.08 DISTRIBUTION (RULE 12b-1) FEES 0.25 SHAREHOLDER SERVICE FEES 0.30 OTHER EXPENSES(1) -- TOTAL ANNUAL OPERATING EXPENSES -- FEE WAIVERS AND EXPENSE REIMBURSEMENTS(2) -- NET EXPENSES(2) 0.68
(1) "OTHER EXPENSES" ARE BASED ON ACTUAL EXPENSES FOR THE CURRENT FISCAL YEAR. (2) REFLECTS A WRITTEN AGREEMENT PURSUANT TO WHICH JPMIM, THE ADMINISTRATOR AND THE DISTRIBUTOR AGREE THAT THEY WILL WAIVE FEES OR REIMBURSE THE FUND TO THE EXTENT TOTAL ANNUAL OPERATING EXPENSES OF THE RESERVE CLASS SHARES (EXCLUDING INTEREST, TAXES AND EXTRAORDINARY EXPENSES AND EXPENSES RELATED TO THE DEFERRED COMPENSATION PLAN) EXCEED 0.68% OF ITS AVERAGE DAILY NET ASSETS FROM 2/19/05 THROUGH 2/19/06. IN ADDITION, THE FUND'S SERVICE PROVIDERS MAY VOLUNTARILY WAIVE OR REIMBURSE CERTAIN OF THEIR FEES, AS THEY MAY DETERMINE, FROM TIME TO TIME. 9 EXAMPLE The example below is intended to help you compare the cost of investing in the Reserve Class Shares with the cost of investing in other mutual funds. The example assumes: - $10,000 initial investment, - 5% return each year, and - net expenses through 2/18/06 and total annual operating expenses thereafter. This example is for comparison only; the actual returns of the Reserve Class Shares and your actual costs may be higher or lower.
1 YEAR 3 YEARS -------------------------------------------------------------------------- YOUR COST ($) (WITH OR WITHOUT REDEMPTION) -- --
10 JPMORGAN TAX FREE MONEY MARKET FUND THE FUND'S OBJECTIVE The Fund aims to provide the highest possible level of current income which is excluded from gross income, while still preserving capital and maintaining liquidity. THE FUND'S MAIN INVESTMENT STRATEGY Under normal circumstances, the Fund will try to invest its assets exclusively in municipal obligations, the interest on which is excluded from regular federal income taxes. As a fundamental policy, the Fund will invest at least 80% of the value of its Assets in municipal obligations. "Assets" means net assets, plus the amount of borrowings for investment purposes. The remaining 20% of its Assets may be invested in securities subject to federal income tax or the federal alternative minimum tax for individuals. The Fund may exceed this limit for temporary defensive purposes. The Fund may also invest in municipal lease obligations. These provide participation in municipal lease agreements and installment purchase contracts. The dollar weighted average maturity of the Fund will be 60 days or less and the Fund will buy only those investments that have remaining maturities of 397 days or less. All securities purchased by the Fund must meet the requirements of Rule 2a-7 under the Investment Company Act of 1940. The Fund may invest significantly in securities with floating or variable rates of interest. Their yields will vary as interest rates change. The Fund invests only in U.S. dollar denominated securities that have the highest possible short-term rating from at least two nationally recognized statistical rating organizations, or one such rating if only one organization rates that security. Alternatively, some securities may have additional third-party guarantees in order to meet the rating requirements mentioned above. If the security is not rated, it must be considered of comparable quality by the Fund's adviser. The Fund's adviser, JPMIM, seeks to develop an appropriate portfolio by considering the differences in yields among securities of different maturities, market sectors and issuers. The Fund seeks to maintain a net asset value of $1.00 per share. The Fund's Board of Trustees may change any of its non-fundamental investment policies (including its investment objective) without shareholder approval. The Fund is diversified as defined in the Investment Company Act of 1940. 11 BEFORE YOU INVEST INVESTORS CONSIDERING THE FUND SHOULD UNDERSTAND THAT: - THERE IS NO ASSURANCE THAT THE FUND WILL MEET ITS INVESTMENT OBJECTIVE. - THE FUND DOES NOT REPRESENT A COMPLETE INVESTMENT PROGRAM. INVESTMENTS IN THE FUND ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED BY, ANY BANK AND ARE NOT INSURED OR GUARANTEED BY THE FDIC, THE FEDERAL RESERVE BOARD OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH THE FUND SEEKS TO PRESERVE THE VALUE OF YOUR INVESTMENT AT $1.00 PER SHARE, IT IS POSSIBLE TO LOSE MONEY BY INVESTING IN THE FUND. THE FUND'S MAIN INVESTMENT RISKS All mutual funds carry a certain amount of risk. You may lose money on your investment in the Fund. Here are some specific risks of investing in the Fund. The Fund may not achieve its objective if the adviser's expectations regarding particular securities or interest rates are not met. The Fund attempts to keep its net asset value constant, but there is no guarantee that it will be able to do so. The value of money market investments tends to fall when prevailing interest rates rise, although they are generally less sensitive to interest rate changes than longer-term securities. Changes in a municipality's financial health may make it difficult for the municipality to make interest and principal payments when due. A number of municipalities have had significant financial problems recently. This could decrease the Fund's income or hurt its ability to preserve capital and liquidity. Under some circumstances, municipal obligations might not pay interest unless the state or municipal legislature authorizes money for that purpose. Some securities, including municipal lease obligations, carry additional risks. For example, they may be difficult to trade or interest payments may be tied only to a specific stream of revenue. Since some municipal obligations may be secured or guaranteed by banks and other institutions, the risk to the Fund could increase if the banking or financial sector suffers an economic downturn. The Fund may invest in securities whose interest is subject to federal income tax or the federal alternative minimum tax on individuals. Consult your tax professional for more information. The Fund may invest in municipal obligations backed by foreign institutions. This could carry more risk than securities backed by U.S. institutions because of political and economic instability, the imposition of government controls or regulations that do not match U.S. standards. Although the Fund seeks to be fully invested, it may at times hold some of its assets in cash. This could hurt the Fund's performance. Securities in the Fund's portfolio may not earn as high a current income as longer-term or lower-quality securities. 12 If the Fund departs from its investment policies during temporary defensive periods or to meet redemptions, it may not achieve its investment objective. WHO MAY WANT TO INVEST THE FUND IS DESIGNED FOR INVESTORS WHO: - WANT AN INVESTMENT THAT STRIVES TO PRESERVE CAPITAL - WANT REGULAR INCOME FROM A HIGH QUALITY PORTFOLIO - WANT A HIGHLY LIQUID INVESTMENT - ARE LOOKING FOR AN INTERIM INVESTMENT - ARE PURSUING A SHORT-TERM GOAL THE FUND IS NOT DESIGNED FOR INVESTORS WHO: - ARE INVESTING FOR LONG-TERM GROWTH - ARE INVESTING FOR HIGH INCOME - REQUIRE THE ADDED SECURITY OF FDIC INSURANCE - ARE INVESTING THROUGH A TAX-DEFERRED ACCOUNT, SUCH AS AN IRA 13 THE FUND'S PAST PERFORMANCE This section shows the Fund's performance record with respect to the Fund's Morgan Shares.* The bar chart shows how the performance of the Fund's Morgan Shares has varied from year to year over the past ten calendar years. This provides some indication of the risks of investing in the Fund. The table shows the average annual total returns for the past one year, five years and ten years. To obtain current yield information call 1-800-480-4111. Past performance is not necessarily an indication of how any class of the Fund will perform in the future. The calculations assume that all dividends and distributions are reinvested in the Fund. Some of the companies that provide services to the Fund have in the past agreed not to collect some expenses and to reimburse others. Without these agreements, the performance figures would have been lower than those shown. [CHART] YEAR-BY-YEAR RETURNS*,(1) 1995 3.13% 1996 2.91% 1997 3.16% 1998 2.99% 1999 2.77% 2000 3.65% 2001 2.38% 2002 0.99% 2003 0.53% 2004 ____%
BEST QUARTER 4th quarter, 2000 0.96% WORST QUARTER 3rd quarter, 2003 0.09%
AVERAGE ANNUAL TOTAL RETURNS (%) SHOWS PERFORMANCE OVER TIME, FOR PERIODS ENDED DECEMBER 31, 2004*,(1)
PAST 1 YEAR PAST 5 YEARS PAST 10 YEARS ------------------------------------------------------------------------------------------------------------------- MORGAN SHARES [ ] [ ] [ ]
* THE PERFORMANCE FOR THE PERIOD BEFORE RESERVE SHARES WERE LAUNCHED ON 2/18/05 IS BASED ON THE PERFORMANCE OF THE MORGAN SHARES OF THE FUND, WHICH INVEST IN THE SAME PORTFOLIO OF SECURITIES, BUT WHOSE SHARES ARE NOT BEING OFFERED IN THIS PROSPECTUS. DURING THIS PERIOD, THE ACTUAL RETURNS OF RESERVE SHARES WOULD HAVE BEEN LOWER THAN SHOWN BECAUSE RESERVE SHARES HAVE HIGHER EXPENSES THAN THE MORGAN SHARES. (1) THE FUND'S FISCAL YEAR END IS 8/31. 14 ESTIMATED INVESTOR EXPENSES FOR RESERVE CLASS SHARES The estimated expenses of the Reserve Class Shares before and after reimbursement are shown below. The table below does not reflect charges or credits which you might incur if you invest through a financial intermediary or service organization. ESTIMATED ANNUAL OPERATING EXPENSES (%) (EXPENSES THAT ARE DEDUCTED FROM RESERVE CLASS SHARES ASSETS) MANAGEMENT FEES 0.08 DISTRIBUTION (RULE 12b-1) FEES 0.25 SHAREHOLDER SERVICE FEES 0.30 OTHER EXPENSES(1) -- TOTAL ANNUAL OPERATING EXPENSES -- FEE WAIVERS AND EXPENSE REIMBURSEMENTS(2) -- NET EXPENSES(2) 0.70
(1) "OTHER EXPENSES" ARE BASED ON ACTUAL EXPENSES FOR THE CURRENT FISCAL YEAR. (2) REFLECTS A WRITTEN AGREEMENT PURSUANT TO WHICH JPMIM, THE ADMINISTRATOR AND THE DISTRIBUTOR AGREE THAT THEY WILL WAIVE FEES OR REIMBURSE THE FUND TO THE EXTENT TOTAL ANNUAL OPERATING EXPENSES OF THE RESERVE CLASS SHARES (EXCLUDING INTEREST, TAXES AND EXTRAORDINARY EXPENSES AND EXPENSES RELATED TO THE DEFERRED COMPENSATION PLAN) EXCEED 0.70% OF ITS AVERAGE DAILY NET ASSETS FROM 2/19/05 THROUGH 12/31/06. IN ADDITION, THE FUND'S SERVICE PROVIDERS MAY VOLUNTARILY WAIVE OR REIMBURSE CERTAIN OF THEIR FEES, AS THEY MAY DETERMINE, FROM TIME TO TIME. 15 EXAMPLE The example below is intended to help you compare the cost of investing in the Reserve Class Shares with the cost of investing in other mutual funds. The example assumes: - $10,000 initial investment, - 5% return each year, and - net expenses through 12/31/06 and total annual operating expenses thereafter. This example is for comparison only; the actual returns of the Reserve Class Shares and your actual costs may be higher or lower.
1 YEAR 3 YEARS -------------------------------------------------------------------------- YOUR COST ($) (WITH OR WITHOUT REDEMPTION) -- --
16 THE FUNDS' MANAGEMENT AND ADMINISTRATION The Funds are series of J.P. Morgan Mutual Fund Series, a Massachusetts business trust. The trust is governed by trustees who are responsible for overseeing all business activities of the Funds. Each of the Funds operates in a multiple class structure. A multiple class fund is an open-end investment company that issues two or more classes of shares representing interests in the same investment portfolio. Each class in a multiple class fund can set its own transaction minimums and may vary with respect to expenses for distribution, administration and shareholder services. This means that one class could offer access to a Fund on different terms, and thus would experience different performance, than another class. Certain classes may be more appropriate for a particular investor. Each Fund may also issue other classes of shares that have different expense levels and performance and different requirements for who may invest. Call 1-800-480-4111 to obtain more information concerning the Funds' other share classes. A financial intermediary who receives compensation for selling Fund shares may receive a different amount of compensation for sales of different classes of shares. THE FUNDS' INVESTMENT ADVISER JPMIM is the investment adviser to the Funds and makes the day-to-day investment decisions for the Funds. JPMIM is located at 522 Fifth Avenue, New York, NY 10036. JPMIM is a wholly-owned subsidiary of J.P. Morgan Fleming Asset Management Holdings, Inc., which is a wholly-owned subsidary of JPMorgan Chase & Co. (JPMorgan Chase), a bank holding company. Pursuant to the Advisory Agreement, each Fund pays the adviser a management fee of 0.08% of average daily net assets. FUND MANAGER COMPENSATION Portfolio managers and research analysts participate in a highly competitive compensation program that is designed to attract and retain outstanding people and closely link the performance of investment professionals to client investment objectives. The total compensation program includes base salary, cash incentives, the value of stock awards, and, in some cases, mandatory deferred compensation. These elements reflect individual performance and the performance of the business as a whole. Each investment professional's performance is formally evaluated annually based on a variety of factors including the size and performance of the portfolios such professional manages. Individual contribution relative to client goals carries the highest impact. For example: - Portfolio manager compensation is primarily driven by meeting or exceeding clients' risk and return objectives, relative performance to competitors or competitive indices, and compliance with firm policies and regulatory requirements. Investment performance is generally more heavily weighted to the long-term. - Research analyst compensation is primarily driven by the accuracy of their forecasts and rankings with respect to the companies and/or sectors for which they have research responsibility. Stock awards are granted as part of an employee's annual performance bonus 17 and comprise from 0% to 35% of an investment professional's total award. As incentive compensation increases, the percentage of compensation awarded in restricted stock, stock appreciation awards, or stock options also increases. Certain investment professionals may also be subject to a mandatory deferral of a portion of their compensation into proprietary mutual funds based on long-term sustained investment performance. Portfolio managers are encouraged to own shares of the JPMorgan Funds they help manage. THE FUNDS' ADMINISTRATOR One Group Administrative Services, Inc. (the Administrator) provides administrative services and oversees each Fund's other service providers. The Administrator receives a pro-rata portion of the following annual fee on behalf of each Fund for administrative services: 0.10% of the first $100 billion of average daily net assets of all money market funds in the JPMorgan Fund Complex and 0.05% of average daily net assets over $100 billion. THE FUNDS' SHAREHOLDER SERVICING AGENT The Trust, on behalf of the Funds, has entered into a shareholder servicing agreement with One Group Dealer Services, Inc. (OGDS) under which OGDS has agreed to provide certain support services to the Funds' customers. For performing these services, OGDS, as shareholder servicing agent, may receive an annual fee of 0.30% of the average daily net assets of Reserve Class Shares of the Fund held by investors serviced by the shareholder servicing agent. OGDS may enter into services contracts with certain entities under which it will pay all or a portion of the 0.30% annual fee to such entities for performing shareholder and administrative services. THE FUNDS' DISTRIBUTOR OGDS (the Distributor) is the distributor for the Funds. The Distributor is an affiliate of JPMIM and the Administrator. ADDITIONAL COMPENSATION TO FINANCIAL INTERMEDIARIES JPMIM, OGDS and, from time to time, other affiliates of JPMorgan Chase may, at their own expense and out of their own legitimate profits, provide additional cash payments to Financial Intermediaries who sell shares of the JPMorgan Funds. For this purpose, Financial Intermediaries include financial advisors, investment advisers, brokers, financial planners, banks, insurance companies, retirement or 401(k) plan administrators and others, including various affiliates of JPMorgan Chase. These additional cash payments are payments over and above the sales charges, Rule 12b-1 fees and shareholder servicing fees which are disclosed elsewhere in this prospectus. These additional cash payments are generally made to Financial Intermediaries that provide shareholder or administrative services or marketing support. Marketing support may include access to sales meetings, sales representatives and Financial Intermediary management representatives, inclusion of the JPMorgan Funds on a sales list, including a preferred or select sales list, or other sales programs. These additional cash payments also may be made as an expense reimbursement in cases where the Financial Intermediary provides shareholder services to JPMorgan Fund shareholders. JPMIM and OGDS may also pay cash compensation in the form of finders' fees that vary depending on the JPMorgan Fund and the dollar amount of shares sold. In 18 addition, OGDS may, on occasion, pay Financial Intermediaries the entire front-end sales charge applicable to the JPMorgan Fund shares sold by the Financial Intermediary or an additional commission on the sale of JPMorgan Fund shares subject to a CDSC. All of the Funds have adopted Rule 12b-1 distribution plans under which they pay up to 0.25% of the average daily net assets attributed to Reserve Shares. These payments cover such things as compensation for services provided by broker-dealers and expenses connected to the sale of shares. Payments are not tied to the amount of actual expenses incurred. Because Rule 12b-1 expenses are paid out of a Fund's assets on an ongoing basis, over time these fees will increase the cost of your investment and may cost you more than other types of sales charges. 19 HOW YOUR ACCOUNT WORKS BUYING FUND SHARES You do not pay any sales charge (sometimes called a load) when you buy Reserve Shares of these Funds. Certain dealers and shareholder servicing agents may receive payments from OGDS or an affiliate. These payments are made at their own expense. The price you pay for your shares is the net asset value (NAV) per share of the class. NAV is the value of everything a class of a Fund owns, minus everything the class owes, divided by the number of shares held by investors. The Funds seek to maintain a stable NAV per share of $1.00. Each Fund uses the amortized cost method to value its portfolio of securities. This method provides more stability in valuations. However, it may also result in periods during which the stated value of a security is different than the price the Fund would receive if it sold the investment. The NAV of each class of shares is generally calculated as of the cut-off time each day the Funds are accepting orders. You will pay the next NAV per share calculated after the JPMorgan Funds Service Center accepts your order. Reserve Class Shares may be purchased by the general public. However, Reserve Class Shares are intended primarily for investors purchasing shares through a Financial Intermediary or service organization that is paid to assist investors in establishing accounts, executing transactions and monitoring their investment. You may purchase Fund shares through your investment representative (Financial Intermediary) or a service organization. Financial Intermediaries may include financial advisors, investment advisers, brokers, financial planners, banks, insurance companies, retirement or 401(k) plan sponsors or other intermediaries, including affiliates of JPMorgan Chase. Shares purchased this way will typically be held for you by the Financial Intermediary or service organization. You may also purchase shares directly from the JPMorgan Funds Service Center. Shares are available on any business day that the Funds are open for business. The Funds will be closed on weekends and days on which the Federal Reserve Bank of New York (Federal Reserve) or the New York Stock Exchange (NYSE) is closed, including the following holidays: New Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Columbus Day, Veterans Day, Thanks giving Day and Christmas Day. On occasion, the NYSE closes before 4:00 p.m. Eastern Time (ET). When the NYSE closes before a Fund's cut-off time, purchase requests received by the Fund or an authorized agent of the Fund after the NYSE closes will be effective the following business day. Each Fund, however, may elect to remain open following an early close of the NYSE or to open on days when the Federal Reserve is open and the NYSE is closed. If your purchase request is received by the Fund or an authorized agent of the Fund before the Fund's close on a day when the NYSE closes early but the Fund remains open, or on a day when the Fund is open but the NYSE is not, it will be effective the same business day. Purchase requests received after a Fund closes will be effective the following business day. Shareholders will receive notice at www.jpmorganfunds.com if and to what extent a Fund remains open following an early close of the NYSE or if and to what extent a Fund will be 20 open on a day when the Federal Reserve is open and the NYSE is not. The Funds may close earlier a few days each year if the Public Securities Association recommends that the U.S. government securities market close trading early. If the Fund or an authorized agent of the Fund receives your order by the Fund's cut-off time listed below, we will process your purchase order at that day's price and you will be entitled to all dividends declared on that day. If the Fund or an authorized agent of the Fund receives your purchase order after the cut-off time, we will process it at the next day's price. Your Financial Intermediary or service organizations will be responsible for transmitting your purchase order to the Fund or an authorized agent of the Fund by the Fund's cut-off time. Your Financial Intermediary or service organization may have an earlier cut-off time. In addition, your Financial Intermediary or service organization may be closed at times when the Fund is open (for example, when the NYSE is closed and the Fund elects to remain open). Normally, the cut-off time for each Fund is: PRIME MONEY MARKET FUND 5:00 PM ET TREASURY PLUS MONEY MARKET FUND 5:00 PM ET NEW YORK TAX FREE MONEY MARKET FUND NOON ET
The Fund must receive "federal funds" before the Fund's cut-off time shown above (unless the Fund closes early, in which case federal funds must be received by the Fund's close). If the Fund does not receive federal funds by its cut-off time, your order may not be effective until the next business day on which federal funds are timely received by the Fund. If you pay by check before the cut-off time, we will generally process your order the next business day the Fund is open for business. The Funds have the right to refuse any purchase order or to stop offering shares for sale at any time. TO OPEN AN ACCOUNT, BUY OR SELL SHARES OR GET INFORMATION, CALL: JPMORGAN FUNDS SERVICE CENTER 1-800-480-4111 MINIMUM INVESTMENTS Reserve Class shares are subject to a $1,000 minimum investment requirement per Fund. There are no minimum levels for subsequent purchases. Investment minimums may be waived for certain types of retirement accounts (e.g., 401(k), 403(b) and SIMPLE IRA) as well as for certain wrap fee accounts. The Funds reserve the right to waive any investment minimum. For further information on investment minimum waivers, call 1-800-480-4111. GENERAL The JPMorgan money market funds (including the Funds in this prospectus), are intended for short-term investment horizons and do not monitor for market timers or prohibit short-term trading activity. Although these Funds are managed in a manner that is consistent with their investment objectives, frequent trading by shareholders may disrupt their management and increase their expenses. Federal law requires all financial institutions to obtain, verify and record information that identifies each person who opens an account. When you open an account, we will ask for your name, residential or business street address, date of birth (for an individual) and other information that will allow us to 21 identify you, including your social security number, tax identification number or other identifying number. The Funds cannot waive these requirements. The Funds are required by law to reject your Account Application if the required identifying information is not provided. We will attempt to collect any missing information required on the Account Application by contacting either you or your Financial Intermediary. If we cannot obtain this information within the established time frame, your Account Application will be rejected. Amounts received prior to receipt of the required information will be held uninvested and will be returned to you without interest if your Account Application is rejected. If the required information is obtained, your investment will be accepted and you will receive the NAV per share next calculated after all of the required information is received. Once we have received all of the required information, federal law requires us to verify your identity. After an account is opened, we may restrict your ability to purchase additional shares until your identity is verified. If we are unable to verify your identity within a reasonable time, the Funds reserve the right to close your account at the current day's NAV per share. If your account is closed for this reason, your shares will be redeemed at the NAV per share next calculated after the account is closed. Send the completed Account Application and a check to: JPMORGAN FUNDS SERVICE CENTER P.O. BOX 8528 BOSTON, MA 02266-8528 If you choose to pay by wire, please call 1-800-480-4111 to notify the Funds of your purchase and authorize your financial institution to wire funds to: JPMORGAN CHASE BANK, NA ATTN: ______________________ ABA 021 000 021 DDA 323125832 FBO YOUR JPMORGAN FUND (EX: JPMORGAN ABC FUND-RESERVE) YOUR FUND NUMBER & ACCOUNT NUMBER (EX: FUND 123-ACCOUNT 123456789) YOUR ACCOUNT REGISTRATION (EX: JOHN SMITH & MARY SMITH, JTWROS) All checks must be in U.S. dollars. The Funds do not accept credit cards, cash, starter checks, money orders or credit card checks. The Funds reserve the right to refuse "third-party checks" and checks drawn on non-U.S. financial institutions even if payment may be effected through a U.S. financial institution. Checks made payable to any individual or company and endorsed to JPMorgan Funds or a Fund are considered third-party checks. ALL CHECKS MUST BE MADE PAYABLE TO ONE OF THE FOLLOWING: - JPMorgan Funds; or - The specific Fund in which you are investing. You can buy shares in one of two ways: THROUGH YOUR FINANCIAL INTERMEDIARY OR SERVICE ORGANIZATION Tell your Financial Intermediary or service organization which Funds you want to buy and they will contact us. Your Financial Intermediary or service organization may charge you a fee and may offer additional services, such as special purchase and redemption programs, "sweep" programs, cash advances and redemption checks. Some Financial Intermediaries and service organizations charge a single fee that covers all services. 22 The Fund or an authorized agent of the Fund must accept your order from your Financial Intermediary or service organization by the Fund's cut-off time in order for us to process your purchase order at that day's price. Your Financial Intermediary or service organization may impose different minimum investments and earlier cut-off times. Your service organization is paid by the Funds to assist you in establishing your account, executing transactions and monitoring your investment. Service organizations may provide the following services in connection with their customers' investments in the Funds: - Acting directly or through an agent, as the sole shareholder of record - Maintaining account records for customers - Processing orders to purchase, redeem or exchange shares for customers - Responding to inquiries from shareholders - Assisting customers with investment procedures. THROUGH THE JPMORGAN FUNDS SERVICE CENTER Call 1-800-480-4111 Or Complete the application form and mail it along with a check for the amount you want to invest to: JPMORGAN FUNDS SERVICE CENTER P.O. BOX 8528 BOSTON, MA 02266-8528 The JPMorgan Funds Service Center will accept your order when federal funds, a wire, a check or ACH transaction is received together with a completed application or other instructions in proper form. SELLING FUND SHARES You can sell your shares on any day that the JPMorgan Funds Service Center is accepting purchase orders. You will receive the next NAV per share calculated after the JPMorgan Funds Service Center accepts your order. We will need the names of the registered shareholders, your account number and other information before we can sell your shares. Your redemption proceeds will be paid within seven days after receipt of the redemption request. However, the Funds will attempt to honor requests for same-day payment if the request is received by the Fund or an authorized agent of the Fund before the Fund's cut-off time. If redemption requests are received by the Fund or an authorized agent of the Fund after a Fund's cut-off time, the Fund will attempt to wire payment the next business day. The Funds also will attempt to honor requests for payment in two business days, if the redemption request is received by the Fund or an authorized agent of the Fund after a Fund's cut-off time. If you have changed your address or payee of record within the previous 30 days, the Funds will not mail your proceeds, but rather will wire them or send them by ACH, and only to a bank account on record with the Funds. The Funds may hold proceeds for shares purchased by ACH or check until the purchase amount has been collected, which may be as long as five business days. You may also need to have medallion signature guarantees for all registered owners or their legal representatives if: - You want to redeem shares with a value of $50,000 or more and you 23 want to receive your proceeds in the form of a check; or - You want your payment sent to an address, bank account or payee other than the one currently designated on your Fund account. We may also need additional documents or a letter from a surviving joint owner before selling the shares. Contact the JPMorgan Funds Service Center for more details. You may sell your shares in one of two ways: THROUGH YOUR FINANCIAL INTERMEDIARY OR SERVICE ORGANIZATION Tell your Financial Intermediary or service organization which Fund's shares you want to sell. The Fund or an authorized agent of the Fund must accept an order from your Financial Intermediary or service organization by the Fund's cut-off time in order for us to process your order at that day's price. Your Financial Intermediary or service organization will send the necessary documents to the JPMorgan Funds Service Center. Your Financial Intermediary or service organization may charge you for this service. THROUGH THE JPMORGAN FUNDS SERVICE CENTER Call 1-800-480-4111. We will mail you a check or send the proceeds via electronic transfer or wire. Or Send a signed letter with your instructions to: JPMORGAN FUNDS SERVICE CENTER P.O. BOX 8528 BOSTON, MA 02266-8528 REDEMPTIONS-IN-KIND Generally, all redemptions will be for cash. However, if you redeem shares worth $250,000 or more of a Fund's assets, the Fund reserves the right to pay part or all of your redemption proceeds in readily marketable securities instead of cash. If payment is made in securities, the Fund will value the securities selected in the same manner in which it computes its NAV. This process minimizes the effect of large redemptions on the Fund and its remaining shareholders. EXCHANGING FUND SHARES You can exchange your Reserve Shares for shares of the same class in certain other JP Morgan Funds. You may need to meet any minimum investment or eligibility requirement. For tax purposes, an exchange is treated as a sale of Fund shares. Carefully read the prospectus of the Fund you want to buy before making an exchange. Call 1-800-480-4111 for details. We reserve the right to limit the number of exchanges or to refuse an exchange. Your exchange privilege will be revoked if the exchange activity is considered excessive. You can exchange your shares in one of two ways: THROUGH YOUR FINANCIAL INTERMEDIARY OR SERVICE ORGANIZATION Tell your Financial Intermediary or service organization which Funds' shares you want to exchange. They will send the necessary documents to the JPMorgan Funds Service Center. Your Financial Intermediary or service organization may charge you for this service. We reserve the right to limit the number of exchanges or to refuse an exchange. Your exchange privilege will be revoked if the exchange activity is considered excessive. 24 THROUGH THE JPMORGAN FUNDS SERVICE CENTER Call 1-800-480-4111 to ask for details. OTHER INFORMATION CONCERNING THE FUNDS The Funds use reasonable procedures to confirm that instructions given by telephone are genuine. These procedures include recording telephone instructions and asking for personal identification. If these procedures are followed, the Funds will not be responsible for any loss, liability, cost or expense of acting upon unauthorized or fraudulent instructions; you bear the risk of loss. Due to the relatively high cost of maintaining small accounts, if your account value falls below the Fund's minimum investment requirement, the Funds reserve the right to redeem all of the remaining shares in your account and close your account or charge an annual sub-minimum account fee of $10 per Fund. Before either of these actions is taken, you will be given 60 days advance written notice in order to provide you with time to increase your account balance. To collect the $10 sub-minimum account fee, the Funds will redeem $10 worth of shares from your account. You may not always reach the JPMorgan Funds Service Center by telephone. This may be true at times of unusual market changes and shareholder activity. You can mail us your instructions or contact your Financial Intermediary or service organization. We may modify or cancel the sale of shares by telephone without notice. You may write to: JP MORGAN FUNDS SERVICE CENTER P.O. BOX 8528 BOSTON, MA 02266-8528 The Funds may suspend your ability to redeem when: 1. Trading on the NYSE is restricted; 2. The NYSE is closed (other than weekend and holiday closings; 3. The SEC has permitted a suspension; or 4. An emergency exists, as determined by the SEC. The Statement of Additional Information offers more details about this process. 25 SHAREHOLDER INFORMATION DISTRIBUTIONS AND TAXES The Funds can earn income and can realize capital gain. The Funds deduct any expenses and then pay out these earnings to shareholders as distributions. The Funds declare dividends daily, so your shares can start earning dividends on the day you buy them. The Funds distribute the dividends monthly in the form of additional shares, unless you tell us that you want distributions in cash or as a deposit in a pre-assigned bank account. The taxation of dividends will not be affected by the form in which you receive them. The Funds distribute any short-term capital gain at least annually. The Funds do not expect to realize long-term capital gain. Dividends of net investment income will generally be taxable as ordinary income at the federal, state and local levels. Dividends of tax-exempt interest income paid by the New York Tax Free Money Market Fund are not subject to federal income taxes, but will generally be subject to state and local taxes. However, for the New York Tax Free Money Market Fund, New York residents will not have to pay New York State or New York City personal income taxes on tax-exempt income from New York municipal obligations. The state or municipality where you live may not charge you state and local taxes on dividends of tax-exempt interest earned on certain bonds. Dividends of interest earned on bonds issued by the U.S. government and its agencies may also be exempt from some types of state and local taxes. It is unlikely that dividends from any of the Funds will qualify to any significant extent for the reduced 15% tax rate applicable to qualified dividend income. If you receive distributions of net capital gain, the tax rate will be based on how long the Fund held a particular asset, not on how long you have owned your shares. The Funds expect substantially all of their distributions of net capital gain to be attributable to short-term capital gain which is taxed at rates applicable to ordinary income. Early in each calendar year, the Funds will send you a notice showing the amount of distributions you received in the preceding year and the tax status of those distributions. Any investor for whom a Fund does not have a valid Taxpayer Identification Number may be subject to backup withholding. The tax considerations described in this section do not apply to tax-deferred accounts or other non-taxable entities. The above is a general summary of the tax implications of investing in the Funds. Because each investor's tax consequences are unique, please consult your tax advisor to see how investing in the Funds will affect your own tax situation. AVAILABILITY OF PROXY VOTING RECORD The Trustees have delegated the authority to vote proxies for securities owned by the Funds to JPMIM. A copy of each Fund's voting record for the most recent 12-month period ended June 30 is available on the SEC's website at www.sec.gov or at the Funds' at www.jpmorganfunds.com no later than August 31 of each year. Each Fund's proxy voting record will include, among other things, a brief description of the matter voted on for each portfolio security, and will state how each vote was cast, for example, for or against the proposal. 26 PORTFOLIO HOLDINGS DISCLOSURE Each business day, each Fund will make available upon request a complete uncertified schedule of its portfolio holdings as of the prior business day. Not later than 60 days after the end of each fiscal quarter, each Fund will make available a complete, certified schedule of its portfolio holdings as of the last day of that quarter. In addition to providing hard copies upon request, the Funds will post these quarterly schedules on the Funds' website at www.jpmorganfunds.com and on the SEC's website at www.sec.gov. The Fund's top ten holdings as of the last day of each month and each calendar quarter are posted on its website at www.jpmorganfunds.com, 15 days after the end of that month or calendar quarter, respectively. Shareholders may request portfolio holdings schedules at no charge by calling 1-800-480-4111. A description of the Funds' policies and procedures with respect to the disclosure of the Funds' portfolio holdings is available in the Statement of Additional Information. 27 WHAT THE TERMS MEAN ASSET-BACKED SECURITIES: Interests in a stream of payments from specific assets, such as auto or credit card receivables. COMMERCIAL PAPER: Short-term securities with maturities of 1 to 270 days which are issued by banks, corporations and others. DEMAND NOTES: A debt security with no set maturity date. The investor can generally demand payment of the principal at any time. DISTRIBUTION FEE: Covers the cost of the distribution system used to sell shares to the public. DOLLAR WEIGHTED AVERAGE MATURITY: The average maturity of the Fund is the average amount of time until the organizations that issued the debt securities in the Fund's portfolio must pay off the principal amount of the debt. "Dollar weighted" means the larger the dollar value of debt security in the Fund, the more weight it gets in calculating this average. FLOATING RATE SECURITIES: Securities whose interest rates adjust automatically whenever a particular interest rate changes. LIQUIDITY: Liquidity is the ability to easily convert investments into cash without losing a significant amount of money in the process. MANAGEMENT FEE: A fee paid to the investment adviser to manage the Fund and make decisions about buying and selling the Fund's investments. MUNICIPAL LEASE OBLIGATIONS: These provide participation in municipal lease agreements and installment purchase contracts, but are not part of general obligations of the municipality. MUNICIPAL OBLIGATIONS: Debt securities issued by or on behalf of states, territories and possessions or by their agencies or other groups with authority to act for them. For securities to qualify as municipal obligations, the municipality's lawyers must give an opinion that the interest on them is not considered gross income for federal income tax purposes. OTHER EXPENSES: Miscellaneous items, including transfer agency, administration, custody and registration fees. QUALIFIED BANKS: (i) U.S. banks with more than $1 billion in total assets, and foreign branches of these banks; or (ii) foreign banks with the equivalent of more than $1 billion in total assets and which have branches or agencies in the U.S. or (iii) other U.S. or foreign commercial banks which the Fund's adviser judges to have comparable credit standing. REPURCHASE AGREEMENTS: A special type of a short-term investment. A dealer sells securities to a Fund and agrees to buy them back later for a set price. This set price includes interest. In effect, the dealer is borrowing the Fund's money for a short time, using the securities as collateral. REVERSE REPURCHASE AGREEMENTS: Contract whereby the Fund sells a security and agrees to repurchase it from the buyer on a particular date and at a specific price. Considered a form of borrowing. SHAREHOLDER SERVICE FEE: A fee to cover the cost of paying shareholder servicing agents to provide certain support services for your account. TAX EXEMPT MUNICIPAL SECURITIES: Securities, generally issued as general obligation and revenue bonds, whose interest is exempt from federal taxation and state and/or local taxes in the state where the securities were issued. U.S. GOVERNMENT SECURITIES: Debt instruments (Treasury bills, notes, and bonds) guaranteed by the U.S. government for the timely payment of principal and interest. VARIABLE RATE SECURITIES: Securities whose interest rates are periodically adjusted. 28 FINANCIAL HIGHLIGHTS The financial highlights tables are intended to help you understand each Fund's financial performance for the past one through five fiscal years. Certain information reflects financial results for a single Fund share. Because the Reserve Class Shares of the Fund had not commenced operations as of the end of the last fiscal year, the financial highlights included here are the financial highlights with respect to the Morgan Shares, which are not offered in this prospectus. The total returns in the tables represent the rate that an investor would have earned (or lost) on an investment in a Fund (assuming reinvestment of all dividends and distributions). This information has been audited by PricewaterhouseCoopers LLP, whose reports, along with each Fund's financial statements, are included in the Fund's annual report, which is available upon request. 29 JPMORGAN FEDERAL MONEY MARKET FUND^
YEAR YEAR YEAR YEAR YEAR ENDED ENDED ENDED ENDED ENDED PER SHARE OPERATING PERFORMANCE: 8/31/04 8/31/03 8/31/02 8/31/01 8/31/00 -------------------------------------------------------------------------------------------------------------------------------- Net Asset Value, Beginning of Period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 -------------------------------------------------------------------------------------------------------------------------------- Income from Investment Operations: Net Investment Income 0.01 0.01 0.05 0.05 Less Dividends from Net Investment Income 0.01 0.01 0.05 0.05 ------- ------- ------- ------- -------- Net Asset Value, End of Period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 -------------------------------------------------------------------------------------------------------------------------------- TOTAL RETURN % 0.70% 1.51% 4.84% 5.29% ================================================================================================================================ RATIOS/SUPPLEMENTAL DATA: Net Assets, End of Period (millions) $ $ 311 $ 452 $ 658 $ 576 -------------------------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS: Net Expenses % 0.70% 0.70% 0.70% 0.70% -------------------------------------------------------------------------------------------------------------------------------- Net Investment Income % 0.72% 1.53% 4.57% 5.17% -------------------------------------------------------------------------------------------------------------------------------- Expenses Without Waivers, Reimbursements and Earnings Credits % 0.79% 0.72% 0.74% 0.75% -------------------------------------------------------------------------------------------------------------------------------- Net Investment Income Without Waivers, Reimbursements and Earnings Credits % 0.63% 1.51% 4.53% 5.12% --------------------------------------------------------------------------------------------------------------------------------
^ Formerly Vista Shares. 30 JPMORGAN 100% U.S. TREASURY SECURITIES MONEY MARKET FUND^
YEAR YEAR YEAR YEAR YEAR ENDED ENDED ENDED ENDED ENDED PER SHARE OPERATING PERFORMANCE: 8/31/04 8/31/03 8/31/02 8/31/01 8/31/00 -------------------------------------------------------------------------------------------------------------------------------- Net Asset Value, Beginning of Period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 -------------------------------------------------------------------------------------------------------------------------------- Income from Investment Operations: Net Investment Income 0.01 0.02 0.05 0.05 Less Dividends from Net Investment Income 0.01 0.02 0.05 0.05 ------- ------- ------- ------- -------- Net Asset Value, End of Period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 -------------------------------------------------------------------------------------------------------------------------------- TOTAL RETURN % 0.75% 1.55% 4.75% 5.02% -------------------------------------------------------------------------------------------------------------------------------- RATIOS/SUPPLEMENTAL DATA: Net Assets, End of Period (millions) $ $ 2,535 $ 3,526 $ 4,027 $ 3,535 -------------------------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS: Net Expenses % 0.59% 0.59% 0.59% 0.59% -------------------------------------------------------------------------------------------------------------------------------- Net Investment Income % 0.77% 1.53% 4.59% 4.92% -------------------------------------------------------------------------------------------------------------------------------- Expenses Without Waivers, Reimbursements and Earnings Credits % 0.69% 0.69% 0.71% 0.71% -------------------------------------------------------------------------------------------------------------------------------- Net Investment Income Without Waivers, Reimbursements and Earnings Credits % 0.67% 1.43% 4.47% 4.80% --------------------------------------------------------------------------------------------------------------------------------
^ Formerly Vista Shares. 31 JPMORGAN TAX FREE MONEY MARKET FUND^
YEAR YEAR YEAR YEAR YEAR ENDED ENDED ENDED ENDED ENDED PER SHARE OPERATING PERFORMANCE: 8/31/04 8/31/03 8/31/02 8/31/01 8/31/00 -------------------------------------------------------------------------------------------------------------------------------- Net Asset Value, Beginning of Period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 -------------------------------------------------------------------------------------------------------------------------------- Income from Investment Operations: Net Investment Income 0.01 0.01 0.03 0.03 Less Dividends from Net Investment Income 0.01 0.01 0.03 0.03 ------- ------- ------- ------- -------- Net Asset Value, End of Period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 -------------------------------------------------------------------------------------------------------------------------------- TOTAL RETURN % 0.69% 1.21% 3.13% 3.37% -------------------------------------------------------------------------------------------------------------------------------- RATIOS/SUPPLEMENTAL DATA: Net Assets, End of Period (millions) $ $ 655 $ 903 $ 907 $ 895 -------------------------------------------------------------------------------------------------------------------------------- RATIOS TO AVERAGE NET ASSETS: Net Expenses % 0.59% 0.59% 0.59% 0.59% -------------------------------------------------------------------------------------------------------------------------------- Net Investment Income % 0.72% 1.14% 3.09% 3.33% -------------------------------------------------------------------------------------------------------------------------------- Expenses Without Waivers, Reimbursements and Earnings Credits % 0.69% 0.69% 0.72% 0.75% -------------------------------------------------------------------------------------------------------------------------------- Net Investment Income Without Waivers, Reimbursements and Earnings Credits % 0.62% 1.04% 2.96% 3.17% --------------------------------------------------------------------------------------------------------------------------------
^ Formerly Vista Shares. 32 LEGAL PROCEEDINGS RELATING TO BANC ONE INVESTMENT ADVISORS CORPORATION AND CERTAIN OF ITS AFFILIATES None of the actions described below allege that any unlawful activity took place with respect to any Fund whose shares are offered in this prospectus. On July 1, 2004, Bank One Corporation, the former corporate parent of the One Group Dealer Services, Inc., One Group Administrative Services, Inc. and Banc One Investment Advisors Corporation (BOIA), the investment adviser to the former One Group Funds, merged into JPMorgan Chase. As a consequence of the merger, on that date, the Distributor, the Administrator and BOIA became affiliates of both JPMIM and JPMorgan Chase Bank. One Group Dealer Services, Inc. (OGDS) and One Group Administrative Services, Inc. became the distributor and administrator, respectively, of the JPMorgan Funds effective February 19, 2005. Prior to becoming an affiliate of JPMorgan Chase, on June 29, 2004, BOIA entered into agreements with the Securities and Exchange Commission (SEC) and the New York Attorney General (NYAG) in resolution of investigations conducted by the SEC and the NYAG into market timing of certain mutual funds advised by BOIA, possible late trading of certain of these funds and related matters. In this connection, BOIA or its affiliates agreed to pay disgorgement and a civil money penalty in an aggregate amount of $50 million. The settlement agreement with the NYAG also requires BOIA to reduce its management fee for certain series of One Group Mutual Funds, in an aggregate amount of approximately $8 million annually over the next five years. In addition, BOIA has agreed to undertakings relating to, among other things, governance and compliance initiatives. In addition to the matters involving the SEC and NYAG, various lawsuits have been filed against BOIA, the incumbent trustees of One Group Mutual Funds and various affiliates of BOIA, including OGDS. The lawsuits generally relate to the same facts that were the subject of the SEC order and NYAG settlement discussed above. These actions seek, among other things, compensatory damages, restitution, disgorgement of unjustly earned profits, punitive damages, removal of the incumbent trustees of One Group Mutual Funds, removal of the One Group Mutual Funds' investment advisers (e.g., BOIA) and distributor (i.e., OGDS), rescission of the distribution and service plans adopted under Rule 12b-1 of the Investment Company Act of 1940, and attorneys' fees. 33 HOW TO REACH US MORE INFORMATION For investors who want more information on these Funds the following documents are available free upon request: ANNUAL AND SEMI-ANNUAL REPORTS Our annual and semi-annual reports contain more information about each Fund's investments and performance. The annual report also includes details about the market conditions and investment strategies that had a significant effect on each Fund's performance during the last fiscal year. STATEMENT OF ADDITIONAL INFORMATION (SAI) The SAI contains more detailed information about the Funds and their policies. It is incorporated by reference into this prospectus. This means, by law, it is considered to be part of this prospectus. You can get a free copy of these documents and other information, or ask us any questions, by calling us at 1-800-480-4111 or writing to: JPMORGAN FUNDS P.O. BOX 8528 BOSTON, MA 02266-8528 If you buy shares through an institution Please contact that institution directly for more information. You can also find information online at www.jpmorganfunds.com. You can write or e-mail the SEC's Public Reference Room and ask them to mail you information about the Funds, including the SAI. They will charge you a copying fee for this service. You can also visit the Public Reference Room and copy the documents while you are there. PUBLIC REFERENCE ROOM OF THE SEC WASHINGTON, DC 20549-0102. 1-202-942-8090 E-MAIL: publicinfo@sec.gov Reports, a copy of the SAI and other information about the Funds are also available on the SEC's website at http://www.sec.gov. Investment Company Act File No. 811-8358. (C) JPMorgan Chase & Co. All Rights Reserved. February 2005. PR-MMR-205 SUBJECT TO COMPLETION - PRELIMINARY STATEMENT OF ADDITIONAL INFORMATION DATED OCTOBER 29, 2004 The information contained in this Statement of Additional Information is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This Statement of Additional Information is not an offer to sell these securities and is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted. J.P. MORGAN MONEY MARKET FUNDS STATEMENT OF ADDITIONAL INFORMATION FEBRUARY 19, 2005 J.P. MORGAN MUTUAL FUND TRUST ("JPMMFT" or the "Trust") JPMorgan Prime Money Market Fund ("Prime Money Market Fund") JPMorgan Liquid Assets Money Market Fund ("Liquid Assets Money Market Fund") JPMorgan U.S. Government Money Market Fund ("U.S. Government Money Market Fund") JPMorgan Treasury Plus Money Market Fund ("Treasury Plus Money Market Fund") JPMorgan Federal Money Market Fund ("Federal Money Market Fund") JPMorgan 100% U.S. Treasury Securities Money Market Fund ("100% U.S. Treasury Securities Money Market Fund") JPMorgan Tax Free Money Market Fund ("Tax Free Money Market Fund") JPMorgan California Municipal Money Market Fund ("California Municipal Money Market Fund") (formerly JPMorgan California Tax Free Money Market Fund) JPMorgan New York Municipal Money Market Fund ("New York Municipal Money Market Fund") (formerly New York Tax Free Money Market Fund) (each a "Fund," and collectively, the "Money Market Funds" or "Funds") This Statement of Additional Information ("SAI") is not a prospectus but contains additional information which should be read in conjunction with the prospectuses dated February 19, 2005 ("Prospectuses"), for the Funds as supplemented from time to time. Additionally, this SAI incorporates by reference the financial statements dated August 31, 2004 ("Financial Statements") included in the Shareholder Reports relating to the Funds. The Prospectuses and Financial Statements, including the Independent Accountants' Reports are available, without charge upon request by contacting One Group Dealer Services, Inc. ("OGDS"), the Funds' distributor, at 1111 Polaris Parkway, Columbus, OH 43271. For more information about the Funds or the Financial Statements, simply write or call for: SELECT CLASS SHARES, MORGAN SHARES, CLASS B SHARES, CLASS C SHARES, PREMIER SHARES, CASH MANAGEMENT SHARES AND AGENCY SHARES, CAPITAL SHARES AND INSTITUTIONAL RESERVE SHARES: CLASS SHARES: JPMorgan Funds Service Center JPMorgan Institutional Funds Service Center P.O. Box 8528 500 Stanton Christiana Road Boston, MA 02266-8528 Newark, DE 19713 1-800-480-4111 1-800-766-7722
SAI-MMKT-205 1
TABLE OF CONTENTS PAGE ----------------- ---- GENERAL 3 INVESTMENT STRATEGIES AND POLICIES 5 INVESTMENT RESTRICTIONS 14 TRUSTEES 17 OFFICERS 23 CODES OF ETHICS 24 PROXY VOTING PROCEDURES AND GUIDELINES 25 PORTFOLIO HOLDINGS DISCLOSURE 26 INVESTMENT ADVISER 26 ADMINISTRATOR 29 DISTRIBUTOR 30 DISTRIBUTION PLAN 30 CUSTODIAN 34 TRANSFER AGENT 34 SHAREHOLDER SERVICING 34 EXPENSES 37 FINANCIAL PROFESSIONALS 37 CASH COMPENSATION TO FINANCIAL INTERMEDIARIES 37 INDEPENDENT ACCOUNTANTS 39 PURCHASES, REDEMPTIONS AND EXCHANGES 39 NET ASSET VALUE 41 PERFORMANCE INFORMATION 41 PORTFOLIO TRANSACTIONS 44 DESCRIPTION OF SHARES, VOTING RIGHTS AND LIABILITIES 46 DISTRIBUTIONS AND TAX MATTERS 48 ADDITIONAL INFORMATION 52 APPENDIX A - DESCRIPTION OF CERTAIN OBLIGATIONS ISSUED OR GUARANTEED BY U.S. GOVERNMENT AGENCIES OR INSTRUMENTALITIES A-1 APPENDIX B-DESCRIPTION OF SECURITY RATINGS B-1
2 GENERAL This SAI relates to the JPMorgan Funds listed below. The Trustees of the Funds have authorized the issuance and sale of the following classes of shares of the Funds. Currently, each Fund offers the following classes of shares: Prime Money Market Fund Class B, Class C, Morgan, Select, Premier, Agency, Institutional, Reserve, Capital and Cash Management Liquid Assets Money Market Fund Morgan, Premier, Agency and Institutional U.S. Government Money Market Fund Morgan, Premier, Agency and Institutional Treasury Plus Money Market Fund Morgan, Premier, Agency, Institutional and Reserve Federal Money Market Fund Morgan, Premier, Reserve, Agency and Institutional 100% U.S. Treasury Securities Money Market Fund Morgan, Premier, Reserve, Agency, Capital and Institutional Tax Free Money Market Fund Morgan, Premier, Reserve, Agency and Institutional California Municipal Money Market Fund Morgan New York Municipal Money Market Fund Morgan and Reserve
Effective February 28, 2001, the following Funds were renamed with the approval of the Board of Trustees:
NEW NAME FORMER NAME JPMorgan Prime Money Market Fund II Chase Vista Prime Money Market Fund JPMorgan U.S. Government Money Market Fund Chase Vista U.S. Government Money Market Fund JPMorgan Treasury Plus Money Market Fund Chase Vista Treasury Plus Money Market Fund JPMorgan Federal Money Market Fund II Chase Vista Federal Money Market Fund JPMorgan 100% U.S. Treasury Securities Money Market Fund Chase Vista 100% U.S. Treasury Securities Money Market Fund JPMorgan Tax Free Money Market Fund Chase Vista Tax Free Money Market Fund JPMorgan California Tax Free Money Market Fund Chase Vista California Tax Free Money Market Fund JPMorgan New York Tax Free Money Market Fund Chase Vista New York Tax Free Money Market Fund
Effective September 10, 2001, the following Funds were renamed with the approval of the Board of Trustees:
NEW NAME FORMER NAME JPMorgan Prime Money Market Fund JPMorgan Prime Money Market Fund II JPMorgan Federal Money Market Fund JPMorgan Federal Money Market Fund II
As of September 10, 2001, the Select Shares were renamed "Morgan Shares" and a new class called Select Shares was introduced. The Institutional Class Shares were renamed "Agency Shares" and a new class of shares called Institutional Class Shares was also introduced on that date. Effective May 1, 2003, the Trust was renamed with the approval of the Board of Trustees to J.P. Morgan Mutual Fund Trust from Mutual Fund Trust. Effective February 19, 2005, the following Funds were renamed with the approval of the Board of Trustees: NAME OF FUND AS OF DECEMBER 28, 2004 NAME OF FUND EFFECTIVE FEBRUARY 19, 2005 JPMorgan California Tax Free Money Market Fund JPMorgan California Municipal Money Market Fund JPMorgan New York Tax Free Money Market Fund JPMorgan New York Municipal Money Market Fund
The shares of the Funds are collectively referred to in this SAI as the "Shares." This SAI describes the financial history, investment strategies and policies, management and operation of each of the Funds listed above in order to enable investors to select the Fund or Funds which best suit their needs. 3 This SAI provides additional information with respect to the Funds and should be read in conjunction with the relevant Fund's current Prospectuses. Capitalized terms not otherwise defined herein have the meanings accorded to them in the applicable Prospectus. The Funds' executive offices are located at 522 Fifth Avenue, New York, NY 10036. The Funds are series of JPMMFT, an open-end management investment company which was organized as a business trust under the laws of the Commonwealth of Massachusetts on February 4, 1994. On April 30, 2003, the name of the Trust was changed from Mutual Fund Trust to J.P. Morgan Mutual Fund Trust. Each Fund is a separate series of the Trust. The Funds are diversified as such term is defined in the Investment Company Act of 1940, as amended (the "1940 Act"). PENDING TRANSACTIONS. On August 19, 2004, the Board of Trustees of the Trust approved the reorganization and redomiciliation of the Funds as series of J.P. Morgan Mutual Funds Series, a Massachusetts business trust ("JPMMFS"), subject to the approval of shareholders of the Funds ("Shell Reorganizations"). On that same date, the Board of Trustees of JPMMFS approved the redomiciliation of JPMMFS as a Delaware statutory trust to be called "JPMorgan Trust I," subject to the approval of shareholders of JPMMFS ("Redomiciliation"). On August 19, 2004, the Board of Trustees of the Trust also approved merger transactions involving five of the Funds included in this SAI. The proposed target and acquiring funds for each of those proposed merger transactions are shown in the table below.
ACQUIRED FUND ACQUIRING FUND One Group Institutional Prime Money Market Fund MERGES WITH JPMorgan Prime Money Market Fund AND INTO JPMorgan Liquid Assets Money Market Fund MERGES WITH One Group Prime Money Market Fund AND INTO JPMorgan U.S. Government Money Market Fund MERGES WITH One Group Government Money Market Fund One Group U.S. Government Securities Money Market AND INTO Fund JPMorgan Treasury Plus Money Market Fund MERGES WITH One Group U.S. Treasury Securities Money Market Fund AND INTO One Group Treasury Only Money Market Fund MERGES WITH JPMorgan 100% U.S. Treasury Securities Money AND INTO Market Fund
Special meetings of shareholders of the Trust and JPMMFS have been scheduled to be held on January 20, 2005 to consider each of the above proposals to the extent applicable to each Fund. If these proposals are approved by shareholders of the affected Funds, each of the transactions described above is expected to be effective after the close of business on February 18, 2005 ("Closing Date"). If shareholders of a Fund APPROVE the Shell Reorganization with respect to that Fund, and shareholders of JPMMFS APPROVE the Redomiciliation, the Fund will become a series of JPMorgan Trust I on the Closing Date. If shareholders of a Fund APPROVE the Shell Reorganization with respect to that Fund, and shareholders of JPMMFS DO NOT APPROVE the Redomiciliation, the Fund will become a series of JPMMFS on the Closing Date. If shareholders of a Fund DO NOT APPROVE the Shell Reorganization with respect to that Fund, the Fund will remain a series of the Trust. Each of the above considerations will apply to JPMorgan Liquid Assets Money Market Fund, JPMorgan U.S. Government Money Market Fund and JPMorgan Treasury Plus Money Market Fund only to the extent that shareholders of these Funds do not approve the proposed merger transaction involving these Funds. The Board of Trustees provides broad supervision over the affairs of the Trust including the Funds. J.P. Morgan Investment Management Inc. ("JPMIM" or the "Adviser") is the investment adviser for all the Funds. Prior to September 1, 2003, the investment adviser to the Funds was J.P. Morgan Fleming Asset Management (USA) Inc. ("JPMFAM (USA)") and prior to February 28, 2001, the investment adviser was The Chase Manhattan Bank ("Chase"). JPMorgan Chase Bank serves as the Trust's administrator (the "Administrator") and supervises the overall administration of the Trust, including the Funds. A majority of the Board of Trustees of the Trust are not affiliated with JPMIM or the Administrator. In addition to these Funds, the Trusts consist of other series representing separate investment funds. Investments in the Funds are not deposits or obligations of, or guaranteed or endorsed by, JPMorgan Chase Bank, NA, an affiliate of the Adviser, or any other bank. Shares of the Funds are not federally insured or guaranteed by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other governmental agency. An investment in a Fund is subject to risk that may cause the value of the investment to fluctuate, and when the investment is redeemed, the value may be higher or lower than the amount originally invested by the investor. 4 INVESTMENT STRATEGIES AND POLICIES The Prospectuses set forth the various investment policies applicable to each Fund. The Money Market Funds invest only in U.S. dollar-denominated high-quality obligations which are determined to present minimal credit risks. This credit determination must be made in accordance with procedures established by the Board of Trustees. The management style used for the Funds emphasizes several key factors. Portfolio managers consider the security quality, that is, the ability of the debt issuer to make timely payments of principal and interest. Also important in the analysis is the relationship of a bond's structure, yield and its maturity, in which the managers evaluate the risks of investing in long-term higher-yielding securities. Another step in the analysis is comparing yields on different types of securities to determine relative risk/reward profiles. MONEY MARKET INSTRUMENTS A description of the various types of money market instruments that may be purchased by the Funds appears below. Also see "Quality and Diversification Requirements." U.S. TREASURY SECURITIES. Each of the Funds may invest in direct obligations of the U.S. Treasury, including Treasury bills, notes and bonds, all of which are backed as to principal and interest payments by the full faith and credit of the United States. ADDITIONAL U.S. GOVERNMENT OBLIGATIONS. Each of the Prime, Liquid Assets, U.S. Government and Federal Money Market Funds may invest in obligations issued or guaranteed by U.S. government agencies or instrumentalities. These obligations may or may not be backed by the "full faith and credit" of the United States. Securities which are backed by the full faith and credit of the United States include obligations of the Government National Mortgage Association, the Farmers Home Administration, and the Export-Import Bank. In the case of securities not backed by the full faith and credit of the United States, each Fund must look principally to the federal agency issuing or guaranteeing the obligation for ultimate repayment and may not be able to assert a claim against the United States itself in the event the agency or instrumentality does not meet its commitments. Securities in which each Fund may invest that are not backed by the full faith and credit of the United States include, but are not limited to: (i) obligations of the Tennessee Valley Authority, the Federal Home Loan Mortgage Corporation, the Federal Home Loan Banks and the U.S. Postal Service, each of which has the right to borrow from the U.S. Treasury to meet its obligations; (ii) securities issued by the Federal National Mortgage Association, which are supported by the discretionary authority of the U.S. government to purchase the agency's obligations; and (iii) obligations of the Federal Farm Credit System and the Student Loan Marketing Association, each of whose obligations may be satisfied only by the individual credits of the issuing agency. The Federal Money Market Fund generally limits its investment in agency and instrumentality obligations to obligations the interest on which is generally not subject to state and local income taxes by reason of federal law. FOREIGN GOVERNMENT OBLIGATIONS. The Prime Money Market Fund and Liquid Assets Money Market Fund, subject to applicable investment policies, may also invest in short-term obligations of foreign sovereign governments or of their agencies, instrumentalities, authorities or political subdivisions. These securities must be denominated in U.S. dollars. See "Foreign Investments." BANK OBLIGATIONS. The Tax Free Money Market Fund, California Municipal Money Market Fund, New York Municipal Money Market Fund (collectively, the "Tax Free and Municipal Funds"), Prime Money Market Fund and Liquid Assets Money Market Fund, unless otherwise noted in the prospectuses or below, may invest in negotiable certificates of deposit, time deposits and bankers' acceptances of (i) banks, savings and loan associations and savings banks which have more than $1 billion in total assets and are organized under the laws of the United States or any state, (ii) foreign branches of these banks or of foreign banks of equivalent size and (iii) U.S. branches of foreign banks of equivalent size. See "Foreign Investments." The Prime Money Market Fund and Liquid Assets Money Market Fund will not invest in obligations for which the Adviser, or any of its affiliated persons, is the ultimate obligor or accepting bank. The Prime Money Market Fund and Liquid Assets Money Market Fund may also invest in obligations of international banking institutions designated or supported by national governments to promote economic reconstruction, development or trade between nations (e.g., the European Investment Bank, the Inter-American Development Bank, or the World Bank). 5 COMMERCIAL PAPER. The Prime Money Market Fund and Liquid Assets Money Market Fund may invest in commercial paper, including master demand obligations. Master demand obligations are obligations that provide for a periodic adjustment in the interest rate paid and permit daily changes in the amount borrowed. Master demand obligations are governed by agreements between the issuer and the Adviser acting as agent, for no additional fee. The monies loaned to the borrower come from accounts managed by the Adviser or its affiliates, pursuant to arrangements with such accounts. Interest and principal payments are credited to such accounts. The Adviser, has the right to increase or decrease the amount provided to the borrower under an obligation. The borrower has the right to pay without penalty all or any part of the principal amount then outstanding on an obligation together with interest to the date of payment. Since these obligations typically provide that the interest rate is tied to the Federal Reserve commercial paper composite rate, the rate on master demand obligations is subject to change. Repayment of a master demand obligation to participating accounts depends on the ability of the borrower to pay the accrued interest and principal of the obligation on demand which is continuously monitored by the Adviser. Since master demand obligations typically are not rated by credit rating agencies, the Prime Money Market Fund and Liquid Assets Money Market Fund may invest in such unrated obligations only if at the time of an investment the obligation is determined by the Adviser to have a credit quality which satisfies each Fund's quality restrictions. See "Quality and Diversification Requirements." Although there is no secondary market for master demand obligations, such obligations are considered by the Prime Money Market Fund and Liquid Assets Money Market Fund to be liquid because they are payable upon demand. The Prime Money Market Fund and Liquid Assets Money Market Fund do not have any specific percentage limitation on investments in master demand obligations. It is possible that the issuer of a master demand obligation could be a client of an affiliate of the Adviser to whom such affiliate, in its capacity as a commercial bank, has made a loan. ASSET-BACKED SECURITIES. The Prime Money Market Fund and Liquid Assets Money Market Fund may invest in asset-backed securities, which directly or indirectly represent a participation interest in, or are secured by and payable from, a stream of payments generated by particular assets, such as motor vehicle or credit card receivables or other asset-backed securities collateralized by such assets. Payments of principal and interest may be guaranteed up to certain amounts and for a certain time period by a letter of credit issued by a financial institution unaffiliated with the entities issuing the securities. The asset-backed securities in which a Fund may invest are subject to the Fund's overall credit requirements. However, asset-backed securities, in general, are subject to certain risks. Most of these risks are related to limited interests in applicable collateral. For example, credit card debt receivables are generally unsecured and the debtors are entitled to the protection of a number of state and federal consumer credit laws, many of which give such debtors the right to set off certain amounts on credit card debt thereby reducing the balance due. Additionally, if the letter of credit is exhausted, holders of asset-backed securities may also experience delays in payments or losses if the full amounts due on underlying sales contracts are not realized. Because asset-backed securities are relatively new, the market experience in these securities is limited and the market's ability to sustain liquidity through all phases of the market cycle has not been tested. Collateralized securities are subject to certain additional risks, including a decline in the value of the collateral backing the security, failure of the collateral to generate the anticipated cash flow or in certain cases more rapid prepayment because of events affecting the collateral, such as accelerated prepayment of loans backing these securities or destruction of equipment subject to equipment trust certificates. In the event of any such prepayment, the Fund will be required to reinvest the proceeds of prepayments at interest rates prevailing at the time of reinvestment, which may be lower. STRUCTURED PRODUCTS. The Funds may invest in interests in entities organized and operated solely for the purpose of restructuring the investment characteristics of certain other investments. This type of restructuring involves the deposit with or purchase by an entity, such as a corporation or trust, of specified instruments (such as commercial bank loans) and the issuance by that entity of one or more classes of securities ("structured products") backed by, or representing interests in, the underlying instruments. The cash flow on the underlying instruments may be apportioned among the newly issued structured products to create securities with different investment characteristics such as varying maturities, payment priorities and interest rate provisions, and the extent of the payments made with respect to structured products is dependent on the extent of the cash flow on the underlying instruments. A Fund may invest in structured products which represent derived investment positions based on relationships among different markets or asset classes. A Fund may invest in a class of structured products that is either subordinated or unsubordinated to the right of payment of another class. Subordinated structured products typically have higher yields and present greater risks than unsubordinated structured products. Although a Fund's purchase of subordinated structured products would have 6 similar economic effect to that of borrowing against the underlying securities, the purchase will not be deemed to be leveraged for purposes of a Fund's fundamental investment restriction related to borrowing and leverage. Certain issuers of structured products may be deemed to be "investment companies" as defined in the 1940 Act. As a result, a Fund's investments in these structured products may be limited by the restrictions contained in the 1940 Act. Structured products are typically sold in private placement transactions, and there currently is no active trading market for structured products. As a result, certain structured products in which the Funds invest may be deemed illiquid and subject to their restrictions on illiquid investments. Investments in structured products generally are subject to greater volatility than an investment directly in the underlying market or security. In addition, because structured products are typically sold in private placement transactions, there may be no active trading market for structured products. REPURCHASE AGREEMENTS. Each of the Funds (other than the Federal Money Market Fund and 100% U.S. Treasury Securities Money Market Fund) may enter into repurchase agreements with brokers, dealers or banks that meet the Adviser's credit guidelines. In a repurchase agreement, a Fund buys a security from a seller that has agreed to repurchase the same security at a mutually agreed upon date and price. The resale price normally is in excess of the purchase price, reflecting an agreed upon interest rate. This interest rate is effective for the period of time a Fund is invested in the agreement and is not related to the coupon rate on the underlying security. A repurchase agreement may also be viewed as a collateralized loan of money by a Fund to the seller. Repurchase agreements maturing in more than seven days are treated as illiquid for purposes of the Funds' restrictions on purchases of illiquid securities. The Funds will always receive securities as collateral whose market value is, and during the entire term of the agreement remains, at least equal to 100% of the dollar amount invested by the Funds in each agreement plus accrued interest, and the Funds will make payment for such securities only upon physical delivery or upon evidence of book entry transfer to the account of the Custodian. The U.S. Government Money Market Fund, Treasury Plus Money Market Fund, Tax Free Money Market Fund, California Municipal Money Market Fund and New York Municipal Money Market Fund may engage only in repurchase agreement transactions that are collateralized fully as defined in Rule 5b-3 of the 1940 Act, which has the effect of enabling the Funds to look to the collateral, rather than the counterparty, for determining whether its assets are "diversified" for 1940 Act purposes. The Liquid Assets Money Market Fund and Prime Money Market Fund may also engage in repurchase agreement transactions that are collateralized by money market instruments or corporate debt securities that, at the time the transaction is entered into, are rated at least investment grade by the requisite nationally recognized statistical rating organizations. For these repurchase agreement transactions, the Funds would look to the counterparty, and not the collateral for determining such diversification. If the seller defaults, a Fund might incur a loss if the value of the collateral securing the repurchase agreement declines and might incur disposition costs in connection with liquidating the collateral. In addition, if bankruptcy proceedings are commenced with respect to the seller of the security, realization upon disposal of the collateral by a Fund may be delayed or limited. OTHER DEBT SECURITIES. The Prime Money Market Fund and Liquid Assets Money Market Fund may make investments in other debt securities with remaining effective maturities of not more than thirteen months, including, without limitation, corporate and foreign bonds, asset-backed securities and other obligations described in the Prospectuses or this SAI. FOREIGN INVESTMENTS The Prime Money Market Fund and Liquid Assets Money Market Fund may invest in certain foreign securities. All investments must be U.S. dollar-denominated. Investment in securities of foreign issuers and in obligations of foreign branches of domestic banks involves somewhat different investment risks from those affecting securities of U.S. domestic issuers. There may be limited publicly available information with respect to foreign issuers, and foreign issuers are not generally subject to uniform accounting, auditing and financial standards and requirements comparable to those applicable to domestic companies. Dividends and interest paid by foreign issuers may be subject to withholding and other foreign taxes which may decrease the net return on foreign investments as compared to dividends and interest paid to a Fund by domestic companies. Investors should realize that the value of a Fund's investments in foreign securities may be adversely affected by changes in political or social conditions, diplomatic relations, confiscatory taxation, expropriation, nationalization, limitation on the removal of funds or assets, or imposition of (or change in) exchange control or tax regulations in those foreign countries. In addition, changes in government administrations or economic or monetary policies in the United 7 States or abroad could result in appreciation or depreciation of portfolio securities and could favorably or unfavorably affect a Fund's operations. Furthermore, the economies of individual foreign nations may differ from the U.S. economy, whether favorably or unfavorably, in areas such as growth of gross national product, rate of inflation, capital reinvestment, resource self-sufficiency and balance of payments position; it may also be more difficult to obtain and enforce a judgment against a foreign issuer. Any foreign investments made by a Fund must be made in compliance with U.S. and foreign currency restrictions and tax laws restricting the amounts and types of foreign investments. MUNICIPAL OBLIGATIONS The Prime Money Market Fund, Liquid Assets Money Market Fund and the Tax Free and Municipal Funds may invest in municipal obligations. The Prime Money Market Fund and Liquid Assets Money Market Fund may invest in high-quality, short-term municipal obligations that carry yields that are competitive with those of other types of money market instruments in which they may invest. Dividends paid by these Funds that are derived from interest on municipal obligations will be taxable to shareholders for federal income tax purposes. Interest on certain municipal obligations (including certain industrial development bonds), while exempt from federal income tax, is a preference item for the purpose of the alternative minimum tax ("AMT"). Where a mutual fund receives such interest, a proportionate share of any exempt-interest dividend paid by the mutual fund may be treated as a preference item to shareholders. Federal tax legislation enacted over the past few years has limited the types and volume of bonds which are not AMT items and the interest on which is not subject to federal income tax. This legislation may affect the availability of municipal obligations for investment by the Tax Free and Municipal Funds. Investments by the Tax Free and Municipal Funds will be made in unrated municipal obligations only if they are determined to be of comparable quality to permissible rated investments on the basis of the Adviser's credit evaluation of the obligor or of the bank issuing a participation certificate, letter of credit or guaranty, or insurance issued in support of the obligation. High-quality instruments may produce a lower yield than would be available from less highly rated instruments. The Board of Trustees has determined that municipal obligations which are backed by the credit of the U.S. Government will be considered to have a rating equivalent to Moody's Aaa. If, subsequent to purchase by the Tax Free or Municipal Funds (a) an issue of rated municipal obligations ceases to be rated in the highest short-term rating category by at least two rating organizations (or one rating organization if the instrument is rated by only one such organization) or the Board of Trustees determines that it is no longer of comparable quality or (b) a Money Market Fund's Adviser becomes aware that any portfolio security not so highly rated or any unrated security has been given a rating by any rating organization below the rating organization's second highest rating category, the Board of Trustees will reassess promptly whether such security presents minimal credit risk and will cause such Money Market Fund to take such action as it determines is in its best interest and that of its shareholders; provided that the reassessment required by clause (b) is not required if the portfolio security is disposed of or matures within five business days of the Adviser becoming aware of the new rating and the Fund's Board of Trustees is subsequently notified of the Adviser's actions. MUNICIPAL BONDS. The Prime Money Market Fund, Liquid Assets Money Market Fund and the Tax Free and Municipal Funds may invest in municipal bonds issued by or on behalf of states, territories and possessions of the United States and the District of Columbia and by their political subdivisions and by duly constituted authorities and corporations. For example, states, territories, possessions and municipalities may issue municipal bonds to raise funds for various public purposes such as airports, housing, hospitals, mass transportation, schools, water and sewer works. They may also issue municipal bonds to refund outstanding obligations and to meet general operating expenses. Public authorities issue municipal bonds to obtain funding for privately operated facilities, such as housing and pollution control facilities, for industrial facilities or for water supply, gas, electricity or waste disposal facilities. The Prime Money Market Fund and Liquid Assets Money Market Fund may invest in municipal notes of various types, including notes issued in anticipation of receipt of taxes, the proceeds of the sale of bonds, other revenues or grant proceeds, as well as municipal commercial paper and municipal demand obligations such as variable rate demand notes and master demand obligations. These municipal bonds and notes will be taxable securities; income generated from these investments will be subject to federal, state and local taxes. Municipal bonds may be general obligation or revenue bonds. General obligation bonds are secured by the issuer's pledge of its full faith, credit and taxing power for the payment of principal and interest. Revenue bonds are payable from revenues derived from particular facilities, from the proceeds of a special excise tax or from other specific revenue sources. They are not generally payable from the general taxing power of a municipality. 8 The Tax Free and Municipal Funds may also invest in industrial development bonds that are backed only by the assets and revenues of the non-governmental issuers such as hospitals or airports, provided, however, that the Tax Free and Municipal Funds may not invest more than 25% of the value of their total assets in such bonds if the issuers are in the same industry. MUNICIPAL NOTES. Municipal notes are short-term obligations with a maturity at the time of issuance ranging from six months to five years. The principal types of municipal notes include tax anticipation notes, bond anticipation notes, revenue anticipation notes, grant anticipation notes and project notes. Notes sold in anticipation of collection of taxes, a bond sale, or receipt of other revenues are usually general obligations of the issuing municipality or agency. Municipal commercial paper typically consists of very short-term unsecured negotiable promissory notes that are sold to meet seasonal working capital or interim construction financing needs of a municipality or agency. While these obligations are intended to be paid from general revenues or refinanced with long-term debt, they frequently are backed by letters of credit, lending agreements, note repurchase agreements or other credit facility agreements offered by banks or institutions. Municipal demand obligations are subdivided into two types: variable rate demand notes and master demand obligations. Variable rate demand notes are tax exempt municipal obligations or participation interests that provide for a periodic adjustment in the interest rate paid on the notes. They permit the holder to demand payment of the notes, or to demand purchase of the notes at a purchase price equal to the unpaid principal balance, plus accrued interest either directly by the issuer or by drawing on a bank letter of credit or guaranty issued with respect to such note. The issuer of the municipal obligation may have a corresponding right to prepay at its discretion the outstanding principal of the note plus accrued interest upon notice comparable to that required for the holder to demand payment. Municipal demand obligations are tax exempt municipal obligations that provide for a periodic adjustment in the interest rate paid and permit daily changes in the amount borrowed. The interest on such obligations is, in the opinion of counsel for the borrower, excluded from gross income for federal income tax purposes. MUNICIPAL LEASE OBLIGATIONS. The Tax Free and Municipal Funds may invest in municipal lease obligations. These typically provide a premium interest rate. Municipal lease obligations do not constitute general obligations of the municipality. Certain municipal lease obligations in which the Tax Free and Municipal Funds may invest contain "non-appropriation" clauses which provide that the municipality has no obligation to make lease or installment payments in future years unless money is later appropriated for such purpose. Each Fund will limit its investments in "non-appropriation" leases to 10% of its assets. Although "non-appropriation" lease obligations are secured by the leased property, disposition of the property in the event of foreclosure might prove difficult. Certain investments in municipal lease obligations may be illiquid. WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. Each of the Funds may purchase securities on a when-issued or delayed delivery basis. For example, delivery of and payment for these securities can take place a month or more after the date of the purchase commitment. The purchase price and the interest rate payable, if any, on the securities are fixed on the purchase commitment date or at the time the settlement date is fixed. The value of such securities is subject to market fluctuation and for money market instruments and other fixed income securities no interest accrues to a Fund until settlement takes place. At the time a Fund makes the commitment to purchase securities on a when-issued or delayed delivery basis, it will record the transaction, reflect the value each day of such securities in determining its net asset value and, if applicable, calculate the maturity for the purposes of average maturity from that date. At the time of settlement a when-issued security may be valued at less than the purchase price. To facilitate such acquisitions, each Fund will maintain with JPMorgan Chase Bank, the Custodian (see "Custodian") a segregated account with liquid assets, consisting of cash, U.S. government securities or other appropriate securities, in an amount at least equal to such commitments. On delivery dates for such transactions, each Fund will meet its obligations from maturities or sales of the securities held in the segregated account and/or from cash flow. If a Fund chooses to dispose of the right to acquire a when-issued security prior to its acquisition, it could, as with the disposition of any other portfolio obligation, incur a gain or loss due to market fluctuation. Also, a Fund may be disadvantaged if the other party to the transaction defaults. 9 INVESTMENT COMPANY SECURITIES. Securities of other investment companies may be acquired by each of the Funds to the extent permitted under the 1940 Act or any order pursuant thereto. These limits currently require that, as determined immediately after a purchase is made, (i) not more than 5% of the value of a Fund's total assets will be invested in the securities of any one investment company, (ii) not more than 10% of the value of its total assets will be invested in the aggregate in securities of investment companies as a group, and (iii) not more than 3% of the outstanding voting stock of any one investment company will be owned by a Fund. As a shareholder of another investment company, a Fund would bear, along with other shareholders, its pro rata portion of the other investment company's expenses, including advisory fees. These expenses would be in addition to the advisory and other expenses that a Fund bears directly in connection with its own operations. INTERFUND LENDING. To satisfy redemption requests or to cover unanticipated cash shortfalls, the Funds may enter into lending agreements ("Interfund Lending Agreements") under which the Funds would lend money and borrow money for temporary purposes directly to and from each other through a credit facility ("Interfund Loan"), subject to meeting the conditions of an SEC exemptive order permitting such interfund lending. No Fund may borrow more than the lesser of the amount permitted by Section 18 of the 1940 Act or the amount permitted by its investment limitations. All Interfund Loans will consist only of uninvested cash reserves that the Fund otherwise would invest in short-term repurchase agreements or other short-term instruments. If a Fund has outstanding borrowings, any Interfund Loans to the Fund (a) will be at an interest rate equal to or lower than any outstanding bank loan, (b) will be secured at least on an equal priority basis with at least an equivalent percentage of collateral to loan value as any outstanding bank loan that requires collateral, (c) will have a maturity no longer than any outstanding bank loan (and in any event not over seven days), and (d) will provide that, if an event of default occurs under any agreement evidencing an outstanding bank loan to the Fund, the event of default will automatically (without need for action or notice by the lending Fund) constitute an immediate event of default under the Interfund Lending Agreement entitling the lending Fund to call the Interfund Loan (and exercise all rights with respect to any collateral) and that such call will be made if the lending bank exercises its right to call its loan under its agreement with the borrowing Fund. A Fund may make an unsecured borrowing through the credit facility if its outstanding borrowings from all sources immediately after the interfund borrowing total 10% or less of its total assets; provided, that if the Fund has a secured loan outstanding from any other lender, including but not limited to another Fund, the Fund's interfund borrowing will be secured on at least an equal priority basis with at least an equivalent percentage of collateral to loan value as any outstanding loan that requires collateral. If a Fund's total outstanding borrowings immediately after an interfund borrowing would be greater than 10% of its total assets, the Fund may borrow through the credit facility on a secured basis only. A Fund may not borrow through the credit facility or from any other source if its total outstanding borrowings immediately after the interfund borrowing would exceed the limits imposed by Section 18 of the 1940 Act. No Fund may lend to another Fund through the interfund lending credit facility if the loan would cause its aggregate outstanding loans through the credit facility to exceed 15% of the lending Fund's net assets at the time of the loan. A Fund's Interfund Loans to any one Fund shall not exceed 5% of the lending Fund's net assets. The duration of Interfund Loans is limited to the time required to receive payment for securities sold, but in no event more than seven days. Loans effected within seven days of each other will be treated as separate loan transactions for purposes of this condition. Each Interfund Loan may be called on one business day's notice by a lending Fund and may be repaid on any day by a borrowing Fund. The limitations detailed above and the other conditions of the SEC exemptive order permitting interfund lending are designed to minimize the risks associated with interfund lending for both the lending fund and the borrowing fund. However, no borrowing or lending activity is without risk. REVERSE REPURCHASE AGREEMENTS. Each of the Funds may enter into reverse repurchase agreements. In a reverse repurchase agreement, a Fund sells a security and agrees to repurchase the same security at a mutually agreed upon date and price reflecting the interest rate effective for the term of the agreement. For purposes of the 1940 Act a reverse repurchase agreement is also considered as the borrowing of money by the Fund and, therefore, a form of leverage. Leverage may cause any gains or losses for a Fund to be magnified. The Funds will invest the proceeds of borrowings under reverse repurchase agreements. In addition, except for liquidity purposes, a Fund will enter into a reverse repurchase agreement only when the expected return from the investment of the proceeds is greater than the expense of the transaction. A Fund will not invest the proceeds of a reverse repurchase agreement for a period which exceeds the duration of the reverse repurchase agreement. A Fund would be required to pay interest on amounts obtained through reverse repurchase agreements, which are considered borrowings under federal securities laws. The repurchase price is generally equal to the original sales prices plus interest. Reverse repurchase agreements are usually for seven days or less and cannot be repaid prior to their expiration dates. Each Fund will establish and maintain with the custodian a separate account with a segregated portfolio of securities in an amount at least equal to its purchase obligations under its reverse repurchase agreements. Reverse repurchase agreements involve the risk that the market value of the portfolio securities transferred may decline below the price at which the Fund is obliged to purchase the securities. All forms of borrowing (including reverse repurchase agreements and securities lending) are limited in the aggregate and may not exceed 33% of each Fund's total assets. FORWARD COMMITMENTS. The Prime Money Market Fund, Liquid Assets Money Market Fund and the Tax Free and Municipal Funds may purchase securities for delivery at a future date, which may increase their overall investment exposure and involves a risk of loss if the value of the securities declines prior to the settlement date. In order to invest a Fund's assets immediately, while awaiting delivery of securities purchased on a forward commitment basis, short-term obligations that offer same-day settlement and earnings will normally be purchased. Although, with respect to the Tax Free and Municipal Funds, short-term investments will normally be in tax-exempt securities or municipal obligations, short-term taxable securities or obligations may be purchased if suitable short-term tax-exempt securities or municipal obligations are not available. When a commitment to purchase a security on a forward commitment basis is made, procedures are established consistent with the General Statement of Policy of the Securities and Exchange Commission ("SEC") concerning such purchases. Since that policy currently recommends that an amount of the respective Fund's assets equal to the amount of the purchase be held aside or segregated to be used to pay for the commitment, a separate account of such Fund consisting of cash, cash equivalents or high quality debt securities equal to the amount of such Fund's commitments will be established at such Fund's custodian bank. For the purpose of determining the adequacy of the securities in the account, the deposited securities will be valued at market value. If the market value of such securities declines, additional cash, cash equivalents or highly liquid securities will be placed in the account daily so that the value of the account will equal the amount of such commitments by the respective Fund. Although it is not intended that such purchases would be made for speculative purposes, purchases of securities on a forward commitment basis may involve more risk than other types of purchases. Securities purchased on a forward commitment basis and the securities held in the respective Fund's portfolio are subject to changes in value based upon the public's perception of the creditworthiness of the issuer and changes, real or anticipated, in the level of interest rates. Purchasing securities on a forward commitment basis can involve the risk that the yields available in the market when the delivery takes place may actually be higher or lower than those obtained in the transaction itself. On the settlement date of the forward commitment transaction, the respective Fund will meet its obligations from then available cash flow, sale of securities held in the separate account, sale of other securities or, although it would not normally expect to do so, from sale of the forward commitment securities themselves (which may have a value greater or lesser than such Fund's payment obligations). The sale of securities to meet such obligations may result in the realization of capital gains or losses, which, for consideration by investors in the Tax Free and Municipal Funds, are not exempt from federal, state or 10 local taxation. Forward commitments involve some risk to a Fund if the other party should default on its obligation and the Fund is delayed or prevented from recovering the collateral in completing the transaction. To the extent a Fund engages in forward commitment transactions, it will do so for the purpose of acquiring securities consistent with its investment objective and policies and not for the purpose of investment leverage, and settlement of such transactions will be within 90 days from the trade date. STAND-BY COMMITMENTS. When a Fund purchases securities it may also enter into put transactions, including those referred to as stand-by commitments, with respect to such securities. Under a stand-by commitment, a bank, broker-dealer or other financial institution agrees to purchase at a Fund's option a specified security at a specified price within a specified period prior to its maturity date and entitles a Fund to same day settlement and to receive an exercise price equal to the amortized cost of the underlying security plus accrued interest, if any, at the time of exercise. A put transaction will increase the cost of the underlying security and consequently reduce the available yield. The amount payable to a Money Market Fund upon its exercise of a stand-by commitment with respect to a municipal obligation normally would be (i) the acquisition cost of the municipal obligation (excluding any accrued interest paid by the Fund on the acquisition), less any amortized market premium or plus any amortized market or original issue discount during the period the Fund owned the security, plus (ii) all interest accrued on the security since the last interest payment date during the period the security was owned by the Fund. Absent unusual circumstances relating to a change in market value, a Money Market Fund would value the underlying municipal obligation at amortized cost. Accordingly, the amount payable by a bank or dealer during the time a stand-by commitment is exercisable would be substantially the same as the market value of the underlying municipal obligation. The Money Market Funds value stand-by commitments at zero for purposes of computing their net asset value per share. The stand-by commitments that may be entered into by the Funds are subject to certain risks, which include the ability of the issuer of the commitment to pay for the securities at the time the commitment is exercised, the fact that the commitment is not marketable by a Fund, and the fact that the maturity of the underlying security will generally be different from that of the commitment. Not more than 10% of the total assets of a Money Market Fund will be invested in municipal obligations that are subject to stand-by commitments from the same bank or broker-dealer. FLOATING AND VARIABLE RATE SECURITIES AND PARTICIPATION CERTIFICATES. Each Fund other than the Treasury Plus Money Market Fund and 100% U.S. Treasury Securities Money Market Fund may invest in floating and variable rate securities. Floating and variable rate demand instruments permit the holder to demand payment upon a specified number of days' notice of the unpaid principal balance plus accrued interest either from the issuer or by drawing on a bank letter of credit, a guarantee or insurance issued with respect to such instrument. The floating or variable rate demand instruments in which the Funds may invest are payable on demand on not more than seven calendar days' notice. The terms of these types of securities provide that interest rates are adjustable at intervals ranging from daily to up to six months and the adjustments are based upon the prime rate of a bank or other short-term rates, such as Treasury Bills or London Interbank Offered Rate ("LIBOR"), as provided in the respective instruments. The Funds will decide which floating or variable rate securities to purchase in accordance with procedures prescribed by the Board of Trustees of the Trust in order to minimize credit risks. The Board of Trustees may determine that an unrated floating or variable rate security meets the Fund's high quality criteria if it is backed by a letter of credit or guarantee or is insured by an insurer that meets such quality criteria, or on the basis of a credit evaluation of the underlying obligor. If the credit of the obligor is of "high quality", no credit support from a bank or other financial institution will be necessary. The Board of Trustees will re-evaluate each unrated floating or variable rate security on a quarterly basis to determine that it continues to meet a Fund's high quality criteria. If an instrument is ever deemed to fall below a Fund's high quality standards, either it will be sold in the market or the demand feature will be exercised. The securities in which the Tax Free and Municipal Funds, Liquid Assets Money Market Fund and Prime Money Market Fund may invest include participation certificates issued by a bank, insurance company or other financial institution in securities owned by such institutions or affiliated organizations ("Participation Certificates"), and, in the case of the Prime Money Market Fund and Liquid Assets Money Market Fund, certificates of indebtedness or safekeeping. Participation Certificates are pro rata interests in securities held by others; certificates of indebtedness or 11 safekeeping are documentary receipts for such original securities held in custody by others. A Participation Certificate gives a Fund an undivided interest in the security in the proportion that the Fund's participation interest bears to the total principal amount of the security and generally provides the demand feature described below. Each Participation Certificate is backed by an irrevocable letter of credit or guaranty of a bank (which may be the bank issuing the Participation Certificate, a bank issuing a confirming letter of credit to the issuing bank, or a bank serving as agent of the issuing bank with respect to the possible repurchase of the Participation Certificate) or insurance policy of an insurance company that the Board of Trustees of the Trust has determined meets the prescribed quality standards for a particular Fund. A Fund may have the right to sell the Participation Certificate back to the institution and draw on the letter of credit or insurance on demand after the prescribed notice period, for all or any part of the full principal amount of the Fund's participation interest in the security, plus accrued interest. The institutions issuing the Participation Certificates would retain a service and letter of credit fee and a fee for providing the demand feature, in an amount equal to the excess of the interest paid on the instruments over the negotiated yield at which the Participation Certificates were purchased by a Fund. The total fees would generally range from 5% to 15% of the applicable prime rate or other short-term rate index. With respect to insurance, a Fund will attempt to have the issuer of the Participation Certificate bear the cost of any such insurance, although a Fund may retain the option to purchase insurance if deemed appropriate. Obligations that have a demand feature permitting a Fund to tender the obligation to a foreign bank may involve certain risks associated with foreign investment. A Fund's ability to receive payment in such circumstances under the demand feature from such foreign banks may involve certain risks such as future political and economic developments, the possible establishments of laws or restrictions that might adversely affect the payment of the bank's obligations under the demand feature and the difficulty of obtaining or enforcing a judgment against the bank. The Adviser has been instructed by the Board of Trustees to monitor on an ongoing basis the pricing, quality and liquidity of the floating and variable rate securities held by the Funds, including Participation Certificates, on the basis of published financial information and reports of the rating agencies and other bank analytical services to which the Funds may subscribe. Although these instruments may be sold by a Fund, it is intended that they be held until maturity. The Internal Revenue Service has not ruled on whether interest on participations in floating or variable rate municipal obligations is tax-exempt. Participation Certificates will only be purchased by the Tax Free and Municipal Funds if, in the opinion of counsel to the issuer, interest income on such instruments will be tax-exempt when distributed as dividends to shareholders of such Fund. Past periods of high inflation, together with the fiscal measures adopted to attempt to deal with inflation, have seen wide fluctuations in interest rates, particularly "prime rates" charged by banks. While the value of the underlying floating or variable rate securities may change with changes in interest rates generally, the floating or variable rate nature of the underlying floating or variable rate securities should minimize changes in value of the instruments. Accordingly, as interest rates decrease or increase, the potential for capital appreciation and the risk of potential capital depreciation is less than would be the case with a portfolio of fixed rate securities. A Fund's portfolio may contain floating or variable rate securities on which stated minimum or maximum rates, or maximum rates set by state law, limit the degree to which interest on such floating or variable rate securities may fluctuate; to the extent this does occur, increases or decreases in value may be somewhat greater than would be the case without such limits. Because the adjustment of interest rates on the floating or variable rate securities is made in relation to movements of the applicable banks' "prime rates" or other short-term rate adjustment indices, the floating or variable rate securities are not comparable to long-term fixed rate securities. Accordingly, interest rates on the floating or variable rate securities may be higher or lower than current market rates for fixed rate obligations of comparable quality with similar maturities. The maturity of variable rate securities is deemed to be the longer of (i) the notice period required before a Fund is entitled to receive payment of the principal amount of the security upon demand or (ii) the period remaining until the security's next interest rate adjustment. The maturity of a variable rate demand instrument will be determined in the same manner for purposes of computing the Fund's dollar weighted average portfolio maturity. TENDER OPTION FLOATING OR VARIABLE RATE CERTIFICATES. The Funds may invest in tender option bonds. A tender option bond is a synthetic floating or variable rate security issued when long term bonds are purchased in the secondary market and are then deposited into a trust. Custodial receipts are then issued to investors, such as the Funds, evidencing ownership interests in the trust. The trust sets a floating or variable rate on a daily or weekly basis which is established through a remarketing agent. These types of instruments, to be money market eligible under Rule 2a-7, must have a liquidity facility in place which provides additional comfort to the investors in case the remarketing fails. The 12 sponsor of the trust keeps the difference between the rate on the long term bond and the rate on the short term floating or variable rate security. ZERO COUPON AND STRIPPED OBLIGATIONS. Each Fund may invest up to 20% of its total assets in stripped obligations. The principal and interest components of U.S. Treasury bonds with remaining maturities of longer than ten years are eligible to be traded independently under the Separate Trading of Registered Interest and Principal of Securities ("STRIPS") program. Under the STRIPS program, the principal and interest components are separately issued by the U.S. Treasury at the request of depository financial institutions, which then trade the component parts separately. The interest component of STRIPS may be more volatile than that of U.S. Treasury bills with comparable maturities. The Prime Money Market Fund, Liquid Assets Money Market Fund and the Tax Free and Municipal Funds may also invest in zero coupon obligations. Zero coupon obligations are sold at a substantial discount from their value at maturity and, when held to maturity, their entire return, which consists of the amortization of discount, comes from the difference between their purchase price and maturity value. Because interest on a zero coupon obligation is not distributed on a current basis, the obligation tends to be subject to greater price fluctuations in response to changes in interest rates than are ordinary interest-paying securities with similar maturities. As with STRIPS, the risk is greater when the period to maturity is longer. The value of zero coupon obligations appreciates more than such ordinary interest-paying securities during periods of declining interest rates and depreciates more than such ordinary interest-paying securities during periods of rising interest rates. Under the rules of the Internal Revenue Code of 1986, as amended (the "Code"), investments in zero coupon obligations will result in the accrual of interest income on such investments in advance of the receipt of the cash corresponding to such income. Zero coupon securities may be created when a dealer deposits a U.S. Treasury or federal agency security with a custodian and then sells the coupon payments and principal payment that will be generated by this security separately. Proprietary receipts, such as Certificates of Accrual on Treasury Securities, Treasury Investment Growth Receipts and generic Treasury Receipts, are examples of stripped U.S. Treasury securities separated into their component parts through such custodial arrangements. CUSTODIAL RECEIPTS. The Prime Money Market Fund and Liquid Assets Money Market Fund may acquire securities in the form of custodial receipts that evidence ownership of future interest payments, principal payments or both on certain U.S. Treasury notes or bonds in connection with programs sponsored by banks and brokerage firms. These are not deemed U.S. government securities. These notes and bonds are held in custody by a bank on behalf of the owners of the receipts. FUNDING AGREEMENTS. The Prime Money Market Fund, Liquid Assets Money Market Fund and the Tax Free and Municipal Funds may invest in short-term funding agreements. A funding agreement is a contract between an issuer and a purchaser that obligates the issuer to pay a guaranteed rate of interest on a principal sum deposited by a purchaser. Funding agreements generally will also guarantee the return of principal and may guarantee a stream of payments over time. A funding agreement has a fixed maturity date and may have either a fixed or variable interest rate that is based on an index and guaranteed for a set time period. Because there generally is no active secondary market for these investments, a funding agreement may be deemed to be illiquid. TEMPORARY DEFENSIVE POSITIONS. For temporary defensive purposes, each Tax Free and Municipal Fund may invest without limitation in high quality taxable money market instruments and repurchase agreements, the interest income from which may be taxable to shareholders as ordinary income for federal income tax purposes. ILLIQUID INVESTMENTS, PRIVATELY PLACED AND CERTAIN UNREGISTERED SECURITIES. The Prime Money Market Fund, Liquid Assets Money Market Fund and the Tax Free and Municipal Funds may invest in privately placed, restricted, Rule 144A or other unregistered securities. No Fund may acquire any illiquid holdings if, as a result thereof, more than 10% of a Fund's net assets would be in illiquid investments. Subject to this non-fundamental policy limitation, the Funds may acquire investments that are illiquid or have limited liquidity, such as the Prime Money Market Fund's investments in private placements or investments that are not registered under the Securities Act of 1933, as amended (the "1933 Act") and cannot be offered for public sale in the United States without first being registered under the 1933 Act. An illiquid investment is any investment that cannot be disposed of within seven days in the normal course of business at approximately the amount at which it is valued by the Funds. The price the Funds pay for illiquid securities or receive upon resale may be lower than the price paid or received for similar securities with a more liquid market. Accordingly the valuation of these securities will reflect any limitations on their liquidity. 13 The Prime Money Market Fund, Liquid Assets Money Market Fund and the Tax Free and Municipal Funds may also purchase Rule 144A securities sold to institutional investors without registration under the 1933 Act. These securities may be determined to be liquid in accordance with guidelines established by the Adviser and approved by the Board of Trustees. The Board of Trustees will monitor the Adviser's implementation of these guidelines on a periodic basis. As to illiquid investments, a Fund is subject to a risk that should the Fund decide to sell them when a ready buyer is not available at a price the Fund deems representative of their value, the value of the Fund's net assets could be adversely affected. Where an illiquid security must be registered under the 1933 Act, before it may be sold, a Fund may be obligated to pay all or part of the registration expenses, and a considerable period may elapse between the time of the decision to sell and the time the Fund may be permitted to sell a security under an effective registration statement. If, during such a period, adverse market conditions were to develop, a Fund might obtain a less favorable price than prevailed when it decided to sell. QUALITY AND DIVERSIFICATION REQUIREMENTS Each of the Funds intends to meet the diversification requirements of the 1940 Act. Current 1940 Act diversification requirements require that with respect to 75% of the assets of each Fund: (1) the Fund may not invest more than 5% of its total assets in the securities of any one issuer, except obligations of the U.S. government, its agencies and instrumentalities, and (2) the Fund may not own more than 10% of the outstanding voting securities of any one issuer. As for the other 25% of the Fund's assets not subject to the limitation described above, there is no limitation on investment of these assets under the 1940 Act, so that all of such assets may be invested in securities of any one issuer. Investments not subject to the limitations described above could involve an increased risk to a Fund should an issuer, or a state or its related entities, be unable to make interest or principal payments or should the market value of such securities decline. At the time the Liquid Assets Money Market Fund, California Tax Free Money Market Fund, or New York Tax Free Money Market Fund acquires its investments, the investments will be rated (or issued by an issuer that is rated with respect to a comparable class of short-term debt obligations) in one of the two highest rating categories for short-term debt obligations assigned by at least two nationally recognized rating organizations (or one rating organization if the obligation was rated by only one such organization). These high quality securities are divided into "first tier" and "second tier" securities. First tier securities have received the highest rating from at least two rating organizations (or one, if only one has rated the security). Second tier securities have received ratings within the two highest categories from at least two rating agencies (or one, if only one has rated the security), but do not qualify as first tier securities. Each of these Funds may also purchase obligations that are not rated, but are determined by the Adviser, based on procedures adopted by the Trustees, to be of comparable quality to rated first or second tier securities. These Funds may not purchase any second tier security if, as a result of its purchase (a) more than 5% of its total assets would be invested in second tier securities or (b) more than 1% of its total assets or $1 million (whichever is greater) would be invested in the second tier securities of a single issuer. At the time any of the other JPMorgan Money Market Funds acquires its investments, the investments will qualify as first tier securities. The Funds may also purchase obligations that are not rated, but are determined by the Adviser, based on procedures adopted by the Trustees, to be of comparable quality to rated first tier securities. The Funds may not purchase any security which qualifies as a second tier security at the time of the Fund's investment. INVESTMENT RESTRICTIONS The investment restrictions below have been adopted by the Trust with respect to the Funds. Except where otherwise noted, these investment restrictions are "fundamental" policies which, under the 1940 Act, may not be changed without the vote of a majority of the outstanding voting securities of a Fund. A "majority of the outstanding voting securities" is defined in the 1940 Act as the lesser of (a) 67% or more of the voting securities present at a meeting if the holders of more than 50% of the outstanding voting securities are present or represented by proxy, or (b) more than 50% of the outstanding voting securities. The percentage limitations contained in the restrictions below apply at the time of the purchase of securities. FUNDAMENTAL INVESTMENT RESTRICTIONS Each Fund: (1) May not borrow money, except that each Fund may borrow money for temporary or emergency purposes, or by engaging in reverse repurchase transactions, in an amount not exceeding 33% of the value of its total assets at the time when the loan is made and may pledge, mortgage or hypothecate no more than 1/3 of its net 14 assets to secure such borrowings. Any borrowings representing more than 5% of a Fund's total assets must be repaid before the Fund may make additional investments; (2) May make loans to other persons, in accordance with the Fund's investment objective and policies and to the extent permitted by applicable law; (3) May not purchase the securities of any issuer (other than securities issued or guaranteed by the U.S. government or any of its agencies or instrumentalities, or repurchase agreements secured thereby) if, as a result, more than 25% of the Fund's total assets would be invested in the securities of companies whose principal business activities are in the same industry. Notwithstanding the foregoing, (i) the Money Market Funds may invest more than 25% of their total assets in obligations issued by banks, including U.S. banks; and (ii) the Tax Free and Municipal Funds may invest more than 25% of their respective assets in municipal obligations secured by bank letters of credit or guarantees, including Participation Certificates; (4) May not purchase or sell physical commodities unless acquired as a result of ownership of securities or other instruments, but this shall not prevent a Fund from (i) purchasing or selling options and futures contracts or from investing in securities or other instruments backed by physical commodities or (ii) engaging in forward purchases or sales of foreign currencies or securities; (5) May not purchase or sell real estate unless acquired as a result of ownership of securities or other instruments (but this shall not prevent a Fund from investing in securities or other instruments backed by real estate or securities of companies engaged in the real estate business). Investments by a Fund in securities backed by mortgages on real estate or in marketable securities of companies engaged in such activities are not hereby precluded; (6) May not issue any senior security (as defined in the 1940 Act), except that (a) a Fund may engage in transactions that may result in the issuance of senior securities to the extent permitted under applicable regulations and interpretations of the 1940 Act or an exemptive order; (b) a Fund may acquire other securities, the acquisition of which may result in the issuance of a senior security, to the extent permitted under applicable regulations or interpretations of the 1940 Act; and (c) subject to the restrictions set forth above, a Fund may borrow money as authorized by the 1940 Act. For purposes of this restriction, collateral arrangements with respect to a Fund's permissible options and futures transactions, including deposits of initial and variation margin, are not considered to be the issuance of a senior security; or (7) May not underwrite securities issued by other persons except insofar as a Fund may technically be deemed to be an underwriter under the 1933 Act in selling a portfolio security. In addition, as a matter of fundamental policy, notwithstanding any other investment policy or restriction, a Fund may seek to achieve its investment objective by investing all of its investable assets in another investment company having substantially the same investment objective and policies as the Fund. For purposes of investment restriction (2) above, loan participators are considered to be debt instruments. For the Tax Free Money Market Fund, California Tax Free Money Market Fund and New York Tax Free Money Market Fund, the Funds' 80% investment policy is fundamental and may not be changed without shareholder approval. For purposes of investment restriction (5) above, real estate includes real estate limited partnerships. For purposes of investment restriction (3) above, industrial development bonds, where the payment of principal and interest is the ultimate responsibility of companies within the same industry, are grouped together as an "industry." Investment restriction (3) above, however, is not applicable to investments by a Fund in municipal obligations where the issuer is regarded as a state, city, municipality or other public authority since such entities are not members of any "industry." Supranational organizations are collectively considered to be members of a single "industry" for purposes of restriction (3) above. FUTURE CHANGES TO FUNDAMENTAL INVESTMENT POLICES AND RESTRICTIONS. On August 19, 2004, the Board of Trustees of the Trust approved a proposal to amend each Fund's fundamental investment restriction with respect to borrowing, subject to the approval of shareholders. Shareholders will be asked to approve this proposed revised restriction at special meetings of shareholders scheduled to be held on January 20, 2005. If approved by shareholders, the fundamental investment restriction with respect to borrowing will be as indicated below. BORROWING: No Fund may borrow money, except to the extent permitted by applicable law. 15 NON-FUNDAMENTAL INVESTMENT RESTRICTIONS In addition, each Fund is subject to the following non-fundamental investment restrictions which may be changed without shareholder approval: (1) Each Fund may not, with respect to 75% of its assets, hold more than 10% of the outstanding voting securities of any issuer or invest more than 5% of its assets in the securities of any one issuer (other than obligations of the U.S. government, its agencies and instrumentalities). (2) Each Fund may not make short sales of securities, other than short sales "against the box," or purchase securities on margin except for short-term credits necessary for clearance of portfolio transactions, provided that this restriction will not be applied to limit the use of options, futures contracts and related options, in the manner otherwise permitted by the investment restrictions, policies and investment program of a Fund. The Funds have no current intention of making short sales against the box. (3) Each Fund may not purchase or sell interests in oil, gas or mineral leases. (4) Each Fund may not invest more than 10% of its net assets in illiquid securities. (5) Each Fund may not write, purchase or sell any put or call option or any combination thereof, provided that this shall not prevent (i) the writing, purchasing or selling of puts, calls or combinations thereof with respect to portfolio securities or (ii) with respect to a Fund's permissible futures and options transactions, the writing, purchasing, ownership, holding or selling of futures and options positions or of puts, calls or combinations thereof with respect to futures. (6) Each Fund may invest up to 5% of its total assets in the securities of any one investment company, but may not own more than 3% of the securities of any one investment company or invest more than 10% of its total assets in the securities of other investment companies. (7) Each Fund may not acquire the securities of registered open-end investment companies or registered unit investment trusts in reliance on Section 12(d)(1)(F) or 12(d)(1)(G) of the 1940 Act. (8) The U.S. Government Money Market Fund may not change its policy of investing, under normal circumstances, at least 80% of its assets in U.S. Government securities, as defined in the Prospectus, unless the Fund provides shareholders with at least 60 days prior written notice of such change. For purposes of investment restriction (4) above, illiquid securities includes securities restricted as to resale unless they are determined to be readily marketable in accordance with procedures established by the Board of Trustees. The investment objective of each Fund is non-fundamental. For purposes of the Funds' investment restrictions, the issuer of a tax-exempt security is deemed to be the entity (public or private) ultimately responsible for the payment of the principal of and interest on the security. If a percentage or rating restriction on investment or use of assets set forth herein or in a Prospectus is adhered to at the time of investment, later changes in percentage or ratings resulting from any cause other than actions by a Fund will not be considered a violation. If the value of a Fund's holdings of illiquid securities at any time exceeds the percentage limitation applicable at the time of acquisition due to subsequent fluctuations in value or other reasons, the Board of Trustees will consider what actions, if any, are appropriate to maintain adequate liquidity. 16 TRUSTEES The names of the Trustees of the Funds, together with information regarding the year of their birth, the date each Trustee first became a board member of the JPMorgan Funds, principal occupations and other board memberships, including those in any company with a class of securities registered pursuant to Section 12 of the Securities Exchange Act of 1934, as amended (the "Securities Exchange Act") or subject to the requirements of Section 15(d) of the Securities Exchange Act or any company registered as an investment company under the 1940 Act, are shown below. The contact address for each of the Trustees is 522 Fifth Avenue, New York, NY 10036.
NUMBER OF PORTFOLIOS IN FUND NAME (YEAR OF BIRTH); COMPLEX(1) POSITIONS WITH THE FUNDS PRINCIPAL OCCUPATIONS OVERSEEN BY OTHER DIRECTORSHIPS HELD (SINCE) DURING PAST 5 YEARS TRUSTEE OUTSIDE FUND COMPLEX INDEPENDENT TRUSTEES WILLIAM J. ARMSTRONG (1941); Retired; Vice-President & Treasurer 69 None Trustee since 1987. of Ingersoll-Rand Company (manufacturer of industrial equipment) (1972-2000). ROLAND R. EPPLEY, JR. (1932); Retired. 69 Director of Janel Hydro Inc. (Automotive) Trustee since 1989. (1993-present) DR. MATTHEW GOLDSTEIN (1941); Chancellor of the City University 69 Trustee of the Albert Einstein School of Trustee since 2003. of New York (1999-present); Medicine (1998-present); Director of President, Adelphi University National Financial Partners (financial (New York) (1998-1999). services distributor) (2003-present); Trustee of Bronx Lebanon Hospital Center (1992-present); Director of New Plan Excel Realty Trust, Inc (real estate investment trust) (2000-present); Director of Lincoln Center Institute for the Arts in Education (1999-present) ANN MAYNARD GRAY** (1945); Vice President of Capital 69 Director of Duke Energy Corporation Trustee since 2001. Cities/ABC, Inc. (communications) (1997-present) Director of Elan (1986-1998). Corporation, Plc (pharmaceuticals) (2001-present); Director of The Phoenix Companies (wealth management services) (2002-present) MATTHEW HEALEY (1937); Retired; Chief Executive Officer of 69 None Trustee since [____]. certain J.P. Morgan Fund trusts (1982-2001).
17
NUMBER OF PORTFOLIOS IN FUND NAME (YEAR OF BIRTH); COMPLEX(1) POSITIONS WITH THE FUNDS PRINCIPAL OCCUPATIONS OVERSEEN BY OTHER DIRECTORSHIPS HELD (SINCE) DURING PAST 5 YEARS TRUSTEE OUTSIDE FUND COMPLEX ROBERT J. HIGGINS (1945); Retired; Director of Administration 69 Director of Providian Financial Corp. Trustee since 2002. of the State of Rhode Island (banking) (2002-present) (2003-2004); President - Consumer Banking and Investment Services Fleet Boston Financial (1971-2002) WILLIAM G. MORTON, JR. Retired; Chairman Emeritus 69 Director of Radio Shack Corporation (1937); Trustee since 2003. (2001-2002), and Chairman and (electronics) (1987-present); Director of Chief Executive Officer, Boston The Griswold Company (securities Stock Exchange (1985-2001) brokerage) (2002-2004); Trustee of Morgan Stanley Institutional Funds (1993-2003); Director of The National Football Foundation and College Hall of Fame (1994-present); Trustee of the Berklee College of Music (1998-present); Trustee of the Stratton Mountain School (2001-present) FERGUS REID, III (1932); Trustee Chairman of Lumelite Corporation 69 Trustee of Morgan Stanley Funds (Chairman) since 1987. (plastics manufacturing) (209 portfolios) (1995-present) (2003-present); Chairman and CEO of Lumelite Corporation (1985-2002) JAMES J. SCHONBACHLER (1943); Retired; Managing Director of 69 None Trustee since 2001. Bankers Trust Company (financial services) (1968-1998) INTERESTED TRUSTEE LEONARD M. SPALDING, JR.* Retired; Chief Executive Officer of 69 None (1935); Trustee since 1998. Chase Mutual Funds (investment company) (1989-1998); Chief Investment Executive of Chase Manhattan Private Bank (investment management) (1990-1998)
(1) A Fund Complex means two or more investment companies that hold themselves out to investors as related companies for purposes of investment and investment services or have a common investment adviser or have an investment adviser that is an affiliated person of the investment adviser of any of the other investment companies. The JPMorgan Fund Complex for which the Board of Trustees serves includes 13 investment companies. 18 * Mr. Spalding is deemed to be an "interested person" due to his ownership of JPMorgan Chase & Co. stock. ** Dana Maynard Gray, the daughter of Ann Maynard Gray, became an employee of JPMorgan Securities, Inc., as an Associate Analyst on May 3, 2004. Each Trustee serves for an indefinite term, subject to the Funds' current retirement policies, which is age 73 for all Trustees, except Messrs. Reid and Eppley, for whom it is age 75. The Boards decide upon general policies and are responsible for overseeing the business affairs of the Trust. STANDING COMMITTEES. The Board of Trustees of each JPMorgan Fund currently has four standing committees: the Audit, Valuation, Investment, and Governance Committees. The Board does not have a Compensation Committee. The members of the Audit Committee are Messrs. Armstrong (Chairman), Eppley and Schonbachler. The purposes of the Audit Committee are: (i) to appoint and determine compensation of the Funds' independent accountants; (ii) to oversee of the performance of the Funds' audit, accounting and financial reporting policies, practices and internal controls; (iii) to approve of non-audit services, as required by the statutes and regulations administered by the SEC, including the 1940 Act and the Sarbanes-Oxley Act of 2002; (iv) to oversee the quality and objectivity of the Funds' independent audit and the financial statements of the Funds; and (v) to act as a liaison between the Funds' independent auditors and the full Board. The Audit Committee met four times during the fiscal year ended August 31, 2004. The members of the Valuation Committee are Mr. Healey (Chairman) and Ms. Gray. The function of the Valuation Committee is to assist the Board in its oversight of the valuation of the Funds' securities by JPMIM, the adviser to the Funds, as well as any sub-adviser. In instances in which the valuation procedures of the Funds require Board action, but it is impracticable or impossible to hold a meeting of the entire Board, the Valuation Committee will act in lieu of the full Board. Consequently the Valuation Committee has been consulted by management of the JPMorgan Funds on [____] occasions during the fiscal year ended August 31, 2004. The members of the Investment Committee are Messrs. Spalding (Chairman) and Goldstein. The function of the Investment Committee is to assist the Board in the oversight of the investment management services provided by the Adviser to the Funds, as well as any sub-adviser to the Funds. The full Board may delegate to the Investment Committee from time to time the authority to make Board level decisions on an interim basis when it is impractical to convene a meeting of the full Board. The Investment Committee met on two occasions during the fiscal year ended August 31, 2004. The members of the Governance Committee are Messrs. Reid (Chairman), Higgins and Morton, who are each Independent Trustees of the JPMorgan Funds. The responsibilities of the Governance Committee include (i) the selection and nomination of persons for election and appointment as Trustees, (ii) the review of shareholder correspondence to the Board, (iii) the review of nominees recommended to the Board; (iv) review of Trustees compensation; and (v) recommendation of Independent Trustee Counsel and Fund legal counsel. The Governance Committee met on __ occasions during the fiscal year ended August 31, 2004. When evaluating a person as a potential nominee to serve as an Independent Trustee, the Governance Committee may consider, among other factors, (i) whether or not the person is "independent" and whether the person is other wise qualified under applicable laws and regulations to serve as a Trustee; (ii) whether or not the person is willing to serve, and willing and able to commit the time necessary for the performance of the duties of an Independent Trustee; (iii) the contribution that the person can make to the Boards and the JPMorgan Funds, with consideration being given to the person's business experience, education and such other factors as the Committee may consider relevant; (iv) the character and integrity of the person; (v) the desirable personality traits, including independence, leadership and the ability to work with the other members of the Board; and (vi) consistency with the 1940 Act. The process of identifying nominees involves the consideration of candidates recommended by one or more of the following: current Independent Trustees, officers, shareholders and other sources that the Governance Committee deems appropriate. The Governance Committee will review nominees recommended to the Boards by shareholders and will evaluate such nominees in the same manner as it evaluate nominees identified by the Governance Committee. At the special meetings of shareholders scheduled to be held on January 20, 2005, shareholders of record on October 27, 2004 will be asked to elect trustees. 19 The following table shows the dollar range of each Trustee's beneficial ownership as of December 31, 2004 in the Funds and each Trustee's aggregate ownership in any Funds that the Trustee oversees in the Family of Investment Companies:
OWNERSHIP OF PRIME MONEY OWNERSHIP OF FEDERAL MONEY OWNERSHIP OF TREASURY NAME OF TRUSTEE MARKET FUND MARKET FUND PLUS MONEY MARKET FUND INDEPENDENT TRUSTEES William J. Armstrong Roland R. Eppley, Jr. Dr. Matthew Goldstein Ann Maynard Gray Matthew Healey Robert J. Higgins William G. Morton, Jr. Fergus Reid, III James J. Schonbachler INTERESTED TRUSTEE Leonard M. Spalding, Jr.
OWNERSHIP OF 100% U.S. OWNERSHIP OF U.S. OWNERSHIP OF TAX FREE MONEY TREASURY SECURITIES GOVERNMENT NAME OF TRUSTEE MARKET FUND MONEY MARKET FUND MONEY MARKET FUND INDEPENDENT TRUSTEES William J. Armstrong Roland R. Eppley, Jr. Dr. Matthew Goldstein Ann Maynard Gray Matthew Healey Robert J. Higgins William G. Morton, Jr. Fergus Reid, III James J. Schonbachler INTERESTED TRUSTEE Leonard M. Spalding, Jr.
OWNERSHIP OF AGGREGATE OWNERSHIP OWNERSHIP OF NEW YORK OWNERSHIP OF OF ALL REGISTERED LIQUID ASSETS MUNICIPAL CALIFORNIA INVESTMENT COMPANIES MONEY MARKET MONEY MARKET TAX FREE OVERSEEN BY NAME OF TRUSTEE FUND FUND MONEY MARKET FUND TRUSTEE(1) INDEPENDENT TRUSTEES William J. Armstrong Roland R. Eppley, Jr. Dr. Matthew Goldstein Ann Maynard Gray Matthew Healey Robert J. Higgins
20
OWNERSHIP OF AGGREGATE OWNERSHIP OWNERSHIP OF NEW YORK OWNERSHIP OF OF ALL REGISTERED LIQUID ASSETS MUNICIPAL CALIFORNIA INVESTMENT COMPANIES MONEY MARKET MONEY MARKET TAX FREE OVERSEEN BY NAME OF TRUSTEE FUND FUND MONEY MARKET FUND TRUSTEE(1) William G. Morton, Jr. Fergus Reid, III James J. Schonbachler INTERESTED TRUSTEE Leonard M. Spalding, Jr.
(1) A Family of Investment Companies means any two or more registered investment companies that share the same investment adviser or principal underwriter and hold themselves out to investors as related companies for purposes of investment and investor services. The Family of Investment Companies for which the Board of Trustees serves includes 11 investment companies. As of December 31, 2004, none of the independent Trustees or their immediate family members owned securities of the Adviser or OGDS, the Funds' distributor or a person (other than a registered investment company) directly or indirectly controlling, controlled by or under common control with the Adviser or OGDS. Each Trustee is currently paid an annual fee of $120,000 for serving as Trustee of the Funds and the JPMorgan Fund Complex. Each is reimbursed for expenses incurred in connection with service as a Trustee. For his services as Chairman of the Board of Trustees of the JPMorgan Fund Complex, Mr. Reid is paid an additional $130,000. As of July 16, 2003 Messrs. Armstrong, Spalding and Healey are paid an additional $40,000 for their services as Committee Chairmen. The Board of Trustees may hold various other directorships unrelated to the JPMorgan Fund Complex. 21 Trustee aggregate compensation expenses paid by the Funds and the JPMorgan Fund Complex for the calendar year ended December 31, 2004 are set forth below: AGGREGATE TRUSTEE COMPENSATION PAID BY THE FUNDS
100% U.S. TREASURY CALIFORNIA NEW YORK SECURITIES TAX FREE FEDERAL TAX FREE MONEY MARKET MONEY MONEY MONEY PRIME MONEY NAME OF TRUSTEES FUND MARKET FUND MARKET FUND MARKET FUND MARKET FUND INDEPENDENT TRUSTEES William J. Armstrong Roland R. Eppley, Jr. Dr. Matthew Goldstein Ann Maynard Gray Matthew Healey Robert J. Higgins William G. Morton, Jr. Fergus Reid, III James J. Schonbachler INTERESTED TRUSTEE Leonard M. Spalding, Jr. *
LIQUID TOTAL TAX FREE TREASURY U.S. ASSETS COMPENSATION MONEY PLUS MONEY GOVERNMENT MONEY PAID FROM MARKET MARKET MONEY MARKET "FUND NAME OF TRUSTEES FUND FUND MARKET FUND FUND COMPLEX"(1) INDEPENDENT TRUSTEES William J. Armstrong Roland R. Eppley, Jr. Dr. Matthew Goldstein Ann Maynard Gray Matthew Healey Robert J. Higgins William G. Morton, Jr. Fergus Reid, III James J. Schonbachler INTERESTED TRUSTEE Leonard M. Spalding, Jr.*
* Mr. Spalding is deemed to be an "interested person" due to his ownership of JPMorgan Chase & Co. stock. (1) A Fund Complex means two or more investment companies that hold themselves out to investors as related companies for purposes of investment and investment services, or have a common investment adviser or have an investment adviser that is an affiliated person of the investment adviser of any of the other investment companies. The JPMorgan Fund Complex for which the Board of Trustees serves includes 13 investment companies. The Trustees instituted a Deferred Compensation Plan for Eligible Trustees (the "Deferred Compensation Plan") pursuant to which each Trustee (who is not an employee of the former Chase Vista Funds' adviser, administrator or distributor or any of their affiliates) may enter into agreements with such Funds whereby payment of the Trustees' 22 fees are deferred until the payment date elected by the Trustee (or the Trustee's termination of service). The deferred amounts are deemed invested in shares of funds as elected by the Trustee at the time of deferral. If a deferring Trustee dies prior to the distribution of amounts held in the deferral account, the balance of the deferral account will be distributed to the Trustee's designated beneficiary in a single lump sum payment as soon as practicable after such deferring Trustee's death. Messrs. Armstrong, Eppley, Reid and Spalding are the only Trustees who have elected to defer compensation under such plan. The Declaration of Trust provides that the Trusts will indemnify their Trustees and officers against liabilities and expenses incurred in connection with litigation in which they may be involved because of their offices with the Trusts, unless, as to liability to the Trusts or their shareholders, it is finally adjudicated that they engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in their offices or with respect to any matter unless it is finally adjudicated that they did not act in good faith in the reasonable belief that their actions were in the best interest of the Trusts. In the case of settlement, such indemnification will not be provided unless it has been determined by a court or other body approving the settlement or disposition, or by a reasonable determination based upon a review of readily available facts, by vote of a majority of disinterested Trustees or in a written opinion of independent counsel, that such officers or Trustees have not engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of their duties. OFFICERS The Funds' executive officers (listed below) are generally employees of the Adviser. The officers conduct and supervise the business operations of the Funds. The officers hold office until a successor has been elected and duly qualified. The Funds have no employees. The names of the officers of the Funds, together with their year of birth, information regarding their positions held with the Funds and principal occupations are shown below. The contact address for each of the officers unless otherwise noted is 522 Fifth Avenue, New York, NY 10036.
NAME (YEAR OF BIRTH), POSITIONS HELD WITH PRINCIPAL OCCUPATIONS THE FUNDS (SINCE) DURING PAST 5 YEARS ----------------- ------------------- George C.W. Gatch (1962), Managing Director, JPMIM; Head of J.P. Morgan Fleming's U.S. Mutual Funds and President (2001) Financial Intermediaries Business ("FFI"); he has held numerous positions throughout the firm in business management, marketing and sales. Robert L. Young (1963), Mr. Young joined Banc One Investment Advisors Corporation in 1996 and in 1999 he Senior Vice President (2004)** became Vice President and Treasurer of One Group Administrative Services, Inc. and One Group Dealer Services, Inc. and in 2001, Mr. Young became the COO of the One Group Mutual Funds. Patricia A. Maleski (1960), Vice President, JPMIM, head of FFI and US Institutional Funds Administration and Vice President and Chief Board Liaison. Prior to joining JPMorgan in 2001, she was the Vice President of Administrative Officer (2004) Finance for the Pierpont Group, Inc., a service provider to the board of trustees of the heritage JPMorgan Funds. Wayne H. Chan (1965), Vice Vice President and Assistant General Counsel, JPMIM, since September 2002; Mr. Chan President and Assistant was an associate at the law firm of Shearman & Sterling from May 2001 through Secretary (2003) September 2002; Swidler Berlin Shereff Friedman LLP from June 1999 through May 2001 and Whitman Breed Abbott & Morgan LLP from September 1997 through May 1999.
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NAME (YEAR OF BIRTH), POSITIONS HELD WITH PRINCIPAL OCCUPATIONS THE FUNDS (SINCE) DURING PAST 5 YEARS ----------------- ------------------- Stephanie J. Dorsey (1969), Director of Mutual Fund Administration, One Group Administrative Services, since Treasurer (2004)** January 2004; Ms. Dorsey worked for Bank One Corporation from January 2003 to January 2004; Prior to joining Bank One Corporation, held various positions at PricewaterhouseCoopers LLP from September 1992. Jessica K. Ditullio (1963), From August 1990 to present, various attorney positions for Bank One Corporation Assistant Secretary (2004)** (now known as JPMorgan Chase & Co.) Nancy E. Fields (1949), From October 1999 to present, Director, Mutual Fund Administration, One Group Assistant Secretary (2004)** Administrative Services, Inc. and Senior Project Manager, Mutual Funds, One Group Dealer Services, Inc. From July 1999 to October 1999, Project Manager, One Group, Banc One Investment Advisors Corporation. Alaina Metz (1967), Assistant Chief Administrative Officer of BISYS Fund Services, Inc.; formerly, Supervisor of Secretary (2001)* the Blue Sky Department of Alliance Capital Management L.P. Martin R. Dean (1963), Vice President of Regulatory Services of BISYS Fund Services, Inc. Assistant Treasurer (2001)* Arthur A. Jensen (1966), Vice President of Financial Services of BISYS Fund Services, Inc., since June 2001; Assistant Treasurer (2001)* formerly Section Manager at Northern Trust Company and Accounting Supervisor at Allstate Insurance Company. Christopher D. Walsh (1965), Vice President, JPMIM; Mr. Walsh manages all aspects of institutional and retail Assistant Treasurer (2004) mutual fund administration and vendor relationships within the mutual funds, commingled/ERISA funds, 3(c)(7) funds, hedge funds and LLC products. Prior to joining JPMorgan in 2000, he was a director from 1996 to 2000 of Mutual Fund Administration at Prudential Investments. Paul M. DeRusso (1954), Vice President, JPMIM; Manager of the Budgeting and Expense Group of Funds Assistant Treasurer (2001) Administration Group. Mary D. Squires (1955), Vice President, JPMIM; Ms. Squires has held numerous financial and operations Assistant Treasurer (2001) positions supporting the JPMorgan Chase organization complex. Stephen M. Ungerman (1953), Vice President, JPMIM; Fund Administration - Pooled Vehicles; prior to joining Chief Compliance Officer JPMorgan Chase in 2000, he held a number of positions in Prudential Financial's (2004) asset management business, including Assistant General Counsel, Tax Director and Co-head of Fund Administration; Mr. Ungerman also served as Assistant Treasurer for all mutual funds managed by Prudential.
* The contact address for the officer is 3435 Stelzer Road, Columbus, OH 43219. ** The contact address for the officer is 1111 Polaris Parkway, Columbus, OH 43271. As of December __, 2004, the Officers and Trustees as a group owned less than 1% of the shares of any class of each Fund. CODES OF ETHICS The Funds, the Adviser and OGDS have adopted codes of ethics pursuant to Rule 17j-1 under the 1940 Act. Each of these codes permits personnel subject to such code to invest in securities, including securities that may be purchased or held by the Funds. Such purchases, however, are subject to procedures reasonably necessary to prevent access persons from engaging in any unlawful conduct set forth in Rule 17j-1. 24 OGDS is the Funds' distributor. See "Distributor" for more information. OGDS has adopted a Code of Ethics that requires that all employees of OGDS must: (i) place the interest of the accounts which are managed by affiliates of OGDS first; (ii) conduct all personal securities transactions in a manner that is consistent with the Code of Ethics and the individual employee's position of trust and responsibility; and (iii) refrain from taking inappropriate advantage of their positions. Employees of OGDS are also prohibited from certain mutual fund trading activity including "excessive trading" of shares of a mutual fund as such term is defined in the applicable mutual fund's prospectus or Statement of Additional Information or effecting or facilitating a mutual fund transaction to engage in market timing. OGDS's Code of Ethics permits personnel subject to the code to invest in securities including securities that may be purchased or held by the Funds subject to the policies and restrictions in such Code of Ethics. PROXY VOTING PROCEDURES AND GUIDELINES The Boards of Trustees of the Funds have delegated to the Funds' investment adviser, JPMIM, and its affiliated advisers, proxy voting authority with respect to the Funds' portfolio securities. Most of the securities in which the Funds invest, however, are rarely required, or permitted, to vote. To ensure that the proxies of portfolio companies are voted in the best interests of the Funds, the Funds' Board has adopted JPMIM's detailed proxy voting procedures (the "Procedures") that incorporate guidelines ("Guidelines") for voting proxies on specific types of issues. The Guidelines have been developed with the objective of encouraging corporate action that enhances shareholder value. Except as noted below, proxy voting decisions will be made in accordance with the Guidelines covering a multitude of both routine and non-routine matters that JPMIM and its affiliated advisers have encountered globally, based on many years of collective investment management experience. To oversee and monitor the proxy-voting process, JPMIM has established a proxy committee and appointed a proxy administrator in each global location where proxies are voted. The primary function of each proxy committee is to review periodically general proxy-voting matters, review and approve the Guidelines annually, and provide advice and recommendations on general proxy-voting matters as well as on specific voting issues. The procedures permit an independent voting service, currently Institutional Shareholder Services, Inc. ("ISS"), to perform certain services otherwise carried out or coordinated by the proxy administrator. Although for many matters the Guidelines specify the votes to be cast, for many others, the Guidelines contemplate case-by-case determinations. In addition, there will undoubtedly be proxy matters that are not contemplated by the Guidelines. For both of these categories of matters and to override the Guidelines, the Procedures require a certification and review process to be completed before the vote is cast. That process is designed to identify actual or potential material conflicts of interest (between a Fund on the one hand, and JPMIM, the Fund's principal underwriter or an affiliate of any of the foregoing, on the other hand) and ensure that the proxy vote is cast in the best interests of the Fund. When a potential material conflict of interest has been identified, the proxy administrator and a subgroup of proxy committee members (composed of a member from the Investment Department and one or more members from the Legal, Compliance or Risk Management Departments) will evaluate the potential conflict of interest and determine whether such conflict actually exists, and if so, will recommend how JPMIM will vote the proxy. In addressing any material conflict, JPMIM may take one or more of the following measures (or other appropriate action): removing or "walling off" from the proxy voting process certain JPMIM personnel with knowledge of the conflict, voting in accordance with any applicable Guideline if the application of the Guideline would objectively result in the casting of a proxy vote in a predetermined manner or deferring the vote to ISS, which will vote in accordance with its own recommendation. The following summarizes some of the more noteworthy types of proxy voting policies of the U.S. Guidelines: - JPMIM considers votes on director nominees on a case-by-case basis. Votes generally will be withheld from directors who: (a) attend less than 75% of board and committee meetings without a valid excuse; (b) implement or renew a dead-hand poison pill; (c) are affiliated directors who serve on audit, compensation or nominating committees or are affiliated directors and the full board serves on such committees or the company does not have such committees; or (d) ignore a shareholder proposal that is approved for two consecutive years by a majority of either the shares outstanding or the votes cast. - JPMIM votes proposals to classify Boards on a case-by-case basis, but will vote in favor of such proposal if the issuer's governing documents contain each of eight enumerated safeguards (for example, a majority of the board is composed of independent directors and the nominating committee is composed solely of such directors). - JPMIM also considers management poison pill proposals on a case-by-case basis, looking for shareholder-friendly provisions before voting in favor. 25 - JPMIM votes against proposals for a super-majority vote to approve a merger. - JPMIM considers proposals to increase common and/or preferred shares and to issue shares as part of a debt restructuring plan on a case-by-case basis, taking into account the extent of dilution and whether the transaction will result in a change in control. - JPMIM votes proposals on a stock option plan, based primarily on a detailed, quantitative analysis that takes into account factors such as estimated dilution to shareholders' equity and dilution to voting power. JPMIM generally considers other management compensation proposals on a case-by-case basis. JPMIM also considers on a case-by-case basis proposals to change an issuer's state of incorporation, mergers and acquisitions and other corporate restructuring proposals and certain social and environmental issue proposals. In accordance with regulations of the SEC, the Funds' proxy voting records for the twelve-month period ended June 30, 2004 are on file with the SEC. PORTFOLIO HOLDINGS DISCLOSURE As described in the Prospectuses and pursuant to the procedures approved by the Trustees, each business day, the Funds will make available to the public, upon request to the JPMorgan Service Center (1-800-348-4782) or the JPMorgan Institutional Funds Service Center (1-800-766-7722), as applicable, an uncertified complete schedule of its portfolio holdings as of the prior business day. The Funds' publicly available uncertified complete list of portfolio holdings information, as described above, may also be provided regularly pursuant to a standing request, such as on a monthly or quarterly basis, to (i) third party service providers, rating and ranking agencies, financial intermediaries, and affiliated persons of the Funds (ii) clients of the Adviser or its affiliates that invest in the Funds or such clients' consultants. No compensation or other consideration is received by the Funds or the Adviser, or any other person for these disclosures. A list of the entities that receive the Funds' portfolio holdings information on such basis and the frequency with which it is provided to them is provided below: In addition, certain service providers to the Funds or the Adviser, Administrator, Shareholder Servicing Agent or Distributor may for legitimate business purposes receive the Funds' portfolio holdings information earlier than as provided in the first paragraph above, including pricing services, accountants, attorneys, and custodians. Such holdings are released on conditions of confidentiality which include appropriate trading prohibitions. "Conditions of confidentiality" include confidentiality terms included in written agreements, implied by the nature of the relationship (e.g., attorney --client relationship), or required by fiduciary or regulatory principles (e.g., custody services provided by financial institutions). Disclosure of the Funds' portfolio securities as an exception to the Funds' normal business practice must be approved by the Funds' Treasurer following business and compliance review, in accordance with the Funds' procedures. No compensation or other consideration is received by the Funds or the Adviser, or any person for these disclosures. The Funds' Trustees' will review at least annually a list of such entities that have received such information, the frequency of such disclosures and the business purpose therefor. These procedures seek to ensure that disclosure of information about the Funds' portfolio securities is in the best interests of the Funds' shareholders. The identity of such entities, the frequency with which they receive such information and the length of the lag between the date of the information and the date it is disclosed is provided below: Portfolio holdings of each Fund will be disclosed on a quarterly basis on forms required to be filed with the SEC as follows: (i) portfolio holdings as of the end of each fiscal year will be filed as part of the annual report filed on Form N-CSR; (ii) portfolio holdings as of the end of the first and third fiscal quarters will be filed on Form N-Q; and (iii) portfolio holdings as of the end of the six month period will be filed as part of the semi-annual report filed on Form N-CSR. The Trust's Form N-CSRs and Form N-Qs will be available on the SEC website at www.sec.gov. Finally, the Funds release information concerning any and all portfolio holdings when required by law. Such releases may include providing information concerning holdings of a specific security to the issuer of such security. INVESTMENT ADVISER Pursuant to an Investment Advisory Agreement (the "Advisory Agreement"), between the Trust on behalf of the Funds and JPMIM, JPMIM serves as investment adviser, as discussed in the "General" section. Subject to the supervision of the Funds' Trustees, the Adviser makes the Funds' day-to-day investment decisions, arranges for the execution of portfolio transactions and generally manages the investments for the Funds. Effective October 1, 2003, JPMIM became a wholly-owned subsidiary of J.P. Morgan Fleming Asset Management Holdings, Inc. ("JPMFAMH"), which is a wholly-owned subsidiary of JPMorgan Chase. Prior to October 1, 2003, JPMIM was a wholly-owned subsidiary of JPMorgan Chase. JPMIM is a registered investment adviser under the Investment Advisers Act of 1940, as amended (the "Investment Advisers Act"). JPMIM acts as investment adviser to individuals, governments, corporations, employee benefit plans, labor unions and state and local governments, mutual funds and other institutional investors. JPMIM is located at 522 Fifth Avenue, New York, NY 10036. Certain of the assets of employee benefit accounts under the Adviser's management are invested in commingled pension trust funds for which JPMorgan Chase Bank, NA serves as trustee. Under separate agreements, One Group Administrative Services, Inc. ("OGA"), an affiliate of the Adviser and OGDS, provides certain financial, fund accounting, record keeping and administrative services to the Trusts, the Corporation and the Funds and shareholder services for the Trusts. OGDS is the shareholder servicing agent for the Funds. See the "Administrator" and "Shareholder Servicing" sections. 26 JPMorgan Chase, a bank holding company organized under the laws of the State of Delaware, was formed from the merger of J.P. Morgan & Co. Incorporated with and into The Chase Manhattan Corporation. JPMorgan Chase has a long history of offering a wide range of banking and investment services to customers throughout the United States and the world. The firm, through its predecessor companies, has been in business for over a century. The investment advisory services the Adviser provides to the Funds are not exclusive under the terms of the Advisory Agreement. The Adviser is free to and does render similar investment advisory services to others. The Adviser serves as investment adviser to personal investors and other investment companies and acts as fiduciary for trusts, estates and employee benefit plans. Certain of the assets of trusts and estates under management are invested in common trust funds for which the Adviser serves as trustee. The accounts which are managed or advised by the Adviser have varying investment objectives and the Adviser invests assets of such accounts in investments substantially similar to, or the same as, those which are expected to constitute the principal investments of the Funds. Such accounts are supervised by employees of the Adviser who may also be acting in similar capacities for the Funds. See the "Portfolio Transactions" section. The Funds are managed by employees of the Adviser who, in acting for their customers, including the Funds, do not discuss their investment decisions with any personnel of JPMorgan Chase or any personnel of other divisions of the Adviser or with any of their affiliated persons, with the exception of certain other investment management affiliates of JPMorgan Chase which execute transactions on behalf of the Funds. On August 19, 2004, the Boards of Trustees of the Trusts approved amendments to the Advisory Agreements reflecting (i) the new names of the Funds effective February 19, 2005, (ii) new advisory fees for certain series of the Funds, (iii) the contingent removal of each of the Funds from the Advisory Agreement effective upon the closing of the reorganization or reorganization and redomiciliation of the Fund, as applicable, to the extent such transaction is approved by shareholders of the Fund. Prior to September 1, 2003, J.P. Morgan Fleming Asset Management (USA) Inc. ("JPMFAM (USA)"), a wholly-owned subsidiary of JPMorgan Chase Bank, was the investment adviser to the Funds. On September 1, 2003, JPMFAM (USA) merged into JPMIM. The investment advisory services and personnel providing investment advice have not changed as a result of the merger. As compensation for the services rendered and related expenses such as salaries of advisory personnel borne by JPMIM or a predecessor, under the Advisory Agreement, the Trusts, on behalf of the Funds, have agreed to pay the Adviser a fee, which is computed daily and may be paid monthly, equal to the annual rate of each Fund's average daily net assets as described in the Prospectuses. The table below sets forth the investment advisory fees paid to or accrued by JPMIM or JPMFAM (USA) (waived amounts are in parentheses) with respect to the fiscal periods indicated (amounts in thousands):
8/31/02 8/31/03 8/31/04 ------- ------- ------- PRIME MONEY MARKET FUND Paid or Accrued $ 59,806,000 $ 52,172,000 WAIVED - - FEDERAL MONEY MARKET FUND Paid or Accrued 5,711,000 4,200,000 Waived - - TREASURY PLUS MONEY MARKET FUND Paid or Accrued 4,225,000 3,856,000 Waived - - 100% U.S. TREASURY SECURITIES MONEY MARKET FUND Paid or Accrued 5,679,000 5,486,000 Waived - - U.S. GOVERNMENT MONEY MARKET FUND Paid or Accrued 8,805,000 9,277,000 Waived - -
27
8/31/02 8/31/03 8/31/04 ------- ------- ------- TAX FREE MONEY MARKET FUND Paid or Accrued 7,441,000 9,952,000 Waived - - CALIFORNIA MUNICIPAL MONEY MARKET FUND Paid or Accrued 146,000 156,000 Waived - - NEW YORK MUNICIPAL MONEY MARKET FUND Paid or Accrued 2,349,000 2,121,000 Waived - - LIQUID ASSETS MONEY MARKET FUND Paid or Accrued 278,000 2,256,000 Waived (259,000) (171,000)
The Advisory Agreement provides that it will continue in effect for a period of two years after execution only if specially approved thereafter annually in the same manner as the Distribution Agreements. See the "Distributor" section. The Advisory Agreement will terminate automatically if assigned and is terminable at anytime without penalty by a vote of a majority of the Trustees, or by a vote of the holders of a majority of a Fund's outstanding voting securities, on 60 days' written notice to the Adviser and by the Adviser on 90 days' written notice to the Trust. See "Additional Information." BOARD REVIEW OF INVESTMENT ADVISORY ARRANGEMENTS The Funds' Board of Trustees, including the Board members who are not "interested persons" (as defined in the 1940 Act) of any party to the Advisory Agreement or its affiliates, have approved the Advisory Agreement for the Trust on behalf of each Fund. As part of its review of the investment advisory arrangements for the Funds, the Board of Trustees has requested that the Adviser prepare on a regular basis information regarding the performance of the Funds, their performance against the Funds' peers and benchmarks and analyses by the Adviser of the Funds' performance. The members of the Adviser's investment staff meet with the Board of Trustees to discuss this information and their intentions with regard to the management of the Funds. The Adviser also periodically provides comparative information regarding the Funds' expense ratios and those of the peer groups. In addition, in preparation for its annual approval meeting, the Board of Trustees requests and reviews, with the assistance of its legal counsel, materials from the Adviser regarding comparative fees, expenses, performance and profitability information pertaining to the relationship of the Adviser and the Funds. In approving the Advisory Agreement, the Board of Trustees of the Funds considered the nature, quality and scope of the operations and services provided by the Adviser to each Fund, including their knowledge of the Adviser's investment staff and executive personnel and the overall reputation and capabilities of the Adviser and its affiliates. The Board of Trustees also considered comparative fee information concerning other investment companies with similar investment objectives and policies. The Funds' Board of Trustees compared the terms of the Funds' advisory arrangements and similar arrangements by other investment companies, particularly with regard to levels of advisory fees relative to its peer group. The Board of Trustees also examined the benefits to the Adviser and its affiliates of their relationship with each Fund. Specifically, the Board of Trustees analyzed the benefits that accrued to the Adviser and its affiliates as a result of the fact that affiliates of the Adviser act as custodian, administrator and Financial Intermediary for each Fund and receive fees from each Fund for acting in such capacities. The Board of Trustees also analyzed the information provided by the Adviser regarding the profitability to the Adviser of its relationship with the Funds. Profitability information is not audited and represents the Adviser's determination of its and its affiliates' revenues from the contractual services provided to the Funds, less expenses of providing such services. Expenses include direct and indirect costs and are calculated using an allocation methodology developed by the Adviser. In addition, the Board of Trustees compared overall expense ratios (both pre- and post-expense reimbursement by the Adviser) for each Fund relative to its peer group. The Board of Trustees also considered the performance of the Funds and the intention of the Adviser with regard to management of the Funds, including the commitment of the Adviser to provide high quality services to the Funds, whether there were any conditions likely to 28 affect the ability of the Adviser to provide such services, and its ability to retain and attract qualified personnel to manage each Fund. In reaching their decision to approve the investment advisory contracts, the Board of Trustees did not identify any single factor as being of paramount importance. Based on its evaluation of the information reviewed and after due consideration, the Board of Trustees of each Fund concluded that the current Advisory Agreement enabled the Fund to obtain high-quality services at costs that it deemed appropriate and reasonable and that approval of the agreement was in the best interest of each Fund and its shareholders. ADMINISTRATOR Pursuant to an Administration Agreement dated [ ______ ] (the "Administration Agreement"), between the Trust on behalf of the Funds and OGA, OGA serves as administrator of the Funds. OGA is an affiliate of JPMorgan Chase Bank, an indirect wholly-owned subsidiary of JPMorgan Chase, and has its principal place of business at 1111 Polaris Parkway, Columbus, OH 43271. Pursuant to the Administration Agreement, OGA will assist in supervising all operations of each Fund for which it serves (other than those performed under the advisory agreement, the custodian agreement, the fund accounting agreement and the transfer agency agreement for that Fund). Under the Administration Agreement, OGA has agreed to maintain the necessary office space for the Funds, to price the portfolio securities of each Fund it serves and compute the net asset value and net income of the Funds on a daily basis, to maintain each Fund's financial accounts and records, and to furnish certain other services required by the Funds with respect to each Fund. The Administrator prepares annual and semi-annual reports to the SEC, prepares federal and state tax returns, and generally assists in all aspects of the Funds' operations other than those performed under the advisory agreement, the custodian agreement, fund accounting agreement and the transfer agency agreement. Under the Administration Agreement, OGA may, at its expense, subcontract with any entity or person concerning the provision of services under the Administration Agreement. Unless sooner terminated, the Administration Agreement will continue in effect through October 31, 2006. Thereafter, if not terminated, the Administration Agreement will continue automatically for successive one year terms, provided that such continuance is specifically approved at least annually by the vote of a majority of those members of the Board of Trustees who are not parties to the Administration Agreement or interested persons of any such party. The Administration Agreement may be terminated without penalty, on not less than 60 days prior written notice, by the Board of Trustees or by OGA. The termination of the Administration Agreement with respect to one Fund will not result in the termination of the Administration Agreement with respect to any other Fund. The Administration Agreement provides that OGA shall not be liable for any error of judgment or mistake of law or any loss suffered by the Funds in connection with the matters to which the Administration Agreement relates, except a loss resulting from willful misfeasance, bad faith, or negligence in the performance of its duties, or from the reckless disregard by it or its obligations and duties thereunder. In consideration of the services to be provided by OGA pursuant to the Administration Agreement, OGA will receive from each Fund a pro rata portion of a fee computed daily and paid monthly at an annual rate of 0.10% on the first $100 billion of the average daily net assets of all the money market funds in the JPMorgan Fund Complex and 0.05% of the average daily net assets of the money market funds in the JPMorgan Fund Complex over $100 billion. For purposes of this paragraph, the "JPMorgan Fund Complex" includes the series of One Group Mutual Funds. Prior to February 19, 2005, pursuant to the administration agreements, effective September 10, 2001, between the Trusts, on behalf of the Funds, and a predecessor of JPMorgan Chase Bank (the "Administration Agreements"), JPMorgan Chase Bank was the administrator of the Funds. In consideration of the services that JPMorgan Chase Bank provided pursuant to the Administration Agreements, JPMorgan Chase Bank received from each Fund a pro-rata portion of a fee computed daily and paid monthly at an annual rate equal to 0.10% of each Money Market Fund's average daily net assets of up to $100 billion on an annualized basis for the Fund's then current fiscal year plus 0.05% of the average daily net assets over $100 billion. JPMorgan Chase Bank may have voluntarily waived a portion of the fees payable to it with respect to each Fund. JPMorgan Chase Bank paid a portion of the fees it receives to BISYS Fund Services, L.P for its services as each Fund's sub-administrator. 29 Prior to February 19, 2005, pursuant to an administration agreement dated September 7, 2001, JPMorgan Chase Bank served as administrator to the Funds. For its services under this administration agreement, The table below sets forth the administration, administrative services and co-administration fees paid or accrued by the Funds or Portfolio (the amounts waived are in parentheses) for the fiscal periods indicated (amounts in thousands).
FISCAL YEAR ENDED FISCAL YEAR ENDED FISCAL YEAR ENDED 8/31/02 8/31/03 8/31/04 ------- ------- ------- PRIME MONEY MARKET FUND Paid or Accrued $ 59,033,000 $ 52,172,000 Waived (9,237,000) (4,474,000) FEDERAL MONEY MARKET FUND Paid or Accrued 5,640,000 4,200,000 Waived (1,039,000) (715,000) TREASURY PLUS MONEY MARKET FUND Paid or Accrued 4,182,000 3,856,000 Waived (1,660,000) (1,406,000) TAX FREE MONEY MARKET FUND Paid or Accrued 7,368,000 9,952,000 Waived (2,206,000) (2,279,000) 100% U.S. TREASURY SECURITIES MONEY MARKET FUND Paid or Accrued 5,616,000 5,486,000 Waived (1,103,000) (852,000) U.S. GOVERNMENT MONEY MARKET FUND Paid or Accrued 8,698,000 9,277,000 Waived (4,152,000) (4,203,000) CALIFORNIA MUNICIPAL MONEY MARKET FUND Paid or Accrued 144,000 156,000 Waived (67,000) (89,000) NEW YORK MUNICIPAL MONEY MARKET FUND Paid or Accrued 2,325,000 2,121,000 Waived (823,000) (63,000) LIQUID ASSETS MONEY MARKET FUND Paid or Accrued 278,000 2,256,000 Waived (278,000) (1,846,000)
DISTRIBUTOR OGDS serves as the Trust's exclusive distributor and holds itself available to receive purchase orders for shares of each of the Funds. In that capacity, OGDS has been granted the right, as agent of the Trust, to solicit and accept orders for the purchase of each of the Fund's shares in accordance with the terms of the Distribution Agreement between the Trust and OGDS. Under the terms of the Distribution Agreement between OGDS and the Trust, OGDS receives no compensation in its capacity as the distributor. OGDS is an affiliate of JPMIM and JPMorgan Chase Bank and is a direct, wholly-owned subsidiary of JPMorgan Chase. The principal offices of OGDS are located at 1111 Polaris Parkway, Columbus, OH 43271. Unless otherwise terminated, the Distribution Agreement will continue in effect until October 31, 2006 and will continue thereafter for successive one-year terms if approved at least annually by: (a) the vote of a majority of those members of the Boards of Trustees who are not parties to the Distribution Agreement or interested persons of any such party, cast in person at a meeting for the purpose of voting on such approval and (b) the vote of the Boards of Trustees or the vote of a majority of the outstanding voting securities of the Fund. The Distribution Agreement may be terminated without penalty on not less than 60 days' prior written notice, by the Boards of Trustees, by vote of majority of the outstanding voting securities of the Fund or by the OGDS. The termination of the Distribution Agreement with respect to one Fund will not result in the termination of the Distribution Agreement with respect to any other Fund. The Distribution Agreement may also be terminated in the event of its assignment, as defined in the 1940 Act. OGDS is a broker-dealer registered with the SEC and is a member of the National Association of Securities Dealers, Inc. 30 Prior to February 19, 2005, J.P. Morgan Fund Distributors, Inc., a wholly-owned indirect subsidiary of The BISYS Group, Inc., served as the Trusts' distributor. DISTRIBUTION PLAN The Trust has adopted a plan of distribution pursuant to Rule 12b-1 under the 1940 Act (the "Distribution Plan") on behalf of the Cash Management, Class B and Class C Shares of the Prime Money Market Fund, the Morgan Shares of the Money Market Funds (except the Prime Money Market Fund) and the Reserve Shares of the Prime Money Market Fund, Federal Money Market Fund, 100% U. S. Treasury Securities Money Market Fund, Treasury Plus Money Market Fund, Tax Free Money Market Fund, Tax Free Money Market Fund and New York Municipal Money Market Fund, which provides that each of such classes shall pay for distribution services a distribution fee (the "Distribution Fee"), including payments to OGDS, at annual rates not to exceed the amounts set forth in their respective Prospectuses. OGDS may use all or any portion of such Distribution Fee to pay for Fund expenses of printing prospectuses and reports used for sales purposes, expenses of the preparation and printing of sales literature and other such distribution-related expenses. Promotional activities for the sale of each such class of shares of each Fund will be conducted generally by the JPMorgan Funds, and activities intended to promote one class of shares of a Fund may also benefit the Fund's other shares and other JPMorgan Funds. Anticipated benefits to the Funds that may result from the adoption of the Distribution Plan are economic advantages achieved through economies of scale and enhanced viability if the Funds accumulate a critical mass. The Institutional Class Shares, Premier Shares, Capital Shares and Agency Shares of the Money Market Funds have no Distribution Plan. No class of shares of a Fund will make payments or be liable for any distribution expenses incurred by other classes of shares of such Fund. Some payments under the Distribution Plan may be used to compensate broker-dealers with trail or maintenance commissions in an amount not to exceed 0.75% annualized of the average daily net asset value of the Class B Shares, 0.75% annualized of the average daily net asset value of the Class C Shares or 0.10% annualized of the average daily net asset value of the Morgan Shares of Liquid Assets Money Market Fund maintained in a Fund by such broker-dealers' customers. With respect to Cash Management Shares of Prime Money Market Fund, broker-dealers will be compensated with trail or maintenance commissions of 0.50% annualized of the average daily net asset value. With respect to Reserve Shares of Prime Money Market Fund, Treasury Plus Money Market Fund, Tax Free Money Market Fund and New York Municipal Money Market Fund, broker-dealers will be compensated with trail or maintenance commissions of 0.25% annualized of the average daily net asset value. For Class B, Class C and Morgan Shares, trail or maintenance commissions will be paid to broker-dealers beginning the 13th month following the purchase of such shares. For other classes of shares, such commissions will generally be paid beginning at the time of initial purchase of such shares. Since the distribution fees are not directly tied to expenses, the amount of distribution fees paid by a class of a Fund during any year may be more or less than actual expenses incurred pursuant to the Distribution Plan. OGDS will use its own funds (which may be borrowed or otherwise financed) to pay such amounts. Because OGDS will receive 0.75% on Class B and C Shares, 0.50% on Cash Management Shares, 0.10% on Morgan Shares and 0.25% on Reserve Shares of average daily net assets, the fee will take OGDS several years to recoup the sales commissions paid to dealers and other sales expenses. For this reason, this type of distribution fee arrangement is characterized by the staff of the SEC as being of the "compensation variety" (in contrast to "reimbursement" arrangements by which a distributor's payments are directly linked to its expenses). However, no class of shares of a Fund will make payments or be liable for any distribution expenses incurred by other classes of shares of such Fund. The Capital Class Shares, Institutional Class Shares, Premier Shares and Agency Shares of the Money Market Funds have no Distribution Plan. Each class of shares is entitled to exclusive voting rights with respect to matters concerning its Distribution Plan. The Distribution Plan provides that it will continue in effect indefinitely if such continuance is specifically approved at least annually by a vote of both a majority of the Trustees and a majority of the Trustees who are not "interested persons" (as defined in the 1940 Act) of the Trust and who have no direct or indirect financial interest in the operation of the Distribution Plan or in any agreement related to such plan ("Qualified Trustees"). 31 The Distribution Plan requires that OGDS shall provide to the Board of Trustees, and the Board of Trustees shall review, at least quarterly, a written report of the amounts expended (and the purposes therefor) under the Distribution Plan. The selection and nomination of Qualified Trustees shall be committed to the discretion of the disinterested Trustees (as defined in the 1940 Act) then in office. The Distribution Plan may be terminated with respect to any class of a Fund at any time by a vote of a majority of the Qualified Trustees or by vote of a majority of the outstanding voting shares of the class of such Fund to which it applies (as defined in the 1940 Act and rules thereunder). The Distribution Plan may not be amended to increase materially the amount of permitted expenses thereunder without the approval of affected shareholders and may not be materially amended in any case without a vote of the majority of both the Trustees and the Qualified Trustees. Each of the Funds will preserve copies of any plan, agreement or report made pursuant to the Distribution Plan for a period of not less than six years from the date of the Distribution Plan, and for the first two years such copies will be preserved in an easily accessible place. The Distribution Plan, which was approved by the Board of Trustees of the Trust on August 19, 2004, represents the combination, amendment and restatement of the existing distribution plans adopted under Rule 12b-1 under the 1940 Act by the Trust with respect to the classes of Shares specified above. The table below sets forth Rule 12b-1 fees that the Funds paid to or that were accrued by J.P. Morgan Fund Distributors, Inc. (waived amounts are in parentheses) with respect to fiscal periods indicated (amounts in thousands):
FISCAL YEAR ENDED FISCAL YEAR ENDED 8/31/03 8/31/04 PAID/ACCRUED WAIVED PRIME MONEY MARKET FUND B Shares $ 90,000 - C Shares 5,000 - Reserve Shares 1,011,000 - Cash Management Shares 1,806,000 - FEDERAL MONEY MARKET FUND Morgan Shares 381,000 $ (278,000) TREASURY PLUS MONEY MARKET FUND Morgan Shares 852,000 (646,000) Reserve Shares 590,000 - TAX FREE MONEY MARKET FUND Morgan Shares 702,000 (562,000) 100% U.S. TREASURY SECURITIES MONEY MARKET FUND Morgan Shares 3,168,000 (2,687,000) CALIFORNIA MUNICIPAL MONEY MARKET FUND Morgan Shares 156,000 (156,000) NEW YORK MUNICIPAL MONEY MARKET FUND Morgan Shares 1,940,000 (1,878,000) Reserve Shares 544,000 (139,000) U.S. GOVERNMENT MONEY MARKET FUND Morgan Shares 3,187,000 (1,638,000) Premier Shares 1,012,000 (771,000) LIQUID ASSETS MONEY MARKET FUND Morgan Shares 18,000 (18,000)
Expenses paid by J.P. Morgan Fund Distributors, Inc. related to the distribution of Fund shares under the Distribution Plan during the fiscal year ended August 31, 2004: PRIME MONEY MARKET FUND Advertising and sales literature Printing, production and mailing of prospectuses and shareholder reports to other than current shareholders Compensation to dealers 32 Compensation to sales personnel Class B Shares financing charges Equipment, supplies and other indirect distribution-related expenses FEDERAL MONEY MARKET FUND Advertising and sales literature Printing, production and mailing of prospectuses and shareholder reports to other than current shareholders Compensation to dealers Compensation to sales personnel Class B Shares financing charges Equipment, supplies and other indirect distribution-related expenses TREASURY PLUS MONEY MARKET FUND Advertising and sales literature Printing, production and mailing of prospectuses and shareholder reports to other than current shareholders Compensation to dealers Compensation to sales personnel Class B Shares financing charges Equipment, supplies and other indirect distribution-related expenses TAX FREE MONEY MARKET FUND Advertising and sales literature Printing, production and mailing of prospectuses and shareholder reports to other than current shareholders Compensation to dealers Compensation to sales personnel Class B Shares financing charges Equipment, supplies and other indirect distribution-related expenses 100% U.S. TREASURY SECURITIES MONEY MARKET FUND Advertising and sales literature Printing, production and mailing of prospectuses and shareholder reports to other than current shareholders Compensation to dealers Compensation to sales personnel Class B Shares financing charges Equipment, supplies and other indirect distribution-related expenses CALIFORNIA MUNICIPAL MONEY MARKET FUND Advertising and sales literature Printing, production and mailing of prospectuses and shareholder reports to other than current shareholders Compensation to dealers Compensation to sales personnel Class B Shares financing charges Equipment, supplies and other indirect distribution-related expenses NEW YORK MUNICIPAL MONEY MARKET FUND Advertising and sales literature Printing, production and mailing of prospectuses and shareholder reports to other than current shareholders Compensation to dealers Compensation to sales personnel Class B Shares financing charges Equipment, supplies and other indirect distribution-related expenses U.S. GOVERNMENT MONEY MARKET FUND 33 Advertising and sales literature Printing, production and mailing of prospectuses and shareholder reports to other than current shareholders Compensation to dealers Compensation to sales personnel Class B Shares financing charges Equipment, supplies and other indirect distribution-related expenses LIQUID ASSETS MONEY MARKET FUND Advertising and sales literature Printing, production and mailing of prospectuses and shareholder reports to other than current shareholders Compensation to dealers Compensation to sales personnel Class B Shares financing charges Equipment, supplies and other indirect distribution-related expenses With respect to the Class B Shares of the Funds, the Distribution Fee was paid to FEP Capital L.P. for acting as finance agent. CUSTODIAN Pursuant to the Global Custody Agreement with JPMorgan Chase Bank, NA ("JPMorgan Chase Bank") 3 Chase MetroTech Center, Brooklyn, NY 11245, dated March 1, 2003, JPMorgan Chase Bank serves as the Funds' custodian and fund accounting agent and is responsible for holding portfolio securities and cash and maintaining the books of account and records of portfolio transactions. JPMorgan Chase Bank also acts as securities lending agent to certain JPMorgan equity funds. JPMorgan Chase Bank is an affiliate of the Adviser. For fund accounting services, the Funds pay to JPMorgan Chase Bank the higher of (a) each Fund's pro rata share of an annual complex-wide charge on the average daily net assets of all U.S. money market funds of 0.011% of the first $5 billion, 0.008% on the next $5 billion, 0.004% on the next $90 billion and 0.0025% for such assets over $100 billion, or (b) the applicable per account minimum charge. The minimum total annual fund accounting charge per U.S. money market fund is $10,000. In addition, there is a $10,000 annual charge per share class and a $6,000 annual charge per manager for multi-managed accounts. JPMorgan Chase Bank is also reimbursed for its reasonable out-of-pocket or incidental expenses, including, but not limited to, legal fees. Prior to May 5, 2003, The Bank of New York served as the Funds' custodian and fund accounting agent. For additional information, see the Prospectuses. TRANSFER AGENT Boston Financial Data Services, Inc. ("BFDS" or "Transfer Agent"), 2 Heritage Drive, North Quincy, Massachusetts 02171 serves as each Fund's transfer and dividend disbursing agent. As transfer agent and dividend disbursing agent, BFDS is responsible for maintaining account records detailing the ownership of Fund shares and for crediting income, capital gains and other changes in share ownership to shareholder accounts. Prior to February 19, 2005, DST Systems, Inc. served as each Fund's transfer and dividend disbursing agent. SHAREHOLDER SERVICING 34 The Trust on behalf of each of the Funds has entered into a shareholder servicing agreement ("Shareholder Servicing Agreement") with OGDS. Under the agreement, OGDS is responsible for performing shareholder account, administrative and servicing functions, which include but are not limited to, answering inquiries regarding account status and history, the manner in which purchases and redemptions of Fund shares may be effected, and certain other matters pertaining to a Fund; assisting customers in designating and changing dividend options, account designations and addresses; providing necessary personnel and facilities to coordinate the establishment and maintenance of shareholder accounts and records, transmitting or assisting in processing purchase and redemption orders and arranging for the wiring or other transfer of funds to and from customer accounts in connection with orders to purchase or redeem Fund shares; verifying purchase and redemption orders, transfers among and changes in accounts; informing OGDS of the gross amount of purchase orders for Fund shares; providing other related services; verifying and guaranteeing shareholder signatures in connection with redemption orders and transfers and changes in shareholder-designated accounts; furnishing (either separately or on an integrated basis with other reports sent to a shareholder by a Financial Intermediary) quarterly and year-end statements and confirmations of purchases and redemptions; transmitting, on behalf of the Funds, proxy statements, annual reports, updated Prospectuses and other communications to shareholders of the Funds; receiving and transmitting to the Funds proxies executed by shareholders with respect to meetings of shareholders of the Funds; and providing such other related services as the Funds or a shareholder may request. Financial Intermediaries may be required to register pursuant to state securities law. Financial Intermediaries may subcontract with parties for the provision of shareholder support services. Under the Shareholder Servicing Agreement, each Fund has agreed to pay OGDS for these services a fee at the following annual rates (expressed as a percentage of the average daily NAV of Fund shares owned by or for shareholders). OGDS may voluntarily agree from time to time to waive a portion of the fees payable to it under the Shareholder Servicing Agreement with respect to each Fund on a month-to-month basis. Class B and Class C Shares 0.25% Premier, Select, Cash Management and Reserve Shares 0.30% Morgan Shares 0.35%* Institutional Class Shares 0.10% Agency Shares 0.15% Capital Shares 0.05%
* The Board of Trustees has determined that the amount payable for "service fees" (as defined by the NASD) does not exceed 0.25% of the average annual net assets attributable to these shares. The 0.10% balance of the fees is for shareholder administrative services. The fee is paid to OGDS for a variety of specific shareholder servicing functions. OGDS may enter into shareholder servicing contracts with affiliated and unaffiliated broker-dealers and intermediaries who provide shareholder services and other related services to their clients or customers who invest in the Morgan, Premier, Reserve, Cash Management, Select, Institutional, Capital, Class B and Class C Shares of a Fund under which OGDS will pay all or a portion of the annual fee to such broker-dealers or intermediaries for performing such services. The Shareholder Servicing Agreement, unless sooner terminated, will continue until October 31, 2006. Thereafter, if not terminated, the shareholder servicing agreement will continue automatically for successive one year terms, provided that such continuance is specifically approved at least annually by the vote of a majority of those members of the Board of Trustees of the Trust who are not parties to the Shareholder Servicing Agreement or interested persons (as defined in the 1940 Act) of any such party. The Shareholder Servicing Agreement may be terminated without penalty, on not less than 60 days prior written notice, by the Board of Trustees of the Trust or by OGDS. The shareholder servicing agreement will also terminate automatically in the event of its assignment. Prior to February 19, 2005, JPMorgan Chase Bank served as shareholder servicing agent for the Funds. The table below sets forth the fees paid or accrued to the JPMorgan Chase Bank and (the amounts voluntarily waived are in parentheses) for the fiscal periods indicated: 35
8/31/02 8/31/03 8/31/04 PAID/ PAID/ PAID/ ACCRUED WAIVED ACCRUED WAIVED ACCRUED WAIVED PRIME MONEY MARKET FUND Morgan Shares $32,753,000 - $20,441,000 $(1,387,000) Premier Shares 13,191,000 $(40,000) 14,274,000 (115,000) Agency Shares 16,771,000 (6,708,000) 13,045,000 (5,261,000) B Shares 34,000 - 30,000 (5,000) C Shares 1,000 - 2,000 - Institutional Class Shares 26,797,000 (26,755,000) 25,882,000 (25,882,000) Reserve Shares 683,000 (26,000) 1,011,000 (13,000) Select Shares 2,778,000 (180,000) 2,292,000 (213,000) Cash Management Shares 514,000 (4,000) 903,000 - FEDERAL MONEY MARKET FUND Morgan Shares 2,195,000 (32,000) 1,335,000 - Premier Shares 4,332,000 (20,000) 3,616,000 (51,000) Agency Shares 887,000 (364,000) 396,000 (191,000) Institutional Class Shares 2,464,000 (2,464,000) 1,976,000 (1,976,000) TREASURY PLUS MONEY MARKET FUND Morgan Shares 4,561,000 (540,000) 2,982,000 - Premier Shares 2,211,000 (7,000) 2,526,000 - Agency Shares 1,288,000 (608,000) 1,183,000 (585,000) Institutional Class Shares 511,000 (511,000) 575,000 (575,000) Reserve Shares 595,000 (12,000) 590,000 (21,000) TAX FREE MONEY MARKET FUND Morgan Shares 3,090,000 (417,000) 2,457,000 - Premier Shares 6,899,000 - 8,550,000 (58,000) Agency Shares 967,000 (391,000) 860,000 (372,000) Institutional Class Shares 2,832,000 (2,820,000) 4,970,000 (4,970,000) 100% U.S. TREASURY SECURITIES MONEY MARKET FUND Morgan Shares 14,236,000 - 11,087,000 - Premier Shares 772,000 - 1,310,000 - Agency Shares 1,125,000 (596,000) 959,000 (550,000) Institutional Class Shares 178,000 (178,000) 835,000 (835,000) CALIFORNIA MUNICIPAL MONEY MARKET FUND Morgan Shares 511,000 (187,000) 547,000 (39,000) NEW YORK MUNICIPAL MONEY MARKET FUND Morgan Shares 7,917,000 - 6,791,000 - Reserve Shares 305,000 - 634,000 (1,000) U.S. GOVERNMENT MONEY MARKET FUND Morgan Shares 13,115,000 - 11,152,000 - Premier Shares 2,791,000 - 2,531,000 - Agency Shares 3,484,000 (414,000) 3,794,000 (418,000) Institutional Class Shares 458,000 (344,000) 1,284,000 (929,000) LIQUID ASSETS MONEY MARKET FUND Morgan Shares 20,000 (3,000) 62,000 (25,000) Premier Shares 18,000 (6,000) 127,000 (12,000) Agency Shares 14,000 (12,000) 246,000 (91,000) Institutional Class Shares 251,000 (242,000) 1,941,000 (1,723,000)
Financial Intermediaries may offer additional services to their customers, including specialized procedures and payment for the purchase and redemption of Fund shares, such as pre-authorized or systematic purchase and redemption 36 programs, "sweep" programs, cash advances and redemption checks. Each Financial Intermediary may establish its own terms and conditions, including limitations on the amounts of subsequent transactions, with respect to such services. Certain Financial Intermediaries may (although it is not required by the Trust to do so) credit to the accounts of their customers from whom they are already receiving other fees amounts not exceeding such other fees or the fees for their services as the Financial Intermediary. OGDS and certain broker-dealers and other Financial Intermediaries may, at their own expense, provide gifts, such as computer software packages, guides and books related to investment or additional Fund shares valued up to $250 to their customers that invest in the JPMorgan Funds. OGDS may from time to time, at its own expense out of compensation retained by it from the Funds or from other sources available to it, make additional payments to certain selected dealers or other Financial Intermediaries for performing administrative services for its customers. These services include maintaining account records, processing orders to purchase, redeem and exchange Fund shares and responding to certain customer inquiries. The amount of such compensation may be up to an additional 0.10% annually of the average net assets of the Funds attributable to shares of the Funds held by the customer of such Financial Intermediaries. Such compensation does not represent an additional expense to the Funds or to its shareholders, since it will be paid by OGDS. OGDS, JPMorgan Funds and their affiliates, agents and subagents may exchange among themselves and other certain information about shareholders and their accounts, including information used to offer investment products and insurance products to them, unless otherwise contractually prohibited. EXPENSES The Funds pay the expenses incurred in their operations, including their pro rata share of expenses of the Trust. These expenses include: investment advisory and administrative fees; the compensation of the Trustees; registration fees; interest charges; taxes; expenses connected with the execution, recording and settlement of security transactions; fees and expenses of the Funds' custodian for all services to the Funds, including safekeeping of funds and securities and maintaining required books and accounts; expenses of preparing and mailing reports to investors and to government offices and commissions; expenses of meetings of investors; fees and expenses of independent accountants, legal counsel and any transfer agent, registrar or dividend disbursing agent of the Trust; insurance premiums; and expenses of calculating the net asset value of, and the net income on, shares of the Funds. Shareholder servicing and distribution fees are all allocated to specific classes of the Funds. In addition, the Funds may allocate transfer agency and certain other expenses by class. Service providers to a Fund may, from time to time, voluntarily waive all or a portion of any fees to which they are entitled. JPMIM, OGA and OGDS have agreed that they will waive fees or reimburse the Funds as described in the Prospectuses. FINANCIAL PROFESSIONALS The services provided by financial professionals may include establishing and maintaining shareholder accounts, processing purchase and redemption transactions, arranging for bank wires, performing shareholder subaccounting, answering client inquiries regarding the Trust, assisting clients in changing dividend options, account designations and addresses, providing periodic statements showing the client's account balance and integrating these statements with those of other transactions and balances in the client's other accounts serviced by the financial professional, transmitting proxy statements, periodic reports, updated prospectuses and other communications to shareholders and, with respect to meetings of shareholders, collecting, tabulating and forwarding executed proxies and obtaining such other information and performing such other services as OGDS or the financial professional's clients may reasonably request and agree upon with the financial professional. Financial professionals may establish their own terms and conditions for providing their services and may charge investors a transaction-based or other fee for their services. Such charges may vary among financial professionals, but in all cases will be retained by the financial professional and will not be remitted to a Fund or OGDS. Each Fund has authorized one or more brokers to accept purchase and redemption orders on its behalf. Such brokers are authorized to designate other intermediaries to accept purchase and redemption orders on a Fund's behalf. A 37 Fund will be deemed to have received a purchase or redemption order when an authorized broker or, if applicable, a broker's authorized designee, accepts the order. These orders will be priced at the Fund's NAV next calculated after they are so accepted. CASH COMPENSATION TO FINANCIAL INTERMEDIARIES OGDS and JPMIM may compensate Financial Intermediaries who sell shares of the Funds. Compensation comes from sales charges, 12b-1 fees and payments by OGDS and JPMIM or their affiliates from their own resources. OGDS may, on occasion, pay Financial Intermediaries the entire front-end sales charge applicable to Fund shares sold by such Financial Intermediaries. Occasionally, OGDS and JPMIM, at their own expense and out of their legitimate profits, may provide cash incentives to Financial Intermediaries. Additional cash incentives may also be paid by other affiliates of JPMIM from time to time. Those additional cash incentives are payments over and above the sales charges (including 12b-1 fees) and service fees paid by the Funds. These additional cash payments are generally made to Financial Intermediaries that provide shareholder servicing, marketing support, and/or access to sales meetings, sales representatives and Financial Intermediary management representatives. Cash compensation may also be paid to Financial Intermediaries for inclusion of the Funds on a sales list including a preferred or select sales list, in other sales programs or as an expense reimbursement in cases where the Financial Intermediary provides shareholder services to Fund shareholders. JPMIM and OGDS may also pay cash compensation in the form of finder's fees that vary depending on the Fund and the dollar amount of shares sold. In addition, OGDS may on occasion pay Financial Intermediaries the entire front-end sales charge applicable to Fund shares sold by the Financial Intermediary or an additional commission on the sale of Fund shares subject to a CDSC. REVENUE SHARING ARRANGEMENTS WITH FINANCIAL INSTITUTIONS. Revenue sharing payments to financial institutions are usually structured in one of three ways: (i) basis point payments on gross sales; (ii) basis point payments on net assets; and/or (iii) fixed dollar amount payments. FINDER'S FEES. Financial Intermediaries who sell over $1 million of Class A shares of the equity and fixed income funds receive a 1% finder's fee. For sales over $2.5 million to $10 million, such Financial Intermediary receives an additional ___ basis points finder's fee. For sales over $10 million to up to $50 million, such Financial Intermediary receives an additional ___ basis points finder's fee. For sales of $50 million or more, such Financial Intermediary receives a further ___ basis points finder's fee. 38 OGDS reserves the right to alter or change the finders' fee policy on these Plans at any time at its own discretion. If a Plan redeems all of the shares for which a finder's fee has been paid within 12 months of the purchase date, OGDS will reclaim the finder's fee paid to the Financial Intermediary rather than charge a CDSC to the Plan. JPMIM, OGDS and their affiliates may also pay non-cash compensation to sales representatives of Financial Intermediaries in the form of (i) occasional gifts; (ii) occasional meals, tickets or other entertainment; and/or (iii) sponsorship support of regional or national events of Financial Intermediaries. INDEPENDENT ACCOUNTANTS The independent accountants of the Trust and the Funds are PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, NY 10036. PricewaterhouseCoopers LLP conducts an annual audit of the financial statements of each of the Funds, assists in the preparation and/or review of each Fund's federal and state income tax returns and consults with the Funds as to matters of accounting and federal and state income taxation. PURCHASES, REDEMPTIONS AND EXCHANGES The Funds have established certain procedures and restrictions, subject to change from time to time, for purchase, redemption, and exchange orders, including procedures for accepting telephone instructions and effecting automatic investments and redemptions. JPMorgan Funds Service Center or JPMorgan Institutional Funds Service Center, as applicable, may defer acting on a shareholder's instructions until it has received them in proper form. In addition, the privileges described in the Prospectuses are not available until a completed and signed account application has been received by JPMorgan Funds Service Center or JPMorgan Institutional Funds Service Center, as applicable. An investor may buy shares of a Fund in one of three ways: (i) through an investment representative (Financial Intermediary) or service organization, as applicable; (ii) through OGDS by calling the JPMorgan Funds Service Center or JPMorgan Institutional Funds Service Center, as applicable; or (iii) through the Systematic Investment Plan, depending upon what type of class of shares. Financial Intermediaries may include financial advisors, investment advisers, brokers, financial planners, banks, insurance companies, retirement or 401(k) plan sponsors or other intermediaries. Upon receipt of any instructions or inquiries by telephone from a shareholder or, if held in a joint account, from either party, or from any person claiming to be the shareholder, and confirmation that the account registration and address given by such person match those on record, a Fund or its agent is authorized, without notifying the shareholder or joint account parties, to carry out the instructions or to respond to the inquiries, consistent with the service options chosen by the shareholder or joint shareholders in his, her or their latest account application or other written request for services, including purchasing, exchanging, or redeeming shares of such Fund and depositing and withdrawing monies from the bank account specified in the Bank Account Registration section of the shareholder's latest account application or as otherwise properly specified to such Fund in writing. The Funds may, at their own option, accept securities in payment for shares. The securities delivered in such a transaction are valued in the same manner as they would be valued for purposes of computing a Fund's NAV, as described in the section entitled "Net Asset Value". This is a taxable transaction to the Shareholder. Purchases by means of in-kind contributions of securities will only be accepted if a variety of conditions are satisfied, including without limitation the following: (i) the securities must be traded on a public securities market or have quoted bid and asked prices available; (ii) JPMIM must determine that acceptance is in the best interest of the Funds and conforms with the applicable Fund's fundamental objectives, policies and restrictions; and (iii) a Fund may not accept unregistered securities which, if transferred, would be required to be registered. Subject to compliance with applicable regulations, each Fund has reserved the right to pay the redemption price of its shares, either totally or partially, by a distribution in-kind of readily marketable portfolio securities (instead of cash). The securities so distributed would be valued at the same amount as that assigned to them in calculating the net asset value of the shares being sold. If a shareholder received a distribution in-kind, the shareholder could incur brokerage or other charges in converting the securities to cash. The Trust has filed an election under Rule 18f-1 under the 1940 Act committing to pay in cash all redemptions by a shareholder of record up to amounts specified by the rule (approximately $250,000). 39 In accordance with section 22(e) of the 1940 Act, the Trust, on behalf of a Fund, reserves the right to postpone the date of payment upon redemption for more than one day for the Prime Money Market Fund and Liquid Assets Money Market Fund and for more than seven days for the other Money Market Funds or suspend the right of redemption as follows: (i) during periods when the New York Stock Exchange is closed for other than weekends and holidays or when trading on such Exchange is restricted as determined by the SEC or by rule or regulation, (ii) during periods in which an emergency, as determined by the SEC, exists that causes disposal by the portfolio of, or evaluation of the net asset value of, its portfolio securities to be unreasonable or impracticable, or (iii) for such other periods as the SEC may by order permit for the protection of the Fund shareholders. Shareholders of other JPMorgan Funds may be entitled to exchange their shares for, or reinvest distributions from their funds in, shares of a Fund at net asset value per share. SPECIAL NOTE REGARDING PURCHASE LIMIT ON CLASS B SHARES. Individual investments in Class B shares are limited to no more than $99,999. However, two or more purchases which are each under $99,999 but which cumulatively amount to an investment of more than $99,999 are not automatically detected, including shares purchased through a systematic investment plan. Purchases in multiple Funds and purchases in multiple accounts in the same Fund are not automatically aggregated. You should carefully consider whether two or more purchases (whether in multiple accounts in the same Fund or in multiple different Funds) totaling $100,000 or more are suitable in light of your own circumstances. It is your responsibility to inform your Financial Intermediary or the Fund of any and all accounts that may be linked together for the purposes of determining whether the application of Right of Accumulation or the use of a Letter of Intent would make Class A shares a more suitable investment than Class B shares. EXCHANGE PRIVILEGE. Shareholders may exchange their shares in a Fund for shares of any other JPMorgan Funds as indicated in the Prospectuses that offer such share class. You may pay a sales charge if you exchange your Morgan Shares for other classes of shares. If you exchange Class B Shares of Prime Money Market Fund for Class B Shares of another JPMorgan Fund or Class C Shares of Prime Money Market Fund for Class C Shares of another JPMorgan Fund, you will not pay a deferred sales charge until you sell the shares of the other fund. The amount of deferred sales charge will be based on when you bought the original shares, not when you made the exchange. The Funds reserve the right to limit the number of exchanges or to refuse an exchange. The Funds may discontinue this exchange privilege at any time. Under the Exchange Privilege, shares may be exchanged only if shares of the JPMorgan Fund exchanged into are registered in the state where the exchange is to be made. Shares of a Fund may only be exchanged into another JPMorgan Fund if the account registrations are identical. With respect to exchanges from any JPMorgan money market fund, shareholders must have acquired their shares in such money market fund by exchange from one of the JPMorgan non-money market funds or the exchange will be done at relative NAV plus the appropriate sales charge. Any such exchange may create a gain or loss to be recognized for federal income tax purposes. Normally, shares of the fund to be acquired are purchased on the redemption date, but such purchase may be delayed by either fund for up to five business days if a fund determines that it would be disadvantaged by an immediate transfer of the proceeds. Class B Shares of the Prime Money Market Fund automatically convert to Morgan Shares (and thus are then subject to the lower expenses borne by Morgan Shares) after a period of time specified below has elapsed since the date of purchase (the "CDSC Period"), together with the pro rata portion of all Class B Shares representing dividends and other distributions paid in additional Class B Shares attributable to the Class B Shares then converting. The conversion of Class B Shares purchased on or after May 1, 1996 will be effected at the relative net asset values per share of the two classes on the first business day of the month following the eighth anniversary of the original purchase. The conversion of Class B Shares purchased prior to May 1, 1996 will be effected at the relative net asset values per share of the two classes on the first business day of the month following the seventh anniversary of the original purchase. If any exchanges of Class B Shares during the CDSC Period occurred, the holding period for the shares exchanged will be counted toward the CDSC Period. At the time of the conversion, the NAV per share of the Morgan Shares may be higher or lower than the NAV per share of the Class B Shares; as a result, depending on the relative NAVs per shares, a shareholder may receive fewer or more Morgan Shares than the number of Class B Shares converted. A Fund may require medallion signature guarantees for changes that shareholders request be made in Fund records with respect to their accounts, including but not limited to, changes in bank accounts, for any written requests for additional account services made after a shareholder has submitted an initial account application to a Fund, and in certain other circumstances described in the Prospectuses. A Fund may also refuse to accept or carry out any transaction that does not satisfy any restrictions then in effect. A medallion signature guarantee may be obtained from an approved bank, broker, savings and loan association or credit union under Rule 17Ad-15 of the Securities Exchange Act of 1934. The Funds reserve the right to change any of these policies at any time and may reject any request to purchase shares at a reduced sales charge. 40 Investors may incur a fee if they effect transactions through a Financial Intermediary. SYSTEMATIC WITHDRAWAL PLAN. Systematic withdrawals may be made on a monthly, quarterly or annual basis. The applicable Class B or Class C CDSC will be deducted from those payments unless such payments are made: (i) monthly and constitute no more than 1/12 of 10% of your then-current balance in a Fund each month; or (ii) quarterly and constitute no more than 1/4 of 10% of your then-current balance in a Fund each quarter. If you withdraw more than the limits stated above in any given systematic withdrawal payment, you will be charged a CDSC for the amount of the withdrawal over the limit for that month or quarter. For accounts that allow systematic withdrawals only as a fixed dollar amount per month or quarter, the applicable Class B or Class C CDSC is waived provided that, on the date of the systematic withdrawal, the fixed dollar amount to be withdrawn, when multiplied by 12 in the case of monthly payments or by four in the case of quarterly payments, does not exceed 10% of your then-current balance in the Fund. If on any given systematic withdrawal date that amount would exceed 10%, you will be charged a CDSC on the entire amount of that systematic withdrawal payment. This calculation is repeated on each systematic withdrawal date. For accounts that allow systematic withdrawals on a percentage basis, a Class B or Class C CDSC will be charged only on that amount of a systematic payment that exceeds the limits set forth above for that month or quarter. Your current balance in a Fund for purposes of these calculations will be determined by multiplying the number of shares held by the then-current net asset value for shares of the applicable class. CUT-OFF TIMES FOR PURCHASE, REDEMPTION AND EXCHANGE ORDERS. Orders to purchase, exchange or redeem shares received by the Funds, or by a Financial Intermediary authorized to receive such orders, by the cut-off times indicated in the Funds' Prospectuses will be processed at the NAV next calculated after the order is received by the Fund or the Financial Intermediary. Under a variety of different types of servicing agreements, Financial Intermediaries that are authorized to receive purchase, exchange and redemption orders from investors are permitted to transmit those orders that are received by the Financial Intermediary before the cut-off times in the various Prospectuses to the Funds by the cut-off times stated in those agreements, which are generally later than the cut-off times stated in the Prospectuses. NET ASSET VALUE The Funds compute their NAV once daily on Monday through Friday at the time indicated in the Prospectuses. The NAV will not be computed on the day the following legal holidays are observed: New Year's Day, Martin Luther King, Jr. Day, President's Day, Good Friday, Memorial Day, Independence Day, Labor Day, Columbus Day, Veterans Day, Thanksgiving Day, and Christmas Day. The Funds may also close for purchases and redemptions at such other times as may be determined by the Board of Trustees to the extent permitted by applicable law. The days on which NAV is determined are the Funds' business days. The NAV of each class of a Fund is equal to the value of such class's pro rata portion of the Fund's investments less the class's pro rata portion of the Fund's liabilities. The following is a discussion of the procedures used by the Funds in valuing their assets. The Funds' portfolio securities are valued by the amortized cost method. The purpose of this method of calculation is to attempt to maintain a constant net asset value per share of each Fund of $1.00. No assurances can be given that this goal can be attained. The amortized cost method of valuation values a security at its cost at the time of purchase and thereafter assumes a constant amortization to maturity of any discount or premium, regardless of the impact of fluctuating interest rates on the market value of the instrument. If a difference of more than 1/2 of 1% occurs between valuation based on the amortized cost method and valuation based on market value, the Board of Trustees will take steps necessary to reduce such deviation, such as changing a Fund's dividend policy, shortening the average portfolio maturity, realizing gains or losses, or reducing the number of outstanding Fund shares. Any reduction of outstanding shares will be effected by having each shareholder contribute to a Fund's capital the necessary shares on a 41 pro rata basis. Each shareholder will be deemed to have agreed to such contribution in these circumstances by his or her investment in the Funds. See "Distributions and Tax Matters." PERFORMANCE INFORMATION From time to time, the Funds may quote performance in terms of yield, actual distributions in reports, sales literature and advertisements published by the Funds. Shareholders may obtain current yield information by calling the number provided on the cover page of this SAI. See also the Prospectuses. YIELD QUOTATIONS Any current "yield" for a class of shares of a Money Market Fund which is used in such a manner as to be subject to the provisions of Rule 482(d) under the 1933 Act shall consist of an annualized historical yield, carried at least to the nearest hundredth of one percent, based on a specific seven calendar day period and shall be calculated by dividing the net change in the value of an account having a balance of one share at the beginning of the period by the value of the account at the beginning of the period and multiplying the quotient by 365/7. For this purpose, the net change in account value would reflect the value of additional shares purchased with dividends declared on the original share and dividends declared on both the original share and any such additional shares, but would not reflect any realized gains or losses from the sale of securities or any unrealized appreciation or depreciation on portfolio securities. In addition, any effective yield quotation for a class of shares of a Money Market Fund so used shall be calculated according to the following formula: EFFECTIVE YIELD = [(BASE PERIOD RETURN + 1) 365/7] - 1 A portion of the Tax Free Money Market Fund's income used in calculating such yields may be taxable. Any taxable equivalent yield quotation of a class of shares of the Tax Free and Municipal Funds shall be calculated as follows. If the entire current yield quotation for such period is tax-exempt, the tax equivalent yield will be the current yield quotation (as determined in accordance with the appropriate calculation described above) divided by 1, minus a stated income tax rate or rates. If a portion of the current yield quotation is not tax-exempt, the tax equivalent yield will be the sum of (a) that portion of the yield which is tax-exempt divided by 1, minus a stated income tax rate or rates and (b) the portion of the yield which is not tax-exempt. If applicable, a Fund's tax equivalent effective yield is calculated by dividing that portion of the Fund's effective yield that is tax-exempt by 1, minus a stated income tax rate and adding the quotient to that portion, if any, of the Fund's effective yield that is not tax-exempt.
EFFECTIVE COMPOUND CURRENT ANNUALIZED ANNUALIZED YIELD AS OF YIELD AS OF 8/31/04 8/31/04 PRIME MONEY MARKET FUND Agency Shares 1.31% 1.32% Class B Shares 0.33% 0.33% Class C Shares 0.33% 0.33% Cash Management Shares 0.60% 0.60% Institutional Class Shares 1.37% 1.38% Morgan Shares 0.98% 0.98% Premier Shares 1.12% 1.12% Reserve Shares 0.87% 0.87% Select Shares 1.13% 1.13% FEDERAL MONEY MARKET FUND Agency Shares 1.23% 1.24% Institutional Class Shares 1.29% 1.30% Morgan Shares 0.79% 0.79% Premier Shares 1.04% 1.05%
42
EFFECTIVE COMPOUND CURRENT ANNUALIZED ANNUALIZED YIELD AS OF YIELD AS OF 8/31/04 8/31/04 TREASURY PLUS MONEY MARKET FUND Agency Shares 1.22% 1.23% Institutional Class Shares 1.27% 1.28% Morgan Shares 0.88% 0.88% Premier Shares 1.02% 1.02% Reserve Shares 0.77% 0.77% 100% U.S. TREASURY SECURITIES MONEY MARKET FUND Agency Shares 1.11% 1.11% Institutional Class Shares 1.16% 1.16% Morgan Shares 0.77% 0.77% Premier Shares 0.90% 0.90% U.S. GOVERNMENT MONEY MARKET FUND Agency Shares 1.22% 1.22% Institutional Class Shares 1.28% 1.28% Morgan Shares 0.89% 0.89% Premier Shares 1.02% 1.03% LIQUID ASSETS MONEY MARKET FUND Agency Shares 1.29% 1.30% Institutional Class Shares 1.35% 1.36% Morgan Shares 0.96% 0.96% Premier Shares 1.10% 1.10%
EFFECTIVE ANNUALIZED CURRENT COMPOUND TAX ANNUALIZED ANNUALIZED EQUIVALENT YIELD AS YIELD AS OF YIELD* AS OF OF 8/31/04 8/31/04 8/31/04 TAX FREE MONEY MARKET FUND Agency Shares 1.06% 1.06% 1.63% Institutional Class Shares 1.12% 1.13% 1.72% Morgan Shares 0.73% 0.73% 1.12% Premier Shares 0.87% 0.87% 1.34% CALIFORNIA MUNICIPAL MONEY MARKET FUND Morgan Shares 0.77% 0.78% 1.31% NEW YORK MUNICIPAL MONEY MARKET FUND Morgan Shares 0.74% 0.74% 1.30% Reserve Shares 0.54% 0.54% 0.95%
* The tax equivalent yields assume a federal income tax rate of 35.00% for the Tax Free Money Market Fund, a combined New York State, New York City and federal income tax rate of 43.10% for the New York Municipal Money Market Fund and a combined California State and federal income tax rate of 41.05% for the California Municipal Money Market Fund. Unlike some bank deposits or other investments which pay a fixed yield for a stated period of time, the yields and the net asset values of the classes of shares of a Fund will vary based on market conditions, the current market value of the securities held by a Fund and changes in the Fund's expenses. The Adviser, Financial Intermediaries, the Administrator, OGDS and other service providers may voluntarily waive a portion of their fees on a month-to-month basis. In addition, OGDS may assume a portion of a Fund's operating expenses on a month-to-month basis. These actions would have the effect of increasing the net income (and therefore the yield and total rate of return) of the classes of shares of a Fund during the period such waivers are in effect. These factors and possible differences in the methods used to calculate the yields and total rates of return should be considered when comparing the yields or total rates of return of the classes of shares of a Fund to yields and total rates of return published for other investment companies and other investment vehicles (including different classes of shares). The Trust is advised that certain Financial 43 Intermediaries may credit to the accounts of their customers from whom they are already receiving other fees amounts not exceeding the Financial Intermediary fees received, which will have the effect of increasing the net return on the investment of customers of those Financial Intermediaries. Such customers may be able to obtain through their Financial Intermediaries quotations reflecting such increased return. Shareholders of the various classes of the Funds bear the fees and expenses described herein and in the Prospectuses. Advertising or communications to shareholders may contain the views of the Adviser as to current market, economic, trade and interest rate trends, as well as legislative, regulatory and monetary developments and may include investment strategies and related matters believed to be of relevance to a Fund. Advertisements for JPMorgan Funds may include references to the asset size of other financial products made available by JPMIM, such as the offshore assets of other funds. PORTFOLIO TRANSACTIONS On behalf of the Funds, the Adviser places orders for all purchases and sales of portfolio securities, enters into repurchase agreements, and may enter into reverse repurchase agreements unless otherwise prohibited. See "Investment Strategies and Policies." Fixed income and debt securities and municipal bonds and notes are generally traded at a net price with dealers acting as principal for their own accounts without a stated commission. The price of the security usually includes profit to the dealers. In underwritten offerings, securities are purchased at a fixed price, which includes an amount of compensation to the underwriter, generally referred to as the underwriter's concession or discount. On occasion, certain securities may be purchased directly from an issuer, in which case no commissions or discounts are paid. In connection with Portfolio transactions, the overriding objective is to obtain the best execution of purchase and sales orders. Subject to the overriding objective of obtaining the best execution of orders, the Adviser may allocate a portion of a Fund's brokerage transactions to affiliates of the Adviser. Under the 1940 Act, persons affiliated with a Fund and persons who are affiliated with such persons are prohibited from dealing with the Fund as principal in the purchase and sale of securities unless a permissive order allowing such transactions is obtained from the SEC. The SEC has granted two exemptive orders permitting each Fund to engage in principal transactions with J.P. Morgan Securities Inc., an affiliated broker. The first order permits each Fund to deal with J.P. Morgan Securities as principal in the purchase and sale of taxable money market instruments (including commercial paper, bankers acceptances and medium term notes) and repurchase agreements. The second order permits each Fund to deal with J.P. Morgan Securities as principal in the purchase and sale of tax exempt money market instruments (including exempt commercial paper, general obligation and revenue anticipation notes, variable rate demand notes and put bonds). The orders are subject to certain conditions. An affiliated person of a Fund may serve as its broker in listed or over-the-counter transactions conducted on an agency basis provided that, among other things, the fee or commission received by such affiliated broker is reasonable and fair compared to the fee or commission received by non-affiliated brokers in connection with comparable transactions. In addition, a Fund may not purchase securities during the existence of any underwriting syndicate for such securities of which JPMorgan Chase Bank or an affiliate is a member or in a private placement in which JPMorgan Chase Bank or an affiliate serves as placement agent except pursuant to procedures adopted by the Boards of Trustees of each Fund that either comply with rules adopted by the SEC or with interpretations of the SEC's staff. Each Fund expects to purchase securities from underwriting syndicates of which certain affiliates of JPMorgan Chase act as a member or manager. Such purchases will be effected in accordance with the conditions set forth in Rule 10f-3 under the 1940 Act and related procedures adopted by the Trustees, including a majority of the Trustees who are not "interested persons" of a Fund. Among the conditions are that the issuer of any purchased securities will have been in operation for at least three years, that not more than 25% of the underwriting will be purchased by a Fund and any other investment company having the same investment adviser, and that no shares will be purchased from OGDS or any of its affiliates. On those occasions when the Adviser deems the purchase or sale of a security to be in the best interests of a Fund as well as other customers including other Funds, the Adviser to the extent permitted by applicable laws and regulations, may, but is not obligated to, aggregate the securities to be sold or purchased for a Fund with those to be sold or purchased for other customers in order to obtain best execution, including lower brokerage commissions if appropriate. In such event, allocation of the securities so purchased or sold as well as any expenses 44 incurred in the transaction will be made by the Adviser in the manner it considers to be most equitable and consistent with its fiduciary obligations to a Fund. In some instances, this procedure might adversely affect a Fund. OGDS and its affiliates may have deposit, loan and other commercial banking relationships with the issuers of securities purchased on behalf of any of the Funds, including outstanding loans to such issuers which may be repaid in whole or in part with the proceeds of securities so purchased. OGDS and its affiliates deal, trade and invest for their own accounts in U.S. government obligations, municipal obligations and commercial paper and are among the leading dealers of various types of U.S. government obligations and municipal obligations. OGDS and its affiliates may sell U.S. government obligations and municipal obligations to, and purchase them from, other investment companies sponsored by the Funds' distributor, OGDS, or its affiliates. JPMIM has informed the Funds that in making its investment decisions, it does not obtain or use material inside information in the possession of any affiliate of JPMIM. Shareholders of the Funds should be aware that, subject to applicable legal or regulatory restrictions, JPMIM and its affiliates may exchange among themselves certain information about the shareholder and his account. The Funds paid the following brokerage commissions for the indicated periods:
FISCAL YEAR ENDED FISCAL YEAR FISCAL YEAR ENDED 8/31/02 ENDED 8/31/03 8/31/04
Allocation of transactions, including their frequency, to various broker-dealers is determined by JPMIM based on its best judgment and in a manner deemed fair and reasonable to Shareholders. The primary consideration is prompt execution of orders in an effective manner at the most favorable price. Subject to this consideration, in selecting broker-dealers to execute a particular transaction, and in evaluating the best overall terms available, JPMIM is authorized to consider the brokerage and research services (as those terms are defined in Section 28(e) of the Securities Exchange Act) provided to the Funds and/or other accounts over which JPMIM exercises investment discretion. JPMIM may cause a Fund to pay a broker-dealer that furnishes brokerage and research services a higher commission than that which might be charged by another broker-dealer for effecting the same transaction, provided that JPMIM determines in good faith that such commission is reasonable in relation to the value of the brokerage and research services provided by such broker-dealer, viewed in terms of either the particular transaction or the overall responsibilities of JPMIM to the Funds. Such brokerage and research services might consist of reports and statistics on specific companies or industries, general summaries of groups of bonds and their comparative earnings and yields, or broad overviews of the securities markets and the economy. Shareholders of the Funds should understand that the services provided by such brokers may be useful to JPMIM in connection with its services to other clients. Supplementary research information so received is in addition to, and not in lieu of, services required to be performed by JPMIM, and does not reduce the advisory fees payable to JPMIM by the Funds. It is possible that certain of the supplementary research or other services received will primarily benefit one or more other investment companies or other accounts for which investment discretion is exercised. Conversely, a Fund may be the primary beneficiary of the research or services received as a result of portfolio transactions effected for such other account or investment company. In an effort to minimize the potential conflicts of interest that arise with the types of "soft-dollar" transactions described above: - Beginning on February 19, 2005, JPMIM will not enter into any new soft-dollar arrangement with respect to its U.S. mutual fund clients whereby a broker is paying for services; and - All soft-dollar arrangements with respect to U.S. mutual fund clients that were in existence as of February 19, 2005 whereby a broker is paying for services will terminate as they are fulfilled and will not be renewed by JPMIM. 45 Because JPMIM may have soft-dollar commitments with respect to U.S. mutual fund clients that were entered into prior to February 19, 2005, it is expected that there may be annual invoices for bills that are paid by soft-dollar brokers for services that are not to be delivered until a later date. In addition, JPMIM may have unused soft dollar credits with respect to U.S. mutual fund clients in connection with brokerage commissions for periods prior to February 19, 2005. Such soft dollar credits will be used to pay for services from the broker until the soft dollar credit balance is zero. Finally, JPMIM entered into soft-dollar arrangements for services that were provided by brokers prior to February 19, 2005, but for which JPMIM has not yet fulfilled its soft-dollar commitments under those arrangements. While JPMIM is in the process of terminating soft dollar arrangements for research services (such as Bloomberg or Factset) with respect to its U.S. mutual fund clients. JPMIM will continue to have some soft-dollar arrangements for other clients and for broker research, including research provided by third party brokers. Total elimination of soft dollar arrangements is presently impeded by the fact that many brokers do not assign a hard dollar value to the research they or another broker provide, but rather bundle the cost of such research into their commission structure. It is noted in this regard that some research that is available only under a bundled commission structure is particularly important to the investment process. This being the case, JPMIM will continue to have some soft dollar arrangements in place. Such arrangements will be limited to research and will be consistent with best execution. During the last fiscal year, JPMIM paid $[____] to brokers for third party research. In the last fiscal year, JPMIM paid brokerage commissions to brokers who provided research services to JPMIM. For the fiscal year ended [_________], total compensation paid to such brokers by the Funds amounted to $[______]. MASSACHUSETTS TRUST Under Massachusetts law, shareholders of a business trust may, under certain circumstances, be held personally liable as partners for its obligations. However, the Trust's Declaration of Trust contains an express disclaimer of shareholder liability for acts or obligations of the Trust and provides for indemnification and reimbursement of expenses out of the Trust property for any shareholder held personally liable for the obligations of the Trust. The Trust's Declaration of Trust also provides that the Trust shall maintain appropriate insurance (for example, fidelity bonding and errors and omissions insurance) for the protection of the Trust, its shareholders, Board of Trustees, officers, employees and agents covering possible tort and other liabilities. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which both inadequate insurance existed and the Trust itself was unable to meet its obligations. No personal liability will attach to the shareholders under any undertaking containing such provision when adequate notice of such provision is given, except possibly in a few jurisdictions. With respect to all types of claims in the latter jurisdictions, (i) tort claims, (ii) contract claims where the provision referred to is omitted from the undertaking, (iii) claims for taxes, and (iv) certain statutory liabilities in other jurisdictions, a shareholder may be held personally liable to the extent that claims are not satisfied by a Fund. However, upon payment of such liability, the shareholder will be entitled to reimbursement from the general assets of the Fund. The Board of Trustees intends to conduct the operations of the Trust in such a way so as to avoid, as far as possible, ultimate liability of the shareholders for liabilities of the Funds. The Declaration of Trust provides that the Trust will indemnify its Board of Trustees and officers against liabilities and expenses incurred in connection with litigation in which they may be involved because of their offices with the Trust, unless, as to liability to the Trust or its shareholders, it is finally adjudicated that they engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in their offices, or with respect to any matter unless it is finally adjudicated that they did not act in good faith in the reasonable belief that their actions were in the best interest of the Trust. In the case of settlement, such indemnification will not be provided unless it has been determined by a court or other body approving the settlement or other disposition, or by a reasonable determination based upon a review of readily available facts, by vote of a majority of disinterested Trustees or in a written opinion of independent counsel, that such officers or Trustees have not engaged in willful misfeasance, bad faith, gross negligence or reckless disregard of their duties. The Trust shall continue without limitation of time subject to the provisions in the Declaration of Trust concerning termination by action of the shareholders or by action of the Trustees upon notice to the shareholders. 46 DESCRIPTION OF SHARES, VOTING RIGHTS AND LIABILITIES The Trust is an open-end management investment company organized as a Massachusetts business trust. Each Fund represents a separate series of shares of beneficial interest. See "Massachusetts Trust." The Declaration of Trust permits the Trustees to issue an unlimited number of full and fractional shares ($0.001 par value) of one or more series and classes within any series and to divide or combine the shares (of any series, if applicable) without changing the proportionate beneficial interest of each shareholder in a Fund (or in the assets of other series, if applicable). Each share represents an equal proportional interest in a Fund with each other share. Upon liquidation of a Fund, holders are entitled to share pro rata in the net assets of a Fund available for distribution to such shareholders. See "Massachusetts Trust." Shares of a Fund have no preemptive or conversion rights and are fully paid and non-assessable. The rights of redemption and exchange are described in the Prospectuses and elsewhere in this SAI. The shareholders of each Fund are entitled to one vote for each dollar of NAV (or a proportionate fractional vote in respect of a fractional dollar amount), on matters on which shares of a Fund shall be entitled to vote. Subject to the 1940 Act, the Trustees themselves have the power to alter the number and the terms of office of the Trustees, to lengthen their own terms, or to make their terms of unlimited duration subject to certain removal procedures, and appoint their own successors, provided, however, that immediately after such appointment the requisite majority of the Trustees have been elected by the shareholders of the Trust. The voting rights of shareholders are not cumulative so that holders of more than 50% of the shares voting can, if they choose, elect all Trustees being selected while the shareholders of the remaining shares would be unable to elect any Trustees. It is the intention of the Trust not to hold meetings of shareholders annually. The Trustees may call meetings of shareholders for action by shareholder vote as may be required by either the 1940 Act or the Trust's Declaration of Trust. Each share of a series or class represents an equal proportionate interest in that series or class with each other share of that series or class. The shares of each series or class participate equally in the earnings, dividends and assets of the particular series or class. Expenses of the Trust which are not attributable to a specific series or class are allocated among all the series in a manner believed by management of the Trust to be fair and equitable. Shares have no pre-emptive or conversion rights. Shares when issued are fully paid and non-assessable, except as set forth below. Shareholders are entitled to one vote for each share held. Shares of each series or class generally vote together, except when required under federal securities laws to vote separately on matters that may affect a particular class, such as the approval of distribution plans for a particular class. Shareholders of a Fund have the right, upon the declaration in writing or vote of more than two thirds of its outstanding shares, to remove a Trustee. The Trustees will call a meeting of shareholders to vote on removal of a Trustee upon the written request of the record holders of 10% of a Fund's shares. In addition, whenever ten or more shareholders of record who have been such for at least six months preceding the date of application, and who hold in the aggregate either shares having a NAV of at least $25,000 or at least 1 % of the Trust's outstanding shares, whichever is less, shall apply to the Trustees in writing, stating that they wish to communicate with other shareholders with a view to obtaining signatures to request a meeting for the purpose of voting upon the question of removal of any Trustee or Trustees and accompanied by a form of communication and request which they wish to transmit, the Trustees shall within five business days after receipt of such application either: (1) afford to such applicants access to a list of the names and addresses of all shareholders as recorded on the books of the Trust; or (2) inform such applicants as to the approximate number of shareholders of record, and the approximate cost of mailing to them the proposed communication and form of request. If the Trustees elect to follow the latter course, the Trustees, upon the written request of such applicants, accompanied by a tender of the material to be mailed and of the reasonable expenses of mailing, shall, with reasonable promptness, mail such material to all shareholders of record at their addresses as recorded on the books, unless within five business days after such tender the Trustees shall mail to such applicants and file with the SEC, together with a copy of the material to be mailed, a written statement signed by at least a majority of the Trustees to the effect that in their opinion either such material contains untrue statements of fact or omits to state facts necessary to make the statements contained therein not misleading, or would be in violation of applicable law, and specifying the basis of such opinion. After opportunity for hearing upon the objections specified in the written statements filed, the SEC may, and if demanded by the Trustees or by such applicants shall, enter an order either sustaining one or more of such objections or refusing to sustain any of them. If the SEC shall enter an order refusing to 47 sustain any of such objections, or if, after the entry of an order sustaining one or more of such objections, the SEC shall find, after notice and opportunity for hearing, that all objections so sustained have been met, and shall enter an order so declaring, the Trustees shall mail copies of such material to all shareholders with reasonable promptness after the entry of such order and the renewal of such tender. The Trustees have authorized the issuance and sale to the public of nine series of the Trust. The Trustees may, however, authorize the issuance of shares of additional series and the creation of classes of shares within any series with such preferences, privileges, limitations and voting and dividend rights as the Trustees may determine. The proceeds from the issuance of any additional series would be invested in separate, independently managed Funds with distinct investment objectives, policies and restrictions, and share purchase, redemption and net asset valuation procedures. Any additional classes would be used to distinguish among the rights of different categories of shareholders, as might be required by future regulations or other unforeseen circumstances. All consideration received by the Funds for shares of any additional series or class, and all assets in which such consideration is invested, would belong to that series or class, subject only to the rights of creditors of the Funds and would be subject to the liabilities related thereto. Shareholders of any additional series or class will approve the adoption of any management contract or distribution plan relating to such series or class and of any changes in the investment policies related thereto, to the extent required by the 1940 Act. For information relating to mandatory redemption of Fund shares or their redemption at the option of the Trust under certain circumstances, see "Purchases, Redemptions and Exchanges". No certificates are issued for shares of the Funds. DISTRIBUTIONS AND TAX MATTERS The following is a summary of certain tax considerations generally affecting each Fund and its shareholders. This section is based on the Internal Revenue Code of 1986, as amended (the "Code"), published rulings and court decisions, all as currently in effect. These laws are subject to change, possibly on a retroactive basis. Please consult your own tax advisor concerning the consequences of investing in a Fund in your particular circumstances under the Code and the laws of any other taxing jurisdiction. Each Fund generally will be treated as a separate corporation for federal income tax purposes, and thus the provisions of the Code generally will be applied to each Fund separately. Net long-term and short-term capital gains, net income and operating expenses therefore will be determined separately for each Fund. QUALIFICATION AS A REGULATED INVESTMENT COMPANY. Each Fund has elected to be taxed as a regulated investment company under Subchapter M of the Code and intends to meet all other requirements that are necessary for it to be relieved of federal taxes on income and gains it distributes to shareholders. As a regulated investment company, each Fund is not subject to federal income tax on the portion of its net investment income (i.e., its investment company taxable income, as that term is defined in the Code, without regard to the deduction for dividends paid) and net capital gain (i.e., the excess of net long-term capital gain over net short-term capital loss) that it distributes to shareholders, provided that it distributes at least 90% of the sum of its net investment income for the year (the "Distribution Requirement"), and satisfies certain other requirements of the Code that are described below. In addition to satisfying the Distribution Requirement, each Fund must derive at least 90% of its gross income from dividends, interest, certain payments with respect to loans of stock and securities, gains from the sale or disposition of stock, securities or foreign currencies and other income (including but not limited to gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies. Each Fund must also satisfy an asset diversification test in order to qualify as a regulated investment company. Under this test, at the close of each quarter of a Fund's taxable year, (1) 50% or more of the value of the Fund's assets must be represented by cash, United States government securities, securities of other regulated investment companies, and other securities, with such other securities limited, in respect of any one issuer, to an amount not greater than 5% of the value of the Fund's assets and 10% of the outstanding voting securities of such issuer and (2) not more than 25% of the value of the Fund's assets may be invested in securities of any one issuer (other than U.S. government securities or securities of other regulated investment companies), or of two or more issuers which the Fund controls and which are engaged in the same, similar or related trades or businesses. 48 If for any year a Fund does not qualify as a regulated investment company, all of its taxable income (including its net capital gain) will be subject to tax at regular corporate rates without any deduction for distributions to shareholders. Such distributions will generally be taxable to the shareholders as qualified dividend income, as discussed below, and generally will be eligible for the dividends received deduction in the case of corporate shareholders. EXCISE TAX ON REGULATED INVESTMENT COMPANIES. A 4% non-deductible excise tax is imposed on a regulated investment company to the extent that it distributes income in such a way that it is taxable to shareholders in a calendar year other than the calendar year in which the Fund earned the income. Specifically, the excise tax will be imposed if a Fund fails to distribute in each calendar year an amount equal to 98% of qualified dividend income and ordinary taxable income for the calendar year and 98% of capital gain net income for the one-year period ending on October 31 of such calendar year (or, at the election of a regulated investment company having a taxable year ending November 30 or December 31, for its taxable year). The balance of such income must be distributed during the next calendar year. For the foregoing purposes, a regulated investment company is treated as having distributed otherwise retained amounts if it is subject to income tax on those amounts for any taxable year ending in such calendar year. Each Fund intends to make sufficient distributions or deemed distributions of its qualified dividend income, ordinary income and capital gain net income prior to the end of each calendar year to avoid liability for this excise tax. However, investors should note that a Fund may in certain circumstances be required to liquidate portfolio investments to make sufficient distributions to avoid excise tax liability. FUND INVESTMENTS. Each Fund may make investments or engage in transactions that affect the character, amount and timing of gains or losses realized by the Fund. Each Fund may make investments that produce income that is not matched by a corresponding cash receipt by the Fund. Any such income would be treated as income earned by the Fund and therefore would be subject to the distribution requirements of the Code. Such investments may require a Fund to borrow money or dispose of other securities in order to comply with those requirements. Each Fund may also make investments that prevent or defer the recognition of losses or the deduction of expenses. These investments may likewise require a Fund to borrow money or dispose of other securities in order to comply with the distribution requirements of the Code. Additionally, a Fund may make investments that result in the recognition of ordinary income rather than capital gain, or that prevent the Fund from accruing a long-term holding period. These investments may prevent a Fund from making capital gain distributions as described below. Each Fund intends to monitor its transactions, will make the appropriate tax elections and will make the appropriate entries in its books and records when it makes any such investments in order to mitigate the effect of these rules. TAX EXEMPT DIVIDENDS. Each tax-exempt Fund intends to qualify to pay exempt-interest dividends to its respective shareholders by having, at the close of each quarter of its taxable year, at least 50% of the value of its total assets consist of tax-exempt securities. An exempt-interest dividend is that part of dividend distributions made by a Fund that consists of interest received by the Fund on tax-exempt securities. Shareholders will not incur any federal income tax on the amount of exempt-interest dividends received by them from a Fund. Interest on indebtedness incurred or continued by a shareholder, whether a corporation or an individual, to purchase or carry shares of a Fund is not deductible to the extent it relates to exempt-interest dividends received by the shareholder. Any loss incurred on the sale or redemption of a Fund's shares held six months of less will be disallowed to the extent of exempt-interest dividends received with respect to such shares. Interest on certain tax-exempt bonds that are private activity bonds within the meaning of the Code is treated as a tax preference item for purposes of the alternative minimum tax, and any such interest received by a Fund and distributed to shareholders will be so treated for purposes of any alternative minimum tax liability of shareholders to the extent of the dividend's proportionate share of a Fund's income consisting of such interest. FUND DISTRIBUTIONS. Each Fund anticipates distributing substantially all of its net investment income for each taxable year. Dividends of net investment income paid to a non-corporate U.S. shareholder before January 1, 2009 that are designated as qualified dividend income will generally be taxable to such shareholder at a maximum rate of 15%. However, the amount of dividend income that may be so designated by a Fund will generally be limited to the aggregate of the eligible dividends received by the Fund. In addition, a Fund must meet certain holding period requirements with respect to the shares on which the Fund received the eligible dividends, and the non-corporate U.S. shareholder must meet certain holding period requirements with respect to the Fund shares. Dividends of net investment income that are not designated as qualified dividend income or exempt-interest dividends and dividends of net short-term capital gains 49 will be taxable to shareholders at ordinary income rates. Dividends paid by a Fund with respect to a taxable year will qualify for the 70% dividends received deduction generally available to corporations to the extent of the amount of dividends received by the Fund from certain domestic corporations for the taxable year. Shareholders will be advised annually as to the U.S. federal income tax consequences of distributions made (or deemed made) during the year, including the portion of dividends paid that qualify for the reduced tax rate. Ordinarily, shareholders are required to take taxable distributions by a Fund into account in the year in which the distributions are made. However, for federal income tax purposes, dividends that are declared by a Fund in October, November or December as of a record date in such month and actually paid in January of the following year will be treated as if they were paid on December 31 of the year declared. Therefore, such dividends will generally be taxable to a shareholder in the year declared rather than the year paid. Each Fund may either retain or distribute to shareholders its net capital gain for each taxable year. Each Fund currently intends to distribute any such amounts. If net capital gain is distributed and designated as a "capital gain dividend", it will be taxable to shareholders as long-term capital gain, regardless of the length of time the shareholder has held his shares or whether such gain was recognized by the Fund prior to the date on which the shareholder acquired its shares. Capital gain of a non-corporate U.S. shareholder that is recognized before January 1, 2009 is generally taxed at a maximum rate of 15% where the property is held by a Fund for more than one year. Capital gain of a corporate shareholder is taxed at the same rate as ordinary income. Conversely, if a Fund elects to retain its net capital gain, the Fund will be taxed thereon (except to the extent of any available capital loss carryovers) at the 35% corporate tax rate. In such a case, it is expected that such Fund also will elect to have shareholders of record on the last day of its taxable year treated as if each received a distribution of its pro rata share of such gain, with the result that each shareholder will be required to report its pro rata share of such gain on its tax return as long-term capital gain, will receive a refundable tax credit for its pro rata share of tax paid by the Fund on the gain, and will increase the tax basis for its shares by an amount equal to the deemed distribution less the tax credit. Distributions by a Fund that do not constitute qualified dividend income, ordinary income dividends, capital gain dividends or exempt-interest dividends will be treated as a return of capital to the extent of (and in reduction of) the shareholder's tax basis in its shares; any excess will be treated as gain from the sale of its shares, as discussed below. Distributions by a Fund will be treated in the manner described above regardless of whether such distributions are paid in cash or reinvested in additional shares of the Fund (or of another fund). Shareholders receiving a distribution in the form of additional shares will be treated as receiving a distribution in an amount equal to the fair market value of the shares received, determined as of the reinvestment date. In addition, prospective investors in a Fund should be aware that distributions from a Fund will, all other things being equal, have the effect of reducing the net asset value of the Fund's shares by the amount of the distribution. If the net asset value is reduced below a shareholder's cost, the distribution will nonetheless be taxable as described above, even if the distribution effectively represents a return of invested capital. Investors should consider the tax implications of buying shares just prior to a distribution, when the price of shares may reflect the amount of the forthcoming distribution. For federal income tax purposes, the following Money Markets Funds had capital loss carryforwards for the fiscal year ended August 31, 2004 (amounts in thousands):
CAPITAL LOSS EXPIRES IN FUND CARRYFORWARDS YEAR ---- ------------- ---------- Treasury Plus Money Market Fund $ (219) August 31, 2008 (36) August 31, 2009 ------------- (255)
To the extent that this capital loss is used to offset future capital gains, it is probable that gains so offset will not be distributed to shareholders. SALE OR REDEMPTION OF SHARES. Each Money Market Fund seeks to maintain a stable net asset value of $1.00 per share; however, there can be no assurance that a Money Market Fund will do this. A shareholder will recognize 50 gain or loss on the sale or redemption of shares in a Fund in an amount equal to the difference between the proceeds of the sale or redemption and the shareholder's adjusted tax basis in the shares. All or a portion of any loss so recognized may be disallowed if the shareholder acquires other shares of the Fund within a period of 61 days beginning 30 days before such disposition, such as pursuant to reinvestment of a dividend in shares of the Fund. Additionally, if a shareholder disposes of shares of a Fund within 90 days following their acquisition, and the shareholder subsequently re-acquires Fund shares pursuant to a reinvestment right received upon the purchase of the original shares, any load charge (i.e., sales or additional charge) incurred upon the acquisition of the original shares will not be taken into account as part of the shareholder's basis for computing profit or loss upon the sale of the shares. In general, any gain or loss arising from (or treated as arising from) the sale or redemption of shares of a Fund will be considered capital gain or loss and will be long-term capital gain or loss if the shares were held for more than one year. However, any capital loss arising from the sale or redemption of shares held for six months or less will be treated as a long-term capital loss to the extent of the amount of capital gain dividends received on (or undistributed capital gains credited with respect to) such shares. Capital gain of a non-corporate U.S. shareholder that is recognized before January 1, 2009 is generally taxed at a maximum rate of 15% where the property is held by the shareholder for more than one year. Capital gain of a corporate shareholder is taxed at the same rate as ordinary income. BACKUP WITHHOLDING. Each Fund will be required in certain cases to backup withhold and remit to the U.S. Treasury a portion of qualified dividend income, ordinary income dividends and capital gain dividends, and the proceeds of redemption of shares, paid to any shareholder (1) who has provided either an incorrect tax identification number or no number at all, (2) who is subject to backup withholding by the IRS for failure to report the receipt of interest or dividend income properly or (3) who has failed to certify to the Fund that it is not subject to backup withholding or that it is a corporation or other "exempt recipient". Backup withholding is not an additional tax and any amounts withheld may be refunded or credited against a shareholder's federal income tax liability, provided the appropriate information is furnished to the IRS. FOREIGN SHAREHOLDERS. Taxation of a shareholder who, as to the United States, is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership ("foreign shareholder") depends on whether the income from a Fund is "effectively connected" with a U.S. trade or business carried on by such shareholder. If the income from a Fund is not effectively connected with a U.S. trade or business carried on by a foreign shareholder, dividends paid to such foreign shareholder from net investment income will be subject to U.S. withholding tax on the gross amount of the dividend. Such a foreign shareholder would generally be exempt from U.S. federal income tax, including withholding tax, on gains realized on the sale of shares of a Fund, capital gain dividends and amounts retained by a Fund that are designated as undistributed capital gains. If the income from a Fund is effectively connected with a U.S. trade or business carried on by a foreign shareholder, then ordinary income dividends, capital gain dividends, undistributed capital gains credited to such shareholder and any gains realized upon the sale of shares of the Fund will be subject to U.S. federal income tax at the graduated rates applicable to U.S. citizens or domestic corporations. In the case of foreign non-corporate shareholders, a Fund may be required to backup withhold U.S. federal income tax on distributions that are otherwise exempt from withholding tax (or taxable at a reduced treaty rate) unless such shareholders furnish the Fund with proper notification of their foreign status. The tax consequences to a foreign shareholder entitled to claim the benefits of an applicable tax treaty may be different from those described herein. Foreign shareholders are urged to consult their own tax advisers with respect to the particular tax consequences to them of an investment in a Fund, the procedure for claiming the benefit of a lower treaty rate and the applicability of foreign taxes. Transfers by gift of shares of a Fund by an individual foreign shareholder will not be subject to U.S. federal gift tax, but the value of shares of a Fund held by such a shareholder at his death will generally be includible in his gross estate for U.S. federal estate tax purposes, subject to any applicable estate tax treaty. STATE AND LOCAL TAX MATTERS. Depending on the residence of the shareholders for tax purposes, distributions may also be subject to state and local taxes. Rules of state and local taxation regarding qualified dividend income, ordinary income dividends and capital gain dividends from regulated investment companies may differ from the U.S. federal income tax rules in other respects. Shareholders are urged to consult their tax advisers as to the consequences of these and other state and local tax rules affecting investment in a Fund. 51 Most states provide that a regulated investment company may pass through (without restriction) to its shareholders state and local income tax exemptions available to direct owners of certain types of U.S. government securities (such as U.S. Treasury obligations). Thus, for residents of these states, distributions derived from a Fund's investment in certain types of U.S. government securities should be free from state and local income taxes to the extent that the interest income from such investments would have been exempt from state and local taxes if such securities had been held directly by the respective shareholders. Certain states, however, do not allow a regulated investment company to pass through to its shareholders the state and local income tax exemptions available to direct owners of certain types of U.S. government securities unless the Fund holds at least a required amount of U.S. government securities. Accordingly, for residents of these states, distributions derived from a Fund's investment in certain types of U.S. government securities may not be entitled to the exemptions from state and local income taxes that would be available if the shareholders had purchased U.S. government securities directly. The exemption from state and local income taxes does not preclude states from asserting other taxes on the ownership of U.S. government securities. To the extent that a Fund invests to a substantial degree in U.S. government securities which are subject to favorable state and local tax treatment, shareholders of a Fund will be notified as to the extent to which distributions from the Fund are attributable to interest on such securities. ADDITIONAL INFORMATION As used in this SAI and the Prospectuses, the term "majority of the outstanding voting securities" means the vote of (i) 67% or more of a Fund's shares or the Fund's outstanding voting securities present at a meeting, if the holders of more than 50% of the Fund's outstanding shares or the Fund's outstanding voting securities are present or represented by proxy, or (ii) more than 50% of the Fund's outstanding shares or the Fund's outstanding voting securities, whichever is less. Telephone calls to the Funds, the Funds' service providers, or a financial professional as Financial Intermediary may be tape-recorded. With respect to the securities offered hereby, this Statement of Additional Information and the Prospectuses do not contain all the information included in the Trusts' Registration Statement filed with the SEC under the 1933 Act and the 1940 Act. Pursuant to the rules and regulations of the SEC, certain portions have been omitted. The Registration Statements, including the exhibits filed therewith, may be examined at the office of the SEC in Washington, D.C. Statements contained in this Statement of Additional Information and the Prospectuses concerning the contents of any contract or other document are not necessarily complete, and in each instance, reference is made to the copy of such contract or other document filed as an exhibit to the applicable Registration Statements. Each such statement is qualified in all respects by such reference. No dealer, salesman or any other person has been authorized to give any information or to make any representations, other than those contained in the Prospectuses and this Statement of Additional Information, in connection with the offer contained therein and, if given or made, such other information or representations must not be relied upon as having been authorized by any of the Trust, the Funds or OGDS. The Prospectuses and this Statement of Additional Information do not constitute an offer by any Funds or by OGDS to sell or solicit any offer to buy any of the securities offered hereby in any jurisdiction to any person to whom it is unlawful for the Funds or OGDS to make such offer in such jurisdictions. 52 PRINCIPAL HOLDERS As of January [__], 2005, the following persons owned of record, or were known by the Trust to own beneficially, 5% or more of the outstanding shares of any class of the Funds:
FUND AND CLASS OF SHARES NAME AND ADDRESS OF SHAREHOLDER PERCENTAGE HELD
The persons listed above as owning 25% or more of the outstanding shares of a Fund may be presumed to "control" (as that term is defined in the 1940 Act) such Funds. As a result, those persons would have the ability to vote a majority of the shares of the Funds on any matter requiring the approval of shareholders of such Funds. FINANCIAL STATEMENTS The Funds' Financial Statements and the reports thereon of PricewaterhouseCoopers LLP are incorporated herein by reference to the Funds' August 31, 2004 annual report filing made with the SEC on November 1, 2004 pursuant to Section 30(b) of the 1940 Act and Rule 30b2-1 thereunder. The foregoing financial reports are available without charge upon request by calling JPMorgan Funds at (800) 480-4111 or JPMorgan Institutional Funds at (800) 766-7722. 53 APPENDIX A DESCRIPTION OF CERTAIN OBLIGATIONS ISSUED OR GUARANTEED BY U.S. GOVERNMENT AGENCIES OR INSTRUMENTALITIES FEDERAL FARM CREDIT SYSTEM NOTES AND BONDS -- are bonds issued by a cooperatively owned nationwide system of banks and associations supervised by the Farm Credit Administration, an independent agency of the U.S. government. These bonds are not guaranteed by the U.S. government. MARITIME ADMINISTRATION BONDS -- are bonds issued and provided by the Department of Transportation of the U.S. government and are guaranteed by the U.S. government. FNMA BONDS -- are bonds guaranteed by the Federal National Mortgage Association. These bonds are not guaranteed by the U.S. government. FHA DEBENTURES -- are debentures issued by the Federal Housing Administration of the U.S. government and are guaranteed by the U.S. government. FHA Insured Notes are bonds issued by the Farmers Home Administration of the U.S. government and are guaranteed by the U.S. government. FHA INSURED NOTES -- are bonds issued by the Farmers Home Administration of the U.S. government and are guaranteed by the U.S. government. GNMA CERTIFICATES -- are mortgage-backed securities which represent a partial ownership interest in a pool of mortgage loans issued by lenders such as mortgage bankers, commercial banks and savings and loan associations. Each mortgage loan included in the pool is either insured by the Federal Housing Administration or guaranteed by the Veterans Administration and therefore guaranteed by the U.S. government. As a consequence of the fees paid to GNMA and the issuer of GNMA Certificates, the coupon rate of interest of GNMA Certificates is lower than the interest paid on the VA-guaranteed or FHA-insured mortgages underlying the Certificates. The average life of a GNMA Certificate is likely to be substantially less than the original maturity of the mortgage pools underlying the securities. Prepayments of principal by mortgagors and mortgage foreclosures may result in the return of the greater part of principal invested far in advance of the maturity of the mortgages in the pool. Foreclosures impose no risk to principal investment because of the GNMA guarantee. As the prepayment rate of individual mortgage pools will vary widely, it is not possible to accurately predict the average life of a particular issue of GNMA Certificates. The yield which will be earned on GNMA Certificates may vary form their coupon rates for the following reasons: (i) Certificates may be issued at a premium or discount, rather than at par; (ii) Certificates may trade in the secondary market at a premium or discount after issuance; (iii) interest is earned and compounded monthly which has the effect of raising the effective yield earned on the Certificates; and (iv) the actual yield of each Certificate is affected by the prepayment of mortgages included in the mortgage pool underlying the Certificates. Principal which is so prepaid will be reinvested, although possibly at a lower rate. In addition, prepayment of mortgages included in the mortgage pool underlying a GNMA Certificate purchased at a premium could result in a loss to a Fund. Due to the large amount of GNMA Certificates outstanding and active participation in the secondary market by securities dealers and investors, GNMA Certificates are highly liquid instruments. Prices of GNMA Certificates are readily available from securities dealers and depend on, among other things, the level of market rates, the Certificate's coupon rate and the prepayment experience of the pool of mortgages backing each Certificate. If agency securities are purchased at a premium above principal, the premium is not guaranteed by the issuing agency and a decline in the market value to par may result in a loss of the premium, which may be particularly likely in the event of a prepayment. When and if available, U.S. government obligations may be purchased at a discount from face value. FHLMC CERTIFICATES AND FNMA CERTIFICATES -- are mortgage-backed bonds issued by the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association, respectively, and are guaranteed by the U.S. government. GSA PARTICIPATION CERTIFICATES -- are participation certificates issued by the General Services Administration of the U.S. government and are guaranteed by the U.S. government. NEW COMMUNITIES DEBENTURES -- are debentures issued in accordance with the provisions of Title IV of the Housing and Urban Development Act of 1968, as supplemented and extended by Title VII of the Housing and Urban Development Act of 1970, the payment of which is guaranteed by the U.S. government. PUBLIC HOUSING BONDS -- are bonds issued by public housing and urban renewal agencies in connection with programs administered by the Department of Housing and Urban Development of the U.S. government, the payment of which is secured by the U.S. government. A-1 PENN CENTRAL TRANSPORTATION CERTIFICATES -- are certificates issued by Penn Central Transportation and guaranteed by the U.S. government. SBA DEBENTURES -- are debentures fully guaranteed as to principal and interest by the Small Business Administration of the U.S. government. WASHINGTON METROPOLITAN AREA TRANSIT AUTHORITY BONDS -- are bonds issued by the Washington Metropolitan Area Transit Authority. Some of the bonds issued prior to 1993 are guaranteed by the U.S. government. FHLMC BONDS -- are bonds issued and guaranteed by the Federal Home Loan Mortgage Corporation. These bonds are not guaranteed by the U.S. government. FEDERAL HOME LOAN BANK NOTES AND BONDS -- are notes and bonds issued by the Federal Home Loan Bank System and are not guaranteed by the U.S. government. STUDENT LOAN MARKETING ASSOCIATION ("SALLIE MAE") NOTES AND BONDS -- are notes and bonds issued by the Student Loan Marketing Association and are not guaranteed by the U.S. government. D.C. ARMORY BOARD BONDS -- are bonds issued by the District of Columbia Armory Board and are guaranteed by the U.S. government. EXPORT-IMPORT BANK CERTIFICATES -- are certificates of beneficial interest and participation certificates issued and guaranteed by the Export-Import Bank of the U.S. and are guaranteed by the U.S. government. In the case of securities not backed by the "full faith and credit" of the U.S. government, the investor must look principally to the agency issuing or guaranteeing the obligation for ultimate repayment, and may not be able to assert a claim against the U.S. government itself in the event the agency or instrumentality does not meet its commitments. Investments may also be made in obligations of U.S. government agencies or instrumentalities other than those listed above. A-2 APPENDIX B-DESCRIPTION OF SECURITY RATINGS* The ratings of Moody's and Standard & Poor's represent their opinions as to the quality of various Municipal Obligations. It should be emphasized, however, that ratings are not absolute standards of quality. Consequently, Municipal Obligations with the same maturity, coupon and rating may have different yields while Municipal Obligations of the same maturity and coupon with different ratings may have the same yield. STANDARD & POOR'S CORPORATE AND MUNICIPAL BONDS AAA-Debt rated AAA have the highest ratings assigned by Standard & Poor's to a debt obligation. Capacity to pay interest and repay principal is extremely strong. AA-Debt rated AA have a very strong capacity to pay interest and repay principal and differ from the highest rated issues only in a small degree. A-Debt rated A have a strong capacity to pay interest and repay principal although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher rated categories. BBB-Debt rated BBB is regarded as having an adequate capacity to pay interest and repay principal. Whereas they normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than for debt in higher rated categories. BB-Debt rated BB is regarded as having less near-term vulnerability to default than other speculative issues. However, they face major ongoing uncertainties or exposure to adverse business, financial or economic conditions which could lead to inadequate capacity to meet timely interest and principal payments. B-An obligation rated B is more vulnerable to nonpayment than obligations rated BB, but the obligor currently has the capacity to meet its financial commitment on the obligation. Adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitment on the obligation. CCC-An obligation rated CCC is currently vulnerable to nonpayment, and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitment on the obligation. In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitment on the obligation. CC-An obligation rated CC is highly vulnerable to nonpayment. C-The C rating may be used to cover a situation where a bankruptcy petition has been filed or similar action has been taken, but payments on this obligation are being continued. Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. DESCRIPTION OF STANDARD & POOR'S RATINGS OF MUNICIPAL NOTES AND TAX-EXEMPT DEMAND BONDS A Standard & Poor's note rating reflects the liquidity concerns and market access risks unique to notes. Notes due in 3 years or less will likely receive a note rating. Notes maturing beyond 3 years will most likely receive a long-term debt rating. The following criteria will be used in making that assessment. * Amortization schedule (the larger the final maturity relative to other maturities the more likely it will be treated as a note). ---------- * As described by the rating agencies. Ratings are generally given to securities at the time of issuance. While the rating agencies may from time to time revise such ratings, they undertake no obligation to do so. B-1 * Source of Payment (the more dependent the issue is on the market for its refinancing, the more likely it will be treated as a note). Note rating symbols are as follows: SP-1--Very strong or strong capacity to pay principal and interest. Those issues determined to possess overwhelming safety characteristics will be given a plus (+) designation. SP-2--Satisfactory capacity to pay principal and interest. SP-3--Speculative capacity to pay principal and interest. Standard & Poor's assigns "dual" ratings to all long-term debt issues that have as part of their provisions a demand or double feature. The first rating addresses the likelihood of repayment of principal and interest as due, and the second rating addresses only the demand feature. The long-term debt rating symbols are used for bonds to denote the long-term maturity and the commercial paper rating symbols are used to denote the put option (for example, "AAA/A-1+"). For the newer "demand notes," S&P's note rating symbols, combined with the commercial paper symbols, are used (for example, "SP-1+/A-1+"). DESCRIPTION OF STANDARD & POOR'S TWO HIGHEST COMMERCIAL PAPER RATINGS A-1--This rating indicates a fund has strong capacity to meet its financial commitments. Standard & Poor's rate it in the highest category. Within this category, certain obligors are designated with a plus sign (+). This indicates that the obligor's capacity to meet its financial commitments is extremely stong. A-2--This rating indicates a fund has satisfactory capacity to meet its financial commitments. However it is somewhat more susceptible to the adverse affects of changes in circumstances and economic conditions than obligors in the highest rating category. MOODY'S CORPORATE AND MUNICIPAL BONDS AAA-Bonds which are rated Aaa are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edge." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. Aa-Bonds which are rated Aa are judged to be of high quality by all standards. Together with the AAA group they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in Aaa securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long term risks appear somewhat larger than in Aaa securities. A-Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment sometime in the future. BAA-Bonds which are rated Baa are considered as medium grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. BA-Bonds which are rated Ba are judged to have speculative elements; their future cannot be considered as well-assured. Often the protection of interest and principal payments may be very moderate, and thereby not well safeguarded during both good and bad times over the future. Uncertainty of position characterizes bonds in this class. B-Bonds which are rated B generally lack characteristics of the desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small. B-2 CAA-Bonds which are rated Caa are of poor standing. Such issues may be in default or there may be present elements of danger with respect to principal or interest. CA-Bonds which are rated Ca represent obligations which are speculative in a high degree. Such issues are often in default or have other marked shortcomings. C-Bonds which are rated C are the lowest rated class of bonds and issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing. Commercial Paper, Including Tax Exempt The Aa, A and Baa rating categories are refined by the inclusion of a modifier. These numeric suffixes (Aa1, Aa2,Aa3, etc.) are intended to provide further differentiation within each category. For instance, a Aa1 rating exhibits the best of the characteristics within the As category, while a Aa3 contains relatively less. COMMERCIAL PAPER, INCLUDING TAX EXEMPT PRIME-1-Issuers rated Prime-1 (or related supporting institutions) have a superior capacity for repayment of short-term promissory obligations. Prime-1 repayment capacity will normally be evidenced by the following characteristics: - Leading market positions in well established industries. High rates of return on funds employed. - Conservative capitalization structures with moderate reliance on debt and ample asset protection. - Broad margins in earnings coverage of fixed financial charges and high internal cash generation. - Well established access to a range of financial markets and assured sources of alternate liquidity. PRIME-2-Issuers rated Prime-2 (or supporting institutions) have a strong ability for repayment of senior short-term debt obligations. This will normally be evidenced by many of the characteristics cited above but to lesser degree. Earnings trends and coverage ratios, while sound, may be more subjects to variation. Capitalization characteristics, while still appropriate, may be more affected by external conditions. Ample alternate liquidity is maintained. PRIME-3-Issuers rated Prime-3 (or supporting institutions) have an acceptable ability for repayment of senior short-term obligations. The effect of industry characteristics and market compositions may be more pronounced. Variability in earnings and profitability may result in changes in the level of debt protection measurements and may require relatively high financial leverage. Adequate alternate liquidity is maintained. SHORT-TERM TAX EXEMPT NOTES MIG-1-The short-term tax-exempt note rating MIG-1 is the highest rating assigned by Moody's for notes judged to be the best quality. Notes with this rating enjoy strong protection from established cash flows of funds for their servicing or from established and broad-based access to the market for refinancing, or both. MIG-2-MIG-2 rated notes are of high quality but with margins of protection not as large as MIG-1. DESCRIPTION OF MOODY'S THREE HIGHEST RATINGS OF STATE AND MUNICIPAL NOTES Moody's ratings for state and municipal short-term obligations will be designated Moody's Investment Grade ("MIG"). Such ratings recognize the differences between short-term credit risk and longterm risk. Factors affecting the liquidity of the borrower and short-term cyclical elements are critical in short-term ratings, while other factors of major importance in bond risk, long-term secular trends for example, may be less important over the short run. A short-term rating may also be assigned on an issue having a demand feature-variable rate demand obligation or commercial paper programs; such ratings will be designated as "VMIG." Short-term ratings on issues with demand features are differentiated by the use of the VMIG symbol to reflect such characteristics as payment upon periodic demand rather than fixed maturity dates and payment relying on external liquidity. Symbols used are as follows: MIG-1/VMIG-1--Notes bearing this designation are of the best quality, enjoying strong protection from established cash flows of funds for their servicing or from established and broad-based access to the market for refinancing, or both. MIG-2/VMIG-2--Notes bearing this designation are of high quality, with margins of protection ample although not so large as in the preceding group. B-3 MIG-3/VMIG-3--Notes bearing this designation are of acceptable credit quality, where all security elements are accounted for but there is lacking the undeniable strength of the preceding grade, liquidity and cash flow protection may be narrow and market access for refinancing is likely to be less well established. FITCH DESCRIPTION OF MOODY'S TWO HIGHEST COMMERCIAL PAPER RATINGS Moody's Commercial Paper ratings are opinions of the ability of issuers to repay punctually promissory obligations not having an original maturity in excess of nine months. Moody's employs three designations, all judged to be investment grade, to indicate the relative repayment capacity of rated issuers: Prime-1, Prime-2 and Prime-3. ISSUERS RATED PRIME-1--(or related supporting institutions) have a superior capacity for repayment of short-term promissory obligations. Prime-1 repayment capacity will normally be evidenced by the following characteristics: (1) leading market positions in well-established industries; (2) high rates of return on funds employed; (3) conservative capitalization structures with moderate reliance on debt and ample asset protection; (4) broad margins in earnings coverage of fixed financial charges and high internal cash generation; and (5) well-established access to a range of financial markets and assured sources of alternate liquidity. ISSUERS RATED PRIME-2--(or related supporting institutions) have a strong capacity for repayment of short-term promissory obligations. This will normally be evidenced by many of the characteristics cited above but to a lesser degree. Earnings trends and coverage ratios, while sound, will be more subject to variation. Capitalization characteristics, while still appropriate, may be more affected by external conditions. Ample alternate liquidity is maintained. CORPORATE AND MUNICIPAL BONDS The ratings represent Fitch's assessment of the issuer's ability to meet the obligations of a specific debt issue or class of debt. The ratings take into consideration special features of the issue, its relationship to other obligations of the issuer, the current financial condition and operative performance of the issuer and of any guarantor, as well as the political and economic environment that might affect the issuer's financial strength and credit quality. AAA--Bonds rated AAA by Fitch are considered to be investment grade and of the highest credit quality. The obligor has an exceptionally strong ability to pay interest and repay principal, which is unlikely to be affected by reasonably foreseeable events. AA--Bonds rated AA by Fitch are considered to be investment grade and of very high credit quality. The obligor's ability to pay interest and repay principal is very strong, although not quite as strong as bonds rated AAA. Because bonds rated in the AAA and AA categories are not significantly vulnerable to foreseeable future developments, short-term debt of these issues is generally rated F-1+ by Fitch. A--Bonds rated A by Fitch are considered to be investment grade and of high credit quality. The obligor's ability to pay interest and repay principal is considered to be strong, but may be more vulnerable to adverse changes in economic conditions and circumstances than bonds with higher ratings. BBB--Bonds rated BBB by Fitch are considered to be investment grade and of satisfactory credit quality. The obligor's ability to pay interest and repay principal is considered to be adequate. Adverse changes in economic conditions and circumstances, however, are more likely to have adverse consequences on these bonds, and therefore impair timely payment. The likelihood that the ratings of these bonds will fall below investment grade is higher than for bonds with higher ratings. Plus (+) and minus (-) signs are used by Fitch to indicate the relative position of a credit within a rating category. Plus and minus signs, however, are not used in the AAA category. SHORT-TERM TAX EXEMPT NOTES F-1+--Issues assigned this rating are regarded as having the strongest degree of assurance for timely payment. B-4 F-1--Issues assigned this rating reflect an assurance of timely payment only slightly less in degree than issues rated F-1+. F-2--Issues assigned this rating have a satisfactory degree of assurance for timely payment but the margin of safety is not as great as for issues assigned F-1+ and F-1 ratings. F-3--Issues assigned this rating have characteristics suggesting that the degree of assurance for timely payment is adequate, although near-term adverse changes could cause these securities to be rated below investment grade. LOC--The symbol LOC indicates that the rating is based on a letter of credit issued by a commercial bank. B-5 APPENDIX C- ADDITIONAL INFORMATION CONCERNING CALIFORNIA MUNICIPAL SECURITIES THE SECURITIES THAT THE FUND OFFERS ARE NOT BEING OFFERED BY THE STATE OF CALIFORNIA. THE STATE OF CALIFORNIA HAS NOT APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THE FUND'S REGISTRATION STATEMENT (INCLUDING THIS STATEMENT OF ADDITIONAL INFORMATION) IS TRUTHFUL OR COMPLETE This Appendix contains information about the State of California as set forth in "Appendix A" to the official statement issued by the State of California for its general obligation bond issue on October 29, 2003. The State of California C-1 TABLE OF CONTENTS
PAGE INTRODUCTION TO APPENDIX A A-1 RECENT DEVELOPMENTS REGARDING STATE ECONOMY AND FINANCES A-3 STATE INDEBTEDNESS AND OTHER OBLIGATIONS A-5 General A-5 Capital Facilities Financing A-5 General Obligation Bonds A-5 Commercial Paper Program A-5 Lease-Purchase Obligations A-6 Non-Recourse Debt A-6 Pension Obligation Bonds A-6 Fiscal Recovery Bonds A-7 Enhanced Tobacco Settlement Revenue Bonds A-7 Cash Flow Borrowings A-8 CASH FLOW A-9 2002-03 Fiscal Year A-9 2003 Revenue Anticipation Warrants A-9 Fiscal Year 2003-04 Revenue Anticipation Notes A-10 STATE FINANCES A-11 The General Fund A-11 The Special Fund for Economic Uncertainties A-11 Inter-Fund Borrowings A-12 State Warrants A-14 Registered Warrants A-14 Reimbursement Warrants A-15 Refunding Warrants A-15 Sources of Tax Revenue A-15 Personal Income Tax A-15 Sales Tax A-16 Corporation Tax A-17 Insurance Tax A-18 Estate Tax; Other Taxes A-18 Special Fund Revenues A-18 Vehicle License Fee A-19 Taxes on Tobacco Products A-19 Recent Tax Receipts A-21 State Expenditures A-23 State Appropriations Limit A-23 Proposition 98 A-25 Local Governments A-26 Welfare Reform A-27 Pension Trusts A-28 Repayment of Energy Loans A-30 Tobacco Litigation Settlement A-30 Investment of Funds A-31 THE BUDGET PROCESS A-32 General A-32 Constraints on the Budget Process A-32
i PRIOR FISCAL YEARS' BUDGETS A-33 2000 Budget Act A-33 2001 Budget Act A-33 2002 Budget Act A-34 CURRENT STATE BUDGET A-35 Background A-35 2003 Budget Act A-36 Addressing the $38.2 Billion Shortfall A-37 Expenditure Cuts/Savings A-38 Fund Shifts A-39 Other Revenues A-39 Loans/Borrowings A-39 Fiscal Recovery Bonds A-39 Budget Controls and Flexibility A-40 Continuing "Structural Deficit" A-40 Election of New Governor A-41 Summary of State Revenues and Expenditures A-42 Revenue and Expenditure Assumptions A-44 Economic Assumptions A-45 FINANCIAL STATEMENTS A-46 OVERVIEW OF STATE GOVERNMENT A-47 Organization of State Government A-47 Employee Relations A-49 ECONOMY AND POPULATION A-49 Introduction A-49 Population and Labor Force A-50 Employment, Income, Construction and Export Growth A-51 LITIGATION A-54 Challenge to Discontinuation of Vehicle License Fee Offset A-54 Bond-Related Matters A-55 Challenge Seeking Payment to Teacher's Retirement Board A-55 Actions Seeking Flood-Related Damages A-55 Tax Refund Cases A-56 Environmental Cleanup Matter A-57 Energy-Related Matters A-58 Escheated Property Claims A-58 Action Seeking Damages for Alleged Violations of Privacy Rights A-59 Actions Seeking Program Modifications A-59 Medically Indigent Adult Mandate Claims A-60 STATE DEBT TABLES A-61 EXHIBIT 1 - STATE CONTROLLER'S STATEMENT OF GENERAL FUND CASH RECEIPTS AND DISBURSEMENTS, JULY 1, 2002 THROUGH JUNE 30, 2003 (UNAUDITED) EX-1 EXHIBIT 2 - STATE CONTROLLER'S STATEMENT OF GENERAL FUND CASH RECEIPTS AND DISBURSEMENTS, JULY 1, 2003 THROUGH SEPTEMBER 30, 2003 (UNAUDITED) EX-2
ii INTRODUCTION TO APPENDIX A IMPORTANCE OF APPENDIX A. APPENDIX A is the part of the Official Statement that provides investors with information concerning the State of California. Investors must read the entire Official Statement, including APPENDIX A, to obtain information essential to making an informed investment decision. ELECTION OF NEW GOVERNOR. Uncertified results from a special election held on October 7, 2003 indicate that the Governor of the State, Gray Davis, has been recalled and that he will be replaced as Governor by Arnold Schwarzenegger. The Secretary of State of the State has until November 15, 2003 to certify the results of the recall election. The new Governor would not take office until the election results are certified. The Governor-elect is in the process of assembling his staff and evaluating the State's financial condition. As a result of his evaluation, he may propose mid-year legislation or take executive actions which could affect the State's receipts, disbursements and proposed borrowings during the current fiscal year. CALIFORNIA'S FINANCIAL SITUATION. In May 2003, Governor Gray Davis stated that the State faced an estimated two-year budget shortfall of $38.2 billion. The recently enacted 2003 Budget Act (as defined herein) addressed the shortfall through, among other proposals, the issuance of approximately $10.7 billion of fiscal recovery bonds which are presently being challenged in court, and $1.9 billion of pension obligation bonds, which a trial court has declined to validate. See "LITIGATION--Bond-Related Matters." Although the 2003 Budget Act is balanced, the Legislative Analyst's Office projects that the State would face an estimated $7.9 billion deficit in fiscal year 2004-05, which will have to be addressed by future legislation or other budget solutions. The ability of the State to meet its current obligations (including its obligations pursuant to various cash flow borrowings becoming due in fiscal year 2003-04 as described herein under "CASH FLOW--2003 Revenue Anticipation Warrants and "--Fiscal Year 2003-04 Revenue Anticipation Notes") depends in large part on its ability to implement the borrowings contemplated by the 2003 Budget Act. The State can make no assurances that such borrowings will not be delayed or cancelled as a result of litigation or other reasons. See "RECENT DEVELOPMENTS REGARDING STATE ECONOMY AND FINANCES" and "CASH FLOW." The credit rating agencies have considered California's financial situation. In December 2002, Fitch downgraded the State's general obligation credit rating to "A." In July 2003, Standard & Poor's downgraded the State's general obligation credit rating to "BBB" and in August 2003, Moody's Investors Services downgraded such rating to "A3." In January 2001, these ratings were "AA," "AA" and "Aa2," respectively. See also "RATINGS" in the first part of this Official Statement. CALIFORNIA'S CREDIT HISTORY. California has always paid the principal of and interest on its general obligation bonds, general obligation commercial paper notes, lease-purchase obligations and short-term obligations, including revenue anticipation notes and revenue anticipation warrants, when due. OVERVIEW OF APPENDIX A. APPENDIX A begins with a description of recent developments regarding the State's economy and finances and then discusses the types of debt instruments that the State has issued and is authorized to issue in the future. See "RECENT DEVELOPMENTS REGARDING STATE ECONOMY AND FINANCES" and "STATE INDEBTEDNESS AND OTHER OBLIGATIONS." A discussion of the State's current and projected cash flow is contained under "CASH FLOW." A-1 APPENDIX A continues with a discussion of the sources and uses of State funds. See "STATE FINANCES." The budget process and constraints on this process, as well as the current budget and the economic assumptions underlying the revenue projections contained in the current budget, are discussed under "THE BUDGET PROCESS" and "CURRENT STATE BUDGET." Then, APPENDIX A incorporates by reference the Audited Annual Financial Statements of the State for the Year Ended June 30, 2002, together with certain information required by governmental accounting and financial reporting standards to be included in the Financial Statements, including a "Management's Discussion and Analysis" that describes and analyzes the financial position of the State and provides an overview of the State's activities for the fiscal year ended June 30, 2002. The State Controller's unaudited reports of cash receipts and disbursements for the period July 1, 2002 through September 30, 2003 are included as Exhibits 1 and 2 to this APPENDIX A. See "FINANCIAL STATEMENTS." Governance, management and employee information is set forth under "OVERVIEW OF STATE GOVERNMENT." Demographic and economic statistical information is included under "ECONOMY AND POPULATION." APPENDIX A concludes with a description of material litigation involving the State (see "LITIGATION") and debt tables (see "STATE DEBT TABLES"). A-2 RECENT DEVELOPMENTS REGARDING STATE ECONOMY AND FINANCES In recent years the State has experienced a decline in State revenues attributable in large part to declines in personal income tax receipts including particularly stock market related income tax revenues, such as capital gains realizations and stock option income. The State estimates that stock market related personal income tax revenue declined from $17.9 billion in fiscal year 2000-01 to $6.1 billion in fiscal year 2001-02, and to $5.0 billion in 2002-03, a total 72 percent decline. The State's economy continued to grow slowly through August of 2003. Slow growth is projected for the balance of 2003, and moderate growth is projected in 2004, generally tracking the national economy. In the budget for fiscal year 2002-03 (July 1, 2002 to June 30, 2003), Governor Davis and the Legislature addressed the continuing decline in tax revenues, primarily with a combination of expenditure reductions and one-time actions, such as bond and asset sales, expenditure deferrals and interfund transfers and loans. See "PRIOR FISCAL YEARS' BUDGETS--2002 Budget Act." The 2003-04 Governor's Budget, as proposed by Governor Davis on January 10, 2003, projected a shortfall or "gap" on a budgetary basis of $34.6 billion over the combined 2002-03 and 2003-04 fiscal years absent corrective action. The 2003-04 Governor's Budget (incorporating requests made in December 2002) called for budget actions totaling over $10.2 billion early in calendar year 2003 in order to achieve maximum savings. In March and April 2003, the Legislature passed revised budget adjustment legislation totaling about $10.4 billion in spending reductions, deferrals and fund transfers (including $5.1 billion for fiscal year 2002-03 and $5.3 billion for fiscal year 2003-04). The May Revision to the 2003-04 Governor's Budget, released on May 14, 2003 (the "May Revision"), projected that while some corrective action was taken in March and April 2003, the pre-corrective action budget gap had increased to about $38.2 billion, primarily due to the cancellation of the sale of tobacco securitization bonds (which bonds have now been issued), lost opportunities for savings with the passage of time, and increased caseload in certain health and correctional programs. The budget proposals contained in the May Revision were significantly changed from the original Governor's Budget, and Governor Davis proposed to address the budget challenge in three phases: (1) eliminate an estimated $10.675 billion budget deficit accumulated through June 30, 2003, by issuing fiscal recovery bonds to be repaid from a temporary one-half cent increase in the State sales tax, (2) balance the fiscal year 2003-04 budget with a combination of expenditure cuts (some already approved by the Legislature in March and April of 2003), fund transfers and loans, and transfer ("realignment") of certain health and social services programs from the State to counties, and (3) pursue legislative action during the balance of the 2003 legislative session to enact structural reforms that would eliminate an estimated $7.9 billion structural deficit for the 2004-05 fiscal year. See "CURRENT STATE BUDGET--Background." The annual Budget Act for fiscal year 2003-04 (the "2003 Budget Act"), adopted by the Legislature on July 29, 2003 and signed by Governor Davis on August 2, 2003, largely reflects the budget proposals contained in the May Revision. Realization of the 2003 Budget Act proposals is dependent upon numerous assumptions and contingencies more fully described herein, including, among others, the successful resolution of pending litigation relating to the issuance of pension obligation bonds and pending litigation relating to the issuance of fiscal recovery bonds (expected to generate approximately $10.7 billion of proceeds). A State trial court has declined to validate the pension obligation bonds and the State has appealed this decision. See "STATE INDEBTEDNESS--Pension Obligation Bonds," "--Fiscal Recovery Bonds" and "LITIGATION--Bond-Related Matters." As reflected in the May Revision, further legislative action will be required to address the remaining funding gap in fiscal year 2004-05. The Legislative Analyst's Office estimated the amount to be $7.9 billion. This "structural deficit" reflects in part the use of one-time revenue enhancements, cost A-3 reductions and fund transfers in fiscal years 2002-03 and 2003-04 that will be unavailable in fiscal year 2004-05 as well as customary expenditure growth due to, among other things, enrollment, caseload, and population growth. See "CURRENT STATE BUDGET--2003 Budget Act--Continuing Structural Deficit." As part of its cash management program, the State has regularly issued short-term obligations to meet cash flow needs. See "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Cash Flow Borrowings." In fiscal year 2002-03, the State retired $7.5 billion of revenue anticipation warrants issued near the end of the preceding fiscal year and issued $12.5 billion of revenue anticipation notes maturing in June 2003. Due to the budget shortfalls described above, the State Controller issued $10.965 billion of revenue anticipation warrants on June 18, 2003. This borrowing provided cash resources necessary to pay the State's obligations in June 2003 (including the maturing $12.5 billion of revenue anticipation notes) and in the first few months of fiscal year 2003-04. To provide further assurance for the repayment of the revenue anticipation warrants, which mature on June 16, 2004, the State entered into agreements with seven financial institutions which committed (subject to the conditions set forth in the agreements, including the State's inability to refund the revenue anticipation warrants) to purchase the revenue anticipation warrants upon their maturity. If the State is required to draw under the agreements, numerous adverse consequences affecting the State's financial condition might occur, as further described herein. See "CASH FLOW--2003 Revenue Anticipation Warrants." The State issued $3.0 billion of revenue anticipation notes on October 28, 2003. To provide further assurance for the payment of the revenue anticipation notes, which mature on June 23, 2004, the State entered into an agreement with certain financial institutions to provide letters of credit to pay principal and interest with respect to certain of such notes when due. If the State is required to draw under such letters of credit, or is otherwise unable to pay principal and interest on the notes at maturity, numerous adverse consequences affecting the State's financial condition might occur, as further described herein. See "CASH FLOW--Fiscal Year 2003-04 Revenue Anticipation Notes." Since the 2003 Budget Act, the Controller has released actual results of receipts and disbursements for the months of August and September. Cash and unused borrowable resources through the end of September, 2003 were $1.1 billion above the projections done in connection with the 2003 Budget Act. See "EXHIBIT 2 - STATE CONTROLLER'S STATEMENT OF GENERAL FUND CASH RECEIPTS AND DISBURSEMENTS, JULY 1, 2003 THROUGH SEPTEMBER 30, 2003 (UNAUDITED)" No assurance can be given by the State that available cash and unused borrowable resources will continue to be above projections. In fiscal year 2002-03 the State paid $8.161 billion in unemployment benefits from the Unemployment Insurance ("UI") Fund. In fiscal year 2003-04 the State expects to pay $8.203 billion in benefits from the UI Fund. The UI Fund (which is not part of the General Fund) is projected to have a $1.2 billion deficit by the end of calendar year 2004 notwithstanding the automatic unemployment insurance tax rate increase that takes effect January 1, 2004. The State may address this issue with one or more of the following options: (1) obtain a loan from the federal government, (2) rollback unemployment benefits and/or (3) increase unemployment insurance taxes which are the sole source of funds for the UI Fund. There is no reason to believe that one or all of these options will not be available to the State. The loan from the federal government would provide cash flow relief so that unemployment benefits can continue to be paid. The federal loan would eventually be repaid from increased UI tax revenue or the available resources resulting from decreased benefits. Interest payments on the loan would be paid by the EDD Contingent Fund and not the General Fund. The new Administration and the Legislature will have to determine how to resolve the cash flow imbalance in the UI Fund for the long-term. This issue is expected to be addressed in the upcoming session of the Legislature. A-4 STATE INDEBTEDNESS AND OTHER OBLIGATIONS GENERAL The State Treasurer is responsible for the sale of debt obligations of the State and its various authorities and agencies. The State has always paid the principal of and interest on its general obligation bonds, general obligation commercial paper notes, lease-purchase debt and short-term obligations, including revenue anticipation notes and revenue anticipation warrants, when due. CAPITAL FACILITIES FINANCING GENERAL OBLIGATION BONDS The State Constitution prohibits the creation of general obligation indebtedness of the State unless a bond measure is approved by a majority of the electorate voting at a general election or a direct primary. General obligation bond acts provide that debt service on general obligation bonds shall be appropriated annually from the General Fund and all debt service on general obligation bonds is paid from the General Fund. Under the State Constitution, debt service on general obligation bonds is the second charge to the General Fund after the application of moneys in the General Fund to the support of the public school system and public institutions of higher education. See "STATE FINANCES--State Expenditures." Certain general obligation bond programs receive revenues from sources other than the sale of bonds or the investment of bond proceeds. As of October 1, 2003, the State had outstanding $30,103,927,000 aggregate principal amount of long-term general obligation bonds, and unused voter authorizations for the future issuance of $24,021,001,000 of long-term general obligation bonds. This latter figure consists of $13,628,542,000 of general obligation bonds which are authorized by State finance committees to be issued initially as commercial paper notes, described below, and $10,392,459,000 of other authorized but unissued general obligation bonds. See the table "Authorized and Outstanding General Obligation Bonds" under "STATE DEBT TABLES." See introduction to "STATE DEBT TABLES" for information as to bonds issued or expected to be issued after October 1, 2003. General obligation bond law permits the State to issue as variable rate indebtedness up to 20 percent of the aggregate amount of long-term general obligation bonds outstanding. The State issued $1.4 billion of variable rate general obligation bonds, representing 4.7% of the State's total outstanding general obligation bonds as of October 1, 2003. The Legislature has approved approximately $22 billion of potential bond authorizations to be placed on the ballot in March of 2004, including the Kindergarten-University Public Education Facilities Bond Act of 2004 and the Safe, Reliable High-Speed Passenger Train Bond Act of the 21st Century. Additional bond proposals may also be added in 2004. COMMERCIAL PAPER PROGRAM Pursuant to legislation enacted in 1995, voter-approved general obligation indebtedness may be issued either as long-term bonds or, for some but not all bond issuances, as commercial paper notes. Commercial paper notes may be renewed or may be refunded by the issuance of long-term bonds. The State issues long-term general obligation bonds from time to time to retire its general obligation commercial paper notes. Commercial paper notes are deemed issued upon authorization by the respective finance committees, whether or not such notes are actually issued. The State's commercial paper credit A-5 facility expired in August 2003. The State is currently negotiating a new credit facility. See "STATE DEBT TABLES." LEASE-PURCHASE OBLIGATIONS In addition to general obligation bonds, the State builds and acquires capital facilities through the use of lease-purchase borrowing. Under these arrangements, the State Public Works Board, another State or local agency or a joint powers authority issues bonds to pay for the construction of facilities such as office buildings, university buildings or correctional institutions. These facilities are leased to a State agency or the University of California under a long-term lease that provides the source of payment of the debt service on the lease-purchase bonds. In some cases, there is not a separate bond issue, but a trustee directly creates certificates of participation in the State's lease obligation, which are then marketed to investors. Under applicable court decisions, such lease arrangements do not constitute the creation of "indebtedness" within the meaning of the State Constitutional provisions that require voter approval. For purposes of this section of the Official Statement and the tables under "STATE DEBT TABLES," "lease-purchase obligation" or "lease-purchase financing" means principally bonds or certificates of participation for capital facilities where the rental payments providing the security are a direct or indirect charge against the General Fund and also includes revenue bonds for a State energy efficiency program secured by payments made by various State agencies under energy service contracts. Certain of the lease-purchase financings are supported by special funds rather than the General Fund. See "STATE FINANCES--Sources of Tax Revenue--Special Fund Revenues." The tables under "STATE DEBT TABLES" do not include equipment leases or leases which were not sold, directly or indirectly, to the public capital markets. The State had $6,620,144,071 General Fund-supported lease-purchase obligations outstanding as of October 1, 2003. The State Public Works Board, which is authorized to sell lease revenue bonds, had $4,781,492,000 authorized and unissued as of October 1, 2003. In addition, as of that date, certain joint powers authorities were authorized to issue approximately $81,000,000 of revenue bonds to be secured by State leases. See introduction to "STATE DEBT TABLES" for information as to bonds issued or expected to be issued after October 1, 2003. NON-RECOURSE DEBT Certain State agencies and authorities issue revenue obligations for which the General Fund has no liability. Revenue bonds represent obligations payable from State revenue-producing enterprises and projects, which are not payable from the General Fund, and conduit obligations payable only from revenues paid by private users of facilities financed by the revenue bonds. The enterprises and projects include transportation projects, various public works projects, public and private educational facilities (including the California State University and University of California systems), housing, health facilities and pollution control facilities. There are 17 agencies and authorities authorized to issue revenue obligations (excluding lease-purchase obligations). State agencies and authorities had $42,558,532,631 aggregate principal amount of revenue bonds and notes which are non-recourse to the General Fund outstanding as of December 31, 2002, as further described in the table "State Agency Revenue Bonds and Conduit Financing" under "STATE DEBT TABLES." Detailed information regarding the State's long-term debt appears in the section "STATE DEBT TABLES." PENSION OBLIGATION BONDS Pursuant to the California Pension Obligation Financing Act, Government Code Section 16910 ET SEQ. (the "Pension Bond Act"), the State proposed to issue $1.9 billion of pension obligation bonds to make fiscal year 2003-04 contributions to the California Public Employees' Retirement System A-6 ("CalPERS"). The payment of debt service on the pension obligation bonds will be payable from the General Fund subject to the priorities specified in the Pension Bond Act. The State would make an interest-only payment on the pension obligation bonds in fiscal year 2003-04 and principal and interest payments in each fiscal year from 2004-05 through 2008-09. The proposed pension obligation bonds are the subject of a validation action brought by the Pension Obligation Bond Committee for and on behalf of the State. In that validation action, the Pension Obligation Bond Committee seeks to obtain the court's determination that the pension obligation bonds will not be in violation of the Constitutional debt limit because the proceeds of the pension obligation bonds will be used to pay the State's employer obligation to CalPERS, which is an "obligation imposed by law." On October 2, 2003, the trial court issued a judgment denying the State's request that the bonds be validated. The State has filed a petition for writ of mandate in the California Supreme Court and has requested the court's expedited consideration of the petition. Pension obligation bonds were not issued in time to make the October 1, 2003 quarterly pension contributions. The next quarterly contribution in the estimated amount of $553 million is due on January 2, 2004. The size of any future bond issue to fund the 2003-04 contributions to CalPERS will be reduced in the event this litigation causes further delay in the issuance of the pension obligation bonds. See "LITIGATION--Bond-Related Matters." FISCAL RECOVERY BONDS The State proposes to issue approximately $10.7 billion of fiscal recovery bonds in February and April, 2004. The California Fiscal Recovery Financing Act (Government Code Section 99000 et seq.), was adopted pursuant to Chapter 13, First Extraordinary Session, Statutes of 2003. The California Fiscal Recovery Financing Act authorizes the issuance of fiscal recovery bonds, proceeds of which would be deposited in the General Fund, to eliminate the estimated $10.675 billion accumulated budget deficit through June 30, 2003. This is the largest and most critical component of the 2003 Budget Act. The State plans to issue the fiscal recovery bonds in February and April of 2004. However, the issuance of the fiscal recovery bonds is the subject of current litigation, as described below. The fiscal recovery bonds will be issued by a Fiscal Recovery Finance Authority, and will be paid from future annual appropriations by the Legislature, if any, from the Fiscal Recovery Fund. The Fiscal Recovery Financing Act establishes the Fiscal Recovery Fund outside of the General Fund. The Legislature has enacted a temporary one-half cent State sales tax beginning July 1, 2004, the revenues of which will be deposited and held in the Fiscal Recovery Fund, available for the Legislature's future appropriations, if any, to pay debt service on the fiscal recovery bonds. See "STATE FINANCES--Sources of Tax Revenue--Sales Tax." Payment of debt service on the fiscal recovery bonds will be subject to future annual appropriation by the Legislature. A legal advocacy institution has filed a lawsuit challenging the proposed issuance of the fiscal recovery bonds alleging that the issuance of such fiscal recovery bonds violates the constitution's debt-limit provisions. See "LITIGATION--Bond-Related Matters." Prior to the filing of that lawsuit, the Attorney General concluded that fiscal recovery bonds issued pursuant to the terms of the Fiscal Recovery Bond Act would not be debt prohibited by the Constitutional debt limit. ENHANCED TOBACCO SETTLEMENT REVENUE BONDS In 1998 the State signed a settlement agreement with the four major cigarette manufacturers. Under the settlement agreement, the manufacturers agreed to make payments to the State in perpetuity. See "STATE FINANCES--Tobacco Settlement Litigation." Chapter 414, Statutes of 2002, as amended, allows the issuance of revenue bonds secured by the tobacco settlement revenues received by the State beginning in the 2003-04 fiscal year. An initial sale of 56.57% of the State's tobacco settlement revenues from July 1, 2003, onward, producing $2.5 billion in proceeds was completed in January 2003. A-7 A second sale of the remaining 43.43% of the State's tobacco settlement revenues, which produced $2.264 billion in proceeds, was completed in September 2003. Chapter 414, Statutes of 2002, as amended, requires the Governor to request an appropriation in the annual budget act to pay debt service and other related costs of the tobacco settlement revenue bonds secured by the second (and only the second) sale of tobacco settlement revenues when such tobacco settlement revenues are insufficient therefor. The 2003 Budget Act authorizes the Director of Finance to make allocations with legislative notification if tobacco settlement revenues are insufficient to cover the cost of the tobacco securitization program. The Legislature is not obligated to make any such requested appropriation in the future. Tobacco settlement revenue bonds are neither general nor legal obligations of the State or any of its political subdivisions and neither the faith and credit nor the taxing power nor any other assets or revenues of the State or of any political subdivision is or shall be pledged to the payment of any such bonds. CASH FLOW BORROWINGS As part of its cash management program, the State has regularly issued short-term obligations to meet cash flow needs. The State has issued revenue anticipation notes ("Notes" or "RANs") in 19 of the last 20 fiscal years to partially fund timing differences between revenues and expenditures, as the majority of General Fund revenues are received in the last part of the fiscal year. By law, RANs must mature prior to the end of the fiscal year of issuance. If additional external cash flow borrowings are required, the State has issued revenue anticipation warrants ("RAWs"), which can mature in a subsequent fiscal year. See "STATE FINANCES--State Warrants." RANs and RAWs are both payable from any "Unapplied Money" in the General Fund of the State on their maturity date, subject to the prior application of such money in the General Fund to pay Priority Payments. "Priority Payments" are payments as and when due to: (i) support the public school system and public institutions of higher learning (as provided in Section 8 of Article XVI of the Constitution of the State), (ii) pay principal of (whether at stated maturity or upon earlier redemption) and interest on general obligation bonds of the State, (iii) provide reimbursement from the General Fund to any special fund or account to the extent such reimbursement is legally required to be made to repay borrowings therefrom, and (iv) pay State employees' wages and benefits, State payments to pension and other State employee benefit trust funds, State Medi-Cal claims, and any amounts determined by a court of competent jurisdiction in a final and nonappealable judgment to be required by federal law or the State Constitution to be paid with State warrants that can be cashed immediately. Priority Payments also includes payments of principal and interest on registered warrants issued to make Priority Payments. See "State Finances" below. The following table shows the amount of RANs and RAWs issued in the past five fiscal years and in the current fiscal year. A-8 TABLE 1 STATE OF CALIFORNIA REVENUE ANTICIPATION NOTES AND WARRANTS ISSUED FISCAL YEARS 1998-99 TO 2003-04
PRINCIPAL AMOUNT FISCAL YEAR TYPE (BILLIONS) DATE OF ISSUE MATURITY DATE ----------------------------------------------------------------------------------------------------------------- 1998-99 Notes 1.70 October 1, 1998 June 30, 1999 1999-00 Notes Series A-B 1.00 October 1, 1999 June 30, 2000 2000-01 No Notes issued 2001-02 Notes Series A-C 5.70 October 4, 2001 June 28, 2002 RAWs Series A 1.50 June 24, 2002 October 25, 2002 RAWs Series B 3.00 June 24, 2002 November 27, 2002 RAWs Series C 3.00 June 24, 2002 January 30, 2003+ 2002-03 Notes Series A and C 6.00 October 16, 2002 June 20, 2003 Notes Series B and D 3.00 October 16, 2002 June 27, 2003 Notes Series E - G 3.50 November 6, 2002 June 20, 2003 RAWs Series A and B 10.965 June 18, 2003 June 16, 2004 2003-04 Notes 3.00 October 28, 2003 June 23, 2004
+ Called by the Controller and paid on November 27, 2002. Source: State of California, Office of the Treasurer. CASH FLOW 2002-03 FISCAL YEAR The State issued a total of $12.5 billion of 2002-03 RANs ("2002 RANs") in October 2002 and November 2002 to partially fund its cash flow needs in fiscal year 2002-03, including repayment of the 2002 RAWs issued in June 2002. The State Controller issued $10.965 billion of RAWs on June 18, 2003, to provide enough additional cash to pay the maturing 2002 RANs and to pay other State obligations in June 2003 and in the first months of the 2003-04 fiscal year. See "2003 Revenue Anticipation Warrants." 2003 REVENUE ANTICIPATION WARRANTS As noted above, the Controller issued, on June 18, 2003, $10.965 billion of 2003 Revenue Anticipation Warrants (the "2003 Warrants"). The 2003 Warrants will all mature on June 16, 2004. At the time of issuance, cash flows prepared by the Department of Finance, based upon the 2003 Budget Act, projected that there would be sufficient available moneys in the General Fund (including from internal borrowing) to repay the 2003 Warrants at maturity. This projection assumed, among other assumptions, the receipt by the State during the year of $2.0 billion tobacco securitization bond proceeds, $10.675 billion of fiscal recovery bond proceeds, and $1.355 billion of pension obligation bond proceeds. The State received $2.264 billion of tobacco securitization bond proceeds in September 2003. The fiscal recovery bonds and the pension obligation bonds are the subject of litigation as described herein. See "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Pension Obligation Bonds" and "LITIGATION--Bond-Related Matters." The payment of principal of and interest on the 2003 Warrants is subject to the prior application of moneys in the General Fund to pay Priority Payments. See "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Cash Flow Borrowings" for a definition of Priority Payments. A-9 If it appears to the Controller that there will be insufficient available money in the General Fund to pay the 2003 Warrants at maturity, the Controller has agreed to use his best efforts to offer for sale at competitive bid and issue refunding warrants to pay the 2003 Warrants in full. See "STATE FINANCES--State Warrants--Refunding Warrants." While no assurance can be given that the State would be able to sell refunding warrants, the State has always been able to borrow funds to meet its cash flow needs in the past and expects to take all steps necessary to continue to have access to the short-term and long-term credit markets. If the Controller were unable to issue refunding warrants in sufficient amounts, the State may decide to borrow under seven Forward Warrant Purchase Agreements into which the State has entered with seven financial institutions ("Participants"), on a several and not joint basis (the "Forward Purchase Agreements"), that will enable the State to borrow up to $11.2 billion to obtain additional cash resources to pay the principal of and interest on the 2003 Warrants on their maturity date. The Forward Purchase Agreements do not constitute a guaranty of the 2003 Warrants and contain certain conditions which must be met in order for the State to obtain advances of funds from the Participants. The conditions to be satisfied on June 16, 2004, include the condition that no event of default under the Forward Purchase Agreements shall have occurred. It is an event of default under the Forward Purchase Agreements if the State fails to pay when due, or otherwise defaults on, any general obligation bond or any short-term debt, or the validity of any general obligation bond or any short-term debt is contested by the State in a judicial or administrative proceeding. Events of default under the Forward Purchase Agreements also include a judgment that any 2003 Warrants issuable to the Participants is illegal or unenforceable or that any representation or warranty of the State in the Forward Purchase Agreements proved to have been untrue in any material respect when made on June 18, 2003. If the State draws upon the Forward Purchase Agreements, it will deliver to the Participants registered warrants due immediately and without a maturity date. Repayment by the State of the registered warrants issued to Participants is subordinate in rank of the use of available cash resources on any day to payment of Priority Payments (defined above) and to rental payments to support lease revenue bonds and principal of and interest on pension obligation bonds. However, the issuance of such registered warrants will severely restrict the State's cash management flexibility. See "STATE FINANCES--State Warrants--Registered Warrants" for a description of the nature of registered warrants and the method by which they are repaid, as it relates to other obligations of the State. The Forward Purchase Agreements contain a number of covenants on the part of the State relating to cash flow management and cash flow borrowing. One covenant requires the State to maximize internal borrowing from special funds prior to borrowing under the Forward Purchase Agreements. See "STATE FINANCES--Inter-Fund Borrowings." Other covenants prohibit the State from issuing any warrants or revenue anticipation notes having a maturity date prior to seven days after the maturity date of the 2003 Warrants. FISCAL YEAR 2003-04 REVENUE ANTICIPATION NOTES The State issued $3 billion of RANs on October 28, 2003 (the "2003-04 RANs"). The 2003-04 RANs will mature on June 23, 2004. As a condition to such issuance, the Department of Finance of the State estimated that there will be sufficient cash and unused borrowable resources available for use by the General Fund to pay principal of and interest on the 2003-04 RANs when due. Just as in the case of the 2003 Warrants, such estimate assumed, among other things, receipt by the State of $10.675 billion of fiscal recovery bond proceeds and $1.355 billion of pension obligation bond proceeds, both of which bond issuances are the subject of litigation. See "LITIGATION--Bond-Related Matters." A-10 If it appears that there will be insufficient available money in the General Fund to pay the principal of and interest on the 2003-04 RANs at maturity, the State has covenanted to use its best efforts to issue registered reimbursement warrants or other obligations, as was done in June 2003, to assure additional cash resources for the General Fund. While no assurance can be given that the State would be able to sell registered reimbursement warrants or other obligations, the State has always been able to borrow funds to meet its cash flow needs in the past and expects to take all steps necessary to continue to have access to the short-term and long-term credit markets. See "STATE FINANCES--State Warrants--Reimbursement Warrants." Repayment of principal of and interest on $1.835 billion of the 2003-04 RANs is required to be paid from draws under letters of credit (the "Letters of Credit") issued by various financial institutions ("Credit Banks"). The remaining $1.165 billion of 2003-04 RANs ("Unenhanced 2003-04 RANs") were issued directly to various financial institutions (the "Parity Note Purchasers"). If the State is unable to repay the draws upon the Letters of Credit or pay the Unenhanced 2003-04 RANs at maturity, it will deliver registered warrants, due immediately and without a maturity date, to the Credit Banks and the Parity Note Purchasers, as applicable. Repayment by the State of any registered warrants issued to Credit Banks and the Parity Note Purchasers is subordinate in rank of the use of available cash resources on any day to payment of Priority Payments (defined above), to rental payments to support lease revenue bonds and principal of and interest on pension obligation bonds and to registered warrants issued to Participants as described above under "2003 Revenue Anticipation Warrants." However, the issuance of such registered warrants will severely restrict the State's cash management flexibility. See "STATE FINANCES--State Warrants--Registered Warrants" for a description of the nature of registered warrants and the method by which they are repaid, as it relates to other obligations of the State. STATE FINANCES THE GENERAL FUND The moneys of the State are segregated into the General Fund and over 900 other funds, including special, bond and trust funds. The General Fund consists of revenues received by the State Treasury and not required by law to be credited to any other fund, as well as earnings from the investment of State moneys not allocable to another fund. The General Fund is the principal operating fund for the majority of governmental activities and is the depository of most of the major revenue sources of the State. For additional financial data relating to the General Fund, see the financial statements incorporated in or attached to this APPENDIX A. See "FINANCIAL STATEMENTS." The General Fund may be expended as a consequence of appropriation measures enacted by the Legislature and approved by the Governor (including the annual budget act), as well as appropriations pursuant to various constitutional authorizations and initiative statutes. THE SPECIAL FUND FOR ECONOMIC UNCERTAINTIES The Special Fund for Economic Uncertainties ("SFEU") is funded with General Fund revenues and was established to protect the State from unforeseen revenue reductions and/or unanticipated expenditure increases. Amounts in the SFEU may be transferred by the State Controller to the General Fund as necessary to meet cash needs of the General Fund and such transfers are characterized as "loans." The State Controller is required to return moneys so transferred without payment of interest as soon as there are sufficient moneys in the General Fund. At the end of each fiscal year, the Controller is required to transfer from the SFEU to the General Fund any amount necessary to eliminate any deficit in the General Fund. The legislation creating the SFEU (Government Code Section 16418) contains a continuous appropriation from the General Fund authorizing the State Controller to transfer to the SFEU, as of the end of each fiscal year, the lesser of (i) the unencumbered balance in the General Fund and (ii) the difference between the State's "appropriations subject to limitation" for the fiscal year then ended and its "appropriations limit" as defined in Section 8 of Article XIII B of the State Constitution and established in the Budget Act for that fiscal year, as jointly estimated by the State's Legislative Analyst's Office and the Department of Finance. For a further description of Article XIII B, see "State Appropriations Limit." In certain circumstances, moneys in the SFEU may be used in connection with disaster relief. A-11 For budgeting and accounting purposes, any appropriation made from the SFEU is deemed an appropriation from the General Fund. For year-end reporting purposes, the State Controller is required to add the balance in the SFEU to the balance in the General Fund so as to show the total moneys then available for General Fund purposes. See the caption "CURRENT STATE BUDGET" for information concerning the recent balances in the SFEU and projections of the balances for the current and upcoming fiscal years. As in any year, the Budget Act and related trailer bills are not the only pieces of legislation which appropriate funds. Other factors, including re-estimates of revenues and expenditures, existing statutory requirements, existing contractual requirements with respect to the 2003 Warrants and additional legislation introduced and passed by the Legislature may impact the fiscal year-end balance in the SFEU. INTER-FUND BORROWINGS Inter-fund borrowing is used to meet temporary imbalances of receipts and disbursements in the General Fund. In the event the General Fund is or will be exhausted, the State Controller is required to notify the Governor and the Pooled Money Investment Board (the "PMIB," comprised of the State Director of Finance, the State Treasurer and the State Controller). The Governor may then order the State Controller to direct the transfer of all or any part of the moneys not needed in special funds to the General Fund from such special funds, as determined by the PMIB. All money so transferred must be returned to the special fund from which it was transferred as soon as there is sufficient money in the General Fund to do so. Transfers cannot be made from a special fund which will interfere with the objective for which such special fund was created, or from certain specific funds. When moneys transferred to the General Fund in any fiscal year from any special fund pursuant to the inter-fund borrowing mechanism exceed ten percent of the total additions to such special fund as shown in the statement of operations of the preceding fiscal year as set forth in the Budgetary (Legal Basis) annual report of the State Controller, interest must be paid on such excess at a rate determined by the PMIB to be the current earning rate of the Pooled Money Investment Account. See also, "CASH FLOW--2003 Revenue Anticipation Warrants" for a description of certain covenants of the State relating to internal borrowings. As of September 30, 2003, $2.5 billion of outstanding loans from the SFEU and $0.3 billion of outstanding loans from other special funds were used to pay expenditures of the General Fund. See "STATE FINANCES--State Warrants," "Exhibit 1--State Controller's Statement of General Fund Cash Receipts and Disbursements, July 1, 2002 through June 30, 2003 (Unaudited)" and "Exhibit 2--State Controller's Statement of General Fund Cash Receipts and Disbursements, July 1, 2003 through September 30, 2003 (Unaudited)." In addition, as of this date, the State had $10.965 billion of RAWs maturing in mid-June 2004. See "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Cash Flow Borrowings." Any determination of whether a proposed borrowing from one of the special funds is permissible must be made with regard to the facts and circumstances existing at the time of the proposed borrowing. The Attorney General of the State has identified certain criteria relevant to such a determination. For A-12 instance, amounts in the special funds eligible for inter-fund borrowings are legally available to be transferred to the General Fund if a reasonable estimate of expected General Fund revenues, based upon legislation already enacted, indicates that such transfers can be paid from the General Fund promptly if needed by the special funds or within a short period of time if not needed. In determining whether this requirement has been met, the Attorney General has stated that consideration may be given to the fact that General Fund revenues are projected to exceed expenditures entitled to a higher priority than payment of internal transfers, i.e., expenditures for the support of the public school system and public institutions of higher education and the payment of debt service on general obligation bonds of the State. At the November 1998 election, voters approved Proposition 2. This proposition requires the General Fund to repay loans made from certain transportation special accounts (such as the State Highway Account) at least once per fiscal year, or up to 30 days after adoption of the annual budget act. Since the General Fund may reborrow from the transportation accounts any time after the annual repayment is made, the proposition does not have any adverse impact on the State's cash flow. In addition to temporary inter-fund borrowings described in this section, some of the budget solutions in the 2003-04 and other recent fiscal years have included other transfers and long-term loans from special funds to the General Fund, specified in legislation. In some cases, such loans and transfers have the effect of reducing internal borrowable resources. See "CURRENT STATE BUDGET--2003 Budget Act--Other Revenues" for a description of such transfers and "CURRENT STATE BUDGET--2003 Budget Act--Loans/Borrowings" for a description of such loans. The following chart shows internal borrowable resources available for temporary loans to the General Fund on June 30 of each of the fiscal years 1999-00 through 2002-03 and estimates, as of August 21, 2003, for 2003-04. The estimates for 2003-04 do not reflect the actual receipts and disbursements through September 2003. See "EXHIBIT 2--STATE CONTROLLER'S STATEMENT OF GENERAL FUND CASH RECEIPTS AND DISBURSEMENTS, JULY 1, 2003 THROUGH SEPTEMBER 30, 2003 (UNAUDITED)" TABLE 2 INTERNAL BORROWABLE RESOURCES (CASH BASIS) (MILLIONS)
JUNE 30 ------------------------------------------------------------------ 2000 2001 2002(a) 2003(b) 2004(c) --------------------------------------------------------------------------------------------------------------- Available Internal Borrowable Resources $ 9,427.2 $ 12,342.4 $ 12,979.7 $ 10,401.5 $ 8,747.9 Outstanding Loans From Special Fund for Economic Uncertainties -0- -0- 2,524.5 -0- 1,902.6 From Special Funds and Accounts -0- -0- 423.5 -0- -0- Total Outstanding Internal Loans -0- -0- 2,948.0 -0- 1,902.6 Unused Internal Borrowable Resources $ 9,427.2 $ 12,342.4 $ 10,031.7 $ 10,401.5 $ 6,845.3
(a) At June 30, 2002, the State also had outstanding $7.5 billion of external borrowings in the form of revenue anticipation warrants. See "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Cash Flow Borrowings." (b) At June 30, 2003, the State also had outstanding $10.965 billion of external borrowings in the form of revenue anticipation warrants. (c) Department of Finance estimates as of August 21, 2003. Source:State of California, Department of Finance. Information for the fiscal years ended June 30, 2000 through June 30, 2003, are actual figures. For the fiscal year ending June 30, 2004, these figures were estimated as of August 21, 2003, by the Department of Finance. A-13 STATE WARRANTS No money may be drawn from the State Treasury except upon a warrant duly issued by the State Controller. The State Controller is obligated to draw every warrant on the fund out of which it is payable for the payment of money directed by State law to be paid out of the State Treasury; however, a warrant may not be drawn unless authorized by law and unless unexhausted specific appropriations provided by law are available to meet it. State law provides two methods for the State Controller to respond if the General Fund has insufficient "Unapplied Money" available to pay a warrant when it is drawn, referred to generally as "registered warrants" and "reimbursement warrants." "Unapplied Money" consists of money in the General Fund for which outstanding warrants have not already been drawn and which would remain in the General Fund if all outstanding warrants previously drawn and then due were paid subject to the prior application of such money to obligations of the State with a higher priority. See "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Cash Flow Borrowings." Unapplied Money may include moneys transferred to the General Fund from the SFEU and internal borrowings from State special funds (to the extent permitted by law). REGISTERED WARRANTS' If a warrant is drawn on the General Fund for an amount in excess of the amount of Unapplied Money in the General Fund, after deducting from such Unapplied Money the amount, as estimated by the State Controller, required by law to be set apart for obligations having priority over obligations to which such warrant is applicable, the warrant must be registered by the State Treasurer on the reverse side as not paid because of the shortage of funds in the General Fund. The State Controller then delivers such a "registered warrant" to persons or entities (e.g., suppliers and local governments) otherwise entitled to receive payments from the State. A registered warrant bears interest at a rate designated by the PMIB up to a maximum of five percent per annum or at a higher rate if issued for an unpaid revenue anticipation note or in connection with some form of credit enhancement such as the Forward Purchase Agreements. Registered warrants may or may not have a fixed maturity date. Registered warrants that have no fixed maturity date, and registered warrants that bear a maturity date but, for lack of Unapplied Moneys, were not paid at maturity, are paid, together with all interest due, when the Controller, with the approval of the PMIB, determines payment will be made. The State Controller then notifies the State Treasurer, who publishes a notice that the registered warrants in question are payable. As described under "CASH FLOW--2003 Revenue Anticipation Warrants" and "--Fiscal Year 2003-04 Revenue Anticipation Notes," if the State is required to obtain advances under the Forward Purchase Agreements to pay some or all of the 2003 Warrants (defined above) or draw on the Letters of Credit (defined above) to pay some or all of the 2003-04 RANs at maturity, or is otherwise unable to pay the 2003-04 RANs at maturity, the State will issue registered warrants without a maturity date to the Participants (defined above), Credit Banks (defined above) or Parity Note Purchasers (defined above), as applicable, bringing into effect the daily application of Unapplied Moneys in the General Fund described in the previous paragraph. The adverse results from issuing these registered warrants could include: (1) the State would be required by law to pay the registered warrants before issuing warrants that could be cashed immediately to persons or entities (e.g., suppliers and certain local governments) otherwise entitled to payments from the State General Fund, and the State's ability to manage its cash would therefore be limited; and (2) a default under the State's bank credit facilities backing the State's variable rate general obligation bonds and/or commercial paper notes (which would increase the State's borrowing costs and debt service payments). A-14 REIMBURSEMENT WARRANTS In lieu of issuing individual registered warrants to numerous creditors, State law provides an alternative procedure whereby the Governor, upon request of the Controller, may authorize utilizing the General Cash Revolving Fund in the State Treasury to borrow from other State special funds to meet payments authorized by law. The Controller may then issue "reimbursement warrants" in the financial market at competitive bid to reimburse the General Cash Revolving Fund, thereby increasing cash resources for the General Fund to cover required payments. The General Cash Revolving Fund exists solely to facilitate the issuance of reimbursement warrants. Reimbursement warrants may have a fixed maturity date. The principal of and interest on reimbursement warrants must be paid by the Treasurer on their respective maturity dates from any Unapplied Money in the General Fund and available for such payment. In the event that Unapplied Money is not available for payment on the respective maturity dates of reimbursement warrants, and refunding warrants (see "--Refunding Warrants") have not been sold at such times as necessary to pay such reimbursement warrants, such reimbursement warrants will be paid, together with all interest due thereon (including interest accrued at the original interest rate after the maturity date), at such times as the Controller, with the approval of the PMIB, may determine. The State issued reimbursement warrants on several occasions in order to meet its cash needs during the period 1992-1994, when State revenues were severely reduced because of an economic recession. Facing renewed economic pressures, the State issued reimbursement warrants in June 2002 and in June 2003 (the 2003 Warrants). See "RECENT DEVELOPMENTS REGARDING STATE ECONOMY AND FINANCES," "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Cash Flow Borrowings," and "CASH FLOW--2003 Revenue Anticipation Warrants." REFUNDING WARRANTS If there is not sufficient Unapplied Money in the General Fund to pay maturing reimbursement warrants, the Controller is authorized under State law, with the written approval of the Treasurer, to offer and sell a new issue of reimbursement warrants as refunding warrants to refund the prior, maturing reimbursement warrants. Proceeds of such refunding warrants must be used exclusively to repay the maturing warrants. In all other respects, refunding warrants have the same legal status and provisions as reimbursement warrants, as described above. SOURCES OF TAX REVENUE The following is a summary of the State's major revenue sources. Further information on State revenues is contained under "CURRENT STATE BUDGET" and "STATE FINANCES--Recent Tax Receipts." See Table 4 entitled "Comparative Yield of State Taxes--All Funds, 1998-99 Through 2003-04" for a comparison, by amount received, of the sources of the State's tax revenue. PERSONAL INCOME TAX The California personal income tax, which accounts for a significant portion of General Fund tax revenues, is closely modeled after the federal income tax law. It is imposed on net taxable income (gross income less exclusions and deductions), with rates ranging from 1.0 percent to 9.3 percent. The personal income tax is adjusted annually by the change in the consumer price index to prevent taxpayers from being pushed into higher tax brackets without a real increase in income. Personal, dependent and other credits are allowed against the gross tax liability. In addition, taxpayers may be subject to an alternative minimum tax (AMT), which is much like the federal AMT. The personal income tax structure is highly A-15 progressive. The State Franchise Tax Board estimated that the top 1 percent of taxpayers paid 39.5 percent of the total personal income tax in tax year 2001. Taxes on capital gains realizations and stock options, which are largely linked to stock market performance, had become a larger component of personal income taxes over the last half of the 1990s. The increasing influence that these stock market-related income sources had on personal income tax revenues linked to the highly progressive structure added a significant dimension of volatility to personal income tax receipts. Just as the State's remarkable revenue growth was driven by stock market related gains, the dramatic decline that occurred in 2001-02 largely reflects the stock market's decline. The 2003 Budget Act estimates that capital gains realizations and stock options accounted for roughly 25 percent of General Fund tax revenues in 2000-01, which dropped to 8.5 percent in 2001-02, and will account for about 7 percent in 2002-03 and in 2003-04. See "CURRENT STATE BUDGET--Economic Assumptions." SALES TAX The sales tax is imposed upon retailers for the privilege of selling tangible personal property in California. Most retail sales and leases are subject to the tax. However, exemptions have been provided for certain essentials such as food for home consumption, prescription drugs, gas delivered through mains and electricity. Other exemptions provide relief for a variety of sales ranging from custom computer software to aircraft. The breakdown of the base state and local sales tax rate of 7.25 percent in 2003 is as follows: - 5 percent is imposed as a State General Fund tax; - 0.5 percent is dedicated to local governments for health and welfare program realignment (Local Revenue Fund); - 0.5 percent is dedicated to local governments for public safety services (Local Public Safety Fund); - 1.25 percent is a local tax imposed under the Uniform Local Sales and Use Tax Law. Of that amount, 0.25 percent is dedicated to county transportation purposes, and 1 percent is for city and county general-purpose use. Effective July 1, 2004, the 1 percent local sales and use tax rate for city and county general-purpose use will decrease to 0.5 percent. Representatives of several local governments have stated their intention to bring a legal action to contest the termination of this one-half cent of sales tax authority. Also on July 1, 2004, a new 0.5 percent sales and use tax for the State will be imposed. Revenues from the new sales and use tax will be deposited in the newly created Fiscal Recovery Fund created by Chapter 13, Statutes of 2003 (the legislation that authorizes the issuance of fiscal recovery bonds) and will be available for the payment of the fiscal recovery bonds proposed to be issued in 2003-04. See "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Fiscal Recovery Bonds" and "CURRENT STATE BUDGET--2003 Budget Act--Fiscal Recovery Bonds." The proposed issuance of fiscal recovery bonds is the subject of current litigation. See "LITIGATION--Bond-Related Matters." Local entities will be allowed to keep property tax revenues that would normally have gone to schools, in the same amounts as their sales and use tax revenues were decreased. A-16 The new 0.5 percent State sales and use tax will end when the fiscal recovery bonds have been repaid, and the local 0.5 percent sales and use tax will be restored to 1 percent. The property tax shift will also end at that time. Effective July 1, 2004, the breakdown of the base state and local sales tax rate of 7.25 percent will be as follows: - 5 percent imposed as a State General Fund tax; - 0.5 percent dedicated to local governments for health and welfare program realignment (Local Revenue Fund); - 0.5 percent dedicated to local governments for public safety services (Local Public Safety Fund); - 0.75 percent local tax imposed under the Uniform Local Sales and Use Tax Law, with 0.25 percent dedicated to county transportation purposes and 0.50 percent for city and county general-purpose use; - 0.5 percent deposited in a special fund available to repay the State's fiscal recovery bonds (Fiscal Recovery Fund). Pursuant to prior law, 0.25 percent of a basic 5.00 percent State tax rate could be terminated upon certification by the Director of Finance by November 1 in any year that the balance in the budget reserve for two consecutive years exceeded 4 percent of General Fund revenues. The 0.25 percent rate would be reinstated if the Director of Finance subsequently determined that the reserve would not exceed 4 percent of General Fund revenues. Pursuant to this law, a 0.25 percent cut in the State sales tax occurred on January 1, 2001 but was reinstated on January 1, 2002. Legislation enacted as part of the 2001-02 annual budget revised this test to provide that 0.25 percent of the basic 5.00 percent State tax rate may be suspended in any calendar year beginning on and after January 1, 2002, upon certification by the Director of Finance by November 1 in any year in which both of the following occur: (1) the General Fund reserve (excluding the revenues derived from the 1/4 cent sales and use tax rate) is expected to exceed 3 percent of revenues in that fiscal year (excluding the revenues derived from the 1/4 cent sales and use tax rate) and (2) actual revenues for the period May 1 through September 30 equal or exceed the May Revision forecast. The 0.25 percent rate will be reinstated the following year if the Director of Finance subsequently determines conditions (1) or (2) above are not met for that fiscal year. The reserve was not sufficient to trigger an additional year of reduction for calendar year 2002 or 2003. The 2003 Budget Act forecast estimates that the reserve level will again be insufficient to trigger a reduction for calendar year 2004. See "CURRENT STATE BUDGET--Summary of State Revenues and Expenditures" for a projection of the 2003-04 General Fund reserve. CORPORATION TAX Corporation tax revenues are derived from the following taxes: 1. The franchise tax and the corporate income tax are levied at an 8.84 percent rate on profits. The former is imposed on corporations for the privilege of doing business in California, while the latter is imposed on corporations that derive income from California sources but are not sufficiently present to be classified as doing business in the State. A-17 2. Banks and other financial corporations are subject to the franchise tax plus an additional tax at the rate of 2 percent on their net income. This additional tax is in lieu of personal property taxes and business license taxes. 3. The alternative minimum tax (AMT) is similar to that in federal law. In general, the AMT is based on a higher level of net income computed by adding back certain tax preferences. This tax is imposed at a rate of 6.65 percent. 4. A minimum franchise tax of up to $800 is imposed on corporations subject to the franchise tax but not on those subject to the corporate income tax. New corporations are exempted from the minimum franchise tax for the first two years of incorporation. 5. Sub-Chapter S corporations are taxed at 1.5 percent of profits. Taxpayers with net operating losses (i.e., an excess of allowable deductions over gross income) are allowed to carry forward those losses for tax purposes and deduct a portion in subsequent years. Chapter 488, Statutes of 2002 (AB 2065), suspends the use of any carryover losses for the 2002 and 2003 tax years, but allows taxpayers to deduct those losses beginning in the 2004 tax year and extends the expiration date for those losses by two years. That Chapter also increases the percent of a taxpayer's net operating loss ("NOL") that can be carried forward from 65 percent to 100 percent beginning January 1, 2004, for NOLs generated after that date. About 85 percent of NOL is deducted from corporation taxes with the balance deducted from personal income tax. INSURANCE TAX The majority of insurance written in California is subject to a 2.35 percent gross premium tax. For insurers, this premium tax takes the place of all other state and local taxes except those on real property and motor vehicles. Exceptions to the 2.35 percent rate are certain pension and profit-sharing plans which are taxed at the lesser rate of 0.5 percent, surplus lines and nonadmitted insurance at 3 percent and ocean marine insurers at 5 percent of underwriting profits. ESTATE TAX; OTHER TAXES The California estate tax is based on the State death tax credit allowed against the federal estate tax. The California estate tax is designed to pick up the maximum credit allowed against the federal estate tax return. The federal Economic Growth and Tax Reconciliation Act of 2001 phases out the federal estate tax by 2010. As part of this, the Act reduced the State pick-up tax by 25 percent in 2002, 50 percent in 2003, and 75 percent in 2004, and eliminates it beginning in 2005. The provisions of this federal act sunset after 2010. At that time, the federal estate tax will be reinstated along with the State's estate tax, unless future federal legislation is enacted to make the provisions permanent. See Table 4 entitled "Comparative Yield of State Taxes--All Funds, 1998-99 Through 2003-04." Other General Fund major taxes and licenses include: Inheritance and Gift Taxes; Cigarette Taxes; Alcoholic Beverage Taxes; Horse Racing License Fees and Trailer Coach License Fees. SPECIAL FUND REVENUES The California Constitution and statutes specify the uses of certain revenue. Such receipts are accounted for in various special funds. In general, special fund revenues comprise four categories of income: A-18 - Receipts from tax levies which are allocated to specified functions, such as motor vehicle taxes and fees and certain taxes on tobacco products. - Charges for special services to specific functions, including such items as business and professional license fees. - Rental royalties and other receipts designated for particular purposes (e.g., oil and gas royalties). - Motor vehicle related taxes and fees accounted for about 41 percent of all special fund revenues and transfers in 2001-02. Principal sources of this income are motor vehicle fuel taxes, registration and weight fees and vehicle license fees. During fiscal year 2001-02, $7.1 billion was derived from the ownership or operation of motor vehicles. This was 15 percent below the 2000-01 level. About $3.1 billion of this revenue was returned to local governments. The remainder was available for various State programs related to transportation and services to vehicle owners. VEHICLE LICENSE FEE Vehicle license fees, over and above the costs of collection and refunds authorized by law, are constitutionally defined local revenues. Chapter 322, Statutes of 1998 ("Chapter 322"), established a vehicle license fee ("VLF") offset program, scheduled to be implemented in successive stages if General Fund revenues met certain targets. Pursuant to Chapter 322, vehicle license fees were reduced (offset) by 25 percent beginning January 1, 1999. Later legislation increased the offset to 35 percent for 2000 and the first half of calendar year 2001, and to 67.5 percent July 1, 2001. Under Chapter 322, a continuous appropriation from the General Fund "backfills" the vehicle license fee revenue that local governments would otherwise lose due to the fee reductions. Chapter 322 also provided that if there were insufficient General Fund moneys to fully backfill the VLF offset, the percentage offset would be reduced proportionately (i.e., the license fee payable by drivers would be increased) to assure that local governments are not disadvantaged. On June 20, 2003, it was determined that insufficient General Fund moneys were available to continue to fund any portion of the VLF offsets to local governments as of that date. Accordingly, the VLF paid by taxpayers returned on October 1, 2003, to the pre-1999 level of two percent of a vehicle's depreciated value and the State will not be obligated to make any offset payments from the General Fund in 2003-04. The suspension of the backfill of the VLF offset is estimated to reduce General Fund expenditures in 2003-04 by $4.2 billion. On July 1, 2003, the Howard Jarvis Taxpayers Association filed a lawsuit challenging the restoration of the VLF to 1998 levels. Until the case is decided, VLF will continue to be collected at the full two percent rate as authorized by statute. See "LITIGATION--Challenge to Discontinuation of Vehicle License Fee Offset." TAXES ON TOBACCO PRODUCTS On November 8, 1988, voters approved Proposition 99, which imposed, as of January 1, 1989, a 25 cents per pack excise tax on cigarettes, and a new, equivalent excise tax on other tobacco products. The initiative requires that funds from this tax be allocated to anti-tobacco education and research, to indigent health services, and to environmental and recreation programs. Proposition 10, approved in 1998, increased the excise tax imposed on distributors selling cigarettes in California to 87 cents per pack effective January 1, 1999. At the same time, this proposition A-19 imposed a new excise tax on cigars, chewing tobacco, pipe tobacco, and snuff at a rate equivalent to the tax increase on cigarettes. In addition, the higher excise tax on cigarettes automatically triggered an additional increase in the tax on other tobacco products effective July 1, 1999, with the proceeds going to the Cigarette and Tobacco Products Surtax Fund. There is litigation pending challenging the enactment of these taxes. See "LITIGATION--Tax Refund Cases." The State excise tax on cigarettes of 87 cents per pack and the equivalent rates on other tobacco product are earmarked as follows: 1. Fifty cents of the per-pack tax on cigarettes, and the equivalent rate levied on non-cigarette tobacco products, are deposited in the California Children and Families First Trust Fund and are allocated primarily for early childhood development programs. 2. Twenty-five cents of the per-pack tax on cigarettes and the equivalent rates levied on non-cigarette tobacco products are allocated to the Cigarette and Tobacco Products Surtax Fund. These funds are appropriated for anti-tobacco education and research, indigent health services, and environmental and recreation programs. 3. Ten cents of the per-pack tax is allocated to the State's General Fund. 4. The remaining two cents of the per-pack tax is deposited into the Breast Cancer Fund. The 2003 Budget Act proposes a tobacco products licensing requirement, which would also reduce overall tobacco tax evasion. The one time license application fee and per pack fee would generate one-time revenues of $22 million in 2003-04 that would be dedicated to a new Cigarette and Tobacco Products Compliance Fund. Reduced evasion associated with this licensure requirement is expected to generate $36 million ($4 million General Fund) in additional tobacco revenues during the implementation phase in 2003-04. A-20 RECENT TAX RECEIPTS The following table shows the trend of major General Fund and total taxes per capita and per $100 of personal income for the past five years and the current fiscal year. TABLE 3 RECENT TAX RECEIPTS
TREND OF STATE TAXES PER $100 TAXES PER CAPITA(a) OF PERSONAL INCOME ----------------------------------------------------------------------------------- FISCAL YEAR GENERAL FUND TOTAL GENERAL FUND TOTAL ---------------------------------------------------------------------------------------------------------------- 1998-99 $ 1,771.02 $ 2,121.72 $ 6.25 $ 7.48 1999-00 2,095.53 2,447.03 7.04 8.22 2000-01 2,223.15 2,589.79 6.88 8.02 2001-02 1,806.41 2,112.36 5.56 6.50 2002-03(b) 1,826.41 2,128.04 5.66 6.60 2003-04(b) 1,873.27 2,271.80 5.72 6.93
(a) Data reflect population figures based on the 2000 Census. (b) Estimated. Source: State of California, Department of Finance. The following table gives the actual and estimated revenues by major source for the last five years and the current fiscal year. This table shows taxes which provide revenue both to the General Fund and State special funds. A-21 TABLE 4 COMPARATIVE YIELD OF STATE TAXES--ALL FUNDS 1998-99 THROUGH 2003-04 (MODIFIED ACCRUAL BASIS) (THOUSANDS OF DOLLARS)
YEAR INHERITANCE, ENDING SALES AND PERSONAL ESTATE AND JUNE 30 USE(a) INCOME CORPORATION TOBACCO(b) GIFT -------------------------------------------------------------------------------------------------------------------------------- 1999 22,890,693 30,894,865 5,724,237 976,512 890,490 2000 25,525,788 39,578,237 6,638,898 1,216,651 928,146 2001 26,616,073 44,618,532 6,899,322 1,150,869 934,709 2002 26,004,521 33,051,107 5,333,030 1,102,806 890,627 2003(e) 24,757,747(f) 32,442,000 6,700,011 1,068,200 694,800 2004(e) 26,063,712(f) 33,595,700 7,035,011 1,049,752 436,500 YEAR MOTOR MOTOR ENDING ALCOHOLIC HORSE VEHICLE VEHICLE JUNE 30 INSURANCE BEVERAGES RACING FUEL(c) FEES(d) -------------------------------------------------------------------------------------------------------------------------------- 1999 1,253,972 273,112 61,185 3,025,226 5,610,374 2000 1,299,777 282,166 44,130 3,069,694 5,263,245 2001 1,496,556 288,450 42,360 3,142,142 5,286,542 2002 1,595,846 292,627 42,247 3,295,903 3,836,795 2003(e) 1,880,150 290,000 44,455 3,307,244 3,923,911 2004(e) 2,068,150 288,000 44,985 3,313,301 7,441,870
(a) Numbers include local tax revenue from the 0.5 percent rate increase enacted by Chapter 85, Statutes of 1991, for the State-local realignment program. The 0.5% rate is equivalent to about $2.3 to $2.5 billion per year. The figures also reflect a 0.25 percent reduction during calendar year 2001. (b) Proposition 10 (November 1998) increased the cigarette tax to $0.87 per pack and added the equivalent of $1.00 tax to other tobacco products. (c) Motor vehicle fuel tax (gasoline), use fuel tax (diesel and other fuels), and jet fuel. (d) Registration and weight fees, motor vehicle license fees and other fees. Vehicle license fee values reflect a 25 percent reduction for 1999 from the 1998 rate of two percent of a vehicle's depreciated value; a 35 percent reduction from such rate for 2000 and the first half of 2001; a 67.5 percent reduction from such rate for the second half of 2001 through September 2003, and no reduction from such rate after September 2003. See "STATE FINANCES--Sources of Tax Revenue--Vehicle License Fee." (e) Estimated. (f) The figures do not include voter approved local revenue, the 0.50 percent Local Public Safety Fund revenue, the 1.0 percent local city and county operations revenue (Bradley-Burns), or the 0.25 percent county transportation funds revenue. NOTE: This table shows taxes which provide revenue both to the General Fund and State special funds. Also, some revenue ources are dedicated to local governments. This accounts for differences between the information in this table and Table 11. Source: Fiscal years 1998-99 through 2001-02: State of California, Office of the State Controller. Fiscal years 2002-03 and 2003-04: State of California, Department of Finance. A-22 STATE EXPENDITURES The following table summarizes the major categories of State expenditures, including both General Fund and special fund programs. TABLE 5 GOVERNMENTAL COST FUNDS (BUDGETARY BASIS) SCHEDULE OF EXPENDITURES BY FUNCTION AND CHARACTER FISCAL YEARS 1997-98 TO 2001-02 (THOUSANDS)
1997-98 1998-99 1999-00 2000-01 2001-02 ---------------------------------------------------------------------------------------------------------------------------- Function Legislative, Judicial, Executive Legislative $ 209,690 $ 219,814 $ 232,323 $ 262,370 $ 265,312 Judicial 766,932 1,346,131 1,372,681 1,478,710 1,633,518 Executive 919,606 958,189 1,241,219 1,352,128 1,371,891 State and Consumer Services 771,444 829,745 856,096 950,192 1,100,942 Business, Transportation and Housing Business and Housing 136,558 136,893 156,499 601,053 240,237 Transportation 3,924,428 4,462,905 5,549,520 4,417,139 6,052,926 Technology, Trade and Commerce 62,235 130,796 488,489 140,833 81,832 Resources 1,323,860 1,695,323 1,858,844 3,349,003 2,284,269 Environmental Protection 605,584 600,060 689,678 869,539 993,144 Health and Human Services 18,059,611 19,616,132 21,806,291 24,204,531 26,563,743 Correctional Programs 3,901,296 4,181,474 4,412,542 4,952,927 5,242,369 Education Education-K through 12 21,574,341 22,783,975 26,356,838 28,720,596 28,078,228 Higher Education 7,022,658 7,838,117 8,553,343 9,655,954 9,945,193 General Government General Administration 764,615 859,703 982,923 1,294,587 2,475,564 Debt Service 1,979,211 1,988,176 2,072,960 2,270,649 2,432,942 Tax Relief 453,030 450,213 1,840,129 4,655,826 3,028,703 Shared Revenues 3,892,036 4,151,197 3,677,687 4,385,429 5,528,996 Brown vs. US Dept. of Health and Human Services 96,000 Other Statewide Expenditures 1,373,823 891,070 580,307 635,475 476,170 Expenditure Adjustment for Encumbrances (162,630) (461,310) (628,506) (1,943,208) (681,856) Credits for Overhead Services by General Fund (125,678) (144,041) (170,594) (197,343) (251,575) Statewide Indirect Cost Recoveries (48,963) (32,791) (37,423) (36,610) (47,862) Total $ 67,403,687 $ 72,501,771 $ 81,891,846 $ 92,019,780 $ 96,910,686 Character State Operations $ 20,199,031 $ 21,092,849 $ 22,864,874 $ 24,850,286 $ 27,994,343 Local Assistance 46,666,925 50,734,442 58,369,828 66,087,018 67,993,721 Capital Outlay 537,731 674,480 657,144 1,082,476 922,622 Total $ 67,403,687 $ 72,501,771 $ 81,891,846 $ 92,019,780 $ 96,910,686
Source: State of California, Office of the State Controller. STATE APPROPRIATIONS LIMIT The State is subject to an annual appropriations limit imposed by Article XIII B of the State Constitution (the "Appropriations Limit"). The Appropriations Limit does not restrict appropriations to pay debt service on voter-authorized bonds. Article XIII B prohibits the State from spending "appropriations subject to limitation" in excess of the Appropriations Limit. "Appropriations subject to limitation," with respect to the State, are A-23 authorizations to spend "proceeds of taxes," which consist of tax revenues, and certain other funds, including proceeds from regulatory licenses, user charges or other fees to the extent that such proceeds exceed "the cost reasonably borne by that entity in providing the regulation, product or service," but "proceeds of taxes" exclude most State subventions to local governments, tax refunds and some benefit payments such as unemployment insurance. No limit is imposed on appropriations of funds which are not "proceeds of taxes," such as reasonable user charges or fees and certain other non-tax funds. There are various types of appropriations excluded from the Appropriations Limit. For example, debt service costs of bonds existing or authorized by January 1, 1979, or subsequently authorized by the voters, appropriations required to comply with mandates of courts or the federal government, appropriations for qualified capital outlay projects, appropriations for tax refunds, appropriations of revenues derived from any increase in gasoline taxes and motor vehicle weight fees above January 1, 1990 levels, and appropriation of certain special taxes imposed by initiative (e.g., cigarette and tobacco taxes) are all excluded. The Appropriations Limit may also be exceeded in cases of emergency. The Appropriations Limit in each year is based on the Appropriations Limit for the prior year, adjusted annually for changes in State per capita personal income and changes in population, and adjusted, when applicable, for any transfer of financial responsibility of providing services to or from another unit of government or any transfer of the financial source for the provisions of services from tax proceeds to non-tax proceeds. The measurement of change in population is a blended average of statewide overall population growth, and change in attendance at local school and community college ("K-14") districts. The Appropriations Limit is tested over consecutive two-year periods. Any excess of the aggregate "proceeds of taxes" received over such two-year period above the combined Appropriations Limits for those two years, is divided equally between transfers to K-14 districts and refunds to taxpayers. The Legislature has enacted legislation to implement Article XIII B which defines certain terms used in Article XIII B and sets forth the methods for determining the Appropriations Limit. California Government Code Section 7912 requires an estimate of the Appropriations Limit to be included in the Governor's Budget, and thereafter to be subject to the budget process and established in the Budget Act. The following table shows the Appropriations Limit for 1999-00 through 2003-04. Because of the extraordinary surge of revenues in 1999-00, the State exceeded its Appropriations Limit by $975 million in that year. Since the excess revenues are calculated over a two-year period, there were no excess revenues for the combined 1999-00 and 2000-01 fiscal years. As of the release of the 2003 Budget Act, the Department of Finance projected the Appropriations Subject to Limit to be $16.902 billion and $13.207 billion under the Appropriations Limit in fiscal years 2002-03 and 2003-04, respectively. A-24 TABLE 6 STATE APPROPRIATIONS LIMIT (MILLIONS)
FISCAL YEARS ------------------------------------------------------------------------ 1999-00 2000-01 2001-02 2002-03 2003-04 ------------------------------------------------------------------------------------------------------------------- State Appropriations Limit $ 50,673 $ 54,073 $ 59,318 $ 59,591 $ 61,702 Appropriations Subject to Limit (51,648) (51,648) (42,240) (42,689)* (48,495)* Amount (Over)/Under Limit $ (975) $ 2,425 $ 17,078 $ 16,902* $ 13,207*
* Estimated/Projected. Source:State of California, Department of Finance. PROPOSITION 98 On November 8, 1988, voters of the State approved Proposition 98, a combined initiative constitutional amendment and statute called the "Classroom Instructional Improvement and Accountability Act." Proposition 98 changed State funding of public education below the university level and the operation of the State Appropriations Limit, primarily by guaranteeing K-14 schools a minimum share of General Fund revenues. Proposition 98 (as modified by Proposition 111, enacted on June 5, 1990) guarantees K-14 schools the greater of (a) in general, a fixed percent of General Fund revenues ("Test 1"), (b) the amount appropriated to K-14 schools in the prior year, adjusted for changes in the cost of living (measured as in Article XIII B by reference to State per capita personal income) and enrollment ("Test 2"), or (c) a third test, which replaces Test 1 and Test 2 in any year the percentage growth in per capita General Fund revenues from the prior year plus one half of one percent is less than the percentage growth in State per capita personal income ("Test 3"). Under Test 3, schools receive the amount appropriated in the prior year adjusted for changes in enrollment and per capita General Fund revenues, plus an additional small adjustment factor. If Test 3 is used in any year, the difference between Test 3 and Test 2 becomes a "credit" (called the "maintenance factor") to schools and the basis of payments in future years when per capita General Fund revenue growth exceeds per capita personal income growth. Proposition 98 implementing legislation adopted prior to the end of the 1988-89 fiscal year determined the K-14 schools' funding guarantee under Test 1 to be 40.3 percent of the General Fund tax revenues, based on 1986-87 appropriations. However, that percent has been adjusted to approximately 35 percent to account for a subsequent redirection of local property taxes, since such redirection directly affects the share of General Fund revenues to schools. The Proposition 98 guarantee is funded from two sources: local property taxes and the General Fund. See "CURRENT STATE BUDGET--2003 Budget Act--Fiscal Recovery Bonds" for a discussion of the impact of the 2003 Budget Act on the level of local property taxes available for Proposition 98 funding. Any amount not funded by local property taxes is funded by the General Fund. Thus, local property tax collections represent an offset to General Fund costs. This is true regardless of whether the year in question is a Test 1, Test 2, or Test 3 year. Proposition 98 permits the Legislature, by two-thirds vote of both houses with the Governor's concurrence, to suspend the K-14 schools' minimum funding formula for a one-year period. The difference between the funding level provided pursuant to such suspension and the minimum guarantee otherwise applicable for such fiscal year must be repaid in future fiscal years. Proposition 98 also A-25 contains provisions for the transfer of certain State tax revenues in excess of the Article XIII B limit to K-14 schools. See "STATE FINANCES--State Appropriations Limit." The State's emphasis on improving education resources has resulted in estimated K-12 spending of $6,624 and $6,887 per-pupil in fiscal years 2002-03 and 2003-04, respectively. These amounts are 52 percent and 58 percent above the 1994-95 level of $4,351 per pupil. Total revenues (General Fund subject to the State Appropriations Limit ("SAL") and local property taxes) have increased significantly since 1994-95. The projected level of General Fund SAL revenue for 2002-03 was $65.036 billion. The revised 2002-03 Proposition 98 appropriations of $29.3 billion reflect a deferral of $1.820 billion to be reappropriated in 2003-04. The General Fund SAL revenue projection for 2003-04 exceeds the revised 2002-03 estimates by approximately $2.353 billion. The General Fund share of the guarantee Proposition 98 will increase approximately $415.3 million, from $29.4 billion in 2002-03 to $29.8 billion in 2003-04. The 2003 Budget Act proposes Proposition 98 funding at $215.2 million above the minimum, with enrollment growth for general apportionments and special education fully funded and total K-14 education funding of approximately $45.7 billion ($6,887 per K-12 pupil), an increase of 4.0 percent per pupil compared to the revised 2002-03 level. Total 2003-04 Proposition 98 appropriations of $30.0 billion reflect the permanent deferral of $1.087 billion. See "CURRENT STATE BUDGET" for further discussion of education funding. LOCAL GOVERNMENTS The primary units of local government in California are the counties, which range in population from 1,200 in Alpine County to approximately 10 million in Los Angeles County. Counties are responsible for the provision of many basic services, including indigent health care, welfare, jails, and public safety in unincorporated areas. There are also 478 incorporated cities and thousands of special districts formed for education, utilities, and other services. The fiscal condition of local governments has been constrained since Proposition 13, which added Article XIIIA to the State Constitution, ("Proposition 13") was approved by California voters in 1978. Proposition 13 reduced and limited the future growth of property taxes and limited the ability of local governments to impose "special taxes" (those devoted to a specific purpose) without two-thirds voter approval. Proposition 218, another initiative constitutional amendment enacted in 1996, further limited the ability of local governments to raise taxes, fees, and other exactions. Counties, in particular, have had fewer options to raise revenues than many other local government entities, while they have been required to maintain many services. In the aftermath of Proposition 13, the State provided aid to local governments from the General Fund to make up some of the loss of property tax moneys, including assuming principal responsibility for funding K-12 schools and community colleges. During the recession of the early 1990s, the Legislature eliminated most of the remaining components of post-Proposition 13 aid to local government entities other than K-12 schools and community colleges by requiring cities and counties to transfer some of their property tax revenues to school districts. However, the Legislature also provided additional funding sources, such as sales taxes, and reduced certain mandates for local services funded by cities and counties. See "STATE FINANCES--Sources of Tax Revenue--Sales Tax" and "CURRENT STATE BUDGET--2003 Budget Act--Fiscal Recovery Bonds" for a discussion of the impact of the 2003 Budget Act on local sales taxes. The 2002 Budget Act expanded such transfers to include community redevelopment agencies, which were not included in the original transfers. These agencies paid $75 million to schools in 2002-03. The 2003 Budget Act increases this payment to $135 million in 2003-04 only. The 2003 Budget Act and related legislation continue to provide significant assistance to local governments, including $238.2 million for various local public safety programs. This amount includes $100 million for A-26 the Citizens' Option for Public Safety ("COPS") program to support local front-line law enforcement, $100 million for county juvenile justice and crime prevention programs, and $38.2 million for reimbursement of jail booking fees. The 2003 Budget Act also provides $40.15 million for open space subvention reimbursements to cities and counties. A program to offset a portion of the vehicle license fees ("VLF") paid by vehicle owners was established in 1998. See "Sources of Tax Revenue--Vehicle License Fee." This offset provided tax relief of $3.985 billion in 2002-03. Since 1999, the General Fund has backfilled the offset so that the tax relief did not result in a revenue loss to local governments. The legislation that established the VLF offset program also provided that if there were insufficient General Fund moneys to fully backfill the VLF offset, the percentage offset would be reduced proportionately (i.e., the license fee payable by drivers would be increased) to assure that local governments are not disadvantaged. On June 20, 2003, it was determined that insufficient General Fund moneys were available to continue to fund any portion of the VLF offsets to local governments as of that date. Accordingly, the VLF paid by taxpayers returned on October 1, 2003 to the pre-1999 level and the State will not be obligated to make any offset payments from the General Fund in 2003-04. This action will reduce General Fund expenditures by about $4.2 billion in fiscal year 2003-04 and result in a reduction of approximately $825 million in transfers to local governments to cover the period of time needed for the Department of Motor Vehicles to phase out the offset from vehicle registration bills. The 2003 Budget Act and related legislation require the State to repay the $825 million VLF "gap" loss to local governments no later than August 15, 2006. However, the Legislature failed to approve legislation that would also advance up to $40 million of the $825 million VLF "gap" loss for those local governments that are disproportionately affected by this reduction. The 2003 Budget Act also increases the portion of VLF revenues that are dedicated to State-local realignment programs in 2003-04 so that those programs are held harmless from the VLF "gap" loss. A case has been filed challenging the restoration of the VLF. See "LITIGATION--Challenge to Discontinuation of Vehicle License Fee Offset." Prior to legislation enacted in 1997, local governments provided the majority of funding for the State's trial court system. The legislation consolidated the trial court funding at the State level in order to streamline the operation of the courts, provide a dedicated revenue source, and relieve fiscal pressure on the counties. This resulted in decreasing the county contribution for court operations by $415 million and allowed cities to retain $68 million in fine and penalty revenue previously remitted to the State. The State's trial court system will receive approximately $1.9 billion in State resources and $475 million in resources from the counties in 2003-04. The entire statewide welfare system was changed in response to the change in federal welfare law enacted in 1996 (see "Welfare Reform"). Under the CalWORKs program, counties are given flexibility to develop their own plans, consistent with State law, to implement the program and to administer many of its elements, with costs for administrative and supportive services capped at the 1996-97 levels. As noted above, counties are also given financial incentives if, at the individual county level or statewide, the CalWORKs program produces savings associated with specified standards. Counties are still required to provide "general assistance" aid to certain persons who cannot obtain welfare from other programs. WELFARE REFORM The Personal Responsibility and Work Opportunity Reconciliation Act of 1996 (P.L. 104-193, the "Law") fundamentally reformed the nation's welfare system. The Law includes provisions to: (i) convert Aid to Families with Dependent Children ("AFDC"), an entitlement program, to Temporary Assistance for Needy Families ("TANF"), a block grant program with lifetime time limits on TANF recipients, work requirements and other changes; (ii) deny certain federal welfare and public benefits to legal noncitizens (subsequent federal law has amended this provision), allow states to elect to deny A-27 additional benefits (including TANF) to legal noncitizens, and generally deny almost all benefits to illegal immigrants; and (iii) make changes in the Food Stamp program, including to reduce maximum benefits and impose work requirements. The block grant formula under the Law is operative through March 31, 2004. Chapter 270, Statutes of 1997, embodies California's response to the federal welfare reforms. Effective January 1, 1998, California Work Opportunity and Responsibility to Kids ("CalWORKs") replaced the former AFDC and Greater Avenues to Independence programs. Consistent with the federal law, CalWORKs contains time limits on the receipt of welfare aid, both lifetime as well as current period. The centerpiece of CalWORKs is the linkage of eligibility to work participation requirements. Welfare caseloads have declined considerably with the implementation of the CalWORKs program. The 2003-04 CalWORKs caseload is projected to be 466,000, down from 480,000 cases in 2002-03. This represents a major decline in caseload from the rapid growth of the early 1990s, when caseload peaked at 921,000 cases in 1994-95. In 2003-04, California will continue to meet, but not exceed, the federally-required $2.7 billion combined State and county maintenance of effort ("MOE") requirement. In an effort to keep program expenditures within the TANF Block Grant and TANF MOE amounts, the 2003 Budget Act suspends the October 2003 statutory cost-of-living adjustment for cash grants. The 2003 Budget Act includes a one-time augmentation of $191.9 million for employment services to enable recipients to leave aid and become self sufficient. The 2003 Budget Act includes total CalWORKs-related expenditures of $6.9 billion for 2003-04, including child care transfer amounts for the Department of Education and the State's general TANF reserve. The 2003 Budget Act also includes a TANF reserve of $175.3 million, which is available for unanticipated needs in any program for which TANF Block Grant funds are appropriated, including CalWORKs benefits, employment services, county administration, and child care costs. This reserve may be needed for such pressures as litigation or the cost of increased participation rate requirements that have been proposed at the federal level with the reauthorization of the TANF program. Authorization for the TANF program currently ends March 31, 2004 (having been extended several times from its original September 30, 2002 expiration date). For the TANF program to continue, the U.S. Congress must pass, and the President must sign, legislation reauthorizing the program prior to that date. Although reauthorization could simply involve extending the funding period, it is more likely that Congress and the President will consider several key policy changes. It is unknown at this time how California's TANF funding will be affected by reauthorization. PENSION TRUSTS The pension contribution liability for the three principal retirement systems in which the State participates, the California Public Employees' Retirement System ("CalPERS"), the California State Teachers' Retirement System ("CalSTRS") and the University of California Retirement System ("UCRS"), is included in the financial statements of the State and described in Note 20 to the Audited Annual Financial Statements of the State of California for the year ended June 30, 2002 (the "Audited Financial Statements"), incorporated by reference in this APPENDIX A. See "FINANCIAL STATEMENTS." The three largest defined benefit retirement plans contained in the retirement systems and the State's share of the excess of the actuarial value of assets over the actuarial accrued liability or unfunded A-28 actuarial accrued liability of those plans at June 30, 2002 (June 30, 2001, for CalSTRS) was reported to be as follows: TABLE 7 STATE SHARE OF ACTUARIAL VALUE
EXCESS OF ACTUARIAL VALUE OF ASSETS OVER ACTUARIAL ACCRUED LIABILITIES NAME OF PLAN (UNFUNDED ACTUARIAL ACCRUED LIABILITY) ----------------------------------------------------------------------------------------------------------------- Public Employees' Retirement Fund (CalPERS) $ (6.653) billion State Teachers' Retirement Fund Defined Benefit Program (CalSTRS) (2.227) billion University of California Retirement Plan 11.549 billion
The actuarial information for CalSTRS for the year ended June 30, 2002, is not yet available, as that information is updated on a two-year cycle. However, according to CalSTRS, its investment portfolio market value as of July 31, 2002, was $92,599,000,000, compared to $102,975,000,000 as of July 31, 2001. The CalPERS reports that its investment portfolio market value as of July 31, 2002, was $135,500,000,000, compared to $155,300,000,000 as of July 31, 2001. These declines in investment portfolio value will adversely affect the foregoing data when new actuarial calculations are made later in 2003. The State's contribution to the CalPERS and the UC Retirement System are actuarially determined each year, while the State's contribution to the CalSTRS is established by statute and is currently 2.017 percent of teacher payroll for the fiscal year ending in the immediately preceding calendar year. The following table shows the State's contributions to CalPERS for fiscal years 1997-98 through 2003-04: TABLE 8 STATE CONTRIBUTION TO CALPERS FISCAL YEARS 1997-98 TO 2003-04 1997-98 $ 1,223,000,000 1998-99 766,100,000 1999-00 463,600,000 2000-01 156,700,000 2001-02 677,200,000 2002-03 1,190,000,000 2003-04 2,213,000,000
Due to investment losses and increased retirement benefits, the State contribution to the CalPERS has increased from $156.7 million in 2000-01 to $2.213 billion in 2003-04. The State plans to issue pension obligation bonds to fund approximately $1.355 billion of the State's 2003-04 retirement obligation to CalPERS and the principal on such bonds would be repaid over five years starting in fiscal year 2004-05. The pension obligation bonds may not be issued or the amount of bonds may be reduced due to a trial court ruling declining to validate the pension obligation bonds. See "LITIGATION--Bond-Related Matters" and "CURRENT STATE BUDGET--2003 Budget Act." A-29 Details concerning the three largest plans and information concerning the other plans contained in the retirement systems are included in Note 20 to the Audited Financial Statements. See "FINANCIAL STATEMENTS." REPAYMENT OF ENERGY LOANS The Department of Water Resources of the State ("DWR") borrowed $6.1 billion from the General Fund of the State for DWR's power supply program between January and June 2001. DWR issued approximately $11.25 billion in revenue bonds in several series and in the fall of 2002 used the net proceeds of the revenue bonds to repay outstanding loans from banks and commercial lenders in the amount of approximately $3.5 billion and a loan from the General Fund in the amount of $6.1 billion plus accrued interest of approximately $500 million. Issuance of the DWR revenue bonds had been delayed since mid-2001 by a number of factors, including administrative and legal challenges. The loans from the General Fund and the banks and commercial lenders financed DWR's power supply program costs during 2001 exceeded DWR's revenues from the sale of electricity. Since that time, the power supply program has become self-supporting, and no additional loans from the General Fund are authorized. As of January 1, 2003, the DWR's authority to enter into new power purchase contracts terminated, and the IOUs resumed responsibility for obtaining electricity for their customers. The general purpose of the power supply program has been to provide to customers of the three major investor-owned electric utilities in the State (the "IOUs") the portion of their power not provided by the IOUs. The primary source of money to pay debt service on the DWR revenue bonds is revenues derived from customers of the IOUs resulting from charges set by the California Public Utilities Commission. The DWR revenue bonds are not a debt or liability of the State and do not directly or indirectly or contingently obligate the State to levy or to pledge any form of taxation whatever therefor or to make any appropriation for their payment. TOBACCO LITIGATION SETTLEMENT In 1998 the State (together with 45 other states and certain U.S. jurisdictions) signed a settlement agreement with the four major cigarette manufacturers. The State agreed to drop its lawsuit and not to sue in the future for monetary damages arising from the use of or exposure to tobacco products. Cigarette manufacturers agreed to billions of dollars in payments and restrictions on marketing activities. Under the settlement agreement, the cigarette manufacturers agreed to make payments to the State in perpetuity, which payments amount to approximately $25 billion (subject to adjustments) over the first 25 years. Under a separate Memorandum of Understanding, approved by the court, half of the payments made by the cigarette manufacturers will be paid to the State and half to local governments (all counties and the cities of San Diego, Los Angeles, San Francisco and San Jose). The specific amount to be received by the State and local governments is subject to adjustment. Details in the settlement agreement allow reduction of the manufacturers' payments for decreases in cigarette shipment volumes by the settling manufacturers, payments owed to certain "Previously Settled States" and certain types of offsets for disputed payments, among other things. However, settlement payments are adjusted upward each year by at least 3% for inflation, compounded annually. During fiscal year 2001-02, the General Fund received $478 million in settlement payments. Of that amount, $76 million was deposited in the General Fund and $402 million was deposited into a special fund to pay certain health care costs. During fiscal year 2002-03, the General Fund received $474 million, all of which was deposited in the special fund. A-30 Chapter 414, Statutes of 2002, as amended, allows the issuance of revenue bonds to generate $5.0 billion for the General Fund secured by the tobacco settlement revenues received by the State beginning in the 2003-04 fiscal year. An initial sale of 56.57% of the State's tobacco settlement revenues from July 1, 2003, onward, producing $2.5 billion in proceeds was completed in January 2003. A second sale of the remaining 43.43% of the State's tobacco settlement revenues, which produced $2.264 billion in proceeds, was completed in September 2003. See "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Enhanced Tobacco Settlement Revenue Bonds." INVESTMENT OF FUNDS Moneys on deposit in the State's Centralized Treasury System are invested by the Treasurer in the Pooled Money Investment Account (the "PMIA"). As of September 30, 2003, the PMIA held approximately $32.5 billion of State moneys, and $21.2 billion invested for about 2,903 local governmental entities through the Local Agency Investment Fund ("LAIF"). The assets of the PMIA as of September 30, 2003, are shown in the following table: TABLE 9 ANALYSIS OF THE POOLED MONEY INVESTMENT ACCOUNT PORTFOLIO*
TYPE OF SECURITY AMOUNT (MILLIONS) PERCENT OF TOTAL ------------------------------------------------------------------------------------- U.S. Treasury Bills and Notes $ 9,236 17.2% Commercial Paper (corporate) 10,185 19.0 Certificates of Deposits 6,545 12.2 Corporate Bonds 2,205 4.1 Federal Agency Securities 12,806 23.8 Bankers Acceptances - - Bank Notes 250 0.5 Loans Per Government Code 6,781 12.6 Time Deposits 5,694 10.6 Repurchases - - Reverse Repurchases - - $ 53,702 100.0%
* Totals may differ due to rounding. Source: State of California, Office of the Treasurer. The State's treasury operations are managed in compliance with the California Government Code and according to a statement of investment policy which sets forth permitted investment vehicles, liquidity parameters and maximum maturity of investments. The PMIA operates with the oversight of the PMIB. The LAIF portion of the PMIA operates with the oversight of the Local Agency Investment Advisory Board (consisting of the State Treasurer and four other appointed members). The Treasurer does not invest in leveraged products or inverse floating rate securities. The investment policy permits the use of reverse repurchase agreements subject to limits of no more than 10 percent of the PMIA. All reverse repurchase agreements are cash matched either to the maturity of the reinvestment or an adequately positive cash flow date which is approximate to the maturity of the reinvestment. A-31 The average life of the investment portfolio of the PMIA as of September 30, 2003, was 214 days. THE BUDGET PROCESS GENERAL The State's fiscal year begins on July 1 and ends on June 30 of the following year. The State operates on a budget basis, using a modified accrual system of accounting for its General Fund, with revenues credited in the period in which they are measurable and available and expenditures debited in the period in which the corresponding liabilities are incurred. The annual budget is proposed by the Governor by January 10 of each year for the next fiscal year (the "Governor's Budget"). Under State law, the annual proposed Governor's Budget cannot provide for projected expenditures in excess of projected revenues for the ensuing fiscal year. Following the submission of the Governor's Budget, the Legislature takes up the proposal. Under the State Constitution, money may be drawn from the Treasury only through an appropriation made by law. The primary source of the annual expenditure appropriations is the annual Budget Act as approved by the Legislature and signed by the Governor. The Budget Act must be approved by a two-thirds majority vote of each House of the Legislature, although initiatives are pending to reduce this to a 55% vote. The Governor may reduce or eliminate specific line items in the Budget Act or any other appropriations bill without vetoing the entire bill. Such individual line-item vetoes are subject to override by a two-thirds majority vote of each House of the Legislature. Appropriations also may be included in legislation other than the Budget Act. Except as noted in the previous paragraph and in the next sentence, bills containing General Fund appropriations must be approved by a two-thirds majority vote in each House of the Legislature and be signed by the Governor. Bills containing appropriations for K-12 schools or community colleges ("K-14 education") only require a simple majority vote. Continuing appropriations, available without regard to fiscal year, may also be provided by statute or the State Constitution. Funds necessary to meet an appropriation need not be in the State Treasury at the time such appropriation is enacted; revenues may be appropriated in anticipation of their receipt. CONSTRAINTS ON THE BUDGET PROCESS Over the years, a number of laws and constitutional amendments have been enacted, often from voter initiatives, which make it more difficult to raise State taxes, or restrict the use of State General Fund or special fund revenues, or otherwise limit the Legislature and Governor's discretion in enacting budgets. Prior examples of provisions that make it more difficult to raise taxes include Proposition 13, which, among other provisions, required that any change in State taxes enacted for the purpose of increasing revenues collected pursuant thereto, whether by increased rates or changes in computation, be enacted by a two-thirds vote in each house of the Legislature. Prior examples of provisions restricting the use of General Fund revenue are Proposition 98, which mandates a minimum percentage of General Fund revenues to be spent on local education, and Proposition 10, which raised taxes on tobacco products but mandated how the additional revenues would be expended. See "STATE FINANCES--Proposition 98" and "--Sources of Tax Revenue--Taxes on Tobacco Products." An initiative statute, called the "After School Education and Safety Program of 2002," was approved by the voters on November 5, 2002, and will require the State to expand funding for before and A-32 after school programs in the State's public elementary and middle schools. Beginning with fiscal year 2004-05 and in the first year that non-Proposition 98 appropriations exceed the base level by $1.5 billion, the initiative will require the State to appropriate up to $550 million annually, depending on the amount above the trigger level. (The initiative defines the base level as the fiscal year during the period July 1, 2000, through June 30, 2004, for which the State's non-guaranteed General Fund appropriations are the highest as compared to any other fiscal year during that period. Using final 2003 Budget Act data from August 2003, the 2003-04 fiscal year is the base year.) Based upon non-Proposition 98 General Fund appropriations in the 2003 Budget Act, the initiative is unlikely to require implementation of the funding increase in 2004-05. By comparison, the 2003 Budget Act includes about $121.6 million for these after school programs, $428.4 million below the amount which the initiative would require if the full funding increase were in effect. PRIOR FISCAL YEARS' BUDGETS Following a severe recession in the early 1990s, the State's financial condition improved markedly starting in 1995-96, due to a combination of better than expected revenues, slowdown in growth of social welfare programs, and continued spending restraint based on actions taken in earlier years. The economy grew strongly between 1994 and 2000, generally outpacing the nation, and as a result, for the five fiscal years from 1995-96 to 1999-00, the General Fund tax revenues exceeded the estimates made at the time the budgets were enacted. These additional funds were largely directed to school spending as mandated by Proposition 98, to make up shortfalls from reduced federal health and welfare aid in 1995-96 and 1996-97 and to fund new program initiatives, including education spending above Proposition 98 minimums, tax reductions, aid to local governments and infrastructure expenditures. The State ended the 1999-00 fiscal year with an $8.9 billion budget reserve. 2000 BUDGET ACT The 2000 Budget Act, signed by Governor Davis on June 30, 2000, assumed General Fund revenues and transfers of $73.9 billion, a 3.8 percent increase over 1999-00 estimates. The 2000 Budget Act appropriated $78.8 billion from the General Fund, a 17.3 percent increase over 1999-00, and reflected the use of $5.5 billion from the SFEU. About $7.0 billion of the increased spending in 2000-01 was for one-time expenditures and investments. Because of the State's strong cash position, the Davis Administration did not undertake a revenue anticipation note borrowing in 2000-01. The 2003-04 Governor's Budget reported that final fiscal year 2000-01 expenditures were $78.0 billion, about $2.0 billion below the 2001 Budget Act estimates, and revenues were $71.4 billion. The 2002-03 Governor's Budget reported that the June 30, 2001 SFEU balance, the budget reserve, was approximately $1.3 billion. This figure recognized the disbursement prior to June 30, 2001, of about $6.2 billion from the General Fund to make loans for the DWR power supply program. See "STATE FINANCES--Repayment of Energy Loans." At the time of enactment of the 2001 Budget Act, the Department of Finance had estimated the June 30, 2001 balance in the SFEU at $6.3 billion, but without recognition of the loans as an expenditure for budget purposes. 2001 BUDGET ACT The 2001 Budget Act (for fiscal year 2001-02) was signed by Governor Davis on July 26, 2001. The spending plan for 2001-02 included General Fund expenditures of $78.8 billion, a reduction of $1.3 billion from the prior year. It was expected that this could be accomplished without serious program cuts because such a large part of the 2000 Budget Act comprised one-time expenditures. The spending plan utilized more than half of the budget surplus as of June 30, 2001, but still left a projected balance in the SFEU at June 30, 2002, of $2.6 billion. The 2001 Budget Act assumed that, during the course of the A-33 fiscal year, the $6.2 billion advanced by the General Fund to the Department of Water Resources for power purchases would be repaid with interest. See "STATE FINANCES--Repayment of Energy Loans." The final estimate of fiscal year 2001-02 revenues and expenditures, included in the 2003-04 Governor's Budget in January 2003, showed an unprecedented drop in revenues compared to the prior year. The final estimate for the three largest tax sources was $59.7 billion, a drop of over $13 billion from 2000-01, the vast bulk of which was attributable to reduced personal income taxes from stock option and capital gains activity. This revenue shortfall and the delay of the DWR power revenue bonds past June 30, 2002, resulted in a substantial budgetary deficit and cash flow difficulties. The Department of Finance estimates that, on a budgetary basis, the General Fund had a $2.1 billion deficit at June 30, 2002. See "RECENT DEVELOPMENTS REGARDING STATE ECONOMY AND FINANCES," "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Cash Flow Borrowings" and "CURRENT STATE BUDGET--Summary of State Revenues and Expenditures." Within a few months after the start of the 2001-02 fiscal year, the Davis Administration recognized that economic growth and stock market levels were not meeting projections, and that revenues were falling below projections. Accordingly, Governor Davis imposed an immediate spending freeze for many State agencies in November 2001, and the Legislature approved spending reductions and deferrals totaling $2.3 billion for the 2001-02 fiscal year in January 2002. Despite these steps, as noted above, the State ended the fiscal year with $2.1 billion negative fund balance. The 2001 Budget Act as initially enacted included Proposition 98 per-pupil spending increases of 4.9 percent. Total General Fund spending of $32.4 billion for K-12 education fully funded enrollment and cost of living increases and also provided additional funding for a number of programs. Higher education funding was increased to allow for enrollment increases at both the University of California and the California State University system with no fee increases. Health and human services generally were fully funded for anticipated caseload growth. Funding for many of these programs was subsequently reduced as a result of the mid-year corrections noted above. The 2001 Budget Act altered the six-year transportation funding plan started in the 2000-01 fiscal year. The Legislature postponed for two years the transfer from the General Fund of $2.5 billion of sales taxes on gasoline to support transportation programs. To allow all current projects to remain on schedule through 2002-03, the Legislature authorized certain internal loans from other transportation accounts. The 2003 Budget Act also partially suspends the transfer of gasoline sales taxes out of the General Fund in 2003-04. Proposition 42, a constitutional amendment approved in March of 2002, made permanent, after 2007-08, the dedication of sales taxes on gasoline to transportation purposes. 2002 BUDGET ACT The 2002-03 Governor's Budget, released on January 10, 2002 (the "2002-03 Governor's Budget"), projected a decline in General Fund revenues due to the national economic recession combined with the stock market decline, which began in mid-2000. Personal income tax receipts, which include stock option and capital gains realizations, were particularly affected by the slowing economy and stock market decline. As a result, the Davis Administration projected a combined budget gap for 2001-02 and 2002-03 of approximately $12.5 billion. The May Revision to the 2002-03 Governor's Budget projected further deterioration in revenues and additional costs, increasing the two year budget gap to $23.6 billion. The 2002 Budget Act was signed by Governor Davis on September 5, 2002. The 2002 Budget Act addressed the $23.6 billion gap between expenditures and resources through a combination of A-34 program reductions, interfund borrowings, fund shifts, payment deferrals, accelerations and transfers, debt service restructuring savings and modest tax changes. Within a few months after the 2002 Budget Act was adopted, it became evident that revenue projections incorporated in the 2002 Budget Act were substantially overstated and that certain program cost savings included in the 2002 Budget Act would not be realized. In late November 2002, Governor Davis directed State agencies to take immediate action to reduce any non-critical or non-essential activities by not filling any vacant positions; to cancel, postpone or amend contracts, grants, purchase orders and similar commitments; to eliminate additional non-essential vacant positions; to delay construction or signing of new leases for space; to cancel or postpone non-essential trips; and to generate new proposals for current year program reductions. In December 2002, Governor Davis released proposals for immediate action to reduce the projected two-year budget gap by about $10.2 billion ($5.5 billion for 2002-03). Governor Davis requested action on these proposals early in 2003 in order to maximize savings in the 2002-03 fiscal year. The Legislature passed budget adjustment legislation in March and April 2003, totaling about $10.4 billion in spending reductions, deferrals and funding transfers ($5.1 billion for 2002-03 and $5.3 billion for 2003-04). The largest part of the reductions (including a $1.1 billion deferral into the 2003-04 fiscal year) were for K-12 education funding. The spending reductions reflected the enactment of legislation in May 2003 permitting the sale of about $1.9 billion of pension obligation bonds to fund the State's 2003-04 payments to the Public Employees' Retirement System. See "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Pension Obligation Bonds" and "CURRENT STATE BUDGET--2003 Budget Act." However, the issuance of the pension obligation bonds may be delayed or cancelled for the 2003-04 fiscal year due to a trial court ruling declining to validate the pension obligation bonds. See "LITIGATION--Bond-Related Matters." In January, 2003, the State General Fund received $2.5 billion from the first sale of the State's portion of future receipt of payments from tobacco companies from the settlement of litigation against the tobacco companies. The second sale, which raised $2.264 billion for the General Fund, was completed in September 2003. CURRENT STATE BUDGET THE DISCUSSION BELOW OF THE FISCAL YEAR 2003-04 BUDGET AND THE TABLE UNDER "SUMMARY OF STATE REVENUES AND EXPENDITURES" ARE BASED ON ESTIMATES AND PROJECTIONS OF REVENUES AND EXPENDITURES FOR THE CURRENT FISCAL YEAR AND FUTURE FISCAL YEARS AND MUST NOT BE CONSTRUED AS STATEMENTS OF FACT. THESE ESTIMATES AND PROJECTIONS ARE BASED UPON VARIOUS ASSUMPTIONS, WHICH MAY BE AFFECTED BY NUMEROUS FACTORS, INCLUDING FUTURE ECONOMIC CONDITIONS IN THE STATE AND THE NATION, AND THERE CAN BE NO ASSURANCE THAT THE ESTIMATES WILL BE ACHIEVED. SEE "RECENT DEVELOPMENTS REGARDING STATE ECONOMY AND FINANCES" AND "CURRENT STATE BUDGET--REVENUE AND EXPENDITURE ASSUMPTIONS." BACKGROUND. The 2003-04 Governor's Budget, released on January 10, 2003 (the "2003-04 Governor's Budget"), projected a significant downward revision in State revenues. The 2003-04 Governor's Budget projected revenues from the three largest tax sources to be about $61.7 billion in 2002-03, more than $6 billion lower than projected in the 2002 Budget Act. The 2003-04 Governor's Budget projected total revenues and transfers of $73.1 billion and $69.2 billion in 2002-03 and 2003-04 respectively. The 2003-04 Governor's Budget projected a $34.6 billion cumulative budget shortfall through June 30, 2004. A-35 The 2003-04 Governor's Budget proposed to close the $34.6 billion budget shortfall with expenditure reductions including the reduction of the vehicle license fee backfill to cities and counties, the "realignment" or shift of responsibility for certain health and welfare programs to cities and counties to be supported by increased sales tax, personal income tax and cigarette tax increases, fund shifts from the General Fund, revenues from the renegotiation of compacts with Indian tribes, and loans and borrowings (including a pension obligation bond issue to pay all or a portion of the 2003-04 retirement obligation for certain state retirement systems). On May 14, 2003, Governor Davis released the May Revision to the 2003-04 Governor's Budget (the "May Revision"). The May Revision reduced the revenue estimate for 2002-03 to $70.8 billion from the 2003-04 Governor's Budget estimate of $73.1 billion, primarily from the loss of $2 billion of revenues due to the delay of the second sale of tobacco securitization bonds. As a result principally of the loss of the tobacco securitization proceeds, together with the lost opportunities for savings because of legislative action in lower amounts than requested by Governor Davis, and higher than expected caseloads/populations for certain health and social services and correctional programs and required school payments, the May Revision estimated the budget gap for 2002-03 and 2003-04 increased from $34.6 billion to $38.2 billion. Governor Davis made a number of fundamental changes in the May Revision from his earlier budget proposals. In summary, in the May Revision, Governor Davis proposed to address the budget shortfalls in three phases: (1) eliminate an estimated $10.675 billion budget deficit accumulated through June 30, 2003 (after accounting for $5.1 billion of budget adjustments enacted in March and April 2003), by issuing fiscal recovery bonds to be repaid from a temporary one-half cent increase in the State sales tax, (2) balance the fiscal year 2003-04 budget with a combination of measures ($5.3 billion of which were approved by the Legislature in March and April) including expenditure cuts, fund shifts, transfers, loans, and the transfer ("realignment") of certain health and social services programs from the State to counties, and (3) pursue legislative action during the balance of the 2003 Legislative session to enact structural reforms that would eliminate an estimated $7.9 billion remaining funding gap for the 2004-05 fiscal year. 2003 BUDGET ACT After months of negotiation between Governor Davis and the Legislature, the 2003 Budget Act was adopted by the Legislature on July 29, 2003, along with a number of implementing measures, and signed by Governor Davis on August 2, 2003, after vetoing $47 million ($1 million General Fund and $46 million bond funds). The 2003 Budget Act largely reflected the proposals contained in the May Revision to the 2003-04 Budget, including the issuance of "fiscal recovery bonds" to address the estimated $10.675 billion budget deficit accumulated through June 30, 2003. See "LITIGATION--Bond-Related Matters." The 2003 Budget Act rejected the proposed "realignment" of certain health and social services programs (to be funded from $1.7 billion of personal and tobacco tax increases), and, instead, increased reliance upon fund shifts and transfers and additional (non-tax) revenues sources, as described below. Under the 2003 Budget Act, General Fund revenues are projected to increase 3.3 percent, from $70.9 billion in 2002-03 to $73.3 billion in 2003-04. The revenue projections incorporate a 4 percent increase in State tax revenues (as projected by the LAO's office), reflecting a correspondingly moderate growth in the State's economy and the State Department of Finance believes such forecast is reasonable. See "Economic Assumptions" below. Significant items of non-tax revenue are described below under "Addressing the $38.2 Billion Shortfall." A-36 General Fund expenditures are estimated to drop 9 percent from $78.1 billion in 2002-03 to $71.1 billion in 2003-04. Most of this decline can be explained by four factors: (1) the suspension of vehicle license fee backfill payments to local governments, which is estimated to result in $4.2 billion of savings in 2003-04. See "STATE FINANCES-Local Governments." In addition, the administrative action which suspended the vehicle license fee offsets has been challenged in court. See "STATE FINANCES--Sources of Tax Revenues--Vehicle License Fee," "Local Governments" and "LITIGATION--Challenge to Discontinuation of Vehicle License Fee Offset"; (2) approximately $1.8 billion of federal funds under the federal Jobs and Growth Tax Relief Reconciliation Act of 2003 to cover State costs in 2003-04. (In comparison, approximately $321 million of such federal funds was received in 2002-03.) Approximately $694 million will be used to offset Medi-Cal costs in 2003-04, and the remainder will be used to cover other critical State program spending. These new federal funds are not expected to be available in 2004-05 and beyond; (3) the receipt of $1.9 billion of pension obligation bond proceeds to cover all of the State's quarterly contributions to CalPERS for 2003-04, which would reduce General Fund expenditures by $900 million and increase revenues by $1 billion. See "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Pension Obligation Bonds." Delays caused by litigation contesting the issuance of such bonds have reduced the anticipated size of the bond proceeds to be derived from such issuance to $1.355 billion. See "LITIGATION--Bond-Related Matters." The next quarterly estimated $553 million CalPERS contribution is due on January 2, 2004. It is possible that, even if the State prevails in the litigation, delays could further reduce the size of, or eliminate the issuance of any of the pension bonds in fiscal year 2003-04, requiring further mitigation measures by the State in order to maintain the estimated budget reserve; and (4) a one-time shift of Medi-Cal accounting from accrual to cash basis ($930 million). In the LAO's Budget Analysis, dated August 1, 2003, the LAO concluded that, absent the above-described factors, underlying spending for 2002-03 and 2003-04 would be roughly equal. Moreover, the LAO concluded that "the 2003-04 spending level is considerably less than what would be required to maintain "baseline spending" for the [2003-04 fiscal] year." The LAO defines "baseline spending" to include spending requirements imposed by existing law, policies and State mandates at the beginning of the fiscal year. The June 30, 2004 reserve is projected in the Budget to be just over $2 billion. This reflects the elimination of the $10.675 billion accumulated deficit through June 30, 2003, through the issuance of the fiscal recovery bonds. See "CURRENT STATE BUDGET--2003 Budget Act--Fiscal Recovery Bonds" below. However, the proposed issuance of the fiscal recovery bonds is the subject of current litigation. See "LITIGATION--Bond-Related Matters." The Legislative Analyst's Office has predicted that additional legislative action will be required in fiscal year 2004-05 to eliminate an estimated $7.9 billion remaining funding gap by the end of 2004-05. See "CURRENT STATE BUDGET--2003 Budget Act--Continuing 'Structural Deficit.'" ADDRESSING THE $38.2 BILLION SHORTFALL In May 2003, Governor Davis projected that, without further corrective action, the State would face an estimated $38.2 billion shortfall for fiscal years 2002-03 and 2003-04 combined. This estimate was based on the expenditure levels as required by the Constitution and State law, mandated by the federal government, or ordered by the courts, and accounted for scheduled cost of living adjustments, as well as increases due, among other things, to enrollment, caseload and population growth. Approximately A-37 $10.4 billion of this shortfall was addressed through legislative action taken in March and April 2003 ($5.1 billion for fiscal year 2002-03 and $5.3 billion for fiscal year 2003-04). The remainder of the shortfall is addressed through the issuance of fiscal recovery bonds which are expected to generate proceeds in the amount of approximately $10.7 billion in 2003-04 and other solutions contained in the 2003 Budget Act. Absent the corrective measures contained in the 2003 Budget Act and described below, the State was projected to expend $90.9 billion in 2003-04 rather than the budgeted $71.1 billion. Set forth below is a summary of the expenditure cuts and savings, fund shifts, new revenues, loans and borrowing, and the fiscal recovery bond financing incorporated into the 2003 Budget Act described above. These amounts include the effects of the legislative action taken in March and April 2003. 2003 BUDGET ACT ADDRESSING THE $38.2 BILLION BUDGET SHORTFALL (DOLLARS IN MILLIONS)
CATEGORY AMOUNT PERCENT OF SOLUTION ------------------------------------------------------------------------------- Cuts/Savings $ 17,589.6 44.6% Fund Shifts 4,357.0 11.1% Tobacco Securitization and Other Revenues 4,466.3 11.3% Pension Obligation Bonds and Interfund Loans 2,326.2 5.9% Fiscal Recovery Bonds 10,675.4 27.1% Totals $ 39,414.5* 100.0%
Note: Numbers may not add due to rounding. * Reflects projected General Fund reserve balance of $2.2 billion at year end. EXPENDITURE CUTS/SAVINGS. Expenditure cuts/savings total $17.6 billion ($2.1 billion in 2002-03 and $15.5 billion in 2003-04), including the following major items: - VLF backfill suspension ($4.2 billion), as described above. - Employee compensation reductions and the abolishment of 16,000 permanent positions to be implemented through collective argaining ($585 million from the General Fund and a total of $1.1 billion from all funds). - Change Medi-Cal accounting from accrual to cash basis ($930 million), as described above. - Partial suspension of transfer of gasoline sales tax revenue to Transportation Investment Fund to be repaid with interest by June 30, 2009 ($856 million). - Community Redevelopment Agency Transfer to the Educational Revenue Augmentation Fund ($135 million). - $3.1 billion in K-12 Education programs, including program cuts ($1.2 billion), elimination of COLAs ($800 million) and permanent Proposition 98 deferrals ($1.087 billion). A-38 - $1.186 billion in Higher Education Programs, including University of California ($484 million), California State University ($409 million) and California Community Colleges ($293 million), some of which will be offset by higher fees. - Deferral of a loan repayment from Caltrans ($500 million). - Defer funding of mandate deficiencies and new mandate costs ($870 million) and reduce non-Proposition 98 mandates ($769 million). - Eliminate equalization funding for revenue limits ($250 million). - Reductions in payments for retired teachers purchasing power maintenance, which the State is obligated to restore if purchasing power is not maintained at the 80 percent level through 2036 ($500 million). See, "LITIGATION - Challenge Seeking Payment to Teacher's Retirement Board." FUND SHIFTS Fund shifts from the General Fund to other fund sources total $4.3 billion ($1.0 billion in 2002-03 and $3.3 billion in 2003-04), including the receipt of approximately $2.2 billion of new federal funds under the federal Jobs and Growth Tax Relief Reconciliation Act of 2003 (as described above), $355 million in new fees to offset General Fund costs, $492 million from shifts to Proposition 98 reversion account, $200 million for community colleges spending deferral, $220 million for healthy families costs funded out of tobacco settlement funds to offset additional costs, $143 million shift to federal funds, and $700 million in other fund shifts. OTHER REVENUES Other revenues total $4.5 billion ($0.3 billion in 2003-03 and $4.2 billion in 2003-04), including approximately $2 billion of proceeds from the tobacco settlement bonds; $680 million additional revenues resulting from renegotiation of compact agreements between Indian tribes and the State (still in progress); $756 million from the adoption of the higher revenues estimates as projected by the Legislative Analyst's Office; $289 million for fees; $112 million for additional unclaimed property revenues; $110 million for additional revenues from property sales and $598 million for other revenue increases and transfers. LOANS/BORROWINGS Loans/Borrowings total $2.3 billion in 2003-04. This includes $1.9 billion in proceeds from the proposed issuance of pension obligation bonds (see "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Pension Obligation Bonds" and "LITIGATION--Bond-Related Matters") and $400 million in loans from other various funds and accounts. FISCAL RECOVERY BONDS The California Fiscal Recovery Financing Act authorizes the issuance of fiscal recovery bonds to eliminate the estimated $10.675 billion accumulated deficit through June 30, 2003. See "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Fiscal Recovery Bonds." This is the largest and most critical component of the 2003 Budget Act. The State plans to issue the fiscal recovery bonds in February and April of 2004. However, the issuance of the fiscal recovery bonds is the subject of current litigation. See "LITIGATION--Bond-Related Matters." A-39 In the event that litigation materially delays or prevents the issuance of the fiscal recovery bonds, the size of the remaining shortfall would most certainly exceed the amount of discretionary spending within the 2003 Budget Act which could be cut to address the shortfall. The resulting shortfall would also cause a cash shortfall. The State would almost certainly be required to substantially reduce 2003-04 spending, raise taxes and/or incur other short term or long term borrowings, to the extent legally feasible and to the extent the State had continued access to the capital markets. The State expects to take all steps necessary to continue to have access to the short-term and long-term credit markets. The State might also be required to issue registered warrants if it requests an advance under the Forward Purchase Agreements, draws on the Letters of Credit or is otherwise unable to pay principal and interest on the 2003-04 RANs at maturity. Issuance of such registered warrants would further restrict the State's cash flow options. See "CASH FLOW--2003 Revenue Anticipation Warrants" and "--Fiscal Year 2003-04 Revenue Anticipation Notes." The Fiscal Recovery Bond Fund, the fund from which appropriations to pay the fiscal recovery bonds may be made by future Legislatures, will be financed by a temporary increase in the State's sales tax. Simultaneously with the temporary increase in the State's sales tax, the local sales tax authorization under State law will be reduced by one-half cent, and local governments' share of local property tax will be increased by a like amount. See "STATE FINANCES--Sources of Tax Revenue--Sales Tax." While this reduces the amount of property tax going to schools, Proposition 98 requires that the State make certain minimum payments to schools. See "STATE FINANCE--Proposition 98." Accordingly, the State will make payments to local governments and schools in amounts generally equal to the reduced amounts of sales taxes available to local governments and reduced property taxes available to school districts. These payments to local governments and school districts will commence in fiscal year 2004-05. The estimated amount of such payments for fiscal year 2004-05 is $2.5 billion. BUDGET CONTROLS AND FLEXIBILITY Chapter 228, Statutes of 2003 (AB 1756), authorizes the Director of Finance to reduce appropriations and to reallocate funds among appropriations available to each department in order to ensure the integrity of the 2003 Budget Act. Additionally, the 2003 Budget Act limits the Department of Finance's authority to approve requests for additional funding in the current year ("deficiency requests"). Deficiency requests to fund prior year expenditures, costs associated with legislation enacted without an appropriation, and start-up costs for programs not yet authorized may not be approved. CONTINUING "STRUCTURAL DEFICIT" Assuming that all of the savings in the 2003 Budget Act are achieved, on August 1, 2003, the Legislative Analyst's Office estimated that, absent further corrective actions, and assuming that the State adheres to the intent of Chapter 228, Statutes of 2003 (AB 1756) (described below), the State would end fiscal year 2004-05 with a $7.9 billion funding gap. The LAO funding gap estimate also assumes the effects of the Legislature's intent (expressed in AB 1756 and described below) limiting, among other expenditures, employee compensation and COLAs. The Department of Finance requested State agencies to submit proposals to reduce 2004-05 spending equivalent to 20-percent of the 2003-04 General Fund funding. The proposals are confidential and will be considered during the fall budget development process to help address the projected $7.9 billion funding shortfall in 2004-05. Any proposals selected by the Administration for implementation will be included in the 2004-05 Governor's proposed budget, to be released on January 10, 2004. A-40 Chapter 228, Statutes of 2003 (AB 1756), states the Legislature's intent that, in assisting the Governor in preparing the State Budget for fiscal year 2004-05, the Department of Finance not include any proposed funding for certain items, including salary increases, enrollment growth, and discretionary price adjustments at the University of California and California State University, discretionary price adjustments to State operations, State employee salary increases, local mandate reimbursements, General Fund capital outlay above $50 million, the All American Canal and Proposition 98 spending in excess of the minimum guarantee for fiscal years 2003-04 and 2004-05. ELECTION OF NEW GOVERNOR Uncertified results from a special election held on October 7, 2003 indicate that the Governor of the State, Gray Davis, has been recalled and that he will be replaced as Governor by Arnold Schwarzenegger. The Secretary of State of the State has until November 15, 2003 to certify the results of the recall election. The new Governor would not take office until the election results are certified. The Governor-elect is in the process of assembling his staff and evaluating the State's financial condition. As a result of his evaluation, he may propose mid-year legislation or take executive actions which could affect the State's receipts, disbursements and proposed borrowings during the current fiscal year. A-41 SUMMARY OF STATE REVENUES AND EXPENDITURES The table below presents the actual revenues, expenditures and changes in fund balance for the General Fund for fiscal years 1999-00, 2000-01 and 2001-02, estimated results for fiscal year 2002-03 and projected results (based upon the 2003 Budget Act) for fiscal year 2003-04. TABLE 10 STATEMENT OF REVENUES, EXPENDITURES, AND CHANGES IN FUND BALANCE-GENERAL FUND (BUDGETARY BASIS)(a) FISCAL YEARS 1999-00 THROUGH 2003-04 (MILLIONS)
ESTIMATED(b) ESTIMATED(b) 1999-00 2000-01 2001-02 2002-03(c) 2003-04(c) --------------------------------------------------------------------------------------------------------------------------------- FUND BALANCE-BEGINNING OF PERIOD $ 3,907.7 $ 9,639.7 $ 9,017.5 $ (2,109.8) $ 1,401.9 Restatements Prior Year Revenue, Transfer Accrual Adjustments (204.6) (158.8) (729.8) 169.5 - Prior Year Expenditure, Accrual Adjustments 217.1 (229.9) 217.4 (43.5) - FUND BALANCE-BEGINNING OF PERIOD, AS RESTATED $ 3,920.2 $ 9,251.0 $ 8,505.1 $ (1,983.8) $ 1,401.9 Revenues $ 71,555.6 $ 77,609.9 $ 64,060.3 $ 68,071.3 $ 71,522.0 Other Financing Sources Deficit Financing Bond(d) 10,675.4 Transfers from Other Funds 423.3 6,561.8(e) 2,143.3 2,780.7 1,831.2 Other Additions 48.1 46.3 33.9 - - TOTAL REVENUES AND OTHER SOURCES $ 72,027.0 $ 84,218.0 $ 66,237.5 $ 81,527.4 $ 73,353.2 Expenditures State Operations $ 15,942.8 $ 17,641.7 $ 19,085.7 $ 18,394.9 $ 16,484.5 Local Assistance 49,974.7 58,441.4 57,142.0 59,598.9 54,574.6 Capital Outlay 186.2 2,044.3 323.5 147.9 77.8 Unclassified - - - - - Other Uses Transfer to Other Funds 203.8 6,324.1(e) 301.2 -(f) -(f) TOTAL EXPENDITURES AND OTHER USES $ 66,307.5 $ 84,451.5 $ 76,852.4 $ 78,141.7 $ 71,136.9 REVENUES AND OTHER SOURCES OVER OR (UNDER) EXPENDITURES AND OTHER USES $ 5,719.5 $ (233.5) $ (10,614.9) $ 3,385.7 $ 2,216.3 Fund Balance Reserved for Encumbrances $ 701.3 $ 1,834.3 $ 1,491.5 $ 1,401.9 $ 1,401.9 Reserved for Unencumbered Balances of Continuing Appropriations(g) 1,115.2 1,436.7 827.3 - 174.9 Reserved for School Loans(h) 699.7 349.7 - - - Unreserved-Undesignated (i) 7,123.5 5,396.8 (4,428.6) - 2,041.4 FUND BALANCE-END OF PERIOD $ 9,639.7 $ 9,017.5 $ (2,109.8) $ 1,401.9 $ 3,618.2
Footnotes on following page. Source: Fiscal years 1999-00 to 2001-02: State of California, Office of the State Controller. Fiscal years 2002-03 and 2003-04: State of California, Department of Finance. A-42 (a) These statements have been prepared on a budgetary basis in accordance with State law and some modifications would be necessary in order to comply with generally accepted accounting principles ("GAAP"). The Supplementary Information contained in the State's Audited Annual Financial Statements for the year ended June 30, 2003, incorporated by reference in this APPENDIX A, contains a description of the differences between the budgetary basis and the GAAP basis of accounting and a reconciliation of the June 30, 2002 fund balance between the two methods. (b) Estimates are shown net of reimbursements and abatements. (c) Estimated as of the 2003 Budget Act, August 2, 2003. (d) Reflects the Davis Administration's proposal to finance the cumulative deficit over several years through the issuance of approximately $10.7 billion of fiscal recovery bonds in 2003-04. See "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Fiscal Recovery Bonds" and "CURRENT STATE BUDGET--2003 Budget Act--Fiscal Recovery Bonds." For accounting purposes, this is shown in 2002-03 to reflect that the accumulated deficit has been eliminated as of the start of fiscal year 2003-04. (e) "Transfers to Other Funds" includes the $6.2 billion General Fund loan to the Department of Water Resources Electric Power Purchase Fund. See "STATE FINANCES--Repayment of Energy Loans" and "CURRENT STATE BUDGET" in this APPENDIX A. "Transfers from Other Funds" includes this loan as a receivable in 2000-01. The loan was subsequently repaid with interest as follows: $116 million in July 2001, $164 million in October 2002, and $6.456 billion in November 2002. The loan was reported in the State's Budgetary/Legal Basis Annual Report as an asset of the General Fund and a liability of the Department of Water Resources Electric Power Purchase Fund. (f) "Transfer to Other Funds" is included either in the expenditure totals detailed above or as "Transfer from Other Funds." (g) For purposes of determining whether the General Fund budget, in any given fiscal year, is in a surplus or deficit condition, Chapter 1238, Statutes of 1990, amended Government Code Section 13307. As part of the amendment, the unencumbered balances of continuing appropriations which exist when no commitment for an expenditure is made should be an item of disclosure, but the amount shall not be deducted from the fund balance. Accordingly, the General Fund condition included in the 2003-04 Governor's Budget includes the unencumbered balances of continuing appropriations as a footnote to the statement ($1.307 billion in 2001-02, $270.0 million in 2002-03 and $174.9 million in 2003-04). However, in accordance with Government Code Section 12460, the State's Budgetary/Legal Basis Annual Report reflects a specific reserve for the encumbered balance for continuing appropriations. (h) During 1995, a reserve was established in the General Fund balance for the $1.7 billion of previously recorded school loans which had been authorized by Chapter 703, Statutes of 1992 and Chapter 66, Statutes of 1993. These loans were repaid from future General Fund appropriations as part of the settlement of litigation. This accounting treatment is consistent with the State's audited financial statements prepared in accordance with GAAP. (i) Includes Special Fund for Economic Uncertainties (SFEU). The Department of Finance generally includes in its estimates of the SFEU and set aside reserves, if any, the items reported in the table under "Reserved for Unencumbered Balances of Continuing Appropriations," "Reserved for School Loans," and "Unreserved--Undesignated." The Department of Finance projects a $2.216 billion SFEU balance on June 30, 2004, based upon the 2003 Budget Act, signed on August 2, 2003. A-43 REVENUE AND EXPENDITURE ASSUMPTIONS The table below presents the Department of Finance's budget basis statements of major General Fund revenue sources and expenditures for the 2001-02 fiscal year and 2003 Budget Act estimates for the 2002-03 and 2003-04 fiscal years. TABLE 11 MAJOR GENERAL FUND REVENUE SOURCES AND EXPENDITURES
REVENUES (MILLIONS) FISCAL YEARS --------------------------------------------------------------- 2001-02(a) 2002-03(b) 2002-03(c) 2003-04(c) SOURCE ACTUAL ENACTED REVISED ENACTED ------------------------------------------------------------------------------------------------ Personal Income Tax $ 33,047 $ 37,626 $ 32,442 $ 33,596 Sales and Use Tax 21,355 22,958 22,330 23,518 Corporation Tax 5,333 7,327 6,700 7,035 Insurance Tax 1,596 1,759 1,880 2,068 Deficit Financing Bond(d) 10,675 All Other 10,908(e) 9,488(f) 7,500(g) 7,136(h) Total Revenues and Transfers $ 72,239 $ 79,158 $ 81,527 $ 73,353 EXPENDITURES (MILLIONS) FISCAL YEARS --------------------------------------------------------------- 2001-02(a) 2002-03(b) 2002-03(c) 2003-04(c) ACTUAL ENACTED REVISED ENACTED ------------------------------------------------------------------------------------------------ FUNCTION K-12 Education $ 29,923 $ 30,769 $ 29,469 $ 29,318 Health and Human Services 21,820 21,633 23,150 23,358 Higher Education 9,645 9,759 9,543 8,679 Youth and Adult Correctional 5,641 5,285 5,833 5,644 Legislative, Judicial and Executive 2,612 2,464 2,486 2,406 Tax Relief 3,029 4,422 4,802 707(i) Resources 1,382 1,041 1,243 865 State and Consumer Services 690 471 480 444 Business, Transportation and Housing 639 228 211 512 All Other 1,371 650 925 -796(j) Total Expenditures $ 76,752 $ 76,722 $ 78,142 $ 71,137
Footnotes continue on following page. Source: State of California, Department of Finance. Figures in this table may differ from the figures in Table 4; see "Note" to Table 4. (a) Figures for 2001-02, prepared by the Department of Finance, are slightly different than the figures in Table 10, prepared by the State Controller's Office, because of certain differences in accounting methods used by the two offices. (b) 2002 Budget Act, September 5, 2002. (c) 2003 Budget Act, August 2, 2003. (d) Reflects the Davis Administration's proposal to finance the cumulative deficit over several years through the issuance of approximately $10.7 billion of fiscal recovery bonds in 2003-04. See "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Fiscal Recovery Bonds" and "CURRENT STATE BUDGET--2003 Budget Act--Fiscal Recovery Bonds." A-44 (e) Reflects the repayment of $6.2 billion in advances (plus interest of $525 million) made from the General Fund to the Department of Water Resources for the power supply program described under "STATE FINANCES--Repayment of Energy Loans." Repayment was made as follows: $116 million in July 2001, $164 million in October 2002, and $6.456 billion in November 2002. (f) Includes $4.5 billion for tobacco securitization bond proceeds and about $2.5 billion in inter-fund loans and transfers. (g) Includes $2.5 billion for tobacco securitization bond proceeds and about $2.8 billion in inter-fund loans and transfers. The Budget Act reflected $4.5 billion for tobacco securitization bond proceeds; however, the second sale ($2.0 billion) was not completed during fiscal year 2002-03. (h) Includes $2.0 billion for tobacco securitization bond proceeds. See "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Enhanced Tobacco Settlement Revenue Bonds." Also includes the anticipated receipt of $996 million from pension obligation bonds, which would be used to offset special fund contributions to pension funds. See "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Pension Obligation Bonds." (i) Reflects the suspension of vehicle license fee backfill payments to local government. See "STATE FINANCES--Sources of Tax Revenue--Vehicle License Fee." (j) Reflects reduced expenditures of $912 million due to the anticipated receipt of pension obligation bond proceeds to cover General Fund contributions to pension funds. See "STATE INDEBTEDNESS AND OTHER OBLIGATIONS--Pension Obligation Bonds." ECONOMIC ASSUMPTIONS The revenue and expenditure assumptions set forth have been based upon certain estimates of the performance of the California and national economies in calendar years 2003 and 2004. In the May Revision of the 2003-04 Governor's Budget, the Department of Finance projected that the California economy would grow slowly in 2003 and moderately in 2004. The California economy has tracked the national economy quite closely in the last calendar year. Both economies have been sluggish. From August 2002 to August 2003, nonfarm payroll employment fell by 0.3 percent in the State and 0.4 percent in the nation. Over that year, state unemployment varied narrowly, never exceeding 6.9 percent or falling below 6.6 percent. The gap between the State and national unemployment rates has narrowed in recent months. In addition, homebuilding was strong in both the State and the nation, as were housing markets. Economic output appears to be growing in both the nation and California. Inflation-adjusted Gross Domestic Product has grown for seven consecutive quarters. Statistics on Gross State Product are not as timely as those on (national) Gross Domestic Product, but the U.S. Commerce Department recently estimated that California personal income grew for the fifth consecutive month in the first quarter of 2003. In addition, personal state income tax withholdings were up 5.6 percent in the first nine months of 2003 from a year earlier. State sales tax revenues also increased over that period. Job losses have slowed down considerably in the San Jose and San Francisco metropolitan areas. Nonfarm payroll employment was down 4.6 percent in August 2003 from a year earlier in the San Jose metropolitan area and 1.8 percent in the San Francisco metropolitan area. A year ago, employment was down 8.4 percent and 5.5 percent, respectively, in the two metropolitan areas. By the same measure, however, job growth has slowed over the last year in the Riverside-San Bernardino and San Diego metropolitan areas. Construction and real estate remain strong. Permits for 130,225 new units were issued in the first eight months of 2003, up 20.3 percent from the year-ago level. A rush to beat large fee increases accounted for some of the increased permit issuance. Still, residential building for the year as a whole is likely to be the highest level since 1989. Private nonresidential building continues to slide, with the San Francisco Bay Area accounting for most of the slowdown. A-45 The median price of existing, single-family houses sold in California in August was a record $404,870, up 21.1 percent from a year ago. Sales were up 14.7 percent from a year earlier. According to the California Association of Realtors, the percentage of households in California able to afford a median-priced home stood at 26 percent in July. The corresponding measure of home affordability in the nation was 56 percent in July. Job growth may remain slow for the rest of 2003. Some industries still have too much capacity, dampening prospects for a strong recovery in the near-term. Moreover, if productivity continues to grow as quickly as in the last year, improvement in the labor markets will likely come first in the form of fewer layoffs and longer workweeks for employed workers. Actual employment gains will trail behind, and declines in the unemployment rate will come even later. The Department of Finance set out the following estimates for the State's economic performance in calendar years 2003 and 2004, which were used in predicting revenues and expenditures for the May Revision of the 2003-04 Governor's Budget. Also shown is the Department of Finance's previous forecast for the same calendar years, which were contained in the 2003-04 Governor's Budget. TABLE 12 ESTIMATES OF STATE'S ECONOMIC PERFORMANCE
FOR CALENDAR YEAR 2003 FOR CALENDAR YEAR 2004 ------------------------------------------------------------ GOVERNOR'S MAY GOVERNOR'S MAY BUDGET(a) REVISION(b) BUDGET(a) REVISION(b) ------------------------------------------------------------------------------------------------------------ Non-farm wage and salary employment (000) 14,623 14,608 14,928 14,922 Percent Change 0.7% 0.6% 2.1% 2.1% Personal income ($ billions) $ 1,176 $ 1,174 $ 1,238 $ 1,232 Percent Change 3.3% 3.1% 5.3% 4.9% Housing Permits (Units 000) 157 179 162 174 Consumer Price Index (percent change) 2.8% 2.9% 3.2% 2.4%
(a) Fiscal Year 2003-04 Governor's Budget Summary: January 10, 2003. (b) Fiscal Year 2003-04 May Revision to the Governor's Budget: May 14, 2003. Source: State of California, Department of Finance. FINANCIAL STATEMENTS The Audited Annual Financial Statements of the State of California for the Year Ended June 30, 2002 (the "Financial Statements") are available. As of June 30, 2002, the State of California has implemented a new financial reporting model, as required by the Governmental Accounting Standards Board ("GASB") in conformity with accounting principles generally accepted in the United States of America. The GASB sets standards of accounting and financial reporting for state and local governments, which have significantly changed the presentation of the financial statements. The Financial Statements consists of an Independent Auditor's Report, a Management Discussion and Analysis, Basic Financial Statements of the State for the Year Ended June 30, 2002 ("Basic Financial Statements"), and Supplementary Information. Only the Basic Financial Statements have been audited, as described in the Independent Auditor's Report. A description of the new accounting and financial reporting standards is contained in Note 1 of the Basic Financial Statements. A-46 Potential investors may obtain or review a copy of the Financial Statements from the following sources: 1. By obtaining from any Nationally Recognized Municipal Securities Information Repository, or any other source, a copy of the State of California's Official Statement dated February 13, 2003, relating to the issuance of $900,000,000 General Obligation Bonds. The Financial Statements are printed in full in such Official Statement. No part of the February 13, 2003 Official Statement is incorporated into this document except the Financial Statements. 2. By accessing the internet website of the State Controller (www.sco.ca.gov) and selecting "California Government--State and Local," then "State Government," then finding the heading "Publications" and selecting "Comprehensive Annual Financial Report--Year Ended June 30, 2002," or by contacting the Office of the State Controller at (916) 445-2636. 3. By accessing the internet website of the State Treasurer (www.treasurer.ca.gov) and selecting "Financial Information" and then "Audited General Purpose Financial Statements," or by contacting the Office of the State Treasurer at (800) 900-3873. The State Controller's unaudited reports of cash receipts and disbursements for the period July 1, 2002 through September 30, 2003 is also included as Exhibits 1 and 2 to this APPENDIX A and is available on the State Controller's website. Periodic reports on revenues and/or expenditures during the fiscal year are issued by the Administration, the State Controller's Office and the Legislative Analyst's Office. The State Controller issues a monthly report on cash receipts and disbursements recorded on the Controller's records. The Department of Finance issues a monthly bulletin, available by accessing the internet website of the Department of Finance (www.dof.ca.gov), which reports the most recent revenue receipts as reported by State departments, comparing those receipts to budget projections. The Administration also formally updates its budget projections three times during each fiscal year, in January, May, and at the time of budget enactment. These bulletins and reports are available on the internet at websites maintained by the agencies and by contacting the agencies at their offices in Sacramento, California. Such bulletins and reports are not part of or incorporated into the Official Statement. Investors are cautioned that interim financial information is not necessarily indicative of results for a fiscal year. Information which may appear in the Official Statement from the Department of Finance concerning monthly receipts of "agency cash" may differ from the State Controller's reports of cash receipts for the same periods because of timing differences in the recording of in-transit items. OVERVIEW OF STATE GOVERNMENT ORGANIZATION OF STATE GOVERNMENT The State Constitution provides for three separate branches of government: the legislative, the judicial and the executive. The Constitution guarantees the electorate the right to make basic decisions, including amending the Constitution and local government charters. In addition, the State voters may directly influence State government through the initiative, referendum and recall processes. California's Legislature consists of a forty-member Senate and an eighty-member Assembly. Assembly members are elected for two-year terms, and Senators are elected for four-year terms. Assembly members are limited to three terms in office and Senators to two terms. The Legislature meets almost year round for a two-year session. The Legislature employs the Legislative Analyst, who provides reports on State finances, among other subjects. The Bureau of State Audits, headed by the State Auditor, A-47 an independent office since 1993, annually issues an auditor's report based on an examination of the General Purpose Financial Statements of the State Controller, in accordance with generally accepted accounting principles. The Governor is the chief executive officer of the State and is elected for a four-year term. The Governor presents the annual budget and traditionally presents an annual package of bills constituting a legislative program. In addition to the Governor, State law provides for seven other statewide elected officials in the executive branch. The current elected statewide officials, their party affiliation and the dates on which they were first elected are as follows:
OFFICE NAME PARTY AFFILIATION FIRST ELECTED --------------------------------------------------------------------------------------------- Governor Gray Davis Democrat 1998 Lieutenant Governor Cruz Bustamante Democrat 1998 Controller Steve Westly Democrat 2002 Treasurer Philip Angelides Democrat 1998 Attorney General Bill Lockyer Democrat 1998 Secretary of State Kevin Shelley Democrat 2002 Superintendent of Public Instruction Jack O'Connell Democrat 2002 Insurance Commissioner John Garamendi Democrat 2002
The current term for each office expires in January 2007. Persons elected to statewide offices are limited to two terms in office (eight years) from the dates shown above. Mr. Garamendi previously served as elected Insurance Commissioner before term limits were enacted. See "INTRODUCTION TO APPENDIX A" for a description of the result of the October 7, 2003 recall election for Governor indicating that Gray Davis has been recalled as Governor and will be replaced by Arnold Schwarzenegger. The executive branch is principally administered through twelve major agencies and departments: Business, Transportation and Housing Agency, Child Development and Education Agency, Environmental Protection Agency, Department of Finance, Department of Food and Agriculture, Health and Human Services Agency, Labor and Workforce Development Agency (formerly Department of Industrial Relations), Resources Agency, State and Consumer Services Agency, Department of Veterans Affairs, Technology, Trade and Commerce Agency (to be eliminated starting January 2004), and Youth and Adult Correctional Agency. In addition, some State programs are administered by boards and commissions, such as The Regents of the University of California, Public Utilities Commission, Franchise Tax Board and California Transportation Commission, which have authority over certain functions of State government with the power to establish policy and promulgate regulations. The appointment of members of boards and commissions is usually shared by the Legislature and the Governor, and often includes ex officio members. California has a comprehensive system of public higher education comprised of three segments: the University of California, the California State University System and California Community Colleges. The University of California provides undergraduate, graduate and professional degrees to students. Approximately 47,000 degrees were awarded in the 2001-02 school year. About 186,600 full-time students were enrolled at the nine UC campuses and the Hastings College of Law in the 2001-02 school year. The California State University System, provides undergraduate and graduate degrees to students. A-48 Approximately 76,000 degrees were awarded in the 2001-02 school year. About 316,400 full-time students were enrolled at the 23 campuses in the 2001-02 school year. The third sector consists of 108 campuses operated by 72 community college districts which provide associate degrees and certificates. Approximately 114,000 associate degrees and certificates were awarded in the 2001-02 school year. About 1.8 million students were enrolled in California's community colleges in the fall of 2002. EMPLOYEE RELATIONS In 2003-04, the State work force is comprised of approximately 328,000 personnel years, of which approximately 118,000 personnel years represent employees of institutions of higher education. Of the remaining 210,000 personnel years, approximately 160,000 are subject to collective bargaining and approximately 50,000 are excluded from collective bargaining. These numbers will be reduced by Control Section 4.10, which requires a $1.1 billion ($585 million General Fund) reduction in 2003-04 employee compensation costs and the abolishment of 16,000 permanent positions. If collective bargaining produces concessions, the number of positions required for abolishment would be reduced. State law provides that State employees, defined as any civil service employee of the State and teachers under the jurisdiction of the Department of Education or the Superintendent of Public Instruction, and excluding certain other categories, have a right to form, join, and participate in the activities of employee organizations for the purpose of representation on all matters of employer-employee relations. The chosen employee organization has the right to represent its members, except that once an employee organization is recognized as the exclusive representative of a bargaining unit, only that organization may represent employees in that unit. The scope of representation is limited to wages, hours, and other terms and conditions of employment. Representatives of the Governor are required to meet and confer in good faith and endeavor to reach agreement with the employee organization, and, if agreement is reached, to prepare a memorandum of understanding and present it to the Legislature for ratification. The Governor and the recognized employee organization are authorized to agree mutually on the appointment of a mediator for the purpose of settling any disputes between the parties, or either party could request the Public Employment Relations Board to appoint a mediator. State employees are represented by 21 collective bargaining units. The State recently signed Memoranda of Understanding with 16 of these collective bargaining units to achieve current year savings in State personnel costs, a way of mitigating the State's difficult fiscal condition. Two of these contracts expire in June 2004, seven of these contracts expire in June 2005, five of these contracts expire in June 2006, and two of these contracts expire in June 2008. Another collective bargaining unit is under contract until July 2006. The remaining four collective bargaining units, comprising less than 5 percent of the State workforce, do not have a signed contract; the terms of the prior agreements remain in effect. The Department of Personnel Administration (DPA) is continuing to negotiate with these units. The State has not experienced a major work stoppage since 1972. The California State Employees' Association (CSEA) is the exclusive representative for nine of the 21 collective bargaining units, or approximately 50 percent of those employees subject to collective bargaining. Each of the remaining exclusive representatives represents only one bargaining unit. ECONOMY AND POPULATION INTRODUCTION California's economy, the largest among the 50 states and one of the largest in the world, has major components in high technology, trade, entertainment, agriculture, manufacturing, tourism, construction and services. California's economy slipped into a recession in early 2001, losing about 290,000 jobs between March 2001 and January 2002. The recession was concentrated in the State's hightech sector and, geographically, in the San Francisco Bay Area. Employment grew by about 79,000 jobs A-49 between January 2002 and May 2002 as the State began to recover. The recovery then stalled, however, and since then, the economy has been sluggish, with unemployment varying narrowly between 6.6 percent and 6.9 percent and employment falling by about 14,000 between May 2002 and June 2003. See "CURRENT STATE BUDGET--Economic Assumptions." POPULATION AND LABOR FORCE The State's July 1, 2002 population of over 35 million represented over 12 percent of the total United States population. California's population is concentrated in metropolitan areas. As of the April 1, 2000 census, 97 percent resided in the 25 Metropolitan Statistical Areas in the State. As of July 1, 2000, the 5-county Los Angeles area accounted for 48 percent of the State's population, with over 16.0 million residents, and the 10-county San Francisco Bay Area represented 21 percent, with a population of over 7.0 million. The following table shows California's population data for 1994 through 2002. TABLE 13 POPULATION 1994-2002(a)
CALIFORNIA % INCREASE OVER UNITED STATES % INCREASE OVER CALIFORNIA AS % YEAR POPULATION PRECEDING YEAR POPULATION PRECEDING YEAR OF UNITED STATES ------------------------------------------------------------------------------------------------ 1994 31,523,080 0.7% 263,125,821 1.2% 12.0 1995 31,711,094 0.6 266,278,393 1.2 11.9 1996 31,962,050 0.8 269,394,284 1.2 11.9 1997 32,451,746 1.5 272,646,925 1.2 11.9 1998 32,861,779 1.3 275,854,104 1.2 11.9 1999 33,417,247 1.7 279,040,168 1.2 12.0 2000 34,036,376 1.9 282,224,348 1.1 12.1 2001 34,698,173 1.9 285,317,559 1.1 12.2 2002 35,301,480 1.7 288,368,698 1.1 12.2
(a) Population as of July 1. Source: U. S. figures from U.S. Department of Commerce, Bureau of the Census; California figures from State of California, Department of Finance. The following table presents civilian labor force data for the resident population, age 16 and over, for the years 1993 to 2002. A-50 TABLE 14 LABOR FORCE 1993-2002 (THOUSANDS)
UNEMPLOYMENT RATE (%) ------------------------------ YEAR LABOR FORCE EMPLOYMENT CALIFORNIA UNITED STATES -------------------------------------------------------------------------- 1993 15,360 13,918 9.4% 6.9% 1994 15,450 14,122 8.6 6.1 1995 15,412 14,203 7.8 5.6 1996 15,520 14,400 7.2 5.4 1997 15,960 14,954 6.3 4.9 1998 16,336 15,367 5.9 4.5 1999 16,596 15,732 5.2 4.2 2000 16,884 16,049 4.9 4.0 2001 17,183 16,260 5.4 4.8 2002 17,405 16,242 6.7 5.8
Source: State of California, Employment Development Department. EMPLOYMENT, INCOME, CONSTRUCTION AND EXPORT GROWTH The following table shows California's non-agricultural employment distribution and growth for 1992 and 2002. TABLE 15 PAYROLL EMPLOYMENT BY MAJOR SECTOR 1992 AND 2002
EMPLOYMENT % DISTRIBUTION (THOUSANDS) OF EMPLOYMENT ------------------------------------------------- INDUSTRY SECTOR 1992 2002* 1992 2002* --------------------------------------------------------------------------------------- Mining 35.4 23.5 0.3% 0.2% Construction 471.7 759.9 3.9 5.2 MANUFACTURING Nondurable goods 708.4 689.8 5.8 4.7 High Technology 584.4 467.1 4.8 3.2 Other Durable Goods 597.6 659.2 4.9 4.5 Transportation and Utilities 607.4 720.7 5.0 4.9 Wholesale and Retail Trade 2,834.8 3,362.4 23.3 22.9 Finance, Insurance And Real Estate 791.9 847.4 6.5 5.8 Services 3,426.3 4,678.2 28.2 31.9 Government Federal 345.9 256.9 2.9 1.7 State and Local 1,749.7 2,193.0 14.4 15.0 TOTAL NON-AGRICULTURAL 12,153.5 14,658.1 100% 100%
* Preliminary Source: State of California, Employment Development Department. A-51 The following tables show California's total and per capita income patterns for selected years. TABLE 16 TOTAL PERSONAL INCOME IN CALIFORNIA 1994-2002(a)
CALIFORNIA % YEAR MILLIONS % CHANGE (b) OF U.S. ----------------------------------------------------------------------- 1994(c) $ 735,104 2.9% 12.5% 1995 771,470 4.9 12.5 1996 812,404 5.3 12.4 1997 861,557 6.1 12.4 1998 931,564 8.1 12.6 1999 994,862 6.8 12.8 2000 1,099,375 10.5 13.1 2001 1,128,256 2.6 13.0 2002(d) 1,138,718 0.9 12.8
---------- (a) BEA's estimates as of September 23, 2002. (b) Change from prior year. (c) Reflects Northridge earthquake, which caused an estimated $15 billion drop in personal income. (d) Estimated by California Department of Finance. Note: Omits income for government employees overseas. Source: U.S. Department of Commerce, Bureau of Economic Analysis (BEA); State of California, Department of Finance. TABLE 17 PER CAPITA PERSONAL INCOME 1994-2002(a)
% % CALIFORNIA % YEAR CALIFORNIA CHANGE (b) UNITED STATES CHANGE (b) OF U.S. --------------------------------------------------------------------------------------- 1994(c) $ 23,348 2.3% $ 22,340 3.7% 104.5% 1995 24,339 4.2 23,255 4.1 104.7 1996 25,373 4.2 24,270 4.4 104.5 1997 26,521 4.5 25,412 4.7 104.4 1998 28,240 6.5 26,893 5.8 105.0 1999 29,712 5.2 27,880 3.7 106.6 2000 32,363 8.9 29,760 6.7 108.7 2001 32,655 0.9 30,413 2.2 107.4 2002 32,996 1.0 30,941 1.7 106.6
---------- (a) Latest estimates by BEA. (b) Change from prior year. (c) Reflects Northridge earthquake, which caused an estimated $15 billion drop in personal income. Note: Omits income for government employees overseas. Source: U.S. Department of Commerce, Bureau of Economic Analysis (BEA). A-52 The following tables show California's residential and non-residential construction. TABLE 18 RESIDENTIAL CONSTRUCTION AUTHORIZED BY PERMITS
UNITS ------------------------------------------------ VALUATION(a) YEAR TOTAL SINGLE MULTIPLE (MILLIONS) ------------------------------------------------------------------------- 1995 85,293 68,689 16,604 $ 13,879 1996 94,283 74,923 19,360 15,289 1997 111,716 84,780 26,936 18,752 1998 125,707 94,298 31,409 21,976 1999 140,137 101,711 38,426 25,783 2000 148,540 105,595 42,945 28,142 2001 148,757 106,902 41,855 28,804 2002 167,761 123,865 43,896 33,305
---------- (a) Valuation includes additions and alterations. Source: Construction Industry Research Board TABLE 19 NONRESIDENTIAL CONSTRUCTION (THOUSANDS OF DOLLARS)
ADDITIONS AND YEAR COMMERCIAL INDUSTRIAL OTHER ALTERATIONS TOTAL ------------------------------------------------------------------------------- 1995 $ 2,308,911 $ 732,874 $ 1,050,693 $ 4,062,273 $ 8,154,751 1996 2,751,925 1,140,574 1,152,443 4,539,219 9,584,161 1997 4,271,378 1,598,428 1,378,220 5,021,792 12,269,818 1998 5,419,251 2,466,530 1,782,337 5,307,901 14,976,019 1999 5,706,719 2,256,166 2,350,213 6,269,194 16,582,292 2000 6,962,031 2,206,169 2,204,754 7,252,004 18,624,958 2001 6,195,368 1,552,047 2,584,321 6,421,551 16,753,287 2002 5,195,348 1,227,754 2,712,681 5,393,329 14,529,112
Source: Construction Industry Research Board A-53 The following table shows California's export growth for the period from 1995 through 2002. TABLE 20 EXPORTS THROUGH CALIFORNIA PORTS (IN MILLIONS)
YEAR EXPORTS (a) % CHANGE -------------------------------------------------- 1995 $ 116,825.5 22.2% 1996 124,120.0 6.2 1997 131,142.7 5.7 1998 116,282.4 -11.3 1999 122,092.8 5.0 2000 148,554.6 21.7 2001 127,255.3 -14.3 2002 111,340.1 -12.5
(a) "Free along ship" Value Basis Source: U.S. Department of Commerce, Bureau of the Census LITIGATION The State is a party to numerous legal proceedings. The following are the most significant pending proceedings, as reported by the Office of the Attorney General. See "LITIGATION" in the main body of the Official Statement. CHALLENGE TO DISCONTINUATION OF VEHICLE LICENSE FEE OFFSET State law establishes an excise tax on motor vehicles and manufactured homes in the amount of two percent (2%) of the vehicle's or home's fair market value. In 1999, pursuant to Revenue and Taxation Code section 10754, the Legislature adopted successive offsets to the vehicle license fee paid by vehicle owners and mobile home owners. As a result of these offsets, the State transferred money each month from the General Fund to local governments in the amount of the cumulative offsets. In June 2003, the Davis Administration determined that there were insufficient moneys available to be transferred from the General Fund to fund vehicle license fee offset payments the State was making to local governments. This caused the State Department of Motor Vehicles and the State Department of Housing and Community Development to discontinue the offsets and, correspondingly, the amount of vehicle license fees paid by vehicle owners and mobile home owners increased. On July 1, 2003, several plaintiffs, including several Republican legislators and a non-profit public interest group, filed HOWARD JARVIS TAXPAYERS ASSOCIATION, ET AL. V. CALIFORNIA DEPARTMENT OF MOTOR VEHICLES (Sacramento County Superior Court, Case No. 03AS03665), in which plaintiffs seek declaratory relief based on several theories, each of which would find the discontinuation of the offset invalid. The court has ruled that the plaintiffs' complaint fails to state a cause of action, and has granted plaintiffs until November 17, 2003, to amend their complaint to adequately plead that they have exhausted their administrative remedies. Plaintiffs have not sought an immediate stay or injunction against the discontinuation of the vehicle license fee offset or on the collection of the statutorily established excise tax. In the event an appellate court judgment declares that the discontinuation of the vehicle license fee offset was invalid, it could result in costs to the State over time in amounts as high as the suspended vehicle license fee offset, which for fiscal year 2003-04 is approximately $4.2 billion. A-54 BOND-RELATED MATTERS The Legislature established the Pension Obligation Bond Committee for the purpose, among others, of issuing bonds to fund all or a portion of the State's fiscal year 2003-04 employer obligation to the Public Employee's Retirement System. In May of 2003, the Committee filed PENSION OBLIGATION BOND COMMITTEE V. ALL PERSONS INTERESTED IN THE MATTER OF THE VALIDITY OF THE STATE OF CALIFORNIA'S PENSION OBLIGATION, ETC. (Sacramento County Superior Court, Case No. 03AS02994), seeking validation of the bonds and certain contracts pertaining to the bonds pursuant to a validation process established by Code of Civil Procedure sections 860 ET SEQ. The Howard Jarvis Taxpayers Association filed an answer to the Committee's complaint and, a judgment was issued in the matter denying the Committee's request for validation of the bonds. The trial court judge declared that he was unwilling to apply the local government "obligation imposed by law" debt limit exception to the State constitutional debt limit. The Committee has filed a petition for writ of mandate in the California Supreme Court (Case No. S119882), and requested the court's expedited consideration of the petition. Granting expedited consideration is a discretionary act on behalf of the court. The Supreme Court has directed the Howard Jarvis Taxpayers Association to file its opposition to all issues raised by the petition by October 31, 2003. The Legislature has adopted a statute (Stats. 2003, 1st Ex. Sess. 2003, ch.13) authorizing the establishment of the Fiscal Recovery Finance Authority for the purpose, among others, of issuing bonds to fund the State's accumulated budget deficit. The amount of the accumulated budget deficit has been identified by the Department of Finance to be approximately $10.7 billion. On September 24, 2003, a complaint was filed in the Sacramento County Superior Court (FULLERTON ASSOCIATION OF CONCERNED TAXPAYERS V. CALIFORNIA FISCAL RECOVERY FINANCING AUTHORITY, ET AL., Case No. 93AS05319), seeking a declaration that any bonds issued pursuant to the statute without prior voter approval would violate the State constitutional debt limit and a determination that such bonds are invalid, and seeking an injunction against issuing bonds pursuant to the statute. This matter has not been served on any State officers. CHALLENGE SEEKING PAYMENT TO TEACHER'S RETIREMENT BOARD In May 2003, the Legislature enacted legislation which reduces a continuing appropriation to the State Teacher's Retirement System's ("CalSTRS") Supplemental Benefit Maintenance Account ("SBMA") for fiscal year 2003-04 by $500 million. The legislative changes also provide that in future fiscal years, the $500 million may be returned if actuarial determinations demonstrate that the money is needed in order for CalSTRS' to make purchasing power protection payments to retired members through 2036. On October 14, 2003, the CalSTRS board and certain CalSTRS members filed TEACHER'S RETIREMENT BOARD, AS MANAGER OF THE CALIFORNIA STATE TEACHERS, RETIREMENT SYSTEM, ET AL. V. STEVE PEACE, DIRECTOR OF CALIFORNIA DEPARTMENT OF FINANCE, AND STEVE WESTLY, CALIFORNIA STATE CONTROLLER, in the Sacramento County Superior Court (Case No. 03CS01503). This lawsuit seeks, primarily, a writ of mandate compelling the State Controller to transfer funds from the State's General Fund to the SBMA in an amount equal to the continuing appropriation as it existed prior to the enactment of the May legislation. It also seeks injunctive and declaratory relief to the same effect. ACTIONS SEEKING FLOOD-RELATED DAMAGES In January of 1997, California experienced major flooding with preliminary estimates of property damage of approximately $1.6 to $2.0 billion. In MCMAHAN V. STATE, (Sacramento County Superior Court, Case No. 02-AS-06058), a substantial number of plaintiffs have joined suit against the State, local agencies, and private companies and contractors seeking compensation for the damages they suffered as a result of the flooding. A trial date has been scheduled for July 12, 2004. The State is vigorously defending the action. A-55 PATERNO V. STATE OF CALIFORNIA is a coordinated action involving 3,000 plaintiffs seeking recovery for damages caused by the Yuba River flood of February 1986. The trial court found liability in inverse condemnation and awarded damages of $500,000 to a sample of plaintiffs. The State's potential liability to the remaining plaintiffs ranges from $800 million to $1.5 billion. In 1992, the State and plaintiffs filed appeals of the decision in the sample plaintiffs' action, and upon remand, plaintiffs' inverse condemnation cause of action was re-tried. The trial court ruled that plaintiffs take nothing from defendants. The outcome of this trial controls with regard to the claims of all other plaintiffs. Plaintiffs filed an appeal with the Court of Appeal (Third Appellate District, Case No. CO40553), and oral argument is presently scheduled for November 19, 2003. TAX REFUND CASES The State has prevailed at the trial court, and following appeal, in two refund actions, CALIFORNIA ASSN. OF RETAIL TOBACCONISTS (CART), ET AL. V. BOARD OF EQUALIZATION, ET AL., AND CIGARETTES CHEAPER!, ET AL. V. BOARD OF EQUALIZATION, ET AL. (consolidated as Court of Appeal, Forth Appellate District, Division 1, Case No. D037599). On September 24, 2003, the California Supreme Court denied the plaintiffs' petitions for review (CALIFORNIA ASSN. OF RETAIL TOBACCONISTS V. STATE OF CALIFORNIA, Case No. S117618). The plaintiffs challenge the constitutionality of Proposition 10, which established the Children and Families Commission ("CFC") and local county commissions and increased the excise tax on tobacco products for the purpose of funding early childhood development programs through the CFC and local commissions. Plaintiffs contend Proposition 10 is unconstitutional under various provisions of the California Constitution, levies an impermissible double tax on certain tobacco products, and violates numerous other provisions of law. It is not yet known whether plaintiffs will seek review by the United States Supreme Court. Any petition must be filed within 90 days after the date review was denied by the California Supreme Court. There is exposure as to the entire $750 million per year collected under Proposition 10 together with interest, which could amount to several billion dollars by the time the case is finally resolved. Four pending cases allege that Revenue and Tax Code section 24402 ("Section 24402"), which establishes a corporate tax deduction for dividends received that are based on the amount of the dividend-paying corporation's income subject to California franchise taxes, violates the commerce clause of the United States Constitution. MONTGOMERY WARD LLC V. FRANCHISE TAX BOARD is pending in the San Diego Superior Court (Case No. 802767). In MICROSOFT CORPORATION V. FRANCHISE TAX BOARD (San Francisco County Superior Court, Case No. 400 444), the trial court issued a proposed statement of decision, ruling against the Franchise Tax Board in which the court failed to discuss Section 24402. A request for further exposition of the decision has been filed. In GENERAL MOTORS CORP. V. FRANCHISE TAX BOARD (Court of Appeal, Second Appellate District, Division 2, Case No. B165665) the trial court determined that Section 24402 violates the commerce clause and the Franchise Tax Board has appealed. In FARMER BROTHERS COMPANY V. FRANCHISE TAX BOARD, the trial court also determined that Section 24402 violates the commerce clause and, on appeal, the Second Appellate District, Division 1, affirmed the trial court's decision (Case No. B160061). On August 27, 2003, the California Supreme Court denied the Board's petition for review. A decision as to whether to seek a writ of certiorari from the United States Supreme Court must be made within 90 days of that denial. No decision has been made to date. A final decision adverse to the State in any of these cases could ultimately result in refunds of approximately $400 million to similarly situated taxpayers, with an ongoing annual loss of revenue of approximately $60 million. The State is vigorously litigating this issue. Five pending cases challenge the Franchise Tax Board's treatment of receipts from investment of cash in short-term financial instruments, and the resulting impact on the apportionment of corporate income allegedly earned outside of California to the corporation's California tax obligation. Three of these cases are also cases in which Revenue and Tax Code section 24402 has been challenged, as A-56 discussed in the previous paragraph. MONTGOMERY WARD LLC V. FRANCHISE TAX BOARD is pending in the San Diego Superior Court (Case No. 802767. TOYS "R" US, INC. V. FRANCHISE TAX BOARD is pending in Sacramento County Superior Court (Case No. 01-AS-04316). The TOYS "R" US trial court has issued a tentative decision in favor of the Franchise Tax Board, but a final judgment has not been issued. THE LIMITED STORES, INC. AND AFFILIATES V. FRANCHISE TAX BOARD is pending in the Court of Appeal, First District (Case No. A102915) and GENERAL MOTORS CORP. V. FRANCHISE TAX BOARD is pending in the Court of Appeal, Second Appellate District, Division 2 (Case No. B165665). The trial courts in both THE LIMITED STORES and GENERAL MOTORS ruled in favor of the Franchise Tax Board on this issue. In MICROSOFT CORPORATION V. FRANCHISE TAX BOARD (San Francisco County Superior Court, Case No. 400 444) the trial court issued a proposed statement of decision, ruling against the Franchise Tax Board. A request for further exposition of the decision has been filed. Other taxpayers have raised this same issue in administrative actions. A final decision in favor of any of these plaintiffs could result in tax refunds to similarly situated taxpayers in an amount exceeding $500 million, with a potential future annual revenue loss of $50 million. The State is vigorously litigating this issue. In EISENHOWER MEDICAL CENTER, ET AL. V. STATE BOARD OF EQUALIZATION (San Francisco Superior Court, Case No. 994985), 117 hospitals claim that certain intravenous sets and diagnostic substances are "medicines" within the meaning of the Revenue and Tax Code, and thus are exempt from sales and use taxes. The State Board of Equalization ("SBE") does not consider intravenous sets (other than those used primarily for feeding) and diagnostic substances to be medicines and, therefore, those items are subject to sales and use taxes. The trial court ruled in favor of the SBE, and an appeal is expected. Due to a retroactive regulatory change that the SBE adopted during the pendency of this case, specified types of enteral feeding supplies are now exempt from sales and use taxes. Therefore, even if the State prevails on appeal, refunds will be required in the amount of approximately $10 million. Should the plaintiffs ultimately prevail on all contested issues, estimated refunds to plaintiffs and others similarly situated hospitals would total approximately $400 million and estimated future revenue loss would be $70 million per year. In COUNTY OF ORANGE V. ORANGE COUNTY ASSESSMENT APPEALS BOARD #3; BEZAIRE, ET AL., REAL PARTIES IN INTEREST, (Orange County Superior Court, Case No. 00CC003385), the trial court determined that the Orange County assessor's office received property taxes from two taxpayers in excess of the amounts collectable under Article XIIIA of the California Constitution (sometimes referred to as "Proposition 13"). The plaintiffs' legal claim focuses on the constitutionality of the practice of the Orange County assessor's office to increase or "recapture" the assessed values of real properties that temporarily decline and then increase in value. The Orange County Superior Court ruled in favor of the plaintiffs in December 2001. That decision was appealed and oral argument is scheduled for December 16, 2003 in the Court of Appeal, Fourth Appellate District. The effects of a final determination by an appellate court that the contested assessment practices are contrary to Proposition 13 could result in an increase in the State general fund component of the financing guarantee to public schools established by Proposition 98 (see "STATE FINANCES--Proposition 98") in an amount in excess of several billion dollars. ENVIRONMENTAL CLEANUP MATTER In a federal Environmental Protection Agency ("U.S. EPA") administrative abatement action entitled IN THE MATTER OF: LEVIATHAN MINE, ALPINE COUNTY, CALIFORNIA, REGIONAL WATER QUALITY CONTROL BOARD, LAHONTAN REGION, STATE OF CALIFORNIA (U.S. EPA Region IX CERCLA Docket No. 00-16(a)), the State, as owner of the Leviathan Mine, is a party through the Lahontan Regional Water Quality Control Board ("Board"), which is the State entity potentially responsible for performing certain environmental remediation at the Leviathan Mine site. Also a party is ARCO, the successor in interest to the mining company that caused certain pollution of the mine site. The Leviathan Mine site is listed on the U.S. EPA A-57 "Superfund" List, and both remediation costs and costs for Natural Resource Damages may be imposed on the State. The Board has undertaken certain remedial action at the mine site, but the U.S. EPA's decision on the interim and final remedies are pending. ARCO has filed several state law claims against the State with the California Victim Compensation and Government Claims Board (an administrative agency with which certain claims must be filed as a prerequisite to litigation seeking damages against the State which was formerly named the Board of Control, the "Government Claims Board"), but litigation on these claims have been tolled by agreement of the parties until at least October, 2004. It is possible these matters could result in a potential loss to the State in excess of $400 million. ENERGY-RELATED MATTERS In PEOPLE V. ACN ENERGY, INC., ET AL. (Sacramento County Superior Court, Case No. 01AS05497), the court is considering whether and to what extent compensation is due to market participants which have claimed compensation as a result of the Governor's issuance of executive orders, under the California Emergency Service Act, "commandeering" power purchase arrangements held by Pacific Gas & Electric Company ("PG&E") and Southern California Edison ("SCE"), referred to as "block forward contracts." In this action the State seeks a declaration that the State is not liable for damages as a result of these orders, nor for compensation for inverse condemnation, and that any damages suffered by any of the defendants is offset by payments made by the Department of Water Resources for electricity received under the "commandeered" "block forward contracts." Complaints and cross-complaints for inverse condemnation, recovery under the Emergency Services Act and other causes of action brought by PG&E, Reliant Energy Services, Dynegy Power Marketing, Williams Energy Services, Sempra Energy Trading, the California Power Exchange, Mirant Americas Energy, Duke Energy Trading and Marketing, and numerous other market participants have been joined with the declaratory relief action in Judicial Council Coordination Proceeding No. 4203, in Sacramento County Superior Court. In an administrative proceeding action before the Government Claims Board (which was dismissed on procedural grounds), the California Power Exchange stated claims for "commandeering" the "block forward contracts" in the amount of approximately $1 billion. PACIFIC GAS AND ELECTRIC COMPANY V. THE STATE OF CALIFORNIA is now pending in the Court of Appeal, Third Appellate District (Case No. C043507). In the trial court, PG&E filed a complaint for breach of contract alleging that statutes enacted in 1996 as part of the restructuring of the electric power industry in California ("AB 1890") established a "regulatory contract" between the State and PG&E that authorized PG&E to sell the output of its retained generation facilities in interstate power markets at prices regulated by FERC and to sell the facilities themselves, and that by amending AB 1890 in 2001, the State deprived PG&E of the right to such sales and thereby breached that "regulatory contract." PG&E's complaint sought damages in an amount to be proven, but in an administrative proceeding before the Government Claims Board, in which PG&E's claims were denied, PG&E sought damages of at least $4.3 billion to compensate for the losses alleged in this action. The trial court sustained the demurrer of the State without leave to amend, dismissing the lawsuit. The pending action is PG&E's appeal of that dismissal. ESCHEATED PROPERTY CLAIMS In five pending cases, plaintiffs claim that the State Controller has a constitutional and statutory duty to give notice prior to the time the Controller sells property that has escheated to the State (in these cases, shares of stock): FONG V. CONNELL (Court of Appeal, Third District, Case No. C042007); HARRIS V. CONNELL (Court of Appeal, Second District, Case No. B160741); LUSBY-TAYLOR V. CONNELL (U.S. Court of Appeals for the Ninth Circuit, Case No. 02-16511); ORFIELD V. CONNELL (Los Angeles County Superior Court, Case No. BC288429); and SUEVER V. CONNELL (United States District Court, Northern District, Case No. C03-001556). The plaintiffs also claim that the Controller failed to comply with statutory notice A-58 requirements when it first received property that had escheated to the State. The plaintiffs seek damages, which the Fong plaintiffs have articulated as being in the amount of the difference between the amount they were paid for the stock upon its sale, and either the current value of the stock or the highest market value of the stock between the date the Controller sold the stock and the present. All of these cases, except Fong are styled as class actions, though in Lusby-Taylor and Harris, that issue was not determined prior to the trial court decisions that are being appealed. If one or more of these cases are successful as a class action and the class ultimately prevails on the merits, damages for the class could be in excess of $500 million. The State has prevailed at the trial court in Fong, Harris and Lusby-Taylor. Both Suever and Orfield are in the early stages of litigation in the trial court. The State is vigorously defending all of these actions. ACTION SEEKING DAMAGES FOR ALLEGED VIOLATIONS OF PRIVACY RIGHTS In GAIL MARIE HARRINGTON-WISELY, ET AL. V. STATE OF CALIFORNIA, ET AL., (Los Angeles County Superior Court, Case No. BC 227373), a proposed class action, plaintiffs seek damages for alleged violations of prison visitors' rights resulting from the Department of Corrections' use of a body imaging machine to search visitors entering state prisons for contraband. If this action is certified as a class action, and a court were to award damages pursuant to the California Civil Code for every use of the body imaging machine, damages could be as high as $3 billion. The State is vigorously defending this action. ACTIONS SEEKING PROGRAM MODIFICATIONS In the following cases, plaintiffs seek court orders or judgments that would require the State to modify existing programs and, except as specified, do not seek monetary damages. Nevertheless, a judgment against the State in any one of these cases could require changes in the challenged program that could result in increased programmatic costs to the State in a future fiscal year in excess of $400 million. Alternatively, in some circumstances, it may be possible that a judgment against the State could be addressed by legislative changes to the program that would cost less. In WILLIAMS, ET AL., V. STATE OF CALIFORNIA, ET AL., (San Francisco County Superior Court, Case No. 312236), a class action for declaratory relief and injunction brought by public school students against the State, the Board of Education, and Department of Education and the Superintendent of Public Instruction, the class alleges inadequacies in the public education system and seeks a variety of programmatic changes to the system including elimination of some types of multi-track, year-round school schedules. The State is vigorously defending this action. Trial is set for August 30, 2004. In NATURAL RESOURCES DEFENSE COUNCIL ET AL., V. CALIFORNIA DEPARTMENT OF TRANSPORTATION ET AL., (United States District Court, Central District, Case No. 93-6073-ER- (JRX)), plaintiffs obtained an injunction requiring the Department of Transportation (the "Department") to comply with National Pollution Discharge Elimination System ("NPDES") requirements under the federal Clean Water Act ("Act") in connection with storm water discharges from State highways and construction sites in an area that includes most of Los Angeles and Ventura Counties. There is an established dispute resolution procedure intended to resolve disputes without a return to federal court. Subsequent modifications of the injunction have provided for, among other things, studies of pilot projects to address control of the sources of storm water pollution and the performance of studies of pilot projects to retrofit highways with storm water pollution control facilities. There has been no agreement regarding what measures arising out of the pilot projects and studies will be implemented. Plaintiffs' position is that the Department should be required to retrofit its facilities to treat storm water, regardless of whether any construction is otherwise planned in any given area. For planning purposes, the Department is including an additional 3 percent in the cost of future statewide construction and maintenance projects to pay for compliance measures. This 3 percent increase amounts to $500 million through fiscal year 2006-07. While the A-59 impact of a judgment of the scope sought by plaintiffs is difficult to determine, it is possible that a judgment that would require the State to retrofit all its highway facilities throughout the State could cost billions of dollars. The following three cases seek reforms to State programs for the treatment of institutionalized disabled persons. Some rough estimates suggest the financial impact of a judgment against the State defendants in any of these cases could be as high as $1 billion per year in programmatic costs going forward. The State is vigorously defending these actions. In CHARLES DAVIS, ET AL. V. CALIFORNIA HEALTH AND HUMAN SERVICES AGENCY, ET AL., (United States District Court - Northern District, Case No. C00-2532 SBA), the plaintiffs brought a class action under a number of federal acts, including the ADA, seeking declaratory and injunctive relief. Plaintiffs allege that disabled persons institutionalized at San Francisco's Laguna Honda Hospital, a 1,200 bed skilled nursing facility, who require long term care should be assessed as to whether they can be treated at home or in community-based facilities, and then provided appropriate care. A settlement has been reached in this matter which, if approved by the court, will result in a State department revising its assessment tool for residents of nursing homes to focus on the propriety of community placement. The parties have agreed that plaintiffs' non-assessment claims will be dismissed without prejudice to plaintiffs' ability to re-file their action once the assessment process is in place. In the event the assessment tool changes are not sufficiently funded, plaintiffs may re-file those claims pertaining to assessment as well. In STEPHEN SANCHEZ, ET AL. V. GRANTLAND JOHNSON, ET AL., (United States District Court - Northern District, Case No. C-00-01593 CW), the plaintiffs have brought a class action seeking declaratory and injunctive relief, alleging, in part, that provider rates for community-based services for developmentally disabled individuals are discriminatory under the ADA, and violate the Social Security Act, Civil Rights Act and the Rehabilitation Act, because they result in unnecessary institutionalization of developmentally disabled persons. The court has issued interim rulings on plaintiffs' ADA and Rehabilitation Act claims, finding that the State has a "comprehensive, effectively working plan" for the de-institutionalization of persons with developmental disabilities." The undetermined allegations remain before the court, and these interim rulings are subject to appeal. In CAPITOL PEOPLE FIRST V. DEPARTMENT OF DEVELOPMENTAL SERVICES (Alameda County Superior Court, Case No. 2002-038715) a consortium of state and national law firms and public-interest groups brought suit against the Departments of Finance, California Department of Developmental Services and California Department of Health Services, alleging violations of the Lanterman Act, the ADA, and section 504 of the Rehabilitation Act by defendants needlessly isolate thousands of people with developmental disabilities in large facilities. The case seeks sweeping reforms, including requiring the State to offer a full range of community-based services. MEDICALLY INDIGENT ADULT MANDATE CLAIMS In 1997, the California Supreme Court ruled, in a challenge by the County of San Diego, that by excluding medically indigent adults ("MIAs") from Medi-Cal, the State had mandated a new program on the counties within the meaning of Article XIIIB, section 6 of the California Constitution. The Court sent the matter back to the Commission on State Mandates (the "Commission") to decide whether and by what amount the County of San Diego had been forced to incur costs for the care of MIAs in excess of funds provided by the State. The County of San Diego appealed from an adverse Commission decision. The appeal was based on facts specific to County of San Diego. On September 24, 2003, in an unpublished decision, the Court of Appeal (COUNTY OF SAN DIEGO V. COMMISSION ON STATE MANDATES ET AL. (Sept. 24, 2003) D039471) ruled in favor of the County of San Diego on certain of its claims and determined that A-60 the State owed the County of San Diego $3.4 million for medical services rendered to MIAs during the two-year period (1991-1992). This decision may be appealed. The Commission has taken the position that it would be bound to apply the holding of the San Diego case to any new claim for prospective relief brought by any county as a "test claim." Currently, there is a test claim pending before the Commission that was filed by the County of San Bernardino, relating to the same mandate (Medically Indigent Adults, 01-TC-26 County of San Bernardino, Claimant, Statutes 1982, Chapters 328 and 1594). The amount demanded in the claim for unreimbursed costs for fiscal year 2000-2001 is just over $9.2 million. The County of San Diego case, together with a test claim on the same subject filed by the County of San Bernardino, poses a potential for a negative impact on the General Fund in the amount of the unreimbursed costs for all similarly situated claimants, as determined by the Commission. Certain estimates of the annual cost of the services rendered by all counties to MIAs exceed $4 billion. How much of that will be determined to be "unreimbursed" to the counties by the State is unknown. Currently the counties receive approximately $1.3 billion in vehicle license fee revenue and $2.3 billion in sales tax revenue to fund various social services, public health and mental health programs which include the programs that provide services to MIAs. The determination of how much of the MIA mandate is "unreimbursed" is likely to be impacted by the fact that the vehicle license fee revenue now available to counties may be terminated as a result of the San Diego decision. In 1991 the Legislature increased the vehicle license fee and dedicated a portion of it to cover costs incurred by the counties for various social programs, including the cost of caring for MIAs. This legislation includes so-called "poison pill" provisions that, by their terms, eliminate the counties' vehicle license fee revenue source if a final appellate court decision holds that the legislation transferring responsibility for providing services to MIAs from the State to the counties established a reimbursable state mandate. Related 1991 legislation also authorized the sales tax increment from which the counties pay, among other costs, the cost of caring for MIAs, and established "poison pill" provisions relating to that sale tax increment. These "poison pill" provisions provide that, in the event a final appellate court decision holds that the legislation transferring responsibility for providing services to MIAs from the State to the counties established a reimbursable state mandate, the sales tax increment revenues are to be paid to the General Fund. This could increase the State's Proposition 98 funding guarantee (See "STATE FINANCES -- Proposition 98"), which, ultimately, could have the effect under certain "poison pill" provisions, of eliminating the sales tax increment. STATE DEBT TABLES The tables which follow provide information on outstanding State debt, authorized but unissued general obligation bonds and commercial paper notes, debt service requirements for State general obligation and lease-purchase bonds, and authorized and outstanding State revenue bonds. For purposes of these tables, "General Fund bonds," also known as "non-self liquidating bonds," are general obligation bonds expected to be paid from the General Fund without reimbursement from any other fund. Although the principal of general obligation commercial paper notes in the "non-self liquidating" category is legally payable from the General Fund, the State expects that principal of such commercial paper notes will be paid only from the issuance of new commercial paper notes or the issuance of long-term general obligation bonds to retire the commercial paper notes. Interest on "non-self liquidating" general obligation commercial paper notes is payable from the General Fund. "Enterprise Fund bonds," also known as "self liquidating bonds," are general obligation bonds for which program revenues are expected to be sufficient to reimburse in full the General Fund for debt A-61 service payments, but any failure to make such a reimbursement does not affect the obligation of the State to pay principal and interest on the bonds from the General Fund. As of October 1, 2003, the State did not have any General Obligation Commercial Paper Notes outstanding. The State expects to issue $1,800,000,000 of general obligation bonds on November 13, 2003. The State Public Works Board expects to issue $430,990,000 of lease revenue bonds on December 2, 2003. A-62 SCHEDULE OF DEBT SERVICE REQUIREMENTS FOR LEASE-PURCHASE DEBT AS OF OCTOBER 1, 2003
FISCAL YEAR CURRENT DEBT ENDING --------------------------------------------------------------------------- JUNE 30 INTEREST PRINCIPAL (a) TOTAL --------------------------------------------------------------------------------------------- 2004 $ 271,725,333.60 $ 239,466,935.00 $ 511,192,268.60(b) 2005 338,647,584.05 352,499,507.20 691,147,091.25 2006 318,759,840.18 372,167,554.60 690,927,394.78 2007 305,084,065.59 325,083,920.44 630,167,986.03 2008 285,872,258.35 333,426,787.98 619,299,046.33 2009 273,102,770.44 355,352,732.44 628,455,502.88 2010 249,521,652.75 343,906,633.76 593,428,286.51 2011 220,648,653.93 356,525,000.00 577,173,653.93 2012 201,992,986.81 339,905,000.00 541,897,986.81 2013 184,141,396.45 348,730,000.00 532,871,396.45 2014 165,903,553.81 351,695,000.00 517,598,553.81 2015 147,011,187.52 370,285,000.00 517,296,187.52 2016 127,321,451.24 351,465,000.00 478,786,451.24 2017 108,189,006.84 356,390,000.00 464,579,006.84 2018 89,324,937.16 370,915,000.00 460,239,937.16 2019 70,168,719.33 329,125,000.00 399,293,719.33 2020 52,930,040.95 299,100,000.00 352,030,040.95 2021 38,665,705.74 232,490,000.00 271,155,705.74 2022 26,543,126.24 202,365,000.00 228,908,126.24 2023 17,687,221.62 147,280,000.00 164,967,221.62 2024 11,178,852.00 56,075,000.00 67,253,852.00 2025 8,216,555.00 59,035,000.00 67,251,555.00 2026 5,574,756.25 45,215,000.00 50,789,756.25 2027 3,273,798.75 47,475,000.00 50,748,798.75 2028 922,862.50 34,170,000.00 35,092,862.50 TOTAL $ 3,522,408,317.10 $ 6,620,144,071.42 $ 10,142,552,388.52
---------- (a) Includes scheduled mandatory sinking fund payments. (b) Total represents the remaining debt service requirements from November 1, 2003 through June 30, 2004. SOURCE: State of California, Office of the Treasurer. A-63 AUTHORIZED AND OUTSTANDING GENERAL OBLIGATION BONDS AS OF OCTOBER 1, 2003 (THOUSANDS)
VOTER AUTHORIZATION BONDS --------------------------- OUTSTANDING DATE AMOUNT (a) ----------------------------------------------------------------------------------------------------------------------------- GENERAL FUND BONDS (NON-SELF LIQUIDATING) California Clean Water, Clean Air, Safe Neighborhood Parks, and Coastal Protection Act of 2002 3/5/2002 $ 2,600,000 $ 41,830 California Library Construction and Renovation Bond Act of 1988 11/8/1988 75,000 46,570 California Library Construction and Renovation Bond Act of 2000 3/7/2000 350,000 4,530 California Park and Recreational Facilities Act of 1984 6/5/1984 370,000 121,705 California Parklands Act of 1980 11/4/1980 285,000 26,550 California Safe Drinking Water Bond Law of 1976 6/8/1976 175,000 37,030 California Safe Drinking Water Bond Law of 1984 11/6/1984 75,000 24,720 California Safe Drinking Water Bond Law of 1986 11/4/1986 100,000 57,790 California Safe Drinking Water Bond Law of 1988 11/8/1988 75,000 49,015 California Wildlife, Coastal, and Park Land Conservation Act of 1988 6/7/1988 776,000 396,050 Class Size Reduction Public Education Facilities Bond Act of 1998 (Hi Ed) 11/3/1998 2,500,000 1,790,920 Class Size Reduction Public Education Facilities Bond Act of 1998 (K-12) 11/3/1998 6,700,000 5,941,750 Clean Air and Transportation Improvement Bond Act of 1990 6/5/1990 1,990,000 1,305,715 Clean Water and Water Conservation Bond Law of 1978 6/6/1978 375,000 34,470 Clean Water and Water Reclamation Bond Law of 1988 11/8/1988 65,000 46,000 Clean Water Bond Law of 1970 11/3/1970 250,000 4,000 Clean Water Bond Law of 1974 6/4/1974 250,000 8,165 Clean Water Bond Law of 1984 11/6/1984 325,000 77,000 Community Parklands Act of 1986 6/3/1986 100,000 39,685 County Correctional Facility Capital Expenditure and Youth Facility Bond Act of 1988 11/8/1988 500,000 296,545 County Correctional Facility Capital Expenditure Bond Act of 1986 6/3/1986 495,000 205,350 County Jail Capital Expenditure Bond Act of 1981 11/2/1982 280,000 54,225 County Jail Capital Expenditure Bond Act of 1984 6/5/1984 250,000 47,250 Earthquake Safety and Public Buildings Rehabilitation Bond Act of 1990 6/5/1990 300,000 205,740 Fish and Wildlife Habitat Enhancement Act of 1984 6/5/1984 85,000 24,240 Hazardous Substance Cleanup Bond Act of 1984 11/6/1984 100,000 7,000 Higher Education Facilities Bond Act of 1986 11/4/1986 400,000 126,000 Higher Education Facilities Bond Act of 1988 11/8/1988 600,000 293,575 Higher Education Facilities Bond Act of June 1990 6/5/1990 450,000 251,490 Higher Education Facilities Bond Act of June 1992 6/2/1992 900,000 646,345 Housing and Emergency Shelter Trust Fund Act of 2002 11/5/2002 2,100,000 0 Housing and Homeless Bond Act of 1990 6/5/1990 150,000 6,410 Kindergarten - University Public Education Facilities Bond Act of 2002 (K-12) 11/5/2002 11,400,000 3,945,990 Kindergarten - University Public Education Facilities Bond Act of 2002 (Hi-Ed) 11/5/2002 1,650,000 15,320 Lake Tahoe Acquisitions Bond Act 8/2/1982 85,000 25,740
CP PROGRAM AUTHORIZED (b) UNISSUED (c) ------------------------------------------------------------------------------------------------------------------ GENERAL FUND BONDS (NON-SELF LIQUIDATING) California Clean Water, Clean Air, Safe Neighborhood Parks, and Coastal Protection Act of 2002 $ 220,810 $ 2,337,360 California Library Construction and Renovation Bond Act of 1988 0 2,595 California Library Construction and Renovation Bond Act of 2000 48,250 297,200 California Park and Recreational Facilities Act of 1984 n.a. 1,100 California Parklands Act of 1980 n.a. 0 California Safe Drinking Water Bond Law of 1976 n.a. 2,500 California Safe Drinking Water Bond Law of 1984 n.a. 0 California Safe Drinking Water Bond Law of 1986 n.a. 0 California Safe Drinking Water Bond Law of 1988 5,100 2,000 California Wildlife, Coastal, and Park Land Conservation Act of 1988 n.a. 7,330 Class Size Reduction Public Education Facilities Bond Act of 1998 (Hi Ed) 675,755 0 Class Size Reduction Public Education Facilities Bond Act of 1998 (K-12) 505,445 0 Clean Air and Transportation Improvement Bond Act of 1990 242,490 40,925 Clean Water and Water Conservation Bond Law of 1978 n.a. 0 Clean Water and Water Reclamation Bond Law of 1988 0 0 Clean Water Bond Law of 1970 n.a. 0 Clean Water Bond Law of 1974 n.a. 0 Clean Water Bond Law of 1984 n.a. 0 Community Parklands Act of 1986 n.a. 0 County Correctional Facility Capital Expenditure and Youth Facility Bond Act of 1988 0 0 County Correctional Facility Capital Expenditure Bond Act of 1986 n.a. 0 County Jail Capital Expenditure Bond Act of 1981 n.a. 0 County Jail Capital Expenditure Bond Act of 1984 n.a. 0 Earthquake Safety and Public Buildings Rehabilitation Bond Act of 1990 59,450 0 Fish and Wildlife Habitat Enhancement Act of 1984 n.a. 3,000 Hazardous Substance Cleanup Bond Act of 1984 n.a. 0 Higher Education Facilities Bond Act of 1986 n.a. 0 Higher Education Facilities Bond Act of 1988 3,440 7,000 Higher Education Facilities Bond Act of June 1990 2,130 0 Higher Education Facilities Bond Act of June 1992 8,010 270 Housing and Emergency Shelter Trust Fund Act of 2002 980,000 1,120,000 Housing and Homeless Bond Act of 1990 n.a. 0 Kindergarten - University Public Education Facilities Bond Act of 2002 7,454,010 0 (K-12) Kindergarten - University Public Education Facilities Bond Act of 2002 266,680 1,368,000 (Hi-Ed) Lake Tahoe Acquisitions Bond Act n.a. 0
A-64
VOTER AUTHORIZATION ------------------------------ BONDS DATE AMOUNT OUTSTANDING (a) -------------------------------------------------------------------------------------------------------------------------------- New Prison Construction Bond Act of 1981 6/8/1982 $ 495,000 $ 44,250 New Prison Construction Bond Act of 1984 6/5/1984 300,000 37,500 New Prison Construction Bond Act of 1986 11/4/1986 500,000 168,820 New Prison Construction Bond Act of 1988 11/8/1988 817,000 401,130 New Prison Construction Bond Act of 1990 6/5/1990 450,000 234,450 Passenger Rail and Clean Air Bond Act of 1990 6/5/1990 1,000,000 583,680 Public Education Facilities Bond Act of 1996 (K-12) 3/26/1996 2,025,000 1,704,115 Public Education Facilities Bond Act of 1996 (Hi-Ed) 3/26/1996 975,000 868,740 1988 School Facilities Bond Act 11/8/1988 800,000 417,525 1990 School Facilities Bond Act 6/5/1990 800,000 439,915 1992 School Facilities Bond Act 11/3/1992 900,000 576,392 Safe, Clean Reliable Water Supply Act of 1996 11/5/1996 995,000 462,425 Safe Drinking Water Bond Act of 2000 3/7/2000 1,970,000 329,600 Safe Neighborhood Parks Bond Act of 2000 3/7/2000 2,100,000 711,005 School Building and Earthquake Bond Act of 1974 11/5/1974 40,000 30,655 School Facilities Bond Act of 1988 6/7/1988 800,000 370,480 School Facilities Bond Act of 1990 11/6/1990 800,000 475,570 School Facilities Bond Act of 1992 6/2/1992 1,900,000 1,175,450 Seismic Retrofit Bond Act of 1996 3/26/1996 2,000,000 1,604,580 Senior Center Bond Act of 1984 11/6/1984 50,000 7,250 State Beach, Park, Recreational and Historical Facilities Bonds 6/4/1974 250,000 495 State School Building Lease-Purchase Bond Law of 1982 11/2/1982 500,000 22,685 State School Building Lease-Purchase Bond Law of 1984 11/6/1984 450,000 102,500 State School Building Lease-Purchase Bond Law of 1986 11/4/1986 800,000 266,800 State, Urban, and Coastal Park Bond Act of 1976 11/2/1976 280,000 13,505 Veterans' Homes Bond Act of 2000 3/7/2000 50,000 0 Voting Modernization Bond Act of 2002 3/5/2002 200,000 0 Water Conservation and Water Quality Bond Law of 1986 6/3/1986 150,000 68,780 Water Conservation Bond Law of 1988 11/8/1988 60,000 37,280 Water Security, Clean Drinking Water, Coastal and Beach Protection Act 11/5/2002 3,440,000 72,670 of 2002 TOTAL GENERAL FUND BONDS $ 63,078,000 $ 27,432,962 ENTERPRISE FUND BONDS (SELF LIQUIDATING) California Water Resources Development Bond Act of 1959 11/8/1960 $ 1,750,000 $ 806,940 Veterans Bonds (d) 4,510,000 1,864,025 TOTAL ENTERPRISE FUND BONDS $ 6,260,000 $ 2,670,965 TOTAL GENERAL OBLIGATION BONDS $ 69,338,000 $ 30,103,927
CP PROGRAM AUTHORIZED (b) UNISSUED (c) ------------------------------------------------------------------------------------------------------------------ New Prison Construction Bond Act of 1981 $ n.a. $ 0 New Prison Construction Bond Act of 1984 n.a. 0 New Prison Construction Bond Act of 1986 n.a. 1,500 New Prison Construction Bond Act of 1988 0 12,260 New Prison Construction Bond Act of 1990 6,125 0 Passenger Rail and Clean Air Bond Act of 1990 10,565 0 Public Education Facilities Bond Act of 1996 (K-12) 46,790 0 Public Education Facilities Bond Act of 1996 (Hi-Ed) 29,630 8,700 1988 School Facilities Bond Act 2,665 0 1990 School Facilities Bond Act 2,990 0 1992 School Facilities Bond Act 6,614 0 Safe, Clean Reliable Water Supply Act of 1996 281,165 226,000 Safe Drinking Water Bond Act of 2000 756,147 873,800 Safe Neighborhood Parks Bond Act of 2000 259,100 1,117,000 School Building and Earthquake Bond Act of 1974 n.a. 0 School Facilities Bond Act of 1988 n.a. 0 School Facilities Bond Act of 1990 2,550 0 School Facilities Bond Act of 1992 17,290 0 Seismic Retrofit Bond Act of 1996 269,645 0 Senior Center Bond Act of 1984 n.a. 0 State Beach, Park, Recreational and Historical Facilities Bonds n.a. 0 State School Building Lease-Purchase Bond Law of 1982 n.a. 0 State School Building Lease-Purchase Bond Law of 1984 n.a. 0 State School Building Lease-Purchase Bond Law of 1986 n.a. 0 State, Urban, and Coastal Park Bond Act of 1976 n.a. 0 Veterans' Homes Bond Act of 2000 45,000 5,000 Voting Modernization Bond Act of 2002 155,000 45,000 Water Conservation and Water Quality Bond Law of 1986 n.a. 27,600 Water Conservation Bond Law of 1988 6,266 5,234 Water Security, Clean Drinking Water, Coastal and Beach Protection Act of 2002 1,259,430 2,107,900 TOTAL GENERAL FUND BONDS $ 13,628,542 $ 9,619,274 ENTERPRISE FUND BONDS (SELF LIQUIDATING) California Water Resources Development Bond Act of 1959 $ n.a. $ 167,600 Veterans Bonds 0 605,585 TOTAL ENTERPRISE FUND BONDS $ 0 $ 773,185 TOTAL GENERAL OBLIGATION BONDS $ 13,628,542 $ 10,392,459
(a) Includes the initial value of capital appreciation bonds rather than the accreted value. (b) Represents the total amount of commercial paper authorized by Finance Committees that could be issued for new money projects. Of this amount, no more than $2 billion of commercial paper can be issued at any time. Currently, there is $0.00 of commercial paper issued and outstanding. The bond acts marked as "n.a." are not legally permitted to utilize commercial paper, or all bonds were issued before the commercial paper program began. (c) Treats full commercial paper authorization as issued; see footnote (b). (d) Various dates. SOURCE: State of California, Office of the Treasurer. A-65 SCHEDULE OF DEBT SERVICE REQUIREMENTS FOR GENERAL FUND GENERAL OBLIGATION BONDS (a) (NON-SELF LIQUIDATING) AS OF OCTOBER 1, 2003
FISCAL YEAR CURRENT DEBT ENDING --------------------------------------------------------------------------- JUNE 30 INTEREST PRINCIPAL (b) TOTAL --------------------------------------------------------------------------------------------- 2004 $ 836,259,033.53 $ 286,555,000.00 $ 1,122,814,033.53(c) 2005 1,357,591,057.59 1,244,789,388.71 2,602,380,446.30 2006 1,283,636,860.00 1,173,910,000.00 2,457,546,860.00 2007 1,214,666,425.93 1,204,445,000.00 2,419,111,425.93 2008 1,149,031,802.93 1,331,543,078.31 2,480,574,881.24 2009 1,075,729,153.75 1,344,375,000.00 2,420,104,153.75 2010 1,000,681,073.06 1,395,720,000.00 2,396,401,073.06 2011 925,998,656.09 1,358,369,045.16 2,284,367,701.25 2012 848,660,462.55 1,000,470,000.00 1,849,130,462.55 2013 796,713,063.75 862,130,000.00 1,658,843,063.75 2014 754,204,683.39 739,730,000.00 1,493,934,683.39 2015 717,751,867.19 750,140,000.00 1,467,891,867.19 2016 678,328,795.21 685,515,000.00 1,363,843,795.21 2017 641,361,433.35 718,375,000.00 1,359,736,433.35 2018 604,119,507.23 742,660,000.00 1,346,779,507.23 2019 565,254,157.25 789,615,000.00 1,354,869,157.25 2020 524,243,981.00 817,080,000.00 1,341,323,981.00 2021 482,907,432.25 766,515,000.00 1,249,422,432.25 2022 443,367,368.50 902,960,000.00 1,346,327,368.50 2023 395,806,562.70 913,720,000.00 1,309,526,562.70 2024 350,253,835.34 785,265,000.00 1,135,518,835.34 2025 310,641,239.08 845,680,000.00 1,156,321,239.08 2026 267,484,176.34 817,740,000.00 1,085,224,176.34 2027 226,226,882.59 819,105,000.00 1,045,331,882.59 2028 184,450,249.09 858,235,000.00 1,042,685,249.09 2029 141,378,340.00 769,830,000.00 911,208,340.00 2030 102,320,895.75 820,835,000.00 923,155,895.75 2031 61,155,454.50 529,160,000.00 590,315,454.50 2032 36,236,695.00 452,070,000.00 488,306,695.00 2033 14,202,037.50 306,425,000.00 320,627,037.50 TOTAL $ 17,990,663,182.44 $ 26,032,961,512.18 $ 44,023,624,694.62
(a) Does not include debt service payments on $1,400,000,000 State of California General Obligation Variable Rate Bonds due 2033. (b) Includes scheduled mandatory sinking fund payments. (c) Total represents the remaining debt service requirements from November 1,2003 through June 30, 2004. SOURCE: State of California, Office of the Treasurer. A-66 STATE PUBLIC WORKS BOARD AND OTHER LEASE-PURCHASE FINANCING OUTSTANDING ISSUES OCTOBER 1, 2003
NAME OF ISSUE OUTSTANDING ----------------------------------------------------------------------------------- GENERAL FUND SUPPORTED ISSUES: STATE PUBLIC WORKS BOARD California Community Colleges $ 536,530,000 Department of the Youth Authority 17,320,000 Department of Corrections * 2,284,626,689 Energy Efficiency Program (Various State Agencies) (a) 74,770,000 The Regents of The University of California *(b) 1,151,602,382 Trustees of The California State University 584,005,000 Various State Office Buildings 1,093,130,000 TOTAL STATE PUBLIC WORKS BOARD ISSUES $ 5,741,984,071 TOTAL OTHER STATE BUILDING LEASE PURCHASE ISSUES (c) $ 878,160,000 TOTAL GENERAL FUND SUPPORTED ISSUES $ 6,620,144,071 SPECIAL FUND SUPPORTED ISSUES: East Bay State Building Authority Certificates of Participation (State of California Department of Transportation) * $ 67,047,955 San Bernardino Joint Powers Financing Authority (State of California Department of Transportation) 55,380,000 San Francisco State Building Authority (State of California Department of General Services Lease) (d) 38,685,000 TOTAL SPECIAL FUND SUPPORTED ISSUES $ 161,112,955 TOTAL $ 6,781,257,026
* Includes the initial value of capital appreciation bonds rather than the accreted value. (a) This program is self-liquidating based on energy cost savings. (b) The Regents' obligations to the State Public Works Board are payable from lawfully available funds of The Regents which are held in The Regents' treasury funds and are separate from the State General Fund. A portion of The Regents' annual budget is derived from General Fund appropriations. (c) Includes $180,450,000 Sacramento City Financing Authority Lease Revenue Bonds State of California - Cal EPA Building, 1998 Series A, which are supported by lease rentals from the California Environmental Protection Agency; these rental payments are subject to annual appropriation by the State Legislature. (d) The sole tenant is the California Public Utilities Commission. SOURCE: State of California, Office of the Treasurer. A-67 SCHEDULE OF DEBT SERVICE REQUIREMENTS FOR ENTERPRISE FUND GENERAL OBLIGATION BONDS (SELF LIQUIDATING) AS OF OCTOBER 1, 2003
FISCAL YEAR CURRENT DEBT ENDING --------------------------------------------------------------------------- JUNE 30 INTEREST PRINCIPAL (a) TOTAL --------------------------------------------------------------------------------------------- 2004 $ 119,440,515.65 $ 66,065,000.00 $ 185,505,515.65(b) 2005 145,344,837.25 131,840,000.00 277,184,837.25 2006 135,947,998.50 144,455,000.00 280,402,998.50 2007 125,907,629.76 156,545,000.00 282,452,629.76 2008 115,116,952.29 152,905,000.00 268,021,952.29 2009 104,513,601.25 153,725,000.00 258,238,601.25 2010 93,545,886.55 168,695,000.00 262,240,886.55 2011 83,950,470.77 126,905,000.00 210,855,470.77 2012 76,437,886.00 169,860,000.00 246,297,886.00 2013 68,092,160.62 171,035,000.00 239,127,160.62 2014 60,721,567.25 136,035,000.00 196,756,567.25 2015 54,714,273.15 118,935,000.00 173,649,273.15 2016 48,788,367.00 122,130,000.00 170,918,367.00 2017 42,549,819.39 130,125,000.00 172,674,819.39 2018 36,508,729.09 105,235,000.00 141,743,729.09 2019 31,151,899.21 101,050,000.00 132,201,899.21 2020 26,763,528.05 66,260,000.00 93,023,528.05 2021 23,192,791.29 60,385,000.00 83,577,791.29 2022 19,895,027.39 56,870,000.00 76,765,027.39 2023 17,273,135.76 38,275,000.00 55,548,135.76 2024 15,128,625.52 40,535,000.00 55,663,625.52 2025 12,831,771.91 43,880,000.00 56,711,771.91 2026 10,584,088.75 38,415,000.00 48,999,088.75 2027 8,956,152.50 20,745,000.00 29,701,152.50 2028 7,987,927.50 14,315,000.00 22,302,927.50 2029 6,890,681.25 25,420,000.00 32,310,681.25 2030 5,404,392.50 28,100,000.00 33,504,392.50 2031 3,892,867.50 25,920,000.00 29,812,867.50 2032 2,395,225.00 27,375,000.00 29,770,225.00 2033 812,977.50 28,930,000.00 29,742,977.50 TOTAL $ 1,504,741,786.15 $ 2,670,965,000.00 $ 4,175,706,786.15
(a) Includes scheduled mandatory sinking fund payments. (b) Total represents the remaining debt service requirements from November 1, 2003 through June 30, 2004. SOURCE: State of California, Office of the Treasurer. A-68 OUTSTANDING STATE DEBT FISCAL YEARS 1997-98 THROUGH 2001-02 (DOLLARS IN THOUSANDS EXCEPT FOR PER CAPITA INFORMATION)
1997-98 1998-99 1999-00 2000-01 2001-02 ------------------------------------------------------------------------------------------------------------------------------- OUTSTANDING DEBT (a) General Obligation Bonds General Fund (Non-Self Liquidating) $ 14,932,766 $ 16,202,211 $ 17,869,616 $ 20,472,893 $ 22,115,362 Enterprise Fund (Self Liquidating) 3,906,950 3,674,020 3,474,900 3,396,215 3,211,310 Total $ 18,839,716 $ 19,876,231 $ 21,344,516 $ 23,869,108 $ 25,326,672 Lease-Purchase Debt 6,639,620 6,671,534 6,627,944 6,413,260 6,341,935 Total Outstanding General Obligation Bonds and Lease-Purchase Debt $ 25,479,336 $ 26,547,765 $ 27,972,460 $ 30,282,368 $ 31,668,607 BOND SALES DURING FISCAL YEAR Non-Self Liquidating General Obligation Bonds $ 1,667,820 $ 2,294,650 $ 2,750,000 $ 4,419,665 $ 3,905,025 Self Liquidating General Obligation Bonds $ 447,535 $ 80,000 $ 126,500 $ 358,625 $ 111,325 Lease-Purchase Debt $ 1,245,190 $ 456,410 $ 293,235 $ 214,585 $ 229,105 DEBT SERVICE (b) Non-Self Liquidating General Obligation Bonds $ 1,878,026 $ 1,934,628 $ 2,045,566 $ 2,279,636 $ 2,367,570 Lease-Purchase Debt $ 577,987 $ 652,131 $ 654,485 $ 670,228 $ 647,568 GENERAL FUND RECEIPTS (b) $ 55,261,557 $ 58,510,860 $ 72,226,473 $ 78,330,406 $ 66,604,508 Non-Self Liquidating General Obligation Bonds Debt Service as a Percentage of General Fund Receipts 3.40% 3.31% 2.83% 2.91% 3.55% Lease-Purchase Debt Service as a Percentage of General Fund Receipts 1.05% 1.11% 0.91% 0.86% 0.97% POPULATION (c) 32,451,746 32,861,779 33,417,248 34,039,611 34,729,535 Non-Self Liquidating General Obligation Bonds Outstanding Per Capita $ 460.15 $ 493.04 $ 534.74 $ 601.44 $ 636.79 Lease-Purchase Debt Outstanding Per Capita $ 204.60 $ 203.02 $ 198.34 $ 188.41 $ 182.61 PERSONAL INCOME (d) $ 861,557,000 $ 931,627,000 $ 997,293,000 $ 1,094,770,000 $ 1,116,602,000 Non-Self Liquidating General Obligation Bonds Outstanding as Percentage of Personal Income 1.73% 1.74% 1.79% 1.87% 1.98% Lease-Purchase Debt Outstanding as Percentage of Personal Income 0.77% 0.72% 0.66% 0.59% 0.57%
(a) As of last day of fiscal year. Includes the initial value of capital appreciation bonds rather than the accreted value. (b) Calculated on a cash basis; debt service costs of bonds issued in any fiscal year largely appear in subsequent fiscal year. (c) As of July 1, the beginning of the fiscal year. (d) Annual Totals: US BEA, revised 1997-2000; DOF Estimated 2001. California Department of Finance. SOURCES: Population: State of California, Department of Finance Personal Income: State of California, Department of Finance; United States, Department of Commerce, Bureau of Economic Analysis (BEA) Outstanding Debt, Bonds Sales During Fiscal Year and Debt Service: State of California, Office of the Treasurer. General Fund Receipts: State of California, Office of the State Controller. A-69 STATE AGENCY REVENUE BONDS AND CONDUIT FINANCING AS OF DECEMBER 31, 2002
ISSUING AGENCY OUTSTANDING(a) ----------------------------------------------------------------------------------- STATE PROGRAMS FINANCING: California State University $ 625,118,000 California Transportation Commission -- Department of Water Resources - Central Valley Project 2,398,180,000 Department of Water Resources - Power Supply Program 11,263,500,000 The Regents of the University of California (b) 3,962,335,000 Trade and Commerce Agency -- HOUSING FINANCING: California Housing Finance Agency 8,158,493,913 Veterans Revenue Debenture 534,040,000 CONDUIT FINANCING: California Alternative Energy and Advanced Transportation Financing Authority 58,610,000 California Educational Facilities Authority 2,632,319,951 California Health Facilities Financing Authority 6,396,805,195 California Infrastructure and Economic Development Bank (c) 1,831,618,173 California Passenger Rail Financing Commission -- California Pollution Control Financing Authority 4,602,162,399 California School Finance Authority 90,000 California Student Loan Authority 95,260,000 California Urban Waterfront Area Restoration Financing Authority -- TOTAL $ 42,558,532,631
(a) Totals for California State University, Department of Water Resources-Central Valley Project, and Veterans Revenue Debenture were provided by the State of California, Office of the Treasurer. All other totals were provided by the listed issuing agency. (b) Includes $319,635,000 in Certificates of Participation. (c) Does not include $6 billion of "rate reduction bonds" issued by special purpose trusts for the benefit of four investor-owned electric utility companies representing interests in certain electric rate surcharges. A-70 APPENDIX D- INFORMATION CONCERNING THE STATE OF NEW YORK THE SECURITIES THAT THE FUND OFFERS ARE NOT BEING OFFERED BY THE STATE OF NEW YORK. THE STATE OF NEW YORK HAS NOT APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THE FUND'S REGISTRATION STATEMENT (INCLUDING THIS STATEMENT OF ADDITIONAL INFORMATION) IS TRUTHFUL OR COMPLETE This Appendix contains the Annual Information Statement of the State of New York (AIS), as updated or supplemented to the date specified therein. The AIS sets forth information about the financial condition of the State of New York. The State intends to update and supplement that Annual Information Statement further as described therein. The AIS set forth in this Appendix is dated May 30, 2003 and contains information only through that date. It has been updated on October 30, 2003 for specified information only through that date. This Appendix sets forth the section of the AIS entitled "Current Fiscal Year." The remaining sections of the AIS set out under the headings "Prior Fiscal Year," "Economic and Demographics," "Debt and other Financing Activities," "State Organization," "Authorities and Localities," "Litigation," and "Exhibits" are not included herein. The entire AIS, including such remaining sections, was filed with each Nationally Recognized Municipal Securities Information Repository (NRMSIR). An official copy of the AIS may be obtained by contacting a NRMSIR, or the Division of the Budget, State Capitol, Albany, NY 12224, Tel. (518) 473-8705. An informational copy of the AIS is available on the Internet at http://www.state.ny.us/dob. D-1 UPDATE TO ANNUAL INFORMATION STATEMENT (AIS) STATE OF NEW YORK OCTOBER 30, 2003 This quarterly update (the "Update") to the AIS of the State of New York is dated October 30, 2003 and contains information only through that date. It is the second quarterly update to the AIS of the State of New York dated May 30, 2003. The first update to the AIS was issued on August 7, 2003. The information in this Update is organized into three parts. PART I contains information on the State's Financial Plan projections. In Part I, readers will find: 1. The Mid-Year Update to the 2003-04 Financial Plan (the "Mid-Year Update") issued by the Division of the Budget (DOB) on October 28, 2003. Part I also reprints information on the GAAP-basis Financial Plan projections for 2003-04 and the State's five-year Capital Program and Financing Plan that first appeared in the in First Quarterly Update to the AIS issued on August 7, 2003. The full Capital Program and Financing Plan for the 2003-04 through 2007-08 fiscal years is incorporated by reference, and is available from DOB at the address below. 2. A discussion of special considerations affecting the State Financial Plan. PART II contains updated disclosure on the State Retirement System, the Metropolitan Transportation Authority (MTA) and the City of New York. As a convenience to readers, Part II also reprints information related to the State's audited basic Financial Statements for the 2002-03 fiscal year that first appeared in the August 7, 2003 Update to the AIS. PART III updates information related to certain litigation against the State. This Update has been supplied by the State to provide information about the financial condition of the State in connection with financings of certain issuers (including public authorities of the State) that may depend in whole or in part on State appropriations as sources of payment of their respective bonds, notes or other obligations, and for which the State has contractually obligated itself to provide such information pursuant to an applicable continuing disclosure agreement (a "CDA"). An Official Copy of this Update has been filed with each Nationally Recognized Municipal Securities Information Repository (NRMSIR) and may be obtained by contacting a NRMSIR or the Division of the Budget, State Capitol, Albany, NY 12224, Tel: (518) 473-8705. An Informational Copy of this Update is available on the DOB website (www.budget.state.ny.us). The availability of this Update in electronic form at DOB's website is being provided solely as a matter of convenience to readers and does not imply that there have been no changes in the financial condition of the State at any time subsequent to its release date. Maintenance of this Update on such website is not intended as a republication of the information therein on any date subsequent to its release date. 1 Neither this Update nor any portion thereof may be included or incorporated by reference in a Preliminary Official Statement, Official Statement, or other offering document without express written consent by DOB and agreement by DOB to execute a CDA relating to the series of bonds or notes described in such Preliminary Official Statement, Official Statement, or other offering document. Any use or incorporation by reference of this Update or any portion thereof in a Preliminary Official Statement, Official Statement, or other offering document without such consent and agreement is unauthorized and the State expressly disclaims any responsibility with respect to the inclusion, intended use, and updating of this Update if so misused. PART I MID-YEAR UPDATE TO THE 2003-04 FINANCIAL PLAN DOB PREPARED THE MID-YEAR UPDATE SET FORTH BELOW. IT CONTAINS ESTIMATES AND PROJECTIONS OF FUTURE RESULTS THAT SHOULD NOT BE CONSTRUED AS STATEMENTS OF FACT. THESE ESTIMATES AND PROJECTIONS ARE BASED UPON VARIOUS ASSUMPTIONS THAT MAY BE AFFECTED BY NUMEROUS FACTORS, INCLUDING FUTURE ECONOMIC CONDITIONS IN THE STATE AND NATION AND POTENTIAL LITIGATION CONCERNING ACTIONS BY THE STATE LEGISLATURE IN ENACTING THE 2003-04 BUDGET. THERE CAN BE NO ASSURANCE THAT ACTUAL RESULTS WILL NOT DIFFER MATERIALLY AND ADVERSELY FROM THE ESTIMATES AND PROJECTIONS CONTAINED HEREIN. INTRODUCTION This is the Mid-Year Update to the State's 2003-04 Financial Plan, submitted pursuant to section 23 of the State Finance Law. The Mid-Year Update includes revised Financial Plan projections, an updated economic forecast, operating results for the first six months of fiscal year 2003-04, and General Fund cash flow projections through the third quarter of fiscal year 2003-04. For a description of the structure of the State Financial Plan and general State operating procedures, please see the 2003-04 New York State Executive Budget Appendix II published on January 29, 2003 and the Annual Information Statement of the State of New York dated May 30, 2003, which are available at www.budget.state.ny.us. The actual cash-basis results and financial plan projections reported in this Mid-Year Update reflect the deferral of $1.9 billion in spending from 2002-03 to 2003-04 that was necessary due to delayed Legislative authorization for issuance of tobacco bonds. Therefore, the projections contained herein are reported on a basis consistent with the actual results reported by the State Comptroller, and with unadjusted Financial Plans previously reported in the Enacted Budget Report and First Quarterly Financial Plan Update. In addition, the State Funds and All Governmental Funds actual results and estimates contained in this Update reflect the reclassification of the Expendable and Non-Expendable Trust Funds from the Fiduciary fund type to the Special Revenue fund type. This fund reclassification conforms to the new accounting standards as set forth in the Governmental Accounting Standards Board (GASB) issued Statement 34, which substantially changed the way in which governments are required to report operations in their financial statements. 2 OVERVIEW At mid-year, the State's 2003-04 Financial Plan remains solidly balanced based on the availability of one-time Federal aid that was authorized after this year's budget was enacted. While these receipts help to ensure balance in the current year, the State continues to face a significant financial gap in 2004-05. Revenue actions enacted by the Legislature over the Governor's objection continue to perform as the Executive had anticipated, with no appreciable receipt collections from several newly authorized sources. Moreover, while the potential for improved performance from the financial services sector shows some promise, the level of revenue from tax law changes has not materialized to the extent anticipated by the Legislature at the time of their enactment. At the same time, governmental spending on economically sensitive entitlement programs is running higher than expected as the State's economic recovery remains anemic. Taken together, these factors represent a fiscal challenge for the 2004-05 fiscal year and beyond. As of this Mid-Year Report, the imbalance between anticipated receipts and disbursements for the 2004-05 fiscal year remains at approximately $5 billion to $6 billion. As previously reported, a number of steps have been taken to address the State's fiscal situation. Aggressive austerity measures that require all State agencies to carefully scrutinize discretionary expenditures are in place, and a strict hiring freeze has been maintained. The Governor is also working with legislative leaders on statutory measures that could be enacted this fall to provide further savings this year and begin to address next year's gap. As indicated, the Division of the Budget (DOB) projects the State will end the 2003-04 fiscal year in balance after year-end reserve transactions. These transactions, totaling $730 million, are comprised of $710 million in the permanent rainy day fund (the Tax Stabilization Reserve Fund) and $20 million in the Contingency Reserve Fund. An additional $75 million in resources, resulting primarily from minor timing revisions to the July Financial Plan projections, have been treated as available for use in 2004-05. As detailed later in this report, the Mid-Year Update reflects modest net increases in both receipts and spending of $30 million from the July Update. The $30 million net increase in the revenue projections include modest upward revisions to tax receipts estimates. Nonetheless, tax receipt projections for the current fiscal year remain slightly below those contained in the Enacted Budget Report. The $30 million net increase in spending reflects higher spending in welfare and Medicaid due to increasing caseloads, expenditure growth and utilization and growth in the Tuition Assistance Program (TAP) due to higher enrollment. These costs are partially offset by the timing of Federal aid that lowers health care costs and savings resulting from recently enacted "clean-up" legislation. In addition, the report updates the status of certain risks to the Financial Plan projections, including possible reductions in anticipated Federal aid for the school supportive health services program. 3 Current revenue and spending estimates for the General Fund, State Funds and All Governmental Funds are summarized in the following table. Detailed information is provided later in this report. 2003-04 REVENUE AND SPENDING ESTIMATES (MILLIONS OF DOLLARS)
CHANGE FROM JULY OCTOBER JULY CHANGE FROM UPDATE UPDATE UPDATE ENACTED BUDGET ------------------------------------------------------------------------- REVENUE: General Fund 42,337 42,367 30 627 State Funds 62,539 62,647 108 592 All Governmental Funds 97,029 98,322 1,293 2,601 SPENDING: General Fund 42,422 42,452 30 (285) State Funds 62,700 62,864 164 (123) All Governmental Funds 96,918 97,979 1,061 1,605
SUMMARY OF MID-YEAR REVISIONS General Fund revenue projections have been revised upward by $30 million from the July Financial Plan Update issued July 30, 2003 (the "July Update") to reflect a modest upward revision in the tax receipts estimate offset by additional costs for the School Tax Relief (STAR) program and a deposit to the Personal Income Tax (PIT) Refund Reserve Account. The spending increase of $30 million is due to higher estimated costs in welfare ($31 million), Medicaid ($100 million), and TAP ($31 million), partially offset by Federal aid which reduces the State share of Medicaid costs ($51 million), other available health care resources ($46 million), implementation of cost containment in recently enacted "clean-up" legislation ($20 million), and projected additional lottery receipts used to finance school aid costs ($15 million). State Funds disbursements increased by $164 million from the July Update reflecting General Fund changes described above ($30 million) and increased spending for STAR ($35 million). The reclassification of Expendable Trust and Non-Expendable Trust Funds from the Fiduciary Fund type to the Special Revenue fund type increases both receipts and disbursements ($60 million and $84 million, respectively) from amounts published in the July Update. The balance of the increase in the State Funds receipts of $108 million from the July Update primarily reflects the General Fund changes discussed above ($30 million). The increase in All Governmental Funds receipts of $1.29 billion over the July Update primarily reflects the receipt of Federal Emergency Management Agency (FEMA) reimbursement aid for costs incurred by the State and New York City associated with the World Trade Center attacks of September 11th ($1.17 billion), as well as the State Funds changes described above ($108 million). 4 All Governmental Funds disbursements increased by $1.06 billion over the July Update due primarily to FEMA aid that flowed through the State to New York City for costs associated with the World Trade Center attacks ($885 million), and State Funds changes described above ($164 million). RECAP OF FINANCIAL PLAN REVISIONS SINCE THE ENACTED BUDGET Since the Enacted Budget Financial Plan, projected General Fund receipts have been increased by $627 million. This increase is attributable to the receipt of $645 million in one-time Federal revenue sharing payments and the expected flow of $170 million in additional sales tax receipts to the General Fund due to the delay in providing payments to New York City associated with the Local Government Assistance Corporation (LGAC)/Municipal Assistance Corporation (MAC) transaction. These increases are partially offset by a net reduction in the estimate for General Fund tax and miscellaneous receipts for 2003-04 of $53 million, additional costs for the STAR program of $35 million, an increased deposit into the PIT Refund Reserve Account of $75 million and a decrease in other transfers of $25 million. General Fund spending has decreased by $285 million from the Enacted Budget Financial Plan. This decrease is primarily attributable to lower costs resulting from a 15-month increase in the Federal matching rate on Medicaid costs ($422 million), the delayed timing of spending for new legislative "member items" ($100 million), additional resources available to Medicaid ($46 million), lower debt service costs ($42 million) and savings from the cap on mentally disabled payments to counties ($20 million). These reductions in spending are partially offset by: growth above budgeted levels for Medicaid ($200 million), welfare ($71 million) and TAP ($31 million); the delayed implementation of employee health insurance cost containment changes ($26 million); and a modest increase in State operations spending ($17 million). The combined benefit of the increased General Fund receipts and lower spending was used to balance the 2003-04 Enacted Budget and help lower the 2004-05 budget gap. The 2004-05 budget gap of roughly $5 billion to $6 billion already reflects these revisions. State Funds receipts increased $592 million over the Enacted Budget Financial Plan primarily reflecting the General Fund increase described above ($627 million). The State Funds disbursements decline of $123 million reflects the decline in General Fund spending detailed above ($285 million) offset by increased spending in STAR ($35 million) and the reclassification of Expendable Trust and Non-Expendable Trust Funds from the Fiduciary fund type to the Special Revenue fund type ($84 million). The increase in All Governmental Funds receipts of $2.60 billion over the Enacted Budget Financial Plan primarily reflects the receipt of Federal Emergency Management Agency (FEMA) reimbursement aid for costs incurred by the State and New York City associated with the World Trade Center attacks of September 11th ($1.17 billion), the State funds changes described above ($592 million), higher projected Federal aid in support of the Medicaid program reflecting the temporary increase in the Federal matching rate ($1.01 billion) and program cost increases ($300 million). All Governmental Funds disbursements increased $1.60 billion over the Enacted Budget primarily due to increases in World Trade Center costs ($885 million) and the Medicaid increases detailed above ($1.31 billion), offset by decreases in all other program areas. 5 The majority of the changes since the Enacted Budget Financial Plan were reflected in the July Update, and thus only the incremental changes from the July Update are discussed in further detail later in this report. RECENT EVENTS The Legislature recently passed "clean-up" bills that provide technical corrections and clarification to the budget bills and Article VII language bills enacted in the 2003 regular legislative session. These bills include necessary corrections and clarifications to achieve several savings and revenue initiatives included in the 2003-04 Financial Plan, as well as $20 million in new cost containment savings (described in more detail below). In addition, the bills include a provision that grants loan forgiveness to local governments of roughly $172 million in advance payments associated with the cost of providing mental health services. This action was already reflected in the Financial Plan. STATUS OF LEGISLATIVE ACTIONS DOB continues to value certain revenue measures adopted by the Legislature at significantly lower amounts. The temporary personal income tax increase is valued at $280 million below legislative estimates, and year-to-date results appear consistent with the lower estimate. In addition, more speculative revenue actions taken by the Legislature are expected to have virtually no positive revenue impact in the current fiscal year, again, consistent with results to date. These actions include Video Lottery Terminals (VLTs) permitted to operate at certain racetracks, the collection of excise and sales taxes from non-exempt purchasers on Native American lands, and the denial of business deductions for the use of certain intangible assets. DOB ANALYSIS OF 2003-04 LEGISLATIVE REVENUE ACTIONS (MILLIONS OF DOLLARS)
LEGISLATIVE VALUE DOB VALUE ------------------------------------------------------------ Temporary PIT Increases 1,680 1,400 Indian Reservation Taxes 164 0 VLTs 150 0 Bonus Depreciation Recapture 146 58 Intangible Holding Companies 115 0 Other Revenue Actions 140 15
It should also be noted that the Legislature assumed savings in certain program areas that have not been attainable and which are still not reflected in this Update. These occur primarily in Medicaid and in shelter allowances for welfare recipients. 6 PROJECTED GENERAL FUND OUTYEAR BUDGET GAPS While the current fiscal year is balanced, the magnitude of future budget gaps requires timely and aggressive measures to restore structural balance. The Governor is continuing implementation of a fiscal management plan that includes measures intended to reduce costs and generate recurring savings in the outyears. General Fund outyear budget gaps are estimated to be roughly $5 billion to $6 billion in 2004-05 and $8 billion in 2005-06, consistent with the range of gaps initially reported by DOB in the May 1 Analysis of Legislative Budget Changes and in the Enacted Budget Report released later in May. The statewide austerity measures limiting discretionary spending, travel, and low priority capital spending will remain in force and all State agencies will continue to operate under a hiring freeze, consistent with existing guidelines. In addition, agencies continue to conduct comprehensive reviews of all existing and new State contracts, fleet management practices, and equipment purchases, as well as management assessments of current agency operations. These reviews will identify opportunities where agencies, through increased administrative flexibility, statutory changes or other means, can achieve greater productivity, improve services, and reduce costs. Savings from these measures, which are not yet reflected in the Financial Plan, should provide a hedge against risk for the remainder of the fiscal year and help reduce the outyear budget gaps. GENERAL FUND FINANCIAL PLAN NATIONAL ECONOMY Revised data for the second quarter of this year, in conjunction with preliminary data for the third quarter, indicate a stronger national economy for 2003 than projected in the July Update. Indeed, U.S. real gross domestic product is expected to grow almost 6 percent during the third quarter, aided by the issuance of tax cut rebate checks and a long-awaited improvement in business spending. Consequently, the DOB forecast for real growth in U.S. GDP for 2003 has been revised up to 2.8 percent. National economic growth is expected to accelerate to 3.8 percent in 2004. The improved outlook for the overall national economy has not yet translated into significant labor market growth. High productivity growth, rising benefit costs, and the trend toward off-shore outsourcing in certain economic sectors has delayed the resumption of hiring by businesses. DOB has reduced its estimate of nonagricultural employment growth for 2003 slightly from the 0.2 percent decline reported in July to a decline of 0.3 percent. Moreover, expected growth for 2004 has been reduced from 0.9 percent to 0.6 percent. The weaker job market, along with slightly lower than expected consumer price inflation, will result in slower wage and personal income growth than reported in the July Update. Wage growth has been revised down from 2.8 percent to 2.1 percent for 2003, partly due to a downward revision to the first quarter of 2003. Overall personal income growth has been revised down as well from 3.5 percent to 3.2 percent. Income growth is expected to accelerate in 2004, but remains well below the historical average. 7 MAJOR ECONOMIC INDICATORS
2002 2003 2004 --------------------------------------------------- Gross Domestic Product (real) 2.4 2.8 3.8 Personal Income 2.7 3.2 4.7 Non Farm Employment (0.3) 0.6 1.7 Consumer Price Index 1.6 2.3 1.9
Note: Numbers above are percent change/calendar year. DOB estimates are based on National Income and Product Account data through September 2003. DOB's forecast is not without risk. With significant labor market slack and the capacity utilization rate at its lowest level since the early 1980s recession, the business sector has been more reluctant to significantly increase investment spending than is typical at this stage of a recovery. If this trend continues, it could result in even slower job growth than expected. In turn, continued weakness in the labor market could depress consumption spending, further reducing the incentive for businesses to spend. In contrast, if the Federal tax reduction, combined with historically low interest rates, has a greater impact on households than expected, or a weaker dollar produces higher export growth than the current forecast, national economic growth could be stronger than expected. STATE ECONOMY DOB's New York State Index of Coincident Economic Indicators shows that the State economy began to emerge from recession in early 2003. The collapse of dot-com equity prices, and the implosion of the high-tech sector that followed, sent the stock market tumbling and precipitated heavy job losses in the State's manufacturing, trade, and finance industries during the first eight months of 2001. The destruction of the World Trade Center wrought catastrophe for the downstate economy, with the finance and travel and tourism industries being the hardest hit. The December 2001 collapse of Enron, the corporate governance scandals that followed, and finally, the run-up to the war in Iraq, further delayed the recovery in equity prices, leading to further financial sector layoffs, as well as reductions in bonuses. As a result of this barrage of negative events, the State recession extended beyond that of the nation. Notwithstanding the upward revision to the national economic forecast, DOB's outlook for the New York economy is little changed from that presented in the July Update. With the State's labor market beginning to recover, DOB has revised its 2003 forecast for total State employment growth marginally upward from a decline of 0.4 percent to a decline of 0.1 percent, on an annual average basis. Private sector job growth has similarly been revised up from a decline of 0.2 percent to a decline of 0.1 percent. Expected employment growth for 2004 has also been revised upward from 0.6 percent to 0.8 percent. Nevertheless, the estimate for the State's unemployment rate, which is often a lagging economic indicator, remains at 6.2 percent for both 2003 and 2004. 8 The recovery of the State's financial sector continues. With the S&P 500 up over 13 percent since the end of 2002, recent months have seen an increase in merger and acquisition activity, as well as strong revenues from bond trading activity, although the latter are expected to weaken with the rise in long-term interest rates. The improved outlook for the financial markets is expected to translate into higher bonus growth for the coming bonus season than was projected in July. DOB's 2003 forecast for State wages and salaries is relatively unchanged from July, but has been revised up for 2004 from 4.1 percent to 4.6 percent. Growth in total State personal income, of which wages and salaries are the largest component, has been revised up to 2.7 percent for 2003, due in large part to revised data for proprietors' income, and to 4.4 percent for 2004. MAJOR ECONOMIC INDICATORS
2002 2003 2004 ---------------------------------------------------- Personal Income (0.2) 2.7 4.4 Nonagricultural Employment (1.8) (0.1) 0.8 Unemployment Rate 6.1 6.2 6.2
Note: Numbers above are percent change/calendar year. Personal income and nonagricultural employment growth for 2002 and all forecasts for 2003 and 2004 are projected by DOB. The volatility of the financial markets remains a significant source of risk to the New York forecast. If the recent rise in equity prices and financial services activity fails to be sustained, industry profitability and associated compensation could be lower than anticipated. In addition, weaker than expected growth for both the national and international economies would, in turn, weaken the State's recovery. This would result in even slower employment and income growth than projected. In contrast, stronger financial services sector growth or stronger national and international growth could result in a healthier economic recovery for the State than projected. GENERAL FUND RECEIPTS 2003-04 GENERAL FUND RECEIPTS (MILLIONS OF DOLLARS)
JULY OCTOBER CHANGE FROM ANNUAL UPDATE UPDATE JULY UPDATE CHANGE ------------------------------------------------------------ Total Tax Receipts 28,406 28,402 (4) 425 All Other Receipts 13,931 13,965 34 4,546 TOTAL RECEIPTS 42,337 42,367 30 4,971
Total General Fund receipts are estimated at $42.37 billion, an increase of $30 million from the July Update, as explained below. The increase of $4.97 billion over the prior year is largely attributable to three factors: the expected receipt of $3.80 billion in tobacco securitization proceeds, $645 million from the Federal revenue sharing grants, and higher receipts resulting from tax and fee increases enacted with the 2003-04 Budget. The tax receipt revisions from the July Update, including transfers, are relatively minor and reflect a modestly more optimistic view of economic trends and financial sector performance balanced against some shortfalls in year-to-date results. Estimates for the impact of legislatively enacted changes remain essentially unchanged. It remains the case that a significant number of the revenue actions taken by the Legislature will generate little or no revenue in fiscal year 2003-04. 9 PERSONAL INCOME TAX Personal income tax receipts for the 2003-04 fiscal year are estimated at $16.28 billion, a decrease of $8 million from the July Update estimate. This decrease is comprised of an additional deposit to the PIT Refund Reserve Account ($75 million) partially offset by higher PIT collections ($67 million). The estimate reflects an increase of $150 million in the non-withholding payments estimate due in part to a change in collection patterns related to tax actions taken with the Enacted Budget. Despite a year-to-date shortfall in withholding results, the estimate is unchanged reflecting better-than-anticipated securities industry profitability and an expected increase in end-of-year bonus payments. Increases are partially offset by a lower assessments estimate ($25 million), increased costs for the STAR program ($35 million) and greater deposits to the Revenue Bond Tax Fund (RBTF) ($23 million). Important risks affecting the personal income tax estimate include the strength of growth in the overall economy, financial sector compensation trends, and collection patterns related to the temporary tax increase enacted earlier this year. CONSUMPTION AND USE TAXES The estimate for user taxes and fees is $7.96 billion, which is $11 million below the July Update. The estimates for sales tax, motor vehicle fees, the alcohol beverage tax, and alcohol beverage control license fees are unchanged from the July Update. The estimate for the cigarette and tobacco tax is $11 million below the July Update estimate, reflecting weaker-than-anticipated cigarette consumption. Overall, consumption and use tax receipts are within $5 million of the estimated cash flow contained in the July Update. BUSINESS TAXES The business tax estimates total $3.44 billion and remain unchanged from the July Update. Business taxes for the first half of the fiscal year were $1.54 billion, which is $43 million below July estimates. This is primarily due to unexpected large refunds in the bank tax and lower-than-expected utility tax payments. Collections are expected to strengthen in the later part of the year as corporate profitability continues to improve. OTHER TAXES Other taxes, comprised of the estate tax, gift tax, real property gains tax, pari-mutuel taxes and other taxes are now expected to total $726 million, a $15 million increase from the July Update. Through the first half of the fiscal year, receipts totaled $398 million, which is $32 million above the cash flow projection in the July Update. The change from the July Update is due to the unexpectedly strong results in the estate tax. The change is based upon the strong year-to-date results, and an upward revision to estimates of household net worth. MISCELLANEOUS RECEIPTS The estimate for miscellaneous receipts is $5.55 billion and remains unchanged from the July Update. Year-to-date collections of miscellaneous receipts are $3.13 billion, which is $2.27 billion higher than last year. The higher receipts are attributable to $2.20 billion in tobacco bond proceeds received in June, offset by lower collections from abandoned property. There is some downside risk in the miscellaneous receipts estimate, stemming from lower-than-expected year-to-date collections from abandoned property, though the majority of revenue from this source is received during the second half of the fiscal year. 10 FEDERAL GRANTS Federal Grants are estimated to total $645 million and remain unchanged from the July Update. TRANSFERS FROM OTHER FUNDS The estimate for transfers from other funds is $7.77 billion, which is $34 million above the July Update. Personal income tax and the real estate transfer tax in excess of debt service requirements are expected to increase by $23 million and $11 million respectively. These changes reflect modest increases in the estimates of the personal income and real estate transfer taxes. GENERAL FUND DISBURSEMENTS 2003-04 GENERAL FUND DISBURSEMENTS (MILLIONS OF DOLLARS)
JULY OCTOBER CHANGE FROM ANNUAL UPDATE UPDATE JULY UPDATE CHANGE --------------------------------------------------------------------- Grants to Local Governments 29,584 29,629 45 4,742 All Other 12,838 12,823 (15) 97 TOTAL DISBURSEMENTS 42,422 42,452 30 4,839
General Fund spending is estimated at $42.45 billion, an increase of $30 million from the July Update as a result of additional net spending of $45 million for Grants to Local Governments partially offset by the anticipated elimination of a $15 million transfer to the State Lottery Fund. Grants to Local Governments disbursements are projected at $29.63 billion, an increase of $45 million from the July Update. This higher local spending consists of increases in welfare ($31 million), TAP ($31 million), and Medicaid ($3 million), partially offset by reduced spending in mental hygiene programs ($20 million). Revised welfare caseload and expenditure estimates result in a net $31 million spending increase above the July Update. Federal Temporary Assistance to Needy Families (TANF) originally programmed to offset school aid costs for the Pre-K program and Higher Education Services Corporation (HESC) spending for the TAP program are now needed to fund welfare costs. As a result, school aid and HESC spending increases by $50 million and $70 million respectively, partially offset by a welfare realignment of $89 million after the TANF reprogramming, including $23 million in TANF bonus funds. 11 In addition to the loss of $70 million of TANF funds to offset TAP spending from the General Fund, HESC local assistance spending is $31 million above the July Update estimate as a result of larger than projected growth in the number of TAP recipients and average award levels. Medicaid spending increased by a net $3 million over the July Update estimate as a result of $100 million in higher costs relating to caseload and utilization ($96 million) and revised cost containment savings ($4 million). This growth is partially offset by an increased State benefit resulting from the 15-month increase in the Federal matching rate used to lower Medicaid costs ($51 million). The gross State benefit of $319 million (for a total State share benefit in 2003-04 of $690 million) is reduced by $268 million to reflect the portion of these savings used to finance programs under the Health Care Reform Act. In addition, there are other available resources to Medicaid to reduce current year costs ($46 million). Local assistance spending estimates for the Office of Mental Retardation and Developmental Disabilities were reduced by $20 million from the July Update estimate due to the implementation of a cap on mentally disabled payments to counties pursuant to the recently enacted "clean-up" bills. Transfers from the General Fund to other funds are reduced by $15 million for the anticipated elimination of a transfer to the Lottery Fund assumed in the July Update. This transfer is no longer required due to an increase in estimated lottery receipts that sufficiently funds a portion of school aid costs as assumed in the Enacted Budget Financial Plan. All other General Fund spending estimates, including State Operations ($7.14 billion), General State Charges ($3.26 billion), Debt Service ($1.54 billion) and Capital Projects ($255 million), remain unchanged from the July Update. ANNUAL CHANGE IN GENERAL FUND DISBURSEMENTS General Fund spending is now projected to total $42.45 billion, an increase of $4.84 billion or 13.0 percent from the prior year. The deferral of $1.90 billion in disbursements from 2002-03 to 2003-04 that was made necessary due to the delay in securing authorization to issue tobacco bonds represents $3.80 billion of the annual growth in General Fund spending. The deferral of $1.9 billion in payments included school aid ($1.31 billion), CUNY Senior Colleges advance ($419 million), Medicaid to New York City relating to the mentally disabled ($82 million), education ($54 million), welfare ($47 million) and several other payments ($186 million). The remaining $1.04 billion in projected annual spending growth in the General Fund is primarily attributable to increased spending for Grants to Local Governments of $1.09 billion. This category is the largest area of General Fund spending and represents over 68 percent of total disbursements. All other General Fund spending is estimated to decrease by $51 million and consists of lower spending for State Operations ($610 million), offset by increases in General State Charges ($493 million) and Transfers To Other Funds ($66 million). Higher local assistance spending of $1.09 billion or 4.1 percent results from higher welfare spending associated with the loss of non-recurring Federal TANF reserve funds used to offset 2002-03 welfare spending and an increased caseload ($582 million), additional spending for legislative member items ($250 million), growth in Medicaid program costs ($130 million), and various other increases in spending across several local assistance programs. 12 State Operations disbursements, which accounts for the second largest area of General Fund spending, are estimated to decline $610 million or 7.9 percent from 2002-03 due to decreased spending for personal service ($677 million) partially offset by modest growth in non-personal service spending ($67 million). Decreases in personal service costs are attributable to the continuation of the strict statewide hiring freeze, an aggressive use of a State employees retirement incentive, and the use of alternative funding sources to finance spending. These alternative funding sources for personal service costs are comprised of additional SUNY revenues including a tuition increase ($289 million), increased Federal revenues used to finance a portion of mental hygiene spending ($227 million), and the shift of transportation-related spending for the Department of Motor Vehicles to the Dedicated Highway Fund ($90 million). This lower spending is partially offset by increased non-personal service spending resulting primarily from inflationary increases across all agencies. General State Charges annual growth of $493 million or 18.0 percent is mostly due to higher costs associated with pensions ($250 million) and health insurance ($204 million). Increases in pension costs are driven by a required minimum contribution rate of 4.5 percent of 2003-04 annual payroll expenditures (versus 1.0 percent in 2002-03), as well as higher costs produced by retirement incentives. The growth in health insurance spending reflects rising costs of employee and retiree health care, including the escalating costs of prescription drugs. Transfers to other funds are projected to grow $66 million or 2.8 percent over the prior year, primarily the result of timing of State subsidy payments to the SUNY hospitals ($107 million), increased General Fund support of capital projects spending for transportation and the environment ($90 million), and underlying growth in debt service costs ($46 million). These increases are partially offset by a decrease in the transfer to the Community Service Provider Assistance Program Fund ($100 million) and in the State's share of Medicaid payments to SUNY hospitals ($48 million). Additional information relating to the annual spending changes is included in the 2003-04 Enacted Budget Report published on May 28, 2003. RESERVES/GENERAL FUND CLOSING BALANCE The Mid-Year Update projects a closing balance of $730 million in the General Fund, and is unchanged from the July Update. The closing fund balance is comprised of $710 million in the permanent rainy day fund (Tax Stabilization Reserve Fund) and $20 million in the litigation reserve (Contingency Reserve Fund). 13 CERTAIN RISKS(1) The Mid-Year Financial Plan does not assume costs that could materialize as a result of adverse rulings in pending litigation, increased school aid funding related to recent court rulings, future collective bargaining agreements with State employee unions, Federal disallowances or other Federal actions that could produce adverse effects on the State's projections of receipts and disbursements. These risks are explained in further detail below. The State is a defendant in several ongoing legal proceedings that could result in costs to the State Financial Plan. The most significant litigation includes ongoing claims by several Indian Nations alleging wrongful possession of lands by the State and several counties, and the recent State Court of Appeals ruling that the State's financing system for New York City public schools was unconstitutional requiring the State to submit its remedy to the Court by July 30, 2004. In addition, in JIGGETTS VS. DOWLING, the State has implemented a court-ordered increase in the shelter allowance schedule for public assistance families effective November 1, 2003. The court has also directed the parties to return on March 30, 2004 for further proceedings. The State and several State employee unions are negotiating new collective bargaining agreements. The recently expired four-year agreement included a $500 non-recurring lump sum payment and salary increases of 1.5 percent in 1999-00, 3.0 percent in 2000-01 and 3.5 percent in 2001-02 and 2002-03. Each one percent salary increase costs roughly $80 million in the General Fund. The Federal government is currently auditing Medicaid claims submitted since 1993 under the school supportive health services program. At this point, these audits have not been finalized, and, as a result, the liability of the State and/or school districts for any disallowances that may result from these audits cannot be determined. Federal regulations include an appeals process that could postpone repayment of any disallowances. In addition, as of September 2003, nearly $300 million in Federal Medicaid payments related to school supportive health services have been deferred by the Federal Centers for Medicare and Medicaid Services. Since the State has continued to reimburse school districts for these costs, these Federal deferrals, if not resolved, could result in a Medicaid cash shortfall in the General Fund. New York State continues to await Federal approval of the Medicaid State Plan Amendment necessary to make planned payments totaling roughly $1.1 billion (half funded by the Federal government) to public hospitals throughout the State, including the New York City Health and Hospitals Corporation, State University of New York hospitals, and other State and county operated facilities. ---------- (1) For a discussion of other risks, please see "Special Considerations" and "Litigation" in this Update. 14 GOVERNMENTAL FUNDS FINANCIAL PLANS The State Funds and All Governmental Funds sections below provide a brief description of the annual change in receipts and disbursements. For a more detailed discussion of these changes, refer to the Enacted Budget Financial Plan. GASB issued Statement 34 (GASB 34), which substantially changed the way in which governments are required to report their operations in their financial statements. In accordance with GASB 34, the Expendable and Non-Expendable Trust Funds have been reclassified from the Fiduciary fund type to the Special Revenue fund type. These fund reclassifications conform to the new accounting standards and are counted in the State Funds and All Governmental Funds actual results and estimates contained in this Update. STATE FUNDS State Funds represent the portion of the State's budget supported exclusively by State revenues: taxes, fees, fines, and other revenues imposed and collected by the State. Federal grants are not typically included as part of State Funds; however, one-time Federal grants received in the General Fund have been included for 2003-04. 2003-04 STATE FUND RECEIPTS (MILLIONS OF DOLLARS)
JULY OCTOBER CHANGE FROM ANNUAL UPDATE UPDATE JULY UPDATE CHANGE ---------------------------------------------------------------- Taxes 42,534 42,577 43 1,901 Miscellaneous Receipts 19,360 19,424 64 5,421 Federal Grants 645 646 1 646 TOTAL RECEIPTS 62,539 62,647 108 7,968
The increase in State Funds receipts of $108 million over the July Update is primarily attributable to General Fund changes including projected increases in tax collections ($43 million). The remaining State Funds receipts change reflects the reclassification of Expendable and Non-Expendable Trust Funds to the Special Revenue Funds pursuant to GASB 34 as discussed above ($60 million). State Funds receipts are projected to total $62.65 billion in 2003-04, an increase of $7.97 billion or 14.6 percent from 2002-03. Tax receipts in State Funds are projected to total $42.58 billion, an increase of $1.90 billion from 2002-03 primarily reflecting a new personal income tax surcharge ($1.4 billion) and a one-quarter percent increase in sales tax ($450 million) as well as other modest tax reestimates. Miscellaneous receipts in State Funds are projected to total $19.42 billion, an increase of $5.42 billion over 2002-03. The growth in miscellaneous receipts primarily reflects receipts from the issuance of tobacco bonds ($3.8 billion), receipt of bond proceeds in support of capital spending ($1.29 billion) and growth in SUNY revenues attributable to a tuition increase ($280 million). Federal grants are projected to total $646 million and reflect one-time Federal revenue sharing payments. 15 2003-04 STATE FUNDS DISBURSEMENTS (MILLIONS OF DOLLARS)
JULY OCTOBER CHANGE FROM ANNUAL UPDATE UPDATE JULY UPDATE CHANGE --------------------------------------- 62,700 62,864 164 7,111
State Funds disbursements increased by $164 million from the July Update. Spending growth is due mostly to General Fund changes, including welfare caseload increases ($31 million) and higher than expected enrollment in the current academic year for TAP ($31 million). The remaining change reflects increased spending in STAR for higher than anticipated school tax increases ($35 million) and fund reclassifications made pursuant to GASB 34 as discussed above ($84 million). State Funds disbursements are projected at $62.86 billion in 2003-04, an increase of $7.11 billion or 12.8 percent from 2002-03. The deferral of payments made necessary due to the delay in securing authorization to issue tobacco bonds accounts for $3.8 billion of the $7.11 billion increase. Spending growth in welfare and HESC ($582 million and $210 million, respectively) results primarily from the loss of non-recurring Federal TANF reserve funds that had previously helped offset 2002-03 General Fund spending. Other State Funds spending growth includes increases in: General State Charges ($543 million) primarily due to higher pension and health insurance costs; Medicaid ($249 million) reflecting growth in program costs; and debt service ($349 million), reflecting planned growth in costs and additional bonding enacted by the Legislature. The remaining annual growth includes: legislative member items ($250 million), public health ($195 million), SUNY ($183 million), STAR ($171 million), transportation ($136 million), environmental conservation ($117 million) and children and family services ($105 million). ALL GOVERNMENTAL FUNDS All Governmental Funds includes activity in the four governmental fund types: the General Fund, Special Revenue Funds, Capital Projects Funds, and Debt Service funds. All Governmental Funds spending combines State Funds with Federal grants across these fund types. 2003-04 ALL GOVERNMENTAL FUND RECEIPTS (MILLIONS OF DOLLARS)
JULY OCTOBER CHANGE FROM ANNUAL UPDATE UPDATE JULY UPDATE CHANGE ---------------------------------------------------------------- Taxes 42,534 42,577 43 1,901 Miscellaneous Receipts 19,582 19,555 (27) 5,413 Federal Grants 34,913 36,190 1,277 2,934 TOTAL RECEIPTS 97,029 98,322 1,293 10,248
16 The increase in All Governmental Funds receipts of $1.29 billion over the July Update primarily reflects the receipt of Federal Emergency Management Agency (FEMA) reimbursement aid for World Trade Center costs ($1.17 billion), and the State Funds changes described above ($108 million). All Governmental Funds receipts are projected to be $98.32 billion in 2003-04, an increase of $10.25 billion or 11.6 percent from 2002-03. The growth in receipts is comprised of the State Funds increase of $7.97 billion discussed above, and additional growth of $2.29 billion in Federal grants. The annual increase in Federal grants primarily reflects the receipt of FEMA aid as described above ($1.13 billion) and higher projected Federal aid in support of the Medicaid program reflecting the temporary increase in the Federal matching rate ($1.01 billion) and program cost increases ($300 million). 2003-04 ALL GOVERNMENTAL FUNDS DISBURSEMENTS (MILLIONS OF DOLLARS)
JULY OCTOBER CHANGE FROM ANNUAL UPDATE UPDATE JULY UPDATE CHANGE --------------------------------------- 96,918 97,979 1,061 8,923
All Governmental Funds disbursements increased by $1.06 billion over the July Update due to FEMA aid that flowed through the State to New York City for costs incurred associated with the World Trade Center attacks ($885 million), and the State funds changes described above ($164 million). All Governmental Funds spending is projected to total $97.98 billion in 2003-04, an annual increase of $8.92 billion or 10 percent from 2002-03. All Governmental Funds Medicaid spending growth of $2.51 billion primarily reflects underlying spending growth ($1.40 billion), the temporary increase in the Federal matching rate ($1.01 billion), and increased aid for disproportionate share payments to public hospitals ($394 million), as well as the State Funds changes described above ($249 million). Also included in the annual increase is higher spending for public health ($475 million), largely related to the Child Health Plus program ($319 million), and welfare ($225 million), which reflects the State Funds increase described above ($582 million) partially offset by decreased Federal spending primarily due to the loss of one-time TANF aid that was used to support 2002-03 spending. All Governmental Funds spending growth largely attributable to State Funds spending includes growth for fringe benefits ($525 million), debt service ($349 million), legislative member items ($250 million), SUNY ($160 million), and STAR ($171 million). 17 MID-YEAR CASH-BASIS RESULTS GENERAL FUND CUMULATIVE GENERAL FUND CASH FLOW RESULTS APRIL 1, 2003 THROUGH SEPTEMBER 30, 2003 (MILLIONS OF DOLLARS)
FAVORABLE (UNFAVORABLE) JULY PLAN ACTUALS VARIANCE --------------------------------------------------------- Total Receipts 21,764 21,649 (115) Total Disbursements 20,316 19,905 411 Cash Balance 2,263 2,559 296
The General Fund ended the second quarter with a balance of $2.56 billion, $296 million higher than the estimate in the July Update to the Financial Plan. The variance primarily reflects timing delays in projected spending of $411 million partially offset by lower receipts of $115 million. Total General Fund receipts, including transfers from other funds, were $21.65 billion in the first six-months. On a net basis, receipts were $115 million lower than the July Update cash flow projections. This variance is primarily attributable to the delay in a transfer from the Dedicated Highway Fund ($118 million), lower sales and business taxes ($46 million) and lower gross personal income tax receipts ($21 million), which are partially offset by higher miscellaneous receipts ($29 million) and other taxes ($32 million). General Fund disbursements, including transfers to other funds, totaled $19.91 billion through the second quarter, and were $411 million lower than the estimate of disbursements in the July Update. This lower spending consists of slower than anticipated 2002-03 school year aid payments primarily for categorical aid programs to school districts ($178 million), timing delays in capital projects in the economic development, environment, education and general government areas ($113 million), and a delay in the receipt of Federal Medicaid disproportionate share monies which are then transferred to SUNY hospitals ($92 million). Almost all of these timing variances are expected to be paid by the end of December and should have no impact on year-end projections, with the exception of the pending Federal approval of the Medicaid State Plan Amendment to make additional intergovernmental transfers and disproportionate share (IGT/DSH) payments to public hospitals as discussed earlier in this document which could result in higher costs. STATE FUNDS Total State Funds receipts were $30.15 billion in the first six months of 2003-04 comprised of $20.48 billion in taxes and $9.67 billion in other receipts. State Funds tax receipts are projected to total $42.58 billion at year-end and all other receipts are projected to total $20.07 billion. State Funds receipts through September represent 48 percent of total year-end projections which is consistent with financial plan assumptions that closely mirror State Funds disbursements. 18 State Funds disbursements totaled $28.42 billion through the second quarter against projected year-end total disbursements of $62.86 billion. Disbursements through September from State Funds amount to 45 percent of total projected disbursements consistent with underlying cash flow assumptions which plan for the disbursement of substantially all of the STAR local tax relief payments, significant school aid payments and Medicaid payments supported by HCRA monies in the second half of the fiscal year. ALL GOVERNMENTAL FUNDS All Governmental Funds receipts totaled $48.81 billion in the first six months of 2003-04 comprised of $20.48 billion in taxes, $9.44 billion in miscellaneous receipts and $18.89 billion in Federal grants. All Governmental Funds receipts are projected to total $98.32 billion at year-end: $42.58 billion in taxes, $19.56 billion in miscellaneous receipts, and $36.19 billion in Federal grants. Total All Governmental Funds disbursements were $46.23 billion through September against projected year-end total disbursements of $97.98 billion. All Governmental Funds receipts and disbursements through September are consistent with cash flow assumptions made in development of the Financial Plan projections and represent 49 percent and 47 percent of total year-end estimates, respectively. GENERAL FUND CASH FLOW PROJECTIONS Actual month-end cash balances through September ranged from a low of $1.33 billion in August to a high of $2.79 billion in April. Total receipts through September included $2.20 billion in tobacco proceeds and $323 million in Federal revenue sharing received in June, which allowed for the repayment of all pending March 2003 payment delays totaling $1.9 billion. The General Fund closing balance on September 30, 2003 was $2.56 billion. General Fund intra-month daily balances can be supplemented with positive balances in other governmental funds as permitted by legislation included in the 2003-04 Enacted Budget that allows the State Comptroller to temporarily access balances in other funds to support the General Fund within a month. This process was utilized in September, as planned, to ensure intra-month payments continued in a timely manner. While the receipt of tobacco securitization proceeds and additional Federal aid has alleviated the tight monthly cash flow position experienced in the first six months of the 2003-04 State Fiscal Year, DOB continues to review cash balances on a daily basis and expects that cash flow in the early part of 2004-05 will have to be carefully monitored. The 2003-04 General Fund cash flow is projected to end the third quarter with a balance of $2.54 billion, an increase of $1.07 billion over the prior fiscal year. 19 DEBT REFORM ACT The Debt Reform Act of 2000 imposed phased-in caps that limit new debt outstanding to four percent of personal income and new debt service costs to five percent of total governmental funds receipts. To immediately constrain State debt levels, the Act applies to all new State-supported debt issued on and after April 1, 2000 (excluding certain refunding bonds). Section 23 of the State Finance Law requires the calculation of the caps imposed by the Act to be submitted with the Financial Plan Update most proximate to October 31 of each year. For the 2002-03 fiscal year, the debt outstanding and debt service caps are 1.65 percent each. As shown in the tables below, actual levels of debt outstanding and debt service costs continue to remain well below the limits imposed by the Act. DEBT OUTSTANDING CAP ($ IN MILLIONS) New Debt Outstanding $ 8,295 Personal Income (CY 2002) $ 684,070 Debt Outstanding (% of PI) 1.21% Cap Imposed by Debt Reform Act 1.65%
DEBT SERVICE CAP ($ IN MILLIONS) New Debt Service $ 470 Governmental Funds Receipts $ 90,174 Debt Service (% of Govn't Fund Receipts) 0.52% Cap Imposed by Debt Reform Act 1.65%
20 CASH FINANCIAL PLAN GENERAL FUND 2003-2004 (MILLIONS OF DOLLARS)
JULY CHANGE OCTOBER ---------- ---------- ---------- OPENING FUND BALANCE 815 0 815 ========== ========== ========== RECEIPTS: Taxes: Personal income tax 16,284 (8) 16,276 User taxes and fees 7,975 (11) 7,964 Business taxes 3,436 0 3,436 Other taxes 711 15 726 Miscellaneous receipts 5,547 0 5,547 Federal grants 645 0 645 Transfers from other funds: PIT in excess of Revenue Bond debt service 5,150 23 5,173 Sales tax in excess of LGAC debt service 1,960 0 1,960 Real estate taxes in excess of CW/CA debt service 199 11 210 All other 430 0 430 ---------- ---------- ---------- TOTAL RECEIPTS 42,337 30 42,367 ========== ========== ========== DISBURSEMENTS: Grants to local governments 29,584 45 29,629 State operations 7,142 0 7,142 General State charges 3,258 0 3,258 Transfers to other funds: Debt service 1,541 0 1,541 Capital projects 255 0 255 State university 145 0 145 Other purposes 497 (15) 482 ---------- ---------- ---------- TOTAL DISBURSEMENTS 42,422 30 42,452 ========== ========== ========== CHANGE IN FUND BALANCE (85) 0 (85) ========== ========== ========== CLOSING FUND BALANCE 730 0 730 ========== ========== ========== Tax Stabilization Reserve Fund 710 0 710 Contingency Reserve Fund 20 0 20
21 CASH FINANCIAL PLAN GENERAL FUND 2003-2004 (MILLIONS OF DOLLARS)
ENACTED CHANGE OCTOBER ---------- ---------- ---------- OPENING FUND BALANCE 815 0 815 ========== ========== ========== RECEIPTS: Taxes: Personal income tax 16,285 (9) 16,276 User taxes and fees 8,007 (43) 7,964 Business taxes 3,498 (62) 3,436 Other taxes 771 (45) 726 Miscellaneous receipts 5,569 (22) 5,547 Federal grants 0 645 645 Transfers from other funds: PIT in excess of Revenue Bond debt service 5,125 48 5,173 Sales tax in excess of LGAC debt service 1,853 107 1,960 Real estate taxes in excess of CW/CA debt service 202 8 210 All other 430 0 430 ---------- ---------- ---------- TOTAL RECEIPTS 41,740 627 42,367 ========== ========== ========== DISBURSEMENTS: Grants to local governments 29,835 (206) 29,629 State operations 7,205 (63) 7,142 General State charges 3,232 26 3,258 Transfers to other funds: Debt service 1,583 (42) 1,541 Capital projects 255 0 255 State university 145 0 145 Other purposes 482 0 482 ---------- ---------- ---------- TOTAL DISBURSEMENTS 42,737 (285) 42,452 ========== ========== ========== FISCAL MANAGEMENT PLAN/FEDERAL AID 912 (912) 0 ========== ========== ========== CHANGE IN FUND BALANCE (85) 0 (85) ========== ========== ========== CLOSING FUND BALANCE 730 0 730 ========== ========== ========== Tax Stabilization Reserve Fund 710 0 710 Contingency Reserve Fund 20 0 20
22 CASH FINANCIAL PLAN GENERAL FUND 2002-2003 AND 2003-2004 (MILLIONS OF DOLLARS)
2002-2003 2003-2004 ANNUAL ACTUAL OCTOBER CHANGE ---------- ---------- ---------- OPENING FUND BALANCE 1,032 815 (217) ========== ========== ========== RECEIPTS: Taxes: Personal income tax 16,791 16,276 (515) User taxes and fees 7,063 7,964 901 Business taxes 3,380 3,436 56 Other taxes 743 726 (17) Miscellaneous receipts 2,091 5,547 3,456 Federal grants 0 645 645 Transfers from other funds: PIT in excess of Revenue Bond debt service 4,215 5,173 958 Sales tax in excess of LGAC debt service 1,919 1,960 41 Real estate taxes in excess of CW/CA debt service 263 210 (53) All other 931 430 (501) ---------- ---------- ---------- TOTAL RECEIPTS 37,396 42,367 4,971 ========== ========== ========== DISBURSEMENTS: Grants to local governments 24,887 29,629 4,742 State operations 7,678 7,142 (536) General State charges 2,699 3,258 559 Transfers to other funds: Debt service 1,496 1,541 45 Capital projects 166 255 89 State university 26 145 119 Other purposes 661 482 (179) ---------- ---------- ---------- TOTAL DISBURSEMENTS 37,613 42,452 4,839 ========== ========== ========== CHANGE IN FUND BALANCE (217) (85) 132 ========== ========== ========== CLOSING FUND BALANCE 815 730 (85) ========== ========== ========== Tax Stabilization Reserve Fund 710 710 0 Contingency Reserve Fund 20 20 0 Community Projects Fund 85 0 (85)
NOTE: ACTUALS REFLECT THE AMOUNTS PUBLISHED IN THE COMPTROLLER'S CASH BASIS REPORT RELEASED ON JULY 29, 2003. 23 CURRENT STATE RECEIPTS GENERAL FUND 2002-2003 AND 2003-2004 (MILLIONS OF DOLLARS)
2002-2003 2003-2004 ANNUAL ACTUAL OCTOBER CHANGE ---------- ---------- ---------- PERSONAL INCOME TAX 16,791 16,276 (515) ---------- ---------- ---------- USER TAXES AND FEES: 7,063 7,964 901 ---------- ---------- ---------- Sales and use tax 6,328 7,250 922 Cigarette and tobacco taxes 446 415 (31) Motor vehicle fees 67 75 8 Alcoholic beverages taxes 180 182 2 Alcoholic beverage control license fees 42 42 0 BUSINESS TAXES: 3,380 3,436 56 ---------- ---------- ---------- Corporation franchise tax 1,407 1,388 (19) Corporation and utilities tax 860 755 (105) Insurance taxes 704 868 164 Bank tax 409 425 16 OTHER TAXES: 743 726 (17) ---------- ---------- ---------- Estate tax 701 692 (9) Gift tax 7 0 (7) Real property gains tax 5 2 (3) Pari-mutuel taxes 29 32 3 Other taxes 1 0 (1) TOTAL TAXES 27,977 28,402 425 ---------- ---------- ---------- MISCELLANEOUS RECEIPTS 2,091 5,547 3,456 ---------- ---------- ---------- FEDERAL GRANTS 0 645 645 ---------- ---------- ---------- TOTAL RECEIPTS 30,068 34,594 4,526 ========== ========== ==========
24 GENERAL FUND PERSONAL INCOME TAX COMPONENTS 2002-2003 AND 2003-2004 (MILLIONS OF DOLLARS)
2002-2003 2003-2004 ANNUAL ACTUAL OCTOBER CHANGE ---------- ---------- ---------- Withholdings 19,959 22,085 2,126 Estimated Payments 4,855 5,035 180 Final Payments 1,334 1,240 (94) Delinquencies 796 595 (201) ---------- ---------- ---------- GROSS COLLECTIONS 26,944 28,955 2,011 State/City Offset (288) (300) (12) Refund Reserve 1,050 84 (966) Refunds (4,008)(1) (4,230)(2) (222) ---------- ---------- ---------- REPORTED TAX COLLECTIONS 23,698 24,509 811 STAR (2,664) (2,835) (171) RBTF (4,243) (5,398) (1,155) ---------- ---------- ---------- GENERAL FUND 16,791 16,276 (515) ========== ========== ==========
Net personal income tax collections are affected by transactions in the tax refund reserve account. The tax refund reserve account is used to hold moneys designated to pay tax refunds. The Comptroller deposits receipts into this account at the discretion of the Commissioner of Taxation and Finance. The deposit of moneys into the account during a fiscal year has the effect of reducing receipts for the fiscal year, and the withdrawal of moneys from the account has the effect of increasing receipts in the fiscal year of withdrawal. The tax refund reserve account also includes amounts made available as a result of the LGAC financing program. Beginning in 1998-99, a portion of personal income tax collections is deposited directly in the School Tax Reduction (STAR) fund and used to make payments to reimburse local governments for their revenue decreases due to the STAR program. NOTE 1: REFLECTS THE PAYMENT OF THE BALANCE OF REFUNDS ON 2001 LIABILITY AND PAYMENT OF $960 MILLION OF CALENDAR YEAR 2002 REFUNDS IN THE LAST QUARTER OF THE STATE'S 2002-03 FISCAL YEAR AND A BALANCE IN THE TAX REFUND RESERVE ACCOUNT OF $627 MILLION. NOTE 2: REFLECTS THE PAYMENT OF THE BALANCE OF REFUNDS ON 2002 LIABILITY AND THE PROJECTED PAYMENT OF $960 MILLION OF CALENDAR YEAR 2003 REFUNDS IN THE LAST QUARTER OF THE STATE'S 2003-04 FISCAL YEAR AND A PROJECTED BALANCE IN THE TAX REFUND RESERVE ACCOUNT OF $543 MILLION. 25 CASH FINANCIAL PLAN STATE FUNDS 2003-2004 (MILLIONS OF DOLLARS)
SPECIAL CAPITAL DEBT GENERAL REVENUE PROJECTS SERVICE (MEMO) FUND FUNDS FUNDS FUNDS TOTAL ---------- ---------- ---------- ---------- ---------- OPENING FUND BALANCE 815 947 (560) 158 1,360 ========== ========== ========== ========== ========== RECEIPTS: Taxes 28,402 4,462 1,750 7,963 42,577 Miscellaneous receipts 5,547 9,943 3,232 702 19,424 Federal grants 645 1 0 0 646 ---------- ---------- ---------- ---------- ---------- TOTAL RECEIPTS 34,594 14,406 4,982 8,665 62,647 ========== ========== ========== ========== ========== DISBURSEMENTS: Grants to local governments 29,629 10,237 1,095 0 40,961 State operations 7,142 4,630 0 8 11,780 General State charges 3,258 410 0 0 3,668 Debt service 0 0 0 3,387 3,387 Capital projects 0 6 3,062 0 3,068 ---------- ---------- ---------- ---------- ---------- TOTAL DISBURSEMENTS 40,029 15,283 4,157 3,395 62,864 ========== ========== ========== ========== ========== OTHER FINANCING SOURCES (USES): Transfers from other funds 7,773 820 280 4,882 13,755 Transfers to other funds (2,423) (229) (947) (10,149) (13,748) Bond and note proceeds 0 0 248 0 248 ---------- ---------- ---------- ---------- ---------- NET OTHER FINANCING SOURCES (USES) 5,350 591 (419) (5,267) 255 ========== ========== ========== ========== ========== CHANGE IN FUND BALANCE (85) (286) 406 3 38 ========== ========== ========== ========== ========== CLOSING FUND BALANCE 730 661 (154) 161 1,398 ========== ========== ========== ========== ==========
THE SPECIAL REVENUE FUNDS OPENING FUND BALANCE HAS BEEN INCREASED BY $54 MILLION TO REFLECT THE RECLASSIFICATION OF THE EXPENDABLE AND NON-EXPENDABLE TRUST FUNDS FROM THE FIDUCIARY FUND TYPE TO THE SPECIAL REVENUE FUND TYPE PURSUANT TO GASB 34. 26 CASH FINANCIAL PLAN ALL GOVERNMENTAL FUNDS 2003-2004 (MILLIONS OF DOLLARS)
SPECIAL CAPITAL DEBT GENERAL REVENUE PROJECTS SERVICE (MEMO) FUND FUNDS FUNDS FUNDS TOTAL ---------- ---------- ---------- ---------- ---------- OPENING FUND BALANCE 815 1,039 (791) 158 1,221 ========== ========== ========== ========== ========== RECEIPTS: Taxes 28,402 4,462 1,750 7,963 42,577 Miscellaneous receipts 5,547 10,074 3,232 702 19,555 Federal grants 645 33,907 1,638 0 36,190 ---------- ---------- ---------- ---------- ---------- TOTAL RECEIPTS 34,594 48,443 6,620 8,665 98,322 ========== ========== ========== ========== ========== DISBURSEMENTS: Grants to local governments 29,629 40,388 1,312 0 71,329 State operations 7,142 7,922 0 8 15,072 General State charges 3,258 576 0 0 3,834 Debt service 0 0 0 3,387 3,387 Capital projects 0 6 4,351 0 4,357 ---------- ---------- ---------- ---------- ---------- TOTAL DISBURSEMENTS 40,029 48,892 5,663 3,395 97,979 ========== ========== ========== ========== ========== OTHER FINANCING SOURCES (USES): Transfers from other funds 7,773 3,302 280 4,882 16,237 Transfers to other funds (2,423) (2,671) (1,079) (10,149) (16,322) Bond and note proceeds 0 0 248 0 248 ---------- ---------- ---------- ---------- ---------- NET OTHER FINANCING SOURCES (USES) 5,350 631 (551) (5,267) 163 ========== ========== ========== ========== ========== CHANGE IN FUND BALANCE (85) 182 406 3 506 ========== ========== ========== ========== ========== CLOSING FUND BALANCE 730 1,221 (385) 161 1,727 ========== ========== ========== ========== ==========
THE SPECIAL REVENUE FUNDS OPENING FUND BALANCE HAS BEEN INCREASED BY $54 MILLION TO REFLECT THE RECLASSIFICATION OF THE EXPENDABLE AND NON-EXPENDABLE TRUST FUNDS FROM THE FIDUCIARY FUND TYPE TO THE SPECIAL REVENUE FUND TYPE PURSUANT TO GASB 34. 27 CURRENT STATE RECEIPTS ALL GOVERNMENTAL FUNDS 2002-2003 AND 2003-2004 (MILLIONS OF DOLLARS)
2002-2003 2003-2004 ANNUAL ACTUAL OCTOBER CHANGE ---------- ---------- ---------- PERSONAL INCOME TAX 23,698 24,509 811 ---------- ---------- ---------- USER TAXES AND FEES 10,804 11,906 1,102 ---------- ---------- ---------- Sales and use taxes 8,796 9,914 1,118 Cigarette and tobacco taxes 446 415 (31) Motor fuel tax 544 515 (29) Motor vehicle fees 612 651 39 Highway use tax 147 149 2 Alcoholic beverage taxes 180 182 2 Alcoholic beverage control license fees 42 42 0 Auto rental tax 37 38 1 BUSINESS TAXES 4,983 5,021 38 ---------- ---------- ---------- Corporation franchise tax 1,612 1,577 (35) Corporation and utilities taxes 1,091 964 (127) Insurance taxes 776 972 196 Bank tax 481 497 16 Petroleum business taxes 1,023 1,011 (12) OTHER TAXES 1,191 1,141 (50) ---------- ---------- ---------- Estate tax 701 691 (10) Gift tax 7 0 (7) Real property gains tax 5 2 (3) Real estate transfer tax 448 415 (33) Pari-mutuel taxes 29 32 3 Other taxes 1 1 0 TOTAL TAXES 40,676 42,577 1,901 ---------- ---------- ---------- MISCELLANEOUS RECEIPTS 14,148 19,555 5,407 ---------- ---------- ---------- FEDERAL GRANTS 33,250 36,190 2,940 ---------- ---------- ---------- TOTAL RECEIPTS 88,074 98,322 10,248 ========== ========== ==========
28 CASH FINANCIAL PLAN SPECIAL REVENUE FUNDS 2003-2004 (MILLIONS OF DOLLARS)
STATE FEDERAL TOTAL ---------- ---------- ---------- OPENING FUND BALANCE 947 92 1,039 ========== ========== ========== RECEIPTS: Taxes 4,462 0 4,462 Miscellaneous receipts 9,943 131 10,074 Federal grants 1 33,906 33,907 ---------- ---------- ---------- TOTAL RECEIPTS 14,406 34,037 48,443 ========== ========== ========== DISBURSEMENTS: Grants to local governments 10,237 30,151 40,388 State operations 4,630 3,292 7,922 General State charges 410 166 576 Debt service 0 0 0 Capital projects 6 0 6 ---------- ---------- ---------- TOTAL DISBURSEMENTS 15,283 33,609 48,892 ========== ========== ========== OTHER FINANCING SOURCES (USES): Transfers from other funds 820 2,482 3,302 Transfers to other funds (229) (2,442) (2,671) Bond and note proceeds 0 0 0 ---------- ---------- ---------- NET OTHER FINANCING SOURCES (USES) 591 40 631 ========== ========== ========== CHANGE IN FUND BALANCE (286) 468 182 ========== ========== ========== CLOSING FUND BALANCE 661 560 1,221 ========== ========== ==========
THE STATE SPECIAL REVENUE FUNDS OPENING FUND BALANCE HAS BEEN INCREASED BY $54 MILLION TO REFLECT THE RECLASSIFICATION OF THE EXPENDABLE AND NON-EXPENDABLE TRUST FUNDS FROM THE FIDUCIARY FUND TYPE TO THE SPECIAL REVENUE FUND TYPE PURSUANT TO GASB 34. 29 CASH FINANCIAL PLAN CAPITAL PROJECTS FUNDS 2003-2004 (MILLIONS OF DOLLARS)
STATE FEDERAL TOTAL ---------- ---------- ---------- OPENING FUND BALANCE (560) (231) (791) ========== ========== ========== RECEIPTS: Taxes 1,750 0 1,750 Miscellaneous receipts 3,232 0 3,232 Federal grants 0 1,638 1,638 ---------- ---------- ---------- TOTAL RECEIPTS 4,982 1,638 6,620 ========== ========== ========== DISBURSEMENTS: Grants to local governments 1,095 217 1,312 State operations 0 0 0 General State charges 0 0 0 Debt service 0 0 0 Capital projects 3,062 1,289 4,351 ---------- ---------- ---------- TOTAL DISBURSEMENTS 4,157 1,506 5,663 ========== ========== ========== OTHER FINANCING SOURCES (USES): Transfers from other funds 280 0 280 Transfers to other funds (947) (132) (1,079) Bond and note proceeds 248 0 248 ---------- ---------- ---------- NET OTHER FINANCING SOURCES (USES) (419) (132) (551) ========== ========== ========== CHANGE IN FUND BALANCE 406 0 406 ========== ========== ========== CLOSING FUND BALANCE (154) (231) (385) ========== ========== ==========
30 CASHFLOW GENERAL FUND 2003-2004 (MILLIONS OF DOLLARS)
APRIL MAY JUNE JULY AUGUST SEPTEMBER OCTOBER NOVEMBER DECEMBER -------- -------- -------- -------- -------- -------- -------- -------- -------- OPENING FUND BALANCE 815 2,786 2,151 1,989 1,466 1,331 2,559 3,245 2,825 ======== ======== ======== ======== ======== ======== ======== ======== ======== RECEIPTS: Taxes Personal income tax 2,811 244 1,545 1,214 1,126 1,791 1,345 1,034 233 Sales tax 450 461 692 547 557 813 567 574 815 User taxes and fees 103 74 40 73 52 65 49 50 55 Business taxes 56 (133) 728 58 42 787 41 1 809 Other taxes 49 93 33 60 67 96 48 52 55 Tobacco bond proceeds 0 0 2,202 0 0 0 0 0 1,598 Federal Grants 0 0 323 0 0 0 323 0 0 Miscellaneous receipts 70 55 116 94 81 187 137 290 102 Transfers from other funds 898 297 770 585 561 816 628 460 359 -------- -------- -------- -------- -------- -------- -------- -------- -------- TOTAL RECEIPTS 4,437 1,091 6,449 2,631 2,486 4,555 3,138 2,461 4,026 ======== ======== ======== ======== ======== ======== ======== ======== ======== Disbursements: Grants to local governments 1,462 604 5,426 1,834 1,723 1,703 1,557 1,871 2,973 State operations 743 799 648 845 606 634 504 656 728 General State charges 32 268 246 359 246 636 275 171 217 Transfers to other funds 229 55 291 116 46 354 116 183 397 -------- -------- -------- -------- -------- -------- -------- -------- -------- TOTAL DISBURSEMENTS 2,466 1,726 6,611 3,154 2,621 3,327 2,452 2,881 4,315 ======== ======== ======== ======== ======== ======== ======== ======== ======== CHANGE IN FUND BALANCE 1,971 (635) (162) (523) (135) 1,228 686 (420) (289) ======== ======== ======== ======== ======== ======== ======== ======== ======== CLOSING FUND BALANCE 2,786 2,151 1,989 1,466 1,331 2,559 3,245 2,825 2,536 ======== ======== ======== ======== ======== ======== ======== ======== ========
NOTE: REFLECTS ACTUALS THROUGH SEPTEMBER PUBLISHED IN THE COMPTROLLER'S MONTHLY REPORT ON STATE FUNDS CASH BASIS OF ACCOUNTING FOR SEPTEMBER 2003 AND DOB PROJECTIONS FOR OCTOBER THROUGH DECEMBER. 31 GAAP-BASIS FINANCIAL PLANS (Reprinted from August 7, 2003 Update to the AIS) DOB also prepares the General Fund and All Governmental Funds Financial Plans in accordance with Generally Accepted Accounting Principles (GAAP). The GAAP results for 2002-03 and the projections for 2003-04 are based on the accounting principles applied by the State Comptroller in the financial statements issued for the 2002-03 State Fiscal Year, and reflect the impact of GASB 34. GASB 34 has significantly changed the presentation of GAAP financial information for State and local governments. The changes are intended to portray the State's net overall financial condition, including activities that affect State assets and liabilities during the fiscal year. Based on the new GASB 34 presentation, the State has a net positive asset condition of $44.9 billion, a decrease of $5.5 billion from the prior year. In the General Fund, the State ended the 2002-03 fiscal year with an operating deficit of $4.22 billion. The operating result is primarily attributable to the use of $1.3 billion in cash reserves to balance the 2002-03 budget, a $1.0 billion decline in revenues as a result of the weak economy and lingering effects of the World Trade Center disaster, and the deferral of $1.9 billion in cash basis spending from 2002-03 until 2003-04. As a result of the operating deficit, the 2001-02 accumulated surplus (as restated) of $901 million has declined to a $3.32 billion accumulated deficit. The General Fund is anticipated to end the 2003-04 fiscal year with an operating surplus of $968 million on a GAAP-basis which is primarily attributable to the receipt of the tobacco bond proceeds originally anticipated in 2002-03 but received in 2003-04, partially offset by the use of cash reserves and other non-recurring actions in 2003-04. As a result, the accumulated deficit is projected to improve to $2.25 billion by the end of the 2003-04 fiscal year. CAPITAL PROGRAM AND FINANCING PLAN UPDATE (Reprinted from August 7, 2003 Update to the AIS) Section 22-c of the State Finance Law requires the Governor to update the five-year Capital Program and Financing Plan (the Plan) submitted with the Executive Budget by the later of July 30 or 90 days after the enactment of the State Budget. The updated 2003-04 through 2007-08 Capital Program and Financing Plan was released with the First Quarterly Update and can be obtained by contacting the Division of the Budget, State Capitol, Albany, NY 12224, (518) 473-8705, or by visiting its website at www.budget.state.ny.us. Total capital spending is projected to be $26.2 billion across the five years of the Plan, an average of $5.2 billion annually. Transportation continues to be largest area of spending, which is projected at $15.3 billion over the five-year Plan. Spending for the environment ($4 billion), education ($2.2 billion), mental hygiene ($1.5 billion), public protection ($1.3 billion), and economic development, housing and other programs ($1.9 billion) constitutes the remainder of the five-year Plan. 32 For 2003-04 through 2007-08, the Plan projects issuances of: $872 million in general obligation bonds; $5.3 billion in Dedicated Highway and Bridge Trust Fund Bonds issued by the Thruway Authority to finance capital projects for transportation; $955 million in Mental Health Facilities Improvement Revenue Bonds issued by DASNY to finance capital projects at mental health facilities; $276 million in SUNY Dormitory Facilities Revenue Bonds to finance capital projects related to student dormitories; and $7.9 billion in State Personal Income Tax Revenue Bonds to finance various capital programs including school construction, university facilities, SUNY community colleges, State court facilities, local highway improvements, prisons, housing, economic development and environmental programs, homeland security, and State facilities. The projections of State borrowings for the 2003-04 fiscal year are subject to change as market conditions, interest rates and other factors vary throughout the fiscal year. The Debt Reform Act of 2000 has improved the State's borrowing practices by imposing phased-in caps on new debt outstanding and new debt service costs, limiting the use of debt to capital works and purposes only, and establishing a maximum term of 30 years on such debt. The Debt Reform Act applies to all new State-supported debt issued on and after April 1, 2000. The most recent annual debt reform calculations show that the State was in compliance with both debt caps, with debt issued after March 31, 2000 and then outstanding at 0.67 percent of personal income and debt service on such debt at 0.36 percent of total governmental receipts as compared to the caps of 1.25 percent each. The State has also enacted statutory limits on the amount of variable rate obligations and interest rate exchange agreements that authorized issuers of State-supported debt may enter into. The statute limits the use of debt instruments which result in a variable rate exposure (e.g., variable rate obligations and interest rate exchange agreements) to no more than 15 percent of total outstanding State-supported debt, and limits the use of interest rate exchange agreements to a total notional amount of no more than 15 percent of total outstanding State-supported debt. All interest rate exchange agreements are subject to various statutory restrictions such as minimum counterparty ratings, monthly reporting requirements, and the adoption of interest rate exchange agreement guidelines. All the authorized issuers have adopted uniform guidelines as required by statute. As of March 31, 2003, there was approximately $1.9 billion in debt instruments resulting in a variable rate exposure. In addition, three authorized issuers entered into a total notional amount of $2.2 billion in interest rate exchange agreements, with a mark-to-market value of about $42 million. Both amounts are less than the authorized totals of 15 percent of total outstanding State-supported debt (about $5.8 billion each). SPECIAL CONSIDERATIONS The Financial Plan is necessarily based upon on forecasts of national and State economic activity. Economic forecasts have frequently failed to predict accurately the timing and magnitude of changes in the national and State economies. DOB believes that its current receipts and spending estimates related to the performance of the State and national economies are reasonable. However, there can be no assurance that actual results will not differ materially and adversely from the current forecast. 33 Labor contracts between the State and most State employee unions expired on March 31, 2003 and collective bargaining negotiations are ongoing. The Financial Plan contains no reserves to finance potential new costs related to any new labor agreements. DOB projects that every one percent increase in salaries for all State employees would result in a General Fund Financial Plan cost of approximately $80 million. DOB continues to forecast that the State's cash flow position will experience pressure in the first quarter of the 2004-05 fiscal year. A number of administrative options are available to DOB to manage General Fund cash flow needs during any fiscal year. The State is prohibited from issuing seasonal notes in the public credit markets to finance cash flow needs, unless the State satisfies certain restrictive conditions imposed under the LGAC statute and related bond covenants. For a discussion of the LGAC restrictions, see the section entitled "Debt and Other Financing Activities -- Local Government Assistance Corporation" in the AIS. On August 6, 2003, the LGAC board of directors, which is comprised of the LGAC chairperson, the State Comptroller, and the Director of DOB, unanimously approved a resolution objecting to the annual payments of $170 million to the City of New York and the refinancing of MAC bonds. The resolution directed LGAC to not participate in the New York City transaction, authorized the co-executive directors of LGAC to engage the services of litigation counsel, and declared that LGAC has no intention to pay such $170 million payments unless legal issues with the transaction (including but not limited to potential LGAC bond covenant violations) are resolved either by litigation or action by the Legislature. For an update on the status of this litigation, see the section entitled "Litigation" in this Update. The Federal government is currently auditing Medicaid claims submitted since 1993 under the school supportive health services program. At this point, these audits have not been finalized, and, as a result, the liability of the State and/or school districts for any disallowances that may result from these audits cannot be determined. Federal regulations include an appeals process that could postpone repayment of any disallowances. In addition, as of September 2003, nearly $300 million in Federal Medicaid payments related to school supportive health services have been deferred by the Federal Centers for Medicare and Medicaid Services. Since the State has continued to reimburse school districts for these costs, these Federal deferrals, if not resolved, could result in a Medicaid cash shortfall, potentially creating a need for additional State support in the short-term. New York State continues to await Federal approval of the Medicaid State Plan Amendment necessary to make planned payments totaling roughly $1.1 billion (half funded by the Federal government) to public hospitals throughout the State, including New York City Health and Hospitals Corporation, State University of New York hospitals, and other State and county operated facilities. 34 The current State Financial Plan assumes no significant Federal disallowances or other Federal actions that could adversely affect State finances. As a result, there can be no assurance that the State's budget projections for 2003-04 will not differ materially and adversely from the projections set forth at this time. 35 PART II PART II OF THIS UPDATE CONTAINS REPRINTED INFORMATION ON GAAP-BASIS RESULTS FOR FISCAL YEAR 2002-03 THAT APPEARED IN THE AUGUST 7, 2003 UPDATE TO THE AIS. IT ALSO CONTAINS UPDATED DISCLOSURE ON THE STATE RETIREMENT SYSTEM, THE METROPOLITAN TRANSPORTATION AUTHORITY, AND THE CITY OF NEW YORK. GAAP-BASIS RESULTS FOR PRIOR FISCAL YEARS (Reprinted from August 7, 2003 Update to the AIS) On July 29, 2003, the State Comptroller issued the Basic Financial Statements and Other Supplementary Information (the 2002-03 Basic Financial Statements) for the 2002-03 fiscal year. The 2002-03 Basic Financial Statements were prepared in accordance with GASB 34 and other applicable GASB statements. The 2002-03 Basic Financial Statements can be obtained by visiting the Office of the State Comptroller's website, www.osc.state.ny.us, or by contacting the Office of the State Comptroller, 110 State Street, Albany, NY 12236. For a brief summary of the 2002-03 GAAP-basis results, see the section entitled "GAAP-basis Financial Plans" in Part I of this Update. STATE ORGANIZATION STATE RETIREMENT SYSTEMS GENERAL The New York State and Local Retirement Systems (the "Systems") provide coverage for public employees of the State and its localities (except employees of New York City and teachers, who are covered by separate plans). The Systems comprise the New York State and Local Employees Retirement System and the New York State and Local Police and Fire Retirement System. The Comptroller is the administrative head of the Systems. State employees made up about 34 percent of the membership during the 2002-03 fiscal year. There were 2,818 other public employers participating in the Systems, including all cities and counties (except New York City), most towns, villages and school districts (with respect to non-teaching employees) and a large number of local authorities of the State. As of March 31, 2003, 650,543 persons were members and 313,597 pensioners or beneficiaries were receiving benefits. The State Constitution considers membership in any State pension or retirement system to be a contractual relationship, the benefits of which shall not be diminished or impaired. Members cannot be required to begin making contributions or make increased contributions beyond what was required when membership began. 36 CONTRIBUTIONS Funding is provided in large part by employer and employee contributions. Employers contribute on the basis of the plan or plans they provide for members. Members joining since mid-1976, other than police and fire members, are required to contribute 3 percent of their salaries for their first 10 years of membership. Legislation enacted in May, 2003 realigns the Retirement Systems billing cycle to match governments' budget cycles and the legislation also institutes a minimum annual payment. The employer contribution for a given fiscal year will be based on the value of the pension fund and its liabilities on the prior April 1. In addition, employers will be required to make a minimum contribution of at least 4.5 percent of payroll every year. The legislation also eliminates the State's ability to delay payments when the amounts owed are greater than the amount budgeted, effective in fiscal year 2004-2005. Also, a portion of the 2004-2005 bill may be amortized over a five-year period at 8 percent interest with the first payment due in 2004-05. Due to the enactment of this legislation, the State bill due in the fiscal year ending March 31, 2004, payable September 1, 2003, was $481.5 million, of which $396.3 million was paid. The difference with 8 percent interest will be due on or before March 1, 2006. Employer contributions due from the State for the fiscal year ending March 31, 2005, payable September 1, 2004, are estimated at $1.15 billion or $797 million if the maximum amount is amortized. ASSETS AND LIABILITIES Assets are held exclusively for the benefit of members, pensioners and beneficiaries. Investments for the Systems are made by the Comptroller as trustee of the Common Retirement Fund, a pooled investment vehicle. OSC reports the net assets available for benefits as of March 31, 2003 were $97.4 billion (including $2.3 billion in receivables), a decline of $15.3 billion or 13.6 percent from the 2001-02 level of $112.7 billion, reflecting, in large part, equity market performance. OSC reports that the present value of anticipated benefits for current members, retirees, and beneficiaries as of March 31, 2003 was $130.5 billion (including $46.1 billion for current retirees and beneficiaries), an increase of $3.5 billion or 2.8 percent from the 2001-02 level of $127 billion. The funding method used by the Systems anticipates that the net assets, plus future actuarially determined contributions, will be sufficient to pay for the anticipated benefits of current members, retirees and beneficiaries. Actuarially determined contributions are calculated using actuarial assets and the present value of anticipated benefits. Actuarial assets differ from net assets in that they are calculated using a five-year smoothing method for valuing equity investments and using amortized cost instead of market value for bonds and mortgages. Actuarial assets decreased from $125.2 billion in 2002 to $106.7 billion on March 31, 2003. The table below shows the actuarially determined contributions that have been made over the last six years. See also "Contributions" above. 37 NET ASSETS AVAILABLE FOR BENEFITS OF THE NEW YORK STATE AND LOCAL RETIREMENT SYSTEMS(1) (MILLIONS OF DOLLARS)
INCREASE/ FISCAL YEAR ENDED (DECREASE) MARCH 31 TOTAL ASSETS(2) FROM PRIOR YEAR -------------------------------------------------------------- 1998 106,319 26.7 1999 112,723 6.0 2000 128,889 14.3 2001 114,044 (11.5) 2002 112,725 (1.2) 2003 97,373 (13.6)
---------- (1) Includes relatively small amounts held under Group Life Insurance Plan. Includes some employer contribution receivables. Fiscal year ending March 31, 2003 includes approximately $2.3 billion of receivables. (2) Includes certain accrued employer contributions to be paid with respect to service rendered during fiscal years other than the year shown. CONTRIBUTIONS AND BENEFITS NEW YORK STATE AND LOCAL RETIREMENT SYSTEMS (MILLIONS OF DOLLARS)
ENDED ALL PARTICIPATING LOCAL BENEFITS MARCH 31 EMPLOYERS(1) EMPLOYERS(1) STATE(1) EMPLOYEES PAID(2) -------- ----------------- ------------ -------- --------- -------- 1998 463 358 105 369 3,395 1999 292 156 136 400 3,570 2000 165 11 154 423 3,787 2001 215 112 103 319 4,267 2002 264 199 65 210 4,576 2003 652 378 274 219 5,030
---------- Sources: State and Local Retirement Systems. (1) Includes employer premiums to Group Life Insurance Plan. (2) Includes payments from Group Life Insurance Plan. 38 AUTHORITIES AND LOCALITIES METROPOLITAN TRANSPORTATION AUTHORITY THE FOLLOWING INFORMATION WAS PREPARED FROM INFORMATION FURNISHED BY THE METROPOLITAN TRANSPORTATION AUTHORITY (MTA) AND IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY. THIS SECTION IS INTENDED TO PROVIDE READERS WITH A BRIEF SUMMARY OF STATE OVERSIGHT AND FINANCIAL ASSISTANCE TO THE MTA. THE OFFICIAL FINANCIAL DISCLOSURE OF THE MTA AND ITS SUBSIDIARIES IS AVAILABLE BY CONTACTING THE METROPOLITAN TRANSPORTATION AUTHORITY, FINANCE DEPARTMENT, 347 MADISON AVENUE, 6TH FLOOR, NEW YORK, NEW YORK 10017 OR BY VISITING THE MTA WEBSITE AT www.mta.info/mta/investor.htm. THE STATE ASSUMES NO LIABILITY OR RESPONSIBILITY FOR ANY FINANCIAL INFORMATION REPORTED BY THE MTA OR FOR ANY ERRORS OR OMISSIONS THAT MAY BE CONTAINED AT THE MTA WEBSITE. The MTA oversees the operation of subway and bus lines in New York City by its affiliates, the New York City Transit Authority and the Manhattan and Bronx Surface Transit Operating Authority (collectively, the TA). The MTA operates certain commuter rail and bus services in the New York metropolitan area through the MTA's subsidiaries, the Long Island Rail Road Company, the Metro North Commuter Railroad Company, and the Metropolitan Suburban Bus Authority. In addition, the Staten Island Rapid Transit Operating Authority, an MTA subsidiary, operates a rapid transit line on Staten Island. Through its affiliated agency, the Triborough Bridge and Tunnel Authority (TBTA), the MTA operates certain intrastate toll bridges and tunnels. Because fare revenues are not sufficient to finance the mass transit portion of these operations, the MTA has depended on, and will continue to depend on, operating support from the State, local governments and TBTA, including loans, grants and subsidies. If current revenue projections are not realized and/or operating expenses exceed current projections, the MTA may be required to seek additional State assistance, raise fares or take other actions. The MTA Board has approved a financial plan for the years 2003 and 2004 for itself and its affiliates and subsidiaries (the 2003-04 Financial Plan) that will enable all such entities to maintain their respective operations on a self-sustaining basis through 2004. The 2003-04 Financial Plan tracks the final two years of the 2000-2004 Capital Programs of the transit and commuter systems (the 2000-2004 Capital Programs) that were approved by the Capital Program Review Board. As part of the 2003-04 Financial Plan, fares on the transit and commuter systems and tolls on TBTA's bridges and tunnels were increased in May 2003. Legal challenges to the fare and toll increases were unsuccessful. On October 28, 2003 the MTA released a revised 2003 budget and a four-year Financial Plan for itself and its affiliates and subsidiaries for 2004 - 2007. This Plan expects balanced budgets for 2003 and 2004. The Plan anticipates budget gaps of $840 million in 2005, $1.34 billion in 2006 and $1.45 billion in 2007. The MTA will solicit wide-ranging comment from the public and elected officials and submit a revised final 2004 budget and 2005 - 2007 Financial Plan to its Board in late December 2003. 39 On May 4, 2000, the Capital Program Review Board approved the MTA's $17.1 billion 2000-2004 Capital Programs. Other amendments were subsequently approved raising the total of the programs to $17.9 billion. The 2000-2004 Capital Programs are the fifth approved capital plan since the Legislature authorized procedures for the adoption, approval and amendment of MTA capital programs and is designed to upgrade the performance of the MTA's transportation systems by investing in new rolling stock, maintaining replacement schedules for existing assets, bringing the MTA system into a state of good repair, and making major investments in system expansion projects such as the Second Avenue Subway project and the East Side Access project. The 2000-2004 Capital Programs approved by the Capital Program Review Board assume the issuance of an estimated $10.6 billion in new money MTA bonds. The remainder of the plan is projected to be financed with assistance from the Federal government, the State, The City of New York, and from various other revenues generated from actions taken by the MTA. Since 1980, the State has enacted several taxes including a surcharge on the profits of banks, insurance corporations and general business corporations doing business in the 12-county Metropolitan Transportation Region served by the MTA and a special one-quarter of one percent regional sales and use tax that provide revenues for mass transit purposes, including assistance to the MTA. Since 1987, State law also has required that the proceeds of a one-quarter of one percent mortgage recording tax paid on certain mortgages in the Metropolitan Transportation Region be deposited in a special MTA fund for operating or capital expenses. In 1993, the State dedicated a portion of certain additional petroleum business tax receipts to fund operating or capital assistance to the MTA. The 2000-01 Enacted Budget initiated a five-year State transportation plan that included nearly $2.2 billion in dedicated revenue support for the MTA's 2000-2004 Capital Programs. This capital commitment includes approximately $800 million of newly dedicated State petroleum business tax revenues, motor vehicle fees, and motor fuel taxes not previously dedicated to the MTA. State legislation accompanying the 2000-01 Enacted Budget increased the aggregate bond cap for the MTA, TBTA and TA to $16.5 billion in order to finance a portion of the 2000-2004 Capital Programs. There can be no assurance that all the necessary governmental actions for the current or future capital programs will be taken or that funding sources currently identified will not be decreased or eliminated. As appropriate, the MTA and the Capital Program Review Board may amend the 2000-2004 Capital Programs from time to time to reflect the level of funding available to pay for the capital projects anticipated to be undertaken during the time period covered by the approved programs. If the 2000-2004 Capital Programs are delayed or reduced, ridership and fare revenue may decline, which could impair the MTA's ability to meet its operating expenses without additional State assistance. THE CITY OF NEW YORK THE FOLLOWING INFORMATION WAS PREPARED FROM INFORMATION FURNISHED BY THE CITY OF NEW YORK AND IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY. THIS SECTION IS INTENDED TO PROVIDE READERS WITH A BRIEF SUMMARY OF THE FINANCIAL CONDITION OF THE CITY OF NEW YORK, WHICH IS THE LARGEST MUNICIPAL RECIPIENT OF STATE ASSISTANCE TO LOCAL GOVERNMENTS. THE FISCAL DEMANDS ON THE STATE MAY BE AFFECTED BY THE FISCAL CONDITION OF THE CITY, WHICH RELIES IN PART ON STATE AID TO BALANCE ITS BUDGET AND MEET ITS CASH REQUIREMENTS. IT IS ALSO POSSIBLE THAT THE STATE'S FINANCES MAY BE AFFECTED BY THE ABILITY OF THE CITY, AND CERTAIN ENTITIES ISSUING DEBT FOR THE BENEFIT OF THE CITY, TO MARKET SECURITIES SUCCESSFULLY IN THE PUBLIC CREDIT MARKETS. THE OFFICIAL FINANCIAL DISCLOSURE OF THE CITY OF NEW YORK AND FINANCING ENTITIES ISSUING DEBT ON ITS BEHALF IS AVAILABLE BY CONTACTING RAYMOND J. ORLANDO, DIRECTOR OF INVESTOR RELATIONS, OR CONTACTING THE NEW YORK CITY OFFICE OF MANAGEMENT AND BUDGET, 75 PARK PLACE, 6TH FLOOR, NEW YORK, NY 10007, (212) 788-5875. THE STATE ASSUMES NO LIABILITY OR RESPONSIBILITY FOR ANY FINANCIAL INFORMATION REPORTED BY THE CITY OF NEW YORK. 40 On June 30, 2003, the City submitted to the State Financial Control Board (the "Control Board") the Financial Plan for the 2003 through 2007 fiscal years, which relates to the City and certain entities which receive funds from the City, and which reflects changes as a result of the City's expense and capital budgets for the 2004 fiscal year which were adopted on June 27, 2003. The Financial Plan is a modification to the financial plans submitted to the Control Board on November 18, 2002, January 31, 2003 and April 23, 2003. The Financial Plan projects revenues and expenditures for the 2003 and 2004 fiscal years balanced in accordance with GAAP, and projects gaps of $2.0 billion, $3.2 billion, and $3.3 billion for fiscal years 2005, 2006, and 2007, respectively. The current Financial Plan reflects changes since the June Financial Plan which decreased projected revenues, by $821 million, $2.3 billion, $2.2 billion and $2.0 billion in fiscal years 2003 through 2006, respectively, and increased projected net expenditures by $1.3 billion, $1.3 billion and $1.6 billion in fiscal years 2004 through 2006, respectively. Changes in projected revenues include a decline in projected tax revenues of $621 million, $1.6 billion, $1.8 billion and $1.9 billion in fiscal years 2003 through 2006, respectively, reflecting primarily decreases in projected personal income, business and sales tax revenues, as well as the elimination of previously assumed non-tax revenues. The decline in projected tax revenue growth reflects the September 11th attack and a continued weak economy, which has resulted in lower wage earnings, lower corporate earnings, local job losses exceeding 117,000 in 2002 and 20,000 in the first half of 2003, a disruption in tourism and related spending and the decline in financial services sector profits and employee income. Changes in projected expenditures since the June Financial Plan include: (i) increased pension costs totaling $213 million, $369 million and $541 million for fiscal years 2004 through 2006, respectively, resulting primarily from additional pension benefits and investments losses in fiscal year 2002, partially offset by projected investment gains in fiscal year 2003; and (ii) the elimination of $223 million, $296 million, $291 million and $412 million of previously assumed labor productivity initiatives in fiscal years 2003 through 2006, respectively. In addition, the City will receive $232 million over the next five years generated by the Battery Park City Authority's (BPCA) recent bond refunding. Of this amount, the City will receive $68 million in fiscal year 2004, which is in addition to the $150 million reflected in the City's Financial Plan from the sale of City-owned land to BPCA. Changes in projected expenditures also include increased agency spending, increased costs for settling claims against the City, increased health and welfare spending primarily for Medicaid, increased debt service costs, an increase in the labor reserve and funding for capital expenditures. The Financial Plan also includes proposed discretionary transfers and prepayments in fiscal year 2003 of $1.3 billion, reflecting discretionary transfers and prepayments in fiscal year 2003 of $679 million in debt service, subsidies and lease debt service due in fiscal year 2004 and a miscellaneous budget grant of $624 million to the Transitional Finance Authority in fiscal year 2003, which increases tax revenue in fiscal year 2004 by $624 million. 41 The gap-closing program included in the Financial Plan reflects: (i) the enacted 18.49 percent property tax increase, effective January 1, 2003, which is projected to continue to generate $837 million, $1.7 billion, $1.8 billion and $1.9 billion in fiscal years 2003 through 2006, respectively, and (ii) a gap-closing program to reduce agency expenditures (including debt service savings reflecting a 24 percent reduction in capital commitments) and increase agency revenues by $950 million in fiscal year 2003 and by between $2.1 billion and $2.2 billion annually in subsequent fiscal years. The gap-closing program included in the Financial Plan also reflects: (i) an enacted increase in the personal income tax rates (which decline after the first year) for City residents with taxable income above specified amounts for three years, commencing January 1, 2003, which is projected to generate $644 million, $545 million and $315 million in fiscal years 2004 through 2006, respectively; (ii) an enacted increase in the City portion of the sales tax by one-eighth percent for two years, commencing in June 2003, which is proposed to generate $115 million and $111 million in fiscal years 2004 and 2005, respectively; (iii) the repeal, beginning June 1, 2003, of the sales tax exemption on the purchase of clothing and footwear under $110 for one year with two one-week periods of exemption which is expected to generate $192 million in fiscal year 2004; (iv) legislation enacted by the State Legislature pursuant to which LGAC is to make available to the City $170 million annually which the City intends to assign to a newly-created financing entity for the purpose of refinancing outstanding indebtedness of the Municipal Assistance Corporation for the City of New York (MAC) which would make available to the City approximately $500 million annually in fiscal years 2004 through 2008 by reducing the amount of City revenues retained for MAC debt service; (v) $200 million, $583 million and $96 million in fiscal years 2004 through 2006, respectively, of back rent and renegotiated future lease payments for the City's airports, which is subject to the settlement of the City's claim for back rent and the renegotiation of the City's airport leases; and (vi) additional Federal assistance and additional State assistance which requires the approval of the State government. Additional Federal gap-closing actions in the Financial Plan include $420 million in fiscal year 2003 (in addition to the $230 million previously provided) to reimburse the City for costs related to the September 11th attack and increased Federal funding for Medicaid which is expected to generate approximately $290 million for the City over the fifteen months ending June 30, 2004. The additional State actions proposed in the Financial Plan include a proposed regional transportation initiative which would produce savings for the City totaling $75 million in fiscal year 2004 and approximately $150 million annually in each of fiscal years 2005 and 2006 by transferring responsibility for the local private bus system to the Metropolitan Transportation Authority. Subsequent to the passage of the State budget by the State Legislature, the Governor vetoed significant portions of the budget and other legislation providing City assistance, including legislation relating to the increase in the in the City personal income tax and the sales tax, the proposed $170 million annual payment by LGAC that the City intends to use to pay for MAC debt and the restoration of State education aid. In his veto message, the Governor raised questions as to the constitutionality of the mandated annual $170 million payment. On May 15 and May 19, 2003, the State Legislature overrode the Governor's vetoes. On August 6, 2003 the LGAC directors adopted a resolution stating that LGAC would not make the $170 million annual payment to the City, expressing legal and policy concerns with the legislation. 42 On August 13, 2003, LGAC, its Chairperson, the State Division of the Budget and its Director sued the City and the Sales Tax Asset Receivable Corporation (STAR Corp.) seeking to prevent the issuance of bonds by STAR Corp., the local development corporation expected to finance the cost of debt service on MAC debt otherwise payable from City sales tax revenues. STAR Corp. debt is expected to be paid from the annual payment of $170 million from LGAC which the City would assign to STAR Corp. The State Supreme Court granted the City's and STAR Corp.'s motion for summary judgment. Plaintiffs appealed that decision to the State Appellate Division which had previously issued a preliminary injunction preventing STAR Corp. from issuing its bonds pending appeal. The appeal is expected to be heard in November. The outcome of this litigation cannot be predicted with certainty. If the $500 million in annual savings in MAC debt service for fiscal years 2004 through 2008 from the STAR Corp. financing is not available to the City, the City would be forced to reduce expenditures or increase revenues to maintain balanced operating results for fiscal year 2004 and would be faced with larger than forecast budget gaps in the subsequent years of the Financial Plan. The Financial Plan does not make any provision for wage increases, other than the pay increases for the 2000-2002 round of bargaining and pay increases to be funded by productivity initiatives. It is estimated that each one percent wage increase for all City employees for subsequent contract periods would cost approximately $212 million annually (including benefits). The City Comptroller and others have issued reports identifying various risks. In addition, the economic and financial condition of the City may be affected by various financial, social, economic, geo-political and other factors which could have a material effect on the City. On October 3, 2003, the City's Office of Management and Budget directed City agencies to detail how they would sustain a three percent reduction in City-funded expenditures, with the goal of achieving budgetary savings of $300 million in fiscal year 2004. On October 15, 2003, the Mayor and the Governor announced that the City and the Port Authority of New York and New Jersey (the "Port Authority") had reached an agreement to extend the current lease on John F. Kennedy International and LaGuardia airports through 2050. The agreement secures a minimum upfront payment to the City of approximately $700 million and a minimum annual rent payment of $93.5 million. The upfront payment, which consists of an approximately $500 million lump sum payment and the annual rent payments for 2002 and 2003, is expected to be received late in fiscal year 2004 or in fiscal year 2005. This agreement is subject to the approval of the Port Authority Board and other closing conditions. 43 MONITORING AGENCIES On July 30, 2003, the City Comptroller released a report on the Financial Plan that identified risks for the fiscal years 2004 through 2007, respectively, which, when added to the gaps in the Financial Plan, result in gaps of $484 million, $3.0 billion, $3.9 billion and $3.9 billion in fiscal years 2004 through 2007, respectively. On July 24, 2003, the Office of the State Deputy Comptroller issued a report on the Financial Plan that identified net risks of $367 million, $806 million, $401 million and $423 million for fiscal years 2004 through 2007, respectively. On July 24, 2003, the staff of the Control Board issued a report reviewing the Financial Plan that identified net risks of $154 million, $775 million, $291 million and $313 million for fiscal years 2004 through 2007, respectively, which, when combined with the gaps projected in the Financial Plan, result in estimated gaps of $154 million, $2.8 billion, $3.5 billion and $3.6 billion for fiscal years 2004 through 2007, respectively. The staffs of the FCB, OSDC, the City Comptroller and the Independent Budget Office, issue periodic reports on the City's financial plans. Copies of the most recent reports are available by contacting: FCB, 123 William Street, 23rd Floor, New York, NY 10038, Attention: Executive Director; Independent Budget Officer, OSDC, 59 Maiden Lane, 29th Floor, New York, NY 10038, Attention: Deputy Comptroller; City Comptroller, Municipal Building, 6th Floor, One Centre Street, New York, NY 10007-2341, Attention: Deputy Comptroller for Budget; and IBO, 110 William Street, 14th Floor, New York, NY 10038, Attention: Director. 44 PART III LITIGATION LOCAL GOVERNMENT ASSISTANCE CORPORATION In LOCAL GOVERNMENT ASSISTANCE CORPORATION ET AL. V. SALES TAX ASSET RECEIVABLE CORPORATION AND THE CITY OF NEW YORK (Supreme Court, Albany County), the petitioners challenge, INTER ALIA, the constitutionality of Public Authorities Law section 3238-a, which requires LGAC to annually transfer $170 million to The City of New York. Section 3238-a was enacted in 2003 as part of legislation (Part A4 of Chapter 62 and Part V of Chapter 63 of the Laws of 2003) authorizing the refinancing of debt incurred by the Municipal Assistance Corporation (the MAC Refinancing Act). By decision and order dated September 17, 2003, the court held that the MAC Refinancing Act was constitutional. Petitioners have appealed from the decision and order to the Appellate Division, Third Department. By decision and order entered August 27, 2003, the Appellate Division, Third Department granted a preliminary injunction restraining defendants, INTER ALIA, from issuing any bonds pursuant to the MAC Refinancing Act pending appeal. SCHOOL AID In CAMPAIGN FOR FISCAL EQUITY, INC. ET AL. V. STATE, ET AL. (Supreme Court, New York County), plaintiffs challenge the State's method of providing funding for New York City public schools. Plaintiffs seek a declaratory judgment that the State's public school financing system violates article 11, section 1 of the State Constitution and Title VI of the Federal Civil Rights Act of 1964 and injunctive relief that would require the State to satisfy State Constitutional standards. This action was commenced in 1993. In 1995, the Court of Appeals affirmed the dismissal of claims under the equal protection clauses of the Federal and State constitutions and Title VI of the Federal Civil Rights Act of 1964. It reversed dismissal of the claims under article 11, section 1 of the State Constitution and implementing regulations of Title VI, and remanded these claims for trial. By decision dated January 9, 2001, following trial, the trial court held that the State's education funding mechanism does not provide New York City students with a "sound basic education" as required by the State Constitution, and that it has a disparate impact on plaintiffs in violation of regulations enacted by the U.S. Department of Education pursuant to Title VI of the Civil Rights Act of 1964. The court ordered that defendants put in place reforms of school financing and governance designed to redress those constitutional and regulatory violations, but did not specify the manner in which defendants were to implement these reforms. The State appealed, and the trial court's decision was stayed pending resolution of the appeal. By decision and order entered June 25, 2002, the Appellate Division, First Department, reversed the January 9, 2001 decision and dismissed the claim in its entirety. On July 22, 2002, the plaintiffs filed a notice of appeal to the decision and order to the Court of Appeals. By decision dated June 26, 2003, the Court of Appeals reversed that portion of the June 25, 2002 decision and order of the Appellate Division, First Department relating to the claims arising under the State Constitution. The Court held that the weight of the credible evidence supported the trial court's conclusion that New York City schoolchildren were not receiving the constitutionally mandated opportunity for a sound basic education and further held that the plaintiffs had established a causal link between the present education funding system and the failure to provide said sound basic education. The Court remitted the case to the trial court for further proceedings in accordance with its decision. 45 MEDICAID Several cases challenge provisions of Chapter 81 of the Laws of 1995 which alter the nursing home Medicaid reimbursement methodology on and after April 1, 1995. Included are NEW YORK STATE HEALTH FACILITIES ASSOCIATION, ET AL., V. DEBUONO, ET AL., ST. LUKE'S NURSING CENTER, ET AL. V. DEBUONO, ET AL., NEW YORK ASSOCIATION OF HOMES AND SERVICES FOR THE AGING V. DEBUONO, ET AL. (THREE CASES), HEALTHCARE ASSOCIATION OF NEW YORK STATE V. DEBUONO AND BAYBERRY NURSING HOME ET AL. V. PATAKI, ET AL. Plaintiffs allege that the changes in methodology have been adopted in violation of procedural and substantive requirements of State and Federal law. In a decision dated June 3, 2003, involving seven consolidated cases (MATTER OF ST. JAMES NURSING HOME V. DEBUONO), the Supreme Court, Albany County, partially granted petitioners claims that the State violated the procedural requirements of the Boren Amendment and directed the State to recalculate the Medicaid rates associated with State Plan Amendment 95-23. The court dismissed petitioners' claims as to the Medicaid rates associated with State Plan Amendments 95-24 and 96-24. The State has appealed from this decision. In related cases, NEW YORK ASSOCIATION OF HOMES AND SERVICES FOR THE AGING, INC. V. NOVELLO, ET AL., VALLEY HEALTH SERVICES V. STATE AND CHARLES T. SITRIN HEALTH CARE CENTER, INC., ET AL. V. SONY, ET AL., plaintiffs seek judgments declaring as unconstitutional, under provisions of the Constitutions of the United States and the State, amendments to Public Health Law Section 2907-d, enacted as part of Chapter 1 of the Laws of 2002, also known as the Health Care Workforce Recruitment & Retention Act of 2002, or "HCRA 2002," which impose a 6 percent assessment on nursing home gross receipts from patient care services and operating income. In a decision dated April 24, 2003, the Court granted summary judgment to defendants dismissing the SITRIN case. Plaintiffs have appealed from this decision. EMPIRE CONVERSION In CONSUMERS UNION OF U.S., INC. V. STATE, plaintiffs challenge the constitutionality of those portions of Chapter 1 of the Laws of 2002 which relate to the authorization of the conversion of Empire Health Choice, d/b/a Empire Blue Cross and Blue Shield from a not-for-profit corporation to a for-profit corporation. Chapter 1 requires, in part, that upon such conversion, assets representing 95 percent of the fair market value of the not-for-profit corporation be transferred to a fund designated as the "public asset fund" to be used for the purpose set forth in Section 7317 of the Insurance Law. The State and private defendants have separately moved to dismiss the complaint. On November 6, 2002, the Supreme Court, New York County, granted a temporary restraining order, directing that the proceeds from the initial public offering of the for-profit corporation be deposited with the State Comptroller in an interest-bearing account, pending the hearing of a motion for a preliminary injunction, which WAS returnable simultaneously with the motions to dismiss, on November 26, 2002. 46 By decision dated February 28, 2003, the Supreme Court, New York County, granted the defendants' motions to dismiss. In its decision, the court also granted plaintiffs leave to amend their complaint to assert a new cause of action and deferred decision on plaintiffs' motion for a preliminary injunction. The plaintiffs and defendants have appealed from the February 28, 2003 decision. Plaintiffs served an amended complaint on April 1, 2003. On April 15, 2003, the defendants moved to dismiss the amended complaint. By decision dated October 1, 2003, the court denied defendants' motions to dismiss, except for the motions to dismiss brought by the individually named members of the board of directors of Empire Healthchoice, Inc. The court also declined to vacate the temporary restraining order directing that the proceeds from the initial public offering of the for-profit corporation be deposited with the State Comptroller in an interest-bearing account. Defendants intend to appeal this decision. REAL PROPERTY CLAIMS In the CANADIAN ST. REGIS BAND OF MOHAWK INDIANS case, plaintiffs seek ejectment and monetary damages with respect to their claim that approximately 15,000 acres in Franklin and St. Lawrence Counties were illegally transferred from their predecessors-in-interest. By decision dated July 28, 2003, the District Court granted, in most respects, a motion by plaintiffs to strike defenses and dismiss counterclaims contained in defendants' answers. By decision dated October 20, 2003, the District Court denied the States motion for reconsideration of that portion of the July 28, 2003 decision which struck a counterclaim against the United States for contribution. In the CAYUGA INDIAN NATION OF NEW YORK case, plaintiffs seek monetary damages for their claim that approximately 64,000 acres in Seneca and Cayuga Counties were illegally purchased by the State in 1795. Prior to trial, the court held that plaintiffs were not entitled to seek the remedy of ejectment. In October 1999, the District Court granted the Federal government's motion to have the State held liable for any damages owed to the plaintiffs. In February 2000, at the conclusion of the damages phase of the trial of this case, a jury verdict of $35 million in damages plus $1.9 million representing the fair rental value of the tract at issue was rendered against the defendants. By decision and judgment dated October 2, 2001, the District Court also granted plaintiffs $211 million in prejudgment interest. The State has appealed from the judgment to the United States Court of Appeals for the Second Circuit. On October 1, 2003, the State served the United States Department of the Interior and the United States Department of Justice with a statement of claim asserting that the United States is jointly and severally liable with the State for the $248 million judgment and post-judgment interest. A statement of claim is a precursor to filing a proceeding in the United States Court of Claims. 47 ANNUAL INFORMATION STATEMENT STATE OF NEW YORK DATED: MAY 30, 2003 TABLE OF CONTENTS ANNUAL INFORMATION STATEMENT 1 Introduction 2 CURRENT FISCAL YEAR 4 ENACTED BUDGET FINANCIAL PLAN 4 Overview 4 Explanation of the Financial Plan 8 The State's Fund Structure 8 2003-04 General Fund Financial Plan 9 Governmental Funds Financial Plans 20 First Quarter Cash Flow 24 GAAP-Basis Financial Plans 25 Outyear General Fund Financial Plan Projections 25 SPECIAL CONSIDERATIONS 42
1 ANNUAL INFORMATION STATEMENT MAY 30, 2003 ANNUAL INFORMATION STATEMENT OF THE STATE OF NEW YORK INTRODUCTION This Annual Information Statement ("AIS") is dated May 30, 2003 and contains information only through that date. This AIS constitutes the official disclosure information regarding the financial condition of the State of New York (the "State"). This AIS, including the Exhibits attached hereto, should be read in its entirety, together with any update or supplement issued during the fiscal year. In this AIS, readers will find: 1. A section entitled the "Current Fiscal Year" that contains (a) the Enacted Budget Financial Plan prepared by the Division of the Budget ("DOB"), including the State's official Financial Plan projections and (b) a discussion of potential risks that may affect the State's Financial Plan during the current fiscal year under the heading "Special Considerations." 2. Information on other subjects relevant to the State's fiscal condition, including: (a) operating results for the three prior fiscal years, (b) the State's revised economic forecast and a profile of the State economy, (c) debt and other financing activities, (d) governmental organization, and (e) activities of public authorities and localities. 3. The status of significant litigation that has the potential to adversely affect the State's finances. DOB is responsible for organizing and presenting the information that appears in this AIS on behalf of the State. In preparing the AIS, DOB relies on information drawn from several sources, including the Office of the State Comptroller ("OSC"), public authorities, and other sources believed to be reliable, but its presentation herein has not been subject to an independent audit process by DOB. Information relating to matters described in the section entitled "Litigation" is furnished by the Office of the State Attorney General. During the fiscal year, the Governor, the State Comptroller, State legislators, and others may issue statements or reports that contain predictions, projections or other information relating to the State's financial condition, including potential operating results for the current fiscal year and projected baseline gaps for future fiscal years, that may vary materially from the information provided in this AIS. Investors and other market participants should, however, refer to this AIS, as revised, updated, or supplemented, for official information regarding the financial condition of the State. The State plans to issue updates to this AIS on a quarterly basis (generally in July, November and January of each fiscal year) and may issue supplements or other disclosure notices as events warrant. The State intends to announce publicly whenever an update or a supplement is issued. The State may choose to incorporate by reference all or a portion of this AIS in Official Statements or related disclosure documents for State or State-supported debt issuance. Readers may obtain informational copies of the AIS, updates, and supplements by contacting Mr. Louis Raffaele, Chief Budget Examiner, New York State Division of the Budget, State Capitol, Albany, NY 12224, (518) 473-8705. This AIS has also been filed with the Nationally Recognized Municipal Securities Information Repositories. The Basic Financial Statements for the 2002-03 fiscal year are expected to be available in July 2003 and may be obtained from the Office of the State Comptroller, 110 State Street, Albany, NY 12236. 2 Informational copies of this AIS are available electronically on the DOB WEBSITE AT www.budget.state.ny.us. Typographical or other errors may have occurred in converting the original source documents to their digital format, and DOB assumes no liability or responsibility for errors or omissions contained at the Internet site. 3 CURRENT FISCAL YEAR The State's current fiscal year began on April 1, 2003 and ends on March 31, 2004. On March 31, 2003, the State Legislature enacted appropriations for all State-supported, contingent contractual, and certain other debt service obligations for the entire 2003-04 fiscal year. On May 2, 2003, the Legislature completed action on the remaining appropriations and accompanying legislation constituting the budget for the 2003-04 fiscal year. The Governor vetoed substantial portions of the budget revisions enacted by the Legislature, but the Legislature overrode the vetoes on May 15, 2003. Accordingly, DOB issued the Enacted Budget Financial Plan on May 28, 2003 that reflected final action on the 2003-04 State Budget by the Legislature. THE ENACTED BUDGET FINANCIAL PLAN SET FORTH BELOW WAS PREPARED BY THE DOB AND REFLECTS ACTIONS BY THE STATE LEGISLATURE THROUGH THE DATE OF THIS AIS. THE ENACTED BUDGET FINANCIAL PLAN CONTAINS ESTIMATES AND PROJECTIONS OF FUTURE RESULTS THAT SHOULD NOT BE CONSTRUED AS STATEMENTS OF FACT. THESE ESTIMATES AND PROJECTIONS ARE BASED UPON VARIOUS ASSUMPTIONS THAT MAY BE AFFECTED BY NUMEROUS FACTORS, INCLUDING FUTURE ECONOMIC CONDITIONS IN THE STATE AND NATION AND POTENTIAL LITIGATION CONCERNING ACTIONS BY THE STATE LEGISLATURE IN ENACTING THE 2003-04 BUDGET. THERE CAN BE NO ASSURANCE THAT ACTUAL RESULTS WILL NOT DIFFER MATERIALLY AND ADVERSELY FROM THE ESTIMATES AND PROJECTIONS CONTAINED IN THE ENACTED BUDGET FINANCIAL PLAN. ENACTED BUDGET FINANCIAL PLAN OVERVIEW The 2003-04 Executive Budget reflected recommendations to close a combined 2002-03 and 2003-04 budget gap of over $11.5 billion. These recommendations included savings from spending restraint of $6.3 billion, tobacco securitization proceeds of $3.8 billion, and revenue/fee increases of $1.4 billion. Assuming these budget recommendations were enacted in their entirety, the Executive Budget projected potential outyear budget gaps of $2.8 billion in 2004-05 and $4.1 billion in 2005-06. The Legislature completed action on the budget for the 2003-04 fiscal year on May 15, overriding the Governor's vetoes of $3.2 billion in tax increases and spending additions. DOB (DOB) analysis of the Enacted Budget, which is detailed in this report and in a preliminary report released on May 1, 2003*, indicates that changes since the Executive Budget will increase General Fund spending by $2.3 billion above the levels recommended by the Governor. As compared to the Executive Budget, revenues are projected to increase by $1.4 billion, reflecting enacted tax and revenue increases offset by lower revenue results for 2002-03 and the April income tax settlement. This leaves the General Fund Financial Plan with a potential imbalance of roughly $900 million in 2003-04, and increases the outyear gaps by $3.7 billion in 2004-05 and $4.2 billion in 2005-06, before potential benefits provided by recently enacted Federal aid changes and savings from a Fiscal Management Plan being developed. Also excluded are revenues from certain measures enacted by the Legislature that DOB considers to be highly speculative at this time. The combination of Federal aid and management actions will keep the 2003-04 budget in balance and are discussed in more detail later in this report. ---------- * Note: Reported in the May 2, 2003 Supplement to the 2002-03 AIS. 4 SUMMARY OF GENERAL FUND REVENUE CHANGES Legislative changes are projected to increase revenues by $1.9 billion in 2003-04, $1.4 billion in 2004-05, and $605 million in 2005-06. The outyear values of the revenue proposals decrease primarily because of "sunset" provisions enacted for the tax increases. In addition to these changes, revenues are projected to decrease from the Executive Budget forecast by $462 million in 2003-04 primarily due to the impact of 2002-03 actuals on the current year, and the April 2003 income tax settlement. The net 2003-04 revenue change since the Executive Budget is therefore $1.4 billion. Not counted within these revenue totals are certain other revenue measures adopted by the Legislature that DOB considers to be speculative. Examples include receipts from video lottery terminals (VLTs) at racetracks, collection of cigarette and motor fuel taxes on Indian reservations, and use tax collections. Net revenue changes since the Executive Budget include the following: NET REVENUE CHANGES FROM 30-DAY ESTIMATES INCREASES (DECREASES) (MILLIONS OF DOLLARS)
2003-04 2004-05 2005-06 ------------------------------------------------------------------------------------------- Personal Income Tax Surcharge 1,400 1,200 1,000 Increase Sales Tax by 1/4 Cent 450 572 100 Restrict Sales Tax on Clothing 86 (315) (435) Recapture Bonus Depreciation 58 100 90 Redirect State Sales Tax to NYC (170) (170) (170) Revenue Losses (462) (609) (609) All Other 39 20 20 NET REVENUE INCREASES 1,401 798 (4)
These revenue changes and speculative revenue sources are described in more detail later in this report. SUMMARY OF GENERAL FUND SPENDING CHANGES General Fund spending is projected to increase from the Executive Budget by a net $2.3 billion in 2003-04, $4.5 billion in 2004-05 and $4.2 billion in 2005-06. This spending increase reflects net legislative restorations and adds to the Governor's 2003-04 Executive Budget, including the denial of the Governor's pension reform proposals included in the Executive Budget ($434 million in 2004-05 and $197 million in 2005-06, after deferring required 2003-04 payments with interest to 2005-06). It also reflects increased outyear costs resulting from the May 15, 2003 school aid database update ($184 million in 2004-05 and $60 million in 2005-06). In addition, the net spending changes include costs DOB projects but which the Legislature believes may not occur. Examples include a $200 million lump sum appropriation for member items which DOB values at $200 million in costs and which the Legislature valued at $100 million; various Medicaid savings DOB believes are not fully attainable; and higher costs associated with shelter allowances for welfare recipients. 5 NET GENERAL FUND SPENDING CHANGES FROM 30-DAY ESTIMATES INCREASES (DECREASES) (MILLIONS OF DOLLARS)
2003-04 2004-05 2005-06 ------------------------------------------------------------------------------------------------------------------- Medicaid (including HCRA) 840 1,681 1,494 School Aid (including 5/15 Database update) 599 1,354 1,409 Member Items 200 0 0 Higher Education 193 323 303 Handicapped/All Other Education 132 110 111 Welfare 114 157 157 Public Health 40 100 136 General State Charges (including pension deferral) 34 555 338 State Operations 2 94 102 All Other 171 132 101 NET SPENDING INCREASES 2,325 4,506 4,151
These spending changes are described in more detail later in this report. SPENDING PROJECTIONS As a result of the deferred tobacco securitization proceeds and payment delays, 2002-03 actual receipts and disbursements were understated by $1.9 billion and 2003-04 estimates will be overstated by a like amount. To provide a meaningful year-to-year comparison of receipts and disbursements, the 2002-03 actuals and 2003-04 Enacted Budget estimates have been adjusted for this transaction in most of the tabular data in this report. Specifically, Miscellaneous Receipts and various spending categories (mainly Grants to Local Governments) were increased by $1.9 billion in 2002-03 and decreased by a like amount in 2003-04. (See Financial Plan tables at the end of this report for the detailed adjustments.) 2002-03 GENERAL FUND PAYMENT DEFERRALS (MILLIONS OF DOLLARS) School Aid 1,312 CUNY Senior Colleges 219 Medicaid Payment to Counties 82 Education 54 Welfare 47 All Other 186 ---------------------------------------------------------------- TOTAL PAYMENT DEFERRALS 1,900 ================================================================
The following table summarizes current spending levels for the General Fund, State Funds and All Governmental Funds under the 2003-04 Enacted Budget, after adjusting for the 2002-03 payment deferrals. 6 2003-04 SPENDING PROJECTIONS (MILLIONS OF DOLLARS)
2002-03 2003-04 $CHANGE % CHANGE ADJUSTED ACTUALS ADJUSTED ENACTED FROM 2002-03 FROM 2002-03 -------------------------------------------------------------------------------------------------------------------------------- GENERAL FUND 39,513 40,837 1,324 3.4 STATE FUNDS 57,712 61,087 3,375 5.8 ALL GOVERNMENTAL FUNDS 90,956 94,474 3,518 3.9
NOTE: ADJUSTED ACTUALS ACCOUNT FOR THE IMPACT OF $1.9 BILLION IN SPENDING DEFERRALS DESCRIBED EARLIER THAT WOULD REDUCE 2002-03 ACTUAL SPENDING AND INCREASE 2003-04 ESTIMATES FROM THE AMOUNTS SHOWN ABOVE. Annual spending is projected to increase by $1.3 billion (3.4 percent) in the General Fund, by $3.4 billion (5.8 percent) in State Funds, and by $3.5 billion (3.9 percent) in All Governmental Funds. These changes are explained in more detail below, and do not reflect any increased Federal aid or possible spending reductions associated with the Fiscal Management Plan. FISCAL MANAGEMENT PLAN/FEDERAL ASSISTANCE The recently enacted Federal economic stimulus legislation provides $20 billion nationwide in fiscal relief to states, to be distributed as $10 billion in revenue sharing grants and $10 billion from a 15-month increase in the Federal share of Medicaid. DOB expects New York to receive $2.1 billion as a result of this legislation over the next two State fiscal years. The State's revenue sharing grant is estimated to be $645 million. The impact of the 2.95 percent increase in the Federal share of Medicaid costs is estimated to yield $1.4 billion for the State and its local governments. The State's share of this total is roughly $900 million. In order to manage cash flow, assure budget balance in the current fiscal year, and begin to address significant 2004-05 and 2005-06 budget gaps, the Governor has directed DOB to develop a Fiscal Management Plan to reduce State operations costs, curtail non-essential spending, and identify other cost containment actions to bring the General Fund into balance. This plan will be developed in cooperation with State agency managers and is expected to be detailed by the time the State's First Quarterly Financial Plan Update is released in July. Elements of the plan are expected to include: - Continuing statewide austerity measures that limit discretionary spending, ban non-essential travel, and restrict or terminate lower-priority capital spending and other contractual liabilities. - Mandating agency management plans to eliminate, consolidate, and streamline governmental services. - Making significant further reductions in the State workforce. - Maximizing Federal aid. - Developing cost containment proposals that can be presented for legislative action later this year. As noted in the messages accompanying the Governor's vetoes, certain appropriations and spending authorizations may be legally flawed. The State will review all such authorizations and continue to assess the degree to which any legal deficiencies may reduce overall spending levels. 7 DOB will also monitor and work to achieve additional revenues, as specified in the Senate Finance Committee Staff Report on the Budget, from certain measures enacted by the Legislature that DOB believes are speculative in nature and thus not reflected in the Financial Plan. These include Video Lottery Terminals (VLTs) at racetracks (legislative value of $150 million), collection of cigarette and motor fuel taxes on Indian Reservations (legislative value of $186 million), and collection of use tax (legislative value of $25 million), as well as other measures that the Legislature believes will reduce the outyear gaps (casino revenue and streamlined sales tax are examples). EXPLANATION OF THE FINANCIAL PLAN The State's Enacted Budget Financial Plan forecasts receipts and disbursements for the fiscal year. The economic forecast of DOB and the State's tax and fee structure serve as the basis for projecting receipts. After consulting with public and private sector experts, DOB prepares a detailed economic forecast for both the nation and New York, showing Gross Domestic Product (GDP), employment levels, inflation, wages, consumer spending, and other relevant economic indicators. It then projects the yield of the State's revenue structure against the backdrop of these forecasts. Projected disbursements are based on agency staffing levels, program caseloads, levels of service needs, formulas contained in State and Federal law, inflation and other factors. The factors that affect spending estimates vary by program. For example, welfare spending is based primarily on anticipated caseloads that are estimated by analyzing historical trends, projected economic conditions and changes in Federal law. In criminal justice, spending estimates are based on recent trends and data from the criminal justice system, as well as on estimates of the State's prison population. All projections account for the timing of payments, since not all the amounts appropriated in the Budget are disbursed in the same fiscal year. THE STATE'S FUND STRUCTURE The State accounts for all of its spending and receipts by the fund in which the activity takes place (such as the General Fund or the Capital Projects Fund), and the broad category or purpose of that activity (such as State Operations or Capital Projects). The Financial Plan tables sort all State projections and results by fund and category. The General Fund receives the majority of State taxes. State Funds include the General Fund and funds specified for dedicated purposes, with the exception of Federal Funds. The All Governmental Funds Financial Plan, which includes State Funds and Federal Funds, is comprised of four major fund types, and includes: - The General Fund, which receives most of the State's tax revenue and accounts for spending on programs that are not supported directly by dedicated fees and revenues; - Special Revenue Funds, which receive Federal grants, certain dedicated taxes, fees and other revenues that are used for a specified purpose; - Capital Projects Funds, which account for costs incurred in the construction and reconstruction of roads, bridges, prisons, and other infrastructure projects; and - Debt Service Funds, which pay principal, interest and related expenses on long-term bonds issued by the State and its public authorities. Within each of these fund types, revenues and spending are classified by major categories of the Financial Plan (e.g., Taxes, Miscellaneous Receipts, Grants to Local Governments, State Operations). Activity in these Financial Plan categories is described in greater detail later in this Report. Summary charts display the annual change for each category of the Financial Plan, and a narrative explanation of major changes follows each chart. The tables at the end of the Report summarize projected General Fund, State Funds and All Governmental Funds receipts and disbursements for the 2003-04 fiscal year. 8 2003-04 GENERAL FUND FINANCIAL PLAN WHERE IT COMES/WHERE IT GOES GENERAL FUND 2003-04 ADJUSTED ENACTED RECEIPTS Personal Income Tax 40% User taxes and fees 20% Business taxes 9% Other taxes 2% Miscellaneous Receipts and Transfers 24% Tobacco Proceeds 5%
DISBURSEMENTS Local Assistance 68% State Operations 18% General State Charges 8% Debt Service 4% Capital/Other 2%
The General Fund is the principal operating fund of the State and is used to account for all financial transactions except those required to be accounted for in another fund. It is the State's largest fund and receives almost all State taxes and other resources not dedicated to particular purposes. In the State's 2003-04 fiscal year, the General Fund is expected to account for approximately 41 percent of All Governmental Funds disbursements. General Fund moneys are also transferred to and from other funds, primarily to support certain capital projects and debt service payments in other fund types. The graphs above depict the components of projected receipts and disbursements in the General Fund (in percent). Many complex political, social and economic forces influence the State's economy and finances, which may in turn affect the State Financial Plan and increase the likelihood that current projections will differ materially from the projections set forth in this Enacted Budget Report. These forces may affect the State unpredictably from fiscal year to fiscal year and are influenced by governments, institutions, and organizations that are not subject to the State's control. The 2003-04 Enacted Plan is also necessarily based upon forecasts of national and State economic activity. Economic forecasts have frequently failed to predict accurately the timing and magnitude of changes in the national and State economies. NATIONAL ECONOMY U.S. economic growth slowed to 1.6 percent during the first quarter of 2003, partly due to severe weather conditions and the uncertainty surrounding the war in Iraq. Now that the war is over, the nation's economic recovery is expected to gain momentum. The national economy grew at a slower pace than anticipated in the Executive Budget during early 2003. However, higher growth toward the end of the year is expected to bring real U.S. GDP growth up to 2.3 percent for 2003, only slightly below the Executive Budget projection of 2.4 percent. Buttressed by low inflation and high productivity growth, the national economy is expected to grow 3.4 percent during 2004. Although a boost in Federal spending contributed positively to GDP growth, the impact of the war on the labor market was clearly negative, with 220,000 reservists having been called up for duty as of April 2003. The Budget Division now expects no net growth in employment for 2003, compared to the 0.6 percent growth projected in the Executive Budget. Income growth for 2003, especially in wages, is also expected to be modestly below the Executive Budget projection. This is mainly due to the downward revision made to the data for the third quarter of 2003 by the U.S. Bureau of Economic Analysis. 9 Higher output growth toward the end of this year is expected to be fueled by a rebound in private investment activity. If business sector financial conditions do not improve, hiring may be delayed, leading to an even weaker labor market than now anticipated. On the positive side of the ledger, given the current and lagged effects of expansionary monetary and fiscal policy, the economy could grow faster than expected. A lower dollar could lead to higher exports and, therefore, higher output growth. MAJOR ECONOMIC INDICATORS
2002 2003 2004 ------------------------------------------------------------------------- Gross Domestic Product (real) 2.4 2.3 3.4 Personal Income 2.8 3.8 5.2 Corporate Profits (0.7) 12.7 15.2 Unemployment Rate 5.8 5.8 5.5 Consumer Price Index 1.6 2.5 2.3
Note: Numbers above are percent change/calendar year, except for unemployment rate. The New York State Division of the Budget estimates are based on National Income and Product Account data through April 2003, except for nonagricultural employment and the unemployment rate which are based on U.S. Department of Labor data through early May 2003. STATE ECONOMY The September 11th terrorist attack had a more severe impact on the New York economy than on that of any other state. Therefore, not surprisingly, the State's economy is only now emerging from the most recent recession. DOB now estimates that State employment fell 1.8 percent in 2002, and wage income is estimated to have declined 3.8 percent. The unemployment rate for 2002 was 6.1 percent and is expected to remain virtually unchanged for 2003. Employment growth was weaker than expected during the last quarter of 2002. The weaker job base, combined with the sluggishness of the national economic recovery, has led DOB to anticipate marginally lower employment growth for the 2003-04 State fiscal year than projected in the Executive Budget. Growth in wages and salaries is expected to be marginally lower as well. In addition to the risks associated with the national economic forecast, there are specific risks to the State economy. Chief among them is a more prolonged downturn in the financial sector than is currently projected, producing sharper declines in both employment and compensation. Moreover, significant numbers of business relocations out of the State could imply slower job and income growth as well. In contrast, a stronger national economy than expected could result in stronger equity market growth and, in turn, a stronger demand for financial market services, fueling a rebound in income growth in that sector. 10 MAJOR ECONOMIC INDICATORS
2002 2003 2004 -------------------------------------------------------------------------------- Personal Income 0.0 3.0 4.1 Nonagricultural (1.8) 0.3 1.0 Employment Unemployment Rate 6.1 6.0 5.5
Note: Numbers above are percent change/calendar year. Personal income and nonagricultural employment growth for 2002 and all forecasts for 2003 and 2004 are projected by DOB. GENERAL FUND REVENUE ACTIONS Revenue actions included with the 2003-04 Enacted Budget include: a personal income tax increase ($1.4 billion); a limited liability company filing fee increase ($26 million); income tax withholding for certain partnerships ($15 million); reduced interest for late refunds ($5 million); increasing the State sales tax rate from 4 percent to 4.25 percent ($450 million); temporarily replacing the permanent sales tax exemption on items of clothing and shoes priced under $110 with a sales tax free week in August 2003 and another in January 2004 for the same items and thresholds ($449 million); including the New York City cigarette excise tax in the sales tax base ($7 million); changing the tax structure for insurance companies ($158 million); decoupling from the Federal bonus depreciation provisions ($58 million); decoupling from Federal expensing provisions for SUVs; and reducing the time period for collecting abandoned property related to the demutualization of insurance companies ($75 million). In total, the Budget includes over $2.4 billion in revenue actions including those contained in the Executive Budget. As part of the Enacted Budget, the Legislature also enacted tobacco securitization legislation that creates a bankruptcy-remote corporation to securitize all or a portion of the State's future share of tobacco settlement payments. The corporation will issue debt backed by payments from the tobacco industry under the master settlement agreement (MSA) and a contingent-contractual obligation on behalf of the State to pay debt service if MSA payments prove insufficient. The structure is designed to reduce overall borrowing costs to a level comparable to a typical State bond sale. The Financial Plan assumes net proceeds of $3.8 billion ($1.9 billion on an adjusted basis) from this transaction in 2003-04 and $400 million in 2004-05; these amounts are reflected as miscellaneous receipts in the Financial Plan. It is possible that, in order to reduce costs of issuance, take advantage of current low interest rates and improve its cash flow balances, the State may securitize amounts sufficient to receive the entire $4.2 billion in 2003-04, reserving the $400 million for 2004-05 budget balance. GENERAL FUND RECEIPTS GENERAL FUND RECEIPTS (MILLIONS OF DOLLARS)
2002-03 2003-04 ANNUAL CHANGE FROM ADJUSTED ACTUALS ADJUSTED ENACTED $CHANGE 30-DAY ESTIMATE ------------------------------------------------------------------------------------------------------------------------- Total Tax Receipts 27,977 28,561 584 1,148 All Other Receipts 11,319 11,279 (40) 255 TOTAL RECEIPTS 39,296 39,840 544 1,403
Total General Fund receipts in support of the 2003-04 Financial Plan are projected to be $39.84 billion, an increase of $544 million from the $39.30 billion recorded in 2002-03. This total includes $28.56 billion in tax receipts, $3.67 billion in miscellaneous receipts, and $7.61 billion in transfers from other funds. The increase largely reflects the impact of revenue actions adopted with the Budget. There are additional legislative actions enacted with the 2003-04 Budget that may have a positive impact on revenues but are too speculative at this point to value with any confidence, including the addition of a use tax line on the personal income tax return, non-resident sales of real property, six-day liquor sales, and VLTs. 11 General Fund receipts net of refund reserve account transactions are estimated at $39.69 billion for 2003-04. Adjusting for the impact of revenue actions, General Fund tax receipts have been reduced by $463 million from estimates released with the 30-day amendments to the Executive Budget. This revision reflects several factors including: the impact of lower-than-anticipated 2002-03 receipts on the 2003-04 revenue base; a modest net loss in personal income tax receipts due to a lower-than-expected net settlement of 2002 income tax liability in April and May; and continued weakness in corporate tax collections. PERSONAL INCOME TAX (MILLIONS OF DOLLARS)
2002-03 2003-04 ANNUAL CHANGE FROM ADJUSTED ACTUALS ADJUSTED ENACTED $CHANGE 30-DAY ESTIMATE ----------------------------------------------------------------------------------------------------------- 16,791 16,285 (506) 833
General Fund personal income tax receipts are projected to decrease by $506 million from 2002-03. This is due to economic improvement in 2003-04 and enactment of a temporary tax increase, more than offset by a lower settlement for 2002 tax returns, a reduction in revenue reserves flowing through the refund reserve accounts, and a higher deposit into the Revenue Bond Tax Fund. Overall, net of law changes, personal income tax payments associated with the 2002 tax year are down modestly from what was anticipated in the Executive Budget. The estimate for withholding tax collections increased by $1.03 billion from the Executive Budget estimate, reflecting the enacted temporary tax increase offset somewhat by lower wage growth than forecast with the Executive Budget. Estimated tax installment payments have been increased by $300 million, again reflecting the enacted temporary tax increase. Additionally, reflecting April and May results on the settlement of 2002 tax liabilities, the estimate for payments with final returns has been increased by $100 million and the estimate for refunds has been increased by $175 million. The estimate for delinquent collections of the personal income tax has been reduced by $50 million, reflecting the State tax amnesty program bringing greater-than-expected receipts forward into 2002-03. General Fund personal income tax receipts, including refund reserve account transactions, are expected to be $833 million higher than the 30-day amendments to the Executive Budget adjusted for a higher net contribution from the refund reserve account. This increase is due to the temporary tax increase, offset somewhat by the lower-than-anticipated income tax settlement for 2002 tax liability, lower withholding resulting from a weaker-than-expected economy for 2003-04, lower expected assessment collections, and a higher STAR fund deposit due to the Legislature's rejection of the STAR spending limitation proposed in the Executive Budget. 12 USER TAXES AND FEES (MILLIONS OF DOLLARS)
2002-03 2003-04 ANNUAL CHANGE FROM ADJUSTED ACTUALS ADJUSTED ENACTED $CHANGE 30-DAY ESTIMATE ----------------------------------------------------------------------------------------------------------- 7,063 8,007 944 499
Receipts for user taxes and fees for 2003-04 are projected to total $8.01 billion, an increase of $944 million from reported 2002-03 collections. Included in this category are: receipts from the State sales tax, cigarette and tobacco products taxes; alcoholic beverage taxes and fees; and motor vehicle license and registration fees. The projected growth in sales tax cash receipts of 15.1 percent is largely attributable to the enactment of a temporary increase in the overall tax rate (to 4.25 percent) and a change in the clothing and footwear exemption. The Enacted Budget eliminated the exemption on items of clothing and footwear for one year, effective June 1, 2003, and replaced it with two temporary one-week exemptions with the same $110 thresholds -- one in August 2003 and another in January 2004. Growth in the sales tax base, after adjusting for tax law changes and other factors, is projected at 4.3 percent. The decline in General Fund cigarette tax receipts is the result of a continuation of the long-term consumption decline in cigarettes. User taxes and fees are expected to rise by $499 million from the 30-day amendments to the Executive Budget. This adjustment mainly reflects tax increases contained in the Enacted Budget. BUSINESS TAXES (MILLIONS OF DOLLARS)
2002-03 2003-04 ANNUAL CHANGE FROM ADJUSTED ACTUALS ADJUSTED ENACTED $CHANGE 30-DAY ESTIMATE ----------------------------------------------------------------------------------------------------------- 3,380 3,498 118 (184)
Receipts for business taxes for 2003-04 are projected to total $3.50 billion, an increase of $118 million from 2002-03 collections. Business taxes include the corporate franchise tax, corporation and utilities taxes, the insurance franchise tax, and the bank franchise tax. Business tax receipts for 2003-04 have been revised down by $184 million from the 30-day amendments to the Executive Budget to reflect lower 2002-03 actuals during closeout and anticipated enhanced refund activity. These negatives in 2002-03 have been offset by the effect of decoupling from the Federal bonus depreciation. Corporate franchise tax receipts have been revised down by $141 million from the 30-day amendments to the Executive Budget. The difference is attributable to a closeout adjustment and enhanced refund activity. These reductions are offset by an increase in revenues of $58 million based on decoupling from Federal bonus depreciation provisions. Corporation and utilities taxes, and insurance franchise tax receipts remain unchanged from the 30-day Executive Budget estimate. Bank tax receipts are estimated to be $43 million lower than the 30-day Executive Budget estimate. This result is primarily attributable to continued weak earnings growth, and the decline in the 2002-03 base. 13 OTHER TAXES (MILLIONS OF DOLLARS)
2002-03 2003-04 ANNUAL CHANGE FROM ADJUSTED ACTUALS ADJUSTED ENACTED $CHANGE 30-DAY ESTIMATE ----------------------------------------------------------------------------------------------------------- 743 771 28 0
Other tax receipts are now projected to total $771 million or $28 million above last year's amount. Sources in this category include the estate and gift tax, the real property gains tax and pari-mutuel taxes. Previously enacted legislation to repeal both the real property gains tax and the gift tax and to reduce the estate and pari-mutuel taxes have significantly reduced the yield from this category of receipts. Other taxes estimated in this category are unchanged from the 30-day estimate. MISCELLANEOUS RECEIPTS (MILLIONS OF DOLLARS)
2002-03 2003-04 ANNUAL CHANGE FROM ADJUSTED ACTUALS ADJUSTED ENACTED $CHANGE 30-DAY ESTIMATE ----------------------------------------------------------------------------------------------------------- 3,991 3,669 (322) 90
Miscellaneous receipts, adjusted for the tobacco securitization, are expected to reach $3.67 billion, a decrease of $322 million from 2002-03 and an increase of $90 million from the 30-day estimate. The annual decrease in receipts is the result of several non-recurring actions taken in the 2002-03 Enacted Budget, including transferring available balances from various State authorities. The increase in receipts from the 30-day estimates is attributed to a delay in the collection of a settlement recovery from various Wall Street firms originally expected in 2002-03, as well as the net impact of several legislative actions, which on balance increase receipts by an estimated $50 million. TRANSFERS FROM OTHER FUNDS (MILLIONS OF DOLLARS)
2002-03 2003-04 ANNUAL CHANGE FROM ADJUSTED ACTUALS ADJUSTED ENACTED $CHANGE 30-DAY ESTIMATE -------------------------------------------------------------------------------------------------------------------------- PIT in Excess of Revenue Bond Debt 4,215 5,125 910 260 Service Sales Tax in Excess of LGAC Debt 1,919 1,853 (66) (146) Service Real Estate Taxes in Excess of 263 202 (61) 0 CW/CA Debt Service All Other Transfers 931 430 (501) 51 TOTAL TRANSFERS FROM 7,328 7,610 282 165
Transfers from other funds are expected to total $7.61 billion, or $282 million more than total receipts from this category during 2002-03 and $165 million higher than the 30-day estimates. The $910 million year-to-year increase in transfers of personal income tax (PIT) in excess of revenue bond debt service requirements is primarily attributable to higher dedicated PIT receipts ($1.1 billion), including legislative tax increases, offset by increased debt service requirements ($222 million). The $260 million net increase from the 30-day estimate reflects the legislative tax increases, offset by increased debt service costs. 14 The annual decrease of $66 million in transfers from the sales tax in excess of LGAC debt service reflects increased debt service requirements ($67 million) and an annual payment to New York City intended to cover debt service costs related to restructuring NYC MAC debt for City fiscal relief ($170 million), offset by increased sales tax receipts ($171 million). The 2003-04 estimate is $146 million lower than the 30-day estimate primarily due to the legislation requiring a payment of State sales tax to New York City. Provisions enacted with the 2003-04 Budget relating to the Local Government Assistance Corporation (LGAC) and the Municipal Assistance Corporation of the City of New York (MAC) appear to intend that the State assume responsibility for debt service payments on the remaining $2.5 billion in outstanding MAC bonds. Thirty annual payments of $170 million from sales tax receipts dedicated to LGAC are authorized to be pledged to a New York City-created not-for-profit corporation allowing the maturity of the debt to be extended through 2034, well beyond the original 2008 maturity of the outstanding MAC debt. The structure of this bonding may be flawed and counsel are continuing to evaluate the constitutional and legal issues raised by the legislation, the implications on the State's Debt Reform Act of 2000, and the impact on LGAC and other bondholders. The annual decline of $61 million in transfers from the real estate transfer tax is due to a projected decrease in tax receipts ($43 million) and an increase in Clean Water/Clean Air debt service requirements ($18 million). The 2003-04 enacted estimate is unchanged from the 30-day estimate. The $501 million expected annual decrease in all other transfers is primarily due to the loss of onetime 2002-03 transfers from the Environmental Protection Fund ($269 million) and Federal reimbursement of World Trade Center related costs ($231 million). All other transfers increased by $51 million from the 30-day estimates due to an increase in expected receipts for the Waste Tire Management Recycling Act ($20 million) and one-time transfers from various non-General funds ($31 million). GENERAL FUND DISBURSEMENTS GENERAL FUND DISBURSEMENTS (MILLIONS OF DOLLARS)
2002-03 2003-04 ANNUAL CHANGE FROM ADJUSTED ACTUALS ADJUSTED ENACTED $CHANGE 30-DAY ESTIMATE -------------------------------------------------------------------------------------------------------------------- Welfare 496 1,127 631 114 General State Charges 2,732 3,199 467 34 Member Items 105 455 350 200 Medicaid (including HCRA) 5,951 6,269 318 840 Public Health 525 566 41 40 School Aid (including 5/15 database update) 12,278 12,312 34 599 Handicapped/All Other Education 1,341 1,323 (18) 132 Higher Education 1,528 1,488 (40) 193 State Operations 7,715 7,168 (547) 2 All Other 6,842 6,930 88 171 TOTAL GENERAL FUND DISBURSEMENTS 39,513 40,837 1,324 2,325
Total General Fund disbursements, including transfers to support capital projects, debt service and other purposes, are estimated at $40.84 billion for 2003-04, an increase of $1.32 billion or 3.4 percent from 2002-03. The annual growth in spending is primarily attributable to the use of non-recurring offsets in the previous fiscal year for welfare assistance programs ($631 million), higher costs for General State Charges mostly due to pensions and health insurance ($467 million), additional spending for member items ($350 million), and growth in Medicaid ($318 million), offset by lower State Operations spending ($547 million). The annual change in spending is explained by financial plan category in more detail below. 15 Total projected spending in the 2003-04 Enacted Budget is $2.33 billion higher than the level recommended in the Governor's Executive Budget. Spending changes primarily reflect net legislative restorations and adds in Medicaid ($840 million), school aid ($599 million), funding for member items ($200 million), higher education programs ($193 million), handicapped/all other education programs ($132 million), and welfare programs ($114 million). In addition, the net spending changes include certain costs resulting from the Legislature's action or inaction on several spending items. Examples include a $200 million lump sum appropriation for member items which the Legislature valued at $100 million; various Medicaid savings DOB believes are not fully attainable including additional Federal reimbursement for prescription drug costs and home care costs; and inaction on cost containment provisions which DOB believes results in higher welfare costs. GRANTS TO LOCAL GOVERNMENTS (MILLIONS OF DOLLARS)
2002-03 2003-04 ANNUAL CHANGE FROM ADJUSTED ACTUALS ADJUSTED ENACTED $CHANGE 30-DAY ESTIMATE ----------------------------------------------------------------------------------------------------------- 26,713 28,009 1,296 2,229
Grants to Local Governments (also known as local assistance) include financial aid to local governments and non-profit organizations, as well as entitlement payments to individuals. The largest shares of spending in local assistance are for aid to public schools (44 percent) and for the State's share of Medicaid payments to medical providers (22 percent). Spending for mental hygiene programs (6 percent), higher education programs (5 percent), welfare assistance (4 percent), and children and families services (4 percent) represent the next largest areas of local aid. Spending in local assistance is estimated at $28.01 billion in 2003-04, an increase of $1.30 billion (4.9 percent) over the 2002-03 fiscal year. This net spending growth is primarily attributable to welfare assistance programs ($631 million), Medicaid ($318 million), additional spending in the Community Projects Fund ($350 million), higher spending for the Higher Education Service Corporation ($123 million) and various other local assistance programs. These increases are partially offset by an annual decline in spending for the City University of New York ($176 million) and a scheduled decline in payments for the Yonkers settlement agreement ($110 million). General Fund spending for school aid on a State fiscal year basis is projected at $12.31 billion in 2003-04, an increase of $34 million over 2002-03. This net increase reflects the "tail" cost of the 2002-03 school year increase offset in part by the reduced spending in the 2003-04 enacted school year aid package. On a school year basis, school aid is projected at $14.43 billion for 2003-04, a decrease of $185 million from the prior school year. This decrease is primarily due to a reduction in operating aid ($285 million), which is partially offset by increases in transportation aid, excess cost aid and BOCES. Medicaid spending is estimated at $6.27 billion in 2003-04, an increase of $318 million (5.3 percent) from the prior year. The net increase is primarily attributable to expected underlying spending growth of approximately 8 percent ($478 million), the sunset of the Tobacco Transfer Fund used to reimburse medical care providers for services rendered to Medicaid patients ($91 million), the Federally mandated phase out of the nursing home intergovernmental transfers ($90 million), and the reduction of the nursing home gross receipts assessment used to offset Medicaid costs ($78 million). The growth in Medicaid spending is partially offset by increased Federal aid from an increase in disproportionate share payments to public hospitals ($324 million), additional financing through the Health Care Reform Act ($117 million), and various cost containment proposals, as well as the phase out of Disaster Relief Medicaid related to the September 11th attack on the World Trade Center. In addition, the Enacted Budget "rolls" the last Medicaid cycle payable on March 31, 2004 to the first day of the 2004-05 fiscal year ($170 million), decreasing 2003-04 and increasing 2004-05 costs. The Medicaid estimate does not include possible savings related to the temporary increase in the Federal share of Medicaid costs. 16 Spending on welfare is projected at $1.13 billion, an increase of $631 million (127.2 percent) from 2002-03. This increase is due primarily to the use of Federal TANF reserve funds to offset welfare spending in 2002-03 ($465 million) and the increased cost of the welfare caseload ($166 million). The projected welfare caseload of 622,067 recipients represents an increase from 2002-03 of approximately 10,248 recipients. Higher Education Services Corporation (HESC) spending is projected at $442 million, an increase of $123 million (38.6 percent) from 2002-03. This increase reflects underlying program growth ($163 million) and a reduction in available Federal TANF funds ($64 million), offset by a deferral of Tuition Assistance Program costs into the 2004-05 fiscal year ($104 million). City University of New York (CUNY) spending is projected at $681 million, a decrease of $176 million (20.5 percent) from 2002-03. The decrease is primarily due to the impact of a tuition increase at the senior colleges used to offset General Fund spending ($91 million) and a reduction in costs due to a one-time retroactive collective bargaining payment made in 2002-03 ($70 million). Spending for all other local assistance programs will total $7.18 billion in 2003-04, a net increase of $366 million (5.4 percent) from the 2002-03 fiscal year. This increase is largely attributable to additional spending for member items ($350 million), increased spending for children and family services ($90 million), public health programs ($41 million), mental hygiene programs ($27 million), and various other local assistance programs. These increases are offset by spending declines across other agencies and programs including an annual decrease in the funding for the Yonkers settlement agreement ($110 million). The 2003-04 enacted estimate for local assistance spending increased by $2.23 billion from the 30-day estimate primarily as a result of net legislative adds and restorations of Executive Budget proposals. The largest adds and restorations occurred in Medicaid ($840 million), school aid ($599 million), additional funding for the Community Projects Fund ($200 million), higher education programs ($193 million), handicapped/all other education programs ($132 million), and welfare programs ($114 million). These net legislative adds reflect resources identified by the Legislature to delay the last Medicaid cycle in the 2003-04 fiscal year to the following fiscal year ($170 million) and defer Tuition Assistance Program payments to colleges out of 2003-04 into 2004-05 ($104 million). STATE OPERATIONS (MILLIONS OF DOLLARS)
2002-03 2003-04 ANNUAL CHANGE FROM ADJUSTED ACTUALS ADJUSTED ENACTED $CHANGE 30-DAY ESTIMATE ---------------------------------------------------------------------------------------------------------- 7,715 7,168 (547) 2
State Operations accounts for the cost of operating the Executive, Legislative, and Judicial branches of government. Spending in this category is projected at $7.17 billion, a decrease of $547 million or 7.1 percent from 2002-03. The annual decline in State Operations spending is comprised of lower spending in both personal service ($493 million) and non-personal service ($54 million). 17 The State Operations estimates reflect $1.03 billion in savings initiatives. Included in these savings are $363 million from continuation of the strict Statewide hiring freeze, aggressive use of a retirement incentive for State employees, and various actions to restrain non-personal service spending in all agencies. A total of $662 million in savings is projected to be available in 2003-04 from a variety of revenue maximization efforts to finance State Operations spending. Among these savings are additional SUNY revenues from an anticipated tuition increase and other revenue measures used to support General Fund costs ($325 million), additional Federal revenues to offset spending on mental hygiene programs ($174 million), and various shifts of General Fund costs to other funds ($133 million) -- most notably funding $93 million in Department of Motor Vehicles transportation-related spending in the Dedicated Highway Fund. The savings initiatives and revenue maximization efforts are partially offset by base spending growth of $478 million, including normal salary step increases and required non-personal service cost increases and the loss of one-time offsets used in 2002-03. Virtually all Executive agencies are held flat or reduced from 2002-03 levels. The 2003-04 State Operations estimate is $2 million higher than the estimate prepared at the time of the 30-day Amendments to the Executive Budget in February 2003. This additional spending represents minor legislative changes to the Executive Budget estimates. The State's All Funds workforce is projected to be 186,000 at the end of 2003-04, a decrease of approximately 10,000 from November 2001 when the Governor announced a series of cost savings actions following the World Trade Center attacks. This reduction resulted from attrition and the use of early retirement incentives. Additional declines are possible as a result of the Fiscal Management Plan to be implemented during the fiscal year. GENERAL STATE CHARGES (MILLIONS OF DOLLARS)
2002-03 2003-04 ANNUAL CHANGE FROM ADJUSTED ACTUALS ADJUSTED ENACTED $CHANGE 30-DAY ESTIMATE ---------------------------------------------------------------------------------------------------- 2,732 3,199 467 34
General State Charges (GSCs) account for the costs of providing fringe benefits to State employees and retirees of the Executive, Legislative and Judicial branches, as well as certain fixed costs of the State. Fringe benefit payments, many of which are mandated by statute or collective bargaining agreements, include employer contributions for pensions, social security, health insurance, workers' compensation and unemployment insurance. Fixed costs include State payments-in-lieu-of-taxes to local governments for certain State-owned lands, and the costs of litigation against the State and its public officers. Total spending for GSCs is estimated at $3.20 billion, an increase of $467 million or 17.0 percent from the prior year. The projected annual growth is primarily attributable to higher pension and health insurance costs. Pension investment losses resulting in significantly higher contributions to the New York State and Local Retirement System for the 2003-04 fiscal year. The employer pension contribution rate is the Executive Budget was projected to increase to 4 percent of payroll in 2003-04, increasing pension costs by $250 million (171 percent). Pension reform legislation approved with the Enacted Budget requires a minimum pension contribution equal to 4.5 percent of payroll annually. This change along with higher than expected retirement incentive costs would increase the 2003-04 fiscal year contribution by an additional $94 million to $344 million. However, the Legislature did not provide sufficient appropriation authority to allow the entire pension bill to be paid to the retirement system in 2003-04. As a result, it is anticipated that the State will pay this unbudgeted amount in 2005-06 at 8 percent annual interest, for a total cost of approximately $110 million. 18 Health insurance premiums are expected to increase by approximately $178 million (11 percent) in 2003-04 to cover the rising costs of employee and retiree health care. The enacted budget reflects $43 million in health benefit changes, which is expected to reduce the underlying growth in employee health insurance costs from $221 million (13.7 percent). These changes, some of which are subject to negotiations with State employee unions, would: place restrictions on pharmacy benefits, require a higher co-payments for prescription drugs, modernize the hospital benefit plan, and increase employee copayments, deductibles and coinsurance levels for doctor visits. The $34 million increase from the 30-day estimate is largely the result of the Legislature's denial of a proposal to change to the current 9 percent statutory interest rate on Court of Claims judgments to market-based rates, and partial restoration of Executive Budget proposals to change employee health insurance benefits. TRANSFERS TO OTHER FUNDS (MILLIONS OF DOLLARS)
2002-03 2003-04 ANNUAL CHANGE FROM ADJUSTED ACTUALS ADJUSTED ENACTED $CHANGE 30-DAY ESTIMATE -------------------------------------------------------------------------------------------------------------------------- Transfers in Support of Debt Service 1,496 1,583 87 0 Transfers in Support of Capital Projects 170 251 81 45 Transfers in Support of State University 26 145 119 0 All Other Transfers 661 482 (179) 15 TOTAL TRANSFERS TO OTHER FUNDS 2,353 2,461 108 60
Transfers to other funds are expected to total $2.46 billion, or $108 million higher than total receipts from this category during 2002-03 and $60 million higher than the 30-day estimates. The annual net increase in debt service transfers of $87 million reflects planned growth in underlying debt service costs, offset by debt reduction efforts. As compared to the 30-day estimate, transfers in support of debt service remain unchanged. Transfers for capital projects provide General Fund support for projects that are not financed by bond proceeds, dedicated taxes, Federal grants or other revenues. The $81 million projected increase in 2003-04 reflects year-to-year increases in pay-as-you-go spending for legislative adds for transportation and the environment ($49 million) and changes in the timing of the receipt of bond proceeds to reimburse capital spending. Compared to the 30-day estimate for 2003-04, the $45 million increase in capital projects transfers reflects the legislative adds for transportation and the environment. The State's cost of transfers to the State University are estimated to increase by $119 million over 2002-03 due to the timing of State subsidy payments to the SUNY hospitals ($107 million) and the use of Dormitory Authority funds in 2002-03 to help subsidize the SUNY hospitals ($12 million). This transfer remained unchanged from the 30-day estimate. All other transfers are estimated to total $482 million in 2003-04, a decline of $179 million from 2002-03. This decline is primarily due to decreases in the Community Service Provider Assistance Program ($100 million), the State's share of Medicaid payments to SUNY hospitals ($48 million), and payments to the State Lottery Fund ($17 million). All other transfers increased $15 million from the 30-day estimates. 19 NON-RECURRING ACTIONS A total of $5.1 billion in gross nonrecurring actions, with a net impact of $3.2 billion on the Financial Plan, are incorporated in the 2003-04 Enacted Budget. These include resources from the securitization of tobacco settlement payments ($3.8 billion), the use of Federal TANF moneys to offset General Fund welfare, HESC, and school aid program spending ($458 million), spending delays for a Medicaid cycle and TAP payments ($274 million), the one-time shift of various pay-as-you-go capital projects to bonding ($122 million), debt management actions to reduce debt service costs ($161 million), recoveries of school aid and welfare overpayments ($88 million), abandoned property collections ($75 million), and various routine fund sweeps ($138 million). The 2003-04 spending projections include $1.9 billion of one-time payment delays from 2002-03 pending receipt of tobacco securitization proceeds. These one-time payment deferrals are "matched-up" with $1.9 billion of the $3.8 billion tobacco proceeds, for a net one-time impact of $3.2 billion ($5.1 billion of total actions offset by $1.9 billion linked to one-time costs). GENERAL FUND CLOSING BALANCE The Enacted Budget Financial Plan projects a closing General Fund balance of $730 million at the end of the 2003-04 fiscal year, unchanged from the 30-day projection. The closing balance represents monies on deposit in the Tax Stabilization Reserve Fund ($710 million) and the Contingency Reserve Fund ($20 million). The balance assumes achievement of $912 million of savings from the Fiscal Management Plan including additional Federal aid described earlier. GOVERNMENTAL FUNDS FINANCIAL PLANS STATE FUNDS State Funds represent the portion of the State's budget supported exclusively by State revenues: taxes, fees, fines, and other revenues imposed and collected by the State. Federal grants are not included as part of State Funds. STATE FUNDS RECEIPTS (MILLIONS OF DOLLARS)
2002-03 2003-04 ANNUAL CHANGE FROM ADJUSTED ACTUALS ADJUSTED ENACTED $CHANGE 30-DAY ESTIMATE ------------------------------------------------------------------------------------------------------------------------ Taxes 40,676 42,672 1,996 1,541 Miscellaneous Receipts 15,903 17,483 1,580 297 TOTAL STATE FUNDS RECEIPTS 56,579 60,155 3,576 1,838
Total State Funds receipts are projected to total $60.16 billion in 2003-04, an increase of $3.58 billion or 6.3 percent from 2002-03. State Funds tax receipts are projected to total $42.67 billion, an increase of $2.0 billion from 2002-03 primarily reflecting a new personal income tax surcharge ($1.4 billion) and a one-quarter percent increase in sales tax ($450 million), offset by revenue losses associated with the closeout of 2002-03 and the April PIT settlement ($462 million). These changes are discussed in more detail in the General Fund section above. Miscellaneous receipts in the State Funds are projected to total $17.48 billion, an increase of $1.58 billion over 2002-03. The growth in miscellaneous receipts primarily reflects the timing of the receipt of bond proceeds to reimburse capital spending from the Dedicated Highway and Bridge Trust Fund ($961 million), economic development spending that is not counted by the State Comptroller as spending even though the bond proceeds are counted as State-supported debt ($325 million), and growth in SUNY revenues primarily attributable to an anticipated tuition increase ($280 million). These increases are offset by a decline in General Fund miscellaneous receipts primarily due to the loss of non-recurring actions ($322 million). 20 The increase in State Funds receipts of $1.84 billion over the 30-day estimates is comprised of a projected tax increase of $1.54 billion and miscellaneous receipts increase of $297 million. The projected tax growth is consistent with the enacted tax increases described above. The growth in miscellaneous receipts is primarily attributable to the timing of the receipt of bond proceeds to reimburse capital spending ($482 million), offset by a decline in State Funds receipts in support of Medicaid due to the legislative restoration of the proposed home care and hospital assessments ($281 million). Total State Funds disbursements are projected at $61.09 billion in 2003-04, an increase of $3.38 billion or 5.8 percent from 2002-03. Of this amount, $1.32 billion is due to a net increase in General Fund spending as described in detail above, and $2.05 billion is due to growth in other State funds. STATE FUNDS DISBURSEMENTS (MILLIONS OF DOLLARS)
2002-03 2003-04 ANNUAL CHANGE FROM ADJUSTED ACTUALS ADJUSTED ENACTED $CHANGE 30-DAY ESTIMATE ------------------------------------------------------------------------------------------------------------------------ Welfare 496 1,127 631 114 General State Charges 3,088 3,608 520 43 Medicaid 8,413 8,852 439 559 Community Projects Fund 105 455 350 200 Debt Service 3,038 3,387 349 27 Public Health 2,023 2,218 195 88 SUNY 4,043 4,225 182 58 STAR 2,664 2,800 136 93 School Aid 14,121 14,225 104 608 Transportation 3,521 3,600 79 42 Handicapped/All Other Education 1,522 1,443 (79) 152 Mental Hygiene 2,645 2,572 (73) 42 Public Protection 2,902 2,899 (3) 18 All Other 9,131 9,676 545 172 TOTAL STATE FUNDS DISBURSEMENTS 57,712 61,087 3,375 2,216
State Funds Medicaid spending growth of $439 million (5.2 percent) reflects increased General Fund spending of $318 million (discussed in the General Fund section above) and an increase of $121 million in Special Revenue Funds. Additional HCRA financing for the Family Health Plus program, workforce recruitment and retention initiatives, and additional funding for Medicaid pharmacy costs represent $389 million of the net growth in the Special Revenue Funds. This increase is partially offset by lower spending attributable to the use of available pool balances in the Indigent Care Fund ($125 million) in 2002-03, the sunset of the Tobacco Transfer Fund used to reimburse medical care providers for services rendered to Medicaid patients ($91 million), and the legislative reduction of the nursing home gross receipts assessment from 6 percent to 5 percent ($45 million). 21 Spending from Debt Service Funds is estimated to increase by $349 million or 11.5 percent from 2002-03. The net increase in debt service spending reflects planned growth in costs, and additional bonding enacted by the Legislature for the CHIPs capital program and equipment for E-911 cellular emergency systems. Net debt service costs increased modestly ($27 million) from the 30-day estimates. Public Health spending supported by State Funds is projected to increase $195 million (9.6 percent) from the prior year, of which the General Fund supports $41 million. The increase in other State-supported spending is primarily attributable to additional spending for the Elderly Pharmaceutical Insurance Coverage Program (EPIC) providing senior citizens with prescription drug insurance ($105 million) and the Child Health Plus program providing health insurance to children up to age 19 ($68 million). Projected annual spending growth of $182 million for SUNY is primarily attributable to enrollment growth at the State-operated campuses, hospital program expansion, and anticipated increases in disbursements for capital programs. The annual growth in the STAR program of $136 million is mainly due to inflation and increased taxpayer participation. Annual State Funds spending growth due mostly to General Fund changes include: Welfare ($631 million), primarily reflecting the use of non-recurring Federal TANF reserve funds to offset 2002-03 welfare spending; General State Charges ($520 million), primarily due to higher pension and health insurance costs; and increased spending from the Community Projects Funds ($350 million). Major areas experiencing modest annual increases or decreases on a State Funds basis include: school aid (up $104 million), transportation (up $79 million), handicapped/all other education (down $79 million), mental hygiene (down $73 million) and public protection (down $3 million). State Funds disbursements increased $2.22 billion over the 30-day estimates primarily due to net legislative changes including school aid ($608 million), Medicaid ($559 million), the Community Projects Fund ($200 million), handicapped/all other education ($152 million), and welfare ($114 million). ALL GOVERNMENTAL FUNDS All Governmental Funds includes activity in the four governmental funds types: the General Fund, Special Revenue Funds, Capital Projects Funds, and Debt Service funds. All Governmental Funds spending combines State funds (discussed earlier) with Federal grants across these fund types. It excludes Fiduciary, Internal Services, and Enterprise Funds. ALL GOVERNMENTAL FUNDS RECEIPTS (MILLIONS OF DOLLARS)
2002-03 2003-04 ANNUAL CHANGE FROM ADJUSTED ACTUALS ADJUSTED ENACTED $CHANGE 30-DAY ESTIMATE -------------------------------------------------------------------------------------------------------------------------- Taxes 40,676 42,672 1,996 1,541 Miscellaneous Receipts 16,056 17,705 1,649 301 Federal Grants 33,242 33,444 202 1,426 TOTAL ALL GOVERNMENTAL FUNDS RECEIPTS 89,974 93,821 3,847 3,268
All Governmental Funds receipts are projected to be $93.82 billion in 2003-04, an increase of $3.85 billion or 4.3 percent from 2002-03. Tax receipts are projected to increase by $2.0 billion to total $42.67 billion primarily reflecting the impact of the enacted tax increases previously discussed. 22 Miscellaneous receipts are projected to increase by $1.65 billion to total $17.71 billion over 2002-03. The growth in All Governmental Funds miscellaneous receipts primarily reflects the timing of the receipt of bond proceeds to reimburse capital spending, economic development spending, and SUNY tuition increases, offset by a decline in General Fund miscellaneous receipts as discussed above. Federal Grants are projected to total $33.44 billion, an increase of $202 million from 2002-03. Federal grants represent reimbursement from the Federal government for programs financed by the State in the first instance. Federal receipts are generally assumed to be received in the State fiscal year in which spending is incurred; therefore, the revisions to Federal receipts correspond to the adjustments to the federally-reimbursed spending revisions described below. The All Governmental Funds receipts increase of $3.27 billion over the 30-day estimates is comprised of enacted tax increases described above and Federal grants of $1.43 billion primarily due to increases in Medicaid spending. All Governmental Funds spending is estimated at $94.47 billion in 2003-04, an annual increase of $3.52 billion or 3.9 percent. The spending growth is comprised of the State Funds increases of $3.38 billion and growth in Federal Funds of $143 million. The growth in Federal spending is primarily due to increases for Medicaid ($1.02 billion), offset by declines in welfare ($426 million), World Trade Center costs ($302 million) and education ($180 million). ALL GOVERNMENTAL FUNDS DISBURSEMENTS (MILLIONS OF DOLLARS)
2002-03 2003-04 ANNUAL CHANGE FROM ADJUSTED ACTUALS ADJUSTED ENACTED $CHANGE 30-DAY ESTIMATE --------------------------------------------------------------------------------------------------------------- Medicaid 25,315 26,778 1,463 2,003 Public Health 3,230 3,778 548 137 General State Charges 3,272 3,774 502 43 Community Projects Fund 105 455 350 200 Debt Service 3,038 3,387 349 27 Welfare 2,803 3,008 205 124 Mental Hygiene 4,983 5,174 191 45 SUNY 4,208 4,368 160 58 STAR 2,664 2,800 136 93 School Aid 14,121 14,225 104 608 Handicapped/All Other Education 3,922 3,663 (259) 187 Transportation 4,907 4,834 (73) 13 Public Protection 3,096 3,027 (69) 18 All Other 15,292 15,203 (89) 109 TOTAL ALL FUNDS DISBURSEMENTS 90,956 94,474 3,518 3,665
All Governmental Funds Medicaid spending growth of $1.46 billion reflects previously discussed State Funds spending growth of $439 million, and an increase of $1.02 billion (6.1 percent) in Medicaid spending supported by Federal Funds, which are estimated to total $26.78 billion in 2003-04. The net increase is primarily attributable to expected underlying spending growth of approximately 8 percent ($1.10 billion) and increased aid governed from an increase in disproportionate share payments to public hospitals ($394 million). This increase is partially offset by the mandated phase out of the nursing home intergovernmental transfers ($119 million), the phase out of Disaster Relief Medicaid related to the September 11th attack on the World Trade Center ($83 million), nonrecurring additional indigent care payments ($72 million), and various other cost containment proposals. The Medicaid estimate does not include possible savings related to the temporary increase in the Federal share of Medicaid costs. 23 Public health spending supported by All Governmental Funds is expected to increase by $548 million from 2002-03 of which $195 million is attributable to increased State Funds support and the remaining $353 million consisting of additional Federal aid. The growth in Federal aid is largely attributable to increased spending for the Child Health Plus program ($324 million). Spending from All Governmental Funds in support of welfare initiatives increased $205 million from 2002-03 actuals and reflects the State Funds increase described above ($631 million) offset by decreased welfare spending from federal funds ($426 million). The decreased spending is primarily due to the loss of one-time credits that were used to support 2002-03 spending. All Governmental Funds spending growth largely attributable to State Funds spending includes growth for General State Charges ($502 million), Community Projects Fund ($350 million), debt service ($349 million), SUNY ($160 million), STAR ($136 million), and school aid ($104 million). Major areas experiencing modest annual increases or decreases on an All Governmental Funds basis include: mental hygiene (up $191 million), handicapped/all other education (down $259 million), transportation (down $73 million), and public protection (down $69 million). All Governmental Funds disbursements increased $3.67 billion over the 30-day estimates due to State Funds spending increases of $2.22 billion described above and growth in Federal Medicaid spending ($1.45 billion) attributable to legislative restorations of various cost containment and revenue maximizations, as well as revised estimates for underlying Federal Medicaid spending. FIRST QUARTER CASH FLOW Unlike previous years, the 2003-04 General Fund first quarter cash flow estimates assume continued implementation of emergency cash management actions implemented after delays in enacting tobacco securitization legislation led to potential cash imbalances. The General Fund cash flow position is expected to be extremely tight during the first quarter of the 2003-04 fiscal year and thus requires continued management actions to maintain positive balances until $2.1 billion of tobacco proceeds are received in late June. DOB continues to monitor cash balances on a daily basis and has administratively managed the flow of funds and disbursements while continuing essential governmental operations through a statewide austerity plan. Under the current cash management plan, daily cash balances are expected to fluctuate significantly. The General Fund balances assume continued deferrals of discretionary payments through June, including school aid payments scheduled in May and early June until the State receives the tobacco securitization proceeds. Thereafter, cash balances are expected to be healthy until March of the fiscal year. The General Fund is projected to end May with a balance of $2.15 billion. This balance, along with June receipts, will be used to make the school aid payment deferred from March on June 2 ($1.2 billion) as well as weekly Medicaid, payroll, and other critical payments. As a result, cash balances are expected to decline to very low levels by mid-June. The State expects to make the remaining May and June school aid payments ($2.5 billion) in late June upon the receipt of tobacco securitization proceeds. Absent these proceeds, General Fund resources would be insufficient to pay school aid and end the month with a positive cash balance. 24 The 2003-04 Enacted Budget amends State Finance Law to permit the State Comptroller to make balances in other funds and accounts temporarily available to the General Fund for intra-month cash flow needs as long as such balances can be repaid by the end of the month. This provision is set to expire on March 31, 2004. GAAP-BASIS FINANCIAL PLANS The February Financial Plan included General Fund Financial Plans prepared in accordance with Generally Accepted Accounting Principles (GAAP) for State fiscal years 2002-03 through 2005-06. The accounting principles that DOB applied in preparing the GAAP projections are consistent with those applied by the State Comptroller for the 2001-02 GAAP-basis Financial Statements. Accordingly, the projections do not reflect the impact of any pending proposals of the Governmental Accounting Standards Board, including GASB 34. The changes mandated by GASB 34 are expected to significantly change the presentation of GAAP-basis financial results for state and local governments in 2002-03. The General Fund GAAP Financial Plan issued as part of the February Financial Plan projected that the State would end the 2002-03 fiscal year with an operating imbalance of $2.74 billion. The operating result reflected the use of reserves in response to the World Trade Center disaster. As a result of the operating deficit, the accumulated surplus was projected to decline from $492 million at the end of 2001-02 to a $2.24 billion accumulated deficit at the end of 2002-03. Certain legislative actions, including deferring a Medicaid Cycle ($170 million), and delaying TAP payments ($104 million) are expected to negatively impact the GAAP Financial Plan. Additionally, the deferral of $1.9 billion in spending from 2002-03 until 2003-04 is expected to increase the 2002-03 accumulated GAAP-basis deficit, since the deferred payments are expected to be accrued to the 2002-03 fiscal year. However, the tobacco settlement revenues originally anticipated in 2002-03 but now expected in 2003-04 are likely to be accrued to the 2003-04 fiscal year resulting in no net change to the accumulated GAAP deficit by the end of 2003-04. DOB expects to update the GAAP Financial Plan estimates for 2003-04 in the First Quarterly Financial Plan Update to be issued in July 2003. OUTYEAR GENERAL FUND FINANCIAL PLAN PROJECTIONS General Fund budget gaps for the 2004-05 and 2005-06 fiscal years have increased significantly from the 30-day projections. It is currently estimated that spending and revenue actions in the Enacted Budget in concert with events since presentation of the Executive Budget will increase gaps to over $6 billion in 2004-05 and $8 billion in 2005-06, before reflecting savings from the Fiscal Management Plan or extra Federal aid. The Fiscal Management Plan savings will be implemented in 2003-04, and these actions coupled with new Federal assistance are expected to produce recurring savings in the outyears, reducing the gaps by approximately $900 million in each year. Future budget gaps are subject to substantial revision as additional information becomes available about the national and State economies, financial sector activity, entitlement spending and social service caseloads, and State reimbursement obligations that are driven by local government activity. Key factors include: end-of-year business tax collections; calendar year economic results; year-end financial sector bonus income data; the school aid database update in November; and quarterly Medicaid cycle trend analysis. These factors have historically been subject to a high degree of fluctuation across the forecast period, and could produce results above or below the current projections. 25 The outyear gap estimates do not assume any collective bargaining salary increases. If the projected budget gap for 2004-05 is closed fully with recurring actions, the 2005-06 budget gap would be reduced to under $2 billion. Revenues are projected to increase from the Executive Budget as a result of legislative changes by $1.4 billion in 2004-05 and $605 million in 2005-06. The revenue proposals decrease primarily because of "sunset" provisions enacted for the tax increases. New revenue actions include a personal income tax surcharge ($1.2 billion in 2004-05 and $1.0 billion in 2005-06), one-quarter percent increase in sales tax ($572 million in 2004-05 and $100 million in 2005-06), and a decoupling from Federal bonus depreciation provisions ($100 million in 2004-05 and $90 million in 2005-06). These revenue actions are offset by the loss of receipts due to the sales tax free week proposed in the Executive Budget ($315 million in 2004-05 and $435 million in 2005-06), and the intended transfer of State sales tax receipts to New York City ($170 million annually). In addition, revenues are expected to decrease by $609 million in 2004-05 and 2005-06 primarily reflecting the impact of 2002-03 actuals and the April 2003 PIT settlement. As compared to the Executive Budget, spending is projected to increase by $4.5 billion in 2004-05 and $4.2 billion in 2005-06. This spending increase reflects revisions based on actual results and net legislative adds to the Governor's Executive Budget, including Medicaid programs ($1.7 billion in 2004-05 and $1.5 billion in 2005-06), school aid, including revised estimates resulting from the May 15 database update ($1.4 billion in 2004-05 and 2005-06), higher education ($323 million in 2004-05 and $303 million in 2005-06), and higher general state charges primarily driven by restorations of health insurance savings initiatives and the planned payment of the full required pension bill in 2004-05 and 2005-06 ($555 million in 2004-05 and $338 million in 2005-06). 2004-05 spending grows $2.2 billion above the $2.3 billion increase in 2003-04 from the Executive Budget (for a total 2004-05 increase of $4.5 billion). This incremental growth is driven by the annualization of Medicaid restorations ($403 million), HCRA ($268 million), and the deferral of a 2003-04 Medicaid cycle into 2004-05 ($170 million), the "tail" of school aid adds and restorations including the loss of proposed BOCES and Building Aid reforms ($571 million), the May 15 school aid database revisions ($184 million), and increased fringe benefits costs including the denial of the Governor's proposed pension reforms and the restoration of proposed health insurance cost containment ($521 million). Fiscal Management Plan savings include continuing the statewide austerity measures implemented during 2003-04, mandating agencies to eliminate, consolidate, and streamline governmental services, reducing the State workforce further, maximizing Federal aid, and planning legislative actions that may include statutory modifications to programs. A more detailed discussion of these revenue and spending changes, as well as the Fiscal Management Plan, is described in the Overview and General Fund sections above. 26 CASH FINANCIAL PLAN GENERAL FUND 2002-2003 AND 2003-2004 ADJUSTED FOR 2002-2003 DELAYS (MILLIONS OF DOLLARS)
2002-2003 2003-2004 ADJUSTED ADJUSTED ANNUAL ACTUAL ENACTED CHANGE -------------- -------------- -------------- OPENING FUND BALANCE 1,032 815 (217) ============== ============== ============== RECEIPTS: Taxes: Personal income tax 16,791 16,285 (506) User taxes and fees 7,063 8,007 944 Business taxes 3,380 3,498 118 Other taxes 743 771 28 Miscellaneous receipts 3,991 3,669 (322) Transfers from other funds: PIT in excess of Revenue Bond debt service 4,215 5,125 910 Sales tax in excess of LGAC debt service 1,919 1,853 (66) Real estate taxes in excess of CW/CA debt service 263 202 (61) All other 931 430 (501) -------------- -------------- -------------- TOTAL RECEIPTS 39,296 39,840 544 ============== ============== ============== DISBURSEMENTS: Grants to local governments 26,713 28,009 1,296 State operations 7,715 7,168 (547) General State charges 2,732 3,199 467 Transfers to other funds: Debt service 1,496 1,583 87 Capital projects 170 251 81 State University 26 145 119 Other purposes 661 482 (179) -------------- -------------- -------------- TOTAL DISBURSEMENTS 39,513 40,837 1,324 ============== ============== ============== FISCAL MANAGEMENT PLAN/FEDERAL AID 0 912 912 ============== ============== ============== CHANGE IN FUND BALANCE (217) (85) 132 ============== ============== ============== CLOSING FUND BALANCE 815 730 (85) ============== ============== ============== Tax Stabilization Reserve Fund 710 710 0 Contingency Reserve Fund 20 20 0 Community Projects Fund 85 0 (85)
27 CASH FINANCIAL PLAN GENERAL FUND 2003-2004 ADJUSTED FOR 2002-2003 DELAYS (MILLIONS OF DOLLARS)
ADJUSTED 30-DAY CHANGE ENACTED -------------- -------------- -------------- OPENING FUND BALANCE 805 10 815 ============== ============== ============== RECEIPTS: Taxes: Personal income tax 15,452 833 16,285 User taxes and fees 7,508 499 8,007 Business taxes 3,682 (184) 3,498 Other taxes 771 0 771 Miscellaneous receipts 3,579 90 3,669 Transfers from other funds: PIT in excess of Revenue Bond debt service 4,865 260 5,125 Sales tax in excess of LGAC debt service 1,999 (146) 1,853 Real estate taxes in excess of CW/CA debt service 202 0 202 All other 379 51 430 -------------- -------------- -------------- TOTAL RECEIPTS 38,437 1,403 39,840 ============== ============== ============== DISBURSEMENTS: Grants to local governments 25,780 2,229 28,009 State operations 7,166 2 7,168 General State charges 3,165 34 3,199 Transfers to other funds: Debt service 1,583 0 1,583 Capital projects 206 45 251 State university 145 0 145 Other purposes 467 15 482 -------------- -------------- -------------- TOTAL DISBURSEMENTS 38,512 2,325 40,837 ============== ============== ============== FISCAL MANAGEMENT PLAN/FEDERAL AID 0 912 912 ============== ============== ============== CHANGE IN FUND BALANCE (75) (10) (85) ============== ============== ============== CLOSING FUND BALANCE 730 0 730 ============== ============== ============== Tax Stabilization Reserve Fund 710 0 710 Contingency Reserve Fund 20 0 20
NOTE: THE 30-DAY OPENING FUND BALANCE WAS REDUCED BY $198 MILLION AND THE PERSONAL INCOME TAX RECEIPTS WERE INCREASED BY $198 MILLION TO REFLECT THE TAX REFUND RESERVE TRANSACTION. 28 CASH FINANCIAL PLAN GENERAL FUND 2002-2003 AND 2003-2004 (MILLIONS OF DOLLARS)
2002-2003 2003-2004 ACTUAL ENACTED CHANGE -------------- -------------- -------------- OPENING FUND BALANCE 1,032 815 (217) ============== ============== ============== RECEIPTS: Taxes: Personal income tax 16,791 16,285 (506) User taxes and fees 7,063 8,007 944 Business taxes 3,380 3,498 118 Other taxes 743 771 28 Miscellaneous receipts 2,091 5,569 3,478 Transfers from other funds: PIT in excess of Revenue Bond debt service 4,215 5,125 910 Sales tax in excess of LGAC debt service 1,919 1,853 (66) Real estate taxes in excess of CW/CA debt service 263 202 (61) All other 931 430 (501) -------------- -------------- -------------- TOTAL RECEIPTS 37,396 41,740 4,344 ============== ============== ============== DISBURSEMENTS: Grants to local governments 24,887 29,835 4,948 State operations 7,678 7,205 (473) General State charges 2,699 3,232 533 Transfers to other funds: Debt service 1,496 1,583 87 Capital projects 166 255 89 State University 26 145 119 Other purposes 661 482 (179) -------------- -------------- -------------- TOTAL DISBURSEMENTS 37,613 42,737 5,124 ============== ============== ============== FISCAL MANAGEMENT PLAN/FEDERAL AID 0 912 912 ============== ============== ============== CHANGE IN FUND BALANCE (217) (85) 132 ============== ============== ============== CLOSING FUND BALANCE 815 730 (85) ============== ============== ============== Tax Stabilization reserve Fund 710 710 0 Contingency Reserve Fund 20 20 0 Community Projects Fund 85 0 (85)
NOTE: ACTUALS REFLECT THE AMOUNTS PUBLISHED IN THE COMPTROLLER'S CASH BASIS REPORT RELEASED ON APRIL 15, 2003. 29 CASH FINANCIAL PLAN GENERAL FUND 2002-2003 (MILLIONS OF DOLLARS)
ADJUSTED ACTUAL ADJUSTMENTS ACTUAL -------------- -------------- -------------- OPENING FUND BALANCE 1,032 0 1,032 ============== ============== ============== RECEIPTS: Taxes: Personal income tax 16,791 0 16,791 User taxes and fees 7,063 0 7,063 Business taxes 3,380 0 3,380 Other taxes 743 0 743 Miscellaneous receipts 2,091 1,900 3,991 Transfers from other funds: PIT in excess of Revenue Bond debt service 4,215 0 4,215 Sales tax in excess of LGAC debt service 1,919 0 1,919 Real estate taxes in excess of CW/CA debt service 263 0 263 All other 931 0 931 -------------- -------------- -------------- TOTAL RECEIPTS 37,396 1,900 39,296 ============== ============== ============== DISBURSEMENTS: Grants to local governments 24,887 1,826 26,713 State operations 7,678 37 7,715 General State charges 2,699 33 2,732 Transfers to other funds: Debt service 1,496 0 1,496 Capital projects 166 4 170 State University 26 0 26 Other purposes 661 0 661 -------------- -------------- -------------- TOTAL DISBURSEMENTS 37,613 1,900 39,513 ============== ============== ============== CHANGE IN FUND BALANCE (217) 0 (217) ============== ============== ============== CLOSING FUND BALANCE 815 0 815 ============== ============== ============== Tax Stabilization Reserve Fund 710 0 710 Contingency Reserve Fund 20 0 20 Community Projects Fund 85 0 85
NOTE: ACTUALS REFLECT THE AMOUNTS PUBLISHED IN THE COMPTROLLER'S CASH BASIS REPORT RELEASED ON APRIL 15, 2003. 30 CASH FINANCIAL PLAN GENERAL FUND 2003-2004 (MILLIONS OF DOLLARS)
ADJUSTED ENACTED ADJUSTMENTS ENACTED -------------- -------------- -------------- OPENING FUND BALANCE 815 0 815 ============== ============== ============== RECEIPTS: Taxes: Personal income tax 16,285 0 16,285 User taxes and fees 8,007 0 8,007 Business taxes 3,498 0 3,498 Other taxes 771 0 771 Miscellaneous receipts 5,569 (1,900) 3,669 Transfers from other funds: PIT in excess of Revenue Bond debt service 5,125 0 5,125 Sales tax in excess of LGAC debt service 1,853 0 1,853 Real estate taxes in excess of CW/CA debt service 202 0 202 All other 430 0 430 -------------- -------------- -------------- TOTAL RECEIPTS 41,740 (1,900) 39,840 ============== ============== ============== DISBURSEMENTS: Grants to local governments 29,835 (1,826) 28,009 State operations 7,205 (37) 7,168 General State charges 3,232 (33) 3,199 Transfers to other funds: Debt service 1,583 0 1,583 Capital projects 255 (4) 251 State University 145 0 145 Other purposes 482 0 482 -------------- -------------- -------------- TOTAL DISBURSEMENTS 42,737 (1,900) 40,837 ============== ============== ============== FISCAL MANAGEMENT PLAN/FEDERAL AID 912 0 912 ============== ============== ============== CHANGE IN FUND BALANCE (85) 0 (85) ============== ============== ============== CLOSING FUND BALANCE 730 0 730 ============== ============== ============== Tax Stabilization Reserve Fund 710 0 710 Contingency Reserve Fund 20 0 20
NOTE: THE 30-DAY OPENING FUND BALANCE WAS REDUCED BY $198 MILLION AND THE PERSONAL INCOME TAX RECEIPTS WERE INCREASED BY $198 MILLION TO REFLECT THE PIT REFUND RESERVE TRANSACTION. 31 CURRENT STATE RECEIPTS GENERAL FUND 2002-2003 AND 2003-2004 ADJUSTED FOR 2002-2003 DELAYS (MILLIONS OF DOLLARS)
2002-2003 2003-2004 ADJUSTED ADJUSTED ANNUAL ACTUAL ENACTED CHANGE -------------- -------------- -------------- PERSONAL INCOME TAX 16,791 16,285 (506) -------------- -------------- -------------- USER TAXES AND FEES 7,063 8,007 944 -------------- -------------- -------------- Sales and use tax 6,328 7,285 957 Cigarette and tobacco taxes 446 425 (21) Motor vehicle fees 67 75 8 Alcoholic beverages taxes 180 180 0 Alcoholic beverage control license fees 42 42 0 BUSINESS TAXES 3,380 3,498 118 -------------- -------------- -------------- Corporation franchise tax 1,407 1,450 43 Corporation and utilities tax 860 805 (55) Insurance taxes 704 818 114 Bank tax 409 425 16 OTHER TAXES 743 771 28 -------------- -------------- -------------- Estate tax 701 737 36 Gift tax 7 0 (7) Real property gains tax 5 2 (3) Pari-mutuel taxes 29 31 2 Other taxes 1 1 0 TOTAL TAXES 27,977 28,561 584 -------------- -------------- -------------- MISCELLANEOUS RECEIPTS 3,991 3,669 (322) -------------- -------------- -------------- TOTAL 31,968 32,230 262 ============== ============== ==============
NOTE: ADJUSTED MISCELLANEOUS RECEIPTS INCLUDE $1.9 BILLION IN TOBACCO SECURITIZATION PROCEEDS IN 2002-03 THAT WILL BE RECEIVED IN 2003-04. 32 CURRENT STATE RECEIPTS ALL GOVERNMENTAL FUNDS 2002-2003 AND 2003-2004 ADJUSTED FOR 2002-2003 DELAYS (MILLIONS OF DOLLARS)
2002-2003 2003-2004 ADJUSTED ADJUSTED ACTUAL ENACTED CHANGE -------------- -------------- -------------- PERSONAL INCOME TAX 23,698 24,460 762 -------------- -------------- -------------- USER TAXES AND FEES 10,804 11,984 1,180 -------------- -------------- -------------- Sales and use taxes 8,796 9,956 1,160 Cigarette and tobacco taxes 446 425 (21) Motor fuel tax 544 537 (7) Motor vehicle fees 612 651 39 Highway use tax 147 149 2 Alcoholic beverage taxes 180 180 0 Alcoholic beverage control license fees 42 42 0 Auto rental tax 37 44 7 BUSINESS TAXES 4,983 5,052 69 -------------- -------------- -------------- Corporation franchise tax 1,612 1,655 43 Corporation and utilities taxes 1,091 993 (98) Insurance taxes 776 903 127 Bank tax 481 500 19 Petroleum business taxes 1,023 1,001 (22) OTHER TAXES 1,191 1,176 (15) -------------- -------------- -------------- Estate tax 701 737 36 Gift tax 7 0 (7) Real property gains tax 5 2 (3) Real estate transfer tax 448 404 (44) Pari-mutuel taxes 29 32 3 Other taxes 1 1 0 TOTAL TAXES 40,676 42,672 1,996 -------------- -------------- -------------- MISCELLANEOUS RECEIPTS 16,056 17,705 1,649 -------------- -------------- -------------- FEDERAL GRANTS 33,242 33,444 202 -------------- -------------- -------------- TOTAL 89,974 93,821 3,847 ============== ============== ==============
NOTE: ADJUSTED MISCELLANEOUS RECEIPTS INCLUDE $1.9 BILLION IN TOBACCO SECURITIZATION PROCEEDS IN 2002-03 THAT WILL BE RECEIVED IN 2003-04. 33 GENERAL FUND TAX REFUND RESERVE ACCOUNT 2002-2003 AND 2003-2004 ADJUSTED FOR 2002-2003 DELAYS (MILLIONS OF DOLLARS)
2002-2003 2003-2004 ADJUSTED ADJUSTED ANNUAL ACTUAL ENACTED CHANGE -------------- -------------- -------------- Withholdings 19,959 22,135 2,176 Estimated Payments 4,855 4,780 (75) Final Payments 1,334 1,241 (93) Delinquencies 796 670 (126) -------------- -------------- -------------- GROSS COLLECTIONS 26,944 28,826 1,882 State/City Offset (288) (300) (12) Refund Reserve 1,050 159 (891) Refunds (4,008)(1) (4,225)(2) (217) -------------- -------------- -------------- REPORTED TAX COLLECTIONS 23,698 24,460 762 STAR (2,664) (2,800) (136) RBTF (4,243) (5,375) (1,132) -------------- -------------- -------------- GENERAL FUND 16,791 16,285 (506) ============== ============== ==============
Net personal income tax collections are affected by transactions in the tax refund reserve account. The tax refund reserve account is used to hold moneys designated to pay tax refunds. The Comptroller deposits receipts into this account at the discretion of the Commissioner of Taxation and Finance. The deposit of moneys into the account during a fiscal year has the effect of reducing receipts for the fiscal year, and the withdrawal of moneys from the account has the effect of increasing receipts in the fiscal year of withdrawal. The tax refund reserve account also includes amounts made available as a result of the LGAC financing program. Beginning in 1998-99, a portion of personal income tax collections is deposited directly in the School Tax Reduction (STAR) Fund and used to make payments to reimburse local governments for their revenue decreases due to the STAR program. NOTE 1: REFLECTS THE PAYMENT OF THE BALANCE OF REFUNDS ON 2001 LIABILITY AND PAYMENT OF $960 MILLION OF CALENDAR YEAR 2002 REFUNDS IN THE LAST QUARTER OF THE STATE'S 2002-03 FISCAL YEAR AND A BALANCE IN THE TAX REFUND RESERVE ACCOUNT OF $627 MILLION. NOTE 2: REFLECTS THE PAYMENT OF THE BALANCE OF REFUNDS ON 2002 LIABILITY AND THE PROJECTED PAYMENT OF $960 MILLION OF CALENDAR YEAR 2003 REFUNDS IN THE LAST QUARTER OF THE STATE'S 2003-04 FISCAL YEAR AND A PROJECTED BALANCE IN THE TAX REFUND RESERVE ACCOUNT OF $468 MILLION. 34 CASH FINANCIAL PLAN STATE FUNDS 2003-2004 (MILLIONS OF DOLLARS)
SPECIAL CAPITAL DEBT GENERAL REVENUE PROJECTS SERVICE (MEMO) FUND FUNDS FUNDS FUNDS TOTAL ------------ ------------ ------------ ------------ ------------ OPENING FUND BALANCE 815 894 (560) 158 1,307 ============ ============ ============ ============ ============ RECEIPTS: Taxes 28,561 4,401 1,765 7,945 42,672 Miscellaneous receipts 5,569 9,880 3,232 702 19,383 Federal grants 0 0 0 0 0 ------------ ------------ ------------ ------------ ------------ TOTAL RECEIPTS 34,130 14,281 4,997 8,647 62,055 ============ ============ ============ ============ ============ DISBURSEMENTS: Grants to local governments 29,835 10,191 1,095 0 41,121 State operations 7,205 4,561 0 8 11,774 General State charges 3,232 410 0 0 3,642 Debt service 0 0 0 3,387 3,387 Capital projects 0 2 3,061 0 3,063 ------------ ------------ ------------ ------------ ------------ TOTAL DISBURSEMENTS 40,272 15,164 4,156 3,395 62,987 ============ ============ ============ ============ ============ OTHER FINANCING SOURCES (USES): Transfers from other funds 7,610 801 401 4,844 13,656 Transfers to other funds (2,465) (231) (1,068) (10,093) (13,857) Bond and note proceeds 0 0 248 0 248 ------------ ------------ ------------ ------------ ------------ NET OTHER FINANCING SOURCES (USES) 5,145 570 (419) (5,249) 47 ============ ============ ============ ============ ============ FISCAL MANAGEMENT PLAN/FEDERAL AID 912 0 0 0 912 ============ ============ ============ ============ ============ CHANGE IN FUND BALANCE (85) (313) 422 3 27 ============ ============ ============ ============ ============ CLOSING FUND BALANCE 730 581 (138) 161 1,334 ============ ============ ============ ============ ============
35 CASH FINANCIAL PLAN STATE FUNDS 2003-2004 ADJUSTED FOR 2002-2003 DELAYS (MILLIONS OF DOLLARS)
SPECIAL CAPITAL DEBT GENERAL REVENUE PROJECTS SERVICE (MEMO) FUND FUNDS FUNDS FUNDS TOTAL ------------ ------------ ------------ ------------ ------------ OPENING FUND BALANCE 815 894 (560) 158 1,307 ============ ============ ============ ============ ============ RECEIPTS: Taxes 28,561 4,401 1,765 7,945 42,672 Miscellaneous receipts 3,669 9,880 3,232 702 17,483 Federal grants 0 0 0 0 0 ------------ ------------ ------------ ------------ ------------ TOTAL RECEIPTS 32,230 14,281 4,997 8,647 60,155 ============ ============ ============ ============ ============ DISBURSEMENTS: Grants to local governments 28,009 10,191 1,095 0 39,295 State operations 7,168 4,561 0 8 11,737 General State charges 3,199 410 0 0 3,609 Debt service 0 0 0 3,387 3,387 Capital projects 0 2 3,057 0 3,059 ------------ ------------ ------------ ------------ ------------ TOTAL DISBURSEMENTS 38,376 15,164 4,152 3,395 61,087 ============ ============ ============ ============ ============ OTHER FINANCING SOURCES (USES): Transfers from other funds 7,610 801 397 4,844 13,652 Transfers to other funds (2,461) (231) (1,068) (10,093) (13,853) Bond and note proceeds 0 0 248 0 248 ------------ ------------ ------------ ------------ ------------ NET OTHER FINANCING SOURCES (USES) 5,149 570 (423) (5,249) 47 ============ ============ ============ ============ ============ FISCAL MANAGEMENT PLAN/FEDERAL AID 912 0 0 0 912 ============ ============ ============ ============ ============ CHANGE IN FUND BALANCE (85) (313) 422 3 27 ============ ============ ============ ============ ============ CLOSING FUND BALANCE 730 581 (138) 161 1,334 ============ ============ ============ ============ ============
36 CASH FINANCIAL PLAN ALL GOVERNMENTAL FUNDS 2003-2004 (MILLIONS OF DOLLARS)
SPECIAL CAPITAL DEBT GENERAL REVENUE PROJECTS SERVICE (MEMO) FUND FUNDS FUNDS FUNDS TOTAL ------------ ------------ ------------ ------------ ------------ OPENING FUND BALANCE 815 986 (791) 158 1,168 ============ ============ ============ ============ ============ RECEIPTS: Taxes 28,561 4,401 1,765 7,945 42,672 Miscellaneous receipts 5,569 10,102 3,232 702 19,605 Federal grants 0 31,806 1,638 0 33,444 ------------ ------------ ------------ ------------ ------------ TOTAL RECEIPTS 34,130 46,309 6,635 8,647 95,721 ============ ============ ============ ============ ============ DISBURSEMENTS: Grants to local governments 29,835 38,677 1,312 0 69,824 State operations 7,205 7,790 0 8 15,003 General State charges 3,232 576 0 0 3,808 Debt service 0 0 0 3,387 3,387 Capital projects 0 2 4,350 0 4,352 ------------ ------------ ------------ ------------ ------------ TOTAL DISBURSEMENTS 40,272 47,045 5,662 3,395 96,374 ============ ============ ============ ============ ============ OTHER FINANCING SOURCES (USES): Transfers from other funds 7,610 3,221 401 4,844 16,076 Transfers to other funds (2,465) (2,594) (1,200) (10,093) (16,352) Bond and note proceeds 0 0 248 0 248 ------------ ------------ ------------ ------------ ------------ NET OTHER FINANCING SOURCES (USES) 5,145 627 (551) (5,249) (28) ============ ============ ============ ============ ============ FISCAL MANAGEMENT PLAN/FEDERAL AID 912 0 0 0 912 ============ ============ ============ ============ ============ CHANGE IN FUND BALANCE (85) (109) 422 3 231 ============ ============ ============ ============ ============ CLOSING FUND BALANCE 730 877 (369) 161 1,399 ============ ============ ============ ============ ============
37 CASH FINANCIAL PLAN ALL GOVERNMENTAL FUNDS 2003-2004 ADJUSTED FOR 2002-2003 DELAYS (MILLIONS OF DOLLARS)
SPECIAL CAPITAL DEBT GENERAL REVENUE PROJECTS SERVICE (MEMO) FUND FUNDS FUNDS FUNDS TOTAL ------------ ------------ ------------ ------------ ------------ OPENING FUND BALANCE 815 986 (791) 158 1,168 ============ ============ ============ ============ ============ RECEIPTS: Taxes 28,561 4,401 1,765 7,945 42,672 Miscellaneous receipts 3,669 10,102 3,232 702 17,705 Federal grants 0 31,806 1,638 0 33,444 ------------ ------------ ------------ ------------ ------------ TOTAL RECEIPTS 32,230 46,309 6,635 8,647 93,821 ============ ============ ============ ============ ============ DISBURSEMENTS: Grants to local governments 28,009 38,677 1,312 0 67,998 State operations 7,168 7,790 0 8 14,966 General State charges 3,199 576 0 0 3,775 Debt service 0 0 0 3,387 3,387 Capital projects 0 2 4,346 0 4,348 ------------ ------------ ------------ ------------ ------------ TOTAL DISBURSEMENTS 38,376 47,045 5,658 3,395 94,474 ============ ============ ============ ============ ============ OTHER FINANCING SOURCES (USES): Transfers from other funds 7,610 3,221 397 4,844 16,072 Transfers to other funds (2,461) (2,594) (1,200) (10,093) (16,348) Bond and note proceeds 0 0 248 0 248 ------------ ------------ ------------ ------------ ------------ NET OTHER FINANCING SOURCES (USES) 5,149 627 (555) (5,249) (28) ============ ============ ============ ============ ============ FISCAL MANAGEMENT PLAN/FEDERAL AID 912 0 0 0 912 ============ ============ ============ ============ ============ CHANGE IN FUND BALANCE (85) (109) 422 3 231 ============ ============ ============ ============ ============ CLOSING FUND BALANCE 730 877 (369) 161 1,399 ============ ============ ============ ============ ============
38 CASH FINANCIAL PLAN SPECIAL REVENUE FUNDS 2003-2004 (MILLIONS OF DOLLARS)
STATE FEDERAL TOTAL -------------- -------------- -------------- OPENING FUND BALANCE 894 92 986 ============== ============== ============== RECEIPTS: Taxes 4,401 0 4,401 Miscellaneous receipts 9,880 222 10,102 Federal grants 0 31,806 31,806 -------------- -------------- -------------- TOTAL RECEIPTS 14,281 32,028 46,309 ============== ============== ============== DISBURSEMENTS: Grants to local governments 10,191 28,486 38,677 State operations 4,561 3,229 7,790 General State charges 410 166 576 Debt service 0 0 0 Capital projects 2 0 2 -------------- -------------- -------------- TOTAL DISBURSEMENTS 15,164 31,881 47,045 ============== ============== ============== OTHER FINANCING SOURCES (USES): Transfers from other funds 801 2,420 3,221 Transfers to other funds (231) (2,363) (2,594) Bond and note proceeds 0 0 0 -------------- -------------- -------------- NET OTHER FINANCING SOURCES (USES) 570 57 627 ============== ============== ============== CHANGE IN FUND BALANCE (313) 204 (109) ============== ============== ============== CLOSING FUND BALANCE 581 296 877 ============== ============== ==============
39 CASH FINANCIAL PLAN CAPITAL PROJECTS FUNDS 2003-2004 ADJUSTED FOR 2002-2003 DELAYS (MILLIONS OF DOLLARS)
STATE FEDERAL TOTAL -------------- -------------- -------------- OPENING FUND BALANCE (560) (231) (791) ============== ============== ============== RECEIPTS: Taxes 1,765 0 1,765 Miscellaneous receipts 3,232 0 3,232 Federal grants 0 1,638 1,638 -------------- -------------- -------------- TOTAL RECEIPTS 4,997 1,638 6,635 ============== ============== ============== DISBURSEMENTS: Grants to local governments 1,095 217 1,312 State operations 0 0 0 General State charges 0 0 0 Debt service 0 0 0 Capital projects 3,057 1,289 4,346 -------------- -------------- -------------- TOTAL DISBURSEMENTS 4,152 1,506 5,658 ============== ============== ============== OTHER FINANCING SOURCES (USES): Transfers from other funds 397 0 397 Transfers to other funds (1,068) (132) (1,200) -------------- -------------- -------------- Bond and note proceeds 248 0 248 ============== ============== ============== NET OTHER FINANCING SOURCES (USES) (423) (132) (555) ============== ============== ============== CHANGE IN FUND BALANCE 422 0 422 ============== ============== ============== CLOSING FUND BALANCE (138) (231) (369) ============== ============== ==============
40 CASH FLOW GENERAL FUND 2003-2004 (MILLIONS OF DOLLARS)
APRIL MAY JUNE -------------- -------------- -------------- OPENING FUND BALANCE 815 2,786 2,145 ============== ============== ============== RECEIPTS: Taxes: Personal income tax 2,811 304 1,582 Sales tax 450 462 737 User taxes and fees 103 56 59 Business taxes 56 (128) 722 Other taxes 49 67 73 Miscellaneous receipts 70 103 2,239 Transfers from other funds 898 330 782 -------------- -------------- -------------- TOTAL RECEIPTS 4,437 1,194 6,194 ============== ============== ============== DISBURSEMENTS: Grants to local governments 1,462 694 5,284 State operations 743 814 611 General State charges 32 241 236 Transfers to other funds 229 86 350 -------------- -------------- -------------- TOTAL DISBURSEMENTS 2,466 1,835 6,481 ============== ============== ============== CHANGE IN FUND BALANCE 1,971 (641) (287) ============== ============== ============== CLOSING FUND BALANCE 2,786 2,145 1,858 -------------- -------------- --------------
41 SPECIAL CONSIDERATIONS Many complex political, social, and economic forces influence the State's economy and finances, which may in turn affect the State's Financial Plan. These forces may affect the State unpredictably from fiscal year to fiscal year and are influenced by governments, institutions, and events that are not subject to the State's control. The Financial Plan is also necessarily based upon forecasts of national and State economic activity. Economic forecasts have frequently failed to predict accurately the timing and magnitude of changes in the national and State economies. DOB believes that its current estimates related to the performance of the State and national economies are reasonable. However, there can be no assurance that actual results will not differ materially and adversely from the current forecast. For a discussion of the DOB economic forecast, see the sections entitled "Economic and Demographics," "Current Fiscal Year - National Economy" and "Current Fiscal Year - State Economy" in this AIS. Based on current projections, the 2003-04 Financial Plan depends in part on the implementation of a fiscal management plan to maintain budget balance in the current fiscal year. The plan currently under development by DOB is expected to contain a range of actions that can be implemented administratively, as well as proposals that may require legislative approval. The fiscal management plan will also integrate savings from the Federal aid package enacted by Congress on May 23, 2003. DOB estimates the Federal package will provide the State and localities a total of $2.1 billion in fiscal relief over the next two State fiscal years, consisting of a temporary 2.95 percent increase in the Federal matching rate for State Medicaid expenditures (valued at $1.5 billion) and unrestricted aid payments (valued at $645 million). The Federal aid is expected to enhance the State's flexibility in preparing the fiscal management plan and maintaining a balanced budget in the 2003-04 fiscal year. DOB expects to incorporate the fiscal management plan into the Financial Plan projections by the release of the First Quarterly Update to the Financial Plan. The Executive is reviewing legal questions surrounding certain actions taken by the Legislature in enacting the 2003-04 budget. The State Constitution provides that the Legislature may not alter an appropriation bill submitted by the Governor except to strike out or reduce items, or to add appropriations that are stated separately and distinctly from the original appropriations. A number of court cases have interpreted and clarified the Legislature's powers to act on the appropriations contained in the Executive Budget (see the section entitled "Litigation" for a discussion of two ongoing cases). In light of the provisions of the State Constitution and existing case law, the Executive believes that the Legislature, in enacting changes to the Governor's Executive Budget for 2003-04, may have acted in a manner that violates State constitutional and statutory requirements. Labor contracts between the State and most State employee unions expired on March 31, 2003 and collective bargaining negotiations are underway on a new round of contracts. The Financial Plan contains no reserves to finance potential new costs related to any new labor agreements. DOB projects that every one percent increase in salaries for all State employees would result in a General Fund Financial Plan cost of approximately $80 million. DOB expects the State's cash flow position to experience pressure in the first quarter of the 2004-05 fiscal year. A number of administrative options are available to DOB to manage General Fund cash flow needs during any fiscal year. The State is prohibited from issuing seasonal notes in the public credit markets to finance cash flow needs, unless the State satisfies certain restrictive conditions imposed under the Local Government Assistance Corporation ("LGAC") statute and related bond covenants. For a discussion of the LGAC restrictions, see the section entitled "Debt and Other Financing Activities - Local Government Assistance Corporation" in this AIS. 42 An ongoing risk to the Financial Plan arises from the potential impact of certain litigation and Federal disallowances now pending against the State, which could produce adverse effects on the State's projections of receipts and disbursements. For example, the Federal government has issued a draft disallowance for certain claims, and deferred the payment of other claims, submitted by school districts related to school supportive health services. It is unclear at this time what impact, if any, such disallowances may have on the State Financial Plan in the current year or in the future. The Financial Plan assumes no significant Federal disallowances or other Federal actions that could adversely affect State finances. For more information on certain litigation pending against the State, see the section entitled "Litigation" in this AIS. In the past, the State has taken management actions to address potential financial plan shortfalls, and DOB believes it could take similar actions should adverse variances occur in its projections for the current fiscal year. To help guard against such risks, the State is maintaining a total of $730 million in General Fund reserves, after implementation of the fiscal management plan. 43 J.P. Morgan Mutual Fund Trust Part C. Other Information Item 22. Exhibits EXHIBIT EXHIBIT NUMBER DESCRIPTION ------- ------------ (a)(1) ARTICLES OF INCORPORATION. Declaration of Trust dated as of February 1, 1994. Incorporated herein by reference to the Registrant's Registration Statement as filed on February 14, 1994. (a)(2) Amendment No. 1 to Declaration of Trust dated December 6, 2001. Incorporated herein by reference to the Registrant's Registration Statement as filed on December 26, 2003. (a)(3) Amendment No. 2 to Declaration of Trust dated February 5, 2003. Incorporated herein by reference to Registrant's Registration Statement as filed on December 26, 2003. (a)(4) Amendment No. 3 to Declaration of Trust dated August 19, 2004. Incorporated herein by reference to Exhibit (1)(o) to the Registrant's Registration Statement on Form N-14 as filed on September 30, 2004 (Accession Number 0001104659-04-029025). (b)(1) BY-LAWS. By-Laws of Registrant dated January 19, 1996. Incorporated herein by reference to the Registrant's Registration Statement as filed on February 14, 1994. (b)(2) Certification of Amendment to By-Laws of Registrant dated January 19, 1996. Incorporated herein by reference to the Registrant's Registration Statement as filed on December 26, 2003. (b)(3) Amendment to By-Laws dated September 5, 2001. Incorporated herein by reference to Post-Effective Amendment No. 27 to the Registrant's Registration Statement as filed on December 20, 2002 (Accession No. 0001047469-02-007862). (c) INSTRUMENTS DEFINING RIGHTS OF SECURITY HOLDERS. Not applicable. (d)(1) INVESTMENT ADVISORY CONTRACTS. Investment Advisory Agreement dated May 6, 1996 by and between Registrant and The Chase Manhattan Bank, N.A. and its Successor. Incorporated herein by reference to Post-Effective Amendment No. 4 to the Registrant's Registration Statement as filed on December 28, 1995 (Accession No. 0000922423-95-000282). (d)(2) Assignment and Assumption Agreement dated February 28, 2001. Incorporated herein from Registrant's post-effective amendment No. 29 to its registration statement on Form N-1A filed on October 28, 2004. (d) (3) Form of Amendment to the Investment Advisory Agreement effective February 19, 2005 by and between Registrant and The Chase Manhattan Bank, NA, as assigned to J.P. Morgan Fleming Asset Management (USA) Inc. in an Assignment and Assumption Agreement dated February 28, 2001, and then succeeded to by J.P. Morgan Investment Management Inc. Incorporated herein by reference to Exhibit (6)(b) to the Registrant's Registration Statement on Form N-14 as filed on September 30, 2004 (Accession Number 0001104659-04-029025). (e)(1) UNDERWRITING CONTRACTS. Distribution Agreement dated June 29, 2001 between Registrant and J.P. Morgan Fund Distributors, Inc. Incorporated herein by reference to the Registrant's Registration Statement as filed on December 26, 2003. (e)(2) Form of Amendment to Distribution Agreement dated July 25, 2002 between Registrant and J.P. Morgan Fund Distributors, Inc. Incorporated herein by reference to the Registrant's Registration Statement as filed on December 26, 2003. (e)(3) Form of Distribution Agreement effective February 19, 2005 by and between Registrants and One Group Dealer Services, Inc. Incorporated herein by reference to Exhibit (7)(c) to the Registrant's Registration Statement on Form N-14 as filed on September 30, 2004 (Accession Number 0001104659-04-029025). (f) BONUS OR PROFIT SHARING CONTRACTS. Not applicable. (g)(1) CUSTODIAN AGREEMENT. Global Custody Agreement dated March 1, 2003 between JPMorgan Chase Bank and Registrant. Incorporated herein by reference to the Registrant's Registration Statement as filed on December 26, 2003. (g)(2) Fee Schedule for Global Custody Agreement dated July 2002. Incorporated herein by reference to the Registrant's Registration Statement as filed on December 26, 2003. (h)(1) OTHER MATERIAL CONTRACTS. Administration Agreement dated September 7, 2001 between Registrant and Morgan Guaranty Trust Company of New York. Incorporated herein by reference to the Registrant's Registration Statement as filed on December 26, 2003. (h)(2) Shareholder Servicing Agreement between Registrant and The Chase Manhattan Bank, N.A. Incorporated herein by reference to Post-Effective Amendment No. 4 to the Registrant's Registration Statement as filed on December 28, 1995 (Accession No. 0000922423-95-000282). (h)(3) Transfer Agency Agreement dated September 1, 2001 between Registrant and DST Systems, Inc. Incorporated herein by reference to the Registrant's Registration Statement as filed on December 26, 2003. (h)(4) Form of Administration Agreement effective February 19, 2005 by and between Registrant and One Group Administrative Services, Inc. Incorporated herein by reference to Exhibit (13)(g) to the Registrant's Registration Statement on Form N-14 as filed on September 30, 2004 (Accession Number 0001104659-04-029025). (h)(6) Form of Shareholder Servicing Agreement effective February 19, 2005 by and between Registrant and One Group Dealer Services, Inc. Incorporated herein by reference to Exhibit (13)(h) to the Registrant's Registration Statement on Form N-14 as filed on September 30, 2004 (Accession Number 0001104659-04-029025). (h)(7) Form of Transfer Agency Agreement effective February 19, 2005 by and between Registrant and Boston Financial Data Services, Inc. Incorporated herein by reference to Exhibit (13)(i) to the Registrant's Registration Statement on Form N-14 as filed on September 30, 2004 (Accession Number 0001104659-04-029025). (i) LEGAL OPINION. Opinion and consent of counsel to be filed by amendment. (j) OTHER OPINIONS. Consent of Independent Accountant to be filed by amendment. (k) OMITTED FINANCIAL STATEMENTS. Financial statements omitted from Item 22. (l) INITIAL CAPITAL AGREEMENTS. Inapplicable. (m)(1) RULE 12B-1 PLAN. Form of Distribution Plan. Incorporated herein by reference to the Registrant's Registration Statement as filed on December 26, 2003. (m)(2) Form of Combined Amended and Restated Distribution Plan dated August 19, 2004. Incorporated herein by reference to Exhibit (10)(c) to the Registrant's Registration Statement on Form N-14 as filed on September 30, 2004 (Accession Number 0001104659-04-029025). (n)(1) RULE 18F-3 PLAN. Rule 18f-3 Multi-Class Plan effective May 6, 1996, as revised June 21, 2001. Incorporated herein by reference to Post-Effective Amendment No. 27 to the Registrant's Registration Statement as filed on December 20, 2002 (Accession No. 0001047469-02-007862). (n)(2) Form of Combined Amended and Restated Rule 18f-3 Multi-Class Plan dated August 19, 2004 Incorporated herein by reference to Exhibit (10)(d) to the Registrant's Registration Statement on Form N-14 as filed on September 30, 2004 (Accession Number 0001104659-04-029025). C-1 (o) Reserved. (p)(1) CODES OF ETHICS. Code of Ethics of The J.P. Morgan Family of Funds. Incorporated herein by reference to the Registrant's Registration Statement as filed on December 26, 2003. (p)(2) Code of Ethics of J.P. Morgan Fund Distributors Inc. Incorporated herein by reference to the Registrant's Registration Statement as filed on December 26, 2003. (p)(3) Code of Ethics of Adviser. Incorporated herein by reference to the Registrant's Registration Statement as filed on December 26, 2003. (p)(4) Effective February 19, 2005, Section 12 of the Written Supervisory Procedures for One Group Dealer Services, Inc. Incorporated herein from Registrant's Post-Effective Amendment No. 29 to its registration statement on October 28, 2004. (99)(a) POWERS OF ATTORNEY. Powers of Attorney for: William J. Armstrong, Roland R. Eppley, Jr., Dr. Matthew Goldstein, Ann Maynard Gray, Matthew Healey, Robert J. Higgins, William G. Morton, Jr., Fergus Reid, III, James J. Schonbachler and Leonard M. Spalding. To be filed by Amendment. ITEM 23. Person Controlled by or Under Common Control with the Fund Not applicable. ITEM 24. Indemnification Reference is hereby made to Article V of the Registrant's Declaration of Trust. The Trustees and officers of the Registrant and the personnel of the Registrant's investment adviser, administrator and distributor are insured under an errors and omissions liability insurance policy. The Registrant and its officers are also insured under the fidelity bond required by Rule 17g-1 under the Investment Company Act of 1940. Under the terms of the Registrant's Declaration of Trust, the Registrant may indemnify any person who was or is a Trustee, officer or employee of the Registrant to the maximum extent permitted by law; provided, however, that any such indemnification (unless ordered by a court) shall be made by the Registrant only as authorized in the specific case upon a determination that indemnification of such persons is proper in the circumstances. Such determination shall be made (i) by the Trustees, by a majority vote of a quorum which consists of Trustees who are neither in Section 2(a)(19) of the Investment Company Act of 1940, nor parties to the proceeding, or (ii) if the required quorum is not obtainable or, if a quorum of such Trustees so directs, by independent legal counsel in a written opinion. No indemnification will be provided by the Registrant to any Trustee or officer of the Registrant for any liability to the Registrant or shareholders to which he would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence or reckless disregard of duty. Insofar as the conditional advancing of indemnification monies for actions based upon the Investment Company Act of 1940 may be concerned, such payments will be made only on the following conditions: (i) the advances must be limited to amounts used, or to be used, for the preparation or presentation of a defense to the action, including costs connected with the preparation of a settlement; (ii) advances may be made only upon receipt of a written promise by, or on behalf of, the recipient to repay that amount of the advance which exceeds that amount to which it is ultimately determined that he is entitled to receive from the Registrant by reason of indemnification; and (iii) (a) such promise must be secured by a surety bond, other suitable insurance or an equivalent form of security which assures that any repayments may be obtained by the Registrant without delay or litigation, which bond, insurance or other form of security must be provided by the recipient of the advance, or (b) a C-2 majority of a quorum of the Registrant's disinterested, non-party Trustees, or an independent legal counsel in a written opinion, shall determine, based upon a review of readily available facts, that the recipient of the advance ultimately will be found entitled to indemnification. Insofar as indemnification for liability arising under the Securities Act of 1933 may be permitted to trustees, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a trustee, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such trustee, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. ITEM 25. Business and Other Connections of Investment Adviser The business of J.P. Morgan Investment Management Inc. (JPMIM), the Adviser, is summarized in the Prospectuses constituting Part A of this Registration Statement, which are incorporated herein by reference. The business or other connections of each director and officer of JPMIM is currently listed in the investment advisor registration on Form ADV for JPMIM (File No. 801-21011). ITEM 26. Principal Underwriters (a)(1) J.P. Morgan Fund Distributors, Inc. (the "Distributor") is the principal underwriter of the Registrant's shares for the period through February 18, 2005. J.P. Morgan Fund Distributors, Inc. is registered with the Securities and Exchange Commission as a broker-dealer and is a member of the National Association of Securities Dealers. J.P. Morgan Fund Distributors, Inc. is located at 522 Fifth Avenue, New York, New York 10036. J.P. Morgan Fund Distributors, Inc. is a wholly-owned subsidiary of The BISYS Group, Inc. J.P. Morgan Fund Distributors, Inc. acts as principal underwriter for the following investment companies: Fleming Mutual Fund Group, Inc. Growth and Income Portfolio J.P. Morgan Funds J.P. Morgan Fleming Series Trust J.P. Morgan Institutional Funds J.P. Morgan Mutual Fund Series J.P. Morgan Series Trust J.P. Morgan Series Trust II J.P. Morgan Mutual Fund Group J.P. Morgan Mutual Fund Investment Trust J.P. Morgan Mutual Select Group J.P. Morgan Mutual Select Trust J.P. Morgan Mutual Fund Trust Mutual Fund Variable Annuity Trust JPMorgan Value Opportunities Fund, Inc. Undiscovered Managers Funds (2) Effective February 19, 2005, One Group Dealer Services, Inc. will become the principal underwriter of the Registrant's shares. One Group Dealer Services, Inc. is registered with the Securities and Exchange Commission as a broker-dealer and is a member of the National Association of Securities Dealers. One Group Dealer Services, Inc. is located at 1111 Polaris Parkway, Columbus, Ohio 43271. As of the date of this post-effective amendment, One Group Dealer Services, Inc. acts as principal underwriter for the following investment company: One Group Mutual Funds. (b)(1) The following is a list of the executive officers, directors and partners of J.P. Morgan Fund Distributors, Inc. NAME AND ADDRESS POSITION AND OFFICES POSITION AND OFFICES WITH THE DISTRIBUTOR WITH REGISTRANT Charles Linn Booth Vice President/Assistant None 3435 Stelzer Road Compliance Officer Columbus, OH 43219 James L. Fox Director/Treasurer None 90 Park Ave. New York, NY 10016 Kevin J. Dell Director/Secretary None 90 Park Ave. New York, NY 10016 Edward S. Forman Assistant Secretary None 90 Park Ave. New York, NY 10016 Stephen Hoffman Financial Operations Officer None 3435 Stelzer Road Columbus, OH 43219 Richard F. Froio Vice President/ Chief None 60 State Street Compliance Officer Boston, MA 02109 William J. Tomko President None 3435 Stelzer Road Columbus, OH 43219
(2) The directors and officers of One Group Dealer Services, Inc. are set forth below. The business address of each director or officer is 1111 Polaris Parkway, Columbus, Ohio 43271. NAME POSITIONS AND OFFICES WITH ONE POSITIONS WITH REGISTRANT GROUP DEALER SERVICES, INC. David Thorp President None Robert L. Young Vice President Senior Vice President Michael R. Machulski Director, Vice President and Treasurer None Nancy E. Fields Vice President Assistant Secretary Scott E. Richter Secretary Secretary and Chief Legal Officer Jessica K. Ditullio Assistant Secretary Assistant Secretary Charles Wooding Assistant Treasurer None
(c) Not applicable. C-3 ITEM 27. Location of Accounts and Records All accounts, books, records and documents required pursuant to Section 31(a) of the Investment Company Act of 1940, as amended, and the rules promulgated thereunder will be maintained at the offices of: J.P. Morgan Investment Management Inc., the Registrant's investment adviser, at 522 Fifth Avenue, New York, NY 10036 (records relating to its functions as investment advisor). J.P. Morgan Fund Distributors, Inc., the Registrant's distributor (through February 18, 2005), 522 Fifth Avenue, New York, New York 10036 (records relating to its functions as distributor). One Group Dealer Services, Inc., the Registrant's distributor (effective February 19, 2005), at 1111 Polaris Parkway, Columbus, Ohio 43240 (records relating to its functions as distributor). JPMorgan Chase Bank, at 3 MetroTech Center, Brooklyn, New York 11245 (records relating to its functions as shareholder servicing agent (through February 18, 2005), custodian and administrative services agent (through February 18, 2005)). One Group Administrative Services, Inc., the Registrant's administrator (effective February 19, 2005), at 1111 Polaris Parkway, Columbus, Ohio 43240 (relating to its functions as administrator). DST Systems Inc., the Registrant's transfer agent (through February 18, 2005), 210 West 10th Street, Kansas City, MO 64105 Boston Financial Data Services, Inc., the Registrant's transfer agent (effective February 19, 2005), at 2 Heritage Drive, North Quincy, Massachusetts 02171. C-4 ITEM 28. Management Services Not applicable ITEM 29. Undertakings Registrant undertakes that its trustees shall promptly call a meeting of shareholders of the Trust for the purpose of voting upon the question of removal of any such trustee or trustees when requested in writing so to do by the record holders of not less than 10 per centum of the outstanding shares of the Trust. In addition, the Registrant shall, in certain circumstances, give such shareholders assistance in communicating with other shareholders of a fund as required by Section 16(c) of the Investment Company Act of 1940. C-5 SIGNATURES Pursuant to the requirements of the Securities Act of 1933 and the Investment Company Act of 1940, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereto duly authorized, in the City of New York and State of New York on the 29th day of October, 2004. J.P. MORGAN MUTUAL FUND TRUST By: /s/ George C.W. Gatch ------------------------------ George C.W. Gatch President Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed below by the following persons in the capacities indicated on the 29th day of October, 2004. Fergus Reid, III* Robert J. Higgins* ----------------- ------------------ Fergus Reid, III Robert J. Higgins Trustee and Chairman Trustee William J. Armstrong* James J. Schonbachler* --------------------- ---------------------- William J. Armstrong James J. Schonbachler Trustee Trustee Roland R. Eppley, Jr.* Leonard M. Spalding* ---------------------- -------------------- Roland R. Eppley, Jr. Leonard M. Spalding Trustee Trustee Ann Maynard Gray* William G. Morton, Jr.* ----------------- ----------------------- Ann Maynard Gray William G. Morton Trustee Trustee Matthew Healey* Dr. Matthew Goldstein* --------------- ---------------------- Matthew Healey Dr. Matthew Goldstein* Trustee Trustee *By /s/ Patricia A. Maleski ----------------------- Patricia A. Maleski Attorney-in-Fact By /s/ Stephanie J. Dorsey ----------------------- Stephanie J. Dorsey Treasurer By /s/ George C.W. Gatch --------------------- George C.W. Gatch President C-6